PAPER 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT Section A : Cost Accounting QUESTIONS 1.

. (a) "Costs may be classified in a variety of ways according to their nature and the information needs of the management." Explain. (b) "Relevant cost analysis helps in drawing the attention of managers to those elements of cost which are relevant for the decision." Comment. 2. The Stock Control Policy of a company is that, each stock is ordered twice a year. The quantum of each order being one-half of the year's forecast demand The materials manager, however, wishes to introduce a policy in which for each item of stock, reorder levels and EOQ is calculated For one of the items X; the following information is available: Forecast annual demand Cost / unit Cost of placing an order Stock holding cost Lead time 3,600 units Rs. 100 Rs.40 20% of average stock value 1 month

It is estimated by the materials manager that for item X, a buffer stock of additional 100 Units should be provided to cover fluctuations in demand. If the new policy is adopted, calculate for stock item X: (i) the reorder level that should be set by the material manager; (ii) the anticipated reduction in the value of the average stock investment; (iii) the anticipated reduction in total inventory costs in the first and subsequent years. 3. (a) What is activity based costing? (b) Explain the concept of cost drivers Indicate what you will consider as cost drivers for the following business functions: (i) 4. Research and development; (ii) Customer service. You are required to calculate a suggested fare per passenger/km from the following information for a Mini Bus: (i) Length of route: 30 km. (ii) Purchase price: Rs. 4,00,000 (iii) Part of above cost met by loan, annual interest of which is Rs. 10,000/ p.a. (iv) Other annual charges: Insurance Rs. 15,000, Garage rent Rs. 9,000, Road tax Rs. 3,000, Repairs & maintenance Rs. 15,000, Administrative charges Rs. 5,000. (v) Running Expenses: Driver & Conductor Rs. 5,000/p.m., Repairs/ Replacement of tyre tube Rs. 3,600 p.a., Diesel and oil cost per km. Rs. 5.(vi) Effective life of vehicle is estimated at 5 years at the end of which it will have a scrap value of Rs. 10,000. (vii) Mini bus has 20 seats and is planned to make Six no. two-way trips for 25 days/p.m. (viii) Provide profit @ 20% of total revenue.

5.

(i)

What is normal and abnormal wastage? How are they dealt in cost accounts?

(ii) Jupiter Manufacturing uses a weighted-average process costing system at its satellite plant. Goods pass from the Major Assembly Department to the Finishing Department to finished goods inventory. The goods are inspected twice in the Finishing Department. The first inspection occurs when the goods are 30% complete, and second inspection occurs at the end of production. The following data pertain to the Finishing Department for the month of July. Units Good units started and completed during July Normal spoilage first inspection Abnormal spoilage second inspection Ending work-in-process inventory, 60% complete 65,000 2,000 150 15,000

There was no beginning work-in-progress inventory in July. Juniper recognizes spoiled units to make the cost of all spoilage visible in their management reporting. What would be the Equivalent units for assigning costs for July ? 6. The profits of cost accounts may be different from those projected by financial accounts and in such cases a memorandum reconciliation statement is needed In the context of this statement, discuss the possible reasons of differences between the two sets of accounts and the need of reconciliation. ABC Ltd operates a historical job costing system, which is not integrated with financial accounts. The company manufactures engines, the technology of which is frequently bought from inventors to whom royalty is needed to be paid. The following are details of the opening balances in the Cost Ledger for the month of May 2004 , Rs Stores ledger control account Work in progress control account Finished goods control account Cost ledger control account The following transactions took place during the month: Rs Material: Purchases Issues to production Issues to general maintenance Issues to construction of manufacturing equipment Factory wages Total gross wages paid 1,24,000 Rs 75,750 of the above wages are direct wages while Rs 12,500 has been expended on the construction of manufacturing equipment; the balance being the amount paid as indirect wages. The actual amount of production overhead incurred excluding the items shown above amounted to Rs 1,52,350 out of which Rs 30,000 was absorbed by the manufacturing equipment under construction and Rs 7,550 was under absorbed. As per the policy of ABC Ltd, the under absorbed overhead needed to be written off at the month end. The company shall also pay Rs 2,150 as royalty for the relevant months production to an inventor from whom technology had been bought. 42,700 63,400 1,450 7,650 85,400 1,67,350 49,250 3,02,000

7.

Selling overheads : Sales :

Rs. 22,000 Rs. 4,10,000

The companys gross profit margin is 25% on factory cost. At the end of the month stocks of work in progress had increased by Rs 12,000. The manufacturing equipment under construction was completed within the month , and transferred out of the cost ledger at the end of the month. You are required to prepare the relevant control accounts, costing profit and loss account and any other accounts you consider necessary to record the above transactions in the cost ledger for the concerned month. 8. A company has three production departments and two service departments. Following details relating to overheads analysed to production and service departments is made available to you. Rs Production department X Y Z Service department 1 2 The expenses of service department are apportioned as follows: Production departments X Service department 1 Service department 2 20% 40% Y 40% 20% Z 30% 20% 20% Service departments 1 2 10% 48,000 42,000 30,000 14,040 18,000

You are required to allocate the service department costs over the production departments using the simultaneous equation method. 9. A factory with two production processes. Normal loss in each process is 10% and scrapped units sell for Rs. 0.50 each from process 1 and Rs. 3 each from process 2. Relevant information for costing purposes relating to period 5 is as follows. Direct materials added: Units Cost Direct labour Production overhead Process 1 2,000 Rs. 8,100 Rs. 4,000 150% of direct labour cost Process 2 1,250 Rs. 1,900 Rs. 10,000 120% of direct labour cost 2,800 units Rs. 17,800

Output to process 2/finished 1,750 units goods Actual production overhead Required

Prepare the accounts for process 1, process 2, scrap, abnormal loss or gain and production overhead.

