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Question 01. With help of two suitable example, Explain following concept under operating
costing in case of a transporter (Hotel / Hospital)
Solution:-
1. Fixed Cost / Standing Cost
Fixed costs are those costs that do not change based on production levels, while variable
costs increase or decrease based on production.
Fixed costs can be assets like buildings and equipment. For example, a beverage company
that bottles water is going to need a physical building and an assembly line that includes
specialized equipment. If we assume the building and equipment are leased, there is a
monthly payment for each of them. The company is responsible for paying 100% of the
monthly payments whether they produce one case of bottled water or 10,000 cases of
bottled water.
It is important to note that fixed costs are NOT always the same. Like the price of
anything, they can change - sometimes unpredictably and sometimes on a regular
schedule, but they do so based on some other factor, NOT the level of production.
Fixed costs are one part of the total cost formula. The formula used to calculate costs is
FC + VC(Q) = TC, where FC is fixed costs, VC is variable costs, Q is quantity, and TC is
total cost
It is important to understand that variable costs, as opposed to fixed costs, are those costs
that change based on the amount of product being produced. For example, our bottled
water company has a variable cost in bottles. The more bottled water they produce, the
higher their cost associated with bottles will be.
2. Variable Cost/ Running Cost:
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Variable costs are expenses that fluctuate proportionally with the quantity of output.
Variable costs are directly tied to the activities of producing volume, which rises when
these activities increase and falls when activities decrease. This effect can be related to
materials, labor, and sales commissions.
For example, if you produce spark plugs, the copper used in production is a variable cost.
This means if you stop producing spark plugs, you would no longer have the cost of
copper. Additionally, regardless of how many spark plugs you produce, the price of
copper for one spark plug remains unchanged.
Formula - Variable Cost
The formula to calculate variable cost is:
Total Variable Cost = Total Quantity of Output X Variable Cost Per Unit of Output.
Example :- HOSPITAL COSTING:
A concern of most countries is health sector resources: the sources of finance for health
services, the ability to maintain past funding levels, resource allocation patterns, and the
efficiency of health services delivery. In aggregate terms,
• hospitals utilize nearly half of the total national expenditure for the health sector;
• hospitals commonly account for 50 to 80 percent of government recurrent health sector
expenditure:
• hospitals use a large proportion of the most highly trained health personnel
A hospital is engaged in providing various types of medical services to the patients.
Hospital costing is applied to decide the cost of these services. A hospital may have following
departments for providing various types of services:
1
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. Outdoor Patient Dept. (O.P.D)
2. Indoor Patient Department (Medical Wards).
3. Medical Services Department:
• X – Ray Department,
• Scanning Centre,
• Pathology Laboratory,
• Sonography Department.
4. General Services Departments:
• Bolier House,
• Power House,
• Catering department,
• Laundry Room,
• Administrative Department,
5. Miscellaneous Services Departments:
• Transport Department,
• Dispensary Department,
• General Porting Department.
UNIT OF COST:
The common units of costs of various departments in a hospital are as follows:
Department Unit of Cost
1. Outdoor Patient Department Per out-patient
2. Indoor Patient Department per Room-day
3. X – Ray Department Per 100 units
4. Scanning centre Per case
5. Pathology Laboratory Per 100 Requests
6. Laundry Department Per 100 items laundered
7. Catering Department Per Patient per week
The cost of hospital is divided into fixed and variable costs. Fixed costs include
staff salaries, depreciations of building, rent of building whereas variable cost
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include light and power, water, laundry charges, food supplied to patients etc.
COST SHEET FOR MONTH/YEAR
A.
B
C.D.E.
FIXED STANDING COSTSSalaries to staff ………….Premises Rent ………….Repairs and maintenance ………….General administration Expenses .…………Cost of Oxygen, X-Ray, etc. .…………Depreciation .……….. RUNNING OR VARIABLE COSTSDoctor’s fees …………Food …………Medicines …………Diagnostic Services …………Laundry .………..Hire charges for Extra Beds .……….TOTAL OPERATING COSTNO. OF PATIENTS DAYSCOST PER PATIENT DAY (C)+(D)
xxxxxxxxxxxx
xxxxxxxxxxxx
XX
XXXXXXXX
Illustration 1:
Apollo Hospital runs an Intensive Care Unit in a hired building at a rent of Rs.
7500 p.m. The Hospital has undertaken to bear the cost of repairs and
maintenance.
The Intensive Care Unit consists of 35 beds and 5 more beds can be conveniently
accommodated whenever required. The permanent staff attached to the unit is as
follows:
2 Supervisors, each at a salary of Rs. 2500 p.m., 4 Nurses each at a salary of Rs.
2000 p.m., 4 Ward boys each at a salary of Rs.500 p.m.
Though the unit was open for the patients all the 365 days in a year but it was
found that only 150 days in a year, the unit has the full capacity of 35 patients
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per day and for another 80 days it had on an average 25 beds only occupied per
day. But there were occasions when the beds were full, extra beds were hired
from outside at a charge of Rs. 10 per bed per day. This did not come to more
than 5 beds extra above the normal capacity any one day. The total hire charges
for the extra beds incurred for the whole year amounted to Rs. 7500.
The unit engaged expert doctors from outside to attend on the patients and fees
were paid on the basis of the number of patients attended and time spent by them
on an average worked out to Rs.25000 per month in the year 2013.
