Capter 1

INTRODUCTION
A business is an activity carried out with the intention of earning the profits. A person carrying out the business is interested in knowing basically two facts about his business (a) What is the result of operations of the business activity? Whether the business has resulted into the profit or loss? Excess of revenue over the expenses will be in the form of profits Whereas excess of expenditure over the revenue will be in the form of loss. (b) Where the business stands in financial terms at any given point of time.

the transactions relating to the business are recorded in a systematic manner. According to American Institute of Certified Public Accountants, Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are of a financial character and interpreting the results thereof. The process of recording the business transactions in a defined set of records, Which in technical words are called as Books of Accounts, is referred to as Book Keeping. Accounting refers to the process of analyzing and interpreting the information already recorded in the books of accounts with the ultimate intention of answering the above stated questions. This intention is satisfied by preparing what are called as Financial Statements. The financial statements prepared by the organization are basically in two forms(a) Profitability Statement, which is the answer to the first question i. e, what is the result of operations of the business activity. Thus, profitability statement indicates the amount of profit earned or the amount of loss incurred. (b) Balance Sheet, which is the answer to the second question i.e. where the business stands in financial terms at any given point of time. Thus, balance sheet indicates the financial status of the business at any given point time in terms of its assets and liabilities. 2 Management Accounting The nature of these financial statements is discussed in details in the following pages. Thus, the process of book keeping is more procedural and clerical in nature while the process of accounting is more managerial in nature. As such, the job of book keeping is entrusted to junior level employees, whereas the job of accounting needs more professional expertise. STREAMS OF ACCOUNTING The process of Accounting gets split into three streams 1. Financial Accounting 2. Cost Accounting 3. Management Accounting Let us discuss the nature of these three streams of accounting in details. Financial Accounting Financial Accounting is the process .of systematic recording of the business transactions in the various books of accounts maintained by the organization with the ultimate intention of preparing the financial statements there from. These financial statements are basically in two forms. One, Profitability Statement which indicates the result of operations carried out by the organization during a given period of time and second Balance Sheet which indicates the state of affairs of the organization at any given point of time in terms of its assets and liabilities.

This nature of Financial Accounting indicates following characteristic features of Financial Accounting (a) Financial Accounting considers those transactions which can be expressed in terms of money. All those transactions which can not be expressed in terms of money, howsoever important they may be from business point of view, find no place in financial accounting and hence in financial statements. E.g. Assuming that the business of an organization is such that it is likely to be injurious to the health of local community. As such, there is a strong opposition from the local community for the companys carrying on the business at that location. This opposition is something which can not be expressed in terms of money and hence finds no place in financial accounting and hence in financial statements though, it is affecting the business operations of the organization to a very great extent. (b) Financial Accounting is referred to as Historical form of accounting. In other words, financial accounting is concerned with recording of transactions which have already taken place. No futuristic transactions and events, howsoever important and significant they may be from business point of view. find any place in financial accounting and hence in financial statements. Introduction 3 (c) In practical circumstances Financial Accounting is more or less a legal requirement. In case of certain organizations like Company form of organization, Banks, Insurance Companies etc., not only it is necessary to maintain the financial accounting records and prepare the financial statements there from, but it is obligatory to get these financial statements audited also by an independent Chartered Accountant. In some cases, there may not be direct legal requirement to prepare the financial statements, but indirectly it is necessary to prepare the financial statements. E.g. If a partnership firm wants to file its Income Tax Return as per the provisions of Income tax Act, 1961, preparation of financial statements is a must to ascertain the profits. (d) Financial Accounting is meant for those people who are external to the organization. In other words, financial accounting is basically meant for those people who are not a part of decision-making process regarding the organization. This class of people may consist of the people like investors, customers, suppliers, banks, financial institutions etc. (e) The information available from Financial Accounting, i.e. financial statement, is available at a delayed point of time. E.g. Balance Sheets as on 31st March 2002 is available after 31st March 2002 is over. The various legal provisions also allow sufficient time lag for the preparation of financial statements. For decision-making purposes, immediate availability of financial data is a prerequisite which is not satisfied by financial accounting. In this sense, financial accounting has the limitation. Further, as sufficient time is allowed for the preparation of financial statements, they are expected to be accurate. (f) Financial Accounting discloses the financial performance and financial status of the business as a whole. It does not indicate the details about the individual department or job or process inside the organization, the information which is more significant from decision-making point of view. In this sense, financial accounting has the limitation. (g) Financial statements are essentially interim reports and cannot be the final ones. E.g. In order to understand the correct profitability and correct position of the assets and liabilities of an organization, it will be necessary to stop the business operations, dispose off all the assets of the organization and liquidate all the liabilities. Obviously it is not feasible and practicable. In order to prepare the financial statements for a specific period, it may be necessary to cut off various transactions involving costs and incomes at the date of closing the accounts. This may involve personal judgements. Various policies and principles are required to be formulated and followed consistently for such cutting off of incomes and costs. (h) As the going concern principle is followed while preparing the financial statements, the various assets and liabilities are shown at the historical prices which may not necessarily represent the current market prices or the liquidation prices. This may affect profitability 4 Management Accounting also due to incorrect provision for depreciation on assets. This problem may be more critical during the periods of extreme inflation or depression.

(i) The process of Financial Accounting gets largely affected due to the various accounting policies followed by the accountants. Even though, attempts are being made to bring in the uniformity in the various accounting policies followed by the accountants, still the accounting policies may differ from organization to organization. These accounting policies may differ basically in two fields : Valuation of Inventory Calculation of Depreciation The effect of these different accounting polices is discussed in the following chapters. Cost Accounting Cost accounting is the process of classifying and recording of the expenditure in a systematic manner with the intention of ascertaining the cost of a cost centre with the intention of controlling the cost. The Institute of Cost and Management Accountants, London has defined Cost Accounting as the application of costing and cost accounting principles, methods and techniques to the science, art and practice of cost control and the ascertainment of profitability as well as the presentation of information for the purpose of managerial decision making. The above description of Cost Accounting reveals the following characteristic features of Cost Accounting (a) Cost Accounting views the organization from the angle of individual components of the organization like department or job or process etc. Cost Accounting is interested in ascertaining the profitability of these individual components of the organization. (b) Cost Accounting is operated with basically three objectives Ascertainment of cost and profitability with the help of various principles, methods and techniques. Cost Control - This indicates the process of controlling the costs of operating the business. Presentation of information to enable the managerial decision-making. (c) Cost Accounting is meant for those people who are internal to the organization. In other words, Cost Accounting is meant for those people who are a part of decision-making process of the organization. The people who are external to the organization do not have any access to the cost accounting records. In fact the basic objective of cost accounting is to facilitate professional decision-making process on the part of managers. Introduction 5 (d) Cost Accounting is not a legal requirement. Maintenance of cost accounting records is not mandatory. However, maintenance of cost accounting records may be a legal requirement in some exceptional cases. Section 209 (1) (d) if the Companies Act, 1956, makes it mandatory for companies falling under certain class of industries to maintain cost accounting records and also get them audited from an independent Cost Accountant (which is technically referred to as Cost Audit). (e) Cost Accounting does not necessarily restrict itself to the historical transactions or historical events. Future transactions or events may find the place in cost accounting. In fact, each and every transaction, whether past or future, which is likely to have an impact on the business is of concern to the cost accounting. (f) As Cost Accounting is supposed to facilitate professional decision making on the part of manager, immediate availability of data is the prerequisite of cost accounting. As such, accuracy is not insisted upon by cost accounting to the extent of hundred percent. Management Accounting Management Accounting is the process of analysis and interpretation of financial data collected with the help of financial accounting and cost accounting with the ultimate intention to draw certain conclusions therefrom in order to assist the management in the process of decisionmaking. Emergence of Management Accounting In the olden days, when size of business operations was small and the complexities involved in the same were limited, financial accounting was considered to be sufficient. Financial Accounting ultimately aims at preparing financial statements which are basically in two forms. (1) Profit and Loss statement which is a period statement and relates to a certain period, usually one year. This tells about the result of operations, either profit or loss, arising out of the conduct of business operations during that period.

(2) Balance Sheet which is a position statement and relates to a particular point of time. This tells about the various properties held by the business (termed as assets) and obligations accepted by the business (termed as liabilities) as on a particular date. The preparation of these financial statements was considered to be sufficient to serve the requirements of all the interested parties, both outsiders as well as insiders. However, due to the increasing size and complexities of the business operations and specifically due to the segregation of ownership and management, only financial accounting was realised to be insufficient. This was specifically due to certain limitations of financial accounting. 6 Management Accounting (a) Financial accounting considers only those transactions which may be expressed in financial terms, either fully or at least partially. However, it ignores the fact that there may be other types of non-financial transactions which may have a bearing on business operations, e.g.. Prestige of business, credit standing of business, efficiency and loyalty of employees, efficiency and intensity of management etc. (b) Financial accounting deals with recording of the past events and as such it is the postmortem record of business transactions. For taking correct decisions regarding the business, the management may need, not only the past details but also the future events, and future events are not the subject matter of financial accounting. As such, financial accounting and preparation of financial statements therefrom is no longer considered to be sufficient for successful and smooth running of business. The analysis and interpretation of data available from financial accounting is also considered to be necessary which may not be directly available from financial accounting itself. Here comes into the picture Management Accounting. Management Accounting deals with, the analysis and interpretation of financial data with the ultimate intention to draw certain conclusions therefrom, in order to assist the management in the process of decision-making. To conclude, it may be said that the role of management accounting has emerged due to the shortcomings of financial accounting. Definition of Management Accounting The Institute of Chartered Accountants of England and Wales has defined management accounting as any from of accounting which enables a business to be conducted more efficiently. Management Accounting Team of Anglo-American Council on Productivity has described the term Management Accounting as the presentation of accounting information in such a way so as to assist management in the creation of policy and the day to day operation of an undertaking. American Accounting Association has defined the term Management Accounting as the application of appropriate techniques and concepts in processing historical and projected economic data of an entity to assist management in establishing plans for reasonable economic objectives and in the making of rational decisions with a view towards these objectives. The various definitions of the term Management Accounting reveal the following features of the same. (1) Management Accounting is a service function which is concerned with providing various information to the management to facilitate decision making and review of implementation of those decisions. Introduction 7 (2) Management Accounting uses not only the historical data but may also use the data based on projections and forecasts for the purpose of evaluation of various possible alternatives. (3) Management Accounting assists the management in establishing the plans to attain the economic objectives and in taking proper decisions required to be taken for the attainment of these objectives. (4) Management Accounting involves the application of various special techniques and concepts for the attainment of its objects. The techniques used in the process of management accounting are discussed in the following chapters. Objects of Management Accounting The above discussions reveal that the Management Accountant is an invaluable aid to the

management to discharge the basic functions of planning, execution and control. This is done by (1) Making available accounting and other data to enable the management to plan effectively. (2) Measuring the actual performance and reporting the same to the various levels of management to indicate the effectiveness of the organisational methods used. (3) Computation of deviation of actual performance from the plans and standards set. (4) Presenting to the management the operating and financial statements at reasonable intervals and interpreting the same to enable the management to take action/decisions regarding future policy and operations. Scope of Management Accounting After considering the various objectives the Management Accounting aims at, it can be noted that the scope of Management Accounting is much wider. It covers virtually every area and every aspect of business operations. However, to be more precise, the various areas covered by Management Accounting can be stated as below. (1) Accounting : It deals with recording, summarising and analysing various business transactions. The process of accounting may take basically two forms. (a) Financial Accounting : It deals with recording the business transaction which are financial in nature. It aims at the preparation of what is called financial statements which may be basically in two forms. Firstly, the Balance Sheet which tells about the state of affairs of the business in terms of the various assets and liabilities and Secondly, the profitability statement which tells about the result of operations of 8 Management Accounting the business i.e. profit earned or loss incurred. The financial statements are mainly meant for the outsiders dealing with the business. (b) Cost Accounting : It deals with recording of income and expenditure, ascertainment of cost and profitability and the presentation of information derived therefrom for the purpose of managerial decision making. Thus, the cost accounting is basically meant for the management to enable it to take decisions. (2) Cost Control Procedures : It deals with the various steps involved in the process of controlling the cost. Thus, in turn it may deal with. (a) Establishment of plans or budgets for the future. (b) Comparison of actual performance with the planned or budgeted performance. (c) Computation of variations between the planned and actual performance. (3) Reporting : It deals with the presentation of cost data, statistical data or any other information to the various levels of management. It may be required for the purpose of decision making or for the purpose of fulfillment of various legal obligations. (4) Taxation : It deals with the computation of income as per the law and filing the tax returns and making the tax payments. (5) Audit : It deals with devising the internal control systems and internal audit system to cover the various operational areas of business. In many cases, it may also deal with the management audit which is the evaluation of the managerial performance. (6) Methods and Services : It deals with providing the management services and the management information systems. It also deals with the various methods of reducing the cost and improve efficiency of accounting and other office operations and preparing and issuing the accounting and other operational manuals. Disadvantages/Limitations of Management Accounting In spite of the various advantages available from the management accounting in the era of ever increasing complex business operations, it suffers from some limitations, (1) A very wide scope of management accounting is the limitation by itself. It attempts to operate in a wide range of areas and it is quite possible that it may not be able to make proper justification to all of them. (2) In spite of the fact that the management accounting provides the various details required for qualitative decision making thus attempting to avoid the possibility of intuitive decision making, in many cases in practice, the decisions are based upon the intuition of the decision maker rather than the scientific data available therefor. Introduction 9

(3) The installation and operation of management accounting requires a very elaborate organisational structure and a large number of rules and regulations. It may make the management accounting system a costly proposition which can be implemented only by large scale organisations. (4) Management Accounting system is still in the evolution stage and hence suffers from the various limitations which any system may face in the initial stages like the requirement of constant improvements of the techniques and uncertainty about the application of the system etc. (5) The installation and operation of management accounting system may call for the radical changes in the entire organisational structure which may cause severe opposition and resistance from the existing personnel. FINANCIAL ACCOUNTING AND COST ACCOUNTING COMPARED (a) Financial Accounting is concerned about the calculation of the profitability and state of affairs of the organization as a whole with the help of preparation of the financial statements. Financial Accounting takes into consideration only the historical data which may not be of any use from the cost control point of view. Cost Accounting may deal with the ascertainment of cost and calculation of profitability of the individual products, departments, branches and so on. Cost Accounting involves a much-detailed study of costs and profitability which takes into consideration not only historical data but also the future events and possibilities. As such, cost accounting proves to be better proposition from the cost control point of view. (b) Due to the various statutory regulations, maintenance of financial accounting records and preparation of financial statements therefrom is more or less a legal requirement. Maintenance of cost accounting records is not a legal requirement except in case of certain company form of organizations where maintenance of cost accounting records has been made compulsory as per the provisions of Section 209 (1) (d) of the Companies Act, 1956. (c) Financial Accounting primarily protects the interests of the outsiders dealing with the organization in various capacities like investors, suppliers, customers, banks, financial institutions, government authority etc. Cost Accounting is primarily meant for the management to enable the same to discharge various functions in a proper manner i.e. planning, execution, co-ordination and decisionmaking. 1 0 Management Accounting This relationship between Cost Accounting and Financial Accounting can be better explained with the help of the following illustration which states the presentation of the profitability statement under both the sets accounting. (a) Financial Accounting Profit and Loss Account for the year ended on 31st march 1990. To, Material Cost 1,50,000 By sales 5,00,000 To, Labour Cost 1,00,000 To, Factory Expenses 50,000 To, Gross Profit c/fd (40% of sales) 2,00,000 5,00,000 5,00,000 To, Administration By Gross Profit Expenses 90,000 C/f 2,00,000 To, Selling Expenses 50,000 To, Net Profit (12% of sales) 60,000 2,00,000 2,00,000 (b) Cost Accounting Products Total A B C Material Cost 1,50,000 20,000 50,000 80,000 Labour Cost 1,00,000 15,000 30,000 55,000 PRIME Cost 2,50,000 35,000 80,000 1,35,000 Factory Expenses 50,000 20,000 10,000 20,000

FACTORY Cost 3,00,000 55,000 90,000 1,55,000 Administration Expenses 90,000 40,000 20,000 30,000 Selling Expenses 50,000 15,000 20,000 15,000 TOTAL COST 4,40,000 1,10,000 1,30,000 2,00,000 Profit 60,000 (-) 10,000 20,000 50,000 SALES 5,00,000 1,00,000 1,50,000 2,50,000 Profit % on sales 12% - 13.33% 20% Introduction 1 1 Financial Accounting and Management Accounting compared (a) For the purpose of extracting the data required for managerial decision-making, Management Accounting may use the information appearing in the financial statements. This information may be used as it is or it can be rearranged or regrouped if required. As such, financial accounting becomes a source of information for management accounting. (b) Financial Accounting considers only the historical financial transactions and does not consider the non-financial transactions. As Management Accounting aims at enabling the management to take the decisions about the future, it may consider future data as well as non-financial factors. (c) As stated earlier, due to the various statutory regulations, maintenance of financial accounting records and preparation of financial statements therefrom is more or less a legal requirement. Moreover, the format in which the financial statements are required to be prepared is also standardized. Management Accounting is not at all a legal requirement. Management is free to install or not to install a management accounting system. Further, these systems have their own reporting formats. (d) As stated earlier, financial accounting primarily protects the interests of the outsiders dealing with organization in various capacities like investors, suppliers, customers, banks, financial institutions, government authorities etc. The reports generated by management accounting are meant for the use by management for effective decision-making. (e) As stated earlier, the financial statements which are generated as a result of financial accounting, report the financial performance of the organization as a whole. Reports generated by the management accounting may deal with the various parts of the organization. As such, management accounting reports may deal with the individual department or the individual product also. (f) The reports generated by financial accounting which are in the form of financial statements are available only after the relevant accounting period is over. E.g. Balance Sheet as on 31st March 2002 is available after 31st March 2002. As such, financial accounting data may not be available to the management for decision-making purposes. Moreover, as the financial accounting data is available after a time lag, the financial statements are required to be accurate. 1 2 Management Accounting In case of management accounting, more emphasis is on making the data available to the management as quickly as possible to facilitate the effective decision-making. If uptodate information is not made available to the management for decision-making, management accounting will loose its utility. As such, accuracy is not the prerequisite of management accounting. Cost Accounting and Management Accounting compared Cost Accounting and Management Accounting are similar to each other in many respects. Both the streams of accounting primarily aim at the effective decision making on the part of management. Both the streams of accounting are on and average not a legal requirement. The various techniques which are used by management accounting viz. Marginal Costing, Budgetary Control, Standard Costing, Uniform Costing etc. are basically regarded as the advanced methods of Cost Accounting. As such Cost Accounting may be considered to be a part of Management Accounting. Management Accounting is an extension of managerial aspects of cost accounting with the ultimate intention to protect the interests of the business. Techniques of Management Accounting

There may be various techniques with the help of which the basic functions of management accounting can be discharged. We will discuss the following techniques in details in the following chapters Marginal Costing (Break Even Analysis) Budgetary Control Standard Costing Uniform Costing Introduction 1 3 QUESTIONS 1. Explain the nature and characteristic features of Financial Accounting and Cost Accounting. How are they related to each other? 2. What do you mean by Management Accounting? State the advantages and limitations of Management Accounting. How Management Accounting is related with other streams of accounting? 1 4 Management Accounting NOTES Basics of Financial Accounting 1 5

Chapter 2
BASICS OF FINANCIAL ACCOUNTING
As stated earlier, financial accounting is the process of recording the past financial business transactions and calculating the net result of these transactions, with the intention to communicate the same to the various persons dealing with the business in the external capacity. However, financial accounting is the technical process. Before we consider the technicalities of financial accounting, let us consider some of the fundamental issues relating to the financial accounting. ACCOUNTING PRINCIPLES In order to bring the uniformity in recording the business transactions, the accountants follow certain basic procedures universally. These are referred to as the Accounting Principles. The Accounting Principles can be classified in two categories a. Accounting Concepts b. Accounting Conventions Accounting Concepts Accounting Concepts indicate those basic assumptions upon which the basic process of accounting is based. Following are the important Accounting Concepts : Business Entity Concept This accounting concept proposes that the business is assumed to be a distinct entity than the person who owns the business. The accounting process is carried out for the business and not for the person who owns the business. E.g. If there is a partnership concern carrying on the business in the name of M/s. XYZ & Co., where Mr. A and Mr. B are the equal partners, M/s. XYZ & Co. is supposed to be a separate entity from Mr. A and Mr. B. The financial statements prepared on the basis of accounting records are of M/s. XYZ & Co. and not of Mr. A or Mr. B individually. It should be noted in this connection that the business entity concept has nothing to do with the legal entity of the business. It applies to both corporate organization 1 6 Management Accounting (which by itself is a separate legal entity from the owners) as well as non-corporate organization (which is not a legal entity separate from the owners). Dual Aspect Concept This concept proposes that every business transaction has two aspects. However, basic relationship between assets and liabilities i.e. assets are equal to liabilities, remains the same. E.g. If Mr. A starts the business by introducing the capital of Rs. 50,000, the assets and liabilities structure will be as below Liabilities Assets Capital 50,000 Cash 50,000

Now, if Mr. A uses the cash to purchase the material worth Rs. 40,000, the assets and liabilities structure will change as below Liabilities Assets Capital 50,000 Cash 10,000 Stock in Trade 40,000 50,000 50,000 If Mr. A sells the above material worth Rs. 40,000 for Rs. 45,000 on credit basis, the assets and liabilities structure will change as below Liabilities Assets Capital 55,000 Cash 10,000 Receivables 45,000 55,000 55,000 Going Concern Concept This concept proposes that the business organization is going to be in existence for an indefinitely longer period of time and is not likely to close down the business in the shorter period of time. This affects the valuation of assets and liabilities. As such, the assets are disclosed in the Balance Sheet at cost less depreciation and not at the current market price. If the assets are to be disclosed in the Balance Sheet at correct value, the current market price will be most suitable. However, as the business is likely to exist for an indefinitely longer period of time and as the assets are not likely to be sold off in the market in the near future, the market price becomes immaterial. Accounting Period Concept Even if the Going Concern Concept proposes that the business is going to be in existence for an indefinitely longer period of time, in order to facilitate the preparation of financial statements on periodical basis, the indefinitely longer life span on the business is divided into shorter time Basics of Financial Accounting 1 7 segments, each one being in the form of Accounting Period. Profitability is computed for this accounting period (by preparing the profitability statement) and the finanial position is assesseed at the end of this accounting period (by preparing the balance sheet). It should be noted that the selection of accounting period may depend upon the various factors like characteristics of the business organization, tax considerations, statutory requirements etc. Cost Concept This concept proposes that the assets acquired by the organization are recorded at their cost of acquisition and this cost is considered for all the subsequent accounting purposes say charging of depreciation. This concept does not take into consideration current market prices of the various assets. Money Measurement Concept This concept proposes that only those transactions and facts find the place in accounting which can be expressed in terms of money. As such, all those transactions and facts which can not be expressed in terms of money (E.g. Morale and motivation of the workers, credibility of the business organization in the market etc.) do not find any place in accounting and that is why in financial statements, though they may be having direct or indirect bearing on the business. This concept imposes severe restrictions on the kind of information available from the financial statements. In fact, this is one of the major drawbacks of financial accounting and financial statements. Matching Concept This concept proposes that while calculating profit for the accounting period in a correct manner, the expenses and costs incurred during the period, whether paid or not, should be matched with the revenues generated during the period. E.g. If the accounting period ends on 31st March, the salaries for the month of March should be considered as cost for the year ending on 31st March, even if they are actually paid for in the month of April. Otherwise, calculation of the profits for the year ending on 31st March will go wrong as the income will be for 12 months while the expenses will be for 11 months only. Accounting Conventions Accounting Conventions indicate those customs and traditions that are followed by the accountants while preparing the financial statements. Following are the important Accounting

Conventions. Convention of Conservation This convention is usually expressed as anticipate all the future losses and expenses, however do not consider the future incomes and profits unless they are actually realized. This convention generally applies to the valuation of current assets and as such, the current assets are valued 1 8 Management Accounting at cost or market price whichever is lower. The valuation of non-curret assets is done at cost (as per the cost concept). Convention of Materiality This convention proposes that, while accounting for the various transactions, only those transactions will be considered which have material impact on profitability or financial status of the organization and other insignificant transactions will be ignored. E.g. If the organization purchases some postal stamps, some of which remain unused at the end of the accounting period. According to matching concept, the cost of such non-used postal stamps should not be considered as the item of cost. However as its impact on the overall profitability is likely to be negligible, the cost of non-used postal stamps may be ignored treating the cost of purchases as the expenditure. Which transactions should be treated as material ones is a subjective concept and depends upon the judgment and knowledge of the accountant. Convention of Consistency This convention proposes that the accounting polices and procedures should be followed consistently on period-to-period basis so as to facilitiate the comparison of finanacial statements on period-to-period basis. If there is any change in the accounting policies and procedures, this fact coupled with its effect on profitabity should be disclosed explicitly while preparing the financial statements. SYSTEMS OF ACCOUNTING a. Cash System of Accounting In this system of accounting, expenses are considered to be the expenses only when they are paid for and the incomes are considered to be incomes only when they are actually received. This system of accounting is mainly used by the organizations established not for earning the profits. This system of accounting is considered to be defective in nature, as it may not represent the true picture of the profitability as well as of the state of affairs. b. Mercantile or Accrual System of Accounting In this system of accounting, expenses are considered as expenses during the period to which they pertain. Similarly, incomes are considered to be incomes during the period to which they pertain. When the expenses are actually paid for or when the incomes are actually received is not significant in case of Mercantile or Accrual system of accounting. This system of accounting is considered to be more ideal, generally preferred by the accountants. However, as the time of physical receipt of cash is immaterial in this system of accounting, Accrual System of Accounting may result into the unrealized profits being Basics of Financial Accounting 1 9 reflected in the books of accounts on which the organization may be required to pay the taxes also. It will not be out of place to mention here that, as per the provisions of Section 209 of the Companies Act, 1956, all the company form of organizations are legally required to follow Mercantile or Accrual system of accounting. Other organizations have a choice to select either of the systems of accounting. TYPES OF EXPENDITURE For the purpose of accounting, the amount of money that is paid for is classified in three ways a. Capital Expenditure Capital Expenditure indicates the amount of funds paid for acquiring the infrastructural properties required for doing the business that are technically referred to as Fixed Assets. Fixed Assets do not give the returns during the same period during which they are paid for. As such, benefits available from capital expenditure are long-term benefits. Hence, it will be wrong to consider the capital expenditure as expenses

while calculating the profitability during a certain period. In technical words, capital expenditure never affects the Profitability Statement, except in case of Depreciation, which in simple words indicates that part of capital expenditure returns equivalent to which are received during the corresponding period. b. Revenue Expenditure Revenue Expenditure indicates the amount of funds paid during a certain period with the intention to receive the return during the same period. As such, the benefits available from revenue expenditure are received during the same period during which they are paid for. The entire amount of revenue expenditure affects the Profitability Statement. c. Deferred Revenue Expenditure Deferred Revenue Expenditure indicates the amount of funds paid which does not result into the acquisition of any fixed asset. However, at the same time benefits from this expenditure are not received during the same period during which they are paid for. The examples of Deferred Revenue Expenditure are a. Initial Advertisement Expenditure b. Research and Development Expenditure c. In case of company form of organization, Preliminary Expenses or Company Formation Expenses. 2 0 Management Accounting Principally, Deferred Revenue Expenditure is not transferred to Profitability Statement during the period during which they are paid for. As such, deferred revenue expenditure does not affect the profitability of the period during which it is paid for. It is transferred to Profitability Statement (in technical words written off to Profitability Statement) over the period over which benefits are received, by passing the adjustment entry. As such, deferred revenue expenditure affects the profitability only when they are written off to Profitability Statement. Till they are written off to Profitability Statement, they are shown on the Asset side of Balance Sheet. GLOSSARY OF TERMS USED IN FINANCIAL ACCOUNTING 1. Account Account is the record of all the transactions pertaining to a person, asset, liability, income or expenditure which have taken place during a specified period and shows the net effect of all these transactions finally. 2. Debit Side Debit Side of the account is left hand side of the account. 3. Credit Side Credit Side of the account is right hand side of the account. 4. Voucher Voucher is any documentary evidence to justify that a particular transaction has taken place. The voucher can be internal voucher or external voucher. 5. Entry Entry means the record of a financial transaction in the books of accounts. 6. To debit To debit an account means to make the entry on debit side of the account. 7. To credit To credit an account means to make the entry on credit side of the account. 8. Journal Journal is the Book of Original Entry or the Book of Prime Entry where the financial transactions are recorded in the chronological order as and when they take place. 9. Ledger Ledger is the book where the transactions of the similar nature are pooled together under one Ledger Account. Ledger or General Ledger as it is referred to in practical circumstances, maintains all types of accounts i.e. Personal, Real and Nominal. Whichever transactions are recorded in the Journal or Subsidiary Books in chronological order, the same transactions are posted in the Ledger, account wise. 10. Narration Narration is the summarized explanation or description of the financial transaction recorded in the books of accounts. 11. Casting Casting refers to totalling of the books of accounts. 12. Posting Posting refers to the process of transferring the transaction entered into the book or original entry or subsidiary book to the ledger account. Basics of Financial Accounting 2 1 13. Folio Folio refers to the page number of the book of original entry or the ledger. 14. Brought Forward When the balances in the ledger account or cash/bank book of the previous year or previous period are entered in the current years books of accounts, the

balances are said to be Brought Forward. 15. Carried Forward When the balances in the ledger account or cash/bank book of the current year or current period are to be transferred to the next years books of accounts, the balances are said to be Carried Forward. 16. Assets All the properties owned by the business are collectively referred to as the assets of the business. 17. Liabilities All the amounts owed by the business to various providers of funds or services are collectively referred to as liabilities. 18. Capital Capital indicates the amount of funds invested by the owner of the business in the business. 19. Drawings Drawings indicates the amount of funds or goods withdrawn by the owner of the business for the personal use. 20. Debtor A Debtor is a customer who owes the money to the business for the goods or services supplied to him on credit basis. 21. Creditor A Creditor is a supplier to whom the business owes the money for the goods or services bought from him on credit basis. 22. Debit Note Debit Note is an intimation sent to a person dealing with the business that his account is being debited for the purpose indicated therein. 23. Credit Note Credit Note is an intimation sent to a person dealing with the business that his account is being credited for the purpose indicated therein. 24. Trade Discount Trade Discount is the discount received on purchases or discount allowed on sales which is an adjustment with the basic purchase or sales price. Trade discount is not accounted for in the books of accounts. Purchase value or sales value is accounted for net of trade discount. 25. Cash Discount Cash discount is the discount received from the suppliers or allowed to customers for making the early payment of dues. Cash discount is accounted for in the books of accounts. Cash discount received from the suppliers is revenue income and cash discount allowed to the customers is revenue expenditure. 2 2 Management Accounting 26. Balance Sheet Balance Sheet is the summarized statement of what the business owns i.e. assets and what the business owes i.e. liabilities at any given point of time. 27. Bills Payable Bills Payable indicates the amount payable to the suppliers for which the negotiable instrument in the form of Bill of Exchange is given to the suppliers. 28. Bills Receivable Bills Receivable indicates the amount receivable from the customers for which the negotiable instrument in the form of Bill of Exchange is received from the customer. 29. Depreciation The term Depreciation applies to fixed assets like Land, Buildings, Machinery, Furniture, Vehicles etc. The term indicates reduction in the value of fixed assets which can arise either due to time factor or use factor or both. A detailed note on Depreciation Accounting is enclosed in the Annexure. DOUBLE ENTRY SYSTEM OF ACCOUNTING The basic presumption made by the Double Entry System of Accounting is that every business transaction has two elements i.e. when the business receives something, it has to pay something. Eg. If the business pays the telephone bill in cash, it gets the benefit of using the telephone, but at the same time cash goes out. Similarly, if goods are sold to the customer for cash, goods of the business go out, but it receives the corresponding amount of cash. Accordingly, if Double Entry System of Accounting is followed, every business transaction affects two accounts. One account is debited, while another account is credited by the similar amount. Thus, Double Entry System of Accounting follows the principle of every debit has a corresponding credit and hence, total of all debits has to be equal to the total of all credits. Double Entry System of Accounting proves to be advantageous due to certain reasons a. It takes into consideration both the aspects of each business transaction. b. Arithmetical accuracy of the accounting records can be verified by preparing the Trial Balance. c. The correct result of operations can be ascertained by preparing the final accounts periodically.

d. Correct valuation of assets and liabilities is possible at any given point of time by preparing the Balance Sheet. TYPES OF ACCOUNTS The various accounts for the purpose of Financial Accounting get classified under the following categories Basics of Financial Accounting 2 3 1. Personal Accounts - These are the accounts of persons with whom the organization deals in various capacities. In practical circumstances, personal accounts may consist of the following types of accounts Accounts of the suppliers Accounts of the customers Bank / Financial Institutions Capital Account 2. Real Accounts These are the accounts of assets and liabilities. In practical circumstances, real accounts may consist of the following types of accounts Land Account Building Account Machinery Account Furniture Account Vehicles Account Real Accounts may also consist of the accounts of some intangible assets like Goodwill Account Patents and Trade Marks Account 3. Nominal Accounts These are the accounts of incomes or expenses. In practical circumstances, nominal accounts may consist of following types of accounts Salary Account Wages Account Printing & Stationary Account Insurance Account Telephone Expenses Account Interest paid or Received Account Commission paid or Received Account RULES OF DOUBLE ENTRY BOOK KEEPING While entering into various financial transactions in the records maintained by the organization, following basic rules for accounting are followed a. In case of Personal Accounts Debit the Receiver, Credit the Giver b. In case of Real Accounts Debit What Comes in, Credit What Goes out c. In case of Nominal Accounts Debit all the expenses, Credit all the incomes 2 4 Management Accounting ANNEXURE Depreciation Accounting Depreciation can be defined as a permanent, continuous and gradual reduction in the book value of a fixed asset. Normally, all the fixed assets except land, depreciate in value rendering the asset useless after the end of certain specific period. Following may be stated as the main causes of depreciation. (1) Use factor : The fixed assets depreciate because they are used for the purpose they are meant for. It is applicable in case of tangible assets like machinery, furniture, office equipments etc. (2) Time factor : The fixed assets depreciate due to the passage of time. (3) Obsolescence : It is the reduction in the value of fixed assets, say a machine, due to its supersession at a date before it is completely worn out. It may take place due to new inventions, modifications or improvements. Need for Depreciation Accounting : According to the nature of fixed assets, these are those assets which may be used for the business purposes over a certain number of future accounting periods and the benefit received from them is spread over the said number of future accounting periods. According to the

matching principle of accounting, the costs incurred during an accounting period are required to be matched with the benefits or revenues earned daring that period. Hence, it is necessary to distribute the cost of a fixed asset, less the scrap or salvage or realisable value, after the useful life of the fixed asset is over, in such a way so as to allocate it as equitably as possible to the periods during which the benefits are received from the use of fixed assets. This system or procedure is called depreciation accounting. Thus the depreciation accounting is necessary for two main purposes. (a) To ascertain due profits by correctly matching the various costs and expenses incurred with various incomes and revenues earned during various accounting periods. (b) To represent the value of a fixed asset on the Balance Sheet at its unexpired cost i.e. at book value less depreciation. If depreciation is not provided, the asset may appear in the Balance Sheet at an overstated amount. It may also be noted in this connection that the depreciation forms a part of cost for arriving at the profits which can be distributed to the owners of the business in the form of dividend. By providing the depreciation, the amount of distributable profits is reduced and retained in the business, which can be utilized for the replacement of the asset at the end of its economic life. Basics of Financial Accounting 2 5 Methods for Calculating Depreciation : There may be various methods available for calculating the amount of depreciation to be charged to Profit and Loss Account. Amount of depreciation is a function of various factors. (1) Time, (2) Usage, (3) Time and Usage, (4) Time and Cost of maintaining the fixed asset, (5) Provision of funds for replacing the assets. As such the various methods available for charging the depreciation can be described as below. (1) Straight Line Method : According to this method, the amount of yearly depreciation is calculated as below. Cost of asset - Estimated scrap value Estimated life in years Eg. C = Cost of Asset. Rs. 1,10,000 Estimated scrap value (At the end of life of the asset) Rs. 10,000 Estimated life 10 years Yearly depreciation = Rs. 1,10,000 - Rs. 10,000 10 years = Rs. 10,000 The benefit of this method is that equal amount of depreciation is charged every year throughout the life of the asset, making the calculation of depreciation and cost comparison easy. The main drawback of this method is that the amount of depreciation in later years is high when the utility of the asset is reduced. (2) Written Down Value (Reducing Balance) Method : According to this method, the depreciation is provided at a predetermined percentage, on the balance of cost of asset after deducting the depreciation previously charged (usually termed as written down value). Eg. Cost of asset Rs. 1,10,000 Estimated scrap value Rs. 10,000 Cost of asset subjected to depreciation Rs. 1,00,000 Rate of depreciation 10% 2 6 Management Accounting The amount of depreciation is calculated as shown below. Year Balance Cost Depreciation Written Down of Assets Value - WDV Rs. Rs. Rs. 1 1,00,000 10,000 90,000 2 90,000 9,000 81,000

3 81,000 8,100 72,900 4 72,900 7,290 65,610 5 65,610 6,561 59,049 The rate of depreciation to be charged is calculated according to the following formula. D=1R C where n = number of years R = Residual / Scrap Value C = Cost of the asset The main benefit of this method is that it recognizes the fact that in the initial years of life of the asset, the repairs and maintenance cost is less which goes on increasing gradually with the progressing life of asset. According to this method, the higher amount of depreciation in the initial years and a gradual decrease therein is counterbalanced by the lower amount of repairs and maintenance cost in the initial years and a gradual increase therein. It should be noted here that the written down value can never become zero. (3) Production Unit Method : According to this method, depreciation is provided at a predetermined rate per unit which in turn is calculated on the basis of total number of units lo be produced during the life of the asset. Eg. Cost of the machine Rs. 1,10,000 Estimated scrap value Rs. 10,000 Estimated number of units to be produced 50,000 Rate of depreciation per unit = Rs. 1,10,000 - Rs. 10,000 50,000 units = Rs. 2 n Basics of Financial Accounting 2 7 If in a particular year, 7,000 units are produced, the depreciation to be charged will be : 7,000 units x Rs. 2 per unit = Rs. 14,000. This method gives more stress on usage factor rather than time factor. Higher the number of units produced, higher is the amount of depreciation and vice versa. (4) Production Hour Method : This method is similar to the production unit method except that instead of number of units to be produced during the life of asset, number of hours for which the asset is expected to work are taken into consideration. Eg. Cost of the machine Rs. 1,10,000 Estimated scrap value Rs.10,000 Estimated number of hours 25,000 Rate of depreciation per hour = Rs. 1,10,000 - Rs. 10,000 25,000 hours = Rs. 4 If in a particular year, the machine works for 2,500 hours, the depreciation to be charged will be : 2,500 hours x Rs. 4 per hour = Rs. 10,000 (5) Joint Factor Rate Method : According to this method, the depreciation is provided partly at a fixed rate on time basis and partly at a variable rate on usage basis. Eg. Cost of the machine Rs. 1,00,000 To be depreciated on time basis over life of the machine i.e. 10 year Rs. 50,000 Estimated number of units to be produced 50,000 Depreciation : (a) On time basis - Rs. 50,000 = Rs. 5,000 per year

10 years (b) On usage basis - Rs. 50,000 = Re. 1 per unit 50,000 units 2 8 Management Accounting If in a particular year, the machine produces 6,000 units, the depreciation to be charged will be : Time basis Rs. 5,000 Usage basis 6,000 units x Re. 1 Rs. 6,000 Rs. 11,000 (6) Annuity Method : This method assumes that the amount of capital invested in the fixed assets would have earned interest had it been invested otherwise. The depreciation to be charged under this method is a constant proportion of the aggregate of the cost of the asset depreciated and interest at the specific rate on written down value of the asset at the beginning of each period. Eg. Cost of the asset (c) Rs. 1,00,000 Life of the asset (n) 5 years Rate of interest (r) 10% Depreciation to be charged is calculated as below. D= Cxr = 1,00,000 x 0.10 = Rs. 26,380 11 1(1 + r)n -1 1(1.10)5 -1 Year Cost/WDV Interest Total Depreciation WDV C/fd Rs. Rs. Rs. Rs. 1 1,00,000 10,000 1,10,000 26,380 83,620 2 83,620 8,362 91,982 26,380 65,602 3 65,602 6,560 72,162 26,380 45,782 4 45,782 4,578 50,360 26,380 23,980 5 23,980 2,400 26,380 26,380 Nil The amount of depreciation is very high under this method and covers the opportunity cost of non-investment of the capital anywhere else. (7) Sinking Fund Method : Unlike any other method, this method attempts to make available funds equivalent to the original cost of asset, at the end of useful life of the asset. According to this method, depreciation to be charged is the fixed period charge which is invested at a compound rate and the amount of investmen with the compounded interest earned over the life of the asset equals to the original cost of the asset. Basics of Financial Accounting 2 9 Eg. Cost of the asset (c) Rs. 1,00,000 Life of the asset (n) 5 years Rate of interest (r) 10% Depreciation to be charged is calculated as below : D= Cxr = 1,00,000 x 0.10 = Rs. 26,380 (1 + r)n - 1 (1.10)5 - 1 Year Bal. B/fd Interest Annual Annual Bal.c/fd

Provision Investment Rs. Rs. Rs. Rs. Rs. 1 16,380 16,380 16,380 2 16,380 1,638 16,380 18,018 34,398 3 34,398 3,440 16,380 19,820 54,218 4 54,218 5,422 16,380 21,802 76,020 5 76,020 7,600 16,380 23,980 1,00,000 (8) Endowment Policy Method : This method is similar to sinking fund method. Under this method, an insurance policy is taken out for the amount required to replace the asset at the end of life of the asset. The amount of depreciation to be charged is equal to the annual premium payable on the insurance policy, which is decided by the insurance company. (9) Revaluation Method : According to this method, the asset is revalued periodically. The amount of depreciation for that period is the difference between the cost of the asset at the beginning of the period and the amount of revaluation at the end of the period. This method of charging the depreciation is extensively used for the assets like livestock, patterns etc. (10) Renewal Method : According to this method, the full cost of the asset is charged as depreciation during the period in which asset is renewed. No depreciation is charged in between the period. This method of charging can be used if the asset is of small value and is renewed frequently. 3 0 Management Accounting Practical considerations relating to depreciation 1. In spite of the fact that there are various methods available for calculating the depreciation, the final choice of the method depends upon the individual organization. It should be noted that Income Tax Act, 1961 which is a very important piece of legislation applicable to all types of business organizations, recognizes only one method for calculating the depreciation i.e. Written Down Value method. The rates at which the depreciation is to be calculated are also specified in the Income Tax Act, 1961. If the organization wants to calculate the depreciation on some different basis or at some different rates, it can do so for financial accounting purposes. However, for calculating the tax liability, the depreciation has to be calculated on Written Down Value basis and that too at the specified rates. 2. The company form of organizations to whom the provision of Companies Act, 1956 apply are required to calculate the depreciation as per the provisions of Schedule XIV of the Companies Act, 1956. The salient features of Schedule XIV of the Companies Act, 1956 can be stated as below a. Schedule XIV of the Companies Act, 1956 provides that the company can calculate the depreciation by using either Written Down Value method or Straight Line method. The companies are given the choice to select between these two methods. The actual choice of the method may depend upon the effect on the profitability of the company. If the company wants to change the method of calculating the depreciation, it amounts to the change in accounting policy. Any change in the method of calculating the depreciation has to be effected with retrospective effect from the date of incorporation of the company. The company is required to disclose the fact of change in the method of calculating the depreciation while preparing its financial statements along with the effect of change in the method of calculating the depreciation. b. The rates at which the companies are required to calculate the depreciation are also specified in Schedule XIV. For this purpose, the fixed assets are classified in various categories. The broad categorization of the fixed assets is as below Buildings - Factory Building as well as Administration Buildings Plant and Machinery Furniture Vehicles Computer Installations

Basics of Financial Accounting 3 1

The rates for calculation of depreciation are as below Nature of the Fixed Assets WDV SLM Buildings - Factory 10% 3.63% Buildings - Administrative 5% 1.63% Plant and Machinery 15% 4.75% Furniture 10% 6.33% Vehicles 20% 9.5% Computer Installations 40% 16.21% c. If during the financial year, any addition has been made to any asset or any asset has been sold, the depreciation on such asset will be calculated on a pro rata basis from the date of such addition or upto the date on which such asset has been sold. There are some of the questions which are normally raised in respect of the nature of depreciation. (1) Is Depreciation a cost? Yes, depreciation is a cost because of the obvious reasons that it reduces the profitability and it is a charge against the profit. At the same time, it should also be noted that it is a non-cash cost as it is never paid or incurred in cash. (2) Does Depreciation generate funds for replacement of assets? If the depreciation is provided under the Sinking Fund Method or Endowment Policy Method, sufficient funds may be available, at the end of life of the asset, equivalent to the original cost of the asset. As such, it can be said that these two methods make available the funds equivalent to the original cost of the asset at the end of life of the asset. However these funds may not be sufficient to replace the asset due to the increased price of the same. Other methods of charging the depreciation do not directly generate the funds required for replacing the assets. The fact that the assets are depreciated to the extent of almost entire of the original cost of the same, does not indicate that the funds are available for the replacement purpose. However, depreciation may be viewed from one more angle. It is a charge to profits which reduces the profits which can be distributed among the shareholders by way of dividends, thus conserving the business funds in the business itself. This may be considered to be a very very indirect way of interpretation that the depreciation involves a source of funds. 3 2 Management Accounting QUESTIONS 1. What do you mean by various accounting principles? Explain the various accounting concepts and conventions used in the financial accounting. 2. Distinguish between the following pairs of terms. Cash Basis of Accounting and Accrual Basis of Accounting Revenue Expenditure and Capital Expenditure Written Down Value Method and Straight Line Method of Depreciation Depreciation as per Companies Act and Income Tax Act 3. What do you mean by depreciation? What are the objectives for calculating the depreciation? Explain the various methods for calculating the depreciation. 4. Write an essay on Depreciation. Basics of Financial Accounting 3 3 NOTES 3 4 Management Accounting NOTES Process of Accounting 35

Chapter 3
PROCESS OF ACCOUNTING

JOURNALIZING Journalizing refers to the process of recording the business transaction in the Journal that is referred to as the Book of Original Entry or the Book of Prime Entry. The various transactions are entered in the journal in the chronological order, as and when the transactions take place. The Journal may look as stated below Journal Date Particulars L.F. Debit Rs. Credit Rs. abcde Account (To be Debited) Dr. To, Account (To be Credited) Narration The Journal may be subdivided in the following five columns a. Date It refers to the date on which a particular transaction has taken place. b. Particulars It refers to titles of the account to be debited or credited. Title of the account to be debited starts from the extreme left and the abbreviation Dr. is written to the extreme right of the same column on the same line. Title of the account to be credited is entered on the next line preceded by the words To leaving some space from the extreme left. In the same column on the next line, brief description of the transaction is written which is referred to as Narration. The narration conventionally starts with the wording Being. c. L.F. This is the abbreviation of Ledger Folio. This column refers to the page number of the ledger. The nature of Ledger is discussed in the following paragraphs. d. Amount Debited The amount to be debited is stated in this column. e. Amount Credited The amount to be credited is stated in this column. 36 Management Accounting Illustration Journalize the following transactions in the books of Mr. Amit Sen a. Mr. Sen commenced business with cash Rs. 10,000, Machinery Rs. 10,000, Buildings Rs. 30,000 and Furniture Rs. 15,000. b. Installed and paid for Neon Sign Board at a cost of Rs. 1,000 c. Mr. Sen borrowed Rs. 25,000 from his wife and the same were deposited by him in bank to open an account. d. Mr. Sen purchased goods for Rs. 7,000 for cash. e. Mr. Sen purchased goods worth Rs. 10,000 from Mr. Rao on credit @2% Cash Discount. f. Sold goods to Ramdas worth Rs. 15,000 against cash after allowing 5% Trade Discount. g. Paid Rs. 1,995 to Mr. Rajesh for purchases of goods after allowing 5% Cash Discount on the invoice. h. Sent a cheque of Rs. 1,000 to Chief Ministers Fund as Mr. Sens personal contribution. i. Placed an order for goods worth Rs. 2,000 with M/s Archana Traders. j. A personal table fan worth Rs. 450 brought in the office for office use. Solution In the Books of Mr. Amit Sen Date Particulars L.F. Debit Rs. Credit Rs. Cash A/c 10,000 Machinery A/c 10,000 Building A/c 30,000 Furniture A/c 15,000 To, Capital A/c 65,000 (Business started with cash, machinery, building and furniture) Advertisement A/c 1,000 To, Cash A/c 1,000 (Being paid for neon sign board installed) Process of Accounting 37 Date Particulars L.F. Debit Rs. Credit Rs.

Bank A/c 25,000 To, Loan from Mrs. Sen A/c 25,000 (Being the amount borrowed from Mrs. Sen to open account with the bank) Purchases A/c 7,000 To, Cash A/c 7,000 (Being paid for cash purchases) Purchases A/c 10,000 To, Cash A/c 9,800 To, Discount Received 200 (Being purchases worth Rs. 10,000 after getting 2% cash discount) Cash A/c 14,250 To, Sales 14,250 (Sold goods worth Rs. 15,000 after allowing trade discount of 5%) Purchases A/c 2,100 To, Cash A/c 1,995 To, Discount Received 105 (Paid Rs. 1,995 for goods purchased after getting 5% cash discount) Drawings A/c 1,000 To, Bank A/c 1,000 (Being donation paid to Chief Ministers Fund as Mr. Sens personal contribution) No Journal Entry will be passed, as the transaction is not a financial transaction. Furniture A/c 450 To, Capital A/c 450 (Being the personal table fan brought for office use) 38 Management Accounting Compound Journal Entry If the similar transactions take place on the same day and the same account is either debited or credited, instead of passing different journal entries, it can be accounted for by passing a compound journal entry. It avoids duplication and makes the journal less bulky. Illustration Mr. A commenced the business with cash Rs. 10,000, Machinery worth Rs. 25,000 and the Computer worth Rs. 50,000. The transaction will be journalized as below Date Particulars L.F. Debit Rs. Credit Rs. 1.4.2002 Cash A/c 10,000 Machinery A/c 25,000 Computer A/c 50,000 To, Capital A/c 85,000 (Commenced business with cash, machinery and computer) SUBSIDIARY BOOKS If the volume of transactions is very large, recording all the transactions in the Journal may prove to be a voluminous job. Hence, the transactions of the similar nature may be entered into a separate Subsidiary Book and the net effect of the similar transactions may be transferred into the main records. In the practical circumstances, following subsidiary books are used very frequently a. Cash Book This records all the cash transactions i.e., Cash Receipts and Cash Payments. In some cases, Cash and Bank Book may be maintained which records Cash as well Bank Receipts and Cash as well as Bank Payments.

The Cash and Bank Book may look as below

Date Particulars L.F. Cash Bank Date Particulars L.F. Cash Bank

b. Purchases Register or Purchases Day Book This records all the credit purchases transactions. Date Name of the Supplier L.F. Invoice No. Amount Note : L.F. stands for Ledger Folio Number which indicates the Page Number in the Creditors Ledger as the Control Ledger. The term Control Ledger is discussed in the following paragraphs. Process of Accounting 39 c. Sales Register or Sales Day Book This records all the credit sales transactions. The Sales Register may look as stated below Date Name of the Customer L.F. Invoice No. Amount Note : L.F. stands for Ledger Folio Number which indicates the Page Number in the Debtors Ledger as the Control Ledger. The term Control Ledger is discussed in the following paragraphs. d. Purchases Returns Register This records the transactions of return of goods to the suppliers from whom purchases were made on credit basis. The Purchases Return Register may look as stated below Date Name of the Supplier L.F. Debit Note No. Amount Note : L.F. stands for Ledger Folio Number which indicates the Page Number in the Creditors Ledger as the Control Ledger. The term Control Ledger is discussed in the following paragraphs. The Debit Note stands for an intimation sent to the supplier at the time of returning the goods which informs the supplier that his account is being debited on account of goods returned to him. e. Sales Returns Register This records all the transactions of return of goods by the customers to whom sales were made on credit basis. The Sales Return Register may look as stated below Date Name of the Customer L.F. Credit Note No. Amount Note : L.F. stands for Ledger Folio Number which indicates the Page Number in the Debtors Ledger as the Control Ledger. The term Control Ledger is discussed in the following paragraphs. The Credit Note stands for an intimation sent to the customer at the time of accepting the returned goods which informs the customer that his account is being credited on account of goods returned by him. f. Journal Proper This records all the residual transaction which cannot be entered into any other subsidiary book. The transactions which can be entered in the Journal proper are a. Opening Entries b. Closing Entries c. Rectification Entries d. Adjustment Entries 40 Management Accounting LEDGER POSTING If Journal or Subsidiary Books are the books which record of the transactions in the chronological order, Ledger is the book where the transactions of the similar nature are pooled together under one Ledger Account. Ledger or General Ledger as it is referred to in practical circumstances, maintains all types of accounts i.e. Personal, Real and Nominal. Whichever transactions are recorded in the Journal or Subsidiary Books in chronological order, the same transactions are posted in the Ledger, account wise. Thus, a ledger account can be defined as the record of all the transactions pertaining to a person, asset, liability, income or expenditure which have taken place during a specified period and shows the net effect of all these transactions finally. As such, the transactions are first entered into Journal or Subsidiary Book when they take place and from there they are transferred to Ledger and this process is called as Ledger Posting. The Ledger Account may be maintained in two ways Type I Dr. Cr.

Date Particulars Folio Rs. Date Particulars Folio Rs. Type II Date Particulars Folio Debit Credit Balance Rs. Rs. Control Ledgers In practical circumstances, if the transactions of purchases and sales are very large, it may not be feasible to carry the accounts of all the suppliers and customers in the Main or General Ledger. In such cases, apart from the Main Ledger or General Ledger, the Control Ledgers can be maintained. Control Ledgers carry the individual accounts whereas the Main Ledger or General Ledger records the consolidated effect of the individual transactions. As such, the balance shown by the consolidated account in the Main Ledger or General Ledger has to tally with the balances in the individual ledger accounts maintained in the control ledger. In practical circumstances, control ledgers may be maintained for the following purposes a. Sundry Debtors b. Sundry Creditors c. Advances to Staff Process of Accounting 41 Balancing of Ledger Accounts To ascertain the net effect of all the transactions recorded in the Ledger Account, the account is required to be balanced. Balancing of Ledger Account involves the following steps a. Take the total of both sides of the Ledger Account. b. Calculate the difference between totals of both the sides. c. If the total of debit side is heavier, place the difference on the amount column of credit side by writing By Balance c/fd. If the total of credit side is heavier, place the difference on the amount column of debit side by writing the To Balance c/fd. If the balance appears on the credit side, the account will be considered to have Debit Balance. If the balance appears on the debit side, the account will be considered to have Credit Balance. d. After balance is placed on the appropriate side, ensure that totals of both the sides match with each other. Illustration Machinery Account Date Particulars Folio Rs. Date Particulars Folio Rs. 01.04.01 Balance b/fd 25,000 31.03.02 Depreciation 10,000 10.04.01 Bank 70,000 31.03.02 Balance c/fd 85,000 (Balancing figure) 95,000 95,000 Steps explained a. Before considering the Balancing Figure, the total of debit side is Rs. 95,000 and the total of credit side is Rs. 10,000. As such, debit side is heavy. b. Difference between both the sides is Rs. 85,000. c. As the debit side is heavy, the difference of Rs. 85,000 is put on the credit side. Trial Balance Trial Balance is the summary of all the balances in all the accounts listed in the General Ledger and Cash / Bank Book of an organization at any given date. Tallying of the Trial Balance is the evidence of the fact that all the transactions have properly been posted in the General Ledger. As such, tallying of Trial Balance generally ensures the arithmetical accuracy of the process of Ledger Posing. 42 Management Accounting Format of Trial Balance Trial Balance as on 31st March 2002 Name of the Account Debit Credit For the preparation of Trial Balance, all the accounts in the General Ledger need to be balanced to ascertain the Closing Balance. Similarly, Cash Book / Bank Book is also required to be balanced to ascertain the Closing Balance. Accounts having the Debit Balance are shown on the Debit Side whereas the accounts having the Credit Balance are shown on the Credit Side. Generally, accounts of the assets will have Debit Balance and hence will be shown on Debit

Side. Generally, accounts of all liabilities will have Credit Balance and hence will be shown on Credit Side. Generally, accounts of all the Expenses will have Debit Balance and hence will be shown on Debit Side. Generally, accounts of all the Incomes will have Credit Balance and hence will be shown on Credit Side. PREPARATION OF FINAL ACCOUNTS FROM TRIAL BALANCE Preparation of the financial statements is the basic objective of financial accounting. These financial statements are basically in two forms a. Profitability Statement This financial statement is referred to as Profit and Loss Account in more technical language. The purpose of this financial statement is to disclose the result of operations of the business transactions during a given period of time. As such, by nature Profit & Loss Account is a period statement which relates to a specific duration of time. Hence, Profit and Loss Account is always referred to as Profit and Loss Account for the year ended on 31st March 2002. b. Balance Sheet The purpose of this financial statement is to disclose the financial status of the organization in terms of its assets and liabilities at any given point of time. Thus, in simple language, Balance Sheet is a listing of the assets and liabilities of an organization at any given point of time. Whichever sources are used by an organization for raising the required amount of funds create an obligation or liability for the organization and whichever ways the funds are used or applied by an organization create the properties or assets for the organization. Hence, in practical circumstances, the liabilities are referred to as Sources of Funds and the assets are referred to Application of Funds. As such, by nature Balance Sheet is a position statement in the sense it relates to a specific point of time or date. Hence, Balance Sheet is always referred to as Balance Sheet as on 31st March 2002. Process of Accounting 43 PROFIT AND LOSS ACCOUNT As stated earlier, Profit and Loss Account is prepared to disclose the result of operation of the business transactions during a certain duration of time. In technical language, Profit and Loss Account may have following four components a. Manufacturing Account This part of Profit and Loss Account discloses the result of manufacturing operations carried out by the organization. The final result disclosed by the Manufacturing Account is the Cost of Production incurred by the organization. Following is the specimen of Manufacturing Account. Manufacturing Account for the year ended on 31st March 2002
Particulars Amount Particulars Amount Opening Stock Closing Stock Raw Material Raw Material Work in Progress Work in Progress Purchases of Raw Material Cost of Production Carriage Inward (Transferred to Trading Account) Wages Paid Power and Fuel Consumable Stores Manufacturing Expenses Depreciation on Production Assets

Total Total b. Trading Account This part of Profit and Loss Account discloses the result of trading operations carried out by the organization. The final result disclosed by the Trading Account is the Gross Profit earned by the organization. Following is the specimen of Trading Account. 44 Management Accounting Trading Account for the year ended on 31st March 2002
Particulars Amount Particulars Amount Opening Stock Sales (Net of Sales Returns) Finished Goods Closing Stock Cost of Production Finished Goods

(Brought from Manufacturing A/c) Gross Profit Total Total

c. Profit and Loss Account This part of Profit and Loss Account discloses the final result of business transactions of the organization. The final result disclosed by the Profit and Loss Account is the Profit After Tax (PAT) earned by the organization. Following is the specimen of Profit and Loss Account. Profit & Loss Account for the year ended on 31st March 2002
Particulars Amount Particulars Amount Administrative Expenses Gross Profit b/fd Office Salaries Postage & Telephone Other Income Traveling & Conveyance Discount Received Legal Charges Commission Received Office Rent Depreciation Non-Trading Income Audit Fees Interest Received Insurance Rent Received Repairs & Renewals Abnormal Income Selling & Distribution Expenses Profit on the sale of assets Advertisement Carriage Outward Free Samples Bad Debts Sales Commission
Process of Accounting 45

Particulars Amount Particulars Amount Financial Expenses Interest & Bank Charges Other Expenses Loss on the sale of assets Salary to Working Partners Interest on Capital Provision for Taxation Net Profit after Taxes (Transferred to Capital Account)

Total Total d. Profit and Loss Appropriation Account This part of Profit and Loss Account, which is mainly applicable to company form of organization, discloses the manner in which the PAT earned by the organization is appropriated. The amount of profit not appropriated or retained is transferred to Reserves and Surplus in the Balance Sheet. Following is the specimen of Profit and Loss Appropriation Account.
Profit & Loss Appropriation Account for the year ended on 31st March 2002 Particulars Amount Particulars Amount Dividend Paid Profit After Tax b/fd Transferred to Reserves Amount withdrawn from Reserves Balance transferred to Balance Sheet Total Total

BALANCE SHEET As stated earlier, the purpose of preparing the Balance Sheet is to disclose the financial status of the organization in terms of its assets and liabilities at any given point of time. As such, the Balance Sheet has two sides a. Liabilities b. Assets 46 Management Accounting Liabilities Credit balances in all the Personal and Real Accounts appear on Liabilities side. Following items may appear on the liabilities side a. Capital

Capital indicates the amount of funds contributed by the owners of the business to the requirement of funds of the business. As owner of the business is considered to be a separate entity than the business itself, any amount contributed by the owner is a liability for the business. Similarly, any amount of profit earned in the past which is not distributed to the owner also belongs to the owner and becomes a part of the capital. b. Long Term Liabilities This indicates the liabilities which are to be paid off over a longer span of time say 5 to 10 years. In practical circumstances, it may consist of long-term loan borrowed from banks or financial institutions. c. Current Liabilities This indicates the liabilities which are supposed to be paid off within a very short span of time say one year. In practical circumstances, it may consist of the flowing items 1. Sundry Creditors Amounts payable to the suppliers of goods and/or services. 2. Advances received from customers This amount may not be paid back to the customers. It gets adjusted with the final selling price. Till it is adjusted with the selling price, it appears as a current liability. 3. Outstanding Expenses This amount indicates the expenses already incurred during the relevant period but not paid for. 4. Income Received in Advance 5. Liability for taxes Assets Debit balances in all the Personal and Real Accounts appear on Asset side. Following items may appear on the assets side a. Fixed Assets As stated earlier, fixed assets indicate the value of infrastructural properties acquired by the business where the benefits are likely to be received over a longer duration of time. Fixed assets are the assets which are not supposed to be sold, but they are supposed to be used to do the business to earn the profits. Some of the fixed assets which can be found in practical circumstances are Land, Building, Machinery, Furniture, Vehicles, and Computers etc. Process of Accounting 47 b. Investments This indicates the amount of funds invested by the organization outside the business. c. Current Assets Current Assets are the assets which are likely to be converted in the form of cash or likely to be consumed during the normal operating cycle of the business within a very short span of time say one year. The purpose of holding the current assets is to sell the current assets or use them during the normal course of operations. Current assets change their form very frequently while doing the business. Some of the current assets which can be found in practical circumstances are Stock, Sundry Debtors, Cash & Bank Balances, Prepaid Expenses etc. Following is the specimen of Balance Sheet. Balance Sheet as on 31st March 2002
Capital & Liabilities Amount Assets & Properties Amount Capital Fixed Assets Land Long Term Liabilities Building Loan from Bank Machinery Furniture Current Liabilities Vehicles Sundry Creditors Computers Advance from Customers Outstanding Expenses Investments Income Received in Advance Current Assets Stock Sundry Debtors

Cash Balance Bank Balance Prepaid Expenses Total Total

Adjustments While preparing the final accounts from the Trial Balance, it should be remembered that the Trial Balance might not reflect all the transactions which have the impact on profitability for the relevant period or the state of affairs of the organization on a particular date. As such, before preparing the final accounts, the effect of such transactions needs to be considered. The same is done by passing the Adjustment Entries. Thus, the effect of Adjustment Entries is yet 48 Management Accounting to be reflected in the Trial Balance. As such, according to the Double Entry principles, the Adjustment Entries always have two effects. Following are some of the main adjustment entries made while preparing the final accounts from the Trial Balance. a. Closing Stock This indicates the amount of stock in hand on the date of Balance Sheet. The basic principle on which the closing stock is valued is at cost or market price whichever is less. Accordingly, the first effect of the closing stock is that it is shown on the credit side of Manufacturing and/or Trading Account and the second effect is that it is shown on Balance Sheet Asset side. The Journal Entry passed for this is Closing Stock A/c Dr. To, Trading Account b. Depreciation This indicates the reduction in the value of fixed assets due to wear and tear. As the basic cost of the fixed assets is not transferred to Profit and Loss Account, this adjustment is necessary to reflect the cost for the use of fixed asset during the year. Accordingly, the first effect of the adjustment for Depreciation is that the amount is debited to Profit & Loss Account reducing the profit or increasing the loss and the second effect is that the corresponding amount is reduced from the value of fixed asset in the Balance Sheet. In other words, the value of fixed assets in the Balance Sheet is net of depreciation. The Journal Entry passed for this is Depreciation A/c Dr. To, Fixed Asset A/c c. Outstanding Expenses This indicates the amount of expenses pertaining to the relevant period which are not paid during the said period. According to Matching Principle of Accounting, income for a certain period needs to be compared with the expenses for the same period, whether it is paid for or not. Accordingly, the first effect of this adjustment is that the corresponding amount of expenses are increased reducing the profit or increasing the loss and the second effect is that the corresponding amount is shown as Current Liability on the Balance Sheet liabilities side. The Journal Entry passed for this is Expenses A/c Dr. To, Outstanding Expenses A/c Process of Accounting 49 d. Prepaid Expenses This indicates the amount of expenses pertaining to the next period which are paid in advance during the relevant period. According to Matching Principle of Accounting, income for a certain period needs to be compared with the expenses for the same period. Accordingly, the first effect of this adjustment is that the corresponding amount of expenses are reduced, thus increasing the profit or reducing the loss and the second effect is that the corresponding amount is shown as Current Asset on the Balance Sheet Asset side. The Journal Entry passed for this is Prepaid Expenses A/c Dr. To, Expenses A/c e. Accrued Income This indicates the amount of income for the current period which is not received during

the current period. According to Matching Principle of Accounting, income for a certain period needs to be compared with the expenses for the same period. Accordingly, the first effect of this adjustment is that the corresponding amount of income is increased, thus increasing the profit or reducing the loss and the second effect is that the corresponding amount is shown as Current Asset on the Balance Sheet Asset side. The Journal Entry passed for this is Accrued Income A/c Dr. To, Income A/c f. Income Received in Advance This indicates the amount of income for the next period which is received during the current period. According to Matching Principle of Accounting, income for a certain period needs to be compared with the expenses for the same period. Accordingly, the first effect of this adjustment is that the corresponding amount of income is reduced, thus reducing the profit or increasing the loss and the second effect is that the corresponding amount is shown as Current Liability on the Balance Sheet Liabilities side. The Journal Entry passed for this is Income A/c Dr. To, Income received in advance A/c g. Bad Debts This indicates the unrecoverable amount from the customers on account of credit sales made to them. If the customer is not likely to pay the amount due from him, the same is written off as Bad Debts. Accordingly, the first effect of this adjustment is that the amount 50 Management Accounting of Bad Debts is debited to Profit and Loss Account, thus reducing the profits or increasing the losses and the second effect is that the amount of Sundry Debtors is reduced. The Journal Entry passed for this is Bad Debts A/c Dr. To, Sundry Debtors h. Provision for Doubtful Debts Provision for doubtful debts is necessary due to the possibility that all the customers to whom the credit sales have been made may not pay the entire amount. Accordingly, the first effect of this adjustment is that the amount equivalent to the provision for doubtful debts is written off to Profit and Loss Account and the second effect is that the corresponding amount is reduced from the Sundry Debtors in the Balance Sheet. It should be noted that if the provision for bad and doubtful debts is to be maintained at a certain percentage of Sundry Debtors and if the provision to some extent has already been made in the books of account, the differential amount only needs to be debited to Profit and Loss Account. The Journal Entry passed for this is Profit and Loss Account Dr. To, Sundry Debtors A/c i. Provision for Discount on Debtors In some cases it is necessary to allow cash discount to the customers for making the early payment. As the amount of debtors who are likely to avail the cash discount is not known in advance, a provision is made in the books of account for the discount to be allowed to debtors. Accordingly, the first effect of this adjustment is that the amount equivalent to the provision for discount on debtors is written off to Profit and Loss Account and the second effect is that the corresponding amount is reduced from the Sundry Debtors in the Balance Sheet. The Journal Entry passed for this is Profit and Loss Account Dr. To, Sundry Debtors A/c j. Interest on Capital In order to calculate the profit earned by the organization properly, in some cases interest may be provided on the amount of capital introduced by the proprietor or partner in the business. It may not be out of place to mention here that in case of partnership firms, interest on capital is considered to be an allowable expenditure for calculating the tax liability as per the provisions of Income tax Act, 1961 if it is payable to the Working

Partners at the rate which is not exceeding 12% p.a. Accordingly, the first effect of this Process of Accounting 51 adjustment is that the amount of Interest on Capital is debited to Profit and Loss Account, thus reducing the profits or increasing the losses and the second effect is that the corresponding amount is credited to the Capital Account of proprietor or partner. The Journal Entry passed for this is Interest on Capital A/c Dr. To, Capital A/c k. Drawings This represents the amount of cash or value of goods withdrawn by the proprietor or partner for personal use. If the amount is withdrawn in cash, the same may be entered in the books of account regularly and thus will be reflected in the Trial Balance. However, the value of goods withdrawn by the proprietor or partner may be required to be considered by way of adjustment. Accordingly, the first effect of this adjustment is that the amount of Sales will be increased, thus increasing the profits or reducing the loss and the second effect is that the corresponding amount will be debited to the Capital Account of the proprietor or partner. The Journal Entry passed for this is Drawing / Capital A/c Dr. To, Sales A/c l. Deferred Revenue Expenditure Written Off This represents that part of Deferred Revenue Expenditure, returns equivalent to which are received during the current period. Accordingly, the first effect of this adjustment is that the deferred revenue expenditure written off will be debited to Profit and Loss Account, thus reducing the profit or increasing the loss and the second effect is that the corresponding amount will be reduced from the Asset side of the Balance Sheet. The Journal Entry passed for this is Deferred Revenue Expenditure Written Off A/c Dr. To, Deferred Revenue Expenditure A/c It should be noted that Deferred Revenue Expenditure Written Off Account is a Nominal Account whereas Deferred Revenue Expenditure Account is a Real Account. m. Abnormal Loss due to fire etc. In some cases, the organization incurs the loss of stock due to some abnormal events like fire, earthquake etc. Accordingly, the first effect of this adjustment is that the Trading Account is credited with the cost of goods lost due to fire, earthquake etc. and the corresponding amount is debited to Profit and Loss Account as Loss due to Fire Account. The Journal Entry passed for this is 52 Management Accounting Loss due to Fire Account Dr. To, Stock Destroyed Account In some cases, the stock held by the organization is insured with the Insurance Company. After the abnormal event like fire or earthquake takes places, the insurance company settles the claim, either in full or in part. The actual loss incurred by the organization is to the extent of difference between the cost of goods destroyed and the amount of claim settled by the insurance company. In such event, the amount of claim settled by the insurance company is debited to the Insurance Companys Account and only the net amount of loss is debited to Profit and Loss Account. The Journal Entry passed for this is Insurance Company A/c Dr. Loss due to Fire A/c Dr. To, Stock Destroyed A/c n. Goods Distributed as Free Samples This represents the value of goods distributed as free samples as a part of sales promotion effort of the organization. This is in the form of advertisement. Accordingly, the first effect of this adjustment is that the amount of goods distributed as free samples is debited to Profit and Loss Account, thus reducing the profits or increasing the losses and the second effect is that the amount of Sales is increased thus increasing the profit or

reducing the loss. The Journal Entry passed for this is Advertisement A/c Dr. To, Sales A/c o. Goods sent on approval basis Goods sent to the customers on approval basis should not be treated as the sales till the goods are finally approved by the customers or the period as agreed upon by both the parties is over. This is due to the fact that the property in the goods is not transferred until the said period is over. If the amount of such goods sent on approval basis is treated as the sales, the effect of this entry needs to be reversed. At the same time, the closing stock needs to be increased by the cost of such goods sent on approval basis. p. Commission payable to the manager In some cases, commission is payable to the manager as a percentage of profit earned by the business. The calculation of this commission may be made in two ways As a percentage of profit before charging such commission to Profit and Loss Account. Process of Accounting 53 As a percentage of profit after charging such commission to Profit and Loss Account. In both the cases, the amount of profit needs to be calculated before the commission is calculated and then the amount of commission is calculated based upon the methods to be used for calculating the same. The journal Entry passed for this is Commission A/c Dr. To, Commission Payable A/c Illustration 1 From the following particulars in respect of M/s Pam Industries, Journalize the following transactions, post them to the ledger, prepare the trial balance and prepare the final accounts. Date Particulars March 2002 1 Started business with the capital of Rs. 50,000 2 Opened a Bank Account by paying Rs. 35,000 3 Purchased goods from Ajay on credit Rs. 20,000 5 Sold the goods to Vijay on credit Rs. 14,000 7 Paid Ajay by cheque Rs. 19,500 in full settlement 9 Received Rs. 13,000 from Vijay in full settlement by cheque 15 Purchased furniture of Rs. 10,000 and paid the amount by cheque 18 Paid for traveling expenses in cash Rs. 3,000 21 Sold the goods to Vinod for cash Rs. 10,000 25 Goods purchased from Ashok against cash Rs. 8,000 27 Cash deposited in bank Rs. 5,000 28 Amount withdrawn by cheque for personal purpose Rs. 3,000 30 Paid salary in cash Rs. 2,000 Adjustments a. Value of goods unsold on 31st March 2002, valued at cost, Rs. 17,000 b. Depreciate furniture @2% c. Telephone bill for the month of March 2002 not yet paid Rs. 1,500 54 Management Accounting Solution In the books of M/s Pam Industries
Date Particulars L.F. Debit Rs. Credit Rs. March 2002 1 Cash A/c Dr. 50,000 To, Capital A/c 50,000 (Capital introduced in the business) 2 Bank A/c Dr. 35,000 To, Cash A/c 35,000 (Opened Bank Account) 3 Purchases A/c Dr. 20,000

To, Ajay A/c 20,000 (Goods purchased on credit) 5 Vijay A/c Dr. 14,000 To, Sales A/c 14,000 (Sold goods on credit) 7 Ajay A/c Dr. 20,000 To, Bank A/c 19,500 To, Discount A/c 500 (Paid Ajay in full settlement) 9 Bank A/c Dr. 13,000 Discount A/c Dr. 1,000 To, Vijay A/c 14,000 (Received from Vijay in full settlement) 15 Furniture A/c Dr. 10,000 To, Bank A/c 10,000 (Furniture purchased against cheque) 18 Traveling Expenses A/c Dr. 3,000 To, Cash A/c 3,000 (Paid for traveling expenses) 21 Cash A/c Dr. 10,000 To, Sales A/c 10,000 (Sold goods for cash) 25 Purchases A/c Dr. 8,000 To, Cash A/c 8,000 (Goods purchased for cash) 27 Bank A/c Dr. 5,000 To, Cash A/c 5,000 (Cash deposited in bank) 28 Drawings A/c Dr. 3,000 To, Bank A/c 3,000 (Withdrawn for personal purpose) 30 Salary A/c Dr. 2,000 To, Cash A/c 2,000 (Paid salary in cash)
Process of Accounting 55

General Ledger of M/s Pam Industries for March 2002 Cash Account
Date Particulars Folio Rs. Date Particulars Folio Rs. 1 To Capital A/c 50,000 2 By Bank 35,000 21 To Sales 10,000 18 By Traveling Exp. 3,000 25 By Purchases 8,000 27 By Bank 5,000 30 By Salary 2,000 31 By Balance c/fd 7,000 60,000 60,000

Bank Account
Date Particulars Folio Rs. Date Particulars Folio Rs. 1 To Cash A/c 35,000 7 By Ajay 19,500 9 To Vijay 13,000 15 By Furniture 10,000 27 To Cash 5,000 27 By Drawings 3,000 31 By Balance c/fd 20,500 53,000 53,000

Purchases Account
Date Particulars Folio Rs. Date Particulars Folio Rs. 3 To Ajay 20,000 31 By Trading A/c 28,000 25 To Cash 8,000 28,000 28,000

Sales Account
Date Particulars Folio Rs. Date Particulars Folio Rs. 31 To Trading A/c 24,000 By Vijay 14,000 By Cash 10,000

24,000 24,000

Traveling Expenses Account

Date Particulars Folio Rs. Date Particulars Folio Rs. 18 To Cash 3,000 31 By Profit & Loss A/c 3,000 3,000 3,000

56 Management Accounting Salary Account

Date Particulars Folio Rs. Date Particulars Folio Rs. 30 To Cash 2,000 31 By Profit & Loss A/c 2,000 2,000 2,000

Telephone Expenses Account

Date Particulars Folio Rs. Date Particulars Folio Rs. 31 To Outstanding Exp. 1,500 31 By Profit & Loss A/c 1,500 1,500 1,500

Discount Account
Date Particulars Folio Rs. Date Particulars Folio Rs. 9 To Vijay 1,000 7 By Ajay 500 By Profit & Loss A/c 500 1,000 1,000

Depreciation Account
Date Particulars Folio Rs. Date Particulars Folio Rs. 31 To Furniture 200 31 By Profit & Loss A/c 200 200 200

Ajay Account
Date Particulars Folio Rs. Date Particulars Folio Rs. 7 To Bank 19,500 3 By Purchases 20,000 7 To Discount 500 20,000 20,000

Vijay Account
Date Particulars Folio Rs. Date Particulars Folio Rs. 5 To Sales 14,000 9 By Bank 13,000 9 By Discount 1,000 14,000 14,000
Process of Accounting 57

Capital Account
Date Particulars Folio Rs. Date Particulars Folio Rs. 28 To Bank 3,000 1 By Cash 50,000 31 To Balance c/fd 47,000 50,000 50,000

Outstanding Expenses Account

Date Particulars Folio Rs. Date Particulars Folio Rs. 31 To Balance c/fd 1,500 31 By Telephone Exp. 1,500 1,500 1,500

Furniture Account
Date Particulars Folio Rs. Date Particulars Folio Rs. 15 To Bank 10,000 31 By Depreciation 200 31 By Balance c/fd 9,800 10,000 10,000

Trial Balance as on 31st March 2002

Name of the Account Debit Credit Cash 7,000 Bank 20,500 Purchases 28,000 Sales 24,000 Traveling Expenses 3,000 Salary 2,000 Telephone Expenses 1,500 Depreciation 200 Discount 500 Capital 47,000 Furniture 9,800

Outstanding Expenses 1,500 Total 72,500 72,500

58 Management Accounting Trading Account for the year ended on 31st March 2002
Particulars Amount Particulars Amount Opening Stock Nil Sales 24,000 Purchases 28,000 Closing Stock 17,000 Gross Profit c/fd 13,000 Total 41,000 Total 41,000

Profit & Loss Account for the year ended on 31st March 2002
Particulars Amount Particulars Amount Traveling Expenses 3,000 Gross Profit b/fd 13,000 Salary 2,000 Telephone Expenses 1,500 Discount 500 Depreciation 200 Profit carried to Capital Account 5,800 Total 13,000 Total 13,000

Balance Sheet as on 31st March 2002

Capital & Liabilities Amount Assets & Properties Amount Capital Fixed Assets Balance 47,000 Furniture 10,000 Add : Profit for year 5,800 Less : Depreciation 200 52,800 9,800 Current Assets Current Liabilities Stock 17,000 Outstanding Expenses 1,500 Cash 7,000 Bank 20,500 Total 54,300 Total 54,300
Process of Accounting 59

Illustration 2 From the following balances and information, prepare Trading and Profit & Loss Account of Mr. X for the year ended 31st March 1998 and a Balance Sheet as on that date. Particulars Dr. Rs. Cr. Rs. Xs Capital Account 10,000 Plant and Machinery 3,600 Depreciation on Plant and Machinery 400 Repairs to Plant 520 Wages 5,400 Salaries 2,100 Income Tax of Mr. X 100 Cash in Hand and at Bank 400 Land and Building 14,900 Depreciation on Building 500 Purchases 25,000 Purchase returns 300 Sales 49,800 Bank Overdraft 760 Accrued Income 300 Salaries Outstanding 400 Bills Receivable 3,000 Provision for Bad Debts 1,000 Bills Payable 1,600 Bad Debts 200 Discount on Purchases 708 Debtors 7,000 Creditors 6,252 Opening Stock 7,400 70,820 70,820 Information

a. Stock as on 31st March 1998 was Rs. 6,000

b. Write off further Rs. 600 for bad Debt and maintain a provision for bad Debts at 5% on Debtors. c. Goods costing Rs. 1,000 were sent to customer for Rs. 1,200 on 30th March 1998 on sale or return basis. This was recorded as actual sales. d. Rs. 240 paid as rent of the office were debited to Landlord Account and were included in the list of Debtors. 60 Management Accounting e. General Manager is to be given commission at 10% of net profits after charging the commission of works manager and his own. f. Works manager is to be given commission at 12% of net profits before charging the commission of General Manager and his own. Solution Trading Account for the year ended on 31st March 1998
Particulars Amount Particulars Amount Opening Stock 7,400 Sales 49,800 Purchases 25,000 Less : Goods on approval 1,200 48,600 Less : Returns 300 24,700 Closing Stock 6,000 Wages 5,400 Add : Goods on approval 1,000 7,000 Gross Profit c/fd 18,100 Total 55,600 Total 55,600 Profit & Loss Account for the year ended on 31st March 1998 Particulars Amount Particulars Amount Salaries 2,100 Gross Profit b/fd 18,100 Depreciation on Plant 400 Discount 708 Depreciation on Building 500 Repairs to Plant 520 Rent 240 Bad Debts 200 Add : Additional Bad Debts 600 Add : Provision for Bad Debts 248 Less : Existing Provision 1000 48 Commission to Works Manager 1,800 Commission to General Manager 1,200 Profit transferred to Capital A/c 12,000 Total 18,808 Total 18,808
Process of Accounting 61

Balance Sheet as on 31st March 1998 Capital & Liabilities Amount Assets & Properties Amount Capital Fixed Assets Balance 10,000 Plant & Machinery 3,600 Add : Profit for year 12,000 Building 14,900 Less : Income Tax 100 21,900 18,500 Current Liabilities Current Assets Creditors 6,252 Closing Stock (Including stock on 7,000 Bills Payable 1,600 Approval) Overdraft 760 Cash 400 Outstanding Salaries 400 Debtors 7,000 Commission Payable 3,000 Less : Bad Debts 600 Less : Goods on approval 1,200 Less : Due from Landlord 240 4,960 Less: Provision for Bad Debt 248 4,712 Bills Receivables 3,000 Accrued Income 300 Total 33,912 Total 33,912 Working Notes : Rs. Profit before calculating the commission 15,000

Commission payable to Works Manager @12% 1,800 Commission payable to General Manager on 13,200 Commission payable to General Manager @10% 1,200 (Calculated as 13200 / 110 x 100) Illustration 3 The following Trial Balance is of Shri Om as on 31st March 1991. You are requested to prepare the Trading and Profit & Loss Account for the year ended 31st March 1991 and a Balance Sheet as on that date after making the necessary adjustments. 62 Management Accounting Particulars Dr. Rs. Cr. Rs. Sundry Debtors 5,00,000 Sundry Creditors 2,00,000 Outstanding Liabilities for Expenses 55,000 Wages 1,00,000 Carriage Outwards 1,10,000 Carriage Inwards 50,000 General Expenses 70,000 Cash Discount 20,000 Bad Debts 10,000 Motor Car 2,40,000 Printing and Stationery 15,000 Furniture and Fittings 1,10,000 Advertisement 85,000 Insurance 45,000 Salesmans Commission 87,500 Postage and Telephones 57,500 Salaries 1,60,000 Rates and Taxes 25,000 Drawings 20,000 Capital Account 14,43,000 Purchases 15,50,000 Sales 19,87,500 Stock as on 1st April 1990 2,50,000 Cash at Bank 60,000 Cash in Hand 10,500 36,30,500 36,30,500 The following adjustments are to be made a. Stock as on 31st March 1991 was valued at Rs. 7,25,000. b. A provision for Bad and Doubtful Debts are to be made to the extent of 5% on Sundry Debtors. Process of Accounting 63 c. Depreciate Furniture & Fixture by 10% and Motor Car by 20%. d. Shri Om had withdrawn goods worth Rs. 25,000 during the year. e. Sales include goods worth Rs. 75,000 sent out to Santi & Company on approval and remaining unsold on 31st March 1991. The cost of the goods was Rs. 50,000. f. The salesman was entitled to a commission of 5% on total sales. g. Debtors include Rs. 25,000 bad debts. h. Printing and Stationery expenses of Rs. 55,000 relating to 1989-90 had not been provided in that year but were paid in this year by debiting outstanding liabilities. i. Purchases include purchases of furniture worth Rs. 50,000. Solution Trading Account for the year ended on 31st March 1991
Particulars Amount Particulars Amount Opening Stock 2,50,000 Sales 1987500 Purchases 1550000 Less : Goods on approval 75000 19,12,500 Less : Furniture purchased 50000 15,00,000 Closing Stock 725000

Wages 1,00,000 Add : Goods on approval 50000 7,75,000 Carriage Inwards 50,000 Goods withdrawn 25,000 Gross Profit c/fd 8,12,500 Total 27,12,500 Total 27,12,500 64 Management Accounting

Profit & Loss Account for the year ended on 31st March 1991
Particulars Amount Particulars Amount Salaries 1,60,000 Gross Profit b/fd 8,12,500 Carriage Outwards 1,10,000 Advertisement 85,000 Loss transferred to Capital A/c 44,625 Insurance 45,000 Salesmans Commission 95,625 Postage & Telephones 57,500 Rates & Taxes 25,000 Bad Debts 10000 Add : Additional Bad Debts 25000 Add : Provision for Bad Debts 20000 55,000 General Expenses 70,000 Cash Discount 20,000 Printing & Stationery 15,000 Depreciation 64,000 Previous Year Expenses 55,000 Total 8,57,125 Total 8,57,125

Balance Sheet as on 31st March 1991

Capital & Liabilities Amount Assets & Properties Amount Capital Fixed Assets Balance 14,43,000 Motor Car 240000 Less : Loss for year 44,625 Less : Depreciation 48000 1,92,000 Less : Drawings 20,000 Less : Goods withdrawn 25,000 Furniture 110000 Add : Purchases 50000 13,53,375 Less : Depreciation 16000 1,44,000 Current Liabilities Current Assets Creditors 2,00,000 Closing Stock (Including stock on 7,75,000 Outstanding Commission 8,125 Approval) Cash at Bank 60,000 Cash in Hand 10,500 Debtors 500000 Less : Bad Debts 25000 Less : Goods on approval 75000 400000 Less: Bad Debt Provision 20000 3,80,000 Total 15,61,500 Total 15,61,500 Process of Accounting 65

Illustration 4 The following is the Trial Balance of Hari as at 31st December 1994 Particulars Dr. Rs. Cr. Rs. Haris Capital Account 76,690 Stock as on 1st January 1994 46,800 Sales 3,89,600 Returns Inwards 8,600 Purchases 3,21,700 Returns Outwards 5,800 Carriage Inward 19,600 Rent and taxes 4,700 Salaries and Wages 9,300 Sundry Debtors 24,000 Sundry Creditors 14,800 Bank Loan @14% 20,000 Bank Interest 1,100 Printing and Stationery 14,400

Bank Balance 8,000 Discount Earned 4,440 Furniture and Fitting 5,000 Discount Allowed 1,800 General Expenses 11,450 Insurance 1,300 Postage and Telegram 2,330 Cash Balance 380 Travelling Expenses 870 Drawings 30,000 5,11,330 5,11,330 The following adjustments are to be made a. Included among the Debtors is Rs. 3,000 due from Ram and included among the Creditors Rs. 1,000 due to him. 66 Management Accounting b. Provision for Bad and Doubtful Debts to be created at 5% and for Discount @2% on Sundry Debtors. c. Depreciation on Furniture and Fitting @10% should be written off. d. Personal purchases of Hari amounting to Rs. 600 had been recorded in the Purchases Day Book. e. Interest on Bank Loan shall be provided for the whole year. f. A quarter of the amount of Printing and Stationary expenses is to be carried forward to the next year. g. Credit Purchase Invoice amounting to Rs. 400 had been omitted from the book. h. Stock as on 31st December 1994 was Rs. 78,600. Prepare Trading and Profit & Loss Account for the year ended on 31st December, 1994 and the Balance Sheet as on that date. Solution Trading Account for the year ended on 31st December, 1994
Particulars Amount Particulars Amount Opening Stock 46,800 Sales 389600 Purchases 321700 Less : Returns Inwards 8600 3,81,000 Less : Personal purchases 600 Add : Unrecorded purchases 400 Closing Stock 78,600 Less : Returns Outwards 5800 3,15,700 Carriage Inwards 19,600 Gross Profit c/fd 77,500 Total 4,59,600 Total 4,59,600 Process of Accounting 67

Profit & Loss Account for the year ended on 31st December 1994
Particulars Amount Particulars Amount Salaries and Wages 9,300 Gross Profit b/fd 77,500 Rent and Taxes 4,700 Discount Earned 4,440 Bank Interest 1100 Add : Outstanding 1700 2,800 Printing and Stationery 14400 Less : Prepaid 3600 10,800 Discount Allowed 1,800 General Expenses 11,450 Insurance 1,300 Postage and Telegram 2,330 Travelling Expenses 870 Provision for Bad Debts 1,150 Discount on Debtors 437 Depreciation 500 Profit transferred to Capital A/c 34,503 Total 81,940 Total 81,940

Balance Sheet as on 31st December, 1994

Capital & Liabilities Amount Assets & Properties Amount Capital Fixed Assets

Balance 76,690 Furniture & Fitting 5000 Add : Profit for year 34,503 Less : Depreciation 500 4,500 Less : Personal Purchases 600 Less : Drawings 30,000 Current Assets Closing Stock 78,600 80,593 Prepaid Printing & Stationary 3,600 Bank Balance 8,000 Current Liabilities Cash in Hand 380 Creditors 14800 Debtors 24000 Add : Unrecorded Purchases 400 Less: Due to Ram 1000 Less : Due to Ram 1000 14,200 23000 Less: Bad Debt Provision 1150 Outstanding Interest 1,700 21850 Less: Discount 437 21,413 Bank Loan 20,000 Total 1,16,493 Total 1,16,493 68 Management Accounting

Illustration 5 From the following trial balance and information, prepare Trading and Profit & Loss Account of Mr. Rishabh for the year ended 31st march 1999 and a Balance Sheet as on that date. Particulars Dr. Rs. Cr. Rs. Capital 1,00,000 Drawings 12,000 Land and Building 90,000 Plant and Machinery 20,000 Furniture 5,000 Sales 1,40,000 Returns outwards 4,000 Debtors 18,400 Loan from Gajanand on 1.7.98 @6% p.a. 30,000 Purchases 80,000 Returns Inward 5,000 Carriage 10,000 Sundry Expenses 600 Printing and Stationery 500 Insurance Expenses 1,000 Provision for bad and doubtful Debts 1,000 Provision for Discount on Debtors 380 Bad Debts 400 Profit of textile Department 10,000 Stock of General Goods on 1st April, 1998 21,300 Salaries and wages 18,500 Creditors 12,000 Trade Expenses 800 Stock of Textile Goods on 31st March, 1999 8,000 Cash at Bank 4,600 Cash in Hand 1,280 2,97,380 2,97,380 Process of Accounting 69 Information a. Stock of General Goods on 31st March, 1999 valued at Rs. 27,300. b. Fire occurred on 23rd March, 1999 and Rs. 10,000 worth of general goods were destroyed. The insurance company accepted claim for Rs. 6,000 only and paid the claim money on 10th April, 1999. c. Bad Debts amounting to Rs. 400 are to be written off. Provision for bad and Doubtful Debts is to be made at 5% and for discount at 2%. d. Received Rs. 6,000 worth of goods on 27th March ,1999, but the invoice of purchase was not recorded in Purchase Book.

e. Rishabh took away goods worth Rs. 2,000 for personal use but no record was made thereof. f. Charge depreciation at 2% on Land and Building, 20% on Plant and Machinery and 5% on Furniture. g. Insurance prepaid amounted to Rs. 200. Solution Trading Account for the year ended on 31st March, 1999
Particulars Amount Particulars Amount Opening stock of General Goods 21,300 Sales 140000 Purchases 80000 Less : Return Inwards 5000 1,35,000 Less : Return Outwards 4000 Add : Unrecorded Purchases 6000 82,000 Goods withdrawn 2,000 Goods destroyed by fire 10,000 Carriage 10,000 Closing Stock of General Goods 27,300 Gross Profit c/fd 61,000 Total 1,74,300 Total 1,74,300 70 Management Accounting

Profit & Loss Account for the year ended on 31st March 1999
Particulars Amount Particulars Amount Salaries & Wages 18,500 Gross Profit b/fd 61,000 Sundry Expenses 600 Profit of Textile Department 10,000 Printing & Stationery 500 Insurance 1000 Provision for Bad Debts 900 Less : Prepaid 200 800 Less : Existing 1000 100 Bad Debts 400 Add : Additional Bad Debts 400 800 Discount on Debtors 342 Trade Expenses 800 Less : Existing 380 38 Depreciation 6,050 Loss by Fire 4,000 Interest on Loan 1,350 Profit carried to Capital A/c 37,738 Total 71,138 Total 71,138

Balance Sheet as on 31st March, 1999

Capital & Liabilities Amount Assets & Properties Amount Capital Fixed Assets Balance 100000 Land & Building 90000 Less : Drawings 12000 Less: Depreciation 1800 88,200 Less : Goods withdrawn 2000 Plant & Machinery 20000 Add: Profit for year 37738 1,23,738 Less : Depreciation 4000 16,000 Furniture 5000 Loan from Gajanand 30,000 Less : Depreciation 250 4,750 Current Liabilities Creditors 12000 Current Assets Add : Unrecorded Purchases 6000 18,000 Stock of General Goods 27,300 Stock of Textile Goods 8,000 Outstanding Interest on Loan 1,350 Sundry Debtors 18400 Less : Bad Debts 400 18000 Less : Bad Debts Provision 900 17100 Less : Discount 342 16,758 Cash at Bank 4,600 Cash in Hand 1,280 Prepaid Insurance 200 Receivable from Insurance Company 6,000 Total 1,73,088 Total 1,73,088 Process of Accounting 71

Illustration 6 Hira and Manik are partners in a firm sharing profits and losses in equal proportion. Following is the Trial Balance as at 31st March, 1989. Debit Balances Rs. Credit Balance Rs. Plant & Machinery 50,000 Sales 2,40,000

Opening Stock 30,000 Discount 2,000 Purchases 80,000 Sundry Creditors 20,000 Land & Building 85,000 Bills Payable 10,750 Carriage Inwards 1,700 Hiras Loan Account 50,000 Carriage Outwards 2,500 Capital Accounts Wages 16,000 Hira 50,000 Sundry Debtors 50,000 Manik 25,000 Salaries 12,000 Furniture 18,000 Trade Expenses 6,000 Return Inwards 950 Advertisement Suspense 12,500 Discount 900 Partners Drawings Hira 3,000 Manik 2,000 Bills Receivable 20,000 Insurance 1,200 Bad Debts 1,000 Cash at Bank 5,000 Total 3,97,750 Total 3,97,750 You are required to prepare Trading and Profit & Loss Account of the firm for the year ended on 31st March 1989 and the Balance Sheet on that date after taking into consideration following adjustments a. Closing Stock Rs. 45,000. b. Depreciate Plant @10% and Furniture @20%. Appreciate Land and Building to Rs. 90,000. c. Bad Debts Reserve to be raised to 2.5% on Sundry Debtors. 72 Management Accounting d. Advertisement Suspense Account to be written off against revenue over five years. e. Partners Drawings are to bear interest @10% p.a. Amounts were withdrawn on 31st December, 1988. f. Annual charges for insurance Rs. 1,000. Balance represents amount paid in advance. g. Hira gave loan to the firm on 30th September, 1988 which carries the interest @6% p.a. h. Manik was to be allowed a salary of Rs. 250 per month. i. The partners agree to contribute 50% of the distributable profit to the National Defence Fund. Solution Trading Account for the year ended on 31st March, 1989
Particulars Amount Particulars Amount Opening Stock 30,000 Sales 240000 Purchases 80,000 Less : Returns Inwards 950 2,39,050 Carriage Inwards 1,700 Closing Stock 45,000 Wages 16,000 Gross Profit c/fd 1,56,350 Total 2,84,050 Total 2,84,050

Profit & Loss Account for the year ended on 31st March, 1989
Particulars Amount Particulars Amount Salaries 12,000 Gross Profit b/fd 1,56,350 Trade Expenses 6,000 Discount Received 2,000 Carriage Outwards 2,500 Interest on Drawings Insurance 1200 Hira 75 Less : prepaid 200 1,000 Manik 50 Discount 900 Bad Debts 1,000 Appreciation of Land & Building 5,000 Bad Debts Reserve 1,250 Advertisement 2,500 Salary Payable to Manik 3,000 Interest on Loan from Hira 1,500

Depreciation 8,600 Sub-Total 40,250 Process of Accounting 73 Particulars Amount Particulars Amount Contribution to National Defence Fund 61,613 Transferred to Capital Account Hira 30,806 Manik 30,806 Total 1,63,475 Total 1,63,475

Balance Sheet as on 31st March, 1989

Capital & Liabilities Amount Assets & Properties Amount Capital Fixed Assets Hiras Capital 50000 Land & Building 85000 Add : Profit for year 30806 Add : Appreciation 5000 90,000 Less : Drawings 3000 Plant & Machinery 50000 Less : Interest on Drawings 75 77,731 Less : Depreciation 5000 45,000 Furniture 18000 Less : Depreciation 3600 14,400 Maniks Capital 25000 Add : Profit for year 30806 Current Assets Add : Salary 3000 Closing Stock 45,000 Less : Drawings 2000 Sundry Debtors 50000 Less : Interest on Drawings 50 56,756 Less : Bad Debt Reserve 1250 48,750 Bills receivables 20,000 Hiras Loan Account 50,000 Cash at Bank 5,000 Prepaid Insurance 200 Current Liabilities Sundry Creditors 20,000 Advertisement Suspense 12500 Bills Payable 10,750 Less : Transferred to revenue 2500 10,000 Interest on Hiras Loan Account 1,500 Contribution to National Defence Fund 61,613 Total 2,78,350 Total 2,78,350

Illustration 7 Following is the Trial Balance of M/s. Pandit Brothers, a partnership firm, as on 31st March, 1992. 74 Management Accounting Particulars Dr. Rs. Cr. Rs. Capital Account H. Pandit 1,00,000 Capital Account K. Pandit 1,00,000 Drawings H. Pandit 16,000 Drawings K. Pandit 16,000 Buildings 80,000 Furniture 20,000 Purchases 2,00,000 Sales 3,00,000 Stock (1st April, 1991) 50,000 Wages 44,000 Rates and Taxes 1,600 Office Expenses 10,000 Salaries 50,000 Sundry Debtors 25,000 Sundry Creditors 12,000 Cash in Hand 400 Bank Overdraft 29,000 Carriage Inwards 28,000 Total 5,41,000 5,41,000 Following further information relating to the firm is made available a. Stock at the end of the year on 31st march, 1992 was Rs. 1,14,500 b. There was a fire in the premises on 26th November, 1991 which damaged a portion of stock and the loss was estimated at Rs. 17,500.

c. H. Pandit is in charge of purchases and is to be paid 2.5% commission on such purchases. d. A steel table purchased on 1st February, 1992 for Rs. 3,000 was debited to purchases account. e. K. Pandit who looks after all other business aspects except purchases is entitled to a commission of 5% on net profits after charging commission on purchases due to H. Pandit and commission payable to himself. f. Depreciation on Buildings @2.5% and on Furniture @10% g. Profits or losses are shared equally. Process of Accounting 75 You are required to prepare Trading and Profit & Loss Account for the year ended on 31st March, 1992 and the Balance Sheet on that date. Solution Trading Account for the year ended on 31st March 1992
Particulars Amount Particulars Amount Opening Stock 50,000 Sales 3,00,000 Purchases 200000 Less : Table Purchased 3000 1,97,000 Closing Stock 1,14,500 Wages 44,000 Carriage Inwards 28,000 Stock destroyed by fire 17,500 Commission on purchases 4,925 Gross Profit c/fd 1,08,075 Total 4,32,000 Total 4,32,000

Profit & Loss Account for the year ended on 31st March 1992
Particulars Amount Particulars Amount Salaries 50,000 Gross Profit b/fd 1,08,075 Rates and Taxes 1,600 Office Expenses 10,000 Stock destroyed by fire 17,500 Depreciation 4,050 83,150 Commission to K. Pandit 1,187 Profit transferred to Capital Account H. Pandit 11,869 K. Pandit 11,869 Total 1,08,075 Total 1,08,075 76 Management Accounting

Balance Sheet as on 31st March, 1992

Capital & Liabilities Amount Assets & Properties Amount Capital Fixed Assets H. Pandit Capital 100000 Building 80000 Add : Profit for year 11869 Less : Depreciation 2000 78,000 Add: Commission 4925 Furniture 20000 Less : Drawings 16000 1,00,794 Add : Purchases 3000 Less : Depreciation 2050 20,950 K. Pandit Capital 100000 Add : Profit for year 11869 Current Assets Add: Commission 1187 Closing Stock 1,14,500 Less : Drawings 16000 97,056 Sundry Debtors 25,000 Cash in Hand 400 Current Liabilities Sundry Creditors 12,000 Bank Overdraft 29,000 Total 2,38,850 Total 2,38,850

Note Commission payable to K. Pandit is calculated as below (108075 83150) x 5 105 Illustration 8 The following is the Trial Balance of Shri Arihant as on 31st December 1999. Particulars Dr. Rs. Cr. Rs.

