Cost and Management Accounting I As Per New B Com CBCS Syllabus 2017 for CU

Cost and Management Accounting I As per new B Com CBCS syllabus 2017 for CU

Press

J.K. Mitra Associate Professor, Durgapur Government College (Formerly Associate Professor, Goenka College of CommerceUniversity and Business Administration, Kolkata)

Oxford

Oxford University Press is a department of the University of Oxford. It furthers the University’s objective of excellence in research, scholarship, and education by publishing worldwide. Oxford is a registered trade mark of Oxford University Press in the UK and in certain other countries.

Published in India by Oxford University Press Ground Floor, 2/11, Ansari Road, Daryaganj, New Delhi 110002, India

The moral rights of the author/s have been asserted.

First published in 2018

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, without the prior permission in writing of Oxford University Press, or as expressly permitted by law, by licence, or under terms agreed with the appropriate reprographics rights organization. Enquiries concerning reproduction outside the scope of the above should be sent to the Rights Department, Oxford University Press, at the address above. Press You must not circulate this work in any other form and you must impose this same condition on any acquirer.

ISBN-13: 978-0-19-947649-7 ISBN-10: 0-19-947649-7

Typeset in Palatino by Macro Tex Solutions, Chennai Printed in India by Magic International (P) Ltd., Greater Noida Cover image:University Martin Maun / Shutterstock Third-party website addresses mentioned in this book are provided by Oxford University Press in good faith and for information only. Oxford University Press disclaims any responsibility for the material contained therein. Oxford

© Oxford University Press. All rights reserved. 3 Preface Oxford University Press is a department of the University of Oxford. It furthers the University’s objective of excellence in research, scholarship, and education by publishing worldwide. Oxford is a registered trade mark of Oxford University Press in the UK and in certain other countries. Cost accounting and management accounting are regarded as specialized branches of accounting. Published in India by As the title suggests, this book is concerned with both cost accounting and management accounting Oxford University Press but emphasis is placed on the former. In the current curricular set up of the University of Calcutta, YMCA Library Building, 1 Jai Singh Road, New Delhi 110001, India the two sub-fi elds of accounting have been brought under a common umbrella. The dependence of © Oxford University Press 2017 both the sub-fi elds of accounting on common basic source data and their reliance on exchange of information pave the way for their unison. The moral rights of the author/s have been asserted. Cost accounting involves accounting and control of cost. It is concerned with the measurement First published in 2017 of cost and communication of cost-related information to the management for their effective decision making. Cost accounting is useful for locating unprofi table activities and ineffi ciencies All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, without the occurring in various forms of wastes. It further facilitates the preparation of projected cost prior permission in writing of Oxford University Press, or as expressly permitted statement and assists in controlling actual cost of production. It is also useful for price fi xation, by law, by licence, or under terms agreed with the appropriate reprographics submission of quotation, tender, etc. Thus, cost-related information becomes imperative for rights organization. Enquiries concerning reproduction outside the scope of the above should be sent to the Rights Department, Oxford University Press, at the planning and controlling the operations of an enterprise. Intelligently used cost information address above. forms the basis of many strategic decisions. Long-term competitivePress success of an enterprise depends on its proper cost management. You must not circulate this work in any other form and you must impose this same condition on any acquirer. Management accounting deals with the presentation of accounting and other information to the management for managerial decision-making purposes. It provides fi nancial data, cost data, ISBN-13: 978-0-19-947649-7 and other qualitative information to the management for their planning, decision making, and ISBN-10: 0-19-947649-7 control purposes. Management accounting acts as a decision support system for providing the Typeset in Palatino right information to the management at the right time. It guides management’s actions and helps by Macro Tex Solutions, Chennai managers to run their organizations smoothly. In recent years, the management accounting profession Printed in India by Magic International (P) Ltd., Greater Noida has gained immense importance due to increased competitiveness as a result of globalization and Cover image: Martin Maun / Shutterstock advancement in technology. Thus, managementUniversity accounting is a subject worthy of serious study by the students and professionals of both management and accounting professions. Therefore, existing Third-party website addresses mentioned in this book are provided by Oxford University Press in good faith and for information only. as well as desirous managers show their keen interest in management accounting. Oxford University Press disclaims any responsibility for the material contained therein. Objective of the Book The aim of this book is to acquaint the readers with a conceptual understanding on various principles of cost and management accountingOxford in a logical and systematic manner. This book intends to provide practical knowledge on various methods and techniques of cost and management accounting. It helps students in learning the basics of cost and management accounting and gathering information they need to make important decisions. It also provides exhaustive treatment of various concepts and principles of cost and management accounting. This will enable students and professionals to understand and use accounting data in various managerial decisions. This knowledge will help students in exploring many career opportunities available in the fi eld of cost and management accounting. Students and professionals will get benefi tted by using relevant cost data in making various business decisions. The materials available in this book will cater well to the requirements of the desired target group of students and the book will turn out to be a student friendly textbook.

Proposed Readers This book is specially conceived for students preparing for B Com (Second Semester) Honours course of the University of Calcutta under CBCS curriculum. Besides, students of other universities in

West Bengal (such as Burdwan University, Kalyani University, Kazi Nazrul University, Barasat State University, North Bengal University, Vidyasagar University, etc.) and students of professional courses, such as CA, CMA, CS, BBA, MBA, etc., may also ﬁ nd this book useful to accomplish their objectives. Therefore, in general, students in the ﬁ eld of business studies are the proposed readers of this book.

Pedagogical Features • This book is written in a simple style, offering clarity of presentation so that the readers can very easily grasp the subject matter. • Proper emphasis has been laid on conceptual clarity, due explanation of formulae, detailed illustrations, and chapter-end assignment for work practice. • It provides an exhaustive treatment of various methods and techniques on cost and management accounting in practical business situations. • Theoretical portion is substantiated with a number of illustrations and diagrams for easy understanding. • This book incorporates current thoughts, latest trends, and balancing theories with practical application. • It contains a suffi ciently large number of worked-out problems on each topic, properly graded and with full-length solutions. Alternative solutions have been givenPress wherever necessary. Special care has been taken in explaining the points that students fi nd diffi cult and tricky. • Terms appearing in the latest terminology of CIMA, London, have been used and thoroughly explained with suitable examples. • Each chapter ends with a set of theoretical and practical assignments so that the students can reinforce their understanding properly and prepare themselves well for examinations. • Questions recently set at various professional and university examinations have been incorporated so as to expose students with the latest trends adopted by those institutions in conducting their examinations. University • This book aims at preparing students effectively by providing conceptual understanding in a logical and systematic manner.

Content and Structure This book contains 10 chapters,Oxford which are as follows: Chapter 1 provides an insight into the basics on cost and management accounting. Chapter 2 deals with the concept of cost, classifi cation of costs, and analysis of total cost. Chapter 3 focuses on the concept of inventory, types of materials, and its accounting treatment. Chapter 4 covers the classifi cation, accounting, and control of labour cost. Chapter 5 describes the concept, classifi cation, and accounting treatment of direct expenses. Chapter 6 discusses various forms of overheads, their absorption, and accounting treatment. Chapter 7 offers various methods of costing (job costing, batch costing, and contract costing). Chapter 8 examines cost accumulation procedure and profi t measurement for process costing.

Chapter 9 deals with the method of costing applicable to service industry (i.e., operating costing). Chapter 10 focuses on cost control accounting, reconciliation of cost and ﬁ nancial proﬁ ts, etc.

Acknowledgements I am indebted to my parents for their constant encouragement, support, and motivation that inspired me to write this textbook. I am grateful to my respected teachers from whom I learnt the basics of this subject. I have relied on authoritative treatises and published articles in the ﬁ eld of cost and management accounting in my country and abroad. The sources have been duly acknowledged at appropriate places. I convey my best wishes to my beloved student Prof. Soumya Mukherjee and my colleague Prof. Amlan Mazumder for their valuable support. I express my gratitude to Oxford University Press for inspiring me to instil quality in this book. I owe a lot to the editorial team of Oxford University Press India for their nice care of the book while composing, proofreading, and printing. I convey my affection to my daughter Miss Alankrita Mitra for her efﬁ cient secretarial assistance at the time of preparing the manuscript. There might have been certain gaps in my work. I request the readers to send me their constructive suggestions, comments, and criticisms for the improvement of the book. Any suggestion sent to me at ‘[email protected]’ will be highly appreciated. Press J.K. Mitra

University

Oxford

Exercises—Review Chapter Outcomes Questions and Provide a bird’s eye view Practical Questions of the topics covered in Exhaustive chapter-end Pressthe chapter. exercises are provided to test understanding of concepts and techniques.

University

Illustrative Examples Numerous examples are provided to lend clarity to the key concepts used in Oxford the chapters.

Solved Question Papers 547

Exercises—Review OR Chapter Outcomes From theQuestions following information, and prepare a Cash Budget for three months ending on 30th July, 2012: Provide a bird’s eye view Practical Month Question Saless (`) Purchase (`) Wages (`) Miscellaneous (`) February 1,20,000 84,000 10,000 7,000 of the topics covered in Exhaustive March chapter-end 1,30,000 1,00,000 12,000 8,000 the chapter. exer cises ar Aprile pr ovided 80,000 1,04,000 8,000 6,000Press to test understanding May 1,16,000 1,06,000 10,000 12,000 of conceptsJune and 88,000 80,000 8,000 6,000 Additionaltechniques. Information: (i) Sales: 20% realized in the month of sales, balance realized equally in two subsequent months. (ii) Purchases: These are paid in the month following the month of supply. (iii) Wages: 75% paid in the current month and 25% paid in the following month. (iv) Miscellaneous Expenses: Paid a month in arreas. (v) Cash in hand (on 01.04.2012): `5,000. 10 [Semester IV (as per new syllabus)] 12. ABC Ltd hasSolved prepared the following Question budget for the Papers year 2013–14: Sales (15,000 units): `1,50,000 University Fixed expenses:(Cost `35,000 and Management Accounting) ` Variable cost: 5 per unit Paper I: 2013 You are required to: Illustrative Examples (i) Find P/V ratio, Break-even PointGroup–A and Margin of Safety. 6 × 5 = 30 1. (a) What do (ii) you Calculate mean by the Costing? revised P/V ratio, Break-even Point and Margin of Safety in each of the2 following Numerous examples are cases: [Refer to Section 1.10] provided to lend clarity to (a) Decrease of 10% in Selling Price; (b) Mention any four objectives of Cost Accounting. 4 the key concepts used in (b) Increase of Oxford10% in Variable Cost. 10 [Refer to Section 1.16] [Semester IV (as per new syllabus)] the chapters. OR A manufacturing company provides you with a summary of the production costs at three production levels: Paper II: 2014 Cost items 1,000 units 2,000 units 3,000 units (`) (`) Group–A(`) 6 × 5 = 30 A 2,000 4,000 6,000 1. Which method of Costing would you recommend for the following industries? B 5,000 5,000 5,000 (a) Construction industry; (b) Transport industry; (c) Chemical industry; (d) Ship-building industry; (e) Spare- C parts manufacturing 1,500 industry; (f)2,000 Agricultural farming2,500 industry. 6 Total 8,500 11,000 13,500 [Ans: (a) Contract Costing (or Job Costing); (b) Operating Costing; (c) Process Costing; (d)Contract CostingCU Solved Question (or Job Costing); (e) Batch Costing; (f) Composite (or Multiple) Costing.] (i) Indicate the cost behaviour of the cost items. 3 OR Papers Solved previous (ii) What would be total cost if the company produces 4,000 units? 3 (a) Defi ne ‘Cost Centre’ and ‘Cost Unit’. 3years’ question papers Solution: [Refer to Sections 1.19. & 1.20]will give students a Review Illustrations (i) Cost items (b) Distinguish Nature between of cost Direct and Indirect cost. 3feel of examination [Refer to Section 2.2.1] A large number of graded A Variable cost B 2. What do youFixed mean cost by Scrap of materials? State the accounting treatments of Scrap of materials. How is itand they can test their solved examples are C controlled?Semi-variable cost (i.e., partly variable and partly fi xed) 2 + 2 + 2understanding of the provided to elucidate the (ii) Computation of total cost for 4,000 units of output: [Refer to Section 3.36]concepts. concepts. Particulars Amount (`) A (4,000 units @ `2) 8,000 B (Fully fi xed cost) © Oxford University5,000 Press. All rights reserved. C (4,000 × `0.50 + `1,000) 3,000 Total cost 16,000

