basic concepts in costing costing theory 1st chapter

8/15/2019 Basic Concepts in Costing Costing Theory 1st Chapter

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M A S T E R M I N D S - Q U A L I T Y E D U C A T I O N B E Y O N D Y O U R I M A G I N A T I O N

1 . BASIC CONCEPTS

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Compare cost accounting with financial accounting.

Compare cost accounting and management accounting?

Define the term ‘cost’. Compare it with “Value” and “Price”?

What are the advantages/ objectives of a cost accounting system.

Discuss the role of the cost accountant in a manufacturing organisation

How are costs classified?

Give different classifications of overheads.

Write short notes on explicit and implicit costs.

Distinguish between committed fixed costs and discretionary fixedcosts?

Distinguish between conversion cost and added value?

How are costs classified on the basis of normality?

Write short notes on period costs and product costs. Why shouldproduct costs be computed?

Distinguish between period costs and product costs?

How is cost ascertainment classified, based on the fine period ofascertaining costs?

Methods of Costing.

Write about unit cost method for ascertaining product cost.

What are the essential features of a good Cost Accounting System?

Steps involved in installing a costing system in a manufacturing unit.

Factors that you will consider before installing a costing system.

You have been asked to install a costing system in a manufacturing business. What practical difficulties, apart from technical costingproblems, would you expect to meet and how would you propose toovercome them?

Reports provided by the cost accounting department.

Items not regarded as cost and not included in cost sheet.

Production account Vs. Cost sheet

What is cost reduction & what are its advantages

Distinguish between cost reduction and cost control



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Q . N O . 1 . C O M P A R E C O S T A C C O U N T I N G W I T H F I N A N C I A L A C C O U N T I N G ( O R ) D O E S C O S T

A C C O U N T I N G S U P P L E M E N T F I N A N C I A L A C C O U N T I N G ? D I S C U S S .

Pa r t i c u l a r s F i n a n c i a l Ac co un t i n g Co st Ac coun t i n g

Users Financial statements are used byinternal management and also byoutsiders (Creditors, Shareholders,

Customers, Government).

Detailed cost information is used byinternal management for properplanning, decision-making and control.

S t a t u t o r y

Requ i r emen t s

Requirements of Companies Act andthe Income Tax Act are to be met.

This is voluntary except when Cost Accounting Records Rules apply.

Na t u r e Accounting of the monetary

transactions of the business. Accounting of product or service

cos t .

Cost An a l y s i s Costs and Profits are shown as awhole for the pe riod.

Costs are analysed product-wise,

departm ent-wise , act iv i ty-wise etc .

Resu l t s i n t o Leads to preparation of incomestatement & balance sheet atperiodical interval.

Leads to development of product orservice cost, indicating the profitabilityof each product or service .

S t o ck Va l u e At Cost or NRV whichever is less. Stocks are valued at cos t .

T im e pe r i o d Financial Statements are generallyprepared at the end of the financialperiod, generally one year.

Cost reports are presented on acontinuous basis for the cost period. The cost period is usu ally < 1 y ear.

A u d i t Subject to financial audit. Cost audit in not compulsory exceptfor a few industries.

Focus Focus of accounting is on recording the transactions.

Focus of accounting is to control cost .

Na t u r e o f

Costs

Generally historical costs are usedfor recording purposes.

It considers both historical and future costs for control & decision making.

Q.NO.2 . COMPARE COST ACCOUNTING AND MANAGEMENT ACCOUNTING? (IY)

Points of dis t inct ion: A comparison of the above definitions of Cost Accoun ting on the one hand,and management account ing , on the other, given by the C.I.M.A. Official terminology, reveals thatit is no longer worthwhile to dist inguish betwee n the two inter – related disciplines as two branchesof accounting. It is, in fact, safe to adopt the view of Dobson that management accounting is so broad and comprehensive as to include both financial and cost accounting.

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What are the precautions in implementation of cost reductionprogramme?

Write about long – range and short – range cost control and cost –reduction programme?

Write short notes on uniform costing & object ives

Write short notes on Uniform Cost Manual?

Write four limitations of inter – firm comparison.

Write short notes on value Analysis.

Write a short note on Direct Expenses?

What are the methods of segregating semi – valuable costs in to fixedand variable costs?

Define the followings:



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From the academic point of view, however, the following points may be cited to distinguish one fromthe other:

a. Cost accounting provides just cost information for managerial purposes, while managementaccounting provides all accounting information, i.e., not merely c o s t information but financial

information as well.

b.

The scope of management accounting is much wider than that of cost accounting. Relatively,therefore, management accounting uses more advanced techniques of management reporting.

c . In providing cost information, cost accounting uses financial information provided by financialaccounting by class i fying the expenses under heads of performance, after minutely dissectingevery item of expenditure. Management accounting uses both c ost and f inancial information.

d. Cost accounting evolved out of financial accounting, while management accounting evolved out

of cost accounting.

e . The main purpose of cost accounting is the reporting of curren t and prospec tive costs ofproduct, service, department, hob, process and operations. It is oriented towards managerial

control of current and future operations of an enterprise.

Management accounting, on the other hand, is concerned with the provision of accounting

information to management at all levels for the purpose of formulation of policies , planning,execution of plans, controlling the activities of an enterprise through measurement ofperformance, investigation of the potential costs and benefit of alternative future courses ofaction, and there by ensure maximization of profit.

f. The cost accountant is interested in preparing budget s , setting standards, measuring actualperformance with the set standards, and reporting significant deviations for necessary action, besides cost ascertainment.

However, the management accountant will go a step further in making variance analys is andsuggesting ways suggesting ways and means of improving the efficiency of operations. Heconcentrates his attention on matters relating to finance, profitability and productivity.

g. While s tewardship acco unting led to the evolution of cost accounting a sound system of cost

accounting led to the evolution of management accounting.

h. While cost accounting may also be called control accounting, management accounting may be

called decision – making accounting

Q.NO.3 . DEFINE THE TERM ‘COST’. COMPARE IT WITH “VALUE” AND “PRICE”? (P)

1. Meaning of Cost:

a) Cost refers to the expenditure incurred in producing a product or in rendering a service.

b) It is expressed from the producer or manufacturer’s viewpoint. (not that of consumer/ enduser).

c) Cost ascertainment is based on uniform principles and techniques. Hence cost is objectively(and subjectively) determined.

2. Com parative Analysis betwee n Value, Price and Cost :

Partic ulars Value Price Cost

Meaning Relative Worth ofa commodity toan individual at aparticular point

of t ime

Amount paid byconsumer in exchange

for a product/ service .

Expenditure incurred

in producing aproduct or inrendering a service.

Ascertainment User’s viewpoint Consumer’s viewpoint Producer’s viewpoint.

Differentiat ion /

SubjectivityDifferent personsattach different

values to a

Price different iat ion /

discr imination ispossible on customer /

Ascertained on the basis of uniform

principles. Hence it is



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product atdifferent points oftime.

time basis objectivelydetermined.

Inference Opinion Policy Fact

Q . N O . 4 . W H A T A R E T H E A D V A N T A G E S / O B J E C T I V E S O F A C O S T A C C O U N T I N G S Y S T E M ?

( M A Y – 0 1 , 0 3 , 0 8 ) ( N O V – 0 2 )

a. It is useful for identi fying the exact causes for decrease or increase in the profit / loss of the business.

b. The application of cost reduction techniques helps in achieving the objective of e c o n o m y i n concern’s operations .

c . Cost com parison helps in cost control. Such a comparison may be made from period to period by using the figures in respect of the sam e f irm or of several units in an indust ry.

d. It helps in identifying unprofitable activities or losses , so that appropriate actions are taken. The use of Standard Costing points out the deviat ions from pre-determined level and thus

facilitate the taking of appropriate action.e . Managers can obtain relevant information from the Cost Accounting System, which helps in

making decis ions .

f. Cost Accounting is quite useful for price fixation .

g. A good cost accounting system provides cost figures for the use of Government, labour courts and other bodies for dealing and solving issues l ike price f ixation, wages leve l f ixat ion, e tc .

