IGNOU SOLVED ASSIGNMENT: ECO - 10 (2013-2014)

Answer of Q.N.1.

Inventory Control

The term ‘Inventory’ is used to denote (i) goods awaiting sale (the stock items of a trading concern and the finished stocks of a manufacturer); (ii) the goods in course of manufacture, known as work-in-progress, and (iii) goods to be used directly or indirectly in production, i.e., raw materials and supplies.

In a manufacturing company, normally the cost of materials constitutes fifty percent of the production cost and the cost of inventory (i.e., raw materials W.I.P., and finished good) represents about one-third of the total assets. As the costs of materials and inventory are quite formidable but at the same time controllable, there is a great need felt for proper planning, purchasing, handling and accounting for the same, and also to organize the system of inventory control in a manner that it may provide the maximum profitably to the management.

Techniques of Inventory Control

The techniques or the tools generally used to effect control over the inventory are the following:

For the purchase of raw materials and stocks, what we required is a purchase Budged to be prepared in terms of quantities and values involved. The sales stipulated as per sales Budget of the corresponding period generally works out to be the key factor to decide the production quantum during the budget period, which ultimately decides the purchases to be made and the inventories to be planned.

To exercise proper control on stores, it is essential that the store items should be classified according to values so that the most valuable items may be paid greater and due a attention regarding their safety and care, as compared to others. The stores are divided into three categories generally, viz., A, B, and C.

In the ABC system, greatest care and control is to be exercised on the items of ‘A’ list as any loss or breakage or wastage of any items of this list may prove to be very costly; proper care need be exercised on ‘B’ list items and comparatively less control is needed for ‘C’ list items. The rules relating to receipt maintenance issue and writing off stores items should be formed in accordance with the utility and value of the items based on the above categorization.

ABC analysis measures the cost significance of each item of materials. It concentrated on important items, so it is also known as ‘Control by importance and Exception’.

                This represents the normal quantity to be placed on order when the stock has reached its re-order level. Re-ordering quantity is to be fixed taking into account the maximum and minimum stock levels. The quantity ordered must be that which, when added to the minimum stock, will not exceed the maximum stock to be carried at any point of time. The following factors govern the re-ordering quantity:

The economic order quantity can be determined by the following simple formula.

EOQ       =             Economic order quantity or number of units in one lot.

A             =             Annual usage in units

S              =             Ordering costs for one order (or set-up costs for one set-up)

I               =             Inventory carrying costs per unit per year.

                VED – Vital, Essential, Desirable – analysis is used primarily for control of spare parts. The spare, parts can be divided into three categories – vital, essential or desirable – keeping in view the critically to production.

                Perpectual Inventory is a system of records maintained by the controlling department, which reflects the physical movement of stocks and their current balance. It aims at devising the system of records by which the receipts and issues of stores may be recorded immediately at the time of each transaction and the balance may be brought out so as to show the up-to-date position. The records used for perpectual inventory are:

The object of fixing stock levels for each item of material is to maintain required quantity of materials in the store and thereby the expenses may be reduced. The different stock levels are: (1) Minimum stock level (2) Maximum stock level (3) Reorder stock level

The control ratios are mainly two –

Inventory Turnover: Inventory Turnover is a ratio of the value of the materials consumed during a period to the average value of inventory held during that period.

If the inventory turnover rate in terms of value of materials is high, or if the length of the inventory turnover period is short, the material is said to be fast moving. So if the rate of consumption is fast or if the inventory turnover rate is good, it is a healthy measure of efficiency of materials control, as the capital employed is properly utilized.

 Input-output Ratio: The Input-output Ratio is the ratio of the raw material put into manufacture and the standard raw materials content of the actual output.

This ratio enables one to find out whether the usage of the materials is favourable or not. A standard ratio of input of materials and output of material should be determined and the actual ratio should be compared with the standard ratio.

Answer of Q.N.2.

COST SHEET

Cost Sheets are statements setting out the costs of a product giving details of all the costs. Presentation of costing information depends upon the method of costing. A cost sheet can be prepared weekly, monthly, quarterly or annually. In a cost sheet besides total expenditure incurred, cost per unit of output in case of each element of cost can be shown in a separate column. The cost sheet should give cost per unit in the previous period for the purposes of comparison.