Notes: `2, 000 (a) Cost per unit of Item A = units = `2 per unit 1, 000 (b) Cost of Item-B = `5,000 (fully ﬁ xed cost) (c) Item-C: Change in total cost 2,, 000− 1 500 500 Variable portion per unit = = = = `05. 0 per unit Change in output 2,, 000− 1 000 1, 000 Fixed cost included therein = 1,500 – (1,000 × 0.50) = `1,000 Brief Contents

Preface iii Features of the Book vi Detailed Contents xi Roadmap to Cost and Management Accounting I xv

1. Basics on Cost and Management Accounting 1 2. Analysis of Costs and Cost Sheet 23 3. Materials Cost 87 4. Labour (Employee) Cost 166 5. Expenses 232 6. Overhead 235 7. Speciﬁ c Order Costing: Job Costing, Contract Costing, and BatchPress Costing 307 8. Process Costing 369 9. Operating Costing 451 10. Cost Book Keeping 481

Solved Question Papers 537 About the Author 581 University

Oxford

Preface iii Features of the Book vi Brief Contents ix Roadmap to Cost and Management Accounting I xv

1.22 Installation of a Cost Accounting System 15 1. Basics on Cost and Management 1.22.1 Guidelines (or Steps) for Installation of a Cost Accounting 1 Accounting System 16 1.1 Accounting—An Information System 1 1.23 Advantages of Cost Accounting 16 1.2 Branches of Accounting 2 1.24 Limitations of Cost Accounting 17 1.2.1 Financial Accounting 2 Section-B: Nature and Scope of Management 1.2.2 Cost Accounting 2 Accounting 17 1.2.3 Management Accounting 2 1.25 Concept of Management Accounting 17 1.3 Financial Accounting and Management 1.26 Nature of ManagementPress Accounting 18 Accounting—A Comparative Study 3 1.27 Common Database for Cost and Management 1.4 Cost Accounting and Financial Accounting— Accounting 18 A Comparative Study 3 1.28 Scope of Management Accounting 19 1.5 Cost Accounting and Management Accounting— 1.29 Objectives of Management Accounting 20 A Comparative Study 4 1.30 Functions of Management Accounting 20 Section-A: Nature and Scope of Cost Accounting 5 1.31 Limitations of Management Accounting 21 1.6 Nature of Cost Accounting 5 1.7 Scope of Cost Accounting 6 2. Analysis of Costs and Cost Sheet 23 1.8 Concept of Cost 7 1.9 Cost, Expense and Loss 7 University2.1 Concept of Cost 23 1.9.1 Cost 7 2.2 Classifi cation of Costs 23 1.9.2 Expense 7 2.2.1 Element-wise Classifi cation of Cost 23 1.9.3 Loss 8 2.2.2 Function-wise Classifi cation of Cost 25 1.10 Concept of Costing 8 2.2.3 Behaviour-wise Classifi cation of Cost 26 1.11 Concept of Cost Accounting 8 2.2.4 Classifi cation of Cost According to 1.12 Concept of Cost Accountancy 8 Controllability 27 1.13 Inter-relationship betweenOxford Costing, Cost 2.2.5 Classifi cation of Cost on the Basis of Accounting and Cost Accountancy 9 Normality 27 1.14 Difference between Costing and Cost 2.3 Costs Based on Time 28 Accounting 9 2.4 Costs Used in Managerial Decisions 28 1.15 Difference between Cost Accounting and Cost 2.5 Analysis of Total Cost 29 Accountancy 9 1.16 Objectives (or Purposes) of Cost Accounting 10 3. Materials Cost 87 1.17 Methods of Costing 10 3.1 Introduction 87 1.17.1 Job Costing (Specifi c Order Costing/Production 3.2 Concept of Inventory 87 Order Costing) 11 3.3 Forms of Inventories 88 1.17.2 Process Costing 12 3.4 Concept of Materials 88 1.18 Techniques of Costing 12 3.5 Types of Materials 88 1.19 Cost Centre 13 1.19.1 Types of Cost Centre 14 Section-I: Purchase Procedure and Purchase 1.20 Cost Unit 14 Control 89 1.21 Difference between Cost Centre and Cost 3.6 Objectives of Scientifi c Purchasing 89 Unit 15 3.7 Responsibilities of Purchase Department 89

3.8 Functions of Purchase Department 89 3.39 Philosophy of JIT 125 3.9 Purchase Procedure 90 3.40 JIT Purchasing 126 3.10 Purchase Requisition 90 3.41 JIT Production 126 3.11 Tenders and Quotations for the Supply 3.42 JIT Delivery 127 of Requisite Quantity and Quality of 3.43 Traditional Attitudes towards Inventory vs. JIT Materials 91 Viewpoints on Inventory 127 3.12 Selection of Suitable Supplier 92 3.44 Features of JIT Approach 127 3.13 Purchase Action (i.e., Placing Purchase 3.45 Benefi ts of Adaptation of JIT 128 Order) 92 3.14 Purchase Control 93 4. Labour (Employee) Cost 166 3.15 Methods of Purchasing 93 Section-I: Accounting and Control of Labour Cost 166 Section-II: Receipt of Goods and Store-keeping 94 4.1 Introduction 166 3.16 Receipt of Goods 94 4.2 Concept of Labour Cost 167 3.17 Meaning and Objectives of Store-keeping 95 4.3 Classifi cation of Workers Constituting the Labour 3.18 Location and Layout of Stores 95 Force 167 3.19 Functions of a Store-keeper 95 4.4 Classifi cation of Labour Cost 168 3.20 Organisation of the Stores Department 96 4.5 Control of Labour Cost 168 3.21 Classifi cation and Codifi cation of Materials 96 4.6 Labour Recruitment 169 3.22 Methods of Codifi cation 96 4.7 Time Recording 170 3.23 Documents Used in Stores (Store Records) 97 4.7.1 Time-keepingPress 170 Section-III: Inventory Control 100 4.7.2 Time-booking 172 3.24 Concept of Inventory Control 100 4.8 Distinction between Time-keeping and Time- 3.25 Objectives of Inventory Control 100 booking 173 3.26 Responsibility for Control of Inventories 100 4.9 Job Evaluation and Merit-rating 174 3.27 Principles of Effective Inventory Control 101 4.9.1 Job Evaluation 174 3.28 Techniques of Inventory Control 101 4.9.2 Merit-rating 174 3.28.1 Setting up of Various Stock Levels 101 4.10 Accounting of Labour Cost 174 3.28.2 Economic Order Quantity (EOQ) 102 4.11 Preparation of Pay-rolls 175 3.28.3 ABC Analysis 105 4.12 Disbursement of Wages 175 3.28.4 Review of Slow and Non-moving Items University4.13 Internal Check for Prevention of Fraud in Wage (Obsolete Materials) 108 Payment 175 3.28.5 Perpetual Inventory System 108 Section-II: Methods of Remuneration 176 3.29 Reasons for Surplus or Defi ciency in Stock 4.14 Concept of Remuneration 176 Verifi cation and Accounting Thereof 109 4.15 Factors to be Considered for Selecting a Sound Section-IV: Material Accounting 111 Remuneration Policy 176 3.30 Stock Valuation 111 Oxford 4.16 Requisites for a Sound Wage Payment Plan 177 3.31 Pricing of Material Issues 111 4.17 Methods of Remunerating Labour 177 3.32 Selection of a Materials Pricing Method 112 4.17.1 Time Rate System 177 3.32.1 Cost Method 112 4.17.2 Payment by Results (or Piece Rate System) 178 3.32.2 Average Price Method 116 4.18 Comparison of Halsey Plan and Rowan 3.32.3 Market Price Method 119 Plan 182 3.32.4 Notional Price Method 119 4.19 Group Bonus Plans 185 3.33 Determination of a Suitable Method of Stock 4.20 Incentive Schemes for Indirect Workers 186 Valuation 120 4.21 Classifi cation of Incentive Schemes 187 3.34 Inventory (or Stock) Turnover 121 4.21.1 Indirect Monetary Incentives 187 Section-V: Accounting and Control of Material Section-III: Labour Costs Requiring Special Losses 122 Treatment 188 3.35 Waste 122 4.22 Idle Time 188 3.36 Scrap 123 4.22.1 Causes of Idle Time 188 3.37 Spoilage 124 4.22.2 Treatment of ‘Idle Time’ in Cost 3.38 Defectives 124 Accounting 188 Section-VI: Just In Time (JIT) Approach 125 4.22.3 Control of Idle Time 189

4.23 Over-time 189 6.13.1 Direct Re-distribution to Production 4.23.1 Causes of Over-time 189 Departments 244 4.23.2 Treatment of Over-time Wages 189 6.13.2 Step Ladder System 245 4.23.3 Control of”Over-time’ 189 6.13.3 Repeated Distribution Method (or Cycles 4.24 Holiday and Vacation Pay 190 Method) 245 4.25 Leave with Pay 190 6.13.4 Simultaneous Equation Method 246 4.26 Casual Workers 190 6.14 Limitations of Apportionment of Overhead 247 4.27 Apprentices’ Wages 190 6.15 Absorption of Overhead 247 4.28 Shift Premium 190 6.15.1 Production Unit Method 248 4.29 Punctuality Bonus 190 6.15.2 Percentage Method 248 6.15.3 Hourly Rate Method 250 Section-IV: Labour Turnover 191 6.16 Actual Overhead Rate vs. Predetermined 4.30 Concept of Labour Turnover 191 Overhead Rate 251 4.31 Measurement of Labour Turnover 191 6.17 Under and Over-absorption of Overhead 251 4.32 Causes of Labour Turnover 192 6.18 Treatment of Under-absorption or Over 4.33 Effect of Labour Turnover 192 absorption of Overhead 253 4.34 Cost of Labour Turnover 192 6.19 Application of the Above Treatments 253 4.35 Treatment of Labour Turnover Cost 193 6.20 Concept of Capacity 253 4.36 Control of Labour Turnover 193 6.21 Utility of Various Capacity Concepts 255 5. Expenses 232 Section-III: Non-productionPress Overheads 256 6.22 Administration Overhead 256 5.1 Concept of Expense 232 6.22.1 Accounting Treatment 256 5.2 Classifi cation of Expenses 232 6.22.2 Control of Administration Overheads 257 5.2.1 Direct Expenses (or Chargeable Expenses) 232 6.23 Selling and Distribution Overheads 257 5.2.2 Indirect Expenses 232 6.23.1 Methods of Absorbing Selling and Distribution 5.3 Difference between Direct Expenses and Indirect Overheads 258 Expenses 233 6.23.2 Control of Selling and Distribution 5.4 Expenses Excluded from Cost Accounts 233 Overheads 258 5.5 Circumstances Where Direct Expenses may be Treated as Overheads 234 University7. Specifi c Order Costing: Job Costing, Contract Costing, and Batch 6. Overhead 235 Costing 307 Section-I: Concept and Classifi cation of Overhead 235 6.1 Concept of Overhead 235 Introduction 307 6.2 Indirect Costs 235 Section-I: Job Costing 307 6.3 Classifi cation of OverheadOxford 236 7.1 Concept of Job Costing 307 6.4 Function-wise Classifi cation of Overhead 236 7.2 Characteristics of Job Costing 308 6.5 Behaviour-wise Classifi cation of Overhead 237 7.3 Advantages of Job Costing 308 6.6 Element-wise Classifi cation of Overhead 239 7.4 Disadvantages of Job Costing 308 6.7 Control-wise Classifi cation of Overhead 239 7.5 Pre-production Procedure Relating to Job 6.8 Classifi cation of Overhead according to Costing 309 Normality 240 7.6 Production Order 309 Section-II: Production Overhead 240 7.7 Job Cost Card (Job Cost Sheet) 309 6.9 Linking Overhead to Cost Centres or Cost 7.8 Collection of Costs 310 Units 240 Section-II: Contract Costing 316 6.10 Collection of Production Overhead 241 7.9 Concept of Contract Costing 316 6.11 Allocation and Apportionment of Overhead to 7.10 Features of Contract Costing 317 Cost Centres or Cost Units 241 7.11 Contract Costing and Job Costing— 6.12 Apportionment of Overhead in Two Stages 241 A Comparison 317 6.12.1 Primary Distribution 241 7.12 Costs for Contracts 318 6.12.2 Secondary Distribution 243 7.13 Items of Costs Related to Contract 318 6.13 Methods of Re-distribution 244 7.14 Surveyor’s Certifi cate and Retention Money 320

