Cost and Management Accounting, Notes BBA V, Unit-2
Unit II
Element
of Cost: Accounting for Material, Labour and Overheads, Assessment of
Cost-Preparation of Cost Sheet and Statement of Cost
ELEMENTS OF COST
The following diagram depicts the various elements of cost-
Material Cost: Material is one of the important elements of cost and it has been
observed that in the total cost structure of a product, material content is
about 60 to 65%. The substantial proportion of material cost in the total cost
demands more and more attention of the management towards this element.
It is divided
in to two-part.
i. Direct Materials - Materials that are present in the finished product or
can be identified in the finished product are called direct materials. For eg. coconuts
in the case of coconut oil or wood in a wooden cupboard.
ii. Indirect Materials - Indirect materials are those materials that do not
normally form part of the finished products or which cannot be directly traced
to the finished product. For eg. stores, oil, grease, cotton wool etc.
Labour Cost: labor is another important an element of cost and for overall cost control and cost reduction, of labor cost
is of paramount importance.
i. Direct Labour - Labour which can be attributed wholly to a particular
product, process or job is called direct labor. It is the labor utilized in
converting raw materials into finished products. For eg. Labour employed in the
crushing department of an oil mill.
ii. Indirect Labour - Labour that cannot be identified with a particular
product, process or job is called indirect labour. Indirect labour cost is
apportioned to cost units or cost centers. For eg. Maintenance workers.
Expenses :
i. Direct Expenses - Expenses incurred (except direct materials and direct
labour) specifically for a product, process or job is known as direct expenses.
They are also called "chargeable expenses". For eg. Hiring charges
for a machine specifically hired for a particular process, excise duty,
royalty.
ii. Indirect Expenses
- Expenses
incurred other than direct expenses are called indirect expenses. For eg.
factory rent & insurance, power, general repairs.
Overheads : Overheads is the sum total of
indirect materials, indirect labour and indirect expenses.
Functionally
overheads can be classified as under –
Production /
Works overheads
ii.
Administrative overheads
iii. Selling
overheads
iv. Distribution
overheads
Material control
Material
cost constitutes a prime part of the total cost of production of a manufacturing
firm. Proper accounting, therefore is required for controlling the material
through purchase control, stores control, issue control and control over
various losses. Material control basically aims at efficient purchasing of
materials, their efficient storing and efficient use or consumption.
“Material control is a systematic control
over purchasing, storing and consumption of materials, so as to maintain a
regular and timely supply of materials, at the same time, avoiding
overstocking.”
Objectives of Materials
Control:
a. Material of desired quality
should be available when needed for efficient and uninterrupted production.
b. Material should be purchased only when it is
needed and in most economic quantities.
c. Investment in the material is
maintained at a minimum level consistent with the operating requirement.
d. Purchasing of material will
be made at the most favorable prices under the best possible terms.
e. Material is stored in such a way that the objective of protection is met fully and at the same time material is made
available easily.
f. Issues of materials are
authorized properly and are accounted for properly.
g. Materials are, at all the
time, charged as the responsibility of some individual.
Importance of material
control:
1. For
keeping the stock of raw materials within limits in the stores i.e., to avoid
overstocking and understocking of raw materials, materials control is
significant.
2. It
ensures proper storage of materials. For the proper preservation and safety of
materials, adequate storage facilities are to be provided. With the help of
proper storing of materials, quantity of materials as and when required can be
issued to various jobs.
3. For
knowing proper cost of production, control over materials is indispensable.
4. Certain
techniques and methods are developed under the system of materials control
thereby ensuring optimum utilization of materials.
5. In
order to undertake continuous checking of materials, the necessity of a proper
system of materials control cannot be ignored.
6. A
well managed system of materials control ensures the availability of different
kinds of materials without delay.
Methods of material control
A-Economic Order Quantity
B-Level Setting
C. ABC System/Analysis
D. Just in Time Inventory:
E. VED Analysis
F. FNSD Analysis
A-Economic Order Quantity:
One of the important question that is to be answered by the
Purchase Manager is how much to purchase at any one time? In other words, how
much quantity is to be ordered at any one point of time? On the other hand,
there are certain costs that are called as carrying costs. The cost of carrying
the inventory is the real out of pocket cost associated with having inventory
on hand, such as warehouse charges, insurance, lighting, losses due to
handling, spoilage, breakage etc, and another important component of carrying cost
is the amount of interest lost due to the investment in the inventory. Carrying
costs will go on increasing if the quantity of material in inventory goes on
increasing. Both, the carrying costs and the ordering costs are variable costs,
however their behavior is exactly opposite of each other.
If orders are more
frequent, ordering costs will go on increasing but as the material ordered will
be in less quantity, the carrying costs will decrease In this situation, the most desirable quantity
to be ordered is that quantity at which both, the ordering costs and carrying
costs will be minimum. This quantity is called as ‘Economic Order Quantity’.
This quantity can be calculated with the help of the following formula.
A = Annual demand / annual consumption in units
B = Cost of placing and receiving an order
CS = Carrying cost per unit per annum/Cost
of storing one unit of material for one year.
Or
This quantity
can be calculated with the help of the following formula.
The Economic Order Quantity is an important concept as it guides
the Purchase Manager regarding the quantity to be purchased of a particular
material. However, this concept is based on some assumptions.
These assumptions are as follows.
• The concerned material will be available all the time without
any difficulty.
