CLASSIFICATION OF COSTS: Manufacturing

We first classify costs according to the three elements of cost:

a) Materials b) Labour c) Expenses

Product and Period Costs: We also classify costs as either

1 Product costs: the costs of manufacturing our products; or
2 Period costs: these are the costs other than product costs that are charged to,
debited to, or written off to the income statement each period.

The classification of Product Costs:

Direct costs: Direct costs are generally seen to be variable costs and they are called
direct costs because they are directly associated with manufacturing. In turn, the
direct costs can include:

Direct materials: plywood, wooden battens, fabric for the seat and the back, nails,
screws, glue.Direct labour: sawyers, drillers, assemblers, painters, polishers,
upholsterersDirect expense: this is a strange cost that many texts don't include; but
(International Accounting Standard) IAS 2, for example, includes it. Direct expenses
can include the costs of special designs for one batch, or run, of a particular set of
tables and/or chairs, the cost of buying or hiring special machinery to make a
limited edition of a set of chairs.

Total direct costs are collectively known as Prime Costs and we can see that Product
Costs are the sum of Prime costs and Overheads.

Indirect Costs: Indirect costs are those costs that are incurred in the factory but that
cannot be directly associate with manufacture. Again these costs are classified
according to the three elements of cost, materials labour and overheads.

Indirect materials: Some costs that we have included as direct materials would be
included here . Indirect labour: Labour costs of people who are only indirectly
associated with manufacture: management of a department or area, supervisors,
cleaners, maintenance and repair technicians Indirect expenses: The list in this
section could be infinitely long if we were to try to include every possible indirect
cost. Essentially, if a cost is a factory cost and it has not been included in any of the
other sections, it has to be an indirect expense. Here are some examples include:

Depreciation of equipment, machinery, vehicles, buildings

Electricity, water, telephone, rent, Council Tax, insurance
Total indirect costs are collectively known as Overheads.

Finally, within Product Costs, we have Conversion Costs: these are the costs
incurred in the factory that are incurred in the conversion of materials into finished
goods.

The classification of Period Costs:

The scheme shows five sub classifications for Period Costs. When we look at
different organisations, we find that they have period costs that might have
sub classifications with entirely different names. Unfortunately, this is the nature of
the classification of period costs; it can vary so much according to the organisation,
the industry and so on. Nevertheless, such a scheme is useful in that it gives us the
basic ideas to work on.

Administration Costs: Literally the costs of running the administrative aspects of an

organisation. Administration costs will include salaries, rent, Council Tax, electricity,
water, telephone, depreciation, a potentially infinitely long list. Notice that there are
costs here such as rent, Council Tax, that appear in several sub classifications; in
such cases, it should be clear that we are paying rent on buildings, for example,
that we use for manufacturing and storage and administration and each area of the
business must pay for its share of the total cost under review.

Without wishing to overly extend this listing now, we can conclude this discussion
by saying that the costs of Selling, the costs of Distribution and the costs of
Research are all accumulated in a similar way to the way in which Administration
Costs are accumulated. Consequently, our task is to look at the selling process and
classify the costs of running that process accordingly: advertising, market research,
salaries, bonuses, electricity, and so on. The same applies to all other classifications
of period costs that we might use.

Finance Costs: Finance costs are those costs associated with providing the
permanent, long term and short term finance. That is, within the section headed
finance costs we will find dividends, interest on long term loans and interest on
short term loans.

Finally, we should say that we can add any number of subclassifications to our
scheme if we need to do that to clarify the ways in which our organisation operates.
We will also add further subclassifications if we need to refine and further refine out
cost analysis.
COST SHEET – FORMAT
Particulars Amou Amou
nt nt

Opening Stock of Raw Material ***

Add: Purchase of Raw materials ***
Add: Purchase Expenses ***
Less: Closing stock of Raw Materials ***
Raw Materials Consumed ***
Direct Wages (Labour) ***
Direct Charges ***

Prime cost (1) ***

Add :- Factory Over Heads:

Factory Rent ***
Factory Power ***
Indirect Material ***
Indirect Wages Supervisor Salary ***
Drawing Office Salary ***
Factory Insurance ***
Factory Asset Depreciation ***
***