7.15 Profi t on Incomplete Contracts 320 8.15 Procedure of Evaluation 385 7.16 Journal Entries in the Books of Contractor 321 7.17 Proforma Contract Account 322 9. Operating Costing 451 7.18 Value of Work-in-progress 323 7.19 Escalation Clause 324 9.1 Introduction 451 7.20 Cost-plus Contracts 324 9.2 Applicability of Operating Costing 451 7.21 Accounting for Construction Contract 9.3 Features of Operating Costing 451 [Accounting Standard-7 (Revised)] 325 9.4 Distinction between Operating Costing and Operation Costing 452 Section-III: Batch Costing 361 9.5 Cost Units 452 7.22 Nature and Use of Batch Costing 361 9.6 Transport Costing 452 7.23 Determination of Economic Batch Quantity 361 9.7 Objectives of Transport Costing 453 9.8 Classifi cation of Costs 453 8. Process Costing 369 9.9 Log Sheet 453 9.10 Selection of Unit of Cost 454 8.1 Concept of Process Costing 369 9.11 Ascertainment of Costs 455 8.2 Characteristics of Process Costing 369 9.12 Control of Operating Costs 457 8.3 Types of Process Costing 370 8.4 Application of Process Costing 370 10. Cost Book Keeping 481 8.5 Process Costing Procedure 371 8.6 Difference between Job Costing and Process 10.1 IntroductionPress 481 Costing 371 10.2 Cost Control Accounting (or Non-integrated 8.7 Advantages of Process Costing 372 Accounting) 482 8.8 Disadvantages of Process Costing 372 10.3 Integrated Accounting 482 8.9 Process Costing Having no Process Loss 372 Section-I: Cost Control Accounting (or Non- Section-I: Normal Loss, Abnormal Loss and integrated Accounting) 482 Abnormal Gain 373 10.4 Introduction 482 8.10 Normal Process Loss 374 10.5 Cost Ledgers 482 8.10.1 Accounting Treatment of Normal Loss 374 10.6 Principal Accounts to be Maintained 483 8.10.2 Journal Entry for Normal Loss 374 10.7 Book-keeping Entries 487 8.11 Abnormal Process Loss 374 University Section-II: Reconciliation of Cost and Financial 8.11.1 Accounting Treatment of Abnormal Process Accounting 520 Loss 375 10.8 Need for Reconciliation of Cost and Financial 8.11.2 Journal Entries for Abnormal Loss 375 Accounts 520 8.12 Abnormal Gain 375 10.9 Reasons for Variation in Profi t between Cost and 8.12.1 Accounting Treatment of Abnormal Gain 375 Financial Accounts 521 8.12.2 Journal Entries for AbnormalOxford Gain 375 10.10 Procedure for Reconciliation of Cost and Section-II: Inter Process Profi ts 378 Financial Accounts 522 8.13 Concept of Inter Process Profi t 378 10.11 Memorandum Reconciliation Account 523 Section-III: Equivalent (or Effective) Production 384 8.14 Meaning of Equivalent Production 384

Solved Question Papers 537 About the Author 581

Unit Topic and Description Chapter

Unit 1 Introduction: Definition of Costing, Cost Accounting and Management 1 Accounting, Objectives of Cost Accounting; Importance of Cost Accounting to Business Concern, Relationship between Cost Accounting, Financial Accounting, Management Accounting; Advantages of a Cost Accounting System, Installing a Cost Accounting System, Essentials of a Good Cost Accounting System Cost Concepts, Terms, and Classiﬁ cation of Costs: Cost, Cost Object, Cost Units and Cost Centres, Types of Costs, Classiﬁ cation of Costs—Direct and Indirect, Elementwise, Functionwise, Behaviourwise, Sunk Cost, Opportunity Cost, Cost Sheet (Introduction Only), Total Costs, and Unit Costs Costing Methods and Techniques: (Introduction Only)

Unit 2 Material Costs a. Purchase of Materials: Purchasing Needs and Organisation, PressPurchase Procedure, 3 Documentation, Material Costs (Direct and Indirect), Determination of Material Purchase Cost b. Storage of Materials: Need for Storage, Location and Types, Functions of a Storekeeper, Requisition, Receipt, Issue and Transfer of Materials, Storage Record, Accounting for Material Costs c. Material Control: Organization, Tools; Just-in-Time Purchase; Various Stock Levels, Economic Ordering Quantity and ABC Analysis; Periodic Inventory, Perpetual Inventory, Physical Veriﬁ cation; Discrepancies in Stock and Their Treatment University d. Methods of Pricing Material Issues: Various methods of pricing materials issues— FIFO, LIFO and Weighted Average; advantages and disadvantages of each method e. Treatment of normal and abnormal loss of materials Unit 3 Employee Cost: Introduction, Recording Labour Cost: Attendance and Payroll 4 Procedures (Time-Keeping,Oxford Time Booking, Payroll Procedure, Payment of Wages— Piece Rate, Differential Piece Rate, Time Rate), Idle Time, (Causes and Treatment in Cost Accounting), Overtime (Its Effects and Treatment in Cost Accounting), Labour Turnover—Causes, Impact and Methods of Calculating Labour Turnover; Cost of Labour Turnover Incentive Systems: Main Principles for Sound System of Wage Incentive Schemes; Labour Utilization; System of Wage Payment (Halsey, Halsey-Weir, Rowan and Emerson) and Incentives; System of Incentive Schemes for Indirect Workers; Component of Wages Cost for Costing Purpose

Unit Topic and Description Chapter

Unit 4 Overheads a. Introduction: Deﬁ nition, Classiﬁ cation of Overhead—Element-wise, Functional 6 and Behavioural; Various Types of Overheads b. Manufacturing Overheads: Allocation and Apportionment of Overhead; Absorption of Overhead: Various Methods and Their Application; Treatment of Under Absorption/Over Absorption of Overheads c. Administration and Selling and Distribution Overheads and their Charging: Introduction only d. Preparation of Cost Sheet (Advanced Level) and Estimation 2

Unit 5 Cost Book-keeping 1. Non-integrated System: Meaning and Features; Ledgers Maintained; Accounts 10 Prepared; General/Cost Ledger Adjustment Account; Meaning of Closing Balance in Various Accounts; Disadvantages 2. Reconciliation: Need for Reconciliation; Items Causing Differences between Cost and Financial Proﬁ ts and their Reconciliation; Memorandum Reconciliation Statement/Account Press

Unit 6 Costing Methods Job Costing (Job Cost Cards and Databases, Collecting Direct Costs of Each Job, 7 Attributing Overhead Cost to Jobs; Application of Job Costing). Batch Costing Contract Costing: Progress Payments, Retention Money, Escalation Clause, 7 Contract Accounts, Accounting for Material, Accounting for Plant Used in a Contract, Contract Proﬁ t and Balance Sheet Entries Service Costing and Output Costing: Introduction; Motor Transport Costing only. 9 Single or Output Costing University Process Costing: Meaning, Features, Process vs Job Costing, Principles of Cost 8 Ascertainment for Materials, Labour, and Overhead; Normal Loss, Abnormal Loss and Gain and Preparation of Process Accounts Inter-process Proﬁ t (Simple Cases)—Meaning, Advantages and Disadvantages and Determination ofOxford Stock Value for the Purpose of Balance Sheet Need for Valuation of WIP, Equivalent Production (Units) and Preparation of Process and Other Relevant Accounts Valuing WIP under Average Method and FIFO Method (Simple Cases)

