MBA 741-Principles of cost accounting (1)

Why Cost and Management Accounting? Financial Accounting is primarily an information system targeted at providing information on business performance to the stakeholders with an historical perspective. Given the serious objective of measuring the effectiveness of the business operations, and the need for the readers of the output to comprehend the information provided in a meaningful, the system follows a well-defined framework referred to as GAAP. However, this system may not be fully helpful for providing relevant information either to take operational decisions or to contemplate on strategic course of actions planned for the business enterprise. For instance, in a multi product environment, statements generated by the financial accounting system may fail to satisfactorily explain as to whether the profitability across product categories has been encouraging or else is there a need to revamp the product mix so as to improve the profitability. Though the overall profitability of the business has been increasing in absolute terms, it could be that one of the product categories is being subsidized by the others. Financial accounting fails to provide the relevant information to analyze such a situation more because of the design of the system than anything else. By definition, it is meant to serve the needs of the external stakeholders than anyone else. On the other hand, operating managers require timely, relevant and accurate information to take various decisions like the one referred to above. It spans from deciding the quantity of material input to be ordered each time an order is placed with a view to optimizing the total cost till planning the optimal product mix given various resource constraints. At times, the business may contemplate on making decisions with long term implications like deciding to stop manufacturing a component in house and start procuring it from outside or agreeing to supply products in the export market at a differential price using the unutilized capacity that exists as of now. In such circumstances, the need is felt to analyze the financial implications of the decisions proposed to be taken and where there are competing alternates, to arrive at one that would result in improvement in profitability and hence wealth maximization of the owners. This is where the role of cost accounting and management accounting comes in. Cost Accounting is that branch of knowledge that encompasses within itself concepts that are relevant to the operational decision making process. Management Accounting indicates a host of tools and techniques used to evaluate the decisions that have futuristic orientation and long term implications. Unlike Financial Accounting, these accounting systems are designed and maintained by the independent business entities without any need for publishing periodical reports or making any pronouncements. In short, Cost and Management accountancy is essentially for internal purposes while financial accounting is for stewardship purposes and is the basis of external reporting.

VIT BS-Chennai Campus-MBA(2012-2014 Batch)-Term IV

Page 1

MBA 741-Principles of cost accounting (1)

COST ACCOUNTING Basic Concepts & Terminologies Cost is defined as the economic value of all resources consumed in producing a product or rendering a service. The process of identification and measurement of cost is done through a process called Cost Accounting. The four main objectives of the study of Cost Accounting arei. Cost ascertainment - To ascertain (historical) cost and hence the profit (which is nothing but the difference between the sales revenues and expired costs of earning those revenues); probably understanding the behavior of costs with volume of production and sales could also enable forecasting of costs for the future periods (which could be useful in situations like providing a quote for a customer order) Cost Reduction - To explore the possibility of cost reduction (without of course influencing the quality aspects or causing any impact on customers perceptions on the product / service utility) Cost Control - To look into areas for cost control (Reduction might involve elimination of activities that probably affect customers perceptions; also, there might be factors beyond the control of the management like the stringent labor laws that do not afford flexibility for reducing certain costs though they may not be adding value. In such cases, control aimed at effective utilization of resources by monitoring the actual usage against a predetermined standard could be of help). Cost Management - To understand the aspects related to Cost Management (For instance, in a fully automated environment, the products produced pass through a technologically sophisticated environment. Such a situation involves huge capital outlay though the customer may not be willing to pay a premium for such technology. For him, the seller or manufacturer providing a high quality product is a realistic expectation. In such situations, the manufacturer must look for ways and means of managing the capacity utilization so that the fixed costs are recovered in full).

ii.

iii.

iv.

