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Chapter 1

INTRODUCTION
A business is an activity carried out with the intention of earning the profits.
A person carrying out the business is interested in knowing basically two facts
about his business (a) What is the result of operations of the business activit
y? In other words, whether the business has resulted into the profit or loss? Ex
cess of revenue over the expenses will be in the form of profits whereas excess
of expenditure over the revenue will be in the form of loss. Where the business
stands in financial terms at any given point of time.
(b)
Providing the answers to the above questions is not possible unless the transact
ions relating to the business are recorded in a systematic manner. Here the proc
ess of accounting comes into the picture. According to American Institute of Cer
tified Public Accountants, Accounting is the art of recording, classifying and su
mmarizing in a significant manner and in terms of money, transactions and events
which are of a financial character and interpreting the results thereof. The pro
cess of recording the business transactions in a defined set of records, which i
n technical words are called as Books of Accounts, is referred to as Book Keepin
g. Accounting refers to the process of analyzing and interpreting the informatio
n already recorded in the books of accounts with the ultimate intention of answe
ring the above stated questions. This intention is satisfied by preparing what a
re called as Financial Statements. The financial statements prepared by the orga
nization are basically in two forms(a) Profitability Statement, which is the ans
wer to the first question i. e, what is the result of operations of the business
activity. Thus, profitability statement indicates the amount of profit earned o
r the amount of loss incurred. Balance Sheet, which is the answer to the second
question i.e. where the business stands in financial terms at any given point of
time. Thus, balance sheet indicates the financial status of the business at any
given point time in terms of its assets and liabilities.
(b)
Introduction
1

The nature of these financial statements is discussed in details in the followin


g pages. Thus, the process of book keeping is more procedural and clerical in na
ture while the process of accounting is more managerial in nature. As such, the
job of book keeping is entrusted to junior level employees, whereas the job of a
ccounting needs more professional expertise. STREAMS OF ACCOUNTING The process o
f Accounting gets split into three streams 1. 2. 3. Financial Accounting Cost Ac
counting Management Accounting
Let us discuss the nature of these three streams of accounting in details. Finan
cial Accounting Financial Accounting is the process .of systematic recording of
the business transactions in the various books of accounts maintained by the org
anization with the ultimate intention of preparing the financial statements ther
e from. These financial statements are basically in two forms. One, Profitabilit
y Statement which indicates the result of operations carried out by the organiza
tion during a given period of time and second Balance Sheet which indicates the
state of affairs of the organization at any given point of time in terms of its
assets and liabilities. This nature of Financial Accounting indicates following
characteristic features of Financial Accounting (a) Financial Accounting conside
rs those transactions which can be expressed in terms of money. All those transa
ctions which can not be expressed in terms of money, howsoever important they ma
y be from business point of view, find no place in financial accounting and henc
e in financial statements. E.g. Assuming that the business of an organization is
such that it is likely to be injurious to the health of local community. As suc
h, there is a strong opposition from the local community for the companys carryin
g on the business at that location. This opposition is something which can not b
e expressed in terms of money and hence finds no place in financial accounting a
nd hence in financial statements though, it is affecting the business operations
of the organization to a very great extent. Financial Accounting is referred to
as Historical form of accounting. In other words, financial accounting is conce
rned with recording of transactions which have already taken place. No futuristi
c transactions and events, howsoever important and significant they may be from
business point of view. find any place in financial accounting and hence in fina
ncial statements.
(b)
2
Management Accounting

(c)
In practical circumstances Financial Accounting is more or less a legal requirem
ent. In case of certain organizations like Company form of organization, Banks,
Insurance Companies etc., not only it is necessary to maintain the financial acc
ounting records and prepare the financial statements there from, but it is oblig
atory to get these financial statements audited also by an independent Chartered
Accountant. In some cases, there may not be direct legal requirement to prepare
the financial statements, but indirectly it is necessary to prepare the financi
al statements. E.g. If a partnership firm wants to file its Income Tax Return as
per the provisions of Income tax Act, 1961, preparation of financial statements
is a must to ascertain the profits. Financial Accounting is meant for those peo
ple who are external to the organization. In other words, financial accounting i
s basically meant for those people who are not a part of decision-making process
regarding the organization. This class of people may consist of the people like
investors, customers, suppliers, banks, financial institutions etc. The informa
tion available from Financial Accounting, i.e. financial statement, is available
at a delayed point of time. E.g. Balance Sheets as on 31st March 2002 is availa
ble after 31st March 2002 is over. The various legal provisions also allow suffi
cient time lag for the preparation of financial statements. For decision-making
purposes, immediate availability of financial data is a prerequisite which is no
t satisfied by financial accounting. In this sense, financial accounting has the
limitation. Further, as sufficient time is allowed for the preparation of finan
cial statements, they are expected to be accurate. Financial Accounting disclose
s the financial performance and financial status of the business as a whole. It
does not indicate the details about the individual department or job or process
inside the organization, the information which is more significant from decision
-making point of view. In this sense, financial accounting has the limitation. F
inancial statements are essentially interim reports and cannot be the final ones
. E.g. In order to understand the correct profitability and correct position of
the assets and liabilities of an organization, it will be necessary to stop the
business operations, dispose off all the assets of the organization and liquidat
e all the liabilities. Obviously it is not feasible and practicable. In order to
prepare the financial statements for a specific period, it may be necessary to
cut off various transactions involving costs and incomes at the date of closing
the accounts. This may involve personal judgements. Various policies and princip
les are required to be formulated and followed consistently for such cutting off
of incomes and costs. As the going concern principle is followed while preparing
the financial statements, the various assets and liabilities are shown at the hi
storical prices which may not necessarily represent the current market prices or
the liquidation prices. This may affect profitability
(d)
(e)
(f)
(g)
(h)
Introduction
3

also due to incorrect provision for depreciation on assets. This problem may be
more critical during the periods of extreme inflation or depression. (i) The pro
cess of Financial Accounting gets largely affected due to the various accounting
policies followed by the accountants. Even though, attempts are being made to b
ring in the uniformity in the various accounting policies followed by the accoun
tants, still the accounting policies may differ from organization to organizatio
n. These accounting policies may differ basically in two fields :
l l
Valuation of Inventory Calculation of Depreciation
The effect of these different accounting polices is discussed in the following c
hapters. Cost Accounting Cost accounting is the process of classifying and recor
ding of the expenditure in a systematic manner with the intention of ascertainin
g the cost of a cost centre with the intention of controlling the cost. The Inst
itute of Cost and Management Accountants, London has defined Cost Accounting as t
he application of costing and cost accounting principles, methods and techniques
to the science, art and practice of cost control and the ascertainment of profi
tability as well as the presentation of information for the purpose of manageria
l decision making. The above description of Cost Accounting reveals the following
characteristic features of Cost Accounting (a) Cost Accounting views the organi
zation from the angle of individual components of the organization like departme
nt or job or process etc. Cost Accounting is interested in ascertaining the prof
itability of these individual components of the organization. Cost Accounting is
operated with basically three objectives l
(b)
Ascertainment of cost and profitability with the help of various principles, met
hods and techniques. Cost Control - This indicates the process of controlling th
e costs of operating the business. Presentation of information to enable the man
agerial decision-making.
l
l
(c)
Cost Accounting is meant for those people who are internal to the organization.
In other words, Cost Accounting is meant for those people who are a part of deci
sion-making process of the organization. The people who are external to the orga
nization do not have any access to the cost accounting records. In fact the basi
c objective of cost accounting is to facilitate professional decision-making pro
cess on the part of managers.
4
Management Accounting

(d)
Cost Accounting is not a legal requirement. Maintenance of cost accounting recor
ds is not mandatory. However, maintenance of cost accounting records may be a le
gal requirement in some exceptional cases. Section 209 (1) (d) if the Companies
Act, 1956, makes it mandatory for companies falling under certain class of indus
tries to maintain cost accounting records and also get them audited from an inde
pendent Cost Accountant (which is technically referred to as Cost Audit). Cost Acc
ounting does not necessarily restrict itself to the historical transactions or h
istorical events. Future transactions or events may find the place in cost accou
nting. In fact, each and every transaction, whether past or future, which is lik
ely to have an impact on the business is of concern to the cost accounting. As C
ost Accounting is supposed to facilitate professional decision making on the par
t of manager, immediate availability of data is the prerequisite of cost account
ing. As such, accuracy is not insisted upon by cost accounting to the extent of
hundred percent.
(e)
(f)
Management Accounting Management Accounting is the process of analysis and inter
pretation of financial data collected with the help of financial accounting and
cost accounting with the ultimate intention to draw certain conclusions therefro
m in order to assist the management in the process of decisionmaking. Emergence
of Management Accounting In the olden days, when size of business operations was
small and the complexities involved in the same were limited, financial account
ing was considered to be sufficient. Financial Accounting ultimately aims at pre
paring financial statements which are basically in two forms. (1) Profit and Los
s statement which is a period statement and relates to a certain period, usually
one year. This tells about the result of operations, either profit or loss, ari
sing out of the conduct of business operations during that period. Balance Sheet
which is a position statement and relates to a particular point of time. This t
ells about the various properties held by the business (termed as assets) and obli
gations accepted by the business (termed as liabilities) as on a particular date.
(2)
The preparation of these financial statements was considered to be sufficient to
serve the requirements of all the interested parties, both outsiders as well as
insiders. However, due to the increasing size and complexities of the business
operations and specifically due to the segregation of ownership and management,
only financial accounting was realised to be insufficient. This was specifically
due to certain limitations of financial accounting.
Introduction
5

(a)
Financial accounting considers only those transactions which may be expressed in
financial terms, either fully or at least partially. However, it ignores the fa
ct that there may be other types of non-financial transactions which may have a
bearing on business operations, e.g.. Prestige of business, credit standing of b
usiness, efficiency and loyalty of employees, efficiency and intensity of manage
ment etc. Financial accounting deals with recording of the past events and as su
ch it is the postmortem record of business transactions. For taking correct deci
sions regarding the business, the management may need, not only the past details
but also the future events, and future events are not the subject matter of fin
ancial accounting.
(b)
As such, financial accounting and preparation of financial statements therefrom
is no longer considered to be sufficient for successful and smooth running of bu
siness. The analysis and interpretation of data available from financial account
ing is also considered to be necessary which may not be directly available from
financial accounting itself. Here comes into the picture Management Accounting.
Management Accounting deals with, the analysis and interpretation of financial d
ata with the ultimate intention to draw certain conclusions therefrom, in order
to assist the management in the process of decision-making. To conclude, it may
be said that the role of management accounting has emerged due to the shortcomin
gs of financial accounting. Definition of Management Accounting The Institute of
Chartered Accountants of England and Wales has defined management accounting as
any from of accounting which enables a business to be conducted more efficiently.
Management Accounting Team of Anglo-American Council on Productivity has descri
bed the term Management Accounting as the presentation of accounting information
in such a way so as to assist management in the creation of policy and the day t
o day operation of an undertaking. American Accounting Association has defined th
e term Management Accounting as the application of appropriate techniques and conc
epts in processing historical and projected economic data of an entity to assist
management in establishing plans for reasonable economic objectives and in the
making of rational decisions with a view towards these objectives. The various de
finitions of the term Management Accounting reveal the following features of the s
ame. (1) Management Accounting is a service function which is concerned with pro
viding various information to the management to facilitate decision making and r
eview of implementation of those decisions.
6
Management Accounting

(2)
Management Accounting uses not only the historical data but may also use the dat
a based on projections and forecasts for the purpose of evaluation of various po
ssible alternatives. Management Accounting assists the management in establishin
g the plans to attain the economic objectives and in taking proper decisions req
uired to be taken for the attainment of these objectives. Management Accounting
involves the application of various special techniques and concepts for the atta
inment of its objects. The techniques used in the process of management accounti
ng are discussed in the following chapters.
(3)
(4)
Objects of Management Accounting The above discussions reveal that the Managemen
t Accountant is an invaluable aid to the management to discharge the basic funct
ions of planning, execution and control. This is done by (1) (2) Making availabl
e accounting and other data to enable the management to plan effectively. Measur
ing the actual performance and reporting the same to the various levels of manag
ement to indicate the effectiveness of the organisational methods used. Computat
ion of deviation of actual performance from the plans and standards set. Present
ing to the management the operating and financial statements at reasonable inter
vals and interpreting the same to enable the management to take action/decisions
regarding future policy and operations.
(3) (4)
Scope of Management Accounting After considering the various objectives the Mana
gement Accounting aims at, it can be noted that the scope of Management Accounti
ng is much wider. It covers virtually every area and every aspect of business op
erations. However, to be more precise, the various areas covered by Management A
ccounting can be stated as below. (1) Accounting : It deals with recording, summ
arising and analysing various business transactions. The process of accounting m
ay take basically two forms. (a) Financial Accounting : It deals with recording
the business transaction which are financial in nature. It aims at the preparati
on of what is called financial statements which may be basically in two forms. F
irstly, the Balance Sheet which tells about the state of affairs of the business
in terms of the various assets and liabilities and Secondly, the profitability
statement which tells about the result of operations of
Introduction
7

the business i.e. profit earned or loss incurred. The financial statements are m
ainly meant for the outsiders dealing with the business. (b) Cost Accounting : I
t deals with recording of income and expenditure, ascertainment of cost and prof
itability and the presentation of information derived therefrom for the purpose
of managerial decision making. Thus, the cost accounting is basically meant for
the management to enable it to take decisions.
(2)
Cost Control Procedures : It deals with the various steps involved in the proces
s of controlling the cost. Thus, in turn it may deal with. (a) (b) (c) Establish
ment of plans or budgets for the future. Comparison of actual performance with t
he planned or budgeted performance. Computation of variations between the planne
d and actual performance.
(3)
Reporting : It deals with the presentation of cost data, statistical data or any
other information to the various levels of management. It may be required for t
he purpose of decision making or for the purpose of fulfillment of various legal
obligations. Taxation : It deals with the computation of income as per the law
and filing the tax returns and making the tax payments. Audit : It deals with de
vising the internal control systems and internal audit system to cover the vario
us operational areas of business. In many cases, it may also deal with the manag
ement audit which is the evaluation of the managerial performance. Methods and S
ervices : It deals with providing the management services and the management inf
ormation systems. It also deals with the various methods of reducing the cost an
d improve efficiency of accounting and other office operations and preparing and
issuing the accounting and other operational manuals.
(4)
(5)
(6)
Disadvantages/Limitations of Management Accounting In spite of the various advan
tages available from the management accounting in the era of ever increasing com
plex business operations, it suffers from some limitations, (1) A very wide scop
e of management accounting is the limitation by itself. It attempts to operate i
n a wide range of areas and it is quite possible that it may not be able to make
proper justification to all of them. In spite of the fact that the management a
ccounting provides the various details required for qualitative decision making
thus attempting to avoid the possibility of intuitive decision making, in many c
ases in practice, the decisions are based upon the intuition of the decision mak
er rather than the scientific data available therefor.
(2)
8
Management Accounting

(3)
The installation and operation of management accounting requires a very elaborat
e organisational structure and a large number of rules and regulations. It may m
ake the management accounting system a costly proposition which can be implement
ed only by large scale organisations. Management Accounting system is still in t
he evolution stage and hence suffers from the various limitations which any syst
em may face in the initial stages like the requirement of constant improvements
of the techniques and uncertainty about the application of the system etc. The i
nstallation and operation of management accounting system may call for the radic
al changes in the entire organisational structure which may cause severe opposit
ion and resistance from the existing personnel.
(4)
(5)
FINANCIAL ACCOUNTING AND COST ACCOUNTING COMPARED (a) Financial Accounting is co
ncerned about the calculation of the profitability and state of affairs of the o
rganization as a whole with the help of preparation of the financial statements.
Financial Accounting takes into consideration only the historical data which ma
y not be of any use from the cost control point of view. Cost Accounting may dea
l with the ascertainment of cost and calculation of profitability of the individ
ual products, departments, branches and so on. Cost Accounting involves a much-d
etailed study of costs and profitability which takes into consideration not only
historical data but also the future events and possibilities. As such, cost acc
ounting proves to be better proposition from the cost control point of view. (b)
Due to the various statutory regulations, maintenance of financial accounting r
ecords and preparation of financial statements therefrom is more or less a legal
requirement. Maintenance of cost accounting records is not a legal requirement
except in case of certain company form of organizations where maintenance of cos
t accounting records has been made compulsory as per the provisions of Section 2
09 (1) (d) of the Companies Act, 1956. (c) Financial Accounting primarily protec
ts the interests of the outsiders dealing with the organization in various capac
ities like investors, suppliers, customers, banks, financial institutions, gover
nment authority etc. Cost Accounting is primarily meant for the management to en
able the same to discharge various functions in a proper manner i.e. planning, e
xecution, co-ordination and decisionmaking.
Introduction
9

This relationship between Cost Accounting and Financial Accounting can be better
explained with the help of the following illustration which states the presenta
tion of the profitability statement under both the sets accounting. (a) Financia
l Accounting Profit and Loss Account for the year ended on 31st march 1990. To,
Material Cost To, Labour Cost To, Factory Expenses To, Gross Profit c/fd (40% of
sales) 2,00,000 5,00,000 To, Administration Expenses To, Selling Expenses To, N
et Profit (12% of sales) 90,000 50,000 60,000 2,00,000 (b) Cost Accounting Produ
cts Total Material Cost Labour Cost PRIME Cost Factory Expenses FACTORY Cost Adm
inistration Expenses Selling Expenses TOTAL COST Profit SALES Profit % on sales
1,50,000 1,00,000 2,50,000 50,000 3,00,000 90,000 50,000 4,40,000 60,000 5,00,00
0 12% A 20,000 15,000 35,000 20,000 55,000 40,000 15,000 1,10,000 (-) 10,000 1,0
0,000 B 50,000 30,000 80,000 10,000 90,000 20,000 20,000 1,30,000 20,000 1,50,00
0 13.33% C 80,000 55,000 1,35,000 20,000 1,55,000 30,000 15,000 2,00,000 50,000
2,50,000 20% 2,00,000 By Gross Profit C/f 2,00,000 5,00,000 1,50,000 1,00,000 50
,000 By sales 5,00,000
10
Management Accounting

Financial Accounting and Management Accounting compared (a) For the purpose of e
xtracting the data required for managerial decision-making, Management Accountin
g may use the information appearing in the financial statements. This informatio
n may be used as it is or it can be rearranged or regrouped if required. As such
, financial accounting becomes a source of information for management accounting
. Financial Accounting considers only the historical financial transactions and
does not consider the non-financial transactions. As Management Accounting aims
at enabling the management to take the decisions about the future, it may consid
er future data as well as non-financial factors. (c) As stated earlier, due to t
he various statutory regulations, maintenance of financial accounting records an
d preparation of financial statements therefrom is more or less a legal requirem
ent. Moreover, the format in which the financial statements are required to be p
repared is also standardized. Management Accounting is not at all a legal requir
ement. Management is free to install or not to install a management accounting s
ystem. Further, these systems have their own reporting formats. (d) As stated ea
rlier, financial accounting primarily protects the interests of the outsiders de
aling with organization in various capacities like investors, suppliers, custome
rs, banks, financial institutions, government authorities etc. The reports gener
ated by management accounting are meant for the use by management for effective
decision-making. (e) As stated earlier, the financial statements which are gener
ated as a result of financial accounting, report the financial performance of th
e organization as a whole. Reports generated by the management accounting may de
al with the various parts of the organization. As such, management accounting re
ports may deal with the individual department or the individual product also. (f
) The reports generated by financial accounting which are in the form of financi
al statements are available only after the relevant accounting period is over. E
.g. Balance Sheet as on 31st March 2002 is available after 31st March 2002. As s
uch, financial accounting data may not be available to the management for decisi
on-making purposes. Moreover, as the financial accounting data is available afte
r a time lag, the financial statements are required to be accurate.
(b)
Introduction
11

In case of management accounting, more emphasis is on making the data available


to the management as quickly as possible to facilitate the effective decision-ma
king. If upto-date information is not made available to the management for decis
ion-making, management accounting will loose its utility. As such, accuracy is n
ot the prerequisite of management accounting. Cost Accounting and Management Acc
ounting compared Cost Accounting and Management Accounting are similar to each o
ther in many respects. Both the streams of accounting primarily aim at the effec
tive decision making on the part of management. Both the streams of accounting a
re on and average not a legal requirement. The various techniques which are used
by management accounting viz. Marginal Costing, Budgetary Control, Standard Cos
ting, Uniform Costing etc. are basically regarded as the advanced methods of Cos
t Accounting. As such Cost Accounting may be considered to be a part of Manageme
nt Accounting. Management Accounting is an extension of managerial aspects of co
st accounting with the ultimate intention to protect the interests of the busine
ss. Techniques of Management Accounting There may be various techniques with the
help of which the basic functions of management accounting can be discharged. W
e will discuss the following techniques in details in the following chaptersl l
l l
Marginal Costing (Break Even Analysis) Budgetary Control Standard Costing Unifor
m Costing
12
Management Accounting

QUESTIONS 1. Explain the nature and characteristic features of Financial Account


ing and Cost Accounting. How are they related to each other? What do you mean by
Management Accounting? State the advantages and limitations of Management Accou
nting. How Management Accounting is related with other streams of accounting?
2.
Introduction
13

NOTES
14
Management Accounting

Chapter 2
BASICS OF FINANCIAL ACCOUNTING
As stated earlier, financial accounting is the process of recording the past fin
ancial business transactions and calculating the net result of these transaction
s, with the intention to communicate the same to the various persons dealing wit
h the business in the external capacity. However, financial accounting is the te
chnical process. Before we consider the technicalities of financial accounting,
let us consider some of the fundamental issues relating to the financial account
ing. ACCOUNTING PRINCIPLES In order to bring the uniformity in recording the bus
iness transactions, the accountants follow certain basic procedures universally.
These are referred to as the Accounting Principles. The Accounting Principles c
an be classified in two categories a. b. Accounting Concepts Accounting Conventi
ons
Accounting Concepts Accounting Concepts indicate those basic assumptions upon wh
ich the basic process of accounting is based. Following are the important Accoun
ting Concepts : Business Entity Concept This accounting concept proposes that th
e business is assumed to be a distinct entity than the person who owns the busin
ess. The accounting process is carried out for the business and not for the pers
on who owns the business. E.g. If there is a partnership concern carrying on the
business in the name of M/s. XYZ & Co., where Mr. A and Mr. B are the equal par
tners, M/s. XYZ & Co. is supposed to be a separate entity from Mr. A and Mr. B.
The financial statements prepared on the basis of accounting records are of M/s.
XYZ & Co. and not of Mr. A or Mr. B individually. It should be noted in this co
nnection that the business entity concept has nothing to do with the legal entit
y of the business. It applies to both corporate organization
Basics of Financial Accounting
15

(which by itself is a separate legal entity from the owners) as well as non-corp
orate organization (which is not a legal entity separate from the owners). Dual
Aspect Concept This concept proposes that every business transaction has two asp
ects. However, basic relationship between assets and liabilities i.e. assets are
equal to liabilities, remains the same. E.g. If Mr. A starts the business by in
troducing the capital of Rs. 50,000, the assets and liabilities structure will b
e as below Liabilities Capital Assets Cash
50,000
50,000
Now, if Mr. A uses the cash to purchase the material worth Rs. 40,000, the asset
s and liabilities structure will change as below Liabilities Capital Assets Cash
Stock in Trade
50,000
10,000 40,000 50,000
50,000
If Mr. A sells the above material worth Rs. 40,000 for Rs. 45,000 on credit basi
s, the assets and liabilities structure will change as below Liabilities Capital
Assets Cash Receivables
55,000
10,000 45,000 55,000
55,000 Going Concern Concept
This concept proposes that the business organization is going to be in existence
for an indefinitely longer period of time and is not likely to close down the b
usiness in the shorter period of time. This affects the valuation of assets and
liabilities. As such, the assets are disclosed in the Balance Sheet at cost less
depreciation and not at the current market price. If the assets are to be discl
osed in the Balance Sheet at correct value, the current market price will be mos
t suitable. However, as the business is likely to exist for an indefinitely long
er period of time and as the assets are not likely to be sold off in the market
in the near future, the market price becomes immaterial. Accounting Period Conce
pt Even if the Going Concern Concept proposes that the business is going to be i
n existence for an indefinitely longer period of time, in order to facilitate th
e preparation of financial statements on periodical basis, the indefinitely long
er life span on the business is divided into shorter time 16
Management Accounting

segments, each one being in the form of Accounting Period. Profitability is comp
uted for this accounting period (by preparing the profitability statement) and t
he finanial position is assesseed at the end of this accounting period (by prepa
ring the balance sheet). It should be noted that the selection of accounting per
iod may depend upon the various factors like characteristics of the business org
anization, tax considerations, statutory requirements etc. Cost Concept This con
cept proposes that the assets acquired by the organization are recorded at their
cost of acquisition and this cost is considered for all the subsequent accounti
ng purposes say charging of depreciation. This concept does not take into consid
eration current market prices of the various assets. Money Measurement Concept T
his concept proposes that only those transactions and facts find the place in ac
counting which can be expressed in terms of money. As such, all those transactio
ns and facts which can not be expressed in terms of money (E.g. Morale and motiv
ation of the workers, credibility of the business organization in the market etc
.) do not find any place in accounting and that is why in financial statements,
though they may be having direct or indirect bearing on the business. This conce
pt imposes severe restrictions on the kind of information available from the fin
ancial statements. In fact, this is one of the major drawbacks of financial acco
unting and financial statements. Matching Concept This concept proposes that whi
le calculating profit for the accounting period in a correct manner, the expense
s and costs incurred during the period, whether paid or not, should be matched w
ith the revenues generated during the period. E.g. If the accounting period ends
on 31st March, the salaries for the month of March should be considered as cost
for the year ending on 31st March, even if they are actually paid for in the mo
nth of April. Otherwise, calculation of the profits for the year ending on 31st
March will go wrong as the income will be for 12 months while the expenses will
be for 11 months only. Accounting Conventions Accounting Conventions indicate th
ose customs and traditions that are followed by the accountants while preparing
the financial statements. Following are the important Accounting Conventions. Co
nvention of Conservation This convention is usually expressed as anticipate all t
he future losses and expenses, however do not consider the future incomes and pr
ofits unless they are actually realized. This convention generally applies to the
valuation of current assets and as such, the current assets are valued
Basics of Financial Accounting
17

at cost or market price whichever is lower. The valuation of non-curret assets i


s done at cost (as per the cost concept). Convention of Materiality This convent
ion proposes that, while accounting for the various transactions, only those tra
nsactions will be considered which have material impact on profitability or fina
ncial status of the organization and other insignificant transactions will be ig
nored. E.g. If the organization purchases some postal stamps, some of which rema
in unused at the end of the accounting period. According to matching concept, th
e cost of such non-used postal stamps should not be considered as the item of co
st. However as its impact on the overall profitability is likely to be negligibl
e, the cost of non-used postal stamps may be ignored treating the cost of purcha
ses as the expenditure. Which transactions should be treated as material ones is
a subjective concept and depends upon the judgment and knowledge of the account
ant. Convention of Consistency This convention proposes that the accounting poli
ces and procedures should be followed consistently on period-to-period basis so
as to facilitiate the comparison of finanacial statements on period-to-period ba
sis. If there is any change in the accounting policies and procedures, this fact
coupled with its effect on profitabity should be disclosed explicitly while pre
paring the financial statements. SYSTEMS OF ACCOUNTING a. Cash System of Account
ing In this system of accounting, expenses are considered to be the expenses onl
y when they are paid for and the incomes are considered to be incomes only when
they are actually received. This system of accounting is mainly used by the orga
nizations established not for earning the profits. This system of accounting is
considered to be defective in nature, as it may not represent the true picture o
f the profitability as well as of the state of affairs. b. Mercantile or Accrual
System of Accounting In this system of accounting, expenses are considered as e
xpenses during the period to which they pertain. Similarly, incomes are consider
ed to be incomes during the period to which they pertain. When the expenses are
actually paid for or when the incomes are actually received is not significant i
n case of Mercantile or Accrual system of accounting. This system of accounting
is considered to be more ideal, generally preferred by the accountants. However,
as the time of physical receipt of cash is immaterial in this system of account
ing, Accrual System of Accounting may result into the unrealized profits being
18
Management Accounting

reflected in the books of accounts on which the organization may be required to


pay the taxes also. It will not be out of place to mention here that, as per the
provisions of Section 209 of the Companies Act, 1956, all the company form of o
rganizations are legally required to follow Mercantile or Accrual system of acco
unting. Other organizations have a choice to select either of the systems of acc
ounting. TYPES OF EXPENDITURE For the purpose of accounting, the amount of money
that is paid for is classified in three ways a. Capital Expenditure Capital Exp
enditure indicates the amount of funds paid for acquiring the infrastructural pr
operties required for doing the business that are technically referred to as Fix
ed Assets. Fixed Assets do not give the returns during the same period during wh
ich they are paid for. As such, benefits available from capital expenditure are
long-term benefits. Hence, it will be wrong to consider the capital expenditure
as expenses while calculating the profitability during a certain period. In tech
nical words, capital expenditure never affects the Profitability Statement, exce
pt in case of Depreciation, which in simple words indicates that part of capital
expenditure returns equivalent to which are received during the corresponding p
eriod. b. Revenue Expenditure Revenue Expenditure indicates the amount of funds
paid during a certain period with the intention to receive the return during the
same period. As such, the benefits available from revenue expenditure are recei
ved during the same period during which they are paid for. The entire amount of
revenue expenditure affects the Profitability Statement. c. Deferred Revenue Exp
enditure Deferred Revenue Expenditure indicates the amount of funds paid which d
oes not result into the acquisition of any fixed asset. However, at the same tim
e benefits from this expenditure are not received during the same period during
which they are paid for. The examples of Deferred Revenue Expenditure are a. b.
c. Initial Advertisement Expenditure Research and Development Expenditure In cas
e of company form of organization, Preliminary Expenses or Company Formation Exp
enses. 19
Basics of Financial Accounting

Principally, Deferred Revenue Expenditure is not transferred to Profitability St


atement during the period during which they are paid for. As such, deferred reve
nue expenditure does not affect the profitability of the period during which it
is paid for. It is transferred to Profitability Statement (in technical words wri
tten off to Profitability Statement) over the period over which benefits are rece
ived, by passing the adjustment entry. As such, deferred revenue expenditure aff
ects the profitability only when they are written off to Profitability Statement
. Till they are written off to Profitability Statement, they are shown on the As
set side of Balance Sheet. GLOSSARY OF TERMS USED IN FINANCIAL ACCOUNTING 1. Acc
ount Account is the record of all the transactions pertaining to a person, asset
, liability, income or expenditure which have taken place during a specified per
iod and shows the net effect of all these transactions finally. Debit Side Debit
Side of the account is left hand side of the account. Credit Side Credit Side o
f the account is right hand side of the account. Voucher Voucher is any document
ary evidence to justify that a particular transaction has taken place. The vouch
er can be internal voucher or external voucher. Entry Entry means the record of
a financial transaction in the books of accounts. To debit To debit an account m
eans to make the entry on debit side of the account. To credit To credit an acco
unt means to make the entry on credit side of the account. Journal Journal is th
e Book of Original Entry or the Book of Prime Entry where the financial transact
ions are recorded in the chronological order as and when they take place. Ledger
Ledger is the book where the transactions of the similar nature are pooled toge
ther under one Ledger Account. Ledger or General Ledger as it is referred to in
practical circumstances, maintains all types of accounts i.e. Personal, Real and
Nominal. Whichever transactions are recorded in the Journal or Subsidiary Books
in chronological order, the same transactions are posted in the Ledger, account
wise.
2. 3. 4.
5. 6. 7. 8.
9.
10. Narration Narration is the summarized explanation or description of the fina
ncial transaction recorded in the books of accounts. 11. Casting Casting refers
to totalling of the books of accounts.
12. Posting Posting refers to the process of transferring the transaction entere
d into the book or original entry or subsidiary book to the ledger account.
20
Management Accounting

13. Folio Folio refers to the page number of the book of original entry or the l
edger. 14. Brought Forward When the balances in the ledger account or cash/bank
book of the previous year or previous period are entered in the current years boo
ks of accounts, the balances are said to be Brought Forward. 15. Carried Forward
When the balances in the ledger account or cash/bank book of the current year o
r current period are to be transferred to the next years books of accounts, the b
alances are said to be Carried Forward. 16. Assets All the properties owned by t
he business are collectively referred to as the assets of the business. 17. Liab
ilities All the amounts owed by the business to various providers of funds or se
rvices are collectively referred to as liabilities. 18. Capital Capital indicate
s the amount of funds invested by the owner of the business in the business. 19.
Drawings Drawings indicates the amount of funds or goods withdrawn by the owner
of the business for the personal use. 20. Debtor A Debtor is a customer who owe
s the money to the business for the goods or services supplied to him on credit
basis. 21. Creditor A Creditor is a supplier to whom the business owes the money
for the goods or services bought from him on credit basis. 22. Debit Note Debit
Note is an intimation sent to a person dealing with the business that his accou
nt is being debited for the purpose indicated therein. 23. Credit Note Credit No
te is an intimation sent to a person dealing with the business that his account
is being credited for the purpose indicated therein. 24. Trade Discount Trade Di
scount is the discount received on purchases or discount allowed on sales which
is an adjustment with the basic purchase or sales price. Trade discount is not a
ccounted for in the books of accounts. Purchase value or sales value is accounte
d for net of trade discount. 25. Cash Discount Cash discount is the discount rec
eived from the suppliers or allowed to customers for making the early payment of
dues. Cash discount is accounted for in the books of accounts. Cash discount re
ceived from the suppliers is revenue income and cash discount allowed to the cus
tomers is revenue expenditure.
Basics of Financial Accounting
21

26. Balance Sheet Balance Sheet is the summarized statement of what the business
owns i.e. assets and what the business owes i.e. liabilities at any given point
of time. 27. Bills Payable Bills Payable indicates the amount payable to the su
ppliers for which the negotiable instrument in the form of Bill of Exchange is g
iven to the suppliers. 28. Bills Receivable Bills Receivable indicates the amoun
t receivable from the customers for which the negotiable instrument in the form
of Bill of Exchange is received from the customer. 29. Depreciation The term Dep
reciation applies to fixed assets like Land, Buildings, Machinery, Furniture, Ve
hicles etc. The term indicates reduction in the value of fixed assets which can
arise either due to time factor or use factor or both. A detailed note on Deprec
iation Accounting is enclosed in the Annexure. DOUBLE ENTRY SYSTEM OF ACCOUNTING
The basic presumption made by the Double Entry System of Accounting is that eve
ry business transaction has two elements i.e. when the business receives somethi
ng, it has to pay something. Eg. If the business pays the telephone bill in cash
, it gets the benefit of using the telephone, but at the same time cash goes out
. Similarly, if goods are sold to the customer for cash, goods of the business g
o out, but it receives the corresponding amount of cash. Accordingly, if Double
Entry System of Accounting is followed, every business transaction affects two a
ccounts. One account is debited, while another account is credited by the simila
r amount. Thus, Double Entry System of Accounting follows the principle of every
debit has a corresponding credit and hence, total of all debits has to be equal t
o the total of all credits. Double Entry System of Accounting proves to be advan
tageous due to certain reasons a. b. It takes into consideration both the aspect
s of each business transaction. Arithmetical accuracy of the accounting records
can be verified by preparing the Trial Balance. c. The correct result of operati
ons can be ascertained by preparing the final accounts periodically. Correct val
uation of assets and liabilities is possible at any given point of time by prepa
ring the Balance Sheet.
d.
TYPES OF ACCOUNTS The various accounts for the purpose of Financial Accounting g
et classified under the following categories
22
Management Accounting

1.
Personal Accounts - These are the accounts of persons with whom the organization
deals in various capacities. In practical circumstances, personal accounts may
consist of the following types of accounts Accounts of the suppliers Accounts of
the customers Bank / Financial Institutions Capital Account
2.
Real Accounts These are the accounts of assets and liabilities. In practical cir
cumstances, real accounts may consist of the following types of accounts Land Ac
count Building Account Machinery Account Furniture Account Vehicles Account
Real Accounts may also consist of the accounts of some intangible assets like 3.
Goodwill Account Patents and Trade Marks Account

Nominal Accounts These are the accounts of incomes or expenses. In practical cir
cumstances, nominal accounts may consist of following types of accounts Salar
ccount Wages Account Printing & Stationary Account Insurance Account Telephone E
xpenses Account Interest paid or Received Account Commission paid or Received Ac
count
RULES OF DOUBLE ENTRY BOOK KEEPING While entering into various financial transac
tions in the records maintained by the organization, following basic rules for a
ccounting are followed a. b. c. In case of Personal Accounts Debit the Receiver,
Credit the Giver In case of Real Accounts Debit What Comes in, Credit What Goes
out In case of Nominal Accounts Debit all the expenses, Credit all the incomes
Basics of Financial Accounting
23

ANNEXURE Depreciation Accounting Depreciation can be defined as a permanent, con


tinuous and gradual reduction in the book value of a fixed asset. Normally, all
the fixed assets except land, depreciate in value rendering the asset useless af
ter the end of certain specific period. Following may be stated as the main caus
es of depreciation. (1) Use factor : The fixed assets depreciate because they ar
e used for the purpose they are meant for. It is applicable in case of tangible
assets like machinery, furniture, office equipments etc. Time factor : The fixed
assets depreciate due to the passage of time. Obsolescence : It is the reductio
n in the value of fixed assets, say a machine, due to its supersession at a date
before it is completely worn out. It may take place due to new inventions, modi
fications or improvements.
(2) (3)
Need for Depreciation Accounting : According to the nature of fixed assets, thes
e are those assets which may be used for the business purposes over a certain nu
mber of future accounting periods and the benefit received from them is spread o
ver the said number of future accounting periods. According to the matching prin
ciple of accounting, the costs incurred during an accounting period are required
to be matched with the benefits or revenues earned daring that period. Hence, i
t is necessary to distribute the cost of a fixed asset, less the scrap or salvag
e or realisable value, after the useful life of the fixed asset is over, in such
a way so as to allocate it as equitably as possible to the periods during which
the benefits are received from the use of fixed assets. This system or procedur
e is called depreciation accounting. Thus the depreciation accounting is necessa
ry for two main purposes. (a) To ascertain due profits by correctly matching the
various costs and expenses incurred with various incomes and revenues earned du
ring various accounting periods. To represent the value of a fixed asset on the
Balance Sheet at its unexpired cost i.e. at book value less depreciation. If dep
reciation is not provided, the asset may appear in the Balance Sheet at an overs
tated amount.
(b)
It may also be noted in this connection that the depreciation forms a part of co
st for arriving at the profits which can be distributed to the owners of the bus
iness in the form of dividend. By providing the depreciation, the amount of dist
ributable profits is reduced and retained in the business, which can be utilized
for the replacement of the asset at the end of its economic life. 24
Management Accounting

Methods for Calculating Depreciation : There may be various methods available fo


r calculating the amount of depreciation to be charged to Profit and Loss Accoun
t. Amount of depreciation is a function of various factors. (1) Time, (2) Usage,
(3) Time and Usage, (4) Time and Cost of maintaining the fixed asset, (5) Provi
sion of funds for replacing the assets. As such the various methods available fo
r charging the depreciation can be described as below. (1) Straight Line Method
:
According to this method, the amount of yearly depreciation is calculated as bel
ow. Cost of asset - Estimated scrap value Estimated life in years Eg. C = Cost o
f Asset. Estimated scrap value (At the end of life of the asset) Estimated life
Rs. 1,10,000
Rs. 10,000 10 years

Rs. 1,10,000 - Rs. 10,000 Yearly depreciation = 10 years Rs. 10,000


=
The benefit of this method is that equal amount of depreciation is charged every
year throughout the life of the asset, making the calculation of depreciation a
nd cost comparison easy. The main drawback of this method is that the amount of
depreciation in later years is high when the utility of the asset is reduced. (2
) Written Down Value (Reducing Balance) Method :
According to this method, the depreciation is provided at a predetermined percen
tage, on the balance of cost of asset after deducting the depreciation previousl
y charged (usually termed as written down value). Eg. Cost of asset Estimated sc
rap value Cost of asset subjected to depreciation Rate of depreciation Rs. Rs. R
s. 1,10,000 10,000 1,00,000 10%
Basics of Financial Accounting
25

The amount of depreciation is calculated as shown below. Year Balance Cost of As


sets Rs. 1,00,000 90,000 81,000 72,900 65,610 Depreciation Rs. 10,000 9,000 8,10
0 7,290 6,561 Written Down Value - WDV Rs. 90,000 81,000 72,900 65,610 59,049
1 2 3 4 5
The rate of depreciation to be charged is calculated according to the following
formula. D = where n = 1n R C
number of years Residual / Scrap Value Cost of the asset
R = C =
The main benefit of this method is that it recognizes the fact that in the initi
al years of life of the asset, the repairs and maintenance cost is less which go
es on increasing gradually with the progressing life of asset. According to this
method, the higher amount of depreciation in the initial years and a gradual de
crease therein is counterbalanced by the lower amount of repairs and maintenance
cost in the initial years and a gradual increase therein. It should be noted he
re that the written down value can never become zero. (3) Production Unit Method
:
According to this method, depreciation is provided at a predetermined rate per u
nit which in turn is calculated on the basis of total number of units lo be prod
uced during the life of the asset. Eg. Cost of the machine Estimated scrap value
Estimated number of units to be produced Rate of depreciation per unit = = Rs.
2 Rs. 1,10,000 Rs. 10,000 50,000 Rs. 1,10,000 - Rs. 10,000 50,000 units
26
Management Accounting

If in a particular year, 7,000 units are produced, the depreciation to be charge


d will be : 7,000 units x Rs. 2 per unit = Rs. 14,000. This method gives more st
ress on usage factor rather than time factor. Higher the number of units produce
d, higher is the amount of depreciation and vice versa. (4) Production Hour Meth
od :
This method is similar to the production unit method except that instead of numb
er of units to be produced during the life of asset, number of hours for which t
he asset is expected to work are taken into consideration. Eg. Cost of the machi
ne Estimated scrap value Estimated number of hours Rate of depreciation per hour
= Rs. 1,10,000 Rs.10,000 25,000 Rs. 1,10,000 - Rs. 10,000 25,000 hours = Rs. 4
If in a particular year, the machine works for 2,500 hours, the depreciation to
be charged will be : 2,500 hours x Rs. 4 per hour = Rs. 10,000 (5) Joint Factor
Rate Method :
According to this method, the depreciation is provided partly at a fixed rate on
time basis and partly at a variable rate on usage basis. Eg. Cost of the machin
e To be depreciated on time basis over life of the machine i.e. 10 year Estimate
d number of units to be produced Depreciation : (a) On time basis Rs. 50,000 10
years (b) On usage basis Rs. 50,000 50,000 units = Rs. 5,000 per year Rs. 1,00,0
00
Rs.
50,000 50,000
=
Re. 1 per unit
Basics of Financial Accounting
27

If in a particular year, the machine produces 6,000 units, the depreciation to b


e charged will be : Time basis Usage basis 6,000 units x Re. 1 Rs. 5,000 Rs. 6,0
00 Rs. 11,000 (6) Annuity Method :
This method assumes that the amount of capital invested in the fixed assets woul
d have earned interest had it been invested otherwise. The depreciation to be ch
arged under this method is a constant proportion of the aggregate of the cost of
the asset depreciated and interest at the specific rate on written down value o
f the asset at the beginning of each period. Eg. Cost of the asset (c) Life of t
he asset (n) Rate of interest (r) Depreciation to be charged is calculated as be
low. D = 1Year Cxr 1 (1 + r)n -1 Cost/WDV Rs. 1 2 3 4 5 1,00,000 83,620 65,602 4
5,782 23,980 = 1Interest Rs. 10,000 8,362 6,560 4,578 2,400 1,00,000 x 0.10 1 (1
.10)5 -1 Total Rs. 1,10,000 91,982 72,162 50,360 26,380 Depreciation Rs. 26,380
26,380 26,380 26,380 26,380 83,620 65,602 45,782 23,980 Nil WDV C/fd = Rs. 26,38
0 Rs. 1,00,000 5 years 10%
The amount of depreciation is very high under this method and covers the opportu
nity cost of non-investment of the capital anywhere else. (7) Sinking Fund Metho
d :
Unlike any other method, this method attempts to make available funds equivalent
to the original cost of asset, at the end of useful life of the asset. Accordin
g to this method, depreciation to be charged is the fixed period charge which is
invested at a compound rate and the amount of investmen with the compounded int
erest earned over the life of the asset equals to the original cost of the asset
. 28
Management Accounting

Eg.
Cost of the asset (c) Life of the asset (n) Rate of interest (r)
Rs. 1,00,000 5 years 10%
Depreciation to be charged is calculated as below : D Year = Cxr (1 + r) - 1 Bal
. B/fd Rs. 1 2 3 4 5 (8) 16,380 34,398 54,218 76,020 Interest Provision Rs. 1,63
8 3,440 5,422 7,600
n
=
1,00,000 x 0.10 (1.10)5 - 1 Annual Investment Rs. 16,380 16,380 16,380 16,380 16
,380
=
Rs. 26,380 Annual Rs. 16,380 18,018 19,820 21,802 23,980 Bal.c/fd Rs. 16,380 34,
398 54,218 76,020 1,00,000
Endowment Policy Method :
This method is similar to sinking fund method. Under this method, an insurance p
olicy is taken out for the amount required to replace the asset at the end of li
fe of the asset. The amount of depreciation to be charged is equal to the annual
premium payable on the insurance policy, which is decided by the insurance comp
any. (9) Revaluation Method :
According to this method, the asset is revalued periodically. The amount of depr
eciation for that period is the difference between the cost of the asset at the
beginning of the period and the amount of revaluation at the end of the period.
This method of charging the depreciation is extensively used for the assets like
livestock, patterns etc. (10) Renewal Method : According to this method, the fu
ll cost of the asset is charged as depreciation during the period in which asset
is renewed. No depreciation is charged in between the period. This method of ch
arging can be used if the asset is of small value and is renewed frequently.
Basics of Financial Accounting
29

Practical considerations relating to depreciation 1. In spite of the fact that t


here are various methods available for calculating the depreciation, the final c
hoice of the method depends upon the individual organization. It should be noted
that Income Tax Act, 1961 which is a very important piece of legislation applic
able to all types of business organizations, recognizes only one method for calc
ulating the depreciation i.e. Written Down Value method. The rates at which the
depreciation is to be calculated are also specified in the Income Tax Act, 1961.
If the organization wants to calculate the depreciation on some different basis
or at some different rates, it can do so for financial accounting purposes. How
ever, for calculating the tax liability, the depreciation has to be calculated o
n Written Down Value basis and that too at the specified rates. The company form
of organizations to whom the provision of Companies Act, 1956 apply are require
d to calculate the depreciation as per the provisions of Schedule XIV of the Com
panies Act, 1956. The salient features of Schedule XIV of the Companies Act, 195
6 can be stated as below a. Schedule XIV of the Companies Act, 1956 provides tha
t the company can calculate the depreciation by using either Written Down Value
method or Straight Line method. The companies are given the choice to select bet
ween these two methods. The actual choice of the method may depend upon the effe
ct on the profitability of the company. If the company wants to change the metho
d of calculating the depreciation, it amounts to the change in accounting policy
. Any change in the method of calculating the depreciation has to be effected wi
th retrospective effect from the date of incorporation of the company. The compa
ny is required to disclose the fact of change in the method of calculating the d
epreciation while preparing its financial statements along with the effect of ch
ange in the method of calculating the depreciation. The rates at which the compa
nies are required to calculate the depreciation are also specified in Schedule X
IV. For this purpose, the fixed assets are classified in various categories. The
broad categorization of the fixed assets is as below l l l l l
2.
b.
Buildings - Factory Building as well as Administration Buildings Plant and Machi
nery Furniture Vehicles Computer Installations
30
Management Accounting

The rates for calculation of depreciation are as below Nature of the Fixed Asset
s Buildings - Factory Buildings - Administrative Plant and Machinery Furniture V
ehicles Computer Installations c. WDV 10% 5% 15% 10% 20% 40% SLM 3.63% 1.63% 4.7
5% 6.33% 9.5% 16.21%
If during the financial year, any addition has been made to any asset or any ass
et has been sold, the depreciation on such asset will be calculated on a pro rat
a basis from the date of such addition or upto the date on which such asset has
been sold. There are some of the questions which are normally raised in respect
of the nature of depreciation. (1) Is Depreciation a cost? Yes, depreciation is
a cost because of the obvious reasons that it reduces the profitability and it i
s a charge against the profit. At the same time, it should also be noted that it
is a non-cash cost as it is never paid or incurred in cash. (2) Does Depreciati
on generate funds for replacement of assets? If the depreciation is provided und
er the Sinking Fund Method or Endowment Policy Method, sufficient funds may be a
vailable, at the end of life of the asset, equivalent to the original cost of th
e asset. As such, it can be said that these two methods make available the funds
equivalent to the original cost of the asset at the end of life of the asset. H
owever these funds may not be sufficient to replace the asset due to the increas
ed price of the same. Other methods of charging the depreciation do not directly
generate the funds required for replacing the assets. The fact that the assets
are depreciated to the extent of almost entire of the original cost of the same,
does not indicate that the funds are available for the replacement purpose. How
ever, depreciation may be viewed from one more angle. It is a charge to profits
which reduces the profits which can be distributed among the shareholders by way
of dividends, thus conserving the business funds in the business itself. This m
ay be considered to be a very very indirect way of interpretation that the depre
ciation involves a source of funds.
Basics of Financial Accounting
31

QUESTIONS 1. What do you mean by various accounting principles? Explain the vari
ous accounting concepts and conventions used in the financial accounting. Distin
guish between the following pairs of terms. 3. Cash Basis of Accounting and Accr
ual Basis of Accounting Revenue Expenditure and Capital Expenditure Written Down
Value Method and Straight Line Method of Depreciation Depreciation as per Compa
nies Act and Income Tax Act
2.
What do you mean by depreciation? What are the objectives for calculating the de
preciation? Explain the various methods for calculating the depreciation. Write
an essay on Depreciation.
4.
32
Management Accounting

NOTES
Basics of Financial Accounting
33

NOTES
34
Management Accounting

Chapter 3
PROCESS OF ACCOUNTING
JOURNALIZING Journalizing refers to the process of recording the business transa
ction in the Journal that is referred to as the Book of Original Entry or the Bo
ok of Prime Entry. The various transactions are entered in the journal in the ch
ronological order, as and when the transactions take place. The Journal may look
as stated below Journal Date a Particulars b Account (To be Debited) Dr. To, Ac
count (To be Credited) Narration The Journal may be subdivided in the following
five columns a. b. Date It refers to the date on which a particular transaction
has taken place. Particulars It refers to titles of the account to be debited or
credited. Title of the account to be debited starts from the extreme left and t
he abbreviation Dr. is written to the extreme right of the same column on the same
line. Title of the account to be credited is entered on the next line preceded
by the words To leaving some space from the extreme left. In the same column on th
e next line, brief description of the transaction is written which is referred t
o as Narration. The narration conventionally starts with the wording Being. L.F. Thi
s is the abbreviation of Ledger Folio. This column refers to the page number of
the ledger. The nature of Ledger is discussed in the following paragraphs. Amoun
t Debited The amount to be debited is stated in this column. Amount Credited The
amount to be credited is stated in this column. L.F. c Debit Rs. d Credit Rs. e
c.
d. e.
Process of Accounting
35

Illustration Journalize the following transactions in the books of Mr. Amit Sen
a. Mr. Sen commenced business with cash Rs. 10,000, Machinery Rs. 10,000, Buildi
ngs Rs. 30,000 and Furniture Rs. 15,000. Installed and paid for Neon Sign Board
at a cost of Rs. 1,000 Mr. Sen borrowed Rs. 25,000 from his wife and the same we
re deposited by him in bank to open an account. Mr. Sen purchased goods for Rs.
7,000 for cash. Mr. Sen purchased goods worth Rs. 10,000 from Mr. Rao on credit
@2% Cash Discount. Sold goods to Ramdas worth Rs. 15,000 against cash after allo
wing 5% Trade Discount. Paid Rs. 1,995 to Mr. Rajesh for purchases of goods afte
r allowing 5% Cash Discount on the invoice. Sent a cheque of Rs. 1,000 to Chief
Ministers Fund as Mr. Sens personal contribution. Placed an order for goods worth
Rs. 2,000 with M/s Archana Traders. A personal table fan worth Rs. 450 brought i
n the office for office use.
b. c.
d. e. f. g. h. i. j.
Solution In the Books of
ilding A/c Furniture A/c
building and furniture)
n board installed) 1,000
Credit Rs.
36
Management Accounting

Mr. Amit Sen Date Particulars Cash A/c Machinery A/c Bu


To, Capital A/c (Business started with cash, machinery,
Advertisement A/c To, Cash A/c (Being paid for neon sig
1,000 L.F. Debit Rs. 10,000 10,000 30,000 15,000 65,000

Date
Particulars Bank A/c To, Loan from Mrs. Sen A/c (Being the amount borrowed from
Mrs. Sen to open account with the bank) Purchases A/c To, Cash A/c (Being paid f
or cash purchases) Purchases A/c To, Cash A/c To, Discount Received (Being purch
ases worth Rs. 10,000 after getting 2% cash discount) Cash A/c To, Sales (Sold g
oods worth Rs. 15,000 after allowing trade discount of 5%) Purchases A/c To, Cas
h A/c To, Discount Received (Paid Rs. 1,995 for goods purchased after getting 5%
cash discount) Drawings A/c To, Bank A/c (Being donation paid to Chief Ministers
Fund as Mr. Sens personal contribution) No Journal Entry will be passed, as the
transaction is not a financial transaction. Furniture A/c To, Capital A/c (Being
the personal table fan brought for office use)
L.F.
Debit Rs. 25,000
Credit Rs.
25,000
7,000 7,000
10,000 9,800 200
14,250 14,250
2,100 1,995 105
1,000 1,000
450 450
Process of Accounting
37

Compound Journal Entry If the similar transactions take place on the same day an
d the same account is either debited or credited, instead of passing different j
ournal entries, it can be accounted for by passing a compound journal entry. It
avoids duplication and makes the journal less bulky. Illustration Mr. A commence
d the business with cash Rs. 10,000, Machinery worth Rs. 25,000 and the Computer
worth Rs. 50,000. The transaction will be journalized as below Date 1.4.2002 Pa
rticulars Cash A/c Machinery A/c Computer A/c To, Capital A/c (Commenced busines
s with cash, machinery and computer) L.F. Debit Rs. 10,000 25,000 50,000 85,000
Credit Rs.
SUBSIDIARY BOOKS If the volume of transactions is very large, recording all the
transactions in the Journal may prove to be a voluminous job. Hence, the transac
tions of the similar nature may be entered into a separate Subsidiary Book and t
he net effect of the similar transactions may be transferred into the main recor
ds. In the practical circumstances, following subsidiary books are used very fre
quently a. Cash Book This records all the cash transactions i.e., Cash Receipts
and Cash Payments. In some cases, Cash and Bank Book may be maintained which rec
ords Cash as well Bank Receipts and Cash as well as Bank Payments. The Cash and
Bank Book may look as below
Date Particulars L.F. Cash Bank Date Particulars L.F. Cash Bank
b.
Purchases Register or Purchases Day Book This records all the credit purchases t
ransactions. Date Name of the Supplier L.F. Invoice No. Amount
Note : L.F. stands for Ledger Folio Number which indicates the Page Number in the
Creditors Ledger as the Control Ledger. The term Control Ledger is discussed in t
he following paragraphs.
38
Management Accounting

c.
Sales Register or Sales Day Book This records all the credit sales transactions.
The Sales Register may look as stated below Date Name of the Customer L.F. Invo
ice No. Amount
Note : L.F. stands for Ledger Folio Number which indicates the Page Number in the
Debtors Ledger as the Control Ledger. The term Control Ledger is discussed in the
following paragraphs. d. Purchases Returns Register This records the transactio
ns of return of goods to the suppliers from whom purchases were made on credit b
asis. The Purchases Return Register may look as stated below Date Name of the Su
pplier L.F. Debit Note No. Amount
Note : L.F. stands for Ledger Folio Number which indicates the Page Number in the
Creditors Ledger as the Control Ledger. The term Control Ledger is discussed in t
he following paragraphs. The Debit Note stands for an intimation sent to the sup
plier at the time of returning the goods which informs the supplier that his acc
ount is being debited on account of goods returned to him. e. Sales Returns Regi
ster This records all the transactions of return of goods by the customers to wh
om sales were made on credit basis. The Sales Return Register may look as stated
below Date Name of the Customer L.F. Credit Note No. Amount
Note : L.F. stands for Ledger Folio Number which indicates the Page Number in the
Debtors Ledger as the Control Ledger. The term Control Ledger is discussed in the
following paragraphs. The Credit Note stands for an intimation sent to the cust
omer at the time of accepting the returned goods which informs the customer that
his account is being credited on account of goods returned by him. f. Journal P
roper This records all the residual transaction which cannot be entered into any
other subsidiary book. The transactions which can be entered in the Journal pro
per are a. b. c. d. Opening Entries Closing Entries Rectification Entries Adjust
ment Entries
Process of Accounting
39

LEDGER POSTING If Journal or Subsidiary Books are the books which record of the
transactions in the chronological order, Ledger is the book where the transactio
ns of the similar nature are pooled together under one Ledger Account. Ledger or
General Ledger as it is referred to in practical circumstances, maintains all t
ypes of accounts i.e. Personal, Real and Nominal. Whichever transactions are rec
orded in the Journal or Subsidiary Books in chronological order, the same transa
ctions are posted in the Ledger, account wise. Thus, a ledger account can be def
ined as the record of all the transactions pertaining to a person, asset, liabil
ity, income or expenditure which have taken place during a specified period and
shows the net effect of all these transactions finally. As such, the transaction
s are first entered into Journal or Subsidiary Book when they take place and fro
m there they are transferred to Ledger and this process is called as Ledger Post
ing. The Ledger Account may be maintained in two ways Type I Dr. Date Particular
s Folio Rs. Date Particulars Folio Rs. Cr.
Type II Date Particulars Folio Debit Credit Rs. Balance Rs.
Control Ledgers In practical circumstances, if the transactions of purchases and
sales are very large, it may not be feasible to carry the accounts of all the s
uppliers and customers in the Main or General Ledger. In such cases, apart from
the Main Ledger or General Ledger, the Control Ledgers can be maintained. Contro
l Ledgers carry the individual accounts whereas the Main Ledger or General Ledge
r records the consolidated effect of the individual transactions. As such, the b
alance shown by the consolidated account in the Main Ledger or General Ledger ha
s to tally with the balances in the individual ledger accounts maintained in the
control ledger. In practical circumstances, control ledgers may be maintained f
or the following purposes a. b. c. Sundry Debtors Sundry Creditors Advances to S
taff
40
Management Accounting

Balancing of Ledger Accounts To ascertain the net effect of all the transactions
recorded in the Ledger Account, the account is required to be balanced. Balancing
of Ledger Account involves the following steps a. b. c. Take the total of both
sides of the Ledger Account. Calculate the difference between totals of both the
sides. If the total of debit side is heavier, place the difference on the amoun
t column of credit side by writing By Balance c/fd. If the total of credit side is
heavier, place the difference on the amount column of debit side by writing the
To Balance c/fd. If the balance appears on the credit side, the account will be c
onsidered to have Debit Balance. If the balance appears on the debit side, the a
ccount will be considered to have Credit Balance. After balance is placed on the
appropriate side, ensure that totals of both the sides match with each other.
d.
Illustration Machinery Account Date Particulars Folio Rs. Date Particulars Depre
ciation Balance c/fd (Balancing figure) Folio Rs. 10,000 85,000 95,000
01.04.01 Balance b/fd 10.04.01 Bank
25,000 31.03.02 70,000 31.03.02 95,000
Steps explained a. Before considering the Balancing Figure, the total of debit s
ide is Rs. 95,000 and the total of credit side is Rs. 10,000. As such, debit sid
e is heavy. Difference between both the sides is Rs. 85,000. As the debit side i
s heavy, the difference of Rs. 85,000 is put on the credit side.
b. c.
Trial Balance Trial Balance is the summary of all the balances in all the accoun
ts listed in the General Ledger and Cash / Bank Book of an organization at any g
iven date. Tallying of the Trial Balance is the evidence of the fact that all th
e transactions have properly been posted in the General Ledger. As such, tallyin
g of Trial Balance generally ensures the arithmetical accuracy of the process of
Ledger Posing.
Process of Accounting
41

Format of Trial Balance Trial Balance as on 31st March 2002 Name of the Account
Debit Credit
For the preparation of Trial Balance, all the accounts in the General Ledger nee
d to be balanced to ascertain the Closing Balance. Similarly, Cash Book / Bank B
ook is also required to be balanced to ascertain the Closing Balance. Accounts h
aving the Debit Balance are shown on the Debit Side whereas the accounts having
the Credit Balance are shown on the Credit Side. Generally, accounts of the asse
ts will have Debit Balance and hence will be shown on Debit Side. Generally, acc
ounts of all liabilities will have Credit Balance and hence will be shown on Cre
dit Side. Generally, accounts of all the Expenses will have Debit Balance and he
nce will be shown on Debit Side. Generally, accounts of all the Incomes will hav
e Credit Balance and hence will be shown on Credit Side. PREPARATION OF FINAL AC
COUNTS FROM TRIAL BALANCE Preparation of the financial statements is the basic o
bjective of financial accounting. These financial statements are basically in tw
o forms a. Profitability Statement This financial statement is referred to as Pro
fit and Loss Account in more technical language. The purpose of this financial st
atement is to disclose the result of operations of the business transactions dur
ing a given period of time. As such, by nature Profit & Loss Account is a period
statement which relates to a specific duration of time. Hence, Profit and Loss
Account is always referred to as Profit and Loss Account for the year ended on 31
st March 2002. Balance Sheet The purpose of this financial statement is to disclo
se the financial status of the organization in terms of its assets and liabiliti
es at any given point of time. Thus, in simple language, Balance Sheet is a list
ing of the assets and liabilities of an organization at any given point of time.
Whichever sources are used by an organization for raising the required amount o
f funds create an obligation or liability for the organization and whichever way
s the funds are used or applied by an organization create the properties or asse
ts for the organization. Hence, in practical circumstances, the liabilities are
referred to as Sources of Funds and the assets are referred to Application of Funds.
As such, by nature Balance Sheet is a position statement in the sense it relate
s to a specific point of time or date. Hence, Balance Sheet is always referred t
o as Balance Sheet as on 31st March 2002.
b.
42
Management Accounting

PROFIT AND LOSS ACCOUNT As stated earlier, Profit and Loss Account is prepared t
o disclose the result of operation of the business transactions during a certain
duration of time. In technical language, Profit and Loss Account may have follo
wing four components a. Manufacturing Account This part of Profit and Loss Accou
nt discloses the result of manufacturing operations carried out by the organizat
ion. The final result disclosed by the Manufacturing Account is the Cost of Prod
uction incurred by the organization. Following is the specimen of Manufacturing
Account. Manufacturing Account for the year ended on 31st March 2002
Particulars Opening Stock Raw Material Work in Progress Amount Particulars Closi
ng Stock Raw Material Work in Progress Amount
Purchases of Raw Material Carriage Inward Wages Paid Power and Fuel Consumable S
tores Manufacturing Expenses Depreciation on Production Assets
Cost of Production (Transferred to Trading Account)
Total b.
Total
Trading Account This part of Profit and Loss Account discloses the result of tra
ding operations carried out by the organization. The final result disclosed by t
he Trading Account is the Gross Profit earned by the organization. Following is
the specimen of Trading Account.
Process of Accounting
43

Trading Account for the year ended on 31st March 2002


Particulars Opening Stock Finished Goods Amount Particulars Sales (Net of Sales
Returns) Amount
Cost of Production (Brought from Manufacturing A/c) Gross Profit
Closing Stock Finished Goods
Total
Total
c.
Profit and Loss Account This part of Profit and Loss Account discloses the final
result of business transactions of the organization. The final result disclosed
by the Profit and Loss Account is the Profit After Tax (PAT) earned by the orga
nization. Following is the specimen of Profit and Loss Account. Profit & Loss Ac
count for the year ended on 31st March 2002
Particulars Administrative Expenses Office Salaries Postage & Telephone Travelin
g & Conveyance Legal Charges Office Rent Depreciation Audit Fees Insurance Repai
rs & Renewals Amount Particulars Gross Profit b/fd Other Income Discount Receive
d Commission Received Non-Trading Income Interest Received Rent Received Amount
Selling & Distribution Expenses Advertisement Carriage Outward Free Samples Bad
Debts Sales Commission
Abnormal Income Profit on the sale of assets
44
Management Accounting

Particulars Financial Expenses Interest & Bank Charges Other Expenses Loss on th
e sale of assets Salary to Working Partners Interest on Capital Provision for Ta
xation Net Profit after Taxes (Transferred to Capital Account)
Amount
Particulars
Amount
Total d.
Total
Profit and Loss Appropriation Account This part of Profit and Loss Account, whic
h is mainly applicable to company form of organization, discloses the manner in
which the PAT earned by the organization is appropriated. The amount of profit n
ot appropriated or retained is transferred to Reserves and Surplus in the Balanc
e Sheet. Following is the specimen of Profit and Loss Appropriation Account.
Profit & Loss Appropriation Account for the year ended on 31st March 2002
Particulars Dividend Paid Transferred to Reserves Balance transferred to Balance
Sheet
Amount
Particulars Profit After Tax b/fd Amount withdrawn from Reserves
Amount
Total
Total
BALANCE SHEET As stated earlier, the purpose of preparing the Balance Sheet is t
o disclose the financial status of the organization in terms of its assets and l
iabilities at any given point of time. As such, the Balance Sheet has two sides
a. b. Liabilities Assets
Process of Accounting
45

Liabilities Credit balances in all the Personal and Real Accounts appear on Liab
ilities side. Following items may appear on the liabilities side a. Capital Capi
tal indicates the amount of funds contributed by the owners of the business to t
he requirement of funds of the business. As owner of the business is considered
to be a separate entity than the business itself, any amount contributed by the
owner is a liability for the business. Similarly, any amount of profit earned in
the past which is not distributed to the owner also belongs to the owner and be
comes a part of the capital. b. Long Term Liabilities This indicates the liabili
ties which are to be paid off over a longer span of time say 5 to 10 years. In p
ractical circumstances, it may consist of long-term loan borrowed from banks or
financial institutions. c. Current Liabilities This indicates the liabilities wh
ich are supposed to be paid off within a very short span of time say one year. I
n practical circumstances, it may consist of the flowing items 1. 2. Sundry Cred
itors Amounts payable to the suppliers of goods and/or services. Advances receiv
ed from customers This amount may not be paid back to the customers. It gets adj
usted with the final selling price. Till it is adjusted with the selling price,
it appears as a current liability. Outstanding Expenses This amount indicates th
e expenses already incurred during the relevant period but not paid for. Income
Received in Advance Liability for taxes
3. 4. 5. Assets
Debit balances in all the Personal and Real Accounts appear on Asset side. Follo
wing items may appear on the assets side a. Fixed Assets As stated earlier, fixe
d assets indicate the value of infrastructural properties acquired by the busine
ss where the benefits are likely to be received over a longer duration of time.
Fixed assets are the assets which are not supposed to be sold, but they are supp
osed to be used to do the business to earn the profits. Some of the fixed assets
which can be found in practical circumstances are Land, Building, Machinery, Fu
rniture, Vehicles, and Computers etc. 46
Management Accounting

b.
Investments This indicates the amount of funds invested by the organization outs
ide the business.
c.
Current Assets Current Assets are the assets which are likely to be converted in
the form of cash or likely to be consumed during the normal operating cycle of
the business within a very short span of time say one year. The purpose of holdi
ng the current assets is to sell the current assets or use them during the norma
l course of operations. Current assets change their form very frequently while d
oing the business. Some of the current assets which can be found in practical ci
rcumstances are Stock, Sundry Debtors, Cash & Bank Balances, Prepaid Expenses et
c.
Following is the specimen of Balance Sheet. Balance Sheet as on 31st March 2002
Capital & Liabilities Capital Long Term Liabilities Loan from Bank Current Liabi
lities Sundry Creditors Advance from Customers Outstanding Expenses Income Recei
ved in Advance Amount Assets & Properties Fixed Assets Land Building Machinery F
urniture Vehicles Computers Investments Current Assets Stock Sundry Debtors Cash
Balance Bank Balance Prepaid Expenses Amount
Total
Total
Adjustments While preparing the final accounts from the Trial Balance, it should
be remembered that the Trial Balance might not reflect all the transactions whi
ch have the impact on profitability for the relevant period or the state of affa
irs of the organization on a particular date. As such, before preparing the fina
l accounts, the effect of such transactions needs to be considered. The same is
done by passing the Adjustment Entries. Thus, the effect of Adjustment Entries i
s yet
Process of Accounting
47

to be reflected in the Trial Balance. As such, according to the Double Entry pri
nciples, the Adjustment Entries always have two effects. Following are some of t
he main adjustment entries made while preparing the final accounts from the Tria
l Balance. a. Closing Stock This indicates the amount of stock in hand on the da
te of Balance Sheet. The basic principle on which the closing stock is valued is
at cost or market price whichever is less. Accordingly, the first effect of the
closing stock is that it is shown on the credit side of Manufacturing and/or Tr
ading Account and the second effect is that it is shown on Balance Sheet Asset s
ide. The Journal Entry passed for this is Closing Stock A/c Dr. To, Trading Acco
unt b. Depreciation This indicates the reduction in the value of fixed assets du
e to wear and tear. As the basic cost of the fixed assets is not transferred to
Profit and Loss Account, this adjustment is necessary to reflect the cost for th
e use of fixed asset during the year. Accordingly, the first effect of the adjus
tment for Depreciation is that the amount is debited to Profit & Loss Account re
ducing the profit or increasing the loss and the second effect is that the corre
sponding amount is reduced from the value of fixed asset in the Balance Sheet. I
n other words, the value of fixed assets in the Balance Sheet is net of deprecia
tion. The Journal Entry passed for this is Depreciation A/c Dr. To, Fixed Asset
A/c c. Outstanding Expenses This indicates the amount of expenses pertaining to
the relevant period which are not paid during the said period. According to Matc
hing Principle of Accounting, income for a certain period needs to be compared w
ith the expenses for the same period, whether it is paid for or not. Accordingly
, the first effect of this adjustment is that the corresponding amount of expens
es are increased reducing the profit or increasing the loss and the second effec
t is that the corresponding amount is shown as Current Liability on the Balance
Sheet liabilities side. The Journal Entry passed for this is Expenses A/c Dr. To
, Outstanding Expenses A/c
48
Management Accounting

d.
Prepaid Expenses This indicates the amount of expenses pertaining to the next pe
riod which are paid in advance during the relevant period. According to Matching
Principle of Accounting, income for a certain period needs to be compared with
the expenses for the same period. Accordingly, the first effect of this adjustme
nt is that the corresponding amount of expenses are reduced, thus increasing the
profit or reducing the loss and the second effect is that the corresponding amo
unt is shown as Current Asset on the Balance Sheet Asset side. The Journal Entry
passed for this is Prepaid Expenses A/c Dr. To, Expenses A/c
e.
Accrued Income This indicates the amount of income for the current period which
is not received during the current period. According to Matching Principle of Ac
counting, income for a certain period needs to be compared with the expenses for
the same period. Accordingly, the first effect of this adjustment is that the c
orresponding amount of income is increased, thus increasing the profit or reduci
ng the loss and the second effect is that the corresponding amount is shown as C
urrent Asset on the Balance Sheet Asset side. The Journal Entry passed for this
is Accrued Income A/c Dr. To, Income A/c
f.
Income Received in Advance This indicates the amount of income for the next peri
od which is received during the current period. According to Matching Principle
of Accounting, income for a certain period needs to be compared with the expense
s for the same period. Accordingly, the first effect of this adjustment is that
the corresponding amount of income is reduced, thus reducing the profit or incre
asing the loss and the second effect is that the corresponding amount is shown a
s Current Liability on the Balance Sheet Liabilities side. The Journal Entry pas
sed for this is Income A/c Dr. To, Income received in advance A/c
g.
Bad Debts This indicates the unrecoverable amount from the customers on account
of credit sales made to them. If the customer is not likely to pay the amount du
e from him, the same is written off as Bad Debts. Accordingly, the first effect
of this adjustment is that the amount
Process of Accounting
49

of Bad Debts is debited to Profit and Loss Account, thus reducing the profits or
increasing the losses and the second effect is that the amount of Sundry Debtor
s is reduced. The Journal Entry passed for this is Bad Debts A/c Dr. To, Sundry
Debtors h. Provision for Doubtful Debts Provision for doubtful debts is necessar
y due to the possibility that all the customers to whom the credit sales have be
en made may not pay the entire amount. Accordingly, the first effect of this adj
ustment is that the amount equivalent to the provision for doubtful debts is wri
tten off to Profit and Loss Account and the second effect is that the correspond
ing amount is reduced from the Sundry Debtors in the Balance Sheet. It should be
noted that if the provision for bad and doubtful debts is to be maintained at a
certain percentage of Sundry Debtors and if the provision to some extent has al
ready been made in the books of account, the differential amount only needs to b
e debited to Profit and Loss Account. The Journal Entry passed for this is Profi
t and Loss Account Dr. To, Sundry Debtors A/c i. Provision for Discount on Debto
rs In some cases it is necessary to allow cash discount to the customers for mak
ing the early payment. As the amount of debtors who are likely to avail the cash
discount is not known in advance, a provision is made in the books of account f
or the discount to be allowed to debtors. Accordingly, the first effect of this
adjustment is that the amount equivalent to the provision for discount on debtor
s is written off to Profit and Loss Account and the second effect is that the co
rresponding amount is reduced from the Sundry Debtors in the Balance Sheet. The
Journal Entry passed for this is Profit and Loss Account Dr. To, Sundry Debtors
A/c j. Interest on Capital In order to calculate the profit earned by the organi
zation properly, in some cases interest may be provided on the amount of capital
introduced by the proprietor or partner in the business. It may not be out of p
lace to mention here that in case of partnership firms, interest on capital is c
onsidered to be an allowable expenditure for calculating the tax liability as pe
r the provisions of Income tax Act, 1961 if it is payable to the Working Partner
s at the rate which is not exceeding 12% p.a. Accordingly, the first effect of t
his
50
Management Accounting

adjustment is that the amount of Interest on Capital is debited to Profit and Lo


ss Account, thus reducing the profits or increasing the losses and the second ef
fect is that the corresponding amount is credited to the Capital Account of prop
rietor or partner. The Journal Entry passed for this is Interest on Capital A/c
Dr. To, Capital A/c k. Drawings This represents the amount of cash or value of g
oods withdrawn by the proprietor or partner for personal use. If the amount is w
ithdrawn in cash, the same may be entered in the books of account regularly and
thus will be reflected in the Trial Balance. However, the value of goods withdra
wn by the proprietor or partner may be required to be considered by way of adjus
tment. Accordingly, the first effect of this adjustment is that the amount of Sa
les will be increased, thus increasing the profits or reducing the loss and the
second effect is that the corresponding amount will be debited to the Capital Ac
count of the proprietor or partner. The Journal Entry passed for this is Drawing
/ Capital A/c Dr. To, Sales A/c l. Deferred Revenue Expenditure Written Off Thi
s represents that part of Deferred Revenue Expenditure, returns equivalent to wh
ich are received during the current period. Accordingly, the first effect of thi
s adjustment is that the deferred revenue expenditure written off will be debite
d to Profit and Loss Account, thus reducing the profit or increasing the loss an
d the second effect is that the corresponding amount will be reduced from the As
set side of the Balance Sheet. The Journal Entry passed for this is Deferred Rev
enue Expenditure Written Off A/c Dr. To, Deferred Revenue Expenditure A/c It sho
uld be noted that Deferred Revenue Expenditure Written Off Account is a Nominal
Account whereas Deferred Revenue Expenditure Account is a Real Account. m. Abnor
mal Loss due to fire etc. In some cases, the organization incurs the loss of sto
ck due to some abnormal events like fire, earthquake etc. Accordingly, the first
effect of this adjustment is that the Trading Account is credited with the cost
of goods lost due to fire, earthquake etc. and the corresponding amount is debi
ted to Profit and Loss Account as Loss due to Fire Account. The Journal Entry pa
ssed for this is
Process of Accounting
51

Loss due to Fire Account Dr. To, Stock Destroyed Account In some cases, the stoc
k held by the organization is insured with the Insurance Company. After the abno
rmal event like fire or earthquake takes places, the insurance company settles t
he claim, either in full or in part. The actual loss incurred by the organizatio
n is to the extent of difference between the cost of goods destroyed and the amo
unt of claim settled by the insurance company. In such event, the amount of clai
m settled by the insurance company is debited to the Insurance Companys Account a
nd only the net amount of loss is debited to Profit and Loss Account. The Journa
l Entry passed for this is Insurance Company A/c Dr. Loss due to Fire A/c Dr. To
, Stock Destroyed A/c n. Goods Distributed as Free Samples This represents the v
alue of goods distributed as free samples as a part of sales promotion effort of
the organization. This is in the form of advertisement. Accordingly, the first
effect of this adjustment is that the amount of goods distributed as free sample
s is debited to Profit and Loss Account, thus reducing the profits or increasing
the losses and the second effect is that the amount of Sales is increased thus
increasing the profit or reducing the loss. The Journal Entry passed for this is
Advertisement A/c Dr. To, Sales A/c o. Goods sent on approval basis Goods sent
to the customers on approval basis should not be treated as the sales till the g
oods are finally approved by the customers or the period as agreed upon by both
the parties is over. This is due to the fact that the property in the goods is n
ot transferred until the said period is over. If the amount of such goods sent o
n approval basis is treated as the sales, the effect of this entry needs to be r
eversed. At the same time, the closing stock needs to be increased by the cost o
f such goods sent on approval basis. p. Commission payable to the manager In som
e cases, commission is payable to the manager as a percentage of profit earned b
y the business. The calculation of this commission may be made in two ways
l
As a percentage of profit before charging such commission to Profit and Loss Acc
ount.
Management Accounting
52

l
As a percentage of profit after charging such commission to Profit and Loss Acco
unt.
In both the cases, the amount of profit needs to be calculated before the commis
sion is calculated and then the amount of commission is calculated based upon th
e methods to be used for calculating the same. The journal Entry passed for this
is Commission A/c Dr. To, Commission Payable A/c Illustration 1 From the follow
ing particulars in respect of M/s Pam Industries, Journalize the following trans
actions, post them to the ledger, prepare the trial balance and prepare the fina
l accounts. Date March 2002 1 2 3 5 7 9 15 18 21 25 27 28 30 Started business wi
th the capital of Rs. 50,000 Opened a Bank Account by paying Rs. 35,000 Purchase
d goods from Ajay on credit Rs. 20,000 Sold the goods to Vijay on credit Rs. 14,
000 Paid Ajay by cheque Rs. 19,500 in full settlement Received Rs. 13,000 from V
ijay in full settlement by cheque Purchased furniture of Rs. 10,000 and paid the
amount by cheque Paid for traveling expenses in cash Rs. 3,000 Sold the goods t
o Vinod for cash Rs. 10,000 Goods purchased from Ashok against cash Rs. 8,000 Ca
sh deposited in bank Rs. 5,000 Amount withdrawn by cheque for personal purpose R
s. 3,000 Paid salary in cash Rs. 2,000 Particulars
Adjustments a. b. c. Value of goods unsold on 31st March 2002, valued at cost, R
s. 17,000 Depreciate furniture @2% Telephone bill for the month of March 2002 no
t yet paid Rs. 1,500
Process of Accounting
53

Solution In the books of M/s Pam Industries


Date March 2002 1 Particulars Cash A/c Dr. To, Capital A/c (Capital introduced i
n the business) Bank A/c Dr. To, Cash A/c (Opened Bank Account) Purchases A/c Dr
. To, Ajay A/c (Goods purchased on credit) Vijay A/c Dr. To, Sales A/c (Sold goo
ds on credit) Ajay A/c Dr. To, Bank A/c To, Discount A/c (Paid Ajay in full sett
lement) Bank A/c Dr. Discount A/c Dr. To, Vijay A/c (Received from Vijay in full
settlement) Furniture A/c Dr. To, Bank A/c (Furniture purchased against cheque)
Traveling Expenses A/c Dr. To, Cash A/c (Paid for traveling expenses) Cash A/c
Dr. To, Sales A/c (Sold goods for cash) Purchases A/c Dr. To, Cash A/c (Goods pu
rchased for cash) Bank A/c Dr. To, Cash A/c (Cash deposited in bank) Drawings A/
c Dr. To, Bank A/c (Withdrawn for personal purpose) Salary A/c Dr. To, Cash A/c
(Paid salary in cash) L.F. Debit Rs. 50,000 50,000 35,000 35,000 20,000 20,000 1
4,000 14,000 20,000 19,500 500 13,000 1,000 14,000 10,000 10,000 3,000 3,000 10,
000 10,000 8,000 8,000 5,000 5,000 3,000 3,000 2,000 2,000 Credit Rs.
2
3
5
7
9
15
18
21
25
27
28
30
54
Management Accounting

General Ledger of M/s Pam Industries for March 2002 Cash Account
Date 1 21 Particulars To Capital A/c To Sales Folio Rs. 50,000 10,000 Date 2 18
25 27 30 31 60,000 Particulars By Bank By Traveling Exp. By Purchases By Bank By
Salary By Balance c/fd Folio Rs. 35,000 3,000 8,000 5,000 2,000 7,000 60,000
Bank Account
Date 1 9 27 Particulars To Cash A/c To Vijay To Cash Folio Rs. 35,000 13,000 5,0
00 53,000 Date 7 15 27 31 Particulars By Ajay By Furniture By Drawings By Balanc
e c/fd Folio Rs. 19,500 10,000 3,000 20,500
53,000
Purchases Account
Date 3 25 Particulars To Ajay To Cash Folio Rs. 20,000 8,000 Date 31 Particulars
By Trading A/c Folio Rs. 28,000
28,000
28,000
Sales Account
Date 31 Particulars To Trading A/c Folio Rs. 24,000 Date Particulars By Vijay By
Cash 24,000 Folio Rs. 14,000 10,000 24,000
Traveling Expenses Account
Date 18 Particulars To Cash Folio Rs. 3,000 Date 31 Particulars By Profit & Loss
A/c Folio Rs. 3,000
3,000
3,000
Process of Accounting
55

Salary Account
Date 30 Particulars To Cash Folio Rs. 2,000 2,000 Date 31 Particulars By Profit
& Loss A/c Folio Rs. 2,000 2,000
Telephone Expenses Account
Date Particulars 31
To Outstanding Exp.
Folio
Rs. 1,500 1,500
Date 31
Particulars By Profit & Loss A/c
Folio
Rs. 1,500 1,500
Discount Account
Date 9 Particulars To Vijay Folio Rs. 1,000 Date 7 Particulars By Ajay By Profit
& Loss A/c 1,000 Folio Rs. 500 500 1,000
Depreciation Account
Date 31 Particulars To Furniture Folio Rs. 200 200 Date 31 Particulars By Profit
& Loss A/c Folio Rs. 200 200
Ajay Account
Date 7 7 Particulars To Bank To Discount Folio Rs. 19,500 500 20,000 20,000 Date
3 Particulars By Purchases Folio Rs. 20,000
Vijay Account
Date 5 Particulars To Sales Folio Rs. 14,000 Date 9 9 14,000 Particulars By Bank
By Discount Folio Rs. 13,000 1,000 14,000
56
Management Accounting

Capital Account
Date 28 31 Particulars To Bank To Balance c/fd Folio Rs. 3,000 47,000 50,000 50,
000 Date 1 Particulars By Cash Folio Rs. 50,000
Outstanding Expenses Account
Date 31 Particulars To Balance c/fd Folio Rs. 1,500 1,500 Date 31 Particulars By
Telephone Exp. Folio Rs. 1,500 1,500
Furniture Account
Date 15 Particulars To Bank Folio Rs. 10,000 Date 31 31 10,000 Particulars By De
preciation By Balance c/fd Folio Rs. 200 9,800 10,000
Trial Balance as on 31st March 2002
Name of the Account Cash Bank Purchases Sales Traveling Expenses Salary Telephon
e Expenses Depreciation Discount Capital Furniture Outstanding Expenses 9,800 1,
500 3,000 2,000 1,500 200 500 47,000 Debit 7,000 20,500 28,000 24,000 Credit
Total
72,500
72,500
Process of Accounting
57

Trading Account for the year ended on 31st March 2002


Particulars Opening Stock Purchases Gross Profit c/fd Total Amount Nil 28,000 13
,000 41,000 Total 41,000 Particulars Sales Closing Stock Amount 24,000 17,000
Profit & Loss Account for the year ended on 31st March 2002
Particulars Traveling Expenses Salary Telephone Expenses Discount Depreciation A
mount 3,000 2,000 1,500 500 200 Particulars Gross Profit b/fd Amount 13,000
Profit carried to Capital Account
5,800
Total
13,000
Total
13,000
Balance Sheet as on 31st March 2002
Capital & Liabilities Capital Balance Add : Profit for year 47,000 5,800 Amount
Assets & Properties Fixed Assets Furniture Less : Depreciation 10,000 200 Amount
52,800 Current Assets Current Liabilities Outstanding Expenses 1,500 Stock Cash
Bank
9,800
17,000 7,000 20,500
Total
54,300
Total
54,300
58
Management Accounting

Illustration 2 From the following balances and information, prepare Trading and
Profit & Loss Account of Mr. X for the year ended 31st March 1998 and a Balance
Sheet as on that date. Particulars Xs Capital Account Plant and Machinery Depreci
ation on Plant and Machinery Repairs to Plant Wages Salaries Income Tax of Mr. X
Cash in Hand and at Bank Land and Building Depreciation on Building Purchases P
urchase returns Sales Bank Overdraft Accrued Income Salaries Outstanding Bills R
eceivable Provision for Bad Debts Bills Payable Bad Debts Discount on Purchases
Debtors Creditors Opening Stock 7,400 70,820 Information 70,820 200 708 7,000 6,
252 300 400 3,000 1,000 1,600 Dr. Rs. 3,600 400 520 5,400 2,100 100 400 14,900 5
00 25,000 300 49,800 760 Cr. Rs. 10,000
a. b. c. d.
Stock as on 31st March 1998 was Rs. 6,000 Write off further Rs. 600 for bad Debt
and maintain a provision for bad Debts at 5% on Debtors. Goods costing Rs. 1,00
0 were sent to customer for Rs. 1,200 on 30th March 1998 on sale or return basis
. This was recorded as actual sales. Rs. 240 paid as rent of the office were deb
ited to Landlord Account and were included in the list of Debtors. 59
Process of Accounting

e. f.
General Manager is to be given commission at 10% of net profits after charging t
he commission of works manager and his own. Works manager is to be given commiss
ion at 12% of net profits before charging the commission of General Manager and
his own.
Solution Trading Account for the year ended on 31st March 1998
Particulars Opening Stock Purchases Less : Returns 25,000 300 24,700 Closing Sto
ck Wages Gross Profit c/fd 5,400 18,100 Add : Goods on approval 6,000 1,000 7,00
0 Amount 7,400 Particulars Sales Less : Goods on approval 49,800 1,200 48,600 Am
ount
Total
55,600
Total
55,600
Profit & Loss Account for the year ended on 31st March 1998 Particulars Salaries
Depreciation on Plant Depreciation on Building Repairs to Plant Rent Bad Debts
200 Add : Additional Bad Debts 600 Add : Provision for Bad Debts 248 Less : Exis
ting Provision 1000 48 1,800 1,200 12,000 18,808 Total 18,808 Amount 2,100 400 5
00 520 240 Particulars Gross Profit b/fd Discount Amount 18,100 708
Commission to Works Manager Commission to General Manager Profit transferred to
Capital A/c Total
60
Management Accounting

Balance Sheet as on 31st March 1998 Capital & Liabilities Capital Balance Add :
Profit for year Less : Income Tax 10,000 12,000 100 21,900 Current Liabilities C
reditors Bills Payable Overdraft Outstanding Salaries Commission Payable 6,252 1
,600 760 400 3,000 Current Assets Closing Stock (Including stock on Approval) Ca
sh Debtors Less : Bad Debts Less : Goods on approval Less : Due from Landlord 7,
000 600 1,200 240 4,960 Less: Provision for Bad Debt 248 Bills Receivables Accru
ed Income Total Working Notes : Rs. Profit before calculating the commission 15,
000 33,912 Total 4,712 3,000 300 33,912 400 7,000 18,500 Amount Assets & Propert
ies Fixed Assets Plant & Machinery Building 3,600 14,900 Amount
Commission payable to Works Manager @12% Commission payable to General Manager o
n Commission payable to General Manager @10% (Calculated as 13200 / 110 x 100) I
llustration 3
1,800 13,200 1,200
The following Trial Balance is of Shri Om as on 31st March 1991. You are request
ed to prepare the Trading and Profit & Loss Account for the year ended 31st Marc
h 1991 and a Balance Sheet as on that date after making the necessary adjustment
s.
Process of Accounting
61

Particulars Sundry Debtors Sundry Creditors Outstanding Liabilities for Expenses


Wages Carriage Outwards Carriage Inwards General Expenses Cash Discount Bad Deb
ts Motor Car Printing and Stationery Furniture and Fittings Advertisement Insura
nce Salesmans Commission Postage and Telephones Salaries Rates and Taxes Drawings
Capital Account Purchases Sales Stock as on 1st April 1990 Cash at Bank Cash in
Hand
Dr. Rs. 5,00,000
Cr. Rs.
2,00,000 55,000 1,00,000 1,10,000 50,000 70,000 20,000 10,000 2,40,000 15,000 1,
10,000 85,000 45,000 87,500 57,500 1,60,000 25,000 20,000 14,43,000 15,50,000 19
,87,500 2,50,000 60,000 10,500
36,30,500 The following adjustments are to be made a. b. Stock as on 31st March
1991 was valued at Rs. 7,25,000.
36,30,500
A provision for Bad and Doubtful Debts are to be made to the extent of 5% on Sun
dry Debtors.
62
Management Accounting

c. d. e.
Depreciate Furniture & Fixture by 10% and Motor Car by 20%. Shri Om had withdraw
n goods worth Rs. 25,000 during the year. Sales include goods worth Rs. 75,000 s
ent out to Santi & Company on approval and remaining unsold on 31st March 1991.
The cost of the goods was Rs. 50,000. The salesman was entitled to a commission
of 5% on total sales. Debtors include Rs. 25,000 bad debts. Printing and Station
ery expenses of Rs. 55,000 relating to 1989-90 had not been provided in that yea
r but were paid in this year by debiting outstanding liabilities. Purchases incl
ude purchases of furniture worth Rs. 50,000.
f. g. h.
i.
Solution Trading Account for the year ended on 31st March 1991
Particulars Opening Stock Purchases Less : Furniture purchased Wages Carriage In
wards Gross Profit c/fd Total 1550000 50000 15,00,000 Closing Stock 1,00,000 Add
: Goods on approval 50,000 Goods withdrawn 8,12,500 27,12,500 Total 27,12,500 2
5,000 725000 50000 7,75,000 Amount Particulars 1987500 75000 19,12,500 Less : Go
ods on approval Amount
2,50,000 Sales
Process of Accounting
63

Profit & Loss Account for the year ended on 31st March 1991
Particulars Salaries Carriage Outwards Advertisement Insurance Salesmans Commissi
on Postage & Telephones Rates & Taxes Bad Debts Add : Additional Bad Debts 10000
25000 55,000 70,000 20,000 15,000 64,000 55,000 Total 8,57,125 Total 8,57,125 A
mount 1,10,000 85,000 Loss transferred to Capital A/c 45,000 95,625 57,500 25,00
0 44,625 Particulars Amount 8,12,500
1,60,000 Gross Profit b/fd
Add : Provision for Bad Debts 20000 General Expenses Cash Discount Printing & St
ationery Depreciation Previous Year Expenses
Balance Sheet as on 31st March 1991
Capital & Liabilities Capital Balance Less : Loss for year Less : Drawings Less
: Goods withdrawn Amount Assets & Properties Fixed Assets 14,43,000 Motor Car 44
,625 Less : Depreciation 20,000 25,000 Furniture Add : Purchases 13,53,375 Less
: Depreciation Current Liabilities Creditors Outstanding Commission 8,125 Curren
t Assets 2,00,000 Closing Stock (Including stock on Approval) Cash at Bank Cash
in Hand Debtors Less : Bad Debts Less : Goods on approval Less: Bad Debt Provisi
on 500000 25000 75000 400000 20000 3,80,000 60,000 10,500 7,75,000 110000 50000
16000 1,44,000 240000 48000 1,92,000 Amount
Total
15,61,500
Total
15,61,500
64
Management Accounting

