Cost and Management Accounting

Bachelor of Business Administration (Financial Investment Analysis) & Bachelor of Management Studies Cost and Management Accounting

Editorial Board and Content Writers

• Editorial Board: Dr. Rishi Taparia, Dr. Kumar Bijoy
• Content Writers: Dr. Saumya Jain, Dr. CA. Madhu Totla, CA. Vishal Goel, Ms. Priya Dahiya, Ms. Chandni Jain, Ms. Rinki Dahiya, Ms. Shalu Garg, Mr. Anil Kumar
• Academic Coordinator: Deekshant Awasthi

Table of Contents

• UNIT-I
  • Lesson 1: Introduction to Cost and Management Accounting (Pages 3-31)
  • Lesson 2: Overheads (Pages 32-77)
  • Lesson 3: Classification of Costs (Pages 78-96)
• UNIT-II
  • Lesson 4: Cost-Volume-Profit Analysis (Pages 99-127)
  • Lesson 5: Relevant Costs and Decision Making (Pages 128-150)
  • Lesson 6: Budgets and Budgetary Control (Pages 151-173)
  • Lesson 7: Standard Cost (Pages 174-196)
• UNIT-III
  • Lesson 8: Contemporary Issues in Cost Accounting and Management Accounting (Pages 199-221)
• Glossary (Pages 223-227)

Lesson 1: Introduction to Cost and Management Accounting

1.1 Learning Objectives

• Understand the purpose and use of cost and management accounting within an organisation.
• Develop an understanding of the difference between cost accounting and management accounting.
• Describe the nature and scope of cost and management accounting.
• Describe the roles of cost accounting and management accounting.
• List and explain the components of cost.
• Describe the costs of production, office and administration, selling, and distribution.

1.2 Introduction

• A business uses inputs (labor, raw materials) to produce outputs (goods/services).
• Accounting offers information for management and other users to evaluate financial health and performance.
• Cost accounting calculates and measures resources used for company operations (manufacturing and service provision).
• Management uses data from cost accounting for taking managerial decision.

1.3 Meaning, Nature, and Scope of Cost Accounting

• Cost accounting involves documenting, categorizing, summarizing costs to:
  • Calculate costs of goods/services.
  • Plan, regulate, and minimize costs.
  • Provide management information for decision-making.
• Cost accounting provides management advice on the best course of action based on cost effectiveness and capacity.
• The Chartered Institute of Management Accountants defines cost accounting as the process of accounting for costs from the point at which expenditure is incurred to its ultimate relationship with cost units, including statistical data preparation, cost control methods, and ascertainment of activities' profitability.
• Cost accounting facilitates management in planning, control, and decision-making tasks.
• It helps in valuing inventories and controlling inventory levels.
• Cost accounting is used by service companies, governments, and professions.
• It includes expenses for administration, marketing, sales, and distribution.
• Cost accounting provides information for management and financial accounting.
• It measures, analyzes, and reports expenses associated with acquiring or using resources within the company.
• Cost accounting systems are not constrained by regulations like GAAP.

Nature of Cost Accounting

• Branch of Knowledge: It's a disciplined body of knowledge with principles, concepts, and conventions.
• Science: It systematically collects knowledge from various fields like law, data processing, and production control.
• Art: It applies cost accountancy concepts to management issues like cost determination and profitability determination.
• Profession: It has emerged as a prominent profession with established organizations like ICWAI.

Objectives of Cost Accounting

• Estimating the Selling Price:
  • Cost accounting helps in determining goods prices and profitability.
  • Businesses operate to make a profit and income must be higher than the cost of producing goods/services.
• Assessing and Optimizing Efficiency:
  • Cost accounting studies production processes to gauge efficiency and improve strategies.
  • Techniques like standard costing and budgetary control are employed for cost control.
  • A budget is created for each item then the actual expenses incurred are compared to the budget.
• Offering Basis for Operating Policy:
  • Cost accounting assists management in developing operational policies such as closing or operating at a loss decision or producing for, or purchasing the goods from external suppliers.
• Making it Easier to Prepare Financial and other Statements:
  • It provides timely information for decisions and preparation of internal audit.
  • According to financial accounting, financial statements are typically prepared once a year or every half- year which may not suit the needs of management.
  • Cost accounting provides suitable analysis along with daily, weekly, or monthly volumes of units produced and accumulated costs.
  • A well-designed cost accounting system gives quick access to data on raw material, work-in-progress, and finished goods inventories.

