CU-BCOM-SEM-III-Cost Accounting-Second Draft-converted

ROQ = √2×14300×100 = 1.196 Kg. 2 (ii) Reorder Level (ROL) = Maximum Usage × Maximum Reorder Period. Reorder Period = 4 to 8 weeks Maximum Reorder Period = 8 Weeks Consumption = 100 Kg. to 450 Kg. Maximum Consumption = 450 Kg. Reorder Level = 450 × 8 = 3,600 Kg. Maximum Level = ROL + ROQ – (Minimum usage × Minimum Reorder Period) = 3,600 + 1,196 – (100 × 4) = 4,796 – 400 = 4,396 Kg. (iii) Minimum Level = ROL – (Normal usage × Normal Reorder Period) Normal Usage = (Maximum Usage + Minimum Usage)/2 = (450 + 100)/2 = 275 Normal Reorder Period = (Maximum Period + Minimum Period)/2 = (4 + 8)/2 =6 Minimum Level = 3600 – (275 × 6)/2 = 1,950 Kg. (iv) Average Level = (Maximum Level + Minimum Level)/2 = (4,396 + 1,950)/2 = 3173 Kg. Or = Minimum Stock Level + ½ of 1,196 = 2,548 Kg. Illustration A factory requires 1,500 units of an item per month. The cost of each unit is 27. The cost per order is 150 and material carrying charge works out to 20% of the average material. Find out the economic order quantity (EOQ) and ascertain the number of orders to be placed per year. Would you accept a 2% price discount on a minimum supply of 1,200 units? 51 CU IDOL SELF LEARNING MATERIAL (SLM)

Solution When No Discount is Available Annual requirement 1500 units × 12 = 18,000 units EOQ = √Ca2r×ryAinnnguCaolsRtePqe×r OUrnditePreinrgACnonsutm = √10,00,000 = 1000 Units. No. of orders per year = 18000 ÷ 1000 = 18 orders If discount is given (original price – 2% discount) Cost price = 27 – 0.54 = 26.46 When 2% Price Discount is Available No of orders to be placed: 18000 ÷ 1200 = 15 orders Material carrying cost: 20% of 26.46 = Rs.5.292. Total cost without discount = ordering cost + carrying cost + purchase price = 18 x 150 + ½ x 1000 x 5.40 + 18000 x 27 = 2700 + 2700 + 486000 = Rs.491400. Total cost with 2% discount = 15 x 150 + ½ x 1200 x 5.292 + 18000 x 26.46 = 2250 + 3175.20 + 4,76,280 = Rs.4,81,705.20 Since the total cost is less with 2% discount, the proposal may be accepted 4.4 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. Labour is of two types: 52 CU IDOL SELF LEARNING MATERIAL (SLM)

• Direct labor: Direct labor is characterized as labor that is directly involved in the production of goods or services and can be easily assigned to a work, method, item, or process. • Labor in the spinning department, for example, can be easily allocated to the spinning phase. • Indirect labor: Indirect labor is described as labor that is not directly involved in the manufacture of goods and services, but indirectly assists direct labor. • Supervisors, sweepers, cooks, timekeepers, and watchmen are examples of indirect labor. Indirect labor costs are difficult to assign to a specific task, order, operation, or post. Time keeping Timekeeping will serve the following purposes: • Payroll preparation for employees who are paid on a time basis. • Complying with legal standards. • Ensuring attendance control. • Keeping track of and employee's time \"in\" and \"out\" of the factory, distinguishing between regular hours, overtime, late arrivals, and early departures. • If overheads are consumed depending on labour hours, for overhead delivery. Methods of Timekeeping • There are two methods of timekeeping. • 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: ▪ Attendance Register Method ▪ Metal Disc Method. ▪ Mechanical Methods: • The mechanical methods that are generally used for the recording of time of workers may be as follows: ▪ Time Recording Clocks ▪ Dial Time Records Time Booking 53 CU IDOL SELF LEARNING MATERIAL (SLM)

• Time booking is the process of keeping track of how much time a worker spends on various jobs or work orders during his shift at the factory. • Ensuring the time spent by a factory worker is adequately used on various jobs or work orders is the aim of time booking. • To figure out how much each task or work order would cost in labour. • To provide a foundation for allocating overhead expenses through several jobs or work orders where the approach for allocating overheads is based on the amount of time spent on - job. • To recognize unproductive or idle time in order to make efforts to hold it to a minimum. • To determine the length of time it takes to finish a specific job so that bonuses can be paid according to reward schemes. • To determine a worker's productivity, compare the real time spent with the time allotted to complete a job. Following documents are generally used for time booking: • Daily Time Sheets • Weekly Time Sheets • Job Tickets or Job Cards. 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. Normal Idle Time: This is the amount of time that cannot be saved and for which the employer is responsible for the labor expense. However, every effort should be made to keep it as low as possible. Time spent getting from the factory gate to the department where the worker is to operate and back at the end of the day, time spent picking up the work for the day, time spent between the completion of one work and the start of another work, time spent for personal needs such as tea or the toilet, time spent for computer repairs, and time spent waiting for orders are all examples of usual idle time. Idle Time is an inevitable expense that should be factored into the production budget. Standard idle time can be viewed as a factory loss that can be recovered as an indirect fee or applied to labor costs. 54 CU IDOL SELF LEARNING MATERIAL (SLM)

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 lockouts 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 work completed outside of a day's or week's usual working hours. Workers are paid twice as much for overtime hours worked. Overtime premium is the extra fee charged as a result of working overtime. Overtime boosts production costs and should not be promoted due to the following drawbacks. • Overtime is compensated more generously. • Overtime is performed at late hours while employees are exhausted, and productivity is equal to that of regular working hours. • Employees will develop the habit of working slowly during regular hours in order to earn more money by working overtime. • Expenditures such as lighting, supervision, and system wear and tear would grow disproportionately. LABOUR TURNOVER People change jobs for a number of reasons, including personal advancement, improved working conditions, or compulsion. The ratio of people leaving in a given time to the average number of people working is known as labor turnover. It refers to a change in an organization's labor force composition. Causes of Labour Turnover Causes of labor turnover: The main causes of labor turnover in an organization/industry can be broadly classified under the following three heads: • Personal Causes • Unavoidable Causes, and 55 CU IDOL SELF LEARNING MATERIAL (SLM)

• Avoidable Causes Personal causes are those which induce or compel workers to leave their jobs such causes include the following: • Change of jobs for betterment. • Premature retirement due to ill health or old age. • Domestic problems and family responsibilities. • Discontentment over the jobs and working environment. In all the above cases the employee leaves the organization at his will and, therefore, it is difficult to suggest any possible remedy in the first three cases. But the last one can be overcome by creating conditions leading to a healthy working environment. • (b) Unavoidable causes are those under which it becomes obligatory on the part of management to ask some or more of their employees to leave the organization, such causes are summed up as listed below: • Seasonal nature of the business. • Shortage of raw materials, power, slack market for the product etc • Change in the plant location. • Disability, making a worker unfit for work. • Disciplinary measures. • Marriage (generally in the case of women). (c) Avoidable causes are those which require the attention of management on a continuous basis so as to keep the labor turnover ratio as low as possible. The main causes under this case are indicated below • Dissatisfaction with job, remuneration, hours of work, working conditions, etc • Strained relationship with management, supervisors or follow workers. • Lack of training facilities and promotional avenues. • Lack of recreational and medical facilities. • Low wages and allowances. Proper and timely management actions reduce the labour turnover appreciably so far as avoidable causes are concerned. Measurement of Labour Turnover Separation Rate Method = Separation during a given period Average number of workers during the period 56 CU IDOL SELF LEARNING MATERIAL (SLM)