Illustration 4 The following is the Trial Balance of Hari as at 31st December 19


94 Particulars Haris Capital Account Stock as on 1st January 1994 Sales Returns I
nwards Purchases Returns Outwards Carriage Inward Rent and taxes Salaries and Wa
ges Sundry Debtors Sundry Creditors Bank Loan @14% Bank Interest Printing and St
ationery Bank Balance Discount Earned Furniture and Fitting Discount Allowed Gen
eral Expenses Insurance Postage and Telegram Cash Balance Travelling Expenses Dr
awings 5,000 1,800 11,450 1,300 2,330 380 870 30,000 5,11,330 The following adju
stments are to be made a. Included among the Debtors is Rs. 3,000 due from Ram a
nd included among the Creditors Rs. 1,000 due to him. 5,11,330 1,100 14,400 8,00
0 4,440 19,600 4,700 9,300 24,000 14,800 20,000 8,600 3,21,700 5,800 46,800 3,89
,600 Dr. Rs. Cr. Rs. 76,690
Process of Accounting
65

b.
Provision for Bad and Doubtful Debts to be created at 5% and for Discount @2% on
Sundry Debtors. Depreciation on Furniture and Fitting @10% should be written of
f. Personal purchases of Hari amounting to Rs. 600 had been recorded in the Purc
hases Day Book. Interest on Bank Loan shall be provided for the whole year. A qu
arter of the amount of Printing and Stationary expenses is to be carried forward
to the next year. Credit Purchase Invoice amounting to Rs. 400 had been omitted
from the book. Stock as on 31st December 1994 was Rs. 78,600.
c. d.
e. f.
g. h.
Prepare Trading and Profit & Loss Account for the year ended on 31st December, 1
994 and the Balance Sheet as on that date.
Solution Trading Account for the year ended on 31st December, 1994
Particulars Opening Stock Purchases Less : Personal purchases Add : Unrecorded p
urchases Less : Returns Outwards 321700 600 400 5800 3,15,700 Closing Stock 78,6
00 Amount Particulars 389600 8600 3,81,000 Amount
46,800 Sales Less : Returns Inwards
Carriage Inwards
19,600
Gross Profit c/fd
77,500
Total
4,59,600
Total
4,59,600
66
Management Accounting

Profit & Loss Account for the year ended on 31st December 1994
Particulars Salaries and Wages Rent and Taxes Bank Interest Add : Outstanding Pr
inting and Stationery Less : Prepaid Discount Allowed General Expenses Insurance
Postage and Telegram Travelling Expenses Provision for Bad Debts Discount on De
btors Depreciation Profit transferred to Capital A/c 1100 1700 14400 3600 10,800
1,800 11,450 1,300 2,330 870 1,150 437 500 34,503 2,800 Amount Particulars Amou
nt 77,500 4,440
9,300 Gross Profit b/fd 4,700 Discount Earned
Total
81,940
Total
81,940
Balance Sheet as on 31st December, 1994
Capital & Liabilities Capital Balance Add : Profit for year Less : Personal Purc
hases Less : Drawings Amount Assets & Properties Fixed Assets 76,690 Furniture &
Fitting 34,503 Less : Depreciation 600 30,000 Current Assets Closing Stock 80,5
93 Prepaid Printing & Stationary Bank Balance Current Liabilities Creditors Add
: Unrecorded Purchases Less : Due to Ram 14800 400 1000 14,200 Less: Bad Debt Pr
ovision Outstanding Interest 1,700 Less: Discount Bank Loan Total 20,000 1,16,49
3 Total 1,16,493 Cash in Hand Debtors Less: Due to Ram 24000 1000 23000 1150 218
50 437 21,413 78,600 3,600 8,000 380 5000 500 4,500 Amount
Process of Accounting
67

Illustration 5 From the following trial balance and information, prepare Trading
and Profit & Loss Account of Mr. Rishabh for the year ended 31st march 1999 and
a Balance Sheet as on that date. Particulars Capital Drawings Land and Building
Plant and Machinery Furniture Sales Returns outwards Debtors Loan from Gajanand
on 1.7.98 @6% p.a. Purchases Returns Inward Carriage Sundry Expenses Printing a
nd Stationery Insurance Expenses Provision for bad and doubtful Debts Provision
for Discount on Debtors Bad Debts Profit of textile Department Stock of General
Goods on 1st April, 1998 Salaries and wages Creditors Trade Expenses Stock of Te
xtile Goods on 31st March, 1999 Cash at Bank Cash in Hand 800 8,000 4,600 1,280
21,300 18,500 12,000 400 10,000 80,000 5,000 10,000 600 500 1,000 1,000 380 18,4
00 30,000 12,000 90,000 20,000 5,000 1,40,000 4,000 Dr. Rs. Cr. Rs. 1,00,000
2,97,380
2,97,380
68
Management Accounting

Information a. b. Stock of General Goods on 31st March, 1999 valued at Rs. 27,30
0. Fire occurred on 23rd March, 1999 and Rs. 10,000 worth of general goods were
destroyed. The insurance company accepted claim for Rs. 6,000 only and paid the
claim money on 10th April, 1999. Bad Debts amounting to Rs. 400 are to be writte
n off. Provision for bad and Doubtful Debts is to be made at 5% and for discount
at 2%. Received Rs. 6,000 worth of goods on 27th March ,1999, but the invoice o
f purchase was not recorded in Purchase Book. Rishabh took away goods worth Rs.
2,000 for personal use but no record was made thereof. Charge depreciation at 2%
on Land and Building, 20% on Plant and Machinery and 5% on Furniture. Insurance
prepaid amounted to Rs. 200.
c.
d. e.
f.
g.
Solution Trading Account for the year ended on 31st March, 1999
Particulars Opening stock of General Goods Purchases Less : Return Outwards Add
: Unrecorded Purchases 80000 4000 6000 82,000 Goods withdrawn Goods destroyed by
fire Carriage 10,000 Closing Stock of General Goods Gross Profit c/fd 61,000 27
,300 2,000 10,000 Amount Particulars 140000 5000 1,35,000 Amount
21,300 Sales Less : Return Inwards
Total
1,74,300
Total
1,74,300
Process of Accounting
69

Profit & Loss Account for the year ended on 31st March 1999
Particulars Salaries & Wages Sundry Expenses Printing & Stationery Insurance Les
s : Prepaid Bad Debts Add : Additional Bad Debts Trade Expenses Depreciation Los
s by Fire Interest on Loan Profit carried to Capital A/c 1000 200 400 400 800 Di
scount on Debtors 800 Less : Existing 6,050 4,000 1,350 37,738 342 380 38 Amount
Particulars Amount 61,000 10,000 900 1000 100
18,500 Gross Profit b/fd 600 Profit of Textile Department 500 Provision for Bad
Debts 800 Less : Existing
Total
71,138
Total
71,138
Balance Sheet as on 31st March, 1999
Capital & Liabilities Capital Balance Less : Drawings Less : Goods withdrawn Add
: Profit for year Loan from Gajanand Current Liabilities Creditors Add : Unrecor
ded Purchases Outstanding Interest on Loan 12000 6000 18,000 Current Assets Stoc
k of General Goods Stock of Textile Goods 1,350 Sundry Debtors Less : Bad Debts
Less : Bad Debts Provision Less : Discount Cash at Bank Cash in Hand Prepaid Ins
urance Receivable from Insurance Company Total 1,73,088 Total 18400 400 18000 90
0 17100 342 16,758 4,600 1,280 200 6,000 1,73,088 27,300 8,000 100000 12000 2000
37738 Amount Assets & Properties Fixed Assets Land & Building Less: Depreciatio
n Plant & Machinery 1,23,738 Less : Depreciation Furniture 30,000 Less : Depreci
ation 90000 1800 20000 4000 5000 250 4,750 16,000 88,200 Amount
70
Management Accounting

Illustration 6 Hira and Manik are partners in a firm sharing profits and losses
in equal proportion. Following is the Trial Balance as at 31st March, 1989. Debi
t Balances Plant & Machinery Opening Stock Purchases Land & Building Carriage In
wards Carriage Outwards Wages Sundry Debtors Salaries Furniture Trade Expenses R
eturn Inwards Advertisement Suspense Discount Partners Drawings Hira Manik Bills
Receivable Insurance Bad Debts Cash at Bank Total 3,000 2,000 20,000 1,200 1,000
5,000 3,97,750 Total 3,97,750 Rs. 50,000 30,000 80,000 85,000 1,700 2,500 16,00
0 50,000 12,000 18,000 6,000 950 12,500 900 Credit Balance Sales Discount Sundry
Creditors Bills Payable Hiras Loan Account Capital Accounts Hira Manik 50,000 25
,000 Rs. 2,40,000 2,000 20,000 10,750 50,000
You are required to prepare Trading and Profit & Loss Account of the firm for th
e year ended on 31st March 1989 and the Balance Sheet on that date after taking
into consideration following adjustments a. b. Closing Stock Rs. 45,000. Depreci
ate Plant @10% and Furniture @20%. Appreciate Land and Building to Rs. 90,000. B
ad Debts Reserve to be raised to 2.5% on Sundry Debtors.
c.
Process of Accounting
71

d. e.
Advertisement Suspense Account to be written off against revenue over five years
. Partners Drawings are to bear interest @10% p.a. Amounts were withdrawn on 31st
December, 1988. Annual charges for insurance Rs. 1,000. Balance represents amou
nt paid in advance. Hira gave loan to the firm on 30th September, 1988 which car
ries the interest @6% p.a. Manik was to be allowed a salary of Rs. 250 per month
. The partners agree to contribute 50% of the distributable profit to the Nation
al Defence Fund.
f. g. h. i.
Solution Trading Account for the year ended on 31st March, 1989
Particulars Opening Stock Purchases Carriage Inwards Wages Amount Particulars 24
0000 950 2,39,050 45,000 Amount
30,000 Sales 80,000 Less : Returns Inwards 1,700 Closing Stock 16,000
Gross Profit c/fd
1,56,350
Total
2,84,050
Total
2,84,050
Profit & Loss Account for the year ended on 31st March, 1989
Particulars Salaries Trade Expenses Carriage Outwards Insurance Less : prepaid D
iscount Bad Debts Bad Debts Reserve Advertisement Salary Payable to Manik Intere
st on Loan from Hira Depreciation Sub-Total 1200 200 1,000 900 1,000 Appreciatio
n of Land & Building 1,250 2,500 3,000 1,500 8,600 40,250 5,000 Amount Particula
rs Amount 1,56,350 2,000 75 50
12,000 Gross Profit b/fd 6,000 Discount Received 2,500 Interest on Drawings Hira
Manik
72
Management Accounting

Particulars Contribution to National Defence Fund Transferred to Capital Account


Hira Manik Total
Amount 61,613
Particulars
Amount
30,806 30,806 1,63,475 Total 1,63,475
Balance Sheet as on 31st March, 1989
Capital & Liabilities Capital Hiras Capital Add : Profit for year Less : Drawings
Less : Interest on Drawings 50000 30806 3000 75 Amount Assets & Properties Fixe
d Assets Land & Building Add : Appreciation Plant & Machinery 77,731 Less : Depr
eciation Furniture Less : Depreciation Maniks Capital Add : Profit for year Add :
Salary Less : Drawings Less : Interest on Drawings 25000 30806 3000 2000 50 Cur
rent Assets Closing Stock Sundry Debtors 56,756 Less : Bad Debt Reserve Bills re
ceivables Hiras Loan Account Current Liabilities Sundry Creditors Bills Payable I
nterest on Hiras Loan Account Contribution to National Defence Fund 20,000 Advert
isement Suspense 10,750 Less : Transferred to revenue 1,500 61,613 12500 2500 10
,000 50,000 Cash at Bank Prepaid Insurance 50000 1250 48,750 20,000 5,000 200 45
,000 85000 5000 50000 5000 18000 3600 14,400 45,000 90,000 Amount
Total
2,78,350
Total
2,78,350
Illustration 7 Following is the Trial Balance of M/s. Pandit Brothers, a partner
ship firm, as on 31st March, 1992.
Process of Accounting
73

Particulars Capital Account H. Pandit Capital Account K. Pandit Drawings H. Pand


it Drawings K. Pandit Buildings Furniture Purchases Sales Stock (1st April, 1991
) Wages Rates and Taxes Office Expenses Salaries Sundry Debtors Sundry Creditors
Cash in Hand Bank Overdraft Carriage Inwards
Dr. Rs.
Cr. Rs. 1,00,000 1,00,000
16,000 16,000 80,000 20,000 2,00,000 3,00,000 50,000 44,000 1,600 10,000 50,000
25,000 12,000 400 29,000 28,000
Total
5,41,000
5,41,000
Following further information relating to the firm is made available a. b. c. d.
e. Stock at the end of the year on 31st march, 1992 was Rs. 1,14,500 There was
a fire in the premises on 26th November, 1991 which damaged a portion of stock a
nd the loss was estimated at Rs. 17,500. H. Pandit is in charge of purchases and
is to be paid 2.5% commission on such purchases. A steel table purchased on 1st
February, 1992 for Rs. 3,000 was debited to purchases account. K. Pandit who lo
oks after all other business aspects except purchases is entitled to a commissio
n of 5% on net profits after charging commission on purchases due to H. Pandit a
nd commission payable to himself. Depreciation on Buildings @2.5% and on Furnitu
re @10% Profits or losses are shared equally.
Management Accounting
f. g. 74

You are required to prepare Trading and Profit & Loss Account for the year ended
on 31st March, 1992 and the Balance Sheet on that date. Solution Trading Accoun
t for the year ended on 31st March 1992
Particulars Opening Stock Purchases Less : Table Purchased Wages Carriage Inward
s Commission on purchases Gross Profit c/fd 200000 3000 1,97,000 Closing Stock 4
4,000 28,000 Stock destroyed by fire 4,925 1,08,075 17,500 1,14,500 Amount Parti
culars Amount 3,00,000
50,000 Sales
Total
4,32,000
Total
4,32,000
Profit & Loss Account for the year ended on 31st March 1992
Particulars Salaries Rates and Taxes Office Expenses Stock destroyed by fire Dep
reciation Amount 1,600 10,000 17,500 4,050 83,150 Commission to K. Pandit 1,187
Particulars Amount 1,08,075
50,000 Gross Profit b/fd
Profit transferred to Capital Account H. Pandit K. Pandit 11,869 11,869
Total
1,08,075
Total
1,08,075
Process of Accounting
75

Balance Sheet as on 31st March, 1992


Capital & Liabilities Capital H. Pandit Capital Add : Profit for year Add: Commi
ssion Less : Drawings 100000 11869 4925 16000 Amount Assets & Properties Fixed A
ssets Building Less : Depreciation Furniture 1,00,794 Add : Purchases Less : Dep
reciation K. Pandit Capital Add : Profit for year Add: Commission Less : Drawing
s 100000 11869 1187 16000 Current Assets Closing Stock 97,056 Sundry Debtors Cas
h in Hand Current Liabilities Sundry Creditors Bank Overdraft 12,000 29,000 1,14
,500 25,000 400 80000 2000 20000 3000 2050 20,950 78,000 Amount
Total
2,38,850
Total
2,38,850

Note Commission payable to K. Pandit is calculated as below (108075 83150) x


ration 8 The following is the Trial Balance of Shri Arihant as on 31st December
1999. Particulars Capital Drawings Opening Stock Purchases Freight on purchases
Wages Sales Salaries 1,00,000 75,000 80,000 16,20,000 15,000 1,10,000 25,00,000
Dr. Rs. Cr. Rs. 14,00,000
76
Management Accounting

Particulars Travelling Expenses Miscellaneous Expenses Printing and Stationery A


dvertisement Expenses Postage and Telegram Discounts Bad Debts written off (afte
r adjusting recovery of bad debts of Rs. 6,000 written off in 1997) Building Mac
hinery Furniture Debtors Provision for Doubtful Debts Creditors Investments (12%
Purchased on 1st October, 1999) Bank Balance
Dr. Rs. 23,000 35,000 27,000 25,000 13,000 7,600
Cr. Rs.
14,500
14,000 10,00,000 75,000 40,000 1,50,000 19,000 1,60,000 6,00,000 83,900
40,93,500 Adjustments a. b. c. Closing Stock Rs. 2,25,000.
40,93,500
Goods worth Rs. 5,000 were taken for personal use but no entry was made in the b
ooks. Machinery worth Rs. 35,000 purchased on 1st January, 1997 was wrongly writ
ten off against Profit & Loss Account. This asset is to be brought into account
on 1st January, 1999 taking depreciation at 10% per annum on straight line basis
upto 31st December, 1998. Depreciation Building at 2.5%, Machinery at 10% and F
urniture at 10%. Provision for Doubtful Debts should be 6% on Debtors. The manag
er is entitled to a commission of 5% of net profits after charging his commissio
n.
d. e. f.
Prepare Trading and Profit & Loss Account for the year ending 31st December, 199
9 and a Balance Sheet as on that date.
Process of Accounting
77

Solution Trading Account for the year ended on 31st December, 1999
Particulars Opening Stock Purchases Freight on purchases Wages Gross Profit c/fd
Total Amount 16,20,000 15,000 Goods withdrawn 1,10,000 Closing Stock 9,05,000 2
7,30,000 Total 27,30,000 2,25,000 5,000 Particulars Amount 25,00,000
80,000 Sales
Profit & Loss Account for the year ended on 31st December 1999
Particulars Salaries Travelling Expenses Miscellaneous Expenses Printing & Stati
onery Advertisement Expenses Postage and Telegram Discount Bad Debts Depreciatio
n Sub-Total Commission to Manager Profit transferred to Capital A/c Amount Parti
culars Amount 9,05,000 6,000 9000 19000 10,000 18,000 14,500
1,00,000 Gross Profit b/fd 23,000 Bad Debts recovered 35,000 Provision for bad D
ebts 27,000 Less : Existing 25,000 Income from investments 13,000 Discount Recei
ved 7,600 20,000 40,000 2,90,600 31,567 6,31,333
Total
9,53,500
Total
9,53,500
78
Management Accounting

Balance Sheet as on 31st December, 1999


Capital & Liabilities Capital Balance b/fd Less : Drawings Less : Goods withdraw
n Add : Profit for year Add : Machine capitalized 1400000 75000 5000 631333 2800
0 Amount Assets & Properties Fixed Assets Building Less : Depreciation Machinery
Add : Capitalized 19,79,333 Less : Depreciation Furniture Less : Depreciation C
urrent Liabilities Sundry Creditors Commission to Manager 1,60,000 Investments 3
1,567 Current Assets Closing Stock Debtors Less : Bad Debt Provision Bank Balanc
e Investment Income outstanding 150000 9000 1,41,000 83,900 18,000 2,25,000 6,00
,000 1000000 25000 75000 28000 11000 40000 4000 36,000 92,000 9,75,000 Amount
Total
21,70,900
Total
21,70,900
Note Value of machine purchased Rs. 35,000. Depreciation for 1997 and 1998 Rs. 7
,000. Value of machine to be capitalized Rs. 28,000. Depreciation for 1999 on th
is machine Rs. 3,500.
Process of Accounting
79

Illustration 9 Following is the Trial Balance of K as on 31st March, 2000. Parti


culars Capital Drawings Opening Stock Purchases Freight on Purchases Wages (11 m
onths up to 29th February, 2000) Sales Salaries Postage, Telegrams, Telephones P
rinting and Stationery Miscellaneous Expenses Creditors Investments Discount Rec
eived Debtors Bad Debts Provision for Bad Debts Building Machinery Furniture Com
mission on sales Interest on Investments Insurance (Year up to 31st July 2000) B
ank Balance 24,000 1,50,000 34,45,000 34,45,000 3,00,000 5,00,000 40,000 45,000
12,000 2,50,000 15,000 8,000 1,00,000 15,000 1,40,000 12,000 18,000 30,000 3,00,
000 60,000 75,000 15,95,000 25,000 66,000 23,10,000 Dr. Rs. Cr. Rs. 8,00,000
80
Management Accounting

Adjustments a. b. Closing Stock Rs. 2,25,000. Machinery worth Rs. 45,000 purchas
ed on 1st October, 1999 was shown as purchases. Freight paid on the machinery wa
s Rs. 5,000 which is included in the freight on purchases. Commission is payable
on sales @2.5% on sales. Investments were sold at 10% profit, but the entire sa
le proceeds have been taken as sales. Write off Bad Debts Rs. 10,000 and create
a provision for Doubtful Debts at 5% of Debtors. Depreciate building by 2.5% p.a
. and Machinery and Furniture at 10% p.a.
c. d.
e.
f.
Prepare Trading and Profit & Loss Account for the year ended on 31st March, 2000
and the Balance Sheet on that date. Solution Trading Account for the year ended
on 31st March 2000
Particulars Opening Stock Purchases Less: Machine Purchased Freight on Purchases
Less : Freight on Machinery Wages Add : Outstanding 1595000 45000 25000 5000 66
000 6000 72,000 20,000 15,50,000 Closing Stock 2,25,000 Amount Particulars 23100
00 110000 22,00,000 Amount
75,000 Sales Less : Sale of Investments
Gross Profit c/fd Total
7,08,000 24,25,000 Total 24,25,000
Process of Accounting
81

Profit & Loss Account for the year ended on 31st March 2000
Particulars Salaries Postage, Telegrams, Telephones Printing and Stationery Misc
ellaneous Expenses Bad Debts Add : Additional Provision for Bad Debts Less : Exi
sting Provision Commission on Sales Add : Outstanding Insurance Less : prepaid D
epreciation Profit transferred to Capital A/c Total 15000 10000 12000 8000 45000
10000 24000 8000 16,000 64,000 3,81,000 7,45,000 Total 7,45,000 55,000 4,000 25
,000 Amount Particulars Amount 7,08,000 15,000 12,000 10,000
1,40,000 Gross Profit b/fd 12,000 Discount Received 18,000 Interest on Investmen
ts 30,000 Profit on sale of Investments
Balance Sheet as on 31st March, 2000
Capital & Liabilities Capital Balance b/fd Add : Profit for year Less : Drawings
800000 381000 60000 Amount Assets & Properties Fixed Assets Building Less: Depr
eciation 11,21,000 Machinery Add : Purchased Less: Depreciation Furniture Curren
t Liabilities Creditors Sales Commission outstanding Wages Outstanding 3,00,000
10,000 Current Assets 6,000 Closing Stock Debtors Less : Bad Debts Less : Bad De
bts Provision Bank Balance Prepaid Insurance 250000 10000 240000 12000 2,28,000
1,50,000 8,000 2,25,000 Less : Depreciation 300000 7500 500000 50000 52500 40000
4000 36,000 4,97,500 2,92,500 Amount
Total
14,37,000
Total
14,37,000
82
Management Accounting

Illustration 10 From the following particulars extracted from the books of Gangu
li, prepare Trading and Profit & Loss Account for the year ended on 31st March 1
994 and Balance Sheet on that date after making the necessary adjustments. Debit
Balances Opening Stock Sales Returns Purchases Carriage Inwards Rent Salaries S
undry Debtors Printing & Stationery Interest Paid Advertisement Cash at Bank Inv
estments at 5% on 1.4.93 Furniture on 1.4.93 Discount Allowed General Expenses A
udit Fees Fire Insurance Premium Travelling Expenses Postage & Telegrams Cash on
Hand Deposits @10% on 1.4.93 Drawings Rs. 23,400 4,300 1,21,550 9,300 2,850 4,6
50 12,000 1,700 450 5,600 4,000 2,500 900 3,770 1,960 350 300 1,165 435 190 15,0
00 5,000 Credit Balance Capital Sales Purchases Returns Sundry Creditors Loan fr
om Bank @12% Interest Received Discount Received Rs. 54,050 1,44,800 2,900 7,400
10,000 725 1,495
Total Adjustments a.
2,21,370
Total
2,21,370
Value of stock as on 31st March, 1994 is Rs. 39,300. This includes goods returne
d by customers on 31st March, 1994 of the value of Rs. 1,500 for which on entry
has been passed in the books. 83
Process of Accounting

b. c. d.
Purchases include furniture purchased on 1st January 1994 for Rs. 1,000. Depreci
ation should be provided on furniture @10% p.a. Bank Loan as on 1st April, 1993
was Rs. 5,000. An amount of Rs. 5,000 was borrowed on 31st March, 1994. Sundry D
ebtors include Rs. 2,000 due from Robert and Sundry Creditors include Rs. 1,000
due to him. Interest paid includes Rs. 300 paid on the Bank Loan. Interest recei
ved represents Rs. 100 from the Sundry Debtors and the balance on investments an
d deposits. Provide for interest payable on Bank Loan and for interest receivabl
e on investments and deposits. Make a provision for doubtful debts @5% on the ba
lance under Sundry Debtors. No such provision is necessary for the deposits.
e.
f. g.
h.
i.
Solution Trading Account for the year ended on 31st March 1994
Particulars Opening Stock Purchases Less : Purchase Returns Less : Furniture Pur
chased Carriage Inwards Gross Profit c/fd 121550 2900 1000 1,17,650 9,300 27,950
Closing Stock 39,300 Amount Particulars 144800 1500 4300 1,39,000 Amount
23,400 Sales Less : Goods returned Less : Sales Returns
Total
1,78,300
Total
1,78,300
84
Management Accounting

Profit & Loss Account for the year ended on 31st March 1994
Particulars Salaries Rent Printing & Stationery Interest paid Add : Interest on
Bank Loan Advertisement Discount Allowed General Expenses Audit Fees Fire Insura
nce Premium Travelling Expenses Postage & Telegrams Depreciation Reserve for Bad
Debts Profit transferred to Capital A/c 450 300 750 5,600 3,770 1,960 350 300 1
,165 435 115 475 7,050 Amount Particulars 725 1000 1,725 1,495 Amount 27,950
4,650 Gross Profit b/fd 2,850 Interest Received 1,700 Add : Receivable Discount
received
Total
31,170
Total
31,170
Balance Sheet as on 31st March, 1994
Capital & Liabilities Capital Balance Less: Drawings Add : Profit for year 54050
5000 7050 Amount Assets & Properties Fixed Assets Furniture Add : Purchases 56,
100 Less : Depreciation Investments Loan from Bank 10,000 Current Assets Closing
Stock Current Liabilities Sundry Creditors Less : Due to Roberts Outstanding In
terest 7400 1000 Sundry Debtors Less : Due to Roberts 6,400 Less : Goods returne
d 300 Less : Bad Debts reserve Cash on Hand Cash at Bank Deposits Interest Recei
vable 12000 1000 1500 475 9,025 190 4,000 15,000 1,000 39,300 900 1000 115 1,785
2,500 Amount
Total
72,800
Total
72,800
Process of Accounting
85

QUESTIONS 1. 2. If the Trial Balance does not agree, what steps will you take to
ensure that it tallies? What do you mean by Final Accounts? Explain in brief th
e structure of Profitability Statement and Balance Sheet. What are the various c
omponents of Profit and Loss Account ? Explain the purpose of each component. Ho
w would you deal with the following while preparing the final accounts a. b. c.
d. e. f. Goods lost by fire Goods distributed as free samples Goods sent on appr
oval basis Bad Debts and Provision for Bad Debts Interest on Capital Prepaid Exp
enses and Outstanding Expenses
3.
4.
86
Management Accounting

PROBLEMS Q.1. The following is the Trial Balance of Shri Paras as on 31st March
1991. You are requested to prepare the Final Accounts after giving effect to the
adjustments. Particulars Sundry Creditors Sundry Debtors Capital Account Drawin
gs Insurance General Expenses Salaries Patents Machinery Freehold Land Building
Stock on 1st April 1990 Carriage on Purchases Carriage on Sales Fuel and Power W
ages Returns Outwards Returns Inwards Sales Purchases Cash at Bank Cash in Hand
4,06,750 26,300 5,400 17,65,800 The following adjustments are to be made a. b. S
tock as on 31st March, 1991 was valued at Rs. 68,000. A provision for Bad and Do
ubtful Debts is to be made to the extent of 5% on Sundry Debtors. Depreciate Mac
hinery @10% and Patents @20%. 17,65,800 6,800 9,87,800 52,450 6,000 30,000 1,50,
000 75,000 2,00,000 1,00,000 3,00,000 57,600 20,400 32,000 47,300 1,04,800 5,000
1,45,000 7,10,000 Dr. Rs. Cr. Rs. 63,000
c.
Process of Accounting
87

d. e. f.
Wages include a sum of Rs. 20,000 spent on erection of a cycle shed for employee
s and customers. Salaries for the month of March 1991 amounting to Rs. 15,000 we
re unpaid. Insurance includes a premium of Rs. 1,700 on a policy, expiring on 30
th September, 1991.
Q.2. Mr. A, a Shopkeeper had prepared the following trial balance from his ledge
r as on 31st March 1989. Particulars Purchases Sales Cash in Hand Cash in Bank S
tock of Goods on 1st April, 1988 Mr. As Capital Drawings Salaries Postage and Tel
ephone Salesmen Commission Insurance Advertising Furniture Printing and Statione
ry Motor Car Bad Debts Cash Discount General Expenses Carriage Inwards Carriage
Outwards Wages Creditors Debtors Dr. Rs. 6,20,000 8,30,000 4,200 24,000 1,00,000
5,77,200 8,000 64,000 23,000 70,000 18,000 34,000 44,000 6,000 96,000 4,000 8,0
00 60,000 20,000 44,000 40,000 80,000 2,00,000 14,87,200 14,87,200 Cr. Rs.
You are requested to prepare Trading and Profit & Loss Account for the year ende
d 31st March, 1989 and Balance Sheet as on that date. You are also given the fol
lowing further information
88
Management Accounting

a. b. c. d. e. f. g. h. i.
Cost of goods in stock as on 31st March, 1989 Rs. 1,45,000 Mr. A had withdrawn g
oods worth Rs. 5,000 during the year. Purchases include purchase of furniture wo
rth Rs. 10,000. Debtors include Rs. 5,000 Bad Debts. Creditors include a balance
of Rs. 4,000 to the credit of Mr. B in respect of which it has been decided and
settled with the party to pay only Rs. 1,000. Sales include goods worth Rs. 15,
000 sent to Ram & Co. on approval and remaining unsold as on 31st March 1989 and
the cost of goods was Rs. 10,000. Provision for bad debts is to be created at 5
% on Sundry Debtors. Depreciate furniture by 15% and Motor Car by 20% The salesm
en are entitled to a commission of 10% on total sales.
Q.3. From the following balances extracted from the books of Mr. Yellow, prepare
Trading and Profit & Loss Account for the year ended 31st December, 1990 and a
Balance Sheet as on that date. Particulars Purchases Mr. Yellows Capital Account
Computer at cost Cash at Bank Cash on Hand Sundry Creditors Bills Payable Accoun
t Furniture & Fittings Account at cost Rent Discount Received Bills Receivables
Account Trade Charges Sundry Debtors Sales Returns Outwards Drawings Account Ren
t Due Discount Wages Salaries Returns Inwards Dr. Rs. 71,280 18,380 4,000 2,836
13,000 10,220 1,540 12,540 22,000 6,720 920 34,156 60,720 11,432 5,200 320 540 1
,800 16,780 1,000 1,77,692 1,77,692 Cr. Rs. 60,000
Process of Accounting
89

Adjustments a. b. c. d. e. f. g. h. i. j. k. Closing Stock on 31st December, 199


0 was valued at cost Rs. 25,000 (Market Value Rs. 16,200) Rs. 6,000 paid to Mr.
Red against Bill Payable were debited by mistake to Mr. Greens Account and includ
ed in the list of Sundry Debtors. Travelling expenses paid to sales representati
ve Rs. 5,000 for the month of December 1990 were debited to his personal account
and included in the list of Sundry Debtors. Depreciation on furniture & fitting
s shall be provided at 10% per annum. Provide for doubtful debts at 5% on Sundry
Debtors. Goods costing Rs. 1,500 used by the proprietor. Salaries include Rs. 1
2,000 paid to sales representative who is further entitled to a commission of 5%
on net sales. Stationary charges Rs. 1,200 due on 31st December, 1990. Purchase
s include opening stock valued at Rs. 7,000 (cost price) Sales representative fu
rther entitled to an extra commission of 5% on net profit after charging his ext
ra commission. No depreciation need to be provided for computer as it had been p
urchased on 31st December, 1990 and not put to use.
Q.4. From the following trial balance of Hari and additional information, prepar
e Trading and Profit & Loss Account for the year ended 31st March, 1995 and a Ba
lance Sheet as on that date. Particulars Capital Furniture Purchases Debtors Int
erest Earned Salaries Sales Purchase returns Wages Rent Sales Returns Bad Debts
written off 20,000 15,000 10,000 7,000 30,000 3,21,000 5,000 20,000 1,50,000 2,0
0,000 4,000 Dr. Rs. Cr. Rs. 1,00,000
90
Management Accounting

Particulars Creditors Drawings Provision for Bad Debts Printing and Stationery I
nsurance Opening Stock Office Expenses Provision for Depreciation
Dr. Rs. 24,000
Cr. Rs. 1,20,000 6,000
8,000 12,000 50,000 12,000 2,000 5,58,000 5,58,000
Additional Information a. b. c. Depreciation furniture by 10% on original cost.
A provision for Doubtful Debts is to be created to the extent of 5% on Sundry De
btors. Salaries for the month of March 1995 amounting to Rs. 3,000 were unpaid w
hich must be provided for. However, salaries include Rs. 2,000 paid in advance.
Insurance amounting to Rs. 2,000 is prepaid. Provide for outstanding office expe
nses Rs. 8,000. Stock used for private purpose Rs. 6,000. Closing Stock in Trade
Rs. 60,000
d. e. f. g.
Q.5. The following is the Trial Balance of Shri Arihant as on 31st December, 199
9. Particulars Capital Drawings Opening Stock Purchases Freight on purchases Wag
es Sales Salaries 1,00,000 75,000 80,000 16,20,000 15,000 1,10,000 25,00,000 Dr.
Rs. Cr. Rs. 14,00,000
Process of Accounting
91

Particulars Travelling Expenses Miscellaneous Expenses Printing and Stationery A


dvertisement Expenses Postage and Telegram Discounts Bad Debts written off (afte
r adjusting recovery of bad debts of Rs. 6,000 written off in 1997) Building Mac
hinery Furniture Debtors Provision for Doubtful Debts Creditors Investments (12%
Purchased on 1 October 1999) Bank Balance
st
Dr. Rs. 23,000 35,000 27,000 25,000 13,000 7,600 14,000 10,00,000 75,000 40,000
1,50,000
Cr. Rs.
14,500
19,000 1,60,000 6,00,000 83,900
40,93,500 Adjustments a. b. c. Closing Stock Rs. 2,25,000.
40,93,500
Goods worth Rs. 5,000 were taken for personal use but no entry was made in the b
ooks. Machinery worth Rs. 35,000 purchased on 1st January, 1997 was wrongly writ
ten off against Profit & Loss Account. This asset is to be brought into account
on 1st January 1999 taking depreciation at 10% per annum on straight line basis
upto 31st December, 1998. Depreciation on Building at 2.5%, Machinery at 10% and
Furniture at 10%. Provision for Doubtful Debts should be 6% on Debtors. The Man
ager is entitled to a commission of 5% of net profits after charging his commiss
ion.
d. e. f.
Prepare Trading and Profit & Loss Account for the year ending 31st December, 199
9 and a Balance Sheet as on that date. Q.6. From the following information, you
are required to prepare Trading Account, Profit & Loss Account and Balance Sheet
as on 31st December, 1999 for SANPAT Co.
92
Management Accounting

Particulars Sundry Debtors Bills Receivables Goodwill Land & Building Plant & Ma
chinery Furniture Motors Telephone Bills Opening Stock Wages Advertisement Royal
ty Power & Fuel Legal Charges Audit Fees Lighting Salaries Repairs Purchases Ren
t Cash in Hand Depreciation Fund Outstanding Taxes Bills Payable Sundry Creditor
s Bank Overdraft Capital General Reserves Bank Loan Provident Fund Purchases Ret
urned Sales Bank Loan Outstanding Interest
Dr. Rs. 40,000 18,500 40,500 1,10,000 40,000 40,200 50,800 11,200 18,700 2,000 1
1,700 12,000 12,800 1,200 4,090 2,000 3,500 110 22,000 1,700 78,000
Cr. Rs.
8,000 1,800 2,200 4,700 3,200 1,50,000 38,000 1,00,000 40,000 1,000 1,20,500 50,
400 1,200 5,21,000 5,21,000
Process of Accounting
93

Adjustments a. b. c. d. e. f. g. Interest on Capital 10%. Closing Stock Rs. 75,0


00. Goods costing Rs. 8,000 lost by fire and insurance company admitted a claim
of Rs. 6,500. Depreciation on Motors 10%, Furniture 20%, Plant & Machinery 5%. P
rovide RDD 10% on Debtors. Outstanding Wages Rs. 1,000. Prepaid Telephone Bill R
s. 1,200.
Q.7. Following Trial Balance was taken out on 31st March, 1996 from the books of
Mr. Raman. You are required to prepare Trading and Profit & Loss Account for th
e year ended 31st March, 1996 and Balance Sheet as at that date, after making th
e necessary adjustments. Debit Balances Wages & Salaries Drawings Purchases Sale
s Returns Office Furniture Buildings Office Expenses Advertisement Opening Stock
Rent and Taxes Commission Bills receivables Travelling Expenses Trade Expenses
Bad Debts Sundry Debtors Cash in Hand Investments Fuel & Power (Factory) Total R
s. 6,000 2,000 18,000 300 4,000 12,000 800 500 5,000 400 200 800 250 350 190 11,
000 1,800 2,000 1,060 66,650 Total 66,650 Credit Balances Sales-Cash Sales-Credi
t Capital Discount earned Purchases Returns Provision for Bad Debts Sundry Credi
tors Bank Overdraft Income from Investments Rs. 8,000 18,000 34,000 340 460 1,50
0 2,800 1,300 250
94
Management Accounting

Adjustments a. b. c. d. e. f. Depreciation to be provided on Building and Furnit


ure @10%. Rent outstanding was Rs. 120. Provision for Doubtful Debts to be maint
ained at 5%. Interest accrued but not received was Rs. 50. Goods of the value of
Rs. 100 were given away as free samples. Closing Stock was valued at Rs. 8,200.
Q.8. From the following Trial Balance and adjustments, prepare Trading and Profi
t & Loss Account for the year ending 31st December 1997 and Balance Sheet as on
that date. Debit Balances Salaries Bad Debts Opening Stock Purchases Wages Commi
ssion Paid Carriage Outwards Octroi Machinery Additions on 1.7.97 Bank Goodwill
Cash Sundry Debtors Legal & Professional Fees 25000 12500 37,500 22,500 25,000 1
5,000 52,500 2,500 Rs. 16,500 1,500 12,500 87,500 5,000 250 2,500 7,000 Credit B
alances Commission Received Sales Interest Received Provision for Bad Debts Capi
tal Loan taken on 1.10.97 @12% p.a. Rs. 1,250 1,70,000 2,250 1,750 1,00,000 12,5
00
Total Adjustments 1. 2. 3.
2,87,750
Total
2,87,750
Closing stock was valued at cost Rs. 37,500. Outstanding salaries amounted to Rs
. 1,500. Commission received but not earned Rs. 250.
Process of Accounting
95

Q.9. From the following Trial Balance and adjustments, prepare Trading and Profi
t & Loss Account for the year ending 31st December, 1997 and Balance Sheet as on
that date. Debit Balances Opening Stock Wages Carriage Salaries Bad Debts Purch
ases Return Inwards Plant & Machinery Furniture as on 1st January, 1997 Furnitur
e purchased 1.7.1997 Investments Patent Rights Cash in Hand Cash at Bank Sundry
Debtors Bills Receivables Postage and Telegrams Rs. 25,000 5,000 1,000 3,800 700
1,10,000 2,000 35,000 20,000 5,000 27,500 3,500 750 13,250 40,000 10,000 200 Cr
edit Balances Rent Received Commission Received Miscellaneous Income Bad Debts r
ecovered RDD Sales Return Outwards Bills Payable Capital Creditors Rs. 1,500 750
250 1,000 700 2,00,000 1,000 7,500 70,000 20,000
Total Adjustments 1. 2. 3. 4. 5.
3,02,700
Total
3,02,700
Write off Bad Debts Rs. 500 and create 5% RDD on Debtors. Salaries Outstanding R
s. 200. Unearned commission Rs. 50. Plant & Machinery and Furniture to be deprec
iated @10% p.a. Closing Stock Rs. 10,000.
Q.10. Melon and Lemon are partners sharing profits equally. From the following T
rial Balance and the additional information, prepare Trading and Profit & Loss A
ccount for the year ending 30th June, 1982 and Balance Sheet on that date.
96
Management Accounting

Debit Balances Drawings - Melon - Lemon Land & Building Machinery Salaries Motor
Car Trade Expenses Carriage Inward Royalties Purchases Return Inwards Debtors D
iscounts Insurance Stock on 1.7.81 Advertisement Cash at Bank
Rs. 2,000 3,500 36,000 18,000 3,700 10,500 1,900 400 1,800 45,300 2,500 24,600 1
,000 1,200 23,800 3,000 2,900
Credit Balances Capital - Melon - Lemon Sales Returns Bad Debts Reserve Creditor
s Commission Bank Loan taken 0n 1.1.82
Rs. 35,000 25,000 95,500 1,300 800 3,000 1,500 20,000
Total Additional Information a.
1,82,100
Total
1,82,100
Stock on 30th June, 1982 was worth Rs. 36,000 at cost while its market value was
Rs. 39,000 Goods worth Rs. 4,000 taken by Lemon for personal use were not enter
ed in the books of accounts. Of the debtors, Rs. 600 were bad and should be writ
ten off and reserve for doubtful debts should be maintained at 5%. 5% interest i
s to be allowed on capital. Provide for interest on bank loan @10% per annum. In
surance is paid for the year ending 31st December, 1982.
b.
c. d. e. f.
Process of Accounting
97

Q.11. From the Trial Balance of M/s. Hocus and Pocus, you are required to prepar
e Trading and Profit & Loss Account for the year ending 31st December 1982 and t
he Balance Sheet as on that date after taking into account the additional inform
ation. Partners share the profits and losses equally. Debit Balances Drawings Ho
cus Drawings Pocus Stock as on 1.1.82 Bills Receivables Purchases Returns Inward
s Plant and Machinery Furniture Sundry Debtors Cash in Hand and at Bank Salaries
Wages Rent and Taxes Insurance Printing and Stationary General Expenses Power a
nd Fuel Rs. 14,450 15,000 2,00,000 25,000 2,75,000 5,000 1,00,000 45,000 1,20,00
0 77,550 12,000 19,000 11,500 3,000 2,000 6,500 4,500 Credit Balances Capital Ho
cus Capital Pocus Sales Bills Payable Return Outwards Sundry Creditors Rs. 1,80,
000 1,50,000 4,00,000 61,000 4,500 1,40,000
Total Additional Information. a. b. c. d. e. f. g.
9,35,500
Total
9,35,500
Stock as on 31st December, 1982 was Rs. 1,60,000. It is discovered that sales ef
fected on 31st December, 1982 of the value of Rs. 2,000 has not been recorded in
the books. Stock worth Rs. 3,000 uninsured has been destroyed by fire. Deprecia
te Plant & Machinery by 20% and Furniture by 5% Provide for bad and doubtful deb
ts Rs. 6,000. Outstanding Expenses Salaries Rs. 2,500, Wages Rs. 1,000. Prepaid
insurance Rs. 500.
98
Management Accounting

Q.12. The Accountant of M/s. Kasturi Agencies extracted the following Trial Bala
nce as on 31st March, 1987. Particulars Capital Drawings Buildings Furniture Mot
or Van Bank Loan at 12% Interest Interest paid on above Sales Purchases Stock as
on 1.4.86 Stock as on 31.3.87 Establishment Expenses Freight Inwards Freight Ou
twards Commission Received Sundry Debtors Bank Balance Sundry Creditors 2,28,500
28,100 20,500 10,000 2.68,500 15,000 2,000 1,000 7,500 75,000 25,000 32,000 15,
000 7,500 25,000 15,000 400 1,00,000 Dr. Rs. Cr. Rs. 1,00,000 18,000
The Accountant located the following errors but is unable to proceed further any
more. a. b. c. A totalling error in bank column of payment side of cash book wh
ereby the column was undercast by Rs. 500. Interest on Bank loan paid for the qu
arter ending 31st December, 1986, Rs. 450, was omitted to be posted in the ledge
r. There was no further payment of interest. You are required to set right the T
rial Balance and prepare the Trading and Profit and Loss Account for the year en
ded on 31st March, 1987 and the Balance Sheet on that date, after carrying out t
he following 1. Depreciation is to be provided on the assets as follows :
l l l
Buildings 2.5% p.a. Furniture 10% p.a. Motor Van 10% p.a.
2.
Balance of interest due on the loan is also to be provided for. 99
Process of Accounting

NOTES
100
Management Accounting

Chapter 4
BANK RECONCILIATION STATEMENT
If the account is opened in a bank in the name of business, the bank periodicall
y gives the bank passbook or the bank statement. The bank passbook or the bank s
tatement is the extract of the account in the name of business as it appears in
the books of the bank. Similarly, in the books of business also, it maintains th
e bank book which is the extract of bank transactions as it appears in the book
of business. As both the bank book in the books of business and bank passbook as
per the books of bank record the same transactions, the balance as per bank boo
k should match with the balance as per passbook. However, in reality, the said b
alances may not match with each other. These balances may not match with each du
e to the following reasons 1. Cheques issued but not debited - The business migh
t have issued some cheques which are not yet presented in the bank for clearing.
As such, the balance as per bank pass book may be higher. Cheques deposited but
not cleared - The business might have deposited some cheques in the bank accoun
t, but the bank might not have received the payment for the same and hence the a
mount is not yet credited to the bank account. As such, balance as per bank book
may be higher. Other Reasons There may be a possibility that certain items may
appear only in the passbook without any corresponding effect of the same in the
bank book. This may be possible due to following reasons a. The bank debits peri
odical bank charges and bank interest to the account. These amounts appear only
in the bank passbook. The business organization makes the entry of the same on t
he receipt of intimation from the bank. Till the entry is passed in the bank boo
k, the bank book may show higher balance than the passbook. If the cheques depos
ited by the business organization get dishonoured, bank immediately debits the s
ame amount to the account. The business organization makes the entry of the same
on the receipt of intimation from the bank. Till the entry is passed in the ban
k book, the bank book may show higher balance than the passbook. 101
2.
3.
b.
Bank Reconciliation Statement

c.
In some cases, some of the customers of the business organization may make the p
ayment directly in the bank account of the business organization. The business o
rganization makes the entry of the same on the receipt of intimation from the ba
nk. Till the entry is passed in the bank book, the bank book may show lower bala
nce than the passbook. In some cases, the business organization may give the sta
nding instructions to the bank to make the recurring payments like rent, electri
city bills, telephone bills etc. as and when they become due for payment. Accord
ingly, the bank might have paid these amounts and on payment, they are debited t
o the account. The business organization makes the entry of the same on the rece
ipt of intimation from the bank. Till the entry is passed in the bank book, the
bank book may show higher balance than the passbook. In some cases, the bank is
given the responsibility of collecting the investment income or the principal am
ount of investment or the bills of exchanges on the date of maturity. Accordingl
y, the bank collects the same and credits the same to the account. The business
organization makes the entry of the same on the receipt of intimation from the b
ank. Till the entry is passed in the bank book, the bank book may show lower bal
ance than the passbook. There may be some clerical error on the part of bank whe
n certain amounts may be wrongly debited or credited by the bank to the account.
The business organization makes the entry of the same on the receipt of intimat
ion from the bank. Till the entry is passed in the bank book, the bank book may
show lower or higher balance than the passbook depending upon the nature of erro
r on the part of bank.
d.
e.
f.
Bank Reconciliation Statement is the statement prepared to explain the reasons a
s to why the bank balance as per passbook and bank balance as per bankbook does
not match. Preparation of Bank Reconciliation Statement The bank reconciliation
starts with the Closing Bank Balance as per Bank Book and by making the addition
s and subtractions therefrom, the Bank Balance as per the Bank Statement or Pass
Book is arrived at. Alternatively, the bank reconciliation statement may start
with Balance as per the Bank Statement or Pass Book and by making the additions
and subtractions therefrom, the Bank Balance as per the Bank Book may be arrived
at. For preparing the bank reconciliation statement, entries on the payment sid
e of Bank Book are compared with the withdrawal column of the Pass Book or Bank
Statement and the entries on the receipts side of Bank Book are compared with th
e deposits column of Bank Statement or Pass Book. If entries on the payment side
or receipt side of the Bank Book appear on the withdrawal or deposit column of
Bank Statement or Pass Book respectively, bank reconciliation statement
102
Management Accounting

does not get affected. Bank reconciliation statement is affected due to those am
ounts which appear on the payment side of Bank Book but are not there in the wit
hdrawals column of Bank Statement or Pass Book or amounts which appear on the re
ceipts side of Bank Book but are not there in the deposits column of Bank Statem
ent or Pass Book. Following is the specimen of bank reconciliation statement Ban
k Reconciliation Statement as on Bank Balance as per Bank Book Add : a. Cheques i
ssued but not presented b. Amount credited in Pass Book but not in Bank Book c.
Deposits made in the account directly d. Wrong credits given by bank Sub-Total L
ess : a. Cheques deposited but not cleared b. Interest/Bank Charges debited by b
ank c. Direct payments made by bank not entered in Bank Book d. Cheques dishonou
red not recorded in Bank Book e. Wrong debits given by bank Sub-Total Bank Balan
ce as per Bank Statement or Pass Book Following points should be remembered a. I
f the bank reconciliation statement is prepared by starting with Bank Balance as
per Bank Statement or Pass Book, amounts added in the above specimen need to be
subtracted and the amounts subtracted in the above specimen need to be added. b
. If the bank has given the overdraft facility, generally the Bank Book will sho
w closing balance as credit balance. If the bank reconciliation statement is pre
pared starting with bank balance as per Bank Book, amounts added in the above sp
ecimen need to be subtracted and the amounts subtracted in the above specimen ne
ed to be added. If the bank reconciliation statement prepared discloses the amou
nts for which the entries have not been made in the Bank book, those entries sho
uld be made in the books of accounts and the balance as per the Bank book should
be modified accordingly. 103
c.
Bank Reconciliation Statement

d.
After all the entries as disclosed by the bank reconciliation statement are pass
ed in the books of account, there will be mainly two amounts appearing in the fi
nal bank reconciliation statement viz. cheques issued but not presented for paym
ent and cheques deposited but not cleared. In some abnormal circumstances, the f
inal bank reconciliation statement may have the amounts which are wrongly debite
d or credited by the bank erroneously for which the bank needs to pass rectifica
tion entries subsequently. For the purpose of preparation of Trial Balance, bank
balance as per Bank Book will be considered and not the balance as per Bank Sta
tement or Pass Book.
e.
Illustration Following are the entries recorded in the Bank Column of the Cash B
ook of Mr. X for the month ending 31st March 1997. Cash Book (Bank Column only)
Date 15.3.97 20.3.97 22.3.97 31.3.97 Particulars To Cash To Roy To Kapoor To Bal
ance c/fd Rs. 36000 24000 10000 7640 Date 01.3.97 04.03.97 06.3.97 15.3.97 20.3.
97 Total 77640 Particulars By Balance b/fd By John By Krishnan By Kailash By Jos
hi Total Rs. 40000 2000 400 240 35000 77640
On 31st March, 1997, Mr. X received the Bank Statement. On perusal of the statem
ent, Mr. X ascertained the following information a. b. c. d. e. f. g. Cheques de
posited but not cleared by bank Rs. 10,000 Interest on securities collected by t
he bank but not recorded in cash book Rs. 1,080 Credit transfers not recorded in
the cash book Rs. 200 Dividend collected by the bank directly but not recorded
in the cash book Rs. 1,000 Cheques issued but not presented for payment Rs. 37,4
00 Interest debited by the bank but not recorded in the cash book Rs. 1,000 Bank
Charges not recorded in the cash book Rs. 340
From the above information you are asked to prepare a Bank reconciliation statem
ent to ascertain the balance as per Bank Statement.
104
Management Accounting

Solution Bank Reconciliation Statement as on 31st March, 1997 Bank Balance as pe


r Cash Book (Overdraft) Add : a. Cheques deposited but not cleared b. Interest d
ebited by bank not recorded in Cash Book c. Bank Charges debited by bank not rec
orded in Cash Book Sub-Total Less : a. Cheques issued but not presented b. Inter
est on securities collected by bank not Recorded on cash book c. Credit transfer
not recorded in cash book d. Dividend collected by bank not recorded in Cash Bo
ok Bank Balance as per Bank Statement (Overdraft) Illustration From the followin
g extracts of the cash book (bank column) and bank pass book of Mr.X, prepare th
e bank reconciliation statement for the month ending on 31st March, 1997. Cash B
ook (Bank Column only) Date 01.3.97 03.3.97 05.3.97 16.3.97 21.3.97 24.3.97 28.3
.97 29.3.97 31.3.97 Particulars To Balance b/fd To A To B To C To Interest To D
To E To F To G Total Rs. 8,680 1,200 1,620 600 700 1,200 3,500 2,200 2.800 22,50
0 Total 22,500 Date 02.3.97 03.3.97 08.3.97 12.3.97 21.3.97 24.3.97 28.3.97 31.3
.97 Particulars By Salaries & Wages By Interest on Loan By Bank Charges By X By
Y By Z By Drawings By Balance c/fd Rs. 3,250 80 5 1,500 200 1,350 800 15,315 1,0
00 39,680 20,700 1,080 200 37,400 340 11,340 18,980 10,000 1,000 7,640
Bank Reconciliation Statement
105

Extracts of Pass Book of Mr. X In the books of Bank of India, Karve Road Branch,
Pune Date 01.4.97 02.4.97 02.4.97 03.4.97 04.4.97 05.4.97 05.4.97 06.4.97 06.4.
97 07.4.97 07.4.97 Solution Bank Reconciliation Statement as on 31st March 1997
Bank Balance as per Bank Book Add : Cheques issued but not presented Mr. Z Mr. Y
Sub-Total Less : Cheques deposited but not cleared Mr. E Mr. D Mr. F Mr. G SubTotal Bank Balance as per Bank Statement or Pass Book 7,165 3,500 1,200 2,200 2,
800 9,700 1,350 200 1,550 16,865 15,315 Particulars Balance b/fd To Z By E By D
To Insurance Premium To M By Cash By F To Y By G To Interest 500 200 2,800 700 1
,200 1,000 2,200 1,350 3,500 1,200 Withdrawals Deposits Dr/Cr Cr Cr Cr Cr Cr Cr
Cr Cr Cr Cr Cr Balance 7,165 5,815 9,315 10,515 9,815 8,615 9,615 11,815 11,615
14,415 13,915
106
Management Accounting

Illustration Following particulars are extracted from the books of accounts of M


r. Bose for the month ending 31st March, 1989. a. b. c. Bank balance as per cash
book Rs. 7,000. Cheques issued but presented after 31st March, 1989 Rs. 1,000.
Three cheques were issued for Rs. 500, Rs. 1,000 and Rs. 1,500 respectively, but
the cheque for Rs. 1,000 was presented on 3rd April, 1989. Cheques issued but n
ot recorded in the cash book Rs. 750. Cheques deposited but credited after 31st
March, 1989 Rs. 250. Three cheques were deposited for Rs. 1,000, Rs. 1,200 and R
s. 1,600 respectively, but the cheque for Rs. 1,600 was credited on 2nd April. C
heques deposited into the bank but not recorded in the cash book Rs. 1,000. Debi
t side of the cash book was overcast by Rs. 500. Credit side of the cash book wa
s undercast by Rs. 800. Bank interest credited for Rs. 150 and debited for inter
est Rs. 50 not recorded in the cash book. Dividend collected by the bank not rec
orded in the cash book Rs. 1,000. A debtor directly deposited into bank but not
recorded in the cash book Rs. 500. Rs. 1,000 in respect of dishonoured cheques a
ppeared in the pass book but not in the cash book. Bank met a Bill Payable of th
e firm Rs. 1,500 on 30th March, 1989 under an advice to the firm on 2nd April, 1
989. Banks charges for a cheque book Rs. 5 were entered in the cash book twice. A
cheque for Rs. 50 drawn by Mr. Mukherjee had been charged to Mr. Boses account i
n error in March, 1989.
d. e. f.
g. h. i. j.
k. l. m.
n.
o. p.
Prepare the bank reconciliation statement as on 31st March, 1989 before and afte
r making the necessary adjustments in the cash book.
Bank Reconciliation Statement
107

Solution Bank Reconciliation Statement as on 31st March, 1989 (Before making adj
ustments in the cash book) Bank Balance as per Bank Book Add : a. Cheques issued
but not presented b. Cheques issued but not presented c. Cheques deposited but
not recorded in cash book d. Bank Interest credited not credited in cash book e.
Dividend collected not entered in cash book f. Deposits made in bank not entere
d in cash book Sub-Total Less : a. Cheques deposited but not cleared b. Cheques
issued but nor recorded in cash book c. Cheques deposited but not cleared d. Deb
it side of cash book overcast e. Credit side of cash book undercast f. Bank Inte
rest debited not debited in cash book g. Bill paid by bank not entered in cash b
ook h. Cheques dishonoured not recorded in cash book i. Cheque wrongly debited b
y bank Sub-Total Bank Balance as per Bank Statement or Pass Book Cash Book (Bank
Column only) Particulars To Balance b/fd To Cheques deposited To Interest Recei
ved Account To Dividend Received Account To Debtors To Bank Charges (debited twi
ce) Rs. 7,000 1,000 150 1,000 500 5 Particulars By Cheques issued By Debit side
overcast By Credit side undercast By Bank Charges By Debtors (Dishonoured cheque
s) By Creditors By Balance c/fd Total 9,655 Total Rs. 750 500 800 50 1,000 1,500
5,055 9,655 250 750 1,600 500 800 50 1,500 1,000 50 6,500 5,155 g. Bank charges
recorded twice in cash book 1,000 1,000 1,000 150 1,000 500 5 4,655 11,655 7,00
0
108
Management Accounting

Bank Reconciliation Statement as on 31st March, 1989 (After making adjustments i


n the cash book) Bank Balance as per Bank Book Add : a. Cheques issued but not p
resented Sub-Total Less : a. Cheques deposited but not cleared b. Wrong debits g
iven by bank for cheque Sub-Total Bank Balance as per Bank Statement or Pass Boo
k Illustration From the following particulars, prepare the bank reconciliation s
tatement for Mr. S.Sarkar as on 31st December, 1985 before and after making nece
ssary adjustments in the cash book. a. b. c. d. e. f. g. h. i. j. k. Bank Balanc
e as per cash book Rs. 610 (Credit). Cheques issued but not presented Rs. 3,000.
Cheques deposited but not cleared Rs. 2,500. A cheque drawn for Rs. 100 has bee
n incorrectly entered as Rs. 10 in the cash book. A debtor directly deposited in
to Sarkars bank account but not recorded in the cash book Rs. 1,000. Payment side
of the cash book was undercast by Rs. 500. A cheque for Rs. 5,000 drawn by Mr.
Banerjee has been charged to Sarkars account in error. Bank paid a Bill Payable f
or Rs. 1,450 but it was recorded in the cash book as Rs. 1,540. The receipt colu
mn of cash book was overcast by Rs. 1,000. Discount allowed Rs. 410 has been ent
ered through mistake with the cheque in the bank column of the cash book. Pursua
nt to instructions dated 30th December, 1985, asking the banker to transfer Rs.
10,000 to fixed deposit account and entry for this was made in the cash book but
the bank acted in January 1986. The bank debited the account with Rs. 500 being
the amount of cheque received from a customer and returned unpaid but not enter
ed in the cash book. Cheques amounting to Rs. 300 though actually banked were no
t entered in the cash book. 5,155 1,850 50 1,900 5,055 2,000 7,055
l. m.
Bank Reconciliation Statement
109

Solution Bank Reconciliation Statement as on 31st December, 1985 (Before making


adjustments in the cash book) Bank Balance as per Cash Book (Overdraft) Add : a.
Cheques deposited but not cleared b. Cheque for Rs. 100, entered as Rs. 10 c. P
ayment side of cash book undercast d. Wrong debit in pass book for Mr. Banerjees
Cheque e. Receipt column of cash book overcast f. Discount allowed treated as re
ceipt of cheque in the cash book g. Cheque dishonoured Sub-Total Less : a. Chequ
es issued but not presented b. Amount deposited by debtor in bank account c. Bil
l Paid for Rs. 1,450 entered as Rs. 1,540 d. Cheques deposited but not entered i
n cash book c. Transfer to fixed deposit Bank Balance as per Bank Statement Cash
Book (Bank Column only) Particulars To Debtor To Creditor To Fixed Deposit Acco
unt To Debtors Rs. 1,000 90 10,000 300 Particulars By Balance b/fd By Creditor B
y Payment side undercast By Receipt side overcast By Discount By Debtors By Bala
nce c/fd Total 11,390 Total Rs. 610 90 500 1,000 410 500 8,280 11,390
Management Accounting
610 2,500 90 500 5,000 1,000
410 500 10,000 10,610 3,000 1,000 90 300 10,000 14,390 3,780
110

Bank Reconciliation Statement as on 31st December, 1985 (After making adjustment


s in the cash book) Bank Balance as per Bank Book Add : a. Cheques issued but no
t presented Sub-Total Less : a. Cheques deposited but not cleared b. Wrong debit
s given by bank for cheque Sub-Total Bank Balance as per Bank Statement or Pass
Book Illustration Following are the cash book and pass book of Mr. X for the mon
th of April, 2002. Cash Book (Bank Column only) Date 01.4.02 04.4.02 08.4.02 13.
4.02 18.4.02 21.4.02 25.4.02 30.4.02 Particulars To balance b/fd To Sales A/c To
P A/c To M A/c To Kamal A/c To Furniture A/c To Sales A/c To F A/c Rs. 12,500 8
,000 1,500 3,400 4,600 1,200 3,800 3,000 Date Particulars Rs. 4,000 3,200 6,000
2,500 5,000 7,500 3780 8,280 3,000 11,280
01.4.02 By Salaries (C.No. 183) 06.4.02 By Purchases (C.No. 184) 11.4.02 By Mach
inery (C.No. 185)
15.4.02 By Omprakash (C.No. 186) 1,000 19.4.02 By Drawings (C.No. 187) 23.4.02 B
y K A/c (C.No. 188) 27.4.02 By S A/c (C.No. 189) 30.4.02 By Printing (C.No. 190)
30.4.02 By Balance c/fd 800 2,000 1,000 500 19,500 38,000
38,000
Bank Reconciliation Statement
111

Pass Book Date 01.4.02 02.4.02 06.4.02 06.4.02 10.4.02 16.4.02 17.4.02 20.4.02 2
4.4.02 28.4.02 28.4.02 30.4.02 30.4.02 30.4.02 Particulars By Balance b/fd To Ch
eque By Cheque To Cheque By Cheque By Cheque To Cheque By Cheque By Cheque To Ch
eque To Cheque By Interest By Deposit (K.Sen) To Charges 10 185 189 6,000 1,000
100 3,000 187 800 4,600 3,800 184 3,200 1,500 3,400 183 4,000 8,000 C.No. Withdr
awals Deposits Dr/Cr. Cr. Cr. Cr. Cr. Cr. Cr. Cr. Cr. Cr. Cr. Cr. Cr. Cr. Cr. Ba
lance 12,500 8,500 16,500 13,300 14,800 18,200 17,400 22,000 25,800 19,800 18,80
0 18,900 21,900 21,890
You are required to prepare a Bank Reconciliation Statement as on 30th April 200
2. Solution Bank Reconciliation Statement as on 30th April, 2002 Bank Balance as
per Cash Book Add : a. Cheques issued but not presented (Rs. 1,000 + Rs. 2,000
+ Rs. 500) b. Deposited by K.Sen c. Interest credited by bank, not in cash book
3,500 3,000 100 6,600 Sub-Total Less : a. Cheques deposited but not cleared (Rs.
1,200 + Rs. 3,000) b. Bank Charges debited by bank Sub-Total Bank Balance as pe
r Bank Statement or Pass Book 4,200 10 4,210 21,890 26,100 19,500
112
Management Accounting

Illustration Fun Fare Limited have a current account with National Bank Limited.
The following is the extract from the Banks books of account for the last week o
f June, 1988. Particulars Balance b/fd Gopal Brothers Madhu Industries N Traders
Ram Gopal Sons Gopal Brothers Ourselves Dividend Warrants Incidental Charges In
terest on Loan Lal Chand It is understood that a. b. c. Cheque no. 214 drawn in
favour of T.W.Traders for Rs. 2,100 was not yet presented to the bank. Advice re
garding the incidental charges, interest on loan and dividend warrants reached F
un Fare Limited only in July. Cheque favouring Lal Chand was towards rent for th
e month of June. 217 10 900 1,000 215 216 4,100 2,400 500 213 7,200 7,500 212 4,
000 5,000 C.No. Withdrawals Deposits Dr/Cr. Cr. Cr. Cr. Cr. Cr. Cr. Cr. Cr. Cr.
Cr. Balance 21,000 17,000 22,000 14,800 22,300 18,200 15,800 16,300 16,290 15,39
0 14,390
From the above data you are required to prepare a cash book (bank column only) o
f Fun Fare Limited and a bank reconciliation statement in their books at the end
of the month. Solution : Cash Book (Bank Column only) Date 30.6.88 Particulars
To Balance b/fd To Madhu Industries To Ram Gopal Rs. 21,000 5,000 7,500 Date Par
ticulars Rs. 4,000 7,200 2,100 4,100 2,400 1,000 12,700 33,500
30.6.88 By Gopal Brothers By N Traders By T W Traders By Gopal Brothers By Cash
By Rent By Balance c/fd
33,500
Bank Reconciliation Statement
113

Bank Reconciliation Statement as on 30th April, 2002 Bank Balance as per Cash Bo
ok Add : a. Cheques issued but not presented b. Dividend collected by bank, not
in cash book 2,100 500 2,600 Sub-Total Less : a. Incidental charges debited by b
ank b. Interest on Loan debited by bank Sub-Total Bank Balance as per Bank State
ment or Pass Book 10 900 910 14,390 15,300 12,700
QUESTIONS 1. What do you mean by Bank Reconciliation Statement ? What are the re
asons for difference between the balance shown by cash book and the one shown by
the pass book? What are the different causes of discrepancy between bank balanc
e as per cash book and pass book ? What is Bank Reconciliation Statement ? Why i
s it prepared ?
2.
3.
114
Management Accounting

PROBLEMS Q. 1 The Bank account of Mukesh was balanced on 31st March, 1992. It sh
owed an overdraft of Rs. 5,000. The Bank Statement of Mukesh showed a credit bal
ance of Rs. 76,750. Prepare a Bank reconciliation statement taking the following
information into account a. b. c. Cheques issued but not presented for payment
till 31st March, 1992 Rs. 12,000. Cheques deposited but not collected by bank ti
ll 31st March, 1992 Rs. 20,000. Interest on term loan Rs. 10,000 debited by bank
on 31st March, 1992 but not accounted in Mukeshs books. Bank charges Rs. 250 was
debited by bank but accounted in the books of Mukesh on 4th April, 1992. An amo
unt of Rs. 1,00,000 representing collection of Mukeshs cheques was wrongly credit
ed to the personal account of Mukesh by the bank in their bank statement.
d.
e.
Q. 2 From the following particulars, prepare a Bank Reconciliation Statement as
on 31st December, 1993. a. On 31st December, 1993, the cash book of a firm showe
d a bank balance of Rs. 6,000 (Debit Balance). Cheques had been issued for Rs. 5
,000, out of which cheque worth Rs. 4,000 only were presented for payment. Chequ
es worth Rs. 1,400 were deposited in the bank on 28th December, 1993 but had not
been credited by the bank. In addition to this, one cheques for Rs. 500 was ent
ered in the cash book on 30th December, 1993 but was banked on 3rd January, 1994
. A cheque from Susan for Rs. 400 was deposited in the bank on 26th December, 19
93 but was dishonoured and the advice was received on 3rd January, 1994. Passboo
k showed bank charges of Rs. 20 debited by the bank. One of the debtors deposite
d a sum of Rs. 500 in the bank account of the firm on 20th December, 1993 but th
e intimation in this respect was received from the bank on 2nd January, 1994. Ba
nk Passbook showed a credit balance of Rs. 5,180 on 31st December, 1993.
b.
c.
d.
e. f.
g.
Bank Reconciliation Statement
115

Q. 3 On 31st May, 1994, the cash book of ABC Ltd. showed a bank overdraft of Rs.
1,234. On an examination of the cash book and bank pass book, the following inf
ormation was gathered a. Two cheques received from P and Q for Rs. 234 and Rs. 4
56 respectively were deposited with the bank on 30th May, 1994, but they were cl
eared only on 1st June 1994. A cheque for Rs. 345 issued on 26th May, 1994 was p
resented to the bank for payment on 3rd June, 1994. A cheque for Rs. 567 deposit
ed by a customer in the companys account with bank directly on 25th May, 1994. Rs
. 5,678 being proceeds of a bill collected on 30th May, 1994 did not appear in t
he cash book. A bill payable for Rs. 5,789 was duly paid off on 31st May, 1994 a
ccording to the instructions of the company, entry of which was made in the cash
book on 1st June, 1994. Interest on overdraft Rs. 111 appears in the pass book.
b.
c.
d. e.
f.
Q. 4 On 31st January, 1988, my cash book showed a bank overdraft of Rs. 12,500.
On comparing it with the pass book, following differences were located a. Cash a
nd cheques amounting Rs. 1,340 were sent to bank on 27th January, but cheques wo
rth Rs. 230 were credited on 2nd February and one cheque for Rs. 45 was returned
by them as dishonoured on 4th February. During the month of January, I issued c
heques worth Rs. 1,760 to my creditors. Out of these, cheques worth Rs. 1,370 we
re presented for payment on 5th February. According to my standing orders, the b
ankers have paid during the month of January the following d. e. f. g. Life insu
rance premium Rs. 170 Driving license fee Rs.40
b. c.
My bankers have collected Rs. 150 as dividend on the shares. My bankers have giv
en me wrong credit for Rs. 150. A bill receivable for Rs. 100 discounted with th
e bank in December, 1987 has been dishonoured on 31st January, 1988. Interest ch
arged by the bank Rs. 125.
Prepare a bank reconciliation statement on 31st January, 1988.
116
Management Accounting

Q. 5 From the following particulars, find out adjusted bank balance as per cash
book and prepare thereafter bank reconciliation statement as on 31st December, 1
995 of Raja Brothers Particulars Bank Overdraft as per Cash Book Cheques deposit
ed as per bank statement but not entered in cash book Cheques recorded for colle
ction but not sent to the bank Credit side of bank column cast short Bank charge
s recorded twice in the cash book Customers cheques returned as per bank statemen
t only Cheques issued but dishonoured on technical grounds Bills collected by ba
nk directly Cheques received entered twice in cash book Rs. 80,000 3,000 10,000
1,000 100 4,000 3,000 20,000 5,000
Q. 6 The cash book of a firm showed an overdraft of Rs. 30,000 on 31st March, 19
99. A comparison of the entries in cash book and pass book revealed that a. On 2
2nd March, 1999, cheques totaling Rs. 6,000 were sent to bankers for collection.
Out of these, a cheques for Rs. 1,000 was wrongly recorded on the credit side o
f the cash book and cheques amounting to Rs. 300 could not be collected by bank
before 1st April, 1999. A cheque for Rs. 4,000 was issued to a supplier on 28th
March, 1999. The cheque was presented to bank on 4th April, 1999. There were deb
its of Rs. 2,600 in the pass book for interest on overdraft and bank charges, bu
t the same had not been recorded in the cash book. A cheque for Rs. 1,000 was is
sued to a creditor on 27th March 1999, but by mistake the same was not recorded
in the cash book. The cheque was however duly encashed on 31st March, 1999. As p
er standing instructions, the banker collected dividend of Rs. 500 on behalf of
the firm and credited the same to its account by 31st March, 1999. The fact was
however intimated to the firm on 3rd April, 1999.
b.
c.
d.
e.
You are required to prepare a bank reconciliation statement as on 31st March, 19
99.
Bank Reconciliation Statement
117

Q. 7 On 31st March, 1998, Mehtas Pass Book showed a debit balance of Rs. 6,350. F
rom the following information, prepare a Bank Reconciliation Statement as on tha
t date 1. Out of total cheques of Rs. 6,000 deposited into the bank in March. 19
98, one cheque of Rs. 500 was collected on 28th March, 1998 and another cheque o
f Rs. 1,000 was collected on 3rd April, 1998. The bank had paid a premium of Rs.
300 on 17th March for which there was no entry made in the cash book. The total
of debit side bank column of cash book was undercast by Rs. 100. Amount withdra
wn from the bank on 26th March Rs. 200 was not recorded in the cash book at all.
During March, cheques issued amounted to Rs. 2,000 of which cheques for Rs. 1,5
00 were presented to the bank on 2nd April 1998.
2. 3. 4.
5.
Q. 8 D. Diwakars Pass Book shows a balance of Rs. 5000 (Credit) on 30th June, 199
8. His cash book shows a different balance. On an examination, it is found that
a. b. No record has been made in the cash book for dishonour of a cheque for Rs.
100. Cash and cheques amounting to Rs. 700 were paid into the bank on 29th June
, 1998 and the same had not been entered in the pass book. Bank charges of Rs. 1
5 have not been entered in the cash book. Cheques amounting to Rs. 1,800 issued
by P. Prabhakar and paid into the bank on 28th June, 1998 had not been credited.
c. d.
Prepare a bank reconciliation statement as on 30th June, 1998. Q. 9 On 30th Sept
ember 1998, cash book of a firm showed a bank balance of Rs. 7,500. From the fol
lowing information, prepare a bank reconciliation statement showing the balance
as per pass book a. Cheques amounting to Rs. 1,200 were paid on 28th September,
1998 had not been credited by the bank. One cheque for Rs. 375 was entered in th
e cash book on 28th September, 1998 but was banked on 3rd October, 1998. Cheques
issued for Rs. 900 had not yet been presented for payment at the bank.
b.
118
Management Accounting

c.
A cheque for Rs. 200 paid on 26th September, 1998 was dishonoured but the advice
was received only on 3rd October, 1998. Bank charges of Rs. 15 were debited in
the pass book by the bank. There was an entry in the pass book for the receipt o
f Rs. 600 collected by the bank as interest.
d. e.
Q. 10 From the following particulars, ascertain the balance by means of a statem
ent that would appear in the pass book of Mr. S.Gavaskar as on 31st December 199
8. a. b. c. d. e. f. Overdraft as per Cash Book Rs. 4,558. Interest on overdraft
for six months ending 31st December, 1998 Rs. 120. Bank charges debited in the
pass book Rs. 24. Cheques drawn but not cashed by the customers prior to 31st De
cember, 1998 Rs. 1,326. Cheques paid into the bank but not cleared before 31st D
ecember, 1998 Rs. 2,412. A Bill Receivable originally discounted with the bank i
n November 1998 is dishonoured Rs. 800.
Q. 11 From the following particulars, ascertain the balance that would appear in
the cash book of Mr. M. Ranganathan as on 31st December, 1998 a. b. Overdraft b
alance as per Pass Book Rs. 24,240. Cheques amounting to Rs. 8,200 were paid int
o the bank on 28th December, 1998 out of which only Rs. 600 was credited by the
bank in the pass book till 31st December, 1998. Cheques for Rs. 5,400 were issue
d on 28th December, 1998 out of which only one cheque for Rs. 800 was presented
for payment. There is a debit of Rs. 200 for interest and Rs. 50 for bank charge
s in the pass book which have not been entered in the cash book. Rs. 400 debited
to bank account in the cash book has been omitted to be banked. There was a wro
ng debit of Rs. 600 in the pass book.
c.
d.
e. f.
Bank Reconciliation Statement
119

Q. 12 On 30th June, 1990, the pass book of Sunil & Co. showed a balance of Rs. 9
,800 as cash at bank a. Prior to that date, they had issued cheques amounting to
Rs. 3,500, of which, cheques amounting to Rs. 1,900 have so far been presented
for payment. Out of the cheques for Rs. 2,000 paid by him into the bank before t
hat date, only cheques for Rs. 1,200 were credited in the pass book. He had also
received a cheque for Rs. 680 which although entered in the cash book had been
omitted to be paid into bank. The bank had collected dividend directly and credi
ted them.
b.
c.
d.
Q. 13 From the following particulars, prepare a Bank Reconciliation Statement as
on 28th February, 1989. Thiru Pandiyan had an overdraft balance of Rs. 80,500 a
s shown by the bank columns of the cash book. Cheques amounting to Rs. 10,000 ha
d been paid into the bank on 24th February, 1989 but of these only Rs. 7,500 wer
e credited in the pass book. He had issued cheques amounting to Rs. 25,000, of w
hich Rs. 20,000 worth only seem to have been presented. The bank has debited in
the pass book Rs. 750 for interest. A cheque for Rs. 600 which was debited in th
e bank column in the cash book has been omitted to have been presented. An entry
appears in the pass book for Rs. 3,000 for a direct deposit by a customer of Th
iru Pandiyan. Q. 14 On 31st March 1991 the cash book of Mr. X showed a bank bala
nce of Rs. 14,850. While verifying with the pass book, the following facts were
noted a. Cheques sent in for collection before 31st March, 1991 and not credited
by bank amounted to Rs. 845. Cheques issued before 31st March, 1991 but not pre
sented for payment amounted to Rs. 885. The banker has debited a sum of Rs. 100
towards the bank charges and credited Rs. 250 for interest received and Rs. 1,00
0 for dividend collected. The banker has given a wrong credit for Rs. 250. Mr. Y
has paid into the bank a sum of Rs. 300 on 28th March, 1991 which has not been
entered in the cash book. A cheque for Rs. 200 sent for collection returned dish
onoured has not been entered in the cash book.
b. c.
d. e.
f.
120
Management Accounting

Q. 15 Find out the balance as per pass book from the following particulars a. b.
c. d. e. Bank overdraft as per cash book on 30th April, 1992 was Rs. 2,000. Che
que issued but not presented for payment Rs. 1,350. Cheques deposited but not ye
t collected by the banker Rs. 500. Bank charges Rs. 80 debited by the bank not y
et entered in the cash book. Interest on investments collected by the bankers an
d credited in the pass book amounted to Rs. 905.
Q. 16 From the following particulars, ascertain the balance that would appear in
the cash book of B as on 31st December, 1998, before and after making necessary
adjustments a. b. c. d. e. f. Overdraft as per pass book as on 31st December 19
98 Rs. 13,880. Interest on overdraft for six months ending 31st December 1998 no
t yet entered in the cash book Rs. 240. Bank charges for the above period not ye
t entered in the cash book Rs. 60. Cheques drawn but not encashed by customers b
efore 31st December, 1998 Rs. 3,300. Cheques paid into the bank but not cleared
before 31st December, 1998 Rs. 4,340. A Bill Receivable, discounted with the ban
k in November, dishonoured on 31st December, 1998 Rs. 1,000.
Q. 17 From the following particulars taken on 31st December, 1989, you are requi
red to prepare a bank reconciliation statement to reconcile the bank balance sho
wn in the cash book with that shown in the pass book a. b. c. d. e. f. Balance a
s per pass book on 31st December, 1989 Rs. 1,027 (Credit). Four cheques drawn on
31st December but not cleared till January Rs. 1,144. Interest on overdraft not
entered in the cash book Rs. 51. Three cheques received on 30th December, 1989
and entered in the bank column of cash book but not lodged in bank for collectio
n till 3rd January, Rs. 5,280. Cost of cheque book Rs. 5 entered twice erroneous
ly in cash book in November. A Bill Receivable for Rs. 250 on 29th December, 198
9 was passed to the bank for collection on 28th December, 1989 and was entered i
n the cash book forthwith, whereas the proceeds were credited in the pass book o
nly in January following. 121
Bank Reconciliation Statement

g.
Chamber of Commerce subscription Rs. 10 paid by bank on 1st December, 1989 had n
ot been entered in the cash book. Bank Charges of Rs. 5 had been debited in the
pass book twice erroneously.
h.
Q. 18 On 30th June, 1981, the pass book of M/s Thin and Short showed a balance o
f Rs. 2,000 at the bank. They had sent cheques amounting to Rs. 10,000 to the ba
nk before 30th June, 1981 but it appears from the pass book that cheques worth R
s. 9,000 had been credited before that date. Similarly, out of the cheques for R
s. 5,000 issued during the month of June, cheques for Rs. 4,000 were presented a
nd paid in July. The pass book showed the following payments a. b. Rs. 320 as pr
emium according to standing instructions. Rs. 2,000 against a promissory note as
per the instructions.
The pass book showed that the bank had collected Rs. 1,800 as interest on Govern
ment Securities. The bank had charged as interest Rs. 50 and incidental expenses
Rs. 20. There was no entry in the cash book for the payment of interest etc. A
bill sent for collection was returned dishonoured on 29th June amounting to Rs.
600. Prepare the Bank Reconciliation Statement as on 30th June, 1981. Q. 19 From
the following particulars, prepare a bank reconciliation statement showing the
balance as per pass book on 31st March, 1989. a. Cheques for Rs. 7,900 was paid
into bank in March, 1989 but were credited only in April, 1989. Cheques for Rs.
11,000 were issued in March, 1989 but were cashed in April, 1989 only. A cheque
for Rs. 1,000 which was received from a customer was entered in the bank column
of the cash book in March, 1989 but the same was paid into the bank in April, 19
89 only. The pass book shows a credit of Rs. 2,500 for interest and a debit of R
s. 500 for bank charges. The bank balance as per cash book was Rs. 1,80,000 on 3
1st March, 1989.
b. c.
d.
e.
122
Management Accounting

Q. 20 From the following particulars, prepare a bank reconciliation statement as


at 31st December, 1991. a. b. c. d. e. f. As on 31st December, 1991, bank overd
raft as per cash book Rs. 2,49,900. Interest debited in the bank pass book only
Rs. 27,870. Cheques issued but not presented for payment Rs. 66,000. Draft depos
ited in the bank but not yet credited in the pass book Rs. 13,500. Dividend coll
ected by the bank Rs. 42,500 has not yet been entered in the cash book. A direct
payment into the bank by a customer Rs. 16,000 has not been recorded in the cas
h book. Bank column on the debit side of the cash book has been undercast by Rs.
3,500.
g.
Q. 21 From the following particulars, prepare a bank reconciliation statement sh
owing the balance as per cash book as on 31st December, 1997. The following cheq
ues were paid into the bank in December 1997 but were credited by the bank in Ja
nuary, 1998. Premnath Rs. 350 Shaym Lal Rs. 250 Ram Lal Rs. 200
The following cheques were issued by the firm in December, 1997 but were present
ed for payment in January, 1998. Suresh Rs. 400 Ramesh Rs. 450
A cheque for Rs. 100 which was received from a customer was entered in the bank
column of cash book in December, 1997 but was omitted to be banked in the month
of December, 1997. The pass book shows a credit of Rs. 100 for interest and a de
bit of Rs. 20 for bank charges. The bank balance as per pass book was Rs. 6,200
as on 31st December, 1997. Q. 22 According to the cash book of Gopi, there was a
balance of Rs. 44,500 standing to his credit on 30th June, 1996. On investigati
on you find that 1. Cheques amounting to Rs. 60,000 issued to creditors have not
been presented for payment till that date.
Bank Reconciliation Statement
123

2.
Cheques paid into bank amounting to Rs. 1,05,000 out of which cheques amounting
to Rs. 55,000 only collected by the bank up to 30th June, 1996. A dividend of Rs
. 4,000 and rent amounting to Rs. 6,000 received by the bank and entered in the
pass book but not recorded in the cash book. Insurance premium (up to 31st Decem
ber, 1996) paid by the bank Rs. 2,700 not entered in the cash book. The payment
side of the cash book had been undercast by Rs. 50. Bank charges Rs. 50 shown in
the pass book had not been entered in the cash book. A bill payable for Rs. 2,0
00 has been paid by the bank but is not entered in the cash book and bill receiv
able for Rs. 6,000 has been discounted with the bank at a cost of Rs. 100 which
has also not been recorded in the cash book.
3.
4.
5. 6. 7.
You are required a. b. to make appropriate adjustments in the cash book. To prep
are a statement reconciling it with the bank pass book.
Q. 23 From the following extracts of the cash book (bank column) and bank pass b
ook of Mr.X, prepare the bank reconciliation statement for the month ending on 3
1st March, 1997. Cash Book (Bank Column only) Date 01.3.97 03.3.97 05.3.97 16.3.
97 21.3.97 24.3.97 Particulars To Balance b/fd To D To A To M To N To R Rs. 1,00
0 750 250 800 2,500 1,700 Date 02.3.97 03.03.97 08.3.97 12.3.97 21.3.97 24.3.97
28.3.97 31.3.97 Total 7,000 Particulars By Drawings By K By Rent By P By S By H
By Wages & Salaries By Balance c/fd Total Rs. 500 700 450 650 330 900 770 2,700
7,000
124
Management Accounting

Extracts of Pass Book of Mr. X In the books of Bank of Baroda, Pune Date 01.4.97
02.4.97 02.4.97 04.4.97 04.4.97 05.4.97 07.4.97 09.4.97 11.4.97 11.4.97 Particu
lars Balance b/fd P N C Pal M S H Sen Bose 470 330 900 300 350 500 800 650 2,500
Withdrawals Deposits Dr/Cr Cr Cr Cr. Cr. Cr. Cr. Cr. Cr. Cr. Cr. Balance 1,280
630 3,130 2,780 3,280 4,080 3,750 2,850 3,150 3,620
Prepare a Bank Reconciliation Statement as on 31st March, 1997. Q. 24 On 31st De
cember, 1982, the bank column of the cash book of P shows a debit balance of Rs.
922. On examination of cash book and statement, you find that a. Cheques amount
ing to Rs. 1,260 issued before 31st December and entered in the cash book were n
ot presented for payment till that date. Cheques amounting to Rs. 500 entered in
the cash book as sent to the bank on 31st December were entered in the bank sta
tement after that date. A cheque from a debtor for Rs. 146 had been dishonoured
prior to 31st December but no record appeared in the cash book. A dividend warra
nt for Rs. 76 was paid direct to the bank and nothing appeared in the cash book.
Bank interest and charges amounting to Rs. 84 were not entered in the cash book
but appeared in the bank statement. There was no entry in the cash book for a c
lub membership subscrption Rs. 20 paid by bankers order in November, 1982. Bank c
harges for a cheque book received by P Rs. 2 were entered in the cash book twice
. 125
b. c.
d.
e.
f.
g.
Bank Reconciliation Statement

h.
A cheque for Rs. 54 drawn by Q had been charged to Ps account in error.
Make appropriate adjustment in the cash book to bring down the correct balance a
nd prepare a bank reconciliation statement reconciling the corrected cash book b
alance with the balance as per bank statement. Q. 25 When Sweetex Limited receiv
ed its bank statement for the period ended 30th June, 1984, this did not agree w
ith the balance shown in the cash book of Rs. 2,972 in the companys favour. An ex
amination of the cash book and bank statement disclosed the following a. A depos
it of Rs. 492 paid on 29th June 1984 had not been collected by the bank until 1s
t July, 1984. Bank charges amounting to Rs. 17 had not been entered in the cash
book. A debit of Rs. 42 appeared in the bank statement for an unpaid cheque whic
h had been returned marked out of date. The cheque had been re-dated by the custom
er of Sweetex Limited and paid into the bank again on 3rd July, 1984. A standing
order for payment of an annual subscription amounting to Rs. 10 had not been en
tered in the cash book. On 25th June, 1984, managing director had given the cash
ier a cheque for Rs. 100 to pay into his personal account at the bank. The cashi
er had paid the same into companys account by mistake. On 27th June, two customer
s of Sweetex Limited had paid direct to the companys bank account Rs. 499 and Rs.
157 respectively for the payment of goods supplied. The advices were not receiv
ed by the company until 1st July and were not entered in the cash book until tha
t date. On 30th March, 1984, the company had entered into a hire purchase agreem
ent to pay by bankers order a sum of Rs. 26 on the 10th day of each month, commen
cing April. No entries had been made in the cash book. A cheque for Rs. 364 rece
ived from Mr. B and paid into the bank had been entered twice in the cash book.
Cheques issued amounting to Rs. 4,672 had not been presented to the bank for pay
ment until 30th June, 1984.
b. c.
d.
e.
f.
g.
h.
i.
126
Management Accounting

j.
A customer of the company who received a cash discount 2.5% on his account of Rs
. 200 paid the company a cheque on 10th June. The cashier in error entered the g
ross amount in the bank column of the cash book.
After making the adjustments required by the foregoing, the bank statement recon
ciled with the balance in the cash book. You are required 1. to show the necessa
ry adjustments in the cash book of Sweetex Limited bringing down the correct bal
ance on 30th June, 1984. to prepare a Bank Reconciliation Statement
2.
Bank Reconciliation Statement
127

NOTES
128
Management Accounting

Chapter 5
RECTIFICATION OF ERRORS
The errors in accounting can be classified into the following main groups a. Err
ors of Omission These errors refer to a situation where a transaction is totally
omitted to be recorded in the subsidiary book or partially omitted while postin
g from subsidiary books to the ledger. Errors of Commission These errors refer t
o wrong posting or totalling errors, calculation errors or errors in carrying fo
rward etc. Following are the examples of errors of commission
l l l l l
b.
Posting of wrong amounts Posting to wrong side of account Posting to wrong accou
nt Wrong totalling of subsidiary books or ledger accounts Errors while carrying
forward figures from one page to another page
c.
Errors of Principle These errors refer to wrong classification of income or expe
nditure. Following are the examples of errors of principle
l l l l
Purchases of fixed assets recorded in the Purchases Register Revenue expenditure
treated as capital expenditure Capital receipt treated as revenue income Revenu
e receipt treated as capital receipt
d.
Compensating Error These errors refer to a situation where excess or less debits
in one or more accounts are compensated by equal amount of excess or less credi
ts in one or more accounts. Due to these errors arithmetical accuracy of the Tri
al Balance does not get affected.
Rectification of Errors
129

EFFECT OF ERRORS ON TRIAL BALANCE Tallying of Trial Balance is the primary indic
ation about the arithmetical accuracy of the books of account. However, it canno
t be the conclusive evidence of the total accuracy of the books of accounts main
tained. This is due to the fact that certain errors as stated above do not affec
t the trial balance. As such, locating the errors requires a lot of skills, part
icularly when they do not affect the agreement of trial balance. Errors affectin
g Trial Balance Following errors may affect the agreement of Trial Balance a. Wr
ong totalling of subsidiary books If the total of any subsidiary books is taken
wrongly but the posting to the individual accounts is made correctly, it will af
fect the agreement of trial balance. Eg. Total of Purchase Register for the mont
h of March is taken as Rs. 1,50,000 instead of Rs. 1,55,000. Posting to the indi
vidual accounts of suppliers total to the correct amount of Rs. 1,55,000, but th
e Purchases Account is debited by Rs. 1,50,000, the trial balance will not agree
. Posting on the wrong side of an account If a transaction is posted on the wron
g side of the account, the trial balance will not agree. Eg. A payment of Rs. 10
,000 made to M/s. Pam Industries is posted on the credit side of M/s. Pam Indust
ries Account, the trial balance will not agree. Omission of posting an amount in
the ledger If an amount is entered in the journal or subsidiary book but not po
sted in the ledger, the trial balance will not agree. Eg. A cash payment of Rs.
1,500 for the conveyance expenses has been entered in the cash book but is not d
ebited to Conveyance Account, the trial balance will not agree. Posting of wrong
amount If an amount is wrongly posted to an account, the trial balance will not
agree. Eg. A cash payment of Rs. 1,500 for the conveyance expenses has been cor
rectly entered in the cash book, but while posting the same to the Conveyance Ac
count, it is posted as Rs. 150, the trial balance will not agree. Error in balan
cing If an error has been committed while calculating the closing balance of cas
h book or a ledger account, the trial balance will not agree.
b.
c.
d.
e.
Errors not affecting the Trial Balance Following types of errors may not affect
the agreement of Trial Balance. a. Errors of Principle If the revenue expenditur
e is treated as capital expenditure or if revenue receipt is treated as capital
receipt or if capital expenditure is treated as revenue expenditure or if capita
l receipt is treated as revenue receipt, it will not affect the agreement
130
Management Accounting

of trial balance. Eg. An amount of Rs. 10,000 paid for maintenance of machinery.
Instead of posting this amount to Machinery Maintenance Account, it is debited
to Machinery Account, the trial balance will still agree but it will not show a
true and fair view. b. Errors of Omission If a transaction is totally omitted wh
ile making the entries in the books of accounts, it will not affect the agreemen
t of trial balance. Eg. A bill for the purchase of material worth Rs. 15,000 has
been received, but it is not entered in the Purchase Register at all, the trial
balance will still agree but it will not show a true and fair view. Errors of C
ommission If an amount is posted to the correct side of a wrong account, it will
not affect the agreement of trial balance. Eg. A payment is Rs. 25,000 made to
Mr. Salim is debited to the account of Mr. Sham, the trial balance will still ag
ree but it will not show a true and fair view. Recording of wrong amount in the
books of prime entry or subsidiary books If a transaction is wrongly entered in
the book of prime entry or the subsidiary book and then correctly posted to the
correct account, it will not affect the agreement of trial balance. Eg. Stationa
ry worth Rs. 4,500 has been purchased but it is entered as Rs. 4,700 in the cash
book, the trial balance will still agree but it will not show a true and fair v
iew. Compensating Errors If one type of error is compensated by the error of the
opposite nature, it will not affect the agreement of trial balance. Eg. While b
alancing the traveling expenses account, the closing debit balance is taken as R
s. 1,40,000 instead of Rs. 1,50,000. Similarly, while balancing the sales accoun
t, the closing credit balance is taken as Rs. 28,90,000 instead of Rs. 29,00,000
. The trial balance will still agree but it will not show a true and fair view.
c.
d.
e.
Steps in locating the errors If the errors result into the disagreement of trial
balance, following steps should be taken to locate the errors. a. b. Total of a
ll the subsidiary books and cash book should be checked carefully. Similarly, th
e total of trial balance should be checked carefully. It should be ensured that
all the opening balances have been correctly brought forward in the current years
books of account. It should be ensured that all the ledger accounts have been p
roperly balanced and the balances of all the ledger accounts have been reflected
in the Trial Balance. If an amount of Rs. 24,000 is debited to a certain accoun
t instead of crediting the same to the same account, the difference between the
debit side and credit side of trial balance 131
c.
d.
Rectification of Errors

will be Rs. 48,000. As such, the difference in trial balance should be halved to
locate such errors. e. If the difference in the trial balance is divisible by 9
without any reminder, it may indicate the transposition or transplacement of th
e amounts. Eg. If the cash payment of Rs. 176 is posted as Rs. 167, the differen
ce in the trial balance will be divisible by 9. The trial balance of the current
year can be compared with the trial balance of the previous year to locate cert
ain highlighting error.
f.
How to rectify the errors The errors should be rectified by any one of the follo
wing methods I. In some cases, if the trial balance does not agree but the books
have to be closed, the difference is placed to a Suspense Account and the trial
balance is tallied. If the credit side of the trial balance is heavy by Rs. 50,
000 and same amount is placed on the debit side of Suspense Account. Subsequentl
y, attempts are made to locate the errors and the rectification entries are rout
ed through the Suspense Account. After all the errors have been located, the bal
ance in Suspense Account will become zero. It should be remembered that the Susp
ense Account is operated till the errors are located and finally the balance in
Suspense Account has to become zero. Further, only the errors affecting the agre
ement of trial balance are routed through the Suspense Account.
Illustration A merchant while balancing his books of account finds that, the tri
al balance shows excess credit of Rs. 1,700. Being required to prepare the final
accounts, he places the difference to a newly opened Suspense Account which he
carries forward. In the next accounting year, the following errors are discovere
d a. Goods bought from Narayan amounting to Rs. 5,000 had been posted to the cre
dit of Narayan as Rs. 5,500. An item of Rs. 1,000 entered in the sales returns b
ook was posted to the debit of Pandey who had returned the goods. Sundry items o
f furniture sold for Rs. 26,000 had been entered in the sales book. Ignore depre
ciation and profit or loss on the sale. Discount amounting to Rs. 200 from a cre
ditor had been duly entered in the creditors account, but not posted to discount
account.
b.
c.
d.
Draft journal entries necessary for rectifying the abovementioned errors. Prepar
e the Suspense Account and show the ultimate effect of the errors on the last ye
ars profit by preparing the Profit and Loss Adjustment Account.
132
Management Accounting

