Cost Accounting परिव्यय लेखांकन

Quick summary

Overheads are all indirect costs – indirect material, indirect labour and indirect expenses. They cannot be traced to one product, so they are first collected by cost centres and then charged to products using a suitable rate. This topic covers classification of overheads, allocation and apportionment (primary distribution), re-apportionment of service departments (secondary distribution), absorption rates such as the machine hour rate, and under- or over-absorption.

Key points

• Overheads (उपरिव्यय) = indirect material + indirect labour + indirect expenses.
• Classified by function into factory (production), administration, selling and distribution overheads; by behaviour into fixed, variable and semi-variable.
• Allocation – charging a whole item to one cost centre (e.g. wages of a machine shop foreman to the machine shop).
• Apportionment – sharing a common item among cost centres on a fair basis.
• Common bases: rent and rates – floor area; power – horse power × machine hours; lighting – number of light points; supervision and canteen – number of workers; depreciation and insurance of machinery – value of machinery; insurance of stock – value of stock.
• Primary distribution – allocation and apportionment of all overheads to production and service departments.
• Secondary distribution – re-apportioning service department costs to production departments: direct redistribution, step method, repeated distribution or simultaneous equation method.
• Absorption – charging overheads to units of output using a rate: percentage of direct material, direct labour or prime cost; direct labour hour rate; machine hour rate; rate per unit.
• Under-absorption – overheads absorbed are less than actual; over-absorption – absorbed are more than actual.
• Treatment of under/over-absorption: write off to Costing P&L (if small or abnormal), use a supplementary rate, or carry forward (seasonal businesses).

Important terms

• Service department – helps production departments (stores, maintenance, power house).
• Machine hour rate – overhead cost of running a machine for one hour.
• Pre-determined rate – rate fixed in advance using budgeted overheads and budgeted base.
• Supplementary rate – rate used to correct the cost of jobs for under- or over-absorption.

Formats and formulas

• Pre-determined overhead rate = budgeted overheads ÷ budgeted base (hours, units).
• Machine hour rate = total overheads of the machine for a period ÷ machine hours in that period.
• Under(−)/over(+) absorption = overheads absorbed − actual overheads.

Worked problem: Production departments P1, P2 and service department S. Rent ₹12,000 (area 2:3:1), power ₹9,000 (H.P. 5:3:1), supervision ₹6,000 (workers 3:2:1). Allocated overheads: P1 ₹2,000, P2 ₹3,000, S ₹1,000. S is shared P1 60%, P2 40%.

If P1 works 3,400 machine hours, machine hour rate = 17,000 ÷ 3,400 = ₹5 per hour. If P2 works 4,000 labour hours, labour hour rate = 16,000 ÷ 4,000 = ₹4 per hour.

5 important questions

Q1. Distinguish between allocation and apportionment.

Allocation charges a whole overhead to one cost centre that alone caused it. Apportionment shares a common overhead among several cost centres on a suitable basis such as floor area.

Q2. What is under-absorption of overheads?

When overheads charged to production using the pre-determined rate are less than the actual overheads. Example: actual ₹52,000, absorbed 10,000 hours × ₹5 = ₹50,000 → under-absorbed ₹2,000.

Q3. Explain the bases of apportionment of overheads.

Outline a table of common items and their bases (rent – area, power – H.P./hours, lighting – points, canteen – workers, depreciation – value, stores – requisitions); principles: benefit, survey, efficiency, ability to pay.

Q4. Explain the methods of secondary distribution.

Outline direct redistribution, step (non-reciprocal) method, and reciprocal methods – repeated distribution and simultaneous equations – with a short example of each.

Q5. Explain the methods of absorption of overheads. Which method is best?

Outline percentage of material, labour, prime cost; labour hour rate; machine hour rate; unit rate; merits and demerits. Machine hour rate is best for machine-intensive departments; labour hour rate where work is mostly manual.

Exam tip

In primary distribution tables, write the basis in brackets next to each item and total each column. Cross-check that the total column equals the sum of the department columns.

