C&ma

Chapter 1
Cost Concepts
• Financial Accounting and Management Accounting
• Kinds of Business Units
• Cost Flow
• Manufacturing and Non-manufacturing Cost
• Cost classification for Assigning Costs to Cost Objects
▪ Direct Cost and Indirect Cost
• Classification of Cost on the Basis of its Behaviour
▪ Fixed Cost and Variable Cost
▪ Mixed Cost
• Classification of Cost from Decision Making Point of View
▪ Relevant cost and Irrelevant cost
▪ Sunk Cost
▪ Opportunity Cost
▪ Differential cost and Differential Revenue
Chapter 2
Job Order Costing

• Process and Job order costing
• Process costing
• Job-Order Costing- An Overview
▪ Measuring direct Material Costs
▪ Measuring Direct labour cost
▪ Application of Manufacturing Overhead
• Choice of an allocation Base for the Overhead cost
• Problems of Overhead application
• Disposition of Under or Over-applied overhead Balances
• Multiple Predetermined Overhead Rates
Chapter 3
Service Department Costing

• Allocations of Service department costs to operation departments
• Primary Distribution of Overheads
• Apportionment of overheads among departments
• Reallocation/ Reapportionment of service department cost to production department
▪ Direct redistribution method
▪ Step method of secondary distribution (or) Non reciprocal method
▪ Reciprocal Distribution method
Chapter 4
Process Costing
• Similarities between job-order and process costing
• Difference between Job-order costing and process costing
• Spoilage(Normal loss/Abnormal Loss)
• Incomplete Units
Chapter 5
Activity Based Costing

• Three basic reasons for ABC
▪ Increase in product diversity
▪ Increase in indirect costs
▪ Competition in product markets
• Designing an Activity Based-Costing(ABC) System
• Identify and Define Activities and Activity Cost pools
▪ Unit-Level activities
▪ Batch Level activities
▪ Product-level activities
▪ Customer level activities
▪ Organisation-sustaining activities
Chapter 6
Cost Behaviour and Cost Volume Analysis

• Types of fixed cost
▪ Committed Fixed costs
▪ Discretionary Fixed Costs
• Mixed Cost
• Cost-Volume-Profit Analysis
• The Contribution Format Income Statement
▪ Contribution Margin Ratio(CM Ratio)
▪ Break Even Point
▪ The Margin of Safety
Chapter 7
Relevant Costs for Decision Making

• Disposal of Assets
• Product mix decisions when capacity constraints exist
• Adding or Dropping Product Lines and Other Segments:
• Make or Buy decisions
• Special order/one time order
Chapter 8
Budget and Budgetary Control

• Types of Budget
▪ operational Budgets
▪ Sales forecasting-- A Critical Step
▪ Zero Base Budgeting(ZBB)
▪ Historical Base budgeting
▪ Top-down and bottom-up approach in Budget preparation
• Budgetary slack
• Kaizen Budgeting
Chapter-1 Cost concepts
I
n the current organisation structure and business models the role of a manager is very crucial to
the successful running of the organisation. The role of a manager came up because of the large
scale manufacturing by business units due to industrialisation in late 18th century and gradual
development in the field of science and technology. Manufacturing through the traditional manual
mode become uncompetitive and replaced by large scale production in the factories where
hundreds of people worked using machineries. Now, these people were to be supervised and the
overall task is required to be managed. Therefore, there was a need felt for a manager, who will not
be involved directly in the production(jobs) but will supervise and control the works to be done by
others. With time, the size of the organisations increased further and the complexity of production
and sales of goods also increased. As a consequence, different functional areas like production,
marketing, personnel, finance, etc gained importance and the whole work force started working
under these functional areas and looking after a particular task or a job. These people developed
expertise in those particular tasks or jobs and works getting done smoothly. Therefore, it is felt
necessary to keep the employee in that job only, so the organisation will get the benefit of his
specialization(expertise) in that task. In the process now there are many managers in every
organisation, small or large to carry out the work of supervising and guiding the subordinates in
different functions to achieve the organisational goals .
As a manager, one is responsible for doing at least, the following four works- making plans,
organising resources, directing personnel, and controlling operations. This is true for all
organisations, whether it is a service organisation, a manufacturing unit or non-business unit. A good
co-ordination among these activities results in the success and growth of the organisation. These
works are done, one after the other and some time required to be done simultaneously. Normally,
planning comes first and then the planned work is to be organised(implemented) and the outcome
is evaluated and controlled but at times, all these works will be going on simultaneously without
following any specific order. When one work is implemented, the planning would be going on for the
other work. Planning is to lay down two or more courses of action for future and any one particular
course of action is to be chosen among the various alternatives available. Once the course of action
has been selected, the people are mobilized to carry out the plan. The final outcome is the effort of
these two steps and this outcome is required to be studied and evaluated. The evaluation of the
performance leads to take further measure to control any significant variation from the planned
estimation. These above activities are done more accurately when the relevant information is
available.
Management Accounting provides those information which help to take the correct decisions while
finalizing the course of action among the alternatives available and also while measuring the
performance and taking corrective steps for future course of action.
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Exhibit 1-1(The role of
Planning a manager)
Controlling Role of a Implementation

(Taking corrective
measures) manager (organising and directing)
Measuring
performance(Compare actual
to plan)
Management Accounting provides those information which help to take the correct decisions while
finalizing the course of action among the alternatives available and also while measuring the
performance and taking corrective steps for future course of action.
Hundreds of decisions, like entering new market, introducing new product, production planning,
make or buy decisions, preparation of budget, setting up new plant, modernisation of old plant,
going for massive sales promotion, shutting down plant, deciding the model of business, cost
structure and many such decisions where there is a decision dilemma, it requires proper study and
sufficient information to choose the right course of action. Lot of information is required in different
forms, a good amount of skill set is required to do analysis of different possibilities, and some
specific techniques are also used for the evaluation of those possibilities. In management
accounting we use lot of common sense, simple logic or mathematical calculations to take decisions
of complicated looking situations. Management accounting is not having any hard and fast rule like
financial accounting, this subject is developed based on practice and observation which has been
standing on the foundation of common sense. There is a considerable difference between
management accounting and financial accounting, although in many situations, both depend on the
same data but their usages are different.
Financial Accounting and Management Accounting
Financial accounting reports the state of financial condition of a company to mainly the external
parties. Although it can also be used by the internal parties but the Management Accounting data
and reports are generally used internally by the management and by various decision makers like
consultants and experts. Management Accounting report is not published and shown to the external
parties. Although both discipline often rely on the same financial data. There is difference not only in
the orientation of their users but also in their emphasis on the past and future. Some of the
comparisons are given below in the Exhibit-2.
Exhibit 1-2 Comparison of Financial and management Accounting
Financial Accounting Management Accounting

▪ Reports to those outside the ▪ Reports to those inside the organisation
organisation for Planning, implementation and
Owners/shareholders Decision making
Creditors/ Lenders
Tax and Govt. Authorities
Regulators
▪ Summarisation of past activities ▪ Decision affecting the future
▪ Verifiability of data is emphasised ▪ Relevance of data is considered
▪ Must follow GAAP ▪ Need not follow GAAP
▪ Mandatory to prepare ▪ Not Mandatory
Hence, we find that management accounting is not a mandatory requirement. It is recorded and
reported for internal use. It helps us in decision making which is of high relevance to the business.
Business organisation makes its competitive strategy and corporate strategy using the data
generated through management accounting and the tools available in management accounting.
Before getting into the tools and techniques, we should understand the basics of management
accounting. We will learn the flow of cost in any organisation, which is recorded and the basic
concepts related to the cost items/units. Gradually we will move to collection of cost, costing the
product/jobs or services, preparation of cost sheet, using the cost data for decision making,
preparation of budget and control aspect of it.
Kinds of business units
If we see the different types of business organisations, we find that, there are at least three kinds of
business set ups existing, manufacturing set up, trading firm and service organisation. Almost all
organisations we see, will be involved in these three kinds of activities. Trading organisations buy
and sell goods, manufacturing organisation manufactures the goods and sell them and service
organisation provides services to customers and they don't deal in goods. While it is also found that
there are business set ups which will be having all the three kinds of operations, for example a
residential hotel will be having room facility, restaurant and bars.
Taking clue from the above discussion, if we take a typical manufacturing organisation we see that it
buys raw material and convert them into finished goods using labour and other manufacturing
process support and sell the finished goods. Labour and other manufacturing process support
activities incurs cost. Hence the cost flows from raw material to work-in-progress to finished goods
and cost of goods sold. In case of a trading organisation(retail shops), it does not involve itself in
manufacturing hence the cost flows from finished goods(buying stock) to cost of goods sold(selling
stocks) and unsold goods remains in inventory of finished goods. Where as in case of a service
organisation like Accounting firm, Legal consultancy, Medicals, Private coaching centres, film houses,
etc there is no goods and hence no cost of goods sold, there is only sell of services. A comparative
study of these three set ups need to studied to understand the flow of cost and calculation of profit.
Exhibit 1-3 shows the comparison between the three set ups.
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Exhibit 1-3
Items Manufacturing Merchandising(trading) firm Service organisation

Company
Examples Examples: Tata Steel, Pentaloon, Big Bazar, Zee TV, KPMG,
Maruti Suzuki, ONGC, Reliance Retail, Dealer of Deloitte, PwC, Appollo
HUL, Voltas, etc Maruti Suzuki, Distributor hospital, AZB and
Of Britania, etc Partners(Law firm), etc.
Deals in Manufactures goods Buy and sell goods Provides services
and sells
Gross Margin Gross margin is Gross margin is calculated, No Gross Margin, as it
calculated, Gross Margin= Sales-COGS does not deal in goods
Gross Margin= Sales-
COGS
COGS COGS= Manufacturing COGS consists of Purchase N/A
cost of goods sold price and buying cost of
goods sold
Cost of goods Cost of Manufacturing N/A N/A
manufactured consists cost of Raw
material, labour and
manufacturing
overhead.
Net Margin Net Margin= Gross Net Margin= Gross margin- Net Margin = total
margin- Adm. and Administration and Selling Revenue- Total
Selling expenses expenses expenses
Exhibit 1-4 Cost flow in a manufacturing Company
Costs
Balance Sheet
Material
Raw Material Inventory
Purchase
d
labour Direct Material used
in production
Manufacturi- Work in process
ng overhead inventory
Goods completed(cost
Income
of goods manufactured) Statement
Cost of goods
Finished Goods
Office and Adm. O/h Inventory
sold
Selling and Selling and

distribution overhead Administrative
overhead
From the above diagram of a manufacturing company's cost flow, we see that material is purchased
and it is converted into finished goods. The labour and manufacturing overheads are incurred to
make the finished goods, these two costs together are termed as conversion cost. But in case of a
trading organisation, there is no manufacturing, goods are purchased from suppliers and sold to
customers. So it only deals in finished goods. So the cost flows from an inventory of finished goods
to cost of goods sold, if inventory is sold and the administrative and selling costs move to the income
statement.
In case of a manufacturing unit all the manufacturing costs are incurred for the production of goods,
therefore these costs will be there in any four forms. Raw material which is consumed is transferred
to work in process, if not consumed it remains in the form of Inventory of material. Then labour and
manufacturing overhead is applied and these costs also move to the work in process, and if the work
is completed then the costs move to the finished goods or else it remains in the form of work in
process inventory. Finally if finished goods are sold then the cost is transferred to Cost of goods
sold, otherwise it appears as inventory of finished goods. All these inventories will appear in the
balance sheet. Hence it does not form part of the cost of goods sold and the sales generated from
the goods sold is compared to find out the gross margin. To find out the net margin(profit) the
administrative and selling expenses are deducted from the gross margin.
From the above explanation what seems that administrative and selling expenses do not form part of
the cost of the product. Only material, labour and manufacturing overhead become the cost of
manufacturing. Therefore these three costs are termed as manufacturing cost and administrative
and selling expenses are termed as non-manufacturing cost.
As the inventory of Raw material, work in process, finished stocks at the end of the period moves to
the next period their cost also moves to the next period. Here the cost moves with the product,
hence manufacturing cost is also termed as product or inventoriable cost. Non-manufacturing cost
does not move to the next period, it is consumed in the period itself. In the next period again it is
incurred, therefore non-manufacturing(Administrative and selling expenses) costs are termed as
period cost. It is also called as non-inventoriable cost as the cost does not form part of the cost of
the inventory(work in process and finished goods). Exhibit 4, shows the different type of cost in a
manufacturing organisation.
Exhibit 1-5
Manufacturing cost(Product cost) Non-Manufacturing cost(Period cost)
Raw material Office and Administrative expenses:

Direct labour(production labour) • Office stationery
• Office rent, electricity, insurance,
Manufacturing Overhead: security
• Indirect labour(supervisor's salary, works • Depreciation of office furniture
manager's salary, salary of maintenance • Telephone expenses
workers, etc) • Salary of office staff
• Indirect material( lubricants used in the • Legal expenses, audit fees
maintenance work, glues and nails used • Directors' fees and meeting expenses
in manufacturing of furniture, etc) • Other miscellaneous expenses
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• Factory rent, insurance, security, etc Selling and Administrative expenses:
• Depreciation of machinery, factory • Warehouse and show room rent
furniture • Warehouse maintenance expenses
• Repairs and maintenance cost • Electricity consumed in the showroom
• Power consumed in the factory • Salary and commission of sales staff
• Water, coal, fuel used • Fair and exhibition participation
expenses
• Advertisement, sales promotion
expenses,
• Transportation cost
In case of a manufacturing and merchandising organisation two statements are prepared, one is
cost sheet and the other one is income statement. Exhibit- 5 shows a typical cost sheet of a
manufacturing organisation.
Exhibit 1-6
Schedule of cost of goods manufactured and cost of goods sold in a manufacturing organisation
Direct Materials
Opening inventory of raw material -----
Add: Purchases of Raw Material* ----- Overhead- All
Raw material available for use ----- indirect
Less: closing inventory of raw material ----- expenses are
Raw Material used in production ----- ----- termed as
Direct labour ----- overhead, apart
from direct
Prime cost -----
material and
Manufacturing Overhead -----
direct labour.
Total Manufacturing costs -----
Add: Opening Work-in-progress
Less: Closing Work-in-progress -----

Cost of goods manufactured(completed) -----
Added: Opening Inventory Finished goods -----
Cost of Goods available for sale -----
Less: Closing inventory of finished goods -----
Cost of goods sold -----
*Purchase of material includes the cost of transportation, insurance and taxes incurred to bring the
goods to the place of manufacturing or business.
In case of a trading organization, calculation of cost of goods manufactured is not required to be

done because there is no manufacturing activity. In trading or merchandising organisation, the
goods are purchased and sold. The cost of goods sold is calculated in the following manner:
Cost of goods sold = Opening inventory of goods + Purchases – closing inventory of goods.
But the income statement is same in both the type of organization. Non-manufacturing costs are
deducted from gross profit to find out the net profit as it is given exhibit-6.
Exhibit 1-7
Income Statement
Sales -----
Less: Cost of goods sold -----
Gross Profit -----
Less: Administrative and selling expenses -----
Net Profit -----
In case of a service providing organisation, the total revenue earned is compared with the revenue
expenses incurred during the year to find out the net profit. There is no goods, hence no cost of
goods sold.
Cost classification for Assigning costs to cost objects

Costs are required to be assigned to different cost objects for a number of different reasons, like
controlling the cost by making a person or department accountable for it, for pricing the goods or
services, for finding out the cost incurred for a specific task/operation, for profitability study, etc. But
when we see the list of expenses incurred we find many kinds of expenses, now the question is
whether those expenses can be added to any activity or job depends on one basic thing i.e., whether
the cost can be identified with the cost object. Based on this fundamental, the cost has been divided
into two types of cost, one is direct cost and the other one is Indirect cost. Earlier in the chapter we
had studied the Direct material and Direct labour as the direct cost, but the direct costs concept is
broader than that. In relation to production units, Direct material and direct labour is a direct cost
because it can be identified with the product manufactured but in relation to many other cost
objects whether a cost can be identified with it or not, this concept is to be developed very carefully.
Next part of the chapter discusses the concepts of direct and indirect cost. The chapter also deals
with the other cost concepts which will let us to develop a basic understanding of the cost and
provide a base to grasp the tools and techniques of management accounting.
Direct Cost and Indirect Cost
Direct cost is a cost which can be easily identified with or traceable to the cost object. The cost
object is something for which we want to know the cost, it may be an individual, product, service or
department, or anything else. If the manager of the production department wants to know the
labour cost of Department-I for a particular month, then that department becomes the cost object.
Now out of the total labour cost incurred in the whole organisation, we have to find out which is
related with Department-I. The cost which can be identified is called direct cost of that cost object.
There are few costs which cannot be identified with the cost object but the cost has been incurred
for that cost object. For example the electricity consumed in the class room, where section C, MBA-
1, is sitting, is not a direct cost because there is no mechanism available to find out easily the cost
incurred for the Section C(LH-11) out of the electricity bill(cost) which has come for all the class
rooms including the administrative block. But the same can be identified if a meter is installed for
each class room to measure the electricity consumption during a particular period of time. So the
same cost which was an indirect cost, becomes a direct cost if it is identified with the cost object.
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Here in the above example Section C(LH-11), is the cost object. In the first instance, the cost could
not be identified hence it is not a direct cost but an indirect cost.
The glue or Fevicol adhesive used to make furniture, cannot be identified with the individual unit of
furniture where many furniture are manufactured and glue is not accounted so minutely in relation
to individual furniture, is an indirect cost(indirect material cost). Similarly a supervisor's salary is an
indirect cost because his effort cannot be identified with any individual product(cost
object)manufactured in a particular department, but if the cost object changes to a particular
department, then the supervisor's salary will become a direct cost as it can be identified with the
department.
Classification of Cost on the basis of its behaviour
To predict or estimate the cost of production or operation we need to know, how a particular cost is
behaving in relation to the change in level of activity. We found that the different types of cost
behave in different ways. Some expenses remains same in total even if we change the level of
activity, where as some of costs change in relation to the change of activity and the change is very
much proportionate to the change in the level of activity. It is also found that some of the cost
change but not proportionately. Therefore without having a good understanding of the behaviour of
individual costs, prediction of total cost for any purpose(estimation or pricing) will lead to many
problems, primarily in planning and decision making. If we consider the behavioural aspect of cost
then there are three types of costs. Let's understand them.
Variable cost: A variable cost is a cost that varies, in total, in direct proportion to the changes in the
level of activity. The change in activity may be in units produced, units sold, hours worked, miles
run, number of customers, no of beds, no of meals, etc. The best example in case of manufacturing
organisation is the amount of material consumed, it varies in proportion to the unit or batches
produced. If more number of units are produced we can estimate the additional quantity of material
required because the varies proportionately and remains same per unit.
Fixed Cost: A fixed cost is a cost that remains constant, even if there is change in the level of activity
but within a given range or capacity. Beyond the given capacity, if it is decided to operate then the
cost may change. Rent of factory, property taxes, Insurance, administrative staff salaries, etc are
fixed cost. We can take one example of a group of students planning to go for a picnic, and the
following major heads of costs are estimated to be incurred (for a batch of 30 students).
Exhibit 1-8
Elements of cost Expected amount Description

of expenses
Food and beverages ₹6,000 ₹200 per student
Cook ₹1,000 For the whole day charge
Transportation(including diesel expenses) ₹5,000 One bus with a capacity of 35
students
Entertainment(music system, etc) ₹2,000 For one day
Tent and Crockery ₹3,000 For 30-40 students
Other expenses ₹1,000 Misc. expenses
When it is declared it is found that 50 students are interested to go and registered for the picnic.
Now cost is to be estimated, Food and beverages will remain ₹200 per student but the total cost will
increase(variable cost), Cook charges will remain same(Fixed Cost), Transportation cost will increase
because they have to hire a bigger size of bus and it will cost them ₹7,000.Here, transportation is a
fixed cost because it is taken on rent including the fuel cost but the cost is varying because the
number of students are increasing beyond a range i.e., 35 students. Entertainment cost is fixed for
one day, will remain ₹2,000. Tent and Crockeries' cost will increase because the number is increasing
beyond the range. Now, it will cost ₹3,500. Other expenses will remain constant, it is a fixed cost.
Now we can better understand that when the cost is varying in total and in direct proportion to
change in the level of activity, it is termed as variable cost. If it does not change or change when the
activities increase beyond the capacity, it is called a fixed cost.
Mixed Cost
If a particular cost is having both the features of fixed and variable cost, then it is termed as a
mixed cost. The other way we can say that the cost is partly variable and partly fixed. This cost is
having a fixed component irrespective of the change in activity and the rest varies to change in
activity. These type of costs are also termed ad semi-fixed or semi-variable cost. In India, telephone
bills(landline), and electricity bill of individual houses are of this nature. Many a time employees are
paid salaries which will be having two components a fixed and a variable. For example salary of a
sales staff in TANISHQ showroom, gets a fixed salary and also a get a percentage of commission on
total sales done by him/her.
A typical example of this type of cost is the power consumption cost of a machinery. Initially when a
machinery is started for a batch of units(like marker pen, assembly of cars, etc), it consumes lot of
electricity for setting up the machinery and then electricity is consumed for running the machinery.
The initial power consumption remains same for the whole batch even if the batch size is 10000
units or it 1000 units. If we consider the no. of units of marker manufactured as the activity then the
initial power consumption cost does not vary with activity and remains fixed and rest part of the
power consumption is variable, which varies direct proportion to the production or machine running
hour Although here it can be said that the initial power consumption cost varies with per set up of
machine(this concept will be covered in the Activity Based Costing chapter) but in relation to units of
production it does not vary. The power consumption by machineries is a mixed cost.
Once it is identified that a particular cost is having both the components of fixed and variable
element. Then we have to find out the fixed cost in total and variable cost per unit.
Ex: Reynolds manufactures white board marker. The power consumption for two batches of markers
are given below. Find out the variable and fixed cost components.
Batch Machine running hours Power consumption(₹)

1 100 4500
2 125 5000
The power consumption cost increases by ₹500 for 25 machine hours(increase in machine running
hours), hence this is how the power costs varies.
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Variable cost of power consumption per machine hour = ₹20 per machine hour(i.e., 500/25).
Fixed cost = Total cost for a given capacity - total variable cost
For 100 machine hours,
Fixed cost = 4500 - (100 x 20) = ₹2500, fixed cost will come same for 125 machine hours also.
Behaviour of cost is useful while one is planning to set up a plant. At that point of time, one can also
design the cost structure keeping in mind, the nature of the business, availability of funds market
condition, economic environment and political situation of the host country. One cost which is fixed
in nature can be designed to be made a variable cost. For example, in a coffee shop, we can have
permanent employees who are paid fixed salary or else we can appoint contractual employees who
will be either paid for no. of hours worked or no. of customers served. The same cost which was
fixed can be designed to be a variable cost.
Similarly in ST Construction, a company into earth moving and road construction, we can buy a
earth moving machine and have depreciation(fixed cost) or otherwise we can take the machine on
operating lease and pay on the basis of hours used. Thus the same cost becomes a variable cost
when it is taken on rent on hourly basis. In the case of fixed cost, commitment is more, where as in
case of a variable cost the cost incurs only when we go for the activity, otherwise we may not be
required to pay for it. So a business manager should design its cost structure keeping various critical
factors like market/economic condition and competition dynamics into consideration.
The other thing to learn from the behaviour of cost is that fixed cost remains same in a given range
and total variable cost changes proportionately with the change in the level of activity, which leads
to decrease in the average cost with the increase in total output/activities. So the statements
frequently made "benefits of large scale operations" is basically because of having fixed cost in the
cost, which reduces per unit when we go for large scale operation(there may be some other reasons
like large scale buying and discount offers, etc, also).
Classification of cost from decision making point of view

