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Introduction to Cost Accounting

Concept of cost accounting

There are three branches of accounting. i.e Financial Accounting, cost accounting and
management accounting. Cost accounting is one of the branches of accounting, which has been
developed due to the limitation of financial accounting. Financial accounting communicates
economic information of an organization as a whole and that is used for external reporting
purpose. The reporting of financial accounting may not be sufficient for internal reporting i.e for
the formulation of policy and strategy, decision making and control.
According to C.Gilespie “cost accounting is a set of producers for determining the cost of a
product and various activities involved in its manufacture and sales and for planning and
measuring performance.
The following are the main features of cost accounting
Nature: Cost accounting is a branch of accounting. It is concerned with recording and reporting
costs of output to the firm’s management.
Objective: Its main objectives are to accumulate costs of output, job, process, unit and
department and report them for different uses.
Status: It is complementary to financial accounting as it provides cost data of different kinds of
stock for preparing financial statements.
Basis: It is the basis for cost estimate, cost control, and price determination of output.
Usefulness: It is useful for decision making and performance evaluation as it uses absorption
or valuation costing technique in preparing income statements.

Objectives of cost accounting

There can be several objectives of cost accounting. However, the following are its important
To ascertain cost:
The important objective of cost accounting is to ascertain cost of a product or services or jobs.
Ascertainment of cost is process of determining cost after they have been incurred. Generally,
there are two methods of determining the cost i.e job costing and process costing. Due to the
different in the nature of activity of industry, different methods of cost may be applied.
To control cost:
The objectives of cost accounting is to control over the cost by using various techniques such as
standard costing, inventory control, marginal costing etc.
To provide information for decision making:
Cost accounting is the formal system of accounting and provides information for various
managerial decisions like
i. Whether to accept or reject the offer
ii.Whether to make or buy a product
iii.Whether to continue or replace the existing machine and
iv.Whether to drop or continue the product or services
To fix the selling price:
Cost accounting can beprovide the detailed information about the cost of a product or service to
determine the selling price.
To ascertain costing profit or loss:
Cost accounting ascertains total cost and total revenue of every product or services or job and
calculates profit or loss by comparing with revenue and cost.
To provide information in preparation of financial statements:
Inventory should be valued for preparation of financial statements by comparing cost price and
market price.

Importance and advantages of cost accounting

Cost accounting provides immense advantages to a firm. It also can be explained in terms of
Helping in ascertaining of cost:
Cost accounting uses different methods of costing such as job costing, process costing etc.
applying this costing method cost of each product, process or job is ascertained.
Helps in inventory control:
It helps in inventory control using various techniques like ABC analysis, economic order
quantity, stock level etc.
Helps in measurement of efficiency:
It helps in measurement of efficiency of operations through establishment if standards and
various analysis.
Helps in preparation of budget:
It helps in preparation of various budgets such as sales budget, production budget, material
purchase budget, flexible budget etc.


Cost accounting also suffers from a number of limitations such as follows:
Unnecessary: It is unnecessary because it involves duplication of work, many good enterprise
are functioning without any costing system.
Expensive: It is expensive because the installation of cost accounting system involves
additional cost.
Inapplicable to many industries: It is inapplicable to many industries. A single costing system
may not be applicable to all industries because the costing system may be specially designed to
meet the need of a specific industry.
Lack of uniform procedure: it is possible that two equally competent cost accounts may arrive
at different result from the same information.
Result shown by cost and financial accounting may not be equal to each other: In cost
accounting certain incomes such as interest, dividend, share transfer fee etc. are not recorded
and certain expenses such interest paid, dividend, loss on sale of fixed assets are not shown
but these items are shown in financial accounting.


Business firms for earning profit perform business activities. Each business activity involves
financial transactions. Such financial transaction needs proper recording and systematic
classification and analysis to know profit or loss and financial position usually at the end of each
year. Financial accounting is the account, which keeps records of financial transaction. It shows
profit or loss and financial position at the end of each year.
In other word, financial accounting is an art of recording, classifying and summarizing the
financial transactions of a firm in such a manner that its profit or loss and financial position are
ascertained at the end year an communicated to the user.


The main objectives of financial accounting are;
To keep systematic record of financial transaction:
The main objective of financial accounting is to record the financial transaction of a business in
a systematically and scientific order. The need to record due to limitated memory power of
human being.
To disclose the result of operation of business organisation: Profit is the main motive of
every firm. Everyone who is related to the firm is keen to know its profit or loss at the end of
each year. It is also one of the importance objectives of financial accounting.
To show financial position: The firm is not only keen to know its profit or loss at the end of
each year, but also its financial health on that date. The firm’s financial health is judged on the
basis of financial position.
To protect assets and properties: Financial accounting not only keeps records of all assets
and properties acquired by the firm, but also records of their use and transfer from one place to
another. Recording of the firm’s assets and properties and their audit helps to protect from
misuse and misappropriation.

Limitations of financial accounting

Financial accounting also suffers from limitations. Some notable ones are as follows:
No detailed cost information:
Financial accounting does not provide detailed cost information for different department,
processes, product, job, different services and functions. But, financial accounting does not
make evaluation performances of units, departments, and processes.
No classification and analysis of cost:
Segregation of costs by nature and behaviour are essential for controlling cost and identifying
responsibilities. Financial accounting does not segregate cost in terms of behaviour such as
variable or fixed costs, nor does it classify in terms of nature such as direct and indirect costs.
No price determination:
Every firm must determine prices of its outputs in order to sell them. But, financial accounting
does not determine the selling prices of the firms output.
No use of standards:
It does not provide any standard costing to measure the efficiency in the use of material, labour
and expenses.
No control over cost:
No information over loss of productivity:
Historical data:


The main objectives of financial accounting
The main objective of cost accounting is to
areto report financial results in terms of
record and report costs of output.
profit or loss and financial position of a firm.
Cost accounting segregates cost into fixed Financial accounting does not segregate
and variable portion. costs into fixed and variable portion.
Its users are owners, managers, creditors,
Its user are mainly managers who use the
employees, workers, consumers and
cost data for their decision making purpose.
It is voluntarily required for the firm to keep It is legally required for the firm to maintain
cost accounts. financial accounts.
It is primarily applied in manufacturing It is generally applied in all types of business
concerns. concerns.
It values inventory based either on cost or
It values inventory on cost basis.
market price whichever is low.
Methods of costing are the procedures of ascertaining costs of output, process or operation.
Since the nature of industry differs from one another, the methods of costing also differ.
Important methods of costing are as follows:
Job order costing: Thismethods is used to gathers and accumulates costs for each job order
or work order received from customers. Since each job order is specific and terminates after it is
completed, therefore all costs that are incurred in the job or order are accumulated after its
Process costing: The costing method that ascertains the cost of each process or stage of
producing output is called process costing. Under this method, a separate account is opened for
each process to which all costs incurred thereon are charged.
Service costing: The method of costing which is used for ascertaining the costs of service
rendered is known as service costing. Under this method, the cost of per unit of service
rendered such as cost per passenger kilometre, cost per ton kilometre, cost per kilo-watt, or
cost per patient day is determined. Therefore, this method is popular in industries and
institutions that provide services instead of manufacturing products.
Contract costing: This costing refers to the form of specific order costing, which applies, where
work is undertaken to customer requirements and each order is long duration as compared to
job order costing. A job, which is big and spreads over long periods of time is known as a
contract. The method of costing which is used in a contract is called contract costing. This
method is used by builders, civil engineering contractors and construction firms.
Batch costing: A batch consists of a lot of common units. Therefore, a number of identical
units/articles manufactured on lot basis is called batch. A uniform size of product is produced in
each batch. The costing method used to determine cost of products produced on lot wise basis
is called batch costing.
Multiple costing: An ascertainment of cost of product by using more than one costing method
is defined as multiple costing. It is also called composite costing. It is adopted in those industries
where several components are used to produce a final product.

Cost is frequently used word. Since all use the word cost as per their own need and purpose,
therefore the meaning of cost differs depending upon the need and purpose. An accountant,
economist, engineer and a manager define it according to their need. Therefore, it is not easy to
define the term “cost”. However, in simple words, cost is defined as an amount of money spent
for obtaining any thing, goods or service. Cost is a resource foregone or sacrifice in monetary
terms, to achieve particular objectives.
According to U.S.A., it is defined as an exchange price, the foregoing, a sacrifice made to
source some benefits.