Cost Object It is something for which cost ascertainment is being done. In other words, it indicates the object for which one makes an attempt to calculate the cost. Cost object could be the output of a production or a manufacturing process (say, sugar produced in a mill), the conversion process itself, the division or department of an organization (say, the marketing department), a service (say, transportation service), a machine or a group of machines, etc. Cost Unit It is a unit of output in the production of which the costs are incurred. For example, if a factory produces motor cars, then the cost unit would be a motor car because the costs are all incurred in producing motor cars. In the case of services like transport services or treatment of patients in hospitals, the costs are normally measured in terms of more than one unit as all of them does
VIT BS-Chennai Campus-MBA(2012-2014 Batch)-Term IV Page 2

MBA 741-Principles of cost accounting (1)

have significance in the measuring of costs. For example, in the case of a transport contractor offering service to passengers, cost is measured in terms of passenger-kilometer. In the case of hospitals, cost per patient bed day is of relevance. These are examples of multiple cost units. Cost Center The smallest segment of activity or area of responsibility for which costs are accumulated. In the manufacture and sale of a product or in the rendering of a service, several activities may have to be performed. These activities are usually carried out by different department or sections of the company. Hence, cost statistics are conveniently accumulated for each department. In Cost Accounting, each department would be called a cost center. Typically cost centers are department, but in some instances, a department may contain several cost centers. For example, a machining department may be under one foreman but it may contain various groups of machines, such as lathes, milling machines, etc. In general, a cost center is a collection or group of men, machine or both that forms the basis of cost accumulation. Cost Classification is the process of grouping costs according to their common characteristics. A suitable classification of costs is of vital importance in order to identify cost with cost centers or cost units. Costs may be classified according to their nature, functions, variability, controllability, normality, time, etc. The following are the few important types of costsDirect Costs and Indirect Costs Direct costs are those costs which are incurred for and may be conveniently identified with a particular cost center or cost unit. By contrast, indirect costs are those costs which are incurred for the benefit of number of cost centers or cost units and cannot be conveniently identified with a particular cost center or cost unit. The important factor to distinguish direct costs from indirect costs with reference to a chosen cost object is the attributability without substantial investment of time or cost. Also, in terms of cost implications, direct costs form the substantial portion of the total costs. Example i. In producing a wooden chair, carpenter makes use of wood as well as nails. Chair being considered as cost object, wood would be the direct cost while nails would be taken as indirect cost. It might be true that nails may be spotted in a chair. However, to ascertain the total number of nails used, time would be consumed. Moreover, as compared to the total cost of producing the chair, the costs of nail would also turn out to be negligible. Accordingly, they are classified as indirect costs. ii. Fixed (or Period) Costs & Variable Costs Fixed Costs are those that remain fixed in total amount with increase or decrease in the volume of output or productive activity for a given period of time and within a given range of activity. E.g., rent, insurance, factor managers salary, etc. On the other hand, variable costs are those which vary in total in direct proportion to the volume of output. These costs per unit remain relatively constant with changes in production. Eg. Direct labor costs, direct
Page 3

VIT BS-Chennai Campus-MBA(2012-2014 Batch)-Term IV

MBA 741-Principles of cost accounting (1)

iii.

iv.

v.

vi.

vii.

viii.

ix.

x. xi.

xii.

material costs, power, etc. However, in real life, most of the costs are semi-variable with an element of fixed component as well as variable factor built into them. Budgeted Costs & Standard Costs Costs can also be classified based on the planning and control aspects. Budgeted costs represent an estimate of expenditure for different phases of business operations such as manufacturing, administration, sales, etc. Budgeted costs are translated into actual operation though the instrument of standard costs. Standard costs are defined as the predetermined costs based on a technical estimate for materials, labor, and overhead for a selected period of time and for a prescribed set of working conditions. Sunk Costs Sunk Costs are those relating to the committed investments which cannot be revoked and any decision in the form of an optimal alternative from a group of alternatives would not in any way influence the costs already incurred. For instance, assume that a company had already invested in a huge parcel of land. A portion of it had been lying vacant for quite some time. Now it is decided to explore the possibility of an expansion project. The cost of the land which has already been procured is a sunk cost in the context of the decision related to the expansion project. Marginal Cost Marginal cost is the total of variable costs i.e. prime cost plus variable overheads. It is normally the incremental costs of producing and selling one additional unit from the present level, within the specified range of activity. It is derived based on the distinction between fixed and variable costs. Within a specified range of activity, fixed costs remain constant and any operating decision is to be based on marginal cost. Opportunity Costs It is the maximum possible alternative earning that might have been earned if the productive capacity or services had been put to some alternative use. In other words, it is the profit foregone by putting the resource to one use as against the other use. Imputed (or Notional) Cost These costs appear in cost accounts only e.g. notional rent charged on business premises owned by the proprietor, interest on capital for which no interest need be paid. Conversion Cost Cost incurred in converting the raw material into finished product. It can also be calculated by deducting the cost of direct materials from the production cost. Committed Cost It is a fixed cost which results from the decisions of the management in the prior period and is not subject to the management control in the present on a short run basis. Discretionary Costs These are costs which are not essential for the decision under consideration or the accomplishment of management objectives. Joint Cost This is the cost which is common to the processing of joint products and by-products till the point of separation and cannot be traced to particular products before the point of split-off. Differential Cost or Incremental Cost If there is a change in costs due to change in the level of activity or pattern or method of production they are known as differential costs. If the change increases the cost, it will be called incremental costs. If there is a decrease in cost resulting from decrease of output, the difference is known as decremental cost.