Exam ques t i o n s :

a. A factory manufactures only one product in one quality and size. Its owner states that he has a

sound system of financial accounting which can provide him with unit cost information and assuch he does not need a cost accounting system. State your arguments to convince him the need

to introduce a cost accounting system.Ans.:

Write the above answer.b.

What is the importance of the cost accounting to business concerns? Ans.: Write the above answer.

Q . N O . 5 . D I S C U S S T H E R O L E O F T H E C O S T A C C O U N T A N T I N A M A N U F A C T U R I N G

O R G A N I S A T I O N .

a. The Cost Accountant es t ab l i s hes the Cost Accounting Department in the firm.

b. The Cost Accountant develops the Cost Ac coun t i n g Manu a l . This specifies the functions of theCost Accounting Department, the format of various documents, forms and reports.

c . Cost of products & services are a s c e r t a i n e d by effective implementation of the costing system.

d.

The Cost Accountant is responsible for generation of various c os t r ep o r t s . These reports assistmanagers in reviewing their own performance.

e . The Cost Accountant provides c os t c ompa r i s on information which is useful for decision making.Some bases of comparison may be (a) Standard Costs with Actual Costs (b) Budget figures withactual figures (c) Financial and Costing Profits etc.

f. Cost a na l y s i s is also performed by the Cost Accountant, which is useful for decision making.

g. The Cost Accountant suggests t e c h n i q u e s f or c os t r e d u c t i o n an d co st c on t r o l .

Q . N O . 6 . H O W C O S T S A R E C L A S S I F I E D ?

1 .

On th e bas i s o f E l em en t s :a. Ma t e r i a l s : Cost of tangible, physical input used in relation to production.

b. Labou r : Cost incurred in relation to hum an resources of the enterprise.





c . Expenses: Cost of operating and running the enterprise, other than materials and labour. This is the residual category of costs.

2 . On t h e ba s i s of F un c t i o n s :

a. Prod uc t i o n Cost : The cost of the set of operations commencing with supply of materials,

labour and services and ends with the primary packing of product. Thus it is equal to thetot al of Direct Materials , Direct Labour, Direct Expense s an d Product ion Overheads .

b. Adm i n i s t r a t i o n Co s t : The cost of planning, organizing, controll ing and general

management expenses of the organisation, which is not directly related to production,selling & distribution. E.g.’s: Office Rent, Audit & Legal Expenses, Directors Remunerationetc.

c . Sel l i n g Cos t : The cost of creating the demand and of securing sales orders . These are also

called marketing costs. E.g.’s: Advertisement, Salesmen remuneration, Show-room Expenses.

d. D i s t r i b u t i o n Co s t : The cost incurred in making the product available to reach the

customer’s destination and gett ing back any returned empty packages. E.g.’s: Carriageoutwards, maintenance of delivery vans.

e . Conve rs ion cos t : The sum of direct wages , direct expenses and overhead cost of

converting raw materials to the finished stage.3 . As Di r ec t & I n d i r ec t :

a. D i r ec t cost means which can be identified and allocated to a particular unit of cost , i.e.,

for a job, product or process. Examples are: the cost of cloth in the ready-made shirt, wagespayable to a worker who is directly involved in production, etc. The term i n d i r ec t c o st means which is of general character and that cannot be identified with a particular unit of

cos t . It has to be distributed or shared. Examples are: The salary of chief manager who looksafter the entire business, Factory rent. All indirect costs are collectively called as Overheads.

b. I m p r a c t i c a b i l i t y : There are certain costs which can be identi f ied with a particular unit ofcost but the process of identifying them is so costly and difficult that it is not worth while t o

do so and, therefore, they are treated as indirect costs . For example, in the case of thread

used in stitching a shirt, though it is possible to find out the amount of thread used in aparticular shirt , but it would not be of much use, therefore, it is treated as indirect.

4 . Cl a s s i f i c a t i o n a c co r d i n g t o v a r i a b i l i t y :

A . F ix ed Cos t : It refers to those costs which do not vary with the volume of production within certain limits. For example, rent of office, salaries. It has the following characteristics:

a. They remain constant whether activity increases or decreases. Even when there is no

production, they are to be incurred.

b. Fixed costs are no t a b sol u t el y f i x e d . For example, if a concern decides to go in for

additional equipment, building and staff, fixed cost will also increase.

c . Total Fixed cost shall always remains fixed. F i x e d cos t p er u n i t v a r i e s with the volume. With increase in volume, fixed cost per unit decreases and vice versa.

d. Fixed costs are, by and large, u n c o n t r o l l a b l e .

e . Cha nge i n t h e p r i c e l evel s affects the fixed nature of fixed cost. E.g. Revision of rent.

B. Var ia b le Cos ts : Variable costs vary in direc t proportion (one to one relation) to the volumeof production. However, variation may not always be in the same proportion. In terms ofdegree of variability, there are three types of variable costs.

a. A 10 0% variable co st which varies directly with output.

b. The variable cost per unit of production is high at lower level of production butgradually decreases as production goes up.

c . The V.C./unit is low at levels of production but gradually increases with the

production.



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C. Sem i Va r i ab l e Cos t /M i xed cos t s : These are the items of cost which are neither fixed nor variable. These have the characteristics of both the fixed and the variable . For instance,telephone bill consist of hire charges (Fixed) & call expenses (Variable). This is of 2 types:

a. Costs vary in relation to the output but the variat ion in cost i s less proportional to

change of output . For example, Repairs and Maintenance, Power and Fuel, Storeshandling, etc.

b.

Costs tend to remain constant within certain range of output, then jum p up and re m ain

cons tant for another range.

5 . Cl a s si f i c a t i o n a c c or d i n g t o c on t r o l l a b i l i t y : (V.IMP)

a. Con t r o l l a b l e cos t s : Costs which can be influenced and controlled by managerial action.

However, Controllability is a relative term and is subject to the following factors.

T ime : Certain costs are controllable in the long run and not in th e sho rt run .

Lo ca t i o n : Certain costs are not influenced and decided at a particular location / costcentre. If rent agreements of all factory premises are executed centrally at the HeadOffice, factory managers cannot control the incurrence of cost.

Na t u r e : Variable costs are generally controllable by department heads.

b. Uncon t r o l l a b l e Cost s : These are other than controllable costs. Fixed costs are generallyuncontrollable. For example, it is very difficult to control costs like factory rent.

6 . Cl a s s i f i c a t i o n on t h e ba s i s of t im e:

a. H is t o r i c a l Cos t s : These are the costs which are ascertained after they have been incurred.

Historical costs are thus nothing but actual costs . These costs are not available until afterthe completion of the manufacturing operations.

b. Pre -de te rm ined cos ts : These are future costs which are ascertained in advance of

production on th e bas is of various es t imations .

Q . N O . 7 . G I V E D I F F E R E N T C L A S S I F I C A T I O N S O F O V E R H E A D S .

1 . Cl a s s i f i c a t i o n b y Fun c t i o n :

a. Factory Overheads, Office & Administrative Overheads & Selling and Distribution Overheads.

b. Base f o r c l a s si f i c a t i o n : Whether an expense belongs to one class or another depends

entirely on the benefit derived from it . For instance, salaries of clerks will be Factoryexpenses, when the clerks concerned work in the factory office, Office and administrativeexpense when the clerks work in the general office and Selling and distribution expense whenthe clerks work in the sales office.

