Costing part 1 (1)

costing
Dr.K.PADMAVATHY, M.Com.,M.Phil.,Ph.D.,
Assistant Professor,
Dept. of Commerce,
E.M.G.Yadava Women’s College,
Madurai

Definition
The term cost has a variety of meaning according to the context. In
common parlance, cost refers to the price of a product . But in management
terminology ,cost refers to expenditure . “The Institute of Cost and
Management Accountants ,(ICMA) London defines Cost as “the amount of
expenditure incurred on a giving things”.
Cost Accounting
Cost Accounting is the process of classifying recording allocating and
reporting the various costs incurred in the operation of an enterprise.
`` The words costing and cost accounting are used interchangeably .
But they do not mean the same thing . Costing denotes the techniques and
process of ascertaining cost . It can be carried out arithmetically . But cost
accounting is a formal system established for recording costs in the books of
accounts.

The objectives of cost accounting
The major objectives of cost accounting are cost ascertainment ,
finishing of cit data for decision making and control of cost. The
objectives are listed below:
 To find out the total cost and cost per unit of various
products manufactured;
 To disclose the proportion of different element (such as
material, labour and overload) in the total cost;
 To provide necessary data for fixing the selling price;
 To ascertain the profitability of cash product and advise
the management as to how these profits can be
maximized;
 To supply estimates of cost ,on the basis of historical data
, for the preparation of tenders, qutations,etc.,;

Financial Accounting
 Data used: only monetary
data are used .
 Periodicity of reporting :
it reports operating
results and financial
position at the end of the
year.
 Scope: it deals with
actual facts and figures
 Stock valuation : stock
are valued at cost price
or market price
whichever is less
 Analysis of cost &profit
:it shows the overall
profit and loss of the
organization
Cost Accounting
 Both monetary and
non –monetary (units)
data are used.
 It give information to
the management as
and when required.
 It deals with facts as
well as estimates.
 Stock are valued at
cost
 It shows the detailed
cost and profit of each
products, job or
process.
Difference between Financial Accounting and Cost Accounting

Cost -elements classification and methods
 The various elements of cost
Total cost of a product is composed of three elements
a. Material b. labour and c. expenses. Each of these
elements army be further divided into two parts – direct
and indirect costs
Direct cost:
Direct costs are those costs which can be identified
with and allocated directly to a particular products,
process or job. These costs are known as prime cost
Indirect cost:
indirect costs are those costs which cannot be
allocated but can be apportioned to it absorbed by a
particular product, process or job. These costs are known
as overheads.

 Materials
The term material means and includes raw materials,
spares parts and components, factory supplies, packing
materials etc.,
from the definition it is clear that the material control
involves efficient functioning of the following
operations:
a. Purchasing material
b. Receiving material
c. Inspection of materials
d. Storage of materials
e. Issusing of materials
f. Maintenance of inventory records
g. Stock audit

Objectives of materials control:
Material control aims at achieving savings
in material cost ,improvement in material
handling, increased production and avoidance
of over investment or under investment in
inventories. The important objectives of
material control are:
a. To make available the right type of raw
material at the right time in order to have
smooth and continuous flow of production.
b. To ensure effective utilisation of material;

Advantage of Material Control:
 It help to eliminate or minimize waste
through control of purchase, storage and
issue of materials.
 It facilitate detection and elimination of
fraud and pilferage by implementing stock
control measures.
 It ensures up- to date maintenance of stock
records.
 It avoid over investment in inventories.

BIN CARD
Bin a place ,rack or cupboard where materials are kept
. A card is attached to each bin to show the position of stock in
the bin . This card is known as bin card or stores card.
Name of the material minimum level
Material code no maximum level
Bin no re-order level
Stores ledger folio no re –order quantity
receipts issuse Balance
date Goods
receiv
ed
note
no
qty Requis
ition
no
qty qty remar
ks

Advantage of Bin card:
1. It enables the stores –keeper to receipts and
issues of materials and keep the stocks within the
minimum and maximum levels.
2. It provides up to date record of materials
received and balance in stocks .this helps in the
successful operation of a perpetural inventory
system.
3. By seeing the bin card, the store-keeper can
send the material requisition for the purchase of
materials in time.

Stores Ledger:
stores ledger is kept in the costing
department .It contains accounts for each class
of material, it is usually maintained in the loose
leaf form.
Name of the material: Minimum level:
Code number: Maximum level:
Description: Re-order level
Re-order quantity

DA
TE
RECEIPTS ISSUES BALANCE
G.R QT
Y
RA
TE
VAL
UE
M.
R
QT
Y
RA
TE
VAL
UE
QT
Y
RA
TE
VAL
UE
RE
MA
RK
S

Bill of Materials:
A bill of material gives a complete list of
material required for a particular job or work order. It
is generally prepared by the planning department as
soon as the work order is received .
Advantage :
1. A bill of material is kind of written autorization
to the store –keeper for issue of materials.
2. Its serves as a purchase requizition to the
purchase department.
3. It is possible to calculate the material cost of all
articles before they are produced.

s.no Descrip
tionuse
Code.n
o
Qty.no For office ue
Rate amount remarks

Bin card Store ledger
 It is maintained by the
store- keeper
 It is a record of
quantities only
 Entries are made at the
time when the
transaction takes place.
 It is attached to the bin
 Each transaction is
individually posted
 It is maintained by the cost
accounting department
 It is a record of quantities
as well as values
 Entries are made only after
the transaction has taken
place.
 It is kept in the cost office
 Transaction may be
summarised and posted
periodically.

