Study Note - 3

COST ACCOUNTING STANDARDS

This Study Note includes

3.1 Preface to Cost Accounting Standards (CASs)

3.2 Objective and Functions of Cost Accounting Standards Board
3.3 CAS 1-24 as issued by The Institute of Cost Accountants of India

3.1 PREFACE TO COST ACCOUNTING STANDARDS

The council of the Institute of Cost Accountants of India, has constituted ‘Cost Accounting Standards
Board’ (CASB) with the objective of formulating Cost Accounting Standards, after recognizing the
need for structured approach to the measurement of cost so as to provide guidance to the user
organizations, government bodies, regulators, research agencies, academic institutions and others to
achieve uniformity and consistency in classification, measurement and assignment of costs.

The composition of the CASB will be broad based and ensure participation of all interest groups in the
standard setting process. The chairman of the CASB will be nominated by the council of the Institute.
Apart from six members of the council nominated on the CASB the following will be represented on
the CASB :-

(a) A nominee of the Central Government representing Ministry of Corporate Affairs.

(b) Adviser (Cost), Cost Audit Branch, Ministry of Corporate Affairs, Government of India.

(c) A nominee of the Central Government representing the Central Board of Excise and Customs,
Government of India.

(d) A nominee of the Central Government representing the Central Board of Direct Taxes.

(e) Two members of the institute representing leading companies.

(f) Four nominees from regulators i.e. CAG, RBI, SEBI, IRDA,TRAI...etc.

(g) Two nominees from professional institutions i.e. ICAI and ICSI.

(h) Three nominees of industry associations viz ASSOCHAM, CII, FICCI....etc.

(i) Two nominees from academic institutions like IIM, MDI, Universities...etc.

(j) Four eminent practicing members of the institute.

(k) President is authorized to include a maximum of two eminent persons having knowledge and
expertise in the Cost and Management Accounting / Accounting Standards not falling under the
categories as defined in the constitution.

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Cost Accounting Standards

3.2 OBJECTIVES AND FUCNTIONS OF THE COST ACCOUNTING STANDARDS BOARD

The objectives of the CASB are to develop high quality Cost Accounting Standards to enable the
management to take informed decisions and to enable regulators to function more effectively by
integrating, harmonizing and standardizing Cost Accounting Principles and Practices.
The following will be the functions of the CASB :-
(a) To issue the framework for the Cost Accounting Standards.
(b) To equip the Cost & Management Accounting professionals with better guide lines on cost
Accounting Principles.
(c) To assists the members in preparation of uniform cost statements under various statutes.
(d) To provide from time to time interpretations on Cost Accounting Standards.
(e) To issue application guidance relating to particular standard.
(f) To propagate the Cost Accounting Standards and to persuade the users to adopt them in the
preparation and presentation of general purpose Cost Statement.
(g) To persuade the government and appropriate authorities to enforce Cost Accounting Standards,
to facilitate the adoption thereof, by industry and corporate entities in order to achieve the desired
objectives of standardization of Cost Accounting Practices.
(h) To educate the users about the utility and the need for compliance of Cost Accounting
Standards.
Overview of Cost Accounting Standards issued till date are as follows:

CAS No Title Objective

CAS 1 Classification of Cost For preparation of Cost Statements.
CAS 2 Capacity Determination To bring uniformity and consistency in the principles and
methods of determination of capacity with reasonable
accuracy.
CAS 3 Production and To bring uniformity and consistency in the principles and methods
Operation Overheads of determining the Production or Operation Overheads with
reasonable accuracy.
CAS 4 Cost of Production for To determine the assessable value of excisable goods used for
Captive consumption captive consumption.
CAS 5 Average (Equalized) To determine averaged / equalized transportation cost.
Cost of Transportation
CAS 6 Material Cost To bring uniformity and consistency in the principles and
methods of determining the Material Cost with reasonable
accuracy in an economically feasible manner.
CAS 7 Employee Cost To bring uniformity and consistency in the principles and
methods of determining the Employee Cost with reasonable
accuracy.
CAS 8 Cost of Utilities To bring uniformity and consistency in the principles and
methods of determining the Cost of Utilities with reasonable
accuracy.
CAS 9 Packing Material Cost To bring uniformity and consistency in the principles and
methods of determining the Packing Material Cost with
reasonable accuracy.

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CAS 10 Direct Expenses To bring uniformity and consistency in the principles and
methods of determining the Direct Expenses with reasonable
accuracy.
CAS 11 Administrative Overheads To bring uniformity and consistency in the principles and
methods of determining the Administrative Overheads with
reasonable accuracy.
CAS 12 Repairs and Maintenance To bring uniformity and consistency in the principles and
Cost methods of determining the Repairs and Maintenance Cost
with reasonable accuracy.
CAS 13 Cost of Service Cost To bring uniformity and consistency in the principles and
Centre methods of determining the Cost of Service Cost Centre with
reasonable accuracy.
CAS 14 Pollution Control Cost To bring uniformity and consistency in the principles and
methods of determining the Pollution Control Costs with
reasonable accuracy.
CAS 15 Selling and Distribution To bring uniformity and consistency in the principles and
overheads methods of determining the selling and Distribution over- heads
with reasonable accuracy
CAS 16 Depreciation and To bring uniformity and consistency in the principles and
Amortisation methods of determining the Depreciation and Amortisation
with reasonable accuracy.
CAS 17 Interest and Financing To bring uniformity and consistency in the principles, methods of
Charges. determining and assigning the Interest and Financing Charges
with reasonable accuracy.
CAS 18 Research and To bring uniformity and consistency in the principles and
Development Costs methods of determining the Research, and Development Costs
with reasonable accuracy and presentation of the same.
CAS 19 Joint Costs To bring uniformity and consistency in the principles and
methods of determining the Joint Costs.
CAS 20 Cost Accounting To bring uniformity and consistency in the principles and
Standard on Royalty and methods of determining the amount of Royalty and Technical
Technical Know- How Fee Know-how Fee with reasonable accuracy.
CAS 21 Cost Accounting To bring uniformity, consistency in the principles, methods of
Standard on Quality determining and assigning Quality Control cost with reasonable
Control accuracy.
CAS 22 Cost Accounting To bring uniformity and consistency in the principles and
Standard on methods of determining the Manufacturing Cost of excisable
Manufacturing Cost goods
CAS 23 Cost Accounting To bring uniformity and consistency in the principles and
Standard on Overburden methods of determining and assigning Overburden Removal
Removal Cost Cost including those requiring attestation.
CAS 24 Cost Accounting To bring uniformity and consistency in the principles and
Standard on Treatment methods for treatment of revenue in cost statements with
of Revenue in Cost reasonable accuracy.
Statements
*Limited Revision 2017 [CAS 6, 7, 8, 9, 10, 11, 12, 13, 14, 16, 17, 20, 21, 22, 23 & 24]
Each of the Cost Accounting standards has been explained in brief as follows

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Cost Accounting Standards

3.3 CAS 1-24 as issued by The Institute of Cost Accountants of India

CAS – 1 COST ACCOUNTING STANDARD ON “CLASSIFICATION OF COST”

This standard deals with the principles of Classification of Cost for determining the cost of a product or
service.

Objective
The objective of this standard is to bring uniformity and consistency in the principles of Classification of
Cost for disclosure and presentation in the cost statements of a product or service.

Scope
This standard shall be applied to cost statements, which require classification, presentation and
disclosure of cost including those requiring attestation.

Principles of Classification of Costs

Costs shall be classified by the process of grouping the components of cost under a common
designation on the basis of similarities of nature, attributes or relations. Items grouped together under
common heads shall be further classified according to their fundamental differences.
Scheme of classification shall be such that every item of cost is classified.
Classification of Costs

(a) By Nature of expenses

(b) By nature of traceability to a cost object

(c) By function

(d) By nature of behaviour

(e) By nature of production or operation process

CAS – 2 COST ACCOUNTING STANDARD ON CAPACITY DETERMINATION

This standard deals with the principles and methods of determining the capacity of a facility for
producing goods or providing services by an entity. This standard deals with the principles and methods
of classification and determination of capacity of an entity for ascertainment of the cost of product or
service, and the presentation and disclosure in cost statements.
Objective
The objective of this standard is to bring uniformity and consistency in the principles and methods of
determination of capacity with reasonable accuracy.
Scope
This standard shall be applied to the cost statements, including those requiring attestation, which
require determination of capacity for assignment of overheads.
Determination of Capacity: Capacity shall be determined in terms of units of production or services or
equivalent machine or man hours.

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Installed capacity:
Installed capacity is usually determined based on:
(i) Technical specifications of facility.
(ii) Technical evaluation.
(iii) Capacities of individual or interrelated production or operation Centres.
(iv) Operational constraints or capacity of critical machines or equipment.
(v) Number of shifts or machine hours or man hours.
Normal Capacity:
Normal capacity is determined after suitable adjustments to the Installed Capacity.
The adjustments may be of the following nature:
(i) Time lost due to scheduled preventive or planned maintenance
(ii) Number of shifts or machine hours or man hours.
(iii) Holidays, normal shut down days, normal idle time,
(iv) Normal time lost in batch change over

CAS-3: COST ACCOUNTING STANDARD ON “PRODUCTION AND OPERATION OVERHEADS”

This standard deals with the principles and methods of determining the Production or Operation
Overheads. This standard deals with the principles and methods of classification, measurement and
assignment of Production or Operation Overheads, for determination of the cost of goods produced
or services provided and for the presentation and disclosure in cost statements.
Objectives
The objective of this standard is to bring uniformity and consistency in the principles and methods of
determining the Production or Operation Overheads with reasonable accuracy.
Scope
This standard shall be applied to cost statements, which require classification, measurement, assignment,
presentation and disclosure of Production or Operation Overheads including those requiring attestation.
Disclosures
The cost statements shall disclose the following:
1. The basis of assignment of Production or Operation Overheads to the cost objects.
2. Production or Operation Overheads incurred in foreign exchange.
3. Production or Operation Overheads relating to resources received from or supplied to related
parties.
4. Any Subsidy, Grant, Incentive or any amount of similar nature received or receivable reduced from
Production or Operation Overheads.
5. Credits or recoveries relating to the Production or Operation Overheads.
6. Any abnormal cost not forming part of the Production or Operation Overheads.
7. Any unabsorbed Production or Operation Overheads.

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Cost Accounting Standards

CAS-4: Cost Accounting Standard on Cost of Production for Captive Consumption

The Cost Accounting Principle for determination of cost of production is well established. Similarly, rules for
levy of excise duty on goods used for captive consumption are also well defined. Captive Consumption
means the consumption of goods manufactured by one division and consumed by another division(s)
of the same organization or related undertaking for manufacturing another product(s). Liability of
excise duty arises as soon as the goods covered under excise duty are manufactured but excise duty
is collected at the time of removal or clearance from the place of manufacture even if such removal
does not amount to sale. Assessable value of goods used for captive consumption is based on cost
of production. According to the Central Excise Valuation (Determination of Price of Excisable Goods)
Rules 2000, the assessable value of goods used for captive consumption is 115% (110% w.e.f. 05-08-
2003) of cost of production of such goods, and as may be prescribed by the Government from time
to time.

Objective

(a) The purpose of this standard is to bring uniformity in the principles and methods used for determining
the cost of production of excisable goods used for captive consumption.

(b) The cost statement prepared based on standard will be used for determination of assessable
value of excisable goods used for captive consumption.

(c) The standard and its disclosure requirement will provide better transparency in the valuation of
excisable goods used for captive consumption.

Scope

The standard is to be followed for determining the cost of production to arrive at an assessable value
of excisable goods used for captive consumption.

Cost of production will include various cost components. They are already defined in Cost Accounting
Standard-1 (‘Classification of Cost’ – CAS-1). Thus, this standard has to be read in conjunction with
standard 1.

CAS-5: Cost Accounting Standard on Determination of Average Cost of Transportation

The Cost Accounting Principles for tracing/identifying an element of cost, its allocation/apportionment
to a product or service are well established. Transportation Cost is an important element of cost
for procurement of materials for production and for distribution of product for sale. Therefore, Cost
Accounting Records should present transportation cost separately from the other cost of inward
materials or cost of sales of finished goods. The Finance Act 2003 also specifies the certification
requirement of Transportation Cost for claiming deduction while arriving at the assessable value of
excisable goods cleared for home consumption/ export. There is a need to standardize the record
keeping of expenses relating to transportation and computation of Transportation Cost.

