Additional Knowledge Material

(Faculty E-notes)

 COURSE BBA 3rd SEMESTER

 UNIVERSITY MAHARSHI DAYANAND UNIVERSITY
 SUBJECT COST AND MANAGEMENT ACCOUNTING
 SUBJECT CODE BBAN-301
 UNIT NO & NAME UNIT 2 LABOUR COST CONTROL, OVERHEADS,
METHODS OF COSTING
 NAME OF FACULTY MS. KHUSHBOO AHUJA

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 Unit II- Labour
Labour cost is a second major element of cost. The control of labour cost and its accounting is very
difficult as it deals with human element. Labour is the most perishable commodity and as such should
be effectively utilized immediately.
Importance of Labour Cost Control
Labour is of two types (a) direct labour, (b) indirect labour. Direct Labour is that labour which is
directly engaged in the production of goods or services and which can be conveniently allocated to the
job, process or commodity or process. For example labour engaged in spinning department can be
conveniently allocated to the spinning process.
Indirect Labour is that labour which is not directly engaged in the production of goods and services
but which indirectly helps the direct labour engaged in production. The examples of indirect labour
are supervisors, sweepers, cleaners, time-keepers, watchmen etc. The cost of indirect labour cannot be
conveniently allocated to a particular job, order, process or article.
The distinction between direct and indirect labour must be observed carefully because payment of
direct labour is a direct expenditure and is a part of prime cost whereas payment of indirect labour is
an item of indirect expenditure and is shown as works, office, selling and distribution expenditure
according to the nature of the time spent by the indirect worker.
Management is interested in the labour costs due to the following reasons.
• To use direct labour cost as a basis for increasing the efficiency of workers.
• To identify direct labour cost with products, orders, jobs or processes for ascertaining the
cost of every product, order, or process.
• To use direct labour cost as a basis for absorption of overhead, if percentage of direct labour
cost to overhead is to be used as a method of absorption of overhead.
• To determine indirect labour cost to be treated as overhead and
• To reduce the labour turnover.
Hence control of labour cost is an important objective of management and the realization of
this objective depends upon the co-operation of every member of the supervisory force from
the top executive to foremen.
Time keeping
Time-keeping will serve the following purposes:
1. Preparation of Pay Rolls in case of time-paid workers.
2. Meeting the statutory requirements.
3. Ensuring discipline in attendance.
4. Recording of each worker's time 'in' and 'out' of the factory making distinction between
normal time, overtime, late attendance, early leaving.
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5. For overhead distribution when overheads are absorbed on the basis of labour hour

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Methods of Time-keeping
There are two methods of time-keeping. They are the manual methods and the mechanical methods.
Whichever method is used it should make a correct record of the time and the method should be cost
effective and minimize the risk of fraud.
The manual methods of time keeping are as follows:
a) Attendance Register Method, and
b) Metal Disc Method
Attendance Register Method
This is the traditional method where an attendance register or muster roll is kept at the time office near the
factory gate or in each department. The timekeeper records the name of the worker, the worker's number,
the department in which he is working, the rate of wages, the time of arrival and departure, normal time
and overtime. If the workers are literate, they may make a record of time themselves in the presence of a
time-keeper or foreman.
This method is simple and inexpensive and can be used in small firms where the number of workers is not
large. However recording the time of workers who work at customers' premises and places which are
situated at a distance from the factory is not practical in this method.
Metal Disc Method
Under this method, each worker is allotted a metal disc or a token with a hole bearing bis identification
number. A board is kept at the gate with pegs on it and all tokens are bung on this board. These boards can
be maintained separately for each department so that the workers can remove the token without delay and
put it in a tray or box kept near the board. Immediately after the scheduled time for entering the factory, the
box is removed and the latecomers will have to give their tokens to the timekeeper and their exact timeof
arrival is recorded. The tokens or disc left on the board will represent the absentee workers. Later the
timekeeper records the attendance in the attendance register and subsequently it is passed on to the Pay Roll
Department.
Mechanical Methods
The mechanical methods that are generally used for the recording of time of workers may be as follows:
(a) Time Recording Clocks
(b) Dial Time Records
Time Recording Clocks
The time recording clock is a mechanical device which automatically records the time of the workers.
Under this method, each worker is given a Time Card which is kept in a tray near the factory gate and as
the worker enters the gate, be picks up his card from the tray, puts it in the time recording clock which
prints the exact time of arrival in the proper space against the particular day. This procedure is repeated for
recording time of departure for lunch, return from lunch and time of leaving the factory in the evening. Late
arrivals and overtime are recorded in red to attract the attention of the management.

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Dial Time Records
Under this method, a dial time recorder machine us used. It has a dial with number of holes (usually about
150) and each hole bears a number corresponding to the identification number of the worker concerned.
There is one radial arm at the centre of the dial. As a worker enters the factory gate, he is to press the radial
arm after placing it at the hole of his number and his time will automatically be recorded on roll of apaper
inside the dial time recorder against the number. The sheet on which the time is recorded provides arunning
account of the worker's time and it can calculate the number of hours and prepare the wage sheets.However,
the high installation cost of the dial time recorder and its use for only a limited number of workerare the
drawbacks of this method.
Time Booking
Time booking is the recording of time spent by the worker on different jobs or work orders canied out by
him during his period of attendance in the factory. The objects of time booking are:
1. To ensure that time spent by a worker in a factory is properly utilized on different jobs or work
orders.
2. To ascertain the labour cost of each individual job or work order.
3. To provide a basis for the apportionment of overhead expenses over various jobs or work orders
when the method for the allocation of overheads depends upon time spent on different jobs.
4. To ascertain unproductive time or idle time so as to make efforts to keep it in limit.
5. To know the time taken to complete a particular job so that bonus can be paid as per the
incentive schemes.
6. To know the efficiency of workers, it is necessary to make the comparison of actual time
taken with time allowed for completing a particular task.
Following documents are generally used for time booking:
1. Daily Time Sheets
2. Weekly Time Sheets
3. Job Tickets or Job Cards.
Daily time sheets are given to each worker where he records the time spent by him on each job or work
order. Weekly time sheets record the same particulars for a week and hence one card is required for a week.
Job cards are used to keep a close watch on the time spent by a worker on each job so that the labourcost of
a job may be conveniently ascertained.

Idle Time
There is always a difference between the time booked to different jobs or work orders and the time recorded at
the factory gate. This difference is known as idle time. Idle time is of two types.
(a) Normal Idle Time
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(b) Abnormal Idle Time

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Normal Idle Time: This represents the time, the wastage of which cannot be avoided and, therefore, the
employer must bear the labour cost of this time. But every effort should be made to reduce it to the lowest
possible level. Examples of normal idle time are: time taken in going from the factory gate to the department
in which the worker is to work and back at the end of the day, time taken in picking up the work for the
day, time between the completion of one work and the start of another work, time taken for personal needs
like tea or toilet, time taken for machine maintenance, time taken for waiting for instructions, printouts,
machine set-up time etc.
Normal Idle Time is unavoidable cost as such should be included in cost of production. The cost of normal
idle time can be treated as an item of factory expenses and recovered as an indirect charge or added to
labour cost.
Abnormal Idle Time: It is that time the wastage of which can be avoided if proper precautions are taken.
Example: time wasted due:- to breakdown of machinery on account of inefficiency of the works engineer,
failure of the power supply, shortage of materials, waiting for instructions, waiting for tools and raw
materials, strikes or lock-outs in the factory.
It is a principle of costing that all abnormal expenses and losses should not be included in costs and as such
wages paid for abnormal idle time should not form part of the cost of production. Hence it is debited to
Costing Profit and Loss Account.
Over Time: - It is the work done beyond the normal working period in a day or week. For overtime done,
the workers are given double the wages for the overtime done. The additional amount paid on account of
overtime is known as overtime premium.
Overtime increases the cost of production and should not be encouraged as it has the following
disadvantages.
1. Overtime is paid at higher rate.
2. Overtime is done at late hours when workers have become tired and efficiency will it be as much
as during the normal working hours.
3. Workers will develop the habit of working slowly during normal hours and complete the
work using overtime to earn more wages.
4. Expenses like lighting, cost of supervision, and wear and tear of machines will increase
disproportionate!y.
Overtime should be recorded separately and thoroughly investigated to see that it is incurred only when
genuinely required.
The treatment of overtime depends on the situation. If overtime is incurred for because of the sequence of
jobs, then normal wages is charged to labour cost for the overtime also but if it is a rush job, then the
overtime wages is added to the cost of labour. On the other hand if overtime arises due to any abnormal
reason like breakdown of machinery or power failure, overtime premium is excluded from the cost of
production and is debited to the Costing Profit and Loss Account.

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Illustration 8: Calculate the normal and overtime wages payable to a workman from
the following data:
Days Hours Worked

Monday 8 hrs
Tuesday 10hrs
Wednesday 9 hrs
Thursday 11hrs
Friday 9 hrs
Saturday 4hrs
Total 51 hrs

Normal Working Hours Normal rate .8 hours per day

Normal rate Re.1 per hour
Overtime Rate :up to 9 hours in a day at single rate and over 9 hours in a day at double rate; or up to 48
hours in a week at single rate and over 48 hours at double rate whichever is more beneficial to the workman.

Solution:

Overtime Hours
Days Total Hours Normal Working Hours At Single rate At Double rate

Monday 8 8 - -
Tuesday 10 8 1 1
Wednesday 9 8 1 -
Thursday 11 8 1 2
Friday 9 8 1 -
Saturday 4 4
Total 51 44 4 3

Wages for 44 hours @ Re. 44

Overtime Wages:
At single rate for 4 hours@ Re.1 = Rs.4
At double rate for 3 hours @ Rs.2 = Rs.6 10
Total Wages Rs 54

Or
Normal Wages for 48 hours @ Re.l per hour= 48
Overtime Wages for 3 hours @ Rs.2 per hour= 6
Rs.54
Therefore, whichever method is followed, the amount of the wages payable to the worker is Rs.54

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System of Wage Payment
There is no single method of wage payment which is acceptable both to the employers and the workers.
The system of wages should result into higher production, improved quality of output and a contented
labour force.

There are two principal wage systems: (i) Payment on the basis of time spent in the factory irrespective of
the amount of work done. This method is known as time wage system. (ii) Payment on the basis of the
work done irrespective of the time taken by the worker. This method is called piece rate system.
Other methods called premium plans or bonus and profit sharing schemes are used with either of the two
principal methods of wage payment.
Time Wage System
Under this method of wage payment, the worker is paid at an hourly, daily, weekly or monthly rate. This
payment is made according to the time worked irrespective of the work done.
This method is highly suitable for following types of work:
1. Where highly skilled and apprentices are working.
2. Where quality of goods produced is of extreme importance eg., artistic goods
3. Where the speed of work is beyond the control of the workers.
4. Where close supervision of work is possible.
5. Where output cannot be
measured.

