UNIT I CMA Accounting and finance bba students

Accounting and finance

1. 1

2. UNIT I
TOPICS
Introduction: Accounting for
management
Role of cost in decision-making
Comparison of management and
Cost accounting
Types of cost
Cost concepts
Elements of cost-Material, labor &
Overheads
Allocation & apportionment
Preparation of cost sheet
Methods of costing
Reconciliation of Cost &
Financial accounting
2

3. Srl. No.Unit Lecture
no
Contents (sub topics) Slide no
1 Ist 1 Accounting for Management 4-11
2 Ist2 Roleof cost in decision making 12-17
3 Ist3 Comparison of Management & Cost Accounting 18-21
4 Ist 4 Types of Cost , Cost Concepts, Elements of Cost –
Material,Labor & overheads
22-37
5 Ist5 Allocation &Apportionment of L,M &O 38-60
6 Ist6 Preparation of Cost sheet 61-67
7 Ist 7 Methods of Costing 68-74
8 Ist 8 Reconciliation of Cost & Financial Accounting75-79
Ist FAQs , Descriptive questions & Assignment
LECTURE PLAN Unit-Ist Sub: Cost & Management Accounting
Academic Consultant : Neelesh Kumar
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4. 4

5. Introduction to Accounting
The actual record making phase (i.e. recording , classifying and
summarizing) of accounting is called book-keeping. Accounting
extends far beyond the actual making of records.
Accounting is concerned with the use to which these records are put ,
their analysis and interpretation. An accountant should be concerned
with more than the record making phase.
The main purpose of accounting is to ascertain profit or loss during a
specified period, to show financial position of the business on a
particular date and to have control over the firm’s property.
Such records are required to measure the income of the business and
communicate the information so that it may be used by the managers,
owners & other parties.
Accounting records, classifies, summarizes, and interprets financial
information about the activities of a concern so that intelligent
decisions can be made about the concern.
Three branches of accounting developed are-Financial accounting,
Cost & Management accounting.
5

6. Functions of accounting
In providing information to users , accounting performs three functions:
1.Accumulation–The accounting system identifies and gathers relevant data.
The process of data accumulation involves recording and analysis of
economic events. These records are essentially historical in nature , as the
events recorded are the ones which have already occurred.
2.Measurement. Accounting also performs the measurement function. It assigns
monetary values to economic events. While performing this function, it acts
in accordance with the generally accepted principles. Some economic events
cannot be measured accurately, they are estimated.
3.Communication.The information is communicated through statements.
Therefore, the information accumulated and measured should be periodically
communicated to users. The information is communicated through
statements and reports. The financial statements and reports should be
reliable and accurate. For the internal use of management, a variety of
reports, depending on the information need, may have to be prepared. In
communicating information to outsiders-investors-standard criteria of full
disclosure, materially, consistency and fairness should be adhered to.
6

7. What is Financial Accounting?
A method to communicate financial information to interested external
parties.
Users include capital providers, regulators, customers, suppliers,
employees, etc
Capital suppliers include debt and equity providers
Financial accounting is used for both prediction and control
7

8. Accounting is rigid and yields the truth
Generally-accepted accounting principles, or GAAP, are a
set of rigid rules that, if followed correctly, will lead to a
unique, “correct” representation of the financial
performance and health of a firm.
The basic financial statements, consisting of a balance
sheet, an income statement, and a statement of cash flows,
reflect a complete, accurate, and timely portrayal of the
financial performance and well-being of a firm
GAAP is created from a comprehensive analytical process,
which is free from political influence.
Accounting is the sole product of accountants
All of a firm’s identifiable assets and liabilities appear on the
balance sheet, and the difference between a firm’s assets
and its liabilities represents the value of the firm.
8

9. The Nature of management accounting
Management accounting is the presentation of accounting information in such a way
as to assist management in the creation of policy and the day-today operation of
an undertaking. Thus, it relates to the use of accounting data collected with the
help of financial accounting and cost accounting for the purpose of policy
formulation, planning, control and decision-making by the management.
Management accounting links management with accounting as any accounting
information required for taking managerial decisions is the subject matter of
management accounting.
“ Management accounting is the application of professional knowledge and skill in
the preparation of accounting information in such a way as to assist management
in the formulation of policies and in the planning and control of the operations of
the undertaking.” -----C.I.M.A. London
Management accounting is “the application of appropriate techniques and concepts
in processing historical and projected economic data of an entity to assist
management in establishing plans for reasonable economic objectives and in the
making of rational decisions with a view towards these objectives.”
---American Accounting Association
9

10. Nature(or characteristics) of management accounting
The following points may be noted :
1.Technique of selective nature .
2.Provides data & not decisions
3.Concerned with future
4.Analysis of different variables
5.No set formats for information
10

11. Scope of management Accounting
The scope of management accounting is very wide and broad-based. It includes
all information which is provided to the management for financial analysis
and interpretation of the business operations.
The following field of activities are included in the scope:
Financial accounting
Cost accounting
Budgeting & forecasting
Cost control Procedures
Reporting
Methods & procedures
Tax accounting
Internal financial control
Interpretation
Office services
Evaluating the performance of the management
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12. LECTURE 2
12

13. Role of Cost in Decision –making
Explain the uses of cost accounting data.
Describe the ethical responsibilities and certification requirements for
management accountants.
Describe the relationship of cost accounting to financial and
managerial accounting.
Some concepts which are used in cost accounting
Types of cost centres
Basis of cost classification and its explanation Identify the three basic
elements of manufacturing costs.
Illustrate basic cost accounting procedures.
Distinguish between the two basic types of cost accounting systems.
Illustrate a job order cost system.
Elements of cost ( including cost sheet)
13

14. Role of Cost Accounting in Decision –making
contd….
Cost accounting provides the detailed cost data
that management needs to control current
operations and plan for the future.
Companies must control costs in order to keep
prices competitive.
In today’s global environment, cost information is
more crucial than ever in remaining competitive.
14

15. 15
Cost Concepts Relevant to Decision-Making
–Differential cost and revenue
–Opportunity costs
–Sunk costs
–Marginal costs
•Thinking on the Margin: Fundamental Economic Decision-Making:
–The basic question to any economic decision: Is it worthwhile?
–Marginal revenues must exceed marginal costs.
•Classifying Costs for Financial Statements:
–Period costs
–Product costs
•Cost Classification for Predicating Cost Behaviors:
–Fixed costs
–Variable costs
–Mixed costs

