Concept Building Approach to Cost Accounting 6.

engaged in converting raw materials into finished products. These wages can be conveniently
identified with a particular product, job or process. Some of the examples include -
" Cost of wages of those workers who are readily identified or linked with a cost centre or
cost object
" It also includes their fringe benefits like provident fund contribution, gratuity, ESI,
overtime, incentives, bonus, ex-gratia, leave encashment and wages for holidays and idle
time.
(b) Direct Expenses : 'Expenses relating to manufacture of a product or rendering a service,
which can be identified or linked with the cost object other than direct material cost and
direct employee cost are direct expenses. Some of the examples of direct expenses are
royalties charged on production, Job charges, hire charges for use of specific equipment for a
specific job, software services specifically required for a job.12 Direct expenses are also
known as chargeable expenses.
Prime Cost
Particulars Total Cost Per Unit
Direct Material Consumed
(Opening Stock + Purchases - Closing Stock)
Direct Employee Cost
Direct Expenses
Prime Cost

2. Cost of Production

'Cost of production or manufacturing cost of each excisable good shall be the aggregate of
direct and indirect cost relating to manufacturing activity. Cost of production consists of
materials consumed, direct wages and salaries, direct expenses, works overheads, quality
control costs, research and development costs, packing costs, administrative overheads relating
to production. To arrive at cost of production of goods dispatched for captive consumption,
adjustment for stock of Work-in-progress, recoveries for sales of scrap, wastages et. shall be
made'3

Cost of Production
Particulars Total Cost Per Unit
Prime Cost
Add: Manufacturing overheads
Add: Opening work in progress
Less: Closing work in progress
Add: Quality control cost
Add: Research &development cost
Add: Administration overheads relating to production
Less Credit for recoveries, if any
Add: Packing cost (primary)

3https://www.icmai. in/upload/CASB/CAS_4_Revised_28022019.pd/
 6.4
Concept 8uilding Approach to Cost Accounting

Add: Cost of free or concessional value Inputs

Cost of Production

() Manufacturing (Works) Overheads

Total overheads is the sum total of indirect material, indirect labour and indirect expenses.
On the basis of functions, total overheads are classified into three broad categories
manufacturing overheads, administration overheads and selling &distribution overheads.
Manufacturing overheads are also known as factory overheads or works overheads. It is sum
total of indirect materials, indirect wages and indirect expenses in relation to the manufacturing
of a product.
Indirect material: These are the materials which cannot be conveniently identified with
individual cost units and are jointly incurred for more than one cost unit. It includes (i) small
and relatively inexpensive items which may become apart of the finished product, e.g., nails,
screws, nuts and bolts, thread, etc., (ii) sundries which do not become a part of the finished
products, e.g, coal, lubricating oil and grease, sand paper used in polishing, soap, etc.
Indirect labour: It is the labour cost which is jointly incurred for more than one cost unit and
need to be distributed. In other words, indirect labour is not directly engaged in the
production operations but only to assist in production operations. Salary of the supervisor,
salary to the storekeeper, wages of factory watchman ete. are some of the examples.
Indirect expenses: These are the expenses which are jointly incurred for more than one cost
unit or cost centre. Some of the exämples are - factory rent and rates, depreciation of plant,
repair and maintenance of plant, insurance of factory building, factory lighting and power,
internal transport expenses.

(ii) Stock of Work-in-progress

This is the stock of semi-finished goods, i.e., the goods which are still in manufacturing process.
The value of opening and closing stocks of work-in-progress are adjusted in order to compute the
manufacturing cost of the complete units. The value of opening work in progress is added and
the value of closing work in progress in subtracted.
(i)Quality Control Cost
The quality control cost is the expenses incurred relating to quality control activities for
adhering to quality standard. These expenses include salaries &wages relating to employees
engaged in quality control activity and other related expenses.
(iv)Research and Development Cost
The research and development cost incurred for development and improvement of the
process or the excisable good.

(v) Administration overheads relating to production

Administration overheads include cost of all activities relating to general management and
administration of an organisation. All the administrative overheads are divided into two
categories - ) administration overheads in relation to manufacturing activities and (i)
administration overheads in relation to other activities.
 Concept Building Approach to Cost Accounting 6.5

