CAF-03

COST &
MANAGEMENT
ACCOUNTING

Vol-I

Practice Manual Examination

Questions & Answers

Book Contains Translations of

QURANIC AYATS & AHADITHS,
Therefore Handle Carefully.
 Table of Contents
Chapter Topic Page No.

1 Cost of Goods Manufacturing (COGM) 1

2 Introduction to Cost Accounting 5

3 Joint By Product 8

4 Process Costing 24

5 Process Costing Tests 55

6 Test of Process Costing Rafique 62

7 Hercules Mix Question 65

8 Variances Part 1 68

9 Test Zahidi 125

10 Marginal and Absorption Costing 127

11 Tests and Extra Practice Questions 142

Manufacturing Business:
In such a business a factory in addition to head office (in which there are admin and selling departments) is
needed to manufacture the goods. In such type of business an extra statement called as cost of goods
manufactured statement is also prepared in addition to an Income Statement.
Before the format of cost of goods manufactured; we have to understand the followings:
There are three types of stocks in a manufacturing business:
Raw Material also called as direct material (which is an integral part of finished goods)
Finished goods (the products which are manufactured for being sold)
Work-in-process (semi-finished goods).
Direct labor
Salary of those employees directly involved in converting the raw material into finished goods
Factory Overheads:
All expenses within factory except direct material and direct labor.
Indirect Material:
Any material other than raw material e.g cleaning material or oil and lubricants of machinery.
Indirect Labour:
Salary of employees within factory but outside the production department e.g security guards.
Cost of Goods Manufactured Statement:
Raw Material (Direct Material)
Opening Stock of Raw Material 10,000
Add: Purchases of Raw Material 500,000
Add: Carriage Inwards 3,000
Add: Import duties (Non-refundable) 2,000
Less: closing Stock of Raw Material (25,000)
Raw Material Consumed 490,000
Direct Labour (Wages) 200,000
Factory Overheads:
Rent --
Utilities --
Depreciation --
Indirect Material --
Indirect Labour -- 300,000
Total Manufacturing Cost 990,000
Opening WIP 25,000
Closing WIP (33,000)
Cost of Goods Manufactured 982,000
After the preparation of cost of goods manufactured statement; an income statement is prepared just like in
a trading business; except the following differences:
Income statement
Sales (of finished goods) --
Cost of Sales (1) (--)
Gross profit --
Other Income --
Selling Expenses (--)
Administrative Expenses (--)
Financial Charges (--)
Net Profit --

----------( 1 )----------
Notes:
(1) Cost of Sales:
Opening Stock --
Add: Cost of Goods Manufactured 982,000
Less: Closing Stock (--)
--

Q. 1 The following information relates to the factory of Hydel and Company limited for the month of March
2015.

Rupees
Inventories on March 1, 2015
Raw material 24,080
Work in process 47,130
Finished goods 34,842
Raw material purchases 148,580
Repair and maintainance 5,924
Gas, light and power 14,565
Indirect material consumed 3,480
Indirect labour 25,024
Direct labour 74,500
Factory supervisor salary 14,290
Inventories on March 31, 2015
Raw material 37,144
Work in process 49,460
Finished goods 32,956
Required:
The following computation for March 2015:
• Cost of raw material consumed
• Cost of goods manufactured
• Total cost of goods sold
Q.2 NKL Enterprises produces a single product. On July 31, 2008, the finished goods stock consisted of
4,000 units valued at Rs. 220 per unit and the stock of raw materials was worth Rs. 540,000. For the month
of August 2008, the books of account show the following:
Rupees
Raw material purchases 845,000
Direct labour 735,000
Selling costs 248,000
Depreciation on plant and machinery 80,000
Distribution costs 89,560
Factory manager’s salary 47,600
Indirect labour 148,000
Indirect material consumed 45,000
Other production overheads 84,000
Other accounting costs 60,540
Other administration overheads 188,600
Other information are as under:
(i) 8,000 units of finished goods were produced during August 2008.
(ii) The value of raw materials on August 31, 2008 amounted to Rs. 600,000.
(iii) There was no work-in-progress at the start of the month. However, on August31, the value of work-
in-progress is approximately Rs. 250,000.
(iv) 5,000 units of finished goods were available in stock as on August 31, 2008.
Required:
Compute the value of closing stock of finished goods as on August 31, 2008 based on
(a) Weighted average cost method.
(b) FIFO
Note: if question is silent then accounting cost is assumed to be an administrative expense.

----------( 2 )----------
Extra practice questions
Q.1 Tuesday Manufacturers Limited produces a single product. The following costs were incurred in the
month of June 2019:

Rs. in '000
Direct labour 2,075
Depreciation on plant and machinery 380
Distribution costs 589
Factory manager’s salary 247
Indirect labour 848
Indirect material consumed 345
Raw material purchases 3,845
Selling costs 1,248
Other production overheads 580
Other administration overheads 388

Following other information is available:

(i) On 1 June 2019, stock of finished goods consisted of 1,350 units valued at Rs. 1,640 per unit
while stock of raw materials was valued at Rs. 1,490,000.
(ii) 5,200 units of finished goods were produced during June 2019.
(iii) There was no work-in-progress at the end of the month whereas work in progress at 1 June
2019 was valued at Rs. 208,000.
(iv) Stock of raw materials on 30 June 2019 was valued at Rs. 970,000.
(v) 1,500 units of finished goods were available in stock as on 30 June 2019.
(vi) Cost of finished goods is determined using FIFO method.

Required:
Compute cost of goods sold for the month of June 2019. (07)

----------( 3 )----------
Answer. 1

Tuesday Manufacturer
Cost of Goods Sold Statement
for the month of June 2019
Rs in (000)

Opening Stock (1,350×1,640) 2,214

Cost of goods manufactured (W-1) 9,048
Closing Stock (W-2) (2,610)
Cost of goods sold 8,652

(W-1)

Rs in (000)
Opening Raw material 1,490
Raw material purchased 3,845
Closing raw material (970)
Raw material consumed 4,365
Direct labour 2,075
Prime cost 6,440
Factory Overheads;
Depreciation on plant and machinery 380
Factory manager’s salary 247
Indirect labour 848
Indirect material consumed 345
Other production overheads 580 2,400
Manufacturing cost 8,840
Opening stock of work in progress 208
Closing stock of work in progress -
Cost of goods Manufactured 9,048

𝑇𝑜𝑡𝑎𝑙 𝑀𝑎𝑛𝑢𝑓𝑎𝑐𝑡𝑢𝑟𝑖𝑛𝑔 𝑐𝑜𝑠𝑡

(W-2) Per unit cost of Goods Manufactured =
𝑇𝑜𝑡𝑎𝑙 𝑈𝑛𝑖𝑡𝑠 𝑚𝑎𝑛𝑢𝑓𝑎𝑐𝑡𝑢𝑟𝑒𝑑

9,048,000
=
5,200

= 1,740 per unit

Closing stock value: (1,500×1,740) =2,610,000

----------( 4 )----------
Cost classification by behavior:
Fixed costs
Fixed costs are items of cost that remain the same in total during a time period, no matter how many units
are produced.

Examples of fixed costs include:

❑ The rental cost of a building is Rs.40,000 per month. The rental cost is fixed for a given period:
Rs.40,000 per month, or Rs.480,000 per year.
❑ The salary costs of a worker who is paid Rs.11,000 per month. The fixed cost is Rs.11,000 per month or
Rs.132,000 per year.
Note that as activity levels increase the cost remains fixed. However, the cost per unit fall because the cost
is being spread over a great number of units

Variable costs
Variable costs are costs that increase by the same amount, for each additional unit of product that is made.
The variable cost of a cost unit is also called the marginal cost of the unit. The variable cost per unit is often
the same amount for each additional unit of output or unit of activity. This means that total variable costs
increase in direct proportion to the total volume of output or activity.
Examples of variable cost items.
❑ The cost of buying raw material is Rs.500 per litre regardless of purchase quantity. The variable cost is:
• the total cost of buying 1,000 litres is Rs.500,000
• the total cost of buying 2,000 litres would be Rs.1,000,000.
❑ The rate of pay for hourly-paid workers is Rs.150 per hour.
• 400 hours of labour would cost Rs.60,000; and
• 500 hours would cost Rs.75,000.
❑ The time needed to produce an item of product is 4 minutes and labour is paid Rs.150 per hour.
• direct labour is a variable cost and the direct labour cost per unit produced is Rs.10 (= Rs.150 ×
4/60).
❑ The cost of telephone calls is Rs.1 per minute.
• The cost of telephone calls lasting 6,000 minutes in total would be Rs.6,000.
Note that as activity levels increase the cost per unit remains fixed. However, total cost increases as more
units are being made

Semi-variable costs
A semi-variable cost, is a cost that is partly fixed and partly variable.

An item of cost that is a mixed cost is an item with a fixed minimum cost per period plus a variable cost for
every unit of activity or output.

Example:
A company uses a photocopier machine under a rental agreement. The photocopier rental cost is Rs.4,000
per month plus Rs.2 per copy produced. The company makes 15,000 copies during a month:
Total cost is as follows:
Rs.
Fixed cost 4,000
Variable cost (15,000 *Rs. 2) 30,000
Total cost for month 34,000

Example:
The management accountant of a manufacturing company has estimated that production costs in a factory
that manufactures Product Y are fixed costs of Rs.250,000 per month plus variable costs of Rs.30 per unit of
Product Y output. The expected output next month is 120,000 units of Product Y.
Expected total costs are therefore:
Rs.
Variable costs (120,000 × Rs.30) 3,600,000
Fixed costs 250,000
Total costs 3,850,000

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Summary of the discussion
A. Fixed cost

In total Constant
Per unit Decrease with increase in production
Increase with decrease in production.
B. Variable cost
In total Increase with increase in production
Decrease with decrease in production
Per unit Constant
C. Total cost

In total Increase with increase in production

Decrease with decrease in production
Per unit Decrease with increase in production
Increase with decrease in production.
Cost estimation: analysing fixed and variable costs
The total costs associated with a business are the sum of the fixed costs and the variable costs. In other
words, the total is semi variable in nature.
Formula: y = a + bx
Where:
y = total costs in a period
x = the number of units of output or the volume of activity in the period
a = the fixed costs in the period
b = the variable cost per unit of output or unit of activity.

The total cost function can be used to estimate costs associated with different levels of activities. This is very
useful in forecasting and decision making.
There are two methods of constructing the total cost function equation and segerating fixed cost and
variable cost:
❑ High/low analysis
❑ Linear regression analysis.(not in syllabus)

For example lets assume a business has a following data in previous periods:
Months Units Total cost(Rs.)
January 100 300
February 200 400
March 300 500
April 400 600
Required:
Calculate
• Per unit variable cost; and
• Fixed cost per month.

High/low analysis
High/low analysis can be used to estimate fixed costs and variable costs per unit as follows:
• Take the highest and the lowest activity levels.
• Take the difference of both levels.(the difference between total cost at highest level of activity and
the lowest level of activity is entirely variable because difference in cost is increased because of
increase in production.)
• Calculate the per unit variable cost as follows:
Difference in cost /difference in activity level
• Multiply the per unit variable cost with any selected activity level (either high or low) to get total
variable cost.
• Total cost - total variable cost = Total fixed cost
• Construct the total cost function i.e. y = a+bx

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Example: High/low method
A company has recorded the following costs in the past six months:

Month Production (units) Total cost (Rs.)

January 5,800 40,300
February 7,700 47,100
March 8,200 48,700
April 6,100 40,600
May 6,500 44,500
June 7,500 47,100

Required:
a) Construct a total cost function by using high/low method.
b) Estimate the total cost of producing 7,000 units.

Step 1: Identify the highest and lowest activity levels and note the costs associated with each level.
Production (units) Total cost (Rs.)
March 8,200 48,700
January 5,800 40,300

Step 2: Compare the different activity levels and associated costs and calculate the variable cost:
Production (units) Total cost (Rs.)
March 8,200 48,700
January 5,800 40,300
2,400 8,400

Therefore: 2,400 units cost an extra Rs. 8,400.

Therefore: The variable cost per unit = Rs. 8,400/2,400 units = Rs. 3.5 per unit

Step 3: Substitute the variable cost into one of the cost functions (either high or low).
Total cost of 8,200 units:
Fixed cost + Variable cost = Rs. 48,700
Fixed cost + 8,200 *Rs. 3.5 = Rs. 48,700
Fixed cost + Rs. 28,700 = Rs. 48,700
Fixed cost = Rs. 48,700 -Rs. 28,700 = Rs. 20,000

Step 4: Construct total cost function

Total cost = a +bx = 20,000 + 3.5x
Note that at step 3 it does not matter whether the substitution of variable cost isinto the high figures or the
low figures.

Example: Cost of other levels of activity

Returning to step 3 above but this time substituting into the low figures.

Step 3: Substitute the variable cost into one of the cost functions (either high or low).
Total cost of 5,800 units:
Fixed cost + Variable cost = Rs. 40,300
Fixed cost + 5,800 *Rs. 3.5 = Rs. 40,300
Fixed cost + Rs. 20,300 = Rs. 40,300
Fixed cost = Rs. 40,300 -Rs. 20,300 = Rs. 20,000
Once derived, the cost function can be used to estimate the cost associated with
other levels of activity.

I. The above calculated figures can be used as follows:

The company is planning to make 7,000 units and wishes to estimate the total
costs associated with that level of production.
Total cost = 20,000 + 3.5x
Total cost of 7,000 units = 20,000 + 3.5 *7,000 = Rs. 44,500

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 Joint & By Product cost
Diesel

Crude Oil Proces Petrol Further Process Hi-octane

s
Grease

In some process manufacturing system, two or more different products are produced from a common
manufacturing process.

Manufacturing Process

Joint product By-product

(Significant value products) (Insignificant value products)
By-products are outputs from a joint that are
These are two or more products generated relatively minor in quantity and/or value.
process

Simultaneously by a single manufacturing

process using common input and being
substantially equal in value . Each joint
product has a substantial sale value relative to
each other.

Joint Product Cost or Common Processing Costs

These are those costs which arise from common processing or manufacturing of products produced from
common raw materials. A joint cost is incurred prior to the point at which separately identifiable products
emerge from the same process.
In order to calculate cost of each of joint product, these common costs must be shared (apportioned)
between the joint products.

Methods of Allocation of Joint Costs to Joint Products

1. Physical quantity or units basis
2. Sale value at split off basis
3. NRV basis (sales value at split off point less selling expenses if any)
*Split off point means a point where separately identifiable products emerge from a common process.

1. Unit basis (Also known as physical QUANTITY method)

In this method total joint production cost is to be apportioned on the basis of physical units of production e.g
 Assume joint processing cost is Rs 120,000

Products Units Allocation

A 20,000 40,000
{(20,000÷60,000)×120,000}
B 25,000 50,000
C 15,000 30,000
Total 60,000 120,000

2. Sale-value ta split-off point

This method enjoys great popularity because of the argument that market value of any product reflects the
cost incurred in its production, means that if a product sells for more than another it is because more cost
was expended to produce it. To apply the method we need to have number of units produced and their
market or sale values at split off point e.g

----------( 8 )----------
 Assume that joint processing costs are Rs 10,000.
Products Units Produced Sale Price/Unit Market Value Allocation
A 1,000 2 2,000 1,000
{(2,000÷20,000)×10,000}
B 2,000 3 6,000 3,000
(6,000/20,000x10,000)
C 3,000 4 12,000 6,000
(12,000/20,000x10,000)
20,000 10,000

Some products are not saleable at the split off point and therefore without any market value; require
additional processing to place them in marketable condition. In such cases, the basis of allocation of the joint
production cost is a hypothetical market value at the split off point.
To arrive at the basis for apportionment, it is necessary to use a working back procedure whereby the after
split off processing cost is subtracted from the ultimate sales value to find a hypothetical market value at split
off point e.g:

 Assume that joint processing costs are Rs 13,200

Market value after Cost after split off Hypothetical Allocation of Joint cost
further processing (Further processing Market value at
cost) split off
A 2,000 500 1,500 1,200
{(1,500÷16,500) ×13,200}
B 6,000 1,000 5,000 4,000
{(5,000÷16,500) ×13,200}
C 12,000 2,000 10,000 8,000
{(10,000÷16,500)×13,200}
20,000 16,500 13,200

Finally total processing cost is:

A Rs.1,700 (500+1,200)
B Rs.5,000 (1,000+4,000)
C Rs.10,000 (2,000+8,000)
In the given situation, certain of joint products may be saleable at the split off point while others are not, the
market values at the split off point would be used for former group while for the latter group hypothetical
market values would values would be used.

Treatment Of By Product
Cost is not allocated to by product. Instead its sale proceeds (if any) are accounted for by using any of the
following methods.
1. As other income
Cash/Receivable ***
Other Income ***
2. As a deduction from joint process cost
Cash/Receivable ***
Joint process cost ***
The expected sale proceeds of by-product are deducted from the joint processing costs. After this deduction,
net joint processing costs are apportioned among the joint products.
Note: if the question is silent then use 2nd method as given above.

----------( 9 )----------
Q.1 M Company buys Zeon for processing. At the end of processing in Department 1, Zeon splits off into
Products A, B, and C. A is sold at the split-off point with no further processing; B and C require further
processing before they can be sold; B is processed in Department 2; and C is processed in
Department 3. The following is a summary of costs and other related data for the year ended June 30,
2015:
Department
1 2 3
Rupees
Cost of Zeon 96,000 - -
Direct labor 14,000 45,000 65,000
Factory overhead 10,000 21,000 49,000
Products
A B C
Units sold 20,000 30,000 45,000
Units on hand at June 30, 2015 10,000 - 15,000
Sales (in Rupees) 30,000 96,000 141,750
There were no inventories on hand at July 1, 2014 and there was no Zeon on hand at June 30, 2015.
All units on hand at June 30 2015, were complete as to processing. M company uses the market value
at split-off point to allocate joint cost.
Required:
(1) The market value at the split-off point for Product A’s total units produced for the year.
(2) The total joint cost for the year ended June 30, 2015, to be allocated.
(3) The cost of Product B sold for the year ended June 30, 2015.
(4) The cost assigned to the Product A ending inventory.
(5) The cost assigned to the Product C ending inventory.

----------( 10 )----------
Discussion of FIFO & weighted Average:
Example:
FIFO / Weighted Average:
Units Amount
Opening Stock -- --
Add: cost of goods manufactured 50,000 1,000,000
Less: Closing Stock (10,000) (200,000)
Cost of sales 40,000 800,000

FIFO:
Units Amount
Opening Stock 5,000 90,000
Add: cost of goods manufactured 50,000 1,000,000
Less: Closing Stock (10,000) (200,000)*
Cost of sales 45,000 890,000
*[1,000,000 / 50,000) x 10,000
Weighted Average:
Units Amount
Opening Stock 5,000 90,000
Add: cost of goods manufactured 50,000 1,000,000
Less: Closing Stock (10,000) (198,182)*
Cost of sales 45,000 891,818

*working:
90,000 + 1,000 ,000
=
5,000 + 50,000

= 19.8182 × 10,000
= 198,182
Conclusion:
Answer of FIFO and weighted Average will be different only when there is opening stock.

Q.2 Binary Limited manufactures three joint products viz. Aay, Bee and Cee in one common process.
Following this process, product Aay and Bee are sold immediately while product Cee is subjected to further
processing. Following information is available for the period ended June 30, 2007:
1.
Aay Bee Cee
Opening stock in kg Nil Nil Nil
Production in kg 335,000 295,000 134,000
Sales in kg 285,000 212,000 -
Sales price per kg (Rs.) 30.85 40.38 -
2. Total costs of production were Rs 17,915,800.
3. 128,000 kg of Cee were further processed during the period and converted into 96,000 kg of Zee.
The additional costs of further processing were as follows:
Direct labor Rs. 558,500
Production overhead Rs. 244,700
4. 94,000 kg of Zee was sold during the period, with total revenue of Rs. 3,003,300. Opening stock of
Zee was 8,000 kg, valued at Rs 172,800. FIFO method is used for pricing transfers of Zee to cost of
sales.
5. 8,000 kg of a bye-product Vee was also produced during further processing and sold @ Rs. 10 per
kg. Sales proceeds of bye-product are adjusted against production cost of product Zee.(treatment of
by-product).

----------( 11 )----------
 6. The cost of production is apportioned among Aay, Bee and Cee on the basis of weight of output
(means physical units basis).
7. Selling and administration costs of Rs. 2,500,000 were incurred during the period. These are
allocated to all the main products based on sales value.

Required:
Prepare a profit and loss account for the period, identifying separately the profitability of each of the three
main products. (19 Marks)[Autumn 2007]
Note: If nothing is mentioned in question then assume that any loss is normal loss.

Treatment of Losses
 
Normal Loss Abnormal Loss
(Expected loss that is uncontrollable) (Unexpected loss)
E.g 1000 units of raw material are imported @ 500 per unit = Rs 500,000.
Suppose it is expected that 50 units of raw material will be of no use (means normal loss).
No cost is allocated to normal loss, cost of normal loss units is absorbed by remaining units.
Therefore simply per unit cost of remaining units will be 500,000 = 526.31/unit
950
If normal loss has recovery value then; (let’s assume 50 units can be sold @ 100/unit as scrap)
500,000-5,000 = 521.05/unit
950
Abnormal Loss:
Suppose 50 units are abnormal loss instead of normal loss (means suppose loss was not expected). Cost is
allocated to abnormal loss units just like good units. Therefore:
500,000 = 500/unit
1,000

50 x 500 = 25,000 will be recognized as abnormal loss in statement of profit or loss. If it has some recovery
value then it is adjusted against cost of abnormal loss.

Normal & Abnormal loss (both):

Suppose instead of 50 units loss which was expected, actual loss is 60 units;
Then:
500,000 = 526.31/unit
950
10 x 526.31 = 5,263 is considered as an abnormal loss (recognized in income statement)
If it has some recovery value than it is adjusted against cost of abnormal loss.

Q.3 Platinum Limited (PL) manufactures two joint products Alpha and Beta and a by-product Zeta from
a single production process. Following information is available from PL’s records for the month of February
2012:
Direct material 25,000 kg. @ Rs. 25 per kg.
Direct labor @ Rs. 15 per hour Rs. 432,000
Normal process loss 20% of the material consumed

Overheads are allocated to the products at the rate of Rs. 10 per direct labour hour. The normal loss is sold
as scrap at the rate of Rs. 8 per kg.
Following data relates to the output from the process:

Product Output Selling price per kg.

ratio (Rs.)
Alpha 75% 95.0
Beta 15% 175.0
Zeta 10% 52.5

----------( 12 )----------
Alpha is further processed at a cost of Rs. 30 per unit, before being sold in the market. Joint costs are
allocated on the basis of net realizable value (sale value at split off point less selling expenses (if any)).
Required:
Compute the total joint manufacturing costs for February 2012. Also calculate the profit per kg for Alpha and
Beta. (10 marks)
Note: treatment of normal loss is like by-product (i.e deduct the sale proceeds from cost of production). No
cost is allocated to normal loss.
Diagram missing

Q.4 Colon Limited (CL) manufactures two joint products Pollen and Stigma in the ratio of 65:35. The
company has two production departments A and B. Pollen can either be sold at split off point or can further
be processed at department-B and sold as a new product Seeds. Stigma is sold without further processing.
Following information relating to the three products is available from CL’s records:
Pollen Stigma Seeds
---------------Rupees---------------
Sales price per kg 90 300 125
Total selling expenses 135,000 306,000 180,000
Following further information relating to the two departments is available:
Department A Department B
Material X 75,000 kg at Rs. 60 per -
kg
Material Y - 12,000 kg at Rs. 25 per
kg
Labor @ Rs. 150 per hour 12,000 hours 3,600 hours
Variable overheads Rs. 125 per labor hour Rs. 65 per labor hour
Fixed overheads Rs. 100 per labor hour Rs. 50 per labor hour
Material input output ratio 100:88 100:96
Material is added at the beginning of the process. Joint costs are allocated on the basis of net realizable
value at split off point (sale value at split-off point less selling expenses).
Required:
a) Calculate the joint costs and apportion them to the two products. (10 Marks)
b) Advise CL whether it should produce Seeds or sell Pollen without further processing. (6 Marks)

Note:
1) If nothing is mentioned then assume that loss is normal.
2) If no information of stocks then assume stocks are nil.

Q.5 Binary Ltd. (BL) manufactures three products, A, B and C. It is the policy of the company to
apportion the joint costs on the basis of estimated sales value at split off point. BL incurred the following joint
costs during the month of August 2008:
Rs. in ‘000
Direct material 16,000
Direct labor 3,200
Overheads (including depreciation) 2,200
Total joint costs 21,400
During the month of August 2008 the production and sales of Product A, B and C were 12,000, 16,000 and
20,000 units respectively. Their average selling prices were Rs. 1,200, Rs. 1,400 and Rs 1,850 per unit
respectively.
In August 2008, processing costs incurred on Product A after the split off point amounted to
Rs 1,900,000.
Product B and C are sold after being packed on a specialized machine. The packing material costs Rs. 40
per square foot and each unit requires the following:
Product Square feet
B 4.00
C 7.50

----------( 13 )----------
The monthly operating costs associated with the packing machine are as follows:
Rupees
Depreciation 480,000
Labor 720,000
Other costs 660,000

All the above costs are fixed and are apportioned on the basis of packing material consumption in square
feet.
Required:
Calculate the joint costs to be apportioned to each product and allocate to the products. (13 Marks)

Note: Always remember if production is equal to sales then there is no of finished stock.

Q.6 J Ltd. manufactures two products Orange and Mango by processing a raw material in Department 1.
Orange is then further processed in Department 2 with no loss. Mango is further processed in department 3.
By-product Leaf is also produced in department 3 which can be sold in the market.
It is estimated that after processing in Department 1, 55% of the raw material is converted into processed
Orange and 40% into processed Mango. No product is in a saleable condition at this stage.
The selling price of Orange is Rs 45 per kilo and Mango is Rs 64 per kilo. Leaf can be sold at Rs. 12 per kilo.
It is estimated that in department 3, 10% of all input becomes leaf and 88% becomes Mango.
During the month of January 198,000 kilos of Orange were produced.
It is company policy to subtract revenue of by products from total costs of the departments in which they are
produced. Joint costs are allocated on the basis of hypothetical market value at split-off point.

Labour Overheads
Department 1 1,060,000 795,000
Department 2 720,000 540,000
Department 3 880,000 660,000
Raw material consumed per unit started is Rs. 32 per kilo.
Required:
a) Calculate the product wise and total profit for the month of January assuming all output is sold.
b) Assume Finished Goods of Orange and Mango is left in stock prepare product wise and in total
income statement for the month of January.
Suppose Stock Left is:
• Orange = 9,800 kgs.
• Mango = 5,500 kgs.

Difference between the joint and by products:

1. Joint products are of high value and importance while by products are of relatively low value.
2. Joint products are produced simultaneously while by products are produced incidentally.
3. Joint products are crucial to commercial viability of organization whereas by products are not.

----------( 14 )----------
Further scenarios in question No. 3:
(a) Binary Limited

Assuming that 100% loss of Cee while further processing in to Zee is abnormal less identified at the
end of further processing)
It means 24,000 kg. of Cee was abnormal loss as follows:

A 96,000 Zee
B 8,000 by Product

C 134,000 24,000 Kgs (bal)

(6,000)

128,000

Income statement
Aay Bee Zee Total
Sales 8,792,250 8,560,560 3,003,300 20,356,110
Cost of sales
Opening Stock -- -- 172,800 172,800
Cost of goods 7,855,750 6,917,750 2,979,840 (W-1) 17,753,340
manufactured
Closing Stock (1,172,500) (1,946,350) (310,400) (W-2) (3,429,250)
(6,683,250) (4,971,400) (2,842,240) (14,496,890)
Gross Profit 2,109,000 3,589,160 161,060 5,857,220
Selling & Admin (1,079,805) (1,051,350) (368,845) (2,500,000)
Abnormal Loss -- -- (744,960) (744,960)
Profit/ (loss) 1,029,195 2,537,810 (952,745)* 2,612,260

*Loss is increased by 77,600 because value of closing stock of Zee is decreased by 77,600 (388,000
– 310,400)
WORKINGS:
W-1 Cost of goods manufactured of Zee
Raw Material: (Cee)
Opening --
COGM 3,142,300 (Cost of 134,000 kgs)
Closing (140,700) (Cost of 6,000 kgs)
3,001,600 (Cost of 128,000 kgs)
Direct Labor 558,500
Factory overheads 244,700
Total Manufacturing Cost 3,804,800 (Cost of 128,000 kgs)
Recovery Value of by product (80,000) (Recovery value of 8,000 kgs)
Net manufacturing cost 3,724,800 (Net cost of 120,000 kgs)
Less: Cost of Abnormal less
3,724 ,800
 24,000 = (744,960) (Cost of 24,000 kgs)
120 ,000
Net Manufacturing cost of Zee 2,979,840 (Cost of 96,000 kgs)
W-2 Calculation of Closing Stock of Zee (FIFO)
2,979,840 ÷ 96,000 × 10,000 = 310,400

----------( 15 )----------
(b) Binary Limited
Assuming that loss of Cee while further processing into Zee is normal upto 10% of input while balance
is abnormal loss which is identified after further processing.

Aay 96,000 kg (Zee Given)

8,000 kg (by product Given)
Bee
12,800 Kgs (normal loss, 10%)
Cee 134,000 11,200 Kgs (bal. abnormal loss)
(6,000)

128,000

Income statement
Aay Bee Zee Total
Sales 8,792,250 8,560,560 3,003,300 20,356,110
Cost of sales
Opening Stock -- -- 172,800 172,800
Cost of goods manufactured 7,855,750 6,917,750 3,335,642 18,109,142
Closing Stock (1,172,500) (1,946,350) (347,463) (3,466,313)
(6,683,250) (4,971,400) (3,160,979) (14,815,629)
Gross Profit 2,109,000 3,589,160 (157,679) 5,540,481
Selling & Admin (1,079,805) (1,051,350) (368,845) (2,500,000)
Abnormal Loss -- -- (389,158) (389,158)
Profit/ (loss) 1,029,195 2,537,810 (915,682) 2,651,323
Loss is increased by 40,537 because value of closing stock of Zee is decreased by 40,537 (388,000 –
347,463).
WORKINGS:
W-1 Cost of goods manufactured of Zee
Raw Material: (Cee)
Opening --
Cost of goods manufactured 3,142,300 (Cost of 134,000 kgs)
Closing (140,700) (Cost of 6,000 kgs)
3,001,600 (Cost of 128,000 kgs)
Direct Labor 558,500
Factory overheads 244,700
Total Manufacturing Cost 3,804,800 (Cost of 128,000 kgs)
Less: Recovery Value of by (80,000) (Recovery value of 8,000 kgs)
product
Net manufacturing cost 3,724,800 (Net cost of 120,000 kgs
but because of normal loss of
12,800 kg it is now cost of
107,200 kg)
Less: Cost of Abnormal less
3,724 ,800
 11,200 = (389,158) (Cost of 11,200 kgs)
107 ,200
Net Manufacturing cost of Zee 3,335,642 (Cost of 96,000 kgs)
W-2 Calculation of Closing Stock of Zee
FIFO:
3,335,642
 10,000 = 347,463
96,000

----------( 16 )----------
Solutions:
A.5
Allocation on the basis of sale value at split-off point
Product A Product B Product C Total
Units produced 12,000 16,000 20,000
Sale price/unit 1,200 1,400 1,850
Total Sale value 14,400,000 22,400,000 37,000,000
Cost after split off point (1,900,000) (3,116,262) (7,303,738)
(Given) (W-1) (W-1)
Sale value at split off point 12,500,000 19,283,000 29,696,262 61,480,000
(hypothetical market value)

Allocation of Joint cost:

A 12,500,000/61,480,000 x 21,400,000 = 4,351,008
B 19,283,000 / 61,480,000 x 21,400,000 = 6,712,040
C 29,696,262 / 61,480,000 x 21,400,000 = 10,336,695

Workings
W-1 Total Further processing cost of Product B and C
a) Packing material cost
Product B Product C Total
Units 16,000 20,000
Packing material/unit 4 sq feet 7.5 sq feet
Total packing material in 64,000 150,000 214,000
sq feet
Cost of packing material 2,560,000 6,000,000 8,560,000
(sq feet x 40)

----------( 17 )----------
Extra practice questions
Question No. 1
Oceanic Chemicals manufactures two joint products Sigma and Beta in a single process at its production
department. Incidental to the production of these products, it produces a by product known as ZEE. Sigma
and ZEE are sold upon completion of processing in production department whereas Beta goes to refining
department where it is converted into Theta.
Joint costs are allocated to Sigma and Beta on the basis of their net realizable values. Proceeds from sale of
by product are treated as reduction in joint costs. In both the departments, losses upto 5% of the input are
considered as a normal loss.
Actual data for the month of June 2015:
Department
Production Refining
Cost ------ Rs. In ‘000’------
Material input at Rs. 50 per liter 3,000 -
Direct labour at Rs. 100 per hour 2,500 350
Production overheads 1,850 890
Output ---------- Liters -----------
Sigma 34,800 -
Beta 16,055 -
ZEE (by product) 5,845 -
Theta - 15,200
Sigma, Theta and by product ZEE were sold at Rs. 300, Rs. 500 and Rs. 40 per liter respectively. There was
no work in process at the beginning and the end of the month.
Required:
Compute the cost per liter of Sigma and Theta, for the month of June 2015.

----------( 18 )----------
Test joint and by product
Q.1 Cricket Chemicals Limited (CCL) is a manufacturing concern and has two production processes.
Process I produces two joint products i.e. X-1 and X-2. Incidental to the production of joint products, it
produces a by-product known as Zee. X-1 is further processed in process II and converted into ‘X1-
Plus’.