16. Types of Businesses that Use Cost Accounting
Manufacturers (Ford, General Motors)
Merchandisers (Wal-Mart, Kmart)
Wholesalers (Beverage Distributors)
For-profit Service Businesses (CPAs, Attorneys)
Not-for-profit Service Agencies (United Way, Red
Cross)
16

17. Determining Product Costs and Pricing
Cost accounting is used to determine product costs
and help with marketing decisions.
Determining the selling price of a product.
Meeting competition.
Bidding on contracts.
Analyzing profitability.
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18. LECTURE 3
18

19. Comparison of Cost & management Accounting
Cost Accounting & management accounting both have the same objectives of helping the
management in planning , control & decision –making. Both are internal to the
organization and use common tools and techniques like standard costing, variable costing,
budgetary control etc. Inspite of these similarities there are certain differences between
the two. They are as follows:
Cost Accounting Management Accounting
1. Dealswith Ascertainment ,
apportionment and
accounting aspect of
costs
The effect andimpact of cost on
the business
2.Base It provides a base for
management accounting
It is derived from both cost 7
financial accounting
3.Role Helpful in collecting
costing data for the
management
It has greater degree of relevance
&objectivity as there is clear idea of
types of costs & items requiring
analysis.
4.Status Status of cost accountant
comes after management
accountant
Management accountant is senior
to cost accountant
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20. Cost Accounting Management Accounting
5.Outlook Cost accountant has a
narrow approach.
Reference to economic &
statistical data
Management accountant reports the
effect of cost on the business along with
cost analysis.
6.Tools &
Techniques
Has standard costing,
variable costing, Break
even analysis as the basic
tools
Apart from cost accounting tools , MA
also has funds flow statements, ratio
analysis as accounting tools &
techniques.
7.Scope Does not include financial
accounting, tax planning &
tax accounting
Includes all of these plus cost
accounting
8.Period of
Planning
Concerned with short-term
planning
Concerned with short-term& long-
range planning & uses techniques such
as sensitivity analysis, probability
structure. Special field is evaluation of
capital investment projects.
9.AssistanceMerely assists management
in itsfunctions
Assists and evaluates the management
performance
10.ApproachHistorical in approachFuturistic in approach
11.InstallationCan be installed without
mgmt. accounting
Needs financial& cost accounting as its
base.
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21. Cost Accounting vs. Financial and
Management Accounting
Characteristics Financial Accounting Managerial Accounting
Users: •External Parties
•Managers
Managers
Focus: Entire business Segments of the business
Uses of Cost Information:Product costs for
calculating cost of goods
sold and finished goods,
work in process, and raw
materials inventory using
historical costs and GAAP.
•Budgeting
•Special decisions such as
make or buy a component,
keep or replace a facility,
and sell a product at a
special price.
•Nonfinancial information
such as defect rates, % of
return products, and on-
time deliveries
Cost Accounting System
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22. LECTURE 4
22

