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Study Material

Accounting for Managers


(Cost Management)

For

MBA (Full Time) – I Semester

Prepared by

Dr. Sachin Mittal


Associate Professor, PIMR, Indore
Basic Cost Concepts

Learning Objectives

• To understand the meaning of different costing terms


• To understand different costing methods
• To have a basic idea of different costing techniques
• To understand the meaning of cost sheet

Meaning of Cost Accounting

According to Charles T. Horngren, cost accounting is a quantitative method that


accumulates, classifies, summarizes and interprets information for the following three
major purposes:

• Operational planning and control


• Special decisions
• Product decisions

According to the Chartered Institute of Management Accountants, London, cost


accounting is the process of accounting for costs from the point at which its expenditure
is incurred or committed to the establishment of the ultimate relationship with cost units.
In its widest sense, it embraces the preparation of statistical data, the application of cost
control methods and the ascertainment of the profitability of the activities carried out or
planned.

Objectives of Cost Accounting

The main objectives of cost accounting can be summarized as follows:


1. Determining Selling Price
2. Determining and Controlling Efficiency
3. Facilitating Preparation of Financial and Other Statements
4. Providing Basis for Operating Policy
• Determination of a cost-volume-profit relationship
• Shutting down or operating at a loss
• Making for or buying from outside suppliers
• Continuing with the existing plant and machinery or replacing them by
improved and economic ones

Concept of Cost

The term cost cannot be exactly defined. Its interpretation depends upon the following
factors:
• The nature of business or industry
• The context in which it is used
Elements of Cost

Following are the three broad elements of cost (refer to figure 12.1):
1. Material
a. Direct Material
b. Indirect Material
2. Labor
a. Direct Labor
b. Indirect Labor
3. Expenses
a. Direct Expenses
b. Indirect Expenses
4. Overhead
a. Factory Overheads
b. Office and Administration Overheads
c. Selling and Distribution Overheads
Components of Total Cost

1. Prime Cost
Direct material
Direct labor
Direct expenses
2. Factory Cost
Work overheads
3. Office Cost
Administrative overhead
4. Total Cost
Selling and distribution expenses

Cost Sheet

Cost sheet is a document that provides for the assembly of an estimated detailed cost in
respect of cost centers and cost units. It analyzes and classifies in a tabular form the
expenses on different items for a particular period. Additional columns may also be
provided to show the cost of a particular unit pertaining to each item of expenditure and
the total per unit cost.
Cost sheet may be prepared on the basis of actual data (historical cost sheet) or on the
basis of estimated data (estimated cost sheet), depending on the technique employed and
the purpose to be achieved.

Classification of Cost

1. Fixed, Variable and Semi-Variable Costs


2. Product Costs and Period Costs
3. Direct and Indirect Costs
4. Decision-Making Costs and Accounting Costs
5. Relevant and Irrelevant Costs
6. Shutdown and Sunk Costs
7. Controllable and Uncontrollable Costs
8. Avoidable or Escapable Costs and Unavoidable or Inescapable Costs
9. Imputed or Hypothetical Costs
10. Differentials, Incremental or Decrement Cost
11. Out-of-Pocket Costs
12. Opportunity Cost
13. Traceable, Untraceable or Common Costs
14. Production, Administration and Selling and Distribution Costs
15. Conversion Cost
Cost Unit and Cost Center

Cost Unit
The quantity upon which cost can be conveniently allocated is known as a unit of cost or
cost unit. The Chartered Institute of Management Accountants, London defines a unit of
cost as a unit of quantity of product, service or time in relation to which costs may be
ascertained or expressed.

examples of units of cost:


(i) Brick works per 1000 bricks made
(ii) Textile mills per yard or per lb. of cloth manufacturing
(iv) Electrical companies per unit of electricity generated
(v) Transport companies per passenger km.
(vi) Steel mills per ton of steel made

Cost Center
According to the Chartered Institute of Management Accountants, London, cost center
means “a location, person or item of equipment (or group of these) for which costs may
be ascertained and used for the purpose of cost control.”

Cost centers may be classified as follows:


• Productive, unproductive and mixed cost centers
• Personal and impersonal cost centers
• Operation and process cost centers

Cost Estimation and Cost Ascertainment

• Budgeting
• Measurement of performance efficiency
• Preparation of financial statements (valuation of stocks etc.)
• Make or buy decisions
• Fixation of the sale prices of products

Cost Reduction and Cost Control


(i) Cost control aims at maintaining the costs in accordance with established
standards whereas cost reduction is concerned with reducing costs. It changes
all standards and endeavors to improve them continuously.
(ii) Cost control seeks to attain the lowest possible cost under existing conditions
whereas cost reduction does not recognize any condition as permanent since a
change will result in lowering the cost.
(iii) In case of cost control, emphasis is on past and present. In case of cost
reduction, emphasis is on the present and future.
(iv) Cost control is a preventive function whereas cost reduction is a correlative
function. It operates even when an efficient cost control system exists.
Methods of Costing

1. Job Costing
2. Contract Costing
3. Cost Plus Costing
4. Batch Costing
5. Process Costing
6. Operation Costing
7. Unit Costing (Output Costing or Single Costing)
8. Operating Costing
9. Departmental Costing
10. Multiple Costing (Composite Costing)

Techniques of Costing
1. Marginal Costing
2. Direct Costing
3. Absorption or Full Costing
4. Uniform Costing
5. Standard Costing

Summary
1.Cost accounting is a quantitative method that accumulates, classifies,
summarizes and interprets information for operational planning and control,
special decisions and product decisions.
2.Cost may be classified into different categories depending upon the purpose of
classification viz. fixed cost, variable cost and semi variable cost.
3.Costing can be defined as the technique and process of ascertaining costs.