• The price of the material will remain constant.
• Ordering cost and carrying costs are variable.
• Impact of quantity discounts on the prices is negligible.
Level Setting
Fixation of Level: Another
important aspect of material procurement is not to purchase too much or too
little. Similarly, the timing of the purchase is also important. Fixation of
levels of materials is done precisely with these objectives in mind.
The following levels of materials are fixed for achieving objectives
like avoiding overstocking, ensuring that the material is ordered at right time
and also avoiding shortage of materials.
Maximum Level: This
is the highest level of material beyond which the inventory of material is not
allowed to rise. Obviously, this level is fixed with the objective of avoiding
overstocking. This level is fixed after taking into consideration the
consumption of material and the re-order period.
Mathematically the level is fixed as under.
Maximum Level = Re-order Level + Re-order Quantity – [Minimum
Consumption _ Minimum Reorder period]
Minimum Leve : This
level is fixed with the objective of avoiding shortage of material. If
production is held up due to shortage of material, there will be huge loss to
the company. In order to avoid this, the minimum level is fixed. Care is taken
that the stock do not fall below this level.
The minimum level is fixed
in the following manner.
Minimum Level = Ordering Level – [Average rate of consumption _ Re-order period]
Re-order Level : This
level is fixed for deciding the time of placing an order. If the stock of
materials reaches this level, fresh order is placed so that by the time the
material is procured, the level of material may fall up to minimum level but
not below that.
This level is fixed in the following manner.
Re-order Level = Maximum Usage per Period _ Maximum Re-order Period
Average Level : This
level is the average of the maximum and minimum level and computed in the following
manner.
Average Level = Maximum Level + Minimum Level / 2
Danger Level: Generally
the danger level of stock is indicated below the safety or minimum stock level.
Sometimes, depending on the practices of the firm and circumstances prevailing,
the danger level is determined between the re-order level and minimum level.
C. ABC System: In
this technique, the items of inventory are classified according to the value of
usage.
Materials are classified as A, B and C according to their value.
Items in class ‘A’ constitute the most important class of inventories so far as the
proportion in the total value of inventory is concerned. The ‘A’ items
constitute roughly about 5-10% of the total items while its value may be about
80% of the total value of the inventory.
Items in class ‘B’ constitute intermediate position. These items may be about 20-25%
of the total items while the usage value may be about 15% of the total value.
Items in class ‘C’ are the most negligible in value, about 65-75% of the total
quantity but the value may be about 5% of the total usage value of the
inventory.
The numbers given above are just indicative, actual numbers may
vary from situation to situation. The principle to be followed is that the high
value items should be controlled more carefully while items having small value
though large in numbers can be controlled periodically.
D. Just in Time Inventory: This is the latest trend in inventory management. This principle
there should not be any intermediate stage like storekeeping. Material
purchased from supplier should directly go the assembly line, i.e. to the
production department. There should not be any need of storing the material.
The storing cost can be saved to a great extent by using this technique.
However the practicality of this technique in Indian conditions
should be verified before practicing the same.
The benefits of Just in time system are
as follows,
o Right quantities are purchased or produced at right time.
o Cost effective production or operation of correct services is
possible.
o Inventory carrying costs are eliminated totally.
o The stores function is eliminated and hence there is a
considerable saving in the stores cost.
o Losses due to breakage, wastage, pilferage etc are avoided.
E. VED Analysis: This
analysis divides items into three categories in the descending order of their criticality
as follows.
• ‘V’ stands for vital items and their stock analysis requires
more attention. The reason is that if these items are not available, the
resulting stock outs will cause heavy losses due to stoppage of production.
Thus these items are required to be stored adequately to ensure smooth
operation of the plant.
• ‘E’ means essential items. Such items are considered essential
for efficient running but without these items, the system will not fail. Care
must be taken to see that they are always in stock.
• ‘D’ stands for desirable items, which do not affect production
immediately but availability of these items will lead to more efficiency and
less fatigue.
• Thus VED analysis can be very useful to capital intensive
process industries. As it analyses items based on their importance and it can
be used for those special raw materials which are difficult to
F. FSND Analysis: Age
of the inventory indicates the duration of inventory in the organization. It
shows the moving position of inventory during the year. This analysis divides
the items of inventory into four categories in the descending order of their
usage rate as follows.
I] ‘F’ stands for fast moving items and stocks of such items are consumed
in a short span of time. Stock of fast moving items must be observed constantly
and replenishment orders be placed in time to avoid stock out position.
II] ‘N’ means normal moving items and such items are exhausted
over a period of time, i.e. say one year. The order levels and quantities for
such items should be on the basis of a new estimate of future demand to
minimize the risks of a surplus stock.
III] ‘S’ indicates slow moving items, existing stock of which
would last for two years or so. These items must be reviewed carefully before
eliminating them.
IV] ‘D’ stands for dead stock which means that there will not be
any further demand for the same. It is necessary to identify these items and if
there cannot be any alternative use for the same, should be eliminated.
C. Issue Control : Another important aspect of material control is the issue control.
Material is issued to production and utmost care is to be taken while issuing
the material. The first thing is that without authorization material should not
be issued to any department. A Material Requisition Note is prepared by the
department that is in need of the material and sent to the stores department.
It is a
written request made to the stores department for sending the
material. In the Material Requisition Note, the details of the material
required such as the quantity, quality, date by which it is required etc.