2 . Cl a s s i f i c a t i o n o f o v er h ead s b y n a t u r e:

a. F i x e d o r Con s t a n t : These are expenses that are not affected by any variat ion in the volume of activity. E.g.: Managerial remuneration, rent etc.

b. Var iab le expense : Variable Expenses that change in proportion to the change in the volume of activity. When output goes up by 10% the variable expenses also go up by 10%.But Variable expenses are const ant per unit of output.

c . Semi varia ble: The expenses that does not change in the same direction a s change in the

level of act iv i ty but not in the same proportion. Semi-variable expenses usual ly have

two parts-fixed and variable. For instance , one view is , the amount of depreciat ion

usually depends on two factors - one on time (Fixed) and the other on wear and tear

(Variable). Thes e t wo t oget her m ake depreciation (as a whole) sem i-variable.





Q . N O . 8 . W R I T E S H O R T N O T E S O N E X P L I C I T A N D I M P L I C I T C O S T S . ( M A Y – 0 1 , 0 5 , 0 7 )

Pa r t i c u l a r s Exp l i c i t Co st s Imp l i c i t Co st s

Mean i n g Costs which involve immediate

cash payment . Cost which do not involveimmediate cash payment.

Ot h e r w i s e k n own a s Out of pocket costs . Notional cost s/imputed costs.Measu r emen t These are actually incurred

and hence can be easilymeasured.

They are not actually incurred

an d can’t be measured easily andinvolve estimation.

Recor d i n g i n b oo k s These are rec orded in books . These are not recorded in books .

Purpose Accounting, Reporting, Cost Control & Decision Making.

For taking inves tment decisions.

Examp l e s Salaries, advertisement etc. Interest on own capital, rent ofown premises, salary of

proprietor

Q.NO.9 . DISTINGUISH BETWEEN COMMITTED FIXED COSTS AND DISCRETIONARY FIXED

COSTS? (P)

Particu lars Com m itte d Fixed Cost s Discretionary Fixed Cost s

Meaning These are Fixed Costs that ariseFrom the posses s ion of –

• Plant, building and equipment(e.g. Depreciation, rent, Taxes,Insurance Premium etc.) or

• A basic organisation (e.g.Salaries of Staff)

• These are Fixed Costs Incurredas a result of management’s

discret ion.

• It arises from periodic (usually yearly) decisions regarding themaximum outlay to beincurred, and

• It is not f ixed to a c lear cause

and effect relationship betweeninputs and outputs.Short Run

Control

These costs rem ain unaffected byany short – term changes in volume of production.

These cannot be changed in the very short – run.

Effect on Long

– term

Objectives

Any reduction in Committed fixedCosts under normal act iv i t ies ofthe concern would have adverseeffects on the concern’s Long –term objectives.

Discretionary Fixed Costs canchange from year to year, withoutdisturbing the long – termobjectives.

Control Such costs cannot be cont rol led These costs can be controlledInference Also known as “ unavoidable”

Fixed Costs Also known as “Avoidable” fixedCosts

Q.NO.1 0 . DISTINGUISH BETWEEN CONVERSION COST AND ADDED VALUE? (P)

(NOV – 86 )(MAY – 03 )

Partic ulars Conve rsion Cost Added Value

Meaning It is the cost of converting raw

mate rials to the f inished s t age orconverting a material from onestage of production to the other

It is the change in market value

resulting from any alteration inthe form, location or availability ofa product or service, excluding thecost of bought – out materials orservices.

Include d Item s Direc t Wages + Direct Expense s +

Production Overheads.

Difference in sales Value of a

product or service between twoplaces, two versions, two markets,etc.



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Excluded I tems It totally excludes Materials andComponents Cost, but includescost resulting from variations inDirect Materials weight or volume

It excludes only cost of

purchased bought – outcomponents and services, butincludes profit element.

Q.NO.1 1 . HOW ARE COSTS CLASS IFIED ON THE BASIS OF NORMALITY? (P)

On the basis of Normality / Expectation, Costs are classified into –

1. Normal Cost: Costs which can be reasonably expected to be incurred under normal, routine,

and regular operating conditions.

2. Abnormal Costs: Costs over and above normal cost, which is not incurred under normal

operating conditions, e.g. fines and penalties.

Q.NO.12. WRITE SHORT NOTES ON PERIOD COSTS AND PRODUCT COSTS.

WHY SHOULD PRODUCT COSTS BE COMPUTED? (NOV – 9 7 ) (P)

On the basis of attributability to the product, Costs are classified into—

1. Period Costs: These are costs which are not ass igned to the products but are charged asexpenses against the revenue of the period in which they are incurred. Non – ManufacturingCosts, e.g. Selling and Distribution Costs are generally recognized as Period Costs. Thesecosts are not inc luded in inventory valuation.

2. Product Costs: These are costs which are ass igned to the product and are included ininventory valuation. These are also called as Inventorable Costs . Under absorption costing,total manufacturing costs are regarded product costs while under marginal costing, only variable manufacturing costs are considered. The purposes of computing product costs are asunder –

a. Preparation of Financial Statements – focus on Inventory Valuation and reportingprofits.

b. Product Pricing – focus on costs assigned and incurred on the product till it is madeavailable to the customer / user.

c . Cost – plus – Contracts with Government Agencies – focus is on reimbursement ofcosts specifically assigned to the particular job / contract.

Q.NO.1 3 . DISTINGUISH BETWEEN PERIOD COST AND PRODUCT COST? (P) (MAY – 0 6 ,0 9 )

Partic ulars Produc t Cost Period Cos t

Meaning Costs which become part of

production costs.Costs which are n ot associated with production

Examples Cost of Raw Materials, Direct Wages, Depreciation of Plant,Equipments etc.

General Administration Costs,Sales men Salary, Depreciationof Office Assets, etc.

Inclus ion in

Inventory

Valuation

These are included in inventory valuation. They are treated asassets till the goods to whichthey are assigned are actuallysold.

These are not included inInventory Valuation. They are written off as expense in theperiod in which they areincurred

Q.NO.1 4 . HOW IS COST ASCERTAINMENT CLASS IFIED, BASED ON THE TIME PERIOD OF

ASCERTAINING COSTS? (P)

Based on the time period at which cost information is collected, there are two methods ofascertaining costs ---





1. Post Costing: Post Costing means analysis of actual information as recorded in financial books. It is accurate and is useful in the case of “Cost – Plus – Contracts” where price is to be determined finally on th e bas is of actual cost .

2. Continuous Costing: Continuous Costing aims at col lect ing information about cost as when the activity takes place. This ensures that the cost of a job will be known, as soon asthe job is completed. This type of costing involves careful estimates of Overheads.

Note: Cost ascertained by the above two methods may be compared with the Standard Costs which are target figures already compiled on the basis of past experience and experiments.

Q.NO.15.METHODS OF COSTING.

Cost i ng Me th ods : The cost method will depend on the nature of industry.

1 . Job Cos t i n g : In this method costs are col lected & accumulated for each job separately. Thisis done because each job requires different work and production in according to customer’srequirements. Each job is t he co s t un it . Industries where this method of costing is used are:printing presses, ship-building, repair shops, etc.

There are some methods which are based on the principle of job costing:

a. Con t r a c t Co st i n g : A contract is a big job and spread over number of years . This method isapplied to find out the costs incurred on each contract separately (Contact wise). This is usedin industries carrying out the building or construction work. Contract is a big job and,therefore, the principles of job costing are applied here. Contract i s the c ost unit .

b. Ba t c h Cost i n g : Under this method, the required production is carried in number of batches

and each batch is treated as one job and cost i s calculated separate ly for each batch (Batch wise). Industries where this method of costing is used are: biscuit manufacture,garments manufacture and spare parts manufacture. Each batch is the cost unit.

2 . Process Cost i ng : This method is applied to find out the costs incurred on each process separately and such cost is divided by the quantity of production to arrive at cost per unit (process wise). This method is used in the industries like paper, soap, textiles, chemicals, etc.

