Cost Accounting Solved Question Paper 2012 (Old Course)
Dibrugarh University B.Com 4th Sem
1. Outline the steps involved in installing a costing system in a manufacturing unit. What are the essentials of an effective costing system?
Ans: Steps in Installation of a Costing System
The costing system of an organization should be carefully planned in order to achieve its objectives. The important steps for the installation of a costing system are discussed below:
1) Determination of objectives: The first step is to clearly lay down the objectives of the costing system. If the objective is only to ascertain the cost, a simple system will be sufficient. However, if the objective is to get information for decision making, planning and control, a more elaborate system of costing is necessary.
2) Study of the nature of business: The nature of the business and other technical aspects like nature of the products, methods and stages of production cycle should be carefully analyzed. Such an analysis is necessary to decide the method of costing to be adopted. For example, contract costing is suitable for large construction projects. Operating costing is adopted by service industries like transport.
3) Study of the nature of the organization: The costing system should be designed to meet the requirements of the organization. Hence, it is necessary to study the nature, size and layout of the organization. The factors to be considered are:
a. Size of the organization and the size of the departments.
b. The physical layout of the organization.
c. The different levels of management.
d. The extent of decentralization of authority.
e. The nature of authority relationships.
4) Deciding the structure of cost accounts: A suitable costing system can be developed on the basis of the study of the nature of business and organization. The structure of cost accounts should be simple and in accordance with the natural production process.
5) Determination of cost rates: This step involves a thorough study of the following points for developing an integrated costing system.
a. Classification of costs into direct and indirect costs.
b. Grouping of indirect costs (overheads) into production, administration, selling and distribution etc.
c. Methods of pricing issues.
d. Treatment of wastes of all types.
e. Absorption of overheads.
f. Calculation of overhead rates.
6) Organization of the cost office: The cost office is responsible for the efficient operation of the costing system. The cost office, with adequate staff must be located a close as possible to the factory. The following are the major functions of the cots office.
a. Stores accounts.
b. Labour accounting
c. Recording of cost data and
d. Cost control.
7) Further, the role and duties and responsibilities of the cost accountant must be clearly defined. He must have the necessary authority to discharge his duties effectively.
8) Introducing the system: After completion of the above steps, the costing system may be formally introduced. Introduction of the system in an existing organization should be done gradually. Before introduction, the feature of the systems, its working and advantages must be explained to the concerned employees to secure their co-operation.
Or
Explain the term “cost accounting”. How does it contribute to the planning of business operations?
Ans: Introduction to Cost Accounting
Cost: The term ‘cost’ has to be studied in relation to its purpose and conditions. As per the definition by the Chartered Institute of Management Accountants (C.I.M.A.), London ‘cost’ is the amount of actual expenditure incurred on a given thing.
Costing: The C.I.M.A., London has defined costing as the ascertainment of costs. “It refers to the techniques and processes of ascertaining costs and studies the principles and rules concerning the determination of cost of products and services”.
Cost Accounting: It is the method of accounting for cost. The process of recording and accounting for all the elements of cost is called cost accounting. I.C.M.A. has defined cost accounting as follows: “The process of accounting for cost from the point at which expenditure is incurred or committed to the establishment of its ultimate relationship with cost centers and cost units. In its widest usage it embraces the preparation of statistical data, the application of cost control methods and the ascertainment of the profitability of activities carried out or planned”.
Cost Accountancy: The term ‘Cost Accountancy’ includes Costing and Cost accounting. Its purposes are Cost-control and Profitability – ascertainment. It serves as an essential tool of the management for decision-making.
I.C.M.A., has defined cost accountancy as follows: “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. It includes the presentation of information derived there from for the purpose of managerial decision making”.