It is signed by the authorized signatory of the concerned
department. On the receipt of this requisition, the stores department takes
action of supplying the required material to the department. While issuing material
care should be taken that exact quantity as per the requirement should be
supplied. If there is surplus material remaining after satisfying the needs of
the concerned department, it should be
returned to the stores department. In such case, Material Return
Note should be prepared and sent along with the material. Similarly if material
is transferred from one site to other site without being returned to the store,
it is necessary to prepare Material Transfer Note for recording the same.
Proper documentation is extremely necessary for minimizing the chances of
errors and frauds.
Pricing
of Issues Materials
Pricing of
Issues One
of the important aspects of issue control is of pricing of the issues. Material
is issued to production and it is necessary to find out the consumption value
of the material.
The various methods of pricing of issues are given below.
1. First In First Out:- As per this method, material
received first is issued first. Thus the material in stock at the beginning of
a period is issued firstly and then the issues are made according to the dates
of purchases made. This method is quite logical as the sequence of issue is as
per the dates of purchases. However the consumption value will be as per the
purchases made earlier and hence the latest price may not be charged to the
consumption. In case of rising prices it will result in charging lower prices
while in case of falling price it will result in charging higher prices to the
material consumption. The closing stock will be shown at the latest prices as
the material purchased towards the end of the period will remain the stock.
2. Last In First Out [LIFO]:- The assumption under this method is
that the material which is purchased last is issued first to the production.
Therefore the issue should be charged at the latest prices. The main advantage
of this method is that the issues are priced at the latest prices and hence
consumption value is also the latest. This will make the product cost more
realistic. However, the inventory valuation will be at the older price as
material in balance will be from the earlier batches of purchases. Valuation of
inventory according to this method is not accepted for inventory valuation in
the preparation of financial statements.
3. Highest In First Out [HIFO]:- Under this method, the materials
with highest prices are issued first, irrespective of the date upon which they
are purchased. The basic assumption is that in fl uctuating and infl ationary
market, the cost of material are quickly absorbed into product cost to hedge
against risk of infl ation. As the issues are shown at highest prices, the
product costs tend to be on the higher side and hence this method is not
suitable in competitive environment.
4. Simple Average Cost Method:- Under this method, the issues are
charged at the average price of the material purchased without taking into
consideration the quantities involved in the same. For example, if materials
are purchased in three batches at prices of Rs.18, Rs.19 and Rs.23, the issue
will be charged at the average price of the three prices, i.e. Rs.18 + Rs.19 +
Rs.23 = Rs.60/3 = Rs.20. This method is not very popular because it takes into
consideration the prices of different batches but not the quantities purchased
in different batches. In the periods of price fluctuations this method is
useful but if fluctuations are too wide, the method may not be useful.
5.Weighted Average Method:- This method takes into
consideration the prices as well as the quantities of materials purchased. Thus
weighted average is computed after each receipt by dividing the total amount by
the total quantity. The issue is charged at prices arrived at according to this
calculation.
For
example, if three consignments of materials are purchased at prices of Rs.10,
Rs.12 and Rs.11 and the quantities involved are respectively 1,000, 1,200 and
1,400. The weighted average price will be calculated as shown below.
6. Periodic Average
Cost Method:-
Under this method, instead of recalculating the simple or weighted average cost
every time there is a receipt, periodic average is computed. The average may be
calculated for the entire period. The price may be calculated as given below. Cost
of Opening Stock + Total Cost of all receipts / Units in Opening Stock + Total
Units received during the period.
7. Standard Cost Method:- Under this method, material
issues are priced at a predetermined standard issue price. Any difference
between the actual purchase price and the standard price is written off to the
Costing Profit and Loss Account. Standard Cost is a predetermined cost and if
it is set accurately, it can be very effective. However revision of standard
cost at regular intervals is required.
8. Replacement Cost [Market Price]:- The replacement cost is the cost at
which material identical to that is to be replaced could be purchased at the
date of pricing of the issues as distinct from the actual cost price at the
date of purchase. The replacement price is the price of replacing the material
at the time of the issue of materials or on the date of valuation of closing
stock. This method is not acceptable for standard accounting practices as it
reflects the price, which has not been paid actually.
Material Losses: One of the main reasons of rising material costs is the
loss of material in the production process. It is of paramount importance that
there should be rigid control over the material losses failing which it will be
very difficult to keep the material costs in check. The material losses can be
categorized as given below.
Waste:-
Waste is a loss of material either in stores or in production due to reasons
like evaporation, chemical reaction, shrinkage, unrecoverable residue etc.
Wastages may be visible or invisible. It is necessary to take steps to control
the material wastage.
In cost accounting, the wastage is divided
into the following categories.
• Normal Wastage:- This wastage is such that it cannot
be avoided. It is inherent in any production process. The normal wastage is
normally estimated in advance and included in the material cost. In other
words, the good units should bear the cost of normal wastage.
• Abnormal
Wastage:- Any wastage over and above the normal wastage is the abnormal
wastage. In other words it is more than the standard wastage. The cost of the
abnormal wastage is not charged to the production, but it is written off to the
Costing Profit and Loss Account.
• Wastage
can be controlled by adopting strict quality control measures. Normal allowance
of waste can be fixed with technical assessment and past experience as well as
by identifying the special features of materials.