Other methods which are based on the principle of process costing but vary due to some specialcharacteristics are:

a. Ope ra t i o n Cost i n g : This involves cost ing of every operation instead of a process. In other words, this is a refinement and more detailed application of process costing. This methodprovides minute analysis of costs.

b. S i n g l e , Ou t p u t o r Un i t Co st i n g : The method is applied where production is uniform and

cons is t s of only a s ingle product . It is a simple method of costing in which the total cost isdivided by the number of units produced to determine the cost per unit. This method is

applied in industries like mines, quarries etc .

c . Oper a t i n g c os t i n g : This method is applicable to service rendering undertakings. This isused to determine the cost of rendering services by airways, railways, road transport,hospital, power house, etc.

3 . Mul t iple Costing: It is a combination of two or more methods outl ined above. Suppose a f irm

manufactures bicycles inc luding i ts components , the parts wi l l be costed by the system of

batch cost ing but the cost of assembling the bicycle wil l be compute d by the single cos t ing

me thod. The whole syst em of cost ing is kno wn as Mult iple Costing.

Q.NO.1 6 .WRITE ABOUT UNIT COST METHOD F OR ASCERTAINING PRODUCT COST.

a. It is a method/ form of costing.

b. Suitable where only one product or different grades/models of the same product is produced.



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c . Under this system the expenditure is not analysed that much, because the whole of theexpenditure is normally incurred for only one type of product.

d. Cost per unit is ascertained by dividing the total expenditure with the number of unitsproduced.

This system of costing is suitable for ceme nt indus try , soft drinks etc.

Q.NO.1 7 .WHAT ARE THE ES SENTIAL FEATURES OF A GOOD COST ACCOUNTING SYSTEM?

(OR) FEATURES OF AN IDEAL COST ACCOUNTING SYSTEM. (NOV – 0 5 )(MAY – 0 4 )

a. S imp l e : The system of costing should be easy to understand and operate.

b. Su i t a b i l i t y : The system must be suitable to th e nature , requirem ent s , size of the company.

c . Rel e va n t d a t a : It should provide the necessary information for ascertaining the cost , decisionmaking and control.

d. Managemen t ’ s s u ppo r t : The management should have a fai th on i t & also support in various

for its successful implementation.

e .

Cooper a t i o n f r om va r i o u s depa r t men t s : Employees of various departm ents must co-operate both in development and implementation of cost accounting system.

f. F l e x i b i l i t y : It should be flexible to change in the c ircumstances . It must be capable ofexpansion/contraction comparing with needs.

g. Compa r a b i l i t y : The information provided by the cost accounting system must be comparablewith past figures and the figures of the other companies in the same industry.

h. Recon c i l i a t i o n : The cost and financial accounts should preferably be integrated. If not,

arrangements must be made for the periodical reconciliation of the profits .

i. Cost -e f fec t ive : The benefi ts from the system should exceed the amount to be spent on i t .

Q . N O . 1 8 . O U T L I N E T H E S T E P S I N V O L V E D I N I N S T A L L I N G A C O S T I N G S Y S T E M .

a. The ob j ec t i v es of i n s t a l l i n g a cos t i n g sys t em and the expectations of the management fromsuch a system should be identified first . (The system will be a simple one in the case of a singleobjective but it will be an elaborate one in the case of multiple objectives.)

b. A study of the o r g a n i s a t i o n s t r u c t u r e, its size and layout etc., is also necessary.

c . Sel e ct i n g a p r o p e r m et h o d o f c os t i n g for manufacturing unit.

d. Overheads : An appropriate overhead recovery method shall be devised for allocation,apportionment and absorption of overheads.

e .

The costing system should be designed i n c o n s u l t a t i o n w i t h t h e s t a f f and should beintroduced only after meeting their objections and doubts, if any.

f. The f o r m s to be used by various departments should be standardized .

g. Details of r e co r d s t o be ma i n t a i n e d should be documented.

h. Necessary a r r a n g eme n t s should be made for proper f l o w o f i n f o rm a t i o n to variousdepartments.

i. Rec on c i l i a t i o n o f c os t & f i n a n c i a l a c co u n t s , if they are maintained separately.

The system of costing to be installed should be ea s y t o u n d e r st a n d a n d o p er a t e .



I P C C _ C o s t i n g t h e o r y _ 2 0 1 0 _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 1 . 1 1


Q.NO.1 9 .FACTORS TO BE CONSIDERED BEFORE INSTALLING A COSTING SYSTEM. OR

ESSENTIAL FACTORS FOR DESIGNING & INSTALLING A COST ACCOUNTING SYSTEM?

(NOV – 99)

a. Na tu r e o f bus i ness: The system of costing should suit the nature of the business.

b.

La you t a s p ec t s : The size & design of the organisation should be studied before designing thesystem.

c . Met h od s & Pr o c edu r es : The system designers should also study various methods and

procedures relating purchase of materials, payment of wages etc.

d. Overheads : An appropriate overhead recovery method shall be devised for allocation,

apportionment and absorption of overheads.

e . Introduction of budget a r y c o n t r o l t ec h n i q u es so that actual performance may be compared with budgetary figures, for measuring efficiency of performance.

f. Managemen t ' s expec t a t i o n s and po l i c i e s : Due regard/respect shall be given for themanagement's expectations and their policies.

g.

S imp l e : The system of costing to be installed should be easy to understand and operate.h.

F orm s S t a n d a r d i z a t i o n : Various forms to be used in the organisation should be standardized.

Q.NO.2 0 . YOU HAVE BEEN ASKED TO INSTALL A COSTING SYSTEM IN A MANUFACTURING

BUSINESS. WHAT PRACTICAL DIFFICULTIES, APART FROM TECHNICAL COSTING

PROBLEMS, WOULD YOU EXPECT TO MEET AND HOW WOULD YOU PROPOSE TO OVERCOME

THEM? (MAY – 9 7 ,0 2 ) (P)

Apart from technical costing problems, there are other practical difficulties which arise duringinstallation of a costing system. Some difficulties and the ways to overcome them are as under –

Problem Description of Problem Rem edial Measure

Lack of Support fromTop Management Top Management may not fullysupport the costing system.Line Managers may view thecosting procedures asinterference in their work oradditional work. Also Managersmay not view it seriously if topmanagement does not endorsethe system.

Before installation, the topmanagement should be madecost conscious. They must bemade aware of the need foroperating a costing system andtheir full support and co –operation to the costing systemshould be obtained.

Resis tance from

Accounting Staff

Existing accounting staff mayfeel that they would lose theirimportance. Hence, they mayresist the system as they may

be unsure of their position inthe Firm.

Staff must be made tounderstand that the costingsystem is only supplementaryand not a substitute to the

financial accounting system.Participative approaches andpositive confidence – buildingmeasures should be used.

Lack of co –

operation at

operating levels

The successful operation of thecosting system depends uponthe active participation of stafflike foremen, supervisors, time – keepers, stores officials etc. These staff may notimmediately provide basicactivity data in variousdocuments and reports.

The Cost Accountant shouldeducate the staff on theimportance of the data to beprovided from their department. They should be made tounderstand that providing datais not additional work but onlypart of their routine work. Attitudinal problems, if any,should be set right first.

Shortage of Trained

Staff

Sufficient staff may not beavailable to perform specialized

The personnel departmentshould recruit adequate staff



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functions like Costascertainment, analysis andcontrol, which calls fortechnical knowledge, adequateknowledge support & training.

possessing the requisite skills.Shortage of staff may beovercome by devising andimplementing a good overallpersonnel policy.

Costs of operating

t h e s y s t e m

The Costing system involvesinitial installation cost andregular operating cost. Use ofnew forms and documents maylead to duplication of effortsand frustration among theemployees. Some reports myprovide unnecessary andredundant data.

The costing system should beimplemented only when the benefits exceed costs thereof. Also, forms, procedures anddocuments should be designedso as to effectively capture therequired information withoutmuch difficulty. Reports shouldprovide timely, adequate andreliable information.

