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Cost and Management Accounting

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Cost & Management Accounting (MGT-402)
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LESSON# 7
MATERIAL
Material means the inventory that is used as input for production of finished output or rendering
of services or for office use and packaging.
Categories
Material
Supplies
Direct Material
Indirect Material
Office Supplies
Shipping Supplies
Categories of Material & Supplies
1. Direct Material
2. Indirect Material
3. Office Supplies
4. Shipping Supplies
Direct Material costs are those cost of material that are traceable in full in the cost of a
product or services. For example: cost of wood in production of table.
Indirect Material/Factory Supplies is the cost that is incurred in producing product but
which can not traced in full in the cost unit. For example: polishing material in production of
furniture.
Office Supplies: This is the cost of those items/goods which are used in the offices for
administration purposes. For example: stationery items.
Shipping Supplies: This is the cost of the material which is used in packaging of the finished
product.
Accrual Concept/Matching Concept
All of the cost of material and supplies purchased is not charged to the production. Only that
much cost is charged which matches the revenue earned in the period. This concept of accounting
is known as accrual concept.
Following the accrual concept will leave a stock of unused/unconsumed supplies and unsold
finished in the stores or warehouses.
Inventory
Inventory is an asset that is held:
 as material and supplies; or
 in the production process as semi finished goods; or
 as finished goods.
Inventory Maintenance Systems
1. Periodic Inventory System:
2. Perpetual Inventory System: `
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Cost & Management Accounting (MGT-402)
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Perpetual Inventory System
Under this system, a complete and continuous record of movement of each inventory item is
maintained. Perpetual records are useful in preparing monthly quarterly or other financial
statement. Record used is normally a "store ledger card" specifying quantity wise receipt, issue and
balance together with values in chronological sequence.
Advantages:
1)
It protects materials from theft or loss.
2)
It helps in reducing wastages and spoilages.
3)
Inventory levels can be fixed and observed.
4)
It serves as a moral check.
5)
It helps in highlighting slow moving and obsolete inventory.
6)
It helps in frequent physical counting.
Disadvantages:
1)
It is very complex.
2)
It is costly.
3)
Complex calculations are required.
4)
Sufficient technical knowledge is required.
Periodic inventory System or Physical system
Under this system, the value of inventory is determined at the end of the year through a physical
count of inventory in store/warehouse. It does not maintain a continuous record of movement of
each inventory item.
Advantages
1)
It is very simple.
2)
It is very cheap.
3)
No calculations required.
4)
No technical knowledge required.
Disadvantages
1)
It does not protect materials from theft or loss.
2)
No help in reducing wastages and spoilages.
3)
Inventory levels cannot be fixed and observed.
4)
It does not help in highlighting slow moving and obsolete inventory.
5)
No help in frequent physical counting.
Inventory costing methods
1. First In First Out (FIFO)
2. Last In First Out (LIFO)
3. Weighted Average (W.Avg)
First in First out (FIFO):
This method assumes that the goods firstly received in the stores or produced firstly are the
first ones to be delivered to the requisitioning department.
For example a bakery produces 200 loaves of bread on 1st of January at a cost of Re.1 each, and
200 more on 2nd. at Rs. 1.25 each. FIFO states that if the bakery sold 100 loaves on 3rd.,
the cost of consumption is Re.1 per loaf (recorded on the income statement) because that was
the cost of each of the first loaves in inventory. The 100 at Re. 1 and 200at Rs.1.25 loaves
would be allocated to ending inventory (appears on the balance sheet).
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Cost & Management Accounting (MGT-402)
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Features
 FIFO gives us a better indication of the value of ending inventory (on the balance
sheet)
 It also increases net income because inventory that might be several years old is used to
value the cost of goods sold.
 Increasing net income sounds good, but do remember that it also has the potential to
increase the amount of taxes that a company must pay.
Advantages:
1)
It is the method that most people feel logically as correct since it assumes that the stock
issues are made in the order in which they are received.
2)
Issue prices are based on the prices actually paid for the stock.
3)
It is an acceptable method for the purposes of financial reporting.
Disadvantages:
1)
FIFO complicates stock records as issues have to be analyzed by delivery.
2)
Issues from stock are not recorded at the most recent prices paid. This could influence
costing of work done and may ultimately affect the revenue.
Last In First Out (LIFO):
This method assumes that the goods received most recently in the stores or produced recently
are the first ones to be delivered to the requisitioning department.
The older  inventory,  therefore, is  left  over  at  the  end  of  the  accounting
period.