The causes
for abnormal wastages should be studied in detail and responsibility should be
fixed for wastage. Better material handling system will also help in
controlling the wastage.
Scrap:-
Scrap is a residual material resulting from a
manufacturing process. It has a recovery value and is measurable.
The
treatment of scrap in cost accounts is normally as per the following details
.• If the
value of scrap is negligible, the good units should bear the cost of scrap and
any income collected will be treated as other income.
• If the
value of scrap is considerable and identifiable with the process or job, the
cost of job will be transferred to scrap account and any realization from sale
of such scrap will be credited to the job or process account and any
unrecovered balance in the scrap account will be transferred to the Costing
Profit and Loss Account.
• If scrap
value is quite substantial and it is not identifiable with a particular job or
process, the amount will be transferred to factory overhead account after
deducting the selling cost. This will reduce the cost of production to the
extent of the scrap value.
• Control of Scrap:- For the control
purpose, scrap may be divided into the following categories.
• Legitimate Scrap:- This is predetermined or
anticipated in advance due to experience in manufacturing operations.
•
Administrative Scrap:- This results from administrative decisions, e.g. change
in design of a product or discontinuation of existing product lines.
• Defective Scrap:- This results from poor
quality of raw material, negligent handling of material etc.
• Scrap can be controlled
through selection of right type of material, selection of right type of
manpower, determination of acceptable limits of scrap, and reporting the source
of waste.
Labor Cost Control
Labor
is another important element of cost and for overall cost control and cost
reduction, of labor cost is of paramount importance. For control and reduction
of labor cost, it is essential to compute the labor cost in a scientific manner
and hence there should be proper systems of systems and processes and
documentation, which will help computation of labor cost in a scientific
manner. The following steps will be useful in controlling and reducing the
labor cost.
Various
aspects of labor cost control
The following steps will be useful in
controlling and reducing the labor cost:
1- Classification of labor cost
2- Production Planning
3- Labor Budget
4- Labor Standards
5- Labor Performance Report
6- Incentive Schemes
7- Labor Cost Accounting
Methods of Wages Payment: One of the important components of labor cost control is the
wages system. A system of wage payment, which takes care of both, i.e.
providing guarantee of minimum wages as well as offering incentive to efficient
workers helps to motivate the workers to a great extent. It should also be
remembered that high wages do not necessarily mean high labor cost because it
may be observed that due to high wages the productivity of workers is also high
and hence the per unit cost of production is actually decreased. On the other
hand, if low wages are paid, it may result in lower productivity and hence
higher wages do not necessarily mean high cost.
The following are the various methods of
payment of wages.
I.
Time Rate System
II.
Piece Rate
III.
Differential Piece Rates:
IV.
Bonus Systems
A-
Individual Bonus for Direct Workers
B-
Group Bonus for Direct Workers
C-
Bonus for Indirect Workers
V-Indirect Monetary
Incentives
A] Profi t
Sharing
B] Co-partnerships
V] Non
monetary incentives like job security, social and general welfare, sports,
medical facilities etc.
A] Time Rate at Ordinary Levels: Under this method, rate of payment
of wages per hour is fixed and payment is made accordingly on the basis of time
worked irrespective of the output produced. However, overtime is paid as per
the statutory provisions.
The main benefit of this method
1-The
workers is that they get guarantee of minimum income irrespective of the output
produced by them.
2-If a
worker is not able to work due to genuine reasons like illness or physical
disability, he will continue to get the wages on the basis of time taken for a
particular job.
3-The worker
is assured of minimum income irrespective of the output produced.
4-He can focus
on quality as there is no monetary incentive for producing more output. limitation
of this method
1-It does not
offer any incentive to the efficient workers.
2-Efficient
and inefficient workers are paid at the same rate of wages.
3-There is a
possibility that even an efficient worker may become inefficient due to lack of
incentive
This method is used in the following situation.
1- Where the work requires high skill
and quality is more important than the quantity.
2- Where the output/services is not
quantifiable, i.e. where the output/services cannot be measured.
3- Where the work done by one person is
dependent upon other person, in other words where a individual worker has no
control over the work.
4- Where the speed of production is governed by time in
process or speed of a machine.
5- Where the workers are learners or
inexperienced.
6- Where continuous supervision
is not possible.
II- Piece Rate
Method:
This method is also called as payment by results
where the workers are paid as per the production achieved by them. Thus if a
worker produces higher output, he can earn higher wages.
In this method, rate per unit is fixed and the
worker is paid according to this rate.
For example, if the rate per unit is fixed at
Rs.10, and the output produced is 300 units, the remuneration to the worker
will be Rs.10 X 300 units = Rs.3,000.
This method thus offers a very strong
incentive to the workers and is particularly suitable where the work is
repetitive.
The benefits of this method are as follows.
The method
is simple and provides a very strong incentive to the workers by linking the
monetary reward directly to the results. Productivity can be increased
substantially if the rate of pay includes a really adequate incentive. Higher
productivity will result in lowering the cost per unit.
The main limitation of this method is that if a worker is not able to
work efficiently due to reasons beyond his control, he will be penalized in the
form of lower wages.
III-
Differential Piece Rates: Under these methods, the rate per standard per
hour of production is increased as the output level rises. The increase in
rates may be proportionate to the increase in output or proportionately more or
less than that as may be decided. In other words, a worker is paid higher wages
for higher productivity as an incentive. The rate per unit will be higher in
this case as compared to the rate paid to a worker with lower productivity. For
deciding the efficiency, comparison is made between the standard production and
actual production of the worker. If the actual production is more, the worker
qualifies for higher rate of wages.
