Advanced Cost Accounting

31
M.COM.
SEMESTER - III (CBCS)
ADVANCED COST
ACCOUNTING
SUBJECT CODE : 72211

© UNIVERSITY OF MUMBAI
Prof. Suhas Pednekar

Vice-Chancellor,
University of Mumbai,
Prof. Ravindra D. Kulkarni Prof. Prakash Mahanwar

Pro Vice-Chancellor, Director,
University of Mumbai, IDOL, University of Mumbai,
Programme Co-ordinator : Prof. Rajashri Pandit

Asst. Prof. in Economic,
Incharge Head Faculty of Commerce,
IDOL, University of Mumbai, Mumbai
Course Co-ordinator : Mr. Vinayak Vijay Joshi

Asst. Professor
Re-Editor : Ms. Neha Bhatia

Asst. Professor, Programme Co-ordinator,
B.Com. (Accounting and Finance)
Course Writer : Dr. P. K. Bandgar

Principal,
Sanpada College of Commerce,
Navi Mumbai - 400705
: Dr. Paulraj Arunachandan

Guru Nanak College,
GTB Nagar,
Mumbai - 400037
: Dr. V. S. Kannan
Vice Principal
K.E.S. Shroff College of Commerce,
Kandivali (E), Mumbai - 400101
May 2022, Print - 1
Published by : Director,
Institute of Distance and Open Learning ,
University of Mumbai,
Vidyanagari, Mumbai - 400 098.
DTP Composed : Mumbai University Press

Printed by Vidyanagari, Santacruz (E), Mumbai
CONTENTS
Unit No. Title Page No.
1 Process Costing 01
2. Cost Allocation 51
3. ResponsibilityAccounting 68
4. Transfer Pricing 83

Revised Syllabus of Courses of
Master of Commerce (M.Com) Programme at Semester III
Group A: Advanced Accounting, Corporate Accounting and

Financial Management
3. Advanced Cost Accounting

Modules at a Glance
No. of
SN Modules
Lectures
1 Process Costing 15
2 Cost Allocation and Activity Based Costing Systems 15
3 Responsibility Accounting 15
4 Strategic Cost Management 15
Total 60
SN Modules/ Units
1 Process Costing
A) Introduction - Features of process, Concept of Process Loss, Abnormal Loss,
Normal Loss, Abnormal Gain.
B) Computation of Inter Process Profit Advantages and Disadvantages
C) Computation of Equivalent Production Weighted Average and FIFO.
2 Cost Allocation and Activity Based Costing Systems
A) Cost Allocation Meaning and its Types, Relationship between resources,
activities, Cost and Cost drivers, Methods of allocating central costs - cost
allocation using Direct Method, Step Down Method and Reciprocal Method.
B) Activity Based Costing Introduction, Advantages, Limitations, Identification of
cost drivers, Practical Problems on Traditional V/s Activity Based Costing
System.
3 Responsibility Accounting
A) Responsibility Accounting Meaning, Features, Objective, Assumptions,
Cost, Profit, Revenue and Investment.
B) Concept of Controllability Introduction, Measuring Managerial Performance
( ROI and Residual Income Approach)
C) Preparation of Managerial Reports using Segmented Costs and Controllable
costs approach.
4 Strategic Cost Management
A) Transfer Pricing Introduction, Advantages and Disadvantages, Setting
Transfer Pricing Negotiated transfer pricing, Cost Based transfer pricing.
B) Target Costing Introduction, Concept, Objectives, Comparison between
Target Costing and Cost Plus Pricing.
C) Inflation Accounting Meaning, Features, Conversion of Income Statement,
Balance Sheet, Stocks and Net Assets Block using Current Purchasing Power
Method.
1
PROCESS COSTING
Unit Structure
1.0 Learning Objectives
1.1 Introduction
1.2 Meaning of process costing
1.3 Distinction between job costing and process costing
1.4 Costing Procedure
1.5 Solved illustrations
1.6 Valuation of Work-in-progress
1.7 Questions
1.8 Exercise
1.0 LEARNING OBJECTIVES
After studying this chapter you should able to understand

 the meaning of Process Costing and its importance
 the distinction between job costing and process costing
 the accounting procedure of process costing including normal loss

abnormal loss (or) gain
 the valuation of work-in-progress, using FIFO, LIFO average and

weighted average methods
 the steps involved in inter process transfer
1.1 INTRODUCTION:
Process costing is a form of operations costing which is used where
standardized homogeneous goods are produced. This costing method
is used in industries like chemicals, textiles, steel, rubber, sugar,
shoes, petrol etc. Process costing is also used in the assembly type of
industries also. It is assumed in process costing that the average cost
presents the cost per unit. Cost of production during a particular
period is divided by the number of units produced during that period
to arrive at the cost per unit.
1
Advanced Cost Accounting 1.2 MEANING OF PROCESS COSTING
Process costing is a method of costing under which all costs are
accumulated for each stage of production or process, and the cost
per unit of product is ascertained at each stage of production by
dividing the cost of each process by the normal output of that
process.
1.2.1 Definition:
CIMA London defines process costing as “that form of operation

costing which applies where standardize goods are produced”
1.2.2 Features of Process Costing:
(a) The production is continuous
(b) The product is homogeneous
(c) The process is standardized
(d) Output of one process become raw material of another process
(e) The output of the last process is transferred to finished stock
(f) Costs are collected process-wise
(g) Both direct and indirect costs are accumulated in each process
(h) If there is a stock of semi-finished goods, it is expressed interms
of equivalent units
(i) The total cost of each process is divided by the normal output of that
process to find out cost per unit of that process.
1.2.3 Advantages of process costing:

1. Costs are be computed periodically at the end of a particularperiod
2. It is simple and involves less clerical work that job costing
3. It is easy to allocate the expenses to processes in order to haveaccurate
costs.
4. Use of standard costing systems in very effective in process
costing situations.
5. Process costing helps in preparation of tender, quotations
6. Since cost data is available for each process, operation and
department, good managerial control is possible.
2
1.2.4 Limitations: Process Costing
1. Cost obtained at each process is only historical cost and are not very
useful for effective control.
2. Process costing is based on average cost method, which is not that
suitable for performance analysis, evaluation and managerial control.
3. Work-in-progress is generally done on estimated basis which leads to
inaccuracy in total cost calculations.
4. The computation of average cost is more difficult in those cases where
more than one type of products is manufactured and a division of the
cost element is necessary.
5. Where different products arise in the same process and common costs
are prorated to various costs units. Such individual products costs may
be taken as only approximation and hence not reliable.
1.3 DISTINCTION BETWEEN JOB COSTING

ANDPROCESS COSTING
Job order costing and process costing are two different systems.
Both the systems are used for cost calculation and attachment of
cost to each unit completed, but both the systems are suitable in
different situations. The basic difference between job costing and
process costing are
Basis of Job order costing Process costing

Distinction
1 Specific Performed against Production iscontentious
. order specific orders
2 Nature Each job many Product is
. bedifferent. Homogeneous
andstandardized.
3 Cost Cost is determined for Costs are compiled for
. determination each job separately. each process for
department on time basis
i.e. for a given
accounting period.
4 Cost Cost is compiled whena Cost is calculated at the
. calculations job is completed. end of the cost period.
5 Control Proper control is Proper control is

. comparatively difficult comparatively easier as
as each product unit is the production is
different and the standardized and is
production is not more suitable.
continuous.
3
Advanced Cost Accounting 6 Transfer There is usually not The output of one
. transfer from one job to process is transferred to
another unless there is another process as input.
some surplus work.
7 Work-in- There may or may not There is always some

. Progress be work-in-progress. work-in-progress
because of continuous
production.
8 Suitability Suitable to industries Suitable, where goods
. where production is are made for stock and
intermittent productions
and customer orders iscontinuous.
can be identified in the
value of production.
1.4 COSTING PROCEDURE

For each process an individual process account is prepared.
Each process of production is treated as a distinct cost center.
1.4.1 Items on the Debit side of Process A/c.
Each process account is debited with –

a) Cost of materials used in that process.
b) Cost of labour incurred in that process.
c) Direct expenses incurred in that process.
d) Overheads charged to that process on some pre-determined.
e) Cost of ratification of normal defectives.
f) Cost of abnormal gain (if any arises in that process)
1.4.2 Items on the Credit side:
Each process account is credited with

a) Scrap value of Normal Loss (if any) occurs in that process.
b) Cost of Abnormal Loss (if any occurs in that process)
1.4.3 Cost of Process:
The cost of the output of the process (Total Cost less Sales valueof
scrap) is transferred to the next process. The cost of each process is
thus made up to cost brought forward from the previous process and
net cost of material, labour and overhead added in that process after
4
reducing the sales value of scrap. The net cost of the finished process Process Costing
is transferred to the finished goods account. The net cost is divided
by the number of units produced to determine the average cost per
unit in that process. Specimen of Process Account when there are
normal loss and abnormal losses.
Dr. Process I A/c. Cr.
Particulars Units Rs. Particulars Units Rs.

To Basic Material xxx xx By Normal Loss xx xx
To Direct Material xx By Abnormal Loss xx xx
To Direct Wages xx By Process II A/c. xx xx
To Direct Expenses xx (output transferred
to
To Production xx Next process)
Overheads
To Cost of xx By Process IStock
xx A/c. xx
Rectification of
Normal Defects
To Abnormal Gains xx
xx xxx xx xx
1.4.4 Process Losses:
In many process, some loss is inevitable. Certain production

techniques are of such a nature that some loss is inherent to the
production. Wastages of material, evaporation of material is un
avoidable in some process. But sometimes the Losses are also
occurring due to negligence of Labourer, poor quality raw material,
poor technology etc. These are normally called as avoidable losses.
Basically process losses are classified into two categories
(a) Normal Loss (b) Abnormal Loss
1. Normal Loss:
Normal loss is an unavoidable loss which occurs due to the inherent

nature of the materials and production process under normal
conditions. It is normally estimated on the basis of past experience
of the industry. It may be in the form of normal wastage, normal
scrap, normal spoilage, and normal defectiveness. It may occur at
any time of the process.
5
Advanced Cost Accounting No of units of normal loss: Input x Expected percentage of Normal
Loss.
The cost of normal loss is a process. If the normal loss units can be
sold as a crap then the sale value is credited with process account. If
some rectification is required before the sale of the normal loss, then
debit that cost in the process account. Afteradjusting the normal loss
the cost per unit is calculates with the help of the following formula:
Cost of good unit:
Total cost increased – Sale Value of ScrapInput – Normal Loss units

2. Abnormal Loss:
Any loss caused by unexpected abnormal conditions such as plant

breakdown, substandard material, carelessness, accident etc. such
losses are in excess of pre-determined normal losses. This loss is
basically avoidable. Thus abnormal losses arrive when actual losses
are more than expected losses. The units of abnormal losses in
calculated as under:
Abnormal Losses = Actual Loss – Normal Loss
The value of abnormal loss is done with the help of following
formula:
Value of Abnormal Loss:
Total Cost increase – Scrap Value of normal Loss x Units of abnormal loss Input
units – Normal Loss Units
Abnormal Process loss should not be allowed to affect the cost of

production as it is caused by abnormal (or) unexpected conditions.
Such loss representing the cost of materials, labour and overhead
charges called abnormal loss account. The sales value of the
abnormal loss is credited to Abnormal Loss Account and the balance
is written off to costing P & L A/c.
Dr. Abnormal Loss A/c. Cr.
Units Rs. Particulars Units Rs.
To Process A/c. xx xx By Bank xx xx
By Costing P & L xx xx
A/c.
xx xxx xx xx
6
3. Abnormal Gains: Process Costing
The 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 anticipates. This difference may be positive or
negative. If it is negative it is called ad abnormal Loss and if it is
positive it is Abnormal gain i.e. if the actual loss is less than the
normal loss then it is called as abnormal gain. The value of the
abnormal gain calculated in the similar manner of abnormal loss.
The formula used for abnormal gain is:
Abnormal Gain
Total Cost incurred – Scrap Value of Normal Loss x Abnormal Gain Unites Input
units – Normal Loss Units
The sales values of abnormal gain units are transferred to Normal

Loss Account since it arrive out of the savings of Normal Loss. The
difference is transferred to Costing P & L A/c. as a Real Gain.
Dr. Abnormal Gain A/c. Cr.
To Normal Loss xx xx By Process A/c. xx xx

A/c.
To Costing P & L xx xx
A/c.
xx xx xx xx
Check Your Progress:

1. Define the following terms
a. Process costing
b. Normal Loss
c. Abnormal Loss
2. Give the formulas of following
a) Cost of good / normal unit
b) Value of Abnormal Loss
7
Advanced Cost Accounting 1.5 SOLVED ILLUSTRATIONS
Illustration 1: (Normal / Abnormal Loss)
Prepare a Process Account, Abnormal Loss Account and Normal

Loss Account from the following information.
Input of Raw material 1000 units @ Rs. 20 per

unit
Direct Material Rs. 4,200/-
Direct Wages Rs. 6,000/-
Production Overheads Rs. 6,000/-
Actual output transferred to process II 900 units
Normal Loss 5%
Value of Scrap per unit Rs. 8/-
Solution :
Dr. Process – I A/c. Cr.
To Raw material @ 1000 20000 By Normal Loss

20
To Direct 4200 (5% on 50 400

Material 1000)
To Direct Wages 6000 By Abnormal 50

Loss A/c.
To Production BY Process – II
A/c.
Overheads 6000 (output transferred) 900
1000 36200 1000 36200
Dr. Abnormal Loss A/c. Cr.
To Process – IA/c. 50 By Bank A/c. 50 400
By Costing P & L
A/c.
50 50 400
8
Dr. Normal Loss A/c. Cr. Process Costing

To Process – IA/c. 50 400 BY Bank 50 400
Working Notes:
(1) Cost of abnormal Loss :
= Total Cost increased – Sales value of Scrap x abnormal units
Input units – Normal Loss Units
= 36200 – 400 x 50
1000 – 50
(2) It has been assumed that units of abnormal loss have also been
sold at the same rate i.e. of Normal Scrap
Illustration 2: (Normal / Abnormal Loss and Abnormal Gain)
The product of a company passes through 3 distinct process. The

following information is obtained from the accounts for the month
ending January 31, 2008.
Particulars Process – A Process – B Process – C

Direct Material 7800 5940 8886
Direct Wages 6000 9000 12000
Production Overheads 6000 9000 12000
3000 units @ Rs. 3 each were introduced to process – I. There was

no stock of materials or work in progress. The output of eachprocess
passes directly to the next process and finally to finished stock A/c.
The following additional data is obtained :
Process Output Percentage of Value of Scrap per

Normal Loss to unit (Rs.)
Input
Process – I 2850 5% 2
Process – II 2520 10 % 4
Process – III 2250 15 % 5
Prepare Process Cost Account, Normal Cost Account and

Abnormal Gain or Loss Account.
9
Advanced Cost Accounting Solution:
Dr. Process – A A/c. Cr.

To Units 3000 9000 By Normal 150 300
introduced LossA/c.
To Direct 7800 By Process – B 2850 28500
Material A/c.
To Direct Wages 6000 (Units
transferred
To Production @ Rs. 10/-)
Overheads 6000
3000 28800 3000 28800
Dr. Process – B A/c. Cr.

To Process – I 2850 28500 By Normal 285 1140
A/c. LossA/c.
To Direct 5940 By Abnormal 45 9000
Material Loss A/c.
To Direct Wages 9000 By Process – 2520 50400
CA/c.
To Production
Overheads 9000
2850 52440 2850 52440
Dr. Process – C A/c. Cr.