The process of fixing costs of activity is defined as costing. The activity refers to manufacture
products/articles or services rendered, or function performed. Each activity needs cost. The
procedure applied to ascertain unit cost of product or service is costing. So, costing comprises
of collection, classification and analysis of cost for ascertaining unit cost of product and
services. Manufacturing and service industries follow costing to ascertain cost of products or
According to W.H. Wheldon, costing is the classifying, recording and appropriate allocation of
expenditure for the determination of the costs of products or services, and for the presentation
of suitability arranged data for purpose of control and guidance of management.

Classification of costs
Classification of cost refers to the division of cost on the basis of characteristics of costs. it is
concerned with dividing cost into different types. it is fact grouping of cost according to their
common characteristics. A suitable classification of cost is important to identify cost by product,
process or operation. Cost can mainly be classified on the following bases:
2.Functions or activities
3.Variability or behaviour

Elements/ Nature
Cost of product of an industry comprises of material cost, labour cost and expenses. Therefore,
cost appears into material cost, labour cost, expenses under the classification of costs based or
physical characteristics. Cost has three main elements such as raw materials, labour and other
expenses. It can be classified into materials, labour and expenses based on physical

Material cost
Material cost represents the total of costs of main raw materials, components, consumable
stores and packing materials. Materials cost also includes import duties, dock charges, transport
cost, storing cost receiving and inspection cost, and other costs associated with the materials

Labour cost
Labour cost is the total of wages incurred for the effort or services made by labours in the
productions of goods and services. Therefore, wages paid to the workers are termed as labour

Expenses are the total of costs incurred for production, administration and selling and
distributing operations. Such expenses include the cost of drawing, cost of special tools, cost of
trial production, royalties, rent, lighting and welfare expenses.
All the three elements of cost can further be divided or grouped into two types based on their
nature such as direct and indirect costs.

Direct costs
Direct costs are those materials, labour and other expenses which can easily be attributed or
identified with a unit of product, process or operation. The cost of raw materials, productive
labour, and carriage of materials paid are the examples of direct cost. The total of direct cost is
termed as prime cost.

Indirect costs
Indirect costs are those types of cost, which cannot easily be attributed to or identified with a
unit of product, process or operation. Therefore, the total of costs of indirect materials, indirect
labour and indirect expenses is referred to as indirect costs. They are also called overhead
costs. The examples of indirect costs are repair charges, salaries, rent, telephone and water.

Direct materials cost: The cost of materials having physical identity with the end product is
defined as direct materials cost. Main raw materials and necessary components are a few
examples of direct materials.
Indirect materials cost: Materials are not used as inputs of product are called indirect
materials. Cost of materials incurred for repair of a machine used for printing of textbook is
defined as indirect materials cost.
Direct labour cost:Labour or wages incurred for the operative workers engaged in production
process are categorized as direct labour cost. Wages paid to the workers involved in production
and handling materials, workers engaged in productive operation by way of supervision and
maintenance etc is direct labour costs.
Indirect labour cost: Smooth operation of an organization needs operation of account
department, marketing department, and internal transport also besides production department.
Indirect labour cost mean salary paid to staff.
Direct expenses: Direct expenses are charged directly to finished product like direct materials
cost. It is also called designed chargeable expenses. These include special layout cost, drawing
and designed charges, royalties and so on.

Indirect expenses:
The cost which is not directly connected with finished product but occur on account of operation
are termed as indirect expenses. Indirect expenses are also more frequently called on cost or
overheads and include expenses such as canteen expenses, lighting, heating charge, rent,
insurance and so on.
Components of indirect materials: Production supplies and consumable stores, greases,
waste, Non-durable tools and equipment, maintenance material and supplies, inspection and
testing materials.
Components of indirect labour: Managerial salary, supervisory salary, foremen salary,
clerical salary, general labour, unallocated times wages, over-time wages and so on.
Components of indirect expenses: factory rent, electricity, lighting, conveyance and travelling,
postage and telegrams, insurance, depreciation of plants and machinery.

Functions or activities
The classification of costs based on the functions like manufacturing, administrative, selling and
distribution is called functional classification. Functional classification of cost focuses on the
different activities and segregate costs accordingly. Production (manufacturing) and non-
production (non-manufacturing) costs are the major costs division made after prime cost under
this classification.
Prime cost known as Basic, Flat or Direct cost comprises direct material, direct labour, direct
expenses. They are attributable to and are identified to particular finished goods.

Production Cost
Production cost is the sum of the cost incurred for realizing finished goods. It includes direct
material cost and conversion cost needed to convert such direct material into finished goods.
So, it is the sum of Prime cost plus manufacturing expenses or factory overhead or work
overhead. It is also called manufacturing cost or factory cost or work cost.
Manufacturing expenses include indirect materials, indirect labour and indirect expenses
associated with manufacturing operations. Conversion cost includes direct labour cost and
manufacturing expenses need to convert input material into finished goods.

Process cost
Production cost depending upon the stage of production operation can be categorized into
different costs.The output of one process becomes input cost of immediate next process. Costs
of each individual process are collected separately and are term as cleaning process cost,
cooking process cost and so on. Each process cost is divided by the number of units produced
by the same process. It goes on cumulating and total manufacturing cost equals the sum of all
cost accumulated at the final process. The cost so accumulated is divided but the number of
units produced to ascertain cost per unit of finished goods.

Components of manufacturing overheads: Work manager’s salary, factory supervisory

salary, Foremen salary, Work Clerks’ salaries, Provident fund contribution of factory employees,
Leave and holiday wages of factory employees, Unallocated time wages, over-time wages,
Production supplies and consumable stores, Non-durable tools and equipment, Maintenance
material and supplies, Greases, Waste, Inspection and testing materials, Inspection and testing
labour, Repairs of maintenance of factory plant and equipment, Depreciation of factory plant
and machinery, Factory rent, Factory electricity, Factory lighting, Factory insurance.

Non-Production cost
Non-production cost refers to the expenses incurred for running administrative and selling and
distribution works. So, non-production cost is known as operation cost or non-manufacturing
cost that include administrative overhead and selling and distribution overheads. Such costs
keep no direct link with production operation therefore defined as non-production cost.
However, cost of production comprises manufacturing cost and administrative expenses.

Administrative overheads
The expenses incurred for administrative work like planning, coordinating, directing, controlling,
are called administrative overheads. It is also called office cost.

Components of administrative overheads:

Director's fees, office rent, rates and taxes, office repairs and maintenance general and
miscellaneous, executive salary, staff salary telephone charges, postage and telegrams, printing
and stationery, electricity, audit fee, office insurance and so on.

Selling and distribution expenses

The expenses paid for selling and distribution of finished goods are called selling and
distribution overheads. It can be categorized into selling overheads and distribution overheads.

Selling overheads
The expenses incurred for selling finished goods to customers are termed as selling expenses.

Components of selling overheads: cost of catalogues/price lists, salaries of sales staff,

Salesman’s commission, Training of salesmen, Travelling expenses of sales representatives,
Commission, rent of sales office and showrooms, Warehouse expenses, Provident fund,
Entertainment and treatment to customers, Samples products, Bad debts and collection
charges, Neon light posts, Customers’ service and service after sales.

DISTRIBUTION OVERHEADS: The expenses associated with transporting finished goods

from warehouse to sales depot, showroom and customers are termed as distribution overheads.

Components of distribution overheads: Packing expenses, Freight outwards, Loading and

unloading, Depreciation of delivery vans, Insurance outward.
Total Cost includes cost of production plus a reasonable proportion of selling and distribution
expenses. It is normally called costof sales or selling cost.
Variability or Behaviour
Knowledge of variability or behaviour of cost is essential for decision making and forecasting of
cost. This helps to study how costs react with volume changes. Management needs to identify
costs from their behaviour to formulate forward planning and select profitable course of action.

Variable Cost
Cost which change proportionality with volume of output or services are called variable costs.
They increase or decrease in total amount with the increase or decrease in volume of output.
However, the per unit variable cost is constant. Variable manufacturing cost are also called
product cost and include direct material, direct labour and fluctuating indirect materials, labour
and manufacturing overheads.