Advantages of Cost Accounting (Aid to Management)
a) Helps in Decision Making: Cost accounting helps in decision making. It provides vital information necessary for decision making. For instance, cost accounting helps in deciding:
a. Whether to make a product buy a product?
b. Whether to accept or reject an export order?
c. How to utilize the scarce materials profitably?
b) Helps in fixing prices: Cost accounting helps in fixing prices. It provides detailed cost data of each product (both on the aggregate and unit basis) which enables fixation of selling price. Cost accounting provides basis information for the preparation of tenders, estimates and quotations.
c) Formulation of future plans: Cost accounting is not a post-mortem examination. It is a system of foresight. On the basis of past experience, it helps in the formulation of definite future plans in quantitative terms. Budgets are prepared and they give direction to the enterprise.
d) Avoidance of wastage: Cost accounting reveals the sources of losses or inefficiencies such as spoilage, leakage, pilferage, inadequate utilization of plant etc. By appropriate control measures, these wastages can be avoided or minimized.
e) Highlights causes: The exact cause of an increase or decrease in profit or loss can be found with the aid of cost accounting. For instance, it is possible for the management to know whether the profits have decreased due to an increase in labour cost or material cost or both.
f) Reward to efficiency: Cost accounting introduces bonus plans and incentive wage systems to suit the needs of the organization. These plans and systems reward efficient workers and improve productivity as well improve the morale of the work -force.
g) Prevention of frauds: Cost accounting envisages sound systems of inventory control, budgetary control and standard costing. Scope for manipulation and fraud is minimized.
h) Improvement in profitability: Cost accounting reveals unprofitable products and activities. Management can drop those products and eliminate unprofitable activities. The resources released from unprofitable products can be used to improve the profitability of the business.
i) Preparation of final accounts: Cost accounting provides for perpetual inventory system. It helps in the preparation of interim profit and loss account and balance sheet without physical stock verification.
j) Facilitates control: Cost accounting includes effective tools such as inventory control, budgetary control and variance analysis. By adopting them, the management can notice the deviation from the plans. Remedial action can be taken quickly.
2. “Store ledgers are essential to an efficient costing system.” Give your views on this statement highlighting the uses and values of stores ledgers.
Ans: Stores ledger: Stores ledger is a manual or computer record of the raw materials and production supplies stores in a production facilities. It is maintained by the person responsible for these assets, such as the warehouse manager. A stores ledger is particularly useful for maintaining perpetual inventory system, since its tracks the current quantity of item in hand.
A store ledger can be used for the following purposes:
a) By auditors, to see ho0w well the company’s inventory records compare to its on-hand quantities.
b) By purchasing staff to determine when and what quantities to purchase additional inventory items.
c) By the accounting staff, to use as the basis for calculating the ending cost of inventory on hand.
d) Reconciliation of store ledger balance means to compare the actual quantity of inventory in store with the quantity which is showing by sore ledger.
e) Store ledger is helpful to apply the perpetual inventory system.
f) When we get the book information of inventory items in store through store ledger, it can be easily compare with physical quantity of inventory.
Or
Your factory buys and uses a component for production at Rs. 10 per piece. Annual requirement is 2000 number of pieces. Carrying cost of inventory is 10% per annum and ordering cost is Rs. 40 per order. The purchase manager argues that as the ordering cost is very high, it is advantageous to place a single order for the entire annual requirement. He also says that if 2000 pieces are ordered at a time, 3% discount can be obtained from the supplier. Evaluate the proposal and make your recommendation.
3. In a factory, Ram and Shyam produce the same product using the same input of same material and at the same normal wage rate. Bonus is paid to both of them in the form of normal time wage rate adjusted by the proportion in which time saved bears to the standard time for the completion of the products. The time allotted to the product is fifty hours. Ram takes 30 hours and Shyam takes 40 hours to produce the product. The factory cost of the product for Ram is Rs. 3100 and for Shyam is Rs. 3280. The factory overhead rate is Rs. 12 per man hour. Calculate (i) normal wage rate, (ii) cost of material used for the product and (iii) the input material if the unit material cost is Rs. 16.