Relevant cost and Irrelevant cost
While planning and even at implementation stage or for taking a decision when two or more
alternatives are available, we evaluate the alternatives using quantitative and qualitative data. Here
in this subject we are giving emphasis mostly to quantitative data, so qualitative aspects are not
discussed. Now, while taking decision we go through lot of data, many of them are useful and many
of them are not useful. We need only useful data other data are of no use and confuses the person
while making decisions. The cost data which is relevant for decision making is called relevant cost
and taken into consideration for evaluating the decision. The cost information which is not relevant
for the decision is called irrelevant cost. The question here is, how to decide, which data is relevant
and which one is irrelevant. We take those data into consideration for decision making, if it differs
for two available alternatives and those cost data are called relevant cost for that decision. The cost
data which is same for both the alternative then it becomes irrelevant for decision making and called
irrelevant cost for that particular decision.
Let us now consider an illustration of the classification of relevant and irrelevant costs. Assume a
company purchased raw materials a few years ago for ₹100 and that there appears to be no
possibility of selling these materials or using them in future production apart from in connection with
an enquiry from a former customer. This customer is ready to pay ₹250 for the product. The
additional costs of converting these materials into the required product are ₹200. Should the
company accept the order for ₹250?
It appears that the cost of the order is ₹300, consisting of ₹100 material cost and 200 hundred
conversion cost , but this is incorrect because the ₹100 material cost will remain the same whether
the order is accepted or rejected. The material cost is therefore irrelevant for the decision, but if the
order is accepted the conversion costs will change by ₹200, and this conversion cost is a relevant
cost. If we compare the revenue of ₹250 with the relevant cost for the order of ₹200, it means that
the order should be accepted, assuming that no higher priced orders can be obtained elsewhere.
The relevant and irrelevant cost concept can be used in the context of avoidability of cost.
Avoidable costs are those costs that may be saved by not adopting a given alternative, whereas
unavoidable costs cannot be saved. The material cost of ₹100 is unavoidable and irrelevant, but the
conversion cost of ₹200 is avoidable and hence relevant.
Sunk cost
Sunk costs are costs that have been incurred in the past. Consequently they do not affect future cost
and cannot be changed by any current or future action. In the previous example, the expenditure of
₹100 on materials (that were no longer required), is an example of a sunk cost. All sunk costs are
irrelevant for decision making, but all irrelevant costs are not sunk cost.
Another example, a machine purchased four years ago for ₹100000 with an expected life of five
years with no scrap value after the life of machine. The written down value of machine will be
₹20000 today, if straight line method of depreciation is used. This written down value will have to
be written off, no matter what possible alternative future action might be chosen. If the machine
was scrapped, the ₹20,000 would be written off; if the machine was used for productive purposes,
the ₹20000 would still have to be written off. This cost cannot be changed by any future decision and
is therefore classified as a sunk cost.
Opportunity Cost
Opportunity cost is the potential benefit sacrificed when one alternative is selected over another.
When we have to go for any one option because of some compulsion(financial, need, resources, use
or time), then we have to leave one option and go for the other. While taking the decision for going
for the second option we have to take the financial benefit sacrificed from the first option as the cost
of the second option, this is termed as opportunity cost.
Example 1. A company has an opportunity to obtain a contract for the production of a special
component. The component will require 100 hours of processing on machine X. Machine X is
working at full capacity on the production of product A, and the only way in which the contract can
be fulfilled is by reducing the output of product A. This will result in a lost profit contribution of
₹200. The contract will also result in additional variable costs of ₹1000.
If the company takes on the contract, it will sacrifice a profit contribution of ₹200 from the lost
output of product A. This represents an opportunity cost, and should be included as part of the cost
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when negotiating for the contract. The price to be asked for should at least cover the additional costs
of ₹1000 plus the ₹200 opportunity cost to ensure that the company will be better off in the short
term by accepting the contract.
Example 2. Vimal has a part-time job that pays him ₹500 per week. Now he wants start a stationery
store, near his house. He is assuming that he will have a good business here and he will be able to
sell around ₹30000 per month(4 weeks), with a margin of 8%.
while taking the decision, Vimal has to take the amount of ₹500 per week or monthly ₹2000 as
opportunity cost(i.e., benefit sacrificed) with the other additional costs and compare it with the
margin of ₹2400 (i.e., ₹30000 x 8%) from stationery store.
Differential cost and Differential Revenue

The concept of differential cost is used while selecting any one alternative between two given
alternatives. The costs of two alternatives are compared and the difference is calculated, it may be
an increase or decrease in relation to the first alternative, if cost increases it is called as incremental
cost and if it decreases it is termed as decremental cost. Both these terms are part of differential
cost. Then the revenue of two alternatives are compared to find out the differential revenue. when
revenue increases it is called as incremental revenue and if it decreases then termed as decremental
revenue. If the difference between the differential revenue and differential cost is positive then we
select the second alternative. All the relevant costs are considered for taking the decision and it
includes fixed as well as variable.
Questions for practiceQ.No.1.The PC WORKS assembles custom computers from components

supplied by various manufacturers The company is very small and its assembly shop and retail sales
store are housed in a single facility in a Redmond, Washington, industrial part. Listed below are some
of the costs that are incurred at the company.
Required:
For each cost, indicate whether it would most likely be classified as direct labour, direct materials,
manufacturing overhead , marketing and selling, or an administrative cost.
a. The cost of a hard drive installed in a computer.

b. The cost of advertising in the Times of India newspaper.
c. The wages of employees who assemble computers from components.
d. Sales commissions paid to the company's salespeople.
e. The wages of the assembly shop's supervisor.
f. The wages of the company's accountant.
g. Depreciation on equipment used to test assembled computers before release to customers.
h. Rent on the facility in the industrial park.
Q.No.2. Classification of Costs as Period or Product cost
A product cost is also known as an inventoriable cost. Classify the following costs as either product
(inventoriable) costs or period(non-inventoriable) costs in a manufacturing company:
1. Depreciation on salespersons' cars.

2. Rent on equipment used in the factory.

3. Lubricants used for maintenance of machines.
4. Salaries of finished goods warehouse personnel.
5. Soap and paper towels used by factory workers at the end of a shift.
6. Factory supervisor's salaries.
7. Heat, water, and power consumed in the factory.
8. Materials used for boxing products for shipment overseas. (Products are not normally boxed)
9. Advertising costs.
10. Workers' compensation insurance on factory employees.
11. Depreciation on chairs and tables in the factory lunchroom.
12. The wages of the receptionist in the administrative offices.
13. Lease cost of the corporate jet used by the company's executives.
14. Rent on rooms at a Florida resort for holding of the annual sales conference.
15. Attractively designed box, for packaging the company's product-breakfast cereal.
Q.No.3. Classification of Costs as Fixed or Variable
Below are a number of costs that are incurred in a variety of organizations.
Required:
Classify each cost as being variable or fixed with respect to the number of units of product or
services sold by the organisation by placing an X in the appropriate column.
1. X-ray film used in the radiology lab at V Mason Hospital in Seattle

2. The costs of advertising a Madonna rock concert in New York City
3. Rental cost of a McDonald's restaurant building in Hong Kong.
4. The electrical costs of running a roller coaster at Magic Mountain
5. Property taxes on your local cinema
6. Commissions paid to salespersons at Bhubaneswar
7. Property insurance on a Mango Frooti bottling plant
8. The costs of synthetic materials used to make Nike running shoes.
9. The costs of shipping Panasonic televisions to retail stores.
10. The cost of leasing an ultra-scan diagnostic machine at the American Hospital in Paris.
Q.No.4. Northwest Hospital is a full-service hospital that provides everything from major surgery and
emergency room care to outpatient clinics.
Required:
For each cost incurred at Northwest Hospital, indicate whether it would most likely be a direct
cost or an indirect cost of the specified cost object by placing an "X" in the appropriate column.
Cost Cost Object Direct Indirect

Cost Cost
Example, Catered food served to patients A particular patient X
1. The wages of pediatric nurses A particular patient
2. Prescription drugs The pediatric department
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3. Heating the hospital A particular patient
4. The salary of the head of pediatrics The pediatric department
5. The salary of the head of pediatrics The pediatric department
6. Hospital chaplain's salary A particular patient
7. lab tests by outside contractor A particular patient
8. Lab tests by outside contractor A particular department
Q.No.5. Listed below are a number of costs typically found in organizations:

1. Property taxes, factory.
2. Boxes used for packaging detergent produced by the company
3. Salesperson's commission.
4. Supervisor's salary, factory.
5. Depreciation, executive autos.
6. Wages of workers assembling computers.
7. Insurance, finished goods warehouses.
8. Lubricants for machines.
9. Advertising costs.
10. Microchips used in producing calculators.
11. shipping costs on merchandise sold.
12. Magazine subscriptions, factory lunchroom.
13. Thread in a garment factory.
14. Billing costs.
15. Executive life insurance.
16. Ink used in textbook production.
17. Fringe benefits, assembly-line workers.
18. Yarn used in sweater production.
19. Wages of receptionist, executive offices.
Required:
Prepare an answer sheet with column headings as shown below:
Cost item Variable Selling Administrative Manufacturing(Product)
or Fixed Cost Cost Cost
Direct Indirect
Property taxes, factory F X
Q.No.6. Various costs associated with the operation of factories are given below:
1. Electricity used in operating machines.
2. Rent on a factory building
3. Cloth used in drapery production.
4. Production superintendent's salary.
5. Wages of labourers assembling a product.
6. Depreciation of air purification equipment used in furniture production.
7. Janitorial(caretaker) salaries.
8. Peaches used in canning fruit.
9. Lubricants needed for machines.
10. sugar used in soft-drink production.
11. Property taxes on the factory.
12. Wages of workers painting a product.
13. Depreciation on cafeteria equipment.
14. Insurance on a building used in production helicopters.
15. Cost of rotor blades used in producing helicopters.
Required:
Classify each cost as either variable or fixed with respect to the number of units produced and
sold. Also indicate whether each cost would typically be treated as a direct cost or an indirect
cost with respect to units of product. Prepare your answer sheet as shown below:
Cost behaviour To units of Product
Cost item Variable Fixed Direct Indirect
Electricity used in operating
machine X X
Q.No.7. Below are listed various costs that are found in organizations.
1. Hamburger buns in a Wendy's outlet.
2. Advertising by a dental office.
3. Apples processed and canned by Del Monte.
4. Shipping canned apples from a Del Monte plant to customers.
5. Insurance on a Bausch & Lomb factory producing contact lenses.
6. Insurance of IBM's corporate headquarters.
7. Salary of a supervisor overseeing production of printers at Hewlett-Packard.
8. Commissions paid to Encyclopaedia Britannica salespersons.
9. Depreciation of factory lunchroom facilities at a General Electric plant.
10. Steering wheels installed in BMWs.
Required: Classify each cost as being either variable or fixed with respect to the number of
units produced and sold. Also classify each cost as either a selling and administrative cost or
a product cost.
Cost behaviour Selling and
Cost item Variable Fixed Admin. cost Product
cost
Q.No.8. Consider the following costs that were incurred during the current year:
1. Tire costs incurred by For Motor Company.

2. sales commissions paid to the sales force of Dell Inc.
3. Wood glue consumed in the manufacture of Thomasville furniture.
4. Hourly wages of refinery security guards employed by ExxonMobil Corporations.
5. the salary of a financial vice president of Hewlett Packard.
6. Advertising costs of Coca-Cola.
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7. Straight-line depreciation on factory machinery of Boeing Corporation.
8. Wages of assembly-line personnel of Whirlpool Corporation.
9. Delivery costs on customer shipments of Ben& Jerry's ice cream
10. Newsprint consumed in printing The New York Times.
11. Plant insurance costs of Texas Instruments.
12. Glass costs incurred in light-bulb manufacturing of General Electric.
Required: Evaluate each of the preceding and determine whether the cost is (a) a product cost
or a period cost, (b) variable or fixed in terms of behaviour, and (c) for the products only,
whether the cost is properly classified as direct material, direct labour, or manufacturing
overhead. Item 1 is done as an example:
Tire costs: Product cost, variable, direct material.
Q.No.9. Martin Shrood purchased a vacant lot outside of London for ₹13,500, because he heard that a
shopping mall was going to be built on the other side of the road. He figured that he could
make a bundle by putting in a fast-food outlet on the site. As it turned out, the rumour was
false. A sanitary landfill was located on the other side of the road, and Martin's land was
worthless. Required: What type of cost is the ₹13,500 that Martin paid for the vacant lot?
Q.No.10. Orbital Communications, Inc. manufactures communications satellites used in TV signal

transmission, the firm currently purchases one component for its satellites from a European
firm. An Orbital Communications engineering team has found a way to use the company's own
component, part number A200, instead of the European component. However, the Orbital
Communications component must be modified at a cost of ₹750 per part. The European
component costs ₹8,900 per part. Orbital Communications' part number A200 costs ₹4,900
before it is modified. Orbital Communications currently uses 20 of the European components
per year.
Required: Calculate the annual differential cost between Orbital Communications' two product
alternative.
Q.No.11. The state Department of Education owns a computer system, which its employees use for
word processing and keeping track of educations statistics. The governor's office recently began
using the computer also. As a result of the increased usage, the demand on the computer soon
exceeded its capacity. The director of the Department of Education was soon forced to lease
several personal computers to meet the computing needs of her employees. The annual cost of
leasing the equipment is ₹14,000.
Required:
1. What type of cost is this ₹14,000?
2. should this cost be associated with the governor's office or the Department of Education?
Why?
Q.No.12. suppose you paid ₹10 for a ticket to see your university's football team compete in a
championship match. someone offered to buy your ticket for ₹25, but you decided to go to the
match.
Required:
1. What did it really cost you to see the game?
2. What type of cost is this?
Q.No.13. Alexandria Aluminium Company, a manufacturer of recyclable soda cans, had the following
inventory balances at the beginning and end of 2014.
Inventory Classification January 1, 2014 December 31, 2014
Raw Material ₹ 50,000 ₹70,000
Work in process 120,000 115,000
Finished goods 100,000 165,000
During 2014, the company purchased ₹250,000 of raw material and spent ₹400,000 on direct
labour.
Manufacturing overhead costs were as follows:
Indirect material ₹10,000
Indirect labour 25,000
Depreciation on plant and equipment 100,000
Utilities 25,000
Other 30,000
Sales revenue was ₹1,105,000 for the year. Selling and administrative expenses for the year
amounted to ₹110,000. The firm's tax rate is 40 percent.
Required:
1. Prepare a schedule of cost of goods manufactured.
2. Prepare a schedule of cost of goods sold.
3. Prepare an income statement.
Q.No.14. The following selected information was extracted from the 2015 accounting records of
Lone Oak Products:
Raw material purchases ₹175,000

Direct labour 254,000
Selling and administrative salaries 133,000
Building Depreciation* 80,000
Other selling and administrative expenses 195,000
Other factory costs 344,000
Sales revenue(₹130 per unit) 1,495,000
*Seventy -five percent of the company's building was devoted to production activities; the remaining
25 percent was used for selling and administrative functions.
Inventory data:
Beginning Ending
Raw material ₹15,800 18,200
Work in process 35,700 62,100
Finished goods* 111,100 97,900
*The January 1 and December 31 finished-goods inventory consisted of 1,350 units and 1,190 units,
respectively.
Required:
1. Calculate Lone Oak's manufacturing overhead for the year.
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2. Calculate Lone Oak's cost of goods manufactured.
3. compute the company's cost of goods sold.
4. Determine net income for 2015, assuming a 30% income tax rate.
5. Determine the number of completed units manufactured during the year.
Q.No.15. Shaheen Plastics, Ltd’s selected data for the month of August related to current year are
presented below(in millions):
Beginning work-in-process inventory ₹2,000

Beginning direct materials inventory 900
Direct materials purchased 3,600
Direct materials consumed 3,750
Manufacturing overhead 4,800
Total manufacturing costs 16,000
Costs of goods manufactured 16,500
Cost of goods sold 17,000
Ending finished goods inventory 1,250
Calculate the following costs:
1. Direct Materials inventory as on 31st August.

2. Direct Labour costs for August
3. Work-in-progress inventory as on 31st August.
4. Goods available for sale in August
5. Beginning Finished goods inventory.
Q.No.16. The following cost and inventory data are taken from the accounting records of Mason
Company for the year just completed:
Costs incurred: ₹
Direct Labour cost 70,000
Purchases of raw materials 118,000
Maintenance, factory equipment 6,000
Advertising expense 90,000
Insurance, factory equipment 800
Sales salaries 50,000
Rent, factory equipment 20,000
Supplies 4,200
Depreciation, office equipment 3,000
Depreciation, factory equipment 19,000
Inventory data:
Beginning of End of the
the year(₹) year(₹)
Raw Materials 7,000 15,000
Work-in-process 10,000 5,000
Finished goods 20,000 35,000
Required:
1. Prepare a schedule of cost of goods manufactured in good form.
2. Prepare the cost of goods sold section of Mason Company's income statement for the year.
Q.No.17. Selected account balances for the year ended December 31 are provided below for
Superior Company:
Purchase of raw materials ₹290,000
Direct labour ?
Advertising expense 80,000
Cleaning supplies, factory 7,000
Sales commissions 50,000
Rent, factory building 120,000
Maintenance, factory 30,000
Selling and administrative salaries 110,000
Insurance, factory 8,000
Utilities, factory 45,000
Inventory balances at the beginning and end of the year were as follows:
Beginning of the End of the Year
Year
Raw materials ₹40,000 ₹10,000
Work -in-process ? 35,000
Finished goods 50,000 ?
The total manufacturing costs for the year were ₹683,000; the goods available for sale totalled
₹740,000; and the cost of goods sold totalled ₹660,000.
Required:
1. Prepare a schedule of cost of goods manufactured and the cost of goods sold.
2. Assume that the dollar amounts given above are for the equivalent of 40000 units produced
during the year. Compute the average cost per unit for direct materials used and the
average cost per unit for rent on the factory building.
Q.No.18. Supply the missing data in the following cases. Each case is independent of the other.
Case
1 2 3
Direct materials ₹4,500 ₹6,000 ₹5,000
Direct labour ? 3,000 7,000
Manufacturing overhead 5000 4,000 ?
Total manufacturing costs 18,500 ? 20,000
Beginning work in process inventory 2,500 ? 3,000
Ending work in process inventory ? 1,000 4,000
Sales 30000 21,000 36,000
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Beginning finished goods inventory 1000 2,500 ?
Cost of goods manufactured 18000 14,000 ?
Goods available for sale ? ? ?
Ending finished goods inventory ? 1500 4,000
Cost of goods sold 17000 ? 18,500
Gross Margin 13000 ? 17,500
Operating expenses ? 3,500 ?
Net operating income 4000 ? 5,000
Q.No.19. Mrs. Ramanujan has taken out a lease of a shop for a down payment of ₹5000.
Additionally, the rent under the lease amounts to ₹5000 per annum. If the lease is cancelled, the
initial payment of ₹ 5000 is forfeit. Mrs. Ramanujan plans to use the shop for the sale of clothing,
and has estimated operations for the next twelve months as follows:
₹ ₹
Sales 115000
Less value added tax (VAT) 15000
Sales less (VAT) 100000
Cost of goods sold 50000
Wages and wage related costs 12000
Rent including the down payment 10000
Rates, heating, lighting and insurance 13000
Audit, legal and general expenses 2000
87000
Net profit before tax 13000
In the figures no provision has been made for the cost of Mrs. Ramanujan but it is estimated that one
half of her time will be devoted to the business. She is undecided whether to continue with her
plans, because she knows that she can sublet the shop to a friend for a monthly rent f ₹ 550 if she
does not use the shop herself.
You are required to:
(a) (i) explain and identify the sunk and opportunity costs in the situation depicted above;
(ii) state what decision Mrs. Ramanujan should make according to the information
given, supporting your conclusion with a financial statement.
Q.No.20. A drug company has initiated a research project which is intended to develop a new
product. Expenditures to date on this particular research total Rs 500000 but it is now estimated that
a further ₹200000 will need to be spent before the product can be marketed. Over the estimated life
of the product the profit potential has a net present value of ₹350000.
You are required to advise management whether they should continue or abandon the project.
Support your conclusion with a numerate statement and state what kind of cost is the ₹500000.
Q.21. The NorthIndia Hospital Trust operates two types of specialist X-ray scanning machines, XR1
and XR50. Details for the next period are estimated as follows:
Machine XR1 XR50

Running hours 1100 2000
Variable running costs(excluding plates) ₹27,500 ₹64,000
Fixed costs 20,000 97,500
A brain scan in normally carried out on machine type XR1: this task uses special X-ray plates costing
₹40 each and takes four hours of machine time. Because of the nature of the process, around 10 per
cent of the scans produce blurred and therefore useless results.
Required:
a) Calculate the cost of a satisfactory brain scan on machine type XR1.
b) Brain scans can also be done on machine type XR50 and would take only 1.8 hours per scan with a
reduced reject rate of 6 per cent. However, the cost of the X-ray plates would be ₹55 per scan.
Required:
Advise which type should be used, assuming sufficient capacity is available on both types of
machine. CIMA Cost Accounting 1
Theory questions:
Q.1. What are the major differences between financial and managerial accounting?
Q.2. Identify the benefits that can result from reducing the set up time for a product?
Q.3. What is the benefit of having fixed cost in the cost structure if we increases the volume of
operation?
Q.4. Briefly explain the following terms:
a. Fixed cost and variable cost
b. opportunity cost
c. sunk cost
d. relevant and irrelevant cost
e. Period cost and product cost
Q.5. Explain whether you agree with each of the following statements:
i) 'All direct costs are variable'.
ii) 'Variable costs are controllable and fixed costs are not'.
iii) 'Sunk costs are irrelevant when providing decision making information'.
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Quiz-1/Practice set-1
1.XYZ Ltd, a company that manufactures sophisticated spy cameras for remote-controlled military
aircraft. Identify the above costs as either product or period costs. (0.25 x 4 =1)
A. Depreciation on salespersons’ car

B. Rent on equipment used in the factory
C. Lubricants used for machine maintenance
D. Salaries of personnel who work in the finished goods warehouse.
2. Classify the following costs of various organizations as Direct or Indirect costs (0.25 x 4=1)
a. Property taxes, factory
b. Boxes used for packaging detergent produced by the company
c. Salespersons salary
d. Depreciation, executive autos
3. Classify the costs on the basis of cost behavior (0.25 x 4=1)
Cost Measure of Activity Cost
Behaviour(Fixed/Variable)
1.The cost of X-ray film Number of X-rays taken
used in the radiology lab
at KIMS
2. Property Insurance on Number of cases of bottles
a Coca-Cola bottling plant produced
3. Supervisor’s salary, Number of units produced
factory
4. Thread in a garment Quantity of garments produced
factory
4. The average cost of goods or services decreases when the volume increases, if there will be:
a. No Fixed Cost (0.5)
b. No Variable Cost
c. Variable cost only
d. Variable cost and Fixed
5. Conversion cost is the total of (0.5)
a. Material, Labour and Manufacturing overhead
b. Material and Labour Cost
c. Labour and Manufacturing overhead
d. Labour and all overhead
6. ABC Ltd. incurred the following cost during the year. Direct material Rs.50,000, Direct
Labour Rs.25,000, Manufacturing Overhead Rs.20,000 and Selling & Administration Overhead
Rs.34,000. During the year 800 units are manufactured and 600 units are sold. You have to find out
the value of inventory.
(1.0)
1. Classify the following costs of various organizations as Direct or Indirect costs (0.25x4 =1)
A. Depreciation, executive autos

B. Supervisor’s salary, factory
C. Wages of workers assembling computers
D. Insurance, finished goods warehouse
2. Conversion cost is the total of (0.5)
a. Material, Labour and Manufacturing overhead

b. Material and Labour Cost
c. Labour and Manufacturing overhead
d. Labour and all overhead
3. Fixed cost is that cost which (0.5)
a. Changes with the volume

b. Remains same within a capacity
c. Changes as a proportion to sales
d. Remains same per unit of output
4. Classify the following costs as variable or fixed (0.25x4=1)

Thread in a garment Quantity of garments produced
factory
Lubricants for production No. of units manufactured
equipment
Advertisement Number of units produced
Depreciation of Plant Number of units produced
5. RELCAM, a company that manufactures sophisticated spy cameras for remote-controlled
military aircraft. Identify the above costs as either product or period costs. (0.25x4=1)
I. Salaries of personnel who work in the finished goods warehouse.