The other expenses for the year were as under:
Repairs and Maintenance (Fixed) Rs. 8100
Food supplied to patients (Variable) Rs. 88000
Janitor and Others Services for patients (Variable) Rs. 30000
Laundry Charges for their bed linen (Variable) Rs.60000
Medicines supplied (Variable) Rs. 75000
Cost Oxygen, X – Ray, etc., other
Then directly borne for treatment of patients (Fixed) Rs. 108000.
General Administration Charges allocated
To the unit (Fixed) Rs. 100000
1. Calculate the profit per patient day made by the unit in the year 2003 if the
unit recovered on the overall amount of Rs. 200 per day on an average from each
patient.
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2. The unit wants to work on a budget for the year 2004, but the number of
patients requiring intensive care is a very uncertain factory.
Solutions:
Calculation of No. of Patients days:
35 beds * 150 days = 525025 beds * 80 days = 2000Extra bed days 7500 / 10 = 750 8000
STATEMENT OF COST
Particulars Rs Rs
1. Income Received (Rs. 200 * 8000 Patient days)1600000
2. Variable Costs (Marginal Costs) Per Annum:
Food 88000
Janitor charges 30000
Laundry Charges 60000
Medicines supplied 75000
Doctors Fees (25000 *12) 300000
Hire Charges for extra beds 7500 560500
Contribution 1039500
3. Fixed costsa. Salaries:
Supervisors (2 * 2500 * 12) Nurses (4 * 2000 *12) Ward Boys (4 * 500 * 12)
600009600024000
b. Rent (7500 *12) 90000
c. Repairs and Maintenance 8100
d. Cost and oxygen etc. 108000
e. General Administration 100000 486100
553400
Profit per Patient-day = 553400 / 8000 patients’ days
= Rs. 69.175
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Illustration:
Care Hospital operates a fitness center to provide counseling on nutrition,
exercise and health care for major surgery patients after their release from the
hospital. Average patient will make three visits to the center. Each visit lasts 40
minutes.
The hospital has estimated the following costs of operating the center:
Particulars Amt
Occupancy costs per monthClerical costs per month Other costs per monthMedication charges per patientRecords charge per patientStaffing cost per visitComputer record update per visit
18000120004000441693
Hospital expects to have an average of 500 visits per month. What should be the
amount charged to each patient in order to cover the above costs?
Solution:
Particulars Amt
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Indirect cost per month
Occupancy
Clerical
Other costs
A. Indirect costs per visit ( 34000/500)
Staffing cost per visit
Computer record update per visit
Total costs per visit
Visits per patient
B. Total cost per patient
Records charge per patient
Medication change per patient
C. Total average cost per patient
C. Or per patient (60+80) per visit
18000
12000
4000
3400
68
9
3____
80
3____
240
16
44____
300
3. Absolute Tonne – Km.
Absolute ton-kms is standard unit of measuring absolute units. Absolute
(weighted average) units are calculated by the total of tone-kms (or
quintal-kms, tone-mile etc), arrived by multiplying the distance with the
respective weight carried.
Absolute tone-km = Distance x Respective weight
4. Commercial Tonne – Km.
Commercial ton-kms is standard unit of measuring Commercial units.
Commercial (simple average) units are calculated by multiplying average
weight carried with the total distance travelled.
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Commercial tone-km = Average weight x Total distance
Example:
A truck starts with a load of 10 tonnes of goods from station P. It unloads 4
tonnes at station Q and rest of the goods at station R. It reaches back directly
to station P after getting reloaded with 8 tonnes of goods at station R. The
distance between P to Q to R and then R to P is 40 Kms, 60 Kms and 80
Kms respectively. Compute Absolute Tonnes-Kilometers and Commercial
Tonnes- Kilometer.
Absolute Tonnes-Kilometers
= (10 tonnes*40km) + (6 tonnes*60km) + (8
tonnes*80 kms)
= 1400
Commercial Tonnes-Kms = Average Load × Total Kms Travelled
= 10+6+8/3 Tonnes×180 Kms.
= 1,440 Tonnes-Kms
Example
A lorry starts with a load of 20 tonnes of goods from station A. It unloads 8
tonnes at station B and rest of goods at station C. It reaches back directly to
station A after getting reloaded with 16 tonnes of goods at station C. The
distance between A to B, B to C and then from C to A are 80 kms, 120 kms.,
and 160 kms., respectively. Compute ‘Absolute tonnes-kms.,’ and
‘Commercial tonnes-kms.
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Solution:
Absolute tonnes-kms. = 20 tonnes × 80 kms + 12 tonnes × 120 kms +16
tonnes × 160 kms.
= 5,600 tonnes-kms.
Commercial Tonnes-kms. = Average load × total kilometres travelled16
tonnes
=(20+12+16)/3) × 360 kms.
= 5,760 tonnes-kms.
5. Effective Passengers Kms:
Effective Kms = Run × Load = (One way trip (Km.) × Trip per day × Days
operated) × (Carriage capacity × Usage rate)
In case of passenger transport, Carriage capacity is in terms of seats; and
Cost unit is Effective Kilometers Per Passenger.
In case of goods transport, Carriage capacity is in terms of Tonnes; and Cost unit
is Effective Kilometers Per Tonne.