Quick summary

Job costing is used where work is done to the customer's order and each order (job) is different, such as printing, furniture making or repair work. Contract costing is a form of job costing used for large, long jobs like buildings, roads and bridges, which usually run beyond one year. This topic covers the job cost sheet, the contract account, work certified and uncertified, retention money, and how much profit on an incomplete contract may be taken to Profit and Loss.

Key points

• Job costing (काम परिव्यय पद्धती) – costs are collected for each job separately using a job number and a job cost sheet.
• Steps: production order → recording material (requisitions), labour (job cards) and overheads (absorption rate) against the job → job completed → cost compared with price.
• Contract costing – each contract is a cost unit; a separate Contract Account is kept, and most costs are direct (even site expenses and plant depreciation).
• Plant used on site: either charge depreciation only, or debit the full cost and credit the written-down value at the end.
• Work certified – value of work approved by the architect/engineer; work uncertified – work done but not yet certified, valued at cost.
• Retention money – part of the certified amount kept back by the contractee (e.g. 20%) as security for defects.
• Notional profit = (work certified + work uncertified) − cost of work to date.
• Work certified below 25% of contract price – no profit is taken.
• 25% to below 50% – ⅓ × notional profit × cash received ÷ work certified.
• 50% or more – ⅔ × notional profit × cash received ÷ work certified.
• Nearly complete – estimated total profit × work certified ÷ contract price (or the cash-based variant).
• Profit on incomplete contracts (traditional rule taught in cost accounting):
• The rest of the notional profit is kept as a reserve. Any loss is fully written off at once.
• Financial accounts under AS-7 / Ind AS 115 recognise revenue by the percentage of completion or stage of completion; the fraction rules above are the cost-accounting convention.
• Escalation clause – allows the price to rise if material or labour costs rise. Cost-plus contract – price = cost + agreed % of profit.

Important terms

• Contractee – the customer who gives the contract.
• Sub-contract – part of the work given to another contractor; its cost is a direct cost.
• Extra work – work beyond the original contract; charged and paid extra.
• Work-in-progress – certified plus uncertified work, less the profit reserve.

Formats and formulas

Worked problem: Contract price ₹10,00,000. Materials sent ₹3,00,000; wages ₹2,00,000; plant sent ₹1,00,000 (depreciation 10%); overheads ₹30,000. Materials at site at year end ₹20,000. Work certified ₹6,00,000; work uncertified ₹40,000. Cash received = 75% of work certified.

Work certified = 6,00,000 ÷ 10,00,000 = 60% (more than 50%). Cash received = 75% × 6,00,000 = ₹4,50,000.
Profit to P&L = ⅔ × 1,20,000 × 4,50,000 ÷ 6,00,000 = 80,000 × 0.75 = ₹60,000. Reserve = 1,20,000 − 60,000 = ₹60,000.

5 important questions

Q1. What is retention money?

It is the part of the value of work certified that the contractee does not pay at once (e.g. 20%) and keeps as security against faulty work. It is paid after the contract is satisfactorily completed.

Q2. Distinguish between work certified and work uncertified.

Work certified is approved by the contractee's architect and valued at contract price. Work uncertified is done but not yet approved; it is valued at cost.

Q3. Explain the features of job costing and the job cost sheet.

Outline: industries using it; each job different and identifiable; job number; job cost sheet heads (materials, labour, overheads, total cost, price, profit); merits and limitations.

Q4. In the problem above, if work certified were only 40% (₹4,00,000) with notional profit ₹60,000 and cash 80% of certified, find the profit to be taken.

Work certified is 40% (between 25% and 50%). Cash received = ₹3,20,000. Profit = ⅓ × 60,000 × 3,20,000 ÷ 4,00,000 = 20,000 × 0.8 = ₹16,000.

Q5. Explain the main features of contract costing.

Outline: large jobs at site; contract as cost unit; mostly direct costs; plant treatment; progress payments and work certification; retention money; escalation and cost-plus clauses; profit on incomplete contracts; sub-contracts; WIP in the Balance Sheet.

