Gauhati University Solved Question Papers
Cost Accounting Solved Question Paper’ 2011
Full Marks: 80
Time: 3 hours
(The figures in the margin indicate full marks for the questions)
Answer all the questions.
1. Answer the following as directed: 1×10=10
a) Aggregate of all direct cost is known as prime cost. (Fill in the blank)
b) Costing systems are classified according to the nature of operations. (State whether the statement is true or false)
c) A cost unit is regarded as a unit of product, service or time in relation to which cost may be ascertained or expressed. (State whether the statement is true or false)
d) Job order costing is not applied where work is undertaken to customers’ special requirements. (State whether the statement is true or false)
e) In periods of rising prices, profit and tax liability under LIFO would be lower than under FIFO. (State whether the statement is true or false)
f) Wages under piece rate system are paid according to the basis of work done. (Fill in the blanks)
g) In Cost Accounting, auditing expenses are examples of office and administrative overhead. (Fill in the blank)
h) Fixed overhead cost per unit remains fixed when output level changes. (State whether the statement is true or false)
Ans: False, increases or decreases with decrease or increase in output
i) Cost of normal loss in process costing is borne by the goods produced. (State whether the statement is true or false)
j) The question of reconciliation of cost accounts with financial accounts arises only under non-integral system. (State whether the statement is true or false)
2. Write short answer to the following in about 50 words each: 2×5=10
a) State the meaning of cost in respect of cost accounting.
Cost: The term ‘cost’ has to be studied in relation to its purpose and conditions. As per the definition by the Chartered Institute of Management Accountants (C.I.M.A.), London ‘cost’ is the amount of actual expenditure incurred on a given thing.
b) State the meaning of idle time in labour costing.
Ans: Idle time refers to the labour time paid for but not utilized on production. It, in fact, represents the time for which wages are paid, but during which no output is given out by the workers. This is the period during which workers remain idle.
c) State the meaning of time rate in wage payment.
Ans: Time Rate System: 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.
d) State the meaning of direct labour.
Ans: Direct Labour: Direct labour cost is cost of labour expended in altering the construction, composition or condition of the product. Direct labour cost is easily identified and allocated to cost units.
e) State the meaning of stores ledger.
Ans: Store Ledger: Store ledger is a document showing the quantity and value of materials received, issued and in balance at the end. One stores ledger is allotted to each component of material. Entries are made in this ledger by the costing clerk with reference to goods received note, material requisition note, material returned note etc.
3. Write short notes on any four of the following: 5×4=20
a) Economic order quantity (EOQ).
Ans: Economics order quantity: Economics order quantity represents the size of the order for which both order, ordering and carrying costs together are minimum. If purchases are made in large quantities, inventory carrying cost will be high. If the order size is small, ordering cost will be high. Hence, it is necessary to determine the order quantity for which ordering and carrying costs are minimum. The formula used for determining economics order quantity is a s follows:
A is the annual consumption of material in units.
O is the cost of placing an order (ordering cost per unit)
C is the cost of interest and storing one unit of material for the one year (carrying cost per unit per annum).
b) Methods of overhead absorption.
Ans: The methods used for absorption are as follows:
a. Direct Material Cost: Under this method, the overheads are absorbed on the basis of percentage of direct material cost. The following formula is used for working out the overhead
absorption percentage: Budgeted or Actual Overhead Cost/ Direct Material Cost X 100
b. Direct Labor Cost Method: This method is used in those organizations where labor is a dominant factor in the total cost. Under this method, the following formula is used for calculating the overhead absorption rate: Budgeted or Actual Overheads/ Direct Labor Cost X 100
c. Prime Cost Method: This method is an improvement over the first two methods. Under this method, the Prime Cost is taken as the base for calculating the percentage of absorption of overheads by using the following formula: Budgeted or Actual Overheads/ Prime Cost X 100
d. Production Unit Method: This method is used when all production units are similar to each other in all respects. Total overhead expenses are divided by total production units for computing the rate per unit of overheads and overheads are absorbed in the product units. If a irm produce more than one products and if they are not uniform to each other, equivalent units are calculated to find out the rate of overheads per unit. The formula of absorption of overheads is as follows: Overhead absorption rate = Budgeted or Actual Overheads/Production Units
e. Direct Labor Hour Method: Under this method, the rate of absorption is calculated by dividing the overhead expenses by the direct labor hours. The formula is as follows. Budgeted or Actual Overhead Expenses/Direct Labor Hours
c) Perpetual inventory system.