Break Even Point

Specific way to show relationship between costs, volume and profit.

It indicates the level of sales at which total revenues is equal to total cost. It is no profit
and no loss point.

BEP (units) = Total fixed cost / selling price per unit (SPPU) – variable cost per unit (VCPU)

Or

Total FC / 1-(VCPU/SPPU)

BEP (Rs.) = FC X Sales / Contribution

Margin of safety: Excess of sales over the break even sales in known as the margin of
safety.

Margin of safety ratio = budgeted or actual sales – BE sales/ budgeted or actual sales
Process Costing

1. Product X requires three distinct processes and after the 3rd process the
product is transferred to finished stock. You are required to prepare various
process accounts from the following information.
Total P1 P2 P3
Rs. Rs. Rs. Rs.
Direct Material 5,000 4,000 600 400
Direct labour 4,000 1,500 1,600 900
Direct expenses 800 500 300 -
Production overheads 6,000 - - -
Production overheads to be allocated to different processes on the basis of
150% of direct wages.
Production during the period was 200 units. Assume there is no opening and
closing stock. (Ans. Finished stock 79 per unit, total amt-15,800 in process III)
2. The product of a manufacturing concern passes through two processes A and
B and then to finished stock. It is ascertained that in each process normally
5% of the total weight is lost and 10% is scrap which from Processes A and B
realizes Rs. 80 per ton and Rs. 200 per ton respectively.
The following are the figures relating to both the process :
Process A Process B
Materials in tons 1,000 70
Cost of materials in rupees per ton 125 200
Wages in rupees 28,000 10,000
Manufacturing expenses in rupees 8,000 5,250
Output in tons 830 780
Prepare Process Cost Accounts showing cost per ton of each process. There
was no stock or work-in-progress in any process (Ans-output 780 tons, Rs. 210
per ton, Amt. 163800)
3. Model Ltd. processes a patent material used in buildings. The material is
produced in three consecutive grades – soft, medium and hard.
Process I Process II Process III
Raw material used 1,000
tones
Cost per tonne Rs. 200
Manufacturing wages and
expenses Rs. 87,500 Rs. 39,500 Rs. 10,710
Weight lost (% of input of
the process) 5% 10% 20%
Scrap (sale price Rs. 50
per tonne) 50 tonnes 30 tonnes 51 tonnes
Sale price per tonne Rs. 350 Rs. 500 Rs. 800
Management expenses were Rs. 17,500 and selling expenses Rs. 10,000.
Two-thirds of the output of Process I and one-half of the output of Process II
are passed on to the next process and the balances are sold. The entire output
of process III is sold. Prepare the three process accounts and a statement of
profit. Make approximations where necessary. (Ans. 153 sales, Rs. 122400, net
loss 3760)
4. Product X is obtained after it passes through three distinct processes. You are
required to prepare Process accounts from the following information :
Process
Total I II III
Rs. Rs. Rs. Rs.
Material 15,084 5,200 3,960 5,924
Direct wages 18,000 4,000 6,000 8,000
Production overheads 18,000
1000 units @ Rs. 6 per unit were introduced in process 1.
Production overhead to be distributed as 100% on direct wages.
Actual output Normal loss Value of scrap
per unit
Unit Rs.
Process I 950 5% 4
Process II 840 10% 8
Process III 750 15% 10
(Ans. Process III Rs. 2736, abnormal gain – 36 unit)
5. A product passes through three processes, A, B and C. 10,000 units at a cost
Re. 1 were issued to process A. The other direct expenses were :
Process A Process B Process C
Sundry materials 1,000 1,500 1,480
Direct labour 5,000 8,000 6,500
Direct expenses 1,050 1,188 1,605
(Ans. Process c unit 8664, 86,640)
6. The output from Process X totaled 2,5000 units. It was considered that 200
units were an abnormal loss. Normal loss allowed was 10%. The other
information is given below :
Material @ Rs. 5 per unit
Labour Rs. 4,000
Overheads Rs. 3,350
Wastage realized Rs. 2.50 per unit
You are required to prepare Process Account and Abnormal Loss Account.
(Ans. Process unit 2500,Rs. 20,000, loss 1100)
7. A factory is engaged in the production of Chemical X and in the course of
manufacture by-product Y is produced which after a separate process has a
commercial value. Following are the information for the month of March.
Joint Expenses Separate Expenses
X Y
Material 10,000 2,000 2,800
Labour 4,000 2,500 2,500
Expenses 2,500 1,400 1,000
The output for the month was 150 quintals of X and 50 quintals of Y.
The selling price of product Y is Rs. 200 per quintal.
The profit on Y product is 33.33 % on cost price. Prepare an account to show
the cost of X per quintal. (Ans. Separate process y-7500 ,x-21,200)
8. X Ltd. manufactures product A which yields two by-products B and C. In a
period the amount spent up to the point of separation was Rs. 20,600.
Subsequent expenses were :
A B C
Materials Rs. 300 Rs. 200 Rs. 150
Direct wages 400 300 200
Overheads 300 270 280
----------- ----------- -----------
1,000 770 630
----------- ----------- -----------
Gross Sales value of products A, B and C was Rs. 15,500, Rs. 10,000, Rs.
5,000 respectively. It was estimated that the net profit as percentage of sales in
case B and C would be 25 per cent and 20 per cent, respectively.
Ascertain the profit earned on A. (Ans. Profit – 3,500)
9. The following details are extracted from the costing records of an oil refinery
for the week ended Sept. 30.
Purchase of 500 tons of copra Rs. 2,00,000.
Crushing plant Refining plant Finished
Cost of labour 2,500 1,000 1,500
Electric Power 600 360 240
Sundry Material 100 2,000 -
Repairs of Machinery and Plant 280 330 140
Steam 600 450 450
Factory Expenses 1,320 660 220
Cost of casks - - 750
300 tons of crude oil was produced.
250 tons of oil was produced by refining process.
248 tons of refined oil was finished for delivery.
Copra sack sold Rs. 400.
175 tons of copra residue sold Rs. 11,000.
Loss in weight in crushing 25 tons.
45 tons by-product was obtained from refining process valued at Rs. 6,750.
You are required to show the accounts in respect of each of the following
stages of manufacture for the purpose of arriving at the cost per ton of each
process and also the total cost per ton of finished oil.
(a) Copra crushing process.
(b) Refining process.
(c) Finished product. (Ans. Finished stock 814.9 per ton, Rs. 202,100)
10. An oil company gives the following cost data. You are required to prepare
various accounts. Purchases of 1000 quintals of copper @ Rs. 500 per
quintal.
Crushing Refining Finishing
Rs. Rs. Rs.
Cost of Labour 6,600 3,000 3,000
Electric Power 1,000 500 400
Sundry Material 700 200 -
Repair to Machinery and Plant 500 400 400
Steam 250 150 100
Other Factory Exp. Rs. 9,450
To be charged 75% of wages
Cost of casks 580
st
Normal loss in 1 Process was 30% of input, actual output 690 quintals.
Process II, By-product 90 quintals value Rs. 6,200.
Process III, Normal loss 5%, Actual output 580 quintals.
Scrap of 1st Process realized Rs. 10 per quintal.
(Ans. Finishing Process 580 quintal, 5,19,100)
11. Opening Stock 500 units @ 6 per unit
Transferred from process II 15,000 units costing Rs. 32,175
Direct Material, Added Rs. 10,350
Direct wages Rs. 27,260
Production wages Rs. 21,845
Units scrapped
Normal loss 5%
Transfer to process IV 13,200 units
Closing stock 1,500 units
Degree of Completion
Opening stock Closing stock Scrapped units
Material 80% 60% 100%
Labour 50% 40% 80%
Overheads 50% 40% 80%
Units scrapped were sold @ Rs. 2 each (Ans. Process III cl. Stock 1500 unit, Rs.
6,150, loss Rs. 380)
12. A factory producing article P also produces a by-product Q which is further
processed into finished product. The joint cost of manufacture is given
below:- Rs.
Material 5,000
Labour 3,000
Overheads 2,000
----------
10,000
----------
Subsequent costs are given below :
P Q
Rs. Rs.
Material 3,000 1,500
Labour 1,400 1,000
Overheads 600 500
----------- -----------
5,000 3,000
----------- ------------
Selling prices are P- Rs. 16,000
Q- Rs. 8,000
Estimated profits on selling prices are 25% for P and 20% for Q. Assume that
selling and distributing expenses are in proportion of sales price. Show how
you would apportion joint cost of manufacture and prepare a statement
showing cost of production of P and Q. (Ans. Cost of production P-11,733, Q-6267)
13. A product passes through two distinct processes A and B and thereafter. It is
transferred to finished stock. The output of A pass to B and that of B to
finished product. From the following information you are required to prepare
process accounts.
Process A Process B
Rs. Rs.
Material consumed 12,000 6,000
Direct labor 14,000 8,000
Manufacturing exp. 4,000 4,000
Input in process A (units) 10,000 -
Input in process A (value) 10,000 -
Output (units) 9,400 8,300
Normal wastage percentage of input 5% 10%
Value of normal wastage
(per 100 units) 8 10
(Ans. Process B normal loss – 940, abnormal loss 160, finished stock-8300, Rs. 56,358)
Uses of Marginal Costing or Cost Analysis for Decision
Making

1. A company has capacity of producing 1,00,000 units of a certain product in a


month. The sales department reports that the following schedule of selling
price is possible :
Volume of Production Selling price per unit
60% 0.90
70% 0.80
80% 0.75
90% 0.67
100% 0.61
The variable costs of manufacture between these levels are Rs. 0.15 per unit
and fixed costs Rs. 40,000. At what volume (level) of production will the
profit be maximum ? (Ans. 80% production will give maximum profit)