VIT BS-Chennai Campus-MBA(2012-2014 Batch)-Term IV

Page 4

MBA 741-Principles of cost accounting (1)

xiii. xiv.

Prime Cost The aggregate of Direct material and Direct labor costs incurred in relation to a cost object is known as the Prime Cost. Conversion Cost It is the aggregate of labor and other variable costs incurred to convert the basic input to a marketable output.

VIT BS-Chennai Campus-MBA(2012-2014 Batch)-Term IV

Page 5

MBA 741-Principles of cost accounting (1)

Some FAQs How do managers decide on a cost object? A cost object is anything for which a separate measurement of costs is needed. Examples include product, service, project, customer, brand category, activity and department. How do managers decide whether a cost is a direct cost or an indirect cost? A direct cost is any cost that is related to a particular cost object and can be traced to that cost object in an economically feasible way. Indirect costs are related to the particular cost object but cannot be traced to it in an economically feasible way. The same cost can be direct for one cost object and indirect for other cost objects. The assignment of direct costs to a cost object is referred to cost tracing and the assignment of indirect costs to a cost object is known as cost allocation. A direct cost can be directly traced to a cost object, while an indirect cost cannot. A manufacturer converts materials into a finished product by using machinery and labor. The cost of materials that are an integral part of the manufactured product is direct materials cost. The cost of wages of employees who are involved in converting materials into the manufactured product is direct labor cost. Costs other than direct materials and direct labor costs are factory overhead costs. Direct materials, direct labor and factory overhead costs are associated with products and are called product costs. Selling and administrative expenses are associated with an accounting period and are called period costs. How do managers decide whether a cost is a variable or a fixed cost? A variable cost changes in total in proportion to changes in the related level of total activity or volume. A fixed cost remains unchanged in total for a given time period despite wide changes in the related level of total activity or volume. How should costs be estimated? In general, focus on total costs, not unit costs. When making total cost estimates, think of variable costs as an amount per unit and fixed costs as a total amount. The unit cost of a cost object should be interpreted cautiously when it includes a fixed cost component.

Classify manufacturing product costs as prime costs and conversion costs. The sum of direct materials and direct labor costs for a product is known as prime cost. Conversion costs are the sum of direct labor and manufacturing overhead costs for a product.

VIT BS-Chennai Campus-MBA(2012-2014 Batch)-Term IV

Page 6

MBA 741-Principles of cost accounting (1)

Cost Accounting Basic Concepts - Elements of Cost Total cost of any product or service consists of Material costs Labor costs and Overheads These are referred to as Elements of Costs. Material costs refer to the inputs to the production activity or service delivery while labor costs refer to the man power costs incurred in connection with the activity. All other costs, say, costs related to utilities or maintenance of infrastructure, administering the business enterprise, creating a market and distributing the product or service, would be classified as overheads. Material costs would be further classified into Direct Material Costs Costs of those inputs which are immediately attributable to the chosen cost object (say, costs of basic raw material) Indirect Material Costs Costs of all those inputs which are incidental and ancillary to the production process (say, costs of lubricants used for maintenance of machinery in working condition) Labor Costs also are further classified into Direct Labor Costs Costs of those man power engaged in the production process or forming an essential part of service delivery (Say, wages paid to workers in the factory shop floor handling all machinery) Indirect Labor Costs Costs of all those supervisory man power as well as handling functions like administration, marketing or other support services (Say, Shop floor supervisors salary, managerial staff salary) Overheads can be classified on the basis of function to which they relate to as Production or factory or works overhead Administrative overhead Selling & Distribution overhead