Following information has been extracted from the budget for the year ending 31 August 2019:

(a) Process wise budgeted cost:

Process I Process II
-------------- Rupees ------------
Direct material (500,000 liters) 98,750,000 -
Conversion cost 72,610,000 19,100,000

(ii) Expected output ratio from process I and selling prices:

Products Output ratio in process I Selling price (Rs. per liter)

Joint product – X-1 55 % -
Joint product – X-2 40 % 532
By-product – Zee 5% 120
X1-Plus - 768

Additional information:

(i) Material is added at the beginning of the process and CCL uses 'weighted average method' for
inventory valuation.
(ii) Joint costs are allocated on the basis of net realizable value of the joint products at the split-off point.
Proceeds from the sale of by-product are treated as reduction in joint costs.
(iii) Joint product X-2 is sold after incurring packing cost of Rs. 75 per liter.
(iv) Normal production loss in process I is estimated at 5% of the input which occurs at beginning of the
process. Loss of each liter results in a solid waste of 0.7 kg which is sold for Rs. 10 per kg. No loss
occurs during process II.
(v) Budgeted conversion cost of process I and process II include fixed factory overheads amounting to
Rs. 7,261,000 and Rs. 3,820,000 respectively.

Required:
Prepare product wise income statement for the year ending 31 August 2019. (14)

----------( 19 )----------
 Ans 1:
Cricket Chemicals Limited
Product wise budgeted income statement:
For the year ended 31-08-2009

-------------------Rupees in thousand-------------------
X1 Plus X2 Total
Sales 200,640 101,080 301,720
COS:
Cost of Goods Manufactured (132,970) (68,715) (201,685)
(113,870+19,100) (54,465+14,250)

Gross profit 67,670 32,365 100,035

Workings: Rs.000

19,100

X1 [261,250] (55%) ll X1 Plus [261,250]

(55%)
X2 [190,000] (40%) Packing Cost @ 75/l
500,000 I
Zee [23,750] (5%) (23,750 x 120) = 2,850
N. Loss [25,000 L] (25,000 x0.7 x10) = 175

D.M 98,750
Conversion 72,610
Zee (2,850)
N. Loss (175)
168,335 Joint cost

Allocation:

Rs. ‘000’
Sale Further Allocation
Units Sale Value NRV
price/units processing
X1 plus 261,250 768 200,640 19,100 181,540 113,871
X2 190,000 532 101,080 14,250 86,830 54,464
(190,000x75)
268,370 168,335

----------( 20 )----------
Question 2:

Scents Limited produces three joint products P, Q and R. Raw material is added at the beginning of process
I. On completion of process I, these three products are split in the ratio of 50:30:20 respectively. Joint costs
incurred in process I are apportioned on the basis of net realizable value of the three products at split-off
point. Products P and Q are sold in the same state whereas product R is further processed in process II
before being sold in the market. A by-product TS is also produced in process II.

Following information relating to the two processes is available for the month of February 2020:

Process I Process II
Raw material at Rs. 411 per kg 744,000 kg -
Direct labour at Rs. 200 per hour 611,568 hours 55,450 hours
Production overheads Rs. 91,456,000 Rs. 7,230,000
Additional information:
(i) Loss of 7% is considered normal in process I.
(ii) Details of opening and closing stocks, estimated cost to sell and selling price are given as
under:
Selling price Cost to sell Opening Closing
per kg (Rs.) per kg (Rs.) stock (kg) stock (kg)
Product P 1,045 15 - 20,200
Product Q 960 10 - 15,140
Product R 1,021 12 7,800 48,134

(iii) Values of opening and closing stocks of product R comprised of cost of both processes. Value of
opening stock of product R is Rs. 5,850,000.
(iv) In process II, 7450 kg of TS was produced and sold at Rs. 175 per kg. Proceeds from sale of TS are
adjusted against cost of process II.
(v) Selling and administration costs are charged to P, Q and R at 12% of sales.

FIFO method is used for inventory valuation.

Required:
Prepare product-wise income statement for the month of February 2020. (15)

----------( 21 )----------
A.2

Scent Limited

Product-wise Income Statement

For the month of Feb. 2020

Rs. ‘000’
P Q R
Sales (W-1) 340,419 184,739 92,503
(325,760 x 1,045) (192,436 x 960) (90,600 x 1,021)
Cost of Sales:
Opening Stock - - 5,850
+ COGM(W1 & W3) 276,889 153,230 106,450
(89,434 + 17,016)
- Closing Stock (W-4) (16,167) (11,176) (39,133)
(260,722) (142,054) (73,167)
Gross Profit 79,697 42,685 19,336
Selling & Admin exp (40,850) (22,169) (11,100)
(12% of revenue)
Net Profit 38,847 20,516 8,236

W-1 Rs. 000

P (50%) 345,960 kgs

744,000Kgs
P-I Q (30%) 207,576 kgs P - II
R (20%) 138,384 kgs TS 7,450 R130,934
kgs
Normal loss 52,080 kgs
(By-product)
7,450 kgs

D.M(744,000 x 411) 305,784 D.L 11,090

D.L (611,568 x 200) 122,314 P-OH 7,230
P-OH 91,456 18,320
Less: by product (1,304)
(7,450 x 175)
519,554 17,016

W-2 Calculation of Units Sold:

P
b/d - Sales 325,760
Production 345,960
c/d 20,200

Q
b/d -- Sales 192,436
Production 207,576
c/d 15,140

----------( 22 )----------
 “Salah is the key to all happiness and success.”

R
b/d 7,800 Sales 90,600
Production 130,934
c/d 48,134

W-3 Allocation of Joint Cost:

Units Sale Sale Further Selling exp NRV Allocation

Produced price/Unit value process
P 345,960 1,045 361,528 - 5,189 356,339 276,889 (356,339/668,633
(345,960 x 15) x 519,554
Q 207,576 960 199,273 - 2,076 197,197 153,230 (197,197/668,633
(207,576 x 10) x 519,554)
R 130,934 1,021 133,684 17,016 1,571 115,097 89,434 (115,097/668,633
(130,934 x 12) x 519,554)
668,633 519,554

W-4 Stock Valuation:

P (276,889/345,960 x 20,200) = 16,167

Q (153,230/207,576 x 15,140) = 11,176

R (106,450/130,934 x 48,134) = 39,133

----------( 23 )----------
Process Costing
In this topic will be learn to prepare a work in process account.
Discussion of factory ledgers
Normal loss:
Loss which is uncontrollable in production process considering the nature of the product and production
process /environment. Cost is not allocated to normal loss. If it has some recovery value then it is deducted
from production cost (as a recovery against cost of production).
Abnormal Loss:
Loss which is controllable, but has not been controlled. This is that loss which is over and above the
expected loss (Normal loss). Cost is allocated to abnormal loss just like other units and recognized as an
expense in income statement (after deducting recovery value if any).
Abnormal gain:
Reduction in the units of normal loss. Units of abnormal gain are measured like other units.

Scenario No.1
Normal loss has no recovery value.
Process A/C
Particulars Units Rs. Particulars Units Rs.
Input Units 1,000 100,000 Output 900 100,000
Normal loss (10% of input) 100 -

1,000 100,000 1,000 100,000

100,000÷900 = 111.111/unit
Scenario No.2
Normal loss has some recovery value
Process A/C
Particulars Units Rs. Particulars Units Rs.
Input Units 1,000 100,000 Output 900 99,000
Normal loss(10% of input) 100 (×10) 1,000

1,000 100,000 1,000 100,000

(100,000 –1,000)÷900 = 110/unit

Scenario No.3
Normal loss has a recovery value and abnormal loss.
Process A/C
Particulars Units Rs. Particulars Units Rs.
Input Units 1,000 100,000 Output 800 88,000
Normal loss (10% of input) 100 (×10) 1,000
Abnormal loss (bal.) 100 11,000

1,000 100,000 1,000 100,000

[(100,000 – 1,000) ÷ (800+100)] = 110/unit
800 × 110 = 88,000
100 × 110 = 11,000

Scenario No.4
Abnormal gain.
Process A/C
Particulars Units Rs. Particulars Units Rs.
Input Units 1,000 100,000 Output 920 101,200
Normal loss (10 % of input) 100 (×10) 1,000
Abnormal gain (bal) 20 2,200

1,020 102,200 1,020 102,200

[(100,000 – 1,000) ÷ (920-20)] = 110/unit
110× 920 = 101,200
110 × 20 = 2,200
----------( 24 )----------
Q.1
Castrol is an industrial lubricant which is formed by subjecting crude chemicals to two successive processes.
The output of process-1 is transferred to process-2 where other chemicals are added. The process-1 and 2
were as follows;
Process-1
Material 3,000 lbs @0.25/lb
Labor Rs.120
Process plant time 12 hours @ 20/hour
Process-2
Material 2,000 lbs @0.4/lb
Labor Rs.84
Process plant time 20 hours @ 13.5/hour

Other production overheads for the period amounted to Rs.357 and is to be allocated to the processes on
the basis of labor cost. The normal output of processs-1 is 80% of input and of process-2 is 90% of input.
Wastage from process-1 is sold for Rs.0.2/lb and that from process-2 for Rs.0.3/lb.
The output from processes were as follows;
Process-1 2,300 lbs
Process-2 4,000 lbs
There is no stock of work in process at either the beginning or the end of the period and assume that all
available waste had been sold at prices indicated above.
Required:
You are required to show that how the above data would be recorded in a system of cost accounts by
preparing Process Account No. 1 & 2, Normal loss account and Abnormal gain/loss account.
Cost Accounting Procedures for factory overhead
The quantity and cost of materials and labour used on a given order can generally be measured in a straight
forward and reasonably exact manner. The cost element, factory overhead, presents a more detailed
problem.
If a company contracts to make 50 units, the material cost and labour cost can be taken from material
requisitions and labour time sheets. But how much depreciation of factory building and other factory assets,
how much power, light, insurance, repairs, security guard salary, plant manager salary etc were necessary
to produce 50 units of this contract. An extra difficulty is that some of these expenses remain fixed
regardless of units produced, while some overheads like lubricating oil, power vary with the quantity of
goods manufactured. How, then is it possible to charge a finished job (means a completed contract) at the
time of completion with reasonable share of factory overhead when actual amount of these expenses is
often not known until the end of accounting period.
Estimated factory overhead
Factory overhead are entered on the job order cost sheets on the basis of a predetermined factory overhead
rate based on an appropriate base like direct labour hours, direct labour cost, machine hours etc. The
procedure is as follows:
Suppose accountant determines a relationship between two factors such as direct labour hours and factory
overhead and uses this relationship as the means of charging factory overhead to jobs. For example,
company’s direct labour hours for the month were estimated to be 7,000 hours and factory overhead were
estimated to 15,400 / month. These estimates lead to the assumption that for each hour of direct labour
there is Rs. 2.2 (15,400/7,000 hours) of factory overhead. The job order cost sheet for any job done during
the period would disclose the factory overheads applicable to the job (direct labour hours worked on the job
multiplied by the factory overhead rate) (e.g. 1,000 hrs × 2.2) = 2,200.
The cost accounting entry of applied factory overheads is:
WIP A /c 2,200
F OH A /c 2,200
The actual amounts of factory overheads are recorded during the period by using the following entry, e.g:
F OH A /c xx
Cash / payable xx
At the end of the period, the difference if any in the factory overheads account is adjusted as over / under
applied overheads either as an adjustment in cost of sales or in gross profit. (Preferably in cost of sales)
----------( 25 )----------
Q.2
A chemical is manufactured by passing through two processes X and Y using two types of direct material, A
and B. In process Y, a by-product is also produced which is then transferred to process Z where it is
completed. For the first week of a month, the actual data has been as follows:
Process
X Y Z
Output of main product (kgs) 9,400 8,000
Output of byproduct (kgs) 1,400 1,250
Direct material - A (9,500 units) (Rs.) 123,500
Direct material - B added in process (kgs) 500 300 20
Direct material - B added in process (Rs.) 19,500 48,100 1,651
Direct wages (Rs.) 15,000 10,000 500
Scrap value (Rs. per unit) 5 10 6
Normal loss as a percentage of input (%) 4 5 5

The factory overheads are absorbed @ 240% of direct wages. Actual factory overheads for the week
amounted to Rs. 65,000. Estimated sales value of the by-product at the time of transfer to process Z was
Rs. 22 per unit.

Required:
Prepare the following:
a) Process accounts for X, Y and Z.
b) Normal loss, abnormal loss and abnormal gain accounts.
c) Factory overhead account.

7.1 QB

Work in process
Sometimes all units started in a process during an accounting period are not fully completed in that
accounting period. For example, let’s assume during the year ended 30-06-2010:
Input 1,000 units
Output 800 units
Closing work in process (40% 200 units
completed)
Cost incurred during the period 100,000
On how many units the work has been done. Definitely 1,000 units, but all units are not converted into
finished goods. In these circumstances to allocate the cost, equivalent production units are calculated.

Equivalent Production Units:

It means the number of units that would have been completed had the resources been directed towards the
completion of units of each period e.g:
800 =fully completed units
80 = (200×40%)
880
These 200 units are equal to 80 completed units; so on 200 units cost of 80 completed units should be
allocated.
Per unit cost = (100,000 ÷ 880) = 113.6364/unit
Therefore cost is allocated as follows:
Cost of output = 800 × 113.63 = Rs.90,909
WIP = 200 × 40% × 113.63 = Rs.9,091

Scenario 2:
Process A/C (Incomplete)
Particulars Units Rs. Particulars Units Rs.
Material 4,000 16,000 Finished goods 2,750 ?
Normal loss (10% of 400 700
Direct Labor 8,125 input)
FOH 3,498 Abnormal Loss 150 ?
c/d 700 ?
4,000 27,623 4,000 ?

----------( 26 )----------
Closing WIP is completed as follows:
Material= 100%
Labor= 50%
FOH = 40%
If nothing is mentioned then assume that abnormal loss units are identified at the end of the process.
Equivalent Units:
Material Labor FOH
Output 2,750 2,750 2,750
Abnormal Loss 150 150 150
Closing WIP 700 350 280
3,600 3,250 3,180
Cost per unit:
Material = (16,000 – 700) =15,300 ÷ 3,600 =4.25
Labor =8,125 ÷ 3,250 =2.50
FOH = 3,498 ÷ 3,180 =1.10
7.85
Cost of output = 2,750 × 7.85 = Rs.21,587
Abnormal loss =150 × 7.85 = Rs.1,178
WIP:
- Material = 700 × 100% × 4.25 = 2,975
- Labor = 700 × 50% × 2.50 = 875
- FOH = 700 × 40% × 1.1 = 308 = Rs.4,158 .
Total Rs.26,923
Opening work in process: if there is opening work in process, then the total equivalent units are calculated
either by using FIFO or weighted average.
Basic discussion:
Units Amount
Opening Stock -- --
Add: Purchases 10,000 500,000
Less: Closing stock (500) (25,000)
Cost of sales 9,500 475,000

‘or’ 9,500 × 50
If there is no opening stock, there is no need of FIFO or weighted average.
Opening stock (FIFO)
Units Amount
Opening Stock 10,000 1,000,000
Add: Purchases 70,000 8,400,000
Less: Closing stock (8,000) (960,000)*
72,000 8,440,000**
*8,400,000 / 70,000 x 8,000 = 960,000
**or 10,000 = 1,000,000
+ 8,400,000 / 70,000 x 62,000 = 7,440,000
8,440,000
Opening stock (Weighted Average)
Units Amount
Opening Stock 10,000 1,000,000
Add: Purchases 70,000 8,400,000
Less: Closing stock (8,000) (940,000)*
72,000 8,460,000**
*[1,000,000 + 8,400,000 / 10,000 + 70,000] x 8,000 = 940,000
** or[1,000,000 + 8,400,000 / 10,000 + 70,000] x 72,000 = 8,460,000

----------( 27 )----------
Q. 4 Production data of ABC Corporation for May 2019 is given below:
Started in May 50,000
Completed in May 46,000
Ending work-in-process 12,000
Beginning work-in-process 8,000
The beginning work-in-process was 90% complete regarding direct materials and 40% complete regarding
conversion costs. The ending work-in-process inventory was 60% complete regarding direct material & 30%
complete regarding conversion costs.
Costs incurred during the period are as follows:
Material 500,000
Conversion 200,000
Cost of opening work in process is 80,000 comprising of 70,000 material and 10,000 conversion.
Required:
Prepare process account by using:
• FIFO method
• Weighted average method

If there is opening work in process then Process Account can be prepared by using either:

FIFO Weighted. Average

Q. 5 On 1st September, 2018 Company’s opening inventory was 400 units, complete as to material and 50%
as to conversion. The material cost of opening stock was 12,000 and the conversion cost was 4,000.
During September, 1,100 units were started and 1,300 were completed. The closing stock was complete as
to materials and ¾ complete as to conversion. Raw material purchases during September were 20,000.
Manufacturing cost of September comprise of:
▪ Raw material consumed of 22,550
▪ Conversion cost is 15,750
Required:
Prepare a process account for the period of September by using.
(i) FIFO ; and
(ii) Weighted Average

Q. 6 Yahya Limited produces a single product that passes through three departments, A, B and C.
The company uses FIFO method for process costing. A review of department A’s cost records for the month
of January 2008 shows the following details:
Units Material Rs. Labor Rs.
` Work in process inventory as at January 1, 2008 16,000 64,000 28,000
(75% complete as to conversion costs)
Additional units started in January 2008 110,000 - -
Material costs incurred - 430,500 -
Labor costs incurred - - 230,000
Work in process inventory as at January 31, 2008 18,000 - -
(50% complete as to conversion costs)
Units completed and transferred in January 2008 100,000 - -
Overheads are applied at the rate of 120% of direct labor. Normal spoilage is 5% of output.
The spoiled units are sold in the market at Rs. 6 per unit.
Required:
Compute the following for the month of January:
a) Equivalent production units.
b) Costs per unit for material, labor and factory overhead.
c) Cost of abnormal loss (or gain), closing work in process and the units transferred to the next
process.
Note: if nothing is mentioned then assume that units are 100 % complete with respect to material.

----------( 28 )----------
Important Points:
Whether we should use FIFO or Weighted Average: (In case of a silent question)
➢ Use of FIFO is only possible where completion stage in terms of % of each cost component (means
Material / Labour / Overhead) of opening WIP is available.
➢ Average method can only be applied in a situation where breakup in terms of amount of opening WIP
is available (means breakup of amount of opening WIP into of Material, Labour and Overhead
amounts are available).
➢ If both are available then make an assumption and then use FIFO because it is a better approach.

Second or Subsequent Department or Processes

Example:
Department – I
Blending Department
Opening WIP --
Units started during the period 50,000
Cost incurred during the period in the department:
Rs.
Material 24,500
Labor 29,140
Factory overheads 28,200
Units transferred to next department = 45,000 units
Closing work in process = 4,000 units (all material, ½ conversion)
Normal loss = 1,000 units
Department – II
Testing Department
Opening WIP --
Units received from Department – I 45,000
Cost incurred during the period in the department:
Rs.
Labor 37,310
Factory overheads 32,800
Units transferred to next department = 40,000
Closing work in process = 3,000 units ( 1/3 conversion)
Normal loss = 2,000 units.

Q. 7 The M S C manufactures a single product on a continuous plan in three departments. On November 1,

the work in process inventory in Department 2 was:

Cost in preceding department Rs.13,130

Materials — Department 2 None
Labor — Department 2 Rs.500
Factory overhead — Department 2 Rs.50
Units in process 5,000
Costs in Department 2 during November were:
Labor Rs.14,200
Factory overhead Rs.3,450
During November, 70,000 units were received from Department 1 at a unit cost of Rs.2.641; 68,000 units
were completed in Department 2, of which 60,000 were transferred to Department 3, and 8,000 were on
hand in Department 2 at the end of the month. Four thousand units were still in process, estimated to be
one-half complete as to labor and factory overhead. The balance was lost within the department; its cost is
to be absorbed by all the finished and unfinished production of the department (means a normal loss).
Required:
A November process account for Department 2, using the average costing method for beginning work in
process inventories.
Note: breakup of cost of opening work in process is given which is required in weighted average method.
----------( 29 )----------
Q.8 F C C Inc. operates three producing departments—Molding, Painting, and Finishing. During August, the
Painting Department transferred 12,400 units to the Finishing Department, lost 500 units, and had 800 units
in process at the end of August. There were 2,400 units in process on August 1 in the Painting Department.
The remaining units started in the Painting Department during August were received from the Molding De-
partment. The costs incurred in the Painting Department during August were: materials, Rs.5,886; labor,
Rs.7,830; and factory overhead, Rs.1,134. The work in process inventory on August 1 was Rs.6,656. The
costs transferred to the Painting Department from the Molding Department amounted to Rs.23,798. The
Painting Department work in process inventory was three-fourths complete on August 1 and one-fourth
complete on August 31.

Required:
The August process account for the painting department using the FIFO method of accounting for beginning
inventories.(Carry unit cost computation to four decimal places)

Note: no need of breakup of amount of opening work in process if FIFO is to be used. Only stage of
completion in terms of % of opening work in process is required.

Q.9 KS Limited operates two production departments A and B to produce a product XP-29. Following
information pertains to Department A for the month of December 2014.

Litres Rs. in ’000

Opening work in process (Material 100%, conversion 80%) 15,000
▪ Material 5,000
▪ Direct labour and overheads - 2,125
Actual cost for the month:
▪ Material 120,000 36,240
▪ Direct labour - 14,224
▪ Overheads - 11,500
Expected losses 5% -
Closing work in process (Material 100%, conversion 80%) 17,000 -
Units transferred to Department B 110,000 -

KS uses FIFO method for inventory valuation. Direct materials are added at the beginning of the process.
Expected losses are identified at the time of inspection which takes place at the end of the process.
Overheads are applied at the rate of 80% of direct labour cost.
Required:
• Equivalent production units
• Cost of goods transferred to Department B
• Accounting entries in the cost accounting system.
Note: if nothing is mentioned then % of loss should be on the basis of inspected units (if inspection stage is
available)

Q.10 Following is the data of Department B of EFG Company for December, 2003:
Work in process (opening) 8,500 units
(Completed as to material 20% and conversion cost 25%) Rs. 43,860
Work in process (ending) 11,540 units
(Completed as to material 50% and conversion cost 25%)
Current period transactions are:
Cost transferred from Department A Rs. 45,600
Units transferred from Department A 12,000 units
Units mishandled and lost before start of any process 460 units
Material consumed Rs. 27,654
Conversion cost incurred Rs. 47,689
Units transferred out 7,500

Normal spoilage is 6% of units transferred out. Company uses FIFO method for inventory valuation.
You are required to prepare a process account of Department B for December 2003

Note: This question can’t be solved by using weighted average method because break up of components of
opening WIP is not available.

----------( 30 )----------
Q. 11 Ravi Limited (RL) is engaged in production of industrial goods. It receives orders from steel
manufactures and follows job order costing. The following information pertains to an order received on 1
December 2016 for 6,000 units of a product:
(i) Production details for the month of December 2016:

Units
Produced and transferred to finished goods 3,200
Delivered to the buyer from the finished goods 3,000
Units rejected during inspection 120
Closing work in process (100% material and 80% conversion) 680

(ii) Actual expenses for the month of December 2016:

Rupees
Direct material 1,140,000
Direct labour (6,320 hours) 948,000
Factory overheads 800,000

Additional information:
• Factory overheads are applied at Rs. 120 per hour. Under/over applied factory overheads are
charged to profit and loss account.
• Units completed are inspected and transferred to finished goods. Normal rejection is estimated at
10% of the units transferred to finished goods. The rejected units are sold as scrap at Rs. 150 per
unit.
• RL uses weighted average method for inventory valuation.
Required:
(a) Prepare work in process account for the month of December 2016. (08)
(b) Prepare accounting entries to record:
• Over/under applied overheads
• Production losses and gains (05)

----------( 31 )----------
Question of reverse working:
Q.12 K International manufactures a single product. The product is processed in three different departments.
The company uses first-in-first-out method for process costing.
During November 2015, the costs incurred and units processed in department 2 were as follows:
Units Rs.
Opening work in process 2,000 128,750
Units received from department 1 53,000 ?
Cost added by department 2:
Materials ?
Direct labor 488,000
Production overheads 244,000
Units transferred to department 3 48,000
Closing work in process 5,000
Defective units (normal loss) 2,000
The defective units are sold at Rs. 15 per unit. Details of percentage of completion of opening and closing
work in process are as follows:
Work in Process
Opening Closing
Materials 80% 70%
Labour and production overheads 60% 50%
Following are per unit costs in department II:
Department I 39.75/unit
Material 19.8/unit
Required:
Prepare process account of department 2 for the month of November 2015.

----------( 32 )----------
SOLUTIONS
A.2
Process Account X
Units Amount Units Amount
Direct Material A 9,500 123,500 Output (transferred to Y) 9,400 188,000
Direct Material B 500 19,500 Normal loss 400 (×5) 2,000
Direct wages 15,000 (9,500 + 500)×4%
F-O.H (240% of D.L) 36,000 Abnormal loss (Bal.) 200 4,000
[15,000 × 240%]
10,000 194,000 10,000 194,000

194 ,000 − 2,000

Per Unit Cost = = 20 / unit
9,400 + 200

Output = 9,400 × 20 = 188,000

Abnormal loss = 200 × 20 = 4,000
Process Account Y
Units Amount Units Amount
Received from X 9,400 188,000 Output (To F.G) 8,000 240,000
Direct Material-B 300 48,100 Normal loss 485 (×10) 4,850
Direct Wages 10,000 (9,400 + 300) × 5%
F-O.H (240%) 24,000 By Product Z 1,400 30,800
(1,400 × 22)
Abnormal Gain (balance) 185 5,550
9,885 275,650 9,885 275,650
Per Unit = 188,000 + 48,100 + 10,000 + 24,000 – 4,850 – 30,800 / 8,000 - 185
= 30 / Unit
 8,000 × 30 = 240,000
 185 × 30 = 5,550
Process Account Z
Units Amount Units Amount
Received Y 1,400 30,800 Output (To F.G) 1,250 [×25] 31,250
Material-B 20 1,651 Normal loss 71 [×6] 426
Wages 500 (1,400 + 20) × 5%
F-O.H (240%) 1,200 Abnormal loss (balance) 99 [×0.5] 2,475
1,420 34,151 1,420 34,151

30,800 + 1,651 + 500 + 1,200 − 426 34,577

Per Unit = = = 25 / unit
1,250 + 99 1,349

 1,250 × 25 = 31,250
 99 × 25 = 2,475

Normal Loss Account Abnormal Loss Account

Units Amount Units Amount Units Amount Units Amount
P-X 400 2,000 Cash-X 400 (×5) 2,000 P-X 200 4,000 Cash-X 200(×5) 100
P-Y 485 4,850 Cash-Y 300(×10) 3,000 P-Z 99 2,475 Cash-Z 99(×6) 594
(485 –185)
P-Z 71 426 Cash-Y 71(×6) 426 P/L -- 4,881
Abnormal 185 1,850
Gain A/c
(Bal.)
956 7,276 956 7,276 299 6,475 299 6,475

----------( 33 )----------
 F-O.H Account Abnormal Gain Account
Actual Amount Applied Amount Units Amount Units Amounts
65,000 X 36,000 Normal loss A/c 185 1,850 P-Y 185 5,550
Y 24,000 --
Z 1,200 P/L Gain -- 3,700
CGS 3,800

A.5
(i) FIFO Process account
Units Amount Units Amount
b/d 400 16,000 Output 1,300 48,310
Input material 1,100 22,550 c/d 200 5,990
Conversion cost 15,750
1,500 54,300 1,500 54,300
Equivalent Units:
Material Conversion
Completed 400 → -- 200 (400 × 50%)
1,300
900 → 900 900
Closing WIP 200 200 150 (200 × 75%)
Total during the period 1,100 1,250
Cost for the period 22,550 15,750
Per unit 20.5 12.6
Cost of Units Completed:

Cost of opening units b/d 16,000

Cost during the period (200 × 12.6) 2,520
18,520
Started & Completed in the period
900 × (20.5 + 12.6)
29,790
Total 48,310
Closing WIP
[200 x 20.5 + 150 x 12.6] 5,990
(ii) Weighted average: Process account
Units Amount Units Amount
b/d 400 16,000 Output 1,300 47,650
Input material 1,100 22,550 c/d 200 6,650
Conversion cost 15,750
1,500 54,300 1,500 54,300
Equivalent Units:
Material Conversion
Completed 1,300 1300
Closing WIP 200 150 (200 × 75%)
Total units 1,500 1,450
Total Cost 34,500 (22,550+12,000) 19,750 (15,750 + 4,000)
Per unit 23.03 13.62

Total cost per unit 36.65

----------( 34 )----------
W-1 Cost of Units Completed:
1,300 × 36.65 47,650
W-2 Closing WIP:
Material = 200 × 23.03 = 4,606
Conversion = 150 × 13.62 = 2,043
6,650
A.6
If Weighted Average:
YAHYA LIMITED
Process Account
Units Amount Units Amount
b/d 16,000 125,600 Units completed 100,000 890,670
Input units 110,000
Material 430,500 Normal loss (5% of 5,000 30,000
output)
Labor 230,000 Abnormal loss (bal.) 3,000 26,720
F-OH (230,000 × 1.2) 276,000
c/d 18,000 114,710
126,000 1,062,100 126,000 1,062,100
Equivalent Units: (Weighted Average)
Material Conversion
Completed 100,000 100,000 100,000
Abnormal loss 3,000 3,000 3,000
c/d WIP 18,000 18,000 9,000
121,000 112,000

Cost/Unit:
Material = (64,000 + 430,500 – 30,000) = 464,500 ÷ 121,000 = 3.8388/unit
Labour = (28,000 + 230,000) = 258,000 ÷ 112,000 = 2.3036/unit
FOH = (33,600 + 276,000) = 309,600 ÷ 112,000 = 2.7643/unit
8.9067/unit
Cost Accounted For:
Units completed = 100,000 × 8.9067 = 890,670
Abnormal loss = 3,000 × 8.9067 = 26,720
Closing WIP = (18,000 × 3.8388) + (9,000 × 2.3036) + (9,000 × 2.7643) = 114,710

A.9 KS Limited
Calculation of normal loss:
15,000 x 5% = 750
(120,000 - 17,000) x 5% = 5,150
Total normal loss = 5,900
(a) Equivalent Production Units (FIFO)
Material Conversion
15,000 -- 3,000 (20%)
Output 110,000
95,000 95,000 95,000
Abnormal loss (At end) 2,100 2,100 2,100
c/d WIP 17,000 17,000 13,600 (80%)
114,100 113,700
----------( 35 )----------
 Cost / Unit:
36,240
Material = = 0.3176
114,100
14,224 + 11,379
Conversion = = 0.2252
113 ,700
Total Cost /unit = = 0.5428
(b) Cost of Output
15,000 units – opening cost = 7,125
+ 3,000 × 0.2252 – cost during the period = 676
= 7,801
+ 95,000 × 0.5428 = 51,566
Total Cost = 59,367

Cost of Abnormal Loss: 2,100 × 0.5428 = 1,140

Cost of Closing Stock: (17,000 × 0.3176) + (13,600 × 0.2252) 8,462

(c) Accounting Entries:

Date Particular Rs. ‘000’ Rs. ‘000’
31-12-2014 WIP – A 36,240
Material Account 36,240
WIP – A 14,224
Payroll Account 14,224
WIP – A 11,379
F-OH Account (14,224 x 80%) 11,379
31-12-2014 F-OH Account 11,500
Cash/Payables 11,500
31-12-2014 COS (W - 1 ) 121
F-OH Account 121
W–I F-OH
Cash 11,500 WIP 11,379
COS (bal) 121

Date Particular Rs. ‘000’ Rs. ‘000’

31-12-2014 WIP Account – B 59,367
WIP Account - A 59,367
31-12-2014 P/L (Abnormal loss) 1,140
WIP Account – A 1,140
Process Account (not required for additional information)
Units Amount Units Amount
b/d 15,000 7,125* WIP – B 110,000 59,367
Material (Input) 120,000 36,240 Normal loss 5,900
Payroll 14,224 Abnormal loss 2,100 1,140
F-OH (80%) 11,379 c/d 17,000 8,462
135,000 68,968 135,000 68,968
• *5,000 + 2,125 = 7,125

----------( 36 )----------
Same question if weighted Average Method:
KS Limited
Process Account
Units Amount Units Amount
b/d 15,000 7,125 Output 110,000 59,400
Input units 120,000 Normal loss 5,900 --
Material 36,240 Abnormal loss 2,100 1,134
Labor 14,224
OH (80%) 11,379 c/d 17,000 8,430
135,000 68,968 135,000 68,964
WORKINGS:
Equivalent Units (Weighted Average)
Material Conversion
Output 110,000 110,000 110,000
Abnormal loss (end) 21,000 2,100 2,100
c/d WIP 17,000 17,000 13,600 (80%)
129,100 125,700

Cost / Litre:
Rs.
Material = [5,000 + 36,240) ÷ 129,100 = 0.3194
Conversion = [2,125 + 14,224] ÷ 125,700 = 0.2206
+ 11,379)
0.54

Cost Accounted For: Rs. ’000’

Output = 110,000 × 0.54 = 59,400
Abnormal loss = 2,100 × 0.54 = 1,134
c/d WIP = (17,000 × 0.3194) + (13,600 × 0.2206) = 8,430