Scope of Cost Accounting

• Cost Ascertainment: Determines overall and per-unit costs using historical or predicted data.
• Cost Control: Employs budgetary control, standard costing, break-even point analysis, etc.
• Cost Records: Maintains cost books, vouchers, ledgers, reports, and other documentation for comparison and future use.

1.4 Meaning, Nature, and Scope of Management Accounting

• Management accounting collects, evaluates, and disseminates financial and nonfinancial data to assist managers in reaching organizational objectives. It helps managers to make wise business decisions and improve their performance.
• Management accountants offer the data necessary to develop short-, medium-, and long-term plans.
• Information from management accounting is used by managers to create, discuss, and carry out strategy.
• Internal users, such as departmental managers, will require a variety of information to ensure the smooth running of their department. The fundamental difference between financial and managerial accounting is that financial accounting serves the interests of individuals outside the company, but management accounting serves the needs of managers who are employed within the business.
• Financial accounting places a strong emphasis on the financial ramifications of past actions, objectivity and verifiability, accuracy, and company-wide performance. Whereas management accounting places a strong emphasis on decisions affecting the future, relevance, timelines, and segment performance.
• Financial accounting is required and must adhere to rules like GAAP or IFRS; management accounting is not required and is exempt from such rules.
• The aim of management accounting is to assist management in decision making, planning, coordinating, controlling, communicating and motivating.
• Generally managerial accounting helps managers to perform three vital activities— planning, controlling, and decision making.

Nature of Management Accounting

• No Fixed Norms Followed: There is no requirement to adhere to rigid standards, the tools used may vary from one organization to another.
• Enhanced Effectiveness: Management accounting is utilized to boost organizational efficiency since that is simply how it works.
• Provides Data but not Decisions: Accounting facts and data are provided by management accountants, but final decision-making rests with higher authorities.
• Concerned with Forecasting: The management accounting temperament is wholly preoccupied with predicting.

Scope of Management Accounting

• Financial Accounting: Forms the basis for analysis and interpretation, for furnishing meaningful data to the management.
• Cost Accounting: The methods and process of determining costs are known as cost accounting. The cost accounting system offers the essential equipment for successfully completing such tasks.
• Budgeting and Forecasting: Budgeting is the process of outlining a company’s future objectives, rules, and goals. On the other hand, forecasting makes predictions about what will occur as a result of a specific set of circumstances.
• Inventory Management: Since inventory includes a sizable sum of money, it must be managed from the moment it is obtained until it is finally disposed of.
• Statistical Approach: Statistical tools are very helpful for planning and forecasting in addition to improving the information’s impressiveness, comprehensiveness, and understandability.
• Data Interpretation: An essential component of managerial accounting is the analysis and interpretation of financial statements.
• Reporting to Management: It is necessary to share the interpreted information with individuals who are interested in it.
• Tax Accounting and Internal Audit: Management accounting investigates all tax-related issues to support management’s investment decisions in light of tax planning as a tool for tax reduction.
• Methods of Procedures: This covers the upkeep of efficient data processing and other office administration functions.