Ans: Overhead in case of Ram= 30hrs x12= Rs. 360
Overhead in case of shyam= 40hrsx 12= Rs.480
Prime cost of Ram’s product= (Rs.3100-Rs.360) = Rs.2740
Prime cost of shyam’s product= (Rs.3280-Rs.480) = Rs.2800
As the material cost of both the cases is equal difference in prime cost of Rs. 60 (i,e Rs 2800-Rs.2740) is due to difference in labour cost.
Suppose wage rate per hour = A
Labour rate is determined by the following equation: (40A+40Ax10/50)-(30A+30Ax30A x20/50)=Rs60
By solving this equation, the value of A=Rs.10
Therefore, wages rate= Rs. 10per hours.
Total wages of ram=30x10+30x10x20/50=Rs 420
Total wages of shyam=40x10+40x10x10/50=Rs.480
Material cost =prime cost-labour cost
Ram = Rs. 2740-Rs420= Rs.2320
Shyam =Rs.2800-Rs.480= Rs.2320
Quantity of material= Rs2320/16=45 units
Or
Distinguish between normal and abnormal idle time. How would you deal with each of them in cost accounting?
Ans: Idle time refers to the labour time paid for but not utilized on production. It, in fact, represents the time for which wages are paid, but during which no output is given out by the workers. This is the period during which workers remain idle.
Types of Idle Time and its treatment:
a. Normal idle time is inherent in any job situation and thus it cannot be eliminated or reduced. For example: time gap between the finishing of one job and the starting of another; time lost due to fatigue etc. The cost of normal idle time should be charged to the cost of production. This may be done by inflating the labour rate. It may be transferred to factory overheads for absorption, by adopting a factory overhead absorption rate.
b. Abnormal idle time is defined as the idle time which arises on account of abnormal causes; e.g. strikes; lockouts; floods; major breakdown of machinery; fire etc. Such an idle time is uncontrollable. The cost of abnormal idle time due to any reason should be charged to Costing Profit & Loss Account.
Difference between normal and abnormal loss:
Difference between normal idle time and abnormal idle time:
Bases
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Normal Idle time
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Abnormal Idle time
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1. Source
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It arises due to internal factors.
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It arises due to external factor.
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2. Nature
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It is recurring in nature.
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It is accidental in nature.
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3. Estimation
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It can be estimated in advance from the past experience.
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It cannot be estimated in advance.
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4. Access to insurance
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It is not insurable loss.
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It is insurance loss.
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5. Avoidance
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It is unavoidable loss.
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It is avoidable.
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4. What do you mean by under absorption and over absorption of production overhead? How do they arise? How are they arise? How are they treated in cost accounts?
Ans: Absorption of Overheads
The most important step in the overhead accounting is ‘Absorption’ of overheads. CIMA defines absorption as, ‘the process of absorbing all overhead costs allocated or apportioned over a particular cost center or production department by the units produced.’ In simple words, absorption means charging equitable share of overhead expenses to the products. As the overhead expenses are indirect expenses, the absorption is to be made on some suitable basis. The basis is the ‘absorption rate’ which is calculated by dividing the overhead expenses by the base selected. A base selected may be any one of the basis given below. The formula used for deciding the rate is as follows,
Overhead Absorption Rate = Overhead Expenses/ Units of the base selected.
Over or under absorption of overheads meaning:
Overhead expenses are usually applied to production on the basis of predetermined rates. The pre-determined rate may present estimated or actual cost. The actual overhead cost incurred and overhead applied to the production will seldom be the same. But due to certain reasons the difference between two may arise.
Over absorptions: If the amount applied exceeds, the actual overhead, it is said to be an over absorption of overheads.
Under absorption: If the amount applied is short fall of the actual overhead in production it is said to be the under absorption of overheads. The over or under absorption of overheads may be termed as overhead variance.
Reason of over or under-absorption of overheads: The under or over-absorption of overhead arises due to following reasons:
a) Errors in estimating overheads.
b) Overhead may change due to change in method of production.
c) The seasonal fluctuation in overhead cost in some industries.
d) Under utilization of available capacity, unexpected change in the volume of out put.
e) Valuation of work in progress in wrong process.