A.10
EFG Company
Process Account
Units Amount Units Amount
b/d 8,500 43,860 Finished goods 7,500 82,839
Received from dep. A 12,000 45,600 Abnormal loss (beg.) 460 1,816
Material 27,654 Normal loss (6% of 7,500) 450 --
Conversion 47,689 Abnormal loss (end.) (bal.) 550 6,404
c/d 11,540 73,766
20,500 164,803 20,500 164,825
Equivalent Units: (FIFO)
Proceeding
Material Conversion
Department
Transferred out (from opening WIP) 7,500 -- 6,000 (80%) 5,625 (75%)
Abnormal loss 550 550 550 550
Abnormal loss (from current period at beg.) 460 460 -- --
Closing WIP (from opening WIP) 1,000 -- 300 (30%) --
Closing WIP (from current period) 10,540 10,540 5,270 (50%) 2,635 (25%)
11,550 12,120 8,810

----------( 37 )----------
Calculation of per Unit Cost:
Rs.
Previous department = 45,600 ÷ 11,550 = 3.9481/unit
Material = 27,654 ÷ 12,120 = 2.2817/unit
Conversion = 47,689 ÷ 8,810 = 5.4131/unit
11.6429/unit
Cost Calculation:
Finished goods 7,500 units
Cost from opening WIP (7,500 × 5.16*) *[43,860/8,500] = 38,700
+ Material (6,000 × 2.2817) = 13,690
+ Conversion (5,625 × 5.4131) = 30,449 82,839

Abnormal loss at beginning: 460 × 3.9481 1,816

Abnormal loss at end: 550 × 11.6429 6,404

Closing WIP:
Cost from opening WIP (1,000 × 5.16*) *[43,860/8,500] = 5,160
+ Material (300 x 2.2817) = 685
From current period:
Preceding department (10,540 x 3.9481) = 41,633
+ Material (5,270 x 2.2817) = 12,025
+ Conversion (2,635 x 5.4131) = 14,263 73,766
A. 11
Ravi Limited
Work in process for the month of December, 2016
Rs.
Units Amount Units Amount
b/d -- -- Finished goods 3,200 2,490,336
Direct material (bal.) 4,000 1,140,000 N. Loss (3,200 × 10%) 320 48,000
(320x150)
Direct labour 948,000
F-OH (6,320 × 120) 758,400 c/d WIP 680 463,714
Ab. Gain 200 155,646
4,200 3,002,046 4,200 3,002,050

Equivalent Units:

Material Conversion
Output 3,200 3,200 3,200
c/d WIP 680 680 544 (80%)
Ab. Gain (200) (200) (200)
3,680 3,544

Cost Per Unit:

1,140 ,000 − 48,000
Material = = 296.74
3,680
948 ,000 + 758 ,400
Conversion = = 481.49
3,544
Total 778.23

----------( 38 )----------
Cost Allocation:
Output = 3,200 × 778.23 = 2,490,336
Closing WIP = 680 × 296.74 + 544 × 481.49 = 463,714
Ab. Gain = 200 × 778.23 = 155,646
Accounting Entries:
(i) F-OH 800,000
Cash 800,000
(ii) WIP 758,400
F-OH 758,400
(iii) PL 41,600
F-OH 41,600
(iv) WIP Account 155,646
Ab. Gain 155,646
(v) Normal loss 48,000
WIP Account 48,000
(vi) Cash 18,000
N. Loss 18,000
(vii) Ab. Gain 30,000
N. Loss 30,000
(viii) Ab. Gain 125,646
P/L 125,646
Workings:
F-OH Account
Cash 800,000 WIP 758,400
PL 41,600

Normal Loss

WIP 320 48,000 Cash 120 18,000

Ab. Gain 200 30,000

Abnormal Gain

Normal Loss 200 30,000 WIP 200 155,646

PL 125,646

A.12
Process Account – Department 2
Units Amount Units Amount
b/d WIP 2,000 128,750 Normal loss 2,000 30,000
Received from dep. I (W) 53,000 2,057,500 Transferred to Dep. III 48,000 3,570,950
Material (W) 988,000
Wages 488,000
F-OH 244,000 c/d WIP 5,000 305,175
55,000 3,906,250 55,000 3,906,250

Equivalent Units: (FIFO)

Department – I Material Labor F-OH
Transferred 2,000 -- 400 (20%) 800 (40%) 800 (40%)
46,000 46,000 46,000 46,000 46,000
Closing WIP 5,000 5,000 3,500 (70%) 2,500 (50%) 2,500 (50%)
51,000 49,900 49,300 49,300

----------( 39 )----------
Cost/ Unit:
Rs.
2,057 ,500 − 30,000
Department – I = = 39.75
51,000
988,000
Material = = 19.8
49,900
488,000
Labor = = 9.9
49,300
244,000
F-OH = = 4.95
49,300
Total 74.4
Cost Calculations:
2,000 128,750 + 400 × 19.8 + 800 × 9.9 + 800 × 4.95 = 148,550
Transferred Units = 48,000
46,000 46,000 × 74.4 = 3,422,400
= 3,570,950

c/d WIP = 5,000 × 39.75 + 3,500 × 19.8 + 2,500 × 9.9 + 2,500 × 4.95 = 305,175

----------( 40 )----------
Extra practice questions
Process Costing Test:
Question 1
Quality Chemicals (QC) produces one of its products through two processes A and B. Following information
has been extracted from the records of process A for the month of January 2016.

Quantity Material Conversion

Units ------ Rs. In ‘000’ ------
Opening work in process 5,000 2,713 1,499
Input during the month 20,000 10,000 5,760
Transferred to process B 18,000 - -
Closing work in process 6,000 - -

Additional information:
(i) Materials are introduced at the beginning of the process. In respect of conversion, opening and
closing work in process inventories were 40% and 60% complete, respectively.
(ii) Inspection is performed when the units are 50% complete. Expected rejection is estimated at 5% of
the inspected units. The rejected units are not processed further and sold at Rs. 100 per unit.
(iii) QC uses ‘weighted average method’ for inventory valuation.
Required:
(a) Compute equivalent production units and cost per unit. (05)
(b) Prepare journal entries to record the above transactions. (06)

Question 2
Beta Enterprises (BE) produces a chemical that requires two separate processes for its completion.
Following information pertains to process II for the month of August 2016:
Kg Rs. In ‘000’
Opening work in process (85% to conversion) 5,000 2,000
Costs for the month:
Received from process I 30,000 18,000
Material added in process II 15,000 10,000
Conversion cost incurred in process II - 11,000
Finished goods transferred to warehouse 40,000
Closing work in process (60% to conversion) 4,000

In process II, material is added at start of the process and conversion costs are incurred evenly throughout
the process. Process losses are determined on inspection which is carried out on 80% completion of the
process. Process loss is estimated at 10% of the inspected quantity and is sold for Rs. 100 per kg.
BE uses FIFO method for inventory valuation.
Required:
(a) Prepare a statement of equivalent production units. (04)
(b) Compute cost of:
(i) finished goods (ii) closing WIP (iii) abnormal loss/gain (09)
(c) Prepare accounting entries to record production gain/loss for the month. (03)

Q.3 A company manufactures various lines of bicycles. The company uses a process cost system using the
weighted average method to determine unit cost. Bicycle parts are manufactured in the Molding Department;
the parts are consolidated into a single bicycle unit in the Molding Department and transferred to the
Assembly Department, where they are assembled. After assembly, the bicycles are sent to the Packing
Department.

----------( 41 )----------
Cost per unit data for the standard model has been completed through the Molding Department. Annual cost
and production figures for the Assembly department are given below:
• Defective bicycles are identified at an inspection point when the assembly labour process is 70%
complete; all assembly materials have been added prior to this point of the process. The normal
rejection % for defective bicycle is 5% of the bicycles reaching the inspection point. Any defective
bicycles above the normal rejection are considered as abnormal spoilage. All defective bicycles are
removed from the production process and disposed off with zero disposal value.
• Assembly Department Cost Data
Assembly
From Assembly
Conversion Total Cost
Molding Materials
Cost
Rs. Rs. Rs. Rs.
Prior Period Costs 82,200 6,660 11,930 100,790
Current Period Costs 1,237,800 96,840 236,590 1,571,230
Total Costs 1,320,000 103,500 248,520 1,672,020
• Assembly Department Production Data
Assembly
Moulding Assembly
Bicycles Conversion
Cost % Materials %
Costs %
Beginning Inventory 3,000 100 100% 80%
Transferred in from moulding dep. 45,000 100 - -
during the year
Transferred out to packing dep. during 40,000 100 100% 100%
the year
Ending Inventory 4,000 100 50% 20%

Required:
Process Account showing necessary computation, relating to assembly department.

----------( 42 )----------
Answer 1
Process Account
Rs. ‘000’
Units Amount Units Amount
b/d 5,000 4,212 Output 18,000 15,624
(2,713+1,499)
Input 20,000 N.Loss (5,000+20,000) × 5% 1,250 125
(1,250 x 100)
Material 10,000
Conversion 5,760 c/d 6,000 4,397
Ab. Gain (balance) 250 175
25,250 20,147 25,250 20,146
Equivalent Units:
Material Conversion
Output 18,000 18,000 18,000
c/d WIP 6,000 6,.000 3,600 (60%)

Ab. Gain 250 (250) (125) (50%)

23,750 21,475
Per Unit:
2,713 + 10,000 − 125
Material = = 530
23,750
Conversion = [1,499+5,760] / 21,475 = 338
868
Cost Allocation:
Output = 18,000 × 868 = 15,624
c/d WIP = 6,000 × 530 + 3,600 × 338 = 4,397
Ab. Gain = 250 × 530 + 125 x 338 = 175

Answer 2
Process Account – II

Units Amount Units Amount

b/d WIP 5,000 2,000,000 Output 40,000 35,524,118
Process I 30,000 18,000,000 Normal loss (working) 4,100 410,000
Material 15,000 10,000,000
Conversion 11,000,000 Abnormal loss (Bal.) 1,900 1,703,221
c/d WIP 4,000 3,363,896
50,000 41,000,000 50,000 41,001,235

Calculation of Normal Loss:

Opening WIP 5,000 100% M ; 85% Conversion (Already tested)
Input (30 + 15) 45,000
Closing WIP (4,000) 100% M : 60% Conversion (will be tested)
Inspections stage 100% M ; 80% Conversion.
41,000 x 10% = 4,100

----------( 43 )----------
(a) Equivalent Production Units: (FIFO)

Process I Material Conversion

5,000 -- -- 750(15%)
Output 40,000
35,000 35,000 35,000 35,000
Ab. Loss 1,900 1,900 1,900 1,520 (80%)
c/d WIP 4,000 4,000 4,000 2,400 (60%)
40,900 40,900 39,670

Per Unit:
18,000 ,000 − 410 ,000
Process – I = = 430.10
40,900

10,000 ,000
Material = = 244.50
40,900

11,000,000
Conversion = = 277.29
39,670
(b) Cost Allocation:
Output = 40,000 units
5,000 units from Opening 2,000,000
+ 750 × 277.29 = 307,968
2,207,968
+ 35,000 × 951.89 = 33,316,150
35,524,118

Ab. Loss:
1,900 × 430.1 + 1,900 × 244.5 + 1,520 × 277.29
1,703,220

c/d WIP:
4,000 × 430.1 + 4,000 × 244.5 + 2,400 × 277.29
3,419,354

(c)
(i) Abnormal loss 1,703,220
Process Account 1,703,220
(ii) Cash/Receivable (1,900 × 100) 190,000
Abnormal loss 190,000
(iii) Normal loss 410,000
Process Account 410,000
(iv) Cash/receivables 410,000
Normal Loss 410,000

----------( 44 )----------
A.3 Process Account
Units Amount Units Amount
b/d 3,000 100,790** Output (to packing dept.) 40,000 1,478,800
From molding 45,000 1,237,800
Material 96,840 *Normal loss (working) 2,050 --
Conversion 236,590 Abnormal loss (bal.) 1,950 68,646
c/d 4,000 124,332
48,000 1,672,020 48,000 1,672,020
**[82,200 + 6,660 + 11,930]
*Working of Normal Loss Units:
Opening Units = 3,000 (should have already inspected at 70% stage in previous
period)
Input Units = 45,000
Less: c/d WIP = (4,000) (should not have been yet inspected in this department
because they are at less than 70% stage)
Units Inspected 41,000
× 5% 2,050
Equivalent Units: (Weighted Average)
Previous Material Conversion
Output 40,000 40,000 40,000 40,000
Abnormal loss 1,950 1,950 1,950 (100%) 1,365 (70%)
Closing WIP 4,000 4,000 2,000 (50%) 800 (20%)
45,950 43,950 42,165

Cost/ Unit:
Rs.
82,200 + 1,237 ,800
Previous department = = 28.73/unit
45,950
6,660 + 96,840
Material = = 2.35/unit
43,950
11,930 + 236 ,590
Conversion = = 5.89/unit
42,165
36.97/unit

Calculation of Cost:
Rs.
Output: [40,000 × 36.97] = 1,478,800
Abnormal loss: [1,950 × 28.73 + 1,950 × 2.35 + 1,365 × 5.89] = 68,646
Closing WIP: [4,000 × 28.73 + 2,000 × 2.35 + 800 × 5.89] = 124,332
1,671,778

If FIFO is used:

Process A/C
Units Amount Units Amount
b/d 3,000 100,790 Packing (Output) 40,000 1,478,170
From Molding 45,000 1,237,800
Material 96,840 Normal Loss 2,050 -
Conversion 236,590 Abnormal Loss 1,950 68,923
c/d 4,000 124,760
48,000 1,672,020 48,000 1,671,,853

----------( 45 )----------
Equivalent Units
Previous department Material Conversion

3,000 - - 600 (20%)

Output 40,000 37,000 37,000 37,000
37,000
Abnormal Loss 1,950 1,950 1,950 1,365(70%)
c/d WIP 4,000 4,000 2,000 800(20%)
42,950 40,950 39,765
Per Unit:
Previous = 1,237,800 = 28.82 Cost Allocation
42,950 Output =40,000 units
3,000 100,790
96,840
+600x5.95 3,570
Material = = 2.36 104,360
40,950
37,000x37.13 1,373,810
236,590 1,478,170
Conversion = = 5.95
39,765 Ab.Loss:
37.13 1,950x28.82+
1,950x2.36+
1365x5.95
68,923
c/d WIP
4,000x28.82+
2,000x2.36+
800x5.95 124,760

----------( 46 )----------
ICAP QUESTION BANK
PROCESS COSTING
7.1 PROCESS COSTING: THE BASIC RULES
The following examples take you through the basic rules for process costing.
Required
For each of the following examples, calculate:
(a) the cost of completed output from the process, and
(b) if there is any, the cost of any abnormal loss or the value of any abnormal gain

Example 1
1,500 litres of a liquid were input to a process at a cost of Rs.7,200. Normal loss is 20% of the
input quantity. Actual loss was equal to the normal loss.

Example 2
1,500 litres of liquid were input to a process at a cost of Rs.7,200. A normal loss of 20% of the
input is expected. The actual output for the period was only 1,100 litres.

Example 3
1,500 litres of liquid were input to a process at a cost of Rs.7,200. A normal loss of 20% of the
input is expected. Loss is sold as scrap, for a net sales price of Rs.0.40 per litre. The actual
output from the process was 1,200 litres.

Example 4
1,500 litres of liquid were input to a process at a cost of Rs.7,200. The output from the process
was 1,100 litres. Normal loss is 20% of the input quantity. Any lost units have a scrap value of
Rs.0.40 per litre.

Example 5
1,500 litres of liquid were input to a process at a cost of Rs.7,200. Normal loss is 20% of the input
quantity but the actual output for the period was 1,250 litres. Loss has no scrap value.

Example 6
1,500 litres of liquid were input to a process at a cost of Rs.7,200. The output from the process
was 1,250 units. Normal loss is 20% of the input quantity. Any lost units have a scrap value of
Rs.0.40 per litre.

7.2 HORNBILL LIMITED

Hornbill Limited (HL) produces certain chemicals for textile industry. The company has three production
departments. All materials are introduced at the beginning of the process in Department-A and
subsequently transferred to Department-B. Any loss in Department-B is considered as a normal loss.
The following information has been extracted from the records of HL for Department- B for the month of
August 20X3:
Department B
Opening work in process (Litres) Nil
Closing work in process (Litres) 10,500
Units transferred from Department-A (Litres) 55,000
Units transferred to Department-C (Litres) 39,500
Labour (Rupees) 27,520
Factory overhead (Rupees) 15,480

Materials from Department-A were transferred at the cost of Rs. 1.80 per litre.
The degree of completion of work in process in terms of costs originating in Department-B was as follows:

WIP Completion %
50% units 40%
20% units 30%
30% units 24.5%
----------( 47 )----------
Required
Prepare the following for department B for the month:
a) A statement of equivalent units.
a) A statement showing cost per equivalent unit.
a) A statement showing the evaluation of output.
a) A process account. (15)

7.3 FOWL LIMITED

Fowl Limited (FL) manufactures two joint products X and Y from a single production process.
Raw material Benz is added at the beginning of the process. Inspection is performed when the
units are 50% complete. Expected loss from rejection is estimated at 10% of the tested units.
Following details are available for the month of May 20X3:

Units Material Conversion cost

(Rs.) (Rs.)
Opening work in process 15,000 90,000 25,000
Cost for the month
547,125 228,875
Transferred to finished goods:

− Product- X 50,000 - -
− Product- Y 25,000
Loss due to rejection 12,500 - -
Closing work in process 10,000 - -

Additional information:
(i) Opening and closing work in process are 75% complete.
(ii) The normal loss is sold as scrap at the rate of Rs. 1.50 per unit.
(iii) Production costs are allocated to joint products on the basis of weight of output.
(iv) The company uses weighted average method for inventory valuation. Prepare
the following for department for the month:
a) A statement of equivalent units.
b) A statement showing cost per equivalent unit.
c) A statement showing the evaluation of output.
d) A process account. (15)

----------( 48 )----------
Solution:
Example 1

litres
Input 1,500
Normal loss (20%) 300
Expected output 1,200
Cost per unit of expected output = Rs.7,200/1,200 litres = Rs.6 per litre. Actual output = 1,200 litres.
Cost of actual output = 1,200 litres × Rs.6 = Rs.7,200. There is no abnormal loss or abnormal gain.
Example 2

litres
Input 1,500
Normal loss (20%) 300
Expected output 1,200
Actual output 1,100
Abnormal loss 100
Cost per unit = same as in Example 1, Rs.6 per litre. Cost of actual output = 1,100 litres × Rs.6 =
Rs.6,600. Cost of abnormal loss = 100 litres × Rs.6 = Rs.600.
Example 3

Rs.
Input cost 7,200
Scrap value of normal loss (300 × Rs.0.40) 120
Net cost of the process 7,080
Cost per unit of expected output = Rs.7,080/1,200 litres = Rs.5.90 per litre. Actual output = 1,200
litres.
Cost of actual output= 1,200 litres × Rs.5.90 = Rs.7,080. There is no abnormal loss or abnormal
gain.
Example 4
Cost per unit = same as in Example 3, Rs.5.90 per litre. Cost of actual output = 1,100 litres ×
Rs.5.90 = Rs.6,490. Cost of abnormal loss = 100 litres × Rs.5.90 = Rs.590.
This cost of abnormal loss is the amount recorded in the process account.

The net cost of abnormal loss is reduced (in the abnormal loss account) by the scrap value of the
lost units.

Rs.
Cost of abnormal loss in the process account 590
Scrap value of abnormal loss (100 × Rs.0.40) (40)
Net cost of abnormal loss (= expense in the income statement) 550
Example 5

litres
Input 1,500
Normal loss (20%) 300
Expected output 1,200
Actual output 1,250
Abnormal gain 50
Cost per unit = same as in Example 1, Rs.6 per litre. Cost of
actual output = 1,250 litres × Rs.6 = Rs.7,500.
Value of abnormal gain = 50 litres × Rs.6 = Rs.300 (= debit entry in the process account)
----------( 49 )----------
Example 6

litres
Input 1,500
Normal loss (20%) 300
Expected output 1,200
Actual output 1,250
Abnormal gain 50
Cost per unit = same as in Example 3, Rs.5.90 per litre. Cost of actual output = 1,250 litres ×
Rs.5.90 = Rs.7,375. Value of abnormal gain = 50 litres × Rs.5.90 = Rs.295.
This value of abnormal gain is the amount recorded in the process account (as a debit entry).
The value cost of abnormal gain is reduced (in the abnormal gain account) by the scrap value of
the units that have not been lost.

Rs.
Value of abnormal gain in the process account 295
Scrap value forgone: (50 × Rs.0.40) (20)
Net value of abnormal gain (= income in the income statement) 275

7.2 Hornbill solution:

Process Account – Department B
Units Amount Units Amount
b/d -- -- Transferred out 39,500 117,710
Previous department 55,000 99,000 N. Loss (balance) 5,000 --
Direct labour 27,520
F-OH 15,480 c/d WIP 10,500 24,290
55,000 142,000 55,000 142,000

WORKINGS:
Equivalent Units:
Previous Direct
F-OH
Department Labour
Transferred out 39,500 39,500 39,500
Closing WIP 10,500 3,500* 3,500*
50,000 43,000 43,000
(should be complete with respect to previous department)
*Units in Process (for labour & F-OH)
10,500 × 50% × 40% = 2,100
10,500 × 20% × 30% = 630
10,500 × 30% × 24.5% = 770
3,500
Cost/Unit:
Previous Department = 99,000 ÷ 50,000 = 1.98
Labour = 27,520 ÷ 43,000 = 0.64
F-OH = 15,480 ÷ 43,000 = 0.36
2.98
Cost Accounted For:
39,500 × 2.98 = 117,710
c/d work in process = (10,500 × 1.98 + 3,500 × 0.64 + 3,500 × 0.36) = 24,290
142,000

----------( 50 )----------
Answer: 7.3

Fowl Limited
Process Account
Units Amount Units Amount
b/d 15,000 115,000 Transferred
(90,000+25,000) X 50,000
750,000
Input (balance) 82,500 Y 25,000

Material 547,125 Abnormal loss 4,250 36,125

Conversion 228,875 Normal loss 8,250(×1.5) 12,375

c/d WIP 10,000 92,500

97,500 891,000 97,500 891,000
Calculation of Input Units:
Units produced – X 50,000
–Y 25,000 75,000
Wastage (given) 12,500
Closing WIP 10,000
Opening WIP (15,000)
82,500

Normal loss is 10% of tested units. No normal loss from opening WIP in current period because opening
WIP is 75% complete (and would have been tested last period). However closing WIP would have been
tested during the period as it is also 75% complete. It means all input during the period would have been
tested therefore 10% of input is normal loss i.e 82,,500 × 10% = 8,250.
Abnormal loss = Total Loss – Normal Loss
= 12,500 – 8,250
= 4,250
Equivalent Production Units:
Material Conversion
Output 75,000 75,000 75,000
Abnormal loss 4,250 4,250 2,125 (50%)
Closing WIP 10,000 10,000 7,500 (75%)
(material at beginning)
89,250 84,625

Per Unit Rate:

90,000 + 547,125 − 12,375
Material = = 7/unit
89,250

25,000 + 228 ,875

Conversion = = 3/unit
84,625
Total = 10/unit

Calculation of Cost:

Units completed (75,000 × 10) 750,000

Abnormal loss (4,250 × 7) + (2,125 × 3) 36,125

Closing WIP (10,000 × 7) + (7,500 × 3) 92,500
878,625

----------( 51 )----------
If it would have been required
750,000
X= × 50,000
75,000
750,000
Y= × 25,000
75,000

Normal loss with cost of disposal (Process Costing)

In other cases, a company might have to pay to dispose-off losses in a process and additional cost
might be incurred to its disposal. The substance scraped off the top of the liquid in the process might
be toxic and has to be disposed-off safely.
The cost of disposal represents an additional cost to the process.
To reflect this in the process account the normal loss is measured at zero but the expected costs of
disposal are debited to the process account.
Formula:

Total process costs + Disposal costs of the normal

Per unit Cost of good output = loss
Expected units of output

Example:
The following information relates to a production process X

Input quantities 2,000 liters

Normal loss 10%
Therefore, expected output 1,800 liters
Actual output 1,800 liters
Disposal cost of normal loss Rs. 1 per liter

The cost per unit produced can be calculated as follows: Rs.

Direct materials 3,600
Direct labour 300
Production overheads 600
Total production cost 4,500
Disposal costs of normal loss (200 litres x 1) 200
4,700
Expected output (90% of 2,000) ÷1,800 litres
Cost per litre Rs. 2.6111

The process account can be completed as follows

Process X
Liters Rs. Liters Rs.
Output (actual) at Rs. 2.6111 each
Materials 2,000 3,600 1,800 4,700
Direct labour 300
Prod. overhead 600
Disposal cost of normal loss
200 Normal loss 200
2,000 4,700 2,000 4,700

----------( 52 )----------
Test:
Q.4. Green Limited (GL) produces a chemical that passes through two processes before being transferred to
warehouse. Following information pertains to Process II for the month of August 2021:

Production (kg) Cost (Rs. in '000)

Opening work in process 7,500 3,000

Transferred from Process I 45,000 27,000
Material added in Process II 22,500 11,250
Conversion costs incurred in Process II - 1,500
Finished goods transferred to warehouse 60,000 -
Closing work in process 9,000 -

In Process II, material is added at start of the process and conversion costs are incurred evenly throughout the
process. Process loss is determined on inspection which is carried out on 60% completion of the process. Process
loss is estimated at 10% of the inspected quantity and is sold for Rs. 200 per kg.

The details of opening and closing work in processes are as follows:

Opening work in process Closing work in process

kg Completion % kg Completion %
5,250 80% 5,400 70%
2,250 40% 3,600 30%

Required :
Prepare Process II account for the month of August 2021. (10)

A.4
Green Limited:
Process II Account

Units Rs. in '000 Units Rs. in '000

Opening WIP 7,500 3,000 Finished goods
Transferred from Process I
45,000 27,000 60,000 36,241
Material added in Process II 22,500 11,250 Normal loss ( W-1) 6,615 1323
(6615 x 200)
Conversion cost incurred in Process II Closing WIP 9,000 5,546
- 1,500
Abnormal gain (bal) 615 380
75,615 43,130 75,615 43,110

W-1
Opening WIP 5,250 (M100%;C.C80%)
Opening WIP 2,250 ( M 100% ; C.C 40% )
Input 67,500 ( 45,000+22,500)
Closing WIP 5,400 ( M 100% ; C.C 70% )
Closing WIP 3,600 (M100%;C.C30%)
Stage of Inspection ( M 100% ; C.C 60% )
2,250+67,500–3,600=66,150x10%
Normal Loss =6,615

----------( 53 )----------
Equivalent Production Units ( FIFO )
Process 1 Material Conversion
5,250 - - 1,050 (20%)
Finished Goods 7,500 2,250 - - 1,350 (60%)
52,500 52,500 52,500 52,500
5,400 5,400 5,400 3,780 (70%)
c/d WIP 9,000
3,600 3,600 3,600 1,080 (30%)
Abnormal gain (615) (615) (369) (60%)
60,885 60,885 59,391

Cost Per Unit:

27000−1323
Process 1 = = 0.42/Unit
60,885

11250
Material = = 0.18/Unit
60,885

1500
Conversion = =0.03/unit
59,391
0.63/unit

Cost Allocation
Finished goods = 60,000 units
7,500 units 3,000
+1,050 × 0.03 + 1,350 × 0.03 =72
+ 52,500 × 0.63 =33,075
36,147
Closing WIP: 54,00 × 0.42 + 5,400 × 0.185 + 3,780 × 0.03
+3,600 × 0.42 +3,600 × 0.185 + 1,082 × 0.03 =5,546
Abnormal gain : 615 × 0.42 + 615 x 0.18 +369 x 0.03 =380

----------( 54 )----------
TEST
Process Costing

Q# 1: Meezan Limited produces a single product that passes through three departments, X, Y and
Z. A review of department X’s cost records for the month of January 2020 shows the following
details:
Units Material Rs. Labor Rs.
` Work in process inventory as at January 1, 2020 20,000 95,000 60,000
(40% complete as to conversion costs)
Additional units started in January 2020 180,000 - -
Material costs incurred - 740,000 -
Labor costs incurred - - 370,000
Work in process inventory as at January 31, 2020 25,000 - -
(60% complete as to conversion costs)
Units completed and transferred in January 2020 155,000 - -

Overheads are applied at the rate of 120% of direct labor. Normal spoilage is 5% of output.
The spoiled units are sold in the market at Rs. 8 per unit.
Required:
Compute the following for the month of January (by using both the FIFO and Weighted Average Method):
a) Equivalent production units.
b) Costs per unit for material, labor and factory overhead.
c) Cost of abnormal loss (or gain), closing work in process and the units transferred to the next
process. (15)

Q# 2: XYZ Limited produces certain chemicals for textile industry. The company has three production
departments. All materials are introduced at the beginning of the process in Department-A and
subsequently transferred to Department-B. Any loss in Department-B is considered as a normal loss.
The following information has been extracted from the records of HL for Department- B for the month of
November 2023:

Department B
Opening work in process (Litres) Nil
Closing work in process (Litres) 21,000
Units transferred from Department-A (Litres) 110,000
Units transferred to Department-C (Litres) 85,000
Labour (Rupees) 270,000
Factory overhead (Rupees) 185,000

Units from Department-A were transferred at the cost of Rs.3 per litre.
The degree of completion of work in process in terms of costs originating in Department-B was 30%.

Required:
Prepare the following for department B for the month:
▪ A statement of equivalent units.
▪ A statement showing cost per equivalent unit.
▪ A statement showing the cost Allocation
(10)

----------( 55 )----------
Test:
Q.1. Blue Limited (BL) produces a chemical that passes through two processes before being transferred to
warehouse. Following information pertains to Process II for the month of August 2021:
Production (kg) Cost (Rs. in '000)

Opening work in process 17,500 30,000

Transferred from Process I 145,000 270,000
Material added in Process II 70,000 112,500
Conversion costs incurred in Process II - 15000
Finished goods transferred to warehouse 200,000 -
Closing work in process 19,000 -
In Process II, material is added at start of the process and conversion costs are incurred evenly throughout
the process. Process loss is determined on inspection which is carried out on 60% completion of the
process. Process loss is estimated at 10% of the inspected quantity and is sold for Rs. 200 per kg.

The details of opening and closing work in processes are as follows:

Opening work in process Closing work in process

kg Completion % kg Completion %
8,600 80% 12,300 70%
8,900 40% 6,700 30%

Required :
Prepare Process II account for the month of August 2021. (15)

Q.2 Rose nterprises (RE) manufactures a product Alpha that requires two separate processes, Aand B.
Following information has been extracted from the cost records of Process B for the month of February 2019:

Process B cost
Quantity Process A
Material Conversion
cost
Liters --------------Rs. In “000”----------------
Opening work-in-process– Process B 8,000 1,500 600 400
(80% complete as to conversion)
Cost for the month:
- Received from process A 85,000 14,000 - -
-Added during process B 10,000 - 7,000 5,600
Closing work-in-process – Process B 7,500 - - -
(70% complete as to conversion)

Additional information:
1. Materials are added at start of the process.
2. Normal loss is estimated at 5% of the inspected units and loss is determined at completion
of theprocess. Loss of each liter results in a solid waste of 0.8kg. During the month of
February 2019, solid waste produced was 4,500 kg.
3. Solid waste needs to be disposed off by incurring a cost of Rs. 20 per kg.
4. TE uses weighted average method for valuation of inventory.

Required:
Prepare accounting entries to record the transactions of process B.
(Narrations to accounting entries are not required)

----------( 56 )----------
A.1
Meezan Limited
Process Account
Units Amount Units Amount
b/d 20,000 227,000 Process B 155,000 1,445,084
(95,000+60,000+60,000×120%)
Material 180,000 740,000
Labour 370,000 Abnormal loss (bal) 12,250 105,443
FOH (370,000×1.2) 444,000 Normal loss (5 %) 7,750 62,000
c/d 25,000 168,476
200,000 1,781,000 200,000 1,781,003

Equivalent Units (fifo):

Material Conversion Cost
Process B
20,000 -- 12,000 (60%)
155,000
135,000 135,000 135,000
Abnormal loss 12,250 12,250 12,250
Closing WIP 25,000 25,000 15,000 (60%)
172,250 174,250

Material = (740,000 – 62,000) ÷ 172,250 = 3.9361

Labour = 370,000 ÷ 174,250 = 2.1234
FOH = 444,000 ÷ 174,250 = 2.5481
8.6076
Cost Calculation:
Units Completed: Rs.
Opening units cost 227,000
Current Period Cost on Opening units:
Labour & overheads (12,000×2.1234)+(12,000×2.5481) 56,058

Cost of 135,000 units (135,000 × 8.6076) 1162,026

1,445,084

Closing WIP: Rs.