(The average of workers is calculated by taking a simple average of workers at the beginning and end of the period.) Net Labour Turnover Rate Method or Number of replacements during a given period Average number of workers during the period ∗ 100Replacement Method= No of seprations +no of new employees Average number of workers during the period ∗ 100Labour Flux Rate Method = BASIC METHODS OF REMUNERATION SYSTEM (1) Time Rate System: The time rate or day rate is related to the hours of wage and is commonly used. The wage rate can be fixed on hourly, daily, weekly, fortnightly or monthly basis depending on the nature of his skill. This method is highly suitable for following types of work: • Where highly skilled and apprentices are working. • Where quality of goods produced is of extreme importance e.g., artistic goods • Where the speed of work is beyond the control of the workers • Where close supervision of work is possible. • Where output cannot be measured. The disadvantages of this method are: • Workers are not motivated. • Workers will get payment for idle time. • Efficient workers will become inefficient in the long run as all of them get same wages. • Employer finds it difficult to calculate labor cost per unit as it varies as production increases and decreases. • Strict supervision is necessary to get the work done. Piece Rate System: Under this system of wage payment, a fixed rate is paid for each unit produced, job completed, or an operation performed. There are four variants of this system. a) Straight piece rate system b) Taylor’s differential piece rate system 57 CU IDOL SELF LEARNING MATERIAL (SLM)

c) Merrick’s multiple piece rate system d) Gant’s task and bonus plan (a) Straight piece rate system Payment is made at a fixed cost per unit based on the number of units generated. Another form is the piece rate with guaranteed time rate, in which the worker is paid at the time rate if his piece rate wages are less than the time rate. (b) Taylor’s Differential Piece Rate system Taylor, the founder of scientific management, devised this method to enable workers to finish their job in the allotted time or less. Efficiency Piece Rate Application Less than 100 % 83 % of normal piece rate 100 % and above 125% of normal piece rate (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. Efficiency level Piece rate Efficiency Piece Rate Application Up to 83% Normal rate 83% to 100% 110% of normal rate Above 100% 120% of normal rate d) Gantt’s Task and Bonus Plan Piece Rate Application Efficiency Normal rate Output below standard 58 CU IDOL SELF LEARNING MATERIAL (SLM)

Output at standard Time rate+ bonus of 20% Output above standard High piece rate fixed to include a bonus of 20% of time rate. e) Barth sharing plan Wages payable = wage per hour * √Time allowed ∗ Time taken f) Emerson’s efficiency plan: Payment Efficiency Normal time rate 0 - 66.67% Normal time rate + 20% bonus 66.67% - 100% Time rate + 20% bonus + 1% for every increase Above 100% (B) PREMIUM BONUS PLANS: 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. The following are some of the important premium plans Halsey Premium Plan Under this 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 33⅓ % to 66⅔ % of the wages of the time saved. Earnings = (Time taken x Hourly rate) + 50% (Time saved x Hourly rate) Illustration Rate per hour = Rs.1.50 per hour Time allowed for job = 20 hours 59 CU IDOL SELF LEARNING MATERIAL (SLM)

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 Therefore, effective rate of earning per hour = Total Wages/ Actual time taken = Rs.26.25 = Rs.1.75 (ii) Rowan Plan: The estimation of the bonus differs between the Halsey and Rowan plans. Staff are guaranteed time wages in this system as well, but the incentive is the proportion of the pay for the time saved relative to the normal time allowed. Total Earnings = T x R +������−������������ x T x R Illustration The following particulars apply to a particular work situation: Standard time allowed 6 hours Rate per hour Re. 10.00 Actual time taken by Worker P - 8 hours Worker Q - 6 hours Worker R - 4 hours Calculate the wages of the workers under Barth Premium System. Also calculate labour cost per hour. Solution: 60 CU IDOL SELF LEARNING MATERIAL (SLM)

Remuneration under Barth Premium System will be calculated as follows: Total wages =√Time taken × Standard time × Hourly Rate Worker P’s remuneration: √8 × 6 × 10 = 69.30 Worker Q’s remuneration: √6 × 6 × 10 = 60 Worker R’s remuneration: √4 × 6 × 10 = 49 Labour cost per hour Total wages paid = 178.30 No. of hours worked = 18 hrs. Labour cost per hour = 178.30 ÷ 18 =9.90. Illustration A workman takes 9 hours to complete a job on daily wages and 6 hours on a scheme of payment by results. His hourly rate is 25 p. The Material cost of the product is ₹4 and factory overheads are recovered at 150% of the total direct wages. Calculate the factory cost of the product under following methods:- (a) Time rate system (b) Halsey Plan (c) Rowan Plan. Solution Computation of factory cost under three systems: Particulars Time Rate HSyaslsteymPlan Rowan Plan Material 444 Labour 2.25 1.88 2 Overheads 3.38 2.82 3 Factory Cost 9.63 8.7 9 Working Notes Halsey Plan Rowan Plan Particulars Time Rate 61 CU IDOL SELF LEARNING MATERIAL (SLM)

Labour 9 x 0.25 6 x 0.25 + 1/2 (9-6) x 6 x 0.25 + (9-6 / 9) x 6 x Total 2.25 0.25 0.25 1.88 2 4.5 OVERHEADS Definition: CIMA defines indirect cost as “expenditure on labor, materials or services which cannot be economically identified with a specific salable cost per unit”. The Indirect cost is the overhead cost and is the total of indirect material cost, indirect labour cost, indirect expenses. It is also called ‘burden’, ‘supplementary costs’, ‘on costs’, ‘indirect expenses’ Classification of Overheads Overheads can be classified on the following basis: Function-wise classification: Overheads can be divided into the following categories on functional basis. Manufacturing or production overheads e.g.: - indirect materials like lubricants, cotton wastes, indirect labor 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. Administration overheads e.g.: - indirect materials like office stationery and printing, indirect labor salaries of office clerks, secretaries, accountants, indirect expenses rent, rates and insurance of office, lighting heating and cleaning of office, etc. Selling and Distribution overheads e.g.: - 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, go down 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. 62 CU IDOL SELF LEARNING MATERIAL (SLM)

(a) Indirect materials (b) Indirect labor (c) Indirect expenses Overheads are costs that can't be readily tracked back to or associated with a single cost category. Such costs are charged for overall production rather than for a certain work order, such as salaries charged to watch and ward workers, factory heating and lighting expenses, and so on. Along with direct supplies and direct labor, overheads are a critical cost factor. Overheads in a production business usually outweigh direct salaries or direct supplies, and in some cases both. On this basis, ignoring overheads when calculating the expense of a work or a commodity, or when managing overall spending, would be a grave error. Overheads also entail costs involved with offering such ancillary equipment or resources that support or allow the manufacturing process to be completed; these services are worthless in and of themselves. A boiler house, for example, generates steam to allow machinery to work, and production would be significantly hindered without it. The boiler house, on the other hand, would be worthless if machinery did not work or did not need steam, and the costs accrued would be a loss. Overheads are incurred not only in the assembly plant, but also in the financial, finance, and logistics divisions. Illustrations 1. From the following information determine the rate per kg of 2 products X and Y PRODUCT A: 6,000 kgs. at Rs.8 per kg. (Rs) PRODUCT B: 4,000 kgs. at Rs.10 per kg. 48000 Tax @ 10% (Credit is not allowed) 40,000 Freight charges 8,800 Total cost 4000 2,28,240 There is a normal loss of 400 kgs of Product A and 400 Kgs of Product B. Solution: Computation of Quantity of Product A and B available for Use: Quantity purchased PRODUCT A (kg.) PRODUCT B (kg.) Less: Normal Loss 6,000 4,000 400 400 63 CU IDOL SELF LEARNING MATERIAL (SLM)