2. Juneja Ltd. manufactures readymade garments and uses its cutpieces of cloth
to manufacture dolls. The following statement of cost has been prepared :
Readymade Dolls Total
Garments
Rs. Rs. Rs.
Materials 1,60,000 12,000 1,72,000
Labour 26,000 2,400 28,400
Variable Overheads 34,000 5,600 39,600
Fixed Overheads 48,000 6,000 54,000
------------ ------------ ------------
Total Cost 2,68,000 26,000 2,94,000
Sales 3,40,000 24,000 3,64,000
------------ ------------ ------------
Profit (+) Loss (-) + 72,000 - 2,000 + 70,000
------------ ------------ ------------
Cutpieces used in the manufacture of dolls have a scrap value of Rs. 4,000, if
sold in the market. As there is loss of Rs. 2,000 in the manufacturing of dolls,
it is suggested to discontinue its manufacture. Advise the management.
(Ans. Co. should not discontinue manufacturing of dolls otherwise profit will
reduce by Rs. 12000)
3. Indian Rupsee Ltd. has three departments. each of which makes a different
product. Cost and related data for the last year (not expected to change next
year) are as follows :
Departments
A B C
Rs. Rs. Rs.
Sales 80,000 40,000 60,000
----------- ----------- -----------
Marginal Costs :
Direct Materials 10,000 5,000 10,000
Direct Labour 4,000 5,000 16,000
Variable Overheads 10,000 5,000 20,000
Fixed Costs Rs. 50,000
The Manager of C department is very perturbed by the result. The product
being made has an assured market and there is no other product which could
be substituted for the product already being made. Prime and variable costs
are down to a low level and there is little hope of these being reduced further.
The fixed costs traceable to a particular departments are :
A – Rs. 14,000; B- Rs. 8,000; C- Rs. 16,000.
The balance of fixed costs is common to all the departments. You are required
to present the information in the most suitable manner indicating whether or
not department C should be closed down. (Ans. Should be closed department C)
4. Indu Enterprises produce three lines. Their details are :
Lines
A B C
Capacity engaged 20% 40/% 40%
Unit produced 2,000 5,000 6,000
Cost per unit : Rs. Rs. Rs.
Materials 20 32 36
Wages 10 12 16
Variable Overheads 7 9 11
Fixed Overheads 6 9 10
------------ ------------ ------------
43 62 73
40 75 85
Selling Price per unit ------------ ------------ ------------
Profit (+) Loss (-) -3 + 13 + 12
------------ ------------ ------------
The management proposes to discontinue the line A and utilise the
disengaged capacity of line A equally in lines B and C.
Expected rise in price and cost B C
Materials 10% 10%
Wages 5% 5%
Selling price 2% 5%
Fixed Overheads shall remain unchanged. You are required to prepare a
statement of projected profitability and advise the management as to whether
the scheme be adopted or abandoned. (Ans: discontinue the line A)
5. M/s. Bharat Furniture is thinking to drop one item from its product lines and
to replace it with another. Below are given its present cost and output data :
Product Price Variable Cost per unit Percentage of Sales
Rs. Rs. Rs.
Chair 60 40 30%
Bench 100 60 20%
Table 200 120 50%
The change under consideration is dropping the Bench and introducing Book-
Shelf. If this change is made, the firm forecasts the following cost and output
data :
Product Price Variable Cost per unit Percentage of Sales
Rs. Rs. Rs.
Chair 60 40 50%
Book-Shelf 160 60 10%
Table 200 120 40%
Total fixed costs and sales for the present and forecasts are :
Present Forecasts
Rs. Rs.
Sales 25,00,000 26,00,000
Fixed Costs 7,50,000 7,50,000
Should the proposal be accepted ? (Ans: proposal should be accepted because profit
will increase by Rs. 61,833)
6. Nisha Ltd. produces three products A, B & C. The following are the cost data
relating to these products :
A B C D
Sales (Rs.) 75,000 45,000 30,000 1,50,000
Variable Costs (Rs.) 60,000 31,500 18,000 1,09,500
---------- ---------- ---------- ------------
Contribution 15,000 13,500 12,000 40,500
---------- ---------- ----------
Fixed Costs 20,250
----------
Profit 20,250
----------
You are required to prove how knowledge of marginal costing can help
management in changing the product-mix in order to increase profit. (Ans:
profit will increse by Rs. 4500)
7. Kailash Motor Ltd. has an annual production of 90,000 units for a motor
component. The component cost structure is as below :
Rs.
Materials p.u. 270
Labour p.u. (25% fixed) 180
Overheads : Variable p.u. 90
Fixed p.u. 135
-------
675
-------
(a) The purchase manager has an offer from a supplier who is willing to
supply the component at Rs. 540. Should the component be purchased and
production stopped ?
(b) Assume the resources now used for this component’s manufacture are to
be used in producing another new product for which selling price is Rs.
485. In such a case, the material price will be Rs. 2000 per unit. 90,000
units of this product can be produced at the same cost basis as above for
labour and overheads. Discuss whether it would be profitable to divert the
resources to manufacture the new product, on the footing that the
component currently being produced would be purchased from the market
instead of being produced. (Ans. Should be purchased from market)
8. K. K. Industries Ltd. purchases 12,000 units p.a. of a spare part from another
manufacturer @ Rs. 4 per unit. The production manager has put forward a
