Ordering Point or Re-order Level related solved problems

Problem 

From the following information, you are required to determine:

(a) Ordering Point or Re-order Level

(b) Minimum Limit or Minimum Stock Level

(c) Maximum Limit or Maximum Stock Level

(d) Danger Level

Maximum daily requirement                              800 units

Time required to receive emergency

                                                supplies            4 days

Average daily requirement                                 700 units

Minimum daily requirement                               600 units

Time required for fresh supply               one month

                                                                        (30 days)

Economic Order Quantity                                 29000 units

Solution:

(a) Ordering Point = Maximum daily requirement × lead time

Ordering Point or Re-order Level = 800 × 30 = 24000 Units

(b) Minimum Limit = Ordering Point – Average Consumption

Minimum Limit or Level = 24000 – (700 × 30)

Minimum Limit or Level = 24000 – 21000 = 3000 Units

(c) Maximum Limit = Ordering Point – Minimum Consumption

while the replacement order is outstanding + E.O.Q

Maximum Limit or Maximum Stock Level =

            24000 – (600 × 30) + 29000

Maximum Limit or Maximum Stock Level =

            24000 – 18000 + 29000 = 35000 Units

(d) Danger Level = Average daily consumption × time required to receive emergency supply

Danger Level = 700 × 4 = 2800 Units

Cost Accounting Solved Problems

The records of Derajat Manufacturing Co. Ltd. show the following data relative to material no: E-4:

Balance: February,        1, 1967            700 units at Rs. 20.50

Purchases: February     3, 1967            800 units at Rs. 21.00

                                    12, 1967          400 units at Rs. 22.00

                                    24, 1967          200 units at Rs. 21.50

Issued: February           2, 1967            500 units

                                    18, 1867          600 units

                                    28, 1967          200 units

Required: Calculate the moving average cost of the material issued and also calculate the cost of inventory balance.

Solution:

Cost of materials issued:

Standard Cost Method and solved problem

Standard Cost Method

Sometimes materials are charged in the factory at an estimated price which represents the normal price. This price is also known as pre-determined price or budgeted price or standard price or standard cost. The determination of a standard price is difficult because prices are controlled by market conditions than by the Board of Directors of the manufacturing company. The standard price is not fixed for all time but it is kept under constant review and is always subject to adjustments for regular increase or decrease in prices.

The standard cost of a material may or may not always coincide with actual price paid. In case the two prices differ, a standard price variance occurs.

Problem :

5,00 units of Material-C 5 with a standard price of Rs. 250 are purchased at Rs. 258. Calculate standard price variance and the unit cost difference.

Solution:

Quantity           Units    Unit cost                       Amount

                                    Rs.                               Rs.

Actual              5,000 × 258 (Actual)                12, 90, 000

Actual              5,000 × 250 (Standard)            12, 50, 000

                                                                                               

Standard Price Variance           5,000 × 8         40, 000

Unit Cost Difference                             8

                                                                                               

Sometimes a factory can work out not only the standard cost of the material but also the standard quantity of consumption of materials for a given job or process. Under these circumstances, we may have to calculate not only the price variance but also the quantity variance.

Solved problems No.5 related to cost accounting

The records of Rajshahi Manufacturing Co. Ltd. show the following data relative to Material No: R-172:

Balance: April 1, 1967…2,700 units at Rs. 41

Received: April 4, 1967….2, 800 units at Rs. 42

                        13, 1967….2, 400 units at Rs. 44

                        25, 1967….2, 200 units at Rs. 43

Issued: April 3, 1967……2, 500 units

                        19, 1967….2, 600 units

                        30, 1967….2, 200 units

Instruction: Find out the inventory balance and the cost of issue of the material on the basis of weighted average.

Solution:

Cost of the material purchased and on hand

However, the weighted average works out Rs. 42,4257 or Rs. 42.43 because the different values have to be multiplied by different frequency weights i.e. different quantities have been purchased at different prices. If purchase is always done in an uniform quantity, the prices need not be multiplied by the quantities purchased because simply average of unit prices paid for in different purchase transactions would yield the same result.

In weighted average basis, the costs are taken into account at the end of the month.

Moving Average Cost

The moving average cost is the weighted average cost calculated at the time of each issuance of materials. This is known as moving average because the cost moves upwards or backwards according to each purchase and / or issue of materials.