Capital 14,00,000 Drawings 75,000 Opening Stock 80,000 Purchases 16,20,000 Freight on purchases 15,000 Wages 1,10,000 Sales 25,00,000 Salaries 1,00,000 Process of Accounting 77 Particulars Dr. Rs. Cr. Rs. Travelling Expenses 23,000 Miscellaneous Expenses 35,000 Printing and Stationery 27,000 Advertisement Expenses 25,000 Postage and Telegram 13,000 Discounts 7,600 14,500 Bad Debts written off (after adjusting recovery of bad debts of Rs. 6,000 written off in 1997) 14,000 Building 10,00,000 Machinery 75,000 Furniture 40,000 Debtors 1,50,000 Provision for Doubtful Debts 19,000 Creditors 1,60,000 Investments (12% Purchased on 1st October, 1999) 6,00,000 Bank Balance 83,900 40,93,500 40,93,500 Adjustments a. Closing Stock Rs. 2,25,000. b. Goods worth Rs. 5,000 were taken for personal use but no entry was made in the books. c. Machinery worth Rs. 35,000 purchased on 1st January, 1997 was wrongly written off against Profit & Loss Account. This asset is to be brought into account on 1st January, 1999 taking depreciation at 10% per annum on straight line basis upto 31st December, 1998. d. Depreciation Building at 2.5%, Machinery at 10% and Furniture at 10%. e. Provision for Doubtful Debts should be 6% on Debtors. f. The manager is entitled to a commission of 5% of net profits after charging his commission. Prepare Trading and Profit & Loss Account for the year ending 31st December, 1999 and a Balance Sheet as on that date. 78 Management Accounting Solution Trading Account for the year ended on 31st December, 1999
Particulars Amount Particulars Amount Opening Stock 80,000 Sales 25,00,000 Purchases 16,20,000 Freight on purchases 15,000 Goods withdrawn 5,000 Wages 1,10,000 Closing Stock 2,25,000 Gross Profit c/fd 9,05,000 Total 27,30,000 Total 27,30,000

Profit & Loss Account for the year ended on 31st December 1999
Particulars Amount Particulars Amount Salaries 1,00,000 Gross Profit b/fd 9,05,000 Travelling Expenses 23,000 Bad Debts recovered 6,000 Miscellaneous Expenses 35,000 Provision for bad Debts 9000 Printing & Stationery 27,000 Less : Existing 19000 10,000 Advertisement Expenses 25,000 Income from investments 18,000 Postage and Telegram 13,000 Discount Received 14,500

Discount 7,600 Bad Debts 20,000 Depreciation 40,000 Sub-Total 2,90,600 Commission to Manager 31,567 Profit transferred to Capital A/c 6,31,333 Total 9,53,500 Total 9,53,500 Process of Accounting 79

Balance Sheet as on 31st December, 1999

Capital & Liabilities Amount Assets & Properties Amount Capital Fixed Assets Balance b/fd 1400000 Building 1000000 Less : Drawings 75000 Less : Depreciation 25000 9,75,000 Less : Goods withdrawn 5000 Machinery 75000 Add : Profit for year 631333 Add : Capitalized 28000 Add : Machine capitalized 28000 19,79,333 Less : Depreciation 11000 92,000 Furniture 40000 Less : Depreciation 4000 36,000 Current Liabilities Sundry Creditors 1,60,000 Investments 6,00,000 Commission to Manager 31,567 Current Assets Closing Stock 2,25,000 Debtors 150000 Less : Bad Debt Provision 9000 1,41,000 Bank Balance 83,900 Investment Income outstanding 18,000 Total 21,70,900 Total 21,70,900

Note Value of machine purchased Rs. 35,000. Depreciation for 1997 and 1998 Rs. 7,000. Value of machine to be capitalized Rs. 28,000. Depreciation for 1999 on this machine Rs. 3,500. 80 Management Accounting Illustration 9 Following is the Trial Balance of K as on 31st March, 2000. Particulars Dr. Rs. Cr. Rs. Capital 8,00,000 Drawings 60,000 Opening Stock 75,000 Purchases 15,95,000 Freight on Purchases 25,000 Wages (11 months up to 29th February, 2000) 66,000 Sales 23,10,000 Salaries 1,40,000 Postage, Telegrams, Telephones 12,000 Printing and Stationery 18,000 Miscellaneous Expenses 30,000 Creditors 3,00,000 Investments 1,00,000 Discount Received 15,000 Debtors 2,50,000 Bad Debts 15,000 Provision for Bad Debts 8,000 Building 3,00,000 Machinery 5,00,000 Furniture 40,000 Commission on sales 45,000 Interest on Investments 12,000 Insurance (Year up to 31st July 2000) 24,000

Bank Balance 1,50,000 34,45,000 34,45,000

Process of Accounting 81

Adjustments a. Closing Stock Rs. 2,25,000. b. Machinery worth Rs. 45,000 purchased on 1st October, 1999 was shown as purchases. Freight paid on the machinery was Rs. 5,000 which is included in the freight on purchases. c. Commission is payable on sales @2.5% on sales. d. Investments were sold at 10% profit, but the entire sale proceeds have been taken as sales. e. Write off Bad Debts Rs. 10,000 and create a provision for Doubtful Debts at 5% of Debtors. f. Depreciate building by 2.5% p.a. and Machinery and Furniture at 10% p.a. Prepare Trading and Profit & Loss Account for the year ended on 31st March, 2000 and the Balance Sheet on that date. Solution Trading Account for the year ended on 31st March 2000
Particulars Amount Particulars Amount Opening Stock 75,000 Sales 2310000 Purchases 1595000 Less : Sale of Investments 110000 22,00,000 Less: Machine Purchased 45000 15,50,000 Freight on Purchases 25000 Closing Stock 2,25,000 Less : Freight on Machinery 5000 20,000 Wages 66000 Add : Outstanding 6000 72,000 Gross Profit c/fd 7,08,000 Total 24,25,000 Total 24,25,000 82 Management Accounting

Profit & Loss Account for the year ended on 31st March 2000
Particulars Amount Particulars Amount Salaries 1,40,000 Gross Profit b/fd 7,08,000 Postage, Telegrams, Telephones 12,000 Discount Received 15,000 Printing and Stationery 18,000 Interest on Investments 12,000 Miscellaneous Expenses 30,000 Profit on sale of Investments 10,000 Bad Debts 15000 Add : Additional 10000 25,000 Provision for Bad Debts 12000 Less : Existing Provision 8000 4,000 Commission on Sales 45000 Add : Outstanding 10000 55,000 Insurance 24000 Less : prepaid 8000 16,000 Depreciation 64,000 Profit transferred to Capital A/c 3,81,000 Total 7,45,000 Total 7,45,000

Balance Sheet as on 31st March, 2000

Capital & Liabilities Amount Assets & Properties Amount Capital Fixed Assets Balance b/fd 800000 Building 300000 Add : Profit for year 381000 Less: Depreciation 7500 2,92,500 Less : Drawings 60000 11,21,000 Machinery 500000 Add : Purchased 50000 Less: Depreciation 52500 4,97,500 Furniture 40000 Current Liabilities Less : Depreciation 4000 36,000 Creditors 3,00,000 Sales Commission outstanding 10,000 Current Assets Wages Outstanding 6,000 Closing Stock 2,25,000 Debtors 250000 Less : Bad Debts 10000 240000 Less : Bad Debts Provision 12000 2,28,000

Bank Balance 1,50,000 Prepaid Insurance 8,000 Total 14,37,000 Total 14,37,000 Process of Accounting 83

Illustration 10 From the following particulars extracted from the books of Ganguli, prepare Trading and Profit & Loss Account for the year ended on 31st March 1994 and Balance Sheet on that date after making the necessary adjustments. Debit Balances Rs. Credit Balance Rs. Opening Stock 23,400 Capital 54,050 Sales Returns 4,300 Sales 1,44,800 Purchases 1,21,550 Purchases Returns 2,900 Carriage Inwards 9,300 Sundry Creditors 7,400 Rent 2,850 Loan from Bank @12% 10,000 Salaries 4,650 Interest Received 725 Sundry Debtors 12,000 Discount Received 1,495 Printing & Stationery 1,700 Interest Paid 450 Advertisement 5,600 Cash at Bank 4,000 Investments at 5% on 1.4.93 2,500 Furniture on 1.4.93 900 Discount Allowed 3,770 General Expenses 1,960 Audit Fees 350 Fire Insurance Premium 300 Travelling Expenses 1,165 Postage & Telegrams 435 Cash on Hand 190 Deposits @10% on 1.4.93 15,000 Drawings 5,000 Total 2,21,370 Total 2,21,370 Adjustments a. Value of stock as on 31st March, 1994 is Rs. 39,300. This includes goods returned by customers on 31st March, 1994 of the value of Rs. 1,500 for which on entry has been passed in the books. 84 Management Accounting b. Purchases include furniture purchased on 1st January 1994 for Rs. 1,000. c. Depreciation should be provided on furniture @10% p.a. d. Bank Loan as on 1st April, 1993 was Rs. 5,000. An amount of Rs. 5,000 was borrowed on 31st March, 1994. e. Sundry Debtors include Rs. 2,000 due from Robert and Sundry Creditors include Rs. 1,000 due to him. f. Interest paid includes Rs. 300 paid on the Bank Loan. g. Interest received represents Rs. 100 from the Sundry Debtors and the balance on investments and deposits. h. Provide for interest payable on Bank Loan and for interest receivable on investments and deposits. i. Make a provision for doubtful debts @5% on the balance under Sundry Debtors. No such provision is necessary for the deposits. Solution Trading Account for the year ended on 31st March 1994
Particulars Amount Particulars Amount Opening Stock 23,400 Sales 144800 Purchases 121550 Less : Goods returned 1500 Less : Purchase Returns 2900 Less : Sales Returns 4300 1,39,000 Less : Furniture Purchased 1000 1,17,650

Carriage Inwards 9,300 Gross Profit c/fd 27,950 Closing Stock 39,300 Total 1,78,300 Total 1,78,300 Process of Accounting 85

Profit & Loss Account for the year ended on 31st March 1994
Particulars Amount Particulars Amount Salaries 4,650 Gross Profit b/fd 27,950 Rent 2,850 Interest Received 725 Printing & Stationery 1,700 Add : Receivable 1000 1,725 Interest paid 450 Discount received 1,495 Add : Interest on Bank Loan 300 750 Advertisement 5,600 Discount Allowed 3,770 General Expenses 1,960 Audit Fees 350 Fire Insurance Premium 300 Travelling Expenses 1,165 Postage & Telegrams 435 Depreciation 115 Reserve for Bad Debts 475 Profit transferred to Capital A/c 7,050 Total 31,170 Total 31,170

Balance Sheet as on 31st March, 1994

Capital & Liabilities Amount Assets & Properties Amount Capital Fixed Assets Balance 54050 Furniture 900 Less: Drawings 5000 Add : Purchases 1000 Add : Profit for year 7050 56,100 Less : Depreciation 115 1,785 Investments 2,500 Loan from Bank 10,000 Current Assets Closing Stock 39,300 Current Liabilities Sundry Debtors 12000 Sundry Creditors 7400 Less : Due to Roberts 1000 Less : Due to Roberts 1000 6,400 Less : Goods returned 1500 Outstanding Interest 300 Less : Bad Debts reserve 475 9,025 Cash on Hand 190 Cash at Bank 4,000 Deposits 15,000 Interest Receivable 1,000 Total 72,800 Total 72,800 86 Management Accounting

QUESTIONS 1. If the Trial Balance does not agree, what steps will you take to ensure that it tallies? 2. What do you mean by Final Accounts? Explain in brief the structure of Profitability Statement and Balance Sheet. 3. What are the various components of Profit and Loss Account ? Explain the purpose of each component. 4. How would you deal with the following while preparing the final accounts a. Goods lost by fire b. Goods distributed as free samples c. Goods sent on approval basis d. Bad Debts and Provision for Bad Debts e. Interest on Capital f. Prepaid Expenses and Outstanding Expenses Process of Accounting 87 PROBLEMS Q.1. The following is the Trial Balance of Shri Paras as on 31st March 1991. You are requested to prepare the Final Accounts after giving effect to the adjustments. Particulars Dr. Rs. Cr. Rs. Sundry Creditors 63,000 Sundry Debtors 1,45,000

Capital Account 7,10,000 Drawings 52,450 Insurance 6,000 General Expenses 30,000 Salaries 1,50,000 Patents 75,000 Machinery 2,00,000 Freehold Land 1,00,000 Building 3,00,000 Stock on 1st April 1990 57,600 Carriage on Purchases 20,400 Carriage on Sales 32,000 Fuel and Power 47,300 Wages 1,04,800 Returns Outwards 5,000 Returns Inwards 6,800 Sales 9,87,800 Purchases 4,06,750 Cash at Bank 26,300 Cash in Hand 5,400 17,65,800 17,65,800 The following adjustments are to be made a. Stock as on 31st March, 1991 was valued at Rs. 68,000. b. A provision for Bad and Doubtful Debts is to be made to the extent of 5% on Sundry Debtors. c. Depreciate Machinery @10% and Patents @20%. 88 Management Accounting d. Wages include a sum of Rs. 20,000 spent on erection of a cycle shed for employees and customers. e. Salaries for the month of March 1991 amounting to Rs. 15,000 were unpaid. f. Insurance includes a premium of Rs. 1,700 on a policy, expiring on 30th September, 1991. Q.2. Mr. A, a Shopkeeper had prepared the following trial balance from his ledger as on 31st March 1989. Particulars Dr. Rs. Cr. Rs. Purchases 6,20,000 Sales 8,30,000 Cash in Hand 4,200 Cash in Bank 24,000 Stock of Goods on 1st April, 1988 1,00,000 Mr. As Capital 5,77,200 Drawings 8,000 Salaries 64,000 Postage and Telephone 23,000 Salesmen Commission 70,000 Insurance 18,000 Advertising 34,000 Furniture 44,000 Printing and Stationery 6,000 Motor Car 96,000 Bad Debts 4,000 Cash Discount 8,000 General Expenses 60,000 Carriage Inwards 20,000 Carriage Outwards 44,000 Wages 40,000

Creditors 80,000 Debtors 2,00,000 14,87,200 14,87,200 You are requested to prepare Trading and Profit & Loss Account for the year ended 31st March, 1989 and Balance Sheet as on that date. You are also given the following further information Process of Accounting 89 a. Cost of goods in stock as on 31st March, 1989 Rs. 1,45,000 b. Mr. A had withdrawn goods worth Rs. 5,000 during the year. c. Purchases include purchase of furniture worth Rs. 10,000. d. Debtors include Rs. 5,000 Bad Debts. e. Creditors include a balance of Rs. 4,000 to the credit of Mr. B in respect of which it has been decided and settled with the party to pay only Rs. 1,000. f. Sales include goods worth Rs. 15,000 sent to Ram & Co. on approval and remaining unsold as on 31st March 1989 and the cost of goods was Rs. 10,000. g. Provision for bad debts is to be created at 5% on Sundry Debtors. h. Depreciate furniture by 15% and Motor Car by 20% i. The salesmen are entitled to a commission of 10% on total sales. Q.3. From the following balances extracted from the books of Mr. Yellow, prepare Trading and Profit & Loss Account for the year ended 31st December, 1990 and a Balance Sheet as on that date. Particulars Dr. Rs. Cr. Rs. Purchases 71,280 Mr. Yellows Capital Account 60,000 Computer at cost 18,380 Cash at Bank 4,000 Cash on Hand 2,836 Sundry Creditors 13,000 Bills Payable Account 10,220 Furniture & Fittings Account at cost 1,540 Rent 12,540 Discount Received 22,000 Bills Receivables Account 6,720 Trade Charges 920 Sundry Debtors 34,156 Sales 60,720 Returns Outwards 11,432 Drawings Account 5,200 Rent Due 320 Discount 540 Wages 1,800 Salaries 16,780 Returns Inwards 1,000 1,77,692 1,77,692 90 Management Accounting Adjustments a. Closing Stock on 31st December, 1990 was valued at cost Rs. 25,000 (Market Value Rs. 16,200) b. Rs. 6,000 paid to Mr. Red against Bill Payable were debited by mistake to Mr. Greens Account and included in the list of Sundry Debtors. c. Travelling expenses paid to sales representative Rs. 5,000 for the month of December 1990 were debited to his personal account and included in the list of Sundry Debtors. d. Depreciation on furniture & fittings shall be provided at 10% per annum. e. Provide for doubtful debts at 5% on Sundry Debtors. f. Goods costing Rs. 1,500 used by the proprietor. g. Salaries include Rs. 12,000 paid to sales representative who is further entitled to a

commission of 5% on net sales. h. Stationary charges Rs. 1,200 due on 31st December, 1990. i. Purchases include opening stock valued at Rs. 7,000 (cost price) j. Sales representative further entitled to an extra commission of 5% on net profit after charging his extra commission. k. No depreciation need to be provided for computer as it had been purchased on 31st December, 1990 and not put to use. Q.4. From the following trial balance of Hari and additional information, prepare Trading and Profit & Loss Account for the year ended 31st March, 1995 and a Balance Sheet as on that date. Particulars Dr. Rs. Cr. Rs. Capital 1,00,000 Furniture 20,000 Purchases 1,50,000 Debtors 2,00,000 Interest Earned 4,000 Salaries 30,000 Sales 3,21,000 Purchase returns 5,000 Wages 20,000 Rent 15,000 Sales Returns 10,000 Bad Debts written off 7,000 Process of Accounting 91 Particulars Dr. Rs. Cr. Rs. Creditors 1,20,000 Drawings 24,000 Provision for Bad Debts 6,000 Printing and Stationery 8,000 Insurance 12,000 Opening Stock 50,000 Office Expenses 12,000 Provision for Depreciation 2,000 5,58,000 5,58,000 Additional Information a. Depreciation furniture by 10% on original cost. b. A provision for Doubtful Debts is to be created to the extent of 5% on Sundry Debtors. c. Salaries for the month of March 1995 amounting to Rs. 3,000 were unpaid which must be provided for. However, salaries include Rs. 2,000 paid in advance. d. Insurance amounting to Rs. 2,000 is prepaid. e. Provide for outstanding office expenses Rs. 8,000. f. Stock used for private purpose Rs. 6,000. g. Closing Stock in Trade Rs. 60,000 Q.5. The following is the Trial Balance of Shri Arihant as on 31st December, 1999. Particulars Dr. Rs. Cr. Rs. Capital 14,00,000 Drawings 75,000 Opening Stock 80,000 Purchases 16,20,000 Freight on purchases 15,000 Wages 1,10,000 Sales 25,00,000 Salaries 1,00,000 92 Management Accounting Particulars Dr. Rs. Cr. Rs. Travelling Expenses 23,000

Miscellaneous Expenses 35,000 Printing and Stationery 27,000 Advertisement Expenses 25,000 Postage and Telegram 13,000 Discounts 7,600 14,500 Bad Debts written off (after adjusting recovery of bad debts of Rs. 6,000 written off in 1997) 14,000 Building 10,00,000 Machinery 75,000 Furniture 40,000 Debtors 1,50,000 Provision for Doubtful Debts 19,000 Creditors 1,60,000 Investments (12% Purchased on 1st October 1999) 6,00,000 Bank Balance 83,900 40,93,500 40,93,500 Adjustments a. Closing Stock Rs. 2,25,000. b. Goods worth Rs. 5,000 were taken for personal use but no entry was made in the books. c. Machinery worth Rs. 35,000 purchased on 1st January, 1997 was wrongly written off against Profit & Loss Account. This asset is to be brought into account on 1st January 1999 taking depreciation at 10% per annum on straight line basis upto 31st December, 1998. d. Depreciation on Building at 2.5%, Machinery at 10% and Furniture at 10%. e. Provision for Doubtful Debts should be 6% on Debtors. f. The Manager is entitled to a commission of 5% of net profits after charging his commission. Prepare Trading and Profit & Loss Account for the year ending 31st December, 1999 and a Balance Sheet as on that date. Q.6. From the following information, you are required to prepare Trading Account, Profit & Loss Account and Balance Sheet as on 31st December, 1999 for SANPAT Co. Process of Accounting 93 Particulars Dr. Rs. Cr. Rs. Sundry Debtors 40,000 Bills Receivables 18,500 Goodwill 40,500 Land & Building 1,10,000 Plant & Machinery 40,000 Furniture 40,200 Motors 50,800 Telephone Bills 11,200 Opening Stock 18,700 Wages 2,000 Advertisement 11,700 Royalty 12,000 Power & Fuel 12,800 Legal Charges 1,200 Audit Fees 4,090 Lighting 2,000 Salaries 3,500 Repairs 110 Purchases 22,000 Rent 1,700 Cash in Hand 78,000 Depreciation Fund 8,000 Outstanding Taxes 1,800 Bills Payable 2,200

Sundry Creditors 4,700 Bank Overdraft 3,200 Capital 1,50,000 General Reserves 38,000 Bank Loan 1,00,000 Provident Fund 40,000 Purchases Returned 1,000 Sales 1,20,500 Bank Loan 50,400 Outstanding Interest 1,200 5,21,000 5,21,000 94 Management Accounting Adjustments a. Interest on Capital 10%. b. Closing Stock Rs. 75,000. c. Goods costing Rs. 8,000 lost by fire and insurance company admitted a claim of Rs. 6,500. d. Depreciation on Motors 10%, Furniture 20%, Plant & Machinery 5%. e. Provide RDD 10% on Debtors. f. Outstanding Wages Rs. 1,000. g. Prepaid Telephone Bill Rs. 1,200. Q.7. Following Trial Balance was taken out on 31stMarch, 1996 from the books of Mr. Raman. You are required to prepare Trading and Profit & Loss Account for the year ended 31st March, 1996 and Balance Sheet as at that date, after making the necessary adjustments. Debit Balances Rs. Credit Balances Rs. Wages & Salaries 6,000 Sales-Cash 8,000 Drawings 2,000 Sales-Credit 18,000 Purchases 18,000 Capital 34,000 Sales Returns 300 Discount earned 340 Office Furniture 4,000 Purchases Returns 460 Buildings 12,000 Provision for Bad Debts 1,500 Office Expenses 800 Sundry Creditors 2,800 Advertisement 500 Bank Overdraft 1,300 Opening Stock 5,000 Income from Investments 250 Rent and Taxes 400 Commission 200 Bills receivables 800 Travelling Expenses 250 Trade Expenses 350 Bad Debts 190 Sundry Debtors 11,000 Cash in Hand 1,800 Investments 2,000 Fuel & Power (Factory) 1,060 Total 66,650 Total 66,650 Process of Accounting 95 Adjustments a. Depreciation to be provided on Building and Furniture @10%. b. Rent outstanding was Rs. 120. c. Provision for Doubtful Debts to be maintained at 5%. d. Interest accrued but not received was Rs. 50. e. Goods of the value of Rs. 100 were given away as free samples. f. Closing Stock was valued at Rs. 8,200. Q.8. From the following Trial Balance and adjustments, prepare Trading and Profit & Loss Account for the year ending 31st December 1997 and Balance Sheet as on that date. Debit Balances Rs. Credit Balances Rs.

Salaries 16,500 Commission Received 1,250 Bad Debts 1,500 Sales 1,70,000 Opening Stock 12,500 Interest Received 2,250 Purchases 87,500 Provision for Bad Debts 1,750 Wages 5,000 Capital 1,00,000 Commission Paid 250 Loan taken on 1.10.97 @12% p.a. 12,500 Carriage Outwards 2,500 Octroi 7,000 Machinery 25000 Additions on 1.7.97 12500 37,500 Bank 22,500 Goodwill 25,000 Cash 15,000 Sundry Debtors 52,500 Legal & Professional Fees 2,500 Total 2,87,750 Total 2,87,750 Adjustments 1. Closing stock was valued at cost Rs. 37,500. 2. Outstanding salaries amounted to Rs. 1,500. 3. Commission received but not earned Rs. 250. 96 Management Accounting Q.9. From the following Trial Balance and adjustments, prepare Trading and Profit & Loss Account for the year ending 31st December, 1997 and Balance Sheet as on that date. Debit Balances Rs. Credit Balances Rs. Opening Stock 25,000 Rent Received 1,500 Wages 5,000 Commission Received 750 Carriage 1,000 Miscellaneous Income 250 Salaries 3,800 Bad Debts recovered 1,000 Bad Debts 700 RDD 700 Purchases 1,10,000 Sales 2,00,000 Return Inwards 2,000 Return Outwards 1,000 Plant & Machinery 35,000 Bills Payable 7,500 Furniture as on 1st January, 1997 20,000 Capital 70,000 Furniture purchased 1.7.1997 5,000 Creditors 20,000 Investments 27,500 Patent Rights 3,500 Cash in Hand 750 Cash at Bank 13,250 Sundry Debtors 40,000 Bills Receivables 10,000 Postage and Telegrams 200 Total 3,02,700 Total 3,02,700 Adjustments 1. Write off Bad Debts Rs. 500 and create 5% RDD on Debtors. 2. Salaries Outstanding Rs. 200. 3. Unearned commission Rs. 50. 4. Plant & Machinery and Furniture to be depreciated @10% p.a. 5. Closing Stock Rs. 10,000. Q.10. Melon and Lemon are partners sharing profits equally. From the following Trial Balance and the additional information, prepare Trading and Profit & Loss Account for the year ending 30th June, 1982 and Balance Sheet on that date. Process of Accounting 97 Debit Balances Rs. Credit Balances Rs. Drawings - Melon 2,000 Capital - Melon 35,000 - Lemon 3,500 - Lemon 25,000 Land & Building 36,000 Sales 95,500

Machinery 18,000 Returns 1,300 Salaries 3,700 Bad Debts Reserve 800 Motor Car 10,500 Creditors 3,000 Trade Expenses 1,900 Commission 1,500 Carriage Inward 400 Bank Loan taken 0n 1.1.82 20,000 Royalties 1,800 Purchases 45,300 Return Inwards 2,500 Debtors 24,600 Discounts 1,000 Insurance 1,200 Stock on 1.7.81 23,800 Advertisement 3,000 Cash at Bank 2,900 Total 1,82,100 Total 1,82,100 Additional Information a. Stock on 30th June, 1982 was worth Rs. 36,000 at cost while its market value was Rs. 39,000 b. Goods worth Rs. 4,000 taken by Lemon for personal use were not entered in the books of accounts. c. Of the debtors, Rs. 600 were bad and should be written off and reserve for doubtful debts should be maintained at 5%. d. 5% interest is to be allowed on capital. e. Provide for interest on bank loan @10% per annum. f. Insurance is paid for the year ending 31st December, 1982. 98 Management Accounting Q.11. From the Trial Balance of M/s. Hocus and Pocus, you are required to prepare Trading and Profit & Loss Account for the year ending 31st December 1982 and the Balance Sheet as on that date after taking into account the additional information. Partners share the profits and losses equally. Debit Balances Rs. Credit Balances Rs. Drawings Hocus 14,450 Capital Hocus 1,80,000 Drawings Pocus 15,000 Capital Pocus 1,50,000 Stock as on 1.1.82 2,00,000 Sales 4,00,000 Bills Receivables 25,000 Bills Payable 61,000 Purchases 2,75,000 Return Outwards 4,500 Returns Inwards 5,000 Sundry Creditors 1,40,000 Plant and Machinery 1,00,000 Furniture 45,000 Sundry Debtors 1,20,000 Cash in Hand and at Bank 77,550 Salaries 12,000 Wages 19,000 Rent and Taxes 11,500 Insurance 3,000 Printing and Stationary 2,000 General Expenses 6,500 Power and Fuel 4,500 Total 9,35,500 Total 9,35,500 Additional Information. a. Stock as on 31st December, 1982 was Rs. 1,60,000. b. It is discovered that sales effected on 31st December, 1982 of the value of Rs. 2,000 has not been recorded in the books. c. Stock worth Rs. 3,000 uninsured has been destroyed by fire. d. Depreciate Plant & Machinery by 20% and Furniture by 5% e. Provide for bad and doubtful debts Rs. 6,000.

f. Outstanding Expenses Salaries Rs. 2,500, Wages Rs. 1,000. g. Prepaid insurance Rs. 500. Process of Accounting 99 Q.12. The Accountant of M/s. Kasturi Agencies extracted the following Trial Balance as on 31st March, 1987. Particulars Dr. Rs. Cr. Rs. Capital 1,00,000 Drawings 18,000 Buildings 15,000 Furniture 7,500 Motor Van 25,000 Bank Loan at 12% Interest 15,000 Interest paid on above 400 Sales 1,00,000 Purchases 75,000 Stock as on 1.4.86 25,000 Stock as on 31.3.87 32,000 Establishment Expenses 15,000 Freight Inwards 2,000 Freight Outwards 1,000 Commission Received 7,500 Sundry Debtors 28,100 Bank Balance 20,500 Sundry Creditors 10,000 2,28,500 2.68,500 The Accountant located the following errors but is unable to proceed further any more. a. A totalling error in bank column of payment side of cash book whereby the column was undercast by Rs. 500. b. Interest on Bank loan paid for the quarter ending 31st December, 1986, Rs. 450, was omitted to be posted in the ledger. There was no further payment of interest. c. You are required to set right the Trial Balance and prepare the Trading and Profit and Loss Account for the year ended on 31st March, 1987 and the Balance Sheet on that date, after carrying out the following 1. Depreciation is to be provided on the assets as follows : Buildings 2.5% p.a. Furniture 10% p.a. Motor Van 10% p.a. 2. Balance of interest due on the loan is also to be provided for. 100 Management Accounting NOTES Bank Reconciliation Statement 101

Chapter 4
BANK RECONCILIATION STATEMENT
If the account is opened in a bank in the name of business, the bank periodically gives the bank passbook or the bank statement. The bank passbook or the bank statement is the extract of the account in the name of business as it appears in the books of the bank. Similarly, in the books of business also, it maintains the bank book which is the extract of bank transactions as it appears in the book of business. As both the bank book in the books of business and bank passbook as per the books of bank record the same transactions, the balance as per bank book should match with the balance as per passbook. However, in reality, the said balances may not match with each other. These balances may not match with each due to the following reasons 1. Cheques issued but not debited - The business might have issued some cheques

which are not yet presented in the bank for clearing. As such, the balance as per bank pass book may be higher. 2. Cheques deposited but not cleared - The business might have deposited some cheques in the bank account, but the bank might not have received the payment for the same and hence the amount is not yet credited to the bank account. As such, balance as per bank book may be higher. 3. Other Reasons There may be a possibility that certain items may appear only in the passbook without any corresponding effect of the same in the bank book. This may be possible due to following reasons a. The bank debits periodical bank charges and bank interest to the account. These amounts appear only in the bank passbook. The business organization makes the entry of the same on the receipt of intimation from the bank. Till the entry is passed in the bank book, the bank book may show higher balance than the passbook. b. If the cheques deposited by the business organization get dishonoured, bank immediately debits the same amount to the account. The business organization makes the entry of the same on the receipt of intimation from the bank. Till the entry is passed in the bank book, the bank book may show higher balance than the passbook. 102 Management Accounting c. In some cases, some of the customers of the business organization may make the payment directly in the bank account of the business organization. The business organization makes the entry of the same on the receipt of intimation from the bank. Till the entry is passed in the bank book, the bank book may show lower balance than the passbook. d. In some cases, the business organization may give the standing instructions to the bank to make the recurring payments like rent, electricity bills, telephone bills etc. as and when they become due for payment. Accordingly, the bank might have paid these amounts and on payment, they are debited to the account. The business organization makes the entry of the same on the receipt of intimation from the bank. Till the entry is passed in the bank book, the bank book may show higher balance than the passbook. e. In some cases, the bank is given the responsibility of collecting the investment income or the principal amount of investment or the bills of exchanges on the date of maturity. Accordingly, the bank collects the same and credits the same to the account. The business organization makes the entry of the same on the receipt of intimation from the bank. Till the entry is passed in the bank book, the bank book may show lower balance than the passbook. f. There may be some clerical error on the part of bank when certain amounts may be wrongly debited or credited by the bank to the account. The business organization makes the entry of the same on the receipt of intimation from the bank. Till the entry is passed in the bank book, the bank book may show lower or higher balance than the passbook depending upon the nature of error on the part of bank. Bank Reconciliation Statement is the statement prepared to explain the reasons as to why the bank balance as per passbook and bank balance as per bankbook does not match. Preparation of Bank Reconciliation Statement The bank reconciliation starts with the Closing Bank Balance as per Bank Book and by making the additions and subtractions therefrom, the Bank Balance as per the Bank Statement or Pass Book is arrived at. Alternatively, the bank reconciliation statement may start with Balance as per the Bank Statement or Pass Book and by making the additions and subtractions therefrom, the Bank Balance as per the Bank Book may be arrived at. For preparing the bank reconciliation statement, entries on the payment side of Bank Book are compared with the withdrawal column of the Pass Book or Bank Statement and the entries on the receipts side of Bank Book are compared with the deposits column of Bank Statement or Pass Book. If entries on the payment side or receipt side of the Bank Book appear on the withdrawal or deposit column of Bank Statement or Pass Book respectively, bank reconciliation statement Bank Reconciliation Statement 103

does not get affected. Bank reconciliation statement is affected due to those amounts which appear on the payment side of Bank Book but are not there in the withdrawals column of Bank Statement or Pass Book or amounts which appear on the receipts side of Bank Book but are not there in the deposits column of Bank Statement or Pass Book. Following is the specimen of bank reconciliation statement Bank Reconciliation Statement as on Bank Balance as per Bank Book Add : a. Cheques issued but not presented b. Amount credited in Pass Book but not in Bank Book c. Deposits made in the account directly d. Wrong credits given by bank Sub-Total Less : a. Cheques deposited but not cleared b. Interest/Bank Charges debited by bank c. Direct payments made by bank not entered in Bank Book d. Cheques dishonoured not recorded in Bank Book e. Wrong debits given by bank Sub-Total Bank Balance as per Bank Statement or Pass Book Following points should be remembered a. If the bank reconciliation statement is prepared by starting with Bank Balance as per Bank Statement or Pass Book, amounts added in the above specimen need to be subtracted and the amounts subtracted in the above specimen need to be added. b. If the bank has given the overdraft facility, generally the Bank Book will show closing balance as credit balance. If the bank reconciliation statement is prepared starting with bank balance as per Bank Book, amounts added in the above specimen need to be subtracted and the amounts subtracted in the above specimen need to be added. c. If the bank reconciliation statement prepared discloses the amounts for which the entries have not been made in the Bank book, those entries should be made in the books of accounts and the balance as per the Bank book should be modified accordingly. 104 Management Accounting d. After all the entries as disclosed by the bank reconciliation statement are passed in the books of account, there will be mainly two amounts appearing in the final bank reconciliation statement viz. cheques issued but not presented for payment and cheques deposited but not cleared. In some abnormal circumstances, the final bank reconciliation statement may have the amounts which are wrongly debited or credited by the bank erroneously for which the bank needs to pass rectification entries subsequently. e. For the purpose of preparation of Trial Balance, bank balance as per Bank Book will be considered and not the balance as per Bank Statement or Pass Book. Illustration Following are the entries recorded in the Bank Column of the Cash Book of Mr. X for the month ending 31st March 1997. Cash Book (Bank Column only) Date Particulars Rs. Date Particulars Rs. 15.3.97 To Cash 36000 01.3.97 By Balance b/fd 40000 20.3.97 To Roy 24000 04.03.97 By John 2000 22.3.97 To Kapoor 10000 06.3.97 By Krishnan 400 31.3.97 To Balance c/fd 7640 15.3.97 By Kailash 240 20.3.97 By Joshi 35000 Total 77640 Total 77640 On 31st March, 1997, Mr. X received the Bank Statement. On perusal of the statement, Mr. X ascertained the following information a. Cheques deposited but not cleared by bank Rs. 10,000

b. Interest on securities collected by the bank but not recorded in cash book Rs. 1,080 c. Credit transfers not recorded in the cash book Rs. 200 d. Dividend collected by the bank directly but not recorded in the cash book Rs. 1,000 e. Cheques issued but not presented for payment Rs. 37,400 f. Interest debited by the bank but not recorded in the cash book Rs. 1,000 g. Bank Charges not recorded in the cash book Rs. 340 From the above information you are asked to prepare a Bank reconciliation statement to ascertain the balance as per Bank Statement. Bank Reconciliation Statement 105 Solution Bank Reconciliation Statement as on 31st March, 1997 Bank Balance as per Cash Book (Overdraft) 7,640 Add : a. Cheques deposited but not cleared 10,000 b. Interest debited by bank not recorded in Cash Book 1,000 c. Bank Charges debited by bank not recorded in Cash Book 340 11,340 Sub-Total 18,980 Less : a. Cheques issued but not presented 37,400 b. Interest on securities collected by bank not Recorded on cash book 1,080 c. Credit transfer not recorded in cash book 200 d. Dividend collected by bank not recorded in Cash Book 1,000 39,680 Bank Balance as per Bank Statement (Overdraft) 20,700 Illustration From the following extracts of the cash book (bank column) and bank pass book of Mr.X, prepare the bank reconciliation statement for the month ending on 31st March, 1997. Cash Book (Bank Column only) Date Particulars Rs. Date Particulars Rs. 01.3.97 To Balance b/fd 8,680 02.3.97 By Salaries & Wages 3,250 03.3.97 To A 1,200 03.3.97 By Interest on Loan 80 05.3.97 To B 1,620 08.3.97 By Bank Charges 5 16.3.97 To C 600 12.3.97 By X 1,500 21.3.97 To Interest 700 21.3.97 By Y 200 24.3.97 To D 1,200 24.3.97 By Z 1,350 28.3.97 To E 3,500 28.3.97 By Drawings 800 29.3.97 To F 2,200 31.3.97 By Balance c/fd 15,315 31.3.97 To G 2.800 Total 22,500 Total 22,500 106 Management Accounting Extracts of Pass Book of Mr. X In the books of Bank of India, Karve Road Branch, Pune Date Particulars Withdrawals Deposits Dr/Cr Balance 01.4.97 Balance b/fd Cr 7,165 02.4.97 To Z 1,350 Cr 5,815 02.4.97 By E 3,500 Cr 9,315 03.4.97 By D 1,200 Cr 10,515 04.4.97 To Insurance Premium 700 Cr 9,815 05.4.97 To M 1,200 Cr 8,615 05.4.97 By Cash 1,000 Cr 9,615 06.4.97 By F 2,200 Cr 11,815 06.4.97 To Y 200 Cr 11,615 07.4.97 By G 2,800 Cr 14,415 07.4.97 To Interest 500 Cr 13,915 Solution Bank Reconciliation Statement as on 31st March 1997

Bank Balance as per Bank Book 15,315 Add : Cheques issued but not presented Mr. Z 1,350 Mr. Y 200 1,550 Sub-Total 16,865 Less : Cheques deposited but not cleared Mr. E 3,500 Mr. D 1,200 Mr. F 2,200 Mr. G 2,800 9,700 Sub-Total Bank Balance as per Bank Statement or Pass Book 7,165 Bank Reconciliation Statement 107 Illustration Following particulars are extracted from the books of accounts of Mr. Bose for the month ending 31st March, 1989. a. Bank balance as per cash book Rs. 7,000. b. Cheques issued but presented after 31st March, 1989 Rs. 1,000. c. Three cheques were issued for Rs. 500, Rs. 1,000 and Rs. 1,500 respectively, but the cheque for Rs. 1,000 was presented on 3rd April, 1989. d. Cheques issued but not recorded in the cash book Rs. 750. e. Cheques deposited but credited after 31st March, 1989 Rs. 250. f. Three cheques were deposited for Rs. 1,000, Rs. 1,200 and Rs. 1,600 respectively, but the cheque for Rs. 1,600 was credited on 2nd April. g. Cheques deposited into the bank but not recorded in the cash book Rs. 1,000. h. Debit side of the cash book was overcast by Rs. 500. i. Credit side of the cash book was undercast by Rs. 800. j. Bank interest credited for Rs. 150 and debited for interest Rs. 50 not recorded in the cash book. k. Dividend collected by the bank not recorded in the cash book Rs. 1,000. l. A debtor directly deposited into bank but not recorded in the cash book Rs. 500. m. Rs. 1,000 in respect of dishonoured cheques appeared in the pass book but not in the cash book. n. Bank met a Bill Payable of the firm Rs. 1,500 on 30th March, 1989 under an advice to the firm on 2nd April, 1989. o. Banks charges for a cheque book Rs. 5 were entered in the cash book twice. p. A cheque for Rs. 50 drawn by Mr. Mukherjee had been charged to Mr. Boses account in error in March, 1989. Prepare the bank reconciliation statement as on 31st March, 1989 before and after making the necessary adjustments in the cash book. 108 Management Accounting Solution Bank Reconciliation Statement as on 31st March, 1989 (Before making adjustments in the cash book) Bank Balance as per Bank Book 7,000 Add : a. Cheques issued but not presented 1,000 b. Cheques issued but not presented 1,000 c. Cheques deposited but not recorded in cash book 1,000 d. Bank Interest credited not credited in cash book 150 e. Dividend collected not entered in cash book 1,000 f. Deposits made in bank not entered in cash book 500 g. Bank charges recorded twice in cash book 5 4,655 Sub-Total 11,655 Less : a. Cheques deposited but not cleared 250 b. Cheques issued but nor recorded in cash book 750 c. Cheques deposited but not cleared 1,600

d. Debit side of cash book overcast 500 e. Credit side of cash book undercast 800 f. Bank Interest debited not debited in cash book 50 g. Bill paid by bank not entered in cash book 1,500 h. Cheques dishonoured not recorded in cash book 1,000 i. Cheque wrongly debited by bank 50 Sub-Total 6,500 Bank Balance as per Bank Statement or Pass Book 5,155 Cash Book (Bank Column only) Particulars Rs. Particulars Rs. To Balance b/fd 7,000 By Cheques issued 750 To Cheques deposited 1,000 By Debit side overcast 500 To Interest Received Account 150 By Credit side undercast 800 To Dividend Received Account 1,000 By Bank Charges 50 To Debtors 500 By Debtors (Dishonoured cheques) 1,000 To Bank Charges (debited twice) 5 By Creditors 1,500 By Balance c/fd 5,055 Total 9,655 Total 9,655 Bank Reconciliation Statement 109 Bank Reconciliation Statement as on 31st March, 1989 (After making adjustments in the cash book) Bank Balance as per Bank Book 5,055 Add : a. Cheques issued but not presented 2,000 Sub-Total 7,055 Less : a. Cheques deposited but not cleared 1,850 b. Wrong debits given by bank for cheque 50 1,900 Sub-Total Bank Balance as per Bank Statement or Pass Book 5,155 Illustration From the following particulars, prepare the bank reconciliation statement for Mr. S.Sarkar as on 31st December, 1985 before and after making necessary adjustments in the cash book. a. Bank Balance as per cash book Rs. 610 (Credit). b. Cheques issued but not presented Rs. 3,000. c. Cheques deposited but not cleared Rs. 2,500. d. A cheque drawn for Rs. 100 has been incorrectly entered as Rs. 10 in the cash book. e. A debtor directly deposited into Sarkars bank account but not recorded in the cash book Rs. 1,000. f. Payment side of the cash book was undercast by Rs. 500. g. A cheque for Rs. 5,000 drawn by Mr. Banerjee has been charged to Sarkars account in error. h. Bank paid a Bill Payable for Rs. 1,450 but it was recorded in the cash book as Rs. 1,540. i. The receipt column of cash book was overcast by Rs. 1,000. j. Discount allowed Rs. 410 has been entered through mistake with the cheque in the bank column of the cash book. k. Pursuant to instructions dated 30th December, 1985, asking the banker to transfer Rs. 10,000 to fixed deposit account and entry for this was made in the cash book but the bank acted in January 1986. l. The bank debited the account with Rs. 500 being the amount of cheque received from a customer and returned unpaid but not entered in the cash book. m. Cheques amounting to Rs. 300 though actually banked were not entered in the cash book. 110 Management Accounting Solution Bank Reconciliation Statement as on 31st December, 1985 (Before making adjustments in the cash book) Bank Balance as per Cash Book (Overdraft) 610 Add : a. Cheques deposited but not cleared 2,500 b. Cheque for Rs. 100, entered as Rs. 10 90

c. Payment side of cash book undercast 500 d. Wrong debit in pass book for Mr. Banerjees Cheque 5,000 e. Receipt column of cash book overcast 1,000 f. Discount allowed treated as receipt of cheque in the cash book 410 g. Cheque dishonoured 500 10,000 Sub-Total 10,610 Less : a. Cheques issued but not presented 3,000 b. Amount deposited by debtor in bank account 1,000 c. Bill Paid for Rs. 1,450 entered as Rs. 1,540 90 d. Cheques deposited but not entered in cash book 300 c. Transfer to fixed deposit 10,000 14,390 Bank Balance as per Bank Statement 3,780 Cash Book (Bank Column only) Particulars Rs. Particulars Rs. To Debtor 1,000 By Balance b/fd 610 To Creditor 90 By Creditor 90 To Fixed Deposit Account 10,000 By Payment side undercast 500 To Debtors 300 By Receipt side overcast 1,000 By Discount 410 By Debtors 500 By Balance c/fd 8,280 Total 11,390 Total 11,390 Bank Reconciliation Statement 111 Bank Reconciliation Statement as on 31st December, 1985 (After making adjustments in the cash book) Bank Balance as per Bank Book 8,280 Add : a. Cheques issued but not presented 3,000 Sub-Total 11,280 Less : a. Cheques deposited but not cleared 2,500 b. Wrong debits given by bank for cheque 5,000 Sub-Total 7,500 Bank Balance as per Bank Statement or Pass Book 3780 Illustration Following are the cash book and pass book of Mr. X for the month of April, 2002. Cash Book (Bank Column only) Date Particulars Rs. Date Particulars Rs. 01.4.02 To balance b/fd 12,500 01.4.02 By Salaries (C.No. 183) 4,000 04.4.02 To Sales A/c 8,000 06.4.02 By Purchases (C.No. 184) 3,200 08.4.02 To P A/c 1,500 11.4.02 By Machinery (C.No. 185) 6,000 13.4.02 To M A/c 3,400 15.4.02 By Omprakash (C.No. 186) 1,000 18.4.02 To Kamal A/c 4,600 19.4.02 By Drawings (C.No. 187) 800 21.4.02 To Furniture A/c 1,200 23.4.02 By K A/c (C.No. 188) 2,000 25.4.02 To Sales A/c 3,800 27.4.02 By S A/c (C.No. 189) 1,000 30.4.02 To F A/c 3,000 30.4.02 By Printing (C.No. 190) 500 30.4.02 By Balance c/fd 19,500 38,000 38,000 112 Management Accounting Pass Book Date Particulars C.No. Withdrawals Deposits Dr/Cr. Balance 01.4.02 By Balance b/fd Cr. 12,500 02.4.02 To Cheque 183 4,000 Cr. 8,500 06.4.02 By Cheque 8,000 Cr. 16,500 06.4.02 To Cheque 184 3,200 Cr. 13,300 10.4.02 By Cheque 1,500 Cr. 14,800 16.4.02 By Cheque 3,400 Cr. 18,200

17.4.02 To Cheque 187 800 Cr. 17,400 20.4.02 By Cheque 4,600 Cr. 22,000 24.4.02 By Cheque 3,800 Cr. 25,800 28.4.02 To Cheque 185 6,000 Cr. 19,800 28.4.02 To Cheque 189 1,000 Cr. 18,800 30.4.02 By Interest 100 Cr. 18,900 30.4.02 By Deposit (K.Sen) 3,000 Cr. 21,900 30.4.02 To Charges 10 Cr. 21,890 You are required to prepare a Bank Reconciliation Statement as on 30th April 2002. Solution Bank Reconciliation Statement as on 30th April, 2002 Bank Balance as per Cash Book 19,500 Add : a. Cheques issued but not presented (Rs. 1,000 + Rs. 2,000 + Rs. 500) 3,500 b. Deposited by K.Sen 3,000 c. Interest credited by bank, not in cash book 100 6,600 Sub-Total 26,100 Less : a. Cheques deposited but not cleared (Rs. 1,200 + Rs. 3,000) 4,200 b. Bank Charges debited by bank 10 Sub-Total 4,210 Bank Balance as per Bank Statement or Pass Book 21,890 Bank Reconciliation Statement 113 Illustration Fun Fare Limited have a current account with National Bank Limited. The following is the extract from the Banks books of account for the last week of June, 1988. Particulars C.No. Withdrawals Deposits Dr/Cr. Balance Balance b/fd Cr. 21,000 Gopal Brothers 212 4,000 Cr. 17,000 Madhu Industries 5,000 Cr. 22,000 N Traders 213 7,200 Cr. 14,800 Ram Gopal Sons 7,500 Cr. 22,300 Gopal Brothers 215 4,100 Cr. 18,200 Ourselves 216 2,400 Cr. 15,800 Dividend Warrants 500 Cr. 16,300 Incidental Charges 10 Cr. 16,290 Interest on Loan 900 Cr. 15,390 Lal Chand 217 1,000 14,390 It is understood that a. Cheque no. 214 drawn in favour of T.W.Traders for Rs. 2,100 was not yet presented to the bank. b. Advice regarding the incidental charges, interest on loan and dividend warrants reached Fun Fare Limited only in July. c. Cheque favouring Lal Chand was towards rent for the month of June. From the above data you are required to prepare a cash book (bank column only) of Fun Fare Limited and a bank reconciliation statement in their books at the end of the month. Solution : Cash Book (Bank Column only) Date Particulars Rs. Date Particulars Rs. 30.6.88 To Balance b/fd 21,000 30.6.88 By Gopal Brothers 4,000 To Madhu Industries 5,000 By N Traders 7,200 To Ram Gopal 7,500 By T W Traders 2,100 By Gopal Brothers 4,100 By Cash 2,400 By Rent 1,000 By Balance c/fd 12,700

33,500 33,500 114 Management Accounting Bank Reconciliation Statement as on 30th April, 2002 Bank Balance as per Cash Book 12,700 Add : a. Cheques issued but not presented 2,100 b. Dividend collected by bank, not in cash book 500 2,600 Sub-Total 15,300 Less : a. Incidental charges debited by bank 10 b. Interest on Loan debited by bank 900 Sub-Total 910 Bank Balance as per Bank Statement or Pass Book 14,390 QUESTIONS 1. What do you mean by Bank Reconciliation Statement ? What are the reasons for difference between the balance shown by cash book and the one shown by the pass book? 2. What are the different causes of discrepancy between bank balance as per cash book and pass book ? 3. What is Bank Reconciliation Statement ? Why is it prepared ? Bank Reconciliation Statement 115 PROBLEMS Q. 1 The Bank account of Mukesh was balanced on 31st March, 1992. It showed an overdraft of Rs. 5,000. The Bank Statement of Mukesh showed a credit balance of Rs. 76,750. Prepare a Bank reconciliation statement taking the following information into account a. Cheques issued but not presented for payment till 31st March, 1992 Rs. 12,000. b. Cheques deposited but not collected by bank till 31st March, 1992 Rs. 20,000. c. Interest on term loan Rs. 10,000 debited by bank on 31st March, 1992 but not accounted in Mukeshs books. d. Bank charges Rs. 250 was debited by bank but accounted in the books of Mukesh on 4th April, 1992. e. An amount of Rs. 1,00,000 representing collection of Mukeshs cheques was wrongly credited to the personal account of Mukesh by the bank in their bank statement. Q. 2 From the following particulars, prepare a Bank Reconciliation Statement as on 31st December, 1993. a. On 31st December, 1993, the cash book of a firm showed a bank balance of Rs. 6,000 (Debit Balance). b. Cheques had been issued for Rs. 5,000, out of which cheque worth Rs. 4,000 only were presented for payment. c. Cheques worth Rs. 1,400 were deposited in the bank on 28th December, 1993 but had not been credited by the bank. In addition to this, one cheques for Rs. 500 was entered in the cash book on 30th December, 1993 but was banked on 3rd January, 1994. d. A cheque from Susan for Rs. 400 was deposited in the bank on 26th December, 1993 but was dishonoured and the advice was received on 3rd January, 1994. e. Passbook showed bank charges of Rs. 20 debited by the bank. f. One of the debtors deposited a sum of Rs. 500 in the bank account of the firm on 20th December, 1993 but the intimation in this respect was received from the bank on 2nd January, 1994. g. Bank Passbook showed a credit balance of Rs. 5,180 on 31st December, 1993. 116 Management Accounting Q. 3 On 31st May, 1994, the cash book of ABC Ltd. showed a bank overdraft of Rs. 1,234. On an examination of the cash book and bank pass book, the following information was gathered a. Two cheques received from P and Q for Rs. 234 and Rs. 456 respectively were deposited with the bank on 30th May, 1994, but they were cleared only on 1st June 1994.

b. A cheque for Rs. 345 issued on 26th May, 1994 was presented to the bank for payment on 3rd June, 1994. c. A cheque for Rs. 567 deposited by a customer in the companys account with bank directly on 25th May, 1994. d. Rs. 5,678 being proceeds of a bill collected on 30th May, 1994 did not appear in the cash book. e. A bill payable for Rs. 5,789 was duly paid off on 31st May, 1994 according to the instructions of the company, entry of which was made in the cash book on 1st June, 1994. f. Interest on overdraft Rs. 111 appears in the pass book. Q. 4 On 31st January, 1988, my cash book showed a bank overdraft of Rs. 12,500. On comparing it with the pass book, following differences were located a. Cash and cheques amounting Rs. 1,340 were sent to bank on 27th January, but cheques worth Rs. 230 were credited on 2nd February and one cheque for Rs. 45 was returned by them as dishonoured on 4th February. b. During the month of January, I issued cheques worth Rs. 1,760 to my creditors. Out of these, cheques worth Rs. 1,370 were presented for payment on 5th February. c. According to my standing orders, the bankers have paid during the month of January the following Life insurance premium Rs. 170 Driving license fee Rs.40 d. My bankers have collected Rs. 150 as dividend on the shares. e. My bankers have given me wrong credit for Rs. 150. f. A bill receivable for Rs. 100 discounted with the bank in December, 1987 has been dishonoured on 31st January, 1988. g. Interest charged by the bank Rs. 125. Prepare a bank reconciliation statement on 31st January, 1988. Bank Reconciliation Statement 117 Q. 5 From the following particulars, find out adjusted bank balance as per cash book and prepare thereafter bank reconciliation statement as on 31st December, 1995 of Raja Brothers Particulars Rs. Bank Overdraft as per Cash Book 80,000 Cheques deposited as per bank statement but not entered in cash book 3,000 Cheques recorded for collection but not sent to the bank 10,000 Credit side of bank column cast short 1,000 Bank charges recorded twice in the cash book 100 Customers cheques returned as per bank statement only 4,000 Cheques issued but dishonoured on technical grounds 3,000 Bills collected by bank directly 20,000 Cheques received entered twice in cash book 5,000 Q. 6 The cash book of a firm showed an overdraft of Rs. 30,000 on 31st March, 1999. A comparison of the entries in cash book and pass book revealed that a. On 22nd March, 1999, cheques totaling Rs. 6,000 were sent to bankers for collection. Out of these, a cheques for Rs. 1,000 was wrongly recorded on the credit side of the cash book and cheques amounting to Rs. 300 could not be collected by bank before 1st April, 1999. b. A cheque for Rs. 4,000 was issued to a supplier on 28th March, 1999. The cheque was presented to bank on 4th April, 1999. c. There were debits of Rs. 2,600 in the pass book for interest on overdraft and bank charges, but the same had not been recorded in the cash book. d. A cheque for Rs. 1,000 was issued to a creditor on 27th March 1999, but by mistake the same was not recorded in the cash book. The cheque was however duly encashed on 31st March, 1999. e. As per standing instructions, the banker collected dividend of Rs. 500 on behalf of the firm and credited the same to its account by 31st March, 1999. The fact was however intimated to the firm on 3rd April, 1999.

You are required to prepare a bank reconciliation statement as on 31st March, 1999. 118 Management Accounting Q. 7 On 31st March, 1998, Mehtas Pass Book showed a debit balance of Rs. 6,350. From the following information, prepare a Bank Reconciliation Statement as on that date 1. Out of total cheques of Rs. 6,000 deposited into the bank in March. 1998, one cheque of Rs. 500 was collected on 28th March, 1998 and another cheque of Rs. 1,000 was collected on 3rd April, 1998. 2. The bank had paid a premium of Rs. 300 on 17th March for which there was no entry made in the cash book. 3. The total of debit side bank column of cash book was undercast by Rs. 100. 4. Amount withdrawn from the bank on 26th March Rs. 200 was not recorded in the cash book at all. 5. During March, cheques issued amounted to Rs. 2,000 of which cheques for Rs. 1,500 were presented to the bank on 2nd April 1998. Q. 8 D. Diwakars Pass Book shows a balance of Rs. 5000 (Credit) on 30th June, 1998. His cash book shows a different balance. On an examination, it is found that a. No record has been made in the cash book for dishonour of a cheque for Rs. 100. b. Cash and cheques amounting to Rs. 700 were paid into the bank on 29th June, 1998 and the same had not been entered in the pass book. c. Bank charges of Rs. 15 have not been entered in the cash book. d. Cheques amounting to Rs. 1,800 issued by P. Prabhakar and paid into the bank on 28th June, 1998 had not been credited. Prepare a bank reconciliation statement as on 30th June, 1998. Q. 9 On 30th September 1998, cash book of a firm showed a bank balance of Rs. 7,500. From the following information, prepare a bank reconciliation statement showing the balance as per pass book a. Cheques amounting to Rs. 1,200 were paid on 28th September, 1998 had not been credited by the bank. One cheque for Rs. 375 was entered in the cash book on 28th September, 1998 but was banked on 3rd October, 1998. b. Cheques issued for Rs. 900 had not yet been presented for payment at the bank. Bank Reconciliation Statement 119 c. A cheque for Rs. 200 paid on 26th September, 1998 was dishonoured but the advice was received only on 3rd October, 1998. d. Bank charges of Rs. 15 were debited in the pass book by the bank. e. There was an entry in the pass book for the receipt of Rs. 600 collected by the bank as interest. Q. 10 From the following particulars, ascertain the balance by means of a statement that would appear in the pass book of Mr. S.Gavaskar as on 31st December 1998. a. Overdraft as per Cash Book Rs. 4,558. b. Interest on overdraft for six months ending 31st December, 1998 Rs. 120. c. Bank charges debited in the pass book Rs. 24. d. Cheques drawn but not cashed by the customers prior to 31st December, 1998 Rs. 1,326. e. Cheques paid into the bank but not cleared before 31st December, 1998 Rs. 2,412. f. A Bill Receivable originally discounted with the bank in November 1998 is dishonoured Rs. 800. Q. 11 From the following particulars, ascertain the balance that would appear in the cash book of Mr. M. Ranganathan as on 31st December, 1998 a. Overdraft balance as per Pass Book Rs. 24,240. b. Cheques amounting to Rs. 8,200 were paid into the bank on 28th December, 1998 out of which only Rs. 600 was credited by the bank in the pass book till 31st December, 1998. c. Cheques for Rs. 5,400 were issued on 28th December, 1998 out of which only one

cheque for Rs. 800 was presented for payment. d. There is a debit of Rs. 200 for interest and Rs. 50 for bank charges in the pass book which have not been entered in the cash book. e. Rs. 400 debited to bank account in the cash book has been omitted to be banked. f. There was a wrong debit of Rs. 600 in the pass book. 120 Management Accounting Q. 12 On 30th June, 1990, the pass book of Sunil & Co. showed a balance of Rs. 9,800 as cash at bank a. Prior to that date, they had issued cheques amounting to Rs. 3,500, of which, cheques amounting to Rs. 1,900 have so far been presented for payment. b. Out of the cheques for Rs. 2,000 paid by him into the bank before that date, only cheques for Rs. 1,200 were credited in the pass book. c. He had also received a cheque for Rs. 680 which although entered in the cash book had been omitted to be paid into bank. d. The bank had collected dividend directly and credited them. Q. 13 From the following particulars, prepare a Bank Reconciliation Statement as on 28th February, 1989. Thiru Pandiyan had an overdraft balance of Rs. 80,500 as shown by the bank columns of the cash book. Cheques amounting to Rs. 10,000 had been paid into the bank on 24th February, 1989 but of these only Rs. 7,500 were credited in the pass book. He had issued cheques amounting to Rs. 25,000, of which Rs. 20,000 worth only seem to have been presented. The bank has debited in the pass book Rs. 750 for interest. A cheque for Rs. 600 which was debited in the bank column in the cash book has been omitted to have been presented. An entry appears in the pass book for Rs. 3,000 for a direct deposit by a customer of Thiru Pandiyan. Q. 14 On 31st March 1991 the cash book of Mr. X showed a bank balance of Rs. 14,850. While verifying with the pass book, the following facts were noted a. Cheques sent in for collection before 31st March, 1991 and not credited by bank amounted to Rs. 845. b. Cheques issued before 31st March, 1991 but not presented for payment amounted to Rs. 885. c. The banker has debited a sum of Rs. 100 towards the bank charges and credited Rs. 250 for interest received and Rs. 1,000 for dividend collected. d. The banker has given a wrong credit for Rs. 250. e. Mr. Y has paid into the bank a sum of Rs. 300 on 28th March, 1991 which has not been entered in the cash book. f. A cheque for Rs. 200 sent for collection returned dishonoured has not been entered in the cash book. Bank Reconciliation Statement 121 Q. 15 Find out the balance as per pass book from the following particulars a. Bank overdraft as per cash book on 30th April, 1992 was Rs. 2,000. b. Cheque issued but not presented for payment Rs. 1,350. c. Cheques deposited but not yet collected by the banker Rs. 500. d. Bank charges Rs. 80 debited by the bank not yet entered in the cash book. e. Interest on investments collected by the bankers and credited in the pass book amounted to Rs. 905. Q. 16 From the following particulars, ascertain the balance that would appear in the cash book of B as on 31st December, 1998, before and after making necessary adjustments a. Overdraft as per pass book as on 31st December 1998 Rs. 13,880. b. Interest on overdraft for six months ending 31st December 1998 not yet entered in the cash book Rs. 240. c. Bank charges for the above period not yet entered in the cash book Rs. 60. d. Cheques drawn but not encashed by customers before 31st December, 1998 Rs. 3,300.

e. Cheques paid into the bank but not cleared before 31st December, 1998 Rs. 4,340. f. A Bill Receivable, discounted with the bank in November, dishonoured on 31st December, 1998 Rs. 1,000. Q. 17 From the following particulars taken on 31st December, 1989, you are required to prepare a bank reconciliation statement to reconcile the bank balance shown in the cash book with that shown in the pass book a. Balance as per pass book on 31st December, 1989 Rs. 1,027 (Credit). b. Four cheques drawn on 31st December but not cleared till January Rs. 1,144. c. Interest on overdraft not entered in the cash book Rs. 51. d. Three cheques received on 30th December, 1989 and entered in the bank column of cash book but not lodged in bank for collection till 3rd January, Rs. 5,280. e. Cost of cheque book Rs. 5 entered twice erroneously in cash book in November. f. A Bill Receivable for Rs. 250 on 29th December, 1989 was passed to the bank for collection on 28th December, 1989 and was entered in the cash book forthwith, whereas the proceeds were credited in the pass book only in January following. 122 Management Accounting g. Chamber of Commerce subscription Rs. 10 paid by bank on 1st December, 1989 had not been entered in the cash book. h. Bank Charges of Rs. 5 had been debited in the pass book twice erroneously. Q. 18 On 30th June, 1981, the pass book of M/s Thin and Short showed a balance of Rs. 2,000 at the bank. They had sent cheques amounting to Rs. 10,000 to the bank before 30th June, 1981 but it appears from the pass book that cheques worth Rs. 9,000 had been credited before that date. Similarly, out of the cheques for Rs. 5,000 issued during the month of June, cheques for Rs. 4,000 were presented and paid in July. The pass book showed the following payments a. Rs. 320 as premium according to standing instructions. b. Rs. 2,000 against a promissory note as per the instructions. The pass book showed that the bank had collected Rs. 1,800 as interest on Government Securities. The bank had charged as interest Rs. 50 and incidental expenses Rs. 20. There was no entry in the cash book for the payment of interest etc. A bill sent for collection was returned dishonoured on 29th June amounting to Rs. 600. Prepare the Bank Reconciliation Statement as on 30th June, 1981. Q. 19 From the following particulars, prepare a bank reconciliation statement showing the balance as per pass book on 31st March, 1989. a. Cheques for Rs. 7,900 was paid into bank in March, 1989 but were credited only in April, 1989. b. Cheques for Rs. 11,000 were issued in March, 1989 but were cashed in April, 1989 only. c. A cheque for Rs. 1,000 which was received from a customer was entered in the bank column of the cash book in March, 1989 but the same was paid into the bank in April, 1989 only. d. The pass book shows a credit of Rs. 2,500 for interest and a debit of Rs. 500 for bank charges. e. The bank balance as per cash book was Rs. 1,80,000 on 31st March, 1989. Bank Reconciliation Statement 123 Q. 20 From the following particulars, prepare a bank reconciliation statement as at 31st December, 1991. a. As on 31st December, 1991, bank overdraft as per cash book Rs. 2,49,900. b. Interest debited in the bank pass book only Rs. 27,870. c. Cheques issued but not presented for payment Rs. 66,000. d. Draft deposited in the bank but not yet credited in the pass book Rs. 13,500. e. Dividend collected by the bank Rs. 42,500 has not yet been entered in the cash book. f. A direct payment into the bank by a customer Rs. 16,000 has not been recorded in the cash book. g. Bank column on the debit side of the cash book has been undercast by Rs. 3,500.

Q. 21 From the following particulars, prepare a bank reconciliation statement showing the balance as per cash book as on 31st December, 1997. The following cheques were paid into the bank in December 1997 but were credited by the bank in January, 1998. Premnath Rs. 350 Shaym Lal Rs. 250 Ram Lal Rs. 200 The following cheques were issued by the firm in December, 1997 but were presented for payment in January, 1998. Suresh Rs. 400 Ramesh Rs. 450 A cheque for Rs. 100 which was received from a customer was entered in the bank column of cash book in December, 1997 but was omitted to be banked in the month of December, 1997. The pass book shows a credit of Rs. 100 for interest and a debit of Rs. 20 for bank charges. The bank balance as per pass book was Rs. 6,200 as on 31st December, 1997. Q. 22 According to the cash book of Gopi, there was a balance of Rs. 44,500 standing to his credit on 30th June, 1996. On investigation you find that 1. Cheques amounting to Rs. 60,000 issued to creditors have not been presented for payment till that date. 124 Management Accounting 2. Cheques paid into bank amounting to Rs. 1,05,000 out of which cheques amounting to Rs. 55,000 only collected by the bank up to 30th June, 1996. 3. A dividend of Rs. 4,000 and rent amounting to Rs. 6,000 received by the bank and entered in the pass book but not recorded in the cash book. 4. Insurance premium (up to 31st December, 1996) paid by the bank Rs. 2,700 not entered in the cash book. 5. The payment side of the cash book had been undercast by Rs. 50. 6. Bank charges Rs. 50 shown in the pass book had not been entered in the cash book. 7. A bill payable for Rs. 2,000 has been paid by the bank but is not entered in the cash book and bill receivable for Rs. 6,000 has been discounted with the bank at a cost of Rs. 100 which has also not been recorded in the cash book. You are required a. to make appropriate adjustments in the cash book. b. To prepare a statement reconciling it with the bank pass book. Q. 23 From the following extracts of the cash book (bank column) and bank pass book of Mr.X, prepare the bank reconciliation statement for the month ending on 31st March, 1997. Cash Book (Bank Column only) Date Particulars Rs. Date Particulars Rs. 01.3.97 To Balance b/fd 1,000 02.3.97 By Drawings 500 03.3.97 To D 750 03.03.97 By K 700 05.3.97 To A 250 08.3.97 By Rent 450 16.3.97 To M 800 12.3.97 By P 650 21.3.97 To N 2,500 21.3.97 By S 330 24.3.97 To R 1,700 24.3.97 By H 900 28.3.97 By Wages & Salaries 770 31.3.97 By Balance c/fd 2,700 Total 7,000 Total 7,000 Bank Reconciliation Statement 125 Extracts of Pass Book of Mr. X In the books of Bank of Baroda, Pune Date Particulars Withdrawals Deposits Dr/Cr Balance 01.4.97 Balance b/fd Cr 1,280 02.4.97 P 650 Cr 630

02.4.97 N 2,500 Cr. 3,130 04.4.97 C 350 Cr. 2,780 04.4.97 Pal 500 Cr. 3,280 05.4.97 M 800 Cr. 4,080 07.4.97 S 330 Cr. 3,750 09.4.97 H 900 Cr. 2,850 11.4.97 Sen 300 Cr. 3,150 11.4.97 Bose 470 Cr. 3,620 Prepare a Bank Reconciliation Statement as on 31st March, 1997. Q. 24 On 31st December, 1982, the bank column of the cash book of P shows a debit balance of Rs. 922. On examination of cash book and statement, you find that a. Cheques amounting to Rs. 1,260 issued before 31st December and entered in the cash book were not presented for payment till that date. b. Cheques amounting to Rs. 500 entered in the cash book as sent to the bank on 31st December were entered in the bank statement after that date. c. A cheque from a debtor for Rs. 146 had been dishonoured prior to 31st December but no record appeared in the cash book. d. A dividend warrant for Rs. 76 was paid direct to the bank and nothing appeared in the cash book. e. Bank interest and charges amounting to Rs. 84 were not entered in the cash book but appeared in the bank statement. f. There was no entry in the cash book for a club membership subscrption Rs. 20 paid by bankers order in November, 1982. g. Bank charges for a cheque book received by P Rs. 2 were entered in the cash book twice. 126 Management Accounting h. A cheque for Rs. 54 drawn by Q had been charged to Ps account in error. Make appropriate adjustment in the cash book to bring down the correct balance and prepare a bank reconciliation statement reconciling the corrected cash book balance with the balance as per bank statement. Q. 25 When Sweetex Limited received its bank statement for the period ended 30th June, 1984, this did not agree with the balance shown in the cash book of Rs. 2,972 in the companys favour. An examination of the cash book and bank statement disclosed the following a. A deposit of Rs. 492 paid on 29th June 1984 had not been collected by the bank until 1st July, 1984. b. Bank charges amounting to Rs. 17 had not been entered in the cash book. c. A debit of Rs. 42 appeared in the bank statement for an unpaid cheque which had been returned marked out of date. The cheque had been re-dated by the customer of Sweetex Limited and paid into the bank again on 3rd July, 1984. d. A standing order for payment of an annual subscription amounting to Rs. 10 had not been entered in the cash book. e. On 25th June, 1984, managing director had given the cashier a cheque for Rs. 100 to pay into his personal account at the bank. The cashier had paid the same into companys account by mistake. f. On 27th June, two customers of Sweetex Limited had paid direct to the companys bank account Rs. 499 and Rs. 157 respectively for the payment of goods supplied. The advices were not received by the company until 1st July and were not entered in the cash book until that date. g. On 30th March, 1984, the company had entered into a hire purchase agreement to pay by bankers order a sum of Rs. 26 on the 10th day of each month, commencing April. No entries had been made in the cash book. h. A cheque for Rs. 364 received from Mr. B and paid into the bank had been entered twice in the cash book. i. Cheques issued amounting to Rs. 4,672 had not been presented to the bank for payment

until 30th June, 1984.