Q.NO.2 1 .LIST OUT THE REPORTS PROVIDED BY THE COST ACCOUNTING DEPARTMENT FOR

DECISION-MAKING PURPOSE.

1 .

Gene ra l :

a. Cost Sheets.

b. Reconciliation of actual profit earned with estimated or budgeted profit.

c . Reconciliation of financial profits with cost accounting profits.

2 . Ma t e r i a l s :

a. Materials Consumption Statements.

b. The number of months for which stocks would be sufficient.

3 . Labou r :

a.

Labour utilization statements.b.

Labour turnover, the cost of recruitment and training of new employees.

c . Labour Overtime payment statement and the causes thereof.

4 . Overheads :

a. Overheads recovery rates based on estimates.

b. Overheads actually charged to production and the difference between the amount actuallyincurred (Actual Overheads) and the amount charged (absorbed Overheads).

5 . Sa les :

a. Actual Sales compared with budgets.

b.

Statement of reasons for difference between budgeted and actual sales.

Q.NO.22.ITEMS NOT REGARDED AS COST AND NOT INCLUDED IN COST SHEET.

a. Expenses or profits of capital natu re like profit or loss on sale of investments.

b. Appropriation of profits for dividends and transfers to reserves.

c . Provisions for taxes.

d. Amortizations like goodwill, preliminary expenses.

e . Amounts representing loss on account of inefficiency of a particular activity e.g. bad debts.

f.

Abnorm al expen ditures and costs e.g. penalties, fines.g. Expenses relating to the raising of c apital.





Q.NO.2 3 .PR ODUCTION/ MANUFACTURING ACCOUNT VS. COST SHEET.

Manu f a c t u r i n g Ac coun t Co st Sheet

It is prepared on the basis of double entry

sys tem of book keeping.It is only a statement and hence double entrysystem is not applicable .

The primary objective of preparation isReporting.

The primary objective is Decis ion-making.

It has two parts – one showing the cos t o f manufacture and the other part showing Salesand Gross Profit .

It is a step by step presentation of total cost and shows Prime Cost, Works Cost, Cost ofProduction, Cost of Goods Sold, Cost of Salesand Net Profit.

Total Cost is shown in aggregate . Product wiseanalysis is not given.

Product wise analysis is given.

This is not use fu l for preparing tenders orquotations.

Estimated Cost Sheets can be prepared based on past experience, and useful for

submitt ing ten ders .

Q.NO.2 4 . WHAT IS COST REDUCTION & WHAT ARE ITS ADVANTAGES?

Cost Redu c t i o n :

a. Cost reduction is defined as the achievement of real reduction in the cost of goodsmanufactured or services rendered without diminution in the qual i ty of the product.

b. Cost reduction should not be a temporary reduction but a permanent reduction.

c . Cost reduction implies the retention of quality of the product and genuine savings in the cost ofmanufacture administrative and selling brought out by el imination of wasteful and non

essent ia l e l ements from the des ign of the product and from the cost reduction techniquescarried out in connection therewith.

d.

Reduction in cost due to reduction in taxation does not me an cost reduction .

Need f o r Cos t Reduc t i o n : These days the cost of production is increasing day by day. But thesell ing price of finished goods can not be increased proportionately due to governmental control orstiff compet i t ion. This naturally reduces profit margin. Thus there is a need to reduce cos t ofproduction.

Advan t a ges of Cos t Redu c t i o n :

a. The society is to be provided with goods of proper quality at reasonable prices.

b. Cost reduction requires better util izations of resources like men, machinery and money,improved methods of production and latest manufacturing techniques.

c .

Efficiency increases & the rate of return to shareholders increase. This increases the sharevalue .

Q.NO.2 5 . DISTINGUISH BETWEEN COST RED UCTION AND COST CONTROL?

(NOV -01 ) (MAY – 0 3 )

Pa r t i c u l a r s Co st Redu c t i o n Co st Con t r o l

Pe rmanence Permanent, Genuine savings in cost. Could be a temporary saving also.

Pr o d u c t Qu a l i t y Quality and characteristics of theproduct is retained .

Quality maintenance is not guaranteed .

A im It aims at im proving s tandards andassumes existence of potential

savings.

It aims at achieving standards (i.e.targets)

Scope Very broader in scope. Very narrow in scope.

Tool s & Techn i q u es Value engineering, Work study, Budgetary Control, Standard



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Standardization, Variety reduction,Quality research, Operationsresearch, Market research, Job Evaluation and Merit rating,Improvement in design,Mechanization and automation.

Costing.

F u n c t i o n It is a corrective function It is a preventive function.

Q.NO.2 6 .WHAT ARE THE PRECAUTIONS IN IMPLEMENTATION OF COST REDUCTION

PROGRAMME? (K&J )

Precautions in Implemen tation o f Cost Reduction Programm e

Before implementation of the cost reduction programme, the following points should be given acareful consideration:

a. Its introduction and implementation must be planned soundly.

b. The success of cost reduction programme would depend upon the co – operation of all those

involved, whether directly or indirectly. Its effects and results should be monitored regularly andclosely.

c . The mechanics and operation of such programmes must be communicated c learly and

concisely to organizational members preferably in writing.

d. Reluctance of the managers and workers should be recognized to change the patterns of their behaviour.

e . There should not be any ove rlap between the cost reduction programme or double counting ofreductions or savings.

f. The cost reduction measures should not have any undesirable effects on external parties, forexample, suppliers of raw material, buyers of finished products and so on.

g.

The programmes are within the letter and spirit of national or local legislation andregulations, for example, in the areas of health and safety standards.

h. Generally, when the enterprise is facing difficulty in trying conditions, the attention of the

managers should focus on costs; when conditions improve, there may be less inclination tocontrol costs and their impacts. It must be recognized, cost reduction is a continuous process.

i. It must be appreciated that perfect scheme covering all eventualities will be both expensive

and complicated to implement. This calls for realistic appreciation of the cost and benefitsinvolved in any cost reduction programme.

j. It must result in reduced unit cos ts .

k. Cost reduction campaigns are often introduced as a rushed, desperate measure instead of acarefully organized, well thought – out exercise.

l. Cost reduction does not happen of its own accord, and managers must make pos it ive decis ions

to reduce costs.

Q.NO.2 7 .WRITE ABOUT LONG – RANGE AND S HORT – RANGE COST CONTROL AND COST –

REDUCTION PROGRAMME? (K&J )

Long – range an d Sh ort – range Cost Cont rol and Cost Reduct ion Programm es

Long – range Programmes Long – range cost control and cost reduction programmes mainly arisedue to huge capital expenditure designed towards a continual reduction in costs, depending upon better layout, relocation of plant, modernization programmes, material handling and so on. They

often operate as perspective plan during which all the aspects of business and the whole sphere ofits operation would be covered.

Short – range Programmes: Short range programmes may arise from the following considerations:





a. A tem porary fall in profits which has to be corrected promptly.

b. An impending unfavorable com peti t ive s i tuation.

c . Identification of certain products which competitors are sell ing at a lower price in the market.

d. Adverse cost variance which calls for immediate action.

e . Some operations which appear to be inefficient and provide opportunities for quick and

substantial cost savings .

f. Some operations or functions which appear to cos t ing too m uch

Q . N O . 2 8 . W R I T E S H O R T N O T E S O N U N I F O R M C O S T I N G & O B J E C T I V E S .

Mean i n g : “The use by several undertakings of the same cost ing principles and/ or practices ". Thus when a number of companies, decide to adhere to one set of accepted costing principles-especially in matters where there can be two opinions - they are said to be following uniform costing.

Object ives :

a. I n t e r - f i rm Compa r i s o n : To facilitate comparison of

costs and performances of differentcompanies in the same industry.

b. Comm on Good o f I n d u s t r y : To promote hea l thy compet i t ion among different participatingunits.

c . Imp r o v emen t i n P r o d u c t i o n Capa c i t y : To improve production capacity level and labour

efficiency by com paring the production c osts of di fferent units with each other.

d. Cost I n f o rm a t i o n t o Gover n m en t : To provide relevant cost information/data to the governmentfor fixing and regulating th e prices of essential products.

e . S t a n d a r d i z a t i o n : To bring Standardization in the operation of participating units .