Fixed Cost
Cost that does not change with output is cost. It remains fixed for a stipulated period and for a
specific capacity output. Fixed cost is called constant or capacity cost. It is also called create
cost as it remains unchanged for a stipulated period. Fixed cost in total amount remains
constant whereas fixed cost per unit changes inversely with output changes. Therefore,
increase in output decreases fixed cost per unit and decrease in output increases fixed cost per
unit. For example: depreciation, rent and salaries.

Semi-variable cost
Those cost which do not change proportionately like variable costs but their increase will be less
than proportionate unlike the variable costs is termed as semi-variable cost. The examples of
semi-variable costs are salary of supervisors, travelling salesman salary, repair and
maintenance costs etc. such costs contain fixed and variable portions. So, semi variable cost is
also called mixed costs.

Step-fixed costs (semi-fixed/ moving fixed costs)

Fixed costs are fixed either to a capacity volume or to a period of time. Therefore, change in
capacity volume or lapses of time create change in fixed cost. It will changes by the original
amount remaining constant for the specific relevant range. Changes take the shape of steps at
the different levels so it is called the step fixed cost. Repairs and maintenance cost; depreciation
of additional machine purchase are some examples of step fixed costs.

Controllability may be defined in terms of change or alternation of costs. An effective cost
control requires knowledge of cost controllability. A sharp division of cost into controllable and
uncontrollability cost is a relative one and is influenced by the action of a person at management
hierarchy. The term controllable cost should not be used as synonymous of variable cost and
direct costs. Knowledge of controllability of cost is important to control cost.
Cost under controllability may be categorized into controllable and uncontrollable costs.
Controllable cost: The cost subject to control or substantial influence of a particular manager
or individual is called controllable cost. In controllable cost, the cost can be changed or altered
by the action of a specific managers. Example; direct materials, direct labour, other overheads
such as indirect labour, factory supplies, cutting tools, power costs, repair and maintenance etc
are controllable costs.

Uncontrollable costs: Costs that are not subject to influence by the action of manager is called
uncontrollable costs. These costs remain unchanged or unaltered. Example: managerial
salaries, staff salaries, depreciation after purchase of equipment, rent. Some costs may be
controllable in the short run but not in the long run.
Accounting for Material
Commodities which are used in the production of finished product are called materials. All those
items, which are used in the process of producing goods or rendering services, are called
materials. It includes all raw materials and supplies like lubricants, fuel and loose tools.
Sometimes materials are also denoted by the term inventory of stores.
Materials are of two types as direct and indirect materials
Direct materials:
Direct materials cost means the cost of materials that can be identified with and allocated to
cost centre or cost units. Cost of paper used to print textbook is direct cost since it is main input
of textbook. Thus, main raw materials, and necessary components are a few examples of direct
Indirect materials:
Indirect materials cost refers to the material costs, which cannot be allocated but can be
apportioned to or absorbed by cost centres or cost units. Cost of materials incurred for repair or
a machine used for printing of text is defined as indirect materials cost. Fuel, lubricating oil,
materials used for repair, coal, maintenance work etc. are few examples of indirect materials.

Material control
The systematic and regular control over purchasing, storing and consumption of materials is
material control. Material control involves the planning, operating, organizing and controlling the
purchasing, storing and using of materials so as to achieve the objectives of minimizing possible
cost of materials and uninterrupted production. In other words, it is a system, which helps to
provide the right quality of materials in the right quantity at the right time and right place with the
right amount of investment. Effective control also requires the systematic preparation of periodic
summaries and reports. It can be defined as a systematic control over purchasing, storing and
consumption of materials. It helps to maintain a regular and timely supply of materials by
avoiding over and under stocking.

Need for materials control

Materials control is necessary for making efficient purchase, storing and consumption of
materials. Every manufacturing company requires to maintain a materials control system that
facilitates efficient purchase, storage and use of the materials. Needs of materials control are
given as follow;
i.To ensure the availability of materials
ii. To ensure optimum investment in materials
iii. To ensure minimum wastage
iv. To provide information about the availability of materials
v. TO ensure reasonable price of material

Objective of materials control

Materials control basically aims at efficient purchase, storage and consumption of materials.
The following are the objectives of material control;

To purchase materials at a reasonable price.

To maintain the cost of materials at the minimum level.
To protect materials against loss by fire, theft, and leakage.
To minimize the handling cost and time in storing and using the materials.
To provide information to management about raw materials, their cost and availability.
To avoid obsolescence of materials by adopting an appropriate method of material issue.
To ensure better quality of materials at right quantity and at right time for efficient

Essentials of Materials Control

The main essentials of materials control are as follows;
There should be up to date record of materials
There should be centralized purchasing
There should be proper co-ordination between sales, production, purchase, receiving,
inspection and storage departments.
All items in stores should be codified, classified and standardised.
Issue of materials should be in the basis of requisition.

The process set by a manufacturing company to control materials is called store routing. It
consists of all the processes involved in proper purchasing, storing and issuing of materials to
the concerned departments. The store routing can be summarized as follows:
1.Purchasing and receiving of materials
Request for purchase of materials
Inquiry and tender quotation forms issued to potential suppliers
Selecting a suitable supplier
Placing the order
2.Storing of materials
Classification and codification of materials
Keeping records of the materials in Bin Cards, Store ledger and so on.
3.Issuig of materials
Requition form
Pricing of materials issued

Purchasing involves acquiring materials of right quality, at right quantity, at right time from right
source, and at a reasonable price. A separate purchase department should be established to
perform purchasing activities. The department which performs purchasing activities in the
manufacturing concern in the managed way is termed as purchasing department. The
purchasing department plays a very important role in an organization because purchasing has
its effect on every vital factor concerning the manufacture, quality, cost efficiency and prompt
delivery of goods to customers.

Purchase control
A manufacturing company is required to invest a huge amount of money in purchasing
materials. It is, therefore, essential to exercise proper materials and purchase control. Purchase
control refers to the purchase of materials of right quality in right quantity at a reasonable price
and at a right time. It requires a good amount of attention to the purchasing procedures of
materials relating to cost, quality, volume, time and delivery of materials.

Centralized purchasing
Centralized purchasing refers to the purchase of materials by a single purchase department.
This department is headed and managed by a purchasing manager. Under centralized
purchasing, all purchase s are made by the purchase department to avoid duplication,
overlapping and the non-uniform procurements. Under this system, the purchasing department
purchases the required materials for all the departments and branches of the company.

It uses the specialized knowledge and skill by appointing specialized and expert purchasing
It brings about economics of bulk purchase.
It facilitates the standardization of materials.
It facilitates effective control over purchases, by maintaining an efficient system of ordering,
receiving inspection, accounting etc.
It ensures consistent policy with regard to purchase such as terms of payment, cost of delivery
It brings about economics of centralized accounting of purchase.
a)When there is only one plant or
b)Several plants are not located far away from each other and are using same materials.

It is expensive due to increase in administration cost of a separate purchase department.
It is not suitable when plants of departments are located far away from one another or are using
different materials.

Decentralized purchasing
Decentralized purchasing refers to purchasing materials by all departments and branches
independently to fulfil their needs. Such a purchasing occurs when departments and branches
purchase separately and individually. Under decentralized purchasing, there is no one
purchasing manager who has the right to purchase materials for all departments and divisions.
The defects of centralized purchasing can be overcome by the decentralized purchasing
system. It helps to purchase the materials immediately in case of an urgent situation.
It avoids unnecessary cost of setting up a purchasing department.
It avoids delay in purchasing because the required material can be easily purchase as and
when required.
Department can get the benefit of localized purchasing.
Due to then provision of purchase of material by the concerned department the material may be
purchased in right quantity and quality.
There is chance of overstocking and blocks the capital of the company.
The benefits of a bulk purchase cannot be obtained.
Fewer chances of effective control of materials.
Lack of proper cooperation and coordination among various departments.
There may be lack of special knowledge about the purchasing with purchasing staff.


Purchasing of materials involves a number of steps which may be different from one company
to another. Generally, the following steps are involves in purchasing and receiving materials:
1.Purchasing requisition
Purchasing requisition is a form used to make a formal request to purchase department to
purchase the materials specified there in. Purchase requisition is received from the store keeper
for all items in regular use, production department for specific items not regularly used and
stored, production regular use, production department development, plant engineer for material
required for special maintenance and departmental heads for any materials required for their
department. The purpose of purchase requisition to authorized the purchasing the materials
specified there in and provides written record of details of material required.
Purchase requisition has three purpose:
To inform the purchasing department of the need or purchase materials.
To fix the responsibility of the department making the purchase requisition.
To use for further reference.