Walter & Bigg define, “The expenditure which has been incurred upon production for a period is extracted from the financial books and the store records, and set out in a memorandum or a statement. If this statement is confined to the disclosure of the cost of the units produced during the period, it is a termed as a cost sheet”. In other words cost sheet is a statement showing the total cost under proper classification in a logical order.

Components of Total Cost

1. Prime Cost

Prime cost consists of costs of direct materials, direct labors and direct expenses. It is also known as basic, first or flat cost.

2. Factory Cost

Factory cost comprises prime cost and, in addition, works or factory overheads that include costs of indirect materials, indirect labors and indirect expenses incurred in a factory. It is also known as works cost, production or manufacturing cost.

3. Office Cost

Office cost is the sum of office and administration overheads and factory cost. This is also termed as administration cost or the total cost of production.

4. Total Cost

Selling and distribution overheads are added to the total cost of production to get total cost or the cost of sales.

Preparation of Cost sheet

The following particulars have been extracted from the costing records of a manufacturing co., for the year ended 30^th June, 1991.

Building is occupied 9/10 by factory and 1/10 by office. Production 20,000 (Units). You are required to prepare a detailed cost statement showing: Materials consumed, Prime cost, Works on cost, Cost of production, Cost of sales and Profit earned.

Solution

Cost statement of the year ended 30^th June, 1991.

Answer of Q.N.3 (a).

Types of Cost:

Cost classification is the process of grouping costs according to their common characteristics. It is the placement of like items together according to their common characteristics. A suitable classification of costs is of vital importance in order to identify the cost with cost centers or cost units. Costs may be classified according to their nature, i.e. material, labour and expenses and a number of other characteristics. The important ways of classification are:

By Nature or Element or Analytical Classification

                According to this classification, the costs are divided into three categories i.e. Materials, Labour and Expenses. There can be further sub classification of each element; for example, material into raw material components, and spare parts, consumable stores, packing material etc. This classification is important as it helps to find out the total cost, how such total cost is constituted and valuation of work in progress.

By Functions

According to this classification costs are divided as follows:

                Manufacturing and Production Cost: This is the total of costs involved in manufacture, construction and fabrication of units of production.

                Commercial Cost: This is the total of costs incurred in the operation of a business undertaking other than the cost of manufacturing and production. Commercial cost may further be sub-divided into (a) administrative cost and (b) selling and distribution cost.

As Direct and Indirect

According to this classification, total cost is divided into direct costs and indirect costs.

                Direct costs are those which are incurred for and may be conveniently identified with a particular cost centre or cost unit. Materials used and labour employed are common examples of direct costs.

                Indirect costs are those cost which are incurred for the benefit of number of cost centers or cost units and cannot be conveniently identified with a particular cost centre or cost unit. Examples of indirect cost include rent of building, management salaries, machinery depreciation etc.

By Variability

According to this classification, costs are classified into three groups viz. fixed, variable and semi-variable.

                (i) Fixed or period costs are commonly described as those which remain fixed in total amount with increase or decrease in the volume of output or productive activity for a given period of time. Examples of fixed costs are rent, insurance of factory building, factory manager’s salary etc.

                (ii) Variable or product costs are those which vary in total in direct proportion to the volume of output. Examples are direct material costs, direct labour costs, power, repairs etc. Such costs are known as product costs because they depend on the quantum of output rather than on time.

                (iii) Semi-variable costs are those which are partly fixed and partly variable. For example, telephone expenses included a fixed portion of annual charge plus variable charge according to calls; thus total telephone expenses are semi-variable. Other examples of such costs are depreciation, repairs and maintenance of building and plant etc.

By Controllability

                Under this, costs are classified according to whether or not they are influenced by the actions of a given member of the undertaking. On this basis it is classified into two categories:

                (i) Controllable costs are those which can be influenced by the action of a specified member of an undertaking, that is to say, costs which are at least partly within the control of management. Generally speaking, all direct costs including direct material, direct labour and some of the overhead expenses are controllable by lower level of management.