A great deal of ground work is required to be done, for the introduction of uniform cost ing in an

industry (not company).

Q.NO.2 9 .WRITE SHORT NOTES ON UNIFORM COST MANUAL? (SA)(NOV – 9 4 ) (MAY – 0 7 )

Uniform Cost Manual: It is written document, which may be in the form of a booklet or bulletin,containing the principles , methods and procedures for the ascertainment and control of cos t in

uniform cost ing. It is necessary for the successful operation of uniform costing system. Such amanual provide guidelines to the participating firms to be organize their cost accounting system on auniform basis.

The following are the salient features of a uniform cost manual.

a.

It includes statement of objectives and purpose of the system, scope of the system, advantagesand extent of co-operation necessary.

b. It contains the general principles of accounting, nature coding, terminology to be followed,

classification, and description of accounts. This section also includes details of stock control,labour and overhead cost collection and control.

c . Essential cost data and various rat ions to be computed for comparison of performance and

efficiency in the operation of the participating units.

d. Mode, format, and time for presenting cost data and reports to the management.

It provides necessary guidel ines about the treatment of depreciation, interest on capital, wastage,scrap, by-product, etc.



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Q.NO.3 0 . WRITE FOUR LIMITAITONS OF INTER – FIRM COMPARISON? (MAY – 9 7 )(SA)

Limitations of Inter-firm comparison:

The following are the limitations in the implementation of a scheme of inter-firm comparison:

a.

Top management feels that secrecy will be lost.b.

Middle managem ent is usually not conv inced with the utility of such a comparison.

c . In the absence of a suitable cost accounting system, the figures supplied may not reliable forthe purpose of comparison.

d. Suitable basis of comparison m ay not be available.

Q.NO.3 1 .WRITE SHORT NOTES ON VALUE ANALYSIS ? (SA) (NOV – 9 7 )

Value Analysis: It is one of the important tools of modern management in the area of cost reduction.It is also known by other names such as value engineering. Value control and product research.

Value analysis is the process of systematic analys is and evaluation of various techniques andfunctions with a view to improve organizational performance . It aims at reducing and controllingthe cost of a product from the point of view of its value by analysis, believes in a planned action toimprove performance and thereby, generates higher value in a product and ultimately causesreduction in i ts cost .

The meaning of the term value may vary from person to person, time to time and place to place.However, in the context of cost reduction and control it refers to the ‘use value’.

The reduction in the costs of a product and thus increasing the profitability of a concern is the mainadvantage of value analysis.

The benefits of value analysis are being derived in many industries, e.g., engineering, buildingconstruction and the Oil industry. It is being applied to components of a product, finished product

and also to be methods of packaging. The various steps involved in value analysis are;

a. Identification of the problem

b.

Collecting information about the function, design, material, labour, overhead costs, etc., of theproduct and finding out the availability of the competitive products in the market; and

c . Exploring and evaluating alternatives and developing them.

Q.NO.32 . WRITE A SHORT NOTES ON DIRECT EXPENSES? (NOV – 9 4 ,0 2 ) (P)

1 . Direct Expenses or Chargeable Expenses: These are expenses other then materials and

labour which can be allocated directly jobs, products, processes, cost centers or cost units.Direct Expenses are “cost other than material and wages which are incurred for a specificproduct or saleable services”

2 . Nature of Direct Expenses: (a) These are expenses other than Direct Materials and DirectLabour, (b) These are either allocated or charged completely to Cost Centers or Cost Units, (c) These are included in the Prime Cost of a product.

3 . Examples:

(a) Hire Charges of special machinery orplant for a particular production order or job.

(b) Payment of Royalties.

(c) Cost of special moulds, designs &patterns.

(d) Sub – Contracting Expenses oroutside work costs, where jobs aresent out for special processing.

(e) Experimental cost beforeundertaking the job.

(f) Travel & Conveyance Exps for aparticular job.





4 . Documentation: The basic document which is used for charging of Direct Expenses to productsor batches or work order is the invoice received from suppliers of such service. The payment tosupplier of service is made on the basis of the invoice and the expenses are booked in theaccounts.

5 . Identification of Direct Expenses: For the identification of Direct Expenses with the main

product or service, the code number of that product or service should be inscribed on invoice

receive from supplier of services. For example, if a machine is hired to complete a particularproduct, then the Hire Charges paid for that machine is a Direct Expense of that particularproduct. For charging these Hire Charges should be coded / inscribed with the Product Code, toensure that this expense is charged to that particular product. Alternatively, if cash is paid, thenthe Cash Book Analysis will show the Product Code which is to be charged with the cost ofhiring machinery.

Q.NO.3 3 .WHAT ARE THE METHODS OF S EGREGATING SEMI – VARIABLE COSTS IN TO FIXED

AND VARIABLE COSTS ? (PCC BOOK)

Methods of segregating Semi – variable costs into fixed and variable costs - The segregation of

semi – variable costs into fixed and variable costs can be carried out be using the following methods:(a) Graphical method

(b) High points and low points method

(c) Analytical method

(d) Comparison by period or level of activity method

(e) Least squares method

a. Graphical m et hod: Under this method, a large num ber of observations regarding the total cos ts

at different levels of output are plotted on a graph with the output on the X – axis and the totalcost on the Y-axis. Then, by judgment, a line of “best – fit”, which passes through all or most ofthe points is drawn. The point at which this l ine cuts the Y-axis indicates the total fixed cost

component in the total cost. If a line is drawn at this point parallel to the X-axis, this indicates thefixed cost. The variable cost, at any level of output, is derived by deducting this fixed cost elementform the total cost. The following graph illustrates this:

b. High points and low points me thod:-

Under this method in the following illustration the difference between the to ta l cos t a t h ighes t

and lowest volume is divided by the difference between the sales value at he highest and

lowest volume. The quotient thus obtained gives us the rate of variable cost in relation to sales value. The fixed cost is the remainder. See the following illustration.

Illustration:

Sales value Total cos t

Rs. Rs. At the Highest volume 1,40,000 72,000

At the Lowest volume 80,000 60,00060,000 12,000

Thus, Variable Cost (Rs. 12,000/Rs. 60,000) = 1/5 or 20% of sales value= Rs. 28,000 (at highest volume)

Fixed cost: Rs. 72000 – Rs. 28,000 i.e., (20% of Rs. 1, 40,000) = Rs. 44,000 Alternatively: Rs. 60,000 – Rs. 16,000 (20% of Rs. 80,000) = Rs. 44,000

c .

Analytical method: Under this method an experienced cost accountant tries to judge

empirically what proportion of the semi – variable cost would be variable and what would befixed. The degree of variability is ascertained for each item of semi – variable expenses. For

example, some semi – variable expenses may vary to the extent of 20% while others may vary tothe extent of 80%. Although it is very difficult to estimate the extent of variability of an expense,the method is easy to apply. (Go through the following illustration for clarity).



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Illustration:

Suppose, last month the total semi – variable expenses amounted to Rs. 3,000. if the degree of variability is assumed to be 70% then variable cost = 70% of Rs. 3,000 = Rs. 2,100. Fixed cost =Rs. 3,000 – Rs. 2,100 = Rs. 900.

Now in the future months, the fixed cost will remain constant, but the variable cost will varyaccording to the change in production volume. Thus, if in the next month production increases by50%, the total semi – variable expenses will be:

Fixed cost of Rs. 900, plus variable cost viz., Rs. 3,150 i.e., (Rs. 2,100(V.C.) plus 50% increase of V.C. i.e., Rs. 1,050) i.e., Rs. 4,050.

d.