Material = (25,000 ×3.9361) 98,403
Labour = (15,000 ×2.1234) 31,851
Overhead = (15,000 ×2.5481) 38,222
168,476
Abnormal Loss: (12250 × 8.6076) = 105,443

If Weighted Average:
Meezan Limited
Process Account
Units Amount Units Amount
b/d 20,000 227,000 Process B 155,000 1,427,783
(95,000+60,000+60,000×120%)
Material 180,000 740,000 Normal loss (5% of 7,750 62,000
output)
Labor 370,000 Abnormal loss (bal.) 12,250 112,841
F-OH (370,000× 1.2) 444,000
c/d 25,000 178,381
200,000 1,781,000 200,000 1,781,005

----------( 57 )----------
Equivalent Units: (Weighted Average)
Material Conversion
Completed 155,000 155,000 155,000
Abnormal loss 12,250 12,250 12,250
c/d WIP 25,000 25,000 15,000(60%)
192,250 182,250

Cost/Unit:
Material = (95,000+740,000-62,000) ÷ 192,250 = 4.0208/unit
Labour = (60,000+370,000) ÷ 182,250 = 2.3594/unit
FOH = (72,000+444,000) ÷ 182,250 = 2.8313/unit
9.2115/unit

Cost Accounted For:

Units completed =155,000 ×9.2115= 1,427,783
Abnormal loss =12,250 ×9.2115= 112,841
Closing WIP = (25,000 ×4.0208) + (15,000× 2.3594) + (15,000× 2.8313) = 178,381

Solution 2:
XYZ limited

Equivalent Units:
Previous Direct
F-OH
Department Labour
Transferred out 85,000 85,000 85,000 85,000
Closing WIP 21,000 21,000 6,300(30%) 6,300(30%)
106,000 91,300 91,300

(should be complete with respect to previous department)

Cost/Unit:
Previous Department 330,000 /106,000 = 3.1132/unit
Direct labour 270,000 /91,300 = 2.9573/unit
F-OH 185,000 /91,300 = 2.0263/unit
Cost Accounted For: 8.096/unit

Department C 85,000×8.0968 688,228

c/d work in process (21,000×3.1132) + (6,300×2.9573) + (6, 300×2.0263) 96,774
Working -1
Process Account - Department B

Units Amount Units Amount

b/d -- Department-C 85,000 688,228
Previous department-(Dep A) 110,000 330,000(N-1) N. Loss (balance) 4,000
--
Direct labour 270,000
F-OH 185,000 c/d WIP 21,000 96,774
110,000 785,000 110,000 785,002

N-1: (110,000×3) = 330,000

----------( 58 )----------
A.1.
Blue Limited:
Process Account II
Units Rs. in '000 Units Rs. in '000
Opening WIP 17,500 30,000 Finished goods 200,000 401,638
Transferred from Process I 145,000 270,000
Material added in Process II 70,000 112,500 Normal loss (W- 21,720 4,344
1) [21,720×200]
Conversion cost incurred in Process Closing WIP 19,000 37,997
II - 15,000

Abnormal gain (bal.) 8,220 16,462

240,720 443,962 240,720 443,979

W-1
Opening WIP 8,600 (M100%; C.C 80%)
Opening WIP 8,900 (M 100%; C.C 40%)
Input 215,000 (145,000 + 70,000)
Closing WIP 12,300 (M 100%; C.C 70%)
Closing WIP 6,700 (M100%; C.C30%)
Stage of Inspection (M 100%; C.C 60%)

Normal Loss
8,900+215,000–6,700 = 217,200 x 10% = 21,720

Equivalent Production Units (FIFO)

Process 1 Material Conversion
8,600 - - 1,720 (20%)
Finished Goods - - 5,340 (60%)
200,000 17,500 8,900
182,500 182,500 182,500 182,500
12,300 12,300 12,300 8,610 (70%)
c/d WIP 19,000
6,700 6,700 2,010 (30%)
6,700
Abnormal gain (8,220) (8,220) (4,932) (60%)
193,280 193,280 195,248

Cost Per Unit:

Process 1 = 270,000 - 4344 = 1.3745/Unit

193,280

Material = 112,500 = 0.5821/Unit

193,280

Conversion = 15,000 = 0.0768/unit

195,248
Total 2.0334/unit

----------( 59 )----------
Cost Allocation
Finished goods = 200,000 units

From Opening 17,500 units 30,000

+ [1,720 × 0.0768] + [5,340 × 0.0768] = 542
30,542
+ [182,500 × 2.0334] = 371,096
401,638
Closing WIP: [12,300 × 1.3745] + [12,300 × 0.5821] + [8,610 × 0.0768]
+ [6,700 × 1.3745] + [6,700 × 0.5821] + [2,010 × 0.0768] = 37,997

Abnormal gain : [8220 × 1.3745] + [8220 x 0.5821] + [4932 x 0.0768] = 16,462

Answer 2:

Rose Enterprises
Accounting entries for Process B:

Process-B 26,676
Process-A 14,000
Raw material 7,000
Conversion 5,600
Normal loss 76

Finished Goods 26,826

Abnormal loss 254
Process-B 27,080

Normal Loss 76
cash 76

Abnormal Loss 14
cash 14

(850/1 x 0.8 x 20 ) = 14 (rounded in 000)

Total cost of abnormal loss to be transferred to profit and loss (257+14) = 271

Workings:
Process-B Rs. ‘000’
Litres Amount Litres Amount
b/d [1,500 + 600+ 400] 8,000 2,500 Finished Goods (Bal.) 89,875 26,828
Process A 85,000 14,000 Normal Loss (Working-1) 4,775 -
Material 10,000 7,000 Abnormal Loss 850 254
(4500/0.8–4775)
Conversion 5,600
Disposal cost of normal 76 c/d 7,500 2,098
loss (w-2)
103,000 29,176 103,000 29,180

(w-1) Calculation of Normal Loss:

Opening WIP (100% M; 80% C.C) 8,000
Input for the month (85,000 + 10,000) 95,000
Closing WIP (100% M; 70% C.C) 7,500
Inspection Stage (100% M; 100% C.C)

(8000+95000-7500) x 5% =4,775

----------( 60 )----------
(w-2) Disposal cost of Normal Loss:
[4,775/1x 0.8 x 20] = 76,400

Equivalent Production Units:

Process A Material Conversion

Finished Goods 89,875 89,875 89,875 89,875
Abnormal Loss 850 850 850 850
C/d WIP 7,500 7,500 7,500 5,250 (70%)
98,225 98,225 95,975

Cost/unit:
Process – A: 1,500 + 14,000 +76 /98,225 = 0.1586/unit
Material: 600 + 7,000/98,225 = 0.0774/unit
Conversion: 400 + 5,600/95,975 = 0.0625/unit
0.2985/unit

Cost Allocation:
Finished Goods (89875 x 0.2985) = 26,828
Abnormal Loss (850 x 0.2985) = 254
C/D WIP (7,500 x 0.1586) + (7500 x 0.0774) + (5,250 x 0.0625) = 2,098

----------( 61 )----------
Test question:
Q.1 Rafiqi Industry Limited (RIL) produces a product which passes through two departments, A and B. The details
relating to its production during the month of February 2023 is as follows:

Department A Department B
Description Material Conversion Material Conversion
Units Units
------- Rs. in '000 ------- ------- Rs. in '000 -------
Opening WIP 20,000 120,000 32,000 144,000 36,000
(100% complete) (40% complete) 18,000 (100% complete) (60% complete)
Input during the
155,000 - - - - -
month
Received from A - - - 140,000 ? ?
Costs for the month - 920,400 673,650 - 194,900 445,500
Transferred out 140,000 ? ? 120,000 ? ?
Closing WIP 25,000 ? ? 30,000 ? ?
(100% (60% (100% (80%
complete) complete) complete) complete)

Other information:
(i) RIL uses FIFO method for valuation of its inventories.
(ii) Rejected units are sold on an “as is, where is” basis. During the month, proceeds from sale of rejected
units in departments A and B were Rs. 4 million and Rs. 6 million respectively.
(iii) In both departments:
▪ 100% material is added at the start of the process.
▪ units are inspected when 90% complete as to conversion.
▪ normal loss is 5% of units transferred out.

Required:
(a) Compute equivalent production units. (10)
(b) Compute the cost of finished goods, closing WIP and abnormal loss/gain. (10)

A.1
Rafiqi Industry Limited

Department A:
a) Equivalent production units:
Material Conversion
20,000 - 12,000(60%)
Process B 140,000 120,000 120,000 120,000
Abnormal Loss 3,000 3,000 2,700(90%) (inspection stage)
C/d WIP 25,000 25,000 15,000(60%)
148,000 149,700

Cost per unit: (FIFO)

𝟗𝟐𝟎,𝟎𝟎𝟎−𝟐,𝟖𝟎𝟎
Material: = 6.20 per unit
𝟏𝟒𝟖,𝟎𝟎𝟎
𝟔𝟕𝟑,𝟔𝟓𝟎
Conversion: = 4.5 per unit
𝟏𝟒𝟗,𝟕𝟎𝟎
.
Total = 10.7 per unit

----------( 62 )----------
b) Cost Allocation:
Process B 140,000 units
From opening 20,000 units 152,000
+ 12,000 x 4.5 54,000
206,000
+ 120,000 x 10.70 1,284,000
Total 1,490,000

Abnormal loss [3,000 x 6.2 + 2,700 x 4.5] 30,750

c/d WIP [25,000 x 6.2 + 15,000 x 4.5] 222,500

Department B

a) Equivalent Production unit:

Process A Material Conversion

18,000 - - 7,200(40%)
Finished goods 120,000
102,000 102,000 102,000 102,000
Abnormal Loss 2,000 2,000 2,000 1,800(90%) (Inspection stage)

c/d WIP 30,000 30,000 30,000 24,000(80%)

134,000 134,000 135,000

Cost per unit: (FIFO)

Process A 1490,000−4,500 = 11.0858 per unit
134,000

Material 194,900 = 1.4545 per unit

134,000

Conversion 445,500 = 3.30 per unit

135,000
Total = 15.8403 per unit

b) Cost Allocation:

Finished Goods = 120,000 units

From opening 18,000 180,000
+ 7,200 x 3.3 23,760
203,760

+ 102,000 x 15.8403 1,615,711

Total 1,819,471

Abnormal Loss [2,000 x 11.0858 + 2,000 x 1.4545 + 1,800 x 3.30] 31,021

c/d WIP [3,000 x 11.0858 + 30,000 x 1.4545 + 24,000 x 3.30] 455,409

----------( 63 )----------
Workings:
Process account A Rs.000
Units Amounts Units Amount
b/d 20,000 152,000 Process B 140,000 1490,000
(120,000+32,000)
Material 155,000 920,400 Normal Loss 7,000 2,800 (7,000 x
400(working
below))
(140,000 x 5%)
Conversion 673,650 Abnormal 3,000 30,750
loss
(bal.)
c/d 25,000 222,500
175,000 1,746,050 175,000 1,746,050

4,000,000
Per unit recovery value: = 400/unit
7,000+3,000

Process Account - B Rs. In ‘000’

Units Amount Units Amounts
b/d 18,000 180,000 Finished 120,000 1,819,471
(144,000+36,000) Goods
Process A 140,000 1490,000 Normal 6,000 4,500 (6,000 x
loss 750(working
below))
(120,000 x 5%)
Material 194,900 Ab. 2,000 31,021
Loss(bal).
Conversion 445,500
c/d 30,000 455,409
158,000 2,310,400 158,000 2,310,401

6,000,000
Per unit recovery value: = 750/unit
6,000+2,000

----------( 64 )----------
Q. Hercules Chemical Company Limited is engaged in the production of chemicals using two processes.
Chemical T is used in Process 1, which produces chemicals L and M along withby-product N, in the ratio of
6:5:1. However, there is a wastage of 10% at Process 1 due to evaporation loss, identified at the end of the
process.

Chemical M undergoes further processing in Process 2, where it is combined with the chemical V to produce
chemical P. 15% of the input is produced as waste, identified at the end of the process, which needs to be
disposed of at a cost of Rs. 50 per litre.

The following data pertains to the month of August 2023:

Process 1 Process 2
Descriptio
n ----------- Litres -----------
Input of Chemical T (Cost per litre – Rs. 240) 20,000 -
Input of Chemical V (Cost per litre – Rs. 180) - 1,750
Production:
– Chemical L 8,700 -
– Chemical M 7,250 -
– Chemical N 1,450 -
– Chemical P - 7,650
– Chemical waste 1,350

Direct labour (Rs. 350 per hour) 12,000 hours -

Direct labour (Rs. 300 per hour) - 2,000 hours

Additional information:
(i) Joint costs are allocated on the basis of net realizable value at the split-off point.
(ii) The net realisable value of the by-product N is credited to Process 1.
(iii) Factory overheads are applied at a rate of 180% of the direct labour cost in bothprocesses. There
were no under/over absorbed factory overheads.
(iv) There was no opening or closing work-in-process inventory.
(v) There was no opening inventory of finished goods. However, 500 litres of L and 400 litres of P
remained unsold at the end of the month.
(vi) The sale prices of the chemicals are as follows:

Sale price
Direct selling costs
(Rs. per litre)
Chemical L 5,000 Rs. 500 per litre plus 4% commission
Chemical N 1,000 Rs. 40 per litre
Chemical P 7,000 Rs. 600 per litre plus 5% commission

Required:
Prepare the following ledger accounts:
(a) Work-in-process - Process 1 (11)
(b) Work-in-process - Process 2 (05)

----------( 65 )----------
A.
Hercules Chemical Company Limited
Process 1
Liters Rupees Liters Rupees
Chemical T 20,000 4,800,000 Transferred to finished 8,700 6,699,292
(20,000×240) goods inventory (W-1)
(Chemical L)
Direct labor 4,200,000 WIP-2 (Chemical M) 7,250 7,918,811
(12,000×350) (W-1)
FOH applied 7,560,000 Finished goods by- 1,450 1,392,000
(4,200,000×180%) Product N (W-1)
Normal loss 2,000 -
(20,000×10%)
Abnormal loss 600 549,897
(Bal. fig.) (W-1)
20,000 16,560,000 20,000 16,560,000

Process 2
Liters Rupees Liters Rupees
WIP-1 7,250 7,918,811 Finished goods 7,650 9,981,311
(Chemical M) (Chemical P)
Chemical V 1,750 315,000 Chemical waste
(1,750×180) [7250+1750]×15% 1,350
[Also given which
means expected is
actual] (1350×180%)
Direct labor 600,000
(2,000×300)
FOH applied 1,080,000
(600,000×180%)
Disposal cost 67,500
(1,350×50)
9,000 9,981,311 9,000 9,981,311

w-1

Chemical V 1750 L
Process 1
20,000 L L 8,700 L
M 7,250 L
N 1,450 L [By-product]
Normal loss 2000 (20000×10%)
Process 2 P[7,650L]
Abnormal loss 600L waste [1,350L]
Note 1: All input is tested as inspection stage is at the end.
Note 2: waste: (7,250+1,750) x 15% = 1,350 L

----------( 66 )----------
W-1.1
Process I Process II

Direct Material (Chemical T) 4,800,000 Direct material 315,000

(20000×240) (1750×180)
(Chemical V)
Direct Labor (12,000×350) 4,200,000 Direct labour 600,000
(2000×300)
F.OH (4,200,000×180%) 7,560,000 F.OH 1,080,000
(600000×180%)
Total 16,560,000 1,995,000

less: Recovery value of by- Add: Disposal 67,500

product [1450×960](1000-40) (1,392,000) cost of Normal
loss (1350×50)
Net cost 15,168,000 Total 2,062,500

less: Cost of Ab. Loss

[15,168,000/(8700+7250+600)×60 (549,897)
0
Net joint cost (to be allocated) 14,618,103

W-2 Allocation table

Unit Sale Sale Further Sale Selling expense
produced price per value processing value at
liter cost split off
Chemical 43,500,0 - 43,500,0 6,090,000
L 8,700 5,000 00 00 (8,700×(500+200)(5,000
×4%)
Chemical 53,550,0 2,062,500 (w- 51,487,5 7,267,500
P 7,650 7,000 00 1.1) 00 (7,650×(600+350)(7,000
×5%)

NRV Allocation
Chemical L 37,410,000 6,699,292
Chemical P 44,220,000 7,918,811
Total 81,630,000 14,618,103 (w-1.1)

----------( 67 )----------
Variance analysis
Fixed Budget:
The original budget prepared at the beginning of the period is known as fixed budget. A fixed budget is a
budget for a specific volume of output and sales activity, and it is the “master plan” for the financial year
that the company tries to achieve.
For example: A company has budgeted to make and sell 1000 units in January.
Selling price/unit is budgeted at Rs 15.
Budget prepared for January is as follows:
Sales (1000 x 15) 15,000
Cost of Sales
Material (1,000 x 2kg @ 3/kg) 6,000
Labor (1,000 x 1hr @ 2.4/hr) 2,400
Variable overheads (1,000 x 1hr @ 0.96/hr) 960
Fixed overheads (1,000 x 2.4/unit) 2,400
(11,760)
Gross Profit 3,240

Fixed overhead Absorption rate = Budgeted fixed overheads = 2,400 = 2.4/unit

Budgeted units 1,000

One of the main purposes of budgeting is to control costs by comparing budgets with actual results.
Actual results: (At the end of January)

Suppose actual units produced and sold are 900.

Sales (900 x 16) 14,400
Cost of Sales
Material (900 x 1.8kg @ 3.5/kg) 5,670
Labor (900 x 1.2hr @ 2/hr) 2,160
Variable overheads (900 x 1.2hr @ 1/hr) 1,080
Fixed overheads Actual 2,500
(11,410)
Gross Profit 2,990

Sales = Actual quantity sold x Actual Rate

= AQS x AR
Material = Actual quantity used x Actual Rate
= AQU x AR
Labor = Actual hour worked x Actual Rate
= AHW x AR
Variable overhead = Actual hour worked x Actual Rate
= AHW x AR
Fixed overheads = Actual

----------( 68 )----------
Variances cannot be calculated by comparing actual results to the fixed budget directly because the figures
relates to different levels of activity. Therefore, a second budget is drawn up at the end of the period (for
comparison) called as flexed budget. It is a budget based on actual level of activity using budgeted sale
rupees/unit and Standard cost/unit. For example flexed budget at 900 units level will be as follows:
Sales (900 x 15) 13,500
Cost of Sales
Material (900 x 2kg @ 3/kg) 5,400
Labor (900 x 1hr @ 2.4/hr) 2,160
Variable overheads (900 x 1hr @ 0.96/hr) 864
Fixed overheads (900 x 2.4) 2,160
(10,584)
Gross Profit 2,916

Sales = Actual quantity sold x Standard Rate

= AQS x SR
Material = Standard quantity used for actual production x Standard Rate
= SQU x SR
Labor = Standard hour worked for actual production x Standard Rate
= SHW x SR
Variable overhead = Standard hour worked for actual production x Standard Rate
= SHW x SR
Fixed overheads = Actual Production x Standard Rate

Comparison of Actual Results with Flexed Budget:

Flexed Actual Variance
Units Produced/sold 900 900
Sales 13,500 14,400 900 F
Cost of Sales
Material 5,400 5,670 270 A
Labor 2,160 2,160 -
Variable overheads 864 1,080 216 A
Fixed overheads 2,160 2,500 340 A
(10,584) (11,410)
Gross Profit 2,916 2,990 74 F

----------( 69 )----------
Subdivision of variances:
Material

SQU for AP x SR
AQU for AP x AR
=900x2x3
=900 x 1.8 x 3.5/kg
=5,400
=5,670

AQU for AP x SR
=900x1.8x3
=4,860

Total Material Variance

Std. Cost Actual Cost

Total material (SQU for AP x SR) (AQU for AP x AR)

Variance
900 x 2 x 3 900 x 1.8 x 3.5
5,400 5,670

270A

= (SQU - AQU) x SR (SR – AR) AQU for AP

[(900 x 2) – (900x1.8)]x3 (3 – 3.5) x (900 x 1.2)
= 540F 180A
Material Usage variance Material Price Variance

----------( 70 )----------
 Labor Variance

SHW for AP x SR
AHW for AP x AR
=900x1x2.4
=900x1.2x2
=2,160
=2,160

AHW for AP x SR
=900x1.2x2.4
=2,592

Std. Cost Actual Cost

Total Labor Variance (SHW for AP x SR) - (AHW for AP x AR)

(900 x 1 x 2.4) - (900 x 1.2 x2)

NIL

= (SHW - AHW) x SR (SR – AR) AHW for AP

= (900x1) – (900x1.2) x2.4 = (2.4 – 2) x (900x1.2)
=432A =432F
Labor efficiency variance Labor Rate variance

Total Variable OH Variance

Std. Cost Actual Cost

Total variable OH (SHW for AP x SR) - (AHW for AP x AR)

Variance
(900 x 1 x 0.96) - (900 x 1.2 x1)
= 864 - 1080
216A

Variable OH Efficiency Variable OH Expenditure/

variance spending variable
= (SHW - AHW) x SR (SR – AR) AHW for AP
= (900 - 1080) x0.96 = (0.96 – 1) x (900x1.2)
=172.8 A =43.2 A

----------( 71 )----------
Q. 1 EPSN enterprises manufactures a food product, Details of which are as under:
Standard cost per unit
Materials 60 Kgs. @ Rs.48 per kg
Labor 480 Hours @ Rs.8 per hour
Actual cost for the month:
Material 5,900 Kgs. @ Rs.50 per kg
Labor 47,500 hours @ Rs.9 per hour
Actual production 100 units

Required:
(a) Compute the material and labor cost variances.
(b) Reconcile the standard and the actual cost of material and labor.

Total fixed overheads variance:

Actual/Applied

Actual overheads Actual production x SR

2,500 900 x 2.4 = 2,160

340A
Under absorbed is adverse variance because actual production is less or actual expense is more.
Over absorbed is favorable variance because actual production is more or actual expense is less.
For example: let assume:
= Budgeted fixed overheads / budgeted production
= 100,000 / 1,000
= 100 / unit (fixed overheads absorption rate)
(a) Suppose actual production is 900 x 100 = 90,000 (applied) and if actual expenditure is still 100,000
(equal to budgeted) then difference is due to production.
(b) Suppose actual production is 1,000 (equal to budgeted) x 100 = 100,000 (applied) and if actual
expenditure is 120,000 (not equal to budgeted) then difference is due to expenditure.

Subdivision of Total Fixed OH Variance

Actual overheads Actual production x SR

2,500 900 x 2.4 = 2,160

Budgeted
overheads
1,000 x
100 A 2.4 240 A
=2,400

----------( 72 )----------
Fixed overheads expenditure variance Fixed overheads volume variance
Actual overheads Budgeted overheads
2,500 2,400
(1,000 x 2.4)
Budgeted overheads Actual production x SR
2,400 2,160
(1,000 x 2.4) (900 x 2.4)

100 A 240 A
How much expense was expected and how much It measures the difference in actual production
is actually incurred. If actual fixed overheads are and budgeted production. If actual production is
more; then adverse otherwise favorable. more; then favorable otherwise adverse.

Q.2 M/s Gamma & Sons produces only one product by the name ‘'Gamma" and the standard'
manufacturing cost of the product is as under:
Direct material (4kg @ Rs.3 per kg) 12
Direct labor (5 hours @ Rs.4 per hour) 20
Variable Overhead 5
Fixed Overhead 15
Total standard per unit cost 52
The budgeted quantity to be produced is 10,000 units and actual production was 9,500 units. The actual
consumption and cost during the period was as under:
Rs.
Direct material cost (37,000 kg) 120,000
Direct labor (49,000 hours) 200,000
Variable Overheads 47,000
Fixed Overheads 145,000
512,000
There was no stock of work in process or finished goods at the beginning or end of the period.
Required:
You are required to calculate the relevant cost variances.

----------( 73 )----------
 Subdivision of Fixed OH volume variance
Data from M/S Gamma & Sons
Fixed OH Volume variance

Budgeted FOH Applied FOH

Budgeted prod x S.R Actual prod x SR
= 10,000 x 15 = 9,500 x 15
= 150,000 = 142,500

7,500 A Because of decrease in actual units

The above variance can also be calculated in hours for more detailed analysis as follows:

Budgeted capacity Std. hrs for AP x SR

hrs x SR = 9,500 x 5 x 3
= 10,000 x 5 x 3 = 142,500
= 150,000
7500A
Actual Consumed
hrs for AP x SR
= 49,000 x 3
= 147,000

Fixed overheads Capacity Variance Fixed overheads Efficiency variance

Budgeted capacity hrs x S.R Actual hrs worked (consumed) x S.R
Actual Hrs worked (Consumed) x S.R Std. hrs for A.P x S.R
How much capacity in terms of hours should be How much hours should be utilized for actual
used (50,000) and how much capacity has actually production (i.e 47,500) and how much hours have
been used (49,000) actually been consumed (i.e 49,000)
If actual capacity in term of hours is utilized more; It If actual consumed hrs are more than adverse;
is favorable otherwise adverse otherwise favorable.

----------( 74 )----------
Q.3 Brain Ltd produces and sells one product only, the Blob, the standard cost for one unit being as
follows:
Rs.
Direct material A (10 kilograms at Rs 20 per kg) 200
Direct material B (5 liters at Rs 6 per liter) 30
Direct wages (5 hours at Rs 6 per hour) 30
Fixed production overhead (5 hours at Rs 10 per hour) 50
Total standard cost 310
The fixed overhead included in the standard cost is based on an expected monthly output of 900 units.
Fixed production overhead is absorbed on the basis of direct labor hours.
During April, the actual results were as follows:
Production 800 units
Material A 7,800 kg used, costing Rs.159,900
Material B 4,300 liters used, costing Rs.23,650
Direct wages 4,200 hours worked for Rs.24,150
Fixed production overhead Rs.47,000
Required:
a) Calculate price and usage variances for each material.
b) Calculate labor rate and efficiency variances.
c) Calculate fixed production overhead expenditure and volume variances and then subdivide the
volume variance.

----------( 75 )----------
IDLE TIME VARIANCE
Generally Actual Hours Worked = Actual Hours Paid but if there is idle time (time when the employees are
being paid but there is no work to do, e.g there is no light or shortage of orders for production) actual Hours
Paid may be more than Actual Hours Worked.
Example:
Idle Time Variance:
Std Labour Cost / unit = (4 hrs × 500/hr) = 2,000 / unit
Actual production = 1000 units
Labour hours paid for = 4,200 hours at a cost of = Rs. 2,121,000
Labour hours worked = 4,100 hours.
Total Labour Variance = (SHW for A.P × S.R) – (AHP × A.R)
 2,121,000 
= (1,000 × 4 × 500) –  4,200  
 4,200 
= 2,000,000 – 2,121,000 = 121,000 A

(SR – A.R) × AHP (SHW – AHP) × S.R

 2,121,000 
 500   × 4,200 (1,000 × 4 – 4,200) × 500
 4,200 
21,000 A 100,000 A

Idle Time variance Efficiency variance

(AHP – AHW) × S.R (SHW – AHW) × S.R
(4,200 – 4,100) × 500 (1,000 × 4 – 4,100) × 500
50,000 A 50,000 A
• Idle hours are not considered while calculating variable overheads variances because it is usually
assumed that variable overheads are incurred during actual working hours and are not incurred
during idle time (e.g if machine is not running then power is not consumed. This mans if labour is
paid for 820 hours but only worked for 760 hours, use actual hours worked (means without idle
time) for variable overhead variances.
• Same rule is for fixed overhead variances.

SALES VARIANCE [there is no concept of calculating total sales variances]

These variances are calculated on the basis of finished goods units.

Sales Volume variance / sales volume Sales Price Variance

profit variance
(Budgeted units sold – Actual Units sold) × [BR – AR] × Actual units sold
Std. Profit / unit
It measures the increase / decrease in It measures the effect on expected profit of a
expected profit as a result of sales volume selling price different to budgeted selling price.
being higher or lower than budgeted.

----------( 76 )----------
Example:
A Company has the following budgeted and actual figures:
Budget Actual
Sales Units 600 620
Selling Price / Unit 30 29
Standard cost of production = 28 / unit.
Required:
Calcualte sale variances.
(a) Sales Volume Variance:
(600 – 620) × 2*
= 40 F
*(30 – 28)
(b) Sales Price Variance:
(30 – 29) × 620
= 620 A

Moongazer At the end

A.
If there is a stock of raw material and it is measured at std. cost then material price variance should be
calculated on AQP rather than AQU.
Budgeted Gross Profit = (100 – 77) × 450 = 10,350
MOON GAZER
Actual Gross Profit
Rs. Rs.
Sales 47,300
Less: Cost of Sales:
Material 17,700
Less: Closing Inventories (125 × 15*) (1,875)
15,825
Labour 14,637
Variable OHs 3,870
Fixed OHs 2,400 36,732
Actual Gross Profit 10,568
*(at Std. Cost as per Question)
Sales Variance

Price Volume
(BR – AR) × AQS (BQS – AQS) × Std profit /unit
 47,300 
100   × 430 (450 – 430) × 23
 430 
4,300 F 460 A

----------( 77 )----------
 Material

(SR – AR) × AQP (SQU – AQU) × S.R

 17,700 
15 −  × 1,200 (430 × 2 – 1,075) × 15
 1,200 
300 F 3,225 A
Labour

 14,637 
 8.5 −  × 1,700 (430 × 4 – 1,700) × 8.5
 1,700 
187 A 170 F
Variable OHs

 3,870 
2 −  × 1,700 (430 × 3 – 1,700) × 2
 1,700 
470 A 40 F
Fixed OHs

Budgeted F-OH 2,250 Budgeted F-OH 2,250

Actual F-OH 2,400 Actual × S.R 2,150
150 A 100 A

Budgeted Gross profit 10,350

Sale Price variance 4,300 F
Sale volume variance (460) A
Cost Variances:
Price variance 300 F
Usage variance (3,225) A
Rate variance (187) A
Efficiency variance 170 F
V-OH – Expenditure variance (470) A
V-OH - Efficiency variance 40 F
F-OH – Expenditure variance (150) A
F-OH – Volume variance (100) A
Actual Gross Profit 10,568

----------( 78 )----------
Extra practice question Jack and Jill
Q.4 Hulk Limited (HL) produces and markets a single product. The company uses standard costing
system. Following is the standard cost card per unit of the finished product:

Direct material 2.8 kg at Rs. 6.75 per kg

Direct labour Rs. 150 per hour
Variable production overheads Rs. 12 per direct labour hour
Fixed production overheads Rs. 18 per direct labour hour

The standard labour hours required for producing one unit of finished product is 30 minutes whereas HL’s
standard operating capacity per month is 15,000 hours.
Actual results for the month of February 2013 were as under:

Direct material @, RS. 6.25 per kg Rs. 504,000

Direct labour Rs. 160 per hour
Variable production overheads Rs. 175,000
Fixed production overheads Rs. 17 per direct labour hour

Actual labour hours consumed by HL for producing 27,000 units was 33 minutes per unit of finished
product.

Required:
• Compute material, labour and overhead variances. (14)
• List any four causes of unfavourable material price variance. (02)
• Reconcile the budgeted expenditure of actual production with actual expenditure.

Discussion of Combined Factory Overhead Expenditure Variance (means sum of VOH Expenditure
+ FOH Expenditure)[this is required if breakup of variable factory overheads and fixed overheads is
not available]
Data from ABC Ltd. At the end Q.6
Factory overheads expenditure Variance
VOH

Expenditure
(SR – AR) × AHW
 26,000,000 
= 25 − × 990,000 = 1,250,000 A
 990,000 

OR AHW × SR = 990,000 × 25 = 24,750,000

26,000 ,000
AHW × AR = 990,000 × = 26,000,000
990 ,000
1,250,000 A

Fixed OH

Expenditure
Actual fixed overheads = 5,100,000
Budgeted fixed overheads = 5,000,000
(500,000 × 10) 100,000 A

----------( 79 )----------
If suppose actual factory overheads are given combined e.g. factory overheads = 31,100 (26,000 + 5,100)
or question requires four overhead variances; then a combined factory overhead expenditure variance can
be calculated as follows:
(Rs. 000)
Actual factory overheads 31,100
Less: Std. Cost of Factory overheads
From Variable overheads: AHW × SR (990,000 × 25) 24,750

From fixed overheads: Budget Production × SR (500,000 × 10) 5,000

29,750
1,250 A
Answer will be equal to sum of variable overheads expenditure and fixed 1,350 A
overheads expenditure variance
100 A
Similarly in Excellent Ltd.
Actual factory overheads (310,000 +290,000) 600,000
Less: Std. Cost of Factory overheads
From Variable overheads: AHW × SR (25,000 x 15) 375,000

From fixed overheads: Budget Production × SR (45000 × 6.5) 292,500

667,500
65,000 F
Answer will be equal to sum of variable overheads expenditure and fixed 67,500 F
overheads expenditure variance
2,500 F

----------( 80 )----------
 Mix & Yield Variances
Material Total Variance
 
Price Usage
 
Mix Yield
(If material are substitutable i.e less of on type of
material can be compensated for by more of
another)

Material usage variance can be subdivided into material mix and yield variance, when more than one
material is used in a product.
Example: A company uses two materials F & B to manufacture a chemical. The standard material usage
and cost of one bottle of chemical are as follows
F 5 kg @ 2/kg 10
B 10 kg @ 3/kg 30
15 kg 40

In the month of March, 80 bottle of chemicals are produced from:

Scenarios
i) 450kgs of F and 750kg of B
ii) 410kgs of F and 820kgs of B; or
iii) 500kgs of F and 730kgs of B
i)
SQ in SM for AQ in AM for
AP AP
F 400 450
(80 x 5)
B 800 750
(80 x 10)
(80 x 15) 1,200 1,200

No problem of quantity of materials used for output (yield) only problem, is quantity of materials have not
been mixed according to standard. So mix variances exist. (Problem of mixing of materials for output)
ii)
SQ in SM for AQ in AM for
AP AP
F 400 410
(80 x 5)
B 800 820
(80 x 10)
(80 x 15) 1,200 1,230

No problem of mixing, mixing is in standard proportions but quantity of materials used for output is different
than what it should be. So Yield variance exist (problem of quantity of materials for output).

----------( 81 )----------
iii)
SQ in SM for AQ in SM for AQ in AM for
AP AP AP
F 400 410 500
(80 x 5) (1,230 x 5/15)
B 800 820 730
(80 x 10) (1,230 x 10/15)
(80 x 15) 1,200 1,230 1,230
In the above scenario, neither mix nor yield is standard so both variances.