                (ii) Uncontrollable costs are those which cannot be influenced by the action of a specified member of an undertaking that it is to say, which are within the control of management. Most of the fixed costs are uncontrollable. For example, rent of the building is not controllable and so are managerial salaries.

By Normality

                Under this, costs are classified according to whether these are cost which are normally incurred as a given level of output in the conditions in which that level of activity is normally attained. On this basis, it is classified into two categories:

                (a) Normal cost: It is the cost which is normally incurred at a given level of output in the conditions in which that level of output is normally attained. It is a part of cost of production.

                (b) Abnormal cost: It is the cost which is not normally incurred at a given level of output in the conditions in which that level of output is normally attained. It is not a part of cost of production and charged to Costing Profit and Loss Account.

By Capital and Revenue or Financial Accounting Classification

                The cost which is incurred in purchasing assets either to earn income or increasing the earning capacity of the business is called capital cost. For example, the cost of a rolling machine in case of steel plan. Such cost is incurred at one point of time but the benefits accruing from it are spread over a number of accounting years.

                It any expenditure is done in order to maintain the earning capacity of the concern such as cost of maintaining an asset or running a business it is revenue expenditure e.g. cost of materials used in production, labour charges paid to convert the material into production, salaries, depreciation, repairs and maintenance charges, selling and distribution charges etc.

By Time

Cost can be classified as (i) Historical costs and (ii) Predetermined costs.

                i) Historical costs: The cost which is ascertained after their incurrence is called historical costs.

                ii) Predetermined costs: Such costs are estimated costs i.e. computed in advance of production taking into consideration the previous period’s costs and the factors affecting such costs. Predetermined cost determined on scientific basis becomes standard cost.

According to Planning and Control

                Planning and control are two important functions of management. Cost accounting furnishes information to the management which is helpful is the due discharge of these two functions. According to this, costs can be classified as budgeted costs and standard costs.

                i) Budgeted costs: Budgeted costs represent an estimate of expenditure for different phases of business operations such as manufacturing, administration, sales, research and development etc. coordinated in a well conceived framework for a period of time in future which subsequently becomes the written expression of managerial targets to be achieved.

                ii) Standard Cost: Standard cost is the predetermined cost based on a technical estimate for materials, labour and overhead for a selected period of time and for a prescribed set of working conditions.

For Managerial Decisions

On this basis, costs may be classified into the following costs:

                i) Marginal cost: Marginal cost is the total of variable costs i.e. prime cost plus variable overheads.

                ii) Out of pocket costs: This is that portion of the cost which involves payment to outsiders i.e., gives rise to cash expenditure as opposed to such costs as depreciation, which do not involve any cash expenditure.

                iii) Differential costs: The change in costs due to change in the level of activity or pattern or method of production is known as differential costs.

                iv) Sunk costs: A sunk cost is an irrecoverable cost and is caused by complete abandonment of a plant. It is the written down value of the abandoned plant less its salvage value.

                v) Imputed costs: These costs are those costs which appear in cost accounts only e.g. national rent charged on business premises owned by the proprietor, interest on capital for which no interest has been paid. These costs are also known as notional costs.

                vi) Opportunity cost: It is the maximum possible alternative earning that might have been earned if the productive capacity or services had been put to some alternative use.

                vii) Replacement cost: It is the cost at which there could be purchased an asset or material identical to that which is being replaced or revalued. It is the cost of replacement at current market price.

                viii) Avoidable and unavoidable cost: Avoidable costs are those which can be eliminated if a particular product or department, with which they are directly related, is discontinued. Unavoidable cost is that cost which will not be eliminated with the discontinuation of a product or department.

Answer of Q.N.3 (b).

Methods of Wages Payment

The methods of remuneration can be classified into:

In this system, a worker is paid on the basis of attendance for the day or according to the hours of the day, regardless of the output. This system is also known as time work, day work, day age rate or day rate. The wage rate of the day worker may be fixed on hourly, daily, weekly, fortnightly, or monthly basis depending on the practice followed in the concern. There are two variants of this system, each differing only in so far as the fixation of the time rate is concerned. They are:

Graduated Time Rate:   Under this method wages are paid at time rates which vary according to

It the cost of living goes up, the wages also go up proportionately, and vice versa. Thus the works get the real wages. Similarly, the workers having higher merit rating get higher wages, and the workers with lower rating get lower wages.