Quantity available 9,500 3600 Statement showing the computation of rate per kg. Purchaseprice 6,[email protected] per kg, PRODUCTA PRODUCT B 4,[email protected] per kg (Rs) (Rs) Add: Tax @10% 48,000 40,000 Add: Freight (intheratioof purchase of goodsi.e.,3:2) 4,800 4000 Total cost (a) Net Quantity (see working above) (b) 2,400 1,600 55200 45600 Rate per kg. (a ÷ b) 9,500 kg. 3600kg. 12.67 5.56 2. A ltd manufactures Product T which requires a Raw material “Q”. The following information for 20xx is given as follows: (i) Demand of Q for the year 4,000 units (ii) Ordering Cost of Q is Rs. 100 per order (iii) Per unit Cost of Q Rs.100 (iv) Carrying cost p.a. 20% The Supplier offers 2% Discount Provided there is a minimum purchase of 2000 Units per order of Q. Determine EOQ and verify whether the discount rate quoted by supplier can be considered. Solution: Calculation of EOQ EOQ = √2CO I Where C = Annual usage of material i.e., 4,000 units. O = Cost of placing one order i.e., Rs.200 I = Annual carrying cost of one unit i.e., Rs.100 x 20%= Rs.20 √= 2∗4000∗100 = 200 Units. 20 Determination about acceptance of Discount offer 64 CU IDOL SELF LEARNING MATERIAL (SLM)

a) Cost When order is based on EOQ 1.Purchase price = 4000*100 = Rs.4,00,000 2.Ordering Cost=20 orders*200= Rs.4000 3.Carrying cost= 200*200*0.5*20/100 =Rs.4000 Total Cost = Rs.4,08,000/- b) Cost When Quantity discount is considered 1.. Purchase price = 4000*100 = Rs.4,00,000 2.Ordering Cost=2 orders*200= Rs.400 3.Carrying Cost = 2000*100*0.5*20/100 = 20000 Total Cost= Rs.4,20,400/- Comparing both options, it is evident from the Total costs in both options that discount based purchase is not favorable to A ltd. 3. Ankur Ltd purchases its Total annual requirement of 16,000 units in 4 instalments. Purchase price of each unit is Rs.2/- and ordering cost is Rs.100 per order. Carrying cost is 10%. Determine the total annual cost of the existing policy. Determine the savings of Ankur Ltd by adopting EOQ technique. Solution: Total Cost Under Existing policy 1.Ordering Cost = 4x100= Rs.400 2.Carrying Cost = 10%x4000x0.5x2=Rs.400 Total cost = Rs.800/- Total Cost when EOQ is adopted EOQ = √2∗16000∗100 = 400 Units 2∗10/100 1.Ordering Cost = 4x100= Rs.400 2.Carrying Cost = 10%x4000x0.5x2=Rs.400 Total cost = Rs.800/- 65 CU IDOL SELF LEARNING MATERIAL (SLM)

Since the existing policy is itself based on EOQ there is no extra savings 4. Calculate Labour turnover rate and Labour flux rate from the following information, Total number of workers in the beginning of the year= 6400 Total number of workers in the end of the year = 7600 Over the year, 60 people resigned and 640 were laid off. 1,400 employees were employed, 350 of whom were hired due to layoffs and the rest were hired in compliance with expansion plans. Labour Turnover rate computation Separation Method = Number of workers left + No. of workers discharged X 100 Average no. workers =60+640 x 100 Avg = 6400+7600/2=7000 7000 = 10% Replacement method = Number of workers replaced X 100 Average no. workers = 350 X 100 = 20% 7000 Flux Method = No. separations + No. accessions X 100 Avg no. workers = 700+1400 X 100 = 30% 7000 QUESTIONS FOR PRACTICE 1. Alpha enterprises produces an exclusive product A For the year 2020, the following information was gathered: Annual consumption 6,000 units (360 days) Per unit Cost Rs.0.5 Ordering cost Rs.6 per order carrying cost 12% 66 CU IDOL SELF LEARNING MATERIAL (SLM)

Normal lead time 15 days 30 days consumption Safety stock Required: (i) Re-order quantity (ii) Re-order level 2. Using Rs.18,00,000 in materials and Rs.3,00,000 in rolling charges, a re-roller created 400 metric tonnes of steel bars. The faulty ten percent of the inventory had to be sold at a discount of ten percent to the price for good supply. Find the purchase price per metric tonne in both types of bars if the sales realization could make the company an overall profit of 25 percent on cost. The scrap produced during the rolling process was sold for Rs.1,20,000. 3. Calculate the minimum stock level, maximum stock level, re-ordering level and average stock level from the following information: (i) Minimum consumption = 100 units per day (ii) Maximum consumption = 150 units per day (iii) Normal consumption = 120 units per day (iv) Re-order period = 10-15 days (v) Re-order quantity = 1,500 units (vi) Normal re-order period = 12 days 4. Two Components X and Y are used as follows Normal Usage - 600 Units per week each. Maximum usage - 900 Units per week each. Minimum Usage - 300 Units per week each. Reorder Quantity – X 4800 units, Y 7200 units. Reorder period: - X=4to6Weeks Y = 2 to 4 weeks. Calculate for each Component: A) Reorder Level B) Minimum Level C) Maximum Level D) Average Stock Level 67 CU IDOL SELF LEARNING MATERIAL (SLM)

5. At a cost of $10 per item, a plastic factory purchases and uses a part for processing. The annual demand is 20,000 units. The annual carrying expense of inventory is 10%, and the cost of buying is $40 per order. The purchasing manager believes that since the buying rate is so high, it is more cost effective to position a large order. A single order for the whole year's supply He also claims that if we buy 20,000 units at once, we can get a discount. The retailer is willing to give us a 3% discount. You must assess this plan and make a decision. 6. Calculate the Economic Order Quantity using the details below. Include the total number of orders that will be placed in a year. Content consumption per year: 5,000 kg The cost of making an order is $20 per order. Cost of raw materials per kilogram: 2 On average, storage costs are 8% of inventory. 7. A, B, and C are three employees in a manufacturing industry that produced 98, 106, and 134 units over a 40-hour work week, respectively. The guaranteed hourly rate is $10, the low piece rate is $4, and the high piece rate is $6 per element. 100 units a week is a high challenge. Under the Taylor, Merrick, and Gantt Task Bonus Plan, calculate gross earnings and labour expense per team. 8. In a warehouse, guaranteed salaries of Rs.2 per hour are charged over the course of a 48- hour workweek. According to a time and motion report, it takes 30 minutes to produce one unit of a specific component, so the time permitted is increased by 25%. A manufactured 360 units of the commodity during the week. Make a calculation of his remuneration in the following ways: (a) Time rate (b) Piece rate with a weekly wage guarantee (c) Premium Bonus from Halsey (d)Rowan Premium Bonus 4.6 SUMMARY • The materials are divided into two categories: direct materials and indirect materials. 68 CU IDOL SELF LEARNING MATERIAL (SLM)

• There are two types of purchasing methods: centralized and localized. Centralized purchasing means that all purchases are done by a single department, while localized purchasing means that each department or division makes its own purchases. • Indenting for goods, issuing tenders and receiving quotes, placing orders, inspecting stores purchased, receiving the stores, and checking and passing bills for payment may all be part of the routine for purchasing materials. • The purpose of receiving supplies, storing them, and issuing them to workshops or departments is known as storekeeping. • Inventory management is the systematic control and regulation of material purchases, storage, and use in order to ensure an even flow of output while preventing unnecessary inventory expenditure. • ABC analysis is a value-based material management method in which materials are analyzed according to their value, with more focus and care paid to more expensive and useful materials. • The Economic Ordering Quantity (EOQ) is the order size that allows for the most cost- effective purchase of any item and, as a result, helps to keep the material at its best performance and lowest cost. • A perpetual inventory system is a way of tracking a store's balances after each receipt and issue, allowing for daily checks and avoiding the need to shut down for stock taking. • Materials are sold to the production department at cost, average, or nominal prices. • Material losses may be graded as either regular or abnormal. • Materials losses may occur as waste, scrap, spoilage, or defectives. • The portion of wages, salaries, or salaries that can be associated with and paid to a single cost unit is known as direct labor cost. • Indirect labor costs are costs that aren't associated with specific cost units. • The term remuneration refers to an employee's overall monetary earnings, which includes hourly or piece-rate salaries as well as other financial benefits. • Workers are paid according to the amount of time they work under the time rate pay structure. • In a piece rate system, wages are determined depending on the amount of work performed. 69 CU IDOL SELF LEARNING MATERIAL (SLM)