Bank Reconciliation Statement 127

j. A customer of the company who received a cash discount 2.5% on his account of Rs. 200 paid the company a cheque on 10th June. The cashier in error entered the gross amount in the bank column of the cash book. After making the adjustments required by the foregoing, the bank statement reconciled with the balance in the cash book. You are required 1. to show the necessary adjustments in the cash book of Sweetex Limited bringing down the correct balance on 30th June, 1984. 2. to prepare a Bank Reconciliation Statement 128 Management Accounting NOTES Rectification of Errors 129

Chapter 5
RECTIFICATION OF ERRORS
The errors in accounting can be classified into the following main groups a. Errors of Omission These errors refer to a situation where a transaction is totally omitted to be recorded in the subsidiary book or partially omitted while posting from subsidiary books to the ledger. b. Errors of Commission These errors refer to wrong posting or totalling errors, calculation errors or errors in carrying forward etc. Following are the examples of errors of commission Posting of wrong amounts Posting to wrong side of account Posting to wrong account Wrong totalling of subsidiary books or ledger accounts Errors while carrying forward figures from one page to another page c. Errors of Principle These errors refer to wrong classification of income or expenditure. Following are the examples of errors of principle Purchases of fixed assets recorded in the Purchases Register Revenue expenditure treated as capital expenditure Capital receipt treated as revenue income Revenue receipt treated as capital receipt d. Compensating Error These errors refer to a situation where excess or less debits in one or more accounts are compensated by equal amount of excess or less credits in one or more accounts. Due to these errors arithmetical accuracy of the Trial Balance does not get affected. 130 Management Accounting EFFECT OF ERRORS ON TRIAL BALANCE Tallying of Trial Balance is the primary indication about the arithmetical accuracy of the books of account. However, it cannot be the conclusive evidence of the total accuracy of the books of accounts maintained. This is due to the fact that certain errors as stated above do not affect the trial balance. As such, locating the errors requires a lot of skills, particularly when they do not affect the agreement of trial balance. Errors affecting Trial Balance Following errors may affect the agreement of Trial Balance a. Wrong totalling of subsidiary books If the total of any subsidiary books is taken wrongly but the posting to the individual accounts is made correctly, it will affect the agreement of trial balance. Eg. Total of Purchase Register for the month of March is taken as Rs. 1,50,000 instead of Rs. 1,55,000. Posting to the individual accounts of suppliers total to the correct amount of Rs. 1,55,000, but the Purchases Account is debited by Rs. 1,50,000, the trial balance will not agree.

b. Posting on the wrong side of an account If a transaction is posted on the wrong side of the account, the trial balance will not agree. Eg. A payment of Rs. 10,000 made to M/s. Pam Industries is posted on the credit side of M/s. Pam Industries Account, the trial balance will not agree. c. Omission of posting an amount in the ledger If an amount is entered in the journal or subsidiary book but not posted in the ledger, the trial balance will not agree. Eg. A cash payment of Rs. 1,500 for the conveyance expenses has been entered in the cash book but is not debited to Conveyance Account, the trial balance will not agree. d. Posting of wrong amount If an amount is wrongly posted to an account, the trial balance will not agree. Eg. A cash payment of Rs. 1,500 for the conveyance expenses has been correctly entered in the cash book, but while posting the same to the Conveyance Account, it is posted as Rs. 150, the trial balance will not agree. e. Error in balancing If an error has been committed while calculating the closing balance of cash book or a ledger account, the trial balance will not agree. Errors not affecting the Trial Balance Following types of errors may not affect the agreement of Trial Balance. a. Errors of Principle If the revenue expenditure is treated as capital expenditure or if revenue receipt is treated as capital receipt or if capital expenditure is treated as revenue expenditure or if capital receipt is treated as revenue receipt, it will not affect the agreement Rectification of Errors 131 of trial balance. Eg. An amount of Rs. 10,000 paid for maintenance of machinery. Instead of posting this amount to Machinery Maintenance Account, it is debited to Machinery Account, the trial balance will still agree but it will not show a true and fair view. b. Errors of Omission If a transaction is totally omitted while making the entries in the books of accounts, it will not affect the agreement of trial balance. Eg. A bill for the purchase of material worth Rs. 15,000 has been received, but it is not entered in the Purchase Register at all, the trial balance will still agree but it will not show a true and fair view. c. Errors of Commission If an amount is posted to the correct side of a wrong account, it will not affect the agreement of trial balance. Eg. A payment is Rs. 25,000 made to Mr. Salim is debited to the account of Mr. Sham, the trial balance will still agree but it will not show a true and fair view. d. Recording of wrong amount in the books of prime entry or subsidiary books If a transaction is wrongly entered in the book of prime entry or the subsidiary book and then correctly posted to the correct account, it will not affect the agreement of trial balance. Eg. Stationary worth Rs. 4,500 has been purchased but it is entered as Rs. 4,700 in the cash book, the trial balance will still agree but it will not show a true and fair view. e. Compensating Errors If one type of error is compensated by the error of the opposite nature, it will not affect the agreement of trial balance. Eg. While balancing the traveling expenses account, the closing debit balance is taken as Rs. 1,40,000 instead of Rs. 1,50,000. Similarly, while balancing the sales account, the closing credit balance is taken as Rs. 28,90,000 instead of Rs. 29,00,000. The trial balance will still agree but it will not show a true and fair view. Steps in locating the errors If the errors result into the disagreement of trial balance, following steps should be taken to locate the errors. a. Total of all the subsidiary books and cash book should be checked carefully. Similarly, the total of trial balance should be checked carefully. b. It should be ensured that all the opening balances have been correctly brought forward in the current years books of account. c. It should be ensured that all the ledger accounts have been properly balanced and the balances of all the ledger accounts have been reflected in the Trial Balance. d. If an amount of Rs. 24,000 is debited to a certain account instead of crediting the same to the same account, the difference between the debit side and credit side of trial balance 132 Management Accounting

will be Rs. 48,000. As such, the difference in trial balance should be halved to locate such errors. e. If the difference in the trial balance is divisible by 9 without any reminder, it may indicate the transposition or transplacement of the amounts. Eg. If the cash payment of Rs. 176 is posted as Rs. 167, the difference in the trial balance will be divisible by 9. f. The trial balance of the current year can be compared with the trial balance of the previous year to locate certain highlighting error. How to rectify the errors The errors should be rectified by any one of the following methods I. In some cases, if the trial balance does not agree but the books have to be closed, the difference is placed to a Suspense Account and the trial balance is tallied. If the credit side of the trial balance is heavy by Rs. 50,000 and same amount is placed on the debit side of Suspense Account. Subsequently, attempts are made to locate the errors and the rectification entries are routed through the Suspense Account. After all the errors have been located, the balance in Suspense Account will become zero. It should be remembered that the Suspense Account is operated till the errors are located and finally the balance in Suspense Account has to become zero. Further, only the errors affecting the agreement of trial balance are routed through the Suspense Account. Illustration A merchant while balancing his books of account finds that, the trial balance shows excess credit of Rs. 1,700. Being required to prepare the final accounts, he places the difference to a newly opened Suspense Account which he carries forward. In the next accounting year, the following errors are discovered a. Goods bought from Narayan amounting to Rs. 5,000 had been posted to the credit of Narayan as Rs. 5,500. b. An item of Rs. 1,000 entered in the sales returns book was posted to the debit of Pandey who had returned the goods. c. Sundry items of furniture sold for Rs. 26,000 had been entered in the sales book. Ignore depreciation and profit or loss on the sale. d. Discount amounting to Rs. 200 from a creditor had been duly entered in the creditors account, but not posted to discount account. Draft journal entries necessary for rectifying the abovementioned errors. Prepare the Suspense Account and show the ultimate effect of the errors on the last years profit by prep aring the Profit and Loss Adjustment Account. Rectification of Errors 133 Solution a. Goods bought from Narayan had been posted to the credit of Narayan Account by Rs. 5,500 instead of Rs. 5,000. As such, Narayan Account has been credited more by Rs. 500. As such, this excess credit needs to be reversed by passing following entry Narayan A/c. Dr. 500 To, Suspense A/c. 500 b. Goods supplied to Pandey worth Rs. 1,000 should have appeared on the debit side of Pandeys account. Instead of that the entry has been made on the credit side of Pandeys account. This excess credit needs to be reversed by passing the following entry To Suspense A/c. Dr. 2,000 Pandey A/c. 2,000 c. As the amount of furniture sold has been entered in the sales book, sales account has been wrongly credited. This wrong credit needs to be reversed by debiting sales account. The journal entry to be passed is Sales A/c. Dr. 26,000 To Furniture A/c. 26,000 d. Discount received from the creditor has been entered in the creditors account bu t discount account has not been credited. As such, the error will be rectified by passing the following entry Suspense A/c. Dr. 200 To Discount Received A/c. 200

Suspense Account
Date Particulars Folio Rs. Date Particulars Folio Rs. 1 To Balance b/fd 1,700 1 By Narayan A/c. 500 1 To Discount Recd. A/c. 200 1 By Pandey A/c. 2,000 To Balance c/fd 600

2,500 2,500 II. The errors which affect two accounts and which do not affect the agreement of trial balance may be rectified by passing the rectification entries. The basic principle for rectifying the errors by this means suggests the following steps to be taken a. What is the wrong entry passed ? 134 Management Accounting b. What should be the correct entry to be passed ? c. Nullify the wrong effect by reversing the same and reinstate the correct by passing the rectification entry. Illustration Pass necessary journal entries to rectify the following errors a. An amount of Rs. 200 withdrawn by the proprietor for his personal use has been debited to trade expenses account. b. A purchase of goods from Nathan amounting to Rs. 300 has been wrongly entered through the sales book. c. A credit sale of Rs. 100 to Santhanam has been wrongly passed through the purchase book. d. Rs. 150 received from Malhotra have been credited to Mehrotra. e. Rs. 375 paid on account of salary to the cashier Dhawan stands debited to his personal account. f. A contractors bill for the extension of premises amounting to Rs. 2,750 has been debited to building repairs account. g. On 25th June, goods of the value of Rs. 500 were returned by Akashdeep and were taken into stock but the returns were entered in the books under date 3rd July i.e. after the expiration of the financial year on 30th June. h. A bill of Rs. 200 for old office furniture sold to Sethi was entered in the sales daybook. i. The periodical total of the sales book was cast short by Rs. 100. j. An amount of Rs. 80 received on account of interest was credited to commission account. Rectification of Errors 135 Solution a Wrong Entry Trade Expenses A/c 200 To Cash A/c 200 Correct Entry Drawings A/c 200 To Cash A/c 200 Rectification Entry Drawings A/c 200 To Trade Expenses A/c 200 b Wrong Entry Nathan A/c 300 To Sales A/c 300 Correct Entry Purchases A/c 300 To Nathan A/c 300 Rectification Entry Sales A/c 300 Purchases A/c 300 To Nathan A/c 600 c Wrong Entry Purchases A/c 100 To Santhanam A/c 100 Correct Entry Santhanam A/c 100 To Sales A/c 100 Rectification Entry Santhanam A/c 200 To, Purchases A/c 100 To Sales A/c 100 d Wrong Entry Cash A/c 150

To Mehrotra A/c 150 Correct Entry Cash A/c 150 To Malhotra A/c 150 Rectification Entry Mehrotra A/c 150 To Malhotra A/c 150 e Wrong Entry Dhawan A/c 375 To Cash A/c 375 Correct Entry Salary A/c 375 To Cash A/c 375 Rectification Entry Salary A/c 375 To Dhawan A/c 375 f Wrong Entry Building Repairs A/c 2,750 To Cash A/c 2,750 Correct Entry Building A/c 2,750 To Cash A/c 2,750 Rectification Entry Building A/c 2,750 To Building Repairs A/c 2,750 g Wrong Entry No entry passed 136 Management Accounting Correct Entry Sales returns A/c 500 To Akashdeep A/c 500 Rectification Entry Sales returns A/c 500 To Akashdeep A/c 500 h Wrong Entry XYZ A/c 200 To Sales A/c 200 Correct Entry XYZ A/c 200 To Furniture A/c 200 Rectification Entry Sales A/c 200 To Furniture A/c 200 i Wrong Entry No entry passed Correct Entry Suspense A/c 100 To Sales A/c 100 Rectification Entry Suspense A/c 100 To Sales A/c 100 j Wrong Entry Cash A/c 80 To Commission A/c 80 Correct Entry Cash A/c 80 To Interest A/c 80 Rectification Entry Commission A/c 80 To Interest A/c 80 QUESTIONS 1. It is said that tallying of Trial Balance is not the conclusive proof of accuracy of the books of account. Why ? 2. What are errors in financial accounting ? What are the different types of errors ? 3. What do you mean by Suspense Account? How is it operated in financial accounting? Can the balance of Suspense Account appear in the Trial Balance in ideal situations? 4. What are errors in financial accounting? Do all the errors affect the Trial Balance? State the errors that affect the Trial Balance and the errors that do not affect the Trial Balance. PROBLEMS Q.1 Ganesh drew a Trial Balance of his operations for the year ended 31st March 1992. There was a difference in the Trial Balance which he closed with a Suspense Account. On a scrutiny by the Auditors, the following errors were found a. Purchases day book for the month of April 1991, was undercast by Rs. 1,000. Rectification of Errors 137 b. Sales day book of October 1991 was overcast by Rs. 10,000.

c. A furniture purchased for Rs. 8,100 was entered in the Furniture Account as Rs. 810. d. A bill for Rs. 10,000 drawn by Ganesh was not entered in the Bills Receivable Book. e. A machinery purchased for Rs. 10,000 was entered in the purchase day book. Pass necessary journal entries to rectify the same and ascertain the difference in the Trial Balance that was shown under the Suspense Account in respect of the above items. Q.2 A bookkeeper while preparing his Trial Balance finds that the debit exceeds by Rs. 7,250. Being required to prepare the final accounts, he places the difference to a Suspense Account. In the next year, the following mistakes were discovered a. A sale of Rs. 4,000 has been passed through the Purchase daybook. The entry in customers account has been correctly recorded. b. Goods worth Rs. 2,500 taken away by the proprietor for his use has been debited to Repairs Account. c. A bill receivable for Rs. 1,300 received from Krishna has been dishonoured on maturity but no entry passed. d. Salary Rs. 650 paid to a clerk has been debited in his Personal Account. e. A purchase of Rs. 750 from Raghubir has been debited to his account. Purchase Account has been correctly debited. f. A sum of Rs. 2,250 written off as depreciation on furniture has not been debited to Depreciation Account. Draft the Journal Entries for rectifying the above mistakes and prepare Suspense Account. Q.3 The accountant of X prepared the Trial Balance for the year ended 31st March 1996. But there was a difference and the accountant put the difference in Suspense Account. Rectify the following errors found and prepare the Suspense Account. a. The total of the Returns Outward book, Rs. 420 has not been posted in the ledger. b. A purchase of Rs. 350 from Y has been entered in the sale book. However, Ys account has been correctly entered. 138 Management Accounting c. A sale of Rs. 390 to Z has been credited to his account as Rs. 290. d. Old furniture sold for Rs. 5,400 has been entered as Rs. 4,500 in sales account. e. Goods taken by proprietor, Rs. 500 have not been entered in the books at all. Q.4 A bookkeeper finds the difference in the Trial Balance amounting to Rs. 1,000 and puts it in the Suspense Account. Later on he detects the following errors a. Purchased goods from Ravi but entered into Sales Book. b. Received one bill for Rs. 25,000 from Arun but recorded in Bills Payable Book. c. An item of Rs. 3,500 relating to prepaid rent account was omitted to be brought forward. d. An item of Rs. 2,000 in respect of purchase returns, had been wrongly entered in the purchase book. e. Rs. 25,000 paid to Hari against our acceptance were debited to Harish Account. f. Bills received from Janaki for repairs done to radio Rs. 2,500 and radio supplied for Rs. 45,000 were entered in the Purchase Book as Rs. 46,000. Give rectifying journal entries with full narration and prepare Suspense Account. Q.5 There is a difference in the Trial Balance of Shri Om. Subsequently, the following errors were found to have been committed. Pass journal entries to rectify them and ascertain the difference in the Trial Balance. a. A sale of Rs. 2,000 to Shanti & Co. was credited to their account. b. The Returns Inward Book had been cast Rs. 1,000 short. c. A sale of Rs. 10,000 had been passed through the Purchase Day Book. The customers account, had, however been correctly debited. d. Rs. 3,750 paid for wages to workmen for making showcases had been charged to Wages Account. e. A purchase of Rs. 6,710 had been posted to the debit of the credit ors account as Rs. 6,170. The creditor was Paras & Co.

Rectification of Errors 139

Q. 6 There was difference in the Trial Balance of Shri Arihant which was put to newly opened Suspense Account. Subsequently, the following mistakes were discovered. Pass journal entries to rectify them and ascertain the difference in the Trial Balance. a. Materials costing Rs. 700 in the erection of machinery and the wages paid for amounting to Rs. 400 were included in the Purchase Account and Wages Account respectively. b. Goods sold under credit terms Rs. 16,900 to Mohan were recorded properly in the Sales Book but were debited to his account as Rs. 19,600 and carriage outward freight paid Rs. 700 chargeable from him were posted to Sales Expenses Account. c. Sales Returns by Yogesh Rs. 2,300 were correctly recorded in the Sales Returns Book from where they were debited to Yogesh Account by Rs. 3,200. d. Old furniture originally purchased for Rs. 1,800 written down to Rs. 1,100 was sold for cash Rs. 1,700 and was credited to Furniture Account. e. Machinery purchased on credit Rs. 17,000 was recorded in Purchase Book and transport charges for the machine Rs. 1,200 were debited to Trade Expenses Account. Q.7 Give journal entries to rectify the following errors a. Rs. 2,500 paid for the purchase of a radio set for the personal use of the proprietor debited to general expenses account. b. Rs. 1,300, the amount of sale of old machinery, has been posted to sales account. c. A sum of Rs. 160 paid by way of rent has been debited to landlords personal account. d. Rs. 245 cost of repairing the floor of room has been charged to buildings account. e. A payment of Rs. 250 made to Harish Brothers for cash purchase of goods from him stands debited to his account. Q.8 Rectify the following errors by passing necessary journal entries a. Goods taken by the proprietor Rs. 1,500 for gift to his daughter were not recorded at all. b. Rs. 1,500 received from Praveen against debts previously written off as bad debts have been credited to his personal account. 140 Management Accounting c. Received interest Rs. 150 posted to loan account. d. A cheque received from Amar, a debtor, for Rs. 2,000 was directly received by the proprietor who deposited it into his personal bank account. Q.9 While preparing the final accounts for the year ended 31st March 1995, Mr. Smart could not get his Trial Balance agreed. He transferred the difference to Suspense Account and prepared the final accounts. In April 1995, following errors were discovered in the books of accounts for the year 1994-95 a. The sales book for January 1995 was undercast by Rs. 1,000. b. Entertainment expenses Rs.150 incurred on 5th January 1995 were omitted to be posted from cash book to the ledger. c. Discount column on the receipt side of the cash book for February 1995 was added as Rs. 2,230 instead of Rs. 2,130. d. A purchase from Mr. Sumer for Rs. 8,200 on 3rd March 1995 was correctly recorded in the purchase book. But the supplier was wrongly debited for the purchase. Pass the necessary journal entries to rectify the above-mentioned errors without affecting the profit for the year 1995-96. Also prepare Suspense Account and Profit & Loss Adjustment Account. Assume that all the errors have been located. Q.10 An accountant could not tally the Trial Balance. The difference was temporarily placed to Suspense Account for preparing the final accounts. The following errors were discovered later on a. The sales book was undercast by Rs. 350. b. Entertainment expenses Rs. 95 though correctly entered in the cash book were omitted to be posted in the ledger.

c. Commission of Rs. 25 paid was posted twice, once to discount account and again to commission account. d. A sales of Rs. 139 to Ramnath, though correctly entered in the sales book was posted wrongly to his account as Rs. 193. Rectification of Errors 141 You are required to pass the necessary journal entries in the books of the next accounting year so as not to affect the profit of that year. Q.11 The Trial Balance of N Ltd. does not tally. In order to give it a semblance of agreement, the accountant of the company transfers the difference to a newly opened Suspense Account. Later on, he discovers the following errors a. An item of Rs. 5,850 paid for purchase of a new typewriter for the accounts department has been wrongly passed through the purchases book. b. An item of Rs. 780 in the sales book has been posted as Rs. 960 in the customers account. c. An addition in the returns inward book has been cast Rs. 240 short. d. An item of Rs. 450 appearing in the discount column on the credit side of the cash book has been posted to the credit side of the concerned personal account as Rs. 540. e. A bill of exchange for Rs. 2,650 accepted by R & Co. and later discounted with the bank has been returned by the bank as dishonoured. On dishonour, the amount of the bill has been debited to sales account. Give journal entries to rectify the above mentioned errors and also show the Suspense Account. Q.12 Pass journal entries to rectify the following errors a. A purchase amounting to Rs. 1,000 made for a staff member was recorded in the purchases book. b. Wages paid to workers for installing machinery, Rs. 750 were debited to wages account. c. A dishonoured bill receivable for Rs. 5,000 returned by the bank with whom it was discounted was credited to bank and debited to bills receivable account. d. A sum of Rs. 1,000 drawn by the proprietor for his personal use was debited to traveling expenses account. 142 Management Accounting Q.13 Pass journal entries to rectify the following errors a. A sum of Rs. 100 paid to Suresh was debited to Subhash. b. A credit sale of Rs. 587 was recorded in the sales book as Rs. 857. c. Goods sold to Prem for Rs. 170 were returned by him, but no entry was passed in the books. d. A bill receivable for Rs. 2,000 accepted by Vimal was recorded in bills payable book. e. Repairs of furniture amounting to Rs. 500 were debited to furniture account. Q.14 Pass journal entries to rectify the following errors and prepare Suspense Account. a. Rs. 1,080 received from Mohan was posted to the debit of his account. b. Rs. 200 being purchase returns were posted to the debit of purchases account. c. Rs. 400 received as discount was posted to the debit of discount account. d. Rs. 1,148 paid for repairs of motor car was debited to motor car account as Rs. 148. e. Rs. 400 paid to Suresh was debited to Satish. Assume that there are no other errors. Q.15 On 28th February 1999, the Trial Balance of X did not agree. X put the difference in a newly opened Suspense Account. Subsequently, following errors were located a. The returns inward book for January 1999 had been cast Rs. 1,000 short. b. A purchase of Rs. 1,671 had been posted to the debit of the creditors account as Rs. 1,617. The creditor is Panna & Co. c. A sale of Rs. 2,000 to Singhi & Co. was credited to the account of the customer. d. A sale of Rs. 4,000 has been passed through the purchase book. The customers account

has however been correctly debited. e. While carrying forward the total of sales book from one page to the next, the amount was written as Rs. 1,76,658 instead of Rs. 1,67,568. Rectification of Errors 143 Pass journal entries to rectify the above-mentioned errors. Also prepare the Suspense Account assuming that all the errors have been located. Q.16 An accountant prepared a Trial Balance on 31st January 2000, which revealed a difference in the books of account. He put the difference in a newly opened Suspense Account. During February 2000, he detected the following errors a. The total of the returns outward book, Rs. 4,200 had not been posted in the ledger. b. A purchase of Rs. 3,500 from Y had not been entered in the purchase book. However, Ys account had been correctly credited with the amount. c. A sale of Rs. 3,900 to Z had been credited to his account as Rs. 2,900. d. Furniture sold for Rs. 5,400 had been entered as Rs. 4,500 in the sales book. e. Goods worth Rs. 500 taken by the proprietor for personal use had not been recorded at all. f. Wages paid for an installation of machinery Rs. 1,000 had been debited to wages account. Pass journal entries to rectify the abovementioned errors and prepare Suspense Account assuming that all the errors have been located. Q.17 Give journal entries to rectify or adjust the following in the books of both the head office and the branch. a. Goods costing Rs. 16,000 purchased by branch, but payment made by head office. The head office has debited the amount to its own purchase account. b. Branch paid Rs. 30,000 as salary to a visiting head office official. The branch has debited the amount to salaries account. c. Depreciation, Rs. 50,000 in respect of branch assets whose accounts are kept in the head office books is to be recorded by both the parties. d. Expenses Rs. 70,000 to be charged to the branch for work done on its behalf by the head office. 144 Management Accounting Q.18 On finding a difference between two sides of the Trial Balance, the accountant transferred the excess debit of Rs. 770 to a suspense account. Subsequently, the following errors were detected. Give journal entries to rectify the errors and show the suspense account. 1. Repairs to machinery Rs. 2,000 were debited to Machinery Account. 2. A sale of Rs. 900 to Patel was recorded in the Purchases Book. 3. The total of the Returns Inwards Book Rs. 400 was not posted. 4. A purchase of Rs. 590 from Sathe was posted to his account as Rs. 950. 5. The bank column of the receipt side of the cash book was undercast by Rs. 110. 6. A cash sale of Rs. 200 to Ramesh was entered both in the cashbook and sales book. 7. A credit purchase of Rs. 300 from Satish was omitted to be recorded. 8. Cash Rs. 150 paid to Brijmohan was posted twice to his account. 9. A credit balance of Rs. 450 to Malasinghs account was carried forward as Rs. 540 on the debit side. 10. The name of Vinod, a creditor, to whom we owed Rs. 500 was omitted from the list of sundry creditors. Q.19 Rectify the following errors 1. Carriage on machinery is debited to Carriage Account Rs. 100. 2. Goods purchased from Sahani Rs. 531 was debited to his account as Rs. 351. 3. A television purchased for the workers canteen in the factory for Rs. 25,000 was debited to Factory Expenses. 4. An amount of Rs. 15,000 paid for the construction of a new hall in the building was debited to Repairs Account.

5. The total of the Sales Book for the month of February was cast short by Rs. 10. 6. A credit sale of Rs. 575 to Mahendra was debited to Mohinders Account. 7. A sum of Rs. 500 paid to Poonawalla for salary was debited to his personal account. 8. A credit sale of Rs. 1,000 to Rashid was correctly entered in the Sales Book but was posted to the credit of his account in the ledger as Rs. 100. 9. Goods sold to Devidas Rs. 590 was recorded in the Sales Book as Rs. 950. Rectification of Errors 145 NOTES 146 Management Accounting NOTES Cost Accountancy [Basic Concepts and Principles] 147

Chapter 6
COST ACCOUNTANCY
[BASIC CONCEPTS AND PRINCIPLES]
INTRODUCTION : The Institute of Cost and Management Accountants, London has defined the Cost Accountancy as The Application of Costing and Cost Accounting principles, methods and techniques to the science, art and practice of cost control and the ascertainment of profitability as well as presentation of information for the purpose of managerial decision making.. The analysis of the above definition reveals the following facts. (1) Cost Accountancy is a science, art and practice of a Cost Accountant. Science indicates the possession and the application of relevant systematic knowledge. Art indicates the skill and ability of the Cost Accountant. Practice indicates a continuous effort on the part of the Cost Accountant. (2) The terms costing and cost accounting should not be confused. Costing indicates the process of ascertaining the costs which can be done arithmetically also. Cost accounting indicates the process of recording the costs in a formal and systematic manner with the intention of preparing statistical data therefrom to ascertain the cost. (3) The objects of Cost Accountancy can be threefold. (a) Ascertainment of cost and profitability with the help of various principles, methods and techniques. (b) Cost control This indicates the process of controlling the costs of operating the business. This process, in turn, involves the following stages. To plan the operations (which can be done by the establishment of budgets and standards), execute the plans, measuring the actual performance, comparison of planned and actual performance, computing the variations between planned and actual performance and taking the decisions to maintain favourable variations or to remove unfavourable variations. 148 Management Accounting (c) Presentation of information to enable managerial decision making. Unless and until the results of any study or action are presented correctly to the person who takes the decision in respect of the same, the study has no meaning. CONCEPT OF COST CENTRE : Cost Centre is defined as a location, person, or item of equipment (or a group of these) in or connected with an undertaking, in relation to which costs may be ascertained and used for the purpose of cost control. Correct identification of a cost centre is pre-requisite for the successful implementation of cost accounting process as the costs are ascertained and controlled with respect to the cost centres. Similarly, correct identification of cost centre facilitates the fixation of responsibility in a correct manner. Eg. A person in-charge of a cost centre may be held responsible for the proper functioning and cost control in relation to that cost centre. As cost centres facilitate this control function, in many cases, they are termed as Responsibility Centres. There may not be any fixed principle for deciding the number and size of cost centres. It depends upon the nature and size of organisation, expenditure involved, requirements

of management from cost control point of view and so on. However, following pattern of classification may be followed to decide the cost centres. (1) Impersonal and Personal Cost Centres : An impersonal cost centre consists of location or item of equipment (or group of these). Eg. A region of sales, a branch, a department, a grinding machine and so on. A personal cost centre consists of a person or a group of persons. Eg. Finance Manager, Sales Manager, Works Manager and so on. (2) Production and Service Cost Centres : Production cost centre is the one where the production activity is carried on. Eg. Machine shop, Paint shop, Assembly shop and so on. Service cost centre is the one which assists the production activity. Eg. Store Dept., Internal Transport Dept., Labour Office, Maintenance Dept., Accounts/Costing Dept., and so on. CONCEPT OF COST : The term cost indicates the amount of expenditure (actual or notional) incurred on or attributable to, a given thing. The term cost can be viewed from various angles. Cost Accountancy [Basic Concepts and Principles] 149 (1) Direct Cost and Indirect Cost : Direct Cost indicates that cost which can be identified with the individual cost centre. It consists of direct material cost, direct labour cost and direct expenses. It is also termed as Prime Cost. Indirect Cost indicates that cost which cannot be identified with the individual cost centre. It consists of indirect material cost, indirect labour cost and indirect expenses. It is also termed as overheads. As it is not possible to identify these costs with individual cost centres, such identification is done in the indirect way by following the process of allocation, apportionment and absorption. (It is discussed in details in the following chapters). (2) Fixed, Variable and Semi-variable/Semi-fixed Cost : Fixed cost indicates that portion of total cost which remains constant at all the levels of production, irrespective of any change in the later. As the volume of production increases, per unit fixed cost may reduce, but not the total fixed cost. Variable cost indicates that portion of the total cost which varies directly with the level of production. Higher the volume of production, higher the variable cost and vice versa, though per unit variable cost remains constant at all the levels of production. Semi-variable or semi-fixed cost indicates that portion of the total cost which are partly fixed and partly variable in relation to the volume of production. (3) Controllable Cost and Uncontrollable Cost : Controllable cost indicates that cost which can be controlled by a specific number of person(s) in the organisation. Eg. A person in charge of a responsibility centre may be in the position to control the costs in relation to that responsibility centre. Uncontrollable cost indicates that cost which cannot be controlled by a specific number of person(s) in the organisation. Eg. The costs relating to one responsibility centre cannot be controlled by a person who is in-charge of another responsibility centre. It should be noted here that a clear-cut distinction between controllable and uncontrollable costs may not be possible. The cost which is controllable for one person may not be controllable by another one. In fact, no cost is completely uncontrollable. The degree of controllability varies in relation to a particular individual and a level of management. In a very broad sense, it can be said that the variable costs are controllable at the lower level of management while fixed costs are controllable at the top level of management. 150 Management Accounting (4) Normal Cost and Abnormal Cost : Normal Cost indicates that cost which is normally incurred at a certain level of output under normal circumstances. Abnormal cost indicates that cost which is normally not incurred at a certain level of output under normal circumstances. SPECIAL TYPES OF COST :

(a) Opportunity Cost : In very simple language, opportunity cost is the cost of opportunity foregone. The resource like men, material, machine, money etc. may be having various alternative uses each one having some specific yield or return. However, if they are used in one particular way, they cannot be used in any other way. Opportunity cost refers to the return or yield which is not available if the resources are used in any specific manner. Eg. Mr. A has Rs. 1,00,000 to invest. He is having two options open. (i) Keep the same with some Bank in Fixed Deposit and get the interest of 10% p.a. (ii) Invest the money in the business and get the return on investment of 12%. If Mr. A decides to invest the money in business, he cannot get the interest on Fixed Deposit from Bank. As such, opportunity cost of investing the money in the business is in the form of lost interest on Fixed Deposits with the Bank. It should be noted that the opportunity cost itself finds no place in the accounting process. However, it is required to be considered in the decision making process, for the comparison purpose. The returns available from a proposal should be more than the cost of opportunity lost, then and then only the proposal can be accepted. (b) Differential Cost : Differential cost indicates increased or decreased cost due to the increased or decreased volume of operations. While assessing the acceptability of a proposed change, the differential costs are compared with differential revenues, and so long as differential revenues are more than the differential costs, the proposed change may be accepted. (c) Sunk Cost : Sunk cost indicates historical cost which is incurred in past. This type of cost is normally not relevant in the decision-making process. Eg. While deciding about the replacement of a machine, the depreciated book value of the machine may not be relevant being in the form of sunk cost. Cost Accountancy [Basic Concepts and Principles] 151 INSTALLATION OF COSTING SYSTEM : At the outset, it should be noted that if it is decided to install a costing system in an organisation there may not be any standard type of costing system applicable. The details of costing system may be required to be worked out in such a way that they satisfy the individual requirements of the organisation. Following factors will have to be considered before installing a costing system. (a) Nature of the Product : Before installing the costing system, the nature of product in respect of which the system is to be installed will have to be studied. If the product is material intensive, more stress may be necessary on inventory control procedures, if the product is labour intensive, more stress may be necessary on control procedures and so on. (b) Nature of the Organisation : The nature of the organisation may be required to be studied from the various angles. (1) Size and layout of the factory. (2) Organisational structure of the organisation. (3) The procedures presently followed in the respect of accounting of material cost, labour cost and overheads. (4) Management requirements from the cost control point of view. (c) Manufacturing Process : Before installing the costing system, the technical process involved in the manufacturing of the product will have to be studied. This may involve the study from the stage of designing of the product, the quantity, quality and mix of the materials used, the degree of automation involved, the production control techniques implemented, the degree of complexities involved in the production process and so on. (d) Simplicity and Cost : The costing system to be installed should be simple to understand and easy to operate. The costing system should be economic in terms of cost of installing and operating the system, and the results obtained therefrom should justify the cost. 152 Management Accounting

(e) Reporting systems : The costing system should be designed in such a way that it generates proper reports in a proper way to facilitate cost control decisions from the managements side. The reporting system should be based upon the principle of Management by Exception. Forms and records required to be maintained to facilitate correct reporting should be designed in such a way that it involves minimum clerical work and minimum cost. Some problems may arise while installing a costing system in an organisation. However, they are faced mainly where the system is not properly planned, executed and communicated. These problems are definitely not of the costing principles as such and can easily be overcome by having systematic planning and communication procedures. The problems which are usually faced while installing a costing system can be stated as below. (1) The costing system may not be suitable considering the nature of product and nature of business. (2) The employees and the executives may resist the installation of the costing system feeling that it is meant for pointing out their drawbacks. This arises only out of ignorance and suspicion. (3) Lack of cost consciousness among the various levels of management. (4) The cost involved in installing a costing system may be too high. (5) Laxity on the part of various employees to complete the forms of cost office and to forward them to the cost office. Cost Accountancy [Basic Concepts and Principles] 153 QUESTIONS 1. Explain the nature of Cost Accounting. Explain the factors which need to be considered for installing a costing system for a medium sized engineering organisation. 2. Write short notes on a) Cost Centre b) Opportunity Cost 154 Management Accounting NOTES Elements of Costs 155

Chapter 7
ELEMENTS OF COSTS
In case of a typical manufacturing type of operation, the activity may consist of conversion of raw material in the form of finished goods with the help of labour and other services and selling the finished goods in the market to earn the profits. In order to interpret the term cost correctly and to ascertain the cost with respect to the centres, the cost attached with the manufacturing process may be subdivided into what is known as Elements of Cost. Broadly there can be three elements of costs. (A) Material : This is the cost of commodities and materials used by the organization. It can be direct or indirect. Direct Material indicates that material which can be identified with the individual cost centre and which becomes an integral part of the finished goods. It basically consists of all raw materials, either purchased from ourside or manufactured in house. Indirect Material indicates that material which cannot be identified with the individual cost centre. This material assists the manufacturing process and does not become an integral part of finished goods. The examples of this type of material may be consumable stores, cotton waste, oils and lubricants, stationery material etc. (B) Labour : This is the cost of remuneration paid to the employees of the organisation. It can be direct or indirect. Direct Labour Cost indicates that labour cost which can be identified with the individual cost

centre and is incurred for those employees who are engaged in the manufacturing process. Indirect Labour Cost indicates that labour cost which cannot be identified with the individual cost centre and is incurred for those employees who are not engaged in the manufacturing process but only assist in the same. The examples of this type of cost are wages paid to foreman/storekeeper, salary of works manager, Accounts/Personnel department salaries etc. 156 Management Accounting (C) Expenses : This is the cost of services provided to the organisation (and the notional cost of assets owned). It can be direct or indirect. Direct Expenses are those expenses, which can be identified with the individual cost centres. The examples of these expenses are hire charges of machinery/ equipments required for a particular job, cost of defective work for a particular job etc. Indirect Expenses are those expenses, which cannot be identified with the individual cost centres. The examples of these expenses are rent, telephone expenses, insurance, lighting etc. The above elements of cost can be shown as below. Cost Material Labour Expenses Direct Indirect Direct Indirect Direct Indirect The aggregate of Direct Material Cost, Direct Labour Cost and Direct Expenses is termed as Prime Cost. The aggregate of Indirect Material Cost, Indirect Labour Cost and Indirect Expenses is termed as Overheads. Overheads : As discussed above, the aggregate of Indirect Material cost, Indirect Labour cost and Indirect Expenses is termed as Overheads. For the proper interpretation and presentation of cost, the term overheads may be further classified as below. (a) Factory Overheads (Also termed as production/works/manufacturing overheads.) (b) Office and Administration Overheads. (c) Selling and Distribution Overheads. (a) Factory Overheads : These overheads consist of all overhead costs incurred from the stage of procurement of material till the stage of production of finished goods. They include : Indirect Material such as consumable stores, cotton waste, oil and lubricants etc. Elements of Costs 157 Indirect Labour Cost such as wages paid to foreman/storekeeper, works managers salary etc. Indirect Expenses such as carriage inward cost, cost of factory lighting/power expenses, rent/insurance/repairs for factory building/machinery, depreciation on factory building or machinery etc. (b) Office and Administration Overheads : These overheads consist of all overhead costs incurred for the overall administration of the organization. They include : Indirect Material such as stationery items, office supplies etc. Indirect Labour cost such as salaries paid to Accounts and Administration staff, Directors remuneration etc. Indirect Expenses such as postage/telephone, rent/insurance/repairs/depreciation on office building, general lighting, legal/audit charges, bank charges etc. (c) Selling and distribution Overheads : These overheads consist of all overhead costs insured from the stage of final manufacturing of finished goods till the stage of sale of goods in the market and collection of dues from the customers. They include : Indirect Material such as packing material, samples etc. Indirect Labour like salaries paid to sales personnel, commission paid to sales manager etc. Indirect Expenses like carriage outwards, warehouse charges, advertisement, bad

debts, repairs and running of distribution van, discount offered to customers etc. 158 Management Accounting The above classification of overheads can be shown as below : Indirect Material Factory Indirect Labour Indirect Expense Indirect Material Overheads Office/Administration Indirect Labour Indirect Expense Indirect Material Selling & Distribution Indirect Labour Indirect Expense Cost Sheet/Cost Statement : The various elements/components of the cost as discussed above can be presented in the form of a statement, popularly known as Cost Sheet or Cost Statement. The cost sheet may be prepared separately for each cost centre and may have the columns like cost per unit or cost of previous period etc. A Proforma cost sheet is shown below : Direct Material Cost Direct Labour cost Direct Expenses PRIME COST Add : Factory Overheads FACTORY/WORKS COST Add : Office and Administration Overheads TOTAL COST Add : Selling and Distribution Overheads COST OF SALES Add : Profit SALES Elements of Costs 159 The above relationship among the various elements of costs can be explained in a better way with the help of following diagram. Note : The difference between sales and factory/works cost is termed as Gross Profit and the difference between sales and cost of sales is termed as Net Profit or Operating Profit. As such, the difference between Gross Profit and Office and Administration Overheads and Selling and Distribution may be different from the Net Profit or Operating Profit. This Net Profit may be different from the net Profit as disclosed by the financial statement in the form of Profit and Loss Account. This is due to the fact that the Profit and Loss Account considers the various non-operating incomes/expenses or incomes/expenses of purely financial nature (as discussed below) while they may be ignored by the cost statement. (a) Non-operating/Financial Incomes : These represent incomes which arise not as a part of regular operations of the organisation. Eg. Profit on the sale of assets/investment, dividend received, windfall income etc. Due to these, the operating profit as per cost statement may be less than profit as per Profit and Loss Account. (b) Non-operating/Financial Expenses : These represent expenses which arise not as a part of regular operations of the organisation. Such expenses may be in the form of those incurred as a result of policy. PROFIT SELLING & DISTRIBUTION OVERHEADS ADMINISTRATION OVEREHEADS FACTORY

OVERHEADS DIRECT EXPENSES DIRECT LABOUR DIRECT MATERIAL SALES COST OF SALES TOTAL COST FACTORY COST PRIME COST 160 Management Accounting Eg. loss on the sale of assets/investment, good-will/ preliminary expenses written off, provision for Income Tax, Interest paid, Dividend paid etc. Due to these, the operating profit as per cost statement may be more than profit as per Profit and Loss Account. As such cost structure may also be presented as below. Sales Less : Factory/Works Cost Gross Profit Less : Office and Administration Overheads Selling and Distribution Overheads Operating Profit Less : Non-Operating/Financial Expenses Add : Non-Operating/Financial Income Net Profit (As per Profit and Loss Account) It goes without saying that if an organisation maintains cost records and financial records separately, there may be a need to reconcile the profits as disclosed by the cost records and the profit as disclosed by the financial records. ILLUSTRATIVE PROBLEMS (1) From the following list of balances, prepare a statement showing Cost of Sales, Gross Profit, Operating Expenses, Operating Profit and Net Profit. Rs. Sales 7,80,000 Purchases 4,83,375 Sales Returns 30,000 Salaries : Office 40,350 Selling 22,950 63,300 Rent and Taxes : Office 2,700 Selling 1,350 4,050 Stationery and Postage 3,850 Depreciation 13,950 Advertising 4,700 Selling expenses 2,350 Travelling expenses 3,000 Elements of Costs 161 Opening Stock 1,14,375 Sundry Expenses : Office 16,500 Selling 8,250 24,750 Closing Stock 1,47,750 Dividend on shares 13,500 Profit and sale of shares 4,500 Loss on sale of shares 6,000 Solution : COST STATEMENT (A) Sales Rs. Rs.

Gross Sales 7,80,000 Less : Sales Returns 30,000 Net Sales 7,50,000 (B) Prime Cost (Material consumed) Opening Stock 1,14,375 Add : Purchases 4,83,375 5,97,750 Less : Closing stock 1,47,750 4,50,000 (C) Gross Profit (i.e. A-B) 3,00,000 (D) (a) Office and Administration Overheads - Salaries 40,350 - Rent and Taxes 2,700 - Stationery and Postage 3,850 - Depreciation 13,950 - Travelling Expenses 3,000 - Sundry Expenses 16,500 80,350 162 Management Accounting (b) Selling and Distribution Overheads - Salaries 22,950 - Rent and Taxes 1,350 - Advertising 4,700 - Selling Expenses 2,350 - Sundry Expenses 8,250 39,600 1,19,950 (E) Operating Profit (i.e. C-D) 1,80,050 (F) (a) Less : Non-operating Expenses Dividend on shares 13,500 Loss on sale of shares 6,000 19,500 1,60,550 (b) Add : Non-operating Income Profit on sale of shares 4,500 (G) Net Profit 1,65,050 Notes : (a) From the available details, it appears that the above activity is a trading activity. As such there will be no factory overheads and prime cost will consist of only material cost. (b) In want of sufficient information, depreciation and travelling expenses are treated as office and administration overheads. (c) Dividend on shares may indicate the non-operating income also. However, in want of sufficient information, it is treated as dividend paid by the company i.e. a part of nonoperating expenses. (2) From the books of accounts of M/s. Aryan Enterprises, the following details have been extracted for the year ending March, 1994. Rs. Stock of Materials Opening 1,88,000 Closing 2,00,000 Materials purchased during the year 8,32,000 Direct Wages paid 2,38,400 Indirect Wages 16,000 Elements of Costs 163 Salaries to administrative staff 40,000 Freights Inward 32,000 Outward 20,000 Cash Discounts allowed 14,000 Bad Debts written off 18,800

Repairs to Plant & Machinery 42,400 Rent, Rates and Taxes Factory 12,000 Office 6,400 Travelling Expenses 12,400 Salesmens Salaries and Commission 33,600 Depreciation Plant & Machinery 28,400 Furniture 2,400 Directors Fees 24,000 Electricity Charges (Factory) 48,000 Fuel (for boiler) 64,000 General Charges 24,800 Managers Salary 48,000 The managers time is shared between the factory and the office in the ratio of 20:80. From the above details, you are required to prepare :a. Prime Cost b. Factory Overheads c. Factory Cost d. Administration Overheads e. Selling Overheads f. Total Cost Solution : COST SHEET Direct Materials Cost Rs. Rs. Opening Stock 1,88,000 Add : Purchases 8,32,000 Less : Closing Stock 2,00,000 8,20,000 Add : Freight Inward 32,000 164 Management Accounting Rs. Rs. 8,52,000 Direct Wages 2,38,400 PRIME COST 10,90,400 Factory Overheads Indirect wages 16,000 Repairs to Plant & Machinery 42,400 Rent, Rates and Taxes 12,000 Depreciation Plant & Machinery 28,400 Electricity Charges 48,000 Fuel for boiler 64,000 Managers Salary 9,600 2,20,400 FACTORY COST 13,10,800 Administration Overheads Salaries 40,000 Rent, Rates and Taxes 6,400 Travelling Expenses 12,400 Depreciation Furniture 2,400 Directors Fees 24,000 General Charges 24,800 Managers Salary 38,400 1,48,400 OFFICE COST 14,59,200 Selling Overheads Freight Outward 20,000 Cash Discount allowed 14,000

Bad Debts written off 18,800 Salesmens Salary & Commission 33,600 86,400 TOTAL COST 15,45,600 Elements of Costs 165 (3) An advertising agency has received an enquiry for which you are supposed to submit the quotation. Bill of Materials prepared by the Production Department for the job states the following requirement of material : Paper 10 reams @ Rs. 1800 per ream Ink & Other printing material Rs. 5,000 Other consumables Rs. 3,000 Some photography is required for the job. The agency does not have a photographer as an employee. It decides to hire a professional photographer who is to be paid professional fees of Rs. 10,000. Estimated job card prepared by the Production Department specifies that services of the following employees will be required for the execution of the job. Monthly remuneration payable to these employees as indicated by the Personnel Department is also given. Artist 80 hours. Paid Rs. 12,000 p.m. Copywriter 75 hours. Paid Rs. 10,000 p.m. Client Servicing 30 hours. Paid Rs. 9,000 p.m. You can assume that a month consists of 25 working days and one working day consists of 6 working hours. An amount of Rs. 4,000 will be required for the cost of primary packing material. Production overheads are likely to be 40% of direct cost while selling and administration overheads are likely to be 25% of production cost. The agency expects the profit of 10% on basic quotation price. COST SHEET Rs. Rs. Direct Materials Cost Paper 18,000 Ink & Other printing material 5,000 Other Consumables 3,000 Primary Packing Material 4,000 30,000 Direct Labour Cost Artist 6,400 Copywriter 5,000 Client Servicing 1,800 13,200 166 Management Accounting Direct Expenses Photography Charges 10,000 DIRECT COST 53,200 Production Overheads 21,280 PRODUCTION COST 74,480 Selling & Administration Overheads 18,620 TOTAL COST 93,100 Profit 10,344 QUOTATION PRICE 1,03,444 (4) Pune Equipments Ltd. manufactured and sold 1,000 refrigerators in year ending 31 December, 1984. The Trading and Profit & Loss Account is as below: Trading and P&L Account for the year ending 31.12.84. To, Cost of material 80,000 By, Sales 4,00,000 To, Direct wages 1,20,000 To, Manufacturing Cost 50,000 To, Gross Profit 1,50,000

4,00,000 4,00,000 To, Mgn. & Staff Salary 60,000 By, Gross Profit 1,50,000 To, Rent, Rates etc. 10,000 To, Selling Expenses 30,000 To, General Expenses 20,000 To, Income Tax 5,000 To, Net Profit 25,000 1,50,000 1,50,000 For the year ending 31.12.85, it is estimated that : 1. Output and sales will be 1,200 refrigerators. 2. Prices of the materials will rise by 20% on the previous years level. 3. Wages will rise by 5%. 4. Manufacturing cost will rise in proportion to combined costs of materials and wages. 5. Selling cost per unit will remain unchanged. 6. Other expenses will remain unaffected by the rise in output. Elements of Costs 167 You are required to prepare a cost statement showing the price at which each refrigerator should be marked so as to show profit of 10% on the selling price. Solution : Cost Statement for the Year Ending 31.12.85 (Base - 1,200 Refrigerators) Per Unit Total Rs. Rs. Material Cost 96.00 1,15,200 Direct Wages 126.00 1,51,200 Prime Cost 222.00 2,66,400 Manufacturing Cost (25% of Prime Cost) 55.50 66.600 Factory Cost 277.50 3,33,000 Management & Staff Salary 50.00 60,000 Rent/Taxes and General Expenses 25.00 30,000 Selling Expenses 30.00 36,000 Cost of Sales 382.50 4,59,000 Profit (1/9th of Total Cost) 42.50 51,000 Sales 425,00 5,10,000 Note : (1) Material Cost and Direct Cost increases both due to increase in volume and increase in prices. (2) Calculation of manufacturing cost percentage Present Materials Cost Rs. 80,000 Present Direct Wages Rs. 1,20,000 Present Prime Cost Rs. 2,00,000 Present Manufacturing Cost Rs. 50,000 Manufacturing Cost is 25% of Prime Cost. (3) Expenditure in the form of income tax will be ignored being non-operating expenditure. 168 Management Accounting (5) The standard production for a particular work order is 20 units per day and piece rate wages is 60 paise per unit if daily production is 20 units or more. The rate is 50 paise per unit if production is less than 20 units. Cost of material is 30 paise per unit. It is proposed to charge factory overhead under one of the following methods. (i) 100% on labour cost. (ii) 80% on prime cost. Tabulate the above data in the form of a suitable statement and indicate in the factory cost per unit, under each of the above methods if the daily production is (a) 15 units (b) 20 units (c) 25 units. Solution : COST SHEET

(a) No. of units produced per day 15 20 25 (b) Material cost (Rs) 4.50 6.00 7.50 (c) Labour cost (Rs) 7.50 12.00 15.00 (d) Prime cost i.e. b+c 12.00 18.00 22.50 Alternative I Alternative II (a) No. of units produced per day 15 20 25 15 20 25 (b) Prime Cost (Rs) 12.00 18.00 22.50 12.00 18.00 22.50 (c) Factory overheads (Rs) 7.50 12.00 15.00 9.60 14.40 18.00 (d) Total factory cost i.e. b+c 19.50 30.00 37.50 21.60 32.40 40.50 (e) Factory cost per unit i.e. d/a (Rs) 1.30 1.50 1.50 1.44 1.62 1.62 Note : According to Alternative I, Factory Overheads are charged @ 100% on Labour Cost. According to Alternative II, Factory Overheads are charged. @ 80% on Prime Cost. Elements of Costs 169 (6) X Ltd. manufactures four brands of toys A, B, C and D. If the Company limits the manufacture to just one brand, the monthly production will beA - 50000 Units B - 100000 Units C - 150000 Units D - 300000 Units You are given the following set of information, from which you are requested to find out the profit or loss made on each brand showing clearly, the following elements. (a) Direct cost (b) Works cost (c) Total cost Brands ABCD Monthly Production (units) 6,750 18,000 40,500 94,500 Direct Wages (Rs.) 15,000 27,500 37,500 1,05,000 Direct Material Cost (Rs.) 50,000 92,500 1,27,500 3,80,000 Selling Price Per Unit (Rs.) 20 15 10 8 Factory overhead expenditure for the month was Rs. 1,62,000. Selling and distribution cost should be assumed @ 20% of works cost. Factory overhead expenses should be allocated to each brand on the basis of the units which could have been produced in a month when a single brand production was in operation. Solution : From the information given, it is observed that One unit of B is equivalent to 2 units of A. One unit of C is equivalent to 3 units of A One unit of D is equivalent to 6 units of A Expressing the actual production in terms of unit equivalents of product A Product A 6,750 units. Product B 9,000 units equivalent of A Product C 13,500 units equivalent of A Product D 15,750 units equivalent of A 45,000 170 Management Accounting The factory overheads of Rs. 1,62,000 are to be distributed over 45,000 equivalent units of product A. As such rate of factory overheads for one unit of Product A will be Rs. 1,62,000 45,000 units = Rs. 3.60/per unit As such, per unit factory overheads for other products will be Product B - Rs. 3.60/2 = Rs. 1.80/ per unit. Product C - Rs. 3.60/3 = Rs. 1.20/ per unit. Product D - Rs. 3.60/6 = Rs. 0.60/ per unit. On this basis, the cost sheet for each product can be worked out as below. ABCD

(a) Direct Material Cost 50,000 92,500 1,27,500 3,80,000 (b) Direct Wages 15,000 27,500 37,500 1,05,000 (c) Total Direct Cost i.e. a+b 65,000 1,20,000 1,65,000 4,85,000 (d) Factory Overheads 24,300 32,400 48,600 56,700 (e) Works cost i.e. c+d 89,300 1,52,400 2,13,600 5,41,700 (f) Selling/Distribution overheads 17,860 30,480 42,720 1,08,340 (g) Cost of Sales e+f 1,07,160 1,82,880 2,56,320 6,50,040 (h) Units Sold/Produced 6,750 18,000 40,500 94,500 (i) Units Selling Price - Rs. 20 15 10 8 (j) Total Sales Rs. 1,35,000 2,70,000 4,05,000 7,56,000 (k) Profit i.e. j-g 27,840 87,120 1,48,680 1,05,960 (7) A manufacturing company has an installed capacity of 1,20,000 units per annum. The cost structure of the product manufactured is as under 1. Variable Cost (Per unit) Materials Rs. 8 Labour (subject to a minimum of Rs. 56,000 per month) Rs. 8 Overheads Rs. 3 2. Fixed overheads Rs. 1,04,000 per annum Elements of Costs 171 3. Semi variable overheads Rs. 48,000 per annum at 60% capacity which increase by Rs. 6,000 per annum for increase of every 10% of the capacity utilization or any part thereof. The capacity utilisation for the next year is estimated at 60% for 2 months, 75% for 6 months and 80% for the balance part of the year. If the company is planning to have a profit of 25% on the selling price, calculate the estimated selling price for each unit of production. Assume that there is no opening or closing stock. Solution : Capacity Utilisation 60% 75% 80% Months 2 6 4 No. of units 6000 7500 8000 Hence, total number of units will be 6000 x 2 months + 7500 units x 6 months + 8000 units x 4 months = 89,000 units Total Materials (Rs.) 96,000 360,000 256,000 7,12,000 Labour 112,000 360,000 256,000 7,28,000 Overheads 36,000 135,000 96,000 2,67,000 Semi-variable Overheads 8,000 30,000 20,000 58,000 Fixed Overheads 1,04,000 Cost of Production 18,69,000 Per Unit Cost of Production i.e. 18,69,000/89,000 = Rs. 21 As profit is 25% on the selling price, selling price will be Rs. 28 per unit. (8) AB & Co. manufactures two types of pens P and Q. The cost data for the year ended 30th September, 1990 is as follows Direct Materials Rs. 4,00,000 Direct Wages Rs. 2,24,000 Production Overheads Rs. 96,000 Rs. 7,20,000 It is further ascertained that : a. Direct Materials in type P cost twice as much direct materials in type Q. b. Direct wages for type Q were 60% of those for type P. c. Production overheads were of same rate for both types. 172 Management Accounting d. Administration overhead for each was 200% of direct labour. e. Selling costs were 50 paise per pen for both types. f. Production during the year Type P 40,000 units

Type Q 1,20,000 units g. Sales during the year Type P 36,000 units Type Q 1,00,000 units h. Selling prices were Rs. 14 per pen for type P and Rs. 10 per pen for type Q. Prepare a statement showing per unit cost of production, profit and total sales value and profit separately for two types of pens P and Q. Solution : Cost Statement for the year ended on 30th September, 1990 Particulars P Q Direct Material 1,60,000 2,40,000 Direct Wages 80,000 1,44,000 Production Overheads 24,000 72,000 Administration Overheads 1,60,000 2,88,000 a. Cost of Production 4,24,000 7,44,000 b. Production (Units) 40,000 1,20,000 c. Per Unit Cost of Production (Rs.) 10.60 6.20 (Being a/b) d. Sales (Units) 36,000 1,00,000 e. Cost of Sales 3,81,600 6,20,000 (Being d x c) f. Selling Cost 18,000 50,000 g. Total Cost 3,99,600 6,70,000 (Being e + f) h. Per Unit Selling Price (Rs.) 14.00 10.00 i. Sales 5,04,000 10,00,000 (Being d x f) j. Profit 1,04,400 3,30,000 Elements of Costs 173 Working Notes : a. Direct Materials Let per unit direct materials cost of Q be Rs. X. Hence, per unit direct materials cost of P will be 2X Total Direct Materials Cost will be 40,000 units x 2X + 1,20,000 units x X = 4,00,000. Solving for X, we get X = Rs. 2 Hence, Direct Materials Cost for P will be Rs. 1,60,000 and Direct Materials Cost for Q will be Rs. 2,40,000. b. Direct Wages Let rate of labour be Rs. X for P Hence, rate of labour for Q will be 0.6X for Q Total Direct Wages will be 40,000 units x X + 1,20,000 units x 0.6X = 2,24,000 Solving for X, we get X = 2 Hence, Direct Wages Cost for P will be Rs. 80,000 and Direct Wages Cost for Q will be Rs. 1,44,000. (9) A company presently sells an equipment for Rs. 35,000. Increase in prices of labour and material are anticipated to the extent of 15% and 10% respectively in the forthcoming year. Material cost represents 40% of cost of sales and labour cost 30% of cost of sales. The remaining relate to overheads. If the existing selling price is retained, despite the increase in labour and material prices, the company would face a 20% decrease in the existing amount of profit on the equipment. You are required to arrive at a selling price so as to give the same percentage of profit on increased cost of sales, as before. Prepare a statement of profit/loss per unit showing the new selling price and cost per unit in support of your answer. Solution : Let cost of sales per unit be Rs. X. Then per unit profit will be 35000 X. Per unit cost structure will be as below Material Cost 0.4X

Labour Cost 0.3X Overheads 0.3X After the price increase, per unit cost structures will change as below Material Cost 0.44X Labour Cost 0.345X Overheads 0.3X 174 Management Accounting However, after the price increase and existing selling price remaining the same, the profit per unit will come down by 20%. Hence, the following equation will emerge 35,000 (0.44X + 0.345X + 0.3X) = 0.8 (35,000 X) Solving for X, we get X = 24,561. Hence, the existing per unit cost of sales is Rs. 24,561. As such, following is the per unit cost structure with the existing prices and after the price increase, Existing Future Materials Cost 9,825 10,808 Labour Cost 7,368 8,473 Overheads 7,368 7,368 Cost of Sales 24,561 26,649 Profit 10,439 8,351 Selling Price 35,000 35,000 Existing profit on cost of sales works out as 10,439 X 100 = 42.5% 24,561 If the same profit percentage is to be maintained after the cost increase, the new selling price will be 26,649 + 42.5% of 26,649 = Rs. 37,975. (10) A firm has purchased a plant for manufacturing a new product, the cost data for which is given below. Estimated Annual Sales 24,000 units. Estimated Costs Material Rs. 4.00 per unit Direct Labour Rs. 0.60 per unit. Overheads Rs. 24,000 per year. Administrative Expenses Rs. 28,800 per year. Selling Expenses 15% of sales. Calculate the selling price if profit per unit is Rs. 1.02. Elements of Costs 175 Solution : Let the selling price be Rs. X Hence, total sales will be Rs. 24000X The cost sheet will be as below Material Cost 24000 x Rs. 4.00 96,000 Direct Labour 24000 x Rs. 0.60 14,400 Overheads 24,000 Administrative Expenses 28,800 Selling Expenses 15% of sales 3,600X Profit Re. 1.02 per unit 24,480 Hence, 24000X = 96000 + 14400 + 24000 + 28800 + 3600X + 24480 24000X = 187680 + 3600X 20400X = 187680 X = 9.20 Hence, selling price will be Rs. 9.20 QUESTIONS

1. What do you mean by Elements of Cost? Explain in details. Draw a standard format of cost sheet for a machine tool manufacturing company. Assume suitable data. 2. How the cost is classified into various elements for presenting the same in the form of a cost sheet. Prepare a standard format of cost sheet for a furniture making unit. Assume suitable data. 176 Management Accounting PROBLEMS (1) The following figures relates to the trading activities of Hind Traders for the year ended 30.6.79. Prepare a statement showing net operating income. Rs. Rs. Sales 5,20,000 Office Salaries 27,000 Purchases 3,22,250 Rent 2,700 Opening Stock 76,250 Stationery & Postage 2,500 Closing Stock 98,500 Depreciation 9,300 Sales Returns 20,000 Other charges 16,500 Interest on Debentures 15,300 Provision for Tax 40,000 Advertising 4,700 Travelling 2,000 (2) From the following list of balances, prepare a statement showing net operating income. Rs. Sales 5,40,000 Purchases 1,60,000 Sales Returns 40,000 Purchases Returns 10,000 Opening Stock 50,000 Closing Stock 60,000 Rent Received 1,50,000 Profit on sale of asset 1,00,000 Office Expenses 25,000 Manufacturing Expenses 30,000 Selling Expenses 10,000 Depreciation 13,000 Interest on Loan 2,000 Income Tax 150 Elements of Costs 177 (3) A Ltd. is a company which is engaged in the business of executing the various jobs as per the customer requirements. It has received one job from one of the customers for which it is required to submit the quotation. The Production Manager of the company has worked out the following details of the cost in respect of the said job Raw Materials Rs. 40,000 Bought Out Components Rs. 50,000 Primary Packing Material Rs. 5,000 Consumable Stores Rs. 4,000 Direct Workers 400 Labour Hours @ Rs. 30 per hour Royalty Payable 20% of Direct Material Other Factory Overheads 15% of Prime Cost Support from administrative staff 100 Man-hours @ Rs. 50 per hour Other administration overheads 15% of Factory Cost Selling Overheads 10% of Total Cost What selling price should be quoted by the Company if it intends to earn a profit of 20% on selling price? (4) Honesty Engineering Works has a machining shop in which it manufactures two Auto Parts P1 and P2 out of forgings F1 and F2. For the quarter ending December 1993, following cost data are available Consumption of Raw Materials - F1 1,50,000 - F2 2,00,000

Wages and Salaries 1,53,000 Stores and Spares 12,000 Repairs and Maintenance 15,000 Power 16,000 Insurance 8,000 Depreciation 50,000 Factory Overheads 68,000 Administration Overheads 64,400 Distribution Overheads 75,000 Total Cost 8,11,400 178 Management Accounting You are given further information a. Production and Sales of P1 and P2 were as under P1 P2 Production (Pieces) 6,000 4,000 Sale of above pieces (Rs.) 4,80,000 5,20,000 b. Direct wages paid were Rs. 36,000 incase of P1 and Rs. 32,000 for P2. This is used for apportioning Wages and Salaries and Factory Overheads. c. Following machine hours were utilized in production of these products P1 550 P2 450 d. Stores & Spares, Repairs & Maintenance, Power, Insurance and Depreciation are charged to cost of both the products on the basis of machine hours used. e. Administration Ovcrheads are apportioned on the basis of respective conversion costs while Distribution Overheads on the basis of their sales realizations. f. All the production was sold out. Required Prepare cost sheets of both the products and work out profit earned of each of them. (5) The cost of manufacturing 5,000 units of a commodity comprises Material Rs. 20,000, Wages Rs. 25,000, Chargeable Expenses Rs. 400. Fixed Overheads Rs. 16,000, Variable Overheads Rs. 4,000. For manufacturing every 1,000 extra units of the commodity, the cost of production increases as follows. 1. Materials : Proportionately. 2. Wages : 10% less than proportionately. 3. Chargeable Expenses : No extra cost. 4. Fixed Overheads : Rs. 200 extra. 5. Variable Overheads : 25% less than proportionately. Calculate the estimated cost of producing 8,000 units of the commodity and show by how much it would differ if a flat rate of factory overhead were charged. (6) The following is the profit and loss account of a manufacturing company for the year 1987-88 (figures in lakhs). Elements of Costs 179 Rs. Rs. Materials 48 Sales 96 Wages 36 Closing Stock of Factory overheads 24 finished goods 18 Gross Profit c/d 12 Work in Progress (at cost) Materials 3.00 Labour 1.80 Works Expenses 1.20 6 120 120 Administration Expenses 6 Gross Profit b/d 12 Goodwill and Preliminary Interest Received 1 Expenses written at 2 Net Profit 5 13 13

During the year 6000 units were manufactured and 4800 units were sold. The costing records show that works expenses have been charged @ Rs. 300 per article,and administration expenses @ Rs. 150 per article. The costing books show a profit of Rs. 12 lakhs. Prepare cost sheet and show the reconciliation (7) A firm manufactured and sold 500 units during the year ended on 31st March, 2001. The summarised Trading and Profit & Loss Account is as below : Particulars Rs. Particulars Rs. Material Consumed 40,000 Sales 2,00,000 Direct Labour 60,000 Manufacturing Cost 25,000 Gross Profit 75,000 2,00,000 2,00,000 Management Expenses 30,000 Gross Profit 75,000 Rent 5,000 General Expenses 10,000 Selling Expenses 15,000 Net Profit 15,000 75,000 75,000 180 Management Accounting For the year 2001-2002, the estimates are : a. Output and sales will be 600 units. b. Material prices will increase by 20% over the previous year. c. Direct Labour rate will rise by 5%. d. Manufacturing expenses will increase in proportion to prime cost. e. There will be no change in selling expenses per unit. f. Rise in output will not affect other expenses. Prepare a statement showing the price in such a way that profit will be 20% on selling price. (8) Following costs were incurred in producing 800 MT of M.S. Rods Materials 2,80,000 Labour 1,00,000 Processing Charges 1,00,000 Total Cost 4,80,000 Of the total output, 10% was defective and had to be sold after a discount of 10% off the normal price. The scrap arising out of the production realized a sum of Rs. 8,760. The sale price is calculated to yield 15% profit on sales. You are required to find out the normal price as well as the discounted price of per MT of M.S. Rods. (9) In a factory, the methods mentioned below are adopted for the allocation of office and selling overheads. (a) Advertisement and Sales Promotion - On Factory Cost figures. (b) Credit and Collection Expenses - On Sales figures. (c) Direct Selling Costs - On Sales figures. (d) Other items - On Factory Cost figures. The factory deals with five different types of products viz. B, C, D, E and F. The following information has been collected from its books. Elements of Costs 181 Particulars B C D E F Rs. Rs. Rs. Rs. Rs. Direct Materials 24,000 48,000 66,000 33,000 40,500 Direct Wages 27,000 36,000 57,000 24,000 34,500 Sales 1,12,500 1,65,000 2,62,500 1,09,500 1,60,500 Factory overhead charges are 80% of direct wages. Office and sales expenses are : Rs. Direct Selling Costs 81,000 Other Items 53,280 Credit and Collection Expenses 8,100 Advertisement and Sales Promotion 79,920

Prepare a statement showing the costs incurred and the profit earned in respect of each product. (Calculations may be made to the nearest rupee). 182 Management Accounting NOTES Material Cost 183

Chapter 8
MATERIAL COST
Material cost is the first and probably the most important element of cost. In case of some specific types of industries, say cement, sugar, chemicals, iron and steel etc., the materials cost forms a very significant portion of the overall cost of production. The term material refers to all commodities which are consumed in the production process. The materials which can be consumed in the production process can be basically classified as: (i) Direct Materials (ii) Indirect Materials The meaning of both these terms has already been discussed. The basic objective of cost accounting i.e. ascertainment of cost and control of cost is equally applicable to material cost as well. The ascertainment of material cost is made from basically two documents i.e. the invoice of the supplier of material and material requisition slip specifying material issued from stores department to production department. However, a whole lot of organisational procedures are also involved in the process, which affect the material cost, either directly or indirectly. E.g. Purchases from improper source of supply may be expensive, non-availability of material in time may result into hold ups and so on. As such, a proper study of the various procedures involved in case of the movement of materials and a proper control thereon enables an organisation to exercise the control on a sizeable manufacturing cost. The movement of material may involve the following stages. (a) Procurement of materials. (b) Storing the material till it is required for consumption. (c) Issue of the material for consumption. (A) Procurement of Materials : Though the practices may differ from organisation to organisation, normally, the process of purchasing the materials involves the following stages. 184 Management Accounting (1) Purchase Requisition : It is an indication given to the purchases department to purchase certain material. It is issued either by storekeeper (in respect of material required for regular production purposes) or by production department (in respect of special materials required). Following particulars must appear in purchase requisition. (i) Material to be purchased : It should be clearly specified. To make it more specific, in addition to the description of the material required, code number should also be specified. (ii) When it is required : Unless the material is required for regular production purposes (when the storekeeper himself will place the purchase requisition as soon as it reaches the ordering level), purchase requisition should mention the last date by which the material is required. Ideally, the material should be purchased whenever the market for the same is favourable. (iii) How much to be purchased : Purchase requisition should state the quantity of the material required. Before deciding the quantity of material to be purchased, the principle which should be kept in mind is that there should not be any overstocking or understocking of materials as both these situations involve costs. Overstocking may have following consequences : - Blocking of working capital. - Risk of deterioration of quality and obsolescence.

- More storage facilities. - Additional Insurance Cost. - More material handling and upkeeping. - Risk of breakage/pilferage etc. Understocking may have following consequences : - Production hold ups, resulting into disturbed delivery schedules. - Frantic eleventh hour purchases which may result into unfavourable prices and quality. - Payment for idle time to workers. Before deciding the quantity to be purchased, consideration will have to be given to the following factors also : (i) Quantity already ordered. Material Cost 185 (ii) Quantity reserved. There may be the case that a particular quantity, though in hand, might have been reserved for a particular job which is not available for other purposes. In such cases, this quantity is such, as if it is not in stock. (iii) Funds availability - Amounts which are kept aside for drawing up purchase budget should be considered. The purchase requisition should be signed by Head of the Department drawing the same. A standard form of Purchase Requisition is as shown below : PURCHASE REQUISITION To : Purchase Department From : Department No. : Date : Please purchase the material stated below.
Sr. No. Description Code No. Quantity Required Quantity on hand Remarks Signed by : Storekeeper Approved by

For the use of Purchase Department only

Date P.O. No. Name of Supplier Delivery Date Remarks Signed : Purchase Manager

(2) Selection of Source of Supply : For this purpose, the purchase department may call for the quotations from the prospective suppliers of a certain type of material. In practice, following types of quotations may be called for : (a) Single Tender : It is addressed to only one selected source when there is only one source of supply available. 186 Management Accounting (b) Limited Tender : It is addressed to a limited number of suppliers known to be reliable sources on the basis of data maintained by the purchase department. (c) Open Tender : It is open to all who can supply specified quality and quantity of the required material. Tenders are called by giving advertisements in the newspapers, journals etc. (d) Global Tender : Anybody from any part of the world can respond to these tenders. To discourage unreliable and unwanted sources from quoting, some tender deposit may be insisted upon. Comparative Statements : After receiving the tenders as stated above, a comparison has to be made among the various available sources so that the best possible source can be selected. All the offers are tabulated in a comparative statement. The authority which is authorised to accept the tender should be specified. The criteria for selecting the final source of supply may depend upon the terms of offer which can be compared in respect of price offered, quality, other terms (like Sales Tax, Octroi, Freight etc.), terms of delivery, terms of payment, guarantee offered by the supplier, goodwill of the supplier etc. Lowest quotation may not necessarily be the best quotation. (3) Purchase Order : The contractual obligation between the supplier and purchaser starts from purchase

order. It is drawn in favour of the supplier by the purchase department. It may specify a number of facts. - Material to be supplied (Description as well as code numbers and quality). - Quantity to be supplied. - Price and other terms (e.g. excise duty, sales tax, octroi, insurance, packing and transportation etc.). - Cash and trade discount. - Instructions in respect of delivery. - Guarantee clause. - Liquidated damages clause. - Escalation clause. - Inspection clause. - Method of settlement of disputes. - Details in respect of letters of credit, import licence etc. - Details in respect of interest payable in the event of late payment of dues. Material Cost 187 Ideally, purchase orders should be serially numbered. Normally, four or five copies of Purchase Orders are drawn, to be distributed as below : - One to Supplier. - One to User Department. - One to Stores Department. - One to Accounts/Costing Department. - One with Purchase Department. A standard form of Purchase Order is as shown below : PURCHASE ORDER No. Date Requisition No. Date Please supply the following material on such terms and conditions as stated therein.
Description Code No. Quantity Rate Rs. Value Rs. Delivery Date Remarks

Delivery : Goods to be delivered at Extra as applicable Excise Duty Sales Tax Packing Charges Insurance Terms of payment For (Purchasing Company) Purchase Manager 188 Management Accounting (4) Receipt and Inspection : After material is received from the supplier, the quantity received actually, is compared with quantity ordered. Variations, if any, are taken up with the supplier again. Excess material received may be dealt with in any of the following ways : Accept all the material received. Accept the material ordered and return the excess to the supplier.Before accepting, material may be subjected to inspection. The extent of inspection may vary from material to material. (5) Checking invoice and accounting for purchases : The suppliers invoice received for the supply of material is subjected to scrutiny before a voucher is passed for the same for making the entry in the books of accounts. For this purpose, the suppliers invoice may be compared alongwith the following documents. (a) Purchase Order. (b) Goods Received Note. (c) Inspection Report.

If the quantity and/or rate as per purchase order and invoice match with each other, the invoice of the supplier is passed for making the entry in the books of accounts. If the quantity and/or rate as per purchase order and invoice differ from each other, the difference is adjusted by raising a debit or credit note in favour of the supplier. (B) Storing and Issue of Material : After the material is received, inspected and approved, the process of storing comes into operation which deals with storing the material in good condition till it is required for use by production departments and issuing the same whenever required. As far as the movement of the material from the stores point of view is concerned, there can be basically four types of movements. (1) Receipt of material. (2) Issue of material (3) Return of material from Production Department to Stores Department. (4) Transfer of material. (1) Receipt of Material :Usually the receipt of material is accompanied by delivery challan given by the supplier. On receipt of the material, quantity received is checked with the quantity ordered by the Stores Department. The received material may be inspected, before acceptance either by separate inspection department or by Stores Material Cost 189 Department itself. A document known as Goods Received Note or Goods Received Report (GRN or GRR) is prepared to record the details of the material received. The usual form in which GRN or GRR is prepared is as below : GOODS RECEIVED NOTE No. Date
S. No. Description Code Qty. Recd. Qty. Accepted Qty. Rejected Remarks

Prepared by Received by Inspected by Store Keeper It may be prepared in quadruplicate to be distributed as follows. One copy to Purchases Department for comparing with purchases order and approving the invoice of the supplier. One copy to Accounts Department for making the payment of suppliers invoice. One copy to Costing Department for pricing and entering in stores record. One copy to be retained by Stores Department. Ideally, GRN/GRR should be serially numbered in order to locate the material which is physically received but for which invoice is not received. Discrepancies in material receipts : The material physically received when compared with material ordered as per the purchase order may reveal certain discrepancies which may take any of the following forms. (1) Quantity received in excess. (2) Quantity received in short. (3) Quantity received of different quality. Excess quantity received may be retained and accepted, if required, with the approval of the purchase department. Alternatively, if it is not accepted, it may be returned to the supplier with Goods Returned Note. The usual form in which Goods Returned Note is prepared is as below: 190 Management Accounting GOODS RETURNED NOTE To : No. Date : Following material supplied by you vide your D.C. No.____________ and Invoice No.____________against our Purchase Order No. ______________is being returned to you for the reasons stated below: Description Quantity Reasons Signature Usually, three copies of Goods Returned Note are prepared to be distributed as below : - One copy to the Supplier. - One copy to the Purchase Department.

- One copy to be retained by the Stores Department. Excess Quantity Accepted : If excess quantity is already billed in the invoice, it will be approved and paid. If not, either the supplier may be asked to give a supplementary invoice or credit note may be issued to the supplier for amending the amount. Excess Quantity Returned : If excess quantity is already billed in the invoice, debit note may be issued to the supplier for amending the amount. In case the quantity received is short, purchase department may take up the case with the supplier or carrier or insurer as per the terms of purchases. If quantity short supplied is billed in the invoice, invoice is suitably amended and debit note is issued to the supplier. If quantity received is of different quality and is rejected in inspection, it can either be retained or returned. It may be retained by accepting some mutually decided concessional price. The variation in prices may be adjusted by issuing either the credit note or debit note in favour of the supplier. (2) Issue of Material : Here, the issue of material refers to issue of material from stores department to production department. The material should not be issued from the stores unless a proper authority in writing is produced before the stores department. Usually, this authority is in the form of Material Requisition Note or Material Requisition Slip. Material Cost 191 The normal contents of this note/slip are : Number and date (Ideally, they should be serially numbered). Department demanding the material. Description and code of material demanded. Quantity of material demanded. Signature of authority approving the demand. Signature of the person receiving the material. Normally one note/slip is prepared for requisitioning a single item of material. The usual form in which it is prepared is as below : MATERIAL REQUISITION NOTE Production/Job Order No. No. Bill of Materials No. Date : Department : Description Code Qty. Unit Cost (for costing Dept. only) Rate per unit Amount Rs. Authorised Issued Received Entered and Valued by by by by Normally, it is prepared in three copies.Two copies to Stores Department which in its turn passes one copy to Costing Department for pricing while second copy is retained by the Stores Department. One copy is for demanding department. (3) Return of material : There can be some situations, when material once issued to production departments is returned back to the stores. It can happen in the following circumstances. (a) Material issued in excess of requirement. (b) Scrap or defective work arising out of the production processes. Under these circumstances, a document in the form of Materials Returned Note is prepared, which is to record return of unused materials. The usual form in which this document is prepared is as below : 192 Management Accounting MATERIALS RETURNED NOTE Production/Job Order No. No. Bill of Materials No. Date : Department : Description Code Qty. Unit Cost (for costing Dept. only) Rate per unit Amount Rs. Authorised Received Posted by by by As far as the valuation of the returned material is concerned, it may be treated as the fresh

receipt of the material or alternatively, it may be treated as the negative(minus) issues. (4) Transfer of Materials :In some situations, considering the urgency for the requirement of the material, it may be necessary to transfer the material from one production/job order to another. Such transfer of material is usually accompanied by preparing a document in the form of Material Transfer Note. The usual form in which this document is prepared is as below : MATERIAL TRANSFER NOTE No. Date : FromDept. To..Dept. Production/Job Production/Job Order No. Order No. Description Code No. Qty. Cost (for costing Dept. only) Rate per unit Amount Rs. Authorised Received Entered by by by Material Cost 193 Transfer of materials does not result into any fresh issue of material. However, material transfer notes will have to be valued and considered in order to compute the material cost as per the job orders and production orders. PROPER CONDUCT OF STORAGE FUNCTION As discussed earlier, proper conduct of storage function requires that material should be properly stored in good condition till it is required for use by production departments and should be issued whenever required. This proper conduct is ensured by what is known as Perpetual Inventory System. The aims of the perpetual inventory system are two fold. (1) Recording receipts and issues in such a way so as to know at any time, the stock in hand, in quantity and/or value, without the need of physical counting. This aim is achieved by maintaining what is called as Bin Card and Stores Ledger. (2) Continuous verification of physical stock at regular intervals. Bin Card It is only a quantitative record of receipts, issues and closing balance of an item of material. Separate bin card is maintained for each item of material. The usual form in which a bin card is maintained is as below. BIN CARD Description Maximum level Code No. Minimum level Location/Unit Recorder level Date Document No. Receipt Issue Balance Remarks Entries in receipts column are made on the basis of Goods Received Note or Material Returned Note. Entries in issues column are made on the basis of Material Requisition Note. After every entry of either receipts or issues, the balance quantity is calculated and recorded so that the balance can be known at any point of time. The levels indicated on bin card enable the stores department to keep a watch on balance and replace the material as soon as it reaches the reorder level. 194 Management Accounting Ideally, bin card should be placed alongwith the material. But it may not be possible in all the cases, then bin cards are placed at a centrally located place but within stores department only. Stores Ledger Like Bin Card, it is maintained to record all receipts and issue transactions of material but with the exception that it records not only the quantities received or issued or in stock but also the financial expressions of the same. The usual form in which the stores ledger is maintained is as following : STORES LEDGER Description Maximum level Code No. Minimum level

Location/Unit Recorder level Date Document No. Receipts Issues Balance Remark Qty. Rate Rs. Qty. Rate Rs. Qty. Rate Rs. By summing up the amounts appearing in the issues column of stores ledger, one can get the cost of material issued to Production Department which forms the Material Cost. As in case of bin card, separate store ledger sheets are maintained in case of each item of material. The stores ledger sheets are maintained either in loose form or in bound book form. Bin Card Vs. Stores Ledger : If the stores ledger is having all the information mentioned in a bin card plus some additional information is also available, the next question which arises is why is it necessary to maintain both bin card and stores ledger simultaneously as it will be only duplication of work. In the situations of computerized inventory accounting system, maintenance of bin card and sotres ledger simultaneously can be avoided. However, in the situations of manual inventory accounting system, it will be ideal to maintain bin card and stores ledger simultaneously due to the following reasons. (1) Bin card is maintained by stores department while stores ledger is maintained by costing department. Material Cost 195 (2) Bin card is not an accounting record but only a quantity record and as such is not concerned with the financial implications of stores transactions. (3) Maintenance of stores ledger provides a second check on maintenance of bin cards. Reconciliation of Bin Card and Stores Ledger : As the source documents for the entries in Bin Card and Stores Ledger are the same, the closing balances disclosed by both of them should match with each other. But in practice, they may not match due to the following reasons. (1) Arithmetical error in calculating balance. (2) Non-posting of certain document in either of these documents. (3) Posting on wrong bin card or stores ledger sheet. (4) Treating receipts transaction as issue transaction or vice versa. If the closing balance as per bin card and stores ledger is not matching, the very purpose of maintaining these two documents simultaneously will be defeated. As such, it is necessary to reconcile both balances at regular intervals by keeping all the postings upto date. If the balances as on a particular day are not matching, all the previous transactions should be checked to locate differences. Valuation of Material Movements : As discussed above, the stores ledger considers not only the movement of material in terms of quantity but also in terms of its financial implications. As such, it is necessary that all the possible movements of material are valued properly and are expressed in terms of money. We will consider this problem under the following heads. (a) Valuation of receipts. (b) Valuation of issues. (c) Valuation of returns from production department to stores department. (a) Valuation of receipts : Valuation of receipts is relatively an easy task, as the invoice or bill received from the supplier of the material is available as a starting point. Following propositions should be considered for this purpose. (1) The price as billed by the supplier will be the valuation of the receipts. The trade discount is deducted from the basic price and all other amounts as billed by the supplier are added viz. Excise Duty, Sales Tax, Octroi Duty, Transport/Insurance charges etc. There are different opinions in respect of the treatment of cash discount. One opinion says that cash discount should be ignored being purely of financial nature while valuing the receipts, while another opinion says that it should be considered while valuing the receipt of the material. 196 Management Accounting (2) In some cases, more than one item of material are included in one single bill and some costs are jointly incurred for all the items of material. Such joint costs may

be distributed on the basis of basic price of the material. (3) In case of the imported material, the cost of the material consists of basic price (which may be stated in foreign currency and should be converted in Indian Rupees), Customs Duty, Clearing Charges, Transport Charges, Octroi Duty etc. In some cases, the point of receipt of imported material and the point of making the payment of invoice amount may be different. As such, rate of foreign currency may be different at the time of payment of customs duty and at the time of payment of invoice amount. In such cases, the rate of exchange existing at the time of making the payment of invoice amount should be considered for valuing basic cost of material imported. Illustration : The particulars relating to 1,200 kgs. of a certain raw material purchased by a company during June, were as below. (a) Lot prices quoted by suppliers and accepted by the company for placing the purchase order. Lot upto 1000 kgs. @ Rs. 22 per kg. For Between 1000 - 1500 kgs. @ Rs. 20 per kg. Supplies Between 1500 - 2000 kgs @ Rs. 18 per kg. to Factory (b) Trade Discount 20%. (c) Additional charge for containers @ Rs. 10 per drum of 25 kgs. (d) Credit allowed on return of containers @ Rs. 8 per drum. (e) Sales Tax at 10% on raw material and 5% on drums. (f) Total freight paid by the purchaser Rs. 240, (g) Insurance at 2.5% (on net invoice value) paid by the purchaser. (h) Stores Overheads applied at 5% on total purchase cost of material. The entire quantity was received and issued to production : The containers are returned .in due course. Draw up a suitable statement to show : (a) Total cost of material purchased. (b) Unit cost of material issued to production.

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Material Cost 197

Solution : (a) Statement showing cost of purchases Basic Cost Rs. Rs. 1,200 kgs x Rs. 20/kg. 24,000 Less : Trade Discount @ 20% 4,800 19,200.00 Container Cost : 48 Drums x Rs. 10 /Drum 480.00 19,680.00 Sales Tax : 10% on Rs. 19,200 1,920.00 5% on Rs. 480 24.00 1,944.00 21,624.00 Other charges Insurance 2.5% on Rs. 21,624.00 540.60 Freight 240.00 22,404.60 Less : Credit for drums returned Rs. 8 per Drum x 48 Drums 384.00

TOTAL COST 22,020.60 Add : Stores Overheads 5% 1,101.03 23,121,63 (b) Unit cost for valuation of issues Rs. 23,121.63. = Rs. 19.268/kg. 1,200 kgs. Illustration : The particulars related to the import of Sealing Ring made by AB & Co. during December 85 are given below. (a) Sealing Ring 1,000 pieces invoiced @ 2 CIF, Bombay Port. (b) Customs Duty was paid @ 100% on invoice value (which was converted to Indian Currency by adopting an Exchange Rate of Rs. 17.20 per ) 198 Management Accounting (c) Clearing charges : Rs. 1,800 for the entire consignment (d) Freight charges : Rs. 1,400 for transporting the consignments from Bombay Port to Factory premises. It was found on inspection that 100 pieces of the above material were broken and therefore rejected. There is no scrap value for the rejected part. No refund of the broken material would be admissible as per the terms of contract. The management decided to treat 60 pieces as normal loss and the rest 40 pieces as abnormal loss. The entire quantity of 900 pieces was issued to production. Calculate : (a) Total cost of material. (b) Unit cost of material issued to production. Also state briefly how the value of 100 pieces rejected in inspection will be treated in costs. Solution : Total Cost of Material (1) Invoice Price Rs. UK - 1,000 pieces x 2 = 2,000 - 2,000 x Rs. 17.2 per UK 34,400 (2) Customs Duty @ 100% 34,400 (3) Clearing Charges 1,800 (4) Freight charges 1,400 Total Cost 72,000 As loss of 40 pieces is considered as abnormal loss, it will be transferred to Costing Profit and Loss Account. Rs. 72,000 Abnormal Loss = X 40 pieces 1,000 pieces = Rs. 2,880 Balance of the cost (i.e. Rs. 72,000 - Rs. 2,880 = Rs. 69,120)Includes cost of units treated as normal loss i.e. 60 pieces. This cost will be borne by good pieces. Material Cost 199 Rs. 69,120 Unit cost of good pieces = 900 pieces = Rs. 76.80 (b) Valuation of Issues : This is a more complex process than the valuation of the receipts. It is because of the reason that the material may be issued out of the various lots which might have been purchased at various prices. As such, a problem may arise as to which of the receipt prices should be used to value the material requisition notes. Various methods may be used for this purpose, main methods of which may be discussed as below. (a) First In First Out (FIFO)Under this method, the price of the earliest available lot is

considered first and if that lot is exhausted, the price of the next available lot is considered. It should be remembered that the physical issue of the material may not be made out of the said lots, though it is presumed that it is made out of these lots as stated above. Illustration : Following transactions have taken place in respect of a material during March 1990. Date : 1 Opening Balance 500 units @ Rs. 6 per unit. 5 Purchased 100 units @ Rs. 7 per unit. 7 Issued 400 units. 9 Purchased 300 units @ Rs. 8 per unit. 19 Issued 250 units. 22 Issued 50 units. 25 Purchased 300 units @ Rs. 7.50 per unit. 30 Issued 250 units. Prepare the Stores Ledger assuming that the issues are valued on FIFO basis. 200 Management Accounting Stores Ledger Description/Code No. Maximum level Unit Minimum level Location Re-order level Date Particulars RECEIPTS ISSUES BALANCE Qty. Rate Rs. Qty. Rate Rs. Qty. Rate Rs. Rs. Rs. Rs. 1 Op. Bal. 500 6 3,000 5 GRN No. 100 7 700 500 6 100 7 3,700 7 MRN No. 400 6 2,400 100 6 1300 100 7 9 GRN No. 300 8 2,400 100 6 100 7 3700 300 8 100 6 19 MRN No. 100 7 1700 250 8 2,000 50 8 22 MRN No. 50 8 400 200 8 1,600 25 GRN No. 300 7.5 2,250 200 8 300 7.5 3850 30 MRN No. 200 8 50 7.5 1975 250 7.5 1,875 Value of closing stock is Rs. 1,875 which considers latest available market price of the material. The advantages of this method are as below : (a) It is simple to operate. (b) It considers the valuation of closing stock at the current market prices. (c) It can be conveniently applied if transactions are not too many and the prices of the material are fairly steady.

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Material Cost 201

The objections raised against this method are as below : (a) Calculations become complicated if the lots are received frequently and at varying prices. (b) Costs may be wrongly presented if the price of different lots of material are used for pricing issues to various batches of production. (c) In case of varying prices, the pricing of issues does not consider current market prices. (b) Last In First Out (LIFO) : Under this method, the price of the latest available lot is considered first and if that lot is exhausted, the price of the lot prior to that is considered. Here also, it should be remembered, that the physical issue of the material may not be made out of the said lots, though it is presumed that it is made out of the lots as stated above. Illustration : Following transactions have taken place in respect of a material during March 1990. Date: 1 Opening Balance 500 units @ Rs. 6 per unit. 5 Purchased 100 units @ Rs. 7 per unit. 7 Issued 400 units. 9 Purchased 300 units @ Rs. 8 per unit. 19 Issued 250 units. 22 Issued 50 units. 25 Purchased 300 units @ Rs. 7.50 per unit. 30 Issued 250 units. Prepare the stores ledger assuming that the issues are valued on LIFO basis. 202 Management Accounting Stores Ledger Description/Code No. Maximum level Unit Minimum level Location Re-order level Date Particulars RECEIPTS ISSUES BALANCE Qty. Rate Rs. Qty. Rate Rs. Qty. Rate Rs. Rs. Rs. Rs. 1 Op. Bal. 500 6 3,000 5 GRN No. 100 7 700 500 6 3,700 100 7 7 MRN No. 100 7 2,500 200 6 1,200 300 6 9 GRN No. 300 8 2,400 200 6 3,600 300 8 19 MRN No. 250 8 2,000 200 6 1,600 50 8 22 MRN No. 50 8 400 200 6 1,200 25 GRN No. 300 7.5 2,250 200 6 3,450 300 7.5 30 MRN No. 250 7.5 1,875 200 6 1,575 50 7.5 Value of closing stock is Rs. 1,575 which consists of 200 units valued at Rs. 6 per unit which happens to be the earliest available price of the material i.e. price of the opening balance available. The advantages of this method are as below :

(a) It is simple to operate. (b) The cost of materials issued considers fairly recent and current prices. The prices quoted on this cost fairly represent its real cost. (c) It can be conveniently applied if transactions are not too many and prices of the material are fairly steady.

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Material Cost 203

The objections raised against this method are as below : (a) Calculations become complicated if the lots are received frequently and at varying prices. (b) Costs may be wrongly presented if the price of different lots of material are used for pricing issues to various batches of production. (c) In case of falling prices in the market, this method may give wrong results. (C) Average Price Method : Both the above methods i.e. FIFO and LIFO, consider the exact or actual cost for valuing the issue of material. However these methods may prove to be disadvantageous if the transactions are too many and are at varying prices. In such cases, instead of considering the exact or actual cost, average cost may be considered to lessen the effect of variation in prices, either upward or downward. E.g. Assume a situation as below : Mar. 1 - Received - 1500 units @ Rs. 10 - Rs. 15,000 Mar. 15 - Received - 1600 units @ Rs. 30 - Rs. 48,000 On March 20, 1800 units were issued to production. If FIFO method is followed to price the issues, the issues will be valued as below. 1500 units @ Rs. 10 per unit Rs. 15,000 300 units @ Rs. 30 per unit Rs. 9,000 Rs. 24,000 The issues will be considerably under-valued and closing stock will be considerably over valued, as compared to the current market prices. If LIFO method is followed to price the issues, the issues will be valued as below. 1600 unite @ Rs. 30 per unit Rs. 48,000 200 units @ Rs. 10 per unit Rs. 2,000 Rs. 50,000 The closing stock will be considerably under valued as compared to the current prices.