Solution a. Goods bought from Narayan had been posted to the credit of Narayan A
ccount by Rs. 5,500 instead of Rs. 5,000. As such, Narayan Account has been cred
ited more by Rs. 500. As such, this excess credit needs to be reversed by passin
g following entry Narayan A/c. Dr. 500 To, Suspense A/c. 500 b. Goods supplied t
o Pandey worth Rs. 1,000 should have appeared on the debit side of Pandeys accoun
t. Instead of that the entry has been made on the credit side of Pandeys account.
This excess credit needs to be reversed by passing the following entry To Suspe
nse A/c. Dr. 2,000 Pandey A/c. 2,000 c. As the amount of furniture sold has been
entered in the sales book, sales account has been wrongly credited. This wrong
credit needs to be reversed by debiting sales account. The journal entry to be p
assed is Sales A/c. Dr. 26,000 To Furniture A/c. 26,000 d. Discount received fro
m the creditor has been entered in the creditors account but discount account has
not been credited. As such, the error will be rectified by passing the followin
g entry Suspense A/c. Dr. 200 To Discount Received A/c. 200 Suspense Account
Date 1 1 Particulars To Balance b/fd To Discount Recd. A/c. To Balance c/fd Foli
o Rs. 1,700 200 600 Date 1 1 Particulars By Narayan A/c. By Pandey A/c. Folio Rs
. 500
2,000 2,500
2,500 II.
The errors which affect two accounts and which do not affect the agreement of tr
ial balance may be rectified by passing the rectification entries. The basic pri
nciple for rectifying the errors by this means suggests the following steps to b
e taken a. What is the wrong entry passed ?
Rectification of Errors
133

b. c.
What should be the correct entry to be passed ? Nullify the wrong effect by reve
rsing the same and reinstate the correct by passing the rectification entry.
Illustration Pass necessary journal entries to rectify the following errors a. A
n amount of Rs. 200 withdrawn by the proprietor for his personal use has been de
bited to trade expenses account. A purchase of goods from Nathan amounting to Rs
. 300 has been wrongly entered through the sales book. A credit sale of Rs. 100
to Santhanam has been wrongly passed through the purchase book. Rs. 150 received
from Malhotra have been credited to Mehrotra. Rs. 375 paid on account of salary
to the cashier Dhawan stands debited to his personal account. A contractors bill
for the extension of premises amounting to Rs. 2,750 has been debited to buildi
ng repairs account. On 25th June, goods of the value of Rs. 500 were returned by
Akashdeep and were taken into stock but the returns were entered in the books u
nder date 3rd July i.e. after the expiration of the financial year on 30th June.
A bill of Rs. 200 for old office furniture sold to Sethi was entered in the sal
es daybook. The periodical total of the sales book was cast short by Rs. 100. An
amount of Rs. 80 received on account of interest was credited to commission acc
ount.
b.
c. d. e.
f. g.
h. i. j.
134
Management Accounting

Solution a Wrong Entry Correct Entry Rectification Entry b Wrong Entry Correct E
ntry Rectification Entry Trade Expenses A/c To Cash A/c Drawings A/c To Cash A/c
Drawings A/c To Trade Expenses A/c Nathan A/c To Sales A/c Purchases A/c To Nat
han A/c Sales A/c Purchases A/c To Nathan A/c Purchases A/c To Santhanam A/c San
thanam A/c To Sales A/c Santhanam A/c To, Purchases A/c To Sales A/c Cash A/c To
Mehrotra A/c Cash A/c To Malhotra A/c Mehrotra A/c To Malhotra A/c Dhawan A/c T
o Cash A/c Salary A/c To Cash A/c Salary A/c To Dhawan A/c Building Repairs A/c
To Cash A/c Building A/c To Cash A/c Building A/c To Building Repairs A/c No ent
ry passed 200 200 200 200 200 200 300 300 300 300 300 300 600 100 100 100 100 20
0 100 100 150 150 150 150 150 150 375 375 375 375 375 375 2,750 2,750 2,750 2,75
0 2,750 2,750
c
Wrong Entry Correct Entry Rectification Entry
d
Wrong Entry Correct Entry Rectification Entry
e
Wrong Entry Correct Entry Rectification Entry
f
Wrong Entry Correct Entry Rectification Entry
g
Wrong Entry
Rectification of Errors
135

Correct Entry Rectification Entry h Wrong Entry Correct Entry Rectification Entr
y i Wrong Entry Correct Entry Rectification Entry j Wrong Entry Correct Entry Re
ctification Entry
Sales returns A/c To Akashdeep A/c Sales returns A/c To Akashdeep A/c XYZ A/c To
Sales A/c XYZ A/c To Furniture A/c Sales A/c To Furniture A/c No entry passed S
uspense A/c To Sales A/c Suspense A/c To Sales A/c Cash A/c To Commission A/c Ca
sh A/c To Interest A/c Commission A/c To Interest A/c
500 500 500 500 200 200 200 200 200 200
100 100 100 100 80 80 80 80 80 80
QUESTIONS 1. It is said that tallying of Trial Balance is not the conclusive pro
of of accuracy of the books of account. Why ? What are errors in financial accou
nting ? What are the different types of errors ? What do you mean by Suspense Ac
count? How is it operated in financial accounting? Can the balance of Suspense A
ccount appear in the Trial Balance in ideal situations? What are errors in finan
cial accounting? Do all the errors affect the Trial Balance? State the errors th
at affect the Trial Balance and the errors that do not affect the Trial Balance.
2. 3.
4.
PROBLEMS Q.1 Ganesh drew a Trial Balance
st March 1992. There was a difference in
a Suspense Account. On a scrutiny by the
nd a. Purchases day book for the month
.
136
Management Accounting

of his operations for the year ended 31


the Trial Balance which he closed with
Auditors, the following errors were fou
of April 1991, was undercast by Rs. 1,000

b. c. d. e.
Sales day book of October 1991 was overcast by Rs. 10,000. A furniture purchased
for Rs. 8,100 was entered in the Furniture Account as Rs. 810. A bill for Rs. 1
0,000 drawn by Ganesh was not entered in the Bills Receivable Book. A machinery
purchased for Rs. 10,000 was entered in the purchase day book.
Pass necessary journal entries to rectify the same and ascertain the difference
in the Trial Balance that was shown under the Suspense Account in respect of the
above items.
Q.2 A bookkeeper while preparing his Trial Balance finds that the debit exceeds
by Rs. 7,250. Being required to prepare the final accounts, he places the differ
ence to a Suspense Account. In the next year, the following mistakes were discov
ered a. A sale of Rs. 4,000 has been passed through the Purchase daybook. The en
try in customers account has been correctly recorded. Goods worth Rs. 2,500 taken
away by the proprietor for his use has been debited to Repairs Account. A bill
receivable for Rs. 1,300 received from Krishna has been dishonoured on maturity
but no entry passed. Salary Rs. 650 paid to a clerk has been debited in his Pers
onal Account. A purchase of Rs. 750 from Raghubir has been debited to his accoun
t. Purchase Account has been correctly debited. A sum of Rs. 2,250 written off a
s depreciation on furniture has not been debited to Depreciation Account.
b.
c.
d. e.
f.
Draft the Journal Entries for rectifying the above mistakes and prepare Suspense
Account.
Q.3 The accountant of X prepared the Trial Balance for the year ended 31st March
1996. But there was a difference and the accountant put the difference in Suspe
nse Account. Rectify the following errors found and prepare the Suspense Account
. a. b. The total of the Returns Outward book, Rs. 420 has not been posted in th
e ledger. A purchase of Rs. 350 from Y has been entered in the sale book. Howeve
r, Ys account has been correctly entered. 137
Rectification of Errors

c. d. e.
A sale of Rs. 390 to Z has been credited to his account as Rs. 290. Old furnitur
e sold for Rs. 5,400 has been entered as Rs. 4,500 in sales account. Goods taken
by proprietor, Rs. 500 have not been entered in the books at all.
Q.4 A bookkeeper finds the difference in the Trial Balance amounting to Rs. 1,00
0 and puts it in the Suspense Account. Later on he detects the following errors
a. b. c. d. Purchased goods from Ravi but entered into Sales Book. Received one
bill for Rs. 25,000 from Arun but recorded in Bills Payable Book. An item of Rs.
3,500 relating to prepaid rent account was omitted to be brought forward. An it
em of Rs. 2,000 in respect of purchase returns, had been wrongly entered in the
purchase book. Rs. 25,000 paid to Hari against our acceptance were debited to Ha
rish Account. Bills received from Janaki for repairs done to radio Rs. 2,500 and
radio supplied for Rs. 45,000 were entered in the Purchase Book as Rs. 46,000.
e. f.
Give rectifying journal entries with full narration and prepare Suspense Account
.
Q.5 There is a difference in the Trial Balance of Shri Om. Subsequently, the fol
lowing errors were found to have been committed. Pass journal entries to rectify
them and ascertain the difference in the Trial Balance. a. b. c. d. A sale of R
s. 2,000 to Shanti & Co. was credited to their account. The Returns Inward Book
had been cast Rs. 1,000 short. A sale of Rs. 10,000 had been passed through the
Purchase Day Book. The customers account, had, however been correctly debited. Rs
. 3,750 paid for wages to workmen for making showcases had been charged to Wages
Account. A purchase of Rs. 6,710 had been posted to the debit of the creditors a
ccount as Rs. 6,170. The creditor was Paras & Co.
e.
138
Management Accounting

Q. 6 There was difference in the Trial Balance of Shri Arihant which was put to
newly opened Suspense Account. Subsequently, the following mistakes were discove
red. Pass journal entries to rectify them and ascertain the difference in the Tr
ial Balance. a. b. Materials costing Rs. 700 in the erection of machinery and th
e wages paid for amounting to Rs. 400 were included in the Purchase Account and
Wages Account respectively. Goods sold under credit terms Rs. 16,900 to Mohan we
re recorded properly in the Sales Book but were debited to his account as Rs. 19
,600 and carriage outward freight paid Rs. 700 chargeable from him were posted t
o Sales Expenses Account. Sales Returns by Yogesh Rs. 2,300 were correctly recor
ded in the Sales Returns Book from where they were debited to Yogesh Account by
Rs. 3,200. Old furniture originally purchased for Rs. 1,800 written down to Rs.
1,100 was sold for cash Rs. 1,700 and was credited to Furniture Account. Machine
ry purchased on credit Rs. 17,000 was recorded in Purchase Book and transport ch
arges for the machine Rs. 1,200 were debited to Trade Expenses Account.
c.
d.
e.
Q.7 Give journal entries to rectify the following errors a. b. c. d. e. Rs. 2,50
0 paid for the purchase of a radio set for the personal use of the proprietor de
bited to general expenses account. Rs. 1,300, the amount of sale of old machiner
y, has been posted to sales account. A sum of Rs. 160 paid by way of rent has be
en debited to landlords personal account. Rs. 245 cost of repairing the floor of
room has been charged to buildings account. A payment of Rs. 250 made to Harish
Brothers for cash purchase of goods from him stands debited to his account.
Q.8 Rectify the following errors by passing necessary journal entries a. b. Good
s taken by the proprietor Rs. 1,500 for gift to his daughter were not recorded a
t all. Rs. 1,500 received from Praveen against debts previously written off as b
ad debts have been credited to his personal account. 139
Rectification of Errors

c. d.
Received interest Rs. 150 posted to loan account. A cheque received from Amar, a
debtor, for Rs. 2,000 was directly received by the proprietor who deposited it
into his personal bank account.
Q.9 While preparing the final accounts for the year ended 31st March 1995, Mr. S
mart could not get his Trial Balance agreed. He transferred the difference to Su
spense Account and prepared the final accounts. In April 1995, following errors
were discovered in the books of accounts for the year 1994-95 a. b. The sales bo
ok for January 1995 was undercast by Rs. 1,000. Entertainment expenses Rs.150 in
curred on 5th January 1995 were omitted to be posted from cash book to the ledge
r. Discount column on the receipt side of the cash book for February 1995 was ad
ded as Rs. 2,230 instead of Rs. 2,130. A purchase from Mr. Sumer for Rs. 8,200 o
n 3rd March 1995 was correctly recorded in the purchase book. But the supplier w
as wrongly debited for the purchase.
c.
d.
Pass the necessary journal entries to rectify the above-mentioned errors without
affecting the profit for the year 1995-96. Also prepare Suspense Account and Pr
ofit & Loss Adjustment Account. Assume that all the errors have been located.
Q.10 An accountant could not tally the Trial Balance. The difference was tempora
rily placed to Suspense Account for preparing the final accounts. The following
errors were discovered later on a. b. The sales book was undercast by Rs. 350. E
ntertainment expenses Rs. 95 though correctly entered in the cash book were omit
ted to be posted in the ledger. Commission of Rs. 25 paid was posted twice, once
to discount account and again to commission account. A sales of Rs. 139 to Ramn
ath, though correctly entered in the sales book was posted wrongly to his accoun
t as Rs. 193.
c.
d.
140
Management Accounting

You are required to pass the necessary journal entries in the books of the next
accounting year so as not to affect the profit of that year.
Q.11 The Trial Balance of N Ltd. does not tally. In order to give it a semblance
of agreement, the accountant of the company transfers the difference to a newly
opened Suspense Account. Later on, he discovers the following errors a. An item
of Rs. 5,850 paid for purchase of a new typewriter for the accounts department
has been wrongly passed through the purchases book. An item of Rs. 780 in the sa
les book has been posted as Rs. 960 in the customers account. An addition in the
returns inward book has been cast Rs. 240 short. An item of Rs. 450 appearing in
the discount column on the credit side of the cash book has been posted to the
credit side of the concerned personal account as Rs. 540. A bill of exchange for
Rs. 2,650 accepted by R & Co. and later discounted with the bank has been retur
ned by the bank as dishonoured. On dishonour, the amount of the bill has been de
bited to sales account.
b.
c. d.
e.
Give journal entries to rectify the above mentioned errors and also show the Sus
pense Account.
Q.12 Pass journal entries to rectify the following errors a. A purchase amountin
g to Rs. 1,000 made for a staff member was recorded in the purchases book. Wages
paid to workers for installing machinery, Rs. 750 were debited to wages account
. A dishonoured bill receivable for Rs. 5,000 returned by the bank with whom it
was discounted was credited to bank and debited to bills receivable account. A s
um of Rs. 1,000 drawn by the proprietor for his personal use was debited to trav
eling expenses account.
b. c.
d.
Rectification of Errors
141

Q.13 Pass journal entries to rectify the following errors a. b. c. d. e. A sum o


f Rs. 100 paid to Suresh was debited to Subhash. A credit sale of Rs. 587 was re
corded in the sales book as Rs. 857. Goods sold to Prem for Rs. 170 were returne
d by him, but no entry was passed in the books. A bill receivable for Rs. 2,000
accepted by Vimal was recorded in bills payable book. Repairs of furniture amoun
ting to Rs. 500 were debited to furniture account.
Q.14 Pass journal entries to rectify the following errors and prepare Suspense A
ccount. a. b. c. d. e. Rs. 1,080 received from Mohan was posted to the debit of
his account. Rs. 200 being purchase returns were posted to the debit of purchase
s account. Rs. 400 received as discount was posted to the debit of discount acco
unt. Rs. 1,148 paid for repairs of motor car was debited to motor car account as
Rs. 148. Rs. 400 paid to Suresh was debited to Satish.
Assume that there are no other errors.
Q.15 On 28th February 1999, the Trial Balance of X did not agree. X put the diff
erence in a newly opened Suspense Account. Subsequently, following errors were l
ocated a. b. The returns inward book for January 1999 had been cast Rs. 1,000 sh
ort. A purchase of Rs. 1,671 had been posted to the debit of the creditors accoun
t as Rs. 1,617. The creditor is Panna & Co. A sale of Rs. 2,000 to Singhi & Co.
was credited to the account of the customer. A sale of Rs. 4,000 has been passed
through the purchase book. The customers account has however been correctly debi
ted. While carrying forward the total of sales book from one page to the next, t
he amount was written as Rs. 1,76,658 instead of Rs. 1,67,568.
c. d.
e.
142
Management Accounting

Pass journal entries to rectify the above-mentioned errors. Also prepare the Sus
pense Account assuming that all the errors have been located.
Q.16 An accountant prepared a Trial Balance on 31st January 2000, which revealed
a difference in the books of account. He put the difference in a newly opened S
uspense Account. During February 2000, he detected the following errors a. b. Th
e total of the returns outward book, Rs. 4,200 had not been posted in the ledger
. A purchase of Rs. 3,500 from Y had not been entered in the purchase book. Howe
ver, Ys account had been correctly credited with the amount. A sale of Rs. 3,900
to Z had been credited to his account as Rs. 2,900. Furniture sold for Rs. 5,400
had been entered as Rs. 4,500 in the sales book. Goods worth Rs. 500 taken by t
he proprietor for personal use had not been recorded at all. Wages paid for an i
nstallation of machinery Rs. 1,000 had been debited to wages account.
c. d. e.
f.
Pass journal entries to rectify the abovementioned errors and prepare Suspense A
ccount assuming that all the errors have been located.
Q.17 Give journal entries to rectify or adjust the following in the books of bot
h the head office and the branch. a. Goods costing Rs. 16,000 purchased by branc
h, but payment made by head office. The head office has debited the amount to it
s own purchase account. Branch paid Rs. 30,000 as salary to a visiting head offi
ce official. The branch has debited the amount to salaries account. Depreciation
, Rs. 50,000 in respect of branch assets whose accounts are kept in the head off
ice books is to be recorded by both the parties. Expenses Rs. 70,000 to be charg
ed to the branch for work done on its behalf by the head office.
b.
c.
d.
Rectification of Errors
143

Q.18 On finding a difference between two sides of the Trial Balance, the account
ant transferred the excess debit of Rs. 770 to a suspense account. Subsequently,
the following errors were detected. Give journal entries to rectify the errors
and show the suspense account. 1. 2. 3. 4. 5. 6. 7. 8. 9. Repairs to machinery R
s. 2,000 were debited to Machinery Account. A sale of Rs. 900 to Patel was recor
ded in the Purchases Book. The total of the Returns Inwards Book Rs. 400 was not
posted. A purchase of Rs. 590 from Sathe was posted to his account as Rs. 950.
The bank column of the receipt side of the cash book was undercast by Rs. 110. A
cash sale of Rs. 200 to Ramesh was entered both in the cashbook and sales book.
A credit purchase of Rs. 300 from Satish was omitted to be recorded. Cash Rs. 1
50 paid to Brijmohan was posted twice to his account. A credit balance of Rs. 45
0 to Malasinghs account was carried forward as Rs. 540 on the debit side.
10. The name of Vinod, a creditor, to whom we owed Rs. 500 was omitted from the
list of sundry creditors. Q.19 Rectify the following errors 1. 2. 3. Carriage on
machinery is debited to Carriage Account Rs. 100. Goods purchased from Sahani R
s. 531 was debited to his account as Rs. 351. A television purchased for the wor
kers canteen in the factory for Rs. 25,000 was debited to Factory Expenses. An am
ount of Rs. 15,000 paid for the construction of a new hall in the building was d
ebited to Repairs Account. The total of the Sales Book for the month of February
was cast short by Rs. 10. A credit sale of Rs. 575 to Mahendra was debited to M
ohinders Account. A sum of Rs. 500 paid to Poonawalla for salary was debited to h
is personal account. A credit sale of Rs. 1,000 to Rashid was correctly entered
in the Sales Book but was posted to the credit of his account in the ledger as R
s. 100. Goods sold to Devidas Rs. 590 was recorded in the Sales Book as Rs. 950.
4.
5. 6. 7. 8.
9.
144
Management Accounting

NOTES
Rectification of Errors
145

NOTES
146
Management Accounting

Chapter 6
COST ACCOUNTANCY
[BASIC CONCEPTS AND PRINCIPLES]
INTRODUCTION : The Institute of Cost and Management Accountants, London has defi
ned the Cost Accountancy as The Application of Costing and Cost Accounting princi
ples, methods and techniques to the science, art and practice of cost control an
d the ascertainment of profitability as well as presentation of information for
the purpose of managerial decision making.. The analysis of the above definition
reveals the following facts. (1) Cost Accountancy is a science, art and practice
of a Cost Accountant. Science indicates the possession and the application of r
elevant systematic knowledge. Art indicates the skill and ability of the Cost Ac
countant. Practice indicates a continuous effort on the part of the Cost Account
ant. The terms costing and cost accounting should not be confused. Costing indic
ates the process of ascertaining the costs which can be done arithmetically also
. Cost accounting indicates the process of recording the costs in a formal and s
ystematic manner with the intention of preparing statistical data therefrom to a
scertain the cost. The objects of Cost Accountancy can be threefold. (a) Ascerta
inment of cost and profitability with the help of various principles, methods an
d techniques. Cost control This indicates the process of controlling the costs o
f operating the business. This process, in turn, involves the following stages.
To plan the operations (which can be done by the establishment of budgets and st
andards), execute the plans, measuring the actual performance, comparison of pla
nned and actual performance, computing the variations between planned and actual
performance and taking the decisions to maintain favourable variations or to re
move unfavourable variations.
(2)
(3)
(b)
Cost Accountancy [Basic Concepts and Principles]
147

(c)
Presentation of information to enable managerial decision making. Unless and unt
il the results of any study or action are presented correctly to the person who
takes the decision in respect of the same, the study has no meaning.
CONCEPT OF COST CENTRE : Cost Centre is defined as a location, person, or item o
f equipment (or a group of these) in or connected with an undertaking, in relati
on to which costs may be ascertained and used for the purpose of cost control. C
orrect identification of a cost centre is pre-requisite for the successful imple
mentation of cost accounting process as the costs are ascertained and controlled
with respect to the cost centres. Similarly, correct identification of cost cen
tre facilitates the fixation of responsibility in a correct manner. Eg. A person
in-charge of a cost centre may be held responsible for the proper functioning a
nd cost control in relation to that cost centre. As cost centres facilitate this
control function, in many cases, they are termed as Responsibility Centres. There
may not be any fixed principle for deciding the number and size of cost centres
. It depends upon the nature and size of organisation, expenditure involved, req
uirements of management from cost control point of view and so on. However, foll
owing pattern of classification may be followed to decide the cost centres. (1)
Impersonal and Personal Cost Centres : An impersonal cost centre consists of loc
ation or item of equipment (or group of these). Eg. A region of sales, a branch,
a department, a grinding machine and so on. A personal cost centre consists of
a person or a group of persons. Eg. Finance Manager, Sales Manager, Works Manage
r and so on. (2) Production and Service Cost Centres : Production cost centre is
the one where the production activity is carried on. Eg. Machine shop, Paint sh
op, Assembly shop and so on. Service cost centre is the one which assists the pr
oduction activity. Eg. Store Dept., Internal Transport Dept., Labour Office, Mai
ntenance Dept., Accounts/Costing Dept., and so on. CONCEPT OF COST : The term co
st indicates the amount of expenditure (actual or notional) incurred on or attri
butable to, a given thing. The term cost can be viewed from various angles.
148
Management Accounting

(1)
Direct Cost and Indirect Cost : Direct Cost indicates that cost which can be ide
ntified with the individual cost centre. It consists of direct material cost, di
rect labour cost and direct expenses. It is also termed as Prime Cost. Indirect
Cost indicates that cost which cannot be identified with the individual cost cen
tre. It consists of indirect material cost, indirect labour cost and indirect ex
penses. It is also termed as overheads. As it is not possible to identify these
costs with individual cost centres, such identification is done in the indirect
way by following the process of allocation, apportionment and absorption. (It is
discussed in details in the following chapters).
(2)
Fixed, Variable and Semi-variable/Semi-fixed Cost : Fixed cost indicates that po
rtion of total cost which remains constant at all the levels of production, irre
spective of any change in the later. As the volume of production increases, per
unit fixed cost may reduce, but not the total fixed cost. Variable cost indicate
s that portion of the total cost which varies directly with the level of product
ion. Higher the volume of production, higher the variable cost and vice versa, t
hough per unit variable cost remains constant at all the levels of production. S
emi-variable or semi-fixed cost indicates that portion of the total cost which a
re partly fixed and partly variable in relation to the volume of production.
(3)
Controllable Cost and Uncontrollable Cost : Controllable cost indicates that cos
t which can be controlled by a specific number of person(s) in the organisation.
Eg. A person in charge of a responsibility centre may be in the position to con
trol the costs in relation to that responsibility centre. Uncontrollable cost in
dicates that cost which cannot be controlled by a specific number of person(s) i
n the organisation. Eg. The costs relating to one responsibility centre cannot b
e controlled by a person who is in-charge of another responsibility centre. It s
hould be noted here that a clear-cut distinction between controllable and uncont
rollable costs may not be possible. The cost which is controllable for one perso
n may not be controllable by another one. In fact, no cost is completely uncontr
ollable. The degree of controllability varies in relation to a particular indivi
dual and a level of management. In a very broad sense, it can be said that the v
ariable costs are controllable at the lower level of management while fixed cost
s are controllable at the top level of management.
Cost Accountancy [Basic Concepts and Principles]
149

(4)
Normal Cost and Abnormal Cost : Normal Cost indicates that cost which is normall
y incurred at a certain level of output under normal circumstances. Abnormal cos
t indicates that cost which is normally not incurred at a certain level of outpu
t under normal circumstances.
SPECIAL TYPES OF COST : (a) Opportunity Cost : In very simple language, opportun
ity cost is the cost of opportunity foregone. The resource like men, material, m
achine, money etc. may be having various alternative uses each one having some s
pecific yield or return. However, if they are used in one particular way, they c
annot be used in any other way. Opportunity cost refers to the return or yield w
hich is not available if the resources are used in any specific manner. Eg. Mr.
A has Rs. 1,00,000 to invest. He is having two options open. (i) (ii) Keep the s
ame with some Bank in Fixed Deposit and get the interest of 10% p.a. Invest the
money in the business and get the return on investment of 12%. If Mr. A decides
to invest the money in business, he cannot get the interest on Fixed Deposit fro
m Bank. As such, opportunity cost of investing the money in the business is in t
he form of lost interest on Fixed Deposits with the Bank. It should be noted tha
t the opportunity cost itself finds no place in the accounting process. However,
it is required to be considered in the decision making process, for the compari
son purpose. The returns available from a proposal should be more than the cost
of opportunity lost, then and then only the proposal can be accepted. (b) Differ
ential Cost : Differential cost indicates increased or decreased cost due to the
increased or decreased volume of operations. While assessing the acceptability
of a proposed change, the differential costs are compared with differential reve
nues, and so long as differential revenues are more than the differential costs,
the proposed change may be accepted. (c) Sunk Cost : Sunk cost indicates histor
ical cost which is incurred in past. This type of cost is normally not relevant
in the decision-making process. Eg. While deciding about the replacement of a ma
chine, the depreciated book value of the machine may not be relevant being in th
e form of sunk cost.
150
Management Accounting

INSTALLATION OF COSTING SYSTEM : At the outset, it should be noted that if it is


decided to install a costing system in an organisation there may not be any sta
ndard type of costing system applicable. The details of costing system may be re
quired to be worked out in such a way that they satisfy the individual requireme
nts of the organisation. Following factors will have to be considered before ins
talling a costing system. (a) Nature of the Product : Before installing the cost
ing system, the nature of product in respect of which the system is to be instal
led will have to be studied. If the product is material intensive, more stress m
ay be necessary on inventory control procedures, if the product is labour intens
ive, more stress may be necessary on control procedures and so on. (b) Nature of
the Organisation : The nature of the organisation may be required to be studied
from the various angles. (1) (2) (3) Size and layout of the factory. Organisati
onal structure of the organisation. The procedures presently followed in the res
pect of accounting of material cost, labour cost and overheads. Management requi
rements from the cost control point of view.
(4) (c)
Manufacturing Process : Before installing the costing system, the technical proc
ess involved in the manufacturing of the product will have to be studied. This m
ay involve the study from the stage of designing of the product, the quantity, q
uality and mix of the materials used, the degree of automation involved, the pro
duction control techniques implemented, the degree of complexities involved in t
he production process and so on.
(d)
Simplicity and Cost : The costing system to be installed should be simple to und
erstand and easy to operate. The costing system should be economic in terms of c
ost of installing and operating the system, and the results obtained therefrom s
hould justify the cost.
Cost Accountancy [Basic Concepts and Principles]
151

(e)
Reporting systems : The costing system should be designed in such a way that it
generates proper reports in a proper way to facilitate cost control decisions fr
om the managements side. The reporting system should be based upon the principle
of Management by Exception. Forms and records required to be maintained to facil
itate correct reporting should be designed in such a way that it involves minimu
m clerical work and minimum cost.
Some problems may arise while installing a costing system in an organisation. Ho
wever, they are faced mainly where the system is not properly planned, executed
and communicated. These problems are definitely not of the costing principles as
such and can easily be overcome by having systematic planning and communication
procedures. The problems which are usually faced while installing a costing sys
tem can be stated as below. (1) The costing system may not be suitable consideri
ng the nature of product and nature of business. The employees and the executive
s may resist the installation of the costing system feeling that it is meant for
pointing out their drawbacks. This arises only out of ignorance and suspicion.
Lack of cost consciousness among the various levels of management. The cost invo
lved in installing a costing system may be too high. Laxity on the part of vario
us employees to complete the forms of cost office and to forward them to the cos
t office.
(2)
(3) (4) (5)
152
Management Accounting

QUESTIONS 1. Explain the nature of Cost Accounting. Explain the factors which ne
ed to be considered for installing a costing system for a medium sized engineeri
ng organisation. 2. Write short notes on a) b) Cost Centre Opportunity Cost
Cost Accountancy [Basic Concepts and Principles]
153

NOTES
154
Management Accounting

Chapter 7
ELEMENTS OF COSTS
In case of a typical manufacturing type of operation, the activity may consist o
f conversion of raw material in the form of finished goods with the help of labo
ur and other services and selling the finished goods in the market to earn the p
rofits. In order to interpret the term cost correctly and to ascertain the cost
with respect to the centres, the cost attached with the manufacturing process ma
y be subdivided into what is known as Elements of Cost. Broadly there can be thr
ee elements of costs. (A) Material : This is the cost of commodities and materia
ls used by the organization. It can be direct or indirect. Direct Material indic
ates that material which can be identified with the individual cost centre and w
hich becomes an integral part of the finished goods. It basically consists of al
l raw materials, either purchased from ourside or manufactured in house. Indirec
t Material indicates that material which cannot be identified with the individua
l cost centre. This material assists the manufacturing process and does not beco
me an integral part of finished goods. The examples of this type of material may
be consumable stores, cotton waste, oils and lubricants, stationery material et
c. (B) Labour : This is the cost of remuneration paid to the employees of the or
ganisation. It can be direct or indirect. Direct Labour Cost indicates that labo
ur cost which can be identified with the individual cost centre and is incurred
for those employees who are engaged in the manufacturing process. Indirect Labou
r Cost indicates that labour cost which cannot be identified with the individual
cost centre and is incurred for those employees who are not engaged in the manu
facturing process but only assist in the same. The examples of this type of cost
are wages paid to foreman/storekeeper, salary of works manager, Accounts/Person
nel department salaries etc.
Elements of Costs
155

(C) Expenses : This is the cost of services provided to the organisation (and th
e notional cost of assets owned). It can be direct or indirect. Direct Expenses
are those expenses, which can be identified with the individual cost centres. Th
e examples of these expenses are hire charges of machinery/ equipments required
for a particular job, cost of defective work for a particular job etc. Indirect
Expenses are those expenses, which cannot be identified with the individual cost
centres. The examples of these expenses are rent, telephone expenses, insurance
, lighting etc. The above elements of cost can be shown as below. Cost Material
Direct Indirect Direct Labour Indirect Direct Expenses Indirect
The aggregate of Direct Material Cost, Direct Labour Cost and Direct Expenses is
termed as Prime Cost. The aggregate of Indirect Material Cost, Indirect Labour Co
st and Indirect Expenses is termed as Overheads. Overheads : As discussed above, t
he aggregate of Indirect Material cost, Indirect Labour cost and Indirect Expens
es is termed as Overheads. For the proper interpretation and presentation of cost,
the term overheads may be further classified as below. (a) (b) (c) (a) Factory
Overheads (Also termed as production/works/manufacturing overheads.) Office and
Administration Overheads. Selling and Distribution Overheads. Factory Overheads
: These overheads consist of all overhead costs incurred from the stage of procu
rement of material till the stage of production of finished goods. They include
:
l
Indirect Material such as consumable stores, cotton waste, oil and lubricants et
c.
156
Management Accounting

l
Indirect Labour Cost such as wages paid to foreman/storekeeper, works managers sa
lary etc. Indirect Expenses such as carriage inward cost, cost of factory lighti
ng/power expenses, rent/insurance/repairs for factory building/machinery, deprec
iation on factory building or machinery etc.
l
(b)
Office and Administration Overheads : These overheads consist of all overhead co
sts incurred for the overall administration of the organization. They include :
l l
Indirect Material such as stationery items, office supplies etc. Indirect Labour
cost such as salaries paid to Accounts and Administration staff, Directors remun
eration etc. Indirect Expenses such as postage/telephone, rent/insurance/repairs
/depreciation on office building, general lighting, legal/audit charges, bank ch
arges etc.
l
(c)
Selling and distribution Overheads : These overheads consist of all overhead cos
ts insured from the stage of final manufacturing of finished goods till the stag
e of sale of goods in the market and collection of dues from the customers. They
include :
l l
Indirect Material such as packing material, samples etc. Indirect Labour like sa
laries paid to sales personnel, commission paid to sales manager etc. Indirect E
xpenses like carriage outwards, warehouse charges, advertisement, bad debts, rep
airs and running of distribution van, discount offered to customers etc.
l
Elements of Costs
157

The above classification of overheads can be shown as below : Indirect Material


Factory Indirect Labour Indirect Expense Indirect Material Overheads Office/Admi
nistration Indirect Labour Indirect Expense Indirect Material Selling & Distribu
tion Indirect Labour Indirect Expense Cost Sheet/Cost Statement : The various el
ements/components of the cost as discussed above can be presented in the form of
a statement, popularly known as Cost Sheet or Cost Statement. The cost sheet may be
prepared separately for each cost centre and may have the columns like cost per
unit or cost of previous period etc. A Proforma cost sheet is shown below : Dir
ect Material Cost Direct Labour cost Direct Expenses PRIME COST Add : Factory Ov
erheads FACTORY/WORKS COST Add : Office and Administration Overheads TOTAL COST
Add : Selling and Distribution Overheads COST OF SALES Add : Profit SALES
Management Accounting
158

The above relationship among the various elements of costs can be explained in a
better way with the help of following diagram. PROFIT SELLING & DISTRIBUTION OV
ERHEADS ADMINISTRATION OVEREHEADS FACTORY OVERHEADS DIRECT EXPENSES PRIME COST D
IRECT LABOUR DIRECT MATERIAL Note : The difference between sales and factory/wor
ks cost is termed as Gross Profit and the difference between sales and cost of sal
es is termed as Net Profit or Operating Profit. As such, the difference between Gros
s Profit and Office and Administration Overheads and Selling and Distribution ma
y be different from the Net Profit or Operating Profit. This Net Profit may be diffe
rent from the net Profit as disclosed by the financial statement in the form of
Profit and Loss Account. This is due to the fact that the Profit and Loss Accoun
t considers the various non-operating incomes/expenses or incomes/expenses of pu
rely financial nature (as discussed below) while they may be ignored by the cost
statement. (a) Non-operating/Financial Incomes : These represent incomes which
arise not as a part of regular operations of the organisation. Eg. Profit on the
sale of assets/investment, dividend received, windfall income etc. Due to these
, the operating profit as per cost statement may be less than profit as per Prof
it and Loss Account. (b) Non-operating/Financial Expenses : These represent expe
nses which arise not as a part of regular operations of the organisation. Such e
xpenses may be in the form of those incurred as a result of policy.
Elements of Costs
COST OF SALES
FACTORY COST
TOTAL COST
SALES 159

Eg. loss on the sale of assets/investment, good-will/ preliminary expenses writt


en off, provision for Income Tax, Interest paid, Dividend paid etc. Due to these
, the operating profit as per cost statement may be more than profit as per Prof
it and Loss Account. As such cost structure may also be presented as below. Sale
s Less : Factory/Works Cost Gross Profit Less : Office and Administration Overhe
ads Selling and Distribution Overheads Operating Profit Less : Add : Non-Operati
ng/Financial Expenses Non-Operating/Financial Income Net Profit (As per Profit a
nd Loss Account) It goes without saying that if an organisation maintains cost r
ecords and financial records separately, there may be a need to reconcile the pr
ofits as disclosed by the cost records and the profit as disclosed by the financ
ial records. ILLUSTRATIVE PROBLEMS (1) From the following list of balances, prep
are a statement showing Cost of Sales, Gross Profit, Operating Expenses, Operati
ng Profit and Net Profit. Rs. Sales Purchases Sales Returns Salaries : Office Se
lling Rent and Taxes : Office Selling Stationery and Postage Depreciation Advert
ising Selling expenses Travelling expenses 160 40,350 22,950 2,700 1,350 4,050 3
,850 13,950 4,700 2,350 3,000
Management Accounting
7,80,000 4,83,375 30,000 63,300

Opening Stock Sundry Expenses : Office Selling Closing Stock Dividend on shares
Profit and sale of shares Loss on sale of shares Solution : COST STATEMENT (A) S
ales Gross Sales Less : Sales Returns Net Sales (B) Prime Cost (Material consume
d) Opening Stock Add : Purchases 16,500 8,250
1,14,375
24,750 1,47,750 13,500 4,500 6,000
Rs. 7,80,000 30,000
Rs.
7,50,000
1,14,375 4,83,375 5,97,750
Less : Closing stock
1,47,750 4,50,000
(C) Gross Profit (i.e. A-B) (D) (a) Office and Administration Overheads Salaries
Rent and Taxes Stationery and Postage Depreciation Travelling Expenses Sundry E
xpenses 40,350 2,700 3,850 13,950 3,000 16,500 80,350
3,00,000
Elements of Costs
161

(b) Selling and Distribution Overheads Salaries Rent and Taxes Advertising Selli
ng Expenses Sundry Expenses 22,950 1,350 4,700 2,350 8,250 39,600 (E) (F) Operat
ing Profit (i.e. C-D) (a) Less : Non-operating Expenses Dividend on shares Loss
on sale of shares 13,500 6,000 19,500 1,60,550 (b) Add : Non-operating Income Pr
ofit on sale of shares (G) Net Profit Notes : (a) From the available details, it
appears that the above activity is a trading activity. As such there will be no
factory overheads and prime cost will consist of only material cost. In want of
sufficient information, depreciation and travelling expenses are treated as off
ice and administration overheads. Dividend on shares may indicate the non-operat
ing income also. However, in want of sufficient information, it is treated as di
vidend paid by the company i.e. a part of nonoperating expenses. From the books
of accounts of M/s. Aryan Enterprises, the following details have been extracted
for the year ending March, 1994. Rs. Stock of Materials Opening Closing Materia
ls purchased during the year Direct Wages paid Indirect Wages 162 1,88,000 2,00,
000 8,32,000 2,38,400 16,000
Management Accounting
1,19,950 1,80,050
4,500 1,65,050
(b)
(c)
(2)

Salaries to administrative staff Freights Inward Outward Cash Discounts allowed


Bad Debts written off Repairs to Plant & Machinery Rent, Rates and Taxes Travell
ing Expenses Salesmens Salaries and Commission Depreciation Plant & Machinery Fur
niture Directors Fees Electricity Charges (Factory) Fuel (for boiler) General Cha
rges Managers Salary Factory Office
40,000 32,000 20,000 14,000 18,800 42,400 12,000 6,400 12,400 33,600 28,400 2,40
0 24,000 48,000 64,000 24,800 48,000
The managers time is shared between the factory and the office in the ratio of 20
:80. From the above details, you are required to prepare :a. b. c. d. e. f. Prim
e Cost Factory Overheads Factory Cost Administration Overheads Selling Overheads
Total Cost
Solution : COST SHEET Direct Materials Cost Opening Stock Add : Purchases Less :
Closing Stock Rs. 1,88,000 8,32,000 2,00,000 8,20,000 Add : Freight Inward 32,0
00 Rs.
Elements of Costs
163

Rs.
Rs. 8,52,000
Direct Wages PRIME COST Factory Overheads Indirect wages Repairs to Plant & Mach
inery Rent, Rates and Taxes Depreciation Plant & Machinery Electricity Charges F
uel for boiler Managers Salary 16,000 42,400 12,000 28,400 48,000 64,000 9,600
2,38,400 10,90,400
2,20,400 FACTORY COST Administration Overheads Salaries Rent, Rates and Taxes Tr
avelling Expenses Depreciation Furniture Directors Fees General Charges Managers S
alary 40,000 6,400 12,400 2,400 24,000 24,800 38,400 1,48,400 OFFICE COST Sellin
g Overheads Freight Outward Cash Discount allowed Bad Debts written off Salesmen
s Salary & Commission 20,000 14,000 18,800 33,600 86,400 TOTAL COST 15,45,600 14,
59,200 13,10,800
164
Management Accounting

(3)
An advertising agency has received an enquiry for which you are supposed to subm
it the quotation. Bill of Materials prepared by the Production Department for th
e job states the following requirement of material : 10 reams @ Rs. 1800 per rea
m Rs. 5,000 Rs. 3,000
Paper Ink & Other printing material Other consumables
Some photography is required for the job. The agency does not have a photographe
r as an employee. It decides to hire a professional photographer who is to be pa
id professional fees of Rs. 10,000. Estimated job card prepared by the Productio
n Department specifies that services of the following employees will be required
for the execution of the job. Monthly remuneration payable to these employees a
s indicated by the Personnel Department is also given. Artist Copywriter Client
Servicing 80 hours. Paid Rs. 12,000 p.m. 75 hours. Paid Rs. 10,000 p.m. 30 hours
. Paid Rs. 9,000 p.m.
You can assume that a month consists of 25 working days and one working day cons
ists of 6 working hours. An amount of Rs. 4,000 will be required for the cost of
primary packing material. Production overheads are likely to be 40% of direct c
ost while selling and administration overheads are likely to be 25% of productio
n cost. The agency expects the profit of 10% on basic quotation price. COST SHEE
T Rs. Direct Materials Cost Paper Ink & Other printing material Other Consumable
s Primary Packing Material 18,000 5,000 3,000 4,000 30,000 Direct Labour Cost Ar
tist Copywriter Client Servicing 6,400 5,000 1,800 13,200 Rs.
Elements of Costs
165

Direct Expenses Photography Charges DIRECT COST Production Overheads PRODUCTION


COST Selling & Administration Overheads TOTAL COST Profit QUOTATION PRICE 10,000
53,200 21,280 74,480 18,620 93,100 10,344 1,03,444
(4)
Pune Equipments Ltd. manufactured and sold 1,000 refrigerators in year ending 31
December, 1984. The Trading and Profit & Loss Account is as below: Trading and
P&L Account for the year ending 31.12.84.
To, Cost of material To, Direct wages To, Manufacturing Cost To, Gross Profit
80,000 1,20,000 50,000 1,50,000 4,00,000
By, Sales
4,00,000
4,00,000 By, Gross Profit 1,50,000
To, Mgn. & Staff Salary To, Rent, Rates etc. To, Selling Expenses To, General Ex
penses To, Income Tax To, Net Profit
60,000 10,000 30,000 20,000 5,000 25,000 1,50,000
1,50,000
For the year ending 31.12.85, it is estimated that : 1. 2. 3. 4. 5. 6. 166 Outpu
t and sales will be 1,200 refrigerators. Prices of the materials will rise by 20
% on the previous years level. Wages will rise by 5%. Manufacturing cost will ris
e in proportion to combined costs of materials and wages. Selling cost per unit
will remain unchanged. Other expenses will remain unaffected by the rise in outp
ut.
Management Accounting

You are required to prepare a cost statement showing the price at which each ref
rigerator should be marked so as to show profit of 10% on the selling price. Sol
ution : Cost Statement for the Year Ending 31.12.85 (Base - 1,200 Refrigerators)
Per Unit Rs. Material Cost Direct Wages Prime Cost Manufacturing Cost (25% of P
rime Cost) Factory Cost Management & Staff Salary Rent/Taxes and General Expense
s Selling Expenses Cost of Sales Profit (1/9th of Total Cost) Sales Note : (1) M
aterial Cost and Direct Cost increases both due to increase in volume and increa
se in prices. Calculation of manufacturing cost percentage Present Materials Cos
t Present Direct Wages Present Prime Cost Present Manufacturing Cost Rs. 80,000
96.00 126.00 222.00 55.50 277.50 50.00 25.00 30.00 382.50 42.50 425,00 Total Rs.
1,15,200 1,51,200 2,66,400 66.600 3,33,000 60,000 30,000 36,000 4,59,000 51,000
5,10,000
(2)
Rs. 1,20,000 Rs. 2,00,000 Rs. 50,000
Manufacturing Cost is 25% of Prime Cost. (3) Expenditure in the form of income t
ax will be ignored being non-operating expenditure.
Elements of Costs
167

(5)
The standard production for a particular work order is 20 units per day and piec
e rate wages is 60 paise per unit if daily production is 20 units or more. The r
ate is 50 paise per unit if production is less than 20 units. Cost of material i
s 30 paise per unit. It is proposed to charge factory overhead under one of the
following methods. (i) (ii) 100% on labour cost. 80% on prime cost.
Tabulate the above data in the form of a suitable statement and indicate in the
factory cost per unit, under each of the above methods if the daily production i
s (a) 15 units (b) 20 units (c) 25 units.
Solution : COST SHEET (a) No. of units produced per day (b) Material cost (Rs) (
c) Labour cost (Rs) (d) Prime cost i.e. b+c Alternative I (a) No. of units produ
ced per day (b) Prime Cost (Rs) (c) Factory overheads (Rs) (d) Total factory cos
t i.e. b+c (e) Factory cost per unit i.e. d/a (Rs) Note : According to Alternati
ve I, Factory Overheads are charged @ 100% on Labour Cost. According to Alternat
ive II, Factory Overheads are charged. @ 80% on Prime Cost. 15 12.00 7.50 19.50
1.30 20 18.00 12.00 30.00 1.50 25 22.50 15.00 37.50 1.50 15 4.50 7.50 12.00 20 6
.00 12.00 18.00 25 7.50 15.00 22.50
Alternative II 15 12.00 9.60 21.60 1.44 20 18.00 14.40 32.40 1.62 25 22.50 18.00
40.50 1.62
168
Management Accounting

(6)
X Ltd. manufactures four brands of toys A, B, C and D. If the Company limits the
manufacture to just one brand, the monthly production will beA - 50000 Units C
- 150000 Units B - 100000 Units D - 300000 Units
You are given the following set of information, from which you are requested to
find out the profit or loss made on each brand showing clearly, the following el
ements. (a) Direct cost (b) Works cost (c) Total cost Brands A Monthly Productio
n (units) Direct Wages (Rs.) Direct Material Cost (Rs.) Selling Price Per Unit (
Rs.) 6,750 15,000 50,000 20 B 18,000 27,500 92,500 15 C 40,500 37,500 1,27,500 1
0 D 94,500 1,05,000 3,80,000 8
Factory overhead expenditure for the month was Rs. 1,62,000. Selling and distrib
ution cost should be assumed @ 20% of works cost. Factory overhead expenses shou
ld be allocated to each brand on the basis of the units which could have been pr
oduced in a month when a single brand production was in operation.
Solution : From the information given, it is observed that One unit of B is equi
valent to 2 units of A. One unit of C is equivalent to 3 units of A One unit of
D is equivalent to 6 units of A Expressing the actual production in terms of uni
t equivalents of product A Product A Product B Product C Product D 6,750 9,000 1
3,500 15,750 45,000 units. units equivalent of A units equivalent of A units equ
ivalent of A
Elements of Costs
169

The factory overheads of Rs. 1,62,000 are to be distributed over 45,000 equivale
nt units of product A. As such rate of factory overheads for one unit of Product
A will be Rs. 1,62,000 45,000 units = Rs. 3.60/per unit
As such, per unit factory overheads for other products will be Product B - Rs. 3
.60/2 = Rs. 1.80/ per unit. Product C - Rs. 3.60/3 = Rs. 1.20/ per unit. Product
D - Rs. 3.60/6 = Rs. 0.60/ per unit. On this basis, the cost sheet for each pro
duct can be worked out as below. A (a) Direct Material Cost (b) Direct Wages (c)
Total Direct Cost i.e. a+b (d) Factory Overheads (e) Works cost i.e. c+d (f) Se
lling/Distribution overheads 50,000 15,000 65,000 24,300 89,300 17,860 1,07,160
6,750 20 1,35,000 27,840 B 92,500 27,500 1,20,000 32,400 1,52,400 30,480 1,82,88
0 18,000 15 2,70,000 87,120 C 1,27,500 37,500 1,65,000 48,600 2,13,600 42,720 2,
56,320 40,500 10 4,05,000 1,48,680 D 3,80,000 1,05,000 4,85,000 56,700 5,41,700
1,08,340 6,50,040 94,500 8 7,56,000 1,05,960
(g) Cost of Sales e+f (h) Units Sold/Produced (i) (j) Units Selling Price - Rs.
Total Sales Rs.
(k) Profit i.e. j-g (7)
A manufacturing company has an installed capacity of 1,20,000 units per annum. T
he cost structure of the product manufactured is as under Variable Cost (Per uni
t) Materials Labour (subject to a minimum of Rs. 56,000 per month) Overheads Rs.
8 Rs. 3 Rs. 8
1.
2.
Fixed overheads Rs. 1,04,000 per annum
170
Management Accounting

3.
Semi variable overheads Rs. 48,000 per annum at 60% capacity which increase by R
s. 6,000 per annum for increase of every 10% of the capacity utilization or any
part thereof.
The capacity utilisation for the next year is estimated at 60% for 2 months, 75%
for 6 months and 80% for the balance part of the year. If the company is planni
ng to have a profit of 25% on the selling price, calculate the estimated selling
price for each unit of production. Assume that there is no opening or closing s
tock. Solution : Capacity Utilisation Months No. of units 60% 2 6000 75% 6 7500
80% 4 8000
Hence, total number of units will be 6000 x 2 months + 7500 units x 6 months + 8
000 units x 4 months = 89,000 units Total Materials (Rs.) Labour Overheads Semivariable Overheads Fixed Overheads Cost of Production Per Unit Cost of Productio
n i.e. 18,69,000/89,000 = Rs. 21 As profit is 25% on the selling price, selling
price will be Rs. 28 per unit. (8) AB & Co. manufactures two types of pens P and
Q. The cost data for the year ended 30th September, 1990 is as follows Rs. Rs.
Rs. Rs. It is further ascertained that : a. b. c. Direct Materials in type P cos
t twice as much direct materials in type Q. Direct wages for type Q were 60% of
those for type P. Production overheads were of same rate for both types. 4,00,00
0 2,24,000 96,000 7,20,000 96,000 112,000 36,000 8,000 360,000 360,000 135,000 3
0,000 256,000 256,000 96,000 20,000 7,12,000 7,28,000 2,67,000 58,000 1,04,000 1
8,69,000
Direct Materials Direct Wages Production Overheads
Elements of Costs
171

d. e. f.
Administration overhead for each was 200% of direct labour. Selling costs were 5
0 paise per pen for both types. Production during the year Type P Type Q 40,000
1,20,000 units units
g.
Sales during the year Type P Type Q 36,000 1,00,000 units units
h.
Selling prices were Rs. 14 per pen for type P and Rs. 10 per pen for type Q.
Prepare a statement showing per unit cost of production, profit and total sales
value and profit separately for two types of pens P and Q. Solution : Cost State
ment for the year ended on 30th September, 1990 Particulars Direct Material Dire
ct Wages Production Overheads Administration Overheads a. b. c. d. e. f. g. h. i
. j. Cost of Production Production (Units) Per Unit Cost of Production (Rs.) (Be
ing a/b) Sales (Units) Cost of Sales (Being d x c) Selling Cost Total Cost (Bein
g e + f) Per Unit Selling Price (Rs.) Sales (Being d x f) Profit P 1,60,000 80,0
00 24,000 1,60,000 4,24,000 40,000 10.60 36,000 3,81,600 18,000 3,99,600 14.00 5
,04,000 1,04,400 Q 2,40,000 1,44,000 72,000 2,88,000 7,44,000 1,20,000 6.20 1,00
,000 6,20,000 50,000 6,70,000 10.00 10,00,000 3,30,000
172
Management Accounting

Working Notes : a. Direct Materials Let per unit direct materials cost of Q be R
s. X. Hence, per unit direct materials cost of P will be 2X Total Direct Materia
ls Cost will be 40,000 units x 2X + 1,20,000 units x X = 4,00,000. Solving for X
, we get X = Rs. 2 Hence, Direct Materials Cost for P will be Rs. 1,60,000 and D
irect Materials Cost for Q will be Rs. 2,40,000. b. Direct Wages Let rate of lab
our be Rs. X for P Hence, rate of labour for Q will be 0.6X for Q Total Direct W
ages will be 40,000 units x X + 1,20,000 units x 0.6X = 2,24,000 Solving for X,
we get X = 2 Hence, Direct Wages Cost for P will be Rs. 80,000 and Direct Wages
Cost for Q will be Rs. 1,44,000. (9) A company presently sells an equipment for
Rs. 35,000. Increase in prices of labour and material are anticipated to the ext
ent of 15% and 10% respectively in the forthcoming year. Material cost represent
s 40% of cost of sales and labour cost 30% of cost of sales. The remaining relat
e to overheads. If the existing selling price is retained, despite the increase
in labour and material prices, the company would face a 20% decrease in the exis
ting amount of profit on the equipment.
You are required to arrive at a selling price so as to give the same percentage
of profit on increased cost of sales, as before. Prepare a statement of profit/l
oss per unit showing the new selling price and cost per unit in support of your
answer. Solution : Let cost of sales per unit be Rs. X. Then per unit profit wil
l be 35000 X. Per unit cost structure will be as below Material Cost Labour Cost
Overheads 0.4X 0.3X 0.3X
After the price increase, per unit cost structures will change as below Material
Cost Labour Cost Overheads
Elements of Costs
0.44X 0.345X 0.3X 173

However, after the price increase and existing selling price remaining the same,
the profit per unit will come down by 20%. Hence, the following equation will e
merge 35,000 (0.44X + 0.345X + 0.3X) = 0.8 (35,000 X) Solving for X, we get X =
24,561. Hence, the existing per unit cost of sales is Rs. 24,561. As such, follo
wing is the per unit cost structure with the existing prices and after the price
increase, Existing Materials Cost Labour Cost Overheads Cost of Sales Profit Se
lling Price 9,825 7,368 7,368 24,561 10,439 35,000 Future 10,808 8,473 7,368 26,
649 8,351 35,000
Existing profit on cost of sales works out as 10,439 24,561 If the same profit p
ercentage is to be maintained after the cost increase, the new selling price wil
l be 26,649 + 42.5% of 26,649 = Rs. 37,975. (10) A firm has purchased a plant fo
r manufacturing a new product, the cost data for which is given below. Estimated
Annual Sales Estimated Costs Material Direct Labour Overheads Administrative Ex
penses Selling Expenses Rs. 4.00 per unit Rs. 0.60 per unit. Rs. 24,000 per year
. Rs. 28,800 per year. 15% of sales. 24,000 units. X 100 = 42.5%
Calculate the selling price if profit per unit is Rs. 1.02. 174
Management Accounting

Solution : Let the selling price be Rs. X Hence, total sales will be Rs. 24000X
The cost sheet will be as below Material Cost Direct Labour Overheads Administra
tive Expenses Selling Expenses 15% of sales Profit Hence, 24000X = 96000 + 14400
+ 24000 + 28800 + 3600X + 24480 24000X = 187680 + 3600X 20400X = 187680 X = 9.2
0 Hence, selling price will be Rs. 9.20 Re. 1.02 per unit 24000 x Rs. 4.00 24000
x Rs. 0.60 96,000 14,400 24,000 28,800 3,600X 24,480
QUESTIONS 1. What do you mean by Elements of Cost? Explain in details. Draw a st
andard format of cost sheet for a machine tool manufacturing company. Assume sui
table data. How the cost is classified into various elements for presenting the
same in the form of a cost sheet. Prepare a standard format of cost sheet for a
furniture making unit. Assume suitable data.
2.
Elements of Costs
175

PROBLEMS (1) The following figures relates to the trading activities of Hind Tra
ders for the year ended 30.6.79. Prepare a statement showing net operating incom
e. Rs. Sales Purchases Opening Stock Closing Stock Sales Returns Interest on Deb
entures Advertising Travelling 5,20,000 3,22,250 76,250 98,500 20,000 15,300 4,7
00 2,000 Office Salaries Rent Stationery & Postage Depreciation Other charges Pr
ovision for Tax Rs. 27,000 2,700 2,500 9,300 16,500 40,000
(2)
From the following list of balances, prepare a statement showing net operating i
ncome. Rs. Sales Purchases Sales Returns Purchases Returns Opening Stock Closing
Stock Rent Received Profit on sale of asset Office Expenses Manufacturing Expen
ses Selling Expenses Depreciation Interest on Loan Income Tax 5,40,000 1,60,000
40,000 10,000 50,000 60,000 1,50,000 1,00,000 25,000 30,000 10,000 13,000 2,000
150
176
Management Accounting

(3)
A Ltd. is a company which is engaged in the business of executing the various jo
bs as per the customer requirements. It has received one job from one of the cus
tomers for which it is required to submit the quotation. The Production Manager
of the company has worked out the following details of the cost in respect of th
e said job Rs. 40,000 Rs. 50,000 Rs. 5,000 Rs. 4,000 400 Labour Hours @ Rs. 30 p
er hour 20% of Direct Material 15% of Prime Cost 100 Man-hours @ Rs. 50 per hour
15% of Factory Cost 10% of Total Cost
Raw Materials Bought Out Components Primary Packing Material Consumable Stores D
irect Workers Royalty Payable Other Factory Overheads Support from administrativ
e staff Other administration overheads Selling Overheads
What selling price should be quoted by the Company if it intends to earn a profi
t of 20% on selling price? (4) Honesty Engineering Works has a machining shop in
which it manufactures two Auto Parts P1 and P2 out of forgings F1 and F2. For t
he quarter ending December 1993, following cost data are available 1,50,000 2,00
,000 1,53,000 12,000 15,000 16,000 8,000 50,000 68,000 64,400 75,000 8,11,400
Consumption of Raw Materials - F1 - F2 Wages and Salaries Stores and Spares Repa
irs and Maintenance Power Insurance Depreciation Factory Overheads Administratio
n Overheads Distribution Overheads Total Cost
Elements of Costs
177

You are given further information a. Production and Sales of P1 and P2 were as u
nder P1 Production (Pieces) Sale of above pieces (Rs.) b. 6,000 4,80,000 P2 4,00
0 5,20,000
Direct wages paid were Rs. 36,000 incase of P1 and Rs. 32,000 for P2. This is us
ed for apportioning Wages and Salaries and Factory Overheads. Following machine
hours were utilized in production of these products P1 550 P2 450
c.
d.
Stores & Spares, Repairs & Maintenance, Power, Insurance and Depreciation are ch
arged to cost of both the products on the basis of machine hours used. Administr
ation Ovcrheads are apportioned on the basis of respective conversion costs whil
e Distribution Overheads on the basis of their sales realizations. All the produ
ction was sold out.
e. f.
Required Prepare cost sheets of both the products and work out profit earned of
each of them. (5) The cost of manufacturing 5,000 units of a commodity comprises
Material Rs. 20,000, Wages Rs. 25,000, Chargeable Expenses Rs. 400. Fixed Overh
eads Rs. 16,000, Variable Overheads Rs. 4,000. For manufacturing every 1,000 ext
ra units of the commodity, the cost of production increases as follows. 1. 2. 3.
4. 5. Materials : Proportionately. Wages : 10% less than proportionately. Charg
eable Expenses : No extra cost. Fixed Overheads : Rs. 200 extra. Variable Overhe
ads : 25% less than proportionately.
Calculate the estimated cost of producing 8,000 units of the commodity and show
by how much it would differ if a flat rate of factory overhead were charged.
(6)
The following is the profit and loss account of a manufacturing company for the
year 1987-88 (figures in lakhs).
178
Management Accounting

Rs. Materials Wages Factory overheads Gross Profit c/d 48 36 24 12 Sales Closing
Stock of finished goods Work in Progress (at cost) Materials Labour Works Expen
ses 120 Administration Expenses Goodwill and Preliminary Expenses written at Net
Profit 2 5 13 6 Gross Profit b/d Interest Received 3.00 1.80 1.20
Rs. 96 18
6 120 12 1
13
During the year 6000 units were manufactured and 4800 units were sold. The costi
ng records show that works expenses have been charged @ Rs. 300 per article,and
administration expenses @ Rs. 150 per article. The costing books show a profit o
f Rs. 12 lakhs. Prepare cost sheet and show the reconciliation (7) A firm manufa
ctured and sold 500 units during the year ended on 31st March, 2001. The summari
sed Trading and Profit & Loss Account is as below : Rs. 40,000 60,000 25,000 75,
000 2,00,000 Management Expenses Rent General Expenses Selling Expenses Net Prof
it 30,000 5,000 10,000 15,000 15,000 75,000 75,000 Gross Profit 2,00,000 75,000
Particulars Sales Rs. 2,00,000
Particulars Material Consumed Direct Labour Manufacturing Cost Gross Profit
Elements of Costs
179

For the year 2001-2002, the estimates are : a. b. c. d. e. f. Output and sales w
ill be 600 units. Material prices will increase by 20% over the previous year. D
irect Labour rate will rise by 5%. Manufacturing expenses will increase in propo
rtion to prime cost. There will be no change in selling expenses per unit. Rise
in output will not affect other expenses.
Prepare a statement showing the price in such a way that profit will be 20% on s
elling price. (8) Following costs were incurred in producing 800 MT of M.S. Rods
Materials Labour Processing Charges Total Cost 2,80,000 1,00,000 1,00,000 4,80,
000
Of the total output, 10% was defective and had to be sold after a discount of 10
% off the normal price. The scrap arising out of the production realized a sum o
f Rs. 8,760. The sale price is calculated to yield 15% profit on sales. You are
required to find out the normal price as well as the discounted price of per MT
of M.S. Rods. (9) In a factory, the methods mentioned below are adopted for the
allocation of office and selling overheads. (a) (b) (c) (d) Advertisement and Sa
les Promotion - On Factory Cost figures. Credit and Collection Expenses - On Sal
es figures. Direct Selling Costs - On Sales figures. Other items - On Factory Co
st figures.
The factory deals with five different types of products viz. B, C, D, E and F. T
he following information has been collected from its books.
180
Management Accounting

Particulars
B Rs.
C Rs. 48,000 36,000 1,65,000
D Rs. 66,000 57,000 2,62,500
E Rs. 33,000 24,000 1,09,500
F Rs. 40,500 34,500 1,60,500
Direct Materials Direct Wages Sales
24,000 27,000 1,12,500
Factory overhead charges are 80% of direct wages. Office and sales expenses are
: Rs. Direct Selling Costs Other Items Credit and Collection Expenses Advertisem
ent and Sales Promotion 81,000 53,280 8,100 79,920
Prepare a statement showing the costs incurred and the profit earned in respect
of each product. (Calculations may be made to the nearest rupee).
Elements of Costs
181

NOTES
182
Management Accounting

Chapter 8
MATERIAL COST
Material cost is the first and probably the most important element of cost. In c
ase of some specific types of industries, say cement, sugar, chemicals, iron and
steel etc., the materials cost forms a very significant portion of the overall
cost of production. The term material refers to all commodities which are consum
ed in the production process. The materials which can be consumed in the product
ion process can be basically classified as: (i) (ii) Direct Materials Indirect M
aterials
The meaning of both these terms has already been discussed. The basic objective
of cost accounting i.e. ascertainment of cost and control of cost is equally app
licable to material cost as well. The ascertainment of material cost is made fro
m basically two documents i.e. the invoice of the supplier of material and mater
ial requisition slip specifying material issued from stores department to produc
tion department. However, a whole lot of organisational procedures are also invo
lved in the process, which affect the material cost, either directly or indirect
ly. E.g. Purchases from improper source of supply may be expensive, non-availabi
lity of material in time may result into hold ups and so on. As such, a proper s
tudy of the various procedures involved in case of the movement of materials and
a proper control thereon enables an organisation to exercise the control on a s
izeable manufacturing cost. The movement of material may involve the following s
tages. (a) (b) (c) Procurement of materials. Storing the material till it is req
uired for consumption. Issue of the material for consumption.
(A) Procurement of Materials : Though the practices may differ from organisation
to organisation, normally, the process of purchasing the materials involves the
following stages.
Material Cost
183

(1)
Purchase Requisition : It is an indication given to the purchases department to
purchase certain material. It is issued either by storekeeper (in respect of mat
erial required for regular production purposes) or by production department (in
respect of special materials required). Following particulars must appear in pur
chase requisition. (i) Material to be purchased : It should be clearly specified
. To make it more specific, in addition to the description of the material requi
red, code number should also be specified. When it is required : Unless the mate
rial is required for regular production purposes (when the storekeeper himself w
ill place the purchase requisition as soon as it reaches the ordering level), pu
rchase requisition should mention the last date by which the material is require
d. Ideally, the material should be purchased whenever the market for the same is
favourable.
(ii)
(iii) How much to be purchased : Purchase requisition should state the quantity
of the material required. Before deciding the quantity of material to be purchas
ed, the principle which should be kept in mind is that there should not be any o
verstocking or understocking of materials as both these situations involve costs
. Overstocking may have following consequences : - Blocking of working capital.
- Risk of deterioration of quality and obsolescence. - More storage facilities.
- Additional Insurance Cost. - More material handling and upkeeping. - Risk of b
reakage/pilferage etc. Understocking may have following consequences : - Product
ion hold ups, resulting into disturbed delivery schedules. - Frantic eleventh ho
ur purchases which may result into unfavourable prices and quality. - Payment fo
r idle time to workers. Before deciding the quantity to be purchased, considerat
ion will have to be given to the following factors also : (i) Quantity already o
rdered.
184
Management Accounting

(ii) Quantity reserved. There may be the case that a particular quantity, though
in hand, might have been reserved for a particular job which is not available f
or other purposes. In such cases, this quantity is such, as if it is not in stoc
k. (iii) Funds availability - Amounts which are kept aside for drawing up purcha
se budget should be considered. The purchase requisition should be signed by Hea
d of the Department drawing the same. A standard form of Purchase Requisition is
as shown below : PURCHASE REQUISITION To : Purchase Department From : Departmen
t No. Date Please purchase the material stated below.
Sr. No. Description Code No. Quantity Required Quantity on hand Remarks
: :
Signed by : Storekeeper
Approved by
For the use of Purchase Department only
Date P.O. No. Name of Supplier Delivery Date Remarks
Signed : Purchase Manager
(2)
Selection of Source of Supply : For this purpose, the purchase department may ca
ll for the quotations from the prospective suppliers of a certain type of materi
al. In practice, following types of quotations may be called for : (a) Single Te
nder : It is addressed to only one selected source when there is only one source
of supply available. 185
Material Cost

(b)
Limited Tender : It is addressed to a limited number of suppliers known to be re
liable sources on the basis of data maintained by the purchase department. Open
Tender : It is open to all who can supply specified quality and quantity of the
required material. Tenders are called by giving advertisements in the newspapers
, journals etc. Global Tender : Anybody from any part of the world can respond t
o these tenders.
(c)
(d)
To discourage unreliable and unwanted sources from quoting, some tender deposit
may be insisted upon. Comparative Statements : After receiving the tenders as st
ated above, a comparison has to be made among the various available sources so t
hat the best possible source can be selected. All the offers are tabulated in a
comparative statement. The authority which is authorised to accept the tender sh
ould be specified. The criteria for selecting the final source of supply may dep
end upon the terms of offer which can be compared in respect of price offered, q
uality, other terms (like Sales Tax, Octroi, Freight etc.), terms of delivery, t
erms of payment, guarantee offered by the supplier, goodwill of the supplier etc
. Lowest quotation may not necessarily be the best quotation. (3) Purchase Order
: The contractual obligation between the supplier and purchaser starts from pur
chase order. It is drawn in favour of the supplier by the purchase department. I
t may specify a number of facts. Material to be supplied (Description as well as
code numbers and quality). Quantity to be supplied. Price and other terms (e.g.
excise duty, sales tax, octroi, insurance, packing and transportation etc.). Ca
sh and trade discount. Instructions in respect of delivery. Guarantee clause. Li
quidated damages clause. Escalation clause. Inspection clause. Method of settlem
ent of disputes. Details in respect of letters of credit, import licence etc. De
tails in respect of interest payable in the event of late payment of dues.
186
Management Accounting

Ideally, purchase orders should be serially numbered. Normally, four or five cop
ies of Purchase Orders are drawn, to be distributed as below : One to Supplier.
One to User Department. One to Stores Department. One to Accounts/Costing Depart
ment. One with Purchase Department.
A standard form of Purchase Order is as shown below : PURCHASE ORDER No. Date Re
quisition No. Date Please supply the following material on such terms and conditi
ons as stated therein.
Description Code No. Quantity Rate Rs. Value Rs. Delivery Date Remarks
Delivery : Goods to be delivered at Extra as applicable Excise Duty Sales Tax Pa
cking Charges Insurance Terms of payment For (Purchasing Company)
Purchase Manager
Material Cost
187

(4)
Receipt and Inspection : After material is received from the supplier, the quant
ity received actually, is compared with quantity ordered. Variations, if any, ar
e taken up with the supplier again. Excess material received may be dealt with i
n any of the following ways : Accept all the material received. Accept the mater
ial ordered and return the excess to the supplier.Before accepting, material may
be subjected to inspection. The extent of inspection may vary from material to
material.
(5)
Checking invoice and accounting for purchases : The suppliers invoice received fo
r the supply of material is subjected to scrutiny before a voucher is passed for
the same for making the entry in the books of accounts. For this purpose, the s
uppliers invoice may be compared alongwith the following documents. (a) (b) (c) P
urchase Order. Goods Received Note. Inspection Report.
If the quantity and/or rate as per purchase order and invoice match with each ot
her, the invoice of the supplier is passed for making the entry in the books of
accounts. If the quantity and/or rate as per purchase order and invoice differ f
rom each other, the difference is adjusted by raising a debit or credit note in
favour of the supplier. (B) Storing and Issue of Material : After the material i
s received, inspected and approved, the process of storing comes into operation
which deals with storing the material in good condition till it is required for
use by production departments and issuing the same whenever required. As far as
the movement of the material from the stores point of view is concerned, there c
an be basically four types of movements. (1) (2) (3) (4) (1) Receipt of material
. Issue of material Return of material from Production Department to Stores Depa
rtment. Transfer of material. Receipt of Material :Usually the receipt of materi
al is accompanied by delivery challan given by the supplier. On receipt of the m
aterial, quantity received is checked with the quantity ordered by the Stores De
partment. The received material may be inspected, before acceptance either by se
parate inspection department or by Stores
188
Management Accounting

Department itself. A document known as Goods Received Note or Goods Received Rep
ort (GRN or GRR) is prepared to record the details of the material received. The
usual form in which GRN or GRR is prepared is as below : GOODS RECEIVED NOTE No
. Date
S. No. Description Code Qty. Recd. Qty. Accepted Qty. Rejected Remarks
Prepared by
Received by
Inspected by
Store Keeper
It may be prepared in quadruplicate to be distributed as follows. One copy to Pu
rchases Department for comparing with purchases order and approving the invoice
of the supplier. One copy to Accounts Department for making the payment of suppl
iers invoice. One copy to Costing Department for pricing and entering in stores r
ecord. One copy to be retained by Stores Department.

Ideally, GRN/GRR should be serially numbered in order to locate the material whi
ch is physically received but for which invoice is not received. Discrepancies i
n material receipts : The material physically received when compared with materi
al ordered as per the purchase order may reveal certain discrepancies which may
take any of the following forms. (1) (2) (3) Quantity received in excess. Quanti
ty received in short. Quantity received of different quality.
Excess quantity received may be retained and accepted, if required, with the app
roval of the purchase department. Alternatively, if it is not accepted, it may b
e returned to the supplier with Goods Returned Note. The usual form in which Goo
ds Returned Note is prepared is as below:
Material Cost
189

GOODS RETURNED NOTE To : No. Date : Following material supplied by you vide your
D.C. No.____________ and Invoice No.____________against our Purchase Order No.
______________is being returned to you for the reasons stated below: Description
Quantity Reasons
Signature
Usually, three copies of Goods Returned Note are prepared to be distributed as b
elow : One copy to the Supplier. One copy to the Purchase Department. One copy t
o be retained by the Stores Department.
Excess Quantity Accepted : If excess quantity is already billed in the invoice,
it will be approved and paid. If not, either the supplier may be asked to give a
supplementary invoice or credit note may be issued to the supplier for amending
the amount. Excess Quantity Returned : If excess quantity is already billed in
the invoice, debit note may be issued to the supplier for amending the amount. I
n case the quantity received is short, purchase department may take up the case
with the supplier or carrier or insurer as per the terms of purchases. If quanti
ty short supplied is billed in the invoice, invoice is suitably amended and debi
t note is issued to the supplier. If quantity received is of different quality a
nd is rejected in inspection, it can either be retained or returned. It may be r
etained by accepting some mutually decided concessional price. The variation in
prices may be adjusted by issuing either the credit note or debit note in favour
of the supplier. (2) Issue of Material : Here, the issue of material refers to
issue of material from stores department to production department. The material
should not be issued from the stores unless a proper authority in writing is pro
duced before the stores department. Usually, this authority is in the form of Ma
terial Requisition Note or Material Requisition Slip.
Management Accounting
190

The normal contents of this note/slip are : Number and date (Ideally, they shoul
d be serially numbered). Department demanding the material. Description and code
of material demanded. Quantity of material demanded. Signature of authority app
roving the demand. Signature of the person receiving the material.
Normally one note/slip is prepared for requisitioning a single item of material.
The usual form in which it is prepared is as below : MATERIAL REQUISITION NOTE
Production/Job Order No. Bill of Materials No. No. Date : Department : Descripti
on Code Qty. Unit Cost (for costing Dept. only) Rate per unit Amount Rs.
Authorised by
Issued by
Received by
Entered and Valued by
Normally, it is prepared in three copies.Two copies to Stores Department which i
n its turn passes one copy to Costing Department for pricing while second copy i
s retained by the Stores Department. One copy is for demanding department. (3) R
eturn of material : There can be some situations, when material once issued to p
roduction departments is returned back to the stores. It can happen in the follo
wing circumstances. (a) (b) Material issued in excess of requirement. Scrap or d
efective work arising out of the production processes.
Under these circumstances, a document in the form of Materials Returned Note is
prepared, which is to record return of unused materials. The usual form in which
this document is prepared is as below :
Material Cost
191

MATERIALS RETURNED NOTE Production/Job Order No. Bill of Materials No. No. Date
: Department : Description Code Qty. Unit Cost (for costing Dept. only) Rate per
unit Amount Rs.
Authorised by
Received by
Posted by
As far as the valuation of the returned material is concerned, it may be treated
as the fresh receipt of the material or alternatively, it may be treated as the
negative(minus) issues. (4) Transfer of Materials :In some situations, consider
ing the urgency for the requirement of the material, it may be necessary to tran
sfer the material from one production/job order to another. Such transfer of mat
erial is usually accompanied by preparing a document in the form of Material Tra
nsfer Note. The usual form in which this document is prepared is as below :
MATERIAL TRANSFER NOTE No. Date : FromDept. Production/Job Order No. Description Cod
e No. Qty. To..Dept. Production/Job Order No. Cost (for costing Dept. only) Rate per
unit Amount Rs.
Authorised by
Received by
Entered by
192
Management Accounting

Transfer of materials does not result into any fresh issue of material. However,
material transfer notes will have to be valued and considered in order to compu
te the material cost as per the job orders and production orders. PROPER CONDUCT
OF STORAGE FUNCTION As discussed earlier, proper conduct of storage function re
quires that material should be properly stored in good condition till it is requ
ired for use by production departments and should be issued whenever required. T
his proper conduct is ensured by what is known as Perpetual Inventory System. The
aims of the perpetual inventory system are two fold. (1) Recording receipts and
issues in such a way so as to know at any time, the stock in hand, in quantity a
nd/or value, without the need of physical counting. This aim is achieved by main
taining what is called as Bin Card and Stores Ledger. Continuous verification of
physical stock at regular intervals.
(2)
Bin Card It is only a quantitative record of receipts, issues and closing balanc
e of an item of material. Separate bin card is maintained for each item of mater
ial. The usual form in which a bin card is maintained is as below. BIN CARD Desc
ription Code No. Location/Unit Date Document No. Receipt Issue Maximum level Min
imum level Recorder level Balance Remarks
Entries in receipts column are made on the basis of Goods Received Note or Mater
ial Returned Note. Entries in issues column are made on the basis of Material Re
quisition Note. After every entry of either receipts or issues, the balance quan
tity is calculated and recorded so that the balance can be known at any point of
time. The levels indicated on bin card enable the stores department to keep a w
atch on balance and replace the material as soon as it reaches the reorder level
.
Material Cost
193

Ideally, bin card should be placed alongwith the material. But it may not be pos
sible in all the cases, then bin cards are placed at a centrally located place b
ut within stores department only. Stores Ledger Like Bin Card, it is maintained
to record all receipts and issue transactions of material but with the exception
that it records not only the quantities received or issued or in stock but also
the financial expressions of the same. The usual form in which the stores ledge
r is maintained is as following : STORES LEDGER Description Code No. Location/Un
it Date Document No. Receipts Qty. Rate Rs. Issues Maximum level Minimum level R
ecorder level Balance Rs. Remark
Qty. Rate Rs. Qty. Rate
By summing up the amounts appearing in the issues column of stores ledger, one can
get the cost of material issued to Production Department which forms the Materia
l Cost. As in case of bin card, separate store ledger sheets are maintained in ca
se of each item of material. The stores ledger sheets are maintained either in l
oose form or in bound book form. Bin Card Vs. Stores Ledger : If the stores ledg
er is having all the information mentioned in a bin card plus some additional in
formation is also available, the next question which arises is why is it necessa
ry to maintain both bin card and stores ledger simultaneously as it will be only
duplication of work. In the situations of computerized inventory accounting sys
tem, maintenance of bin card and sotres ledger simultaneously can be avoided. Ho
wever, in the situations of manual inventory accounting system, it will be ideal
to maintain bin card and stores ledger simultaneously due to the following reas
ons. (1) Bin card is maintained by stores department while stores ledger is main
tained by costing department.
194
Management Accounting

(2) (3)
Bin card is not an accounting record but only a quantity record and as such is n
ot concerned with the financial implications of stores transactions. Maintenance
of stores ledger provides a second check on maintenance of bin cards.
Reconciliation of Bin Card and Stores Ledger : As the source documents for the e
ntries in Bin Card and Stores Ledger are the same, the closing balances disclose
d by both of them should match with each other. But in practice, they may not ma
tch due to the following reasons. (1) (2) (3) (4) Arithmetical error in calculat
ing balance. Non-posting of certain document in either of these documents. Posti
ng on wrong bin card or stores ledger sheet. Treating receipts transaction as is
sue transaction or vice versa.
If the closing balance as per bin card and stores ledger is not matching, the ve
ry purpose of maintaining these two documents simultaneously will be defeated. A
s such, it is necessary to reconcile both balances at regular intervals by keepi
ng all the postings upto date. If the balances as on a particular day are not ma
tching, all the previous transactions should be checked to locate differences. V
aluation of Material Movements : As discussed above, the stores ledger considers
not only the movement of material in terms of quantity but also in terms of its
financial implications. As such, it is necessary that all the possible movement
s of material are valued properly and are expressed in terms of money. We will c
onsider this problem under the following heads. (a) (b) (c) (a) Valuation of rec
eipts. Valuation of issues. Valuation of returns from production department to s
tores department. Valuation of receipts : Valuation of receipts is relatively an
easy task, as the invoice or bill received from the supplier of the material is
available as a starting point. Following propositions should be considered for
this purpose. (1) The price as billed by the supplier will be the valuation of t
he receipts. The trade discount is deducted from the basic price and all other a
mounts as billed by the supplier are added viz. Excise Duty, Sales Tax, Octroi D
uty, Transport/Insurance charges etc. There are different opinions in respect of
the treatment of cash discount. One opinion says that cash discount should be i
gnored being purely of financial nature while valuing the receipts, while anothe
r opinion says that it should be considered while valuing the receipt of the mat
erial. 195
Material Cost

(2)
In some cases, more than one item of material are included in one single bill an
d some costs are jointly incurred for all the items of material. Such joint cost
s may be distributed on the basis of basic price of the material. In case of the
imported material, the cost of the material consists of basic price (which may
be stated in foreign currency and should be converted in Indian Rupees), Customs
Duty, Clearing Charges, Transport Charges, Octroi Duty etc. In some cases, the
point of receipt of imported material and the point of making the payment of inv
oice amount may be different. As such, rate of foreign currency may be different
at the time of payment of customs duty and at the time of payment of invoice am
ount. In such cases, the rate of exchange existing at the time of making the pay
ment of invoice amount should be considered for valuing basic cost of material i
mported.
(3)
Illustration : The particulars relating to 1,200 kgs. of a certain raw material
purchased by a company during June, were as below. (a) Lot prices quoted by supp
liers and accepted by the company for placing the purchase order. Lot upto 1000
kgs. Between 1000 - 1500 kgs. Between 1500 - 2000 kgs (b) (c) (d) (e) (f) (g) (h
) Trade Discount 20%. Additional charge for containers @ Rs. 10 per drum of 25 k
gs. Credit allowed on return of containers @ Rs. 8 per drum. Sales Tax at 10% on
raw material and 5% on drums. Total freight paid by the purchaser Rs. 240, Insu
rance at 2.5% (on net invoice value) paid by the purchaser. Stores Overheads app
lied at 5% on total purchase cost of material. The entire quantity was received
and issued to production : The containers are returned .in due course. Draw up a
suitable statement to show : (a) (b) Total cost of material purchased. Unit cos
t of material issued to production. @ Rs. 22 per kg. @ Rs. 20 per kg. @ Rs. 18 p
er kg.
}
For Supplies to Factory
196
Management Accounting

Solution : (a) Statement showing cost of purchases Basic Cost 1,200 kgs x Rs. 20
/kg. Less : Trade Discount @ 20% Rs. 24,000 4,800 19,200.00 Container Cost : 48
Drums x Rs. 10 /Drum 480.00 19,680.00 Sales Tax : 10% on Rs. 19,200 5% on Rs. 48
0 1,920.00 24.00 1,944.00 21,624.00 Other charges Insurance 2.5% on Rs. 21,624.0
0 Freight 540.60 240.00 22,404.60 Less : Credit for drums returned Rs. 8 per Dru
m x 48 Drums TOTAL COST Add : Stores Overheads 5% 384.00 22,020.60 1,101.03 23,1
21,63 (b) Unit cost for valuation of issues Rs. 23,121.63. 1,200 kgs. Illustrati
on : The particulars related to the import of Sealing Ring made by AB & Co. duri
ng December 85 are given below. (a) (b) Sealing Ring 1,000 pieces invoiced @ 2 C
IF, Bombay Port. Customs Duty was paid @ 100% on invoice value (which was conver
ted to Indian Currency by adopting an Exchange Rate of Rs. 17.20 per ) 197 = Rs.
19.268/kg. Rs.
Material Cost

(c) (d)
Clearing charges : Rs. 1,800 for the entire consignment Freight charges : Rs. 1,
400 for transporting the consignments from Bombay Port to Factory premises.
It was found on inspection that 100 pieces of the above material were broken and
therefore rejected. There is no scrap value for the rejected part. No refund of
the broken material would be admissible as per the terms of contract. The manag
ement decided to treat 60 pieces as normal loss and the rest 40 pieces as abnorm
al loss. The entire quantity of 900 pieces was issued to production. Calculate :
(a) (b) Total cost of material. Unit cost of material issued to production.
Also state briefly how the value of 100 pieces rejected in inspection will be tr
eated in costs. Solution : Total Cost of Material (1) Invoice Price UK - 1,000 p
ieces x 2 = 2,000 - 2,000 x Rs. 17.2 per UK (2) (3) (4) Customs Duty @ 100% Clear
ing Charges Freight charges Total Cost 34,400 34,400 1,800 1,400 72,000 Rs.
As loss of 40 pieces is considered as abnormal loss, it will be transferred to C
osting Profit and Loss Account. Abnormal Loss = Rs. 72,000 1,000 pieces X 40 pie
ces
= Rs. 2,880 Balance of the cost (i.e. Rs. 72,000 - Rs. 2,880 = Rs. 69,120)Includ
es cost of units treated as normal loss i.e. 60 pieces. This cost will be borne
by good pieces.
198
Management Accounting


Rs. 69,120 Unit cost of good pieces = 900 pieces = Rs. 76.80
(b)
Valuation of Issues : This is a more complex process than the valuation of the r
eceipts. It is because of the reason that the material may be issued out of the
various lots which might have been purchased at various prices. As such, a probl
em may arise as to which of the receipt prices should be used to value the mater
ial requisition notes. Various methods may be used for this purpose, main method
s of which may be discussed as below. (a) First In First Out (FIFO)Under this me
thod, the price of the earliest available lot is considered first and if that lo
t is exhausted, the price of the next available lot is considered. It should be
remembered that the physical issue of the material may not be made out of the sa
id lots, though it is presumed that it is made out of these lots as stated above
.
Illustration : Following transactions have taken place in respect of a material
during March 1990. Date : 1 5 7 9 19 22 25 30 Opening Balance 500 units @ Rs. 6
per unit. Purchased 100 units @ Rs. 7 per unit. Issued 400 units. Purchased 300
units @ Rs. 8 per unit. Issued 250 units. Issued 50 units. Purchased 300 units @
Rs. 7.50 per unit. Issued 250 units.
Prepare the Stores Ledger assuming that the issues are valued on FIFO basis.
Material Cost
199

Stores Ledger Description/Code No. Unit Location Date Particulars Qty. RECEIPTS
Rate Rs. Rs. Qty. ISSUES Rate Rs. Rs. Qty. Maximum level Minimum level Re-order
level BALANCE Rate Rs. 6 Rs.
1 5
Op. Bal. GRN No. 100 7 700
500 500 100
3,000
7
MRN No.
400
6
2,400 100 100
} }
6 7 6 7 6 7 8 3700 3,700 1300
9
GRN No.
300
8
2,400
100 100 300 100
}
}
19 22 25
MRN No. MRN No. GRN No. 300 7.5 2,250
100 50 50
}
}
6 7 8 8 400 200 200 300 8 8 7.5 3850 1,600 1700 250 8 2,000
30
MRN No.
200 50
8 7.5 1975 250 7.5 1,875

Value of closing stock is Rs. 1,875 which considers latest available market pric
e of the material. The advantages of this method are as below : (a) (b) (c) It i
s simple to operate. It considers the valuation of closing stock at the current
market prices. It can be conveniently applied if transactions are not too many a
nd the prices of the material are fairly steady.
200
Management Accounting

The objections raised against this method are as below : (a) (b) Calculations be
come complicated if the lots are received frequently and at varying prices. Cost
s may be wrongly presented if the price of different lots of material are used f
or pricing issues to various batches of production. In case of varying prices, t
he pricing of issues does not consider current market prices. Last In First Out
(LIFO) : Under this method, the price of the latest available lot is considered
first and if that lot is exhausted, the price of the lot prior to that is consid
ered. Here also, it should be remembered, that the physical issue of the materia
l may not be made out of the said lots, though it is presumed that it is made ou
t of the lots as stated above. Illustration : Following transactions have taken
place in respect of a material during March 1990. Date: 1 5 7 9 19 22 25 30 Open
ing Balance 500 units @ Rs. 6 per unit. Purchased 100 units @ Rs. 7 per unit. Is
sued 400 units. Purchased 300 units @ Rs. 8 per unit. Issued 250 units. Issued 5
0 units. Purchased 300 units @ Rs. 7.50 per unit. Issued 250 units.
(c) (b)
Prepare the stores ledger assuming that the issues are valued on LIFO basis.
Material Cost
201

Stores Ledger Description/Code No. Unit Location Date Particulars Qty. RECEIPTS
Rate Rs. Rs. Qty. ISSUES Rate Rs. Rs. Qty. Maximum level Minimum level Re-order
level BALANCE Rate Rs. 6 Rs.
1 5
Op. Bal. GRN No. 100 7 700
500 500 100
3,000 3,700
} }
6 7 6
7
MRN No.
100 300
}
7 6
2,500 200
1,200
9 19
GRN No. MRN No.
300
8
2,400 250 8
200 300 2,000 200 50
} } } }
6 8 6 8 6
3,600 1,600
22 25
MRN No. GRN No. 300 7.5 2,250
50
8
400 200 200 300
1,200 3,450
30

MRN No.
250
7.5
1,875 200 50
} } } }
6 7.5 6 7.5
1,575
Value of closing stock is Rs. 1,575 which consists of 200 units valued at Rs. 6
per unit which happens to be the earliest available price of the material i.e. p
rice of the opening balance available. The advantages of this method are as belo
w : (a) (b) It is simple to operate. The cost of materials issued considers fair
ly recent and current prices. The prices quoted on this cost fairly represent it
s real cost. It can be conveniently applied if transactions are not too many and
prices of the material are fairly steady.
(c)
202
Management Accounting

The objections raised against this method are as below : (a) (b) Calculations be
come complicated if the lots are received frequently and at varying prices. Cost
s may be wrongly presented if the price of different lots of material are used f
or pricing issues to various batches of production. In case of falling prices in
the market, this method may give wrong results.
(c)
(C) Average Price Method : Both the above methods i.e. FIFO and LIFO, consider t
he exact or actual cost for valuing the issue of material. However these methods
may prove to be disadvantageous if the transactions are too many and are at var
ying prices. In such cases, instead of considering the exact or actual cost, ave
rage cost may be considered to lessen the effect of variation in prices, either
upward or downward. E.g. Assume a situation as below : Mar. 1 Mar. 15 Received R
eceived 1500 units @ Rs. 10 1600 units @ Rs. 30 - Rs. 15,000 - Rs. 48,000
On March 20, 1800 units were issued to production. If FIFO method is followed to
price the issues, the issues will be valued as below. 1500 units @ Rs. 10 per u
nit 300 units @ Rs. 30 per unit Rs. 15,000 Rs. 9,000 Rs. 24,000 The issues will
be considerably under-valued and closing stock will be considerably over valued,
as compared to the current market prices. If LIFO method is followed to price t
he issues, the issues will be valued as below. 1600 unite @ Rs. 30 per unit 200
units @ Rs. 10 per unit Rs. 48,000 Rs. 2,000 Rs. 50,000 The closing stock will b
e considerably under valued as compared to the current prices. To lessen the eff
ect of such drastic price variation, both on the valuation of issues as well as
of closing stock, instead of considering the actual/exact price of Rs. 10 per un
it or Rs. 30 per unit, average price may be taken into consideration. There are
mainly two ways in which average prices may be considered.
Material Cost
203