• Incentive wage programs are a compromise between time and piece rate schemes in which workers are paid for their hard work. Both the employer and the employees profit from the saved time, and both labor and overhead costs are reduced. • The rate of change in the composition of an organization's labor force is referred to as labor turnover. • Idle time refers to the time spent by employees who are paid on time. • A payroll is a report that indicates the gross wages earned by each employee in a given time, as well as the deductions made and the net wages due. Payroll may be prepared on a weekly, biweekly, or monthly basis. It can be prepared according to department or change. 4.7 KEYWORDS • ABC Analysis: A B C Analysis is the analysis of a range of items, e.g. stock levels, customers, etc. into three groups, viz. A = most important, B = important, C = less important. • Bin Card: Bin Card is a prime entry record of the quantity of stocks, kept on in/out/balance, held in designated storage areas. • Danger Level: Danger Level is the level where only emergency materials are issued and normal issue of materials is stopped. Danger Level = Normal Rate of Consumption × Maximum Re−order period for emergency purchases. • Defectives: Defectives are the goods that can be rectified and turned out as good units by using additional labour or other services. • Direct Material Cost: Direct Material Cost is the cost of materials entering into and becoming constituent elements of a product or saleable service and which can be identified separately in product costs. • First in First Out (FIFO): FIFO is a method of pricing material issues using the oldest purchase price first. • Goods Received Note: Goods Received Note is a document prepared by the Goods Receiving Department that unpacks the goods received and verify the quantities and other details. • Indirect Material Cost: Indirect Material Costs are the materials costs which are not charged directly to a product, e.g. cotton waste, cleaning materials, etc. • Just−in−Time (JIT) Inventory System: Just−in−Time (JIT) Inventory System is a system in which materials are purchased when it is actually needed for production purpose. It is a Japanese philosophy which is used for managing all types of inventory, purchase and production functions in an organization. The main purpose of this philosophy is to reduce inefficiency and unproductive time and cost in the production process. 70 CU IDOL SELF LEARNING MATERIAL (SLM)

• Scrap: Scrap is the discarded material which has some recovery value and which is usually either disposed of without further treatment or reintroduced into the production process in place of raw material. • Simple Average Price: Simple Average Price is the average price of issuing materials which is computed by dividing the total of all units rate by the number of units. Simple Average Issue Price = Total of unit prices of each purchase ÷ Total number of units • Spoilage: Spoilage is the goods damaged beyond rectification to be sold without further processing. • Stores Ledger: Stores Ledger is a ledger containing a separate account for each item of material and component stored giving details of the receipts, issues and balance both in terms of quantity and value. • Abnormal Idle Time: Abnormal Idle Time arises on account of abnormal causes and is generally charged to Costing Profit & Loss Account. • Differential Piece Rate: Differential Piece Rates are applicable for different levels of output below and above the standard. • Differential Time Rate: Under Differential Time Rate System of wage payment different hourly rates are fixed for different levels of efficiency. A fixed rate is paid up to a certain level and thereafter the hourly rate increases gradually depending on the efficiency level. • Direct Labour Cost: Direct Labour Cost is the cost of remuneration for employee’s efforts and skills applied directly to a product or saleable service and which can be identified separately in product costs. • Direct Labour Cost Rate: Direct Labour Cost Rate is the rate calculated by dividing the budgeted or estimated overhead cost attributable to a cost center by the amount of direct labor cost expected to be incurred. • Employee Cost: Employee Costs are the benefits paid or payable to the employees of an entity, whether permanent or temporary, for the services rendered by them. It includes payments made in cash or kind. • Idle Time: Idle Time is the period of time for which the shop floor is available for production but is not utilized due to shortage of materials, tools, operators etc. • Indirect Labor Cost: Indirect Labor Costs are the labor costs which are not charged directly to a product, e. g. supervision. • Labor Turnover: Labor Turnover is the rate of change in employee force during a specified period due to resignation, retirement and retrenchment. If the employee turnover is high, it is a signal of instability and may affect the profitability of the firm. • Normal Idle Time: Normal Idle Time is the time which cannot be avoided or reduced in the normal course of business. The cost of normal idle time is generally charged to the cost of production. 71 CU IDOL SELF LEARNING MATERIAL (SLM)

• Overtime: Overtime is the time an employee works beyond the normal working hours. Generally, over time is to be paid to the employees’ at double the rate of normal hours. • Overtime Premium: Overtime Premium is the amount of extra payment paid to an employee for extra work done • Administrative Overheads: Administrative overheads are the cost of management, secretarial, accounting, and administrative services, which cannot be directly related to the production, marketing, research and development functions of the enterprise. • Classification of Overheads: Classification of Overheads is defined by CIMA as the arrangement of items in logical groups having regard to their nature (subjective classification) or the purpose to be fulfilled (objective classification). • Cost Apportionment: Cost apportionment is that part of cost attribution which shares costs among two or more cost centres or cost units in proportion to the estimated benefit received. In other words, distribution of various items of overheads in proportion to the departments or products on logical or equitable basis is called cost apportionment. • Direct Distribution Method: Under direct distribution method service department costs are apportioned over the production departments only, ignoring the services rendered by one service department to the other. • Reciprocal Service Method: Reciprocal service method is used when different service departments render services to each other, in addition to rendering services to production departments. In such cases various services departments have to share overheads of each other. 4.8 LEARNING ACTIVITY 1. List out variable, fixed and semi variable costs involved in running a Coffee shop ___________________________________________________________________________ ___________________________________________________________________________ 2. Understand EOQ formula derivation. ___________________________________________________________________________ ___________________________________________________________________________ 3. Understand costing in case of Security service agency ___________________________________________________________________________ ___________________________________________________________________________ 4. Determination of cost of service based on the activity in a service providing organization: 72 CU IDOL SELF LEARNING MATERIAL (SLM)

i. Filing income tax return ii. Designing in an Architect firm ___________________________________________________________________________ ___________________________________________________________________________ 4.9 UNIT END QUESTIONS QUESTIONS A. Descriptive Questions Short Questions 1. Define inventory control. Why is inventory control necessary? 2. Distinguish between direct material and indirect material. 3. Re-write the following sentences after filling-in the blank spaces with appropriate word(s)/figure(s): Long Questions: 1. Explain the different methods of time recording for workers. 2. What is idle time? 3. Standard output in 10 hours is 240 units; actual output in 10 hours is 264 units. Wages rate is Rs10 per hour. Calculate the amount of bonus and total wages under Emerson Plan. 4. Following information in an inventory problem is available: • Annual demand 8,400 units • Unit price Rs.2.4 • Ordering cost Rs.4.0 • Storage cost Rs.2% • Interest rate 10% p.a. • Lead time 1/2 month Calculate EOQ, Reorder level and total annual inventory cost. How much does the total inventory cost vary if the unit price is changed to Rs.5? 5. Using Taylor’s differential piece rate system find out the earnings of X and Y from the following particulars: • Standard time per piece - 20 minutes • Normal rate per hour - 90 paise • In a 9 hour day: X produced - 25 units • Y produced - 30 units 73 CU IDOL SELF LEARNING MATERIAL (SLM)