To lessen the effect of such drastic price variation, both on the valuation of issues as well as of closing stock, instead of considering the actual/exact price of Rs. 10 per unit or Rs. 30 per unit, average price may be taken into consideration. There are mainly two ways in which average prices may be considered. 204 Management Accounting (1) Simple Average Method :Under this method, the simple average of the prices of the lots available for making the issues is considered for pricing the issues. After the receipt of new lot, a new average price is worked out. It should be remembered in this connection that, for deciding the possible lots out of which the issues could have been made, the method of First In First Out is followed. Illustration : Following transactions have taken place in respect of a material during March 1990. Date : 1 Opening Balance 500 units @ Rs. 6 per unit 5 Purchased 100 units @ Rs. 7 per unit. 7 Issued 400 units. 9 Purchased 300 units @ Rs. 8 per unit. 19 Issued 250 units. 22 Issued 50 units. 25 Purchased 300 units @ Rs. 7.50 per unit. 30 Issued 250 units. Prepare the stores ledger assuming that the issues are valued on Simple Average basis. Stores Ledger Description/Code No. Maximum level Unit Minimum level Location Re-order level Date Particulars RECEIPTS ISSUES BALANCE Qty. Rate Rs. Qty. Rate Rs. Qty. Rate Rs. Rs. Rs. Rs. 1 Op. Bal. 500 6 3,000 5 GRN No. 100 7 700 600 3,700 7 MRN No. 400 6.5 2,600 200 1,100 9 GRN No. 300 8 2,400 500 3,500 19 MRN No. 250 7 1,750 250 1,750 22 MRN No. 50 7 350 200 1,400 25 GRN No. 300 7.5 2,250 500 3,650 30 MRN No. 250 7.30 1,825 250 1,825 Material Cost 205 This method is suitable if the material is received in uniform quantity.If the material quantity of each lot varies widely, this method may lead to wrong results. (2) Weighted Average Method :As stated above, the simple average method of valuation of issues may lead to wrong results, if the quantity of each lot of material received varies widely. Eg. Assume the following situation. Mar. 1 Received 100 units @ Rs. 10 Rs. 1,000 Mar. 10 Received 5,000 units @ Rs. 30 Rs. 1,50,000 Rs. 1,51.000 On March 20, 4800 units were issued to production. As both the lots are possible lots for making the issue, the average of prices of both the lots will be taken into account if simple average method is considered. Hence, per unit issue price will be Rs. 10 + Rs. 30 2 i.e. Rs. 20 As such, the issue quantity will be priced at : 4,800 units x Rs.20 i.e. Rs. 96,000, which will be incorrect, as considering the quantity of issue, the price of the material received on March 10 should get more weightage. To overcome this drawback of simple average method, weighted average method may be

used which considers not only the price of each lot but also the quantity of the same. Though this method involves considerable amount of clerical work, in practice, this method proves to be very useful in the event of varying prices and quantities. In practice, the calculation of weighted average rate proves to be very simple. The products of quantity and price divided by the total quantity of all lots, just before the issue, gives the unit price in respect of the subsequent issues. Illustration : Following transactions have taken place in respect of a material during March 1990. Date : 1 Opening Balance 500 units @ Rs. 6 per unit 5 Purchased 100 units @ Rs. 7 per unit. 7 Issued 400 units. 9 Purchased 300 units @ Rs. 8 per unit. 19 Issued 250 units. 22 Issued 50 units. 206 Management Accounting 25 Purchased 300 units @ Rs. 7.50 per unit. 30 Issued 250 units. Prepare the Store Ledger assuming that the issues are valued on Weighted Average Basis. Stores Ledger Description/Code No. Maximum level Unit Minimum level Location Re-order level Date Particulars RECEIPTS ISSUES BALANCE Qty. Rate Rs. Qty. Rate Rs. Qty. Rate Rs. Rs. Rs. Rs. 1 Op. Bal. 500 6.00 3,000 5 GRN No. 100 7 700 600 6.16 3,700 7 MRN No. 400 6.16 2,467 200 6.16 1,233 9 GRN No. 300 8 2,400 500 7.27 3,633 19 MRN No. 250 7.27 1,817 250 7.27 1,816 22 MRN No. 50 7.27 363 200 7.27 1,453 25 GRN No. 300 7.5 2,250 500 7.41 3,703 30 MRN No. 250 7.41 1,851 250 7.41 1,852 (d) Highest In First Out :This method assumes that the stock should always be shown at the minimum value and hence the issues should always be valued at the highest value of receipts. E.g. Assume a situation as follows. Mar. 1 Purchased 100 units @ Rs. 12 Mar. 5 Purchased 125 units @ Rs. 18 Mar. 10 Purchased 75 units @ Rs. 15 On March 20, 120 units are issued to production and they will be valued at Rs. 18 per unit being the highest price. This method is not very popular. It always overvalues the issues and undervalues the closing stock. This method may be useful in case of the organisations dealing with monopoly products which is a rare possibility. Material Cost 207 (e) Market Price : Under this method, market price is considered to be the base for pricing the issues. In this case, market price may be treated as latest purchase price, realisable price or replacement price. This method is used mainly in respect of obsolete stock items or non-moving stock items. The defect in respect of this method is that the price concessions obtained in respect of bulk purchases are not reflected in cost of material. (f) Specific Price : If the material is purchased against a specific job or production order, the issue of material is priced at actual purchase price. This method can be adopted if purchase prices are fairly stable. (g) Standard Price :

This is the normal or ideal price which will be paid in the normal circumstances, based on the basis of estimated market conditions, transportation costs and normal quantity of purchases. Any issue of material will be priced at standard prices irrespective of actual prices. This enables the simplification of accounting system with reduced clerical work and also enables to decide the efficiency of purchase department, (c) Valuation of Returns : This indicates the material returned by production departments to stores department The way in which returned material may be valued can be as below : (a) At the same price at which issued : The original price of issue will be a base for valuing the returns for which original material requisition note will be the base. (b) At the current price of issues : The method which is followed for valuing the issue on the same date is considered for valuing the returns. This will avoid the clerical efforts, but at the same time the track of original issue of material cant be maintained. Treatment of shortages : In some cases, the physical verification of stock may reveal that the physical stock is less than the stock as per stores ledger. For proper accounting, the shortage has to be treated as an issue so that the book stock can be brought down to the level of physical stock. The 208 Management Accounting valuation of this shortage is done as if it is an issue of material. The treatment given to the valuation of shortages in Cost Accounts depends upon the nature of the shortage i.e. Normal Shortage or Abnormal Shortage. Inventory Control : The object of inventory control is to reduce the investment in inventory without affecting the efficiency in the area of production and sales. It should be remembered that the object is not only to reduce the investment in inventory. If that would have been the object, no organisation would have maintained inventory of any kind, thereby making the investment in inventory as Nil. However, that is not the ultimate object as it is likely to affect the production and sales function adversely. E.g. If sufficient stock of raw material is not available, the production activity is likely to be interrupted. If sufficient stock of finished goods is not available, it may not be possible for the organisation to serve the customers properly and they may shift to the competitors. The object of inventory control is to avoid the situation of over investment as well as under investment. The level of inventories should be maintained at the optimum level. Techniques of Inventory control (1) Economic Order Quantity : It indicates that quantity which is fixed in such a way that the total variable cost of managing the inventory can be minimised. Such cost basically consists of two parts. First, Ordering Cost (which in turn consists the costs associated with the administrative efforts connected with preparation of purchase requisitions, purchase enquiries, comparative statements and handling of more number of bills and receipts) Second, Carrying Cost i.e. the cost of carrying or holding the inventory (which in turn consists of the cost like godown rent, handling and upkeep expenses, insurance, opportunity cost of capital blocked i.e. interest etc.) There is a reverse relationship between these two types of costs i.e. If the purchase quantity increases, ordering cost may get reduced but the carrying cost increases and vice versa. A balance is to be struck between these two factors and it is possible at Economic Order Quantity where the total variable cost of managing the inventory is minimum. It is possible to fix the Economic Order Quantity with the help of mathematical formula. The following assumptions may be made for this purpose. Let Q be Economic Order Quantity. A be Annual Requirement of material in units. O be cost of placing an order (which is assumed to remain constant irrespective of size of order.) C be cost of carrying one unit per year.

Material Cost 209

Now, if A is the annual requirement and Q is the size of one order, the total number of orders will be A/Q and the total ordering cost will be - A/Q x O Similarly, if the size of one order is Q and if it is assumed that the inventory is reduced at a constant rate from order quantity to zero when it is repurchased, the average inventory will be Q/2 and the cost of carrying one unit per year being C, the total carrying cost will be Q/2 X C. Thus, Total Cost = Ordering Cost + Carrying Cost AQ =XO+XC Q2 The intention is that the value of Q should be such that the total cost should be minimum. Hence, taking the first derivative of the equation with respect to Q and setting the result to zero, do 1 C = AO ( ) + = O OR dq Q2 2 Q = 2 x A X O Where C Q = Economic Order Quantity A = Annual Requirement in Units O = Cost of Placing an Order C = Cost of Carrying One Unit Per Year Illustration : A manufacturer uses 200 units of a component every month and he buys them entirely from outside supplier. The order placing and receiving cost is Rs. 100 and annual carrying cost is Rs. 12. From this set of data, calculate Economic Order Quantity. Solution : EOQ = 2 x A x O C = 2 x 2400 x 100 12 = 200 units

210 Management Accounting In some cases, the carrying cost may be expressed as an annual percentage of the unit cost of purchases, in which case, the calculation of Economic Order Quantity takes the following form. EOQ = 2 x A x O where Cxi A = Annual Requirement in units O = Cost of placing an order C = Unit purchase price i = Carrying cost expressed as a percentage of unit purchase price. Illustration : From the Following data, work out the EOQ of a particular component.

Annual Demand : 5000 Units Ordering Cost : Rs. 60 per Order Price per Unit : Rs. 100 Inventory carrying Cost : 15% on average inventory, Solution : EOQ = 2 x 5000 x 60 15% of 100 = 200 units The total cost of managing inventory will be Ordering Cost - 5000 X 60 i.e. 25 X 60 Rs. 1,500 200 Carrying Cost 200 X 15% of 100 Rs. 1,500 2 (Based on average inventory) Rs. 3,000 Now, the next question is whether the purchases in Economic Order Quantity really reduce the total cost of managing inventory to the minimum, We can verify this, by trial and error method, by considering the above results.

Material Cost 211

Order No. of Ordering Carrying Total Quantity Orders Cost Cost Cost A/Q A/Q x O Q/2 x Ci Rs. Rs. Rs. 50 100 6,000 375 6,375 100 50 3,000 750 3,750 200 25 1,500 1,500 3,000 250 20 1,200 1,875 3,075 1,000 5 300 7,500 7,800 1,250 4 240 9,375 9,615 2,500 2 120 18,750 18,870 It can be observed from the above, that the order size of 200 units proves to be the most economic one in terms of minimum total cost. If the purchases are made in any other way, the same may not necessarily result into minimum total cost. Illustration : Kapil Motors purchase 9,000 motor spare parts for its annual requirements, ordering onemonth usage at a time. Each spare part costs Rs. 20. The ordering cost per order is Rs. 15 and the carrying charges are 15% of the average inventory per year. You have been asked to suggest a more economical purchasing policy for the company. What advice would you offer and how much would it save the company per year. Solution : Present Policy : Number of Orders = Annual Requirement Order size = 9000 = 12 750

Ordering Cost = 12 X 15 = 180 ...(1) Carrying Cost = Order Size X Cost Price X Carrying cost in % 2 = 750 X 15% of Rs. 20 2 = 375 X 3 = 1,125 ...(2) Total Cost i.e. 1 + 2 = 180 + 1125 = 1305 ...(3) 212 Management Accounting Proposed Policy : To purchase in Economic Order Quantity EOQ = 2xAxO Cxi = 2 x 9000 x 15 15% of 20 = 300 units Now, the revised total cost will be Number of Orders = 9000 = 30 300 Ordering Cost = 30 x 15 = 450 ...(4) Carrying Cost = 300 X 15% of 20 ...(5) 2 = 150 X 3 = 450 Total Cost i.e. 4 + 5 = 450 + 450 = 900 ...(6) Thus, purchases in Economic Order Quantity will result into the yearly saving of Rs. 405 (i.e. Rs. 1305 - Rs. 900) (2) Fixation of Inventory Levels : Fixation of various inventory levels facilitates initiating of proper action in respect of the movement of various materials in time so that the various materials may be controlled in a proper way. However, the following propositions should be remembered. (i) Only the fixation of inventory levels does not facilitate the inventory control. There has to be a constant watch on the actual stock level of various kinds of materials so that proper action can be taken in time. (ii) The various levels fixed are not fixed on a permanent basis and are subject to revision regularly. The various levels which can be fixed are as below. (1) Maximum Level : It indicates the level above which the actual stock should not exceed. If it exceeds, it may involve unnecessary blocking of funds in inventory. While fixing this level, following factors are considered.

Material Cost 213

(i) Maximum usage. (ii) Lead time. (iii) Storage facilities available, cost of storage and insurance etc.

(iv) Prices for the material. (v) Availability of funds. (vi) Nature of material e.g. If a certain type of material is subject to Government regulations in respect of import of goods etc., maximum level may be fixed at a higher level. (vii) Economic Order Quantity. (2) Minimum Level : It indicates the level below which the actual stock should not reduce. If it reduces, it may involve the risk of non-availability of material whenever it is required. While fixing this level, following factors are considered. (i) Lead time. (ii) Rate of consumption. (3) Re-order Level: It indicates that level of material stock at which it is necessarily to take the steps for procurement of further lots of material. This is the level falling in between the two extremes of maximum level and minimum level and is fixed in such a way that the requirements of production are met properly till the new lot of material is received. (4) Danger Level : This is the level fixed below minimum level. If the stock reaches this level, it indicates the need to take urgent action in respect of getting the supply. At this stage, the company may not be able to make the purchases in a systematic manner but may have to make rush purchases which may involve higher purchases cost. Calculation of various Levels : The various levels can be decided by using the following mathematical expressions. (1) Re-order Level : Maximum Lead Time x Maximum Usage. (2) Maximum Level : Reorder Level + Reorder Quantity - (Minimum Usage X Minimum Lead Time). 214 Management Accounting (3) Minimum Level : Reorder Level - (Normal Usage x Normal Lead Time.) (4) Average Level : Maximum Level + Minimum Level. (5) Danger Level : Normal Usage x Leadtime for emergency purchases. Note : It should be noted that the expression of the Reorder Quantity in the calculation of Maximum Level indicates Economic Order Quantity. Illustration : Two components X and Y are used as follows. Normal usage 50 units per week each. Minimum usage 20 units per week each. Maximum usage 75 units per week each. Reorder quantity X - 400 units Y - 600 units Recorder period X - 4 to 6 weeks Y-2 to 4 weeks Calculate for each component : a. Reorder level b. Minimum level c. Maximum level d. Average stock level. Solution : (1) Reorder Level : Maximum Lead time x Maximum Usage X = 6 weeks x 75 units = 450 units Y = 4 weeks x 75 units = 300 units. (2) Minimum Level : Reorder Level (Normal Usage x Normal Leadtime) X = 450 units (50 units X 5 weeks) = 200 units. Y = 300 units (50 units x 3 weeks) = 150 units Material Cost 215

(3) Maximum Level : Reorder Level + Reorder Quantity - (Minimum Usage x Minimum Leadtime) X = 450 units + 400 units - (25 units x 4 weeks) = 750 units. Y = 300 units + 600 units - (25 units x 2 weeks) = 850 units. (4) Average Stock Level : Minimum Level + Maximum Level 2 200 units + 750 units X = = 475 units 2 150 units + 850 units Y = = 500 units 2 As stated above, the expression of the Reorder Quantity in the calculation of Maximum level indicates Economic Order Quantity. Hence, in some cases, it may be necessary to decide the Economic Order Quantity before fixing the inventory levels. Illustration : Shriram Enterprises manufactures a special product ZED The following particulars are collected for the year 1986. (a) Monthly demand of ZED - 1000 units. (b) Cost of placing an Order - Rs. 100. (c) Annual carrying cost per unit - Rs. 15. (d) Normal Usage 50 units per week. (e) Minimum Usage 25 units per week. (f) Maximum Usage 75 units per week. (g) Re-order period 4 to 6 weeks. Compute from the above: (1) Re-order Quantity. (2) Re-order Level. (3) Minimum Level. (4) Maximum Level. (5) Average Stock Level. 216 Management Accounting Solution : (1) Reorder Quantity : 2 x A x O where C A = Annual Requirement O = Ordering cost per cost C = Carrying cost per unit per year EOQ = 2 x 12000 x 100 15 = 400 units (2) Reorder Level : Maximum Lead Time x Maximum Usage. 6 weeks X 75 units = 450 units (3) Minimum Level : Reorder Level - (Normal Usage x Normal Lead Time) 450 units - (50 units X 5 weeks) = 200 units (4) Maximum Level : Reorder Level + Reorder Quantity (Minimum Usage X Minimum Leadtime) 450 units + 400 units - ( 25 units X 4 Weeks) = 750 units. (5) Average Stock Level : Minimum Level + Minimum Level 2 200 units + 750 units

= 475 units 2 There may be one more way in which the various inventory levels may be fixed and for this determination of the safety stock (also called as minimum stock or buffer stock) is essential. Safety stock is that level of stock below which the actual should not be allowed to fall. The safety stock may be calculated as -

Material Cost 217

(Maximum Usage X Maximum Leadtime) less (Normal Usage X Normal Leadtime) According to this method, the various inventory levels as discussed above may be fixed as below. (1) Minimum Level : It is equal to safety stock. (2) Maximum Level : It can be calculated as - Safety Stock + EOQ. (3) Reorder Level : It can be calculated as : Safety Stock + (Normal Usage x Normal Leadtime) (4) Average Stock Level : It can be calculated as Minimum Level + Maximum Level 2 = Safety Stock + Safety stock + EOQ 2 = Safety Stock + EOQ 2 Illustration : You have been asked to calculate the following levels for Part No. 007 from the information given thereunder: (a) Re-ordering level, (b) Maximum level (c) Minimum level, (d) Danger level, (e) Average level. The ordering quantity is to be calculated from the following data : (i) Total cost of purchasing relating to the order Rs. 20. (ii) Number of units to be purchased during the year 5,000 (iii) Purchase price per unit including transportation costs Rs. 50. 218 Management Accounting (iv) Annual cost of storage of one unit Rs. 5. Lead Times : Average ... 10 days Maximum .. 15 days Minimum .. 6 days Maximum for emergency purchases ... 4 days Rate of consumption:Average .. 15 units per day Maximum .. 20 units per day Solution : Working Notes : (a) Calculation of Safety Stock : (Maximum Usage x Maximum Leadtime) - (Normal Usage x Normal Leadtime)

= (20 units x 15 days) - (15 days x 10 days) = 300 units - 150 units = 150 units. (b) Calculation of EOQ : 2xAxO where C A = Annual requirement O = Ordering cost per order C = Carrying cost per unit per year. Hence, EOQ = 2 X 500 X 20 5 = 200 units. (1) Reordering Level : It can be calculated as Safety Stock + (Normal Usage x Normal Leadtime) = 150 units + (15 units X 10 days) = 150 units + 150 units = 300 units.

Material Cost 219

(2) Maximum Level : It can be calculated as Safety Stock + EOQ = 150 units + 200 units = 350 units. (3) Minimum Level : It is equal to Safety Stock = 150 units. (4) Danger Level : Normal Usage X Leadtime for emergency purchases = 15 units X 4 days = 60 units. (5) Average Stock Level : It can be calculated as EOQ Safety Stock + 2 200 = 150 units + units = 250 units 2 (3) Inventory Turnover : Inventory turnover indicates the ratio of materials consumed to the average inventory held. It is calculated as below : Value of material consumed Average inventory held where Value of material consumed can be calculated as : Opening Stock + Purchases - Closing Stock. Average inventory held can be calculated as : Opening Stock + Closing Stock 2

Inventory turnover can be indicated in terms of number of days in which average inventory is consumed. It can be done by dividing 365 days (a year) by inventory turnover ratio. 220 Management Accounting Illustration : From the following data for the year ended 31st December, 1986, calculate the inventory turnover ratio of the two items and put forward your comments on them. Material A Material B Rs. Rs. Opening Stock 1.1.86 10,000 9,000 Purchases during the year 52,000 27,000 Closing Stock 31.12.86 6,000 11,000 Solution : Inventory turnover ratio = Value of material consumed Average Inventory held Material A Material B Inventory Turnover = 56,000 25,000 8,000 10,000 = 7 2.5 Material A Material B Inventory Turnover Period = 365 365 7 2.5 = 52 days 146 days A high inventory turnover ratio or low inventory turnover period indicates that maximum material can be consumed by holding minimum amount of inventory of the same, thus indicating fast moving items. Thus high inventory turnover ratio or lower inventory turnover period will always be preferred. Thus, knowledge of inventory turnover ratio or inventory turn over period in case of various types of material will enable to reduce the blocked up capital in undesirable types of stocks and will enable the organisation to exercise proper inventory control. (4) ABC Analysis : This technique assumes the basic principle of Vital Few Trivial Many while considering the inventory structure of any organisation and is popularly known as Always Better Control. It is an analytical method of inventory control which aims at concentrating efforts in those areas where attention is required most. It is usually observed that, in practice, only a few number of items of inventory prove to be more important in terms of amount of investment in inventory or Material Cost 221 value of consumption, while a very large number of items of inventory account for a very meager amount of investment in inventory or value of consumption. This technique classifies the various inventory items according to their importance. E.g. A Class consists of only a small percentage of total number of items handled but are most important in nature. B Class items include relatively less important items. C Class items consist of a very large number of items which are less important. The importance of the various items may be decided on the basis of following factors. (i) Amount of investment in inventory. (ii) Value of material consumption. (iii) Critical nature of inventory items. An example of ABC Analysis can be given as below. Class No. of items % of total Value/ % of Total Value/ No. of Consumption Consumption items Rs. A 300 6 5,60,000 70 B 1500 30 1,60,000 20 C 3200 64 80,000 10 5000 100 8,00,000 100 In order to exercise proper inventory control, A Class items are watched very closely and control is exercised right from initial stages of estimating the requirements, fixing minimum

level/leadtimes, following proper purchase/ storage procedures etc. Whereas in case of C Class of items, only those inventory control measures may be implemented which are comparatively simple, elaborate and inexpensive in nature. Advantage of ABC Analysis : (a) A close and strict control is facilitated on the most important items which constitute a major portion of overall inventory valuation or overall material consumption and due to this the costs associated with inventions may be reduced. (b) The investment in inventory can be regulated in a proper manner and optimum utilisation of the available funds can be assured. (c) A strict control on inventory items in this manner helps in maintaining a high inventory turnover ratio.However it should be noted that the success of ABC analysis depends mainly upon correct categorisation of inventory items and hence should be handled by only experienced and trained personnel. 222 Management Accounting (5) Bill of Materials : In order to ensure proper inventory control, the basic principle to be kept in mind is that proper material is available for production purposes whenever it is required. This aim can be achieved by preparing what is normally called as Bill of Materials. A bill of material is the list of all the materials required for a job, process or production order. It gives the details of the necessary materials as well as the quantity of each item. As soon as the order for the job is received, bill of materials is prepared by Production Department or Production Planning Department. The form in which the bill of material is usually prepared is as below : BILL OF MATERIALS No. Date of Issue Production/Job Order No. Department authorised
S. No. Description Code Qty. For Department Use only Remarks of Material No. Material Date Quantity Requisition No. demanded

The functions of bill of materials are as below : (1) Bill of material gives an indication about the orders to be executed to all the persons concerned. (2) Bill of material gives an indication about the materials to be purchased by the Purchases Department if the same is not available with the stores. (3) Bill of material may serve as a base for the Production Department for placing the material requisitions ships. (4) Costing/Accounts Department maybe able to compute the material cost in respect of a job or a production order. A bill of material prepared and valued in advance may serve as a base for quoting the price for the job or production order. Material Cost 223 (6) Perpetual Inventory System : As discussed earlier, in order to exercise proper inventory control, perpetual inventory system may be implemented. It aims basically at two facts. (1) Maintenance of Bin Cards and Stores Ledger in order to know about the stock in quantity and value at any point of time. (2) Continuous verification of physical stock to ensure that the physical balance and the book balance tallies. The continuous stock taking may be advantageous from the following angles : (1) Physical balances and book balances can be compared and adjusted without waiting for the entire stocktaking to be done at the year-end Further, it is not necessary to close down the factory for Annual stocktaking. (2) The figures of stock can be readily available for the purpose of periodic Profit and Loss Account. (3) Discrepancies can be located and adjusted in time. (4) Fixation of various levels and bin cards enables the action to be taken for the placing the order for acquisition of material.

(5) A systematic maintenance of perpetual inventory system enables to locate and slow and non-moving items and to take remedial action for the same. (6) Stock details are available correctly for getting the insurance of stock. ILLUSTRATIVE PROBLEMS (1) The following informative is extracted from the Stores ledger in respect of Material X Opening Stock Nil Purchases Jan. 1 100 @ Re. 1 per unit Jan. 20 100 @ Rs. 2 per unit Issues Jan. 22 60 for Job W 16 Jan. 23 60 for Job W 17 Complete the receipts and issues valuation by adopting the First In First Out, Last In First Out and Weighted Average method. Tabulate the values allocated to Job W 16 and 17 and the closing stock under the methods aforesaid. 224 Management Accounting Solution : (a) Valuation of receipts : (For all methods) Jan. 1 100 x 1.00 = Rs. 100 Jan. 20 100 x 2.00 = Rs. 200 200 units Rs. 300 Weighted Average Rate = Rs. 300 = Rs. 1.50/Unit 200 units (b) Valuation of Issues/Closing Stock (1) Issues FIFO LIFO Weighted Average Qty. Rate Amt. Qty. Rate Amt. Qty. Rate Amt. Date Unit Rs. Rs. Unit Rs. Rs. Unit Rs. Rs. Jan. 22-W16 60 1.00 60.00 60 2.00 120.00 60 1.50 90.00 Jan.23-W17 40 1.00 40.00 40 2.0 80.00 60 1.50 90.00 20 2.00 40.00 20 1.00 20.00 140.00 220.00 180.00 (2) Closing Stock 80 2.00 160.00 80 1.00 80.00 80 1.50 120.00 (c) Values allocated to individual jobs W 16 W 17 Rs. Rs. FIFO 60 80 LIFO 120 100 Weighted Average 90 90 (2) From the records of an oil distributing company, the following summarised information is available for the month of March 1986. Sales for the month - Rs. 19,25,000 Opening Stock as on 1-3-86 - 1,25,000 Litres @ Rs. 6.50 litre Purchases (including freight and insurance) March 5 -1,50,000 litres @ Rs. 7.10 litre Material Cost 225 March 27 - 1,00,000 litres @ Rs. 7.00 litre. Closing stock as on 31-3-86 - 1,30,000 litres General Administrative expenses for the month Rs. 45,000 On the basis of the above information, work out the following using FIFO and LIFO methods of inventory valuation assuming pricing of issues is being done at the end of the month (after all receipts during the month). (a) Value of Closing Stock as on 31-3-86

(b) Cost of goods sold during March 86 (c) Profit or Loss for March 86. Solution : (a) Value of Closing Stock (1) FIFO : Under this method, the value of closing stock will constitute the value of latest available lot for consumption, earlier lots assumed to have been consumed. As such, value of closing stock will be: Purchased on 27-3-86 1,00,000 Its. x Rs. 7.00 = Rs. 7,00,000 Purchased on 5-3-86 30,000 Its. x Rs. 7.10 = Rs. 2,13,000 Rs. 9,13.000 (2) LIFO : Under this method, the value of closing stock will constitute the value of earliest available lot for consumption, latest lots assumed to have been consumed. As such, value of closing stock will be : Opening Stock on 1-3-86 1,25,000 Its. x Rs. 6.50 = Rs. 8,12,500 Purchased on 5-3-86 5,000 Its. x Rs. 7.10 = Rs. 35,500 Rs. 8,48,000 226 Management Accounting (b) Cost of goods sold during March 1986 FIFO LIFO Rs. Rs. Opening Stock 1,25,000 Its. x Rs. 6.50 8,12,500 8,12,500 Purchases 17,65,000 17,65,000 25,77.500 25,77,500 Less : Closing Stock (as per a above) 9,13,000 8,48,000 16,64,500 17,29,500 The value of purchases is calculated as below : Purchased on 5-3-86 1,50,000 X Rs. 7.10 = Rs. 10,65,000 Purchased on 27-3-86 1,00,000 X Rs. 7.00 = Rs. 7.00,000 Rs. 17,65,000 (c) Profit or Loss for March 1986 FIFO LIFO Rs. Rs. (1) Sales 19,25,000 19,25,000 Total Cost Cost of goods sold 16,64,500 17,29,500 Administrative Expenses 45,000 45,000 17,09,500 17,74,500 (2) Profit (1 - 2) 2,15,500 1,50,500 (3) A company uses annually 50,000 units of an item each costing Rs.1.20. Each older costs Rs. 45 and inventory carrying costs 15% of the annual average inventory value. (a) Find EOQ (b) If the company operates 250 days a year, the procurement time is 10 days, and safety stock is 500 units, find reorder level, maximum, minimum and average inventory. Material Cost 227 Solution : (a) Economic Order Quantity 2XAXO Ci = 2 X 50,000 X 45 15% of 1.20 = 5,000 units (b) (1) Reorder Level :

Safety Stock + (Normal Usage x Normal Leadtime) = 500 units + (200 units x 10 days) = 2,500 units (2) Maximum Level : Safety stock + EOQ = 500 units + 5,000 units = 5,500 units (3) Minimum Level It is equal to safety stock i.e. 500 units (4) Average Level Safety Stock + EOQ 2 = 500 units + 5000 units 2 = 3000 units (4) M/s. Kailas Pumps Ltd. uses about 75,000 valves per year and the usage is fairly constant at 6,250 per month. The valve costs Rs. 1.50 per unit when purchased in quantities and inventory carrying cost is 20%. The average inventory investment on annual basis. The cost to place an order and to process the delivery is Rs. 18. It takes 45 days to receive from the date of an order and minimum stock of 3,250 valves is desired. You are required to determine -

228 Management Accounting a. The most economical order quantity and the number of orders in year. b. The reorder level c. The most economic order quantity if valve costs Rs. 4.50 each instead of Rs. 1.50 each. Solution : (a) Economic Order Quantity : 2xAxO EOQ = Ci = 2 x 75,000 x 18 = 3,000 units 20% of 1.50 Number of Orders : Annual Consumption EOQ = 75,000 units = 25 3,000 units (b) Reorder Level : Safety stock + (Normal Usage x Normal Leadtime) = 3,250 units + (6,250 units x 1.5 months) = 12,625 units (c) Revised EOQ (If unit cost is Rs. 4.50 instead of Rs. 1.50) 2xAxO

EOQ = Ci = 2 x 75,000 x 18 20% of 4.50 = 1,732 units

Material Cost 229

(5) The Purchase Department of your Organisation has received an offer of quantity discounts on its orders of materials as under : Price Per Tonne Tonnes 1,200 Less than 500 1,180 500 and less than 1000 1,160 1000 and less than 2000 1,140 2000 and less than 3000 1,120 3000 and above. The annual requirement for the material is 5000 tonnes. The delivery cost per order is Rs. 1,200 and the stock holding cost is estimated at 20% of material cost per annum. You are required to advice the Purchase Department the most economic purchase level. Solution : As the price discount varies with lot size, EOQ will have to be decided by Trial and Error Method. Lot Size Price per Purchase Ordering Carrying Total (Units) Tonne-Rs. Cost for Cost Cost Cost Q P 5,000 Rs. 1 2 3 4 5 6(3+4+5) 100 1200 60,00,000 60,000 12,000 60,72,000 250 1200 60,00,000 24,000 30,000 60,54,000 500 1180 59,00,000 12,000 59,000 59,71,000 625 1180 59,00,000 9,600 73,750 59,83,350 1,000 1160 58,00,000 6,000 1,16,000 59,22,000 1,250 1160 58,00,000 4,800 1,45,000 59,49,800 2,000 1140 57,00,000 3,000 2,28,000 59,31,000 2,500 1140 57,00,000 2,400 2,85,000 59,87,400 3,000 1120 56,00,000 2,000 3,36,000 59,38,000 4,000 1120 56,00,000 1,500 4,48,000 60,49,500 5000 Q Tonnes X 1200 X P X 20% Rs. Q 2 230 Management Accounting It will be observed, that if the purchases are made in the lot size of 1,000 units it proves to be most economical. (6) (a) A company needs 24,000 units of raw materials which costs Rs. 20 per unit and ordering cost is expected to be Rs. 100 per order. The company maintains safety stock of 1 months requirements to meet emergency. The holding cost of carrying

inventory is supposed to be 10% per unit of average inventory. Find out : 1. Economic lot size. 2. Ordering cost 3. Holding cost 4. Total cost (b) The supplier of raw material has agreed to supply the goods at a discount of 5% in price on a lot size of 4,000 units. Find whether the concession price should be availed. Solution : (a) (1) Economic Lot Size 2xAxO Ci = 2 x 24,000 x 100 10% of 20 = 1,550 units (Approx.) (2) Ordering Cost Annual Requirement X Ordering cost per order EOQ = 24,000 X 100 = Rs. 1,548 (Approx.) 1550 (3) Holding Cost : As the company maintains safety stock of one months requirement, the average inventory held at any point of time will not only be EOQ/2 but safety stock + EOQ/2. Assuming that the usage of raw material is steady throughout the year i.e. 2,000 units per month, holding cost will be :

Material Cost 231

(Safety Stock + EOQ/2) / Carrying cost per unit per year = (2,000 units + 1,550 units ) X 10% of Rs. 20 2 = 2,775 units X Rs. 2 = Rs. 5,550 (4) Total cost : Cost of material 24,000 x 20 = Rs. 4,80,000 Ordering Cost = Rs. 1,548 Holding Cost = Rs. 5,550 Total Cost = Rs. 4,87,098 (b) Revised Total Cost : (with 5% discount) (1) Ordering Cost : As order size is going to be 4,000 units, total 6 orders will be placed. Hence total ordering cost will be 6 orders x Rs. 100 per order i.e. Rs. 600 (2) Holding Cost : The holding cost will be as below : (Safety Stock + Order Size ) x Carrying cost per unit per year

2 = (2,000 units + 4000 units ) x 10% of Rs. 19 2 = Rs. 7,600 (3) Total Cost : Total Cost of material - 24,000 x 19 = Rs. 4,56,000 Ordering Cost = Rs. 600 Holding Cost = Rs. 7,600 Total Cost = Rs. 4,64,200 232 Management Accounting Conclusion : If purchased in Economic Lot Size, total cost (including material cost) is Rs. 4,87,098. If purchased in Lot Size of 4,000 units with 5% discount, total cost (including material cost) is Rs. 4,64,200. As purchases in Lot Size of 4,000 units result in the saving of Rs. 22,898 (i.e. Rs. 4,87,098 Rs. 4,64,200) that alternative will be preferred. QUESTIONS 1. Explain the various steps in which a raw material moves in a manufacturing organization till it gets consumed in the production. Give the format of various documents which are prepared in the process. 2. Write a detailed essay on a) Valuation of Receipts b) Valuation of Issues c) Valuation of Returns Material Cost 233 PROBLEMS (1) The following is the record of receipts and issues of certain material in a factory during the week ending May 1979. Opening balances 100 tons at Rs. 10 per ton. Issued 60 tons. Received 120 tons at Rs. 10 per ton Issues - 50 tons (Stock verifier reported shortage of 2 tons) Received back from order 20 tons (originally issued at Rs. 9.90) Issued 80 tons. Received 44 tons at Rs. 10.20 per ton. Issued 66 tons. Received 44 tons at Rs. 10.20 per ton. Issued 66 tons. From the above particulars prepare stores ledger separately under e method charging issues at weighted and simple average method. (2) Following transactions appeared in a specified material during month of August 1980. Date Particular Quantity (Tons) Rate per ton 1 Opening balance 100 24 4 Purchased 50 26 5 Issued 30 12 Issued 40 13 Purchased 30 25 19 Issued 40 25 Issued 30 30 Purchased 40 28 31 Issued 30 The stock verifier noticed shortage in stock on 26th August of 5 tons and on 29th August of 4 tons. Write up stores ledger by charging issues by FIFO and by weighted average methods.

(3) The following is the history of the receipt and issue of materials in a factory during February 1980, 234 Management Accounting Feb. 1 Opening balance -500 tons at Rs. 25 2 Issued 70 tons 4 Issued 100 tons 8 Issued 80 tons 13 Received from vendor 200 tons at Rs. 24.50 14 Refund of surplus from a work order 15 tons at Rs. 24 16 Issued 180 long 20 Received from vendor 240 tons at Rs. 24.40 24 Issued 304 tons 25 Received from vendor 320 tons at Rs. 24.30 26 Issued 112 tons 27 Refund of surplus from a work order 12 tons at Rs. 24.50 28 Received from vendor 100 tons at Rs. 25 Issues are to be priced on the principle of LIFO and simple average method. The stock verifier of the factory noted that on the 15th he had found a shortage of 5 tons and on 27th another shortage of 8 tons. Write out complete stores ledger account in respect of the material. (4) A cloth manufacturer commenced the business on 1.1.82. Textile materials used include two types - M & N. During 6 months ending on 30.6.82, transactions were as follows : Date Purchased (Mtrs.) Issued (Mtrs.) M N Rates per Mt. M N 4.1.82 1000 10 6.1.82 1600 15 7.1.82 700 12.1.82 1200 18.3.82 2300 12 28.3.82 1420 16.4.82 3000 16 22.4.82 2860 26.5.82 800 9.50 1.6.82 1580 2.6.82 1000 17.50 8.6.82 1300 Material Cost 235 You are required to prepare stores ledger account for M type of material by charging issues by LIFO method and N type of material by charging the issues on weighted average method. (5) The stores ledger account of material C in the books of Saurabh and Sweta Ltd. revealed following transactions for September 1984, Sept. 1 Opening stock 200 kgs at Rs. 7.50 per kg. 5 Received from supplier 400 kgs at Rs. 7.75 per kg GRN 448 8 Issued to Production Dept. 240 kgs SR No. 883 10 Received from supplier 500 kgs at Rs. 7.90 per kg. GRN 45 12 Issued to Production Dept. 160 kgs SR No. 897 15 Issued to Production Dept. 400 kgs SR No. 912 16 Received from supplier 250 kgs at Rs. 8.00 per kg GRN 469 19 Received from supplier 600 kgs at Rs. 8.25 per kg GRN 561 21 Issued to Production Dept. 350 kgs SR No. 946 24 Issued to Production Dept. 260 kgs SR No. 959 27 Issued to Production Dept. 340 kgs SR No. 974 You are required to price the issues and draw out the closing balance in the stores ledger account under the pricing method in which the material costs charged to production

would be closely related to current prices. (6) Record the following transactions in a store ledger and show the cost of consumption and closing stock by using FIFO method of pricing issues. For the month of January 1985 : Jan. 1 Opening Stock 300 units at Jan. 11 Issues 400 units Rs. 9.70 per unit 20 Issues 210 units 3 Purchases 250 units at 29 Issues 100 units Rs. 9.80 per unit 15 Purchases 300 units at Rs. 10.50 per unit 25 Purchases 150 units at Rs. 10.30 per unit 236 Management Accounting (7) Prepare a stores ledger account on the basis of FIFO method. Jan. 1 Opening stock 250 units @ Re. 1 each 3 Purchased 100 units @ Rs. 1.05 each 4 Purchased 200 units @ Rs. 1.05 each 6 Issued 400 units 10 Purchased 400 units @ Rs. 1.20 each 12 Issued 150 units 13 Issued 100 units 16 Purchased 100 units @ Re. 1 each 22 Purchased 200 units @ Rs. 1.25 each 31 Issued 300 units (8) The following is a summary of the receipts and issues of a material in a factory during a month. 1st Opening Balance 500 units at Rs. 25 per unit. 3rd Issued 70 units. 4th Issued 100 units. 8th Issued 80 units. 13th Receipts 200 units at Rs. 24.50 per unit (Supplier) 14th Returned to stores 15 units at Rs. 24 per unit. 16th Issued 180 units. 20th Receipts 240 units at Rs. 24.75 per unit (Supplier) 24th Issued 304 units. 25th Receipts 320 units at Rs. 24.50 per unit (Supplier) 26th Issued 112 units. 27th Returned to stores 12 units at Rs. 24.50 per unit 28th Received from supplier 100 units at Rs. 25 per unit. Stock verification revealed that on 15th there was a shortage of 5 units and another on 27th of 8 units. Prepare Stores Ledger Account on the basis of FIFO basis. Material Cost 237 (9) Following is an extract of receipts and issues for the month of January 1989 of a manufacturing company. Date 2 Purchased 8,000 units @ Rs. 2 4 Purchased 1,000 units @ Rs. 2.50 6 Issued 4,000 units 10 Purchased 12,000 units @ Rs. 3 15 Issued 8,000 units 19 Issued 2,000 units 22 Issued 4,000 units 25 Purchased 9,000 units @ Rs. 2.75 30 Issued 6,000 units Draw up store Ledger Account by LIFO method showing balance as on 31.1.89 (10) The transactions in connection with the materials are as follows : Days Receipts Issues (Units)

Unit Rate per unit Rs. 1st 40 15.00 2nd 20 16.50 3rd - - 30 4th 50 14.30 5th - - 20 6th - - 40 Calculate the cost of material issued under FIFO method and Weighted Average method of issue of materials. (11) From the following details of stores receipts and issues of Material EXE in a manufacturing unit, prepare the stock ledger using Weighted Average method of valuing the issues. Nov. 1 Opening Stock 2,000 units (S) Rs. 5.00 each Nov. 3 Issued 1,500 units to production Nov. 4 Received 4,500 units @ Rs. 6.00 each Nov. 8 Issued 1,600 units to production. Nov. 9 Returned to stores 100 units by production department (from the issues of Nov. 3) Nov. 16 Received 2,400 units @ Rs. 6.50 each 238 Management Accounting Nov. 19 Returned to supplier 200 units out of the quantity received on Nov. 4Nov. 20 Received 1,000 units @ Rs. 7 each. Nov. 24 Issued to production 2,100 units Nov. 27 Received 1,200 units @ Rs. 7.50 each Nov. 29 Issued to Production 2,800 units (Use rates upto two decimal places) (12) The following are the transactions in respect of purchases and issues of components forming part of an assembly of a product manufactured by a firm which requires, to update its cost of production very often for bidding tenders and finalising cost plus contracts. Date Quantity Particulars 1986 (in Nos.) January 5 1,000 Purchased @ Rs. 1.20 each 11 2,000 Issued February 1 1,500 Purchased @ Rs. 1.30 each 18 2,400 Issued 26 1,000 Issued March 8 1,000 Purchased @ Rs. 1.40 each 17 1,500 Purchased @ Rs. 1.30 each 28 2,000 Issued. The stock on 1st January 1986 was 5,000 Nos. valued at Rs. 1.10 each. State the method you would adopt in pricing the issues of components giving reasons. What value would you place on stocks as on 31st March which happens to be the financial year end and how would you treat the difference in value, if any, on the stock account. (13) The following are the extract from the transactions on the bin card of Job No. 12-3-89 for March 1987 Date On order Receipt Rate Issue Balance 2 - 40 25.00 - 40 6 - - - 20 20 8 - 50 28.00 - 70 12 - - - 30 40 15 - 30 24.00 - 70 18 50 - 26.00 - 70 28 - - - 50 20 Material Cost 239 Find out the pricing of material issue under LIFO, FIFO and simple average method. (14) XYZ Ltd. requires 20,000 units of product A per annum. The purchase price is Rs. 4 per unit. The inventory carrying cost is 20% per annum and the cost of ordering is Rs. 100 per order. Advise the company, on how many times they should order in a year, so as to

minimise the cost of product A? (15) A Manufacturer buys certain essential spares from outside suppliers at Rs. 40 per set. Total annual requirements are 45000 sets. The annual cost of investment in inventory is 10% and costs like rent, stationery, insurance, taxes etc. per unit per year work to Re. 1, cost of placing an order is Rs. 5. Calculate the Economic Order Quantity. (16) Following information relating to a type of raw material is available. Annual Demand 2,400 units Unit Price Rs. 2.40 Ordering cost per order Rs. 4.00 Storage cost 27% p.a. Interest Rate 10% p.a. Lead Time Half month Calculate Economic Order Quantity and total annual inventory cost in respect of the particular raw material. (17) From the particulars given below, you are required to compute. (a) Economic Order Quantity (b) Maximum Level (c) Minimum Level (d) Re-ordering Level (e) Average stock Level (i) Quantity required annually 3,000 units @ Rs. 5 per unit. (ii) Interest and cost of storing 10%. (iii) Cost of placing an order Rs. 30 per order. (iv) Consumption per week Normal 60 units Maximum 70 units Minimum 50 units. (v) Lead time (in weeks) Normal 5 Maximum 6 Minimum 4 240 Management Accounting (18) The Stock-Ledger Account for material X in a manufacturing concern reveals the following data for the quarter ended September 30, 1989. Receipts Issues Quantity Price Quantity Amount Units Rs. Units Rs. July 1 Balance b/d 1.600 2.00 July 9 3,000 2.20 July 13 1,200 2,556 August 5 900 1,917 August 17 3,600 2.40 August 24 1,800 4,122 September 11 2,500 2.50 September 27 2,100 4,971 September 29 700 1,656 Physical verification on September 30, 1989 revealed an actual stock of 3,800 units. You are required to : (a) Indicate the method of princing employed in the above. (b) Complete the above account by making entries you would consider necessary including adjustments, if any, and giving explanations for such sdjustments. (19) Following information is available in respect of two components A and B. Particulars A B Normal Usage Units 50 50 Minimum Usage Units 25 25 Maximum Usage Units 75 75 Lead Time Week 4-6 2-4

Annual Consumption Units 9,000 6,250 Ordering cost per order Rs. 45 100 Carrying cost per unit per year Rs. 9 5 Calculate for each component. Material Cost 241 (i) Re-order level (ii) Minimum level (iii) Maximum level (iv) Average level (20) P. Ltd. uses three types of materials, A, B and C for production of X, the final product. The relevant monthly data for the components are as given below : ABC Normal Usage (Units) 200 150 180 Minimum Usage (Units) 100 100 90 Maximum Usage (Units) 300 250 270 Re-older Quantity (Units) 750 900 720 Re-order period (Months) 2 to 3 3 to 4 2 to 3 Calculate for each component. (1) Re-order Level (2) Minimum Level (3) Maximum Level (4) Average stock Level (21) The following data are available from the records of M/s. Naveen Industries Ltd. using two types of materials A and B for the manufacture of their product. AB Normal Usage (Units per month) 250 200 Minimum Usage (Units per month) 100 200 Maximum Usage (Units per month) 350 400 Reorder Quantity (Units) 900 1000 Reorder Period (Months) 2 to 3 3 to 4 Compute for each type of material, the following levels. (1) Reorder Level (2) Minimum Level (3) Maximum Level (4) Average Stock Level 242 Management Accounting (22) Following details are available in respect of a material. (i) Ordering cost per order Rs. 45 (ii) Annual consumption 9,000 units (iii) Carrying cost per unit per year Rs. 9 (iv) Lead Times - Average - 10 days Minimum 6 days Maximum 15 days Maximum for emergency purchases 4 days (v) Rate of consumption - Average 15 units per day Maximum 20 units per day Calculate : (i) Reordering Level (ii) Maximum Level (iii) Minimum Level (iv) Average Level (23) Certain purchased part of which annual requirements are 8000 units, involves ordering cost equal to Rs. 12.50 per order, cost per piece Re. 1 and the annual carrying cost 20%. In addition, average daily usage is 32 units (based on 250 operating days per year), lead time is 10 days and safety stock has been calculated to be 100 units. Calculate :

(a) Economic Order Quantity (b) Reorder point (24) (i) XYZ Company buys in the lot of 500 boxes which is a 3 months supply. The cost per box is Rs. 125 and the ordering cost is Rs. 150. The inventory carrying cost is estimated at 20% of unit value. What is the total annual cost of the existing inventory policy? (ii) How much money could be saved by employing the economic order quantity? (25) To decided to buy an item, the following data is given. Annual Demand 600 units Ordering Cost - Rs. 400 Holding Cost - 40% Material Cost 243 Cost per unit - Rs. 15 Discount 10% if the order quantity is 500 What should be the decision? Justify your answer. (26) A manufacturer requires 10 lakhs components for use during the next year which is assumed to consist of 250 working days. The cost of storing one component for one year is Rs. 4 and the cost of placing order is Rs. 32. There must always be a safety stock equal to two working days usage and the lead time from the supplier, which has been guaranteed, will be 5 working days throughout the year. Assuming usage takes place steadily throughout the working days, delivery takes place at the end of the day and orders are placed at the end of working day, you are required to calculate. (i) Economic Order Quantity. (ii) Reorder point. (27) Anil Company buys its annual requirement of 36,000 units in six instalments. Each unit costs Re. 1 and the ordering cost is Rs. 25. The inventory carrying cost is estimated at 20% of the unit value. Find the total cost of the existing inventory policy. How much money can be saved by using Economic Order Quantity? (28) A Company, for one of the A class items, placed 6 orders each of size 200 in a year. Given ordering cost Rs. 600, holding cost 40%, cost per unit Rs. 40, find out the loss to the Company by not operating scientific inventory policy. What are your recommendations for the future? (29) A manufacturer has to supply his customers 600 units of his product per year. Shortages are not allowed and the inventory carrying cost amounts to Rs. 0.60 per unit per year. The set up cost per run is Rs.80. Find (a) The Economic Order Quantity (b) The minimum average yearly cost. (c) The optimum number of orders per year. (30) A purchase manager has decided to place order for minimum quantity of 500 numbers of a particular item in order to get a discount of 10%. From the records, it was found that in the last year, 8 orders each of size 200 number have been placed. Given Ordering cost Rs. 500 per order, Inventory carrying cost 40% of the inventory value and cost per unit Rs. 400, is the purchase manager justified in his decision. What is the effect of his decision on the company? 244 Management Accounting (31) A publishing house purchases 2000 units of a particular item per year at a unit cost of Rs. 20, the ordering cost per order is Rs. 50 and the inventory carrying cost is 25%. Find the optimal order quantity and minimum total cost including purchase cost. If a 3% discount is offered by the supplier for purchase in lots of 1000 or more, should the publishing house accept the proposal? (32) Calculate for each Component A and B the following (a) Reorder Level (b) Maximum Level (c) Minimum Level (d) Average stock Level

Normal Usage - 300 units per week each. Maximum Usage - 450 units per week each Minimum Usage - 150 units per week each Reorder Quantity - A - 2,400 units B - 3,600 units Reorder Period - A - 4 to 6 weeks B - 2 to 4 weeks Material Cost 245 NOTES 246 Management Accounting NOTES Labour Cost 247

Chapter 9
LABOUR COST
Labour Cost is another important element of cost in the manufacturing cost. It is important element of cost eventhough the production is material intensive. The basic factor which gives rise to the labour cost is the remuneration paid to workers. However, the objective of cost accounting (i.e. cost ascertainment with respect to the individual cost centre and cost control) can not be fulfilled properly unless and until the functions performed by the related departments are properly considered. These functions can be stated as below : (1) Personnel Department : This ensures the availability of correct workers to perform the jobs which are best suited for them. This is done by selecting them properly and training them properly. This department may also be involved with maintenance of records of job classification/ wage rates payable to workers, preparation of wages sheet and procedural aspects of wage payment. (2) Time Keeping Department : This is concerned with recording of workers time. This is not only for the purpose of wage calculations but also for the purpose of cost analysis and apportionment of cost over various jobs. The main functions performed by this department are time keeping and time booking. (3) Cost Accounting Department : This department accumulates and classifies cost data with respect to labour cost from the analysis of wages sheet and presents the reports to management to facilitate the control over labour cost. The starting point for ascertaining the labour cost is in the form of Time Keeping and Time Booking. Time Keeping : This is the process of recording attendance time of the workers. It is the responsibility of Time Keeping Department which may function as separate department in some cases or else may function as the part of Personnel Department. Attendance time recording may be necessary as the payment of wages may depend on the attendance. Even when the payment of wages does not depend on time attended, say in case piece rate payment, the recording of time attended may be necessary from the following angles. 248 Management Accounting (1) To Maintain discipline. (2) Though the regular wages may not depend upon the time attended, in some cases, the other payments like overtime wages, dearness allowance etc. may be linked with the attendance. (3) The fringe benefits like Pension, Gratuity on retirement. Provident Fund etc. may depend on the continuity of service which will be available only if time attended is recorded properly. (4) Attendance records may be required for research and other purposes. Methods of Time Keeping : For the purpose of time keeping, various methods may be followed, though the selection of the method may depend upon nature of organization and policy of management. Main such methods may be stated as below:

(1) Hand-Written Method : Under this method, names of the workers are recorded in the attendance register with provision of various columns for various days. The attendance of the worker may be recorded either by calling out his name or by physical check. Alternatively, the workers themselves may sign in the attendance register. This method, though simple, has become outdated. This method can also result in malpractices with the collusion between workers and time keeping/ personnel department. Also recording of late coming, overtime, short leave etc. may involve more clerical work and may be subject to errors. (2) Token or Disc Method : Under this method, each worker is allotted an identification number and a disc or token bearing that number. Immediately before the scheduled opening time, all the tokens/ discs will be placed at the factory gate. Every incoming worker will take out his token and drop it in a separate box or hang it on a separate board. The tokens/discs not removed will indicate that the said worker is absent. Similar procedure is followed while the workers leave the factory. In addition to the physical handling of tokens/ discs, it will be required to record the attendance time separately. Though it is an improved method, as compared to manual/handwritten method, it is also subject to errors.mistakes and frauds. Further care should be taken to see that a worker does not remove the disc/token of his absent fellow in addition to his own. Labour Cost 249 (3) Time Recording Clock Method : Under this method, every worker is alloted individual ticket number and a clock card which bears that ticket number. The cards are placed on two racks on either side of the time recording clock denoting separately In rack and Out rack. At the opening time, all the cards are placed in Out rack. On arrival, worker takes out his own card, puts it in the slot available on the time clock recorder which punches the time on that card, and places the card in In rack. All the cards, left in the Out rack indicate absent workers. At the time of departure, he removes the card from In rack, gets it punched and places it in Out rack. Though, this method involves heavy capital outlay initially, it has certain advantages also. (1) It is economical in the sense it avoids clerical work: involved in manual/handwritten method. (2) It is clean, safe and quick and has printed records to avoid disputes. (3) Chances of fraudulent entries being made can be avoided. Time Booking : The ultimate aim of costing is to decide the cost of each cost centre. As such, recording of time attended is not sufficient. Equally important is to record the time spent for individual cost centres. This process is in the form of time booking. The methods followed for this purpose, may be considered as below : (a) Daily time sheets : Under this method, each worker is provided with a daily time sheet on which time spent by him on various jobs/work orders is expected to be mentioned. If the worker works on various jobs in a particular day, the daily time sheets move along with the worker. The entries on the same may be made by the worker himself or by the foreman. This method may be conveniently used if the worker works on various jobs of short duration. Say in case of maintenance jobs. This method is disadvantageous in the sense that it involves considerable paper work. The form in which the daily time sheets may be prepared is as below : 250 Management Accounting DAILY TIME SHEET (b) Weekly Time Sheets : Under this method also; one sheet is alloted to each worker but instead of recording the work done for a day only, record of time for all the jobs during the week is made. These types of time sheets are useful for intermittent types of jobs like building or construction work. It involves

comparatively less paper work. The form in which weekly time sheets may be prepared is as below. WEEKLY TIME SHEET Name of Employee Employee No. Date : Job No. Dept. Time Record Time taken ON OFF Checked by Cost office reference Name of Employee Week ending on... Employee No. Day Job No. Time Time Standard Rate Amount On Off taken TOTAL Checked by Cost office reference Labour Cost 251 (c) Job Card : Under this method, the details of time are recorded with reference to the jobs or production/ work orders undertaken by the workers rather than with reference to individual workers, and this facilitates the computation of labour cost with reference to jobs or production/work orders. There may be two ways in which job card may be maintained. (1) According to first method, each job or production/work order is alloted a number. When a worker takes up a job, the time of starting and finishing the job is entered on the card meant for that worker. The summary of this card states the total time taken by that worker for that job. In order to compute the total time booked for the job as a whole, all cards of all the workers with respect to that job are required to be analysed. The form in which this card may be prepared is as below. JOB CARD Name of Employee Job No. Employee No. Day Time Time Standard Rate Amount ON OFF Taken Rs. Rs. FRI SAT SUN MON TUE WED Checked by Cost office reference (2) According to this method, a job card is prepared for each job production/work order accepted by the organization for execution. It describes the various operations/stages involved in the execution of the job. Time taken by the various workers to complete the job is entered on the card. This provides the information about the time taken by various workers to complete a particular job. 252 Management Accounting The form in which this card may be prepared is as below. JOB CARD WITH OPERATIONS Job No. Drawing No. Job Description Operation Employee ON OFF Time Rate Amount No. taken Cutting 1 2 Drilling 1 2

Grinding 1 2 Painting 1 2 Assembly 1 2 3 TOTAL Checked by Cost office reference Reconciliation of time attended and time booked If a combined time and job card is maintained, the problem of reconciliation will be relatively simple as both the details will be available on the same card. In other cases, at the end of the wage period or at a shorter interval also, the total time attended has to be compared with the time booked on job cards on the various jobs. If the time booked as per the job cards, is less than the attendance time, this indicates the idle time during which the worker has not done any work, though he was present in the factory. Labour Cost 253 Methods of remunerating the workers : Remuneration to workers indicate the reward for labour and services. The remuneration may be paid in monetary terms (which in turn may be in direct form or indirect form) or nonmonetary terms. The remuneration paid in the monetary form may be by way of basic wages or salaries and other allowances and may be paid either on time basis or on work basis. However, payment of only basic wages or salaries may not be sufficient enough to induce the workers to work efficiently, hence they may be remunerated in the form of some incentives. In case of remuneration in non-monetary form, the workers may not receive anything in the from money but they may get facilities which induce them to stay with the organization. It may be in the form of the provision of health or welfare or recreational facilities, provision of working conditions and so on. We will discuss these methods of remuneration under the following heads. (1) Remuneration on Time Basis i.e. Time Rate System. (2) Remuneration on Work Basis i.e. Payment by Results. (3) Incentive/Bonus Systems. (a) Individual Incentive Systems (b) Group Incentive Systems. (4) Indirect monetary remuneration (a) Profit sharing (b) Co-partnership (5) Non-monetary incentives Principles of a good wage payment system : (1) As a general rule, if the efficiency of the workers can be measured in the objective terms, the wages receivable by a worker should be in conformity with his efficiency. Otherwise an efficient worker is likely to be demotivated from working efficiently. At the same time, the standards fixed to measure the efficiency of a worker should be normal which can be attained by a normal worker under normal conditions. (2) The wage payment system should be clearly defined and communicated to the workers leaving no scope for any ambiguity. At the same time, a good wage payment system should be simple to understand and easy to operate. (3) No upper limit should be imposed on the wages which can be earned by an efficient worker. 254 Management Accounting (4) A good wage payment system will not punish the workers for the matters beyond the control of the workers. E.g. Workers should not be punished in terms of reduced wages due to the circumstances like machinery break down or power failures etc.

(5) A good wage payment system should be reasonably permanent in nature. Frequent changes in the same should be avoided. If any changes are proposed to be made in system of wages payment, they should not be thrust upon the workers by force, but should be implemented by having mutual discussions with and due approval from the workers. (6) Wage payment system should be properly tied up with quality control procedures to ensure that the workers are paid only for good and quality production. (7) The basic objective of the wage payment system should be to get maximum cooperation from the workers, improve the morale and productivity of the workers and to minimize the cost of supervision and labour turnover. (8) The wage payment system should take into consideration the external obligations to which the organization may be subjected to. These obligations may be in the form of various statutes like Minimum Wage Act and the agreement entered into with the workers and so on. (A) Time Rate System : Under this, a worker is paid on the basis of time attended by him. He is paid at a specific rate irrespective of the production achieved by him. The pay rate may be fixed on daily basis, weekly basis or monthly basis. This type of remuneration system is helpful in the following circumstances. (a) If the output of the worker is beyond his control e.g. His speed depends upon speed of a machine or speed of other workers. (b) If the output cant be measured or standard time cant be fixed e.g. Maintenance work. (c) If close supervision is possible. (d) If quality, accuracy and precision in work is of prime importance e.g. Artist, Ad-agency person. The time rate system of remunerating the workers is useful due to the following features : (a) Useful for highly efficient and highly inefficient workers. (b) Easy for calculations. (c) Easy to understand for the worker. (d) Assurance of minimum wages. Labour Cost 255 The time rate system has one most important disadvantage attached to it that the efficiency of the worker is disregarded while paying remuneration to him. To avoid this difficulty, some variations as discussed below can be applied in practice. (i) High Wage Plan : Under this system, timely wage rate of the workers may be fixed at such a level which is higher as compared to wages paid to workers in the same industry or locality. Suitable working conditions are provided. Correspondingly, a high standard of efficiency is expected from the workers. Those who are not able to come up to the standard, are taken off the scheme. (ii) Differential Time Rate : Under this method, different hourly rates are fixed for different levels of efficiency. Up to a certain level of efficiency, normal day rate is applicable which gradually increases as efficiency increases. This can be illustrated as below : Up to 80% efficiency : Re. 1.00 per hour (Normal Rate) 80% to 90% efficiency : Rs. 1.25 per hour 90% to 100% efficiency : Rs. 1.40 per hour 101% to 125% efficiency : Rs. 1.50 per hour (B) Payments by results : Under this system, workers are paid according to the production achieved by them. In many cases, time attended is not material. These methods can be reclassified as below. (a) Straight Piece Rate System : Under this method, each job, production or unit of production is termed as a piece and the rate of payment is fixed per piece. The worker is paid on the basis of production achieved irrespective of the time taken for its performance. Thus, the earnings of the worker can be computed as : Wages = No. of units produced x Piece Rate per unit This method can be suitably applied if

the production is of standard or repetitive nature. It cant be applied if the production cant be measured in suitable units. It can be seen that the crux of this method is to decide the time required to complete a piece. The fixation of this time should be done in such a way that within that much time, a normal worker can complete the piece. This can be done either on the basis of previous experience or on the basis of time and motion study. 256 Management Accounting (b) Piece Rate With Guaranteed Time Rate : Under the straight piece rate system, the remuneration of a worker depends upon the production achieved. If the production is less due to some factors beyond his control, he is likely to be penalised. To remove this difficulty, it may be decided that he will be paid on time rate if his piece rate earnings fall below time rate earnings, so that the worker is assured of minimum earnings on time basis. However, if this guaranteed time rate payment is too high, the incentive to increase output to get piece rate payment is less. (c) Differential Piece Rate System : Under this system, higher rewards are guaranteed to more efficient workers. The piece rates are fixed in such a way that normal piece rate is paid for work performed within and upto the standard level of efficiency. If efficiency exceeds the standard, payment at higher piece rate is made. This can be illustrated as below : Up to 83% efficiency - Normal Piece Rate. Up to 100% efficiency - 10% above normal piece rate. Above 100% efficiency - 30% above normal piece rate. This method offers more inducement to the workers to work more efficiently and earn higher wages. But it is complicated to understand and expensive to operate. Following systems use this principle of differential piece rates. (1) Taylor Differential Piece Rate System : This was introduced by F.W. Taylor. It provides two piece rates, a low piece rate for output below standard and a high piece rate for output above standard and does not provide for any guaranteed time rate payment. Eg. If standard output is 10 units and piece rate is Re.l per unit, the total wages are : (i) If actual hourly output is 8 units i.e. below standard, the piece rate is say 80% of normal piece rate i.e. Re. 0.80. Hence total wages are 8 units x Re. 0.80 = Rs.6.40. (ii) If actual hourly output is 12 units i.e. above standard, the piece rate is say 120% of normal piece rate i.e. Rs. l.20. Hence, total wages are 12 units x Rs.l.20 = Rs. 14.40. The basic defect with this system is that eventhough the efficiency of the worker is below standard even marginally, he is punished heavily and even though the efficiency of the worker is above standard even marginally, he is benefited to a very great extent. Labour Cost 257 (2) Merrick Differential Piece-rate System : To remove the defect existing in case of Taylors System which heavily punishes the worker who produces below standard, the Merrick System provides for three piece rates Eg. Efficiency Piece rate Up to 83% Normal Up to 100% 110% of normal piece rate Above 100% 130% of normal piece rate It should be noted that under this method also, no guaranteed time rate payment is provided. Illustration : The following particulars relate to a company. Piece Rate - 6 paise per unit. Production of the workers M - 125 units per day N - 80 units per day O - 150 units per day Standard production per day 120 units. Calculate the wages of the workers on the basis of Merricks Differential piece rate system,

when basic piece rate is guaranteed below the standard and workers get 108% of the basic piece rate between 100% and 120% of the basic piece rate above 120% efficiency. Solution : Calculation of total wages : (a) Worker M : Actual production 125 units i.e. 104% efficiency. Applicable piece rate - 108% of normal i:e. 6.48 paise per unit. Total wages : 125 units x 6.48 paise = 810 paise i.e. Rs. 8.10 (b) Worker N : Actual production 80 units i.e. below the standard. Applicable piece rate : basic piece rate i.e. 6 paise per unit Total wages : 80 units x 6 paise = 480 paise i.e. Rs. 4.80 258 Management Accounting (c) Worker O : Actual production 150 units i.e. 125% efficiency. Applicable piece rate - 120% of normal i.e. 7.20 paise per unit. Total wages 150 units x 7.20 paise = 1080 paise i.e. Rs. 10.80 (3) Gantt Task Bonus System : This system is a combination of time rate and piece rate and provides for minimum time rate payment. A high task or standard is set. The wage structure may be fixed as below. Output below standard - Minimum time rate payment. Output at standard - Time wages plus some increase in wage rates. Output above standard - High piece rate for entire output. (C) Individual Incentive Systems : In case of time rate systems, the losses due to inefficiency of workers or benefits due to efficiency of workers are suffered or enjoyed by the employer alone. Similarly in case of piecerate systems, the losses due to inefficiency of workers or benefits due to efficiency of workers are suffered or enjoyed by the worker alone. (The employer may be indirectly affected in the form of increased or decreased per unit overheads.) The incentive systems differ from both these systems in such a way that the financial advantages arising out of the efficiency of workers are enjoyed by both employer as well as workers. There are various systems by which the incentive may be paid to workers. We will consider following main systems. (a) Halsey Premium System : Under this system, if the actual time taken is equal to or more than standard time, worker is paid at the time rate. If actual time is less than standard time, the worker, in addition to time wages for hours actually worked, gets a bonus payment. The bonus is equivalent to the wages for the time saved in the decided percentage to be shared with the employer The percentage allowed to worker may vary from 30% to 70% (usually 50%). The total wages payable to the worker under this system, can be computed as below. AH X HR + (SH - AH) X HR Assuming 50% - 50% sharing 2 Where - AH - Actual hours SH - Standard hours HR - Hourly rate Labour Cost 259 (b) Halsey - Weir Premium System : This system is a deviation of Halsey Premium System only with the exception that the ratio of sharing between the worker and the employer is fixed as 1/3 : 2/3. The computation of total wages is the same as in case of Halsey Premium System, except the change in this ratio. (c) Rowan Premium System : Under this system also, guaranteed time rate payment is made. The amount of bonus paid is a percentage of hourly rate which is in proportion to the time saved. The total wages payable to the workers under this system can be computed as below :

AH X HR + SH - AH X AH X HR SH Where AH - Actual Hours SH - Standard Hours HR - Hourly Rate Comparative study of Halsey and Rowan System : Comparative study of total wages under both these systems reveals that if time saved is less than 50% of the standard time. Rowan system assures more wages than those under Halsey system. But if time saved exceeds 50% of the standard time, Halsey system proves to be more beneficial. In Rowan System a less efficient worker gets the same bonus as a more efficient worker. As such Rowan System may be implemented in case of loose fixation of standards. The fall in bonus as time saved increases, offsets the damage done by loose standards. Illustration : The following are the particulars given to yon. Standard time .. 10 hours. Time rate .. Re. 1 per hour. Prepare a comparative table under Halsey Premium System and Rowan Premium System, if time taken is 9 hours, 8 hours, 6 hours, 5 hours 4 hours and 3 hours. Also calculate the amount of total wages and labour cost per hour under two methods. What conclusions do you draw from the table. 260 Management Accounting Solution : Hours Halsey Premium system Rowan Premium system. taken Wages = Actual Hours x Hourly rate Wages = Actual Hours x Hourly rate + 1/2 (Time Saved x Hourly rate) + Time Saved/Time Allowed Actual Hours x Hourly rate (a) 9 Wages = 9x1+1/2 (I x 1) Wages = 9 x 1 + 1/10 x 9 x 1 = Rs. 9.50 = Rs. 9.90 (b) 8 Wages = 8x1+1/2 (2 x 1) Wages = 8 x 1+ 2/10 x 8 x 1 = Rs. 9 = Rs. 9.60 (c) 6 Wages = 6x1+1/2 (4 x 1) Wages = 6 x 1 + 4/10 (6 x 1) = Rs. 8 = Rs. 8.40 (d) 4 Wages = 4 x 1 1/2 (6 x 1) Wages = 4 x 1 + 6/10 (4 x 1) = Rs. 7.00 = 6.40 (e) 3 Wages = 3 X l+ 1/2 (7 x 1) Wages = 3 x 1 + 7/10 (3 x 1) = Rs. 6.50 = Rs. 5.10 Conclusion : It can be concluded from the above table that so long as time saved is less than 50% of standard time, the total wages are more under Rowan Premium system than under Halsey Premium System. If the time saved is more than 50% of standard time, Halsey system proves to be more beneficial in terms of the total wages. The other systems for making the payment of premium can be briefly described as below. (a) Barth Premium System : Under this system, the wages payable to the workers are computed as below. Wages = Hourly Rate x Standard Hours x Actual Hours Eg. Standard Hours are 10 Actual hours are 8 Hourly rate is Rs. 2 per hour. Total wages will be 2 x 10x8 = Rs. 17.89 Labour Cost 261

It should be noted that this system does not provide for any guaranteed time wages. This system is suitable for beginners or apprentices. (b) Emersonss Efficiency Bonus System : Under this system the wages payable to the workers are computed as below. Wages = Actual Hours x Hourly Rate + Bonus Percentage x Actual -Hours x Hourly rate. For calculating bonus percentage, following directions are provided. Efficiency Bonus (1) Below 66.2/3 % No bonus is payable. Only the guaranteed time wages are payable. (2) 66.2/3% to 100% In Addition to time wages, bonus is paid at different percentages increasing rapidly to 20% at 100% efficiency. (3) Above 100 % In addition to time wages and bonus @ 20%, 1% bonus for each 1% increase in efficiency beyond 100% is paid. Eg. 101 % efficiency - 21 % Bonus 110 % efficiency - 30 % Bonus 120 % efficiency - 40 % Bonus & so on. The efficiency percentage can be calculated as below. (1) On time basis : Standard Hours x 100 Actual Hours (2) On output basis : Actual output x 100 Standard output Eg. Standard Hours are 10 Actual Hours are 8 Hourly Rate is Rs. 2 per hour. 262 Management Accounting Efficiency percentage will be as below. Standard Hours 10 Actual Hours 8 Bonus percentage will be 45% Total Wages = 8 x 2+ 45% of 8 x 2 = 16 + 45% of 16 = 16 + 7.20 = Rs. 23.20 It can be seen that the abovestated system is similar to that of piece rate with guaranteed time rate. This system may be suitable for non efficient workers for improving their efficiency. (c) Bedaux Point System : Under this system, the standard time is divided into standard minutes, each standard minute identified as Bedaux Point or B. The wages payable to the worker are computed as below. Wages = Actual Hours x Hourly Rate + 75 % of BS x Hourly Rate 60 Where BS indicates the number of Bs saved i.e. the difference between Bs earned and standard Bs allowed for the job. Eg. Standard points for a job - 400 points in 8 hours. Hourly Rate - Rs. 3 per hour. Wages = 8 x 3 + 75% of (450 - 400) x 3 60 = 24 + 75% of 2.50 = 24 + 1.875 = Rs. 25.875.

It should be noted that a very accurate system of work study is required for this system. It is difficult to understand and involves a lot of clerical efforts. X 100 = X 100 = 125% Labour Cost 263 (d) Accelerating Premium System : Under this system, incentive increases at a fast rate with the increase in output. Total wages payable to the worker are computed as below. Y = 0.8 X2 where Y = Earnings X = Efficiency. i.e. If efficiency is 140%, the earnings will be : 0.8 x 140 140 100 100 x 1.568 of basic wages i.e. 100% wages, 56.8% bonus. Eg. Standard hours are 10 Actual Hours are 8 Hourly rate is Rs. 2 per hour. Efficiency percentage will be 10/8 x 100 = 125% 125 125 Earnings = 0.8 x 100 x 100 = 1.25 Earnings will be 125% of basic wages i.e 100% basic wages, 25% bonus. Basic, wages - 8 x 2 = 16 Bonus - 25% of Rs. 16 = 4 Total Wages = 20 This system is very difficult to understand. (e) Baum Differential Plan : This is a combination of Taylors differential piece rate system and Halsey system and is also known as Milwaukee Plan. x 264 Management Accounting (f) Diemer System : This is a combination of Halsey System and Gantt system. (D) Group Incentive System : In many cases, the output of the individual workers cannot be measured though the output of a group of workers can be measured. In such cases, the individual time rates or in some specified proportion depending upon the skill of the workers or equally, can be applied. (E) Indirect Monetary Remuneration : This may take the following two forms. (a) Profit Sharing : According to this method, the workers, are entitled to share in profits earned by an organisation, in addition to the regular wages, at a specified percentage. The legal provisions in this regard are enacted by way of Payment of Bonus Act, 1965. According to the provisions of this Act, all the employees drawing a monthly remuneration of Rs. 2,500 or less are entitled to a bonus at the minimum rate of 8.33% of wages of the subject to the maximum ceiling of 20 % of the wages. It should be noted that the statutory requirement of the payment of bonus does not depend on the profit earned necessarily, as the bonus is payable eventhough there are no profits. It is also worth noting that the statutory requirement of payment of bonus is the specific percentage of the wages or salaries paid to the workers and hence remains unaffected by any changes, either upwards or downward, in the profits earned by the organisation. (b) Co-partnership :

According to this method, the workers are granted ownership rights in the operations of the organisation by which the workers are in the position to control the affairs of the organisation. In corporate organisations, it may be in the form of offering the shares of the company to the workers or granting of loans to the workers to buy companys shares, according to which the workers get the voting rights to control the affairs of the company. The workers get dividend on the shares as bonus. With the help of this method, the morale of the workers is increased. However, certain objections are raised against this method. First, the increase in earnings is too small. Second, the shareholding of the workers is too small to control the affairs of the company. Third, the workers are not rewarded according to the individual efficiency. Labour Cost 265 (F) Non-monetary Incentives : The intention of these incentives is to attract better workers, retain the existing workers, encourage loyalty, reduce labour turnover, provide better working conditions to workers and so on. Various benefits as stated below may be granted to the workers, either free or at reduced rates, remaining amount being contributed by the workers. (1) Health and safety services. (2) Education and training to workers and their children. (3) Canteen facility. (4) Pension, superannuation fund etc. (5) Loans at reduced rate of interest. IMPORTANT TERMS IN CASE OF LABOUR COST : (A) Labour Turnover : In every business organisation, the process of employees leaving the organisation and new workers being recruited is a normal feature. Labour Turnover indicates this change in labour force showing a highly increasing trend or highly decreasing trend. Labour turnover showing sharp increasing trend may involve the reduction in labour productivity and increasing costs. Too low a labour turnover trend may be due to inefficient workers who would not like to leave the organisation. Causes of labour turnover : The causes of labour turnover can be broadly classified as below : (a) Avoidable causes : (1) Dissatisfaction with job. (2) Dissatisfaction with remuneration. (3) Dissatisfaction with working conditions. (4) Dissatisfaction with hours of work. (5) Relationship with supervisors and workers. (b) Unavoidable causes : (1) Betterment/Personal. (2) Illness or accident. (3) Move from locality. 266 Management Accounting (4) Discharge. (5) Marriage. (6) Retirement. (7) Death. (8) National service. Costs of labour turnover The cost of labour turnover may be classified under two headings. (a) Preventive Costs : These refer to all the costs which may be incurred by the organisation to keep workers happy and discourage them from leaving the job. This, in turn, may include the costs like : (1) Cost of Personnel Administration - To maintain good relations with the workers. (2) Cost of medical services- To keep the workers and their families in healthy condition, as healthy workers are assets for the organisation who contribute towards higher

efficiency and productivity. (3) Costs of welfare activities - To give facilities like transport, canteen etc. (4) Other incentive schemes like pension, provident fund, superannuation fund, Bonus etc. (b) Replacement Costs : These refer to the costs incurred for recruitment and training of new workers and the resulting losses, wastages and reduced productivity due to the inefficiency and inexperience of new workers. This in its turn may include the costs like(1) Inefficiency of new workers. (2) Cost of selection and placement. (3) Training costs. (4) Loss of output due to delay in getting new workers (5) Increased spoilage and defectives. (6) Cost of tools and machine breakages. Labour Cost 267 Measurement of labour turnover : There are three methods for measuring the labour turnover. (1) Separation Method Under this method, it is computed as : No. of Separations in a period X 100 Average no. of workers (2) Replacement Method Under this method, it is computed as No. of Replacements in a period X 100 Average no. of workers. (3) Flux Method Under this method, it is computed as No. of separations + No. of replacement X 100 Average no. of workers Illustration : From the following data given by Personnel Department, calculate the labour turnover rate by applying : (a) Separation Method (b) Replacement Method (c) Flux Method No. of workers on pay-roll - At the beginning of the month 900 - At the end of the month 1,100 During the month, 10 workers left, 40 persons were discharged and 150 workers were recruited. Of these 25 workers are recruited in the vacancies of those leaving while the rest were for an expansion scheme. 268 Management Accounting Solution : Calculation of Labour Turnover (1) Separation Method No. of separations in a period X 100 Average No. of workers = 50 X 100 = 5 1000

Monthly Turnover Rate : 5% Annual Turnover Rate : 5 X 365 = 60.83% 30 (2) Replacement Method : No. of replacements in a period X 100 Average No. of workers 25 = X 100 = 2.5% 1000 Monthly turnover Rate : 2.5% 365 Annual Turnover Rate : 2.5 X = 30.42% 30 (3) Flux Method : No. of separations + No. of replacements X 100 Average No. of workers 50 +25 = = 100 = 7.5% 1,000 Monthly Turnover Rate : 7.5% 365 Annual Turnover Rate : 7.5 X = 91.25% 30 Labour Cost 269 Working Notes : Average number of workers is calculated as No. of workers at beginning + No. of worker at end 2 = 900 + 1,100 2 = 1,000 (B) Idle Time : It indicates the time for which wages are paid to the workers but during which no production is obtained. To exercise proper control on idle time, causes of the same should be analysed properly and studied from its controllability point of view. The causes of idle time can be analysed as below : (a) Productive causes : These can be further classified as : (i) Due to machine breakdown. (ii) Power failures. (iii) Waiting for tools, work or raw materials. (iv) Waiting for instructions. These causes are supposed to be controllable causes and can be controlled if planned properly. (b) Administrative causes : Some idle time may be caused due to administrative decisions. E.g. the organisation is having excess machine capacity or during the depression period, it is not having sufficient work to be performed, but it has decided not to get rid of trained workers temporarily. As such cost of idle time is accepted. (c) Economic causes : Economic causes may be of seasonal nature, cyclical nature or industrial nature. E.g. if

the product manufactured is of a seasonal nature, for other periods of the year, the capacity may remain unused, unless some other product to take care of slack season is introduced. In case it is not possible to make alternate use of such idle capacity, some 270 Management Accounting idle time is unavoidable. In case of cyclical causes, the causes are similar to seasonal fluctuations but these causes are beyond the control of management. Treatment of idle time cost : If Idle time payment is normal and controllable, it should be classified as overheads. If it is possible to allocate the same to some department, it should be allocated and absorbed in the production department cost. If idle time is normal and uncontrollable, the labour rates should be suitably modified. E.g. if time attended is 8 hours but time booked is only 7.5 hours and labour cost is Rs. 1.5 per hour, the hourly labour rate should be computed as 8 hours X Rs. 1.5 i.e. Rs. 1.60 7.5 hours If idle time payment is uncontrollable and abnormal, it should not be considered as a part of manufacturing cost but should be written off to Costing Profit and Loss Account. (C) Internal Control Problems in Labour Cost : In todays world, labour is one of the most important factors of production, and contributing to a very great extent to the cost of production. As such, it will be the intention of every organisation to have proper control on the labour cost. The implementation of various Internal Control Procedures indicate the following of all those methods and procedures which ensures fluent and smooth running of the operations of the organisation and also of achieving protection of assets, prevention of errors and frauds, proper recording of information whenever necessary. The cost of labour may be high due to the various reasons stated below : (1) Excess staffing - Having more staff than the requirement. (2) Lack of experienced and efficient personnel. (3) Excessive remuneration pattern - Settlement of the wage rates or piece rates on higher side which may not be justified on the basis of efficiency of workers. (4) Clerical errors or fraudulent practices taking place in the area of time keeping, computation of wages payable, procedure for payment of wages to the workers etc. (5) Idle time or unusual overtime wages. (6) Increase of spoilage due to lack of proper supervision and inspection. (7) High labour turnover. After locating the reasons for increasing labour costs, attempts can be made to keep the same in control after following various internal control measures as discussed below. Labour Cost 271 (1) To avoide the problem of excess staffing, the employment of the workers should be made only after the receipt of labour placement requisition from the concerned department. After the receipt of this requisition, it should be seen, whether it is possible to meet the requirement of said department with the help of existing staff only or at least by transferring the existing excess staff in other departments. Before proceeding with the actual process of selection of the staff, care should be taken to decide in advance about the nature of work which may be assigned to the individual employee. (2) To ensure that correct personnel is employed to work in the correct places, care should be taken to analyse the requirements of the job and then to select the personnel which suits these requirements. This process may be in the form of job evaluation. Selection of the proper personnel may not be enough. To train the selected personnel to extract maximum of their efficiency is equally necessary. (3) The problem of setting the excessive rate structure in the form of higher time rate or piece rates or bonus rates may be avoided by setting the standards in the most scientific manner. For this purpose, the techniques like time and motion study, work study etc. may be implemented. (4) To avoid the clerical errors or fraudulent practices in the areas of wage sheet preparation or wage payments, proper internal check procedures may be implemented, so that the

work of one person is properly checked by another person. For this, following steps may be taken : (a) Time recording clock should be installed, wherever possible. Proper supervision is required to ensure that one person punches his own card only. (b) The terms of remuneration should be set and made known to the workers in very very clear terms. (c) Proper internal checks should be executed while preparing the wages sheets. Cashier should not be allowed to handle the wages sheets and the person preparing the sheets should not be allowed to prepare wage packets. Personnel officer/manager should check and authorize the wages sheets. (d) The wages should be paid to workers after they are properly identified. The wages should not be paid to any other person, unless proper authorization letter is produced in exceptional circumstances. (e) Distribution of wages should be made in all the departments at a time so as to avoid the possibility of one person being present at two places. 272 Management Accounting (5) Existence of idle time should be properly analyzed according to controllability. The causes of controllable idle time should be attempted to be avoided. If it is necessary to work overtime, it should be properly authorized and should be paid and accounted for properly. Care should be taken to see that proper returns are obtained for making overtime wages payment. (6) If the labour cost is higher due to spoilage of work which in turn may be due to lack of proper supervision or inspection, it is a cost which can very will be controlled by having proper supervision or inspection. (7) The causes of labour turnover should be analysed according to normality. All the avoidable causes of labour turnover should be paid proper attention. Higher trend of labour turnover adds to the costs in two ways mainly. It reduces the labour productivity and at the same time, increases the costs. If the workers have the grievances which are of avoidable nature, say dissatisfaction with remuneration or other benefits or working hours or working conditions or job itself or relations with the fellow workers or the supervisors, attempts can be made to avoid those causes of labour turnover. ILLUSTRATIVE PROBLEMS (1) The standard hours for job X is 100 hours. The job can be completed by A in 60 hours, by B in 70 hours and by C in 95 hours. The bonus system applicable to the job is as follows : % of time saved to time allowed Bonus Saving upto 10% 10% of time saved Saving from 11% to 20% 15% of time saved Saving from 21% to 40% 20% of time saved Saving from 41% to 100% 25% of time saved. Rate of pay per hour is Rs.1 Calculate the total earnings of each worker and also the rate of earnings per hour. Labour Cost 273 Solution : ABC (1) Standard Hours 100 100 100 (2) Actual Hours 60 70 95 (3) Hours Saved 40 30 5 (4) % Hours saved 40% 30% 5% (5) Applicable bonus rate (% of wages for time saved) 20% 20% 10% (6) Hourly Rate (Rs.) 1 1 1 (7) Basic wages (Rs.) - 2 x 6 i.e. Actual Hours x Hourly rate 60 70 95 (8) Wages for time saved (Rs.) - 3 x 6 i.e. Hours Saved x Hourly Rate 40 30 5

(9) Bonus (Rs.) - 8 x 5 i.e. Wages for time saved x Bonus Rate 8 6 0.5 (10) Total - (Rs.) 7+ 9 68 76 95.5 Note : It is assumed that the amount of bonus is not decided on rates of bonus on cumulative basis. (2) During one week X makes 200 units. He receives wages for a guaranteed 44 hours per week at a rate of Rs. 1.50 per hour. Estimated time to produce one unit is 15 minutes. Time allowed is increased by 20% allowance on estimated time, under incentive scheme. Calculate earnings as per : (i) Time rate (ii) Piece rate (iii) Rowan scheme (iv) Halsey scheme Solution : (i) Time Rate : No. of Hours X Hourly Rate = 44 Hours x Rs. 1.50 = Rs. 66 274 Management Accounting (ii) Piece Rate : Hourly Rate Units produced X Units per hour = 200 units X Rs. 1.50 = Rs. 75 4 units (iii) Rowan Scheme : Time Saved Actual Hours X Hourly Rate + X Actual Hours X Hourly rate Time Allowed 16 Hours = 44 Hours x Rs. 1.50 + X 44 Hours X Rs. 1.50 60 Hrs = Rs. 66 + Rs. 17.60 = Rs. 83.60 (iv) Halsey Scheme : Actual Hours X Hourly Rate + 1/2 (Time Saved X Hourly Rate) = 44 Hours X Rs. 1.50 + 1/2 (16 Hours X Rs. 1.50) = Rs. 66 + Rs. 12 = Rs. 78 Working Notes : For incentive scheme, time allowed is increased by 20% of estimated time Estimated time is 15 minutes per unit For incentive scheme, time allowed will be 15 minutes + 20% = 18 minutes Time allowed for 200 units will be 18 minutes X 200 units = 60 Hours 60 minutes Actual time taken is 44 Hours. Hence, time saved will be 16 hours ( i.e. 60 hours - 44 hours) Labour Cost 275 It is assumed that the allowance of 20% is available only in case of incentive systems and not in case of time rate or piece rate systems. (3) In a factory under bonus system, bonus hours are credited to the employee in the proportion of time taken which time saved bears to time allowed. Jobs are carried forward

from one week to another. No overtime is worked and payment is made in full for all units worked on, including those subsequently rejected. From the following information, you are required to calculate for each employee. (1) Bonus hours and amount of bonus earned. (2) Total wages cost. (3) Wage cost of each unit (good) produced. Employee A B C Basic wage rate per hour Rs. 5 Rs. 8 Rs. 7.5 Units issued for production 2,500 2,200 3,600 Time allowed for 100 units 2H 36M 3H 1H 30M Time taken 52H 75H 48H Rejections 100 units 40 units 400 units Solution : The description of the bonus system indicates that it is Rowan system of incentive payment. ABC (1) Time allowed for 100 units 156 min. 180 min. 90 min. (2) Units issued for production 2,500 2,200 3,600 (3) Time allowed for actual production 65 hours 66 hours 54 hours (4) Time taken 52 hours 75 hours 48 hours (5) Time saved i.e. 3-4 13 hours - 6 hours (6) Hourly basic wage rate (Rs.) 5 8 7.5 (7) Basic wages i.e. 4 x 6 (Rs.) Time taken x Hourly rate 260 600 360 (8) Bonus earned : (Rs.) Time Hourly Time saved XX taken rate Time allowed 52 - 40 (9) Total wages i.e. 7 + 8 (Rs.) 312 600 400 276 Management Accounting ABC (10) Rejections (units) 100 40 400 (11) Good units i.e. 2-10 2,400 2,160 3,200 (12) Wages per good unit i.e. 9/11 Re. 0.13 Re. 0.28 Re. 0.125 (4) From the following particular, you are required to work out the earnings of a worker under. (a) Straight Piece Rate (b) Differential Piece Rate (c) Halsey Premium Scheme (50% Sharing) (d) Rowan Premium Scheme Weekly working hours - 48 Hourly wage rate - Rs. 7.50 Piece Rate per unit - Rs. 3.00 Normal time taken per piece - 20 minutes Normal output per week - 120 pieces Actual output for the week - 150 pieces Differential piece rate - 80% of piece rate when output below normal and 120% of piece rate when output above normal. Solution : (a) Straight Piece Rate : Actual output x piece rate per unit = 150 pieces x Rs. 3 = Rs. 450 (b) Differential Piece Rate : Actual output is more than normal output. Hence, piece rate will be 120% of normal piece rate. Applicable piece rate 120% of Rs. 3 i.e. Rs. 3.60 Wages = Actual output x Applicable piece rate per unit

= 150 piece x Rs.3.60 = Rs. 540 Labour Cost 277 (c) Halsey Premium Scheme : Actual Hours X Hourly Rate + (Time Saved x Hourly Rate) 2 = 48 hours X Rs. 7.50 + 2 hours X Rs. 7.50 2 = Rs. 360 + Rs. 15/2 = Rs. 367.50 (d) Rowan Premium Scheme : Time Saved Actual Hours x Hourly Rate + X Actual Hours X Hourly Rate Time Allowed 2 hours = 48 hours X Rs.7.5 + X 48 hours x Rs. 7.50 50 hours = Rs. 360 + Rs. 14.40 = Rs. 374.40 Note : Time saved is calculated as below : Normal time per piece - 20 minutes Pieces per hour - 3 Pieces produced - 150 Hours allowed for pieces produced - 50 i.e. 150/3 Actual hours taken - 48 Hours saved - 2 (5) In an engineering workshop, 15 persons work in a group. If the weekly production of the group exceeds 120 units per hour (which is standard), each man gets a bonus in addition to his hourly earnings. Bonus regulation - Each workers share should be 1/2 of the percentage in excess of standard production. The bonus shall be payable at this percentage of wage rate Rs.1.50 per hour. There is no relationship between individual workers hourly rate and bonus rate. 278 Management Accounting The following is a weekly output : Day Hours worked Output in units Monday 150 24,700 Tuesday 160 25,500 Wednesday 145 17,060 Thursday 155 18,050 Friday 170 28,900 Saturday 160 21,150 940 1,35,360 Compute a. The rate and amount of bonus for the week. b. Total earnings of David who worked 40 hours during the week and his basic wage was Rs. 1.20 per hour and that of Abdulla who worked for 48 hours and his basic wage was Rs. 1.25 per hour. Solution : (a) Actual Production for the week 1,35,360 units Standard production i.e. 940 x 120 1,12,800 units Excess Production 22,560 units 22,560

Excess production percentage = X 100 = 20% 1,12,800 Bonus percentage for the group = 1/2 of 20% = 10% Bonus Rate : 10% of Rs. 1.50 = Re. 0.15 per hour Labour Cost 279 (b) (1) Total Earnings of David : Basic wages - 40 hours x Rs. 1.20 hours Rs. 48.00 Bonus - 40 hours x Re. 0.15/hour Rs. 6.00 Rs. 54.00 (2) Total Earnings of Abdulla : Basic wages - 48 hours x Rs. 1.25/hour Rs. 60.00 Bonus - 48 hours x Rs. 0.15/hour Rs. 7.20 Rs. 67.20 (6) Two fitters, a labourer and a boy, undertake a job on piece rate basis for Rs. 1,290. The time spent by each of them is 220 ordinary working hours. The rates of pay on time rate basis are Rs. 1.50 per hour for each of the two fitters. Re. 1 per hour for the labourer and Re. 0.50 per hour for the boy. Calculate : (a) The amount of piece-work premium and the share of each worker, when the piece work premium is divided proportionately to the wages paid. (b) The selling price of the above job on the basis of following data - Cost of Direct Materials is Rs. 2,010, works overhead at 20% of Prime Cost, selling overhead at 10% of works cost and Profit at 25% of cost of sales. Solution : (A) (1) wages payable on time basis Fitter 220 hrs. x 2 x Rs. 1.50 = Rs. 660 Labourer 220 hrs. x Re. 1 = Rs. 220 Boy 220 hrs. x Re. 0.50 = Rs. 110 Basic Wages = Rs. 990 (2) Price of the job Rs. 1,290 (3) Premium received i.e. b - a Rs. 300 (4) Share of each worker Fitters Rs. 300 X Rs. 660 Rs. 200.00 Rs. 990 280 Management Accounting Labourer Rs. 300 X Rs. 220 - Rs. 66.67 Rs. 990 Boy Rs. 300 X Rs. 110 - Rs. 33.33 Rs. 990 Rs. 300.00 (b) Fixation of selling price : Cost of Direct Material Rs. 2,010.00 Cost of Labour Rs. 1,290.00 Prime Cost Rs. 3,300.00 Works Overheads (20% of Prime Cost) Rs. 660.00 Works Cost Rs. 3,960.00 Selling Overheads (10% of works cost) Rs. 396.00

Cost of Sales Rs. 4,356.00 Profit (25% on cost of sale) Rs. 1,089.00 Selling Price Rs. 5,445.00 (7) A worker, whose daily work wages is Rs. 2.50 an hour, received production bonus under the Rowan scheme. He carried out the following works in a 48 hours week. Job 1 - 1,500 items at 4 hours per 1000 Job 2 - 1,800 items at 3 hours per 1000 Job 3 - 9,000 items at 6 hours per 1000 Job 4 - 1,500 items for which no Standard time was fixed and it was arranged that the worker would be paid a bonus of 25%. Actual time taken on the job was 4 hours. Job 5 - 2,000 items at 8 hours per 1000, each item was estimated to be half finished. Job No. 2 was carried out on a machine running at 90% efficiency and an extra allowance of 1/9th of actual time was given to compensate the worker. Labour Cost 281 4 hours were lost due to power cut. Calculate the earnings of the worker, clearly stating your assumptions for the treatment given by you for the hours last due to power cut. Solution : (a) Calculation of time allowed Job 1 - 6 hours Job 2 - 6 hours Job 3 - 54 hours Job 4 - 5 hours Job 5 - 8 hours 79 hours (b) Time taken 44 hours (Except idle time) (c) Time saved 35 hours (d) Total wages (As per Rowan system) Time saved Time taken X Hourly rate + X Time taken X Hourly Rate Time allowed 35 hours = 44 hours X Rs. 2.50 + X 44 hours X Rs. 2.50 79 hours = Rs. 110 + Rs. 48.73 = Rs. 158.73 (e) Idle time wages (At hourly rate) 4 hours X Rs. 2.50 = Rs. 10 (f) Total earnings - i.e. d + e Rs.158.73 + Rs. 10.00 = Rs.168.73 282 Management Accounting Note : (1) The idle time is not treated for computing time taken. For idle hours, the worker will get the wages at normal hourly rate. (2) Time allowed for Job 2, Job 4 and Job 5 is calculated as below : (a) Job 2 : Time taken for 1,800 units 5.40 hour Add :Extra allowance 1/9 0.60 hour Time allowed 0.60 hour (b) Job 4 : Time taken for 1500 units 4 hours Add : Allowance @ 25 1 hour Time allowed 5 hours

(c) Job 5 : Time taken for 2000 16 hours Each item half finished Equivalent finished units 1,000 Time for equivalent finished units 8 hours QUESTIONS 1. Explain the various steps in the process of identifying the direct labour cost with the individual cost center. 2. What do you mean by idle time. Explain in details the cost accounting treatment of idle time. 3. Explain the term Labour Turnover. What are the causes responsible for labour turnover? Explain the costs of labour turnover. How the Labour turnover is measured? Labour Cost 283 PROBLEMS (1) During the first week of March, 1984 the workman Mr. Saurabh manufactured 300 articles. He receives wage for a guaranteed 48 hours week at the rate of Rs. 4/- per hour. The estimated time to produce one article is 10 minutes and under incentive scheme the time allowed is increased by 20%. Calculate his gross wages according to : (a) Piece work with guaranteed weekly wage. (b) Rowan premium bonus and (c) Halsey premium bonus 50% to workman. (2) Calculate total monthly remuneration of three workers A, B and C from the following data. (a) Standard production per month per worker 1,000 units. (b) Actual production during the month A - 850 units, B - 750 units, C - 950 units. (c) Piece rate is Re. 0.10 per unit. (d) Additional production bonus is Rs. 10 for each percentage of actual production exceeding 80% over standard. (Example 79% Nil, 80% - Rs. 10, 81% - Rs. 20 and so on) (e) Dearness allowance fixed Rs. 60 per month. (3) Following are the particulars as regards a worker who worked on jobs No. 122 and 133. Job No. Time allowed Time taken 122 26 hours 20 hours 133 26 hours 30 hours His normal and basic rate of wages was Rs. 28 per day of 8 hours and the dearness allowance was Rs. 42 per week of 48 hours. Calculate the amount payable to him by showing your workings on the following basis. (a) Time basis. (b) Halsey Incentive Plan basis (Bonus at 50% of time saved) (c) Rowan Incentive Plan basis. 284 Management Accounting (4) Standard time fixed for a job is 40 hours and time rate is Rs. 4 per hour. You are required to prepare a comparative table under Halsey Plan 50 - 50 and Rowan Plan, if actual time taken is 36 hours, 32 hours, 24 hours, 16 hours and 12 hours. The table should clearly show (a) Bonus payable, (b) Total earnings, (c) Effective rate of earnings per hour. (5) Calculate the earnings of a workman under Halsey Premium Plan and Rowan Premium Plan for executing a piece of work in 60 hours as against 75 hours allowed. His hourly rate is 25 paise and under Halsey system, he is to be paid bonus at 50% of time saved. In addition, he gets a dearness allowance for Re. 1 per day of 8 hours worked. (6) From the following information, calculate the earnings of A, B and C under Halsey and Rowan premium bonus plans. ABC Standard time in hours per 100 units 35 40 42 Wages per unit of output Rs. 2 Rs. 3 Rs. 4

Wage rate per hour Rs. 7 Rs. 8 Rs. 10 Actual hours taken 50 48 46 Actual no. of units produced 200 150 125 (7) The firm employs 5 workers at an hourly rate of Rs. 2.00. During the week they worked for 4 days for a total period of 40 hours each and completed a job for which standard time was 48 hours for each worker. Calculate the labour cost under the Halsey Method and Rowan Method of incentive Plan Payments. (8) Compute the total time wages and total earnings of a worker, the rate earned per hour and the bonus per hour in respect of three workers X,Y, and Z under the Halsey-Weir bonus plans. The following are the particulars supplied. Standard Time : 20 hours. Hourly Rate of Wages : Re. 1.00 per hour. Time Taken X = 16 hours, Y = 12 hours and Z = 10 hours. Labour Cost 285 (9) The three workers Govind, Ram and Shyam produced 80, 100 and 120 pieces of a product X on a particular day in May 1987 in a factory. The time allowed for 10 units of Product X is 1 hour and their hourly rate is Rs. 4. Calculate for each of these three workers the following : (a) Earnings for the day (b) Effective rate of earnings per hour under (i) Straight piece Rate (ii) Halsey Premium Bonus (50% sharing) (iii) Rowan Premium Bonus methods of Labour Remuneration (10) A worker takes 6 hours to complete a job under a scheme of payment by results. The standard time allowed for the job is 9 hours. His wage rate is Rs. 1.50 per hour. Material cost of the job is Rs. 16 and the overheads are recovered at 150% of the total direct wages. Calculate the factory cost of the job under - (a) Rowan and (b) Halsey scheme of incentive payments. (11) In an engineering concern, the employees are paid incentive bonus in addition to their normal wages at hourly rates. Incentive bonus is calculated in proportion of time taken to time allowed, of the time saved. The following details are made available in respect of employees X, Y and Z for a particular week. XYZ Normal Wages (Rs. per hour) 4.00 5.00 6.00 Completed units of production 6000 3000 4800 Time Allowed (per 100 units) 0.8 hr. 1.5 hrs. 1 hr. Actual time taken (hours) 42 40 48 You are required to work out for each employee (a) The amount of bonus earned. (b) The total amount of wages received. (c) The total wages cost per 100 units of output. 286 Management Accounting (12) A workman whose basic rate of pay under Rowan plan of premium bonus is Rs. 2 per hour. In addition, he receives a cost of living bonus of Rs. 33 per week of 66 hours on actual hours worked. During a week, he does the following jobs. (i) Job A for which 30 hours are allowed in 20 hours. (ii) Job B for which 36 hours are allowed in 20 hours. During this week, his waiting time was 4 hours. Calculate his earnings and amount to be charged to each job. (13) An operator engaged on a machine, receives an ordinary day rate of Rs. 1.60 per day of 8 hours. The standard output has been fixed at 80 pieces per hour (time as fixed for premium bonus.) On a certain day, the output of a worker on this machine is 800 pieces. Find the labour cost per 100 pieces and the wages that should have been actually earned by the workman under the following (a) If a bonus of Re. 0.23 is paid per 100 of extra output.