1.5 Comparison between Cost Accounting and Management Accounting

• Cost accounting entails computing cost per unit from financial accounting and cost accounting, while management accounting generates analyses and statements derived from the same data.
• Comparison between Cost Accounting and Management Accounting
  • Meaning:
    • Cost Accounting: The classification, record- ing, allocation, and report- ing of the numerous ex- penses incurred throughout an enterprise’s operation are done through the pro- cess of cost accounting.It aims at planning, reg- ulating, and minimizing such costs, as well as pro- viding management with information so that they can make decisions. Cost accounting merely assists the management with functioning.
    • Management Accounting: collect, evaluates, and disseminates financial and nonfinancial data to as- sist managers in reaching organisational objectives. It makes use of financial accounting and cost ac- counting principles; it assists and assesses the management performance.
  • Different Aspects:
    • Cost Accounting: The ascertainment, allocation, and apportionment accounting aspects of expenses are dealt with.
    • Management Accounting: The influence and impact of costs on the firm are the subject.
  • Objective:
    • Cost Accounting: The primary goal is to support management’s efforts to control costs and make decisions.
    • Management Accounting: To supply the management with the data it needs for decision-making, planning, controlling, and performance evaluation.
  • Functions:
    • Cost Accounting: Cost determination and cost control.
    • Management Accounting: To ensure an organisation performs efficiently and effectively.
  • Foundation/Base:
    • Cost Accounting: Cost-related data gleaned from financial ac- counting.
    • Management Accounting: Data from cost accounting and financial accounting.
  • role:
    • Cost Accounting: can be in- stalled with management accounting.
    • Management Accounting: cannot be installed without cost and financial accounting.
  • Data used :
    • Cost Accounting: on historical cost data and provides decisions about future costs.
    • Management Accounting: gives decision-makers ac- cess to both past and future knowledge.
  • Qualitative Data:
    • Cost Accounting: quantitative cost data that can be monitored.
    • Management Accounting: Data that is both quanti- tative and qualitative are used. Additionally, it makes use of information that cannot be valued in monetary terms.
  • Users:
    • Cost Accounting: management of a compa- ny, together with the share- holders and creditors.
    • Management Accounting: intended for the management.

1.6 Cost Control, Cost Reduction and Cost Management

• Cost control is achieving the cost target as its objective whereas cost reduction is directed to explore the possibilities of improving the targets.
  • Cost Control: Focuses on maintaining costs within reasonable caps/limits. Cost control methods are required when actual costs significantly exceed budgeted expenditures.
    • The first step in cost control procedure includes setting the acceptable or expected level of cost for specific operations, monitoring the actual cost of those activities as they happen, then comparing those real costs to the predetermined costs, and, if necessary, remedial action are all included in this process.
  • Cost Reduction: Positive action with the goal of bringing down the price of goods or services without degrading their usability or quality. Concentrated on anticipated costs. Cost reduction starts with the premise that current cost levels or planned cost levels are too high. The scope of cost reduction includes all business operations, from production to marketing, and all organizational levels, from the lowest to the highest. Cost-cutting/reduction measures include:
    • Material Costs, which may include cash discounts for early payment to suppliers or quantity discounts.
    • Labour Costs, which include replacing labour-intensive positions with jobs related to automated machinery.
    • Finance Costs: By properly managing cash flow, bank overdraft fees may be more effectively decreased.
    • Rationalization Measures
  • Difference between Cost Control and Cost Reduction
    • Cost control is static; cost reduction seeks to reduce expenses.
    • Cost control tries to maintain costs in line with accepted norms; cost reduction focus on cutting costs.
    • Cost control strives to achieve the lowest cost achievable under current conditions; cost reduction does not acknowledge any state as permanent.
    • Cost control is a continuous/ permanent activity; cost reduction occurs on a tem- porary basis.
    • The focus is on the past and present when it comes to cost control; the focus is on the present and future when it comes to cost re- duction.
    • Cost control is a preventive function; cost reduction is a corrective function.
  • Cost Management:
    • Managers use resources to increase value to consumers and accomplish organizational objectives. Making judgements about entering new markets, implementing new organizational procedures, and changing product designs are all examples of cost management considerations.
    • Cost management has many different objectives and is not only about reduction in costs. In order to increase sales and profits, cost management decisions may be made to incur additional costs, such as those made to develop new goods and improve consumer satisfaction and quality.
    • Cost management is the application of management accounting principles, techniques for gathering, analysing, and presenting data to produce the data required for cost planning, monitoring, and control.
    • A cost management system is useful for locating, gathering, classifying, and compiling data that managers can use for planning, managing, and making wise decisions to maintain costs within acceptable bounds.

1.7 Components of Total Cost and Preparation of Cost Sheet

• Cost is the money spent to produce a good or service, excluding the profit margin mark-up.
• Cost, in general, refers to the amount of money spent on or related to an item, whether it be real or hypothetical.
• Cost, in the viewpoint of a seller, is the sum of money used to create a good or a product.
• The price of a product is what it costs from the perspective of the consumer.
• The nature of the industry or business and the setting in which it is employed mainly determine how to interpret it.

