Unit 4

Operating costing

Q1) What is operating costing?

A1) Operating costing is a method of ascertaining cost of providing or operating a service. In this method, cost is determined in the same way as in the unit costing method or output costing method by preparing a cost sheet. Operating costing method is applied in undertakings which provide service or fall in the category of public utilities. The method is also called service costing.

This method of costing is employed in those undertakings which are engaged in providing or operating services rather than in manufacturing tangible products. This method is applicable to road transport undertakings, railways, tramways, airways, shipping companies, electricity companies, gas companies, hospitals, cinemas, hotels, canteens, water works etc.

According to Wheldon – “operating costing actually is unit costing as applied to the cost of services.”

According to CIMA, London, “Operating Costing is that form of operation costing which applies where standardized services are rendered either by an undertaking or by a service cost centre within an undertaking.”

Features

1. Uniformity of service to all the customers.

2. Involves fixed and variable costs. The distinction is necessary to ascertain the cost of service and the unit cost of service.

3. Service undertakings do not produce physical articles for stock and sale. But services are sold to consumers.

4. It is not concerned with accounting for inventories, other than those for miscellaneous supplies. There is nothing like finished services inventory similar to finished goods inventory.

5. The cost unit may be simple in certain cases, and composite or compound in other cases like transport undertakings.

6. Total costs are averaged over the total amount of service rendered.

7. It can be applied to the services within the organisation as well as extending services to the community at large.

8. Documents like the daily log sheet, operating cost sheet, boiler house cost sheet, canteen cost sheet etc. are used for the collection of cost data.

Objectives

i) To calculate the cost of uniform service rendered to the customers.

Ii) To ascertain cost of all services produced within an undertaking viz., internal and external services.

Iii) To keep the operating cost at the optimum level.

Iv) To make a comparative analysis of operating cost incurred for different periods.

v) To make proper evaluation of different alternatives available.

Vi) To determine whether to produce a service or buy it from outside.

Vii) To ascertain whether the cost incurred on maintenance is excessively incurred or not.

Q2) What are the features of operating costing?

A2) Operating costing is a method of ascertaining cost of providing or operating a service. In this method, cost is determined in the same way as in the unit costing method or output costing method by preparing a cost sheet. Operating costing method is applied in undertakings which provide service or fall in the category of public utilities. The method is also called service costing.

This method of costing is employed in those undertakings which are engaged in providing or operating services rather than in manufacturing tangible products. This method is applicable to road transport undertakings, railways, tramways, airways, shipping companies, electricity companies, gas companies, hospitals, cinemas, hotels, canteens, water works etc.

According to Wheldon – “operating costing actually is unit costing as applied to the cost of services.”

According to CIMA, London, “Operating Costing is that form of operation costing which applies where standardized services are rendered either by an undertaking or by a service cost centre within an undertaking.”

Features

1. Uniformity of service to all the customers.

2. Involves fixed and variable costs. The distinction is necessary to ascertain the cost of service and the unit cost of service.

3. Service undertakings do not produce physical articles for stock and sale. But services are sold to consumers.

4. It is not concerned with accounting for inventories, other than those for miscellaneous supplies. There is nothing like finished services inventory similar to finished goods inventory.

5. The cost unit may be simple in certain cases, and composite or compound in other cases like transport undertakings.

6. Total costs are averaged over the total amount of service rendered.

7. It can be applied to the services within the organisation as well as extending services to the community at large.

8. Documents like the daily log sheet, operating cost sheet, boiler house cost sheet, canteen cost sheet etc. are used for the collection of cost data.

Objectives

i) To calculate the cost of uniform service rendered to the customers.

Ii) To ascertain cost of all services produced within an undertaking viz., internal and external services.

Iii) To keep the operating cost at the optimum level.

Iv) To make a comparative analysis of operating cost incurred for different periods.

v) To make proper evaluation of different alternatives available.

Vi) To determine whether to produce a service or buy it from outside.

Vii) To ascertain whether the cost incurred on maintenance is excessively incurred or not.

Q3) What is the application of operating costing?

A3) Operating costing is applied by an organization, which provides service to the public as a whole instead of manufacturing an article, and sells the same. For example, Transport undertaking electricity, theatre, hospitals, schools and the like. Similarly, the same type of an organization or cost center renders service to production departments. For example, Electricity, powerhouse, canteen and the like.

The service cost in operating cost should be find out to understand whether an organization or cost center render services to others or sell the services to the general public. If the services are sold, the operating expenses and the extent of services rendered are taken into consideration to find out the service cost. On the other hand, if the services are sold, the service expenses should be apportioned to the production department on a suitable basis.