The disadvantages of this method are:

1. Workers are not motivated.
2. Workers will get payment for idle time.
3. Efficient workers will become inefficient in the long run as all of them get same wages.
4. Employer finds it difficult to calculate labour cost per unit as it varies as production
increases and decreases.
5. Strict supervision is necessary to get the work done.
6. Inefficiency results in upsetting the production schedule and increases the cost per unit.
7. It will encourage a tendency among workers to go slow so as to earn overtime wages.
Thus this method does not establish a proportionate relationship between effort and reward and the result
is that it is not helpful in
increasing production and lowering labour cost per unit.
Piece Rate System (payment by result)
Under this system of wage payment, a fixed rate is paid for each unit produced, job completed or an
operation performed. Thus, payment is made according to the quantity of work done no consideration is
given to the time taken by the workers to perform the work.
There are four variants of this system.
a) Straight piece rate system

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b) Taylor's differential piece rate system

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 c) Merrick's multiple piece rate system
d) Gant's task and bonus plan
(a) Straight piece rate system
Payment is made as per the number of units produced at a fixed rate per unit. Another method is piece rate
with guaranteed time rate in which the worker is given time rate wages if his piece rate wages is less than
the time rate.

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Advantages
1. Wages are linked to output so workers are paid according to their merits.
2. Workers are motivated to increase production to earn more wages.
3. Increased production leads to decreased cost per unit of production and hence profit per
unit increases.
4. Idle time is not paid for and is minimized.
5. The employer knows his exact labour cost and hence can make quotations confidently.
6. Workers use their tools and machinery with a greater care so tl1at the production may not be held
up on account of their defective tools and machinery.
7. Less supervision is required because workers get wages for only the units produced.
8. Inefficient workers are motivated to become efficient and earn more wages by producing more.
Disadvantages
1. Fixing of piece work rate is difficult as low piece rate will not induce workers to increase production.
2. Quality of output will suffer because workers will try to produce more quickly to earn more wages.
3. There may not be an effective use of material, because of the efforts of workers to increase the
production. Haste makes waste. Thus there will be more wastage of material.
4. When there is increased production, there may be increased wastage of materials, high cost of
supervision and inspection and high tools cost and hence cost of production might increase.
5. Increased production will not reduce the labour cost per unit because the same rate will be paid for all
units. On the other hand, increased production will reduce the labour cost per unit under the time wage
system.
6. Workers have the fear of losing wages if they are not able to work due to some reason.
7. Workers may work for long hours to earn more wages, and thus, may spoil their health.
8. Workers may work at a very high speed for a few days, earn good wages and then absent
themselves for a few days, upsetting the uniform flow of production.
9. Workers in the habit of producing quality goods will suffer because they will not get any extra
remuneration for good quality.
10. The system will cause discontentment among the slower workers because they are not able to
earn more wages.
This method can be successfully applied when:
1. The work is of a repetitive type.
2. Quantity of output can be measured.
3. Quality of goods can be controlled.
4. It is possible to fix an equitable and acceptable piece rate
5. The system is flexible and rates can be adjusted to changes in price level.
6. Materials, tools and machines are sufficiently available to cope with the possible increase in
production.
7. Time cards are maintained so that workers are punctual and regular so that production may not
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slow down.

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 (b) Taylor's Differential Piece Rate system
This system was introduced by Taylor, the father of scientific management to encourage the
workers to complete the work within or less than the standard time. Taylor advocated two piece
rates, so that if a worker performs the work within or less than the standard time, he is paid a
higher piece rate and if he does not complete the work within the standard time, be is given a
lower piece rate.
Illustration 9 : Calculate the earnings of workers A and B under Straight Piece-rate System and
Taylor's Differential Piece-rate System form the following particulars.
Normal rate per hour = Rs.1.80
Standard time per unit= 20 seconds
Differentials to be applied:
80 % of piece rate below standard
120% of piece rate at or above standard.
Worker A produces 1,300 units per day and worker B produces 1,500 units per day.
SOLUTION
Standard production per 20 seconds = 1 unit
Standard production per minute = 60120= 3 units
Standard production per hour= 3 x 60 = 180 units
Standard production per day of 8 hrs(assumed) = 180 x 8 = 1440 units
Normal rate per hour= Rs.1.80
Normal piece rate= Rs.1.80/ 180 units= 1 paisa
Low piece rate below standard production IP x 80 = 0.8 paise
100
High piece rate at or above standard lP x 120 = 1.2 paise
100
Earning of worker A
Under straight piece rate system
1300 units@ IP= 1300 x 1 = Rs.13
100
Under Taylor's Differential Piece-rate System
1300 units@ 0.8 P =1300 x 0.8 =Rs.10.40
100
Low piece rate bas been applied because worker A's daily production of 1300 units is less than the
standard daily production of 1,440 units.
Earnings of Worker B
Under Straight Piece-rate System
1500 units @ IP= 1500 x 1 = Rs.15
100
Under Taylor's Differential Piece-rate System
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1500 units@ 1.2P = 1500 x 1.2= Rs.18
100

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-High piece-rate has been applied because worker B's daily production of 1500 units is more than the
standard daily production of 1440 units.
c) Merrick's Multiple Piece Rate System
This method seeks to make an improvement in the Taylor's differential piece rate system. Under this
method, three piece rates are applied for workers with different levels of performance. Wages are paid at
ordinary piece rate to those workers whose performance is less than 83% of the standard output, 110% of
the ordinary piece rate is given to workers whose level of performance is between 83% and 100% of the
standard and 120% of the ordinary piece rate is given to workers who produce more than 100% of the
standard output.
This method is not as harsh as Taylor's piece rate because penalty for slow workers is relatively lower.

Premium and Bonus Plan

The object of a premium plan is to increase the production by giving an inducement to the workers in the
form of higher wages for less time worked.

Under a premium plan, a standard time is fixed for the completion of a specific job or operation at an hourly
rate plus wages for a certain fraction of the time saved by way of a bonus. The plan is also known as
incentive plan because a worker has the incentive to earn more wages by completing the work in less time.

This system of wage payment is in between the time wage system and piece work system. In time wage
system, worker does not get any reward for the time saved and in piece work system, the worker gets full
payment for time saved whereas in a premium plan both the worker and the employer share the labour cost
of the time saved.
The following are some of the important premium plans.
(i) Halsey Premium Plan: Under th.is method, the worker is given wages for the actual time taken
and a bonus equal to half of wages for time saved. The standard time for doing each job or
operation is fixed. In practice the bonus may vary from 33 % to
66 % of the wages of the time saved.
Thus if S is the standard time, T the time taken, R the labour rate per hour, and % the percentage
of the wages of time saved to be given as bonus, total earnings of the worker will be:
T X R + % (S-T) R
Uoder Halsey-Weir plan, the premium is set at 30% of the time saved.

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 Illustration 11:
Rate per hour = Rs.1.50 per hour
Time allowed for job = 20 hours
Time taken = 15 hours
Calculate the total earnings of the worker under the Halsey Plan. Also find out effective rate of
earnings.
SOLUTION:
Standard time (S) = 20 hours
Time taken (T) = 15 hours
Rate per hour (R)= Rs.1.50 per hour
Total Earnings= T x R + 50% (S-T) x R
= 15 X Rs. 1.50 + 50 (20-15) x Rs.1.50
100
=Rs.26.25
Total wages for 15 hours = Rs.26.25 Therefore,
effective rate of earning per hour
= Total Wages = Rs.26.25 = Rs.1.75
Actual Time Taken
(The percentage of bonus is taken as 50% when not given)

The advantages of the Halsey Premium Plan are:

It is simple to understand and relatively simple to calculate.
1. It guarantees time wages to workers.
2. The wages of time saved are shared by both employers and workers, so it is helpful in reducing
labour cost per unit.
3. It motivates efficient workers to work more as there is increasing incentive to efficient workers.
4. Fixed overhead cost per unit is reduced with increase in production.
5. The employer is able to reduce cost of production by having reduction in labour cost and fixed
overhead cost per unit. So, he is induced to provide the best possible equipment and working
conditions.
Disadvantages
1. Quality of work suffers because workers are in a hurry to save more and more time to get more
and more bonus.
2. Workers criticize this method on the ground that the employer gets a share of wages of the time
saved.

(ii) Rowan Plan: The difference between Halsey plan and Rowan Plan is the calculation of the
bonus. Under this method also the workers are guaranteed the time wages but the bonus is that
proportion of the wages of the time taken which the time saved bears to the standard time
allowed.
Total Earnings= T x R + S-T x T x R
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s

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Illustration 12:

A worker completes a job in a certain number of hours. The standard time allowed for the job is 10 hours,
and the hourly rate of wages is Rs.1. The worker earns a 50% rate of bonus of Rs. 2 under Halsey Plan.
Ascertain his total wages under the Rowan Premium Plan.

Solution: The worker earns Rs.2 as bonus at 50%; so total bonus at 100% should be Rs.4. The hourly rate
of wages being Re. I, the time saved should be 4 hours.
Standard time allowed 10 hours
Less: Time Saved
Time Taken
4 hours 6 hours

Earnings under the Rowan Premium Plan

Earnings =T x R + S-T x T x R
s
Where, T = 6 hours
S = 10 hours
R = Re.1 per hour Earnings
= 6 x 1 + 10-6 x 6 x 1
10
= 6 + Rs.2.40 = Rs.8.40

Advantages
1. It guarantees time wages to workers
2. The quality of work does not suffer as they are not induced to rush through production
as bonus increases at a decreasing rate at higher levels of efficiency.
3. Labour cost per unit is reduced because wages of time saved are shared by employer and
employee.
4. Fixed overhead cost is reduced with increase in production.
Disadvantages
1. The Rowan plan is criticized by workers on the ground that they do not get the full benefit of
the time saved by them as they are paid bonus for a po11ion of the time saved.
2. The Rowan plan suffers from another drawback that two workers, one very efficient and the other
not so efficient, may get the same bonus.

Overheads: -
Cost related to a cost center or cost unit may be divided into two ie. Direct and Indirect cost. The Indirect
cost is the overhead cost and is the total of indirect material cost, indirect labour cost, indirect expenses.
CIMA defines indirect cost as "expenditure on labour, materials or services which cannot be
economically identified with a specific salable cost per unit". Indirect costs are thosecosts which are
incurred for the benefit of a number of cost centers or cost units. So any expenditure over
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and above prime cost is known as overhead. It is also called 'burden', 'supplementary costs', 'on costs',
'indirect expenses'.

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Classification of Overheads
Overheads can be classified on the following basis:
i) Function-wise classification: Overheads can be divided into the following categories on
functional basis.
(a) Manufacturing or production overheads eg:- indirect materials like lubricants, cotton
wastes, indirect labour like salaries and wages of supervisors, inspectors, storekeepers,
indirect expenses like rent, rates and insurance of factory, power, lighting of factory,
welfare expenses like canteen, medical etc.
(b) Administration overheads eg:- indirect materials like office stationery and printing,
indirect labour salaries of office clerks, secretaries, accountants, indirect expenses rent,
rates and insurance of office, lighting heating and cleaning of office, etc.
(c) Selling and Distribution overheads eg:- indirect materials like catalogues, printing,
stationery, price list, indirect salary of salesmen, agents, travellers, sales managers, indirect
expenses like rent, rates and insurance of showroom, finished goods, godown etc.,
advertising expenses, after sales service, discounts, bad debts etc.
ii) Behavior-wise classification: Overheads can be classified into the following categories as per
behavior pattern.
(a) Fixed overheads like managerial remuneration, rent of building, insurance of building,
plant etc.
(b) Variable overheads like direct material and direct labour.
(c) Semi-variable overheads like depreciation, telephone charges,
repair and maintenance of buildings, machines and equipment etc.
iii) Element-wise classification: Overheads can be classified into the following categories as per
element.
(a) Indirect materials
(b) Indirect labour
(c) Indirect expenses
Allocation and Apportionment of Overhead to Cost Centres (Depart-mentalisation of Overhead)
When all the items are collected properly under suitable account headings, the next step is
allocation and apportionment of such expenses to cost centres. This is also known as departmentalization
or primary distribution of overhead.
A factory is administratively divided into different departments like Manufacturing or Producing
department, Service department, partly producing departments.
Allocation of Overhead Expenses
Allocation is the process of identification of overheads with cost centres. An expense which is directly
identifiable with a specific cost centre is allocated to that centre. Thus it is allotment of a whole item of cost
to a cost centre or cost unit. For example the total overtime wages of workers of a department should be
charged to that department. The electricity charges of a department if separate meters are there should
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be charged to that particular department only.