II. Soap and paper towels used by factory workers at the end of a shift.
III. Factory supervisors’ salaries.
IV. Heat, water and power consumed in the factory.
6. ABC Ltd. incurred the following cost during the year. Direct material Rs.60,000, Direct Labour
Rs.15,000, Manufacturing Overhead Rs.20,000 and Selling & Administration Overhead
Rs.24,000. During the year 2000 units are manufactured and 1500 units are sold. You have to
find out the conversion cost, prime cost, product cost and period cost. (1.00)
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1. Manufacturing cost is the total of (0.5)

a. All Manufacturing Overhead
b. Material, Labour and Manufacturing overhead
c. Material, labour and All other overheads
d. None of the above
2. Variable cost varies with output, whereas the fixed cost per unit remains constant. (True /
False) (0.5)
3. (0.25x4= 1)
Yarn used in sweater Number of sweaters produced
production
Microchips used in Number of calculators produced
producing calculators
Ink used in text book Number of books published
production
Insurance of Factory Number of units manufactured
Building
4. Compac Ltd., a company that manufactures sophisticated spy cameras for remote-controlled
military aircraft. Identify the following costs as either product or period costs. (0.25x4 =1)
I. Heat, water and power consumed in the factory.
II. Materials used for boxing products for shipment overseas.
III. Workers’ compensation insurance for factory employees
IV. Depreciation on chairs and tables in the factory lunchroom.
5. Classify the following costs of various organizations as Direct or Indirect costs

(0.25x4=1)
a. Insurance, finished goods warehouse
b. Ink used in text book production
c. Fringe benefits assembly-line workers
d. Yarn used in sweater production
6. ABC Ltd. incurred the following cost during the year. Direct material Rs.204,000, Direct
Labour Rs.105,000, Manufacturing Overhead Rs.80,000 and Selling & Administration
Overhead Rs.204,000. During the year 2000 units are manufactured and 1200 units are sold.
You have to find out the value of inventory and the conversion cost. (1.00)
Chapter-2 Job Order Costing
Job Order Costing
I n the first chapter we learned the cost concepts, classification of cost on various basis for the
purpose of identifying the cost with the cost object and for other decision making purposes.
Also, we learned how to prepare cost sheet and income statement for ascertaining the profit or
loss of an organisation for a specific period. The cost concepts are useful for us in planning and
taking business decisions. It is comparatively easy to calculate the cost for the period and ascertain
the profit if all cost elements(manufacturing, selling and administrations costs) are given because it
can be identified with the period rather than calculating the cost of the product, where all costs
cannot be easily identified with the product. The challenge furthers when we have to find out the
cost of a product, which is manufactured in a complex manufacturing organization where many
other kinds of products are also produced using the same resources. The challenge is to allocate the
cost of utilities and facilities which are consumed by other products also.
Now, the cost of direct material and direct labour can be identified with the product(the cost object)
but manufacturing overhead which is also part of product cost cannot be identified with the product
or batch of products. So this cost is to be charged to the product using some basis. If in a particular
case, the basis is given then it is not difficult to find out the product cost otherwise we have to take
the most appropriate basis in a given situation.
In this chapter we will learn how the cost of a job/batch is ascertained. As discussed in the previous
paragraph, the manufacturing overheads are charged to the product or job applying a
manufacturing overhead rate calculated using a certain basis. We use a manufacturing overhead
rate as we cannot identify the manufacturing overhead with the cost object. We learn, why any
basis is used to calculate the overhead rate, how that basis is decided and how that rate is
calculated.
We will understand here, how the manufacturing overhead rate will be calculated. What should be
the overhead rate basis(what drives the cost), whether only one overhead rate(blanket overhead
rate) will be there for the whole factory or we will have different overhead rates(departmental
overhead rates) for individual departments, etc. It is quite interesting to learn the techniques in
order to get the answers to these questions.
Process and Job-order Costing
There are two commonly used costing systems in a manufacturing company, one is Job order
costing and the other one is Process costing. A job/batch order costing system is used in situations
where different products are produced in a period. For example, a Levi Straus clothing factory would
typically make many different types of jeans for both men and women during a month. A particular
order might consist of 1000 stonewashed men's blue denim jeans, style number 312. This order of
1000 jeans is called a batch or a job. In a job-order costing systems, costs are traced and allocated to
jobs and then the costs of the job are divided by the number of units in the job to arrive at an
average cost per unit.
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Exhibit 2-1 A job manufacturing unit
Process Costing
A process costing system is used in situations where the company produces many units of a single
product for long periods. Examples include producing paper at Weyerhaeuser, refining aluminium
ingots at Nalco, cement production at Ambuja Cement and sugar production at Balarampur Chini
mills, salt production at Tata Salt. All of these industries will be producing homogeneous product
that flows through the production process on a continuous basis.
Exhibit 2-2 A processing unit
Job-Order Costing- An Overview
If we recall the discussion in the previous chapter, we find that the companies normally classify the
manufacturing cost into three categories: (i) direct materials, (ii) direct labour, and (iii)
manufacturing overhead. Here we will learn how these costs are collected and recorded.
Measuring direct Material Costs
If the manufacturing company is producing a standard product, then for a given production order a
bill of material will be raised. A bill of materials is a document that lists the type and quantity of each
item of materials needed to complete a unit of product. If the order is not for a standard product
then a Materials Requisition Note or Form is prepared by the production department mentioning the
material required for the production and a copy is sent to the Accounts and one copy is sent to the
store. Exhibit 2.1 is a format of a material requisition note with some assumed figures. This is how
the material consumed for Job No- M21 has been collected.
Exhibit 2-3
Materials Requisition Form
Materials Requisition Number 1421 Date March 21

Job Number to Be charged M21
Department Milling
Description Quantity Unit cost Total Cost
M1 Housing 3 ₹100 ₹300
C7 Connector 3 ₹75 225
525
Authorised
Signature
Measuring Direct labour cost
Labour cost which can be traced directly to any job is treated as Direct labour and if, it could not be
traced to a job then it is treated as part of manufacturing overhead and termed as indirect labour
cost. To collect the labour cost, each labour is provided with a time ticket(Exhibit 2.2), where the
employee notes the job number on the time ticket and notes the amount of time spent on that job.
when not assigned to a particular job, the employee records the nature of the indirect labour
task(such as cleanup and maintenance) and the amount of time spent on the task.
Exhibit 2.2
Employee Time Ticket
Time Ticket No.634 Date March 21
Employee Deepak Panda Station 3
Started Ended Time Rate Amount Job Number
Completed
7.30 10.00 2.5 ₹10 ₹25 M21
10.30 2.30 4 ₹10 40 M22
2.30 4.00 1.5 ₹10 15 Maintenance
Totals 8.0 hours ₹80
Supervisor:
Application of Manufacturing Overhead
Manufacturing overhead must be included with direct materials and direct labour in the job cost
sheet to find out the manufacturing cost or product cost. However, assigning manufacturing
overhead to units of product can be a difficult task. There are three reasons for this:
29 | P a g e
1. Manufacturing overhead is an indirect cost. This means that it is either impossible or difficult to
trace these costs to a particular product or job.
2. Manufacturing overhead consists of many different items ranging from the grease used in
machines to the annual salary of the production manager.
3. Even though output may fluctuate due to seasonal or other factors, total manufacturing overhead
costs tend to remain relatively constant due to the presence of fixed costs.
Given these problems, about the only way to assign overhead costs to products is to use an
allocation process. This allocation of overhead costs is accomplished by selecting an allocation base
that is common to all of the company's products and services. The allocation base is used to
compute the predetermined overhead rate(POHR). Using the POHR the manufacturing overhead is
charged to the products, which is called application(absorption) of overhead.
𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑡𝑜𝑡𝑎𝑙 𝑚𝑎𝑛𝑢𝑓𝑎𝑐𝑡𝑢𝑟𝑖𝑛𝑔 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑐𝑜𝑠𝑡
Predetermined overhead rate = 𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑡𝑜𝑡𝑎𝑙 𝑢𝑛𝑖𝑡𝑠 𝑖𝑛 𝑡ℎ𝑒 𝑎𝑙𝑙𝑜𝑐𝑎𝑡𝑖𝑜𝑛 𝑏𝑎𝑠𝑒
Note that the predetermined overhead rate is based on estimates rather than actual result. This is
because the predetermined overhead rate is computed before the period begins and used to apply
overhead cost to jobs throughout the period. The process of assigning overhead cost to jobs is called
overhead application. The formula for determining the amount of overhead cost to be applied to a
particular job is:
Overhead applied to a job = 𝑃𝑟𝑒𝑑𝑒𝑡𝑒𝑟𝑚𝑖𝑛𝑒𝑑 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑟𝑎𝑡𝑒 ×

𝐴𝑐𝑡𝑢𝑎𝑙 𝐴𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑡ℎ𝑒 𝑎𝑙𝑙𝑜𝑐𝑎𝑡𝑖𝑜𝑛 𝑏𝑎𝑠𝑒 𝑖𝑛𝑐𝑢𝑟𝑟𝑒𝑑 𝑓𝑜𝑟 𝑡ℎ𝑒 𝑗𝑜𝑏
In the following Exhibit, the overhead applied is calculated taking a POHR of ₹12 Per labour hour.
Labour hour is the allocation base for the manufacturing overhead.
Exhibit 2.3(A completed Job Cost Sheet)
Job Number : M21 Date Initiated : March 21

Department : Milling Date Completed: March 25
Item : Special Order Coupling Units completed: 3
Direct materials Direct Labour Manufacturing Overhead

Requisition Amount Ticket Hours Amount Hours Rate Amount
No. ₹ ₹ ₹
1421 525 634 2.5 25 11.5 ₹12/PLH ₹138
1425 600 642 6 54
1431 300 651 3 27
₹1425 11.5 ₹106
Cost Summary Units Shipped

Direct Material.......................................................... ₹1425 Date Number Balance
Direct labour..................................................................106
Manufacturing Overhead..............................................138
Total Cost 1669
Unit Product Cost ₹556.33
Choice of an allocation Base for the Overhead cost
Before the industrial revolution in Britain and the other European countries, most of the production
work were done manually and the labour requirement was quite high that time. Then gradually
engines and machineries were invented which helped in mass production and reduced the
involvement of labour to some extent. Now products were manufactured with the help of electricity
and other energy supported machineries. Companies were formed to manufacture standardised
products in large scale. That made us more competitive and we priced less for those goods. Thus we
found machine driven plants everywhere in the world instead of manual works. Even then quite a
good number of workers were required to work on machineries and dependence on labour was still
there. After the invention and development of computer and computer driven machineries, the
requirement of workers in the production reduced further. Now, we have got completely automatic
manufacturing units. By a simple click in the computer, the machine will operate and the production
will run. Now production departments need very less labour.
The result of the above development in the manufacturing process led to the change in the cost
structure. Earlier when labour was almost a significant cost of the manufacturing cost, varying from
20 to 50 percent and manufacturing overhead was quite less. But now as the dependence over the
machineries has grown and most of the works are done through automatic machines, the
manufacturing cost has grown. The electricity cost, machinery depreciation, machine maintenance
cost has increased and has become a very significant cost of the total manufacturing cost.
As the complications of manufacturing process has changed from a simple and manually producing
units to an automated units, the basis of charging manufacturing overhead to products or jobs has
also changed. Earlier industry was using unit or material cost as a basis of charging overhead. At that
time it was considered that the material cost is driving the other manufacturing overheads. But
gradually it is found that there is a high co-relation between the labour cost and manufacturing
overhead and then industry started using the labour cost or labour hour as a basis of charging
manufacturing overhead to job.
Now when machineries are doing most of the work, manufacturing overhead has increased a lot and
labour cost has decreased and the co-relation does not stand good any more. Now industry is using
machine hour as the basis of charging manufacturing overhead to jobs. In this chapter mostly we
will use machine hour or labour hour/cost as the basis, depending on the amount of automation
done or required in a department. If most of the things are done manually then we use labour hour
or cost as the basis, otherwise if it is the production process is machine driven then machine hour is
used as the basis.
Example- The following particulars related to the production department of a factory for the month
of June, current year.
Materials used ₹ 80,000

Direct wages ₹ 72,000
Factory overhead charges allocated to the department ₹ 90,000
Direct labour-hours worked 20,000
Hours of machine operation 25,000
Cost data of a particular work carried out in the above department during June are given below:
Material used ₹ 8,000

Direct wages ₹ 6,250
Labour-hours booked 3,300
Machine hours booked 2,400
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What would be factory cost of the work order under the following methods of charging overheads:(i)
Direct labour cost rate, (ii) Machine-hour rate and (iii) Direct labour-hour rate.
Sol:-
Manufacturing overhead rate
Basis of absorption Labour cost Machine hour Labour cost

Manufacturing overhead during the period ₹ 90,000 ₹ 90,000 ₹ 90,000
Labour cost during the period ₹ 72,000
Machine hours during the period 25,000 hours
Labour hours during the period 20,000 hours
= 90,000/72000 =90,000/25,000 =90,000/20,000
= 1.25 times of =₹ 3.6 per =₹ 4.5 per labour
labour cost machine hour hour
Manufacturing Cost of the job:
Basis of absorption Labour cost Machine hour Labour cost

Material ₹ 8,000 ₹ 8,000 ₹ 8,000
Labour 6,250 6,250 6,250
Manufacturing Overhead 7,812.5 8,640 14,850
(6,250x1.25; 2,400x3.6; 3300x4.5)
Manufacturing cost of the job 22,062.5 22,890 29,100
Observation: the cost of manufacturing the same job is coming different when we are taking
different basis for absorbing the manufacturing overhead.
When manufacturing overhead is absorbed using different basis, the cost will vary. The question
here arises that which method is to be adopted. It is suggested that if production process involves
more manual work then labour should be taken as the basis and if the manufacturing is machine
driven then machine hour should be taken to calculate the manufacturing overhead rate.
One very significant thing to be discussed here regarding the manufacturing overhead rate and its
importance is related to cross subsidisation of overhead cost to jobs. The total manufacturing
overhead estimated or incurred in an organisation is charged to different products or jobs, but many
a time it happens that because of wrong basis of absorption, some products or jobs are charged
more manufacturing overhead and some are charged less. In the process one product subsidise the
cost of the other product and because of that error, the actual profit always differs from the
estimated profit for the period.
The product which is charged less manufacturing overhead, is priced less and customers pays less for
that. Because of less pricing the demand increases and it sells more. When we estimate high profit
for the product due to our costing method, but actually the product or job gives us less profit or no
profit at all. The vice-versa happens with the jobs where the manufacturing overhead is charged
more and the product is priced more, as a result the demand of the product falls, where as the
product is actually more profitable because of wrong costing its sale suffers and organisation loses
profit. Therefore, application(absorption) of manufacturing overhead is very important and
especially when the manufacturing overhead is a significant amount of the total manufacturing cost.
Problems of Overhead application
Since the POHR is established before the beginning of the period and is based entirely on estimated
data, the overhead cost applied to jobs and products will generally vary from the amount of
overhead cost actually incurred during a period. If the overhead applied to the job is more than the
actual overhead incurred(on the basis of actual figure), then it is termed as over-applied and if the
overhead applied is less than the actual overhead incurred for the job then it is termed as under-
applied. To arrive at the actual profit of the firm this difference is to be transferred to the income
statement.
Disposition of Under or Over-applied overhead Balances
The under or over-applied balance remaining the manufacturing overhead account at the end of a
period is treated in one of the following two ways:
1. Closed out and transferred to Cost of Goods Sold.
2. Allocated between Work in Process, Finished Goods, and Cost of Goods Sold in proportion to the
overhead applied during the current period that is in the ending balances of these accounts.
The second method, which allocates the under or over-applied overhead among ending inventories
and Cost of Goods sold, is equivalent to using an "actual" overhead rate and is for that reason
considered by many to be more accurate than the first method.
Multiple Predetermined Overhead Rates
Till now, we discussed about single POHR for a factory, which is true for small companies. But in large
companies, multiple predetermined overhead rates are often used. In a multiple predetermined
overhead rate system each production department may have its own predetermined overhead rate.
Such a system, while more complex, is considered to be more accurate, since it can reflect
differences across departments in how overhead costs are incurred. For example overhead might be
allocated based on direct labour-hours in departments that are relatively labour intensive and based
on machine-hours that are relatively machine intensive. When multiple predetermined overhead
rates are used, overhead is applied in each department according to its own overhead rate as a job
proceed through the department.
Practice Problems:
Q.No.1. Selected data concerning the past year's operations of the Desktop Manufacturing Company
are as follows:
Inventories
Beginning Ending
Raw material............................................................................ ₹71,000 ₹81,000
Work in process....................................................................... 80,000 30,000
Finished goods ........................................................................ 90,000 110,000
Other data:
Direct material used ................................................................ 326,000
Total manufacturing costs charged to production during the
year (includes direct material, direct labour, and
manufacturing overhead applied at a rate of 60% of direct
labour cost) ............................................................................. 666,000
Cost of goods available for sale............................................... 826,000
Selling and administrative expenses........................................ 31,500
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Required:
1. What was the cost of raw materials purchased during the year?
2. What was the direct labour cost charged to production during the year?
3. What was the cost of goods manufactured during the year?
4. What was the cost of goods sold during the year?
Q.No.2. Sigma Company applies overhead cost to jobs on the basis of direct labour cost. Job A, which
was started and completed during the current period, shows charges of ₹5,000 for direct materials,
₹8,000 for direct labour, and ₹6,000 for overhead on its job cost sheet. Job B, which is still in process
at year-end, shows charges of ₹2,500 for direct materials and ₹4,000 for direct labour. Should any
overhead cost be added to Job B at year-end? Explain.
Q.No.3. A company assigns overhead cost to completed jobs on the basis of 125% of direct labour
cost. The job cost sheet for job 313 shows that ₹10,000 in direct materials has been used on the job
and that ₹12,000 in direct labour cost has been incurred. If 1,000 units were produced in Job 313,
what is the unit product cost?
Q.No.4. Harris Fabrics computes its predetermined overhead rate annually on the basis of direct
labour hours At the beginning of the year it estimated that its total manufacturing overhead would
be ₹134000 and the total direct labour would be 20,000 hours Its actual total manufacturing
overhead for the year was ₹123,900 and its actual total direct labour was 21,000 hours.
Compute the company’s predetermined overhead rate for the year.
Q.No.5. Luthan Company uses a predetermined overhead rate of ₹23.40 per direct labour -hour. This
predetermined rate was based on 11,000 estimated direct labour-hours and ₹257,400 of estimated
total manufacturing overhead.
The company incurred actual total manufacturing overhead costs of ₹249,000 and 10,800 total
direct labour hours during the period.
Required:
Determine the amount of manufacturing overhead that would have been applied units product
during the period.
Q.No.6. The following data pertain to the Odisha Restaurant Supply Company for the year just
ended.
Budgeted sales revenue............................................................... ₹205,000

Actual manufacturing overhead................................................... 340,000
Budgeted machine hours(based on practical capacity) ............... 10,000
Budgeted direct labour hours(based on practical capacity)......... 20,000
Budgeted direct labour rate......................................................... ₹ 14
Budgeted manufacturing overhead.............................................. ₹378,000
Actual machine hours.................................................................. 11,000
Actual direct labour hours........................................................... 18,000
Actual direct labour rate............................................................... ₹ 15
Required:
1. Compute the firm's predetermined overhead rate for the year each of the following common cost
drive₹(basis): (a) machine hours, (b) direct labour hours, and (c) direct labour dollars
2. Calculate the over-applied or under applied overhead for the year using each of the cost drivers
listed above.
Q.No.7. The following cost data relate to the manufacturing activities of Change Company during just
completed year:
Manufacturing Overhead costs incurred:

Indirect materials ₹15,000
Property taxes, factory 8,000
Utilities, factory 70,000
Depreciation, factory 240,000
Insurance, factory 10,000
Total actual manufacturing overhead costs incurred ₹473,000

Other costs incurred:
Purchases of raw material(both direct and indirect) ₹400,000
Direct labour cost ₹60,000
Inventories:
Raw materials, beginning ₹20,000
Raw materials, ending 30,000
Work in process, beginning 40,000
Work in process, ending 70,000
The company uses a predetermined overhead rate to apply overhead costs to production. The rate
for the year was ₹25 per machine-hour. A total of 19,400 machine-hours was recorded for the year.
Required:
1. Compute the amount of under or over-applied overhead cost for the year.
2. Prepare a schedule of cost of goods manufactured for the year.
Q.No.8.. Consider the following selected cost data for the Bharat Forge Co, for the current year
Budgeted manufacturing overhead ₹70,00,000

Budgeted machine-hours 2,00,000
Actual Labour hours 1,20,000
Actual manufacturing overhead ₹68,00,000
Actual Machine-hours 1,95,000
The company uses normal costing. Its job costing system has a single manufacturing overhead cost
pool. Costs are allocated to jobs using a budgeted machine-hour rate.
1. Compute the budgeted manufacturing overhead rate.