proposal that the production of this spare part may be undertaken by the
company in order to have full control over the supply of the spare part. He has
submitted the following information alongwith the proposal :
(i) Material & Labour would cost Re. 0.60 and Re. 0.50 respectively
per unit.
(ii) Variable overhead will be 100% of labour.
(iii) A foreman will be employed at Rs. 1,000 p.m.
(iv) Machine needed would cost Rs. 50,000. It will have a production
capacity of 15,000 units and its economic life will be 5 years.
(v) Funds need for the above (iv) can be obtained at an interest rate of
10% p.a.
You are required to advise the management about the proposal. (Ans.
Should produce 12000 unit)
9. Jayco Ltd. has tow factories – main and feeder. Main factory is run at 70%
capacity (installed capacity is 1,20,000 units) and feeder factory supplies its
requirements by working at 80% capacity. The cost structure of feeder factory
is given below :
Rs.
Materials 1,68,000
Wages (50 paise per unit plus fixed D.A.) 60,000
Overheads : Fixed 75,000
Variable 42,000
-----------
3,45,000
The production of main factory is to be raised to 80% capacity. The
component can be bought from the market at Rs. 3.50 per unit. As cost of
feeder factory exceeds Rs. 4 per unit, it is proposed to procure the additional
requirements from the market instead of having them from the feeder factory.
Advise the management. (Ans. Additional 12000 unit should get from feeder
factory)
10. You are Management Accountant of a company. The Managing Director of
the company seeks your advice on the following problem :
The company produces a variety of products each having a number of
component parts. Product B takes 5 hours to produce on a machine working at
full capacity. B has a selling price of Rs. 50 and a marginal cost of Rs. 30 per
units. ‘A/10’ a component part could be made on the same machine in 2 hours
for a marginal cost of Rs. 5 per unit. The supplier’s price is Rs. 12.50 per unit.
Should the company make or buy ‘A/10’ ? Assume that machine hour is
limiting factor.
Selling Price Rs. 50
Less : Marginal Cost Rs. 30
---------
Contribution Rs. 20
---------
Contribution per machine hour = 20 = Rs. 4
5
Contribution Lost if A/10 is made = 4 x 2 = Rs. 8
(Opportunity Cost)
Marginal Cost of A/10 Rs. 5.00
Opportunity cost Rs. 8.00
----------
Total Cost Rs. 13.00
Buying Price Rs. 12.50
----------------
Saving if bought Re. 00.50
----------------
(Ans. Saving if bought .50)
11. Naithani Automobiles Ltd. manufactures certain parts. Following are the total
costs and cost per unit of processing a component :
Units Cost Total Costs for
1,00,000 units
Rs. Rs.
Materials 5 5,00,000
Labour 8 8,00,000
Variable Factory Exp. 6 6,00,000
Fixed Factory Expenses 5 5,00,000
------- -------------
24 24,00,000
------- -------------
Another manufacturer has offered to sell the same part to Naithani
Automobiles Ltd. for Rs. 22 each. Fixed factory expenses would continue to
be incurred even if the component is bought out, although there would be
reduction of Rs. 1,50,000 due to savings in salaries of supervising personnel.
(a) Should the part be made or bought considering that the present facility
when released following a buying decision would remain idle ?
(b) In the case the present facility can be rented to another manufacturer for
Rs. 50,000 as there is good demand for spare facilities, what will be the
position ? (Ans. Saving when make – Rs. 100,000)
12. A radio manufacturer finds that while it costs Rs. 6.25 per unit to make
component XX-09 the same is available in the market at Rs. 5.75 each.
Continuous supply is also assured. The break-down of costs is :
Per unit
Rs.
Materials 2.75
Labour 1.75
Other Variable Expenses 0.50
Depreciation & Other Fixed Costs 1.25
--------
6.25
---------
(a) Will you make or buy ?
(b) What would be your decision, if the supplier offered the component at Rs.
4.85 per unit ? (Ans. Saving when bought .15)
13. A manufacturing company is considering whether to buy a commodity with
an annual sales potential of Rs. 10,00,000 and thereafter discontinue the
manufacture of that commodity. Manufacturing Costs are Rs. 7,00,000 while
purchase cost would be Rs. 7,50,000. Selling costs are Rs. 1,00,00.
Administrative Costs are Rs. 40,000 and would be Rs. 10,000 less if the
commodity was bought.
Capital requirements are Rs. 16,00,00 for making and Rs. 9,60,000 for buying.
The manufacturing plant has a life of four years of which three years have
elapsed and before its renewal, a decision on making or buying has to be
made. You are required to advise the management on the basis of above data
whether to buy or to make the commodity. (Ans. Profit in buying is 12.5%)
14. Part 555 is being manufactures and used by Modern Engineers Ltd. in finished
goods. The annual requirements of this part are 12,000 units. The lowest price
quotation so far received from an outside supplier is Rs. 21.50 per unit. This is
being considered as the company wants to discontinue the manufacture of this
part and buy it from outside. You are asked to help the company for taking a
decision. In this connection, following figures are given to you :
The expenses when part 555 was in production for 12,000 units were :
Rs.
Materials 3,50,000
Direct Labour 4,00,000