To Process – II 2520 50400 By Normal Loss 378 1890
A/c. A/c.
To Direct Material 8886 By Finished Stock 2250 85500
A/c A/c.
To Direct Wages 12000
To Production
Overheads 12000
To AbnormalGain 108 4104
A/c.
2628 87390 2628 87390
10
Process Costing

To Normal LossA/c. 108 540 By Process – CA/c. 108 4104
To Costing P&LA/c. 3564
108 4104 108 4104
Dr. Normal Loss A/c. Cr.

To Process – AA/c. 150 300 By Bank A/c.
(Sales)
To Process – BA/c. 285 1140 Process – A 150 300
A/c.
To Process – CA/c. 378 1890 Process – B A/c. 285 1140
Process – C 270 1350

A/c.
By Abnormal Gain 108 540
A/c.
813 3330 813 3330
1.6 INTER PROCESS PROFITS:

Normally the output of one process is transferred to another process
at cost but sometimes at a price showing a profit to the transfer
process. The transfer price may be made at a price corresponding to
current wholesale market price or at cost plus an agreed percentage.
The advantage of the method is to find out
Whether the particular process is making profit (or) loss. This will
help the management whether to process the product or to buy the
product from the market. If the transfer price is higher than the cost
price then the process account will show a profit. The complexity
brought into the accounting arises from the fact that the inter process
profits introduced remain a part of the prices of process stocks,
finished stocks and work-in-progress. The balance cannot show the
stock with profit. To avoid the complication a provision must be
created to reduce the stock at actual cost prices. This problem arises
only in respect of stock on hand at the end of the period because
goods sold must have realized the internal profits. The unrealized
11
Advanced Cost Accounting profit in the closing stock is eliminated by creating a stock reserve.
The amount of stock reserve is calculated by the following formula.
Stock Reserve = Transfer Value of stock x Profit included in transfer price
Transfer Price
Illustration 3 :
A product passes through three processes before its completion. The

output of each process s charged to the next process at a price
calculated to give a profit of 20% on transfer price. The output of
Process III is transferred to finished stock account on a similar basis.
There was no work-in-progress at the beginning of the years. Stock
in each process has been valued at prime cost of the process. The
following data is available at the endof 31st March, 2009.
ProcessI ProcessII ProcessIII Finished

Stock Rs.
Direct Material 20000 30000 10000 --
Direct Wages 30000 20000 40000 --
Stock on 31st March 10000 20000 30000 15000
2009
Sale during the year -- -- -- 180000
From above information prepare:

1. Process Cost Account showing the profit at each stage.
2. Actual realized profit and
3. Stock Valuation as would appear in the balance sheet
Solution:
Dr. Process – I A/c. Cr.
Particulars TotalRs. CostRs. Profit Particulars Total Cost Profit

Rs. Rs. Rs. Rs.
To Materials 20000 20000 -- By Process 50000 40000 10000

IIA/c.
(Transfer)
To Wages 30000 30000 --
Total 50000 50000 --
Les Closing
Stock c/d 10000 10000 --
12
Prime Cost 40000 40000 -- Process Costing
To Gross
Profit 10000 -- 10000
(20% on
TransferPrice)
50000 40000 10000 50000 40000 10000
ToStockB/d. 10000 10000 --
Dr. Process – II A/c. Cr.

Particulars TotalRs. CostRs. ProfitRs. Particulars TotalRs. CostRs. ProfitRs.
To Process 50000 40000 10000 By Process-III
– I A/c.
A/c. 100000 72000 28000
To Material 30000 30000 -- (Transfer)
To Wages 20000 20000 --
100000 90000 10000
Less :
Closing
StockC/d. 20000 18000 2000
Prime Cost 80000 72000 8000
To Gross
Profit
(20% on
TransferPrice) 20000 -- 20000
100000 72000 28000 100000 72000 28000
To Stock 20000 18000 2000

B/d.
13
Advanced Cost Accounting Process III A/c
Particulars Total Cost Profit Particulars Total Cost Profit

Rs. Rs. Rs. Rs. Rs. Rs.
ToprocessII 100000 72000 28000 By 150000 97600 52400
Finished
A/c stock A/c
To Material 10000 10000
To Wages 40000 40000 -------
TOTAL
150000 122000 28000
Less.Closing
stock 30000 24400 5600
To Gross 120000 97600 22400
profit
(20%of 30000 -------- 30000
transfer
price)
150000 97600 52400 150000 97600 52400
To Stock b/d 30000 24000 5600
Finished stock A/c
Particulars Total Cost Profit Particulars Total Cost Profit

Rs. Rs. Rs. Rs. Rs. Rs.
To process 115000 97600 52400 By Sales 180000 87840 92160
III A/c
(-)Stock 15000 9760 5240
To gross 135000 87840 92160

profit
45000 --- 45000
180000 87840 92160 180000 87840 92160
To Stock 15000 9760 5240
A/c
Calculation of profit on closing stock

Profit included in stock = Profit included in transfer price x Value of stock
Transfer price
Process I = No profit
Process Ii =10000x20000=2000
100000
Process Iii =28000x30000=5600
150000
Finished stock= 52400x15000=5240
150000
14
Illustration 4 : Process Costing
A product process through three process A, B and C. The details of

expenses incurred on the three process during the year 2008 were as
under :
ProcessA ProcessB ProcessC
Units introduced 10000

Cost per unit is Rs. 50/-
Rs. Rs. Rs.
Sundry Material 6000 9000 3233
Labour 18000 48000 39000
Direct Expenses 3000 11000 18000
Selling price per unit of output 70 100 200
Management expenses during the year were Rs. 80000 and selling
were Rs. 5000. There are not allocable to the processes. Actual
output of the three process were A – 9300 units, B – 5400 units and
C 2100 units. Two-thirds of the output of process A and one half of
the output of process B was passed on to the next process A and
one-half of the output of process B was passed on to the next
process and the balance was sold. The entire output of process C was
sold.
The normal losses of the three process, calculated on the input of
every process was : Process A – 5%, B – 15% and C – 20%. The
loss of process A was sold @ Rs. 3 per unit, that of B @ Rs. 5 per
unit and of process C @ Rs. 10 per unit.
Prepare process A, B and C account and the Profit and LossAccount.
Solution :
Dr. Process A A/c. Cr.
ToUnits Introduced 10000 5,00,000 By Normal Loss 500 1,500
@RS.50
By Abnormal loss 200 11063
ToSundryMaterials 6,000 By process B 6,200 342958
To Labour 18,000 By output sold 3,100 171479
ToDirect 3,000
Expenses
10000 5,27,000 10000 5,27,000
15
Advanced Cost Accounting Dr. Process B A/c. Cr.

To Process A 6200 342958 By Normal Loss 930 4650
A/c.
ToSundryMaterials 9000 By Process C 2700 2,08,165
A/c.
To Labour 48000 By output sold 2700 2,08,165
To Direct 11000
Expenses
ToAbnormalGains 100221
A/c. (@ 77.19)
6330 420980 6,330 4,20,980
Dr. Process C A/c. Cr.

To Process B 2700 208165 By Normal Loss 540 5400
A/c.
ToSundryMaterials 3233 By AbnormalLoss 60 7305
To Labour 39000 By output sold 2100 255693

To Direct 18000 ( @ 12.76)
Expenses
2700 268398 2700 268398
Dr. Profit & Loss A/c. Cr.

To Process AA/c. 3100 171479 By Sales( @ Rs. 70) 3100 217000
To Process BA/c. 2700 208165 By Sales(@Rs. 100) 2700 270000
To Process CA/c. 2700 265693 BySales(@Rs.2000) 2700 420000
To Management 80000 BY Abnormal GainA/c. 9372

Expenses A/c.
ToSellingExpenses 50000
To Abnormal 17168
Loss A/c.
To Net Profit 133867
916372 916372
16
Dr. Abnormal Loss A/c. Cr. Process Costing

To Process A A/c. 200 11063 By Bank Sales
To Process B A/c. 60 7305 (@ Rs. 30) 200 600
By Bank
(@ Rs. 10) 60 600
By P & L A/c. 17168
260 18368 260 18368

To Normal Loss 130 650 By Process B /c. 130 10022
A/c.
To Costing P & L 9372
A/c.
130 10022 130 10022
Illustration 5
Mahesh Ltd process a material which passes through three

processes. Figures relating to production for the first 6 months of
2009 are as follows.
ProcessA ProcessB ProcessC
Raw material used 1000 tones @

Rs. 200
Manufacturing Wages Rs. 40000 Rs. 30000 Rs. 7000
Expenses Rs. 32500 Rs. 10800 Rs. 3710
Scrap sold @ Rs. 50 pertone 50 tones 30 tones 51 tones
Selling price per tone Rs. 320 Rs. 450 Rs. 800
Weight Loss 5% 10% 20%
Management expenses were Rs. 10500, selling expenses Rs. 8000

and interest on borrowed capital Rs. 2000. Two third of process I
and one half of process 2 are passed on to the next process and the
balance are sold.
17
Advanced Cost Accounting Prepare Process Account, Process Stock Account and Costing Profit
& Loss A/c.
Solution
Dr. Process No. 1 A/c. Cr.

To Material @ 1000 200000 By Normal Loss 50 2500
Rs. 200 (sale of Scrap)
To Wages 40000 By Weight Loss 50 --
To Expenses 32500 By Process I Stock 900 270000
A/c.(@300per tone)
1000 272500 1000 272500
Dr. Process No. 1 Stock A/c. Cr.

To Process I A/c. 900 270000 By Bank (@ 320) 300 96000
To Costing Profit & 6000 ByProcessNo.2A/c. 600 180000
Loss A/c.
900 276000 900 276000

To Process 1 600 180000 By Normal Loss (@ 30 1500
Stock A/c. Rs. 50)
To wages 30000
To Expenses 10800 By Weight Loss 60 --
By Process 2
Stock
A/c(@ Rs. 430) 510 219300
600 220800 600 220800
18
Dr. Process No. 2 Stock A/c. Cr. Process Costing

To Process 2 A/c. 510 219300 By Bank
ToCosting P&L 5100 (sale @ 450) 255 114750
A/c.
By Process 3 255 109650
A/c.
510 244400 510 244400

To Process 2 255 109650 By scrap 51 2550
Stock A/c.
To wages 7000 By Weight Loss 51 --
To Expenses 3710 By Process 3 153 117810
stock A/c
255 120360 255 120360
Dr. Process No. 3 Stock A/c. Cr.

To Process 3 A/c. 153 117810 By Bank
To Costing P & L 4590 (sale @ 800) 153 122400
A/c.
153 122400 153 122400
Dr. Costing Profit & Loss A/c. Cr.
Particulars Rs. Particulars Rs.

To Management Expenses 10500 By Process 1 Stock A/c. 6000
To Selling Expenses 8000 By Process 2 Stock A/c. 5100
To Interest on Capital 2000 By Process 3 Stock A/c. 4590
By Net Loss 4810
20500 20500
19
Advanced Cost Accounting 1.7 VALUATION OF WORK-IN-PROGRESS
1.7.1 Meaning of Work-in-Progress:
Since production is a continuous activity, there may be some

incomplete production at the end of an accounting period.Incomplete
units mean those units on which percentage of completion with
regular to all elements of cost (i.e. material, labour and overhead) is
not 100%. Such incomplete production units are known as Work-in-
Progress. Such Work-in-Progress is valued in terms of equivalent or
effective production units.
1.7.2 Meaning of equivalent production units :
This represents the production of a process in terms of complete

units. In other words, it means converting the incomplete production
into its equivalent of complete units. The term equivalent unit means
a notional quantity of completed units substituted for an actual
quantity of incomplete physical units in progress, when the
aggregate work content of the incomplete units is deemed to be
equivalent to that of the substituted quantity. The principle applies
when operation costs are apportioned between work in progress and
completed units.
Equivalent units of work in progress = Actual no. of units in progress x
Percentage of work completed
Equivalent unit should be calculated separately for each element of

cost (viz. material, labour and overheads) because the percentage of
completion of the different cost component may be different.
1.7.3 Accounting Procedure:
The following procedure is followed when there is Work-in-

Progress
(1) Find out equivalent production after taking into account of the
process losses, degree of completion of opening and / or closing
stock.
(2) Find out net process cost according to elements of costs i.e. material,
labour and overheads.
(3) Ascertain cost per unit of equivalent production of each element of
cost separately by dividing each element of costs by respective
equivalent production units.
(4) Evaluate the cost of output finished and transferred work in progress
The total cost per unit of equivalent units will be equal to the total
cost divided by effective units and cost of work-in-progress will be
20
equal to the equivalent units of work-in- progress multiply by the Process Costing
cost per unit of effective production. In short the following from
steps an involved.
Step 1 – prepare statement of Equivalent
production Step 2 – Prepare statement of cost per
Equivalent unitStep 3 – Prepare of Evaluation
Step 4 – Prepare process account
The problem on equivalent production may be divided into four
groups.
I. when there is only closing work-in-progress but without process
losses
II. when there is only closing work-in-progress but withprocess losses
III. when there is only opening as well as closing work-in- progress
without process losses
IV. when there is opening as well as closing work-in- progress with
process losses
Situation I :
Only closing work-in-progress without process losses :
In this case, the existence of process loss is ignored. Closingwork-in-

progress is converted into equivalent units on the basis of estimates
on degree of completion of materials, labour and production
overhead. Afterwards, the cost pr equivalent unit is calculated and
the same is used to value the finished output transferred and the
closing work-in-progress
Situation II:
When there is closing work-in-progress with process loss orgain.
If there are process losses the treatment is same as already discussed

in this chapter. In case of normal loss nothing should be added to
equivalent production. If abnormal loss is there, it should be
considered as good units completed during the period. If units
scrapped (normal loss) have any reliable value, the amount should be
deducted from the cost of materials in the cost statement before
dividing by equivalent production units. Abnormal gain will be
deducted to obtain equivalent production.
21
Advanced Cost Accounting Situation III:
Opening and closing work-in-progress without processlosses.
Since the production is a continuous activity there is possibility of

opening as well as closing work-in-progress. The procedure of
conversion of opening work-in-progress will vary depending on the
method of apportionment of cost followed viz, FIFO, Average cost
Method and LIFO.
Let us discuss the methods of valuation of work-in-progress one by
one.
(a) FIFO Method: The FIFO method of costing is based on the
assumption of that the opening work-in-progress units arethe first to be
completed. Equivalent production of opening work-in-progress can be
calculated as follows:
Equivalent Production = Units of Opening WIP x Percentage of work needed to
finish the units
(b) Average Cost Method: This method is useful when price fluctuate
from period to period. The closing valuation of work-in-progress in the
old period is added to the cost of new period and an average rate obtained.
In calculating the equivalent production opening units will not be shown
separately as units of work-in-progress but included in the units completed and
transferred.
(c) Weighted Average Cost Method: In this method no distinction is

made between completed units from opening inventory and completed
units from new production. All units finished during the current
accounting period are treated as if they were started and finished during
that period. The weighted average cost per unit is determined by dividing
the total cost (opening work-in-progress cost + current cost) by equivalent
production.
(d) LIFO Method: In LIFO method the assumption is that the units
entering into the process is the last one first to be completed. The cost of
opening work-in-progress is charged to the closing work-in-progress and
thus the closing work-in- progress appears cost of opening work-in-
progress. The completed units are at their current cost.
22
(1) Format of statement of Equivalent Production : Process Costing
Input Output EquivalentProduction
Particulars Units Particulars Units Material Labour Overheads

% Units % Units % Units
OpeningStock xx Units xx xx xx xx xx
completed
Units xx NormalLoss xx -- -- -- --
Introduced
Abnormal xx xx xx xx xx
Loss
xx Equivalent xx xx xx xx xx xx Xx
Units
(2) Statement of cost per Equivalent Units :
Element of costing CostRs. Equivalent Cost per

