Treatment of Some specific expenses in Cost accounting
Cost Accounting Notes B.Com CBCS Pattern
1. Carriage and cartage inward
Normally, carriage and cartage inward for materials purchased is included in the cost of materials. Carriage for bringing materials from stores to the workshop and also the cost of internal transport facilities is treated as works overhead. The expenses on carriage inward for bringing back the goods sold to customers may be treated differently, depending upon the cause of such return. If the return is due to defective manufacture, the carriage inward should be treated as works overhead. If the return is due to defect arising out of faulty packing, the carriage inward should be treated as selling and distribution overhead.
2. Carriage outward
It is an expenses incurred for delivery of goods to the customers. If the customers pay the cost, the carriage outward is included in selling price and, therefore, it has to be excluded from cost. If, however, delivery is made free of cost, carriage outward constitutes a cost to be included in the distribution overhead.
3. Packing charges
Packing is done for three different purposes –
(a) for protecting an article or for containing an article (for example, tubes, bottles, cartons etc.);
(b) for facilitating delivery; and (c) for effecting advertisement, partly at least.
Packing cost for ‘a’ above is a direct expense to be included in the prime cost.
Packing cost for ‘b’ above is to be treated as distribution overhead and packing cost for ‘c’ above is to be treated as selling overhead.
4. After-sales service cost
Many concerns offer free service of repairs and replacement during a particular period after sale. The concern, therefore, incurs cost in respect of salaries, wages and travelling expenses of the service staff and also in respect of parts and components replaced free of cost. These items together constitute ‘after-sales services cost’ to be treated as selling overhead in cost accounts.
5. Advertisement and sales promotion
Advertisement may be incurred for various purposes mentioned:
(a) for short-period sales promotion for single product or all products;
(b) for long-term sales promotion for single product or all products;
(c) for staff requirements, change of office address or telephone numbers opening new branches etc; and for fulfilling legal requirements in respect of closure of share transfer books, calling meetings, notices of legal proceedings etc; and
(d) for inviting tenders or quotations for purchase etc.
Short-period advertisement cost for sales promotion should be treated as selling overhead to be recovered from the sales of the period.
Long-term sales promotion cost should not be charged as selling overhead in the year of its incidence. Only that part of the cost which benefits the sale of the period should be treated as selling overhead to be recovered from the sales of that period and the balance should be deferred and charged to the goods sold in future periods as selling overhead.
Advertisement cost for the purpose mentioned in ‘c’ above should be treated as administration overhead.
Advertisement cost for inviting tenders etc. for purchase should be treated as a cost of purchase department to be included in the cost of particular material purchased or to be apportioned to different materials purchased or to be included in works overhead, depending upon the circumstances of each individual case.
6. Managerial remuneration
This expense refers to the remuneration of director’s managers etc. The treatment of this item depends upon the functions performed by such directors or managers. Remuneration of the works manager, technical director etc, who work in connection with production is obviously treated as works overhead. Similarly, remuneration of the administrative director’s, general manager etc. who perform general administrative functions should be treated as administration overhead. The remuneration of the sales director’s, sales manager etc. should be treated as selling overhead. Similarly, remuneration of the transport manager should be treated as distribution overhead.
7. Research and experimental cost
These are costs incurred in the discovery of new ideas or process by experiment or otherwise and for putting the results of such experiments on commercial basis. Research may also be done for improvement of an existing process or product.
Research may be of two types – (a) fundamental research, and (b) applied research.
(a) Fundamental research does not aim at a specific tangible result and is a continuous process. So, cost incurred on such a continuous process during a particular period should be treated as works overhead of that period. If, however, the process is not a continuous one for any reasons, the cost may be spread over a number of years depending upon the amount involved.
(b) When expenses are incurred on applied research for improving an existing product or method, such expenses should be treated as works overhead of the period in which they have been incurred. When expenses are incurred in a research for new product or method, separate project number should be allotted for research for each purpose and expenses should accordingly. Now, this research may either end in failure or end in success. In case of cost should be written off to costing profit and loss account. If it is a success, the expenses should be debited to development cost. The total of research and development cost for each project should be treated as deferred revenue expenditure to be charged to product or products over a number of periods. If such research and development cost relates to a particular product, it should be directly charged to that product only over a number of periods. If it relates to a production method, such cost should be charged to works overhead account over a number of periods.
8. Bad debt
Bad debt to some extent is almost unavoidable, if goods are sold on credit. Bad debt may be classified into normal bad debt (limited upto a certain per cent of credit sales) and abnormal bad debt. Normal bad debt should be included to the selling overhead, while the abnormal bad debt should be excluded from cost and written off to costing profit and loss account.
Discounts are of two types – trade discount and cash discount. Trade discount received on purchases is deducted from the price of purchase and trade discount allowed on sales is deducted from gross selling price. So trade discount does not enter into cost accounts.
Treatment of cash discount depends upon the treatment of interest on capital. Cash discount is nothing but a payment to compensate interest foregone by the party making the payment. Cash discount may be allowed to customers or received from suppliers. The former is an expenses and the latter is a revenue. There is a controversy as to whether interest on capital should be included in cost or not. If interest is included in cost, cash discount should also be included on the same grounds.
10. Interest on Capital
This item of expenses is a controversial one. Some accountants suggest that this is purely a financial cost and has got nothing to do in cost accounts. Others contend that, like other factor prices, interest on capital should also be treated as an element of cost. The arguments for and against inclusion of interest in cost are as follows:
Arguments for inclusion:
a) As rent is paid for the use of accommodation, interest is paid for the use of capital. If rent is included in cost why interest should be excluded?
b) Comparison of cost in two organisations cannot be dependable unless interest is considered in both.
c) If interest is excluded from cost, time element is ignored; but time element is an important consideration in production. If a person purchases logs of timber and immediately manufactures some furniture, he gets a price which is definitely lower than the price received by another person who purchases logs of timber, seasons the same over a few months and then manufactures furniture for sale. The latter person only loses interest on capital blocked for the months concerned. So, unless interest is included in cost, his exact profit cannot be ascertained.
When an organisation produces both cheap articles and costly articles involving smaller and larger investments respectively, inclusion of interest in cost is of significant importance.
Arguments against inclusion:
a) Interest is a matter of internal finance and hence it is not connected with cost of production.
b) Interest is paid on borrowed capital. No interest is payable on proprietor’s own capital. Since it is difficult to decide as to whether interest on borrowed capital or interest on entire capital should be considered for cost accounts, it is better to exclude the item altogether.
c) If interest is considered in respect of all investments in fixed as well as current assets, the matter becomes very complicated.
d) Where the capital is owned and no interest is payable, interest is automatically excluded; but in order to facilitate comparison, interest paid on borrowed capital, as well, should be excluded.
e) Rates of interest may vary according to the extent of security offered, guarantee provided etc. Comparison of costs of two organisations does not become dependable if interest is included in costs and rates of such interest and/or nature of guarantee vary widely.