Works cost Incurred ***

Add: Opening Stock of WIP ***

Less: Closing Stock of WIP ***

Works cost (2) ***

Add:- Administration Over Heads:-

Office Rent ***
Asset Depreciation ***
General Charges ***
Audit Fees ***
Bank Charges ***
Counting house Salary ***
Other Office Expenses ***

Cost of Production (3) ***

Add: Opening stock of Finished Goods ***

Less: Closing stock of Finished Goods ***

Cost of Goods Sold ***

 Add:- Selling and Distribution OH:-
Sales man Commission ***
Sales man salary ***
Traveling Expenses ***
Advertisement ***
Delivery man expenses ***
Sales Tax ***
Bad Debts ***

Cost of Sales (5) ***

Profit (balancing figure) ***

Sales ***

Notes:-

1) Factory Over Heads are recovered as a percentage of direct wages

2) Administration Over Heads, Selling and Distribution Overheads are recovered as

a percentage of works cost.
MATERIAL

1) Reorder level = Maximum usage * Maximum lead time

(Or) Minimum level + (Average usage * Average Lead time)

2) Minimum level = Reorder level – (Average usage * Average lead time)

3) Maximum level = Reorder level + Reorder quantity – (Minimum usage *

Minimum lead time)

4) Average level = Minimum level +Maximum level (or)

2
Minimum level + ½ Reorder quantity

5) Danger level (or) safety stock level

=Minimum usage * Minimum lead time (preferred)
(or) Average usage * Average lead time
(or) Average usage * Lead time for emergency purposes

6) EOQ (Economic Order Quantity - Wilson’s Formula) = √2AO/C

Where A = Annual usage units
O = Ordering cost per unit
C = Annual carrying cost of one unit
i.e. Carrying cast % * Carrying cost of unit

7) Associated cost = Buying cost pa + Carrying cost pa

8) Under EOQ Buying cost = Carrying cost

9) Carrying Cost = Average inventory * Carrying cost per unit pa * Carrying cost %

(Or) Average Inventory * Carrying cost per order pa

10) Average inventory = EOQ/2

11) Buying cost = Number of Orders * ordering cost

12) Number of Orders = Annual Demand / EOQ

13) Inventory Turnover (T.O) Ratio = Material consumed

Average Inventory

14) Inventory T.O Period = 365 .

Inventory Turn over Ratio

15) safety stock = Annual Demand *(Maximum lead time - Average lead time)

365

16) Total Inventory cost = Ordering cost + Carrying cost of inventory +Purchase
cost

17) Input Output Ratio = Quantity of input of material to production

Standard material content of actual output

Remarks :-

1) High Inventory T.O Ratio indicates that the material in the question is fast moving

2) Low Inventory T.O Ratio indicates over investment and locking up of working

Capital in inventories

Pricing of material Issues:-

1) Cost price method:-

a) Specific price method

b) First in First Out method (FIFO)

c) Last in First Out method (LIFO)

d) Base stock method

2) Average price method:-

a) Simple average price method = Total unit price

Total No. of purchases

b) Weighted average price method = Total cost

Total No. of units

c) Periodic simple average price method = Total unit price of certain period
Total Number of purchases of that period (This rate is used for all issues for that
period. Period means a month (or) week (or) year)

d) Periodic weighted average price method = Total cost of certain period

Total Number of units of that period

e) Moving simple average price method

= Total of periodic simple average of certain number of periods

Number of periods

f) Moving weighted average price method

= Total of periodic weighted average of certain number of periods

Number of periods

3) Market price method:-

a) Replacement price method = Issues are valued as if it was purchased now at

current market price
b) Realizable price method = Issues are valued at price if it is sold now

4) Notional price method:-

a) Standard price method = Materials are priced at pre determined rate (or)
Standard rate

b) Inflated price method = The issue price is inflated to cover the losses incurred
due to natural(or)climatic losses

5) Re use price method = When materials are returned (or) rejected it is valued at
different price. There is no final procedure for this method.