23. TYPES OF COSTS & COST CLASSIFICATION
Cost classification is the process of grouping costs according to their common
characteristics. It is the placement of like items together according to their common
characteristics. A suitable classification of costs is of vital importance in order to
identify the cost with cost centres or cost units.
Cost may be classified according to their nature , i.e., material;, labor & expenses and a
number of other characteristics. The same cost figures are classifies according to
different ways of costing depending upon the purpose to be achieved and
requirements of a particular concern.
The important ways of classification are:
1.By nature or Elements
2.By Functions
3.By degree of Traceability to the product
4.By changes in activity or Volume
5.By Controllability
6.By Normality
7.By relationship with Accounting Period (Capital & revenue)
8.By time
9.According to planning & control
10.By association with the product
11.For managerial decisions
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24. BY NATURE OR ELEMENT OR ANALYTICAL CLASSIFICATION –Under this classification costs are
divided into three categories, i.e., Materials, Labor & factory Overheads. Each element can undergo
further sub-classification ; for example , material into raw material, components, and spare parts,
consumable stores , packing material,etc.
MATERIALS -Materials are the principal substances that go into the production process and are
transformed into finished goods. They are further classified as direct & indirect materials. Direct
materials can be easily and directly identified and easily traced with the production of finished goods.
The cost of direct materials generally comprises the major cost of the finished product. All the other
materials that go into the production of the finished goods are called indirect material costs. They
generally form a part of the manufacturing overheads.
LABOUR -Labor is the human physical & mental effort that goes into the production of a product. It
is further classified as direct and indirect labor. Direct labor is directly involved in the production of the
product. Direct labor cost generally comprises major labor cost.
OVERHEADS –All other costs that are incurred by the company other than direct material & doirect
labor are called overheads. Hence, overheads consist of indirect materials, indirect labor & other
expenses. The overheads are further sub-divided into factory overheads, office and administrative
overheads and selling & distribution overheads. Examples are factory lighting, rent of the factory, rent
of administrative building, wages of administrative staff, managers, depreciation of machinery,etc.
constitute overheads.
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25. BY FUNCTIONS
Under this classification costs are grouped according to the broad division of functions of a business
undertaking or basic managerial activities,i.e., production, administration, selling and distribution.
As per this classification , costs are classified as follows:
MANUFACTURING AND PRODUCTION COSTS
Production costs include the total of costs incurred in manufacture, construction and fabrication of units of
production. The manufacturing and production costs comprise direct materials, direct labor and factory
overheads.
ADMINISTRATIVE COSTS
Administrative costs includes costs incurred in planning , directing , controlling and operating a company.
For example , salaries paid to managers and other administrative staff.
SELLING AND DISTRIBUTION COSTS
Selling costs are defined as “ the cost of seeking to create and stimulate demand and of securing orders.”
Example of selling costs are advertisement , salesmen salaries etc. Distribution costs are defined as “ the cost
of sequence of operations which begin with making the packed product available for dispatch and ends
with making the reconditioned , returned empty packages, if any available for re-use.” Examples are
insurance on goods-in-transit, warehousing,etc.
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26. BY TRACEABILITY
According to this classification, total cost is divided into direct costs and indirect costs.
Direct costs are incurred for and may be conveniently identified or easily traceable
with a particular cost center or cost unit. The common examples are materials used
and labor employee in manufacturing an article or in a particular process of
production. Indirect costs are incurred for the benefit of a number of cost centers or
cost units and cannot be conveniently identified with a particular cost center or cost
unit. Examples include rent of building, management salaries, machinery
depreciation,etc.
The nature of the business and the cost unit chosen will determine the costs as direct
and indirect. For example, the hire charges of a mobile crane used onsite by a
contractor would be regarded as a direct cost since it is identifiable with the project
/site on which it is employed , but if the crane is used as apart of the services of a
factory, the hire charges would be regarded as indirect costs because they will
probably benefit more than one cost center or department. The distinction between
these two costs is essential because the direct costs of a product or activity can be
accurately identified with the cost object while the indirect costs have to be
apportioned n the basis of certain assumptions about their incidence.
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27. BY VARIABILITY
The basis for this classification is the behavior of costs in relation to changes
in the level of activity or volume of production . On this basis, costs are
classified into three groups,viz; fixed, variable and semi-variable.
FIXED COSTS
Fixed costs remain fixed in total with increase or decrease in the volume of
output or activity for a given period of time or for a given range of output.
Fixed costs per unit vary inversely with the volume of production, i.e., fixed
cost per unit decreases as production increase and increases as production
decreases. Examples are rent , insurance of factory building , factory
manager’s salary, etc. These costs are constant in total amount but fluctuate
per unit as production level changes. Also known as capacity costs.
VARIABLE COSTS
These costs vary in total directly in proportion to the volume of production or
output. These costs per unit remain relatively constant with changes in
volume of production or activity. Thus, variable costs fluctuate in total
amount but tend to remain constant per unit as production level changes.
Examples are direct material costs , direct labor costs , power , repairs,etc.
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28. SEMI-VARIABLE COSTS
Semi-variable costs are partly fixed and partly variable. For example, telephone
expenses include a fixed portion of monthly charge plus variable charge according to
the number of calls made; thus total telephone expenses are semi-variable. Other
examples of such costs are depreciation, repairs and maintenance of building and
plant,etc. These are also called semi-fixed costs or mixed costs.
BY CONTROLLABILITY
On the basis of controllability costs are classified into two categories, viz., controllable costs and
uncontrollable costs.
Controllable costs
If the costs are influenced by the action of a specific member of an undertaking, that is to say,
costs, which are at least partly within the control of management , they are called
controllable costs. An organization s divided into a number of responsibility centers and
controllable costs incurred in a particular cost center can be influenced by the action of the
manager responsible for the center. Generally speaking, all direct costs including direct
materials, direct labor and some of the overhead expenses are controllable by lower level of
management .
Uncontrollable costs –If the costs cannot be influence by the action of a specified member of an
undertaking, that is to say, costs which are not within the control of management are called
uncontrollable costs. Most of the fixed costs are uncontrollable. For example, rent of the
building is uncontrollable and so are managerial salaries. Overhead cost, which is incurred
by one service station or department and is apportioned to another, which receives the
service, is also not controllable by the latter.
Reference: Book on Cost & mgmt.accounting by Jain & Narang(2008), Ch-2,pages 28 -35.
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29. BY NORMALITY
On the basis of normality , the costs are classified into two categories, viz., normal and
abnormal cost.
Normal cost-it is the cost which is normally incurred at a given level of output in
conditions which are favorable for that level of output. This cost forms the cost of
production of a product.
Abnormal cost-It is the cost, which is normally incurred at a given level of output in
conditions which are not favorable for that level of output. It is not considered as a
part of cost of production and charged to Costing Profit and Loss Account.
BY CAPITAL AND REVENUE OR FINANCIAL ACCOUNTING CLASSIFICATION
According to financial accounting terminology , costs are of two types viz., capital costs &
revenue costs.
Capital cost-If the cost is incurred in purchasing assets either to earn income or to increase the
earning capacity of the business , it is called capital cost. For example, the cost of a rolling
machine in a steel plant. Though the cost is incurred at one point of time the benefits
accruing from it are spread over a number of accounting years.
Revenue cost-Revenue expenditure is any expenditure incurred to maintain the earning
capacity of the concern such as cost of maintaining an asset or running a business. Example,
cost of materials used in production, labor charges paid to convert the material into
production, salaries, depreciation, repairs and maintenance charges, selling and distribution
charges,etc. While calculating cost, revenue items are considered whereas capital items are
completely ignored.
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30. Cost Classifications
Costs
Cost
Traceability
Costs
Behavior
Value-Adding
Attributes
Financial
Reporting
Direct Indirect
Fixed
Value-
Adding
Nonvalue-
Adding
Product Period
Variable
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31. Planning and Control
Planning is the process of establishing objectives or goals for the firm and
determining the means by which the firm will attain them. Effective if facilitated
by the following:
Clearly defined objectives of the manufacturing operation.
A production plan that will assist and guide the company in reaching its
objectives.
Control is the process of monitoring the company’s operations and determining
whether the objectives identified in the planning process are being accomplished.
Effective control is achieved through the following:
Assigning responsibility.
Periodically measuring and comparing results.
Taking necessary corrective action.
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32. Cost Concepts
Some concepts which are used in cost accounting are discussed below--
a.(a)Cost –It is the amount of resources given up in exchange for some goods or services. The resources
given up are expressed in monetary terms. Cost is defined as “ the amount of expenditure(actual or
notional) incurred on or attributable to a given thing or to ascertain the cost of a given thing.”The
American Accounting Association has defined cost as “the foregoing , in monetary terms, incurred or
potentially to be incurred in the realization of the objective of management which may be
manufacturing of a product or rendering of a service.”
b.A cost must always be studied with reference to its purpose and conditions. Different costs may be
ascertained for different purposes and under different conditions. For the valuation of work-in-
progress, factory cost is used but for valuation of finished goods , cost of production is used.
c.Expenses –Expenses are costs which have been applied against revenue of particular accounting
period in accordance with the principle of matching cost to revenue, e.g., cost of goods sold, office
salaries of the period in which they are incurred.
d. Loss –It represents diminution in ownership equity other than from withdrawal of capital for which
no compensating value has been received.,e.g., destruction of property by fire. Thus the central idea of
the cost concept is that of giving up, parting with or sacrificing something or value to acquire some
other thing or value; expense refers to that portion of such sacrifices which are assigned to a particular
accounting period. Loss denotes sacrifice for which there are no corresponding return whereas cost
implies sacrifices for the sake of , and accompanied by, the securing of some other value.
e. Cost centres -A cost centre is the smallest segment of activity or area or responsibility for which costs
are accumulated. Typically cost centres are departments which may consist of sub-departments of an
organization with reference to which cost is collected for cost ascertainment and cost control . For
example, although an assembly department may be supervised by one foreman, it may contain several
assembly lines. A cost centre can be a location, i.e., an area such as department , store yard or sales area
or an item of equipment , e.g., lathe machine, delivery vehicle or a person, e.g., sales man , foreman.
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33. Cost concepts contd……
Types of Cost centres:
(i)Personal & impersonal cost centres
(ii)Operation of Cost centres
(iii)Product & Service cost centres
(iv)Profit centres, Cost driver , Conversion cost
(v)Contribution margin, carrying cost, ordering cost
(vi)Development costs, Policy costs, & discretionary
costs
(vii)Idle facilitates cost , Expired cost , urgent costs
(viii)Postponable costs
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34. The three elements of product cost are:
1.Direct Materials (Materials directly related to the product)
2.Direct Labor (Employees who worked in manufacturing the product)
3.Manufacturing Overhead (All other cost including: Indirect
materials, Indirect Labor, and other supplies)
Prime Cost
Primary cost of a product, Direct Materials and
Direct Labor
Conversion cost
The cost of converting a unit of production into a
finished good, Direct materials and Manufacture
Overhead.
ELEMENTS OF COST –MATERIAL, LABOUR & OVERHEADS
34