For the 200 loaves sold on 3rd. January, the same bakery would assign Rs. 1.25 per loaf to cost
of consumption while the remaining 200 at Re.1 and 100 at Rs.1.25 loaves would be used to
calculate the value of inventory at the end of the period.
Features
 LIFO is not a good indicator of ending inventory value because the left over inventory
might be extremely old and, perhaps, obsolete.
 LIFO results in a valuation that is much lower than today's prices. LIFO results in
lower net income because cost of goods sold is higher.
Weighted Average Method (W.Avg):
This method recalculates the average cost of inventory held each time a new delivery is
received. Issues are then recorded at this weighted average price.
It takes the weighted average of all units available for sale during the accounting period. The
formula to calculate the weighted average rate is:
Total Cost = weighted average rate per unit
Total Units
Weighted Average cost is used to determine the value of cost of consumption and ending
inventory.
In our bakery example, the weighted average cost for inventory would be Rs. 1.125 per unit,
calculated as [(200 x Rs. 1) + (200 x Rs. 1.25)]
400
Features
 Weighted Average cost produces results that fall somewhere between FIFO and LIFO.
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Cost & Management Accounting (MGT-402)
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PRACTICE QUESTION
Q. 1
Periodic System
Date
Units
Total
1 Jan
100
@ 10
Rs. 1,000
5 Jan
100
@ 11
1,100
10 Jan
150
@ 12
1,600
During the period 300 unit were sold
Required: Calculate cost of inventory under each of the costing methods.
Solution
Cost of inventory:
As per FIFO
50 @ 12
= 600
As per LIFO
50 @ 10
= 500
As per W.Avg 50 @ 10.5714 = 529
Q. 2
Perpetual System
100 units of material "M" costing Rs. 8.00 per unit were in stores on January 1, 2006. Following
are the receipts and issues during January.
Jan.
1
Received
100 units @ 8.50
Jan.
5
Issued
100 units
Jan.
8
Received
200 units @ Rs. 8.85
Jan.
15
Received
100 units @ Rs. 9.25
Jan
25.
Issued
220 units
Jan.
31
Issued
80 units
Required:
Prepare Materials Ledger card based on the above information using each of the
following methods:
IFO Method
F
LIFO Method
Weighted Average cost Method
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Cost & Management Accounting (MGT-402)
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Solution
Materials Ledger Card
FIFO
Material ­M
Received
Issued
Balance
Date
Units
Units Amount Unit
Unit Amount Units
Unit Amount
Cost
Cost
Cost
19xx
Rs.
Rs.
Rs.  Rs.
Rs.  Rs.
Jan 1
100
8.00  800
Jan 1
100
8.50
850
100
8.00
800
100
8.50
850
Jan 5
100
8.00
800
100
8.50
850
Jan.8
200
8.85
1,770
100
8.50
850
200
8.85
1,770
Jan15
100
9.25
925
100
8.50
850
200
8.85
1,770
100
9.25
925
Jan25
100
8.50
850
80
8.85
708
120
8.85
1062
100
9.25
925
Jan31
80
8.85
708
100
9.25
925
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Cost & Management Accounting (MGT-402)
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Materials Ledger Card
FIFO
Material ­M
Received
Issued
Balance
Date
Units
Units Amount Unit
Unit Amount Units
Unit Amount
Cost
Cost
Cost
19xx
Rs.
Rs.
Rs.  Rs.
Rs.  Rs.
Jan 1
100
8.00  800
Jan 1
100
8.50
850
100
8.00
800
100
8.50
850
Jan 5
100
8.50
850
100
8.00
800
Jan.8
200
8.85
1,770
100
8.00
800
200
8.85
1,770
Jan15
100
9.25
925
100
8.00
800
200
8.85
1,770
100
9.25
925
Jan25
100
9.25
925
100
8.00
800
120
8.85
1062
80
8.85
708
Jan31
80
8.85
708
100
8.00
800
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Cost & Management Accounting (MGT-402)
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Materials Ledger Card
Weighted Average
Material ­M
Received
Issued
Balance
Date
Units
Units Amount Unit
Unit Amount Units
Unit Amount
Cost
Cost
Cost
19xx
Rs.
Rs.
Rs.  Rs.
Rs.  Rs.