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Apportionment of Overhead Expenses
Cost apportionment is the allotment of proportions of cost to cost centres or cost units. If a cost is incmTed
for two or more divisions or departments then it is to be apportioned to the different departments on the
basis of benefit received by them. Common items of overheads are rent and rates, depreciation, repairs and
maintenance, lighting, works manager's salary etc.
Basis of Apportionment
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 selected should be correlated to the expenses and the expense should be measurable
by the basis. This process of distribution of common expenses over the departments on some equitable
basis is known as 'Primary Distribution'.
The following are the main bases of overhead apportionment utilized in manufacturing concerns:
Direct Allocation. Under direct allocation, overheads are directly allocated to the department for which
it is incmTed. Example overtime premium of workers engaged in a particular department, power, repairs
of a particular department etc.
(i) Direct Labour/Machine Hours. Under this basis, 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.
(ii) Value of materials passing through cost centres. This basis is adopted for expenses
associated with material such as material handling expenses.
(iii) Direct wages. Expenses which are booked with the amounts of wages eg:- worker's
insurance, their contribution to provident fund, worker's compensation etc. are distributed
amongst the departments in the ratio of wages.
Illustration 13: The Modern Company is divided into four departments: A, B and C are producing departments,
and D is a service departments. The actual costs for a period are as follows:

Rent Rs.1000

Supervision Rs.1500
Depreciation of Plant Rs.450
Light Rs.120

Repairs to Plant Rs.600

Fire Insurance in respect of Stock Rs.500

Power Rs.900
Employers' liability for insurance Rs.150
The following information is available in respect of the four departments;
Dept.A Dept.B Dept.C Dept.D
Area (sq.mtrs) 1,500 1,100 900 500
Number of Employees 20 15 10 5
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 Total Wages (Rs.) 6,000 4,000 3,000 2,000
Value of Plant (Rs.) 24,000 18,000 12,000 6,000
Value of stock (Rs.) 15,000 9,000 6,000
H.P. of Plant 24 18 12 6

Apportion the costs to the various departments on the most equitable basis.

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SOLUTION
OVERHEADS DISTRIBUTION SUMMARY
Total Amount Product Departments Service
Basis of A B C Department
Items
apportionment Rs. D
Rs. Rs. Rs.
Rs.
Rent Floor Area 1,000 375 275 225 125
Supervision No. of Employees 1,500 600 450 300 150
Depreciation Plant Value 450 180 135 90 45
Light Floor area 120 45 33 27 15
Repairs to Plant Plant Value 600 240 180 120 60
Fire Insurance Stock Value 500 250 150 100 -
Power HP. Of Plant 900 360 270 180 90
Employer's Liability No. of Employees 150 60 45 30 15
Total 5,220 2,110 1,538 1,07 500
2
Re-apportionment of Service Department Costs to Production Departments
Service department costs are to be reapportioned to the production departments or the cost centres
where production is going on. This process of re-apportionment of overhead expenses is known as 'Service
Distribution'. The following is a list of the bases of apportionment which may be accepted for the service
departments noted against

Service Department Cost Basis of Apportionment

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1. Maintenance Department -Hours worked for each department
2. Payroll or time-keeping department -Total labour or Machine hours or number of
employees in each department
3. Store keeping department - no. of requisitions or value of materials
of each department.
4. Employment or Personnel epartment.
- Rate of labour turnover or number of
employees in each department.
5. Purchase Department
6. Welfare, ambulance, canteen service, -no. of purchase orders or value of materials
recreation room expenses. -No. of employees in each department.
7. Building service department -Relative are in each department
8. Internal transport service -Weight, value graded product handled, weight and
or overhead crane service distance travelled.
9. Transport Department -crane hours, truck hours, truck mileage, truck
tonnage, truck tonne-hours, tonnage handled,
10. Power House (Electric power cost) number of packages.
-wattage, horse power, horse power machine
hours, number of electric points etc.

26
The following are the various methods of re-distribution of service department costs to production
departments.
1. Direct re-distribution method
2. Step distribution method
3. Reciprocal Services method
a. Simultaneous Equation Method
b. Repeated Distribution Method
c. Trial and Error Method
Direct re-distribution method
Under this method, the costs of service departments are directly apportioned to production departments
without taking into consideration any service from one service department to another service
department. Thus, proper apportionment cannot be done on the assumption that service departments
do not serve each other and as a result the production departments may either be overcharged or
undercharged. The share of each service department cannot be ascertained accurately for control
purposes. Budget for each department cannot be prepared thoroughly. Therefore, Department
Overhead rates cannot be ascertained correctly.
lliustration 14:In an Engineering factory, the following paiticulars have been collected for the three
months' period ended on 31st March, 2007. You are required to prepare Production Overheads
Distribution Summary showing clearly the basis of app01tionment where necessary.

Production Departments Service Departments

A B C D E

Direct Wages Rs. 2000 3000 4000 1000 2000

Direct Material Rs. 1000 2000 2000 1500 1500

Staff Nos. 100 150 150 50 50

Electricity Kwh. 4000 3000 2000 1000 1000

Light Points No. 10 16 4 6 4

Asset Value Rs. 60,000 40,000 30,000 10,000 10000

Area Occupied 150 250 50 50 50

Sq.m.

The expenses for the period were:

Motive power Rs.550; Lighting Power Rs.100; Stores Overheads Rs.400; Amenities to Staff Rs.1500;
Depreciation Rs.15,000; Repairs and Maintenance Rs.3,000; General Overheads Rs.6000; and Rent
and Taxes Rs. 275.
27
Apportion the expenses of service department E in proportion of 3:3:4 and those of service department
D in the ratio of 3:1:1 to departments A, B and C respectively.

28
SOLUTION
PRODUCTION OVERHADS DISTRIBUTION SUMMARY
1
For the quarter ending 3r' March, 2007

Production Departments Service Total

Departments
Rs.
A B C D E

Rs. Rs. Rs. Rs. Rs.

Direct Wages 1000 2000 3000

Direct Materials 1500 1500 3000

Motive Power@ Sp.per Kwh 200 150 100 50 50 550

Lighting Power @ Rs.2.50per Point 25 40 10 15 10 JOO

Stores Overhead @ 5% of Direct Material 50 100 100 75 75 400

Amenities to staff @ Rs.3 per employee 300 450 450 150 150 1500

Depreciation @ 10% of the value of asset. 6000 4000 3000 1000 1000 15000

Repairs and maintenance@ 2% of value 1200 800 600 200 200 3000

General Overheads @ 50% of Direct 1000 1500 2000 500 1000 6000
Wages
75 125 25 25 25 275
Rent and Taxes @Re.0.50 per sq.meter

Total 8,850 7,165 6,285 4,515 6,010 32,825

Dept. E ( 3: 3 : 4) 1,803 1,803 2,404 (6,010)

Dept. D (3 : 1 : 1) 2,709 903 903 (4,515)

Total 13,362 9,871 9,592 32,825

Step Distribution Method

Under this method, the cost of most serviceable department is first apportioned to other service departments
and production departments. The next service department is taken up and its cost is apportioned and this
process goes on till the cost of the last service department is apportioned. Thus, the cost of last service
department is apportioned only to production departments.

Illustration 15: A manufacturing company has two Production Departments, Pl and P2 and three Service
Departments, Time-keeping, Stores and Maintenance. The Departmental Summary showed the following
expenses for July, 2007 .
29
Production Departments Service Departments (in

order of their importance)

Pl P2 Sl S2 S3

(Time-keeping) (Stores) (Maintenance)

Rs. Rs. Rs. Rs. Rs.

16,000 10,000 4,000 5,000 3,000

The other information relating to departments were:

Service Departments Production Departments

Sl S2 S3(Main- Pl P2
(Time (Stores) tenance)
-
keeping)
No. of Employees - 20 10 40 30

No. of Stores requisitions - - 6 24 20

Machine Hours - - - 2400 1600

SOLUTION:

As per Primary
Department Distribution
System
S1 (Time-keeping) 4000 (-) 4000

S2 Stores 5000 800 (-) 5800

S3 Maintenance 3000 400 696 (-) 4096

Pl 16000 1600 2784 2458 22,842

30
P2 10000 1200 2320 1638 15,158

38,000 38,000

31
Note: basis of apportionment

(a) Time-keeping - No. of employees (ie. 2:1:4:3)

(b) Stores - No. of stores requisitions ( ie. 3:12:10)
(c) Maintenance- Machine Hours (ie. 3:2)
The most important limitation of this method is that the cost of one service centre to other service cost
centres is ignored and thus the cost of individual cost centres are not truly reflected.

Reciprocal Services Method

In order to avoid the limitation of Step Method, this method is adopted. This method recognizes the fact
that if a given department receives service from another department, the department receiving such service
should be charged. If two deprutments provide service to each other, each department should be charged
for the cost of services rendered by the other. There are three methods available for dealing with inter-
service departmental transfer:
a. Simultaneous Equation Method
b. Repeated Distribution Method
c. Trial and Error Method

(a) Simultaneous Equation method

Under this method, the true cost of the service departments are ascertained first with the help of
simultaneous equation ; these ru·e then redistributed to production departments on the basis of given
percentage. The following illustration may be taken to discuss the application of this method.

Illustration 16:
A company has three production departments and two service departments, and for a period the
departmental distribution summary has the following totals.

Production Departments
Pl- Rs. 800; P2- Rs. 700; P3- Rs.500 2000
Service Departments:
S1 - Rs. 234; S2- Rs.300 534

Rs. 2534
The expenses of the service departments are charged out on a percentage basis as follows

Pl P2 P3 SI S2

Service Department SI 20% 40% 30% 10%

32
Service Department S2 40% 20% 20% 20%

33
Prepare a statement showing the apportionment of two service departments expenses to production departments
by Simultaneous Equation Method.

SOLUTION:
By Simultaneous Equation Method
Let x = total overheads of department S1 y
= total overheads of department S2
Then,
x=Rs.234+. 2y
y=Rs.300+. lx
Rearranging and multiplying to eliminate decimals;
10x-2y=Rs.2,340 (1)
-x+lOy=Rs.3,000 (2)
Multiplying equation (1) by 5 and add result to (2), we get 49x=Rs.14,700
x=Rs.300
Substituting this value in equation (1), we get
y=Rs.330
All that now remains to be done is to take these values x=Rs.300 and y=Rs.330 and apportion them on
the basis of the agreed percentage to the three production departments; thus:

Total Pl P2 P3

Per distribution summary 2,000 800 700 500

Service department S1 270 60 120 90

Service department S2 264 132 66 66

2,534 992 886 656

This method is recommended in more than two service departments if the data is processed with computers
and in two service departments only where the data is processed manually.