(1)
Simple Average Method :Under this method, the simple average of the prices of th
e lots available for making the issues is considered for pricing the issues. Aft
er the receipt of new lot, a new average price is worked out. It should be remem
bered in this connection that, for deciding the possible lots out of which the i
ssues could have been made, the method of First In First Out is followed.
Illustration : Following transactions have taken place in respect of a material
during March 1990. Date : 1 5 7 9 19 22 25 30 Opening Balance 500 units @ Rs. 6
per unit Purchased 100 units @ Rs. 7 per unit. Issued 400 units. Purchased 300 u
nits @ Rs. 8 per unit. Issued 250 units. Issued 50 units. Purchased 300 units @
Rs. 7.50 per unit. Issued 250 units.
Prepare the stores ledger assuming that the issues are valued on Simple Average
basis. Stores Ledger Description/Code No. Unit Location Date Particulars Qty. 1
5 7 9 19 22 25 30 Op. Bal. GRN No. MRN No. GRN No. MRN No. MRN No. GRN No. MRN N
o. 300 7.5 2,250 250 7.30 300 8 2,400 250 50 7 7 100 7 700 400 6.5 RECEIPTS Rate
Rs. Rs. Qty. ISSUES Rate Rs. Rs. Qty. 500 600 2,600 200 500 1,750 250 350 200 5
00 1,825 250 Maximum level Minimum level Re-order level BALANCE Rate Rs. 6 Rs. 3
,000 3,700 1,100 3,500 1,750 1,400 3,650 1,825
204
Management Accounting

This method is suitable if the material is received in uniform quantity.If the m


aterial quantity of each lot varies widely, this method may lead to wrong result
s. (2) Weighted Average Method :As stated above, the simple average method of va
luation of issues may lead to wrong results, if the quantity of each lot of mate
rial received varies widely. Eg. Assume the following situation. Mar. 1 Received
100 units @ Rs. 10 Mar. 10 Received 5,000 units @ Rs. 30 Rs. 1,000 Rs. 1,50,000
Rs. 1,51.000 On March 20, 4800 units were issued to production. As both the lot
s are possible lots for making the issue, the average of prices of both the lots
will be taken into account if simple average method is considered. Hence, per u
nit issue price will be Rs. 10 + Rs. 30 2 i.e. Rs. 20
As such, the issue quantity will be priced at : 4,800 units x Rs.20 i.e. Rs. 96,
000, which will be incorrect, as considering the quantity of issue, the price of
the material received on March 10 should get more weightage. To overcome this d
rawback of simple average method, weighted average method may be used which cons
iders not only the price of each lot but also the quantity of the same. Though t
his method involves considerable amount of clerical work, in practice, this meth
od proves to be very useful in the event of varying prices and quantities. In pr
actice, the calculation of weighted average rate proves to be very simple. The p
roducts of quantity and price divided by the total quantity of all lots, just be
fore the issue, gives the unit price in respect of the subsequent issues. Illust
ration : Following transactions have taken place in respect of a material during
March 1990. Date : 1 5 7 9 19 22 Opening Balance 500 units @ Rs. 6 per unit Pur
chased 100 units @ Rs. 7 per unit. Issued 400 units. Purchased 300 units @ Rs. 8
per unit. Issued 250 units. Issued 50 units.
Material Cost
205

25 30
Purchased 300 units @ Rs. 7.50 per unit. Issued 250 units.
Prepare the Store Ledger assuming that the issues are valued on Weighted Average
Basis. Stores Ledger Description/Code No. Unit Location Date Particulars Qty. 1
5 7 9 19 22 25 30 (d) Op. Bal. GRN No. MRN No. GRN No. MRN No. MRN No. GRN No.
MRN No. 300 7.5 2,250 250 7.41 300 8 2,400 250 50 7.27 7.27 100 7 700 400 6.16 R
ECEIPTS Rate Rs. Rs. Qty. ISSUES Rate Rs. Rs. Qty. 500 600 2,467 200 500 1,817 2
50 363 200 500 1,851 250 Maximum level Minimum level Re-order level BALANCE Rate
Rs. 6.00 6.16 6.16 7.27 7.27 7.27 7.41 7.41 Rs. 3,000 3,700 1,233 3,633 1,816 1
,453 3,703 1,852
Highest In First Out :This method assumes that the stock should always be shown
at the minimum value and hence the issues should always be valued at the highest
value of receipts. E.g. Assume a situation as follows. Mar. 1 Purchased 100 uni
ts @ Rs. 12 Mar. 5 Purchased 125 units @ Rs. 18 Mar. 10 Purchased 75 units @ Rs.
15 On March 20, 120 units are issued to production and they will be valued at R
s. 18 per unit being the highest price. This method is not very popular. It alwa
ys overvalues the issues and undervalues the closing stock. This method may be u
seful in case of the organisations dealing with monopoly products which is a rar
e possibility.
206
Management Accounting

(e)
Market Price : Under this method, market price is considered to be the base for
pricing the issues. In this case, market price may be treated as latest purchase
price, realisable price or replacement price. This method is used mainly in res
pect of obsolete stock items or non-moving stock items. The defect in respect of
this method is that the price concessions obtained in respect of bulk purchases
are not reflected in cost of material.
(f)
Specific Price : If the material is purchased against a specific job or producti
on order, the issue of material is priced at actual purchase price. This method
can be adopted if purchase prices are fairly stable.
(g)
Standard Price : This is the normal or ideal price which will be paid in the nor
mal circumstances, based on the basis of estimated market conditions, transporta
tion costs and normal quantity of purchases. Any issue of material will be price
d at standard prices irrespective of actual prices. This enables the simplificat
ion of accounting system with reduced clerical work and also enables to decide t
he efficiency of purchase department,
(c)
Valuation of Returns : This indicates the material returned by production depart
ments to stores department The way in which returned material may be valued can
be as below : (a) At the same price at which issued : The original price of issu
e will be a base for valuing the returns for which original material requisition
note will be the base. (b) At the current price of issues : The method which is
followed for valuing the issue on the same date is considered for valuing the r
eturns. This will avoid the clerical efforts, but at the same time the track of
original issue of material cant be maintained.
Treatment of shortages : In some cases, the physical verification of stock may r
eveal that the physical stock is less than the stock as per stores ledger. For p
roper accounting, the shortage has to be treated as an issue so that the book st
ock can be brought down to the level of physical stock. The
Material Cost
207

valuation of this shortage is done as if it is an issue of material. The treatme


nt given to the valuation of shortages in Cost Accounts depends upon the nature
of the shortage i.e. Normal Shortage or Abnormal Shortage. Inventory Control : T
he object of inventory control is to reduce the investment in inventory without
affecting the efficiency in the area of production and sales. It should be remem
bered that the object is not only to reduce the investment in inventory. If that
would have been the object, no organisation would have maintained inventory of
any kind, thereby making the investment in inventory as Nil. However, that is no
t the ultimate object as it is likely to affect the production and sales functio
n adversely. E.g. If sufficient stock of raw material is not available, the prod
uction activity is likely to be interrupted. If sufficient stock of finished goo
ds is not available, it may not be possible for the organisation to serve the cu
stomers properly and they may shift to the competitors. The object of inventory
control is to avoid the situation of over investment as well as under investment
. The level of inventories should be maintained at the optimum level. Techniques
of Inventory control (1) Economic Order Quantity : It indicates that quantity w
hich is fixed in such a way that the total variable cost of managing the invento
ry can be minimised. Such cost basically consists of two parts. First, Ordering
Cost (which in turn consists the costs associated with the administrative effort
s connected with preparation of purchase requisitions, purchase enquiries, compa
rative statements and handling of more number of bills and receipts) Second, Car
rying Cost i.e. the cost of carrying or holding the inventory (which in turn con
sists of the cost like godown rent, handling and upkeep expenses, insurance, opp
ortunity cost of capital blocked i.e. interest etc.) There is a reverse relation
ship between these two types of costs i.e. If the purchase quantity increases, o
rdering cost may get reduced but the carrying cost increases and vice versa. A b
alance is to be struck between these two factors and it is possible at Economic
Order Quantity where the total variable cost of managing the inventory is minimu
m. It is possible to fix the Economic Order Quantity with the help of mathematic
al formula. The following assumptions may be made for this purpose. Let Q be Eco
nomic Order Quantity. A be Annual Requirement of material in units. O be cost of
placing an order (which is assumed to remain constant irrespective of size of o
rder.) C be cost of carrying one unit per year.
Management Accounting
208

Now, if A is the annual requirement and Q is the size of one order, the total nu
mber of orders will be A/Q and the total ordering cost will be - A/Q x O Similar
ly, if the size of one order is Q and if it is assumed that the inventory is red
uced at a constant rate from order quantity to zero when it is repurchased, the
average inventory will be Q/2 and the cost of carrying one unit per year being C
, the total carrying cost will be Q/2 X C. Thus, Total Cost = Ordering Cost + Ca
rrying Cost = A Q X O + Q 2 XC
The intention is that the value of Q should be such that the total cost should b
e minimum. Hence, taking the first derivative of the equation with respect to Q
and setting the result to zero, do dq Q = = AO ( 1 Q2 ) + C 2 Where = O OR

2xAXO C
Q = Economic
an Order C =
es 200 units
upplier. The
t is Rs. 12.
: EOQ =

Order Quantity A = Annual Requirement in Units O = Cost of Placing


Cost of Carrying One Unit Per Year Illustration : A manufacturer us
of a component every month and he buys them entirely from outside s
order placing and receiving cost is Rs. 100 and annual carrying cos
From this set of data, calculate Economic Order Quantity. Solution

=

2xAxO C
2 x 2400 x 100 12 200 units 209
=
Material Cost

In some cases, the carrying cost may be expressed as an annual percentage of the
unit cost of purchases, in which case, the calculation of Economic Order Quanti
ty takes the following form. EOQ =

2xAxO Cxi
where
A
=
Annual Requirement in units Cost of placing an order Unit purchase price Carryin
g cost expressed as a percentage of unit purchase price.
O = C i = =
Illustration : From the Following data, work out the EOQ of a particular compone
nt. Annual Demand Ordering Cost Price per Unit : 5000 Units : Rs. 60 per Order :
Rs. 100
Inventory carrying Cost : 15% on average inventory, Solution : EOQ =

2 x 5000 x 60 15% of 100


= 200 units The total cost of managing inventory will be Ordering Cost - 5000 20
0 Carrying Cost 200 2 X 60 i.e. 25 X 60 Rs. 1,500
X 15% of 100
Rs. 1,500 Rs. 3,000
(Based on average inventory)
Now, the next question is whether the purchases in Economic Order Quantity reall
y reduce the total cost of managing inventory to the minimum, We can verify this
, by trial and error method, by considering the above results.
210
Management Accounting

Order Quantity
No. of Orders A/Q Rs. 100 50 25 20 5 4 2
Ordering Cost A/Q x O Rs. 6,000 3,000 1,500 1,200 300 240 120
Carrying Cost Q/2 x Ci Rs. 375 750 1,500 1,875 7,500 9,375 18,750
Total Cost
50 100 200 250 1,000 1,250 2,500
6,375 3,750 3,000 3,075 7,800 9,615 18,870
It can be observed from the above, that the order size of 200 units proves to be
the most economic one in terms of minimum total cost. If the purchases are made
in any other way, the same may not necessarily result into minimum total cost.
Illustration : Kapil Motors purchase 9,000 motor spare parts for its annual requ
irements, ordering onemonth usage at a time. Each spare part costs Rs. 20. The o
rdering cost per order is Rs. 15 and the carrying charges are 15% of the average
inventory per year. You have been asked to suggest a more economical purchasing
policy for the company. What advice would you offer and how much would it save
the company per year. Solution : Present Policy : Number of Orders = = Annual Re
quirement Order size 9000 750 Ordering Cost Carrying Cost = = = = 12 ...(1) X Ca
rrying cost in %
12 X 15 = 180 Order Size 2 750 2 X Cost Price
X 15% of Rs. 20 ...(2) ...(3)
= Total Cost i.e. 1 + 2
Material Cost
375 X 3 = 1,125 = 180 + 1125 = 1305
211

Proposed Policy : To purchase in Economic Order Quantity EOQ =


=

2xAxO Cxi
2 x 9000 x 15 15% of 20 = 300 units
Now, the revised total cost will be Number of Orders Ordering Cost Carrying Cost
= = = = Total Cost i.e. 4 + 5 = 9000 300 = 30 ...(4) ...(5)
30 x 15 = 450 300 2 X 15% of 20
150 X 3 = 450 450 + 450 = 900 ...(6)
Thus, purchases in Economic Order Quantity will result into the yearly saving of
Rs. 405 (i.e. Rs. 1305 - Rs. 900) (2) Fixation of Inventory Levels : Fixation o
f various inventory levels facilitates initiating of proper action in respect of
the movement of various materials in time so that the various materials may be
controlled in a proper way. However, the following propositions should be rememb
ered. (i) Only the fixation of inventory levels does not facilitate the inventor
y control. There has to be a constant watch on the actual stock level of various
kinds of materials so that proper action can be taken in time. The various leve
ls fixed are not fixed on a permanent basis and are subject to revision regularl
y.
(ii)
The various levels which can be fixed are as below. (1) Maximum Level : It indic
ates the level above which the actual stock should not exceed. If it exceeds, it
may involve unnecessary blocking of funds in inventory. While fixing this level
, following factors are considered.
212
Management Accounting

(i) (ii)
Maximum usage. Lead time.
(iii) Storage facilities available, cost of storage and insurance etc. (iv) (v)
(vi) Prices for the material. Availability of funds. Nature of material e.g. If
a certain type of material is subject to Government regulations in respect of im
port of goods etc., maximum level may be fixed at a higher level.
(vii) Economic Order Quantity. (2) Minimum Level : It indicates the level below
which the actual stock should not reduce. If it reduces, it may involve the risk
of non-availability of material whenever it is required. While fixing this leve
l, following factors are considered. (i) (ii) (3) Lead time. Rate of consumption
.
Re-order Level: It indicates that level of material stock at which it is necessa
rily to take the steps for procurement of further lots of material. This is the
level falling in between the two extremes of maximum level and minimum level and
is fixed in such a way that the requirements of production are met properly til
l the new lot of material is received.
(4)
Danger Level : This is the level fixed below minimum level. If the stock reaches
this level, it indicates the need to take urgent action in respect of getting t
he supply. At this stage, the company may not be able to make the purchases in a
systematic manner but may have to make rush purchases which may involve higher
purchases cost.
Calculation of various Levels : The various levels can be decided by using the f
ollowing mathematical expressions. (1) (2) Re-order Level : Maximum Lead Time x
Maximum Usage. Maximum Level : Reorder Level + Reorder Quantity - (Minimum Usage
X Minimum Lead Time).
Material Cost
213

(3) (4) (5)


Minimum Level : Reorder Level - (Normal Usage x Normal Lead Time.) Average Level
: Maximum Level + Minimum Level. Danger Level : Normal Usage x Leadtime for eme
rgency purchases.
Note : It should be noted that the expression of the Reorder Quantity in the cal
culation of Maximum Level indicates Economic Order Quantity. Illustration : Two
components X and Y are used as follows. Normal usage Minimum usage Maximum usage
Reorder quantity 50 units per week each. 20 units per week each. 75 units per w
eek each. X - 400 units Y - 600 units Recorder period X - 4 to 6 weeks Y-2 to 4
weeks Calculate for each component : a. b. c. d. Reorder level Minimum level Max
imum level Average stock level.
Solution : (1) Reorder Level : Maximum Lead time x Maximum Usage X = 6 weeks x 7
5 units = 450 units Y = 4 weeks x 75 units = 300 units. (2) Minimum Level : Reor
der Level (Normal Usage x Normal Leadtime) X = 450 units (50 units X 5 weeks) =
200 units. Y = 300 units (50 units x 3 weeks) = 150 units
214
Management Accounting

(3)
Maximum Level : Reorder Level + Reorder Quantity - (Minimum Usage x Minimum Lead
time) X = 450 units + 400 units - (25 units x 4 weeks) = 750 units. Y = 300 unit
s + 600 units - (25 units x 2 weeks) = 850 units.
(4)
Average Stock Level : Minimum Level + Maximum Level 2 200 units + 750 units X =
2 Y = 150 units + 850 units 2
= 475 units
= 500 units
As stated above, the expression of the Reorder Quantity in the calculation of Ma
ximum level indicates Economic Order Quantity. Hence, in some cases, it may be n
ecessary to decide the Economic Order Quantity before fixing the inventory level
s. Illustration : Shriram Enterprises manufactures a special product ZED The follo
wing particulars are collected for the year 1986. (a) (b) (c) (d) (e) (f) (g) Mo
nthly demand of ZED - 1000 units. Cost of placing an Order - Rs. 100. Annual car
rying cost per unit - Rs. 15. Normal Usage 50 units per week. Minimum Usage 25 u
nits per week. Maximum Usage 75 units per week. Re-order period 4 to 6 weeks.
Compute from the above: (1) (2) (3) (4) (5) Re-order Quantity. Re-order Level. M
inimum Level. Maximum Level. Average Stock Level. 215
Material Cost

Solution : (1) Reorder Quantity :

2xAxO C
where
A = Annual Requirement O = Ordering cost per cost C = Carrying cost per unit per
year EOQ =

2 x 12000 x 100 15
= 400 units (2) Reorder Level : Maximum Lead Time x Maximum Usage. 6 weeks X 75
units = 450 units (3) Minimum Level : Reorder Level - (Normal Usage x Normal Lea
d Time) 450 units - (50 units X 5 weeks) = 200 units (4) Maximum Level : Reorder
Level + Reorder Quantity (Minimum Usage X Minimum Leadtime) 450 units + 400 uni
ts - ( 25 units X 4 Weeks) = 750 units. (5) Average Stock Level : Minimum Level
+ Minimum Level 2 200 units + 750 units 2 There may be one more way in which the
various inventory levels may be fixed and for this determination of the safety
stock (also called as minimum stock or buffer stock) is essential. Safety stock
is that level of stock below which the actual should not be allowed to fall. The
safety stock may be calculated as 216
Management Accounting
= 475 units

(Maximum Usage X Maximum Leadtime) less (Normal Usage X Normal Leadtime) Accordi
ng to this method, the various inventory levels as discussed above may be fixed
as below. (1) Minimum Level : It is equal to safety stock. (2) Maximum Level : I
t can be calculated as - Safety Stock + EOQ. (3) Reorder Level : It can be calcu
lated as : Safety Stock + (Normal Usage x Normal Leadtime) (4) Average Stock Lev
el : It can be calculated as Minimum Level + Maximum Level 2 = Safety Stock + Sa
fety stock + EOQ 2 Safety Stock + EOQ 2
=
Illustration : You have been asked to calculate the following levels for Part No
. 007 from the information given thereunder: (a) (c) (e) Re-ordering level, Mini
mum level, Average level. (b) Maximum level (d) Danger level,
The ordering quantity is to be calculated from the following data : (i) (ii) Tot
al cost of purchasing relating to the order Rs. 20. Number of units to be purcha
sed during the year 5,000
(iii) Purchase price per unit including transportation costs Rs. 50.
Material Cost
217

(iv)
Annual cost of storage of one unit Rs. 5. Lead Times : Average Maximum Minimum M
aximum for emergency purchases Rate of consumption:Average Maximum .. 15 units p
er day .. 20 units per day ... 10 days .. 15 days .. 6 days ... 4 days
Solution : Working Notes : (a) Calculation of Safety Stock : (Maximum Usage x Ma
ximum Leadtime) - (Normal Usage x Normal Leadtime) = = = (b) (20 units x 15 days
) - (15 days x 10 days) 300 units - 150 units 150 units.
Calculation of EOQ :

A O C = = = Hence, EOQ =
2xAxO C
where
Annual requirement Ordering cost per order Carrying cost per unit per year.

2 X 500 X 20 5
= (1)
200 units.
Reordering Level : It can be calculated as Safety Stock + (Normal Usage x Normal
Leadtime) = 150 units + (15 units X 10 days) = 150 units + 150 units = 300 unit
s.
218
Management Accounting

(2)
Maximum Level : It can be calculated as Safety Stock + EOQ = 150 units + 200 uni
ts = 350 units.
(3)
Minimum Level : It is equal to Safety Stock = 150 units.
(4)
Danger Level : Normal Usage X Leadtime for emergency purchases = 15 units X 4 da
ys = 60 units.
(5)
Average Stock Level : It can be calculated as Safety Stock + EOQ 2 200 2 units =
250 units
= 150 units + (3)
Inventory Turnover : Inventory turnover indicates the ratio of materials consume
d to the average inventory held. It is calculated as below : Value of material c
onsumed Average inventory held where
Value of material consumed can be calculated as : Opening Stock + Purchases - Cl
osing Stock. Average inventory held can be calculated as : Opening Stock + Closi
ng Stock 2 Inventory turnover can be indicated in terms of number of days in whi
ch average inventory is consumed. It can be done by dividing 365 days (a year) b
y inventory turnover ratio.
Material Cost
219

Illustration : From the following data for the year ended 31st December, 1986, c
alculate the inventory turnover ratio of the two items and put forward your comm
ents on them. Material A Rs. Opening Stock 1.1.86 Purchases during the year Clos
ing Stock 31.12.86 Solution : Inventory turnover ratio = Value of material consu
med Average Inventory held Material A Inventory Turnover = 56,000 8,000 = 7 Mate
rial A Inventory Turnover Period = 365 7 = 52 days Material B 25,000 10,000 2.5
Material B 365 2.5 146 days 10,000 52,000 6,000 Material B Rs. 9,000 27,000 11,0
00
A high inventory turnover ratio or low inventory turnover period indicates that
maximum material can be consumed by holding minimum amount of inventory of the s
ame, thus indicating fast moving items. Thus high inventory turnover ratio or lo
wer inventory turnover period will always be preferred. Thus, knowledge of inven
tory turnover ratio or inventory turn over period in case of various types of ma
terial will enable to reduce the blocked up capital in undesirable types of stoc
ks and will enable the organisation to exercise proper inventory control. (4) AB
C Analysis :
This technique assumes the basic principle of Vital Few Trivial Many while conside
ring the inventory structure of any organisation and is popularly known as Always
Better Control. It is an analytical method of inventory control which aims at co
ncentrating efforts in those areas where attention is required most. It is usual
ly observed that, in practice, only a few number of items of inventory prove to
be more important in terms of amount of investment in inventory or 220
Management Accounting

value of consumption, while a very large number of items of inventory account fo


r a very meager amount of investment in inventory or value of consumption. This
technique classifies the various inventory items according to their importance.
E.g. A Class consists of only a small percentage of total number of items handle
d but are most important in nature. B Class items include relatively less import
ant items. C Class items consist of a very large number of items which are less
important. The importance of the various items may be decided on the basis of fo
llowing factors. (i) (ii) Amount of investment in inventory. Value of material c
onsumption.
(iii) Critical nature of inventory items. An example of ABC Analysis can be give
n as below. Class No. of items % of total No. of items 6 30 64 100 Value/ Consum
ption Rs. 5,60,000 1,60,000 80,000 8,00,000 % of Total Value/ Consumption
A B C
300 1500 3200 5000
70 20 10 100
In order to exercise proper inventory control, A Class items are watched very cl
osely and control is exercised right from initial stages of estimating the requi
rements, fixing minimum level/leadtimes, following proper purchase/ storage proc
edures etc. Whereas in case of C Class of items, only those inventory control me
asures may be implemented which are comparatively simple, elaborate and inexpens
ive in nature. Advantage of ABC Analysis : (a) A close and strict control is fac
ilitated on the most important items which constitute a major portion of overall
inventory valuation or overall material consumption and due to this the costs a
ssociated with inventions may be reduced. The investment in inventory can be reg
ulated in a proper manner and optimum utilisation of the available funds can be
assured. A strict control on inventory items in this manner helps in maintaining
a high inventory turnover ratio.However it should be noted that the success of
ABC analysis depends mainly upon correct categorisation of inventory items and h
ence should be handled by only experienced and trained personnel.
(b)
(c)
Material Cost
221

(5)
Bill of Materials :
In order to ensure proper inventory control, the basic principle to be kept in mi
nd is that proper material is available for production purposes whenever it is r
equired. This aim can be achieved by preparing what is normally called as Bill of
Materials. A bill of material is the list of all the materials required for a jo
b, process or production order. It gives the details of the necessary materials
as well as the quantity of each item. As soon as the order for the job is receiv
ed, bill of materials is prepared by Production Department or Production Plannin
g Department. The form in which the bill of material is usually prepared is as b
elow : BILL OF MATERIALS No. Date of Issue Production/Job Order No.
Department authorised
S. No. Description of Material Code No. Qty. For Department Use only Material Re
quisition No. Date Quantity demanded Remarks
The functions of bill of materials are as below : (1) Bill of material gives an
indication about the orders to be executed to all the persons concerned. Bill of
material gives an indication about the materials to be purchased by the Purchas
es Department if the same is not available with the stores. Bill of material may
serve as a base for the Production Department for placing the material requisit
ions ships. Costing/Accounts Department maybe able to compute the material cost
in respect of a job or a production order. A bill of material prepared and value
d in advance may serve as a base for quoting the price for the job or production
order.
(2)
(3)
(4)
222
Management Accounting

(6)
Perpetual Inventory System : As discussed earlier, in order to exercise proper i
nventory control, perpetual inventory system may be implemented. It aims basical
ly at two facts. (1) Maintenance of Bin Cards and Stores Ledger in order to know
about the stock in quantity and value at any point of time. Continuous verifica
tion of physical stock to ensure that the physical balance and the book balance
tallies.
(2)
The continuous stock taking may be advantageous from the following angles : (1)
Physical balances and book balances can be compared and adjusted without waiting
for the entire stocktaking to be done at the year-end Further, it is not necess
ary to close down the factory for Annual stocktaking. The figures of stock can b
e readily available for the purpose of periodic Profit and Loss Account. Discrep
ancies can be located and adjusted in time. Fixation of various levels and bin c
ards enables the action to be taken for the placing the order for acquisition of
material. A systematic maintenance of perpetual inventory system enables to loc
ate and slow and non-moving items and to take remedial action for the same. Stoc
k details are available correctly for getting the insurance of stock.
(2)
(3) (4)
(5)
(6)
ILLUSTRATIVE PROBLEMS (1) The following informative is extracted from the Stores
ledger in respect of Material X Opening Stock Purchases Jan. 1 Jan. 20 Issues J
an. 22 Jan. 23 60 for Job W 16 60 for Job W 17 100 @ Re. 1 per unit 100 @ Rs. 2
per unit Nil
Complete the receipts and issues valuation by adopting the First In First Out, L
ast In First Out and Weighted Average method. Tabulate the values allocated to J
ob W 16 and 17 and the closing stock under the methods aforesaid.
Material Cost
223

Solution : (a) Valuation of receipts : (For all methods) Jan. 1 Jan. 20 100 x 1.
00 100 x 2.00 200 units Weighted Average Rate = = = Rs. 100 Rs. 200 Rs. 300 Rs.
300 200 units (b) Valuation of Issues/Closing Stock = Rs. 1.50/Unit
(1) Issues FIFO Date Jan. 22-W16 Jan.23-W17 Qty. Unit 60 40 20 Rate Rs. 1.00 1.0
0 2.00 Amt. Rs. 60.00 40.00 40.00 140.00 160.00 Qty. Unit 60 40 20 LIFO Rate Rs.
2.00 2.0 1.00 Amt. Rs. 120.00 80.00 20.00 220.00 80.00 Weighted Average Qty. Un
it 60 60 Rate Rs. 1.50 1.50 Amt. Rs. 90.00 90.00 180.00 80 1.50 120.00
(2)
Closing Stock
80
2.00
80
1.00
(c)
Values allocated to individual jobs W 16 Rs. FIFO LIFO Weighted Average 60 120 9
0 W 17 Rs. 80 100 90
(2)
From the records of an oil distributing company, the following summarised inform
ation is available for the month of March 1986. Sales for the month - Rs. 19,25,
000 Opening Stock as on 1-3-86 - 1,25,000 Litres @ Rs. 6.50 litre Purchases (inc
luding freight and insurance) March 5 -1,50,000 litres @ Rs. 7.10 litre
224
Management Accounting

March 27 - 1,00,000 litres @ Rs. 7.00 litre. Closing stock as on 31-3-86 - 1,30,
000 litres General Administrative expenses for the month Rs. 45,000 On the basis
of the above information, work out the following using FIFO and LIFO methods of
inventory valuation assuming pricing of issues is being done at the end of the
month (after all receipts during the month). (a) (b) (c) Value of Closing Stock
as on 31-3-86 Cost of goods sold during March 86 Profit or Loss for March 86.
Solution : (a) (1) Value of Closing Stock FIFO :
Under this method, the value of closing stock will constitute the value of lates
t available lot for consumption, earlier lots assumed to have been consumed. As
such, value of closing stock will be: Purchased on 27-3-86 Purchased on 5-3-86 1
,00,000 Its. x Rs. 7.00 30,000 Its. x Rs. 7.10 = = Rs. 7,00,000 Rs. 2,13,000 Rs.
9,13.000 (2) LIFO :
Under this method, the value of closing stock will constitute the value of earli
est available lot for consumption, latest lots assumed to have been consumed. As
such, value of closing stock will be : Opening Stock on Purchased on 1-3-86 1,2
5,000 Its. x Rs. 6.50 5-3-86 5,000 Its. x Rs. 7.10 = = Rs. 8,12,500 Rs. 35,500 R
s. 8,48,000
Material Cost
225

(b)
Cost of goods sold during March 1986 FIFO Rs. LIFO Rs. 8,12,500 17,65,000 25,77,
500 8,48,000 17,29,500
Opening Stock 1,25,000 Its. x Rs. 6.50 Purchases
8,12,500 17,65,000 25,77.500
Less : Closing Stock (as per a above)
9,13,000 16,64,500
The value of purchases is calculated as below : Purchased on Purchased on 5-3-86
1,50,000 X Rs. 7.10 27-3-86 1,00,000 X Rs. 7.00 = = Rs. 10,65,000 Rs. 7.00,000
Rs. 17,65,000 (c) Profit or Loss for March 1986 FIFO Rs. (1) Sales Total Cost Co
st of goods sold Administrative Expenses 16,64,500 45,000 17,09,500 (2) (3) Prof
it (1 - 2) 2,15,500 17,29,500 45,000 17,74,500 1,50,500 19,25,000 LIFO Rs. 19,25
,000
A company uses annually 50,000 units of an item each costing Rs.1.20. Each older
costs Rs. 45 and inventory carrying costs 15% of the annual average inventory v
alue. Find EOQ If the company operates 250 days a year, the procurement time is
10 days, and safety stock is 500 units, find reorder level, maximum, minimum and
average inventory.
(a) (b)
226
Management Accounting

Solution : (a) Economic Order Quantity


=

2 X A X O Ci
2 X 50,000 X 45 15% of 1.20 5,000 units
= (b) (1)
Reorder Level :
Safety Stock + (Normal Usage x Normal Leadtime) = 500 units + (200 units x 10 da
ys) = (2) Maximum Level : Safety stock + EOQ = 500 units + 5,000 units = 5,500 u
nits (3) Minimum Level It is equal to safety stock i.e. 500 units (4) Average Le
vel Safety Stock + EOQ 2 5000 units 2 2,500 units
= = (4)
500 units + 3000 units
M/s. Kailas Pumps Ltd. uses about 75,000 valves per year and the usage is fairly
constant at 6,250 per month. The valve costs Rs. 1.50 per unit when purchased i
n quantities and inventory carrying cost is 20%. The average inventory investmen
t on annual basis. The cost to place an order and to process the delivery is Rs.
18. It takes 45 days to receive from the date of an order and minimum stock of
3,250 valves is desired. You are required to determine Material Cost
227

a. b. c.
The most economical order quantity and the number of orders in year. The reorder
level The most economic order quantity if valve costs Rs. 4.50 each instead of
Rs. 1.50 each.
Solution : (a) Economic Order Quantity :
EOQ
= =

2xAxO Ci = 3,000 units
2 x 75,000 x 18 20% of 1.50
Number of Orders : Annual Consumption EOQ = (b) 75,000 units 3,000 units = 25
Reorder Level : Safety stock + (Normal Usage x Normal Leadtime) = = 3,250 units
+ (6,250 units x 1.5 months) 12,625 units
(c)
Revised EOQ (If unit cost is Rs. 4.50 instead of Rs. 1.50) EOQ = =

2xAxO Ci
2 x 75,000 x 18 20% of 4.50 1,732 units
=
228
Management Accounting

(5)
The Purchase Department of your Organisation has received an offer of quantity d
iscounts on its orders of materials as under : Price Per Tonne 1,200 1,180 1,160
1,140 1,120 Tonnes Less than 500 500 and less than 1000 1000 and less than 2000
2000 and less than 3000 3000 and above.
The annual requirement for the material is 5000 tonnes. The delivery cost per or
der is Rs. 1,200 and the stock holding cost is estimated at 20% of material cost
per annum. You are required to advice the Purchase Department the most economic
purchase level. Solution : As the price discount varies with lot size, EOQ will
have to be decided by Trial and Error Method. Lot Size (Units) Q Price per Tonn
e-Rs. P Purchase Cost for 5,000 Tonnes Rs. 3 60,00,000 60,00,000 59,00,000 59,00
,000 58,00,000 58,00,000 57,00,000 57,00,000 56,00,000 56,00,000 5000 X 1200 Q 4
60,000 24,000 12,000 9,600 6,000 4,800 3,000 2,400 2,000 1,500 2 5 12,000 30,00
0 59,000 73,750 1,16,000 1,45,000 2,28,000 2,85,000 3,36,000 4,48,000 6(3+4+5) 6
0,72,000 60,54,000 59,71,000 59,83,350 59,22,000 59,49,800 59,31,000 59,87,400 5
9,38,000 60,49,500 Ordering Cost Q X P X 20% Carrying Cost Total Cost Rs.
1 100 250 500 625 1,000 1,250 2,000 2,500 3,000 4,000
2 1200 1200 1180 1180 1160 1160 1140 1140 1120 1120
Material Cost
229

It will be observed, that if the purchases are made in the lot size of 1,000 uni
ts it proves to be most economical. (6) (a) A company needs 24,000 units of raw
materials which costs Rs. 20 per unit and ordering cost is expected to be Rs. 10
0 per order. The company maintains safety stock of 1 months requirements to meet
emergency. The holding cost of carrying inventory is supposed to be 10% per unit
of average inventory. Find out : 1. 2. 3. 4. (b) Economic lot size. Ordering co
st Holding cost Total cost
The supplier of raw material has agreed to supply the goods at a discount of 5%
in price on a lot size of 4,000 units. Find whether the concession price should
be availed.
Solution : (a) (1) Economic Lot Size
=

2xAxO Ci
2 x 24,000 x 100 10% of 20
= (2)
1,550 units (Approx.)
Ordering Cost Annual Requirement EOQ = 24,000 1550 X 100 = Rs. 1,548 (Approx.) X
Ordering cost per order
(3)
Holding Cost : As the company maintains safety
he average inventory held at any point of time
stock + EOQ/2. Assuming that the usage of raw
year i.e. 2,000 units per month, holding cost
230
Management Accounting

stock of one months requirement, t


will not only be EOQ/2 but safety
material is steady throughout the
will be :

(Safety Stock + EOQ/2) / Carrying cost per unit per year = = = (4) (2,000 units
+ 1,550 units 2 ) X 10% of Rs. 20
2,775 units X Rs. 2 Rs. 5,550
Total cost : Cost of material 24,000 x 20 Ordering Cost Holding Cost Total Cost
= = = = Rs. 4,80,000 Rs. 1,548 Rs. 5,550 Rs. 4,87,098
(b) (1)
Revised Total Cost : (with 5% discount) Ordering Cost :
As order size is going to be 4,000 units, total 6 orders will be placed. Hence t
otal ordering cost will be 6 orders x Rs. 100 per order i.e. Rs. 600 (2) Holding
Cost :
The holding cost will be as below : (Safety Stock + Order Size 2 4000 units 2 )
x 10% of Rs. 19 ) x Carrying cost per unit per year
= = (3)
(2,000 units + Rs. 7,600 Total Cost :
Total Cost of material - 24,000 x 19 Ordering Cost Holding Cost Total Cost
= = = =
Rs. 4,56,000 Rs. 600 Rs. 7,600 Rs. 4,64,200
Material Cost
231

Conclusion : If purchased in Economic Lot Size, total cost (including material c


ost) is Rs. 4,87,098. If purchased in Lot Size of 4,000 units with 5% discount,
total cost (including material cost) is Rs. 4,64,200. As purchases in Lot Size o
f 4,000 units result in the saving of Rs. 22,898 (i.e. Rs. 4,87,098 Rs. 4,64,200
) that alternative will be preferred.
QUESTIONS 1. Explain the various steps in which a raw material moves in a manufa
cturing organization till it gets consumed in the production. Give the format of
various documents which are prepared in the process. Write a detailed essay on
a) b) c) Valuation of Receipts Valuation of Issues Valuation of Returns
2.
232
Management Accounting

PROBLEMS (1) The following is the record of receipts and issues of certain mater
ial in a factory during the week ending May 1979. Opening balances 100 tons at R
s. 10 per ton. Issued 60 tons. Received 120 tons at Rs. 10 per ton Issues - 50 t
ons (Stock verifier reported shortage of 2 tons) Received back from order 20 ton
s (originally issued at Rs. 9.90) Issued 80 tons. Received 44 tons at Rs. 10.20
per ton. Issued 66 tons. Received 44 tons at Rs. 10.20 per ton. Issued 66 tons.
From the above particulars prepare stores ledger separately under e method charg
ing issues at weighted and simple average method. (2) Following transactions app
eared in a specified material during month of August 1980. Date 1 4 5 12 13 19 2
5 30 31 Particular Opening balance Purchased Issued Issued Purchased Issued Issu
ed Purchased Issued Quantity (Tons) 100 50 30 40 30 40 30 40 30 28 25 Rate per t
on 24 26
The stock verifier noticed shortage in stock on 26th August of 5 tons and on 29t
h August of 4 tons. Write up stores ledger by charging issues by FIFO and by wei
ghted average methods. (3) The following is the history of the receipt and issue
of materials in a factory during February 1980,
Material Cost
233

Feb. 1 2 4 8 13 14 16 20 24 25 26 27 28
Opening balance -500 tons at Rs. 25 Issued 70 tons Issued 100 tons Issued 80 ton
s Received from vendor 200 tons at Rs. 24.50 Refund of surplus from a work order
15 tons at Rs. 24 Issued 180 long Received from vendor 240 tons at Rs. 24.40 Is
sued 304 tons Received from vendor 320 tons at Rs. 24.30 Issued 112 tons Refund
of surplus from a work order 12 tons at Rs. 24.50 Received from vendor 100 tons
at Rs. 25
Issues are to be priced on the principle of LIFO and simple average method. The
stock verifier of the factory noted that on the 15th he had found a shortage of
5 tons and on 27th another shortage of 8 tons. Write out complete stores ledger
account in respect of the material. (4) A cloth manufacturer commenced the busin
ess on 1.1.82. Textile materials used include two types - M & N. During 6 months
ending on 30.6.82, transactions were as follows : Date M 4.1.82 6.1.82 7.1.82 1
2.1.82 18.3.82 28.3.82 16.4.82 22.4.82 26.5.82 1.6.82 2.6.82 8.6.82 1000 17.50 1
300 800 9.50 1580 3000 16 2860 2300 12 1420 1000 1600 Purchased (Mtrs.) N Rates
per Mt. 10 15 700 1200 Issued (Mtrs.) M N
234
Management Accounting

You are required to prepare stores ledger account for M type of material by char
ging issues by LIFO method and N type of material by charging the issues on weig
hted average method. (5) The stores ledger account of material C in the books of
Saurabh and Sweta Ltd. revealed following transactions for September 1984, Sept
. 1 5 8 Opening stock 200 kgs at Rs. 7.50 per kg. Received from supplier 400 kgs
at Rs. 7.75 per kg GRN 448 Issued to Production Dept. 240 kgs SR No. 883
10 Received from supplier 500 kgs at Rs. 7.90 per kg. GRN 45 12 Issued to Produc
tion Dept. 160 kgs SR No. 897 15 Issued to Production Dept. 400 kgs SR No. 912 1
6 Received from supplier 250 kgs at Rs. 8.00 per kg GRN 469 19 Received from sup
plier 600 kgs at Rs. 8.25 per kg GRN 561 21 Issued to Production Dept. 350 kgs S
R No. 946 24 Issued to Production Dept. 260 kgs SR No. 959 27 Issued to Producti
on Dept. 340 kgs SR No. 974 You are required to price the issues and draw out th
e closing balance in the stores ledger account under the pricing method in which
the material costs charged to production would be closely related to current pr
ices. (6) Record the following transactions in a store ledger and show the cost
of consumption and closing stock by using FIFO method of pricing issues. For the
month of January 1985 : Jan. 1 Opening Stock 300 units at Rs. 9.70 per unit 3 P
urchases 250 units at Rs. 9.80 per unit 15 Purchases 300 units at Rs. 10.50 per
unit 25 Purchases 150 units at Rs. 10.30 per unit Jan. 11 Issues 20 Issues 29 Is
sues 400 units 210 units 100 units
Material Cost
235

(7)
Prepare a stores ledger account on
g stock Purchased Purchased Issued
nits 150 units 100 units 100 units
ach @ Rs. 1.20 each @ Re. 1 each @

the
250
200
Rs.

basis of FIFO method. Jan. 1 3 4 6 Openin


units 100 units 200 units 400 units 400 u
units 300 units @ Re. 1 each @ Rs. 1.25 e
1.05 each @ Rs. 1.05 each

10 Purchased 12 Issued 13 Issued 16 Purchased 22 Purchased 31 Issued (8)


The following is a summary of the receipts and issues of a material in a factory
during a month. 1st Opening Balance 500 units at Rs. 25 per unit. 3rd Issued 70
units. 4th Issued 100 units. 8th Issued 80 units. 13th Receipts 200 units at Rs
. 24.50 per unit (Supplier) 14th Returned to stores 15 units at Rs. 24 per unit.
16th Issued 180 units. 20th Receipts 240 units at Rs. 24.75 per unit (Supplier)
24th Issued 304 units. 25th Receipts 320 units at Rs. 24.50 per unit (Supplier)
26th Issued 112 units. 27th Returned to stores 12 units at Rs. 24.50 per unit 2
8th Received from supplier 100 units at Rs. 25 per unit. Stock verification reve
aled that on 15th there was a shortage of 5 units and another on 27th of 8 units
. Prepare Stores Ledger Account on the basis of FIFO basis.
236
Management Accounting

(9)
Following is an extract of receipts and issues for the month of January 1989 of
a manufacturing company. Date 2 4 6 10 15 19 22 25 30 Purchased Purchased Issued
Purchased Issued Issued Issued Purchased Issued 8,000 units 1,000 units 4,000 u
nits 12,000 units 8,000 units 2,000 units 4,000 units 9,000 units 6,000 units @
Rs. 2.75 @ Rs. 3 @ Rs. 2 @ Rs. 2.50
Draw up store Ledger Account by LIFO method showing balance as on 31.1.89 (10) T
he transactions in connection with the materials are as follows : Days Unit 1st
2nd 3rd 4th 5th 6th 40 20 50 Receipts Rate per unit Rs. 15.00 16.50 14.30 Issues
(Units)
30 20 40
Calculate the cost of material issued under FIFO method and Weighted Average met
hod of issue of materials. (11) From the following details of stores receipts an
d issues of Material EXE in a manufacturing unit, prepare the stock ledger using
Weighted Average method of valuing the issues. Nov. 1 Opening Stock 2,000 units (
S) Rs. 5.00 each Nov. 3 Issued 1,500 units to production Nov. 4 Received 4,500 u
nits @ Rs. 6.00 each Nov. 8 Issued 1,600 units to production. Nov. 9 Returned to
stores 100 units by production department (from the issues of Nov. 3) Nov. 16 R
eceived 2,400 units @ Rs. 6.50 each
Material Cost
237

Nov. 19 Returned to supplier 200 units out of the quantity received on Nov. 4Nov
. 20 Received 1,000 units @ Rs. 7 each. Nov. 24 Issued to production 2,100 units
Nov. 27 Received 1,200 units @ Rs. 7.50 each Nov. 29 Issued to Production 2,800
units (Use rates upto two decimal places) (12) The following are the transactio
ns in respect of purchases and issues of components forming part of an assembly
of a product manufactured by a firm which requires, to update its cost of produc
tion very often for bidding tenders and finalising cost plus contracts. Date 198
6 January February 5 11 1 18 26 March 8 17 28 Quantity (in Nos.) 1,000 2,000 1,5
00 2,400 1,000 1,000 1,500 2,000 Particulars
Purchased @ Rs. 1.20 each Issued Purchased @ Rs. 1.30 each Issued Issued Purchas
ed @ Rs. 1.40 each Purchased @ Rs. 1.30 each Issued.
The stock on 1st January 1986 was 5,000 Nos. valued at Rs. 1.10 each. State the
method you would adopt in pricing the issues of components giving reasons. What
value would you place on stocks as on 31st March which happens to be the financi
al year end and how would you treat the difference in value, if any, on the stoc
k account. (13) The following are the extract from the transactions on the bin c
ard of Job No. 12-3-89 for March 1987 Date 2 6 8 12 15 18 28 On order 50 Receipt
40 50 30 Rate 25.00 28.00 24.00 26.00 Issue 20 30 50 Balance 40 20 70 40 70 70
20
238
Management Accounting

Find out the pricing of material issue under LIFO, FIFO and simple average metho
d. (14) XYZ Ltd. requires 20,000 units of product A per annum. The purchase pric
e is Rs. 4 per unit. The inventory carrying cost is 20% per annum and the cost o
f ordering is Rs. 100 per order. Advise the company, on how many times they shou
ld order in a year, so as to minimise the cost of product A? (15) A Manufacturer
buys certain essential spares from outside suppliers at Rs. 40 per set. Total a
nnual requirements are 45000 sets. The annual cost of investment in inventory is
10% and costs like rent, stationery, insurance, taxes etc. per unit per year wo
rk to Re. 1, cost of placing an order is Rs. 5. Calculate the Economic Order Qua
ntity. (16) Following information relating to a type of raw material is availabl
e. Annual Demand Unit Price Ordering cost per order Storage cost Interest Rate L
ead Time 2,400 units Rs. 2.40 Rs. 4.00 27% p.a. 10% p.a. Half month
Calculate Economic Order Quantity and total annual inventory cost in respect of
the particular raw material. (17) From the particulars given below, you are requ
ired to compute. (a) (b) (c) (d) (e) Economic Order Quantity Maximum Level Minim
um Level Re-ordering Level Average stock Level (i) (ii) (iii) (iv) Quantity requ
ired annually 3,000 units @ Rs. 5 per unit. Interest and cost of storing 10%. Co
st of placing an order Rs. 30 per order. Consumption per week Normal 60 units Ma
ximum 70 units Minimum 50 units. (v) Lead time (in weeks) Normal 5 Maximum 6 Min
imum 4
Material Cost
239

(18) The Stock-Ledger Account for material X in a manufacturing concern reveals


the following data for the quarter ended September 30, 1989. Receipts Quantity U
nits July 1 Balance b/d 1.600 July July August August August September September
September 9 13 5 17 24 11 27 29 3,000 3,600 2,500 2.00 2.20 2.40 2.50
1,800 2,100 700 2,556 1,917 4,122 4,971 1,656 Price Rs. Quantity Units Issues A
mount Rs.
Physical verification on September 30, 1989 revealed an actual stock of 3,800 un
its. You are required to : (a) (b) Indicate the method of princing employed in t
he above. Complete the above account by making entries you would consider necess
ary including adjustments, if any, and giving explanations for such sdjustments.
(19) Following information is available in respect
rticulars Normal Usage Minimum Usage Maximum Usage
Ordering cost per order Carrying cost per unit per
nent. Units Units Units Week Units Rs. Rs. A 50 25
2-4 6,250 100 5
240
Management Accounting

of two components A and B. Pa


Lead Time Annual Consumption
year Calculate for each compo
75 4-6 9,000 45 9 B 50 25 75

(i) (ii)
Re-order level Minimum level
(iii) Maximum level (iv) Average level
(20) P. Ltd. uses three types of materials, A, B and C for production of X, the
final product. The relevant monthly data for the components are as given below :
A Normal Usage (Units) Minimum Usage (Units) Maximum Usage (Units) Re-older Qua
ntity (Units) Re-order period (Months) Calculate for each component. (1) (2) (3)
(4) Re-order Level Minimum Level Maximum Level Average stock Level 200 100 300
750 2 to 3 B 150 100 250 900 3 to 4 C 180 90 270 720 2 to 3
(21) The following data are available from the records of M/s. Naveen Industries
Ltd. using two types of materials A and B for the manufacture of their product.
A Normal Usage (Units per month) Minimum Usage (Units per month) Maximum Usage
(Units per month) Reorder Quantity (Units) Reorder Period (Months) Compute for e
ach type of material, the following levels. (1) (2) (3) (4) Reorder Level Minimu
m Level Maximum Level Average Stock Level 250 100 350 900 2 to 3 B 200 200 400 1
000 3 to 4
Material Cost
241

(22) Following details are available in respect of a material. (i) (ii) Ordering
cost per order Rs. 45 Annual consumption 9,000 units
(iii) Carrying cost per unit per year Rs. 9 (iv) Lead Times Average - 10 days Mi
nimum 6 days Maximum 15 days Maximum for emergency purchases 4 days (v) Rate of
consumption - Average 15 units per day Maximum 20 units per day Calculate : (i)
(ii) Reordering Level Maximum Level
(iii) Minimum Level (iv) Average Level
(23) Certain purchased part of which annual requirements are 8000 units, involve
s ordering cost equal to Rs. 12.50 per order, cost per piece Re. 1 and the annua
l carrying cost 20%. In addition, average daily usage is 32 units (based on 250
operating days per year), lead time is 10 days and safety stock has been calcula
ted to be 100 units. Calculate : (a) (b) (24) (i) Economic Order Quantity Reorde
r point XYZ Company buys in the lot of 500 boxes which is a 3 months supply. The
cost per box is Rs. 125 and the ordering cost is Rs. 150. The inventory carryin
g cost is estimated at 20% of unit value. What is the total annual cost of the e
xisting inventory policy? How much money could be saved by employing the economi
c order quantity?
(ii)
(25) To decided to buy an item, the following data is given. Annual Demand 600 u
nits Ordering Cost - Rs. 400 Holding Cost - 40%
242
Management Accounting

Cost per unit - Rs. 15 Discount 10% if the order quantity is 500 What should be
the decision? Justify your answer. (26) A manufacturer requires 10 lakhs compone
nts for use during the next year which is assumed to consist of 250 working days
. The cost of storing one component for one year is Rs. 4 and the cost of placin
g order is Rs. 32. There must always be a safety stock equal to two working days
usage and the lead time from the supplier, which has been guaranteed, will be 5
working days throughout the year. Assuming usage takes place steadily throughou
t the working days, delivery takes place at the end of the day and orders are pl
aced at the end of working day, you are required to calculate. (i) (ii) Economic
Order Quantity. Reorder point.
(27) Anil Company buys its annual requirement of 36,000 units in six instalments
. Each unit costs Re. 1 and the ordering cost is Rs. 25. The inventory carrying
cost is estimated at 20% of the unit value. Find the total cost of the existing
inventory policy. How much money can be saved by using Economic Order Quantity?
(28) A Company, for one of the A class items, placed 6 orders each of size 200 i
n a year. Given ordering cost Rs. 600, holding cost 40%, cost per unit Rs. 40, f
ind out the loss to the Company by not operating scientific inventory policy. Wh
at are your recommendations for the future? (29) A manufacturer has to supply hi
s customers 600 units of his product per year. Shortages are not allowed and the
inventory carrying cost amounts to Rs. 0.60 per unit per year. The set up cost
per run is Rs.80. Find (a) (b) (c) The Economic Order Quantity The minimum avera
ge yearly cost. The optimum number of orders per year.
(30) A purchase manager has decided to place order for minimum quantity of 500 n
umbers of a particular item in order to get a discount of 10%. From the records,
it was found that in the last year, 8 orders each of size 200 number have been
placed. Given Ordering cost Rs. 500 per order, Inventory carrying cost 40% of th
e inventory value and cost per unit Rs. 400, is the purchase manager justified i
n his decision. What is the effect of his decision on the company?
Material Cost
243

(31) A publishing house purchases 2000 units of a particular item per year at a
unit cost of Rs. 20, the ordering cost per order is Rs. 50 and the inventory car
rying cost is 25%. Find the optimal order quantity and minimum total cost includ
ing purchase cost. If a 3% discount is offered by the supplier for purchase in l
ots of 1000 or more, should the publishing house accept the proposal? (32) Calcu
late for each Component A and B the following (a) (b) (c) (d) Reorder Level Maxi
mum Level Minimum Level Average stock Level 300 units per week each. 450 units p
er week each 150 units per week each
Normal Usage Maximum Usage Minimum Usage Reorder Quantity
- A - 2,400 units B - 3,600 units
Reorder Period
A - 4 to 6 weeks B - 2 to 4 weeks
244
Management Accounting

NOTES
Material Cost
245

NOTES
246
Management Accounting

Chapter 9
LABOUR COST
Labour Cost is another important element of cost in the manufacturing cost. It i
s important element of cost eventhough the production is material intensive. The
basic factor which gives rise to the labour cost is the remuneration paid to wo
rkers. However, the objective of cost accounting (i.e. cost ascertainment with r
espect to the individual cost centre and cost control) can not be fulfilled prop
erly unless and until the functions performed by the related departments are pro
perly considered. These functions can be stated as below : (1) Personnel Departm
ent : This ensures the availability of correct workers to perform the jobs which
are best suited for them. This is done by selecting them properly and training
them properly. This department may also be involved with maintenance of records
of job classification/ wage rates payable to workers, preparation of wages sheet
and procedural aspects of wage payment. Time Keeping Department : This is conce
rned with recording of workers time. This is not only for the purpose of wage ca
lculations but also for the purpose of cost analysis and apportionment of cost o
ver various jobs. The main functions performed by this department are time keepi
ng and time booking. Cost Accounting Department : This department accumulates an
d classifies cost data with respect to labour cost from the analysis of wages sh
eet and presents the reports to management to facilitate the control over labour
cost.
(2)
(3)
The starting point for ascertaining the labour cost is in the form of Time Keepi
ng and Time Booking. Time Keeping : This is the process of recording attendance
time of the workers. It is the responsibility of Time Keeping Department which m
ay function as separate department in some cases or else may function as the par
t of Personnel Department. Attendance time recording may be necessary as the pay
ment of wages may depend on the attendance. Even when the payment of wages does
not depend on time attended, say in case piece rate payment, the recording of ti
me attended may be necessary from the following angles.
Labour Cost
247

(1) (2)
To Maintain discipline. Though the regular wages may not depend upon the time at
tended, in some cases, the other payments like overtime wages, dearness allowanc
e etc. may be linked with the attendance. The fringe benefits like Pension, Grat
uity on retirement. Provident Fund etc. may depend on the continuity of service
which will be available only if time attended is recorded properly. Attendance r
ecords may be required for research and other purposes.
(3)
(4)
Methods of Time Keeping : For the purpose of time keeping, various methods may b
e followed, though the selection of the method may depend upon nature of organiz
ation and policy of management. Main such methods may be stated as below: (1) Ha
nd-Written Method : Under this method, names of the workers are recorded in the
attendance register with provision of various columns for various days. The atte
ndance of the worker may be recorded either by calling out his name or by physic
al check. Alternatively, the workers themselves may sign in the attendance regis
ter. This method, though simple, has become outdated. This method can also resul
t in malpractices with the collusion between workers and time keeping/ personnel
department. Also recording of late coming, overtime, short leave etc. may invol
ve more clerical work and may be subject to errors. (2) Token or Disc Method : U
nder this method, each worker is allotted an identification number and a disc or
token bearing that number. Immediately before the scheduled opening time, all t
he tokens/ discs will be placed at the factory gate. Every incoming worker will
take out his token and drop it in a separate box or hang it on a separate board.
The tokens/discs not removed will indicate that the said worker is absent. Simi
lar procedure is followed while the workers leave the factory. In addition to th
e physical handling of tokens/ discs, it will be required to record the attendan
ce time separately. Though it is an improved method, as compared to manual/handw
ritten method, it is also subject to errors.mistakes and frauds. Further care sh
ould be taken to see that a worker does not remove the disc/token of his absent
fellow in addition to his own.
248
Management Accounting

(3)
Time Recording Clock Method : Under this method, every worker is alloted individ
ual ticket number and a clock card which bears that ticket number. The cards are
placed on two racks on either side of the time recording clock denoting separat
ely In rack and Out rack. At the opening time, all the cards are placed in Out rack. O
n arrival, worker takes out his own card, puts it in the slot available on the t
ime clock recorder which punches the time on that card, and places the card in In
rack. All the cards, left in the Out rack indicate absent workers. At the time of
departure, he removes the card from In rack, gets it punched and places it in Out r
ack. Though, this method involves heavy capital outlay initially, it has certain
advantages also. (1) It is economical in the sense it avoids clerical work: inv
olved in manual/handwritten method. It is clean, safe and quick and has printed
records to avoid disputes. Chances of fraudulent entries being made can be avoid
ed.
(2) (3)
Time Booking : The ultimate aim of costing is to decide the cost of each cost ce
ntre. As such, recording of time attended is not sufficient. Equally important i
s to record the time spent for individual cost centres. This process is in the f
orm of time booking. The methods followed for this purpose, may be considered as
below : (a) Daily time sheets :
Under this method, each worker is provided with a daily time sheet on which time
spent by him on various jobs/work orders is expected to be mentioned. If the wo
rker works on various jobs in a particular day, the daily time sheets move along
with the worker. The entries on the same may be made by the worker himself or b
y the foreman. This method may be conveniently used if the worker works on vario
us jobs of short duration. Say in case of maintenance jobs. This method is disad
vantageous in the sense that it involves considerable paper work. The form in wh
ich the daily time sheets may be prepared is as below :
Labour Cost
249

DAILY TIME SHEET Name of Employee Employee No. Job No. Dept. Time Record ON OFF
Date : Time taken
Checked by (b) Weekly Time Sheets :
Cost office reference
Under this method also; one sheet is alloted to each worker but instead of recor
ding the work done for a day only, record of time for all the jobs during the we
ek is made. These types of time sheets are useful for intermittent types of jobs
like building or construction work. It involves comparatively less paper work.
The form in which weekly time sheets may be prepared is as below. WEEKLY TIME SH
EET Name of Employee Employee No. Day Job No. On Time Off Time taken Standard Ra
te Amount Week ending on...
TOTAL Checked by Cost office reference
250
Management Accounting

(c)
Job Card :
Under this method, the details of time are recorded with reference to the jobs o
r production/ work orders undertaken by the workers rather than with reference t
o individual workers, and this facilitates the computation of labour cost with r
eference to jobs or production/work orders. There may be two ways in which job c
ard may be maintained. (1) According to first method, each job or production/wor
k order is alloted a number. When a worker takes up a job, the time of starting
and finishing the job is entered on the card meant for that worker. The summary
of this card states the total time taken by that worker for that job. In order t
o compute the total time booked for the job as a whole, all cards of all the wor
kers with respect to that job are required to be analysed. The form in which thi
s card may be prepared is as below. JOB CARD Name of Employee Employee No. Day O
N FRI SAT SUN MON TUE WED Time OFF Time Taken Standard Rate Rs. Amount Rs. Job N
o.
Checked by (2)
Cost office reference
According to this method, a job card
der accepted by the organization for
ons/stages involved in the execution
rs to complete the job is entered on
ut the time taken by various workers
Labour Cost
251

is prepared for each job production/work or


execution. It describes the various operati
of the job. Time taken by the various worke
the card. This provides the information abo
to complete a particular job.

The form in which this card may be prepared is as below. JOB CARD WITH OPERATION
S Job No. Job Description Operation Employee No. ON OFF Time taken Rate Amount D
rawing No.
Cutting 1 2 Drilling 1 2 Grinding 1 2 Painting 1 2 Assembly 1 2 3 TOTAL
Checked by Reconciliation of time attended and time booked
Cost office reference
If a combined time and job card is maintained, the problem of reconciliation wil
l be relatively simple as both the details will be available on the same card. I
n other cases, at the end of the wage period or at a shorter interval also, the
total time attended has to be compared with the time booked on job cards on the
various jobs. If the time booked as per the job cards, is less than the attendan
ce time, this indicates the idle time during which the worker has not done any w
ork, though he was present in the factory.
252
Management Accounting

Methods of remunerating the workers : Remuneration to workers indicate the rewar


d for labour and services. The remuneration may be paid in monetary terms (which
in turn may be in direct form or indirect form) or nonmonetary terms. The remun
eration paid in the monetary form may be by way of basic wages or salaries and o
ther allowances and may be paid either on time basis or on work basis. However,
payment of only basic wages or salaries may not be sufficient enough to induce t
he workers to work efficiently, hence they may be remunerated in the form of som
e incentives. In case of remuneration in non-monetary form, the workers may not
receive anything in the from money but they may get facilities which induce them
to stay with the organization. It may be in the form of the provision of health
or welfare or recreational facilities, provision of working conditions and so o
n. We will discuss these methods of remuneration under the following heads. (1)
(2) (3) Remuneration on Time Basis i.e. Time Rate System. Remuneration on Work B
asis i.e. Payment by Results. Incentive/Bonus Systems. (a) (b) (4) Individual In
centive Systems Group Incentive Systems.
Indirect monetary remuneration (a) (b) Profit sharing Co-partnership
(5)
Non-monetary incentives
Principles of a good wage payment system : (1) As a general rule, if the efficie
ncy of the workers can be measured in the objective terms, the wages receivable
by a worker should be in conformity with his efficiency. Otherwise an efficient
worker is likely to be demotivated from working efficiently. At the same time, t
he standards fixed to measure the efficiency of a worker should be normal which
can be attained by a normal worker under normal conditions. The wage payment sys
tem should be clearly defined and communicated to the workers leaving no scope f
or any ambiguity. At the same time, a good wage payment system should be simple
to understand and easy to operate. No upper limit should be imposed on the wages
which can be earned by an efficient worker.
(2)
(3)
Labour Cost
253

(4)
A good wage payment system will not punish the workers for the matters beyond th
e control of the workers. E.g. Workers should not be punished in terms of reduce
d wages due to the circumstances like machinery break down or power failures etc
. A good wage payment system should be reasonably permanent in nature. Frequent
changes in the same should be avoided. If any changes are proposed to be made in
system of wages payment, they should not be thrust upon the workers by force, b
ut should be implemented by having mutual discussions with and due approval from
the workers. Wage payment system should be properly tied up with quality contro
l procedures to ensure that the workers are paid only for good and quality produ
ction. The basic objective of the wage payment system should be to get maximum c
ooperation from the workers, improve the morale and productivity of the workers
and to minimize the cost of supervision and labour turnover. The wage payment sy
stem should take into consideration the external obligations to which the organi
zation may be subjected to. These obligations may be in the form of various stat
utes like Minimum Wage Act and the agreement entered into with the workers and s
o on. Time Rate System :
(5)
(6)
(7)
(8)
(A)
Under this, a worker is paid on the basis of time attended by him. He is paid at
a specific rate irrespective of the production achieved by him. The pay rate ma
y be fixed on daily basis, weekly basis or monthly basis. This type of remunerat
ion system is helpful in the following circumstances. (a) If the output of the w
orker is beyond his control e.g. His speed depends upon speed of a machine or sp
eed of other workers. If the output cant be measured or standard time cant be fixe
d e.g. Maintenance work. If close supervision is possible. If quality, accuracy
and precision in work is of prime importance e.g. Artist, Ad-agency person.
(b) (c) (d)
The time rate system of remunerating the workers is useful due to the following
features : (a) (b) (c) (d) 254 Useful for highly efficient and highly inefficien
t workers. Easy for calculations. Easy to understand for the worker. Assurance o
f minimum wages.
Management Accounting

The time rate system has one most important disadvantage attached to it that the
efficiency of the worker is disregarded while paying remuneration to him. To av
oid this difficulty, some variations as discussed below can be applied in practi
ce. (i) High Wage Plan :
Under this system, timely wage rate of the workers may be fixed at such a level
which is higher as compared to wages paid to workers in the same industry or loc
ality. Suitable working conditions are provided. Correspondingly, a high standar
d of efficiency is expected from the workers. Those who are not able to come up
to the standard, are taken off the scheme. (ii) Differential Time Rate :
Under this method, different hourly rates are fixed for different levels of effi
ciency. Up to a certain level of efficiency, normal day rate is applicable which
gradually increases as efficiency increases. This can be illustrated as below :
Up to 80% efficiency 80% to 90% efficiency 90% to 100% efficiency 101% to 125%
efficiency (B) Payments by results : : : : : Re. 1.00 per hour (Normal Rate) Rs.
1.25 per hour Rs. 1.40 per hour Rs. 1.50 per hour
Under this system, workers are paid according to the production achieved by them
. In many cases, time attended is not material. These methods can be reclassifie
d as below. (a) Straight Piece Rate System :
Under this method, each job, production or unit of production is termed as a pie
ce and the rate of payment is fixed per piece. The worker is paid on the basis o
f production achieved irrespective of the time taken for its performance. Thus,
the earnings of the worker can be computed as : Wages = No. of units produced x
Piece Rate per unit This method can be suitably applied if the production is of
standard or repetitive nature. It cant be applied if the production cant be measur
ed in suitable units. It can be seen that the crux of this method is to decide t
he time required to complete a piece. The fixation of this time should be done i
n such a way that within that much time, a normal worker can complete the piece.
This can be done either on the basis of previous experience or on the basis of
time and motion study.
Labour Cost
255

(b)
Piece Rate With Guaranteed Time Rate :
Under the straight piece rate system, the remuneration of a worker depends upon
the production achieved. If the production is less due to some factors beyond hi
s control, he is likely to be penalised. To remove this difficulty, it may be de
cided that he will be paid on time rate if his piece rate earnings fall below ti
me rate earnings, so that the worker is assured of minimum earnings on time basi
s. However, if this guaranteed time rate payment is too high, the incentive to i
ncrease output to get piece rate payment is less. (c) Differential Piece Rate Sy
stem :
Under this system, higher rewards are guaranteed to more efficient workers. The
piece rates are fixed in such a way that normal piece rate is paid for work perf
ormed within and upto the standard level of efficiency. If efficiency exceeds th
e standard, payment at higher piece rate is made. This can be illustrated as bel
ow : Up to 83% efficiency Up to 100% efficiency Above 100% efficiency Normal Pie
ce Rate. 10% above normal piece rate. 30% above normal piece rate.
This method offers more inducement to the workers to work more efficiently and e
arn higher wages. But it is complicated to understand and expensive to operate.
Following systems use this principle of differential piece rates. (1) Taylor Dif
ferential Piece Rate System :
This was introduced by F.W. Taylor. It provides two piece rates, a low piece rat
e for output below standard and a high piece rate for output above standard and
does not provide for any guaranteed time rate payment. Eg. If standard output is
10 units and piece rate is Re.l per unit, the total wages are : (i) If actual h
ourly output is 8 units i.e. below standard, the piece rate is say 80% of normal
piece rate i.e. Re. 0.80. Hence total wages are 8 units x Re. 0.80 = Rs.6.40. I
f actual hourly output is 12 units i.e. above standard, the piece rate is say 12
0% of normal piece rate i.e. Rs. l.20.
(ii)
Hence, total wages are 12 units x Rs.l.20 = Rs. 14.40. The basic defect with thi
s system is that eventhough the efficiency of the worker is below standard even
marginally, he is punished heavily and even though the efficiency of the worker
is above standard even marginally, he is benefited to a very great extent.
256
Management Accounting

(2)
Merrick Differential Piece-rate System :
To remove the defect existing in case of Taylors System which heavily punishes th
e worker who produces below standard, the Merrick System provides for three piec
e rates Eg. Efficiency Up to 83% Up to 100% Above 100% Piece rate Normal 110% of
normal piece rate 130% of normal piece rate
It should be noted that under this method also, no guaranteed time rate payment
is provided. Illustration : The following particulars relate to a company. Piece
Rate M N O 6 paise per unit. Production of the workers 125 units per day 80 uni
ts per day 150 units per day
Standard production per day 120 units. Calculate the wages of the workers on the
basis of Merricks Differential piece rate system, when basic piece rate is guara
nteed below the standard and workers get 108% of the basic piece rate between 10
0% and 120% of the basic piece rate above 120% efficiency. Solution : Calculatio
n of total wages : (a) Worker M : Actual production 125 units i.e. 104% efficien
cy. Applicable piece rate - 108% of normal i:e. 6.48 paise per unit. Total wages
: 125 units x 6.48 paise = 810 paise i.e. Rs. 8.10 (b) Worker N : Actual produc
tion 80 units i.e. below the standard. Applicable piece rate : basic piece rate
i.e. 6 paise per unit Total wages : 80 units x 6 paise = 480 paise i.e. Rs. 4.80
Labour Cost
257

(c)
Worker O : Actual production 150 units i.e. 125% efficiency. Applicable piece ra
te - 120% of normal i.e. 7.20 paise per unit. Total wages 150 units x 7.20 paise
= 1080 paise i.e. Rs. 10.80
(3)
Gantt Task Bonus System :
This system is a combination of time rate and piece rate and provides for minimu
m time rate payment. A high task or standard is set. The wage structure may be f
ixed as below. Output below standard Output at standard Output above standard (C
) Minimum time rate payment. Time wages plus some increase in wage rates. High p
iece rate for entire output.
Individual Incentive Systems :
In case of time rate systems, the losses due to inefficiency of workers or benef
its due to efficiency of workers are suffered or enjoyed by the employer alone.
Similarly in case of piecerate systems, the losses due to inefficiency of worker
s or benefits due to efficiency of workers are suffered or enjoyed by the worker
alone. (The employer may be indirectly affected in the form of increased or dec
reased per unit overheads.) The incentive systems differ from both these systems
in such a way that the financial advantages arising out of the efficiency of wo
rkers are enjoyed by both employer as well as workers. There are various systems
by which the incentive may be paid to workers. We will consider following main
systems. (a) Halsey Premium System :
Under this system, if the actual time taken is equal to or more than standard ti
me, worker is paid at the time rate. If actual time is less than standard time,
the worker, in addition to time wages for hours actually worked, gets a bonus pa
yment. The bonus is equivalent to the wages for the time saved in the decided pe
rcentage to be shared with the employer The percentage allowed to worker may var
y from 30% to 70% (usually 50%). The total wages payable to the worker under thi
s system, can be computed as below. AH X HR Where AH SH HR + (SH - AH) X HR 2 Ac
tual hours Standard hours Hourly rate Assuming 50% - 50% sharing
258
Management Accounting

(b)
Halsey - Weir Premium System :
This system is a deviation of Halsey Premium System only with the exception that
the ratio of sharing between the worker and the employer is fixed as 1/3 : 2/3.
The computation of total wages is the same as in case of Halsey Premium System,
except the change in this ratio. (c) Rowan Premium System :
Under this system also, guaranteed time rate payment is made. The amount of bonu
s paid is a percentage of hourly rate which is in proportion to the time saved.
The total wages payable to the workers under this system can be computed as belo
w : AH X HR Where AH SH HR + SH - AH SH Actual Hours Standard Hours Hourly Rate
X AH X HR
Comparative study of Halsey and Rowan System : Comparative study of total wages
under both these systems reveals that if time saved is less than 50% of the stan
dard time. Rowan system assures more wages than those under Halsey system. But i
f time saved exceeds 50% of the standard time, Halsey system proves to be more b
eneficial. In Rowan System a less efficient worker gets the same bonus as a more
efficient worker. As such Rowan System may be implemented in case of loose fixa
tion of standards. The fall in bonus as time saved increases, offsets the damage
done by loose standards. Illustration : The following are the particulars given
to yon. Standard time Time rate .. 10 hours. .. Re. 1 per hour.
Prepare a comparative table under Halsey Premium System and Rowan Premium System
, if time taken is 9 hours, 8 hours, 6 hours, 5 hours 4 hours and 3 hours. Also
calculate the amount of total wages and labour cost per hour under two methods.
What conclusions do you draw from the table.
Labour Cost
259

Solution : Hours taken Halsey Premium system Wages = Actual Hours x Hourly rate
+ 1/2 (Time Saved x Hourly rate) Rowan Premium system. Wages = Actual Hours x Ho
urly rate + Time Saved/Time Allowed Actual Hours x Hourly rate Wages = 9 x 1 + 1
/10 x 9 x 1 = Rs. 9.90 Wages = 8 x 1+ 2/10 x 8 x 1 = Rs. 9.60 Wages = 6 x 1 + 4/
10 (6 x 1) = Rs. 8.40 Wages = 4 x 1 + 6/10 (4 x 1) = 6.40 Wages = 3 x 1 + 7/10 (
3 x 1) = Rs. 5.10
(a) (b) (c) (d) (e)
9 8 6 4 3
Wages = 9x1+1/2 (I x 1) = Rs. 9.50 Wages = 8x1+1/2 (2 x 1) = Rs. 9 Wages = 6x1+1
/2 (4 x 1) = Rs. 8 Wages = 4 x 1 1/2 (6 x 1) = Rs. 7.00 Wages = 3 X l+ 1/2 (7 x
1) = Rs. 6.50
Conclusion : It can be concluded from the above table that so long as time saved
is less than 50% of standard time, the total wages are more under Rowan Premium
system than under Halsey Premium System. If the time saved is more than 50% of
standard time, Halsey system proves to be more beneficial in terms of the total
wages. The other systems for making the payment of premium can be briefly descri
bed as below. (a) Barth Premium System :
Under this system, the wages payable to the workers are computed as below. Wages
= Hourly Rate x
Standard Hours x Actual Hours
Eg. Standard Hours are 10 Actual hours are 8 Hourly rate is Rs. 2 per hour. Tota
l wages will be 2x
10x8
= Rs. 17.89
260
Management Accounting

It should be noted that this system does not provide for any guaranteed time wag
es. This system is suitable for beginners or apprentices. (b) Emersonss Efficienc
y Bonus System :
Under this system the wages payable to the workers are computed as below. Wages
= Actual Hours x Hourly Rate + Bonus Percentage x Actual -Hours x Hourly rate. F
or calculating bonus percentage, following directions are provided. Efficiency (
1) Below 66.2/3 % Bonus No bonus is payable. Only the guaranteed time wages are
payable. (2) 66.2/3% to 100% In Addition to time wages, bonus is paid at differe
nt percentages increasing rapidly to 20% at 100% efficiency. In addition to time
wages and bonus @ 20%, 1% bonus for each 1% increase in efficiency beyond 100%
is paid. Eg. 101 % efficiency - 21 % Bonus 110 % efficiency 120 % efficiency - 3
0 % Bonus - 40 % Bonus & so on.
(3) Above 100 %
The efficiency percentage can be calculated as below. (1) On time basis : Standa
rd Hours Actual Hours (2) On output basis : Actual output Standard output x 100
x 100
Eg. Standard Hours are 10 Actual Hours are 8 Hourly Rate is Rs. 2 per hour.
Labour Cost
261

Efficiency percentage will be as below. Standard Hours Actual Hours X 100 = 10 8


X 100 = 125%
Bonus percentage will be 45% Total Wages = 8 x 2+ 45% of 8 x 2 = 16 + 45% of 16
= 16 + 7.20 = Rs. 23.20 It can be seen that the abovestated system is similar to
that of piece rate with guaranteed time rate. This system may be suitable for n
on efficient workers for improving their efficiency. (c) Bedaux Point System :
Under this system, the standard time is divided into standard minutes, each stan
dard minute identified as Bedaux Point or B. The wages payable to the worker are
computed as below. Wages = Actual Hours x Hourly Rate + 75 % of BS x Hourly Rat
e 60
Where BS indicates the number of Bs saved i.e. the difference between Bs earned an
d standard Bs allowed for the job. Eg. Standard points for a job - 400 points in
8 hours. Hourly Rate - Rs. 3 per hour. Wages = = = = 8x3+ 75% of (450 - 400) x 3
60
24 + 75% of 2.50 24 + 1.875 Rs. 25.875.
It should be noted that a very accurate system of work study is required for thi
s system. It is difficult to understand and involves a lot of clerical efforts.
262
Management Accounting

(d)
Accelerating Premium System :
Under this system, incentive increases at a fast rate with the increase in outpu
t. Total wages payable to the worker are computed as below. Y = 0.8 X2 where Y =
Earnings X = Efficiency.
i.e. If efficiency is 140%, the earnings will be : 0.8 x 140 x 140 100 100 x 1.5
68 of basic wages i.e.
100% wages, 56.8% bonus. Eg. Standard hours are 10 Actual Hours are 8 Hourly rat
e is Rs. 2 per hour. Efficiency percentage will be
10/8 x 100 = 125% Earnings = 0.8 x = 1.25 Earnings will be 125% of basic wages i
.e 100% basic wages, 25% bonus. 8x2 25% of Rs. 16 = 16 =4 = 20 125 125 x 100 100
Basic, wages Bonus Total Wages
This system is very difficult to understand. (e) Baum Differential Plan :
This is a combination of Taylors differential piece rate system and Halsey system
and is also known as Milwaukee Plan.
Labour Cost
263

(f)
Diemer System :
This is a combination of Halsey System and Gantt system. (D) Group Incentive Sys
tem :
In many cases, the output of the individual workers cannot be measured though th
e output of a group of workers can be measured. In such cases, the individual ti
me rates or in some specified proportion depending upon the skill of the workers
or equally, can be applied. (E) Indirect Monetary Remuneration :
This may take the following two forms. (a) Profit Sharing : According to this me
thod, the workers, are entitled to share in profits earned by an organisation, i
n addition to the regular wages, at a specified percentage. The legal provisions
in this regard are enacted by way of Payment of Bonus Act, 1965. According to t
he provisions of this Act, all the employees drawing a monthly remuneration of R
s. 2,500 or less are entitled to a bonus at the minimum rate of 8.33% of wages o
f the subject to the maximum ceiling of 20 % of the wages. It should be noted th
at the statutory requirement of the payment of bonus does not depend on the prof
it earned necessarily, as the bonus is payable eventhough there are no profits.
It is also worth noting that the statutory requirement of payment of bonus is th
e specific percentage of the wages or salaries paid to the workers and hence rem
ains unaffected by any changes, either upwards or downward, in the profits earne
d by the organisation. (b) Co-partnership : According to this method, the worker
s are granted ownership rights in the operations of the organisation by which th
e workers are in the position to control the affairs of the organisation. In cor
porate organisations, it may be in the form of offering the shares of the compan
y to the workers or granting of loans to the workers to buy companys shares, acco
rding to which the workers get the voting rights to control the affairs of the c
ompany. The workers get dividend on the shares as bonus. With the help of this m
ethod, the morale of the workers is increased. However, certain objections are r
aised against this method. First, the increase in earnings is too small. Second,
the shareholding of the workers is too small to control the affairs of the comp
any. Third, the workers are not rewarded according to the individual efficiency.
264
Management Accounting

(F)
Non-monetary Incentives :
The intention of these incentives is to attract better workers, retain the exist
ing workers, encourage loyalty, reduce labour turnover, provide better working c
onditions to workers and so on. Various benefits as stated below may be granted
to the workers, either free or at reduced rates, remaining amount being contribu
ted by the workers. (1) (2) (3) (4) (5) Health and safety services. Education an
d training to workers and their children. Canteen facility. Pension, superannuat
ion fund etc. Loans at reduced rate of interest.
IMPORTANT TERMS IN CASE OF LABOUR COST : (A) Labour Turnover :
In every business organisation, the process of employees leaving the organisatio
n and new workers being recruited is a normal feature. Labour Turnover indicates
this change in labour force showing a highly increasing trend or highly decreas
ing trend. Labour turnover showing sharp increasing trend may involve the reduct
ion in labour productivity and increasing costs. Too low a labour turnover trend
may be due to inefficient workers who would not like to leave the organisation.
Causes of labour turnover : The causes of labour turnover can be broadly classi
fied as below : (a) Avoidable causes : (1) (2) (3) (4) (5) (b) Dissatisfaction w
ith job. Dissatisfaction with remuneration. Dissatisfaction with working conditi
ons. Dissatisfaction with hours of work. Relationship with supervisors and worke
rs.
Unavoidable causes : (1) (2) (3) Betterment/Personal. Illness or accident. Move
from locality. 265
Labour Cost

(4) (5) (6) (7) (8)


Discharge. Marriage. Retirement. Death. National service.
Costs of labour turnover The cost of labour turnover may be classified under two
headings. (a) Preventive Costs : These refer to all the costs which may be incu
rred by the organisation to keep workers happy and discourage them from leaving
the job. This, in turn, may include the costs like : (1) (2) Cost of Personnel A
dministration - To maintain good relations with the workers. Cost of medical ser
vices- To keep the workers and their families in healthy condition, as healthy w
orkers are assets for the organisation who contribute towards higher efficiency
and productivity. Costs of welfare activities - To give facilities like transpor
t, canteen etc. Other incentive schemes like pension, provident fund, superannua
tion fund, Bonus etc.
(3) (4)
(b)
Replacement Costs : These refer to the costs incurred for recruitment and traini
ng of new workers and the resulting losses, wastages and reduced productivity du
e to the inefficiency and inexperience of new workers. This in its turn may incl
ude the costs like(1) (2) (3) (4) (5) (6) Inefficiency of new workers. Cost of s
election and placement. Training costs. Loss of output due to delay in getting n
ew workers Increased spoilage and defectives. Cost of tools and machine breakage
s.
266
Management Accounting

Measurement of labour turnover : There are three methods for measuring the labou
r turnover. (1) Separation Method Under this method, it is computed as : No. of
Separations in a period Average no. of workers (2) Replacement Method Under this
method, it is computed as No. of Replacements in a period Average no. of worker
s. (3) Flux Method Under this method, it is computed as No. of separations + No.
of replacement Average no. of workers Illustration : From the following data gi
ven by Personnel Department, calculate the labour turnover rate by applying : (a
) (b) (c) Separation Method Replacement Method Flux Method No. of workers on pay
-roll - At the beginning of the month - At the end of the month 900 1,100 X 100
X 100 X 100
During the month, 10 workers left, 40 persons were discharged and 150 workers we
re recruited. Of these 25 workers are recruited in the vacancies of those leavin
g while the rest were for an expansion scheme.
Labour Cost
267

Solution : Calculation of Labour Turnover (1) Separation Method No. of separatio


ns in a period Average No. of workers = 50 X 100 = 5 1000 X 100
Monthly Turnover Rate : 5% Annual Turnover Rate : 5 X (2) Replacement Method : N
o. of replacements in a period Average No. of workers = 25 1000 X 100 = 2.5% X 1
00 365 30 = 60.83%
Monthly turnover Rate : 2.5% 365 Annual Turnover Rate : 2.5 X 30 = 30.42%
(3)
Flux Method : No. of separations + No. of replacements Average No. of workers =
50 +25 1,000 Monthly Turnover Rate : 7.5% 365 Annual Turnover Rate : 7.5 X 30 =
91.25% = 100 = 7.5% X 100
268
Management Accounting

Working Notes : Average number of workers is calculated as No. of workers at beg


inning + No. of worker at end 2 = = (B) 900 + 1,100 2 1,000
Idle Time :
It indicates the time for which wages are paid to the workers but during which n
o production is obtained. To exercise proper control on idle time, causes of the
same should be analysed properly and studied from its controllability point of
view. The causes of idle time can be analysed as below : (a) Productive causes :
These can be further classified as : (i) (ii) Due to machine breakdown. Power f
ailures.
(iii) Waiting for tools, work or raw materials. (iv) Waiting for instructions.
These causes are supposed to be controllable causes and can be controlled if pla
nned properly. (b) Administrative causes : Some idle time may be caused due to a
dministrative decisions. E.g. the organisation is having excess machine capacity
or during the depression period, it is not having sufficient work to be perform
ed, but it has decided not to get rid of trained workers temporarily. As such co
st of idle time is accepted. (c) Economic causes : Economic causes may be of sea
sonal nature, cyclical nature or industrial nature. E.g. if the product manufact
ured is of a seasonal nature, for other periods of the year, the capacity may re
main unused, unless some other product to take care of slack season is introduce
d. In case it is not possible to make alternate use of such idle capacity, some
Labour Cost
269

idle time is unavoidable. In case of cyclical causes, the causes are similar to
seasonal fluctuations but these causes are beyond the control of management. Tre
atment of idle time cost : If Idle time payment is normal and controllable, it s
hould be classified as overheads. If it is possible to allocate the same to some
department, it should be allocated and absorbed in the production department co
st. If idle time is normal and uncontrollable, the labour rates should be suitab
ly modified. E.g. if time attended is 8 hours but time booked is only 7.5 hours
and labour cost is Rs. 1.5 per hour, the hourly labour rate should be computed a
s 8 hours X Rs. 1.5 7.5 hours If idle time payment is uncontrollable and abnorma
l, it should not be considered as a part of manufacturing cost but should be wri
tten off to Costing Profit and Loss Account. (C) Internal Control Problems in La
bour Cost : i.e. Rs. 1.60
In todays world, labour is one of the most important factors of production, and c
ontributing to a very great extent to the cost of production. As such, it will b
e the intention of every organisation to have proper control on the labour cost.
The implementation of various Internal Control Procedures indicate the followin
g of all those methods and procedures which ensures fluent and smooth running of
the operations of the organisation and also of achieving protection of assets,
prevention of errors and frauds, proper recording of information whenever necess
ary. The cost of labour may be high due to the various reasons stated below : (1
) (2) (3) (4) (5) (6) (7) Excess staffing - Having more staff than the requireme
nt. Lack of experienced and efficient personnel. Excessive remuneration pattern
- Settlement of the wage rates or piece rates on higher side which may not be ju
stified on the basis of efficiency of workers. Clerical errors or fraudulent pra
ctices taking place in the area of time keeping, computation of wages payable, p
rocedure for payment of wages to the workers etc. Idle time or unusual overtime
wages. Increase of spoilage due to lack of proper supervision and inspection. Hi
gh labour turnover.
After locating the reasons for increasing labour costs, attempts can be made to
keep the same in control after following various internal control measures as di
scussed below.
270
Management Accounting

(1)
To avoide the problem of excess staffing, the employment of the workers should b
e made only after the receipt of labour placement requisition from the concerned
department. After the receipt of this requisition, it should be seen, whether i
t is possible to meet the requirement of said department with the help of existi
ng staff only or at least by transferring the existing excess staff in other dep
artments. Before proceeding with the actual process of selection of the staff, c
are should be taken to decide in advance about the nature of work which may be a
ssigned to the individual employee. To ensure that correct personnel is employed
to work in the correct places, care should be taken to analyse the requirements
of the job and then to select the personnel which suits these requirements. Thi
s process may be in the form of job evaluation. Selection of the proper personnel
may not be enough. To train the selected personnel to extract maximum of their e
fficiency is equally necessary.
(2)
(3)
The problem of setting the excessive rate structure in the form of higher time r
ate or piece rates or bonus rates may be avoided by setting the standards in the
most scientific manner. For this purpose, the techniques like time and motion s
tudy, work study etc. may be implemented. To avoid the clerical errors or fraudu
lent practices in the areas of wage sheet preparation or wage payments, proper i
nternal check procedures may be implemented, so that the work of one person is p
roperly checked by another person. For this, following steps may be taken : (a)
Time recording clock should be installed, wherever possible. Proper supervision
is required to ensure that one person punches his own card only. The terms of re
muneration should be set and made known to the workers in very very clear terms.
Proper internal checks should be executed while preparing the wages sheets. Cas
hier should not be allowed to handle the wages sheets and the person preparing t
he sheets should not be allowed to prepare wage packets. Personnel officer/manag
er should check and authorize the wages sheets. The wages should be paid to work
ers after they are properly identified. The wages should not be paid to any othe
r person, unless proper authorization letter is produced in exceptional circumst
ances. Distribution of wages should be made in all the departments at a time so
as to avoid the possibility of one person being present at two places.
(4)
(b)
(c)
(d)
(e)
Labour Cost
271

(5)
Existence of idle time should be properly analyzed according to controllability.
The causes of controllable idle time should be attempted to be avoided. If it i
s necessary to work overtime, it should be properly authorized and should be pai
d and accounted for properly. Care should be taken to see that proper returns ar
e obtained for making overtime wages payment.
(6)
If the labour cost is higher due to spoilage of work which in turn may be due to
lack of proper supervision or inspection, it is a cost which can very will be c
ontrolled by having proper supervision or inspection. The causes of labour turno
ver should be analysed according to normality. All the avoidable causes of labou
r turnover should be paid proper attention. Higher trend of labour turnover adds
to the costs in two ways mainly. It reduces the labour productivity and at the
same time, increases the costs. If the workers have the grievances which are of
avoidable nature, say dissatisfaction with remuneration or other benefits or wor
king hours or working conditions or job itself or relations with the fellow work
ers or the supervisors, attempts can be made to avoid those causes of labour tur
nover.
(7)
ILLUSTRATIVE PROBLEMS (1) The standard hours for job X is 100 hours. The job can
be completed by A in 60 hours, by B in 70 hours and by C in 95 hours. The bonus
system applicable to the job is as follows : % of time saved to time allowed Sa
ving upto 10% Saving from 11% to 20% Saving from 21% to 40% Saving from 41% to 1
00% Bonus 10% of time saved 15% of time saved 20% of time saved 25% of time save
d.
Rate of pay per hour is Rs.1 Calculate the total earnings of each worker and als
o the rate of earnings per hour.
272
Management Accounting

Solution : A (1) (2) (3) (4) (5) Standard Hours Actual Hours Hours Saved % Hours
saved Applicable bonus rate (% of wages for time saved) (6) (7) Hourly Rate (Rs
.) Basic wages (Rs.) - 2 x 6 i.e. Actual Hours x Hourly rate (8) Wages for time
saved (Rs.) - 3 x 6 i.e. Hours Saved x Hourly Rate (9) Bonus (Rs.) - 8 x 5 i.e.
Wages for time saved x Bonus Rate (10) Total - (Rs.) 7+ 9 Note : It is assumed t
hat the amount of bonus is not decided on rates of bonus on cumulative basis. (2
) During one week X makes 200 units. He receives wages for a guaranteed 44 hours
per week at a rate of Rs. 1.50 per hour. Estimated time to produce one unit is
15 minutes. Time allowed is increased by 20% allowance on estimated time, under
incentive scheme. Calculate earnings as per : (i) (ii) Time rate Piece rate 8 68
6 76 0.5 95.5 40 30 5 60 70 95 20% 1 20% 1 10% 1 100 60 40 40% B 100 70 30 30%
C 100 95 5 5%
(iii) Rowan scheme (iv) Halsey scheme
Solution : (i) Time Rate : No. of Hours X Hourly Rate = 44 Hours x Rs. 1.50 = Rs
. 66
Labour Cost
273

(ii)
Piece Rate : Hourly Rate Units produced X Units per hour = 200 units X Rs. 1.50
4 units = Rs. 75
(iii) Rowan Scheme : Actual Hours X Hourly Rate + Time Saved Time Allowed 16 Hou
rs 60 Hrs X Actual Hours X Hourly rate
=
44 Hours x Rs. 1.50 +
X 44 Hours X Rs. 1.50
= =
Rs. 66 + Rs. 17.60 Rs. 83.60
(iv) Halsey Scheme : Actual Hours X Hourly Rate + 1/2 (Time Saved X Hourly Rate)
= = = 44 Hours X Rs. 1.50 + 1/2 (16 Hours X Rs. 1.50) Rs. 66 + Rs. 12 Rs. 78
Working Notes : For incentive scheme, time allowed is increased by 20% of estima
ted time Estimated time is 15 minutes per unit For incentive scheme, time allowe
d will be 15 minutes + 20% = 18 minutes Time allowed for 200 units will be 18 minutes X 60
minutes Actual time taken is 44 Hours. Hence, time saved will be 16 hours ( i.e
. 60 hours - 44 hours) 274
Management Accounting
200 units = 60 Hours

It is assumed that the allowance of 20% is available only in case of incentive s


ystems and not in case of time rate or piece rate systems. (3) In a factory unde
r bonus system, bonus hours are credited to the employee in the proportion of ti
me taken which time saved bears to time allowed. Jobs are carried forward from o
ne week to another. No overtime is worked and payment is made in full for all un
its worked on, including those subsequently rejected. From the following informa
tion, you are required to calculate for each employee. (1) (2) (3) Bonus hours a
nd amount of bonus earned. Total wages cost. Wage cost of each unit (good) produ
ced. A Rs. 5 2,500 2H 36M 52H 100 units B Rs. 8 2,200 3H 75H 40 units C Rs. 7.5
3,600 1H 30M 48H 400 units
Employee Basic wage rate per hour Units issued for production Time allowed for 1
00 units Time taken Rejections Solution :
The description of the bonus system indicates that it is Rowan system of incenti
ve payment. A (1) (2) (3) (4) (5) (6) (7) Time allowed for 100 units Units issue
d for production Time allowed for actual production Time taken Time saved i.e. 3
-4 Hourly basic wage rate (Rs.) Basic wages i.e. 4 x 6 (Rs.) Time taken x Hourly
rate (8) Bonus earned : (Rs.) Time X taken (9) rate Hourly X Time allowed 52 31
2 600 40 400 Time saved 260 600 360 156 min. 2,500 65 hours 52 hours 13 hours 5
B 180 min. 2,200 66 hours 75 hours 8 C 90 min. 3,600 54 hours 48 hours 6 hours 7
.5
Total wages i.e. 7 + 8 (Rs.)
Labour Cost
275

A (10) Rejections (units) (11) Good units i.e. 2-10 (12) Wages per good unit i.e
. 9/11 (4) 100 2,400 Re. 0.13
B 40 2,160 Re. 0.28
C 400 3,200 Re. 0.125
From the following particular, you are required to work out the earnings of a wo
rker under. (a) (b) (c) (d) Straight Piece Rate Differential Piece Rate Halsey P
remium Scheme (50% Sharing) Rowan Premium Scheme 48 Rs. 7.50 Rs. 3.00 20 minutes
120 pieces 150 pieces 80% of piece rate when output below normal and 120% of pi
ece rate when output above normal.
Weekly working hours Hourly wage rate Piece Rate per unit Normal time taken per
piece Normal output per week Actual output for the week Differential piece rate
Solution : (a) Straight Piece Rate : Actual output x piece rate per unit = = (b)
150 pieces x Rs. 3 Rs. 450
Differential Piece Rate : Actual output is more than normal output. Hence, piece
rate will be 120% of normal piece rate. Applicable piece rate 120% of Rs. 3 i.e
. Rs. 3.60 Wages = Actual output x Applicable piece rate per unit = 150 piece x
Rs.3.60 = Rs. 540
276
Management Accounting

(c)
Halsey Premium Scheme : Actual Hours X Hourly Rate + (Time Saved x Hourly Rate)
2 2 hours X Rs. 7.50 2
= = = (d)
48 hours X Rs. 7.50 + Rs. 360 + Rs. 15/2 Rs. 367.50
Rowan Premium Scheme : Actual Hours x Hourly Rate + Time Saved Time Allowed 2 ho
urs = = = 48 hours X Rs.7.5 + 50 hours Rs. 360 + Rs. 14.40 Rs. 374.40 X 48 hours
x Rs. 7.50 X Actual Hours X Hourly Rate
Note : Time saved is calculated as below : Normal time per piece Pieces per hour
Pieces produced Hours allowed for pieces produced i.e. 150/3 Actual hours taken
Hours saved (5) 48 2 20 minutes 3 150 50
In an engineering workshop, 15 persons work in a group. If the weekly production
of the group exceeds 120 units per hour (which is standard), each man gets a bo
nus in addition to his hourly earnings. Bonus regulation - Each workers share sho
uld be 1/2 of the percentage in excess of standard production. The bonus shall b
e payable at this percentage of wage rate Rs.1.50 per hour. There is no relation
ship between individual workers hourly rate and bonus rate.
Labour Cost
277

The following is a weekly output : Day Monday Tuesday Wednesday Thursday Friday
Saturday Hours worked 150 160 145 155 170 160 940 Compute a. b. The rate and amo
unt of bonus for the week. Total earnings of David who worked 40 hours during th
e week and his basic wage was Rs. 1.20 per hour and that of Abdulla who worked f
or 48 hours and his basic wage was Rs. 1.25 per hour. Output in units 24,700 25,
500 17,060 18,050 28,900 21,150 1,35,360
Solution : (a) Actual Production for the week Standard production i.e. 940 x 120
Excess Production 22,560 Excess production percentage = 1,12,800 Bonus percenta
ge for the group = 1/2 of 20% = 10% Bonus Rate : 10% of Rs. 1.50 = Re. 0.15 per
hour X 100 = 20% 1,35,360 units 1,12,800 units 22,560 units
278
Management Accounting

(b)
(1) Total Earnings of David : Basic wages - 40 hours x Rs. 1.20 hours Bonus - 40
hours x Re. 0.15/hour Rs. 48.00 Rs. 6.00 Rs. 54.00
(2)
Total Earnings of Abdulla : Basic wages - 48 hours x Rs. 1.25/hour Bonus - 48 ho
urs x Rs. 0.15/hour Rs. 60.00 Rs. 7.20 Rs. 67.20
(6)
Two fitters, a labourer and a boy, undertake a job on piece rate basis for Rs. 1
,290. The time spent by each of them is 220 ordinary working hours. The rates of
pay on time rate basis are Rs. 1.50 per hour for each of the two fitters. Re. 1
per hour for the labourer and Re. 0.50 per hour for the boy. Calculate : (a) Th
e amount of piece-work premium and the share of each worker, when the piece work
premium is divided proportionately to the wages paid. The selling price of the
above job on the basis of following data - Cost of Direct Materials is Rs. 2,010
, works overhead at 20% of Prime Cost, selling overhead at 10% of works cost and
Profit at 25% of cost of sales.
(b)
Solution : (A) (1) wages payable on time basis Fitter Labourer Boy Basic Wages (
2) (3) (4) Price of the job Premium received i.e. b - a Share of each worker Fit
ters Rs. 300 Rs. 990 X Rs. 660 Rs. 200.00 220 hrs. x 2 x Rs. 1.50 220 hrs. x Re.
1 220 hrs. x Re. 0.50 = Rs. 660 = Rs. 220 = Rs. 110 = Rs. 990 Rs. 1,290 Rs. 300
Labour Cost
279

Labourer
Rs. 300 Rs. 990 Rs. 300 Rs. 990
X
Rs. 220
- Rs. 66.67
Boy
X
Rs. 110
- Rs. 33.33 Rs. 300.00
(b)
Fixation of selling price : Cost of Direct Material Cost of Labour Prime Cost Wo
rks Overheads (20% of Prime Cost) Works Cost Selling Overheads (10% of works cos
t) Cost of Sales Profit (25% on cost of sale) Selling Price Rs. 396.00 Rs. 4,356
.00 Rs. 1,089.00 Rs. 5,445.00 Rs. 660.00 Rs. 3,960.00 Rs. 2,010.00 Rs. 1,290.00
Rs. 3,300.00
(7)
A worker, whose daily work wages is Rs. 2.50 an hour, received production bonus
under the Rowan scheme. He carried out the following works in a 48 hours week. J
ob 1 Job 2 Job 3 Job 4 1,500 items at 4 hours per 1000 1,800 items at 3 hours pe
r 1000 9,000 items at 6 hours per 1000 1,500 items for which no Standard time was
fixed and it was arranged that the worker would be paid a bonus of 25%. Actual t
ime taken on the job was 4 hours. 2,000 items at 8 hours per 1000, each item was
estimated to be half finished.
Job 5
Job No. 2 was carried out on a machine running at 90% efficiency and an extra al
lowance of 1/9th of actual time was given to compensate the worker.
280
Management Accounting

4 hours were lost due to power cut. Calculate the earnings of


y stating your assumptions for the treatment given by you for
to power cut. Solution : (a) Calculation of time allowed Job
4 Job 5 6 hours 6 hours 54 hours 5 hours 8 hours 79 hours (b)
idle time) (c) (d) Time saved 35 hours 44 hours

the worker, clearl


the hours last due
1 Job 2 Job 3 Job
Time taken (Except

Total wages (As per Rowan system) Time saved Time taken X Hourly rate + Time all
owed 35 hours 79 hours X Time taken X Hourly Rate
=
44 hours X Rs. 2.50 +
X 44 hours X Rs. 2.50
= = (e)
Rs. 110 + Rs. 48.73 Rs. 158.73
Idle time wages (At hourly rate) 4 hours X Rs. 2.50 = Rs. 10
(f)
Total earnings - i.e. d + e Rs.158.73 + Rs. 10.00 = Rs.168.73
Labour Cost
281

Note : (1) The idle time is not treated for computing time taken. For idle hours
, the worker will get the wages at normal hourly rate. Time allowed for Job 2, J
ob 4 and Job 5 is calculated as below : (a) Job 2 : Time taken for 1,800 units A
dd :Extra allowance 1/9 Time allowed (b) Job 4 : Time taken for 1500 units Add :
Allowance @ 25 Time allowed (c) Job 5 : Time taken for 2000 Each item half fini
shed Equivalent finished units Time for equivalent finished units QUESTIONS 1. E
xplain the various steps in the process of identifying the direct labour cost wi
th the individual cost center. What do you mean by idle time. Explain in details
the cost accounting treatment of idle time. Explain the term Labour Turnover. Wha
t are the causes responsible for labour turnover? Explain the costs of labour tu
rnover. How the Labour turnover is measured? 1,000 8 hours 16 hours 4 hours 1 ho
ur 5 hours 5.40 hour 0.60 hour 0.60 hour
(2)
2.
3.
282
Management Accounting

PROBLEMS (1) During the first week of March, 1984 the workman Mr. Saurabh manufa
ctured 300 articles. He receives wage for a guaranteed 48 hours week at the rate
of Rs. 4/- per hour. The estimated time to produce one article is 10 minutes an
d under incentive scheme the time allowed is increased by 20%. Calculate his gro
ss wages according to : (a) (b) (c) Piece work with guaranteed weekly wage. Rowa
n premium bonus and Halsey premium bonus 50% to workman.
(2)
Calculate total monthly remuneration of three workers A, B and C from the follow
ing data. (a) (b) Standard production per month per worker 1,000 units. Actual p
roduction during the month A - 850 units, B - 750 units, C - 950 units. (c) (d)
Piece rate is Re. 0.10 per unit. Additional production bonus is Rs. 10 for each
percentage of actual production exceeding 80% over standard. (Example 79% Nil, 8
0% - Rs. 10, 81% - Rs. 20 and so on) (e) Dearness allowance fixed Rs. 60 per mon
th.
(3)
Following are the particulars as regards a worker who worked on jobs No. 122 and
133. Job No. 122 133 Time allowed 26 hours 26 hours Time taken 20 hours 30 hour
s
His normal and basic rate of wages was Rs. 28 per day of 8 hours and the dearnes
s allowance was Rs. 42 per week of 48 hours. Calculate the amount payable to him
by showing your workings on the following basis. (a) (b) (c) Time basis. Halsey
Incentive Plan basis (Bonus at 50% of time saved) Rowan Incentive Plan basis.
Labour Cost
283

(4)
Standard time fixed for a job is 40 hours and time rate is Rs. 4 per hour. You a
re required to prepare a comparative table under Halsey Plan 50 - 50 and Rowan P
lan, if actual time taken is 36 hours, 32 hours, 24 hours, 16 hours and 12 hours
. The table should clearly show (a) Bonus payable, (b) Total earnings, (c) Effec
tive rate of earnings per hour.
(5)
Calculate the earnings of a workman under Halsey Premium Plan and Rowan Premium
Plan for executing a piece of work in 60 hours as against 75 hours allowed. His
hourly rate is 25 paise and under Halsey system, he is to be paid bonus at 50% o
f time saved. In addition, he gets a dearness allowance for Re. 1 per day of 8 h
ours worked.
(6)
From the following information, calculate the earnings of A, B and C under Halse
y and Rowan premium bonus plans. A Standard time in hours per 100 units Wages pe
r unit of output Wage rate per hour Actual hours taken Actual no. of units produ
ced 35 Rs. 2 Rs. 7 50 200 B 40 Rs. 3 Rs. 8 48 150 C 42 Rs. 4 Rs. 10 46 125
(7)
The firm employs
orked for 4 days
ch standard time
he Halsey Method

5 workers at an hourly rate of Rs. 2.00. During the week they w


for a total period of 40 hours each and completed a job for whi
was 48 hours for each worker. Calculate the labour cost under t
and Rowan Method of incentive Plan Payments.