Indirect Labour 1,60,000
Lighting 20,000
Power 30,000
Depreciation 2,00,000
Insurance 15,000
Miscellaneous 27,000
Fringe benefits to labour work out 10% of total labour cost. Discontinuing the
production of this component would not in any way permit the disposal of any
of the factory’s assets. The following proportion of expenses can be avoided if
the manufacture of part 555 is stopped :
Materials 30%
Direct Labour 35%
Indirect Labour 25%
Power 20%
When the part is purchased from an outside supplier, shipping charges would
averages 75 paise per unit and indirect labour cost would be increased by Rs.
2,000 annually for receiving, inspecting and handling the purchased parts.
Prepare a schedule showing the relative costs of buying and making and give
your recommendation. (Ans. Net saving in bought is 39,800)
15. A new product was manufactured by Shobha Ltd. and was placed for sale in
three regional markets for launching it nationally. Three prices were selected
for testing each market. From the following particulars, ascertain the price to
give maximum profitability :
Selected Prices (Rs.) p.u. 10 12.50 15
Estimated Sales (Nos.) 800 600.00 300
Variable Costs (Total) :
Production (Rs.) 2,520 1,890.00 945
Selling (Rs.) 400 350 200
Traceable Fixed Costs (Rs.) 700 700 600
(Ans .Profit at 12.5 is highest i.e. 4560)
16. An umbrella manufacturer makes an average profit of Rs. 2.50 per piece in
selling at price of Rs. 14.30 by producing and selling 60,000 pieces or 60
percent of potential capacity. The cost of sales is :
Rs.
Direct Material 3.50
Direct Wages 1.25
Works Overhead 6.25 (50% Fixed) – 3.12
Sales Overhead 0.80 (25% Variable)
During the current year he intends to produce the same number but anticipates
that his Fixed Charges will go up by 10 per cent while rates of direct labour
and direct material will increase by 8% and 6% respectively. But he has no
option of increasing the selling price. Under this situation he obtains an offer
for a further 20% of his capacity. What minimum price will you recommend
for the offer to ensure the manufacturing an overall profit of Rs. 1.673 Lakhs ?
Reason your recommendation. (Ans. fixed cost – 2,45,850)
17. Sri Ram Prasad manufactures lighters. He sells his product at Rs. 20 each and
makes profit of Rs. 5 on each lighter. He worked 50% of his machinery
capacity at 50,000 lighters. The cost of each lighter is as under : -
Rs.
Direct Material 6
Wages 2
Works Overhead 5 (50% fixed)
Selling Expenses 2 (25% variable)
His anticipation for the next year is that the costs will go up as under :
There will not be any change in selling price. There is an additional order for
20,000 lighters in the next year. What is the lowest rate he quote so that he can
earn the same profit as the current year? (Ans. Lowest rate 14.45 per lighter)
18. On account of trade depression, Dall Ltd. is experiencing a difficult trading
period and as a result is operating well below the normal capacity to produce
and to sell.
An enquiry has been received for 100 0units of product X and the directors are
very anxious to obtain the order. The cost data relating to product X are as
under :
(ii) Direct labour per unit 2 hours at Rs. 4 per hour.
(iii) Direct Material Cost per unit Rs. 8.
(iv) Overheads are recovered on the basis of Rs. 16 for direct labour hour for
variable cost and Rs. 24 for direct labour for fixed costs.
(v) Additional costs relate to special moulds which have to be purchased @
one per product at Rs. 1.60 each and special equipment costing Rs. 2,000
is also to be bought. In both the cases, there is no hope of the costs being
recovered by other products.
(vi) It is also desired that 40% of the fixed costs should be recovered.
Assuming that the order can be fitted into existing capacity without difficulty,
advise the price to be settled. (Ans. selling price 88.80)
19. B Ltd. is running its plant at present at 50% of capacity. The management has
supplied you the following details :
Cost of Production
per unit (Rs.)
Direct Materials 4
Direct Labour 2
Variable Overhead 6
Fixed Overheads (fully absorbed) 4
-------
16
-------
Production per month 40,000 units.
Total cost of product = 40,000 x 16 = Rs. 6,40,000
Total Sales = 40,000 x 14 = Rs. 5,60,000
---------------
Loss Rs. 80,000
---------------
An exporter has offered to purchase 10,000 units per month @ Rs. 13 per unit
and the company is hesitating in accepting the offer due to the fear that it will
increase its already large operating losses. Advise the company as to accept or
to decline the offer. (Ans. Profit Rs.10,000 is offer will accept )
20. Rajhans Ltd. makes a single product and sales for Rs. 30 per unit and there is
great demand of the product. The variable cost of the product is Rs. 16 as
detailed below :
Rs.
Direct Materials 8
Direct Labour (2 hrs.) 4
Variable overhead 4
------
16
------
The labour force is currently working at full capacity and no extra time can be
made available. Mr. S.S. Lal, a customer has approached the company with a
request for manufacture of a special order at Rs. 8,000. The cost of the order
would be Rs. 300 for Direct Material and 600 hours (labour) will be required
and variable overhead per hour shall be Rs. 2. Should the order be accepted ?
(Ans. should not accept because loss is RS.1600)