2.Request for quotations or tenders

After receiving a purchase requisition, the next step of purchase procedure is to find the
convenient and economical sources of supply. The purchase department must maintain a list of
suppliers. Selection of a particular supplier is usually made after inviting tenders or quotations
from possible sources of supply. Invitations for tender in a prescribed format are sent to
prospective suppliers. It contains detailed information about the availability of goods, price of
materials, and terms and conditions of purchasing.

3.Purchase order
After completion of the above procedure, the purchase department prepares a purchases order
for the supply of materials. The purchase order is a contractual agreement with the suppliers for
the supply of materials. It is prepared in five copies, the original copy is sent to the supplier, the
second copy for receiving department, third for account department, fourth for imitating
department and the fifth one is retained in the purchasing department for reference.

4.Receiving and inspecting materials

The receiving department should perform the unction of unloading and receiving of material
dispatched by the suppliers. The receiving department verifies the materials with the help if
delivery note and the copy of the purchase order after receiving the delivery of goods. The
suppliers sends detailed information and an invoice of the materials supplied by it. It has to
verify and check the quantity and physical condition of materials by making a comparison of the
purchase order and the materials received in large companies, an inspector is appointed to
inspect all the materials received and to prepare an inspection report.

5.Checking and passing of bills for payment

When the invoices are received from the supplier, they are sent to the stores and accounting
departments for the verification of the quantity and price of materials mentioned in the invoices.
After checking the required documents, the store department requests the accounting
department for making the payment of the invoice to the suppliers.

Store keeping refers to the act of storing materials for their safe custody till these are issued to
the production and other departments. It involves receiving, storing and issuing of materials.
The place where materials are kept is known as 'store'. The term 'stores' has wide meaning and
includes raw materials used in production, consumable store such as oil, grease etc, tools,
patterns, maintenance materials etc, stock of work in progress and stock of finished goods.

Objectives of storekeeping
All of proper place for every item of store
Keep every item of store in fixed place
Maintain proper and upto date records
Issuing materials quickly to department
Classify and codify the materials for easy identification

Types of stores
1.Centralized stores
A centralized stores is that store which receives materials for and issue them to all departments
divisions and production floors of the company. Such a store is only one in the company which
receives materials for and issues them to all who need them. The materials required for all the
departments and branches are stored and issued by only one store.
Economy in cost
Better supervision of store
Better layout and control of stores
Minimum investment in store
Less space is occupied
Better safety and security of stock
Delay in sending materials to the department and branch.
increase in the material handling cost.
Greater risk of loss by fire.
Not suitable for a large company.

2.Decentralized Stores
Decentralized stores is that type of store which receives materials for and issues them to only
one department and not to the whole company. The decentralized store may be many in the
company, as each department has its own such store. Purchasing and handling of materials are
undertaken by each and every department separately. Each and every branch has their own
store for operation of production activities.
Saving in material handling cost
Prompt issue of material is possible
Storing and control will be easy and effective
Smooth production will be possible
Risk of loss by fire can be minimized
Higher cost of supervision.
More space is required for individual departments.
Higher amount of investment is required.
More time for stock taking and checking.
Higher cost for staff and stationery.
Improved technique is less possible for controlling of materials.

3.Centralized stores with sub-stores

This is a mix store system, a mix of centralized and decentralized stores, under this store
system, sub-stores are established in different departments according to the requirement of the
company. Sub-store are maintained at each department when the central store is at a distance
from the production department. Such sub-stores are managed and controlled by the central
store itself. At the beginning of a period, the central store issues a fixed quantity of materials to
the sub-stores. At the end of the period, sub-stores send a filled requisition from to the central
store to maintain the stock to a pre-determined level.
Overcoming the demerits of centralized store
Offering an easier location for storing of materials.
Avoiding delay in issuing materials.
Providing services to meet the special needs of individual departments.
Reducing the internal transportation cost.
High cost for stationery and staffing.
High material handling cost.
More time in stock talking.
Extra set-up stock taking.
Complicated store control.

It refers to the place where stores are situated. The location of stores should be near to the
receiving department so that the materials handling charges are at a minimum. There should be
an easy excess to all other department so that the minimum of expenses is incurred in
unloading. The stores should be located considering the nature of materials; the bulky materials
should be stored nearer to the user's department to minimize the labour and transport, the
planned location charges. In conclusion, the planned location of the store will avoid delay in the
movement of materials to the department in which these needed.

A manufacturing company appoints a person for careful storing and safeguarding materials in a
store who is called storekeeper. A storekeeper is a person who is the chief of the stores and
who is given the responsibility of store management. He is responsible for safeguarding the
materials and supplies in proper place until they are required for production activities. A
storekeeper should be well-experienced, well-trained, honest and familiar with the tricks of
The main functions of storekeeper are as follows;
To maintain a proper record of materials relating to the receipt and issue of materials.
Checking the physical quantity of materials and verify with a bin card.
To prevent unauthorized entrance into the storeroom.
To maintain the stock registers, entering therein all receipts, issues and balance of materials.
To check and control losses due to evaporation, leakage, theft, and so on.
To arrange for physical verification of store items periodically.
To keep the stores always neat clean and tidy.
To supply information of materials, stock position, and so on whenever needed.


The process of grouping of materials on the basis of their nature or usage is known as
classification. The process of giving district names and symbols for each item is called
codification. A good system of store keeping requires an appropriate classification codification.
Materials are classified either on the basis of their nature or on the basis of their consumption.
On the basis of nature is most commonly used such as materials are classified as construction
materials, consumable stores, spare parts, lubricating oils etc. After the classification of
materials, these are codified alphabetically or numerically each item of store by giving it a
separate stores code number are used to indicate the main group and the decimals to indicate
primary, secondary and other groups. The main code consists of first two digits, sub-code
consists of the next two or three digits upon the requirement and last one or two digits indicate
to details of the size, quality etc upon the requirements.
Advantages :
Quick and easy identification of materials.
Helps ensure a proper material control.
Secrecy of materials.
Saving of time in materials handling.
Essential for mechanized accounting system.


The following are the important store recording methods that are used for keeping records of the
various items to store:
A document used in the stores department to show receipt, issue and balance of each item of
materials is called bin card. In the bin card, the stock level like minimum stock level, maximum
stock level, reorders level of each items are mentioned. All the receipts and issues entries made
in bin card can supported by relevant documents such as good received note, materials return
note, stores requisition note etc. An entry is made at the time of each receipt or issue and the
balance in hand of the stock is calculated. The bin card shows the quantity of materials but not
the value of materials.
2.Two-bin system
In some manufacturing companies, a bin is divided into two parts: a smaller and a larger one.
The smaller bin stores the quantity equal to the minimum quantity and the larger part stores the
remaining quantity. The quantity in the smaller part is not issued so long as the quantity is
available in the large part. New supply is ordered as soon as the larger bin is empty.
3.Store Ledger
A store ledger is a record of stock, both in quantity and value and is maintained by the store
accounting section. It consists of the same columns of a bin card, but in addition, there is an
amount column in which the value are entered. Thus, this ledger provides information for the
pricing of materials issued and the value of materials at any time of each item of stores.


Bin cards Stores ledgers
It is maintained by the storekeeper. It is prepared by cost accounting department.
It is a record of quantity only. It is record of quantities and values.
Entries are made immediately after each
Entries are made periodically.
Posting are made before a transaction. Posting are made after a transaction
It is kept inside the store. It is kept outside the store.


It is also known as Automatic inventory system. Perpetual inventory system is a technique of
controlling stock items by maintaining store records in a manner such that stock balances at any
point of time are readily available. The terms "Perpetual inventory" refer to the system of record-
keeping and a continue physical verification of the stocks, with reference to store-records.
According to Wheldon, perpetual inventory system is a method of recording stores balance
after every receipt and issue to facilitate regular checking and to obviate closing down for stock-
The two main functions are:
Recording store receipts and issues to determine the stock in hand at any time, in quantity or
value or both without the need for physical counting of the stock.
Continuous verification of the physical stock with reference to the balance recorded in the store
record is convenient for the management.
It helps in rapid stock taking which, in turn, helps in the preparation of interim accounts.
A moral check on the store staff to maintain proper stock records.
The investment in materials and supplies may be kept at the lowest point.
It is not necessary to stop production so as to carry out a complete physical stocktaking.
Deterioration, obsolescence etc, can be avoided.
Discrepancies and error can be quickly discovered and remedial action can be taken.