Problems of Cost Accounting and Fifo Versus Lifo Methods

The Sanghar Manufacturing Co. Ltd. reports purchases and issues of material no: Special – C as under:

                        Purchases                                 Issued

Date                 Units                Unit Price         Units

                                                      Rs.

July 2, 1967                                                     1,000

       3, 1967     2,000                  42/00

       5, 1967                                                     1,500

       7, 1967     1,000                  43/50

      10, 1967                                                    2,000

      15, 1967    2,000               44/00

      31, 1967                                                    1,000

The opening inventory on July 1, 1967 consisted of 3000 units valued at Rs. 1,21,500

Required: Calculate the cost of the material issued under the following assumptions:

(1) The Lifo, costs calculated at the time of issuance of the material.

(2) The Lifo, costs calculated at the end of the month.

Solution:

(1) Lifo method: Costs calculated at the time of issuance of the material.

Cost of the material issued:

July 2, 1967                                                                 Rs.

(to be issued from

opening balance).          1,000 units at 40/50                  40,500

July 5, 1967                 1,500 units at 42/00                  63,000

                                                                        Rs.

July 10, 1967               1,000 units at 43/50      43,500

                                    500 units at 42/00         21000

                                    500 units at 40/50         20,250

                                    (issued out of opening               84,750

                                       balance)

July 31, 1967               1,000 units at 44/00                  44,000

Cost of the                                                                              

material issued.              5,500 units                             2,32,250

Cost of the ending inventory:                                         Rs.

Material at hand July 1, 1967    1500 units 40/50          60,750

Purchase of July 15, 1967         1000 units at 44/00       44,000

                                                2500 units                  1,04,750

(2) Lifo method: Cost calculated at the end of the month.

Cost of the material issued:                                            Rs.

Purchase of July 15, 1967 – 2,000 units at 44/- 88,000

Purchase of July 7, 1967 – 1,000 units at 43/50            43,500

Purchase of July 3, 1967 – 2,000 units at 42/00            84,000

Material on hand, July 1,1967 -    

                                     500 units at 40 / 50       20,250

Cost of the material issued: 5,500 units  2, 35,750

Cost of the ending inventory:

Comprising of 2,500 units at Rs. 40 / 50           Rs

that were on hand on July 1, 1967…..   1, 01, 250

Fifo and Lifo method

Looked at from the long term point of view both fifo and lifo methods yield the same cost of production. In the periods of rising prices, the fifo method results in increased net income because the oldest costs are matched against the income. As against fifo method, the lifo results in reduced net income in periods of rising prices because the altest costs are charged against the income. Lifo is being widely used because these are the years of rising prices.

The use of lifo method may result in losses if the manufacturer is forced to sell away a substantial part of his stock of materials at a price different from the one shown against the stock. The application of lifo may stimulate profit manipulation. The manufacturer may purchase unduly large quantities of materials at the close of the period to show high profits or the purchases may be postponed so that the costs of prior periods may be matched against income.

Weighted Average Cost Method

The average cost of various units of materials in stock is used when it becomes impractical to identify cost with the materials as these move forward. Average costs carry the effects of high as well as low prices of raw materials and thereby these costs render the cost estimates somewhat more reliable and stable. By average cost is meant the ‘weighted’ average cost and not the ‘simple’ average cost. The weighted average cost is a more dependable concept as compared to simple average cost because these costs are more realistic and dependable.

Solved problems related to material costing

Records of the Sylhet Co. Ltd. show the following data relative to Material No. e—71:

Balance: July 1, 1967 … 1,050 units at Rs. 10/25

Purchases: July 3, 1967 … 1,200 units at Rs. 10/50

                        12, 1967 … 600 units at Rs. 11/00

                        24, 1967 … 300 units at Rs. 10/75

Issued:  July 2, 1967 … 750 units

                  18, 1967 … 900 units

                  29, 1967 … 300 units

Required: calculate the inventory balance and the cost of the material issued on each of the following bases:

(1) Last-in, first-out, Perpetual inventories are maintained and costs are charged out currently.

(2) Last-in, first-out. No book inventory is maintained.

Solution:           (1) Lifo-perpetual inventory

Material No. E—71

Cost of the material issued        Rs.   20,662/50

(2) Lifo-no book inventory

Cost of purchases of the material:

                                                            Rs.