Treatment of under and over absorption of overheads
Once the under/over absorption is noticed, the following corrective steps are to be taken to rectify the same.
a) Use of supplementary Rate: The under/over absorption can be rectified by using the supplementary rate. This rate is calculated by dividing the under/over absorbed amount of overheads by the units of the base. The rate so arrived is known to be supplementary rate.
b) Carrying forward to future period: If the amount of under/over absorption of overheads is small, it may be carried forward to the future period hoping that it will be rectified in the future.
c) Writing off to Profit and Loss A/c: Amount of under/over absorption can be written off to Costing Profit and Loss Account and thus not reflected in the total costs.
Or
What do you understand by codification of overheads? What are the essential characteristics of a good system of codification? Enumerate various methods of codification.
Ans: Codification of Overheads
Codification is a process of representing each item by a number, the digits of which indicate the group, the subgroup, the type and the dimension of the item. It is always advisable to codify the overhead expenses. Codification helps in easy identification of different items of overheads. There are numerous items of overheads and a code number to each one will facilitate identification of these items easily. Codification can be done by allotting numerical codes or alphabetical codes or a combination of both. Whatever system is followed, it should be remembered that the system is simple for understanding and easy to implement without any unnecessary complications.
Objectives of Codification:
The main objectives of codification of overheads are:
1. To group items of overheads of similar nature as these may be apportioned using the same basis.
2. To facilitate allocation and apportionment of overheads to different departments or cost centres.
3. To have analysis of overhead expenses for control purposes.
4. To reduce the task of maintaining a huge number of accounts.
5. To help the task of machine accounting system in a large organisation.
Requirements of a System of Codification of Overhead Expenses:
The basic requirements of a system of codification of overhead expenses are:
1. It should classify the expenses according to nature, object or function in order to distinguish each element or group from the other.
2. It should be simple and easy to comprehend, it should be easy to memorise.
3. It should be concise and preferably numerical to facilitate mechanisation of accounts.
4. It should be flexible i.e. there should be enough provision for inclusion of new items.
5. It should conform to the statutory requirements as specified in the Scheduled VI of the Companies Act.
6. It should be economical and according to the needs of the concern.
7. It should facilitate the process of allocation, apportionment and absorption of overheads.
Advantages of Codification
1. It enables systematic grouping of similar items and avoids confusion caused by long description of the items.
2. It serves as the starting point of implication and standardization.
3. It helps in avoiding duplication of items and results in the minimisation of number of items, leading to accurate records.
4. It helps in allocation and apportionment of overheads to different cost centres.
5. It assists the grouping of overheads for cost control.
6. It helps in reducing clerical efforts to the minimum.
Methods of Codification
There are different methods used for codification. The following are the three important methods used:
1. Numerical Codes Method.
2. Decimal Codes Method.
3. Codes with a Combination of Numbers and Alphabets.
1. Numerical Method: Under this method, numerical codes are assigned to each item of expenses. For example,
100 Indirect labour.
400 Power.
500 Maintenance.
800 Fixed charges.
2. Decimal Codes: Under this method, the whole numbers are allotted to indicate master group and the decimals indicate the sub-group. For example,
Factory Overheads:
1.1.1 Indirect materials.
1.1.2 Consumable stores.
1.1.3 Lubricating oils.
3. Codes with a Combination of Numbers and Alphabet: Under this method the alphabet indicates the main group and the type of expenses is indicated by the numerical. For example,
Rl - Repairs to machinery.
R2 - Repairs to plant.
R3 - Repairs to furniture.
5. Journalise the following transactions assuming that cost and financial accounts are integrated. [ignore narrations]:
Raw material purchased
Direct materials issued to production
Wages paid (30% indirect)
Wages charged to production
Manufacturing expenses incurred
Manufacturing overhead charged to production
Selling and distributive cost
Finished product at cost
Sales
Receipts from customers
Paid to creditors
Closing stock
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150000
112500
90000
75000
63000
69000
15000
150000
225000
52500
82500
Nil
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Or
State the reasons for the difference between the profits shown in the cost accounts and those shown in the financial accounts of an industrial organisation. Explain the need for reconciliation of cost and financial accounts.