21. The following flexible budget of Pyramid Ltd. indicates the cost position at
60% level :
15,000 units
Production in units Cost per unit Total
Rs. Rs.
Materials 3.00 45,000
Wages 1.50 22,500
Overheads : Fixed 2.00 30,000
Variable 0.50 7,500
-------
7.00
Sales per unit 9.00
-------
Profit per unit 2.00
-------
It is informed by the Chief Marketing Officer that the existing market will not
absorb mass production. A special order for 5,000 units from Government
may be obtained if the goods can be supplied at Rs. 6.50 per unit. Do you
think that the order is worth trying ? (Ans. profit Rs. 7500, if order accepts)
22. A firm having a capacity of 15,000 units per year produces 10,000 units which
are consumed in the home market at Rs. 25 per unit. The Cost Sheet (per unit)
on the basis of this output is under :
Rs.
Material 8.00
Labour 6.00
Fixed Factory Expenses 2.00
Variable Factory Expenses 1.50
Office Expenses : 1.00
Selling Expenses :
Fixed 0.50
Variable 1.00
--------
Total Cost 20.00
--------
A foreign customer is interested in the product but he is willing to buy only
5,000 units and that too at a price of Rs. 18 per unit. Do you advise the firm to
accept to order? (Ans. should accept the offer, profit increase by Rs.7500)
23. Hind Motors Ltd. specialized manufacturer of a Motor Part, is operating at
60% of its capacity of producing 20,000 units per month. Its monthly budget
for fixed expenses (including dep.) is Rs.1,20,000 p.m. The variable cost of
making the part is as under :
Rs.
Direct Material 11.00 per unit
Direct Labour 2.00 per unit
Expenses 5.00 per unit
-------
18.00 per unit
-------
The company has invested Rs. 48 lakhs in the business and currently earning a
return of 6% p.a. before tax. The Managing Director is prepared to accept a
new business at any price which will raise the return to 20% before tax.
A car manufacturer has offered to buy 8,000 units of the part every month, if
it could be supplied at Rs. 21 per unit. Would you advise the company to
accept the offer ? (Ans. should not accept the offer because return is only
12%.)
Standard Costing
Standard Cost is a predetermined cost which determines what each product or service
should under given circumstances.