(b) If paid on straight piece work basis at the standard rate. (c) If Halsey Premium System is adopted. (14) In a manufacturing concern, 20 workmen work in a group. The concern follows a group incentive bonus system whereby each workman belonging to the group is paid a bonus on the excess output over the hourly production standard of 250 pieces, in addition to his normal wages at hourly rate. The excess of production over the standard is expressed as a percentage and two thirds of this percentage is considered to be the share of the workman and is applied to the normal hourly rate of Rs. 6.00 (Considered only for purpose of computation of bonus.) The output data for a week are stated below. Days Manhours worked Output (in pieces) Monday 160 48,000 Tuesday 172 53,000 Wednesday 164 40,000 Thursday 168 52,000 Friday 160 46,000 Saturday 160 42,000 984 2,81,000 Labour Cost 287 You are required to (a) Work out the amount of bonus for the week and the average rate of which each workman is to be paid the same. (b) Compute the total wages including bonus payable to Ram Jadhav who worked for 48 hours at an hourly rate of Rs. 2.50 and to Francis Williams who worked for 52 hours at an hourly rate of Rs. 3.00. (15) Following data for the month of October 1990 is available for a company. No. of workers on payroll on 1st October, 90 - 1450 No. of workers on payroll on 31st October 90 - 1550 During the month 10 workers left the company, 70 persons were discharged and 200 workers were recruited. Of these workers, 40 workers were recruited in the vacancies of those who had left and the remaining were recruited for an expansion programme. Calculate the labour turnover rate by using (i) Separation Method (ii) Replacement Method (iii) Flux Melhod 288 Management Accounting NOTES Overhead Cost 289

Chapter 10
OVERHEAD COST
It has already been discussed that the term cost can be basically classified as Direct Cost and Indirect Cost. Direct Cost indicates all those costs which can be identified with the individual cost centre and indirect cost indicates all those costs which cannot be identified with the individual cost centre. The total of indirect costs are termed as overheads. There may be various ways in which the overheads may be classified. (1) Elementwise Classification : As the cost can be basically classified as per the Elements of Cost i.e. Material Cost, Labour Cost and Expenses, the indirect cost i.e. overheads may be classified as per the elements of cost. This classification of overheads takes the form of : (a) Indirect Material (b) Indirect Labour (c) Indirect Expenses. The meaning and the type of expenses included in this classification have already been discussed in the chapter on Cost Sheet.

(2) Functionwise Classification : Under this classification, the overheads are classified according to the functions they perform. This classification of overheads takes the form of : (a) Factory Overheads (also termed as production or works or manufacturing overheads) (b) Administration Overheads. (c) Selling and Distribution Overheads.The meaning and the type of expenses included in this classification have already been discussed in the chapter on Cost Sheet. (3) Variabilitywise Classification : (i) Fixed overheads : These overheads indicate the costs which remain unaffected by variations in volume of output. E.g. Rent, Insurance on building, salary to 290 Management Accounting administrative staff etc. Per unit cost of overheads may reduce as the volume of output increases but the total overheads remain constant. (ii) Variable overheads : These overheads indicate the costs which vary directly in proportion to volume of output. E.g. Consumable stores, nuts/bolts, loose tools etc. Per unit cost of overheads remains the same but total overheads may increase or decrease as per volume of output. (iii) Semi-variable overheads : These overheads indicate those which are neither fixed nor variable in nature. These may remain fixed at certain levels of activity while may vary proportionately at other levels of activity. E.g. maintenance cost, power, electricity, supervision cost etc. (4) Controllabilitywise Classification : Under this classification, the overheads are classified according to their controllable nature. This classification takes the form of : (a) Controllable overheads. (b) Uncontrollable overheads.This classification has already been discussed. (5) Normalitywise Classification : Under this classification, the overheads are classified according to the fact as to whether the overheads are normally incurred at a certain level of output under normal circumstances. This classification takes the form of : (a) Normal overheads. (b) Abnormal overheads. This classification has already been discussed. It should be noted in this connection, that the above classification refers to the classification of same amount of overheads in different forms to suit the individual requirements. E.g. For the purpose of preparing the cost statement, overheads may be classified according to functions while for the purpose of marginal costing applications, overheads may be classified according to variability. Procedure for Charging the Overheads : The basic aim of costing is to find out the cost of each cost centre. The cost of each cost centre can be either the direct cost or the indirect cost. The direct cost can be identified with the individual cost centre and hence poses no difficulties. To charge the indirect costs i.e. overheads to the individual cost centres is the major problem. For this, the following procedure may be followed. Overhead Cost 291 (A) Allocation/Primary Apportionment : There can be some overheads which are incurred for the company as a whole, i.e. for all the departments. i.e. Production as well as Service departments. To identify the common costs with the individual departments is the first stage problem. This can be solved in two ways. (1) If at all it is possible to identify some overheads with the individual departments they should be identified by following the procedure of allocation of overheads. E.g. Wages paid to the maintenance department workers can be obtained from wages sheet and can be allocated to maintenance department. Similarly, cost of indirect material can be allocated to individual departments by pricing material requisition slips. (2) It may not be possible in all the cases to allocate the overheads, i.e. in case of common expenses for the entire factory. In this case, they can be apportioned among the various

departments on some suitable basis, i.e. to all production as well as service departments. This process is in the form of Primary apportionment or distribution of overheads. The selection of the base on which overheads are or should be apportioned depends on the following principles : (a) Service or use basis : If the benefit obtained by various departments from the overheads can be measured, overheads can be apportioned on that basis. (b) Survey basis : If amount of services rendered cant be measured, survey basis may be applied. E.g. If it can be noted that a supervisor is giving 60% of his services to department A and 40 % to department B, his wages can be apportioned on that basis. (c) Ability to pay basis : In this case, the apportionment may depend upon the factors like total sales/profitability. It may not be fair in some cases as most efficient departments may have to bear higher amounts of overheads, though actual overheads of that department may be lower than those of other departments. The usual bases which can be selected for Primary Apportionment may be as below : Item of expenditure Base (1) Canteen expenses/Staff Supervision Number of workers. (2) Rent/Taxes Area (3) Power HP/KWh (4) General Lighting Number of light points/area (5) Depreciation Value of assets (6) Supervision Number of Employees/wages paid 292 Management Accounting (7) Telephone expenses Number of telephone calls made (8) Fire Insurance. Value of stocks held/value of Assets. Illustration : The Omega Co, is having four departments. A, B, and C are production departments and D is a servicing department. The actual costs for a period are as follows. Rs. Rent 2,000 Repairs 1,200 Depreciation 900 Light 200 Supervision 3,000 Insurance 1,000 Employees Insurance (Employers liability) 300 Power 1,800 The following data are also available in respect of departments. Dept. A Dept. B Dept. C Dept. D Area sq. ft. 150 110 90 50 Number of workers 24 16 12 8 Total wages (Rs.) 8,000 6,000 4,000 2,000 Value of plant (Rs.) 24,000 18,000 12,000 6,000 Value of stock (Rs.) 15,000 9,000 6,000 Apportion the cost to the various departments on the most equitable method. Overhead Cost 293 Solution : Apportionment of Overheads Particulars Base Total Dept. Dept. Dept. Dept. Rs. A B C D Rs. Rs. Rs. Rs. Rent Area sq. ft. 2,000 750 550 450 250 Repairs Total wages 1,200 480 360 240 120 Depreciation Value of Plant 900 360 270 180 90 Light Area sq. ft. 200 75 55 45 25 Supervision No. of workers 3,000 1,200 800 600 400

Insurance Value of stock 1,000 500 300 200 Employees Insurance (Employers Liabilities) No. of workers 300 120 80 60 40 Power Value of Plant 1,800 720 540 360 180 10,400 4,205 2,955 2,135 1,105 Notes : It is assumed that the insurance is payable only on stock. Had it been assumed that it is payable on stock as well as plant, the base would have been the combined value of stock and plant. For the apportionment of power cost, Kwh/HP rating would have been an ideal base. As relevant data is not available, it is apportioned on the basis of value of plant. Repairs are apportioned on the basis of total wages assuming that repair charges consist of mainly labour charges. (3) Secondary Apportionment : With the process of primary apportionment or distribution, the loading of overheads for all the departments i.e. production as well as service departments can be obtained. Next step is to transfer the overheads of non-production departments to production departments, as the various cost centres move through the production departments only. This is in the form of Secondary apportionment or distribution of overheads. 294 Management Accounting The usual bases which can be selected for the secondary apportionment may be as below : (1) Maintenance Dept. - Number of hours worked. (2) Stores Dept. - Number of requisitions. (3) Purchase Dept. - Number of Purchase orders (4) Building Service Dept. - Area (5) Welfare/ Canteen and other facilities - Number of employees. (6) Personnel or Time keeping Dept. - Number of employees. (7) Internal Transport - Weight/value of goods moved. While apportioning the overheads of non-production departments to production departments, the problem will be there if non-production departments are rendering the services inter-se. There can be two ways to handle the situation like this (A) Ignore the services given by one service department to another. The defects involved with this method are very obvious. Illustration : Following figures are extracted from the accounts of M/s. Vasant Works for the month of July 1983. Production Depts. Service Depts. P1 P2 S1 S2 S3 Indirect Material 280 140 170 350 160 Indirect Wages 324 312 296 190 218 Power and Light Rs. 3,000 Supervision Charges Rs. 2,200 Rent and Taxes Rs. 500 Insurance on assets Rs. 60 Depreciation at 12% p.a. on capital value of assets to be considered. From the above information and the following departmental data, prepare overhead recovery rates for the production departments PI and P2 on the basis of direct labour hours. The expenses of service departments should be apportioned straight to the production depts. with the information that SI is tool room, S2 is maintenance dept. and S3 is stores dept. Overhead Cost 295 Departmental Data : P1 P2 S1 S2 S3 Area (sq. ft.) 400 200 100 200 100 Capital Value of Assets (Ps.) 8000 4000 7000 5000 6000 Kilowatt Hours 4000 3000 1000 1000 1000

Number of employees 150 100 75 100 125 Direct Labour Hours 5000 5000 Number of requisitions 1000 300 Solution : Statement showing apportionment of overheads Items Base P1 P2 S1 S2 S3 Rs. Rs. Rs. Rs. Rs. Indirect Material Allocation 280 140 170 350 160 Indirect wages Allocation 324 312 296 190 218 Power & Light Kilowatt Hrs 1200 900 300 300 300 Supervision No. of employees 600 400 300 400 500 Rent & Taxes Area 200 100 50 100 50 Insurance on Assets Value of assets 16 8 14 10 12 Depreciation Value of assets 80 40 70 50 60 2700 1900 1200 1400 1300 Dept. S1 Labour Hours 600 600 (-)1200 Dept. S2 Labour Hours 700 700 (-)1400 Dept. S3 No. of requisitions 1000 300 (-)1300 5,000 3,500 (B) If it is decided to consider the services rendered by one service department to another, the first problem will be to decide the percentage in which services are given by service departments inter-se. After such percentage is decided, the secondary apportionment can be made by either of the following methods. (i) Simultaneous Equation Method : Under this method the amount of overheads of each production department can be obtained by solving simultaneous equations. 296 Management Accounting (ii) Repeated Distribution Method : Under this method service dept. overheads are distributed to other departments, production as well as service, on agreed percentage and this process is repeated till the figures of service departments are exhausted or are too small to consider further apportionment. Illustration : A company has 3 production depts. and 2 service depts. and for a period departmental distribution summary has the following totals. Production Depts. A ..Rs. 800 B Rs. 700 C. Rs. 500 Service Depts. 1 ....Rs. 234 2.. Rs. 300 The expenses of service depts. are charged out on a percentage basis as : ABC12 Service Dept. 1 20% 40% 30% - 10% Service Dept. 2 40% 20% 20% 20% You are required to show the apportionment of overheads. Solution : (a) Simultaneous Equation Method : Let x = total overheads of Dept. 1 y = total overheads of Dept. 2 x = 234+ 2/10 y and y = 300 1/10 x 10 x = 2340 + 2y ...(1) and 10 y = 3000 + x ...(2) Rearranging equation 2 and multiplying equation I by 5 10y = 11700 - 50x 10y = 3000 + x Adding 0 = 14700 49x 49 x = 14700 x = 300 ...(3) However, Y = 300 + 1/10 x Y = 300 + 1/10 x 300

Y = 330 ...(4)
Overhead Cost 297

Total overheads can be apportioned on the basis of agreed percentages to production departments as below. Total Dept. A Dept. B Dept. C Rs. Rs. Rs. Rs. As per Primary appointment 2,000 800 700 500 Dept. 1 (90% of Rs. 300) 270 60 120 90 Dept. 2 (80% of Rs. 330) 264 132 66 66 2534 992 886 656 (b) Repeated Distribution Method : Dept. A Dept. B Dept. C Dept. 1 Dept. 2 Rs. Rs. Rs. Rs. Rs. As per Primary appointment 800 700 500 234 300 Dept. 1 47 94 70 (-) 234 23 Dept. 2 129 65 64 65 (-) 323 Dept. 1 13 26 20 (-) 65 6 Dept. 2 3 1 2 - (-) 6 992 886 656 - (3) Absorption : The process of secondary apportionment of overheads, ensures the loading of overheads to production departments. Now the next stage is that each job or product should get the loading of the overheads while it is moving through the production department and this process is in the form of Absorption or Recovery of overheads. There can be a number of methods for absorbing the overheads but the ultimate selection of method has to be made after considering various factors like type of industry, nature of products, manufacturing process, requirements and policy of management, cost of operating the system etc. The various methods which can be considered for deciding the rates of overhead absorption are as below : (1) Direct Materials Cost Percentage Rate : This is calculated as : Amount of overheads to be absorbed X 100 Direct Materials cost 298 Management Accounting E.g. If production overheads to be absorbed are Rs. 25,000/and Direct materials cost is Rs. 50,000, the absorption rate will be : 25,000 X 100 i.e. 50% 50,000 Now if the direct materials cost of a job is Rs. 500, it will be getting the loading of overheads to the extent of 50% of direct materials cost, i.e. Rs. 250. This method is useful if materials cost forms a major part of production cost and is normally used if materials costs are stable and equipments used remain unchanged. This method leads to unsatisfactory results due to following reasons. (i) There can be some situations where material prices vary without any change in the amount of over heads, in which case, this method may show wrong results. (ii) If this method is used, a job using expensive material may get high loading of overheads as compared to a job using cheap material, which may not be fair. (2) Direct Wages Percentage Rate : This is calculated as : Amount of overheads to be absorbed X 100 Direct wages cost E.g. If the production overheads to be absorbed are Rs. 10,000 and direct wages cost is

Rs. 40,000, the absorption rate will be : 10,000 X 100 i.e. 25% 40,000 Now if the direct wages cost of a job is Rs. 400, it will be getting the loading of overheads to the extent of 25% of direct wages cost, i.e. Rs. 100. This method is useful if labour cost forms a major part of production cost and also if the work performed by all the workers is uniform, ratio of skilled and unskilled workers is constant and labour rates do not fluctuate widely. The problem with this method is that there is very little relationship between direct wages and overhead expenses. It may give wrong results if the workers vary in ability. Overhead Cost 299 (3) Prime Cost Percentage Rate : This is calculated as : Amount of overheads to be absorbed X 100 Prime Cost E.g. if the production overheads to be absorbed are Rs. 16,000 and prime cost is Rs. 80,000, the absorption rate will be : 16,000 X 100 i.e. 20% 80,000 Now if the prime cost of a job is Rs. 250, it will be getting the loading of overheads to the extent of 20% of prime cost, i.e. Rs. 50. This method is useful in this sense that it considers both the materials cost as well as labour cost. (4) Labour Hour Rate : This is calculated as : Amount of overheads to be absorbed Labour hours required for production. E.g. if production overheads to be absorbed are Rs. 50,000 and labour hours worked are 100,000, the absorption rate will be : Rs. 50,000 i.e. Re. 0.50 per labour hour. 100,000 Now, if a job requires 20 labour hours to complete it, the loading of overheads to the same will be Re. 0.50 per labour hour i.e. Rs. 10/-. This method is useful if labour is the most important element of cost. However, additional records are required to be kept for time booking per job. Further, if machinery forms a dominant portion in production cost, this method may lead to wrong results. 300 Management Accounting (5) Machine Hour Rate : This is calculated as : Amount of overheads to be absorbed Number of Machine Hours E.g. if production overheads to be absorbed are Rs. 20,000 and machine hours worked as 5000, the absorption rate will be Rs, 20,000 i. e. Rs. 4 per machine hour. 5,000 Now if a job requires 25 machine hours to complete, the loading of overheads to the same will be Rs. 4 per machine hour, i.e. Rs. 100. If the machine use accounts for a large element of cost in the overall production cost, then this method can be used conveniently. This rate can be considered to be useful and ideal especially in the days of high mechanisation and automation.

While computing the machine hour rate, it is necessary to consider the various overheads required to be incurred for running a machine or group of machines treating the same as distinct cost centres. Illustration : Following information relates to activities of a production dept. of a factory for a certain period. Direct Materials used Rs. 4,000 Direct wages Rs. 6,000 Direct Labour hours worked (Including 20,000 hrs. of Machine operations) 24,000 Overheads chargeable to the dept. Rs. 5,000 For order No. 156 carried out in dept. relevant figures were. Direct Materials used Rs. 200 Direct wages Rs. 165 Direct labour hours (Including 800 machine hours) 820 Calculate the overheads chargeable to Order No. 156 by 5 cost rates. Overhead Cost 301 Solution : Calculation of overhead absorption rate (a) Direct Material Cost percentage : Amount of overheads X 100 Direct Material Cost = Rs. 5,000 X 100 = 125% Rs. 4,000 (b) Direct Labour Cost percentage : Amount of overheads X 100 Direct Labour Cost = Rs. 5,000 X 100 = 83 1/3% Rs. 6,000 (c) Prime Cost percentage : Amount of overheads X 100 Prime Cost = Rs. 5,000 X 100 = 50% Rs. 10,000 (d) Labour Hour Rate : Amount of overheads Direct Labour Hours = Rs. 5,000 = Re. 0. 2083 / Labour Hour. 24,000 (e) Machine Hour Rate Amount of overheads Machine Hours = Rs. 5,000 = Rs 0.25 / Machine Hour.

20,000 302 Management Accounting The overheads chargeable to Order No. 156 and the total cost of the same can be calculated as below : Material Labour Overheads Total Rs. Rs. Rs. Rs. (a) Direct Material Cost percentage 200.00 165.00 250.00 615.00 (b) Direct Labour Cost percentage 200.00 165.00 137.50 502.50 (c) Prime Cost percentage 200.00 165.00 182.50 547.50 (d) Labour Hour Rate 200.00 165.00 170.83 535.83 (e) Machine Hour Rate 200.00 165.00 200.00 565.00 Illustration : Compute the machine hour rate from the following data. Cost of the machine Rs. 1,00,000 Installation charges Rs. 10,000 Estimated scrap value after the expiry of life (15 years) Rs. 5,000 Rent and Rates for the shop per month Rs. 200 General lighting for the shop per month Rs. 300 Insurance charges for the machine per annum Rs. 960 Repairs and Maintenance expenses per month Rs. 1,000 Power consumption 10 Units per hour. Estimated working hours per annum 2,200 (This includes setting up time of 200 hours) Rate of power per 100 Units Rs. 20 Shop supervisors salary per month Rs. 600 The machine occupies 1/4 of the total area of the shop. The supervisor is expected to devote 1/5 of the total time for the supervision of the machine. Overhead Cost 303 Calculation of Machine Hour Rate : (a) Standing Charges Rs. Depreciation 7,000.00 Rent and Rates 600.00 General lighting 900.00 Insurance Charges 960.00 Repairs and Maintenance 12,000.00 Shop Supervisors salary 1,440.00 Annual standing charges 22,900.00 Annual Machine Hours (Excluding setting up time) 2000 Hourly standing charges Rs. 11.45 (b) Running charges : Power Expenses Rate of power 20 paise per unit. Power consumption - 10 units per hour. Hourly power expenses Rs. 2.00 (c) Machine Hour Rate i.e. a + b Rs. 13.45 Working Notes : (1) It is assumed that during the setting up time, the machine will not be used for the intended purpose and hence the said time is ignored for the calculation of machine hour rate. (2) It is assumed that the depreciation is charged on straight-line basis. Hence, it is calculated as : Cost of Machine + Installation charges Estimated scrap value Estimated life of machine =

Rs. 100,000 + Rs. 10,000 Rs 5000 = Rs. 7,000 p.a. 15 years (3) It is assumed that the Repairs and Maintenance expenses are incurred only for the machine. 304 Management Accounting Actual V/s. Predetermined Overhead Absorption Rates The overhead absorption rates can be considered on actual basis or predetermined basis. For computing the absorption rates on actual basis, the actual data for the previous period is considered, i. e. Actual overheads, actual direct materials/wages cost, actual prime cost, actual labour hours worked, actual machine hours worked etc. However, the actual overhead absorption rates have certain limitations. (1) The actual details are available only after the end of actual accounting period and required details may not be available either for proper control of overheads or for price fixation. (2) If the production is of seasonal nature, overhead absorption rates will not be constant monthwise and comparison of production costs monthwise will be difficult. As such, it is customary to consider predetermined overheads absorption rates instead of actual overhead absorption rates. By predetermined rates it is meant that instead of considering actual data in respect of Direct Materials/Wages/Prime Cost or Labour/Machine Hours, estimations are made in respect of the same and predetermined overhead absorption rate is applied whenever computations are to be made in respect of product cost of a job. Under Absorption or Over Absorption of Overheads If the organization follows the policy of considering predetermined overhead absorption rates, it may face the problem of under or over absorption of overheads if the actual overheads to be absorbed or the bases for the absorption, i.e. Materials/ Wages/ Prime cost or Labour/Machine Hours etc. vary from the assumption. E.g. A Company considers the overhead absorption rate as a direct materials cost percentage rate. It is decided that predetermined overhead absorption rate should be considered for the forthcoming year 1989. As such, the predetermined overhead rate was estimated on the basis of following details. i.e. Estimated amount of overheads X 100 Estimated Direct Materials cost i.e. Rs. 10,000 X 100 i.e. 20% Rs. 50,000 Now, on this basis all the jobs moving through that department during 1989 will be getting the loading of overheads @ 20% of Direct Materials Costs. After the year 1989 ended, the actual details are computed and it is found out that whereas Direct Materials cost was as estimated, i.e. Rs. 50,000, the actual amount of overheads was reduced to Rs. 9,000. As such, the rate at which the overheads should have been absorbed, should have been Overhead Cost 305 Rs. 9,000 X 100, i.e. 18% and not 20% as originally considered Rs. 50,000 Such situation gives rise to the under absorption or over absorption of overheads. The situation of under absorption arises if the overheads absorbed are less than the actual overheads. The situation of over absorption arises if the overheads absorbed are more than the actual overheads. E.g. Overheads Actual Remarks Period Absorbed Overheads Rs. Rs. I 7,500 9,000 Underabsorption II 10,000 8,000 Overabsorption. Causes :

Under absorption of overheads may take place due to the reasons like. Actual overheads being more than the estimated overheads or Actual output or hours worked being less than those as estimated. Over absorption of overheads may take place due to the reasons like Actual overheads being less than the estimated overheads OR Actual output or hours worked being more than those as estimated. Treatment of Under or Over Absorbed Overheads : The overheads which are under or over absorbed may be treated in either of the following ways (1) Use of supplementary rate : If the amount of under or over absorbed overheads is considerably significant, the cost of the cost centres may be adjusted by means of the use of supplementary overhead absorption rate. This method of treating the over or under absorption of overheads is most important where the cost is considered as a base for quoting selling prices, E.g. Cost plus contracts. E.g. The predetermined overhead absorption rate, for the forthcoming period of months, was decided as below. Amount of overheads = Rs. 50,000 = Rs. 2 / Labour Hour. Total labour Hours 25,000 306 Management Accounting A mid term review of 6 monthly operations revealed that whereas the total labour hours during the period were 12,500, the amount of overheads incurred was Rs. 30,000. The overheads actually absorbed will be 12,500 hours x Rs. 2 i.e. Rs. 25,000. Considering the same trend of amount of overheads, the total annual overheads are likely to be Rs. 60,000, out of which Rs. 25,000 are already absorbed. As such, for the remaining 6 months, the overhead absorption rate may be calculated as : Revised amount of overheads Number of Labour Hours = Rs. 60,000 Rs. 25,000 12,500 = Rs. 35,000 = Rs. 2.80 / Labour Hour. 12,500 (2) Carrying over to remaining period : In case of seasonal types of organization, the overheads under or over absorbed during a certain period may be carried over to the remaining part of the accounting period with the hope that they may be compensated during the remaining period of time. (3) Writing off to Costing Profit and Loss Account : In case of the under or over absorption of the overheads arising out of the abnormal circumstances, they are written off to Costing Profit and Loss Account. Illustration : The budgeted working conditions of a cost centre are as follows : Normal working per week - 42 hours No. of machines - 14 Normal weekly loss of hours on maintenance etc. - 5 hours per machine No. of weeks worked per year - 48 Estimated annual overheads - Rs. 1,24,320 Estimated direct wage rate - Rs. 4 per hour. Actual result in respect of a 4 week period are : Wages incurred - Rs. 9,000 Overheads incurred - Rs. 10,200 Machine hours produced - 2,000 Overhead Cost 307 You are required to calculate :

(a) The overhead rate per machine hour (b) The amount of under or overabsorption of wages and overheads. Solution : (a) Normal working hours per year 42 weekly hours per machine (For all 14 machines) x 14 machines x 48 weeks = 28,224 machine hours. (b) Hours lost on maintenance 5 hours per week x 14 machines x 48 weeks = 3,360 machine hours. (c) Effective machine hours i.e., a - b 24,864 machine hours. (d) Estimated annual overheads Rs. 1,24,320 (e) Machine hour rate i.e., d / c Rs. 5 (f) Overheads absorbed 2000 machine hours x Rs. 5 = Rs. 10,000 (g) Overheads actually incurred Rs. 10,200 (h) Overheads underabsorbed i.e., g - f Rs. 200 WAGES (a) Labour hours for 4 weeks 42 hours x 4 week = 168 hours (b) For 14 machines 168 hours x 14 machines = 2,352 hours (c) Estimated direct wage rate Rs. 4 per hour (d) Estimated direct wages for4 weeks i.e., b x c Rs. 9,408 (e) Wages actually incurred Rs. 9,000 (f) Wages overabsorbed i.e., d-e Rs. 408 Control Over Overheads : As the basic intention of cost accounting is to exercise the control over the costs and as the overheads is a part of cost, cost accounting procedures attempt to control the overheads also. For this purpose, the following propositions should be remembered : (1) The success of procedures to control the overheads largely depends upon the correct classification of the overheads. This classification can be done from the various angles. 308 Management Accounting (a) Functionwise : This takes the form of classification in the form of factory overheads, administration overheads and selling and distribution overheads. (b) Variabilitywise : This takes the form of classification in the form of fixed overheads, variable overheads and semi-fixed or semi variable overheads. (c) Normalitywise : This takes the form of classification in the form of normal overheads and abnormal overheads. Fixed overheads normally arise as a result of policy and are largely uncontrollable at the lower level of management. They can be controlled at the top level of management. However, the variable overheads can be controlled at the lower or middle level of management as well. Most of the administration overheads are fixed in nature and can be controlled mainly at top management level. However, the factory overheads can be controlled at lower or middle management level also. (2) After the correct classification of overheads, use may be made of following two techniques with the intention to exercise proper control over overheads. (a) Budgetary control (b) Standard costing Both these techniques are discussed in details in the following chapters. However, both these techniques necessarily involve the following stages in the process of implementation. (i) Planning : This lays down the course of action to be taken in future. In case of budgetary control, it is in the form of the budgets and in case of standard costing, it is in the form of the standard cost. (ii) Implementation of plan : This indicates actual steps to execute the plan. For this,

downward communication may be necessary from top management level to lower management level. (iii) Measuring actual performance, comparison with plans and computing variances : Measurement of actual performance may be in terms of actual costs or actual output. Actual costs and actual output is compared with the planned performance and variations, if any are calculated. (iv) Analysis of variances and decision making : Variations between actual performance and planned performance is required to be analysed as to the causes and proper corrective actions are required to be taken to remove unfavourable variations or maintain favourable variations. Overhead Cost 309 (3) Classification of overheads as fixed and variable, facilitates the preparation of flexible budgets which provides proper base for comparison in the form of budgeted overheads for any level of activity actually attained. Flexible budgets may be treated as an improved method to control the overheads. ILLUSTRATIVE PROBLEMS (1) Meera Industries Limited is a single product organization having a manufacturing capacity of 6,000 units per week of 48 hours. The output data vis-a-vis different elements of cost for three consecutive weeks are given below : Units Direct Direct Total factory overheads Produced Material Labour (Variable and Fixed) Rs. Rs. Rs. 2,400 4,800 6,000 37,200 2,800 5,600 7,000 38,400 3,600 7,200 9,000 40,800 As a cost Accountant, you are asked by the company to work out the selling price assuming level of 4,000 units per week and a profit of 20% on selling price. Solution : It can be observed that an increase in production by 400 units increases the total factory overheads by Rs. 1,200 indicating that per unit variable overheads are Rs. 3. Hence, at the activity level of 2,400 units, the total variable overheads are Rs. 7,200 i.e. 2400 units x Rs.3 per unit, out of total overheads of Rs. 37,200. Hence, the balance amount represents fixed overheads. It should be noted that the direct material cost and direct labour cost represents the variable cost of production. At 2,400 units, per unit cost is as below : Direct material - Rs. 4800 / 2400 units = Rs. 2 / per unit. Direct Labour - Rs. 6000 / 2400 units = Rs. 2.5 per unit The cost sheet for the production of 4000 units can be worked out as below : 310 Management Accounting Cost Sheet - 4000 units Per Unit Total Rs. Rs. Direct Material Cost 2.00 8,000 Direct Labour Cost 2.50 10,000 Variable Overheads 3.00 12,000 Fixed Overheads 7.50 30,000 Total Cost 15.00 60,000 Add : Profit i.e. 20% of selling price of Or 25% of total cost 3.75 15,000 Sales 18.75 75,000 (2) XYZ Ltd., a manufacturing company, having an extensive marketing net work throughout the country, sells its products through four zonal sales offices viz. A,B,C and D. The budgeted expenditure for the year are given below : Rs. Sales Managers salary 1,20,000 Expenses relating to Sales Managers office 80,000 Travelling salesmens salaries 3,20,000

Travelling Expenses 36,000 Advertisement 30,000 Godown Rent-Zone A 15,000 B 25,200 C 9,800 D 18,000 68,000 Insurance on inventories 20,000 Commission on sales @ 5% on sales 6,00,000 Overhead Cost 311 The following further particulars are also available : ABCD Sales (Rs. in lakhs) 36 48 16 20 No. of salesmen 5 6 2 3 Total mileage covered 6000 14000 4500 5500 Allocation of Advertisement 30% 30% 20% 20% Average stock (Rs. in lakhs) 6 8 4 2 Based on the above details, compute zonewise selling overheads, as a percentage to sales. Solution : Calculation of Sales Overheads - Zone wise
Items Base Total A B C D Rs. Rs. Rs. Rs. Rs.
1. Sales Sales 1,20,000 36,000 48,000 16,000 20,000 Managers Salary 2. Expenses of Sales Sales 80,000 24,000 32,000 10,667 13,333 Managers office 3. Travelling salesmens No. of Salesman 3,20,000 1,00,000 1,20,000 40,000 60,000 Salaries 4. Travelling Expenses Mileage covered 36,000 7,200 16,800 5,400 6,600 5. Advertisement Allocation 30,000 9,000 9,000 6,000 6,000 6. Godown Rent Allocation 68,000 15,000 25,200 9,800 18,000 7. Insurance on Average stock 20,000 6,000 8,000 4,000 2,000 inventories 8. Sales Commission Sales 6,00,000 1,80,000 2,40,000 80,000 1,00,000 Total Overheads 12,74,000 3,77,200 4,99,000 1,71,867 2,25,933 Sales in Lakhs Rs. 120 36 48 16 20 Overheads as % of sales 10.62% 10.48% 10.40% 10.74% 11.30%

(3) The following yearly charges are incurred in respect of a machine where work is done by means of 5 machines of exactly same type. (1) Rent and Rates Rs. 4,800 (2) Depreciation on each machine Rs. 500 (3) Repairs & maintenance of 5 machines Rs. 1,000 (4) Power consumed (as per meter at 5 paise per unit) Rs. 3,000 (5) Electric charges for the shop Rs. 450 312 Management Accounting (6) Two attendants looking after 5 machines and are paid Rs. 700 per year each Rs. 1,400 (7) Supervision One supervisor looking after 5 machines and paid Rs. 3,000 (8) Sundry supplies for the shop Rs. 450 The machine uses 10 units of power per hour. Calculate the machine hour rate. Solution : Calculation of Machine Hour Rate Rs. (a) Standing charges : Rent and Rates 960 Depreciation 500 Repairs and Maintenance 200

Electricity charges 90 Attendants salary 280 Supervisors Salary 600 Sundry Supplies 90 Annual standing charges 2,720 Annual Machine Working Hours 1,200 Hourly Standing Charges Rs. 2.27 (b) Running charges : Power charges - Rate of power - 5 paise per unit Power consumption - 10 units per hour Hourly power expenses Rs. 0.50 (c) Machine Hour Rate i.e. a + b Rs. 2.77 Working Notes : Number of machine working hours are calculated as below : (a) Total power cost for the shop - Rs. 3.000 (b) Power cost relating to the machine - Rs. 600 (c) Rate of power - 5 paise per unit Overhead Cost 313 (d) Total power consumption in units Rs. 600 = 12.000 units Paise 5 (e) Rate of power consumption - 10 units per hour (f) If total units consumed are 12.000 and if rate of power consumption is 10 units per hour, it means that the machine must have worked for 1,200 hours. (4) From the following data, work out the predetermined machine hour rates for departments A and B of a factory. Preliminary Estimates of Expenses Total Dept. A Dept. B Rs. Rs. Rs. Power 15,000 Spare Parts 8,000 3,000 5,000 Consumable Stores 5,000 2,000 3,000 Depreciation on Machinery 30,000 10,000 20,000 Insurance on Machinery 3,000 Indirect Labour 40,000 Building Maintenance 7,000 The final estimates are to be prepared on the basis of above figures after taking into consideration the following factors : (1) An increase of 10% in the price of spare parts. (2) An increase of 20% in the consumption of spare parts for Department B only. (3) Increase in the straightline method of depreciation from 10% on the original value of machinery to 12%. (4) 15% general increase in wage rates. The following information is available Dept. A Dept. B Estimated Direct Labour Hours 80,000 1,20,000 Ratio of K W Rating 3 2 Estimated Machine Hours 25,000 30,000 Floor Space (sq. ft.) 15,000 20,000 314 Management Accounting Solution : Calculation of machine hour rate Expenses Base Total Dept. A Dept. B Rs. Rs. Rs. Power KW Rating 15,000 9,000 6,000

Spare Parts Allocation and adjustment for Final Estimates 9,900 3,300 6,600 Consumable stores Allocation 5,000 2,000 3,000 Depreciation on Machinery Allocation and adjustments for Final Estimates 36,000 12,000 24,000 Insurance on Machinery Ratio of depreciation 3,000 1,000 2,000 Indirect Labour Direct Labour Hours and adjustment for Final Estimates 46,000 18,400 27,600 Building Maintenance Floor space 7,000 3,000 4,000 1,21,900 48,700 73,200 Estimated Machine Hours 25,000 30,000 Machine Hour Rate Rs. 1.948 2.44 Working Notes : (1) Spare Part Cost Total Dept A Dept B Original Estimate 8,000 3,000 5,000 + Extra consumption 1,000 - 1,000 9,000 3,000 6,000 + 10% Price Increase 900 300 600 9,900 3,300 6,600 (5) The factory overhead costs of four production departments of a company engaged in executing job orders, for an accounting year, are as follows : Depts. Rs. A 19,300 B 4,200 C 4,000 D 2,000 Overhead Cost 315 Overhead has been applied as under Dept A - Rs. 1.50 per machine hour for 14,000 hours Dept B - Rs. 1.30 per Direct Labour Hour for 3,000 hours Dept C - 80% of Direct Labour cost of Rs. 6,000 Dept D - Rs. 2 per piece for 950 pieces. Find out the amount of departmentwise under or over absorbed factory overheads. Solution : (a) Factory Overheads absorbed Dept. Rs. Base A 21,000 Rs. 1.50 per Machine Hour for 14,000 hours B 3,900 Rs. 1.30 per Direct Labour Hour for 3,000 hours C 4,800 80% of Direct Labour cost of Rs. 6,000 D 1,900 Rs. 2 per piece for 950 pieces (b) Calculation of under or over absorption Dept. Overheads Overheads Over Under Incurred Absorbed Absorption Absorption Rs. Rs. Rs. Rs. A 19,300 21,000 1,700 B 4,200 3,900 - 300 C 4,000 4,800 800 D 2,000 1,900 - 100 29,500 31,600 2,500 400 Net Over absorption Rs. 2,100 (6) In a factory, annual average charges for direct wages amount to Rs. 4,80,000. Following are some of the expenses incurred in factory. a. Works Managers salary Rs. 50,000 b. Factory Rent Rs. 36,000. The total area is 45,000 Sq. Ft. out of which shop is in 40,000 Sq. Ft. c. Wages of Peons and Sweepers Rs. 7,000

d. Other factory overheads Rs. 53,000 316 Management Accounting A work order is executed in a shops part occupying an area of 6,000 Sq. Ft. and costs Rs. 10,000 in wages. If the total wages for all work orders executed in the shop amount to Rs. 1,60,000, calculate the total amount of factory overheads charges to be allocated to this work order. Solution : Factory Rent Rs. 36,000 Rent of shop Rs. 32,000 i.e., Rs. 36,000 X 40,000 Sq. ft. 45,000 Sq. ft. Rent for that area of shop where work order is executed. i.e. Rs. 32,000 X 6,000 Sq. ft. = Rs. 4,800 40,000 Sq. ft. Apportionment of rent to work order on the basis of wages Rs. 10,000 X Rs. 4,800 = Rs. 300 Rs. 160,000 Other factory overheads Rs. Works Managers Salary 50,000 Factory Rent (Balance) 4,000 Wages of Peons /Sweepers 7,000 Others 53,000 1,14,000 Apportionment of overheads to works order on the basis of wages Rs. 10,000 X Rs. 1,14,000 = Rs. 2,375 Rs. 4,80,000 Factory overheads chargeable to the work order Rent Rs. 300 Factory overheads Rs. 2,375 Rs. 2.675 Overhead Cost 317 (7) Superclass Co. Ltd. has three production departments X, Y and Z and two service Departments A and B. The following estimated figures for a certain period have been made available. Rs. Rent and Rates 10,000 Lighting and Electricity 1,200 Indirect wages 3,000 Power 3,000 Depreciation of machinery 20,000 Other expenses and sundries 20,000 The following further details are also available. Total X Y Z A B Floor space (Sq. Mts.) 10,000 2,000 2,500 3,000 2,000 500 Light Points (Nos.) 120 20 30 40 20 10 Direct wages (Rs.) 20,000 6,000 4,000 6,000 3,000 1,000 Horsepower of machines 300 120 60 100 20 Cost of Machinery (Rs.) 1,00,000 24,000 32,000 40,000 2,000 2,000 Working Hours 4,670 3,020 3,050 The expenses of the service departments are to be allocated as follows. XYZAB

A 20% 30% 40% - 10% B 40% 20% 30% 10% You are required to calculate the overhead absorption rate per hour in respect of the three production departments. What will the total cost of an article with material cost of Rs. 50 and direct labour cost of Rs. 40 which passes through X, Y and Z for 2, 3 and 4 hours respectively. 318 Management Accounting Solution : Primary Apportionment of Overheads Expenses Base X Y Z A B Rs. Rs. Rs. Rs. Rs. Rent & Rates Floor space 2000 2500 3000 2000 500 Lighting & Electricity Light points 200 300 400 200 100 Indirect wages Direct wages 900 600 900 450 150 Power HP of machines 1200 600 1000 200 Depreciation Cost of machines 4800 6400 8000 400 400 Other expenses Direct wages 6000 4000 6000 3000 1000 Direct wages (Only Service Depts.) Allocation 3000 1000 15100 14400 19300 9250 3150 Secondary Apportionment of Overheads Result of Primary Apportionment X - Rs. 15,100 Y - Rs. 14,400 Z - Rs. 19,300 A - Rs. 9,250 B - Rs. 3,150 Let X = Total overheads of Dept. A Y = Total overheads of Dept. B X = 9,250 + Y/10 Y = 3,150 + X/10 10 X = 92,500 + Y ...(1) 10 Y = 31,500 + X ...(2) Multiplying equation 1 by 10 and rearranging : -10 Y = 9,25,000 - 100 X 10 Y = 31,500 + X Adding, 0 = 9,56,500 - 99X 99X = 9,56,500 X = 9,662 ...(3) Y = 4,116 ...(4) Overhead Cost 319 Total overheads can be apportioned to production departments at agreed percentages to calculate the overhead absorption rate as below : Total X Y Z Rs. Rs. Rs. Rs. As per Primary apportionment 48,800 15,100 14,400 19,300 Dept A 90% of Rs. 9662 8,696 1,933 2,898 3,865 Dept B 90% of Rs. 4116 3,704 1,647 822 1,235 61,200 18,680 18,120 24,400 Working Hours - 4,670 3,020 3,050 Labour Hour Rate Rs. 4.00 6.00 8.00 Calculation of Total Cost Rs. Direct Material Cost 80 Direct Labour Cost 40 Overheads Dept X - 2 Hrs x Rs. 4/ Hour = Rs. 8 Dept Y - 3 Hrs x Rs. 6/ Hour = Rs. 18 Dept 2 - 4 Hrs x Rs. 8/ Hour = Rs. 32

58 178 (8) The expenses of a machine cost centre for a particular month are as under. (i) Power - Rs. 50,000 (ii) Maintenance and Repairs - Rs. 10,000 (iii) Machine operators wages - Rs. 2,000 (iv) Supervision - Rs. 6,000 (v) Depreciation - Rs. 40,000 320 Management Accounting Other particulars are given below : Products Rate of Production Production Units A 30 Units per hour 1,800 B 10 Units per hour 500 C 6 Units per hour 300 D 4 Units per hour 260 The entire production was to be offered to Government on Cost Plus 20% basis. Material Costs per unit are A - Rs. 40, B - Rs. 60, C - Rs. 100 and D - Rs. 300 Prepare a statement showing product wise cost and offer price. Solution : Total Cost of Machine Centre Rs. Power 50,000 Maintenance and Repairs 10,000 Machine operators wages 2,000 Supervision 6,000 Depreciation 40,000 1,08,000 On the basis of rate of production and number of units produced of each product, number of machine hours used can be calculated as below : Product Rate of Production Production Machine Hours (Units) used A 30 Units per hour 1,800 60 B 10 Units per hour 500 50 C 6 Units per hour 300 50 D 4 Units per hour 260 65 225 Machines Hour Rate = Rs. 1,08,000 = Rs. 480 Machine Hour 225 Machine Hour Overhead Cost 321 Calculation of per unit total cost and offer price Product Material Machine Cost Total Profit Offer Cost Machine Machine Total Cost 20% of Price Hours Hour Machine Total Rate Cost Cost 1 2 3 4 5 6(2+5) 7 8 Rs. Rs. Rs. Rs. Rs. Rs. Rs. A 40.00 1/30 480 16.00 56.00 11.20 67.20 B 60.00 1/10 480 48.00 108.00 21.60 129.60 C 100.00 1/6 480 80.00 180.00 36.00 216.00 D 300.00 480 120.00 420.00 84.00 504.00 322 Management Accounting QUESTIONS 1. Discuss the factors which would create unabsorbed factory overheads and overabsorbed

factory overheads. 2. Mention the broad principles on which overhead expenses are generally apportioned. Upon what basis would you apportion the following expenses to individual cost centres in an engineering unit? (a) Rent (b) Power (c) Fire Insurance Premium (d) Lighting 3. Explain the term underabsorption and overabsorption of overheads. Explain any three methods of absorbing production overheads into the cost of production. 4. Distinguish between actual and predetermined rates for absorption of factory overheads. Cite the major problems involved in using actual rates and discuss how predetermined rates eliminate this problem. 5. How do you deal with under or over absorption of overheads? Mention the various items that go into (a) Manufacturing overheads. (b) Administration overheads. (c) Selling overheads. (d) Distribution overheads. 6. What basis would you recommend for the apportionment of the following items of expenses to production departments, giving justification for the suggested one. (a) Internal Transport. (b) Air-Conditioning. (c) General Factory Maintenance. (d) Stores. (e) Rent. (f) Labour office. 7. What is meant by apportionment of overheads? What can be considered as a good base for apportioning the following overheads with reference to a Diesel Engine Manufacturing Company? Overhead Cost 323 (i) Internal Transport (ii) Time Keeping expenses (iii) Shop supervision (iv) Power, lighting and other utilities Short Notes : (a) Machine Hour Rate (b) Control of overheads (c) Underabsorption and overabsorption of overheads (d) Treatment of over- absorption of overheads (e) Primary and Secondary apportionment of overheads PROBLEMS (1) A certain type of factory produces a uniform type of article and has a capacity to produce 1,500 units per week of 48 hours. Following data shows different elements of costs for 3 weeks of 48 hours each when output has changed from one week to another. Units Produced Direct Material Direct Labour Factory Overheads (Fixed & Variable) Rs. Rs. Rs. 400 800 1,600 3,800 500 1,000 2,000 4,000 800 1,600 3,200 4,600 You are asked to find out selling price per unit when weekly output is 1,000 units and a profit of 8.33% on selling price will be made. (2) A factory is having three production departments A, B and C and two service departmentsBoiler House and Pump Room. The Boiler House has to depend upon the Pump Room for the supply of water and the Pump room in its turn is dependent on the boiler house for

supply of steam power for driving the pump. The expenses incurred by the production departments during a period are A Rs. 8,00,000, B Rs. 7,00,000 and C - Rs. 5,00,000. The expenses for boiler house is Rs. 2,34,000 and the pump room is Rs. 3,00,000. The expenses of the boiler house and pump room are apportioned to the production departments on the following basis. 324 Management Accounting A B C BH PR Expenses of BH 20% 40% 30% - 10% Expenses of PR 40% 20% 20% 20% Show clearly as to how the expenses of boiler house and pump room would be apportioned to A, B and C departments. Use an Algebrical equation. (3) The overheads distribution summary for the month of September 1980 disclosed following overheads expenses for departments mentioned below : Production Depts. Service Depts. ABCDE Overheads Rs. 7,810 Rs. 12,543 Rs. 4,547 Rs. 4,000 Rs. 2,600 Expenses of service departments D and E are apportioned as follows. ABCDE D 30% 40% 20% - 10% E 10% 20% 50% 20% You are required to find out the total cost of each production dept. by charging the respective costs of service depts. by simultaneous equations method. (4) The primary distribution of expenses disclosed the following details in respect of production departments PI, P2 and P3 and Service Departments S1 and S2 Dept. P1 P2 P3 S1 S2 Overheads (Rs.) 6.300 7,400 2,800 4,500 2,000 The services given by S1 and S2 are as follows. Dept. P1 P2 P3 S1 S2 S1 40% 30% 20% - 10% S2 30% 30% 20% 20% Find out the overheads to production Departments by using simultaneous equations method. (5) A company has three production cost centres A, B and C and two service cost centres X and Y. Costs allocated to service cost centres are required to be apportioned to the Overhead Cost 325 production centres to find out cost of production of different products. It is found that benefit of service cost centres is also received by each other along with the production cost centres. Overhead costs as allocated to the five cost centres and estimates of benefits of service cost centres received by each of them are as under Cost Centres Overhead Costs Estimates of benefits as allocated received from service Rs. centres % XY A 80,000 20 20 B 40,000 30 25 C 20,000 40 50 X 20,000 - 5 Y 10,000 10 Required Work out final overhead costs of each of the production departments including apportioned cost of service centres using a. Continuous Distribution Method b. Simultaneous Equations Method (6) The following particulars related to the production department of a factory for the month of June 1985. Rs. Material Used 80,000

Direct Wages 72,000 Direct Labour Hours Worked 20,000 Hours of Machine operation 25,000 Overhead charges allocated to the department 90,000 Cost data of a particular work order carried out in the above department during June 1985 are given below. Rs. Material Used 8,000 Direct wages 6,250 Labour hours booked 3,300 Machine hours booked 2,400 326 Management Accounting What would be the factory cost of the work order under the following methods of charging overheads? (i) Direct Labour Cost Rate (ii) Machine Hour Rate (iii) Direct Labour Hour Rate (7) The following information is extracted from the budget of A Ltd. for 1985. Factory Overheads .. Rs. 62,000 Direct Labour cost .. Rs. 1,00,000 Direct Labour hours .. 1,55,000 Machine hours .. 50,000 The following details are available for job 195 Direct Material Cost Rs. 45 Direct Labour Cost Rs. 50 Direct Labour hours 40 Machine hours 30 You are required to work out the overhead application rates and ascertain the cost of job 195 by using the following methods of overheads absorption. (1) Direct Labour Hours Rate, (2) Direct Labour Cost, (3) Machine Hour Rate (8) Atlas Engineering Ltd. accepts a variety of jobs which require both manual and machine operations. The budgeted Profit and Loss Account for the period 1996-97 is as follows : (Rs. in Lakhs) Sales 75 Cost : Direct Materials 10 Direct Labour 5 Prime Cost 15 Production Overhead 30 Production Cost 45 Other Overheads 15 60 Profit 15 Overhead Cost 327 Other budgeted data Labour Hours for the period 2,500 Machine Hours for the period 1,500 No. of jobs for the period 300 An enquiry has been received recently from a customer and the production department has prepared the following estimate of the prime cost required for the job Direct Material 2,500 Direct Labour 2,000 Prime Cost 4,500 Labour Hours required = 80 Machine Hours required = 50 You are required to -

a. Calculate by different methods, six overhead absorption rates for absorption of production overhead and comment on the suitability of each. b. Calculate the production overhead cost of the order based on each of the above rates. c. Give your recommendation to the company. (9) A company has two production departments and two service departments. The data relating to a period are as under : Production Depts. Service Depts. PD1 PD2 SD1 SD2 Direct Materials (Rs.) 80000 40000 10000 20000 Direct Wages (Rs.) 95000 50000 20000 10000 Overheads (Rs.) 80000 50000 30000 20000 Power requirement at normal capacity operation (kwh) 20000 35000 12500 17500 Actual power consumption during the period (Kwh) 13000 23000 10250 10000 The power requirement of these departments are met by a power generation plant. The said plant incurred an expenditure, which is not included above, of Rs. 1,21,875 out of which a sum of Rs. 84,375 is variable and the rest fixed. 328 Management Accounting After apportionment of power generation plant costs to four departments, the service department overheads are to be redistributed on the following bases : PD1 PD2 SD1 SD2 SD1 50% 40% 10% SD2 60% 20% 20% You are required to : a. Apportion the power generation plant costs to the four departments. b. Re-apportion service department cost to the production departments. c. Calculate the overhead rates per direct labour hour of production departments, given that the direct wages rates of PD1 and PD2 are Rs.- 5 and Rs. 4 respectively. (10) Following information is extracted from the cost records of Hilton Ltd. which specialises in the manufacture of automobile spares. The parts are manufactured in Department A and assembled in Department B. Total Dept. A Dept. B Direct Labour hours worked 80,000 30,000 50,000 Machine Hours worked 30,000 25,000 5,000 Machine Horse Power 400 353 47 Book Value of Machines (Rs.) 50,000 40,000 10,000 Floor Space (Sq.Ft.) 20,000 10,000 10,000 Direct Material 65,000 50,000 15,000 Direct Labour 90,000 40,000 50,000 Factory Rent 15,000 - Supervision 6,000 2,500 3,500 Depreciation on Machines 5,000 - Power 4,000 - Repairs to Machines 2,000 1,600 400 Indirect Labour 4,000 2,000 2,000 The prime cost of batch B-401 has been booked as under Total Dept. A Dept. B Materials 3,200 2,700 500 Labour 7,500 3,000 4,500 Overhead Cost 329 Direct Labour hours worked on Batch B-401 were 2,500 in Department A and 5,000 in Department B. Machine hours worked on this batch were 1,250 in Department A and 600 in Department B. Allocate overhead expenditure and calculate the cost of each unit in Batch B401 which consists of 1,000 units.

(11) Strongman Ltd. has three production departments A,B and C and two service departments X and Y. The data available for the month of March 1991 concerning the organization Rs. Rent 15,000 Municipal Taxes 5,000 Electricity 2,400 Indirect wages 6,000 Power 6,000 Depreciation on Machinery 40,000 Canteen Expenses 30,000 Other Labour related costs 10,000 Following particulars are also available Total A B C X Y Floor Space (Sq. Mts.) 5,000 1,000 1,250 1500 1,000 250 Light Points (Nos.) 240 40 60 80 40 20 Direct Wages (Rs.) 40,000 12,000 8,000 12,000 6,000 2,000 HP of Machines 150 60 30 50 10 Cost of Machines (Rs.) 20,0000 48,000 64,000 80,000 4,000 4,000 Working Hours 2,335 1,510 1,525 The expenses of Service Departments are to be allocated in following manner ABCXY X 20% 30% 40% 10% Y 40% 20% 30% 10% You are requested to calculate the overhead absorption rate per hour in respect of the three production departments. 330 Management Accounting (12) A company has 3 production departments A, B and C and two service departments X and Y. The following data are extracted from the records of the company for a particular given period. Rs. Rent and Taxes 25,000 General Lighting 3,000 Indirect Wages 7,500 Power 7,500 Depreciation on Machinery 50,000 Sundries 50,000 Additional data departmentwise Total A B C X Y Direct Wages (Rs.) 50000 15000 10000 15000 7500 2500 HP of Machines 150 60 30 50 10 Cost of Machines (Rs. in Lakhs) 12.50 3.00 4.00 5.00 0.25 0.25 Floor Space (Sq.Mts.) 10000 2000 2500 3000 2000 500 Lighting Points (Nos.) 60 10 15 20 10 5 Production Hours 6226 4028 4066 Sundries can be apportioned on the basis of Direct Wages. Service Departments expenses allocation ABCXY X 20% 30% 40% 10% Y 40% 20% 30% 10% You are required to a. Compute the overhead rate of production departments using repeated distribution method. b. Determine the total cost of a product whose direct material cost and direct labour cost are Rs. 150 and Rs. 150 respectively and which would consume 4 hours, 5 hours and 3 hours in departments A, B and C respectively. (13) Universal Ltd. has four production departments A, B, C and D and two service departments viz. Transport and Power Supply.

Overhead Cost 331

Particulars of expenses of the respective departments are as follows : A Rs. 2,000 B Rs. 1,800 C Rs. 1,600 D Rs. 1,400 Transport Rs. 1,100 Power Supply Rs. 760 The service departments expenses are charged out on a percentage basis as given below : A B C D Transport Power Transport 10% 30% 20% 20% - 20% Power 30% 20% 30% 10% 10% Using the above information, apportion the service department overheads to various production departments using a. Simultaneous Equations Method b. Repeated Distribution Method (14) A shop has 2 newly purchased machines, each occupying equal area of space. One is 4 - spindle drilling machine and the other is 6-spindle drilling machine costing Rs. 80,000 and Rs. 1,00,000 respectively. Following are the expenses for one year : a. Rent Rs. 40,000 b. Rates and Taxes Rs. 17,000 c. Lighting and heating Rs. 12,600 d. power expenses - 4 spindle machine Rs. 10,000 - 6 spindle machine Rs. 15,000 e. Administration expenses Rs. 38,000 f. Running and Maintenance Rs. 80,000 The life of each machine is 10 years without any salvage value. Each machine works for 45 hours a week for 50 weeks in a year. 250 hours per machine are used for repairs. Running and repairs expenses are shared between two machines on the basis of power expenses. You are required to prepare statement showing computation of Machine Hour Rate. 332 Management Accounting (15) Calculate the machine hour rate in respect of machine No. 179 from the following particulars : Cost of machine Rs. 20,000 Estimated Life 15,000 hours Estimated scrap value Rs. 500/Estimated working hours per annum 2200 Estimated hours required for maintenance 100 (included in above) Setting up time (Hours) 100 (included in above) Power 20 units @ Rs.0.17 per unit Repairs and maintenance per annum Rs. 1500/No. of operators (looking after also 3 other machines) 2 Wages per operator per month Rs. 150/Chemical required for operating the machine Rs. 100/- p.m. Overheads chargeable to the machine Rs. 200/- p.m. Insurance premium -1% p.a. on the cost of machine. (16) You are required to calculate the composite machine hour rate from the following particulars in respect of a jig boring machine whose scrap value is Rs. 50,000 after its working life of 10 years. 1. Cost of the machine - Rs. 2,00,000 2. Importation charges & Customs duty etc.- Rs. 50,000 3. Working hours per year - 2,000 4. Repairs & Maintenance charges - 50% of depreciation charge. 5. Lubricating oil - Rs. 20 per working day of 8 hours 6. Consumable stores - Rs. 500 per month of 25 working days.

7. Power 10 units per working hour at Re. 0.30 per unit 8. Wages of the operator - Rs. 1,000 per month of 25 working days. Overhead Cost 333 (17) From the particulars furnished below, compute a machine hour rate : Name of the Equipment - Single spindle Automat Date of purchase - 1.4.1983 Cost - Rs. 75,000 Estimated Life - 10 years Depreciation - 15% on original cost Insurance - Rs. 4,000 p.a. Repairs - Rs.1,800 p.a. Consumable stores - Rs. 1,500 p.a. Rent - Rs. 2,400 p.a. Superintendence - Rs. 2,500 p.a. (l/5th for the machine) The machine can work for 200 hours in a month and had actually worked for 80% of the normal working hours. Cost of oils and greases consumed per hour is Rs.4.50, (18) A dept. is having 3 machines. The figures indicate the departmental expense of these machines. Calculate the machine hour rate from the data below : Depreciation of machines Rs. 12,000 Rent Rs. 2,880 Repairs to machines Rs. 4,000 Insurance of machines Rs. 800 Indirect wages Rs. 6,000 Power Rs. 6,000 Lighting Rs. 800 Misc. Expenses Rs. 4,200 Rs 36,680 334 Management Accounting Other information : M/c1 M/c2 M/c3 Direct wages Rs. 1,200 2,400 2,400 Power units 30,000 10,000 20,000 No. of workers 4 8 8 Light points 8 24 48 Space occupied (Sq. Ft.) 400 800 800 Cost of machine Rs. 3,00,000 1,20,000 1,80,000 Hours worked 200 300 300 (19) Following particulars relate to a machine : Rs. Purchase Price of machine 80,000 Installation Expenses 20,000 Rent per Quarter 3,000 General Lighting for the total area 200 per month Supervisors salary 6,000 per quarter Insurance premium 600 per annum Estimated repairs 1,000 per annum Estimated consumable stores 800 per annum Power 2 units per hour @ Rs. 50 per 100 units The estimated life of the machine is 10 years and the estimated scrap value is Rs. 20,000. The machine is expected to run 20,000 hours in its life time. The machine occupies 25% of the total area. The supervisor devotes l/6th of his time for the machine. You are required to work out machine hour rate. (20) From the following particulars, calculate the machine hour rate of machine installed in a Department. Cost of Machine Rs. 16,000

Estimated scrap value after the expiry of its life (15 years) Rs. 1,000 Overhead Cost 335 Estimated working hours of the machine per year 2,000 Monthly salary of a foreman engaged in supervision of this machine and other two identical machines. Rs. 1,500 Repails and Maintenance of the machine Rs. 2,400 per year Insurance premium for the machine Rs. 120 per year Departmental rent and rates are Rs. 1,200 per year. The space occupied by the machine is l/6th of the floor space of the department. Power consumption of the machine is 2 units per hour @ 10 paise per unit. (21) A machine costing Rs. 20,000 is expected to work for 10 years and at the end of which the scrap value is estimated Rs. 2,000, installation charges amount to Rs. 200. repairs over 10 years life is expected Rs. l,800 and the machine is expected to run for 2.190 hours in a year. Its power consumption would be 15 units per hour at Rs. 5 per 100 units. The machine occupies l/4th of the area of the department and has two points out of ten for lighting. The foreman has to devote l/3rd of his time for this machine. The rent for the department is Rs. 300 p.m. and charges for lighting Rs. 80 p.m. The foreman is paid salary Rs. 960 p.m. Find out the hourly rate assuming insurance is 1% per annum and expenses on oil etc. Rs. 9 per month. (22) Following data is available relating to a company for a certain month. Territory I II III Selling Expenses (Rs.) 7,600 4,200 6,240 Distribution Costs (Rs.) 4,000 1,800 2,000 No. of units sold 16,000 6,000 10,000 Sales (Rs.) 76,000 28,000 52,000 The company adopts sales basis and quantity basis for application of selling and distribution costs respectively. Compute (a) The territorywise overhead recovery rates separately for Selling and Distribution costs. (b) The amounts of selling and distribution cost chargeable to a consignment of 2,000 units of a product, sold in each territory at Rs. 4.50 per unit. 336 Management Accounting (23) A machine is purchased for cash at Rs. 9,200. Its working life is estimated to be 18,000 hours after which its scrap value is estimated at Rs. 200. It is assumed from the past experience that a. The machine will work for 1,800 hours annually. b. The repair charges will be Rs. 1,080 during the whole period for life of the machine. c. The power consumption will be 5 units per hour at 6 paise per unit. d. Other annual standing charges are estimated to be 1. Rent of department (machine l/5th) 780 2. Light (12 points in the department, 2 points engaged in the machine) 288 3. Foremans salary (l/4th of his time is occupied in the machine) 6000 4. Insurance premium for machine 36 5 Cotton Waste 60 Find out the machine hour rate on the basis of above data for allocation of the works expenses to all jobs for which the machine is used. (24) The following particulars relate to a new machine purchased. Purchase Price of the machine Rs. 4,00,000 Installation Expenses Rs. 1,00,000 Rent per Quarter Rs. 15,000 General Lighting for the total area Rs. 1,000 p.m. Foremans Salary Rs. 30,000 p.a. Insurance Premium for the machine Rs. 3,000 p.a.

Estimated repair for the machine Rs. 5,000 p.a. Estimated Consumable Stores Rs. 4,000 p.a. The estimated life of the machine is 10 years and the estimated value at the end of 10 years is Rs. 1,00,000. The machine is expected to run 20,000 hours in its life time. The machine occupies 25% of the total area. The foreman devotes l/6th of his time for the machine. Calculate the machine hour rate for the machine. Overhead Cost 337 (25) A manufacturing unit has added a new machine to its fleet of five existing machines. The total cost of purchase and installation of the machine is Rs. 7,50,000. The machine has an estimated life of 15 years and is expected to realise Rs. 30,000 as scrap at the end of its working life. Other relevant data are as follows : a. Budgeted working hours are 2,400 based on 8 hours per day for 300 days. This includes 400 hours for plant maintenance. b. Electricity used by the machine is units per hour at a cost of Rs. 2 per unit. No current is drawn during maintenance. c. The machine requires special oil for heating which is replaced once in every month at a cost of Rs. 2,500 on each occasion. d. Estimated cost of maintenance of the machine is 500 per week of 6 working days. e. 3 operators control the operations of the entire battery of six machines and the average wages per person amounts to Rs. 450 per week plus 40% fringe benefits. f. Departmental and general overheads allocated to the operation during the last year were Rs. 60,000. During the current year it is estimated that there will be an increase of 12.5% of this amount. No incremental overhead is envisaged for the installation of the new machine. You are required to compute the machine hour rate for the recovery of the running cost of the machine. (26) The following annual charges are incurred in respect of a machine in a shop where manual labour is almost nil and where work is done by means of five machines of exactly similar type and specification. (a) Rent and Taxes (Proportionate to the floor space occupied) for the shop - Rs. 4,803. (b) Depreciation on each machine - Rs. 500. (c) Repairs and maintenance for five machines - Rs. 1,000 (d) Power consumed @ 6.25 paise per unit for the shop Rs. 3,750. (e) Electric charges for light in the shop - Rs. 540. (f) Attendants - There are two attendants for the five machines and they are each paid Rs. 60 per month. (g) Supervision - There is one supervisor in the shop for the five machines and he is paid Rs. 250 per month. 338 Management Accounting (h) Sundry supplies such as lubricants, jute and cotton waste etc. for the shop - Rs. 494. (i) Hire Purchase - Instalment payable for the machine (including Rs. 300/- as interest) Rs. 1,200. (j) The machine uses 10 units of power per hour. Calculate the machine hour rate for the year. (27) In a manufactring concern ABC Ltd., die machine shop has 8 identical machines manned by 6 operators. The machines cannot be worked without an operator wholly engaged on them. The total cost of the machines are Rs. 8,00,000. Following information relates to a six monthly period ended 30th June, 1990. Normal available hours per month 208 Absenteeism (without pay) hours per month. 18 Leave (with pay) hours per month 20 Normal idle time (unavoidable) hours per month 10 Average rate of wages per day of 8 hours Rs. 20

Production hours 15% on wages Power and Fuel consumption Rs. 9,000 Supervision and Indirect Labour Rs. 3,300 Electricity Rs. 1,200 The following particulars are on a yearly basis. Repairs and Maintenance 3% of value of machines Insurance Rs. 42,000 Depreciation 10% of original cost. Other factory expenses Rs. 12,000 Allocated General Management Expenses Rs. 63,670 You are required to work out a comprehensive machine hour rate for the machine shop. Overhead Cost 339 (28) In a factory, the following particulars have been extracted for the quarter ending 30th June, 2001 in respect of Production Department P1, P2 and P3 and service Departments S1 and S2. Compute the departmental overhead rate for each of the production departments, assuming that overheads are absorbed as a percentage of direct wages. Particulars P1 P2 P3 S1 S2 Direct Wages (Rs.) 30000 45000 60000 15000 30000 Direct Material (Rs.) 15000 30000 30000 22000 22000 No. of Workers 150 225 225 75 75 Power (KWHrs.) 6000 4500 3000 1500 1500 Asset Value 60000 40000 30000 10000 10000 Light Points 10 16 4 6 4 Area in Sq. Fts. 150 250 50 50 50 Expenses for the period were Power Rs. 1,100 Lighting Rs. 200 Stores overheads Rs. 800 Staff Welfare Rs. 3,000 Depreciation Rs. 36,000 Rent Rs. 550 General Overheads Rs. 12,000 Apportion general overheads in the proportion of direct wages. Apportion the expenses of S1 according to direct wages and those of S2 in the ratio of 5 : 3: 2 to the production departments. (29) A Ltd. has 3 production departments A, B and C and 2 service departments D and E. The following are the figures of the company. Rs. Rent and Rates 5,000/General lighting 600/Indirect wages 1,500/Power 1,500/Depreciation of Machinery 10,000/Sundry Expenses 10,000/340 Management Accounting The following further details are available : ABCDE Floor Space (Sq.Ft) 2000 2500 3000 2000 500 Light points 10 15 20 10 5 Direct wages (Rs.) 3000 2000 3000 1500 500 Value of Machinery (Rs.) 60,000 80,000 1,00,000 5,000 5,000 H.P. of Machines 60 30 50 10 Sundry expenses are apportioted on the basis of direct wages The expenses of D and E are allocated as under : ABCDE D 20% 30% 40% - 10%

E 40% 20% 30% 10% Find the rate per hour if the working hours are as under : A Department 6226 B Department 4028 C Department 4066 (30) In a light engineering factory, the following particulars have been collected for the three monthly period ended 31.12.80. Compute the departmental overhead rates for each of the production departments assuming that the overheads are recovered as a percentage of direct wages. Production Dept. Service Dept. ABCDE Direct wages Rs. 2,000 3,000 4,000 1,000 2,000 Direct materials Rs. 1,000 2,000 2,000 1,500 1,500 Staff Nos. 100 150 150 50 50 Electricity Kwh. 4,000 3,000 2,000 1,000 1,000 Light points Nos. 10 16 4 6 4 Asset value Rs. 60,000 40,000 30,000 10,000 10,000 Area occupied Sq.Ft. 150 250 50 50 50 Overhead Cost 341 The expenses for the period were : Motive power Rs. 550 Lighting power Rs. 100 Stores overhead Rs. 400 Amenities to staff Rs. 1,500 Depreciation Rs. 15,000 Repairs and Maintenance Rs. 3,000 General overheads Rs. 6,000 Rent and Taxes Rs. 275 Apportion the expenses of service dept. E proportionate to direct wages and that of service dept. D in the ratio of 5 : 3 : 2 to depts A, B and C respectively. 342 Management Accounting NOTES Marginal Costing 343

Chapter 11
MARGINAL COSTING
In the conventional system of cost ascertainment, the direct cost may be identified with the individual cost center. However, the indirect costs i.e. the overheads are identified with the individual cost center on the most equitable basis. This results into some problems in the process of managerial decision-making. a. The above process does not take into consideration the behaviour of cost. All the costs in the practical circumstances do not behave in the same manner. Some of the costs tend to remain constant despite the changes in the level of activity or volume of operations. These types of costs are comparatively irrelevant in the managerial decision-making. b. The above process results into the under absorption or over absorption of overheads. The said limitations have given rise to a managerial decision making technique that basically tries to classify the costs based upon the behaviour of cost. The technique is referred to as Marginal Costing. The basic proposition made by this technique is that the costs should be classified on the basis of behaviour of the costs. From this angle, the costs can be viewed as fixed costs and variable costs, Fixed Cost is the cost that tends to remain constant irrespective of the level of activity or volume of operations. Fixed Cost tends to vary with time rather than with level of activity. Basic characteristic feature of fixed cost is that this cost in terms of amount may remain constant at all the levels of activities, however per unit fixed cost goes on decreasing with the increasing

level of activity and vice-a-versa. Variable Cost is the cost that varies in direct proportion with the level of activity or volume of operations. Basic characteristic feature of variable cost is that variable cost in terms of amount may increase or decrease with the changing level of activity or volume of operations. However, per unit variable cost remains constant. In practical circumstances, some costs may not be entirely fixed or entirely variable. They are technically in the form of semi-fixed costs or semi-variable costs. For the purpose of marginal costing, the semi-fixed costs or semi-variable costs are required to be classified in the individual 344 Management Accounting components of fixed cost and variable cost. For segregating the semi-fixed or semi-variable cost into the individual components of fixed cost and variable cost, various techniques or methods may be available viz. Comparison by period or level of activity Range or High and Low method Analytical method Scattergraph method Lease Square method Based upon the above discussions, let us make some calculations for a manufacturing organization manufacturing and selling a single product, operating at various levels of activities. Level of Activity Units 1000 1500 2000 Per Unit Selling Price Rs. 100 100 100 Total Sales Rs. 1,00,000 1,50,000 2,00,000 Variable Cost Rs. 60,000 90,000 1,20,000 Fixed Cost Rs. 30,000 30,000 30,000 Total Cost Rs. 90,000 1,20,000 1,50,000 Per Unit Variable Cost Rs. 6 6 6 Per Unit Fixed Cost Rs. 3 2 1.5 Per Unit Total Cost Rs. 9 8 7.5 It can be observed from the above calculations that if the fixed cost is included in the calculation of total cost, per unit total cost becomes non-comparable with the changes in the level of activity in one cost-period to another cost-period. To avoid this non-comparability, it is necessary to eliminate the fixed costs while determining the total cost. As such, the technique of Marginal Costing proposes that fixed cost tends to remain stagnant at least over a shorter period of time and hence should be ignored in the entire decision making process. As such, marginal costing considers only the variable cost as the relevant cost in the decision making process. The Concept Marginal Cost is defined as the amount at any given volume of output by which the aggregate costs are changed if the volume of output is increased or decreased by one unit. The aggregate cost consists of both fixed cost and variable cost. As in the short run, fixed costs remain constant irrespective of changes in the volume, aggregate costs may increase or decrease Marginal Costing 345 with the changes in volume, specifically due to variable cost. As such, in simple words, marginal cost indicates Per Unit Variable Cost. Marginal Costing is defined as the ascertainment, by differentiating between fixed and variable costs, of the marginal costs and of the effect on profit of changes in volume and type of output. Basic assumptions made by Marginal Costing The entire technique of Marginal Costing is based upon the following assumptions. a. Variable Cost varies in direct proportion with the level of activity. However, per unit variable cost remains constant at all the levels of activities. b. Per unit selling price remains constant at all the levels of activities. c. Whatever is produced by the organization is sold off. In other words, there are no variations due to the stock. Features of Marginal Costing 1. The product costs are classified as fixed costs and variable costs. Semi-variable costs are also classified in their individual components of fixed cost and variable cost.