10. Your company uses an integrated accounting system and applies overheads on the basis of predetermined rates. The following are the figures from the Trial Balance as at 31-3-2005: Rs. Manufacturing overheads Manufacturing overheads applied Work-in-progress Finished goods stock Cost of goods sold (i) Write off to profit and loss account. 4,26,544 Dr. 3,65,904 Cr. 1,41,480 Dr. 2,30,732 Dr. 8,40,588 Dr.

You are required to show the profit implications under the following two methods, (ii) Adjustment to cost of sales and inventories of WIP and finished goods. 11. (a) Pane Company uses a job costing system and applies overhead to products on the basis of direct labour cost. Job No. 75, the only job in process on January 1, had the following costs assigned as of that date: direct materials, Rs. 40,000; direct labor, Rs. 80,000; and factory overhead, Rs. 120,000. The following selected costs were incurred during the year. Traceable to jobs: Direct materials Direct labor Not traceable to jobs: Factory materials and supplies Indirect labor Plant maintenance Depreciation on factory equipment Other factory costs 46,000 2,35,000 73,000 29,000 76,000 4,59,000 Rs. 1,78,000 3,45,000 Rs. 523,000

Panes profit plan for the year included budgeted direct labor of Rs. 3,20,000 and factory overhead of Rs. 4,48,000. There was no work-in-process on December 31. What were Panes overhead for the year? (b) Define the following terms: (i) Cost Driver (ii) Activity Cost Pool. 12. A transport service company is running five buses between two towns which are 50 kms apart. Seating capacity of each bus is 50 passengers. The following particulars were obtained from their books for April 2005: Rs. Wages of drivers, conductors and cleaners Salaries of office staff Diesel oil and other oil Repairs & maintenance Taxation, insurance etc. Depreciation Interest and other expenses 24,000 10,000 35,000 8,000 16,000 26,000 20,000 1,39,000

Actually passengers carried were 75% of seating capacity. All buses ran all 30 days of the month. Each bus made one round trip per day. Find out the cost per passenger kilometer. 13. ABC Ltd has received a request for a price quotation from one of its regular customers for an order of 500 units with the following characteristics, Direct labour per unit produced Direct material per unit produced Machine hours per unit produced Number of component and material purchases Number of production runs for the component prior to the assembly Average set up time per production run Number of deliveries Number of customer visits Engineering design and support Customer support Details of the activities required for the order are as follows: Direct labour processing and assembly activities Machine processing Purchasing and receiving materials and components Scheduling production Setting up machines Packaging and delivering orders to customers Invoicing and account administration Marketing and order negotiation Customer support activities including after sales service Engineering design and support Rs 10 per labour hour Rs 30 per machine hour Rs 100 per purchase order Rs 250 per production run Rs 120 per set up hour Rs 400 per delivery Rs 120 per customer order Rs 300 per customer visit Rs 50 per customer service hour Rs 80 per engineering hour 2 hours Rs 22 1 hour 6 4 3 hours 1 2 50 hours 50 hours

You are required to estimate the full cost of the order under an activity based setup classifying expenses as Unit level expenses Batch level expenses Product sustaining expenses Customer sustaining expenses 14. The following particulars extracted from the books of Mr. Colin. Calculate cost per unit under (i) Traditional volume based costing and (ii) Activity based costing Machine Direct labour hrs. per hour per unit unit Product A Product B 2 2 4 4 Annual output (units) 1,000 10,000 Total machine hours 2,000 20,000 22,000 Total direct labour 4,000 40,000 44,000 No. of purchase order 80 160 240 No. of set ups 40 60 100

The cost of activities is as follows: Rs Volume related Purchasing related Set-up related 1,10,000 1,20,000 2,10,000 4,40,000 15. ABC Ltd is a construction company, which has undertaken three contracts. Information for the previous year along with other details is provided to you below; Contract A (Rs.000). Contract price Balances brought forward at the beginning of the year: Material on site Written down value of plant and machinery Wages accrued Transactions during previous year: Profit previously transferred to profit and loss a/c Cost of work certified (cost of sales) Transactions during current year: Material delivered to site Wages paid Salaries and other cost Written down value of plant issued to site Head office expenses apportioned during the year Balances c/fwd at the end of the year: Material on site Written down value of plant and machinery Wages accrued Value of work certified at the end of the year 20 150 5 200 20 10 860 230 15 2100 88 45 15 190 10 220 100 40 35 20 50 396 220 50 418 35 814 20 77 5 30 374 10 1,760 Contract B (Rs.000). 1,485 Contract C (Rs.000) 2,420

Cost of work not certified at the end of the year 55 The agreed retention rate is 10% of the value of work certified by the contractees architect. Contract C is scheduled to be handed over to the contractee in the near future. It is estimated that Rs 3,05,000 shall be needed to be spent in addition to what has been tabulated above to complete this particular contract. This amount includes an allowance for plant depreciation, construction services and for contingencies. You are required to prepare contract accounts for each of the three contracts and recommend how much profit or loss should be taken up for the year. 16. (a) Discuss briefly the Step method and Reciprocal Service method of secondary distribution of overheads. (b) Differentiate between Job costing and Batch costing. 17. (a) What is the purpose of Cost Audit?. Discuss (b) What is Cost reduction. Explain its Advantages. .