Units Equivalent Units
Rs
Material Cost (Net) Xx Xx Xx
Labour Cost Xx Xx Xx
Overheads Cost Xx xx Xx
xx Xx
(3) Statement of Evaluation
Particulars Element ofcost Equivalent Cost per Cost Total

Units equivalent Rs. Cost
units Rs.
Rs.
Units completed Material xx xx xx
Labour xx xx xx
Overheads xx xx xx Xx
Closing WIP Material xx xx xx
Labour xx xx xx
Abnormal Loss Material xx xx xx
Labour xx xx xx
23
Advanced Cost Accounting Illustration 6: (Average Costing)
Prepare a statement of equivalent production, statement of cost,

process account from the following information using average
costing method.
Opening Stock 50000 Units
Material Rs. 25000
Labour Rs. 10000
Overheads Rs. 25000
Units Introduced 2000000 Units
Material Rs. 100000
Wages Rs. 75000
Overheads Rs. 70000
During the period 1,50,000 units were completed and transferred to

Process II.
Material 100 %
Labour 50 %
Overheads 40 %
Solution :
Input Output Equivalent Production
Opening Units
Stock 50,000 Produced 150000 100 150000 100 150000 100 150000
Introduced 200,000 Closing
Stock 100000 100 100000 50 50000 40 40000
250000 250000 250000 200000 190000
Closing stock 1,00,000 units. Degree of completion.
24
Statement of Cost : Process Costing
Element Opening cost Current cost Total Cost Equivalent Cost per
Rs. Rs. Rs. units unit
Material 25,000 1,00,000 1,25,000 2,50,000 0.500
Labour 10,000 75,000 85,000 2,00,000 0.425
Overheads 25,000 70,000 95,000 1,90,000 0.500
60,000 2,45,000 3,05,000 1.425
Statement of Apportionment of Cost
Particulars Units Cost perunit Cost Totalcost
1. Units introduced & 1,50,000 1.425 213750

transferred
2. Closing work-in-progress
Material 1,00,000 0.500 50,000
Labour 50,000 0.425 21,250
Overheads 40,000 0.500 20,000 91,250
3,05,000
Dr. Process I A/c. Cr.
To Opening 50,000 60,000 By Units

Stock
completed
To Materials 2,00,000 1,00,000 & transfer 50,000 2,13,750
To Labour 75,000 By Closing Stock 50,000 91,250
To Overheads 70,000
2,50,000 3,05,000 2,50,000 3,05,000
25
Advanced Cost Accounting Illustration 7: (FIFO Method)
From the following information relating to KKN Company Ltd.

Prepare Process Cost Account for Process III for the year 2008.
Opening Stock IN Process III 5000
units ofRs. 36,000
Transfer from Process II 2,13,000
units ofRs. 8,27,000
Direct Material added in Process III Rs. 4,01,800
Direct Wages Rs. 1,98,100
Production Overhead Rs. 99,050
Units Scrap 11,000 units
Transferred to Process IV 1,89,000
units
Closing Stock 18,000 units
Degree of Completion :
Opening Closing Scrap
Stock Stock
Material 70 % 80 % 100 %
Labour 50 % 60 % 80 %
Overhead 50 % 60 % 80 %
There was a normal loss of 5% production and unit scraped were

sold at Rs. 1.50
26
Solution : Process Costing
Input Output Equivalent Production

Opening Normal
Stock 5,000 Loss 10000
Process II Op. Stock
Transfer 213,000 Processed 5000 - - 30 1500 50 2500
Introduces &
Completed 184000 100 184000 100 184000 100 184000
Abnormal
Loss 1000 100 1000 100 1000 80 800
Closing
Stock 18000 100 18000 80 14400 60 10800
218000 218000 203000 200900 198100
Note : Units Produced: Opening stock + units introduced – closing stock
: 5000 +213000 – 18000 = 200000
Normal Loss : 5 % of 200000 = 10000 units
Statement of Cost
Particulars CostRs. Equivalent Cost Per

Units Rs. UnitRs.
Material – I
Transfer from Previous 8,27,000
process
Less – Value of scrap 15,000 8,12,000 2,03,000 4.00
(normal)
Material – II
Added+ in the process 4,01,800 2,00,900 2.00
Direct Wages 1,98,100 1,98,100 1.00
Overheads 99,050 1,98,100 0.50
7.50
27
Advanced Cost Accounting Statement of Apportionment of Cost
Particulars Elements Equivalent Cost Per CostRs. Total costRs.

Units Unit
Rs.
Op. Stock Material I -- --
Processed
Material II 1,500 2.00 3,000
Wages 2,500 1.00 2,500
Overheads 2,500 0.50 1,250 6,750
Units introducedand Material I 1,84,000 4.00 7,36,000
Completed Material II 1,84,000 2.00 3,68,000

Wages 1,84,000 1.00 1,84,000
Overheads 1,84,000 0.50 92,000 13,80,000
Closing stock Material I 18,000 4.00 72,000 13,86,750
Material II 14,400 2.00 28,800
Wages 10,800 1.00 10,800
Overheads 10,800 0.50 5,400 1,17,000
Abnormal loss Material I 1,000 4.00 4,000
Material II 1,000 2.00 2,000
Wages 800 1.00 800
Overheads 800 0.50 400 7,200
TOTAL 15,10,950
Dr. Process III A/c. Cr.

To Balanceb/d. 5,000 36,000 By Normal 10,000 15,000
Loss
To Process II 2,13,000 8,27,000 By Process IV 1,89,000 14,22,750
A/c. A/c.
To Materials 4,01,800 By Abnormal 1,000 7,200
Loss
To Wages 1,98,100 By Closing 18,000 1,17,000

Stock
To 99,050
Overheads
2,18,000 15,61,950 2,18,000 15,61,950
28
Note : Process Costing
Cost of goods transferred to Process IV :

Value of Opening Stock 36,000
Cost incurred in this process for Opening Stock 6,750
Cost incurred for the units introduced & Processed 13,80,000
Total 14,22,750
Illustration 8
The following information is given in respect of Processcosting 10 :

3 for the month of January 2009.
Opening stock – 2,000 units made up of
Rs.
Direct Material – I 12,350
Direct Material – II 13,200
Direct Labour 17,500
Overheads 11,000
Transferred from Process 2 – 20,000 units @ Rs. 6 per unit.

Transferred to Process 4 – 17,000 units
Expenditure incurred in process – 3
Rs.
Direct Material 30,000
Direct Labour 60,000
Overheads 60,000
Scrap:1,000 units-Direct Materials 100%,Direct Labour 60%,
Overheads 40%.
Normal Loss 10 % of Production. Scrapped units realized Rs. 4/- per
unit
Closing stock : 4,000 units – Degree of completion. DirectMaterials
80 %, Direct Labour 60 % and Overheads 40 %.
Prepare Process 3 Account using average price method along with
necessary supporting statements.
[C. A. – Inter, May 2001]
29
Advanced Cost Accounting Solution :
Statement of Equivalent Production (weighted Average cost

Material)
Particulars Total Material – I Material – II Labour Overheads
Units
Units Completely
Processed 17000 100 17000 100 17000 100 17000 100 17000
Normal Loss 1800 --
10% of (2000 +
20000 – 4000)
Abnormal Gain 800 100 800 100 800 100 800 100 800
Closing Stock 4000 100 4000 80 3200 60 2400 40 1600
22000 20200 19400 18600 17800
Statement of Cost
Particulars CostRs. Equivalent Rate / EquivalentUnits

Units Rs.
Material – I :
Opening balance 2000 units 12,350
Cost of 20000 units @ Rs. 6
Per unit 1,20,000
1,25,150 20,200 6.1955
Material – II :
Opening Stock 13,200
In Process II 30,000
43,200 19,400 2.2268
Labour :
Opening Labour 17,500
77,500 18,600 4.1667
Overheads :
Opening Stocks 11,000
71,000 17,800 3.9888
Total cost per unit 16.5778
30
Valuation of Equivalent Unit Process Costing
Rs.
Finished goods (17000 units x Rs. 16.5778) 2,81,822

Abnormal Units
Workinprogress (800 units x Rs. 16.5778) 13,262
Material I Material
II 24,782
(4000 units x Rs. 6.1955) 7,126
Labour Overheads
(3200 units x Rs. 2.2268) 10,000
(2400 units x Rs. 4.1667) 6,382 48,290
(1600 units x Rs. 3.9888)
Dr. Process III A/c. Cr.

To Opening 2,000 57,050 By Normal Loss 1,800 7,200
WIP
To Process 2 20,000 1,20,000 By Finished Goods
To Direct Units 17,000 2,81,822
Material II 30,000 By Closing Balance 4,000 48,290
To Direct 60,000
Labour
To Overheads 60,000
To Abnormal 800 13,262
Gain
22,800 3,37,312 22,800 3,37,312
Illustration.9
The finished product of a factory pass through two processes.The

entire material being placed in process at the beginning of the first
process. From the following production and last data relating to the
first process, work out the value of the closing inventory and the
value of the materials transferred to the second process.
31
Advanced Cost Accounting Process I Rs.
Opening inventory 10,000
Material 27,500
Labour 50,000
Manufacturing Overheads 40,000
Opening inventory (25 percent complete) 4,000
Put into Process 12,000
Transferred to II Process 10,000
Closing inventory (20 percent completed) 5,000
Spoilage during process 1,000
[I.C.W.A., Final]
Solution :
Process I A/c
Particulars Kg. AmountRs. Particulars Kg. AmountRs.
Opening Inventory 4,000 10,000 Transferred to 10,000 1,15,750

Process II
Material 12,000 27,500 Normal Loss 1,000 --
Labour 50,000 Closing 5,000 11,750
Inventory
Manufacturing
Overheads 40,000
16,000 1,27,500 16,000 1,27,500
Working Note :
Statement of Equivalent Production Units
Particulars OutputKg. Material Labour Overheads

Qty. % Qty. % Qty. %
Opening Stock 4,000 3,000 75 3,000 75 3,000 75
Processed
Completely Processed 6,000 6,000 100 6,000 100 6,000 100
Normal Loss 1,000 -- -- -- -- -- --

Closing Inventory 5,000 1,000 20 1,000 20 1,000 20
16,000 10,000 10,000 10,000
32
Statement of Element of Cost on the basis of EquivalentProduction Process Costing
Particulars CostRs. Equivalent Cost per UnitRs.

Units
Material 27,500 10,000 2.75
Labour 50,000 10,000 5.00
Overheads 40,000 10,000 4.00
Total 11.75
Particulars Elements Equivalent Cost Per CostRs. Total cost

Units UnitRs. Rs.
Op. Stock Material 3,000 2.75 8,250

Processed
Labour 3,000 5.00 15,000
Overheads 3,000 4.00 12,000 35,250
Completely Material 6,000 2.75 16,500
Processed
Labour 6,000 5.00 30,000
Overheads 6,000 4.00 24,000 70,500
Closing Material 1,000 2.75 2,750
Inventory
Labour 1,000 5.00 5,000
Overheads 1,000 4.00 4,000 11,750
TOTAL 1,17,500
Value of goods transferred to next process
Rs. Units
Value of opening stock (given) 10,000
Additional cost on opening stock 35,250 4,000
Value of completely processed units 70,500 6,000
1,15,750 10,000
33
Advanced Cost Accounting Illustration 10
ABC Limited manufactures a product ‘2X’ by using the process

normally R. T. for the month of May 2009, the following data is
available.
Process R. T.
Material Introduced 16,000 units
Transfer to next process 14,000 units
Work-in-Process 4,000 units
At the beginning of the month (4/5 completed) 3,000 unitsAt the end
of the month (2/3 completed)
Cost records:
Work-n-Process at the beginning of the month
Material Rs. 30,000
Conversioncost Rs. 29,200
Cost during the month Materials Rs. 1,20,000
Conversion cost Rs. 1,60,800
Normal spoiled units are 10% of goods finished output transferred to
next process.
Defects in these units are identified in their finished state.
Materials for the product is put in the process at the beginning of the
cycle of operation, whereas labour and other indirect cost flow
evenly over the year. It has no realizable value for spoiled units.
Required :
(1) Statement of equivalent production (average cost method)
(2) Statement of cost and distribution of cost
(3) Process accounts
[C.A. PCE. Nov. 2007]
34
Solution : Process Costing
Statement of Equivalent Production (average cost method)

Inputunits Particulars Output Equivalent Production
Units
Materials Conversion cost
% completed Equivalent % EquivalentUnits
Units Completed
4000 Opening WIP -- --
16000 Introduced and 14,400 100 14,400 100 14,400
Completed to
next
Normal spoilage 1,440 100 1,440 100 1,440
Abnormalspoilage 1,160 100 1,160 100 1,160
Closing WIP 3,000 100 3,000 66.67 2,000
20000 20000 20000 19000
Statement showing cost of each element
Particulars Materials Conversion

cost
Opening 30,000 29,200
Cost in process 1,20,000 1,60,800
Total (a) 1,50,000 1,90,000
Equivalent Units (b) 20,000 19,000
Cost per unit (a ÷ b) 7.50 10.00
Statement showing distribution of cost
Particulars Equivalent Cost per (Rs.)

Units unit
Units completed
Materials 14,400 7.50 1,08,000
Conversion cost 14,400 10.00 1,44,000 2,52,000
Normal spoilage 1,440 17.50 25,200
(10 %)
Closing stock :
Material 3,000 7.50 22,500
Conversion cost 2,000 10.00 20,000 42,500
Abnormal Stock:
Material 1,160 7.50 8,700
Conversion Stock 1,160 10.00 11,600 20,300
35
Advanced Cost Accounting Dr. Process A/c. Cr.
Particulars Rs. Particulars Rs.

To Opening WIP 59,200 By Profit and Loss
A/c.
To Material 1,20,000 (abnormal) 20,300
Introduced
To Conversion cost 1,60,800 By Transfer to Next 2,77,200
Incurred Process
By Closing WIP 42,500
340000 3,40,000
Illustration.11
GH & Co. manufactures a product. The process costing is followed

and work-in-progress stocks at the end of each month are valued at
FIFO basis.
At the beginning of the month of June, the inventory of work- in-
progress showed 400 units, 40% complete, valued as follows:
Rs.
Material 3,600
Labour 3,400
Overheads 1,000
Total 8,000
In the month of June, materials were purchased for Rs. 75,000.

Wages and overheads in the month amounted to Rs. 79,800 and Rs.
21,280 respectively. Actual issue of material to production was Rs.
68,500. Finished stock in the month was 2500 units. There was no
loss in process.
All the end of the month, the work-in-process inventory was 500
units, 60 percent complete as to labour and overheads and 80 %
complete as to materials.
Prepare a Process Account for recording the month’s transactions
and prepare a Process Cost Sheet showing total and units costs
[I.C.W.A., Final]
36
Solution: Process Costing
Dr. Process A/c. Cr.
To Opening 400 8,000 BY Transfer to
Stock
To Material 2,600 68,500 Finished stock 2,500 1,56,094
To Labour 79,800 By Work-in-
To Overheads 21,280 Progress 500 21,486
3000 1,77,580 3000 1,77,580
Working Note :
Statement of Equivalent Production (Units)

Input Particulars Output Material Labour Overhead
Qty. % Qty. % Qty. %
400 Opening Stock 400 240 60 240 60 240 60

Completely
Processed Work-
in- Progress
2600 2,100 2,100 100 2,100 100 2,100 100
500 400 80 300 60 300 60
3000 3,000 2,740 2,640 2,640
Working Note :
(1) For opening stock also equivalent production has been calculated as
it was partly complete and it has to be converted into finished
product in this period. They werecompleted 60 % in this period.
(2) Total units produced in a month are 2,50 units. Out of this 400 units
of opening stock has been deducted because they have been partly
processed in this particular month and we have already calculated
equivalent units of opening stock. Only, 2,100 units have been
introduced and completed in theparticular period.
(3) For closing stock also equivalent production in terms of total units
completed has been calculated.
37
Advanced Cost Accounting Statement of Element of cost on the basis of Equivalent Units
CostRs. Equivalent Cost perunit Rs.