It is customary to include indirect material and indirect labor costs as an integral part of overheads. i.e. Production overheads would include indirect material costs, indirect labor costs and expenses related to production process to the extent they relate to activities within the production shop floor (say, rent of factory building, repairs and maintenance, power or fuel or electricity costs to the extent relatable to the production process, depreciation of machinery used in production process). Administrative overhead, as the name suggests include those cost items incurred to provide the administrative support to the business enterprise, say, salary to clerical and managerial staff for functions like accounting or HR,
VIT BS-Chennai Campus-MBA(2012-2014 Batch)-Term IV Page 7

MBA 741-Principles of cost accounting (1)

postage and stationery, communication expenses, etc. Selling and Distribution expenses include traveling and conveyance of sales staff, selling commissions, advertisement costs, business promotion expenses, etc. Based on the variability with reference to the level of activity, Overheads can also be classified into fixed overheads and variable overheads. i.e. there are certain overheads which do not increase or decrease with increase or decrease in the level of activity, say, increase or decrease in the volume of production or sales (within a given range of activity). On the other hand, others do. The former are called fixed and the latter referred to as variable. Accordingly, we can think of the following classification Type of overhead Fixed Production Overhead Variable Production Overhead Fixed Administrative Overhead Variable Administrative Overhead Fixed Selling Overhead & Illustration Rent of the factory Building Power cost for operating the machines Salary to say, accountant Call charges for telephone usage

Distribution Advertisement in print media as budgeted

Variable Selling & Distribution Commission based on sales volume Overhead

Significance of overhead In the case of a simple production process or service delivery with homogeneity, i.e. single product being produced or single service being delivered, all the costs are relatable to the end output. However, imagine a situation wherein a factory produces three different types of products. In such a case, it might be easier to spot the direct material and direct labor costs. i.e. the store keeper and the foreman would be in a position to provide details as to how much of and what type of raw material was consumed for different product categories. Given that the workers in various production processes can be physically identified, the personnel department would be able to provide details of whose costs relate to which product category. However, when it comes to overheads, we face a complex problem. These are most of the times, common across all product categories and need to be distributed in an equitable manner. This is where cost accounting advocates concepts like Cost allocation, Cost apportionment and Cost absorption.
VIT BS-Chennai Campus-MBA(2012-2014 Batch)-Term IV Page 8

MBA 741-Principles of cost accounting (1)

Concept of Overhead Absorption Given that all costs other than direct material and direct labor and incurred within a factory are classified as production overheads, it may be difficult for a cost accountant to account for so many items before arriving at the actual cost of production. In fact, some of these items may not be known immediately. For instance, power supply is metered and it may be the practice for the concerned government department to bill the cost once in two months. If the cost accountant were to wait to record all such expenses based on the actuals, then, there seems to be no difference between cost and financial accounting. We know that the purpose of cost accounting is purely internal i.e. this accounting system provides information for operational decision making. In other words, what is important is the timeliness with which the information is provided and accuracy could be sacrificed a little. Thus, the cost accountant, would rather instead of waiting for recording the actuals when it comes to overheads, proceed accounting for them on a predetermined basis. For example, given the budgeted levels of activity (measured in terms of units of production, say) he would estimate in advance the overhead per unit and record the same with a view to get a quick estimate of the cost. This technique is referred to as Absorption. The basis of absorption is chosen depending upon the cost accountants understanding of what influences the costs more. If he thinks that the nature of production activity is such that majority of the costs inside the factory are influenced by the time for which various machines are run, then, he might choose the basis of cost estimation as machine hours. If he thinks that the work is labor oriented, he might choose labor hours. In other words, the basis of cost absorption is what is known as the Cost driver (that which drives the cost). At the end of specified periods, the cost accountant would exchange notes with the financial accountant as to what is the actual overheads with a view to revise his basis of estimation for the forthcoming period. In other words, he will attempt to work out the difference between overheads accounted in the cost accounting system based on a predetermined basis against the actuals recorded in the financial accounting system. The difference would be referred to as over or under absorption. If what is recorded in the cost accounting system is more than the actuals, we have over absorption while the reverse is true of under absorption. In case, the cost forms the basis of decision making for setting up prices, then, over absorption would lead to overpricing and under absorption would result in under pricing. Neither of course, is desirable. Illustration of Absorption of Overheads Production overheads would be absorbed at 40% of Direct Labor cost This would mean that production overheads are estimated to be approximately 40% of the direct labor costs.