The following
are the major systems of differential piece rate system
I-Taylor
II-Merrick
III- Gantt Task and Bonus
I- Taylor’s Differential Piece Rate System:
Taylor is
regarded as father of scientific management and he has recommended a system of
differential piece rate. According to him, there are only two classes of
workers, efficient and inefficient. He suggests that while efficient workers
should be encouraged to the maximum possible extent, the inefficient workers
should be penalized. In order to do this, he has suggested two rates for the
two classes of workers. Thus according to Taylor, if the workers are efficient,
they should be paid @ 120% of the normal piece rate and if they are
inefficient, they should be paid @ 80% of the normal piece rate. For measuring
efficiency, each worker will be given a standard production quantity to be
produced in the time allowed for the same and the actual production produced
should be compared with the same. If a worker exceeds the standard, he will be
regarded as efficient while if he fails to do so, he will be regarded as in efficient.
The positive and negative points of this system are
as follows.
Merits:
1-There is a
very strong incentive to the workers, which helps to achieve higher
productivity.
2-Due to the
incentive, best workers are attracted to the company.
3-This method
is quite simple and hence easy to understand.
Limitations:
1-Slow workers
and beginners are penalized severely.
2-Similarly
workers get penalized for reasons beyond their control, e.g. medical reasons,
accidents etc.
3- Therefore
it is said that there is no human element in this system.
4-In an
anxiety to produce more, quality may be neglected in order to achieve higher
quantity of production.
II- Merrick Differential Piece Rate System:
Merrick’s
system is modification of Taylor’s system and is comparatively less harsh on
the workers. The scale of remunerations is as follows.
As mentioned earlier, this method is less
harsh on the workers as compared to Taylor’s system. It is particularly useful to beginners and
also offers an incentive who have potential of higher productivity.
III- Gantt Task Bonus Plan: In this method, there is a
combination of time rate, bonus and piece rate plan. The remuneration is
computed as shown below. Production Payment Production below
This method assures minimum wages even too
less efficient workers and hence is a preferred method of payment of wages. It
also offers reasonably good incentive to efficient workers. However, the main
limitation is that the method is complicated to understand by the workers and
hence may create confusion amongst them
C- Individual Bonus Plans: We have seen earlier that in the time rate
system, the workers are paid according to the time taken while in case of piece
rate system, the output produced by the worker decides his wages as rate per
unit is fixed rather than rate per hour.
In the premium
bonus plan, the gain arising out of increased productivity is shared by both,
the employer and employee. The bonus to be paid to the workers is computed on
the basis of savings in the hours, i.e. the difference between the time allowed
and time taken.
The time
allowed is the standard time, which is fixed by conducting a time and motion
study by the work-study engineers. While fixing the standard time, due
allowance is given for physical and mental fatigue as well as for normal idle
time. The actual time taken is compared with this standard time and bonus is
payable to the worker is the time taken is less than the standard time
The individual bonus schemes commonly used
are as follows.
I] Halsey
Premium Plan
II]
Halsey-Weir Premium Plan
III] Rowan
Plan
IV] Barth
Variable Sharing Plan These methods are discussed below.
I] Halsey
Premium Plan:
This plan was introduced by F.A. Halsey, an American engineer. In this plan,
bonus is paid on the basis of time saved. Standard time is fixed for a job and
if the actual time taken is less than the same, the worker becomes ligible for bonus.
However bonus is paid equal to wages of 50%
of the time saved. A worker is assured of time wages if he takes longer time
than the allowed time.
The
formula for computing the total wages is as follows.
Total Earnings = H x R + 50% [S – H] R
Where, H = Hours worked, R = Rate per hour, S
= Standard time
II] Halsey –
Weir Plan:
Under this method, there is only one difference as compared to the Halsey Plan
and that is instead of 50% bonus for the time saved, it is 331/3rd % of the
time saved. Accordingly the formula for this method is modified as follows.
Total Earnings = H x R + 33x1/3% [S – H] RH = Hours worked.
R = Rate per hour. S = Standard time
III] Rowan
Plan: This
premium bonus plan was introduced by Mr. James Rowan. It is similar to that of
Halsey plan in respect of time saved, but bonus hours are calculated as the
proportion of the time taken which the time saved bears to the time allowed and
they are paid for at time rate.
The formula for computation of total earnings
is as follows.
Total Earnings = H x R + [S – H]/S x H x R
Where H = Hours worked, R = Rate per hour, S
= Standard time,
IV] Barth
Variable Sharing Plan: In this system, the total earnings are calculated as follows:
Total Earnings = Rate per hour / Standard
hours Actual hours worked
D] Group Bonus
Plan: Many
times output of individuals cannot be measured. Similarly, the output of
individual is dependent on the performance of the group. In such cases, rather
than implementing individual bonus systems, group bonus system is implemented.
The total amount of bonus, which is determined according to productivity, can
then be shared equally or in agreed proportion between the group members.
The
main objects of group bonus system are as follows.
1. Creation of team spirit.
2. Elimination of excessive
waste of materials and time.
3. Recognition of group
efforts.
4. Improving productivity
The various
group bonus plans are discussed below.