6. The following are particulars applicable to a work process: • Time rate: Rs.5 per hour. High task: 40 units per week. • Piece rate above high task: Rs.6.50 per unit. • In a 40 hour week, the production of the workers: • A - 35 units B - 40 Units C - 41 units D - 52 units Calculate the wages of the workers under Gantt Task Bonus. 11. What do you understand by Semi-Variable Overheads? 12. Write short notes on the following: (a) Out of Pocket Cost. (b) Sunk Cost (c) Opportunity Cost (d) Imputed Costs 13. From the following particulars, prepare stores ledger account under LIFO method. The stock of a material as on 1st April 2008 was 200 units at Rs. 2 each. The following purchases and issues were made subsequently. • April 5 Purchases 100 units at Rs. 2.20 each • 2020 April 10 Purchases 150 units at Rs. 2.40 each • 2020 April 20 Purchases 180 units at Rs. 2.50 each • 2020 April 2 Issues 150 units • 2020 April 7 Issues 100 units • 2020 April 12 Issues 100 units • 2020 April 28 Issues 200 units B. Multiple choice questions 1. Quantitative records of receipts, issue and balance items of material in stores are entered in ___________. a. Stores ledger b. Bin – card c. Job order d. None of these 2. Two important opposing factors in fixing the economic order quantity are __________ and Carrying Cost. a. Holding cost 74 CU IDOL SELF LEARNING MATERIAL (SLM)

b. Purchase cost c. Ordering cost d. None of these 3. The process of physical verification of stores throughout the year is known as_______________. a. Periodic Inventory System b. Perpetual Inventory System c. Both (a) and (b). d. None of these 4. The three categories of inventory for a manufacturer are raw material, work-in-process and __________. a. Loose tools and spares b. Inventory c. Closing stock d. Finished goods 5. A system that keeps a running and continuous record that tracks inventories and cost of goods sold on day-to-day basis is called ___________. a. Periodic Inventory System b. Perpetual Inventory System c. Both (a) and (b). d. None of these. Answers 1 – b, 2 – c, 3 – b, 4 – d, 5 – b. 4.10 REFERENCES Reference Books: • Introduction to Cost Accounting, Charles T. Horngren, PHI. • Cost Accounting, Jawahar Lall & Seema Srivastava, TMH, 4th edition. Textbooks: • Cost and Management Accounting, Arora M N, Vikas Publishing, 8thedition. • Cost Accounting, S.N Maheshwari, S.Chand Publications 75 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT 5: OVERHEAD ALLOCATION AND APPORTIONMENT Structure 5.0 Learning Objectives 5.1 Allocation of Overheads 5.2 Basis of allocation 5.3 Basis of apportionment 5.4 Methods 5.5 Absorption 5.6 Cost ascertainment 5.7 Summary 5.8 Keywords 5.9 Learning Activity 5.10 Unit End Questions 5.11 References 5.0 LEARNING OBJECTIVES After studying this unit students will be able to: • Examine Allocation of Overheads • Analyze Basis of allocation • Describe Methods of overheads. • Examine Cost Ascertainment • Understand basis of apportionment 5.1 ALLOCATION AND APPORTIONMENT OF OVERHEAD TO COST CENTRES (DEPARTMENTALIZATION OF OVERHEAD) After all of the products have been correctly compiled under appropriate account headings, the next move is to allocate and apportion those expenditures to cost centres. This is often referred to as departmentalization or main overhead allocation. Manufacturing or producing units, service departments, and partially producing departments are the administrative divisions of a plant. Overhead Expenses Allocation The method of allocating overheads to cost centres is known as allocation. An expense that can be traced back to a particular cost centre is assigned to that 76 CU IDOL SELF LEARNING MATERIAL (SLM)

centre. As a result, it is the allocation of a complete cost item to a cost centre or cost unit. For instance, a department's overall overtime wages should be paid to that department. Overhead Expenses Reimbursement The allotment of proportions of cost-to-cost centres or cost units is known as cost apportionment. If an expense is incurred by two or more divisions or units, it must be divided among them according to the value they get. Rent and rates, depreciation, repairs and maintenance, lighting, and the wage of the works manager are all examples of overheads. 5.2 BASIS OF APPORTIONMENT 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’. Direct Allocation: Under direct allocation, overheads are directly allocated to the department for which it is incurred. • 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. • Value of materials passing through cost centers This basis is adopted for expenses associated with material such as material handling expenses. • Direct wages Expenses which are booked with the amounts of wages ex: worker’s insurance, their contribution to provident fund, worker’s compensation etc. are distributed amongst the departments in the ratio of wages. Service Department Cost Basis of Apportionment Maintenance Department Hours worked for each department Payroll or time-keeping Total labour or Machine hours or number of employees in department each department Store keeping department no. of requisitions or value of materials of each department. 77 CU IDOL SELF LEARNING MATERIAL (SLM)

Employment or Personnel Rate of labour turnover or number of employees in each department. department. Purchase Department no. of purchase orders or value of materials 5.3 METHODS OF RE-DISTRIBUTION The following are the various methods of re-distribution of service department costs to production departments. • Direct re-distribution method • Step distribution method • Reciprocal Services method • Repeated Distribution Method • Trial and Error Method Direct re-distribution method • In this form, service department expenses are directly apportioned to production departments without taking into account any service provided by one service department to another. As a result, proper apportionment cannot be achieved based on the premise that service departments do not represent one another, and production departments can be overcharged or undercharged as a result. • The share of each service department cannot be reliably determined for control purposes. • It is impossible to plan a detailed budget for each department. As a result, the rates of Department Overhead cannot be accurately calculated. Step Distribution Method • In this process, the most serviceable department's expense is distributed first to other service and development departments. • The cost of the next service department is apportioned, and so on until the cost of the last service department is apportioned, leaving only development departments with the cost of the last service department. Reciprocal Services Method • This approach is used to avoid the drawbacks of the Phase Method. 78 CU IDOL SELF LEARNING MATERIAL (SLM)

• This system recognizes that if one agency receives service from another, the department that receives the service should be paid. • If two agencies offer services to one another, each should be responsible for the expense of the other's services. Repeated Distribution Method The totals are shown in the departmental delivery summary, laid out in a line, and then the service department totals are exhausted one by one according to the negotiated percentages until the figures become insignificant. Trial and Error Method The expense of one service department is apportioned to another centre using this process. The cost of another centre, plus the share earned from the first, is apportioned to the first cost centre once more, and the procedure is repeated until the balancing figure is negligible. 5.5 ABSORPTION OF OVERHEAD The distribution of overhead expenses allocated to a specific department over the units generated in that department is known as absorption. Overhead rates are used to absorb overhead costs. 5.6 COST ASCERTAINMENT • Cost accounting gathers and analyses expenditures, tracks commodity output at various levels of production, and connects production with expenses. • It thus determines or estimates Historical or Actual costs, estimated costs, normal costs, and so on. • It also uses various costing techniques to connect production and expenditures, such as the marginal cost technique, total cost technique, direct cost technique, and so on. Illustrations 79 CU IDOL SELF LEARNING MATERIAL (SLM)

Illustration A factory has 3 production departments (P1, P2, P3) and 2 service departments (S1 & S2). The following overheads & other information are extracted from the books for the month of January 2016. Rent 6,000 Repair 3,600 Depreciation 2,700 Lighting Supervision 600 Fire Insurance for stock 9,000 ESI contribution 3,000 Power 900 5,400 Particulars P1 P2 P3 S1 S2 Area sq ft No. of workers 400 300 270 150 80 Wages Value of plant 54 48 36 24 18 Stock Value Horse power of plant 18,000 15,000 12,000 9,000 6,000 72,000 54,000 48,000 6,000 45,000 27,000 18,000 600 400 300 150 50 Allocate or apportion the overheads among the various departments on suitable basis. Solution: The primary distribution of overheads is as follows:- Expense Total Basis P1 P2 P3 S1 S2 Rent Repair 6,000 Area sq ft 2,000 1,500 1,350 750 400 Depreciation Lighting 3,600 Plant value 1,440 1,080 960 120 Supervision Fire Insurance for stock 2,700 Plant value 1,080 810 720 90 ESI contribution Power 600 Area sq ft 200 150 135 75 40 Total 9,000 No of workers 2,700 2,400 1,800 1,200 900 3,000 Stock value 1,500 900 600 900 wages 270 225 180 135 90 5,400 Horse power 2,160 1,440 1,080 540 180 31,200 11,350 8,505 6,825 2,910 1,610 1.From the information given for first and second quarter for the year ended of Alpha Ltd., Compute the variable cost per unit, fixed cost, and segregate semi-variable cost. QUARTER 1 QUARTER 2 Production 18000 units Production 21,000 units 80 CU IDOL SELF LEARNING MATERIAL (SLM)