A) Mix Variances (Problem of Mixing of materials for output)

It is the differences between:
1) How much actual materials should have been mixed according to standard mix for actual
production (AQU in SM for AP) and
2) How much actual materials have been actually mixed for actual production (AQU in AM for
AP).
B) Yield Variance: (Problem of quantity of material used for output)
It is the difference between:
1) How much standard material in standard mix should have been used for actual production
(SQU in SM for AP) and
2) How much actual material in standard mix should have been used for actual production (AQU
in SM for AP)
As 1 in mix variance and 2 in yield variance are same so a table can be constructed as follows:
A B C
SQU in SM for AP AQU in SM for AP AQU in AM for AP

Yield Variance Mix Variance

(A - B) x SR (B - C) x SR
Usage Variance
(A - C) x SR

Usage Variance:
(A – C) × S.R
F (400 – 500) × 2 = 200 A
B (800 – 730) × 3 = 210 F
10 F

Mix Variance:
(B – C) × S.R
F (410 – 500) × 2 = 180 A
B (820 – 730) × 3 = 270 F
90 F
Yield Variance:
(A – B) × S.R
F (400 – 410) × 2 = 20 A
B (800 – 820) × 3 = 60 A
80 A

----------( 82 )----------
Q.7 Pelican Limited produces and markets a single product Zeta. The company uses a standard costing
system. Following is the standard material mix for the production of 400 Units of Zeta.
Weight (Kg.) Standard rate per Kg.
(Rs.)
Material A 30 240
Material B 25 320

Actual costs on the production of 192 units of Zeta for the month of August 2011 were as follows:
Weight (Kg.) Actual rate per Kg. (Rs.)

Material A 16 230
Material B 13 308

Required:
Calculate the following material variances, from the above data:
(i) Cost variance (ii) Price variance (iii) Mix variance
(iv) Yield variance (v) Usage variance

Q. 8 GHI Company produces 817 kg 'Y’ for which following standard chemical mix is used:

Material Standard Qty (kg) Standard Rate Per kg

(Rs)
A 750 38.00
B 150 53.00
C 50 59.50

Purchase department, knowing the standard mix, made efforts for reducing the average price of material mix
and achieved the result as under;
Material Rate
A 37.00
B 56.25
C 62.75
Production department concentrating on yield aspect experienced a different ratio of raw material mix and
got 876 kgs out of following mix:
Material Qty (kgs)
A 750
B 185
C 65

Required:
Find out the effect off deviation from standards by calculating:
(a) Price Variance
(b) Mix Variance
(c) Yield Variance

----------( 83 )----------
Discussion of marginal and absorption costing:
Absorption Costing:
In Absorption costing, fixed production overheads are included in the cost of production (and therefore to
closing stock). Therefore fixed production overheads are charged in the income statement of the period in
which inventory is sold. [Fixed production overheads are treated as product cost].
Marginal Costing:
In marginal costing, fixed production overhead are not included in cost of production (and therefore to
closing stock). Therefore fixed production overheads are charged in the income statement of the period in
which they are incurred. [Fixed production overheads are treated as a period cost].
Sometimes costs of the business are presented in income statement according to variable and fixed for the
purpose of decision making.
Important points to remember:
 Variable cost varies with production/sale; therefore controllable with production / sale decisions.
 Fixed cost remains constant irrespective of production and sales; therefore not controllable with
production / sale decisions.

Example:
A company makes and sells a single product:
Rs.
Selling price / unit 150
Variable cost per unit:
Direct material 35
Direct labour 25
Variable production overheads 10
70
Fixed production overheads 110,000/month
Variable Admin & Selling Expenses 5 / unit sold
Fixed Admin & Selling Expenses 20,000 / month
Units Production 2,000
Units Sold 1,500
Assume that there was no opening stock of finished goods.
Required:
Prepare statement of profit or loss for the month using;
(a) Absorption Costing Technique.
(b) Marginal Costing Technique.

----------( 84 )----------
STANDARD MARGINAL COSTING:
Previous discussion relates to companies; using standard total absorption costing.
Now we discuss what happens when a company uses std. marginal costing instead.
Marginal costing variances are calculated exactly as before with two important differences:
(a) Sales Volume Variance is calculated as follows:
(Budgeted Units Sold – Actual Units Sold) × Std. Contribution / Unit*
*(Std. Contribution / Unit = Sale price / Unit – Variable Cost / Unit)
(b) In marginal costing, fixed costs are not absorbed into product costs and so there is no fixed cost
variance to explain any under / over absorption of overheads. There will therefore be no fixed
overheads volume variance (and if no volume variance then no subdivision will be relevant). There
will only be fixed overhead expenditure variance which is calculated in exactly the same way as for
absorption costing system.
CARAT At the end
Lettuce At the end (Marginal Costing)
Solution:
(a)
Budgeted Profit (W-1) 5,700
Budgeted Fixed Cost 6,000
Budgeted Contribution 11,700
Sale Price 2,200 F
Sale Volume 1,800 A
Variable Cost Variances:
Material Price 3,300 A
Material Usage 3,200 A
Labour Rate 180 F
Labour Efficiency 1,200 A
V OH. Expenditure 900 A
V OH. Efficiency 900 A
Actual Contribution 2,780
Budgeted Fixed Cost 6,000
Fixed Overhead Expenditure 2,000 F (4,000)
Actual Loss (W 2) (1,220)

Calculation of variances:
Sale

(BR – AR) × AQS (BQS – AQS) × Std

Contribuiton/unit
 57,200 
 50 −  × 1,100 (1,300 – 1,100) × 9
 1,100 
2,200 F 1,800 A

----------( 85 )----------
 Material

(SR – AR) × AQP (SQU – AQU) × SR

 29,700 
4 −  × 6,600 [(1,100 × 5) – 6,300) × 4
 6,600 
3,300 A 3,200 A
Labour

(SR – AR) × AHW (SHW for AP – AHW) × SR

 14,220 
4 −  × 3,600 (1,100 × 3 – 3,600) × 4
 3,600 
180 F 1,200 A
VOH

(SR – AR) × AHW (SHW – AHW) × SR

 11,700 
3 −  × 3,600 [(1,100 × 3) – 3,600) × 3
 3,600 
900 A 900 A
FOH

Budgeted FOH 6,000 No Volume Variance

Actual F OH 4,000
2,000 F
WORKING:
W-1 Budgeted Profit (Marginal costing)
Sales (1,300 × 50) 65,000
V. Cost of Sales
Opening Stock
Cost of goods manufactured:
Material 1,300 × 20 26,000
Labour 1,300 × 12 15,600
VOH 1,300 × 9 11,700
(53,300)
Gross Contribution 11,700
Fixed Cost 6,000
Budgeted profit 5,700

OR
* Sale price per unit 50
Variable cost per unit 41
Contribution per unit 9
(1,300 × 9) 11,700
Fixed Cost 6,000
Budgeted profit 5,700

----------( 86 )----------
W 2 ACTUAL PROFIT/LOSS
Sales 57,200
Less: Variable Cost of sales
Opening Stock --
Cost of goods manufactured:
Raw Material Purchase 29,700
Closing Stock (300 × 4) (1,200) 28,500
Direct Labour (14,220)
VOH (11,700)
(54,420)
Contribution 2,780
Fixed Cost (4,000)
Actual Loss (1,220)

(b) If company uses absorption costing with a direct labour hour absorption rate, we can calculate a
fixed overheads volume variance and then can sub-divide it.
The first step is to calculate budgeted absorption rate / hour.
Budgeted labour hours = 1,300 × 3 = 3,900 hrs.
Budgeted fixed cost = 6,000
Budgeted Absorption rate = 6,000 / 3,900 = 1.54/hr
OR 6,000/1,300 = 4.61/unit (1.54 * 3)
Fixed OH Expenditure Variance will be same
Volume Variance
1,300 × 4.61 6,000
1,100 × 4.61 5,077
923 A
923 A

Capacity Efficiency
1,300 × 3 × 1.54 6,006 3,600 × 1.54 5,544
3,600 × 1.54 5,544 1,100 × 3 × 1.54 5,082
462A 462 A

 AQP = AQU ; Unless there is some stock of raw material left.

 If raw material stock are measured at std. cost then material price variance is calculated by using
actual quantity purchased. [10.7 lettuce].
 If however raw material stock is measured at actual cost then price variance should be calculated by
using actual quantity used.
 [lettuce same question except that raw stocks are to be measured at actual cost] (solution attached).
 If nothing is mentioned then assume stocks are measured at actual cost (and therefore price
variance should be on the basis of AQU)

----------( 87 )----------
Solution of same above question assuming as if raw material stock is measured at actual cost then:
Operating Statement
Budgeted Profit 5,700
Budgeted Fixed Cost 6,000
Budgeted Contribution 11,700
Sale Volume Variance 2,200 F
Sale Price Variance 1,800 A

Variable Cost Variances:

 29,700 
Material Price  4 −  × 6,300 = 3,150 A 3,150 A
 6,600 
Material Usage 3,200 A
Labour Rate 180 F
Labour Efficiency 1,200 A
V-OH Expenditure 900 A
V-OH Efficiency 900 A
Actual Contribution 2,930
Budgeted Fixed Cost 6,000
F-OH Expenditure Variance 2,000 F (4,000)
Actual Loss (Working below) (1,070)

Working of Actual Profit / Loss

Sales 57,200
Variable cost of sale:
Material 29,700
Closing Stock (300  4.5 *)
29,700 (1,350) (28,350)
*
6,600
Labour (14,220)
V-OH (11,700)
Actual Contribution 2,930
Fixed Cost (4,000)
Actual Loss (1,070)

Example:
The standard direct material cost of product X is Rs. 96 (16 kgs × Rs. 6 per kg) and the standard direct
labour cost is Rs. 72 (6 hours × Rs. 12 per hour). The following variances were among those reported in
relation to product X.
Direct material price: Rs. 18,840 favourable; Direct labour rate: Rs. 10,580 adverse
Direct material usage: Rs. 480 adverse; Direct labour efficiency: Rs. 8,478 favourable
Actual direct wages cost Rs. 171,320 and Rs. 5.50 was paid for each kg of direct material. There was no
opening or closing stocks of the material.
Required:
Calculate the following:
(a) Actual output.
(b) Actual hours worked.
(c) Average actual wage rate per hour.
(d) Actual number of kilograms purchased and used.
----------( 88 )----------
Solution of Example
Material

Price Variance Usage Variance

(SQU – AQU) × S.R
(SR – AR) × AQU
18,840 = (6 – 5.5) × AQU (480) = (SQU – AQU) × S.R
18,840 = 0.5 × AQU (480) = (SQU – 37,680) × 6
18,840
AQU = = 37,680 kg. (d) = 6 SQU – 226,080
0.5
6 SQU = 225,600
SQU = 37,600 kgs.
Per unit kgs = 16
So actual units = 2,350 (a)
Labour

Rate Variance Efficiency Variance

(SHW – AHW) × S.R
(SR – AR) × AHW
(10,580) = (S.R – AHW) – (AR × AHW) 8,478 = (SHW – 13,395) × 12
(10,580) = (12 – AHW) – 171,320 8,478 = 12 SHW – 160,740
12 AHW = 171,320 – 10,580 12 SHW = 169,218
12 AHW = 160,740 SHW = 169,218/12
AHW = 13,395 hours (b) = 14,101.5 hours
Per unit hours = 6 hrs.
So actual units = 2,350 (a)
Average Actual Wages Rate = 171,320 ÷ 13,395
= 12.79 hours (c)

Q. 10 You have recently been appointed as the Financial Controller of Watool Limited. Your immediate task
is to prepare a presentation on the company’s performance for the recently concluded year. You have
noticed that the records related to cost of production have not been maintained properly. However, while
scrutinizing the files you have come across certain details prepared by your predecessor which are as
follows:
i) Annual production was 50,000 units which is equal to the designed capacity of the plant.
ii) The standard cost per unit of finished product is as follows:
Raw material X 6 kg at Rs. 50 per kg
Raw material Y 3 kg at Rs. 30 per kg
Labour- skilled 1.5 hours at Rs. 150 per hour
Labour- unskilled 2 hours at Rs. 100 per hour
Factory overheads Variable overheads per hour are Rs. 100 for skilled labour and Rs.
80 for unskilled labour. Fixed overheads are Rs. 4,000,000.

Data related to variation in cost of materials is as under:

Material X price variance Rs. 95,000 (Adverse)
Material Y actual price 6% below the standard price
Material X quantity variance Nil
Material Y quantity variance Rs. 150,000 (Adverse)

----------( 89 )----------
 • Opening raw material inventories comprised of 25 days of standard consumption whereas closing
inventories comprised of 20 days of standard consumption.[raw material stocks are measured at
standard cost]
• Actual labour rate for skilled and unskilled workers was 10% and 5% higher respectively.
• Actual hours worked by the workers were 168,000 and the ratio of skilled and unskilled labour
hours was 3:4 respectively.
• Actual variable overheads during the year amounted to Rs. 16,680,000. Fixed overheads were 6%
more than the budgeted amount.
Required:
• Actual purchases of each type of raw materials.
• Labour and overhead variances.

Q. 11 Hexa Limited is a manufacturer of various machine parts. Following information has been extracted
from the cost records of one of its products AXE for the month of June 2014:
Standard cost per unit:
Rupees
Raw material 170.00
Direct labour (1.25 hours) 150.00
Overheads 137.50
Based on normal capacity of 128,000 direct labour hours, fixed overheads are estimated at Rs. 2,560,000.

Following information pertains to production of 100,000 units of product AXE:

Actual direct labour hours worked 130,000
Unfavorable material usage variance Rs. 820,000
Unfavorable material price variance Rs. 600,000
Actual direct labour cost Rs. 16,250,000
Actual fixed and variable overheads (fixed:
2,500,000) Rs. 15,500,000
Required:
Compute the following for the month of June 2014:
(a) Actual material cost (02)
(b) Labour variances (04)
(c) Overhead variances (10)

----------( 90 )----------
Solution:
A.3
Material Variance
Material A

Price Usage
 159,900 
20 − 7,800  × 7,800 [(800 × 10) – 7,800] × 20
 
3,900 A 4,000 F
Material B

Price Usage
 23,650
6 − 4,300  × 4,300 [(800 × 5) – 4,300] × 6
 
2,150 F 1,800 A
Labour Variances

Rate Efficiency
 24,150
6 − 4,200  ×4,200 [(800 × 5) – 4,200] × 6
 
1,050 F 1,200 A
a) Fixed OH Variance
Total Variance = Actual – Applied
= 47,000 – 800 × 50
= 7,000 A

F-OH Expenditure Variance F-OH Volume Variance

Actual = 47,000 Budgeted (900 × 50) = 45,000
Budgeted (900 × 50) = 45,000 Actual production × S.R (800×50) = 40,000
2,000 A 5,000 A

Break up of Volume variance

F-OH Capacity Variance F-OH Efficiency Variance

Budgeted capacity hrs × S.R = 900×5 ×10
45,000 Actual Consumed hrs × S.R = 4,200 × 10 = 42,000
=
Actual Consumed hrs × S.R = 4,200×10 = 42,000 Std. hrs for Actual prod.× S.R = 800×5×10 = 40,000
3,000 A 2,000 A

----------( 91 )----------
A. 8
Material Cost Variance
SQU X .S .R  AQU  A.R 
 − 
   
A [[750⁄817 × 876] 𝑋 38 − [750 𝑋37] = 2,808 F

B [[150⁄817 × 876] 𝑋 53 − [185 𝑋 56.25] =1,882 A

C[[50⁄817 × 876] 𝑋 59.5 − [65 𝑋 62.75]= 889 A

37 F
Price Usage
[S.R – A.R] × AQU [SQU – AQU] × SR
A [38 – 37] × 750 = 750 F A 750 817  876 − 750   38 = 2,058 F

B [53 – 56.25] × 185 = 601.25 A B [[150⁄817 × 876] − 185] × 53 = 1,281 A

C [59.5 – 62.75] × 65 = 211.25 A C 50  817

 
 876 − 65  59 .5 = 678 A
62.5 A 99 F
99 F
(A) (B) (C)
SQ in Std Mix for Actual AQ in Std. Mix for Actual AQ in Actual Mix for Actual
Production Product Production
750 × 876 = 804.16 1,000 × 750 = 789.47 750
817 950
150 × 876 = 160.83 1,000 × 150 = 157.89 185
817 950
50 × 876 = 53.61 1,000 × 50 = 52.63 65
817 950
1,018.6 1,000 1,000

Yield Variance (A – B) × S.R Mix Variance (B – C) × S.R

A [804.16 – 789.47] × 38 = 558 F [789.47 – 750] × 38 = 1,500 F
B [160.83 – 157.89] × 53 = 157 F [157.89 – 185] × 53 = 1,436 A
C [53.61 – 52.63] × 59.5 = 58 F [52.63 – 65] × 59.5 = 736 A
773 F 672 A

A.10
(a) Material X:
Price Variance = 95,000 A
Quantity Variance = NIL
50,000  6
Opening RM Inventory =
365 × 25 = 20,548 kgs.
50,000  6
Closing RM Inventory =
365 × 20 = 16,438 kgs.
Material Quantity Variance (usage) = (SQU for Actual Production – AQU) × S.R
0 = (50,000 × 6 – AQU) × 50
= (300,000 – AQU) × 50
50 AQU = 15,000,000
AQU = 15,000,000 ÷ 50
= 300,000 kgs.

----------( 92 )----------
 Quantity Purchased = Consumed + Closing – Opening
= 300,000 + 16,438 – 20,548
= 295,890 kgs.
Also material price variance = (SR – AR) × AQP
(95,000) = (50 – AR) × 295,890
(95,000) = 14,794,500 – 295,890 A.R
295,890 AR = 14,794,500 + 95,000
14,889 ,500
AR =
295 ,890
Actual Rate = 50.32
Actual Purchase = 295,890 × 50.32 = 14,889,500.
Material Y:
Quantity Variance = 150,000 A
50,000  3
Opening RM = × 25 = 10,274 kgs.
365
50,000  3
Closing RM = × 20 = 8,219 kgs.
365
Material Quantity Variance (usage) = (SQU for Actual Production – AQU)×S.R Rate prod.
(150,000) = (50,000 × 3 – AQU) × 30
(150,000) = (150,000 – AQU) × 30
(150,000) = 4,500,000 – 30 AQU
30 AQU = 4,500,000 + 150,000
AQU = 155,000 kgs
Quantity Purchased = Consumed + Closing – Opening
= 155,000 + 8,219 – 10,274
= 152,945 kgs.
Std. Price of Y = 30/kg.
Actual Price of Y = 30 × 94% = 28.2/kg.
Therefore actual purchase of Y = 152,945 × 28.2
= 4,313,049

(b) Skilled Labour:

Std. rate = 150/hour
Actual Rate = 165 (150 × 110%)
Std. hours required for A.P = 50,000 × 1.5 = 75,000
Actual hours spent/worked = 3/7 × 168,000 = 72,000
Total Skilled Labour Cost Variance:
Standard Labour Cost of Actual Production – Actual Labour Cost
(SHW for A.P × SR) – (AHW × A.R)
= (50,000 × 1.5 × 150) – (72,000 × 165)
= 630,000 A

Labour Rate Variance Labour Efficiency Variance

(SR – AR) × AHW (SHW for Actual Production – AHW)
(150 – 165) × 72,000 (50,000 × 1.5 – 72,000) × 150
= 1,080,000 A = 450,000 F

----------( 93 )----------
 Unskilled Labour:
Std. rate = 100/hours.
Actual rate = 105/hour (100 × 105%)
Std. hours required = 50,000 × 2 = 100,000
Actual hours = 4/7 × 168,000 = 96,000
Total Unskilled Labour Cost Variance:
Standard Labour Cost of Actual Production – Actual Labour Cost
(SHW for A.P × S.R) – (AHW × A.R)
= (50,000 × 2 × 100) – (96,000 × 105)

80,000 A
Labour Rate Variance Labour Efficiency Variance
(SR – AR) × AHW (SHW for Actual Production – AHW) x
SR
(100 – 105) × 96,000 (50,000 × 2 – 96,000) × 100
= 480,000 A = 400,000 F

Total Variable OH Cost Variance:

Standard OH Cost of Actual Production – Actual Variable OH Cost
(SHW for A.P × S.R) – (AHW × A.R)
= [(50,000 × 1.5 × 100) + (50,000 × 2 × 80)] – 16,680,000
= 1,180,000 A
V-OH Spending Variance V-OH Efficiency Variance
(SR – AR) × AHW (SHW for AP - AHW) × S.R
Or
(SR × AHW) – (AR × AHW) (50,000 × 1.5 – 72,000) × 100 = 300,000 F
= 14,880,000* – 16,680,000 (50,000 × 2 – 96,000) × 80 = 320,000 F
*[100 × 72,000 + 80 × 96,000]
= 1,800,000 A 620,000 F
Or
V-OH Spending Variance
(SR – AR) × AHW
(100 – 16,680,000/168,000) × 72,000 = 51,429 F
(80 – 16,680,000/168,000) × 96,000 = 1,851,429 A
1,800,000 A
This calculation cannot be performed as follows:
(180 – 16,680,000/168,000) × 168,000 = 51,429 F
In this case both types of rates are included and combined rate per hour is not 180(100+80)
Fixed OHs total Variance:
Actual Fixed OH = 4,240,000
Actual Production × S.R (50,000 × 80*) = 4,000,000
240,000 A
*fixed overhead rate / unit = 4,000,000 / 50,000 = 80 / unit
**fixed overhead rate / hour = 4,000,000 / 175,000*** = 22.858 / hour
***[50,000 x (1.5 + 2)]

Fixed-OH Expenditure Variance Fixed-OH Volume Variance

Actual Fixed OH (4,000,000 x 1.06) 4,240,000 Budgeted F-OH (50,000 × 80) = 4,000,000
Budgeted F OH Actual Production × S.R
(50,000 × 80) 4,000,000 (50,000 × 80) = 4,000,000
240,000 A -
----------( 94 )----------
 The only F-OH Variance that can be calculated is expenditure variance. There should not be any volume
variance as budgeted production capacity is equal to actual production. However volume variance can be sub-
divided into F-OH Capacity and F-OH Efficiency Variances as follows:
F-OH Volume Variance

Capacity Variance Efficiency Variance

Budgeted capacity hrs. × S.R Actual hours × S.R
50,000 × (1.5 + 2) × 22.858** 4,000,000 168,000 × 22.858 = 3,840,000
Actual hours × S.R Std. hours for A.P × S.R
168,000 × 22.858 = 3,840,000 50,000 × (1.5 + 2) × 22.858 = 4,000,000
160,000 A 160,000 F

[not required for additional information]

If factory overheads expenditure variance is to be calculated combined; then:
Actual F-OH (16,680,000 + 4,240,000) = 20,920,000
Less:
AHW × S.R (100 × 72,000) + (80 × 96,000) = 14,880,000
Budgeted Production × S.R (50,000 × 80) = 4,000,000
18,880,000
2,040,000 A

Total Factory Overheads Variance (not required just for additional information)
Actual (16,680,000 + 4,240,000) 20,920 =
Applied F-OH (50,000 × 390*) 19,500 1,180 A
1,420 A
240 A

Expenditure VOH Efficiency Volume

Actual F-OH = 20,920 (SHW for A.P – AHW) × S.R
Less: Std. Cost of F-OH: (50,000×1.5 – 300,000F Budgeted F-OH 400,000
AHW × S.R 72,000)× 100 = 50,000×80 =
(50,000×1.2 – 320,000F Actual prod×S.R 400,000
96,000)× 80 = 50,000×80 =
620,000F --
72,000×100 + 14,880
96,000×80 =

Budgeted Prod. 4,000

50,000×80
18,880
2,040A

Calculation of rates:
*V-OH rate /unit = [100 × 1.5 + 80 × 2] = 310
F-OH rate/unit = 4,000,000 ÷ 50,000 = 80
390

----------( 95 )----------
A.11
Actual Material Cost:
[Std. Material Cost of A.P] – [Actual Material Cost]
(SQU × SR) – (AQU × AR)
(100,000 × 170) – 18,420,000 = 1,420,000 A

Usage = 820,000 A Price = 600,000 A

Direct Labour Variances

Rate Efficiency
(SR – AR) × AHW (SHW for A.P – AHW) x SR
 16,250,000 
120 −  × 130,000 (100,000 × 1.25 – 130,000) × 120
 130,000 
650,000 A 600,000 A
Variable overheads total variance:
[SHW for A.P × S.R] – (AHW × AR)
(100,000 × 1.25 × 90) – (13,000,000) =1,750,000 A

(SR – AR) × AHW (SHW for A.P – AHW)

 13,000,000 
 90 −  × 130,000 (100,000 × 1.25 – 130,000) × 90
 130,000 
1,300,000 A 450,000 A
Fixed-OH Total variance
 Actual = 2,500,000 
  Nil
 Applied = 2,500,000 
(100,000 × 25)

Actual F-OH = 2,500,000 102,400 × 25 = 2,560,000

Budgeted F-OH (102,400 × 25) 2,560,000 100,000 × 25 = 2,500,000
60,000 F 60,000 A
60,000 A

Budgeted Capacity hrs × S.R Actual Consumed hrs × S.R

Actual Consumed hrs × S.R Std. hours for actual prod x SR
128,000 × 20 = 2,560,000 130,000 × 20 = 2,600,000
130,000 × 20 = 2,600,000_ 100,000 × 1.25 × 20 = 2,500,000
40,000 F 100,000 A
(W-1) Fixed and Variable OH per Hours
Std. total OH rate / labour hour (137.5 ÷ 1.25) = 110/hr.
Std. fixed OH rate / labour hour (2,560,000 ÷ 128,000) = 20/hr.
Std. Variable OH rate / labour hour (balance) = 90/hr.
2,560,000
Fixed OH Rate/Unit = = 25
102,400 *
*Budgeted Production – 128,000 ÷ 1.25 = 102,400
----------( 96 )----------
Extra practice questions:
Question 1
Jack and Jill (JJ) manufactures various products. The following information pertains to one of its main
products:
(i) Standard cost card per unit

Rupees
Direct material (5 kg at Rs. 40 per kg) 200
Direct labour (1.5 hours at Rs. 80 per hour) 120
Factory overheads 130% of direct labour
(ii) Fixed overheads are budgeted at Rs. 3 million based on normal capacity of 75,000 direct labour
hours per month.
(iii) Actual data for the month of June 2015

Units
Opening work in process (80% converted) 8,000
Started during the month 50,000
Transferred to finished goods 48,000
Closing work in process (60% converted) 7,000
Rupees
Material issued to production at: Rs. 38 per kg 1,900,000
Rs. 42 per kg 8,400,000
Direct labour at Rs. 84 per hour 6,048,000
Variable factory overheads 6,350,000
Fixed factory overheads 2,850,000

(iv) Materials are added at the beginning of the process. Conversion costs are incurred evenly
throughout the process. Losses up to 3% of the units are considered as normal. However, losses are
determined at the time of inspection which takes place when units are 90% complete.
(v) JJ uses FIFO method for inventory valuation.
Required:
(a) Compute equivalent production units (05)
(b) Calculate the following variances for the month of June 2015:
• Material rate and usage (03)
• Labour rate and efficiency (03)
• Variable factory overhead expenditure and efficiency (04)
• Fixed factory overhead expenditure and volume (04)
(c) reconcile the budgeted expenditure of actual production with the actual expenditure. (03)
Note: if inspection stage is given, then multiply the normal loss percentage with the inspected units to get
the normal loss units.

----------( 97 )----------
A. 1
Jack & Jill:
Equivalent Units Using FIFO
Quantity Schedule Equivalent Production Units
Material Conversion
Opening Units (80% Conversion) 8,000
Units started 50,000
58,000
Units transferred 48,000 8,000 -- 1,600
40,000 40,000 40,000
Closing WIP (60% Conversion) 7,000 7,000 4,200 (60%)
Normal loss (58,000 – 7,000) × 3% 1,530 -- --
Abnormal loss (90% Conversion) 1,470 1,470 1,323 (90%)
58,000 48,470 47,123
(b) Variances:
Material

Rate Usage
(40 – 38) × 50,000* = (48,470 × 5 – 250,000) × 40 = 306,000 A
100,000 F
300,000 A
(40 – 42) × 200,000** =
400,000 A
*1,900,000 ÷ 38 = 50,000
250,000 kgs
**8,400,000 ÷ 42 = 200,000
Labour

Rate Efficiency
(80 – 84) × 72,000* = 288,000 A (47,123 × 1.5 – 72,000) × 80 = 105,240 A
[6,048,000 ÷ 84]
Variable -OH

Expenditure Efficiency
(64 – 6,350,000/72,000) × 72,000 = (47,123 × 1.5 – 72,000) × 64 = 84,192 A
1,742,000 A
Fixed -OH

Expenditure Volume
2,850,000 50,000 × 60 = 3,000,000
3,000,000 47,123 × 60 = 2,827,380
150,000 F 172,620 A

(W-1) Std. FOH rate/hr & per Unit:

Std. F-OH rate/hr (120 × 130%) ÷ 1.5 = 104/ hr & 156/unit
Std. Fixed F-OH rate / hr [3,000,000 ÷ 75,000] = 40 / hr & 60/unit
Std. Variable F-OH rate / hr (104 – 40) 64 / hr & 96/unit

----------( 98 )----------
Reconciliation:
Budgeted Expenditures for actual production (W-1) 22,699,948
Variances: (Workings above)
Material price 300,000 A
Material usage 306,000 A
Labor rate 288,000 A
Labor efficiency 105,240 A
Variable overhead expenditure 1,742,000 A
Variable overhead efficiency 84,192 A
Fixed OH Expenditure Variance (150,000 F)
Fixed OH Volume Variance 172,620 A
Actual Expenditure[1,900,000 + 8,400,000 + 6,048,000 + 6,350,000 +2,850,000] 25,548,000

W-1 :
Budgeted Expenditure for Actual Production:
Direct Material 48,470 x 200 9,694,000
Direct Labor 47,123 x 120 5,654,760
Factory OH Expenditure 47,123 x 120 x 130% 7,351,188
Budgeted Expenditure 22,699,948

Question 2
Sigma Limited (SL) is a manufacturer of product A. SL operates at a normal capacity of 90% against its
available annual capacity of 50,000 machine hours and uses absorption costing. The following summarised
profit statements were extracted from SL’s budget for the year ending 31 December 2015.

Actual – 2014 Budget – 2015

Units Rs. In ‘000’ Units Rs. In ‘000’
Sales 4,125 49,500 4,600 56,580
Opening inventory 400 (3,400) 600 (5,400)
Cost of production 4,325 (38,925) 4,500 (44,325)
Closing inventory 600 5,400 500 4,925
Under absorbed production overheads (100)
Selling and administration cost (30% fixed) (3,000) (5,250)
Net profit 9,475 6,530
Other relevant information is as under:

2014 Budget - 2015

Standard machine hours per unit 10 hours 10 hours
Standard production overhead rate per unit Rs. 2,000 Rs. 2,250
Estimated fixed production overheads at normal capacity Rs. 3,600,000 Rs. 4,050,000
Actual production overheads (Actual machine hours 44,000) Rs. 8,750,000 -
Required:
(a) What do you understand by under / over absorbed production overheads? (02)
(b) Analyse the under absorbed production overheads of SL for the year ended 31 December 2014, into
spending (means expenditure) and volume variances. Give two probable reasons for each variance.
(06)
(c) Prepare budgeted profit and Loss Statement for the year ending 31 December 2015, using
marginal costing. (07)
(d) Analyse the difference between budgeted profit determined under absorption and marginal costing,
for the year ending 31 December 2015. (02)
----------( 99 )----------
Q. 3 MZ Limited (MZL) manufactures a single product X and uses standard marginal costing system. The
standard cost card of product X is as follows:
Rupees
Raw material (13 kg @ Rs. 135 per kg) 1,755
Labour (14 hours @ Rs. 100 per hour) 1,400
Variable production overheads (Rs. 75 per labour hour) 1,050

Following data is available in respect of operations for the month of February 2018:
1. 55,000 units were put into process. 1,500 units were lost in process which were considered to be
normal loss. Process losses occur at the end of the process.
2. 698,000 kg of material was purchased at Rs. 145 per kg. Material is added at the start of the
process and conversion costs are incurred evenly throughout the process.
3. 755,000 labour hours were worked during the month. However, due to certain labour related
issues, wages were paid at Rs. 115 per hour.
4. Fixed production overheads are budgeted at Rs. 40 million for the month of February 2018. Total
actual production overheads amounted to Rs. 95 million. Actual fixed production overheads
exceeded budgeted fixed overheads by Rs. 1.1 million.
5. Inventory balances were as under:

01 February 2018 28 February 2018

Raw material (kg) 15,000 17,000
Work in process (units) 5,000 (60% converted) 6,000 (80% converted)
Finished goods (units) 10,000 12,000

(a) MZL uses FIFO method for valuing the inventories.