ABC analysis
Efficient store- keeper requries sufficient
control over all items of stores. However, greater care
is necessary in the case of costlier item. Therefore
,ABC analysis envisage varied degree of care and
control for different categories of materials, according
to their value. Hence, it is known as selective value
approach. It is also referred to as Always Better
Control system.
Category A – High value materials
Category B - Medium value materials
Category C - Low value materials

1. It ensures closer and stricter control on
costly items in which large amount of
capital has been invested.
2.Management time is saved since attention
is paid only to some of the items having more
value.
3. Investment in inventory can be regulated
and funds can be utilised in the best possible
manner.

Maximum level
This is the level above which the stock should not be
level above allowed to exceed at any time. This is fixed by
taking into account the following factors:
 Availability of capital
 Storage space available
 Seasonal price fluctuation
 The cost of maintenance
 Economic order quantity.
Maximum level formula :
Maximum level=re order level+ re order qty-
(min.cons*min.re order period)

Minimum level
This is the level below which stock should not
be allowed to fall at any time .
a) Rate of consumption of materials
b) Time required to obtain fresh supply of materials
c) Re-order level.
Minimum level formula:
minimum level = Re-order level-(Normal
consumption x Normal Re-order period)

Re order level:
This is the level at which a new order for
material is to be placed by the store –keeper. In other
words, this is the level at which a purchase requisition
is made out.
a) Rate of consumption of material
b) Minimum level
c) Delivery time
d) Variation in delivery time
Reorder level formula:
Re order level=maximum consumption*maximum re
order period

Economic Order Quantity : [EOQ]
It is not a stock level. It is ideal quantity
material to be purchased at any time . If purchase are
made of purchase are made in large quantity ,the cost
of holding the stock will be higher but the cost of
purchasing would be less.
Formula
EOQ=√2AO
C
A= Annual consumption in units
O=Ordering and receiving cost per order
C=Cost of carrying inventory per unit per annum

Danger level:
This is fixed below minimum level.When the stock
reaches this level, urgent action for purchase of material is
taken.
Formula:
Danger level = min. rate of consumption x Emergency
delivery time .
Average stock level :
This is level indicates the average stock held by
the firm. It is calculated as follows:
Formula:
Minimum level+1/2 of Re-order quantity
(or)
Maximum level+ Minimum level
2

First in first our method (FIFO)
under this is method ,materials are issued in
the order in which they are received in the store. It
means that the materials received first will be issued
first.
Advantage:
a) This method is simple to understand and easy to
operate.
b) The closing stock is valued at the current market
price.
c) Deterioration and obsolescence can be avoided.

Disadvantages:
a. When prices fluctuate, calculation becomes
complicated. This increases the possibility of
electrical errors.
b. During the period of price fluctuation,
Material charged to jobs vary.
Therefore,comparison between jobs is
difficult.
c. During the period of rising prices, product
costs are under stated and profits are
overstated. This may result in payment of
higher dividend out of capital.

Last In First out Method (LIFO)
This method is opposite to FIFO . Here materials last
are issued first . Issues are made from the latest
purchase.
Advantages:
a. Issues are based on actual cost.
b. Issues price reflects current market price.
c. There is no unrealised profit or loss.
d. Simple to operate if purchases are not many and
prices are steady or rising.

Disadvantage:
a. This method involves considerable clerical work.
b. Stock of material shown in the balance sheet will
not reflect market price.
c. This method is not accepted by the income tax
authorities.
d. Under falling prices, issues are period at lower
prices and stocks are valued at higher rates.
e. Due to variation in prices, comparison of cost of
similar jobs is difficult.

 Each business concern usually maintains a
minimum quantity of material in stock. This
minimum quantity is known as base stock.
This stock will be used only when an
emergency arises. This base stock is
considered to be a fixed asset valued at cost
price irrespective of the price fluctuations.
This quantity in excess of this stock may be
valued either by using FIFO or LIFO Method.
 Base Stock Method is not an independent
method.

 The simple average is determined by adding
different prices of materials in stock and dividing
the total by number of prices. Quantity
purchased in each lot is ignored.
 Advantages:
 1.This method is simple to understand and easy
to operate.
 2. It reduces clerical work.
 Disadvantages:
 1. It does not take into account the quantities
purchased.
 2. The value of costing stock becomes
unrealistic.

 This method takes into account both quantity
and price for arriving at the average price.
The weighted average is obtained by dividing
the total cost of material in the stock by
total quantity of material in the stock.
 Advantages:
 It gives more accurate results than simple
average price because it considers both
quantity as well as price.
 It is suitable in the case of materials subject
to wide price fluctuations.

 Disadvantages:
 1. Stock on hand does not represent current
market price.
 2. When large number of purchases are made
at different rates, the calculation is tedious.
So, there are more chances of clerical error.
 3. With some approximation in average
price, there will be profit or loss due to over
or under charging of material cost of jobs.

Costing part 1 (1)

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