1,050 units at 10/25 (Inventory)            10,762/50

1,200 units at 10/50                              12,600/00

600 units 11/00                                    6,600/00

300 units at 10/75                                 3,225/00

                                                                        33,187/50

Less inventory of the material (earliest costs):

July 1, 1967(inventory), 1,050 units

                                    at Rs. 10/25     10,762/50

            3, 1967 (balance) 150 units

                                    at Rs. 10/50     1,575/00

                                                                        12,337/50

Cost of the material issued.                         Rs. 20,850/00

(It will be observed that there was no difference in the cost of the material issued by fifo system both under perpetual inventory and under no book inventory, but here the two figures are different).

Material Costing - Solved Problem No.2

The records of the Khulna Manufacturing Co. Ltd. Show the following data relative to Material No: B—198:

Balance: March 1, 1967           1,350 units at Rs. 20.50

Received: March 4, 1967         1,400 units at Rs. 21.00

                         13, 1967         1,200 units at Rs. 22.00

                         25, 1967         1,100 units at Rs. 21.50

Issued:      March 3, 1967         1,250 units

                         19, 1967         1,300 units

                         30, 1967         1,100

Instructions:      Find out the inventory balance and the cost of issue of the material on each of the following bases:

(1) Fifo. Perpetual inventories are kept and costs are charged out currently.

(2) Fifo. No book inventory is kept.

Solution:

(1) Fifo – Perpetual Inventory

(2) Fifo – No Book Inventory                           Rs.

Cost of purchases of the material                       1,07,125

Less inventory of the material (latest costs):

January 25, 1967: 1100 units at Rs. 21/50 = 13,650

            13, 1967: 300 units at Rs. 22/00 = 6,600

                                                                             30,250

Cost of the material issued:                                     76,875

Last—in, First—out (LIFO) Method:

Under this method the materials purchased are issued in the opposite order to FIFO i.e. the items last entered in the stores are first to be issued. Under this method also the value assigned to the materials issued is same as paid for. This method has the following advantages:

(1) As the most recent costs are charged, it renders the calculation of earnings more accurate.

(2) The fluctuations of net earnings are minimised on account of latest costs being matched with current revenues.

(3) As the most recent purchase prices are charged under this system, it enables in the periods of rising prices to postpone partially the payments of income-taxes because the profits are shown at reduced figures.

The method is a little difficult to operate on account of various types of calculations to be made. Moreover, as the oldest purchases are shown at the purchase prices then ruling, ruling market prices, particularly in the event of rising prices. This system can be applied easily where there are not more than three purchased lots on the stores cards.

The Lifo method ensures that the most recent costs are charged to work-in-process or other operating expenses by leaving the oldest costs in the inventory valuations.

In the words of Matz, Curry and Frank, “The lifo method of inventory valuation does not give an appropriate measure of consumed materials costs in many types of business, and detailed issues on the lifo basis are appropriate in relatively few situations……The lifo method is more appropriate in process costing where individual material requisitions are seldom used and the materials move into process in bulk lots as in flour mills, spinning mills, oil refineries, and sugar refineries.”

Sometimes instead of charging the materials with the different costs of purchases, the latest cost is used for all the issues of materials. But this method should be used only when very frequent purchases and issues are involved. If this is not so sometimes a negative value might have to be assigned on the stores card. For example:

It will be seen that although 1,000 lbs are on hand, there is a negative value of Rs. 15,000 on the stores card.

We give below two problems to explain the procedures involved in the lifo method.

Material Costing - Solved Problems

Problem:

With the help of the following data calculate the cost of the ending inventory of Material No: c—154 on the basis of the most recent costs (fifo).

Solution:           Material No: C—154

What is Material Costing

Generally raw materials form a very big proportion of the total cost of production. Materials costing involves the determination of the cost of materials acquired, the cost of materials issued and the cost of the inventory. Cost of materials acquired (also called the ‘acquisition cost’) includes the net price paid to the vendor plus freight-in plus the costs of maintaining the purchasing department, the stores department, the accounting department and the costs of inspection, testing and insurance. A great proportion of the requisition costs consists of fixed expenses. 

On account of this fixed factor and also on account of various complications, generally the materials are priced at the net amount paid to the seller. It does not mean that the cost referred to above is in any case not relevant to the concept of acquisition cost. This extra cost is generally charged to production as manufacturing overhead.