Ans: Perpetual Inventory System: Perpetual Inventory system means continuous stock taking. CIMA defines perpetual inventory system as ‘the recording as they occur of receipts, issues and the resulting balances of individual items of stock in either quantity or quantity and value’. Under this system, a continuous record of receipt and issue of materials is maintained by the stores department and the information about the stock of materials is always available. Entries in the Bin Card and the Stores Ledger are made after every receipt and issue and the balance is reconciled on regular basis with the physical stock. The main advantage of this system is that it avoids disruptions in the production caused by periodic stock taking. Similarly, it helps in having a detailed and more reliable check on the stocks. The stock records are more reliable and stock discrepancies are investigated and appropriate action is taken immediately.
Salient features of perpetual inventory system
a) It requires more efforts to maintain inventory under this method.
b) Quantity balances shown by the store ledger and bin cards are reconciled.
c) A number of items are physically checked systematically and by rotation.
d) The method is comparatively costly as compared to periodical inventory system.
d) Cost centre.
Ans: Cost Centre: 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.
e) Cost accounting vs. financial accounting.
Ans: DISTINGUISH BETWEEN FINANCIAL AND COST ACCOUNTING
4. Explain the advantages and limitations of cost accounting. How is a cost accounting system installed? 10
Ans: Advantages of Cost Accounting (Aid to Management)
a) Helps in Decision Making: Cost accounting helps in decision making. It provides vital information necessary for decision making. For instance, cost accounting helps in deciding:
1. Whether to make a product buy a product?
2. Whether to accept or reject an export order?
3. How to utilize the scarce materials profitably?
b) Helps in fixing prices: Cost accounting helps in fixing prices. It provides detailed cost data of each product (both on the aggregate and unit basis) which enables fixation of selling price. Cost accounting provides basis information for the preparation of tenders, estimates and quotations.
c) Formulation of future plans: Cost accounting is not a post-mortem examination. It is a system of foresight. On the basis of past experience, it helps in the formulation of definite future plans in quantitative terms. Budgets are prepared and they give direction to the enterprise.
d) Avoidance of wastage: Cost accounting reveals the sources of losses or inefficiencies such as spoilage, leakage, pilferage, inadequate utilization of plant etc. By appropriate control
measures, these wastages can be avoided or minimized.
e) Highlights causes: The exact cause of an increase or decrease in profit or loss can be found with the aid of cost accounting. For instance, it is possible for the management to know
whether the profits have decreased due to an increase in labour cost or material cost or both.
f) Reward to efficiency: Cost accounting introduces bonus plans and incentive wage systems to suit the needs of the organization. These plans and systems reward efficient workers and improve productivity as well improve the morale of the work -force.
g) Prevention of frauds: Cost accounting envisages sound systems of inventory control, budgetary control and standard costing. Scope for manipulation and fraud is minimized.
h) Improvement in profitability: Cost accounting reveals unprofitable products and activities. Management can drop those products and eliminate unprofitable activities. The resources released from unprofitable products can be used to improve the profitability of the business.
i) Preparation of final accounts: Cost accounting provides for perpetual inventory system. It helps in the preparation of interim profit and loss account and balance sheet without physical stock verification.
j) Facilitates control: Cost accounting includes effective tools such as inventory control, budgetary control and variance analysis. By adopting them, the management can notice the
deviation from the plans. Remedial action can be taken quickly.
Limitations of Cost Accounting
In spite of the various advantages claimed by cost accounting, the discipline suffers from the following limitations:
a) Cost Accounting is costly to operate: It involves heavy expenditure to operate. The benefits derived by operating the system are more than the cost.
b) Cost Accounting involves many forms and statements: It involves usage of many forms and statements which leads to increase of paper work.
c) Costing may not be applicable in all types of Industries: Existing methods of cost accounting may not be applicable in all types of industries. Cost accounting methods can be devised for all types of industries, and services.
d) It is based on Estimations: Costing system relies on predetermined data and therefore it is not reliable. Costing system estimates costs scientifically based on past and present situations and with suitable modifications for the future. This leads to accurate cost figures based on which management can initiate decisions. But for the predetermined costs, cost accounting also becomes another ‘Historical Accounting’.
e) It is not an exact science: Like any others accounting system, it is not an exact science but an art that has developed through theories and practices.
f) Bias Judgments: Many judgments are biased and depend on individual discretion.
g) Difference in opinion: Different views are held by different cost accounts about the items to be includes in cost.