(b) Repeated Distribution Method

Under this method, the totals are shown in the departmental distribution summary, are put out in a line,
and then the service department totals are exhausted in turn repeatedly according to the agreed
percentages until the figures become too small to matter.
By solving illustration 16 by Repeated Distribution Method, we get the Secondary Distribution
34
Summary which is given as follows:

35
SECONDARY DISTRIBUTION SUMMARY

Pl P2 P3 Sl S2
Rs. Rs. Rs. Rs. Rs.

As per summary 800 700 500 234 300

Service Department 51 47 94 70 (234) 23

Service Department 52 129 65 65 64 (323)

Service Department 51 14 25 19 (64) 6

Service Department 52 2 2 2 (6)

992 886 656 - -

(c) Trial and Error Method

Under this method, the cost of one service department is apportioned to another centre. The cost
of another centre plus the share received from the first centre is again apportioned to the first cost
centre and this process is repeated till the balancing figure becomes negligible.
By solving illustration 16 by Trial and Error Method, we get the following:

Service Departments

SI S2

Rs. Rs.
Original apportionment 234 300
(23) 23 (10% of 234)
65(20% of 323) (323)
(65) 7 (10% of 65)
1(20% of 7) (7)
Total of positive figures
300 330
ABSORPTION OF OVERHEAD
Absorption means the distribution of the overhead expenses allotted to a particular department
over the units produced in that department. Overhead absorption is accomplished by overhead
rates.
Methods of Absorption of Manufacturing Overhead
The following are the main methods of absorption of manufacturing or factory overheads.
(a) Direct Material Cost Method. Under this method percentage of factory expenses to value
of direct materials consumed in production is calculated to absorb manufacturing overheads.

The formula is Overhead Rate= Production Overhead Expenses (Budgeted)

36
Anticipated Direct Material Cost

37
 If in a factory the anticipated cost of direct material is Rs. 4,00,000 and the over head budgeted
expenses are Rs. 1,00,000, then the overhead rate will be 25% ie.( Rs.1,00,000-;- Rs.4,00,000) of the
materials used. It is assumed that relationship between materials and factory expenses will not
change. This method is simple and can be adopted under the following circumstances:
(i) Where the proportion of overheads to the total cost is significant.
(ii) Where the prices of materials are stable.
(iii) Where the output is uniform ie. Only one kind of article is produced.
(b) Direct Labour Cost (or Direct Wages) Method. This is a simple and easy method and
widely used in most of the concerns. The overhead rate is calculated as under:
Overhead Rate= Production Overhead Expenses
Direct Labour Cost
If from past expeiience, the percentage of factory expenses to direct wages is 50%, then the factory
expenses in the next year is taken as 50% of the direct wages.
This method is suitable under the following situations:

(i) Where direct Jabour constitutes a major proportion of the total cost of production.
(ii) Where production is uniform.
(iii) Where labour employed and types of work performed are uniform.
(iv) Where the ratio of skilled and unskilled labour is constant.
(v) Where there are no variations in the rates of pay ie., the rates of pay and the methods are the
same for the majority of the workers in the concern.
In some concerns a separate rate is calculated for the fringe benefits and applied on the basis of direct
labour cost.

(c) Prime Cost Method. Under this method the recovery rate is calculated dividing the budgeted
overhead expenses by the aggregate of direct materials and direct labour cost of all the products of
a cost centre. The formula is
Overhead Recovery Rate= Production Budgeted Overhead Expenses
Anticipated Direct Materials and Direct Labour Cost

Suppose if the budgeted overheads are Rs.50,000 and the estimated values of direct materials and
direct labour are Rs.30,000 and Rs.20,000, then overhead recovery rate will be 100%
1.e., 50000 X 100.
30000+20000

(d) Direct Labour (or Production) Hour Method. This rate is obtained by dividing the overhead
expenses by the aggregate of the productive hours of direct workers. The formula is

38
 Overhead rate = Production Overhead Expenses
Direct Labour Hours

If in a particular period the overhead expenses are Rs.50,000 and direct labour hours are
1,00,000, then overhead labour rate will be Re.0.50 (i.e., Rs.50,000 -:-1,00,000).
This rate is suitable where:
(i) The production is done using more of labour and less technology is used.
(ii) It is desired to taken into consideration the time factor.
(iii) The rate may not be affected by the method of wage payment or the grade or the rate
of workers.

Illustration17: From the following particulars find out "Direct Labour Rate".

(a) Total number of labourers working in the department. 400

(b) Total working days in a year 300
(c) Number of working hours per day 8
(d) Total departmental overheads per year Rs.1,82,400
(e) Normal idle time allowed. 5%

SOLUTION:
CALCULATION OF DIRECT LABOUR RATE FOR DEPARTMENTAL OVERHEADS

Total working days in a year 300

Number of working hours per day 8

Total working hours available per worker per year 2,400 (300 X 8)
Less: normal idle time allowed (5% of 2,400hrs) 120

Effective working hours per worker per year (2400-120) 2280

Number of workers working in the department 400
Total effective working hours in the department(2280 x 400) 9,12,000
Total departmental overheads per year Rs,1,82,400

Direct Labour Rate for absorption of overheads per hour Re.0.20

(e) Machine Hour Rate. Machine hour rate is the cost of running a machine per hour. It is one of
the methods of absorbing factory expenses to production. There is a basic similarity betweenthe
machine hour and the direct labour hour rate methods, in so far as both are based on the time

39
factor. The choice of one or the other method depends on the actual circumstances of the

40
individual case. In respect of departments or operations, in which

41
machines predominate and the operators perform a relatively a passive part, the machine hour rate
is more appropriate. This is generally the case for operations or processes performed by costly
machines which are automatic or semi-automatic and where operators are needed merely for
feeding and tending them rather than for regulating the quality or quantity of their output. In such
cases, the machine hour rate method alone can be depended on to correctly apportion the
manufacturing overhead expenses to different items of production. What is needed for computing
the machine hour rate is to divide overhead expenses for a specific machine or group of machines
for a pe1iod by the operating hours of the machine or the group of machines for the period. It is
calculated as follows:

Machine hour rate = Amount of overheads

Machine hours during a given period

The following steps are required to be taken for the calculation of machine hour rate:

1) Each machine or group of machine should be treated as a cost centre.

2) The estimated overhead expenses for the period should be determined for each machine or
group of machines.
3) Overheads relating to a machine are divided into two parts i.e., fixed or standing charges and
variable or machine expenses.
4) Standing charges are estimated for a period for every machine and the amount so estimated is
divided by the total number of normal working hours of the machine during that period in order
to calculate an hourly rate for fixed charges. For machine expenses, an hourly rate is calculated
for each item of expenses separately by dividing the expenses by the normal working hours.
5) Total of standing charges and machines expenses rates will give the ordinary machine hour
rate.
Some of the bases which may be adopted for apportioning the different expenses for the purpose
of calculation of machine hour rate are given below.
Some of the expenses and the basis of apportionment are given below.

1. Rent and Rates

Floor area occupied by each machine including the surrounding space.
2. Heating and Lighting - The number of points used plus cost of special lighting or heating
for any individual machine, alternatively according to floor area occupied by each machine.
3. Supervision - estimated time devoted by the supervisory staff to each machine.
4. Lubricating Oil and Consumable Stores - On the basis of past experience.
5. Insurance - Insurable value of each machine
6. Miscellaneous Expenses - Equitable basis depending upon facts.
42
 Machine Expenses
1. Depreciation - cost of machine including cost of stand-by equipment such as spare
motors, switchgears etc., less residual value spread over its working life.
2. Power - Actual consumption as shown by meter readings or estimated consumption
ascertained from past experience.
3. Repairs - Cost of repairs spread over its working life.
Illustration 18: A machine is purchased for cash at Rs.9,200. Its working life is estimated to be 18,000
hours after which its scrap value is estimated at Rs.200. it is assumed from past experience that:

(i) The machine will work for 1,800 hours annually.

(ii) The repair charges will be Rs.1,800 dming the whole period of life of the machine.
(iii) The power consumption will be 5 units per hour at 6 paisa per unit.
(iv) Other annual standing charges are estimated to be: Rs.

(a) Rent of department (machine occupies 115th of total space) 780

(b) Light (12 points in the department-2 points engaged in the machine) 288
(c) Foreman's salary (114th of his time is occupied in the machine) 6000
(d) Insurance premium (fire) for machinery 36
(e) Cotton waste 60

Find out the machine hour rate on the basis of above data for allocation of the works expenses to all jobs
for which the machine is used.
SOLUTION:
CALCULATION OF MACHINE HOUR RATE
Per Annum Per Hour
Rs. Rs.
Standing Charges:
156
Rent[ Rs.780 ..;.Rs.5]
48
Light [ 2/12 x Rs.288]
36
Insurance Charges Cotton
60
waste
1,500
Total Standing Charges
1,800
Hourly rate of standing charges Rs.1800
1800
Machine Expenses:
1.00
Depreciation (Rs.9,200-Rs.200)-:-18,000 = Rs.9000 .;-18,000
0.50
Repairs and Maintenance (Rs.1,080.;-18,000)
0.06
Power (0.06 x 5)
0.30
43
Machine Hour Rate 1.86

44
(f) Rate Per Unit of Production. This method is simple, direct and easy. It is suitable for mining
and other extractive industries, foundries and brick laying industries, where the output is measured
in convenient physical units like number, weight, volume etc. the rate is calculated as under:

Overhead Rate= Overhead expenses (budgeted)

Budgeted production

For example, if the overhead expenses (budgeted) are Rs. 30,000 and the budgeted production is
10,000 tonnes, then overhead rate according to this method will be Rs. 3 per tonne.

The main limitation of this method is that it is restricted to those concerns which produce only one
item of product or a few sizes, qualities or grades of the same product. If more than one itemare
produced, then it is essential to express dissimilar units against a common denominator on
weightage or point basis.

(g) Sale Price Method: Under this method, budgeted overhead expenses are divided by the sale price
of units of production in order to calculate the overhead recovery rate. The formula is sale price of
units of production in order to calculate the overhead recovery rate, the formula
IS
Overhead Recovery Rate= Budgeted overhead expenses
Sale value of units of production

The method is more suitable for apportioning of administration, selling and distribution, research,
development and design costs of products. It can also be used with advantage for the appropriation
of joint products costs.

45
 Module IV
Methods of Costing
1. UNIT COSTING

It is an important method of costing. It is also known as output costing or single costing. It is used to ascertain the cost
of producing a unit of output.. This method is called 'unit' costing since every unit of production is identical in all
respects and the cost unit is a standard product.

According to J.R Batliboi, "Single or output cost system is used m business where a standard product
is turned out and it is desired to find out the cost of a basic unit of production."

Features:

1. It is used where output can be measured in convenient physical unit

2. It is followed in concern s engaged in the production of a single product
3. It is followed in industries where manufacturing process is continuous
4. It is followed where all units of production are identical

Cost sheet:

Cost sheet is a device used to determine and present the cost under unit costing. It is a statement of costs incurred at
each level of manufacturing a product or service. In a Cost sheet all the elements of cost is taken into consideration.
It includes Prime cost, Factory/manufacturing cost, cost of production, cost of sale Profit/loss etc.