VIT BS-Chennai Campus-MBA(2012-2014 Batch)-Term IV

Page 9

MBA 741-Principles of cost accounting (1)

Production overheads would be absorbed at Rs. 6 per unit produced This would mean that in addition to direct material and direct labor costs, all other expenses incurred inside the factory is expected to amount to Rs. 6 per unit produced. Administrative overhead could be absorbed as to Rs. Per unit produced or as a specified percentage of works cost or cost of production. Selling and distribution overhead is normally absorbed as to Rs. Per unit sold or a specified percentage of cost of goods sold.

VIT BS-Chennai Campus-MBA(2012-2014 Batch)-Term IV

Page 10

MBA 741-Principles of cost accounting (1)

Concept of a Cost Sheet Let us consider the simple case of a manufacturing unit producing homogenous products based on a customer order. To ascertain the historical cost, it is customary to use a Cost Sheet which indicates the total cost computed in stages as shown belowCost Sheet of __________________ Limited for the period_________________ Volume of Production : Volume of Sales Component Direct material consumed Opening stock of raw material Add Purchases Add Costs directly related to purchases Less Closing stock of raw materials Direct material costs Direct labor costs Prime Costs Add Factory or production or works overhead Factory Cost or Works Cost (Gross) Add Opening stock of Work-inProcess Less Closing stock of Work-inProcess Factory Cost or Works Cost (Net) Add Administrative overheads Costs of production Add Opening stock of Finished goods Less Closing stock of Finished goods Costs of goods sold Add Selling and administrative overheads Costs of sales Profit or Loss Sales : Units Units Total Costs (Rs.) Cost (Rs.) Per Unit

VIT BS-Chennai Campus-MBA(2012-2014 Batch)-Term IV

Page 11

MBA 741-Principles of cost accounting (1)

Cost Sheet - Illustration From the following particulars, prepare the cost sheet for the year ended 31st March 2006 Raw materials consumed Wages Sales (60000 units) 2740000 1510000 6000000

Factory overheads have been absorbed at 20% of Prime Cost Administrative expenses have been absorbed at Rs. 6 per unit produced Selling expenses have been absorbed at Rs. 8 per unit sold You are given that during the period the company produced 62000 units. At the end of the period, the company had valued the work-in-process at Rs. 1,20,000. Solution Components Direct Material Cost - Raw material consumed Direct Labor Cost - Wages Prime Cost Add - Factory Overheads - 20% of Prime Cost Works Cost (Gross) Less - Closing stock of WIP Works Cost (Net) Add - Administrative Overheads - Rs. 6 per unit for 62000 units Costs of production Less - Closing stock of Finished goods 372000 5352000 6.00 86.32 850000 5100000 120000 4980000 80.32 13.71 82.25 1510000 4250000 24.35 68.54 2740000 44.19 Total cost Cost per unit

VIT BS-Chennai Campus-MBA(2012-2014 Batch)-Term IV

Page 12

MBA 741-Principles of cost accounting (1)

- valued at Rs.86.32 per unit - (Rs. 5352000 / 62000 units) Costs of good sold Add - Selling & Distribution expenses - Rs. 8 per unit sold (8*60000) Costs of sales Profit Sales 480000 5659360 340640 6000000 8.00 94.32 5.68 100.00 172640 5179360 86.32