Chapter ChapterOutcome Outcomess Syllabus Mapping ◗ ◗ ◗ ◗ AccountingAccounting — — an an Information Information System System Branches ◗ Branches of Accountingof Accounting Financial ◗ Financial Accounting Accounting Vs. Management ◗ ◗ AccountingVs. Management ◗ Cost AccountingAccounting Vs. Cost Financial AccountingChapter Accounting Vs.Outcomes Financial ◗ Cost Accounting Accounting Vs. ManagementCost Accounting Accounting Vs. Management Accounting ◗ ◗ ◗Section-A: Accounting Nature — an and Information Scope of SystemCost Accounting ◗ Branches ofNature Accounting of Cost ◗ Accounting Financial Accounting Scope of Vs.Cost Management Accounting ◗Section-A: Nature ◗and Scope of Cost Accounting◗ ◗ Nature of Cost Accounting◗ ◗ Scope ◗ AccountingConcept of ◗ Cost Cost AccountingCost, Expense Vs. andFinancial Loss AccountingConcept of ◗Costing Cost Accounting Concept Vs.of Cost Management Accounting Accounting Concept of Cost AccountingAccountancy ◗ Concept◗ Interrelationship of Cost ◗ Cost, of Costing, Expense Cost and Accounting Loss ◗ Concept and ofCost Costing Accountancy ◗ Difference Section-A:◗ ◗ ◗ ◗ ◗ between Concept Costing ofNature Cost andAccountingand ScopeCost Accounting of CostConcept Accounting ◗of Difference Cost AccountancyNature between of Cost Cost Interrelationship Accounting Accounting Scope andof ofCost Cost Accountancy Accounting ◗ ◗ ◗ ◗ ◗ ◗Costing, ObjectivesConcept Cost of of CostAccounting Cost Cost,Accounting andExpense Cost ◗ AccountancyMethodsand Loss ofConcept Costing ◗ Difference of◗ TechniquesCosting between Concept Costing of Costing andof Cost Cost◗ Cost Accounting Centre ◗ CostConcept Unit ◗ Press ◗ ◗ofAccounting Difference Cost Accountancy ◗between Difference a Cost Interrelationshipbetween Centre Cost and Accounting a Costof Costing, Unit and ◗ Installation Cost AccountancyAccounting of a Cost and ◗ Objectives Accounting Cost Accountancy of System ◗ UnitAdvantagesDifference 1 ◗ betweenofCost Cost Accounting Accounting Costing ◗ Methodsand ◗ Limitations Cost of Accounting Costing of Cost ◗ Techniques AccountingDifference of Costing between ◗ Cost Cost Centre Accounting ◗ Cost Unit and Cost Accountancy ◗ ObjectivesDifference betweenof Cost Accounting a Cost Centre ◗ Methodsand a Cost of UnitCosting ◗ Installation ◗ Techniques of a Costof Costing Accounting ◗ Cost Centre ◗ Cost Unit Section-B: Nature and Scope of Management Accounting ◗ Concept of Management Accounting ◗ Difference◗ between a Cost Centre and a Cost◗ Unit ◗ Installation of a Cost Accounting System ◗ Advantages ◗System Advantages of Cost Accounting◗ Limitations of Cost Accounting ◗ ofNature Cost Accounting of Management ◗ Limitations Accounting of Cost ScopeAccounting of Management Accounting Objectives of Management AccountingSection-B: Nature ◗ Functions and Scope of Management of Management Accounting Accounting ◗ Limitations ◗ Concept of ofManagement Management Accounting Section-B:Accounting Nature◗ Nature andof Management Scope of Management Accounting ◗ ScopeAccounting of Management ◗ Concept Accounting of Management Accounting ◗ Nature of Management Accounting ◗ Scope◗ of Management Accounting ◗ Objectives of Management 1.1 ObjectivesAccounting—An of Management Information Accounting System Functions of Management Accounting Accounting◗ Limitations ◗ ofFunctions Management of Management Accounting Accounting ◗ Limitations of Management Accounting Accounting is a business language. Every 1.1language Accounting—An has a grammar Information and it is necessary SystemUniversity Flow Chart Showing Accounting Mechanism Accountingto have a good is commanda business over language. the grammar Every Transactions Supported Vouchers by Documents languageto understand has a the grammar language. and Accounting it is necessary has Flow Chart Showing Accounting Mechanism also its grammar, generally called accounting to have a good command over the grammar Transactions Supported Vouchers toprinciples. understand It is the essential language. to acquaint Accounting with hasthe Recordingby Documents of Transactions Books of Prime Entry alsoaccounting its grammar, principles generally to read called and understand accounting from Documents (Journal, Day book) the accounting statements. principles. It is essential toOxford acquaint with the Recording of Transactions Books of Prime Entry accountingAccounting principles is defined to read as and a system understand for Classificationfrom Documents of Transactions (Journal, Day book) Ledger Accounts thecollecting, accounting summarising, statements. analysing, presenting under appropriate head and reporting, in monetary terms, the relevant Accounting is defined as a system for Classification of Transactions information about the enterprise. The overall under appropriate head Ledger Accounts collecting, summarising, analysing, presenting Summarisation of Trial Balance andobjective reporting, of inan monetary accounting terms, information the relevant Transactions informationsystem is to aboutprovide the information enterprise. The to various overall Summarisation of Trial Balance objectiveusers. The ofinputs an accountingfor an accounting information system PresentationTransactions of Financial Final Accounts Statements (Profit & Loss A/c systemare usually is to economicprovide information events. The tooutput various of & Balance Sheet etc.) an accounting information system serves as users. The inputs for an accounting system Presentation of Financial Final Accounts the basis for users’ actions. As a business Statements (Profit & Loss A/c are usually economic events. The output of Audit of Accounting Audited& Balance Final Sheet etc.) anlanguage, accounting accounting information communicates system serves business as Books Accounts thetransactions basis for andusers’ their actions. results As toa businessvarious interested parties. Audit of Accounting Audited Final language, accounting communicates business Books Fig. 1.1 Accounts transactions and their results to various interested parties. Fig. 1.1 © Oxford University Press. All rights reserved. 2 Cost and Management Accounting I

1.2 Branches of Accounting Three main branches of accounting are: (1) Financial Accounting; (2) Cost Accounting; and (3) Management Accounting. 1.2.1 Financial Accounting Financial Accounting records monetary transactions, prepares necessary accounts, analyses and interprets fi nancial statements. It reveals the profi tability and fi nancial results of a business concern over a particular period of time. The main purposes of Financial Accounting are: (i) To record the transactions affecting the business; (ii) To prepare the necessary accounts and balance sheet; (iii) To evaluate the results of operations over a particular period; (iv) To report results on year to year basis; (v) To furnish information on both the operating and non-operating activities; (vi) To provide information on end-result to various interested partiesPress for taking proper decisions. 1.2.2 Cost Accounting Cost accounting is accounting for costs. Cost Accounting may be regarded as a specialised branch of accounting which involves collection, classifi cation, accumulation, assignment and control of costs. Cost Accounting is a discipline concerned with measurement and communication of cost information. It is the science, art and practice of Cost Accountants. The main purposes of Cost Accounting are: (i) To accumulate cost data for determiningUniversity the product (or service) costs; (ii) To provide cost data to the management for the preparation of budgets and fi xing standard costs; (iii) To assist the management in their decision making; (iv) To ascertain the cost of products, activities, functions, processes, etc.; (v) To apply various costOxford control techniques; (vi) To improve effi ciency in order to control and reduce costs. 1.2.3 Management Accounting Management Accounting is concerned with the presentation of accounting information to the management in such a way as to assist them in their managerial functions of decision-making, planning and control. Thus, Management Accounting deals with accounting and other information for managerial decision making purposes. The main purposes of Management Accounting are: (i) To provide management with fi nancial data, cost data and other qualitative information for planning and decision making; (ii) To get an insight into the profi tability, solvency, liquidity, etc., of the organisation; (iii) To measure and interpret the results of operations with necessary comments and conclusion;

(iv) To report on the effectiveness of the organisation as regards utilisation of resources; (v) To meet the changing needs of management functions. 1.3 Financial Accounting and Management Accounting—A Comparative Study Financial Accounting records monetary transactions and prepares necessary accounts concerning the business. Thereafter, it analyses and interprets fi nancial statements to serve the interests of various parties. Management accounting is concerned with the presentation of accounting information (both fi nancial and cost) and other relevant qualitative facts to the management. These information assist the management in their managerial functions of decision-making, planning and control. Management accounting is having its roots in fi nancial accounting. Management Accounting data are mostly derived from fi nancial accounting. Both fi nancial and management accounting study the impact of business transactions and interpret results thereof. However, the differences between fi nancial and management accounting are enumerated below: Table 1.1 Difference between Financial Accounting and Management Accounting Points of Differentiation Financial Accounting Management Accounting

(i) Basic function Recording of monetary Supporting decisions of the transactions and publication of Pressmanagement by providing fi nancial statements. relevant information. (ii) Party to be served For use of external parties (may For use of internal parties only. also be used by internal parties). (iii) Format of reports Format is specifi ed by the relevant Format is tailored to the provisions of the Companies Act. requirement, suitability and convenience. (iv) Objectivity of reports Report is supported by relevant Reports may contain both the fi gures. It laysUniversity emphasis on objective and subjective fi gures. objectivity of data. (v) Auditing of reports Financial reports are subject to Management reports are not statutory audit. subject to statutory audit. (vi) Publication of reports Annual reports are to be Management reports are meant published for circulation among for internal use only. Oxfordthe external parties. (vii) Period coverage Usually one year. As required by the management. (viii) Availability of reports Publicly available. Confi dential in nature. (ix) Unit of study Overall performance of the Detailed study of a segment. organisation. (x) Governed by Companies Act. Needs of management.

1.4 Cost Accounting and Financial Accounting—A Comparative Study Cost Accounting and Financial Accounting rest on the same principles concerning debit and credit and have the same sources of recording transactions. Both collect, record, classify and summarise transactions and report these to the appropriate authority. However, there are differences between the two, which are as follows:

Table 1.2 Difference between Cost Accounting and Financial Accounting Points of Differentiation Cost Accounting Financial Accounting

(i) Applicability Cost Accounting is applicable to Financial Accounting is applicable manufacturing concerns. to all types of accounting entity. (ii) Principles followed It adheres to costing concepts and It adheres to Generally Accepted principles. Accounting Principles (GAAP). (iii) Scope of measurement It measures cost of each product It measures the fi nancial line, department, process, etc. performance of the entity as a whole during a particular period. (iv) Requirements served Cost Accounts are prepared as per Financial Accounts are prepared the requirement of Management. according to the requirements of Companies Act and Income Tax Act. (v) Periodicity of reporting Cost reporting is a continuous Financial reports (Profi t & Loss process and it may be prepared as A/c; Balance Sheet etc.) are and when desired (either daily or prepared periodically, usually at weekly or monthly etc.) the end of an accounting period. (vi) System of control It provides for a detailed system ItPress does not attach importance to of controls with the help of certain control the transactions. special techniques (like Standard Costing, Budgetary Control, etc.). (vii) Party to be served It is mainly meant for providing It is mainly meant for providing detailed cost information to the information to shareholders, management. Therefore, cost creditors, government, employees, information are not meant for etc. outsiders. (viii) Nature of approach It deals partlyUniversity with actual fi gures It deals mainly with actual (i.e., historical data) and partly fi gures and thus, it is historical in with estimates. approach. (ix) Valuation of stock Stocks are always valued at cost. Stocks are valued at cost or market price whichever is lower. (x) Statutory need It is not compulsory. It is compulsory to meet the Oxford requirements of Companies Act, Income Tax Act, etc. 1.5 Cost Accounting and Management Accounting—A Comparative Study Management Accounting is developed because of the management’s demand for information on past and present operations for predicting future trends. It integrates Cost and Financial Accounting information to analyse and interpret past and present results and providing forecasts for the future. Therefore, the scope of Management Accounting is broader than that of Cost Accounting. However, the differences between Cost and Management Accounting are enumerated below: Table 1.3 Difference between Cost Accounting and Management Accounting Points of Differentiation Cost Accounting Management Accounting (i) Principles and It uses the principles and It uses the principles and practices followed practices of Cost Accounting. practices of both Cost and Financial Accounting.

Points of Differentiation Cost Accounting Management Accounting (ii) Nature of approach It generally deals with current It looks ahead through long operations. term planning apart from current operations. (iii) Scope of study It is a complement of It is an extension of managerial Management Accounting. aspects of Cost Accounting. (iv) Primary objective The primary object is to ascertain The primary object is to provide the cost of product (or service) the relevant information to and to control the cost after careful the management for taking analysis. appropriate decision. (v) Main emphasis The main emphasis is on cost The main emphasis is on determination and cost control. effi cient running of business. (vi) Contents of report Cost Accountant compares Management Accountant not Actual Cost with Standard only makes variance analysis Cost and submits reports to the but also suggests the ways management regarding variances and means for improving for appropriate action. operations.Press (vii) System of recording Double entry system of recording Double entry system is not transactions can be adopted. adopted while submitting reports to the management. (viii) Type of data used It deals with cost data only. It uses both fi nancial and cost data. (ix) Accounting period It is done for a specifi c accounting It does not follow any specifi c period. accounting period as such. (x) Derivation of data It derives dataUniversity from fi nancial It derives data from both records. fi nancial records and cost records.

SECTION-A: NATURE AND SCOPE OF COST ACCOUNTING

1.6 Nature of Cost AccountingOxford The nature of cost accounting can be enumerated in the following ways: (i) Branch of accounting: Cost accounting may be regarded as a specialised branch of accounting. It has its own principles, concepts and conventions. It analyses and interprets cost information and presents cost report to the management for necessary action. (ii) Science, art and practice of cost accountants: Cost accounting is a social science as it is a body of systematic knowledge. It is an art in the sense it requires skills on the part of cost accountants in applying the principles, methods and techniques of cost accounting. It is a practice in the sense that practical application of the theoretical knowledge is a constant pursuit of cost accountants. (iii) Regarded as profession: Cost accounting is a profession as it is a body of specialised knowledge that can be applied to practical situations. Professional knowledge on this subject can be acquired through formal education system and training programmes. In India, the Institute of Costs Accountants of India (ICAI) renders professional assistance to qualiﬁ ed cost accountants. It formulates a code of behaviour for its members.