Semi-variable cost Rs.1,40,000 Semi-variable cost Rs.1,50,000 Solution: Variable cost per unit = change in semivariable cost change in units = 155000−140000 21000−18000 = Rs. 5 per. unit Fixed cost = Semi Variable cost – Variable cost For Quarter 1= 1,40,000 – (18,000 x 5) = 1,40,000 – 90,000 = Rs. 50,000/- For Quarter 2 = 1,55,000 – (21,000 x 5) = 1,55,000 – 1,05,000 = Rs.50,000/- 2: From the following information given, Compute the Departmental overhead rates for each production department. Overheads are recovered on the basis of direct wages PARTICULARS PRODUCTION SERVICE DEPARTMENT DEPARTMENT XY Z AB Direct material 30000 60000 60000 45000 45000 No. of employees 3000 4500 4500 1500 1500 Wages 60000 90000 120000 30000 60000 Assets 120000 80000 60000 20000 20000 Area(in sq.meters) 300 500 100 100 100 81 CU IDOL SELF LEARNING MATERIAL (SLM)

No. of Light 20 32 8 12 8 Points Electricity 12000 9000 6000 3000 3000 consumed The expenses incurred during the period is given as follows: Depreciation- 60000; Repairs – 12000; General overheads – 24000; Power – 2200; Lighting – 400; Rates and Taxes – 1100; Staff Welfare – 6000; Stores – 1600; Apportion the services department expenses of Depart. B According to direct wages and of Depart. A in 5:3:2. Solution: Statement showing apportionment of overheads Particulars Basis Total(Rs.) X (Rs.) Y (Rs.) Z A (Rs.) B (Rs.) (Rs.) Material Actual 90000 - - - 45000 45000 Wages Actual 90000 - - - 30000 60000 Power Consumption 2200 800 600 400 200 200 (4:3:2:1:1) Lighting Lighting Points 400 100 160 40 60 40 (5:8:2:3:2) Depreciation Asset 60000 24000 16000 12000 4000 4000 Value(6:4:3:1:1) Repairs Asset 12000 4800 3200 2400 800 800 Value(6:4:3:1:1) Staff No. of workers 6000 1200 1800 1800 600 600 Welfare Stores Materials 1600 200 400 400 300 300 (2:4:4:3:3) Rates and Area (3:5:1:1:1) 1100 300 500 100 100 100 Taxes General Direct 24000 4000 6000 8000 2000 4000 82 CU IDOL SELF LEARNING MATERIAL (SLM)

Overheads Wages(2:3:4:1:2) 35400 28660 25140 83060 115040 41530 24918 16612 (83060) 287300 25564 38346 51130 (115040) COSTS OF 5:3:2 A 102494 91924 92882 COSTS OF 2:3:4 B TOTAL Overhead rate as a percentage of direct wages X = (102494 / 60000) x 100 = 170.8 Y = (91924 / 90000) x 100 = 102.13 Z = (92882 / 120000) x 100 = 77.401 3: From the following information, determine the overheads chargeable to the job using 4 commonly used methods. PARTICULARS Labour Hours 6000 Direct material 18000 Direct wages 15000 Hours of operation of machinery 10000 hrs. Overhead chargeable to dept. 12500 From the data collected, when Job 101 was executed by the dept. It reveals as, Direct materials used------3000 83 CU IDOL SELF LEARNING MATERIAL (SLM)

Direct wages---------------2475 Machine Hrs.-----------------600 Labour Hrs.-------------------825 Solution: Based on the four common methods of recovering overheads, Percentage of overheads on materials = 12500 x 100 18000 = 69.43 Percentage of overheads on direct wages = 12500 x 100 15000 = 83.32 Overhead rate per labor hour = 12500 6000 = 2.0833 Machine hour rate = 12500 10000 = 1.25 Overheads chargeable based on the above methods is as follows Material = 3000 x 69.44% = 2083.2 Wages = 2475 x 83.33% = 2062.4 Labour hour rate = 825 x 2.083 = 1718.75 Machine hour rate = 600 x 1.25 = 750 4.Manju Ltd a manufacturing company has 2 production departments F and G and 3 service departments Stores, Maintenance and Time Office. Overheads of each of these departments is listed below for the month of September Production Department F- 12000 Production Department G- 8000 Stores – 2500 Maintenance – 1500 Time Office – 2000 84 CU IDOL SELF LEARNING MATERIAL (SLM)

Production Service departments departments Particulars G Stores Time Maintenance F office No of employees No of stores requisition slips 20 15 10 8 5 12 10 3 Machine Hours 1200 800 Apportion to the production departments the costs of service departments using Primary Distribution Method. Solution: The following is the logical and sequential basis on which overheads shall be distributed 1.Time office- Staff strength 2.Stores- No. of store requisitions 3.Maintenance- Machine hours Solution Based on the information given we can observe that Time office provides service to all departments, Stores department provides services to Production departments and maintenance department Particulars Total Basis F G Time Stores Maintenance 8,000 office As per26,000 as given 12000 2,000 2,500 1,500 primary distribution Time office 2,000 no of 8,00 6,00 (2,000) 400 200 1160 (2,900) 348 employees 819 (2,048) 10579 Stores 2900 no of req. 1392 slips Maintenance 2048 Machine 1229 hours Total 15421 85 CU IDOL SELF LEARNING MATERIAL (SLM)

5. Three components are manufactured from various materials in a factory using a common technique. Production costs for a given time are as follows: Product A Product B Product C 4,000 1600 Material used 3200 2,000 800 1300 700 Direct labor cost 2400 Overhead (actual) 1600 Overhead is charged at a rate of 20% on prime cost to each product's output. Is there something fundamentally wrong with this form of charging overheads? If this is the case, recommend a better form. Solution Since various materials are used to make goods, it is more advisable, preferable, and necessary to absorb overheads dependent on percent of materials rather than percent of prime cost, as seen below. Materials ABC 3200 4,000 1600 Labour Prime Cost 2400 2,000 800 OH @ 20% on prime cost 5600 6,000 2400 1120 1200 480 % of OH on Material Cost: A = [1120/3200 x 100] = 35% B = [1200/4000 x 100] = 30% C= [480/1600 x 100] = 30% Questions for practice 1. You are required to calculate the machine hour rate from the following particulars. a. Cost of the machine Rs10,000/- its estimated working life is 10 years and the estimated scrap value at the end of its life is Rs1,000. The estimated working time per year (50 weeks of 40 hours each) is 2,000 hours. 86 CU IDOL SELF LEARNING MATERIAL (SLM)

b. Electricity used by the machine is 16 units per hour at the cost of Rs.0.10 per unit. c. The machine requires a chemical solution which is replaced at the end of each week at cost of Rs.20/- each time. d. The estimated cost of maintenance per year is Rs.1,200. e. Two attendants control the operation of the machine together with five other identical machines their combined week wages amount to Rs.120. f. Departmental and General works overheads allocated to the machine for the year were Rs. 2,000 (CMA Exam) 2. The following details pertain to the production department of a factory. Materials consumed Rs.60,000 Direct Wages Rs.40,000 Machine Hours 50,000 Labour hours worked 25,000 Factory overhead relating to the department Rs.50,000 Calculate overhead absorption rates under different possible methods from the above details. 5.7 SUMMARY • Administrative Overheads: Administrative overheads are the cost of management, secretarial, accounting and administrative services, which cannot be directly related to the production, marketing, research and development functions of the enterprise. CAS- 3 defines administrative overheads as the cost of all activities relating to general management and administration of an organization. • Blanket Overhead Rates: Blanket overhead rate refers to the computation of one single overhead rate for the whole factory. • Cost Allocation: CIMA defines cost allocation as the charging of discrete, identifiable items of cost to cost centres or cost units. It is the complete distribution of an item of overhead to the departments or products on logical or equitable basis. In other words, cost 87 CU IDOL SELF LEARNING MATERIAL (SLM)