Exercise in Cost Sheet 1. A factory uses a job costing system. The following cost data are available from the books for the year ended 31st March 2006Rs. Direct Materials 9,00,000 Direct Wages 7,50,000 Profit 6,09,000 Selling and Distribution Overhead 5,25,000 Administrative Overhead 4,20,000 Factory Overhead 4,50,000 Requireda. Prepare a Cost Sheet, indicating the Prime Cost, Works Cost, Cost of Production, Cost of Sales and Sales Value. b. In 2006-07, the factory has received an order for a number of jobs. It is estimated that the direct materials would be Rs. 12,00,000 and direct labor would cost Rs. 7,50,000. What would be the price for these jobs if the factory intends to earn the same rate of profit on sales, assuming that the selling and distribution overhead has gone up by 15%. The factory recovers factory overhead as a percentage of direct wages and administrative and selling distribution overheads as a percentage of works cost, based on the cost rates prevalent in the previous year. 2. From the information given below you are required to a. prepare a standard cost sheet for one unit and enter on the standard cost sheet the costs to show sub-totals for i. prime cost ii. cost of production
VIT BS-Chennai Campus-MBA(2012-2014 Batch)-Term IV Page 13

MBA 741-Principles of cost accounting (1)

iii. cost of sales b. calculate the selling price per unit allowing for a profit of 15% of the selling price Budgeted output for the year 9800 units Standard details for one unitDirect materials 40 square metres at Rs. 5.30 per square metre Direct wages Bonding department 48 hours at Rs. 2.50 per hour Finishing department 30 hours at Rs. 1.90 per hour Budgeted costs and hours per annumVariable overheadBonding department Rs. 375000 (500000 hours) Finishing department Rs. 150000 (300000 hours) Fixed overhead Production -Rs. 392000 Selling and distribution Rs. 196000 Administration Rs. 98000 3. The following cost data for 2003 pertains to Heartstrings Limited, a greeting card manufacturerDirect material used in production 11,00,000 Advertising expenses 1,20,000 Depreciation on factory building 1,15,000 Direct labor wages 4,85,000 Cost of finished goods inventory at year end 1,15,000 Indirect labor wages 1,40,000 Production supervisors salary 45,000 Service department costs* 1,00,000 Direct labor amenities and benefits 95,000 Indirect labor amenities and benefits 30,000 Fringe benefits for production supervisor 9,000 Total overtime premiums paid 55,000 Cost of idle time production employees 40,000 Administrative costs 1,50,000 Rental of office space for sales personnel $ 15,000 Sales commissions 5,000 Production promotion costs 10,000 * All services are provided to manufacturing department. $ The rental of sales space was made necessary when the sales offices were converted to storage space for raw material. Find out the Total cost for the period and the profit if the sales revenue were Rs. 30,00,000. 4. A factory provides the following estimates in respect of its two products A and B: Estimated Production and Sales 10,000 units of A and 20,000 units of B
VIT BS-Chennai Campus-MBA(2012-2014 Batch)-Term IV Page 14

MBA 741-Principles of cost accounting (1)

Direct Material consumed - Rs.75,000; 1 unit of B requires twice as much materials as that of 1 unit of A 75 Workers will be engaged in the production process, with each worker spending 8 hours per day for 25 days. They shall be paid Rs.10 per hour. The total labour cost for product B shall be 1 times that of labour cost for product A Factory overheads are absorbed at 33 1/3% of direct labour cost. Administration overheads are absorbed at 50% of works cost. S&D overheads per unit are the same for both the products and is 10% of selling price per unit The total expected sales is Rs.6,00,000 Analyze the cost structure of both the products in as much details as possible using cost sheet. 5. Prepare the cost sheet for 2008 considering the following detailsOpening stock of direct materials = Rs. 3,20,000 Opening stock of WIP = Rs. 72,500 Opening stock of finished goods = Rs. 4,10,000 Direct materials purchased = Rs. 10,96,000 Carriage inwards = Rs. 35,700 Direct labor cost = Rs. 6,60,000 Closing stock of direct materials = Rs. 1,30,000 Closing stock of WIP = Rs. 56,600 Closing stock of finished goods = Rs. 4,20,000 Production overheads are absorbed at 40% of prime cost Administrative overheads are absorbed at 40% of works cost Selling and distribution overheads are absorbed at 20% of cost of sales The company maintains a profit margin of 25% of sales