Administrative overheads in relation to manufacturing activities are included in the

manufacturing cost and administration overheads in relation to other activities (marketing,
projects management, corporate office, etc.) are excluded from manufacturing cost.
(vi) Credit for recoveries
In some cases, the manufacturing process results into some kind of scrap and spoilage. The
sale value of this scrap and spoilage is subtracted as it reduces the manufacturing cost. However,
if some rectification cost (repair and refurbishing cost) is incurred on defectives to bring them up
to the standards, these are added in computing the manufacturing cost.
(vii) Primary Packing cost
The cost of primary packing which is necessary for the preservation of the product is
included in the manufacturing cost. In case any packing material is supplied free of cost or at
concessional value by the buyer of the excisable good, the cost of such material shall be included
in the manufacturing cost.
(viii) Cost of free or concessional value of Inputs
Cost of inputs received free of cost or at concessional value from the buyer of excisable good
shall be included in the manufacturing cost. The amortisation cost of free tools, pattern, dies,
design work etc. which are necessary for production of excisable good are also included in the
manufacturing cost.
3. Cost of Goods Sold
In order to compute the profit relating to goods sold, the cost of the units sold are matched
against the revenues realised from the same units. However cost of production, which is the
manufacturing cost of the total units available for sale, needs to be adjusted for the value of
opening stock of finished goods and closing stock of finished goods.
Cost of Goods Sold
Particulars Total Cost Per Unit
Cost of production
Add: Opening stock of finished goods
Less Closing stock of finished goods
Cost of Goods Sold
4. Cost of Sales
It is the total cost relating to the unit sold during the period. All the additional items of
overheads - administration overheads, selling overheads and distribution overheads are added to
the 'cost of goods sold' to get the 'Cost of Sales'.
Cost of Sales
Particulars Total Cost Per Unit
Cost of Goods Sold
Add: Administration overheads
Add: Selling overheads
 Concept Building Approach to Cost Accounting

Manufacturing Overheads ? 110,000

Administration overheads (2/5 part for manufacturing department) 80,000
Selling expenses per units sold I5
Interest on loan for purchase of Machine 25,600
Hire charges of equipment used for Manufacturing Product 7 16,000
Penalty for violating Patent 10,000
The government pays an incentive per units produced 7 50
Selling Price per unit 7 175

Solution:
Cost Sheet for the year ended 31# December, 2020
Particulars |Total Cost Per Unit
Direct materials cost (20,000 x 100) 20,00,000
+Expenses on purchases :
Cartage 15,000
Insurance 5,000
GST 10,000
Direct employee cost (10,000 x 80) 8,00,000
Direct expenses :
Royalty for production (20,000 x 10) 2,00,000
Design charges 30,000
Hiring charges for equipment 16,000
Prime Cost 30,76,000 153.80
Manufacturing overheads 1,10,000
Administration overheads relating to production (80,000 x 2/5) 32,000
(-) government incentives (20,000 x 50) |(10,00,000)
Cost of Production 22,18,000 110.90
() Closing Stock of Finished Goods (4,43,600)
Cost of Goods Sold 17,74,400 110.90
Administration overheads (3/5th of 80,000) 48,000
Selling expenses (16000 x * 1S) 240,000
Financial Charges (Interest on loan) 25,600
Royalty paid on sales (16,000 x 20) 3,20,000
Cost of Sales 24,08,000 150.50
Profit (balancing figure) 3,92,000 24.50
Sales (16,000 x 175) 28,00,000 175.00

Working notes:
1. Royalty for production is a direct expense.
2. Royalty for sale is a selling overhead cost.
 Concept Building Approach to Cost Accounting 6.8

Royalty paid for use of asset or on technology transfer, in any form, will form part of cost
of production; however royalty paid on brand usage shall be part of selling overheads.
Interest and Financing Charges, finance costs, and borrowing costs are used
interchangeably. Interest and financing charges shall be presented in the cost
statement as a separate item of cost of sales and shall not include imputed costs.
Some of the examples of interest costs are - Interest and commitment charges on
borrowings, financing charges in respect of finance leases and other similar
arrangements, and exchange differences arising from foreign currency borrowings the
extent they are regarded as an adjustment to the interest costs.
Impairment loss on assets shall not form part of cost of production.
e
Imputed costs shall not form part of cost of production
Fines, penalties, damages, demurrage and similar levies paid to statutory authorities or
other third parties shall not form part of the cost of production
The forex component of imported material or other element of cost shall be converted at
the rate on the date of the transaction. Any subsequent change in the exchange rate till
payment or otherwise shall not form part of the cost of production.
Compensation paid to employees for the past period on account of any dispute / court
orders shall not form part of employee cost.
Remuneration paid to non-executive directors shall not form part of Employee Cost but
shall form part of Administrative Overheads.
Separation costs related to voluntary retirement, retrenchment, termination etc. shall be
amortised over the period benefitting from such costs. However unamortized amount
relating to discontinued operations, shall not be treated as employee cost.
In case of leased assets, if the lease is an operating lease, the entire rentals shall be
included in the administrative overheads. If the lease is a financial lease, the finance cost
portion shall be segregated and treated as part of finance costs.
llustration 6.1 From the following information provided by Gagan Manufacturing Company,
prepare a cost statement for the year ended on 31" December, 2020:
Units Produced 20,000
Units Sold 16,000
Direct materials cost per units 100
Direct labour hours: 10000 labour rate per Hour 80
Expenses paid for direct materials purchase:
Cartage { 15,000
Insurance { 5,000
GST * 10,000
Royalty per unit of sale * 20
Royalty per unit of Production { 10
Design Charges * 30,000
 Concept Building Approach to Cost Accounting 6.6