2. Compute the amount of under or over-application of manufacturing overhead.
3. Briefly write the methods of disposition(adjustments) of the over or under-application of
manufacturing overhead at the end of the period.
4. Find out the cost of the Job 2F3 if it consumes 1,200 machine hours and 700 labour hours
and the material and labour costs are ₹ 50,000 and ₹30,000 respectively.
Q.No.9. The following information pertains to Trenton Glass Works for the year just ended.
Budgeted direct-labour cost : 75 hours(practical capacity) at ₹16 per hour

Actual direct-labour cost : 80000 hours at ₹17.50 per hour
Budgeted manufacturing overheads : ₹997,500
Actual selling and administration : ₹435,000
expenses
35 | P a g e
Actual manufacturing overhead:
Depreciation ............................................................... ₹231,000

Property taxes............................................................. 21,000
Indirect labour............................................................ 82,000
supervisory salaries.................................................... 200,000
Utilities....................................................................... 59,000
Insurance.................................................................... 30,000
Rental of space........................................................... 300,000
Indirect material (see data below)............................. 79,000
Indirect material:
Beginning inventory, January 1.................................. ₹48,000

Purchases during the year.......................................... 94,000
Ending inventory, December 31................................. 63,000
Required:
1. Compute the firm's predetermined overhead rate, which is based on direct labour hours
2. Calculate the over-applied or under-applied overhead for the year.
Q.No.10. S&T Manufacturing uses a predetermined overhead rate of ₹18.20 per direct labour-hour.
This predetermined rate was based on 12,000 estimated direct labour-hours and ₹218,400 of
estimated total manufacturing overhead. The company incurred actual total manufacturing
overhead costs of ₹215,000 and 11,500 total direct labour-hours during the period.
Required:
1. Determine the amount of under-applied or over-applied manufacturing overhead for the period.
2. Assuming that the entire amount of the under-applied or over-applied overhead is closed out to
Cost of Goods Sold, what would be the effect of the under-applied or over-applied overhead on the
company 's gross margin for the period.
Q.No.11. White Company has two departments, Cutting and Finishing. The company uses a job-order
cost system and computes a predetermined overhead rate in each department. The Cutting
Department bases its rate on machine-hours, and the Finishing Department bases its rate on direct
labour cost. At the beginning of the year, the company made the following estimates:
Department
Cutting Finishing
Direct labour-hours 6,000 30,000
Machine-hours 48,000 5,000
Manufacturing overhead cost ₹360,000 ₹486,000
Direct labour cost ₹50,000 ₹270,000
Required:
1. Compute the predetermined overhead rate to be used in each department.
2. Assume that the overhead rates that you computed in (1) above are in effect. The job cost sheet
for Job 203, which was started and completed during the year, showed the following:
Department
Cutting Finishing
Direct labour-hours 6 20
Machine-hours 80 4
Materials requisitioned ₹500 ₹310
Direct labour cost ₹70 ₹150
Compute the total overhead cost applied to Job 203.
3. Would you expect substantially different amounts of overhead cost to be assigned to some jobs if
the company used a plantwide overhead rate based on direct labour cost, rather than using the
departmental rates? Explain. No computations are necessary.
Q.No.12. High Desert Pottery works makes a variety of pottery products that it sells to retailers such
as Home Depot. The company uses a job-order costing system in which predetermined overhead
rates are used to apply manufacturing overhead cost to jobs. The predetermined overhead rate in
the Moulding Department is based on machine-hours, and the rate in the Painting Department is
based on direct labour cost. At the beginning of the year, the company's management made the
following estimates:
Department
moulding Painting
Direct Materials cost ₹510,000 ₹650,000
Manufacturing overhead ₹602,000 ₹735,000
Job 205 was started on August 1 and completed on August 10. The company's cost records show the
following information concerning the job:
Department
Moulding Painting
Machine-hours 110 20
Materials placed into production ₹470 ₹332
Direct labour cost ₹290 ₹680
Required:
1. Compute the predetermined overhead rate used during the year in the Moulding Department,
Compute the rate used in the Painting Department.
2. Compute the total overhead cost applied to Job 205
3. What would be the total cost recorded for Job 205? If the job contained 50 units, what would be
the unit product cost?
4. At the end of the year, the records of High Desert Pottery works revealed the following actual cost
and operating data for all jobs worked on during the year:
Department
Moulding Painting
Direct materials cost ₹430,000 ₹680,000
Manufacturing overhead cost ₹570,000 ₹750,000
What was the amount of under-or over-applied overhead in each department at the end of the year?
Theory Questions:
Q.No.1. What is a plantwide overhead rate? Why are multiple overhead rates, rather than a plant
wide rate, used in some companies?
Q.No.2. What happens to overhead rates based on direct labour when automated equipment
replaces direct labour?
37 | P a g e
Q.No.3. What is under-applied overhead? Over-applied overhead? What disposition is made of these
amounts at the end of the period?
Q.No.4. Why aren't actual overhead costs traced to jobs just as direct materials and direct labour
costs are traced to job?
Q.No.5. Why do companies use predetermined overhead rates rather than actual manufacturing
overhead costs to apply overhead to jobs?
Q.No.6. What factor should be considered in selecting a base to be used in computing the
predetermined overhead rate?
Q.No.7. Briefly explain the following terms:
i) POHR ii) Under-applied overhead iii) Over-applied overhead
iv) Overhead allocation base v) Material requisition form vi) Job cost sheet
Chapter-4 Process Costing
Service Department Costing
M ost of large organisations have both operating (production) departments and service
departments. The central purpose of the organisation are carried out in the operating
departments. In contrast, service departments do not directly engage in the operating
activities. Instead, they provide services or assistance to the operating departments. In a typical
manufacturing firm the products are manufactured in the production department and cost is
collected for the product or job using job costing or process costing in the production department.
In this way the service department cost does not transfer to the product, which creates costing and
pricing problem for the jobs. Therefore, the cost of the support departments should be transferred
to the jobs so that pricing of the product can be done, cost can be accurately estimated and
controlled etc. Following are some of the reasons for which the service department costs are
allocated to operating departments:
• To encourage operating departments to make wise use of service department resources. If

services were provided free, operating managers would be inclined to waste these
resources.
• To provide operating departments with more complete cost data for making decisions.
Actions taken by operating departments have impact on service departments.
• To help measure the profitability of operating departments. Allocating service department
costs to operating departments provides a more complete accounting of the costs incurred
as a consequences of activities in the operating departments.
• Allocating service department costs to operating departments provides a system of checks
and balances in the sense that cost-conscious operating departments will take an active
interest in keeping service department costs low.
• To value inventory for external financial reporting purposes.
• When cost-plus pricing is used, service department costs are commonly allocated to the
operating departments so as to include these costs in the cost base.
Allocations of Service department costs to operation departments
The cost is collected for each and every service departments. Sometimes few of the costs incurred in
the organisation can directly be identified with individual department. In such cases collecting cost
for service department is very easy. Suppose for each and every department separate electricity
meters are installed to measure the electricity consumption for a certain period. It can easily be
calculated the amount of electricity consumed by each departments. Similarly based on separate
telephone line connections, we can also find out the telephone bill of individual departments. But in
case it is centrally located, it becomes very challenging to find out the actual amount of these
expenses for individual departments. In those cases it is distributed among the departments on
certain basis. This initial distribution of overheads among various departments using some basis is
called primary distribution. Once the primary distribution is done and it has been transferred to
individual service departments then the cost is required to be transferred from service departments
to production or operation departments, where the products are manufactured. Then on the basis
of services consumed by individual production departments, the service department costs are
39 | P a g e
allocated/apportioned among production departments. This process is called secondary
distribution of overhead.
Exhibit 4-1
Service Dept-I Allocation of overhead
Operating
Department-I
Service Dept-II Product or

service
Operating
Department-II
Service Dept-III
Service department Operating department overhead

costs are allocated to costs, plus allocated service
operating department department costs are applied to
product and services
Primary Distribution of Overheads:
As it is discussed in the previous paragraph, first costs are directly identified with each and every
departments including service departments. There after we try to see the expenses incurred in the
firm which cannot be directly identified with the service departments but are also incurred for the
service departments. Then for those expenses we have to find out a suitable allocation base using
which we will allocate or distribute the cost among all departments and collect it for service
departments. For example, if separate electricity meters are not there to measure the unit
consumed in individual departments then we have to count the electric points for fan, light, ACs, etc
and on the basis of those points we have to divide the electricity expenses among various
departments.
Allocation base is selected keeping in mind the base which drives the cost. Ideally, all of the costs
that are being allocated should be driven by the allocation base in the sense that the costs being
allocated are directly proportional to the allocation base. Exhibit 1-1 gives a list of overhead
expenses which can be allocated/ apportioned among all the departments in the following basis:
Exhibit 4-2
Apportionment of overheads among departments
Overheads Allocation base

a) Stores service expenses ............................. Value of materials consumed
b) Factory rent ............................................... Floor area
c) Municipal rent, rates and taxes................. Floor area
d) Insurance on Building and machinery........ Insurable value
e) Labour Welfare department expenses..... Number of employees/Direct wages
f) Supervision ............................................... Number of employees/Direct wages
g) Amenities to employee’s ......................... Number of employees/Direct wages
h) Employees liability for insurance............. Number of employees/Direct wages
j) Lighting power .......................................... Plug point
k) Stores overheads....................................... Direct material
l) General overheads .................................... Direct wages
After collecting the cost for all service departments we have to find out the way the production
departments are consuming the services of service departments. The service department costs are
apportioned among the production departments in the ratio of their consumption or services availed
from service departments. Following is given a chart of service departments and the way their cost is
apportioned among the production or operating departments.
Exhibit 4-3
Reallocation/ Reapportionment of service department cost to production department :-
1) Maintenance dept ......................................... Hours worked for each dept.
2) Pay roll and time keeping .............................. Total labour (or) machine hours (or) Number of
employees in each department
3) Personnel(HR) department........................... Rate of labour T.O (or) No. of
employees in each department
4) Stores Keeping department........................... No. of requisitions (or) value of materials of each
department
5) Purchase department ................................... No. of purchase orders value of materials of each
department
6) Welfare, ambulance, canteen,
service, recreation room expenses.................... No. of employees in each department.
7) Building service department ........................ Relative area each dept.
8) Internal transport service (or) Weight, value graded product handled, weight
overhead crane service..................................... and distance travelled
9) Transport department................................... Crane Hours, truck hours, truck mileage, Number
of packages.
10) Power house ............................................... Housing power, horse power machine hours,
(electric power cost) No. of electric points etc.
41 | P a g e
The above table shows how the service department costs are to be allocated to production
department. But while doing so we face a challenge, when we see one service department's services
are used by another service department. In such a situation, if we transfer directly cost of service
departments to production department them we don't get correct cost figure therefore we need to
first find out the cost incurred for the service department. For example, we see accounts department
maintain accounts related data of all department, similarly IT or computer department also provides
services for all the department. Hence, here both the departments provide services to each other. In
some other cases we find that one service department provides services to other departments but
don't availed services from them or provides services to many departments but avails services from
few. Now, these issues are to be handled properly. Otherwise, accurate costing of product and
services will not happen. Therefore, companies follow any of the following three methods for
redistribution of their service department costs to production or operation departments.
Some time they follow the method, which suits them better and some time they compromise with it
when they find it very time consuming and expensive and the service department costs are not very
substantial.
1) Direct redistribution method:
This method is the simple method, where assumptions are service departments avail no service from
other service departments and only provides services to the production department. Practically may
not be the thing like that but allocation becomes simple as cost flows from service departments to
only production or operations departments. Small firms prefer to follow this method, as well as firms
with less proportion of service cost can afford to follow this method. Two features are give below:
• Service department costs are divided over production department.
• Ignore service rendered by one dept. to another
2) Step method of secondary distribution (or) Non reciprocal method:

This method is suitable to those situations where we can make hierarchy of service departments on
the basis of services provided by them to number of other service departments. Here, service
department which serves largest number of service department is divided first and thus it goes on.
We move one step down each and every time we allocate the cost of one service department. The
problem with this is to make that hierarchy, many a time we will have a tie, then we have to take a
call as to which is to be allocated first.
3) Reciprocal Distribution method:

Under this method the assumption is one service department provides services to as well as avails
services from other service department. Therefore, this allocation of cost is repeated a number of
time get their individual and independent cost which is then allocated to production departments.
There are few ways in which the calculation can be carried out for the allocation, which are given
below:
i) Simultaneous equation method (or) Algebraic method
• Equation is formed between service departments and is solved to find the amount due.
ii) Repeated distribution method:

• Service department cost separated repeatedly till figure of service dept. is exhausted or too
small.
iii) Trial and Error method:
• Cost of service department is apportioned among them repeatedly till the amount is
negligible and the total is divided among production department.
Practice Questions:
Q.No.1. KSOM has provided the following data to be used in its service department cost allocations:
Service Departments Operating Departments
Administrat Facility Undergraduate Graduate
-ion Services Programme Programme
Departmental costs before
allocation ₹ 24,00,000 ₹ 16,00,000 ₹2,68,00,000 ₹ 57,00,000
Student credit-hours 20,000 5,000
Space occupied-square feet 25,000 10,000 70,000 30,000
Required: Using the direct method, allocate the costs of the service departments to the two
operating departments. Allocate administrative costs on the basis of student credit-hours and facility
services costs on the basis of space occupied.
Q.No.2. Royal Garden Co-op, a whole foods grocery and gift shop, has provided the following data to
be used in its service department cost allocations:
Service Departments Operating Departments
Administrat Janitorial Groceries Gifts
-ion
Departmental costs before
allocation ₹ 7,50,000 ₹ 2,00,000 ₹46,40,000 ₹ 19,00,000
Employee-hours 640 320 6,200 1480
Space occupied-square feet 500 200 8000 2000
Required: Using the step method, allocate the costs of the service departments to the two operating
departments. Allocate administrative costs first on the basis of employee-hours and then janitorial
costs on the basis of space occupied.
Q.No.3. The Vrinda Publishing Company has three service departments and two operating
departments. Selected data from a recent period on the five departments follow:
Service Departments Operating
Departments
Administration Janitorial Maintenance Binding Printing
Overhead costs ₹ 1,40,000 ₹1,05,000 ₹ 48,000 ₹ 2,75,000 ₹4,30,000
Number of employees 60 35 140 315 760
Square feet of space
occupied 15,000 10,000 20,000 40,000 1,85,000
Hours of press time 30,000 90,000
The company allocates service department costs by the step method in the following order:
Administration (number of employees), Janitorial (Space occupied), and Maintenance (hours of press
time).
Required:
Using the step down method, allocate the service department costs to the operating departments
and find out POHR taking press time as the basis.
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Q.No.4. Modern Manufacturers Ltd. have three production departments P1, P2,P3 and two service
departments S1 and S2 , the details pertaining to which are as under:
Particulars P1 P2 P3 S1 S2
Direct Wages(₹ ) 3000 2000 3000 1500 195
Labour hours 3070 4475 2419 - -
Value of machines (₹ ) 60000 80000 100000 5000 5000
H.P. of machines 60 30 50 10 -
Light points 10 15 20 10 5
Floor space(sq.ft.) 2000 2500 3000 2000 500
The following figures extracted from the accounting records are relevant: ₹
Rent and rates 50000
General lighting 6000
Indirect wages 19390
Power 15000
Depreciation 100000
Sundries 96950
The expenses of the service departments are allocated as under:

P1 P2 P3 S1 S2
S1(%) 20 30 40 -- 10
S2(%) 40 20 30 10 --
Find out the total cost of product X which is processed for manufacture in Departments P1,P2 and P3
for 4, 5 and 3 hours respectively, given that its direct material cost is ₹ 500 and direct labour cost
₹ 300.
Q.No.5. Premier Ltd. has three production departments A,B and C and two service departments D
and E. The following figures are extracted from the records of the company:
₹
Rent and rates 5000
General lighting 600
Indirect Wages 1500
Power 1500
Depreciation of machinery 10000
Sundries 10000
The following further details are available:

Particulars Total A B C D E
Floor area(sq.ft.) 10000 2000 2500 3000 2000 500
Light points(Nos.) 60 10 15 20 10 5
Direct wages (₹) 10000 3000 2000 3000 1500 500
Horse power of machines 150 60 30 50 10 -
Value of machinery(₹) 250000 60000 80000 100000 5000 5000
Working hours 6226 4027 4066 - -
The expenses of service departments D and E are allocated using repeated distribution method as
follows:
A B C D E
D 20% 30% 40% - 10%
E 40% 20% 30% 10% -
What is the total cost of an article if its raw material cost is ₹ 250, labour cost ₹ 130 and it passes
through departments A, B and C for 14, 15 and 8 hours respectively?
Q.No.6. Goodson Company has two support departments—Human Resources and General
Factory—and two producing departments—Grinding and Assembly. Budgeted data for each
department is given below:
Human General Grinding Assembly

Resources Factory
Direct costs ₹70,000 ₹230,000 ₹63,900 ₹39,500
Square feet 4,000 -- 2000 6,000
Direct labour hours 600 11,000 20,000 80,000
Machine hours --- 1,000 4,000 1,000
Required:
1. Allocate overhead costs to the producing departments using the direct method.
2. Calculate departmental overhead rates, using machine hours for Grinding and direct labour
hours for Assembly.
3. If a unit has a prime costs of ₹123 and spends one hour in Grinding and 12 hours in
Assembly, what is the unit cost?
Q.No.7. ATLAS Ltd. has got three production cost centres of Machining, Finishing and Assembly and
two service cost centers, Materials handling and Quality. The costs incurred by the service centers
are re-apportioned to the production centers. The following are the overhead cost which have been
allocated and apportioned to the five cost centers: (₹ ‘000)
Machining 400
Finishing 200
Assembly 100
Materials Handling 100
Quality 50
Estimates of the benefits received by each cost center are as follows:

Machining Finishing Assembly Materials handling Quality
Materials Handling(%) 30 25 35 -- 10
Quality (%) 20 30 45 5 --
You are required to :
Calculate the charge for overhead to each of the three production cost centers, including the
amounts reapportioned from the two service centers, using:
Repeated distribution method(Reciprocal)
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Q.No.8. The Sendai Co., Ltd., of Japan has budgeted costs in its various departments as follows for
the coming year:
Factory Administration ......................... ¥ 270,000,000

Custodial Services ................................. 68,760,000
Personnel............................................... 28,840,000
Maintenance ......................................... 45,200,000
Machining - overhead............................ 376,300,000
Assembly- overhead.............................. 175,900,000
Total cost .............................................. ¥ 965,000,000
The Japanese currency is the yen, denoted by ¥. The company allocates service department costs to
other departments in the order listed below.
Department Number of Total Square Feet of Direct Machine-

Employees Labour- Space Labour- hours
Hours Occupied Hours
Factory Administration 12 --- 5,000 --- ---
Custodial Services 4 3,000 2,000 --- ---
Personnel 5 5,000 3,000 --- ---
Maintenance 25 22,000 10,000 --- ---
Machining 40 30,000 70,000 20,000 70,000
Assembly 60 90,000 20,000 80,000 10,000
146 150,000 110,000 100,000 80,000
Machining and Assembly are operating departments; the other departments are service
departments. The company does not make a distinction between fixed and variable service
department costs. Factory Administration is allocated on the basis of labour-hours; Custodial
Services on the basis of square feet occupied; Personnel on the basis of number of employees; and
Maintenance on the basis of machine-hours.
Required:
1. Allocate service department costs to consuming departments by the step method. Then compute
predetermined overhead rates in the operating departments using a machine-hours basis in
Machining and a direct labour-hours basis in Assembly.
2. Repeat (1) above, this time using the direct method. Again compute predetermined ovehread
rates in Machining and Assembly.
3. Assume that the company doesn't bother with allocating service department costs but simply
computes a single plantwide overhead rate based on total overhead costs (both service department
and operating department costs) divided by total direct labour-hour Compute the plantwide
overhead rate.
4. Suppose a job requires machine and labour time as follows:
Machine- Direct Labour-

hours Hours
Machining department 190 25
Assembly department 10 75
Total hours 200 100
Using the overhead rates computed in (1), (2) and (3) above, compute the amount of overhead cost
that would be assigned to the job if the overhead rates were developed using the step method, the
direct method, and plantwide method.
Q.No.9. “This is really an odd situation,” said Jim Carter, general manager of Moonland Publishing
Company. “We get most of the jobs we bid on that require a lot of press time in the Printing
Department, yet profits on those jobs are never as high as they out to be. On the other hand, we lost
most of the jobs we bid on that require a lot of time in the Binding Department. I would be inclined
to think that the problem is without overhead rates, but we’re already computing separate overhead
rates for each department. So what else could be wrong?”
Highland Publishing Company is a large organization that offers a variety of printing and binding
work. The Printing and Binding departments are supported by three service departments. The cost of
these service departments are allocated to other departments in the order listed on the following
page. (For each service department, use the allocation base that provides the best measure of
service provided, as discussed in the chapter.)
Department Total Square Feet Number of Machine- Direct

Labour of Space Employees Hours Labour-
Hours Occupied Hours
Personnel 20,000 4,000 10
Custodial Services 30,000 6,000 15
Maintenance 50,000 20,000 25
Printing 90,000 80,000 40 150,000 60,000
Binding 260,000 40,000 120 30,000 175,000
450,000 150,000 210 180,000 235,000
Budgeted Overhead costs in each department for the current year are shown below:
Personnel ₹ 360,000
Custodial Services 141,000
Maintenance 201,000
Printing 525,000
Binding 373,500
₹1,600,500
Because of its simplicity, the company has always used the direct method to allocate service
department costs to the two operating departments.
Required:
1. Using the step-down method, allocate the service department costs to the consuming
departments. Assuming that Personnel Department is providing services to all the rest of the
departments, then Custodial service which does not provide service to Personnel
department but to all others and last Maintenance Department which provides services to
Production departments only. Then compute predetermined overhead rates for the current
year using machine-hours as the allocation base in the Printing Department and direct
labour-hours as the allocation base in the Binding Department.
2. Repeat(1) above, this time using the direct method. Again compute predetermined
overhead rates in the Printing and Binding departments.
3. Give your comment on the problem faced by Jim Carter based on your above calculations.
47 | P a g e
Process Costing
J
ob-order costing and process costing are two common methods for determining unit product
costs. A job-order costing system is used in situations where many different jobs or products are
worked on each period. Examples of industries that would typically use job-order costing
include furniture manufacturing, special-order printing, shipbuilding, repairing workshops, and many
types of service organisations like legal consultancy firms, accounting firms.
By contrast, process costing is most commonly used in industries that produce essentially
homogenous(i.e., uniform) products on a continuous basis, such as bricks, soaps, cornflakes, paper,
cement, or sugar. Process costing is particularly used in companies that convert basic raw materials
into homogenous products. Examples of such companies in India are Nalco(Aluminium), Indian
Oil(petroleum), Tata Steel(steel), Ambuja(Cement), etc. In addition, process costing may also be used
in utilities that produce gas, water, and electricity.
The objective of this chapter is to tell you how product costing works in a process costing system.
Similarities between job-order and process costing
1. The basic purpose of both the system of costing is to find out the product cost by assigning the
cost of material, labour and manufacturing overhead.
2. The flow of costs through the manufacturing accounts is basically the same in both the system,
like work-in-progress, finished goods and cost of goods sold.
Exhibit 3-1
Difference between Job-order costing and process costing
Job-order costing Process Costing

1. Many different jobs are worked on during 1. A single product is produced either on a
each period, with each job having different continuous basis or for long periods of time. All
production requirements. units of product are identical.
2. Costs are accumulated by individual job. 2. Costs are accumulated by department.
3. The job cost sheet is the key document 3. The department production report is the key
controlling the accumulation of costs by a job.
document showing the accumulation of costs in a
department and how those costs were assigned to
units of product.
4. Unit costs are computed by job on the job 4. Unit costs are computed by department on the
cost sheet. department production report.
In a firm where the raw material passes through different processing for getting completed, we
apply process costing. In process costing, the cost is accumulated for each process or department. In
a given period, material consumed, labour applied in a particular process is collected for that
process/department, and then departmental overheads are added. This total cost is divided by the
total number of completed units during the same period to calculate the cost of each unit after the
completion of each process. Lets understand the cost collection process through the following
example.
Chapter 5 Activity Based Costing
Example.1. A product passes through two processes, A and B. During the month ended June 30,
1500 units were produced. The detailed cost break-up is as follows:
Process A Process B
Direct materials ₹ 90,000 ₹ 75,000
Direct labour 75,000 1,50,000
Direct Expenses 15,000 18,000
Indirect overhead costs during the period were ₹60,000 apportioned to the processes on the basis of
direct labour cost. No work-in-progress existed at the beginning and end of the period.
Prepare relevant process accounts and find out the cost of each unit after each process.
Sol: Process A
Particulars Units Particulars Units Amount
Amount(₹) (₹)
Direct Materials 1,500 90,000 Transferred to Process-B 1500 2,00,000
Direct labour 75,000 @133.33 per unit
Direct Expenses 15,000
Indirect Labour 20,000
1500 2,00,000 1500 2,00,000
Indirect labour(apportioned on the basis of direct labour cost i.e. 75,000:1,50,000)

Process A = 60000 x 1/3 = 20,000; Process B= 60000 x 2/3 = ₹40,000
Process B
Particulars Units Particulars Units Amount
Amount(₹) (₹)
Transferred from Proc-A 1500 2,00,000 Transferred to Finished 1500 4,83,000
Direct Materials 75,000 Goods @322 per unit
Direct labour 1,50,000
Direct Expenses 18,000
Indirect Labour 40,000
1,500 4,83,000 1500 4,83,000
The cost of finished goods at the end process B is ₹322 per unit.
Spoilage(Normal loss/Abnormal Loss)