Generally the perpetual inventory system is used because it ensures a continuous book record of various materials in stock. The main advantages of a perpetual inventory system are: (i) control over inventory is easy and effective because the latest inventory position is always available and (ii) the book inventory can always be compared with the results of physical counting.

The net amount paid to the seller is entered by the stores clerks on the stores ledger cards. He enters both the unit cost and the total cost. Then the problem which arises relates to pricing the materials issued. The following methods of costing materials issued are generally used:

(i) First-in, First-out (FIFO).

(ii) Last-in, First-out (LIFO).

Solved Problems of Cost Accounting

Problem 5:

The Rustam Company has developed the following data to assist in controlling one of its inventory items:

Economic Order Quantity: 1000 Kg

Average daily use: 100 Kg

Minimum daily use: 80 Kg

Maximum daily use: 120 Kg

Working days per year 250 days

Safety stock  400 Kg

Cost of carrying Inventory  Rs. 1.00 per Kg. per year

Lead Time 7 working days

Required:

(i) Order Point

(ii) Average Inventory

(iii) Normal Maximum Inventory

(iv) Absolute Maximum Inventory

(v) Cost of Placing one order.

Solution:

(i) Order Point = Normaldaily use x lead time + safety stock

Order Point = (100 x 7) + 400 = 1100 Kg.

Inventory Turn Over:

Inventory turnover is a ratio of the value of materials used or finished goods sold during a certain period to the average inventory of materials or finished goods held during the period. In the form of formula, it may be written as following:

Solved answers of Inventory Quantity Standards

Problem 4:

The ABC Company provides the following information:

Estimated requirements for next year: 2400 units

Per unit Cost: Rs. 150

Ordering Cost (Per order): Rs. 20

Carrying Cost: 10%

From the above information you are required to calculate:

(a) Economic Order Quantity

(b) The Number of orders to be placed per year

(c) The Frequency of orders

(d) Prove your answer

Solution:

* From the above table, it is clear that if 3 orders are placed per year according to the Economic Order Quantity of 800 units per order; then the total cost (carrying + order cost) comes to Rs. 120 which is the lowest of all other different combinations. Hence it is proved that the most Economic Order Quantity is 800 units.

Note: When 800 units (EOQ) are purchased the ordering costs and carrying costs are equal.

Solved Problems of Inventory Quantity Standards

Problem 1:

Normal usage: 100 units per day

Maximum usage: 130 units per day

Minimum usage: 70 units per day

Economic Order Quantity:5000 units

Re-order Period: 25 to 30 days

From the above information you are required to calculate:

(i) Re-order Level

(ii) Minimum Level

(iii) Maximum Level

Solution:

(i) Re-order Level = Maximum daily usage × Maximum Re-order period

Reorder Level = 130 × 30 = 3900 units

(ii) Minimum Level = Re-order Level – Average usage for average re-order period.

Minimum Level = 3900 – (100 × 27.5)

Minimum Level = 3900 – 2750 = 1150 units

(iii) Maximum Level = Re-order Level – Minimum quantity used in re-order period + Economic Order Quantity

Maximum Level = 3900 – (70 × 25) + 5000

Maximum Level = 3900 – 1750 + 5000 = 7150 units

Problem 2:

Two types of materials A and B are used as follows:

Minimum usage: 20 units per week each

Normal usage: 40 units per week each

Maximum usage: 60 units per week each

Re-order Quantity (EOQ): A 400 units, B 600 units

Reorder Period: A: 3 to 5 weeks, B: 2 to 4 weeks

Calculate for two types of materials:

(a) Ordering Point or Re-order Level

(b) Minimum Level

(c) Maximum Level

(d) Average Stock Level

Solution:

(a) Ordering Point or Re-order Level = Maximum usage × Maximum re-order period

Ordering Point of Material A = 60 × 5 = 300 units

Ordering Point of Material B = 60 × 4 = 240 units

(b) Minimum Level = Ordering Point – (Normal usage × Normal re-order period)

Minimum Level of Material A = 300 – (40 × 4) = 140 units

Minimum Level of Material B = 240 – (40 × 3) = 120 units

(c) Maximum Level = Ordering Point – (Minimum usage × Minimum re-order period) + EOQ