Objective

(a) To bring uniformity in the application of principles and methods used in the determination of
averaged/equalized Transportation Cost.

(b) To prescribe the system to be followed for maintenance of records for collection of cost of
transportation, its allocation/apportionment to cost centres, locations or products.

(c) To provide transparency in the determination of cost of transportation.

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Scope
This standard should be applied for calculation of cost of transportation required under any statute or
regulations or for any other purpose. For example, this standard can be used for :
(a) Determination of average transportation cost for claiming the deduction for arriving at the
assessable value of excisable goods.
(b) Insurance claim valuation.
(c) Working out claim for freight subsidy under Fertilizer Industry Coordination Committee.
(d) Administered price mechanism of freight cost element.
(e) Determination of inward freight costs included or to be included in the cost of purchases
attributable to the acquisition.
(f) Computation of freight included in the value of inventory for accounting on inventory or valuation
of stock hypothecated with Banks / Financial Institution ...etc.

CAS-6: Cost Accounting Standard on Material Cost [Limited Revision 2017]

This standard deals with principles and methods of determining the Material Cost. Material for the
purpose of this standard includes raw materials, process materials, additives, manufactured / bought
out components, sub-assemblies, accessories, semi finished goods, consumable stores, spares and
other indirect materials. This standard does not deal with Packing Materials as a separate standard is
being issued on the subject.
This standard deals with the principles and methods of classification, measurement and assignment of
Material Cost, for determination of the Cost of product or service, and the presentation and disclosure
in cost statements.
Objective
The objective of this standard is to bring uniformity and consistency in the principles and methods of
determining the Material Cost with reasonable accuracy.
Scope
This standard should be applied to Cost Statements which require classification, measurement,
assignment, presentation and disclosure of Material Costs including those requiring attestation.

CAS-7: Cost Accounting Standard on Employee Cost [Limited Revision 2017]

This standard deals with the principles and methods of determining the Employee Cost. This standard
deals with the principles and methods of classification, measurement and assignment of Employee
Cost, for determination of the cost of product or service and the presentation and disclosure in Cost
Statements.
Objective
The objective of this standard is to bring uniformity and consistency in the principles and methods of
determining the Employee Cost with reasonable accuracy.
Scope
This standard should be applied to cost statements which require classification, measurement,
assignment, presentation and disclosure of Employee Cost including those requiring attestation.

CAS-8: Cost Accounting Standard on Cost of Utilities [Limited Revision 2017]

This standard deals with the principles and methods of determining the Cost of Utilities. This standard

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Cost Accounting Standards

deals with the principles and methods of classification, measurement and assignment of Cost of
Utilities, for determination of the cost of product or service and the presentation and disclosure in Cost
Statements.
Objective
The objective of this standard is to bring uniformity and consistency in the principles and methods of
determining the Cost of Utilities with reasonable accuracy.
Scope
This standard shall be applied to cost statements which require classification, measurement, assignment,
presentation and disclosure of Cost of Utilities including those requiring attestation.
For determining the cost of production to arrive at an assessable value of excisable utilities used for
captive consumption, Cost Accounting Standard 4 on Cost of Production for Captive Consumption
(CAS 4) shall apply. This standard shall not be applicable to the organizations primarily engaged in
generation and sale of utilities. This standard does not cover issues related to the ascertainment and
treatment of carbon credits, which shall be dealt with in a separate standard.

CAS-9: Cost Accounting Standard on Packing Material Cost [Limited Revision 2017]
This standard deals with the principles and methods of determining the Packing Material Cost. This
standard deals with the principles and methods of classification, measurement and assignment of
Packing Material Cost, for determination of the cost of product, and the presentation and disclosure
in Cost Statements. Packing Materials for the purpose of this standard are classified into primary and
secondary packing materials.
Objective
The objective of this standard is to bring uniformity and consistency in the principles and methods of
determining the packing material cost with reasonable accuracy.
Scope
This standard should be applied to cost statements, which require classification, measurement,
assignment, presentation and disclosure of Packing Material Cost including those requiring attestation.

CAS-10: Cost Accounting Standard on Direct Expenses [Limited Revision 2017]

This standard deals with the principles and methods of determining the Direct Expenses. This standard
deals with the principles and methods of classification, measurement and assignment of Direct
Expenses, for determination of the cost of product or service, and the presentation and disclosure in
Cost Statements.
Objectives
The objective of this standard is to bring uniformity and consistency in the principles and methods of
determining the Direct Expenses with reasonable accuracy.
Scope
This standard should be applied to Cost Statements, which require classification, measurement,
assignment, presentation and disclosure of Direct Expenses including those requiring attestation.

CAS-11: Cost Accounting Standard on Administrative overheads [Limited Revision 2017]

This standard deals with the principles and methods of determining the Administrative Overheads.
This standard deals with the principles and methods of classification, measurement and assignment of
Administrative Overheads, for determination of the cost of product or service, and the presentation
and disclosure in Cost Statements.
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Objective
The objective of this standard is to bring uniformity and consistency in the principles and methods of
determining the Administrative Overheads with reasonable accuracy.

Scope
The standard should be applied to Cost Statements, which require classification, measurement,
assignment, presentation and disclosure of Administrative Overheads including those requiring
attestation.

CAS-12: Cost Accounting Standard on Repairs and Maintenance [Limited Revision 2017]
This standard deals with the principles and methods of determining the Repairs and Maintenance Cost.
This standard deals with the principles and methods of classification, measurement and assignment of
Repairs and Maintenance Cost, for determination of the cost of product or service, and the presentation
and disclosure in Cost Statements.

Objective
The objective of this standard is to bring uniformity and consistency in the principles and methods of
determining the Repairs and Maintenance Cost with reasonable accuracy.

Scope
The standard should be applied to Cost Statements, which require classification, measurement,
assignment, presentation and disclosure of Repairs and Maintenance Cost including those requiring
attestation.

CAS-13: Cost Accounting Standard on Cost of Service Cost Centre [Limited Revision 2017]
This standard deals with the principles and methods of determining Cost of Service Cost Centres.
This standard covers the service cost centre and excludes utilities and repair & maintenance costs
dealt with in CAS - 8 & CAS 12 respectively. This standard deals with the principles and methods of
classification, measurement and assignment of Cost of Service Cost Centre, for determination of the
cost of product or service, and the presentation and disclosure in Cost Statements.

Objective
The objective of this standard is to bring uniformity and consistency in the principles and methods of
determining the Cost of Service Cost Centre with reasonable accuracy.

Scope
The standard should be applied to the preparation & presentation Cost Statements, which require
classification, measurement and assignment, of Cost of Service Cost Centres including those requiring
attestation.

CAS-14: Cost Accounting Standard on Pollution Control Cost [Limited Revision 2017]
This standard deals with the principles and methods of determining Pollution Control Cost. This standard
deals with the principles and methods of classification, measurement and assignment of Pollution
Control Costs, for determination of the cost of product or service, and the presentation and disclosure
in Cost Statements.

Objective
The objective of this standard is to bring uniformity and consistency in the principles and methods of
determining the Pollution Control Costs with reasonable accuracy.

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Cost Accounting Standards

Scope
The standard should be applied to Cost Statements, which require classification, measurement,
assignment, presentation and disclosure of Pollution Control Costs including those requiring attestation.

CAS-15: Cost Accounting Standard on Selling and Distribution Overheads

This standard deals with the principles and methods of determining the Selling and Distribution
Overheads.
This standard deals with the principles and methods of classification, measurement and assignment of
Selling and Distribution Overheads, for determination of the cost of sales of product or service, and the
presentation and disclosure in cost statements.

Objective:
The objective of this standard is to bring uniformity and consistency in the principles and methods of
determining the Selling and Distribution Overheads with reasonable accuracy.

Scope:
This standard should be applied to cost statements, which require classification, measurement,
assignment, presentation and disclosure of Selling and Distribution Overheads including those requiring
attestation.

CAS -16 : Cost Accounting Standard on Depreciation and Amortisation [Limited Revision 2017]
This standard deals with the principles and methods of determining Depreciation and Amortisation
Cost.
This standard deals with the principles and methods of measurement and assignment of Depreciation
and Amortisation for determination of the cost of product or service, and the presentation and
disclosure in cost statements.

Objective :
The objective of this standard is to bring uniformity and consistency in the principles and methods of
determining the Depreciation and Amortisation with reasonable accuracy.

Scope :
This standard shall be applied to cost statements which require measurement, assignment, presentation
and disclosure of Depreciation and Amortisation, including those requiring attestation.

CAS-17 : Cost Accounting Standard on Interest and Financing Charges [Limited Revision 2017]
This standard deals with the principles and methods of determining Interest and Financing Charges.
This standard deals with the principles and methods of classification, measurement and assignment of
Interest and Financing Charges.

Objective
The objective of this standard is to bring uniformity and consistency in the principles ,methods of
determining and assigning the Interest and Financing Charges with reasonable accuracy.

Scope
This standard should be applied to cost statements which require classification, measurement,
assignment, presentation and disclosure of Interest and Financing Charges including those requiring
attestation. This standard does not deal with costs relating to risk management through derivatives.

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CAS -18 : Cost Accounting Standard on Research and Development Costs
This standard deals with the principles and methods of determining Research and Development Cost.
This standard deals with the principles and methods of determining the Research, and Development
Costs and their classification, measurement and assignment for determination of the cost of product
or service, and the presentation and disclosure in cost statements.
Objective
The objective of this standard is to bring uniformity and consistency in the principles and methods of
determining the Research, and Development Costs with reasonable accuracy and presentation of
the same.
Scope
This standard should be applied to cost statements that require classification, measurement, assignment,
presentation and disclosure of Research, and Development Costs including those requiring attestation.

CAS-19 : Cost Accounting Standard on Joint Costs

This standard deals with the principles and methods of determining Joint Cost.
The standard deals with the principles and methods of measurement and assignment of Joint Costs
and the presentation and disclosure in cost statement.
Objective
The objective of this standard is to bring uniformity, consistency in the principles, methods of determining
and assigning Joint Costs with reasonable accuracy.
Scope
The standard shall be applied to cost statements which require classification, measurement, assignment,
presentation and disclosure of Joint Costs including those requiring attestation.

CAS-20 : Cost Accounting Standard on Royalty And Technical Know-How Fee [Limited Revision 2017]
This standard deals with the principles and methods of determining the amount of Royalty and Technical
Know-how Fee.
This standard deals with the principles and methods of classification, measurement and assignment
of the amount of Royalty and Technical Know-how Fee, for determination of the cost of product or
service, and their presentation and disclosure in cost statements.
Objective
The objective of this standard is to bring uniformity and consistency in the principles and methods of
determining the amount of Royalty and Technical Know-how Fee with reasonable accuracy.
Scope
This standard should be applied to cost statements, which require classification, measurement,
assignment, presentation and disclosure of the amount of Royalty and Technical Know-how Fee
including those requiring attestation.

CAS-21 : Cost Accounting Standard on Quality Control [Limited Revision 2017]

The standard deals with the principles and methods of measurement and assignment of Quality Control
cost and the presentation and disclosure in cost statement.
Objective
The objective of this standard is to bring uniformity, consistency in the principles, methods of determining
and assigning Quality Control cost with reasonable accuracy.

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Cost Accounting Standards

Scope
The standards shall be applied to cost statements which require classification, measurement,
assignment, presentation and disclosure of Quality Control cost including those requiring attestation.

CAS – 22 : Cost Accounting Standard on Manufacturing Cost [Limited Revision 2017]

This standard deals with the principles and methods of determining the Manufacturing Cost of excisable
goods.
This standard deals with the principles and methods of classification, measurement and assignment for
determination of the Manufacturing Cost of excisable goods and the presentation and disclosure in
cost statements.
Objective
The objective of this standard is to bring uniformity and consistency in the principles and methods of
determining the Manufacturing Cost of excisable goods.
Scope
This standard should be applied to cost statements which require classification, measurement,
assignment, presentation and disclosure of Manufacturing Cost of excisable goods.

