UNDER THE GUIDANCE OF PROF SRIRAM SANE

SUBMITTED BY NEERAJ PC JAIN (071154)

DEPARTMENT OF INDUSTRIAL ENGINEERING V IS H WA K A RMA INS T IT UT E OF T EC H NOLOG Y PUNE 411037 2011-12

In the modern business world, the nature and functioning of business organizations have become very complicated. They have to serve the needs of variety of parties who are interested in the functioning of the business. These parties constitute the owners, creditors, employees, government agencies, tax authorities, prospective investors, and management of the business. The business has to serve the needs of these different category of people by way of supplying various information from time to time.

The history of cost accounting can be traced back to the fourteenth century. In the course of its evolution it passed through following stages.
(1) In the first stage of its development, cost accounting was concerned only with the three prime cost elements, viz., direct material cost, direct labour cost and direct expenses. For recording the transactions relating to materials the important documents used were (a) stores ledger, (b) a material requisition note, and (c) materials received note. To account for labour cost, employee time card and labour cost card were devised by Mr. Metcalfe.

Later on a distinction between manufacturing and non-manufacturing cost was made by Mr. Norton. Thus material cost, labour cost and manufacturing cost constituted prime cost.

(2) Secondly, In 19th century , the importance of nonmanufacturing cost (overheads) was recognized as one of the distinct element of cost. The method of charging non-manufacturing cost to the production cost was devised under this stage. (3) Thirdly, the techniques of estimation and standards are devised. Instead of using actual cost, standard costs are used and by comparing with the actual cost the differences are noted, analysed and disposed off accordingly
(4) Fourthly, the costing principles and techniques were applied to all types of business undertakings. (5) In modern times the development of electronic data processing has occupied significant stage in the growth of cost accounting system.

The application of cost accounting methods in Indian industries was felt from the beginning of the 20th century. The following factors have accelerated the system of cost accounting in our country.
(a) Increased awareness of cost consciousness by Indian industrialists with a view to ascertain costs more accurately for each product or job. (b) Growing competition among manufacturers led to fixation of prices at a lower level so as to attract more customers. (c) Economic policy of government which laid emphasis on planned economy with a view to achieve the targets led to cost reduction programmes by Indian industrialists. (d) Increased government control over pricing led the Indian manufacturers to give utmost importance to the installation of cost accounts. (e) The establishment of National Productivity Council in 1958 and the Statutory

Awareness of cost accounting in manufacturing industry (i.e. water storage tanks). To develop standard costing for manufacturing industry (i.e. water storage tanks). Determining selling price, Controlling cost Providing information for decision-making Ascertaining Costing profit Facilitating preparation of financial and other statements.

Costing involves the classifying, recording and appropriate allocation of expenditure for the determination of costs of products or services; the relation of these costs to sales value; and the ascertainment of profitability.

Cost accounting is the process of determining and accumulating the cost of product or activity. It is a process of accounting for the incurrence and the control of cost. It also covers classification, analysis, and interpretation of cost. In other words, it is a system of accounting, which provides the information about the ascertainment, and control of costs of products, or services. It measures the operating efficiency of the enterprise.

Costing, Cost Accounting, Cost Control Techniques, Budgeting and Cost Audit.

These are predetermined costs. They are target costs that should be incurred under efficient operating conditionson a per unit basis Standard costing is most suited for organisations where the activities are common or repetitive. The examples we shall use will be for manufacturing organisations.

The term standard cost refers to the cost that management believes should be incurred to produce a good or service under anticipated conditions. The primary benefit of a standard cost system is that it allows for comparison of standard versus actual costs. Differences are referred to as standard cost variances and should be investigated if significant.

Basic cost standards Left unchanged over long periods of time. Helps to establish efficiency trends. Seldom used, as they do not represent current target costs, so not very useful for control.
Ideal standards Represent perfect performance. Minimum costs under the most efficient operating conditions. Can be demotivating and unlikely to be used in practice. Currently attainable standards Costs that should be incurred under efficient operating conditions. Difficult, but not impossible, to achieve. Can be set at various levels of difficulty.