(iv) Providing cost information: Cost accounting is concerned with the measurement and communication of cost information. It presents relevant cost information to the management derived from various cost records for the purpose of their managerial decision-making. Cost information (with proper interpretation) is provided to the management through cost reports. (v) Means of controlling cost: Cost accounting is a means of controling cost. Cost control is exercised through various techniques (such as standard costing, budgetary control, inventory control, quality control, etc.). Cost control helps in utilising the available resources in the best possible manner by reducing various wastages and losses. (vi) System of foresight: Now-a-days, cost accounting is used for forecasting the cost of the goods to be produced (or services to be rendered). The estimated cost of a product (or service) can be ascertained after careful consideration of present cost data and future trends. Cost accounting helps in the preparation of budgeted cost statements on the basis of pre-determined cost estimates. 1.7 Scope of Cost Accounting The scope of cost accounting refers to the various areas of study under the purview of cost accounting as follows: (i) Cost classifi cation: This refers to the grouping of homogenous items of cost into a common group. Cost classifi cation is a process of arranging the items of cost Pressinto certain categories on the basis of a defi ned criteria. Three common bases of cost classifi cation are: (a) element-wise classifi cation; (b) function-wise classifi cation; (c) behaviour-wise classifi cation. (ii) Cost recording: This refers to the posting of cost transactions into the various ledgers maintained under cost accounting system. This involves recording of cost data according to pre-arranged classifi cation. (iii) Cost allocation: This refers to the allotment of costs to various departments or products on predetermined basis. Cost allocation is the part attribution which charges specifi c cost to a cost centre or cost unit. University (iv) Cost determination: This refers to the determination of cost of products (or services), departments and operations of a manufacturing concern. Cost is ascertained in two ways, namely, (a) Statement method (popularly known as cost sheet or cost statement); (b) Account method (i.e., Production account is prepared under double entry principle). (v) Cost comparison: This involves comparison of the cost of alternative products, activities and areas of operation in the Oxfordfi eld of production. (vi) Cost control: Cost control is a device of regulating cost of output (or operation) by careful use of the techniques of cost accounting. Cost control is exercised through various techniques (such as standard costing, budgetary control, inventory control, quality control, etc.). Cost control helps in utilisation of resources in the best possible manner. (vii) Cost reporting: This refers to furnishing relevant cost information to the management on a regular basis so as to meet the requirements of management. It is a formal system designed to ensure timely supply of pertinent cost information to the management for their policy-making and operating decisions. (viii) Cost reduction: Cost reduction represents achievement of real and permanent reduction in the unit cost of goods manufactured and services rendered. Cost reduction may be brought about by the elimination of wasteful and non-essential elements in the design of products. The fi nal aim of cost accounting is the reduction of real cost of goods (or services) on a permanent basis through maintaining quality.

1.8 Concept of Cost Cost is an expenditure that has actually been incurred or that can be notionally attributed to a specifi ed thing or activity. According to CIMA [Chartered Institute of Management Accountants, London] cost is “the amount of expenditure (actual or notional) incurred on, or attributable to a specifi c thing or activity.” A cost may be an actual cost that has been incurred and ascertained after it has been incurred. For example, the expenditure on materials incurred and ascertained in the process of producing any commodity, is a cost. A cost may also be a notional cost for which there has not been any cash payment (or outfl ow of cash) but whose benefi t has been enjoyed in the process of production of a commodity (or rendering of a service). Rent on own premise, interest on own capital, etc., are examples of notional costs. Thus, a cost refers to a payment which can be associated with a commodity or service. It need not necessarily be a cash payment. For this reason, the American Accounting Association has defi ned it as “a foregoing, measured in monetary terms, incurred or potentially to be incurred to achieve a specifi c objective.” Anthony and Welsch defi ned cost as “a measurement, in monetary terms, of the amount of resources used for some purposes.” Press 1.9 Cost, Expense and Loss ‘Cost’ should be distinguished from ‘expense’ and ‘loss’ though the terms cost and expense are used synonymously. 1.9.1 Cost Cost is the amount of cash (or equivalent resources) given to acquire goods or service. Cost is incurred (or potentially to be incurred) to achieve a specifi c objective. It is the resources sacrifi ced (or benefi ts foregone) measurable in terms of money. Cost includes both expired cost and unexpiredUniversity (or deferred) cost. Expired cost represents an expenditure from which no further benefi t is expected. Expired cost may be either an ‘expense’ or a ‘loss’. On the other hand, unexpired (or deferred) cost refers to the cost for which expenditure has been incurred but the economic benefi t has not been received during the current accounting period (for example, prepaid rent, prepaid insurance, unutilised part of asset, etc.,). Unexpired (or deferred) cost does not form part of productOxford cost. It is shown as an asset in the Balance Sheet.

Cost

Expired Cost Unexpired (or Deferred) Cost [It is shown as an asset in the Balance Sheet]

Expense Loss (or utilised expired cost) (or unutilised expired cost) [It is charged to P/L A/c] [It is written off to P/L A/c]

Fig. 1.2 1.9.2 Expense An expense may be defi ned as an expired cost with a matching economic benefi t (such as postage paid, rent paid, depreciation, etc.). Expense is that part of expired cost, the benefi t (or utility) of © Oxford University Press. All rights reserved. 8 Cost and Management Accounting I which is directed towards the productive activities. Expense may also be referred to as utilised part of expired cost. An expense is matched (or charged) against revenue in order to arrive at the profi t or loss of the period. Normally, an expense forms part of product cost and is charged to the Profi t & Loss Account for that period. [Important points to remember: Sometimes, the term ‘expense’ is used in a narrow sense in Cost Accounting. According to the element-wise classifi cation of cost, total cost is composed of three elements of costs (i.e,. material cost, labour cost and expenses). Therefore, expense may be used to signify the cost of sevices provided to an undertaking (such as, rent, rates, taxes, cost of postage, cost of lighting & heating, insurance, maintenance cost, etc.)]. 1.9.3 Loss Loss may be defi ned as an expired cost without any matching economic benefi t (such as, loss of stock by fi re, abnormal idle time, etc.). Loss is that part of expired cost, the utility of which is lost before it is being used for productive purposes. Loss may also be referred to as unutilised part of expired cost. Normally, loss does not form part of product cost. Loss is written off by transferring it to the Profi t & Loss Account. 1.10 Concept of Costing Press According to the CIMA, London, costing refers to “The techniques and methods of ascertaining costs.” Techniques are used as principles and rules for the ascertainment of cost. For example, Marginal Costing, Standard Costing, Budgetary Control, Uniform Costing, etc., are applied as techniques. Methods are used to lead to the process (or procedure) of ascertaining costs. For examples, Job Costing, Batch Costing, Process Costing, Operating Costing, Operation Costing, etc., are used as methods of costing. Different methods and techniques embodied within costing are applied depending on the nature of the product, Universityproduction procedure, etc. 1.11 Concept of Cost Accounting Cost Accounting means accounting for costs. It is regarded as a specialised branch of accounting. It involves classifi cation, accumulation, assignment and control of costs. It is concerned with the measurement and communication of cost information. It starts with the recording of all costs related to the manufacturing processOxford and ends with the presentation of cost report to the management. CIMA, London defi nes Cost Accounting as “an application of costing principles, methods and techniques for determination of costs and the analysis of deviations (favourable or adverse) as compared with standards.” So, Cost Accounting renders information for the guidance of the management for proper planning, operation, control and decision making. 1.12 Concept of Cost Accountancy Cost accountancy is a subject which is related to the accounting of goods produced or services rendered. It involves the application of cost accounting to the practice of cost control and the ascertainment of profi tability. It also covers the presentation of information derived therefrom for the purpose of managerial decision making. CIMA (London) defi nes Cost Accountancy as “the application of Cost Accounting principles, methods and techniques to the science, art and practice of cost ascertainment and control.”

It is a science so far as it involves the application of a systematic body of knowledge. It is an art so long as it involves some skill for its application. It is a practice as practical application of the theoretical knowledge is a constant pursuit of the Cost Accountant. 1.13 Inter-relationship between Costing, Cost Accounting and Cost Accountancy Costing = Methods and techniques of ascertaining costs. Cost Accounting = Costing + Application of cost control techniques. [Therefore, Costing is an integral part of Cost Accounting] Cost Accountancy = Cost Accounting + Presentation of relevant information to the management for decision-making. [Therefore, Cost Accountancy covers a wider ﬁ eld than Cost Accounting]

1.14 Difference between Costing and Cost Accounting Points of Differentiation Costing Cost Accounting (i) Basic concept Costing is related to the techniques Cost Accounting is concerned and processes of ascertaining costs withPress the accounting for costs. of goods produced or services rendered. (ii) Accounting mechanism It does not necessarily require It involves accounting for costs. formal accounting. (iii) Application of It does not necessitate the It requires the application of accounting principles application of all accounting accounting principles. principles. (iv) Coverage It is an integral part of Cost It encompasses a much wider Accounting.University ﬁ eld. It has to deal with the presentation and interpretations of cost data to the management. (v) Procedure It involves classiﬁ cation of expenses It involves analysis of costs for according to cost elements. It the preparation of necessary also deals with the allocation and information. It is related Oxfordapportionment of costs to the cost to reporting of current and centres and cost units. prospective costs.

1.15 Difference between Cost Accounting and Cost Accountancy Points of Differentiation Costing Cost Accounting

(i) Basic concept It is an application of costing It is an application of cost principles, methods and techniques accounting principles, methods for determination of costs and and techniques to the practice of analysis of deviations from the cost control and ascertainment of standards. proﬁ tability. (ii) Applicability Its ﬁ eld of application is limited. It covers a much wider area. (iii) Objective Its objects are determination of Its objects are cost determination, costs and control of costs. cost control, preparation of relevant information necessary for the purpose of decision making. © Oxford University Press. All rights reserved. 10 Cost and Management Accounting I

Points of Differentiation Costing Cost Accounting (iv) Coverage It is an integral part of cost It denotes a body of knowledge accountancy. involving a practice of Cost Accounting.