2. Only variable costs are considered while computing the product costs. The closing stock of finished goods and semi-finished goods is valued after considering variable costs only. 3. Fixed costs are written off during the period of incurrence and hence do not find the place in product cost determination or inventory valuation. 4. Prices of the product are based on variable costs only. 5. Profitability of the products or departments is decided in terms of marginal contribution. Marginal Costing and Cost-Volume-Profit Relationship The definition of the term Marginal Costing requires the computation ofa. Marginal Cost b. Cost-Volume Profit Relationship a. Determination of Marginal Cost As stated earlier, the marginal cost is the additional cost for manufacturing one additional unit, which is nothing else but the variable cost per unit. Thus the marginal cost or variable cost includes the direct cost plus the variable overheads. Fixed overheads get clubbed with the fixed cost. 346 Management Accounting b. Cost Volume-Profit Relationship : The intention of every business activity is to earn the profit and to maximize the profit. Determination of the profits depends upon the interplay between the following factors and there exists a close relationship among these factors : (1) Selling price per unit and total sales amount. (2) Total cost which in its turn may be in the form of variable cost or fixed cost. (3) Volume of sales Cost-Volume-Profit Analysis aims at studying the relationships existing among these factors and its impact on the amount of profits. The relationships existing among these factors may be basically presented in two forms. (a) In statement or report form (b) In graphical form, the graphs or charts taking the form of break even chart, contribution break even chart or profit chart. Form of operating statement : Under the marginal costing technique, the operating statement takes the form as specified below. (a) In case of a single product company Rs. Sales x Less : Marginal cost Direct Material Cost x Direct Labour Cost x Direct Expenses x Variable Overheads x x Contribution x Less : Fixed costs x Profit x Marginal Costing 347 (b) In case of a multi product company Product Product Product Total ABC Rs. Rs. Rs. Rs. Sales x x x x Less : Marginal cost Direct Material cost x x x x Direct Labour cost x x x x Direct Expenses x x x x Variable Overheads x x x x Contribution x x x x

Less : Fixed costs x Profit x Basic concepts in Marginal Costing : (1) Basic equation of Marginal Costing : The basic intention of the business is to earn the profit which is the excess of sales over the total costs. Profit = Sales - Total Cost However, total cost can be either fixed cost or variable cost. As such the basic equation takes the following forms. Profit = Sales - (Variable Cost + Fixed Cost) Profit = Sales - Variable cost - Fixed cost Profit + Fixed cost = Sales - Variable cost. This is the basic equation of marginal costing. Both the expressions of Sales - Variable Cost and Profit + Fixed cost are technically termed as contribution. Sales - Variable Cost = Contribution = Fixed Cost + Profit Contribution - Fixed cost = Profit 348 Management Accounting (2) Contribution : As discussed earlier, the term contribution can be expressed in two ways basically : (a) Sales - Variable Cost (b) Fixed cost + Profit As in the short period, fixed costs are ineffective due to their stagnant nature, variable cost becomes the most important cost in deciding the profitability. As such, the situation which generates higher contribution is treated as profitable situation. Further, the term contribution, plays an important role in a situation where there are more than one products and the profits on individual products cannot be ascertained due to the problems of apportionment of fixed costs to different products. This is due to the fact that the fixed costs are ignored by marginal costing. (3) Profit Volume (P/V) Ratio : This ratio indicates the contribution earned with respect to one rupee of sales. As such, it is expressed as Contribution X 100 Sales As in the short run, fixed cost remains the same, if there is any change in profits, that is only due to change in contribution. Hence P/V ratio may also be expressed as : Change in Profits X 100 Change in Sales E.g. Sales price is Rs. 10 per unit, variable cost is Rs.6 per unit, and fixed costs are Rs.300, we observe that for 100 and 150 units, P/V Ratio works out as : 100 Units 150 Units Rs. Rs. Sales 1,000 1,500 Variable cost 600 900 Contribution 400 600 Fixed cost 300 300 Profit 100 300 Marginal Costing 349 Hence, P/V Ratio is Contribution 400 600 X 100 = X 100 = X 100 Sales 1,000 1,500 OR i.e. 40% = 40%

Increase in Profits X 100 i.e. 200 X 100 = 40% Increase in Sales 500 The fundamental property of P/V Ratio is that it remains constant at all the levels of activities, provided per unit sales price and variable cost remains constant. It should be noted that P/V Ratio remains unaffected by any variation in fixed costs though overall profits may change due to this variation. A high P/V Ratio indicates that a slight increase in sales without corresponding increase in fixed costs will result in higher profits and vice-versa. This is a pointer to increased sales promotion efforts to increase sales volume. A low P/V Ratio indicates low profitability so that efforts can be made to increase the profits by increasing selling price or by reducing variable cost. Overall profitability may also be increased by concentrating more on products having high P/V Ratio. Note : The basic expression of P/V Ratio i.e.Contribution/Sales may lead to other useful conclusion as (a) Sales x P/V Ratio = Contribution (b) Contribution = Sales P/V Ratio (4) Break Even Point (BEP) : This is a situation of no profit no loss. It means that at this stage, contribution is just enough to cover the fixed costs i.e. Contribution = Fixed Cost. It also means that contribution generated by all sales beyond Break Even Point will directly result into profits. As such, it will be intention of every business to reach the Break Even Point, as early as possible. The Break Even Point may be expressed in two ways. (a) In terms of quantity Fixed Costs Contribution per unit 350 Management Accounting (b) In term of amount Fixed Costs P/V Ratio (5) Margin of Safety : These are the sales beyond Break even point. A business will like to have a high margin of safety because this is the amount of sales which generates profits. As such, the soundness of the business is indicated by the margin of safety. A high margin of safety indicates that the Break Even Point is much below the actual sales and even if there is reduction in sales, business will be still in profits. A low margin of safety accompanied by high fixed cost and high P/V Ratio indicates that efforts are required to be made for reducing the fixed cost or increasing sales volume. A low margin of safety accompanied by a law P/V Ratio indicates that efforts are required to be made for reducing the variable cost or increasing the selling price. Margin of safety may be expressed as below : Margin of Safety = Sales - Break Even Sales = Sales Fixed cost P/V Ratio Margin of Safety = Sales x P/V Ratio - Fixed Cost P/V Ratio = Contribution - Fixed Cost P/V Ratio

= Profit P/V Ratio Margin of safety may be expressed as a ratio or as a percentage. E.g. If actual sales are Rs.l,00,000 and Break Even Sales are Rs.60,000, Margin of Safety will be Sales - Break Even Sales X 100 Sales i.e. 1,00,000 - 60,000 40,000 X 100 = = X 100 1,00,000 1,00,000 i.e. 40% of Sales Marginal Costing 351 Illustrations : (1) Following details are available : Sales Total Cost Rs. Rs. Period I 39,000 34,800 Period II 43,000 37,600 Calculate variable cost, fixed cost and contribution for each period. Solution : As Sales - Total Cost = Profit, we know as below : Sales Total Cost Profit Rs. Rs. Rs. Period I 39,000 34,800 4,200 Period II 43,000 37,600 5,400 As P/V Ratio = Increase in Profits X 100 Increase in Sales = 5,400 - 4,200 X 100 = 1,200 X 100 = 30% 43,000 - 39,000 4,000 As Sales x P/V Ratio = Contribution,For period I, Contribution = 39,000 x 30% = 11,700 For period II, Contribution = 43,000 x 30% = 12,900 As Sales - Contribution = Variable Cost, For period I, Variable Cost = 39,000 - 11,700 = 27,300 For period II, Variable Cost = 43,000 - 12,900 = 30,100 As Contribution - Profit = Fixed Cost, For period I, Fixed Cost = 11,700- 4,200 = 7,500 For period II. Fixed Cost = 12,900 - 5,400 = 7,500 To summarise, Period I Period II Rs. Rs. Contribution 11,700 12,900 Variable cost 27,300 30,100 Fixed cost 7,500 7,500 352 Management Accounting (2) Following details arc available : Sales Profit Rs. Rs. Period I 2,00,000 20,000 Period II 3,00,000 40,000

Find out Break even Sales Solution : We know that P/V Ratio = Increase in Profits X 100 Increase in Sales P/v Ratio = 20,000 X 100 = 20% 100,000 Margin of safety = Profit P/V Ratio For period I, Margin of Safety is = 20,000 = 1,00,000 20% As Break Even Sales = Sales - Margin of Safety. Considering Period I, Break Even Sales = 2,00,000 - 1,00,000 = 1,00,000 (3) Following details are available: Actual Sales Rs. 20,000 Break Even Sales Rs. 10,000 Fixed Cost Rs. 5,000 Find out the profit at actual sales, Solution : At break Even Point, Contribution = Fixed Cost At Break Even Point, sales are Rs. 10,000 and contribution Rs. 5,000 Marginal Costing 353 However we know that, P/V Ratio = Contribution X 100 = 5,000 X 100= 50% Sales 10,000 We also know that. Sales x P/V Ratio = Contribution, At actual sales of Rs. 20,000 Contribution = 20,000 x 50% = 5,000 We know that Contribution - Fixed cost = Profit Profit = 10,000 - 5,000 = 5,000 (4) Following details are available: Break Even Sales Rs. 20,000 Fixed cost Rs. 10,000 Profit Rs. 5,000 Find out the margin of safety. Solution : At Break Even Point, Fixed Cost = Contribution When sales are Rs. 20,000, Contribution is Rs. 10,000 However, we know that Contribution X 100 = P/V ratio Sales

P/V Ratio = 10,000 X 100 = 50% 20,000 We also know that, Margin of safety = Profit P/V Ratio = 5,000 = 10,000 50% 354 Management Accounting (5) Find, out the Break Even Point and Profit if sales are Rs. 50,00,000 and P/V Ratio is 50% and Margin of safety is 40%. Solution : Sales are Rs. 50,00,000 and Margin of safety is 40% of sales, hence margin of safety is Rs. 20,00,000. As Break Even Sales = Sales Margin of Safety. BEP = Rs. 50,00,000 - Rs. 20,00,000 = Rs. 30,00,000 We know that, Margin of Safety = Profit P/V Ratio Margin of Safety x P/V Ratio = Profit As Margin of Safety is Rs. 20,00,000 and P/V Ratio is 50%, Profit = 20,00,000 x 50% = 10,00,000 GRAPHICAL PRESENTATION OF COST-VOLUME-PROFIT RELATIONSHIPS As discussed earlier, the Cost-Volume-Profit relationships may be expressed in the form of visual aids like graphs and charts. There may be various ways in which these charts and graphs can be prepared depending upon the purpose for which they are prepared. We will discuss three of these ways. (1) Simple Break Even Chart It can be prepared as below. Y OX TC TS SL BEP VOLUME MOS LOSS FC a

}
COST/REVENUE
Marginal Costing 355

TS = Total Sales Line TC = Total Cost Line BEP = Break Even Point SL = Selected Level of Activity FS = Fixed Cost MOS = Margin of Safety Angle a = Angle of Incidence. Note : It will be observed from the above chart, that the angle formed by total sales line and

total cost line is termed as Angle of Incidence. As the difference between total sales and total cost is in the form of profits, higher the angle of incidence better will be the situation. The limitation of Simple Break Even Chart is that contribution cannot be shown separately. As such, the following type of Break Even Chart may be prepared i.e. Contribution Break Even Chart. (2) Contribution Break Even Chart : This is a chart where the contribution is shown more clearly and specifically than in a simple break even chart. It can be prepared as below. Y OX TC TS SL BEP VOLUME MOS VC a COST/REVENUE FC TS = Total Sales Line TC = Total Cost Line BEP = Break Even Point SL = Selected Level of Activity C = Contribution PC = Fixed Cost VC = Variable Cost MOS = Margin Of Safety Angle a = Angle of Incidence. VC 356 Management Accounting (3) Profit Graph : In case of this type of break even chart, horizontal axis represents sales volume and vertical axis represents profit or loss. The diagonal line represents contribution. The point where the contribution line cuts horizontal axis indicates sales at the Break Even Point indicating that at this point, there is no profit or no loss. PL SALES BEP FC P L PL = Profit Line FC = Fixed Cost P = Profit Area L = Loss Area BEP = Break Even Point PRACTICAL APPLICATIONS OF MARGINAL COSTING : The technique of marginal costing can be profitably employed in the following situations. (1) Evaluation of Performance : The performance of various segments of a business, say a department or a product or a branch and so on, can be evaluated with the help of marginal costing and the evaluation of the performance will be based upon the contribution generating capacity of these segments. If the fixed costs are apportioned over these segments on any basis whatsoever, it will be ignored while evaluating the performance.

Marginal Costing 357

Illustration : Following details are available in respect of 3 products. Products ABC Rs. Rs. Rs. Sales 1,00,000 1,50,000 2,50,000 Total Cost Variable Cost 90,000 1,00,000 1,50,000 Fixed cost (Apportioned on the basis of sales) 20,000 30,000 50,000 Total Cost 1,10,000 1,30,000 2,00,000 Profit (Loss) (10,000) 20,000 50,000 As product A is incurring the losses, it is decided to close down its production. Advise the management, Solution : It will not be advisable to close down the production of product A, because it is generating the positive contribution (i.e. Rs. 1,00,000 - Rs. 90,000 = Rs. 10,000) Closing down of product A will mean loss of contribution generated by it, fixed cost still remaining the same. Assuming that the production of product A is closed down, what will be the effect on profitability? Let us verify by applying marginal costing principles. Product B Product C Total Rs. Rs. Rs. Sales 1,50,000 2,50,000 4,00,000 Variable Cost 1,00,000 1,50,000 2,50,000 Contribution 50,000 1,00,000 1,50,000 Fixed costs 1,00,000 Profits 50,000 It means that existing total profits of Rs. 60,000 will reduce to Rs. 50,000 which will affect profitability adversely. 358 Management Accounting (2) Profit Planning : Marginal costing, through the calculations of P/V Ratio, enables the management to plan the activities in such a way that the profits can be maximised or to maintain a specific level of profits. As such, this technique helps the planning of profits. Illustration : (1) M/s. C and P Ltd. Produces and sells industrial containers and packing cases. Due to competition, the company proposes to reduce the selling price. If the present level of profit is to be maintained, indicate the number of units to be sold if the proposed reduction in price is (a) 10% and (b) 15%. The following information is available: Rs. Rs. (1) Present Sales (30,000 Units) 6,00,000 (2) Variable Cost (30,000 Units) 3,60,000 (3) Fixed Cost 1,40,000 5,00,000 (4) Net Profit 1,00,000 Solution : The present cost structure can be stated as below: Per Unit Total Rs. Rs. Sales 20 6,00,000 Variable Cost 12 3,60,000 Contribution 8 2,40,000 Fixed Cost 1,40,000 Net Profit 1,00,000

If the price is reduced by 10% or 15%, the per unit cost structure is going to change as below : Present 10% Price Reduction 15% Price Reduction Rs. Rs. Rs. Sales 20 18 17 Variable Cost 12 12 12 Contribution 8 6 5 Marginal Costing 359 If the present level of profits is to be maintained i.e. Rs. 1,00,000, the revised total contribution which the sales will have to generate with reduced per unit contribution will be Expected Profit + Fixed Cost, and the number of units which will have to be sold will be : Expected Profit + Fixed Cost Revised per unit contribution As such, the number of units which will have to be sold in the above cases of price reduction will be 10% Price Reduction 15% Price Reduction Rs. 1,00,000 + Rs. 1,40,000 Rs. 1,00,000 + Rs. 1,40,000 Rs. 6 Rs. 5 = Rs. 2,40,000 = Rs. 2,40,000 Rs. 6 Rs. 5 = 40,000 Units = 48,000 Units (2) Per Unit cost structure of a single product manufacturing company is as below : Selling Price Rs. 100 Direct Material Rs. 60 Direct Labour Rs. 10 Variable overheads Rs. 10 Number of Units sold in the year are 5,035. As per the agreement with the employees union, there will be an increase of 10% in Direct wages. Work out (a) How many more units have to be sold next year to maintain same quantum of profits. (b) By what percentage the selling price has to be raised to maintain same P/V Ratio? 360 Management Accounting Solution : The present profitability structure is as below : (i) Total number of units sold 5,035 (ii) Per unit cost structure Selling price Rs. 100 Variable cost Direct Material Rs. 60 Direct Labour Rs. 10 Variable Overheads Rs. 10 Rs. 80 Contribution per unit Rs. 20 (iii) Total Contribution Rs. 1,00,700 In the next year, the per unit Direct Labour Cost will be more by 10% i.e. Rs. 11 per unit which will reduce the per unit contribution to Rs. 19. Alternative (a) : If the same quantum of profits is to be maintained, same amount of contribution will have to be generated with reduced per unit contribution. As such, number of units required to be sold will be : = Amount of contribution

Revised per unit contribution = Rs. 1,00,700 Rs. 19 = 5.300 Units Hence, the company will have to sell 265 units more (i.e. 5,300 Units - 5,035 Units) to maintain same quantum of profits. Alternative (b) : At present, when selling price is Rs. 100, contribution is Rs. 20 meaning that per unit variable cost is Rs. 80. In future, the variable cost is likely to be Rs. 81 per unit instead of Rs. 80. Accordingly, the selling price will also be required to be increased if it is intended that the same P/V Ratio should be maintained. Marginal Costing 361 The new selling price will be : Rs. 81 X 100 = Rs. 101.25 Rs. 80 As such, the selling price has to be raised by 1.25% to maintain the same P/V Ratio. The profitability structure will be Selling Price Rs. 101.25 Variable Cost Rs. 81.00 Contribution Rs. 20.25 P/V Ratio = Contribution per unit X 100 Selling Price per unit 20.25 X 100 = 20% 101.25 (3) Fixation of Selling Price : The technique of marginal costing may be applied in the area of price fixation in such a way that prices fixed should cover atleast the variable cost. As in the short run, the fixed cost is a stagnant cost, it can be ignored, though it can not be ignored in the long run because of the simple fact, that it is a cost. In the short run, the prices fixed above the variable cost may generate some positive contribution which may help in the recovery of fixed cost. However, if the fixed cost is ignored in the long run, it may put the business into serious troubles as the business will never be able to earn the profits. In this connection, following propositions should be kept in mind. (a) In some exceptional circumstances viz. during the phase of depression, serious competition in the market, to introduce the new product in the market by keeping the price as low as possible in the initial stages, to dispose off the product which may deteriorate in quality etc., it may be necessary to fix the selling price even below the variable cost, however it is a deliberate decision taken by the management. (b) The above principle is equally applicable while fixing the export price as well. The export price over and above the variable cost will result into increased amounts of profits if the fixed costs can be taken care of by the inland sales and if the home market is not likely to get affected by the export price fixed. However, if certain specific costs, either fixed or variable, are required to be incurred specifically for the execution of the export order, they will have to be recovered while fixing the export price as if it is a part of the variable cost. 362 Management Accounting Illustration : (1) The operating statement of a company is as follows : Rs. Sales (80,000 Units @ Rs. 15) 12,00,000 Costs Variable

Materials 2,40,000 Labour 3,20,000 Overheads 1,60,000 7,20,000 Fixed 3,20,000 Total Costs 10,40,000 Profit 1,60,000 The plant capacity is 1,00,000 units. A customer from U.S.A. is desirous of baying 20,000 units at a net price of Rs. 10 each unit. Advice the company whether or not offer should be accepted? Will your advice be different if the customer is a local one? Solution : At present, variable cost per unit is Rs. 9 i.e. Rs. 7,20,000 80,000 units So long as the export price is more than Rs. 9, it is going to generate additional contribution which is going to increase the profits, as the fixed costs are already covered by the local sales. As the export price offered is Rs. 10 i.e., Re. 1 more than the variable cost per unit, the company should accept the offer. The advice will be the same even it the customer is a local one, provided the price discrimination, i.e. Rs. 15 per unit for 80,000 units and Rs. 10/- per unit for 20,000 units is not going to adversely affect the current market for 80,000 units at the current price of Rs. 15. If the company accepts the export offer of Rs. 10 per unit, the revised profitability structure will be as below: Rs. Sales : 80,000 units @ Rs. 15 12,00,000 20,000 units @ Rs. 10 2,00,000 14,00,000 Marginal Costing 363 Costs : Variable 1,00,000 units @ Rs. 9 9,00,000 Fixed 3,20,000 Total costs 12,20,000 Profit 1,80,000 The revised amount of profit will be more by Rs. 20,000 as compared to the existing amount of profits. Hence, the export order should be accepted by the company. (4) Make or buy decision : If the management is facing problem to decide whether a component or a product should be manufactured in house which can be purchased from an outside source as well, the technique of marginal costing may render useful assistance. E.g. The following cost data is made available in respect of two components A and B. Component A Component B Rs. per unit Rs. per unit If manufactured Variable Cost 30 30 Fixed Cost 25 20 55 50 If purchased 40 25 If the above data is viewed from total cost point of view, without considering the classification of cost like fixed or variable, it may be concluded that the purchase proposition may be profitable for both the components A and B. However, the conclusion may be misleading as the total cost in case of component A, if purchased, is not going to be only Rs. 40 per unit, but it is going to be Rs. 65 (i.e. Rs. 40 purchase price per unit plus Rs. 25 fixed cost per unit) which being more than present total cost, manufacturing proposition will be beneficial. On the other hand, in case of component B, total cost, if purchased, is going to be Rs. 45/- per unit (i.e. Rs. 25 purchase price per unit plus Rs. 20 fixed cost per unit) which being less than present total cost, buying proposition will be beneficial.

The above conclusions may be simplified in the following way : If Purchases Price < Variable Cost, go in for purchase proposition. If Purchase Price > Variable Cost, go in for manufacturing proposition. 364 Management Accounting Before taking any make or buy decision only on the basis of marginal cost analysis, following points should also be taken into consideration. (1) If buying proposition is beneficial in case of a component or product, the final decision to buy may depend on other factors also viz. whether the supplier is reliable one, whether the supplier can assure required quality, whether the supplier can assure uninterrupted supply etc. (2) If it is decided to buy a component or a product which was being manufactured till now, the manufacturing capacity released should be profitably used for some other purposes. If it is decided to manufacture a companent which was being purchased till now, there may be two possibilities. One, production capacity used for same component or product may be diverted to manufacture another component or product. In this case, the loss of contribution of that another component or product should be considered as a part of cost. Second, if additional production facilities are required to be acquired for the manufacturing proposition, the additional fixed costs attached with the manufacturing proposition should be considered. (5) Optimising product mix : Product mix refers to the proportion in which various products of a company can be sold. If a concern is dealing in a number of products, a problem which usually arises is to decide a mix or proportion in which the sales of the various products should be made so that the profits can be maximized. Such a problem can be solved by studying the contributions generated by the various products individually and by selecting that mix which generates the maximum total contribution. Illustration : Following information has been made available from the cost records of Universal Automobiles Ltd. manufacturing spare parts Direct Materials per unit X Rs. 8 Y Rs. 6 Direct wages X 24 hours @ 25 paise per hour. Y 16 hours @ 25 paise per hour. Variable overheads - 150% of wages Fixed overheads - Rs. 750 Selling price X Rs. 25 Y Rs. 20 Marginal Costing 365 The Directors want to be acquainted with the desirability of adopting any one of the following alternative sales mixes in the budget for the next period. (a) 250 units of X and 250 units of Y (b) 400 units of Y only (c) 400 units of X and 100 units of Y (d) 150 units of X and 350 units of Y State which of the alternatives you would recommend to management. Solution : Productwise Profitability Structure Product X Product Y Rs. Rs. (1) Selling Price per unit 25 20 (2) Variable cost per unit Direct Material 8 6 Direct Wages 6 4

Variable Overheads 9 6 23 16 (3) Contribution per unit 2 4 Evaluation of various alternative sales mixes as per Total Contribution Alternative Product X Product Y Total Rs. Rs. Rs. a. 250 x 2 = 500 250 x 4 = 1,000 1,500 b. 400 x 4 = 1,600 1,600 c. 400 x 2 = 800 100 x 4 = 400 1,200 d. 150 x 2 = 300 350 x 4 = 1,400 1,700 Fixed overheads are going to be the same in all these alternatives. As such, the alternative which generates maximum contribution is the maximum profitable one.As alternative d i.e. 150 units of X and 350 mills of Y generates maximum of contribution, it will be recommended to the management. 366 Management Accounting (6) Cost control : Marginal costing is necessarily a technique of cost classification and cost presentation. The segregation of total costs as fixed costs and variable costs itself facilitates the cost control. Variable costs are the controllable costs at the lower level of management whereas fixed costs can be controlled only on the top level of management and that too, to a limited extent only. Classification of costs as fixed costs and variable costs enables the management to concentrate on the controllable costs. At the same time, the fixed costs are not completely ignored. The only thing is that they are collected and reported separately as an amount deducted from total contribution. As such, the fixed costs can also be controlled as they can be programmed and estimated in advance. (7) Flexible Budget Preparation : Marginal costing technique and more particularly the classification of costs as fixed and variable, facilitates the preparation of flexible budgets which is discussed in details in the chapter Budgetary Control. PROBLEM OF KEY FACTOR : Under the marginal costing technique, profitability is measured in terms of the contribution and the products generating maximum contribution or having maximum P/V Ratio are treated as the maximum profitable products. As the intention of every business is to maximize the profits, the company will concentrate maximum on the products having highest P/V Ratio and will thus maximize the profits. However, in practice, there may be some factors which may come into play which may restrict the companys intention or capability to maximize the profits E.g. In case of the products having highest P/V Ratio, market may be limited, or in case of a maximum profitable product, raw material may not be available. These factors are in the form of Key Factor or Limiting Factor or Scarce Factor. A key factor is defined as the factor which, at a particular point of time or over a period, will limit the volume of output. The key factor may be in various forms viz. sales/market, material, labour, machine availability and so on. In order to evaluate the profitability of a product under key factor situations, the contribution per unit of key factor is the basic criteria. A product generating maximum contribution per unit of key factor is the maximum profitable product. Marginal Costing 367 Illustration : From the following details, which product would be recommended if time is the key factor. Product A Product B Direct Material per unit Rs. 24 Rs. 14 Direct Labour @ Rs. 2 per hour Rs. 20 Rs. 30 Variable Overheads (% of labour cost) 200% 300% Selling Price per unit Rs. 150 Rs. 200 Solution : Product A Product B (1) Selling Price Unit Rs. 150 200 (2) Variable Cost per unit Rs.

Direct Material 24 14 Direct Labour 20 30 Variable Overheads 40 90 84 134 (3) Contribution per unit Rs. 66 66 (4) Number of labour hours 10 15 (5) Contribution per labour hour Rs. 6.6 4.4 As labour hours is the key factor and contribution per labour hour is more in case of product A, it will be recommended for production. Multiplicity of Key Factors In practice, more than one key factors may come into play and any decision regarding product mix ascertainment or profitability ascertainment will have to be decided on the basis of consideration of multiplicity of key factors. The situation of multiplicity of key factors is a more complex situation, the solutions to which may be found in the more advanced techniques like linear programming. 368 Management Accounting Illustration : Following data is available to decide the product mix. ABC Raw material per unit 10 kgs 6 kgs 15 kgs. Labour Hours required 15 25 20 (Rate Rs. 1 per hour) Selling price per unit Rs. 125 100 200 Maximum production Possible Units 6,000 4,000 3,000 1,00,000 kgs of raw material is available at Rs. 10 per kg. Maximum production hours are 1,84,000 with a facility for a further 15,000 hours on overtime basis at twice the normal wage rate. Solution : Product A Product B Product C (1) Selling Price per units Rs. 125 100 200 (2) Variable cost Material 100 60 150 Labour 15 25 20 115 85 170 (3) Contribution per unit Rs. 10 15 30 (4) Contribution per Kg of Raw material - Rs. 1.00 2.50 2.00 (5) Contribution per labour hrs Rs. 0.66 0.60 1.50 Considering the contribution per kg of raw material as well as per labour hour, the rankings among the various products will be as below. I - Product C II - Product B III - Product A Hence, the available raw material and labour hours will be used for the manufacture of Product C and Product B respectively. Marginal Costing 369 Product Units Raw Material Kgs. Labour Hours No. C 3,000 45,000 60,000 B 4,000 24,000 1,00,000 69,000 1,60,000 Hence, the balance of raw material and labour hours available for manufacturing of Product A will be as below. Raw Material - Kgs. - 31,000 kgs. (i.e. 1,00,000 kgs - 69,000 kgs) Labour Hours - 24,000 (i.e. 1,84,000 - 1,60,000) Plus 15,000 extra hours by paying double the normal wage rate. If extra labour hours are used for the manufacture of product A by paying double the normal

wage rate, the cost structure of product A will be as below : (1) Selling Price per unit Rs. 125 (2) Variable cost per unit Material Rs. 100 Labour Rs. 30 Rs. 130 (3) Contribution per unit (-) Rs. 5 As there cannot be the positive contribution generated, it will not be advisable to use the labour hours which require the payment of wages at double the normal wage rate. As such, product A will be manufactured by utilising the labour hours which require the payment of wages at the normal wage rate only i.e. 24,000 hours with the help of which 1,600 units of A (24,000 Hours/ 15 Hours per unit) can be manufactured. As such, the final product mix will be as below. Product A 1,600 Units Product B 4,000 Units Product C 3,000 Units Note : One alternate solution is possible to solve the problem of key factors. If the labour hours which require the payment of wages at double the normal wage rate can be utilised for the manufacture of Product C, its cost structure will be as below. 370 Management Accounting (1) Selling Price Per Unit Rs. 200 (2) Variable cost per unit Material Rs. 150 Labour Rs. 40 Rs. 190 (3) Contribution per unit Rs. 10 As such, apparently it may be possible to utilise the labour hours carrying double the normal wage rate for manufacturing product C and utilise the released labour hours carrying the normal wage rate for manufacturing Product A (i.e. 15,000 hours) In this case, the final product mix will be as below. Product A 2,600 Units Product B 4,000 Units Product C 3,000 Units The calculation of total contribution generated under both those alternatives is as below. Alternative I Product No. of Units Contribution Total Contribution Per Unit Rs. Rs. A 1,600 10 16,000 B 4,000 15 60,000 C 3,000 30 90,000 1,66,000 Alternative II Product No. of Units Contribution Total Contribution Per Unit Rs. Rs. A 2,600 10 26,000 B 4,000 15 60,000 C 2,250 30 67,500 C 750 10 7,500 1,61,000 As in the second alternative, the total contribution generated is less than the one generated in the first alternative, the second alternative can not be accepted. As such, it will be advisable for the company not to utilise the labour hours requiring the payment of wages at double the normal wage rate. Marginal Costing 371 LIMITATIONS OF MARGINAL COSTING (1) The classification of total cost as variable cost and fixed cost is difficult. No cost can be

completely variable or completely fixed. In some cases, the cost which is considered to be variable, may not be variable in practical terms E.g. Direct Labour Cost. Under normal situations this cost is treated as variable cost. However, in India, considering the tremendous legal backing the workers are having, the direct labour cost may not be variable in nature. As such, it may be necessary to consider the direct labour cost as a part of fixed cost. (2) Under the marginal costing, the fixed costs are eliminated for the valuation of inventory of finished goods and semi-finished goods, inspite of the fact that they might have been actually incurred. As such, it is not correct to eliminate the fixed costs. Further, such an elimination affects the profitability adversely. (3) In the age of increased automation and technological development, the component of fixed costs in the overall cost structure may be sizeable. Any technique like marginal costing which ignores the fixed costs altogether, may not be proper under these circumstances as a major portion of cost is not taken care of. (4) Marginal costing technique does not provide any standard for the evaluation of performance. In that sense, the techniques of budgetory control and standard costing may be considered to be better techniques from cost control point of view. (5) Fixation of selling price on marginal cost basis may be useful for short term only. Here also, an undue importance given to only variable cost may result into taking on heavy business with low margin which in turn may increase the fixed costs. As such, over the long run, the prices should be decided on total cost basis only. Fixation of selling price on the marginal cost basis in the long run may be dangerous. Moreover, consideration of fixed costs may be necessary in price fixation under certain circumstances like cost plus contracts unless a very high percentage over the marginal cost is considered to take care of both fixed costs as well as profit margin. (6) Marginal costing does not take into consideration the fixed overheads, as such the problem of under or over absorption of fixed overheads can be avoided. But the problem of under or over absorption of variable overheads cannot be avoided. (7) Marginal costing can be used for assessment of profitability only in the short run. However, in the long run, one has to consider the fixed costs also in order to assess the profitability. Moreover, interpretation of the term short run is a subjective concept. For how long the decision can be taken on the basis of marginal costing principles cannot be decided in the objective manner. 372 Management Accounting ILLUSTRATIVE PROBLEMS (1) Profit and sales for the year 1984 are as follows. Profit Rs. 18,000, Sales Rs. 2,40,000. In 1985, the sales increased by Rs. 40,000 and the profit naturally increased by Rs. 8,000. You are required to calculate. (1) P/V Ratio (2) Sales required to achieve a profit of Rs. 1,00,000. (3) Sales at Break even Point. Solution : We know that P/V Ratio = Increase in Profits X 100 Increase in Sales P/V Ratio = 8,000 X 100 = 20% ...(a) 40,000 We also know that Sales x P/V Ratio = Contribution and Contribution - Profit = Fixed Cost. Applying this to the information available for the year 1984 2,40,000 x 20% = Rs. 48,000 is the contribution and 48,000 - 18,000 = Rs .30,000 is the fixed cost

If the company wants to achieve the profit of Rs. 1,00,000 the total contribution which will have to be generated will be Expected Profit + Fixed cost i.e. Rs. 1,00,000 + Rs. 30,000 i.e. Rs. 1,30,000 We know that Sales = Contribution P/V Ratio As such sales required to achieve a profit of Rs. 1,00,000 will be Expected Profit + Fixed Cost P/V Ratio Marginal Costing 373 = 1,00,000 + 30,000 20% = 1,30,000 = Rs. 6,50,000 ...(b) 20% We know that Break Even Point = Fixed Cost P/V Ratio Sales at Break Even Point = 30,000 20% = Rs. 1,50,000 (c) (2) The Directors of Sports Material Manufacturing Co. gives the following information. Sales - (1,00,000 Units) - Rs. 1,00,000 Variable Costs - Rs. 40,000 Fixed Costs - Rs. 50,000 (a) Find out P/V Ratio, Break Even Point and Margin of Safety. (b) Evaluate the effects on P/V Ratio, Break Even Point and Margin of safety of the following (i) 20% increase in physical sales volume. (ii) 10% increase in fixed costs. (iii) 5% decrease in variable costs. (iv) 10% increase in selling price. Solution : (A) Present profitability structure is as below. Sales - 1,00,000 Units Per Unit (Rs.) Total (Rs.) Sales 1.00 1,00,000 Variable Costs 0.40 40,000 Contribution 0.60 60,000 Fixed Costs 50,000 Profit 10,000 374 Management Accounting (1) P/V Ratio Contribution X 100 = 60,000 X 100 = 60% Sales 1,00,000 (2) Break Even Point Fixed Cost = 50,000 = Rs. 83,333

P/V Ratio 60% (3) Margin of Safety Profit = 10,000 = Rs. 16,667 P/V Ratio 60% (B) Effect of 20% increase in Physical Sales Volume. Revised Profitability structure will be as below. Sales 1,20,000 Units Per Unit (Rs.) Total (Rs.) Sales 1.00 1,20,000 Variable Costs 0.40 48,000 Contribution 0.60 72,000 Fixed Costs 50,000 Profit 22,000 (1) P/V Ratio Contribution X 100 = 72,000 X 100 = 60% Sales 1,20,000 (2) Break Even Point Fixed Cost = 50,000 = Rs. 83,333 P/V Ratio 60% (3) Margin of Safety Profit = 22,000 = Rs. 36,667 P/V Ratio 60% Marginal Costing 375 (C) Effect of 10% increase in fixed costs. Revised profitability structure will be as below : Sales 1,00,000 Units Per Unit (Rs.) Total Rs. Sales 1.00 1,00,000 Variable Costs 0.40 40,000 Contribution 0.60 60,000 Fixed Costs 55,000 Profit 5,000 (1) P/V Ratio Contribution X 100 = 60,000 X 100 = 60% Sales 1,00,000 (2) Break Even Point Fixed Cost = 55,000 = Rs. 91,667 P/V Ratio 60% (3) Margin of Safety Profit = 5,000 = Rs. 8,333 P/V Ratio 60%

(D) Effect of 5% decrease in variable costs. Revised profitability structure will be as below. Sales 1,00,000 Units Per Unit (Rs.) Total (Rs.) Sales 1.00 1,00,000 Variable Costs 0.38 38,000 Contribution 0.62 62,000 Fixed Costs 50,000 Profit 12,000 (1) P/V Ratio Contribution X 100 = 62,000 X 100 = 62% Sales 1,00,000 376 Management Accounting (2) Break Even Point Fixed Cost = 50,000 = Rs. 80,645 P/V Ratio 62% (3) Margin of Safety Profit = 12,000 = Rs. 19,355 P/V Ratio 62% (E) Effect of 10% increase in selling price. Revised Profitability structure will be as below. Sales 1,00,000 Units Per Unit (Rs.) Total (Rs.) Sales 1.10 1,10,000 Variable Costs 0.40 40,000 Contribution 0.70 70,000 Fixed Costs 50,000 Profit 20,000 (1) P/V Ratio Contribution X 100 = 70,000 X 100 = 63.64% Sales 1,10,000 (2) Break Even Point Fixed Cost = 50,000 = Rs. 78,567 P/V Ratio 63.64% (3) Margin of Safety Profit = 20,000 = Rs. 31,426 P/V Ratio 63.64% Note : The difference between Sales and Break Even Point is not matching with Margin of Safety, due to the rounding off differences. (3) From the following figures find out the break even volume.

Selling Price per tonne Rs. 69.50 Variable Cost per tonne Rs. 35.50 Fixed Expenses Rs. 18,02,000 Marginal Costing 377 If this volume represents 40% capacity, what is the additional profit for an added production of 40% capacity, the selling price of which is 10% lower for 20% capacity production and 15% lower, than the existing price, for the other 20% capacity. Solution : Selling Price per Unit Rs. 69.5 Variable cost per Unit Rs. 35.5 Contribution per Unit Rs. 34.0 Break Even Point = Fixed Cost (in terms of quantity) Contribution per Unit = Rs. 18,02,000 Rs. 34 = 53,000 Units Additional production of 53,000 units is envisaged, which can be classified in two parts for convenience purposes. Part I Part II Selling Price per Unit Rs. 62.55 59.075 Variable Cost per Unit Rs. 35.50 35.500 Contribution per Unit Rs. 27.05 23.575 Number of Units 26,500 26,500 Total Contribution Rs. 7,16,825.00 6,24,737.50 As the fixed cost is already covered till the break even point, the contribution beyond the break even point will directly result into profit. Hence, additional profit will be Rs. 7,16,825.00 + Rs. 6,24,137.50 = Rs. 13,41,562.50. (4) The Quality Product Ltd. manufacture and markets a single product Following data is available. Rs. Per Unit Material 16 Conversion (Variable) 12 Dealers Margin 4 Selling Price 40 Fixed Cost - Rs. 5,00,000 Present Sales - 90,000 Units Capacity Utilisation - 60% 378 Management Accounting There is acute competition. Extra efforts are necessary to sell. Suggestions have been made for increasing sales. (a) By reducing sales price by 5%. (b) By increasing dealers margin by 25% over the existing rate. Which of these two suggestions would you recommend if the company desires to maintain present profits. Give reasons. Solution : The present profitability statement will be as below, when 90,000 units are being sold. Per Unit (Rs.) Total (Rs.) (a) Sales 40 36,00,000 (b) Variable Costs Material 16 14,40,000 Conversion 12 10,80,000 Dealers Margin 4 3,60,000 32 28,80,000

(c) Contribution a b 8 7,20,000 (d) Fixed cost 5,00,000 (e) Profit c d 2,20,000 Alternative I To reduce selling price by 5%. In this alternative the profitability structure will be revised as below. Selling Price per Unit Rs. 38 Variable Cost per Unit Rs. 32 Contribution per Unit Rs. 06 If the company wishes to maintain the same profits, the total contribution which the sales will have to generate with the reduced amount of per unit contribution will be Expected Profits + Fixed Cost. And total number of units to be sold will be No. of Units to be sold = Expected Profit + Fixed Cost Revised contribution per Unit = 2,20,000 + 5,00,000 6 = 1,20,000 Units Marginal Costing 379 Alternative II To increase the dealers margin by 25%. In this alternative, the variable cost will be more by Rs. 1 and the profitability structure will be revised as below. Selling Price per Unit Rs. 40 Variable cost per Unit Rs. 33 Contribution per Unit Rs. 07 If the company wishes to maintain the same profits, the total contribution which the sales will have to generate with the reduced amount of per unit contribution will be Expected Profits + Fixed Cost. And total number of units to be sold will be No. of Units to be sold = Expected Profit + Fixed Cost Revised contribution per unit = 2,20,000 + 5,00,000 7 = 1,02,857 Units Acute competition in the market is the basic problem area. As such, the company will like to accept the alternative where less number of units will be required to be sold, the profits remaining the same under both the alternatives. As Alternative II requires 1,02,857 Units to be sold vis-a-vis 1,20,000 units required to be sold under Alternative I, the company will prefer Alternative II. Note : It is assumed that both the alternatives are exclusive alternatives i.e. Even when selling price is reduced by 5%, the dealers margin is unaffected and vice versa. (5) Frazer Ltd. manufactures and sells a product, the selling price and raw material cost of which have remained unchanged during the past two years. The following are the relevant data: Particulars Year 1 Year 2 Quantity sold (Kgs.) 100 150 Sales Value Rs. 20,000 ? Raw Material Rs. 10,000 ? Direct Wages Rs. 3,000 ? Factory Overheads Rs. 5,000 Rs. 5,700 Profit Rs. 2,000 Rs. 2,550 380 Management Accounting During year 2, direct wage rates increased by 50% but there was a saving of Rs. 300 in fixed factory overheads. Required : What quantity in Kgs. the company should have produced and sold in year 2 in order to maintain the same amount of net profit per Kg. as it earned during the year 1?

Solution : The Profitability statement for both the years is as below Year 1 Year 2 Quantity Sold (Kgs.) 100 150 Sales (Rs.) 20,000 30,000 Variable Cost Raw Material 10,000 15,000 Direct Wages 3,000 6,750 Variable Factory Overheads 2,000 3,000 Total Variable Cost 15,000 24,750 Contribution 5,000 5,250 Fixed Cost 3,000 2,700 Profit 2,000 2,550 Profit per Kg. (Rs.) 20 17 Per Unit Variable Cost in Year 2 works out to Rs. 165 i.e. Rs. 24,750 / 150 Kgs. Let us assume that the quantity to be sold in Year 2 is X Kgs. Hence, the profitability statement will be 200X - 165X - 2700 = 20X Solving for X, we get the value of X to be 180 Kgs. Hence, the company should have produced and sold 180 Kgs. in year 2 in order to maintain the same amount of net profit per Kg. as it earned during Year 1. Working Note Factory Overheads in Year 1 were Rs. 5,000 which became Rs. 5,700 in Year 2 with the information that there was a saving of Rs. 300 in fixed factory overheads. Assuming that there was no saving, the factory overheads would have been Rs. 6,000 in Year 2. Hence, the data would have been as below Marginal Costing 381 Year 1 Year 2 Quantity Sold (Kgs.) 100 150 Factory Overheads (Rs.) 5,000 6,000 For the increased quantity of 50 Kgs. the overheads would have increased by Rs. 1,000. It means that the variable factory overheads are Rs. 20 per unit. (6) Garden Products Limited manufacture the Rainpour garden pour. The acc ounts of the company for the year 1981 are expected to reveal a profit of Rs. 14,00,000 from the manufacture of Rainpour after charging fixed costs of Rs. 10,00,000. The Rainpour is sold for Rs.50 per unit and has a variable unit cost of Rs. 20. Market sensitivity tests suggest the following responses to price changes. Alternatives Selling Price Quantity sold Reduced by increased by A 5% 10% B 7% 20% C 10% 25% Evaluate these alternatives and state which, on profitability consideration, should be adopted for the forthcoming year, assuming cost structure unchanged from 1981. Solution : At present, the expected profit is Rs. 14,00,000 after recovering the fixed cost of Rs. 10,00,000. Hence, the total expected contribution is Rs. 24,00,000 i.e. Rs. 14,00,000 + Rs. 10,00,000. Per Unit cost structure is as below. Selling Price Rs. 50 Variable Cost Rs. 20 Contribution Rs. 30 If total contribution is Rs. 24,00,000 and per unit contribution is Rs. 30, it means that the presently expected sales in terms of quantity are 80,000 units. 382 Management Accounting In the light of above, the results of the various alternatives can be calculated as below.
Alternatives Revised Selling Revised contribution Revised sold Revised total

Price Per Unit Per Unit Per Unit Quantity contribution 1 2 3 4 5(3x4)

A 47.50 27.50 88,000 24,20,000 B 46.50 26.50 96,000 25,44,000 C 45.00 25.00 100,000 25,00,000 As profitability is the criteria on which the various alternatives are to be evaluated, Alternative B will be selected, as it generates maximum contribution, fixed cost remaining the same under all the alternatives. (7) Shri Kiron manufactures Lighters. He sells his product at Rs. 20 each and makes profit of Rs. 5 on each lighter. He worked 50% of his machinery capacity at 50,000 lighters. The cost of each lighter is as under. Rs. Direct Material 6 Wages 2 Works Overheads 5 (50% fixed) Sales Expenses 2 (25% variable) His anticipation for the next year is that the cost will go up as under. Fixed Charges 10% Direct Labour 20% Material 5% There will not be any change in selling price. There is an additional order for 20,000 lighters in the next year. What is the lowest rate he can quote so that he can earn the same profit as the current year? Marginal Costing 383 Solution : The profitability statement in the current year is as below : Sales 50,000 Units Per Unit (Rs.) Total (Rs.) (A) Sales 20.00 10,00,000 (B) Variable Costs Direct Material 6.00 3,00,000 Wages 2.00 1,00,000 Works overheads 2.50 1,25,000 Sales Expenses 0.50 25,000 11.00 5,50,000 (C) Contribution (A B) 9.00 4,50,000 (D) Fixed Costs Works Overheads 2.50 1,25,000 Sales Expenses 1.50 75,000 2,00,000 (E) Profits (C D) 2,50,000 In the next year, material cost will increase by 5% i.e., by 30 paise and direct labour cost will increase by 20% i.e., by 40 paise. As such, the total variable cost will increase by 70 paise. Hence, the total variable cost will be Rs. 11.70 per unit. The revised profitability structure for 50,000 unit will be : Selling price per unit Rs. 20.00 Variable cost per unit Rs. 11.70 Contribution per unit Rs. 8.30 Total contribution Rs. 4,15,000 In the next year, fixed charges will increase by 10% i.e., total fixed charges of Rs. 2,00,000 in this year will become Rs. 2,20,000. As we know that Contribution - Fixed Charges = Profit, the profit generate by 50,000 units will be Rs. 4,15,000 Rs. 2,20,000 = Rs. 1,95,000 384 Management Accounting If in the next year, the company wants to earn the same total profits as in the current year i.e.

Rs. 2,50,000 there will be a shortfall of Rs. 55,000 i.e., Rs. 2,50,000 - Rs. 1,95,000 and the shortfall will have to be recovered by additional 20,000 units proposed to be sold in the next year. Hence, over and above the variable cost, each of these additional units will have to recover the profit of : Rs. 55,000 = Rs. 2.75 per Unit 20,000 units Hence, the lowest rate which can be quoted will be : Expected variable cost per unit in the next year + Expected profit per unit in the next year i.e., Rs. 11.70 + Rs. 2.75 = Rs. 14.45 per unit (8) Following details are available in respect of a single product manufacturing company operating at 75% capacity. Units Sold 15,000 Selling Price Per Unit Rs. 12.5 Material Cost Rs. 3 per Unit Labour hours required 2 per unit Labour hour rate Re. 1 per hour Variable expenses 200% of labour cost Fixed cost Rs. 20,000 The company has received an offer to export 8,000 units. Due to the Government backing, the material will be available at a price lower by 25% than the existing price. An additional expenditure of Rs. 10,000 will have to be incurred for execution of this export order. But an export incentive is available from the Government which will be equivalent to 25% of the export price. What minimum price should be charged if it is intended that per unit exported should earn a clear margin of Rs. 2 and the profits from inland sales remaining the same. Ignore the benefits available as per the provisions of Income Tax Act, 1961 and the time required to receive the export incentive in cash since the date of actual export. Assume that Selling price in inland market cannot be increased. Marginal Costing 385 Solution : Present cost structure is as below: Sales -15,000 Units Per Unit (Rs.) Total (Rs.) (A) Selling price 12.50 1,87,500 (B) Variable Costs Material Cost 3.00 45,000 Labour Cost 2.00 30,000 Variable Expenses 4.00 60,000 9.00 1,35,000 (C) Contribution (A - B) 3.50 52,500 (D) Fixed Cost 20,000 (E) Profit (C D) 32,500 When sales are 15,000 Units, capacity utilisation is 75%. It means that maximum 20,000 units can be sold both in inland or export market. The export order received is for 8,000 units. Now, the company has two alternatives. Alternative I : Accept the export order only for 5,000 units which can be manufactured. Alternative II : Accept the export order for 8,000 units by reducing the inland sales by 3,000 units. Alternative I : Only 5,000 Units to be exported. The amounts which export price will have to cover are as below: Per Unit (Rs.) Material Cost 2.25 Labour Cost 2.00 Variable Expenses 4.00 Additional Expenditure (Rs. 10,000 distributed over 5,000 units) 2.00

Expected margin 2.00 12.25 The above amount can be covered either by way of export price of the export incentive which is 25% of export price. If we assume export price to be Rs. x, the following relationship is established. 386 Management Accounting x + 25% of x = 12.25 i.e. x + x = 12.25 4 i.e. 5x = 12.25 4 i.e. x = 9.80 Hence, export price should be minimum Rs. 9.80. Alternative II : 8,000 units to be exported, inland sales being only 12,000 units.If 8,000 units are to be exported, inland sales will be less by 3,000 units, which will result in the loss of contribution of Rs. 10,500 (i.e. 13000 units x Rs. 3.50 per unit) This loss of contribution also will have to be covered by the units to be exported, as the selling price in the inland market can not be increased. As such per unit amount to be covered by export price is as below: Rs. 12.25 (As calculated in Alternative 1) plus Rs. 10,500 = Rs. 1.3125 8,000 units = Rs. 12.25 + Rs. 1.3125 = Rs. 13.5625 This amount can be covered either by way of export price or by export incentive, which is 25% of export price. Assuming export price to be Rs. x, x + 25% of x = 13.5625 x + x = 13.5625 4 5x = 13.5625 4 x = 10.85 Hence export price should be minimum Rs. 10.85 Marginal Costing 387 (9) A Ltd. operating at 75% level of activity produces and sells two products X and Y. The cost sheets of these two products are as under : Particulars Product X Product Y Units produced and sold 3,000 2,000 Selling Price Per Unit (Rs.) 115 95 Cost : Direct Materials 10 20 Direct Labour 20 20 Factory Overheads (40% fixed) 25 15 Administration & Selling Overheads (60% fixed) 40 25 Total Cost Per Unit 95 80 Factory overheads are absorbed on the basis of machine hour rate which is the limiting factor. The machine hour rate is Rs. 10 per hour. The company receives an offer from Japan for the purchase of Product X at a price of Rs. 87.50 per unit. Alternatively, the company has another offer from Bangkok for the purchase of Product Y at a price of Rs. 77.50 per unit. In both the cases, a special packing charge of Rs. 2.50 per unit has to be borne by the company. The company can accept either of the two export orders

by utilising the balance of 25% of its capacity. Advise the company with the detailed workings as to which proposal should be accepted and prepare a statement showing the overall profitability of the company after incorporating the export proposal suggested by you. Solution : The existing profitability structure as per marginal costing works out as below Product X Product Y Selling Price 115 95 Variable Cost Direct Materials 10 20 Direct Labour 20 20 Factory Overheads 15 9 Administration & Selling Overheads 16 10 61 59 Contribution 54 36 388 Management Accounting Hence, Total Contribution Product X - 3000 Units x Rs. 54 per unit = Rs. 1,62,000 Product Y - 2000 Units x Rs. 36 per unit = Rs. 72,000 Rs. 2,34, 000 Fixed Cost can be calculated as below: Product X - 3000 Units x Rs. 34 per unit = Rs. 1,02,000 Product Y - 2000 Units x Rs. 21 per unit = Rs. 42,000 Rs. 1,44,000 Hence, profit i.e. Contribution - Fixed Cost Rs. 90,000. As Factory Overheads as absorbed on the basis of machine hour rate and as machine hour rate is Rs. 10, Product X takes 2.5 hours and Product Y takes 1.5 hours. Hence, the total number of hours consumed by the existing level of activity can be calculated as below: Product X - 3000 Units x 2.5 hours per unit = 7,500 hours Product Y - 2000 Units x 1.5 hours per unit = 3,000 hours 10,500 hours As 10,500 hours are equivalent to 75% level of activity, balance number of hours available for the execution of the export order are 3,500 which is equivalent to balance 25% level of activity. With the balance number of hours available, the maximum number of units which can be manufactured for export order work out as below: Product X - 3,500 hours / 2.5 hours per unit = 1,400 units Product Y - 3,500 hours / 1.5 hours per unit = 2,333 units The contribution generated by the units to be exported can be worked out as below : Product X Product Y Selling Price 85 75 (Net of packing charge) Variable Cost 61 59 Contribution 24 16 Total contribution generated by executing the export order can be worked out as below: Product X - 1400 Units x Rs. 24 per unit = Rs. 33,600 Product Y - 2333 Units x Rs. 16 per unit = Rs. 37,328 Marginal Costing 389 As the contribution generated by exporting Product Y is higher, it will be profitable to export Product Y. Hence, the total profitability works out as below: Existing Profits Rs. 90,000 Contribution generated by exports Rs. 37,328 Total Profits Rs. 1,27,328 (10) A Ltd. manufactures three different products and the following information has been collected from the books of account. Product STY

Sales Mix 35% 35% 30% Selling Price Rs. 30 Rs. 40 Rs. 20 Variable Cost Rs. 15 Rs. 20 Rs. 12 Total Fixed costs Rs. 1,80,000 Total Sales Rs. 6,00,000 The company has currently under discussion a proposal to discontinue the manufacture of product Y and replace it with product M, when the following results are anticipated: Product STM Sales Mix 50% 25% 25% Selling Price Rs. 30 Rs. 40 Rs. 30 Variable Cost Rs. 15 Rs. 20 Rs. 15 Total Fixed Cost Rs. 1,80,000 Total Sales Rs. 6,40,000 Will you advice the company to changeover to production of M? Give reasons for your answer. Solution : PRESENT PROFITABILITY STRUCTURE : Product STY Rs. Rs. Rs. (1) Sales 2,10,000 2,10,000 1,80,000 (2) Selling Price per Unit 30 40 20 (3) Variable Cost per Unit 15 20 12 (4) Contribution per Unit 15 20 8 (5) Units Sold (1/2) 7,000 5,250 9,000 (6) Total Contribution (4X5) 1,05,000 1,05,000 72,000 = Rs. 2,82,000 390 Management Accounting PROPOSED PROFITABILITY STRUCTURE : Product STM Rs. Rs. Rs. (1) Sales 3,20,000 1,60,000 1,60,000 (2) Selling Price per Unit 30 40 30 (3) Variable cost per Unit 15 20 15 (4) Contribution per Unit 15 20 15 (5) Units Sold (1/2) 10,667 4,000 5,333 (6) Total contribution (4X5) 1,60,005 80,000 79,995 = Rs. 3,20,000 As the total contribution in the proposed alternative i.e. to change over to production of M is likely to be more than in the present situation, the company should change over to production of M. (11) The budgeted results of A Co. Ltd. include Product Sales Value (Rs.) P/V Ratio (%) A 50,000 50 B 80,000 40 C 1,20,000 30 Fixed overheads for the period were Rs. 1,00,000. The Directors are worried about the results of the company. They have requested you to prepare a statement showing the amount of loss expected and recommend a change in the sales of each product or in total mix which will eliminate the expected loss. Solution : We know that (1) Sales x P/V Ratio = Contribution (2) Contribution - Fixed Cost = Profit Product Sales Value (Rs.) P/V Ratio Contribution

A 50,000 50% 25,000 B 80,000 40% 32,000 C 1,20,000 30% 36,000 2,50,000 93,000 Less Fixed Cost 1,00,000 Profit (-) 7,000 Marginal Costing 391 Hence, the expected loss is Rs. 7,000. To eliminate the expected loss, the sales of individual products may be increased, depending upon the P/V Ratio. The additional sales required to be achieved will be calculated as Loss to be eliminated P/V Ratio Hence, additional sales will be as below : Product A - 7,000/50% = Rs. 14,000. Product B - 7.000/40% = Rs. 17,500. Product C - 7,000/30% = Rs. 23,333. As an alternative, the overall sales may also be increased to eliminate the expected loss as stated below: At present, overall P/V Ratio is Contribution X 100 = 93,000 X 100 = 37.2% Sales 2,50,000 To cover the expected loss, the additional sales which will be required to be made will be Expected Loss = 7,000 = Rs. 18,817 Overall P/V Ratio 37.2 % These additional sales may be increased in the existing proportion only i.e. 50,000 : 80,000 : 1,20,000. Hence, the productwise additional sales and the contribution generated by these additional sales will be as below : Product Additional Sales P/V Ratio Contribution Rs. Rs. A 3,763 50% 1,882 B 6,021 40% 2,408 C 9,033 30% 2,710 18,817 7,000 (12) A Ltd. been producing a standard mix as below : Product X 15,000 units. Product Y and Z 10,000 units. 392 Management Accounting The total variable costs amount to Rs. 2,09,000 and the variable cost ratio among the products is 1 : 1.5 : 1.75 respectively per unit The fixed, charges amount to Rs. 2 per unit. Selling prices are Rs. 6.40 for X, Rs. 7.60 for Y and Rs. 10.70 for Z. It is desired to change the mix as below : Product Mix 1 Mix 2 Mix 3 X 18,000 15,000 22,000 Y 12,000 6,000 8,000 Z 7,000 13,000 8,000 Which mix should be recommended? Solution : The variable cost ratio among products X, Y and Z is I : 1.5: 1.75 respectively per unit. If all the products are expressed in terms of Product X, it can be as below : Product X - 15,000 units

Product Y - 15,000 units (10,000 x 1.5) Product Z - 17,500 units (10,000 x 1.75) 47,500 Units Total Variable cost is Rs. 2,09,000. Hence, per unit variable cost will be as below: Product X Rs. 2,09,000 = Rs. 4.40 47,500 Product X - Rs. 4.40 X 1.5 = Rs. 6.60 Product Z - Rs. 4.40 X 1.75 = Rs. 7.70 Product X Product Y Product Z Rs. Rs. Rs. Selling Price 6.40 7.60 10.70 Less : Variable Cost 4.40 6.60 7.70 Contribution 2.00 1.00 3.00 Marginal Costing 393 The total contribution generated by various alternative mixes will be as below : MIX 1 Rs. X 18,000 x 2 36,000 Y 12,000 x 1 12,000 Z 7,000 x 3 21,000 69,000 Mix 2 X 15,000 x 2 30,000 Y 6,000 x 1 6,000 Z 13,000 x 3 39,000 75,000 Mix 3 X 22,000 x 2 44,000 Y 8,000 x 1 8,000 Z 8,000 x 3 24,000 76,000 As Mix 3 generates maximum contribution, it will be recommended. Fixed cost will be ignored, as it will be same under all the circumstances. (13) A firm can produce three different products from the same raw material using the same production facilities. The requisite labour is available in plenty at Rs.8 per hour for all the products. The supply of raw material which is imported at Rs.8 per Kg. is limited to 10,400 Kgs. for the budget period. The variable overheads are RS.5.60 per hour. The fixed overheads are Rs. 50,000. The selling commission is 10% on sales. a. From the following information, you are required to suggest the most suitable sales mix which will maximise the firms's profits. Also determine the profit that will be earned at that level : Product Market Demand Selling Price Labour Hours Raw Material Units Per unit (Rs.) Per Unit (Rs.) Per Unit (Kgs.) x 8,000 30 1 0.7 y 6,000 40 2 0.4 z 5,000 50 1.5 1.5 b. Assume, in the above situation, if additional 4,500 Kgs of raw material is made available for production, should the firm go in for further production, if it will result in 394 Management Accounting the additional fixed overheads of Rs.20,000 and 25% increase in the rates per hour for labour and variable overheads ? Solution : The profitability statement is as below : XYZ

Selling Price per unit 27.00 36.00 45.00 (Net of commission) Variable Cost per unit Raw Material 5.60 3.20 12.00 Direct Labour 8.00 16.00 12.00 Variable Overheads 5.60 11.20 8.40 Total Variable Cost 19.20 30.40 32.40 Contribution per unit 7.80 5.60 12.60 Contribution per Kg. of 11.14 14.00 8.40 Raw Material As availability of raw material is the key factor, the order of preference among the products will be Y, X and Z. 6,000 units of Y consume 2,400 Kgs. of material. Balance left for X and Z are 8,000 Kgs. 8,000 units of X consume 5,600 Kgs. of material. Balance left for Z are 2,400 Kgs. With 2,400 Kgs. of material, maximum possible production for Z will be 1,600 units i.e. 2,400 / 1.5 Hence, the most suitable sales mix and said sales mix will be Product No. of Units Contribution Total Contribution Per Unit Rs. Rs. Y 6,000 5.60 33,600 X 8,000 7.80 62,400 Z 1,600 12.60 20,160 1,16,160 Less : Fixed Cost 50,000 Profit 66,160 Marginal Costing 395 If additional 4,500 Kgs. of raw material is made available, the additional 3,000 units of Z can be sold. However, the profitability per unit of Z will be different as below : Selling Price 45.00 Variable Cost Direct Material 12.00 Direct Labour 15.00 Variable Overheads 10.50 Total Variable Cost 37.50 Contribution 7.50 Total Contribution generated by these 3,000 units will be Rs. 22,500 i.e. 3,000 units x Rs. 7.50 per unit. As the fixed overheads are also likely to increase by Rs. 20,000, the additional 3,000 units will generate positive contribution of Rs. 2,500. Hence, it is advisible to go for further production with the additional raw material available. (14) The following particulars are obtained from the records of a factory manufacturing Products A and B. Product A Product B (Per unit) (Per Unit) Selling Price 100 200 Material Cost at Rs. 10 per Kg. 20 50 Wages @ Rs. 3 per hour 30 60 Variable overheads 10 20 Total fixed costs : Rs. 5,000 State which of the product is better to be produced and why in the following cases: (a) If total sales in units is key factor (b) If total sales in value is key factor (c) If law material is in short supply

(d) If labour hours is the Limiting factor (e) If raw material available is 2,000 kgs. and maximum sales of each product is 500 units, advice about the sales mix. 396 Management Accounting Solution : Product A Product B Per Unit Per Unit Rs. Rs. (1) Selling Price 100 200 (2) Variable cost : Material 20 50 Wages 30 60 Variable Overheads 10 20 60 130 (3) Contribution (1 - 2) 40 70 (4) P/V ratio (3/1) 40% 35% (5) Material consumption 2 Kgs. 5 Kgs. Contribution per kg. of material 20 14 (3/5) (6) Labour Hours 10 20 Contribution per labour hour 4 3.5 (3/6) (a) If total sales in units is the key factor, Product B will be better as its per unit contribution is more. (b) If total sales in value is the key factor, Product A will be better as its P/V Ratio is more. (c) If raw material is in short supply, Product A will be better as its contribution per Kg. of material is more. (d) If labour hours is the limiting factor, Product A will be better as its contribution per labour hour is more. (e) If total available raw material is 2,000 Kgs., it will first utilised to manufacture Product A as its contribution per Kg. of material is more. However the maximum sales potential of Product A is restricted to 500 units which consumes 1,000 Kgs. of material (i.e. 500 units x 2 Kgs. per unit). Remaining material of 1,000 Kgs. can be used for the manufacture of Product B, with the help of which only 200 units of Product B can be manufactured i.e., 1,000 Kgs = 200 Units 5 Kgs. per Unit Marginal Costing 397 Hence, the desirable product mix will be 500 units of Product A 200 units of Product B (15) Small-Tools Factory has a plant capacity adequate to provide 19,800 hours of machine use. The plant can produce all A type tools or all B type tools or a mixture of the two types. The following information is relevant. Per Type A B Selling Price Rs. 10 15 Variable Cost Rs. 8 12 Hours required to produce 3 4 Market conditions are such that no more than 4,000 A type tools and 3,000 B type tools can be sold in a year. Annual fixed costs are Rs. 9,900. Compute the product mix that will maximize the net income to the company and find that maximum net income. Solution : It is a situation of multiplicity of key factors, first key factor being availability of machine hours

and second one being market conditions. The contribution per machine hour can be computed as below : AB Selling Price Per unit Rs. 10 15 Variable cost per mat Rs. 8 12 Contribution per unit Rs. 2 3 Machine hours required per unit 3 4 Contribution per machine your Rs. 0.66 0.75 Ranking when machine hours availability is key factor II I As such, tool B will be produced to the maximum possible extent i.e. 3,000 units and the balance machine hours should be utilised for the production of tool A. 398 Management Accounting The net income can be worked out as below: Tool Units Machine hours Contribution Total required per unit contribution Rs. Rs. B 3,000 12,000 3 9,000 A 2,600 7,800 2 5,200 19,800 14,200 Less : Annual fixed costs 9,900 Net Profit 4,300 (16) An umbrella manufacturer makes an average net profit of Rs. 2.50 per piece on a selling price of Rs. 14.30 by producing and selling 6,000 pieces or 60% of the potential capacity. His cost of sales is as follows: Per Unit Direct material Rs. 3.50 Direct wages Rs. 1.25 Works overheads Rs. 6.25 (50% fixed) Sales overheads Rs. 0. 80 (25% varying) During the current year, he intends to produce the same number but anticipates that his fixed expenses will go up by 10% while rate of direct labour and direct material will increase by 8% and 6% respectively. But he has no option of increasing the selling price. Under this situation he obtains an offer for a further 20% of capacity. What minimum price will you recommend for acceptance to ensure the manufacturer an overall profit of Rs. 16,730? Solution : Profitability structure Previous year Current Year Per Unit Total Per Unit Total Rs. Rs. Rs. Rs. (1) Selling Price 14.30 85,800 14.30 85,800 (2) Variable Cost Direct Material 3.50 21,000 3.71 22,260 Direct Wages 1.25 7,500 1.35 8,100 Works Overhead 3.125 18,750 3.125 18,750 Sales Overheads 0.20 1,200 0.20 1,200 8.075 48,450 8.385 50,310 Marginal Costing 399 Previous year Current Year Per Unit Total Per Unit Total Rs. Rs. Rs. Rs. (3) Contribution (1 2) 6.225 37,350 5.915 35,490 (4) Fixed Cost Works Overheads 3.125 18,750 - 20,625 Sales Overheads 0.60 3,600 - 3,960 3.725 22,350 24,585 (5) Profit (3 4) 2.50 15,000 10,905

From the above, it can be seen that the present sales of 6,000 units will generate a total profit (after recovering the fixed cost) of Rs. 10,905. If it is intended that the overall profit should be Rs. 16,730, there will be a shortfall of Rs. 5,825 which will have to be covered by the additional 2.000 units to be sold. As such, every additional unit to be sold will have to generate a clear margin of Rs. 2.9125 i.e., Rs. 5,825/2,000 units. Hence the minimum price to be recommended will be Revised per unit variable cost + Expected per unit margin i.e., Rs. 8.385 + Rs. 2.9125 i.e., Rs. 11.2975 (17) The cost profile of a company, manufacturing only one product, is as under : Rs. Direct Material 5.60 Direct Labour 1.50 Variable factory overheads 0.40 7.50 Fixed factory overhead is budgeted at Rs. 3,30,000 for an annual sales of 4,00,000 units.Selling, Distribution and Administration costs are budgeted at Rs. 1,80,000. Capital employed is Rs. 4,50,000 in fixed assets and 50% of sales in current assets. Determine a selling price for the product to yield 20% return on capital employed. Solution : Let us assume that the selling price per unit is Rs. X. Hence, total sales will be Rs. 4,00,000 X. 400 Management Accounting The total amounts to be covered by this amount of sales will be Rs. Variable Cost - 4,00,000 x 750 30,00,000 Fixed Factory overheads 3,30,000 Selling Distribution and Administration cost 1,80,000 Profit 90,000 + 40,000 x 36,00,000 + 40,000 x Note : Profit is calculated as below : Expected yield - 20% of capital employed where Capital employed = 4,50,000 + 50% of sales = 4,50,000 + 50% of 4,00,000 x = 4,50,000 + 2,00,000 x Hence, Profit = 20% (4,50,000 + 2,00,000 x) = 90,000 + 40,000 x Thus, 4,00,000 x = 36,00,000 + 40,000 x = 3,60,000 x = 36,00,000 x = Rs. 10 Hence the selling price for the product should be Rs. 10 per unit. (18) V Ltd. produces two products P and Q. The draft budget for the next month is as under. PQ Budgeted Production and sales (Units) 40,000 80,000 Selling Price Rs / Unit 25 50 Total Costs Rs / Unit 20 40 Machine Hours / Unit 2 1 Maximum Sales Potential (Units) 60,000 100,000 The fixed expenses are estimated at Rs. 9,60,000 per month. The company absorbs fixed overheads on the basis of machine hours which are fully utilised by the budgeted production and cannot be further increased. Marginal Costing 401 When the budget was discussed, the Managing Director stated that the product mix should be altered to yield optimum profit.

The Marketing Director suggested that he could introduce Product C, each unit of which will take 1.5 machine hours. However, a processing vat involving a capital outlay of Rs. 2,00,000 is to be installed for the processing of product C. The additional fixed overheads relating to the processing vat was estimated to be Rs. 60,000 per month. The variable cost of Product C was estimated of Rs. 21 per unit. Required (i) Calculate the profit as per draft budget for the next month. (ii) Revise the product mix based on data given for P and Q to yield optimum profit. (iii) The company decides to discontinue either product P or Q whichever is giving lower profit and proposes to substitute product C instead. Fix the selling price of Product C in such a way so as to yield 15% return on additional capital employed besides maintaining the same overall profits as envisaged in (ii) above. Solution : At present, the utilisation of the machine hours is as below. Product P - 40,000 units x 2 = 80,000 Hrs. Product Q - 80,000 units x 1 = 80,000 Hrs. 1,60,000 Hrs. Fixed Expenses are Rs. 9,60,000 per month and are absorbed on the basis of utilisation of machine hours. Hence, Machine Hour Rate = Rs. 9,60,000 = Rs. 6/Hr. 1,60,000 Hrs. As such, the fixed overheads absorbed by the product (which must have been included in the total cost.) are as below : Product P - 2 Hrs. x Rs. 6 = Rs. 12 Product Q - 1 Hr. x Rs. 6 = Rs. 6 402 Management Accounting Hence, the cost structure of the products can be amended as below : Product P Product Q Rs. Rs. Rs. Rs. Selling Price / Unit 25 50 Less : Variable cost 8 34 Fixed Cost 12 6 Total Cost 20 40 Profit 5 10 (1) Profit as per draft budget for the next month are (a) Sales - P - 40,000 Unit x Rs. 25/ Unit Rs. 10,00,000 Q - 80,000 Units x Rs. 50/ Unit Rs. 40,00,000 Rs. 50,00.000 (b) Variable Cost - P - 40,000 Units x Rs. 8/ Unit Rs. 3,20,000 Q - 80,000 Units x Rs. 34/ Unit Rs. 27,20,000 Rs. 30,40.000 (c) Contribution a b Rs. 19,60,000 (d) Fixed Expenses Rs. 9,60,000 (e) Profit c d Rs. 10,00,000 (2) Revised Product Mix to yield Optimum Profit. The machine hours are available in limited quantity and hence are the key factor of production. The revised cost structure of the products is as under. Prod. P Prod Q. Selling Price - Rs./ Unit 25 50 Variable Cost - Rs./ Unit 8 34 Contribution Rs./ Unit 17 16 Machine Hours/ Unit 2 1

Contribution Rs./ Machine Hour 8.5 16 As the contribution per unit of key factor i.e. Machine Hour is more in case of Product Q, the available machine hours will be utilised for the manufacture of Product Q subject to its maximum sales potential. Marginal Costing 403 Thus, the revised product mix will be: Product Machine Hours Machine Units Hours/Unit Product Q - 1,00,000 Units x 1 Hr. = 1,00,000 1 1,00,000 Product P - 1,60,000 Hrs. 1,00,000 Hrs. = 60,000 2 30,000 The revised profitability will be (a) Sales - Q 1,00,000 Units x Rs. 50/ Unit Rs. 50,00,000 - P 30,000 Units x Rs. 25/ Unit Rs. 7,50,000 Rs. 57,50,000 (b) Variable Cost - Q 1,00,000 Units X Rs. 34/ Unit Rs. 34,00,000 P 30,000 Units x Rs. 8/ Unit Rs. 2,40,000 Rs. 36,40,000 (c) Contribution a-b Rs. 21,10,000 (d) Fixed Expenses Rs. 9,60,000 (e) Profit c-d Rs. 11,50,000 (3) Calculation of Selling Price of Product C : The various amounts to be covered by the sales of product C are as below: Variable cost - 40,000 Units x Rs. 21/ Unit Rs. 8,40,000 Fixed Expenses to be absorbed 40,000 Units x Rs. 6/ Machine Hour x 1.5 Hrs/ Unit Rs. 3,60,000 Additional fixed overheads Rs. 60,000 Yield on capital employed 15% on Rs. 2,00,000 Rs. 30,000 Deficit of Profit Rs. 1,50,000 Rs. 14,40,000 Hence, the per unit selling price will beRs. 14,40,000 = Rs. 36/ Unit 40,000 units 404 Management Accounting Notes : (1) As availability of machine hours is the key factor and the contribution per machine hour is less in case of Product P, it will be discontinued. Production of Product Q will be continued subject to its maximum sales potential. As such, 1,00,000 units of product Q will be produced and sold, thus leaving 60,000 machine hours for the production and sales of product C. As one unit of product C consumes 1.5 Machine Hours, maximum 40,000 units of product C can be produced and sold i.e., 60,000 Machine Hours 1.5 Machine Hrs./Unit (2) It is assumed that Product Q will continue to absorb the fixed expenses at the current rate of absorption. Hence, the profit generated by product Q will be as below: (a) Sales - 1,00,000 Units x Rs.50/ Unit Rs. 50,00,000 (b) Variable Cost - 1,00,000 Units x Rs. 34/ Unit Rs. 34,00,000 (c) Contribution - a-b Rs. 16,00,000 (d) Fixed Expenses absorbed 1,00,000 units x Rs. 6/ Machine Hr. Rs. 6,00,000 (e) Profit c-d Rs. 10,00,000 As the profit is desired to be maintained at Rs. 11,50,000 the deficit should be covered by the sales of product C (3) As the fixed overhead relating to the processing vat will be incurred specifically due to Product C, it will be as if the variable cost of Product C.

Marginal Costing 405

QUESTIONS 1. What do you understand by the terms Break Even Point, Contribution and Margin of Safety? Explain your answer by drawing a chart with assumed figures. 2. How does Break Even Analysis help in business decisions? 3. Describe the importance of the following terms in relation to marginal costing. (a) Break Even Point (b) Profit Volume Ratio (c) Margin of Safety 4. Explain what is meant by Break Even Analysis? Discuss (a) The assumptions that are involved in this technique (b) The various uses of this technique. 5. Explain any four circumstances in which the technique of marginal costing will help the management in taking decisions. What are the limitations of this technique? 6. The rate of earning profit mainly depends upon the magnitude of the angle of incidence projected on break even chart.- Explain as to whether this statement is correct. What measures can be adopted to increase the magnitude of angle of incidence. 7. Write a critical note about uses, applications, advantages and limitations of Marginal Costing technique. 8. The work of separating the overheads into fixed and variable costs is purely academic, but practically very difficult and as such the technique of Marginal Costing is of very little use in managerial decisions. How will yon make out a case for introducing the technique of Marginal Costing when encountered with the above argument? 9. Discuss the most important areas of managerial decisions opened up by the application of marginal costing technique. 10. Write Short Notes on (a) Profit Volume Ratio(b) Contribution (c) Break Even Point (d) Margin of Safety (e) Marginal Costing (f) Importance of Break Even analysis 406 Management Accounting PROBLEMS (1) Following information is made available to you about a company for two periods. Period. Sales (Rs) Profit (Rs) (I) 1,20,000 9,000 (II) 1,40,000 13,000 Find out (a) Profit Volume Ratio (b) Break Even Point for sales (c) Profit when sales are Rs. 1,00,000 (d) Sales required to earn a profit of Rs. 20,000 (e) Safety Margin in period II (2) The sales turnover and profits during two periods are as under. Period I - Sales Rs. 20 Lakhs, Profit Rs. 2 Lakhs Period II - Sales Rs. 30 Lakhs, Profit Rs. 4 Lakhs Calculate: (1) P/V Ratio (2) The sales required to earn the profit of Rs. 5 Lakhs (3) Following figures relate to a company manufacturing a varied range of products : Total Sales Total Cost Year ended 31st Dec., 1987 22,23,000 19,83,600 Year ended 31st Dec., 1988 24,51,000 21,43,200 Assuming stability in price with variable costs carefully controlled to reflect predetermined relationship and an unvarying figure for fixed costs, calculate :

(a) The profit volume ratio to reflect the rates of growth for profits and sales. (b) Fixed Costs. (c) Fixed Cost as % to Sales. (d) Break even point (e) Margin of safety for the year 1987 and year 1988. Marginal Costing 407 (4) Gee Ltd. has two factories producing an identical product and realising the same selling price net i.e. Rs.60 per unit. The costs in the two factories can be summarised as follows. Factory A Factory B Capacity (Units) (Rs.) 1,00,000 1,50,000 Variable Cost per unit (Rs.) 20 15 Fixed Costs per annum (Rs.) 20,00,000 45,00,00 The demand for the product is 2,00,000 units. State how much should be produced at each factory. (5) Calculate the Break Even Point in units and in rupees and also arrive at Margin of Safety ratio from the following information. Estimated sales (1,00,000 Units) Rs. 20,00,000 Variable Cost Rs. 12,00,000 Fixed Cost Rs. 4,00,000 Rs.16,00,000 Net Profit Rs. 4,00,000 (6) From the following data relating to a company, calculate : (1) Break Even Sales (2) Sales required to earn a profit of Rs.6,000 per period Period Total Sales Total Costs Rs. Rs. 1 42,500 38,700 2 39,200 36,852 (7) (a) A company budgets a production of 5,00,000 units at a variable cost of Rs. 20 each. The fixed costs are Rs. 20,00,000. The selling price is fixed to yield 25% profit on cost. Calculate (i) Break Even Point (ii) P/V Ratio (b) If the selling price is reduced by 20% find (i) The effect of the price reduction on the break even point and the P/V Ratio (ii) The number of units required to be sold at the reduced selling price to obtain an increase of 20% on the budgeted profit. 408 Management Accounting (8) (1) The following figures for profit and sales are obtained from the account of XYZ Co. Ltd. Year Sales (Rs.) Profit (Rs.) 1985 20,000 2,000 1986 30,000 4,000 Calculate (a) P/V Ratio (b) Fixed Cost (c) Break Even Sales (d) Sales to earn a profit of Rs. 5.000 (2) Calculate all the above figures, if the company has a fixed overhead of Rs. 1,000 in addition to the expenses considered above. (9) The following data are obtained from the records of a company. First Year Second Year Rs. Rs. Sales 80,000 90,000 Profit 10,000 14,000

Calculate : (a) P/V Ratio (b) Break Even Point (c) Profit or loss when sales amount to Rs. 50,000 (d) Sales required to earn a profit of Rs. 19,000 (e) Sales position if company sustained a loss of Rs. 19,000 (10) The following figures relating to the performance of a company for Year I and Year II are available. Assuming that the ratio of variable costs to sales and the fixed costs are the same for both the years, ascertain a. Profit Volume Ratio b. Amount of the fixed costs c. Break Even Point d. Budgeted profit for Year III if the budgeted sales are Rs. 1 Crore. Total Sales Total Costs Year I Rs. 70 Lakhs Rs. 58 Lakhs Year II Rs. 90 Lakhs Rs. 66 Lakhs Marginal Costing 409 (11) S Ltd. furnishes you the following information relating to the half year ending 30th June 1980. Rs. Fixed Expenses 50,000 Sales Value 2,00,000 Profit 50,000 During the second half of the year, the company has projected a loss of Rs. 10,000. Calculate (1) The P/V Ratio, Break Even Point and Margin of safety for six months-ending 30th June 1980. (2) Expected sales volume for the second half of the year assuming that selling price and fixed expenses remain unchanged in the second half year also. (3) The break even point and margin of safety for the whole year 1980. (12) PQ Limited has been offered a choice to buy a machine between A and B. You are required to compute : (a) Break Even Point for each of the machines. (b) The level of sales at which both machines earn equal profits. (c) The range of sales at which one is more profitable than the others. The relevant data is given below : Machines AB Annual output in units 10,000 10,000 Fixed Cost (Rs.) 30,000 16,000 Profit at above level of production (Rs.) 30,000 24,000 The market price of the product, is expected to be Rs.10 pet Unit (13) The following is the basic cost of a firm ABC. (1) (i) Fixed Operating Cost Rs. 2,500 (ii) Sales Price (Per Unit) Rs. 10 (iii) Variable Cost (Per Unit) Rs. 5 Determine BEP in units and rupees 410 Management Accounting (2) If fixed operating cost increases to Rs. 3,000, what will be the new BEP ( in Units)? (3) If sale price increases to Rs. 12.50 and the variable operating cost to Rs.7.50, what would be the impact on BEP? (14) A Ltd. manufactures & sells four types of products under the brand names -P, Q, R and S. Sales mix in value comprises. 33.33%, 41.66%,16.66% and 8.33% of P, Q, R and S respectively. The total budgeted sales (100%) are Rs. 60,000 per month. Operating Costs are Variable Costs

Product P - 60% of selling price Product Q - 68% of selling price Product R - 80% of selling price Product S - 40% of selling price Fixed Costs : Rs. 14,700 per month Calculate the BEP for the products on an overall basis i.e. in total (15) Following information is presented by the costing department to the management accountant of the company. 1. Contribution Rs. 10,000 2. Fixed Cost Rs. 5,000 3. P/V Ratio 1/3 The Management Accountant is asked to find out the margin of safety if P/V Ratio is brought down to 1/2. (16) A company produces and sells 100 units of A at Rs. 20. Marginal cost per unit is Rs. 12 and the fixed costs are Rs. 300 per month. It is proposed to reduce the price by 20%. Find out the additional sales required to earn the same amount of profits as before. (17) A ball pen manufacturer has developed a new ball pen with unique features. His development executive has suggested three possible retail price viz. Rs.15 for super star, Rs.10 for deluxe and Rs. 7.50 for economy model. His marketing manager opines that the whole sellers and retailers have to be given at least 30% discount. The estimated fixed cost would be around Rs.70,000 and the variable cost per unit would be Rs. 3.50 (a) Calculate breakeven point for each model of ball pen. (b) How much should the manufacturer sell in order to make a profit of Rs. 21,000? Work out for each model of ball pen. Marginal Costing 411 (18) ABC Pvt. Ltd. manufactures and sells a standard product at fixed selling price. The budgeted figures for 1986-87 are as under. Production and sales - 2,00,000 Units. Variable cost - Rs. 56 Per Unit Fixed Cost - Rs. 48,00,000 Profit Margin - 33.33% of selling price. You are required to determine sales at break even both in terms of quantity and value for the budget year 1986-87 at the above selling price. (19) The Laila Shoe Company sells five different styles of ladies chappals with identical purchase cost and selling price. The company is trying to find out the profitability of opening another store which will have the following expenses and revenues. Per Pair (Rs) Selling Price 30.00 Variable cost 19.50 Salesmens commission 1.50 Total Variable Cost 21.00 Annual Fixed expenses are : Rent Rs. 60,000 Salaries Rs. 2,00,000 Advertising Rs. 80,000 Other fixed expenses Rs. 20,000 Rs. 3,60,000 Required : a. Calculate the annual break even point in units and in value. Also determine the profit or loss if 35,000 pairs of chappals are sold. b. The sales commissions are proposed to be discontinued, but instead a fixed amount of Rs. 90,000 is to be incurred in fixed salaries. A reduction in selling price of 5% is also proposed. What will be the break even point in units ? c. It is proposed to pay the stores manager 50 paise per pair as further commission. The selling price is also proposed to be increased by 5%. What would be the break

even point in units? 412 Management Accounting d. Refer to the original data. If the stores manager were to be paid 30 paise commission on each pair of chappal sold in excess of the break even point, what would be the stores net profit if 50,000 pairs were sold ? (20) Speedy Airline can carry a maximum of 10,000 passengers per month on one of its routes at a fare of Rs. 85. Variable costs are Rs. 10 per passenger and fixed costs are Rs. 3,00,000 p.m. calculate (1) Break Even quantity (2) Break Even sales (3) Break Even Percentage of capacity. (4) Suppose that the management sets a profit target of Rs. 2,00,000 What would be the required profit before taxes to achieve this profit target, if the corporate tax rate of the company is 46%. (21) Three firms X, Y and Z manufacture the same product. The selling price is Rs.8 per unit of the product equal for all the firms. The fixed costs for the firms X, Y and Z respectively are Rs. 80,000 Rs. 2,00,000 and Rs. 3,30,000 while the variable costs per unit are Rs. 6, Rs. 4 and Rs. 3 (a) Determine the break even point for all the firms in units. (b) How much profits are earned by the firms if each of them sells 80,000 units? (c) What will be the impact percentagewise .on profits if sales increase by 20%. (22) Merry Manufacturers Ltd. has supplied you the following information in respect of one of its products. Rs. Total Fixed costs 18,000 Total Variable Costs 30,000 Total Sales 60,000 Units Sold 20,000 Find out (a) Contribution per unit (b) Break Even Point (c) Margin of Safety (d) Profit (e) Volume of sales to earn a profit of Rs. 24,000. Marginal Costing 413 (23) From the following information relating to Quick Standards Ltd., you are required to find out - (a) Contribution (b) BEP in units (c) Margin of Safety (d) Profits. Rs. Total fixed costs 4,500 Total variable costs 7,500 Total sales 15,000 Units sold 5,000 (Units) Also calculate the volume of sales to earn a profit of Rs. 6,000 (24) Bindra Ltd. is running its plant at present at 50% of capacity. The management has supplied you the following details. Cost of production per unit Rs. Direct Material 4 Direct Labour 2 Variable Overheads 6 Fixed Overheads (fully absorbed) 4 16 Production per month 40,000 Units Total cost of products 40,000 Units x Rs. 16 = Rs. 6,40,000 Sales Price 40,000 Units x Rs. 14 = Rs. 5,60,000 Loss Rs. 80,000 An exporter offers to purchase 10,000 units per month @ Rs. 13 per unit and the company is hesitating in accepting the offer due to the fear that it will increase its already large operating losses. Advice whether the company should accept or decline this offer.

(25) Mega Corporation manufactures and sells three products to the automobile industry. All the products must pass through a machining process, the capacity of which is limited to 20,000 hours per annum, both by equipment design and government regulation. 414 Management Accounting Following additional information is available. Product X Product Y Product Z Selling Price Rs./Unit 1,900 2,400 4,000 Variable cost Rs./Unit 700 1,200 2,800 Machining requirements hrs/Unit 3 2 1 Maximum possible sales units 10,000 2,000 1,000 Required - A statement showing the best possible production mix which would provide the maximum profits for Mega Corporation, together with supporting workings. (26) (a) A companys turnover in a year was Rs. 50,00,000, its profit was Rs. 500,000 and its P/V Ratio was 40% What is the break even point? (b) A factory furnishes the following figures. August 84 September 84 Output (Units) 50,000 55,000 Total Cost (Rs.) 6,70,000 7,10,000 What is the amount of fixed expenses per month? (27) (a) Calculate the Break Even Point from the following data. (i) Sales Price per unit Rs. 10 (ii) Variable cost per unit Rs. 6 (iii) Fixed overheads Rs.20,000 (b) Calculate the revised Break Even Point if (i) Sales price is increased to R.11 per unit (ii) Sales price is reduced to Rs.9 per unit (iii) Variable cost increased to Rs.7 per unit (iv) Variable cost reduced to Rs.5 per unit (v) Fixed overheads rise to Rs.25,000 (vi) Fixed overheads fall to Rs.15,000 (28) The Modern Machine Co. Ltd. places before yon the following figures Sales (Rs.) Profit (Rs.) 1974 2,00,000 10,000 1975 1,80,000 2,000 Marginal Costing 415 You are required to (a) Calculate profit or loss when sales amount to Rs. 1,50,000 and Rs-3,00,000. (b) Calculate Profit Volume Ratio. (c) Determine sales at Break Even Point. (29) The selling price of a product is Rs.40 which yields a margin of 20%. The total fixed expenditure are Rs. 10,000 a month. What should be the level of sales to yield an annual profit of Rs.20,000? (30) The following is the annual profit plan of XYZ Company. (1) Budgeted sales (2,00,000) units @ Rs. 25) 50,00,000 (2) Budgeted Costs Fixed Variable Direct Material 9,00,000 Direct Labour 10,00,000 Factory Overheads 7,00,000 3,00,000 Administrative Expenses 6,00,000 1,00,000 Distribution Expenses 5,00,000 3,00,000 18,00,000 26,00,000 44,00,000 Budgeted Profit 6,00,000 Production capacity - 2,40,000 Units. (A) (a) Determine the break even point in rupees. (b) Would you accept an export order for 60,000 units @ Rs. 20 per unit and

why? (c) Briefly enumrate the basic assumptions underlying break even analysis. (B) Compute BEP in the following independent situations if (i) a 10% increase is effected in fixed costs (ii) a 10% increase is effected in variable costs (iii) a 10% increase in fixed costs and 5% decrease in-variable costs is effected. (31) You are the company Accountant of Machine Manufacturing Ltd. which was incorporated in February 1979. The company has started production from 1st January 1980. It was proposed that the company will produce and sell 8,000 units in the first year of its operations. Estimated costs of production are given below. 416 Management Accounting Raw Materials Rs. 20 per unit Direct Labour Rs. 10 per unit Other variable costs 200% of direct labour Fixed costs Rs.1,50,000 (1) The company fixed a target to earn a profit of Rs. 1,50,000 in the first year. (2) Further, the company expects that annual fixed costs will increase by Rs. 1,00,000 in the second year of operations. The marketing manager has planned to spend a sum of Rs. 80,000 on promotion and advertising in the second year, keeping in view the target of the company to earn a profit of Rs. 2,50,000 in the second year of operations. It is expected that direct material, direct labour and other variable costs will not change in the second year. (3) The company wishes to sell the product in the second year at a price of Rs.75 per unit. Advice the company about the following : (a) Selling price for the first year. (b) Sales turnover ( in Units) for the second year. (32) The Asian Industries specialise in the manufacture of small capacity of Motors. The cost structure of a motor is as under. Material Rs. 50 Labour Rs. 80 Variable Overheads 75% of labour cost. Fixed overheads of the company amount to Rs. 2.40 lakhs per annum. The sale price of the motor is Rs. 230 each. (a) Determine the number of motors that have to be manufactured and sold in a year to break even. (b) How many motors have to be made and sold to make a profit of Rs.1 lakh per year? (c) If the sale price is reduced by Rs. 15, how many motors will have to be sold to break even? (33) Repographics Ltd. manufactures a document reproducing machine which has the variable cost structure as follows : Material Rs. 40 Labour Rs. 10 Overheads Rs. 4 Selling price per unit is Rs. 90 Marginal Costing 417 Sales during the current year are expected to be Rs. 13,50,000 and fixed overheads Rs. 1,40,000. Under a wage agreement, an increase of 10% is payable to all direct workers from the beginning of the forthcoming year, whilst material costs are expected to increase by 7.5%, variable overheads by 5% and fixed overhead costs by 3%. You are required to calculate : a. The new selling price if the current Profit Volume Ratio is to be maintained. b. The quantity to be sold during the forthcoming year to yield the same amount of profit as the current year, assuming the selling price to remain at Rs. 90. (34) Cookwell Ltd.manufactures pressure cookers the selling price of which is Rs. 300 per

unit. Currently the capacity utilisation is 60% with a sales turnover of Rs. 18 lakhs. The company proposes to reduce the selling price by 20% but desires to maintain the same profit position by increasing the output. Assuming that the increased output could be made and sold, determine the level at which the company should operate, to achieve the desired objective. The following further data are available. (a) Variable cost per unit Rs.60 (b) Semi variable cost (including a variable element of R1. 10 per unit) Rs. 1,80,000 (c) Fixed cost Rs. 3,00,000 will remain constant Upto 80% level. Beyond this, an additional of Rs. 60,000 will be incurred. (35) The MYZ Co. has the following budget for the year 1986-87. Rs. Sales (1,00,000 Units a Rs.20) 20,00,000 Variable Cost 10.00,000 Contribution 10,00,000 Fixed cost 4,00,000 Net Profit 6,00,000 From the above set of information find out, (a) The adjusted profits for 1986-87 if the following two sets of changes are introduced and also suggest which plan should be implemented. 418 Management Accounting Plan A Plan B Increase in Price 20% Decrease in Price 20% Decrease in Volume 25% Increase in Volume 25% Increase in variable cost 10% Decrease in Variable cost 10% Increase in fixed cost 5% Decrease in fixed cost 5% (b) The P/V Ratio and break even points under the two plans referred above. (36) A review made by the top management of Sweat and Struggle Ltd. which makes only one product, of the result of the first quarter of the year revealed the following details : Sales in units 10,000 Loss in Rs. 10,000 Fixed Cost (For the year Rs.1,20,000) in Rs. 30,000 Variable cost per unit in Rs. 8 The Finance Manager who feels perturbed suggests that the company should at least break even in the second quarter with a drive for increased sales. Towards this, the company should introduce a better packing which will increase the cost by Re. 0.50 per unit. The sales manager has an alternative proposal. For the second quarter, additional sales promotion expenses can be increased to the extent of Rs. 5,000 and a profit of Rs. 5,000 can be aimed with increased sales. The production manager feels otherwise. To improve the demand, the selling price per unit has to be reduced by 3%. As a result, the sales volume can be increased to attain a profit level of Rs. 4,000 for the quarter. The Managing Director asks you as a Cost Accountant to evaluate these three proposals and calculate the additional sales volume that would be required in each case, in order to help him take a decision. (37) Following is the summarised Trading account of a manufacturing concern which makes two products X and Y. Marginal Costing 419 Summarised Trading Account for the four months to 30th April 1984 X Y Total Rs. Rs. Rs. Sales 10,000 4,000 14,000 Less : Cost of Sales (a) Direct costs Labour 3,000 1,000

Material 1,500 1,000 4,500 2,000 6,500 5,500 2,000 7,500 Indirect costs (a) Variable Expenses 2,000 1,000 3,000 3,500 1,000 4,500 (b) Fixed Expenses Common to both X and Y 1,250 1,250 2,500 Net Profit 2,250 (-)250 2,000 (a) These costs tend to vary in direct proportion to physical output. (b) These costs tend to remain constant irrespective of physical outputs of X and Y. It has been the practice of the concern to allocate these costs equally between X and Y. The following proposals have been made by the Board of Directors for your consideration as financial advisor. (1) Discontinue Product Y. (2) As an alternative to (1), reduce the price of Y by 20%. (It is estimated that the demand then will increase by 40%.) (3) Double the price of X (It is estimated that the demand then will reduce by three fifths.) You are required to recommend the proposal to be taken after evaluating each of these three proposals. 420 Management Accounting (38) A Multi-Product company has the following costs and output data for the last year. Product X Product Y Product Z Sales Mix (in value) 40% 35% 25% Selling Price per unit Rs. 20 Rs. 25 Rs. 30 Variable cost per unit Rs. 10 Rs. 15 Rs. 18 Total Fixed cost Rs. 1,50,000 Total Sales Rs. 5,00,000 The company proposes to replace Product Z by Product S. Estimated cost and output data are Product X Product Y Product S Sales Mix (in value) 50% 30% 20% Selling Price per Unit Rs. 20 Rs. 25 Rs. 28 Variable cost per Unit Rs.10 Rs. 15 Rs. 14 Total fixed cost Rs. 1,50,000 Total Sales Rs. 5,00,000 Analyse the proposed change and suggest what decision the company should take. Also state the break even point for the company as a whole in the two situations. (39) A manufacturer has planned his level of production at 50% of his plant capacity of 30,000 units. At 50% of the capacity, his expenses are as follows. (a) Direct Labour Rs.11,160 (b) Direct Material Rs. 8,280 (c) Variable and other manufacturing expenses Rs. 3,960 (d) Total fixed expenses regardless production Rs. 6,000 The home selling price is Rs.2.00 per unit. Now, the manufacturer receives a trade enquiry from overseas for 6,000 units at a price of Rs. 1.45 per unit If you were the manufacturer, would yon accept or reject the offer? Support your statement with suitable cost and profit details. (40) A manufacturer sells his product at Rs.5 each variable costs are Rs.2 per unit and the fixed costs amount to Rs.60,000. (a) Calculate the break even point (b) What would be the profit if he sells 30,000 units? (c) What would be the BEP if he spends Rs.3,000 on advertisement?