Steps in Installation of a Costing System
The costing system of an organization should be carefully planned in order to achieve its objectives. The important steps for the installation of a costing system are discussed below:
1) Determination of objectives: The first step is to clearly lay down the objectives of the costing system. If the objective is only to ascertain the cost, a simple system will be sufficient.
However, if the objective is to get information for decision making, planning and control, a more elaborate system of costing is necessary.
2) Study of the nature of business: The nature of the business and other technical aspects like nature of the products, methods and stages of production cycle should be carefully analyzed. Such an analysis is necessary to decide the method of costing to be adopted. For example, contract costing is suitable for large construction projects. Operating costing is adopted by service industries like transport.
3) Study of the nature of the organization: The costing system should be designed to meet the requirements of the organization. Hence, it is necessary to study the nature, size and layout of the organization. The factors to be considered are:
a. Size of the organization and the size of the departments.
b. The physical layout of the organization.
c. The different levels of management.
d. The extent of decentralization of authority.
e. The nature of authority relationships.
4) Deciding the structure of cost accounts: A suitable costing system can be developed on the basis of the study of the nature of business and organization. The structure of cost accounts should be simple and in accordance with the natural production process.
5) Determination of cost rates: This step involves a thorough study of the following points for developing an integrated costing system.
a. Classification of costs into direct and indirect costs.
b. Grouping of indirect costs (overheads) into production, administration, selling and distribution etc.
c. Methods of pricing issues.
d. Treatment of wastes of all types.
e. Absorption of overheads.
f. Calculation of overhead rates.
6) Organization of the cost office: The cost office is responsible for the efficient operation of the costing system. The cost office, with adequate staff must be located a close as possible to the factory. The following are the major functions of the cots office.
a. Stores accounts.
b. Labour accounting
c. Recording of cost data and
d. Cost control.
7) Further, the role and duties and responsibilities of the cost accountant must be clearly defined. He must have the necessary authority to discharge his duties effectively.
8) Introducing the system: After completion of the above steps, the costing system may be formally introduced. Introduction of the system in an existing organization should be done gradually. Before introduction, the feature of the systems, its working and advantages must be explained to the concerned employees to secure their co-operation.
Rangia Trading Company furnishes the following data relating to the manufacture of a standard product during the month of April 2009.
Raw materials consumed
Direct labour charges
Machine hours worked
Machine hour rate
Administration overhead 20% on works cost
Re. 0.50 per unit
16,000 at Rs. 4 per unit.
Prepare a cost sheet from the above showing
1) The cost per unit.
2) Cost per unit sold and profit for the period. 10
5. The following information is provided by Shorbhog Candle Producing Company for the fortnight of April, 2011: 10
Materials in hand:
Stock on 1.4.2011 = 100 units at Rs. 5 per unit
Purchases of materials:
5.4.2011 – 300 units at Rs. 6
8.4.2011 – 500 units at Rs. 7
12.4.2011 – 500 units at Rs. 83
Issues of materials
6.4.2011 – 250 units
10.4.2011 – 400 units.
14.4.2011 – 500 units
Calculating using FIFO and LIFO methods of pricing issues;
1) The value of materials consumed during the period; and
2) The value of stock of materials on 15.4.2011.
State the significance of inventory control. Explain the various techniques of inventory control. 10
Ans: Significance/Advantages of Inventory control
1. Protects from fluctuations in demand: There are always chances of fluctuations in the demand of a material. These fluctuations can be adjusted if there are sufficient items in the stock of inventory. Therefore, proper inventory control protects the company from fluctuations in demand.
2. Better services to customers: If the company maintains a proper inventory of raw-materials, then it can complete its production in time. So, it can deliver the finished goods to the customers in time. Similarly, if the company has a proper inventory of finished goods, then it can satisfy the additional demand of the customers.
3. Continuity of production operations: Proper inventory control helps to maintain continuity of production operations. This is because it maintains a smooth flow of raw materials. So, there are no shortages of raw-materials required for production process.
4. Reduces the risk of loss: Proper inventory control helps to reduce the risk of loss due to obsolescence (outdated) or deterioration of items. This is because it checks all the items regularly.
5. Minimizes the administrative workload: Proper inventory control helps to minimize the administrative work load of purchasing, inspection, warehousing, etc. This will reduce the manpower requirement and will minimize the labour cost too.