Items excluded from Cost Sheet:

1. Pure financial expenses like interest on capital, interest on loan, discount on debentures, loss on sale of
fixed asset provision for bad debts and doubtful debts, writing off goodwill, copyright, preliminary expenses
etc.
2. Pure financial incomes like interest received, profit on sale of investment, dividend received, rent received,
commission received, discount received etc.
In addition to the above, no appropriation items will include in cost sheet

Form of a Cost Sheet: Cost sheet for the period ending --------------

Total Per Unit

Direct material Xxx Xx
Direct wages Xxx Xx
Direct Expenses Xxx Xx
Prime Cost Xxx Xx
Add Factory OH xx Xx
Factory Cost XXX Xx
Add Administration OH xx Xx
Cost of Production Add
XXX Xx
selling and distribution OH
xx Xx

46
 XXX Xx
Total Cost /Cost of sale ------------ --------

47
 Treatment of Stock:

While preparing a cost sheet we have to consider the opening and closing stocks of the following three
items

1. Stock of Raw materials

2. Stock of finished goods
3. Stock of work in progress

Stock of Raw materials: In order to get the cost of material consumed, opening stock of material
is added to the cost of raw materials purchased and closing stock of raw materials is deducted from it.
Opening stock of raw materials
Add; Purchase of RM

Less; closing stock of RM

Cost of materials consumed
Stock of Work - in - progress: The Cost of work in progress are adjusted at the work cost stage

Prime cost
Add works OH

Add opening stock of WIP

Less closing stock of WIP

Works cost

Stock of finished goods: It is adjusted immediately after ascertaining the cost of production.

Cost of production
Add opening stock of FG
Less closing stock of FG
We get, Cost of Goods sold

Illustration 1
From the following particulars prepare a cost sheet for the month of March 2008.
Rs.
Stock in hand 1st March Raw materials 26,000

Finished goods 18,300

48
Work in Progress 9,200
Stock on hand - 31st March
Raw materials 27,200
Finished goods 16,700
Work in Progress 10,100
Purchase of Raw materials 23,000
Carriage on purchases 1,500
Direct wages 18,500
Indirect wages 1,000
Sale of finished goods 76,000
Chargeable expenses 2,200
Factory overheads 9,500
Administration OH 4,000
Selling and Distribution OH 5,200
Solution
Cost sheet for the month of March 2008
Rs. Rs.
Opening stock of materials 26,000
Add Purchases 23,000
Add car1iages on Purchases 1,500
50,500
Less closing stock of materials 27,200
Cost of materials consumed

, ,Direct wages 23,300

Chargeable expenses 18,500
PRIME COST 2,200
Factory OH 44,000
Indirect wages 9,500
Add opening stock of WIP 1,000
9,200
Less closing stock of WIP
63,700
Factory Cost 10,100
Add Administration OH
Cost of Production 53,600
Add opening stock of finished goods 4,000
57,600
18,300
Less closing stock of finished goods
75,900
Cost of goods sold Add
16,700
selling and distribution OH

49
 Total cost 59,200
Profit 5,200

Sales 64,400
11,600

76,000

50
Tenders or Quotations: A tender or quotation is an offer made by a person to supply certain goodsat
a specified price. It is an estimated price which is determined in advance of production. A reasonable
margin of profit is added to the estimated cost to get the tender price. A tender has to be prepared very
carefully as the receipts of orders depend upon the acceptance of quotations or tenders supplied by the
manufacturers. It requires information regarding Prime cost, works cost, administration and selling
overhead cost and profit of the preceding period.
Computation of Tender price
I. Calculation of Tender price on the basis of Percentages of Overheads
In this case a cost sheet is prepared for the past period with the total amount of different
elements of cost. Here Indirect or overhead costs are charged on a percentage basis. The
percentage is calculated on the basis of the past year's cost sheet. These are calculated as
follows:
a. Factory OH is charged as a percentage if direct wages.
=Factory OH x 100
Direct wages
b. Administration OH is charged as a percentage of Factory cost
= Administration OH x 100
Factory Cost
c. Selling and Distribution OH is charged as percentage of Factory cost
= Selling and Distribution x 100
Factory cost
Profit may be calculated either as a percentage of cost or selling price. If the given percentage
of profit is on selling price, the percentage of profit on selling price should be converted into percentage
of profit on cost.
Illustration 1. Following particulars relates to the manufacture of machines by ABC Co Ltd for the
year ending 31st March 2011
Materials used 2,50,000
Direct wages 1,90,000
Factory OH 38,000
Establishment charges 35900
Prepare a cost sheet showing the cost of Production of the Machines. What price the company should
quote to manufacture a machine which, it is estimated will require an expenditure of Rs. 12,000 in
material and Rs. 10,000 in wages so that it will yield a profit of 20% on selling price.
Solution:
Cost sheet for the year ending 31st March 2011
Rs.
Materials used 2,50,000
Direct wages 1,90,000
Prime cost 4,40,000
Factory Over head 38,000

51
 Factory Cost 4,78,000
Establishment charges 35,900
Cost of Production 5,13,900

52
a. Percentage of factory overhead on direct wages = 38,000 x 100
1,90,000
=20%
b. Percentages of establishment charges on factory OH
= 35900 xlOO
4,78,000
=7.5%
Estimated Cost Sheet
Rs.
Materials 12,000
Direct wages 10,000
Prime Cost 22,000
Factory OH (20% on direct wages) 2,000
Factory Cost 24,000
Establishment charges (7.5% on factory cost) 1,800
Cost of Production 25,800
Profit (20 % on selling price or 25% on cost) 6,450
Selling price
32,250

II. Computation of Tender price on the basis of Previous year's per unit cost:
Under this situation , previous periods cost and output figures are available. Tender price
is fixed by multiplying the quantity with previous periods per unit cost and adding the
required percentage of profit. There are three different situations under this method.
a. When there is no change in past cost and past percentage of profit. In this case
a detailed probable cost sheet is prepared by multiplying previous period's cost of each
unit with the quantity of tender. Profit is added at the same percentage of profits of
the past period.
b. When there is change in past cost, but no change in past percentage of profit: -
Here the cost of the tender is calculated by making necessary adjustments in the
elements of cost. Same percentage of cost is added as profit to get tender price.
c. When there is change in past cost and past percentage of profit: - Here the total
cost tender is calculated by making necessary adjustments in the cost and the tender
price is then calculated by adding the required percentage of profit.
53
Illustration II. The following is the Trading and Profit and loss account of XYZ Co. for the year
ending 31st March 2011 in which half year 1000 refrigerators manufactured and sold.

Trading and Profit & Loss Account

Rs. Rs.
To materials 80,000 By sales 4,00,000
To wages 1,20,000
To Manufacturing exp 50 000
To GIP CID 1,50,000
4,00,000 4,00,000
To staff salaries By GP/bid
"Selling Exp 60,000 1,50,000
"General Exp 30,000
20,000
" Rent & Taxes
10,000
"NIP
30,000

1,50,000 1,50,000

For the year ending 31st March 2012, it is estimated that:

1. The price of raw materials will increase by 20% on the previous year's level.
2. Rate of wages will rise by 5%
3. The output and sale will be 1,200 Refrigerators
4. Selling exp. Per unit will remain constant.
5. Manufacturing OH will rise in proportion to combined cost of material and wages
6. Other expenses remain unaffected by the rise in output.
You are required to prepare an estimated cost sheet for the year 2012, showing the prices at
which a refrigerator should be sold keeping a net profit of 10% on the selling price.

Solution: Cost sheet for the year ended 31st March 2011

Total Rs(l 000) Per unit cost(Rs.)

Material 80,000 80
Labour 1,20,000 120
Prime cost 2,00,000 200
Manufacturing OH 50,000 50
Factory cost 2,50,000 250

Office OH 90,000 90
3,40,000 340
Cost of Production 30,000 30
Selling Exp. 3,70,000 370
Cost of Sale 30,000 30
54
 Profit 4,00,000 400
Sales ------- --- --

55
Estimated cost sheet for the year ended 31st March 2012

Total (1200)Rs Per unit(Rs)

Material (80+20) 1,15,200 96

Labour (120+5) 1,51,200 126

Prime Cost 2,66,400 222

Manufacturing OH(50x 222/200) 66,600 55.5

Factory Cost 3,33,000 277.5

Office OH (90,000/1,200) 90,000 75
Cost of Production 4,23,000 352.5
Selling exp. 36,000 30

4,59,000 382.5
Cost of Sale
51,000 42.5
Profit (10% of selling price, ie 1/9 of cost)
5,10,000 425
Sales

ill Calculation of Tender price based on fixed and variable costs: Here, costs are classified
according to variability into three types,, fixed, variable and semi variable. Tender price is
calculated on the basis of degree of variability

illustration ill The Cost of manufacturing 5000 units of a commodity comprises Material cost Rs.
40,000, wages Rs. 50,000 Direct expenses Rs. 800, Variable OH Rs. 8000 and fixed OH Rs. 32,000.
For the manufacturing of every 1000 extra units of the commodity, the cost of production increases as
follows:

a. Fixed OH Rs. 400 extra

b. Direct expenses propo1tionately
c. Wages 10% less than proportionately
d. Materials proportionately
e. Variable OH 25% less than proportionately.

Calculate the estimated cost of producing 8,000 units of the commodity.

56
Solution:

Statement of Cost

5000 units 3000 extra 8000 units

(Rs) units(Rs) (Rs)
Materials 40,000 24,000 64,000
Wages 50,000 27,000 77,000
Direct expenses 800 480 1,280
Prime Cost 90,800 51,480 1,42,280
Fixed OH 32,000 1,200 33,200
Variable OH 8,000 3,600 11,600

1,30,800 56,280 1,87080

Notes:

Increase in the Value of Materials = 40,000/5000 x 3000 = Rs. 24,000

"Wages= 50000/5000 x3000-10% = Rs. 27,000

" Direct expenses = 800/5000 x 3000 = Rs. 480

" Fixed Expenses = 400 x3 =Rs. 1200

"Variable expenses = 8000/5000 x 3000 - 25% = Rs. 3,600

JOB COSTING

It means ascertaining costs of an individual job, work order or project separately. According to ICMA
London, "job costing is that form of specific order costing which applies where work is undertaken to
customer's specific requirements and each order is of comparatively of short duration." Under this
method of costing, each job is considered to be a distinct cost unit. As such, each job is separately
identifiable.

In the case of a job, work is usually carried out within the factory or workshop. Sometimes,
a job is accomplished even in the customer's premises. This method of costing is applicable to ship
building, printing, engineering, machine tools, readymade garments, shoes, hats, furniture, musical
instruments, interior decorations etc.
Features:

1. Each job has its own characteristics, depending up on the special order placed by
the customer.
2. Each job is treated as a cost unit.
3. A separate job cost sheet is made out for each job on the basis of distinguishing numbers.
4. A separate work in progress ledger is maintained for each job.
57
5. The duration of the job is normally a short period.
6. Profit or loss is determined for each job independently of others

58
Advantages of Job costing:

1. It helps to distinguish profitable jobs from unprofitable jobs

2. It helps to identify defective work and spoilage with a department or person
3. Selling price of special orders can easily be fixed.
4. It helps to prepare estimates of cost for submitting quotations and tender for similar jobs
5. It helps to control future cost.

Requisites of Job costing system:

1. A sound system of production control

2. An effective time booking system
3. Clearly defined cost centre
4. Appropriate overhead absorption rate, and
5. Proper material issue pricing method.
Procedure for Job order costing system:

The Procedure for job order costing system may be summarized as follows:-

1. Receiving an enquiry from the customer regarding price, quality etc

2. Make an estimation of the price of the job after considering the cost incurred for
the execution of similar job in the previous year
3. Receiving an order, if the customer is satisfied with the quotation price and other terms
of execution.
4. If the job is accepted, a production order is made by the Planning department.
5. The costs are collected and recorded for each job under separate production order Number,
and a Job Cost Sheet is maintained for that purpose.
6. On completion of job, a completion report is sent to costing department.