CAS 23 Cost Accounting Standard on Overburden Removal Cost [Limited Revision 2017]
The standard deals with the principles and methods of measurement and assignment of Overburden
Removal Cost and the presentation and disclosure in cost statements.
Objective:
The objective of this standard is to bring uniformity, consistency in the principles, methods of determining
and assigning Overburden Removal Cost with reasonable accuracy.
Scope
The standard shall be applied to cost statements which require classification, measurement, assignment,
presentation and disclosure of Overburden Removal Cost including those requiring attestation.

CAS 24 Cost Accounting Standard on Treatment of Revenue in Cost Statements [Limited Revision 2017]
This standard deals with the principles and methods of classification, measurement, treatment and
assignment of revenue and its presentation and disclosure in cost statements.
Objective
The objective of this standard is to bring uniformity and consistency in the principles and methods for
treatment of revenue in cost statements with reasonable accuracy.
Scope
This standard shall be applied to cost statements which require classification, measurement, treatment,
assignment, presentation and disclosure of revenue including those requiring attestation.

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Study Note - 4
COST BOOK KEEPING

This Study Note includes

4.1 Cost Accounting Records, Ledgers and Cost Statements

4.2 Items excluded from Cost and Normal and Abnormal Items/Cost
4.3 Integral Accounts
4.4 Reconciliaton of Cost Accounting Records with Financial Accounts
4.5 Infrastructure, Educational, Healthcare and Port Services

4.1 COST ACCOUNTING RECORDS, LEDGERS AND COST STATEMENTS

COST STATEMENT
In the preceding sections, we have dealt with the basic concepts of costs and the various elements of
costs. We have also seen the different steps followed in determination of cost of a product or rendering
a service. Treatment of various costs has been discussed at length. You are by now very well aware
that the term cost has wide connotations and would not mean anything in isolation. Costs must be
understood if they are to be controlled. Measurement of costs is the first step in the process of control
simply because you cannot control unless you measure. Measurement of cost would mean different
when applied to different industries.
The cost has to be measured with respect to the cost centers first and then at a broader level with
respect to the cost unit. The journey towards the aim of determining cost of a product or service may
take various routes. But the logic is same i.e. collect all relevant costs in the process of converting raw
material into finished product and accumulate the total costs.
To put in simple words, to generate any product or service, resources are needed called as inputs.
Theses inputs are used in a process of conversion. The end result is the output which could either be a
product or a service. The resources consume costs. While determining total cost of resources, the costs
of all resources used (directly or indirectly) in the process are accumulated. This requires establishing
the relationship between the resource and the product or service.

Process - One or many

Input/resources operations - independent Output - Finished
or sequential

Basic law Labour, staff, facilities, utilities

The process of accumulating costs will differ according to the nature of business and the activities carried
out. The common way to accumulate costs is to prepare cost sheets.

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Cost Book Keeping

Cost Accumulation
The logic of Cost Accumulation is to track costs in the same sequence as the resources get used. See
the following flow of activities:
(a) Raw material & other material are purchased and stored
(b) The material is used up in process of conversion
(c) People or machines work upon the material while in the process
(d) The process results into some products that are finished
The cost data needs to be collected along this whole chain that ends when a final product is produced.
The cost accumulation is done based on the source documents which are used in booking the costs.
Depending upon the type of business, a cost unit is determined for which costs must be accumulated.
The departmentalisation of the business organisation is done to suit the production process. For example,
in a fruit processing industry, the costs would be accumulated as per different process involved i.e.
cutting, pulp formation, blending, purifying and final packing. As the physical flow of material happens
from one process to the other, costs are also passed on from one process to the next in line.
As we know all the direct element of cost together make Prime Cost. Sequentially, production overheads
are added to get Factory Cost or Works Cost. Then Administration overheads are added to the Factory
Cost to get Cost of Production. Once the product is ready for sale, the selling and distribution overheads
are added to get Cost of Sales or Cost of Goods Sold. When this is deducted from Sales revenue we
get profit or loss.
Process of accumulation of cost comprises of:
l Identification of costs to the cost centers or departments.
l Apportionment of service costs to production costs.
l Absorption of costs into cost units.

Cost Collection
Cost Collection is the process of booking costs against a particular Cost Account code under a particular
cost center or directly under a cost unit, as the case may be. Source documents are used to generate
the record of the costs incurred or to be incurred. These source documents are properly authorised and
numbered. They act as the primary source of entry. In additions to these documents there could be
other documents and reports such as allocation sheets, labour utilisation reports, idle time & overtime
analysis, scrap reports etc which help in identifying costs. Let us see how the costs are collected.

Material costs
These costs are identified with cost unit with the help of ‘stores issue summary’. In case of job costing,
there will be job-wise summary prepared on the basis of ‘material issue notes’. In case of contracts,
the summary will be made contract-wise. At times instead of procuring & storing material, it may be
procured and directly used on contract site. ‘Purchase Invoice’ may be the basis to capture such direct
material costs. In case of process industry, the material is issued to different processes. Here, the costs
input to a process may be collected based on the cost of materials processed in the previous process. A
process-wise summary of material issues is maintained. Some material may get added to a process but
may not become part of final product. The cost of such material is apportioned on the output of that
process. The indirect material costs may be gathered on the basis of consumable issues, scrap reports,
standard parts list etc. Care should be taken to account for material losses. Normal material losses are

186 COST ACCOUNTING

to be apportioned to the good units produced, whereas, abnormal losses should be excluded from
computation of cost of good units and should be directly taken to P & L Account.

Labour Cost
Salaries and wages summary prepared after the monthly payroll run is the main basis for labour cost
collection. The summary shows department-wise break up, so that the Direct Labour Cost of production
department is separately known and that for the other indirect departments is also available to be
charged as overheads. In case of contracting business, labour force is usually dedicated to various
sites. The cost of labour used on different contracts can be found based on wages sheet maintained
for each contract site. In addition, the idle time reports, overtime reports are used for booking of the
costs of idle time & overtime. In case labourers are common to various jobs or contracts or processes, an
estimate of the time that they spend on each of them is made and the costs are allocated accordingly.

Expenses
Accounting entries in cash book or journal proper help to collect the expenses. Direct expenses which
are job or contract or process specific may be collected on the basis of vouchers. The indirect expenses
are collected and then apportioned in a summarised form using apportionment sheets.

Collection of Budgeted costs

The cost calculation for the selected cost unit could be either of actual cost or budgeted cost. While
actual costs are collected on the basis of documents explained above, the budgeted costs are
computed using the standard bill of material, and predetermined overhead rates. For budgeted direct
material, a bill of material is prepared for each product (including sub-assemblies). This is a quantitative
estimate. Based on the estimates a budgeted material price is considered to value the material cost.
Estimated labour hours are costed using estimated Labour Hour Rates. Pre-determined overheads are
also computed considering the base selected for absorption. Thus an estimate of total cost with full
composition may be made.

Cost Accountant & Cost Data collection

The Cost Accountant must play a pivotal role in ensuring that the process of cost data collection is
very strong. The cost analysis and reporting will not be useful for managerial decision-making if the
data collection process is wrong. Presence of a strong and robust Costing System is needed to ensure
comprehensive data collection process. The Costs Account may carry out periodical checks to evaluate
the system and also may do the Internal Audit. He can use all his expertise in the process of establishing
cost estimates which will help in decision making.
Cost data collected must be reported in proper format to make it more informative and meaningful. As
can be understood, the report must serve the purpose for which it was sought. A complete cost sheet
may not be always necessary. The production manager may require the cost of production only. The
cost report should be able to give this figure separately broken up into all its elements. The sales and
marketing cost may be given for each channel of distribution, customers, regions etc in addition to the
product-wise break up.
The cost data should be collected in a manner that will make available cost information to all those
who are responsible for the costs. A cost sheet should give the figures of each element of cost broken
up into direct and indirect and also according to functions like production, administration and selling
& distribution. It is therefore logical that the format of the Cost Sheet is derived from the requirements
for which it is to be used. Apart from exhibiting the total cost deducted logically, it should highlight
other cost also, so that comparison with budget can be made, variances analysed and cost could be
controlled to increase profits.

COST ACCOUNTING 187

Cost Book Keeping

Cost Sheet Formats & Preparation

The cost concept itself being subjective, there is no standard format in which the collected costs can
be presented. It has to suit the type of business, need of the details, and management’s requirement
of control over costs. Yet a simple way to show the Total Cost of any cost unit is shown below:

Specimen Cost Sheet

Period From …………………… Cost Units

To ……………………………………… …………
Cost Items Amount (`) Amount (`)
Direct Material
Opening Stock xxxxx
Add: Purchases xxxxx
Add: Incidental charges xxxxx
Less: Closing Stock xxxxx xxxxx
Direct Labour xxxxx
Direct Expenses xxxxx
PRIME COST xxxxx
Add: Production Overheads xxxxx
Add: Opening work in process xxxxx
Less: Closing work in process xxxxx xxxxx
FACTORY COST OR WORKS COST xxxxx
Add: Administrative Overheads xxxxx
COST OF GOODS MANUFACTURED xxxxx
Add: Opening Finished goods stock xxxxx
Less: Closing Finished goods stock xxxxx xxxxx
COST OF FINISHED GOODS SOLD xxxxx
Add: Selling & Distribution overheads xxxxx
COST OF GOODS SOLD xxxxx

You can observe the logical way in which the cost flow has been shown in the above chart. The focus
in this specimen is on elements and functions split further into direct and indirect costs with respect to
the cost units. Although the formats could be different, the contents of a cost sheet must be understood
and interpreted correctly so that one can analyse it for control and decision making. For example if it
has to be prepared for a process industry, the format would reflect the portion up to factory cost for
each process separately. Then the administration costs will be added together. The cost per unit will be
computed for every process separately. The stock for processes subsequent to process one will mean
stocks transferred from earlier processes and stocks transferred to the next processes. The objective here
is to compute the cost per process. The cost sheet format here could be:

188 COST ACCOUNTING

Specimen Cost Sheet

Period From ………………… To ………………………………… Cost Units …………

Cost Items Amount (`) Amount (`)
Direct Material
Opening Stock xxxxx
Add: Purchases xxxxx
Add: Incidental charges xxxxx
Less: Closing Stock xxxxx xxxxx
Direct Labour xxxxx
Direct Expenses xxxxx
PRIME COST xxxxx
Add: Production overheads xxxxx
Add: Opening work in process xxxxx
Less: Closing work in process xxxxx xxxxx
FACTORY COST OR WORKS COST xxxxx
Add: Administrative Overheads xxxxx
COST OF GOODS MANUFACTURED xxxxx
Add: Opening Finished goods stock xxxxx
Less: Closing Finished goods stock xxxxx xxxxx
COST OF FINISHED GOODS SOLD xxxxx
Add: Selling & Distribution overheads xxxxx
COST OF GOODS SOLD xxxxx
Depending on number of processes, the working will be shown up to factory cost. Subsequently, the
administration, selling & distribution overheads are added like that shown in the first format. Some process
companies may prepare a different cost sheet for each process. When it is available process wise, control
of process costs and process losses could be better controlled by the concerned process managers.
Important Components of Cost Sheet
(a) Cost sheet has reference to the job or contract or a batch or production or a service undertaken
to be rendered. If the completion of the job at hand relates to more than one accounting period,
it is better that separate columns are provided to mention figures for those period. The job or batch
reference should also be mentioned on the header.
(b) If there is an estimate made for the costs, a separate column must be provided for estimated costs
against which the actual costs should be plotted to get ready comparison. This will make cost sheets
more user-friendly and meaningful.
(c) In certain cases, material may not form any significant portion of the total cost and as such may
be treated as an overhead item. In such cases, the Prime Cost will mainly constitute as labour and
other expenses.
(d) Treatment of raw material stocks should be carefully understood. As the costs are to be linked to
the units produced, the material consumption, completion of earlier period’s semifinished goods
and the finished goods sold needs to be properly computed.
Raw Material Consumed: Opening Stock + Purchases – Closing Stock
One has to go into the depth of this arithmetical formula. Where do we get the figure of purchases
from? It is from the suppliers invoices for purchase of stockable material. It also should include all charges
incidental to purchase of goods like carriage, insurance, customs duty etc. which is directly associated
with the incoming material.