6. Protects fluctuation in output: Inventory control tries to reduce the gap between planned production and actual production. There are cases where the production schedule cannot be followed because of Sudden breakdown of machines, Problems in supply of materials, Sudden labour strikes, Loss due to failure of power supply, etc. In such cases, the difference between planned production and actual production can be bridged by inventories held in stock.
INVENTORY CONTROL TECHNIQUES
The techniques or the tools generally used to effect control over the inventory are the following:
1) Budgetary techniques for inventory planning;
2) A-B-C. System of inventory control; (SHORT NOTE)
3) Economic Order Quantity (E.O.Q.) i.e. how much to purchase at one time economically; (SHORT NOTE)
4) VED Analysis;
5) Perpetual inventory system and the system of store verification; (SHORT AND BROAD QUESTION)
6) Fixation of Stock Level;
7) Control Ratios.
1) Budgetary Techniques: 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.
2) ABC Analysis: ABC System: In this technique, the items of inventory are classified according to the value of usage. Materials are classified as A, B and C according to their value. Items in class ‘A’ constitute the most important class of inventories so far as the proportion in the total value of inventory is concerned. The ‘A’ items constitute roughly about 5-10% of the total items while its value may be about 80% of the total value of the inventory.
Items in class ‘B’ constitute intermediate position. These items may be about 20-25% of the total items while the usage value may be about 15% of the total value. Items in class ‘C’ are the most negligible in value, about 65-75% of the total quantity but the value may be about 5% of the total usage value of the inventory.
The numbers given above are just indicative, actual numbers may vary from situation to situation. The principle to be followed is that the high value items should be controlled more carefully while items having small value though large in numbers can be controlled periodically.
3) Economics order quantity: Economics order quantity represents the size of the order for which both order, ordering and carrying costs together are minimum. If purchases are made in large quantities, inventory carrying cost will be high. If the order size is small, ordering cost will be high. Hence, it is necessary to determine the order quantity for which ordering and carrying costs are minimum. The formula used for determining economics order quantity is a s follows:
A is the annual consumption of material in units.
O is the cost of placing an order (ordering cost per unit)
C is the cost of interest and storing one unit of material for the one year (carrying cost per unit per annum).
4) VED Analysis: 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.
5) Perpetual Inventory System: Perpetual Inventory system means continuous stock taking. CIMA defines perpetual inventory system as ‘the recording as they occur of receipts, issues and the resulting balances of individual items of stock in either quantity or quantity and value’. Under this system, a continuous record of receipt and issue of materials is maintained by
the stores department and the information about the stock of materials is always available. Entries in the Bin Card and the Stores Ledger are made after every receipt and issue and the balance is reconciled on regular basis with the physical stock. The main advantage of this system is that it avoids disruptions in the production caused by periodic stock taking. Similarly, it helps in having a detailed and more reliable check on the stocks. The stock records are more reliable and stock discrepancies are investigated and appropriate action is taken immediately.
6) Fixation of stock level: 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
a. Minimum stock level: It represents the minimum quantity of an item of material to be kept in the store at any time. Material should not be allowed to fall below this level. If the stock goes below this level, production may be held up for want of materials. This stock is also known as safety stock level or buffer stock.
b. Maximum stock level: It is the stock level above which stock should not be allowed to rise. This is the maximum quantity of stock of raw materials which can be had in the stock. It is goes above, it will be overstocking.
c. Reorder stock level: It is the point at which the storekeeper should initiate purchase requisition for fresh supply. This level lies between the maximum level and the minimum level.
7) Control Ratios: The control ratios are mainly two:
a) Inventory Turnover Ratio which we have studied and
b) Input-output Ratio.
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.
6. The following are the particulars extracted from the ice cream factory of Sonapur: 10
Standard time = 10 hours
Time rate = Rs. 3 per hour
Prepare a comparative table under Halsey Plan and Rowan Plan if time taken is 9 hours, 8 hours and 6 hours. From the calculated table show the amount of bonus payable; the amount of total wages and labour cost per hour under the two methods.
a) Explain the difference between direct and indirect expenses and highlight the importance of such a distinction.
Ans: TYPES OF LABOURS LABOUR COST
Labour is classified into (a) direct labour and (b) indirect labour.(a) Direct labour cost is cost of labour expended in altering the construction, composition or condition of the product. Direct labour cost is easily identified and allocated to cost units.