·
Budgeted Expenses Bonus:
·
Cost Efficiency Bonus:
·
Profit Sharing Plan:
·
Waste Reduction Bonus: etc
Bonus System for Indirect Workers:
Indirect workers do not take part in the
production process directly but they play important role in the production
process. It is difficult to chalk 71out a bonus system for indirect workers, as there is a diffi culty in
measuring their output. However it is advisable to plan a bonus system for
indirect workers in order to motivate them for better productivity. Bonus to
indirect workers is paid on the basis of output of the department, saving in
time or expenditure against the budgeted, product quality, reduction of waste
and scrap and reduction of labor turnover.Indirect Monetary Incentives: These
methods aim at giving additional remuneration based on the prosperity of the
concern. The following schemes fall in this category. o Profi t Sharing: In
this system, the profi ts of the organization are shared by workers in agreed
proportion. The Payment of Bonus Act in India makes it mandatory to pay minimum
bonus of 8.33% of salary and maximum bonus of 20% of salary to the workers. o
Co-partnership: In this system, the workers get an opportunity to participate
in the ownership of the organization and to receive the part of share of profi
ts. The employees are given assistance to purchase shares of the company. Thus
the employees get dividend and bonus also. These schemes help to boost the
morale of workers to a great extent.
Non-Monetary Incentives: These incentives are
given in addition to monetary incentives for further boosting the moral of the
employees. Though these benefi ts do not result in additional remuneration,
they help to improve productivity by boosting the morale of the employees. Some
of the non-monetary incentives are as follows.o Free education and training. o
Medical benefi ts o Subsidized canteens o Superannuation benefi ts like
pensions, gratuity, life assurance schemeso Sports and recreation facilities,
housing facilities, long service awards.o Job security, promotion schemeso
Benevolent funds and welfare funds.
Overhead Accounting
The ultimate aim of overhead accounting is to
absorb them in the product units produced by the fi rm. Absorption of overhead
means charging each unit of a product with an equitable share of overhead
expenses.
Overheads are all indirect costs, it becomes
difficult to charge them to the product units. In view of this, it becomes
necessary to charge them to the product units on some equitably basis which is
called as ‘Absorption’ of overheads.
The important steps involved in overhead
accounting are as follows
.A. Collection, Classification and Codification
of Overheads
B. Allocation, Apportionment and
Reapportionment of overheads
C. Absorption of Overheads.
Collection, Classification and Codification
of Overheads:-
These concepts are discussed below.
Collection of Overheads :- Overheads
collection is the process of recording each item of cost in the records
maintained for the purpose of ascertainment of cost of each cost center or
unit.
The following are the source documents for
collection of overheads.
i. Stores Requisition
ii. Wages Sheet
iii.
Cash Book
iv. Purchase Orders and Invoices
V. Journal Entries
vi. Other Registers and Records
II. Classification
of Overheads :-
Classification is defined by CIMA as, ‘the
arrangement of items in logical groups having regard to their nature (
subjective Classification ) or the purpose to be fulfilled. ( Objective Classification
) In other words, Classification is the process of arranging items into groups
according to their degree of similarity. Accurate classification of all items
is actually a prerequisite to any form of cost analysis and control system.
Classification is made according to following basis
Classification
according to Elements :- Indirect Materials, Indirect Labour, Indirect expence
Functional
Classification :- Manufacturing Overheads :- Administrative Overheads, Selling and
Distribution Overheads :-
Research and
Development Overheads :
Classification
according to Behavior
Fixed Overheads :- Variable Overheads :-
Semi-variable Overheads :-
III. Codification
of Overheads :-
B. Allocation, Apportionment and
Reapportionment of Overheads :-
After the collection, Classification and Codification
of overheads, the next step is allocation, apportionment wherever allocation is
not possible and fi nally absorption of overheads into the product units. The
following steps are required to complete this process.
Departmentalization :- Before
the allocation and apportionment process starts, the fi rst step in this
direction is ‘Departmentalization’ of overhead expenses. Departmentalization
means creating departments in the fi rm so that the overhead expenses can be
conveniently allocated or apportioned to these departments. For effi cient
working and to facilitate the process of allocation, apportionment and
reapportionment process, an organization is divided into number of departments
like, machining, personnel, fabrication, assembling, maintenance, power, tool
room, stores, accounts, costing etc and the overheads are collected, allocated
or apportioned to these departments.
This
process is known as ‘departmentalization’ of overheads which will help in
ascertainment of cost of each department and control of expenses. Thus
departmentalization is the fi rst step in allocation and apportionment process.
Allocation:- CIMA defi nes cost allocation as, ‘the charging of
discrete, identifi able items of cost to cost centers or cost units. Where a
cost can be clearly identifi ed with a cost center or cost unit, then it can be
allocated to that particular cost center or unit. In other words, an allocation is
the process by which cost items are charged directly to a cost unit or cost
center.
For
example, electricity charges can be allocated to various departments if
separate meters are installed, depreciation of machinery can be allocated to
various departments as the machines can be identified, salary of stores clerk
can be allocated to stores department, cost of coal used in boiler can be
directly allocated to boiler house division.
Thus
allocation is a direct process of identifying overheads to the cost units or
cost center.
Apportionment:- Wherever
possible, the overheads are to be allocated. However, if it is not possible to
charge the overheads to a particular cost center or cost unit, they are to be
apportioned to various departments on some suitable basis. This process is
called as ‘Apportionment’ of overheads.