COST ACCOUNTING 189

Cost Book Keeping

As we know that the stocks are always valued at cost or market price whichever is less. This norm has
to be applied to the rates of all the items of material in stock, and then the total valuation of stock is
done. The stock ledger records all receipts and issues of the quantity and rate of material items. The
valuation of material issues has to be properly done based on correctly chosen method of issue pricing.
This summary figure as per the issue column should exactly match with the raw material consumed figure
as included in the cost sheet.
The normal losses on account of material shortages must be included in the cost of raw material
consumed. Care should be taken to remove the abnormal losses there from.
(e) Treatment of work in process is another important step. If the format is carefully seen, it will be noticed
that the cost of WIP stocks is adjusted specifically after adding Factory Overheads! Why adjusted?
And why at that stage only? Please note that Cost Sheet is prepared for a period of time for a cost
unit. At the beginning of that period, if the job has been carried forward from the previous period,
there may be some partly finished work that is carried forward. At the same time there may be
partly finished production at the end of current period. These stocks must be adjusted to reflect
the cost consumed during the current period. Further, the work in process is normally valued at
Factory Cost. It does not include Administration Overheads as the production of goods is not yet
fully complete. Administration costs are absorbed at the stage of finished production. Hence the
adjustment of WIP stocks is to be done before adding the Administration Overheads.
(f) Similarly, the adjustment for the opening and closing stocks of finished goods should be done. This
has to be done after the stage of cost of production.
(g) One could have separate columns for total costs and per unit costs side by side. This will help have
a quick glance at the per unit figures. Management at operating level will find this very helpful.

Illustration 1
Following data is available from the cost records of a company for the month of March 2017:
(1) Opening stock of job as on 1st March 2017
Job no. A 99: Direct Material `80, Direct Wages `150 and Factory Overheads `200
Job no. A 77: Direct Material `420, Direct Wages `450 and Factory Overheads `400
(2) Direct material issued during the month of February 2017 was:
Job no A 99 `120
Job no A 77 `280
Job no A 66 `225
Job no A 55 `300
(3) Direct labour details for March 2017 were:
Job no Hours Amount (`)
A 99 400 600
A 77 200 450
A 66 300 675
A 55 100 225
(4) Factory Overheads are applied to jobs on production according to direct labour hour rate which
is `2 per hour.
(5) Factory Overhead incurred in March 2017 were `2100.

190 COST ACCOUNTING

Cost Book Keeping

4.5 INFRASTRUCTURE, EDUCATIONAL, HEALTHCARE AND PORT SERVICES

INFRASTRUCTURE SECTOR
The Infrastructure activity which, inter alia includes building / re-building / restoring structures or
infrastructure facilities, typically using civil, mechanical or other branches of engineering, plays an
important role in the development of the economy as it has multiplier effect across various sectors
creating investment opportunities.
The infrastructure industry contributes a significant share of the country’s GDP and employment.
Features of an infrastructure contract / project are as follows:
• Execution of projects as a contractor / sub-contractor or as a developer.
• Projects involving design, detailed engineering, procurement, manufacturing/fabrication,
installation, commissioning.
• The contracts / projects are finalised normally through a bidding process and the projects are
executed as per client’s requirements at client’s project site.
• The client normally makes payment based on the progress of work as per the contract.
• Contracts also normally stipulate work / quality certification by a client nominated third party
consultant.
• Contracts also lay down performance guarantee conditions, warranty / defect liability period,
liquidated damages for schedule delay, price variation clause if any, client’s obligations during
construction period, method to be followed for any change in scope of work, claim management,
force-majeure clause, arbitration etc.
• The duration of a project may vary from project to project for different industries. Normally the
projects are of long duration (more than 12 months) and revenue is recognised generally based
on Indian Accounting Standard (Ind AS-11) notified by Government of India, Ministry of Corporate
Affairs.

Cost Management in Infrastructure Sector

To have uniformity and consistency in the treatment of various elements of cost, it is desirable that
companies shall lay down a cost accounting policy which shall be adopted for determining the cost
of the project. The policy shall cover the following areas:
• Identification of cost centres / cost objects (projects) and cost drivers.
• Accounting for material cost, stores at store yards, employee cost, and other relevant cost
components.
• Accounting, allocation and absorption of Overheads
• Accounting for Depreciation / Amortization, Transfer in and transfer out of equipment from the site.
• Accounting for scarps, wastage etc.
• Basis for Inventory Valuation
• Methodology for valuation of Inter-Unit / Inter Company and Related Party transactions.
• Treatment of abnormal and non-recurring costs including classification of other non cost item.

224 COST ACCOUNTING

EDUCATION SECTOR
Education imparts knowledge and skills and shapes values and attitudes. Education is vital for progress
of a civil society. Education forms the backbone of a nation and is one of the most important key
indicators of a country’s growth and development. The rise of knowledge economy at a global level
has reinforced education, in all its forms (elementary, secondary, higher, vocational, and adult), as the
key economic and business driver.
Education acts as a driver for technological innovation and facilitates absorption of developed
technology for the benefit of the mankind. It is now widely accepted that knowledge capital, holds
the key to development of economy.
With the emergence of India as a knowledge-based economy human capital has now become its
major strength. This has put the spotlight on severe inadequacies of India’s infrastructure for delivery of
education, particularly higher education.
The social rates of return on investments in all levels of education much exceed the long-term
opportunity cost of capital. At the same time, since it is difficult to measure the social rate of return, the
financial ROI, becomes a key driver for sustaining and enhancing the investments in education sector.
Cost Management in Education Sector
Today, the aim of the top management of colleges and universities is to improve
transparency into their services, operations and finances for their stakeholder and the public. There is
also a growing interest among the institutions of higher education to enhance risk management through
better controls over their entity systems, policies and procedures, and to promote the importance of
accountability among professionals.
Within these organizations, management information system, performance management and cost
review plays a pivotal role in working with administrators, management and boards to establish strong
cost spending controls and derive the many resulting benefits in terms of organizational performance
and cost efficiencies.
The cost/finance controller can help the Higher Educational Institutions in overcoming the threats
and weaknesses of their internal management and system. And can also open and widen the areas
according to their strengths and visible opportunities.
The Management of Higher Educational Institutions shall undertake the following review to evaluate
and improve the effectiveness of risk management, cost control and governance processes:
• Systems evaluation – assessing the control systems in place within a specific area, to support the
achievement of the areas objectives;
• Stock evaluation – undertake stock take of library books, IT equipment, laboratory equipment,
stationary, college furniture etc.
• Compliance evaluation – assessing compliance against an agreed set of standards, e.g. UGC
norms, AICTE norms ;
• Contract evaluation and cost review– auditing procurement projects and capital programmes,
assessing compliance with best practice (policies and procedures), cost reviews for expenditure
on institution infrastructure, staff payroll, administration etc.;
• Thematic work reviews – to be undertaken across a number of departments, identifying areas of
good practice and producing an overall report for all areas of Institution with respect to budgetary
controls, spending analysis, achieving value for money etc.;
• Revenue assurance – undertaking assurance review to confirm that departments have appropriate
controls in place for fee collections, timely deposits, etc.;
• Grant reviews – to ensure that the grants are used for the intended purpose.

COST ACCOUNTING 225

Cost Book Keeping

HEALTHCARE SECTOR:
One of the important objectives of Government is to improve in standard of living and health status
of its population. For this, government endeavors to provide its populations accessible, affordable,
awareness and quality healthcare. Indian Government is also making continuous efforts to improve
the standard of living and health status of its population and it remains one of the primary objectives
in Indian planning. The 12th five year plans (2012-17) focuses on providing universal healthcare
infrastructure, promoting R&D and enacting strong regulation for the Health Sector. India’s health care
system have mixed treatment ownership patterns and with different systems of medicine – primary
Allopathy & Homoeopathy, co existing with indigenous system like Ayurvedic, Unani, and Siddha.
The proper goal of a health care delivery system is to “Touch & Enriching billion Lives with creating
certain set of value” i.e. Patient Centricity, Ownership, & integrity to patients. Objective in health care
is measured in terms of the patient outcomes achieved per rupee expended. It is not the number of
different services provided or the volume of services delivered that matters but the true status of health.

Cost Management can be a useful tool for management in Health Care Sector to:
• Estimate the reasonable cost of Health care resources used in patient care.
• Performance measurement of all the Cost & Revenue drivers.
• Lower health care cost without compromising on quality of services rendered or extended.
• Define the Health care delivery value chain.
• Determine the fees or tariffs for goods and services.
• Estimate the capacity of each resources and comparison with actual utilization.
• Authorise, modify or discontinue a programme or activity.
• Manage materials & its storage and associated costs in terms of consumables, drugs, etc.

Cost Management in Health Care Sector:

• Break down the revenue streams from different services
• Break down the costs to different cost centers & map costs to activities
• Match the revenues with costs using the activity links
• Remove non cost items like discretionary costs, sunk costs
• Remove non operating revenues like interest received, miscellaneous income
• Add risk premium to cover inherent risks in the project
• Identify and quantify cost drivers
• Match cost pools with suitable cost drivers
• Decide on suitable allocation keys and apportion costs to objects
• Compare cost of each service group with revenues generated and arrive at profitability

226 COST ACCOUNTING

PORT SECTOR:
The ports sector in India is divided into “Major Ports” and “Non-Major Ports” which are under the
jurisdiction of Central Government and State Governments respectively. The legal framework governing
the sector comprises the Indian Ports Act of 1908 and the Major Port Trusts Act of 1963. Major Ports
under Central jurisdiction are governed by policy and directives of Ministry of Shipping of Government
of India. Minor Ports under State’s jurisdiction and governed by policy and directives of respective State
Government’s nodal departments/ agencies.
Tariff Authority for Major Ports (TAMP) has been constituted for regulating tariffs in major ports and its
functioning/role is being revised to ensure uniform and transparent norms relating to fixing tariffs as well
as prescribing quality of service for port authorities/terminal operators.
The Management of Port Sector shall undertake the following review to evaluate and improve the
effectiveness of risk management, cost control and governance process;
• To ensure that the internal control are in place as set by the management for the attainment of the
objective of the business,
• Management need to review that the internal control are in place in relation to revenue collection
and its proper accounting,
• To ensure that the grant if issued by the government must be used for the specific purpose for
which it is granted,
• To ensure that the contract enter with the various client is operating in order and its adherence are
in place as this is incidental with the revenue of the entity.

SELF EXAMINATION QUESTIONS:

1. Give the specimen of Cost Sheet.
2. Discuss the Cost Management techniques used in the following sector:
a. Infrastructure sector
b. Education sector
c. Healthcare sector
d. Port sector
3. How do you prepare Cost Sheet?