(b) Indirect labour cost is the amount of wages paid to workmen who are not directly involved in altering the composition of the product. Labour costs represent the various items of expenditure incurred on workers by the employer and would include the following:
(a) Monetary Benefits e.g.: (i) Basic Wages; (ii) Dearness Allowance; (iii) Employer’s Contribution to Provident Fund: (iv) Employer’s Contribution to Employees’ State Insurance (ESI) Scheme; (v) Production Bonus; (vi) Profit Bonus; (vii) Old age Pension; (viii) Retirement Gratuity.
(b) Fringe Benefits, e.g.: (i) subsidized Food; (ii) Subsidized Housing; (iii) Subsidized Education to the children of the workers; (iv) Medical facilities; (v) Holidays Pay; (vi) Recreational facilities.
Distinction between direct labour and indirect labour is necessary because Direct labour cost forms part of prime cost, whereas indirect labour cost forms part of overheads.
b) Describe the causes of labour turnover and indicate technique of its measurement. 5+5=10
Ans: Causes of Labour turnover: The causes for labour turnover can be broadly classified under three heads.
(1) Personal Causes
(2) Unavoidable Causes
(3) Avoidable Causes
i) Personal Causes: Some of the employees may leave the organization on account of personal reasons as given below:
(a) Circumstances of family.
(b) Retirement on reaching the prescribed age.
(c) Change in material status in case of women employees.
(d) Dislike for the job or place;
(e) Death of the employee.
(f) Employee getting recruited in a better job.
(g) Permanent disability due to accidents.
(h) Involvement of employee in activities of moral turpitude.
ii) Unavoidable Causes: In certain instances, the organization may discharge the employees due to unavoidable reasons as mentioned below:
(a) Termination of workers on account of insubordination or inefficiency
(b) Discharge of workers on account of irregularity or long absence.
(c) Retrenchment of workers by the company on account of shortage of work.
iii) Avoidable Causes: Some of the employees may leave the organization account of the following reasons:
(a) Non availability of promotion opportunities
(b) Dissatisfaction with incentive schemes
(c) Unhappy with remuneration
(d) Unsuitable to job due to wrong placement
(e) Unhappy with working conditions
(f) Non availability of accommodation, health and recreational facilities
(g) Lack of stability of Tenure.
Measurement of Labor Turnover
It is essential for any organisation to measure the labor urnover. This is necessary for having an idea about the turnover in the organisation and also to compare the labor turnover of the previous period with the current one. The following methods are available for measurement of the labor turnover:
1. Additions Method: Under this method, number of employees added during a particular period is taken into consideration for computing the labor turnover. The method of computing is as follows:
Labour Turnover = Number of additions/Average number of workers during the period X 100
2. Separations Method: In this method, instead of taking the number of employees added, number of employees left during the period is taken into consideration. The method of computation is as follows:
Labour Turnover = Number of separations/Average number of workers during the period X 100
3. Replacement Method: In this method neither the additions nor the separations are taken into consideration. The number of employees replaced is taken into consideration for computing the labour turnover.
Labour Turnover = Number of replacements/Average number of workers during the period X 100
4. Flux Method: Under this method labor turnover is computed by taking into consideration the additions as well as separations. The turnover can also be computed by taking replacements and separations also. Computation is done as per the following methods:
Labor Turnover = ½ [Number of additions + Number of separations] /Average number of workers during the period X 100
7. From the following information, you are asked to pass journal entries under the integrated accounts system: 10
Materials purchased on credit
Wages – productive
Wages – unproductive
Materials issued to production
Works expenses incurred
Works expenses charged to production
Administration expenses paid
Administration expenses charged to production
Finished goods at cost
What are the different methods of classifying overheads? Explain the principles on which apportionment of overhead is based. 10
Ans: Classification of Overheads
Classification of overheads is the process of grouping of costs based on the features and objectives of the business organization. Classification is made according to following basis:
a) Classification according to Elements: According to this classification overhead are divided according to their elements. The classification is done as per the following details.
1. Indirect Materials: Materials which cannot be identified with the given product unit of cost center is called as indirect materials. For example, lubricants used in a machine is an ndirect material, similarly thread used to stitch clothes is also indirect material. Small nuts and bolts are also examples of indirect materials.
2. Indirect Labour: Wages and salaries paid to indirect workers, i.e. workers who are not directly engaged on the production are examples of indirect wages.