Required:
Compute material, labour and overhead variances. (14)

----------( 100 )----------

A. 3 MZL Limited
Variances:
Material

Rate (Price) Usage

(SR – AR) × AQU (SQU – AQV) × S.R
(135 – 145) × 696,000 [(53,500 × 13) – 696,000] × 135
6,960,000 A 67,500 A
Labour

Rate Efficiency
(SR – AR) × AHW (SHW – AHW) × S.R
(100 – 115) × 755,000 [(54,300 × 14) – 755,000] × 100
11,325,000 A 520,000 F
Variable OH

Expenditure Efficiency
(SR – AR) × AHW (SHW – AHW) × S.R
 53,900,000 *  [(54,300 × 14) – 755,000] × 75
75 − 755 ,000 
× 755,000

2,725,000 F 390,000 F

*Actual Production OH = 95,000,000

Actual Fixed OH [40,000,000 + 1,100,000] 41,100,000
Variable Production OH (Actual) 53,900,000

Fixed OH

Expenditure
Budgeted Fixed OH 40,000,000
Actual Fixed OH 41,100,000
1,100,000 A
Workings:
(W-1) Process Account

b/d 5,000 F.G (Output) 52,500

Input 55,000 N. Loss 1,500 --
c/d 6,000

----------( 101 )----------

 Equivalent Units:
Material Conversion
5000 -- 2,000 (40%)
Output 52,500
47,500 47,500 47,500
c/d WIP 6,000 6,000 4,800 (80%)
53,500 54,300
Material A/c in kgs

b/d 15,000 Used 696,000

Purchased 698,000
c/d 17,000
Q. 4 (a)
Following information has been extracted from the records of Silver Industries Limited (SIL) for the month of
June 2017:
Production Direct labour Variable & fixed
Units hours Overheads (Rs.)
Available capacity 10,000 30,000 -
Budget 8,000 24,000 3,600,000
Actual 8,600 25,000 3,900,000

Fixed overheads were budgeted at Rs. 1,200,000. Applied fixed overheads exceeded actual fixed
overheads by Rs. 20,000.
SIL uses standard absorption costing. Over/under applied factory overheads are charged to profit and loss
account.

Required:
(i) Prepare accounting entries to record the factory overheads. (03)
(ii) Analyse under/over applied overheads into expenditure, efficiency and capacity
variances. (11)
(b) Comment on the difference between overhead variances under marginal and
absorption costing. (03)

A. 4
a) (i) Entries

1) F – OH 3,900,000
Cash/Payable 3,900,000
2) WIP 3,870,000
F – OH 3,870,000
3) P/L 30,000
F – OH 30,000

Actual Fixed OH (balancing) = 1,270,000

Applied Fixed OH (8,600 x 150*) = 1,290,000
Over applied Fixed OH 20,000
*[1,200,000 ÷ 8,000 = 150/unit]

----------( 102 )----------

 Total Factory OH – Budgeted = 3,600,000
Fixed OH – Budgeted = 1,200,000
Variable Factory OH – Budgeted 2,400,000
Fixed OH Std. Rate/Unit 1,200,000/8,000 = 150/Unit
Fixed OH Std. Rate/Hour 1,200,000/24,000 = 50/Hour

Total Factory OH – Actual = 3,900,000

Actual Fixed OH – Actual = 1,270,000
Actual Variable Factory OH 2,630,000
(a) Overall Under/Over Applied Factory OH:
Actual Factory OH = 3,900,000
Applied Factory OH (8,600 x *450) = 3,870,000
30,000 A

*[ F-OH Std. Rate/Unit]

3,600,000/8,000 = 450/Unit
Under Absorbed Factory-OH 30,000 A

Factory-OH Expenditure V-OH Efficiency Variance (Not Required for Extra Information)
Variance (SHW – AHW) x SR Fixed – OH Volume Variance
Actual Factory-OH 3,900,000 (8,600 x 3 – 25,000) x 100 Budgeted Fixed OH = 1,200,000
Std. cost of Factory-OH: 80,000 F (8,000 x 150)
From fixed OH: Applied Fixed OH = 1,290,000
Budgeted Fixed OH1,200,000 (8,600 x 150) 90,000 F
From V – OH:
AHW x SR*(W-1) 2,500,000
(25,000 x 100)* 3,700,000
200,000 A

Fixed OH Capacity Variance Fixed OH Efficiency Variance

Budgeted capacity hrs x S.R Actual Cons. hrs x S.R
= 1,200,000 = 1,250,000
(24,000 x 50) (25,000 x 50)
Actual Consumed hrs x S.R Std. hrs for A.P x S.R
= 1,250,000 = 1,290,000
(25,000 x 50) (8,600 x 3* x 50)
50,000 F 40,000 F

*[24,000 hrs/8,000 hrs]

If Factory OH expenditure variance is calculated separately:

Variable OH Expenditure Variance Fixed OH Expenditure Variance

[S.R – A.R] x AHW

Actual Fixed OH 1,270,000
2,630,000 Budgeted Fixed OH 1,200,000
(100 – ) x 25,000
25,000
70,000 A
130,000 A

----------( 103 )----------

W-1) V – OH rate/hr
[300 ÷ 3] = 100/hr
W-2) F – OH rate/unit = 450
Fixed OH rate/unit = 150
V – OH rate/unit 300
(b) Comments on the difference between overhead variances under marginal and absorption
costing:
In absorption costing, fixed overheads are allocated to the products and these are included in the
inventory valuations as product cost (means applied to production).
In marginal costing, only variable overheads are assigned to the product; fixed overheads are regarded as
period costs and recognized as an expense in the period in which they are incurred.
Variable and fixed overhead variances under marginal and absorption costing are same, except for the
Fixed overhead volume variance and therefore Fixed overhead capacity and Fixed overhead efficiency
variance are calculated only under absorption costing. In addition Fixed overhead total variance is only
calculated under Absorption costing.

Q. 5 Seema Enterprises (SE) produces various leather goods. It operates a standard marginal costing
system. For one of its products Bela, following information was extracted for the month of December
2015 from SE's budget document for the year 2015.

Rs. in million
Sales 9,800 units 25.00
Cost of production of 10,000 units:
Direct material 5,000 kg 9.00
Direct labour 24,000 hrs 3.60
Variable overheads 2,000 machine hrs 4.40
Fixed overheads 3.80
Actual production for the month of December 2015 was 12,000 units whereas SE earned revenue of Rs.
30 million by selling 11,000 units of Bela. Following information pertains to actual cost of production for
the month:

(i) 5,700 kg material was issued to production. Raw materials are valued using FIFO method.
Other details relating to the raw material used for Bela are as follows:

kg Rs. in million
1-Dec-2015 Opening balance 3,000 5.70
10-Dec-2015 Purchases 15,000 26.25

(ii) To minimise labour turnover, SE increased production wages by 10% above the standard rate,
effective 1 December 2015. This improved labour efficiency by 5% as compared to budget.
(iii) 2,100 machine hours were worked. Details of overheads are as under:
• Depreciation amounted to Rs. 1.6 million (same as budgeted)
• Factory building rent amounted to Rs. 1.20 million (same as budgeted)
• All other overheads were 4% in excess of the budget

(iv) There was no opening finished goods inventory of Bela. Actual closing inventory may be valued at
standard marginal production costs.

Required:
a) Compute budgeted and actual profit of Bela for the month of December 2015 using marginal costing.(6)
b) Reconcile the budgeted profit with actual profit using relevant variances under marginal costing. (14)

----------( 104 )----------

Scenario 2: If actual profit is measured by using standard cost for raw material stock as well; then actual
profit will be:

Seema Enterprises

Actual profit: for the month of December 2015

Sales (11,000 units) 30.00
Variable Cost of Sale:
Opening Finished Goods -
+ variable COGM:
Direct Material Consumed:
Opening stock [3000 Kg x 1,800][at std]5.4
+Purchases [15,000 Kg] 26.25
Closing cost [12,300 Kg x 1800] (22.14) 9.51
Direct labor [27,360*x165*] 4.51
*Actual labor hr`s
[24,000/10,000] = 2.4x12,000x95% =27,360
**Actual labor rate
[3,600,000/24,000 =150x1.1=165
Variable OH [2,100x2,288*] 4.80
*Actual variable OH rate/hr
[ 4,400,000/2,000] =2,200x1.04=2,288/machine hr. 18.82

Less: Closing finished goods inventory (at standard cost) (1.70) (17.12)
Gross Contribution 12.88
Fixed cost [1.6+1.2+(3.8-1.6-1.2) 1.04] (3.84)
Actual Profit 9.04
In this case material price variance would be calculated as follows and all other variances remain
same:
(SR – AR) × AQP
[1,800–26.25/15,000)]× 15,000=0.75 F

Reconciliation:
Budgeted profit 4.54
Budgeted fixed cost 3.80
Budgeted contribution 8.34
Variances: (Workings below)
Sales price 1.94F
Sales volume 1.02F
Material price 0.75F
Material usage 0.54F
Labor rate 0.41A
Labor efficiency 0.22F
Variable overhead expenditure 0.18A
Variable overhead efficiency 0.66F
Actual Contribution: 12.88
Budgeted fixed cost 3.8
Fixed OH Expenditure Variance 0.04A (3.84)
Actual Profit 9.04

----------( 105 )----------

Scenario 3: If actual profit is measured by using actual cost for raw material stock as well as finished goods
stock; then actual profit will be:

Seema Enterprises

Actual profit: for the month of December 2015

Sales (11,000 units) 30.00
Variable Cost of Sale:
Opening Finished Goods -
+ variable COGM:
Direct Material Consumed:[as originally
calculated] 10.43
Direct labor [27,360*x165*] 4.51
*Actual labor hr`s
[24,000/10,000] = 2.4x12,000x95% =27,360
**Actual labor rate
[3,600,000/24,000 =150x1.1=165
Variable OH [2,100x2,288*] 4.80
*Actual variable OH rate/hr
[ 4,400,000/2,000] =2,200x1.04=2,288/machine hr. 19.74
Less: Closing finished goods inventory
[19.74/12,000 x 1,000] (1.65) (18.09)
Gross Contribution 11.91
Fixed cost [1.6+1.2+(3.8-1.6-1.2) 1.04] (3.84)
Actual Profit 8.07
In this case material price variance would be calculated on the basis of actual quantity used as
discussed previously and all other variances remain same, however there will be additional stock
difference to reconcile the budgeted and actual profit

Budgeted profit 4.54

Budgeted fixed cost 3.80
Budgeted contribution 8.34
Variances:
Sales price 1.94F
Sales volume 1.02F
Material price 0.17A
Material usage 0.54F
Labor rate 0.41A
Labor efficiency 0.22F
Variable overhead expenditure 0.18A
Variable overhead efficiency 0.66F
Actual Contribution: 11.96
Budgeted fixed cost 3.8
Fixed OH Expenditure Variance 0.04A (3.84)
Actual Profit if stocks are measured at standard cost 8.12
less: Closing stock of finished goods at standard cost (1.7)
Add: Closing stock of finished goods at actual cost 1.65
Actual Profit if stocks are measured at actual cost 8.07

----------( 106 )----------

Question 6
Zamil Industries (ZI) produces and markets an industrial product Zeta. ZI uses standard absorption costing
system. The break-up of Zeta’s standard cost per unit is as under:

Rupees
Materials: Axe – 1 kg 160
Zee – 2 kg 210
Direct labour – 0.8 hours 200
Overheads – 0.8 hours 180

Production of Zeta for the month of August 2016 was budgeted at 15,000 units. Information pertaining to
production of Zeta for August 2016 is as under:
(i) Raw material inventory is valued at lower of cost and net realizable value. Cost is determined under
FIFO method. Stock cards of materials Axe and Zee are reproduced below:
Axe Zee
Date Description Cost per kg Cost per kg
Kg Kg
(Rs.) (Rs.)
1-Aug Opening balance 9,000 150 4,000 120
- - 8,000 122
3-Aug Purchase returns - - (2,000) 122
4-Aug Purchase 17,000 148 35,000 125
6-Aug Issues to production (16,000) - (29,000) -
(ii) Actual direct wages for the month were Rs. 3,298,400 consisting of 11,780 direct labour hours.
(iii) Fixed overheads were estimated at Rs. 540,000 based on budgeted direct labour hours.
(iv) The actual fixed overheads for the month were 583,000.
Actual sales of Zeta for the month of August 2016 was 12,000 units. Opening and closing finished goods
inventory of Zeta was 5,000 and 8,500 units respectively.
Required:
(a) Compute following variances:
(i) Material price, mix and yield variances (07)
(ii) Labour rate and efficiency variances (04)
(b) Compute applied fixed overheads and analyse ‘under/over applied fixed factory overheads’ into
expenditure, efficiency and capacity variances. (08)
Answer 6
(a) (i) Material Variances:
1: Material Price Variance [Axe] [FIFO] [SR – AR] × AQU
(i) [160 – 150] × 9,000 = 90,000 F
(ii) [160 – 148] × 7,000 = 84,000 F
16,000 kgs 174,000 F
Zee: [SR – AR] × AQU
(i) [105* - 120] × 4,000 = 60,000 A
[105 – 122] × 6,000 = 102,000 A
[105 – 125] × 19,000 = 380,000 A
29,000 kgs 542,000 A
* [210 ÷ 2]

----------( 107 )----------

2. Material Mix and Yield Variance
Working of Actual Production:
Finished Goods Account

b/d 5,000 Sold 12,000

Produced 15,500
c/d 8,500

SQU in SM for AP AQU in SM for AP AQU in AM for AP

Axe 15,500 15,000 16,000
(15,500 × 1) (45,000 × 1/3)
Zee 31,000 30,000 29,000
(15,500 × 2) (45,000 × 2/3)
46,500 45,000 45,000

Yield Variance. Mix Variance

Yield Variance:
Axe (15,500 – 15,000) × 160 = 80,000 F

Zee (31,000 – 30,000) × 105 = 105,000 F

185,000 F

Mix Variance:
Axe (15,500 – 16,000) × 160 = 160,000 A

Zee (30,000 – 29,000) × 105 = 105,000 F

55,000 A

(ii) Labour Variances

[SR – AR] × AHW [SHW – AHW] × S.R

 3,298 ,400 
250 − 11,780  × 11,780 [(15,500 × 0.8) – 11,780] × 250
 
353,400 A 155,000 F
(b) Analyses of Under / Over applied Fixed OH
Actual Fixed Overheads = 583,000
Applied Fixed Overheads [15,500 × 36*] = 558,000
Under Applied Fixed overheads 25,000 A
*Standard Fixed OH rate per hour [540,000 ÷ 15,000 × 0.8] = 45
Standard Fixed OH rate per Unit [45 × 0.8] = 36

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 Fixed Overheads Expenditure Fixed OH Volume Variance
Variance
Actual Fixed OH = 583,000 (Given) Budgeted F-OH (15,000×36) 540,000
Budgeted Fixed OH 540,000 (Given) Applied F-OH (15,500×36) 558,000
43,000 A 18,000 F

Fixed OH Capacity Variance Fixed OH Efficiency Variance

Budgeted Capacity hrs × S.R = 540,000 Actual Consumed hrs × SR = 530,100
[12,000 (15,000 x 0.8) x 45] [11,780 × 45]
Actual consumed hrs × S.R = 530,100 Std. hrs for A.P × S.R 558,000
[11,780 × 45] [12,400 (15,500 x 0.8) x 45]
9,900 A 27,900 F

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Variance Analysis
1.LETTUCE
Lettuce makes a product – the vegetable guard. It is the organic alternative to slug pellets and chemical
sprays.
For the forthcoming period budgeted fixed costs were Rs.6,000 and budgeted production and sales were
1,300 units.
The vegetable guard has the following standard cost:

Rs.
Selling price 50
Materials 5kg Rs.4/kg 20
Labour 3hrs Rs.4/hr 12
Variable overheads 3hrs Rs.3/hr 9
Actual results for the period were as follows:
1,100 units were made and sold, earning revenue of Rs.57,200.
6,600kg of materials were bought at a cost of Rs.29,700 but only 6,300 kg were used
3,600 hours of labour were paid for at a cost of Rs.14,220. The total cost for variable overheads was
Rs.11,700 and fixed costs were Rs.4,000.
The company uses marginal costing and values all inventory at standard cost.
Required:
(a) Produce a statement reconciling actual and budgeted profit using appropriate variances. (15)
(b) Assuming now that the company uses absorption costing, recalculate the fixed production overhead
variances (6)
(c) Discuss possible causes for the labour variances you have calculated. (4)

2. MOONGAZER
MoonGazer produces a product – the telescope. Actual results for the period were:
❑ 430 units made and sold, earning revenue of Rs.47,300.
❑ Materials: 1,075 kg were used.
❑ 1,200 kg of materials were purchased at a cost of Rs.17,700
❑ Direct labour: 1,700 hours were worked at a cost of Rs.14,637
❑ Fixed production overheads expenditure: Rs.2,400.
❑ Variable production overheads expenditure: Rs.3,870. The standard cost card for the
product is as follows:
Rs.
Direct material 2 kg Rs.15 30
Direct labour 4hrs Rs.8.50 34
Variable overhead 4hrs Rs.2.00 8
Fixed production overhead per unit 5
77

The standard unit selling price is Rs.100. The cost card is based on production and sales of 450
units in each period.
The company values its inventories at standard cost.

Required
Produce an operating statement to reconcile budgeted and actual gross profit. (14)

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 3. CARAT
Carat plc, a premium food manufacturer, is reviewing operations for a three-month period. The
company operates a standard marginal costing system and manufactures one product, ZP, for
which the following standard revenue and cost data per unit of product is available:

Selling price Rs. 12.00

Direct material A 2.5 kg at Rs. 1.70 per kg
Direct material B 1.5 kg at Rs. 1.20 per kg
Direct labour 0.45 hrs at Rs. 6.00 per hour

Fixed production overheads for the three-month period were expected to be Rs. 62,500.

Actual data for the three-month period was as follows:

Sales and production 48,000 units of ZP were produced and sold for Rs.
580,800
Direct material A 121,951 kg were used at a cost of Rs. 200,000
Direct material B 67,200 kg were used at a cost of Rs. 84,000
Direct labour Employees worked for 18,900 hours, but 19,200 hours
were paid at a cost of Rs. 117,120
Fixed production overheads Rs. 64,000
Budgeted sales for the three-month period were 50,000 units of Product ZP.

Required
(a)Calculate the following variances:
(i) sales volume contribution and sales price variances;
(ii) price, mix and yield variances for each material;
(iii) labour rate, labour efficiency and idle time variances. (15)
(b) Prepare an operating statement that reconciles budgeted profit to actual profit with each variance clearly
shown. (5)

5. EXCELLENT LIMITED
Excellent Limited makes and sells a single product. The standard cost card for the product, based on normal
capacity of 45,000 units per month is as under:

Rupees
Material 60 kgs at Rs. 0.60 per kg 36.00
Labour ½ hour at Rs. 50.00 per hour 25.00
Variable factory overheads, 30% of direct labour cost 7.50
Fixed factory overheads 6.50
Total 75.00

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 Actual data for the month of August 20X3 is as under:

Work in process on August 1, 20X3 (60% converted) Units 10,000

Started during the month Units 50,000
Transferred to finished goods Units 48,000
Work in process on August 31, 20X3 (50% converted) Units 10,000
Material purchased at Rs. 0.50 per kg Rs. 1,750,000
Material issued to production Kgs 3,100,000
Direct labour at Rs. 52 per hour Rs. 1,300,000
Factory overheads (including fixed costs of Rs. 290,000) Rs. 600,000
The company uses FIFO method for inventory valuation.
All materials are added at the beginning of the process. Conversion costs are incurred evenly
throughout the process. Inspection takes place when the units are 80% complete. Under normal
conditions, no spoilage should occur.
Required

• Prepare a quantity and equivalent production schedules for material and conversion costs.
• Calculate material, labour and variable overhead variances. (Assume that the material price
variance is calculated as materials are used rather than as they are purchased).
• Calculate the over(under) absorption of fixed production overhead and analyse it into
expenditure variance and volume variance.
• Analyse the fixed production overhead volume variance into efficiency and capacity
variances. (20)

6. ABC LIMITED
ABC Limited produces and markets a single product. The company operates a standard costing
system. The standard cost card for the product is as under:

Sale price Rs. 600 per unit

Direct material 2.5 kg per unit at Rs. 50 per kg
Direct labour 2.0 hours per unit at Rs. 100 per hour
Variable overheads Rs. 25 per direct labour hour
Fixed overheads Rs. 10 per unit
Budgeted production 500,000 units per month

Actual results for the month of August 2023 were as under:

Rupees in ‘000
Sales 480,000 units 295,000
Direct material 950,000 kgs 55,000
Direct labour 990,000 hours 105,000
Variable overheads 26,000
Fixed overheads 5,100

Required: Reconcile budgeted profit with actual profit using relevant variances. (18)

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7. STANDARD COST SHEET
The following data relates to actual output, actual costs and variances for the four- weekly accounting
period number 4 of a company which makes only one product.

Actual production of Product XY 18,000 units

Actual costs incurred: Rs.000
Direct materials purchased and used (150,000 kg) 210
Direct labour costs (32,000 hours) 136
Variable production overhead 38
Rs.000
Variances:
Direct materials price 15 Favourable
Direct materials usage 9 Adverse
Direct labour rate 8 Adverse
Direct labour efficiency 16 Favourable
Variable production overhead expenditure 6 Adverse
Variable production overhead efficiency 4 Favourable
Variable production overhead varies with labour hours worked. A standard marginal costing
system is operated.

Required
Present a standard product cost sheet for one unit of Product XY, showing how the standard
marginal production cost of the product is made up.

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VARIANCE ANALYSIS (Reasons)
Direct materials: possible causes of variances
When variances occur and they appear to be significant, management should investigate the reason for the
variance. If the cause of the variance is something within the control of management, control action should
be taken. Some of the possible causes of materials variances are listed below.

Materials price variance: causes

Possible causes of favorable materials price variances include:
• Different suppliers were used and these charged a lower price (favorable price variance) than the usual
supplier.
• Materials were purchased in sufficient quantities to obtain a bulk purchase discount (a quantity
discount), resulting in a favorable price variance.
• Materials were bought that were of lower quality than standard and so cheaper than expected.
Possible causes of adverse materials price variances include:
• Different suppliers were used and these charged a higher price (adverse price variance) than the usual
supplier.
• Suppliers increased their prices by more than expected. (Higher prices might be caused by an
unexpected increase in the rate of inflation.)
• There was a severe shortage of the materials, so that prices in the market were much higher than
expected.
• Materials were bought that were better quality than standard and more expensive than expected.

Materials usage variance: causes

Possible causes of favorable materials usage variances include:
• Wastage rates were lower than expected.
• Improvements in production methods resulted in more efficient usage of materials (favorable usage
variance).
• Materials were of higher quality.
Possible causes of adverse materials usage variances include:
• Wastage rates were higher than expected.
• Poor materials handling resulted in a large amount of breakages (adverse usage variance). Breakages
mean that a quantity of materials input to the production process are wasted.
• Materials used were of cheaper quality than standard, with the result that more materials had to be
thrown away as waste.
Direct labor: possible causes of variances
When labor variances appear significant, management should investigate the reason why they occurred, and
take control measures where appropriate to improve the situation in the future. Possible causes of labor
variances include the following.
Possible causes of favorable labor rate variances include:
• Using direct labor employees who were relatively inexperienced and new to the job (favorable rate
variance, because these employees would be paid less than ‘normal’).
• Actual pay increase turning out to be less than expected.

Possible causes of adverse labor rate variances include:

• An increase in pay for employees.
• Working overtime hours paid at a premium above the basic rate (because overtime rate is more than
normal rate)
• Using direct labor employees who were more skilled and experienced than the ‘normal’ and who are
paid more than the standard rate per hour (adverse rate variance).

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 Possible causes of favorable labor efficiency variances include:
• More efficient methods of working.
• Good morale amongst the workforce and good management with the result that the work force is more
productive.
• If incentive schemes are introduced to the workforce, this may encourage employees to work more
quickly and therefore give rise to a favorable efficiency variance.
• Previously unaccounted for learning and experience curves (will be discussed in next chapters as well)
• Using employees who are more experienced than ‘standard’, resulting in favorable efficiency variances
as they are able to complete their work more quickly than less-experienced colleagues.
Possible causes of adverse labor efficiency variances include:
• Using employees who are less experienced than ‘standard’, resulting in adverse efficiency variances.
• An event causing poor morale.(e.g management is not honoring its commitment of bonus)

Variable production overhead: possible causes of variances

Possible causes of favorable variable production overhead expenditure variances include:
• Forecast increase in costs not materializing
Possible causes of adverse variable production overhead variances include:
• Unexpected increases in energy prices
Anything that causes labor efficiency variance will have an impact on variable production overhead
efficiency variances as variable production overhead is incurred as the labor force carries out
production.(same as labor efficiency variances)
Possible causes of favorable variable production overhead efficiency variances include:
• More efficient methods of working.
• Good morale amongst the workforce and good management with the result that the work force is more
productive.
• If incentive schemes are introduced to the workforce, this may encourage employees to work more
quickly and therefore give rise to a favorable efficiency variance.
• Using employees who are more experienced than ‘standard’, resulting in favorable efficiency variances
as they are able to complete their work more quickly than less-experienced colleagues.
Possible causes of adverse variable production overhead efficiency variances include:
• Using employees who are less experienced than ‘standard’, resulting in adverse efficiency variances.
• An event causing poor morale.

Fixed production overheads: possible causes of variances

Fixed overhead expenditure variance

• Poor budgeting for overhead spending. If the budget for overhead expenditure is unrealistic, there will be
an expenditure variance due to poor planning rather than poor expenditure control.
• Poor control over overhead spending (adverse variance) or good control over spending (favorable
variance).
• Unplanned increases or decreases in items of expenditure for fixed production overheads, for example,
an unexpected increase in factory rent.

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Fixed overhead volume variance (discussion of its breakup)
A fixed overhead volume variance can be explained by anything that made actual output volume different
from the budgeted volume. The reasons could be:
• Efficient working by direct labor: a favorable labor efficiency variance results in a favorable fixed
overhead efficiency variance.
• Working more hours or less hours than budgeted (capacity variance).
• An unexpected increase or decrease in demand for a product, with the result that shorter/longer hours
were worked (adverse/favorable capacity variance)
• Strike action by the workforce, resulting in a fall in output and therefore actual hours worked below
budgeted hours (adverse capacity variance).
• Extensive breakdowns in machinery, resulting in lost production and therefore actual hours worked
below budgeted hours (adverse capacity variance).

INTERRELATIONSHIPS BETWEEN VARIANCES

The nature of interrelationships between variances
Some causes of individual variances have already been listed.
The reasons for variances might also be connected, and two or more variances might arise from the same
cause. This is known as an interrelationship between two variances.
For example, one variance might be favorable and another variance might be adverse. Taking each
variance separately, the favorable variance might suggest good performance and the adverse variance
might suggest bad performance. However, the two variances might be inter-related, and the favorable
variance and the adverse variance might have the same cause. When this happens, management should
look at the two variances together, in order to assess their significance and decide whether control action is
needed.
Interrelationships between variances are given below.
Materials price and usage
A materials price variance and usage variance might be inter-related. For example, if a company decides to
use a material for production that is more expensive than the normal or standard material, but easier to use
and better in quality, there will be an adverse price variance. However, a consequence of using better
materials might be lower wastage. If there is less wastage, there will be a favorable material usage variance.
Therefore, using a different quality of material can result in an adverse price variance and a favorable usage
variance.
Labor rate and efficiency
If there is a change in the grade of workers used to do some work, both the rate and efficiency variances
may be affected.
For example, if a lower grade of labor is used instead of the normal higher grade:
• there should be a favorable rate variance because the workers will be paid less than the standard
rate
• however, the lower grade of labor may work less efficiently and take longer to produce goods than
the normal higher grade of labor would usually take. If the lower grade of labor takes longer, then
this will give rise to an adverse efficiency variance.
Therefore, the change in the grade of labor used results in two ‘opposite’ variances, an adverse efficiency
variance and a favorable rate variance.
When inexperienced employees are used, they might also waste more materials than more experienced
employees would, due to mistakes that they make in their work. The result might be not only adverse labor
efficiency, but also adverse materials usage.
Labor rate and variable overhead efficiency
When a production process operates at a different level of efficiency the true cost of that difference is the
sum of any costs associated with labor hours. Therefore, the issues described above also affect the variable
overhead efficiency variance.(means if lower grade of labor is used than rate variance will be favourable but
labor efficiency as well as variable overhead efficiency variance will be adverse because of increase in
hours)

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Fixed overheads Capacity and efficiency
If a production process operates at a higher level of efficiency that might mean that it does not have to
operate for as long to produce the budgeted production volume. The favorable fixed production overhead
efficiency variance would cause an adverse fixed production overhead capacity variance.(if employees
works efficiently then budgeted production will be achieved in less actual hours resulting into adverse
capacity variance and vice versa)
The reverse is also true. If a production process operates at a lower level of efficiency that might mean that it
has to operate for longer than was budgeted. The adverse efficiency fixed production overhead variance
would cause a favorable fixed production overhead capacity variance.
The importance of reliable standard costs
It is important to remember that the value of variances as control information for management depends on
the reliability and accuracy of the standard costs. If the standard costs are inaccurate, comparisons between
actual cost and standard cost will have no meaning. Adverse or favorable variances might be caused by
inaccurate standard costs rather than by inefficient or efficient working.

MATERIALS MIX AND YIELD VARIANCES

Substitutable materials
If the materials are substitutable (i.e. less of one type of material can be compensated for by more of
another) the direct materials usage variance can be analyzed into:
• a materials mix variance; and
• a materials yield variance
The total of these two variances is the total material usage variance.
It is vital to understand that this further analysis should only be performed if the materials can be substituted
for each other. Mix and yield variances have a useful meaning only when the proportions (or ‘mix’) of the
different raw materials in the final product can be varied and so are subject to management control.

Factors to consider when changing the mix

Analysis of the material usage variance into the mix and yield components is worthwhile if management
have control of the proportion of each material used. Management will seek to find the optimum mix (it is a
mix which result into maximum cost saving and therefore profit) for the product and ensure that the process
operates as near to this optimum as possible.
Identification of the optimum mix involves consideration of several factors:(means management should
consider the following factors while deciding the optimum production mix)
• Cost. The cheapest mix may not be the most cost effective. Often a favorable mix variance is offset by
an adverse yield variance and the total cost per unit may increase.
• Quality. Using a cheaper mix may result in a lower quality product and the customer may not be
prepared to pay the same price. A cheaper product may also result in higher sales returns and loss of
repute of business.
• The fall in quality would make the company vulnerable to reputational risk.

USING AND DERIVING STANDARD COSTS

Standard costing
Standard costing involves the establishment of predetermined estimates of the costs of products or services,
the collection of actual costs and the comparison of the actual results with the predetermined estimates. The
predetermined costs are known as standard costs and the difference between standard and actual is known
as variance.
• Standard cost is an estimated or predetermined cost of performing an operation or producing a
good or service, under normal conditions.
• Standard costing is a control technique that reports variances by comparing actual costs to pre-set
standards so facilitating action through management by exception.

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Standard costing may be used with either a system of absorption costing or a system of marginal costing. In
simple words…
Standard costing involves using an expected cost (standard cost) as a substitute for actual cost in the
accounting system. Periodically the standard costs are compared to the actual costs. Differences
between the standard and actual are recorded as variances in the costing system.

When is standard costing appropriate?

Standard costing can be used in a variety of situations.
• It is most useful when accounting for homogenous goods produced in large numbers, when there is
a degree of repetition in the production process.
• A standard costing system may be used when an entity produces standard units of product or
service that are identical to all other similar units produced.
• Standard costing is usually associated with standard products, but can be applied to standard
services too.
A standard unit should have exactly the same input resources (direct materials, direct labor time) as all
other similar units, and these resources should cost exactly the same. Standard units should therefore
have the same cost.

Standard cost
A standard cost is a predetermined unit cost based on expected direct materials quantities and expected
direct labor time, and priced at a predetermined rate per unit of direct materials and rate per direct labor hour
and rate per hour of overhead.
Standard costs of products are usually restricted to production costs only, not administration and selling and
distribution overheads.
Overheads are normally absorbed into standard production cost at an absorption rate per direct labor
hour.(if absorption costing is used)
Who sets standard costs?
Standard costs are set by managers with the expertise to assess what the standard prices and rates should
be. Standard costs are normally reviewed regularly, typically once a year as part of the annual budgeting
process.
• Standard prices for direct materials should be set by managers with expertise in the purchase costs
of materials. This is likely to be a senior manager in the purchasing department (buying department).
• Standard rates for direct labor should be set by managers with expertise in labor rates. This is likely
to be a senior manager in the human resources department (personnel (HR) department).
• Standard usage rates for direct materials and standard efficiency rates for direct labor should be
set by managers with expertise in operational activities. This may be a senior manager in the
production or operations department, or a manager in the technical department.(Production
deparment)
• Standard overhead rates should be identified by a senior management accountant, from budgeted
overhead costs and budgeted activity levels that have been agreed in the annual budgeting process (at
the beginning of the period)

The purposes of standard costing

Standard costing has four main uses.
• It is an alternative system of cost accounting. In a standard costing system, all units produced are
recorded at their standard cost of production.
• When standard costs are established for products, they can be used to prepare the budget.
• It is a system of performance measurement. The differences between standard costs (expected
costs) and actual costs can be measured as variances. Variances can be reported regularly to
management, in order to identify areas of good performance or poor performance.