(8)
Compute the total time wages and total earnings of a worker, the rate earned per
hour and the bonus per hour in respect of three workers X,Y, and Z under the Ha
lsey-Weir bonus plans. The following are the particulars supplied. Standard Time
Hourly Rate of Wages : 20 hours. : Re. 1.00 per hour.
Time Taken X = 16 hours, Y = 12 hours and Z = 10 hours.
284
Management Accounting

(9)
The three workers Govind, Ram and Shyam produced 80, 100 and 120 pieces of a pro
duct X on a particular day in May 1987 in a factory. The time allowed for 10 uni
ts of Product X is 1 hour and their hourly rate is Rs. 4. Calculate for each of
these three workers the following : (a) (b) Earnings for the day Effective rate
of earnings per hour under (i) (ii) (iii) Straight piece Rate Halsey Premium Bon
us (50% sharing) Rowan Premium Bonus methods of Labour Remuneration
(10) A worker takes 6 hours to complete a job under a scheme of payment by resul
ts. The standard time allowed for the job is 9 hours. His wage rate is Rs. 1.50
per hour. Material cost of the job is Rs. 16 and the overheads are recovered at
150% of the total direct wages. Calculate the factory cost of the job under - (a
) Rowan and (b) Halsey scheme of incentive payments.
(11) In an engineering concern, the employees are paid incentive bonus in additi
on to their normal wages at hourly rates. Incentive bonus is calculated in propo
rtion of time taken to time allowed, of the time saved. The following details ar
e made available in respect of employees X, Y and Z for a particular week. X Nor
mal Wages (Rs. per hour) Completed units of production Time Allowed (per 100 uni
ts) Actual time taken (hours) You are required to work out for each employee (a)
The amount of bonus earned. (b) The total amount of wages received. (c) The tot
al wages cost per 100 units of output. 4.00 6000 0.8 hr. 42 Y 5.00 3000 1.5 hrs.
40 Z 6.00 4800 1 hr. 48
Labour Cost
285

(12) A workman whose basic rate of pay under Rowan plan of premium bonus is Rs.
2 per hour. In addition, he receives a cost of living bonus of Rs. 33 per week o
f 66 hours on actual hours worked. During a week, he does the following jobs. (i
) Job A for which 30 hours are allowed in 20 hours. (ii) Job B for which 36 hour
s are allowed in 20 hours. During this week, his waiting time was 4 hours. Calcu
late his earnings and amount to be charged to each job.
(13) An operator engaged on a machine, receives an ordinary day rate of Rs. 1.60
per day of 8 hours. The standard output has been fixed at 80 pieces per hour (t
ime as fixed for premium bonus.) On a certain day, the output of a worker on thi
s machine is 800 pieces. Find the labour cost per 100 pieces and the wages that
should have been actually earned by the workman under the following (a) If a bon
us of Re. 0.23 is paid per 100 of extra output. (b) If paid on straight piece wo
rk basis at the standard rate. (c) If Halsey Premium System is adopted.
(14) In a manufacturing concern, 20 workmen work in a group. The concern follows
a group incentive bonus system whereby each workman belonging to the group is p
aid a bonus on the excess output over the hourly production standard of 250 piec
es, in addition to his normal wages at hourly rate. The excess of production ove
r the standard is expressed as a percentage and two thirds of this percentage is
considered to be the share of the workman and is applied to the normal hourly r
ate of Rs. 6.00 (Considered only for purpose of computation of bonus.) The outpu
t data for a week are stated below. Days Monday Tuesday Wednesday Thursday Frida
y Saturday Manhours worked 160 172 164 168 160 160 984 Output (in pieces) 48,000
53,000 40,000 52,000 46,000 42,000 2,81,000
286
Management Accounting

You are required to (a) Work out the amount of bonus for the week and the averag
e rate of which each workman is to be paid the same. Compute the total wages inc
luding bonus payable to Ram Jadhav who worked for 48 hours at an hourly rate of
Rs. 2.50 and to Francis Williams who worked for 52 hours at an hourly rate of Rs
. 3.00.
(b)
(15) Following data for the month of October 1990 is available for a company. No
. of workers on payroll on 1st October, 90 - 1450 No. of workers on payroll on 3
1st October 90 - 1550 During the month 10 workers left the company, 70 persons w
ere discharged and 200 workers were recruited. Of these workers, 40 workers were
recruited in the vacancies of those who had left and the remaining were recruit
ed for an expansion programme. Calculate the labour turnover rate by using (i) (
ii) Separation Method Replacement Method
(iii) Flux Melhod
Labour Cost
287

NOTES
288
Management Accounting

Chapter 1 0
OVERHEAD COST
It has already been discussed that the term cost can be basically classified as
Direct Cost and Indirect Cost. Direct Cost indicates all those costs which can b
e identified with the individual cost centre and indirect cost indicates all tho
se costs which cannot be identified with the individual cost centre. The total o
f indirect costs are termed as overheads. There may be various ways in which the
overheads may be classified. (1) Elementwise Classification : As the cost can b
e basically classified as per the Elements of Cost i.e. Material Cost, Labour Co
st and Expenses, the indirect cost i.e. overheads may be classified as per the e
lements of cost. This classification of overheads takes the form of : (a) (b) (c
) Indirect Material Indirect Labour Indirect Expenses.
The meaning and the type of expenses included in this classification have alread
y been discussed in the chapter on Cost Sheet. (2) Functionwise Classification :
Under this classification, the overheads are classified according to the functi
ons they perform. This classification of overheads takes the form of : (a) (b) (
c) Factory Overheads (also termed as production or works or manufacturing overhe
ads) Administration Overheads. Selling and Distribution Overheads.The meaning an
d the type of expenses included in this classification have already been discuss
ed in the chapter on Cost Sheet.
(3)
Variabilitywise Classification : (i) Fixed overheads : These overheads indicate
the costs which remain unaffected by variations in volume of output. E.g. Rent,
Insurance on building, salary to
Overhead Cost
289

administrative staff etc. Per unit cost of overheads may reduce as the volume of
output increases but the total overheads remain constant. (ii) Variable overhea
ds : These overheads indicate the costs which vary directly in proportion to vol
ume of output. E.g. Consumable stores, nuts/bolts, loose tools etc. Per unit cos
t of overheads remains the same but total overheads may increase or decrease as
per volume of output.
(iii) Semi-variable overheads : These overheads indicate those which are neither
fixed nor variable in nature. These may remain fixed at certain levels of activ
ity while may vary proportionately at other levels of activity. E.g. maintenance
cost, power, electricity, supervision cost etc. (4) Controllabilitywise Classif
ication : Under this classification, the overheads are classified according to t
heir controllable nature. This classification takes the form of : (a) (b) (5) Co
ntrollable overheads. Uncontrollable overheads.This classification has already b
een discussed.
Normalitywise Classification : Under this classification, the overheads are clas
sified according to the fact as to whether the overheads are normally incurred a
t a certain level of output under normal circumstances. This classification take
s the form of : (a) (b) Normal overheads. Abnormal overheads.
This classification has already been discussed. It should be noted in this conne
ction, that the above classification refers to the classification of same amount
of overheads in different forms to suit the individual requirements. E.g. For t
he purpose of preparing the cost statement, overheads may be classified accordin
g to functions while for the purpose of marginal costing applications, overheads
may be classified according to variability. Procedure for Charging the Overhead
s : The basic aim of costing is to find out the cost of each cost centre. The co
st of each cost centre can be either the direct cost or the indirect cost. The d
irect cost can be identified with the individual cost centre and hence poses no
difficulties. To charge the indirect costs i.e. overheads to the individual cost
centres is the major problem. For this, the following procedure may be followed
.
290
Management Accounting

(A)
Allocation/Primary Apportionment :
There can be some overheads which are incurred for the company as a whole, i.e.
for all the departments. i.e. Production as well as Service departments. To iden
tify the common costs with the individual departments is the first stage problem
. This can be solved in two ways. (1) If at all it is possible to identify some
overheads with the individual departments they should be identified by following
the procedure of allocation of overheads. E.g. Wages paid to the maintenance de
partment workers can be obtained from wages sheet and can be allocated to mainte
nance department. Similarly, cost of indirect material can be allocated to indiv
idual departments by pricing material requisition slips. (2) It may not be possi
ble in all the cases to allocate the overheads, i.e. in case of common expenses
for the entire factory. In this case, they can be apportioned among the various
departments on some suitable basis, i.e. to all production as well as service de
partments. This process is in the form of Primary apportionment or distribution
of overheads. The selection of the base on which overheads are or should be appo
rtioned depends on the following principles : (a) Service or use basis : If the
benefit obtained by various departments from the overheads can be measured, over
heads can be apportioned on that basis. Survey basis : If amount of services ren
dered cant be measured, survey basis may be applied. E.g. If it can be noted that
a supervisor is giving 60% of his services to department A and 40 % to department
B, his wages can be apportioned on that basis. Ability to pay basis : In this cas
e, the apportionment may depend upon the factors like total sales/profitability.
It may not be fair in some cases as most efficient departments may have to bear
higher amounts of overheads, though actual overheads of that department may be
lower than those of other departments.
(b)
(c)
The usual bases which can
: Item of expenditure (1)
Rent/Taxes Power General
rs. Area HP/KWh Number of
wages paid
Overhead Cost
291

be selected for Primary Apportionment may be as below


(2) (3) (4) (5) (6) Canteen expenses/Staff Supervision
Lighting Depreciation Supervision Base Number of worke
light points/area Value of assets Number of Employees/

(7) (8)
Telephone expenses Fire Insurance.
Number of telephone calls made Value of stocks held/value of Assets.
Illustration : The Omega Co, is having four departments. A, B, and C are product
ion departments and D is a servicing department. The actual costs for a period a
re as follows. Rs. Rent Repairs Depreciation Light Supervision Insurance Employe
es Insurance (Employers liability) Power 2,000 1,200 900 200 3,000 1,000 300 1,80
0
The following data are also available in respect of departments. Dept. A Area sq
. ft. Number of workers Total wages (Rs.) Value of plant (Rs.) Value of stock (R
s.) 150 24 8,000 24,000 15,000 Dept. B 110 16 6,000 18,000 9,000 Dept. C 90 12 4
,000 12,000 6,000 Dept. D 50 8 2,000 6,000
Apportion the cost to the various departments on the most equitable method.
292
Management Accounting

Solution : Apportionment of Overheads Particulars Base Total Rs. Dept. A Rs. 750
480 360 75 1,200 500 120 720 4,205 Dept. B Rs. 550 360 270 55 800 300 80 540 2,
955 Dept. C Rs. 450 240 180 45 600 200 60 360 2,135 Dept. D Rs. 250 120 90 25 40
0 40 180 1,105
Rent Repairs Depreciation Light Supervision Insurance Employees Insurance (Employ
ers Liabilities) Power
Area sq. ft. Total wages Value of Plant Area sq. ft. No. of workers Value of sto
ck No. of workers Value of Plant
2,000 1,200 900 200 3,000 1,000 300 1,800 10,400
Notes : It is assumed that the insurance is payable only on stock. Had it been a
ssumed that it is payable on stock as well as plant, the base would have been th
e combined value of stock and plant. For the apportionment of power cost, Kwh/HP
rating would have been an ideal base. As relevant data is not available, it is
apportioned on the basis of value of plant. Repairs are apportioned on the basis
of total wages assuming that repair charges consist of mainly labour charges. (
3) Secondary Apportionment : With the process of primary apportionment or distri
bution, the loading of overheads for all the departments i.e. production as well
as service departments can be obtained. Next step is to transfer the overheads
of non-production departments to production departments, as the various cost cen
tres move through the production departments only. This is in the form of Seconda
ry apportionment or distribution of overheads.
Overhead Cost
293

The usual bases which can be selected for the secondary apportionment may be as
below : (1) (2) (3) (4) (5) (6) (7) Maintenance Dept. - Number of hours worked.
Stores Dept. - Number of requisitions. Purchase Dept. - Number of Purchase order
s Building Service Dept. - Area Welfare/ Canteen and other facilities - Number o
f employees. Personnel or Time keeping Dept. - Number of employees. Internal Tra
nsport - Weight/value of goods moved.
While apportioning the overheads of non-production departments to production dep
artments, the problem will be there if non-production departments are rendering
the services inter-se. There can be two ways to handle the situation like this (
A) Ignore the services given by one service department to another. The defects i
nvolved with this method are very obvious. Illustration : Following figures are
extracted from the accounts of M/s. Vasant Works for the month of July 1983. Pro
duction Depts. P1 P2 Indirect Material Indirect Wages Power and Light Supervisio
n Charges Rent and Taxes Insurance on assets Rs. 3,000 Rs. 2,200 Rs. Rs. 500 60
280 324 140 312 Service Depts. S1 S2 S3 170 296 350 160 190 218
Depreciation at 12% p.a. on capital value of assets to be considered. From the a
bove information and the following departmental data, prepare overhead recovery
rates for the production departments PI and P2 on the basis of direct labour hou
rs. The expenses of service departments should be apportioned straight to the pr
oduction depts. with the information that SI is tool room, S2 is maintenance dep
t. and S3 is stores dept.
294
Management Accounting

Departmental Data : Area (sq. ft.) Capital Value of Assets (Ps.) Kilowatt Hours
Number of employees Direct Labour Hours Number of requisitions
P1 400 8000 4000 150 5000 1000
P2 200 4000 3000 100 5000 300
S1 100 7000 1000 75
S2 200 5000 1000 100
S3 100 6000 1000 125
Solution : Statement showing apportionment of overheads Items Base P1 Rs. 280 32
4 1200 600 200 16 80 2700 Dept. S1 Dept. S2 Dept. S3 Labour Hours Labour Hours N
o. of requisitions 600 700 1000 5,000 P2 Rs. 140 312 900 400 100 8 40 1900 600 7
00 300 3,500 S1 Rs. 170 296 300 300 50 14 70 1200 (-)1200 (-)1400 (-)1300 S2 Rs.
350 190 300 400 100 10 50 1400 S3 Rs. 160 218 300 500 50 12 60 1300
Indirect Material Indirect wages Power & Light Supervision Rent & Taxes Insuranc
e on Assets Depreciation
Allocation Allocation Kilowatt Hrs No. of employees Area Value of assets Value o
f assets
(B) If it is decided to consider the services rendered by one service department
to another, the first problem will be to decide the percentage in which service
s are given by service departments inter-se. After such percentage is decided, t
he secondary apportionment can be made by either of the following methods. (i) S
imultaneous Equation Method : Under this method the amount of overheads of each
production department can be obtained by solving simultaneous equations.
Overhead Cost
295

(ii)
Repeated Distribution Method : Under this method service dept. overheads are dis
tributed to other departments, production as well as service, on agreed percenta
ge and this process is repeated till the figures of service departments are exha
usted or are too small to consider further apportionment.
Illustration : A company has 3 production depts. and 2 service depts. and for a
period departmental distribution summary has the following totals. Production De
pts. Service Depts. A ..Rs. 800 1 ....Rs. 234 B Rs. 700 2.. Rs. 300 C. Rs. 500
The expenses of service depts. are charged out on a percentage basis as : A Serv
ice Dept. 1 Service Dept. 2 20% 40% B 40% 20% C 30% 20% 1 20% 2 10%
You are required to show the apportionment of overheads. Solution : (a) Simultan
eous Equation Method : Let x y x = = = = = total overheads of Dept. 1 total over
heads of Dept. 2 234+ 2/10 y 300 1/10 x 2340 + 2y 3000 + x ...(1) ...(2)
and y 10 x
and 10 y =
Rearranging equation 2 and multiplying equation I by 5 10y = 11700 - 50x 3000 +
x 14700 49x 14700 300 300 + 1/10 x 300 + 1/10 x 300 330 ...(4) ...(3)
10y = Adding 0 = 49 x x = =
However, Y = Y Y = =
296
Management Accounting

Total overheads can be apportioned on the basis of agreed percentages to product


ion departments as below. Total Rs. As per Primary appointment Dept. 1 (90% of R
s. 300) Dept. 2 (80% of Rs. 330) 2,000 270 264 2534 (b) Repeated Distribution Me
thod : Dept. A Rs. As per Primary appointment Dept. 1 Dept. 2 Dept. 1 Dept. 2 80
0 47 129 13 3 992 (3) Absorption : The process of secondary apportionment of ove
rheads, ensures the loading of overheads to production departments. Now the next
stage is that each job or product should get the loading of the overheads while
it is moving through the production department and this process is in the form
of Absorption or Recovery of overheads. There can be a number of methods for abs
orbing the overheads but the ultimate selection of method has to be made after c
onsidering various factors like type of industry, nature of products, manufactur
ing process, requirements and policy of management, cost of operating the system
etc. The various methods which can be considered for deciding the rates of over
head absorption are as below : (1) Direct Materials Cost Percentage Rate : This
is calculated as : Amount of overheads to be absorbed Direct Materials cost X 10
0 Dept. B Rs. 700 94 65 26 1 886 Dept. C Rs. 500 70 64 20 2 656 Dept. 1 Rs. 234
(-) 234 65 (-) 65 Dept. 2 Rs. 300 23 (-) 323 6 (-) 6 Dept. A Rs. 800 60 132 992
Dept. B Rs. 700 120 66 886 Dept. C Rs. 500 90 66 656
Overhead Cost
297

E.g. If production overheads to be absorbed are Rs. 25,000/and Direct materials


cost is Rs. 50,000, the absorption rate will be : 25,000 50,000 X 100 i.e. 50%
Now if the direct materials cost of a job is Rs. 500, it will be getting the loa
ding of overheads to the extent of 50% of direct materials cost, i.e. Rs. 250. T
his method is useful if materials cost forms a major part of production cost and
is normally used if materials costs are stable and equipments used remain uncha
nged. This method leads to unsatisfactory results due to following reasons. (i)
There can be some situations where material prices vary without any change in th
e amount of over heads, in which case, this method may show wrong results. If th
is method is used, a job using expensive material may get high loading of overhe
ads as compared to a job using cheap material, which may not be fair.
(ii)
(2)
Direct Wages Percentage Rate : This is calculated as : Amount of overheads to be
absorbed Direct wages cost X 100
E.g. If the production overheads to be absorbed are Rs. 10,000 and direct wages
cost is Rs. 40,000, the absorption rate will be : 10,000 40,000 Now if the direc
t wages cost of a job is Rs. 400, it will be getting the loading of overheads to
the extent of 25% of direct wages cost, i.e. Rs. 100. This method is useful if
labour cost forms a major part of production cost and also if the work performed
by all the workers is uniform, ratio of skilled and unskilled workers is consta
nt and labour rates do not fluctuate widely. The problem with this method is tha
t there is very little relationship between direct wages and overhead expenses.
It may give wrong results if the workers vary in ability. X 100 i.e. 25%
298
Management Accounting

(3)
Prime Cost Percentage Rate : This is calculated as : Amount of overheads to be a
bsorbed Prime Cost E.g. if the production overheads to be absorbed are Rs. 16,00
0 and prime cost is Rs. 80,000, the absorption rate will be : 16,000 80,000 Now
if the prime cost of a job is Rs. 250, it will be getting the loading of overhea
ds to the extent of 20% of prime cost, i.e. Rs. 50. This method is useful in thi
s sense that it considers both the materials cost as well as labour cost. X 100
i.e. 20% X 100
(4)
Labour Hour Rate : This is calculated as : Amount of overheads to be absorbed La
bour hours required for production. E.g. if production overheads to be absorbed
are Rs. 50,000 and labour hours worked are 100,000, the absorption rate will be
: Rs. 50,000 100,000 Now, if a job requires 20 labour hours to complete it, the
loading of overheads to the same will be Re. 0.50 per labour hour i.e. Rs. 10/-.
This method is useful if labour is the most important element of cost. However,
additional records are required to be kept for time booking per job. Further, i
f machinery forms a dominant portion in production cost, this method may lead to
wrong results. i.e. Re. 0.50 per labour hour.
Overhead Cost
299

(5)
Machine Hour Rate : This is calculated as : Amount of overheads to be absorbed N
umber of Machine Hours E.g. if production overheads to be absorbed are Rs. 20,00
0 and machine hours worked as 5000, the absorption rate will be Rs, 20,000 5,000
i. e. Rs. 4 per machine hour.
Now if a job requires 25 machine hours to complete, the loading of overheads to
the same will be Rs. 4 per machine hour, i.e. Rs. 100. If the machine use accoun
ts for a large element of cost in the overall production cost, then this method
can be used conveniently. This rate can be considered to be useful and ideal esp
ecially in the days of high mechanisation and automation. While computing the ma
chine hour rate, it is necessary to consider the various overheads required to b
e incurred for running a machine or group of machines treating the same as disti
nct cost centres. Illustration : Following information relates to activities of
a production dept. of a factory for a certain period. Direct Materials used Dire
ct wages Direct Labour hours worked (Including 20,000 hrs. of Machine operations
) Overheads chargeable to the dept. For order No. 156 carried out in dept. relev
ant figures were. Direct Materials used Direct wages Direct labour hours (Includ
ing 800 machine hours) Calculate the overheads chargeable to Order No. 156 by 5
cost rates. 820 Rs. 200 Rs. 165 24,000 Rs. 5,000 Rs. 4,000 Rs. 6,000
300
Management Accounting

Solution : Calculation of overhead absorption rate (a) Direct Material Cost perc
entage : Amount of overheads Direct Material Cost = (b) Rs. 5,000 Rs. 4,000 X 10
0
X 100 = 125%
Direct Labour Cost percentage : Amount of overheads Direct Labour Cost Rs. 5,000
= Rs. 6,000 X 100 X 100 = 83 1/3%
(c)
Prime Cost percentage : Amount of overheads Prime Cost = Rs. 5,000 Rs. 10,000 X
100 = 50% X 100
(d)
Labour Hour Rate : Amount of overheads Direct Labour Hours = Rs. 5,000 24,000 =
Re. 0. 2083 / Labour Hour.
(e)
Machine Hour Rate Amount of overheads Machine Hours = Rs. 5,000 20,000 = Rs 0.25
/ Machine Hour.
Overhead Cost
301

The overheads chargeable to Order No. 156 and the total cost of the same can be
calculated as below : Material Rs. (a) (b) Direct Material Cost percentage Direc
t Labour Cost percentage (c) (d) (e) Prime Cost percentage Labour Hour Rate Mach
ine Hour Rate 200.00 200.00 200.00 200.00 165.00 165.00 165.00 165.00 137.50 182
.50 170.83 200.00 502.50 547.50 535.83 565.00 200.00 165.00 250.00 615.00 Labour
Rs. Overheads Rs. Total Rs.
Illustration : Compute the machine hour rate from the following data. Cost of th
e machine Installation charges Estimated scrap value after the expiry of life (1
5 years) Rent and Rates for the shop per month General lighting for the shop per
month Insurance charges for the machine per annum Repairs and Maintenance expen
ses per month Power consumption 10 Units per hour. Estimated working hours per a
nnum 2,200 (This includes setting up time of 200 hours) Rate of power per 100 Un
its Shop supervisors salary per month Rs. Rs. 20 600 Rs. 1,00,000 Rs. Rs. Rs. Rs.
Rs. Rs. 10,000 5,000 200 300 960 1,000
The machine occupies 1/4 of the total area of the shop. The supervisor is expect
ed to devote 1/5 of the total time for the supervision of the machine.
302
Management Accounting

Calculation of Machine Hour Rate : (a) Standing Charges Depreciation Rent and Ra
tes General lighting Insurance Charges Repairs and Maintenance Shop Supervisors s
alary Annual standing charges Annual Machine Hours (Excluding setting up time) H
ourly standing charges (b) Running charges : Power Expenses Rate of power 20 pai
se per unit. Power consumption - 10 units per hour. Hourly power expenses (c) Ma
chine Hour Rate i.e. a + b Rs. 2.00 Rs. 13.45 Rs. 7,000.00 600.00 900.00 960.00
12,000.00 1,440.00 22,900.00 2000 Rs. 11.45
Working Notes : (1) It is assumed that during the setting up time, the machine w
ill not be used for the intended purpose and hence the said time is ignored for
the calculation of machine hour rate. It is assumed that the depreciation is cha
rged on straight-line basis. Hence, it is calculated as : Cost of Machine + Inst
allation charges Estimated scrap value Estimated life of machine = (3) Rs. 100,0
00 + Rs. 10,000 Rs 5000 15 years = Rs. 7,000 p.a.
(2)
It is assumed that the Repairs and Maintenance expenses are incurred only for th
e machine.
Overhead Cost
303

Actual V/s. Predetermined Overhead Absorption Rates The overhead absorption rate
s can be considered on actual basis or predetermined basis. For computing the ab
sorption rates on actual basis, the actual data for the previous period is consi
dered, i. e. Actual overheads, actual direct materials/wages cost, actual prime
cost, actual labour hours worked, actual machine hours worked etc. However, the
actual overhead absorption rates have certain limitations. (1) The actual detail
s are available only after the end of actual accounting period and required deta
ils may not be available either for proper control of overheads or for price fix
ation. If the production is of seasonal nature, overhead absorption rates will n
ot be constant monthwise and comparison of production costs monthwise will be di
fficult.
(2)
As such, it is customary to consider predetermined overheads absorption rates in
stead of actual overhead absorption rates. By predetermined rates it is meant th
at instead of considering actual data in respect of Direct Materials/Wages/Prime
Cost or Labour/Machine Hours, estimations are made in respect of the same and p
redetermined overhead absorption rate is applied whenever computations are to be
made in respect of product cost of a job. Under Absorption or Over Absorption o
f Overheads If the organization follows the policy of considering predetermined
overhead absorption rates, it may face the problem of under or over absorption o
f overheads if the actual overheads to be absorbed or the bases for the absorpti
on, i.e. Materials/ Wages/ Prime cost or Labour/Machine Hours etc. vary from the
assumption. E.g. A Company considers the overhead absorption rate as a direct m
aterials cost percentage rate. It is decided that predetermined overhead absorpt
ion rate should be considered for the forthcoming year 1989. As such, the predet
ermined overhead rate was estimated on the basis of following details. i.e. Esti
mated amount of overheads Estimated Direct Materials cost i.e. Rs. 10,000 Rs. 50
,000 X 100 i.e. 20% X 100
Now, on this basis all the jobs moving through that department during 1989 will
be getting the loading of overheads @ 20% of Direct Materials Costs. After the y
ear 1989 ended, the actual details are computed and it is found out that whereas
Direct Materials cost was as estimated, i.e. Rs. 50,000, the actual amount of o
verheads was reduced to Rs. 9,000. As such, the rate at which the overheads shou
ld have been absorbed, should have been
304
Management Accounting

Rs. 9,000 Rs. 50,000


X 100, i.e. 18% and not 20%
as originally considered
Such situation gives rise to the under absorption or over absorption of overhead
s. The situation of under absorption arises if the overheads absorbed are less t
han the actual overheads. The situation of over absorption arises if the overhea
ds absorbed are more than the actual overheads. E.g. Period Overheads Absorbed R
s. 7,500 10,000 Actual Overheads Rs. 9,000 8,000 Remarks
I II Causes :
Underabsorption Overabsorption.
Under absorption of overheads may take place due to the reasons like. Actual ove
rheads being more than the estimated overheads or Actual output or hours worked
being less than those as estimated.
Over absorption of overheads may take place due to the reasons like Actual overh
eads being less than the estimated overheads OR Actual output or hours worked be
ing more than those as estimated.
Treatment of Under or Over Absorbed Overheads : The overheads which are under or
over absorbed may be treated in either of the following ways (1) Use of supplem
entary rate : If the amount of under or over absorbed overheads is considerably
significant, the cost of the cost centres may be adjusted by means of the use of
supplementary overhead absorption rate. This method of treating the over or und
er absorption of overheads is most important where the cost is considered as a b
ase for quoting selling prices, E.g. Cost plus contracts. E.g. The predetermined
overhead absorption rate, for the forthcoming period of months, was decided as
below. Amount of overheads Total labour Hours = Rs. 50,000 25,000 = Rs. 2 / Labo
ur Hour.
Overhead Cost
305

A mid term review of 6 monthly operations revealed that whereas the total labour
hours during the period were 12,500, the amount of overheads incurred was Rs. 3
0,000. The overheads actually absorbed will be 12,500 hours x Rs. 2 i.e. Rs. 25,
000. Considering the same trend of amount of overheads, the total annual overhea
ds are likely to be Rs. 60,000, out of which Rs. 25,000 are already absorbed. As
such, for the remaining 6 months, the overhead absorption rate may be calculate
d as : Revised amount of overheads Number of Labour Hours = = (2) Rs. 60,000 Rs.
25,000 12,500 Rs. 35,000 12,500 = Rs. 2.80 / Labour Hour.
Carrying over to remaining period : In case of seasonal types of organization, t
he overheads under or over absorbed during a certain period may be carried over
to the remaining part of the accounting period with the hope that they may be co
mpensated during the remaining period of time. Writing off to Costing Profit and
Loss Account : In case of the under or over absorption of the overheads arising
out of the abnormal circumstances, they are written off to Costing Profit and L
oss Account.
(3)
Illustration : The budgeted working conditions of a cost centre are as follows :
Normal working per week No. of machines Normal weekly loss of hours on maintena
nce etc. No. of weeks worked per year Estimated annual overheads Estimated direc
t wage rate Actual result in respect of a 4 week period are : Wages incurred Ove
rheads incurred Machine hours produced Rs. 9,000 Rs. 10,200 2,000 42 hours 14 5
hours per machine 48 Rs. 1,24,320 Rs. 4 per hour.
306
Management Accounting

You are required to calculate : (a) (b) The overhead rate per machine hour The a
mount of under or overabsorption of wages and overheads.
Solution : (a) Normal working hours per year (For all 14 machines) Hours lost on
maintenance 42 weekly hours per machine x 14 machines x 48 weeks = 28,224 machi
ne hours. 5 hours per week x 14 machines x 48 weeks = 3,360 machine hours. 24,86
4 machine hours. Rs. 1,24,320 Rs. 5 2000 machine hours x Rs. 5 = Rs. 10,000 Rs.
10,200
(b)
(c) (d) (e) (f) (g) (h)
Effective machine hours i.e., a - b Estimated annual overheads Machine hour rate
i.e., d / c Overheads absorbed Overheads actually incurred Overheads underabsor
bed i.e., g - f
Rs. 200
WAGES (a) (b) (c) (d) (e) (f) Labour hours for 4 weeks For 14 machines Estimated
direct wage rate Estimated direct wages for4 weeks i.e., b x c Wages actually i
ncurred Wages overabsorbed i.e., d-e 42 hours x 4 week = 168 hours 168 hours x 1
4 machines = 2,352 hours Rs. 4 per hour Rs. 9,408 Rs. 9,000 Rs. 408
Control Over Overheads : As the basic intention of cost accounting is to exercis
e the control over the costs and as the overheads is a part of cost, cost accoun
ting procedures attempt to control the overheads also. For this purpose, the fol
lowing propositions should be remembered : (1) The success of procedures to cont
rol the overheads largely depends upon the correct classification of the overhea
ds. This classification can be done from the various angles.
Overhead Cost
307

(a)
Functionwise : This takes the form of classification in the form of factory over
heads, administration overheads and selling and distribution overheads. Variabil
itywise : This takes the form of classification in the form of fixed overheads,
variable overheads and semi-fixed or semi variable overheads. Normalitywise : Th
is takes the form of classification in the form of normal overheads and abnormal
overheads.
(b)
(c)
Fixed overheads normally arise as a result of policy and are largely uncontrolla
ble at the lower level of management. They can be controlled at the top level of
management. However, the variable overheads can be controlled at the lower or m
iddle level of management as well. Most of the administration overheads are fixe
d in nature and can be controlled mainly at top management level. However, the f
actory overheads can be controlled at lower or middle management level also. (2)
After the correct classification of overheads, use may be made of following two
techniques with the intention to exercise proper control over overheads. (a) (b
) Budgetary control Standard costing
Both these techniques are discussed in details in the following chapters. Howeve
r, both these techniques necessarily involve the following stages in the process
of implementation. (i) Planning : This lays down the course of action to be tak
en in future. In case of budgetary control, it is in the form of the budgets and
in case of standard costing, it is in the form of the standard cost. (ii) Imple
mentation of plan : This indicates actual steps to execute the plan. For this, d
ownward communication may be necessary from top management level to lower manage
ment level.
(iii) Measuring actual performance, comparison with plans and computing variance
s : Measurement of actual performance may be in terms of actual costs or actual
output. Actual costs and actual output is compared with the planned performance
and variations, if any are calculated. (iv) Analysis of variances and decision m
aking : Variations between actual performance and planned performance is require
d to be analysed as to the causes and proper corrective actions are required to
be taken to remove unfavourable variations or maintain favourable variations. 30
8
Management Accounting

(3)
Classification of overheads as fixed and variable, facilitates the preparation o
f flexible budgets which provides proper base for comparison in the form of budg
eted overheads for any level of activity actually attained. Flexible budgets may
be treated as an improved method to control the overheads.
ILLUSTRATIVE PROBLEMS (1) Meera Industries Limited is a single product organizat
ion having a manufacturing capacity of 6,000 units per week of 48 hours. The out
put data vis-a-vis different elements of cost for three consecutive weeks are gi
ven below : Units Produced Direct Material Rs. 4,800 5,600 7,200 Direct Labour R
s. 6,000 7,000 9,000 Total factory overheads (Variable and Fixed) Rs. 37,200 38,
400 40,800
2,400 2,800 3,600
As a cost Accountant, you are asked by the company to work out the selling price
assuming level of 4,000 units per week and a profit of 20% on selling price. So
lution : It can be observed that an increase in production by 400 units increase
s the total factory overheads by Rs. 1,200 indicating that per unit variable ove
rheads are Rs. 3. Hence, at the activity level of 2,400 units, the total variabl
e overheads are Rs. 7,200 i.e. 2400 units x Rs.3 per unit, out of total overhead
s of Rs. 37,200. Hence, the balance amount represents fixed overheads. It should
be noted that the direct material cost and direct labour cost represents the va
riable cost of production. At 2,400 units, per unit cost is as below : Direct ma
terial - Rs. 4800 / 2400 units = Rs. 2 / per unit. Direct Labour - Rs. 6000 / 24
00 units = Rs. 2.5 per unit The cost sheet for the production of 4000 units can
be worked out as below :
Overhead Cost
309

Cost Sheet - 4000 units Per Unit Rs. Direct Material Cost Direct Labour Cost Var
iable Overheads Fixed Overheads Total Cost Add : Profit i.e. 20% of selling pric
e of Or 25% of total cost Sales (2) 3.75 18.75 15,000 75,000 2.00 2.50 3.00 7.50
15.00 Total Rs. 8,000 10,000 12,000 30,000 60,000
XYZ Ltd., a manufacturing company, having an extensive marketing net work throug
hout the country, sells its products through four zonal sales offices viz. A,B,C
and D. The budgeted expenditure for the year are given below : Rs.
Sales Managers salary Expenses relating to Sales Managers office Travelling salesm
ens salaries Travelling Expenses Advertisement Godown Rent-Zone A B C D 15,000 25
,200 9,800 18,000
1,20,000 80,000 3,20,000 36,000 30,000
68,000 Insurance on inventories Commission on sales @ 5% on sales 20,000 6,00,00
0
310
Management Accounting

The following further particulars are also available : A Sales (Rs. in lakhs) No
. of salesmen Total mileage covered Allocation of Advertisement Average stock (R
s. in lakhs) 36 5 6000 30% 6 B 48 6 14000 30% 8 C 16 2 4500 20% 4 D 20 3 5500 20
% 2
Based on the above details, compute zonewise selling overheads, as a percentage
to sales. Solution : Calculation of Sales Overheads - Zone wise
Items Base Total Rs.
1. Sales Managers Salary 2. Expenses of Sales Managers office 3. Travelling salesm
ens Salaries 4. Travelling Expenses 5. Advertisement 6. Godown Rent 7. Insurance
on inventories 8. Sales Commission Total Overheads Sales in Lakhs Rs. Overheads
as % of sales 12,74,000 120 10.62% 3,77,200 36 10.48% 4,99,000 1,71,867 48 10.40
% 16 10.74% 2,25,933 20 11.30% Sales Sales No. of Salesman Mileage covered Alloc
ation Allocation Average stock Sales 1,20,000 80,000 3,20,000 36,000 30,000 68,0
00 20,000 6,00,000
A Rs.
36,000 24,000 1,00,000 7,200 9,000 15,000 6,000 1,80,000
B Rs.
48,000 32,000 1,20,000 16,800 9,000 25,200 8,000 2,40,000
C Rs.
16,000 10,667 40,000 5,400 6,000 9,800 4,000 80,000
D Rs.
20,000 13,333 60,000 6,600 6,000 18,000 2,000 1,00,000
(3)
The following yearly charges are incurred in respect of a machine where work is
done by means of 5 machines of exactly same type. (1) (2) (3) (4) (5) Rent and R
ates Depreciation on each machine Repairs & maintenance of 5 machines Power cons
umed (as per meter at 5 paise per unit) Electric charges for the shop Rs. Rs. Rs
. Rs. Rs. 4,800 500 1,000 3,000 450
Overhead Cost
311

(6)
Two attendants looking after 5 machines and are paid Rs. 700 per year each Rs. R
s. Rs. 1,400 3,000 450
(7) (8)
Supervision One supervisor looking after 5 machines and paid Sundry supplies for
the shop
The machine uses 10 units of power per hour. Calculate the machine hour rate. So
lution : Calculation of Machine Hour Rate Rs. (a) Standing charges : Rent and Ra
tes Depreciation Repairs and Maintenance Electricity charges Attendants salary S
upervisors Salary Sundry Supplies Annual standing charges Annual Machine Working
Hours Hourly Standing Charges (b) Running charges : Power charges - Rate of powe
r - 5 paise per unit Power consumption - 10 units per hour Hourly power expenses
(c) Machine Hour Rate i.e. a + b Working Notes : Number of machine working hour
s are calculated as below : (a) (b) (c) Total power cost for the shop Power cost
relating to the machine Rate of power - 5 paise per unit - Rs. - Rs. 3.000 600
Rs. 0.50 Rs. 2.77 960 500 200 90 280 600 90 2,720 1,200 Rs. 2.27
312
Management Accounting

(d)
Total power consumption in units Rs. 600 = 12.000 units Paise 5 Rate of power co
nsumption - 10 units per hour
(e) (f)
If total units consumed are 12.000 and if rate of power consumption is 10 units
per hour, it means that the machine must have worked for 1,200 hours.
(4)
From the following data, work out the predetermined machine hour rates for depar
tments A and B of a factory. Preliminary Estimates of Expenses Total Rs. Dept. A
Rs. 3,000 2,000 10,000 Dept. B Rs. 5,000 3,000 20,000
Power Spare Parts Consumable Stores Depreciation on Machinery Insurance on Machi
nery Indirect Labour Building Maintenance
15,000 8,000 5,000 30,000 3,000 40,000 7,000
The final estimates are to be prepared on the basis of above figures after takin
g into consideration the following factors : (1) (2) (3) An increase of 10% in t
he price of spare parts. An increase of 20% in the consumption of spare parts fo
r Department B only. Increase in the straightline method of depreciation from 10%
on the original value of machinery to 12%. 15% general increase in wage rates.
(4)
The following information is available Dept. A Estimated Direct Labour Hours Rat
io of K W Rating Estimated Machine Hours Floor Space (sq. ft.) 80,000 3 25,000 1
5,000 Dept. B 1,20,000 2 30,000 20,000
Overhead Cost
313

Solution : Calculation of machine hour rate Expenses Base Total Rs. 15,000 9,900
5,000 Dept. A Dept. B Rs. Rs. 9,000 3,300 2,000 6,000 6,600 3,000
Power Spare Parts Consumable stores Depreciation on Machinery
KW Rating Allocation and adjustment for Final Estimates Allocation Allocation an
d adjustments for Final Estimates
36,000 3,000
12,000 1,000
24,000 2,000
Insurance on Machinery Indirect Labour
Ratio of depreciation Direct Labour Hours and adjustment for Final Estimates
46,000 7,000 1,21,900
18,400 3,000 48,700 25,000 1.948
27,600 4,000 73,200 30,000 2.44
Building Maintenance
Floor space
Estimated Machine Hours Machine Hour Rate Working Notes : (1) Spare Part Cost Or
iginal Estimate + Extra consumption Total 8,000 1,000 9,000 + 10% Price Increase
900 9,900 (5) Rs.

Dept A 3,000 3,000 300 3,300
Dept B 5,000 1,000 6,000 600 6,600
The factory overhead costs of four production departments of a company engaged i
n executing job orders, for an accounting year, are as follows : Depts. A B C D
Rs. 19,300 4,200 4,000 2,000
314
Management Accounting

Overhead has been applied as under Dept A - Rs. 1.50 per machine hour for 14,000
hours Dept B - Rs. 1.30 per Direct Labour Hour for 3,000 hours Dept C - 80% of
Direct Labour cost of Rs. 6,000 Dept D - Rs. 2 per piece for 950 pieces. Find ou
t the amount of departmentwise under or over absorbed factory overheads. Solutio
n : (a) Factory Overheads absorbed Dept. A B C D (b) Rs. 21,000 3,900 4,800 1,90
0 Base Rs. 1.50 per Machine Hour for 14,000 hours Rs. 1.30 per Direct Labour Hou
r for 3,000 hours 80% of Direct Labour cost of Rs. 6,000 Rs. 2 per piece for 950
pieces
Calculation of under or over absorption Dept. Overheads Incurred Rs. 19,300 4,20
0 4,000 2,000 29,500 Overheads Absorbed Rs. 21,000 3,900 4,800 1,900 31,600 Over
Absorption Rs. 1,700 800 2,500 Under Absorption Rs. 300 100 400 Rs. 2,100
A B C D
Net Over absorption (6)
In a factory, annual average charges for direct wages amount to Rs. 4,80,000. Fo
llowing are some of the expenses incurred in factory. a. b. Works Managers salary
Rs. 50,000 Factory Rent Rs. 36,000. The total area is 45,000 Sq. Ft. out of whi
ch shop is in 40,000 Sq. Ft. Wages of Peons and Sweepers Rs. 7,000 Other factory
overheads Rs. 53,000
c. d.
Overhead Cost
315

A work order is executed in a shops part occupying an area of 6,000 Sq. Ft. and c
osts Rs. 10,000 in wages. If the total wages for all work orders executed in the
shop amount to Rs. 1,60,000, calculate the total amount of factory overheads ch
arges to be allocated to this work order. Solution : Factory Rent Rs. 36,000 40,
000 Sq. ft. Rent of shop Rs. 32,000 i.e., Rs. 36,000 X 45,000 Sq. ft.
Rent for that area of shop where work order is executed. i.e. Rs. 32,000 X 6,000
Sq. ft. 40,000 Sq. ft. = Rs. 4,800
Apportionment of rent to work order on the basis of wages Rs. 10,000 Rs. 160,000
X Rs. 4,800 = Rs. 300
Other factory overheads Rs. Works Managers Salary Factory Rent (Balance) Wages of
Peons /Sweepers Others 50,000 4,000 7,000 53,000 1,14,000 Apportionment of over
heads to works order on the basis of wages Rs. 10,000 Rs. 4,80,000 X Rs. 1,14,00
0 = Rs. 2,375
Factory overheads chargeable to the work order Rent Factory overheads Rs. Rs. Rs
. 300 2,375 2.675
316
Management Accounting

(7)
Superclass Co. Ltd. has three production departments X, Y and Z and two service
Departments A and B. The following estimated figures for a certain period have b
een made available. Rs. Rent and Rates Lighting and Electricity Indirect wages P
ower Depreciation of machinery Other expenses and sundries 10,000 1,200 3,000 3,
000 20,000 20,000
The following further details are also available. Total Floor space (Sq. Mts.) L
ight Points (Nos.) Direct wages (Rs.) Horsepower of machines Cost of Machinery (
Rs.) Working Hours 10,000 120 20,000 300 1,00,000 X 2,000 20 6,000 120 24,000 4,
670 Y 2,500 30 4,000 60 32,000 3,020 Z 3,000 40 6,000 100 40,000 3,050 A 2,000 2
0 3,000 20 2,000 B 500 10 1,000 2,000
The expenses of the service departments are to be allocated as follows. X A B 20
% 40% Y 30% 20% Z 40% 30% A 10% B 10% You are required to calculate the overhead absorption rate per hour in respect o
f the three production departments. What will the total cost of an article with
material cost of Rs. 50 and direct labour cost of Rs. 40 which passes through X,
Y and Z for 2, 3 and 4 hours respectively.
Overhead Cost
317

Solution : Primary Apportionment of Overheads Expenses Base X Rs. 2000 200 900 1
200 4800 6000 15100 Secondary Apportionment of Overheads Result of Primary Appor
tionment X - Rs. 15,100 A - Rs. 9,250 Let X = Y = X = Y = 10 X = 10 Y = Y - Rs. 1
4,400 B - Rs. 3,150 Z - Rs. 19,300 Y Rs. 2500 300 600 600 6400 4000 14400 Z Rs.
3000 400 900 1000 8000 6000 19300 A Rs. 2000 200 450 200 400 3000 3000 9250 B Rs
. 500 100 150 400 1000 1000 3150
Rent & Rates Lighting & Electricity Indirect wages Power Depreciation Other expe
nses Direct wages (Only Service Depts.)
Floor space Light points Direct wages HP of machines Cost of machines Direct wag
es Allocation
Total overheads of Dept. A Total overheads of Dept. B 9,250 + Y/10 3,150 + X/10
92,500 + Y 31,500 + X ...(1) ...(2)
Multiplying equation 1 by 10 and rearranging : -10 Y = 10 Y Adding, 0 99X X Y =
= = = = 9,25,000 - 100 X 31,500 + X 9,56,500 - 99X 9,56,500 9,662 4,116 ...(3) .
..(4)
318
Management Accounting

Total overheads can be apportioned to production departments at agreed percentag


es to calculate the overhead absorption rate as below : Total Rs. As per Primary
apportionment Dept A 90% of Rs. 9662 Dept B 90% of Rs. 4116 48,800 8,696 3,704
61,200 Working Hours Labour Hour Rate Rs. Calculation of Total Cost Rs. Direct M
aterial Cost Direct Labour Cost Overheads Dept X - 2 Hrs x Rs. 4/ Hour Dept Y 3 Hrs x Rs. 6/ Hour Dept 2 - 4 Hrs x Rs. 8/ Hour = = = Rs. Rs. Rs. 8 18 32 58 17
8 (8) The expenses of a machine cost centre for a particular month are as under.
(i) (ii) Power Maintenance and Repairs Rs. Rs. Rs. Rs. Rs. 50,000 10,000 2,000
6,000 40,000 80 40 X Rs. 15,100 1,933 1,647 18,680 4,670 4.00 Y Rs. 14,400 2,898
822 18,120 3,020 6.00 Z Rs. 19,300 3,865 1,235 24,400 3,050 8.00
(iii) Machine operators wages (iv) (v) Supervision Depreciation
Overhead Cost
319

Other particulars are given below : Products A B C D Rate of Production 30 Units


per hour 10 Units per hour 6 Units per hour 4 Units per hour Production Units 1
,800 500 300 260
The entire production was to be offered to Government on Cost Plus 20% basis. Mate
rial Costs per unit are A - Rs. 40, B - Rs. 60, C - Rs. 100 and D - Rs. 300 Prep
are a statement showing product wise cost and offer price. Solution : Total Cost of
Machine Centre Rs. Power Maintenance and Repairs Machine operators wages Supervis
ion Depreciation 50,000 10,000 2,000 6,000 40,000 1,08,000 On the basis of rate
of production and number of units produced of each product, number of machine ho
urs used can be calculated as below : Product Rate of Production Production (Uni
ts) 1,800 500 300 260 Machine Hours used 60 50 50 65 225 Machines Hour Rate = Rs
. 1,08,000 225 Machine Hour = Rs. 480 Machine Hour
A B C D
30 Units per hour 10 Units per hour 6 Units per hour 4 Units per hour
320
Management Accounting

Calculation of per unit total cost and offer price Product Material Cost Machine
Cost Machine Machine Hours Hour Rate 3 Rs. 1/30 1/10 1/6 4 Rs. 480 480 480 480
Total Cost Profit 20% of Total Cost 7 Rs. 11.20 21.60 36.00 84.00 Offer Price
Total Machine Cost 5 Rs. 16.00 48.00 80.00 120.00
1
2 Rs. 40.00 60.00 100.00 300.00
6(2+5) Rs. 56.00 108.00 180.00 420.00
8 Rs. 67.20 129.60 216.00 504.00
A B C D

Overhead Cost
321

QUESTIONS 1. Discuss the factors which would create unabsorbed factory overheads
and overabsorbed factory overheads. Mention the broad principles on which overh
ead expenses are generally apportioned. Upon what basis would you apportion the
following expenses to individual cost centres in an engineering unit? (a) (b) (c
) (d) 3. Rent Power Fire Insurance Premium Lighting
2.
Explain the term underabsorption and overabsorption of overheads. Explain any th
ree methods of absorbing production overheads into the cost of production. Disti
nguish between actual and predetermined rates for absorption of factory overhead
s. Cite the major problems involved in using actual rates and discuss how predet
ermined rates eliminate this problem. How do you deal with under or over absorpt
ion of overheads? Mention the various items that go into (a) (b) (c) (d) Manufac
turing overheads. Administration overheads. Selling overheads. Distribution over
heads.
4.
5.
6.
What basis would you recommend for the apportionment of the following items of e
xpenses to production departments, giving justification for the suggested one. (
a) (b) (c) (d) (e) (f) Internal Transport. Air-Conditioning. General Factory Mai
ntenance. Stores. Rent. Labour office.
7.
What is meant by apportionment of overheads? What can be considered as a good ba
se for apportioning the following overheads with reference to a Diesel Engine Ma
nufacturing Company?
322
Management Accounting

(i) (ii)
Internal Transport Time Keeping expenses
(iii) Shop supervision (iv) Power, lighting and other utilities
Short Notes : (a) (b) (c) (d) (e) Machine Hour Rate Control of overheads Underab
sorption and overabsorption of overheads Treatment of over- absorption of overhe
ads Primary and Secondary apportionment of overheads
PROBLEMS (1) A certain type of factory produces a uniform type of article and ha
s a capacity to produce 1,500 units per week of 48 hours. Following data shows d
ifferent elements of costs for 3 weeks of 48 hours each when output has changed
from one week to another. Units Produced Direct Material Rs. 400 500 800 800 1,0
00 1,600 Direct Labour Rs. 1,600 2,000 3,200 Factory Overheads (Fixed & Variable
) Rs. 3,800 4,000 4,600
You are asked to find out selling price per unit when weekly output is 1,000 uni
ts and a profit of 8.33% on selling price will be made.
(2)
A factory is having three production departments A, B and C and two service depa
rtmentsBoiler House and Pump Room. The Boiler House has to depend upon the Pump
Room for the supply of water and the Pump room in its turn is dependent on the b
oiler house for supply of steam power for driving the pump. The expenses incurre
d by the production departments during a period are A Rs. 8,00,000, B Rs. 7,00,0
00 and C - Rs. 5,00,000. The expenses for boiler house is Rs. 2,34,000 and the p
ump room is Rs. 3,00,000. The expenses of the boiler house and pump room are app
ortioned to the production departments on the following basis.
Overhead Cost
323

A Expenses of BH Expenses of PR 20% 40%


B 40% 20%
C 30% 20%
BH 20%
PR 10% Show clearly as to how the expenses of boiler house and pump room would be appor
tioned to A, B and C departments. Use an Algebrical equation.
(3)
The overheads distribution summary for the month of September 1980 disclosed fol
lowing overheads expenses for departments mentioned below : Production Depts. A
B Rs. 12,543 C Rs. 4,547 Service Depts. D Rs. 4,000 E Rs. 2,600
Overheads
Rs. 7,810
Expenses of service departments D and E are apportioned as follows. A D E 30% 10
% B 40% 20% C 20% 50% D 20% E 10% You are required to find out the total cost of each production dept. by charging
the respective costs of service depts. by simultaneous equations method.
(4)
The primary distribution of expenses disclosed the following details in respect
of production departments PI, P2 and P3 and Service Departments S1 and S2 Dept.
P1 6.300 P2 7,400 P3 2,800 S1 4,500 S2 2,000
Overheads (Rs.)
The services given by S1 and S2 are as follows. Dept. S1 S2 P1 40% 30% P2 30% 30
% P3 20% 20% S1 20% S2 10% Find out the overheads to production Departments by using simultaneous equations
method. (5) A company has three production cost centres A, B and C and two serv
ice cost centres X and Y. Costs allocated to service cost centres are required t
o be apportioned to the
324
Management Accounting

production centres to find out cost of production of different products. It is f


ound that benefit of service cost centres is also received by each other along w
ith the production cost centres. Overhead costs as allocated to the five cost ce
ntres and estimates of benefits of service cost centres received by each of them
are as under Cost Centres Overhead Costs as allocated Rs. Estimates of benefits
received from service centres % X A B C X Y Required Work out final overhead co
sts of each of the production departments including apportioned cost of service
centres using a. b. (6) Continuous Distribution Method Simultaneous Equations Me
thod The following particulars related to the production department of a factory
for the month of June 1985. Rs. Material Used Direct Wages Direct Labour Hours
Worked Hours of Machine operation Overhead charges allocated to the department 9
0,000 80,000 72,000 20,000 25,000 80,000 40,000 20,000 20,000 10,000 20 30 40 10
Y 20 25 50 5 Cost data of a particular work order carried out in the above department during
June 1985 are given below. Rs. Material Used Direct wages Labour hours booked Ma
chine hours booked 8,000 6,250 3,300 2,400
Overhead Cost
325

What would be the factory cost of the work order under the following methods of
charging overheads? (i) (ii) Direct Labour Cost Rate Machine Hour Rate
(iii) Direct Labour Hour Rate (7) The following information is extracted from th
e budget of A Ltd. for 1985. Factory Overheads Direct Labour cost Direct Labour
hours Machine hours .. .. .. .. Rs. Rs. 62,000 1,00,000 1,55,000 50,000
The following details are available for job 195 Direct Material Cost Direct Labo
ur Cost Direct Labour hours Machine hours Rs. 45 Rs. 50 40 30
You are required to work out the overhead application rates and ascertain the co
st of job 195 by using the following methods of overheads absorption. (1) Direct
Labour Hours Rate, (2) Direct Labour Cost, (3) Machine Hour Rate (8) Atlas Engi
neering Ltd. accepts a variety of jobs which require both manual and machine ope
rations. The budgeted Profit and Loss Account for the period 1996-97 is as follo
ws : (Rs. in Lakhs) Sales Cost : Direct Materials Direct Labour Prime Cost Produ
ction Overhead Production Cost Other Overheads Profit 10 5 15 30 45 15 60 15 75
326
Management Accounting

Other budgeted data Labour Hours for the period Machine Hours for the period No.
of jobs for the period 2,500 1,500 300
An enquiry has been received recently from a customer and the production departm
ent has prepared the following estimate of the prime cost required for the job D
irect Material Direct Labour Prime Cost Labour Hours required Machine Hours requ
ired You are required to a. Calculate by different methods, six overhead absorpt
ion rates for absorption of production overhead and comment on the suitability o
f each. Calculate the production overhead cost of the order based on each of the
above rates. Give your recommendation to the company. A company has two product
ion departments and two service departments. The data relating to a period are a
s under : Production Depts. PD1 PD2 Direct Materials (Rs.) Direct Wages (Rs.) Ov
erheads (Rs.) Power requirement at normal capacity operation (kwh) Actual power
consumption during the period (Kwh) 13000 23000 10250 10000 20000 35000 12500 17
500 80000 95000 80000 40000 50000 50000 Service Depts. SD1 SD2 10000 20000 30000
20000 10000 20000 2,500 2,000 4,500 = 80 = 50
b. c. (9)
The power requirement of these departments are met by a power generation plant.
The said plant incurred an expenditure, which is not included above, of Rs. 1,21
,875 out of which a sum of Rs. 84,375 is variable and the rest fixed.
Overhead Cost
327

After apportionment of power generation plant costs to four departments, the ser
vice department overheads are to be redistributed on the following bases : PD1 S
D1 SD2 You are required to : a. b. c. Apportion the power generation plant costs
to the four departments. Re-apportion service department cost to the production
departments. Calculate the overhead rates per direct labour hour of production
departments, given that the direct wages rates of PD1 and PD2 are Rs.- 5 and Rs.
4 respectively. 50% 60% PD2 40% 20% SD1 20% SD2 10%
(10) Following information is extracted from the cost records of Hilton Ltd. whi
ch specialises in the manufacture of automobile spares. The parts are manufactur
ed in Department A and assembled in Department B. Total Direct Labour hours work
ed Machine Hours worked Machine Horse Power Book Value of Machines (Rs.) Floor S
pace (Sq.Ft.) Direct Material Direct Labour Factory Rent Supervision Depreciatio
n on Machines Power Repairs to Machines Indirect Labour 80,000 30,000 400 50,000
20,000 65,000 90,000 15,000 6,000 5,000 4,000 2,000 4,000 Dept. A 30,000 25,000
353 40,000 10,000 50,000 40,000 2,500 1,600 2,000 Dept. B 50,000 5,000 47 10,00
0 10,000 15,000 50,000 3,500 400 2,000
The prime cost of batch B-401 has been booked as under Total Materials Labour 3,
200 7,500 Dept. A 2,700 3,000 Dept. B 500 4,500
328
Management Accounting

Direct Labour hours worked on Batch B-401 were 2,500 in Department A and 5,000 i
n Department B. Machine hours worked on this batch were 1,250 in Department A an
d 600 in Department B. Allocate overhead expenditure and calculate the cost of e
ach unit in Batch B401 which consists of 1,000 units. (11) Strongman Ltd. has th
ree production departments A,B and C and two service departments X and Y. The da
ta available for the month of March 1991 concerning the organization Rs. Rent Mu
nicipal Taxes Electricity Indirect wages Power Depreciation on Machinery Canteen
Expenses Other Labour related costs Following particulars are also available To
tal Floor Space (Sq. Mts.) Light Points (Nos.) Direct Wages (Rs.) HP of Machines
Cost of Machines (Rs.) Working Hours 5,000 240 40,000 150 20,0000 A 1,000 40 12
,000 60 48,000 2,335 B 1,250 60 8,000 30 64,000 1,510 C 1500 80 12,000 50 80,000
1,525 X 1,000 40 6,000 10 4,000 Y 250 20 2,000 4,000 15,000 5,000 2,400 6,000 6
,000 40,000 30,000 10,000
The expenses of Service Departments are to be allocated in following manner A X
Y 20% 40% B 30% 20% C 40% 30% X 10% Y 10%
You are requested to calculate the overhead absorption rate per hour in respect
of the three production departments.
Overhead Cost
329

(12) A company has 3 production departments A, B and C and two service departmen
ts X and Y. The following data are extracted from the records of the company for
a particular given period. Rs. Rent and Taxes General Lighting Indirect Wages P
ower Depreciation on Machinery Sundries Additional data departmentwise Total Dir
ect Wages (Rs.) HP of Machines Cost of Machines (Rs. in Lakhs) Floor Space (Sq.M
ts.) Lighting Points (Nos.) Production Hours 50000 150 12.50 10000 60 A 15000 60
3.00 2000 10 6226 B 10000 30 4.00 2500 15 4028 C 15000 50 5.00 3000 20 4066 X 7
500 10 0.25 2000 10 Y 2500 0.25 500 5 25,000 3,000 7,500 7,500 50,000 50,000
Sundries can be apportioned on the basis of Direct Wages. Service Departments exp
enses allocation A X Y You are required to a. b. Compute the overhead rate of pr
oduction departments using repeated distribution method. Determine the total cos
t of a product whose direct material cost and direct labour cost are Rs. 150 and
Rs. 150 respectively and which would consume 4 hours, 5 hours and 3 hours in de
partments A, B and C respectively. 20% 40% B 30% 20% C 40% 30% X 10% Y 10%
(13) Universal Ltd. has four production departments A, B, C and D and two servic
e departments viz. Transport and Power Supply.
330
Management Accounting

Particulars of expenses of the respective departments are as follows : A B C D T


ransport Power Supply Rs. Rs. Rs. Rs. Rs. Rs. 2,000 1,800 1,600 1,400 1,100 760
The service departments expenses are charged out on a percentage basis as given b
elow : A Transport Power 10% 30% B 30% 20% C 20% 30% D 20% 10% Transport 10% Pow
er 20% Using the above information, apportion the service department overheads to vario
us production departments using a. b. Simultaneous Equations Method Repeated Dis
tribution Method
(14) A shop has 2 newly purchased machines, each occupying equal area of space.
One is 4 - spindle drilling machine and the other is 6-spindle drilling machine
costing Rs. 80,000 and Rs. 1,00,000 respectively. Following are the expenses for
one year : a. b. c. d. Rent Rates and Taxes Lighting and heating power expenses
- 4 spindle machine - 6 spindle machine e. f. Administration expenses Running a
nd Maintenance Rs. 10,000 Rs. 15,000 Rs. 38,000 Rs. 80,000 Rs. 40,000 Rs. 17,000
Rs. 12,600
The life of each machine is 10 years without any salvage value. Each machine wor
ks for 45 hours a week for 50 weeks in a year. 250 hours per machine are used fo
r repairs. Running and repairs expenses are shared between two machines on the b
asis of power expenses. You are required to prepare statement showing computatio
n of Machine Hour Rate.
Overhead Cost
331

(15) Calculate the machine hour rate in respect of machine No. 179 from the foll
owing particulars : Cost of machine Estimated Life Estimated scrap value Estimat
ed working hours per annum Estimated hours required for maintenance Setting up t
ime (Hours) Power 20 units @ Rs.0.17 per unit Repairs and maintenance per annum
No. of operators (looking after also 3 other machines) Wages per operator per mo
nth Chemical required for operating the machine Overheads chargeable to the mach
ine Insurance premium -1% p.a. on the cost of machine. Rs. 1500/2 Rs. 150/Rs. 10
0/- p.m. Rs. 200/- p.m. Rs. 20,000 15,000 hours Rs. 500/2200 100 (included in ab
ove) 100 (included in above)
(16) You are required to calculate the composite machine hour rate from the foll
owing particulars in respect of a jig boring machine whose scrap value is Rs. 50
,000 after its working life of 10 years. 1. 2. 3. 4. 5. 6. 7. 8. Cost of the mac
hine - Rs. 2,00,000 Importation charges & Customs duty etc.- Rs. 50,000 Working
hours per year - 2,000 Repairs & Maintenance charges - 50% of depreciation charg
e. Lubricating oil - Rs. 20 per working day of 8 hours Consumable stores - Rs. 5
00 per month of 25 working days. Power 10 units per working hour at Re. 0.30 per
unit Wages of the operator - Rs. 1,000 per month of 25 working days.
332
Management Accounting

(17) From the particulars furnished below, compute a machine hour rate : Name of
the Equipment - Single spindle Automat Date of purchase Cost Estimated Life Dep
reciation Insurance Repairs Consumable stores Rent Superintendence (l/5th for th
e machine) 1.4.1983 Rs. 75,000 10 years 15% on original cost Rs. 4,000 p.a. Rs.1
,800 p.a. Rs. 1,500 p.a. Rs. 2,400 p.a. Rs. 2,500 p.a.
The machine can work for 200 hours in a month and had actually worked for 80% of
the normal working hours. Cost of oils and greases consumed per hour is Rs.4.50
,
(18) A dept. is having 3 machines. The figures indicate the departmental expense
of these machines. Calculate the machine hour rate from the data below : Deprec
iation of machines Rent Repairs to machines Insurance of machines Indirect wages
Power Lighting Misc. Expenses Rs. Rs. Rs. Rs. Rs. Rs. Rs. Rs. Rs 12,000 2,880 4
,000 800 6,000 6,000 800 4,200 36,680
Overhead Cost
333

Other information : M/c1 Direct wages Rs. Power units No. of workers Light points
Space occupied (Sq. Ft.) Cost of machine Rs. Hours worked 1,200 30,000 4 8 400
3,00,000 200 M/c2 2,400 10,000 8 24 800 1,20,000 300 M/c3 2,400 20,000 8 48 800
1,80,000 300
(19) Following particulars relate to a machine : Rs. Purchase Price of machine I
nstallation Expenses Rent per Quarter General Lighting for the total area Superv
isors salary Insurance premium Estimated repairs Estimated consumable stores Powe
r 2 units per hour @ Rs. 50 per 100 units The estimated life of the machine is 1
0 years and the estimated scrap value is Rs. 20,000. The machine is expected to
run 20,000 hours in its life time. The machine occupies 25% of the total area. T
he supervisor devotes l/6th of his time for the machine. You are required to wor
k out machine hour rate. 80,000 20,000 3,000 200 6,000 600 1,000 800 per month p
er quarter per annum per annum per annum
(20) From the following particulars, calculate the machine hour rate of machine
installed in a Department. Cost of Machine Estimated scrap value after the expir
y of its life (15 years) Rs. 16,000
Rs. 1,000
334
Management Accounting

Estimated working hours of the machine per year Monthly salary of a foreman enga
ged in supervision of this machine and other two identical machines. Repails and
Maintenance of the machine Insurance premium for the machine
2,000
Rs. 1,500 Rs. 2,400 per year Rs. 120 per year
Departmental rent and rates are Rs. 1,200 per year. The space occupied by the ma
chine is l/6th of the floor space of the department. Power consumption of the ma
chine is 2 units per hour @ 10 paise per unit.
(21) A machine costing Rs. 20,000 is expected to work for 10 years and at the en
d of which the scrap value is estimated Rs. 2,000, installation charges amount t
o Rs. 200. repairs over 10 years life is expected Rs. l,800 and the machine is e
xpected to run for 2.190 hours in a year. Its power consumption would be 15 unit
s per hour at Rs. 5 per 100 units. The machine occupies l/4th of the area of the
department and has two points out of ten for lighting. The foreman has to devot
e l/3rd of his time for this machine. The rent for the department is Rs. 300 p.m
. and charges for lighting Rs. 80 p.m. The foreman is paid salary Rs. 960 p.m. F
ind out the hourly rate assuming insurance is 1% per annum and expenses on oil e
tc. Rs. 9 per month.
(22) Following data is available relating to a company for a certain month. Terr
itory I Selling Expenses (Rs.) Distribution Costs (Rs.) No. of units sold Sales
(Rs.) 7,600 4,000 16,000 76,000 II 4,200 1,800 6,000 28,000 III 6,240 2,000 10,0
00 52,000
The company adopts sales basis and quantity basis for application of selling and
distribution costs respectively. Compute (a) (b) The territorywise overhead rec
overy rates separately for Selling and Distribution costs. The amounts of sellin
g and distribution cost chargeable to a consignment of 2,000 units of a product,
sold in each territory at Rs. 4.50 per unit. 335
Overhead Cost

(23) A machine is purchased for cash at Rs. 9,200. Its working life is estimated
to be 18,000 hours after which its scrap value is estimated at Rs. 200. It is a
ssumed from the past experience that a. b. c. d. The machine will work for 1,800
hours annually. The repair charges will be Rs. 1,080 during the whole period fo
r life of the machine. The power consumption will be 5 units per hour at 6 paise
per unit. Other annual standing charges are estimated to be 1. 2. 3. 4. 5 Rent
of department (machine l/5th) Light (12 points in the department, 2 points engag
ed in the machine) Foremans salary (l/4th of his time is occupied in the machine)
Insurance premium for machine Cotton Waste 780 288 6000 36 60
Find out the machine hour rate on the basis of above data for allocation of the
works expenses to all jobs for which the machine is used.
(24) The following particulars relate to a new machine purchased. Purchase Price
of the machine Installation Expenses Rent per Quarter General Lighting for the
total area Foremans Salary Insurance Premium for the machine Estimated repair for
the machine Estimated Consumable Stores Rs. 4,00,000 Rs. 1,00,000 Rs. Rs. Rs. R
s. Rs. Rs. 15,000 1,000 p.m. 30,000 p.a. 3,000 p.a. 5,000 p.a. 4,000 p.a.
The estimated life of the machine is 10 years and the estimated value at the end
of 10 years is Rs. 1,00,000. The machine is expected to run 20,000 hours in its
life time. The machine occupies 25% of the total area. The foreman devotes l/6t
h of his time for the machine. Calculate the machine hour rate for the machine.
336
Management Accounting

(25) A manufacturing unit has added a new machine to its fleet of five existing
machines. The total cost of purchase and installation of the machine is Rs. 7,50
,000. The machine has an estimated life of 15 years and is expected to realise R
s. 30,000 as scrap at the end of its working life. Other relevant data are as fo
llows : a. Budgeted working hours are 2,400 based on 8 hours per day for 300 day
s. This includes 400 hours for plant maintenance. Electricity used by the machin
e is units per hour at a cost of Rs. 2 per unit. No current is drawn during main
tenance. The machine requires special oil for heating which is replaced once in
every month at a cost of Rs. 2,500 on each occasion. Estimated cost of maintenan
ce of the machine is 500 per week of 6 working days. 3 operators control the ope
rations of the entire battery of six machines and the average wages per person a
mounts to Rs. 450 per week plus 40% fringe benefits. Departmental and general ov
erheads allocated to the operation during the last year were Rs. 60,000. During
the current year it is estimated that there will be an increase of 12.5% of this
amount. No incremental overhead is envisaged for the installation of the new ma
chine.
b.
c.
d. e.
f.
You are required to compute the machine hour rate for the recovery of the runnin
g cost of the machine. (26) The following annual charges are incurred in respect
of a machine in a shop where manual labour is almost nil and where work is done
by means of five machines of exactly similar type and specification. (a) (b) (c
) (d) (e) (f) Rent and Taxes (Proportionate to the floor space occupied) for the
shop - Rs. 4,803. Depreciation on each machine - Rs. 500. Repairs and maintenan
ce for five machines - Rs. 1,000 Power consumed @ 6.25 paise per unit for the sh
op Rs. 3,750. Electric charges for light in the shop - Rs. 540. Attendants - The
re are two attendants for the five machines and they are each paid Rs. 60 per mo
nth. Supervision - There is one supervisor in the shop for the five machines and
he is paid Rs. 250 per month. 337
(g)
Overhead Cost

(h) (i)
Sundry supplies such as lubricants, jute and cotton waste etc. for the shop - Rs
. 494. Hire Purchase - Instalment payable for the machine (including Rs. 300/- a
s interest) Rs. 1,200. The machine uses 10 units of power per hour. Calculate th
e machine hour rate for the year.
(j)
(27) In a manufactring concern ABC Ltd., die machine shop has 8 identical machin
es manned by 6 operators. The machines cannot be worked without an operator whol
ly engaged on them. The total cost of the machines are Rs. 8,00,000. Following i
nformation relates to a six monthly period ended 30th June, 1990. Normal availab
le hours per month Absenteeism (without pay) hours per month. Leave (with pay) h
ours per month Normal idle time (unavoidable) hours per month Average rate of wa
ges per day of 8 hours Production hours Power and Fuel consumption Supervision a
nd Indirect Labour Electricity The following particulars are on a yearly basis.
Repairs and Maintenance 3% of value of machines Insurance Depreciation Other fac
tory expenses Allocated General Management Expenses Rs. 63,670 Rs. 42,000 10% of
original cost. Rs. 12,000 10 Rs. 20 15% on wages Rs. 9,000 Rs. 3,300 Rs. 1,200
18 20 208
You are required to work out a comprehensive machine hour rate for the machine s
hop.
338
Management Accounting

(28) In a factory, the following particulars have been extracted for the quarter
ending 30th June, 2001 in respect of Production Department P1, P2 and P3 and se
rvice Departments S1 and S2. Compute the departmental overhead rate for each of
the production departments, assuming that overheads are absorbed as a percentage
of direct wages. Particulars Direct Wages (Rs.) Direct Material (Rs.) No. of Wo
rkers Power (KWHrs.) Asset Value Light Points Area in Sq. Fts. Expenses for the
period were Power Lighting Stores overheads Staff Welfare Depreciation Rent Gene
ral Overheads Rs. Rs. Rs. Rs. Rs. Rs. Rs. 1,100 200 800 3,000 36,000 550 12,000
P1 30000 15000 150 6000 60000 10 150 P2 45000 30000 225 4500 40000 16 250 P3 600
00 30000 225 3000 30000 4 50 S1 15000 22000 75 1500 10000 6 50 S2 30000 22000 75
1500 10000 4 50
Apportion general overheads in the proportion of direct wages. Apportion the exp
enses of S1 according to direct wages and those of S2 in the ratio of 5 : 3: 2 t
o the production departments. (29) A Ltd. has 3 production departments A, B and
C and 2 service departments D and E. The following are the figures of the compan
y. Rs. Rent and Rates General lighting Indirect wages Power Depreciation of Mach
inery Sundry Expenses 5,000/600/1,500/1,500/10,000/10,000/Overhead Cost
339

The following further details are available : A Floor Space (Sq.Ft) Light points
Direct wages (Rs.) Value of Machinery (Rs.) H.P. of Machines 2000 10 3000 60,00
0 60 B 2500 15 2000 80,000 30 C 3000 20 3000 1,00,000 50 D 2000 10 1500 5,000 10
E 500 5 500 5,000
Sundry expenses are apportioted on the basis of direct wages The expenses of D a
nd E are allocated as under : A D E 20% 40% B 30% 20% C 40% 30% D 10% E 10% Find the rate per hour if the working hours are as under : A B C Department Depa
rtment Department 6226 4028 4066
(30) In a light engineering factory, the following particulars have been collect
ed for the three monthly period ended 31.12.80. Compute the departmental overhea
d rates for each of the production departments assuming that the overheads are r
ecovered as a percentage of direct wages. Production Dept. A Direct wages Direct
materials Staff Electricity Light points Asset value Area occupied Rs. Rs. Nos.
Kwh. Nos. Rs. Sq.Ft. 2,000 1,000 100 4,000 10 60,000 150 B 3,000 2,000 150 3,00
0 16 40,000 250 C 4,000 2,000 150 2,000 4 30,000 50 Service Dept. D 1,000 1,500
50 1,000 6 10,000 50 E 2,000 1,500 50 1,000 4 10,000 50
340
Management Accounting

The expenses for the period were : Motive power Lighting power Stores overhead A
menities to staff Depreciation Repairs and Maintenance General overheads Rent an
d Taxes Rs. Rs. Rs. Rs. Rs. Rs. Rs. Rs. 550 100 400 1,500 15,000 3,000 6,000 275
Apportion the expenses of service dept. E proportionate to direct wages and that
of service dept. D in the ratio of 5 : 3 : 2 to depts A, B and C respectively.
Overhead Cost
341

NOTES
342
Management Accounting

Chapter 1 1
MARGINAL COSTING
In the conventional system of cost ascertainment, the direct cost may be identif
ied with the individual cost center. However, the indirect costs i.e. the overhe
ads are identified with the individual cost center on the most equitable basis.
This results into some problems in the process of managerial decision-making. a.
The above process does not take into consideration the behaviour of cost. All t
he costs in the practical circumstances do not behave in the same manner. Some o
f the costs tend to remain constant despite the changes in the level of activity
or volume of operations. These types of costs are comparatively irrelevant in t
he managerial decision-making. The above process results into the under absorpti
on or over absorption of overheads.
b.
The said limitations have given rise to a managerial decision making technique t
hat basically tries to classify the costs based upon the behaviour of cost. The
technique is referred to as Marginal Costing. The basic proposition made by this
technique is that the costs should be classified on the basis of behaviour of t
he costs. From this angle, the costs can be viewed as fixed costs and variable c
osts, Fixed Cost is the cost that tends to remain constant irrespective of the l
evel of activity or volume of operations. Fixed Cost tends to vary with time rat
her than with level of activity. Basic characteristic feature of fixed cost is t
hat this cost in terms of amount may remain constant at all the levels of activi
ties, however per unit fixed cost goes on decreasing with the increasing level o
f activity and vice-a-versa. Variable Cost is the cost that varies in direct pro
portion with the level of activity or volume of operations. Basic characteristic
feature of variable cost is that variable cost in terms of amount may increase
or decrease with the changing level of activity or volume of operations. However
, per unit variable cost remains constant. In practical circumstances, some cost
s may not be entirely fixed or entirely variable. They are technically in the fo
rm of semi-fixed costs or semi-variable costs. For the purpose of marginal costi
ng, the semi-fixed costs or semi-variable costs are required to be classified in
the individual
Marginal Costing
343

components of fixed cost and variable cost. For segregating the semi-fixed or se
mi-variable cost into the individual components of fixed cost and variable cost,
various techniques or methods may be available viz.
l l l l l
Comparison by period or level of activity Range or High and Low method Analytica
l method Scattergraph method Lease Square method
Based upon the above discussions, let us make some calculations for a manufactur
ing organization manufacturing and selling a single product, operating at variou
s levels of activities. Level of Activity Units Per Unit Selling Price Rs. Total
Sales Rs. Variable Cost Rs. Fixed Cost Rs. Total Cost Rs. Per Unit Variable Cos
t Rs. Per Unit Fixed Cost Rs. Per Unit Total Cost Rs. 1000 100 1,00,000 60,000 3
0,000 90,000 6 3 9 1500 100 1,50,000 90,000 30,000 1,20,000 6 2 8 2000 100 2,00,
000 1,20,000 30,000 1,50,000 6 1.5 7.5
It can be observed from the above calculations that if the fixed cost is include
d in the calculation of total cost, per unit total cost becomes non-comparable w
ith the changes in the level of activity in one cost-period to another cost-peri
od. To avoid this non-comparability, it is necessary to eliminate the fixed cost
s while determining the total cost. As such, the technique of Marginal Costing p
roposes that fixed cost tends to remain stagnant at least over a shorter period
of time and hence should be ignored in the entire decision making process. As su
ch, marginal costing considers only the variable cost as the relevant cost in th
e decision making process. The Concept Marginal Cost is defined as the amount at
any given volume of output by which the aggregate costs are changed if the volu
me of output is increased or decreased by one unit. The aggregate cost consists
of both fixed cost and variable cost. As in the short run, fixed costs remain co
nstant irrespective of changes in the volume, aggregate costs may increase or de
crease
344
Management Accounting

with the changes in volume, specifically due to variable cost. As such, in simpl
e words, marginal cost indicates Per Unit Variable Cost. Marginal Costing is def
ined as the ascertainment, by differentiating between fixed and variable costs,
of the marginal costs and of the effect on profit of changes in volume and type
of output. Basic assumptions made by Marginal Costing The entire technique of Ma
rginal Costing is based upon the following assumptions. a. Variable Cost varies
in direct proportion with the level of activity. However, per unit variable cost
remains constant at all the levels of activities. Per unit selling price remain
s constant at all the levels of activities. Whatever is produced by the organiza
tion is sold off. In other words, there are no variations due to the stock.
b. c.
Features of Marginal Costing 1. The product costs are classified as fixed costs
and variable costs. Semi-variable costs are also classified in their individual
components of fixed cost and variable cost. Only variable costs are considered w
hile computing the product costs. The closing stock of finished goods and semi-f
inished goods is valued after considering variable costs only. Fixed costs are w
ritten off during the period of incurrence and hence do not find the place in pr
oduct cost determination or inventory valuation. Prices of the product are based
on variable costs only. Profitability of the products or departments is decided
in terms of marginal contribution.
2.
3.
4. 5.
Marginal Costing and Cost-Volume-Profit Relationship The definition of the term M
arginal Costing requires the computation ofa. b. a. Marginal Cost Cost-Volume Pro
fit Relationship Determination of Marginal Cost As stated earlier, the marginal
cost is the additional cost for manufacturing one additional unit, which is noth
ing else but the variable cost per unit. Thus the marginal cost or variable cost
includes the direct cost plus the variable overheads. Fixed overheads get clubb
ed with the fixed cost.
Marginal Costing
345

b.
Cost Volume-Profit Relationship : The intention of every business activity is to
earn the profit and to maximize the profit. Determination of the profits depend
s upon the interplay between the following factors and there exists a close rela
tionship among these factors : (1) (2) (3) Selling price per unit and total sale
s amount. Total cost which in its turn may be in the form of variable cost or fi
xed cost. Volume of sales
Cost-Volume-Profit Analysis aims at studying the relationships existing among th
ese factors and its impact on the amount of profits. The relationships existing
among these factors may be basically presented in two forms. (a) (b) In statemen
t or report form In graphical form, the graphs or charts taking the form of brea
k even chart, contribution break even chart or profit chart.
Form of operating statement : Under the marginal costing technique, the operatin
g statement takes the form as specified below. (a) In case of a single product c
ompany Rs. Sales Less : Marginal cost Direct Material Cost Direct Labour Cost Di
rect Expenses Variable Overheads x x x x x Contribution Less : Fixed costs Profi
t x x x x
346
Management Accounting

(b)
In case of a multi product company Product A Rs. Sales Less : Marginal cost Dire
ct Material cost Direct Labour cost Direct Expenses Variable Overheads Contribut
ion Less : Fixed costs Profit x x x x x x x x x x x x x x x x x x x x x x x Prod
uct B Rs. x Product C Rs. x Total Rs. x
Basic concepts in Marginal Costing : (1) Basic equation of Marginal Costing : Th
e basic intention of the business is to earn the profit which is the excess of s
ales over the total costs. Profit = Sales - Total Cost However, total cost can b
e either fixed cost or variable cost. As such the basic equation takes the follo
wing forms. Profit = Sales - (Variable Cost + Fixed Cost) Profit = Sales - Varia
ble cost - Fixed cost Profit + Fixed cost = Sales - Variable cost. This is the b
asic equation of marginal costing. Both the expressions of Sales - Variable Cost
and Profit + Fixed cost are technically termed as contribution. Sales - Variabl
e Cost = Contribution = Fixed Cost + Profit Contribution - Fixed cost = Profit
Marginal Costing
347

(2)
Contribution : As discussed earlier, the term contribution can be expressed in t
wo ways basically : (a) (b) Sales - Variable Cost Fixed cost + Profit
As in the short period, fixed costs are ineffective due to their stagnant nature
, variable cost becomes the most important cost in deciding the profitability. A
s such, the situation which generates higher contribution is treated as profitab
le situation. Further, the term contribution, plays an important role in a situa
tion where there are more than one products and the profits on individual produc
ts cannot be ascertained due to the problems of apportionment of fixed costs to
different products. This is due to the fact that the fixed costs are ignored by
marginal costing. (3) Profit Volume (P/V) Ratio : This ratio indicates the contr
ibution earned with respect to one rupee of sales. As such, it is expressed as C
ontribution Sales X 100
As in the short run, fixed cost remains the same, if there is any change in prof
its, that is only due to change in contribution. Hence P/V ratio may also be exp
ressed as : Change in Profits Change in Sales X 100
E.g. Sales price is Rs. 10 per unit, variable cost is Rs.6 per unit, and fixed c
osts are Rs.300, we observe that for 100 and 150 units, P/V Ratio works out as :
100 Units Rs. Sales Variable cost Contribution Fixed cost Profit 1,000 600 400
300 100 150 Units Rs. 1,500 900 600 300 300
348
Management Accounting