6. The Cost Sheet of Innovative Automotive Solutions Limited for the year ended 31 st March 2008 is as followsDirect Material cost = Rs. 9,00,000 Direct Labor cost Profit S & D overheads Administrative Overheads Works Overheads = Rs. 7,50,000 = Rs. 6,09,000 = Rs. 5,25,000 = Rs. 4,20,000 = Rs. 4,50,000

For the year 2008-2009, the Direct material cost is estimated to be Rs. 12,00,000 while Direct labor cost is expected to remain the same. If the company intends to earn the same rate of profit on sales for 2008-2009 at the same rate as in 2007-2008, compute the budgeted sales given thatVIT BS-Chennai Campus-MBA(2012-2014 Batch)-Term IV Page 15

MBA 741-Principles of cost accounting (1)

i. ii. iii.

Factory overheads are recovered as % of direct wages Administrative and selling & distribution overheads are recovered as % of works cost S & D overheads is expected to go up by 15%

7. Alpha Industries produces only one product. The company expects a return of 12% after tax on capital employed (consisting of fixed assets of Rs. 10,00,000 and working capital equivalent to 20% of sales). The company pays tax at 40% on its profits. The other relevant information are Units budgeted to be produced and sold Direct materials at this level of activity Direct labour at this level of activity Production overhead Administrative overhead Selling and distribution costs - 20,000 - Rs. 1,25,000 - Rs. 1,75,000 - Rs. 1,20,000 - Rs. 80,000 - 20% on sales

Compute the sales price at which the product should be sold in the market in order to meet the return requirement.

VIT BS-Chennai Campus-MBA(2012-2014 Batch)-Term IV

Page 16

MBA 741-Principles of cost accounting (1)

Exercises in An introduction to cost terms and concepts 1. Classify each of the following as being usually fixed (F), variable (V), semi-fixed (SF) or semi-variable (SV): a. Direct labor b. Depreciation of machinery c. Factory rental d. Supplies and other indirect materials e. Advertising f. Maintenance of machinery g. Factory managers salary h. Supervisory personnel i. Royalty payments 2. The list of representative cost drivers in the right column below are randomized with respect to the list of functions in the left columns. That is, they do not match. Function Representative Cost Driver 1. Accounting A. Number of invoices sent 2. Personnel B. Number of purchase orders 3. Data processing C. Number of research scientists 4. R & D D. Hours of computer processing unit (CPU) 5. Purchasing E. Number of new hires 6. Billing F. Number of transactions processed Required- a. Match each function with its representative cost driver. b. Give a second example of a cost driver for each function. 3. A dissatisfied employee, Frank, put a torch to a manufacturing plant on February 26. The resulting fire destroyed the plant and its contents. Fortunately, certain accounting records were kept in another building. They reveal the following for the period from January 1, 2004 to February 26, 2004Direct material purchased Rs. 160000 Work in process (1st Jan 2004) Rs. 34000 Direct materials (1st Jan 2004) Rs. 16000 st Finished goods (1 Jan 2004) Rs. 30000 Indirect manufacturing costs 40% of conversion costs Revenues Rs. 500000 Direct manufacturing labor Rs. 180000 Prime costs Rs. 294000 Gross margin percentage based on revenues 20% Cost of goods available for sale Rs. 450000

VIT BS-Chennai Campus-MBA(2012-2014 Batch)-Term IV

Page 17

MBA 741-Principles of cost accounting (1)