35. Elements of Manufacturing Costs
Direct materials
Materials that become part of and can be readily
identified.
Direct labor
Labor of employees who work directly on the product
manufactured.
Factory overhead
Includes all costs related to production other than direct
materials and direct labor.
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36. Flow of Manufacturing Costs
Direct Materials
Direct Labor
Factory Overhead
Work in Process
(Assets)
Finished Goods
(Assets)
Cost of Goods Sold
(Expenses)
36

37. ELEMENTS OF COST CONTD…..
Meaning of material control-Material control may be
defined as a comprehensive frmaework for the accounting
and control of material cost designed with the object of
maintaining material surplus at a level so as to ensure
uninterrupted production but at the same time minmising
investment of funds.
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38. 38

39. Allocation & Apportionment -
Introduction
In Cost Accounting the analysis and collection of overheads, their allocation and
apportionment to different cost centers and absorption to products or services plays
an important role in determination of cost as well as control purposes. A system of
better distribution of overheads can only ensure greater accuracy in determination of
cost of products or services. It is, therefore, necessary to follow standard practices
for allocation, apportionment and absorption of overheads for preparation of cost
statements.
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40. 2. Objective
The standard is to prescribe the methods of collection, allocation, apportionment of
overheads to different cost centres and absorption thereof to products or services on a
consistent and uniform basis in the preparation of cost statements and to facilitate
inter-firm and intra-firm comparison.
3.Scope
The standard should be followed for treatment of overheads by all enterprises
including companies covered under Cost Accounting Records Rules issued in pursuant
to Sec 209(1)(d) of the Companies Act, 1956 or under the provisions of any other Act,
Rules and Regulations.

The standard shall be applied in Cost and Management Accounting practices
relating to
Cost of products, services or activities
Valuation of stock
Transfer pricing
Segment Performance
Excise / Custom duty, VAT, Income Tax, Service Tax and other levies, duties and
abatement fixation
Cost statements for any other purpose

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41. 4. Definitions:

Overheads –Overheads comprise of indirect materials, indirect
employee costs and indirect expenses which are not directly
identifiable or allocable to a cost object in an economically feasible
way.
Overheads are to be classified on the basis of functions to
which the overheads are related-
Production overheads
Administrative overheads
Selling overheads
Distribution overheads
Overheads may also be classified on the basis of behavior
such as variable overheads, semi-variable overheads and
fixed overheads.
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42. Variable overheads comprise of expenses which vary in
proportion to the change of volume of production. For example,
cost of utilities etc.
Fixed overheads comprise of expenses whose value do not change
with the change in volume of production such as salaries, rent
etc.
Semi-variable overheads are partly affected by change in the
production volume. They are further segregated into variable
overheads and fixed overheads
Collection of Overheads -Collection of overheads means the
pooling of indirect items of expenses from books of account
and supportive/ corroborative records in logical groups having
regards to their nature and purpose.
Overheads are collected on the basis of pre-planned groupings,
called cost pools. Homogeneity of the cost components in
respect of their behavior and character is to be considered in
developing the cost pool. Variable and fixed overheads should
be collected in separate cost pools under a cost centre.
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43. Allocation of overheads –Allocation of overheads is assigning a
whole item of cost directly to a cost centre.
An item of expense which can be directly related to a cost centre
is to be allocated to the cost centre. For example, depreciation
of a particular machine should be allocated to a particular cost
centre if the machine is directly attached to the cost centre.
Apportionment of overhead -Apportionment of overhead is
distribution of overheads to more than one cost centre on some
equitable basis.
When the indirect costs are common to different cost centres,
these are to be apportioned to the cost centres on an equitable
basis. For example, the expenditure on general repair and
maintenance pertaining to a department can be allocated to that
department but has to be apportioned to various machines (Cost
Centres) in the department. If the department is involved in the
production of a single product, the whole repair & maintenance
of the department may be allocated to the product.
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44. Primary and Secondary Distribution of Overheads :
In case of multi-product environment, there are common service cost centres which are
providing services to the various production cost centres and other service cost centres.
The costs of services are required to be apportioned to the relevant cost centres. First step
to be followed is to apportion the overheads to different cost centres and then second step
is to apportion the costs of service cost centres to production cost centres on an equitable
basis. The first step is termed as primary distribution and the second step is termed as
secondary distribution of overheads.
4.6 Absorption of overheads -Absorption of overheads is charging of overheads from
cost centres to products or services by means of absorption rates for each cost center
which is calculated as follows :
Total overheads of the cost centre
 Overhead absorption Rate =_____________________________
Total quantum of base
The base ( denominator) is selected on the basis of type of the cost centre and its
contribution to the products or services, for example, machine hours, labor hours,
quantity produced etc.
Overhead absorbed = Overhead absorption rate x units of base in product or service
•4.7 Normal Capacity is the production achieved or achievable on an average over a
period or season under normal circumstances taking into account the loss of capacity
resulting from planned maintenance.
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45. 5. Apportionment and absorption of Production Overheads

Overheads are to be apportioned to different cost centres based on following two
principles :
Cause and Effect -Cause is the process or operation or activity and effect is the
incurrence of cost. Apportionment of overheads based on this criterion ensures
better rationality as it is guided by the relationship between cost object and cost.