Comparison by period or level of activity method: Under this method, the variable overheadmay be determined by comparing two levels of output with the amount of expenses at thoselevels. Since the fixed element does not change, the variable element may be ascertained with thehelp of the following formula.

output quantitytheinchange

expenseof amount theinChange

Suppose the following information is available:

Production Units Semi – variable expensesRs.

January 100 260February 140 300

Difference 40 40

The variable cost:

volumeproductioninChange

expenses variable-SemiinChange =

units40

40Rs. = Re. 1/unit

Thus, in January, the variable cost will be 100 X Re. 1 = Rs. 100 and the fixed cost element will be(Rs. 260 – Rs. 100) or Rs. 160. In February, the variable cost will be 140X Re. 1 = Rs. 140 whereas

the fixed cost element will remain the same, i.e., Rs. 160.

e . Least squared method: This is the best method to segregate semi – variable costs into its fixedand variable components. This is a statistical method and is based o n f inding out a l ine of best

fit for a number of observations. The method uses the linear equation y = mx + c, where marepresents the variable element of cost per unit, ‘c´ represents the total fixed cost, ‘y’

represents the total cost , ‘x’ represents the volume of output. The total cost is thus split intoits fixed and variable elements by solving this equation. By using this method, the expenditureagainst an item is determined at various levels of output and values of x and y are fitted in theabove formula to find out the values of m and c. The following illustration may be helpful tounderstand this method.

Leve l of activity

Capacity % 60% 80% Volume (Labour hours)X 150 200

Semi – variable expenses Rs. 1,200 Rs. 1,275

Substituting the values of x and y in the equation, y = mx + c, at both the level of activity, we get

1,200 = 150 m + c1,275 = 200 m + c

© (Fixed cost) = Rs. 975 and m (Variable cost) = Rs. 1.50 per labour hour.





Q.NO.3 4 . DE FINE THE FOLLOWING.

1 .

Research Cost: The cost of researching for new or improved products, new applications ofmaterials or improved methods. (Nov - 92 ,98 ,00 ) (May - 96 )

2 .

Pre – Production Cost: The part of development cost incurred in making a trial production

run prior to formal production (Nov - 0 0 )

3 . Out – of – pock et Cost s: These are costs which entail current or near future outlays of cash forthe decision at hand as opposed to costs which do not require any cash outlay like depreciation.Such costs are relevant for decision – making, as these will occur in near future. It is thatportion of total cost which involves cash outf low. This cost concept is a short – run conceptand is used in decisions relating to fixation of selling price in recession, make or buy, etc. Out –of – pocket Costs can be avoided or saved if a particular proposal under consideration is not

accepted.

4 .

Replacement Cost: It is the cost at which there could be purchase of an asset or materialidentical to that which is being replaced or revalued. It is the cost of replacement at current

market price and is relevant for decision – making.

5 .

Engineered Costs: These are costs that result specifically from a clear cause and effect

re lat ionship between inputs and outputs . The relationship is usually directly and personallyobservable. Examples of inputs are Direct Material Costs, Direct Labour Costs, etc. Examples ofoutput are the products.

6 . Absolute costs and Alternative costs: Absolute costs which are also known as out lay c os ts , involve an outlay of funds, and are recorded in the books of account. Alternative or opportunity

cos ts , on the other hand, refer to the cost of forgone opportunities, or a comparison between thepolicy chosen ad the policy rejected. Accordingly, these costs are not recorded in the books ofaccount.

Alternative cost is more important than outlay cost for the solution of many managerial

problems. The concept is applicable to all situations where a thing can have alternative uses. If

there is no alternative use, opportunity cost is zero. If, for instance, a firm decides to stay in business, it must make a certain amount of profit which is not less than that it could make inan alternative line of activity. Thus, the alternative cost of any resource is measured by therevenue it can fetch in the alternative use.

7 . Past and future costs: Actual costs incurred in t he past and recorded in the books of accountare known as past costs. Income is measured on the basis of past costs, and an analysis of thesame is merely a post – mortem examination of what has happened in the past. All thatmanagement could do about past costs is to find out the cause o f exces s ive cos ts , if any, andnothing more.

Future costs are those that are l ikely to be incurred in a future period. These are not recordedin the books of account, and hence, have to be estimated. Their estimation depends upon past

costs. Thus, past costs serve as the basis for estimating future costs.Managerial decision – making centers round future costs and not past costs. Future costs can be controlled and reduced, met or avoided. Accordingly, they are relevant for a variety of

managerial decisions: capital expenditure, pricing, profit, expense control, etc.

8 .

Shut – down and Abandonme nt costs :

Costs which should be incurred in the event of a tem porary ce ssat ion of act iv i t ies , and whichcan be saved if activities are allowed to continue are known as shut – down costs. If, for instance, business operations are temporarily suspended, there is still the need to incur costs ofconstruction of shelter for property exposed. Further, if machinery has been purchased out ofborrowed funds, interest on such funds should also be considered as shut down cost whichmust be incurred.

Unlike shutdown costs, abandonment costs are those that result from a permanent cessat ion of

bus iness act iv i t ies . In other words, when a fixed asset is retired from service and is a to bedisposed of, the costs connected with disposal are known as abandonmen costs.



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9 . Escapable and Inesc apable cos ts :

Escapable costs refer to those costs that may not only be postponed but may also be avoidedentirely as a result of contraction of business activity. Such costs are the net costs arrived at afterdeducting from the decreased cost by terminating an activity, the costs incurred as a result ofincrease in activity in any other part of the organisation. For example, the escapable cost ofeliminating middlemen is the cost resulting from such elimination minus the increased cost ofthe selling unit which is not sufficiently equipped to handle the extra work.

Inescapable costs or unavoidable costs are those that must be met even if there is contraction of business activity. Manufacturing plants, for instance, must incur minimum power costs

regardless of the volume of sales. Such costs cannot be avoided and cannot also be postpone d.

1 0 .

Dist inguish between Estimate d cost and s t andard cost

Estimated c ost and s tandard cost :

Kohler defines estimated costs as ‘the expec ted cos t of manufacture or acquisition, often interms of a unit of product computed on the basis of information available in advance of actualproduction or purchase’ Estimated cost are prospective costs since they refer to prediction of

cos ts .

Standard Cost means a pre – determined c ost . It attempts to show what the cost should be for

clearly def ined condit ions and c ircumstances . Standard costs represent’ planned cost of aproduct. They are expected to be achieved under a particular production process under normalconditions.’

Although pre – determination is the essence of both standard costs and estimated costs, butthey differ from each other in the following respects:

a) Difference in computation

b) Difference in emphasis

c) Difference in use

d) Difference in records

e) Applicability

1 1 . Synergetic e ffect s he lp in reduction in cost s : (May - 20 07 )

Two or more products are produced and managed together. The result of combined efforts are

higher than sum of the results of individual products . Analysis of synergetic effect is helpfulin cost control

1 2 . Relevant cost s : (Nov - 20 07 ) Relevant costs are those expected future cost which are essential but differ for alternative

course of act ion.

a. Historical cost or sunk costs are irrelevant as they do not play any role in the decisionmaking process.

b. Variable costs which will not differ under various alternatives are irrelevant.

1 3 . Capitalized Cost: These are costs which are initially recorded as assets and subsequently treated as expense s . (Nov - 20 07 )

1 4 . Oppo r t u n i t y Cos t : When we decide to follow one alternative, we are also deciding not to followanother. The value of sacrifice made or benefit of opportunity foregone in accepting analternative in preference to other is called opportunity cost. For example, a company owns a building, it could be either used for business or rented to others. If a decision is taken to use the building, the rent foregone becomes opportunity cost. (May - 03)

1 5 . Sun k Cost : It is a cost which has already been incurred in the past. It is not relevant fordecision-making. Thus, if a firm has obsolete stock of materials amounting to Rs.10,000 whichcan be sold as scrap for Rs.2,000 or can be utilised in a special job, the value of opening stock of

Rs.10,000 is a sunk cost and is not relevant for decision-making. “Don’t cry over split milk”should be the management’s attitude towards such cost. (May – 03,05)(Nov - 00)





1 6 . Cost Un i t : It is a unit of product/service in relation to which costs may be expressed. For e.g.cost expressed as cost per tone of steel, per tone kilometer. Sometimes a job or contractconstitutes a Cost Unit. A few examples of cost units are given below: Refer to the last question.