Variance
Variance as the difference between a standard cost and the comparable actual cost
incurred during a given period. The purpose of knowing the variance is to enable the
management to exercise control over cost. It enable to know whether the standards set is
achieved or not.

A variance is said to be favorable when the actual results are better than the standards and
an adverse or unfavorable variance when actual are not up to the standards.

VARIANCE

Material Labour Overhead

Material Cost Labour cost OH Cost


Material Usage Labour Efficiency OH Values
Material Price Labour Rate

MATERIAL VARIANCE

SQ = Standard Quantity SP = Standard Price


AP = Actual Price AQ = Actual Quantity

1) Material Cost Variance (MCV)


MCV = (SQ x SP) – (AQ x AP)
MCV = MPV – MUV
or
SC – AC
2) Material Usage Variance (MUV)
MUV = (SQ - AQ) x SP

3) Material Price Variances (MPV)


MPV = (SP – AP) x AQ

4) Material Mix Variance (SQ - AQ) x SP

LABOUR VARIANCE
SR = Standard Rate
AR = Actual Rate
AH = Actual Hours
SH = Standard Hours
AY = Actual Yield
SY = Standard Yield

1) Labour rate variance = (SR - AR)AH


2) Labour usage / efficiency variance
(SH - AH) x SR
3) Labour cost variance
(SH x SR) – (AH x AR)
Material yield variance (MYV) : Difference between Standard Normal Loss and Actual
Normal Loss.

(MYV) = (AY - SY) x SC per unit


Some time revised yield will be used
(MYV) = (AY - RV) x SC
Standard Costing
1. The standard cost card shows the following details relating to material requirement to
produce one kg. of groundnut oil.
Quantity of Groundnut 3 kgs.
Price of Groundnut 75 ps. per kg.
Actual Production data :
Production during one month 1,000 kgs.
Quantity used 3,500 kgs.
Price of Groundnut Re. 1 per kg.
Calculate and analyse Material Cost Variance. (Ans. total 1250)

2. Following is the standard for producing ‘M’ :


Material X 60 units @ Rs. 5 per unit.
Material Y 40 units @ Rs. 10 per unit.
Actual :
Material X 50 units @ Rs. 6 per unit.
Material Y 50 unmits @ Rs. 8 per unit.
Analysis Material Cost Variance. (Ans. total nil)

3. Reliance Petrochemicals Ltd. which produces a product P uses Standard Cost System.
Its Standard Product Cost specification per 1,000 kg. of P are :
Raw Material Qty. Price per kg. Cost
(kg.) Rs. Rs.
A 600 4.00 2,400
B 600 1.00 600
Materials records for the month of January 2001 showed as under :
Materials Consumed
A 6,800 kg. @ 4.10
B 7,600 kg. @ 1.10
Actual finished product achieved during the month of January 2001 was 12,000 kg.
Purchase Manager was quite surprised to learn that there has been favourable total
raw material cost variance while the actual price paid for A and B raw materials have
been higher than standard price. Can it really be so ? Why ? Show your calculations.