PRACTICE PROBLEMS:
4. Prakash Transport Company has been given a route of 20 km long to run a bus. The bus costs
`12,50,000 with an estimated useful life of 5 years. It is insured @ 3% pa of the cost. Annual tax
amounted to `25,000. The garage rent is `5,000 per month. Annual repairs cost is estimated as
`50,000.
The driver is paid a salary of `7500 per month and the conductor is paid `5000 per month in addition
to a 10% of takings as commission to be shared equally by them.
Office Stationery would `1000 pm and Office Salaries `10000 pm.
Diesel will cost @ `30 per liter and the bus would travel a distance of 5 km per liter. The bus will
make 3 round trips carrying on an average 40 passengers on each trip. Assuming a profit of 15% on
takings, calculate the fare to be charged from each passenger. The bus will operate for 25 days
in a month.
[Ans: Price per Passenger KM = ` 0.85]

COST ACCOUNTING 227

Study Note - 5
METHODS OF COSTING

This Study Note includes

5.1 Job Costing

5.2 Batch Costing
5.3 Contract Costing
5.4 Process Costing – Joint & By-Products
5.5 Operating Costing or Service Costing – Transport, Hotel and Hospital

5.1 JOB COSTING

Methods or Types of Costing

Costing is the technique and process of ascertaining costs. In order to do the same, it is necessary to
follow a particular method of ascertaining cost. Different methods of costing are applied to different
industries depending upon the type of manufacture and their nature. Broadly the costing methods are
classified into the following:
(a) Specific Order Costing (Job or Terminal Costing)
(b) Operation Costing or Process or Period Costing
Specific Order Costing: Specific order costing is the category of basic costing methods applicable where
the work consists of separate jobs, batches or contracts each of which is authorised by a specific order
or contract. It includes job costing consisting batch costing and contract costing.
Job Order Costing:
Industries which manufacture products or render services against specific orders as distinct from
continuous production for stock or sales use the job costing or job order method of cost accounting.
The method is also known under various other names, such as specific order costing, production order
costing, job lot costing or lot costing. Every order in job costing is separate and it is not essential that the
same manufacturing operations be carried out or the same materials be utilized in respect of each.
However, a number of identical orders or identical products may be combined together to form lots or
batches, each such lot or batch constituting a job order. In the job costing system, an order or a unit,
lot, or batch of a product may be taken as a cost unit, i.e. a job.
In job costing, there is no averaging of costs except to the extent that in the ascertainment of unit cost,
the cost of a lot of products in one order is obtained. A job or an order may extend to several accounting
periods and job costs are, therefore, not related to particular periods.
Job cost accounting is followed in three types of manufacturing organisations:
(i) Jobbing concerns.
(ii) Small firms.
(iii) Large enterprises manufacturing a variety of products.

COST ACCOUNTING 233

Methods of Costing

(i) Jobbing concerns:

Some concerns manufacture a variety of products according to customer’s specifications and
do not generally confine their activities to producing uniformly any specific product for sale in the
market. The jobs, products or services are dissimilar or unique and non-repetitive having different
specifications and methods of manufacture, and each one requires different types, sizes and
quantities of materials and equipments and utilizes different labour hours. Such concerns must of
necessity to use job cost accounting.
(ii) Small firms:
Though manufacturing a number of specific products, small manufacturing concerns may find
process costing difficult to apply because due to small sales, no product can have a run long
enough to establish a product line. On account of the frequent changes from one product to
another, job costing would be suitable for determining the cost of each lot of products.
(iii) Large enterprises manufacturing a variety of products:
A single department would be manufacturing several products, perhaps all at a time, so that
none of the departments is specialized for continuous runs of product lines. As definite process
departments cannot be established, job costing is more suitable in such cases.
Job costing is applicable to engineering concerns, construction companies, ship-building, furniture
making, hardware and machine manufacturing industries, repair shops, automobile garages and
several such other industries where jobs or orders can be kept separate.
Procedure for Job Cost Accounting:
On receipt of an order from the customer or an indication from the sales department for manufacturing
a particular product, the production planning department prepares a suitable design for the product
or job. It also works out the requirements of materials for the product and prepares a list of operations
indicating the various operations to be carried out and their sequence, and the shops, departments,
plants or machines to be entrusted with each of the operations.
A Production Order is issued giving instructions to the shops to proceed with the manufacture of the
product. The production order constitutes the authority for work. Usually a production order contains
all relevant information regarding production, such as detailed particulars of the job or product, the
quantity or units to be manufactured, date of start of production, probable date of completion, details of
materials required as per the bill of materials, the operations and the various shops involved in performing
them and the route of the job should take.
The production order usually lays down only the quantities of materials required and the time allowed
for the operations, but the values of materials and labour are also sometimes indicated. In the later
case, the production order serves the combined purpose of an order for manufacture as well as the
cost sheet on which the cost of the order is compiled.
The production order also provides for the material and labour on account of normal wastage or spoilage
of the product in the final stage or during the various stages of manufacture.
Production orders may, in general, be of three types:
(i) Assembly type of order.
(ii) Sub-assembly type of order.
(iii) Components or parts production type.
(i) Assembly type of order:
Where components are purchased and assembled into a product in the factory. A production
order for assembly only is required.

234 COST ACCOUNTING

(ii) Sub-assembly type of order:
Components are purchased and sub-assemblies and assemblies are made in the factory. Production
orders for each sub-assembly and final assembly will be necessary.
(iii) Components or parts production type:
Components are manufactured and sub-assembled and the sub-assemblies are assembled into the
final product. Separate production orders for each component, sub-assembly and final assembly
are issued.

Copies of Production Orders May be Distributed as Follows:

(a) One copy to the stores for provisioning and issue of materials on demand.
(b) One copy each to the departments or shops concerned to undertake production by demanding
materials and employing men and machines on the operations.
(c) One copy to the cost department for working out the cost of the job.
Separate job cost sheets are maintained for each job. If a job consists of several major or important
operations, separate cost sub-sheets for recording the costs of the various operations may be maintained
and the aggregate cost, in summary, shown in the main cost sheet.

Material Cost:
On receipt of a production order, the shop draws the requisite materials from the stores. Surplus, excess
or incorrect materials are returned from the shops to the stores on materials return notes. Scrap and
waste arising in the course of manufacture are returned in a similar manner. The materials requisitions,
materials return notes and materials transfer notes are ‘costed’ in accordance with the methods of
pricing adopted by the concern.

Labour Cost:
Labour summaries or wages analysis sheets are prepared for each accounting period and the totals of
these statements are debited to Work-in-Progress Account or Overhead Control Account by credit to
Wages Control Account. Amounts on account of overtime, idle time, shift differential and fringe benefits
may also be included in the wages analysis sheet. Direct labour costs are posted on the respective cost
sheets and indirect labour is treated in the manner indicated for indirect material.

Manufacturing Overhead:
Overhead costs are accumulated against standing order numbers and against cost centres. Overhead
rates, predetermined or actual as the case may be, are worked out for each such centre. The overhead
applied to each job is obtained by multiplying the overhead rate by the actual base variable spent
on the job.

Completion of Jobs:
Postings of direct material, direct labour, direct expenses and manufacturing overhead costs to the cost
sheet for a job or production order are made periodically throughout the run of the job or order. The
completion report is an indication that the manufacturing operations are over and further expenditure
on the job should cease so that the cost sheet may not be closed.

Work-in-Progress:
The cost of an incomplete job i.e., a job on which some manufacturing processes or operations are still
due before it can be made into the finished product is termed Work-in-Progress or Work-in-Process. If
a production order has been only partly completed by the end of an accounting period, it is essential
that the closing stock of the work-in-progress be determined.

COST ACCOUNTING 235

Methods of Costing

Cost Control in Job Order System:

Control over job costs may be exercised by comparison of the actual costs with the estimated costs
established as basis for fixing job prices. Here again, adequate cost control is available for direct
material and direct labour only; overhead costs cannot be controlled in terms of individual jobs. Control
of overhead is, therefore, confined to the department as a whole for which predetermined overhead
rate has been determined.
Comparison may also be made with the costs of previous periods or of earlier batches of production,
if any.
Standard costs may be used in job type plants, particularly where the product or the particular operations
of the job are of a standardised nature.
Advantages of Job Costing:
Job costing offers the following advantages:
(a) The cost of material, labour and overhead for every job or product in a department is available
daily, weekly or as often as required while the job is still in progress.
(b) On completion of a job, the cost under each element is immediately ascertained. Costs may be
compared with the selling prices of the products in order to determine their profitability and to
decide which product lines should be pushed or discontinued.
(c) Historical costs for past periods for each product, compiled by orders, departments, or machines,
provide useful statistics for future production planning and for estimating the costs of similar jobs to
be taken up in future. This assists in the prompt furnishing of price quotations for specific jobs.
(d) The adoption of predetermined overhead rates in job costing necessitates the application of a
system of budgetary control of overhead with all its advantages.
(e) The actual overhead costs are compared with the overhead applied at predetermined rates; thus,
at the end of an accounting period, overhead variances can be analyzed.
(f) Spoilage and defective work can be easily identified with specific jobs or products.
(g) Job costing is particularly suitable for cost-plus and such other contracts where selling price is
determined directly on the basis of costs.
Limitations of Job Costing:
The limitations of job costing are:
(a) Job costing is comparatively more expensive as more clerical work is involved in identifying each
element of cost with specific departments and jobs.
(b) With the increase in the clerical processes, chances of errors are enhanced.
(c) The cost as ascertained, even where they are compiled very promptly, are historical as they are
compiled after incidence.
(d) The cost compiled under job costing system represents the cost incurred under actual conditions
of operation. The system does not have any scientific basis.
Reports in Job Costing System:
Report on profits on completed jobs:
A statement may be prepared monthly to indicate the gross profit earned on all jobs completed during
the month. This statement is useful for the management for evaluating past performances. Net profit
analysis may also be made in a similar manner if administration, selling and distribution overheads for
the job are included in the statement.

236 COST ACCOUNTING

Report on cost variances:
If cost estimates are developed, a cost variance report showing the deviations of actual costs from
the estimated costs may be prepared in order that significant differences may be brought to light
and investigated. The report may be prepared separately for a job, or for a department showing the
variances in respect of all jobs undertaken by the department during a period.
Illustration 1:
As newly appointed Cost Accountant, you find that the selling price of Job No. 9669 has been calculated
on the following basis:

Particulars `
Materials 12.08
Direct Wages – 22 hours at 25 paise per hour 5.50
Department A – 10 hours,
B – 4 hours
C - 8 hours
17.58
Plus 33% on Prime Cost 5.86
23.44
An analysis of the previous year’s profit and loss account shows the following:

Particulars ` Particulars `
Materials Used 77,500 Factory Overheads:
Direct Wages: A 2,500
A 5,000 B 4,000
B 6,000 C 1,000
C 4,000 Selling Costs 30,000

You are required to:

(a) Draw up a Job Cost Sheet;
(b) Calculate and enter the revised costs using the previous year’s figures as a basis;
(c) Add to the total job cost 10% for profit and give the final selling price.

Solution:
In order to draw up Job Cost Sheet, the factory overhead rates of different departments and percentage
of selling cost will have to be determined first on the basis of previous year’s figures as follow:

Factory Overhead Rates:

Particulars Department
A B C
` ` ``
Factory Overheads 2,500 4,000 1,000
Direct Labour Hours (D.W. x 4) 20,000 24,000 16,000
Factory Overhead Rates per hour 0.125 0.167 0.063

` 30,000
Percentage of Selling Cost on Works Cost = × 100 = 30%
`1,00,000

COST ACCOUNTING 237

 5.2 BATCH COSTING

Meaning
Batch Costing is that form of specific order costing under which each batch is treated as a cost unit and
costs are accumulated and ascertained separately for each batch. Each batch consists of a number
of like units.
Basic Features
(a) Each batch is treated as a cost unit.
(b) All costs are accumulated and ascertained for each batch.
(c) A separate Batch Cost Sheet is used for each batch and is assigned a certain number by which
the batch is identified.
(d) The cost per unit is ascertained by dividing the total cost of a batch by the number of items produced
in that batch.
Applications
Batch Costing is applied in those industries where the similar articles are produced in definite batches
for internal consumption in the production of finished products or for sale to customers generally. It is
generally applied in –
(a) Read made Garments Manufacturing Industries
(b) Pharmaceutical/ Drug Industries
(c) Spare parts and Components Manufacturing Industries
(d) Toys Manufacturing Industries
(e) Tyre and Tubes Manufacturing Industries.

Economic Batch Quantity (EBQ)

Meaning
Economic Batch Quantity refers to the optimum quantity batch which should be produced at a point
of time so that the Set up & Processing Costs and Carrying Costs are together optimized.
Setting up & Processing Costs
The setting up and processing costs refer to the costs incurred for setting up and processing operations
before the start of production of a batch. There is an inverse relationship between batch size and set
up & processing costs.
Large the Batch size : Lower the set up costs because of few batches
Smaller the Batch Size : Higher the set up costs because of more batches
Carrying Costs
The carrying costs refer to the costs incurred in maintaining a given level of inventory. There is positive
relationship between batch size and carrying costs.
Large the Batch size : Higher the carrying costs because of high average inventory
Smaller the Batch Size : Lower the carrying costs because of low average inventory

COST ACCOUNTING 245

Methods of Costing

Trade off
The optimum quantity of batch which should be produced at a point of time determined after achieving
a trade off between set up costs and carrying costs. Such batch size is known as EBQ because annual
total cost of set up and carrying is minimum at this batch size.