Preparation and treatment of requisition form
The storekeeper receives materials and other items, stores them carefully and finally issues
them for the purpose of production. But, the storekeeper must not issue materials unless a
properly authorized materials requisition is presented to him. Request for the issue of materials
should be made to the storekeeper in the prescribed form signed by the person demanding
them. The document, which authorizes and records the issues of materials, is known as
material requisition from.

Method of pricing material issued

There are various methods, in use, of pricing issues of materials form store. The selection of a
suitable method is significant from the viewpoint of cost absorbed and consequently on profit.
Materials are purchased specifically for a job. The material issued is charged to the job at its
landed cost. Landed cost includes the invoice price, fright, cartage, insurance and control
charges on materials. Issue of such items cannot be linked with a particular 'lot' and therefore,
exact landed cost of the particular unit issued cannot be identified.
Some important methods of pricing are as follows:

First-In-First-Out (FIFO) Method

The method in which materials are issued from the store on a first come first serve basis is
called FIFO. Under this method, the materials received first in stores are issues first. Materials
are issued strictly on a chronological order. The first issue is made out of the unit of opening
stock, next issue from the first purchase and the closing stock is remained in stock always from
the latest purchase.
This method is easy to understand and operate.
It is used where transactions are not voluminous and prices of the materials are falling.
This method is suitable for bulky materials with high unit prices.
Deterioration and obsolescence can be avoided.
Value of closing stock of materials will reflect the current market price.
It is improper if many lots are purchased during the period at different prices.
The objectives of matching current costs with current revenue cannot be achieved under this
If the prices of materials are raising rapidly, the current production costs may be understand.
This method overstates profit especially in inflation.

Last-In-First-Out (LIFO) Method

This method follows the principle that the last items of materials purchased are issued at first.
The valuation of the materials issued is made according to the latest purchase price of
materials. The closing stocks of the materials are valued always on the earliest prices of the
materials. In case of a rising price, this method is suitable because material is issued at current
market prices.

This method is appropriate for matching cost and revenue.
This method is simple to operate and easy to understand.
It facilitates complete recovery of material cost.
It is most suitable when prices are rising.
Inventory valuation does not reflect the current prices and therefore are useless in the context of
current conditions.
Due to variation of prices, comparison of cost of similar job is not possible.
Calculations become complicated and cumbersome when rates of receipts are highly
It involves considerable clerical work.

Simple Average Method

Under this method, issue prices of materials are fixed at average unit price. According
to CIMA,LondonA price which is calculated by dividing the total prices of the materials in the
stock from which the material to be priced could be drawn by the number of the prices used in
that total.
The simple average is an average of prices without considering the quantities involved.
It is very suitable when materials are received in uniform lot quantities.
This method is very easy to operate,
It reduces clerical work.
If the quantity in each lot varies widely, the average price will lead to erroneous costs.
Costs are not fully recovered.
Closing stock is not valued at the current cost.

Materials returned to the store

Defective and unused materials are returned to the store. When the materials are returned, they
should be treated as receipts and are recorded in the store ledger like purchase of materials.
After receiving the returned materials, the storekeeper prepares a Material Return Note, which
records the return of unused materials.
Materials returned in the original condition may be based under one of the following
a)At the same price at which they were issued
b)At the current price of issue
According to the first method, the returned materials are set apart and at the time of next issue
they are priced at the original price rate. This method treats the return as a new purchase but
values it at the original price. Under the second method, the return is priced at the rate at which
any material requisition placed on the date would have been priced.

Stock level
Inventory refers to the stock maintained by the manufacturing concern and trading organization
to meet their future requirement for smooth production and sales. It refers to the different level
of stocks, which are required for an efficient and effective control of materials and to avoid over
and under stocking of materials. The purpose of materials control is to maintain the stock of raw
materials as low as possible and at the same time they may be made available as and when
In a scientific system of inventory system of inventory control the following levels of materials
are fixed.
Re-order level
Minimum level(Safety stock)
Maximum level
Average stock level
Re-order quantity

Re-order level
It is that level of inventory which the store keeper should initiate the purchase procedure for
fresh supplies of inventory. Re-order point is the quantity or level of the inventory on hand that
triggers a new purchase order. It is the level at which storekeeper initiates purchase requisition
purchase for fresh supplies of material. Fresh order should be placed before the actual stock
reaches the minimum level to continue the business activities properly.
It is calculated by,
Re-order level= Minimum level (Safety stock) + (Average lead time X average consumption)
Re-order level=Maximum consumption X Maximum re-ordering period

Minimum Level or Safety Stock

It is the level stock where new order should be placed considering daily usage rate and lead-
time. When the volume or quantity of materials in production fall in below minimum stock level; it
shows potential leading to stock out position. Stock falls below minimum level if consumption is
more than normal consumption or re-order period is more than normal re-order period or both of
these condition appeared. Minimum stock level is considered as buffer stock for use during
The following is the formula of it,
Minimum stock level = Re-order level - (Normal consumption X Normal lead time)

Maximum stock level

The level of stock which is generally not allowed to be exceeded is said maximum stock level. It
represents the maximum quantity of an item of material which can be held in stock at any time.
The quantity is fixed so that their may be no over stocking
It is calculated by,
Maximum stock level = Re-order level +Re-order quantity- (Min. consumption X Min. lead time)

Re-order quantity
First of all company determines the quantity or size to be ordered at a time. Thereafter, it places
the order for purchasing materials by the same size or quantity, which is known as re-order
quantity. In other words, the quantity of single purchase order while purchasing any materials is
called re-order quantity.
It is calculated by,
Re-order quantity= (Max stock level - ROL) + (Min. consumption X Min. period)

Average stock level

Average stock level denotes the normal/moderate/average stock maintained by the firm. This
level, which indicated the average stock to be held by the firm is known as average stock level.
It is ascertained by using the following formula:
Average stock level =(Max stock level + Mini stock level)/2
Average stock level = mini stock level + (1/2 + re-order quantity)

Economic Order Quantity (EOQ)

Economic order quantity is also known as re-order quantity. It is that level of inventory where the
total cost of holding inventory is at minimum. It is the level of quantity at which the cost of
ordering will be equal with the storage cost of materials. In other words, the quantity of
materials, which is economical to be ordered at one time, is known as economic order quantity.
The total cost of materials consists of the ordering cost and carrying cost. While determining the
economic order quantity, the ordering cost and carrying cost should be considered.

Carrying cost
This refers to the cost of keeping items in stock for a certain period of time. Carrying cost is
concerned with the storing of materials. It suggests purchasing in small quantities. If small
quantities of materials are purchased, the storing cost will be low. The following costs are
included in the carrying cost.
Storage cost
Insurance of material
Obsolescence loss due to a change in process or product
Internet on capital blocked on materials
Maintaining cost of material to avoid deterioration.

Ordering cost
All the cost, which is related with placing an order and secure the supplied are called ordering
cost .in others it refers to the cost related to the purchase related activities. The ordering cost is
the repurchase cost and is repeated in nature. Purchasing of large quantities of materials helps
reduce the ordering cost. The following costs are included in the ordering cost.
Cost of staff appointed in the purchasing, inspection and payment departments.
Cost of stationary purchases, telephone charge, email charge, faxes charge etc.
Formula of EOQ,
A= Annual requirement
O = Ordering cost
C = Carrying cost


Accounting for Labour

Labour is also one of the prime inputs of production system. All manufacturing concerns require
the labour for carrying out their production activities. The labour consists of workers who are
essential to convert materials into finished products. The labour can be either direct or indirect.
First and foremost thing is to pay the demanded amount by labours. Dissatisfaction and
discontented labour always results in high labour cost and low quality outputs.
Labour is human resources and participates in the process of production. It is an essential factor
of production. The amount, which is paid to the labour, is known as labour cost and it is a
significant element of cost of a product. Labour cost includes monetary benefit e.g basic wages
and fringe benefit such as fooding, housing, education to the children of workers, holiday pay,
medical facilities etc.
In other words, labour cost is the amount of remuneration paid to a worker or an employee for
his work or service in producing goods and services.