At the outset, it is important to understand the subtle differences in definitions of standard cost and budgeted cost.
Standard cost:

the standard cost of a single unit.

Budgeted cost:

the cost, at standard, of the total number of budgeted units.

Standard costs are developed in a variety of ways they are: Specified by formulas or recipes. Developed from price lists provided by suppliers. Determined time and motion studies conducted by industrial engineers. Developed from analyses of past data.

In developing standard costs, there are two schools of thought Ideal standards: developed under the assumption that no obstacles to the production process will be encountered. They are sometimes referred to as perfection standards.
Attainable

Standards: developed under the assumption that there will be occasional problems in the production process such as equipment failure, labor turnover, and materials defects.

An analysis of the difference between a standard cost and and actual cost is called variance analysis. The process decomposes the difference in two components. For direct material: materials price and materials quantity variance. For direct labor: labor rate (price) and labor efficiency (quantity) variance. For overhead: overhead volume variance and controllable overhead variance.

The material price variance is expressed as (AP SP)AQp where: (AP) = actual price per unit of material. (SP) = standard price per unit of direct material. (AQp) = actual quantity of material purchased.
If actual price > standard price, then the variance is unfavorable. If actual price < standard price, then the variance is favorable.

The material quantity variance is expressed as (AQu SQ)SP where:

(AQ ) = actual quantity of material used. (SQ) = standard quantity of material allowed. (SP) = standard price of material.
u

If actual quantity > standard quantity, then the variance is unfavorable If actual quantity < standard quantity, then the variance is favorable.

The labor rate (price) variance is expressed as (AR SR)AH where:

(AR) = actual wage rate (price). (SR) = standard wage rate (price). (AH) = actual number(quantity) of

labor hours.

If actual rate > standard rate, then the variance is unfavorable. If actual rate < standard rate, then the variance is favorable.

The labor efficiency (quantity) variance is expressed as (AH SH)SR where:

(AH) = actual number of hours worked. (SH) = standard number of hours worked. (SR) = standard labor wage rate.

If actual hours > standard hours, then the variance is unfavorable. If actual hours < standard hours, then the variance is favorable.

The

controllable overhead variance is expressed as (actual overhead - flexible budget level of overhead) for actual level of production. It is referred to as controllable because managers are expected to control costs so they are not substantially different from budget.
If actual > budget, then the variance is unfavorable. If actual < budget, then the variance is favorable.

The

overhead volume variance is expressed as (flexible budget level of overhead for actual level of production - overhead applied to production using standard overhead rate). This variance is solely the product of more or less units being produced than planned in the static budget. Its usefulness is limited.

It is important to note that standard cost variances are not a definitive sign of good or bad performance. These variances are merely indicators of potential problems which must be investigated. And there are many plausible explanations for them.

In a standard costing system, the costs added to the Raw Materials Inventory, Work in Process Inventory, Finished Goods Inventory, and Cost of Goods Sold accounts are all recorded at standard rather than actual cost. Variances are also calculated and recorded for managements use in performance evaluation.

Purchase of raw materials inventory: Account dr. cr. Raw Material Inventory (std.) x Material Price Variance x Accounts Payable (actual) x (This is an unfavorable price variance) Usage of raw materials inventory: Account dr. cr. Work in Process Inventory x Material Quantity Variance x Raw Material Inventory x (This is an unfavorable quantity variance)

Account dr. cr. Work in Process Inventory (std.) x Labor Rate Variance x Labor Efficiency Variance x Salaries Payable (actual) x (Note: both the labor rate variance and efficiency variance are unfavorable)

Recording manufacturing overhead in a standard costing system is a three-step process:

1. 2. 3.

Actual overhead is recorded in the manufacturing overhead account. Overhead is applied to Work in Process Inventory at the standard cost. The difference between actual overhead and overhead applied at standard is closed and overhead variances are identified. More

To record actual overhead cost:

Account Manufacturing Overhead *Various Accounts dr. x cr. x

*Various accounts include indirect wages payable, utilities payable and accumulated depreciation.