allocation is that part of cost attribution which charges specific cost to a cost centre or cost unit. • Cost Apportionment: Cost apportionment is that part of cost attribution which shares costs among two or more cost centres or cost units in proportion to the estimated benefit received. Direct Distribution Method: Service department costs are apportioned over the production departments only in the direct delivery process, ignoring services provided by one service department to another. • A factory overhead object is assigned a code number called a standing order number. • Overhead allocation is the method of allocating all of a company's overhead costs to a single cost centre. • Primary overhead distribution entails the redistribution or apportionment of various overhead products to all factory departments. This is also known as overhead departmentalization. • Secondary overhead allocation is the method of allocating service department overheads to production departments. • The allotment of overheads to cost units is referred to as absorption of overheads. • A pre-determined overhead rate is measured by dividing an accounting period's budgeted overheads by the period's budgeted base. • The amount by which real overhead exceeds the overhead consumed by applying a fixed rate is referred to as unabsorbed overhead. 5.8 KEYWORDS • Reciprocal Service Method: Reciprocal service method is used when different service departments render services to each other, in addition to rendering services to production departments. In such cases various services departments have to share overheads of each other. • Under or Over-absorbed Overhead: Under or over-absorbed overhead is the difference between overhead cost incurred and overhead cost absorbed. If the amount absorbed is less than the amount incurred, which may be due to actual expenses exceeding the estimate and/ or the output or the hours worked being less than the estimate, the difference denotes under-absorption. On the other hand, if the amount absorbed is more than the expenditure incurred, which may be due to the expense 88 CU IDOL SELF LEARNING MATERIAL (SLM)

being less than estimate and/ or the output or hours worked being more than the estimate, this would indicate over- absorption. • Variable Overheads: Variable overheads are the costs which vary totally in direct proportion to the volume of output. These costs fluctuate in total amount but tend to remain constant per unit as production activity changes. 5.9 LEARNING ACTIVITY 1. Determine how overheads like building insurance premium, electricity, Canteen expenses, Fuel expenses, Rent, Security services, Customer Vehicle parking rent, Housekeeping salary, repair and maintenance are allotted to various departments in a shopping complex having 5 floors: 1.Floor-1 Jewelry shop 4. Floor -4 Canteen for customers and employees 2.Floor-2-Grocery shop 5. Floor-5 Home appliances 3.Floor -3-Dress material ___________________________________________________________________________ ___________________________________________________________________________ 5.10 UNIT END QUESTIONS QUESTIONS A. Descriptive Questions Short Questions 1. You are required to calculate the machine hour rate from the following particulars. (a) Cost of the machine 10,000/- its estimated working life is 10 years and the estimated scrap value at the end of its life is Rs.1,000. (b) The estimated working time per year (50 weeks of 40 hours each) is 2,000 hours. (c) Electricity used by the machine is 16 units per hour at the cost of 0.10 per unit. (d) The machine requires a chemical solution which is replaced at the end of each week at cost of 20/- each time. (e) The estimated cost of maintenance per year is 1,200. (f) Two attendants control the operation of the machine together with five other identical machines their combined week wages amount to 120. (g) Departmental and General works overheads allocated to the machine for the year were 2,000. 2. From the following data segregate fixed cost and variable costs. Particulars Level of Activity 89 CU IDOL SELF LEARNING MATERIAL (SLM)

Capacity 80 100 Labour hours 400 500 Maintenance expense 2600 2750 3. What is meant by classification of overheads and why it should be attempted? 4. What do you understand by Semi-Variable Overheads? Explain the various methods of segregating Fixed and Variable Overhead Costs. 5. What are the main sources of overhead expenses? State with examples the procedure for such collection from these sources. Long Questions 1. How are the following items treated in Cost Accounts? a. Defectives due to bad workmanship and bad materials. b. Major repairs of a plant to prolong its useful life. c. Labour amenities. d. ESI contribution e. Fringe benefits to workers. f. After sales service cost g. Losses due to obsolescence. h. Lay off wages paid to workers. 2. Explain redistribution of Overheads by service department to other departments 3. Explain departmentalization of Overheads 4. What is meant by a cost center and apportionment of various overheads to cost centers 5. State the statement is true or false: (a) Departments that assist producing Department indirectly are called service departments. (b) Factory overhead cost applied to a job is usually based on a per-determined rate. (c) Variable overhead very with time. (d) When actual overhead are more than absorbed overheads, it is known as over- absorption. (e) Cash discounts are generally excluded completely from the costs. (f) Cost of indirect materials is apportioned to various departments. (g) A blanket overhead rate is a single overhead rate computed for the entire factory. (h) Under-absorption of overhead means that actual overhead are more than absorbed overhead. (i) The principal based used for applying factory overhead are: units of production, material cost, direct wages, direct labour hours and machine hours. (j) Allocation, for overhead implies the identification of overhead cost centres to which they relate. 90 CU IDOL SELF LEARNING MATERIAL (SLM)

[Ans: True: a, b, e, j False: c, d, f, g, h, i] B. Multiple Choice questions 1. The allotment of whole items of cost of centers or cost unit is called a. Cost allocation b. Cost apportionment c. Overhead absorption d. None of these 2. Packing cost is a a. Production of cost b. Selling cost c. Distribution cost d. It may be any or the above 3. Director’s remuneration and expenses form a part of a. Production overhead b. Administration overhead c. Selling overhead d. Distribution overhead 4. Charging to a cost center those overheads that result solely for the existence of that cost Center is known as a. Allocation b. Apportionment c. Absorption d. Allotment 5. Absorption means a. Charging or overheads to cost centers b. Charging or overheads to cost units c. Charging or overheads to cost centers or cost units d. None of these 91 CU IDOL SELF LEARNING MATERIAL (SLM)

6. Which method of absorption of factory overheads do you suggest in a concern which Produces only one uniform time of product a. Percentage of direct wages basis b. Direct labor rate c. Machine hour rate d. A rate per units of output Answer 1-A,2- D,3- B,4- A,5- B,6- D 5.11 REFERENCES Textbooks: • T1 Introduction to Cost Accounting, Charles T. Horngren, PHI. • T2 Cost Accounting, Jawahar Lall & Seema Srivastava, TMH, 4th edition. Reference Books: • R1 Cost and Management Accounting, Arora M N, Vikas Publishing, 8thedition. • R2 Cost Accounting, S.N Maheshwari, S.Chand Publications 92 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT 6: UNIT COSTING Structure 6.0 Learning Objectives 6.1 Introduction 6.2 Cost sheet 6.3 Treatment 6.4 Uses of cost sheet 6.5 Items excluded in cost sheet 6.6 Tender/Quotation Price 6.7 Summary 6.8 Keywords 6.9 Learning Activity 6.10 Unit End Questions 6.11 References 6.0 LEARNING OBJECTIVES After studying this unit students will be able to: • Prepare Cost sheet • Uses of cost sheet • Treatment of stock, raw material etc. 6.1 INTRODUCTION Unit costing refers to the costing procedure, under which costs are accumulated and analyzed under different elements of cost and then cost per unit is ascertained by dividing the total cost by number of units produced. It is ideally used in case of concerns producing a single article on large scale by continuous manufacture. The units of output are identical. The products are homogenous. Concern using single or output costing produces basically one product or two or more grades of one product. It is not necessary to maintain separate cost accounts under this system. as all the information required can be obtained only by organizing and analyzing the financial accounts. On dividing the total expenditure incurred by the number of units produced, the cost per unit is ascertained. This system of costing is suitable for breweries, collieries, cement works, steel, brick making, flour mills etc. In all these cases the unit cost of the article produced requires to be ascertained. 93 CU IDOL SELF LEARNING MATERIAL (SLM)

The information on expenditure incurred on material, labour and direct expenses can be available without any special difficulty. The works and administration expenses actually incurred also are included in the total cost. Items of indirect expenses which are paid at periodical intervals are included in cost accounts on the basis of estimates. Selling and distributing expenses are not included in cost sheets since these have no connection with the quantity produced, If, however, it is decided to include them, the same also are estimated on the basis of past experience. 6.2 COST SHEET Cost sheet is a document which provides for the assembly of the detailed cost of a cost centre or cost unit. It is a periodical statement of cost designed to show in detail the various components of cost of goods produced like prime cost, factory cost, cost of production, total cost and cost per unit. A specimen of a simple cost sheet is given below: Cost sheet for the period …………. Units produced ……….. Particulars Total cost (in Rs.) Cost per unit (in Rs.) Direct material Direct labour Direct expenses Prime cost Add: Works overheads Works cost Add: Admin. Overheads Cost of production Add: Selling and distribution Overheads Cost of goods sold Add: Margin Sales The terms “direct expenses” have been excluded from prime cost as per CIMA terminology i.e. according to CIMA, prime cost is “the total cost of direct material and direct Labour”. 94 CU IDOL SELF LEARNING MATERIAL (SLM)