Illustration I

From the following particulars calculate the cost of Job No.SOS and price for the job to give a profit
of 25% on the selling price.

Material Rs. 6820

Wage details:

Department X 60 hrs @ Rs. 3 per hr

Y 50 hrs @ Rs. 3 per hr

Z 30 hrs@ Rs.5per

The variable Overheads are as follows:

Department X Rs. 5000 for 5000 hrs
59
Y Rs. 4000 for 2000 hrs

Z Rs. 2000 for 500 hrs

60
 The total fixed expenses amounted to Rs. 20,000 for 10,000 working hours.
Calculate the cost of Job No. 505 and price for the job to give a profit of 25% on selling price
Solution:
Job Cost Sheet No. 505
Rs.
Direct Material 6,820
Wages:
Department X 60x3=180
Department Y 50x3=150
Department Z 30x5=150 480

Prime Cost 7,300

Overheads: - Variables
Department X 60 xl = 60
Department Y 50 x2= 100
Department Y 30x 4= 120 280

7,580
Fixed OH 140 x 2 = 280(60+50+30 x 2) 280

Total cost 7,860

Profit 25% on selling price ie 1/3 of cost 7860 x1/3 2,620

Selling price 10,480

Practical problem 1

The following information is extracted from the Job ledger in respect of Job No. 205
Materials Rs. 8,500
Wages : 80 hours @ Rs. 6 per hour
Variable OH incurred for all jobs is Rs. 10,000 for 4,000 labour hours. Find the profit if the job is
billed for Rs. 8,400.
Practical Problem 2
From the following information, ascertain the work cost of Job No. 505

The job was commenced on 10th January 2011 and completed on 1st Feb.2011. Materials used were
Rs. 2,400 and labour charges were Rs. 1,600. Other details were as follows:

1. Indirect labour cost in the factory amounted to Rs. 1,200

61
2. Machine X was used for 50 hours @ Rs. 20 per hour

62
3. Machine Z was used for 40 hours @ Rs. 22 per hour

63
CONTRACT COSTING
Meaning
It is a special form of job costing and it is the most appropriate method to be adopted in such
industries as building and construction work, civil engineering, mechanical fabrication and ship building.
In other words, it is a form of specific order costing which applies where the work is undertaken to
customer's requirements and each order of long duration as compared to job costing. It is also known as
terminal costing.
The official CIMA terminology defines contract costing as " a form of specific order costing
in which costs are attributed to individual contracts."
Basic features:
1. Each contract itself a cost unit.
2. Work is executed at customers site
3. The existence of sub contract
4. Most of the expenses incurred upon the contracts are direct.
5. Cost control is very difficult in contract costing.

Types of contracts
Generally there are three types of contracts:

1. Fixed price contracts: Under these contracts both parties agree to a fixed contract price.
2. Fixed price contract with Escalation clause
3. Cost plus contract: Under this contract no fixed price could be settled for a contract.

Contract Account
A contract account is a nominal account in nature. It is prepared to find out the cost of contract and to know
profit or loss made on the contract. A contractor may undertake a number of contracts at a time. Foreach
contract a separate account is opened. In the contract account all direct cost such as material, labour and
other direct expenses incurred during an accounting period are debited and the indirect expenses are
apportioned on an equitable basis. The differences between the two sides are known as Notional profit or
notional loss.
SPECIAL TERMS IN CONTRACT ACCOUNT
1. Work in Progress: It is the unfinished contract at the end of the accounting period and it
includes amount of work certified and amount of work uncertified. Work in progress is an asset,
shown in the balance sheet by deducting there from any advance received from the contractee.
2. Work certified: The sales value of work completed as certified by the architect is known as
'work certified . In the case of contracts of long duration, the amount payable by the customer to
the contractor is based on the sales value of work done as ce1tified by the architect. At the end of
the financial year, the total sales value of work done and certified by the architect is credited to the
contract account.
64
 3. Work Uncertified: It means work which has been carried out by the contractor but has not been
certified by the architect. Sometimes, work which is complete remains uncertified at theend of
the financial year. The reasons for the same may be
a. Work not sufficient enough to be certified
b. Work has not reached the stipulated stage to qualify for certification It is
always valued at cost and credited to the contract account.

4. Retention money: - Regardless of the amount of work certified, the contractor is paid a
specified percentage of the same and the balance is held or retained by the contractee. This is
because of the fact that the contractee has to safe guard himself against any contingency arising
from the non fulfillment of the terms of the contract by the contractor. The unpaid balance of work
certified or the amount held back or retained by the contractee is known as 'retention money'.

5. Sub contract: Sometimes the contractor enters into contracts with another contractor to give a
portion of work undertaken by him. In such cases the work performed by the subcontractor s forms
a direct charge to the contract concerned. Sub contract cost will be shown on the debit side of the
contract account.

6. Escalation clause: This is clause which is provided in the contract to cover up any increase in the
price of the contract due to increase in the prices of raw material or labour or in the utilization of
any other factors of production. If material and labour utilization exceeds a particular limit, the
customer agrees to bear the additional cost occasioned by excessive utilization. Here, the contractor
has to satisfy the customer that excessive utilization is not the result of decreased efficiency.
SPECIMEN FORM OF CONTRACT ACCOUNT (Unfinished contract)

Contract A/C

To materials Xxx By work in progress:

To Labour Xxx Work certified
To Plant Xxx XXX Xxx
To Overheads Xxx Work uncertified Xxx
To cost of sub contracts Xxx XXX
To Notional Profit c/d(B/F) Xxx By material returned By Xxx
plant Xxx
Xxx XXX Xxx
Less:Depreciation xx
To Profit and Loss NC Xxx By material lying at site Xxx
To Will (B/F) Xxx
Xxx Xxx
-------
By Notional profit B/d --------

65
Treatment of Plant and Machinery:
One of the distinguishing features of a contract is the use of special plant and machinery. The cost of these
is capital expenditure, but yet, the usage of these should be reflected in the form of depreciation. There are
two distinct methods of charging depreciation.
1. At the time of issue of plant to contract the contract account is debited with the full value of the
plant. At the end of the period contract account is credited with the depreciated value. This method
is used when plant and machinery is used at the contract site for a long period.
2. In the second method, contract account is debited with an hourly rate of depreciation for the number
of hours the plant is used on the contract. A cost centre is set up for each machine. An estimate is
made is made of the cost such as maintenance, depreciation, driver's wage etc to be incurred. The
total of this cost is divided by the number of hours that the machine is expected to be used.
Profit on Incomplete Contract:
In the case of a small contract extending over the financial period, profit or loss on the same may be
ascertained by crediting it with the contract price due by the contractee. This procedure cannot be adopted
in the case of contracts extending beyond the accounting period, and taking a long time for completion. If
there is any profit upon the incomplete contract, it cannot be taken as actual profit. The profit upon the
incomplete contract is called notional profit.
For the purpose of determining the amount of profit to be transferred to profit and loss account and
making provision for future contingencies, the following guidelines may be kept in mind.
1. When the work has not reasonably advanced (1/4 or less than ¼) : - No profit shouJd be
taken to the credit of p/L account in the case of contracts which have just commenced and a small
portion of the work is complete.
2. Where the work is complete more than ¼ but less than ½ of contract price: In this case 1/3
of the notional profit as reduced by the percentage of cash received may be credited to profit and
loss account. The usual formula is
Notional profit xl/3 x Cash received
Work certified
The balance of notional profit shall be kept as reserve till the completion
3. If the contract completed is more than 1/2 but less than 90%: Here 2/3 rd of the notional
profit should be taken to profit and loss account.
Notional profit x2/3 x Cash received
Work certified
The balance of notional profit shall be transferred to work in progress as reserve. Ut is to be noted
that in order to find out how much p011ion of contract is completed, work certified should be
compared with contract price.
4. If the contract is nearing completion: Here, estimated profit may be ascertained by deducting
the total cost of contract to date plus estimated additional expenses to complete the contract , from
the contract price. It is calculated by using the following formula

Estimated profit x Cash received

Contract price
66
 The loss on incomplete contract should be fully transferred to profit and loss account.
Example 1
The following was the expenditure on a contract for Rs. 6,00,000
Material 1,20,000
Wages 1,64,000
Plant 20,000
Overheads 8,600
Cash received on account of the contract was Rs. 2,40,000 being 80% of the work certified. The
Value of material in hand was Rs. 10,000. The plant has undergone 20% depreciation.
Solution:
CO TRACT ACCOUNT
Rs. Rs.
To materials 1,20,000 By material in hand 10,000
To Wages 1,64,000 By plant on hand 16,000
To Plant 20,000 By work certified
To overheads 8,600 (2,40,000x 100/80) 3,00,000
To Notional profit 13,400

3,26,000 3,26,000

To P/L account 7,147 By notional profit b/d 13,400

To Balance c/d 6,253

13,400 13,400

13,400 13,400
Example 2
XY Ltd undertook a contract, the following was the expenditure on a contract for Rs. 6,00,000.
Material issued to contract Rs. 1,02,000
Plant issued for contract Rs.30000
Wages Rs.1,62,000
Other expenses Rs. 10,000
67
 Cash received on account of contract up to 31st march 2011 amounted to Rs. 2,56,000 being
80% of work certified. Of the plant and material charged to the contract plant costing Rs. 3000 and
material costing Rs. 4000/ were Jost. On 1st March 2011, Plant which cost Rs. 2,000 was returned to
the store, the cost of work done but not certified was Rs. 3000 and material costing Rs. 2,500 were in
hand on site. Provide 10% depreciation on plant, reserve 1/3 of profit received and prepare contract
account from the above particulars.

68
Solution

CONTRACT ACCOUNT

To materials 1,02,000 By work in progress:

To Plant 30,000 Work certified
256000x100180
To wages 1,62,000 3,20000 3,23,000
To other expenses 10,000 Work uncertified 3000
By P & L Account
Plant lost 3000 7000
Material lost 4000
By plant returned: 2,000 1,800
Less: depreciation 200 2,500
To Notional profit cld (B. F) 52800 By material in hand
By plant at site(30000-3000-
2000) 25000 22500
356800 Less: depr 2500 356800
To PIL Account 28160 -------------
--
52800x213x801100 By notional profit Bid 52 800
24640
- Reserve BF 52 800
52 800
---- -- - --- -

WORK IN PROGRESS ACCOUNT

To contract Ale 323,000 By Contract Ale (reserve) 24640
By Balance cld 2,98,360
3,23,000 3,23,000

Note: It is assumed that the contract has begun on 114110.

Example- 3
Mr. A has undertaken several contract works. He maintains a separate record for each contract. From
the records for the year ending 31-12-98, Prepare contract account for Contract No.SO and find the
amount transferred to profit and loss account.
Direct purchase of material 1,80,000
Material issued from stores 50,000

69
Wages 2,44000
Direct expenses 24,000
Machinery purchased 1,60,000
Establishment charges 54,000

70
The contract price was Rs. 15,00,000. Cash received up to 31-12-2008 was Rs. 6,00,000 which is
80% of work certified. Material at site Rs. 16,000. Depreciation for Machine Rs. 16,000.