For example, if separate meters are provided in
each department, the electricity expenses can be allocated to various
departments. However if separate meters are not provided, electricity expenses
will have to be apportioned to the departments on some suitable basis like
number of light points. Similarly rent will have to be apportioned to various
departments on the basis of fl oor space, insurance of machinery on the basis
of value of machinery, power on the basis of horsepower etc.
A
statement showing the apportionment of overheads is called as ‘Primary
Distribution Summary’ of overheads.
C. Absorption
of Overheads :- The most important step in
the overhead accounting is ‘Absorption’ of overheads. CIMA defi nes absorption
as, ‘the process of absorbing all overhead costs allocated or apportioned over
a particular cost center or production department by the units produced.’ In
simple words, absorption means charging equitable share of overhead expenses to
the products. As the overhead expenses are indirect expenses, the absorption is
to be made on some suitable basis. The basis is the ‘absorption rate’ which is
calculated by dividing the overhead expenses by the base selected. A base
selected may be any one of the basis given below. The formula used for deciding
the rate is as follows,
Overhead Absorption Rate = Overhead Expenses/
Units of the base selected.
The methods used for absorption are as
follows.
Direct
Material Cost :- Under this method, the overheads are absorbed on the basis of
percentage of direct material cost.
The following formula is used for working out
the overhead absorption percentage. Budgeted or Actual Overhead Cost/ Direct
Material Cost 100
Thus if the overhead expenses are Rs.
2,00,000 and Direct Material Cost is Rs. 4,00,000 the percentage of overheads
to direct material cost will be, 2,00,000/4,00,000 X 100 = 50%. Overheads will
be thus absorbed on the basis of percentage of 50% to material costs.
Direct Labor
Cost Method :-
This method is used in those organizations where labor is a dominant factor in
the total cost. Under this method, the following formula is used for
calculating the overhead absorption rate.
Budgeted or Actual Overheads/ Direct Labor
Cost X 100
Prime Cost
Method :-
This method is an improvement over the fi rst two methods. Under this method,
the Prime Cost is taken as the base for calculating the percentage of
absorption of overheads by using the following formula.
Budgeted or Actual Overheads/ Prime Cost 100
Direct Labor
Hour Method :-
Under this method, the rate of absorption is calculated by dividing the
overhead expenses by the direct labor hours.
The
formula is as follows.Budgeted or Actual Overhead Expenses/Direct Labor Hours
Machine Hour
Rate :
Machine hour rate is the cost of operating a machine on per hour basis. The
formula for calculating the machine hour rate is,Budgeted or Actual Overhead
Expenses/ Machine Hours – Actual or Budgeted
Selling Price
Method :-
In this method, selling price of the products is used as a basis for absorbing
the overheads. The logic used is that if the selling price is high, the product
should bear higher overhead cost. Ratio of selling price is worked out and the
overheads are absorbed.
Cost Sheet
Cost Sheet is a statement of cost showing the
total cost of production and profi t or loss from a particular product or
service. A Cost Sheet shows the cost in a systematic manner and element wise. A
typical format of the Cost Sheet is given below.
Objects of Preparing a Cost Sheet:
A cost sheet is prepared for:
(i) The total cost and cost per unit of the product can
be ascertained;
(ii) It helps the management to fix up
the selling price on the basis of the cost per unit of the product after
charging certain percentage of profit on cost;
(iii) It also helps the management
presenting a comparative study of current cost with the existing cost per
unit;
(iv) After proper comparison the
management can take the corrective measures;
(v) It helps the management while formulating suitable
production policy;
(vi) It is very helpful to submit a
price quotation for tenders; and
(vii) It also helps the management by
supplying suitable information for management control.
Method of Preparation of Cost Sheet:
Step I = Prime Cost = Direct Material + Direct Labour + Direct
Expenses.
Step II = Works Cost = Prime Cost + Factory/Indirect Expenses.
Step III = Cost of Production = Works Cost + Office and
Administration Expenses.
Step IV = Total Cost = Cost of Production + Selling and
Distribution Expenses. Profit = Sales – Total Cost.
1.3.13 Cost Control and Reduction :- One of the important functions of cost accounting is cost control
and cost reduction. Cost control implies various actions taken in
order to ensure that the cost
do not rise beyond a particular level while cost reduction means
reducing the existing cost of
production. Both these concepts are discussed below.
Cost Control :- As
mentioned above, cost control means keeping the expenses within limits or
control. Cost control has the following features.
A. Cost control is a continuous process. It involves setting
standards and budgets for
deciding targets of different expenses and constant comparison of
actual the budgeted and
standards.
B. Cost control involves creation of responsibilities center with
clearly defi ned authorities and
responsibilities.
C. It also involves, timely cost control reports showing the
variances between standard and
actual performance.
D. Motivating and encouraging employees to accomplish budgetary
goals is also one of the
essential aspects of cost control.
E. Actually cost control not only means monetary limits on cost but
it also involves optimum
utilization of resources or performing the same job at same cost.
Cost Reduction :- Cost
control means attempts to reduce the costs. For example, if the present
costs are Rs. 1,000 per unit, attempts can be made to reduce it to
bring it down below Rs. 1,000. For
doing this, all out efforts will have to be made for achieving
this target. The goal of cost reduction
can be achieved in two ways, fi rst is reducing the cost per unit
and the second one is increasing
productivity. Reducing wastages, improving effi ciency, searching
for alternative materials, and
a constant drive to reduce costs, can effect cost reduction. The
following tools and techniques are
normally used for cost reduction.