Types of labour cost

Direct cost
The cost that is easily identified and vary with level of production.Direct cost is that labours,
which can be easily, identified with specified product, job or work order. It includes all labour
engaged in converting raw materials into finished goods or in altering two form of labour which
is incurred wholly or specifically for any particular job or work order. For example: carpenter in
furniture house, tailors in garments industry,washer in dry clinic etc. Remuneration paid to direct
labour is termed as direct labour cost. It is treated as part of prime cost.

Indirect cost
The cost, which is not easily identified and not vary with level of production.It is that labour
which cannot be easily identified with a specific product or job. It includes all labour indirectly
involved in converting raw materials into finished goods or in altering the construction,
consumption or condition of the product. For example: labour employed in repair and
maintenance, time keeping, cost accounting, store department etc. Remuneration paid to
indirect labour is termed as indirect labour cost and it treated as part of overheads. Payments
made to the sweepers, watchmen, cleaners, supervisors and accounting personnel are the
examples of indirect cost.

Importance of labour cost

Labour cost is a main element of cost, which covers one of the major portions of the total
cost of a product or job.
It is more difficult to control as compared to material cost due to the involvement of human
It is affected due to a change in government policy and requirement of trade union.
It is adversely affected due to dissatisfaction, irregularity, inefficiency, idle time, and high labour
of the workers.
It is important from the fact that the direct labour cost is taken as the basis for estimating the
amount of factory overheads while determining the product cost.

Labour cost control

Labour cost is an element of cost of production. It may be excessive due to the various reasons
such as lack of supervision on the labours, high labour turnover, inefficiency of labour etc.
Reducing the cost of production, an optimum utilization of labours is needed for each and
individual firm. Therefore, labour cost control refers to the system that ensures effective
employment and proper utilization of labours.
Management is concerned with controlling labour cost. Labour cost control involves such
systems, procedures, techniques and tools used by the management in order to keep the labour
cost of the product or job as minimum as possible.

The need of labour cost control arises to fulfil the following purposes:
To obtain better quality output with the least effort and time of the workers.
To reduce the cost of production of the products manufactures or services rendered.
To ensure the satisfaction of the workers by creating a good working environment in the factory.
To adopt a fair system of wage payment and to minimize labour turnover.
To minimize wastage of materials by workers, idle time and unusual overtime work.
To maintain safe environment.
To increase the profitability and competitiveness of the organization.

Departments involved in controlling labour cost

In a large manufacturing concern, the following department are set up for proper accounting and
controlling of labour cost:
Personnel department
The personnel department concerned with the recruiting, training, placing and promoting the
workers for the jobs to which they are best suited. It executes the employees policies laid down
by the board of directors of the company. It keeps complete records of the employees and
reports to the management regarding labourutilisation, labour efficiency, labour turnover and
Personnel department starts the recruitment of workers immediately after receiving the labour
requisition from the concerned departments. The labour requisition is also known as employee
requisition or employee placement requisition. Personnel department keeps complete records of
each employees working in the organisation in a card known as employee's history card.

The main functions of personnel department are as follows:

Selection and recruitment of required labour.
Conduct the training program to employees.
Maintaining services and leave record to employees.
Preparation and submission of various reports to concerned authorities.

Engineering department
The engineering department involves in preparing plans and specifications for each job. This
department is established with the view of determining the production procedure and working
technique and creating sound working condition for each workers. It inspects the jobs being
done at different production stages to ensure that they are being done as per plans and
Its main functions are as follows:
Making job analysis.
Setting piece rate.
Preparing the performance evaluation.
Creation of safe environment to minimize the risk of accident.
Preparing of plans.

Time and motion study department

This department works properly coordinating with personnel, engineering and cost department.
This department performs the following functions of making of time and motion studies of
Motion study
A worker or a machine makes various moments of the part of his body while performing a job or
a work. It is a study of moments of workers in performing a job or work for the propose of
eliminating useless, ill directed and inefficient motions to improve the productivity. It is
conducted while the worker in the job. Motion study is also known as methods study because its
main objectives are to find out the best method of completing the job.

Time study
It is conducted after the motion study. The main objectives of the time study is to determine the
required time for performing the job or work. Various methods are used for the determination of
basic time. Standard or basic time is fixed for a job or operation providing allowances to worker
for drinking water, smoking and other so on selecting an average workers as model rather than
exceptionally fast or slow workers.

Main functions of time and motion study department are ;

To divide a given job into detailed elements or parts.
To make a study of the movements of a worker while performing each element of job.
To determine and eliminate unnecessary or wasteful motions or movements.
To observe and record the time required for each necessary movement and to fix standard time
required to complete a given job.
To set reasonable piece rate for different job.

Time-keeping department
This department is related with the recording of time of each worker engaged in the factory to
know the attendance and ascertainment of wages. The main objective of this department is to
prepare pay roll, meeting the statutory requirements, maintaining discipline in attendance,
recording of each worker's time 'in' and 'out' of the factory making distinction between normal
time. Over time, late attendance and early leaving and to provide basis for the distribution of
overheads when overheads are absorbed on the basis of labour hours.
To record the time of each worker properly, either an attendance register or time card can be

Time booking
It is concerned with recording the time spent by each worker in the factory on different jobs is
work orders. It determines the exact time spent by the worker in different departments or
processes or products or jobs for the purpose of calculating the correct amount of labour cost.
When the workers spends his time on several jobs or work orders then the need of time
booking arises for the purpose of cost analysis and apportionment.

The following forms are used for time booking:

Daily time sheet: it is given for each worker to record the details of time spent daily on different
Weekly time sheet: It is similar to the daily time sheet which records the details of time sent by
a worker in a week on different jobs or work orders. It is an improvement over the daily time
sheet because each worker is given a single sheet for a week to record his time.
Job card: It is used to keep the correct record of the time spent by each worker on each job. It
helps to calculate the labour cost of a job accurately ad conveniently. The card can be used for
each worker or for each job as per the need of the factory.
Piece work card: It is used to record the quantity of output produced by a worker along with the
time spent by him. It is issued to each worker when the wages is payable on piece rate basis.
Idle time card: It records the time wasted by each worker. It is the difference between the time
booked to different jobs and the gate time. It shows the reasons of not doing a work while the
workers remains present in the factory.

The main functions of time keeping department are:

To keep attendance record of each worker showing arrival time, departure time and overtime.
To keep an accurate record of time spent by each worker in the factory for calculating wages.
To maintain discipline to ensure a regular attendance of the workers.
To record and determine the exact time spent by the workers on different jobs or work orders for
calculating the correct amount of labour cost,
To ascertain the unproductive or idle time of each worker and to minimise it.

Pay-roll department
The pay-roll department involves in verifying the time of the workers, calculating wages due to
each worker and preparing the pay roll or wage sheet. It prepares the pay roll or wage sheet for
each department separately and distributed wages and salaries to the workers.

Pay slip
It is prepared for each worker showing the net payable amount of wages. Pay roll is prepared
for each department but pay slip is prepared for each worker. Pay slips of a worker, in fact, is
the copy of the pay roll.

The main functions of the pay-roll department are as follows:

To keep the records of the workers, departments, jobs and wages rate of each worker.
To verify and summarise the time of each worker as shown on the Time Card.
It should provide more wages to efficient and skilled workers.
It should follow the government policy and trade unions' norms.
It should be simple and understandable to all the workers.
It should help in improving performance and productivity of the workers.
It should be flexible enough to suit the needs of an organization.

Cost accounting department

The cost accounting department involves in determining the labour cost of each product,
process and job. It collects, records, classifies and analyses the labor cost.

The functions of a accounting department are;

To collect, record and classify the labour cost.
To analyse, allocate and apportion the labour costs of different products or jobs.
To determine the correct amount of labour cost, process, job.
To supply information regarding labour cost through cost reports to the management when

System of wage payment

System of wages payment is the method adopted by manufacturing concerns to remunerate
workers. It is the way of giving financial compensation to the workers for the time and efforts
invested by them in converting materials into finished product.
It is important because of following reasons;
It facilitates the preparation of a wage plan for future.
It helps to determine the cost of production and the profitability of the organisations.
It determines the amount of earning of the workers and their living standards.
It affects the interest and attitude of the workers.