FORMULA
2AS
E.B.Q =
C

Where, E.B.Q = Economic Batch Quantity

A = Annual Demand
S = Set up Cost per batch
C = Carrying Costs per unit per year

Illustration 7:
From the following information, calculate Economic Batch Quantity for a company using batch costing:

Annual Demand for the components 2400 units

Setting up cost per batch ` 100

Manufacturing cost per unit ` 200

Carrying cost per unit 6% p.a.

Solution :

2AS 2 × 2,400 (units)× ` 100

EBQ = = = 200 Units
C 6% of ` 200

Illustration 8:
A customer has been ordering 90,000 special design metal columns at the columns at the rate of 18,000
per order during the past years. The production cost comprises `120 for material, ` 60 for labour and ` 20
for fixed overheads. It costs ` 1,500 to set up for one run of 18,000 column and inventory carrying cost
is 15% since this customer may buy at least 5000 columns this year, the company would like to avoid
making five different production runs. Find the most economic production run.

Solution :
Economic Production Run

2 × Annual Output × Setup Cost Per Pr oduction Run

=
Inventory Carrying Cost per unit p.a.

2 × 90,000 (units)× ` 1,500

= = 3,000 units
15% of ` 200 (120 + 60 + 20)

246 COST ACCOUNTING

Illustration 9:
AB [Link] committed to supply 24,000 bearings per annum to CD Ltd. On a steady basis. It is estimated
that it costs 10 paise as inventory holding cost per bearing per month and that the set-up cost per run
of bearing manufacture is ` 324.
(a) What would be the optimum run size for bearing manufacture?
(b) What is the minimum inventory holding cost at optimum run size?
(c) Assuming that the company has a police of manufacturing 6000 bearing per run, how much extra
costs would the company be incurring as compared to the optimum run suggested in (a)?
Solution :
2AS
(a) Optimum production Run Size (Q) =
C
Where, A = No. of units to be produced within one year = 24,000 (units) bearing
O = Set-up cost per production run = ` 324
C = Carrying cost per unit per annum = 0.10 × 12 = ` 1.2

2 × 24,000 (units)× ` 324

= = 3,600 units (bearing)
` 1.2

(b) Minimum inventory Holding Cost, if run size is 3600 bearings

= Average inventory x carrying cost per unit
= ( 3600/2) x (.10 x 12) = ` 2160
(c) Statement showing Total Cost at Production Run sizes of 3600 and 6000 bearings

A. Annual requirements 24000 24000

B. Run size 3600 6000
C. No. of runs (A/B) 6.667 4
D. Set up cost per run ` 324 ` 324
E. Total set up cost (C X D) ` 2160 ` 1296
F. Average inventory( B/2) 1800 3000
G. Carrying cost per unit p.a. 1.20 1.20
H. Total carrying cost ( F x G) 2160 3600
I. Total cost (E + H) 4320 4896
Extra cost incurred , if run size is of 6000 = ` 4896 – ` 4320 = ` 576

Illustration 10:
Component ‘Gold’ is made entirely in cost centre 100. Material cost is 6 paise per component and
each component takes 10 minutes to produce. The machine operator is paid 72 paise per hour, and
machine hour rate is ` 1.50. The setting up of the machine to produce the component ‘Gold’ takes 2
hours 20 minutes.
On the basis of this information, prepare a cost sheet showing the production and setting up cost, both
in total and per component, assuming that a batch of :
(a) 10 components,
(b) 100 components, and
(c) 1000 components is produced.

COST ACCOUNTING 247

 5.3 CONTRACT COSTING

Contract Costing or Terminal Costing as it is often termed, is a variant of the job costing system, which is
applied in businesses engaged in building or other construction work. The jobs are usually the contracts
entered into with the customers. As the number of such contracts handled at a time by a business may
not be usually large, Contract Costing is comparatively simpler in operation than job costing system.
The basic principles applied in Contract Costing are the same as those used in job costing except that
these are modified to suit the particular requirements of the contracts.
Differences between Job costing and Contract costing:
(a) While the number of jobs in hand at any time in a concern may be large, only a few contracts may
be undertaken at a time.
(b) The accumulation, analysis, apportionment, allocation and control of costs is simplified in Contract
Costing.
(c) Most of the expenses are chargeable direct to the Contract Account. Direct allocation to such an
extent is not possible in job costing.
(d) As contracts may run for long periods, there arises the problem of assessment and crediting of
profits on incomplete contracts at the end of the accounting period.
Contract Costing is a type of costing used in constructional activities such as construction of buildings,
roads, bridges etc. The person who takes contract for a price is called the Contractor and the person from
whom it is taken is called the Contractee. We are mainly concerned with the books of the contractor.
To find out profit earned or loss incurred on the contract, the contractor prepares a nominal account
in his books called ‘Contract Account’. In this account, all the expenses incurred by the contractor are
debited and the income i.e mainly work certified is credited; the difference represents profit or loss.
The items generally debited are materials, wages, establishment expenses & other expenses. Depreciation
of assets used in the contract will also be debited, but unlike in other types of accounts it is customary
in Contract Accounts to debit the opening balance of the assets and credit the closing balance of
the same instead of depreciation, wherever it is convenient to do so. Amounts credited are work-in-
progress, which consists of work certified and cost of work uncertified and any scrap of materials etc.
Further some special items which are discussed here under will also be taken care of.
The contracts run for or number of years; however it is necessary to find out the profit or loss at the end
of every year. The profit earned on a Contract Account is primarily called Notional Profit and a portion
of which would be kept on reserve against contingencies. The profit to be transferred to Profit & Loss
Account out of notional profit is ascertained by taking into consideration the degree of completion of
the work, cash received etc.
Some special items under contract accounting are explained below:
(i) Sub-Contract:
Sub-contracting, usually of a part of the work, is another essential feature which we frequently come
across in contract work. Sub-contracting may be necessary under the following circumstances:
(a) Work of a specialized nature for which facilities are not internally available within the concern
is offered to a sub-contractor.
(b) It may be advantageous to get a part or component from outside, if it is costlier to manufacture
it.
(c) Consideration of opportunity cost; the management may not like to invest capital which may
be utilized for other more profitable lines.
(d) The capacity of the firm may be limited and in order to keep time schedule, work may be
speeded by offering it to sub-contractors.

COST ACCOUNTING 249

Methods of Costing

The payments made to sub-contractors are charged in totals to the concerned Contract Account
as direct expense and no detailed records or break-up of the sub-contract amount is necessary
for cost purposes.
(ii) Surveyor’s Certificate and Retention Money:
In the case of contracts running for long periods of time, it is customary for the contractor’s firm to get
‘on account’ payments against the portion of contract completed. The amount received depends
upon the extent of work certified by the technical assessor i.e. on the surveyor’s certificates, as these
are called. Normally such payments are not received to the full extent of the work completed but
a small percentage is held back as retention money, payable on completion of the contract. The
retention money is a sort of safeguard available to the contractee in case the contractor is not
able to fulfill one or more of the conditions laid down in the contract.
(iii) Defective Work:
Defective work will not evidently be paid for by the contractee but the cost of such defective
work should be charged to the Contract Account. Sometimes, rectification of the defective work is
required to be made at the contractor’s cost; the cost of such rectification should also be charged
to the Contract Account but shown separately.
(iv) Escalation Clause:
Escalation clauses are often provided in contracts as safeguards against any likely changes in price
or utilisation of material and labour. Such a clause in a contract would provide that in the event of
a specified contingency happening, the contract price would be suitably enhanced. This clause is
particularly necessary where the price of certain raw materials are likely to rise, where labour rates
are anticipated to increase, or where the quantity of material or labour time cannot be properly
assessed or estimated unless the work has sufficiently advanced. There may also be ‘De-escalation
or Reserve Clause’ to provide for any future decrease in price etc. so that the benefit may be
passed on to the contractee.
(v) Work-in-progress:
In Contract Accounts, the value of the work-in-progress consists of:-
(a) the cost of work completed, both certified and uncertified,
(b) the cost of work not yet complete, and
(c) the amount of profit taken as credit.
In the Balance Sheet, the work-in-progress is usually shown under two heads, viz. certified and
uncertified. The cost of work completed and certified and the profit credited will appear under
the head ‘certified’ work-in-progress, while the completed work not yet certified and the cost of
labour, material and expenses of work which has not reached the stage of completion are shown
under the head ‘uncertified’ work-in-progress.
(vi) Profit on incomplete contracts:
For the purpose of finding out the portion of the profit out of notional profit to be transferred to Profit
and Loss Account, the contracts are divided in the following manner:-
(A) Contracts which have just commenced:
In this case no portion of the notional profit shall be transferred to Profit and Loss Account and the
entire amount is kept as reserve. There are no hard and fast rules to determine that a particular
contract is just commenced or reasonably advanced or almost complete. However, as per general
norms, the contracts in which less than 1/4th work is done are regarded as the contracts which have
just commenced.

250 COST ACCOUNTING

(B) Contracts which have reasonably advanced:
In this case the profit to be transferred to Profit and Loss Account out of notional profit is based on
the degree of completion of the contract. The degree of completion of the contract can be found
out by comparing work certified and the contract price.
(a) If the degree of the completion of the contract is less than or equal to 1/4th no portion of the
notional profit shall be transferred to Profit and Loss Account and the entire amount would be
kept as reserve.
(b) If the degree of completion of work is (> 1/4 and < 1/2), 1/3 of the notional profit shall be
transferred to Profit and Loss Account and the remaining amount would be kept as reserve.
(c) If the degree of completion of work is more than or equal to 1/2, 2/3rd of the notional profit
shall be transferred to Profit and Loss Account and the remaining amount would be kept as
reserve.
The profit so arrived in the above manner shall further be reduced in the ratio of cash received to
work certified. Thus, the formula is as follows:
2 1 (Cash received)
(Notional Profit x or (as the case may be) x
3 3 (Work certified)

(C) Contracts which are almost complete:

In this case the portion of the profit to be transferred to Profit and Loss Account is calculated by
using the estimated total profit which is ascertained by subtracting the total cost to date and the
additional cost to complete the contract from the contract price. The different formulas for such
computations of profit are as follows:-

(Work certified)
(i) Estimated Profit x
(Contract price)

(Work certified) (Cash received)

(ii) Estimated Profit x x
(Contract price) (Work certified)

(Total cost to date)

(iii) Estimated Profit x
(Total cost)

(Total cost to date) (Cash received)

(iv) Estimated Profit x x
(Total cost) (Work certified)
Illustration 11:
A firm of Builders, carrying out large contracts kept in contract ledger, separate accounts for each
contract on 30th June, 2017, the following were shown as being the expenditure in connection with
Contract No. 555.

`
Materials purchased 1,16,126
Materials issued from stores 19,570
Plant, which has been used on other contracts 25,046
Additional plant 7,220
Wages 1,47,268
Direct expenses 4,052
Proportionate establishment expenses 17,440

COST ACCOUNTING 251

Methods of Costing

Dr. Contract Account Cr.