Components of cost

• Materials, labor costs, and expenses make up the three components of cost.
• Costs can be broadly categorized into direct cost and indirect cost.
  • Direct Cost:
    • Direct costs directly relate to a unit of operation. They can be clearly and directly identified. A certain product or process is connected to the nature of the direct costs. “Traceable costs” is another name for it. Direct costs are those costs for materials and labour that are reasonably and readily traceable for a good, a service, or a project.
    • Direct Material: Materials whose costs may easily be linked to the finished product, and which are included into the final product.
    • Direct Labour: All labor that is used and directly involved in transforming the product’s condition, composition, or construction is referred to as direct labour.
    • Direct Expenses: Those costs that are expressly incurred and that can be directly and entirely attributed to a single good, task, or service (royaltes, interest etc)
  • Indirect Cost:
    • Indirect costs are those costs incurred for those things that aren’t directly related to production. The indirect costs are additional costs incurred for maintaining the administration. Non-traceable expenses are another name for indirect costs.
    • Indirect Material: All materials that are not easily ascribed to particular physical units are referred to as “indirect material”.
    • Indirect Labour: The term “indirect labor” refers to labor that is used to carry out tasks that are incidental to the manufacturing of commodities or for office, sales, and distribution activities.
    • Indirect Expenses: The term “indirect expenses” refers to all costs that cannot be directly and entirely attributed with a specific good, task, or service, except indirect material and indirect labor.

Cost Sheet

• A cost sheet is used to display the breakdown of the costs associated with producing output.
• It is a statement that is created on a regular basis to show the precise costs associated with a cost unit or cost centre.
• A cost sheet displays both the total cost and the numerous costs that make up the total cost.
• A cost sheet’s time frame can be a year, a month, a week, etc.
• The cost sheet performs the following functions:
  • It reveals different cost components.
  • It shows the per-unit cost as well as the total cost of production.
  • It helps with tender price preparation, and it helps with cost comparison.

Overheads

• It consists of the aggregate of indirect costs, indirect labour, and indirect materials.
• Categories and Types of Overheads
  • Production Overheads: (factory or manufacturing overheads). These are the unrelated expenses incurred during the production of a cost unit. Includes indirect materials, indirect labour, maintenance and repairs of production equipment, heat and light, real estate taxes, deprecia- tion, and insurance on manufacturing facilities
  • Office and Administration Overheads: Expenses associated with creating policies and managing activities that are not immediately related to production, sales, distribution, or research and development. Includes executive remuneration, general accounting, secretarial, public relations, and other expenses related to the overall, general management of the business.
  • Selling and Distribution Overheads: Also known as marketing expenses. All expenses incurred to acquire customer orders and deliver the finished product to the customer are considered selling and distribution overhead. Advertising, shipping, payments for salespeople’s wages and commissions, warehouse rent and insurance, sales travel, commissions, salaries, fees for collecting bad debts, and cash discount allowed etc. are a few examples of selling expenses.

Format of Cost Sheet

$Cost Sheet$
$For the period………………$
$Number of units manufactured…….$

Conversion Cost and Prime Cost

• Direct labour and material costs are combined to form the prime cost.
• Direct labour expense and manufacturing overhead expense are added to determine conversion cost.
• The cost of converting raw materials into finished goods is referred to as conversion cost.

1.8 Cost Ascertainment: Cost Unit and Cost Centre

• Cost unit means an individual unit of a good or service for which costs can be determined independently.
• Cost centre means the locations or functions in respect of which costs are accumulated.