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 • It is also a system of control reporting. When differences between actual results and expected
results (the budget and standard costs) are large, this could indicate that operational performance is not
as it should be, and that the causes of the variance should be investigated. Management can therefore
use variance reports to identify whether control measures might be needed, to improve poor
performance or continue with good performances.
Variances and controllability
The principle of controllability should be applied in any performance management system
When variances are used to measure the performance of an aspect of operations, or the performance of a
manager, they should be reported to the manager who is:
• responsible for the area of operations to which the variances relate, and
• able to do something to control them.
Deriving a standard cost
Deriving the standard usage for materials
The standard usage for direct materials can be obtained by using:
• historical records for material usage in the past, or
• the design specification for the product
Deriving the standard efficiency rate for labor
The standard efficiency rate for direct labor can be obtained by using:
• historical records for labor time spent on the product in the past, or
• making comparisons with similar work and the time required to do this work, or
• ‘time and motion study’ to estimate how long the work ought to take. (Time and motion study means
observe the employees in normal working environment to get the standard of time)
Deriving the standard price for materials
The standard price for direct materials can be estimated by using:
• historical records for material purchases in the past, and
• allowing for estimated changes in the future, such as price inflation and any expected change in the
trade discounts available
Deriving the standard rate of pay for labor
Not all employees are paid the same rate of pay, and there may be differences to allow for the experience of
the employee and the number of years in the job (means experience). There is also the problem that
employees may receive an annual increase in pay each year to allow for inflation, and the pay increase may
occur during the middle of the financial year.
• The standard rate of pay per direct labor hour will be an average rate of pay for each category or grade
of employees.
• The rate of pay may be based on current pay levels or on an expected average pay level for the year,
allowing for the expected inflationary pay rise during the year.
Types of standard & their behavioral aspects
Standards are predetermined estimates of unit costs but how is the level of efficiency inherent in the
estimate determined? Should it assume perfect operating conditions or should it incorporate an allowance
for waste and idle time? The standard set will be a performance target and if it seen as unattainable this may
have a detrimental impact on staff motivation. If the standard set is too easy to attain there may be no
incentive to find improvements.
There are four types of standard, and any of these may be used in a standard costing system. One of
the purposes of standard costing is to set performance standards that motivate employees to improve
performance. The type of standard used can have an effect on motivation and incentives. The types of
standards and their behavioral aspects are given below:

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 1. Ideal standards.
These assume perfect operating conditions. No allowance is made for wastage, labor inefficiency or
machine breakdowns. The ideal standard cost is the cost that would be achievable if operating conditions
and operating performance were perfect. In practice, the ideal standard is not achieved.
Ideal standards are unlikely to be achieved. They may be very useful as long term targets and may provide
senior managers with an indication of the potential for savings in a process but generally the ideal standard
will not be achieved. Consequently, the reported variances will always be adverse. Employees may be
becoming de- motivated when their performance level is always worse than standard and they know that the
standard is unachievable.
2. Attainable standards.
These assume efficient but not perfect operating conditions. An allowance is made for waste and
inefficiency. However, the attainable standard is set at a higher level of efficiency than the current
performance standard, and some improvements will therefore be necessary in order to achieve the standard
level of performance.
Attainable standards are the most likely to motivate employees to improve performance as they are
based on challenging but attainable targets. It is for this reason that standards are often based on
attainable conditions. However, a problem with attainable standards is deciding on the level of performance
that should be the target for achievement. For example, if an attainable standard provides for some
improvement in labor efficiency, should the standard provide for a 1% improvement in efficiency, or a 5%
improvement, or a 10% improvement?
3. Current standards.
These are based on current working conditions and what the entity is capable of achieving at the
moment. Current standards do not provide any incentive to make significant improvements in performance,
and might be considered unsatisfactory when current operating performance is considered inefficient.
Current standards may be useful for producing budgets as they are based on current levels of
efficiency and may therefore give a realistic guide to resources required in the production process.
However current standards are unlikely to motivate employees to improve their performance, unless there
are incentives for achieving favorable variances (for achieving results that are better than the standard),
such as annual cash bonuses.
4. Basic standards.
These are standards which remain unchanged over a long period of time (out dated standards
prepared sometimes in past). Variances are calculated by comparing actual results with the basic
standard, and if there is a gradual improvement in performance over time, this will be apparent in an
improving trend in reported variances.
Basic standards will not motivate employees to improve their performance as they are based on achievable
conditions at some time in the past. They are also not useful for budgeting because they will often be out of
date. In practice, they are the least common type of standard.
Example 02:
A company produces bookshelves. Each bookshelf requires three planks of wood. A box of
wood contains 15 planks and costs Rs.45.
Currently 20% of wood is wasted during production. Management would like to reduce this
wastage to 10%.
Calculate a standard material cost for a bookshelf based on
a) Ideal conditions
Standard cost per plank = Rs.45/15 planks = Rs.3 per plank
Ideal standard: 3 planks Rs.3 = Rs.9 per bookshelf
b) Current conditions
Current standard: 3/0.80 planks = 3.75 planks at Rs.3 = Rs.11.25 per bookshelf
c) Attainable conditions
Attainable or target standard: 3/0.9 = 3.33 planks at Rs.3 = Rs.10 per bookshelf

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Reviewing standards
How often should standards be revised? Standards should be reviewed regularly.
There are several reasons why standards should be revised regularly.
Regular revision leads to standards which are meaningful targets that employees may be motivated to
achieve (for example, through incentive schemes).
Variance analysis is more meaningful because reported variances should be realistic.
In practice, standards are normally reviewed annually. Standards by their nature are long-term averages
and therefore some variation is expected over time. The budgeting process can therefore be used to review
the standard costs in use.

ALLOWING FOR WASTE AND IDLE TIME

Materials wastage in standard costing
Waste is an unavoidable feature of some production processes. The actual amount of materials wasted may
vary from one period to another, but there may be a standard rate of wastage or a ‘normal’ rate of loss which
is a measure of the average rate of wastage or loss.
An allowance for expected loss can be included in a standard cost. The standard cost can be based on the
expected quantity of input materials required to produce one unit of output
Example 03:
A company manufactures a product in a process production system. There is some wastage in production,
and normal loss is 10% of the number of units input to the process. One unit of raw material is required to
produce one unit of finished goods.
The standard price per unit of direct material is Rs.4.50 per unit.
a) If an ideal standard is used, and the standard does not provide for any loss in process, standard direct
material cost per unit of output would be as follows
Ideal standard
No loss; therefore, standard cost =
1 unit of direct materials at Rs.4.50 per unit of material = Rs.4.50 per unit of output.
b) If the standard cost allows for a loss of 10% of input materials in producing each unit of output, then
Standard Direct material cost per unit of output would be:
Attainable or current standard: allow for 10% loss
Standard input to produce one unit of = 1/0.9 units = 1.111 units. Therefore, standard cost = 1.111 units of
materials at Rs.4.50 per unit = Rs.5 per unit of output.

Example 04:
A company produces sandwiches. Each sandwich requires two slices of bread and a loaf (packet) of bread
contains 24 slices. Each loaf of bread costs Rs.6. It is estimated that currently 20% of bread is wasted.
Management would like to reduce this wastage to 10%.
Calculation of a standard material cost for a sandwich based on various conditions are given below
a) Ideal conditions
Standard cost per slice of bread = Rs.6/24 slices = Rs.0.25

Ideal standard: 2 slices Rs.0.25 = Rs.0.50

b) Current conditions
Current standard: 2/0.80 slices = 2.5 slices at Rs.0.25 = Rs.0.625
c) Attainable conditions
Attainable or target standard: 2/0.9 = 2.22 slices at Rs.0.25 = Rs.0.555.
Note that the current and attainable standard costs include an allowance for wastage, and a materials usage
variance will occur only if the actual wastage rate differs from the standard wastage rate.

----------( 121 )----------

Test question
Q. Following information pertains to one of the products ‘Violet’ of Blue Limited (BL), for the month of August
2021:

(i) Production for the month was budgeted at 12,000 units. The standard cost per unit of Violet is as
follows:

Rupees
Direct materials:
Alpha – 4 kg 800
Beta – 6 kg 900
Direct labour – 2 hours 300
*Production overheads – 2 direct labour hours 260
*Fixed production overheads were estimated at Rs. 1.2 million based on budgeted
direct labour hours

(ii) Direct materials are added at the beginning of the production process. BL accounts for material
price variance at the time of issuance of material to production and uses FIFO method for inventory
valuation. Following information has been extracted from the stock cards of Alpha and Beta:

Alpha Beta
Date Description Cost per kg Cost per kg
kg kg
(Rs.) (Rs.)
2,000 220 4,000 140
1-Aug Opening balance
4,000 190 4,000 150
2-Aug Purchase returns (1,000) 190 - -
3-Aug Purchases 75,000 195 86,000 155
5-Aug Purchase returns - - (500) 140
7-Aug Issues to production (60,000) - (70,000) -

(iii) Conversion costs are incurred evenly throughout the process. Conversion costs incurred for
August 2021 are as under:

Rupees
Direct labour paid for 24,300 hours 4,000,000

Variable production overheads 2,000,000

Fixed production overheads 1,400,000

(iv) Actual sales for the month of August 2021 were 12,500 units. Details of opening and closing
inventories are hereunder:

Opening Closing
Finished goods 1,200 units 1,500 units
Work in process 1,000 units (60% complete) 500 units (80% complete)

(v) BL uses standard absorption costing system.

Required:
a) Prepare a statement of equivalent production units.(02)
b) Compute the following variances:
(i) Material price, Mix and Yield variances. (09)
(ii) Variable production overhead rate and efficiency variances. (04)
(iii) Fixed production overhead expenditure, efficiency and capacity variance.(05)

----------( 122 )----------

A.1 violet Limited
Statement of Equivalent Units:
Material Conversion
F.G 12,800 1000 → -- 400 (1,000 × 40%)

11,800 → 11,800 11,800

Closing WIP 500 500 400 (1,000 × 80%)
12,300 12,600

W-1)
Finished goods
b/d 1,200 Sales 12,500

Production (bal.) 12,800

c/d 1,500

W-2)
Work in process A/C (Units)
b/d 1,000 F.G(from F.G) 12,800

Input (bal.) 12,300

c/d 500

b) (i) Material price variance:

ALPHA:
(SR-AR) X AQU for A.P
(200*-220) x2,000 =40,000 A
(200-190) x3,000 =30,000 F
(200-195) x55,000 =275,000 F
*800/4 60,000 265,000 F
BETA:
(SR-AR) X AQU for A.P
(150*-140) x3,500 =35,000 F
(150-150) x4,000 - -
(150-155) x62,500 =312,500 A
*900/6 70,000 277,500 A

(ii) Material Mix Variance:

Alpha (52,000-60,000)X200 = 1,600,000 A
Beta (78,000-70,000)x150 = 1,200,000 F
400,000 A
Material Yeild Vaiance:
Alpha (49,200-52,000)X200 = 560,000 A
Beta (73,800-78,000)x150 = 630,000 A
1,190,000 A

Working:
SQ in SM for AP AQ in SM for AP AQ in AM for AP
Alpha 49,200 52,000 60,000
(12,300 x 4) (130,00 x 4/10)
Beta 73,800 78,000 70,000
(12,300 x 6) (130,000 x 6/10)
123,000 130,000 130,000

----------( 123 )----------

(ii) Variable Overhead

Expenditure Efficiency
(SR – AR) × AHW (SHW – AHW) × S.R
(80 – 2,000,000/24,300)x24,300 [(12,600 × 2) – 24,300]× 80
56,000 A 72,000 F
Working:
Std.Production OH rate/hr (260/2) = 130
Std.Fixed OH rate/hr (1,200,000/(12,000x2)) = (50)
Std.Variable OH rate/hr 80

(iii) Fixed Production Overhead:

Expenditure Variance :
Actual fixed overheads 1,400,000
Budgeted fixed overheads 1,200,000
200,000 A

Efficiency Capacity

Std.hrs for A.P x S.R Budgeted capacity hrs x S.R

((12,600x2)x50) = 1,260,000 (12,000x2=24,000x50) =1,200,000
Acual consumed hrs x S.R Actual consumed hrs x S.R
(24,300x50) = 1,215,000 (24,300 x 50) = 1,215,000

45,000 F 15,000 F

----------( 124 )----------

 Q.6 Zahid Enterprises (ZE) produces a single product F-85 using raw materials X and Y. Thebeak-up
of standard cost per ton (1,000 kg) of F-85 is as follows:

Rupees
Raw material – X (Rs. 50 per kg) 40,000
Raw material – Y (Rs. 80 per kg) 20,000
Direct labour (Rs. 300 per hour) 30,000

Factory overheads (40% are variable) 150% of direct labour

The details of ZE’s operations for the month of August 2023 are as follows:
(i) 30 tons of F-85 were produced, compared to a budgeted production of 33 tons.
(ii) The opening inventory of X was 4,000 kg at Rs. 50 per kg.
(iii) The opening inventory of Y was 1,000 kg at Rs. 80 per kg.
(iv) 23,000 kg of X and 8,000 kg of Y were purchased at Rs. 52 and Rs. 79 per kg,
respectively.
(v) The closing inventory of X and Y was 2,000 kg and 1,800 kg, respectively.
(vi) 3,200 direct labour hours were used, and the total direct labour cost amounted toRs.
920,000.
(vii) Due to inflation, the actual factory overheads exceeded the budget by 5%.

Required:
Compute the following:
• Material price and usage variances (also calculate the breakup of usage variance)
• Labour rate and efficiency variances
• Variable overhead expenditure and efficiency variances
• Fixed overhead expenditure variance (10)

Answer # 6: Zahidi Enterprises

Explanation of figures: [standard per ton]
Raw material X [800kgs (40,000/50) ×50/kg] = 40,000
Raw material Y [250kgs (20,000/80) ×80/kg] = 20,000
Direct labour [100hrs (30,000/300) ×300/hr.] = 30,000
Factory Overheads [30,000×150%] = 45,000
Variable overheads [45,000×40%] = 18,000
Fixed overheads [ 45,000×60%] = 27,000
Variable OH per hour (18000/100) = 180 /hr.
Fixed OH per hour (27000/100) = 270/hr.

Material price variance [Based on Quantity Used]

X (50-50) ×4,000 = 0
(50-52) ×21,000 = 42,000 A
Y (80-80) ×1,000 = 0
Y (80-79) ×6,200 = 6,200 F
= 35,800 A
Material price variance [Based on Quantity Purchased]
X (50-52) × 23,000 = 46,000 A
Y (80-79) × 8,000 = 8,000 F
= 38,000 A
----------( 125 )----------
 Material X Material Y
b/d 4,000 Consumed 25,000 b/d 1,000 Consumed 7,200

Purchase 23,000 c/d 2,000 Purchase 8,000 c/d 1,800

Material usage variance (W1)

X (24000-2500) ×50 = 50,000 A
Y (7500-7200) ×80 = 24,000 F
= 26,000 A

Material yield variance (W1) Material mix variance (W1)

X (24,000-24,533) ×50 = 26,650 A X (24,533-25000) ×50 = 23,350 A
Y (7,500-7,667) ×80 = 13,360 A Y (7,667-7,200) ×80 = 37,360 F
` = 40,010 A = 14,010 F

Labour variances

Labour rate variance Labour efficiency variance

[SR - AR] × AHW [SHW - AHW] × SR
920,000
(300 − ) ×3200 [(30 × 100) - 3200] × 300
3200
= 40,000 F = 60,000 A
Variable OH variances

VOH Expenditure variance VOH Efficiency variance

(SR-AR) × AHW (SHW-AHW) × SR
[180-189(180×1.05)] ×3,200 [(30×100) ×3,200] ×180
= 28,800 A = 36,000 A
Fixed OH expenditure Variance:
Budgeted fixed overheads [33×27,000] = 891,000
Actual fixed OH [891,000×1.05] = 935,550
= 44,550 A
Fixed OH capacity variance:
Budgeted capacity hours × S.R/hr. [33×100=3300×270] = 891,000
Actual consumed hours ×S. R/hr. [3200×270] = 864,000
27,000 A
Fixed OH efficiency variance:
Standard rate for A.P × S.R/hr. [30×100=3000×270] = 810,000
Actual consumed hours ×S. R/hr. [3200×270] = 864,000
54,000 A

Working 1:
Material SQU in SM for A. P AQU in SM for A. P AQU in AM for A. P
X 24000 24,533 25,000
(30×800) (32,200 × 800/1,050)
Y 7500 7,667 7,200
(30×250) (32,200 × 250/1,050)
31,500 32,200 32,200

----------( 126 )----------

Marginal and Absorption Costing
In absorption costing fixed production overheads are included in cost of production (and therefore to
closing stock). Therefore fixed production overheads are charged in the profit and loss account of the period
in which the inventory is sold (Fixed production overheads are treated as product cost).

In Marginal costing fixed production overheads are not included in cost of production (and therefore to
closing stock).Therefore fixed production overheads are treated as period cost and are charged in the profit
and loss account of the period in which they are incurred. (Fixed production overheads are treated as period
cost).

Q. 1 Following information has been extracted from the financial records of ATF Limited:

Production during the year Units 35,000

Finished goods at the beginning of the year Units 3,000
Finished goods at the end of the year Units 1,500
Sale price per unit Rs. 200
Fixed overhead cost for the year Rs. 1,000,000
Administration and selling expenses Rs. 200,000
Annual budgeted capacity of the plant Units 40,000

The actual cost per unit, incurred during the year, was as follows:
Rupees
Material 70
Labor 40
Variable overheads 30
Company uses FIFO method for valuation of inventory. The cost of opening finished goods inventory
determined under the absorption costing method system was Rs. 450,000. Fixed overhead constituted 16%
of the total cost last year.
Required:
(a) Prepare profit statements for the year30.06.2020, under absorption and marginal costing systems.
(b) Prepare reconciliation between the net profits determined under each system. (12 Marks)
Note:
If there is no indication, then budgeted fixed overheads are equal to actual fixed overheads.
If there is no information then assume administrative and selling expenses as fixed.

Q. 2 XY Limited manufactures and sells a single product. The selling price and costs for the year ended 31
December 2013 were as follows:

Rs. per unit

Selling price 1,600
Direct material 630
Direct labour 189
Production overheads (40% fixed) 220
Selling and distribution overheads (60% fixed) 165
Other information is as follows:
(a) During the year, 12,000 units were produced.
(b) The opening and closing stocks were 4,000 and 3,000 units respectively
(c) Fixed overhead cost per unit is based on normal capacity which is 15,000 units.
(d) Overhead costs have increased by 10% over the previous year and raw material and labour by 5%.
(e) The company uses FIFO method for costing its inventory.
Required:
• Profit and loss account for the year ended 31 December 2013 under absorption costing
and marginal costing. (14)
• Reconciliation of profit worked out under the two methods. (02)

Note: if there is no information then assume that normal capacity is equal to budgeted capacity.

----------( 127 )----------

Q. 3 Silver limited (SL) produces and markets a single product. Following information is available from SL’s
records for the month of March 2012
Volumes:
Sales 100,000 Units
Production 120,000 Units
Cost per unit:
Direct material per unit 0.8 Kg @ Rs. 60/Kg
Labor per unit 27 Minutes @ Rs. 80/Hour
Variable production overheads Rs. 40/Labor hour
Variable selling expenses Rs. 15/Unit
Fixed selling expenses Rs. 800,000
Fixed production overheads at a normal output level of 105,000 units per month are estimated at
Rs. 2,100,000. The estimated selling price is Rs. 180/unit.
Required:
Assuming there is no opening stock; prepare profit statement for the month of March using:
➢ Absorption Costing
➢ Marginal Costing

----------( 128 )----------

Solutions
A. 3
Silver Ltd.
Absorption Costing
Per Unit
Sales [100,000 × 180] 18,000,000
Cost of Sales:
Opening Stock Nil
Cost of Production:
Direct Material: (120,000 × 0.8 × 60) 5,760,000 48
 27 
Direct Labour: 120,000  80 
60 
4,320,000 36

 27 
Variable OH: 120,000  40 
60 
2,160,000 18


102
 2,100,000 
Fixed OH:   120,000  2,400,000 20
 105 ,000 
14,640,000 122
Less: Closing Stock 122 × 20,000) (2,440,000)
Cost of Sales 12,200,000
Less: Over absorbed [2,400,000 – 2,100,000] (300,000)
Gross Profit 6,100,000
Selling Expenses
Variable (100,000 × 15) 1,500,000
Fixed (Given) 800,000
Net Profit 3,800,000
Marginal Costing
Sales 18,000,000
Variable Cost of Sales
Opening Stock Nil
Variable Cost of Production:
Direct Material 5,760,000
Direct Labour 4,320,000
Variable OH 2,160,000
12,240,000
Closing Stock (20,000 x 102) (2,040,000)
10,200,000
Gross contribution 7,800,000
Variable Selling Expenses (100,000 × 15) (1,500,000)
Net Contribution 6,300,000
Fixed cost:
(2,100,000)
Production
(800,000)
Selling
Net Profit 3,400,000

Reconciliation:
Profit As per Absorption costing 3,800,000
Closing Stock A.C (2,440,000)
Closing Stock M.C 2,040,000
Profit as per Marginal costing 3,400,000

----------( 129 )----------

Extra practice questions:
1. Question
A division of Electronic Appliances Limited sold 6,000 units of refrigerators during the year ended September
30, 2008, the sale price being Rs. 24,000 per unit.
The opening work in progress comprised of 500 units which were complete as regards material but only 40%
complete as to labour and overheads. The closing work in progress comprised of 1,200 units which were
also complete as regards material but only 50% complete as to labour and overheads. The finished goods
inventory was 800 units at the beginning of the year and 1000 units at the year end.
The work in progress account had been debited during the year with the following costs:

Rs. In ‘000’
Direct material 83,490
Direct labour 14,256
Variable overheads 10,890
Fixed overheads 17,490

As compared to the previous year, the costs per units have increased as follows:

Direct material 10%

Direct labour 8%
Variable overheads 10%
Fixed overheads 6%
The selling and administration cost for the year were:

Rupees
Variable cost per unit sold 1,600
Fixed costs 12,000,000

Required:
(a) Compute the cost per unit by element of cost and in total, assuming FIFO basis.
(b) Prepare profit statements on the basis of:
(i) Absorption costing
(ii) Marginal costing.
(c) Prepare a reconciliation between profits.

----------( 130 )----------

Q.2 Frappe Limited (FL) manufactures and sells a single product Sigma. Following information is available:

During the year ended 31 December 2018, FL sold 5,500 units at Rs. 25,000 per unit. Details of opening
and closing work in process and finished goods are as follows:

Percentage of completion
Number of units Conversion
Direct material costs
Work in process:
Opening 400 100% 60%
Closing 800 100% 40%
Finished goods:
Opening 600 - -
Closing 900 - -

The work in process account had been debited during the year with the following costs:
Rs. in '000
Direct material 82,350
Conversion costs (including fixed overheads of Rs. 16.762 million) 44,217

Variable operating costs amounted to Rs. 500 per unit whereas fixed operating costs for the year were Rs.
7,500,000.
Effective from 1 January 2018, direct material price and conversion costs were increased by 5% and 10%
respectively.

FL uses FIFO method for valuation of its inventories.

Required:
• Prepare statements of equivalent units and cost per equivalent unit.
• Prepare profit statements on the basis of:
marginal costing
absorption costing
(Round off all figures to the nearest rupee amount)

----------( 131 )----------

Test
Q. (a) Discuss the assumptions used in marginal costing. (04)

(b) Kenya Limited (KL) is involved in the manufacture of a single product and has a total
production capacity of 60,000 units per month. It is currently operating at its normal
capacity of 80% and uses absorption costing. Below is the extract from KL's budget
for the month of February 2022:
Rupees
Selling price per unit 210

Variable costs per unit:

Prime cost 75
Factory overheads 45
Selling and admin expenses 15

Fixed costs:
Factory overheads 2,016,000
Selling and admin expenses 800,000

Actual operating data for the month of February 2022:

- Due to an unexpected fault in KL's manufacturing plant, it was able to operate at
75% of its production capacity only.
- Sales of 47,000 units were made at the selling price budgeted by KL.
- Opening stock of 10,000 units costing Rs. 1,600,000 was held by KL. Fixed
factory overheads were absorbed in prior month at the rate of Rs. 40 per unit.
- Fixed factory overheads exceeded the budget by Rs. 500,000 due to increase in
electricity cost.

Required:
(i) Prepare profit or loss statement for the month of February 2022 using marginal
costing and absorption costing. (11)
(ii) Reconcile the difference in profits under the two methods. (02)

----------( 132 )----------

Test answer:
(a)
For the purpose of marginal costing, the following assumptions are normally made:

i. All elements of cost-production, administration and selling and distribution can be segregated into
fixed and variable components.
ii. Variable cost remains constant per unit of output irrespective of the level of output and thus fluctuates
directly in proportion to changes in the volume of output.
iii. The selling price per unit remains unchanged or constant at all levels of activity.
iv. Fixed cost remains unchanged or constant for the entire volume of production.
v. The volume of production or output is the only factor which influences the costs.

(b)
(i)
Kenya Limited
Profit Statement under Absorption Costing
Rupees
Sales (47,000×210) 9,870,000
Cost of sales
Opening stock (10000 units) 1,600,000
Cost of Goods manufactured:
Prime cost (45,000 x 75) 3,375,000
V.OH (45,000 x 45) 2,025,000
F. OH (45,000 x 2,016,000/48,000) 1,890,000 7,290,000

Less: Closing stock (7,290,000/45,000 x 8,000) (1,296,000)

Unadjusted cost of sales (7,594,000)

Under applied FOH (W) (626,000)
Adjusted cost of sales (8,220,000)
Gross profit 1,650,000
Less: selling and admin [(47,000×15) +800,000] (1,505,000)
Profit 145,000
Profit Statement under Marginal Costing

Rupees
Sales (47,000×210) 9,870,000
Variable Cost of sales
Opening stock (1,600,000 – 10,000 x 40) 1,200,000
Variable Cost of Goods manufactured:
Prime cost (45,000 x 75) 3,375,000
V.OH (45,000 x 45) 2,025,000
5,400,000

Less: Closing stock (5,400,000/45,000 x 8,000) (960,000)

(5,640,000)
Gross contribution 4,230,000
Less: Variable selling Expense (47,000 x 15) (705,000)
Net contribution 3,525,000
Less: Fix costs
Fix selling expense (800,000)
Fix FOH (Actual) (2,016 + 500) (2,516,000)
Profit 209,000

----------( 133 )----------

(ii) Reconciliation of profit worked out under marginal and absorption costing

Rupees
Profit under absorption costing 145,000
Opening stock as per absorption costing 1,600,000
Closing stock as per absorption costing (1,296,000)
Opening stock as per marginal costing (1,200,000)
Closing stock as per marginal costing 960,000
Profit under marginal costing 209,000

Workings:
Finished Goods (Units)

b/d 10,000 Sale

Production 45,000 47,000

Closing (bal.) 8,000

FOH

Actual FOH 2,516,000 Applied FOH

(2016000 + 500000) 1,890,000

COS (bal.)
626,000

----------( 134 )----------

Solution:2 Process A/c
(000)
Units Amount Units Amount

b/d 400 Finished Goods 5,800

Input(bal.)
6,200

Direct Material 82,350

Conversion Variable 27,455
Conversion Fixed 16,762
c/d 800

Finished Goods A/c

b/d Sales
600 5,500

Production (bal.)
5,800 c/d
900

Equivalent Units:
Material Conversion
Finished Goods - 160 (40%)
400
5,800 5,400 5,400
800 320 (40%)
5,400
c/d 800 6,200 5,880

Rate/Unit:
Material = 82,350/6,200 = 13.28
Conversion Variable = 27,455/5,880 = 4.67
17.95
Conversion-Fixed = 16,762/5,880 = 2.85
20.8
Last Year
13.28/105 ×100 = 12.65
4.67/110 ×100 = 4.25
16.90
2.85
× 100 = 2.6
110
19.5

Profit statement (Absorption Costing)

--------------- Rs” 000’’ -------------

Sales (5,500 × 25,000) 137,500
Cost of sales:
Opening stock (600×19.5) 11,700
+Cost of goods manufactured:
Direct material 82,350
Conversion variable 27,455
Conversion – fixed 16,762
126,567

----------( 135 )----------

 Opening WIP 6,704
(400 × 12.65 + 400 × 60% × 4.25 + 400 × 60% × 2.60)
Closing WIP (13,030)
(800 × 13.28 + 800 × 40% × 4.67 + 800 × 40% × 2.85)
120,241
Closing stock(900×20.8) (18,720) (113,221)
Gross profit 24,279
Operating Expenses:
Variable (5500×500) (2,750)
Fixed (7,500)
Net profit 14,029

Profit Statement (Marginal Costing)

--------------- Rs” 000’’ -------------
Sales (5500  25000) 137,500
Variable Cost Of Sale:
Opening Stock (600  16.9) 10,140
Variable COGM
Direct Material 82,350
Conversion Variable 27,455
109,805
Opening WIP 6,080
(400  12.65 + 400  60%  4.25)
Closing WIP (12,118)
(800  13.28+ 800  40%  4.67)
103,767
Closing Stock(900  7.95) (16,155)
(97,752)
Gross Contribution 39,748
Variable Operating Cost(5500  500) (2,750)
Net Contribution 36,998
Fixed Cost:
Production (16,762)
Operating (7,500)
Net Profit 12,736

MARGINAL COST AND MARGINAL COSTING

Marginal cost
The marginal cost of an item is its variable cost (means variable cost is also called as marginal cost)
Marginal production cost = Direct materials + Direct labor + Direct expenses (if any) + Variable
production overhead.
It is usually assumed that direct labor costs are variable (marginal) costs, but often direct labor costs
might be fixed costs, and so would not be included in marginal cost. E.g. If the workers are not being paid
on piece rate basis but rather on fixed salary (monthly or weekly)
Variable overhead costs might be difficult to identify. In practice, variable overheads might be measured
using a technique such as high/low analysis or linear regression analysis, to separate total overhead costs
into fixed costs and a variable cost per unit of activity.
• For variable production overheads, the unit of activity is often either direct labor hours or machine
hours, although other suitable measures of activity might be used.
• For variable selling and distribution costs, the unit of activity might be sales volume or sales
revenue.
• Administration overheads are usually considered to be fixed costs, and it is very unusual to come
across variable administration overheads.
In simple words…
In marginal costing the cost of the product is variable Production Cost only.

----------( 136 )----------

Marginal costing and its uses
Marginal costing is a method of costing with marginal costs. It is an alternative to absorption costing as a
method of costing. In marginal costing, fixed production overheads are not absorbed into product costs.
There are several reasons for using marginal costing:
• To measure profit (or loss), as an alternative to absorption costing
• To forecast what future profits will be
• To calculate what the minimum sales volume must be in order to
make a profit It can also be used to provide management with information
for decision making (means used in breakeven analysis, target profit
analysis and decision making of limiting factor or make or buy decision
etc.)
Its main uses, however, are for planning (for example, budgeting), forecasting and decision making as
it deals with costs that can be directly changed in the short term.

Assumptions in marginal costing

For the purpose of marginal costing, the following assumptions are normally made:
• Every additional unit of output or sale, or every additional unit of activity, has the same variable cost
as every other unit. In other words, the variable cost per unit is a constant value.
• Fixed costs are costs that remain the same in total in each period, regardless of how many units are
produced and sold.
• Costs are either fixed or variable, or a mixture of fixed and variable costs. Mixed costs can be
separated into a variable cost per unit and a fixed cost per period.
• The marginal cost of an item is therefore the extra cost that would be incurred by making and selling
one extra unit of the item. Therefore, marginal costing is particularly important for decision making as it
focuses on what changes as a result of a decision.

Contribution margin
Contribution is a key concept in marginal
costing.

Contribution margin = Sales – Variable costs

Fixed costs are a constant total amount in each period. To make a profit, an entity must first make enough
contribution to cover its fixed costs. Contribution therefore means: ‘contribution towards covering fixed
costs and making a profit’.
Total contribution margin – Fixed costs =
Profit

In simple words…
Contribution margin is sales minus all Variable costs

----------( 137 )----------

MARGINAL COSTING AND ABSORPTION COSTING COMPARED

The difference in profit between marginal costing and absorption costing

The profit for an accounting period calculated with marginal costing is different from the profit calculated
with absorption costing.
The difference in profit is entirely due to the differences in inventory valuation as fixed production overheads
are treated as period cost in marginal costing and as product cost in absorption costing.
The main difference between absorption costing and marginal costing is that in absorption costing,
inventory cost includes a share of fixed production overhead costs.
• The opening inventory contains fixed production overhead that was incurred last period. Opening
inventory is written off against profit in the current period. Therefore, part of the previous period’s
costs is written off in the current period income statement provided that the opening inventory is
sold during the current year.
• The closing inventory contains fixed production overhead that was incurred in this period.
Therefore, this amount is not written off in the current period income statement but carried forward
to be written off in the next period income statement.
Always remember:
Fixed selling overhead or fixed administration overhead are recognized as an expense in full as a period
cost in both absorption costing and marginal costing, and only fixed production overheads are included in
inventory values.

ADVANTAGES AND DISADVANTAGES OF ABSORPTION AND MARGINAL COSTING

Advantages and disadvantages of absorption costing.