18. (a) Discuss briefly the treatment of overtime in cost accounting. (b) Discuss briefly the Gantt Task and Bonus system 19. (a) Briefly explain the concept of 'Opportunity Cost'. (b) Distinguish between 'Cost control' and 'Cost reduction '. 20. (a) What is 'Defective Work'? How it is accounted for in cost accounts? (b) Distinguish between 'Committed Fixed Costs' and 'Discretionary Fixed Costs'. (c) How will you treat the research and development costs in connection with (i) job undertaken on behalf of a customer; and (ii) improvement in existing products ? SUGGESTED ANSWERS/HINTS 1. (a) Cost classification is the process of grouping costs according to their characteristics. Costs are classified or grouped according to their common characteristics. Costs may be classified according to elements, according to functions or operations, according to their behaviour, according to controllability or according to normality. The break up of the aggregate costs into relevant types, is an essential pre-requisite of decision making as well as of controlling costs. Classification of costs on different bases is thus necessary for various purposes. For the purpose of decision-making and control, costs are distinguished on the basis of their relevance to different type of decisions and control functions. The importance of distinguishing costs as direct or indirect lies in the fact that direct costs of a product or an activity can be accurately allocated while indirect costs have to be apportioned on the basis of certain assumptions. This is so because direct costs are controllable at the operational level whereas indirect costs are not amenable to such control. (b) Relevant costs are pertinent or valid costs for a decision. These bear upon or influence decision' and are directly related to the decisions to be made. These are critical to the decision, and have significance for it. These are the costs which generally respond to managerial decision making, and have significance in arriving at correct conclusions. These costs are capable of making a difference in user-decisions and enter into a choice between alternative courses of action. In specific terms, relevant costs for decisions are defined as "expected future costs that will differ under alternatives". Relevant costs are futuristic in nature. These are the costs that are expected to occur during the time period covered by the decision. These costs are different between alternatives being considered. Only costs that differ among decision alternatives are relevant to a decision. 2. (i) Reorder level (to be set by the material manager) = Safety stock + lead time consumption = 100 units + 3,600 units /12 = 400 units EOQ =
2 x 3,600 units x Rs.40 = 120 units 0.2 x Rs.100

(ii) Anticipated reduction in the value of average stock investment

The average of total stock held under new system: = Safety stock + EOQ/2= 100 units + 60 units = 160 units The average stock investment under new system = 160 units x Rs.I00 = Rs. 16,000 The average of total stock held under old system Previously, 1,800 units were ordered at a time and so the average stock held was 900 units.

The average stock investment under old system Rs. 90,000 (900 units x Rs.100). Therefore, anticipated reduction in the value of the average stock investment = Rs. (90,000 - 16,000) =Rs. 74,000

(iii) Anticipated reduction in total inventory costs (in the first and subsequent years)
Under new system: Annual ordering cost (3, 600 units x Rs.40 / 120units) Stock holding cost (0.20 x Rs.16,000) Total inventory cost Under old system: Annual ordering cost (2 orders x Rs. 40) Stock holding cost (0.20 x Rs. 90, 000) Total inventory cost 80 18,000 18,080

Rs.
1,200 3,200 4,400

Thus, anticipated reduction in total inventory costs is Rs. 13,680 (Rs.18,080 - Rs.4,400) However, in the first year, the safety stock of 100 units is to be purchased at a cost of Rs. 10,000 (100 units x Rs.100). Therefore, while the saving would be of Rs. 13,680, the cost reduction in the system would be only Rs.3,680. In subsequent years, however, the cost reduction will be of Rs. 13,680.

3.

(a) It focuses on activities as the fundamental cost objects and uses the costs of these activities as building blocks for compiling the costs of other objects.
Activity Based Costing can be defined as "Cost attribution to cost units on the basis of benefits received from indirect activities i.e. ordering, setting-up, assuring quality etc." Under activity based costing costs are accumulated for each activity as a separate cost object. The collected costs are applied to products based on the benefits received from various activities. The final product cost are built up from the costs of the specific activities undergone. In the first stage the activity driven overhead cost is charged to activity based cost pools and in the second stage cost driver based rates are derived to charge cost to product lines. The cost driver based rates are based on activities. Activity based costing can be used for; (a) Pricing of products; (b) Design and development of new products

(b) A cost driver is any factor whose change causes a change in the total cost of a related cost object. In other words, a change in the level of cost driver will cause a change in the level of the total cost of a related cost object.
The cost drivers for business functions viz. Research & Development and Customer Service are as below: Business functions:

Cost drivers
Research & Development Customer Service Number of research projects Personnel hours on a project Technical complexities of projects Number of service calls Number of products serviced Hours spent on servicing products

4.