Differential Time Rate: Workers are paid rate accounting to their individual efficiency. They are paid normal rate upto a certain percentage of efficiency and the rate increases in steps for efficiency slabs beyond the standard. As the efficiency is measured in terms of output, this method does not fall strictly under the area of time rate system.

                The payment of wages under this system is based upon the out turn of the worker. The rate is fixed per piece of work and the worker is paid according to the pieces of work completed or the volume of work done by him, irrespective of the time taken by him in completing that work. A workman is free to earn as much as his ability, energy, or skill would allow to him to produce. The piece rate System can be classified into:

Straight Piece Rates: It is a simple method of making payment at a fixed rate per unit for the units manufactured. Earnings = Number of units X Rate per unit.

Differential Piece Rates: Under this system, efficient workers are paid wages at a lower rate. A definite standard of efficiency is set for each job and for efficiency below or above the standard different piece rates are paid according to different levels of efficiency. The following two methods of wage payment are studied under this system:

                Taylor Differential Piece-Rate: F.W. Taylor thought to improve the efficiency of workers by suggesting two rates of payment of wages:

A higher rate to the workers who product equal to or more than the standard fixed for production during the day, and a lower rate to the workers who do not achieve the standard.

                Merrick Differential Piece-rate: In the Taylor Method, the effect on the wages is quite sharp in the marginal cases. To remove this defect Merrick suggested three piece rates for a job as follows:

Percentage of Standard Output                Payment under Merrick Method

Upto 83%                                                            Normal piece rate

Above 83% and upto 100%                          110% of normal piece rate

Above 100%                                                       120% of normal piece rate

Under this heading, we study the following methods:

Halsey Premium Scheme: Under this plan,

                Total wages under this scheme is calculated with the help of the following formula:

                Earnings = Time taken x Rate per hour + 50% (Time saved x Rate per hour)

Halsey – Weir Scheme: This schedule is similar to Halsey scheme except that in this scheme the workers and employers share the premium in 1:2 ratio.

Rowan Premium Scheme (variable sharing plan): Mr. James Rowan introduced this scheme in Glasgow in 1898. It is similar to Halsey scheme but the premium concept here is different. Here the premium is in the ratio of Time saved to Standard time, calculated on the ordinary wages.

Total wages under this scheme is calculated with the help of the following formula:

Earnings = Time taken x Rate per hour + Time saved / Standard time (Time taken x Rate per hour)

Answer of Q.N.4. Differentiate between the following:

(a) FIFO and LIFO

Ans: Difference between FIFO and LIFO Method:

FIFO method:  According to this method the units first entering the process are completed first. Thus the units completed during a period would consist partly of the units which were incomplete at the beginning of the period and partly of the units introduced during the period.  The cost of completed units is affected by the value of the opening inventory, which is based on the cost of the previous period. The closing inventory of work-in-process is valued at its current cost.

LIFO method: According to this method units last entering the process are to be completed first. The completed units will be shown at their current cost and the closing-work in process will continue to appear at the cost of the opening inventory of work-in-progress along with current cost of work in progress if any.

(b) Allocation and Apportionment

Ans: Difference between Allocation and Apportionment

(c) Job Costing and Contract costing

Ans: Difference between Job costing and Contract Costing

Job costing:  It is also called specific order costing. It is adopted by industries where there is no standard product and each job or work order is different from the others. The job is done strictly according to the specifications given by the customer and usually the job takes only a short time for completion. The purpose of job costing is to ascertain the cost of each job separately. Job costing is used by printing presses, motor repair shops, automobile garages, film studios, engineering industries etc.

Contract costing: It is also known as terminal costing. Basically, this method is similar to job costing. However, it is used where the job is big and spread over a long period of time. The work is done according to the specifications of the customer. The purpose of contract costing is to ascertain the cost incurred on each contract separately. Hence a separate account is prepared for each contract. This method is used by firms engaged in ship building, construction of buildings, bridges, dams and roads.