6. Cost Per Passenger Kms:
Cost Per Passenger Kms = Operating Cost ÷ Effective Kilometres
Example
From the following information calculate total kms and total passengers
Kms
No. of Buses=6
Days Operated in the month=25
Trips mage by each bus = 4
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Distance of route 20 Kms (one way)
Capacity of Bus = 40 passengers
Normal passenger travelling 90% of capacity.
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Solution:
Total Kms covered = Run
Distance * Two ways * No. of trips * No. of days * No. of buses
20 Kms * 2 * 4 *25 * 6 = 24000 Kms
Total passenger-Kms. Covered = Run * Load
Load = Maximum capacity* Used capacity = 40 * 90% = 36
Total Passenger Kms Covered = 24000*36
= 864000
Question 02. We help of suitable example. Explain how the decisions are made by
management under following situation.
1. Decision regarding optimum product mix.
When a factory manufactures more than one product, a problem is faced by management as to
which product mix will give maximum profits. The best product mix is that which yields the
maximum contribution. The products which give the maximum contribution are to be retained
and their production should be increased. The products, which give comparatively less
contribution, should be reduced or closed down altogether. The effect of sales mix can also be
seen by comparing the P/V ratio and breakeven point. The new sales mix will be favourable if it
increases P/V ratio and reduced the breakeven point.
Illustration: A manufacturer with an overall capacity of one lakh machine hours
(interchangeable among products) has so far been producing a standard mix of 15,000 units of
product A, 10,000 units of Product B and C each. The total expenditure exclusive of fixed
charges is Rs. 2.09 lakhs and variable cost ratio among the products approximates
1:1.5:1.75respectively per unit. The fixed charges came to Rs. 2.00 per unit. When the unit
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selling prices are Rs. 6.25 for A, Rs 7.50 for B and Rs. 10.50 for C, he incurs a loss. He desires to
change the product mix as under:
Mix 1 Mix 2 Mix 3A 18,000 15,000 22,000B 12,000 6,000 8,000C 7,000 13,000 8,000
As an accountant what mix will you recommend ?
Solution:
(i) Computation of variable cost per unit
Total variable cost of Rs. 2,09,000 will be apportioned among the three products in the following
ratio:
A 15,000 x 1= Rs.15000: B 10,000 x 1.5 = Rs. 15000 C 10,000 x 1.75 = Rs. 17,500
or 6:6:7
Hence, total variable cost of each product will be
A: 2,09,000 x 6/19 = Rs.66,000
B: 2,09,000 x 6/19 = Rs.66,000
C: 2,09,000 x 7/19 = Rs.77,000
And per unit variable cost of each product:
A: 66,000/15000= Rs. 4.40 per unit
B: 66,000/10,000 = Rs.6.60 per unit
C: 77,000/ 10,000 = Rs. 7.70 per unit
(ii) Computation of contribution per unit of each product:
Product A Product B Product CSelling Price 6.25 7.50 10.50Variable Cost 4.40 6.60 7.70Contribution 1.85 0.90 7.80
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(iii) It is assumed that the fixed cost of Rs. 70,000 (35,000 unit of present mix at Rs. 2) remains
constant for all proposed mixes.
Comparative profitability statement to evaluate here product mixes.
Product Contribut
ion rate
per unit
Mix 1 Mix 2 Mix 3Units Total
Contributio
n
Units Total
Contributio
n
Units Total
Contribution
A
B
C
1.85
0.90
2.80
18000
12000
7000
33300
10800
19600
15000
6000
13000
27750
5400
36400
22000
8000
8000
40700
7200
22400Contribution 63700 69550 70300Less: Fixed
Charges
70000 70000 70000
Profit/(Loss) (6300) (450) 300
Note: It is evident from the above statement that Mix 3 gives the maximum total contribution
and gives a net profit of Rs.300 after recovering fixed cost hence Mix 3 is recommended.
2. Decision regarding Make or Buy
Make-or-Buy Business Decision or Make or buy decisions arise in business when a company
must decide whether to produce goods internally or to purchase them externally. This typically is
an issue when a company has the ability to manufacture material inputs required for its
production operations that are also available for purchase in the marketplace. For example, a
computer company may need to decide whether to manufacture circuit boards internally or
purchase them from a supplier.
When analyzing a make or buy business decision, it is necessary to look at several factors. The
analysis must examine thoroughly all of the costs related to manufacturing the product as well as
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all the costs related to purchasing the product.Such analysis must include quantitative factors and
qualitative factors. The analysis must also separate relevant costs from irrelevant costs and look
only at the relevant costs. The analysis must also consider the availability of the product and the
quality of the product under each of the two scenarios.
A concern can utilize its idle capacity by making component parts instead of buying them from
market. In arriving at such a make or buy decision, the price asked by the outside suppliers
should be compared with the marginal cost of producing the component parts. If the marginal
cost is lower than the price demanded by the outside suppliers, the component parts should be
manufactured in the factory itself to utilize unused capacity. Fixed expenses are not taken in the
cost of manufacturing component parts on the assumption that have been already incurred, the
additional cost involved is only variable cost.
Factors that influence Make or Buy Decision
In make or buy decision the following cost and non‐cost factors must be considered:
1. Cost Factors:
(1) Availability of plant facility
(2) The space required for production
of item.
(3) Any special machinery or
equipment required.
(4) Cost of acquiring special know
how required for the item
(5) Any transportation involved due
to location of production
(6) As to labour factors like
availability of required labour, sheet
required and other must be kept in
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view.