Maximum Level of Material A = 300 – (20 × 3) + 400

Maximum Level of Material A = 300 – 60 + 400 = 640 units

Maximum Level of Material B = 240 – (20 × 2) + 600 = 800 units

(d) Average Stock Level = ½(Minimum Level + Maximum Level)

Average Stock Level of Material A = ½(140 + 640) = 390 units

Average Stock Level of Material B = ½(120 + 800) = 460 units

Equation problems related to Inventory Quantity Standards

From the following information, you are required to determine:

(a) Ordering Point or Re-order Level

(b) Minimum Limit or Minimum Stock Level

(c) Maximum Limit or Maximum Stock Level

(d) Danger Level

Maximum daily requirements                             800 units

Time required receiving emergency supplies       4 days

Average daily requirement                                 700 units

Minimum daily requirement                               600 units

Time required for fresh supply                           one month (30 days)

Economic Order Quantity                                 29000 units

Solution:

(a) Ordering Point = Maximum daily requirement × lead time

Ordering Point or Re-order Level = 800 × 30 = 24000 units

(b) Minimum Limit = Ordering Point – Average Consumption

Minimum Limit or Level = 2400 – (700 × 30)

Minimum Limit or Level = 24000 – 21000 = 3000 units

(c) Maximum Limit = Ordering Point – Minimum consumption while the replacement order is outstanding + E.O.Q

Maximum Limit or Maximum Stock Level =

24000 – (600 × 30) + 29000

Maximum Limit or Maximum Stock Level =

24000- 18000 + 29000 = 25000 units

(d) Danger Level = Average daily consumption × time required to receive emergency supply

Danger Level = 700 × 4 = 2800 units

Inventory Quantity Standards

Inventory Quantity Standards

1.         Ordering Level or Ordering Point or Re-ordering Level:

This is that level of material at which a new order for supply of material is to be placed. In other words, at this level a purchase requisition is made out. This level is fixed some where between maximum and minimum levels. Order points are based on usage during time necessary to requisition order, and receive materials, plus an allowance for protection against stock out.

The order point is reached when inventory on hand and quantities due in are equal to the lead time usage quantity plus the safety stock quantity.

The following two formulas are used for the calculation of re-ordering level or point:

(i) Ordering Point or Re-order level = Maximum daily or weekly or monthly usage × lead time

(Lead time would mean the time required to get fresh or new supply of material)

The above formula is used when usage and lead time are known with certainty; therefore, no safety stock is provided.

When safety stock is provided then the following formula will be applicable:

(ii) Ordering point or Re-order Level = Normal daily or weekly or monthly usage × lead time + Safety Stock.

2.         Minimum Level or Minimum Limit:

The minimum stock or level is the lowest level to which the inventory should be allowed to fall. It is the cushion stock which allows some margin of safety.

In other words, the minimum level is that level of stock below which stock should not normally be allowed to fall. In case of any item falling below this level, there is danger of stoppage of production and, therefore, the management should give top priority to the acquisition of new supplies.

Minimum level or limit may be calculated as follows:

Minimum Limit or Level = Re-order Level or Ordering Point – Average or Normal Usage × Normal reorder period

Or it can be written as follows:

Minimum Level = Reorder Level – Average usage for normal reorder period.

3.         Maximum Level or Maximum Limit:

The maximum stock limit is upper level of the inventory and the quantity that must not be exceeded without specific authority from management. In other words, the maximum stock level is that quantity of material above which the stock of any item should not normally be allowed to go. This level is fixed after taking into account such factors as: Capital available, rate of consumption of materials, storage space available, insurance cost, risk of deterioration and obsolescence, and Economic order quantity.

The maximum level or limit may be calculated by the help of following formula:

Maximum Limit or Level = Reorder Level – minimum usage × minimum reorder period + Economic Order Quantity.

4.         Danger Level:

Some enterprises also calculate ‘danger level’. When this level of stock is reached, then emergency steps are taken by the management to acquire material supplies. When this level is reached, the try is made to purchase materials from the nearest possible source or place so that the workers and plant and machinery may not remain idle due to shortage of material supplies. It may be calculated as follows:

Danger Level = Average daily requirement × time required to get emergency supply.

5.         Economic Order Quantity

economic Order Quantity is that size of the order which gives maximum economy in purchasing any material and ultimately contributes towards maintaining the material at the optimum level and at the minimum cost. In other words, the Economic Order Quantity is the amount of inventory to be ordered at one time for purposes of minimising annual inventory cost.