(Ans. total 240)

4 Standard Mix for production of ‘X’ :


‘A’ 60 tons @ Rs. 5 per ton
‘B’ 40 tons @ Rs. 10 per ton.
Actual Mixture being :
‘A’ 80 tons @ Rs. 4 per ton
‘B’ 70 tons @ Rs. 8 per ton
Reconcile Actual Material Cost with Standard Material Cost. (Ans.A-320, B-560 )

5 In a brass foundry, the Standard Mixture consists of 60% Copper and 40% Zinc. The
Standard Loss of production is 10% on input. From the actual production in a month,
calculate the Material Cost Variance and analyse it :
Copper 25 kgs. @ Rs. 15 per kg. (Standard 30 kgs.), Zinc 25 kgs. @ Rs. 10 per kg.
(Standard 20 kgs.)
Actual output : 43 kgs. There is no difference between SP and AP. (Ans. total 4)

6. In a brass foundry, the Standard Mixture consists of 60% Copper and 40% Zinc. The
Standard Loss of production is 30%. Standard Mixture and Yield were :
Copper 60 kgs. Rs. 5 per kg.
Zinc 40 kgs. @ Rs. 10 per kg.
Standard yield 70 kg.
The actual Mixture and Yield were :
Copper 80 kgs. @ Rs. 4.50 per kg.
Zince 70 kgs. @ Rs. 8.00 per kg.
Actual yield 115 kg.
Calculate the Mix Variance, Price Variance, Yield Variance and Usage Variance.

(Ans.180,50,450,350 )

7 The following standar and actual data relate to a manufacturing concern :


Standard
Material X 40 kg. @ Rs. 6 = Rs. 240
Material Y 60 kg. @ Rs. 4 = Rs. 240
Standard output is 80% of input i.e., 700 units. Process Loss is 20%.
Actual
Material X 600 kgs. at Rs. 4
Material Y 400 kgs. at Rs. 6
Actual output is 70% of input i.e., 700 units. Process loss is 30%.
You are required to calculate material cost variances. (Ans. total 600)
8 Raja Bros. manufactures a product ‘X’. It is estimated that for each ton of material
consumed, 100 units should be produced. The standard price per ton of material is Rs.
10. During the first week of January 2001, 100 tons of materials were issued to
production, the price of which was Rs. 10.50 per ton. Production during the week was
10,200 units. Calculate variances. (Ans .total 30 )
9 Calculate (i) Material Cost Variance, (ii) Material Price Variance, (iii) Material Usage
Variance from the following information :
Materials purchased 3,000 kg.
Value of Materials purchased Rs. 9,000
Standard Quantity – 25 kg. for one kg. of finished goods
Standard Price – Rs. 2 per kg.
Closing Stock of Materials – 500 kg.
Finished goods produced – 80 kg. (Ans. Total 3500)

10 Standard set for material consumption was 100 kg. @ Rs. 2.25 per kg.
In a cost period :
Opening Stock was 100 kg. @ 2.25 per kg.
Purchases made 500 kg. @ 2.15 per kg.
Consumption 100 kg.
Calculate :
(a) Usage Variance
(b) Price Variance, when
(i) It is calculated at point of purchase.
(ii) It is calculated at point of issue on FIFO basis.
(iii) It is calculated at point of issued on LIFO basis. (Ans. price variance Rs.11)

11. The following information is obtained form a Standard Cost records :


Labour Rate 90 Paise per hour
Hour – 3 Hours per unit
Actual production data are :
Units produced 250.
Labour Rate Rs. 1.05 per hour
Hours worked 800.
Calculate Labour Rate and Labour Efficiency Variances. (Ans. 120, 45)
12. Given for a factory :
Normal number of workers in the department 50
Number of hours paid for in a week 40
Standard rate of wages per hour Re. 0.80
Standard output of the department per hour
taking into account normal idle time 20 units
In the first week of March, it was ascertained that 1,000 units were produced despite
20% idle time due to power failure and actual rate of wages was Re. 0.90 per hour.
Calculate Labour Variance. (Ans. total 200 )

13. Analyse the labour cost variance from the following information
Standard Actual
Hrs. Rates (Rs.) Hrs. Rates (Rs.)
Workman A 20 3 30 2.90
Workman B 25 4 15 4.50
(Ans. Total5.50 )
14. The following information relates to a manufacturing process of a company :
Number of employees 200
Weekly hours 40
Standard wage rate 50 Paise per hour
Standard output 250 Units per hour
During the first week of February, four employees were paid at 45 Paise per hour and
two employees at 55 Paise per hour, the rest employees were paid at standard rates.
Idle time is one hour per employees. Actual output was 10,250 units. Calculate
Labour Cost Variance. (Ans. total labour variance104)
15 Calculate the various Fixed Overheads Variance from the following data :
Standards Actual
Output in units 4,000 5,000
Working hours 2,500 2,400
Fixed Overheads Rs. 20,000 Rs. 30,000
(Ans.5000)
16 A Manufacturing Company operates a Standard Costing System and showed the
following information for October 2001 :
Budget Actual
Units of Output 4,000 4,250
Working Days 20 22
Labour Hours 40,000 43,000
Overheads Expenses Rs. 20,0900 Rs. 19,000
Calculate various overhead variances. (Ans. 2250)