If possible, the cost sheet should have columns for (i) total cost. (ii) percentage to total cost. (iii) cost per unit; and (iv) Corresponding figures of the previous period and clear figures for each element of cost. 6.3 TREATMENT OF STOCK,RAW MATERIAL,WIP AND FINISHED GOODS Stock requires special treatment while preparing a cost sheet. Stock may be of raw materials, work-in progress and finished goods Stock of raw material If opening stock of raw material, purchase of raw materials and closing stock of raw materials are given, then, raw material consumed can be calculated as follows: Raw material consumed = Opening stock + Purchases – Closing stock Stock of Work in progress (WIP) Work-in-progress is valued at prime cost or works cost basis, but latter is preferred. If it is valued at works or factory cost, then opening and closing stock will be adjusted as follows: Works cost = Prime cost + Factory overheads + opening WIP – Closing WIP Stock of Finished goods (FG) If opening and closing stock of finished goods are given, then these must be adjusted before calculating cost of goods sold: Cost of goods sold = Cost of Production + opening FG – Closing FG 6.4 USES OF COST SHEET • It offers information to management for cost control. • It provides a comparative analysis of real current costs with the cost of comparable periods, enabling management to detect and correct inefficiencies and waste. • It serves as a reference for manufacturers in establishing acceptable and definitive strategies and deciding the selling price. 95 CU IDOL SELF LEARNING MATERIAL (SLM)

6.5 ITEMS EXCLUDED FROM COST SHEET The following items are of financial nature and thus not included while preparing a cost sheet. • Cash discount • Interest paid • Preliminary expenses written off • Goodwill written off • Provision for taxation • Provision for bad debts • Transfer to reserves • Donations • Income tax paid • Dividend paid • Profit/loss on sale of assets • Damages payable at law etc. Illustration The following particulars have been extracted from the books of a manufacturing company for the month of March 2013: Out of 48 working hours in a week, the time devoted by the Manager to the factory and office was on an average 40 hours and 8 hours respectively throughout the month. 1,00,000 units were produced and sold; there was no opening or closing stock of it. Prepare a cost sheet showing the following: Cost of Materials Consumed; (ii) Prime Cost; (iii) Works Overhead; (iv) Works Cost; (v) Office and Administration Overhead; (vi) Cost of Production; (vii) Selling and Distribution Overhead; and (viii) Total Cost or Cost Sales. 96 CU IDOL SELF LEARNING MATERIAL (SLM)

Particulars Amount in Rs. Stock of materials as on 1st March, 2013 47,000 Stock of materials as on 31st March, 2013 50,000 Materials purchased during the month Drawing office salaries 2,08,000 Counting house salaries 9,600 Carriage on purchases 14,000 Carriage on sales 8,200 Cash discount allowed 5,100 Bad debts written off 3,400 Repairs of plant, machinery and tools 4,700 Rent, rates, taxes and insurance (factory) 10,600 Rent, rates, taxes and insurance (office) 3,000 Travelling expenses 1,000 Travellers’ salaries and commission 3,100 Productive wages 8,400 Depreciation written off on plant, machinery and tools Depreciation written off on office furniture 1,40,000 Directors’ fees 7,100 Gas and water charges (factory) 600 Gas and water charges (office) 6,000 General charges 1,500 Manager’s salary 300 5,000 Solution: 12,000 Note: Cash discount to be excluded from the cost sheet 97 CU IDOL SELF LEARNING MATERIAL (SLM)

Particulars Rs. Total Cost % to total cost Cost per unit Stock of materials as on 1st March, 2013 47,000 Add: Purchase of material 2,13,200 47.89% 2.132 Add: Carriage on purchases 2,08,000 1,40,000 31.45% 1.4 Available for consumption 8,200 3,53,200 79.34% Less: Stock of materials as on 31st March, 2013 3.532 Direct labour 2,63,200 Prime cost 50,000 Add: Works OH Drawing office salaries 9,600 41,800 9.39% 0.418 Repairs of plant, machinery and tools 10,600 Rent, rates, taxes and insurance (factory) 3,000 Depreciation written off on plant, machinery and tools 7,100 Gas and water charges (factory) Manager's salary (12,000 * 40/48) 1,500 10,000 Works Cost 14,000 3,95,000 88.72% 3.95 Add: Admin OH 1,000 28,900 6.49% 0.289 Counting house salaries Rent, rates, taxes and insurance (office) 600 Depreciation written off on office furniture 6,000 Directors’ fees Gas and water charges (office) 300 General charges 5,000 Manager's salary (12,000 * 8/48) 2,000 Cost of production 4,23,900 95.22% 4.239 Add: Selling and Distribution OH Carriage on sales 5,100 0.213 Bad debts written off 4,700 4.452 Travelling expenses 3,100 Travellers’ salaries and commission 8,400 21,300 4.78% Cost of sales 4,45,200 100.00% 98 CU IDOL SELF LEARNING MATERIAL (SLM)

6.6 TENDER/QUOTATION PRICE . A manufacturer of consumable durable goods, capital goods, and other commodities is often requested to estimate the price at which they will deliver their output. It is necessary to estimate various cost components. The price at which the production goods are sold for sale is referred to as a \"tender\" or \"quotation.\" A tender must be properly prepared before being approved, and supplies must be supplied at the quoted price in the future. In order to prepare a tender, the following details are to be analyzed. 1. Raw material 2. Direct Labour ex. 3. Direct expenses (or) chargeable expenses 4. Factory/ work overheads 5. Office and administration overheads 6. Selling & Distribution overheads 7. Estimated profit It is necessary to estimate various cost components. Direct material and Labour costs are typically measured using the previous period's cost per unit, which is subject to variations in material and Labour prices. Overhead is calculated as a percentage based on previous experience as follows: Generally, Overheads are Estimated on the basis of past experience on the following basis: 1.Percentage of Factory overheads to wages = Factory Overheads/ direct wages X 100 2.Percentage of Office and administrative overheads to works cost = Administration overheads X100 Works cost 3.Percentage of selling and distribution overheads = Selling & distribution overheads X100 Works cost Estimation of profit: Sometimes profit is given as percentage of cost (profit on cost). In that profit for the tender (or) question is ascertained as given below. Profit = Cost of goods sold X percentage of profit 99 100 CU IDOL SELF LEARNING MATERIAL (SLM)

When profit is determined as a percentage of selling price Profit = Selling Price X percentage of profit on sales 100 Standard assumption: In the context of tender or quotations, the following assumptions can be made if nothing contrary is given in the problem. (a) Factory / work overheads to direct wages ratio of the preceding period holds good for current period also (b) Office and Administrative overhead to work/ factory cost ratio of the previous period is applicable in current period also. Illustration From the following information of a Manufacturing entity calculate the price which the company must Quote for manufacturing a Consumer durable X Direct material- Rs.300000/- Wages- Rs.2,40,000/- Factory Overheads- Rs.60,000/- Administrative expenses- Rs.30,000/- Prepare cost sheet and for manufacturing one unit of a product it requires material worth Rs.2500/- and expenditure in wages Rs.1500/- and estimated price must yield a profit of 20% on selling price STATEMENT OF COST PARTICULARS AMOUNT(RS.) 1.Material 3,00,000 2.Wages 2,40,000 3.Prime Cost(1+2) 5,40,000 4.Factory Overheads 60,000 5.Works Cost(3+4) 6,00,000 100 CU IDOL SELF LEARNING MATERIAL (SLM)