Units
Material 68,500 2.740 25.000

Labour 79,800 2.640 30.2273
Overheads 21,280 2.640 8.0606
Particulars Equivalent Cost DetailsRs. TotalRs.

Units Per Unit
Rs.
Op. Stock Material 240 25.0000 6,000
Processed
Labour 240 30.2273 7,255
Overheads 240 8.0606 1,935 15,190
Completely Material 2,100 25.0000 52,500
Processed
Labour 2,100 30.2273 63,477
Overheads 2,100 8.0606 16,927 1,32,904
Work-in- Material 400 25.0000 10,000
Process
Labour 300 30.2273 9,068
Overheads 300 8.0606 2,418 21,486
TOTAL 1,69,580
Total Cost of 2500 units
Rs.
Cost of opening stock 8,000
Additional cost of opening stock processed 15,190
Cost of completely processed 1,32,904
1,56,094
Illustration 12
The following data is available in respect of Process I for

February 1990.
38
(1) Opening stock of work-in-process 800 units at a total cost of Rs. Process Costing
4,000.
(2) Degree of completion of opening work inprocess
Materials 100 %
Labour 60 %
Overheads 60 %
(3) Input of materials at a total cost of Rs. 36,800for 9,200 units
(4) Direct wages incurred Rs. 16,7540
(5) Production overheads Rs. 8,370
(6) Units scrapped 1,200 units. The stage of completion of these units
was
Materials 100 %
Labour 80 %
Overheads 80 %
(7) Closing work-in-process : 900 units. The stage of completion of
these units was :
Materials 100 %
Labour 70 %
Overheads 70 %
(8) 7,900 units were completed and transferred tothe next process.
(9) Normal Loss is 80 % of the total input (opening stock plus units put
in)
(10) Scrap value is Rs. 4 per unit
You are required to :

(a) Compute equivalent production
(b) Calculate the cost per equivalent unit for each element
(c) Calculate the cost of abnormal loss (or gain), closing work in process
and the units transferred to the next process using the FIFO method.
(d) Show the Process Account for February 1990
[C.A., Inter]
39
Advanced Cost Accounting (a) Statement of Equivalent Production (FIFO Method)
input Output Equivalent

Particulars units Particulars Units Material Labour &
Overheads
Units % Units %
Op. Stock Units
of completed
W.I.P. 800 Work on Op. 800 -- 320 40
stock
Units New units 7100 7100 100 7,100 100
9,200 Closing stock 900 900 100 630 70
Introduced
Normal Loss 800 -- --
Abnormal 400 400 100 320 100
Loss
10,000 10,000 8,400 8,370
(b) Statement of cost per equivalent units for each element
Particulars CostRs. EquivalentUnit Cost PerUnit
Material 36,800
Less : Scraprealization
(800 units @ Rs. 4) 3,200 33,600 8,400 4.00
Labour
16,740 8,370 2.00
Overheads
8,370 8,370 1.00
I Statement showing cost of abnormal loss, closing WIP and units
transferred to the next process :
Particulars Cost per unit Equivalent Total costRs.
Rs. unit
Abnormal Loss
Materials 4.00 400 1,600
Labour 2.00 320 640
Overheads 1.00 320 320
2,560
Closing WIP
Material 4.00 900 3,600
Labour 2.00 630 1,260
7900 units transferred to next 5,490
Process
(i) Cost of opening WIP (80 units) 4,000
(ii) Cost incurred on opening WIP
Material -- --
Labour 2.00 320 640
960
40
Process Costing
(iii) Cost of completing 7100 units

Material 4.00 7100 28400
Labour 2.00 7100 14200
Overheads 1.00 7100 7100
49700
Total (I + ii + iii) 54600
Dr. Process A/c. for February 1990 Cr.
To Opening 800 4000 By Finished 7900 54660
WIP Goods
To Materials 9200 36800 By Closing WIP 900 5490
To Labour -- 16740 By Normal Loss 800 3200
To Overheads -- 8370 By Abnormal 400 2560
Loss
10000 65910 10000 65910
1.8 EXERCISE
1.8.1 Objective type:

Answer in Brief
1. State any four features of process costing.
2. Define process costing,
3. What do you mean by normal loss? How is it treated in process
cost accounts?
4. What do you mean by abnormal loss? How is it treated in process
cost accounts?
5. Distinguish between normal loss and abnormal loss.
6. What do you mean by abnormal effective? How is it treated in
process cost accounts?
7. What do you mean by inter process profit? What purpose does it
serve?
8. What do you mean be equivalent production?
41
Advanced Cost Accounting 9. Name any four industries in which process costing isapplicable?
10. Enumerate any two advantages of process costing.
11. Enumerate any two disadvantages of process costing.
12. What do you meant by equivalent units?
Multiple Choice Questions

1. The type of spoilage that should not affect the cost ofinventories is
(a) Abnormal spoilage (c) Seasonal spoilage
(b) Normal spoilage (d) Indirect spoilage
2. Materials may not be put into process
(a) At the beginning of an operation
(b) Continuously
(c) At the end of the operation
(d) In the shipping department.
3. Process cost method is especially suitable for
(a)Custom production (c) FIFO
(b) Standard costs (d) LIFO

4. In process costing, costs follow
(a) Price rise (c) Product flow
(b) Price declines (d) Finished goods
5. When average costing is used, the opening inventory costsare
(a) Kept separate from the costs for the new period
(b) Added to the costs of the new period
(c) Subtracted from the new costs
(d) Averaged with other costs to arrive at total cost.
6. A disadvantage of FIFO costing is that
(a) The first units produced cannot be distinguished from later
production.
(b) Several units costs are used at the same time.
(c) The units have to be kept separate
(d) The shipping costs are higher
42
Process Costing
7. Which of the following method of costing can be used in a large

oil refinery?
(a) Process costing (c) Unit costing
(b) Operating costing (d) Job costing
8. Which of the following paid is odd :

(a) Construction-Contract costing
(b) Ship-building-Job costing
(c) Brick manufacturing – Process costing
(d) Transport undertaking – Operating costing
9. A product which has practically no sales or utility value is
(a) Waste (c) Spoilage
(b) Scrap (d) Defectives
10. Trimmings in timber industry should be treated as a :
(a) Waste (c) Spoilage
(b) Scrap (d) Defectives
11. The type of process loss that should not affect the cost of
inventory is
(a) Abnormal loss (c) Seasonal loss
(b) normal loss (d) standard loss
12. The stage where joint products are separated from each other is
known as
(a) break-even point (b) angle of incidence
(c) split-off point

13. Fifty units are put in a process at a total cost of Rs. 90. Wastage is
normally 10% without any scrap value. If output is 40 units the amount of
abnormal loss would be
(a) Rs. 80 (c) Rs. 10

(b) Rs. 8 (d) Rs. 9
43
Advanced Cost Accounting 14. Abnormal loss is charged to
(a) process account (b) costing profit and loss account
(c) Normal loss account

(Answers: 1(a), 2 (d), 3 (b), 4(c), 5(a), 6(b), 7(a), 8(c), 9(a),
10(b).)11 (a), 12(c), 13 (c), 14(b) )
1.8.2 Short notes
1. Write a short note-Inter process profits.(Apr-08)
2. Write a Short Note-Treatment of losses in Process.(Apr 07)
3. Write a short Note-Equivalent Production. (Apr-07)
4. Describe the main features of process costing.
5. Explain the features of process costing
6. How would you treat abnormal gain?
1.8.3. Long questions
1. What do you mean by inter-process profits in process cost accounts.
2. Explain the methods to be adopted in the treatment of joint products
and by-products in process account.
3. What do you understand by `Normal’ and `Abnormal’ Wastage
during the process of manufacture?
4. Describe briefly the method known as Process Costing, stating four
types of manufactures which would be suitable for its application. A
description of the method of dealing with by- products is not
required.
5. Explain the concept of Equivalent Production. Discuss the two
methods of its valuation.
1.8.4 Practical ProblemsIllustration 1:
During a particular period 2,000 units at a cost of ` 60,000 were

introduced into Process ‘A’ (at the beginning). The normal loss was
estimated at 5% of the input. At the end, 1,400 units were produced
and transferred to the Process ‘B’, 460 units being partially
completed and 140 units scrapped. The partially completed units had
reached the following state of production:
Materials 100% complete
Labour 50% complete
Overheads 50% complete
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Additional costs incurred during the process were:Materials Rs. Process Costing
17,000
Labour Rs.33, 400
Overheads Rs. 16,700
The units scrapped realised Rs.10 per unit. Prepare Process ‘A’ A/c
with all relevant statements.
(Ans.: Equivalent Units, Material: 1,900, Labour: 1670, Overheads: 1,670
Transfer to Process B 1,400 units @Rs. 70 p.u.)
(M.Com. Mar. 2002)
Illustration 2 :
XYZ Ltd. is engaged in process industry. During the month August

2000, 2000 Units were introduced in process ‘X’. The normal loss
was estimated at 5% of input. At the end of the month 1,400 units
had been produced and transferred to process ‘Y’. 460 units were
incomplete and 140 units, after passing through fully the entire
process had to be scrapped. The incomplete units had reached the
following state of completion:
Materials 75% Completed
Labour 50% Completed
Overheads 50% Completed
Following are the further information on the process ‘X’ :
Cost of the 2000 units Rs. 58,000
Additional Direct materials Rs. 14,400 Direct
Labour Rs. 33,400
Direct Overheads Rs. 16,700
Units scrapped realised Rs. 10 each
Prepare statement of equivalent production, statement of cost,
statement of evaluation and process ‘X’ account.
(M.Com. Mar. 2005)
Ans. (Equivalent Units, Material: 1,785, Labour: 1,670, Overheads: 1,670)
Illustration 3 : (FIFO)
The following information is available for Process IV of

SwastikFabrications Ltd. for the month of March 2005.
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Advanced Cost Accounting Opening Stock: 4,800 units @ Rs.16,500
Degree of Completion: Material 70%
Labour 60%
Overheads 60%Transfer from Process III: 30,600 units @ Rs. 30,600
Transfer to Process V: 27,600 units
Direct Material introduced in Process IV: Rs. 13,440 Direct Labour
introduced in Process IV: Rs. 39,420 Production overheads incurred
Rs. 52,560
Units scrapped: 2,400
Degree of completion: Material 100%
Labour 70%
Overheads 70%
Closing stock 5400 units
Degree of completion: Material 60%
Labour 40%
Overheads 40%
There was a normal loss of 10% of production in the process.

Unites scrapped were realised at Re. 1 per unit. From the above
information prepare:
1) Statement of equivalent production
2) Cost of equivalent unit for each element of the cost, the loss, the
work-in-process, etc.
3) Process account using FIFO method.
(M.Com. Oct. 2005)

Ans. (Equivalent Units, Material I: 27,600, Material II: 26,880, Labour: 26,460,
Overheads: 26,460)
Illustration 4 : (FIFO)
The following data pertains to Process I for March 2003 of Beta

Limited :
46
Particulars Units Rs. Process Costing
Opening Work-in-Progress … … … … . 1,500 15,000

Degree of completion :
Materials 100%; Labour and
overheads 33⅓%
Input of Materials … … … … . 18,500 52,000
Direct Labour …………. 14,000
Overheads …………. 28,000
Closing Work-in-Progress … … … … . 5,000
Degree of Completion Materials 90% and Labour and Overheads

30%.
Normal Process Loss is 10% of total input (opening work in
progress units + units put in).
Scrap value 2.00 per unit.
Units transferred to the next process 15,000 units. You are required
to:
1) Compute equivalent units of production.
2) Compute cost per equivalent unit for each cost element i.e.,
materials, labour and overheads.
3) Compute the cost of finished output and closing work-in-progress.
4) Prepare the process and other Account.
Assume:
i) FIFO Method is used by the Company.
ii) The cost of opening work-in-progress is fully transferred to the next
process.
(M.Com. Mar.2006)
Ans. (Equivalent Units, Material: 16000, Labour:14,000, Overheads: 14,000)
Illustration 5: (Weighted Average)
From the following details prepare Statement at Equivalent

Production, statement of Cost and find the value of: (a) Output
transferred and (b) Closing work in progress
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Advanced Cost Accounting Opening work in progress (units) 2,000
Materials (100% Complete) 7,500
Labour (60 % Complete) 3,000
Overheads (60% Complete) 1,500
Units introduced into this process 8,000
There are 2,000 units in process at the end and the stage of
completion is estimated to be :
Materials 100%
Labour 50%
Overheads 50%
8,000 units are transferred to next process. The process costs for the
period are:
Materials Rs. 1, 00,000
Labour Rs.78,000
Overheads Rs. 39,000
(M.Com. Oct. 2006)
Ans. (Equivalent Units, Material:10,000, Labour: 9,000, Overheads: 9,000)
Illustration 6 : (Average)
Shete and Shete Pvt. Ltd. gives the following particulars relating to
process ‘P’ in its plants for the month of January 2007 :
Particulars Rs. Rs.
Work-in-Progress (500 units)
01-01-2007
Material (100%) … … … … 12,000 -
Degree of Completion Labour (50%) … … … … 7,200 -
Overheads (50%) … … … … 16,000 35,200
Units introduced during the Month
January, 2007 – Units – 19,500 …………- -
Processing Cost incurred during the
Month
January, 2007 Materials … … … … 4,65,500 -
Labour … … … … 1,80,000 -
Overheads … … … … 2,64,800 9,10,300
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Process Costing
Particulars Units
Output transferred to Process Q … … … … 18,200

Units Scrapped (Degree of Completion Material 100%, 1,400
Labour 80% and Overheads 80%) … … … … 400
Work-in-Progress (Closing Balance) …………
(Degree of Completion-Materials 100%, Labour and Overheads
50%)
Normal loss in processing is 5% of total input and scrapped units

fetch 2.50 each. Prepare the following statements for Process ‘P’
for January, 2007 :
a) Statement of Equivalent Production
b) Statement of Cost and Statement of Evaluation
c) Process ‘P’ A/c
d) Abnormal Loss A/cUse Average Method
(Mar. 07, adapted)

Ans. (Equivalent Units, Material: 19,000, Labour: 18,720, Overheads: 18,720)
Illustration 26 : (FIFO – No Losses)
Avdoot Ltd., a manufacturer of a specialized product, is have a

process costing system. The stock of work-in-progress at the end of
each month is valued on First in First Out (FIFO) basis. At the
beginning of January 2008 the stock of work-in-progress was 2000
units (40% completed) which was valued as :
Material Rs. 18,000
Labour Rs. 17,000
Overheads Rs. 5,300
During the month of January 2008, actual issue of materials for the
production purpose was Rs. 3,42,500. wages and overheads in
the month of January, 2008 amounted to Rs. 4,02,600 and Rs.
1,12,200 respectively. Finished production taken into the stock in the
month was 12,500 units. There was no loss in the process. At the end
of the month of January, 2008 the stock of Work-in-Progress was
49
Advanced Cost Accounting 2500 units (60% complete as to Labour and Overheads and 80%
complete as to materials). Prepare the following statements for
January, 2008.
a) No. of units introduced in the process b) Statement of Equivalent Production
c) Statement of Cost d) Statement of Evaluation e) Process Account.
(Apr. 08, adapted) (Equivalent Units, Material: 13,700, Labour:

13,200, Overheads:13,200)
Illustration 27 : (FIFO – Process A/c with Abnormal Loss)
From the following information prepare Process account as per

FIFO assumption:
Opening stock Degree of completion
80 units @ Rs. 6 per unit Rs. 4,800
Material 60%
Labour 40%
Overheads 40%
Transfer from previous process : 12,000 units costing Rs. 16,350
Transfer to next process : 9,700; Units scrapped 1,300 units Normal
loss 10%; Closing stock : 1,800 units
Degree of completion
For units scrapped : For closing stock :
Material 100% Material 60%
Labour 50% Labour 50%
Overheads 50% Overheads 50%
Scrap realised Re. 1.00 per unit
Other information Rs.
Material 10,500
Labour 20,760
Overheads 16,470
(M.Com, Oct. 2008, adapted) (Ans. Equivalent Units, Material I: 10,900, Material
II: 10,500, Labour: 10,380, Overheads: 10,380)

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2
COST ALLOCATION
Unit Structure
2.0 Introduction
2.1 Types of cost
2.2 Cost driver
2.3 Methods of allocation of cost
2.4 Step Down Method
2.5 Reciprocal Method of cost allocation
2.6 Activity Based costing
2.7 Difference between Traditional Cost System and ABC system
2.8 Illustrations
2.0 INTRODUCTION
Cost Allocation or cost assignment is the process of identifying and
assigning costs to the various cost objects. These cost objects could be
those for which the company needs to find out the cost separately. A few
examples of cost objects can be a product, customer, project, department,
and so on. The need for cost allocation arises because some costs are not
directly attributable to the particular cost object. In other words, these
costs are incurred for various objects, and then the sum is split and
allocated to multiple cost objects. These costs are generally indirect. Since
these costs are not directly traceable, an accountant uses their due
diligence to allocate these costs in the best possible way. It results in an
allocation that could be partially arbitrary, and thus, many refer cost
allocation exercise as the spreading of a cost. Cost allocation is the process
of identifying, accumulating, and assigning costs to costs objects such as
departments, products, programs, or a branch of a company. It involves
identifying the cost objects in a company, identifying the costs incurred by
the cost objects, and then assigning the costs to the cost objects based on
specific criteria.
When costs are allocated in the right way, the business is able to trace the
specific cost objects that are making profits or losses for the company. If
costs are allocated to the wrong cost objects, the company may be
assigning resources to cost objects that do not yield as much profits as
expected.
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Advanced Cost Accounting 2.1 TYPES OF COSTS
There are several types of costs that an organization must define before
allocating costs to their specific cost objects. These costs include:
1. Direct cost
Direct costs are costs that can be attributed to a specific product or service,
and they do not need to be allocated to the specific cost object. It is
because the organization knows what expenses go to the specific
departments that generate profits and the costs incurred in producing
specific products or services. For example, the salaries paid to factory
workers assigned to a specific division is known than does not need to be
allocated again to that division.
2. Indirect Cost
Indirect costs are costs that are not directly related to a specific cost object
like a function, product, or department. They are costs that are needed for
the sake of the company’s operations and health. Some common examples
of indirect costs include security costs, administration costs, etc. The costs
are first identified, pooled, and then allocated to specific cost objects
within the organization.
Indirect costs can be divided into fixed and variable costs. Fixed costs are
costs that are fixed for a specific product or department. An example of a
fixed cost is the remuneration of a project supervisor assigned to a specific
division. The other category of indirect cost is variable costs, which vary
with the level of output. Indirect costs increase or decrease with changes
in the level of output.
3. Overhead costs
Overhead costs are indirect costs that are not part of manufacturing costs.
They are not related to the labor or material costs that are incurred in the
production of goods or services. They support the production or selling
processes of the goods or services. Overhead costs are charged to the
expense account, and they must be continually paid regardless of whether
the company is selling goods or not .Some common examples of overhead
costs are rental expenses, utilities, insurance, postage and printing,
administrative and legal expenses and research and development costs.
2.2 COST DRIVER

A cost driver triggers a change in the cost of an activity. The concept
is most commonly used to assign overhead costs to the number of
produced units. It can also be used in activity-based costing analysis to
determine the causes of overhead, which can be used to minimize
overhead costs. A large number of cost drivers may be used within an
activity-based costing system. If a business is only concerned with
following the minimum accounting requirements to allocate overhead
to produced goods, then just a single cost driver should be used. It is an
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activity that is the root cause of why a cost occurs. It must be applicable Cost Allocation
and relevant to the event that is incurring a cost. A cost driver assists with
allocation expenses in a systematic manner that results in more accurate
calculations of the true costs of producingspecific products.
Cost pool: It is an aggregate of all the costs associated with performing a
particular business activity.
An activity cost driver refers to actions that cause variable cost to
increase or decrease for a business. Therefore, identifying what
product/service is causing particular costs can help the business to become
more profitable by better understanding the specific activities that are
driving the costs. Allocating cost drivers appropriately is important in
accurately determining the cost of producing a good or service, as well
as making financial projections.
Activity cost drivers are specific activities that cause variable expenses to
be incurred. One variable expense can comprise more than a single
activity cost driver. For example, machine hours and labor hours can be
activity cost drivers in the manufacturing of a product.
All variable expenses can be broken down and looked at by one or several
activity cost drivers, which can also be influenced by several factors. For
example, if the minimum wage increases, it can cause the cost of
producing a product to also increase.
Examples of Activity Cost Drivers
 Direct labour hours
 Machine setups required
 Number of customer contacts
 Number of customer change orders
53
Advanced Cost Accounting 2.3 METHODS OF ALLOCATING COST
Direct method of cost allocation
The direct method is considered the most simple method of allocating the
cost of service departments to operating departments. In the direct
method, interactions between service departments are ignored and costs
are allocated just to operating departments. Under this method, the costs
incurred by service departments are not allocated to each other; rather,
they are directly allocated to operating departments using some
appropriate allocation base. In other words, we can say that the direct
method of departmental cost allocation ignores the service provided by
a service department to itself and to other service departments.
A firm generates various expenses that can be assigned to a specific “cost
item” — such as a commodity, program, function, or service. These costs
include anything from mop floors to functional equipment. You should,
however, generate enough income to pay such corporation overhead
expenditures. This means that revenue must surpass total costs. The direct
allocation technique is one of numerous cost allocation strategies used to
allocate indirect costs to activities. It is one of the most often used
techniqueThe direct technique is the easiest in terms of cost allocation,
even though it has several shortcomings. Nevertheless, because of its
simplicity of using it, it became one of the most widely applied cost
allocation techniques in recent years. In a nutshell, it assumes that service
departments do not give facilities or services to each other, and it merely
distributes the service departments’ costs in the company’s manufacturing
departments.
The direct approach of transferring service department costs to the
operational department is the simplest way of allocating costs between
divisions. As a result of this technique, the expenses involved by service
departments are not assigned to one another. Still, they are instead allotted
straight to operational departments using a suitable rate of allocation.
The direct approach assigns the expenses of all the support departments to
every other manufacturing unit calculated based on the rates of each
operational department rates. Services that other support departments
receive are not considered in this method of cost allocation. With the help
of this approach, it is possible to completely charge operational
departments with the overhead expenditures for which they are
accountable. Firms that use the direct method completely transfer excess
costs from service departments to inventories, even though there may be
cross-costs across service departments, because of the nature of the
business.
For instance, the cleaning crew offers services to sanitize all business
buildings. In contrast, the maintenance department oversees the firm’s
machinery, and the information technology department oversees
maintaining the organization’s computer networks. Assume that a service
Department 1 utilizes a few of the facilities provided by Service
54
Department 2. Such services will be excluded from consideration Cost Allocation
throughout the cost allocation procedure. Because such services are not
assigned to certain other service divisions, many cost auditors think that
the direct approach is not as precise as other methods.
Advantages and disadvantages

Many organizations use direct method for allocating departmental costs
because it is very simple and easy to employ.
The major disadvantage of direct method is that it ignores
interdepartmental services and can therefore lead to distorted products and
services cost. Moreover, it is commonly considered a less accurate method
when compared with other methods available for departmental cost
allocation.
There is, however, a disadvantage to using this approach. Direct allocation
does not enable companies to shift expenditures from one support
department to another support department and vice versa. Depending on
the nature of your company, this is a possibility. Assume that there is an
HR and maintenance department. Allowing for the possibility that almost
all the HR and maintenance department support expenditures are assigned
to an operational unit through direct allocation. As a result, HR and
maintenance department expenses are completely depleted.
Q.1) The Murphy Company has two service departments and two
operating departments as shown below:
The two service departments provide service to each other as well as to

operating departments. The department A’s cost is allocated on the basis
of employee hours and department B’s cost is allocated on the basis of
square feet occupied.
Required: Allocate the cost of service departments to operating
departments using direct method of cost allocation.
55
Advanced Cost Accounting Solution
Department A’s cost has been allocated on the basis of employee hours:
9,000 hours + 15,000 hours = 24,000 hours.
Allocated to department X: $180,000 × (9/24) = $67,500
Allocated to department Y: $180,000 × (15/24) = $112,500
Department B’s cost has been allocated on the basis of spaces occupied:
3,000 square feet + 22,000 square feet = 25,000 square feet.
On the other hand, the human resources department assists the
maintenance department throughout the same time frame. It goes without
saying that the maintenance department should bear a portion of the costs
of human resources. However, the expenditures of the maintenance
department have already been transferred in whole to another operating
unit.
2.4 STEP DOWN METHOD:

In the step down method, one service department’s costs are allocated to
another service department as well as operating departments that use it.
Any amount of the allocation base attributable to the service department
whose cost has already been allocated is ignored. Each service department
assigns its own costs to operating departments plus the costs that have
been allocated to it from other service departments.
The step technique of distributing service department expenses is the
second way of allocating costs. As part of a sequential process, service
expenses are allocated to operational departments and other service
departments by using this approach. The following are the critical phases
in the allocation process:
1. Service departments that offer services to the greatest number of other
service departments or that have the greatest proportion of their expenses
used by the other service departments receive priority in allocating their
56
expenses to certain other service departments. It also distributes the Cost Allocation
remainder of its expenses across the operational divisions.
2. The service department that offers services to the second-
highest number of other services departments or has the second-
highest proportion of its expenses absorbed by other service departments,
oversees allocating its expenses towards the other service departments. At
this point, all the company’s other expenses have been assigned to the
operational divisions.
3. Till the service department offering services to the fewest amount of
other service departments or having the lowest proportion of its expenses
absorbed by the other service departments is assigned its expenses, the
procedure is repeated. The procedure comes to an end when all the
allotment has been accomplished.
Advantages
This technique is easy and uncomplicated to execute and can be finished
quickly. Due to the higher level of convenience, supervisors willing and
eager to reduce the time spent on record keeping and forming accounting
reports are far more likely to select it, even though the precision offered is
not the highest in this cost allocation.
Q.1) The TCS Company uses the step method for allocating the costs of its
service departments to operating departments. The company has two
service departments and two operating departments. The selected
information for the four departments is given below:
The company uses employee hours as the base for allocating the cost of
department A and space occupied for allocating the cost of department B.
departments using step down method.
57
Advanced Cost Accounting Solution
Allocation of department A’s cost:

Allocation ratio:
Department B: 3,000/(3000 + 9000 + 15,000 ) = 3,000/27000 or 3/27
Department X: 9,000/(3000 + 9000 + 15,000 ) = 9,000/27000 or 9/27
Department Y: 15,000/(3000 + 9000 + 15,000 ) = 15,000/27000 or 15/27
Allocated to department B: $180,000 × (3/27) = $20,000
Allocation of department B’s cost:

Allocation ratio:
Department X: 3,000/(3,000 + 22,000) = 3,000/25,000 or 3/25
Department Y: 22,000/(3,000 + 22,000) = 22,000/25,000 or 22/25
Total cost of department B: $45,000 + $20,000 = $65,000
Q.2) The Religare Company provides the following selected data about its
three service and two operating departments:
58
The order and bases for allocating service department costs is given Cost Allocation
below:
1. Department A; allocation base is “number of employees”.
2. Department B; allocation base is “space occupied”.
3. Department C; allocation base is “hours of time”.
departments using step down method of cost allocation.
Solution
2.5 RECIPROCAL METHOD OF COST ALLOCATION

Reciprocal method is a method of allocating service department costs to
other departments that gives full recognition to interdepartmental services
.Although it is the most accurate, it is also the most complicated. In the
reciprocal method, the relationship between the service departments is
recognized. This means service department costs are allocated to and
from the other service departments. The reciprocal method gives full
recognition to interdepartmental services. Under the step method, only
partial recognition of interdepartmental services is possible. The step
method always allocates costs forward never backward. The reciprocal
method, by contrast, allocates service department costs in both directions.
The reciprocal allocation requires the use of simultaneous equations.Other
names for the reciprocal method are simultaneous solution method, cross
59
Advanced Cost Accounting allocation method, matrix allocation method and double distribution
method.
Under this method the true cost of the service departments are computed
first with the help of simultaneous equations and these are then distributed
to producing departments on the basis of given percentage or ratio.
Remember that true cost of the service department means the cost of the
service department which includes original cost of the department plus the
share of the other service department. The main advantage of this method
is to have an accurate distribution in a single step in the distribution
summary.
Use of Reciprocal Method

This method is rarely used in practice for two reasons. First, the
computations are relatively complex. Although the complexity issue could
be overcome by use of computers, there is no evidence that computers
have made the reciprocal method more popular. Second, the step method
usually provides results that are a reasonable approximation of the results
that the reciprocal method would provide. Thus, companies have little
motivation to use the more complex reciprocal method.
Q.1) A company has two service and two producing departments. The two
service departments serve not only to producing departments but also to
each other. The departmental estimates for the next year are as follows.
Producing departments:
A
B 50,000
Service departments: 40,000
X 10,000
Y 8,800
The service departments costs are to be distributed as under:

Cost of X : 50% to A, 40% to B, and 10% to Y
Cost of Y : 40% to A, 40% to B, and 20% to X
Required:
Transfer the service departments costs to each other and to producing
departments.
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Cost Allocation
Solution:
Now we solve the given illustration first using the simultaneous equation
method as follows:Original costs of service departments:
X = Rs.10,000
Y = Rs. 8,800
After getting the share from distribution of service departments:
X = Rs. 10,000 + 20% Y
Y = Rs. 8,800 + 10% X
By putting the value of Y in equation (1)
X = Rs. 10,000 + 20%(Rs.8,800 + 10%X)
X = Rs. 10,000 + 1760 + 0.2X
X – 0.02X = Rs. 10,000 + Rs.1,760
0.98X = Rs. 11,760
X = 11760 / 0.98
= Rs. 12,000
By putting the value of X in equation (2)
Y = Rs. 8,800 + 10%(Rs. 12000)
Y = Rs. 8,800 + Rs. Rs. 1,200
= Rs. 10,000
Distribution Summary
Department Producing Service
Original
costs
Distribution
of service A B X
department Rs Rs Rs Y
costs: 50,000 40,000 10,000 Rs
X 6,000 4,800 (12,000) 8,8001,200
Y 4,000 4,000 2,000 (10,000)
Total ——- —— ——- ——-
departmental 60,000 48,800 Nil Nil
overheads ===== ===== ===== =====
2.6 ACTIVITY BASED COSTING