(7) As to overhead expenses,
adoption of lease for apportioning
them must be taken into
consideration including other factors.
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2. Non‐Cost Factors:
(1) In favour of making, the factors
like:
Secrecy of company
production
Ideal facility available
Tax considerations
Quality and stability of
market supply
(2) In favour of buying factors:
Lack of capital required
Wide selection
Passing know how to
suppliers or not
Uneven production of end
product.
(3) The outside supplier should not
be competitor.
(4) In case there are large fluctuation
in demand, it is better to purchase
from outside, but if demand is likely
to increase substantially own
production may lead to lower cost
latter.
Illustration: (Make or Buy Decision) Auto Parts Ltd. has an annual production of 90,000
units for a motor component. The component cost structure is as below:
Materials Rs. 270 per unitLabour (25% fixed) 180 per unitExpenses:Variable 90 per unitFixed 135 per unitTotal 675 per unit(a) The purchase manager has an offer from a supplier who is willing to supply the
component at Rs.540. Should the component be purchased and production stopped?
(b) Assume the resources now used for this component's manufacture are to be used to
produce another new product for which the selling price is Rs.485.In the latter case the
material price will be Rs.200 per unit. 90,000 units of this product can be produced at the
same cost basis as above for labour and expenses. Discuss whether it would be advisable to
divert the resources to manufacture that new product, on the footing that the component
presently being produced would, instead of being produced, be purchased from the market.
Solution: Rs.Material 270Labour (75% of Rs.180) 135Variable expenses 90 . Total variable cost when component is produced 495Suppliers price 540Excess of purchase price over variable cost = 540 – 495 = Rs.45 (a) Fixed expenses are not
affected whether the component is made or purchased. Thus company should make the
component itself because if purchased from outside it will have to pay Rs.45 per unit more
and on 90,000 units @ Rs.45 it comes to Rs.40,50,000.
(b) Cost implications of proposal to divert available production facilities for a new product:
Rs.Selling price of per unit of new product 485
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Less: Variable costs Material 200Labour 135Expenses 90 425Contribution per unit 60
Loss if present component is purchased = 540 – 495 = Rs.45.
If company diverts the resources for the production of a new product, it will benefit by Rs.15
(i.e. Rs.60 – 45) per unit. On 90,000 units it will save @ Rs.15 i.e. Rs.13,50,000. Thus, it is
advisable to divert the production facilities in the manufacture of the new product and the
component presently being manufactured should be bought from outside. This will result in
additional profit of Rs.13,50,000.
3. Decision regarding accept/reject a special order
One issue likely to be appropriate to all managers at some time in their careers is whether to
accept what we will refer to as a special order. By this we mean, ‘Are there circumstances in
which it might make sense in financial terms to sell products or services at a lower price than
normal, or alternatively, to provide a service internally at less than its full cost?’
In considering such decisions, it is most important to be quite clear about the meaning of the
term full cost. In many organisations external and internal prices for products and services are
generated with reference to the full or total cost of its provision plus a percentage margin, a
practice known as cost-plus pricing. Within the full cost, there will usually be allocated and
apportioned fixed overheads required to be covered, irrespective of whether a special order is
accepted. Such non-relevant costs must be ignored since the criteria for accepting a special
order must only consider whether the direct benefits which result, exceed those costs that
could be avoided by not taking it.
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Such evidence, as exists from surveys of pricing, reveals that some organisations do accept
special orders using some form of the contribution analysis, although the bias towards its use
is not as significant as many textbooks would imply.
You should be aware that the acceptance of a special order with reference to direct costs and
benefits can be problematic if it generates a special order ‘culture’. If all orders are priced as
special, how will fixed overheads ever be recovered!
There are also other considerations to be taken into account that may have financial
consequences. For example, if it became widely known that special orders were negotiable
then the subsequent marketing and selling of products, or services, may be far more difficult,
and require a good deal more effort to be expended than currently.
Generally speaking, a special contract should not be accepted if it will affect consumer
behavior adversely within the same marketplace. General knowledge of the availability of
special orders may well lead to "consumer games" with the supplier. Special orders might
relate to Government contracts or customers in a separate market segment; possibly in an
overseas market.
4. Decisions regarding Key or Limiting Factor – Raw Material
A key factor is that factor which puts a limit on production and profit of a business. Usually
the limiting factor is sales. A concern may not be able to sell as much as it can produce. But
sometimes a concern can sell all it produces but production is limited due to shortage of
materials, labour, plant capacity or capital. In such a case, a decision has to be taken
regarding the choice of the product whose production is to be increased, reduced or stopped.
When there is no limiting factor the choice of the product will be on the basis of the highest
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P/V ratio. But when there are scarce or limited resources, selection of the product will be on
the basis of contribution per unit of scarce factor of production.
Illustration:
A company manufactures and markets three products A, B and C. All the three products are
made from the same set of machines. Production is limited by machine capacity. From data
given below indicate priorities for products A, B and C with a view to maximizing profits.
Product A Product B Product CRaw Material Cost per unit Rs.2.25 Rs.3.25 Rs. 4.25Direct Labour cost per unit Re.0.50 Re.0.50 Re 0.50Other variable cost per unit Re. 0.30 Re.0.45 Re.0.71Selling price per unit Rs.5.00 Rs.6.00 Rs.7.00Standard machine time required per unit 39 minutes 20 minutes 28 minutesIn the following year the company faces extreme shortage of raw materials. It is noted
that 3kg, 4kg and 5 kg of raw materials are required to produce one unit of A, B and C
respectively. How would products priorities change?