Hence, P/V Ratio is Contribution Sales X 100 = 400 1,000 i.e. 100 X 100 = 600 1,
500 40% X 100
OR Increase in Profits Increase in Sales X
40% 200 i.e. 500
=
X 100 = 40%
The fundamental property of P/V Ratio is that it remains constant at all the lev
els of activities, provided per unit sales price and variable cost remains const
ant. It should be noted that P/V Ratio remains unaffected by any variation in fi
xed costs though overall profits may change due to this variation. A high P/V Ra
tio indicates that a slight increase in sales without corresponding increase in
fixed costs will result in higher profits and vice-versa. This is a pointer to i
ncreased sales promotion efforts to increase sales volume. A low P/V Ratio indic
ates low profitability so that efforts can be made to increase the profits by in
creasing selling price or by reducing variable cost. Overall profitability may a
lso be increased by concentrating more on products having high P/V Ratio. Note :
The basic expression of P/V Ratio i.e.Contribution/Sales may lead to other usef
ul conclusion as (a) (b) Sales x P/V Ratio = Contribution Contribution P/V Ratio
(4) = Sales
Break Even Point (BEP) : This is a situation of no profit no loss. It means that
at this stage, contribution is just enough to cover the fixed costs i.e. Contri
bution = Fixed Cost. It also means that contribution generated by all sales beyo
nd Break Even Point will directly result into profits. As such, it will be inten
tion of every business to reach the Break Even Point, as early as possible. The
Break Even Point may be expressed in two ways. (a) In terms of quantity Fixed Co
sts Contribution per unit
Marginal Costing
349

(b) (5)
In term of amount
Fixed Costs P/V Ratio
Margin of Safety : These are the sales beyond Break even point. A business will
like to have a high margin of safety because this is the amount of sales which g
enerates profits. As such, the soundness of the business is indicated by the mar
gin of safety. A high margin of safety indicates that the Break Even Point is mu
ch below the actual sales and even if there is reduction in sales, business will
be still in profits. A low margin of safety accompanied by high fixed cost and
high P/V Ratio indicates that efforts are required to be made for reducing the f
ixed cost or increasing sales volume. A low margin of safety accompanied by a la
w P/V Ratio indicates that efforts are required to be made for reducing the vari
able cost or increasing the selling price. Margin of safety may be expressed as
below : Margin of Safety = = Sales - Break Even Sales Sales Fixed cost P/V Ratio
Margin of Safety
=
Sales x P/V Ratio - Fixed Cost P/V Ratio
=
Contribution - Fixed Cost P/V Ratio Profit
=
P/V Ratio
Margin of safety may be expressed as a ratio or as a percentage. E.g. If actual
sales are Rs.l,00,000 and Break Even Sales are Rs.60,000, Margin of Safety will
be Sales - Break Even Sales Sales i.e. i.e. 1,00,000 - 60,000 1,00,000 40% of Sa
les X 100 = X 100 40,000 1,00,000 = X 100
350
Management Accounting

Illustrations : (1) Following details are available : Sales Rs. Period I Period
II 39,000 43,000 Total Cost Rs. 34,800 37,600
Calculate variable cost, fixed cost and contribution for each period. Solution :
As Sales - Total Cost = Profit, we know as below : Sales Rs. Period I Period II
As P/V Ratio = = Increase in Profits Increase in Sales 5,400 - 4,200 43,000 - 3
9,000 X 100 = 39,000 43,000 X 100 1,200 4,000 X 100 = 30% Total Cost Rs. 34,800
37,600 Profit Rs. 4,200 5,400
As Sales x P/V Ratio = Contribution,For period I, Contribution = 39,000 x 30% =
11,700 For period II, Contribution = 43,000 x 30% = 12,900 As Sales - Contributi
on = Variable Cost, For period I, Variable Cost = 39,000 - 11,700 = 27,300 For p
eriod II, Variable Cost = 43,000 - 12,900 = 30,100 As Contribution - Profit = Fi
xed Cost, For period I, Fixed Cost = 11,700- 4,200 = 7,500 For period II. Fixed
Cost = 12,900 - 5,400 = 7,500 To summarise, Period I Rs. Contribution Variable c
ost Fixed cost
Marginal Costing
Period II Rs. 12,900 30,100 7,500 351
11,700 27,300 7,500

(2)
Following details arc available : Sales Rs. Period I Period II 2,00,000 3,00,000
Profit Rs. 20,000 40,000
Find out Break even Sales Solution : We know that P/V Ratio = Increase in Profit
s Increase in Sales P/v Ratio = 20,000 100,000 Profit P/V Ratio For period I, Ma
rgin of Safety is = 20,000 20% = 1,00,000 X 100 = 20% X 100
Margin of safety
=
As Break Even Sales = Sales - Margin of Safety. Considering Period I, Break Even
Sales = = (3) 2,00,000 - 1,00,000 1,00,000
Following details are available: Actual Sales Rs. 20,000
Break Even Sales Rs. 10,000 Fixed Cost Rs. 5,000
Find out the profit at actual sales, Solution : At break Even Point, Contributio
n = Fixed Cost At Break Even Point, sales are Rs. 10,000 and contribution Rs. 5,
000
352
Management Accounting

However we know that, P/V Ratio = Contribution Sales X 100 = 5,000 10,000 X 100=
50%
We also know that. Sales x P/V Ratio = Contribution, At actual sales of Rs. 20,0
00 Contribution = = 20,000 x 50% 5,000
We know that Contribution - Fixed cost = Profit Profit = = (4) 10,000 - 5,000 5,
000
Following details are available: Break Even Sales Fixed cost Profit Rs. Rs. Rs.
20,000 10,000 5,000
Find out the margin of safety. Solution : At Break Even Point, Fixed Cost = Cont
ribution When sales are Rs. 20,000, Contribution is Rs. 10,000
However, we know that Contribution Sales P/V Ratio We also know that, Margin of
safety = Profit P/V Ratio 5,000 50% 353 = 10,000 X 100 = 10,000 20,000 P/V ratio
=
X 100 = 50%
=
Marginal Costing

(5)
Find, out the Break Even Point and Profit if sales are Rs. 50,00,000 and P/V Rat
io is 50% and Margin of safety is 40%.
Solution : Sales are Rs. 50,00,000 and Margin of safety is 40% of sales, hence m
argin of safety is Rs. 20,00,000. As Break Even Sales = Sales Margin of Safety.
BEP = Rs. 50,00,000 - Rs. 20,00,000 = Rs. 30,00,000 We know that, Margin of Safe
ty = Profit P/V Ratio
Margin of Safety x P/V Ratio = Profit As Margin of Safety is Rs. 20,00,000 and P
/V Ratio is 50%, Profit = 20,00,000 x 50% = 10,00,000 GRAPHICAL PRESENTATION OF
COST-VOLUME-PROFIT RELATIONSHIPS As discussed earlier, the Cost-Volume-Profit re
lationships may be expressed in the form of visual aids like graphs and charts.
There may be various ways in which these charts and graphs can be prepared depen
ding upon the purpose for which they are prepared. We will discuss three of thes
e ways. (1) Simple Break Even Chart It can be prepared as below. Y
TS TC
COST/REVENUE
BEP
a
LOSS MOS FC X
O
VOLUME
}
SL
354
Management Accounting

TS TC BEP SL FS MOS Angle a


= = = = = = =
Total Sales Line Total Cost Line Break Even Point Selected Level of Activity Fix
ed Cost Margin of Safety Angle of Incidence.
Note : It will be observed from the above chart, that the angle formed by total
sales line and total cost line is termed as Angle of Incidence. As the differenc
e between total sales and total cost is in the form of profits, higher the angle
of incidence better will be the situation. The limitation of Simple Break Even
Chart is that contribution cannot be shown separately. As such, the following ty
pe of Break Even Chart may be prepared i.e. Contribution Break Even Chart. (2) C
ontribution Break Even Chart : This is a chart where the contribution is shown m
ore clearly and specifically than in a simple break even chart. It can be prepar
ed as below. Y TS TC COST/REVENUE a BEP FC VC
MOS
VC SL X
O
VOLUME
TS TC BEP SL C
= = = = =
Total Sales Line Total Cost Line Break Even Point Selected Level of Activity Con
tribution
}
PC VC MOS Angle a = = = =
Fixed Cost Variable Cost Margin Of Safety Angle of Incidence.
Marginal Costing
355

(3)
Profit Graph : In case of this type of break even chart, horizontal axis represe
nts sales volume and vertical axis represents profit or loss. The diagonal line
represents contribution. The point where the contribution line cuts horizontal a
xis indicates sales at the Break Even Point indicating that at this point, there
is no profit or no loss. PL BEP
P SALES
} FC
PL FC P = = =
L
Profit Line Fixed Cost Profit Area
L BEP
= =
Loss Area Break Even Point
PRACTICAL APPLICATIONS OF MARGINAL COSTING : The technique of marginal costing c
an be profitably employed in the following situations. (1) Evaluation of Perform
ance : The performance of various segments of a business, say a department or a
product or a branch and so on, can be evaluated with the help of marginal costin
g and the evaluation of the performance will be based upon the contribution gene
rating capacity of these segments. If the fixed costs are apportioned over these
segments on any basis whatsoever, it will be ignored while evaluating the perfo
rmance.
356
Management Accounting

Illustration : Following details are available in respect of 3 products. Product


s B Rs. 1,50,000
A Rs. Sales Total Cost Variable Cost Fixed cost (Apportioned on the basis of sal
es) Total Cost Profit (Loss) 20,000 1,10,000 (10,000) 90,000 1,00,000
C Rs. 2,50,000
1,00,000
1,50,000
30,000 1,30,000 20,000
50,000 2,00,000 50,000
As product A is incurring the losses, it is decided to close down its production
. Advise the management, Solution : It will not be advisable to close down the p
roduction of product A, because it is generating the positive contribution (i.e.
Rs. 1,00,000 - Rs. 90,000 = Rs. 10,000) Closing down of product A will mean los
s of contribution generated by it, fixed cost still remaining the same. Assuming
that the production of product A is closed down, what will be the effect on pro
fitability? Let us verify by applying marginal costing principles. Product B Rs.
Sales Variable Cost Contribution 1,50,000 1,00,000 50,000 Product C Rs. 2,50,00
0 1,50,000 1,00,000 Total Rs. 4,00,000 2,50,000 1,50,000 1,00,000 50,000
Fixed costs Profits
It means that existing total profits of Rs. 60,000 will reduce to Rs. 50,000 whi
ch will affect profitability adversely.
Marginal Costing
357

(2)
Profit Planning : Marginal costing, through the calculations of P/V Ratio, enabl
es the management to plan the activities in such a way that the profits can be m
aximised or to maintain a specific level of profits. As such, this technique hel
ps the planning of profits.
Illustration : (1) M/s. C and P Ltd. Produces and sells industrial containers an
d packing cases. Due to competition, the company proposes to reduce the selling
price. If the present level of profit is to be maintained, indicate the number o
f units to be sold if the proposed reduction in price is (a) 10% and (b) 15%. Th
e following information is available: Rs. (1) (2) (3) Present Sales (30,000 Unit
s) Variable Cost (30,000 Units) Fixed Cost 3,60,000 1,40,000 5,00,000 (4) Net Pr
ofit 1,00,000 Rs. 6,00,000
Solution : The present cost structure can be stated as below: Per Unit Rs. Sales
Variable Cost Contribution Fixed Cost Net Profit 20 12 8 Total Rs. 6,00,000 3,6
0,000 2,40,000 1,40,000 1,00,000
If the price is reduced by 10% or 15%, the per unit cost structure is going to c
hange as below : Present Rs. Sales Variable Cost Contribution 20 12 8 10% Price
Reduction Rs. 18 12 6 15% Price Reduction Rs. 17 12 5
358
Management Accounting

If the present level of profits is to be maintained i.e. Rs. 1,00,000, the revis
ed total contribution which the sales will have to generate with reduced per uni
t contribution will be Expected Profit + Fixed Cost, and the number of units whi
ch will have to be sold will be : Expected Profit + Fixed Cost Revised per unit
contribution As such, the number of units which will have to be sold in the abov
e cases of price reduction will be 10% Price Reduction Rs. 1,00,000 + Rs. 1,40,0
00 Rs. 6 = = (2) Rs. 2,40,000 Rs. 6 40,000 Units = = 15% Price Reduction Rs. 1,0
0,000 + Rs. 1,40,000 Rs. 5 Rs. 2,40,000 Rs. 5 48,000 Units
Per Unit cost structure of a single product manufacturing company is as below :
Selling Price Direct Material Direct Labour Variable overheads Rs. Rs. Rs. Rs. 1
00 60 10 10
Number of Units sold in the year are 5,035. As per the agreement with the employ
ees union, there will be an increase of 10% in Direct wages. Work out (a) How man
y more units have to be sold next year to maintain same quantum of profits. By w
hat percentage the selling price has to be raised to maintain same P/V Ratio?
(b)
Marginal Costing
359

Solution : The present profitability structure is as below : (i) (ii) Total numb
er of units sold Per unit cost structure Selling price Variable cost Direct Mate
rial Direct Labour Variable Overheads Rs. 60 Rs. 10 Rs. 10 Rs. 80 Contribution p
er unit (iii) Total Contribution Rs. 20 Rs. 1,00,700 Rs. 100 5,035
In the next year, the per unit Direct Labour Cost will be more by 10% i.e. Rs. 1
1 per unit which will reduce the per unit contribution to Rs. 19. Alternative (a
) : If the same quantum of profits is to be maintained, same amount of contribut
ion will have to be generated with reduced per unit contribution. As such, numbe
r of units required to be sold will be : = Amount of contribution Revised per un
it contribution Rs. 1,00,700 Rs. 19 5.300 Units
= =
Hence, the company will have to sell 265 units more (i.e. 5,300 Units - 5,035 Un
its) to maintain same quantum of profits. Alternative (b) : At present, when sel
ling price is Rs. 100, contribution is Rs. 20 meaning that per unit variable cos
t is Rs. 80. In future, the variable cost is likely to be Rs. 81 per unit instea
d of Rs. 80. Accordingly, the selling price will also be required to be increase
d if it is intended that the same P/V Ratio should be maintained. 360
Management Accounting

The new selling price will be : Rs. 81 Rs. 80 X 100 = Rs. 101.25
As such, the selling price has to be raised by 1.25% to maintain the same P/V Ra
tio. The profitability structure will be Selling Price Variable Cost Contributio
n P/V Ratio Rs. 101.25 Rs. 81.00 Rs. 20.25 = Contribution per unit Selling Price
per unit 20.25 101.25 (3) Fixation of Selling Price : The technique of marginal
costing may be applied in the area of price fixation in such a way that prices
fixed should cover atleast the variable cost. As in the short run, the fixed cos
t is a stagnant cost, it can be ignored, though it can not be ignored in the lon
g run because of the simple fact, that it is a cost. In the short run, the price
s fixed above the variable cost may generate some positive contribution which ma
y help in the recovery of fixed cost. However, if the fixed cost is ignored in t
he long run, it may put the business into serious troubles as the business will
never be able to earn the profits. In this connection, following propositions sh
ould be kept in mind. (a) In some exceptional circumstances viz. during the phas
e of depression, serious competition in the market, to introduce the new product
in the market by keeping the price as low as possible in the initial stages, to
dispose off the product which may deteriorate in quality etc., it may be necess
ary to fix the selling price even below the variable cost, however it is a delib
erate decision taken by the management. The above principle is equally applicabl
e while fixing the export price as well. The export price over and above the var
iable cost will result into increased amounts of profits if the fixed costs can
be taken care of by the inland sales and if the home market is not likely to get
affected by the export price fixed. However, if certain specific costs, either
fixed or variable, are required to be incurred specifically for the execution of
the export order, they will have to be recovered while fixing the export price
as if it is a part of the variable cost. 361 X 100 = 20% X 100
(b)
Marginal Costing

Illustration : (1) The operating statement of a company is as follows : Rs. Sale


s (80,000 Units @ Rs. 15) Costs Variable Materials Labour Overheads 2,40,000 3,2
0,000 1,60,000 7,20,000 Fixed Total Costs Profit 3,20,000 10,40,000 1,60,000 12,
00,000
The plant capacity is 1,00,000 units. A customer from U.S.A. is desirous of bayi
ng 20,000 units at a net price of Rs. 10 each unit. Advice the company whether o
r not offer should be accepted? Will your advice be different if the customer is
a local one? Solution : At present, variable cost per unit is Rs. 9 i.e. Rs. 7,
20,000 80,000 units So long as the export price is more than Rs. 9, it is going
to generate additional contribution which is going to increase the profits, as t
he fixed costs are already covered by the local sales. As the export price offer
ed is Rs. 10 i.e., Re. 1 more than the variable cost per unit, the company shoul
d accept the offer. The advice will be the same even it the customer is a local
one, provided the price discrimination, i.e. Rs. 15 per unit for 80,000 units an
d Rs. 10/- per unit for 20,000 units is not going to adversely affect the curren
t market for 80,000 units at the current price of Rs. 15. If the company accepts
the export offer of Rs. 10 per unit, the revised profitability structure will b
e as below: Rs. Sales : 80,000 units @ Rs. 15 20,000 units @ Rs. 10 12,00,000 2,
00,000 14,00,000
362
Management Accounting

Costs
:
Variable 1,00,000 units @ Rs. 9 Fixed Total costs 9,00,000 3,20,000 12,20,000 1,
80,000
Profit
The revised amount of profit will be more by Rs. 20,000 as compared to the exist
ing amount of profits. Hence, the export order should be accepted by the company
. (4) Make or buy decision : If the management is facing problem to decide wheth
er a component or a product should be manufactured in house which can be purchas
ed from an outside source as well, the technique of marginal costing may render
useful assistance. E.g. The following cost data is made available in respect of
two components A and B. Component A Rs. per unit If manufactured Variable Cost F
ixed Cost 30 25 55 If purchased 40 30 20 50 25 Component B Rs. per unit
If the above data is viewed from total cost point of view, without considering t
he classification of cost like fixed or variable, it may be concluded that the p
urchase proposition may be profitable for both the components A and B. However,
the conclusion may be misleading as the total cost in case of component A, if pu
rchased, is not going to be only Rs. 40 per unit, but it is going to be Rs. 65 (
i.e. Rs. 40 purchase price per unit plus Rs. 25 fixed cost per unit) which being
more than present total cost, manufacturing proposition will be beneficial. On
the other hand, in case of component B, total cost, if purchased, is going to be
Rs. 45/- per unit (i.e. Rs. 25 purchase price per unit plus Rs. 20 fixed cost p
er unit) which being less than present total cost, buying proposition will be be
neficial. The above conclusions may be simplified in the following way : If Purc
hases Price < Variable Cost, go in for purchase proposition. If Purchase Price >
Variable Cost, go in for manufacturing proposition.
Marginal Costing
363

Before taking any make or buy decision only on the basis of marginal cost analys
is, following points should also be taken into consideration. (1) If buying prop
osition is beneficial in case of a component or product, the final decision to b
uy may depend on other factors also viz. whether the supplier is reliable one, w
hether the supplier can assure required quality, whether the supplier can assure
uninterrupted supply etc. If it is decided to buy a component or a product whic
h was being manufactured till now, the manufacturing capacity released should be
profitably used for some other purposes. If it is decided to manufacture a comp
anent which was being purchased till now, there may be two possibilities. One, p
roduction capacity used for same component or product may be diverted to manufac
ture another component or product. In this case, the loss of contribution of tha
t another component or product should be considered as a part of cost. Second, i
f additional production facilities are required to be acquired for the manufactu
ring proposition, the additional fixed costs attached with the manufacturing pro
position should be considered.
(2)
(5)
Optimising product mix : Product mix refers to the proportion in which various p
roducts of a company can be sold. If a concern is dealing in a number of product
s, a problem which usually arises is to decide a mix or proportion in which the
sales of the various products should be made so that the profits can be maximize
d. Such a problem can be solved by studying the contributions generated by the v
arious products individually and by selecting that mix which generates the maxim
um total contribution.
Illustration : Following information has been made available from the cost recor
ds of Universal Automobiles Ltd. manufacturing spare parts Direct Materials per
unit X Rs. 8 Y Rs. 6 Direct wages X Y 24 hours @ 25 paise per hour. 16 hours @ 2
5 paise per hour.
Variable overheads - 150% of wages Fixed overheads - Rs. 750 Selling price X Y 3
64 Rs. 25 Rs. 20
Management Accounting

The Directors want to be acquainted with the desirability of adopting any one of
the following alternative sales mixes in the budget for the next period. (a) (b
) (c) (d) 250 units of X and 250 units of Y 400 units of Y only 400 units of X a
nd 100 units of Y 150 units of X and 350 units of Y
State which of the alternatives you would recommend to management. Solution : Pr
oductwise Profitability Structure Product X Rs. (1) (2) Selling Price per unit V
ariable cost per unit Direct Material Direct Wages Variable Overheads 8 6 9 23 (
3) Contribution per unit 2 6 4 6 16 4 25 Product Y Rs. 20
Evaluation of various alternative sales mixes as per Total Contribution Alternat
ive Product X Rs. 250 x 2 = 500 400 x 2 = 800 150 x 2 = 300 Product Y Rs. 250 x
4 = 1,000 400 x 4 = 1,600 100 x 4 = 400 350 x 4 = 1,400 Total Rs. 1,500 1,600 1,
200 1,700
a. b. c. d.
Fixed overheads are going to be the same in all these alternatives. As such, the
alternative which generates maximum contribution is the maximum profitable one.
As alternative d i.e. 150 units of X and 350 mills of Y generates maximum of con
tribution, it will be recommended to the management.
Marginal Costing
365

(6)
Cost control : Marginal costing is necessarily a technique of cost classificatio
n and cost presentation. The segregation of total costs as fixed costs and varia
ble costs itself facilitates the cost control. Variable costs are the controllab
le costs at the lower level of management whereas fixed costs can be controlled
only on the top level of management and that too, to a limited extent only. Clas
sification of costs as fixed costs and variable costs enables the management to
concentrate on the controllable costs. At the same time, the fixed costs are not
completely ignored. The only thing is that they are collected and reported sepa
rately as an amount deducted from total contribution. As such, the fixed costs c
an also be controlled as they can be programmed and estimated in advance.
(7)
Flexible Budget Preparation : Marginal costing technique and more particularly t
he classification of costs as fixed and variable, facilitates the preparation of
flexible budgets which is discussed in details in the chapter Budgetary Control.
PROBLEM OF KEY FACTOR : Under the marginal costing technique, profitability is m
easured in terms of the contribution and the products generating maximum contrib
ution or having maximum P/V Ratio are treated as the maximum profitable products
. As the intention of every business is to maximize the profits, the company wil
l concentrate maximum on the products having highest P/V Ratio and will thus max
imize the profits. However, in practice, there may be some factors which may com
e into play which may restrict the companys intention or capability to maximize t
he profits E.g. In case of the products having highest P/V Ratio, market may be
limited, or in case of a maximum profitable product, raw material may not be ava
ilable. These factors are in the form of Key Factor or Limiting Factor or Scarce Fact
or. A key factor is defined as the factor which, at a particular point of time or
over a period, will limit the volume of output. The key factor may be in variou
s forms viz. sales/market, material, labour, machine availability and so on. In
order to evaluate the profitability of a product under key factor situations, th
e contribution per unit of key factor is the basic criteria. A product generatin
g maximum contribution per unit of key factor is the maximum profitable product.
366
Management Accounting

Illustration : From the following details, which product would be recommended if


time is the key factor. Product A Direct Material per unit Direct Labour @ Rs.
2 per hour Variable Overheads (% of labour cost) Selling Price per unit Solution
: Product A (1) (2) Selling Price Unit Rs. Variable Cost per unit Rs. Direct Ma
terial Direct Labour Variable Overheads 24 20 40 84 (3) (4) (5) Contribution per
unit Rs. Number of labour hours Contribution per labour hour Rs. 66 10 6.6 14 3
0 90 134 66 15 4.4 150 Product B 200 Rs. 24 Rs. 20 200% Rs. 150 Product B Rs. 14
Rs. 30 300% Rs. 200
As labour hours is the key factor and contribution per labour hour is more in ca
se of product A, it will be recommended for production. Multiplicity of Key Fact
ors In practice, more than one key factors may come into play and any decision r
egarding product mix ascertainment or profitability ascertainment will have to b
e decided on the basis of consideration of multiplicity of key factors. The situ
ation of multiplicity of key factors is a more complex situation, the solutions
to which may be found in the more advanced techniques like linear programming.
Marginal Costing
367

Illustration : Following data is available to decide the product mix. A Raw mate
rial per unit Labour Hours required (Rate Rs. 1 per hour) Selling price per unit
Rs. Maximum production Possible Units 6,000 4,000 3,000 125 100 200 10 kgs 15 B
6 kgs 25 C 15 kgs. 20
1,00,000 kgs of raw material is available at Rs. 10 per kg. Maximum production h
ours are 1,84,000 with a facility for a further 15,000 hours on overtime basis a
t twice the normal wage rate. Solution : Product A (1) (2) Selling Price per uni
ts Rs. Variable cost Material Labour 100 15 115 (3) (4) (5) Contribution per uni
t Rs. Contribution per Kg of Raw material - Rs. Contribution per labour hrs Rs.
10 1.00 0.66 60 25 85 15 2.50 0.60 150 20 170 30 2.00 1.50 125 Product B 100 Pro
duct C 200
Considering the contribution per kg of raw material as well as per labour hour,
the rankings among the various products will be as below. I II III Product C Pro
duct B Product A
Hence, the available raw material and labour hours will be used for the manufact
ure of Product C and Product B respectively.
368
Management Accounting

Product C B
Units 3,000 4,000
Raw Material Kgs. 45,000 24,000 69,000
Labour Hours No. 60,000 1,00,000 1,60,000
Hence, the balance of raw material and labour hours available for manufacturing
of Product A will be as below. Raw Material - Kgs. 31,000 kgs. (i.e. 1,00,000 kg
s - 69,000 kgs)
Labour Hours - 24,000 (i.e. 1,84,000 - 1,60,000) Plus 15,000 extra hours by payi
ng double the normal wage rate. If extra labour hours are used for the manufactu
re of product A by paying double the normal wage rate, the cost structure of pro
duct A will be as below : (1) (2) Selling Price per unit Variable cost per unit
Material Labour Rs. Rs. Rs. (3) Contribution per unit 100 30 130 Rs. 125
(-) Rs. 5
As there cannot be the positive contribution generated, it will not be advisable
to use the labour hours which require the payment of wages at double the normal
wage rate. As such, product A will be manufactured by utilising the labour hour
s which require the payment of wages at the normal wage rate only i.e. 24,000 ho
urs with the help of which 1,600 units of A (24,000 Hours/ 15 Hours per unit) ca
n be manufactured. As such, the final product mix will be as below. Product A Pr
oduct B Product C 1,600 Units 4,000 Units 3,000 Units
Note : One alternate solution is possible to solve the problem of key factors. I
f the labour hours which require the payment of wages at double the normal wage
rate can be utilised for the manufacture of Product C, its cost structure will b
e as below.
Marginal Costing
369

(1) (2)
Selling Price Per Unit Variable cost per unit Material Labour
Rs. 200
Rs. 150 Rs. 40
Rs. 190 (3) Contribution per unit Rs. 10
As such, apparently it may be possible to utilise the labour hours carrying doub
le the normal wage rate for manufacturing product C and utilise the released lab
our hours carrying the normal wage rate for manufacturing Product A (i.e. 15,000
hours) In this case, the final product mix will be as below. Product A Product
B Product C 2,600 Units 4,000 Units 3,000 Units
The calculation of total contribution generated under both those alternatives is
as below. Alternative I Product No. of Units Contribution Per Unit Rs. 10 15 30
Total Contribution Rs. 16,000 60,000 90,000 1,66,000 Alternative II Product No.
of Units Contribution Per Unit Rs. 10 15 30 10 Total Contribution Rs. 26,000 60
,000 67,500 7,500 1,61,000 As in the second alternative, the total contribution
generated is less than the one generated in the first alternative, the second al
ternative can not be accepted. As such, it will be advisable for the company not
to utilise the labour hours requiring the payment of wages at double the normal
wage rate. 370
Management Accounting
A B C
1,600 4,000 3,000
A B C C
2,600 4,000 2,250 750

LIMITATIONS OF MARGINAL COSTING (1) The classification of total cost as variable


cost and fixed cost is difficult. No cost can be completely variable or complet
ely fixed. In some cases, the cost which is considered to be variable, may not b
e variable in practical terms E.g. Direct Labour Cost. Under normal situations t
his cost is treated as variable cost. However, in India, considering the tremend
ous legal backing the workers are having, the direct labour cost may not be vari
able in nature. As such, it may be necessary to consider the direct labour cost
as a part of fixed cost. Under the marginal costing, the fixed costs are elimina
ted for the valuation of inventory of finished goods and semi-finished goods, in
spite of the fact that they might have been actually incurred. As such, it is no
t correct to eliminate the fixed costs. Further, such an elimination affects the
profitability adversely. In the age of increased automation and technological d
evelopment, the component of fixed costs in the overall cost structure may be si
zeable. Any technique like marginal costing which ignores the fixed costs altoge
ther, may not be proper under these circumstances as a major portion of cost is
not taken care of. Marginal costing technique does not provide any standard for
the evaluation of performance. In that sense, the techniques of budgetory contro
l and standard costing may be considered to be better techniques from cost contr
ol point of view. Fixation of selling price on marginal cost basis may be useful
for short term only. Here also, an undue importance given to only variable cost
may result into taking on heavy business with low margin which in turn may incr
ease the fixed costs. As such, over the long run, the prices should be decided o
n total cost basis only. Fixation of selling price on the marginal cost basis in
the long run may be dangerous. Moreover, consideration of fixed costs may be ne
cessary in price fixation under certain circumstances like cost plus contracts u
nless a very high percentage over the marginal cost is considered to take care o
f both fixed costs as well as profit margin. Marginal costing does not take into
consideration the fixed overheads, as such the problem of under or over absorpt
ion of fixed overheads can be avoided. But the problem of under or over absorpti
on of variable overheads cannot be avoided. Marginal costing can be used for ass
essment of profitability only in the short run. However, in the long run, one ha
s to consider the fixed costs also in order to assess the profitability. Moreove
r, interpretation of the term short run is a subjective concept. For how long the
decision can be taken on the basis of marginal costing principles cannot be deci
ded in the objective manner.
(2)
(3)
(4)
(5)
(6)
(7)
Marginal Costing
371

ILLUSTRATIVE PROBLEMS (1) Profit and sales for the year 1984 are as follows. Pro
fit Rs. 18,000, Sales Rs. 2,40,000. In 1985, the sales increased by Rs. 40,000 a
nd the profit naturally increased by Rs. 8,000. You are required to calculate. (
1) (2) (3) P/V Ratio Sales required to achieve a profit of Rs. 1,00,000. Sales a
t Break even Point.
Solution : We know that P/V Ratio = Increase in Profits Increase in Sales P/V Ra
tio = 8,000 40,000 We also know that Sales x P/V Ratio = Contribution and Contri
bution - Profit = Fixed Cost. Applying this to the information available for the
year 1984 2,40,000 x 20% = Rs. 48,000 is the contribution and 48,000 - 18,000 =
Rs .30,000 is the fixed cost If the company wants to achieve the profit of Rs.
1,00,000 the total contribution which will have to be generated will be Expected
Profit + Fixed cost i.e. Rs. 1,00,000 + Rs. 30,000 i.e. Rs. 1,30,000 We know th
at Sales = Contribution P/V Ratio As such sales required to achieve a profit of
Rs. 1,00,000 will be Expected Profit + Fixed Cost P/V Ratio X 100 = 20% ...(a) X
100
372
Management Accounting

=
1,00,000 + 30,000 20%
= We know that Break Even Point
1,30,000 20%
=
Rs. 6,50,000
...(b)
=
Fixed Cost P/V Ratio
Sales at Break Even Point
=
30,000 20% (c)
= Rs. 1,50,000 (2)
The Directors of Sports Material Manufacturing Co. gives the following informati
on. Sales - (1,00,000 Units) Variable Costs Fixed Costs (a) (b) - Rs. - Rs. - Rs
. 1,00,000 40,000 50,000
Find out P/V Ratio, Break Even Point and Margin of Safety. Evaluate the effects
on P/V Ratio, Break Even Point and Margin of safety of the following (i) (ii) (i
ii) (iv) 20% increase in physical sales volume. 10% increase in fixed costs. 5%
decrease in variable costs. 10% increase in selling price.
Solution : (A) Present profitability structure is as below. Sales - 1,00,000 Uni
ts Per Unit (Rs.) Sales Variable Costs Contribution Fixed Costs Profit 1.00 0.40
0.60 Total (Rs.) 1,00,000 40,000 60,000 50,000 10,000
Marginal Costing
373

(1)
P/V Ratio Contribution Sales X 100 = 60,000 1,00,000 X 100 = 60%
(2)
Break Even Point Fixed Cost P/V Ratio = 50,000 60% = Rs. 83,333
(3)
Margin of Safety Profit P/V Ratio = 10,000 60% = Rs. 16,667
(B) Effect of 20% increase in Physical Sales Volume. Revised Profitability struc
ture will be as below. Sales 1,20,000 Units Per Unit (Rs.) Sales Variable Costs
Contribution Fixed Costs Profit (1) P/V Ratio Contribution Sales (2) Break Even
Point Fixed Cost P/V Ratio (3) Margin of Safety Profit P/V Ratio = 22,000 60% =
Rs. 36,667 = 50,000 60% = Rs. 83,333 X 100 = 72,000 1,20,000 X 100 = 60% 1.00 0.
40 0.60 Total (Rs.) 1,20,000 48,000 72,000 50,000 22,000
374
Management Accounting

(C) Effect of 10% increase in fixed costs. Revised profitability structure will
be as below : Sales 1,00,000 Units Per Unit (Rs.) Sales Variable Costs Contribut
ion Fixed Costs Profit (1) P/V Ratio Contribution Sales (2) X 100 = 60,000 1,00,
000 X 100 = 60% 1.00 0.40 0.60 Total Rs. 1,00,000 40,000 60,000 55,000 5,000
Break Even Point Fixed Cost P/V Ratio = 55,000 60% = Rs. 91,667
(3)
Margin of Safety Profit P/V Ratio = 5,000 60% = Rs. 8,333
(D) Effect of 5% decrease in variable costs. Revised profitability structure wil
l be as below. Sales 1,00,000 Units Per Unit (Rs.) Sales Variable Costs Contribu
tion Fixed Costs Profit (1) P/V Ratio Contribution Sales X 100 = 62,000 1,00,000
X 100 = 62% 1.00 0.38 0.62 Total (Rs.) 1,00,000 38,000 62,000 50,000 12,000
Marginal Costing
375

(2)
Break Even Point Fixed Cost P/V Ratio = 50,000 62% = Rs. 80,645
(3)
Margin of Safety Profit P/V Ratio = 12,000 62% = Rs. 19,355
(E) Effect of 10% increase in selling price. Revised Profitability structure wil
l be as below. Sales 1,00,000 Units Per Unit (Rs.) Sales Variable Costs Contribu
tion Fixed Costs Profit (1) P/V Ratio Contribution Sales (2) X 100 = 70,000 1,10
,000 X 100 = 63.64% 1.10 0.40 0.70 Total (Rs.) 1,10,000 40,000 70,000 50,000 20,
000
Break Even Point Fixed Cost P/V Ratio = 50,000 63.64% = Rs. 78,567
(3)
Margin of Safety Profit P/V Ratio = 20,000 63.64% = Rs. 31,426
Note : The difference between Sales and Break Even Point is not matching with Ma
rgin of Safety, due to the rounding off differences. (3) From the following figu
res find out the break even volume. Selling Price per tonne Variable Cost per to
nne Fixed Expenses Rs. 69.50 Rs. 35.50 Rs. 18,02,000
376
Management Accounting

If this volume represents 40% capacity, what is the additional profit for an add
ed production of 40% capacity, the selling price of which is 10% lower for 20% c
apacity production and 15% lower, than the existing price, for the other 20% cap
acity. Solution : Selling Price per Unit Variable cost per Unit Contribution per
Unit Break Even Point (in terms of quantity) = = = Rs. 69.5 Rs. 35.5 Rs. 34.0 F
ixed Cost Contribution per Unit Rs. 18,02,000 Rs. 34 53,000 Units
Additional production of 53,000 units is envisaged, which can be classified in t
wo parts for convenience purposes. Part I Selling Price per Unit Variable Cost p
er Unit Contribution per Unit Number of Units Total Contribution Rs. Rs. 62.55 R
s. 35.50 Rs. 27.05 26,500 7,16,825.00 Part II 59.075 35.500 23.575 26,500 6,24,7
37.50
As the fixed cost is already covered till the break even point, the contribution
beyond the break even point will directly result into profit. Hence, additional
profit will be Rs. 7,16,825.00 + Rs. 6,24,137.50 = Rs. 13,41,562.50. (4) The Qu
ality Product Ltd. manufacture and markets a single product Following data is av
ailable. Rs. Per Unit Material Conversion (Variable) Dealers Margin Selling Price
Fixed Cost - Rs. 5,00,000 Present Sales - 90,000 Units Capacity Utilisation - 6
0%
Marginal Costing
16 12 4 40
377

There is acute competition. Extra efforts are necessary to sell. Suggestions hav
e been made for increasing sales. (a) (b) By reducing sales price by 5%. By incr
easing dealers margin by 25% over the existing rate.
Which of these two suggestions would you recommend if the company desires to mai
ntain present profits. Give reasons. Solution : The present profitability statem
ent will be as below, when 90,000 units are being sold. Per Unit (Rs.) (a) (b) S
ales Variable Costs Material Conversion Dealers Margin 16 12 4 32 (c) (d) (e) Con
tribution a b Fixed cost Profit c d 8 14,40,000 10,80,000 3,60,000 28,80,000 7,2
0,000 5,00,000 2,20,000 40 Total (Rs.) 36,00,000
Alternative I To reduce selling price by 5%. In this alternative the profitabili
ty structure will be revised as below. Selling Price per Unit Variable Cost per
Unit Contribution per Unit Rs. 38 Rs. 32 Rs. 06
If the company wishes to maintain the same profits, the total contribution which
the sales will have to generate with the reduced amount of per unit contributio
n will be Expected Profits + Fixed Cost. And total number of units to be sold wi
ll be No. of Units to be sold = Expected Profit + Fixed Cost Revised contributio
n per Unit 2,20,000 + 5,00,000 6 1,20,000 Units
= =
378
Management Accounting

Alternative II To increase the dealers margin by 25%. In this alternative, the va


riable cost will be more by Rs. 1 and the profitability structure will be revise
d as below. Selling Price per Unit Variable cost per Unit Contribution per Unit
Rs. 40 Rs. 33 Rs. 07
If the company wishes to maintain the same profits, the total contribution which
the sales will have to generate with the reduced amount of per unit contributio
n will be Expected Profits + Fixed Cost. And total number of units to be sold wi
ll be No. of Units to be sold = Expected Profit + Fixed Cost Revised contributio
n per unit 2,20,000 + 5,00,000 7 1,02,857 Units
=
=
Acute competition in the market is the basic problem area. As such, the company
will like to accept the alternative where less number of units will be required
to be sold, the profits remaining the same under both the alternatives. As Alter
native II requires 1,02,857 Units to be sold vis-a-vis 1,20,000 units required t
o be sold under Alternative I, the company will prefer Alternative II. Note : It
is assumed that both the alternatives are exclusive alternatives i.e. Even when
selling price is reduced by 5%, the dealers margin is unaffected and vice versa.
(5) Frazer Ltd. manufactures and sells a product, the selling price and raw mat
erial cost of which have remained unchanged during the past two years. The follo
wing are the relevant data: Year 1 100 Rs. 20,000 Rs. 10,000 Rs. 3,000 Rs. 5,000
Rs. 2,000 Year 2 150 ? ? ? Rs. 5,700 Rs. 2,550
Particulars Quantity sold (Kgs.) Sales Value Raw Material Direct Wages Factory O
verheads Profit
Marginal Costing
379

During year 2, direct wage rates increased by 50% but there was a saving of Rs.
300 in fixed factory overheads. Required : What quantity in Kgs. the company sho
uld have produced and sold in year 2 in order to maintain the same amount of net
profit per Kg. as it earned during the year 1? Solution : The Profitability sta
tement for both the years is as below Year 1 Quantity Sold (Kgs.) Sales (Rs.) Va
riable Cost Raw Material Direct Wages Variable Factory Overheads Total Variable
Cost Contribution Fixed Cost Profit Profit per Kg. (Rs.) 10,000 3,000 2,000 15,0
00 5,000 3,000 2,000 20 15,000 6,750 3,000 24,750 5,250 2,700 2,550 17 100 20,00
0 Year 2 150 30,000
Per Unit Variable Cost in Year 2 works out to Rs. 165 i.e. Rs. 24,750 / 150 Kgs.
Let us assume that the quantity to be sold in Year 2 is X Kgs. Hence, the profi
tability statement will be 200X - 165X - 2700 = 20X Solving for X, we get the va
lue of X to be 180 Kgs. Hence, the company should have produced and sold 180 Kgs
. in year 2 in order to maintain the same amount of net profit per Kg. as it ear
ned during Year 1. Working Note Factory Overheads in Year 1 were Rs. 5,000 which
became Rs. 5,700 in Year 2 with the information that there was a saving of Rs.
300 in fixed factory overheads. Assuming that there was no saving, the factory o
verheads would have been Rs. 6,000 in Year 2. Hence, the data would have been as
below 380
Management Accounting

Year 1 Quantity Sold (Kgs.) Factory Overheads (Rs.) 100 5,000


Year 2 150 6,000
For the increased quantity of 50 Kgs. the overheads would have increased by Rs.
1,000. It means that the variable factory overheads are Rs. 20 per unit. (6) Gar
den Products Limited manufacture the Rainpour garden pour. The accounts of the com
pany for the year 1981 are expected to reveal a profit of Rs. 14,00,000 from the
manufacture of Rainpour after charging fixed costs of Rs. 10,00,000. The Rainpour i
s sold for Rs.50 per unit and has a variable unit cost of Rs. 20. Market sensiti
vity tests suggest the following responses to price changes. Alternatives A B C
Selling Price Reduced by 5% 7% 10% Quantity sold increased by 10% 20% 25%
Evaluate these alternatives and state which, on profitability consideration, sho
uld be adopted for the forthcoming year, assuming cost structure unchanged from
1981. Solution : At present, the expected profit is Rs. 14,00,000 after recoveri
ng the fixed cost of Rs. 10,00,000. Hence, the total expected contribution is Rs
. 24,00,000 i.e. Rs. 14,00,000 + Rs. 10,00,000. Per Unit cost structure is as be
low. Selling Price Variable Cost Rs. 50 Rs. 20
Contribution Rs. 30 If total contribution is Rs. 24,00,000 and per unit contribu
tion is Rs. 30, it means that the presently expected sales in terms of quantity
are 80,000 units.
Marginal Costing
381

In the light of above, the results of the various alternatives can be calculated
as below.
Alternatives Price Per Unit 1 Revised Selling Per Unit 2 Revised contribution Pe
r Unit 3 Revised sold Quantity 4 Revised total contribution 5(3x4)
A B C
47.50 46.50 45.00
27.50 26.50 25.00
88,000 96,000 100,000
24,20,000 25,44,000 25,00,000
As profitability is the criteria on which the various alternatives are to be eva
luated, Alternative B will be selected, as it generates maximum contribution, fi
xed cost remaining the same under all the alternatives. (7) Shri Kiron manufactu
res Lighters. He sells his product at Rs. 20 each and makes profit of Rs. 5 on e
ach lighter. He worked 50% of his machinery capacity at 50,000 lighters. The cos
t of each lighter is as under. Rs. Direct Material Wages Works Overheads Sales E
xpenses 6 2 5 (50% fixed) 2 (25% variable)
His anticipation for the next year is that the cost will go up as under. Fixed C
harges Direct Labour Material 10% 20% 5%
There will not be any change in selling price. There is an additional order for
20,000 lighters in the next year. What is the lowest rate he can quote so that h
e can earn the same profit as the current year?
382
Management Accounting

Solution : The profitability statement in the current year is as below : Sales 5


0,000 Units Per Unit (Rs.) (A) Sales (B) Variable Costs Direct Material Wages Wo
rks overheads Sales Expenses 6.00 2.00 2.50 0.50 11.00 (C) Contribution (A B) (D
) Fixed Costs Works Overheads Sales Expenses 2.50 1.50 1,25,000 75,000 2,00,000
(E) Profits (C D) 2,50,000 9.00 3,00,000 1,00,000 1,25,000 25,000 5,50,000 4,50,
000 20.00 Total (Rs.) 10,00,000
In the next year, material cost will increase by 5% i.e., by 30 paise and direct
labour cost will increase by 20% i.e., by 40 paise. As such, the total variable
cost will increase by 70 paise. Hence, the total variable cost will be Rs. 11.7
0 per unit. The revised profitability structure for 50,000 unit will be : Sellin
g price per unit Variable cost per unit Contribution per unit Total contribution
Rs. 20.00 Rs. 11.70 Rs. 8.30 Rs. 4,15,000
In the next year, fixed charges will increase by 10% i.e., total fixed charges o
f Rs. 2,00,000 in this year will become Rs. 2,20,000. As we know that Contributi
on - Fixed Charges = Profit, the profit generate by 50,000 units will be Rs. 4,1
5,000 Rs. 2,20,000 = Rs. 1,95,000
Marginal Costing
383

If in the next year, the company wants to earn the same total profits as in the
current year i.e. Rs. 2,50,000 there will be a shortfall of Rs. 55,000 i.e., Rs.
2,50,000 - Rs. 1,95,000 and the shortfall will have to be recovered by addition
al 20,000 units proposed to be sold in the next year. Hence, over and above the
variable cost, each of these additional units will have to recover the profit of
: Rs. 55,000 20,000 units = Rs. 2.75 per Unit
Hence, the lowest rate which can be quoted will be : Expected variable cost per
unit in the next year + Expected profit per unit in the next year i.e., Rs. 11.7
0 + Rs. 2.75 = Rs. 14.45 per unit (8) Following details are available in respect
of a single product manufacturing company operating at 75% capacity. Units Sold
Selling Price Per Unit Material Cost Labour hours required Labour hour rate Var
iable expenses Fixed cost 15,000 Rs. 12.5 Rs. 3 per Unit 2 per unit Re. 1 per ho
ur 200% of labour cost Rs. 20,000
The company has received an offer to export 8,000 units. Due to the Government b
acking, the material will be available at a price lower by 25% than the existing
price. An additional expenditure of Rs. 10,000 will have to be incurred for exe
cution of this export order. But an export incentive is available from the Gover
nment which will be equivalent to 25% of the export price. What minimum price sh
ould be charged if it is intended that per unit exported should earn a clear mar
gin of Rs. 2 and the profits from inland sales remaining the same. Ignore the be
nefits available as per the provisions of Income Tax Act, 1961 and the time requ
ired to receive the export incentive in cash since the date of actual export. As
sume that Selling price in inland market cannot be increased.
384
Management Accounting

Solution : Present cost structure is as below: Sales -15,000 Units Per Unit (Rs.
) (A) (B) Selling price Variable Costs Material Cost Labour Cost Variable Expens
es 3.00 2.00 4.00 9.00 (C) (D) (E) Contribution (A - B) Fixed Cost Profit (C D)
3.50 45,000 30,000 60,000 1,35,000 52,500 20,000 32,500 12.50 Total (Rs.) 1,87,5
00
When sales are 15,000 Units, capacity utilisation is 75%. It means that maximum
20,000 units can be sold both in inland or export market. The export order recei
ved is for 8,000 units. Now, the company has two alternatives. Alternative I : A
lternative II : Accept the export order only for 5,000 units which can be manufa
ctured. Accept the export order for 8,000 units by reducing the inland sales by
3,000 units. Only 5,000 Units to be exported.
Alternative I :
The amounts which export price will have to cover are as below: Per Unit (Rs.) M
aterial Cost Labour Cost Variable Expenses Additional Expenditure (Rs. 10,000 di
stributed over 5,000 units) Expected margin 2.00 2.00 12.25 The above amount can
be covered either by way of export price of the export incentive which is 25% o
f export price. If we assume export price to be Rs. x, the following relationshi
p is established.
Marginal Costing
2.25 2.00 4.00
385

x i.e. i.e. i.e.


+ 25% of x +
x x 4 5x 4 x
= = = =
12.25 12.25 12.25 9.80
Hence, export price should be minimum Rs. 9.80. Alternative II : 8,000 units to
be exported, inland sales being only 12,000 units.If 8,000 units are to be expor
ted, inland sales will be less by 3,000 units, which will result in the loss of
contribution of Rs. 10,500 (i.e. 13000 units x Rs. 3.50 per unit) This loss of c
ontribution also will have to be covered by the units to be exported, as the sel
ling price in the inland market can not be increased. As such per unit amount to
be covered by export price is as below: Rs. 12.25 (As calculated in Alternative
1) plus Rs. 10,500 8,000 units = Rs. 12.25 + Rs. 1.3125 = Rs. 13.5625 This amou
nt can be covered either by way of export price or by export incentive, which is
25% of export price. Assuming export price to be Rs. x, x + 25% of x x+ x 4 5x
4 x = = 13.5625 13.5625 = Rs. 1.3125
= 13.5625 = 10.85
Hence export price should be minimum Rs. 10.85
386
Management Accounting

(9)
A Ltd. operating at 75% level of activity produces and sells two products X and
Y. The cost sheets of these two products are as under : Product X 3,000 115 Prod
uct Y 2,000 95
Particulars Units produced and sold Selling Price Per Unit (Rs.) Cost : Direct M
aterials Direct Labour Factory Overheads (40% fixed) Administration & Selling Ov
erheads (60% fixed) Total Cost Per Unit
10 20 25
20 20 15
40 95
25 80
Factory overheads are absorbed on the basis of machine hour rate which is the li
miting factor. The machine hour rate is Rs. 10 per hour. The company receives an
offer from Japan for the purchase of Product X at a price of Rs. 87.50 per unit
. Alternatively, the company has another offer from Bangkok for the purchase of
Product Y at a price of Rs. 77.50 per unit. In both the cases, a special packing
charge of Rs. 2.50 per unit has to be borne by the company. The company can acc
ept either of the two export orders by utilising the balance of 25% of its capac
ity. Advise the company with the detailed workings as to which proposal should b
e accepted and prepare a statement showing the overall profitability of the comp
any after incorporating the export proposal suggested by you. Solution : The exi
sting profitability structure as per marginal costing works out as below Product
X Selling Price Variable Cost Direct Materials Direct Labour Factory Overheads
Administration & Selling Overheads 10 20 15 16 61 Contribution 54 20 20 9 10 59
36 115 Product Y 95
Marginal Costing
387

Hence, Total Contribution Product X - 3000 Units x Rs. 54 per unit = Product Y 2000 Units x Rs. 36 per unit = Rs. 1,62,000 Rs. 72,000 Rs. 2,34, 000 Fixed Cost
can be calculated as below: Product X - 3000 Units x Rs. 34 per unit = Product
Y - 2000 Units x Rs. 21 per unit = Rs. 1,02,000 Rs. 42,000 Rs. 1,44,000 Hence, p
rofit i.e. Contribution - Fixed Cost Rs. 90,000. As Factory Overheads as absorbe
d on the basis of machine hour rate and as machine hour rate is Rs. 10, Product
X takes 2.5 hours and Product Y takes 1.5 hours. Hence, the total number of hour
s consumed by the existing level of activity can be calculated as below: Product
X - 3000 Units x 2.5 hours per unit = Product Y - 2000 Units x 1.5 hours per un
it = 7,500 hours 3,000 hours 10,500 hours As 10,500 hours are equivalent to 75%
level of activity, balance number of hours available for the execution of the ex
port order are 3,500 which is equivalent to balance 25% level of activity. With
the balance number of hours available, the maximum number of units which can be
manufactured for export order work out as below: Product X - 3,500 hours / 2.5 h
ours per unit = 1,400 units Product Y - 3,500 hours / 1.5 hours per unit = 2,333
units The contribution generated by the units to be exported can be worked out
as below : Product X Selling Price (Net of packing charge) Variable Cost Contrib
ution 85 61 24 Product Y 75 59 16
Total contribution generated by executing the export order can be worked out as
below: Product X - 1400 Units x Rs. 24 per unit = Rs. 33,600 Product Y - 2333 Un
its x Rs. 16 per unit = Rs. 37,328
388
Management Accounting

As the contribution generated by exporting Product Y is higher, it will be profi


table to export Product Y. Hence, the total profitability works out as below: Ex
isting Profits Contribution generated by exports Total Profits Rs. 90,000 Rs. 37
,328 Rs. 1,27,328
(10) A Ltd. manufactures three different products and the following information
has been collected from the books of account. S Sales Mix Selling Price Variable
Cost Total Fixed costs Total Sales 35% Rs. 30 Rs. 15 Rs. 1,80,000 Rs. 6,00,000
Product T 35% Rs. 40 Rs. 20 Y 30% Rs. 20 Rs. 12
The company has currently under discussion a proposal to discontinue the manufac
ture of product Y and replace it with product M, when the following results are
anticipated: S Sales Mix Selling Price Variable Cost Total Fixed Cost Total Sale
s 50% Rs. 30 Rs. 15 Rs. 1,80,000 Rs. 6,40,000 Product T 25% Rs. 40 Rs. 20 M 25%
Rs. 30 Rs. 15
Will you advice the company to changeover to production of M? Give reasons for y
our answer. Solution : PRESENT PROFITABILITY STRUCTURE : S Rs. (1) (2) (3) (4) (
5) (6) Sales Selling Price per Unit Variable Cost per Unit Contribution per Unit
Units Sold (1/2) Total Contribution (4X5) = Rs. 2,82,000 2,10,000 30 15 15 7,00
0 1,05,000 Product T Rs. 2,10,000 40 20 20 5,250 1,05,000 Y Rs. 1,80,000 20 12 8
9,000 72,000
Marginal Costing
389

PROPOSED PROFITABILITY STRUCTURE : S Rs. (1) (2) (3) (4) (5) (6) Sales Selling P
rice per Unit Variable cost per Unit Contribution per Unit Units Sold (1/2) Tota
l contribution (4X5) = Rs. 3,20,000 3,20,000 30 15 15 10,667 1,60,005 Product T
Rs. 1,60,000 40 20 20 4,000 80,000 M Rs. 1,60,000 30 15 15 5,333 79,995
As the total contribution in the proposed alternative i.e. to change over to pro
duction of M is likely to be more than in the present situation, the company sho
uld change over to production of M. (11) The budgeted results of A Co. Ltd. incl
ude Product A B C Sales Value (Rs.) 50,000 80,000 1,20,000 P/V Ratio (%) 50 40 3
0
Fixed overheads for the period were Rs. 1,00,000. The Directors are worried abou
t the results of the company. They have requested you to prepare a statement sho
wing the amount of loss expected and recommend a change in the sales of each pro
duct or in total mix which will eliminate the expected loss. Solution : We know
that (1) (2) Sales x P/V Ratio = Contribution Contribution - Fixed Cost = Profit
Product A B C Sales Value (Rs.) 50,000 80,000 1,20,000 2,50,000 Less Fixed Cost
Profit P/V Ratio 50% 40% 30% Contribution 25,000 32,000 36,000 93,000 1,00,000
(-) 7,000
390
Management Accounting

Hence, the expected loss is Rs. 7,000. To eliminate the expected loss, the sales
of individual products may be increased, depending upon the P/V Ratio. The addi
tional sales required to be achieved will be calculated as Loss to be eliminated
P/V Ratio Hence, additional sales will be as below : Product A - 7,000/50% = Rs
. 14,000. Product B - 7.000/40% = Rs. 17,500. Product C - 7,000/30% = Rs. 23,333
. As an alternative, the overall sales may also be increased to eliminate the ex
pected loss as stated below: At present, overall P/V Ratio is Contribution Sales
X 100 = 93,000 2,50,000 X 100 = 37.2%
To cover the expected loss, the additional sales which will be required to be ma
de will be Expected Loss Overall P/V Ratio = 7,000 37.2 % = Rs. 18,817
These
000 :
ution
ional
ix as
% 40%

additional sales may be increased in the existing proportion only i.e. 50,
80,000 : 1,20,000. Hence, the productwise additional sales and the contrib
generated by these additional sales will be as below : Product A B C Addit
Sales Rs. 3,763 6,021 9,033 18,817 (12) A Ltd. been producing a standard m
below : Product X 15,000 units. Product Y and Z 10,000 units. P/V Ratio 50
30% Contribution Rs. 1,882 2,408 2,710 7,000

Marginal Costing
391

The total variable costs amount to Rs. 2,09,000 and the variable cost ratio amon
g the products is 1 : 1.5 : 1.75 respectively per unit The fixed, charges amount
to Rs. 2 per unit. Selling prices are Rs. 6.40 for X, Rs. 7.60 for Y and Rs. 10
.70 for Z. It is desired to change the mix as below : Product X Y Z Which mix sh
ould be recommended? Solution : The variable cost ratio among products X, Y and
Z is I : 1.5: 1.75 respectively per unit. If all the products are expressed in t
erms of Product X, it can be as below : Product X Product Y Product Z 15,000 uni
ts 15,000 units (10,000 x 1.5) Mix 1 18,000 12,000 7,000 Mix 2 15,000 6,000 13,0
00 Mix 3 22,000 8,000 8,000
- 17,500 units (10,000 x 1.75) 47,500 Units
Total Variable cost is Rs. 2,09,000. Hence, per unit variable cost will be as be
low: Product X Product X Product Z Rs. 2,09,000 47,500 Rs. 4.40 X 1.5 = = Rs. 6.
60 Rs. 7.70 Product Y Rs. 7.60 6.60 1.00 Product Z Rs. 10.70 7.70 3.00 = Rs. 4.4
0
Rs. 4.40 X 1.75
Product X Rs. Selling Price Less : Variable Cost Contribution 6.40 4.40 2.00
392
Management Accounting

The total contribution generated by various alternative mixes will be as below :


MIX 1 X Y Z 18,000 x 2 12,000 x 1 7,000 x 3 Rs. 36,000 12,000 21,000 69,000 Mix
2 X Y Z 15,000 x 2 6,000 x 1 13,000 x 3 30,000 6,000 39,000 75,000 Mix 3 X Y Z
22,000 x 2 8,000 x 1 8,000 x 3 44,000 8,000 24,000 76,000 As Mix 3 generates max
imum contribution, it will be recommended. Fixed cost will be ignored, as it wil
l be same under all the circumstances. (13) A firm can produce three different p
roducts from the same raw material using the same production facilities. The req
uisite labour is available in plenty at Rs.8 per hour for all the products. The
supply of raw material which is imported at Rs.8 per Kg. is limited to 10,400 Kg
s. for the budget period. The variable overheads are RS.5.60 per hour. The fixed
overheads are Rs. 50,000. The selling commission is 10% on sales. a. From the f
ollowing information, you are required to suggest the most suitable sales mix wh
ich will maximise the firmss profits. Also determine the profit that will be ea
rned at that level : Market Demand Units 8,000 6,000 5,000 Selling Price Per uni
t (Rs.) 30 40 50 Labour Hours Per Unit (Rs.) 1 2 1.5 Raw Material Per Unit (Kgs.
) 0.7 0.4 1.5
Product x y z b.
Assume, in the above situation, if additional 4,500 Kgs of raw material is made
available for production, should the firm go in for further production, if it wi
ll result in 393
Marginal Costing

the additional fixed overheads of Rs.20,000 and 25% increase in the rates per ho
ur for labour and variable overheads ? Solution : The profitability statement is
as below : X Selling Price per unit (Net of commission) Variable Cost per unit
Raw Material Direct Labour Variable Overheads Total Variable Cost Contribution p
er unit Contribution per Kg. of Raw Material 27.00 Y 36.00 Z 45.00
5.60 8.00 5.60 19.20 7.80 11.14
3.20 16.00 11.20 30.40 5.60 14.00
12.00 12.00 8.40 32.40 12.60 8.40
As availability of raw material is the key factor, the order of preference among
the products will be Y, X and Z. 6,000 units of Y consume 2,400 Kgs. of materia
l. Balance left for X and Z are 8,000 Kgs. 8,000 units of X consume 5,600 Kgs. o
f material. Balance left for Z are 2,400 Kgs. With 2,400 Kgs. of material, maxim
um possible production for Z will be 1,600 units i.e. 2,400 / 1.5 Hence, the mos
t suitable sales mix and said sales mix will be Product No. of Units Contributio
n Per Unit Rs. 5.60 7.80 12.60 Total Contribution Rs. 33,600 62,400 20,160 1,16,
160 50,000 66,160
Y X Z Less : Fixed Cost Profit
6,000 8,000 1,600
394
Management Accounting

If additional 4,500 Kgs. of raw material is made available, the additional 3,000
units of Z can be sold. However, the profitability per unit of Z will be differ
ent as below : Selling Price Variable Cost Direct Material Direct Labour Variabl
e Overheads Total Variable Cost Contribution 12.00 15.00 10.50 37.50 7.50 45.00
Total Contribution generated by these 3,000 units will be Rs. 22,500 i.e. 3,000
units x Rs. 7.50 per unit. As the fixed overheads are also likely to increase by
Rs. 20,000, the additional 3,000 units will generate positive contribution of R
s. 2,500. Hence, it is advisible to go for further production with the additiona
l raw material available. (14) The following particulars are obtained from the r
ecords of a factory manufacturing Products A and B. Product A (Per unit) Selling
Price Material Cost at Rs. 10 per Kg. Wages @ Rs. 3 per hour Variable overheads
Total fixed costs : Rs. 5,000 State which of the product is better to be produc
ed and why in the following cases: (a) (b) (c) (d) (e) If total sales in units i
s key factor If total sales in value is key factor If law material is in short s
upply If labour hours is the Limiting factor If raw material available is 2,000
kgs. and maximum sales of each product is 500 units, advice about the sales mix.
100 20 30 10 Product B (Per Unit) 200 50 60 20
Marginal Costing
395

Solution : Product A Per Unit Rs. (1) (2) Selling Price Variable cost : Material
Wages Variable Overheads 20 30 10 60 (3) (4) (5) Contribution (1 - 2) P/V ratio
(3/1) Material consumption (6) Contribution per kg. of material (3/5) Labour Ho
urs (a) Contribution per labour hour (3/6) If total sales in units is the key fa
ctor, Product B will be better as its per unit contribution is more. If total sa
les in value is the key factor, Product A will be better as its P/V Ratio is mor
e. If raw material is in short supply, Product A will be better as its contribut
ion per Kg. of material is more. If labour hours is the limiting factor, Product
A will be better as its contribution per labour hour is more. If total availabl
e raw material is 2,000 Kgs., it will first utilised to manufacture Product A as
its contribution per Kg. of material is more. However the maximum sales potenti
al of Product A is restricted to 500 units which consumes 1,000 Kgs. of material
(i.e. 500 units x 2 Kgs. per unit). Remaining material of 1,000 Kgs. can be use
d for the manufacture of Product B, with the help of which only 200 units of Pro
duct B can be manufactured i.e., 1,000 Kgs 5 Kgs. per Unit = 200 Units 10 4 20 3
.5 40 40% 2 Kgs. 20 50 60 20 130 70 35% 5 Kgs. 14 100 Product B Per Unit Rs. 200
(b)
(c)
(d)
(e)
396
Management Accounting

Hence, the desirable product mix will be 500 units of Product A 200 units of Pro
duct B (15) Small-Tools Factory has a plant capacity adequate to provide 19,800
hours of machine use. The plant can produce all A type tools or all B type tools
or a mixture of the two types. The following information is relevant. Per Type
Selling Price Rs. Variable Cost Rs. Hours required to produce A 10 8 3 B 15 12 4
Market conditions are such that no more than 4,000 A type tools and 3,000 B type
tools can be sold in a year. Annual fixed costs are Rs. 9,900. Compute the prod
uct mix that will maximize the net income to the company and find that maximum n
et income. Solution : It is a situation of multiplicity of key factors, first ke
y factor being availability of machine hours and second one being market conditi
ons. The contribution per machine hour can be computed as below : A Selling Pric
e Per unit Rs. Variable cost per mat Rs. Contribution per unit Rs. 10 8 2 3 0.66
II B 15 12 3 4 0.75 I
Machine hours required per unit Contribution per machine your Rs.
Ranking when machine hours availability is key factor
As such, tool B will be produced to the maximum possible extent i.e. 3,000 units
and the balance machine hours should be utilised for the production of tool A.
Marginal Costing
397

The net income can be worked out as below: Tool Units Machine hours required 12,
000 7,800 19,800 Less : Annual fixed costs Net Profit Contribution per unit Rs.
3 2 Total contribution Rs. 9,000 5,200 14,200 9,900 4,300
B A
3,000 2,600
(16) An umbrella manufacturer makes an average net profit of Rs. 2.50 per piece
on a selling price of Rs. 14.30 by producing and selling 6,000 pieces or 60% of
the potential capacity. His cost of sales is as follows: Direct material Direct
wages Works overheads Sales overheads Per Unit Rs. 3.50 Rs. 1.25 Rs. 6.25 (50% f
ixed) Rs. 0. 80 (25% varying)
During the current year, he intends to produce the same number but anticipates t
hat his fixed expenses will go up by 10% while rate of direct labour and direct
material will increase by 8% and 6% respectively. But he has no option of increa
sing the selling price. Under this situation he obtains an offer for a further 2
0% of capacity. What minimum price will you recommend for acceptance to ensure t
he manufacturer an overall profit of Rs. 16,730? Solution : Profitability struct
ure Previous year Per Unit Rs. (1) (2) Selling Price Variable Cost Direct Materi
al Direct Wages Works Overhead Sales Overheads 3.50 1.25 3.125 0.20 8.075 21,000
7,500 18,750 1,200 48,450 3.71 1.35 3.125 0.20 8.385 22,260 8,100 18,750 1,200
50,310 14.30 Total Rs. 85,800 Per Unit Rs. 14.30 Current Year Total Rs. 85,800
398
Management Accounting

Previous year Per Unit Total Rs. Rs. (3) (4) Contribution (1 2) Fixed Cost Works
Overheads Sales Overheads 3.125 0.60 3.725 (5) Profit (3 4) 2.50 18,750 3,600 2
2,350 15,000 6.225 37,350
Current Year Per Unit Total Rs. Rs. 5.915 35,490
20,625 3,960 24,585 10,905
From the above, it can be seen that the present sales of 6,000 units will genera
te a total profit (after recovering the fixed cost) of Rs. 10,905. If it is inte
nded that the overall profit should be Rs. 16,730, there will be a shortfall of
Rs. 5,825 which will have to be covered by the additional 2.000 units to be sold
. As such, every additional unit to be sold will have to generate a clear margin
of Rs. 2.9125 i.e., Rs. 5,825/2,000 units. Hence the minimum price to be recomm
ended will be Revised per unit variable cost + Expected per unit margin i.e., Rs
. 8.385 + Rs. 2.9125 i.e., Rs. 11.2975 (17) The cost profile of a company, manuf
acturing only one product, is as under : Rs. Direct Material Direct Labour Varia
ble factory overheads 5.60 1.50 0.40 7.50 Fixed factory overhead is budgeted at
Rs. 3,30,000 for an annual sales of 4,00,000 units.Selling, Distribution and Adm
inistration costs are budgeted at Rs. 1,80,000. Capital employed is Rs. 4,50,000
in fixed assets and 50% of sales in current assets. Determine a selling price f
or the product to yield 20% return on capital employed. Solution : Let us assume
that the selling price per unit is Rs. X. Hence, total sales will be Rs. 4,00,0
00 X.
Marginal Costing
399

The total amounts to be covered by this amount of sales will be Rs. Variable Cos
t - 4,00,000 x 750 Fixed Factory overheads Selling Distribution and Administrati
on cost Profit 30,00,000 3,30,000 1,80,000 90,000 + 40,000 x 36,00,000 + 40,000
x Note : Profit is calculated as below : Expected yield - 20% of capital employe
d where Capital employed = = = Hence, Profit = = Thus, 4,00,000 x = 36,00,000 +
40,000 x = 3,60,000 x = 36,00,000 x = Rs. 10 Hence the selling price for the pro
duct should be Rs. 10 per unit. (18) V Ltd. produces two products P and Q. The draft
budget for the next month is as under. P Budgeted Production and sales (Units)
Selling Price Rs / Unit Total Costs Rs / Unit Machine Hours / Unit Maximum Sales
Potential (Units) 40,000 25 20 2 60,000 Q 80,000 50 40 1 100,000 4,50,000 + 50%
of sales 4,50,000 + 50% of 4,00,000 x 4,50,000 + 2,00,000 x 20% (4,50,000 + 2,0
0,000 x) 90,000 + 40,000 x
The fixed expenses are estimated at Rs. 9,60,000 per month. The company absorbs
fixed overheads on the basis of machine hours which are fully utilised by the bu
dgeted production and cannot be further increased.
400
Management Accounting

When the budget was discussed, the Managing Director stated that the product mix
should be altered to yield optimum profit. The Marketing Director suggested tha
t he could introduce Product C, each unit of which will take 1.5 machine hours. Ho
wever, a processing vat involving a capital outlay of Rs. 2,00,000 is to be inst
alled for the processing of product C. The additional fixed overheads relating to
the processing vat was estimated to be Rs. 60,000 per month. The variable cost o
f Product C was estimated of Rs. 21 per unit. Required (i) (ii) Calculate the prof
it as per draft budget for the next month. Revise the product mix based on data
given for P and Q to yield optimum profit.
(iii) The company decides to discontinue either product P or Q whichever is givi
ng lower profit and proposes to substitute product C instead. Fix the selling pric
e of Product C in such a way so as to yield 15% return on additional capital emplo
yed besides maintaining the same overall profits as envisaged in (ii) above. Sol
ution : At present, the utilisation of the machine hours is as below. Product P
- 40,000 units x 2 Product Q - 80,000 units x 1 = = 80,000 Hrs. 80,000 Hrs. 1,60
,000 Hrs. Fixed Expenses are Rs. 9,60,000 per month and are absorbed on the basi
s of utilisation of machine hours. Hence, Machine Hour Rate = Rs. 9,60,000 1,60,
000 Hrs. = Rs. 6/Hr.
As such, the fixed overheads absorbed by the product (which must have been inclu
ded in the total cost.) are as below : Product P - 2 Hrs. x Rs. 6 = Rs. 12 Produ
ct Q - 1 Hr. x Rs. 6 = Rs. 6
Marginal Costing
401

Hence, the cost structure of the products can be amended as below : Product P Rs
. Selling Price / Unit Less : Variable cost Fixed Cost Total Cost Profit (1) 8 1
2 20 5 Rs. 25 34 6 40 10 Product Q Rs. Rs. 50
Profit as per draft budget for the next month are (a) Sales - P - 40,000 Unit x
Rs. 25/ Unit Q - 80,000 Units x Rs. 50/ Unit Rs. 10,00,000 Rs. 40,00,000 Rs. 50,
00.000 (b) Variable Cost - P - 40,000 Units x Rs. 8/ Unit Q - 80,000 Units x Rs.
34/ Unit Rs. 3,20,000 Rs. 27,20,000 Rs. 30,40.000 (c) (d) (e) Contribution a b
Fixed Expenses Profit c d Rs. 19,60,000 Rs. 9,60,000 Rs. 10,00,000
(2)
Revised Product Mix to yield Optimum Profit. The machine hours are available in
limited quantity and hence are the key factor of production. The revised cost st
ructure of the products is as under. Prod. P Selling Price - Rs./ Unit Variable
Cost - Rs./ Unit Contribution Rs./ Unit Machine Hours/ Unit Contribution Rs./ Ma
chine Hour 25 8 17 2 8.5 Prod Q. 50 34 16 1 16
As the contribution per unit of key factor i.e. Machine Hour is more in case of
Product Q, the available machine hours will be utilised for the manufacture of P
roduct Q subject to its maximum sales potential.
402
Management Accounting

Thus, the revised product mix will be: Product Product Q Product P Machine Hours
1,00,000 Units x 1 Hr. = 1,00,000 1,60,000 Hrs. 1,00,000 Hrs. = 60,000 Machine
Hours/Unit 1 2 Units 1,00,000 30,000
The revised profitability will be (a) Sales - Q 1,00,000 Units x Rs. 50/ Unit P 30,000 Units x Rs. 25/ Unit Rs. 50,00,000 Rs. 7,50,000 Rs. 57,50,000 (b) Varia
ble Cost - Q 1,00,000 Units X Rs. 34/ Unit P 30,000 Units x Rs. 8/ Unit Rs. 34,0
0,000 Rs. 2,40,000 Rs. 36,40,000 (c) (d) (e) (3) Contribution a-b Fixed Expenses
Profit c-d Calculation of Selling Price of Product C : Rs. 21,10,000 Rs. 9,60,0
00 Rs. 11,50,000
The various amounts to be covered by the sales of product C are as below: Variab
le cost - 40,000 Units x Rs. 21/ Unit Fixed Expenses to be absorbed 40,000 Units
x Rs. 6/ Machine Hour x 1.5 Hrs/ Unit Additional fixed overheads Yield on capit
al employed 15% on Rs. 2,00,000 Deficit of Profit Rs. 30,000 Rs. 1,50,000 Rs. 14
,40,000 Hence, the per unit selling price will beRs. 14,40,000 40,000 units = Rs
. 36/ Unit Rs. 3,60,000 Rs. 60,000 Rs. 8,40,000
Marginal Costing
403

Notes : (1) As availability of machine hours is the key factor and the contribut
ion per machine hour is less in case of Product P, it will be discontinued. Prod
uction of Product Q will be continued subject to its maximum sales potential. As
such, 1,00,000 units of product Q will be produced and sold, thus leaving 60,00
0 machine hours for the production and sales of product C. As one unit of produc
t C consumes 1.5 Machine Hours, maximum 40,000 units of product C can be produce
d and sold i.e., 60,000 Machine Hours 1.5 Machine Hrs./Unit (2) It is assumed th
at Product Q will continue to absorb the fixed expenses at the current rate of a
bsorption. Hence, the profit generated by product Q will be as below: (a) (b) (c
) (d) Sales - 1,00,000 Units x Rs.50/ Unit Rs. 50,00,000 Variable Cost - 1,00,00
0 Units x Rs. 34/ Unit Rs. 34,00,000 Contribution - a-b Rs. 16,00,000 Fixed Expe
nses absorbed 1,00,000 units x Rs. 6/ Machine Hr. Rs. 6,00,000 (e) Profit c-d Rs
. 10,00,000 As the profit is desired to be maintained at Rs. 11,50,000 the defic
it should be covered by the sales of product C (3) As the fixed overhead relatin
g to the processing vat will be incurred specifically due to Product C, it will
be as if the variable cost of Product C.
404
Management Accounting

QUESTIONS 1. What do you understand by the terms Break Even Point, Contribution
and Margin of Safety? Explain your answer by drawing a chart with assumed figure
s. How does Break Even Analysis help in business decisions? Describe the importa
nce of the following terms in relation to marginal costing. (a) (b) (c) 4. Break
Even Point Profit Volume Ratio Margin of Safety
2. 3.
Explain what is meant by Break Even Analysis? Discuss (a) (b) The assumptions th
at are involved in this technique The various uses of this technique.
5.
Explain any four circumstances in which the technique of marginal costing will h
elp the management in taking decisions. What are the limitations of this techniq
ue? The rate of earning profit mainly depends upon the magnitude of the angle of
incidence projected on break even chart.- Explain as to whether this statement is
correct. What measures can be adopted to increase the magnitude of angle of inc
idence. Write a critical note about uses, applications, advantages and limitatio
ns of Marginal Costing technique. The work of separating the overheads into fixed
and variable costs is purely academic, but practically very difficult and as su
ch the technique of Marginal Costing is of very little use in managerial decisio
ns. How will yon make out a case for introducing the technique of Marginal Costin
g when encountered with the above argument? Discuss the most important areas of
managerial decisions opened up by the application of marginal costing technique.
6.
7.
8.
9.
10. Write Short Notes on (a) (b) (c) (d) (e) (f) Profit Volume RatioContribution
Break Even Point Margin of Safety Marginal Costing Importance of Break Even ana
lysis Marginal Costing
405

PROBLEMS (1) Following information is made available to you about a company for
two periods. Period. (I) (II) Find out (a) (b) (c) (d) (e) (2) Profit Volume Rat
io Break Even Point for sales Profit when sales are Rs. 1,00,000 Sales required
to earn a profit of Rs. 20,000 Safety Margin in period II Sales (Rs) 1,20,000 1,
40,000 Profit (Rs) 9,000 13,000
The sales turnover and profits during two periods are as under. Period I - Sales
Rs. 20 Lakhs, Profit Rs. 2 Lakhs Period II - Sales Rs. 30 Lakhs, Profit Rs. 4 L
akhs Calculate: (1) (2) P/V Ratio The sales required to earn the profit of Rs. 5
Lakhs
(3)
Following figures relate to a company manufacturing a varied range of products :
Total Sales Year ended 31st Dec., 1987 Year ended 31st Dec., 1988 22,23,000 24,
51,000 Total Cost 19,83,600 21,43,200
Assuming stability in price with variable costs carefully controlled to reflect
predetermined relationship and an unvarying figure for fixed costs, calculate :
(a) (b) (c) (d) (e) The profit volume ratio to reflect the rates of growth for p
rofits and sales. Fixed Costs. Fixed Cost as % to Sales. Break even point Margin
of safety for the year 1987 and year 1988.
406
Management Accounting

(4)
Gee Ltd.
selling
mmarised
.) Fixed
,00

has two factories producing an


price net i.e. Rs.60 per unit.
as follows. Factory A Capacity
Costs per annum (Rs.) 1,00,000

identical product and realising the same


The costs in the two factories can be su
(Units) (Rs.) Variable Cost per unit (Rs
20 20,00,000 Factory B 1,50,000 15 45,00

The demand for the product is 2,00,000 units. State how much should be produced
at each factory. (5) Calculate the Break Even Point in units and in rupees and a
lso arrive at Margin of Safety ratio from the following information. Estimated s
ales (1,00,000 Units) Variable Cost Fixed Cost Rs. 12,00,000 Rs. 4,00,000 Rs.16,
00,000 Net Profit (6) From the following data relating to a company, calculate :
(1) (2) Break Even Sales Sales required to earn a profit of Rs.6,000 per period
Period Total Sales Rs. 1 2 (7) (a) 42,500 39,200 Total Costs Rs. 38,700 36,852
Rs. 4,00,000 Rs. 20,00,000
A company budgets a production of 5,00,000 units at a variable cost of Rs. 20 ea
ch. The fixed costs are Rs. 20,00,000. The selling price is fixed to yield 25% p
rofit on cost. Calculate (i) Break Even Point (ii) P/V Ratio
(b)
If the selling price is reduced by 20% find (i) (ii) The effect of the price red
uction on the break even point and the P/V Ratio The number of units required to
be sold at the reduced selling price to obtain an increase of 20% on the budget
ed profit.
Marginal Costing
407

(8)
(1)
The following figures for profit and sales are obtained from the account of XYZ
Co. Ltd. Year 1985 1986 Calculate (a) (b) (c) (d) P/V Ratio Fixed Cost Break Eve
n Sales Sales to earn a profit of Rs. 5.000 Sales (Rs.) 20,000 30,000 Profit (Rs
.) 2,000 4,000
(2)
Calculate all the above figures, if the company has a fixed overhead of Rs. 1,00
0 in addition to the expenses considered above.
(9)
The following data are obtained from the records of a company. First Year Rs. Sa
les Profit Calculate : (a) (b) (c) (d) (e) P/V Ratio Break Even Point Profit or
loss when sales amount to Rs. 50,000 Sales required to earn a profit of Rs. 19,0
00 Sales position if company sustained a loss of Rs. 19,000 80,000 10,000 Second
Year Rs. 90,000 14,000
(10) The following figures relating to the performance of a company for Year I a
nd Year II are available. Assuming that the ratio of variable costs to sales and
the fixed costs are the same for both the years, ascertain a. b. c. d. Profit V
olume Ratio Amount of the fixed costs Break Even Point Budgeted profit for Year
III if the budgeted sales are Rs. 1 Crore. Year I Year II Total Sales Rs. 70 Lak
hs Rs. 90 Lakhs Total Costs Rs. 58 Lakhs Rs. 66 Lakhs
408
Management Accounting

(11) S Ltd. furnishes you the following information relating to the half year en
ding 30th June 1980. Rs. Fixed Expenses Sales Value Profit 50,000 2,00,000 50,00
0
During the second half of the year, the company has projected a loss of Rs. 10,0
00. Calculate (1) The P/V Ratio, Break Even Point and Margin of safety for six m
onths-ending 30th June 1980. Expected sales volume for the second half of the ye
ar assuming that selling price and fixed expenses remain unchanged in the second
half year also. The break even point and margin of safety for the whole year 19
80.
(2)
(3)
(12) PQ Limited has been offered a choice to buy a machine between A and B. You
are required to compute : (a) (b) (c) Break Even Point for each of the machines.
The level of sales at which both machines earn equal profits. The range of sale
s at which one is more profitable than the others.
The relevant data is given below : Machines A Annual output in units Fixed Cost
(Rs.) Profit at above level of production (Rs.) 10,000 30,000 30,000 B 10,000 16
,000 24,000
The market price of the product, is expected to be Rs.10 pet Unit (13) The follo
wing is the basic cost of a firm ABC. (1) (i) (ii) (iii) Fixed Operating Cost Rs
. 2,500 Sales Price (Per Unit) Rs. 10 Variable Cost (Per Unit) Rs. 5 Determine B
EP in units and rupees
Marginal Costing
409

(2) (3)
If fixed operating cost increases to Rs. 3,000, what will be the new BEP ( in Un
its)? If sale price increases to Rs. 12.50 and the variable operating cost to Rs
.7.50, what would be the impact on BEP?
(14) A Ltd. manufactures & sells four types of products under the brand names -P
, Q, R and S. Sales mix in value comprises. 33.33%, 41.66%,16.66% and 8.33% of P
, Q, R and S respectively. The total budgeted sales (100%) are Rs. 60,000 per mo
nth. Operating Costs are Variable Costs Product P Product Q Product R Product S
60% of selling price 68% of selling price 80% of selling price 40% of selling pr
ice
Fixed Costs : Rs. 14,700 per month Calculate the BEP for the products on an over
all basis i.e. in total (15) Following information is presented by the costing d
epartment to the management accountant of the company. 1. 2. 3. Contribution Rs.
10,000 Fixed Cost Rs. 5,000 P/V Ratio 1/3
The Management Accountant is asked to find out the margin of safety if P/V Ratio
is brought down to 1/2. (16) A company produces and sells 100 units of A at Rs.
20. Marginal cost per unit is Rs. 12 and the fixed costs are Rs. 300 per month.
It is proposed to reduce the price by 20%. Find out the additional sales requir
ed to earn the same amount of profits as before. (17) A ball pen manufacturer ha
s developed a new ball pen with unique features. His development executive has s
uggested three possible retail price viz. Rs.15 for super star, Rs.10 for deluxe
and Rs. 7.50 for economy model. His marketing manager opines that the whole sel
lers and retailers have to be given at least 30% discount. The estimated fixed c
ost would be around Rs.70,000 and the variable cost per unit would be Rs. 3.50 (
a) (b) Calculate breakeven point for each model of ball pen. How much should the
manufacturer sell in order to make a profit of Rs. 21,000? Work out for each mo
del of ball pen.
410
Management Accounting

(18) ABC Pvt. Ltd. manufactures and sells a standard product at fixed selling pr
ice. The budgeted figures for 1986-87 are as under. Production and sales Variabl
e cost Fixed Cost Profit Margin 2,00,000 Units. Rs. 56 Per Unit Rs. 48,00,000 33
.33% of selling price.
You are required to determine sales at break even both in terms of quantity and
value for the budget year 1986-87 at the above selling price. (19) The Laila Sho
e Company sells five different styles of ladies chappals with identical purchase
cost and selling price. The company is trying to find out the profitability of
opening another store which will have the following expenses and revenues. Per P
air (Rs) Selling Price Variable cost Salesmens commission Total Variable Cost Ann
ual Fixed expenses are : Rent Salaries Advertising Other fixed expenses Rs. 60,0
00 Rs. 2,00,000 Rs. 80,000 Rs. 20,000 Rs. 3,60,000 Required : a. Calculate the a
nnual break even point in units and in value. Also determine the profit or loss
if 35,000 pairs of chappals are sold. The sales commissions are proposed to be d
iscontinued, but instead a fixed amount of Rs. 90,000 is to be incurred in fixed
salaries. A reduction in selling price of 5% is also proposed. What will be the
break even point in units ? It is proposed to pay the stores manager 50 paise p
er pair as further commission. The selling price is also proposed to be increase
d by 5%. What would be the break even point in units? 30.00 19.50 1.50 21.00
b.
c.
Marginal Costing
411

d.
Refer to the original data. If the stores manager were to be paid 30 paise commi
ssion on each pair of chappal sold in excess of the break even point, what would
be the stores net profit if 50,000 pairs were sold ?
(20) Speedy Airline can carry a maximum of 10,000 passengers per month on one of
its routes at a fare of Rs. 85. Variable costs are Rs. 10 per passenger and fix
ed costs are Rs. 3,00,000 p.m. calculate (1) (2) (3) (4) Break Even quantity Bre
ak Even sales Break Even Percentage of capacity. Suppose that the management set
s a profit target of Rs. 2,00,000
What would be the required profit before taxes to achieve this profit target, if
the corporate tax rate of the company is 46%. (21) Three firms X, Y and Z manuf
acture the same product. The selling price is Rs.8 per unit of the product equal
for all the firms. The fixed costs for the firms X, Y and Z respectively are Rs
. 80,000 Rs. 2,00,000 and Rs. 3,30,000 while the variable costs per unit are Rs.
6, Rs. 4 and Rs. 3 (a) (b) (c) Determine the break even point for all the firms
in units. How much profits are earned by the firms if each of them sells 80,000
units? What will be the impact percentagewise .on profits if sales increase by
20%.
(22) Merry Manufacturers Ltd. has supplied you the following information in resp
ect of one of its products. Rs. Total Fixed costs Total Variable Costs Total Sal
es Units Sold 18,000 30,000 60,000 20,000
Find out (a) Contribution per unit (b) Break Even Point (c) Margin of Safety (d)
Profit (e) Volume of sales to earn a profit of Rs. 24,000.
412
Management Accounting

(23) From the following information relating to Quick Standards Ltd., you are re
quired to find out - (a) Contribution (b) BEP in units (c) Margin of Safety (d)
Profits. Rs. Total fixed costs Total variable costs Total sales Units sold 4,500
7,500 15,000 5,000 (Units)
Also calculate the volume of sales to earn a profit of Rs. 6,000 (24) Bindra Ltd
. is running its plant at present at 50% of capacity. The management has supplie
d you the following details. Cost of production per unit Rs. Direct Material Dir
ect Labour Variable Overheads Fixed Overheads (fully absorbed) 4 2 6 4 16 Produc
tion per month Total cost of products Sales Price 40,000 Units 40,000 Units x Rs
. 16 = Rs. 6,40,000 40,000 Units x Rs. 14 = Rs. 5,60,000 Loss Rs. 80,000
An exporter offers to purchase 10,000 units per month @ Rs. 13 per unit and the
company is hesitating in accepting the offer due to the fear that it will increa
se its already large operating losses. Advice whether the company should accept
or decline this offer. (25) Mega Corporation manufactures and sells three produc
ts to the automobile industry. All the products must pass through a machining pr
ocess, the capacity of which is limited to 20,000 hours per annum, both by equip
ment design and government regulation.
Marginal Costing
413

Following additional information is available. Product X Selling Price Rs./Unit


Variable cost Rs./Unit Machining requirements hrs/Unit Maximum possible sales un
its 1,900 700 3 10,000 Product Y 2,400 1,200 2 2,000 Product Z 4,000 2,800 1 1,0
00
Required - A statement showing the best possible production mix which would prov
ide the maximum profits for Mega Corporation, together with supporting workings.
(26) (a) A companys turnover in a year was Rs. 50,00,000, its profit was Rs. 500
,000 and its P/V Ratio was 40% What is the break even point? A factory furnishes
the following figures. August 84 Output (Units) Total Cost (Rs.) 50,000 6,70,00
0 September 84 55,000 7,10,000
(b)
What is the amount of fixed expenses per month? (27) (a) Calculate the Break Eve
n Point from the following data. (i) (ii) (iii) (b) Sales Price per unit Rs. 10
Variable cost per unit Rs. 6 Fixed overheads Rs.20,000
Calculate the revised Break Even Point if (i) (ii) (iii) (iv) (v) (vi) Sales pri
ce is increased to R.11 per unit Sales price is reduced to Rs.9 per unit Variabl
e cost increased to Rs.7 per unit Variable cost reduced to Rs.5 per unit Fixed o
verheads rise to Rs.25,000 Fixed overheads fall to Rs.15,000
(28) The Modern Machine Co. Ltd. places before yon the following figures Sales (
Rs.) 1974 1975 2,00,000 1,80,000 Profit (Rs.) 10,000 2,000
414
Management Accounting

You are required to (a) (b) (c) Calculate profit or loss when sales amount to Rs
. 1,50,000 and Rs-3,00,000. Calculate Profit Volume Ratio. Determine sales at Br
eak Even Point.
(29) The selling price of a product is Rs.40 which yields a margin of 20%. The t
otal fixed expenditure are Rs. 10,000 a month. What should be the level of sales
to yield an annual profit of Rs.20,000? (30) The following is the annual profit
plan of XYZ Company. (1) (2) Budgeted sales (2,00,000) units @ Rs. 25) Budgeted
Costs Direct Material Direct Labour Factory Overheads Administrative Expenses D
istribution Expenses Fixed Variable 9,00,000 10,00,000 3,00,000 1,00,000 3,00,00
0 26,00,000 44,00,000 6,00,000
50,00,000
7,00,000 6,00,000 5,00,000 18,00,000
Budgeted Profit Production capacity - 2,40,000 Units. (A) (a) (b) (c) Determine
the break even point in rupees.
Would you accept an export order for 60,000 units @ Rs. 20 per unit and why? Bri
efly enumrate the basic assumptions underlying break even analysis.
(B) Compute BEP in the following independent situations if (i) (ii) (iii) a 10%
increase is effected in fixed costs a 10% increase is effected in variable costs
a 10% increase in fixed costs and 5% decrease in-variable costs is effected.
(31) You are the company Accountant of Machine Manufacturing Ltd. which was inco
rporated in February 1979. The company has started production from 1st January 1
980. It was proposed that the company will produce and sell 8,000 units in the f
irst year of its operations. Estimated costs of production are given below.
Marginal Costing
415

Raw Materials Direct Labour Other variable costs Fixed costs (1) (2)
Rs. 20 per unit Rs. 10 per unit 200% of direct labour Rs.1,50,000
The company fixed a target to earn a profit of Rs. 1,50,000 in the first year. F
urther, the company expects that annual fixed costs will increase by Rs. 1,00,00
0 in the second year of operations. The marketing manager has planned to spend a
sum of Rs. 80,000 on promotion and advertising in the second year, keeping in v
iew the target of the company to earn a profit of Rs. 2,50,000 in the second yea
r of operations. It is expected that direct material, direct labour and other va
riable costs will not change in the second year. The company wishes to sell the
product in the second year at a price of Rs.75 per unit.
(3)
Advice the company about the following : (a) (b) Selling price for the first yea
r. Sales turnover ( in Units) for the second year.
(32) The Asian Industries specialise in the manufacture of small capacity of Mot
ors. The cost structure of a motor is as under. Material Labour Rs. 50 Rs. 80
Variable Overheads 75% of labour cost. Fixed overheads of the company amount to
Rs. 2.40 lakhs per annum. The sale price of the motor is Rs. 230 each. (a) (b) (
c) Determine the number of motors that have to be manufactured and sold in a yea
r to break even. How many motors have to be made and sold to make a profit of Rs
.1 lakh per year? If the sale price is reduced by Rs. 15, how many motors will h
ave to be sold to break even?
(33) Repographics Ltd. manufactures a document reproducing machine which has the
variable cost structure as follows : Material Labour Overheads Rs. 40 Rs. 10 Rs
. 4
Selling price per unit is Rs. 90
416
Management Accounting

Sales during the current year are expected to be Rs. 13,50,000 and fixed overhea
ds Rs. 1,40,000. Under a wage agreement, an increase of 10% is payable to all di
rect workers from the beginning of the forthcoming year, whilst material costs a
re expected to increase by 7.5%, variable overheads by 5% and fixed overhead cos
ts by 3%. You are required to calculate : a. b. The new selling price if the cur
rent Profit Volume Ratio is to be maintained. The quantity to be sold during the
forthcoming year to yield the same amount of profit as the current year, assumi
ng the selling price to remain at Rs. 90.
(34) Cookwell Ltd.manufactures pressure cookers the selling price of which is Rs
. 300 per unit. Currently the capacity utilisation is 60% with a sales turnover
of Rs. 18 lakhs. The company proposes to reduce the selling price by 20% but des
ires to maintain the same profit position by increasing the output. Assuming tha
t the increased output could be made and sold, determine the level at which the
company should operate, to achieve the desired objective. The following further
data are available. (a) (b) (c) Variable cost per unit Rs.60 Semi variable cost
(including a variable element of R1. 10 per unit) Rs. 1,80,000 Fixed cost Rs. 3,
00,000 will remain constant Upto 80% level. Beyond this, an additional of Rs. 60
,000 will be incurred.
(35) The MYZ Co. has the following budget for the year 1986-87. Rs. Sales (1,00,
000 Units a Rs.20) Variable Cost Contribution Fixed cost Net Profit From the abo
ve set of information find out, (a) The adjusted profits for 1986-87 if the foll
owing two sets of changes are introduced and also suggest which plan should be i
mplemented. 20,00,000 10.00,000 10,00,000 4,00,000 6,00,000
Marginal Costing
417

Plan A Increase in Price Decrease in Volume Increase in variable cost Increase i


n fixed cost (b) 20% 25% 10% 5%
Plan B Decrease in Price Increase in Volume Decrease in Variable cost Decrease i
n fixed cost 20% 25% 10% 5%
The P/V Ratio and break even points under the two plans referred above.
(36) A review made by the top management of Sweat and Struggle Ltd. which makes
only one product, of the result of the first quarter of the year revealed the fo
llowing details : Sales in units Loss in Rs. 10,000 10,000
Fixed Cost (For the year Rs.1,20,000) in Rs. 30,000 Variable cost per unit in Rs
. 8
The Finance Manager who feels perturbed suggests that the company should at leas
t break even in the second quarter with a drive for increased sales. Towards thi
s, the company should introduce a better packing which will increase the cost by
Re. 0.50 per unit. The sales manager has an alternative proposal. For the secon
d quarter, additional sales promotion expenses can be increased to the extent of
Rs. 5,000 and a profit of Rs. 5,000 can be aimed with increased sales. The prod
uction manager feels otherwise. To improve the demand, the selling price per uni
t has to be reduced by 3%. As a result, the sales volume can be increased to att
ain a profit level of Rs. 4,000 for the quarter. The Managing Director asks you
as a Cost Accountant to evaluate these three proposals and calculate the additio
nal sales volume that would be required in each case, in order to help him take
a decision. (37) Following is the summarised Trading account of a manufacturing
concern which makes two products X and Y.
418
Management Accounting

Summarised Trading Account for the four months to 30th April 1984 X Rs. Sales Le
ss : Cost of Sales (a) Direct costs Labour Material 3,000 1,500 4,500 5,500 Indi
rect costs (a) Variable Expenses 2,000 3,500 (b) Fixed Expenses Common to both X
and Y Net Profit (a) (b) 1,250 2,250 1,250 (-)250 2,500 2,000 1,000 1,000 3,000
4,500 1,000 1,000 2,000 2,000 6,500 7,500 10,000 Y Rs. 4,000 Total Rs. 14,000
These costs tend to vary in direct proportion to physical output. These costs te
nd to remain constant irrespective of physical outputs of X and Y. It has been t
he practice of the concern to allocate these costs equally between X and Y.
The following proposals have been made by the Board of Directors for your consid
eration as financial advisor. (1) (2) (3) Discontinue Product Y. As an alternati
ve to (1), reduce the price of Y by 20%. (It is estimated that the demand then w
ill increase by 40%.) Double the price of X (It is estimated that the demand the
n will reduce by three fifths.) You are required to recommend the proposal to be
taken after evaluating each of these three proposals.
Marginal Costing
419

(38) A Multi-Product company has the following costs and output data for the las
t year. Product X Sales Mix (in value) Selling Price per unit Variable cost per
unit Total Fixed cost Total Sales 40% Rs. 20 Rs. 10 Rs. 1,50,000 Rs. 5,00,000 Pr
oduct Y 35% Rs. 25 Rs. 15 Product Z 25% Rs. 30 Rs. 18
The company proposes to replace Product Z by Product S. Estimated cost and outpu
t data are Product X Sales Mix (in value) Selling Price per Unit Variable cost p
er Unit Total fixed cost Total Sales 50% Rs. 20 Rs.10 Rs. 1,50,000 Rs. 5,00,000
Product Y 30% Rs. 25 Rs. 15 Product S 20% Rs. 28 Rs. 14
Analyse the proposed change and suggest what decision the company should take. A
lso state the break even point for the company as a whole in the two situations.
(39) A manufacturer has planned his level of production at 50% of his plant cap
acity of 30,000 units. At 50% of the capacity, his expenses are as follows. (a)
(b) (c) (d) Direct Labour Rs.11,160 Direct Material Rs. 8,280 Variable and other
manufacturing expenses Rs. 3,960 Total fixed expenses regardless production Rs.
6,000
The home selling price is Rs.2.00 per unit. Now, the manufacturer receives a tra
de enquiry from overseas for 6,000 units at a price of Rs. 1.45 per unit If you
were the manufacturer, would yon accept or reject the offer? Support your statem
ent with suitable cost and profit details. (40) A manufacturer sells his product
at Rs.5 each variable costs are Rs.2 per unit and the fixed costs amount to Rs.
60,000. (a) (b) (c) (d) Calculate the break even point What would be the profit
if he sells 30,000 units? What would be the BEP if he spends Rs.3,000 on adverti
sement? How much should the manufacturer sell to make a profit of Rs.30,000 assu
ming he spends Rs.3,000 on advertisement?
Management Accounting
420

(41) Texemat Private Limited has been manufacturing track suits for athletes cur
rently, its output is around 70% of its rated capacity of 19,000 units per annum
. One exporter has approved the sample and has offered to buy 5000 units at a sp
ecial price of Rs. 150 per suit. At present, the company has been selling the tr
ack suit @ Rs.210.The standard cost per unit is as under. . Cost Items (a) (b) (
c) (d) (a) (b) Cloth and other materials Labour Fixed cost Administrative variab
le cost Total Cost Should the company accept the offer? What would be your advic
e if the exporter offers to buy 10,000 units instead of 5000 units? Rs. 82 25 42
11 160
(42) The variable cost structure of a product manufactured by a company during t
he current year is as under Rs. Material Labour 0verheads Per Unit 120 30 12
The selling price per unit is Rs. 270 and the fixed cost and sales during the cu
rrent year are Rs. 14 Lakhs and Rs. 40.50 Lakhs respectively. During the forthco
ming year, the direct workers will be entitled to a wage increase of 10% from th
e beginning of the year and the materials cost, variable overhead and fixed over
head are expected to increase by 7.5%, 5% and 3% respectively. The following are
required to be computed a. b. New selling price in the forthcoming year if the
current P/V ratio is to be maintained. Number of units that would be required to
be sold during the forthcoming year so as to yield the same amount of profit in
the current year, assuming that the selling price per unit will not be increase
d.
Marginal Costing
421

(43) A company currently operating at 80% capacity has the following particulars
. Rs. Sales Direct Materials Direct Labour Variable Overheads Fixed Overheads 32
,00,000 10,00,000 4,00,000 2,00,000 13,00,000
An export order has been received that would utilise half the capacity of the fa
ctory. The order cannot be split i.e. it has either to be taken in full and exec
uted at 10% below the normal domestic prices or rejected totally. The alternativ
es available to the management are : a. b. c. Reject the order and continue with
the domestic sales only (as at present) or Accept the order, split capacity bet
ween overseas and domestic sales and turn away excess domestic demand or Increas
e capacity so as to accept the export order and maintain the present domestic sa
les by i) ii) buying an equipment that will increase the capacity by 10%. This w
ill result in an increase of Rs. 1,00,000 in fixed costs and work overtime to me
et the balance of required capacity. In that case, labour will be paid at one an
d half times the normal wage rate.
Prepare a comparative statement of profitability and sugget the best alternative
. (44) A company produces a single product which is sold by it presently in the
domestic market at Rs. 75 per unit. The present production and sales is 40,000 u
nits per month representing 50% of the capacity available. The cost data of the
product was as under Variable cost per unit Rs. 50 Fixed costs per month Rs. 10
Lakhs To improve the profitability, the management has 3 proposals on hand as un
der a. to accept an export supply order for 30,000 units per month at a reduced
price of Rs. 60 per month, incurring additional variable costs of Rs. 5 per unit
towards the export packing, duties etc. to increase the domestic market sales b
y selling to a domestic chain stores 30,000 units at Rs. 55 per unit retaining t
he existing sales at existing price
b.
422
Management Accounting

c.
to reduce the selling price for the increased domestic sales as advised by the s
ales department as under Reduce selling price per unit by Rs. 5 8 11 Increase in
sales expected (units) 10,000 30,000 35,000
Prepare a table to present the results of the above proposals and give your comm
ents and advice on the proposals. (45) A company producing a single product sell
s it at Rs. 50 per unit. Unit variable cost is Rs. 35 and fixed cost amounts to
Rs. 12 Lakhs per annum. With this data, you are required to calculate the follow
ing, treating each independent of the other a. b. c. d. P/V Ratio and the Break
Even Point New Break Even Sales if variable cort increase by Rs. 3 per unit, with
out increase in the selling price. Increase in sales required if profits are to
be increased by Rs. 2.40 lakhs Percentage increase/decrease in sales volume to o
ffset
l l
An increase of Rs. 3 in the variable cost per unit A 10% increase in selling pri
ce without affecting existing profits quantum
e.
Quantum of advertisement expenditure permissible to increase sales by Rs. 1.20 L
akhs without affecting profits quantum.
(46) A manufacturer of fountain pens selling in the market at Rs.100 per dozen m
akes an average net profit of 20% on sales by producing 50,000 dozen per annum a
gainst a capacity of 75,000 dozens. His cost sheet for 1984 was as under. Cost p
er dozen in Rs. Direct Materials Direct Wages Works overheads (50% of this is va
riable) Sales overheads (25% of this is variable) 4 10 36 30
In 1985, he anticipates his fixed costs to increase by 6%, cost of direct materi
als by 5%, and labour (with whom an agreement has been concluded) by 10%. Market
enquiries revealed that the selling price of the product and quantity will rema
in unchanged in 1985.
Marginal Costing
423

An inquiry has been received for the supply of 10,000 dozens to a customer. What
could be the lowest quotation, if the business wants to make a minimum profit o
f Rs. 8 lakhs in 1985? Give detailed workings. (47) The following figures relate
to the current years position in an engineering industry operating at 70% capaci
ty level. Break Even Point P/V Ratio Margin of Safety Rs.80 Crores 40% Rs 20 cro
res
The board at its last
% capacity level with
price by 5% Increase
ditions but excluding

meeting have taken a decision to increase the output to 98


the following modifications. (i) (ii) Reduction in selling
in fixed cost by Rs.8 crores (Including depreciation on ad
interest burden.).