ABC Analysis (or) Pareto Analysis :- In this materials are categorized into
ParticularsQuantityValue
“A” – Important material 10% 70%
“B” – Neither important nor unimportant 20% 20%
“C” – UN Important 70% 10%

Note:-

1) Material received as replacement from supplier is treated as fresh supply

2) If any material is returned from Department after issue, it has to be first

disposed in the next issue of material

3) loss in the book balance of stock and actual is to be transferred to Inventory

adjustment a/c and from there if the loss is normal it is transferred to Over
Head control a/c. If it is abnormal it is transferred to costing profit and loss a/c.

4) CIF = Cost Insurance and Freight (This consignment is inclusive of prepaid

insurance and freight)

5) FOB = Free on Board (Materials moving by sea – insurance premium is not

paid)

6) FOR = Free on Rail (Insurance and freight is not borne by the supplier but paid
by the company or purchase)

7) For each receipt of goods = Goods Receipt note

8) For each issue of goods = Materials Requisition note (or) Material Issue note

Accounting Treatment :-

1) Normal Wastage = It should be distributed over goods output increasing per unit
cost

2) Abnormal Wastage= It will be charged to costing profit and loss a/c

 3) Sale value of scrap is credited to costing profit and loss a/c as an abnormal gain.

4) Sale proceeds of the scrap can be deducted from material cost or factory
overheads.

5) Sale proceeds of scrap may be credited to particular job.

6) Normal Defectives = cost of rectification of defectives should be charged to

specific

7) Abnormal Defectives = This should be charged to costing profit and loss a/c

8) Cost of Normal spoilage is to borne by good units

9) Abnormal spoilage should be charged to costing profit and loss a/c.

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1. 02-11-2011, 04:53 PM#4
amrita
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CA Final year - Notes - Costing Formulae.

LABOUR

Method of Remuneration:

1) Time Rate system

a) Flat time Rate
b) High wage system
c) Graduated time rate

2) Payment by Results

a) Piece rate system

i) Straight piece rate
ii) Differential piece rate
  Taylor system
 Merrick system

b) Group Bonus System

i) Budgeted Expenses
ii) Towne gain sharing scheme
iii) Cost efficiency bonus
iv) Priest man system

c) Combination of Time and Piece rate

i) Gantt task and Bonus scheme
ii) Emerson Efficiency system
iii) Point scheme

 Bedaux system
 Haynes manit system

d) Premium bonus plans

i) Halsey premium plan
ii) Halsey weir premium plan
iii) Rowan scheme
iv) Barth scheme
v) Accelerating premium bonus scheme

e) Other incentive schemes

i) Indirect monetary incentive

 Profit sharing
 Co-partnership

ii) Non-Monetary Incentive

1) Time rate system = Hours worked * Rate per hour (Basic wages)

2) Piece rate system:

i) Straight piece rate earnings = Number of units produced * Rate per unit

ii) Differential Piece rate

 7. F.W.Taylor’s differential rate system

» 83% of piece rate when below standard

» 125% of piece rate when above or at standard

8. Merrick differential or multiple piece rate

system

Efficiency levelPiece rate

» up to 83% »Normal piece rate
» 83% to 100% » 110% of Normal rate
» Above 100% » 120% of Normal rate

iii) Gantt Task and Bonus system

OutputPayment
» Below standard » Time rate (guaranteed)
» At standard » 20% Bonus of Time rate
» Above standard » 120% of ordinary piece rate

iv) Emerson’s Efficiency system

EfficiencyPayment
» Below 66.7% » Hourly Rate
» from 66.7% » Hourly rate (+) increasing bonus according to degree
to 100% of efficiency on the basis of step bonus rates
» Above 100% » Hourly rate (+) 20% Bonus (+) additional bonus of 1%
of hourly rate for every 1% increase in efficiency

v) Halsey Premium Plan = Basic wages + 50% of time saved * Hourly Rate

vi) Halsey Weir Premium Plan = Basic wages + 30% of time saved * Hourly rate

vii) Rowan Plan = Basic wages + Time saved * Basic Wages Time allowed
 viii) Bedaus Point system = Basic wages + 75% * Bedaus point/60 * Rate/hr
ix) Barth’s System = Hourly rate * √Std time *Time taken

Labour Turnover:-

1) Separation rate method = Separation during the period

Average No. of worker’s during the period

2) Net labour T.O rate (or) Replacement method

= Number of replacements
Average No. of worker’s during the period

3) Labour flux rate = No. of separation + No. of replacement

Average No. of worker’s during the period

Accounting Treatment

1) Normal Idle time = Charged to factory overheads

2) Normal but un-controllable = It should be charged to job by inflating wage rate.