Advantages of absorption costing
• Inventory values include an element of fixed production overheads. This is consistent with the
requirement in financial accounting that (for the purpose of financial reporting) inventory should
include production overhead costs (consistent with financial reporting i.e. IAS 2)
• Calculating under/over absorption of overheads may be useful in controlling fixed overhead
expenditure.
• By calculating the full cost of sale for a product and comparing it will the selling price, it should be
possible to identify which products are profitable and which are being sold at a loss.
Disadvantages of absorption costing
• Absorption costing is a more complex costing system than marginal costing.
• Absorption costing does not provide information that is useful for decision making (like marginal
costing does).
• Assigning of Production overheads always include an element of discretion (means whether on the
basis of machine hours or labor hours);
Advantages and disadvantages of marginal costing
Advantages of marginal costing
• It is easy to account for fixed overheads using marginal costing. Instead of being apportioned they
are treated as period costs and written off in full as an expense the income statement for the
period when they occur.
• There is no under/over-absorption of overheads with marginal costing, and therefore no
adjustment necessary in the income statement at the end of an accounting period.
• Marginal costing provides useful information for decision making.
Disadvantages of marginal costing

• Marginal costing does not value inventory in accordance with the requirements of financial
reporting. (However, for the purpose of cost accounting and providing management information,
there is no reason why inventory values should include fixed production overhead, other than
consistency with the financial accounts.) (not consistent with financial reporting i.e. IAS 2)

----------( 138 )----------

 • Marginal costing can be used to measure the contribution per unit of product, or the total
contribution earned by a product, but this is not sufficient to decide whether the product is
profitable enough. Total contribution has to be big enough to cover fixed costs and make a
profit.(the decision as to whether the products are generating the profit or loss cannot be made by
using the marginal costing)

Absorption costing
We have already discussed the use of factory overhead rate for product costing. When this is
established, the production capacity volume must be selected, so that all costs and expenses can be
expected to be recovered over a certain period of time. This concept of costing is known as
“Absorption costing” and it is, sometimes, termed as “Full costing” or “Conventional costing”. It
includes direct materials, direct labour, direct expenses, variable production overheads and fixed
production overheads. In absorption costing, fixed production cost is product cost, and inventory is
valued at full production cost. Still, fixed non-production overheads are period cost and charged to
profit or loss for the year.
At end of each period, differences between absorbed and fixed production overheads are closed to
cost of sales. The under or over absorption of production overheads arise because of actual
production level was less or more than budgeted or normal activity level.
Arguments in favour of absorption costing
• Absorption costing does not understate the importance of fixed production overheads. Inventory
in this method is calculated on realistic cost of production because of inclusion of fixed
production overheads.
• Absorption costing avoids fictitious losses being reported as in seasonal sales situation, it
provides realistic profit or loss for the period. Unlike in marginal costing, where in low sales
season, fixed cost in total is deducted from contribution margin, resulting losses.
• Another argument towards absorption costing is that the production of goods is not possible
without incurring fixed manufacturing cost. As a result, we add fixed production overhead in
inventory valuation.
• Most important argument is that absorption costing is in consistent with external reporting.

----------( 139 )----------

Example:
The following information relates to a manufacturing company for a period.

Production 16,000 units Fixed production costs Rs.80,000

Sales 14,000 units Fixed selling costs Rs.28,000

Using absorption costing, the profit for this period would be Rs.60,000. Assuming there is no opening
inventory

What would have been the profit for the year if marginal costing had been used?
Ignore the fixed selling overheads. These are irrelevant since they do not affect the difference in profit
between marginal and absorption costing.
There is an increase in inventory by 2,000 units, since production volume (16,000 units) is higher than sales
volume (14,000 units).
If absorption costing is used, the fixed production overhead cost per unit is Rs.5 (Rs.80,000 / 16,000 units).
The difference between the absorption costing profit and marginal costing profit is therefore Rs.10,000
(2,000 units x Rs.5).
Absorption costing profit is higher, because there has been an increase in inventory. Marginal costing profit
would therefore be Rs.60,000 – Rs.10,000 = Rs.50,000.

Example:
Red Company is a manufacturing company that makes and sells a single product. The following information
relates to the company’s manufacturing operations in the next financial year.

Opening stock: Nil

Production: 18,000 units
Sales: 15,000 units
Fixed production overheads: Rs.117,000
Fixed sales overheads: Rs.72,000

Using absorption costing, the company has calculated that the budgeted profit for the year will be Rs.43,000.
What would be the budgeted profit if marginal costing is used, instead of absorption costing?
In completing the requirement, Production overhead per unit, with absorption costing, please see below:
= Rs.117,000/18,000 units
= Rs.6.50 per unit.
The budgeted increase in inventory = 3,000 units (18,000 – 15,000).
Production overheads in the increase in inventory = 3,000 × Rs.6.50 = Rs.19,500.
With marginal costing, profit will be lower than with absorption costing, because there is an increase in
inventory levels.
Marginal costing profit = Rs.43,000 - Rs.19,500 = Rs.23,500.

Example:
Entity T manufactures a single product, and uses absorption costing. The following data relates to the
performance of the entity during October.

Profit Rs.37,000
Over-absorbed overhead Rs.24,000
Sales (48,000 units) Rs.720,000
Non-production overheads (all fixed costs) Rs.275,000
Opening inventory Rs.144,000
Closing inventory Rs.162,000
Units of inventory are valued at Rs.9 each, consisting of a variable cost (all direct costs) of Rs.3 and a fixed
overhead cost of Rs.6. All overhead costs are fixed costs.
Required:
Calculate the actual production overhead cost for October and the profit that would have been reported in
October if Entity T had used marginal costing.

----------( 140 )----------

Answer:

Statement of Profit or Loss (Absorption Costing)

Sales 720,000
Cost of sales:
Opening cost [16,000(w-1) x 9] 144,000
+ Cost of goods manufactured
Variable Cost [50,000 (w-1) x 3] 150,000
Fixed OH [50,000 X 6] 300,000
-Closing Stock [18,000(w-1) x 9] (162,000)
Unadjusted Cost of sales 432,000
Over-absorbed Fixed OH (24,000)
Adjusted Cost of Sales 408,000
Gross Profit 312,000
Non-Production OH (275,000)
Profit 37,000

a)
Fixed Production OH
Factory Expenses 276,000 WIP 300,000
COS 24,000 [50,000 x 6]

b) Profit Under Marginal Costing:

Profit As Per Absorption Costing 37,000

Opening Stock as Per Absorption Costing 144,000
Closing Stock as Per Absorption Costing (162,000)
Opening Stock as Per Marginal Costing (16,000 x 3) (48,000)
Closing Stock as Per Marginal Costing (18,000 x 3) 54,000
Profit As Per Marginal Cost 25,000

W-1)

Finished Goods (Units)

b/d 16,000 Sales 48,000
(144,000/9)
Production 50,000
c/d 18,000
(162,000/9)

----------( 141 )----------

Test joint and by product and variance

Q.1 Cricket Chemicals Limited (CCL) is a manufacturing concern and has two production processes.
Process I produces two joint products i.e. X-1 and X-2. Incidental to the production of joint products, it
produces a by-product known as Zee. X-1 is further processed in process II and converted into ‘X1-Plus’.
Following information has been extracted from the budget for the year ending 31 August 2019:
(i) Process wise budgeted cost:
Process I Process II
--------------Rupees ------------
Direct material (500,000 liters) 98,750,000 -
Conversion cost 72,610,000 19,100,000

(ii) Expected output ratio from process I and budgeted selling prices:
Output ratio Selling price
Products
in process I (Rs. per liter)
Joint product – X-1 55% -
Joint product – X-2 40% 532
By-product – Zee 5% 120
X1-Plus - 768

Additional information:
1. Material is added at the beginning of the process and CCL uses 'weighted average method' for
inventory valuation.
2. Joint costs are allocated on the basis of net realizable value of the joint products at the split-off point.
Proceeds from the sale of by-product are treated as reduction in joint costs.
3. Joint product X-2 is sold after incurring packing cost of Rs. 75 per liter.
4. Normal production loss in process I is estimated at 5% of the input which occurs at beginning of the
process. Loss of each liter results in a solid waste of 0.7 kg which is sold for Rs. 10 per kg. No loss
occurs during process II.
5. Budgeted conversion cost of process I and process II include fixed factory overheads amounting to
Rs. 7,261,000 and Rs. 3,820,000 respectively.
Required:
1. Prepare product wise budgeted income statement for the year ending 31 August 2019, under
absorption costing. (8)
2. Prepare product wise budgeted income statement for the year ending 31 August 2019, under
marginal costing. (7)

Question: 2
Safety Products (Pvt) Limited (SPL) is engaged in the manufacturing of safety products for the construction
industry. The following production information, for further analysis, has been provided by SPL:
Rupees
Per unit Budgeted Cost:
Direct material (10 kg @ Rs. 22 per kg) 220
Direct labour (1.5 hours @ Rs. 110 per hour) 165
Variable overhead (1.5 hours @ Rs. 55 per hour) 82.5
Fixed overhead (1.5 hours @ Rs. 110 per hour) 165
Total per unit budgeted cost 632.5
Budgeted variable overhead 866,250
Budgeted fixed overhead 1,732,500

Fixed and variable overheads are absorbed on the basis of direct labour hours, which are estimated to be
15,750 hours per month.

----------( 142 )----------

 Rupees
Actual cost results:
Direct material (100,000 kg) 1,650,000
Direct labour (13,000 hours) 1,573,000
Variable overhead 910,000
Fixed overhead 1,692,900
Total actual cost 5,825,900
Budgeted sales of SPL is 10,500 units at a price of Rs. 1,210 per unit and the actual sales revenue of the
company is Rs. 12,540,000 for 9,500 units.
Required:
a) Calculate the following variances: (1.5 x 08 =12)
i. Sales price variance
ii. Sales volume profit variance
iii. Material price variance
iv. Materials usage variance
v. Labour rate variance
vi. Labour efficiency variance
vii. Variable overhead expenditure variance
viii. Variable overhead efficiency variance

b) Calculate the following fixed overhead variances: (1.5 x 4 = 08)

i. Fixed overhead expenditure variance
ii. Fixed overhead volume variance
iii. Fixed overhead volume efficiency variance
iv. Fixed overhead volume capacity variance

Question:3
Choc Co is a company which manufactures and sell three types of biscuits in packets. One of them is called
‘Ooze’ and contains three types of sweeteners: honey, sugar and syrup. The standard materials usage and
cost for one unit of ‘Ooze’ (one packet) is as follows:
Honey 20 grams at 0.02 per gram 0.40
Sugar 15 grams at 0.03 per gram 0.45
Syrup 10 grams at 0.025 per gram 0.25
1.10

In the three months ended 30 November 2011, Cho Co produced 101,000 units of ‘Ooze’ using 2,200 kg of
honey, 1,400 kg of sugar and 1,050 kg of syrup.
Note: there are 1,000 grams in a kilogram (kg).
Required:
Calculate the following variance for materials in Ooze:
i. Total materials usage variance. (4 marks)
ii. Total materials mix variance. (4 marks)
iii. Total materials quantity (yield) variance. (4 marks)

Question: 4
Titan Manufacturing Company produces a consumer product. The company prepares its fixed production
budget annually and standard costing for the production budget annually and standard costing for the
production on monthly basis. The budget, the standard production cost and actual data for the month ended
June 30, 2016 are given below:
Budgeted and Standard Cost Data
Budgeted sales and production for the month (Units) 25,000
Standard cost for each unit of product:
Direct material: Beta 15 kgs @ Rs. 2 per kg
Gama 10 kgs @ Rs. 7 per kg
Direct labour incurred 10 hours @ Rs. 4 per hour
Fixed production overhead 200% of direct labour
Budgeted sales price has been calculated to give a profit of 20% on sales price.
----------( 143 )----------
 Actual Data for the Month
Production (units sold at a price 20% higher than budgeted) 14,500
Direct material consumed: Beta 150,000 kgs @ Rs. 3 per kg
Gama 75,000 kgs @ Rs. 6 per kg
Direct labour incurred 72,000 hours at Rs. 5 per hour
Fixed production overheads incurred (Rs.) 1,800,000

Other information:
Volume efficiency variance (Rs.) 584,000 (F)
Volume capacity variance (Rs.) 1,424,000 (A)

Required:
a) Prepare a statement for month ended June 30, 2016 showing:
i. The standard production cost and selling price per unit. (03)
ii. The actual profit for the period.
(03)
b) Determine the variance for:
i. Direct material price and usage.
(03)
ii. Direct labour rate and efficiency.
(03)
iii. Fixed overhead expenditure and volume.
(02)
iv. Sales price and volume.
(02)
c) Reconcile the budgeted and actual profit.
(04)

----------( 144 )----------

Ans. 1 (a)
Cricket Chemicals Limited
Product wise budgeted income statement (Absorption costing)
for year ended 31-8-2019 Rs.000
X1 Plus X2 Total
Sales 200,640 101,080 301,720
COS:
Cost of goods (132,971) (68,714) (201,685)
manufactured
(113,871+19,100) (54,464 + 14,250)
Gross profit 67,669 32,366 100,035

Workings:

(475,000 x 55%) 19,100

X1 [261,250] (55%) ll X1 Plus [261,250]

(55%)
X2 [190,000] (40%) Packing Cost 75/L
500,000
Zee [23,750] (5%) (23,750 x 120) = 2,850
N. Loss [25,000 L] (25,000 x0.7 x10) = 175

D.M 98,750
Conversion 72,610
Zee (2,850)
N. Loss (175)
168,335

Allocation:
Rs. ‘000’
Sale price / Further Allocation
Units Sale Value NRV
unit processing
X1 plus 261,250 768 200,640 19,100 181,540 113,871
X2 190,000 532 101,080 14,250 86,830 54,464
(190,000x75)

268,370 168,335
(b)
Cricket Chemicals Limited
Product wise budgeted income statement (marginal costing)
for year ended 31-8-2019 Rs.000
X1 Plus X2 Total
Sales 200,640 101,080 301,720
Variable COS:
Variable Production Cost (124,971) (65,633)
(190,604)
109,691 + 15,280 51,383 + 14,250
Net Contribution 75,669 35,447 111,116
Fixed Cost (7,261 + 3,820) (11,081)
Net profit 100,035

----------( 145 )----------

Workings:

(475,000 x 55%) (19,100 - 3,820 = 15,280)

X1[26,1250](55%) ll X1 Plus [261,250]

(55%)
X2 [190,000] (40%) Packing Cost 75/L
500,000
Zee [23,750] (5%) (23,750 x 120) = 2,850
N. Loss [25,000 L] (25,000 x0.7 x10) = 175

D.M 98,750
Conversion 72,610
Zee (2,850)
N. Loss (175)
Fixed Cost (7,261)
161,074

Allocation:
Rs. ‘000’
Sale price / Further Allocation
Units Sale Value NRV
unit processing
X1 plus 261,250 768 200,640 15,280 185,360 109,691
X2 190,000 532 101,080 14,250 86,830 51,383
(190,000x75)
272,190 161,074

Ans 2. Calculation of Variances:

Sales

Price Volume
(BR – AR) × AQS (BQS – AQS) × Std. profit / unit
12,540,000 [(10,500 – 9500)x 577.5 (1210-632.5)
[1210 - ] x 9500
9,500
1,045,000 F 577,500 A
Material

Price Usage
(SR – AR) × AQU (SQU – AQU) × S.R
1,650,000 [(9.500 x 10)-100,000]x22
[22 - ] x 100,000)
100,000
550,000 F 110,000 A

Labour

Rate Efficiency
(SR – AR) × AHW (SHW – AHW) × S.R
1,573,,000 [(9500 × 1.5) – 13,000] × 110
[110 - ] x 13,000
13,000
143,000 A 137,500 F
----------( 146 )----------
 Variable OH

Rate Efficiency
(SR – AR) × AHW (SHW – AHW) × S. R
910,000 [(9500× 1.5) –13,000] × 55
[55 - ] x 13,000
13,,000
195,000 A 68,750 F

(b) Calculation of Fixed Overhead Variances:

(1)Fixed Overhead expenditure variance:
Budgeted expenditure 1,732,500
Actual expenditure 1,692,900
39,600 F
(2)Fixed Overhead volume variance:
Budgeted F-OH (10,500x165) 1,732,500
Applied F-OH (9500x165) 1,567,500
165,000 A

(3) Fixed Overhead volume Efficiency variance:

Std hrs for AP (9500x1.5x110) 1,567,500
Actual consumed (13,000x110) 1,430,000
137,500 F

(4) Fixed Overhead volume capacity variance:

Budgeted hrs (10,500x1.5 x110) 1,732,500
Actual hrs (13,000x110) 1,430,000
302,500 A

Answer:3
SQU in SM for A.P AQU in SM for A.P AQU in AM for A.P
H 2,020 (110,000*0.02) 2,067 (4,650*20/45) 2,200
S 1,515 (101,000*0.010) 1,550 (4,650*15/45) 1,400
S 1,010 (101,000*0.010) 1,033 (4,650*10/25) 1,050
4,545 4,650 4,650

Usage variance:
H (2,020 – 2,200) x 20 = 3,600 A
S (1,515 – 1,400) x 30 = 3,450 F
S (1,010 – 1,050) x 25 = 1,000 A
1,150 A

Mix variance:
H (2,067 – 2,200) x 20 = 2,660 A
H (1,515 – 1,400) x 30 = 4,500 F
S (1,033 – 1,050) x 25 = 425 A
1,415 F

Yield variance:
H (2,020 – 2,067) x 20 = 940 A
S (1,515 – 1,550) x 30 = 1,050 A
S (1,010 – 1,033) x 25 = 575 A
2,565 A

----------( 147 )----------

Answer: 4
(a) Operating Statement for the month ended June 30, 2016.
(i) Calculation of standard Product cost and selling price/unit:
Rs. /unit
Direct Material:
Beta (15 Kg @ rs. 2) 30
Gama (10 Kg @ Rs.7) 70
Direct Labour:
(10 hours @ Rs. 4) 40
Fixed production overhead (Rs. 40 x 200%) 80
Standard Cost: 220
Profit (220 x 20/80) 55
Budgeted sale Price 275

(ii) Calculation of Actual Profit for the period:

Rs. 000
Sales (275 x 120% = 330 x 14,500 units) 4,785
Direct Material:
Beta (150,000 Kg @ Rs. 3) 450
Gama (75,000 Kg @ Rs. 6) 450
Direct Labour
(72,000 @ Rs. 5) 360
Fixed production overhead 1,800
Total (3,060
Actual Profit 1,725

(b) Variances:
Price Variance:
Beta 150,000 kgs. (Rs. 2 - @ Rs.3) (150) A
Gamma 75,000 kgs. (Rs. 7 - @ Rs. 6) 75 F
(75) A
Usage Variance:
Beta Rs. 2 (14,500 units x 15 kg – 150,000) 135 F
Gamma Rs. 7 (14,500 units x 10kg – 75,000) 490 F
625

(ii) Direct labour rate and efficiency variances:

Rate variance 72,000 hrs. (Rs. 4 – Rs. 5) (72) A
Efficiency Variance Rs:4 (14,500 units x 10 Hrs – 72,000) 292 F
220 F

(iii) Fixed overhead variance:

Expenditure variance (25,000 units x Rs 80 – 1,800,000) 200 F
Volume Variance:
Volume efficiency variance (Given) 584 F
Volume capacity variance (Given) (1,424) A
(640) A

(iv) Sales variance:

Price variance 14,500 units x (Rs. 330 – Rs 275) 797.5 F
Volume variance (14,500 units – 25,000 units) x Rs. 55 577.5 A
220 F

(c) Reconciliation
Budgeted profit (25,000 x 55) 1,375
Material variance (625 – 75) 550 F
Labour variance (292 – 72) 220 F
FOH variance (200 – 840) (640) A
Sales variance (797.5 – 577.5) 220 F
Actual profit 1,725
----------( 148 )----------
Extra questions
Q.1 Tulip Enterprises (TE) manufactures a product Alpha that requires two separate processes, A and B.
Following information has been extracted from the cost records of Process B for the month of
February 2019:
Quantity Process A Process B cost
cost Material Conversion
Liters ------------- Rs. in '000 -------------
Opening work-in-process – Process B 10,000 1,500 600 400
(80% complete as to conversion)
Cost for the month:
- Received from process A 90,000 14,000 - -
- Added during process B 12,000 - 7,000 5,600
Closing work-in-process – Process B 9,500 - - -
(70% complete as to conversion)
Additional information:
1. Materials are added at start of the process.
2. Normal loss is estimated at 5% of the inspected units and loss is determined at completion of the
process. Loss of each liter results in a solid waste of 0.75 kg. During the month of February 2019,
solid waste produced was 6,000 kg.
3. Solid waste is sold for Rs. 170 per kg after incurring further cost of Rs. 20 per kg.
4. TE uses weighted average method for valuation of inventory.

Required:
Prepare accounting entries to record the transactions of process B.
(Narrations to accounting entries are not required)
(12)
Q.2 Daisy Limited (DL) manufactures and markets product Zee. DL uses standard absorption costing.
Following information pertains to product Zee for the month of February 2019.

(a) Data extracted from the budget for the month of February 2019:
Production Units 27,000

Cost of production: Rs. in '000

Direct material X: 16,000 kg @ Rs. 400 per kg 6,400
Y: 14,000 kg @ Rs. 300 per kg 4,200
Direct labour 10,000 hours @ Rs. 220 per hour 2,200
Factory overheads
(including fixed overheads of Rs. 900,000) Rs. 250 per labour hour 2,500

(i) Actual input ratio of X and Y was 55:45 respectively.

(ii) Direct materials are added at the beginning of the process. Actual process losses were 6% of
the output. There is no change in the direct material prices during the month.
(iii) DL increased wages by 12% as against the budgeted increase of 8% which improved labour
efficiency by 5%.
(iv) Due to higher than expected inflation, actual factory overhead rate was 6% higher than the
budgeted rate.
(v) Conversion costs were incurred evenly throughout the process.
(vi) 27,400 units of Zee were transferred to finished goods. There was no opening or closing work
in process. Finished goods inventory at the beginning and closing of the month was 1,000
units and 1,500 units respectively.
Required:
Compute the following:
(a) Material price, mix and yield variances (06)
(b) Labour rate and efficiency variances (04)
(c) Over/under applied overheads and analyse it into:
1. variable overhead expenditure and efficiency variances
2. fixed overhead expenditure and volume variances
----------( 149 )----------
Q.3 Hexa Limited is using a standard absorption costing system to monitor its costs. The management is
considering to adopt a marginal costing system. In this respect, following information has been extracted
from the records for the month of December 2016:
(i) Actual as well as budgeted sale was 10,500 units at Rs. 2,000 per unit.
(ii) Standard cost per unit is as follows:

Rupees
Direct material 5 kg @ Rs. 158 790
Direct labour 3 hours @ Rs. 150 450
Production overheads (fixed & variable) Rs. 120 per labour hour 360
1,600

(iii) Budgeted fixed overheads were Rs. 1,650,000.

(iv) Production and actual costs were as under:

Units
Production: Budgeted 11,000
Actual 12,000

Actual variable costs: Rupees

Direct material (58,000 kg @ Rs. 160) 9,280,000
Direct labour (35,000 hours @ Rs. 155) 5,425,000
Variable overheads 2,975,000

(v) Applied fixed overheads exceeded actual overheads by Rs. 200,000.

(vi) There was no opening finished goods inventory. Actual Closing finished goods inventory was 1,500
units. Measure the actual closing finished goods inventory at the standard variable production cost.

Required:
(a) Compute the budgeted and actual profit for the month of December 2016, using standard marginal
costing. (8)
(b) Reconcile the above profit by incorporating the related variances. (8)

Q.4 Cricket Chemicals Limited (CCL) is a manufacturing concern and has two production processes.
Process I produces two joint products i.e. X-1 and X-2. Incidental to the production of joint products, it
produces a by-product known as Zee. X-1 is further processed in process II and converted into ‘X1-Plus’.
Following information has been extracted from the budget for the year ending 31 August 2019:

Process wise budgeted cost:

Process I Process II
--------------Rupees ------------
Direct material (500,000 liters) 98,750,000 -
Conversion cost 72,610,000 19,100,000

Expected output ratio from process I and budgeted selling prices:

Output ratio Selling price
Products
in process I (Rs. per liter)
Joint product – X-1 55% -
Joint product – X-2 40% 532
By-product – Zee 5% 120
X1-Plus - 768
Additional information:
1. Material is added at the beginning of the process and CCL uses 'weighted average method' for
inventory valuation.
2. Joint costs are allocated on the basis of net realizable value of the joint products at the split-off point.
Proceeds from the sale of by-product are treated as reduction in joint costs.
----------( 150 )----------
 3. Joint product X-2 is sold after incurring packing cost of Rs. 75 per liter.
4. Normal production loss in process I is estimated at 5% of the input which occurs at beginning of the
process. Loss of each liter results in a solid waste of 0.7 kg which is sold for Rs. 10 per kg. No loss
occurs during process II.
5. Budgeted conversion cost of process I and process II include fixed factory overheads amounting to
Rs. 7,261,000 and Rs. 3,820,000 respectively.
Required:
(a) Prepare product wise budgeted income statement for the year ending 31 August 2019, under
marginal costing. (14)
(b) CCL has recently received an offer from Football Industries Limited (FIL) to purchase the entire
expected output of X-1 during the year ending 31 August 2019 at Rs. 670 per liter. It is estimated
that if process II is not carried out, fixed costs associated with it would reduce by Rs. 2,500,000.
Advise whether FIL’s offer may be accepted. (02)

----------( 151 )----------

Answer 1:
Tulip Enterprises
Accounting entries for Process B:

WIP-B 26,600
WIP-A 14,000
Raw material 7,000
Conversion 5,600

Finished Goods 25,326

WIP-B 25,326

Normal Loss 577

WIP-B 577
Cash 577
Normal loss 577
Abnormal Loss 771
WIP-B 771

2,875 x 0.75 x 150 = 323

Cash 323
Ab. Loss 323

Workings:
Process-B Rs. ‘000’
Litres Amount Litres Amount
b/d [1,500 + 600+ 400] 10,000 2,500 Finished Goods (Bal.) 94,500 25,326
Process A 90,000 14,000 Normal Loss (Working) 5,125 577
Material 12,000 7,000 Abnormal Loss 2,875 771
(6,000 / 75 – 5,125)
Conversion 5,600
c/d 9,500 2,381

Calculation of Normal Loss:

Opening WIP (100% M; 80% C.C) 10,000
Input for the month (90,000 + 12,000) 102,000
Closing WIP (100% M; 70% C.C) 9,500
Inspection Stage (100% M; 100% C.C)
[10,000 + 102,000 – 9,500] x 5% = 5,125 litres

Recovery value of Normal Loss:

[5,125 x 0.75 x 150 (170 - 120)] = 577

Equivalent Production Units:

Process A Material Conversion

Finished Goods 94,500 94,500 94,500
94,500
Ab.Loss 2,875 2,875 2,875
2,875
C/d WIP 9,500 9,500(100%) 6,650 (70%)
9,500
106,875 106,875 104,025

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 Cost/unit:
Process – A: 1,500 + 14,000 – 577 / 106,875 = 0.14
Material: 600 + 7,000 / 106,875 = 0.07
Conversion: 400 + 5,600 / 104,025 = 0.058
0.268

Cost Allocation:
Finished Goods = 94,500 x 0.268 = 25,326
Ab.Loss =2,875 x 0.268 =771
C/D WIP =9,500 X 0.14 +
9,500 X 0.07 +
6,650 X 0.058 = 2,381

Answer 2:
a) Material Price, Mix and Yield Variances:
i. Material Price Variance: no variance as there is no change in prices of material.
ii. Material Yield Variances:
X [16,237 – 15,490] x 400 = 298,800 F
Y [14,207 – 13,554] X 300 = 195,900 F
494,700 F
iii. Material Mix Variances:
X [15,490 – 15,974] x 400 = 193,600 A
Y [13,554 – 13,070] X 300 = 145,200 F
48,400 A
Workings:

SQU in SM for A.P AQU in SM for A.P AQU in AM for A.P

X 16,237 15,490 15,974
(16,000 / 27,000 X 27,400) (29,044 X 16,000 / 30,000) (55%)
Y 14,207 13,554 13,070
(14,000 / 27,000 X 27,400) (29,044 X 14,000 / 30,000) (45%)
30,444 29,044 29,044 (W-1)

(W-1)Calculation of actual quantity used for actual production

27,400 / 100 X 106 = 29,044

106 100
6
b) Labor rate variance:
(SR - AR) X AHW for A.P
(220 – 228.15*) X 9,641** = 78,574 A
*(220 / 108 x 112) = 228.15
**(10,000 / 27,000 x 27,400 x 95%) = 9,641

Labor Efficiency variance:

(SHW for A.P - AHW) X S.R
[(27,400 X 10,000 / 27,000) – 9,641] X 220
[(10,148 – 9,641)] X 220 = 111,540 F

c) Under / over absorbed Factory overheads:

Actual overheads:
Variable OH : [9,641 X 160* X 1.06] =1,635,114
Fixed OH : [900,000 X 1.06] =954,000
2,589,114
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 Applied OH:
Actual Production x Std OH rate/ unit
[27,400 x (2,500,000 / 27,000)] =2,537,037
Overheads under applied = 52,077 A

*Standard Fixed OH rate / hour [900,000 / 10,000] = 90/hr

*Standard variable OH rate / hour [250 – 90] = 160/hr

Analysis of under applied overheads:

i. Variable OH expenditure variance:
(SR – AR) X AHW for A.P
[160 – (160 X 1.06)] X 9,641 = 92,554 A

Variable OH Efficiency variance:

[SHW for A.P - AHW] X S.R
[(27,400 X 10,000 / 27,000) – 9,641] X 160
(10,148 – 9,641) X 160 = 81,144 F

ii. Fixed OH expenditure variance:

Budgeted Fixed OH 900,000
Actual Fixed OH (900,000 X 1.06) 954,000
54,000 A
Fixed OH volume variance:
Budgeted Fixed OH (27,000 x 33.33) 900,000
Applied Fixed OH (27,400 x 33.33*) 913,333
13,333F
*[900,000 / 27,000] = 33.33/unit

A.3 Hexa Limited

(i) Budgeted profit for the month of December 2016 (Marginal costing)

Sales [10,500 x 2,000] 21,000,000

Variable cost of sales:
Opening stock -
+ Variable COGM:
Direct Material [11,000 x 790] 8,690,000
Direct Labour [11,000 x 450] 4,950,000
Variable – OH [11,000 x 210*] 2,310,000
15,950,000
Closing stock [500 x (790 + 450 +210)] (725,000) (15,225,000)
Gross contribution 5,775,000
Fixed cost (1,650,000)
Net profit 4,125,000

Per Unit Per Hour

*Standard OH rate 360 120 (360 ÷ 3)
Less : Standard fixed OH rate [1,650,000 ÷ 11,000) (150) (50) (150 ÷ 3)
Standard Variable OH rate 210 70

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ii) Actual profit for the month of December 2016 (Marginal costing)

Sales [10,500 x 2,000] 21,000,000

Variable cost of sales:
Opening stock -
+ Variable COGM: (12,000 units)
Direct Material 9,280,000
Direct Labour 5,425,000
Variable – OH 2,975,000
17,680,000
Closing stock [1500 x (790 + 450 +210)] (2,175,000) (15,505,000)
Gross contribution 5,495,000
Fixed cost* (1,600,000)
Net profit 3,895,000

*Applied Fixed OH [12,000 x 150] = 1,800,000

Actual Fixed OH = 1,600,000
Over applied Fixed OH 200,000F

(b) Reconciliation Of Budgeted Profit With Actual Profit

Budgeted profit 4,125,000
Budgeted fixed cost 1,650,000
Budgeted contribution 5,775,000
Variances:
Material price
Material usage 116,000A
Labor rate 316,000F
Labor efficiency 175,000A
Variable overhead expenditure 150,000F
525,000A
Variable overhead efficiency
70,000F
Actual Contribution: 5,495,000
Budgeted fixed cost 1,650,000
Fixed OH Expenditure Var. 50,000 F (1,600,000)
Actual Profit 3,895,000
Working:
Calculation of Variances:
Sales

Price Volume
(BR – AR) × AQS (BQS – AQS) × Std.cont/unit
(2,000 - 2,000) × 10,500 [(10,500 - 10,500) x 550 [2,000-790-450-210]
NIL Material NIL

Price Usage
(SR – AR) × AQU (SQU – AQU) × S.R
(158 ̶ 160) x 58,000 [(12,000 x 5)-58,000]x158
116,000 A 316,000 F
Labour

Rate Efficiency
(SR – AR) × AHW (SHW – AHW) × S.R
(150 – 155) × 35,000 [(12,000 × 3) – 35,000] × 150
175,000 A 150,000 F
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 Variable OH

Expenditure Efficiency
(SR – AR) × AHW (SHW – AHW) × S. R
2,975,000 [(12,000 × 3) –35,000] × 70
[70 - ] x 35,000
35,000
525,000 A 70,000 F

Fixed OH

Expenditure
Budgeted Fixed OH 1,650,000
Actual Fixed OH 1,600,000
50,000 F

Ans. 4 (a):
Cricket Chemicals Limited
Product wise budgeted income statement (marginal costing)
for year ended 31-8-2019 Rs.000
X1 Plus X2 Total
Sales 200,640 101,080 301,720
Variable COS:
Variable Production Cost (124,971) (65,633) (190,604)
109,691 + 15,280 51,383 + 14,250
Net Contribution 75,669 35,447 111,116
Fixed Cost (7,261 + 3,820) (11,081)
Net profit 100,035

Workings:
(475,000 x 55%)
(19,100 - 3,820 = 15,280)
X1 [261,250] (55%) ll X1 Plus [261,250]
(55%)
X2 [190,000] (40%) Packing Cost 75/L
500,000
Zee [23,750] (5%) (23,750 x 120) = 2,850
N. Loss [25,000 L] (25,000 x0.7 x10) = 175

D.M 98,750

Conversion 72,610

Zee (2,850)

N. Loss (175)

Fixed Cost (7,261)

161,074

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Allocation:
Rs. ‘000’
Sale price / Further Allocation
Units Sale Value NRV
unit processing
X1 plus 261,250 768 200,640 15,280 185,360 109,691
X2 190,000 532 101,080 14,250 86,830 51,383
(190,000x75)

272,190 161,074

b) Evaluation of offer from FIL

Rs. in million
Loss of revenue if offer is accepted [261,250 x (768 -670) (25.60)
Variable cost saved in process – II (19.10 m – 3.82 m) 15.28
Fixed cost saved 2.50
(Decrease)/Increase in budgeted profits (7.82)

Conclusion:
Offer should not be accepted.

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