Cost Unit

• A unit of cost or cost unit is the amount that can readily be used to assign costs.
• A unit of cost, according to the Chartered Institute of Management Accountants (CIMA), London, is a quantity of a good or service or a period of time that can be used to calculate or represent costs.
• Cost units are tools used to divide costs into more manageable portions.
• Typically, a cost unit will be expressed as a count, weight, dimension, etc.
• The unit of measurement for various product kinds is the cost unit.
• The chosen unit should be clear, straightforward, and frequently used.
• Examples:
  • Electrical Companies: Per unit of electricity generated
  • Brickworks: Per 1,000 bricks manufactured
  • Textile Mills: Per yard or pound of cloth manufactured
  • Transportation: Per passenger km
  • Collieries: Per tonne of coal raised
  • Educational Institutions: Number of Students
  • Printing Press: Per copy or No. of copies
  • Flour: Tonne
  • Carpets: Square foot

Cost Center

• Cost centre is defined as “a location, person, or item of equipment (or collection of these) for which costs may be identified and used for the purpose of cost control” by the Chartered Institute of Management Accountants, London.
• Cost centres are thus one of the practical divisions that have been made for costing purposes to split the entire manufacturing or organisation.
• The smallest area of responsibility or segment of activity for which costs are amassed or determined is known as a cost centre.
• These Cost Centres can be Categorised Production, Service, and Mixed Cost Centres/ Personal and impersonal Cost Centres
  • Production Cost centres are ones that are genuinely producing goods.
  • Service or non-productive cost centres support the productive centres, but they do not produce the goods themselves (administrative division, Department of maintenance and repairs etc)
  • Mixed cost centres are ones that occasionally do both service and production tasks.
• A cost centre is referred to as an operation cost centre if it includes individuals or machines that perform the same task. A cost centre is referred to be a process cost centre if it includes a continuous series of operations.

Cost Drivers: These are underlying factors which causes incurrence of cost related to the activity.

1.9 Summary

• Cost accounting is concerned with the calculation and assessment of resources used for various business activities, often production and service providing. It has to do with fig- uring out cost per unit utilising various costing techniques.
• Management accounting is about getting information from cost accountants and using it for decision-making.

Lesson 2: Overheads

2.1 Learning objectives

• Understanding the concept of overheads
• Comprehend the method of overhead classification
• Discuss the concepts of allocation
• apportionment and re-apportionment Know the varies methods of overhead absorption
• Under the overhead variance and their
  accounting treatment
• Understand the treatment of certain overhead items in costing.

2.2 Introduction

• Overheads are total of all indirect expenses. The term overheads is synonymous with the other terms like supplementary cost. These costs are essential element of the total cost as these are required to be incurred to manufacture the goods.

2.3 Classification of Overheads

• Overheads can be classified on the basis of different criteria such as on element/nature, by function and by behaviour.

On the Basis of Elements/Nature

• Indirect Material: These are those material costs which cannot be traced directly to a cost unit or a cost centre.
• Indirect Labour: Those wages which have to be apportioned or absorbed by the cost units or cost centres since they cannot be directly traced to a cost unit and hence cannot be allocated.
• Indirect Expenses: Those expenses which have to be apportioned or absorbed by the cost centres or cost units are indirect expenses. They cannot be conveniently and directly allocated to a cost centre.

On the Basis of Function

• Production Overheads: Also called factory overheads, works overheads or manufacturing overheads. This consists of indirect material, indirect labour, and indirect expenses. Example oil, grease, stationery
• Office and Administrative Overheads: The expenses incurred in for- mulation of policies and plans, direction and motivation of personnel and accounting, secretarial and financial control of the operations of the organization fall under this category of overheads. General overheads incurred in general administrative office. Example office stationery, directors salary etc
• Selling and Distribution Overheads: Selling overheads are the costs of seeking to creation or stimulation of demand or the cost of securing orders in other words, costs of creating customers and retaining them. Distribution overheads are the costs of making the product available to the customer. That means the cost incurred after the product completion till the time it is delivered to the customer. Example transit insurance, bad debts, warehouse rent

On the Basis of Behaviour

• Fixed Overheads: Do not change with volume of output (rent, insurance, legal expenses).
• Variable Overheads: Change directly with volume of output (indirect material, indirect labour, fuel, light).
• Semi Variable Overheads: Salary of supervisor, repairs, maintenance

2.4 Distribution of Overheads

• Overheads are indirect costs that cannot be directly traced to a product or cost unit and need to be distributed.
• The distribution of overheads includes the pre-determination of overhead rates, distribution to other production units, and determining the differences between the actual overheads incurred. The difference maybe either under-absorption or over absorption.