Essential criteria of a good wage system

It should be fair and justifiable to the workers and organisation.
It should help in maximising workers satisfaction and minimising labour turnover.
It should assure minimum guaranteed wages to all workers.
It should assure equal pay for equal work.
Piece rate system of wage payment
The piece is that system of wages payment in which the workers are paid on the basis of the
units of output produced. It does not consider the time spent by the workers. It is a method of
remunerating the workers according to the number of units produced or job completed. It is also
known as payment by result or output. It pays wages at a fixed piece rate for each unit of output
It is calculated by,
Total wages earned = output * Piece rate
It pays wages according to the output produced by the workers.
It helps to reduce idle time.
It gives incentive to the workers to adopt a better method of production for increasing their
production and earning.
It helps the management to determine the exact labour cost per unit for submitting quotation.
It reduces per unit cost of production due to increased volume if production.
It requires less supervision cost.
It does not help in producing quality output as the workers are concentrates more on quantity
instead of quality.
It does not help for a uniform flow of production and makes difficult to regulate the production
It is very difficult to fix an acceptable and reasonable piece rate for each item of output or job.
It creates greater chances of ineffective use of materials, tools and equipment due to more
concentration on increasing output.
It may adversely affect the workers health as well.
It requires extra supervision cost for quality output and effective use of materials, tools and


The time rate is that system of wages payment in which the workers are paid on the basis of
time spent by them in the factory. Under this system, the workers and employees are paid
wages on the basis of the time they have worked rather than the volume of output they have
produced. Hence, according to this system, wages are paid on hourly, weekly or monthly basis.
Under it, the wages earned by a worker is determined by using the following formula;
Wages earned = hours spent * wages rate per hour
It is simple to understand and easy to calculate.
It is quite useful for organisations that use costly inputs for quality outputs.
It is beneficial for average and below average workers.
It assures regular income and creates the feeling of economic security among the workers.
It does not discriminate the workers and is preferred by trade unions.
It does not help in increasing output and improving as there is no correlation between effort and
It is not justifiable to differentiate between efficient and inefficient workers and skilled and
unskilled workers.
It pays for idle time, which increase the cost of production.
It encourages a go-slow tendency among workers during working hours and encourages them
to work for overtime.
It is difficult to estimate exact labour cost in advance.

Differences between piece rate and time rate system

Piece rate system Time rate system
Piece rate system is a method of wage Time rate system is a method of wage
payment to workers based in the quantity of payment to workers based on time spent by
output they have produced them for the production of output.
It pays the workers according to the units of It pays the work according to the time spent
output produced. in the factory.
It does not pay for idle time. It pays for idle time.
It requires strict supervision to get the It requires strict supervision to get the
required quality output. required quantity of output.
It does not fix labour cost per unit in
It helps to fix per unit labour cost in advance.
It does not bring uniformity in the flow of It helps maintain a uniform flow of
production and causes an excessive wastage production and ensures an efficient use of
of inputs. materials, tools and equipment.


Wages are one of the major portions in the total cost of production. There is always a chance of
fraud in wage payment. Therefore, an effective administrative and accounting control system
must be implemented by the management to minimise fraud and to keep the labour cost minim
in. The management should evaluate and revise its controlling system to find out leakage and to
stop leakages in time.
The following are the steps to minimise fraud in wage payment:
The time of job card and idle card should be compared with the time shown by the time card.
The wages sheet should be prepared by involving two or more than two responsible employees.
The organisation should issue identify cards to all the workers for their identification.
The pay roll or wage sheet should be prepared for each department separately and wages
should be distributed in the presence of the concerned authority of the department.
The cashier should not be allowed to involve in the preparation of wage sheet.
The cashier should be allowed to draw only the net amount of wages as per wage sheet from
the bank in required denominations of notes

Accounting for Overheads

A manufacturing concern incurs different items of costs while converting raw materials into
finished outputs. Such costs can be classified on different bases. One such basis is the
directness of the costs to the product unit or identification of costs with a particular product unit.
The direct portion of the total costs is called known as prime cost and the indirect portion is
called overheads.


The cost that can be easily defined with and directly allocated to a particular cost centre or cost
is known as direct cost. The cost is divided into direct and indirect cost. Direct materials, direct
labours, and direct expenses are some examples of direct costs and the total of these costs is
known as prime cost.


A manufacturing concern carries out mainly two types of functions. These are manufacturing
and non-manufacturing functions. Manufacturing functions are concerned with converting raw
materials into finished goods while non-manufacturing functions are concerned with general
administration, selling and distribution of goods. The organisation incurs several indirect
expenses while performing such manufacturing and non-manufacturing activities.
The major types of overheads are;
1.Manufacturing overheads: They are also known as production overheads or works or
factory overheads. These are indirect expenses that are incurred in carrying out manufacturing
activities of the concern. Manufacturing overheads include all the indirect expenses incurred in
converting raw materials into finished goods. Power, factory rent, factory insurance, indirect
materials, indirect wages depreciation and repair and maintenance are the example of
manufacturing overhead.
2.Non-manufacturing overheads: The non-manufacturing overheads include the following two
3. Administrative overheads:
These are indirect expenses that are incurred in connection with the general administration of
the whole concern. These overheads incur while carrying out office and administrative activities.
Example: office salaries, rent, printing and stationary, telephone and electricity, depreciation and
repair and maintenance of office building, furniture and other office expenses.
4. Selling and distribution overheads:
All the indirect expenses incurred for selling and distribution of finished goods are known as
selling and distribution overheads. Selling overheads are incurred for creating demand,
attracting present and potential customers and retaining old customers. Examples: free gift,
advertisement, showroom expenses, and so on.
Distribution overheads are incurred in maintaining stocks and carrying the goods to customer
destinations. Examples: packing charges, carriage and freight out, warehouse expenses,
depreciation and others.

Classification of overheads based on behaviour

This classification is based on the behaviour or variability of overheads. Such a classification of
overheads is based on change in the amount of overheads with the change in output. There are
four types of overheads;
1.Fixed overheads: These overheads are also called period costs or capacity costs. They are
incurred for creating an output capacity of the concern for a fixed period of time, say, month or a
year. They are the costs, which remain fixed or constant in total despite changes in the volumes
of production or sale. Examples: rent, salaries, depreciation, interest and legal expenses.
2.Variable overheads: These are the overheads which vary positively with the production and
sales volume. Hence, they vary directly in proportion to the volume. They increase in total with
the increase in volume and vice versa. Examples; indirect materials, indirect wages, indirect
3.Semi-variable overheads: These variables are neither completely fixed nor variable.
Therefore, they are also called semi-fixed costs. These overheads comprise the quality of both
the fixed and variable costs. They vary disproportionately with the change in the volume of
output. Examples; salesman remuneration, heating, lighting, supervision etc.
4.Step fixed: These overhead remain fixed within a certain range of output level and jump up
once the range of output level exceeds. They remain constant for a given volume, but increase
by another fixed amount the moment there is addition of volume, and keep on focusing by a
fixed amount with the addition of volume.
Classification of overhead based on elements
Based on the components or elements, overheads can be classified as indirect materials,
indirect labour and other indirect expenses. This classification is also known as classification of
overheads according to their nature of sources.

Each element of such overheads is described below;

1.Indirect materials: All materials other than direct ones are indirect materials. They do not
form the part of the finished product. They cannot be identified with or traceable to a particular
cost unit or cost centre. They cannot be allocated but can be apportioned to a number of cost
units or centres. Examples: cost of lubricants, cotton waste, grease and others.
2.Indirectlabour: The labour that is not directly involved in production process is called indirect
labour and wages paid to such labour are called indirect wages. Indirect labour, however,
assists in the production process. Examples; watchmen, sweepers, worker in department
services, supervisors and so on.
3.Other indirect expenses: The indirect expenses other than indirect materials and indirect
labour are called other indirect expenses. These expenses also cannot be directly traced to any
product unit or cost centre. Examples: rent, insurance, telephone, charges, lighting, office
salaries and depreciation.