3) Abnormal = It should be charged to costing P & L a/c.

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2. 02-11-2011, 04:55 PM#5
amrita
Guest

CA Final year - Notes - Costing Formulae.

OVER HEADS

Reapportionment of service department expenses over production department :-

1) Direct redistribution method:

 Service department costs are divided over

production department.
  Ignore service rended by one dept. to another

2) Step method of secondary distribution (or) Non reciprocal method:

 Service department which serves largest

number of service department is divided first
and go on.

3) Reciprocal service method:

i) Simultaneous equation method (or) Algebraic method

 Equation is formed between service

departments and is solved to find the amount
due.

ii) Repeated distribution method:

 Service department cost separated repeatedly

till figure of service dept. is exhausted or too
small.

iii) Trial and Error method:

 Cost of service department is apportioned

among them repeatedly till the amount is
negligible and the total is divided among
production department.

Treatment of Over/Under absorption of overheads:-

i) If under absorbed and over absorbed overheads are of small value then it should
be
transferred to costing profit and loss a/c

ii) If under and over absorption occurs due to wrong estimates then cost of product
manufactured should be adjusted accordingly.

iii) If the same accrued due to same abnormal reasons the same should be
transferred
to costing profit & loss a/c

Apportionment of overhead expenses – Basis

a) Stores service expenses = Value of materials consumed

b) Factory rent = Floor area

c) Municipal rent, rates and taxes = floor area

d) Insurance on Building and machinery = Insurable value

e Welfare department
) expenses

f) Supervision
Number of
employees

g Amenities to employee’s
)

h Employees liability for

) insurance

j) Lighting power = Plug point

k) Stores over heads = Direct material

l) General over heads = Direct wages

Reapportionment of service department cost to production department :-

 1) Maintenance dept. = Hours worked for each dept.

2) Pay roll and time keeping = Total labour (or) machine hours (or) Number of
employees in each department

3) Employment (or) Personnel department = Rate of labour T.O (or) No. of

employees of each department

4) Stores Keeping department = No. of requisitions (or) value of materials of each

department

5) Purchase department = No. of purchase orders value of materials of each

department

6) Welfare, ambulance, canteen, service, recreation room expenses

= No. of employees in each department.

7) Building service department = Relative area each dept.

8) Internal transport service (or) overhead crane service

= weight, value graded product handled, weight and distance traveled.

9) Transport department = Crane hours, truck hours, truck mileage,

Number of packages.

10) Power house (electric power cost) = Housing power, horse power machine
hours,
No. of electric points etc.

11) Power house = Floor area, cubic content.

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3. 02-11-2011, 04:56 PM#6
amrita
Guest
 CA Final year - Notes - Costing Formulae.

RECONCILATION OF COST AND FINANCIAL A/C

Causes of differences:-

1) Purely financial items :

i) Appropriation of profits ►Transferred to reserves, goodwill, preliminary
expenses, dividend paid etc.

ii) Loss on sale of investment, penalties and fines

iii) Income ► Interest received on Bank deposits, profit on sale of investments,
fixed assets, transfer fees.

2) Purely cost account items: - Notional Rent / Interest / Salary

3) Valuation of stock:-

i) Raw-material = In financial a/c’s stock is valued at cost or market value

Whichever is less, while in cost a/c’s it is valued at LIFO, FIFO etc.

ii) Work in progress = In financial a/c’s administrative expenses are also

considered while valuing stock, but in cost a/c’s it may be
valued at prime (or) factory cost (or) cost of production

iii) Finished Goods = In financial a/c’s it is valued at cost or market price

whichever is less, in cost a/c’s it is valued at total cost of production.

4) Overheads: In financial = Actual expenses are taken

In cost = Expenses are taken at predetermined rate.

5) Depreciation: In financial = Charged in diminishing or fixed balance method

In cost = Charged in machine hour rate

6) Abnormal Gains: In financial = Taken to profit & Loss a/c

In cost = Excluded to cost a/c’s or charged in costing
profit & Loss a/c
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4. 02-11-2011, 05:01 PM#7
amrita
 Guest

CA Final year - Notes - Costing Formulae.