(d) How much should the manufacturer sell to make a profit of Rs.30,000 assuming he spends Rs.3,000 on advertisement? Marginal Costing 421 (41) Texemat Private Limited has been manufacturing track suits for athletes currently, its output is around 70% of its rated capacity of 19,000 units per annum. One exporter has approved the sample and has offered to buy 5000 units at a special price of Rs. 150 per suit. At present, the company has been selling the track suit @ Rs.210.The standard cost per unit is as under. . Cost Items Rs. (a) Cloth and other materials 82 (b) Labour 25 (c) Fixed cost 42 (d) Administrative variable cost 11 Total Cost 160 (a) Should the company accept the offer? (b) What would be your advice if the exporter offers to buy 10,000 units instead of 5000 units? (42) The variable cost structure of a product manufactured by a company during the current year is as under Rs. Per Unit Material 120 Labour 30 0verheads 12 The selling price per unit is Rs. 270 and the fixed cost and sales during the current year are Rs. 14 Lakhs and Rs. 40.50 Lakhs respectively. During the forthcoming year, the direct workers will be entitled to a wage increase of 10% from the beginning of the year and the materials cost, variable overhead and fixed overhead are expected to increase by 7.5%, 5% and 3% respectively. The following are required to be computed a. New selling price in the forthcoming year if the current P/V ratio is to be maintained. b. Number of units that would be required to be sold during the forthcoming year so as to yield the same amount of profit in the current year, assuming that the selling price per unit will not be increased. 422 Management Accounting (43) A company currently operating at 80% capacity has the following particulars. Rs. Sales 32,00,000 Direct Materials 10,00,000 Direct Labour 4,00,000 Variable Overheads 2,00,000 Fixed Overheads 13,00,000 An export order has been received that would utilise half the capacity of the factory. The order cannot be split i.e. it has either to be taken in full and executed at 10% below the normal domestic prices or rejected totally. The alternatives available to the management are : a. Reject the order and continue with the domestic sales only (as at present) or b. Accept the order, split capacity between overseas and domestic sales and turn away excess domestic demand or c. Increase capacity so as to accept the export order and maintain the present domestic sales by i) buying an equipment that will increase the capacity by 10%. This will result in an increase of Rs. 1,00,000 in fixed costs and ii) work overtime to meet the balance of required capacity. In that case, labour will be paid at one and half times the normal wage rate. Prepare a comparative statement of profitability and sugget the best alternative. (44) A company produces a single product which is sold by it presently in the domestic

market at Rs. 75 per unit. The present production and sales is 40,000 units per month representing 50% of the capacity available. The cost data of the product was as under Variable cost per unit Rs. 50 Fixed costs per month Rs. 10 Lakhs To improve the profitability, the management has 3 proposals on hand as under a. to accept an export supply order for 30,000 units per month at a reduced price of Rs. 60 per month, incurring additional variable costs of Rs. 5 per unit towards the export packing, duties etc. b. to increase the domestic market sales by selling to a domestic chain stores 30,000 units at Rs. 55 per unit retaining the existing sales at existing price Marginal Costing 423 c. to reduce the selling price for the increased domestic sales as advised by the sales department as under Reduce selling price per unit by Rs. Increase in sales expected (units) 5 10,000 8 30,000 11 35,000 Prepare a table to present the results of the above proposals and give your comments and advice on the proposals. (45) A company producing a single product sells it at Rs. 50 per unit. Unit variable cost is Rs. 35 and fixed cost amounts to Rs. 12 Lakhs per annum. With this data, you are required to calculate the following, treating each independent of the other a. P/V Ratio and the Break Even Point b. New Break Even Sales if variable cort increase by Rs. 3 per unit, without increase in the selling price. c. Increase in sales required if profits are to be increased by Rs. 2.40 lakhs d. Percentage increase/decrease in sales volume to offset An increase of Rs. 3 in the variable cost per unit A 10% increase in selling price without affecting existing profits quantum e. Quantum of advertisement expenditure permissible to increase sales by Rs. 1.20 Lakhs without affecting profits quantum. (46) A manufacturer of fountain pens selling in the market at Rs.100 per dozen makes an average net profit of 20% on sales by producing 50,000 dozen per annum against a capacity of 75,000 dozens. His cost sheet for 1984 was as under. Cost per dozen in Rs. Direct Materials 36 Direct Wages 30 Works overheads (50% of this is variable) 10 Sales overheads (25% of this is variable) 4 In 1985, he anticipates his fixed costs to increase by 6%, cost of direct materials by 5%, and labour (with whom an agreement has been concluded) by 10%. Market enquiries revealed that the selling price of the product and quantity will remain unchanged in 1985. 424 Management Accounting An inquiry has been received for the supply of 10,000 dozens to a customer. What could be the lowest quotation, if the business wants to make a minimum profit of Rs. 8 lakhs in 1985? Give detailed workings. (47) The following figures relate to the current years position in an engineering industry operating at 70% capacity level. Break Even Point - Rs.80 Crores P/V Ratio - 40% Margin of Safety - Rs 20 crores The board at its last meeting have taken a decision to increase the output to 98% capacity level with the following modifications. (i) Reduction in selling price by 5%

(ii) Increase in fixed cost by Rs.8 crores (Including depreciation on additions but excluding interest burden.). (iii) Reduction in variable cost by 5% of sales. (iv) Additional finance for capital expenditure and working capital Rs.20 crores. (a) You are required to determine the revised sales figure necessary to yield the existing quantum of profits plus additional profit of Rs.4 crores on account of increased activity and 20% Interest burden on fresh capital inputs. (b) Also determine the revised (i) Break Even point (ii) P/V Ratio (iii) Margin of safety. (48) The following data are obtained from the records of a factoryRs. Rs. Sales 4,000 Units @ Rs.25 each 1,00,000 Materials consumed 40,000 Variable Overheads 10,000 Labour overheads 20,000 Fixed overheads 18,000 88,000 Net Profit 12,000 Marginal Costing 425 Calculate : (1) The number of units by selling which the company will neither loose or gain anything. (2) P/V Ratio and Margin of Safety at present level. (3) The extra units which should be sold to obtain the present profit if it is proposed to reduce the selling price by (a) 20% and (b) 25%. (4) The selling to be fixed price to bring down its break even point to 500 units under present condition. (5) The sales required to earn profit of Rs.60,000 at the present selling price of Rs.25 per unit, (49) You are given the following data pertaining to a factory. Present (1986) Forecast (1987) Sales (in Units) 10,000 15,000 Fixed cost (in Rs.) 25,000 25,000 Loss (in Rs.) 5,000 Profit (in Rs.) 5,000 For the above working purposes, variable cost of sales has been taken at Rs.7 per unit upto 15000 units and it shall be Rs.8 per unit beyond 15,000 units. You are required to state as to (1) What percentage of increase in sales is required to cover additional 50 paise per unit towards extra packing cost in 1987 for achieving the additional sales target? (2) What percentage of increase in sales is required to maintain budgeted profit with a price reduction of 25 paise per unit? (3) What percentage of increase in sales is required to meet additional publicity expenses of Rs. 2,000 and also maintain the targeted profits? (4) What is the maximum increase in fixed cost (additional depreciation) per period to justify the proposal for buying a new machine which will reduce variable cost of sales by Rs. 2 per unit at all levels? Sales to remain at 10,000 units and the targeted profit to be achieved. (The above situations have to be considered independently of each other.) (50) The anticipated sales of Electronic Corporation Ltd. is Rs. 4,00,000 and unit sales price of product is Rs.20 each. The cost of direct material is Rs.9 each and the labour cost is Rs.3 each and other variable expenses are Rs.3 per unit. The company is earning a net profit of 5% and to improve the profitability, following propositions were discussed in the Executive Committee Meeting, 426 Management Accounting

(a) The present administration set up is on the regional basis and it was felt that centralisation will reduce the fixed cost by Rs. 12,000. (b) The production manager has agreed that he will try to Work on a cost reduction programme which will reduce the cost by Re.1 per unit but there will be little impact on the quality which will be negligible to the customer. The sales manager opposed the two proposals and suggests that it may be possible to increase the number of units sold by 20% provided the selling price is reduced by 5%. Alternatively, if the selling price is increased by 10%, the sales number of units will be reduced by 5%. As the Accountant of the company, discuss in detail the various pros and cons of the proposals and also put forward any other proposal to improve the situation. (51) Zed Ltd. reported the following figures for 1983 and 1984. 1983 1984 Sales Rs. 50,00,000 Rs. 60,00,000 Total Cost Rs. 45,00,000 Rs. 52,00,000 The company anticipated that in 1985. (i) Variable cost rates, on the average, would record an increase of 10% over the 1984 levels. (ii) Sales would record an increase of 20% over the 1984 level in volume. (iii) Selling prices on the average would be increased by 5%. (iv) In addition, another Rs.10 Lakhs of sale (1984 level) would be made to Government at a special discount of 10% thereof. (v) Fixed costs would increase by Rs. 3,00,000. Ascertain the expected profit/loss in 1985. If the increase in fixed costs mentioned above arises only if sales to Government is made, would you recommend the sale to be made? What is the P/V Ratio for 1985, at normal sales? Give workings. (52) Two business AB Ltd. and CD Ltd. sell same type of product in the same type of market. Their budgeted profit and loss account for the year 1984 is as follows : Marginal Costing 427 AB Ltd. CD Ltd. Rs. Rs. Rs. Rs. Sales 1,50,000 1,50,000 Cost Fixed 15,000 35,000 Variable 1,20,000 1,00,000 1,35,000 1,35,000 Net Profit 15,000 15,000 You are required to (a) Calculate the Break Even Point of each business. (b) State winch business is likely to earn greater profits in condition of(i) Heavy demand for the product (ii) Low demand for the product (53) In a factory producing two different kinds of articles, key factor is the availability of labour. From the following information for the factory for 1986. show which product is more profitable. Product A Product B cost per Cost per Unit Rs. Unit Rs. Material 5.00 5.00 Labour 6 hrs @ Rs. 0.50 3.00 3 hrs @ Rs. 0.50 1.50 Overheads - Fixed (50% of labour) 1.50 0.75 - Variable 1.50 1.50 11.00 8.75 Selling Price 14.00 11.00 Profit 3.00 2.25 Total Production per month (Units) 500 600

Maximum capacity per month 4,800 hours Maximum capacity of product B 1,000 Units 428 Management Accounting (54) (a) The following particulars are extracted from the records of a company. Product A Product B per Unit per Unit Sales Rs. 1.00 Rs. 1.20 Consumption of material 2 kgs 3 kgs. Material Cost Rs. 10 Rs. 15 Direct Wages Cost Rs. 15 Rs. 10 Direct Expenses Rs. 5 Rs. 6 Machine hours used 3 : 2 Overhead Expenses Fixed Rs. 5 Rs. 10 Variable Rs. 15 Rs. 20 Direct Wages per hour is Rs.5. Comment on profitability of each product (both use the same raw material) When (i) Total Sales Potential is limited. (ii) Raw Material is in short supply. (iii) Production capacity ( in terms of machine hours) is the limiting factor. (b) Assuming raw material is the key factor, availability of which is 10,000 kgs. and maximum sales potential of each product being 3,500 units, find out the product mix which will yield the maximum profit. (55) The following particulars are available from a manufacturing unit ABC Units Sold 80,000 80,000 2,00,000 Sales Rs. 40,000 Rs. 80,000 Rs. 50,000 Material Cost Rs. 20,000 Rs. 30,000 Rs. 25,000 Labour Cost Rs. 6,000 Rs. 10,000 Rs. 8,000 Variable Expenses Rs. 4,000 Rs. 4,000 Rs. 5,000 Fixed overheads. Rs. 7,000 Rs. 10,000 Rs. 5,000 The key factor of production is an imported raw material and the consumption of the material in product A is 400 litres. Product B is 1,000 litres and Product C is 600 litres. The sales manager gives an assurance that it is possible for him to sell whatever produced. The management of the company has decided to close down one product line and Marginal Costing 429 concentrate on two lines to increase the profitability of the company. As the company Accountant, prepare a report to the Directors recommending the closure of one of the lines which is not more profitable. (56) Ambika Condiments bring out 2 products SUCHI and RUCHI which are popular in the market. The management has the option to alter the sales mix of the 2 products from the following combinations Option SUCHI (units) RUCHI (units) I 800 600 II 1,600 III 1,300 IV 1,100 500 The per unit production cost/sales data are SUCHI (units) RUCHI (units) Direct Materials (Rs.) 25 30 Direct Labour (hours) 10 12 Selling Price (Rs.) 75 90 Variable factory overheads are 100% of direct labour cost for both products. Labour rate is Rs. 2 per hour. Common fixed overheads for both products Rs. 10,000. You are required to -

a. Prepare a marginal cost statement for the two products. b. Evaluate options and identify the most profitable sales mix. (57) From the following particulars, find the most profitable product mix and prepare a statement of profitability of that product mix. Product A Product B Product C Units budgeted to be produced and sold 1,800 3,000 1,200 Selling Price per unit (Rs.) 60 55 50 Requirement per unit : Direct Materials (Kgs) 5 3 4 Direct Labour (Hours) 4 3 2 Variable Overheads (Rs.) 7 13 8 Fixed Overheads (Rs.) 10 10 10 Maximum possible units of sales 4,000 5,000 1,500 430 Management Accounting Cost of material per Kg is Rs. 4 and labour hour rate is Rs. 2. All the three products are produced from the same direct material using the same types of machines and labour. Direct labour which is the key factor is limited to 18,600 hours. (58) The Skyrock Ltd. produces and sells three types of products P, Q, and R. The management committee has decided to discontinue the production of Q since there is not much profit in it. From the following set of information, find out the profitability of the products and give your short comments on the decision of the management. Product Selling Direct Direct Wages Price Material Per unit Per unit Per unit Dept. A Dept. B Dept. C Rs. Rs. Rs. Rs. Rs. P 300 60 20 15 10 Q 275 30 20 20 10 R 305 70 12 10 20 The absorption rate of overheads on the Direct Wages are Dept. A Dept. B Dept. C Variable Overheads 150% 120% 200% Fixed overheads 200% 240% 150% (59) You had asked your accountant to prepare fair budgets based on different economic forecasts. After doing part A the work, he fell sick. Incomplete workings done by him were as under. Economic Forecast Depressed Average Good Excellent Variable Cost (Rs. 000) 40 60 90 140 There are fixed costs of Rs.72,000 and P/V Ratio is 60%. Calculate. (a) The profit or loss at each of the four levels. (b) The break even point in sales value and (c) The sales value at which a profit of Rs .15000 would be made. (60) Following is the abridged Profit and Loss Account of W Ltd. for 1987 (Rs. in Lakhs) Sales (10 Lakhs Units @ Rs. 2.50 Per unit) 25.00 Less : Variable Cost 16.00 Contribution 9.00 Less : Fixed Costs 9.20 Loss: (-) 0.20 Marginal Costing 431 S. Ltd. approaches W Ltd. which has spare capacity and offers to purchase 2 lakh units from W Ltd. If W Ltd. accepts this offer, it will save Rs. 0.25 per unit in sales commission. Existing scales will continue as above. What is the price per unit on this special offer that W Ltd. must charge in order that an Overall profit of Rs. 50,000 can be earned on total sales. (61) The profit of a company works out to 12.5% on capital employed in 1986. The details are as follows.

Rs. 000s Sales 500 Direct Material 250 Direct Labour 100 Variable overheads 40 Capital Employed 400 (a) Forecast for 1987 indicates sales will increase by 10%, selling price will go up by 4% and cost elements will go down by 2%. Assuming no change in the capital employed, calculate the return on capital employed. (b) The new sales manager who has joined the company recently estimates for the next year a profit of about 23% on capital employed, provided the volume of sales is increased by 10% and simultaneously there is an increase in selling price of 4% and an overall cost reduction in all elements of cost by 2%. Find out by computing in details the cost and profit for the next year. Whether the proposal of sales manager can be adopted? (62) A multi product company has the following costs and output data for the last year. Products XYZ Sales Mix 40% 35% 25% Selling Price Rs. 20 25 30 Variable cost per unit Rs. 10 15 18 Total Fixed cost Rs. 1,50,000 Total Sales Rs. 5,00,000 The company proposes to replace Product Z by product S. Estimated cost and output data are : 432 Management Accounting Products XYS Sales Mix 50% 30% 20% Selling Price Rs. 20 25 28 Variable cost per unit Rs. 10 15 14 Total Fixed cost Rs 1,50,000 Total Sales Rs. 5,00,000 Analyse the proposed change and suggest what decision the company should take. (63) The following set of information is presented to you by your client AB Ltd. (1) Direct Materials ( per unit ) X-Rs. 20 Y- Rs.l8. (2) Direct Wages (per unit) X - Rs.6 Y- Rs. 4 (3) Fixed expenses during the period are expected to be Rs. 1,600 (4) Variable expenses are allocated to products @ 100% of Direct Wages. (5) Sales Price (Per Unit) X - Rs.40 Y- Rs.30 (6) Proposed Sales mixes (i) 100 Units of X and 200 units of Y (ii) 150 Units of X and 150 Units of Y (iii) 200 Units of X and 100 Units of Y As a Cost Accountant, you are requested to present to the management of AB Ltd. the following. (a) The unit marginal cost and unit contribution. (b) The total contribution and resultant profit from each of the above sales mixes, (c) The proposed sales mixes to earn a profit of Rs.300 and Rs.600 with the total sales of X and Y being 300 units. (64) An enthusiastic marketing manager suggests to his managing director that if only he is permitted to reduce the selling price of a product by 20%, he would be able to achieve a 30% increase in sales volume. The Managing Director, finding that the sales volume exceeds in percentage the extent of required reduction in price, gives the clearance. You are given the following information. Present selling price per unit Rs. 7.50

Present volume of sales 2,00,000 Nos. Total variable costs Rs. 10,50,000 Total fixed costs Rs. 3,60,000 Marginal Costing 433 Assuming no changes in the cost in the continuing period, (i) Examine the consequences of the Managing Directors decision assuming that 30% increase in sales is realised. (ii) At what volume of sales can the present quantum of profits be achieved after effecting the price reduction. (65) SV Ltd. has budgeted the manufacture of 30,000 units of its only product A for the next quarter. The capacity of the factory has not been fully utilised. The variable cost per unit of product A is as under : Rs. Direct Material 48.00 Direct Wages (Rs.4 per hour) 36.80 Factory variable overheads 27.60 Selling variable overheads 18.00 Product A is sold at Rs.200 per unit. Fixed overheads for the quarter are Rs. 15,00,000. At present, the company manufactures component P one uni t of which is used in each unit of Product A. The cost of this component is already included in the cost structure of Product A as aforesaid. Anyhow, the cost per batch of 1000 units of component P is separately supplied as under. Rs. Direct Material 6,000 Direct Wages 4,800 Factory variable overheads 3,600 Fixed overheads apportioned to the component 3,600 18,000 It is proposed to utilise the spare capacity by manufacture of 1,500 units of product B for export. The details are as under : Export selling price Rs. 228 per unit Direct Material cost Rs. 80 per unit Direct labour 16 hours per unit Variable expenses applicable to this product - Rs. 20 per unit. Factory variable overheads have to be charged, calculated on the basis of Direct Labour Hour Rate applicable to Product A. It has to be noted that component P is not used in the manufacture of product B. 434 Management Accounting You are required to (i) Present a statement showing the profit as originally envisaged in the budget. (ii) State whether component P should be manufactured or bought from the market if this can be procured at a price of Rs. 16 per unit. (iii) Calculate the contribution on account of accepting the export order of product B. (66) A small scale manufacturer produces an article at the operated capacity of 10,000 units while the normal capacity of his plant is 14,000 units. Working at a profit margin of 20% on sales realisation, he has formulated his Budget as under 10,000 14,000 Rs. Rs. Sales Realisation 2,00,000 2,80,000 Variable overheads 50,000 70,000 Semi- Variable overheads 20,000 22,000 Fixed overheads 40,000 40,000 He gets an order for a quantity equivalent to 20% of the operated capacity and even on this additional production, profit margin is desired at the same percentage on sales realisation as for production to operated capacity.

Assuming prime cost is constant per unit of production, what should be the minimum price to realise this objective? (67) The executives of B Co., a small manufacturer of one product are developing the annual profit plan. They have just reviewed the First Cut at the annual income statement and are concerned with the Rs. 1,10,000 indicated profit on a sales volume of 20,000 units. The fixed cost structure of Rs.9,90,000 appears to be high and they have some doubts about departing from the unit sale price of Rs.100. There is a general agreement that the Profit target should be Rs. 2,20,000. This case deals with several tentative alternatives suggested during the meeting of the executives committee that just reviewed the tentative profit plan. You are required to compute (a) The budgeted break even point in rupees and in units and the number of units that would have to be sold to earn the target profit? (b) You are also required to respond directly to each of the following two alternatives under consideration by the management. Consider each independent of the other and state any assumptions that you would like to make. Alternative 1 - A sale price increase of 15% is contemplated, the sales executive estimates that this will cause a drop in units that can be sold by 15%. What would be the new breakeven point in Rs. and in units? What would be the new profit figure? How many units would have to be sold to earn the target profit? Marginal Costing 435 Alternative 2 - A decrease in fixed costs of Rs-55,000 and a decrease of variable costs of 6% are contemplated. What would be the new BEP in Rs. How many units must be sold to earn the target profit. (68) Stoner company uses three different components (Materials) in manufacturing its primary product. Stoner manufactures two of the components and purchases one (designated as component 1) from outside suppliers. The company is currently developing the annual profit plan. Sales are highly seasonal, component 2 cannot be acquired from outsiders, however component 3 can be purchased. The three components have critical specifications. The annual profit plan provided data for the following computations. Component 3 Unit Cost (at 12,000 units) Rs. Material (Direct) 1.40 Labour (Direct) 2.20 Fixed overheads (apportioned) 0.40 Annual machine rental (Special machine used only for component 3) 0.50 Variable factory overhead 1.00 Average storage cost per year (fixed) 0.40 Total 5.90 Average inventory level 500 units. The Purchase Manager investigated outside suppliers and found one that would sign a one year contract to deliver 12,000 quality units as needed during the year at Rs.5.20 per unit. Serious consideration is being given to this alternative . Should Stoner make or buy component 3? Explain the relevant factors influencing your decision. (69) From the following data, which product would you recommend to be manufactured in the factory when(1) Time is the key factor. (2) Raw material is in short supply. (3) Sales potential in units is a limiting factor. (4) Sales potential in value is a limiting factor. Per unit of Product A Per unit of Product B Rs. Rs. Direct Material (Rs. 2 per Kg.) 24 14

Direct Labour (Rs. 1 per Hour) 2 3 Variable Overheads 4 6 Selling Price 100 110 436 Management Accounting NOTES Budgetary Control 437

Chapter 12
BUDGETARY CONTROL
INTRODUCTION : Budget and Budgetary control : The term Budget is defined as a financial and/or quantitative statement, prepared prior to a defined period of time, of the policy to be pursued during that period for the purpose of attaining a given objective. The analysis of this definition reveals the following characteristics of the budget. (1) It may be prepared in terms of quantity or money or both. (2) It is prepared for a fixed or set period of time. (3) It is prepared before the defined period of time commences. (4) It spells out the objects to be attained and the policies to be pursued to achieve that objective. The term Budgetary Control is defined as the establishment of budgets, relating the responsibilities of executives to the requirements of a policy and the continuous comparison of actual with budgeted results, either to secure by individual action the objective of that policy or to provide the basis for its revision. The analysis of this definition reveals the following facts about budgetary control. (1) It deals with the establishment of the budgets.. (2) It deals with the comparison of budgeted results with the actual results. (3) It deals with computation of the variations and the actions to be taken for maintaining the favourable variations, removing the adverse variation or revising the Budgets themselves. 438 Management Accounting ADVANTAGES OF BUDGETARY CONTROL : (1) It is a powerful tool available to the management for the purpose of cost control and maximization of profits through the same. It enables the management to utilize the available resources in the most profitable manner. (2) A budget sets the plan of action. Plans in respect of various functional areas of operations are expressed in the form of the budgets. As such, the Budgetary Control systems acts as a means of declaration of the policies of the management. (3) It acts a means of communication. The plans and objects laid down by top level management are communicated to middle level and lower level management by way of the budgets. As such, each and every person working in the organisation is aware of his duties and responsibilities in relation to those of the others. This maximizes the utilization of resources. (4) It acts as a means of improving the co-ordination. The budgets prepared in the various functional areas of operations are prepared in such a way that the efforts are co-ordinated in the direction of achievement of common and defined objective. It develops the team spirit and help of various people can be sought to solve the common problem. (5) The comparison between the budgeted results and the actual results may reveal the areas where there are adverse variations which may be identified as weak areas or delicate areas. As such, efforts can be made to remove these adverse variations, keeping aside the areas where there are no variations. This enables the concentration of efforts of the management on a smaller portion of activities which facilitates Management by exception. (6) Budgetary control system enables the delegation of authority and makes possible the

principles of Responsibility Accounting. (7) It is a powerful tool available to the management for Performance Appraisal. The executives responsible for those functions where there is favourable variation may be rewarded, whereas the executives responsible for those functions where there is adverse variation may be punished. In this sense, budgetary control system provides a basis for establishment of the incentive systems. Pre-requisites for the implementation of Budgetary Control If the organization decides to install the Budgetary Control system as a cost control technique, it will have to comply with the following preliminaries. Budgetary Control 439 (1) Deciding the Budget Centre : A Budget Centre is that section of the organization with respect to which the budgets will be prepared. A Budget centre may be in the form of a product or a department or a branch of the company and so on. Budget centre should be clearly defined and established as the budgets will be prepared with respect to each and every Budget Centre. (2) Deciding the Budget Period : A Budget Period is that period of time for which the budget will be prepared and operated. The selection of the Budget Period should be made very carefully- Too long a budget period makes the correct estimation more difficult while too short a budget period may prove to be more costly. The selection of Budget Period may depend upon the nature of operations and the purpose of preparing the budgets. As such, in case of industries like the ones engaged in generation and distribution of electricity, transport operations etc. where capital expenditure is too high, budgets may be prepared even for a period of 5 to 10 years, while in case of industries like the ones engaged in manufacturing of motor vehicles or radios etc., where the customer demand may change more frequently, the budget period may be shorter. Similarly, a sales budget may be prepared for a period of 5 years, whereas the short term cash budget may be prepared on weekly or even daily basis. (3) Establishment of Accounting Records : There should be an efficient and proper system of accounting so that the information and data as required for the efficient implementation of the Budgetary Control system will be available in time. (4) Organization for Budgetary Control : A properly prepared organization chart may make the duties and responsibilities of each level of executive very clear to himself. The budgetary control organization will be headed by a senior executive in the form of budget controller or budget officer. In small or medium sized organizations, he himself will be involved in all types of works involved with the budgetary control system. However, in case of large organizations, be may have a budget committee under him which may consist of Chief Executive, budget officer himself and heads of main departments. The role of budget committee may be only advisory and its decision may become binding only if accepted by the Chief Executive. The functions performed by the budget committee can be broadly stated as below. (a) To receive and scrutirize the functional budgets. 440 Management Accounting (b) To revise the functional budgets, if necessary. (c) To approve the revised budgets. (d) To receive the budget reports and comparative statements. (e) To locate the responsibilities and recommend the corrective and remedial action. The usual and normal organization for the budgetary control may be expressed by way of the following organization chart. Chief Executive Budget Officer Budget committee Production Personnel Finance Purchase Sales Manager Manager Manager Manager Manager

(5) Preparation of a budget mannual : A budget mannual is a document setting out the responsibilities of the persons engaged in and the forms and procedures required for the budgetary control. A budget manual enables the standardization of the methods and procedures in relation to the budgetary control. It should be well written, indexed and divided into the sections. It may be in bound book form or loose leaf form. A budget mannual may contain the following particulars. (a) Introduction of principles and objectives of budgetary control and the definitions and brief explanations. (b) Duties and responsibilities of the various executives and the organization chart. (c) Functions and duties of budget officer and budget committee. (d) Scope of the budget and areas to be covered, whether budget will be a fixed budget or flexible budget. (e) Accounts codes, budget center codes and other codes operated. (f) The forms of reports and statements to be used. (g) The last date for submission of budgets. (h) Budget diagrams. Budgetary Control 441 (6) Determination of Budget Key Factor : A budget key factor is that the impact of which should be assessed first before other functional budgets are prepared to ensure that other functional budgets are capable of fulfillment. The key factor may take various forms Eg.Sales, Raw material, Labour, Production capacity, availability of funds and Government restrictions. Once the key factor is established, the budget with respect to that function will be prepared first and the other budgets will be prepared to conform to that Eg. If sales is the key factor, the sales manager will prepare and submit sales forecast first. The production manager will then decide whether it is possible to produce the quantity to meet sales demand. In case of the situations where there are more than one key factors, the importance of key factors themselves will be assessed first. The problem of multiplicity of key factors may be solved with the help of techniques like linear programming, operations research etc. TYPES OF BUDGETS : There can be basically four areas in which management can function and the types of budgets can be studied with respect to these functional areas of management viz. Sales/Marketing, production, personnel and finance. (A) Sales/Marketing : The budgets in this area may be of following types. (I) Sales Budget : It is a forecast of total sales expressed in terms of quantity and or money. It is inevitably the interplay between two factors i.e. sales quantity and selling price. Sales quantity may be forecasted after taking into consideration various factors. (1) Analysis of Past Trend : Analysis of the past trend over the last 5-10 years, may reveal the long term trends, seasonal trends and the cyclical trends. With the help of this trend analysis, the future trend can be established. For this purpose, reference can be made to the reports published by trade organizations and Government publications. (2) Reports by Salesmen : Being in the actual field, probably the sales staff may be best able to estimate the quantity which can be sold in the market. Before using this estimate as an official sales forecast, necessary adjustments may be made for error of judgment or to avoid the possibility of overestimation on the part of the salesmen. (3) Market Research and Market Survey : This is a very specialized technique available to assess which of the companys products can be sold, in which market, 442 Management Accounting in what quantity and at what selling price. Such an analysis will facilitate the preparation of sales forecast areawise, productwise, salesmenwise and channel of distribution wise. (4) General Economic Conditions : General Trade and Business conditions affect

the sales forecast of the company. They may be in the form of competition from other companies, supply condition for material and labour, trade conditions of the customers of the company and so on. Selling price at which products of the company can be sold may depend upon various factors viz. (1) Cost price of the product (2) Selling price charged by the competitors. (3) Expected amount of profits. (4) Advertisement and other sales promotion efforts carried out by the company. If the company envisages to sell higher quantity than the past sales or the existing production capacity, and if some capital investment proposal is involved to increase the production, then the feasibility of the proposal and the availability of funds may also be required to be considered. If the sales forecast is less than the past sales but the top management insists upon a certain amount of additional profits, then the possibility of increasing the selling price or selling efforts and reduction in the cost price may be required to be considered. (II) Selling and Distribution Cost Budget : It shows the selling and distribution cost for selling the quantities considered in sales budget. The sales manager, the distribution manager, the advertising manager and the finance manager will be the persons involved in the preparation of this budget. This budget may be prepared on the principles of flexible budgeting (as discussed later in this chapter) for each head of selling and distribution costs, on the basis of volume of sales to be achieved. (III) Advertising Cost Budget : This cost is closely associated with sales. The intention of incurring this cost is to increase the sales. However, the result of incurring this cost i.e. increased sales may not be immediate and even if there is increase in sales, it is difficult to measure the portion of increased sales which is due to advertising cost. As such, normally, advertising cost budget is established in the form of a fixed amount for a specific period. Budgetary Control 443 The various ways in which the amount of budgeted advertising cost can be decided are as below : (1) Percentage of Sales or Profits : Here the advertising cost may be decided as a fixed percentage of sales or profits. However, the past data may not be suitable in view of recent business situations. (2) Funds Available : Here the advertising cost depends upon the capability of the company to spend on advertising. This may be a hypothetical method and may not necessarily consider the relationship between advertising cost and benefits there from. (3) Competitors Policy : Here the advertising cost may depend upon the amount which the competitors are spending on advertising. This method may pose some difficulty as the amount spent by competitors may not be known and it may be wrong to assume that the company may be able to derive the same benefits from advertising as the competitors derive. (B) Production : The budgets in this area may be of following types : (I) Production Budget : It is a forecast of production for the budget period. It may be prepared from two angles. (i) Production Budget in terms of Quantity. (ii) Production Budget in terms of money i.e. the production Cost Budget further classified under each element of cost such as Direct Material Cost, Direct Labour Cost and Overheads Cost. The material cost can be estimated by preparing the materials budget which indicates the estimated quantities as well as costs of various materials required for carrying out production as per production budget. The labour cost can be estimated by preparing Direct Labour Cost budget which indicates

the direct labour requirements required to produce the quantity as specified in the production budget. For the purpose of this budget, labour requirement in terms of number of workers of different grades will be decided first. Afterwards, the rates of pay and allowances will be considered to decide the labour cost. The production overheads can be estimated by preparing production overhead budget which indicates all items of production overheads classified as fixed, variable and semi-variable. The process of allocation and apportionment can be followed to decide the loading of overheads to each budget centre. Following factors will have to be considered before preparing the production budget in terms of quantity. 444 Management Accounting (1) Coordination with Sales Forecast : Before the quantity to be produced is decided, it will be necessary to confirm whether it is possible to sell the quantity which is produced during the budget period. If it is not possible to sell whatever can be produced, inspite of all the sales promotion efforts, then the production budget should be adjusted to conform to the sales forecast. If the expected sales exceed existing production capacity, possibility of overtime working or extra shift working should be considered. (2) Production Capacity : Production Budget estimates the quantity to be produced. If it is not possible to produce the quantity with the existing capacity available, it will be necessary to increase the capacity by incurring additonal capital expenditure. (3) Consideration of Stocks : Whatever is to be sold need not be produced necessarilly. The quantity to be produced, after giving due consideration to the sales forecast, may depend upon the opening and closing stock of finished goods. The quantity to be produced during the budget period may be decided as Estimated Closing stock of finished goods. Add : Quantity to be sold, Less : Opening Stock of Finished Goods. (4) Management Policy : Sometimes, the policy decisions taken by the management are required to be considered before setting the production budget Eg. It will have to be considered whether certain components are decided to be produced instead of purchasing or vice versa. (II) Purchases Budget : It is a forecast of quantity and value of materials, direct or indirect, required to be purchased during the budget period. It is needless to state that the purchases budget is closely connected to the production budget. Following factors are required to be considered before setting the purchases budget, (1) Orders already placed for the purchases of materials. (2) Material already purchased but reserved for some specific purposes. (3) Opening and closing stocks. (4) Storing facilities and economic order quantity. (5) Availability of funds. (6) Prices of the materials. Budgetary Control 445 (C) Personnel : In this functional area, the budget to be prepared takes the form of a personnel budget, which indicates the requirement of personnel or labour force, either direct or indirect, to conform to the sales forecast and the production budget. The labour requirement may be decided in terms of number and grade of workers, number of labour hours, rupee value etc. Consideration is also required to be made of the overtime working or shift working. This budget may also indicate the training plans for new workers. (D) Finance : The most important budget which is prepared under this functional area is the cash budget. It is an estimate of the expected cash receipts and cash payments during the budget period. Thus by preparing the cash budget, it is possible to predict whether at any point of time, there is likely to be excess or shortage of cash. If the shortage of cash is estimated, it may be required to arrange the cash from some other source. If the excess of cash is estimated, it

may be possible to explore the investment opportunities. Before preparing the cash budget, following principles should be kept in mind. (i) The period for which cash budget is prepared should be selected very carefully. There is no fixed rule as to the period to be covered by the cash budget. It may vary from company to company depending upon the individual requirements. As a general rule, the period covered by the cash budget should neither be too long or too short. If it is too long, it is possible that the estimate will not be accurate. If it is too short, the factors which are beyond the control of management will not be given due consideration. (ii) The items which should appear in the cash budget, should be carefully decided. Naturally, all those items which do not involve cash flow will not be considered while preparing the cash budget. Eg. As the cost of depreciation does not involve any cash outflow, it does not affect the cash budget, though the amount of depreciation affects the determination of tax liability which involves cash outflow. A cash budget may be prepared in any of the following three methods. (1) Receipts and Payments Method : This method is useful for short term estimations. It lists the various estimated sources of cash receipts on one hand and the various estimated applications of cash on the other. While preparing the cash budget by this method, the various items appearing on the same may be classified under the following two categories : (i) Operating Cash Flows : These are the items of cash flow which arise as a result of regular operations of the business. 446 Management Accounting (ii) Non operating Cash Flows : These are the items of cash flow which arise as the result of other operations of the business. The standard items which may appear on the cash budget prepared by this method may be stated as below : Cash Inflow Cash Outflow Operating : Operating : Cash sales Payment to creditors Collection from debtors Cash Purchases of raw materials Interest/Dividend received Wages/Salaries Various kinds of overheads. (To the extent they are actually paid) Non-operating Non-operating Issue of shares/debentures Redemption of shares/debentures. Receipt of loans/borrowings Loan Installments Sales of Fixed Assets Purchases of Fixed Assets Sales of Investments Interest Taxes Dividends. Thus, finally cash budget appears in the form of opening cash balance, to which various estimated cash receipts are added, the estimated cash payments being deducted from this sum to arrive at the closing cash balance. (2) Balance Sheet Method : This method is useful for long term estimates. According to this method, the budgeted Balance Sheet is prepared for the following budget period, after considering the various terms viz. Capital, Long Term Liabilities, Current liabilities, Fixed Assets, Current Assets, but except cash. After both the sides of Balance Sheet are balanced, the balancing figure indicates the estimated cash balance in hand at the end of that period. This method does not consider the expenses and assumes the regular pattern of inflow and outflow of cash. Further, it indicates the cash requirement only at the end of budget period, any excess or shortage of cash during the budget period are not considered. (3) Adjusted Profits/Losses Method : This method also is useful for long term estimates. According to this method, the cash budget is prepared in the following way to show the estimated cash balance at the end of the budget period. Budgetary Control 447

Opening cash balance. Add : Profit before depreciation, provisions and other non-cash expenses. Add : Decrease in Current Assets or Increase in Current Liabilities. Add : Capital Receipts. Add : Receipt of loans/borrowings Less : Capital Expenditure Less : Repayment of loan installments Less : Payment of dividends/taxes Less : Increase in Current Assets or Decrease in Current Liabilities In other words, cash budget prepared as per this method is in the form of cash flow statement. (E) Miscellaneous Budgets : In addition to the various budgets as described above, which can be prepared in prime functional areas of marketing, production, personnel and finance, some other types of budgets may also be prepared. (I) Overheads Cost Budget : It indicates the various types of overheads to be incurred during the budget period. For the correct establishment of overheads cost budget, it will be necessary to classify the various overheads. In order to exercise proper control on the overheads, it will be necessary to analyse the overheads as fixed, variable and semi-variable. The semi-variable overheads are further required to be split into fixed and variable elements. (II) Capital Expenditure Budget : It is the plan of proposed investment in the fixed assets. It is closely related to the sales budget, production budget and cash budget. As such, capital expenditure budget should be properly coordinated with other functional budgets. The capital expenditure may be required to be incurred for the replacement purposes or expansion purposes. The requirements of capital expenditure may be basically received from the various functional executives viz. production manager, sales manager, finance manager and so on. If the investment in fixed assets is considered to be economically and financially feasible, then the arrangement is required to be made for the acquisition of the same. If the cash budget reveals the excess funds available, it may not be necessary to arrange the funds for acquiring the fixed assets from outside source. However, if no excess cash balance is available, then it may be necessary to borrow the funds from some outside source. 448 Management Accounting (F) Master Budget : After all the functional budgets are prepared individually and are properly coordinated with each other, the master budget can be prepared by incorporating all the functional budgets. The ultimate incorporation of all the functional budgets takes the form of budgeted Profit and Loss Account and the Budgeted Balance Sheet. It may involve the presentation of current years budgeted figures as well as those of the previous year showing clearly why there is a change. FIXED AND FLEXIBLE BUDGETS : Any budget in any functional area of operation can be established as a fixed budget or a flexible budget. A fixed budget is established for a specific level of activity and is not adjusted to the actual level of activity attained at the time of comparison between the budgeted and actual results. Naturally, fixed budget is established only for a short period of time where the budgeted level of activity is expected to be attained to the maximum possible extent. Fixed budgets are more suitable for fixed expenses i.e. the expenses which have no relation with the level of activity. The fixed budgets do not indicate that they cannot be changed at all. A fixed budget can be revised if the actual level of activity is likely to differ widely from the budgeted level of activity. The fixed budget cannot be used as a effective tool of cost control while computing the variations between the budgeted result and the actual result, the variance cannot be explained properly and it is not possible to say whether the variance is due to the changes in the level of activity or due to the efficiency or inefficiency of the executive responsible

for the execution of the budget. A flexible budget is designed to change with the fluctuations in the level of activity and provides a basis for comparison for any level of activity actually attained. A flexible budget is more elastic, and practical. It can be properly used as an effective tool for evaluation of performance and cost control. It explains the variations between the budgeted results and actual results stating the variations which are due to changes in the level of activity (which is beyond the control of operating executive) and which are due to the operational efficiency or inefficiency (for which the operating executive is responsible.) For the purpose of establishment of the flexible budgets, it is necessary to classify the costs as fixed costs, variable costs and semi-variable costs. The fixed costs remain the same at all the levels of activity whereas the variable costs change directly in proportion to the level of activity. So far as the semi-variable costs are concerned, each item of cost is examined and classified into its fixed and variable elements and a trend is established regarding the nature and behavior of each item of cost. ILLUSTRATIVE PROBLEMS (1) An estimate shows that there is a market for 10,00,000 units of an electric bell. Two big companies producing this electric bell will probably divide 80% of the market. Among Budgetary Control 449 other companies, producing the bell, Ghatanad Ltd. should get 15% of the total market. 60% of the Ghatanad sales will probably be evenly divided between the first and last calendar quarters, with twice as many sales being made in the second quarter as in the third. The bell sells for Rs.30 an unit, with the manufacturing cost as follows. The cost is worked out with reference to normal working capacity for the production which is 1,50,000 bells a year. Direct Materials Cost Rs. 15.00 Direct Labour Cost Rs. 7.50 Variable overheads cost Rs. 2.50 Fixed overhead cost Rs. 1,00,000 Prepare a sales budget for the year showing cost of production and gross profit by calendar quarters. Assume no change in the inventory levels during the year. Solution : SALES BUDGET Particulars Qtr. I Qtr. II Qtr. III Qtr. IV Total (A) Sales - Units 45,000 40,000 20,000 45,000 1,50,000 Rs. 13,50,000 12,00,000 6,00,000 13,50,000 45,00,000 (B) Cost of Production Direct Materials Rs. 6,75,000 6,00,000 3,00,000 6,75,000 22,50,000 Direct Labour Rs. 3,37,500 3,00,000 1,50,000 3,37,500 11,25,000 Variable Overheads Rs. 1,12,500 1,00,000 50,000 1,12,500 3,75,000 Fixed Overhead Rs. 25,000 25,000 25,000 25,000 1,00,000 11,50,000 10,25,000 5,25,000 11,50,000 38,50,000 (c) Gross Profit i.e. A - B 2,00,000 1,75,000 75,000 2,00,000 6,50,000 Note : It is assumed that the fixed overheads are apportioned evenly over the various quarters. (2) XYZ Ltd. manufactures product C and G. During January, it expects to sell 5,000 Kgs of C and 20,000 Kgs of G at Rs. 20 and Rs. 10 each respectively. Direct materials A, B and E are mixed in equal proportion to produce product C. Materials D, B and E are mixed in the proportion of 5:3:2 to produce product G. There is no loss of weight in the production. 450 Management Accounting Actual and budgeted inventories in quantities and costs for the month are as follows : Opening Inventory Desired Closing Anticipated Cost Kgs. Inventory Kgs. per kg. Material A 1,500 1,000 5.50 B 1,000 2,000 5.00 D 10,000 3,000 1.00 E 5,000 6,000 3.50

Product C 1,000 500 G 5,000 6,000 You are required to prepare (i) the production budget (ii) the materials purchase budget, indicating the expenditure on raw materials for January. Solution : (A) Production Budget : January 1987 Product C Product G Anticipated Sales - kgs. 5,000 20,000 Desired closing stock - kgs 500 6,000 5,500 26,000 Less : Opening stock kgs. 1,000 5,000 Production during month kgs. 4,500 21,000 (B) Materials Purchase Budget - January 1987 ABDE (a) Requirement for production (As per production Budget) For product C - kgs 1,500 1,500 1,500 For product G - kgs. 6,300 10,500 4,200 Total requirement - kgs. 1,500 7,800 10,500 5,700 (b) Desired closing stock - kgs 1,000 2,000 3,000 6,000 (c) Sub total a +b kgs 2,500 9,800 13,500 11,700 (d) Opening stock kgs 1,500 1,000 10,000 5,000 (e) To be purchased during month kgs. c - d 1,000 8,800 3,500 6,700 (f) Anticipated cost per kg. Rs. 5.50 5.00 1.00 3.50 (g) Anticipated cost of purchases Rs. 5,500 44,000 3,500 23,450 Budgetary Control 451 (3) Lookahead Ltd. produces and sells a single product. Sales budget for the calender year 1987 by quarter is as under Quarter No. of units to be sold I 12,000 II 15,000 III 16,500 IV 18,000 The year 1987 is expected to open with an inventory of 4,000 units of finished product and close with an inventory of 6,500 units. Production is customarily scheduled to provide for two third of the current quarter s sales demand plus one third of the following quarters demand. Thus production anticipates sales volume by about one month. The standard cost details for one unit of the product is as below Direct Materials 10 Ibs @50 paise per Ib. Direct Labour 1 hour 30 minutes @Rs. 4 per hour. Variable Overheads 1 hour 30 minutes @Re. 1 per hour. Fixed Overheads 1 hour 30 minutes @Rs. 2 per hour, based on a budgeted production volume of 90,000 direct labour hours for the year. a. Prepare a production budget for 1987, by quarters, showing the number of units to be produced and the total costs of direct material, direct labour, variable overheads and fixed overheads. b. If the budgeted selling price per unit is Rs. 17, what would be the budgeted profit for the year as a whole ? c. in which quarter of the year is the company expected to break even ? Solution : a. Production Budget We know that Opening Stock + Production - Sales = Closing Stock Hence we know that Closing Stock + Sales - Opening Stock = Production 452 Management Accounting Q1 Q2 Q3 Q4

Opening Stock 4000 5000 5500 6000 Production 13000 15500 17000 18500 Sales 12000 15000 16500 18000 Closing Stock 5000 5500 6000 6500 Hence, the total production for all the quarters will be 64,000 units. b. Production Cost Budget Direct Materials 64000 units x Rs. 5 = 3,20,000 Direct Labour 96000 hours x Rs. 4 = 3,84,000 Variable Overheads 96000 hours x Re. 1 = 96,000 Total Variable Cost 8,00,000 Fixed Cost 1,80,000 Total Cost 9,80,000 Total Variable Cost for 64000 units is Rs. 8,00,000. Hence, per unit variable cost is Rs. 12.50. c. Calculation of Profit Sales 61500 units @Rs. 17 per unit 10,45,500 Variable Cost of units sold 61500 units @Rs. 12.50 per unit 7,68,750 Contribution 2,76,750 Less : Fixed Cost 1,80,000 Profit 96,750 d. Break Even Point Per Unit Selling Price is Rs. 17 and Per Unit Varaible Cost is Rs. 12.50. Hence, Per Unit Contribution Rs. 4.50. As Fixed Cost is Rs. 1,80,000, Break Even Point in units will be 180000 / 4.50 = 40000 units. This target is achieved by the company in Quarter 3, hence the company is expected to break even in Quarter Three. (4) A single product company estimated its sales for the next year quarterwise as under Rs. Budgetary Control 453 Quarter Sales units I 30,000 II 37,500 III 41,250 IV 45,000 The opening stock of the finished goods is 10,000 units and the company expects to maintain the closing stock of finished goods at 16,250 units at the end of the year. The production pattern in each quarter is based on 80% of the sales of the current quarter and 20% of the sales of the next quarter. The opening stock of raw materials in the begining of the year is 10,000 Kgs. and the closing stock at the end of the year is required to be maintained at 5,000 Kgs. Each unit of finished output requires 2 Kgs. of raw material. The company proposes to purchase the entire annual requirement of raw materials in the first three quarters in the proportion and at the prices given below Quarter Purchases of raw materials Price per Kg. % of total annual requirement Rs. in quantity I 30% 2 II 50% 3 III 20% 4 The value of the opening stock of raw materials in the beginning of the year is Rs. 20,000. You are required to present the following for the next year, quarterwise a. Production Budget in units. b. Raw Materials consumption budget in quantity. c. Raw Materials purchase budget in quantity and value. Solution :

a. Production Budget We know that Opening Stock + Production - Sales = Closing Stock Hence we know that Closing Stock + Sales - Opening Stock = Production 454 Management Accounting Q1 Q2 Q3 Q4 Opening Stock 10000 11500 12250 13000 Production 31500 38250 42000 48250 Sales 30000 37500 41250 45000 Closing Stock 11500 12250 13000 16250 Hence, the total production for all the quarters will be 1,60,000 units. b. Raw Materials Consumption Budget Production Budget is 1,60,000 units. Each unit of the final product requires 2 Kgs. of raw material. Hence, the raw material consumption budget in quantity will be 3,20,000 Kgs. c. Raw Materials Purchase Budget Total quantity of raw materials to be purchased will be Closing Stock + Consumption - Opening Stock 5000 + 320000 - 10000 = 315000 The quarterwise purchases will be as below Q1 30% of 315000 Kgs. i.e 94500 Kgs. @Rs. 2 per Kg. = 1,89,000 Q2 50% of 315000 Kgs. i.e. 157500 Kgs. @Rs. 3 per Kg. = 4,72,500 Q3 20% of 315000 Kgs. i.e. 63000 Kgs. @Rs. 4 per Kg. = 2,52,000 9,13,500 Hence, total purchase budget in terms of value is Rs. 9,13,500. (5) A private Limited company is formed to take over a running business. It has decided to raise Rs.55 Lakhs by issue of Equity shares and the balance of the capital required in the first six months is to be financed by a financial institution against an issue for Rs.5 Lakhs 8% Debentures (Interest payable annually) in its favour. Initial outlay consists of Freehold premises Rs. 25 Lakhs Plant & Machinery Rs. 10 Lakhs Stock Rs. 6 Lakhs Vehicle & Other items Rs. 5 Lakhs Payments on the above items are to be made in the month of incorporation. Sales during the first 6 months ending on 30th June are estimated as under. Budgetary Control 455 January Rs. 14 Lakhs April Rs. 25 Lakhs February Rs. 15 Lakhs May Rs. 26.50 Lakhs March Rs. 18.50 Lakhs June Rs. 28 Lakhs Lag in payment - Debtors 2 months - Creditors 1 month Other information : (1) Preliminary expenses Rs.50,000 (Payable in February) (2) General Expenses Rs.50,000 p.m.(Payable at the end of each month) (3) Monthly wages (payable on 1st day of next month) Rs. 80,000 p.m. for first 3 months and Rs. 95,000 p.m. there after. (4) Gross Profit rate is expected to be 20% on sales. (5) The shares and debentures are to be issued on 1st January. (6) The stock levels throughout is to be the same as the outlay. Prepare cash budget for the 6 months ended 30th June. Solution : Cash Budget (For 6 month sending 30th June) (Rs. in Lakhs) Jan. Feb. Mar. Apr. May Jun (A) Cash Inflow Issue of shares 55.00

Issue of Debentures 5.00 Collection from Debtors 14.00 15.00 18.50 25.00 60.00 14.00 15.00 18.50 25.00 (B) Cash Outflow Fixed Assets 40.00 Stock (Initial) 6.00 Preliminary Expenses 0.50 Sundry Creditors 10.40 11.20 14.00 19.05 20.25 General Expenses 0.50 0.50 0.50 0.50 0.50 0.50 Wages 0.80 0.80 0.80 0.95 0.95 46.50 12.20 12.50 15.30 20.50 21.70 (C) Net cash Inflows (A-B) 13.50 (12.20) 1.50 (0.30) (2.00) 3.30 Opening Balance 13.50 1.30 2.80 2.50 0.50 + Surplus for the month 13.50 (12.20) 1.50 (0.30) (2.00) 3.30 Closing Balance 13.50 1.30 2.80 2.50 0.50 3.80 456 Management Accounting Working Notes : (1) It is assumed that the company is incorporated in January. (2) Assuming that the company is carrying on manufacturing operations, the purchase say for the month of January are computed as below. Sales for January 14.00 Less Gross profit @ 20% 2.80 Cost of goods 11.20 Less wages for January 0.80 Purchases 10.40 (6) A newly started company Green Co. Ltd. wishes to prepare cash budget from January. Prepare a cash budget for the first 6 months from the following estimated revenue and expenditure. Month Total Material Wages Overheads Sales Production Selling & Distribution Rs. Rs. Rs. Rs. Rs. Jan. 20,000 20,000 4,000 3,200 800 Feb. 22,000 14,000 4,400 3,300 900 Mar. 24,000 14,000 4,600 3,300 800 Apr. 26,000 12,000 4,600 3,400 900 May 28,000 12,000 4,800 3,500 900 June 30,000 16,000 4,800 3,600 1000 Cash balance on 1st January was Rs.10,000. A new machine is to be installed at Rs.30,000 on credit, to be repaid by two equal installments in March and April. Sales commission @ 5% on total sales is to be paid within the month following actual sales. Rs. 10,000 being the amount of second call may be received in March. Share premium amounting to Rs. 2,000 is also obtainable with 2nd call. Period of credit allowed by suppliers 2 month period of credit allowed to customers 1 month Delay in payment of overheads 1 month Delay in payment of wages 1/2 month Assume cash sales to be 50% of total sales. Budgetary Control 457 Solution : Cash Budget of Green Co. Ltd. Jan. Feb. Mar. Apr. May Jun. (A) Cash Inflows Cash sales 10,000 11,000 12,000 13,000 14,000 15,000 Collection from debtors - 10,000 11,000 12,000 13,000 14,000

Share Capital (2nd call) - - 10,000 - - Share Premium - - 2,000 - - 10,000 21,000 35,000 25,000 27,000 29,000 (B) Cash Outflows Sundry Creditors - - 20,000 14,000 14,000 12,000 Wages For current month 2,000 2,200 2,300 2,300 2,400 2,400 For last month - 2,000 2,200 2,300 2,300 2,400 Production Overheads - 3,200 3,300 3,300 3,400 3,500 Selling & Distribution Overheads - 800 900 800 900 900 Instalment for Machine purchased - - 15,000 15,000 - Sales commission - 1,000 1,100 1,200 1,300 1,400 2,000 9,200 44,800 38,900 24,300 22,600 (C) Net Cash Inflows or outflows (A-B) 8,000 11,800 (-) 9800 (-) 13,900 2,700 6,400 Opening cash balance 10,000 18,000 29,800 20,000 6,100 8,800 + Surplus for month 8,000 11,800 (-) 9,800 (-) 13,900 2,700 6,400 Closing cash balance 18,000 29,800 20,000 6,100 8,800 15,200 (7) Prepare a cash budget for the quarter ended 30th September 1987 based on the following information Cash at Bank on 1st July 1987 Rs. 25,000 Salaries and wages estimated monthly Rs. 10,000 Interest Payable August 1987 Rs. 5,000 458 Management Accounting June July August September Rs. Rs. Rs. Rs. Estimated Cash sales - 1,40,000 1,52,000 1,21,000 Credit Sales 1,00,000 80,000 1,40,000 1,20,000 Purchases 1,60,000 1,70,000 2,40,000 1,80,000 Other Expenses - 20,000 22,000 21,000 (Payable in same month) Credit sales are collected 50% in the month of sales are made and 50% in the month following. Collection from credit sales are subject to 5% discount if payment is received in the month of sales and 2.5% if payment is received in the following month. Creditors are paid either on a prompt or 30 days basis. It is estimated that 10% of the creditors are in the prompt category. Solution : Cash Budget (For Quarter ending September 1987) July August September Rs. Rs. Rs. (A) Cash Inflows Cash Sales 1,40,000 1,52,000 1,21,000 Collection from Debtors Last month 48,750 39,000 68,250 Current month 38,000 66,500 57,000 2,26,750 2,57,500 2,46,250 (B) Cash Outflows Sundry Creditors Prompt Basis 17,000 24,000 18,000 Others 1,44,000 1,53,000 2,16,000 Salaries & wages 10,000 10,000 10,000 Other Expenses 20,000 22,000 21,000 Interest - 5,000 -

1,91,000 2,14,000 2,65,000 (C) Net Cash Inflow (A-B) 35,750 43,500 (18,750) Opening Balance 25,000 60,750 1,04,250 + Surplus for the month 35,750 43,500 (18,750) Closing Balance 60,750 1,04,250 85,500 Budgetary Control 459 Working Notes : It is assumed that salaries and wages are paid in the same month. (8) From the following information you are required to prepare a cash budget for six months from January 1987 to June 1987, Month by month, showing also the cash credit facility available from the Bank. Opening overdrawn balance is Rs. 1,50,000.
Month Sales Materials Wages Prod. Selling & Adm. Purchases Expenses Dist. Expases Expenses Rs. Rs. Rs. Rs. Rs. Rs.

January 1,44,000 50,000 20,000 12,000 8,000 3,000 February 1,94,000 62,000 24,200 12,600 10,000 3,400 March 1,72,000 51,000 21,200 12,000 11,000 4,000 April 1,77,200 61,200 50,000 13,000 13,400 4,400 May 2,05,000 74,000 44,000 16,000 17,000 5,000 June 2,17,400 77,600 46,000 16,400 18,000 5,000 Following further information is available. (1) Out of total sales, 50% are cash sales and balance 50% is received in the month following month of sale. (2) Payment for purchase of assets is to be made Rs.16,000 in February, Rs. 25,000 in March and Rs. 50,000 in April. (3) Proceeds from sales of scrap are to be received in May, amounting to Rs.6,000. (4) Dividend of Rs. 90,000 is to be paid in June. (5) Sales commission is to be paid at 3% of total sales in same month in which sales are made. (6) Suppliers for materials are paid in the month following the month of purchases of materials. (7) Cash credit facility granted is Rs. 2,00,000. (8) Wages are paid in the same month. (9) Creditors of Production, Selling & Distribution and Administration expenses are given one months credit period. 460 Management Accounting Solution :
Jan. Feb. Mar. Apr. May Jun. 87 87 87 87 87 87 (A) Cash Inflows Cash sales 72,000 97,000 86,000 88,600 1,02,500 1,08,700 Collection from debtors - 72,000 97,000 86,000 88,600 1,02,500 Sales of scrap - - - - 6,000 72,000 1,69,000 1,83,000 1,74,600 1,97,100 2,11,200 (B) Cash Outflows Creditors for Materials - 50,000 62,000 51,000 61,200 74,000 Wages 20,000 24,200 21,200 50,000 44,000 46,000 Production Expenses - 12,000 12,600 12,000 13,000 16,000 Sales & Dist. Expenses - 8,000 10,000 11,000 13,400 17,000 Admin Expenes - 3,000 3,400 4,000 4,400 5,000 Purchases of Assets - 16,000 25,000 50,000 - Dividend - - - - - 90,000 Sales Commission 4,320 5,820 5,160 5,316 6,150 6,522 24,320 1,19,020 1,39,360 1,83,316 1,42,150 2,54,522 (c) Net Cash inflows or outflows (A-B) 47,680 49,980 43,640 (-)8,716 54,950 (-) 43,322

Opening over drafting 1,50,000 1,02,320 52,340 8,700 17,416 (-) 37,534 +Surplus/Deficit for the month 47,680 49,980 43,640 (-) 8,716 54,950 (-) 43,322 Closing overdrawing 1,02,320 52,340 8,700 17,416 (-) 37,534 5,788

Note : Eventhough, the Cash Credit Facility is granted to the extent of Rs.2,00,000, the company is not likely to utilise it fully. At the end of June 1987, the overdrawn balance is likely to be only Rs.5,788. (9) ABC Co. Ltd. wishes to arrange overdraft facilities with its bankers during the period April to June 1987 when it will be manufacturing mostly for stock. Prepare a cash budget for the above period from the following data, indicating the extent of the bank facility the company will require at the end of each month. Budgetary Control 461 Month Sales Purchases Wages Rs. Rs. Rs. February 1,80,000 1,24,800 12,000 March 1,92,000 1,44,000 14,000 April 1,08,000 2,43,000 11,000 May 1.74,000 2,46,000 10,000 June 1,26,000 2,68,000 15,000 Additional Information : (1) All Sales are Credit Sales 50% of Credit Sales are realised in the month following the sales and the remaining 50% in the Second month following. (2) Creditors are paid in the month following the month of purchases. (3) Cash at Bank of 1.4.87 (Estimated) Rs.25,000. Solution : Cash Budget of ABC Co. Ltd. Apr. 87 May 87 June 87 (A) Cash Inflows Sundry Debtors First 50% 96,000 54,000 87,000 Second 50% 90,000 96,000 54,000 1,86,000 1,50,000 1,41,000 (B) Cash Outflows Sundry Creditors 1,44,000 2,43,000 2,46,000 Wages 11,000 10,000 15,000 1,55,000 2,53,000 2,61,000 (C) Net Cash Inflows or outflows (A-B) 31,000 (-) l,03,000 (-) l,20,000 (D) Estimated Cash Surplus or shortage Opening Cash Balance 25,000 56,000 (-) 47,000 + Surplus/Deficit for the month 31,000 (-) l,03,000 (-) l,20,000 Closing cash balance 56,000 (-) 47,000 (-) 1,67,000 462 Management Accounting Note : It can be seen that the company will be required to arrange for the bank finance of Rs. 47,000 at the end of May 1987 and an additional amount of Rs.1,20,000 at the end of June 1987. (10) The manager of a Repairs and Maintenance Department has submitted the following budget estimates that are to be used to construct a flexible budget to be used during the coming budget year. Details of cost Planned at 6000 Planned at 9000 direct repairs direct repairs hours hours Employee Salaries 30,000 30,000 Indirect Repair Materials 40,200 60,300

Miscellaneous Costs 13,200 16,800 a. Prepare a flexible budget for the department up to activity level of 10,000 repair hours (use increment of 1000). b. What would be the budget allowance at 8,500 repair hours? Solution : 8500 Hours 10000 Hours Employee Salaries 30,000 30,000 Indirect Repair Materials 56,950 67,000 Miscellaneous Costs 16,200 18,000 1,03,150 1,15, 000 Working Notes : From the analysis of the costs, it is observed that a. Employee salaries is a fixed cost as they remain constant for both 6000 repair hours and 9000 repair hours. b. Indirect repair materials is a variable cost as it proportionately increases from 6000 hours to 9000 hours. c. Miscellaneous costs is a semi-variable cost. This cost neither remained constant nor increased proportionately the activity level of 6000 hours to 9000 hours. The cost increased by Rs. 3,600 for the increase of 3000 hours. means that the variable portion of this cost is Rs. 1.20 hour. Hence, out of total miscellaneous cost of Rs. 13,200 for 6000 hours, Rs. 7,200 is variable portion and balance 6,000 is the fixed portion. Budgetary Control 463 (11) Viveka Elementary School has a total of 150 students consisting of 5 sections with 30 students per section. The school plans for a picnic around the city during the week end to places such as the zoo, the amusement park, the planetarium etc. A private transport operator has come forward to lease out the buses for taking the students. Each bus will have a maximum capacity of 50 (excluding 2 seats reserved for the teacher accompanying the students). The school will employ 2 teachers for each bus paying them an allowance of Rs. 50 per teacher. It will also lease out the required number of buses. The following are the other cost estimates Cost per student Rs. Breakfast 5 Lunch 10 Tea 3 Entrance fee at zoo 2 Rent Rs. 650 per bus. Special permit fee Rs. 50 per bus. Block entrance fee of the planetarium Rs. 250. Prizes to the students for games Rs. 250. No costs are incurred in respect of the accompanying teachers (except the allowance of Rs. 50 per teacher). You are required to prepare a. A flexible budget estimating the total cost for the levels of 30, 60, 90, 120 and 150 students. Each item of cost is to be indicated separately. b. Compare the average cost per student of these levels. c. What will be your conclusions regarding the break even level of students if the school proposes to collect Rs. 45 per student? 464 Management Accounting Solution : No. of Students 30 60 90 120 150 a. Variable Cost 600 1200 1800 2400 3000 b. Semi-fixed costs Rent of the bus 650 1300 1300 1950 1950 Permit Fees 50 100 100 150 150 Allowances to teachers 100 200 200 300 300

c. Fixed Costs Entrance Fees 250 250 250 250 250 Prizes to students 250 250 250 250 250 Total Costs 1900 3300 3900 5300 5900 Average Cost per student 63.33 55.00 43.33 44.17 39.33 Total Cost No. of students (12) Prepare the flexible budget for overheads on the basis of data given below. Ascertain the overheads rates at 50%, 60% and 70% capacity. At 60% capacity Rs. Variable Overheads Indirect Material 6,000 Indirect Labour 18,000 Semi-Variable Overheads Electricity (40% fixed, 60% variable) 30,000 Repairs and Maintenance (80% fixed, 20% variable) 3,000 Fixed Overheads : Depreciation 16,500 Insurance 4,500 Salaries 15,000 Total Overheads 93,000 Estimated Direct Labour Hours 1,86,000 Budgetary Control 465 Solution : Calculation of Overheads Rates 50% 60% 70% Capacity Capacity Capacity Rs. Rs. Rs. Variable Overheads Indirect Material 5,000 6,000 7,000 Indirect Labour 15,000 18,000 21,000 Semi Variable Overheads Electricity 27,000 30,000 33,000 Repairs and Maintenance 2,900 3,000 3,100 Fixed Overheads Depreciation 16,500 16,500 16,500 Insurance 4,500 4,500 4,500 Salaries 15,000 15,000 15,000 Total Overheads 85,900 93,000 1,00,100 Estimated Direct Labour Hours 1,55,000 1,86,000 2,17,000 Overhead Rate (Labour Hour Rate) Re.0.55 Re.0.50 Re.0.46 (13) A Factory can produce 60,000 units per annum at its 100% capacity. The estimated costs of production are as under. Direct Materials Rs. 3 per unit. Direct Labour Rs. 2 per unit Indirect Expenses Fixed Rs. 1,50,000 per annum Variable Rs. 5 per unit Semi-variable Rs. 50,000 per annum up to 50% capacity and an extra expenses of Rs. 10,000 for every 20% increase in capacity or part thereof.

The factory produces only against orders. If the production programme of the factory is as indicated below, and the management desires to ensure a profit of Rs.1,00,000 for the year, work out the average selling price at which each unit should be quoted. 466 Management Accounting For three months of the year - 50% capacity Remaining nine months of the year - 80% capacity Solution : Calculation of total cost 50% 80% Total capacity capacity capacity Number of units produced 7,500 36,000 43,500 Direct Material - Rs. 22,500 1,08,000 1,30,500 Direct Labour - Rs. 15,000 72,000 87,000 Variable Expenses - Rs. 37,500 1,80,000 2,17,500 Fixed Expenses 37,500 1,12,500 1,50,000 Semi-Variable Expenses - Rs. 12,500 32,500 45,000 Total Cost 1,25,000 5,05,000 6,30,000 Thus, the total cost during the year is likely to be Rs.6,30,000. If it is desired to earn a profit of Rs. 1,00,000 the total amount to be covered by the units to be sold will have to be Rs.7,30,000 (i.e. Rs. 6,30,000 + Rs. 1,00,000). As the total units produced are estimated to be 43,500, the above amount will have to be covered by 43,500 units. Hence, the average selling price per unit will be Rs.7,30,000 = Rs. 16.78 per unit (approx.) 43,500 Notes : (1) It is assumed that whatever units are produced can be sold. (2) It is assumed that the production and the incidence of all the indirect expenses is equally spread during the year. (3) From the following particulars, prepare a flexible budget for the three months ending 30th September showing the estimated sales, sales cost and profit for 60%, 80% and 100% activity. Assume that all items produced are sold. Fixed Expenses Rs. Management salaries 4,20,000 Rent and Taxes 2,80,000 Depreciation on machinery 3,50,000 Sundry office cost 4,45,000 14,95,000 Budgetary Control 467 Rs. Semi-variable expenses at 50% capacity Plant Maintenance 1,25,000 Indirect Labour 4,95,000 Salesmens Salary & Expenses 1,45,000 Sundry Expenses 1,30,000 8,95,000 Variable Expenses at 50% capacity Materials 12,00,000 Labour 12,80,000 Salesmens Commission 1,90,000 26,70,000 Semi-variable expenses remain constant between 41% and 70% activity, increase by 10% of the above figures between 71% and 80% activity and increase by 15% of the above figures between 81% and 100% activity. Fixed expenses remain constant whatever may be the level

of activity. Sales at 60% activity are Rs.51,00,000, at 80% activity are Rs. 68,00,000 and at 100% activity are Rs.85,00,000. Flexible Budget 60% 80% 100% capacity capacity capacity Rs. Rs. Rs. (A) Sales 51,00,000 68,00,000 85,00,000 (B) Sales Cost (1) Fixed Expenses Management Salaries 4,20,000 4,20,000 4,20,000 Rent and Taxes 2,80,000 2,80,000 2,80,000 Depreciation on Machinery 3,50,000 3,50,000 3,50,000 Sundry office cost 4,45,000 4,45,000 4,45,000 14,95,000 14,95,000 14,95,000 468 Management Accounting 60% 80% 100% capacity capacity capacity Rs. Rs. Rs. (2) Semi Variable Expenses Plant Maintenance 1,25,000 1,37,500 1,43,750 Indirect Labour 4,95,000 5,44,500 5,69,250 Salesmens Salary and Expenses 1,45,000 1,59,500 1,66,750 Sundry Expenses 1,30,000 1,43,000 1,49,500 8,95,000 9,84,500 10,29,250 (3) Variable Expenses Material 14,40,000 19,20,000 24,00,000 Labour 15,36,000 20,48,000 25,60,000 Salesmans Commission 2,28,000 3,04,000 3,80,000 32,04,000 42,72,000 53,40,000 Total Sales Cost 1 + 2 + 3 55,94,000 67,51,500 78,64,250 (C) Profit A - B (4,94,000) 48,500 6,35,750 (15) Based on sales foreast for the season, C Ltd. has prepared the following production scheme for the coming month. 30,000 units of Product A and 20,000 units of product B. the manufacturing specifications for the products are as follows. Product A Product B 2 Kgs. Material X @ Rs. 3 3 Kgs. Material W Rs. 8 1/2 Kg. Material Y @ Rs. 2 3/4 Kg. Material Y @ Rs. 2 2 hours direct labour @ Rs. 20 11/2 hours direct labour @ Rs. 20 To the direct labour hours, a 5% allowance for idleness (accounted for as overheads) should be added. Indirect labour time is estimated to be 5% of direct labour hours (excluding idleness) and the wage rate for indirect labour is Rs. 15. The overhead estimate (not shown above) is as follows Fixed Cost per month Depreciation Rs. 69,000 Insurance Rs. 8,000 Superintendence Rs. 30,000 Rs. 1,07,000 Budgetary Control 469 Variable Costs : Rs 8 per direct labour hour. Note : This rate includes the cost of idle lime and indirect labour. It is planned to increase the inventory of raw material X by 4,000 Kgs and to decrease the inventory of raw material W by 2,000 Kgs. as of the begining after next month. You are required to prepare and estimate of the amount of cash necessary for manufacturing operations of the coming month.

Assume that the materials and wages cost are paid in the month of purchase. Solution : Computation of Requirement of Cash (A) For Raw Material : (Both Products A & B) Rs. Rs. X - 60,000 Kgs @ Rs. 3 1,80,000 Y - 30,000 Kgs @ Rs. 2 60,000 W - 60,000 Kgs @ Rs. 8 4,80,000 7,20,000 Add : Increase in stock of X 4,000 kgs @ Rs. 3 12,000 7,32,000 Less : Decrease in stock of W 2,000 Kgs @ Rs. 8 16,000 7,16,000 (B) For Direct Wages Product A - 60,000 hours @ Rs. 20 12,00,000 Product B - 30,000 hours @ Rs. 20 6,00,000 18,00,000 (C ) For Overheads (1) Idle Time - 5% of 90,000 hours i.e. 4,500 hours @ Rs. 20 90,000 (2) Indirect Labour - 5% of 90,000 hours i.e. 4,500 hours @ Rs. 15 67,500 (3) Variable Costs - 90,000 hours @ Rs. 8 7,20,000 (4) Fixed Overheads 1,07,000 9,84,500 35,00,500 470 Management Accounting (16) A company is at present working at 90% of its capacity and producing 13,500 units perannum. It operates a flexible budgetary control system. The following figures (excluding material and labour cost) are obtained from its budget : 90% 100% (a) Sales Rs. 15,00,000 16,00,000 (b) Fixed Expenses Rs. 3,00,500 3,00,500 (c) Semi-Fixed Expenses Rs. 97,500 1,00,500 (d) Semi-Variable Expenses Rs. 1,42,000 1,49,500 Material and Labour Cost per unit are constant under present conditions. Profit margin is 10% at 90% capacity : (a) You are required to determine the cost of producing an additional 1,500 units. (b) What would you recommend for an export price for these 1,500 units taking into account that overseas prices are much lower than indigenous prices? Solution : Cost Sheet 90% Capacity 100% Capacity Variable Cost Material / Labour 8,10,000 9,00,000 Variable portion of Semi-Fixed Expenses 27,000 30,000 Variable portion of Semi-Variable Expenses 67,500 75,000 a. Total Variable Cost 9,04,500 10,05,000 Fixed Cost Fixed Expenses 3,00,500 3,00,500 Fixed portion of Semi-Fixed Expenses 70,500 70,500 Fixed portion of Semi-Variable Expenses 74,500 74,500 b. Total Fixed Cost 4,45,500 4,45,500

c. Total Cost (a+b) 13,50,000 14,50,500 d. Profit 1,50,000 1,49,500 e. Sales 15,00,000 16,00,000 Budgetary Control 471 Hence, the cost of producing 1,500 units will be Rs. 1,00,500 i.e. Rs. 14,50,500 less Rs. 13,50,000. Recommended export price for these 1,500 units will be Rs. 67 i.e. Rs. 1,00,500 / 1,500. Working Notes : a. Semi-Fixed Expenses With every 10% capacity increase, semi-fixed expenses increase by Rs. 3,000. This means that variable portion of semi-fixed expenses is Rs. 3,000 for 10% capacity. For 90% capacity it will be Rs. 27,000 and for 100% capacity, it will be Rs. 30,000. b. Semi-Variable Expenses With every 10% capacity increase, semi-variable expenses increase by Rs. 7,500. This means that variable portion of semi-fixed expenses is Rs. 7,500 for 10% capacity. For 90% capacity it will be Rs. 67,500 and for 100% capacity, it will be Rs. 75,000. (17) Develope the proforma (estimated) income statement for the months of October, November and December of Ajax Lunatics Ltd. from the following information. (a) Sales are projected at Rs. 2,50,000, Rs. 3,00,000 and Rs. 2,00,000 for October, November and December respectively. (b) Cost of goods sold is Rs. 75,000 plus 20% of sales per month. (c) Selling Expenses are 3% of sales. (d) Rent is Rs. 7,500 per month. Administrative Expenses is 15% of sales per month. (e) The company has Rs. 3,00,000 at 10% loan-The interest is payable monthly. (f) Corporate tax rate is 60% Solution : Proforma (Estimated) Income Statement of Ajax Lunatics Limited. October November December (A) Sales 2,50,000 3,00,000 2,00,000 (B) Cost Cost of goods sold 1,37,500 1,50,000 1,25,000 Selling Expenses 7,500 9,000 6,000 Rent 7,500 7,500 7,500 Administretive Expenses 37,500 45,000 30,000 Interest on Loan 2,500 2,500 2,500 Total Cost 1,92,500 2,14,000 1,71,000 (C ) Profit before tax (A - B) 57,500 86,000 29,000 (D) Income Tax - 60% of C 34,500 51,600 17,400 (E) Profit after tax (C - D) 23,000 34,400 11,600 472 Management Accounting (18) M/s. Agarval fabricating and Manufacturing Co. Ltd. is presently working at 50% capacity, producing and selling, 1,000 units of a product. You are required to find out the profits the concern will make by working at 60% and 80% capacity. At 50% capacity, the selling price is Rs. 200 per unit. Whereas the product cost is Rs. 160 as given below. Rs. Materials Cost 80 Direct wages 30 Factory overheads 30 (of which 60% is variable) Selling and Admn. overheads 20 (of which 50% is fixed). At 60% capacity, material prices go up by 10% and selling price reduced by 5%. At 80% capacity, there is increase in labour cost by 10% and variable factory overheads go up by Rs. 2 per unit. The variable selling and administration overheads increase by Re. I per unit, the other costs and selling price remain unchanged as at 60%. Flexible Budget 50% 60% 80%

Capacity Capacity Capacity (A) Number of units sold 1,000 1,200 1,600 Selling Price per unit Rs. 200 190 190 Sales Rs. 2,00,000 2,28,000 3,04,000 (B) Cost Rs. (1) Materials Cost 80,000 1,05,600 1,40,800 (2) Direct Wages 30,000 36,000 52,800 (3) Variable Overheads Factory 18,000 21,600 32,000 Selling & Administration 10,000 12,000 17,600 (4) Fixed Overheads Factory 12,000 12,000 12,000 Selling & Administration 10,000 10,000 10,000 Total Cost 1,60,000 1,97,200 2,65,200 (C) Profit i.e. A - B 40,000 30,800 38,800 Budgetary Control 473 QUESTIONS 1. What do you mean by Budget and Budgetary Control? What are the advantages of Budgetary Control as a cost control technique? What are the prerequisites for the successful implementation of Budgetary Control System? 2. What is the meaning of Budget and Budgetary Control. State and explain various budgets which can be established in the following functional areas of operation a) Sales/Marketing b) Production c) Finance 3. Write short notes on a) Budget Manual b) Fixed and Flexible Budgets c) Cash Budget 474 Management Accounting PROBLEMS (1) The sales manager of a manufacturing company expects to sell 25,000 units of a certain product. The production director provides the following information. Two kinds of raw materials X and Y are required for each unit of final product and 2 units of X and 3 units of Y are required for one unit of final product. The estimated opening balance at the commencement of next year areFinal product - 5,000 units X - 6,500 units Y - 8,000 units The desirable closing balance at the end of next year are Final Product - 7,000 units X - 6,500 units Y - 8,000 units Draw the production budget for the next year. (2) A Ltd. manufactures two products X and Y making the use of following raw materials in the proportion shown. Raw material Product X Product Y Rl 80% R2 20% R3 50% R4 50% The finished weight of products X and Y are equal in weight of their ingredients. During a month, it is expected that 1200 kgs. of X and 4000 kgs of Y will be sold. Budgetary Control 475 Actual and budgeted inventories for the month are as below.