Jan 1
100
8.00  800
Jan 1
100
8.50
850
200
8.00
1,650
Jan 5
100
8.25
825
100
8.25
825
Jan.8
200
8.85
1,770
300
8.65
2595
Jan15
100
9.25
925
400
8.80
3520
Jan25
220
8.80
1,936
180
8.80
1584
Jan31
80
8.80
704
100
8.80
880
A comparison, based on above illustration, of cost of materials issued and cost of ending inventory
obtained under the three methods is presented below:
FIFO
Average Cost
LIFO
Cost of materials issued
Rs. 3,420
Rs. 3,465
Rs. 3,545
Ending inventory
925
880
800
It is clear that FIFO gives the lowest cost of materials issued and the highest cost of ending
inventory, consequently the highest gross profit. On the other hand LIFO gives the highest cost of
issues and lowest cost ending inventory, consequently the lowest gross profit. Whereas, the cost
and as a result the gross profit, calculated under average cost method are in between FIFO and
LIFO. The illustration demonstrates a period of rising prices. In a period of falling prices,
naturally, the results would have been reverse.
ASSIGNMENT QUESTIONS
Q. 1
Jamshed & company is a manufacturing concern. Following is the receipts & issues record for the
month of January, 2006
Receipts
Issues
Date
Jan 1
Opening Balance 50 @ 40
Jan 8
200 units @ Rs. 50/unit
Jan 11
60 units
Jan 13
150 units @ Rs. 60/unit
Jan 18
100 units @ Rs. 75/unit
Jan 20
150 units
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Cost & Management Accounting (MGT-402)
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Prepare Inventory sheets under:
FIFO Method
LIFO Method
Weighted Average cost Method
Q. 2
Assuming nil opening stocks prepare store ledger cards and calculate the value of the closing
stock from the data provided below using each of the following methods:
 FIFO
 LIFO
 W.Avg
Receipts
Date
Units
Rate
October 1
100
12.50
October 8
85
15.00
October 16
95
11.95
October 20
115
13.00
Issues
October
55
October
65
October
50
October
25
October
115
Q. 3
Following transaction appeared in the books of accounts of a trading concern.
PURCHASE
Month
Quantity (Units)
Cost per unit (Rs)
Jan
100
41
Feb
200
50
April
400
51.87
SALES
Month
Quantity (Units)
Cost per unit (Rs)
March
250
64
May
350
70
June
100
There was an opening balance of 100 units for Rs 3,900.
From the information given above, for the six month ended June 30, show the store ledger
records including the closing stock balance and stock evaluation by using weighted average and
FIFO methods of costing under periodic and perpetual system of accounting.
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Cost & Management Accounting (MGT-402)
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Q. 4
Receipts
1-12-1993 80kg @ Rs. 5 per kg
10-12-1993 80 kg @ Rs. 6 per kg
Issued
2-12-1993 60 kg
11-12-1993 60 kg
What is the value of 40 units of closing stock under each of the methods? Using the
periodic and perpetual accounting system.
FIFO
Rs.__________
LIFO
Rs.__________
Weighted average price
Rs.__________
MULTIPLE CHOICE QUESTIONS
1) In most of the industries, the most important element of cost is
a) Material
b) Labor
c) Overheads
d) Prime cost
2) According to which of the following method of pricing, issue; are close to current economic
values?
a) Last in first out price
b) First in first out price
c) Highest in first out price
d) Weighted average price
3) In which of the following of pricing, costs lag behind the current economic values?
a) Last in first out price
b) First in first out price
c) Replacement price
d) Weighted average price
4) Which of the following items of cost should not be treated as direct material?
a) Electricity representing 90% of the total cost
b) Stand paper used in production
c) Thread used in stitching garments
d) All of the above
5) When prices fluctuate widely, the method that will smooth out the effect of fluctuation is
a) Simple average
b) Weighted average
c) FIFO
d) LIFO
Data for MCQ No. 6 to 9
Given-opening stock on 1-1-1994
-200 kg @ Rs. 4 per kg.
Purchase on 4-1-1994
- 300 kg @ Rs. 5 per kg
Issued on  8-1-1994
- 350 kg
Market price on8-1-1994 = Rs. 5 per kg
On the basis of above information, select the correct answer in each of the following:
6) At what amount materials issued on 8-1-1994 will be charged if FIFO method is used?