A. Value analysis or value engineering.
B. Setting standards for all elements of costs and constant
comparison of actual with standard
and analysis of variances.
C. Work study
D. Job evaluation and merit rating
E. Quality control
F. Use of techniques like Economic Order Quantity
G. Classification and Codification
H. Standardization and simplifi cation
I. Inventory management
J. Benchmarking
K. Standardization
L. Business Process Re-engineering.
What is normal wastage/loss of material?
Normal wastage of
material means any wastage due to normal reason like
evaporation.
What is abnormal wastage/loss of
matterials?
Ans. Any wastage arise due to abnormal. Reason like loss
by fire, loss by
earthquake.
What is ABC technique?
It is a technique to control under these material
classified three parts AB &
C A include high value material B include. Medium value
material and C
include low value material.
Q.17 What is JIT purchase.
Ans. Under this technique no stock maintain and material
purchase when
having its demand.
Q.18 What is economic order quantity
?
Ans. Economic order quantity is that quantity of material
where ordering &
carrying cost minimum.
Q.19 What is meant by wages
abstracts?
10
Ans. It is a statement and it include detail of wages prepare
by cost department
with the help of time card, wages sheet.
Q.20 What is idle time?
Ans. Idle time means no production hour but wages paid
for that time.
Q.21 Name the method of giving
remuneration to workers.
Ans. (1) Time rate method.
(2) Piece rate method.
(3) Piece rate with guaranteed pay rate
(4) Differential piece rate method.
Q.22 Howlabour separation rate is
computed.
Ans. Labor turnover rate =
no of spepratoin
Avg No of workers
x 100
Q.23 What do you understand by time
study?
Ans. Time study is useful is determination of time
require by an average
worker in a Job.
Q.24 Write the formula of
Halsey-weir premium plan.
AT X RATE + [30% of ts x rate]
Q.25 What is meant by overhead?
Ans. Indirect material indirect labour&Indirect
expenses are known as
Indirect overhead.
Q.26 Explain variable overhead.
Ans. The cost which increase according to production known as variable
overhead.
Q.27 Explain semi variable overhead.
Ans. Overhead upto certain level fixed and after that
variable known as semi
variable overhead.
Q.28 In how many classes are the
indirect expenses classified under the
functional classification name them.
Ans. (1) Factory overhead.
(2) Office overheard
(3) Selling & Distribution overheard.
Q.29 State the name of four
industries where unit costing is applied.
Ans. (1) Brick Industry
(2) Sugar Industry
(3) Steel industry
(4) Cement Industry
Q.30 What is meant by sub contract ?
Ans. When contractor assign a portion of contract to any
other person for
completion of that portion.
Q.31 What do you mean by cost plus
contract?
Ans. Contract price is determined after adding a certain
percentage of profit or
certain amount of profit on actual cost.
Q.32 Explain escalation clause in
the context of contract costing/
What is the importance of escalation clause?
Ans. Under this clause contract price will change in
proportion to change in
price of material labour& other expenses.
Q.33 What is meant by retention
money?
Ans. In case of incomplete contract a part of the
certified work is paid by the
contractee to contractor. Rest of the amount is known as
retention money.
Q.34 Mention the names of industries
where process costing method may be
used.
Ans. (1) Chemical industries
(2) Mining industries.
(3) Water & Gas Industries
(4) Electric supply
Q.35 Define joint product
Ans. Joint product is same type of product equal
importance & value.
Q.36 What is scrap?
Ans. It is residue material from certain manufacturing
operation
Q.37 What do you mean by abnormal
effective.
Ans. When actual wastage is less than normal wastage then
difference is
termed as abnormal effective the balance transferred to P
& L .
Q.39 Give name of any five industries where operating costing method is used.
Ans. (1) Bus
(2) Hospital
(3) Water supply industry
(4) Canteen
Q.40 What do you meant by marginal
costing?
Ans. Marginal costing is the ascertainment of marginal
cost and its effect on profit
of changes in value of type of output by differentiating
between fixed cost and
variable cost.
Q.41 Explain absolute tone kilometer
Ans. Journey from one station to another is treated as
independent inurned distance is
multiplied by weight total of all journey is absolute
tone kilometer.
Q.42 What do you understand by
commercial tone kilometer?
Ans. Commercial tone kilometer is compared by multiplying
average weight by total
distance of journeys.
Q.43 Why cost and financial accounts
are reconciled?
Ans. Cost and financial accounts are reconcile. To verify
the accuracy of both
accounts.
Q.44. Explain two reason for difference
in profit as per cost book and financial
books
Ans. (1) it may be due to under/over absorption of
overhead
(2) it may be due to valuation of stock
Q.45 What do you meant by marginal
costing?
Ans. Marginal costing is mean ascertainment of marginal cost and its effect on profit of
changes in volume of type of output by differentiating
between fixed cost and
variable cost.
Q.46 What do you mean by break even
point.
Ans. Break even point is that point where no profit/ no
loss. At this point contribution
is just equal to fixed cost.
Q.48 State two factors effecting break even point.
Ans. (1) Increase in FC
(2) Decrease in FC
(3) Increase /Decrease in V.C
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