Solution
ProductsCurrent Year A B CSelling price per unit 5.00 6.00 7.00Less Marginal cost per unitRaw materials cost 2.25 3.25 4.25Direct labour cost 0.50 0.50 0.50Other variable cost 0.30
3.050.45 4.20
0.71 5.46
Contribution per unit 1.95 1.80 1.54Standard machine timerequired per unit (minutes)
39 20 28
Contribution per machine Minute
5 paise 9 paise 5 ½ paise
Priorities for products III I IIFollowing yearRaw materials required to produce one unit
3 kg 4 kg 5 kg
Contribution per kg of raw 65 paise 45 paise 30.80 paise
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MaterialPriorities for products I II III
5. Decisions regarding Limiting factor and key factor- Labour
Example:
Sausage makes two products, the Mash and the Sauce. Unit variable costs are as follows.
Mash SauceRs. Rs.
Direct materials 1 3Direct labour (Rs.3 per hour) 6 3Variable overhead 1 1
8 7
The sales price per unit is Rs.14 per Mash and Rs.11 per Sauce. During July the available
direct labour is limited to 8,000 hours. Sales demand in July is expected to be as follows.
Mash 3,000 unitsSauce 5,000 unitsRequired:
Determine the production budget that will maximize profit, assuming that fixed costs per
month are Rs.20,000 and that there is no opening inventory of finished goods or work in
progress.
Solution:
1. Determine the limiting factor
Mash Sauces TotalLabour hours per unit 2 hrs 1 hrSales demand 3,000 units 5,000 unitsLabour hours needed 6,000 hrs 5,000 hrs 11,000 hrsLabour hours available 8,000 hrsShortfall 3,000 hrs
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Labour is the limiting factor on production.
2. Identify the contribution earned by each product per unit of scarce resource, that is, per
labour hour worked.
Mash SauceRs. Rs.
Sales price 14 11Variable cost 8 7Unit contribution 6 4Labour hour per unit 2 hrs 1 hrContribution per labour hour (= per unit of limiting factor) Rs.3 Rs.4Ranking 2 1
3. Determine the budgeted production and sales.
Product Units Hours needed Contribution per unit TotalRs. Rs.
Sauces 5,000 5,000 4 20,000Mashes (Bal.) 1,500 3,000 6 9,000
8,000 29,000Less: fixed costs 20,000Profit 9,000Conclusion:
(1) Unit contribution is not the correct way to decide priorities.
(2) Labour hours are the scarce resource, therefore contribution per labour hour is the correct
way to decide priorities.
(3) The Sauce earns Rs.4 contribution per labour hour, and the Mash earns Rs.3 contribution
per labour hour. Sauces therefore make more profitable use of the scarce resource, and should
be manufactured first.
6. Decisions regarding Limiting factor and key factor- Machine Hours
In the examples which we have examined so far, the selection of alternative courses of action
has been made on the basis of seeking the most profitable result. Business enterprises are
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limited in the pursuit of profit by the fact that they have limited resources at their disposal, so
that quite apart from the limitation on the quantities of any product which the market will buy
at a given price, the firm has its own constraints on the volume of output. Hence at a given
price, which may be well above costs of production, the firm may be unable to increase its
overall profit simply due to its inability to increase its output.
The limiting factors which affect the level of production may arise out of shortages of labour,
material, equipment and factory space to mention but a few obvious examples. Faced with
limiting factors of whatever nature, the firm will wish to obtain the maximum profit from the
use of the resources available, and in making decisions about the allocation of its resources
between competing alternatives, management will be guided by the relative contribution
margins which they offer. Since the firm will be faced with limiting factors, however, the
contribution margins must be calculated not in terms of units of product sold which fail to
reflect constraints on the total volume of output, but should be related to the unit of quantity
of the most limited factor. A simple example will serve to explain this point.
ExampleMultiproduct Ltd manufactures three products about which is derived the following data:Product Machine hours required per unit - Margin per unit - Margin per mac. hour
A 3 hours Rs.9.0 Rs.3.0
B 2 hours Rs.7.00 Rs.3.5
C 1 hour Rs.5.00 Rs.5.0
The three products can be made by the same machine, and on the basis of this information, it is evident that product C is the most profitable product yielding a contribution of Rs.5 per machine hour, as against product A, which shows the smallest contribution per machine hour.
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Hence, in deciding how to use the limiting factor the firm should concentrate on the production of product C, rather than products A and B. If there were no limits to the market demand for product C, there would be no problem in deciding which product to produce-it would be product C alone.
Firms undertake the manufacture of different products because the market demand for any one product is limited, so that firms seek to find that product-mix which will be the most profitable. Let us assume that the maximum weekly demand for the three products and the total machine capacity necessary to meet this demand is as follows:
Product Maximum demand in Machine hours - Product units equivalents
A 100 300
B 100 200
C 100 100
This product-mix reflects the order of priority in allocating machine use to the products with the highest contribution margin per hour. Product C receives the highest priority, then product B, and lastly product A. If machine hours were further limited to 300 hours, the firm would cease to make product A.