Particulars Amount Particulars Amount
` `
To, Material purchased A/c 1,00,000 By, Material on hand 25,000
To, Wages A/c 50,000 Work certified 2,05,000 2,20,000
To, General Expenses A/c 10,000 Work uncertified 15,000
To, Depreciation on plant 5,000
To, P & L A/c 19,512
To, Reserve c/d 60,488
2,45,000 2,45,000

5.4 PROCESS COSTING AND JOINT & BY PRODUCTS

Process Costing
Process costing is that aspect of operation costing which is used to ascertain the cost of the product at
each process or stage of manufacture. This method of accounting used in industries where the process
of manufacture is divided into two or more processes. The objective is to find out the total cost of the
process and the unit cost of the process for each and every process. Usually the industries where process
costing used are textile, oil industries, cement, pharmaceutical etc.
Features of Process Costing:
(a) Production is done having a continuous flow of products having a continuous flow of identical
products except where plant and machinery is shut down for repairs etc.
(b) Clearly defined process cost centres and the accumulation of all costs by the cost centres.
(c) The maintenance of accurate records of units and part units produced and cost incurred by each
process.
(d) The finished product of one process becomes the raw material of the next process or operation
and so on until the final product is obtained.
(e) Avoidable and unavoidable losses usually arise at different stages of manufacture for various
reasons.
(f) In order to obtain accurate average costs, it is necessary to measure the production at various
stages of manufacture as all the input units may not be converted into finished goods.
(g) Different products with or without by-products are simultaneously produced at one or more stages
or processes of manufacture. The valuation of by-products and apportionment of joint cost before
joint of separation is an important aspect of this method of costing.
(h) Output is uniform and all units are exactly identical during one or more processes. So the cost
per unit of production can be ascertained only by averaging the expenditure incurred during a
particular period.
Applications of Process Costing:
The industries in which process costs may be used are many. In fact a process costing system can
usually be devised in all industries except where job, batch or unit or operation costing is necessary. In
particular, the following are examples of industries where process costing is applied:
Chemical works Textile, weaving, spinning etc.
Soap making Food products
Box making Canning factory
Distillation process Coke works
Paper mills Paint, ink and varnishing etc.
Biscuit works Meat products factory
Oil refining Milk dairy

264 COST ACCOUNTING

Difference between Job Costing and Process Costing:

Job Costing Process Costing

(i) The form of specific order costing which applies That form of costing which applies where
where the work is undertaken to customer’s standardised goods are produced and
special requirements. production is in continuous flow, the products
being homogeneous.
(ii) The job is the cost unit and costs are collected Costs are collected by process or department
for each job. on time basis and divided by output for a period
to get an average cost per unit.
(iii) Losses are generally not segregated. Normal losses are carefully predetermined and
abnormal losses are segregated.
(iv) Overheads are allocated and apportioned to Units pass through the same processes.
cost centres then absorbed by jobs, in proportion Overheades are apportioned to processes on
to the time taken. some suitable basis, some times, pre-detarmined
rates may be used
(v) Joint products / By-products do not usually arise Joint products/By-products do arise and joint
in jobbing work. cost apportionment is necessary.
(vi) Standard costing is generally not suitable for The standardised nature of products and
jobbing work. processing methods lends itself to the adoption
of standard costing.
(vii) Work-in-progress valuation is specific and is For WIP valuation operating costs have to be
obtained from analysis of outstanding jobs. spread over fully complete output and partially
complete products using the concept of
equivalent units.
(viii) Each job is separate and independent of others. Products lose their individual identity as they are
Costs are computed when a job is complete. manufactured in a continuous flow. Costs are
calculated at the end of cost period.
(ix) There are usually no transfers from one job to Transfer of costs from one process to another is
another unless there is a surplus work or excess made, as the product moves from one process
production. to another.
(x) There may or may not be work-in-progress at There is always some work-in-process at
the beginning or end of the accounting period. the beginning as well as at the end of the
accounting period.
(xi) Proper control is comparatively difficult as each Proper control is comparatively easier, as the
product unit is different and the production is production is standardised and is more stable.
not continuous.
(xii) It requires more forms and details. It requires few forms and less details.
Normal Process Loss:
It is the loss which is unavoidable on account of inherent nature of production process. Such loss can
be estimated in advance on the basis of past experience or available data. The normal process loss is
recorded only in terms of quantity and the cost per unit of usable production is increased accordingly.
Where scrap possesses some value as a waste product or as raw material for an earlier process, the
value thereof is credited to the process account. This reduces the cost of normal output; process loss
is shared by usable units.
Abnormal Process Loss:
Any loss caused by unexpected or abnormal conditions such as plants breakdown, sub-standard
materials, carelessness, accident etc., or loss in excess of the margin anticipated for normal process loss
should be regarded as abnormal process loss. The units of abnormal loss or gain are calculated as under:

COST ACCOUNTING 265

Methods of Costing

Abnormal loss (or gain) = Total Loss – Normal Loss

The valuation of abnormal loss should be done with the help of this formula:

(Normal Cost of Normal Output)

Value of Abnormal Loss = x Units of Abnormal Loss
(Normal Output)
Abnormal Gain:
We know that margin allowed for normal loss is an estimate, (i.e., on the basis of expectation in process
industries in normal conditions) and slight differences are bound to occur between the actual output of
a process and that anticipated. These differences will not always represent increased loss, on occasions
the actual loss will be less than that expected. Thus, when actual loss in a process is smaller than that
was expected, an abnormal gain results. The value of the gain will be calculated in similar manner to
an abnormal loss.
The Abnormal Gain Account is to be debited for the loss of income on account of less quantity of sale
of scrap available as a result of abnormal gain and Normal Process Loss Account credited accordingly.
The balance is transferred to Costing Profit and Loss Account as abnormal gain.

Equivalent Production:
This represents the production of a process in terms of completed units. In other words it means converting
the incomplete production units into its equivalent of complete units. In each process an estimate
is made of the percentage completion of any work-in-progress. A production schedule and a cost
schedule will then be prepared. The work-in-progress is inspected and an estimate is made of the degree
of completion, usually on a percentage basis. It is most important that this estimate is as accurate as
possible because a mistake at this stage would affects the stock valuation used in the preparation of
final accounts. The formula for equivalent production is:
Equivalent units of work-in-progress
= Actual [Link] units in process of manufacture x Percentage of work completed
For example, if 20% work has been done on the average of 1,000 units still in process, then 1,000 such units
will be equal to 200 completed units. The cost of work-in-progress will be equal to 200 completed units.

Calculation of Equivalent Production:

The following steps are worth noting in its calculation:
(a) State the opening work-in-progress in equivalent completed units by applying the percentage of
work needed to complete the unfinished work of the previous period. If the opening work-in-progress
is 100 units which is 40 percent completed, then the equivalent units of this will be 100 x 60% i.e. 60
units.
(b) Add to (a), the number of units started and completed during the period. This can be found out by
deducting the units in the closing work-in-progress from the number of units put into the process.
(c) Add to the above, the equivalent completed units of closing work-in-progress. This can be found
out by applying the percentage of work done on the finished units at the end of the period.
There are mainly three methods of calculating cost per unit, out of which FIFO method and Weighted
Average Method is used in equivalent production.
First In First Out Method [FIFO]:
In this method, the assumption is that the incomplete units from the opening stock are completed first
and then the units introduced in the process are completed. The costs added in each process during
the current period is prorated to the production necessary to complete the opening work in progress, to

266 COST ACCOUNTING

complete the units added in the process and units in the work in progress. The objective of the first in first
out method is to value the inventory at the current costs and as such the main problem is to calculate
the equivalent production under this method.
Average Method:
Process costs are sometimes computed on the basis of average costs. Where degree of completion of
opening work in progress is not given, average method is used. The average process cost is obtained
by adding the cost of opening work in progress and the cost of units introduced in the process during
the current period and dividing this total cost by total equivalent units obtained by adding the number
of units completed and equivalent units of the closing work in progress of each element, material, labor
and overheads. The main object of average method is to even out the fluctuations in prices and hence
is used when the prices fluctuate widely during a particular period.
Weighted Average Method:
If a manufacturing unit is manufacturing two or more products, which are quite dissimilar to each other,
weighted average method is used. Under this method, weighted average is computed and used in
valuation of the incomplete units.

Illustration 24:
The following particulars for process II are given:

Particulars UNITS `
Transfer to process II at cost 4,000 9,000
Direct wages 2,000
Direct material 3,000
Transfer to Finished stock 3,240
Factory overheads in process are absorbed at a rate of 400% of direct material. Allowance for Normal
loss is 20% of Units worked. Scrap value is ` 5 per unit.
Evaluate the cost of transfer to finished stock. Using the information supplied above, show the amount
of gain or loss in the process to be taken to Cost Profit and Loss A/c.

Solution:

Dr. PROCESS-II- Account Cr.

Particulars Units ` Particulars Units `

To, Transfer from Process - I 4000 9,000 By Normal Loss A/c 800 4000
To, Direct Wages A/c 2,000 (4000 x 20%) x 5
To, Direct Material A/c 3,000 By Transfer to Finished Stock A/c 3,240 22,275
To, Factory Overheads 12,000 @ 6.875 per unit
3000x 400%
To, Abnormal Gain A/c 40 275
(26000 - 4000)
×40 = 6.875
(4000 - 800)
4,040 26,275 4,040 26,275

COST ACCOUNTING 267

Methods of Costing

Dr. Process – 3 Account Cr.

Units Amount Units Amount

Particulars Particulars
` `
To, Opening Stock A/c 1000 695 By, Normal loss A/c 250 50
To, Transfer from Process 2 A/c 6000 2,360 By, Abnormal loss A/c 50 42
To, Material A/c 520 By, Closing stock A/c 2000 1,360
To, Labour A/c 1,036 By, Transfer to process 4 A/c 4700 4,700
To, Overheads A/c 1,541 @ ` 1 per unit
7000 6,152 7000 6,152

Joint and By-Products

Meaning of Joint Products:
In several industries more than one product emerge from the manufacturing process. These products
are sometimes produced intentionally while in some cases they emerge out of the main manufacturing
process. Such products are termed as either joint products or by-products. Though sometimes these terms
are used interchangeably, there is a major difference between the two and therefore it is necessary to
understand clearly the difference between them. Similarly there is a difference between the accounting
of the two and hence it is essential to define clearly the concepts of joint products and by-products.
In CIMA Terminology defines joint products as “two or more products separated in the course of processing
each having a sufficiently high value to merit recognition as a main product”. Joint products imply that
they are produced from the same basic raw material, are comparatively of equal importance, are
produced simultaneously by a common process and may require further processing after the point of
separation.
Difference Between Joint products and Co-products:
Joint products are frequently confused with co-products. However, there is significant difference between
the two, the former being indivisible and the latter divisible. Common costs are allocable among products
or services performed because each of the products or services could have been obtained separately.
Therefore, any shared cost of obtaining them can be meaningfully allocated on the basis of relative
usage of the common facilities. For example, the cost of fuel or power may be allocated to products
based on production volumes and metered usage. Co-products do not always arise from the same
operation or raw materials and the quantity of co-products is within the control of manufacturer. Thus
different quantities of car, jeep and trucks can be produced in car manufacturing industry according
to the need of the concern.
Features of Joint Products:
(a) Joint products are the result of utilization of the same raw material and same processing operations.
The processing of a particular raw material may result into the output of two or more products.
(b) All the products emerging from the manufacturing process are of the same economic importance.
In other words, the sales value of those products may be more or less same and none of them can
be termed as the major product.
(c) The products are produced intentionally which implies that the management of the concerned
organization has intention to produce all the products.
(d) Some of joint products may require further processing or may be sold directly after the split off point.
(e) The manufacturing process and raw material requirement is common up to a certain stage of
manufacturing. After the stage is crossed, further processing becomes different for each product.
This stage is known as ‘split off’ point. The expenditure incurred up to the split off point is called as

280 COST ACCOUNTING

 joint cost and the apportionment of the same to different products is the main objective of the
joint product accounting.
(f) The management has little or no control over the relative quantities of the various products that
will result.
(g) Joint products are commonly produced in industries like, chemicals, oil refining, mining, meatpacking,
automobile etc. In oil refining, fuel, oil, petrol, diesel, kerosene, lubricating oil are few examples of
the joint products.
Accounting for Joint Product Cost:
Before we proceed to discuss the methods of accounting in case of joint products and by-products, it
will be necessary to understand certain terms clearly. These terms are explained below:
(i) Split Off Point: This is a point up to which, input factors are commonly used for production of multiple
products, which can be either joint products or by-products. After this point, the joint products
or byproducts gain individual identity. In other words, up to a certain stage, the manufacturing
process is the same for all the products and a stage comes after which, the individual processing
becomes different and distinct. For example, in a dairy, several products like, milk, ghee, butter,
milk powder, ice-cream etc. may be produced. The common material is milk. The pasteurization
of milk is a common process for all the products and after this process; each product has to be
processed separately. This point is of special significance in the accounting of joint product and
by-products because the joint cost incurred before this point is to be apportioned appropriately
in the joint products.
(ii) Joint Costs: Joint cost is the pre separation cost of commonly used input factors for the production
of multiple products. In other words, all costs incurred before or up to the split off point are termed
as joint costs or pre separation costs and the apportionment of these costs is the main objective
of joint product accounting. Costs incurred after the split off point are post separation costs and
can be easily identified with the products.
Accounting Treatment:
In case of joint products, the main objective of accounting of the cost is to apportion the joint costs
incurred up to the split off point. As discussed earlier, the manufacturing process is same up to a certain
stage and after crossing that stage; each product has distinct manufacturing process. Therefore the
main problem is apportionment of the joint cost or the cost incurred up to the split off point. The total
cost of production of the joint product will be cost incurred up to the split off point duly apportioned
plus the cost incurred after the split off point. There is no problem of charging the cost incurred after the
split off point as the cost can be identified easily. The main problem therefore is that of apportionment
of the joint cost and the following methods are used for apportioning the same.
(i) Physical Quantity Method: Under this method, cost apportionment is made in proportion to the
volume of production. These physical measures may be units, pounds, liters, kilos, tones, gallons
etc.
(ii) Average Unit Cost Method: Under this method, the joint cost is apportioned to the joint products
by computing the average unit cost of the product units. The average unit cost is computed by
dividing the total manufacturing cost by the total number of units produced of all products. This
method is useful where all the products produced are uniform with each other in all the respects.
This method will not be useful if the production units are not similar with each other.
(iii) Weighted Average Method: Under this method, weights are assigned to each unit based upon
size of the units, difference in type of labor employed, material consumption, market share, efforts
of labour required and so on. The joint cost is apportioned on the basis of the weights assigned to
each product. This method is highly useful if the weights assigned are on objective basis. If subjective
element creeps in, the method may not give accurate results.