1.16 Objectives (or Purposes) of Cost Accounting The main purposes of cost accounting are enumerated as follows: (i) Ascertainment of cost: Cost ascertainment means computation of actual costs after they have been incurred. The primaryprimary objectiveobjective ofof costcost accountingaccounting isis toto ascertainsascertain the cost of various products, jobs, activities, services, etc. Ascertainment of cost is a pre-requisite for cost control and for furnishing cost information to the management for its decisions. Generally, costs are ascertained by using principles of different methods of costing. (ii) Estimation of cost: Estimated cost is a futuristic concept. It is the process of determining in advance the cost of products, jobs, activities, services, etc. In cost estimation, an allowance is generally made for anticipated fl uctuations in the prices of different elements of cost (such as material cost, labour cost and expenses). Cost estimation serves the following purposes: (a) It is required for offering quotations of prices, sending tenders,Press bidding for contracts, etc.; (b) It is useful in the preparation of various budgets; (c) It is helpful in the evaluation of projected performance; (d) It facilitates preparation of projected fi nancial statements. (iii) Control of cost: Cost control is the regulation of operating cost of an undertaking by executive action. Cost control aims at improving effi ciency by controlling and reducing cost. The budgetary control and standard costing are two important techniques used to control cost. Cost control improves the effi ciency by achieving maximum output at minimum cost. The cost accountant identifi es the areas wherein the company has to improveUniversity its effi ciency, reduce costs, wastage, etc,. (iv) Reduction of cost: Cost reduction means real and permanent reduction in the unit cost of goods manufactured (or services rendered). It is a genuine saving in the cost by the elimination of wasteful and inessential elements from the design of the product. Cost reduction must arise from continuous scientifi c research. The areas of cost reduction are vast which include product design, production method, marketing, administration, fi nance, etc. (v) Preparation of cost Oxfordstatement: Cost statement is prepared to show the different components of the total cost. It generally shows total cost, per unit cost, output produced and sold, units and value of closing stock, etc. Properly developed cost accounting system can provide ready information regarding cost of production, value of stock, etc., as and when required. (vi) Helping in managerial decisions: Cost accounting is designed primarily to serve the needs of the management. Cost accounting provides relevant information to the management to take various decisions such as: (a) product diversifi cation, (b) fi xing of selling prices, (c) make or buy decisions, (d) selection of profi table product-mix, (e) determination of alternative methods of manufacture, (f) dropping a product line, (g) suspending activities of a region, (h) factory shut-down decision, (i) scarce resource (i.e., key factor) allocation decision, (j) effect of change in selling price, (k) level of activity planning, (l) opening of extra shift work, (m) selection of optimum volume of production etc. 1.17 Methods of Costing Costing methods refer to the systems of collating and presenting costs for the purpose of product costing (or service costing). Several methods of costing have been designed to suit the needs of each business condition. In other words, different methods are used because business enterprises vary in

© Oxford University Press. All rights reserved. Basics on Cost and Management Accounting 11 their nature and in the type of the products they produce (or services they render). The basic principles of ascertaining costs are the same in all methods, but the way of analysing and presenting the costs vary from industry to industry. Basically, there are two principal methods of costing, namely, (1) Job Costing (2) Process Costing Variations of Job Costing are: Variations of Process Costing are: (a) Batch Costing; (a) Operation Costing; (b) Contract Costing (or Terminal Costing); (b) Operating Costing; (c) Composite Costing (or Multiple Costing). (c) Single (or Output) Costing. 1.17.1 Job Costing (Specifi c Order Costing/Production Order Costing) This refers to a method of costing in which costs are ascertained in terms of specifi c jobs or orders, which are not comparable with each other. Industries manufacturing products (or rendering services) against specifi c orders, use the Job Costing method. In the Job Costing method, an order may be taken as a Cost Unit (i.e. Job). In Job Costing, all costs of direct materials, direct labour and other direct expenses are directly charged to the specifi c job or product. Applicability: Job Costing is used by organisations whose products or services can readily be identifi ed by individual units or batches. Industries where thisPress method of costing is generally applied are: printing presses, repair shops, ship-building, house-building, automobile garages, engine and machine construction, furniture making, hardware and machine manufacturing, consulting engagements, research projects and other industries where jobs or orders can be kept separate. (a) Batch Costing: This method is also a special type of Job Costing. Batch Costing refers to that method of costing which determines the cost of a group of identical products. It is then used to determine the unit cost of the articles produced by dividing the total cost of the batch by the total batch quantity. It should, however, be noted that the articles produced should not lose their identity in manufacturing operations. In batch costing, a batch constitutes the costUniversity unit for which costs are compiled. Separate Job Cost Sheets are maintained for each batch of components manufactured and for the assembly of fi nished products. The cost of each batch is determined separately by charging with its own costs. Applicability: Batch Costing can be applied to enterprises engaged in manufacturing radio, television, V. C. R., watch, electronic goods, biscuits, car, medicines, toy making, readymade garments, etc. (b) Contract Costing (Terminal Costing/Construction Costing): In Contract Costing, a specifi c contract becomes the CostOxford Unit. A particular contract is treated as a whole job and the cost of the contract is determined accordingly. Therefore, Contract Costing is that form of Job Costing where work is undertaken as per customer’s special requirements and each order is of long duration. It is also known as Terminal Costing since the job cost is completed with the completion of the work. Applicability: Contract Costing is used in ship building, building construction, civil engineering works, aircraft manufacture, etc. (c) Composite Costing (Multiple Costing): Multiple costing is a combination of various methods of Costing. The manufacture of certain products involves a lot of complexities. Therefore, any one of the basic methods cannot be used for collating and presenting product cost. In other words, in multiple costing, we experience the application of various costing methods. Multiple Costing is used where there are a variety of components separately produced and subsequently assembled in the complex production. Applicability: Multiple costing is applicable to manufacturing concerns producing motor cars, machine tools, radios, sewing machines, aeroplanes, cycles, typewriters, locomotives, etc.

1.17.2 Process Costing Process Costing is used to ascertain the cost of the product at each process, operation or stage of manufacture. In process costing, production follows a series of sequential processes. The fi nished goods of the earlier process becomes the raw materials of the latter process. Costs are identifi ed for each process and charged to that process. Cost of each process is determined separately. It is suitable for organisations which manufacture goods on a continuous basis. Applicability: Process Costing is generally adopted in textile industries, chemical industries, oil refi neries, soap manufacturing, paper manufacturing, paints, food processing, steel, rubber industries, etc. (a) Operation Costing: A manufacturing process may sometimes be divided into a number of parts, each of which is known as an operation. Operation Costing refers to the determination of cost of each operation. It is a special type of Process Costing. The cost unit is the ‘operation’ instead of the process. The per unit cost is arrived at by dividing the total cost of an operation by the number of units completed in the operation centre. For large undertakings, it is frequently necessary to ascertain the cost of various operations. The procedure for costing of operations is broadly the same as for Process Costing. Cost control can be exercised more effectively with Operation Costing. (b) Operating Costing: This method of costing is applicable to undertakingsPress which provide services. Here, the cost of whole services rendered is ascertained. Thereafter, total costs of the operation are divided by the total units and cost per unit of service is arrived at. Where an undertaking (or a department within an undertaking) provides services, the costing method used is termed as Operating Costing. Service organisations do not make or sell tangible goods. Service organisations include transport companies, hospitals, schools, etc. Applicability: Operating Costing is applicable to: (i) Transport concerns (railways, motor cars, shipping and air transport); (ii) Public utility concerns (electricity, gas,University hospitals, telephones, schools, colleges, etc.); (iii) Catering establishments (hotels, canteens, hostels, etc.). (c) Single (or Output) Costing: This method is used where a single article is produced (or a service is rendered) by continuous manufacturing activity. The cost of whole production cycle is ascertained as a process. The per unit cost is obtained by dividing the total cost by the total number of units manufactured. The unit ofOxford cost is chosen according to the nature of the product, e.g. for coal and iron ore, the cost unit is “per ton”; for brick, the cost unit is “per thousand brick” etc. Applicability: This method is suitable in industries like brick-making, cement manufacturing, collieries, fl our-mills, etc. 1.18 Techniques of Costing Costing techniques refer to the manner in which it is decided to present cost information to the management. The following fi ve basic techniques are commonly used by Cost Accountants: (i) Marginal Costing: This is an important technique used for decision making. It refers to the ascertainment of marginal costs by differentiating between fi xed costs and variable costs and the effect on profi t of the changes in volume. In marginal costing, there is no room for semi-variable costs. Semi-variable costs are split up into variable and fi xed elements. Variable portion of semi-variable cost is added with variable cost and fi xed portion of semi-variable cost is added with fi xed cost. In marginal costing, only variable costs are charged to products (or operations) while fi xed costs are

© Oxford University Press. All rights reserved. Basics on Cost and Management Accounting 13 attributed to the business in general (i.e. fi xed costs are written off in full in the period to which they are attributable). In other words, fi xed cost is not allocated to Cost Units. (ii) Standard Costing: Standard Costing is used as an effective tool for planning and control of costs. It is a technique where standard costs are determined in advance. After the production, actual costs are compared to standard costs to develop variances. Once the variances (favourable or adverse) are determined, the management fi nds out the reasons for such variances for taking remedial measures. Standard Costing provides the base for control through variance accounting. It helps the management to maintain maximum effi ciency in production. (iii) Budgetary Control: Budget should be viewed as an activity plan. Budgets are prepared for each and every function and accordingly targets are fi xed for each executive who is responsible for achieving results. Budgetary Control should be viewed as a feedback system. Actual performances are continuously compared with budgets and variance reports are issued, as a feedback to executives at all levels. Budgetary Control is defi ned as, “The establishment of budgets relating to responsibilities of executives to the requirements of a policy and the continuous comparison of actual results with budgeted results either to secure by individual action the objective of that policy or to provide a basis for its revision.” [C.I.M.A. Offi cial Terminology] Budgetary Control refers to: Press (a) Establishment of a budget for a defi ned period of time; (b) Continuous comparison of actual results with budgeted results; (c) Investigation into the deviations (variances) arising out of such comparison; (d) Finding out the causes of variances; (e) Taking corrective actions to remedy the causes in order to achieve the defi ned objectives; (f) Planning again by considering feed-back. Budgetary control is an aid to management for controlling costs and maintaining maximum effi ciency in production. University (iv) Historical Costing (or Absorption Costing): This refers to the ascertainment of costs after they have been incurred. This is also termed as traditional costing. This technique takes into account the total costs of running an enterprise. An effort is made to absorb the entire cost into the individual units. This technique is also called “full costing”. This technique does not help in exercising control on costs. (v) Uniform Costing: UniformOxford Costing is the use of the same cost accounting principles and/ or practices by several undertakings. Uniform Costing promotes operating effi ciency by ensuring inter-unit and inter-fi rm comparison. Here, a number of manufacturers under common control, may lay down defi nite and detailed instructions regarding uniform procedures to be adopted. It helps in increasing productivity and locates the ‘Weakest Spots’ of member concerns. 1.19 Cost Centre Cost Centre is the smallest segment of activity (or area of responsibility) for which costs are ascertained. Such a sub-division helps in the collection of costs and absorption of costs to cost units. Cost Centre may be a location or person or item of equipment or group of all these in respect of which cost may be ascertained and used for the purpose of Cost Control. So, a Cost Centre may be a warehouse or an individual or a machine in the factory. CIMA, London, defi nes a Cost Centre as “a production or service location, function, activity or item of equipment whose costs may be attributed to cost units.” It may be a location (such as, department,

© Oxford University Press. All rights reserved. 14 Cost and Management Accounting I section, storeyard, sales area); a person (such as, a salesman, a foreman, a machine operator); an item of equipment (such as, a machine, a delivery van) or a group of all these. The cost centres are known as ‘responsibility centres’ as control is exercised over costs in relation to particular cost centres. For a cost centre, the person in its charge is responsible for the control of its costs. Cost centres help in the process of recovery of overheads. For the correct ascertainment and control over costs, prudent division of cost centres become necessary. Otherwise, too many cooks may spoil the broth. 1.19.1 Types of Cost Centre (i) Personal Cost Centre: Personal Cost Centre consists of a person or group of persons. (ii) Impersonal Cost Centre: An impersonal cost centre consists of a location or item of equipment or group of these. A cost centre, determined according to location, may be an area or region of sales, a depot or warehouse. There are two main types of cost centres in manufacturing concerns: (a) Production Cost Centres: These centres are engaged in production work. Machine shops, Assembly shops are examples of production cost centres in a factory. (b) Sevice Cost Centres: These centres render valuable services to production centres. Only indirect costs are charged to Service Cost Centres. A few examples of ServicePress Cost Centre are: (i) Administration Centres, e.g. General offi ce, Accounts offi ce, Cash section; (ii) Material Service Centres, e.g. Stores, Internal transport; (iii) Personal Service Centres, e.g. Labour offi ce, Canteen; (iv) Plant Maintenance Centres, e.g. Tool room, Carpenter shop. 1.20 Cost Unit Cost unit is a quantitative unit of product (or service) in relation to which costs are ascertained (or expressed). A cost unit differs from industryUniversity to industry. The unit selected should be one which is the most natural to the business and is acceptable to all concerned. Examples: (i) Cost per kg. of sugar; (ii) Cost per 1,000 bricks; (iii) Cost per tonne of cement, etc. More typical examples of Cost Units are given below: Industry or Product Cost Unit Transport Oxford Tonne-Kilometre; Passenger-kilometre Steel Per ton Cement Per ton Power (Electricity) Kilo-watt hour Automobile Number Cable Metre or Kilometre Gas Cubic metre Mines and Quarries Tonne Chemical Litre Fertilizer Per ton Television/Radio/VCR Per set Building Per square ft Nuts and bolts Gross