2.4.1 - 2.4.3 Distribution Procedure:

• The procedure includes collection, departmentalisation, code allotment, distribution to different departments, and absorption to other units.

2.5 Accounting of Factory Overheads

• Collection involves classifying overheads under subheadings and allotting standing order numbers
• Departmentalisation involved departmentalizing the factory overheads and apportioning them to various departments and code allotment.

Departmentalisation will involve Following Steps:

• Primary Distribution of Overheads (Allocation and Apportionment)
  • Allocation: The assignment of whole items of cost to a centre.
  • Re-Apportionment of Service Department Costs: Re-apportion the overheads costs allocated/apportioned to service departments over the other departments involved.

Apportionment Of Service Department Overheads

• Apportion to Production Departments Only
• Apportion to Production and Service Departments
  • Non-Reciprocal basis (step ladder method)
  • Reciprocal basis
    • Simultaneous equations method
    • Repeated distribution method
    • Trial and error method

Absorption of Factory Overheads

• Involves charging each departments costs to the cost units of products manufactured within those departments.
  • Percentage methods
    • Percentage of Direct Material Cost: Overhead rate = Factory overheads/Direct materials *100
    • Percentage of Direct Labour Cost: Overhead rate = Factory overheads/Direct labour cost *100
    • Percentage of Prime Cost: Overhead rate = Factory overheads/Prime cost *100
  • Hourly Rate Methods
    • Direct Labour Hour Rate: Overhead rate = Factory overheads/Direct labour hours
    • Machine Hour Rate: Overhead rate = Factory overheads/Number of machine hours
    • Rate per Unit of Output: Overhead rate = Factory overheads/Number of units

2.6 Types of Overhead Rates

• Overhead absorption rate may be calculated on the basis of actual overheads incurred or the estimated overheads for a period.

Actual Rate or Pre-Determined Rate

• Actual vs. Pre-determined Rate
  • Actual is determined at the end of a period for which is meant to be used and pre-determined is created before a period begins. Predetermined rate = Budgeted Amount/Budgeted base
    Actual Overhead rate = Actual amount of overheads/Actual Base

Blanket Rate or Departmental Rate (Plant wise rate or Plant wide rate

• Blanket Rate
  • A single overhead rate is calculated for the entire factory, termed as blanket rate. Blanket rate=Total overheads for the factory/Total number of units of base for the factory
• Multiple Rate calculated for different departments or cost centers termed as multiple rates. Rate= overhead of the department/corresponding base unit.

2.7 Accounting of Office and Administration Overheads

• Admin overheads can be distributed between production and selling or they can be excluded from the cost of production by charging them to costing profit and loss account or regarded as a separate functional element of cost.

2.7.3 Office and Administration Overheads are Treated as a Separate Functional Element of Cost

• Collection: Classification → Standing Order Numbers.
• Departmentalisation: Distribute over departments and cost centres by those which are identified with are assigned them and the remaining are apportioned

Absorption

• A single blanket rate is calculated on a percentage basis. Various methods to make these calculations are: Percentage of Factory Cost, Conversion Cost and Percentage of Sales

$Administration overhead rate = Total administration cost/Total factory cost *100$
$Administration overhead rate = Total administration overhead/Total conversion cost *100$
$Administration overhead rate =Total administration overhead/Total sales *100$

2.8 Accounting of Selling and Distribution Overheads

• Their accounting treatment is discussed as under
  • Collection of Overheads: Same as discussed earlier under Factory Overheads and Administrative overheads.
  • Departmentalisation of Overheads: costs which can be directly identified with a cost centre is allocated and those which cannot are apportioned.

Overhead Absorption

• These overheads are charged to various production departments, the formula used to calculate the selling and distribution overhead costs is as follows:
  • Rate per Unit of Sales

$Overhead absorption rate = Selling and distribution overheads/Number of units sold$

• Percentage of Sales Value:

$Overhead absorption rate = Selling and distribution overheads /<br /> Sales *100$

• Percentage of Works Cost

$Overhead absorption rate = (Selling and distribution overheads/Total works cost) *100$

2.9 Treatment of Under-Absorption and Over-Absorption of Overheads

• When actual rate is used for overhead absorption, the problem of over or under-absorption does not arise. This is because actual overheads incurred during the period are used to calculate the actual rate.
• But when the pre-determined rates are used, due to use of estimated figures, the amount of overheads absorbed can be either more than, less than or equal to the actual overheads incurred. This leads to under-absorption or over-absorption.