Benefits received –overheads are to be apportioned to the various cost centres in
proportion to the benefits received by them.

Primary Distribution of overheads :
Basis of primary apportionment of items of production overheads is to be selected to
distribute them among the cost centres following the above two principles as given above
in 5.1.

Basis of apportionment must be rational to distribute overheads. Once the base is
selected, the same is to be followed consistently and uniformly. However, change in
basis for apportionment can be adopted only when it is considered necessary due to
change in circumstances like change in technology, degree of mechanization, product
mix, etc. In case of such changes, proper disclosure in cost records is essential.
45

46. Item of Cost * BasisofApportionment
Power H.P. rating of machines X hours X L.F.**
Fuel Consumption rate X hour
Jigs, tools & fixtures Machine hours or man hours
Crane Hire charges Crane hours or weight of materials handled
Supervisors’ salary & fringe benefits Number of employees
Labor welfare cost Number of employees
Rent & rates Floor or spacearea
Insurance Value of fixed asset
Depreciation Valueof fixed asset
46

47. 5.4.2 Trial and Error Method
This method is to be followed when the question of distribution of costs of
service cost centres which are interlocked among themselves arises. In the first
stage, gross costs of services of service cost centres are determined and then in
the second stage, costs of service centres are apportioned to production cost
centres. Steps to be followed :
The proportion at which the costs of a service cost centre to be distributed to
production cost centres and other service cost centres is determined.
Cost of first service cost centre is distributed to the other service centres in
the proportion of service they received from the first as assessed in step (i).
In the next step, total cost of second service cost centre so arrived has to be
distributed to the other service centres in the proportion of service they
received from the second as assessed in step (i).
Similarly, the cost of other service cost centres are to be apportioned to the
service cost centres.
This process as described in (iii) and (iv) is to be continued till the figures
remaining undistributed in the service cost centres are negligibly small.
At the last, total cost of service cost centres to be distributed to
production cost centres.
47

48. 5.4.3 Simultaneous Equation Method
The simultaneous equation method is to be adopted to take
care of secondary distribution of cost of service cost
centres to production cost centres with the help of
mathematical formulation and solution. Steps to be
followed :

Proportion of service benefits received by different cost
centres from a cost centre are assessed on the basis of
records
The same ratios are used as coefficients in the equations
framed for apportionment of cost of service cost centres
to production cost centres.
Solution of the equations gives the cost of service cost
centres.
Cost of service cost centres to be distributed to production
cost centres
48

49. 5.9 A pre-determined rate may be used on a provisional basis for
internal management decision making such as cost estimates for
quotation, fixation of selling price etc. These rates are to be calculated
for each cost centre for a particular period. Budgeted overheads for the
respective cost centres for the period concerned are to be taken as
numerator and budgeted normal base for the period as denominator for
determining the rate.

Pre-determined overhead Rate = Budgeted
Overheads for the
period____________
 Budgeted normal base for the period

The amount of total overheads absorbed by a product, service or activity
will be the sum total of the overheads absorbed from individual cost
centres on pre-determined basis. The difference between overheads
absorbed on pre-determined basis and the actual overheads incurred is
the under-or over-absorption of overheads.

The under-or over-absorption of overheads is mainly due to variation
between the estimation and actual.
49

50. 6. Apportionment and absorption of Administrative Overheads

Administrative overheads include the following items of cost :
Printing and stationery, other office supplies
Employees cost –salaries of administrative staff
Establishment expenses –Office rent & rates, insurance, depreciation of office building and other
assets, legal expenses, audit fees, bank charges etc.

Administrative overheads are to be collected in different cost pools such as :
General Office
Personnel department
Accounts department
Legal department
Secretarial department etc

Administrative overheads are to be further analyzed into two –one for production activities and other
for sales and distribution activities. Costs collected under the cost pools indicated in 6.2 above are to be
distributed to administrative overheads relating to production activities and administrative overheads
relating to selling and distribution activities on rational basis for each cost pool.

Administrative overheads relating to production activities are to be apportioned to different
production cost centres on the basis conversion costs of production cost centres. The apportioned
overheads are absorbed to products on the basis of the normal capacity or actual capacity, whichever is
higher.

In case of under-absorption or over-absorption of administrative overheads relating to
production, the same shall also be adjusted with Costing Profit & Loss Account.
50

51. 7. Apportionment and absorption of Selling overheads and
Distribution overheads

7.1 The selling overheads and distribution overheads are collected under
different cost pools such as :
Selling Overheads ,Sales Employees cost,Rent,Traveling expenses,
Warranty claim ,brokerage & Commission, Advertisement relating to
sales and sales promotion, Sales incentive, Bad debt etc.
Distribution Overheads :
Secondary Packaging
Freight & forwarding
Warehousing & storage
Insurance etc.

Some items of selling overheads and distribution overheads are directly
identified and absorbed to products or services and remaining part of selling and
distribution overhead along with the with share of administration overheads
relating to selling and distribution activities are to be apportioned to various
products or jobs or services on the basis of net actual sales value (i.e. Gross sales
value less excise duty, sales tax and other government levies).


51

52. Definition of Overhead
Factory overhead is
indirect materials
indirect labor and
all other factrory expenses wich cannot be identified with or
charged directly to specific jobs (Schaum, p. 39)
Overhead is expenditure on labor, materials or services
which cannot be economically identifies with a specific
saleable cost unit (CIMA 1991, Williamson p. 152)
It is overhead, that makes cost accounting problematic
52

53. Example: Different bases
53MU MU
Materials Cost 100.000 5.000
Labor 150.000 6.000
Prime Cost 250.000 11.000
Overheads 150.000
Total Costs 400.000
Labor hours worked 75.000 3.000
Machine hours worked50.000 500
Units produced 50.000 3.000
Data for the Production
Department (January 200x):
Data for batch A produced
in January 200x

54. Models in Overhead Accounting (2)
The relevant base for the allocation of overhead is
units of output: if just one product or a line of very
similar products is produced
direct labor hours: if production is very labor intensive
and the number of workers drives activity of „overhead“
machine hours: if production is highly automated
cost percentage rates: fit very seldom
54