JOB AND BATCH COSTING

With job costing, we are dealing with one off situations. We are dealing with
organisations that carry out functions and services on a one at a time basis. Good
examples of job costing situations include jobbing builders: the builder who will
provide a householder, or a shop owner, or a factory owner with a service that he
provides for no one else. The jobbing builder will build an extension, or renovate
some property to a design that will probably not be copied anywhere else at any
time: it is a one off job. Job costing can apply in non manufacturing situations as
well as in manufacturing situations.

Even though many jobbing enterprises are small scale, we are not suggesting that
all jobbing enterprises are small scale enterprises. An engineering shop may be
working on a job for a customer that takes several months and many man and
machine hours to complete.

Here are two definitions:

A job is “A customer order or task of relatively short duration”

Job costing is “A form of specific order costing; the attribution of cost to jobs”

Batch costing is not normally seen as much of an advance on job costing.

A batch is A group of similar articles which maintains its identity throughout one or
more stages of production and is treated as a cost unit Batch costing is A form of
specific order costing; the attribution of costs to batches.

Economic Batch Quantity = EBQ = √2AS/C

Where A = Annual Demand
S = Setting up cost per batch
C= Carrying cost / unit of production.
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5. 02-11-2011, 05:12 PM#8
amrita
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CA Final year - Notes - Costing Formulae.

 PROCESS COSTING

Format of process a/c

Particulars Uni Rat Rs Particulars Uni Rat Rs

t e . t e .

To Direct By Normal Loss

material

To Direct By Units
Labour transferred
to other
process

To Indirect
material

To Other By Abnormal
Expenses loss (B/F)

To Abnormal
gain(B/F)

Total Total

Format of Abnormal loss

Particula Uni Rs Particulars Uni Rs

rs t . t .

To By Sale of
Process wasted units
a/c

By costing P &
L a/c

Total Total

Format of Abnormal gain a/c

 Particulars Unit Rs Particulars Unit Rs
s . s .

To Normal By Process a/c (names of

Loss a/c different process)

To costing P&l
a/c

Total Total

1)To find the cost per unit for valuation of units to be trans. to next process and
also
for abnormal, loss or gain = Total process cost – Salvage value of normal spoilage
Total units introduced – Normal loss in units

2) To find abnormal loss (or) gain (all in units):

= Units from previous process + fresh units introduced – Normal loss – units
transferred to next process (If the result is positive then abnormal loss. If
negative then abnormal gain)

3) In case of opening WIP and closing WIP are given then there are different
methods of valuation of closing WIP
i) FIFO Method ii) LIFO Method
iii) Average Method iv) Weighted Average Method

4) Various statements to be prepared while WIP is given:

i) Statement of equivalent production
ii) Statement of cost
iii) Statement of apportionment of cost
iv) Process cost a/c
5) FIFO Method: In these method total units transferred to next process includes
full opening stock units and the closing stock includes the units
introduced during the process. In this method the cost incurred
during the process is assumed as to be used

a) First to complete the units already in process

b) Then to complete the newly introduced units
c) For the work done to bring closing inventory to given state of completion

6) LIFO Method = Cost incurred in process is used for:

 a) First to complete newly introduced units

b) Then to complete units already in process in this method closing stock is

divided into two :
i) Units which represent opening stock but lie at the end of the period
ii) Newly introduced units in closing stock.

7) Average Method: In this method

a) No distinction is made between opening stock and newly introduced material.

b) In finding cost per unit, cost incurred for opening stock is also to be added with
current cost. (This addition is not done in LIFO & FIFO method as cost
incurred in that process is only taken)

8) Weighted average method: This method is only used when varied product in
processed through a single process. General procedure is adopted here.

a) Statement of weighted average production should be prepared. Under this

statement output of each products is expressed in terms of points.

1. Cost of each type of product is computed on

basis of Points.

Points of vital importance in case of Abnormal Gain / Loss:

a) Calculate cost per unit by assuming there is no abnormal loss / gain

b) Cost per unit arrived above should be applied for valuation of both abnormal
Loss/gain units and output of the process.

c) Separate a/c for both abnormal loss/gain is to be prepared.