For example, if raw material is the limiting factor, the profitability of each product is
determined by contribution per Kg of raw material. If machine capacity is a limiting factor
then contribution per machine hour is calculated. It electricity is the limiting factor, then
contribution per unit of electricity of each product is calculated.
Question 03. Differentiate between Non- integral accounting system and Integral
accounting system on the basis of following points-
a) Nature and Features
b) Advantages of each system of Accounts
c) Books to be maintained in each system of accounts.
Solution:-
I. Nature and Features
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A. Non-Integrated Accounting System
It is a system of accounting under which separate ledgers are maintained for cost and
financial accounts by Accountants. This system is also referred to as cost ledger accounting
system. Under such a system the cost accounts restricts itself to recording only those
transactions which relate to the product or service being provided. Hence items of expenses
which have a bearing with sales or, production or for that matter any other items which are
under the factory management are the ones dealt with in such accounts. This leads to the
exclusion of certain expenses like interest, bad debts and revenue/income from ‘other than the
sale of product or service’.
A special feature of the non-integrated system of accounts is its ability to deal with
notional expenses like rent or interest on capital tied up in the stock. The accounting of
notional rent facilitates comparisons amongst factories (some owned and some rented).
Non-Integrated Accounting Systems contain fewer accounts when compared with financial
accounting because of the exclusion of purchases, expenses and also Balance Sheet items like
fixed assets, debtors and creditors. Items of accounts which are excluded are represented by
an account known as Cost ledger control account.
B. Integrated (or Integral) Accounting System
Integrated Accounts is the name given to a system of accounting, whereby cost and financial
accounts are kept in the same set of books. Obviously, then there will be no separate sets of
books for Costing and Financial records. Integrated accounts provide or meet out fully the
information requirement for Costing as well as for Financial Accounts. For Costing it
provides information useful for ascertaining the Cost of each product, job, process, operation
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of any other identifiable activity and for carrying necessary analysis. Integrated accounts
provide relevant information which is necessary for preparing profit and loss account and the
balance sheets as per the requirement of law and also helps in exercising effective control
over the liabilities and assets of its business.
The following are the essential features of an integral an accounting system:
1. This system records financial transitions not normally required for cost accounting be sided
recording internal costing transaction prepayments and accruals are opened.
2. Stores transactions are recorded in the stores control account.
This account is debited with the cost of stores purchased corresponding credit being given to
cash or sundry creditors depending whether the purchase is made for cash or on credit.
3. Wages control account is debited with the wages paid, contra credit is taken in cash or bank
account
4. Overhead expenses are debited to the overhead control account, corresponding credit being
given to cash or band account or the sundry creditors.
5. Transactions relating to material, labour cost overheads are posted in the stores wages and
overhead control account after making suitable cost analysis and tat the end of the period
transfer of the totals is made to the work in progress accounts by crediting various control
accounts. The day to day cost analysis made for this purpose is known as making third etc.
These entries do not mean entries in the same sense a entry of transaction in the ledger but
such entries are simply a sort of cash analysis.
6. All advance payments are credited and accruals debited to the respective control account
by contra entries in the prepayments and accrual accounts.
7. Capital asset account is debited and respective control accounts are credited in the process
of cost analysis of capital expenditure.
II. Advantages of each system of Accounts
A. Non-Integrated Accounting System
The following are some of the advantages of interlocking accounting system:
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a) When separate set of costing books are maintained it facilitates ready accomplishment of
its objectives’ If avoids the complications or recording the entries if it is integrated with
financial accounts.
b) It can be maintained according to convenience as it need not be statutorily maintained
The following are some of the limitations
a) When cost accounts are independently maintained, it amounts to duplication of expenses
along with financial accounts.
b) The profit shown by cost books may vary with that shown by financial accounts. This
requires reconciliation which involves time and effort.
B. Integrated Accounting System
The following are the main advantages of integral accounting:
a. There is no need to reconcile the profit ascertained by the cost accounts with that of
financial accounts since only one profit and loss account is prepared from the information
recorded in the cost accounts.
b. There is no duplication of recording and effort as in non integral system and as such this
system is simple and economical.
c. This system tends to coordinate the functions of different selections of the accounts
department since all efforts are integrated and directed towards achievement of one aim that
is providing a high level of efficiency.
d. The accounting procedures can be simplified and the system can be centralised with the
object of achieving a greater control over the organization.
e. The system creates conditions which are eminently suitable for the introduction of
mechanized accounting.
f. There is no possibility of overlooking any expense under the system .
g. As cost accounts are posted straight from the books of original entry, there is no delay in
obtaining the data.
h. There is automatic check on the correctness of the cost data. It ensures that all legitimate
expenditure is included in Cost accounts and reliable and proved data is provided to the
management for its decisions’.
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i. Integrated accounting widens the outlook of the accountant and his staff ad they can take
broader view of things.
III. Books to be maintained
A. Non-Integrated Accounting System
Subsidiary books maintained under interlocking system of accounting:
The following are some of the subsidiary books maintained under interlocking system of
accounting:
1) Stores ledger; this ledger is used to record both the quantity and amount of receipts, issues
and balance of materials and supplies. The basis for recording the transactions are (a)
Materials received note (b) Material transfer note, and (d) Material returned note.
2) Payroll and wage analysis book; this ledger is used to record the wages. The basis for
recording the transactions are (a) clock cards,(b)time tickets, and (c)piece work tickets
3) Job ledger: this ledger is used to record the material cost, wages, and overheads incurred in
respect of a job.