The quantity to order at a given time must be determined by balancing two factors (1) the cost of possessing (carrying) materials and (2) the cost of acquiring (ordering materials). Purchasing a larger quantities may decrease the unit cost of acquisition, but this saving may not be more than offset by the cost of carrying materials in stock for a longer period of time.

The carrying cost of inventory may include:

Interest on investment of working capital; property tax and Insurance, storage cost, handling cost, deterioration and shrinkage of stocks, obsolescence of stocks.

The different formulas have been developed for the calculation of Economic Order Quantity.

The following formula is usually used for the calculation of Economic Order Quantity (E. O. Q):

What is Material Control? Explain the its need and define the requirements of system of cost control

Material control is the system that ensures the provision of the required quantity of material of the required quality at the required time with the minimum of capital investment. It covers the following functions:

(i) Stock control

(ii) Scheduling of requirements

(iii) Purchasing

(iv) Receiving and inspecting

(v) Storing and issuing.

Need for Material Control:

One of the first steps in the installation of a cost system is planning the proper control of materials and supplies from the time orders are placed with supplier until they have been consumed in plant and office operation or have been sold as merchandise. Material represents an important asset and is the largest single item of cost in almost every business; accordingly, the success or failure of a concern may depend largely upon efficient material purchasing, storage, accounting, utilisation and control.

Where materials are not properly controlled, excess stock of some items are likely to occur with a result unnecessary tying up of capital and loss through deterioration and obsolescence. Shortages of other materials may arise at the time when they are urgently needed and production will then be delayed.

The purchasing of materials is a highly specialized function. By ordering the right quantity and quality of material at the most favourable price, and by ensuring that it arrives at the right time, the efficient buyer is able to make a valuable contribution to the success of a business.

Efficient material control costs out losses and forms of waste that otherwise tend to pass unnoticed. Theft, misappropriation, deterioration, breakage and additional storage costs can be reduced to a minimum by proper controls, and much avoidable idle time in the factory will be cut out if materials are available to meet the demands of the production staff. Finally, and most important to the cost accountant, it is impossible to produce reliable costing information if the records of material issues are unsatisfactory, because a cost statement cannot be more accurate than the information on which it is based.

Requirements of a System of Material Control

The important requirements or essentials of adequate and satisfactory system of material control are as follows:

(i) Proper co-ordination: Proper co-ordination of all departments involved, in material purchasing, receiving, testing, approving, storage, issue and in accounting, is essential.

(ii) Competent Purchasing agent: Centralisation of purchasing in a purchasing department under the direct and authority of a competent and trained purchasing agent is also considered essential.

(iii) Use of Standard Forms: The use of standard forms for orders, requisitions etc, upon which written and signed instruction are given, are essential for proper control of materials.

(iv) Control by budgeting material and Equipment: Use of materials, supplies and equipment budgets so that the economy in purchasing and use of materials can be realized, is important factor for adequate control of material.

(v) Storage Location: Storage of all materials and supplies should be in a designated location properly safe guarded under supervision and proper planning should be there for storing and issuing of materials.

(vi) Operation of perpetual Inventory: Operation of proper perpetual inventory system should be used so that it is possible to determine at any time the amount and value of each kind of material in stock. It also enables the comparison of book inventory with the results of physical counting.

(vii) Standards or Levels to be fixed: A minimum quantity of each item of material, below which point the inventory is not allowed to drop, and a maximum quantity, above which stock is not carried should be fixed. In the same manner ordering level and Economic Order Quantities may be determined.

(viii) Storage Control and Issue: The proper operation of a system of stores control and issue is introduced so that there will be delivery of materials upon requisitions to departments in the right amount at the time they are needed.

(ix) Internal Check: The operation of internal check should be introduced to ensure that transactions involving materials and equipment are checked by reliable and independent officials.

(x) Development of Controlling Accounts and Subsidiary Records: Controlling accounts and subsidiary records reveal summary of detailed materials costs at each stage of material receipt and consumption from the store room to finished goods.

(xi) Regular Reports: Regular reports and informations should be provided to the management in connection with the purchases of materials, issues from stock, inventory balances, obsolete stock, goods returned to vendors, and spoiled or defective units.