Working notes:
1. Depreciation per annum: = = 2.
Purchase price Scrap value Estimated life (Rs.4,00,000 Rs.10,000) = Rs.78,000 5 years

Total distance travelled by mini-bus in 25 days: = = = Length of the route (two-sides) x No. of trips per day x No. of days 60 km x 6 trips x 25 days 9,000 km Total distance travelled by mini-bus in 25 days x No. of seats 9,000 km 20 seats = 1,80,000 passenger - km

3.

Total passenger km = =

Statement suggesting fare per passenger km Cost per annum Rs.

Fixed expenses Insurance Garage rent Road tax Administrative charges Depreciation (Refer to working note 1) Interest on loan Running expenses: Repair and maintenance Replacement of tyre-tube Diesel and oil cost 9,000 km x Rs. 5 Driver and conductors salary Total cost (per month) Add: Profit 20% of total revenue or 25% of total cost Total revenue Rate per passenger-km (Rs. 76,937.50/1,80,000 passenger km (Refer to working note 3) = 0.4274305 or 0.43 paise) -5,000 61,550 15,387.50 76,937.50 15,000 3,600 -1,250 300 45,000 10,000 1,20,000 10,000 15,000 9,000 3,000 5,000 78,000

Cost per month Rs.

5.

(i)

Normal wastage: It is defined as the loss of material which is inherent in the nature of work. Such wastage can be estimated in advance on the basis of past experience or technical specifications. If the wastage is within the specified limit, it is considered as normal. Suppose a company states that the normal wastage in Process A will be 5% of input. In such

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a case wastage upto 5% of input will be considered as normal wastage of the process. When the wastage fetches no value, the cost of normal wastage is absorbed by good production units of the process and the cost per unit of good production is increased accordingly. If the normal wastage realises some value, the value is credited to the process account to arrive at normal cost of normal output.

Abnormal wastage: It is defined as the wastage which is not inherent to manufacturing operations. This type of wastage may occur due to the carelessness of workers, a bad plant, design etc. Such a wastage cannot be estimated in advance. In other words any wastage excess of normal wastage is abnormal wastage.
The units representing abnormal wastage are valued like good units produced and debited to the separate account which is known as abnormal wastage account. If the abnormal wastage fetches some value, the same is credited to abnormal wastage account. The balance of abnormal wastage account i.e. difference between value of units representing abnormal wastage minus realisation value is transferred to Costing Profit and Loss account for the year. (ii) Started and completed during month(100%) Normal spoilage (30%) Abnormal spoilage(100%) Ending work in process inventory (60%)

Physical units
65,000 2,000 150 15,000 82,150

Equivalent units
65,000 600 150 9,000 74,750

6.

Differences between the two sets of accounts arises when separate books are maintained for both cost accounts and financial accounts. The various reasons for disagreement of profits may be listed as below: 1. Items appearing only in financial accounts The following items of income and expenditure are normally included in financial accounts and not in cost accounts. Their inclusion in cost accounts might lead to unwise managerial decisions. These items are: (i) Income: (a) Profit on sale of assets (b) Interest received (c) Dividend received (d) Rent receivable (e) Share transfer fees (ii) Expenditure: (a) Loss on sale of assets (b) Uninsured destruction of assets (c) Loss due to scrapping of plant and machinery (d) Preliminary expenses written off (e) Goodwill written off (f) Underwriting commission and debenture discount written off (g) Interest on mortgage and loans (h) Fines and penalties

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2.

Items appearing only in cost accounts There are some items which are included in cost accounts but not in financial accounts. These are: (a) Notional interest on capital; (b) Notional rent on premises owned

3.

Under or over-absorption of overhead In cost accounts overheads are charged to production at pre-determined rates whereas in financial accounts actual amount of overhead is charged, the difference gives rise to underor over-absorption; causing a difference in profits. When such under absorption or over absorption is charged or credited respectively to the Costing Profit and Loss Account, there shall be no need of reconciliation.

4.

Different bases of stock valuation In financial books, stocks are valued at cost or market price, whichever is lower. In cost books, however, stock of materials may be valued on FIFO or LIFO basis and work-inprogress may be valued at prime cost or works cost. Differences in stock valuation may thus cause a difference between the two profits.

5.

Depreciation The amount of depreciation charged may be different in the two sets of books either because of the different methods of calculating depreciation or the rates adopted. In cost accounts, for instance, the straight line method may be adopted whereas in financial accounts it may be the diminishing balance method.