Material Actual Opening Stock Budgeted Closing Stock Kgs. Kgs. R 1 300 400 R 2 200 800 R 3 4000 6000 R 4 5000 4000 X 200 100 Y 1000 1200 The purchase price of materials is expected to be as below. Cost Per Kg. Rs. R 1 50 R 2 40 R 3 10 R 4 20 All materials will be purchased on 1st of the month. Prepare -(a) Production Budget. (b) Purchases Budget. (3) A Ltd. produces a standard product. The estimated cost per unit in given below. Rs. Raw materials 10 Direct wages 8 Direct Expenses 2 Variable Overhead 5 Fixed overheads are estimated to Rs. 70,000 selling price per umt is Rs. 40. Prepare a flexible budget at 50%, 70% and 90% level of activity. Assume that output at 100% level of activity is 10,000 units. 476 Management Accounting (4) The following expenses relate to a cost centre operating at 80% of normal capacity (Sales are Rs.1,20,000) Draw up flexible Administration, Selling and Distribution costs budget operating at 90%, 100% and 110% of normal capacity. Administration Costs Office Salaries Rs. 3,000 General Expenses 1.5% of sales Depreciation Rs. 1,500 Rates and Taxes Rs. 1,750 Selling Costs Salaries 4% of sales Travelling Expenses 1.5% of sales Sales Office Expenses 1% of sales General Expenses 1% of sales Distribution Costs Wages Rs.3,000 Rent 0.5% of sales Other Expenses 2% of sales (5) The expenses budgeted for production of 10,000 units in a factory are furnished below. Per Unit Rs. Materials 70 Labour 25 Variable Overheads 20 Fixed Overheads ( Rs.1,00,000) 10 Variable Expenses (Direct) 5 Selling Expenses (10% Fixed) 13 Distribution Expenses (20% Fixed) 7 Adinimstrative Expenses (Rs.50,000) 5

Total Cost of sale per unit 155 (to make and sale) Prepare a budget for the production of a. 8,000 units and b. 6,000 units. Budgetary Control 477 Assume that administrative expenses are rigid for all levels of production. (6) Following are the actuals for the year 1985. Rs. Sales 20,000 units @ Rs.3 per unit 60,000 Raw Material 26,500 Direct Labour Cost 5,000 Variable Overheads 8,000 Fixed Overheads 10,000 The management expects following estimate in 1986. Sales to increase to 30,000 units, selling price remaining unchanged. Raw materials prices increase by 10%, wage rate to increase by 10% but labour productivity improves by 5%. Fixed overheads are expected to increase by Rs. 2,000. You are required to prepare the budget for 1986. (7) Production costs of a factory for a year are as follows. Direct Wages Rs. 90,000 Direct Materials Rs. 1,20,000 Production Overheads : Fixed Rs. 40,000 Variable Rs. 60,000 During the forthcoming year, it is anticipated that : (a) The average rate for direct labour remuneration will fall from 90 paise to 75 paise per hour. (b) Production efficiency will be reduced by 5%. (c) Price per unit of direct material and other materials and services which comprise overheads will remain unchanged and (d) Direct labour hours will increase by 33 1/3. Draw up a budget and compute a factory overhead rate, the overheads being absorbed on a direct wages. (8) ABC Ltd. manufacturing a single product is facing a severe competition in selling at Rs. 50 per unit. The company is operating at 60% level of activity at which level sales are Rs. 12,00,000. Variable costs are Rs.30 per unit. Semi variable costs may be considered 478 Management Accounting as fixed at Rs. 90,000 when output is nil and variable element is Rs.250 for each additional 1% level of activity. Fixed costs are Rs, 1,50,000 at the present level of activity, but at the level of activity of 80% or above if reached, these costs are expected to increase by Rs.5,000. To cope with the competition, the management of the company is considering a proposal to reduce the selling price by 5%. You are required to : (a) Prepare a statement showing the operating profit at levels of activity of 60%, 70% and 80%. Assuming that the selling price remains at Rs.50 per unit. (b) If selling price is reduced by 5%, show the number of units which will be required to be sold to maintain the present profits. (9) A company, producing electronic watches, estimates the following factory overheads costs for producing 5,000 Units Indirect Materials Rs. 16,000 Indirect Labour Rs. 30,000 Inspection Cost Rs. 16,000 Heat, light & power Rs. 8,000 Expendable tools Rs. 8,000 Supervision Costs Rs. 8,000 Equipment depreciation Rs. 4,000

Factory Rent Rs. 4,000 Indirect labour, indirect material and expendable tools are entirely variable. Heat, light and power and inspection costs are variable to the extent of 50% and 40% respectively. Other costs are fixed costs for a month. Prepare a flexible budget for overheads for production of 4,000 and 6,000 units per month. Also find out the average factory overheads per unit for these two production levels. (10) Anil and Avinash Enterprises is currently working at 50% capacity and produces 10,000 units. Estimate the profits of the company when it works at 60% and 70% capacity. At 60% capacity, the raw materials cost increases by 2% and the selling price falls by 3%. At 70% capacity the raw materials cost increases by 4% and selling price falls by 5%. At 50% capacity, the product costs Rs. 180 per unit and is sold for Rs.200 per unit. Budgetary Control 479 The unit cost of Rs. 180 is made up as below. Materials cost Rs. 100 Wages Rs. 30 Factory overheads Rs. 20 (40% Fixed) Administration overheads Rs. 30 (50% fixed) (11) ABC Ltd. manufactures a single product for which market demand exists for additional quantity. Present sale of Rs. 60,000 per month utilities only 60% capacity of the plant. Sales Manager assures that with a reduction of 10% in the price, he would be in a position to increase the sale by about 25% to 30% . The following data are available. (a) Selling price - Rs. 10 per unit (b) Variable cost - Rs. 3 per unit (c) Semi-variable cost - Rs. 6,000 plus Rs.0.50 per unit (d) Fixed coct - Rs. 20,000 at present level, estimated to be Rs.24,000 at 80% output. You are required to submit the following statements to the Board showing. (1) The operating profits at 60%, 70% and 80% levels at current selling price and at proposed selling price. (2) The percentage increase in the present output which will be required to maintain the present profit margin at the proposed selling price. (12) A manufacturing company has an installed capacity of 1,20,000 units per annum. The cost structure of the products manufactured is as under : (i) Variable Cost ( Per Unit) Materials Rs. 8 Labour Rs. 8 (Subject to a minimum of Rs.56,000 per month) Overheads Rs. 3 (ii) Fixed overheads are Rs. 1,04,000 per annum. (iii) Semi variable overheads Rs.48,000 per annum at 60% capacity, which will increase by Rs.6000 per annum for increase of every 10% of the capacity utilization or any part thereof. 480 Management Accounting The capacity utilization for the next year is estimated at 60% for 2 months, 75% for 6 months and 80% for the balance part of the year. If the company is planning to have a profit of 25% on the selling price, calculate the estimated selling price for each unit of production. Assume there is no opening or closing stock. (13) The monthly budgets for manufacturing overhead of a concern for two levels of activity were as follows Capacity 60% 100% Budgeted Production (units) 600 1000 (Rs.) (Rs.) Wages 1,200 2,000 Consumable Stores 900 1,500

Maintenance 1,100 1,500 Power and Fuel 1,600 2,000 Depreciation 4,000 4,000 Insurance 1,000 1,000 9,800 12,000 You are required to a. Indicate which of the items are fixed, variable and semi-variable. b. Prepare a budget for 80% capacity. c. Find out the total cost, both fixed and variable, per unit of output at 60%, 80% and 100% capacity. (14) From the following data, prepare a flexible budget for the production of 40,000 units, 60,000 units and 75,000 units, distinctly showing variable and fixed costs as well as total costs. Also indicate element wise cost per unit. Budgeted output and budgeted cost per unit Budgeted output 100000 units Per unit cost Rs. Direct Material 90 Direct Labour 45 Direct Variable Expenses 10 Manufacturing Variable Overheads 40 Fixed Production Overheads 5 Administration Overheads (Fixed) 5 Selling Overheads 10 (10% fixed) Distribution Overheads 15 (20% fixed) Budgetary Control 481 (15) The budget manager of Progressive Electrical Limited, is preparing a flexible budget for the accounting year commencing 1st April 1995. The company produces one product a component - Kaypee. Direct Material costs Rs. 7 per unit. Direct Labour averages Rs. 2.50 per hour and requires 1.60 hours to produce one unit of Kaypee. Salesmen are paid a commission of Re. 1 per unit sold. Fixed selling and administration expenses amount to Rs. 85,000 per year. Manufacturing overheads under specified conditions of volume have been estimated as follows Volume of Production (units) 1,20,000 1,50,000 Rs. Rs. Indirect Materials 2,64,000 3,30,000 Indirect Labour 1,50,000 1,87,500 Inspection 90,000 1,12,500 Maintenance 84,000 1,02,000 Supervision 1,98,000 2,34,000 Depreciation 90,000 90,000 Engineering Services 94,000 94,000 Total Manufacturing Overheads 9,70,000 11,50,000 Normal capacity of production of the company is 1,25,000 units. Prepare a budget of total cost at 1,40,000 units of output. (16) Excellent Manufacturers can produce 4000 units of a certain product at 100% capacity. The following information is obtained from the books of accounts June 94 July 94 Units produced 2,800 3,600 Rs. Rs. Repairs and Maintenance 500 560 Power 1,800 2,000 Shop Labour 700 900 Consumable Stores 1,400 1,800 Salaries 1,000 1,000 Inspection 200 240

Depreciation 1,400 1,400 The rate of production is 10 units per hour. Direct Materials cost is Re. 1 and Direct Wages per hour is Rs. 4. You are required to 482 Management Accounting a. Compute the cost of production at 100%, 80% and 60% capacity showing the variable, fixed and semi-fixed items under the flexible budget. b. Find out the overhead absorption rate per unit at 80% capacity. (17) The following data are available for a manufacturing company for a yearly period Rs. in Lakhs Fixed Expenses - Wages and Salaries 9 .5 - Rent, Rates and Taxes 6.6 - Depreciation 7.4 - Sundry Administrative Expenses 6 .5 Semi-Variable Expenses (at 50% capacity) - Maintenance and Repairs 3 .5 - Indirect Labour 7 .9 - Sales Department Salaries 3 .8 - Sundry Administrative Salaries 2.8 Variable Expenses (at 50% capacity) - Material 21.7 - Labour 20.4 - Other Expenses 7.9 98.0 Assume that the fixed expenses remain constant at all levels of production, semi-variable expenses remain constant between 45% and 65% of capacity increasing by 10% between 65% and 80% capacity and by 20% between 80% and 100% capacity. Sales at various levels are Rs. in Lakhs 50% capacity 100 60% capacity 120 75% capacity 150 90% capacity 180 100% capacity 200 Prepare a flexible budget for the year at 60% and 90% capacities and estimate the profits at these levels of output. Budgetary Control 483 (18) A factory is currently running at 50% capacity and produces 5,000 units at a cost of Rs. 90/- per unit as per details below : Rs. Material 50 Labour 15 Factory overheads 15 (Rs. 6/- fixed) Administrative overheads 10 (Rs. 5/- fixed) The current selling price is Rs. 100/- per unit. At 60% working, material cost per unit increases by 2% and selling price per unit falls by 2%. At 80% working, material cost per unit increases by 5% and selling price per unit falls by 5%. Estimate profits of the factory at 60% and 80% working and offer your comments. (19) On 30th September 1990, the Balance Sheet of Melodies Pvt. Ltd. retailers of musical instruments, was as under Liabilities Rs. Assets Rs. Ordinary shares of Rs.10 Equipment (at cost) 20,000 each fully paid 20,000 Less : Depreciation 5,000 Reserves and surplus 10,000 15,000

Trade Creditors 40,000 Stock 20,000 Proposal Dividend 15,000 Trade Debtors 15,000 Balance at Bank 35,000 85,000 85,000 The company is developing a system of forward planning and on 1st October 1990, it supplies the following information. Credit Sales Cash Sales Credit Purchases Rs. Rs. Rs. Sept. 90 (Actual) 15,000 14,000 40,000 Oct. 90 (Budget) 18,000 5,000 23,000 Nov. 90 (Budget) 20,000 6,000 27,000 Dec. 90 (Budget) 25,000 8,000 26,000 All trade debtors are allowed one months credit and are expected to settle promptly. All trade creditors are paid in the month following delivery. 484 Management Accounting On 1st October 1990, all the equipment was replaced at a cost of Rs. 30,000. Rs. 14,000 was allowed in exchange for the old equipment and a net payment of Rs. 16,000 was made. Depreciation is to be allowed at the rate of 10% per annnm. The proposed dividend will be paid in December 1990. The following expenses will be paidWages Rs. 3,000 per month. Administration Rs. 1500 per month. Rent Rs. 3600 for the year to 30th September 1991 (to be paid in October, 1990) The gross profit percentage on sales is estimated at 25%. You are required (1) To prepare cash budget for the months of October, November and December. (2) To prepare Income Statement for the three months ended 31st December 1990. (20) Develop Performa income statement for the months of July, August and September for a company for the following information. (a) Sales are projected at Rs. 2,25,000, Rs. 2,40,000 and Rs. 2,15,000 for July, August and September respectively. (b) Cost of goods sold is Rs.50,000 plus 30% of selling price per month. (c) Selling Expenses are 3% of sales. (d) Rent is Rs. 7,500 per month, administrative expenses for July are expected to be Rs. 60,000 but are expected to rise 1% per month over the previous months expenses. (e) The company has Rs.3,00,000 of 8% loan interest payable monthly. (f) Corporate Tax rate is 70%. (21) The projected sales and purchases of ABC Ltd. for the months July to November 1983 are Sales (Rs.) Purchases (Rs.) July 6,20,000 3,80,000 August 6,40,000 3,33,000 September 5,80,000 3,50,000 October 5,60,000 3,90,000 November 6,00,000 3,40,000 Budgetary Control 485 The wages are expected to be Rs.100,000 per month. The management is expected to pay two months wages as bonus during October 1983. The company is expected to pay advance income tax Rs. 90,000 before 15th September 1983. The company has ordered in June 1983 for a machine costing Rs. 16,00,000. The Bank has agreed to finance the purchase of the machine which is expected to be delivered in January 1984. The company has advanced 5% in June 1983 and they have agreed to pay another 10% advance after 3 months. The company extends 2 months credit for the customers and enjoys one month credit from the suppliers. The general expenses for the company is Rs.60,000 per month payable at the end of each month. The company anticipates to receive dividends

of 10% for the investments of 90,000 shares of Rs. 10 each during October 1983. The company anticipates to have an overdraft of Rs. 40,000 on 1st September 1983 (limit sanctioned is Rs. 55,000). Draw a cash budget for September 83 to November 83 for approaching bankers for a short term further credit. (22) From the following budgeted data of ABC Ltd., prepare cash budget for the quarter ending 31st December 1984. Month Sales Purchases Wages Misc. Exp. August 1,20,000 84,000 10,000 7,000 September 1,30,000 1,00,000 12,000 8,000 October 80,000 1,04,000 8,000 6,000 November 1,16,000 1,06,000 10,000 12,000 December 88,000 80,000 8,000 6,000 Additional information : Cash on hand on 1,10.84 Rs. 5,000 Sales 20% realised in the month of sale. Discount allowed 2%. Balance realised in subsequent month. Purchases - These are paid in the following the month of supply. Wages - 25% in arrears paid in the following month. Misc. Expenses - Paid a month in arrears. Rent - Rs.1,000 per month paid quarterly in advance, due in October. Income Tax - Instalments of Rs. 25,000 due on or before 15.12 84. Income from investment - Rs. 5,000 received quarterly April, July, October etc. Insurance claim - Rs. 72,936 receivable in December. 486 Management Accounting (23) A firm expects to have to Rs. 30,000 in Bank on 1.10.86 and requires you to prepare an estimate of cash position during the three months October 86 to December 86. The following information is supplied to you. Month Sales Purchases Wages Factory Office Selling Exp. Exp. Exp. Rs. Rs. Rs. Rs. Rs. Rs. August 40,000 24,000 6,000 3,000 4,000 3,000 September 46,000 28,000 6,500 3,500 4,000 3,500 October 50,000 32,000 6,500 4,000 4,000 3,500 November 72,000 36,000 7,000 4,000 4,000 4,000 December 84,000 40,000 7,250 4,250 4,000 4,000 Other information : (1) 25% of the sales are for cash, remaining amount in the month following that of sale. (2) Suppliers supply goods at 2 months credit. (3) Delay in the payment of wages and all other expenses one month. (4) Income Tax of Rs.l0,000 is due to be paid in December. (5) Preference shares dividend of 10% on Rs.l ,00,000 is to be paid in October. (24) Mr. Ashok Kumar, the Finance Manager of Mazumdar Castings Ltd. is preparing the cash budget for the first six months of 1982, on the basis of the following information : (i) Costs and Price remains unchanged. (ii) Out of the total sales, cash sales are 25%, the balance being credit sales. 60% of the credit sales are collected in the month after sales, 30% are collected in the second month, and the balance 10% in the third month after sale. He does not expect any bad debts. (iii) The Gross Profit Margin is expected to be 20% (iv) Actual sales and forecast sales are as follows : Oct. 81 Rs. 12,00,000 Mar. 82 Rs. 8,00,000 Nov. 81 Rs. 14,00.000 April 82 Rs. 12,00,000 Dec. 81 Rs. 16,00,000 May 82 Rs. 12,00,000 Jan. 82 Rs. 8,00,000 Jun. 82 Rs. 8,00,000 Feb. 82 Rs. 8,00,000 Jul. 82 Rs. 10,00,000 Budgetary Control 487

(v) Anticipated Cash Purchases, there being no Credit Purchases: Jan 82 Rs. 6,40,000 April 82 Rs. 9,10,000 Feb. 82 Rs. 7,00,000 May 82 Rs. 6,40,000 Mar. 82 Rs. 10,00,000 Jun. 82 Rs. 9,60,000 (vi) Wages and salaries to be paid in cash : Jan 82 Rs. 1,40,000 Feb. 82 Rs. 1,60,000 Mai. 82 Rs. 2,00,000 Apr. 82 Rs. 2,20,000 May 82 Rs. 1,60,000 Jun 82 Rs. 1,40,000 (vii) Interest on 20,00,000 8% Debentures was due on June 30, 1982 (half yearly) (viii) Excise deposit due on March 31, 1982 Rs. 3,00,000. (ix) Acquisition of plant and equipment planned for May 1982 Rs. 10,00,000. (x) Miscellaneous Expenses on a cash basis every month at Rs. 15,000 plus 10% of sale. (xi) The company will have a cash balance of Rs. 5,00,000 on 31.12,81. Mr. Ashok Kumar believes that this is a high level and is planning on a continuous balance of Rs. 4,00,000 (a) Prepare the Cash budget for six months to June 1982 . (b) If additional finance is required, recommend the type of finance to be obtained. (25) A company has its cost of goods of 70% of its sales, 70% of this cost is paid in the month of the sale and the balance in the next month. Salary and administrative expenses amount to Rs. 40,000 per month plus 5% of sales. These expenses must be paid during the month following the month when expenses are actually incurred . The company has also 10% Debentures of Rs. 1,50,000 and interest has to be paid in 4 quarters from January onwards. The company gives its actual and forecast sales as below. Actual Sales Rs. Forecast sales Rs. January 2,00,000 May 2,00,000 February 2,00,000 June 2,50,000 March 3.00,000 July 2,50,000 April 3,00,000 August 3,00,000 488 Management Accounting You are required to prepare a cash flow schedule for six months from March onwards. (26) Following details are available in case of Pam Industries Ltd. Actual Sales Rs. Estimated sales Rs. January 65,000 May 1,05,000 February 75,000 June 1.20,000 March 90,000 July 1,25,000 April 80,000 August 1,35,000 Consider the following additional information : (1) Cash sales are 50 per cent of the total sales. The remaining 50 per cent will be collected equally during the following two months. (2) Cost of goods manufactured is 70 per cent of sales. 90 per cent of this cost is paid during the first month after incurrence and the balance is paid in the following month. (3) Sales and administrative expenses are Rs. 15,000 per month plus 10 per cent of sales. All these expenses are paid during the month of incurrence. (4) Half- yearly interest of 6 per cent on Rs. 4,50,000 Debentures is paid during July. (5) Rs. 60,000 are expected to be invested in fixed assets during July. (6) A dividend of Rs. 15,000 will be paid in July. (7) An income tax of Rs. 15,000 will be paid in July. It is the policy of the company to have a minimum cash balance of Rs. 30,000/-. Accordingly as on 30th April, the actual cash balance was Rs. 30,000/-. The Management wishes to know whether it will be required to borrow during the quarter ending on 31st July and if so when and how much.

(27) Prepare a cash budget for the three months ending 30th June 1986 from the information given below. (a) Month Sales Materials Wages Overheads Rs. Rs. Rs. Rs. February 14,000 9,600 3,000 1,700 March 15,000 9,000 3,000 9,900 April 16,000 9,200 3,200 2,000 May 17,000 10,000 3,600 2,200 June 18,000 10,400 4,000 2,300 Budgetary Control 489 (b) Credit terms are : Sales/Debtors - 10% of sales are on cash, 50% of the credit sales are collected next month and balance in the month following Creditors - Materials - 2 months Wages - 1/4 month Overheads - 1/2 month (c) Cash and Bank balance on 1st April 1986 is expected to be Rs.6,000. (d) Other relevant information : (i) Plant and Machinery will be installed in February 1986 at a cost of Rs. 96,000. The monthly instalments of Rs. 2,000 is payable from April onwards. (ii) Dividend @ 5% on preference share capital of Rs.2,00,000 will be paid on 1st June. (iii) Advance to be received for sale of vehicle Rs. 9,000 in June. (iv) Dividends from investment amounting to Rs. 1,000 expected to be received in June (v) Income Tax advance is to be paid in June - Rs. 2,000. (28) Prepare a cash budget of XYZ Ltd. on the basis of the six months commencing from April 1989. (1) Cost and prices remain unchanged. (2) Cash sales are 25% of the total sales and balance 75% will be credit sales. (3) 60% of credit sales are collected in the month following the sales, balance 30% and 10% in the two following months thereafter. No bad debts are anticipated. (4) Sales forecasts are as follows - (Rs. in lakhs) Jan. 89 - 12 Feb. 89 - 14 March 89 - 16 April 89 - 6 May 89 - 8 June 89 - 8 July 89 - 12 August 89 - 10 Sept. 89 - 8 Oct. 89 -12 (5) Gross Profit margin 20% (6) Anticipated purchases - (Rs. in lakhs) April 89 - 6.40 May 89 - 6.40 June 89 - 9.60 July 89 - 8.00 August 89 - 6.40 Sept. 89 - 9.60 490 Management Accounting (7) Wages and Salaries to be paid - (Rs. in lakhs) April 89 - 1.20 May 89 - 1.60 June 89 - 2.00 July 89 - 2.00 August 89 - 1.60 Sept. 89 - 1.40 (8) Capital expenditure for plant and machinery planned for September 1989 is Rs. 1,20,000. (9) Company has a cash balance of Rs. 4,00,000 as at 31st March, 1989 and will maintain it in future also at minimum level. (10) The Company can borrow on monthly basis. (11) Rent is Rs. 8,000 per month. (29) Lal and Company has given the forecast sales for January 1989 to July 1989 and actual sales for November and December 1988 as under. With the other particulars given, prepare a Cash Budget for the five months i.e. from January 1989 to May 1989. (1) Sales November 88 1.60 Lakhs April 89 2.00 Lakhs December 88 1.40 Lakhs May 89 1.80 Lakhs January 89 1.60 Lakhs June 89 2.40 Lakhs

February 89 2.00 Lakhs July 89 2.00 Lakhs March 89 1.60 Lakhs (2) Sales 20% cash and 80% credit, payable in the third month (January sales in March). (3) Variable expenses 5% on turnover, time lag half month. (4) Commission 5% on credit sales payable in the third month. (5) Purchases being 60% of the sales of the third month, payment will be made on 3rd month of purchases. (6) Rent and other expenses Rs. 6,000 paid every month. (7) Other Payments Fixed Assets Purchases - March Rs. 1,00,000 Taxes - April Rs. 40,000 (8) Opening cash balance Rs. 50,000 Budgetary Control 491 NOTES 492 Management Accounting NOTES Standard Costing 493

Chapter 13
STANDARD COSTING
INTRODUCTION : The determination of the actual cost on the basis of various costing records maintained is no doubt important, but such actual cost (or historical cost) involves some limitations as to its utility. (1) The actual cost information is available only after the completion of the job, process or service and hence is of no practical utility from control point of view, as no basis is provided with which the actual costs can be compared. (2) There are various kinds of managerial decisions where cost is an inevitable basis E.g. price fixation or submission of quotations. However if the details of actual cost are available too late, such cost details are of no practical utility for the purpose of price fixation or submission of quotation. (3) The actual costs may be affected due to the inefficient functioning. The actual costs may be excessive due to abnormal expenses, avoidable wastes, inefficient use of labour and excessive use of materials. As such, actual costs are not useful for providing a yardstick for measuring efficiency of performance. (4) Actual costing is comparatively expensive as it involves the maintenance of various records and documents. The above stated limitations involved with the determination of actual costs has given rise to the technique of standard costing. CONCEPT OF STANDARD COST AND STANDARD COSTING : The term standard cost has been defined as a pre-determined cost which is calculated from the managements standards of efficient operation and the relevant necessary exp enditure. The term standard costing has been defined as the preparation and use of standard costs, their comparison with actual costs and the measurement and analysis of variances to their causes and points of incidence. 494 Management Accounting Thus, standard cost is the normal cost under the ideal circumstances. It may be used as a base for the purpose of price fixation and submission of quotations. Moreover, the standards when compared with the actual cost may also be used as tools for cost control and as a yardstick for measuring efficiency of performance, which is possible with standard costing system. As such, the process of standard costing involves the following stages. (1) Predetermination of technical data related to production i.e. details of materials and labour operations required for each product, the quantum of inevitable losses, level of activity etc.

(2) Predetermination of standard costs in full details under each element of cost i.e. Labour, Material and Overhead. (3) Comparison of actual performance and costs with standards and working out the variances i.e. the difference between the actual and the standards. (4) Analysis of variances in order to determine the reasons for deviations of actuals from the standards. (5) Presentation of information to the appropriate level of management to enable suitable action being taken, or revision of standards. It should be noted in this connection that standard costing is not a separate system of accounting but only a technique used with the intention of controlling the costs. Though it can be used in case of all methods of costing like job costing, process costing etc.; it can be more effective in case industries producing the standard products on continuous basis. Advantages of standard costing : (1) Standard costing provides a yardstick with reference to which the efficiency/inefficiency in performance may be established. This facilitates the basic management function of cost control. (2) Standard costing provides the incentive and motivation to work with greater effort for achieving the standard. (3) Standard costs may be used as the basis for the process of price fixation, filing the tenders and offering the quotations. If the prices are to be quoted on cost plus basis, actual costs may not be available in which case standard costs can be the base for fixation of selling prices. (4) Standard costing system facilitates delegation of authority and fixation of responsibility for each individual or department. This also tones up the general organization of the concern. Standard Costing 495 (5) Variance analysis and reporting is based on the principle of management by exception. The top management may not be interested in details of actual performances but only in the variations from the standard, so that corrective measures may be taken in time. (6) When constantly reviewed, the standards provide means for and encourage action for cost reduction. Focus on out of control situations, leads to cost reduction through the improved methods, improved quality of products, better material and workers, effective selection and use of capital resource etc. (7) A properly laid down system of standard costing may facilitate the correct implementation of the technique of budgetary control which also is a good system of cost control. Limitations of standard costing : (1) Establishment of standard costs is difficult in practice. Even though, standards are fixed after defining properly, there is no guarantee that the standards established will have the same tightness or looseness as envisaged. (2) In the course of time, even in a short period, the standards become rigid. It may not be possible to maintain the standards to keep pace with the changes in manufacturing conditions. Revision of standards is costly. (3) Sometimes, standards set create adverse effects. If standards are set tightly and there is non-achievement of the same, it creates frustration. (4) The standard costing may not be suitable in all types of organizations e.g. (i) In case of small concerns- Where the production cannot be properly scheduled. In small concerns, personal contacts may be more effective than the standard costing. (ii) In case of industries having non-standardized products. (iii) In case of industries having repair jobs which keep changing as per customer requirements. (iv) In case of industries where products take more than one accounting period to complete e.g. contract jobs. (5) Due to the play of random factors, it may be difficult to properly examine the variance and distinguish between controllable and uncontrollable variances. e.g. Adverse labour time variance may be due to poor grade of labour, poor quality of material, defective plant and machinery and lack of trained workers.

(6) Lack of interest in standard costing on the part of the management makes the system ineffective and cant be used as a proper means of cost control. 496 Management Accounting Standard costing and budgetary control compared : Both standard costing and budgetary control are the best possible tools available to the management for the purpose of controlling the costs. Both the techniques involve the process of setting the targets or standards, measurement of actual performance, comparison of actual performance with targets or standard set, computation and analysis of variations and the attempts to maintain favorable variations and remove unfavorable variations. The technique of budgetary control can be used effectively if the system of standard costing is prevailing. Thus, both the techniques complement each other but are not necessary dependent upon each other. On the other hand, in spite of the various similarities, both the techniques differ from each other in certain respects. (1) System of budgetary control may be operated even if no standard costing system is in use in the concern. (2) Budgets are the ceilings or limits on expenses above which actual expenditure should not normally exceed and if it does, the planned profits will be reduced. Standard costs are minimum targets to be attained by the actual performance. (3) Budgets may be prepared in the various areas of activities like sales, production, purchases, capital investment etc. Whereas standard costing specifically relates to the function of production and manufacturing costs. (4) A more searching analysis is required to be made in case of standard costing variances than in case of budgetory control variances. Variances in case of budgets may point out efficiency or inefficiency. But variances in case of standard costing provide material for further probe and investigation. (5) The scope of standard costing is much wide than that of budgetary control. Adherence to budgeted performance may indicate that the business is out of difficulties. A genuine attempt to attain the standards always provides the scope for improved performance. (6) Budgets are based upon the future or estimated costs which may be used for forecasting the requirements of various factors of production like material, labour, finance etc. Standard costs are planned or ideal costs under the ideal situations as to operating efficiency, capacity level attainment and so on. Standard costs may not be necessarily useful for forecasting purposes. Preliminaries for Establishing Standard Costing System : Before the standard costing system is established in an organization, the following preliminaries will have to be complied with. Standard Costing 497 (1) Establishment of cost centres : As explained before, a cost centre is any unit with respect to which the costs will be ascertained. If the standard costing system is to be implemented, the cost centres should be defined very clearly so that the responsibility can be fixed in case of non standard performance. (2) Design of Accounts : As the standard costing essentially involves the process of comparing the actual performance to standard performance and computation of variances therefrom, the accounts should be designed in such a way that the information about the actual performance is available as correctly as possible and as speedily as possible. For this purpose, the codification of accounts may be considered. (3) Establishment of standards : This is probably the most critical part of the implementation of standard costing i.e. to establish the standards with respect to the individual elements of cost i.e. Direct Material Cost, Direct Labour Cost and Overheads. It is necessary to exercise maximum care while establishing the standards as wrongly established standards may defeat the purpose of standard costing. Following steps are involved in the process of establishing the standards. (a) Study of technical and operational details of the organization like the manufacturing

process, levels of managements and their responsibilities, units and nature of inputs and outputs, details regarding wastes and losses, expected efficiency and capacity utilization etc. (b) Study of existing cost accounting systems and formats in use. (c) Decision about the types of standards to be used. It may be noted that there may be various types of standards. Basic Standards : These are established for an unaltered use over a longer period of time and they dont reflect the current conditions. These types of standards are not useful from the cost control point of view and can be used in case of industries where technical processes are fully established or in case of those types of costs which are fixed in nature viz. rent, remuneration to managerial personnel etc. 498 Management Accounting Current Standards : These are established for a shorter period of time and are adaptable to change in current conditions. As current conditions are likely to change, the current standards are also subject to revision as per the changes in current conditions. Current standards may be of three types. Ideal Standards : These are the standards which are set which are attainable under the most favourable conditions possible and assumes the maximum utilization of various factors of production (like men, material and machines) which is not practicable and attainable. Thus, the ideal standards are generally theoretical in nature and the variances always show an unfavorable trend. The basic limitation of these types of standards is that the constant non achievement of these standards causes frustration among the staff and the constant reporting of unfavorable variances is presumed which results into lost impact of system itself. Expected Standards : These are the standards which are anticipated to be attained during the budget period. These are based upon the expected performance based upon the conditions which are likely to prevail during the budget period. Allowances are provided for the unavoidable deviations from the ideal performance e.g. Labour time wastage, excess material use, break down of machinery etc. Thus, these standards are more realistic in nature and are more useful from cost control point of view. Normal Standards : These are the standards which may be anticipated to be achieved in future, over a longer period of time, considering the past performance. As such, the inefficiencies of the past performance, if any, get reflected in these types of standards. Further, the problems faced in estimating the future over a longer period of time also restrict the use of these standards for cost control purposes. After the consideration of various types of standards which may be used, the process of establishment of standards with respect to various elements of costs comes into operation. As discussed above, the standards may be set for the various elements of costs i.e. Direct Material Cost, Direct Labour Cost and Overheads. (a) Direct Material Cost : Setting the Standard Cost for Direct Material, involves two stages i.e. To decide Price Standard and to decide Use Standard. Standard Costing 499 Price Standard : It may involve the consideration of following factors. (i) Current market conditions and likely changes. (ii) Prices of current supply orders. (iii) Prices of long term supply contracts. Along with the basic prices, it may involve the consideration of the factors like discount, packing charges, insurance, sales tax, octroi etc. It may be the primary responsibility of the Purchase Department to supply the details required for this purpose. Use Standard :

It may be the primary responsibility of Engineering or Design Department to supply the details required for this purpose, on the basis of standard bill of material.This may involve the process of product study. Sufficient provisions should be made for unavoidable scrap or wastages. (b) Direct Labour Cost : Setting the standard cost for Direct Labour involves two stages i.e. To decide the wage rate standard and to decide Labour Efficiency standard. Wage Rate Standards : It may involve the consideration of following factors. (i) The system of wages payments prevailing i.e. Piece Rate Wages or Time Rate Wages (ii) Systems prevailing for bonus payments (iii) The provisions of agreements with workers covering a future period of time. (iv) Provisions of various laws and guidelines governing the fixation of wage rates (v) Grades of workers required and likely trends of market conditions in respect of availability thereof. Labour Efficiency Standards : It may be decided on the basis of the consideration of following factors. (i) Records of past performance. (ii) Time and motion study considering the details in respect of an average worker as the base. 500 Management Accounting (iii) Trial Runs, specifically in respect of a new product. Sufficient provision should be made in respect of the unavoidable idle time. (c) Overheads Cost : Setting the standard cost of overheads involves the following stages. (i) Estimation of standard overheads cost. (ii) Estimation of standard level of activity ( in terms of labour hours, machine hours or units of production) (iii) Estimation of standard overhead absorption rate which may be decided as below. Standard Overhead Cost Standard Level of Activity Thus, the standard absorption rate may be per unit of production, per labour hour or per machine hour. For better control purposes, the standards for overhead cost may be decided separately for fixed overheads and variable overheads, as fixed overbeads are normally uncontrollable at the lower level of management. (4) Reporting of Variances : The basic intention of implementation of standard costing system as a cost control device is not complete till the variances computed in respect of each element of cost are properly reported to the relevant level of management for the decision making purposes. For this purpose, the following propositions should be considered. (a) For effective cost control, the organizational structure should be clearly defined and responsibility of each individual should be clearly defined. (b) The reports reporting the variances should be simple, clear and quick. (c) The computation and analysis of variances in respect of each element of cost should be accurate. A wrong analysis of variances may result into misleading conclusions. (d) For more effectiveness, the variances should be segregated as controllable variances and non controllable variances. However, the analysis of uncontrollable variances should be made with the same care as in case of controllable variances. (e) The reporting of variances should contain a comparison with the planned results. Standard Costing 501 (f) The format and the contents of reports reporting the variances may depend upon the level of management to whom reports are being made, The reports to top management would be obviously formal containing only the broad details and final results. The reports to lower level of management may contain the full analysis of each variance showing the causes therefor and locating the responsibilities therefor.

ANALYSIS OF VARIANCES : As stated earlier, the process of standard costing involves the establishment of standard costs and the computation of actual costs under each element of cost and the comparison between standard costs and actual costs. The difference between standard cost and actual cost is termed as Variance. If the actual cost is less than the standard cost, the variance is a favourable variance. If the actual cost is more than the standard cost, the variance is a unfavorable or adverse variance. The utility of standard costing as a technique of cost control is not complete only by the computation of variances unless these variances are further analysed as to the causes responsible for these variances. The basic objective of variance analysis is to classify the variances as controllable and uncontrollable ones E.g. If material actually used is in excess of standard quantity or if time actually taken by the workers is more than standard time, the variance will be an unfavorable one for which the responsibility can be assigned on the executives concerned. However if the variances occur due to general strike, general increase in wage rates, devaluation of currency, change in customers demands etc., the variances will be uncontrollable ones for which no responsibility can be assigned to any executive. By concentrating most on controllable and adverse variances, it is possible for the management to exercise control through exception which is the basic objective of standard costing. Thus, the stress can be laid on variances only and no further action will be necessary in cases where standard costs are matching with the actual costs, provided that the conditions underlying the fixation of standards remain unchanged. The variances arising in one period may be compared with a variances in the previous period for a better control. Thus a detailed analysis of variances, specifically the controllable ones, as to the causes leading to these variances, and the corrective actions required to be taken to reduce these variances enables the management to exercise proper cost control. However, it does not mean that the favourable variances need no investigation. A constant occurrence of favourable variance may indicate incorrect fixation of standards that need to be revised. A constant favourable variance may be due to a genuine improvement in performance or due to the manufacture of sub- standard products. We will discuss the variance under each element of cost. 502 Management Accounting (A) MATERIAL COST VARIANCE : It is the difference between standard material cost and actual material cost. It may be further analysed as (i) Material Price Variance (ii) Material Usage Variance (i) Material Price Variance : Its that portion which is due to difference between standard price specified and actual price paid. It is calculated as Actual Quantity (Actual Price - Standard Price) The causes for this may be traced as (1) Change in price of material. (2) Change in quantity of purchase or uneconomical size of parchase order. (3) Rush order to meet shortage of supply or purchase in less favourable market. (4) Failure to take advantage of off season prices. (5) Failure to get cash/trade discounts. (6) Weak purchase organization. (7) Payment of excess/less freight. (8) Transit losses/discrepancies if prices include them. (9) Change in quality or specification of material purchased. (10) Use of substitute materials at different prices. (11) Change in pattern or amount of taxes or duties. From the above, it can be seen that the responsibility for this type of variance may be normally placed on Purchase Department. However, there may be some situations where the responsibility for this type of variance can not be placed on purchase department. E.g. When the purchases are made in uneconomic quantities due to the lack of working

capital. (ii) Material Usage Variance : It is that portion which is due to the difference between standard quantity specified and actual quantity used. Its calculated as Standard Costing 503 Standard Price (Actual Qantity - Standard Qantity) The causes to this may be traced as : (1) Inefficient or careless use of materials. (2) Change in specification/design of the product. (3) Inefficient/inadequate inspection of materials. (4) Change in quality of material or purchases of inferior material. (5) Production inefficiency resulting in wastages. (6) Use of substitute materials. (7) Theft/pilferage of materials. (8) Inefficient labour not able to handle material properly. (9) Defective machines and not proper maintenance of the same. (10) Change in the composition of material mix. If more than one materials are mixed to get the final product, any change in the standard mix may result into material usage variance. It may arise in case of textile, chemical, rubber industries etc. (11) Change in the yield. If a certain amount of standard output is expected from some inputs, any variance in actual output may result in material usage variance. It may arise in case of processing industries. The material usage variances may further be analysed in the following ways: (a) Materials Mix Variance : As stated above, it is that part of usage variance which may arise due to change in the standard composition of material mix where more than one materials are required to be mixed together to get the final product. This may be a peculiar feature of the industries like textile, chemical, rubber etc. The actual mix of materials may be different than the standard mix due to non - availability of specified material. Increased proportion of costly material in the mix results into adverse materials mix variance and vice-versa. This variance is calculated as Standard price (Actual mix - Standard mix) 504 Management Accounting (b) Materials Yield Variance : As stated above, it is that part of usage variance which may arise due to difference between standard yield expected and the actual yield obtained, where a certain specified yield is expected from a given input of materials. This may be a peculiar feature of the processing industries. A low actual yield indicates consumplion of materials in excess of standards set resulting into an adverse variance and vice versa. This variance is calculated as : Standard Yield Price (Actual Loss - Standard Loss) Where standard yield price is calculated as : Total Standard Cost Total Standard Output Illustration : I Material Standard Actual Qty. Price Total Qty. Price Total Kgs. Rs. Rs. Kgs. Rs. Rs. A 500 6.00 3,000 400 6.00 2,400 B 400 3.75 1,500 500 3.60 1.800 C 300 3.00 900 400 2.80 1,120 1200 1300 Less : 10% Actual Normal Loss 120 Loss 220 1,080 5,400 1080 5,320 Calculate material cost variances.

Solution : (A) Material Cost Variance Standard Material Cost - Actual Material Cost. 5,400 - 5,320 = 80 (Favourable) Standard Costing 505 (B) Material Price Variance AQ (AP - SP) Where AQ = Actual Quantity. AP = Actual Price SP = Standard Price Material A = 400 (6.00 - 6.00) = Nil Material B = 500 (3.60 - 3.75) = 75 (Favourable) Material C = 400 (2.80 - 3.00) = 80 (Favourable) 155 (Favourable) (C) Material Usage Variance SP (AQ - SQ) Where SP = Standard Price AQ = Actual Quantity SQ = Standard Quantity Material A = 6.00 (400 - 500) = 600 (Favourable) Material B = 3.75 (500 - 400) = 375 (Adverse) Meterial C = 3.00 (400 - 300) = 300 (Adveise) 75 (Adverse) (D) Materials Mix Variance Standard Price (Actual Mix - Standard Mix) Material A = 6.00 (400 - 541.67) = 850 (Favourable) Material B = 3.75 (500 - 433.33) = 250 (Adverse) Material C = 3.00 (400 - 325) = 225 (Adverse) 375 (Favourable) Note : The standard mix is calculated as below. When total input is 1,200 Kgs, the Materials A,B, and C are mixed in the proportion of 500 Kgs,, 400 Kgs and 300 Kgs. respectively. When total input is 1,300 Kgs. the materials should have been mixed in the following proportion. 500 Material A = 1200 X 1300 = 541.67 Kgs. 400 Material B = 1200 X 1300 = 433.33 Kgs. 300 Material C = 1200 X 1300 = 325.00 Kgs. 506 Management Accounting (E) Materials Yield Variance Standard Yield Price (Actual Loss - Standard Loss) 5 (220 - 130) = 450 (adverse) Note : Standard Yield Price is calculated as below Total standard cost = Rs. 5400 = Rs.5/Per Kg. Total standard output 1080 Kgs. Check : Material Cost Variance = Materials Price Variance + Material Usage Variance Materials Usage Variance = Materials Mix Variance + Materials Yield Variance 80 (F) = 155 (F) + 375 (F) + 450 (A) Where, F indicates favourable and A indicates adverse variance.

LABOUR COST VARIANCES : It is the difference between standard direct wages specified and actual wages paid. It is further analysed as (i) Wage/Labour Rate Variance : It is that portion which is due to difference between standard pay of wages specified and actual rate paid. It is calculated as Actual Hours (Actual Rate - Standard Rate) The causes of this may be traced as (1) Change in wage structure or piece-work rate. (2) Variation due to different grades of workers and their wages differing from those specified. (3) Use of different methods of payment e.g. Actual payment on time basis whereas standards are set on piece rate basis. (4) Employment of casual/temporary workers to meet seasonal demands. (5) New workers not being allowed full normal wages. (6) Overtime or night shift allowance more or less than standard. (7) Composition of gang as regards the skill and rates of wages different than specified standards. Standard Costing 507 Though the responsibility of wages/labour rate variances can be placed on Personnel Department, in practice, this type of variance is usually an uncontrollable one. (ii) Labour Efficiency Time Variance : It is that portion which is due to difference between standard labour hours specified and the actual labour hours expended. It is calculated as : Standard Rate (Actual Hours - Standard Hours) The causes of this may be traced as : (1) Lack of proper supervision. (2) Poor working conditions. (3) Delays due to waiting for materials, tools, instructions etc, if not treated as idle time. (4) Defective tools, equipments etc. (5) Machine break down if not treated as idle time. (6) Work on new machines requiring less time. (7) Basic inefficiency of workers due to lack of morale, insufficient training, faulty instructions etc. (8) Use of non-standard material requiring higher lime for processing. (9) Operations not provided for and booking them under direct wages. (10) Wrong selection of workers. (11) Increase in labour turnover. (12) Incorrect recording of performance i.e. time or output. The labour efficiency variance may be further analysed in the following manner. (a) Idle Time Variance : It is the standard cost of actual hours recorded as idle time due to abnormal circumstances like strike, lock out, power failure, machinery breakdown etc. It is calculated as Standard rate x Idle Hours This type of variance is normally calculated separately and not kept only as a part of efficiency variance, as the employees should not be blamed for inefficiency when the idle time arises due to circumstances beyond their control, say power failure. It is needless to state that this variance is always unfavorable and needs further investigation as to the causes for abnormal idle time. 508 Management Accounting (b) Labour Mix Variance (Gang Composition Variance) : It indicates that part at efficiency variance which arises due to change in Actual Gang of labour from that of Standard Gang of labour if various grades of labour are included in a gang and if certain grades of labour are not available. It is calculated as : Standard Rate (Revised Standard Hours- Actual Hours) Where the revised standard hours indicate the actual labour hours divided in the ratio of

standard hours. It should be noted that if the idle time variance is calculated separately, the idle time hours should be excluded from actual total hours in standard ratio. (c) Labour Yield Variance : In many cases, this variance is calculated separately which indicates the effect on labour cost of actual yield or output being different from standard yield or output. In numerical terms, it is equal to revised efficiency variance i.e. after separating Mix Variance and Idle Time Variance from Efficiency Variance, which is calculated as Standard Rate (Standard Hours - Revised Standard Hours) Illustration 2 : Following details are available from the records of A Ltd. for a month regarding the standard labour hours and rates of an hour for a product Hours Rate per hour Rs. Total Rs. Skilled 10 3.00 30.00 Semi- Skilled 8 1.50 12.00 Unskilled 16 1.00 16.00 58.00 The actual production for the product was 1,500 units for which the actual hours worked and rates were as below. Hours Rate per hour Rs. Total Rs. Skilled 13,500 3.50 47,250 Semi- Skilled 12,600 1.80 22,680 Unskilled 30,000 1.20 36,000 Standard Costing 509 Compute : (a) Labour Cost Variance (b) Labour Rate Variance (c) Labour Efficiency Variance (d) Labour Mix Variance (a) Labour Cost Variance : Solution : Standard Actual Hours Rate per Hr. Total Hours Rate per Hr. Total Rs. Skilled 15,000 3.00 45,000 13,500 3.50 47,250 Semi-Skilled 12,000 1.50 18,000 12,600 1.80 22,680 Unskilled 24,000 1.00 24,000 30,000 1.20 36,000 51,000 87,000 56,100 1,05,930 Actual Cost - Standard Cost 1,05,930 - 87,000 = 18,930 (A) (b) Labour Rate Variance : Actual Hours (Actual Rate - Standard Rate) 13,500 (3.50 - 3.00) = 6,750 (A) 12,600 (1.80 - 1.50) = 3,780 (A) 30,000 (1.20 - 1.00) = 6,000 (A) 16,530 (A) (c) Labour Efficiency Variance : Standard Rate (Actual Hours- Standard Hours) 3.00 (13,500 - 15,000) = 4,500 (F) 1.50 (12,600 - 12,000) = 900 (A) 1.00 (30,000 - 24,000) = 6,000 (A) 2,400 (A) 510 Management Accounting (d) Labour Mix Variance : Standard Rate (Actual Hours - Revised Standard Hours) 3.00 (13,500 - 16,500) = 9,000 (F) 1.50 (12,600 - 13,200) = 900 (F) 1.00 (30,000 - 26,400) = 3,600 (A)

6,300 (F) OVERHEAD COST VARIANCES : The analysis of overheads variances is different and the most complex task than the calculation of material and labour variances. It is so due to the fact that establishment of a standard overhead absorption rate is difficult as a part of total overheads is fixed, which affects the overhead absorption rate with the change in volume. It should be noted in this connection that the overhead absorption rate can be computed in the following way. (a) If the overhead rate is expressed in terms of labour hours. Hourly Rate = Budgeted Overhead Cost Budgeted Labour Hours (b) If the overhead rate is expressed in terms of units produced Unit Rate = Budgeted Overhead cost Budgeted output in units As the overheads can be either the variable overheads or fixed overheads, the overhead cost variances may be seperately calculated for variable overheads and fixed overheads. Variable Overheads Variance : It is that amount of overheads which change directly with the level of activity and per unit variable overheads remain constant. As such, the variable overheads are not affected with the change in volume of operations. The common method of analyzing the variable overheads variances is shown in the chart below. Overhead Cost Variance Expenditure Variance Efficiency Variance Standard Costing 511 (a) Overheads Cost Variance It is the difference between standard overheads cost absorbed and actual overheads cost incurred. It is calculated as Standard Hours for X Standard Hourly Actual production Rate Actual Overhead (b) Overheads Expenditure Variance : It is the difference between the standard allowance for the output achieved and actual overheads cost incurred. It is calculated as Revised Budgeted Overheads for Actual Hours - Actual Overheads (c) Overhead Efficiency Variance : It is due to the difference between budgeted efficiency of production and actual efficiency attained. It is calculated as Standard Hourly Standard Hours for Rate X Actual production Actual Overheads Fixed Overheads Variances : In modern times, especially in the days of rapid mechanization of production processes, the fixed overheads form a major portion of the production cost. As such, it is necessary that the management is properly informed about the standard fixed overheads or any deviations therefrom. The common method of analyzing the fixed overheads variances is shown in the chart below. Overhead Cost Variance Expenditure variance Volume Variance Efficiency Capacity Calender Variance Variance Variance

As each of the above variances can be computed either on the basis of units of production or on the basis of hours. We will first study the nature of the above variances and then the methods of computation.

[ [
512 Management Accounting (a) Overhead Cost Variance : It is the difference between the total standard overheads cost absorbed in the output achieved and the total actual overheads cost. Thus, it can be seen that the overheads cost variance is simply the under or over absorption of overheads. (b) Expenditure Variance : It is the difference between the standard allowance for the output achieved and the actual overheads cost incurred. The causes of this variance may be (1) Change in the quality/ price of indirect material. (2) Change in the labour rates for indirect workers or change in the grade of indirect workers. (3) Change in the rate of power, insurance and other overheads. (c) Volume Variance : It is that protion of the overhead variance which is due to the difference between the budgeted level of output and the actual level of output. The causes of this variance may be as below. (1) Labour problems like strikes, lockouts etc. (2) Material shortage (3) Machinery Breakdown (4) Waiting for tools/instructions/material (5) Power failure. (6) Change in the demand for product It will not be out of place to mention here that in case of the variable overheads, per unit or per hour overheads remain constant and are not affected by the change in the level of output. As such, volume variance does not arise in case of variable overheads. (d) Efficiency Variance : It is that portion of the overhead variances, as a part of volume variance, which is due to the difference between budgeted efficiency of production and the actual efficiency attained. The causes of this variance may be as below. Standard Costing 513 (1) Poor working conditions. (2) Change in the labour performance (3) Defective and faulty tools. (4) Incorrect Machine operations. (5) Defective or inferior material. (e) Capacity Variance : It is that portion of the overhead variances, as a part volume variance, which is due to the working at higher or lower capacity than standard. The causes of this variance may be as below. (1) Seasonal variations. (2) Shortage of labour force. (3) Abnormal idle time due to the reasons like power failures, strikes, lock outs etc. (4) Change in the customer demand. (f) Calender Variance : It is that portion of overhead variances, as a part of volume variance, which is due to the difference between the number of working days in the budget period and the actual

number of working days in the period in which the budget is applied. Calender Variance arises only if there is abnormal increase or decrease in the number of working days, as the normal holidays are already considered while setting the standard. Thus, the declaration of an unexpected day as holiday may result into calender variance. COMPUTATION OF FIXED OVERHEADS VARIANCES : As discussed earlier, the fixed overheads variances may be computed on the basis of units of production or on the basis of hours. (A) On the basis of units of production : (1) Overheads Cost Variance : Standard Overhead Cost - Actual Overhead Cost (2) Expenditure Variance : Budgeted Overhead Cost - Actual Overhead Cost 514 Management Accounting (3) Volume Variance : Standard Rate per unit X [Actual Production - Budgeted Production] (4) Efficiency Variance : Standard Rate per unit X [Actual Production - Standard Production in Actual Hours] (5) Capacity Variance: Standard Rate X Standard Production Revised Budgeted per unit in Actual Hours Production (6) Calender Variance : Standard Rate per unit X [Revised Budgeted Production - Budgeted Production] ILLUSTRATION 3 : An Engineering Company has furnished you the following data Budget Actual July 1986 No of working days 25 27 Production in Units 20,000 22,000 Fixed overheads in Rs. 30,000 34,000 Budgeted fixed overhead rate is Rs. 1 per hour. In July 1986, the actual hours worked were 31,500. Calculated the following variances. (a) Total overheads Variance (b) Expenditure Variance (c) Volume Variance (d) Efficiency Variance (e) Capacity Variance (f) Calender variance Solution : (1) Total Overheads Variance : Standard Overheads Cost - Actual Overheads Cost 33,000 - 34,000 = 1,000 (A)

[
Standard Costing 515

(2) Expenditure Variance : Budgeted Overheads Cost - Actual Overheads Cost 30,000 - 34,000 = 4,000 (A) (3) Volume Variance : Standard Rate per unit x [Actual Production - Budgeted Production] 1.5 X (22,000 - 20,000) = 3,000 (F) (4) Efficiency Variance :

Standard Rate per unit x [Actual Production - Standard Production in Actual Hours] 1.5 X ( 22,000 - 21,000) = 1.500 (F) (5) Capacity Variance : Standard Rate per unit x [Standard Production in Actual Hours - Revised Budgeted Production] 1.5 X (21,000 - 21,600) = 900 (A) (6) Calender Variance : Standard Rate per Unit x [Revised Budgeted Production - Budgeted Production] 1.5 x (21,600 - 20,000) = 2,400 (F) Check : Volume variance = Efficiency Variance + Capacity Variance + Calender Variance 3000 (F) = 1500 (F) + 900 (A) + 2400 (F) Total Variance = Expenditure Variance + Volume Variance 1000 (A) = 4000 (A) + 3000 (F) Working Note : (A) (1) Standard Rate per unit is calculated as below Budgeted Overhead Cost Budgeted Production 516 Management Accounting 30,000 20,000 Rs. 1.5 Per Unit (2) Standard Production in actual hours is calculated as below : Budgeted overheads are Rs.30,000, while budgeted fixed overhead rate is Rs. l per hour. Therefore, budgeted hours are 30,000, while budgeted production is 20,000 units. It means that one unit requires 1.5 hours.(standard) As actual hours worked are 31.500, the standard production in those many hours will be 31,500 = 21,000 Units 1.5 (3) Revised Budgeted Production is calculated as below. Budgeted Number of working days are 25 while budgeted production is 20,000 units. It means that standard production in one day is 20,000 Units 25 days = 800 Units As actual number of working days is 27, the standard production in those many days will be 800 units x 27 days = 21,600 units (B) On the basis of hours : (1) Overheads Cost Variance : Standard Overheads Cost - Actual Overheads Cost (2) Expenditure Variance : Budgeted Overheads Cost - Actual Overheads Cost (3) Volume Variance : Standard Hourly Rate x [Standard Hours for Actual Production - Budgeted Hours] (4) Efficiency Variance : Standard Hourly Rate x [Standard hours for Actual Production - Actual Hours] (5) Capacity Variance : Standard Hourly Rate x [Actual Hours - Revised Budgeted Hours] (6) Calender Variance : Standard Hourly Rate x [Revised Budgeted Hours - Budgeted Hours] Standard Costing 517

ILLUSTRATION : 4 An engineering company has furnished you with the following data. Budget Actual (July 1986) No. of working days 25 27 Production in Units 20,000 22,000 Fixed 0verheads (in Rs.) 30,000 34,000 Budgeted fixed overhead rate is Rs. 1 per hour. In July 1986, the actual hours worked were 31,500. Calculate the following variances (a) Total Overheads Variance (b) Expenditure Variance (c) Volume Variance (d) Efficiency Variance (e) Capacity Variance (f) Calender Variance Solution : Calculation of overhead variances will be as below. (1) Total Overhead Variance : Standard Overheads - Actual Overheads 33,000 - 34,000 = 1,000 (A) (2) Expenditure Variance : Budgeted Overheads - Actual Overheads. 30,000 - 34,000 = 4,000 (A) (3) Volume Variance : Standard Hourly Rate X [Standard Hours for Actual Production - Budgeted Hours] = 1 (33,000 - 30,000) = 3,000 (F) (4) Efficiency Variance : Standard Hourly Rate (Standard hours - Actual hours) 1 (33,000 - 31,500) = 1,500 (F) 518 Management Accounting (5) Capacity Variance : Standard Hourly Rate (Actual hours - Revised Budgeted Hours) 1 (31,500 - 32,400) = 900 (A) (6) Calender Variance : Standard Hourly Rate (Revised Budgeted Hours - Budgeted Hours) 1 (32,400 - 30,000) = 2,400 (F) Check : Volume Variance = Efficiency Variance + Capacity Variance + Calender Variance. 3000 (F) = 1500 (F)+900 (A)+ 2400 (F) Total Overhead Cost Variance = Expenditure Variance + Volume Variance 1000 (A) = 4000 (A) + 3000 (F) Working Notes : (1) Standard rate per hour is known to be Rs. 1. As Budgeted overheads are Rs.30,000, Budgeted Hours will be 30,000. (2) Budgeted Hours are known to be 30,000 for the Budgeted production of 20,000 units, indicating that standard time required for one unit is 1 1/2 hours. If the actual production is 22,000 units, the standard time required for actual production will be 33,000 hours. (3) The budgeted number of working days are 25 and budgeted hours are 30,000, indicating that the standard hours available in one day are 1,200. If the company has actually worked for 27 days, the revised budgeted hours will be 32,400 i.e. 1,200 hours per day x 27 days. SALES VARIANCES :

While standard costing principles are mainly applied in the area of costs i.e. Material cost, Labour cost and overheads cost, some companies calculate the sales variances also which is the difference between budgeted sales and actual sales and its impact on profits. There may be two ways to calculate sales variances. (A) The turnover/value method. (B) The margin/profit method. Standard Costing 519 (A) The Turnover/Value Method : The common method of analysing sales variances under this method is shown in the chart below. Sales Value Variance Sales Price Variance Sales Volume Variance Mix Variance Quantity Variance (1) Sales Value Variance : It is the difference between the budgeted sales and the actual sales. It is calculated as Actual Sales - Budgeted Sales (2) Sales Price Variance : It is that portion of sales variance which is due to the difference between standard price specified and the actual price charged. It is calculated as Actual Sales Volume x [Actual Price - Standard Price] (3) Sales Volume Variance : It is that portion of sales variance which is due to the difference between the standard quantity specified and the actual quantity sold. It is calculated as Standard Price x [Actual sales volume - Standard sales volume] (4) Sales Mix Variance : It is that portion of sales volume variance which may arise due to change in actual composition of sales mix from the standard composition of sales mix, where more than one products are dealt with. It is calculated as Standard Sales - Revised Standard Sales Where Standard Sales are actual quantity sold at budgeted price. Revised Budgeted sales are standard sales rearranged in the budgeted ratio. 520 Management Accounting Note : It should be noted that the sales mix variance, under turnover method will always be zero. This is so because though the sales mix is varied, the actual sales at budgeted price are rearranged in the budgeted ratio. (5) Sales Quantity Variance : It is that portion of sales volume variance, which may arise due to the difference between standard value of actual sales at standard mix and budgeted sales. It is calculated as Revised Standard Sales - Budgeted Sales. Illustration 5 : Standard Actual Product Qty. Sale Price Total Qty. Sale Price Total Rs. Rs. Rs. Rs. A. 500 5 2,500 500 5.40 2,700 B. 400 6 2,400 600 5.50 3,300 C. 300 7 2,100 400 7.50 3,000 1200 7,000 1500 9,000 Calculate the Sales Variances. Solution : (A) (1) Sales Value Variance :

Actual Sales - Budgeted Sales 7,000 - 9,000 = 2,000 (F) (2) Sales Price Variance : Actual Sales Volume (Actual Price - Standard Price) A - 500 (5.40 - 5.00) = 200 (F) B - 600 (5.50 - 6.00) = 300 (A) C - 400 (7.50 - 7.00) = 200 (F) 100 (F) Standard Costing 521 (3) Sales Volume Variance : Standard Price (Actual Sales Volume - Standard Sales Volume) A - 5 (500 - 500) = Nil B - 6 (600 - 400) = 1200 (F) C - 7 (400 - 300) = 700 (F) 1900 (F) (4) Sales Mix Variance : Standard Sales - Revised Standard Sales Where standard sales are actual quantity at standard price and Revised standard sales are standard sales rearranged in budgeted ratio. Standard Sales Revised Standard Sale Qty. Price Rs. Total Rs. Ratio Total A 500 5 2500 35.71% 3178 B 600 6 3600 34.29% 3052 C 400 7 2800 30.00% 2670 8900 8900 Ratio is calculated as below A2500 X 100 = 35.71% 7000 B - 2400 X 100 = 34.29 7000 C - 2100 X 100 = 30% 7000 Sales Mix Variance A 2500 - 3178 = 678 (A) B 3600 - 3052 = 548 (F) C 2800 - 2670 = 130 (F) Nil 522 Management Accounting (5) Sales Quantity Variance Revised Standard Sales - Budgeted Sales : A 3178 - 2500 = 678 (F) B 3052 - 2400 = 652 (F) C 2670 - 2100 = 570 (F) = 1900 (F) Check : Sales Value Variance = Sales Price Variance + Sales Mix Variance + Sales Quantity Variance = 2000 (F) = 100(F)+Nil +1900 (F) (B) The Margin / Profit Method : This method of sales variances measures the effect of actual sales and budgeted sales on profit. As this method does not consider the cost variances, all costs are assumed to be standard costs. The common method of analysing sales variances under this method is shown in the chart below. Total Sales Margin Variance Sales Margin Price Variance Sales Margin Volume Variance

Sales Margin Sales Margin Mix Variance Quantity Variance (1) Total Sales Margin Variance : It is the difference between actual margin (by considering standard costs) and budgeted margin. It is calculated as Actual Profit - Budgeted Profit (2) Sales Margin Price Variance : It is that portion of total sales margin variance which is due to the difference between standard price of actual sales made and actual price. It is calculated as Actual Profit - Standard Profit Standard Costing 523 (3) Sales Margin Volume Variance : It is that portion of total sales-margin variance which is due to the difference between standard profit and budgeted profit. It is calculated as Standard Profit - Budgeted Profit. (4) Sales Margin Mix Variance : It is that portion of sales margin volume variance which is due to the difference between standard profit and revised standard profits. It is calculated as Standard Profit - Revised Standard Profit. (5) Sales Margin Quantity Variance : It is that portion of sales margin volume variance which is due to the difference between budgeted profit and revised standard profits. It is calculated asRevised Standard Profits - Budgeted Profit. Illustration 6 : A Ltd. has budgeted the following sales for the month A - 900 units at Rs. 50 per unit. B - 650 units at Rs, 100 per unit. C - 1200 units at Rs. 75 per unit. Actual sales were A - 950 units at Rs. 58 per unit. B - 700 units at Rs. 90 per unit. C - 1200 units at Rs. 80 per unit. Costs per unit of A, B and C were Rs. 40, Rs. 88 and Rs.60 respectively. Compute the Sales Margin variances. 524 Management Accounting Solution : SALES COST OF SALES PROFIT Product Qty Price Total Per unit Total Per unit Total Rs. Rs. Rs. Rs. Rs. BUDGET A 900 50 45,000 40 36,000 10 9,000 B 650 100 65,000 88 57,200 12 7,800 C 1200 75 90,000 60 72,000 15, 18,000 2,00,000 1,65,200 34,800 ACTUAL A 950 58 55,100 40 38,000 18 17,100 B 700 90 63,000 88 61,600 2 1,400 C 1200 80 96,000 60 72,000 20 24,000 2,14,100 1,71,600 42,500 Standard sales and revised standard sales are calculated as below STANDARD SALES :

SALES COST OF SALES PROFIT Product Qty Price Total Per unit Total Per unit Total Rs. Rs. Rs. Rs. Rs. A 950 50 47,500 40 38,000 10 9,500 B 700 100 70,000 88 61,600 12 8,400 C 1200 75 90,000 60 72,000 15 18,000 2,07,500 1,71,600 35,900 REVISED STANDARD SALE Product Revised Revised Standard sales Standard profit Rs. Rs. A 46,688 9,338 B 67,437 8,092 C 93,375 18,675 2,07,500 36,105 Standard Costing 525 Calculation of Variances (1) Total Sales Margin Variance : Actual Profit - Budgeted Profit 42,500 - 34,800 = 7,700 (F) (2) Sales Margin Price Variance Actual Profit - Standard Profit 42,500 - 35,900 = 6,600 (F) (3) Sales Margin Volume Variance Standard Profit - Budgeted Profit. 35,900 - 34,800 = 1,100 (F) (4) Sales Margin Mix Variance : Standard Profit - Revised Standard Profit. 35.900 - 36,105 = 205 (A) (5) Sales Margin Quantity Variance : Revised Standard Profit - Budgeted Profit 36,105 - 34,800 = 1,305 (F) ILLUSTRATIVE PROBLEMS (1) Following standard and actual data relates to a manufacturing concern. Material Standard X 40 kgs. at Rs. 6 240 Y 60 kgs. at Rs. 4 240 480 Standard output is 80% of input i.e. 80 units. Process loss is 20%. Material Actual X 600 kgs. at Rs. 4 Y 400 kgs. at Rs. 6 Actual output is 70% of input i.e. 700 units. Process loss is 30%. 526 Management Accounting Calculate (1) Cost variance (2) Price variance (3) Total Quantity usage variance (4) Mix variance (5) Revised usage variance Solution : (1) Cost Variance : Actual Material Cost - Standard material Cost 4800 - 4200 = 600 (A) (2) Price Variance :

Actual Quantity (Actual Price - Standard Price) X 600 (4-6) = 1200 (F) Y 400 (6-4) = 800 (A) 400 (F) (3) Total Usage Variance : Standard Price (Actual Quantity - Standard Quantity) X - 6 ( 600 - 350) = 1500 (A) Y - 4 ( 400 - 525) = 500 (F) 1000 (A) (4) Mix Variance : Standard Price (Actual Mix- Revised Standard Quantity X - 6 (600 - 400) = 1200 (A) Y - 4 (400-600) = 800 (F) 400 (A) (5) Revised Usage Variance : Standard Price (Revised Standard Quantity - Standard Quantity) X - 6 (400 - 350) = 300 (A) Y - 4 ( 600 - 525) = 300 (A) 600 (A) Standard Costing 527 (6) Yield Variance : Standard Cost per unit (Actual Loss - Standard Loss) 6 (300 - 200) = 600 (A) Check : Cost Variance = Price Variance + Mix Variance + Yield Variance 600 (A) = 400 (F) + 400 (A) + 600 (A) Notes : (1) Standard Cost is calculated as below . Standard input for the output of 80 units is 100 kgs. If the actual output is 700 units, the standard input for the same will be 700 X 100 = 875 kgs. 80 The standard proportion of the materials is 40% for X and 60% for Y. As such, for the standard input of 875 kgs, the standard proportion will be X - 40% of 875 kgs i.e. 350 kgs. Y - 60% of 875 kgs i.e. 5:25 kgs. The standard cost will be as follows. Material Standard Standard Cost Quantity Price Rs. kgs. Rs. X 350 6 2,100 Y 525 4 2,100 4.200 (2) Revised standard quantity is calculated as below. Total input is 1000 kgs. The standard proportion of the materials is 40% for X and 60% for. Y. As such, the revised standard quantity should have been X - 40% of 1000 kgs. i.e. 400 kgs. Y - 60% of 1000 kgs. i.e. 600 kgs. 528 Management Accounting (3) The standard material cost of a normal mix of one tonne of chemical X is based on Chemical Usage Kgs. Price per Kg. A 240 6 B 400 12 C 640 10 During a month, 6.25 tonnes of X were produced from

Chemical Consumption Cost (Tonnes) (Rs.) A 1.6 11,200 B 2.4 30,000 C 4.5 47,250 Analyse the variances. Solution : Calculation of standard cost Chemical Quantity Rate per kg. Total Cost kgs. Rs. Rs. A 1500 6 9,000 B 2500 12 30,000 C 4000 10 40,000 79.000 Calculation of Actual cost Chemical Quantity Rate per kg. Total cost kgs. Rs. Rs. A 1600 7 11,200 B 2400 12.5 30,000 C 4500 10.5 47,250 88,450 (1) Material Cost Variance : Standard Cost - Actual Cost 79,000 - 88,450 = 9,450 (A) Standard Costing 529 (2) Material Price Variance : Actual Quantity (Actual Price - Standard Price) A - 1600 (7-6) = 1,600 (A) B - 2400 (12.5-12) = 1,200 (A) C - 4500 (10.5 - 10) = 2,250 (A) 5,050 (A) (3) Material Usage Variance : Standard Price (Actual Quantity - Standard Quantity) A - 6 (1,600 - 1500) = 600 (A) B - 12 (2,400 - 2500) = 1200 (F) C - 10 (4,500 - 4000) = 5000 (A) 4,400 (A) (4) Material Mix Variance : Standard Price (Actual Mix - Standard Mix) A - 6 (1,600 - 1593.75) = 37.5 (A) B - 12 (2,400 - 2656.25) = 3075.0 (F) C - 10 (4500 - 4250) = 2500.0 (A) 537.5 (F) Note : The standard mix is calculated as below. When total input is 8000 kgs. Chemicals A, B and C are mixed in the proportion of 1500 kgs, 2500 kgs and 4000 kgs respectively. When total input is 8500 kgs, the chemicals should have been mixed in the following proportion. 1500 Chemical A - X 8500 = 1593.75 kgs. 8000 2500 Chemical B - X 8500 = 2656.25 kgs. 8000 4000 Chemical C - X 8500 = 4250 kgs. 8000

530 Management Accounting (5) Material Sub-usage Variance : Standard Price (Standard Quantity - Standard Mix) A - 6 (1500 - 1593.75) = 562.5 (A) B - 12 (2500 - 2656.25) = 1875.0 (A) C - 10 (4000 - 4250) = 2500.0 (A) 4937.5 (A) (6) XYZ forecasts its overhead expenditure for a period as under. Rs. 30,000 for 10,000 hours. Rs. 27,500 for 9,000 hours. Rs. 25,000 for 8,000 hours. The normal volume of activity is 10,000 hours. During a period 8,750 hours were utilised for a total overhead expenditure of Rs. 28,750 of which fixed overheads totalled to Rs. 5,250. The standard utilisation of labour should have been less by 5%. How will you analyse the overhead variance. Solution : From the variation of total overheads, it is noted that for the variation of 1,000 hours. The overheads very to the extent of Rs. 2,500. Thus, indicates that the rate of variable overheads is Rs. 2.50 per hour. At the normal level of activity, the distribution of overheads will be as below. Variable Overheads - 10,000 hours x Rs.2.50 Rs. 25,000 Fixed Overheads - Balance Rs. 5,000 Rs. 30,000 Variable Overheads Variances : (1) Overheads Cost Variance : Standard Hours for X Standard Hourly Rate - Actual Overheads actual production 8930 X 2.50 - 23.500 = 22,325 - 23,500 = 1,175 (A)

[
Standard Costing 531

(2) Expenditure Variance : [Revised Budgeted Overheads for Actual hours] - Actual Overheads. 8,750 x 2.50 - 23,500 = 21,875 - 23,500 = 1,625 (A) (3) Efficiency Variance : [Standard Hours for Actual Production - Actual Hours] x Standard Hourly Rate [8,930 - 8.750] x 2.50 = 450 (F) Notes : (a) Total overheads cost actually incurred is Rs. 28,750 out of which fixed overheads are Rs. 5,250. Hence, balance is variable overheads i.e. Rs. 28,750 - Rs. 5,250 = Rs. 23,500 (b) Standard Hourly Rate is calculated as below. Total Budgeted Variable Overheads/Total Budgeted Hours. = Rs. 25,000 Rs. 2.50 per hour. 10,000 (c) Standard-hours for actual production are calculated as below. Actual overheads are Rs. 23,500. As the standard hourly rate is Rs.2.50 per hour, the ideal hours should have been Rs. 32,500 = 9,400

Rs. 2.50 However, standard utilisation should have been less by 5%. Hence, standard hours will be 95% of 9,400 hours i.e. 8,930 hours. (d) Revised budgeted overheads for Actual Hours are worked out as below. Actual hours are 8,750 and standard hourly rate is Rs. 2.50 per hour. Hence, the revised budgeted overheads should have been Rs. 21,875 i.e. 8,750 x 2.50. 532 Management Accounting Check : Overheads Cost Variance = Expenditure Variance + Efficiency Variance 1175 (A) = 1625 (A) + 450 (F) Fixed Overheads Variance : (1) Overheads Cost Variance : Standard Overheads Cost - Actual Overheads Cost 4,987.5 - 5,250 = 262.5 (A) (2) Overheads Expenditure Variance : Budgeted Overheads Cost - Actual Overheads Cost 5000 - 5250 = 250 (A) (3) Overheads Volume Variance : Standard Hourly Rate x [Standard Hours for Actual Production - Budgeted Hours] 0.50 X (9,975 - 10,000) = 0.50 x 25 = 12.5 (A) (4) Overheads Efficiency Variance : Standard Hourly Rate x [Standard Hours for Actual Production - Actual Hours] 0.50 X (9,975 - 8750) = 0.50 x 1225 = 612.5 (F) (5) Overheads Capacity Variance : Standard Hourly Rate X [Actual Hours - Budgeted Hours] 0.50 X (8,750 - 10,000) = 0.50 x 1250 = 625 (A) Notes : (a) Standard Hourly Rate is calculated as below, Total Budgeted Fixed Overhead Total Budgeted Hours Rs. 5,000 = Rs. 0.50 per hour 10,000 Standard Costing 533 (b) Standard Hours for actual production are calculated as below. Actual Overheads are Rs. 5,250. As the standard hourly rate is Rs, 0.50 per hour, the ideal hours should have been 10,500. However, standard utilisation should have been less by 5%. Hence, standard hours will be 95% of 10,500 hours i.e. 9,975 hours., (c) Standard overheads cost is calculated as Standard Hours x Standard Hourly Rate 9,975 x 0.50 = 4,987.50 (d) As the details of capacity variation due to the change in the number of working days is not known, calender variance cannot be calculated. As such, the calculation of capacity variance is made on the basis of comparison between actual hours and budgeted hours. Check : Overheads Cost Variance = Expenditure Variance + Efficiency Variance + Capacity Variance. = 262.5 (A) = 250 (A)+612.5 (F)+625 (A) (4) The sales manager a company engaged in the manufacture and sale of three products P, Q and R gives you are following information for the month of October 1982. Budgeted Sales : Product Units sold Selling Price Standard

Per unit Margin per Rs. unit Rs. P 2,000 12 6 Q 2,000 8 4 R 2,000 5 1 Actual Sales P - 1,500 units for Rs. 15,000 Q - 2,500 units for Rs. l7,500 R - 3,500 units for Rs. 21,000 You are required to Calculate the following variances (i) The Sales Price Variance (ii) The Sales Volume Variance (iii) The Sales Quantity Variance (iv) The Sales Mix Variance 534 Management Accounting Solution : (A) As per Turnover/ Value Method : (1) Sales Price Variance : Actual Sales Volume (Actual Price - Standard Price) P - 1,500 (10 - 12) = 3,000 (A) Q - 2,500 (7 - 8) = 2,500 (A) R - 3,500 (6 - 5) = 3,500 (F) 2,000 (A) (2) Sales Volume Variance : Standard Price (Actual Sales Volume - Standard Sales Volume) P - 12 (1,500 - 2,000) = 6,000 (A) Q - 8 ( 2,500 - 2,000) = 4,000 (F) R - 5 (3,500 - 2,000) = 7,500 (F) 5,500 (P) (3) Sales Mix Variance : Standard Sales - Revised Standard Sales Where standard sales are actual quantity at standard price and revised standard sales are standard sales rearranged in budgeted ratio. Standard Sales Revised Standard Sales Qty. Price Rs. Total Rs. Ratio Total Rs. P 1,500 12 18,000 1/3 18,500 Q 2,500 8 20,000 1/3 18,500 B 3,500 5 17,500 1/3 18,500 55,500 55,500 Sales Mix Variance : P 18,000 - 18,500 = 500 (A) Q 20,000 - 18,500 = 1,500 (F) R 17,500 - 18,500 = 1,000 (A) NIL Standard Costing 535 (4) Sales Quantity Variance : Revised Standard Sales - Budgeted Sales : P - 18,500 - 2,000 x 12 = 5,500 (A) Q - 18,500 - 2,000 x 8 = 2,500 (F) Q - 18,500 - 2,000 X 5 = 8,500 (F) 5,500 (B) As per Margin/ Profit Method Cost per unit = Selling price per unit - Contribution per unit P 12 - 6 = 6 Q 8 -4 = 4 R 5 -l = 4

PRODUCT SALES COST OF SALES PROFIT Qty. Price Rs. Total Rs. Per unit Rs. Total Rs. Per unit Rs. Total Rs. Budgeted

P 2,000 12 24,000 6 12,000 6 12,000 Q 2,000 8 16,000 4 8,000 4 8,000 R 2,000 5 10,000 4 8,000 1 2,000 50,000 28,000 22,000 Actual P 1,500 10 15,000 6 9,000 4 6,000 Q 2,500 7 17,500 4 10,000 3 7,500 R 3,500 6 21,000 4 14,000 2 7,000 53,500 33,000 20,500 Standard sales and revised standard sales are calculated as below : Standard Sales P 1,500 12 18,000 6 9,000 6 9,000 Q 2,500 8 20,000 4 10,000 4 10,000 R 3,500 5 17,500 4 14,000 1 3,500 55,500 33,000 22,500 536 Management Accounting Revised Standard Sales Revised Standard Revised Standard Sales Rs. Profit Rs. P 25,680 12,840 Q 17,120 8,560 R 10,700 2,140 53,500 23,540 (1) Sales Margin Price Variance : Actual Profit - Standard Profit 20,500 - 22,500 = 2,000 (A) (2) Sales Margin Volume Variance : Standard Profit - Budgeted Profit 22,500 - 22,000 = 500 (F) (3) Sales Margin Mix Variance : Standard Profit - Revised Standard Profit 22,500 - 23,540 = 1,040 (A) (4) Sales Margin Quantity Variance : Revised standard Profit - Budgeted Profit 23,540 - 22,000 = 1,540 (F) QUESTIONS 1. What do you mean by standard costing? Differentiate between Standard Costing and Budgetary Control as cost control techniques. state the advantages and limitations of standard costing. 2. What do you understand by standard costing? What preliminaries will have to be complied with before introducing the technique of standard costing. 3. Describe the procedure of establishing standard costs in the area of materials cost, labour cost and overheads cost. 4. What do you mean by variances and variance analysis. Explain the various factors affecting the variances in the area of materials cost, labour cost and overheads cost. Standard Costing 537 PROBLEMS 1. The standard materials cost to produce a tonne of chemcial X is 300 kgs of material A @ Rs. 10 per kg. 400 kgs of material B @ Rs. 5 per kg. 500 kgs of material C @ Rs. 6 per kg. During the period 100 tones of chemical X were produced from the usage of

35 tonnes of material A for a cost of Rs.9,000 per tonne 42 tonnes of material B for a cost of Rs. 6,000 per tonne 53 tonnes of material C for a cost of Rs. 7,000 per tonne Calculate price, mix and usage variances. 2. Mixers Ltd. is engaged in producing a standard mix using 60 kgs. of chemical X and 40 kgs of chemical Y. The standard loss of production is 30%. The standard price of X is Rs.5 per kg. and of Y is Rs. 10 per kg. The actual mixture and yield were as follows. X 80 kgs. @ Rs. 4.50 per leg and Y 70 kgs @ Rs.8.00 per kg. Actual yield 115 kgs. Calculate material variances (Price, Usage, Yield, Mix) 3. Given that the cost standards for material consumption are 40 kgs at Rs. 10 per kg., compute the variance when the actuals are a. 48 kgs @ Rs. 10 per kg. b. 40 kgs @ Rs. 12 per kg. c. 48 kgs @ Rs. 12 per kg. d. 36 kgs @ Rs. 10 per kg. 4. The standard cost of material for manufacturing a unit of a particular product FEE is estimated as follows. 16 kgs of raw material @ Re. 1 per kg. On completion of the unit, it was found that 20 kgs of raw material costing Rs.1.50 per kg. has been consumed. Compute material variances (price, usage, cost) 5. A company manufacturing distempers operates a standard costing system. The standard cost for one of the products of the company shows the following materials standards. 538 Management Accounting Materials Quantity Standard Price Total Rs. per kg Rs. A 40 75 3,000 B 10 50 500 C 50 20 1,000 Material cost per unit (Total) 4,500 The standard input mix is 100 kgs and the standard output of the finished product is 90 kgs. The actual results for a period are Material Used. A - 2,40,000 kgs @ Rs. 80/kg B - 40,000 kgs. @ Rs. 52/kg C - 2,20,000 kgs @ Rs. 21/kg Actual output of the finished product - 4,20,000 kgs. Yon are required to calculated the material price, mix and yield variance. 6. In a factory 100 workers are engaged and the average rate of wages is 50 paise. Standard working hours per week are 40 and the standard performance is 10 units per gang hour. During a week in March, wages paid for 40 workers were at the rate of 50 paise per hour, 10 workers at 70 paise per hour and 40 workers at 40 paise per hour. Actual output was 380 units. Factory did not work for 5 hours due to breakdown of machinery. Calculate appropriate labour variances 7. The standard cost of a unit shows the following costs of material and labour Material 4 pices @ Rs. 5.00 Labour 10 hours @ Rs. 1.50 5,700 units of the product were manufactured during the month of March 1987 with the following material and labour costs. Material 23,000 pieces at Rs. 4.95 Labour 56,800 hours at Rs. 1.52 Standard Costing 539

You are required to calculate (1) Material Price variance (2) Material Cost variance (3) Material Usage variance (4) Labour Rate variance (5) Labour Efficiency variance (6) Labour Cost variance 8. The standard labour component and the actual labour component engaged in a week for a job are as under. Skilled Semi Skilled Unskilled Workeis Workers Workers (a) Standard number of workers in the gang 32 12 6 (b) Standard wage rate per hour (Rs.) 3 2 I (c) Actual number of workers employed 28 18 4 in the gang during the week. (d) Actual wage rate per hour (Rs.) 4 3 2 During the 40 hours working week, the gang produced 1800 standard hours of work. Calculate the following variances. (i) Labour cost variance (ii) Labour efficiency variance (iii) Labour rate variance (iv) Labour mix variance 9. Items Budget Actual No. of working days 20 22 Month hours per day 8,000 8,400 Output per manhour in units 1.0 0.9 Overhead cost (Rs.) 1,60,000 1,68,000 Calculate overhead variances. 10. From the following data of A Co. Ltd. relating to budgeted and actual performance for the month of March 87, compute the Direct Material and Direct Labour cost variances. 540 Management Accounting Budgeted data for March : Units to be manufactured 1,50,000 Units of direct material required (Based on standard rates) 4,95,000 Planned purchases of Raw Materials (Units) 5,40,000 Average unit cost of Direct Material Rs.8 Direct Labour hours per unit of finished goods 3/4 hr. Direct Labour cost (Total) Rs. 29,92,500 Actual data at the end of March : Units actually manufactured 1,60,000 Direct Material cost (Purchase cost based on units actually issued) Rs. 43,41,900 Direct Material cost (Purchase cost based on units actually purchased) Rs. 45,10,000 Average unit cost of Direct Material Rs.8.20 Total Direct Labour hours for March 1,25,000 Total Direct Labour cost for March. Rs. 33,75,000 11. The following details relating to the Product X during the month of March 1989 are available. You are required to compute the material and labour cost variance and also to reconcile the standard and the actual cost with the help of such variances. Standard cost per unit Materials 50 kgs. @ Rs. 40 per kg. Labour 400 hours @ Rs. 1.00 per hour. Actual cost for the month -

Material 4900 kgs @ Rs. 42 per kg. Labour 39,600 hours @ Rs. 1.10 per hour Actual production - 100 units. Standard Costing 541 12. Following data are available in respect of a particular department for weekly operations: Standard output for 40 hours week - 2,000 units Standard fixed overheads - Rs. 2,000 Actual output - 1,800 units Actual hours worked - 32 Actual fixed overheads -Rs. 2,250 Calculate overhead variances 13. Dustfree Products manufactures and sells a patented vaccum cleaner for domestic use and the following data is available for October 1983. Actual Standard Direct Labour hours 10,500 10,000 (10 hrs. per unit) Direct Labour cost (Rs.) 21,500 2.10 per hour Direct Material (Tonnes) 550 540 Direct Material cost (Rs.) 52,250 100 per Tonne Actuals Budgeted (For October) (For the year) Overheads: Fixed 6,200 72,000 Variable (varies with volume 15,200 216,000 of production) Overhead is budgeted for normal activity of 1,44,000 hours of direct labour per annum, equally phased. Compute labour, material and overheads variances. 14. The budgeted and actual sales of a concern manufacturing and marketing a single product are furnished below. Budgeted sales Actual sales Qty. Price per Amount Qty. Price per unit Amount Units Rs. Rs. units Rs. Rs. 10,000 3.00 30,000 5,000 3.00 15,000 8,000 2.50 20,000 Ascertain, (a) Sales Price Variance (b) Sales Volume Variance. 542 Management Accounting 17. From the following information about sales, calculate (a) Total Sales Variance (b) Sales Price Variance (c) Sales Volume Variance (d) Sales Mix Variance (e) Sales Quantity Variance Standard Actual Product Nos. Rate (Rs.) Rs. Nos. Rate (Rs.) Rs. A 5,000 5 25,000 6,000 6 36,000 B 4,000 6 24,000 5,000 5 25,000 C 3,000 7 21,000 4,000 8 32,000 12,000 70,000 15,000 93,000 18. Budgeted and actual sales for a month of two products A and B were as below Budget Actual Units Unit Price Units Unit Price Rs. Rs. A 3,000 10.00 2,500 10.00 1,000 9.50

B 5,000 2.00 4,000 2.00 1,200 1.90 Budgeted costs for the products A and B were Rs.8 and Rs. 1.50 respectively. Work out the following variances. (a) Sales Value Variance (b) Sales Volume Variance (c) Sales Price Variance (d) Sales Mix Variance (e) Sales Qunatity Variance 19. X Ltd. operates a budgetory control and standard costing system. From the following data calculate (a) Sales Variance (b) Sales Volume Variance (c) Sales Price Variance Standard Costing 543 Budgeted Actual Product Units to be Sales Value Units sold Sales value Rs. Rs. A 100 1,200 100 1,100 B 50 600 50 600 C 100 900 200 1,700 D 75 450 50 300 325 3,150 400 3,700 20. The records of an engineering company indicate the following for the month of April 1986 Standards Factors Unit cost (Rs.) Direct Materials 4 gallons @ Rs. 1.20 4.80 Direct Labour 3 hours @ Rs. 1.80 5.40 Factory overheads Rs.0.60 per labour hour 1.80 Total manufacturing cost 12.00 Activity for the month of April 1986 (1) Production during the month of April 1986 has been 6,500 units with no beginning or ending work in progress inventories. (2) Materials purchased 32,000 gallons @ Rs. 1.18 per gallon. Used in production 25,600 gallons. (3) Labour hours worked 20,000. Average hourly wage rate Rs. 1.75 (4) Factory overheads - Total overheads costs incurred Rs. 12,500 Calculate material variances, labour variances and total variance for factory overheads. 21. A factory supplies the following figures of production and overheads for September 1983 Budgeted Actual Production (Units) 50,000 52,000 Variable overheads (Rs.) 4,00,000 4,10,000 Fixed overheads (Rs.) 6,00,000 6,20,000 Number of hours 2,00,000 2,20,000 Work out the variances that are involved. 544 Management Accounting 22. It is estimated that in the manufacture of a product, for each ton of material consumed, 100 articles should be produced. The Standard Price per ton of material is Rs. 10. During the first week of January, 200 tons of materials were issued to the production department, the purchase price of which was Rs. 10.50 per ton. The actual output for the period was 20,500 units. Calculate the Material Variances. Standard Costing 545 NOTES 546 Management Accounting NOTES Uniform Costing 547

Chapter 14
UNIFORM COSTING
It refers to the use of same costing principles and methods by several undertakings. Its not a separate method of cost accounting but only a particular technique which applies the usual accounting methods like process costing, job costing, standard costing, budgetory costing and marginal costing. Main feature of uniform costing is that whenever a particular method of costing is applied it is applied uniformly in a number of concerns in the same industry or even different but similar industries. This enables cost and accounting data of the member undertakings to be compiled on a comparable basis so that useful and crucial decisions can be taken. It attempts to establish uniform methods so that comparison of performances in the various undertakings can be made to the common advantages of all the constituent units. Scope of Uniform Costing : Uniform costing methods may be advantageously applied (i) In single organisation having a number of branches, each of which may be a separate manufacturing unit. In this case, the head office controls the operations of the uniform costing methods. (ii) In a number of concerns in the same industry bound together through a trade association or otherwise. In this case, the procedure for uniform costing may be devised and controlled by the association or any other central body prescribed for this purpose. (iii) In industries which are similar such as gas and electricity, cotton, jute and woolen textiles. Requisites for uniform costing : The success of uniform costing will depend upon the following : (1) There should be a spirit of mutual trust and policy of give and take. (2) There should be free exchange of ideas and methods. 548 Management Accounting (3) Bigger units should be ready to share with smaller ones, improvements, achievements of efficiency and know how. (4) There should not be any hiding or withholding of information. (5) There should be no rivalry, competition or sense of jealousy among the members. Advantages of uniform costing : (1) Uniform costing is a useful tool for management control. Performances of individual units can be measured against norms set for the industry as a whole. (2) It avoids cut throat competition by ensuring that competition among the members will proceed on healthy lines. (3) Weaker units in the industry can take the advantage of the efficient methods of production and production control of better managed units so as to increase their own efficiency. (4) The fruits of the research and development programmes which can be carried out only by the bigger units, may be shared by the smaller units. (5) By showing one best way of doing things, it creates cost consciousness and provides the best system of cost control or cost presentation in the entire industry. (6) Prices based on uniform costing may be taken to be reliable and representative of the whole industry. This creates customer confidence and improves relations between customer and business. (7) It assists in educating the less informed units as regards the cost accounting methods. (8) In India, where public undertakings operate alongwith the private sector undertakings, uniform costing enables a comparitive assessment to be made of the two sectors. (9) Uniform costing enables the furnishing of suitable statistics to the Government wherever called upon to do so. This may be required by Government for effective price control or to give protection or subsidy to a particular industry etc. (10) It simplifies the work of wage boards set up to fix minimum wages and fair wages for an industry. Uniform Costing 549

Disadvantages of Uniform Costing : (1) The practices and methods followed by various units in the industry may vary from one unit to another. The factors for such differences like location, age, capital investment and condition of plant, degree of mechanisation etc. may be so wide from each other that to have a uniform costing system suitable for big as will as small units becomes impossible. (2) For small units, cost of installation and operation of uniform costing system may not be commensurate to the advantages therefrom. (3) If some reservations are made while giving certain information by some units or if some information is withheld on the grounds of secrecy or privacy, the statistics presented cannot be relied upon. (4) It may create conditions which are likely to develop monopolistic tendencies within the industry. Prices may be raised arbitrarily and supplies curtailed. Fields covered by uniform costing : Considering the basic nature of uniform costing as discussed above, it goes without saying that the success of uniform costing system depends upon the extent to which uniformity can be brought about in various areas. The various areas in which uniformly can be attempted to be brought are as discussed below. (1) Method of cost accounting to be implemented viz. job costing, process costing, unit costing and so on. (2) Costing Techniques employed i.e. marginal costing, standard costing etc. (3) Methods of pricing the issues from stores. viz. FIFO, LIFO, Weighted Average and so on. (4) Method followed for valuation of inventories. (5) Methods followed for inventory control. (6) Method followed for charging depreciation viz. written down value, straight line etc. (7) Methods of remunerating the workers. (8) Treatment given to certain specific types of costs like bonus, idle time wages and so on. (9) Methods for apportionment and absorption of overheads and treatment given to under or over absorption of overheads. (10) Treatment given to material scrap, wastes, spoilages and defectives. 550 Management Accounting (11) Treatment given to research and development costs. (12) Definition of the term capacity for setting overhead absorption rates. (13) Procedure for classification and codification of accounts. (14) Items to be excluded from cost accounts. Uniform Cost Manual : It is a document which lays down the cost accounting plans and procedures to be followed by the constituent units. This document once circulated among the constituent units helps to guide them to formulate their system of accounting in such a way that the principles of uniform costing can be uniformly and correctly applied. The various contents of an uniform cost manual can be stated us below : (1) Introduction : This part may state the objects and purposes of uniform cost system, advantages derived therefrom and the cooperation expected from constituent units. (2) Organisation : This part may include the organisation for establishing and running the uniform cost system. E.g. whether the system is to be established and run by outside cost consultants or by those internal to the various constituent units. (3) Cost Accounting System : This part includes accounting systems and procedures to be followed lo bring about uniformity E.g. classification and codification of accounts, definition of a cost centre and cost unit, relationship between cost and financial accounting, items to he included in or excluded from cost accounting, collection of various costs viz. material, labour and overheads and so on. (4) Presentation of information : This part may include the forms and contents of various cost and financial ratios, presentation of various production and operation costs and so on. (5) Miscellaneous : This part may include any of their information to be communicated to the constituent units but not included in any of the above mentioned sections.

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QUESTIONS 1. What are the advantages and limitations of uniform costing? 2. Write short notes Uniform Costing Manual 3. What do you mean by Uniform Costing? What are the various advantages and disadvantages of Uniform Costing? State the pre-requisites for the success of Uniform Costing. Explain the various areas where uniform costing can be used. 552 Management Accounting NOTES