(iii) Reduction in variable cost by 5% of sales. (iv) Additional finance for cap
ital expenditure and working capital Rs.20 crores. (a) You are required to deter
mine the revised sales figure necessary to yield the existing quantum of profits
plus additional profit of Rs.4 crores on account of increased activity and 20%
Interest burden on fresh capital inputs. Also determine the revised (i) (ii) Bre
ak Even point P/V Ratio
(b)
(iii) Margin of safety. (48) The following data are obtained from the records of
a factoryRs. Sales 4,000 Units @ Rs.25 each Materials consumed Variable Overhea
ds Labour overheads Fixed overheads 40,000 10,000 20,000 18,000 88,000 Net Profi
t 12,000 Rs. 1,00,000
424
Management Accounting

Calculate : (1) (2) (3) (4) (5) The number of units by selling which the company
will neither loose or gain anything. P/V Ratio and Margin of Safety at present
level. The extra units which should be sold to obtain the present profit if it i
s proposed to reduce the selling price by (a) 20% and (b) 25%. The selling to be
fixed price to bring down its break even point to 500 units under present condi
tion. The sales required to earn profit of Rs.60,000 at the present selling pric
e of Rs.25 per unit,
(49) You are given the following data pertaining to a factory. Present (1986) Sa
les (in Units) Fixed cost (in Rs.) Loss (in Rs.) Profit (in Rs.) 10,000 25,000 5
,000 5,000 Forecast (1987) 15,000 25,000
For the above working purposes, variable cost of sales has been taken at Rs.7 pe
r unit upto 15000 units and it shall be Rs.8 per unit beyond 15,000 units. You a
re required to state as to (1) (2) (3) (4) What percentage of increase in sales
is required to cover additional 50 paise per unit towards extra packing cost in
1987 for achieving the additional sales target? What percentage of increase in s
ales is required to maintain budgeted profit with a price reduction of 25 paise
per unit? What percentage of increase in sales is required to meet additional pu
blicity expenses of Rs. 2,000 and also maintain the targeted profits? What is th
e maximum increase in fixed cost (additional depreciation) per period to justify
the proposal for buying a new machine which will reduce variable cost of sales
by Rs. 2 per unit at all levels? Sales to remain at 10,000 units and the targete
d profit to be achieved. (The above situations have to be considered independent
ly of each other.) (50) The anticipated sales of Electronic Corporation Ltd. is
Rs. 4,00,000 and unit sales price of product is Rs.20 each. The cost of direct m
aterial is Rs.9 each and the labour cost is Rs.3 each and other variable expense
s are Rs.3 per unit. The company is earning a net profit of 5% and to improve th
e profitability, following propositions were discussed in the Executive Committe
e Meeting,
Marginal Costing
425

(a)
The present administration set up is on the regional basis and it was felt that
centralisation will reduce the fixed cost by Rs. 12,000. The production manager
has agreed that he will try to Work on a cost reduction programme which will red
uce the cost by Re.1 per unit but there will be little impact on the quality whi
ch will be negligible to the customer.
(b)
The sales manager opposed the two proposals and suggests that it may be possible
to increase the number of units sold by 20% provided the selling price is reduc
ed by 5%. Alternatively, if the selling price is increased by 10%, the sales num
ber of units will be reduced by 5%. As the Accountant of the company, discuss in
detail the various pros and cons of the proposals and also put forward any othe
r proposal to improve the situation. (51) Zed Ltd. reported the following figure
s for 1983 and 1984. 1983 Sales Total Cost Rs. 50,00,000 Rs. 45,00,000 1984 Rs.
60,00,000 Rs. 52,00,000
The company anticipated that in 1985. (i) (ii) Variable cost rates, on the avera
ge, would record an increase of 10% over the 1984 levels. Sales would record an
increase of 20% over the 1984 level in volume.
(iii) Selling prices on the average would be increased by 5%. (iv) (v) In additi
on, another Rs.10 Lakhs of sale (1984 level) would be made to Government at a sp
ecial discount of 10% thereof. Fixed costs would increase by Rs. 3,00,000.
Ascertain the expected profit/loss in 1985. If the increase in fixed costs menti
oned above arises only if sales to Government is made, would you recommend the s
ale to be made? What is the P/V Ratio for 1985, at normal sales? Give workings.
(52) Two business AB Ltd. and CD Ltd. sell same type of product in the same type
of market. Their budgeted profit and loss account for the year 1984 is as follo
ws :
426
Management Accounting

AB Ltd. Rs. Sales Cost Fixed Variable 15,000 1,20,000 1,35,000 Net Profit You ar
e required to (a) (b) Calculate the Break Even Point of each business. 15,000 Rs
. 1,50,000 35,000 1,00,000 Rs.
CD Ltd. Rs. 1,50,000
1,35,000 15,000
State winch business is likely to earn greater profits in condition of(i) (ii) H
eavy demand for the product Low demand for the product
(53) In a factory producing two different kinds of articles, key factor is the a
vailability of labour. From the following information for the factory for 1986.
show which product is more profitable. Product A cost per Unit Rs. Material Labo
ur 6 hrs @ Rs. 0.50 3 hrs @ Rs. 0.50 Overheads - Fixed (50% of labour) - Variabl
e 5.00 3.00 1.50 1.50 11.00 Selling Price Profit Total Production per month (Uni
ts) Maximum capacity per month Maximum capacity of product B 14.00 3.00 500 4,80
0 hours 1,000 Units Product B Cost per Unit Rs. 5.00 1.50 0.75 1.50 8.75 11.00 2
.25 600
Marginal Costing
427

(54) (a)
The following particulars are extracted from the records of a company. Product A
per Unit Product B per Unit Rs. 1.20 3 kgs. Rs. 15 Rs. 10 Rs. 6
Sales Consumption of material Material Cost Direct Wages Cost Direct Expenses Ma
chine hours used 3 : 2 Overhead Expenses Fixed Variable
Rs. 1.00 2 kgs Rs. 10 Rs. 15 Rs. 5
Rs. 5 Rs. 15
Rs. 10 Rs. 20
Direct Wages per hour is Rs.5. Comment on profitability of each product (both us
e the same raw material) When (i) (ii) Total Sales Potential is limited. Raw Mat
erial is in short supply.
(iii) Production capacity ( in terms of machine hours) is the limiting factor. (
b) Assuming raw material is the key factor, availability of which is 10,000 kgs.
and maximum sales potential of each product being 3,500 units, find out the pro
duct mix which will yield the maximum profit.
(55) The following particulars are available from a manufacturing unit A Units S
old Sales Material Cost Labour Cost Variable Expenses Fixed overheads. 80,000 Rs
. 40,000 Rs. 20,000 Rs. 6,000 Rs. 4,000 Rs. 7,000 B 80,000 Rs. 80,000 Rs. 30,000
Rs. 10,000 Rs. 4,000 Rs. 10,000 C 2,00,000 Rs. 50,000 Rs. 25,000 Rs. 8,000 Rs.
5,000 Rs. 5,000
The
the
is
to
own

key factor of production is an imported raw material and the consumption of


material in product A is 400 litres. Product B is 1,000 litres and Product C
600 litres. The sales manager gives an assurance that it is possible for him
sell whatever produced. The management of the company has decided to close d
one product line and

428
Management Accounting

concentrate on two lines to increase the profitability of the company. As the co


mpany Accountant, prepare a report to the Directors recommending the closure of
one of the lines which is not more profitable. (56) Ambika Condiments bring out
2 products SUCHI and RUCHI which are popular in the market. The management has th
e option to alter the sales mix of the 2 products from the following combination
s Option I II III IV SUCHI (units) 800 1,600 1,100 RUCHI (units) 600 1,300 500
The per unit production cost/sales data are SUCHI (units) Direct Materials (Rs.)
Direct Labour (hours) Selling Price (Rs.) 25 10 75 RUCHI (units) 30 12 90
Variable factory overheads are 100% of direct labour cost for both products. Lab
our rate is Rs. 2 per hour. Common fixed overheads for both products Rs. 10,000.
You are required to a. b. Prepare a marginal cost statement for the two product
s. Evaluate options and identify the most profitable sales mix.
(57) From the following particulars, find the most profitable product mix and pr
epare a statement of profitability of that product mix. Product A Units budgeted
to be produced and sold Selling Price per unit (Rs.) Requirement per unit : Dir
ect Materials (Kgs) Direct Labour (Hours) Variable Overheads (Rs.) Fixed Overhea
ds (Rs.) Maximum possible units of sales
Marginal Costing
Product B 3,000 55 3 3 13 10 5,000
Product C 1,200 50 4 2 8 10 1,500 429
1,800 60 5 4 7 10 4,000

Cost of material per Kg is Rs. 4 and labour hour rate is Rs. 2. All the three pr
oducts are produced from the same direct material using the same types of machin
es and labour. Direct labour which is the key factor is limited to 18,600 hours.
(58) The Skyrock Ltd. produces and sells three types of products P, Q, and R. T
he management committee has decided to discontinue the production of Q since the
re is not much profit in it. From the following set of information, find out the
profitability of the products and give your short comments on the decision of t
he management. Product Selling Price Per unit Rs. 300 275 305 Dept. A Variable O
verheads Fixed overheads 150% 200% Direct Material Per unit Rs. 60 30 70 Dept. B
120% 240% Direct Wages Per unit Dept. A Dept. B Rs. Rs. 20 20 12 15 20 10 Dept.
C 200% 150%
Dept. C Rs. 10 10 20
P Q R
The absorption rate of overheads on the Direct Wages are
(59) You had asked your accountant to prepare fair budgets based on different ec
onomic forecasts. After doing part A the work, he fell sick. Incomplete workings
done by him were as under. Economic Forecast Variable Cost (Rs. 000) Depressed 4
0 Average 60 Good 90 Excellent 140
There are fixed costs of Rs.72,000 and P/V Ratio is 60%. Calculate. (a) (b) (c)
The profit or loss at each of the four levels. The break even point in sales val
ue and The sales value at which a profit of Rs .15000 would be made.
(60) Following is the abridged Profit and Loss Account of W Ltd. for 1987 (Rs. i
n Lakhs) Sales (10 Lakhs Units @ Rs. 2.50 Per unit) Less : Variable Cost Contrib
ution Less : Fixed Costs Loss: 25.00 16.00 9.00 9.20 (-) 0.20
Management Accounting
430

S. Ltd. approaches W Ltd. which has spare capacity and offers to purchase 2 lakh
units from W Ltd. If W Ltd. accepts this offer, it will save Rs. 0.25 per unit
in sales commission. Existing scales will continue as above. What is the price p
er unit on this special offer that W Ltd. must charge in order that an Overall p
rofit of Rs. 50,000 can be earned on total sales. (61) The profit of a company w
orks out to 12.5% on capital employed in 1986. The details are as follows. Rs. 00
0s Sales Direct Material Direct Labour Variable overheads Capital Employed (a) 5
00 250 100 40 400
Forecast for 1987 indicates sales will increase by 10%, selling price will go up
by 4% and cost elements will go down by 2%. Assuming no change in the capital e
mployed, calculate the return on capital employed. The new sales manager who has
joined the company recently estimates for the next year a profit of about 23% o
n capital employed, provided the volume of sales is increased by 10% and simulta
neously there is an increase in selling price of 4% and an overall cost reductio
n in all elements of cost by 2%. Find out by computing in details the cost and p
rofit for the next year. Whether the proposal of sales manager can be adopted?
(b)
(62) A multi product company has the following costs and output data for the las
t year. Products Y 35% 25 15
X Sales Mix Selling Price Variable cost per unit Total Fixed cost Rs. 1,50,000 T
otal Sales Rs. 5,00,000 40% Rs. 20 Rs. 10
Z 25% 30 18
The company proposes to replace Product Z by product S. Estimated cost and outpu
t data are :
Marginal Costing
431

X Sales Mix Selling Price Variable cost per unit Total Fixed cost Rs 1,50,000 To
tal Sales Rs. 5,00,000 50% Rs. 20 Rs. 10
Products Y 30% 25 15
S 20% 28 14
Analyse the proposed change and suggest what decision the company should take. (
63) The following set of information is presented to you by your client AB Ltd.
(1) (2) (3) (4) (5) (6) Direct Materials ( per unit ) X-Rs. 20 Y- Rs.l8. Direct
Wages (per unit) X - Rs.6 Y- Rs. 4 Fixed expenses during the period are expected
to be Rs. 1,600 Variable expenses are allocated to products @ 100% of Direct Wa
ges. Sales Price (Per Unit) X - Rs.40 Y- Rs.30 Proposed Sales mixes (i) (ii) (ii
i) 100 Units of X and 200 units of Y 150 Units of X and 150 Units of Y 200 Units
of X and 100 Units of Y
As a Cost Accountant, you are requested to present to the management of AB Ltd.
the following. (a) (b) (c) The unit marginal cost and unit contribution. The tot
al contribution and resultant profit from each of the above sales mixes, The pro
posed sales mixes to earn a profit of Rs.300 and Rs.600 with the total sales of
X and Y being 300 units.
(64) An enthusiastic marketing manager suggests to his managing director that if
only he is permitted to reduce the selling price of a product by 20%, he would
be able to achieve a 30% increase in sales volume. The Managing Director, findin
g that the sales volume exceeds in percentage the extent of required reduction i
n price, gives the clearance. You are given the following information. Present s
elling price per unit Present volume of sales Total variable costs Total fixed c
osts Rs. 7.50 2,00,000 Nos. Rs. 10,50,000 Rs. 3,60,000
432
Management Accounting

Assuming no changes in the cost in the continuing period, (i) Examine the conseq
uences of the Managing Directors decision assuming that 30% increase in sales is
realised. At what volume of sales can the present quantum of profits be achieved
after effecting the price reduction.
(ii)
(65) SV Ltd. has budgeted the manufacture of 30,000 units of its only product A fo
r the next quarter. The capacity of the factory has not been fully utilised. The
variable cost per unit of product A is as under : Rs. Direct Material Direct Wage
s (Rs.4 per hour) Factory variable overheads Selling variable overheads 48.00 36
.80 27.60 18.00
Product A is sold at Rs.200 per unit. Fixed overheads for the quarter are Rs. 15
,00,000. At present, the company manufactures component P one unit of which is use
d in each unit of Product A. The cost of this component is already included in the
cost structure of Product A as aforesaid. Anyhow, the cost per batch of 1000 unit
s of component P is separately supplied as under. Rs. Direct Material Direct Wages
Factory variable overheads Fixed overheads apportioned to the component 6,000 4
,800 3,600 3,600 18,000 It is proposed to utilise the spare capacity by manufact
ure of 1,500 units of product B for export. The details are as under : Export sell
ing price Direct Material cost Direct labour Rs. 228 per unit Rs. 80 per unit 16
hours per unit
Variable expenses applicable to this product - Rs. 20 per unit. Factory variable
overheads have to be charged, calculated on the basis of Direct Labour Hour Rat
e applicable to Product A. It has to be noted that component P is not used in the
manufacture of product B.
Marginal Costing
433

You are required to (i) (ii) Present a statement showing the profit as originall
y envisaged in the budget. State whether component P should be manufactured or b
ought from the market if this can be procured at a price of Rs. 16 per unit.
(iii) Calculate the contribution on account of accepting the export order of pro
duct B. (66) A small scale manufacturer produces an article at the operated capaci
ty of 10,000 units while the normal capacity of his plant is 14,000 units. Worki
ng at a profit margin of 20% on sales realisation, he has formulated his Budget
as under 10,000 Rs. Sales Realisation Variable overheads Semi- Variable overhead
s Fixed overheads 2,00,000 50,000 20,000 40,000 14,000 Rs. 2,80,000 70,000 22,00
0 40,000
He gets an order for a quantity equivalent to 20% of the operated capacity and e
ven on this additional production, profit margin is desired at the same percenta
ge on sales realisation as for production to operated capacity. Assuming prime c
ost is constant per unit of production, what should be the minimum price to real
ise this objective? (67) The executives of B Co., a small manufacturer of one pr
oduct are developing the annual profit plan. They have just reviewed the First Cu
t at the annual income statement and are concerned with the Rs. 1,10,000 indicate
d profit on a sales volume of 20,000 units. The fixed cost structure of Rs.9,90,
000 appears to be high and they have some doubts about departing from the unit s
ale price of Rs.100. There is a general agreement that the Profit target should b
e Rs. 2,20,000. This case deals with several tentative alternatives suggested dur
ing the meeting of the executives committee that just reviewed the tentative prof
it plan. You are required to compute (a) (b) The budgeted break even point in ru
pees and in units and the number of units that would have to be sold to earn the
target profit? You are also required to respond directly to each of the followi
ng two alternatives under consideration by the management. Consider each indepen
dent of the other and state any assumptions that you would like to make.
Alternative 1 - A sale price increase of 15% is contemplated, the sales executiv
e estimates that this will cause a drop in units that can be sold by 15%. What w
ould be the new breakeven point in Rs. and in units? What would be the new profi
t figure? How many units would have to be sold to earn the target profit?
434
Management Accounting

Alternative 2 - A decrease in fixed costs of Rs-55,000 and a decrease of variabl


e costs of 6% are contemplated. What would be the new BEP in Rs. How many units
must be sold to earn the target profit. (68) Stoner company uses three different
components (Materials) in manufacturing its primary product. Stoner manufacture
s two of the components and purchases one (designated as component 1) from outsi
de suppliers. The company is currently developing the annual profit plan. Sales
are highly seasonal, component 2 cannot be acquired from outsiders, however comp
onent 3 can be purchased. The three components have critical specifications. The
annual profit plan provided data for the following computations. Component 3 Un
it Cost (at 12,000 units) Rs. Material (Direct) Labour (Direct) Fixed overheads
(apportioned) Annual machine rental (Special machine used only for component 3)
Variable factory overhead Average storage cost per year (fixed) Total Average in
ventory level 500 units. The Purchase Manager investigated outside suppliers and
found one that would sign a one year contract to deliver 12,000 quality units as
needed during the year at Rs.5.20 per unit. Serious consideration is being given
to this alternative. Should Stoner make or buy component 3? Explain the relevan
t factors influencing your decision. (69) From the following data, which product
would you recommend to be manufactured in the factory when(1) Time is the key f
actor. (2) (3) (4) Raw material is in short supply. Sales potential in units is
a limiting factor. Sales potential in value is a limiting factor. Per unit of Pr
oduct A Rs. Direct Material (Rs. 2 per Kg.) Direct Labour (Rs. 1 per Hour) Varia
ble Overheads Selling Price
Marginal Costing
1.40 2.20 0.40 0.50 1.00 0.40 5.90
Per unit of Product B Rs. 14 3 6 110
24 2 4 100
435

NOTES
436
Management Accounting

Chapter 1 2
BUDGETARY CONTROL
INTRODUCTION : Budget and Budgetary control : The term Budget is defined as a fina
ncial and/or quantitative statement, prepared prior to a defined period of time,
of the policy to be pursued during that period for the purpose of attaining a g
iven objective. The analysis of this definition reveals the following characteri
stics of the budget. (1) (2) (3) (4) It may be prepared in terms of quantity or
money or both. It is prepared for a fixed or set period of time. It is prepared
before the defined period of time commences. It spells out the objects to be att
ained and the policies to be pursued to achieve that objective.
The term Budgetary Control is defined as the establishment of budgets, relating th
e responsibilities of executives to the requirements of a policy and the continu
ous comparison of actual with budgeted results, either to secure by individual a
ction the objective of that policy or to provide the basis for its revision. The
analysis of this definition reveals the following facts about budgetary control
. (1) (2) (3) It deals with the establishment of the budgets.. It deals with the
comparison of budgeted results with the actual results. It deals with computati
on of the variations and the actions to be taken for maintaining the favourable
variations, removing the adverse variation or revising the Budgets themselves.
Budgetary Control
437

ADVANTAGES OF BUDGETARY CONTROL : (1) It is a powerful tool available to the man


agement for the purpose of cost control and maximization of profits through the
same. It enables the management to utilize the available resources in the most p
rofitable manner. A budget sets the plan of action. Plans in respect of various
functional areas of operations are expressed in the form of the budgets. As such
, the Budgetary Control systems acts as a means of declaration of the policies o
f the management. It acts a means of communication. The plans and objects laid d
own by top level management are communicated to middle level and lower level man
agement by way of the budgets. As such, each and every person working in the org
anisation is aware of his duties and responsibilities in relation to those of th
e others. This maximizes the utilization of resources. It acts as a means of imp
roving the co-ordination. The budgets prepared in the various functional areas o
f operations are prepared in such a way that the efforts are co-ordinated in the
direction of achievement of common and defined objective. It develops the team
spirit and help of various people can be sought to solve the common problem. The
comparison between the budgeted results and the actual results may reveal the a
reas where there are adverse variations which may be identified as weak areas or
delicate areas. As such, efforts can be made to remove these adverse variations
, keeping aside the areas where there are no variations. This enables the concen
tration of efforts of the management on a smaller portion of activities which fa
cilitates Management by exception. Budgetary control system enables the delegation
of authority and makes possible the principles of Responsibility Accounting. It
is a powerful tool available to the management for Performance Appraisal. The e
xecutives responsible for those functions where there is favourable variation ma
y be rewarded, whereas the executives responsible for those functions where ther
e is adverse variation may be punished. In this sense, budgetary control system
provides a basis for establishment of the incentive systems.
(2)
(3)
(4)
(5)
(6)
(7)
Pre-requisites for the implementation of Budgetary Control If the organization d
ecides to install the Budgetary Control system as a cost control technique, it w
ill have to comply with the following preliminaries.
438
Management Accounting

(1)
Deciding the Budget Centre : A Budget Centre is that section of the organization
with respect to which the budgets will be prepared. A Budget centre may be in t
he form of a product or a department or a branch of the company and so on. Budge
t centre should be clearly defined and established as the budgets will be prepar
ed with respect to each and every Budget Centre.
(2)
Deciding the Budget Period : A Budget Period is that period of time for which th
e budget will be prepared and operated. The selection of the Budget Period shoul
d be made very carefully- Too long a budget period makes the correct estimation
more difficult while too short a budget period may prove to be more costly. The
selection of Budget Period may depend upon the nature of operations and the purp
ose of preparing the budgets. As such, in case of industries like the ones engag
ed in generation and distribution of electricity, transport operations etc. wher
e capital expenditure is too high, budgets may be prepared even for a period of
5 to 10 years, while in case of industries like the ones engaged in manufacturin
g of motor vehicles or radios etc., where the customer demand may change more fr
equently, the budget period may be shorter. Similarly, a sales budget may be pre
pared for a period of 5 years, whereas the short term cash budget may be prepare
d on weekly or even daily basis.
(3)
Establishment of Accounting Records : There should be an efficient and proper sy
stem of accounting so that the information and data as required for the efficien
t implementation of the Budgetary Control system will be available in time.
(4)
Organization for Budgetary Control : A properly prepared organization chart may
make the duties and responsibilities of each level of executive very clear to hi
mself. The budgetary control organization will be headed by a senior executive i
n the form of budget controller or budget officer. In small or medium sized orga
nizations, he himself will be involved in all types of works involved with the b
udgetary control system. However, in case of large organizations, be may have a
budget committee under him which may consist of Chief Executive, budget officer
himself and heads of main departments. The role of budget committee may be only
advisory and its decision may become binding only if accepted by the Chief Execu
tive. The functions performed by the budget committee can be broadly stated as b
elow. (a) To receive and scrutirize the functional budgets.
Budgetary Control
439

(b) (c) (d) (e)


To revise the functional budgets, if necessary. To approve the revised budgets.
To receive the budget reports and comparative statements. To locate the responsi
bilities and recommend the corrective and remedial action.
The usual and normal organization for the budgetary control may be expressed by
way of the following organization chart. Chief Executive Budget Officer Budget c
ommittee Production Manager (5) Personnel Manager Finance Manager Purchase Manag
er Sales Manager
Preparation of a budget mannual : A budget mannual is a document setting out the
responsibilities of the persons engaged in and the forms and procedures require
d for the budgetary control. A budget manual enables the standardization of the
methods and procedures in relation to the budgetary control. It should be well w
ritten, indexed and divided into the sections. It may be in bound book form or l
oose leaf form. A budget mannual may contain the following particulars. (a) Intr
oduction of principles and objectives of budgetary control and the definitions a
nd brief explanations. Duties and responsibilities of the various executives and
the organization chart. Functions and duties of budget officer and budget commi
ttee. Scope of the budget and areas to be covered, whether budget will be a fixe
d budget or flexible budget. Accounts codes, budget center codes and other codes
operated. The forms of reports and statements to be used. The last date for sub
mission of budgets. Budget diagrams.
(b) (c) (d)
(e) (f) (g) (h)
440
Management Accounting

(6)
Determination of Budget Key Factor : A budget key factor is that the impact of w
hich should be assessed first before other functional budgets are prepared to en
sure that other functional budgets are capable of fulfillment. The key factor ma
y take various forms Eg.Sales, Raw material, Labour, Production capacity, availa
bility of funds and Government restrictions. Once the key factor is established,
the budget with respect to that function will be prepared first and the other b
udgets will be prepared to conform to that Eg. If sales is the key factor, the s
ales manager will prepare and submit sales forecast first. The production manage
r will then decide whether it is possible to produce the quantity to meet sales
demand. In case of the situations where there are more than one key factors, the
importance of key factors themselves will be assessed first. The problem of mul
tiplicity of key factors may be solved with the help of techniques like linear p
rogramming, operations research etc.
TYPES OF BUDGETS : There can be basically four areas in which management can fun
ction and the types of budgets can be studied with respect to these functional a
reas of management viz. Sales/Marketing, production, personnel and finance. (A)
Sales/Marketing :
The budgets in this area may be of following types. (I) Sales Budget : It is a f
orecast of total sales expressed in terms of quantity and or money. It is inevit
ably the interplay between two factors i.e. sales quantity and selling price. Sa
les quantity may be forecasted after taking into consideration various factors.
(1) Analysis of Past Trend : Analysis of the past trend over the last 5-10 years
, may reveal the long term trends, seasonal trends and the cyclical trends. With
the help of this trend analysis, the future trend can be established. For this
purpose, reference can be made to the reports published by trade organizations a
nd Government publications. Reports by Salesmen : Being in the actual field, pro
bably the sales staff may be best able to estimate the quantity which can be sol
d in the market. Before using this estimate as an official sales forecast, neces
sary adjustments may be made for error of judgment or to avoid the possibility o
f overestimation on the part of the salesmen. Market Research and Market Survey
: This is a very specialized technique available to assess which of the companys
products can be sold, in which market,
(2)
(3)
Budgetary Control
441

in what quantity and at what selling price. Such an analysis will facilitate the
preparation of sales forecast areawise, productwise, salesmenwise and channel o
f distribution wise. (4) General Economic Conditions : General Trade and Busines
s conditions affect the sales forecast of the company. They may be in the form o
f competition from other companies, supply condition for material and labour, tr
ade conditions of the customers of the company and so on. Selling price at which
products of the company can be sold may depend upon various factors viz. (1) (2
) (3) (4) Cost price of the product Selling price charged by the competitors. Ex
pected amount of profits. Advertisement and other sales promotion efforts carrie
d out by the company.
If the company envisages to sell higher quantity than the past sales or the exis
ting production capacity, and if some capital investment proposal is involved to
increase the production, then the feasibility of the proposal and the availabil
ity of funds may also be required to be considered. If the sales forecast is les
s than the past sales but the top management insists upon a certain amount of ad
ditional profits, then the possibility of increasing the selling price or sellin
g efforts and reduction in the cost price may be required to be considered. (II)
Selling and Distribution Cost Budget : It shows the selling and distribution co
st for selling the quantities considered in sales budget. The sales manager, the
distribution manager, the advertising manager and the finance manager will be t
he persons involved in the preparation of this budget. This budget may be prepar
ed on the principles of flexible budgeting (as discussed later in this chapter)
for each head of selling and distribution costs, on the basis of volume of sales
to be achieved. (III) Advertising Cost Budget : This cost is closely associated
with sales. The intention of incurring this cost is to increase the sales. Howe
ver, the result of incurring this cost i.e. increased sales may not be immediate
and even if there is increase in sales, it is difficult to measure the portion
of increased sales which is due to advertising cost. As such, normally, advertis
ing cost budget is established in the form of a fixed amount for a specific peri
od.
442
Management Accounting

The various ways in which the amount of budgeted advertising cost can be decided
are as below : (1) Percentage of Sales or Profits : Here the advertising cost m
ay be decided as a fixed percentage of sales or profits. However, the past data
may not be suitable in view of recent business situations. Funds Available : Her
e the advertising cost depends upon the capability of the company to spend on ad
vertising. This may be a hypothetical method and may not necessarily consider th
e relationship between advertising cost and benefits there from. Competitors Poli
cy : Here the advertising cost may depend upon the amount which the competitors
are spending on advertising. This method may pose some difficulty as the amount
spent by competitors may not be known and it may be wrong to assume that the com
pany may be able to derive the same benefits from advertising as the competitors
derive.
(2)
(3)
(B)
Production :
The budgets in this area may be of following types : (I) Production Budget : It
is a forecast of production for the budget period. It may be prepared from two a
ngles. (i) (ii) Production Budget in terms of Quantity. Production Budget in ter
ms of money i.e. the production Cost Budget further classified under each elemen
t of cost such as Direct Material Cost, Direct Labour Cost and Overheads Cost.
The material cost can be estimated by preparing the materials budget which indic
ates the estimated quantities as well as costs of various materials required for
carrying out production as per production budget. The labour cost can be estima
ted by preparing Direct Labour Cost budget which indicates the direct labour req
uirements required to produce the quantity as specified in the production budget
. For the purpose of this budget, labour requirement in terms of number of worke
rs of different grades will be decided first. Afterwards, the rates of pay and a
llowances will be considered to decide the labour cost. The production overheads
can be estimated by preparing production overhead budget which indicates all it
ems of production overheads classified as fixed, variable and semi-variable. The
process of allocation and apportionment can be followed to decide the loading o
f overheads to each budget centre. Following factors will have to be considered
before preparing the production budget in terms of quantity.
Budgetary Control
443

(1)
Coordination with Sales Forecast : Before the quantity to be produced is decided
, it will be necessary to confirm whether it is possible to sell the quantity wh
ich is produced during the budget period. If it is not possible to sell whatever
can be produced, inspite of all the sales promotion efforts, then the productio
n budget should be adjusted to conform to the sales forecast. If the expected sa
les exceed existing production capacity, possibility of overtime working or extr
a shift working should be considered. Production Capacity : Production Budget es
timates the quantity to be produced. If it is not possible to produce the quanti
ty with the existing capacity available, it will be necessary to increase the ca
pacity by incurring additonal capital expenditure. Consideration of Stocks : Wha
tever is to be sold need not be produced necessarilly. The quantity to be produc
ed, after giving due consideration to the sales forecast, may depend upon the op
ening and closing stock of finished goods. The quantity to be produced during th
e budget period may be decided as Estimated Closing stock of finished goods. Add
: Quantity to be sold, Less : Opening Stock of Finished Goods.
(2)
(3)
(4)
Management Policy : Sometimes, the policy decisions taken by the management are
required to be considered before setting the production budget Eg. It will have
to be considered whether certain components are decided to be produced instead o
f purchasing or vice versa.
(II)
Purchases Budget : It is a forecast of quantity and value of materials, direct o
r indirect, required to be purchased during the budget period. It is needless to
state that the purchases budget is closely connected to the production budget.
Following factors are required to be considered before setting the purchases bud
get, (1) (2) (3) (4) (5) (6) Orders already placed for the purchases of material
s. Material already purchased but reserved for some specific purposes. Opening a
nd closing stocks. Storing facilities and economic order quantity. Availability
of funds. Prices of the materials.
444
Management Accounting

(C)
Personnel :
In this functional area, the budget to be prepared takes the form of a personnel
budget, which indicates the requirement of personnel or labour force, either di
rect or indirect, to conform to the sales forecast and the production budget. Th
e labour requirement may be decided in terms of number and grade of workers, num
ber of labour hours, rupee value etc. Consideration is also required to be made
of the overtime working or shift working. This budget may also indicate the trai
ning plans for new workers. (D) Finance :
The most important budget which is prepared under this functional area is the ca
sh budget. It is an estimate of the expected cash receipts and cash payments dur
ing the budget period. Thus by preparing the cash budget, it is possible to pred
ict whether at any point of time, there is likely to be excess or shortage of ca
sh. If the shortage of cash is estimated, it may be required to arrange the cash
from some other source. If the excess of cash is estimated, it may be possible
to explore the investment opportunities. Before preparing the cash budget, follo
wing principles should be kept in mind. (i) The period for which cash budget is
prepared should be selected very carefully. There is no fixed rule as to the per
iod to be covered by the cash budget. It may vary from company to company depend
ing upon the individual requirements. As a general rule, the period covered by t
he cash budget should neither be too long or too short. If it is too long, it is
possible that the estimate will not be accurate. If it is too short, the factor
s which are beyond the control of management will not be given due consideration
. The items which should appear in the cash budget, should be carefully decided.
Naturally, all those items which do not involve cash flow will not be considere
d while preparing the cash budget. Eg. As the cost of depreciation does not invo
lve any cash outflow, it does not affect the cash budget, though the amount of d
epreciation affects the determination of tax liability which involves cash outfl
ow. A cash budget may be prepared in any of the following three methods. (1) Rec
eipts and Payments Method : This method is useful for short term estimations. It
lists the various estimated sources of cash receipts on one hand and the variou
s estimated applications of cash on the other. While preparing the cash budget b
y this method, the various items appearing on the same may be classified under t
he following two categories : (i) Operating Cash Flows : These are the items of
cash flow which arise as a result of regular operations of the business.
(ii)
Budgetary Control
445

(ii)
Non operating Cash Flows : These are the items of cash flow which arise as the r
esult of other operations of the business.
The standard items which may appear on the cash budget prepared by this method m
ay be stated as below : Cash Inflow Operating : Cash sales Collection from debto
rs Interest/Dividend received Cash Outflow Operating : Payment to creditors Cash
Purchases of raw materials Wages/Salaries Various kinds of overheads. (To the e
xtent they are actually paid) Non-operating Redemption of shares/debentures. Loa
n Installments Purchases of Fixed Assets Interest Taxes Dividends.
Non-operating Issue of shares/debentures Receipt of loans/borrowings Sales of Fi
xed Assets Sales of Investments
Thus, finally cash budget appears in the form of opening cash balance, to which
various estimated cash receipts are added, the estimated cash payments being ded
ucted from this sum to arrive at the closing cash balance. (2) Balance Sheet Met
hod : This method is useful for long term estimates. According to this method, t
he budgeted Balance Sheet is prepared for the following budget period, after con
sidering the various terms viz. Capital, Long Term Liabilities, Current liabilit
ies, Fixed Assets, Current Assets, but except cash. After both the sides of Bala
nce Sheet are balanced, the balancing figure indicates the estimated cash balanc
e in hand at the end of that period. This method does not consider the expenses
and assumes the regular pattern of inflow and outflow of cash. Further, it indic
ates the cash requirement only at the end of budget period, any excess or shorta
ge of cash during the budget period are not considered. Adjusted Profits/Losses
Method : This method also is useful for long term estimates. According to this m
ethod, the cash budget is prepared in the following way to show the estimated ca
sh balance at the end of the budget period.
(3)
446
Management Accounting

Opening cash balance. Add : Profit before depreciation, provisions and other non
-cash expenses. Add : Decrease in Current Assets or Increase in Current Liabilit
ies. Add : Capital Receipts. Add : Receipt of loans/borrowings Less : Capital Ex
penditure Less : Repayment of loan installments Less : Payment of dividends/taxe
s Less : Increase in Current Assets or Decrease in Current Liabilities In other
words, cash budget prepared as per this method is in the form of cash flow state
ment. (E) Miscellaneous Budgets : In addition to the various budgets as describe
d above, which can be prepared in prime functional areas of marketing, productio
n, personnel and finance, some other types of budgets may also be prepared. (I)
Overheads Cost Budget : It indicates the various types of overheads to be incurr
ed during the budget period. For the correct establishment of overheads cost bud
get, it will be necessary to classify the various overheads. In order to exercis
e proper control on the overheads, it will be necessary to analyse the overheads
as fixed, variable and semi-variable. The semi-variable overheads are further r
equired to be split into fixed and variable elements. (II) Capital Expenditure B
udget : It is the plan of proposed investment in the fixed assets. It is closely
related to the sales budget, production budget and cash budget. As such, capita
l expenditure budget should be properly coordinated with other functional budget
s. The capital expenditure may be required to be incurred for the replacement pu
rposes or expansion purposes. The requirements of capital expenditure may be bas
ically received from the various functional executives viz. production manager,
sales manager, finance manager and so on. If the investment in fixed assets is c
onsidered to be economically and financially feasible, then the arrangement is r
equired to be made for the acquisition of the same. If the cash budget reveals t
he excess funds available, it may not be necessary to arrange the funds for acqu
iring the fixed assets from outside source. However, if no excess cash balance i
s available, then it may be necessary to borrow the funds from some outside sour
ce.
Budgetary Control
447

(F)
Master Budget :
After all the functional budgets are prepared individually and are properly coor
dinated with each other, the master budget can be prepared by incorporating all
the functional budgets. The ultimate incorporation of all the functional budgets
takes the form of budgeted Profit and Loss Account and the Budgeted Balance She
et. It may involve the presentation of current years budgeted figures as well as
those of the previous year showing clearly why there is a change. FIXED AND FLEX
IBLE BUDGETS : Any budget in any functional area of operation can be established
as a fixed budget or a flexible budget. A fixed budget is established for a spe
cific level of activity and is not adjusted to the actual level of activity atta
ined at the time of comparison between the budgeted and actual results. Naturall
y, fixed budget is established only for a short period of time where the budgete
d level of activity is expected to be attained to the maximum possible extent. F
ixed budgets are more suitable for fixed expenses i.e. the expenses which have n
o relation with the level of activity. The fixed budgets do not indicate that th
ey cannot be changed at all. A fixed budget can be revised if the actual level o
f activity is likely to differ widely from the budgeted level of activity. The f
ixed budget cannot be used as a effective tool of cost control while computing t
he variations between the budgeted result and the actual result, the variance ca
nnot be explained properly and it is not possible to say whether the variance is
due to the changes in the level of activity or due to the efficiency or ineffic
iency of the executive responsible for the execution of the budget. A flexible b
udget is designed to change with the fluctuations in the level of activity and p
rovides a basis for comparison for any level of activity actually attained. A fl
exible budget is more elastic, and practical. It can be properly used as an effe
ctive tool for evaluation of performance and cost control. It explains the varia
tions between the budgeted results and actual results stating the variations whi
ch are due to changes in the level of activity (which is beyond the control of o
perating executive) and which are due to the operational efficiency or inefficie
ncy (for which the operating executive is responsible.) For the purpose of estab
lishment of the flexible budgets, it is necessary to classify the costs as fixed
costs, variable costs and semi-variable costs. The fixed costs remain the same
at all the levels of activity whereas the variable costs change directly in prop
ortion to the level of activity. So far as the semi-variable costs are concerned
, each item of cost is examined and classified into its fixed and variable eleme
nts and a trend is established regarding the nature and behavior of each item of
cost. ILLUSTRATIVE PROBLEMS (1) An estimate shows that there is a market for 10
,00,000 units of an electric bell. Two big companies producing this electric bel
l will probably divide 80% of the market. Among
Management Accounting
448

other companies, producing the bell, Ghatanad Ltd. should get 15% of the total m
arket. 60% of the Ghatanad sales will probably be evenly divided between the fir
st and last calendar quarters, with twice as many sales being made in the second
quarter as in the third. The bell sells for Rs.30 an unit, with the manufacturi
ng cost as follows. The cost is worked out with reference to normal working capa
city for the production which is 1,50,000 bells a year. Direct Materials Cost Di
rect Labour Cost Variable overheads cost Fixed overhead cost Rs. Rs. Rs. Rs. 15.
00 7.50 2.50 1,00,000
Prepare a sales budget for the year showing cost of production and gross profit
by calendar quarters. Assume no change in the inventory levels during the year.
Solution : SALES BUDGET Particulars (A) Sales - Units Rs. (B) Cost of Production
Direct Materials Rs. Direct Labour Rs. Variable Overheads Rs. Fixed Overhead Rs
. 6,75,000 3,37,500 1,12,500 25,000 11,50,000 (c) Gross Profit i.e. A - B 2,00,0
00 6,00,000 3,00,000 1,00,000 25,000 10,25,000 1,75,000 3,00,000 1,50,000 50,000
25,000 5,25,000 75,000 6,75,000 3,37,500 1,12,500 25,000 11,50,000 2,00,000 22,
50,000 11,25,000 3,75,000 1,00,000 38,50,000 6,50,000 Qtr. I 45,000 13,50,000 Qt
r. II 40,000 12,00,000 Qtr. III 20,000 6,00,000 Qtr. IV 45,000 13,50,000 Total 1
,50,000 45,00,000
Note : It is assumed that the fixed overheads are apportioned evenly over the va
rious quarters. (2) XYZ Ltd. manufactures product C and G. During January, it ex
pects to sell 5,000 Kgs of C and 20,000 Kgs of G at Rs. 20 and Rs. 10 each respe
ctively.
Direct materials A, B and E are mixed in equal proportion to produce product C.
Materials D, B and E are mixed in the proportion of 5:3:2 to produce product G.
There is no loss of weight in the production.
Budgetary Control
449

Actual and budgeted inventories in quantities and costs for the month are as fol
lows : Opening Inventory Kgs. Material A B D E Product C G 1,500 1,000 10,000 5,
000 1,000 5,000 Desired Closing Inventory Kgs. 1,000 2,000 3,000 6,000 500 6,000
Anticipated Cost per kg. 5.50 5.00 1.00 3.50
You are required to prepare (i) the production budget (ii) the materials purchas
e budget, indicating the expenditure on raw materials for January. Solution : (A
) Production Budget : January 1987 Product C Anticipated Sales - kgs. Desired cl
osing stock - kgs 5,000 500 5,500 Less : Opening stock kgs. Production during mo
nth kgs. (B) Materials Purchase Budget - January 1987 A (a) Requirement for prod
uction (As per production Budget) For product C - kgs For product G - kgs. Total
requirement - kgs. Desired closing stock - kgs Sub total a +b kgs Opening stock
kgs To be purchased during month kgs. c - d Anticipated cost per kg. Rs. Antici
pated cost of purchases Rs. B D E 1,000 4,500 Product G 20,000 6,000 26,000 5,00
0 21,000
(b) (c) (d) (e) (f) (g)
1,500 1,500 1,000 2,500 1,500 1,000 5.50 5,500
1,500 6,300 7,800 2,000 9,800 1,000 8,800 5.00 44,000
10,500 10,500 3,000 13,500 10,000 3,500 1.00 3,500
1,500 4,200 5,700 6,000 11,700 5,000 6,700 3.50 23,450
450
Management Accounting

(3)
Lookahead Ltd. produces and sells a single product. Sales budget for the calende
r year 1987 by quarter is as under Quarter I II III IV No. of units to be sold 1
2,000 15,000 16,500 18,000
The year 1987 is expected to open with an inventory of 4,000 units of finished p
roduct and close with an inventory of 6,500 units. Production is customarily sch
eduled to provide for two third of the current quarter s sales demand plus one t
hird of the following quarters demand. Thus production anticipates sales volume b
y about one month. The standard cost details for one unit of the product is as b
elow Direct Materials 10 Ibs @50 paise per Ib. Direct Labour 1 hour 30 minutes @
Rs. 4 per hour. Variable Overheads 1 hour 30 minutes @Re. 1 per hour. Fixed Over
heads 1 hour 30 minutes @Rs. 2 per hour, based on a budgeted production volume o
f 90,000 direct labour hours for the year. a. Prepare a production budget for 19
87, by quarters, showing the number of units to be produced and the total costs
of direct material, direct labour, variable overheads and fixed overheads. If th
e budgeted selling price per unit is Rs. 17, what would be the budgeted profit f
or the year as a whole ? in which quarter of the year is the company expected to
break even ?
b. c.
Solution : a. Production Budget We know that Opening Stock + Production - Sales
= Closing Stock Hence we know that Closing Stock + Sales - Opening Stock = Produ
ction
Budgetary Control
451

Q1 Opening Stock Production Sales Closing Stock 4000 13000 12000 5000
Q2 5000 15500 15000 5500
Q3 5500 17000 16500 6000
Q4 6000 18500 18000 6500
Hence, the total production for all the quarters will be 64,000 units. b. Produc
tion Cost Budget Direct Materials Direct Labour Variable Overheads Total Variabl
e Cost Fixed Cost Total Cost 64000 units x Rs. 5 96000 hours x Rs. 4 96000 hours
x Re. 1 = = = Rs. 3,20,000 3,84,000 96,000 8,00,000 1,80,000 9,80,000
Total Variable Cost for 64000 units is Rs. 8,00,000. Hence, per unit variable co
st is Rs. 12.50. c. Calculation of Profit Sales 61500 units @Rs. 17 per unit Var
iable Cost of units sold 61500 units @Rs. 12.50 per unit Contribution Less : Fix
ed Cost Profit d. Break Even Point Per Unit Selling Price is Rs. 17 and Per Unit
Varaible Cost is Rs. 12.50. Hence, Per Unit Contribution Rs. 4.50. As Fixed Cos
t is Rs. 1,80,000, Break Even Point in units will be 180000 / 4.50 = 40000 units
. This target is achieved by the company in Quarter 3, hence the company is expe
cted to break even in Quarter Three. (4) A single product company estimated its
sales for the next year quarterwise as under 7,68,750 2,76,750 1,80,000 96,750 1
0,45,500
452
Management Accounting

Quarter I II III IV
Sales units 30,000 37,500 41,250 45,000
The opening stock of the finished goods is 10,000 units and the company expects
to maintain the closing stock of finished goods at 16,250 units at the end of th
e year. The production pattern in each quarter is based on 80% of the sales of t
he current quarter and 20% of the sales of the next quarter. The opening stock o
f raw materials in the begining of the year is 10,000 Kgs. and the closing stock
at the end of the year is required to be maintained at 5,000 Kgs. Each unit of
finished output requires 2 Kgs. of raw material. The company proposes to purchas
e the entire annual requirement of raw materials in the first three quarters in
the proportion and at the prices given below Quarter Purchases of raw materials
% of total annual requirement in quantity I II III 30% 50% 20% 2 3 4 Price per K
g. Rs.
The value of the opening stock of raw materials in the beginning of the year is
Rs. 20,000. You are required to present the following for the next year, quarter
wise a. b. c. Production Budget in units. Raw Materials consumption budget in qu
antity. Raw Materials purchase budget in quantity and value.
Solution : a. Production Budget We know that Opening Stock + Production - Sales
= Closing Stock Hence we know that Closing Stock + Sales - Opening Stock = Produ
ction
Budgetary Control
453

Q1 Opening Stock Production Sales Closing Stock 10000 31500 30000 11500
Q2 11500 38250 37500 12250
Q3 12250 42000 41250 13000
Q4 13000 48250 45000 16250
Hence, the total production for all the quarters will be 1,60,000 units. b. Raw
Materials Consumption Budget Production Budget is 1,60,000 units. Each unit of t
he final product requires 2 Kgs. of raw material. Hence, the raw material consum
ption budget in quantity will be 3,20,000 Kgs. c. Raw Materials Purchase Budget
Total quantity of raw materials to be purchased will be Closing Stock + Consumpt
ion - Opening Stock 5000 + 320000 - 10000 = 315000 The quarterwise purchases wil
l be as below Q1 30% of 315000 Kgs. i.e 94500 Kgs. @Rs. 2 per Kg. Q2 50% of 3150
00 Kgs. i.e. 157500 Kgs. @Rs. 3 per Kg. Q3 20% of 315000 Kgs. i.e. 63000 Kgs. @R
s. 4 per Kg. = = = 1,89,000 4,72,500 2,52,000 9,13,500 Hence, total purchase bud
get in terms of value is Rs. 9,13,500. (5) A private Limited company is formed t
o take over a running business. It has decided to raise Rs.55 Lakhs by issue of
Equity shares and the balance of the capital required in the first six months is
to be financed by a financial institution against an issue for Rs.5 Lakhs 8% De
bentures (Interest payable annually) in its favour. Initial outlay consists of F
reehold premises Plant & Machinery Stock Vehicle & Other items Rs. Rs. Rs. Rs. 2
5 10 6 5 Lakhs Lakhs Lakhs Lakhs
Payments on the above items are to be made in the month of incorporation. Sales
during the first 6 months ending on 30th June are estimated as under.
454
Management Accounting

January February March


Rs. Rs. Rs.
14 15 18.50
Lakhs Lakhs Lakhs
April May June
Rs. Rs. Rs.
25 26.50 28
Lakhs Lakhs Lakhs
Lag in payment
- Debtors 2 months - Creditors 1 month

Other information : (1) (2) (3) (4) (5) (6) Preliminary expenses Rs.50,000 (Paya
ble in February) General Expenses Rs.50,000 p.m.(Payable at the end of each mont
h) Monthly wages (payable on 1st day of next month) Rs. 80,000 p.m. for first 3
months and Rs. 95,000 p.m. there after. Gross Profit rate is expected to be 20%
on sales. The shares and debentures are to be issued on 1st January. The stock l
evels throughout is to be the same as the outlay. Prepare cash budget for the 6
months ended 30th June. Solution : Cash Budget (For 6 month sending 30th June) J
an. (A) Cash Inflow Issue of shares Issue of Debentures Collection from Debtors
(B) Cash Outflow Fixed Assets Stock (Initial) Preliminary Expenses Sundry Credit
ors General Expenses Wages (C) Net cash Inflows (A-B) Opening Balance + Surplus
for the month Closing Balance 55.00 5.00 60.00 40.00 6.00 0.50 46.50 Feb.
0.40 0.50 0.80 12.20 Mar. 14.00 14.00 11.20 0.50 0.80 12.50 1.50 1.30 1.50 2.80
Apr. 15.00 15.00 14.00 0.50 0.80 15.30 (0.30) 2.80 (0.30) 2.50 (Rs. in Lakhs) Ma
y Jun 18.50 18.50 19.05 0.50 0.95 20.50 (2.00) 2.50 (2.00) 0.50 25.00 25.00
5 0.50 0.95 21.70 3.30 0.50 3.30 3.80
13.50 (12.20) 13.50 13.50 (12.20) 13.50 1.30
Budgetary Control
455

Working Notes : (1) (2) It is assumed that the company is incorporated in Januar
y. Assuming that the company is carrying on manufacturing operations, the purcha
se say for the month of January are computed as below. Sales for January Less Gr
oss profit @ 20% Cost of goods Less wages for January Purchases (6) 14.00 2.80 1
1.20 0.80 10.40
A newly started company Green Co. Ltd. wishes to prepare cash budget from January.
Prepare a cash budget for the first 6 months from the following estimated reven
ue and expenditure. Month Total Sales Rs. Jan. Feb. Mar. Apr. May June 20,000 22
,000 24,000 26,000 28,000 30,000 Material Wages Overheads Production Selling & D
istribution Rs. Rs. 3,200 3,300 3,300 3,400 3,500 3,600 800 900 800 900 900 1000
Rs. 20,000 14,000 14,000 12,000 12,000 16,000
Rs. 4,000 4,400 4,600 4,600 4,800 4,800
Cash balance on 1st January was Rs.10,000. A new machine is to be installed at R
s.30,000 on credit, to be repaid by two equal installments in March and April. S
ales commission @ 5% on total sales is to be paid within the month following act
ual sales. Rs. 10,000 being the amount of second call may be received in March.
Share premium amounting to Rs. 2,000 is also obtainable with 2nd call. Period of
credit allowed by suppliers period of credit allowed to customers Delay in paym
ent of overheads Delay in payment of wages Assume cash sales to be 50% of total
sales. 2 month 1 month 1 month 1/2 month
456
Management Accounting

Solution : Cash Budget of Green Co. Ltd. Jan. (A) Cash Inflows Cash sales Collec
tion from debtors Share Capital (2nd call) Share Premium Feb. Mar. 12,000 11,000
10,000 2,000 35,000 Apr. 13,000 12,000 25,000 May Jun.
10,000 11,000 - 10,000 14,000 15,000 13,000 14,000 10,000 21,000 (B) Cash Outflows Sundry Creditors Wages For current month For las
t month Production Overheads Selling & Distribution Overheads Instalment for Mac
hine purchased Sales commission 2,000 (C) Net Cash Inflows or outflows (A-B) Ope
ning cash balance + Surplus for month Closing cash balance (7) 1,000 9,200 800 2
,000 2,200 2,000 3,200
27,000 29,000
20,000 2,300 2,200 3,300
14,000 2,300 2,300 3,300
14,000 12,000 2,400 2,300 3,400 2,400 2,400 3,500
900
800
900
900
15,000 1,100 44,800
15,000 1,200 38,900
1,300
1,400
24,300 22,600
8,000 11,800 10,000 18,000 8,000 11,800 18,000 29,800
(-) 9800 (-) 13,900 29,800 20,000 20,000 6,100
2,700 6,100 2,700
6,400 8,800 6,400
(-) 9,800 (-) 13,900
8,800 15,200
Prepare a cash budget for the quarter ended 30th September 1987 based on the fol
lowing information Cash at Bank on 1st July 1987 Salaries and wages estimated mo
nthly Interest Payable August 1987 Rs. Rs. Rs. 25,000 10,000 5,000
Budgetary Control
457

June Rs. Estimated Cash sales Credit Sales Purchases Other Expenses (Payable in
same month) 1,00,000 1,60,000 July Rs. 1,40,000 80,000 1,70,000 20,000
August Rs. 1,52,000 1,40,000 2,40,000 22,000
September Rs. 1,21,000 1,20,000 1,80,000 21,000
Credit sales are collected 50% in the month of sales are made and 50% in the mon
th following. Collection from credit sales are subject to 5% discount if payment
is received in the month of sales and 2.5% if payment is received in the follow
ing month. Creditors are paid either on a prompt or 30 days basis. It is estimat
ed that 10% of the creditors are in the prompt category. Solution : Cash Budget
(For Quarter ending September 1987) July Rs. (A) Cash Inflows Cash Sales Collect
ion from Debtors Last month Current month 1,40,000 48,750 38,000 2,26,750 (B) Ca
sh Outflows Sundry Creditors Prompt Basis Others Salaries & wages Other Expenses
Interest August Rs. 1,52,000 39,000 66,500 2,57,500 September Rs. 1,21,000 68,2
50 57,000 2,46,250
17,000 1,44,000 10,000 20,000 1,91,000
24,000 1,53,000 10,000 22,000 5,000 2,14,000 43,500 60,750 43,500 1,04,250
18,000 2,16,000 10,000 21,000 2,65,000 (18,750) 1,04,250 (18,750) 85,500
(C) Net Cash Inflow (A-B) Opening Balance + Surplus for the month Closing Balanc
e
35,750 25,000 35,750 60,750
458
Management Accounting

Working Notes : It is assumed that salaries and wages are paid in the same month
. (8) From the following information you are required to prepare a cash budget f
or six months from January 1987 to June 1987, Month by month, showing also the c
ash credit facility available from the Bank. Opening overdrawn balance is Rs. 1,
50,000.
Sales Materials Purchases Rs. Rs. Rs. Wages Prod. Expenses Rs. Selling & Dist. E
xpenses Rs. Adm. Expases Rs.
Month
January February March April May June
1,44,000 1,94,000 1,72,000 1,77,200 2,05,000 2,17,400
50,000 62,000 51,000 61,200 74,000 77,600
20,000 24,200 21,200 50,000 44,000 46,000
12,000 12,600 12,000 13,000 16,000 16,400
8,000 10,000 11,000 13,400 17,000 18,000
3,000 3,400 4,000 4,400 5,000 5,000
Following further information is available. (1) Out of total sales, 50% are cash
sales and balance 50% is received in the month following month of sale. Payment
for purchase of assets is to be made Rs.16,000 in February, Rs. 25,000 in March
and Rs. 50,000 in April. Proceeds from sales of scrap are to be received in May
, amounting to Rs.6,000. Dividend of Rs. 90,000 is to be paid in June. Sales com
mission is to be paid at 3% of total sales in same month in which sales are made
. Suppliers for materials are paid in the month following the month of purchases
of materials. Cash credit facility granted is Rs. 2,00,000. Wages are paid in t
he same month. Creditors of Production, Selling & Distribution and Administratio
n expenses are given one months credit period.
(2)
(3) (4) (5)
(6) (7) (8) (9)
Budgetary Control
459

Solution :
Jan. 87 (A) Cash Inflows Cash sales Collection from debtors Sales of scrap 72,00
0 72,000 (B) Cash Outflows Creditors for Materials Wages Production Expenses Sal
es & Dist. Expenses Admin Expenes Purchases of Assets Dividend Sales Commission
20,000 4,320 24,320 (c) Net Cash inflows or outflows (A-B) Opening over drafting
+Surplus/Deficit for the month Closing overdrawing 47,680 1,50,000 47,680 1,02,
320 49,980 1,02,320 49,980 52,340 43,640 52,340 (-)8,716 8,700 54,950 (-) 43,322
17,416 (-) 37,534 54,950 (-) 43,322 5,788 97,000 72,000 1,69,000 50,000 24,200
12,000 8,000 3,000 16,000 5,820 1,19,020 86,000 97,000 88,600 86,000 1,02,500 88
,600 6,000 1,97,100 61,200 44,000 13,000 13,400 4,400 6,150 1,42,150 1,08,700 1,
02,500 2,11,200 74,000 46,000 16,000 17,000 5,000 90,000 6,522 2,54,522 Feb. 87
Mar. 87 Apr. 87 May 87 Jun. 87
1,83,000 1,74,600 62,000 21,200 12,600 10,000 3,400 25,000 5,160 51,000 50,000 1
2,000 11,000 4,000 50,000 5,316
1,39,360 1,83,316
43,640 (-) 8,716 8,700
17,416 (-) 37,534
Note : Eventhough, the Cash Credit Facility is granted to the extent of Rs.2,00,
000, the company is not likely to utilise it fully. At the end of June 1987, the
overdrawn balance is likely to be only Rs.5,788. (9) ABC Co. Ltd. wishes to arr
ange overdraft facilities with its bankers during the period April to June 1987
when it will be manufacturing mostly for stock. Prepare a cash budget for the ab
ove period from the following data, indicating the extent of the bank facility t
he company will require at the end of each month.
460
Management Accounting

Month February March April May June Additional Information : (1)


Sales Rs. 1,80,000 1,92,000 1,08,000 1.74,000 1,26,000
Purchases Rs. 1,24,800 1,44,000 2,43,000 2,46,000 2,68,000
Wages Rs. 12,000 14,000 11,000 10,000 15,000
All Sales are Credit Sales 50% of Credit Sales are realised in the month followi
ng the sales and the remaining 50% in the Second month following. Creditors are
paid in the month following the month of purchases. Cash at Bank of 1.4.87 (Esti
mated) Rs.25,000.
(2) (3)
Solution : Cash Budget of ABC Co. Ltd. Apr. 87 (A) Cash Inflows Sundry Debtors F
irst 50% Second 50% 96,000 90,000 1,86,000 (B) Cash Outflows Sundry Creditors Wa
ges 1,44,000 11,000 1,55,000 (C) Net Cash Inflows or outflows (A-B) (D) Estimate
d Cash Surplus or shortage Opening Cash Balance + Surplus/Deficit for the month
Closing cash balance 25,000 31,000 56,000 56,000 (-) l,03,000 (-) 47,000 (-) 47,
000 (-) l,20,000 (-) 1,67,000 31,000 (-) l,03,000 (-) l,20,000 2,43,000 10,000 2
,53,000 2,46,000 15,000 2,61,000 54,000 96,000 1,50,000 87,000 54,000 1,41,000 M
ay 87 June 87
Budgetary Control
461

Note : It can be seen that the company will be required to arrange for the bank
finance of Rs. 47,000 at the end of May 1987 and an additional amount of Rs.1,20
,000 at the end of June 1987. (10) The manager of a Repairs and Maintenance Depa
rtment has submitted the following budget estimates that are to be used to const
ruct a flexible budget to be used during the coming budget year. Details of cost
Planned at 6000 direct repairs hours 30,000 40,200 13,200 Planned at 9000 direc
t repairs hours 30,000 60,300 16,800
Employee Salaries Indirect Repair Materials Miscellaneous Costs a.
Prepare a flexible budget for the department up to activity level of 10,000 repa
ir hours (use increment of 1000). What would be the budget allowance at 8,500 re
pair hours?
b.
Solution : 8500 Hours Employee Salaries Indirect Repair Materials Miscellaneous
Costs 30,000 56,950 16,200 1,03,150 Working Notes : From the analysis of the cos
ts, it is observed that a. Employee salaries is a fixed cost as they remain cons
tant for both 6000 repair hours and 9000 repair hours. Indirect repair materials
is a variable cost as it proportionately increases from 6000 hours to 9000 hour
s. Miscellaneous costs is a semi-variable cost. This cost neither remained const
ant nor increased proportionately the activity level of 6000 hours to 9000 hours
. The cost increased by Rs. 3,600 for the increase of 3000 hours. means that the
variable portion of this cost is Rs. 1.20 hour. Hence, out of total miscellaneo
us cost of Rs. 13,200 for 6000 hours, Rs. 7,200 is variable portion and balance
6,000 is the fixed portion.
Management Accounting
10000 Hours 30,000 67,000 18,000 1,15, 000
b.
c.
462

(11) Viveka Elementary School has a total of 150 students consisting of 5 sectio
ns with 30 students per section. The school plans for a picnic around the city d
uring the week end to places such as the zoo, the amusement park, the planetariu
m etc. A private transport operator has come forward to lease out the buses for
taking the students. Each bus will have a maximum capacity of 50 (excluding 2 se
ats reserved for the teacher accompanying the students). The school will employ
2 teachers for each bus paying them an allowance of Rs. 50 per teacher. It will
also lease out the required number of buses. The following are the other cost es
timates Cost per student Rs. Breakfast Lunch Tea Entrance fee at zoo Rent Rs. 65
0 per bus. Special permit fee Rs. 50 per bus. Block entrance fee of the planetar
ium Rs. 250. Prizes to the students for games Rs. 250. No costs are incurred in
respect of the accompanying teachers (except the allowance of Rs. 50 per teacher
). You are required to prepare a. A flexible budget estimating the total cost fo
r the levels of 30, 60, 90, 120 and 150 students. Each item of cost is to be ind
icated separately. Compare the average cost per student of these levels. What wi
ll be your conclusions regarding the break even level of students if the school
proposes to collect Rs. 45 per student? 5 10 3 2
b. c.
Budgetary Control
463

Solution : No. of Students a. b. Variable Cost Semi-fixed costs Rent of the bus
Permit Fees Allowances to teachers c. Fixed Costs Entrance Fees Prizes to studen
ts Total Costs Average Cost per student Total Cost No. of students (12) Prepare
the flexible budget for overheads on the basis of data given below. Ascertain th
e overheads rates at 50%, 60% and 70% capacity. At 60% capacity Rs. Variable Ove
rheads Indirect Material Indirect Labour Semi-Variable Overheads Electricity (40
% fixed, 60% variable) Repairs and Maintenance (80% fixed, 20% variable) Fixed O
verheads : Depreciation Insurance Salaries Total Overheads Estimated Direct Labo
ur Hours 16,500 4,500 15,000 93,000 1,86,000 3,000 30,000 6,000 18,000 250 250 1
900 63.33 250 250 3300 55.00 250 250 3900 43.33 250 250 5300 44.17 250 250 5900
39.33 650 50 100 1300 100 200 1300 100 200 1950 150 300 1950 150 300 30 600 60 1
200 90 1800 120 2400 150 3000
464
Management Accounting

Solution : Calculation of Overheads Rates 50% Capacity Rs. Variable Overheads In


direct Material Indirect Labour Semi Variable Overheads Electricity Repairs and
Maintenance Fixed Overheads Depreciation Insurance Salaries Total Overheads Esti
mated Direct Labour Hours Overhead Rate (Labour Hour Rate) Re.0.55 Re.0.50 Re.0.
46 1,55,000 1,86,000 2,17,000 16,500 4,500 15,000 85,900 16,500 4,500 15,000 93,
000 16,500 4,500 15,000 1,00,100 27,000 2,900 30,000 3,000 33,000 3,100 5,000 15
,000 6,000 18,000 7,000 21,000 60% Capacity Rs. 70% Capacity Rs.
(13) A Factory can produce 60,000 units per annum at its 100% capacity. The esti
mated costs of production are as under. Direct Materials Direct Labour Indirect
Expenses Fixed Variable Semi-variable Rs. 1,50,000 per annum Rs. 5 per unit Rs.
50,000 per annum up to 50% capacity and an extra expenses of Rs. 10,000 for ever
y 20% increase in capacity or part thereof. Rs. 3 per unit. Rs. 2 per unit
The factory produces only against orders. If the production programme of the fac
tory is as indicated below, and the management desires to ensure a profit of Rs.
1,00,000 for the year, work out the average selling price at which each unit sho
uld be quoted.
Budgetary Control
465

For three months of the year - 50% capacity Remaining nine months of the year 80% capacity Solution : Calculation of total cost 50% capacity Number of units p
roduced Direct Material - Rs. Direct Labour - Rs. Variable Expenses - Rs. Fixed
Expenses Semi-Variable Expenses - Rs. Total Cost 7,500 22,500 15,000 37,500 37,5
00 12,500 1,25,000 80% capacity 36,000 1,08,000 72,000 1,80,000 1,12,500 32,500
5,05,000 Total capacity 43,500 1,30,500 87,000 2,17,500 1,50,000 45,000 6,30,000
Thus, the total cost during the year is likely to be Rs.6,30,000. If it is desir
ed to earn a profit of Rs. 1,00,000 the total amount to be covered by the units
to be sold will have to be Rs.7,30,000 (i.e. Rs. 6,30,000 + Rs. 1,00,000). As th
e total units produced are estimated to be 43,500, the above amount will have to
be covered by 43,500 units. Hence, the average selling price per unit will be R
s.7,30,000 43,500 Notes : (1) (2) It is assumed that whatever units are produced
can be sold. It is assumed that the production and the incidence of all the ind
irect expenses is equally spread during the year. From the following particulars
, prepare a flexible budget for the three months ending 30th September showing t
he estimated sales, sales cost and profit for 60%, 80% and 100% activity. Assume
that all items produced are sold. Rs. 4,20,000 2,80,000 3,50,000 4,45,000 14,95
,000 466
Management Accounting
=
Rs. 16.78 per unit (approx.)
(3)
Fixed Expenses Management salaries Rent and Taxes Depreciation on machinery Sund
ry office cost

Rs. Semi-variable expenses at 50% capacity Plant Maintenance Indirect Labour Sal
esmens Salary & Expenses Sundry Expenses 1,25,000 4,95,000 1,45,000 1,30,000 8,95
,000 Variable Expenses at 50% capacity Materials Labour Salesmens Commission 12,0
0,000 12,80,000 1,90,000 26,70,000 Semi-variable expenses remain constant betwee
n 41% and 70% activity, increase by 10% of the above figures between 71% and 80%
activity and increase by 15% of the above figures between 81% and 100% activity
. Fixed expenses remain constant whatever may be the level of activity. Sales at
60% activity are Rs.51,00,000, at 80% activity are Rs. 68,00,000 and at 100% ac
tivity are Rs.85,00,000. Flexible Budget 60% capacity Rs. (A) Sales (B) Sales Co
st (1) Fixed Expenses Management Salaries Rent and Taxes Depreciation on Machine
ry Sundry office cost 4,20,000 2,80,000 3,50,000 4,45,000 14,95,000 4,20,000 2,8
0,000 3,50,000 4,45,000 14,95,000 4,20,000 2,80,000 3,50,000 4,45,000 14,95,000
51,00,000 80% capacity Rs. 68,00,000 100% capacity Rs. 85,00,000
Budgetary Control
467

60% capacity Rs. (2) Semi Variable Expenses Plant Maintenance Indirect Labour Sa
lesmens Salary and Expenses Sundry Expenses 1,25,000 4,95,000 1,45,000 1,30,000 8
,95,000 (3) Variable Expenses Material Labour Salesmans Commission 14,40,000 15,3
6,000 2,28,000 32,04,000 Total Sales Cost 1 + 2 + 3 (C) Profit A - B 55,94,000 (
4,94,000)
80% capacity Rs.
100% capacity Rs.
1,37,500 5,44,500 1,59,500 1,43,000 9,84,500
1,43,750 5,69,250 1,66,750 1,49,500 10,29,250
19,20,000 20,48,000 3,04,000 42,72,000 67,51,500 48,500
24,00,000 25,60,000 3,80,000 53,40,000 78,64,250 6,35,750
(15) Based on sales foreast for the season, C Ltd. has prepared the following pr
oduction scheme for the coming month. 30,000 units of Product A and 20,000 units
of product B. the manufacturing specifications for the products are as follows.
Product A 2 Kgs. Material X @ Rs. 3 1/2 Kg. Material Y @ Rs. 2 2 hours direct l
abour @ Rs. 20 Product B 3 Kgs. Material W Rs. 8 3/4 Kg. Material Y @ Rs. 2 11/2
hours direct labour @ Rs. 20
To the direct labour hours, a 5% allowance for idleness (accounted for as overhe
ads) should be added. Indirect labour time is estimated to be 5% of direct labou
r hours (excluding idleness) and the wage rate for indirect labour is Rs. 15. Th
e overhead estimate (not shown above) is as follows Fixed Cost per month Depreci
ation Insurance Superintendence Rs. Rs. Rs. 69,000 8,000 30,000
Rs. 1,07,000 468
Management Accounting

Variable Costs : Rs 8 per direct labour hour. Note : This rate includes the cost
of idle lime and indirect labour. It is planned to increase the inventory of ra
w material X by 4,000 Kgs and to decrease the inventory of raw material W by 2,0
00 Kgs. as of the begining after next month. You are required to prepare and est
imate of the amount of cash necessary for manufacturing operations of the coming
month. Assume that the materials and wages cost are paid in the month of purcha
se. Solution : Computation of Requirement of Cash (A) For Raw Material : (Both P
roducts A & B) X - 60,000 Kgs @ Rs. 3 Y - 30,000 Kgs @ Rs. 2 W - 60,000 Kgs @ Rs
. 8 Rs. 1,80,000 60,000 4,80,000 7,20,000 Add : Increase in stock of X 4,000 kgs
@ Rs. 3 12,000 7,32,000 Less : Decrease in stock of W 2,000 Kgs @ Rs. 8 16,000
7,16,000 (B) For Direct Wages Product A - 60,000 hours @ Rs. 20 Product B - 30,0
00 hours @ Rs. 20 12,00,000 6,00,000 18,00,000 (C ) For Overheads (1) Idle Time
- 5% of 90,000 hours i.e. 4,500 hours @ Rs. 20 (2) Indirect Labour - 5% of 90,00
0 hours i.e. 4,500 hours @ Rs. 15 (3) (4) Variable Costs - 90,000 hours @ Rs. 8
Fixed Overheads 67,500 7,20,000 1,07,000 9,84,500 35,00,500 90,000 Rs.
Budgetary Control
469

(16) A company is at present working at 90% of its capacity and producing 13,500
units perannum. It operates a flexible budgetary control system. The following
figures (excluding material and labour cost) are obtained from its budget : 90%
(a) (b) (c) (d) Sales Fixed Expenses Semi-Fixed Expenses Semi-Variable Expenses
Rs. Rs. Rs. Rs. 15,00,000 3,00,500 97,500 1,42,000 100% 16,00,000 3,00,500 1,00,
500 1,49,500
Material and Labour Cost per unit are constant under present conditions. Profit
margin is 10% at 90% capacity : (a) (b) You are required to determine the cost o
f producing an additional 1,500 units. What would you recommend for an export pr
ice for these 1,500 units taking into account that overseas prices are much lowe
r than indigenous prices?
Solution : Cost Sheet 90% Capacity Variable Cost Material / Labour Variable port
ion of Semi-Fixed Expenses Variable portion of Semi-Variable Expenses a. Total V
ariable Cost Fixed Cost Fixed Expenses Fixed portion of Semi-Fixed Expenses Fixe
d portion of Semi-Variable Expenses b. c. d. e. 470 Total Fixed Cost Total Cost
(a+b) Profit Sales 74,500 4,45,500 13,50,000 1,50,000 15,00,000 74,500 4,45,500
14,50,500 1,49,500 16,00,000
Management Accounting
100% Capacity
8,10,000
9,00,000
27,000
30,000
67,500 9,04,500
75,000 10,05,000
3,00,500
3,00,500
70,500
70,500

Hence, the cost of producing 1,500 units will be Rs. 1,00,500 i.e. Rs. 14,50,500
less Rs. 13,50,000. Recommended export price for these 1,500 units will be Rs.
67 i.e. Rs. 1,00,500 / 1,500. Working Notes : a. Semi-Fixed Expenses With every
10% capacity increase, semi-fixed expenses increase by Rs. 3,000. This means tha
t variable portion of semi-fixed expenses is Rs. 3,000 for 10% capacity. For 90%
capacity it will be Rs. 27,000 and for 100% capacity, it will be Rs. 30,000. b.
Semi-Variable Expenses With every 10% capacity increase, semi-variable expenses
increase by Rs. 7,500. This means that variable portion of semi-fixed expenses
is Rs. 7,500 for 10% capacity. For 90% capacity it will be Rs. 67,500 and for 10
0% capacity, it will be Rs. 75,000. (17) Develope the proforma (estimated) incom
e statement for the months of October, November and December of Ajax Lunatics Lt
d. from the following information. (a) (b) (c) (d) (e) (f) Sales are projected a
t Rs. 2,50,000, Rs. 3,00,000 and Rs. 2,00,000 for October, November and December
respectively. Cost of goods sold is Rs. 75,000 plus 20% of sales per month. Sel
ling Expenses are 3% of sales. Rent is Rs. 7,500 per month. Administrative Expen
ses is 15% of sales per month. The company has Rs. 3,00,000 at 10% loan-The inte
rest is payable monthly. Corporate tax rate is 60%
Solution : Proforma (Estimated) Income Statement of Ajax Lunatics Limited. Octob
er (A) Sales (B) Cost Cost of goods sold Selling Expenses Rent Administretive Ex
penses Interest on Loan Total Cost (C ) Profit before tax (A - B) (D) Income Tax
- 60% of C (E) Profit after tax (C - D) 2,50,000 1,37,500 7,500 7,500 37,500 2,
500 1,92,500 57,500 34,500 23,000 November 3,00,000 1,50,000 9,000 7,500 45,000
2,500 2,14,000 86,000 51,600 34,400 December 2,00,000 1,25,000 6,000 7,500 30,00
0 2,500 1,71,000 29,000 17,400 11,600
Budgetary Control
471

(18) M/s. Agarval fabricating and Manufacturing Co. Ltd. is presently working at
50% capacity, producing and selling, 1,000 units of a product. You are required
to find out the profits the concern will make by working at 60% and 80% capacit
y. At 50% capacity, the selling price is Rs. 200 per unit. Whereas the product c
ost is Rs. 160 as given below. Rs. Materials Cost Direct wages Factory overheads
Selling and Admn. overheads 80 30 30 (of which 60% is variable) 20 (of which 50
% is fixed).
At 60% capacity, material prices go up by 10% and selling price reduced by 5%. A
t 80% capacity, there is increase in labour cost by 10% and variable factory ove
rheads go up by Rs. 2 per unit. The variable selling and administration overhead
s increase by Re. I per unit, the other costs and selling price remain unchanged
as at 60%. Flexible Budget 50% Capacity (A) Number of units sold Selling Price
per unit Sales (B) Cost (1) Materials Cost (2) Direct Wages (3) Variable Overhea
ds Factory Selling & Administration (4) Fixed Overheads Factory Selling & Admini
stration Total Cost (C) Profit i.e. A - B 12,000 10,000 1,60,000 40,000 12,000 1
0,000 1,97,200 30,800 12,000 10,000 2,65,200 38,800 18,000 10,000 21,600 12,000
32,000 17,600 Rs. Rs. Rs. 80,000 30,000 1,05,600 36,000 1,40,800 52,800 1,000 20
0 2,00,000 60% Capacity 1,200 190 2,28,000 80% Capacity 1,600 190 3,04,000
472
Management Accounting

QUESTIONS 1. What do you mean by Budget and Budgetary Control? What are the adva
ntages of Budgetary Control as a cost control technique? What are the prerequisi
tes for the successful implementation of Budgetary Control System? What is the m
eaning of Budget and Budgetary Control. State and explain various budgets which
can be established in the following functional areas of operation a) b) c) 3. Sa
les/Marketing Production Finance
2.
Write short notes on a) b) c) Budget Manual Fixed and Flexible Budgets Cash Budg
et
Budgetary Control
473

PROBLEMS (1) The sales manager of a manufacturing company expects to sell 25,000
units of a certain product. The production director provides the following info
rmation. Two kinds of raw materials X and Y are required for each unit of final
product and 2 units of X and 3 units of Y are required for one unit of final pro
duct. The estimated opening balance at the commencement of next year areFinal pr
oduct X Y - 5,000 units - 6,500 units - 8,000 units
The desirable closing balance at the end of next year are Final Product X Y - 7,
000 units - 6,500 units - 8,000 units
Draw the production budget for the next year.
(2)
A Ltd. manufactures two products X and Y making the use of following raw materia
ls in the proportion shown. Raw material Rl R2 R3 R4 Product X 80% 20% 50% 50% P
roduct Y
The finished weight of products X and Y are equal in weight of their ingredients
. During a month, it is expected that 1200 kgs. of X and 4000 kgs of Y will be s
old.
474
Management Accounting

Actual and budgeted inventories for the month are as below. Material Actual Open
ing Stock Kgs. R1 R2 R3 R4 X Y 300 200 4000 5000 200 1000 Budgeted Closing Stock
Kgs. 400 800 6000 4000 100 1200
The purchase price of materials is expected to be as below. Cost Per Kg. Rs. R1
R2 R3 R4 50 40 10 20
All materials will be purchased on 1st of the month. Prepare -(a) Production Bud
get. (b) Purchases Budget. (3) A Ltd. produces a standard product. The estimated
cost per unit in given below. Rs. Raw materials Direct wages Direct Expenses Va
riable Overhead 10 8 2 5
Fixed overheads are estimated to Rs. 70,000 selling price per umt is Rs. 40. Pre
pare a flexible budget at 50%, 70% and 90% level of activity. Assume that output
at 100% level of activity is 10,000 units.
Budgetary Control
475

(4)
The following expenses relate to a cost centre operating at 80% of normal capaci
ty (Sales are Rs.1,20,000) Draw up flexible Administration, Selling and Distribu
tion costs budget operating at 90%, 100% and 110% of normal capacity. Administra
tion Costs Office Salaries General Expenses Depreciation Rates and Taxes Selling
Costs Salaries Travelling Expenses Sales Office Expenses General Expenses Distr
ibution Costs Wages Rent Other Expenses Rs.3,000 0.5% of sales 2% of sales 4% of
sales 1.5% of sales 1% of sales 1% of sales Rs. 3,000 1.5% of sales Rs. 1,500 R
s. 1,750
(5)
The expenses budgeted for production of 10,000 units in a factory are furnished
below. Per Unit Rs. Materials Labour Variable Overheads Fixed Overheads ( Rs.1,0
0,000) Variable Expenses (Direct) Selling Expenses (10% Fixed) Distribution Expe
nses (20% Fixed) Adinimstrative Expenses (Rs.50,000) Total Cost of sale per unit
(to make and sale) Prepare a budget for the production of a. 8,000 units and b.
6,000 units. 70 25 20 10 5 13 7 5 155
476
Management Accounting

Assume that administrative expenses are rigid for all levels of production. (6)
Following are the actuals for the year 1985. Rs. Sales 20,000 units @ Rs.3 per u
nit Raw Material Direct Labour Cost Variable Overheads Fixed Overheads 60,000 26
,500 5,000 8,000 10,000
The management expects following estimate in 1986. Sales to increase to 30,000 u
nits, selling price remaining unchanged. Raw materials prices increase by 10%, w
age rate to increase by 10% but labour productivity improves by 5%. Fixed overhe
ads are expected to increase by Rs. 2,000. You are required to prepare the budge
t for 1986. (7) Production costs of a factory for a year are as follows. Direct
Wages Direct Materials Production Overheads : Fixed Variable Rs. 40,000 Rs. 60,0
00 Rs. 90,000 Rs. 1,20,000
During the forthcoming year, it is anticipated that : (a) The average rate for d
irect labour remuneration will fall from 90 paise to 75 paise per hour. Producti
on efficiency will be reduced by 5%. Price per unit of direct material and other
materials and services which comprise overheads will remain unchanged and Direc
t labour hours will increase by 33 1/3.
(b) (c)
(d)
Draw up a budget and compute a factory overhead rate, the overheads being absorb
ed on a direct wages. (8) ABC Ltd. manufacturing a single product is facing a se
vere competition in selling at Rs. 50 per unit. The company is operating at 60%
level of activity at which level sales are Rs. 12,00,000. Variable costs are Rs.
30 per unit. Semi variable costs may be considered
Budgetary Control
477

as fixed at Rs. 90,000 when output is nil and variable element is Rs.250 for eac
h additional 1% level of activity. Fixed costs are Rs, 1,50,000 at the present l
evel of activity, but at the level of activity of 80% or above if reached, these
costs are expected to increase by Rs.5,000. To cope with the competition, the m
anagement of the company is considering a proposal to reduce the selling price b
y 5%. You are required to : (a) Prepare a statement showing the operating profit
at levels of activity of 60%, 70% and 80%. Assuming that the selling price rema
ins at Rs.50 per unit. If selling price is reduced by 5%, show the number of uni
ts which will be required to be sold to maintain the present profits.
(b)
(9)
A company, producing electronic watches, estimates the following factory overhea
ds costs for producing 5,000 Units Indirect Materials Indirect Labour Inspection
Cost Heat, light & power Expendable tools Supervision Costs Equipment depreciat
ion Factory Rent Rs. 16,000 Rs. 30,000 Rs. 16,000 Rs. 8,000 Rs. 8,000 Rs. 8,000
Rs. 4,000 Rs. 4,000
Indirect labour, indirect material and expendable tools are entirely variable. H
eat, light and power and inspection costs are variable to the extent of 50% and
40% respectively. Other costs are fixed costs for a month. Prepare a flexible bu
dget for overheads for production of 4,000 and 6,000 units per month. Also find
out the average factory overheads per unit for these two production levels. (10)
Anil and Avinash Enterprises is currently working at 50% capacity and produces
10,000 units. Estimate the profits of the company when it works at 60% and 70% c
apacity. At 60% capacity, the raw materials cost increases by 2% and the selling
price falls by 3%. At 70% capacity the raw materials cost increases by 4% and s
elling price falls by 5%. At 50% capacity, the product costs Rs. 180 per unit an
d is sold for Rs.200 per unit.
478
Management Accounting

The unit cost of Rs. 180 is made up as below. Materials cost Wages Factory overh
eads Administration overheads Rs. 100 Rs. 30 Rs. 20 (40% Fixed) Rs. 30 (50% fixe
d)
(11) ABC Ltd. manufactures a single product for which market demand exists for a
dditional quantity. Present sale of Rs. 60,000 per month utilities only 60% capa
city of the plant. Sales Manager assures that with a reduction of 10% in the pri
ce, he would be in a position to increase the sale by about 25% to 30% . The fol
lowing data are available. (a) (b) (c) (d) Selling price Variable cost Semi-vari
able cost Fixed coct - Rs. 10 per unit - Rs. 3 per unit - Rs. 6,000 plus Rs.0.50
per unit Rs. 20,000 at present level, estimated to be Rs.24,000 at 80% output.
You are required to submit the following statements to the Board showing. (1) Th
e operating profits at 60%, 70% and 80% levels at current selling price and at p
roposed selling price. The percentage increase in the present output which will
be required to maintain the present profit margin at the proposed selling price.
(2)
(12) A manufacturing company has an installed capacity of 1,20,000 units per ann
um. The cost structure of the products manufactured is as under : (i) Variable C
ost ( Per Unit) Materials Labour Rs. 8 Rs. 8
(Subject to a minimum of Rs.56,000 per month) Overheads (ii) Rs. 3
Fixed overheads are Rs. 1,04,000 per annum.
(iii) Semi variable overheads Rs.48,000 per annum at 60% capacity, which will in
crease by Rs.6000 per annum for increase of every 10% of the capacity utilizatio
n or any part thereof.
Budgetary Control
479