7.
Sales a/c Capital under construction a/c Balance c/f

Cost ledger control account Rs

4,10,000 50,150 2,37,500 1.5.04 Balance b/f Stores ledger a/c Purchases Wages control a/c Production a/c overhead

Rs
3,02,000 42,700 1,24,000 1,52,350 2,150 22,000 52,450 6,97,650

WIP a/c - Royalty Selling overhead a/c Profit 6,97,650

Stores ledger control account Rs

1,5,04 Balance b/f Cost ledger control a/cPurchases 85,400 WIP A/C 42,700 Production overhead control a/c Capital a/c 31.5.04 Balance 1,28,100

Rs
63,400 1,450 7,650 55,600 1,28,100

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Wages control a/c Rs

Cost ledger control a/c 1,24,000 Capital a/c Production WIP a/c 1,24,000

Rs
12,500 35,750 7,550 1,24,000

Production overhead control account Rs

Stores ledger a/c Wages control a/c Cost ledger control a/c 1,450 35,750 1,52,350 1,89,550 Capital a/c WIP a/c Absorption(balancing figure) Costing P/L a/c (under absorption)

Rs
30,000 1,52,000 7,550 1,89,550

Work in progress control account

1.5.04 Balance b/f Stores ledger a/c issues Wages control a/c Production overhead absorbed Cost ledger control a/c-Royalty

Rs 1,67,350
63,400 75,750 1,52,000 2,150 4,60,650

Finished goods a/c(balancing figure) 31.5.04 Balance c/f

control

Rs 2,81,300
1,79,350

4,60,650

Finished goods control account Rs

1.5.04 Balance b/f WIP a/c 49,250 2,81,300 Cost sales a/c 31.5.04 Balance c/f

Rs
3,28,000 2,550 3,30,550

3,30,550 Capital under construction account

Rs
Stores ledger a/c Wages control a/c Production overhead absorbed 7,650 12,500 30,000 50,150 Cost ledger control a/c

Rs
50,150

50,150

Sales account Rs
Costing P/L a/c 4,10,000 Cost ledger control a/c

Rs
4,10,000

Cost of sales a/c Rs

Finished goods a/c 3,28,000 Costing P/L a/c

Rs
3,28,000

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Selling overhead account Rs

Cost ledger control a/c 22,000 Costing P/L a/c

Rs
22,000

Costing profit and loss account Rs Selling overhead a/c 22,000 Production overhead (under absorbed) 7,550 Cost of sales a/c 3,28,000 Profit Cost ledger control a/c 52,450 4,10,000 Notes :
1. Closing balance of work in progress

Sales a/c

Rs 4,10,000

4,10,000

Rs 1,67,350(opening balance) Rs 12,000 (increase as per question) Rs 1,79,350

2.

Transfer from finished goods stock to cost of sales account : Rs 4,10,000 sales multiplied by 100/125 = Rs. 3,28,000 = total overhead of service department 1 = total overhead of service department 2 = 14,040 +0.2 Y = 18,000 + 0.1 X ..(1) ..(2)

8.

Let X Y X Y

The total overhead transferred into service departments 1 and 2 can be expressed as

Rearranging the above equations: X 0.2 Y =14,040 - 0.1X + Y=18,000 5X Y =70,200

Multiplying equation (1) by 5 and equation (2) by 1, we get -0.1X + Y =18,000 Adding the above equations together we have 4.9X =88,200 or X =18,000 and hence Y =19,800 Apportioning the values of X and Y to the production departments in the agreed percentages, we have

X
Allocation analysis as per overhead 48,000 3,600(20%) 7,920(40%) 59,520

Y
42,000 7,200(40%) 3,960(20%) 53,160

Z
30,000 5,400(30%) 3,960(20%) 39,360

Total
1,20,000 16,200 15,840 1,52,040

Allocation of service department 1 Allocation of service department 2

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9.

Output and losses Process 1 Units 1,750 200 50 2,000 Process 2 Units 2,800 300 (100) 3,000*

Output Normal loss (10% of input) Abnormal loss Abnormal gain * 1,750 units from Process 1 + 1,250 units input to process. Cost per unit of output and losses

Process 1 Rs.
Cost of input - material - from process 1 -labour -overhead 8,100 4,000 6,000 18,100 (100) 18,000 Expected output 90% of 2,000 90% of 3,000 Cost per unit Rs. 18,000 1,800 Rs. 40,500 2,700 Total cost of output and losses 1,800

Process 2 Rs.
1,900 17,500 10,000 12,000 41,400 (900) 40,500

(1,750 Rs. 10) (120% Rs. 10,000) (300 Rs 3)

(150% Rs. 4,000)

Less scrap value of (200 Rs 0.50) normal loss

2,700 Rs. 10 Rs. 15

Output (1,750 Rs. 10) Normal loss (200 Rs. 0.50)* Abnormal loss (50 Rs. 10) Abnormal gain

Process 1 Rs. 17,500 (2,800 Rs. 15) 100 (300 Rs. 3)* 500 18,100 - (100 Rs. 15) 18,100

Process 2 Rs. 42,000 900 42,900 (1,500) 41,400

* Normal loss is valued at scrap value only. Complete accounts

Direct material Direct labour Production overhead a/c

Units 2,000

PROCESS 1 ACCOUNT Rs. 8,100 Scrap a/c (normal loss) 4,000 Process 2 a/c 6,000 Abnormal loss a/c
18,100

Units 200 1,750 50

2,000

Rs. 100 17,500 500

18,100

2,000

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PROCESS 2 ACCOUNT Units Rs.

Direct materials From process 1 Added materials Direct labour Production overhead Abnormal gain 1,750 1,250 17,500 1,900 10,000 12,000 41,400 1,500 42,900 Scrap a/c (normal loss) Finished goods a/c

Units
300 2,800

Rs.
900 42,000

3,000 100 3,100

3,100

42,900

ABNORMAL LOSS ACCOUNT Rs.