Add: Distribution overheads

Add: Finance cost
Cost of Sales

(a) Administration overheads

It is the cost of all activities relating to general management and administration of an
organisation. Cost Accounting standard - 11 requires that administrative overheads shall be
presented as a separate cost head in the cost statement. It is the aggregate of indirect material,
indirect labour and indirect expenses incurred in relation to general administration of the
business.
Indirect material: some of the examples are stationery used in general administrative office,
postage, sweeping broom and brush, all accounts and audit expenses etc.
Indirect labour: Salary of office staff, salary of managing director, salary of peon and
watchman of the office etc.
Indirect expenses: Rent of office building, legal expenses, office lighting and power,
telephoneexpenses, depreciation of office furniture and equipment, office air-conditioning,
sundry office expenses etc.
(b) Selling Overheads
According to Cost Accounting standard- 15, selling overheads are the expenses related to
sale of products or services and include all indirect expenses incurred in selling the products or
services. Some of the examples of selling costs are -
1. Salaries of sales personnel
2. Travelling expenses of sales personnel
3. Commission to sales agents
4. Sales and brand promotion expenses including advertisement, publicity, sponsorships,
endorsements and similar other expenses.
5. Receivable Collection costs
6. After sales service costs
7. Warranty costs

(c) Distribution overheads

According to Cost Accounting standard - 15, distribution costs are the costs incurred in
handling a product or service from the time it is ready for dispatch or delivery until it reaches the
ultimate consumer including the units receiving the product or service in an inter-unit transfer.
The cost of packing, repacking, labeling, etc. at an intermediate storage location will be part
of distribution cost. Some of the examples of distribution costs are
labeling at an intermediate storage location, transportation cost, cost ofPacking, repacking /
warehousing (cover
depots, godowns, storage yards, stock yards) etc.
The following format of the cost sheet may be followed in computing the
unit cost of the product. total cost and per
Cost Sheet of Product A for the period ended...
(Output =.... units)
Particulars Per l Lnt
 6 7
Concept Building Approach to Cost Accounting

(Opening Stock + Purchases - Closing Stock)

Direct Employee Cost
Direct Expenses
Prime Cost
Add: Manufacturing Overheads
Add: Opening Work in Progress
Less: Closing Work in Progress
Add: Quality Control Cost
Add: Research & Development Cost
Add: Administration overheads relating to production
Less Credit for Recoveries, if any
Add: Packing Cost (Primary)
Add: Cost of free or concessional value Inputs
Cost of Production
Add: Opening stock of Finished Goods
Less Closing Stock of Finished Goods
Cost of Goods Sold
Add: Administration Overheads
Add: Selling Overheads
Add: Distribution Overheads
Add : Finance Cost
Cost of Sales
Add: Profit
Sales

IMPORTANT PROVISINS OF COST ACCOUNTING STANDARDS

Following are some of the important provisions of Cost Accounting Standards (CAS) impacting
the statement of cost:
" COP shall be determined on 'normal cost' basis.
Any abnormal cost, where it is material and quantifiable, shall not form part of the cost of
goods.
The variable production or operation overheads shall be absorbed based on actual
production.
The fixed production or operation overheads and other similar item of fixed costs such as
quality control cost, research and development costs and administrative overheads
relating to manufacturing shall be absorbed in the cost of production on the basis of the
normal capacity or actual capacity utilization of the plant, whichever is higher and
unabsorbed cost, if any, shall be treated as abnormal cost.
Royalty and Technical know-how fee for production paid or incurred in lump-sum or
'one-time' payment, shall be amortized the basis of the estimated output or benefit to
be derived from the related technical know-how.
 Concept Building Approach to Cost Accounting 6.10

3. Finance cost is assumed not for a qualifying asset. Otherwise it will be added to the cost of
the machine.
4. Penalty for patent violation is not taken as part of cost of production.
5. Any incentive received from government is reduced from the cost.
Illustration 6.2 Following cost information relates to Himadri Toys Ltd. for the year ending 31
March, 2020.
Particulars Amount Amount