In case of firms whose output passes through several stages of production, some wastage/spoilage
of units takes place for a variety of reasons, such as evaporation, transportation loss, breakdown of
machines, use of substandard material, poor workmanship, shrinkage, and so on. The effect of
wastage is that the actual units produced at the end of the process are less than the units introduced
initially.
The treatment of spoiled units depends on the nature of the spoilage/wastage/loss. The wastage
may be normal or abnormal. Normal loss may be defined as the loss of units which is an inherent
part of the production process, caused by natural and unavoidable causes such as milling, drying,
breaking, weighing, evaporation, processing, loading, unloading and so on. Any loss in excess of the
normal loss is called abnormal loss. Abnormal loss is a controllable loss. It involves consumption of
resources without accruing corresponding benefits to the firm. On the other hand, if the number of
49 | P a g e
units actually lost are less than the number of units normally expected to get lost, the difference
would represent an abnormal gain or effectiveness in cost accounting term.
Normal spoilage forms part of the product cost. Since it is inherent in the production process, it
occurs even under efficient operating conditions. Therefore, the cost of production of spoiled units is
recovered from the good units left and therefore we say that normal loss is recovered from the
customers. Abnormal loss is treated as a period cost and is written off as a loss of the period in
which it occurs. It is relevant for determining the process cost. Likewise, abnormal gain is transferred
to the profit and loss account of the period.
It is possible that the wasted units(normal as well as abnormal) may have a salvage value. The sale
proceeds of the units in normal waste would reduce the cost of production. The loss on abnormal
wastage charged against the costing profit and loss account will be lower to the extent of the
revenue received from their sale.
Example, Suppose in an oil refinery 1000 barrels of crude oil is introduced at the beginning of the
process. It is the standard practice in the industry, that 40% of the input is treated as normal loss.
During that period, (1) 670 barrels of refined oil is produced, (2) 560 barrels of refined oil is
produced. The expected output is 600 barrels of oil. In the first situation, the actual output is more
than expected output, hence the abnormal gain is 70 barrels. In the second situation, the actual
output is less than expected output and the abnormal loss is 40 barrels of oil.
Incomplete Units
Given the nature of production process, some units may remain incomplete at the time of
accounting for the total cost of production. In such a situation, some units are complete while others
are incomplete or partially complete. For the purpose of cost accumulation, the units of production
are to be converted into comparable units. They are referred to as equivalent units. For instance,
100 units of inventory estimated to be 40 per cent complete are considered equivalent to 40
completed units. Therefore, for cost determination purposes, 100 partially completed units will be
considered equal to 40 units of equivalent production. The equivalent units will be calculated for
each elements of cost i.e., material, labour and overhead.
Equivalent units(material, labour, overhead) = Actual number of partially completed units x stage of
completion.
The concept of equivalent units is very important for the calculation of cost of completed units
produced and incomplete units.
Example.2. Clonex Labs uses a process costing system. The following data are available for one
department for October:
Percent Completed
Units Materials Conversion
Work-in-process, Oct.1. 30,000 65% 30%
Work-in-process, Oct.31 15,000 80% 40%
The department started 175,000 units into production during the month and transferred 190,000
completed units to the next department. Compute the equivalent units produced using FIFO
method.
Sol: Total units processed during the month = 30,000 + 175,000 = 2,05,000
Units completed = 190,000

Units incomplete = 2,05,000 -1,90,000 = 15,000
As we are using FIFO method of inventory valuation, this 15,000 units belongs to inputs introduced
during the month, not belonging to opening W-I-P, as opening W-I-P is processed first and
completed as FIFO says first in first out.
The other way, it can be said that the completed units 190,000 units includes, opening W-I-P of
30,000 units and 160,000 units from recent units introduced during the month.
Sol:
Here we have to find out the equivalent units produced by taking into account the amount of work
done in relation to material and conversion cost during the period. It is done in the following table
format:
Equivalent units produced
Units Materials Labour
Percentage Equivalent Percentage Equivalent
completed units completed units
Opening W-I-P completed 30,000 35% 10500 70% 21,000
Input introduced and 160,000 100% 160,000 100% 160,000
completed(i.e.175,000-15,000)
Input introduced but not 15,000 80% 12,000 40% 6,000
completed
Total 2,00,000 182,500 187,000
The amount of material consumed is equivalent to produce 182,500 completed units and the
labour cost incurred is sufficient to manufacture 187,000 completed units.
Practice Questions:
Q.No.1. XYZ Chemical Ltd. processes a range of products including a detergent, 'Washo', which
passes through three processes before completion and transfer to the finished goods warehouse.
During April, data relating to this product were as follows:
Process I Process II Process III Total
Basic raw material(10,000 units) ₹6000 -- -- ₹6,000
Direct raw material added in process 8,500 9,500 5,500 23,500
Direct wages 4,000 6,000 12,000 22,000
Direct expenses 1,200 930 1,340 3,470
Production overhead 16,500
Outputs(units) 9,200 8,700 7,900
Normal loss in process of input(%) 10 5 10
Scrap value loss per unit 0.20 0.50 1
The production overhead is absorbed as a percentage of direct wages. There was no stock at the end
of any process.
You are required to prepare the following accounts: (i) Process I; (ii) Process II; (iii) Process III; (iv)
Abnormal loss; and (v) abnormal gain.
Q.No.2. A chemical company processes a patent material used in buildings. The material is produced
in three consecutive grades: soft, medium and hard. The details of its operations are as follows:
51 | P a g e
Process I Process II Process III
Raw materials used(tonnes) 1000
Cost per tonne ₹200
Total manufacturing expenses 87,500 ₹39,500 ₹10,710
Weight lost(per cent of input of the process) 5 10 20
Scrap in tonnes (sale price ₹50 per tonne) 50 30 51
Sale price per tonne 350 500 800
Management expenses were ₹7,500 and selling expenses, ₹5,000. Two-thirds of the output of
process I and one-half of the output of process II is passed on to the next process and the balance is
sold. The entire output of process III is sold. Prepare relevant process accounts.
Q.No.3. XYZ Chemical Ltd processes a range of products including a detergent, 'Washo', which passes
through three processes before completion and transfer to the finished goods warehouse. During
April, data relating to this product were as follows:
Process I Process II Process III Total
Basic raw material(5,000 units) ₹36000 -- -- ₹36,000
Direct raw material added in process 17,000 19,000 11,000 47,000
Direct wages 30,000 12,000 25,000 60,000
Direct expenses 15,500 12,560 13,400 51,460
Production overhead 1,80,000
Outputs(units) 4,400 4,000 3,750
Normal loss in process of input(%) 10 5 10
Scrap value loss per unit 2.00 5.00 10.00
The production overhead is absorbed as a percentage of direct wages. There was no stock at the end
of any process.
You are required to prepare the following accounts: (i) Process I; (ii) Process II; (iii) Process III; (iv)
Abnormal loss; and (v) abnormal gain. Find out the cost of each unit after every process.
Q.No.4. A chemical company processes a patent material used in buildings. The material is produced
in three consecutive grades: soft, medium and hard. The details of its operations are as follows:
Process I Process II Process III

Raw materials used(tonnes) 1000
Cost per tonne ₹200
Total manufacturing expenses 87,500 ₹39,500 ₹10,710
Weight lost(per cent of input of the process) 5 10 20
Scrap in tonnes (sale price ₹50 per tonne) 50 30 51
Sale price per tonne 350 500 800
Management expenses were ₹7,500 and selling expenses, ₹5,000. Two-thirds of the output of
process I and one-half of the output of process II is passed on to the next process and the balance is
sold. The entire output of process III is sold. Prepare relevant process accounts and find out the cost
of each units after each and every process and also find out the value of abnormal loss unit.
Q.No.5. NK Enterprise processes wood pulp for various manufacturers of paper products, Data
relating to tons of pulp processed during June are provided below:
Percent Completed
Units Materials Conversion
Work-in-process, June.1. 20,000 90% 80%
Work-in-process, June.30 30,000 60% 40%
Started into production
during June 1,90,000
Required:
1. Compute the number of tons of pulp completed and transferred out during June.
2. Compute the equivalent units of production for June.
Q.No.6. From the following production record of XYZ Manufacturing Company Ltd, prepare a
statement of equivalent units:
Units in process(Opening) 2,000
Stage of completion(%): Material 100
Labour 60
Overhead 50
New units introduced 20,000
Units completed 18,000
Units in process(Closing) 4,000
Stage of completion(%): Material 100
Labour 50
Overhead 40
Q.No.7. From the following details, prepare(a) statement of equivalent production, (b) statement of
cost, and (c) find the value output transferred and (d) closing work-in-progress.
Opening work-in-progress 2000 units
Materials(100% completed) ₹7500
Labour(60% completed) ₹3000
Manufacturing overhead(60% completed) ₹1500
Units introduced to the process 8000
There are 2500 units in process at the end of the period, and the stage of completion is estimated to
be material: 100%; labour: 50% and manufacturing overhead: 50%.
Units transferred to the next process are 7500 units. The process costs for the period are material
₹1,20,000, Labour: 90,000 and manufacturing overhead: 45,000.
Q.No.8. The finished output of a factory passes through two processes, the entire material being
introduced at the beginning of the first process. From the following production and cost data
relating to the first process, work out the value of closing inventory and the value of materials
transferred to the second process. Also prepare process I account.
Process I : Opening stock, 10,000 units at ₹50,000
Stage of completion of opening inventory: Materials, 100 percent; Labour, 60 per cent; Overheads,
50 percent.
Units introduced during the process: 50,000 units at ₹144,000; During labour ₹81,000; Overheads
₹80000.
53 | P a g e
Units transferred to next process: 38,000
spoilage during the process(units): 7,000
Stage of completion of closing inventory, 15,000 units: Material, 100 percent; labour, 50 percent;
overheads, 40 percent.
Normal loss, 10 per cent of input. Sale value of spoilage, ₹2 per unit.
Q.No.9.The product of ABC Ltd passes through three distinct processes for completion. From past
experience, it is ascertained that normal wastage in each process is as under:
Process Wastage(%) Sale value of wastage per unit
A 2 0.25
B 4 0.50
C 2.5 0.60
The expenses were as follows:

Process A Process B Process C
Materials ₹12,000 ₹10,000 ₹9,000
Direct labour 16,000 5,000 4,900
Manufacturing expenses 2,000 3,400 3,590
Other factory expenses 3,500 2,005 2,004
4000 units were initially introduced in process at a cost of ₹13,560. The output of each process was
as under: A, 3,850 units; B, 3,600; and C, 3,500 units.
Prepare process accounts and also work out the sale price per unit of finished stock so as to realise
20% profit on selling price.
Q.No.10. LML Limited furnishes you the following information relating to process B for the month of
October.
1. Opening work-in-process, Nil
2. Units introduced, 10,000 units @ Rs 3 per unit
3. Expenses debited to the process
Direct materials, ₹14,650
Labour, ₹ 21,148
Overheads, ₹42,000
4. Normal loss in process, 1 percent of input
5. Closing work-in-process, 350 units
Degree of completion:
Material,100 percent
Labour and overheads, 50 percent
6. Finished output, 9,500 units
7. Degree of completion of abnormal loss:
Material, 100 per cent
Labour and overheads, 80 per cent
8. Units scrapped as normal loss were sold at ₹1 per unit
9. All units of abnormal loss were sold at ₹2.50 per unit.
Prepare: (a) statement of equivalent production, (b) Statement of cost, (c) Process B account, and (d)
Abnormal Loss account.
Q.No.11. Product X in a manufacturing unit passes through three process—A, B and C. The expense
incurred in the three processes during the year 2007 were as under:
Process A Process B Process C
Units of input issued 9000
Cost per unit 150 --- ---
Sundry materials 23500 25000 15000
Direct Labour 80000 207200 26110
Direct expenses 2250 7200 8100
Selling price per unit of output 200 280 600
The actual outputs obtained vis-à-vis normal process losses from the three processes were:
Process Output(units) Process loss (%)
A 8400 5
B 5700 10
C 3660 3
During the year, three-fourth of the output of Process A and two-third of the output of Process B
were transferred to the next process and the balances were sold outside. The entire output of
Process C was, however, sold outside. The losses of the three processes were sold at ₹5 per unit for
Process A, ₹10 per unit for Process B and ₹15 per unit for Process C.
Prepare the three Process Accounts and a Statement of Income considering a total selling and
distribution expenses of ₹45,000 which is not allocated to processes.
Theory Questions:
Q.1. Briefly explain the following terms:
i) Normal loss; ii) Abnormal loss; iii) Equivalent units; iv) Abnormal gain
Q.2. Explain the difference between job costing and process costing.
55 | P a g e
1. A document that shows the quantity of each type of direct material required to make a
productis called __________________________. 1 mark
2. Which method of determining product costs, job-order costing or process costing, would be
more appropriate in each of the following situations? 2 marks
a. An Elmer’s glue factory

b. A text book published such as McGraw-Hill.
c. An Exxon oil refinery.
d. A facility that makes Minute Maid frozen orange juice
3. If a company has different departments and most of the works are done manually, then
what basis is appropriate for overhead absorption. 1 mark
Ans.
4. Elliott Company estimated that costs of production for the coming year would be
Raw Materials Rs.75,000
Direct Labour 90,000
Production overhead 135,000
Labour hours 20,000
Required:
Calculate the overhead rate for the next year, assuming that it is based on direct labour cost.
POHR_____________________________
For the month of May if the raw materials put into production totaled Rs.6,000 and direct
labour was Rs.6,600. If the actual production overhead costs incurred in May were Rs.9,550,
calculate the amount of overhead absorbed for the month and find out the overhead
overapplied or underapplied .
__________________________________ and _________________ 3

marks
5. Write (True or False). 1 mark
a. Overheads are also known as indirect cost.
b. Under-applied means the actual cost is less than the cost applied to jobs.
6. A company uses process costing to value its output. The following was recorded for the
period:
Input materials 2000 units at $4.50 per unit
Conversion costs $13,340
Normal loss 5% of input, scrap value at $3 per unit
Actual loss 150 units
There were no opening or closing stocks.
find out the abnormal loss/gain and find out the cost of each unit of output to one decimal
place?
1. A costing system used in situations where a single, homogeneous product is produced for
long periods of time is called __________________________ 1 mark
2. If a company has two departments and in one department most of the works are done
manually and in the other department things are done machineries. A plant-wide overhead
rate is good for absorbing manufacturing overhead.(Yes or No ) 1 mark
3. Luthan Company uses a predetermined overhead rate of $23.40 per direct labour-hour. This
predetermined rate was based on 11,000 estimated direct labour-hours and $257,400 of
estimated total manufacturing overhead. The company incurred actual total manufacturing
overhead costs $249,000 and 10,800 total direct labour hours during the period.
Determine the amount of manufacturing overhead that would have been applied to units of
product during the period __________________________and the amount of under(___) or
over (_____) applied_Rs.__________________________. 3 marks
more appropriate in each of the following situations?
a. An Elmer’s glue factory
b. A text book published such as McGraw-Hill. 1 mark
5. The following information has been given about process-I of a manufacturing company:
Labour cost Rs.5000

Material(1000) 20,000
Production overheads 3,500
The normal process loss has been estimated at 7% of the input which can be sold at Rs.10 per
unit. Actual product was 950 units.
Find out the abnormal loss and cost per unit of output produced. 3 marks
6. Write (true or false). 1 mark
a. Normal loss is avoidable in nature.
b. If actual output is more than expected output then there will be abnormal gain.
57 | P a g e
1. A document that is used to record the amount of time an employee spends on various
activities is called ________________________ 1 mark
2. A costing system used in situations where customized products are manufactured is called
___________________ 1 mark
more appropriate in each of the following situations? 1 mark
a. A Scott paper mill
b. A custom home builder
4. If a company has two departments and in one department(Assembly) most of the works are
done manually and in the other department(Machining) things are done through
machineries. What basis should be used in machining departments to apply overhead.
___________________________ 1 mark
5. Public Company uses a job-order costing system. Overhead costs are applied to jobs on the
basis of machine hours. At the beginning of the year, management estimated that the
company would incur $175,000 in manufacturing overhead costs and work 70000 machine-
hours and 60000 labour hours. The actual overhead incurred during the period is $190,000
and 72000 labour hours and 80,000 machine hours are consumed.
• Compute the company’s predetermined overhead rate___________________
• Assume that during the year the company works only 80,000 machine-hours, find
out the overhead under-applied (___)or over-applied(___)

Rs.___________________________ 2 mark
6. Write (true or false)

a. Manufacturing overhead should be absorbed by machine hour in those cost centers
where the work is dominantly done by machines.
b. Abnormal loss should be charged to customers. 1 mark
7.A company uses process costing to value its output and all materials are input at the start of
the process. The following information relates to the process for one month:
Input 3000units
Opening stock 400 units
Losses 10% of input is expected to be lost
Closing stock 200 units
How many good units were produced from the process if actual losses were 400 units?
2 marks
Quiz-3/Practice set-1 .
1. The allocation of service department 's costs directly to operating departments without
recognising services provided to other service departments is called _________________ method of

allocation. 0.5 marks
2. choose the appropriate answer from the followings:
i) Stores service expenses are to be apportioned in the ratio of
a. Floor area
b. Direct wages
c. Value of material consumed
d. No. of employees 0.5 marks
3. In a manufacturing company, there are two production(P1, P2) and two service departments(S1,
S2). The overheads collected for them are given below:
P1 P2 P3 S1 S2
Manufacturing overhead 180000 120000 140000 70000 60000
Machine hour 30000 18000 12000 500
Floor area 5000 2000 3000 2000 500
Using direct method allocate the costs of support departments to the production departments and
calculate the POHR using the machine hour. 2 marks
4. Which statement is wrong
a. Normal loss is due to inherent nature of product

b. Normal loss is avoidable in nature
c. Normal loss is recovered from the customer
d. Normal loss is unavoidable in nature 0.5 marks
5. Find out the cost per kilogram of product in a process industry after process 1, using the following
data:
700 kilograms of material, costing Rs. 54,000 is introduced and processing cost incurred Rs.30000
during the processing. 5% is normal loss(no scrap realisation). The output was 660 kilograms. Also
find out the value of abnormal loss/gain.(No Accounts but calculations will form part of answer).
59 | P a g e
Activity Based Costing
I
n the previous chapters we learned how to charge the manufacturing overhead using
Predetermined overhead rate(POHR). Unlike direct material and direct labour which can be
identified with the job or process on the basis of documents like material requisition note and
time ticket, manufacturing overhead cannot be identified or traced with the job hence we use
some basis to allocate the manufacturing overhead. Then we found that some companies are there
where their departments are operating in different ways. Some departments are completely
automatic and most of the works are done through machineries whereas some departments are
there which is very labour intensive and most of the works are done manually. So instead of using
blanket overhead rate, it is better to use multiple overhead rates or separate overhead rates for
each individual departments. So a department which is mostly equipped through machineries,
machine hour is taken as the basis to calculate the POHR, like a machining department of a company
and at the same time if in assembly primarily the works are done manually and less through
machineries then labour hour or labour cost is taken as the basis.
Even after using multiple POHR, still it is observed that overheads are not correctly assigned to jobs
due to various reasons. Few of the reasons we will discuss now. Let's take factory rent and factory
insurance, these two costs are supposed to be assigned on the basis of labour hour or machine hour.
we are finding that these manufacturing overheads are neither driven by the labour hours nor by
machine hours. Even if there is any increase in these two factors in a particular period, the factory
rent or factory insurance will not change because factory rent is calculated on the basis of area and
factory insurance is calculated on the basis of the value of factory assets. Now the other interesting
fact is, these two costs are incurred if no production is done. Hence, these costs are there as part
business sustenance cost or cost related to facility.
Let's take few more costs like power consumption of machinery. This cost can be segregated into
two components one is set up cost i.e., every time a batch is to be produced the machine will start it
will consume a certain amount of power, irrespective of the size of the batch and then per hour or
per unit power consumption will vary. What we find that power consumption cost is not only
depending on the no. of units manufactured or batch produced but it is also partly driven by the no.
of time machine is set up for production. Similarly for purchase order processing and despatch of
goods we have to follow certain procedure which drives the cost without considering the size of
dealing. If you buy any amount of chicken from KFC, the billing and the cost incurred by the
salesman does not depend on the volume or amount of purchase.
Above discussions are raising finger towards the problems in the use of POHR, using the traditional
method of costing. Therefore there was a need felt for a better method of costing which will give us
more accurate cost of jobs and processes leading to better estimation of costs and better pricing of
products and having the advantage of accurate costing. Therefore instead of using any one or two
basis for recovering the overhead, a method should be used which will take care of each and every
activity, which is driving the cost. Thus the Activity Based costing method is developed. Activity-
based costing is a techniques that is designed to reflect diverse factors which affects the cost more
accurately. It attempts to accomplish this goal by identifying the major activities such as batch
setups, purchase order processing, and so on, that consume overhead resources and thus cause
costs. An activity is an event that causes the consumption of overhead resources. The costs of
carrying out these activities are assigned to the products that cause the activities.
Chapter 6 Cost Behaviour and Cost Volume Analysis
Three basic reasons for ABC

There are basically three major reasons that have contributed for the demand of a new and better
method called Activity Based costing:
1. Increase in product diversity: Day by day demands are increasing for customised products as a
result the companies are manufacturing larger variety of products and providing varieties of
services. If you take a bank, it offers many different types of accounts and services. These products
and services places different kind of pressure on resources because of their difference in volume,
complexity and requirements. So a broad average using POHR is likely to cause inaccurate cost of the
product and services.
2. Increase in indirect costs: As it is discussed previously that the advancement of technology and
advancement in computer aided manufacturing systems led to reduction of manual work and most
of the production work is done through machineries. Therefore the indirect expenses have become a
significant cost in the manufacturing cost of the product. Therefore a little mistake in the charging
the overhead to product will lead to over costing of some product and under costing of some
product and ultimately the firm will suffer loss. This is one of the reason for the need of a new and
better costing method so that the costing of products and services can be done to a greater
accuracy.
3. Competition in product markets: As markets have become more competitive, managers have felt
the need to obtain more accurate cost information to help them make important strategic decisions,
such as how to price products and which product o sell. Making correct pricing and product mix
decisions is critical in competitive markets because competitors quickly capitalize on a company's
mistake.
Below you can see the chart of both the costing methods:
Traditional costing system
Overhead cost accounts

(for each individual category of expenses e.g. property taxes, depreciation, etc)
First stage
allocation
Cost centres Cost centres Cost centres

1 2 3
(normally (normally (normally
departments) departments) departments)
Second stage
allocations(direct
Designing
labour orABC Systems
machine hours)
Cost objects(products, services and customers)
61 | P a g e
(b) Activity-based costing systems
Overhead cost accounts

(for each individual category of expenses e.g. property taxex, depreciation,
etc)
First stage
allocation
(cost pools)
Activity cost Activity cost Activity cost

centre centre centre
1 2 3
Second stage
allocation
(activity cost
drivers)
Cost objects(products, services and customers)
This new system of costing requires a detailed study of each and every activity done in an
organisation, which needs lot of time investment, patience, coordination among functional areas
and people and support from higher authority. Now after the advancement of computing technology
the computation work has become little easy but the collection of information takes lot of time. Due
to this reason every organisation does not adopt this system but those who are adopting this system
will be having advantage over other regarding cost information. Now we will see, how this can be
designed in an organisation.
Designing an Activity Based-Costing(ABC) System