Process 1 (50 units) 500 500 Scrap a/c: sale of scrap of extra loss (50 units) Profit and loss a/c

Rs.
25 475 500

ABNORMAL GAIN ACCOUNT Rs. Scrap a/c (loss of scrap revenue due 300 Process 2 abnormal gain (100 units) to abnormal gain, 100 units Rs. 3) Profit and loss a/c 1,200 1,500 SCRAP ACCOUNT Rs. Cash a/c cash received 100 Loss in process 1(250 units) 900 Loss in process 2 (200 units) 25 Abnormal gain a/c (process 2) 1,025 Rs.
Overhead incurred Over-absorbed overhead a/c (or P & L a/c) 200 18,000 17,800 Process 1 a/c Process 2 a/c

Rs. 1,500

1,500

Rs.
125 600 300 1,025

Scrap value of normal loss Process 1 (200 units) Process 2 (300 units) Abnormal loss a/c (process 1)

PRODUCTION OVERHEAD ACCOUNT Rs.

6,000 12,000 18,000

10.
Actual overheads

Rs. Less: Overhead recovered

Overhead under-absorbed (i) Write off to profit and loss account. Under the Write off to profit and loss account. Rs.60,640 will be debited to Costing Profit and Loss Account resulting in the reduction of figure of profit for the year by Rs.60,640. 4,26,544 3,65,904 60,604 (ii) Adjustment to cost of sales and inventories of WIP and finished goods.

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Under the Adjustment to cost of sales and inventories of WIP and finished goods method under-absorbed overhead should be distributed to three Control Accounts i.e. Work-inProgress, Finished Goods Stock Account, and Cost of Goods Sold Account. This distribution can be attempted as follows:

Balances
Rs. 1,41,480 2,30,732 8,40,588 12,12,800

Work-in-Progress Finished Goods A/c Cost of Sales A/c Working Notes

Additional Overhead (under-absorbed) Rs. 7,074* 11,537** 42,029*** 60,640

Total
Rs. 1,48,554 2,42,269 8,82,617 12,73,440 Rs. 7,074 11,537 42,029

*(1,41,480 12,12,800) 60,640 **(2,30,732 12,12,800) 60,640 ***(8,40588+12,12,800) 60,640

By using this method, profit for the year will be reduced by Rs. 23,418 i.e. Rs. 42,029(7,074+11,537). Amount of Rs. 42,029 will be debited to Profit and Loss Account with cost of sales. Amount of Rs. 18,611 i.e. Rs. 7,074 + Rs. 11,537 will get credited to Profit and Loss Account as value of closing stock. The amount of Rs. 18,611 will again get debited to Profit and Loss Account next year as value of opening stock.

11. (a) Applied overhead actual = amount over/under applied

Rs. 4,48,000/Rs 3,20,000 = budgeted application rate of 1.4 Rs. 3,45,000 direct labour actual 1.4 = Rs 4,83,000 applied Rs. 4,83,000 applied Rs 4,59,000 total not traceable = Rs 24,000 over applied.

(b) (i)

Cost Driver: A cost driver is a characteristic of an event or activity that results in the increase of costs. In activity based costing the most significant cost drivers are identified.

(ii) Activity cost pool: It is a measure of the frequency and intensity of demand placed on activities by cost objects. It is used to assign activity cost to cost objects. 12. Calculation of passenger kilometer
No. of Buses Distance To and Fro Seating capacity Percentage of seating capacity No. of days in a month = 5 50 2 50

75 30 = 5,62,500 kms 100

Operating cost sheet Rs 24,000 10,000 16,000 20,000 70,000 Rs

Standing charges:Wages of drives, conductors and cleaners Salaries of office staff Taxation, Insurance Interest & other expenses

Running & Maintenance cost:Repairs and maintenance

8,000

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Diesel and other oil Depreciation

35,000 26,000 69,000 1,39,000

Cost per passenger km =

1,39,000 = 0.2471 . 5,62,500

Estimate of cost Rs Rs

13. Unit level expenses

Direct materials (500 Rs 22)

11,000 10,000 15,000 600 1,000 1,440 400 3,440 4,000 600 2,500 3,100 46,540 36,000

Direct labour (500 2 hours Rs 10) Machining (500 1 hour Rs 30)

Batch level expenses

Purchasing and receiving materials and components( 6 Rs 100) Scheduling production (4 production runs Rs 250) Setting up machines (4 production runs 3 hours Rs 120) Packaging and delivering( 1 delivery at Rs 400)

Product sustaining expenses

Engineering design and support( 50 hours Rs 80)

Customer sustaining expenses

Marketing and order negotiating ( 2 visits Rs 300 per visit) Customer support ( 50 support hours Rs 50) Estimated Cost

14. Traditional volume based costing system Rs.

Total cost allocated to cost centre Machine Hour Rate = = Labour Hour Rate = = Cost per unit 4,40,000

Total overheads Total Machine hours

4,40,000 = Rs. 20 22,000

Total overheads Total labour hours

4,40,000 = Rs. 10 44,000

= Machine hour rate machine hours per unit 20 2 = 40 = Labour hour rate Labour hours per unit = 10 4 = 40