Activity based costing (ABC) assigns manufacturing overhead costs to
products in a more logical manner than the traditional approach of simply
allocating costs on the basis of machine hours. Activity based costing first
assigns costs to the activities that are the real cause of the overhead. It then
assigns the cost of those activities only to the products that are actually
demanding the activities. ABC works best in complex environments,
where there are many machines and products, and tangled processes
that are not easy to sort out. Conversely, it is of less use in a
streamlined environment where production processes are abbreviated,
so that costs are easy to assign.
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Advanced Cost Accounting Activity based costing is basically a change in accent. People perform
activities and activities use resources. Thus, by controlling activities the
manager is making sure that costs are controlled at their source. A wise
manager will not focus on how to estimate product costs, but will focus
more on why the costs were there in the first place. When intending an
activity based costing system this should be utilized as a departure point.
Advantages of Activity Based Costing System

 The first and most significant benefit is the accuracy in the procedure
of costing with regards to the product line, the consumers of the
product, the stock-keeping units employed by the administration and
the channel and group which streamline the flow of the product from
the maker to the consumer.
 This system better helps in the procedure of understanding the concept
of overhead costs i.e. the distribution of common business resources as
they are utilized by particular product lines and their association to
particular cost driver.
 The system is simple to interpret and understand is it is available,
useable and specifically implement capable across all norms of
business set-ups.
 This procedure consumes unitary cost, or marginal cost as the
calculation base in comparison to the conventional cost accounting
techniques which employ total cost.
 This system is specifically useful in recognizing and ear-marking some
of the matters business activities which are a stress or burden on the
business i.e. wasteful or non value adding services..
 This procedure permits firms to implement costing policies across
another diagonal of the company as business procedures, supply chains
and value addition channels are capably and optimally analyzed in this
procedure.
 This system mimics the actual business procedure as the appropriation
of common pool resources takes place in the same way as common
resources are utilized in the business.
 Disadvantages of Activity Based Costing System
 Data collection procedure for this system is very time consuming.
 The capital expense on the activity based system and its subsequent
running costs can be a road block for companies.
 The system is very apparent which some managers would not
authorize of as they would like to keep some things out of the view of
the owners of the firm.
 ABC Costing System is very costly to implement and maintain in a
manufacturing and serving departments. Data concerning numerous
62
activity measures must be collected, checked, and entered into the Cost Allocation
system.
 ABC costing systems produces the reports that are different from
the profit and loss reports produced through traditional costing
systems.
 As most of the companies are using , traditional costing systems, so
because of the difference in the costing basis the costing and financial
reports of the two companies of the same industry could not be
compared for performance evaluation purposes.
 Adaptability of ABC Costing System is not suitable for all kind of
companies because small companies have not many resources to ad
 Data Produced through ABC Costing System can easily misinterpret
and can lead towards wrong decisions. So manager should use the data
produced through ABC Costing System with extreme care and should
assign the costs that are relevant to the products, customers and should
not consider the other cost objects that are irrelevant.
 ABC costing system does not comply with the GAAP and a company
has to produce its reports for internal and external purposes by using
traditional and ABC costing system both at a time.
 In ABC costing system costs are allocated on the base of cost drivers
and activities undertaken to manufacture the product, definitely, it
provides the accurate and proper allocation of the costs to the products
but there is a danger of over or under costing of the products when
irrelevant cost drivers or activities are assigned to the products or
services produced.
Steps in ABC
 Identify which activities are necessary to create a product
 Separate each activity into its own cost pool
 Assign activity cost drivers to each cost pool
 Divide the total overhead in each cost pool by the total cost drivers
to get your costdriver rate
 Compute how many hours, parts, units, etc. that the activity used and
multiply it by thecost driver rate to find total cost
 Calculate Cost per Unit by dividing the Total Cost by Total Units
produced.
63
Advanced Cost Accounting Uses of ABC
 Identification of necessary activities: The ABC system shows how

overhead is used, which helps to determine whether certain activities
are necessary for production.
 Focus on Value adding activities: The Activity Based Costing helps the
management on focusing the forces on value adding activities and
eliminate non-value adding activities.
 Ensuring profit margin: The specific allocation of costs also helps to set
prices that produce a healthy small business profit margin.
 Product pricing: With an ABC system, the business can assign costs to
each activity inthe production process, allowing it to more accurately set
a price that accounts for howmuch it costs to create a product.
 Measures to improve productivity: The accurate cost information helps

the management to adopt productivity improvement approaches like
Total Quality Management (TQM), Business Process Re-engineering
(BPR) etc.
 Help in deciding Make or Buy: The management can take make or buy
decisions by considering the cost of manufacture of a product or sub
contract the same with an outside agency through Activity Based
Costing analysis.
2.7 DIFFERENCE BETWEEN TRADITIONAL COST

SYSTEM AND ABC SYSTEM
Basis Traditional ABC

1. Cost pools One or limited number Many
2. Applied Rate Volume based Activity Based
3. Applied for Labour Intensive Capital Intensive
4. Benefits Simple, Inexpensive Accurate product
costing, identification of
necessary activitiesetc
5. Cost assignments Primary and secondary Allocation of cost pool
distribution of based on cost drivers
Overhead and then then allocation of costs to
allocation of Overhead as product or service based
per the suitable rate on the drivers used by
the particular product or
service
6. Focus Departments or Processes and activities
responsibility centres
64
Cost Allocation
2.8 PRACTICAL SUM

Problems involving calculations of Total cost and CPU under both
Traditional and ABCmethods.
Question:
Amrit Company produces 3 products A, B and C. The company follows
Activity Based Costing system. Information related to various costs of
these products for the last year:
Particulars A B C
Production and Sales (Units) 15000 12000 18000
Selling Price p.u. (Rs.) 7.5 12 13
Raw Material Usage (kg) p.u. 2 3 4
Direct labour hours p.u. 0.1 0.15 0.2
Machine Hours p.u. 0.5 0.7 0.9
No. of Production runs p.a. 16 12 8
No. of purchase orders p.a. 24 28 42
No. of deliveries to retailers p.a. 48 60 32
The price of Raw materials remained constant through out the year at
Rs.1.2 per kg and the labour cost was Rs.14.8 per hour. The annual
Overhead costs are as follows:
Overheads Rs
Machine set up costs 26550
Machine running costs 66400
Procurement Costs 48000
Delivery costs 54320
65
Advanced Cost Accounting
Solution: Traditional Method

a) Calculation of Total Overhead
Overheads Rs
Machine set up costs 26550
Machine running costs 66400
Procurement Costs 48000
Delivery costs 54320
Total 195270
b) Calculation of Overhead Absorption rate
Particulars A B C Total
Production Volumes 15000 12000 18000
Labour hours p.u. 0.1 0.15 0.2
Total Labour hours 1500 1800 3600 6900
Overhead absorption rate = 195270/6900 = Rs.28.30 per hour.

c) Calculation of Cost p.u.
Particulars A B C
Raw material cost (Usage * Rs.1.20) 2.4 3.6 4.8
Direct Labour Cost (Labour hours * Rs.14.80) 1.48 2.22 2.96
Overhead (Labour hours * Rs.28.30) 2.83 4.25 5.66
CPU 6.71 10.07 13.42
66
ABC Method Cost Allocation
a) Calculation of Overhead Absorption rate
Cost Pool Rs. Cost Rate of OH per

Driver activity (Rs.)
Machine 26550 No. of (16+12+8) = 36 runs 26550/36=
costs set Production 737.50 per run
up runs p.a.
Machine 66400 No. of (7500+8400+16200)# 66400/32100 =
costs Machine = 32100 hours 2.0685 per hour
running Hours p.a.
Procureme 48000 No. of (24+28+42) = 94 48000/94=
nt Costs purchase orders 510.6383per
orders p.a. order
Delivery 54320 No. of (48+30+62) = 140 54320/140=
costs deliveries deliveries 388 per
to retailers delivery
p.a.
# Total Machine hours p.a. = Machine hours p.u. * Total units produced A
= 0.5*15000 = 7500
B = 0.7*12000 = 8400 C = 0.9*18000 = 16200
b) Calculation of Cost p.u.
Particulars A B C
Material Cost 2.4 3.6 4.8
Labour Cost 1.48 2.22 1.96
Overhead: ##
Machine set up (737.50*16)/15000 = (737.50*12)/12000 = (737.5*8)/18000 =
Costs 0.7867 0.7375 0.3278
Machine running (2.0685*7500)/15000 (2.0685*8400)/12000 (2.0685*16200)/18000
Costs = 1.034 = 1.4479 = 1.8616
Procurement (510.6383*24)/15000 (510.6383*28)/12000 (510.6383*42)/18000
Costs = 0.817 = 1.1915 = 1.1915
Delivery costs (388*48)/15000 = (388*30)/12000 = (388*62)/18000 =
1.2416 0.97 1.3364
Total CPU 7.7593 10.1669 11.4773
## Overheads p.u. for products A, B and C

= (Overhead absorption rate* No. of cost drivers used by the individual
products p.a.)/ No. of units produced

67
3
RESPONSIBILITY ACCOUNTING
Unit Structure
3.0 Introduction
3.1 Objectives of responsibility accounting
3.2 Assumptions and Requisites of responsibility accounting
3.3 Types of cost centres
3.4 Concept of controllability
3.5 Residual income
3.6 Segment performance
3.7 Illustrations
3.8 Controllable cost
3.9 Exercise
3.0 INTRODUCTION
Responsibility accounting is a kind of management accounting that is
accountable for all the management, budgeting, and internal accounting of
a company. The primary objective of this accounting is to support all the
Planning, costing, and responsibility centers of a company.
The accounting generally includes the preparation of a monthly and annual
budget for an individual responsibility center. It also accounts for the cost
and revenue of a company, where reports are accumulated monthly or
annually and reported to the concerned manager for the feedback.
Responsibility accounting mainly focuses on responsibilities centers.
For instance, if Mr X, the manager of a unit, plans the budget of his
department, he is responsible for keeping the budget under control. Mr X
will have all the required information about the cost of his department. In
case, if the expenditure is more than the allocated budget than Mr X will
try to find the error and take necessary action and measures to correct it.
Mr X will be personally accountable for the performance of his unit.
Features of Responsibility accounting
 The main feature of responsibility accounting is to define the cost
centers at the initial stage which we earlier referred to as responsibility
centers.
68
 For each center, there should be a fixed target which the department Responsibility Accounting
has to achieve in the defined deadline, so setting targets for the center
is very crucial.
 Then, we must track the performance of each responsibility center and
also compare the actual performance with the target performance.
 The variance between the actual performance and target performance
is analyzed and post that the responsibility of each center should be
fixed.
 Then corrective action has to be taken by the management and it
should be individually communicated to the concerned person taking
care of the responsibility center.
3.1 OBJECTIVES
 Know how cost and management accounting will be used for
managerial planningand control.
 Appreciate the structure and process in designing responsibility
accounting system;
 Understand the concept of responsibility centres;
 Familiar with different methods of evaluating the performance of
different segments of an organisation; and
 Identify the benefits, and essentials of success of measuring and
reporting of costs by managerial levels of responsibility.
2.2 ASSUMPTIONS AND REQUISITES

(1) The areas of responsibility are defined for which managers should be
held responsible.
(2) Managers are only charged with the items and responsibility over
which they can exercise a significant degree of direct control.
(3) Managers should actively participate in establishing the goals or
budgets against which their performance is measured.
(4) Goals defined for each area of responsibility should be attainable with
efficient and effective performance.
(5) Control (performance) reports should contain significant information
related to each area of responsibility.
(6) Responsibility centre managers should try to accomplish the budgets
and objectives established for their respective areas of responsibility.
69
Advanced Cost Accounting Requisites
The following are must for efficient implementation of responsibility
accounting:
1) A company must have a clearly defined organizational structure that is
understandable to all without any ambiguity.
2) There should be clear measures and standards for the evaluation of
performance.
3) A manager who is accountable for a responsibility center must know
all the evaluation parameters with utmost clarity in advance.
4) All those accountability and evaluation parameters should be
controllable at the level of the manager.
5) Uncontrollable factors need to be addressed separately.
3.3 TYPES OF COST CENTERS:

Cost center
It is a unit in a company that has control over the cost only, such as the
production department. The cost center does not exercise control over
other functions, such as revenues or investments. A point to note is that a
manager responsible for any cost center is only responsible for the
controllable costs, and not uncontrollable costs.
Revenue center
This unit is only responsible for generating revenues, and not any other
business function. The sales and marketing department are an example of
a revenue center
Profit centre
It is accountable for both costs and revenues. One example of this is the
factory, whose cost is the raw material, and revenue is the products it
transfers to other departments. Also, branches of a company in different
regions are responsible for both costs and revenues.
Investment centre
It has control over costs, revenues, and investments. Or, we can say the
person is responsible for investing the assets of a company most
efficiently. Such a cost center works as a separate entity, such as a
corporate headquarters. A company measures the performance of an
investment center by using ratios, such as ROI (return on investment),
economic value-added, and more.
70
Responsibility Accounting
3.4 CONCEPT OF CONTROLLABILITY
Responsibility accounting is closely related with the goal of
controllability. Controllability is the degree of influence that a specific
manager has over costs, revenues, or other items in question. Accordingly,
in responsibility accounting those elements in a certain area of activity are
identified which are controllable and then a person is given the
responsibility for managing such elements.
Responsibility accounting implies that individuals in an organisation can
not be responsible for those items which they can not control. They should
also not claim any authority over those revenues which are not the result
of their actions and performances. For instance, a foreman in a production
department can be held responsible only for direct material and direct
labour costs, because these are the costs which are controllable by him.
On the other hand, divisional manager of the production division can be
held accountable for all direct and indirect costs incurred in his division.
Generally, those decision makers who are placed higher in the authority
hierarchy, are held responsible for a greater number of activities and
financial elements. In the long run, however, all costs are controllable by
someone in the organisation.
There are various criteria to measure divisional performance such as profit
on turnover, sales per employee and sales growth etc.
The most popular criteria are:
Return on Investment (ROI)
Residual Income (RI)
Return on investment
Divisional operating profit is generally, used as a common measure of
performance.But divisional profit by itself does not provide a basis for
measuring a divisionperformance in generating a return on the funds
invested in the division. For example, Division A and Division B had an
operating profit of Rs.1,00,000 and Rs.80,000 respectively does not
necessarily mean that Division A was more successful than Division B.
The difference in profit levels may be due to the difference in the size of
the divisions. Therefore, a suitable measure may be used to scale the profit
for the amount of capital invested in the division. One common method is
Return on Investment (ROI) which will be calculated as follows :
71
Advanced Cost Accounting Profit
Return on Investment = ——————— x 100
Capital employed
Profit sales
ROI = ——— x ———————
Sales Capital employed
Q.1) Peacock Company Ltd. has six segments for which the following
information is available for the year 31st March, 2005:
I II III IV V VI
(Rs. in (Rs. in (Rs. in (Rs. in (Rs. in (Rs. in
Lakhs) Lakhs) Lakhs) Lakhs) Lakhs) Lakhs)
Capital
employed
1500 1200 3000 2400 4500 6000
Sales 3000 3000 6000 3600 18000 12000
Net profit 150 300 150 720 450 1200
You are required to measure the performance of different segments.