The capacity utilization for the next year is estimated at 60% for 2 months, 75%
for 6 months and 80% for the balance part of the year. If the company is planni
ng to have a profit of 25% on the selling price, calculate the estimated selling
price for each unit of production. Assume there is no opening or closing stock.
(13) The monthly budgets for manufacturing overhead of a concern for two levels
of activity were as follows Capacity Budgeted Production (units) Wages Consumab
le Stores Maintenance Power and Fuel Depreciation Insurance You are required to
a. b. c. Indicate which of the items are fixed, variable and semi-variable. Prep
are a budget for 80% capacity. Find out the total cost, both fixed and variable,
per unit of output at 60%, 80% and 100% capacity. 60% 600 (Rs.) 1,200 900 1,100
1,600 4,000 1,000 9,800 100% 1000 (Rs.) 2,000 1,500 1,500 2,000 4,000 1,000 12,
000
(14) From the following data, prepare a flexible budget for the production of 40
,000 units, 60,000 units and 75,000 units, distinctly showing variable and fixed
costs as well as total costs. Also indicate element wise cost per unit. Budgete
d output and budgeted cost per unit Budgeted output Direct Material Direct Labou
r Direct Variable Expenses Manufacturing Variable Overheads Fixed Production Ove
rheads Administration Overheads (Fixed) Selling Overheads Distribution Overheads
100000 units Per unit cost Rs. 90 45 10 40 5 5 10 (10% fixed) 15 (20% fixed)
480
Management Accounting

(15) The budget manager of Progressive Electrical Limited, is preparing a flexib


le budget for the accounting year commencing 1st April 1995. The company produce
s one product a component - Kaypee. Direct Material costs Rs. 7 per unit. Direct
Labour averages Rs. 2.50 per hour and requires 1.60 hours to produce one unit o
f Kaypee. Salesmen are paid a commission of Re. 1 per unit sold. Fixed selling a
nd administration expenses amount to Rs. 85,000 per year. Manufacturing overhead
s under specified conditions of volume have been estimated as follows Volume of
Production (units) 1,20,000 Rs. Indirect Materials Indirect Labour Inspection Ma
intenance Supervision Depreciation Engineering Services Total Manufacturing Over
heads 2,64,000 1,50,000 90,000 84,000 1,98,000 90,000 94,000 9,70,000 1,50,000 R
s. 3,30,000 1,87,500 1,12,500 1,02,000 2,34,000 90,000 94,000 11,50,000
Normal capacity of production of the company is 1,25,000 units. Prepare a budget
of total cost at 1,40,000 units of output. (16) Excellent Manufacturers can pro
duce 4000 units of a certain product at 100% capacity. The following information
is obtained from the books of accounts June 94 2,800 Rs. 500 1,800 700 1,400 1,
000 200 1,400 July 94 3,600 Rs. 560 2,000 900 1,800 1,000 240 1,400
Units produced Repairs and Maintenance Power Shop Labour Consumable Stores Salar
ies Inspection Depreciation
The rate of production is 10 units per hour. Direct Materials cost is Re. 1 and
Direct Wages per hour is Rs. 4. You are required to Budgetary Control
481

a. b.
Compute the cost of production at 100%, 80% and 60% capacity showing the variabl
e, fixed and semi-fixed items under the flexible budget. Find out the overhead a
bsorption rate per unit at 80% capacity.
(17) The following data are available for a manufacturing company for a yearly p
eriod Rs. in Lakhs Fixed Expenses - Wages and Salaries - Rent, Rates and Taxes Depreciation - Sundry Administrative Expenses Semi-Variable Expenses (at 50% ca
pacity) - Maintenance and Repairs - Indirect Labour - Sales Department Salaries
- Sundry Administrative Salaries Variable Expenses (at 50% capacity) - Material
- Labour - Other Expenses 9 .5 6.6 7.4 6 .5 3 .5 7 .9 3 .8 2.8 21.7 20.4 7.9 98.
0 Assume that the fixed expenses remain constant at all levels of production, se
mi-variable expenses remain constant between 45% and 65% of capacity increasing
by 10% between 65% and 80% capacity and by 20% between 80% and 100% capacity. Sa
les at various levels are Rs. in Lakhs 50% capacity 60% capacity 75% capacity 90
% capacity 100% capacity 100 120 150 180 200
Prepare a flexible budget for the year at 60% and 90% capacities and estimate th
e profits at these levels of output.
482
Management Accounting

(18) A factory is currently running at 50% capacity and produces 5,000 units at
a cost of Rs. 90/- per unit as per details below : Rs. Material Labour Factory o
verheads Administrative overheads 50 15 15 (Rs. 6/- fixed) 10 (Rs. 5/- fixed)
The current selling price is Rs. 100/- per unit. At 60% working, material cost p
er unit increases by 2% and selling price per unit falls by 2%. At 80% working,
material cost per unit increases by 5% and selling price per unit falls by 5%. E
stimate profits of the factory at 60% and 80% working and offer your comments. (
19) On 30th September 1990, the Balance Sheet of Melodies Pvt. Ltd. retailers of
musical instruments, was as under Liabilities Ordinary shares of Rs.10 each ful
ly paid Reserves and surplus Trade Creditors Proposal Dividend 20,000 10,000 40,
000 15,000 Stock Trade Debtors Balance at Bank 85,000 Rs. Assets Equipment (at c
ost) Less : Depreciation Rs. 20,000 5,000 15,000 20,000 15,000 35,000 85,000
The company is developing a system of forward planning and on 1st October 1990,
it supplies the following information. Credit Sales Rs. Sept. 90 (Actual) Oct. 9
0 (Budget) Nov. 90 (Budget) Dec. 90 (Budget) 15,000 18,000 20,000 25,000 Cash Sa
les Rs. 14,000 5,000 6,000 8,000 Credit Purchases Rs. 40,000 23,000 27,000 26,00
0
All trade debtors are allowed one months credit and are expected to settle prompt
ly. All trade creditors are paid in the month following delivery.
Budgetary Control
483

On 1st October 1990, all the equipment was replaced at a cost of Rs. 30,000. Rs.
14,000 was allowed in exchange for the old equipment and a net payment of Rs. 1
6,000 was made. Depreciation is to be allowed at the rate of 10% per annnm. The
proposed dividend will be paid in December 1990. The following expenses will be
paidWages Rs. 3,000 per month. Administration Rs. 1500 per month. Rent Rs. 3600
for the year to 30th September 1991 (to be paid in October, 1990) The gross prof
it percentage on sales is estimated at 25%. You are required (1) (2) To prepare
cash budget for the months of October, November and December. To prepare Income
Statement for the three months ended 31st December 1990.
(20) Develop Performa income statement for the months of July, August and Septem
ber for a company for the following information. (a) Sales are projected at Rs.
2,25,000, Rs. 2,40,000 and Rs. 2,15,000 for July, August and September respectiv
ely. Cost of goods sold is Rs.50,000 plus 30% of selling price per month. Sellin
g Expenses are 3% of sales. Rent is Rs. 7,500 per month, administrative expenses
for July are expected to be Rs. 60,000 but are expected to rise 1% per month ov
er the previous months expenses. The company has Rs.3,00,000 of 8% loan interest
payable monthly. Corporate Tax rate is 70%.
(b) (c) (d)
(e) (f)
(21) The projected sales and purchases of ABC Ltd. for the months July to Novemb
er 1983 are Sales (Rs.) July August September October November 6,20,000 6,40,000
5,80,000 5,60,000 6,00,000 Purchases (Rs.) 3,80,000 3,33,000 3,50,000 3,90,000
3,40,000
484
Management Accounting

The wages are expected to be Rs.100,000 per month. The management is expected to
pay two months wages as bonus during October 1983. The company is expected to p
ay advance income tax Rs. 90,000 before 15th September 1983. The company has ord
ered in June 1983 for a machine costing Rs. 16,00,000. The Bank has agreed to fi
nance the purchase of the machine which is expected to be delivered in January 1
984. The company has advanced 5% in June 1983 and they have agreed to pay anothe
r 10% advance after 3 months. The company extends 2 months credit for the custom
ers and enjoys one month credit from the suppliers. The general expenses for the
company is Rs.60,000 per month payable at the end of each month. The company an
ticipates to receive dividends of 10% for the investments of 90,000 shares of Rs
. 10 each during October 1983. The company anticipates to have an overdraft of R
s. 40,000 on 1st September 1983 (limit sanctioned is Rs. 55,000). Draw a cash bu
dget for September 83 to November 83 for approaching bankers for a short term fu
rther credit. (22) From the following budgeted data of ABC Ltd., prepare cash bu
dget for the quarter ending 31st December 1984. Month August September October N
ovember December Additional information : Cash on hand on 1,10.84 Rs. 5,000 Sale
s 20% realised in the month of sale. Discount allowed 2%. Balance realised in su
bsequent month. Purchases - These are paid in the following the month of supply.
Wages - 25% in arrears paid in the following month. Misc. Expenses - Paid a mon
th in arrears. Rent - Rs.1,000 per month paid quarterly in advance, due in Octob
er. Income Tax - Instalments of Rs. 25,000 due on or before 15.12 84. Income fro
m investment - Rs. 5,000 received quarterly April, July, October etc. Insurance
claim - Rs. 72,936 receivable in December. Sales 1,20,000 1,30,000 80,000 1,16,0
00 88,000 Purchases 84,000 1,00,000 1,04,000 1,06,000 80,000 Wages 10,000 12,000
8,000 10,000 8,000 Misc. Exp. 7,000 8,000 6,000 12,000 6,000
Budgetary Control
485

(23) A firm expects to have to Rs. 30,000 in Bank on 1.10.86 and requires you to
prepare an estimate of cash position during the three months October 86 to Dece
mber 86. The following information is supplied to you. Month Sales Purchases Rs.
August September October November December 40,000 46,000 50,000 72,000 84,000 R
s. 24,000 28,000 32,000 36,000 40,000 Wages Rs. 6,000 6,500 6,500 7,000 7,250 Fa
ctory Exp. Rs. 3,000 3,500 4,000 4,000 4,250 Office Exp. Rs. 4,000 4,000 4,000 4
,000 4,000 Selling Exp. Rs. 3,000 3,500 3,500 4,000 4,000
Other information : (1) (2) (3) (4) (5) 25% of the sales are for cash, remaining
amount in the month following that of sale. Suppliers supply goods at 2 months
credit. Delay in the payment of wages and all other expenses one month. Income T
ax of Rs.l0,000 is due to be paid in December. Preference shares dividend of 10%
on Rs.l ,00,000 is to be paid in October.
(24) Mr. Ashok Kumar, the Finance Manager of Mazumdar Castings Ltd. is preparing
the cash budget for the first six months of 1982, on the basis of the following
information : (i) (ii) Costs and Price remains unchanged. Out of the total sale
s, cash sales are 25%, the balance being credit sales. 60% of the credit sales a
re collected in the month after sales, 30% are collected in the second month, an
d the balance 10% in the third month after sale. He does not expect any bad debt
s.
(iii) The Gross Profit Margin is expected to be 20% (iv) Actual sales and foreca
st sales are as follows : Oct. 81 Nov. 81 Dec. 81 Jan. 82 Feb. 82 486 Rs. Rs. Rs
. Rs. Rs. 12,00,000 14,00.000 16,00,000 8,00,000 8,00,000 Mar. 82 April 82 May 8
2 Jun. 82 Jul. 82 Rs. Rs. Rs. Rs. Rs. 8,00,000 12,00,000 12,00,000 8,00,000 10,0
0,000
Management Accounting

(v)
Anticipated Cash Purchases, there being no Credit Purchases: Jan 82 Feb. 82 Mar.
82 Rs. Rs. Rs. 6,40,000 7,00,000 10,00,000 April 82 May 82 Jun. 82 Rs. Rs. Rs.
9,10,000 6,40,000 9,60,000
(vi)
Wages and salaries to be paid in cash : Jan 82 Feb. 82 Mai. 82 Apr. 82 May 82 Ju
n 82 Rs. Rs. Rs. Rs. Rs. Rs. 1,40,000 1,60,000 2,00,000 2,20,000 1,60,000 1,40,0
00
(vii) Interest on 20,00,000 8% Debentures was due on June 30, 1982 (half yearly)
(viii) Excise deposit due on March 31, 1982 Rs. 3,00,000. (ix) Acquisition of p
lant and equipment planned for May 1982 Rs. 10,00,000. (x) Miscellaneous Expense
s on a cash basis every month at Rs. 15,000 plus 10% of sale.
(xi) The company will have a cash balance of Rs. 5,00,000 on 31.12,81. Mr. Ashok
Kumar believes that this is a high level and is planning on a continuous balanc
e of Rs. 4,00,000 (a) (b) Prepare the Cash budget for six months to June 1982 .
If additional finance is required, recommend the type of finance to be obtained.
(25) A company has its cost of goods of 70% of its sales, 70% of this cost is pa
id in the month of the sale and the balance in the next month. Salary and admini
strative expenses amount to Rs. 40,000 per month plus 5% of sales. These expense
s must be paid during the month following the month when expenses are actually i
ncurred . The company has also 10% Debentures of Rs. 1,50,000 and interest has t
o be paid in 4 quarters from January onwards. The company gives its actual and f
orecast sales as below. Actual Sales January February March April Rs. 2,00,000 2
,00,000 3.00,000 3,00,000 Forecast sales May June July August Rs. 2,00,000 2,50,
000 2,50,000 3,00,000
Budgetary Control
487

You are required to prepare a cash flow schedule for six months from March onwar
ds. (26) Following details are available in case of Pam Industries Ltd. Actual S
ales January February March April Rs. 65,000 75,000 90,000 80,000 Estimated sale
s May June July August Rs. 1,05,000 1.20,000 1,25,000 1,35,000
Consider the following additional information : (1) Cash sales are 50 per cent o
f the total sales. The remaining 50 per cent will be collected equally during th
e following two months. Cost of goods manufactured is 70 per cent of sales. 90 p
er cent of this cost is paid during the first month after incurrence and the bal
ance is paid in the following month. Sales and administrative expenses are Rs. 1
5,000 per month plus 10 per cent of sales. All these expenses are paid during th
e month of incurrence. Half- yearly interest of 6 per cent on Rs. 4,50,000 Deben
tures is paid during July. Rs. 60,000 are expected to be invested in fixed asset
s during July. A dividend of Rs. 15,000 will be paid in July. An income tax of R
s. 15,000 will be paid in July.
(2)
(3)
(4) (5) (6) (7)
It is the policy of the company to have a minimum cash balance of Rs. 30,000/-.
Accordingly as on 30th April, the actual cash balance was Rs. 30,000/-. The Mana
gement wishes to know whether it will be required to borrow during the quarter e
nding on 31st July and if so when and how much. (27) Prepare a cash budget for t
he three months ending 30th June 1986 from the information given below. (a) Mont
h February March April May June 488 Sales Materials Rs. Rs. 14,000 15,000 16,000
17,000 18,000 9,600 9,000 9,200 10,000 10,400 Wages Rs. 3,000 3,000 3,200 3,600
4,000 Overheads Rs. 1,700 9,900 2,000 2,200 2,300
Management Accounting

(b)
Credit terms are : Sales/Debtors - 10% of sales are on cash, 50% of the credit s
ales are collected next month and balance in the month following Creditors Mater
ials Wages Overheads - 2 months - 1/4 month - 1/2 month
(c) (d) (i)
Cash and Bank balance on 1st April 1986 is expected to be Rs.6,000. Other releva
nt information : Plant and Machinery will be installed in February 1986 at a cos
t of Rs. 96,000. The monthly instalments of Rs. 2,000 is payable from April onwa
rds. Dividend @ 5% on preference share capital of Rs.2,00,000 will be paid on 1s
t June.
(ii)
(iii) Advance to be received for sale of vehicle Rs. 9,000 in June. (iv) (v) Div
idends from investment amounting to Rs. 1,000 expected to be received in June In
come Tax advance is to be paid in June - Rs. 2,000.
(28) Prepare a cash budget of XYZ Ltd. on the basis of the six months commencing
from April 1989. (1) (2) (3) Cost and prices remain unchanged. Cash sales are 2
5% of the total sales and balance 75% will be credit sales. 60% of credit sales
are collected in the month following the sales, balance 30% and 10% in the two f
ollowing months thereafter. No bad debts are anticipated. Sales forecasts are as
follows - (Rs. in lakhs) Jan. 89 April 89 July 89 Oct. 89 (5) (6) - 12 -6 - 12
-12 Feb. 89 May 89 August 89 - 14 -8 - 10 March 89 June 89 Sept. 89 - 16 -8 -8
(4)
Gross Profit margin 20% Anticipated purchases - (Rs. in lakhs) April 89 July 89
- 6.40 - 8.00 May 89 August 89 - 6.40 - 6.40 June 89 Sept. 89 - 9.60 - 9.60
Budgetary Control
489

(7)
Wages and Salaries to be paid - (Rs. in lakhs) April 89 July 89 - 1.20 - 2.00 Ma
y 89 August 89 - 1.60 - 1.60 June 89 Sept. 89 - 2.00 - 1.40
(8)
Capital expenditure for plant and machinery planned for September 1989 is Rs. 1,
20,000. Company has a cash balance of Rs. 4,00,000 as at 31st March, 1989 and wi
ll maintain it in future also at minimum level.
(9)
(10) The Company can borrow on monthly basis. (11) Rent is Rs. 8,000 per month.
(29) Lal and Company has given the forecast sales for January 1989 to July 1989
and actual sales for November and December 1988 as under. With the other particu
lars given, prepare a Cash Budget for the five months i.e. from January 1989 to
May 1989. (1) Sales November 88 December 88 January 89 February 89 March 89 (2)
1.60 1.40 1.60 2.00 1.60 Lakhs Lakhs Lakhs Lakhs Lakhs April 89 May 89 June 89 J
uly 89 2.00 Lakhs 1.80 Lakhs 2.40 Lakhs 2.00 Lakhs
Sales 20% cash and 80% credit, payable in the third month (January sales in Marc
h). Variable expenses 5% on turnover, time lag half month. Commission 5% on cred
it sales payable in the third month. Purchases being 60% of the sales of the thi
rd month, payment will be made on 3rd month of purchases. Rent and other expense
s Rs. 6,000 paid every month. Other Payments Fixed Assets Purchases - March Rs.
1,00,000 Taxes - April Rs. 40,000
(3) (4) (5)
(6) (7)
(8)
Opening cash balance Rs. 50,000
490
Management Accounting

NOTES
Budgetary Control
491

NOTES
492
Management Accounting

Chapter 1 3
STANDARD COSTING
INTRODUCTION : The determination of the actual cost on the basis of various cost
ing records maintained is no doubt important, but such actual cost (or historica
l cost) involves some limitations as to its utility. (1) The actual cost informa
tion is available only after the completion of the job, process or service and h
ence is of no practical utility from control point of view, as no basis is provi
ded with which the actual costs can be compared. There are various kinds of mana
gerial decisions where cost is an inevitable basis E.g. price fixation or submis
sion of quotations. However if the details of actual cost are available too late
, such cost details are of no practical utility for the purpose of price fixatio
n or submission of quotation. The actual costs may be affected due to the ineffi
cient functioning. The actual costs may be excessive due to abnormal expenses, a
voidable wastes, inefficient use of labour and excessive use of materials. As su
ch, actual costs are not useful for providing a yardstick for measuring efficien
cy of performance. Actual costing is comparatively expensive as it involves the
maintenance of various records and documents. The above stated limitations invol
ved with the determination of actual costs has given rise to the technique of st
andard costing.
(2)
(3)
(4)
CONCEPT OF STANDARD COST AND STANDARD COSTING : The term standard cost has been de
fined as a pre-determined cost which is calculated from the managements standards
of efficient operation and the relevant necessary expenditure. The term standard
costing has been defined as the preparation and use of standard costs, their comp
arison with actual costs and the measurement and analysis of variances to their
causes and points of incidence.
Standard Costing
493

Thus, standard cost is the normal cost under the ideal circumstances. It may be
used as a base for the purpose of price fixation and submission of quotations. M
oreover, the standards when compared with the actual cost may also be used as to
ols for cost control and as a yardstick for measuring efficiency of performance,
which is possible with standard costing system. As such, the process of standar
d costing involves the following stages. (1) Predetermination of technical data
related to production i.e. details of materials and labour operations required f
or each product, the quantum of inevitable losses, level of activity etc. Predet
ermination of standard costs in full details under each element of cost i.e. Lab
our, Material and Overhead. Comparison of actual performance and costs with stan
dards and working out the variances i.e. the difference between the actual and t
he standards. Analysis of variances in order to determine the reasons for deviat
ions of actuals from the standards. Presentation of information to the appropria
te level of management to enable suitable action being taken, or revision of sta
ndards.
(2)
(3)
(4)
(5)
It should be noted in this connection that standard costing is not a separate sy
stem of accounting but only a technique used with the intention of controlling t
he costs. Though it can be used in case of all methods of costing like job costi
ng, process costing etc.; it can be more effective in case industries producing
the standard products on continuous basis. Advantages of standard costing : (1)
Standard costing provides a yardstick with reference to which the efficiency/ine
fficiency in performance may be established. This facilitates the basic manageme
nt function of cost control. Standard costing provides the incentive and motivat
ion to work with greater effort for achieving the standard. Standard costs may b
e used as the basis for the process of price fixation, filing the tenders and of
fering the quotations. If the prices are to be quoted on cost plus basis, actual
costs may not be available in which case standard costs can be the base for fix
ation of selling prices. Standard costing system facilitates delegation of autho
rity and fixation of responsibility for each individual or department. This also
tones up the general organization of the concern.
(2)
(3)
(4)
494
Management Accounting

(5)
Variance analysis and reporting is based on the principle of management by excep
tion. The top management may not be interested in details of actual performances
but only in the variations from the standard, so that corrective measures may b
e taken in time. When constantly reviewed, the standards provide means for and e
ncourage action for cost reduction. Focus on out of control situations, leads to
cost reduction through the improved methods, improved quality of products, bett
er material and workers, effective selection and use of capital resource etc. A
properly laid down system of standard costing may facilitate the correct impleme
ntation of the technique of budgetary control which also is a good system of cos
t control.
(6)
(7)
Limitations of standard costing : (1) Establishment of standard costs is difficu
lt in practice. Even though, standards are fixed after defining properly, there
is no guarantee that the standards established will have the same tightness or l
ooseness as envisaged. In the course of time, even in a short period, the standa
rds become rigid. It may not be possible to maintain the standards to keep pace
with the changes in manufacturing conditions. Revision of standards is costly. S
ometimes, standards set create adverse effects. If standards are set tightly and
there is non-achievement of the same, it creates frustration. The standard cost
ing may not be suitable in all types of organizations e.g. (i) In case of small
concerns- Where the production cannot be properly scheduled. In small concerns,
personal contacts may be more effective than the standard costing. In case of in
dustries having non-standardized products.
(2)
(3)
(4)
(ii)
(iii) In case of industries having repair jobs which keep changing as per custom
er requirements. (iv) In case of industries where products take more than one ac
counting period to complete e.g. contract jobs.
(5)
Due to the play of random factors, it may be difficult to properly examine the v
ariance and distinguish between controllable and uncontrollable variances. e.g.
Adverse labour time variance may be due to poor grade of labour, poor quality of
material, defective plant and machinery and lack of trained workers. Lack of in
terest in standard costing on the part of the management makes the system ineffe
ctive and cant be used as a proper means of cost control.
(6)
Standard Costing
495

Standard costing and budgetary control compared : Both standard costing and budg
etary control are the best possible tools available to the management for the pu
rpose of controlling the costs. Both the techniques involve the process of setti
ng the targets or standards, measurement of actual performance, comparison of ac
tual performance with targets or standard set, computation and analysis of varia
tions and the attempts to maintain favorable variations and remove unfavorable v
ariations. The technique of budgetary control can be used effectively if the sys
tem of standard costing is prevailing. Thus, both the techniques complement each
other but are not necessary dependent upon each other. On the other hand, in sp
ite of the various similarities, both the techniques differ from each other in c
ertain respects. (1) System of budgetary control may be operated even if no stan
dard costing system is in use in the concern. Budgets are the ceilings or limits
on expenses above which actual expenditure should not normally exceed and if it
does, the planned profits will be reduced. Standard costs are minimum targets t
o be attained by the actual performance. Budgets may be prepared in the various
areas of activities like sales, production, purchases, capital investment etc. W
hereas standard costing specifically relates to the function of production and m
anufacturing costs. A more searching analysis is required to be made in case of
standard costing variances than in case of budgetory control variances. Variance
s in case of budgets may point out efficiency or inefficiency. But variances in
case of standard costing provide material for further probe and investigation. T
he scope of standard costing is much wide than that of budgetary control. Adhere
nce to budgeted performance may indicate that the business is out of difficultie
s. A genuine attempt to attain the standards always provides the scope for impro
ved performance. Budgets are based upon the future or estimated costs which may
be used for forecasting the requirements of various factors of production like m
aterial, labour, finance etc. Standard costs are planned or ideal costs under th
e ideal situations as to operating efficiency, capacity level attainment and so
on. Standard costs may not be necessarily useful for forecasting purposes.
(2)
(3)
(4)
(5)
(6)
Preliminaries for Establishing Standard Costing System : Before the standard cos
ting system is established in an organization, the following preliminaries will
have to be complied with.
496
Management Accounting

(1)
Establishment of cost centres : As explained before, a cost centre is any unit w
ith respect to which the costs will be ascertained. If the standard costing syst
em is to be implemented, the cost centres should be defined very clearly so that
the responsibility can be fixed in case of non standard performance.
(2)
Design of Accounts : As the standard costing essentially involves the process of
comparing the actual performance to standard performance and computation of var
iances therefrom, the accounts should be designed in such a way that the informa
tion about the actual performance is available as correctly as possible and as s
peedily as possible. For this purpose, the codification of accounts may be consi
dered.
(3)
Establishment of standards : This is probably the most critical part of the impl
ementation of standard costing i.e. to establish the standards with respect to t
he individual elements of cost i.e. Direct Material Cost, Direct Labour Cost and
Overheads. It is necessary to exercise maximum care while establishing the stan
dards as wrongly established standards may defeat the purpose of standard costin
g.
Following steps are involved in the process of establishing the standards. (a) S
tudy of technical and operational details of the organization like the manufactu
ring process, levels of managements and their responsibilities, units and nature
of inputs and outputs, details regarding wastes and losses, expected efficiency
and capacity utilization etc. Study of existing cost accounting systems and for
mats in use. Decision about the types of standards to be used. It may be noted t
hat there may be various types of standards.
(b) (c)
Basic Standards : These are established for an unaltered use over a longer perio
d of time and they dont reflect the current conditions. These types of standards
are not useful from the cost control point of view and can be used in case of in
dustries where technical processes are fully established or in case of those typ
es of costs which are fixed in nature viz. rent, remuneration to managerial pers
onnel etc.
Standard Costing
497

Current Standards : These are established for a shorter period of time and are a
daptable to change in current conditions. As current conditions are likely to ch
ange, the current standards are also subject to revision as per the changes in c
urrent conditions. Current standards may be of three types. Ideal Standards : Th
ese are the standards which are set which are attainable under the most favourab
le conditions possible and assumes the maximum utilization of various factors of
production (like men, material and machines) which is not practicable and attai
nable. Thus, the ideal standards are generally theoretical in nature and the var
iances always show an unfavorable trend. The basic limitation of these types of
standards is that the constant non achievement of these standards causes frustra
tion among the staff and the constant reporting of unfavorable variances is pres
umed which results into lost impact of system itself. Expected Standards : These
are the standards which are anticipated to be attained during the budget period
. These are based upon the expected performance based upon the conditions which
are likely to prevail during the budget period. Allowances are provided for the
unavoidable deviations from the ideal performance e.g. Labour time wastage, exce
ss material use, break down of machinery etc. Thus, these standards are more rea
listic in nature and are more useful from cost control point of view. Normal Sta
ndards : These are the standards which may be anticipated to be achieved in futu
re, over a longer period of time, considering the past performance. As such, the
inefficiencies of the past performance, if any, get reflected in these types of
standards. Further, the problems faced in estimating the future over a longer p
eriod of time also restrict the use of these standards for cost control purposes
. After the consideration of various types of standards which may be used, the p
rocess of establishment of standards with respect to various elements of costs c
omes into operation. As discussed above, the standards may be set for the variou
s elements of costs i.e. Direct Material Cost, Direct Labour Cost and Overheads.
(a) Direct Material Cost : Setting the Standard Cost for Direct Material, invol
ves two stages i.e. To decide Price Standard and to decide Use Standard.
498
Management Accounting

Price Standard : It may involve the consideration of following factors. (i) (ii)
Current market conditions and likely changes. Prices of current supply orders.
(iii) Prices of long term supply contracts. Along with the basic prices, it may
involve the consideration of the factors like discount, packing charges, insuran
ce, sales tax, octroi etc. It may be the primary responsibility of the Purchase
Department to supply the details required for this purpose. Use Standard : It ma
y be the primary responsibility of Engineering or Design Department to supply th
e details required for this purpose, on the basis of standard bill of material.T
his may involve the process of product study. Sufficient provisions should be ma
de for unavoidable scrap or wastages. (b) Direct Labour Cost : Setting the stand
ard cost for Direct Labour involves two stages i.e. To decide the wage rate stan
dard and to decide Labour Efficiency standard. Wage Rate Standards : It may invo
lve the consideration of following factors. (i) (ii) The system of wages payment
s prevailing i.e. Piece Rate Wages or Time Rate Wages Systems prevailing for bon
us payments
(iii) The provisions of agreements with workers covering a future period of time
. (iv) (v) Provisions of various laws and guidelines governing the fixation of w
age rates Grades of workers required and likely trends of market conditions in r
espect of availability thereof.
Labour Efficiency Standards : It may be decided on the basis of the consideratio
n of following factors. (i) (ii) Records of past performance. Time and motion st
udy considering the details in respect of an average worker as the base.
Standard Costing
499

(iii) Trial Runs, specifically in respect of a new product. Sufficient provision


should be made in respect of the unavoidable idle time. (c) Overheads Cost : Se
tting the standard cost of overheads involves the following stages. (i) (ii) Est
imation of standard overheads cost. Estimation of standard level of activity ( i
n terms of labour hours, machine hours or units of production)
(iii) Estimation of standard overhead absorption rate which may be decided as be
low. Standard Overhead Cost Standard Level of Activity Thus, the standard absorp
tion rate may be per unit of production, per labour hour or per machine hour. Fo
r better control purposes, the standards for overhead cost may be decided separa
tely for fixed overheads and variable overheads, as fixed overbeads are normally
uncontrollable at the lower level of management. (4) Reporting of Variances : T
he basic intention of implementation of standard costing system as a cost contro
l device is not complete till the variances computed in respect of each element
of cost are properly reported to the relevant level of management for the decisi
on making purposes. For this purpose, the following propositions should be consi
dered. (a) For effective cost control, the organizational structure should be cl
early defined and responsibility of each individual should be clearly defined. T
he reports reporting the variances should be simple, clear and quick. The comput
ation and analysis of variances in respect of each element of cost should be acc
urate. A wrong analysis of variances may result into misleading conclusions. For
more effectiveness, the variances should be segregated as controllable variance
s and non controllable variances. However, the analysis of uncontrollable varian
ces should be made with the same care as in case of controllable variances. The
reporting of variances should contain a comparison with the planned results.
(b) (c)
(d)
(e)
500
Management Accounting

(f)
The format and the contents of
he level of management to whom
ment would be obviously formal
ts. The reports to lower level
ch variance showing the causes
or.

reports reporting the variances may depend upon t


reports are being made, The reports to top manage
containing only the broad details and final resul
of management may contain the full analysis of ea
therefor and locating the responsibilities theref

ANALYSIS OF VARIANCES : As stated earlier, the process of standard costing invol


ves the establishment of standard costs and the computation of actual costs unde
r each element of cost and the comparison between standard costs and actual cost
s. The difference between standard cost and actual cost is termed as Variance. If
the actual cost is less than the standard cost, the variance is a favourable var
iance. If the actual cost is more than the standard cost, the variance is a unfa
vorable or adverse variance. The utility of standard costing as a technique of c
ost control is not complete only by the computation of variances unless these va
riances are further analysed as to the causes responsible for these variances. T
he basic objective of variance analysis is to classify the variances as controll
able and uncontrollable ones E.g. If material actually used is in excess of stan
dard quantity or if time actually taken by the workers is more than standard tim
e, the variance will be an unfavorable one for which the responsibility can be a
ssigned on the executives concerned. However if the variances occur due to gener
al strike, general increase in wage rates, devaluation of currency, change in cu
stomers demands etc., the variances will be uncontrollable ones for which no resp
onsibility can be assigned to any executive. By concentrating most on controllab
le and adverse variances, it is possible for the management to exercise control
through exception which is the basic objective of standard costing. Thus, the st
ress can be laid on variances only and no further action will be necessary in ca
ses where standard costs are matching with the actual costs, provided that the c
onditions underlying the fixation of standards remain unchanged. The variances a
rising in one period may be compared with a variances in the previous period for
a better control. Thus a detailed analysis of variances, specifically the contr
ollable ones, as to the causes leading to these variances, and the corrective ac
tions required to be taken to reduce these variances enables the management to e
xercise proper cost control. However, it does not mean that the favourable varia
nces need no investigation. A constant occurrence of favourable variance may ind
icate incorrect fixation of standards that need to be revised. A constant favour
able variance may be due to a genuine improvement in performance or due to the m
anufacture of sub- standard products. We will discuss the variance under each el
ement of cost.
Standard Costing
501

(A) MATERIAL COST VARIANCE : It is the difference between standard material cost
and actual material cost. It may be further analysed as (i) (ii) (i) Material P
rice Variance Material Usage Variance Material Price Variance :
Its that portion which is due to difference between standard price specified and
actual price paid. It is calculated as Actual Quantity (Actual Price - Standard
Price) The causes for this may be traced as (1) (2) (3) (4) (5) (6) (7) (8) (9)
Change in price of material. Change in quantity of purchase or uneconomical size
of parchase order. Rush order to meet shortage of supply or purchase in less fa
vourable market. Failure to take advantage of off season prices. Failure to get
cash/trade discounts. Weak purchase organization. Payment of excess/less freight
. Transit losses/discrepancies if prices include them. Change in quality or spec
ification of material purchased.
(10) Use of substitute materials at different prices. (11) Change in pattern or
amount of taxes or duties. From the above, it can be seen that the responsibilit
y for this type of variance may be normally placed on Purchase Department. Howev
er, there may be some situations where the responsibility for this type of varia
nce can not be placed on purchase department. E.g. When the purchases are made i
n uneconomic quantities due to the lack of working capital. (ii) Material Usage
Variance :
It is that portion which is due to the difference between standard quantity spec
ified and actual quantity used. Its calculated as 502
Management Accounting

Standard Price (Actual Qantity - Standard Qantity) The causes to this may be tra
ced as : (1) (2) (3) (4) (5) (6) (7) (8) (9) Inefficient or careless use of mate
rials. Change in specification/design of the product. Inefficient/inadequate ins
pection of materials. Change in quality of material or purchases of inferior mat
erial. Production inefficiency resulting in wastages. Use of substitute material
s. Theft/pilferage of materials. Inefficient labour not able to handle material
properly. Defective machines and not proper maintenance of the same.
(10) Change in the composition of material mix. If more than one materials are m
ixed to get the final product, any change in the standard mix may result into ma
terial usage variance. It may arise in case of textile, chemical, rubber industr
ies etc. (11) Change in the yield. If a certain amount of standard output is exp
ected from some inputs, any variance in actual output may result in material usa
ge variance. It may arise in case of processing industries. The material usage v
ariances may further be analysed in the following ways: (a) Materials Mix Varian
ce : As stated above, it is that part of usage variance which may arise due to c
hange in the standard composition of material mix where more than one materials
are required to be mixed together to get the final product. This may be a peculi
ar feature of the industries like textile, chemical, rubber etc. The actual mix
of materials may be different than the standard mix due to non - availability of
specified material. Increased proportion of costly material in the mix results
into adverse materials mix variance and vice-versa. This variance is calculated
as Standard price (Actual mix - Standard mix)
Standard Costing
503

(b)
Materials Yield Variance : As stated above, it is that part of usage variance wh
ich may arise due to difference between standard yield expected and the actual y
ield obtained, where a certain specified yield is expected from a given input of
materials. This may be a peculiar feature of the processing industries. A low a
ctual yield indicates consumplion of materials in excess of standards set result
ing into an adverse variance and vice versa. This variance is calculated as : St
andard Yield Price (Actual Loss - Standard Loss) Where standard yield price is c
alculated as : Total Standard Cost Total Standard Output
Illustration : I Material Qty. Kgs. A B C 500 400 300 1200 Less : 10% Normal Los
s 120 1,080 5,400 Actual Loss 220 1080 5,320 Standard Price Rs. 6.00 3.75 3.00 T
otal Rs. 3,000 1,500 900 Actual Qty. Kgs. 400 500 400 1300 Price Rs. 6.00 3.60 2
.80 Total Rs. 2,400 1.800 1,120
Calculate material cost variances. Solution : (A) Material Cost Variance Standar
d Material Cost - Actual Material Cost. = 5,400 - 5,320 80 (Favourable)
504
Management Accounting

(B) Material Price Variance AQ (AP - SP) Where AP Material A Material B Material
C = = = = Actual Price 400 (6.00 - 6.00) 500 (3.60 - 3.75) 400 (2.80 - 3.00) AQ
= SP = = = = Actual Quantity. Standard Price Nil 75 (Favourable) 80 (Favourable
) 155 (Favourable) (C) Material Usage Variance SP (AQ - SQ) Where AQ = Actual Qu
antity SP = SQ = = = = Standard Price Standard Quantity 600 (Favourable) 375 (Ad
verse) 300 (Adveise) 75 (Adverse) (D) Materials Mix Variance Standard Price (Act
ual Mix - Standard Mix) Material A = 6.00 (400 - 541.67) Material B = 3.75 (500
- 433.33) Material C = 3.00 (400 - 325) = = = 850 (Favourable) 250 (Adverse) 225
(Adverse) 375 (Favourable) Note : The standard mix is calculated as below. When
total input is 1,200 Kgs, the Materials A,B, and C are mixed in the proportion
of 500 Kgs,, 400 Kgs and 300 Kgs. respectively. When total input is 1,300 Kgs. t
he materials should have been mixed in the following proportion. 500 Material A
= 1200 400 Material B = Material C = 1200 300 1200 X 1300 = 541.67 Kgs. X 1300 =
433.33 Kgs.
Material A = 6.00 (400 - 500) Material B = 3.75 (500 - 400) Meterial C = 3.00 (4
00 - 300)
X 1300 = 325.00 Kgs.
Standard Costing
505

(E)
Materials Yield Variance Standard Yield Price (Actual Loss - Standard Loss) 5 (2
20 - 130) = 450 (adverse) Note : Standard Yield Price is calculated as below Tot
al standard cost Total standard output = Rs. 5400 1080 Kgs. = Rs.5/Per Kg.
Check : Material Cost Variance = Materials Price Variance + Material Usage Varia
nce
Materials Usage Variance = Materials Mix Variance + Materials Yield Variance 80
(F) = 155 (F) + 375 (F) + 450 (A)
Where, F indicates favourable and A indicates adverse variance. LABOUR COST VARI
ANCES : It is the difference between standard direct wages specified and actual
wages paid. It is further analysed as (i) Wage/Labour Rate Variance : It is that
portion which is due to difference between standard pay of wages specified and
actual rate paid. It is calculated as Actual Hours (Actual Rate - Standard Rate)
The causes of this may be traced as (1) (2) Change in wage structure or piece-w
ork rate. Variation due to different grades of workers and their wages differing
from those specified. Use of different methods of payment e.g. Actual payment o
n time basis whereas standards are set on piece rate basis. Employment of casual
/temporary workers to meet seasonal demands. New workers not being allowed full
normal wages. Overtime or night shift allowance more or less than standard. Comp
osition of gang as regards the skill and rates of wages different than specified
standards.
Management Accounting
(3)
(4) (5) (6) (7)
506

Though the responsibility of wages/labour rate variances can be placed on Person


nel Department, in practice, this type of variance is usually an uncontrollable
one. (ii) Labour Efficiency Time Variance : It is that portion which is due to d
ifference between standard labour hours specified and the actual labour hours ex
pended. It is calculated as : Standard Rate (Actual Hours - Standard Hours) The
causes of this may be traced as : (1) (2) (3) Lack of proper supervision. Poor w
orking conditions. Delays due to waiting for materials, tools, instructions etc,
if not treated as idle time. Defective tools, equipments etc. Machine break dow
n if not treated as idle time. Work on new machines requiring less time. Basic i
nefficiency of workers due to lack of morale, insufficient training, faulty inst
ructions etc. Use of non-standard material requiring higher lime for processing.
Operations not provided for and booking them under direct wages.
(4) (5) (6) (7)
(8) (9)
(10) Wrong selection of workers. (11) Increase in labour turnover. (12) Incorrec
t recording of performance i.e. time or output. The labour efficiency variance m
ay be further analysed in the following manner. (a) Idle Time Variance : It is t
he standard cost of actual hours recorded as idle time due to abnormal circumsta
nces like strike, lock out, power failure, machinery breakdown etc. It is calcul
ated as Standard rate x Idle Hours This type of variance is normally calculated
separately and not kept only as a part of efficiency variance, as the employees
should not be blamed for inefficiency when the idle time arises due to circumsta
nces beyond their control, say power failure. It is needless to state that this
variance is always unfavorable and needs further investigation as to the causes
for abnormal idle time.
Standard Costing
507

(b)
Labour Mix Variance (Gang Composition Variance) :
It indicates that part at efficiency variance which arises due to change in Actu
al Gang of labour from that of Standard Gang of labour if various grades of labo
ur are included in a gang and if certain grades of labour are not available. It
is calculated as : Standard Rate (Revised Standard Hours- Actual Hours) Where th
e revised standard hours indicate the actual labour hours divided in the ratio o
f standard hours. It should be noted that if the idle time variance is calculate
d separately, the idle time hours should be excluded from actual total hours in
standard ratio. (c) Labour Yield Variance :
In many cases, this variance is calculated separately which indicates the effect
on labour cost of actual yield or output being different from standard yield or
output. In numerical terms, it is equal to revised efficiency variance i.e. aft
er separating Mix Variance and Idle Time Variance from Efficiency Variance, whic
h is calculated as Standard Rate (Standard Hours - Revised Standard Hours) Illus
tration 2 : Following details are available from the records of A Ltd. for a mon
th regarding the standard labour hours and rates of an hour for a product Hours
Skilled Semi- Skilled Unskilled 10 8 16 Rate per hour Rs. 3.00 1.50 1.00 Total R
s. 30.00 12.00 16.00 58.00 The actual production for the product was 1,500 units
for which the actual hours worked and rates were as below. Hours Skilled SemiSkilled Unskilled 13,500 12,600 30,000 Rate per hour Rs. 3.50 1.80 1.20 Total Rs
. 47,250 22,680 36,000
508
Management Accounting

Compute : (a) (b) (c) (d) Labour Cost Variance Labour Rate Variance Labour Effic
iency Variance Labour Mix Variance
(a)
Labour Cost Variance :
Solution : Standard Hours Rate per Hr. Skilled Semi-Skilled Unskilled 15,000 12,
000 24,000 51,000 Actual Cost - Standard Cost 1,05,930 - 87,000 = 18,930 (A) (b)
Labour Rate Variance : Actual Hours (Actual Rate - Standard Rate) 13,500 (3.50
- 3.00) = 12,600 (1.80 - 1.50) = 30,000 (1.20 - 1.00) = 6,750 3,780 6,000 16,530
(c) Labour Efficiency Variance : Standard Rate (Actual Hours- Standard Hours) 3
.00 (13,500 - 15,000) = 4,500 1.50 (12,600 - 12,000) = 900 (F) (A) (A) (A) (A) (
A) (A) (A) 3.00 1.50 1.00 Total 45,000 18,000 24,000 87,000 Hours 13,500 12,600
30,000 56,100 Actual Rate per Hr. 3.50 1.80 1.20 Total Rs. 47,250 22,680 36,000
1,05,930
1.00 (30,000 - 24,000) = 6,000 2,400
Standard Costing
509

(d)
Labour Mix Variance : Standard Rate (Actual Hours - Revised Standard Hours) 3.00
(13,500 - 16,500) = 9,000 1.50 (12,600 - 13,200) = 900 (F) (F) (A) (F)
1.00 (30,000 - 26,400) = 3,600 6,300 OVERHEAD COST VARIANCES :
The analysis of overheads variances is different and the most complex task than
the calculation of material and labour variances. It is so due to the fact that
establishment of a standard overhead absorption rate is difficult as a part of t
otal overheads is fixed, which affects the overhead absorption rate with the cha
nge in volume. It should be noted in this connection that the overhead absorptio
n rate can be computed in the following way. (a) If the overhead rate is express
ed in terms of labour hours. Hourly Rate (b) = Budgeted Overhead Cost Budgeted L
abour Hours
If the overhead rate is expressed in terms of units produced Unit Rate = Budgete
d Overhead cost Budgeted output in units
As the overheads can be either the variable overheads or fixed overheads, the ov
erhead cost variances may be seperately calculated for variable overheads and fi
xed overheads. Variable Overheads Variance : It is that amount of overheads whic
h change directly with the level of activity and per unit variable overheads rem
ain constant. As such, the variable overheads are not affected with the change i
n volume of operations. The common method of analyzing the variable overheads va
riances is shown in the chart below. Overhead Cost Variance Expenditure Variance
Efficiency Variance
510
Management Accounting

(a)
Overheads Cost Variance It is the difference between standard overheads cost abs
orbed and actual overheads cost incurred. It is calculated as [
(b)
Standard Hours for Actual production
X
Standard Hourly Rate Actual Overhead
Overheads Expenditure Variance : It is the difference between the standard allow
ance for the output achieved and actual overheads cost incurred. It is calculate
d as Revised Budgeted Overheads for Actual Hours - Actual Overheads
(c)
Overhead Efficiency Variance : It is due to the difference between budgeted effi
ciency of production and actual efficiency attained. It is calculated as Standar
d Hourly X Rate
[
Standard Hours for Actual production
Actual Overheads
Fixed Overheads Variances : In modern times, especially in the days of rapid mec
hanization of production processes, the fixed overheads form a major portion of
the production cost. As such, it is necessary that the management is properly in
formed about the standard fixed overheads or any deviations therefrom. The commo
n method of analyzing the fixed overheads variances is shown in the chart below.
Overhead Cost Variance Expenditure variance Volume Variance Efficiency Variance
Capacity Calender
Variance Variance
As each of the above variances can be computed either on the basis of units of p
roduction or on the basis of hours. We will first study the nature of the above
variances and then the methods of computation.
Standard Costing
511

(a)
Overhead Cost Variance : It is the difference between the total standard overhea
ds cost absorbed in the output achieved and the total actual overheads cost. Thu
s, it can be seen that the overheads cost variance is simply the under or over a
bsorption of overheads.
(b)
Expenditure Variance : It is the difference between the standard allowance for t
he output achieved and the actual overheads cost incurred. The causes of this va
riance may be (1) (2) Change in the quality/ price of indirect material. Change
in the labour rates for indirect workers or change in the grade of indirect work
ers. Change in the rate of power, insurance and other overheads.
(3) (c)
Volume Variance : It is that protion of the overhead variance which is due to th
e difference between the budgeted level of output and the actual level of output
. The causes of this variance may be as below. (1) (2) (3) (4) (5) (6) Labour pr
oblems like strikes, lockouts etc. Material shortage Machinery Breakdown Waiting
for tools/instructions/material Power failure. Change in the demand for product
It will not be out of place to mention here that in case of the variable overhea
ds, per unit or per hour overheads remain constant and are not affected by the c
hange in the level of output. As such, volume variance does not arise in case of
variable overheads. (d) Efficiency Variance : It is that portion of the overhea
d variances, as a part of volume variance, which is due to the difference betwee
n budgeted efficiency of production and the actual efficiency attained. The caus
es of this variance may be as below.
512
Management Accounting

(1) (2) (3) (4) (5) (e)


Poor working conditions. Change in the labour performance Defective and faulty t
ools. Incorrect Machine operations. Defective or inferior material.
Capacity Variance : It is that portion of the overhead variances, as a part volu
me variance, which is due to the working at higher or lower capacity than standa
rd. The causes of this variance may be as below. (1) (2) (3) (4) Seasonal variat
ions. Shortage of labour force. Abnormal idle time due to the reasons like power
failures, strikes, lock outs etc. Change in the customer demand.
(f)
Calender Variance : It is that portion of overhead variances, as a part of volum
e variance, which is due to the difference between the number of working days in
the budget period and the actual number of working days in the period in which
the budget is applied. Calender Variance arises only if there is abnormal increa
se or decrease in the number of working days, as the normal holidays are already
considered while setting the standard. Thus, the declaration of an unexpected d
ay as holiday may result into calender variance.
COMPUTATION OF FIXED OVERHEADS VARIANCES : As discussed earlier, the fixed overh
eads variances may be computed on the basis of units of production or on the bas
is of hours. (A) On the basis of units of production : (1) Overheads Cost Varian
ce : Standard Overhead Cost - Actual Overhead Cost (2) Expenditure Variance : Bu
dgeted Overhead Cost - Actual Overhead Cost
Standard Costing
513

(3)
Volume Variance : Standard Rate per unit X [Actual Production - Budgeted Product
ion]
(4)
Efficiency Variance : Standard Rate per unit X [Actual Production - Standard Pro
duction in Actual Hours]
(5)
Capacity Variance: Standard Rate per unit X Standard Production in Actual Hours
[
Revised Budgeted Production
(6)
Calender Variance : Standard Rate per unit X [Revised Budgeted Production - Budg
eted Production]
ILLUSTRATION 3 : An Engineering Company has furnished you the following data Bud
get No of working days Production in Units Fixed overheads in Rs. 25 20,000 30,0
00 Actual July 1986 27 22,000 34,000
Budgeted fixed overhead rate is Rs. 1 per hour. In July 1986, the actual hours w
orked were 31,500. Calculated the following variances. (a) (b) (c) (d) (e) (f) T
otal overheads Variance Expenditure Variance Volume Variance Efficiency Variance
Capacity Variance Calender variance
Solution : (1) Total Overheads Variance : Standard Overheads Cost - Actual Overh
eads Cost 33,000 - 34,000 = 1,000 (A)
514
Management Accounting

(2)
Expenditure Variance : Budgeted Overheads Cost - Actual Overheads Cost 30,000 34,000 = 4,000 (A)
(3)
Volume Variance : Standard Rate per unit x [Actual Production - Budgeted Product
ion] 1.5 X (22,000 - 20,000) = 3,000 (F)
(4)
Efficiency Variance : Standard Rate per unit x [Actual Production - Standard Pro
duction in Actual Hours] 1.5 X ( 22,000 - 21,000) = 1.500 (F)
(5)
Capacity Variance : Standard Rate per unit x [Standard Production in Actual Hour
s - Revised Budgeted Production] 1.5 X (21,000 - 21,600) = 900 (A)
(6)
Calender Variance : Standard Rate per Unit x [Revised Budgeted Production - Budg
eted Production] 1.5 x (21,600 - 20,000) = 2,400 (F)
Check : Volume variance = Efficiency Variance + Capacity Variance + Calender Var
iance 3000 (F) Total Variance 1000 (A) Working Note : (A) (1) Standard Rate per
unit is calculated as below Budgeted Overhead Cost Budgeted Production
Standard Costing
= 1500 (F) + 900 (A) + 2400 (F) = Expenditure Variance + Volume Variance = 4000
(A) + 3000 (F)
515

(2)
30,000 20,000
Rs. 1.5 Per Unit
Standard Production in actual hours is calculated as below : Budgeted overheads
are Rs.30,000, while budgeted fixed overhead rate is Rs. l per hour. Therefore,
budgeted hours are 30,000, while budgeted production is 20,000 units. It means t
hat one unit requires 1.5 hours.(standard) As actual hours worked are 31.500, th
e standard production in those many hours will be 31,500 = 21,000 Units 1.5 Revi
sed Budgeted Production is calculated as below. Budgeted Number of working days
are 25 while budgeted production is 20,000 units. It means that standard product
ion in one day is 20,000 Units = 25 days 800 Units
(3)
As actual number of working days is 27, the standard production in those many da
ys will be 800 units x 27 days = 21,600 units (B) On the basis of hours : (1) Ov
erheads Cost Variance : Standard Overheads Cost - Actual Overheads Cost (2) Expe
nditure Variance : Budgeted Overheads Cost - Actual Overheads Cost (3) Volume Va
riance : Standard Hourly Rate x [Standard Hours for Actual Production - Budgeted
Hours] (4) Efficiency Variance : Standard Hourly Rate x [Standard hours for Act
ual Production - Actual Hours] (5) Capacity Variance : Standard Hourly Rate x [A
ctual Hours - Revised Budgeted Hours] (6) Calender Variance : Standard Hourly Ra
te x [Revised Budgeted Hours - Budgeted Hours]
516
Management Accounting

ILLUSTRATION : 4 An engineering company has furnished you with the following dat
a. Budget No. of working days Production in Units Fixed 0verheads (in Rs.) 25 20
,000 30,000 Actual (July 1986) 27 22,000 34,000
Budgeted fixed overhead rate is Rs. 1 per hour. In July 1986, the actual hours w
orked were 31,500. Calculate the following variances (a) (b) (c) (d) (e) (f) Tot
al Overheads Variance Expenditure Variance Volume Variance Efficiency Variance C
apacity Variance Calender Variance
Solution : Calculation of overhead variances will be as below. (1) Total Overhea
d Variance : Standard Overheads - Actual Overheads 33,000 - 34,000 = 1,000 (A) (
2) Expenditure Variance : Budgeted Overheads - Actual Overheads. 30,000 - 34,000
= 4,000 (A) (3) Volume Variance : Standard Hourly Rate X [Standard Hours for Ac
tual Production - Budgeted Hours] = 1 (33,000 - 30,000) = 3,000 (F) (4) Efficien
cy Variance : Standard Hourly Rate (Standard hours - Actual hours) 1 (33,000 - 3
1,500) = 1,500 (F)
Standard Costing
517

(5)
Capacity Variance : Standard Hourly Rate (Actual hours - Revised Budgeted Hours)
1 (31,500 - 32,400) = 900 (A)
(6)
Calender Variance : Standard Hourly Rate (Revised Budgeted Hours - Budgeted Hour
s) 1 (32,400 - 30,000) = 2,400 (F)
Check : Volume Variance = Efficiency Variance + Capacity Variance + Calender Var
iance. 3000 (F) = 1500 (F)+900 (A)+ 2400 (F) Total Overhead Cost Variance = Expe
nditure Variance + Volume Variance 1000 (A) = 4000 (A) + 3000 (F) Working Notes
: (1) Standard rate per hour is known to be Rs. 1. As Budgeted overheads are Rs.
30,000, Budgeted Hours will be 30,000. (2) Budgeted Hours are known to be 30,000
for the Budgeted production of 20,000 units, indicating that standard time requ
ired for one unit is 1 1/2 hours. If the actual production is 22,000 units, the
standard time required for actual production will be 33,000 hours. (3) The budge
ted number of working days are 25 and budgeted hours are 30,000, indicating that
the standard hours available in one day are 1,200. If the company has actually
worked for 27 days, the revised budgeted hours will be 32,400 i.e. 1,200 hours p
er day x 27 days. SALES VARIANCES : While standard costing principles are mainly
applied in the area of costs i.e. Material cost, Labour cost and overheads cost
, some companies calculate the sales variances also which is the difference betw
een budgeted sales and actual sales and its impact on profits. There may be two
ways to calculate sales variances. (A) The turnover/value method. (B) The margin
/profit method.
Management Accounting
518

(A)
The Turnover/Value Method : The common method of analysing sales variances under
this method is shown in the chart below. Sales Value Variance Sales Price Varia
nce Mix Variance (1) Sales Value Variance : It is the difference between the bud
geted sales and the actual sales. It is calculated as Actual Sales - Budgeted Sa
les (2) Sales Price Variance : It is that portion of sales variance which is due
to the difference between standard price specified and the actual price charged
. It is calculated as Actual Sales Volume x [Actual Price - Standard Price] (3)
Sales Volume Variance : It is that portion of sales variance which is due to the
difference between the standard quantity specified and the actual quantity sold
. It is calculated as Standard Price x [Actual sales volume - Standard sales vol
ume] (4) Sales Mix Variance : It is that portion of sales volume variance which
may arise due to change in actual composition of sales mix from the standard com
position of sales mix, where more than one products are dealt with. It is calcul
ated as Standard Sales - Revised Standard Sales Where Standard Sales are actual
quantity sold at budgeted price. Revised Budgeted sales are standard sales rearr
anged in the budgeted ratio. Sales Volume Variance Quantity Variance
Standard Costing
519

Note : It should be noted that the sales mix variance, under turnover method wil
l always be zero. This is so because though the sales mix is varied, the actual
sales at budgeted price are rearranged in the budgeted ratio. (5) Sales Quantity
Variance : It is that portion of sales volume variance, which may arise due to
the difference between standard value of actual sales at standard mix and budget
ed sales. It is calculated as Revised Standard Sales - Budgeted Sales. Illustrat
ion 5 : Standard Product A. B. C. Qty. 500 400 300 1200 Calculate the Sales Vari
ances. Solution : (A) (1) Sales Value Variance : Actual Sales - Budgeted Sales (
2) 7,000 - 9,000 = 2,000 (F) Sale Price Rs. 5 6 7 Total Rs. 2,500 2,400 2,100 7,
000 Qty. 500 600 400 1500 Actual Sale Price Rs. 5.40 5.50 7.50 Total Rs. 2,700 3
,300 3,000 9,000
Sales Price Variance : Actual Sales Volume (Actual Price - Standard Price) A - 5
00 (5.40 - 5.00) = B - 600 (5.50 - 6.00) = C - 400 (7.50 - 7.00) = 200 300 200 1
00 (F) (A) (F) (F)
520
Management Accounting

(3)
Sales Volume Variance : Standard Price (Actual Sales Volume - Standard Sales Vol
ume) A - 5 (500 - 500) B - 6 (600 - 400) C - 7 (400 - 300) = = = Nil 1200 700 19
00 (F) (F) (F)
(4)
Sales Mix Variance : Standard Sales - Revised Standard Sales
Where standard sales are actual quantity at standard price and Revised standard
sales are standard sales rearranged in budgeted ratio.
Standard Sales Qty. A B C 500 600 400 Price Rs. 5 6 7 Total Rs. 2500 3600 2800 8
900 Ratio is calculated as below A B C 2500 7000 2400 7000 2100 7000 X X X 100 1
00 100 = = = 35.71% 34.29 30%
Revised Standard Sale Ratio 35.71% 34.29% 30.00% Total 3178 3052 2670 8900
Sales Mix Variance A B C 2500 - 3178 = 678 3600 - 3052 = 548 2800 - 2670 = 130 N
il (A) (F) (F)
Standard Costing
521

(5)
Sales Quantity Variance Revised Standard Sales - Budgeted Sales : A B C 3178 - 2
500 3052 - 2400 2670 - 2100 = = = = 678 652 570 1900 (F) (F) (F) (F)
Check : Sales Value Variance = Sales Price Variance + Sales Mix Variance + Sales
Quantity Variance = 2000 (F) = 100(F)+Nil +1900 (F) (B) The Margin / Profit Met
hod : This method of sales variances measures the effect of actual sales and bud
geted sales on profit. As this method does not consider the cost variances, all
costs are assumed to be standard costs. The common method of analysing sales var
iances under this method is shown in the chart below. Total Sales Margin Varianc
e Sales Margin Price Variance Sales Margin Volume Variance Sales Margin Mix Vari
ance (1) Total Sales Margin Variance : It is the difference between actual margi
n (by considering standard costs) and budgeted margin. It is calculated as Actua
l Profit - Budgeted Profit (2) Sales Margin Price Variance : It is that portion
of total sales margin variance which is due to the difference between standard p
rice of actual sales made and actual price. It is calculated as Actual Profit Standard Profit Sales Margin Quantity Variance
522
Management Accounting

(3)
Sales Margin Volume Variance : It is that portion of total sales-margin variance
which is due to the difference between standard profit and budgeted profit. It
is calculated as Standard Profit - Budgeted Profit.
(4)
Sales Margin Mix Variance : It is that portion of sales margin volume variance w
hich is due to the difference between standard profit and revised standard profi
ts. It is calculated as Standard Profit - Revised Standard Profit.
(5)
Sales Margin Quantity Variance : It is that portion of sales margin volume varia
nce which is due to the difference between budgeted profit and revised standard
profits. It is calculated asRevised Standard Profits - Budgeted Profit.
Illustration 6 : A Ltd. has budgeted the following sales for the month A - 900 u
nits at Rs. 50 per unit. B - 650 units at Rs, 100 per unit. C - 1200 units at Rs
. 75 per unit. Actual sales were A - 950 units at Rs. 58 per unit. B - 700 units
at Rs. 90 per unit. C - 1200 units at Rs. 80 per unit. Costs per unit of A, B a
nd C were Rs. 40, Rs. 88 and Rs.60 respectively. Compute the Sales Margin varian
ces.
Standard Costing
523

Solution : SALES Product BUDGET A B C 900 650 1200 50 100 75 45,000 65,000 90,00
0 2,00,000 ACTUAL A B C 950 700 1200 58 90 80 55,100 63,000 96,000 2,14,100 40 8
8 60 38,000 61,600 72,000 1,71,600 18 2 20 17,100 1,400 24,000 42,500 40 88 60 3
6,000 57,200 72,000 1,65,200 10 12 15, 9,000 7,800 18,000 34,800 Qty Price Rs. T
otal Rs. COST OF SALES Per unit Rs. PROFIT Total Rs.
Total Per unit Rs.
Standard sales and revised standard sales are calculated as below STANDARD SALES
: SALES Product A B C Qty 950 700 1200 Price Rs. 50 100 75 Total Rs. 47,500 70,
000 90,000 2,07,500 REVISED STANDARD SALE Product Revised Standard sales Rs. A B
C 46,688 67,437 93,375 2,07,500 Revised Standard profit Rs. 9,338 8,092 18,675
36,105 COST OF SALES Per unit Rs. 40 88 60 PROFIT Total Rs. 9,500 8,400 18,000 3
5,900
Total Per unit Rs. 38,000 61,600 72,000 1,71,600 10 12 15
524
Management Accounting

Calculation of Variances (1) Total Sales Margin Variance : Actual Profit - Budge
ted Profit 42,500 - 34,800 = 7,700 (F) (2) Sales Margin Price Variance Actual Pr
ofit - Standard Profit 42,500 - 35,900 = 6,600 (F) (3) Sales Margin Volume Varia
nce Standard Profit - Budgeted Profit. 35,900 - 34,800 = 1,100 (F) (4) Sales Mar
gin Mix Variance : Standard Profit - Revised Standard Profit. 35.900 - 36,105 =
205 (A) (5) Sales Margin Quantity Variance : Revised Standard Profit - Budgeted
Profit 36,105 - 34,800 = 1,305 (F) ILLUSTRATIVE PROBLEMS (1) Following standard
and actual data relates to a manufacturing concern. Material X Y Standard 40 kgs
. at Rs. 6 60 kgs. at Rs. 4 240 240 480 Standard output is 80% of input i.e. 80
units. Process loss is 20%. Material X Y Actual 600 kgs. at Rs. 4 400 kgs. at Rs
. 6
Actual output is 70% of input i.e. 700 units. Process loss is 30%.
Standard Costing
525

Calculate (1) (2) (3) (4) (5) Cost variance Price variance Total Quantity usage
variance Mix variance Revised usage variance
Solution : (1) Cost Variance : Actual Material Cost - Standard material Cost 480
0 - 4200 = 600 (A) (2) Price Variance : Actual Quantity (Actual Price - Standard
Price) X 600 (4-6) Y 400 (6-4) = = 1200 800 400 (3) Total Usage Variance : Stan
dard Price (Actual Quantity - Standard Quantity) X - 6 ( 600 - 350) Y - 4 ( 400
- 525) = = 1500 500 1000 (4) Mix Variance : Standard Price (Actual Mix- Revised
Standard Quantity X - 6 (600 - 400) Y - 4 (400-600) = = 1200 800 400 (5) Revised
Usage Variance : Standard Price (Revised Standard Quantity - Standard Quantity)
X - 6 (400 - 350) Y - 4 ( 600 - 525) = = 300 300 600 (A) (A) (A) (A) (F) (A) (A
) (F) (A) (F) (A) (F)
526
Management Accounting

(6)
Yield Variance : Standard Cost per unit (Actual Loss - Standard Loss) 6 (300 - 2
00) = 600 (A)
Check : Cost Variance = Price Variance + Mix Variance + Yield Variance 600 (A) =
400 (F) + 400 (A) + 600 (A) Notes : (1) Standard Cost is calculated as below .
Standard input for the output of 80 units is 100 kgs. If the actual output is 70
0 units, the standard input for the same will be 700 X 100 80 = 875 kgs.
The standard proportion of the materials is 40% for X and 60% for Y. As such, fo
r the standard input of 875 kgs, the standard proportion will be X - 40% of 875
kgs i.e. 350 kgs. Y - 60% of 875 kgs i.e. 5:25 kgs. The standard cost will be as
follows. Material Standard Quantity kgs. 350 525 Standard Price Rs. 6 4 Cost Rs
. 2,100 2,100 4.200 (2) Revised standard quantity is calculated as below. Total
input is 1000 kgs. The standard proportion of the materials is 40% for X and 60%
for. Y. As such, the revised standard quantity should have been X - 40% of 1000
kgs. i.e. 400 kgs. Y - 60% of 1000 kgs. i.e. 600 kgs.
X Y
Standard Costing
527

(3)
The standard material cost of a normal mix of one tonne of chemical X is based o
n Chemical A B C Usage Kgs. 240 400 640 Price per Kg. 6 12 10
During a month, 6.25 tonnes of X were produced from Chemical A B C Analyse the v
ariances. Solution : Calculation of standard cost Chemical A B C Quantity kgs. 1
500 2500 4000 Rate per kg. Rs. 6 12 10 Total Cost Rs. 9,000 30,000 40,000 79.000
Calculation of Actual cost Chemical A B C Quantity kgs. 1600 2400 4500 Rate per
kg. Rs. 7 12.5 10.5 Total cost Rs. 11,200 30,000 47,250 88,450 (1) Material Cos
t Variance : Standard Cost - Actual Cost 79,000 - 88,450 = 9,450 (A) Consumption
(Tonnes) 1.6 2.4 4.5 Cost (Rs.) 11,200 30,000 47,250
528
Management Accounting

(2)
Material Price Variance : Actual Quantity (Actual Price - Standard Price) A - 16
00 (7-6) B - 2400 (12.5-12) C - 4500 (10.5 - 10) = = = 1,600 1,200 2,250 5,050 (
A) (A) (A) (A)
(3)
Material Usage Variance : Standard Price (Actual Quantity - Standard Quantity) A
- 6 (1,600 - 1500) B - 12 (2,400 - 2500) C - 10 (4,500 - 4000) = = = 600 1200 5
000 4,400 (A) (F) (A) (A)
(4)
Material Mix Variance : Standard Price (Actual Mix - Standard Mix) A - 6 (1,600
- 1593.75) = B - 12 (2,400 - 2656.25) = C - 10 (4500 - 4250) = 37.5 3075.0 2500.
0 537.5 (A) (F) (A) (F)
Note : The standard mix is calculated as below. When total input is 8000 kgs. Ch
emicals A, B and C are mixed in the proportion of 1500 kgs, 2500 kgs and 4000 kg
s respectively. When total input is 8500 kgs, the chemicals should have been mix
ed in the following proportion. Chemical A 1500 8000 Chemical B 2500 8000 4000 C
hemical C 8000 X 8500 = 4250 kgs. X 8500 = 2656.25 kgs. X 8500 = 1593.75 kgs.
Standard Costing
529

(5)
Material Sub-usage Variance : Standard Price (Standard Quantity - Standard Mix)
A - 6 (1500 - 1593.75) B - 12 (2500 - 2656.25) C - 10 (4000 - 4250) = = = 562.5
(A) 1875.0 (A) 2500.0 (A) 4937.5 (A)
(6)
XYZ forecasts its overhead expenditure for a period as under. Rs. 30,000 for 10,
000 hours. Rs. 27,500 for 9,000 hours. Rs. 25,000 for 8,000 hours.
The normal volume of activity is 10,000 hours. During a period 8,750 hours were
utilised for a total overhead expenditure of Rs. 28,750 of which fixed overheads
totalled to Rs. 5,250. The standard utilisation of labour should have been less
by 5%. How will you analyse the overhead variance. Solution : From the variatio
n of total overheads, it is noted that for the variation of 1,000 hours. The ove
rheads very to the extent of Rs. 2,500. Thus, indicates that the rate of variabl
e overheads is Rs. 2.50 per hour. At the normal level of activity, the distribut
ion of overheads will be as below. Variable Overheads - 10,000 hours x Rs.2.50 F
ixed Overheads - Balance Rs. 25,000 Rs. 5,000
Rs. 30,000 Variable Overheads Variances : (1) Overheads Cost Variance : Hours fo
r [ Standard actual production = X Standard Hourly Rate - Actual Overheads
8930 X 2.50 - 23.500 22,325 - 23,500 = 1,175 (A)
530
Management Accounting

(2)
Expenditure Variance : [Revised Budgeted Overheads for Actual hours] - Actual Ov
erheads. 8,750 x 2.50 - 23,500
= 21,875 - 23,500 = 1,625 (A) (3) Efficiency Variance : [Standard Hours for Actu
al Production - Actual Hours] x Standard Hourly Rate [8,930 - 8.750] x 2.50 = 45
0 (F) Notes : (a) Total overheads cost actually incurred is Rs. 28,750 out of wh
ich fixed overheads are Rs. 5,250. Hence, balance is variable overheads i.e. Rs.
28,750 - Rs. 5,250 = Rs. 23,500 (b) Standard Hourly Rate is calculated as below
. Total Budgeted Variable Overheads/Total Budgeted Hours. = (c) Rs. 25,000 10,00
0 Standard-hours for actual production are calculated as below. Actual overheads
are Rs. 23,500. As the standard hourly rate is Rs.2.50 per hour, the ideal hour
s should have been Rs. 32,500 = 9,400 Rs. 2.50 However, standard utilisation sho
uld have been less by 5%. Hence, standard hours will be 95% of 9,400 hours i.e.
8,930 hours. (d) Revised budgeted overheads for Actual Hours are worked out as b
elow. Actual hours are 8,750 and standard hourly rate is Rs. 2.50 per hour. Henc
e, the revised budgeted overheads should have been Rs. 21,875 i.e. 8,750 x 2.50.
Rs. 2.50 per hour.
Standard Costing
531

Check : Overheads Cost Variance = Expenditure Variance + Efficiency Variance 117


5 (A) = 1625 (A) + 450 (F) Fixed Overheads Variance : (1) Overheads Cost Varianc
e : Standard Overheads Cost - Actual Overheads Cost 4,987.5 - 5,250 = 262.5 (A)
(2) Overheads Expenditure Variance : Budgeted Overheads Cost - Actual Overheads
Cost 5000 - 5250 = 250 (A) (3) Overheads Volume Variance : Standard Hourly Rate
x [Standard Hours for Actual Production - Budgeted Hours] 0.50 X (9,975 - 10,000
) = 0.50 x 25 = 12.5 (A) (4) Overheads Efficiency Variance : Standard Hourly Rat
e x [Standard Hours for Actual Production - Actual Hours] 0.50 X (9,975 - 8750)
= 0.50 x 1225 = 612.5 (F) (5) Overheads Capacity Variance : Standard Hourly Rate
X [Actual Hours - Budgeted Hours] 0.50 X (8,750 - 10,000) = 0.50 x 1250 = 625 (
A) Notes : (a) Standard Hourly Rate is calculated as below, Total Budgeted Fixed
Overhead Total Budgeted Hours Rs. 5,000 10,000 = Rs. 0.50 per hour
532
Management Accounting

(b)
Standard Hours for actual production are calculated as below. Actual Overheads a
re Rs. 5,250. As the standard hourly rate is Rs, 0.50 per hour, the ideal hours
should have been 10,500. However, standard utilisation should have been less by
5%. Hence, standard hours will be 95% of 10,500 hours i.e. 9,975 hours.,
(c)
Standard overheads cost is calculated as Standard Hours x Standard Hourly Rate 9
,975 x 0.50 = 4,987.50
(d)
As the details of capacity variation due to the change in the number of working
days is not known, calender variance cannot be calculated. As such, the calculat
ion of capacity variance is made on the basis of comparison between actual hours
and budgeted hours.
Check : Overheads Cost Variance = Expenditure Variance + Efficiency Variance + C
apacity Variance. = 262.5 (A) = 250 (A)+612.5 (F)+625 (A) (4) The sales manager
a company engaged in the manufacture and sale of three products P, Q and R gives
you are following information for the month of October 1982. Budgeted Sales : P
roduct Units sold Selling Price Per unit Rs. 12 8 5 Standard Margin per unit Rs.
6 4 1
P Q R Actual Sales P - 1,500 units for Rs. 15,000 Q - 2,500 units for Rs. l7,500
R - 3,500 units for Rs. 21,000
2,000 2,000 2,000
You are required to Calculate the following variances (i) (ii) The Sales Price V
ariance The Sales Volume Variance
(iii) The Sales Quantity Variance (iv) The Sales Mix Variance 533
Standard Costing

Solution : (A) As per Turnover/ Value Method : (1) Sales Price Variance :
Actual Sales Volume (Actual Price - Standard Price) P - 1,500 (10 - 12) Q - 2,50
0 (7 - 8) R - 3,500 (6 - 5) = = = 3,000 2,500 3,500 2,000 (2) Sales Volume Varia
nce : (A) (A) (F) (A)
Standard Price (Actual Sales Volume - Standard Sales Volume) P - 12 (1,500 - 2,0
00) Q - 8 ( 2,500 - 2,000) R - 5 (3,500 - 2,000) = = = 6,000 4,000 7,500 5,500 (
3) Sales Mix Variance : (A) (F) (F) (P)
Standard Sales - Revised Standard Sales Where standard sales are actual quantity
at standard price and revised standard sales are standard sales rearranged in b
udgeted ratio. Standard Sales Price Rs. 12 8 5 Revised Standard Sales Ratio Tota
l Rs. 1/3 1/3 1/3 18,500 18,500 18,500 55,500
Qty. P Q B 1,500 2,500 3,500
Total Rs. 18,000 20,000 17,500 55,500
Sales Mix Variance : P Q R 18,000 20,000 17,500 18,500 18,500 18,500 = = = 500 (
A) 1,500 (F) 1,000 (A) NIL
534
Management Accounting

(4)
Sales Quantity Variance :
Revised Standard Sales - Budgeted Sales : P - 18,500 - 2,000 x 12 Q - 18,500 - 2
,000 x 8 Q - 18,500 - 2,000 X 5 = = = 5,500 2,500 8,500 5,500 (B) As per Margin/
Profit Method Cost per unit = Selling price per unit - Contribution per unit P
Q R
PRODUCT Qty. Budgeted
(A) (F) (F)
12 - 6 8 -4 5 -l
=6 =4 =4
SALES COST OF SALES Per unit Rs. Total Rs. PROFIT Per unit Rs. Total Rs.
Price Rs.
Total Rs.
P Q R Actual P Q R
2,000 2,000 2,000
12 8 5
24,000 16,000 10,000 50,000
6 4 4
12,000 8,000 8,000 28,000
6 4 1
12,000 8,000 2,000 22,000
1,500 2,500 3,500
10 7 6
15,000 17,500 21,000 53,500
6 4 4
9,000 10,000 14,000 33,000
4 3 2
6,000 7,500 7,000 20,500
Standard sales and revised standard sales are calculated as below : Standard Sal
es P Q R 1,500 2,500 3,500 12 8 5 18,000 20,000 17,500 55,500 6 4 4 9,000 10,000
14,000 33,000 6 4 1 9,000 10,000 3,500 22,500
Standard Costing
535

Revised Standard Sales Revised Standard Sales Rs. P Q R 25,680 17,120 10,700 53,
500 (1) Sales Margin Price Variance : Actual Profit - Standard Profit (2) 20,500
- 22,500 = 2,000 (A) Revised Standard Profit Rs. 12,840 8,560 2,140 23,540
Sales Margin Volume Variance : Standard Profit - Budgeted Profit 22,500 - 22,000
= 500 (F)
(3)
Sales Margin Mix Variance : Standard Profit - Revised Standard Profit 22,500 - 2
3,540 = 1,040 (A)
(4)
Sales Margin Quantity Variance : Revised standard Profit - Budgeted Profit 23,54
0 - 22,000 = 1,540 (F)
QUESTIONS 1. What do you mean by standard costing? Differentiate between Standar
d Costing and Budgetary Control as cost control techniques. state the advantages
and limitations of standard costing. 2. What do you understand by standard cost
ing? What preliminaries will have to be complied with before introducing the tec
hnique of standard costing. 3. Describe the procedure of establishing standard c
osts in the area of materials cost, labour cost and overheads cost. What do you
mean by variances and variance analysis. Explain the various factors affecting t
he variances in the area of materials cost, labour cost and overheads cost.
4.
536
Management Accounting

PROBLEMS 1. The standard materials cost to produce a tonne of chemcial X is 300


kgs of material A @ Rs. 10 per kg. 400 kgs of material B @ Rs. 5 per kg. 500 kgs
of material C @ Rs. 6 per kg. During the period 100 tones of chemical X were pr
oduced from the usage of 35 tonnes of material A for a cost of Rs.9,000 per tonn
e 42 tonnes of material B for a cost of Rs. 6,000 per tonne 53 tonnes of materia
l C for a cost of Rs. 7,000 per tonne Calculate price, mix and usage variances.
2. Mixers Ltd. is engaged in producing a standard mix using 60 kgs. of chemical
X and 40 kgs of chemical Y. The standard loss of production is 30%. The standard
price of X is Rs.5 per kg. and of Y is Rs. 10 per kg. The actual mixture and yi
eld were as follows. X 80 kgs. @ Rs. 4.50 per leg and Y 70 kgs @ Rs.8.00 per kg.
Actual yield 115 kgs. Calculate material variances (Price, Usage, Yield, Mix) 3
. Given that the cost standards for material consumption are 40 kgs at Rs. 10 pe
r kg., compute the variance when the actuals are a. b. c. d. 4. 48 kgs @ Rs. 10
per kg. 40 kgs @ Rs. 12 per kg. 48 kgs @ Rs. 12 per kg. 36 kgs @ Rs. 10 per kg.
The standard cost of material for manufacturing a unit of a particular product F
EE is estimated as follows. 16 kgs of raw material @ Re. 1 per kg. On completion
of the unit, it was found that 20 kgs of raw material costing Rs.1.50 per kg. h
as been consumed. Compute material variances (price, usage, cost)
5.
A company manufacturing distempers operates a standard costing system. The standar
d cost for one of the products of the company shows the following materials stan
dards.
Standard Costing
537

Materials A B C
Quantity 40 10 50
Standard Price per kg Rs. 75 50 20
Total Rs. 3,000 500 1,000
Material cost per unit (Total) 4,500 The standard input mix is 100 kgs and the s
tandard output of the finished product is 90 kgs. The actual results for a perio
d are Material Used. A - 2,40,000 kgs @ Rs. 80/kg B - 40,000 kgs. @ Rs. 52/kg C
- 2,20,000 kgs @ Rs. 21/kg Actual output of the finished product - 4,20,000 kgs.
Yon are required to calculated the material price, mix and yield variance. 6. I
n a factory 100 workers are engaged and the average rate of wages is 50 paise. S
tandard working hours per week are 40 and the standard performance is 10 units p
er gang hour. During a week in March, wages paid for 40 workers were at the rate
of 50 paise per hour, 10 workers at 70 paise per hour and 40 workers at 40 pais
e per hour. Actual output was 380 units. Factory did not work for 5 hours due to
breakdown of machinery. Calculate appropriate labour variances 7. The standard
cost of a unit shows the following costs of material and labour Material 4 pices
@ Rs. 5.00 Labour 10 hours @ Rs. 1.50 5,700 units of the product were manufactu
red during the month of March 1987 with the following material and labour costs.
Material 23,000 pieces at Rs. 4.95 Labour 56,800 hours at Rs. 1.52
538
Management Accounting

You are required to calculate (1) (2) (3) (4) (5) (6) 8. Material Price variance
Material Cost variance Material Usage variance Labour Rate variance Labour Effi
ciency variance Labour Cost variance
The standard labour component and the actual labour component engaged in a week
for a job are as under. Skilled Workeis (a) Standard number of workers in the ga
ng (b) (c) Standard wage rate per hour (Rs.) Actual number of workers employed i
n the gang during the week. (d) Actual wage rate per hour (Rs.) 4 3 2 32 3 28 12
2 18 6 I 4 Semi Skilled Workers Unskilled Workers
During the 40 hours working week, the gang produced 1800 standard hours of work.
Calculate the following variances. (i) (ii) Labour cost variance Labour efficie
ncy variance
(iii) Labour rate variance (iv) 9. Labour mix variance Budget 20 8,000 1.0 1,60,
000 Actual 22 8,400 0.9 1,68,000
Items No. of working days Month hours per day Output per manhour in units Overhe
ad cost (Rs.) Calculate overhead variances.
10. From the following data of A Co. Ltd. relating to budgeted and actual perfor
mance for the month of March 87, compute the Direct Material and Direct Labour c
ost variances.
Standard Costing
539

Budgeted data for March : Units to be manufactured Units of direct material requ
ired (Based on standard rates) Planned purchases of Raw Materials (Units) Averag
e unit cost of Direct Material Direct Labour hours per unit of finished goods Di
rect Labour cost (Total) Rs. Actual data at the end of March : Units actually ma
nufactured Direct Material cost (Purchase cost based on units actually issued) R
s. Direct Material cost (Purchase cost based on units actually purchased) Rs. Av
erage unit cost of Direct Material Total Direct Labour hours for March Total Dir
ect Labour cost for March. 11. 45,10,000 Rs.8.20 1,25,000 Rs. 33,75,000 43,41,90
0 1,60,000 4,95,000 5,40,000 Rs.8 3/4 hr. 29,92,500 1,50,000
The following details relating to the Product X during the month of March 1989 a
re available. You are required to compute the material and labour cost variance
and also to reconcile the standard and the actual cost with the help of such var
iances. Standard cost per unit Materials 50 kgs. @ Rs. 40 per kg. Labour 400 hou
rs @ Rs. 1.00 per hour. Actual cost for the month Material 4900 kgs @ Rs. 42 per
kg. Labour 39,600 hours @ Rs. 1.10 per hour Actual production - 100 units.
540
Management Accounting

12. Following data are available in respect of a particular department for weekl
y operations: Standard output for 40 hours week Standard fixed overheads Actual
output Actual hours worked Actual fixed overheads Calculate overhead variances 1
3. Dustfree Products manufactures and sells a patented vaccum cleaner for domest
ic use and the following data is available for October 1983. Actual Direct Labou
r hours Direct Labour cost (Rs.) Direct Material (Tonnes) Direct Material cost (
Rs.) 10,500 21,500 550 52,250 Actuals (For October) Overheads: Fixed Variable (v
aries with volume of production) Overhead is budgeted for normal activity of 1,4
4,000 hours of direct labour per annum, equally phased. Compute labour, material
and overheads variances. 14. The budgeted and actual sales of a concern manufac
turing and marketing a single product are furnished below. Budgeted sales Qty. P
rice per Units Rs. 10,000 3.00 Actual sales Price per unit Amount Rs. 3.00 2.50
Rs. 15,000 20,000 6,200 15,200 Standard 10,000 (10 hrs. per unit) 2.10 per hour
540 100 per Tonne Budgeted (For the year) 72,000 216,000 - 2,000 units - Rs. 2,0
00 - 1,800 units - 32 -Rs. 2,250
Amount Rs. 30,000
Qty. units 5,000 8,000
Ascertain, (a) (b) Sales Price Variance Sales Volume Variance.
Standard Costing
541

17. From the following information about sales, calculate (a) (b) (c) (d) (e) To
tal Sales Variance Sales Price Variance Sales Volume Variance Sales Mix Variance
Sales Quantity Variance Standard Rate (Rs.) 5 6 7 Actual Rate (Rs.) 6 5 8
Product A B C
Nos. 5,000 4,000 3,000 12,000
Rs. 25,000 24,000 21,000 70,000
Nos. 6,000 5,000 4,000 15,000
Rs. 36,000 25,000 32,000 93,000
18. Budgeted and actual sales for a month of two products A and B were as below
Budget Unit Price Rs. 10.00 Actual Units 2,500 1,000 B 5,000 2.00 4,000 1,200 Un
it Price Rs. 10.00 9.50 2.00 1.90
Units A 3,000
Budgeted costs for the products A and B were Rs.8 and Rs. 1.50 respectively. Wor
k out the following variances. (a) (b) (c) (d) (e) Sales Value Variance Sales Vo
lume Variance Sales Price Variance Sales Mix Variance Sales Qunatity Variance
19. X Ltd. operates a budgetory control and standard costing system. From the fo
llowing data calculate (a) (b) (c) Sales Variance Sales Volume Variance Sales Pr
ice Variance
542
Management Accounting

Product A B C D
Budgeted Units to be Sales Value Rs. 100 50 100 75 325 1,200 600 900 450 3,150
Actual Units sold Sales value Rs. 100 50 200 50 400 1,100 600 1,700 300 3,700
20. The records of an engineering company indicate the following for the month o
f April 1986 Standards Direct Materials Direct Labour Factors 4 gallons @ Rs. 1.
20 3 hours @ Rs. 1.80 Unit cost (Rs.) 4.80 5.40 1.80 12.00
Factory overheads Rs.0.60 per labour hour Total manufacturing cost Activity for
the month of April 1986 (1)
Production during the month of April 1986 has been 6,500 units with no beginning
or ending work in progress inventories. Materials purchased 32,000 gallons @ Rs
. 1.18 per gallon. Used in production 25,600 gallons. Labour hours worked 20,000
. Average hourly wage rate Rs. 1.75 Factory overheads - Total overheads costs in
curred Rs. 12,500
(2)
(3) (4)
Calculate material variances, labour variances and total variance for factory ov
erheads. 21. A factory supplies the following figures of production and overhead
s for September 1983 Budgeted Production (Units) Variable overheads (Rs.) Fixed
overheads (Rs.) Number of hours Work out the variances that are involved. 50,000
4,00,000 6,00,000 2,00,000 Actual 52,000 4,10,000 6,20,000 2,20,000
Standard Costing
543

22. It is estimated that in the manufacture of a product, for each ton of materi
al consumed, 100 articles should be produced. The Standard Price per ton of mate
rial is Rs. 10. During the first week of January, 200 tons of materials were iss
ued to the production department, the purchase price of which was Rs. 10.50 per
ton. The actual output for the period was 20,500 units. Calculate the Material V
ariances.
544
Management Accounting

NOTES
Standard Costing
545

NOTES
546
Management Accounting

Chapter 1 4
UNIFORM COSTING
It refers to the use of same costing principles and methods by several undertaki
ngs. Its not a separate method of cost accounting but only a particular technique
which applies the usual accounting methods like process costing, job costing, s
tandard costing, budgetory costing and marginal costing. Main feature of uniform
costing is that whenever a particular method of costing is applied it is applie
d uniformly in a number of concerns in the same industry or even different but s
imilar industries. This enables cost and accounting data of the member undertaki
ngs to be compiled on a comparable basis so that useful and crucial decisions ca
n be taken. It attempts to establish uniform methods so that comparison of perfo
rmances in the various undertakings can be made to the common advantages of all
the constituent units. Scope of Uniform Costing : Uniform costing methods may be
advantageously applied (i) In single organisation having a number of branches,
each of which may be a separate manufacturing unit. In this case, the head offic
e controls the operations of the uniform costing methods. In a number of concern
s in the same industry bound together through a trade association or otherwise.
In this case, the procedure for uniform costing may be devised and controlled by
the association or any other central body prescribed for this purpose.
(ii)
(iii) In industries which are similar such as gas and electricity, cotton, jute
and woolen textiles. Requisites for uniform costing : The success of uniform cos
ting will depend upon the following : (1) (2) There should be a spirit of mutual
trust and policy of give and take. There should be free exchange of ideas and m
ethods.
Uniform Costing
547

(3)
Bigger units should be ready to share with smaller ones, improvements, achieveme
nts of efficiency and know how. There should not be any hiding or withholding of
information. There should be no rivalry, competition or sense of jealousy among
the members.
(4) (5)
Advantages of uniform costing : (1) Uniform costing is a useful tool for managem
ent control. Performances of individual units can be measured against norms set
for the industry as a whole. It avoids cut throat competition by ensuring that c
ompetition among the members will proceed on healthy lines. Weaker units in the
industry can take the advantage of the efficient methods of production and produ
ction control of better managed units so as to increase their own efficiency. Th
e fruits of the research and development programmes which can be carried out onl
y by the bigger units, may be shared by the smaller units. By showing one best w
ay of doing things, it creates cost consciousness and provides the best system o
f cost control or cost presentation in the entire industry. Prices based on unif
orm costing may be taken to be reliable and representative of the whole industry
. This creates customer confidence and improves relations between customer and b
usiness. It assists in educating the less informed units as regards the cost acc
ounting methods. In India, where public undertakings operate alongwith the priva
te sector undertakings, uniform costing enables a comparitive assessment to be m
ade of the two sectors. Uniform costing enables the furnishing of suitable stati
stics to the Government wherever called upon to do so. This may be required by G
overnment for effective price control or to give protection or subsidy to a part
icular industry etc.
(2)
(3)
(4)
(5)
(6)
(7) (8)
(9)
(10) It simplifies the work of wage boards set up to fix minimum wages and fair
wages for an industry.
548
Management Accounting

Disadvantages of Uniform Costing : (1) The practices and methods followed by var
ious units in the industry may vary from one unit to another. The factors for su
ch differences like location, age, capital investment and condition of plant, de
gree of mechanisation etc. may be so wide from each other that to have a uniform
costing system suitable for big as will as small units becomes impossible. For
small units, cost of installation and operation of uniform costing system may no
t be commensurate to the advantages therefrom. If some reservations are made whi
le giving certain information by some units or if some information is withheld o
n the grounds of secrecy or privacy, the statistics presented cannot be relied u
pon. It may create conditions which are likely to develop monopolistic tendencie
s within the industry. Prices may be raised arbitrarily and supplies curtailed.
(2)
(3)
(4)
Fields covered by uniform costing : Considering the basic nature of uniform cost
ing as discussed above, it goes without saying that the success of uniform costi
ng system depends upon the extent to which uniformity can be brought about in va
rious areas. The various areas in which uniformly can be attempted to be brought
are as discussed below. (1) Method of cost accounting to be implemented viz. jo
b costing, process costing, unit costing and so on. Costing Techniques employed
i.e. marginal costing, standard costing etc. Methods of pricing the issues from
stores. viz. FIFO, LIFO, Weighted Average and so on. Method followed for valuati
on of inventories. Methods followed for inventory control. Method followed for c
harging depreciation viz. written down value, straight line etc. Methods of remu
nerating the workers. Treatment given to certain specific types of costs like bo
nus, idle time wages and so on. Methods for apportionment and absorption of over
heads and treatment given to under or over absorption of overheads.
(2) (3)
(4) (5) (6) (7) (8) (9)
(10) Treatment given to material scrap, wastes, spoilages and defectives.
Uniform Costing
549

(11) Treatment given to research and development costs. (12) Definition of the t
erm capacity for setting overhead absorption rates. (13) Procedure for classific
ation and codification of accounts. (14) Items to be excluded from cost accounts
. Uniform Cost Manual : It is a document which lays down the cost accounting pla
ns and procedures to be followed by the constituent units. This document once ci
rculated among the constituent units helps to guide them to formulate their syst
em of accounting in such a way that the principles of uniform costing can be uni
formly and correctly applied. The various contents of an uniform cost manual can
be stated us below : (1) Introduction : This part may state the objects and pur
poses of uniform cost system, advantages derived therefrom and the cooperation e
xpected from constituent units. Organisation : This part may include the organis
ation for establishing and running the uniform cost system. E.g. whether the sys
tem is to be established and run by outside cost consultants or by those interna
l to the various constituent units. Cost Accounting System : This part includes
accounting systems and procedures to be followed lo bring about uniformity E.g.
classification and codification of accounts, definition of a cost centre and cos
t unit, relationship between cost and financial accounting, items to he included
in or excluded from cost accounting, collection of various costs viz. material,
labour and overheads and so on. Presentation of information : This part may inc
lude the forms and contents of various cost and financial ratios, presentation o
f various production and operation costs and so on. Miscellaneous : This part ma
y include any of their information to be communicated to the constituent units b
ut not included in any of the above mentioned sections.
(2)
(3)
(4)
(5)
550
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QUESTIONS 1. 2. What are the advantages and limitations of uniform costing? Writ
e short notes Uniform Costing Manual 3. What do you mean by Uniform Costing? Wha
t are the various advantages and disadvantages of Uniform Costing? State the pre
-requisites for the success of Uniform Costing. Explain the various areas where
uniform costing can be used.
Uniform Costing
551

NOTES
552
Management Accounting