Need, Importance and Advantages of Cost Accounting

The science of cost accounting has developed primarily to serve the needs of the management. The techniques of cost accounting are the best tools by which management may conduct a business towards profitable operations. It is so much allied to management that it is difficult to indicate where the cost accounting ends and managerial control begins.

Cost Accounting has many advantages. The following are the most important advantages of a good cost accounting system:

1.         Profitable and unprofitable Activities:

In Cost Accounting profitable and unprofitable activities are disclosed. Management can take steps to eliminate or to reduce those activities from which little or no profit is earned. It can change the method of production in order to render such activities more profitable.

2.         Classification and Subdivision of costs:

Costs are accumulated and classified by every possible division of business. In a good costing system data regarding costs by functions, departments, processes, jobs or orders, contracts and services can be easily computed. Thus it helps management to ascertain the profitability of each product, sales area, division etc. in order to improve profit.

3.         Cost Finding and Price-Fixing:

It provides accurate cost data which help in the fixation of selling price and for submitting quotations. In periods of depression it enables the management to determine the extent to which prices can be reduced.

4.         Control of Materials and supplies:

Since in all types of cost accounting, materials and supplies must be accounted for in terms of departments, processes, and units of production or services; a system of receiving, handling, and issuing materials and supplies is an essential part of cost control. This will eliminate or reduce misappropriation, embezzlement, obsolescence, and losses from scrap, defective, and spoiled materials and supplies.

5.         Control of Wages and Salaries:

Cost Accounting activities encourage accounting for labour by jobs and by operations. In many manufacturing concerns daily summary reports are prepared to show the number of hours and minutes worked and the wage rate for each worker per job or operation.

Cost Accounting is a benefit to the employer by establishing standards to measure the efficiency of labour to assist in assignment of work to employees best fitted for it, and to determine the unit cost of labour arising from each activity.

6.         Overhead costs:

The Cost accountant first separates costs into direct and indirect items. Direct costs consists of materials and labour that can be definitely

Difference between Cost Accounting and Financial Accounting

The function of every accounting is to provide the financial information for different parties. Both financial accounting and cost accounting are concerned with the accumulation and presentation of information to serve the needs of management and outsiders. The source of two accounts of recording the transactions is the same. Cost Accounting is based on the same principles regarding debit and credit as are applied in financial accounting. But the two differ in their purpose and scope.

The following are the important points of difference:

1.         Purpose:

Cost Accounting and financial accounting have different purposes. Financial Accounting provides information about the enterprise in a general way. It safeguards the interests of business and other parties by providing suitable information in the financial statements i.e. Profit and Loss Account and Balance Sheet. Cost Accounting gives information for the guidance of the management for the proper planning, operation, control and decision making.

2.         Recording:

Financial Accounting consists of classification, recording and analysis of transaction in a subjective manner according to the nature of expenditures. Cost Accounting records expenditures in an objective manner, i.e. according to the purpose for which costs are incurred.

3.         Analysis of Profit:

Financial Accounting reveals the profit and loss of the business as a whole at the end of a trading period, usually a year. Cost Accounting discloses the result of each operation, process and product.

The total results, at the end of certain period, as reported by the financial accountant will not be of much help to the management for control and various other purposes; while the cost accountant reveals the profit and loss as and when the job or process is completed which helps the management in taking prompt and effective measures.

4.         Control:

Financial Accounting lays emphasis on the recording aspect, no consideration is given to control aspect. Cost Accounting provides information for a detailed system of control with the help of standard costing and budgetary control.

5.         Periodicity of Reporting:

Financial Accounting reports about the business performance and financial state of affairs usually at the end of the accounting year. Cost Accounting supplies cost data and other related information in the form of cost reports to management promptly and quite frequently. In General or Financial Accounting day-to-day cost information are not available thus costs can not be controlled.

6.         Checking of Efficiency:

General or Financial Accounting does not give costs of each process or activity, therefore management is unable to judge efficiency and inefficiency of each department or worker. While in Cost Accounting, efficiency and inefficiency in consumption of materials, labour and other costs can be judged, compared, analysed and controlled.

7.         Classification of Costs:

In Cost Accounting, costs are classified according to functions (manufacturing, selling, distribution and administration); according to elements of cost (Direct Materials, Direct Labour and Factory Overhead); according to variability (Fixed Cost, Variable Cost, and Semi Variable Cost). These classifications indicate controllable and uncontrollable production costs, but this information cannot be obtained from financial accounting.