Solution:
To materials: By material at site 16,000
Direct purchase 1,80,000 Machinery on hand 1, 44,000
Issued from stores 50,000 (1,60,000- 16000)
Wages 2,44,000 Wark certified 7, 50,000
Direct expenses 24,000
Machinery purchased 1,60,000
Establishment 54,000
Notional profit 1.98.000
9,10,000
-------
------- 9, 10,000
To P/L account 1,05,600 By notional profit bid ---
Wark in progress Ale 92,400
1,98,000
1,98,000

1,98,000

PROCESS COSTING
Process costing is the method of costing applied in the industries engaged in continuous or
mass production. Process costing is a method of costing used to ascertain the cost of a product at each
process or stage of manufacturing.
According to ICMA terminology, "Process Costing is that form of operation costing which
applies where standardized goods are produced".
So it is a basic method to ascertain the cost at each stage of manufacturing. Separate accounts
are maintained at each process to which expenditure incurred. At the end of each process the cost per
unit is determined by dividing the total cost by the number of units produced at each stage. Hence, this
costing is also called as "Average Costing" or "Continuous Costing". Process Costing is used in the
industries like manufacturing industries, chemical industries, mining works and public utility
undertakings.

Characteristics of Process Costing

1. Production is continuous
2. Products pass through two or more distinct processes of completion.
3. Products are standardized and homogeneous.
4. Products are not distinguishable in processing stage.

71
5. The finished product of one process becomes the raw material of the subsequent process.
6. Cost of material, labour and overheads are collected for each process and charged accordingly.

72
Advantages of Process Costing
1. It is easy to compute average cot because the products are homogeneous in Process Costing.
2. It is possible to ascertain the process costs at short intervals.
3. Process Costing is simple and less expensive in relation o job costing.
4. By evaluating the performance of each process effective managerial control is
possible. Disadvantages of Process Costing
1. Valuation of work in progress is difficult.
2. It is not easy to value losses, wastes, scraps etc.
3. The apportionment of total cost among joint products and by-products is difficult.
4. Process cost are not accurate, they are only average costs
5. Process costs are only
historical. Principles of Process Costing
The following points are considered while determining the cost under Process Costing.
1. Production activity should be divided into different processes or departments.
2. A separate account is opened for each process.
3. Both direct and indirect costs are collected for each process.
4. The quantity of output and costs are recorded in the respective process accounts.
5. The cost per unit is determined by dividing the total cost at the end of each process by the
number of output of each process.
6. Normal loss and abnormal loss are credited in the process account
7. The accumulated cost of each process is transfen-ed to subsequent process along with output.
The output of the last process along with cost is transfen-ed to the fini hed goods account.
8. In case of by-products and joint products their share in joint cost should be estimated and
credited to the min process.
9. When there is work in progress at the end of the period the computation of inventory is
made I terms of complete units.
Difference between Process Costing and Job Costing
Process Costing Job Costing
1. Production is continuous 1. Production is
2. Production is for stock according to customers'
orders
3. All units produced are identical 2. Production is not for stock
or homogeneous
3. Each job is different from the other
4. There is regular transfer of cost of one 4. There is no regular transfer of cost
process to subsequent processes from one job to another
5. Work in progress always exists
5. Work in progress may or may
not exist
Procedure for Process Costing
1. Each process is separately identified. Separate process account is opened for each process.

73
2. Along with 'Particulars Column', two columns are provided on both sides of the process
account - units (quantity) and amount (Rupees).
3. All the expenses are debited in the respective process account.

74
 4. Wastage, sale of scrap, by-products etc are reordered on the credit side Of the process
account.
5. The difference between debit and credit side shows the cost of production and output of that
particular process which is transferred to the next process.
6. The cost per unit in every process is calculated by dividing the net cost by the output.
7. The output of last process is transferred to the Finished Stock Account.
8. Incomplete units at the end of the each period ion every process s converted in terms of
completed units.
Specimen of Process Account
Process Account
Units Rs. Units Rs.
To Direct materials By Loss lil
To Direct Wages weight (Normal
To Direct Expenses Loss)
To Indirect expenses By sale of Scrap
To Other Expenses (if any) By Next Process
Account(Transfer)

Preparation of Process Accounts

The preparation of Process Account depends upon the following situations
1. Simple Process Account
2. Process costing with normal process loss
3. Process costing with abnormal process loss
4. Process costing with abnormal process gains
5. Inter - process profits.
Simple Process Account
Under this case it is very easy to prepare process account. A separate account is opened for
each process. All costs are debited to the process account. The total cost of the process is transferred
to the next process. At the end of each process the cost per unit is obtained by dividing the total cost
by the number of units.
Illustration 1: Product A requires three distinct processes and after the third process the product is
transferred to finished stock. Prepare various process accounts from the following information.
Total Pl P2 P3
Direct Materials 5000 4000 600 400
Direct Labour 4000 1500 1600 900
Direct Expenses 800 500 300
Production overheads 6000

Production overheads to be allocated to different processes on the basis of 150% of direct

wages. Production during the period was 200 units. Assume Shere is no opening or closing stock.

75
Solution:
Process I Account
Units Rs. Units Rs.
To Direct materials 200 4000 By Process II
To Direct Wages 1500 Account(Transfer) 200 8250
To Direct Expenses 500 Cost per unit 8250 =
To Production overheads 2250 41.25
(1500x150%) 200 8250 200 200 8250
Process ITI Account
Units Rs. Units Rs.
To Process I Ale 200 8250 By Process III
To Direct materials 600 Account(Transfer) 200 13150
To Direct Wages 1600 Cost per unit 13150 =
To Direct Expenses 300 65.75
To Production overheads 2400 200
(1600x150%)
200 13150 200 13150
Process III Account
Units Rs. Units Rs.
To Process II Ale 200 13150 By Finished stock Ale
To Direct materials 400 (Output Transferred ) 200 15800
To Direct Wages 900 Cost per unit 15800 = 79
To Production overheads 1350 200
(900xl50%)

200 15800 200 15800

Process losses
The process loss is classified into two- normal process loss and abnormal process loss.

Normal process loss

This is the loss which is unavoidable on account of inherent nature of production process. It
arises under normal conditions. It is usually calculated as a certain percentage of input. Normal process
los includes either waste or scrap r both. Waste is unsalable and has no value. Loss in weight is an
example of waste. Loss in weight should be credited to the concerned process account. It should be
recorded only in terms of quantity.
Loss in weight= Opening Stock+ output from the preceding process - (output of the
Concerned process + closing stock)

76
Illustration 2: From the following figures, show the cost of three processes of manufacture. The
production of each process is passed on to the next process immediately on completion.

77
 Process Process Process
A B C
Wages and Materials 30400 12000 29250
Works Overhead 5600 5250 6000
Production ion units 36000 37500 48000
Stock on 1 July 2012 (units from preceding
process) 4000 16500
Stock on 31 July 2012 (units from preceding
process) 1000 5500
Solution:
Process A Account
Units Rs. Units Rs.
To Wages and Materials To 36000 30400 By Process B Ale
Works Overhead 5600 (Transfer) 36000 36000
Cost per unit 36000 = 1
36000
36000 36000 36000 36000
Process B Account

Units Rs. Units Rs.

To Opening Stock (Re. l p.u) 4000 4000 By loss in weight (Bal. fig) 1500
To Process A Ale (transfer) 36000 36000 By Closing stock @ Re. I 1000 1000
To Wages and Materials 12000 p.u
To Works Overhead 5250 By Process C Ne (Transfer) 37500 56250
Cost per unit 56250 = 1.50
37500
40000 57250 40000 57250

Process C Account
Units Rs. Units Rs.
To Opening Stock (Rs.1.50 16500 24750 By loss m weight (Bal. 500
p.u) 37500 56250 fig) 5500 8250
To Process B Ale (transfer) 29250 By Closing
To Wages and Materials 6000 stock@Rs.1.5p.u 48000 108000
To Works Overhead By Finished stock Ale
(Transfer)
Cost per unitl08000 =
2.25
78
54000 116250 48000 54000 116250

79
Illustration 3: Bihar Chemicals Ltd produced three chemicals during the month of July 2012 by three
consecutive processes. In each process 2% of the total weight put in is lost and 10 % is scrap which
from process 1 and 2 realizes Rs.100 a ton and from process 3Rs.20 a ton.
The product of three processes is dealt with as follows:

Process 1 Process 2 Process 3

Passed on to the next process 75% 50%
Sent to warehouse for sale 25% 50% 100%

Expenses incurred:
Rs Tons Rs Tons Rs Tons
Raw materials 120000 1000 28000 140 107840 1348
Manufacturing wages 20500 18520 15000
General expenses 10300 7240 3100
Prepare Process Cost Accounts showing the cost per ton of each product.
Solution:
Process 1 Account
Tons Rs. Tons Rs.
To Raw materials 1000 120000 By loss in weight (2%) 20
To Manufacturing wages 20500 By Sale of scrap (10%) 100 10000
To General expenses 10300 By Warehouse - transfer
(880x25%) 220 35200
By Process 2 660 105600
Nc(Transfer )
Cost per unit 140800 =
160
1000 150800 1000 150800
880

Process 2 Account
Tons Rs. Tons Rs.
To Process 1 Nc(Transfer ) 660 105600 By loss in weight (2%) 16
To Raw materials 140 28000 By Sale of scrap (10%) 80 8000
To Manufacturing wages 18520 By Warehouse - transfer
To General expenses 7240 (704x50%) 352 75680
By Process 2 352 75680
Nc(Transfer )
Cost per unit 151360 =

80
800 159360 800 159360
215
704

81
Process 3 Account
Tons Rs. Tons Rs.
To Process 2 A/c(Transfer) 352 75680 By loss in weight (2%) 34
To Raw materials 1348 107840 By Sale of scrap (10%) 170 3400
To Manufactming wages 15000 By Warehouse - transfer 198220
To General expen es 3100 Cost p unit 1496
198220
=132.5
1700 201620 1496 1700 201620

Abnormal Process Loss

Any loss caused by unexpected or abnormal conditions such as plant break don, substandard
materials, carelessness, accident etc. or loss in exceeds of the margin anticipated for normal process
loss can be called as abnormal process loss. It is controllable and avoidable. When actual loss in the
process is greater than the estimated normal loss, it is a case of abnormal loss. It may also be determined
by comparing actual output with expected or normal output. If actual output is les than the normal
output, the difference is abnormal loss.
Value of Abnormal loss= Normal cost of normal output x Units of Abnormal loss
Normal output
Normal cost of normal output= Total expenditure (i.e., total debit of process Ale) - Sale
Proceeds of scrap (i.e. Value of normal loss)

Normal output= Input - Units of normal loss

illustration 4: tin process A 100 units of raw materials were introduced at a cost of Rs.1000. the other
expenditure incurred by the process was Rs. 602. Of the units introduced 10% are normally lost in
the course of manufacture and them posses a scrap value of Rs.3 each. The output of process A was
only 75 units. Prepare Process A Ale and Abnormal loss Ale.
Solution:
Process A Ale
Units Rs. Units Rs.
To Raw Materials 100 1000 By Normalloss-
To Other expenses 602 100xl0% @Rs.3 each 10 30
By Abnormal loss 15 262*
(Bal.Fig) 75 1310
By Process B Ale
100 1602 100 1602
(transfer)

Working Note:
Normal cost of normal output = Total expenditure - Sale Proceeds of scrap
= 1602-30= 1572
82
Normal output = Input - Units of normal loss
= 100- 10 = 90

83
Value of Abnormal loss= Normal cost of normal output x Units of Abnormal loss
Normal output
= 1572 x 15 = Rs. 262
90
Abnormal Loss Ale
Units Rs. Units Rs.
To Process A 15 262 By Cash (scrap value of
loss @ Rs.3) 15 45
By Costing P&L Ale 217

15 262 15 262

Abnormal Gain (or Abnormal Effective)

Sometimes actual loss or wastage in a process is less than expected normal loss. In this case
the difference between actual loss and expected loss is known as abnormal gain or abnormal effective.
It is the excess of actual production over normal output.
Abnormal gain is valued in the same manner as abnormal loss. The value of abnormal gain
is debited to process Ale and credited to abnormal gain Ale. the value of scrap is debited to abnormal
gain A/.c and credited to normal loss Ale. finally abnormal loss Ale is closed by transferring the credit
balance to Costing P&L Ale.