4) Finished goods stock ledger: This ledger is used to record the receipt of finished goods
from production department, the sale and stock of finished goods both in terms of quantity
and value.
The basis for recording the transactions is delivery note issued by the production
departments, sales returns note and sales order requisitions.
5) Standing order ledger: This ledger is used to record overheads incurred.
Accounts Maintained Under Cost Books
The following important accounts are maintained under cost books:
1) General ledger adjustment account: This ledger is also known as cost ledger control
account or nominal ledger control account. In this accounts transactions with only one entry
is recorded and contra appears in financial book. On the credit side of this account are
recorded
(a) Opening Balance of materials, work in progress and finished stock, (b) expenses of
material, wages and overheads on the credit side, (c) on the debit side returns of materials to
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the supplier, (d) sales income: and (e) on the debit side balancing entries of P&L accountant
closing stock.
2) Stores ledger control account: the total of stores ledger is entered in this account.
3) Wages control account: In this account the wages accrued and paid and allocation of wages
in this account are recorded.
4) Work in progress control account: This account represents cost ledger in summary form.
5) Finished goods stock ledger control account: This account represents finished goods stock
ledger transactions in total form.
6) Selling, distribution, and administration overhead control account:”This account represents
selling, distribution and administration overheads
B. Integrated Accounting System
In non-integral system, a cost control account or general ledger adjustment account is used in
cost ledger. In this system, general ledger adjustment account is eliminated and detailed
accounts for assets and liabilities are maintained. In other words, following accounts are used
for “General Ledger Adjustment Account” of non-integrated system:
(a) Bank account
(b) Debtors account
(c) Creditors account
(d) Provision for depreciation account etc.
In integrated system, all accounts necessary for showing classification of cost will be used
but the general ledger adjustment account of non-integrated accounting is replaced by use of
following accounts:
(a) Bank account
(b) Debtors account
(c) Creditors account
(d) Provision for depreciation
account
(e) Fixed assets account
(f) Share capital account
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Accounts to be opened in the Integral Accounting System are as
follows:-
1. Store ledger control
account
2. Wages control account
3. Factory Overheads
Control Account
4. Work in Progress
Control Account
5. Office and
Administrative
Overheads Control
Account
6. Finished Goods Control
Account
7. Selling and Distribution
Overheads Control
Account
8. Cost of Sales Account
9. Sales Account
10. Costing Profit and Loss
Account
11. All remaining accounts.
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Question 04 :- With the help of example, prepare journal and various ledger accounts under Integral Accounting System and Non- Integral Accounting System.Solution:-I. Integral Accounting System Following transactions took place in Lovely & Co. during the month of March, 2013 :1. Raw material purchased on credit 40,0002. Direct material issued to production 30,0003. Wage paid (30% indirect) 24,0004. Manufacturing expenses incurred (cash) 16,8005. Manufacturing overhead charged to production 16,0006. Selling and distribution cost (cash) 4,0007. Finished goods at cost 40,0008. Sales 58,0009. Receipts from debtors 13,80010. Payments to creditors 22,000You are required to journalise the above transactions.Solution:-
Lovely & Co.Journal (Integral Accounting System)
Dr. Cr.1. Stores Control A/c Dr. 40,000
To Creditors A/c 40,000(Being the raw material purchased on credit)
2. Work-in-progress A/c Dr. 30,000
To Stores Control A/c 30,000(Being the material issued to jobs)
3. (a) Wages Control A/c Dr. 24,000
To Cash 24,000(Being the entry for direct and indirect wages paid) 3. (b) Work-in-progress A/c Dr. 16,800
Production overhead A/c Dr. 7,200To Wages Control A/c 24,000
(Being the entry for direct and indirect wages)4. Production overhead A/c Dr. 16,800
To Cash 16,800(Being the production overhead incurred)
5. Work-in-progress A/c Dr. 16,000
To Production overhead A/c 16,000(Being the overhead charged to production)
6. Selling and Distribution overhead A/c Dr. 4,000
To Cash 4,000(Being the selling and distribution expenses Incurred)
7. Finished goods A/c Dr. 40,000
To work-in-progress A/c 40,000(Being the cost of production of finished goods)
8. Debtors A/c Dr. 58,000
To Sale A/c 58,000(Being the amount of sale)
9. Bank A/c Dr. 13,800
To Debtors A/c 13,800(Being the receipt from debtors)
10. Sundry Creditors A/c Dr. 22,000
To Cash 22,000(Being the amount paid to creditors)
II. Non- Integral Accounting System or Cost Ledger Accounting SystemFrom the following balances and transactions extracted from the books of East-West
Company Ltd., journalize and write up the accounts in the cost ledger and prepare a trial