1. Identifying the major activities that take place in an organisations;
2. Assigning costs to cost pools/cost centres for each activity;
3. Determining the cost driver for each major activity;
4. Calculate the cost driver or activity rates.
5. Assigning the cost of activities to products using the activity rates and activity measures.
The first two steps relate to the first stage, the last three steps to the second stage of the two stage
allocation process shown in Figure 10.1. Let us now consider each of these stages in more detail.
Identify and Define Activities and Activity Cost pools
The first step in implementing an ABC system is to identify the activities that will form the
foundation for the system. This can be difficult, time-consuming, and involves a great deal of
judgment. Ordinarily, this results in a very long list of activities and designing and maintaining a
system with such a large numbers of activities is very difficult. Therefore all these activities are
reduced into a handful by combining similar activities, where there will one common cost driver or
activity measure.
A useful way to think about activities is to organize them into five general levels: Unit -level, batch
level, product level, customer-level, and organization-sustaining activities. These levels are described
as follows:
1. Unit-Level activities are performed each time a unit produced. The costs of unit level activities
should be proportional to the number of units manufactured. For example, providing power to run
processing equipment would be a unit-level activity since power tends to be consumed in
proportion to the number of units produced.
2. Batch Level activities are performed each time a batch is processed, regardless of how many
units are in the batch. Setting up equipment, placing purchase orders are examples of batch level
activities. Costs at the batch level depend on the number of batches processed rather than on the
number of units produced. For example, the cost of setting up a machine for batch processing is the
same regardless of whether the batch contains on or thousands of items.
3. Product-level activities relate to specific products and typically must be carried out regardless of
how many batches are run or units of product are produced or sold. For example, activities such as
designing a product, advertising a product, and maintaining a product manager and staff are all
product-level activities.
4. Customer level activities relate to specific customers and include activities such as sales calls,
catalogue mailings, and general technical support that are not tied to any specific product.
5. Organisation-sustaining activities are carried out regardless of which customers are served, which
products are produced, how many batches are run, or how many units are produced. This category
includes activities such a heating the factory, cleaning executive offices, providing a computer
network, arranging for loans, preparing annual reports to shareholders, and so on.
Once the activities are identified, we have to combine them at the appropriate level. A batch level
activity should not be combined in the unit level activity. Now, we have to find out the activity
measure(driver) which drives them. This process needs a lot of judgement. Normally people working
in the overhead departments are interviewed and asked to describe their activities. Then we have to
find out the measure which drives the activity. if, some activities are driven by one activity measure
then those activities are brought under one activity cost pool. An activity cost pool is a bucket in
which costs are accumulated that relate to a single activity measure in the ABC system. For example,
machine depreciation, power consumption and maintenance of machinery all these three can be
pooled to one cost pool as they are driven by one activity measure i.e., machine running hour.
Q.No.1. SecuriCorp operates a fleet of armoured cars that make scheduled pickups and deliveries in
the Los Angeles area. The company is implementing an activity-based costing system that has four
activity cost pools: Travel, Pickup and Delivery, Customer Service, and Other. The activity measures
are miles for the Travel cost pool, number of pickups and deliveries for the Pickup and Delivery cost
pool, and number of customers for the Customer Service cost pool. The other cost pool has no
activity measure. The following costs will be assigned using the activity-based costing system:
Driver and guard wages $720,000

Vehicle operating expenses 280,000
Vehicle depreciation 120,000
Customer representative salaries and expenses 160,000
Office expenses 30,000
Administrative expenses 320,000
Total cost $1,630,000
63 | P a g e
The distribution of resource consumption across the activity cost pool is as follows:
Travel Pickup and Customer Other Totals

Delivery service
Driver and guard wages 50% 35% 10% 5% 100%
Vehicle operating expenses 70% 5% 0% 25% 100%
Vehicle depreciation 60% 15% 0% 25% 100%
Customer representative salaries and exp. 0% 0% 90% 10% 100%
Office expenses 0% 20% 30% 50% 100%
Administrative expenses 0% 5% 60% 35% 100%
Required:
Carry out the first stage allocations of costs to activity cost pools.
Q.2. Classic Windows is a small company that builds specialty wooden windows for local builders.
For years the company has been using direct labour hours (DLH) for assigning overhead. However,
the company's president became interested in activity-based costing after attending a workshop on
Activity Based Costing. An activity-based costing design team was put together, and within a few
months a simple system consisting of four activity cost pools had been created consisting of making
windows, processing orders, customer relations and other(organisation-sustaining costs). The total
overhead cost (both nonmanufacturing and manufacturing) for the year is $1,370,000 and includes
the following costs:
Manufacturing Overhead costs:

Indirect factory wages....................................................... $400,000
Production equipment depreciation................................. 300,000
Other factory costs............................................................ 80,000 $ 780,000
Selling and administrative expenses:
Administrative wages and salaries.................................... 300,000
Office expenses................................................................. 40,000
Marketing expenses.......................................................... 250,000 590,000
Total Overhead cost.......................................................... $1,370,000
Based largely on interviews with employees, the distribution of resource consumption across the
activities has been estimated as follows:
Distribution of Resource Consumption Across Activities

Making Processing Customer Other Total
windows Order relations
Indirect factory wages 35% 40% 10% 15% 10 T0%
Production equipment depreciation 90% 0% 0% 10% 100%
Other factory costs 30% 0% 0% 70% 100%
Administrative wages and salaries 0% 20% 30% 50% 100%
Office expenses 0% 30% 10% 60% 100%
Marketing expenses 0% 0% 60% 40% 100%
Required:
Carry out the first stage allocations of costs to activity cost pools.
Q.3. Advanced Products Corporation has supplied the following data from its activity-based
costing system:
Overhead Costs
Indirect Wages and Salaries Rs.300,000
Other overhead costs 100,000
Total Overhead Rs.400,000
Activity Cost Pool Activity Measure Total Activity for the year
Supporting direct labour Number of direct labour-hours 20,000 DLHs
Order processing Number of customer orders 400 orders
Customer support Number of customers 200 customers
Other This is an organisation- Not Applicable
sustaining activity
Distribution of Resource Consumption Across Activities

Supporting Order Customer Other Total
Direct labour Processing Support
Indirect wages 40% 30% 20% 10% 100%
Other overhead costs 30% 10% 20% 40% 100%
During the year, Advanced Products completed one order for a new customer, Shenzhen
Enterprises. This customer did not order any other products during the year. Data concerning that
order follow:
Data concerning the Shenzhen Enterprises Order
Units ordered 10 units
Direct labour-hours 2 DLHs per unit
Selling price ₹ 300 per unit
Direct Materials ₹ 180 per unit
Direct labour ₹ 50 per unit
Required:
a) Prepare a first stage allocations of overhead costs to the activity cost pools
b) Compute the activity rates for the activity cost pools.
c) Prepare a report showing the cost to be charged to customer with customer margin for
Shenzhen Enterprises.
Q.No.4. The budgeted overheads and cost driver volumes of XYZ Ltd. are as follows:
Cost pool Budgeted Cost driver Budgeted volume
Overhead(₹)
Material procurement 580000 No. of orders 1100
Material handling 250000 No. of movements 680
Set-up 415000 No. of set-ups 520
Maintenance 970000 Maintenance hours 8400
Quality control 176000 No of inspections 900
Machinery 720000 No. of machine hours 24000
The company has produced a batch of 2600 components of AX-15, its material cost was ₹130000
and labour cost was ₹ 245000. The usage activities of the said batch are as follows:
Materials orders 26 maintenance hours 690
Material movements 18 Inspection 28
Set-ups 25 Machine hours 1800
65 | P a g e
Required:
(a) Calculate cost driver rates that are used for tracing appropriate amount of overheads to the
said batch.
(b) Ascertain the cost of batch of components using ABC.
Q.No.5. The Aeronautical Ltd. has production facility specializing in jobs for the aircraft components
market. The traditional co
sting system has two direct-cost categories, namely, direct materials and direct manufacturing
labour and a single direct cost pool, that is, manufacturing overhead allocated on the basis of direct
labour-hours. The indirect cost allocation rate would have been ₹115 direct manufacturing labour-
hour.
The company has now decided to replace the single indirect cost pool with five indirect cost
pools, representing five activity areas each with its own supervising and budget responsibility. The
relevant data are as follows:
Activity area Cost driver used as an Cost allocation rate
Allocation base
Material handling Parts ₹ 0.40
Lathe work Turns 0.20
Milling Machine-hours 20.00
Grinding Parts 0.80
Testing Units tested 15.00
Two representative jobs processed under the new system of the facility at the most recent period
had the following features:
Particulars Job 101 Job 102
Direct material cost per job ₹ 9700 ₹ 59900
Direct manufacturing labour cost per job 750 11250
Direct manufacturing labour-hours per job 25 375
Parts per job 500 2000
Turns per job 20000 60000
Machine-hours per job 150 1050
Units per job 10 200
Required:
Compute the per unit manufacturing costs of each job under the traditional job costing system and
Activity based costing system.
Q.No.6. FOAMSTAR LTD. makes three main products using broadly the same production method and
equipment for each. A conventional product costing system is used at present although an ABC
system is being considered. Details of the three products for a typical period are:
Hours per unit Material per Volume units
Products Direct Production unit (₹)
labour overhead
P 0.50 1.50 20 750
Q 1.50 1.00 12 1250
R 1.00 3.00 25 7000
Direct labour costs Rs 6 per hr and production overheads are absorbed on a machine hour basis. The
rate for the period is Rs 28 per machine hr.
Further analysis shows that the total production overheads can be divided as follows:
Cost relating to set ups: 35%

Cost relating to machinery: 20%
Cost relating to materials handling: 15%
Cost relating to inspection: 30%
Total production overhead 100%
The following activity volumes are associated with the product line for the period as a
whole.
Total activities for the period:
Products No of set ups No of movements No of
of materials inspection
P 75 12 150
Q 115 21 180
R 480 87 670
Total 670 120 1000
Required:
a. Calculate the cost per unit for each product using conventional methods
b. Calculate the cost per unit for each product using ABC principles
c. Comment on the reasons for any differences in the costs in your answers to (a) and (b).
Q.No.7. Green Thumb Gardening is a small gardening service that uses activity-based costing to
estimate costs for pricing and other purposes. The proprietor of the company believes that costs are
driven primarily by the size of customer lawns, the size of customer garden beds, the distance to
travel to customers, and the number of customers. In addition, the costs of maintaining garden beds
depends on whether the beds are low maintenance beds(mainly ordinary trees and shrubs) or high
maintenance beds (mainly flowers and exotic plants). Accordingly, the company uses the five activity
cost pools listed below:
Activity Cost Pool Activity Measure

Caring for lawn............................................... Square feet of lawn
Caring for garden beds-low maintenance...... Square feet of low maintenance beds
Caring for garden beds-high maintenance..... Square feet of high maintenance beds
Travel to jobs.................................................. Miles
Customer billing and service........................... Number of customers
The company has already carried out is first stage allocation of costs and has summarized its annual
costs and activity as follows:
Activity Cost Pool Estimated Expected Activity

overhead cost
Caring for lawn............................... $72,000 150,000 square feet of lawn
Caring for garden beds-low 20,000 square feet of low maintenance
maintenance.................................... $26,000 beds
Caring for garden beds-high 15,000 square feet of high maintenance
maintenance.................................. $41,400 beds
Travel to jobs.................................. $3,250 12,500 miles
Customer billing and service.......... $8,750 25 customers
Required:
Compute the activity rate for each of the activity cost pools.
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Q.No.8. Klumper Corporation is a diversified manufacturer of industrial goods. The company's
activity based costing system contains the following six activity cost pools and activity rates:
Activity Cost Pool Activity Rates
Labour related $6.00 per direct labour-hour
Machine related $4.00 per machine-hour
Machine setups $50.00 per setup
Production orders $90.00 per order
Shipments $14.00 per shipment
Product sustaining $840.00 per product
Activity data have been supplied for the following two products:
M425 N430
Number of units produced per year 200 2,000
Machine-hours 100 1,500
Machine setups 1 4
Production orders 1 4
Shipments 1 10
Product sustaining 1 1
Required:
Compute the total and average per unit cost of each of the products listed.
Cost Behaviour and Cost Volume Analysis
Cost behaviour refers to how a cost will change as the level of activity changes. Managers who
understand how costs behave can predict how costs will change under various alternatives.
Conversely, managers who attempt to make decisions without a thorough understanding of cost
behaviour patterns can create disastrous consequences.
The chapter briefly reviews the definitions of variable and fixed costs and then discusses the
behaviour of these costs in greater depth than was done in Chapter 2. The chapter also introduces
the concept of a mixed cost, which is a cost that has variable and fixed cost elements. The chapter
concludes by introducing a new income statement format- called the contribution format, in which
costs are organised by behaviour rather than by the traditional function of production, sales and
administration.
Variable cost is a cost whose total rupees amount varies in direct proportion to changes in the
activity level. Fixed Costs remains constant within the relevant range of activity. Refer chapter 2 to
understand these costs in detail.
Types of fixed cost
Fixed costs are sometimes referred to as capacity costs, since they result from outlays made for
buildings, equipment, skilled professional employees, and other items needed to provide the basic
capacity for sustained operations. For planning purposes, fixed costs can be viewed as either
committed or discretionary.
Committed Fixed costs relate to the investment in facilities, equipment, and basic organisational
structure. Examples of such costs include depreciation of buildings and equipment, taxes on real
estate, insurance, and salaries of top management and operating personnel.
The two key characteristics of committed fixed costs are that (1) they are long term in nature, and
(2) they can't be significantly reduced even for short periods of time without seriously impairing the
profitability or long-run goals of the organisation. Even if operations are interrupted or cut back, the
committed fixed costs will still continue largely unchanged. During a recession, for example, a
company won't usually discharged key executives or sell off key facilities.
Discretionary Fixed Costs (often referred to as managed fixed costs) usually arise from annual
decisions by management to spend in certain fixed cost areas. Examples of discretionary fixed costs
include advertising, research, public relations, management development programs, and internships
for students.
The trend towards Fixed Costs The trend in many industries is toward greater fixed costs relative to
variable costs. Tasks that used to be performed by hand have been taken over by machines. For
example, grocery clerks at stores like Safeway and Kroger used to key in prices by hand on cash
registers. Now, most store equipped with barcode readers that enter price and other product
information automatically.
Mixed Costs
A mixed cost contains both variable and fixed cost elements. Mixed costs are also known as semi-
variable costs. For example the electricity charges for residential area in Bhubaneswar is Rs.60 as
compulsory charges and Rs.2.50 per unit of consumption till first 50 units and then for the next 100
units it is Rs.4.20 per unit. So if one customer, the electricity consumption is 40 units in a month.
69 | P a g e
The electricity bill will be, the total of fixed compulsory charges and the variable component.
Total electricity charges = Rs.60 + 40 x Rs. 2.50 = 60 + 100 = Rs.160
In practice, mixed costs are very common. The fixed portion of a mixed cost represents the minimum
cost of having a service ready and available for use. The variable portion represents the cost incurred
for actual consumption of the service. The variable element varies in proportion to the amount of
service that is consumed.
There are few methods to identify and estimate the fixed and variable cost out of the mixed costs. If
the cost is not changing in proportion to the output/volume/activity then it may be a fixed or mixed
cost and if it does not remain same within the range with the change in the volume or activity then it
is not completely fixed. For few months/volume/activity we collect the cost and then using the
following methods we can find out the variable and fixed portion of the cost:
1. High Low Method;
2. Least-squares Regression Method;
3. Multiple regression method, etc.
Q.No.1. Hoi Chong Transport, Ltd., operates a fleet of delivery trucks in Singapore. The company has
determined that if a truck is driven 105,000 kilometres during a year, the average operating cost is
11.4 cents per kilometre. If a truck is driven only 70,000 kilometres during a year, the average
operating cost increases to 13.4 cents per kilometre. (The Singapore dollar is the currency used in
Singapore.)
Required:
1. Using the high-low method, estimate the variable and fixed cost elements of the annual cost of
truck operation.
2. Express the variable and fixed costs in the form Y = a + bX
3. If a truck were driven 80,000 kilometres during a year, what total cost would you expect to be
incurred.
Q.No.2. The Cheyenne Hotel in Big Sky, Montana, has accumulated records of the total electricity
costs of the hotel and the number of occupancy-days over the last year. An occupancy-day
represents a room rented out for one day. The hotel's business is highly seasonal, with peaks
occurring during the ski season and in the summer.
Month Occupancy-days Electrical Costs
January 1,736 ₹4,127
February 1,904 4,207
March 2,356 5,083
April 960 2,857
May 360 1,871
June 744 2,696
July 2,108 4,670
August 2,406 5,148
September 840 2,691
October 124 1,588
November 720 2,454
December 1,364 3,529
Required:
Using the high-low method, estimate the fixed cost of electricity per month and the variable cost of
electricity per occupancy-day. Round off the fixed cost to the nearest whole dollar and the variable
cost to the nearest whole cent.
Q.No.3. St. Mark's Hospital contains 450 beds. The average occupancy rate is 80% per month. In
other words, on average, 80% of the hospital's beds are occupied by patients. At this level of
occupancy, the hospital's operating costs are ₹32 per occupied bed day, assuming a 30-day month.
This ₹32 figure contains both variable and fixed cost elements.
During June, the hospital's occupancy rate was only 60%. A total of ₹326,700 in operating cost was
incurred during the month.
Required:
1. Using the high-low method, estimate.
a. The variable cost per occupied bed on a daily basis.
b. The total fixed operating costs per month.
2. Assume an occupancy rate of 70% per month. What amount of total operating cost would you
expect the hospital to incur?
Q.No.4. Zarello Company manufactures pacemakers. Based on past experience, Zarello has found
that its total cost of inspecting finished product can be represented by the following formula:
Inspection cost = $310,000 + $1.60X,
where X(the driver) is the number of pacemakers. The inspection activity uses the following
resources: inspectors, x-ray machines, x-ray film, and developing supplies. Last year, Zarello
produced 100,000 pacemakers. (Round unit costs to the nearest cent.)
Required
1. Which resources are likely to vary with the driver over the relevant range? Assume the
relevant range is 50,000 to 150,000 pacemakers.
2. What is the total cost of inspecting pacemakers incurred by Zarello last year? Total Fixed
cost? Total variable cost?
3. What is the cost of inspection per unit?
4. What is the fixed cost per unit?
5. What is the variable cost of inspection per unit?
Q.No.5.Nova Company's total overhead costs at various levels of activity are presented below:
Month Machine hours Total overhead

costs
April 70,000 ₹198,000
May 60,000 174,000
June 80,000 222,000
July 90,000 246,000
Assume that the total overhead costs above consist of utilities, supervisory salaries, and
maintenance. The breakdown of these costs at the 60,000 machine-hour level of activity is:
Utilities(variable) ₹48,000
Supervisory salaries(fixed) 21,000
Maintenance(mixed) 105,000
Total overhead costs ₹174,000
Nova Company's management wants to break down the maintenance cost into its variable and fixed
cost elements.
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Required:
1. Estimate how much of the ₹246,000 of overhead cost in July was maintenance cost. (Hint: to do
this, it may be helpful to first determine how much of the ₹246,000 consisted of utilities and
supervisory salaries. Think about the behaviour of variable and fixed costs!)
2. Using the high-low method, estimate a cost formula for maintenance.
3. Express the company's total overhead costs in the linear equation form Y = a+bX.
4. What total overhead costs would you expect to be incurred at an operating activity level of 75,000
machine hours?
Cost-Volume-Profit Analysis
Cost-Volume-Profit(CVP) analysis is one of the most powerful tools that managers have at their
command. It helps them understand the relationships among cost, volume, and profit by focusing on
interactions among the following five elements:
1. Prices of products.
2. volume or level of activity
3.Per unit variable costs
4. Total fixed costs.
5. Mix of products sold.
Because CVP analysis helps managers understand the interrelationships among cost, volume, and
profit, it is a vital tool in many business decisions. These decisions include what products and
services to offer, what pricing policy to follow, what marketing strategy to employ, and what basic
cost structure
The Contribution Format Income Statement
Although an income statement prepared in the functional format may be useful for external
reporting purposes, it has serious limitations when used for internal purposes. Internally, the
manager needs cost data organised in a format that will facilitate planning, control, and decision
making.
Rs.
Sales --------
Less: Variable cost --------
Contribution margin --------
Less: Fixed Cost --------
Profit --------
In the above we notice that the contribution approach separates costs into fixed and variable
categories, first deducting variable expenses from sales to obtain what is known as the contribution
margin. The contribution margin is the amount remaining from sales revenues after variable
expenses have been deducted. This amount contributes toward covering fixed expenses and then
toward profits for the period. The contribution margin approach helps managers organize data
pertinent to all kinds of special decisions such as product-line analysis, pricing, use of scarce
resources, and make or buy analysis.
Contribution Margin Ratio(CM Ratio)

The contribution margin as a percentage of total sales is referred to as the contribution margin
ratio(CM Ratio). This ratio is computed as follows:
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑀𝑎𝑟𝑔𝑖𝑛 𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
CM ratio = or
𝑆𝑎𝑙𝑒𝑠 𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
Break Even Point
Break Even point is the point of sales(Rs or units) at which profit is zero. It signifies that at this point
of sales the total cost is equal to total revenue. In contribution margin format if we see this, then we
found that the total contribution is only sufficient enough to recover the fixed costs only. Other way
we can say that the total contribution is equal to fixed cost, so profit is nil.
Any sales over and above the Break Even Sales will generate profit at CM ratio.
Break Even Point can be ascertained using two methods i.e., Equation method or the contribution
margin method.
Profit = (Sales - Variable expenses)- Fixed expenses
The above equation can be rearranged in the following way:
Sales = Variable expenses + Fixed expenses + Profit
Contribution Margin Approach
This approach centres on the idea that each unit sold provides a certain amount of contribution
margin that goes toward covering fixed costs. To find out how many units must be sold to break
even, divide the total fixed expenses by the unit contribution margin:
𝐹𝑖𝑥𝑒𝑑 𝐸𝑥𝑝𝑒𝑛𝑠𝑒𝑠
Break-even point in units sold =
𝑈𝑛𝑖𝑡 𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑚𝑎𝑟𝑔𝑖𝑛
𝐹𝑖𝑥𝑒𝑑 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠
and to find out the Break-even point in total sales(Rupees) = 𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑀𝑎𝑟𝑔𝑖𝑛 𝑅𝑎𝑡𝑖𝑜
Q.No.6.The Alpine House, Inc., is a large retailer of winter sports equipment. An income statement
for the company's Ski Department for a recent quarter is presented below:
The Alpine House, Inc.

Income Statement- Ski Department
For the Quarter Ended March 31
Sales ₹150,000
Less: cost of goods sold 90,000
Gross margin 60,000
Less: operating expenses
Selling expenses ₹30,000
Administrative expenses 10,000 40,000
Net operating income ₹20,000
Skis sell, on the average, for ₹750 per pair. Variable selling expenses are ₹50 per pair of skis sold. The
remaining selling expenses are fixed. The administrative expenses are 20% variable and 80% fixed.
The company does not manufacture its own skis; it purchases them from a supplier for ₹450 per
pair.
Required:
1. Prepare an income statement for the quarter using the contribution approach.
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2. For every pair of skis sold during the quarter, what was the contribution towards covering fixed
expenses and toward earning profits?
The Margin of Safety
The margin of safety is the excess of budgeted(or actual) sales dollars over the break-even volume of
sales dollars. It states the amount by which sales can drop before losses are incurred. The higher the
margin of safety, the lower the risk of not breaking even. The formula for its calculation is
Margin of safety = Total budgeted(or actual) sales - Break-even sales
The margin of safety can also be expressed in percentage form by dividing the margin of safety in
dollars by total sales:
𝑀𝑎𝑟𝑔𝑖𝑛 𝑜𝑓 𝑠𝑎𝑓𝑒𝑡𝑦 𝑖𝑛 𝑑𝑜𝑙𝑙𝑎𝑟𝑠
Margin of safety = 𝑇𝑜𝑡𝑎𝑙 𝑏𝑢𝑑𝑔𝑒𝑡𝑒𝑑 (𝑜𝑟 𝑎𝑐𝑡𝑢𝑎𝑙) 𝑠𝑎𝑙𝑒𝑠
Q.No.7. Data for Hermann Corporation are shown below:
Per unit Percent of Sales

Selling price ₹90 100%
Less Variable expenses 63 70
Contribution Margin 27 30
Fixed Expenses are ₹30,000 per month and the company is selling 2000 units per month.
Required:
1. The marketing manager argues that a ₹5,000 increase in the monthly advertising budget would
increase monthly sales by ₹9,000. Should the advertising budget be increased?
2. Refer to the original data. Management is considering using higher-quality components that
would increase the variable cost by ₹2 per unit. the marketing manager believes the higher quality
product would increase sales by 10% per month. Should the higher-quality components be used?
Q.No.8. Metro Products has a single product, a woven basket whose selling price is ₹15 and whose
variable cost is ₹12 per unit. The company's monthly fixed expenses are ₹4,200.
Required:
1. Solve for the company's break-even point in unit sales and in sales dollar using the equation
method.
2. Solve for the company's break-even point in unit sales and in sales dollar using the contribution
margin method.
Q.No.9. Linco Corporation has a single product whose selling price is ₹120 and whose variable cost is
₹80 per unit. The company's monthly expenses is ₹50,000.
Required:
1. Using the equation method, solve for the unit sales that are required to earn a target profit of
₹10,000.
2. Using the contribution margin approach, solve for the dollar sales that are required to earn a
target profit of ₹15,000.
Q.No.10. Outback Outfitters sells recreational equipment. One of the company's products, a small
camp stove, sells for ₹50 per unit. Variable expenses are ₹32 per stove, and fixed expenses
associated with the stove total ₹108,000 per month.
Required:
1. Compute the break-even point in number of stoves and in total sales dollars.
2. If the variable expenses per stove increase as a percentage of the selling price, will it result in a
higher or a lower break-even point? Why?(Assume that the fixed expenses remain unchanged.)
3. At present, the company is selling 8,000 stoves per month. The sales manager is convinced that a
10% reduction in the selling price would result in a 25% increase in monthly sales of stoves. Prepare
two contribution income statements, one under present operating conditions, and one operation
would appear after the proposed changes. Show both total and per unit data on your statements.
4. Refer to the data in (3) above. How many stoves would have to be sold at the new selling price to
yield a minimum net operating income of ₹35,000 per month?
Q.No.11. Molander Corporation is a distributor of a sun umbrella used at resort hotels. Data
concerning the next month's budget appear below:
Selling price.............. ₹30 per unit

Variable expense...... ₹20 per unit
Fixed expense........... ₹7,500 per month
Units sales................ 1000 units per month
Required:
1. Compute the break-even point in unit and margin of safety in sales dollar.
2. Compute the company's margin of safety as a percentage of its sales.
Q.No.12. Miller Company's most recent contribution format income statement is shown below:
Total Per unit

Sales(20,000) ₹300,000 ₹15.00
Less: Variable expenses 180,000 9.00
Contribution margin 120,000 ₹6.00
Less: Fixed expenses 70,000
Net operating income 50,000
Required:
Prepare a new contribution format income statement under each of the following
conditions(consider each case independently):
1. The sales volume increases by 15%.