Value of Abnormal Gain= Normal cost of normal output x Units of Abnormal gain
Normal output
Normal cost of normal output= Total expenditure- Sale Proceeds of scrap
Normal output= Input - Units of normal loss

Units of Abnormal gain= Nom1al loss- Actual loss

Or = Actual output - Normal output

Illustration 5: Product X is obtained after it passes through three distinct processes. 2000 kg of
materials at Rs.5 per kg were issued to the first process. Direct wages amounted to Rs.900 and
production overhead incurred was Rs.500. Normal loss is estimated at 10% of input. This wastage is
sold at Rs.3 per kg. The actual output is 1850 kg. Prepare process I Ale and Abnormal Gain/ Abnormal
loss Ale as the case may be.
Solution:
Process I Account
Kg Rs. Koe,- Rs.
To Materials 2000 10000 By Normal loss (Sale of
To Direct wages 900 scrap) 200 600
To Production OH 500 By Process 11 - transfer 1850 111002
To Abnormal gain (Bal.) so' 3003
2050 11700 2050 11700

84
 Abnormal Gain Ale
Koe-, Rs. Kg Rs.
To Normalloss (loss so 150 By Process I A/c so 300
of income) 150
To Costing P&L Ale (Bal.)

so 300 so 300

Working note:
l. (200+1850)-2000=50
2. (10000+900+500)-600 = Rs.2
1850-50
1850x6=11100
3. 50x6=30
Illustration 6: The product of a company passes through three distinct processes to completion - A,B
and C. from the past experience its ascertained that loss incurred in each process as - A-2%, B-5% and
C-10%.
In each case the percentage of loss is computed on te number of units entering the process
concerned. The loss of each process possesses a scrap value. The los of processes A and B sold at Rs.5
per 100 units and that of C at Rs.20 per 100 units.
The output of each process passes immediately to the next process and the finished units are
passed from process C into stock.

Process A Process B Process C

Materials consumed 6000 4000 2000
Direct labour 8000 6000 3000
Manufacturing expenses 1000 1000 1500
20000 units have been issued to process A at a cost of Rs. I0000. the output of each process
has been as under:
A-19500, B- 18800 and C - 16000.
There is no work in progress in any process. Prepare process accounts. Calculations should be made
to the nearest rupee.
Solution:
Process A Account
Units Rs. Units Rs.
To Units introduced 20000 10000 By Normal loss 400 20
To Materials 6000 By Abnormal loss (Bal.) 100 127
To Direct labour 8000 By Process B - transfer 19500 24853
To Manufacturing Expenses 1000
20000 25000 20000 25000

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 Process B Account
Uruts Rs. Uruts Rs.
To Process A Ale 19500 24853 By Normal loss 975 49
To Materials 4000 By Process C - transfer 18800 36336
To Direct labour 6000
To Manufacturing Expenses 1000
To abnormal gain 275 532
19775 36385 19775 36385
Process C Account
Units Rs. Units Rs.
To Process B Ale 18800 36336 By Normal loss 1880 376
To Materials 2000 By To abnormal loss 920 2309
To Direct labour 3000 By Finished stock Ale - 16000 40151
To Manufacturing Expenses 1500 transfer
18800 42836 18800 42836
Finished Stock Ale
Units Rs. Units Rs.
To Process C Ale 16000 40151

16000 40151 16000 40151

Abnormal Loss Ale
Units Rs. Units Rs.
To Process A 100 127 By Cash (lO0@Rs.5 per
To Process C 100+920@Rs.20per 100) 1020 189
920 2309
By Costing P&L Ale 2247
1020 2436 1020 2436

Normal loss Ale

Units Rs. Units Rs.
To Process A 400 20 By Abnormal Gain 275 14
To Process B By Cash/Debtors Ale 2980 431
975 49
To Process C
1880 376

3255 445 3255 445

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 Abnormal Gain Ale

Units Rs. Units Rs.

To Normal loss (loss 275 14 By Process C Ale 275 532
of
income)
538
To Costing P&L Ale (Bal.)
275 532 275 532

Working note:
Process A:
Value of Abnormal loss= Rs.24980/19600 units x 100 units= Rs. 127.
Process B:
Value of Abnormal gain= Rs.35804/18525 units x 275 units= Rs. 532.
Process C:
Value of Abnormal loss= Rs.42460/16920 units x 920 units= Rs. 2309.

Work-in-Progress
In most of the firms manufacturing is on a continuous basis and the problem of work-in progress is
quite common. The work-in-progress consists of direct materials, direct wages and production overhead.
Equivalent Production
Equivalent production represents the production of a process in terms of completed units. In other
words, it means converting the incomplete units into its equivalent of completed units. It is also known as
effective production. For calculating equivalent production, work-in-progress needs to be inspected. Then
an estimate is made of the degree of completion, usually on a percentage basis.

Steps and procedure of computation of Equivalent Production

1. Ascertain Equivalent Production in respect of opening work-in-progress, if any. In this case the
Equivalent Production is computed by taking into consideration the percentage of work required to finish
now in the process. The following formula is used.
Opening WIP (Units) x % of work needed to complete.
2. Find the units introduced and completed and add this to (1). It is calculated as follows:
Units completed and transferred - Opening work-in-progress.
3. Convert the equivalent production of closing work-in-progress and add to the above.The
formula is:
Closing work-in-progress (units) x% of work completed.
4. Obtain the total Equivalent Production terms of materials, labour and overhead separately (if
degree of completion is different). For this, 'Statement of Equivalent Production' is prepared.
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5. Find out the net process costs, element wise- materials, labour and overheads.

88
6. Ascertain the cost per unit of Equivalent Production for each element of cost
separately. Material cost per unit= M_a_te_r_ial_c_o_st _
Equivalent Production in respect of materials
Labour cost per unit= L_ab_o_u_r_c_o_s_t _ Equivalent
Production in respect of labour
Overhead cost per unit= _ ,O"-v-'--'e=-=r=h=e=ad=-=-c=o=st'----------
Equivalent Production in respect of overhead For
this purpose 'Statement of Cost is prepared'
7. Find out the value of opening work-in-progress, finished units and closing work-in-progress. The
formula is:
Equivalent Production in respect of mate1ials x Mate1ial cost per unit
Equivalent Production in respect of labour x Labour cost per unit
Equivalent Production in respect of overhead x Overhead cost per unit

For this purpose 'Statement of Evaluation or Apportionment' is prepared.

In short, the following three statements are to be prepared:
1. Statement of Equivalent Production
2. Statement of Cost
3. Statement of Evaluation.
I. When there is only closing work-in-progress but with no process losses
Under this case the closing work-in-progress is converted into equivalent units on the basis
of estimate as regards degree of completion o materials, labour and production overhead.
lliustration 7: Input 3800 units, Output 3000 units and closing work-in-progress 800 units.
Degree of
Process costs Rs.
completion
Materials 80% 7280
Labour 70% 10680
Overheads 70% 7120

Find out Equivalent Production, Cost per unit of equivalent production and prepare the
Process A Ale assuming that there is no opening work-in-progress and process loss.
Solution:
Statement of Equivalent Production
Input Output Equivalent Production
Labour &
Materials
Items Units Items Units Overhead
Units % Units %
Units Units completed
introduced 3800 & transferred 3000 3000 100 3000 100
Work in progress 800 640 80 560 70
3800 3800 3640 3560

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Statement of Cost
Equivalent Production Cost per completed
Elements of cost Cost (Rs.)
(units) unit
Materials 7280 3640 2.00
Labour 10680 3560 3.00
Overheads 7120 3560 2.00
25080 7.00

Statement of Evaluation

Finished goods 3000x7 21000

Work-in-progress:
Materials 640x2 1280
Labour 560x3 1680
Overhead 560x2 1120
4080

Process A Ne
Units Rs. Units Rs.
To Materials 3800 7280 By Finished stock Ale -
To Labour 10680 transfer 3000 21000
To Overhead 7120 By Work-in-progress 4080
800

3800 25080 3800 25080

II. When there is only closing work-in-progress but with process losses
In case of normal loss, nothing should be added as equivalent production. However, abnormal
loss should be considered as production of good units completed during the period.
Illustration 8: During January 2000 units were introduced into Process I. the normal loss was
estimated at 5% on input. At the end of the month, 1400 units had been produce and transferred to the
next process, 460 units were uncompleted and 140 units had been scrapped. It was estimated that
uncompleted units had reached a stage in production as follows:
Material 75% completed
Labour 50% completed
Overheads 50% completed
The cost of 20000 units was Rs.5800
Direct material introduced during the process Rs.1440
Direct wages Rs.3340
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Production overheads incurred were Rs. 1670
Units scrapped realized Re. l each.

91
Units scrapped passed through the process, so were 100% completed as regards material, labour and
overhead.
Find out Equivalent Production, Cost per unit and prepare the necessary accounts.
Solution:
Statement of Equivalent Production

Input Equivalent Production

Output Materials Labour &
Units
Units Overhead
Units % Units %
2000 Normal loss 100
Abnormal loss 40 40 100 40 100
Finished production 1400 1400 100 1400 100
Work in progress 460 345 75 230 50
2000 2000 1785 1670
Statement of Cost
Elements of cost Cost Equivalent Cost per
(Rs.) Production (units) completed unit
Materials
Cost of units introduced 5800
Direct Materials 1440
7240
Less: Scrap vale of normal loss 100
7140 1785 4
Direct wages 3340 1670 2
Overheads 1670 1670 l
Total 12150 5125 7
Statement of Evaluation
Production Cost Elements Equivalent Production Cost per unit Cost Total Cost
Abnormal Material 40 4 160
loss Labour 40 2 80
Overheads 40 l 40 280
Finished Material 1400 4 5600
production Labour 1400 2 2800
Overheads 1400 l 1400 9800

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Work-in- Material 345 4 1380
progress Labour 230 2 460
Overheads 230 1 230 2070
12150

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 Process I Ne
Units Rs. Units Rs.
To Units introduced 2000 5800 By Normal loss 100 100
To Materials 1440 By abnormal loss 280
40
To Labour 3340 By Finished production 9800
To Overhead 1670 By Balance c/d 1400
(Work-in-progress) 2070

460

2000 1225 2000 1225

0 0
Finished Production Ne
Units Rs. Units Rs.
To Process I Ne 1400 9800

Abnormal Loss Ne
Units Rs. Units Rs.
To Process I Ne 40 280 By Cash (sale @ Re.l p.u) 40 40
By Costing P&L Ne (loss) 240

40 280 40 280

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