balance as at 31st December 2014. Also show the profit or loss for the month:
Dr. Cr. Balances as on 1.12.2014:
Work-in-progress a/c 5,200Finished goods a/c 2,300Factory overhead suspense a/c 50Office overhead suspense a/c 30Stores ledger control a/c 1,150General ledger adjustment a/c 8,730
8,730 8,730 Transactions for the month were: Rs.Direct wages 7,500Indirect wages 500Works overhead absorbed in production 2,200Office overhead absorbed in production 1,200Stores issued to production 4,900Goods finished during the month 18,000Finished goods sold 21,000Stores purchased 5,000Stores issued to factory repair orders 200
Carriage inwards on stores issued for production 80Factory expenses 1,450Office expenses 1,170Solution:
JOURNAL ENTRIES1. Work-in-progress ledger control a/c Dr. 5,200
Finished goods ledger control a/c Dr. 2,300Factory overhead suspense a/c Dr. 50Office overhead suspense a/c Dr. 30Stores ledger control a/c Dr. 1,150
To general ledger adjustment a/c 8,730(Being the opening entries for the balances)
2. Stores ledger control a/c Dr. 5,000
To general ledger adjustment a/c 5,000(Being stores purchased)
3. Work-in-progress ledger control a/c Dr. 4,980
To stores ledger control a/c 4,980(Being the stores issued to production Rs. 4,900 andcarriage inward on stores issued Rs. 80)
4. Factory overhead control a/c Dr. 200
To stores ledger control a/c 200(Being stores issued to factory repairs)
5. Work-in-progress ledger control a/c Dr. 7,500
To wages control a/c 7,500(Being direct wages charged to production)
6. Factory overhead control a/c Dr. 500
To wages control a/c 500(Being indirect wages charged to factory overhead)
7. Wages control a/c Dr. 8,000
To general ledger adjustment a/c 8,000(Being the total wages brought into costing book fromfinancial books)
8. Factory overhead control a/c Dr. 50
To factory overhead suspense a/c 50(Being the latter transferred to former a/c)
9. Factory overhead control a/c Dr. 1,450
To general ledger adjustment a/c 1,450(Being the actual factory expenses brought into costing books)
10. Work-in-progress ledger control a/c Dr. 2,200
To factory overhead control a/c 2,200(Being the overheads charged to production)
11. Office overhead control a/c Dr. 30
To office overhead suspense a/c 30(Being suspense a/c transferred to former a/c
12. Office overhead control a/c Dr. 1,170
To general ledger adjustment a/c 1,170(Being the actual office overheads brought into costingbooks)
13. Work-in-progress ledger control a/c Dr. 1,200
To office overhead control a/c 1,200(Being the office overheads charged to production)
14. Finished goods control a/c Dr. 18,000
To work-in-progress ledger control a/c 18,000(Being the work-in-progress transferred to former a/c)
15. Cost of sales a/c Dr. 20,300
To finished goods control a/c 20,300(Being the finished stock transferred to former a/c)
16. Costing profit & loss a/c Dr. 20,300
To cost of sales a/c 20,300(Being cost of sales transferred to profit & loss a/c)
17. General ledger adjustment a/c Dr. 21,000
To costing profit & loss a/c 21,000(Being the amount of sales brought into costingprofit & loss a/c)
18. Costing profit & loss a/c Dr. 700
To general ledger adjustment a/c 700(Being the amount of profit)
COST LEDGERGENERAL LEDGER ADJUSTMENT A/C
To costing P & L a/c 21,000 By balance b/d 8,730To balance c/d 4,050 By stores ledger control a/c 5,000
By wages control a/c 8,000By factory overhead control a/c 1,450By office overhead control a/c 1,170By costing P & L a/c 700
25,050 25,050
STORES LEDGER CONTROL ACCOUNTTo balance b/d 1,150 By WIP ledger control a/c 4,980To general ledger adjustment a/c 5,000 By factory overhead control a/c 200
By balance c/d 970
6,150 6,150
WAGES CONTROL ACCOUNTTo general ledger adjustment a/c 8,000 By WIP ledger control a/c 7,500
By factory overhead control a/c 5008,000 8,000
FACTORY OVERHEAD CONTROL ACCOUNTTo stores ledger control a/c 200 By WIP ledger control a/c 2,200To wages control a/c 500To factory overhead suspense a/c 50To general ledger adjustment a/c 1,450
2,200 2,200
OFFICE OVERHEAD CONTROL ACCOUNTTo office overhead suspense a/c 30 By WIP ledger control a/c 1,200To general ledger adjustment a/c 1,170
1,200 1,200
WORK-IN-PROGRESS LEDGER CONTROL ACCOUNTTo balance b/d 5,200 By finished goods control a/c 18,000To stores ledger control a/c 4,900 By balance c/d 3,080To wages control a/c 7,500To factory overhead control a/c 2,200To office overhead control a/c 1,200
21,080 21,080
FINISHED GOODS CONTROL ACCOUNTTo balance b/d 2,300 By cost of sales a/c 20,300To WIP ledger control a/c 18,000
20,300 20,300
COST OF SALES ACCOUNTTo finished goods control a/c 20,300 By costing P & L a/c 20,300
COSTING PROFIT & LOSS ACCOUNTTo cost of sales a/c 20,300 By general ledger adjustmentTo general ledger adjustment a/c a/c (sales) 21,000(profit) 700
21,000 21,000
TRIAL BALANCE AS ON 31.12.2014Dr. Cr.
General ledger control a/c 4,050Stores ledger control a/c 970WIP ledger control a/c 3,080
4,050 4,050
Reference/ Bibliography
• © 20142015 e Notes MBA
• http://icmai.in/
• ICAI Institute
• Advanced Cost Accounting MCom Sem II
Sheth Publishers Pvt. Ltd.
L. N. Chopde
• Advanced Cost Accounting – Manan Prakashan
• Search Engine – www.google.com