3. Indirect Expense: Expenses such as rent and taxes, printing and stationery, power, insurance, electricity, marketing and selling expenses etc. are the examples of indirect expenses.
b) Functional Classification: Overheads can also be classified according to their functions. This classification is done as given below.
1. Manufacturing Overheads: Indirect expenses incurred for manufacturing are called as manufacturing overheads. For example, factory power, works manager’s salary, factory insurance, depreciation of factory machinery and other fixed assets, indirect materials used in production etc. It should be noted that such expenditure is incurred for manufacturing but cannot be identified with the product units.
2. Administrative Overheads: Indirect expenses incurred for running the administration are known as Administrative Overheads. Examples of such overheads are, office salaries, printing and stationery, office telephone, office rent, electricity used in the office, salaries of administrative staff etc.
3. Selling and Distribution Overheads: Overheads incurred for getting orders from consumers are called as selling overheads. On the other hand, overheads incurred for execution of order are called as distribution overheads. Examples of selling overheads are sales promotion expenses, marketing expenses, salesmen’s salaries and commission, advertising expenses etc. Examples of distribution overheads are warehouse charges, transportation of outgoing goods, packing, commission of middlemen etc.
4. Research and Development Overheads: In the modern days, firms spend heavily on research and development. Expenses incurred on research and development are known as Research and Development overheads.
c) Classification according to Behavior: According to this classification, overheads are classified as fixed, variable and semi-variable. These concepts are discussed below.
1. Fixed Overheads: Fixed overheads are commonly described as those that do not vary in total amount with increase or decrease in production volume, for a given period of time, may be a year. Salaries, depreciation of fixed assets, property taxes, are some of the examples of fixed costs. Total fixed costs remain same irrespective of changes in volume of production but per unit of fixed cost is variable. It increases if production decreases while if production increases, it decreases.
2. Variable Overheads: Variable overheads are those which go on increasing if production volume increases and go on decreasing if the volume decreases. Such increase or decrease may or may not be in the same proportion. Variable overheads are generally considered to be controllable as they are directly connected with the production.
3. Semi-variable Overheads: These types of overheads remain constant over a relatively short range of variation in output and then are abruptly changed to a new level. In other words, they remain same up to a certain level of output and after crossing that level, they start increasing. For example, supervisor’s salary is treated as fixed but if a decision is taken to operate a second shift, additional supervisor may have to be appointed which results into increase in the salary of the supervisor. This indicates that it is a semi-variable overhead. Similarly, maintenance expenditure, fire insurance are also semi-variable overheads.
Suitable bases have to be found out for apportioning the items of overhead cost to production and service departments and then for reapportionment of service departments costs to other service and production departments. The basis adopted should be such by which the expenses being apportioned must be measurable by the basis adopted and there must be proper correlation between the expenses and the basis. Therefore, the common expenses have to be apportioned or distributed over the departments on some equitable basis. The process of distribution is usually known as ‘Primary Distribution’.
The guidelines or principles which facilitate in determining a suitable basis for apportionment of overheads are explained below:
Derived Benefit: According to this principle, the apportionment of common item of overheads should be based on the actual benefit received by the respective cost centers. This method is applicable when the actual benefits are measurable. For example, rent can be apportioned on the basis of floor area occupied by each department.
Potential Benefit: According to this principle, the apportionment of common item of overheads should be based on potential benefits (i.e. benefits likely to be received). When the measurement of actual benefit is difficult or impossible or uneconomical this method is adopted. For example, the cost of canteen can be apportioned as the basis of number of employees in each department which is a potential benefit.
Ability to pay: According to this method, overheads should be apportioned on the basis of the sales ability or income generating ability of respective departments. In other words, the departments which contribute more towards profit should get a higher proportion of overheads.
Efficiency method: According to this principle, the apportionment of overheads is made on the basis of the production targets. If the target is higher, the unit cost reduces indicating higher efficiency. If the target is not achieved the unit cost goes up indicating inefficiency of the department.
Specific criteria method: According to this principle, apportionment of overheads is made on the basis of specific criteria determined in a survey. Hence this method is also known as ‘Survey method’. When it is difficult to select a suitable basis in other methods, this method is adopted. For example, while apportioning salary of foreman, a careful survey is made to know how much time and attention is given by him to different departments. On the basis of the above survey the apportionment is made.
Also Read: Gauhati University Cost Accounting Solved Question Papers