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Total cost changed to product = Annual output Cost per unit A B ABC System Volume related cost Purchase related cost Set-up related cost Cost charged to products:Product X Volume related cost Purchase related cost Set up related cost Product Y:Volume related cost Purchase related cost Set up related cost = = = 20,000 5 160 500 60 2,100 = 1,00,000 80,000 1,26,000 3,06,000 = = = 2,000 5 80 500 40 2100 = = = 10,000 40,000 84,000 1,34,000 = = = = 1, 000 40 = = 10,000 40 = 40,000 4,00,000

1,10,000 22,000
1,20,000 240 2,20,000 100

= = =

Rs, 5 per Machine Hour Rs. 500 per order Rs. 2,100 per set up

15.
A Material on site b/fwd Plant on site b/fwd Material control a/c Wages control a/c Salaries Plant control a/c Apportionment expenses of HO 88 45 15 190 10 5 353 Cost of sales b/fwd Profit taken this period 183 Cost of work not certified b/fwd Material on site b/fwd Plant on site b/fwd 20 150 20 230 497 183 B 20 77 220 100 40 35 20 10 522 497 50 15 1,135 840 282 1,122 55 C 30 374 396 220 50

Contract Accounts
(in Rs 000) A Wages accrued b/fwd Material on site c/fwd Plant on site c/fwd Cost of work not certified c/fwd Cost of sales current period (balance) c/fwd 183 497 20 150 20 230 55 840 B 5 C 10

Wages accrued c/fwd

353 Attributable sales revenue (current period)* Loss taken 183 Wages accrued b/fwd 5 183

522 442 55 497 10

1,135 1,122

1,122 15

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* Profit taken plus cost of sales for the current period or cost of sales less loss to date

Note
Profit/loss on the three contracts are calculated by deducting the cost of sales (both previous years and current year) from the value of work certified Contract A Contract B Contract C Recommendation Computation of profit taken for Contract C is as follows 17 (55) 446

(Rs 000) (Rs 200 Rs 183)

(Rs 860 Rs 915) (Rs 2,100 Rs 1,654)

(Rs000)
Cost of work certified(cost of sales to date = 814 + 840) Cost of work not certified Estimated costs to complete Estimated cost of contract Contract price Anticipated profit Profit taken = 1,654 55 305 2,014 2,420 406

(0.90 Rs2,100) Rs406 less profit previously transferred Rs2,420

= Rs 3,17,000 Rs 35,000 = Rs 2,82,000 No profit has been taken for Contract A as it is in very early stages of completion Prudence concept has been utilized for Contract B. All loss has been taken.

16. (a) Step method: This method gives cognizance to the service rendered by service department to another service deptt, thus sequence of apportionments has to be selected. The sequence here begins with the deptt that renders service to the max number of other service deptt. After this, the cost of service deptt serving the next largest number of deptt is apportioned. Reciprocal service method: This method recognizes the fact that where there are two or more service deptt they may render service to each other and, therefore, these inter deptt services are to be given due weight while re-distributing the expense of service deptt. The methods available for dealing with reciprocal equation method are:
Simultaneous equation method Repeated distribution method Trial and error method

(b) Job Costing and batch costing

According to job costing, costs are collected and accumulated according to jobs. Each job or unit of production is treated as a separate entity for the purpose of costing. Job costing may be employed when jobs are executed for different customers according to their specifications. Batch costing is a form of job costing , a lot of similar units which comprises the batch may be used as a cost unit for ascertaining job. Such a method of costing is used in case of

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pharmaceutical industry readymade garment s, industries manufacturing parts of TV, radio sets etc.

17. (a) Purpose of Cost Audit: The purpose of cost audit is to examine whether the methods laid down for ascertaining cost and the decisions are being properly implemented and whether the Cost Accounting plan has been adhered to or not.
Broadly, the purposes of cost audit can be classified as : (i) protective, and (ii) constructive.

Protective purpose of Cost Audit: Under this, cost audit aims at examining that there is no undue wastage or losses and the costing system brings out the correct and realistic cost of production or processing. The benefit of this protective function is derived by the organisation, its owners and consumers. Constructive purpose of Cost Audit: Cost audit has a constructive purpose as well. Cost auditor plays a constructive role by providing management of the company with information useful in regulating production; choosing economical methods of operation, reducing operations cost and re-formulating plans etc., on the basis of his findings during the course of cost audit. (b) Cost reduction may be defined as the achievement of real and permanent reduction in the unit cost of goods manufactured or services rendered without impairing their suitability for the use intended or diminution in the quality of the product. Advantages of Cost reduction
The advantages accruing from cost reduction programme can be discussed under following three heads: (i) In so far as an individual company is concerned, cost reduction results in profit improvement. The more the profits, the more stable the company becomes. It enhances the share value, improves investment opportunities and facilitates collection of capital.

(ii) Society will be benefitted by reduced prices which may be possible by savings from cost reduction programmes. Competitive position will improve and the industry as a whole will strive to improve productivity and pass on the advantage of such programmes to the society. Workers and staff of the industry may also be benefitted throughout increased wages and improved welfare amenities. (iii) The country also stands to gain immensely by cost reduction programme. Industry will be able to maintain the international parity in prices of exportable commodities and consequential increase in export will result in increased foreign exchange savings. Also internal revenue will increase through more tax revenues.