1 7 . Im pu t ed Cost s : These are notional costs appearing in the cost accounts only e.g. notional rent,interest on own capital. Where investment projects are being evaluated, it is necessary toconsider the interest on capital before a decision is arrived at, as to which is the most profitable

project. (Nov - 0 9 )

1 8 . D i s cr e t i o n a r y c os t s : These are “escapable” or “avoidable” costs. These can be avoided if aparticular course of action is not chosen.

19 . Di f f eren t i a l cost : It represents the change (increase or decrease) in total cost (variable as wellas fixed) due to change in activity level, technology, process or method of production, etc. Forexample if any change is proposed in one existing level or in the existing method of production,the increase or decrease in total cost will be known as incremental cost or decremental cost.

2 0 . Absor p t i o n Cost i n g : It is the practice of charging all costs, both variable and fixed to operations,processes or products. This differs from marginal costing where fixed costs are excluded.

2 1 . Ma r gi n a l c o s t i n g : It is defined as the ascertainment of marginal cost by differentiating

between fixed and variable costs. It is used to ascertain effect of changes in volume ortype of out put on profit.

2 2 . Respons i b i l i t y Cen t e r s : It is defined as an activity centre/department of an organisationassigned with a special task. These are mainly established for the purpose of control. By thenature of responsibility assigned, responsibility centers can broadly be classified into threecategories. They are: Cost centers, Profit centers & Investment centers.

2 3 . Cos t Cen t r e : ( Nov- 02 )

a. It is a segment of the organisation. These are created for computation of the cost centre wiseand for the control of the cost. For example, in a laundry, various activities such ascollecting, sorting and washing are performed. For the purpose of cost computation each ofthese activities may be treated as cost centre.

b.

Such centers make all possible efforts to reduce/minimize costs. Budgeted/Standard cost to be incurred by each centre is predetermined. Then the actual cost will be compared tomeasure the performance of each centre.

c . While judging the performance of managers of cost centers, it is essential to differentiate between controllable costs and uncontrollable costs.

d. Types o f cost cen t er s a r e o f :

A Personal cost centre consists of a person or group of persons.

Impersona l cost centre consists of a plant (Machine ‘A’) or location (like Hyderabad

factory) (or group of these).

Production cost centre: It is a Cost Centre where raw material is handled for

convers ion into f inished product . Here both direct and indirect expenses areincurred.

Service cost centre: It is a Cost Centre which serves as an ancillary unit to a

production Cost Centre. Power house, gas production shop, material service

cent ers , plant mainten ance ce nters are exam ples of Service c ost c ente rs .

2 4 . Pr o f i t c en t r e : (May - 0 6 )

a. It is a segment of the organisation. These are created for computation of profits centre wise. Itis responsible for both revenues and expenses.

b. Such centers make all possible efforts to maximize the profits. Budgeted profits to be

achieved by each centre are predetermined. Then the actual profit will be compared to

measure the performance of each centre.c .

The authority of each such centre enjoys certain powers to adopt such policies as arenecessary to achieve its targets.



B A S I C C O N C E P T S _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 1 . 2 2


2 5 . I n ves tm en t Cen t r e : A centre whose managers are responsible for some capital investmentdecisions. Return on investment (ROI) is usually used to evaluate the performance of them.

(May - 06)

2 6 . Cost Centre: It is defined as – (Nov – 91 ,02 )(May – 95 ,97 )

(a) A location – e.g. Chennai Factory, Kolkata Factory etc.

(b) A person – e.g. Sales Manager L, M etc

(c) An item of equipment – e.g. Machinery P,Q or Process I, II etc.

Or a group of these, for which cost may be ascertained and used for the purpose of CostControl.

Based on Activit y:

Operation Cost Cent re Proce ss Cost Cen tre

It consists of machines and / orpersons, carrying out similar

operations.

It consists of machines and / orpersons, engaged on a specif ic

process or a continuous sequence

of operations. All machines / operators performingthe same operation are broughttogether under a cost centre, thepurpose being ascertainment of c o s t

of each operation irrespective of itslocation inside the factory.

Cost is analysed and related to aser ies of operations in sequence . Generally, these constitute a singlelocation, as in Oil Refineries andother process industries.

Give the me thod of cost ing & cost unit against each industry (Nov – 98 ,99 ,08 )

I n d u s t r y Met h o d Cost Un i t

Nursing HomeRoad transportSteelCoalBicyclesBridge constructionInterior Decoration AdvertisingFurnitureSugar company having its own sugar-cane fields Aircraft AutomobileBeerCarpetsCement

Dry cleaningIce creamPetrochemicalsPharmaceuticals

EducationElectricityBrick – works Toy makingRadioShip buildingHospitals

Operating costingOperating costingProcess costingSingle costingMultiple costingContract costing Job costing Job costingMultiple costingProcess costing Job costingProcess costingProcess costingProcess costingProcess costing

Job costingProcess costingProcess costingBatch costing

Operating costingOperating costingSingle or outputBatchMultipleContractOperating

Per Bed per week/DayPer Ton Kilometer/ per milePer TonPer TonEach unitEach contractEach JobEach JobEach unitPer Quintal/TonNumberNumberPer Bottle/Per gallonPer square footPer ton cement

Per cloth/garmentPer gallon, per case or cup Tons, gallons litres1,000 nos., tablets,Strips, capsulesPer Student hourPer Kilo watt-hour1,000 bricksPer BatchPer radio or per batchPer shipPer bed per day orper patient per day




PAST EXAM QUESTIONS:

S.No. Ques t i o n Appearing in year

1 .

2 .

3 .

4 .

5 .

6 .

7 .

8 .

9 .

1 0 .

1 1 .

1 2 .

1 3 .

What are the advantages/ objectives of a cost accounting system.

Write short notes on explicit and implicit costs.

Distinguish between conversion cost and added value?

Write short notes on period costs and product costs. Why shouldproduct costs be computed?

Distinguish between period costs and product costs?

What are the essential features of a good Cost Accounting System?

Factors that you will consider before installing a costing system.

You have been asked to install a costing system in a manufacturing business. What practical difficulties, apart from technical costingproblems, would you expect to meet and how would you propose toovercome them?

Distinguish between cost reduction and cost control

Write short notes on Uniform Cost Manual?

Write four limitations of inter – firm comparison.

Write short notes on value Analysis.

Define the following

1. Pre – production cost2. Cost centre3. Synergetic effects help in reduction in costs4. Relevant costs5. Capitalized Cost6. Opportunity Cost7. Sunk Cost8. Imputed costs9. Cost centre10. Profit centre

11.

Investment centre

May -03,01,08, Nov 02

May - 05,01,07

Nov – 86,May – 03

Nov – 97

May – 06,09

May – 04, Nov – 05

Nov – 99

May – 97,02

Nov – 01, May – 03

Nov – 94, May – 07

May – 97

Nov – 97

Nov – 00Nov – 97,02 May – 95,97

May – 07Nov – 07Nov – 09May – 03

May – 03,05 Nov – 00Nov – 09Nov – 02May – 06

May – 06

ABC Analysis

A. Category: 9, 12, 13, 17, 18, 19, 20, 24, 25, 28, 29, 30, 31, 32

B. Catego ry: 4, 5, 8, 10, 15, 16, 21, 26

C. Category: 1, 2, 3, 6, 7, 11, 14, 22, 23, 27, 33

The end

basic concepts in costing costing theory 1st chapter

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