Under-Absorption of Overheads

• Absorbed overheads Rs. 4,000 Actual overheads incurred = 4,500 (Under-Abs)Under-Absorption = Actual Overheads – Overheads Absorbed = Rs. 4,500 – Rs. 4,000 = Rs. 500

Over-Absorption of Overheads:

• When the amount of overheads absorbed is more than the amount of overheads actually incurred.
• Treatment of Under-Absorption or Over-Absorption
  • Supplementary Rate Units of finished stock
    • cost of work in progress
      • cost of sales are multiplied by supplementary rate per unit
  • Write off to Costing P&L Account
    * When the amount is very low
    * Result of abnormal factors
    * Carry over to Next Year

2.10 Concepts Related to Capacity

• Licensed Capacity: The production capacity for which the appropriate authority has issued a license.
• Installed Capacity: The maximum production capacity of the plant that can be achieved only under perfect operating conditions. Also known as rated capacity.
• Practical Capacity (or available capacity or net capacity): It is (maximum capacity) minus the loss of time or output due to certain unavoidable reasons like repairs and maintenance, Sundays and holidays, stock taking, setting up time, etc.
• Actual Capacity: The capacity which is achieved during a given period of time
• Normal Capacity: The average capacity utilization of the plant over a long period of time/ also known as average capacity.
• Idle Capacity: The difference between installed capacity and actual capacity when actual capacity is less than installed capacity.   *Normal: Difference between installed and practical capacity *Abnormal: IT is the difference between practical and actual capacity.
  • Treatment of Costs of Idle Capacity
    • If idle capacity arises as a result of normal factors supplementary rate is used.
    • If idle capacity arises due to abnormal reasons charge to Costing P&L Account.
    • If idle capacity is due to seasonal fluctuations: inflate overhead and charged to cost of production.

2.11 Treatment of Special Items

• Interest on Capital: ( Inclusion vs exclusion on interest has its own viewpoint).
  Arguments for Inclusion: It is the reward for capital just like wages, need for replacement of manual labour and inclusion allows correct decision, ascertainment of true cost of maintaining the stocks.
  Arguments for Exclusion: difficult to ascertain the exact amount of capital employed, inclusion of interest in costing creates complications which are unnecessary and can be avoided.
• Depreciation (Fixed costs and variable costs)
• Packing and material Costs: Classification as primary or secondary materials for product packaging.
• Fringe Benefits: Additional payments or facilities provided to workers (dearness allowance, house rent allowances and other allowances) for Direct and Indirect workers
  *Bad and Debt costs: (Include or exclude in the cost accounts depending to what limit they have occurred.
• Training Expenses: Training is required to guide the new recruits and is charged different cost depending whether it involves a factory worked or office work.
• Expenses on Removal or Re- Erection of Machinery: a result from a major change and is treated and seen as a part of production.
  *Carriage and Cartage Expenses: expenses for transportation of a product (Treated as a direct expense, indirect or to be borne from something abnormal)
  Labour Welfare Expenses: providing food/cantina
  *Night Shift Allowance: Compensation given at night and charged as factor
• Research and Develpment expenses: searching for new products (Charged as office overheads, revenue expenditure etc.)

Lesson 3:Classification of Costs

3.1 Learning Objectives

• Understanding of Different Types of Costs: After learning about cost classification, the student will have a clear understanding of the different types of costs such as direct costs, indirect costs, fixed costs, and variable costs.
• Ability to Differentiate between Direct and Indirect Costs: The student will be able to identify and differentiate between direct costs, which are directly tied to a specific product or service, and indirect costs, which are not tied to a specific product or service.
• Knowledge of Fixed and Variable Costs: The student will have a clear understanding of the difference between fixed costs, which do not change with production levels, and variable costs, which vary with production levels.
• Understanding of Cost Behaviour: The student will be able to analyse the behaviour of costs in different business situations and understand how