The loss is fully covered by insurance. The insurance company wants to know the historical cost of the inventories as a basis for negotiating a settlement, although the settlement is actually to be based on replacement cost, not historical cost. Calculate the value of inventory lost due to fire. 4. S Plastics Limited provides the following data for August 2009 (in Rs. Millions) WIP inventory (1/8/2009) 200 Direct materials inventory (1/8/2009) 90 Direct materials purchased 360 Direct materials used 375 Variable manufacturing overhead 250 Total manufacturing overhead 480 Total manufacturing costs 1600 Cost of goods manufactured 1650 Cost of goods sold 1700 Finished goods inventory (31/8/2009) 125 Calculate the followinga. Direct materials inventory (31/8/2009) b. Fixed manufacturing overhead costs for August 2009 c. Direct manufacturing labor costs for August 2009 d. WIP inventory (31/8/2009) e. Goods available for sale in August 2009 f. Finished goods inventory (31/8/2009) 5. Prepare the cost sheet for 2008 given the followingProduction = 40000 units; Sales = 36000 units Opening stock of Raw materials: 15000 kg. atRs. 4.50 per kg Purchases: 100000 kg. atRs. 4.25 per kg. Closing stock : 35000 kg. Carriage inwards: Rs. 75000 Direct Labor Rs. 360000 Production overheads 75% of Direct labor cost Opening stock of work-in-process = Rs. 36000 & Closing stock of work-in-process = Rs. 48000 Administrative overheads Rs. 6 per unit produced Opening stock of finished goods = 9000 units at Rs. 29 per unit Selling and distribution overheads Rs. 5 per unit sold Sales value indicates a profit of 20% on cost 6. Prepare the cost sheet for 2008 in respect of ABC Limited, given the following Production of product X = 20000 units Sales = 17500 units Raw material:
Page 18

VIT BS-Chennai Campus-MBA(2012-2014 Batch)-Term IV

MBA 741-Principles of cost accounting (1)

Opening stock : 12000 kg. valued at Rs. 7 per kg. Purchases: 143000 kg. atRs. 7.50 per kg. Consumed: 15000 kg. Carriage inwards: Rs. 71500 30 workers were employed in production process. They worked for 8 hours a day for 25 days a month throughout the year. They were paid Rs. 12 per hour. Production overheads were absorbed at 25% of prime cost. It was found that 60% of this was variable. Administrative overheads were absorbed at the rate of Rs. 18 per unit produced. It was found that the entire overheads were fixed in nature. Opening stock of work-in-process amounted to Rs.124800 while closing stock of work-in process was valued at Rs. 375300 There was no opening stock of finished goods. The selling and distribution overheads were absorbed at the rate of Rs.16 per unit sold of which 75% was variable. Selling price per unit was Rs. 175.

Also, compute the selling price for 2009 given the following estimates made by the company Sales volume is expected to go up by 20% Raw material cost is expected to increase by 8% while labor rates would increase by 6%. However, efficiency of labor will increase by 5%. All fixed overheads will increase by 10% while variable overheads are expected to remain the same. The company would like to have a profit margin of 20% on sales.

7. The controller for Onida Vineyards Limited has predicted the following costs at various levels of wine outputWine output (0.75 liter bottles) 10,000 15,000 20,000 Bottles bottles bottles Variable production costs Fixed production costs 100,000 Variable selling and administrative costs Fixed selling and administrative costs Total 35,000 52,500 70,000 100,000 100,000

2,000 3,000 4,000 40,000 40,000 40,000 177,000 195,500 241,000

The companys marketing manager has predicted the following prices for the firms fine wines at various levels of salesWine sales 10,000 Bottles
VIT BS-Chennai Campus-MBA(2012-2014 Batch)-Term IV

15,000 bottles bottles

20,000

Page 19

MBA 741-Principles of cost accounting (1)

Sales price per 0.75 liter bottle

18.00

15.00

12.00

Required-a. Calculate the unit cost of wine production and sales at each level of output. At what level of output is the unit cost minimized? B.Calculate the companys profit at each level of production. Assume that the company will sell all of its output. At what production level is profit maximized? c. Which of the three output levels is the best for the company? D. Why does the unit cost of wine decrease as the output level increases? Why might the sales price per bottle decline as sales volume increases?

VIT BS-Chennai Campus-MBA(2012-2014 Batch)-Term IV

Page 20