1.21 Difference between Cost Centre and Cost Unit Cost Centre Cost Unit 1. A cost centre is the smallest segment or 1. A cost unit is a quantitative unit of product activity or area of responsibility for which or service in relation to which costs are costs are ascertained. expressed and ascertained. 2. A cost centre is one segment of the total 2. A cost unit is the unit of expressing cost. organisation. 3. A cost centre helps to determine costs by 3. A cost unit is used for the sub-division location, person, etc. of costs which may be attributed to the products or services. 4. A cost centre is devised before applying the 4. Application of cost unit arises after the cost unit. functions of devising cost centres are over. 5. A concern which even produces only one 5. A cost unit is assigned to one distinct product (or renders only one service) may product or service. have several cost centres. 1.22 Installation of a Cost Accounting System Press For appropriate treatment of costs and correct reporting of cost information, a sound cost accounting system should be installed in an organisation. But there is no standard system that may become suitable for every organisation. So, considering some factors, the details of the cost accounting system should be worked out. These factors are: (i) Nature of the product and nature of the organisation: All products do not absorb costs in the similar way. Some products need more use of materials than other elements of costs. For such material-intensive products, the cost accounting system must include inventory control measures. Where more use of labour is important,University there should be labour cost control measures. Where overheads are incurred at a high rate, the cost accounting system should contain ample measures for proper recovery of overheads. The structure of the organisation, size, layout, the requirements related to its managerial control, etc, also govern the nature and pattern of the cost accounting system. (ii) Workability: The system installed must be workable in the organisation. It should be easily understandable. It shouldOxford be easy to apply. (iii) Economy of cost: The costs of installing and operating the system should be economical. (iv) Manufacturing process: The nature of manufacturing process should be carefully studied. The types of materials used, their quantity and quality, the nature and degree of automation applicable and the peculiarities of the production process should be kept in mind. The technical aspects and the human factors should get equal attention. (v) Reporting ability: The system should be so devised that the receivers of information, particularly the persons authorised to take managerial decisions, are beneﬁ tted. (vi) Documents involved: The documents (like forms and vouchers) to be used in the cost accounting procedure, should be ascertained. The volume of clerical work and costs should be kept minimum. (vii) Nature of selling the products: In some concerns, the production is carried on as per the customers’ orders. Some concerns manufacture for general sales. The cost accounting system depends upon nature of selling the products.

1.22.1 Guidelines (or Steps) for Installation of a Cost Accounting System The following guidelines (or steps) may be suggested for installing a sound cost accounting system: (i) Study the objectives to be achieved; (ii) Study the nature of the product to be produced; (iii) Study the size and nature of the organisation; (iv) Study the nature of materials required, methods related to their purchase, receipt, storage and issue; (v) Study the method of wage payments to be followed; (vi) Ascertain the clerical documents required and the cost of documentation; (vii) Ascertain the information requirements of different cost centres; (viii) Consider the effects of increase or decrease of operations on variable costs; (ix) Ascertain the level of integrating cost accounting and fi nancial accounting records; (x) Decide whether the system will economise costs; (xi) Ensure the accuracy of the data collected; (xii) Consider external factors like government regulations and integrityPress of departments involved; (xiii) Study the marketing procedure, policy and set up; (xiv) Consider the suitability of the system and its reporting effi ciency; and (xv) Decide the applicability of costing techniques like Marginal Costing, Budgetary Control, etc. 1.23 Advantages of Cost Accounting (a) As an aid to the Management: The various advantages derived by the management from a good system of Cost Accounting are as follows: (i) A cost accounting system locates unprofi table activities, losses and ineffi ciencies occurring in various forms of waste; University (ii) Cost accounting is useful for price fi xation, submission of quotation, tender, etc.; (iii) Cost accounting locates the causes for increase or decrease in the profi t or loss of the organisation; (iv) Proper cost information makes it possible for the management to distinguish between profi table and non-profi table operations. Profi t can be maximised by concentrating on profi table operations; (v) More reliable and Oxfordaccurate fi nancial accounts can be prepared with the help of perpetual inventory system of stock control; (vi) Inter-fi rm comparisons will enable the management to study the causes of unfavourable developments. A cost comparison helps in cost control; (vii) Adequate cost records provide the management with such data as may be necessary for preparation of Profi t & Loss Account and Balance Sheet at such interval as may be desired by the management; (viii) The introduction of effective cost accounting system prevents manipulation and fraud. (b) As an aid to Creditors: Investors, banks and other money lending institutions are benefi tted immensely by the installation of an effi cient system of cost accounting. They can base their judgement about profi tability and future prospects of the enterprise when there is a sound cost accounting system. (c) As an aid to Employees: Employees are benefi tted by a number of ways by the installation of an effi cient system of cost accounting. They are benefi tted through continuous employment and higher

© Oxford University Press. All rights reserved. Basics on Cost and Management Accounting 17 remuneration by way of incentives, bonus plans, etc. Thus, an effective cost accounting system ensures maximum utilization of human resources. (d) As an aid to the National Economy: An effi cient system of cost accounting brings prosperity to the business enterprise, which in turn, results in increasing Government revenue. The overall economic development of a country takes place as a result of an increase in production. A cost accounting system provides ready fi gures for use by the Government, Wage Tribunals, Trade Unions, etc., for settling to problems like price fi xation, price control, wage level fi xation, payment of dividends, tariff protection etc. 1.24 Limitations of Cost Accounting Some objections have been raised against cost accounting system despite its numerous benefi ts. These objections are as follows: (i) Duplication of work: A good number of business concerns have proved themselves effi cient even without using cost accounting system. It is argued that cost accounting system is not necessary as it involves duplication of work. So it is unnecessary and creates a burden to the organisation. (ii) Unsuitable for many industries: It cannot advantageously be applied to all types of industries. There is no such cost accounting system which can readily be applied to all industries (especially, certain unique or special type industries). Press (iii) Failure to produce desired results: The adoption of cost accounting system has failed to produce the desired result in many industries. (iv) Expensive system: The installation and operation of a cost accounting system requires a huge initial capital expenditure and high operating expenses. (v) Stereotyped and mechanical system: This system is stereotyped and mechanical as it involves fi lling in large number of forms continuously. It degenerates itself into merely one of forms and rulings. (vi) Excessive estimation: Cost computationUniversity involves a large number of conventions, estimations, arbitrary allocation of joint costs, etc. As a result, no costs can be said to be exact. This leads to misleading picture on the cost statement and on cost information. (vii) Relative approach: Accuracy in cost accounting is relative. Certain assumptions are always made while ascertaining cost to suit a particular situation. Thus, costs presented by two cost accountants may not always be identical. (viii) Unsuitable for allOxford purposes: No single cost is suitable for all purposes and under all circumstances. The computation and presentation of a particular cost depends on the purpose to which cost data are required. (ix) Improper analysis of notional cost: Notional cost is a hypothetical cost for which there is no outfl ow of cash (such as rent on own premise, interest on own capital, etc.). Notional cost should be properly attributed to a specifi c product, job, activity, etc. The purpose of cost accounting cannot be fulfi lled without proper analysis and allocation of notional cost.

SECTION-B: NATURE AND SCOPE OF MANAGEMENT ACCOUNTING 1.25 Concept of Management Accounting Management accounting is concerned with the presentation of accounting information to the management for assisting their managerial functions of decision-making, planning and control. Management accounting is developed because of managements’ demand for information on past

© Oxford University Press. All rights reserved. 18 Cost and Management Accounting I and present operations, for predicting future trends. Management accounting system acts as decision support system for providing the right information to the right people at the right time. It deals with accounting information for managerial decision-making purposes. Management accounting is dynamic and forward-looking. It provides various techniques for solving problems, making decisions, planning and controlling the business. It aims to help managers to run their organisations smoothly. It is a value adding process that guides management’s action and motivates behaviour of organisational people. Management accounting information can be both fi nancial (i.e., monetary) and non-fi nancial (such as process time, quality, customer satisfaction, employee capabilities, new product performance, etc.). Management accounting information is an informational source for decision-making, improvement and control in the organisation. Effective management accounting system can create considerable value to organisational success. 1.26 Nature of Management Accounting The nature of management accounting can be enumerated as follows: (i) Advisory in nature: It provides relevant information to the management to achieve an organisation’s strategic, tactical and operating objectives. It gets an insight into the profi tability, solvency, liquidity, etc., of the organisation and renders advise to the management in these regards. (ii) Analytical in nature: Management accounting is analytical inPress nature. It analyses and interprets accounting and other data to make them understandable and usable to the management. Such an indepth analysis assists the management in pinpointing responsibilities and to effect necessary changes in the organisational set-up. (iii) Interpreting results of operation: It measures and interprets the results of operations at all levels of management with necessary comments and conclusions. It reports on the effectiveness of utilisation of resources at various levels of the organisation. (iv) Aid to the management: It provides both quantitative and qualitative information to the management to assist them in their managerial functions of decision-making, planning and control. (v) Feedback control: It expresses fi nanciallyUniversity the plans in terms of individual responsibilities for all levels of management. It develops a chain of responsibility reporting and monitors performance against plans. (vi) Future oriented: Management accounting is forward-looking and dynamic. It processes historical data for projecting the future trends in order to make better decisions. (vii) Absence of standard format: There is no standard format to present management accounting information. ManagementOxford accountant prepares formats according to the demand of the situation. Thus, style of presentation of information is tailored to the requirement of the situation. (viii) Selective approach: It takes into account only relevant information which are affecting decision-making from voluminous fi nancial and cost data. It provides useful and understandable information to the management for their proper decision-making. 1.27 Common Database for Cost and Management Accounting Cost accounting and management accounting both utilise the same basic data to a signifi cant extent. Cost accounting gathers information about production, personnel, other facilities, etc., to determine the cost of goods sold during the period. Management accounting uses the same data to develop budgets, performance reports and analyses the same for other decisions. Much of the data used to generate cost accounting reports, is also used to prepare management accounting reports. Therefore, in most of the cases, the common data are used in preparing both cost accounts and management accounts. A sound cost accounting system manages the database to provide both cost accounting information and managerial accounting information. However, the management accounting data is derived both from the cost accounts and fi nancial accounts. © Oxford University Press. All rights reserved. Basics on Cost and Management Accounting 19

Fig. 1.3

1.28 Scope of Management Accounting The management accounting covers the following areas of knowledge: (i) Financial accounting: Management accounting data are mostly derived from fi nancial accounting. Management accounting is having its roots in fi nancial accounting. Both study the impact of business transactions and interpret the results thereof. (ii) Cost accounting: Management accounting involves the application of appropriate techniques and concepts drawn from cost accounting. Management accounting can be viewed as an extension of managerial aspects of cost accounting. However, the scope of management accounting is broader than the scope of cost accounting. (iii) Management Information System (MIS): MIS provides relevantPress information to the management for its decision-making. Computer adds new dimension to MIS by facilitating the processing of large volume of data with huge speed and accuracy. MIS is expected to supply information as needed at different levels in the organisation. (iv) Quantitative Techniques: The Operation Research (OR) technique is used by management accountants to solve the existing problems in the decision-making process. In a decision-making situation, all variables are quantifi ed for the purpose of analysis. Operation research makes an attempt to diagnose and tackle a problem by optimum utilisation of resources. Operation research techniques include linear programming, simulation Universitymethod, queing (or waiting line) theory, transportation theory, game theory, etc. (v) Statistical Tools: Business forecasting refers to the statistical analysis of past and current movements for obtaining clues about the future trend. Time series analysis, regression analysis, extrapolation, etc., are often used in management accounting for predicting the future trend. Forecasting facilitates the planning function of management. Forecasting provides information about future risks and uncertainties of the business.Oxford (vi) Just-in-Time (JIT) Technique: JIT approach is an operational control technique. JIT approach is used in management accounting for elimination of wastes and continuous improvement of productivity. The objective of JIT approach is to purchase, produce and deliver products just when needed. JIT ensures overall qualitative improvement of the organisation. (vii) Total Quality Management (TQM): Quality plays a key role in keeping costs low, revenues high and profi ts robust. TQM aims at zero defect (i.e., products free from all kinds of defects). Improved quality and customer service would result into high reputation of the organisation. Management should try to create a quality environment to eliminate all kinds of defect. (viii) Benchmarking Technique: Benchmarking is the process of studying and adapting the best practices of competing organisations to improve the organisation’s own performance. Benchmarking helps to understand own performance against the best practice in the industry. It measures how well an organisation and its managers are performing. Benchmarking is a modern technique for strategic improvement.