(d) Normal Process loss and Abnormal Process Loss

Ans: Difference between Normal Process loss and Abnormal Process Loss

Normal loss: It is part of process cost which is caused under normal circumstances. It is inevitable. Example, weight loss, scrap loss, pilferage. Normal loss is calculated at a certain % of input in unit in respective process. It may have scrap value. The cost of such normal loss is included in the total process cost but the scrap value is deducted with total cost by crediting scrap value in process account.

Abnormal Loss: It is the part of the process loss caused due to abnormal circumstances in the factory. For Ex, labour strike, break down of machinery. It is avoidable and controllable by mgmt. Abnormal loss occurs in addition to normal loss. Abnormal spoilage or defective work may arise in a process due to unforeseen factors. The cost of such abnormal loss is not included in the total process cost but the average cost of the lost units is charged to an Abnormal Loss Account which is credited with the scrap and closed to the Profit and Loss Account. Thus, in computing the abnormal loss, scrap value of the abnormal lost units will be ignored but in working out the loss for charging to Profit and Loss Account, this will be taken into consideration.

Answer of Q.N.5.

A large business is divided into a number of functional departments (such as production, marketing and finance) for administrative convenience. These departments are further divided into smaller divisions for cost ascertainment and control. These smaller divisions are called cost centers. A cost centre is a location, person or item of equipment (or group of these) in relation to which cost can be ascertained and controlled. In simple words, it is a subdivision of the organization to which cost can be charged.

The determination of suitable cost centre is very important for the purpose of cost ascertainment and control. The manager of a cost centre is held responsible for control of cost of his cost centre. The number and size of cost centers vary from organization to organization. The selection of a suitable cost centre depends on the following factors:

a. Nature and size of the business.

b. Layout and organization of the factory.

c. Availability of various cost data and information.

d. Management policy regarding cost ascertainment and control.

When workers spent their whole time at different jobs, then the time booked for jobs must with the gate time. Ordinarily the time booked for jobs does not agree with the gate time. It so happens, because of reasons like, waiting for materials, machine breakdown, waiting for instruction, power failure etc. Reconciliation of gate time with time booked is facilitated by preparing an idle time card.

Causes of Idle Time: Idle time arises because of:

Control of Idle Time: Following steps are suggested to control idle time:

Selling overhead relates to the expenses incurred for promoting the marketing of the products, securing and executing the orders. Examples are salaries, commission and travelling expenses of salesmen, sales office expenses, advertisement and publicity; cost of price lists and catalogues, market research expenses, bad debts, etc.

Distribution overhead is the cost of delivery and dispatch of finished products from the factory to warehouse and from warehouse to customers, and includes the cost of bringing returnable containers, if any, to the factory till they are ready for reuse. Examples are carriage and freight, depreciation of delivery vans, repairs and maintenance and insurance of delivery vans, warehouse rent and expenses, transit insurance of finished goods.

Selling and Distribution are therefore, two distinct functions, but in most of the organisations, they are grouped together as selling and distribution expenses for the purpose of accounting and control. With the increase in advertisement and sales promotional activities, widening of sales territories and direct handling of distribution, the importance of these costs has grown up considerably.

Work in process (WIP) is inventory that has been partially converted to finished goods through the production process, but which requires additional work before it can be recorded as finished goods inventory. WIP excludes inventory of raw materials at the start of the production cycle and finished products inventory at the end of the production cycle.

The cost of work-in-process typically includes all of the raw material cost related to the final product, since raw materials are usually added at the beginning of the conversion process. Also, a portion of the direct labor cost and factory overhead will also be assigned to work-in-process; more of these costs will be added as part of the remaining manufacturing process.

The calculation of ending work in process is:

Beginning WIP + Manufacturing costs - Cost of goods manufactured

For example, ABC International has beginning WIP of Rs. 5,000, incurs manufacturing costs of Rs. 29,000 during the month, and records Rs. 30,000 for the cost of goods manufactured during the month. Its ending work in process is:

Rs. 5,000 Beginning WIP + Rs. 29,000 Manufacturing costs – Rs. 30,000 cost of goods manufactured = Rs. 4,000 Ending WIP

This formula only yields an approximate ending work in process number, since such factors as scrap; spoilage etc. can cause a considerable divergence between the results of the formula and the cost of the actual WIP on hand.