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Cost & Management Accounting (MGT-402)
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a)
1,100
b)
1,550
c)
1,700
d)
1,750
7) At what amount materials issued will be charged if LIFO method is used?
a) 1,550
b) 1,575
c) 1,700
d) 1,750
8) At what amount materials, issued will be charged if simple average price is used?
a) 1,550
b) 1,575
c) 1,610
d) 1,700
9) What amount materials issued will be charged if weighted average price is used?
a) 1,575
b) 1,610
c) 1,625
d) None of these
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Table of Contents:
  1. COST CLASSIFICATION AND COST BEHAVIOR INTRODUCTION:COST CLASSIFICATION,
  2. IMPORTANT TERMINOLOGIES:Cost Center, Profit Centre, Differential Cost or Incremental cost
  3. FINANCIAL STATEMENTS:Inventory, Direct Material Consumed, Total Factory Cost
  4. FINANCIAL STATEMENTS:Adjustment in the Entire Production, Adjustment in the Income Statement
  5. PROBLEMS IN PREPARATION OF FINANCIAL STATEMENTS:Gross Profit Margin Rate, Net Profit Ratio
  6. MORE ABOUT PREPARATION OF FINANCIAL STATEMENTS:Conversion Cost
  7. MATERIAL:Inventory, Perpetual Inventory System, Weighted Average Method (W.Avg)
  8. CONTROL OVER MATERIAL:Order Level, Maximum Stock Level, Danger Level
  9. ECONOMIC ORDERING QUANTITY:EOQ Graph, PROBLEMS
  10. ACCOUNTING FOR LOSSES:Spoiled output, Accounting treatment, Inventory Turnover Ratio
  11. LABOR:Direct Labor Cost, Mechanical Methods, MAKING PAYMENTS TO EMPLOYEES
  12. PAYROLL AND INCENTIVES:Systems of Wages, Premium Plans
  13. PIECE RATE BASE PREMIUM PLANS:Suitability of Piece Rate System, GROUP BONUS SYSTEMS
  14. LABOR TURNOVER AND LABOR EFFICIENCY RATIOS & FACTORY OVERHEAD COST
  15. ALLOCATION AND APPORTIONMENT OF FOH COST
  16. FACTORY OVERHEAD COST:Marketing, Research and development
  17. FACTORY OVERHEAD COST:Spending Variance, Capacity/Volume Variance
  18. JOB ORDER COSTING SYSTEM:Direct Materials, Direct Labor, Factory Overhead
  19. PROCESS COSTING SYSTEM:Data Collection, Cost of Completed Output
  20. PROCESS COSTING SYSTEM:Cost of Production Report, Quantity Schedule
  21. PROCESS COSTING SYSTEM:Normal Loss at the End of Process
  22. PROCESS COSTING SYSTEM:PRACTICE QUESTION
  23. PROCESS COSTING SYSTEM:Partially-processed units, Equivalent units
  24. PROCESS COSTING SYSTEM:Weighted average method, Cost of Production Report
  25. COSTING/VALUATION OF JOINT AND BY PRODUCTS:Accounting for joint products
  26. COSTING/VALUATION OF JOINT AND BY PRODUCTS:Problems of common costs
  27. MARGINAL AND ABSORPTION COSTING:Contribution Margin, Marginal cost per unit
  28. MARGINAL AND ABSORPTION COSTING:Contribution and profit
  29. COST VOLUME PROFIT ANALYSIS:Contribution Margin Approach & CVP Analysis
  30. COST VOLUME PROFIT ANALYSIS:Target Contribution Margin
  31. BREAK EVEN ANALYSIS MARGIN OF SAFETY:Margin of Safety (MOS), Using Budget profit
  32. BREAKEVEN ANALYSIS CHARTS AND GRAPHS:Usefulness of charts
  33. WHAT IS A BUDGET?:Budgetary control, Making a Forecast, Preparing budgets
  34. Production & Sales Budget:Rolling budget, Sales budget
  35. Production & Sales Budget:Illustration 1, Production budget
  36. FLEXIBLE BUDGET:Capacity and volume, Theoretical Capacity
  37. FLEXIBLE BUDGET:ANALYSIS OF COST BEHAVIOR, Fixed Expenses
  38. TYPES OF BUDGET:Format of Cash Budget,
  39. Complex Cash Budget & Flexible Budget:Comparing actual with original budget
  40. FLEXIBLE & ZERO BASE BUDGETING:Efficiency Ratio, Performance budgeting
  41. DECISION MAKING IN MANAGEMENT ACCOUNTING:Spare capacity costs, Sunk cost
  42. DECISION MAKING:Size of fund, Income statement
  43. DECISION MAKING:Avoidable Costs, Non-Relevant Variable Costs, Absorbed Overhead
  44. DECISION MAKING CHOICE OF PRODUCT (PRODUCT MIX) DECISIONS
  45. DECISION MAKING CHOICE OF PRODUCT (PRODUCT MIX) DECISIONS:MAKE OR BUY DECISIONS