Solution
The return on investment can be analysed as follows:
Segments
I II III IV V VI
Profit/ Sales
(Profit ÷ Sales
x 100)
5% 10% 2.5% 20% 2.5% 10%
Turnover of
capital (Sales
2 2.5 2 1.5 4 2
÷ Capital
Employed)
ROI (Profit ÷
Capital
Employed 10% 25% 5% 30% 10% 20%
x 100)
72
The above analysis gives the following conclusions regarding the Responsibility Accounting
performance ofdifferent segments:
1) The manager of segment I is not showing a satisfactory level of ROI
even though his turnover of capital is not too bad. He must be
motivated to increase his profit sales ratio.
2) Segment II is performing well as profit, sales ratio and turnover of
capital, are relatively good.
3) The performance of segment III is not satisfactory as its profit margin
andcapital turnover is Poor.
4) The performance of segment IV is good as its profit margin is high
with areasonable capital turnover.
5) In respect of segment VI, the manager should be motivated to
increase its profit margin but maintains a very good turnover of capital.
6) The manger of segment VI is performing well comparing to other
segments, as it maintains a good ROI, fairly good capital turnover and
reasonably good profit margin.
The segments which show a low capital turnover should be investigated
and remedial action should be initiated particularly in segments IV, I
and III.
3.5 RESIDUAL INCOME

Residual income is the profit remaining after deduction of the cost of
capital on investment. It is the excess of net earnings over the cost of
capital. Any income earned above the cost of capital is profit to the firm.
The cost of capital charged to each division will be the same rate that is
applicable to the organization as a whole. The more the income earned
above the cost of capital, the better off the firm will be.
The Residual Income may be calculated as follows:
RI = Profit – (Capital Charge x Investment Centre Asset)
Where, capital is the minimum acceptable rate of return on investment.
This method is used as a substitute for or along with ROI as means of
evaluating managerial performance and motivates the managers to act to
the aims of goal congruence. The firm is interested to maximise its
income above the cost of capital. If the divisional managers are measured
only through ROI, they will not necessarily maximise RI. If managers are
encouraged to maximise RI, they will accept all projects above the
minimum acceptable rate of return. That is why most managers recognise
the weakness of ROI and take into account when ROI is lowered by a
new investment.
73
Advanced Cost Accounting Q.1) A division of a company earns a profit of Rs.1,00,000 for an
investment of Rs.4,00,000. There is an opportunity to make an additional
investment of Rs.2,00,000 which earns an annual income of Rs.40,000.
You are required to calculate residual income if the company requires a
minimum return of 15 per cent on its investment and comment.
Solution
Before the additional Investment:
RI = Rs.1,00,000 – (15% of Rs.4,00,000)
= Rs.1,00,000 – Rs.60,000
= Rs.40,000
RI from additional Investment
RI = Rs.40,000 – (15% of 2,00,000)
= Rs.40,000 – Rs.30,000
= Rs. 10,000
Total Residual Income on an investment of Rs.6,00,000 is Rs.50,000. The
additional investment increases residual income and is improving the
measure of performance.
Q.2) Sunrise Company has three divisions A, B and C. The investment in
these divisions amounted to Rs.2,00,000, Rs.6,00,000 and Rs.4,00,000
respectively. The profits in these divisions were Rs.50,000, Rs.60,000 and
Rs.80,000 respectively. The cost of capital is 10 per cent. From the above
data, comment the performance of the threedivisions.
Solution
Divisions
A B C
Profit Investment Rs. 50,000 Rs. 60,000 Rs. 80,000
ROI Rs. 2,00,000 Rs.6,00,000 Rs. 4,00,000
Profit x 100 10% 20%
( ) 25% 60,000 80,000
x 100 ) x 100 )
Investment 50,000 ( (
x 100
( ) ———— ————
RI = Profit – Cost of ———— 6,00,000 4,00,000
capital: 2,00,000
NIL Rs.40,000 (80,000–
Rs. 30,000 (60,000–10% of 10% of 4,00,000)
(50,000–20,000) 6,00,000)
In terms of profit division C has done best performance. If evaluation is
done on the basis of ROI criteria division A is the best performer. If
residual income is the criterian, division C is the best.
74
3.6 SEGMENT PERFORMANCE
A segment or division may be either a profit centre having responsibility
for both revenues and operating costs, or an investment centre, having
responsibility for assets in addition to revenues and operating costs.
The manager of each segment are free to take decisions regarding the
performance of their centres. When an orgainzation grows it is inevitable
to create divisions or segments to control operations of different divisions.
This requires accounting information which discloses not only the
objectives and performances of divisions but also whether or not each
division is performing in the interest of the organization as a whole. This
section illustrates how segment data should be presented so that
meaningful decisions regarding segment performance can be taken.
A manager’s performance is evaluated generally on the basis of
comparison of costs incurred with costs budgeted. It is therefore,
important to allocate appropriate costs to the respective segments. While
allocating the costs, the costs relating to general administration or head
office should not be charged to any segment as these costs remain constant
irrespective of the volume of sales by each department. Letus see the
following illustration:
1) A simplified representation of organization of Digital Co. Ltd. is

presented below:
President
Vice President Marketing Vice President Manufacturing
Sales Advertising Credit Production Production

Manager Manager Manager Manager Engineer
Sewing Department
Cutting Department
The company manufacturers cloth potholders in a simple process of
cutting the potholders in various shapes and then sewing the contrasting
pieces together to form the finished potholder.
75
Advanced Cost Accounting The accounting system reports the following data for the year 2004-05:
Budgeted Actual
Rs. Rs.
Bad debt losses 500 300
Cloth used 3,100 3,400
Advertising 400 400
Credit reports 120 105
Sales representatives’ travel exp. 900 1,020
Sales commissions 700 700
Cutting labour 600 660
Thread 50 45
Sewing labour 1,700 1,840
Cutting utilites 80 70
Credit department salaries 800 800
Sewing utilities 90 95
Vice-President, Marketing office exp. 2,000 2,140
Production engineering expense 1,300 1,220
Sales management office expenses 1,600 1,570
Production manager’s office exp. 1,800 1,700
Vice-President, manufacturing office expenses 2,100 2,010
Using the data given, prepare responsibility accounting reports for the two
vice-presidents.
Solution
Responsibility accounting tailors reports to each level of management to
include those items which they can control and for which they are
responsible. The items for which they are responsible are generally
determined by the organization structure as reflected in the organization
chart. Responsibility report highlights variances to assist in the process of
management by exception. Reports for higher-level managers are in
summary form in order to avoid flooding them with more detail than is
needed.
With these general ideas in mind, one can turn to the responsibility reports
required by the problem. Each report is assumed to contain a one-line
summary of the expenses of the subordinate departments. From the
organization chart, the contents of the reports will, therefore, be as follows:
76
Vice-president, marketing : Sales expense + advertising Responsibility Accounting
expense + credit expense
Sales expense : Sales representatives’ travel
expense + sales commissions +
sales management office
Advertising expense : Advertising
Credit expense : Credit reports + credit department
salaries + bad debt losses
Vice-president, manufacturing : Production expense + production
engineering expense + production
manager’s officeexpenses
Production Manager : Sewing department + cutting
department, i.e. thread + sewing
labour + sewing utilities + cloth
used + cutting labour + cutting
utilities
Notice that these reports do not contain the expenses of the vice-
president’s offices. Although sometimes included, they are not here on the
ground that the vice presidents cannot control their own salaries, the major
component of these categories. If they are excluded on these reports, they
would be included as an item on the president’s report, where they are
controllable.
Since the lower level reports are summarized in the higher-level reports, it
is usuallyeasier to begin with the lower-level reports.
i) Production Manager Budgeted Actual Variance
Controllable expense report: Rs. Rs. Rs.
Sewing department 1,840 1,980 140U
Cutting department 3,780 4,130 350U
Total 5,620 6,110 490U
ii) Vice-President, Manufacturing
Controllable expense report:5,620 6,110 490U
Production departments
Production manager’s expenses 1,800 1,700 100F
Production engineer’s expenses 1,300 1,220 80F
Total 8,720 9,030 310U
iii) Vice-President, Marketing
Controllable expenses summary:
Sales manager’s expense 3,200 3,290 90U
77
Advanced Cost Accounting Advertising expense 400 400 -
Credit expense 1,420 1,205 215F
Total 5,020 4,895

125F
Standard Costing Probably the most significant variances are in the
production departments, with an average unfavourable variance of 8.7
percent ( 490 x 100 ) of the budgeted amount and the credit department,
with a 5620
favourable variance of 15.1 percent ( 215 x 100 ) of the budgeted amount.

The credit 1420
department variance results primarily from a better than normal bad debt
loss experience. The production department’s variance should be
investigated if 8.7 percent appears large relative to past experience.
Illustration 2
Kelly Services Ltd. has five plants---A,B,C,D and E. Each plant has a
forming, cleaning and packing department. Each level of management at
the company has responsibility over costs incurred at its level. The budget
for the year ended March, 2005 has been set up as follows:
Plant Budgeted Cost (Rs.)

A 1,35,000
B 1,22,500
C 1,08,400
D 1,35,000
E 1,35,000
Budgeted information for Plant C is as

follows: Rs.
Plant manager’s office 2,350
Forming department 30,000
Cleaning department 55,450
Packing department 20,600
78
Budgeted information for Plant C forming department is as follows: Responsibility Accounting
Rs.
Direct material 8,333
Direct labour 15,000
Factory overhead 6,667
The following additional budgeted costs available:
Rs.
President’s Office 16,250
Vice President---Marketing 20,000
Vice President---Manufacturing office 4,167
The following actual costs were incurred during the year:
Plant Budgeted Cost Rs.
A 1,27,650
B 1,24,300
C 1,08,475
D 1,31,100
E 1,36,800
Actual costs for Plant C Forming department were as follows:
Rs.Responsibility Accounting
Direct materials 333 Under budget
Direct labour 4,000 Under budget
Factory overhead 333 Over budget
Actual cost for Plant C plant manager were:

Rs.
Plant manager’s office 2,475
Cleaning department 57,500
Packing department 22,500
Forming department ?
79
Advanced Cost Accounting Actual costs for the president’s level were:
Rs.
President’s Office 16,375
Vice president---marketing 29,800
Vice-president---manufacturing 6,33,315
Prepare a responsibility report for the year showing the details of the
budgeted, actual and variance amounts for levels 1 through 4 for the
following areas:
Level 1-Forming department---Plant C Level 2-Plant manager---Plant C
Level 3-Vice president-manufacturingLevel 4-President.
Solution
Kelly Services
Responsibility Report for the Year ended March 2005
BudgetedActualVariance
Level 4-President:
Rs. Rs. Rs.
President’s Office 16,250 16,375 125
Vice-president---marketing 20,000 29,800
9,800
Vice-president---manufacturing 6,40,000 6,33,315
(6,752)
Total Controllable costs 6,76,250 6,79,490
3,173 79
Standard Costing Level3-Vice
President---
Manufacturing 4,990* 823
Vice-president---
manufacturing office:
Plant A 1,27,650 (7,350)
Plant B 1,24,300 1,800
Plant C 1,08,475 75
Plant D 1,31,100 (3,900)
80
Plant E 1,36,800 1,800
Total Controllable 6,33,315 (6752)

Costs
Level 2 - Plant
Manager ---Plant C:
Plant manager’s office
2,475 125
Forming department 26,000 (4,000)
Cleaning department 57,500 2,050
Packing department 22,500 1,900
Total controllable costs 1,08,475 75
Level 1-Forming
Department-Plant C:
8,000 (333)
Direct material
Direct labour 11,000 (4,000)
Factory overhad 7,000 333
Total controllable costs 26,000 4,000
* The difference in the actual total controllable cost arrived and the figure
as given in the illustration is to be treated as the actual cost of
manufacturing office of vicepresident.
( ) Variance favourable (Figures within parentheses indicate favourable
variance
3.8 CONTROLLABLE COST

Controllable cost are costs which can be controlled. Such costs are
controllable in the short run and the discretion lies with the managers or
production supervisors whether to incur them or not.
Also, the “controllable” factor is relative and depends upon the
hierarchy and level of management taking the decision. For instance,
consider the case of yarn purchase in a cotton mill. Now since the yarn is a
direct material for the production of cotton and the management is
81
Advanced Cost Accounting authorized to negotiate vendor contracts best suited to organization needs.
However, the production supervisor charged with the running of day to
day operations has no say in yarn prices. Direct material cost is
consequently a controllable cost for the management but an uncontrollable
cost for the supervisor.
Controllable costs can also be referred to as variable costs as is commonly
used in the accounting parlance. In short, controllable costs are likely
direct costs related to the level of production or core services of a
business.
If an item of expense directly impacts the manufacturing process it a
controllable cost. Secondly, the controllable cost is incurred in direct
proportion to the production volume.
Controllable cost constitutes the bulk of production costs. As a result, it
has a direct impact on profitability margins. For this reason, it is also
intuitive that such costs remain controllable. The management would
always like to control or tailor these costs in order to ensure they are in
line with the profit forecasts and budgetary requirements. To sum up,
direct materials, direct labour & factory overheads are prime examples of
controllable costs.
3.9 EXERCISE
Q.1)Fill in the blanks
1) ___________ is a controllable cost
2) ___________ is also called as variable cost
3) A segment or division may be a ___________.
4) __________ is the profit remaining after deduction of the cost of capital
on investment
(5)_______ is only responsible for generating revenues, and not any other
business function
(1) Material, 2) Controllable cost , 3) Profit centre 4) Residual income
5) Revenue centre
Q.2)Short notes
1) Controllable cost
2) Segment reporting
3) Responsibility centres

82
4
TRANSFER PRICING
Unit Structure
4.0 Introduction
4.1 Objectives
4.2 Advantages and Disadvantages
4.3 Cost based transfer pricing
4.4 Negotiated Transfer Pricing
4.5 Target Costing
4.6 Comparision between Target costing and Cost plus pricing
4.7 Inflation accounting
4.8 Illustrations
4.0 INTRODUCTION
Transfer pricing is the setting of the price for goods and services sold
between controlled (or related) legal entities within an enterprise. For
example, if a subsidiary company sells goods to a parent company, the
cost of those goods paid by the parent to the subsidiary is the transfer
price. Legal entities considered under the control of a single corporation
include branches and companies that are wholly or majority owned
ultimately by the parent corporation. Certain jurisdictions consider entities
to be under common control if they share family members on their boards
of directors. Transfer pricing can be used as a profit allocation method to
attribute a multinational corporation's net profit (or loss) before tax to
countries where it does business. Transfer pricing results in the setting of
prices among divisions within an enterprise.Transfer pricing accounting
occurs when goods or services are exchanged between divisions of the
same company.A transfer price is based on market prices in charging
another division, subsidiary, or holding company for services
rendered.Companies use transfer pricing to reduce the overall tax burden
of the parent company.
4.1 OBJECTIVES
 True and fair reporting of financial statements
 Better estimation of profits generated by entities from associated
transfers
 Avoidance of double taxation and avoiding tax evasion by entities
 Promoting competitiveness among the associated enterprises.
83
Advanced Cost Accounting 4.2 ADVANTAGES AND DISADVANTAGES
 The critical importance of Transfer Pricing provisions is that there will
be an equal and fair distribution of resources between associated
entities leading to nondiscriminatory trade transactions.
 This provides opportunities for associated enterprises to transact
business between them as the transactions are valued at market price,
this will enhance the scope of business and have a positive impact on
the group company as a whole due to internal profits generated by these
associated entities,
 Also, it is useful for the tax authorities to determine the actual value of
such transactions and to estimate the profits derived from such
transactions taking place between associate entities. Without transfer
pricing provision, there would be a reduction or avoidance of tax by
misleading authorities and transferring or reporting profits based on the
limitation presents in tax provisions.
 It is used not only by multi-company organizations but also by entities
that satisfy the conditions of associated enterprises.
Disadvantages
 This would require additional administrative cost and a time-consuming
process.
 There are few limitations in the determination of arms-length price as
two products cannot be compared due to the homogenous nature of
such commodities or services.
4.3 COST BASED TRANSFER PRICING:

When external markets do not exist or are not available to the company or
when information about external market prices is not readily available,
companies may decide to use some forms of cost-based transfer pricing
system.Cost-based transfer prices may be in different forms such as
variable cost, actual full cost, full cost plus profit margin, standard full
cost.
(a) Variable Cost:

Variable cost-based pricing approach is useful when the selling division is
operating below capacity. The manager of the selling division will
generally not like this transfer price because it yields no profit to that
division. In this pricing system, only variable production costs are
transferred. These costs are direct materials, direct labour and variable
factory overhead.
Variable cost has the major advantage of encouraging maximum profits
for the entire firm. By passing only variable costs alone to the next
division, production and pricing decisions are based on cost- volume-
profit relationships for the firm as a whole. The obvious problem is that
84
selling division is left holding all its fixed costs and operating expenses. Transfer pricing
That division is now a loss division, no where near a profit centre.
(b) Actual Full Cost:

In actual full cost approach, transfer price is based on the total product
cost per unit which will include direct materials, direct labour and factory
overhead. When full cost is used for transfer pricing, the selling division
can not realise a profit on the goods transferred. This may be disincentive
to the selling division. Further, full cost transfer pricing can provide
perverse incentives and distort performance measures. A full cost transfer
price would have shutdown the chances of any negotiation between
divisions about selling at transfer prices.
(c) Full Cost Plus Profit Margin:

Full cost plus mark up (or profit margin) overcomes the weaknesses of full
cost basis transfer pricing system. The full cost plus price include the
allowed cost of the item plus a mark up or other profit allowance. With
such a system, the selling division obtains a profit contribution on units
transferred and hence, benefits if performance is measured on the basis of
divisional operating profits. However, the manager of the buying division
would naturally object that his costs (and hence reported performance) are
adversely affected.
The basic question in full cost plus mark up is ‘what should be the
percentage of mark up.’ It can be suggested that the mark up percentage
should cover operating expenses and provide a target return on sales or
assets.
(d) Standard Costs:

In actual cost approaches, there is a problem of measuring cost. Actual
cost does not provide any incentive to the selling division to control cost.
All product costs are transferred to the buying division. While transferring
actual costs any variances or inefficiencies in the selling division are
passed along to the buying division.
The problem of isolating the variances that have been transferred to
subsequent buyer division becomes extremely complex. To promote
responsibility in the selling division and to isolate variances within
divisions, standard costs are usually used as a basis for transfer pricing in
cost-based systems.
Whether transferring at differential costs or full costs, standard costs,
where available, are often used as the basis for the transfer. This
encourages efficiency in the selling division because inefficiencies are not
passed onto the buying division. Otherwise, the selling division can
transfer cost inefficiencies to the buying division. Use of standard cost
reduces risk to the buyer. The buyer knows that standard costs will be
transferred and avoids being charged with suppliers’ cost overruns
85
Advanced Cost Accounting 4.4 NEGOTIATED TRANSFER PRICING:
Negotiated prices are generally preferred as a middle solution between
market prices and cost- based prices. Under negotiated prices, the
managers involved act much the same as the managers of independent
companies. Negotiation strategies may be similar to those employed when
trading with outside markets. If both divisions are free to deal either with
each other or in the external market, the negotiated price will likely be
close to the external market price. If all of a selling division’s output can
not be sold in the external market (that is, a portion must be sold to the
buying division), the negotiated price will likely be less than the market
price and the total margin will be shared by the divisions.
Negotiated price avoids mistrusts, bad feelings and undesirable bargaining
interests among divisional managers. Also, it provides an opportunity to
achieve the objectives of goal congruence, autonomy and accurate
performance evaluation. The overall company is beneficiary if selling and
buying divisions can agree upon some mutually transfer prices. Negotiated
transfer price is considered as a vital integrating tool among divisions of a
company which is necessary to achieve goal congruence.
If negotiations help ensure goal congruence, top management has little
temptation to intervene between divisions. The agreed prices also can be
used for performance measurement without creating any friction. The use
of negotiated prices is consistent with the concept of decentralised
decision-making in the divisionalised firms.
However, negotiated prices have the following disadvantages:

(1) A great deal of management effort, time and resources can be
consumed in the negotiating process.
(2) The final emerging negotiated price may depend more on the
divisional manager’s ability and skill to negotiate than on the other
factors. Thus, performance measures will be distorted leading to
incorrect evaluation of divisional performance.
(3) One divisional manager having some private information may take
advantage of another divisional manager.
(4) It is time-consuming for the managers involved.
(5) It leads to conflicts between divisions.
(6) It may lead to a suboptimal level of output if the negotiated price is
above the opportunity cost of supplying the transferred goods.
4.5 TARGET COSTING

Target costing is a structural approach to determine the cost at which
a proposed product with specified function and quality must be
produced, to generate a desired level of profitability at its anticipated
selling price.
86
In other words, Target Costing is a cost management tool for Transfer pricing
producing overall cost of product over its entire life cycle with the
help of the function engineering and research and development.
Target cost is called estimated cost of the product that helps a
manufacturing unit to remain.It competes in the market in the long
run. Target costing is a cost management technique. Target cost is the
difference between target sales minus target margin. It is, thus, the
difference between estimated selling price of a proposed product with
specified functionality and quality and the target margin.
The features of target costing are as follows:

1. It is viewed as an integral part of the design and introduction of new
products.
2. A target selling price is determined using various sales forecasting
techniques.
3. The target selling price is the establishment of target production
volumes, given the relationship between price and volume.
4. Target costing process is to determine, cost reduction targets.
5. A fair degree of judgement is needed where the allowable cost and the
target cost differ.
Characteristics of Target Costing
The main characteristics of target costing system are as under:
(1) Identification of Opportunities –
With the help of value engineering and value analysis, opportunities, for
cost reduction can be identified easily. Value engineering involves
searching the opportunities to modify the design for reducing the cost
without reducing the quality of the product.
Similarly, value analysis involves rejecting non-value adding activities
which may minimise the cost without reducing quality of the product.
Thus current cost is reduced to the level of target cost. It is presumed that
when production commences, the total cost will meet the target and profit
also.
(2) Target Cost –

Target cost is decided by deducting target income from the target price.
(3) Integral Part of Design –

Target costing is known as an integral part of the design and introduction
of new products.
87
Advanced Cost Accounting (4)Target Price –
It is the estimated market price of the product. It is a target price which is
determined by using various sales forecasting techniques in which
consideration is made for design specifications of the product and
competitive market conditions.
(5) Cost Reduction Target –

Cost reduction target is fixed, which requires estimation of current cost of
the new product. It is based on existing technologies and its various
components. The excess of current cost over target cost indicates the cost
reduction.
Objectives
1. To lower the costs of new products so that the required profit level can
be ensured.
2. The new products meet the levels of quality, delivery timing and price
required by the market.
3. To motivate all company employees to achieve the target profit during
new product development by making target costing a company wide
profit management activity.
4.6 COMPARISION BETWEEN TARGET COSTING AND COST

PLUS PRICING
Target costing and cost-plus pricing are two different things. In product
development, target costing is a management technique used to determine
the cost of manufacturing a product, while cost-plus pricing is a system
used to determine the selling price of the product. Cost-plus pricing starts
with an estimate of the costs incurred to build a product, and a certain
profit percentage is added to establish the price. ... Target
costing integrates the product design, desired price, desired profit, and
desired cost into one process beginning at the product development stage.
1.7) Inflation Accounting.
Inflation accounting refers to the adjustment of the financial statements
during inflationary periods. This special accounting technique is only used
in inflationary periods where the general level of prices is usually high for
three consecutive quarters.
It involves the recording of the income and expenditure of the business at
the current prices and reinstating all the three statements of the company
and analyze the cost and the trend of the current company.
There are various kinds of techniques that are involved in inflation
accounting and there are various methods attached to it.
 Current Purchasing Power Method: This technique involves the
adjustment of the financial statements to the current price changes. It
88
involves recalculating the historical financial figures of the company at Transfer pricing
the current purchasing power which is done by applying a certain
conversion factor.
 Current Cost Accounting: Under this method, the cost categories and
the various cost items and the items in the balance sheet are shown at
the current cost rather than the historical cost and the profit is
determined on the actual cost period and not on the basis of the sales.
 Current Value: Under this method, all assets and liabilities are
measured and are reinstated at their current cost structure.
 Replacement Cost Accounting: The cost of replacing is the
parameter under which all the assets and the liabilities on the balance
sheet are recorded.
Advantages of Inflation Accounting

The following are the advantage of Inflation Accounting:
 It reflects the current and not the historical cost of the balance sheet.
 It is highly effective in times of general inflation or hyperinflation.
 Depreciation of the business is valued and cost on the current price and
not on the historical or the carrying value of the asset which is the
correct method.
 Profit and loss will reflect the true condition of the company.
 Financial ratios based on figures, adjusted to the current value, are
more meaningful.
Disadvantages of Inflation Accounting

The following are the disadvantage of Inflation Accounting:
 Changing in price is a never-ending process hence it becomes difficult
every time to reinstate the figures of the company and present the
financial statements.
 Inflation accounting is a complicated process and it involves too much
calculation and the data gathering process.
 In times of deflation, the depreciation cost will be on a lower side
hence it does not reflect the true picture.
4.8 ILLUSTRATIONS
Q1)A firm had Rs 2,00,000 as cash at bank on April 1, 2011. The
consumer price index on that date was 200. During the year ended
31st March, 2012 the receipts and payments were stated below:
89
Solution:
Statement showing Profit/Loss on Cash during the year ended 31st
March, 2012:
The balance according to Constant Rupees should have been Rs 1,16,667

whereas the actual balance is only Rs 85,000. Therefore, as a result of
changes in prices, there has been a loss of Rs 31,667.
Q.2)Below is given a simplified balance sheet and statement of profit
and loss of a company in existence for about 10 years:
90
Transfer pricing
Depreciation charge comes to Rs 124 lakhs.
The following facts are established:

(1) The price indices of tangible assets had climbed to 200 in the
beginning of 2011-2012 and to 225 by the end of the year with the prices
ten years ago being 100; the price increase in 2010-2011 was only 6%. Till
the end of 2010-2011 the company had not made any substantial additions
to the tangible assets. The company considers the life of the tangible assets
to be 20 years and would prefer the straight line basis of depreciation.
(2) Prices of materials rose by 54% and of finished goods by 35% during
2011-2012; rates relating to manufacturing costs increased by 20%.
(3) The value of finished goods stock in the beginning and at the end of
the year was respectively Rs 158 lakhs and Rs 203 lakhs.
Prepare the current cost accounting balance sheet as at 31st March, 2012
and statement of profit and loss for the year 2011-2012 on that basis.
Solution:
The following assumptions are made:
(a) Material stocks are valued on FIFO basis.
(b) Loans and advance are against supplies of materials and stores, so also
current liabilities.:
91
Advanced Cost Accounting The various adjustments required under CCA are worked out below
(to the nearest lakh of rupee):
92
Transfer pricing
93
94
Some observations: Transfer pricing
The accounts given above are naturally much too simple compared to the
actual situation but, nevertheless, they are based on reality.The following
observations on these accounts may be pertinent:
(i) The additional depreciation for the current year is only Rs 8 lakh; this
low figure is because the depreciation actually charged in the accounts is
much higher than that warranted on straight line basis with a life of 20
years. Generally, in industrial concerns the adjustment required for
depreciation will be heavy.COSA in the above case is very large. This is
because there was a very big increase in the prices of materials — 54%.
Normally, the adjustment may not be large. Still the point that emerges is
that if prices rise rapidly and if there is big time lag between purchase and
consumption, the adjustment in respect of cost of sales will be material.
Trading concerns cannot naturally ignore COSA.The gearing adjustment
has reduced the debit to the Profit and Loss Account by Rs 130 lakhs.
Indian companies normally resort to loans in a big way and, hence, for
Indian companies this adjustment will be generally substantial. In the case
under discussion, interest payment was only Rs 108 lakhs, showing that
due to rise in prices, there was a saving of Rs 22 lakhs because of the fixed
nature of monetary obligations.
On 31st March, 2002, when the general price index was say 100, Forward
Ltd. purchased fixed assets of Rs one crore. It had also permanent working
capital of Rs 40 lakh. The entire amount required for purchase and
permanent working capital was financed by 10% redeemable preference
share capital. Forward Ltd. wants to maintain its physical capital.
On 31st March, 2012, the company had reserves of Rs 1.75 crore. The
general price index on this day was 200. The written down value of fixed
assets was Rs 10 lakh and they were sold for Rs 1.5 crore. The proceeds
were utilised for redemption of preference shares.
On the same day (31st March, 2012) the company purchased a new
factory for Rs 10 crore. The ratio of permanent working capital to cost of
assets is to be maintained at 0.4 : 1.
The company raised the additional funds required by issue of equity
shares.
Based on the above information (a) Quantify the amount of equity capital
raised and (b) Show the Balance Sheet as on 1.4.2012.
95

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31

SUBJECT CODE : 72211

Prof. Suhas Pednekar

Prof. Ravindra D. Kulkarni Prof. Prakash Mahanwar

Programme Co-ordinator : Prof. Rajashri Pandit

Course Co-ordinator : Mr. Vinayak Vijay Joshi

Re-Editor : Ms. Neha Bhatia

Course Writer : Dr. P. K. Bandgar

: Dr. Paulraj Arunachandan

DTP Composed : Mumbai University Press

Group A: Advanced Accounting, Corporate Accounting and

3. Advanced Cost Accounting

2 Cost Allocation and Activity Based Costing Systems 15

4 Strategic Cost Management 15

1.0 LEARNING OBJECTIVES

After studying this chapter you should able to understand

 the distinction between job costing and process costing

 the accounting procedure of process costing including normal loss

 the valuation of work-in-progress, using FIFO, LIFO average and

 the steps involved in inter process transfer

CIMA London defines process costing as “that form of operation

1.2.3 Advantages of process costing:

1.3 DISTINCTION BETWEEN JOB COSTING

Basis of Job order costing Process costing

5 Control Proper control is Proper control is

7 Work-in- There may or may not There is always some

1.4 COSTING PROCEDURE

Each process account is debited with –

1.4.2 Items on the Credit side:

Each process account is credited with

1.4.3 Cost of Process:

Particulars Units Rs. Particulars Units Rs.

1.4.4 Process Losses:

In many process, some loss is inevitable. Certain production

Normal loss is an unavoidable loss which occurs due to the inherent

Total cost increased – Sale Value of ScrapInput – Normal Loss units

Any loss caused by unexpected abnormal conditions such as plant

Abnormal Process loss should not be allowed to affect the cost of

Units Rs. Particulars Units Rs.

To Process A/c. xx xx By Bank xx xx

The margin allowed for normal loss is an estimate (i.e. on the

The sales values of abnormal gain units are transferred to Normal

Particulars Units Rs. Particulars Units Rs.

To Normal Loss xx xx By Process A/c. xx xx

Check Your Progress:

Prepare a Process Account, Abnormal Loss Account and Normal

Input of Raw material 1000 units @ Rs. 20 per

Particulars Units Rs. Particulars Units Rs.

To Raw material @ 1000 20000 By Normal Loss

To Direct 4200 (5% on 50 400

To Direct Wages 6000 By Abnormal 50

Overheads 6000 (output transferred) 900

1000 36200 1000 36200

Dr. Abnormal Loss A/c. Cr.

Particulars Units Rs. Particulars Units Rs.

To Process – IA/c. 50 By Bank A/c. 50 400

Particulars Units Rs. Particulars Units Rs.

The product of a company passes through 3 distinct process. The

Particulars Process – A Process – B Process – C

3000 units @ Rs. 3 each were introduced to process – I. There was