2. The selling price decreases by ₹1.50 per unit, and the sales volume increases by 25%.
3. The selling price increases by ₹1.50 per unit, fixed expenses increase by ₹20, 000, and the
sales volume decreases by 5%.
4. The selling price increases by12%, variable expenses increase by 60 cents per unit, and the
sales volume decreases by 10%.
Q.No.13. New East company is the exclusive distributor for an automotive product that sells for ₹40
per unit and has a CM ratio of 30%. The company's fixed expenses are ₹180,000 per year.
Required:
1. What are the variable expenses per unit?
2. Using the equation method:
a. What is the break-even point in units and sales in Rupees?
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b. What sales level in units and in sales dollars is required to earn an annual profit of
₹90,000?
c. Assume that by using a more efficient shipper, the company is able to reduce its variable
expenses by Rs 4 per unit. What is the company's new break-even point in units and sales Rupees.
Q.No.14. For the coming year, a manufacturing company has budgeted as under:
Contribution/Sales Ratio: 45%
Margin of Safety Ratio: 33 ½ %
Fixed costs: ₹5, 85,000
Required: Determine total sales-volume for the coming year and profit thereon.
Q.No.15. A company has a contribution/sales ratio of 40%. It maintains a margin of safety of 20%. If
its annual fixed cost amounts to ₹24 lakhs, calculate its:
a. Break-even sales
b. Margin of safety
c. Total sales
d. Total variable costs and
e. Profit
Q.No.16. A company annually manufactures and sells 20000 units of a product, the selling price of
which is ₹50 and profit earned is ₹10 per unit.
The analysis of cost of 20000 units is:
Material cost: ₹ 3, 00,000
Labour cost: ₹ 1, 00,000
Overheads: ₹4, 00,000 (50% variable)
You are required to compute:
a. Break-even sales in units and in rupees.
b. Sales to earn a profit of ₹ 3, 00,000
c. Profit when 15000 units are sold.
Q.No.17. BREAK-FEAST Pvt. Ltd, a food processing firm, has cake, biscuit, bread, burgers, etc in its
product mix. Recently it introduced a new product, processed and formed potato chips. The chips
are sold in 1-pound canisters, but they are packed in cases of 50 canisters. A case is therefore
considered the basic sales unit. Although management had made detailed estimates of cost and
volume prior to undertakings this venture, new projections based on our actual cost experience are
now desired
Income statements for the last two quarters are each thought to be representative of the costs and
productive efficiency we can expect in the next few quarters. There were virtually no inventories on
hand at the end of either quarter. These income statements reveal the following.
First quarter ₹ Second quarter ₹

Sales (50000@ ₹24) 1200000 (70000@ ₹24) 1680000
Cost of goods sold 700000 880000
Gross margin 500000 800000
Selling and administration 650000 690000
Net income before tax (150000) 110000
Tax (60000) 44000
Net income (90000) 66000
The earnings and losses incurred by this product line are, so far, negligible in relation to the firm’s
overall earnings. The firm’s overall marginal and average income tax rate is 40%. This 40% figure
has been used to estimate the tax liability arising from the potato chip operation.
Required:
(a) Management would like to know the break-even point in terms of quarterly case sales for
the chips.
(b) Management estimates that there is an investment of ₹30,00,000 in this product line.
What quarterly case sales and total revenue are required each quarter to earn an after-tax
return of 20% on investment?
(c) The firm’s marketing people predict that if the selling price is reduced by ₹1.50 per case
(₹0.03 off per canister) and a ₹150000 advertising campaign is mounted to call consumers’
attention to the new reduced price, sales will increase by 20% over second-quarter sales.
Should the plan be implemented?
Q.18. Sun&Moon Company manufactures three products, X,Y and Z. Company has separate
marketing manager for each product. It is the practice of the company to divide the actual
advertisement expenses among three products on the basis of the relative net sales of each
product. In the last year, the company spent ₹30,000 for advertising for the three products
and it is divided in the ratio of sales of the three products. This year company has budgeted to
spent ₹90,000 and spent the money during the year. Half of this money was spent on general
institutional advertising with the objective of enhancing overall image of the company. Of the
other half, ₹20,000 was spent on Product X, ₹30,000 on Product Y and rest on product Z. For
the purpose of income measurement, all advertising expenses continued to be allocated on
the basis of sales. Some of the relevant data for the last year is given below.
Product X Product Y Product Z Total
Net sales ₹20,70,000 ₹12,80,000 ₹12,42,000 ₹46,00,000
Advertising expenses 4,05,000 2,52,000 243,000 90,000
Income 2,55,000 1,20,000 1,75,000 5,50,000
When the marketing manager of Product X received these figures, he complained that his
department was charged with an unfair portion of advertising, and that he should be held
responsible only for the actual amount spent to advertise Product X.
Required:
a. Comment on the sales manager's complaint.
b. In your view, how much advertising expenses should be charged to the department for
marketing Product X.
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Relevant Costs for Decision Making
I n this chapter we are going to focus on measuring costs and benefits for non-routine decisions.
The term 'special studies' is sometimes used to refer to decisions that are not routinely made at
frequent intervals. In other words, special studies are undertaken whenever a decision needs to
be taken; such as discontinuing a product or a channel of distribution, making a component within
the company or buying from an outside supplier, introducing a new product and replacing existing
equipment.
Managers usually follow a decision model for choosing among different courses of action. A decision
model is a method of making a choice, and it often involves both quantitative and qualitative
analysis. Management accountants work with managers by analyzing and presenting relevant data
to guide decisions. Decision making should normally follow a five step process. The process is (a)
identify the problem and uncertainties, (b) obtain information, (c) make predictions about the
future, (d) make decisions by choosing among alternatives, and (e) implement the decision, evaluate
performance, and learn.
In the above process of decision making, we need relevant information for the decision making. To
be relevant for a particular decision, a revenue or cost item must meet two criteria: (a) it must be an
expected future revenue or expected future cost, and (b) it must differ among alternative courses of
action. The outcomes of alternative actions can be quantitative and qualitative. Quantitative
outcomes are measured in numerical terms. Some quantitative outcome can be expressed in
financial terms, others cannot. Qualitative factors are difficult to measure accurately in numerical
terms. Consideration must be given to relevant quantitative and qualitative factors in making
decisions
We begin by introducing the concept of relevant cost and applying this principle to special studies
relating to the following situations:
1. Disposal of Assets
2. Product-mix decisions;
3. Special selling price decisions;
4. Decisions on replacement of equipment;
5. Outsourcing (make or buy) decisions;
6. Discontinuation decisions.
Disposal of Assets
In case of disposal of assets or material we have to ignore the sunk cost, which is irrelevant today.
We have to see the future benefits and additional cost to be incurred for the alternatives available
before us. If the future benefits are more than the future costs then we should go for disposal of
asset, otherwise not. But there are many qualitative decisions that affects management decision
making. A policy of management to go for modernisation of plant may ignore the above financial
viability. In this chapter, the qualitative aspects of decision making is ignored to make student
understand the basic skills of decision making using cost information.
Q.No.1. A company has an inventory of 100 assorted parts for a line of missiles that has been
discontinued. The inventory cost is ₹80,000. The parts can be either (a) remachined (reworked) at
total additional costs of ₹30,000 and then sold for ₹35,000 or (b) sold as scrap for ₹2,000. Which
action is more profitable? Show your calculations.
Chapter 7 Relevant Costs for Decision Making
Sol: In the above situation we have two alternatives, (i) these parts can be remachined or (ii) it
can be sold as scrap. The cost of inventory is irrelevant for decision making because it is a sunk
cost(past cost).
If we go for remachining, we get additional profit of ₹5,000(i.e., ₹35,000- 30,000) and if we sell as
scrap, we get ₹2,000. Hence we should go for remaching the parts as it gives us an incremental profit
of ₹3,000.
Q.No.2. A motor, costing ₹1,00,000 and uninsured, is wrecked its first day in use. It can be either (a)
disposed of for ₹10,000 cash and replaced with a similar motor costing ₹1,02,000 or (b) built for
₹85,000 and thus become brand new as far as operating characteristics and looks are concerned.
Which action is less costly? Show your calculations.
Product mix decisions when capacity constraints exist
An organisation tries to manufacture as many number of units as it is having a demand in the

market. But this is not always possible because the production capacity of any organisation will be
limited due to limited machine capacity, material availability, skilled labour availability, capacity
constraint in other processes, etc. These scarce resources are known as limiting factors(constraint
resources). Within a short-term time period it is unlikely that production constraints can be removed
and additional resources acquired. Where limiting factors apply, managers must decide how the
constraint resource should be used.
In such situations, the first job as a manager of the department or business unit is to identify the
limiting factor(s). The contribution of each product is to be ascertained for every limiting factor.
Decision to manufacture a particular product over the other, is based on the contribution
generated by the product for the limiting factors. Fixed costs are ignored for these decisions, they
are usually unaffected by such choices, so the course of action that will maximize the company's
contribution margin should ordinarily be selected. But, if there is any future fixed cost which is
attached with the product, then it should be considered for decision making.
Q.1. Benoit Company produces three products, A,B and C. Data concerning the three products
follow(per unit):
Products
A B C
Selling price............................................. ₹80 ₹56 ₹70
Less: Variable expenses..........................
Direct materials...................................... 24 15 9
Other variable expenses......................... 24 27 40
Total variable expenses.......................... 48 42 49
Contribution margin............................... 32 ₹14 ₹21
Contribution margin ratio....................... 40% 25% 30%
Demand for the company's products is very strong, with far more orders each month than the
company has raw materials available to produce. The same material is used in each product costing
₹ 3 per pound with a maximum of 5,500 pounds available each month.
Required:
Which orders would you advise the company to accept first, those for A, for B, or for C? Which
orders second? Third? Also find out the estimated profit with the proposed quantity of output.
79 | P a g e
Q.No.2. Super India Ltd is producing three products X, Y and Z. A minimum of 1000 units of each
product is to be produced by the company for keeping a product mix to compete with other
companies' products. The manager of the company is asked to come out with a product mix in the
following constraint resource situations. The following data has been provided by the accounting
department regarding the three products:
X Y Z
Maximum Capacity 5000 units 2000 units 3000 units
Direct material @ Rs 10 per kg Rs. 40 Rs 10 Rs 30
Other variable costs 36 25 10
Selling price 100 50 60
Fixed costs (unavoidable) 20,000 15,000 10,000
Calculate the best product mix in each of the following three independent cases:
a. Total availability of raw materials is limited to 18,000 kgs.
b. Under a trade agreement the firm cannot produce more than 7500 units of the three
products taken together.
c. Total sales value of the three products cannot exceed Rs 6, 50,000.
Q.No.3. A company produces three products. The cost data are as under:
Products A B C
Direct Materials Rs 64 Rs 152 Rs 117

Direct Labour:
Deptt. Rate per hr. Hrs Hrs Hrs
1 Rs 5 18 10 20
2 Rs 6 5 4 7
3 Rs 4 10 5 20
Variable overheads Rs 16 Rs 9 Rs 21
Fixed overheads Rs 4,00,000 per month
The budget was prepared at a time when the market was sluggish. Keeping the market
condition into consideration the budgeted quantities and selling prices were decided, which
is given below:
Product Budgeted Quantity Selling Price/Unit
A 9750 270
B 7800 280
C 7800 400
Later the market improved and the sales team suggested that the sales quantities could be
increased by 20% for the product A and 25% each for products B and C. The sales manager
confirmed that the increased quantities could be achieved at the prices originally budgeted.
But the production manager stated that the output cannot be increased beyond the
budgeted level due to limitation of direct labour hours in Dept-2.
Required:
a. Present a statement of budgeted profitability
b. Set optimal product mix and calculate the optimal profit.
Q.No.4. Children Toy Company produces two models of toy Car, Deluxe and Super. Pertinent data
are as follows:
Per Deluxe Super
Selling price ₹100.00 ₹70.00
Costs:
Direct Material 28.00 13.00
Direct Manufacturing labour 15.00 25.00
Variable Manufacturing overhead* 25.00 12.50
Fixed manufacturing overhead* 10.00 5.00
Market cost (all variable) 14.00 10.00
Total Cost 92.00 65.50
Operating income 8.00 4.50
*Allocated on the basis of machine-hours.
The car craze is such that enough of either Deluxe or Super can be sold to keep the plant operating
at full capacity. Both products are processed through the same production departments.
Which products should be produced? Briefly explain your answer.
Q.No.5. A company manufactures three products. The budgeted quantity, selling prices and unit
costs are as under:
Products A B C
Raw materials (@ Rs 20 per kg) Rs.80 Rs.40 Rs.20
Direct wages (@ Rs 5 per hr) 5 15 10
Variable overheads (Rs) 10 30 20
Fixed overheads (Rs) 9 22 18
Budgeted production (units) 6400 3200 2400
Selling price per unit (Rs) 140 120 90
Required:
a. Present a statement of budgeted profit
b. Set optimal product mix and determine the profit if the supply of raw material is
restricted to 18,400 kg.
Adding or Dropping Product Lines and Other Segments:

Decisions relating to dropping a product line or closing a department, is the most difficult
decision for a manager. Apart from emotional aspects there are many qualitative and
quantitative aspects to be considered for the decision making. Ultimately, however, any final
decision to drop an old segment or to add a new one is going to hinge primarily on the impact,
the decision will have on net operating income. To assess this impact, costs must be carefully
analyzed.
In such situations, we should carefully see the cost which continues even after dropping the
product or closing the department. Such costs become irrelevant for our decision making, as
these costs remain there in both the alternatives of continuing or discontinuing. Some time it
happens that such costs does not remain same in amount, then those costs become relevant for
the decision.
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Q.No.6. Vanjanagar, sports shoe company is considering dropping one line of product, whose
information is given below.
Revenue ₹ 950,700
Cost of goods sold 861,840
Gross Margin 88,920
Selling and administrative expenses 136,800
Net Loss ₹ (47,880)
Factory overhead accounts for 35% of the cost of the goods sold and is one-third fixed. These
data are believed to reflect conditions in the immediate future.
Required:
Should the line be dropped?
Q.No.7. The Discount Drug Company has three major product lines-- drugs, cosmetics, and
housewares. Sales and cost information for the preceding month for each separate product line
and for the store in total are given below:
Product line
Total Drugs Cosmetics Housewares
Sales ₹250,000 ₹125,000 ₹75,000 ₹50,000
Less: Variable expenses 105,000 50,000 25,000 30,000
Contribution margin 145,000 75,000 50,000 20,000
Less- fixed expenses:
Salaries 50,000 29,500 12,500 8,000
Advertising 15,000 1,000 7,500 6,500
Utilities 2,000 500 500 1,000
Depreciation-fixtures 5,000 1,000 2,000 2,000
Rent 20,000 10,000 6,000 4,000
Insurance 3,000 2,000 500 500
General Administrative 30,000 15,000 9,000 6,000
Total fixed expenses 125,000 59,000 38,000 28,000
Net operating income(loss) ₹20,000 ₹16,000 ₹12,000 ₹(8,000)
What can be done to improve the company's overall performance? One product line--
housewares --shows a net operating loss for the month. Should this be dropped or continued?
Q.No.8. The Regal Cycle company manufactures three types of bicycles-- a dirt bike, a mountain
bike, and a racing bike. Data on sales and expenses for the past quarter follow:
Total Dirt Bikes Mountain Racing

Bikes Bikes
Sales ₹300,000 ₹90,000 ₹150,000 ₹60,000
Less variable expenses 120,000 27,000 60,000 33,000
Contribution margin 180,000 63,000 90,000 27,000
Less: Fixed expenses:
Advertising, traceable 30,000 10,000 14,000 6,000
Depreciation of special equipment 23,000 6,000 9,000 8,000
Salaries of product-line managers 35,000 12,000 13,000 10,000
Allocated common fixed expenses* 60,000 18,000 30,000 12,000
Total fixed expenses 148,000 46,000 66,000 36,000
Net operating income(loss) ₹32,000 17,000 ₹24,000 ₹(9,000)

*Allocated on the basis of sales dollars.
Management is concerned about the continued losses shown by the racing bikes and wants a
recommendation as to whether or not the line should be discontinued. The special equipment
used to produce racing bikes has no resale value and does not wear out.
Required:
1. Should production and sale of the racing bikes be discontinued? Explain. Show computations
to support your answer.
2. Recast the above data in a format that would be more usable to management in assessing
the long-run profitability of various product line.
Make or Buy decisions

Some time we get offers from some suppliers to supply the parts or services, we would be
otherwise manufacturing or having our own service departments to take care of. They come
with many lucrative offers. Decisions on whether to produce components or avail services
within the organization or to acquire them from outside suppliers are called outsourcing or
make or buy decisions. Such decisions are to be taken very carefully after considering the
financial merits as well as the qualitative aspects. The long term impact of such decisions over
ride on short term impact. Even though it looks profitable in short term, we need to see long
term horizon for continuity of service, quality of products and services, availability of
alternatives, reliability of the supplier, etc. Here we are going to consider the financial aspects
only for our decision making, although the qualitative aspects will also be discussed in the class.
Q.No.9. Auto Parts Ltd has an annual production of 90,000 units for a motor component. The
company’s cost structure per unit is given below:
Materials Rs.270
Labour (25% fixed) 180
Other Manufacturing Exp:
Fixed exp. 90
Variable exp. 135
Total Rs.675
a. The purchase manager has an offer from a supplier who is willing to supply the
component at Rs 540. Should the component be purchased and production stopped?
b. There is one other alternative available, that is the resources now used for this
component’s manufacturing are to be used to produce another new product for which
the selling price is Rs 485.
In the latter case, the material price will be Rs 200 per unit. 90,000 units of this product can
be produced on the same cost basis as above for labour and expenses. Discuss whether it
would be advisable to divert the resources to manufacture the new products, on the
footing that the component presently being produced would, instead of being produced, be
purchased from the market.
Special order/one time order
some time as a manufacturer or service provider we get special orders at either a special
price or we get an opportunity to enter a new market. We have to decide the price of the
product or to decide on the offered price. Now many a cases you may not be having
sufficient capacity or resources to meet the order, then either you have to drop your
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existing order/client to fulfil the special order. The loss of benefit(opportunity cost) from
the loss of existing order should be considered for the decision making.
These decisions are to be taken very carefully because sometime you have to trade off
between long term and short term benefits. It also depends on the strategy of the firm. A
firm can suffer loss or not to make any profit initially to have a foothold in a new
promising market.
Q.No.10. A company currently operating at 80% capacity has the following particulars:
Sales ...................................... Rs.32 lakhs