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6. 02-11-2011, 05:14 PM#9
amrita
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 CA Final year - Notes - Costing Formulae.

JOINT PRODUCT AND BY PRODUCT COSTING

Methods of apportioning joint cost over joint products :

1) Physical unit method = Physical base to measure (i.e.) output quantity is used
to separate joint cost. Joint cost can be separated on the basis of ratio of
output quantity. While doing this wastage is also to be added back to find total
quantity.

2) Average unit cost method = In this method joint cost is divided by total
units Produced of all products and average cost per unit is arrived and is
multiplied With number of units produced in each product.

3) Survey method or point value method = Product units are multiplied by points
or weights and the point is divide on that basis.

4) Standard cost method = Joint costs are separated on the basis of standard cost
set for respective joint products.

5) Contribution margin method = Cost are divided into two categories (i.e.)
variable and fixed. Variable costs are separated on unit produced. Fixed on the
basis of contribution ratios made by different products.

6) Market value method:-

a) Market value at the point of separation: Joint cost to sales revenue percentage
is found which is called as multiplying factor = Joint cost * 100
Sales Revenue

 Joint cost for each product is apportioned by

applying this % on sales revenue

of each product.

 Sales revenue = Sales Revenue at the point of

separation.
  This method cannot be done till the sales
revenue at the separation point is

given.

b) Market value after processing: Joint cost is apportioned on the basis of total sales
Value of each product after further processing.

c) Net Realizable value method = Form sales value following items are deducted

i) Estimated profit margin

ii) Selling and distribution expenses if any included.

iii) Post split off cost
The resultant amount is net realizable value. Joint cost is apportioned on this basis.

Bi-product → Method of accounting

 Treat as other income in profit and loss a/c

 Net Realizable value of Bi-product is reduced

from cost of main product.

 Instead of standard process, Standard cost or

comparative price or re-use price is credited
to joint process a/c.
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7. 02-11-2011, 05:15 PM#10
amrita
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CA Final year - Notes - Costing Formulae.

OPERATION COSTING
Service costing is “A cost accounting method concerned with establishing the costs
of services rendered”. Service costing is also applied within
a manufacturing setting.

The Differences Between Product Costing and Service Costing?

 There may be very few, if any, materials to

worry about
 Overheads will comprise the most significant
portion of any costs of which, labour costs
may well comprise as much as 70%

No Enterprise Cost per unit

.

1. Railways or bus Per passenger-kilometer

companies

2. Hospital Per patient/day, per

bed/day

3. Canteen Meals served , cups of

tea

4. Water supply service Per 1000 gallons

5. Boiler House 1000 kg of steam

6. Goods Transport Per tonne km, quintal

km

7. Electricity Boards Per kilowatt – hours

8. Road maintenance Per mile or road

department maintenance

9. Bricks One thousand

10. Hotel Per room/day

In this various terms such as passenger km, quintal km, tonne km, these are all
known as composite units and are computed in 2 ways:
a) Absolute (weighted average): (e.g.) tones km - Multiplying total distance by
respective load quantity.

b) Commercial (simple average): (e.g.) tonne Km–Multiplying total distance by

average load quantity

All accumulated cost is classified into 3 categories:

1) Standing charges (or) fixed cost

2) Running cost (or) variable cost
3) Maintenance charges (or) semi variable cost

Running charges = Fuel, Driver Wages, Depreciation, oil etc.

Maintenance charges = Supervision salary, Repairs and Maintenance

Note:-

 % of factory overheads on direct wages

 % of administration overheads on works cost
 % of selling & distribution overheads on works
cost
 % of profit on sales

Operating cost sheet :-

Particulars Total Cost per

cost km

A Standing charges :-
License fees
Insurance Premium
Road tax
Garage rent
Driver’s wages
Attendant-cum-cleaner’s wages
 Salaries and wages of other staff

Total

B Running charges :-
Repairs and maintenance
Cost of fuel (diesel, petrol etc.)
Lubricants, grease and oil
Cost of tires, tubes and other spare
parts
Depreciation

Total

C Total charges [ (A) + (B) ]