Ans: When cost accounts and financial accounts are maintained in two different sets of books, there will be prepared two profit and loss accounts - one for costing books and the other for financial books. The profit or loss shown by costing books may not agree with that shown by financial books. Such a system is termed as, ‘Non-Integral System’ whereas under the integral system of accounting, there are no separate cost and financial accounts. Consequently, the problem of reconciliation does not arise under the integral system.
However, where two sets of accounting systems, namely, financial accounting and cost accounting are being maintained, the profit shown by the two sets of accounts may not agree with each other. Although both deal with the same basic transactions like purchases consumption of materials, wages and other expenses, the difference of purpose leads to a difference in approach in a collection, analysis and presentation of data to meet the objective of the individual system.
Financial accounts are concerned with the ascertainment of profit or loss for the whole operation of the organisation for a relatively long period, usually a year, without being too much concerned with cost computation, whereas cost accounts are concerned with the ascertainment of profit or loss made by manufacturing divisions or products for cost comparison and preparation and use of a variety of cost statements. The difference in purpose and approach generally results in a different profit figure from what is disclosed by the financial accounts and thus arises the need for the reconciliation of profit figures given by the cost accounts and financial accounts.
The reconciliation of the profit figures of the two sets of books is necessary due to the following reasons
a) It helps to identity the reasons for the difference in the profit or loss shown by cost and financial accounts.
b) It ensures the arithmetical accuracy and reliability of cost accounts.
c) It contributes to the standardization of policies regarding stock valuation, depreciation and overheads.
d) Reconciliation helps the management in exercising a more effective internal control.
Reasons for disagreement between Profits as per financial accounting and Profits as per cost accounting:
The difference in the profitability of cost and financial records may be due to the following reasons.
A. Items included in the financial accounts but not in cost accounts.
1) Purely financial income- such as interest received on bank deposits, interest and dividend on investments, rent receivables, transfer fee received, profit on the sale of assets etc.
2) Purely financial charges – such as losses due to scraping of machinery, losses on the sale of investments and assets, interest paid on the bank loans, mortgages, debentures etc., expenses of company’s transfer office, damages payable at law etc.
3) Appropriation of profit – the appropriation of profit is again a matter which concerns only financial accounts. Items like payment of income tax and dividends transfer to reserve, heavy donations, writing off of preliminary expenses, goodwill and patents appear only in profit and loss appropriation account and the costing profit and loss a/c is not affected.
B. Items included in cost accounts only: There are certain items which are included in cost accounts but not in financial accounts. They are: Charges in lieu of rent where premises are owned, interest on capital employed in production but upon which no interest is actually paid.
C. Under/Over absorption of overhead expenses: In cost accounts, overheads are absorbed at predetermined rates which are based on past data. In the financial accounts the actual amount incurred is taken into account. There arise a difference between the actual expenses and the predetermined overheads charged to product or job.
If overheads are not fully recovered, which means that the amount of overheads absorbed in cost accounts is less than the actual amount, the shortfall is called as under recovery or under absorption. If overhead expenses recovered in cost accounts are more than that of the actually incurred, it is called over absorption. Thus, both the over and under recovery may cause the difference in the profits of both the records.
D. Different basis of stock valuation: In cost accounts, the stock of finished goods is valued at cost by FIFO, LIFO, average rate, etc. But, in financial accounts stocks are valued either at cost or market price, whichever is less.
The valuation of work-in-progress may also lead to variation. In financial books only prime cost may be taken into account for this purpose whereas in cost accounts, it may be valued at prime cost plus factory overhead.
E. Different basis of depreciation adopted: The rates and methods of charging depreciation may be different in two sets of accounts.