Exam tip

Find the "% of completion" first and write which rule (⅓ or ⅔) applies before calculating; examiners look for this statement.

Quick summary

Process costing is used in industries where production passes through a series of continuous processes and all units are alike – sugar, paper, cement, chemicals, textiles, oil refining. The output of one process becomes the input of the next. This topic covers process accounts, normal loss, abnormal loss and abnormal gain, and the idea of equivalent production.

Key points

• Process costing (प्रक्रिया परिव्यय) – a method of costing where costs are collected for each process and the cost per unit is found by dividing by the output of that process.
• Features: continuous production, standard products, output of one process is the raw material of the next, losses at each stage, by-products and joint products are common.
• A Process Account is debited with materials, labour, direct expenses and overheads, and credited with normal loss (scrap value), abnormal loss and the output transferred to the next process.
• Normal loss – unavoidable loss expected under normal conditions (evaporation, chemical change). Its cost is borne by good units; only its scrap value is credited.
• Abnormal loss – loss above normal loss, due to carelessness, accidents or bad material. It is valued like good units and transferred to Abnormal Loss A/c, then to Costing P&L after crediting its scrap value.
• Abnormal gain – when actual loss is less than normal loss. It is valued like good units and debited in the process account; the scrap value given up is adjusted in Abnormal Gain A/c.
• Equivalent production – incomplete units (WIP) converted into an equal number of complete units, e.g. 100 units 50% complete = 50 equivalent units.
• Inter-process profit – when output is transferred at a price above cost (taught as an extension).
• By-products – low-value products produced along with the main product; joint products – two or more products of similar importance from the same input.

Important terms

• Scrap – residue with small sale value.
• Spoilage – goods damaged beyond repair.
• Equivalent units – units completed + completed portion of WIP.
• Process costing vs job costing – continuous and uniform vs specific and different.

Formats and formulas

• Cost per unit = (total cost − scrap value of normal loss) ÷ (input units − normal loss units).
• Abnormal loss units = normal output − actual output; abnormal gain units = actual output − normal output.

Worked problem: Process A: input 1,000 units at ₹20 = ₹20,000; labour ₹5,000; overheads ₹2,500. Normal loss 10% of input, sold as scrap at ₹5 per unit. Actual output 850 units.

Cost per unit = (27,500 − 500) ÷ (1,000 − 100) = 27,000 ÷ 900 = ₹30. Abnormal loss = 900 − 850 = 50 units.

Abnormal Loss A/c: debit ₹1,500; credit scrap sale 50 × ₹5 = ₹250 and Costing P&L ₹1,250.
If output had been 920 units: abnormal gain = 920 − 900 = 20 units × ₹30 = ₹600, debited in the process account.

5 important questions

Q1. What is normal loss? How is it treated?

Normal loss is the unavoidable loss expected in a process. Its cost is absorbed by the good units; the process account is credited only with its scrap value (if any).

Q2. Distinguish between abnormal loss and abnormal gain.

Abnormal loss is actual loss more than normal loss; it is credited to the process account at the cost of good units and its net cost goes to Costing P&L. Abnormal gain is actual loss less than normal; it is debited to the process account and the net gain goes to Costing P&L.

Q3. Explain the features of process costing and the industries where it is used.

Outline the features listed above; industries – sugar, cement, chemicals, paper, textile, soap, oil refining, food processing; merits and limitations.

Q4. Input 2,000 units @ ₹10, other costs ₹8,000, normal loss 5% (scrap ₹4), output 1,880 units. Find cost per unit and abnormal loss.

Total cost = 20,000 + 8,000 = ₹28,000. Normal loss = 100 units, scrap ₹400. Cost per unit = (28,000 − 400) ÷ 1,900 = 27,600 ÷ 1,900 = ₹14.53 (rounded). Abnormal loss = 1,900 − 1,880 = 20 units × 14.53 ≈ ₹291.

Q5. Distinguish between job costing and process costing.