To apply overhead cost to work in process inventory at cost:

Account dr. Work in Process Inventory x Manufacturing Overhead cr. x

To close out manufacturing overhead cost to work in process inventory at cost:

Account Manufacturing Overhead Overhead Volume Variance Controllable Overhead Variance dr. x cr.

x x

To record completed units sent to finished goods:

Account Finished Goods Inventory Work in Process Inventory dr. x cr.

To apply overhead cost to work in process inventory at cost:

Account Cost of Goods Sold Finished Goods Inventory dr. x cr.

At the end of the accounting period, the temporary variance accounts must be closed. As a practical matter this is usually accomplished by debiting or crediting the variances to cost of goods sold. Account dr. cr. Cost of Goods Sold x Overhead Volume Variance x Controllable Overhead Variance x Material Price Variance x Material Quantity Variance x Labor Rate Variance x Labor Efficiency Variance x

It has been incorporated in 1989 Small trading firm of various building material such as pvc pipes, cement, water storage tanks, fitting etc In 2011, started it new division UPKAR POLYMER manufacturing of water storage tank

The production basis for a typical tiny unit would be as under: Working hours/day : 12 (1 shift) Working days in a month : 30 Monthly Production capacity : 500 ltrs Tank : 1800 pcs.

Description

TC

TFC

TVC

FC PER UNIT

VC PER UNIT

TC PER UNIT

Material cost

2052000

2052000

1140

1140

Color granules

51750

51750

28.75

28.75

Fuel diesel

135450

135450

75.25

75.25

Direct labour

39600

39600

22

22

Screening& lids

97200

97200

54

54

Manufacturing overhead

214750

88550

126200

49.14

70.11

119.25

Administrative overhead

65000

30000

35000

16.67

19.44

36.11

TC per unit

65.81

1409.55

1475.36

+ Desired profit

15%

15%

Desired selling price / unit

1700

PARTICULARS 1.Direct material +Opening stock of raw material + Material purchased during the year

TC

COST PER UNIT

1504000

1193.65

+ Material purchased
- Closing stock at the end 2. Direct wages 3. Direct expense PRIME COST 4.Work expense + Indirect expense

37800
-82720 31500 68040 1520820 151200

30
-65.6 25 54 120 120

- Sale of scrap 5.+ Opening work in progress 6.- Closing work in progress WORK COST 7.Administrative expense Office salaries, rent COST OF PRODUCTION 8.+ opening stock of finished goods 9.- Closing stock of finished goods

151200

120

1357

115523

91.68 1448.68

COST OF GOODS SOLD

10.Selling and Distribution Overhead Carriage outward, commission, bad debt COST OF SALES + profit(Balancing Figure) 72520 57.54 1506.22 225.93

SALES

1732

BASIC CALCULATION
STANDARD FOR 1800 UNITS ACTUAL FOR 1260 UNITS

Material used

Rate

Amount

Material used

Rate

Amount

21600

1140

2052000

15120

1128

1421280

450

115

51750

315

120

37800

2103750

1459080

Material Cost Variance = (SC of actual output AC) = (1472625.00 1459080.00) MCV = Rs.13545 (F)

Material Price Variance = (SP AP) A Material A = (1140 1128) 15120 = Rs.181440.00 (F) Material B = (115 120) 315 = Rs. 1575.00 (A) MPV = Rs. 179865.00 (F)

Material Usage Variance = (Standard for actual output Actual ) SP Material A = (21600*(1800/1260)-15120)*1140 =Rs. 17940343.00(F) Material B = (450*(1800/1260)-315)*115 =Rs. 37703.57 (F) MUV= Rs.17678047 (F)

PARTICULARS
Standard time for job Standard rate per hour Actual time taken Actual wages paid 252 Hours RS 110 258 hours 31500

(a) Std. labour cost (252 hours Re. 110) (b) Actual wages paid (c) Actual rate per hour: Rs. 31500/258 hours

27720Rs 31500Rs 122Rs

Labour Rate variance = Actual time (Std. rate Actual rate) = 252 hours (Re.110 Re.122) = Rs. 3054 (A)

Labour Efficiency variance = Std. rate per hr. (Std. time Actual time) = Re.110 (252 hrs. 258 hrs.) = Rs.660 (A)

Total labour cost variance = Std. labour cost Actual labour cost =Rs 27720 Rs 31500 = Rs 3780 (A)

Company has established the following standards for factory overheads.