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Methods of Costing

(iv) Selling Price Method: Under this method, the joint cost is apportioned on the basis of sales value at
the split off point. The logic is that a product should bear the share of the joint cost according to
its sale price. If sales price is higher than that of the other products, more share of joint cost should
be charged to that product and if it is comparatively less than that of other products, less share
of joint cost should be charged to the same. Though logically this method seems to be sound, in
practice, charging higher share of joint cost to the product with higher sales value may not be
justified due to the fact that lesser efforts are required for manufacturing of the same.
Meaning of By-Products:
The term ‘by-products’ is sometimes used synonymously with the term ‘minor products’. The by-product is
a secondary product, which incidentally results from the manufacture of a main product. By–products are
also produced from the same raw material and same process operations but they are secondary results
of operation. The main difference between the joint product and byproduct is that there is no intention
to produce the by-product while the joint products are produced intentionally. The relationship between
the by-product and the main product changes with changes in economic or industrial conditions or
with advancement of science. The by-product of an industry may become a main product and main
product may become a by-product subsequently.
For example, (a) in sugar industry, sugar is a main product and molasses is a by-product (b) in coke
ovens, gas and tar are incidentally produced in addition to the main product coke. Gas and tar are,
therefore, treated as by-products. These minor secondary products have saleable or usable value and
are incidentally produced in addition to the main product.
In CIMA Terminology, By-product is “a product which is recovered incidentally from the material used in
the manufacture of recognized main products such as having either a net realizable value or a usable
value which is relatively low in comparison with the saleable value of the main products. By products
may further be processed to increase their realizable value”.
Thus the term ‘by-product’ is generally used by businessmen and accountants to denote one or more
products of relatively small value that are produced simultaneously with a product of greater value.
Classification of By-Products:
By-products can be classified into two groups according to marketable conditions at the split off point:
(a) Those sold in the same form as originally produced, and
(b) Those which may undergo further processing before sale.
Accounting treatment:
By-products are jointly produced products of minor importance and do not have separate costs until the
split off point. They are not produced intentionally but are emerging out of the manufacturing process
of the main products. The following methods are used for accounting of by-products. The methods are
broadly divided into Non-Cost Methods and Cost Methods.
(A) Non-Cost Methods: The following methods are included in this category.
(i) Other income or miscellaneous income method: Under this method, sales value of by-products
is credited to the Profit and Loss Account and no credit is given in the Cost Accounts. The credit
to the Profit and Loss Account is treated as other income or miscellaneous income. No effort
is made for ascertaining the cost of the product. No valuation of inventory is made and all
costs and expenses are charged to the main product. This is the least scientific method and
is used where the sales value of the by-product is negligible.
(ii) Total sales less total cost: Under this method, sales value of by-product is added to the sales
value of the main product. Further the total cost of the main product including the cost of the

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 by-product is deducted from the sales revenue of the main product and by-product. All costs
and expenses are charged to the main product.
(iii) Total cost less sales value of by-product: In this method, the total cost of production is reduced
by the sales value of the by-product. This method seems to be more acceptable because like
waste and scrap, by-product revenue reduces the cost of major products.
(iv) Total cost less sales value of by-products after setting off selling and distribution overheads
of by-products: Sales value of the by-product minus the selling and distribution overheads of
byproduct is deducted from the total cost. Selling and distribution overheads are charged
against by-products actually sold.
(v) Reverse cost method: This method is based on the view that the sales value of the by-product
contains an element of profit. It is agreed that this element of profit should not be credited
to the Profit and Loss Account. The cost of by-product is arrived at by working backwards.
Selling price of the by-product is deflated by an assumed gross profit margin. Thus under this
method, sales value of the by-product is first reduced by, an estimated profit margin, selling and
distribution expenses and then the post split off costs and then the cost of the main product
is thus reduced by this net figure.
(B) Cost Methods: The following methods are included in this category.
(i) Replacement or opportunity cost method: If the by-products are consumed captively, they
are valued at the opportunity cost method or replacement cost method. This means the
cost which would have been incurred had the by-product been purchased from outside. For
example, bagasse, which is one of the main by-product of sugar industry and which is used
for the factory as a fuel in the boiler is valued at the market value, i.e. the price that would
have been paid if it would have been purchased from outside.
(ii) Standard cost method: Under this method, the by-product is valued at the standard cost
determined for each product. The standard cost may be based on technical assessment.
Standard cost of the by-product is credited to the process account of the main product.
Accordingly, the cost control of main product can be exercised effectively.
(iii) Joint cost proration: Where the by-product is of some significance, it is appropriate that the
joint costs should be apportioned between the main products and by-products on a most
suitable and acceptable method. Thus in this method, no distinction is made between the
joint product and byproduct. Industries, where the by-products are quite important, use this
method. For example, in a petroleum refinery, gas was earlier considered as a by-product.
Now it has assumed the importance like petrol, diesel etc. and is being treated as joint product.
Accordingly, the joint cost is prorated between the joint product and the by-product.
Difference between Main product & Joint and By-Products:
It is very difficult to make distinction between the joint products, main products and by-products. There
are, however, two checks which may be applied to determine if a product is a by-product or a joint
product or a main product:
(i) Value: If one of the products is of considerably large value than the others it will usually be considered
the main product. Conversely any product which is of considerably less value is likely to be classified
as a by-product. If both or some or all the products are more or less of equal value, they are likely
to be classified as joint products.
(ii) Manufacturing objective: If the company’s objective is to produce A, then B, C and D produced
simultaneously will be classified as by-products. This is independent of the comparative values of
the various products. If the objective is to produce A and B, they become joint products and C
and D become by-products. For example, in coke oven, the objective being production of coke,
this is considered as the main product, and gas and tar as by-products.

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Methods of Costing

Computation of Profit by distribution on the basis of Sales :

Particulars A B Total
` ` `
(i) Sales 8,000 6,000 14,000
(ii) Total cost 6,857 5,143 12,000
(iii) Profit 1,143 857 2,000

5.5 OPERATING COSTING OR SERVICE COSTING – TRANSPORT, HOTEL AND HOSPITAL

Operating or Service Costing

Cost Accounting has been traditionally associated with manufacturing companies. However in the
modern competitive market, cost accounting has been increasingly applied in service industries like
banks, insurance companies, transportation organizations, electricity generating companies, hospitals,
passenger transport and railways, hotels, road maintenance, educational institutions, road lighting,
canteens, port trusts and several other service organizations. The costing method applied in these
industries is known as ‘Operating Costing’.
According to CIMA [London] operating costing is, ‘that form of operating costing which applies where
standardized services are provided either by an undertaking or by a service cost center within an
undertaking’.

Nature of Operating Costing:

The main objective of operating costing is to compute the cost of the services offered by the organization.
For doing this, it is necessary to decide the unit of cost in such cases. The cost units vary from industry
to industry. For example, in goods transport industry, cost per ton kilometer is to be ascertained while in
case of passenger transport, cost per passenger kilometer is to be computed. Cost units used in different
service units are explained in detail later in chapter. The next step is to collect and identify various costs
under different headings.
The headings used are,
(a) Fixed or standing charges
(b) Semi-fixed or maintenance charges
(c) Variable or running charges.
One of the important features of operating costing is that mostly such costs are fixed in nature. For
example, in case of passenger transport organization, most of the costs are fixed while few costs like
diesel and oil are variable and dependent on the kilometers run.
Because of the diverse nature of activities carried out in service undertakings, the cost system used is
obviously different from that of manufacturing concern. Let us discuss the method of computing costs
in various service organisations .
Transport Organisation:
Costing in a transport industry consists of determining the operating cost of each vehicle and applying
this cost to find out the cost per unit of service rendered by a vehicle. The cost unit is selected with proper
care keeping in view the needs of each concern, the weight, bulk, volume and type of goods carried
and distance covered in each trip. Transport undertakings include goods transport organizations as well
as passenger transport organizations. The cost unit is either ton kilometer or passenger kilometer. The
meaning is cost of carrying one ton over a distance of one kilometer or cost of carrying one passenger
for a distance of one kilometer.

296 COST ACCOUNTING

Collection of Costs: A log book is maintained for each vehicle to record details of trips made by the
vehicle during a specified period of time. Log book is maintained usually on a daily basis. The details
shown in the log book enables the management to make suitable allocation of vehicles, to avoid the
duplicate trips, or to avoid idle running capacity. The log book also provides the information relating
to the fuel consumed, distance travelled, no of hours travelled, chargeable kilo meters. The log book
provide the data for proper allocation of cost and in this respect these may be compared with the
production details available in a manufacturing concern
Classification of Costs:
The costs of a transport organisation can be classified and accumulated under the following heads:-
(a) Fixed or stand-by costs: These costs which include garage charges, insurance, taxes, license,
depreciation, wages of drivers, cleaner’s salary, establishment cost of workshop and office. Out
of the above some of the costs are directly identifiable for each vehicle such as license fee and
some are apportioned such as office expenses
(b) Maintenance Charges: These costs are in the nature of semi-variable nature includes expenditure
on maintenance, repairs, tyres, tubes and other charges.
(c) Operating and Running costs: These costs are variable in nature, includes fuel, lubricating oil, wages
of drivers / cleaners (if paid on per trip / kilometer). These costs can be easily identifiable with each
of the vehicle.
Significance of Operating or Running Costs:
(i) Control of operating and running cost and avoidance of waste of fuel and other consumable
material.
(ii) Cost of running own vehicles may compared with the hired or other forms of transport.
(iii) Facilitates quotation of hiring rates to outside parties who ask for the transport service.
(iv) If transport service is treated as a separate department or service cost center, the costs to be
charged to the requesting department may be easily determined.
(v) Suitable information is obtained for efficient routing of vehicles.
(vi) Cost of idle vehicles and lost running time is easily obtained.
Illustration 46 :
There are two warehouses for storing finished goods produced in a factory. Warehouse ‘A’ is at a distance
of 10 kms. and Warehouse ‘B’ is at a distance of 15 kms from the factory. A fleet of 5 tonne lorries is
engaged in transporting the finished goods from the factory. The records show that the lorries average
a speed of 30 kms. per hour when running and regularly take 40 minutes to load at the factory. At
warehouse ‘A’ unloading takes 30 minutes per load while at warehouse ‘B’ it takes 20 minutes per load.
Drivers’ Wages, depreciation, insurance and taxes amount to `18 per hour operated. Fuel oil, tyres,
repairs and maintenance cost ` 2.40 per kilometer. You are required to draw up a statement showing
the cost per tonne kilometer of carrying the finished goods to the two warehouses.

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