(ix) Management By Objectives (MBO): MBO is a technique which helps a manager to achieve his objectives in an effi cient manner. MBO leads to effective management by integrating the goals of an organisation and individuals. It increases the organisational capability of achieving goals at all levels through a high degree of satisfaction among employees. (x) Management Reporting: It provides relevant information to various levels of management in the forms of reports at regular intervals. It supplies data for policy-making and operating decisions. It is an instrument for making decisions and controls effective. Management takes proper decisions on the basis of these reports. 1.29 Objectives of Management Accounting Management accounting acts as a decision-support system for providing right information to the right people at the right time. The objectives of the management accounting can be enumerated from the following points: (i) Interpretation of fi nancial results: Management accounting analyses and interprets the fi nancial results of the concern. Various tools (such as ratio analysis, fund and fl ow statement, etc.) are used by the management accountant for analysing and interpreting fi nancial position of the organisation. (ii) Proper planning: Management accounting helps in preparation of plans and policies of an organisation. Management accountant uses various forecasting Presstechniques (such as Regression analysis, Time series analysis, etc.) to predict the future trends. Forecasting is necessary for planning process. Planning is the strategic area of management. (iii) Proper controlling: Management control is a process that assures use of resources effectively and effi ciently for achieving objectives of the organisation. The management accountant uses various techniques for ensuring effi cient managerial control (such as standard costing, budgetary control, internal audit, responsibility accounting, management audit, etc.). (iv) Proper communication: Communication has become an essence of management. Management functions cannot be performed effi cientlyUniversity without effective network of communication in the organisation. MIS supplies information as needed at different levels in the organisation. This system is used by the management accountant for supplying relevant information to various levels in the organisation. (v) Making decisions: Decision-making is necessary for effective functioning of management. The success of managementOxford depends on the quality of decision. Management accountant helps the management in taking various decisions (by applying marginal costing, differential costing, etc.). (vi) Tax planning: Management accountant helps the management in determining various tax reliefs and rebates. He assists the management in planning, computation of different tax liabilities and reduction of burden of tax. 1.30 Functions of Management Accounting Management accounting is called management-oriented accounting. The following are the major functions of management accounting: (i) Supplying relevant information: Management accounting furnishes relevant facts and fi gures to the managerial personnel. It assists management to take appropriate decisions on the basis of supplied information. It presents pertinent data to the management whenever required and in the suitable form. (ii) Presenting modifi ed data: It modifi es extracted data to suit the requirements of the decision. Relevant information is extracted from voluminous data and presented in a suitable form as desired © Oxford University Press. All rights reserved. Basics on Cost and Management Accounting 21 by the management. It modifi es data to serve the need of the decision under consideration. (iii) Interpretation of accounts: Financial data are to be analysed and interpreted properly to get an insight into the profi tability, solvency, liquidity, etc., of the organisation, Management Accountant analyses and interprets fi nancial data and presents the results with necessary comments to the management. (iv) Ensuring overall control: Management accounting identifi es areas where managerial control is desired. It uses various tools and techniques (such as standard costing, budgetary control, responsibility accounting, etc.) for identifying weak areas where appropriate managerial attention is needed. It also identifi es the factors and personnel who are responsible for the poor performance. Management can take corrective measures on the basis of these information. (v) Providing qualitative information: Management accountant submits comprehensive reports to the management which include both quantitative and qualitative information. Qualitative information (such as performance of employees, motivation of workers, reputation of the concern, customer satisfaction, etc.) are also relevant for the decisions under consideration. 1.31 Limitations of Management Accounting Management Accounting suffers from the following limitations: Press (i) Wide scope: The scope of management accounting is very vast. It requires the services of cost accounting, fi nancial accounting, operation research, statistics, production engineering, etc. It is diffi cult to develop a management accounting department with people who have full knowledge of all these disciplines. (ii) High installation cost: It is necessary to make an elaborate arrangements for installing a sound management accounting system. This requires high initial cost. Moreover, the operating (or running) cost of management accounting department is also high. As a result, small organisations cannot afford to instal this system. University (iii) Reliance on accounting data: Management accountant relies heavily on the quantitative data (i.e., fi nancial as well as cost data). Management reporting is based on the data gathered from fi nancial and cost books of accounts. The entire effort of management accountant becomes useless when fi nancial and cost accounts fail to provide true and fair view. (iv) Lack of objectivity: Management accountant uses both quantitative and qualitative information when preparing reportsOxford for the management. Reports (especially qualitative information) are infl uenced by personal judgement. Therefore, management reports may be subjective and lack objectivity. (v) Inability to respond to changing environment: The traditional system of keeping records no longer provides accurate information about the effi ciency and profi tability of internal operations. As a result, management accounting system fails to respond to rapidly-changing environment. It fails to support the strategic management decisions of the organisation.

Exercises Review Questions 1.1 Deﬁ ne Cost. Distinguish between Costing and Cost Accounting. 1.2 What is Costing? What are its objects and advantages?

© Oxford University Press. All rights reserved. Basics on Cost and Management Accounting 21 by the management. It modifi es data to serve the need of the decision under consideration. (iii) Interpretation of accounts: Financial data are to be analysed and interpreted properly to get an insight into the profi tability, solvency, liquidity, etc., of the organisation, Management Accountant analyses and interprets fi nancial data and presents the results with necessary comments to the management. (iv) Ensuring overall control: Management accounting identifi es areas where managerial control is desired. It uses various tools and techniques (such as standard costing, budgetary control, responsibility accounting, etc.) for identifying weak areas where appropriate managerial attention is needed. It also identifi es the factors and personnel who are responsible for the poor performance. Management can take corrective measures on the basis of these information. (v) Providing qualitative information: Management accountant submits comprehensive reports to the management which include both quantitative and qualitative information. Qualitative information (such as performance of employees, motivation of workers, reputation of the concern, customer satisfaction, etc.) are also relevant for the decisions under consideration. 1.31 Limitations of Management Accounting Management Accounting suffers from the following limitations: (i) Wide scope: The scope of management accounting is very vast. It requires the services of cost accounting, fi nancial accounting, operation research, statistics, production engineering, etc. It is diffi cult to develop a management accounting department with people who have full knowledge of all these disciplines. (ii) High installation cost: It is necessary to make an elaborate arrangements for installing a sound management accounting system. This requires high initial cost. Moreover, the operating (or running) cost of management accounting department is also high. As a result, small organisations cannot afford to instal this system. (iii) Reliance on accounting data: Management accountant relies heavily on the quantitative data (i.e., fi nancial as well as cost data). Management reporting is based on the data gathered from fi nancial and cost books of accounts. The entire effort of management accountant becomes useless when fi nancial and cost accounts fail to provide true and fair view. (iv) Lack of objectivity: Management accountant uses both quantitative and qualitative information when preparing reports for the management. Reports (especially qualitative information) are infl uenced by personal judgement. Therefore, management reports may be subjective and lack objectivity. (v) Inability to respond to changing environment: The traditional system of keeping records no longer provides accurate information about the effi ciency and profi tability of internal operations. As a result, management accounting system fails to respond to rapidly-changing environment. It fails to support the strategic management decisions of the organisation. 22 Cost and Management Accounting I 1.3 Explain the following methods of CostingExercises and state the name of industries to which they are applicable: (i) Job Costing, (ii) Process Costing, (iii) Operating Costing, (iv) Batch Costing, (v) Operation Costing Review(vi) Multiple Questions Costing, (vii) Contract Costing. 1.4 Explain the following techniques of Costing: (i) Marginal Costing, (ii) Standard Costing, (iii) Uniform 1.1 Defi ne Cost. Distinguish between Costing and Cost Accounting. 22 Costing,Cost and (iv) Management Historical Costing. Accounting 1.21.5 What (a) What is Costing? is a Cost What Centre? are itsExplain objects various and advantages? types of it. 1.3 Explain (b) Defi the ne Costfollowing Unit. methodsGive Six ofexamples Costing of and Cost state unit the applicable name of industriesto different to industries. which they are applicable: 1.6 (i) (a) Job Explain Costing, the (ii)utility Process of maintaining Costing, (iii) a Cost Operating Accounting Costing, System. (iv) Batch Costing, (v) Operation Costing (vi) Multiple Costing, (vii) Contract Costing. (b) As a consultant, how would you proceed to install a suitable cost accounting system in a large 1.4 Explainmanufacturing the following concern? techniques of Costing: (i) Marginal Costing, (ii) Standard Costing, (iii) Uniform Costing, (iv) Historical Costing. 1.7 “Cost Accounting has become an essential tool of management,”—Give your comments on this statement. 1.5 (a) What is a Cost Centre? Explain various types of it. 1.8 What is the importance of Cost Accounting to the management in the discharge of their function? (b) Defi ne Cost Unit. Give Six examples of Cost unit applicable to different industries. 1.9 State the limitations of Cost Accounting. 1.6 (a) Explain the utility of maintaining a Cost Accounting System. 1.10 (a) Discuss the relationship between Cost Accounting and Financial Accounting. (b) As a consultant, how would you proceed to install a suitable cost accounting system in a large (b) Discuss the relationship between Cost Accounting and Management Accounting. manufacturing concern? 1.11 Discuss the nature and scope of Cost Accounting? 1.7 “Cost Accounting has become an essential tool of management,”—GivePress your comments on this statement. 1.12 Defi ne management accounting. Discuss the nature and scope of management accounting. 1.8 What is the importance of Cost Accounting to the management in the discharge of their function? 1.13 What are the objectives of cost and management accounting? 1.9 State the limitations of Cost Accounting. 1.14 State the functions of management accounting. 1.10 (a) Discuss the relationship between Cost Accounting and Financial Accounting. 1.15 Discuss the limitations of both cost and management accounting. (b) Discuss the relationship between Cost Accounting and Management Accounting. 1.11 Discuss the nature and scope of Cost Accounting? 1.12 Defi ne management accounting. Discuss the nature and scope of management accounting. 1.13 What are the objectives of cost and managementUniversity accounting? 1.14 State the functions of management accounting. 1.15 Discuss the limitations of both cost and management accounting.

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