Variable overhead per unit: Rs. 89.55/Fixed overheads per month Rs. 1,18,550/Capacity of the plant. 1800 units/month

The actual data for the month are as follows: Actual overheads incurred Rs. 1,88,043/ Actual output (units) 1260 units

Required: Calculate overhead variances viz : (i) Production volume variance (ii) Overhead expense variance
Solution: Unutilised capacity : 1800 units less 1260 units = 540 units Standard fixed overheads per unit = Rs. 65.86 per unit Production volume variance = 540 units Rs. 65.86 = Rs. 35,564.5 (Adverse) Std variable overheads for actual production : Rs. 89.55 1260 units = Rs. 1,12,833 Std fixed overheads = Rs. 118550 Total overheads on standards for actual production = Rs. 231383 Actual overheads incurred = Rs. 1,88,043 Overhead expense variance = Rs. 43,340

The following information was obtained from the records of a manufacturing unit using standard costing system. Standard Actual Production 1800 units 1260 units Working days 30 21.5 Fixed Overhead Rs.118550 Rs.98,000 Variable Overhead Rs 161200 Rs 90,043

(a) For Variable Overhead Variance: Actual variable overhead = Rs.90, 043 Standard variable overhead for production (Budgeted output Std. variable overhead rate per unit) = (161200/ 1800) 1260 = Rs.112,840 Variable overhead variance: Actual variable overhead Standard variable overhead = Rs.112840 Rs.90043 = 22797 (A) (b) For Fixed Overhead Variance: Actual fixed overhead incurred = Rs. 98000 Budgeted fixed overhead for the period = Rs. 118550 Standard fixed overhead for production (Standard output for actual time Standard Fixed Overhead per unit) = (Rs.118550/ 1800 units) 1260 units = Rs.82,985

Variances: (i) Fixed Overhead Expenditure Variances: Actual fixed overhead Budgeted fixed overhead = Rs.98000 Rs.118550 = 20,550 (ii) Fixed Overhead Volume Variance : Budgeted fixed overhead Standard fixed overhead = Rs.118550 Rs.82,985 = Rs.35565 (A) (iii) Fixed Overhead Variance : Actual fixed overhead Standard fixed overhead = Rs.98000 Rs.82985 = Rs.15, 015 (F)

Product

Budget Quantity

Quantity Budgeted Price Rs.

Actual Quantity Rs.

Actual Price

Upkar tank

1800

1700

1260

1732

Solution Basic Calculation :

Product price Budgeted price Actual price Budgeted Quantity sales Actual Quantity sales Budgeted sales Actual Sales at Budgeted price Actual sales

e = a*c

f = (a*d)

g = (b*d)

Upkar tank

1700

1732

1800

1260

3060000

2142000

2182320

Sales price variance = Actual quantity (Actual price Budgeted price) = Actual sales Standard sales = Rs. 2182320 Rs. 2142000 = Rs. 40320(F) Sales volume variance = Budgeted price (Actual quantity Budgeted quantity) = Std. sales Budgeted sales = Rs. 26,000 Rs. 25,000 = Rs. 1,000 (F) Total variance = Actual sales Budgeted sales = Rs. 2182320 Rs. 3060000 = Rs.877680 (A)

Arthur Hindmarch and Marry Simpsons (1991) Financial accounting. Janet Brammer , David Cox ,Michael Fardon ,Aubrey Penning (2002) Active Accounting Cost Accounting Vol1 The Institute Of Chartered Accountants Of India Cost Accounting Vol 2 The Institute Of Chartered Accountants Of India The Standard Costing System At SKF: A Case Study Of A Swedish Manufacturing Company http://www.mccc.edu/~horowitk/documents/VanDerbeck15e_ www.accountingformanagement.com/standard_costing_variance_analysis_ case_study http://www.globusz.com/ebooks/Costing/00000011.htm http://www.nos.org/srsec320newe/320el29a.pdf http://www.globusz.com/ebooks/Costing/00000010.htm http://www.slideshare.net/hemanthcrpatna/a-study-on-formulation-ofcosting-system