Raw materials purchased 20,000,000

GST paid on the above purchases @18% (eligible for input 3,600,000
tax credit)
Freight inward 224,120
Wages paid to factory workers 584,000
Contribution to EPF 72,000
Production bonus paid to factory workers 58,000
Royalty paid for production 34,520
Amount paid for power & fuel 92,400
Amount paid for purchase of moulds and patterns (life is 179,200
equivalent to two years production)
Job charges paid to job workers 162,400
Stores and spares consumed 22,400
Depreciation on:
Factory building 16,800
Office building 11,200
Plant & Machinery 25,200
Delivery vehicles 17,200 70,400
Salary paid to supervisors 25,200
Repairs & Maintenance paid for:
Plant & Machinery 9,600
Sales office building 3,600
Vehicles used by directors 3,920 17,120
Insurance premium paid for:
Plant & Machinery 6,240
Factory building 3,620
Stock of raw materials & WIP 7,200 17,060
Expenses paid for quality control check activities 3,920
Salary paid to quality control staffs 19,240
Research & development cost paid improvement in 3,640
production process
Expenses paid for pollution control and engineering & 5,320
maintenance
 Concept Building Approach to Cost Accounting 6.11

Expenses paid for administration of factory work 23,720

Salary paid to functional mangers:
Production control 192,000
Finance & Accounts 183,600
Sales & Marketing 202,400 578,000
Salary paid to General Manager 251,200
Packing cost paid for:
- Primary packing necessary to maintain quality 19,200
For re-distribution of finished goods 22,400 41,600
Interest and finance charges paid 144,000
Fee paid to auditors 36,000
Fee paid to legal advisors 24,000
Fee paid to independent directors 44,000
Performance bonus paid to sales staffs 36,000
Value of stockas on Ist April, 2019:
Raw materials 360,000
Work-in-process 184,000
Finished goods 220,000 764,000
Value of stock as on 31st March, 2020:
Raw materials 192,000
Work-in-process 174,000
Finished goods 364,000 730,000
Scrap and waste generated during manufacturing process was sold at 17,200.
You are required to prepare a cost statement for the year ended 31st March, 2020 showing Prime
cost, Cost of Production, Cost of goods sold and Cost of sales. (ICAL, Modified)

Solution :

Statement of Cost of Himadri Toys Ltd. for the year ended 31st March, 2020
Particulars Amount Total Cost
Material Consumed:
Raw materials purchased 20,000,000
Freight inward 224,120
Add: Opening stock of raw materials 360,000
Less: Closing stock of raw materials (192,000) 20,392,120
Direct employee (labour) cost:
Wages paid to factory workers 584,000
Contribution made towards EPF 72,000
Production bonus paid to factory workers 58,000 714,000
Direct expenses:
Royalty paid for production 34,520
 Concept Building Approach to Cost Accounting 6.12

Amount paid for power & fuel 92,400

Amortised cost of moulds and patterns 89,600
Job charges paid to job workers 162,400 378,920
Prime Cost 21,485,040
Production overheads:
Stores and spares consumed 22,400
Depreciation on factory building 16,800
Depreciation on plant & machinery 25,200
Repairs & Maintenance paid for plant & machinery 9,600
Insurance premium paid for plant & machinery 6,240
Insurance premium paid for factory building 3,620
Insurance premium paid for stock of raw materials &
WIP 7,200
Salary paid to supervisors 25,200
Expenses paid for pollution control and engineering & 5,320 121,580
maintenance
Add: Opening value of W-1-P 184,000
Less: Closing value of W-1-P (174,000)
Quality control cost:
Expenses paid for quality control check activities 3,920
Salary paid to quality control staffs 19,240 23,160
Research & development cost paid improvement in production 3,640
process
Administration cost related with production:
Expenses paid for administration of factory work 23,720
Salary paid to Production control manager 192,000 215,720
Less: Realisable value on sale of scrap and waste (17,200)
Add: Primary packing cost 19,200
Cost of Production 21,861,140
Add: Opening stock of finished goods 220,000
Less: Closing stock of finished goods (360,000)
Cost of Goods Sold 21,721,140
Administrative overheads:
Depreciation on office building 11,200
Repairs & Maintenance paid for vehicles used by directors 3,920
Salary paid to Manager- Finance & Accounts 183,600
Salary paid to General Manager 251,200
Fee paid to auditors 36,000
Fee paid to legal advisors 24,000
Fee paid to independent directors 44,000
Interest & finance charges 144,000 697,920
(assuming related with non-equity fund) Selling overheads:
Repairs & Maintenarnce paid for sales office building 3,600
Salary paid to Manager- Sales & Marketing 202,400
Performance bonus paid to sales staffs 36,000 242,000
 Concept Building Approach to Cost Accounting 6.13

Distribution overheads:
Depreciation on delivery vehicles 17,200
Packing cost paid for re-distribution of finished goods 22,400 39,600
Cost of Sales 22,700,660