Classification of overheads based on control

Control of costs is one of the prime concerns of management. There are some expenses that
can easily be controlled by the management while some other cannot be. From the point of view
of cost control, therefore, overheads can be divided into two types;
1.Controllable overhead: These are the indirect expenses that the management of a
manufacturing concern can keep under its control, as they are influenced by its decisions.
Therefore, those overheads that vary due to the management decisions are called controllable
overheads. Examples: indirect materials, power expenses and lighting expenses.
2.Uncontrollable overhead: On the other hand, those indirect expenses that are beyond the
control of the management are known as uncontrollable overheads. Examples; factory rent,
office salaries, depreciation and legal expenses.

Allocation of overheads
Allocation of overheads is the process of charging overhead costs to a particular department or
cost centre. It is the allotment or assignment of an overhead cost to a particular cost unit. If the
overhead cost is associated with a single department or cost centre, the whole amount is
charged or distributed among the units of output of that particular department. For example, the
whole amount of repair and maintenance expenses for a machine is charged pr allocated to that
department where the machine has been installed.
Apportionment of overhead
Distribution of an overhead cost to several department or cost centre is known as apportionment
of overheads. It is the process of charging or apportioning costs to a number of cost centres or
cost units. If a given cost is common to two or more departments or cost centres, such cost
should be apportioned or divided among theses departments on an equitable basis. For
examples, the amount of factory rent should be apportioned to all the departments. Similarly,
the amount of remuneration to the general manager should be distributed to the production,
administration and marketing departments, as the general manager is associated with all these

Differences between allocation and apportionment of overheads

Allocation Apportionment
It involves a particular department or cost It involves two or more department of=r cost
centre. centres.
The process of charging the costs to a The process of charging the costs to a
particular department or cost centre is number of departments or cost centres is
allocation of overheads. apportionment of overheads.
It is distributed on some equitable bases like
It is based on direct distribution. direct labour hours, number of workers,
machine hours and space and area occupied.
It is applicable when the overhead cost is It is applicable when the overhead cost is
associated with a single department or cost associated with two or more departments or
centre. cost centres.
Allocation of overhead is done when the Apportionment of overhead is done when the
most centre uses while of the benefits of the cost centres use only a portion of the benefits
expenses. of the whole expenses.

Absorption of overhead
The absorption of overheads is also called the recovery of the overhead costs. It is the process
of sharing the overhead costs by all products of a particular department. It is the application of
overheads to each unit of output. In other words, the process of ascertaining the total overhead
costs if each unit of output or job by using overhead rate is known as the absorption of
overhead. Thus, the distribution of the overhead expenses allotted to a department over the
units produced in that department is absorption of overheads.
Unit or Output Costing
A manufacturing concern converts raw materials into finished products and sells them at a
certain price. In the manufacturing process, it incurs different types of expenses such as
manufacturing, administrative and selling and distribution expenses.
Concept and meaning
Output or unit costing is one of the important methods of costing under which cost of production
and in turn the selling price unit are determined. This costing method is used by the
manufacturing concern which produces homogeneous products such as sugar, cloth, cement
and so on. A costing method used to ascertain unit cost output is called output-costing method.

Importance of output costing

A cost sheet is used to determine total and unit cost of a product under the unit cost method.
The followings are the importance;
Simple: This method is very simple and easy to understand.
Determination of cost: It helps to determine the total and unit cost if production for a given
period of time.
Fixation of selling price: It helps to determine the selling price of the product.
Elements of cost: It provides the detail information of the cost under different heading
incorporating step-wise cost as well as total cost.
Comparison: It facilitates to compare the current cost with the previous period.
Corrective measures: It enables to find out the causes of variation if any and take corrective
Tender sheet: It helps in the preparation of tender sheet for submitting tender price with fair
degree of accuracy and reliability.
Decision making: It facilitates for making different types of decisions and formulation policy of
the manufacturing concern.
Limitation of unit costing
Cost sheet is very importance method for determining the unit cost or total cost of production.
Not applicable for heterogeneous products: manufacturing concerns engaged in
manufacturing different types of product cannot apply this method.
Not applicable for service sector: Services oriented concern like school, college, and hospital
cannot apply this method.
Cost sheet or statement of cost
A cost sheet is a periodical statement, which is designed to show in detail all the elements of
cost of good manufactured. The elements of costs are prime cost, factory cost, cost of
production and total cost. In simple words, a statement which is designed to show the total cost
as well as cost per unit of output for the given period of time is called cost sheet.

Components of cost sheet

Cost sheet is a statement, which collects the detail information about the cost of different cost
centre for determining the total cost and unit cost of production. It is prepared for the specific
period of time.
The main components of statement of cost are as follows;

Prime cost
Prime costs of product are the sum of direct costs, which varies in proportion to volume of
production. Prime cost includes direct expenses like cost of materials, direct labour and direct
expenses. These costs are directly identifiable with the product and constitute the major part of
total cost of the product.

Factory cost
Factory cost are the total of prime costs and factory expenses. Factory expenses are also as
factory, manufacturing or works overheads. They includes indirect expenses which are incurred
inside the work place where manufacturing takes place.
Factory cost= prime cost + factory overhead

Cost of production
Cost of production includes factory costs and office and administrative overheads. Office
overheads include all expenses incurred in performing administrative activities like planning,
coordinating, staffing and controlling.
Cost of production = Factory cost +Office overheads

Total costs
Total costs are the sum of costs of production and selling and distribution overheads. Selling
and distribution overheads are necessary for the promotion of sales.

Treatment or adjustment of stock

There are three types of stock, which are adjusted in the process of preparing statement of cost.
They are as follows;
Stock of raw materials
Stock of work-in-progress or partly finished goods
Stock of finished goods

Stock of raw materials

Opening stock of raw materials value is added to the raw materials purchased and closing stock
of raw materials value is subtracted therefrom in order to calculate cost of raw materials
consumed. Cost of materials consumed is then considered as direct material cost.

Stock of work-in-progress
The stocks of work-in-progress are those units of commodities on which some work has been
done but are in process of completion. These units can neither be treated as raw materials nor
finished product, because such units requires further process to be completely finished
products. Stock of work-in-progress may be both opening and closing.

Stock of finished goods

All types of overhead other than selling and distribution overhead are absorbed by finished
goods. Therefore, stock of finished goods is adjusted after calculating cost of production.

Tender or quotation price

It is the price to be quoted for the supply of the particular product or for executing the work order
as quotation invited. The manufacturer has to quote price of its product in advance. In the
preparation of tender sheet, direct materials, direct wages and overhead are predetermined on
the basis of the costs of the proceeding period. It takes into account the possible changes in
price in future.
The overhead costs can be estimated by taking labour hour or machine hour basis. The basis of
machine hour rate or labour rate is used for the absorption the overheads. In the preparation of
tender sheet, the following steps can be taken:
The direct materials direct wages, and overheads should be added along with any changes if
any, to determine prime cost.
The other overhead should be absorbed on the basis of percentage of various years’ cost.

1.Absorption of factory overhead:

The factory overhead may be absorbed as a percentage on direct materials, direct wages and
chargeable expenses.

% of factory overhead on direct wages =

2.Absorption of office and administrative overhead:

The office and administrative overhead is absorbed as the same percentage of office and
administrative overhead on factory cost

% of office and administrative overhead=

3.Absorption of selling and distribution overhead

% of selling and distribution overhead

Manufacturing account
Manufacturing account is the alternative method of determination of total cost and fixation of
selling price. The manufacturing needs to ascertain the cost of goods manufactured and
manufacturing profit or loss during the year. Therefore, an account is prepared for the purpose,
which is known as manufacturing account. Generally, it is prepared by such concerns which do
not have cost office and maintain any cost account.

Features of manufacturing account

The opening and closing stock of finished goods are not recorded because the purpose of
preparation of the account is, to determined cost of goods manufactured and manufacturing
profit during the specified period. This represent ledger account consisting of debit and credit
the difference between two sides will be cost of goods manufactured or manufacturing
profit/loss based on the type of manufacturing account.

Importance of manufacturing account

Cost of goods manufactured and manufacturing profit/loss can be determined.
it helps to fix the selling price .
It assists to reduce and control the cost on manufacturing process.
Performance of manufacturing department can be evaluated by comparing profit/loss of current

Preparation of manufacturing account

Preparation of manufacturing account would depend upon the purpose that is sought to be
obtained information therefrom. The purpose may be either to ascertain cost of manufactured or
manufacturing profit or loss. However it is prepared in two different formats:
For showing cost of production
For showing manufacturing profit of loss