55. Budgeting of OARs
OARs must be predeterminedin order to calculate
jobs near to their production time
a job to be produced on 1st feb. should not be calculated
in march, when historical overhead costs are known for
february
it should not be calculated in january next year, when
overheads for the whole year are known.
55

56. OARs and levels of activity
When based on units of output, labor hours or machine
hours, OARs need an estimate of the according activity
level
theoretical activity level: no allowances made for any
stoppages
practical activity level: allowances for unavoidable stoppages
(maintenance, repairs, disturbances); highly important in
reality
expected actual activity: allows for stoppages that could
theoretically be avoided but eare not in practice
normal activity: kept constant for e.g. a year and eliminates e.g.
seasonal variations(Williamson, 163-164)
56

57. Over-and Underabsorption of Overheads
57
(OAR) *
(Actual
Activity)
(OAR) *
(Actual
Activity)
Actual
Overhead
Costs
Actual
Overhead
Costs
Cost of Goods must
be credited, why?
Cost of Goods must
be debited, why?

58. Overabsorption
58
Factory Overhead Applied
(Estimates)
1/1010.000
1/2020.000
1/3115.000
Factory Overhead Controlled
(Reality)
1/0714.000
1/1716.000
1/2410.000
1/3145.000 1/3145.000
Cost of Goods Sold
(Reality)
1/0812.000
1/1525.000
1/2718.000
1/315.000
1/31 5.000
Either Cost of Goods Sold
and / or
Work-in-Process Inventory
must be credited:
Products have been costed to high,
due to overestimated OARS

59. Cost assignment
Cost Allocation: That part of cost attribution
which charges a specific cost to a cost centre or
cost unit
Cost Apportionment: That part of cost
attribution which shares costs among two or
more cost centres or cost units in proportion to
the estimated benefit received, using a proxy,
e.g. square meters.
59

60. Cost Apportionment
(Example, Williamson, p. 165-168)
60Departmental factory overhead summary: after apportionment of overheads
Production departments Service departmentsTotal
1 2 3A B
Supervision Costs 9,0008,0008,00010,000 12,00047,000
Indirect Labor 1,0002,0001,0001,000 1,0006,000
Indirect Materials 10,0002,5002,5007,500 12,50035,000
Repairs and Maintenance 5001,0001,000 0 5003,000
Depreciation
Plant5,0003,5001,250 100 15010,000
Buildings1,2501,0001,500 0 03,750
Rates 1,000 8001,200 0 03,000
Electricity 1,7501,050 700 0 03,500
Water 1,5001,0001,0002,000 1,0006,500
31,00020,85018,15020,600 27,150117,750

61. LECTURE 6
61

62. You are running a factory which manufactures electronic toys. You incur
expenses on raw material, labor and other expenses which can be directly
attributed to cost and which cannot be directly attributed but are incurred
upto their sales. You need to know the composition of cost at different
stages. This will help you in the analysis of cost of a product so that same
can be used for its proper management. In this lesson you will learn about
cost sheet and its various components.
OBJECTIVES
After studying this lesson, you will be able to:
_ state the meaning and type of Cost Sheet;
_ state the importance of Cost Sheet;
_ explain the components of total cost;
_ prepare the cost sheet as per format.
62

63. COST SHEET : MEANING AND ITS IMPORTANCE
Cost sheet is a statement, which shows various components of total cost
of a product. It classifies and analyses the components of cost of a product.
Previous periods data is given in the cost sheet for comparative study. It
is a statement which shows per unit cost in addition to Total Cost. Selling
price is ascertained with the help of cost sheet. The details of total cost
presented in the form of a statement is termed as Cost sheet. Cost sheet
is prepared on the basis of :
Historical Cost 2. Estimated Cost
Historical Cost
Historical Cost sheet is prepared on the basis of actual cost incurred. A
statement of cost prepared after incurring the actual cost is called Historical
Cost Sheet.
Estimated Cost
Estimated cost sheet is prepared on the basis of estimated cost. The
statement prepared before the commencement of production is called
estimated cost sheet. Such cost sheet is useful in quoting the tender price
of a job or a contract.

63

64. Importance of Cost Sheet
The importance of cost sheet is as follows:
_ Cost ascertainment
The main objective of the cost sheet is to ascertain the cost of a product.
Cost sheet helps in ascertainment of cost for the purpose of determining
cost after they are incurred. It also helps to ascertain the actual cost or
estimated cost of a Job.
_ Fixation of selling price
To fix the selling price of a product or service, it is essential to prepare the
cost sheet. It helps in fixing selling price of a product or service by providing
detailed information of the cost.
_ Help in cost control
For controlling the cost of a product it is necessary for every manufacturing
unit to prepare a cost sheet. Estimated cost sheet helps in the control of
material cost, labor cost and overheads cost at every point of production.
_ Facilitates managerial decisions
It helps in taking important decisions by the management such as: whether
to produce or buy a component, what prices of goods are to be quoted in
the tender, whether to retain or replace an existing machine etc.
64

65. COMPONENTS OF TOTAL COST
The Components of cost are shown in the classified and analytical form
in the cost sheet. Components of total cost are as follows:
_ Prime Cost
It consists of direct material, direct wages and direct expenses. In other
words “Prime cost represents the aggregate of cost of material consumed,
productive wages, and direct expenses”. It is also known as basic, first, flat
or direct cost of a product.
Prime Cost = Direct material + Direct Wages + Direct expenses
Direct material means cost of raw material used or consumed in production.
It is not necessary that all the material purchased in a particular period is
used in production. There is some stock of raw material in balance at
opening and closing of the period. Hence, it is necessary that the cost of
opening and closing stock of material is adjusted in the material purchased.
Opening stock of material is added and closing stock of raw material is
deducted in the material purchased and we get material consumed or used
in production of a product. It is calculated as :
Material Consumed = Material purchased + Opening stock of material
–Closing stock of material.
65

66. Illustration 1
Calculate prime cost from the following particulars for a production unit:
Rs.
Cost of material purchased 30,000
Opening stock of material 6,000
Closing stock of material 4,000
Wages paid 3,000
Rent of hire of a special machine for production 5,000
Solution:
Statement showing Prime Cost Details Amount(Rs.)
Direct Material: Material Consumed
Opening stock of material 6,000
Add : Material Purchased 30,000
Material available for consumption 36,000
Less : Closing stock of material 4,000
Material consumed 32,000
Direct Labor : Wages 3,000
Direct Expenses: Rent of hire a special machine 5,000
Prime cost 40,000
Factory Cost
In addition to prime cost it includes works or factory overheads. Factory
overheads consist of cost of indirect material, indirect wages, and indirect
expenses incurred in the factory. Factory cost is also known as works cost,
production or manufacturing cost.
Factory Cost = Prime cost + Factory overheads 66