Points: nature of production (orders vs continuous), cost unit (job vs process output), cost collection (job cost sheet vs process account), WIP (usually none vs common at each stage), control, transfers, uniformity of products, examples.

Exam tip

In every process problem, draw the units column on both sides and make the unit totals agree before you work out the money columns.

Quick summary

When a firm keeps cost accounts and financial accounts separately (non-integrated system), the profit shown by the two sets of books is usually different. A reconciliation statement explains the reasons for the difference and proves that both sets of accounts are arithmetically correct. This topic covers the need for reconciliation, the causes of difference and the method of preparing the statement.

Key points

• Reconciliation (समन्वय) – bringing the costing profit and the financial profit into agreement by listing every item that causes a difference.
• Need: to check the accuracy of both sets of accounts, find reasons for differences, improve cost control and give management confidence in cost data.
• Items shown only in financial accounts – purely financial charges (interest on loans, loss on sale of assets, discount on issue of shares, preliminary expenses written off, fines, donations, income tax) and purely financial incomes (interest and dividend received, rent received, profit on sale of assets, transfer fees).
• Items shown only in cost accounts – notional charges such as interest on own capital and notional rent of own premises.
• Under- or over-absorption of overheads – cost accounts use pre-determined rates; financial accounts use actual amounts.
• Different stock valuation – opening and closing stock valued differently in the two books.
• Different depreciation methods or rates.
• Abnormal losses and gains – sometimes kept out of cost accounts.
• Causes of difference:
• Rules (starting from costing profit): add items that increase financial profit; deduct items that reduce financial profit.
• Over-absorbed overhead in cost books → financial profit is higher → add. Under-absorbed → deduct.
• Closing stock valued higher in cost books → costing profit is higher → deduct. Opening stock valued higher in cost books → add.
• Instead of a statement, a Memorandum Reconciliation Account may be prepared.
• Under an integrated accounting system, one set of books is kept, so no reconciliation is needed.

Important terms

• Costing profit – profit shown by the Costing Profit and Loss Account.
• Financial profit – profit shown by the financial Profit and Loss Account.
• Notional cost – a cost not actually paid but charged in cost accounts to show the true cost (e.g. rent of own building).
• Integrated accounts – one system serving both cost and financial needs.

Formats and formulas

Worked problem: Costing profit ₹1,00,000. Factory overheads under-absorbed in cost accounts ₹6,000; office overheads over-absorbed ₹4,000; interest received ₹3,000 (not in cost books); preliminary expenses written off ₹5,000 and donation ₹2,000 (financial books only); closing stock: cost books ₹50,000, financial books ₹45,000; depreciation: cost books ₹12,000, financial books ₹10,000.

5 important questions

Q1. Why is reconciliation of cost and financial accounts necessary?

Because the two profits differ under a non-integrated system. Reconciliation checks the arithmetical accuracy of both books, explains the reasons for difference and makes cost data reliable for management.

Q2. Give two items that appear only in financial accounts.

Income tax paid and interest received on investments (also loss on sale of fixed assets, donations, preliminary expenses written off).

Q3. Explain the reasons for the difference between costing profit and financial profit.

Outline the six causes listed above with one example each and the effect (add or less) when starting from costing profit.

Q4. Starting with financial profit ₹80,000, adjust: interest on own capital charged in cost books ₹6,000; dividend received ₹4,000; opening stock under-valued in cost books by ₹3,000. Find costing profit.

Notional interest reduces costing profit → less 6,000. Dividend received is only in financial books → less 4,000. Opening stock lower in cost books makes costing profit higher → add 3,000. Costing profit = 80,000 − 6,000 − 4,000 + 3,000 = ₹73,000.

Q5. Prepare a reconciliation statement from given data and explain the method.

Steps: choose the starting profit; list each difference; decide its effect on the other profit; place under add or less; total; arrive at the other profit. Use the worked table above; alternatively prepare a Memorandum Reconciliation Account.

Exam tip

For each item, ask: "Does this make the profit I am going towards higher or lower?" Write that reasoning in one word beside the item while practising; it removes sign errors.