Direct Materials...................... 10 lakhs
Direct Labour.......................... 4 lakhs
Variable Overheads................ 2 lakhs
Fixed overheads..................... 13 lakhs
An export order has been received that would utilize half the capacity of the factory. The
order cannot be split, that is, it has to be taken in full and executed at 10% below the
normal domestic prices, or rejected totally. The alternatives available to the management
are:
i. Reject the order and continue with the domestic sales only (as at present); or
ii. Accept the order, split capacity between overseas and domestic sales and turn
away excess domestic demand.
Prepare a comprehensive statement of profitability and suggest the best alternative.
Q.No.11. Following data are in respect of a firm manufacturing a single product for a particular
period:
Sales (20,000 units) : Rs 2, 00,000
Cost of production (20,000 units) : Rs 1, 20,000
Selling and distribution expenses : Rs 30,000
Maximum capacity is 25,000 units
Fixed costs included in cost of production are Rs 40,000 and only variable cost included in
selling and distribution expenses are commission @ 10% on sales and packing expenses @
20p. per unit.
a. An offer for purchase of 4000 units is received from outside India. No sales commission
is payable on such foreign order but packing costs will be 80p. per unit.
What minimum price may be quoted for the foreign offer?
b. What should be the minimum price had the offer size been 8000 units instead of 4000
units?
Case-1 (Make or Buy)
The management of an engineering company manufacturing a range of products, is considering next
year’s production, purchase and sales budgets. Shown below are the budgeted total unit costs of
two of the components and two of the products manufactured by the company.
Comp. 12 comp. 14 product VW product XY
Per unit(Rs.) per unit(Rs.) per unit(Rs.) per unit(Rs.)
Direct material 18 26 12 28
Direct Labour 16 4 12 24
Variable overhead 8 2 6 12
Fixed overhead 20 5 15 30
62 37 45 94
Components 12 and 14 are incorporated into other products manufactured and sold by the
company, but not the two products shown above. It is possible to purchase components 12 and 14
from another company for Rs.60 per unit and Rs.30 per unit respectively.
The anticipated selling prices of products VW and XY are Rs.33 and Rs.85 respectively.
Required:
(a) Advise the management of the company whether it would be profitable to :
(i) Purchase either of the above components,
(ii) Sell either of the above products.
(b) State clearly, and where appropriate comment upon, the assumptions you have made in
answering (a) above
(c) Consider how the following additional information would affect your advice in (a) above.
(i) Next year’s budgeted production requirements for the two components are 7000
units of component 12 and 6000 units of Components 14. Next year’s budgeted
sales for the two products are Product VW 5,000 units and Product XY 4,000 units.
(ii) A special machine is used exclusively by the above two components and two
products and technical reasons the machine can only be allowed to operate for
80,000 machine hours next year.
The budgeted usage of the machine is:
Component 12- 8 machine hours Product VW- 6 machine hours
Component 14- 2 machine hours Product XY- 12 machine hours
The operating costs of the machine have been included in the unit costs shown in (a)
above.
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1. Activity based costing is a method of charging:
a. Direct expenses to cost unit
b. Overhead to production department
c. Overhead to cost units
d. None of the above 0.5 mark
2. Activity-based costing is suitable for product costing when:
a. One product is manufactured by the organization
b. Many products of different types are manufactured by the organization
c. Products are similar and consume same resources
3. In activity based costing, costs are accumulated by:
a. Cost objects
b. Cost benefit analysis
c. Cost pool
4. In activity-based costing, a facility(organization)-sustaining activity is:
a. Related to any particular product or service
b. Related to only particular batch of product
c. Not related to any particular product or service or batch of product
5. In activity-based costing, a product sustaining activity supports:
a. The production of a specific product or service
b. The efficient operation of organization
c. The production of a batch of product
d. None of the above. 0.5 mark
6. The three products manufactured by DEL Co. and further information is given below:
A(Rs.) B(Rs.) C(Rs.)
S.P 400 350 600
Variable Cost per unit:
Material 100 75 150
Labour 80 40 90
Variable manufacturing Overhead 60 50 100
Fixed overhead per unit 40 50 40
Material consumed per unit 4 kgs 3 kgs 6 kgs
Labour hour per unit 8 hours 4 hours 9 hours
a. Which product is most profitable, if material availability is limited?
b. Which product is most profitable, if no. of units to be sold is limited?
c. Which product is most profitable, if sales value(Rs.) is the limiting factor?
d. Which product is most profitable, labour hour is limited? 2 marks
7. If the average cost of the product is Rs.100, marginal(Variable cost) cost per unit is Rs.60 and
fixed cost is Rs.60,000(unavoidable), then what will be minimum price for export sale?
0.5mark
Ans.
1. Activity-based costing is suitable for product costing when:
e. One product is manufactured by the organization
f. Many products of different types are manufactured by the organization
g. Products are similar and consume same resources
h. None of the above 0.5 mark
2. Activity based costing is a method of charging:
e. Direct expenses to cost unit
f. Overhead to production department
g. Overhead to cost units
3. In activity-based costing, a product sustaining activity supports:
e. The production of a specific product or service
f. The efficient operation of organization
g. The production of a batch of product
h. None of the above. 0.5 mark
4. In activity based costing, costs are accumulated by:
e. Cost objects
f. Cost benefit analysis
g. Cost pool
5. In activity-based costing, a facility(organization)-sustaining activity is:
e. Related to any particular product or service
f. Related to only particular batch of product
g. Not related to any particular product or service or batch of product
6. The three products manufactured by DEL Co. and further information is given below:
A(Rs.) B(Rs.) C(Rs.)
S.P 400 350 600
Variable Cost per unit:
Material 100 60 150
Labour 80 40 120
Variable manufacturing Overhead 60 50 100
Fixed overhead per unit 40 50 40
Material consumed per unit 5 kgs 3 kgs 7.5 kgs
Labour hour per unit 6 hours 3 hours 9 hours
a. Which product is most profitable, if material availability is limited?
b. Which product is most profitable, if no. of units to be sold is limited?
c. Which product is most profitable, if sales value(Rs.) is the limiting factor?
d. Which product is most profitable, labour hour is limited? 2 marks
7. If the average cost of the product is Rs.100, marginal(Variable cost) cost per unit is Rs.60 and
fixed cost is Rs.60,000(unavoidable), then what will be minimum price for export sale?
0.5mark
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Budget and Budgetary Control
D
eveloping a budget is a critical step in planning any economic activity. This is true for
business organizations, government agencies and for individuals. We all must budget our
money to meet day-to-day expenses and to plan for major expenditures, such as buying a
car or paying for college tuition fees. Similarly, businesses of all types and government units
at every level must make financial plans to carry out routine operations, to plan for major
expenditures, and to help in making financial decisions.
Need for budgeting systems
As we know planning is a vital exercise in the process of managing any organization, similarly budget
is also a very important activity for the organization. We budget the planning or plan according to
budget, these two are complimentary to each other. One can ignore budget and similarly ignore
planning and do haphazardly or take random steps, may be successful or may not be, no way the
success or failure can be measured because there was no standard fixed previously to be matched
with the actual outcome.
Contrast to the random steps, a budget is a detailed plan, expressed in quantitative terms, that
specifies how resources will be acquired and used during a specified period of time. The budget
involves few of the following purposes:
Planning
The most obvious purpose of a budget is to quantify a plan of action. The budgeting process forces
the individuals who make up an organization to plan ahead.
Facilitating Communication and Coordination
For any organization to be effective, each manager throughout the organization must be aware of
the plans made by other. The budgeting process pulls together the plans of each manager in an
organization.
Allocating Resources
Generally, an organization's resources are limited, and budgets provide one means of allocating
resources among competing uses. In fact, the need for budget arises due to scarcity of resources, it
may be physical resources or limited time or space anything.
Controlling Profit and Operations
A budget is a plan, and plans are subject to change. Nevertheless, a budget serves as a useful bench
mark with which actual results can be compared. Such a comparison can help managers evaluate the
firm's effectiveness.
Evaluating Performance and providing incentives
Comparing actual results with budgeted also helps managers to evaluate the performance of
individuals, departments, divisions, or entire companies. Since budgets are used to evaluate
performance, they also can be used to provide incentives for people to perform well.
Types of Budgets
Different types of budgets serve different purposes. A master budget, or profit plan, is a
comprehensive set of budgets covering all phases of an organization's operations for a specified
period of time. It is comprised of Budgeted financial statements and capital budget of an
organization. Budgeted financial statements include a budgeted income statement, a budgeted
balance sheet, and a budgeted statement of cash flow. A capital budget is a plan for the acquisitions
of capital assets, such as buildings and equipment.
Budgets are developed for specific time periods. Short-range budgets cover a year, a quarter, or a
month, whereas long-range budgets cover period longer than a year. Rolling budgets are
continually updated by periodically adding a new incremental time period, such as a quarter, and
Chapter 8 Budget and Budgetary Control
dropping the periods just completed. Rolling budgets are also called revolving budgets or
continuous budgets.
The Master Budget, the principal out of a budgeting system is a comprehensive profit plan that ties
together all phases of an organization's operations. The master budget comprises many separate
budgets, or schedule, that are interdependent. It consists of operating budget as well as financial
budget. The following budgets forms part of the Master budget.
Sales forecasting or sales budget
Production budget
Material budget
Labour Budget
Manufacturing overhead budget
Selling and Administration Overhead budget
Budgeted income statement
Cash budget
Budgeted Balance sheet
Budgeted Statement of Cash Flows
operational Budgets
Based on the sales budget, a company develops a set of operational budgets that specify how its
operations will be carried out to meet the demand for its goods or services. It constitutes production
budget, material, labour and other overhead budgets.
Cash Budget
Once the operating budgets (sales, production, and so on) have been established, the cash budget
and other financial budgets can be developed. A cash budget is detailed plan showing how cash
resources will be acquired and used over some specified time period.
Sales forecasting-- A Critical Step
The sales budget is usually based on the company's sales forecast. Sales from prior years are
commonly used as a starting point in preparing the sales forecast. In addition, the analyst may
examine the company's unfilled back orders, the company's pricing policy and marketing plans,
trends in the industry, and general economic conditions. Sophisticated statistical tools may be used
to analyze the data and to build models that are helpful in predicting key factors influencing the
company's sales. Some companies use computer simulations to enhance their marketing strategies
and sales forecasts.
Although in the above paragraph we learned that sales budget is a critical step but the critical
starting point in the preparation of budget is the limiting factor. Hence, it is said that budget is the
creation of scarcity. When we have limited resources we think of using it carefully and then we plan
for its use. Suppose, the availability of material is limited then the process of budgeting starts with
material availability and the allocation of material is done for different products for various periods.
Similarly some time plant capacity may be limited, in that case, we don't plan for sales, rather we
see the production which can be done, although forecasting of sales is always done to see all
permutations and combinations of production.
Zero Base Budgeting

Zero Base Budgeting is used in a wide variety of organizations. Under zero-base budgeting, the
budget for virtually every year activity in the organization is initially set to zero. To receive funding
during the budgeting process, each activity must be justified in terms of its continued usefulness.
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The zero-base-budgeting approach forces management to rethink each phase of an organization's
operations before allocating resources
Historical Base budgeting
Some organizations use a historical base-budgeting approach without going to the extreme of zero-
base budgeting. While preparing the budget for the organization, the previous year's budget is taken
as the base budget and incremental package to the budgeted figure is considered on the basis of
cost and benefit from the additional activities. The inflationary effect is taken into account for
preparing the budget, if no additional activities are added.
Top-down and bottom-up approach in Budget preparation
Some time budget is decided at top level and implemented by lower levels as per the allocations
made by the top level. The people working at the bottom level are not consulted during the
preparation of budget. This approach of preparing the budget is called top-down budget. The other
way is bottom-up approach, where people working at lower level are consulted and taking data from
them the budget is prepared. Both approach has its advantages and disadvantages.
Budgetary slack
Budgetary slack is a cushion created by managers to achieve their targets. It is created both the way,
in relation to revenue and expenses. It is the deliberate under-estimation of revenue and over-
estimation of expenses. This helps managers in their performance appraisal at the end of the
budgeted period. Normally, a manager tries to estimate the expenses little in higher side, so that
the manager will have little space in spending money, and vice versa in the case of revenue.
Kaizen Budgeting
Kaizen is a Japanese word which means continuous improvement. Kaizen Budgeting explicitly
incorporates continuous improvement anticipated during the budget period into the budget
numbers. A significant aspect of kaizen budgeting is employee suggestions. Companies
implementing kaizen budgeting believe that employees who actually do the job, whether in
manufacturing, sales, or distribution, have the best information and knowledge of how the job is to
be done. These companies create a culture in which employee suggestions are valued, recognized,
and renewed.
Q.No.1. You are producing an alloy. Production of one ton of alloy requires 1.5 tons Iron and 0.5 ton
of zinc. The producer plans to sell 50,000 tons of alloys during the year 2005. Prepare Materials
Procurement Budget for the year 2005 from the following:
Balances as on January 01, 2005:

Stock of alloy: 6000 tons
Stock of iron ore: 12000 tons
Stock of zinc: 4000 tons
Iron ore on order: 5000 tons
Zinc on order: 3000 tons
Balances as desired on December 31, 2005:
Stock of alloy: 5000 tons
Stock of iron ore: 8000 tons
Stock of zinc: 3000 tons
Iron ore on order: 7000 tons
Zinc on order: 2000 tons
Q.No.2. Nestley Ltd has prepared the following sales budget for the first five months of 1998:
Month Sales Budget

January 10,800
February 15,600
March 12,200
April 10,400
May 9,800
Inventory of finished goods at the end of every month is to be equal to 25% of sales estimate for the
next month. On 1st January, 1998, there were 2700 units of product on hand. There is no work-in-
progress at the end of any month. Every unit of product requires two types of materials in the
following quantities:
Material A: 4 kg
Material B: 5 kg
Materials equal to one half of the requirement of next month’s production are to be in hand at the
end of every month. This requirement was met on 1st Jan, 1998.
Prepare the following budgets for the quarter ending 31st March, 1998:
(i) Production budget (Quantitative)
(ii) Materials purchase budget (Quantitative)
Q.No.3. Green Grass Fertilizer Company plans to sell 200,000 units of finished product in July and
anticipates a growth rate in sales of 5 percent per month. The desired monthly ending inventory in
units of finished product is 80 percent of the next month's estimated sales. There are 160,000
finished units in inventory on June 30. Each unit of finished product requires four pounds of raw
material at a cost of ₹1.15 per pound. There are 700,000 pounds of raw material in inventory on
June 30.
Required:
1. Compute the company's total required production in units of finished product for the entire three-
month period ending September 30.
2. Independent of your answer to requirement (1), assume the company plans to produce 600,000
units of finished product in the three-month period ending September 30, and to have raw material
inventory on hand at the end of the three-month period equal to 25 percent of the use in that
period. compute the total estimated cost of raw material purchases for the entire three-month
period ending September 30.
Q.No.4 The following information is from Binghamton Film Corporation's financial records.
Month Sales Purchases

April ₹72000 ₹42,000
May 66000 48,000
June 60,000 36,000
July 78,000 54,000
Collections from customers are normally 70 percent in the month of sale, 20 percent in the month
following the sale, and 9 percent in the second month following the sale. The balance is expected to
be uncollectible. All purchases are on account. Management takes full advantage of the 2 percent
discount allowed on purchases paid for by the tenth of the following month. Purchases for August
are budgeted at ₹60,000, and sales for August are forecasted at ₹66,000. Cash disbursements for
91 | P a g e
expenses are expected to be ₹14,400 for the month of August. The company's cash balance on
August 1 was ₹22,000.
Required: Prepare the following schedules.
1. Expected cash collections during August.

2. Expected cash disbursements during August.
3. Expected cash balance on August 31.
Q.No.5. Silver Company makes a product that is very popular as a Mother's Day gift. Thus, peak sales
occur in May of each year. These peak sales are shown in the company's sales budget for the second
quarter given below (all sales are on account):
April May June Total

Budgeted sales ₹3,00,000 ₹5,00,000 ₹2,00,000 ₹10,00,000
From past experience, the company has learned that 20% of a month's sales are collected in the
month of sale, another 70% are collected in the month following sale, and the remaining 10% are
collected in the second month following sale. Bad debts are negligible and can be ignored. February
sales totalled ₹2,30,000, and March sales totalled ₹2,60,000.
Required:
1. Prepare a schedule of expected cash collections from sales, by month and in total, for the second
quarter.
2. Assume that the company will prepare a budgeted balance sheet as on June 30. Compute the
accounts receivable as of that date.
Q.No.6. Down Under Products, Ltd., of Australia has budgeted sales of its popular boomerang for the
next four months as follows:
Sales in Units
April 50,000
May 75,000
June 90,000
July 80,000
The company is now in the process of preparing a production budget for the second quarter. Past
experience has shown that end-of-month inventory levels must equal 10% of the following month's
sales. The inventory at the end of March was 5,000 units.
Required:
Prepare a production budget for the second quarter; in your budget, show the number of units to
be produced each month and for quarter in total.
Q.No.7. From the following forecast of income and expenditure, prepare a Cash Budget for the three months ending
one June, 2008:
Sales(₹) Purchases(₹) Wages(₹) Misc.(₹)
February 120,000 84,000 10,000 7,000
March 130,000 100,000 12,000 8,000
April 80,000 104,000 8,000 6,000
May 116,000 106,000 10,000 12,000
June 88,000 80,000 8,000 6,000
Additional Information:
i) Sales: 20% realized in the month of sales, balance realized equally in two subsequent
months.
ii) Purchases: These are paid in the month following the month of supply.
iii) Misc. Expenses: Paid a month in arrears.
iv) Wages: 25% paid in arrears following month.
v) Rent: ₹1,000 per month paid quarterly in advance due in April.
vi) Income tax: first instalment of advance tax of ₹27,000 due on or before 15th June to be
paid within the month.
vii) Income from investment: ₹5,000 received quarterly in April, July, etc.
viii) Cash in hand: ₹5,000 on April 1, 2008
ix) The firm is having arrangement with the bank for short term borrowing for a
maximum amount of ₹40,000 and the firm has to maintain a balance of ₹5,000 at the
end of each month.
Q.No.8. The production department of Zan Corporation has submitted the following forecast of units
to be produced by quarter for the upcoming fiscal year.
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter

Units to be produced 5,000 8,000 7,000 6,000
In addition, the beginning raw materials inventory for the 1st Quarter is budgeted to be 6,000 grams
and the beginning accounts payable for the 1st Quarter is budgeted to be ₹2,880.
Each unit requires 8 grams of raw material that costs ₹1.20 per gram. Management desires to end
each quarter with an inventory of raw materials equal to 25% of the following quarter's production
needs. The desires ending inventory for the 4th Quarter is 8,000 grams. Management plans to pay
for 60% of raw material purchases in the quarter acquired and 40% in the following quarter. Each
unit requires 0.20 direct labour-hour and direct labourers are paid ₹20.50 per hour.
Required:
1. Prepare the company's direct materials budget and schedule of expected cash disbursements for
materials for the upcoming fiscal year.
2. Prepare the company's direct labour budget for the upcoming fiscal year, assuming that the direct
labour workforce is adjusted each quarter to match the number of hours required to product the
forecasted number of units produced.
Q.No.9. The production Department of Harish Corporation has submitted the following forecast of
units to be produced by quarter for the upcoming fiscal year.
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter

Units to be produced 12,000 10,000 13,000 14,000
Each unit requires 0.2 direct labour-hour and direct labourers are paid ₹12.00 per hour.
In addition, the variable manufacturing overhead rate is ₹1.75 per direct labour-hour. The fixed
manufacturing overhead ₹86,000 per quarter. The only noncash element of manufacturing overhead
is depreciation, which is ₹23,000 per quarter.
Required:
1. Prepare the company's direct labour budget for the upcoming fiscal year, assuming that the direct
labour work force is adjusted each quarter to match the number of hours required to produce the
forecasted number of units produced.
2. Prepare the company's manufacturing overhead budget.
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Q.No.10. You have asked to prepare a December cash budget for Ashton Company, a distributor of
exercise equipment. The following information is available about the company's operations:
a. The cash balance on December 1 is ₹40,000.
b. Actual sales for October and November and expected sales for December are as follows:
October November December

Cash sales ₹65,000 ₹70,000 ₹83,000
Sales on account ₹4,00,000 ₹5,25,000 ₹6,00,000
Sales on account are collected over a three-month period as follows: 20% collected in the month of
sale, 60% collected in the month following sale, and 18% collected in the second month following
sale. The remaining 2% is uncollectible
c. Purchases of inventory will total ₹2,80,000 for December. Thirty percent of a month's inventory
purchases are paid during the month of purchase. The accounts payable remaining from November's
inventory purchases total ₹1,61,000, all of which will be paid in December.
d. Selling and administrative expenses are budgeted at ₹4,30,000 for Decemberr. Of this amount
₹50,000 is for depreciation.
e. A new web server for the Marketing Department costing ₹76,000 will be purchased for cash
during December, and dividends totalling ₹9,000 will be paid during the month.
f. The company maintains a minimum cash balance of ₹20,000. An open line of credit is available
from the company's bank to bolster the cash position as needed.
Required:
1. Prepare a schedule of expected cash collections for December.
2. Prepare a schedule of expected cash disbursements for merchandise purchases for December.
3. Prepare a cash budget for December. Indicate in the financing section any borrowing that will be
needed during the month.
Master Budget
Q.No.11. The Max_Enterprise Company manufactures two products, known as alpha and sigma.
Alpha is produced in department 1 and sigma in department 2. The following information is available
for 2007.
Standard material and labour costs:
₹
Material X 7.20 per unit
Material Y 16.00 per unit
Direct labour 12.00 per hour
Overhead is recovered on a direct labour hour basis.

The standard material and labour usage for each product is as follows:
Alpha Sigma
Material X 10 units 8 units
Material Y 5 units 9 units
Direct labour 10 units 15 units
The balance sheet for the previous year ending, 2007 was as follows:
₹ ₹ ₹
Fixed assets:
Land 170000
Buildings and equipment 1292000
Less depreciation 255000 1037000 1207000
Current assets:
Stock, finished goods 99076
raw materials 189200
Debtors 289000
Cash 34000
611276
Less current liabilities
Creditors 248800 362476
Net assets 1569476
Represented by shareholder’s interest:

120000 ordinary shares of Rs.10 each 1200000
Reserves 369476
1569476
Other relevant data is as follows for the year 2007:

Finished product
Alpha Sigma
Forecast sales(units) 8500 1600
Selling price per unit ₹400 ₹560
Ending inventory required(units) 1870 90
Beginning inventory(units) 170 85
Direct material
Material X Material Y
Beginning inventory(units) 8500 8000
Ending inventory(units) 10200 1700
Department 1(₹) Department 2(₹)

Budgeted variable overhead rates
(per direct labour hours):
Indirect materials 1.20 0.80
Indirect labour 1.20 1.20
Power (variable portion) 0.60 0.40
Maintenance (variable portion) 0.20 0.40
95 | P a g e
Budgeted fixed overheads
Depreciation 100000 80000
Supervision 100000 40000
Power(fixed portion) 40000 2000
Maintenance (fixed portion) 45600 3196
Estimated non-manufacturing overheads: ₹

Stationery etc. (Administration) 4000
Salaries
Sales 74000
Office 28000
Commissions 60000
Car expenses (Sales) 22000
Advertising 80000
Miscellaneous 8000
276000
Budgeted cash flows are as follows:
Quarter 1(₹) Quarter 2 (₹) Quarter 3(₹) Quarter 4(₹)
Receipts from customers 1000000 1200000 1120000 985000
Payments:
Materials 400000 480000 440000 547984
Payments for wages 400000 440000 480000 646188
Other costs and expenses 120000 100000 72016 13642
You are required to prepare a master budget for the year 2007 and the following budgets:
1. Sales budget;
2. Production budget;
3. Direct material usage budget;
4. Direct material purchase budget;
5. Direct labour budget;
6. Factory overhead budget;
7. Selling and administration budget;
8. Cash budget.

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Chapter 1

Job Order Costing

Service Department Costing

Activity Based Costing

Cost Behaviour and Cost Volume Analysis

Relevant Costs for Decision Making

Budget and Budgetary Control

Controlling Role of a Implementation

Financial Accounting and Management Accounting

Exhibit 1-2 Comparison of Financial and management Accounting

Financial Accounting Management Accounting

Kinds of business units

Items Manufacturing Merchandising(trading) firm Service organisation

Exhibit 1-4 Cost flow in a manufacturing Company

Selling and Selling and

Manufacturing cost(Product cost) Non-Manufacturing cost(Period cost)

Raw material Office and Administrative expenses:

Less: Closing Work-in-progress -----

In case of a trading organization, calculation of cost of goods manufactured is not required to be

Cost classification for Assigning costs to cost objects

Direct Cost and Indirect Cost

Classification of Cost on the basis of its behaviour

Elements of cost Expected amount Description

Batch Machine running hours Power consumption(₹)

For 100 machine hours,

Classification of cost from decision making point of view

Differential cost and Differential Revenue

Questions for practiceQ.No.1.The PC WORKS assembles custom computers from components

a. The cost of a hard drive installed in a computer.

Q.No.2. Classification of Costs as Period or Product cost

1. Depreciation on salespersons' cars.

2. Rent on equipment used in the factory.

Q.No.3. Classification of Costs as Fixed or Variable

Below are a number of costs that are incurred in a variety of organizations.

1. X-ray film used in the radiology lab at V Mason Hospital in Seattle

Cost Cost Object Direct Indirect

Q.No.5. Listed below are a number of costs typically found in organizations:

1. Tire costs incurred by For Motor Company.

Q.No.10. Orbital Communications, Inc. manufactures communications satellites used in TV signal

Raw material purchases ₹175,000

Beginning work-in-process inventory ₹2,000

Calculate the following costs:

1. Direct Materials inventory as on 31st August.

Machine XR1 XR50

A. Depreciation on salespersons’ car

A. Depreciation, executive autos

2. Conversion cost is the total of (0.5)

a. Material, Labour and Manufacturing overhead

3. Fixed cost is that cost which (0.5)

a. Changes with the volume

Cost Measure of Activity Cost

I. Salaries of personnel who work in the finished goods warehouse.

1. Manufacturing cost is the total of (0.5)

5. Classify the following costs of various organizations as Direct or Indirect costs

Job Order Costing

Process and Job-order Costing

Exhibit 2-2 A processing unit

Job-Order Costing- An Overview

Measuring direct Material Costs

Materials Requisition Number 1421 Date March 21

Application of Manufacturing Overhead

Overhead applied to a job = 𝑃𝑟𝑒𝑑𝑒𝑡𝑒𝑟𝑚𝑖𝑛𝑒𝑑 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑟𝑎𝑡𝑒 ×

Exhibit 2.3(A completed Job Cost Sheet)

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__________________ and _ 3

product during the period ________________________and the amount of under(_) or

out the overhead under-applied (_)or over-applied(_)