67. Illustration 2
Calculate factory cost from the following particulars:
Rs.
Material consumed 60,000
Productive wages 20,000
Direct Expenses 5,000
Consumable stores 2,000
Oil grease/Lubricating 500
Salary of a factory manager 6,000
Unproductive wages 1,000
Factory rent 2,000
Repair and Depreciation on Machine 600
Solution:
Statement showing Factory cost
Details Amount
(Rs.)
Direct Material: Material Consumed 60,000
Direct Labor: Productive wages 20,000
Direct Expenses 5,000
Prime cost 85,000
Add : Factory overheads
Indirect Material:
Consumable stores 2,000
Oil grease/lubricants 500 2,500
Indirect Labor:
Unproductive wages 1,000
Salary of a factory Manager 6,000 7,000
Indirect Expenses:
Factory rent 2,000
Repair and Depreciation on Machine 600 2,600
Factory cost 97,100
67

68. LECTURE 7
68

69. Methods of Costing
Job Order Cost System
Output consists of special or custom-made products.
Provides a separate record for the cost of each quantity
of these special or custom-made products.
Process Cost System
Accumulates costs for each department or process in the
factory.
69

70. Job Order Cost System
Direct Materials
Direct Labor
Factory Overhead
Job Cost Sheets Finished Goods
Work in Process
Account
70

71. Standard Cost System
May be used with either a job order or a process
cost system.
Uses predetermined standard costs to furnish a
measurement that helps management make
decisions regarding the efficiency of operation.
Standard costsare costs that would be incurred
under efficient operating conditions and are
forecast before the manufacturing process
begins.
71

72. Costing Methods -
Actual Costing Method
Uses the know cost of materials, labor, and overhead.
EI:Manufacturing 3,000 candy bars costing the following:
Direct Materials $540 / 3,000 = .18 each bar
Direct Labor$420 / 3,000 = .14
Overhead $421 / 3,000 = .08
Total Production Cost per bar = $.40
72

73. Costing Methods -
Normal Costing Method
Uses the know cost of materials, labor, and estimates
overhead cost using a rate.
EI: Overhead rate is based on 60% of direct labor.
Manufacturing 3,000 candy bars costing the following:
Direct Materials $540 / 3,000 = .18 each bar
Direct Labor$420 / 3,000 = .14
Overhead $420 x 60% = 252 / 3,000 = .08 (rounded)
Total Production Cost per bar = $.40
73

74. Costing Methods -
Standard Costing Method
Uses predetermined rates for materials, labor, and
overhead.
Manufacturing 3,000 candy bars costing the following:
Direct Materials = .18 each bar
Direct Labor = .14
Overhead = .09
Total Production Cost per bar = $.44
74

75. LECTURE 8
75

76. Reconciliation of cost & Finance accounting
Need for reconciliation
When cost & financial accounts are maintained independent of each other, it is
imperative that periodically two accounts are reconciled. Though both sets of
books are concerned with the same basic transactions but the figure of profit
disclosed by the former does not agree with that disclosed by the latter.
Thus reconciliation is necessary due to the following reasons:
To ensure the mathematical accuracy and reliability of cost accounts in order
to have cost ascertainment, cost control and to have check on financial
accounts
To contribute in the standardization of policies regarding stock valuation,
depreciation and overheads
To facilitate coordination and promote better cooperation between the
activities of financial and cost sections of the accounting department
To find out the reasons for the difference in the profit or loss in cost and
financial accounts to indicate the position clearly and to ensure no mistakes
have been committed.
76

77. Reasons of Disagreement in profit
1.There are items which are included in financial accounts but find no
place in cost accounts .These may be items of expenditure or
appropriation of profit or items of income. The former reduce the
profit while the latter have the reverse effect. The items are purely
financial charges , appropriation of profit, writing off intangibles and
fictitious assets, Purely financial incomes.
2.Items shown only in cost accounts but not in profit accounts such as
notional charges. For example, the nominal cost of employing the
capital such as interest rate shown to be paid, nominal rent for
premises charged to production , depreciation charge even when
book value reduced to zero, salary of the proprietor.
3.Overheads absorbed in cost accounts on the basis of estimation like
percentage on direct materials, percentage on direct wages, etc. may
be more or less than the actual amount incurred. Under or over
absorption of overheads leads to difference in two accounts.
Sometimes selling & distribution costs are ignored in cost accounts
and as such costing profit will be higher and thus requires
reconciliation.
77

78. Reasons for disagreement in profit contd…..
4.The valuation of all stocks in financial accounts is done on the basic
principle of cost or realizable value whichever is less. The valuation of stock
in cost accounts is dependent on the fact whether it is raw material, work –
in-progress and finished goods. Different bases adopted for valuation of
raw materials, work in progress and finished goods may differ and cause
disagreement in the results.
5.The methods of charging depreciation may differ in financial accounts and
cost accounts and may cause disagreement in profits of the two books of
accounts. For example, Straight line or diminishing balance method is
adopted in financial accounts whereas in cost accounts machine hour rate
or production hour or unit method may have been adopted.
6.Abnormal items as abnormal wastage of material by theft, cost of abnormal
idle time, cost of abnormal idle facilities , exceptional bad debts, abnormal
gain on manufacturing may be shown in financial accounts but are
excluded from the cost accounts as these are taken directly to the costing
and profit accounts but are excluded from the cost accounts as these are
taken directly to the costing and profit and loss account.
78

79. Methods of reconciliation
The reconciliation of costing and financial profit can be attempted
either
(a)By preparing a Reconciliation statement or
(b)By preparing a Memorandum Reconciliation Account
Reconciliation statement
When reconciliation is attempted by preparing a reconciliation statement,
profit shown by one set of accounts is taken as baser profit and items of
difference are either added to it or deducted from it to arrive at the figure of
profit shown by other set of accounts.
Memorandum Reconciliation Account
Reconciliation can also be done by preparing a memorandum Reconciliation
Account. This account is only a memorandum account only & does not
form part of the double entry. When reconciliation is attempted through
Memorandum Reconciliation Account , profit to be taken as “ base profit” is
shown like opening balance of this account.Allitems of difference required
to be deducted are debited and those to be added are credited to this
account, the balancing figure of this account is the profit shown by other
set of accounts. 79