18. (a) Treatment of Overtime Premium in Cost Accounting

If overtime is restored to at the desire of the customer, then overtime premium may be charged to the job directly. If overtime is required to cope with general production programme or for meeting urgent orders, the overtime premium should be treated as overhead cost of the particular department or cost center, which works overtime. If overtime is worked in a dept. Due to the fault of another dept, the overtime premium should be charged to the latter dept. Overtime worked on account of abnormal conditions such as flood, earthquake etc should not be charged to cost but to costing P/L A/C.

(b) Gantt Task and Bonus System

This system is a combination of time and piecework system. According to this system a high standard or task is set and payment is made at time rate to a worker for production below

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the set standard. Wages payable to workers under the plan are calculated as under:

Output
(i) (ii) Output below standard Output at standard

Payment
Guaranteed time rate Time rate plus bonus of 20% (usually of time rate) High price rate on workers output. It is so fixed, so as to include a bonus of 20% of time rate.

(iii) Output over standard

19. (a) Opportunity cost is primarily an economic concept. In Economics, the opportunity cost of a designated alternative is the greatest 'net benefit lost by selecting an alternative. It is the benefit given by rejecting one alternative and, selecting another."
Accounting takes the same view and defines it as the benefits forgone by rejecting the second best alternative in favour of the best. Opportunity costs represent the measurable value of opportunity bypassed by rejecting an alternative use of resources. It is the value in its best alternative use - the profit that is lost by the diversion of an input factor from one use to another. It is defined as the maximum contribution that is forgone by using limited resources for a particular purpose. Opportunity cost concept is helpful to the management in making profitability calculations when one or more of the inputs required by one or more of the alternative courses of action is already available.

(b) The main points of distinction between "Cost control' and 'Cost reduction' are as follows: Cost Control
1. It aims at achieving the established cost standards

Cost Reduction
It aims at achieving a reduction in cost by using any suitable technique like value analysis engineering; work study; standardisation; simplification etc., It is a continuous process of critical. cost examination,' analysis and challenging of established standards. Each aspect of the business. viz., products, process, procedures, methods, organisation, personnel, etc.-, is critically. examined and reviewed, with a view to improving- the efficiency and effectiveness and reducing the costs. It assumes the existence of concealed potential savings in norms or standards. It is a corrective action.

2. It is 'operated through targets or established standards and comparing them with actual performance. Identifying deviations from standards and taking corrective actions. Thus it lacks dynamic approach.

3. It assumes existence of norms or standards which are not challenged. 4. It is a preventive function.

20. (a) 'Defective Work' is the work output which does not meet out the prescribed laid down standard specifications. Such a situation may arise due to various causes, such as use of sub-standard materials, bad workmanship, carelessness in planning, laxity in inspection, etc. Defectives can be reworked or reconditioned by the application of additional material, labour and/or processing and may be brought to the point of either standard work/products or sub-standard products. Reworked units of defectives may be sold through regular channels as first or seconds as the case may be.
Cost Accounting treatment: It intact is concerned with the accounting for costs of their rectification and their nature as - normal or abnormal. The possible ways of treatment are as below:

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1.

When defectives are normal and it is not beneficial to try to identify them job wise, the following methods are generally used: (a) Charged to good products: The cost of rectification of normal defectives is charged to good units. This method is used when defectives rectified are normal. (b) Charged to general overheads: Where the department responsible for defective cannot be correctly identified, because defectives caused in one department are reflected only on further processing, the rework costs are charged to general overheads. (c) Charged to departmental overheads: If the department responsible for defectives can be correctly identified, the rectification costs should be charged to that department.

2. 3.

Where normal defectives are easily identifiable with specific jobs, the rework costs are debited to the jobs. When defectives are abnormal and are due to causes within the control of the organisation, the rework cost should be charged to the costing profit and loss account.

(b) Committed fixed costs , are those fixed costs that arise from the possession of: (i) a plant, building and equipment (e.g. depreciation, rent, taxes, insurance premium etc.) or (ii) a functioning organisation (i.e. salaries of staff). These costs remain unaffected by any shortrun actions. These costs are affected primarily by long-run sales forecasts that, in turn indicates the long-run capacity targets. Hence careful long range planning, rather than dayto-day monitoring, is the key to managing committed costs.
Discretionary fixed costs, (sometimes called managed costs or programmed costs). These costs have two important features: (i) they arise from periodic (usually yearly) decisions regarding the maximum outlay to be incurred, and

(ii) they are not tied to a clear cause-and-effect relationship between inputs and outputs. Examples of discretionary fixed costs includes - advertising, public relations, executive training, teaching, research, health care etc. These costs are controllable.

(c) (i)

Cost of R & D project undertaken on behalf of a specific customer should not be treated as manufacturing overhead. It should be regarded as a separate profit centre. All expenses to meet such costs should be debited to "Outside R & D Project Account". Receipts against such requests are to be credited against this account.

(ii) Where research and development of products are undertaken on continuous basis the expenditure is treated as product costs. The cost of incomplete research project should be carried out continuously in order to retain company's place in the industry, the expenditure should be treated as general overhead. Some companies prefer to charge such costs of continuous research, to the Profit & Loss Account.