80. Numerical
A manufacturer buys certain equipment from outside
suppliers at Rs. 30 per unit. Total annual needs are 800
units. The following further data are available:
Annual return on investments ,10%
Rent, insurance , taxes per unit per year, Re 1
Cost of placing an order , Rs. 100
Determine the economic order quantity.
80

81. NUMERICAL
Q. From the following information., prepare cost sheet.
Rs.
Direct material 1,60,000
Direct Labor 45,000
Direct Expenses 15,000
Factory overheads 35,000
Office and administration overheads 20% of works cost
Selling and distribution overheads 45,000
Opening stock of finished goods 25,000
Closing stock of finished goods 10,000
Profit on Sales 10%
81

82. Assignment
Question. Try to evaluate the difference between cost accounting &
management accounting from the perspective of an industrial
organization which is into the manufacturing of wooden & steel
furniture of different varieties and markets its products in a regional
market? Also analyze the difference in the approach of financial
accounting & cost accounting techniques for assessing the financial
needs of the firm?
Hint –This assignment requires the student to find out the meaning and
relevance of management accounting, its application in business
organizations & difference in its approach from cost & financial
accounting . Also required is the analysis of nature , characteristics &
scope of management accounting.
Refer to Chapter 1, pages 1-25 of book on Cost & management accounting
by Jain , Narang, Agarwal & Sehgal.(Kalyani Publishers)
82

83. ASSIGNMENT
Take example of any industrial unit or plant like a machine or finished
product manufacturing company ( like a refrigerator manufacturing
company), and explain the working of concepts such as allocation &
apportionment of different types of overheads. Also identify the
different items which are absorbed in manufacturing of a refrigerator.
Hint : Collect this data from the purchase manager of a refrigerator
manufacturing firm like LG Electronics. Also try to segregate the items
into direct & indirect costs.
83

84. Descriptive questions
Q1. What are the main features of job order costing ?Also give advantages
and weaknesses of this method of costing.
Q2.What is the purpose of reconciling cost accounts and financial
accounts? Indicate the possible sources of difference between them.
How will you prepare reconciliation statement to reconcile the cost
accounts and financial accounts.
Q3.Explain FIFO & LIFO methods of valuation of material issues. Discuss
the effect of rising prices and falling prices on these two methods of
pricing material issues.
Q4.Bring out clearly the significance of each of the following cost
classifications and explain the meaning of the terms used therein: (i)
direct & indirect(ii) Variable & fixed (iii) Controllable &
Uncontrollable.
Q5.Explain the nature & scope of management accounting. Also
distinguish it from cost & financial accounting.
84

85. Objective Questions
Q1. The statement –”All monetary or non-monetary transactions are recorded in financial
accounting is (a)True (b) false ( c) Can’t say (d) cannot determine
Q2.The statement –” Cost accounting , financial accounting and management accounting are not
branches of accounting is (a)True (b) False(c) Can’t say (d) Cannot determine
Q3.The statement –“Cost accounting is an instrument of management control is :
(a) False (b) true ( c) Can’t say (d) Cannot determine
Q4.That branch of accounting which has been developed due to limitations of financial
accounting is (a) Management accounting (b) Financial accounting (c) Cost accounting
Q5.The statement that management accounting does not include financial accounting, tax
planning and tax accounting is (a) True (b) false (c) Both (a) & (b) (d) Can’t say
Q6.According to which classification of costs, the costs are divided into three categories:
(a).By nature or elements (b)By functions (c) By Normality (d) By Controllability
Q7.The first budget to be prepared in Budgeting in any organization is:
(a)Purchase budget (b) Production budget (c) Sales budget (d) Master budget
Q8. Q5.ABC analysis of inventory control emphasizes on categorizing raw materials on the basis
of:
(a)Quantity of input (b) Value of input (c) A balance of both (a) & (b) (d) Can’t say
85

86. Q9.The statement –“Direct cost is one which can be conveniently identified with
and charged to a particular unit of cost is: (a) False (b) true (c)
Both (a) & (b) (d) Can’t say
Q10.Under or overvaluation of stocks in cost accounts while preparing
reconciliation statement leads to error in (a) Balance sheet (b) Profit & loss
account(c) Both (a) & (b) (d) Can’t say
Q11.The statement that margin of safety falls before the break-even point in
management accounting is: (a) true (b) false (c) Both (a) &
(b) (d) Cant’ say
Q12.If sales mix and variable cost change by equal amount but in opposite
direction, then P/E ratio is going to: (a) decrease (b) increase (c)
Remain constant (d) Cannot determine
Q13.The statement-“In marginal costing, managerial decisions are guided by
contribution margin rather than by profit” is (a) False (b) true (c) Both
(a) & (b) (d) Can’t say
Q14.There will be difference in profits under absorption costing & marginal
costing when production is equal to sales is : (a) false (b) true (c)
Both (a) & (b) (d) Can’t say
Q15.A fixed budget is useful only when the actual level of activity corresponds to
the budgeted level of activity is: (a) False (b) True (c) Both
(a) &(b) (d) Can’t say
86

87. Q16.For control purposes, long-term budgets should be prepared & estimate
of the sales given in the sales budget is a guess is (a) True (b) False
(c) Both (a) & (b) (d) Can’t say
Q17.Labour rate variance is calculated by multiplying actual hours into
difference between standard rate & actual rate is : (a) false (b) true
(c)Both (a) & (b) (d) Can’t say
Q18.Materials price variance is calculated by multiplying standard quantity
purchased by difference between actual and standard price is: (a) True (b)
false (c) Both (a) &(b) (d) Can’t say
Q19.An unfavorable material price variance occurs because of: (a) Price
increase
(a)Price decrease (c) Anticipated normal wastage (d) All of the above
Q20.The summation of direct material costs , direct labor cost & direct
expenses is known as :
(a) Prime cost (b) Cost of production ( c) Cost of sales (d) Selling cost
87

88. References
1.www.google.com/Accountingconcepts*
2.Reference: http://www.cgu.edu/pages/3472.asp
3.Book –Cost & management accounting
(Kalyani publishers)
4.Icfai University Press on Management Accounting,.
88