Generally, the basis may be the extent of service availed by the production departments. It may also become necessary to compare the cost of such a service with the cost of an outside service for deciding whether it is profitable to buy a service from outside rather than make the same available from within an organization.

Q4) Explain process costing?

A4) Process costing is a method of costing under which all costs are accumulated for each stage of production or process, and the 2 cost per unit of product is ascertained at each stage of production by dividing the cost of each process by the normal output of that process.

CIMA London defines process costing as “that form of operation costing which applies where standardize goods are produced”

Features of Process Costing:

(a) The production is continuous

(b) The product is homogeneous

(c) The process is standardized

(d) Output of one process become raw material of another process

(e) The output of the last process is transferred to finished stock

(f) Costs are collected process-wise

(g) Both direct and indirect costs are accumulated in each process

(h) If there is a stock of semi-finished goods, it is expressed in terms of equalent units

(i) The total cost of each process is divided by the normal output of that process to find out cost per unit of that process.

Advantages of process costing:

1. Costs are be computed periodically at the end of a particular period

2. It is simple and involves less clerical work that job costing

3. It is easy to allocate the expenses to processes in order to have accurate costs.

4. Use of standard costing systems in very effective in process costing situations.

5. Process costing helps in preparation of tender, quotations

6. Since cost data is available for each process, operation and department, good managerial control is possible.

Limitation

1. Cost obtained at each process is only historical cost and are not very useful for effective control.

2. Process costing is based on average cost method, which is not that suitable for performance analysis, evaluation and managerial control.

3. Work-in-progress is generally done on estimated basis which leads to inaccuracy in total cost calculations.

4. The computation of average cost is more difficult in those cases where more than one type of products is manufactured and a division of the cost element is necessary.

5. Where different products arise in the same process and common costs are prorated to various costs units. Such individual products costs may be taken as only approximation and hence not reliable.

Q5) What is the features of process costing?

A5) Process costing is a method of costing under which all costs are accumulated for each stage of production or process, and the 2 cost per unit of product is ascertained at each stage of production by dividing the cost of each process by the normal output of that process.

CIMA London defines process costing as “that form of operation costing which applies where standardize goods are produced”

Features of Process Costing:

(a) The production is continuous

(b) The product is homogeneous

(c) The process is standardized

(d) Output of one process become raw material of another process

(e) The output of the last process is transferred to finished stock

(f) Costs are collected process-wise

(g) Both direct and indirect costs are accumulated in each process

(h) If there is a stock of semi-finished goods, it is expressed in terms of equalent units

(i) The total cost of each process is divided by the normal output of that process to find out cost per unit of that process.

Q6) What is the advantages and disadvantages of process costing?

A6) Advantages of process costing:

1. Costs are be computed periodically at the end of a particular period

2. It is simple and involves less clerical work that job costing

3. It is easy to allocate the expenses to processes in order to have accurate costs.

4. Use of standard costing systems in very effective in process costing situations.

5. Process costing helps in preparation of tender, quotations

6. Since cost data is available for each process, operation and department, good managerial control is possible.

Limitation

1. Cost obtained at each process is only historical cost and are not very useful for effective control.

2. Process costing is based on average cost method, which is not that suitable for performance analysis, evaluation and managerial control.

3. Work-in-progress is generally done on estimated basis which leads to inaccuracy in total cost calculations.

4. The computation of average cost is more difficult in those cases where more than one type of products is manufactured and a division of the cost element is necessary.

5. Where different products arise in the same process and common costs are prorated to various costs units. Such individual products costs may be taken as only approximation and hence not reliable.

Q7) What is integral system?

A7) Integral or Integrated system is a system of accounting under which only one set of account books is maintained to record both the Cost and Financial transactions. The system implies the merger of both cost and financial accounts in one set of books. The two sets of account books merge into a composite system.

CIMA, London defines Integral system as a system in which the financial and cost accounts are interlocked to ensure that all relevant expenditure is absorbed into the cost accounts.

The system of accounting has the following advantages:

(i) There is no need for reconciliation because there will be only one figure of profit or loss as there is only one set of books.

(ii) This system is economical because it avoids duplication of recording the transactions in two separate set of books.

(iii) Accounting information is readily available and the correctness of the data is automatically checked.

(iv) It enables the introduction of mechanised accounting.

(v) A better understanding exists among the staff.

Q8) Write the features of integral system?

A8) (a) There is no need for cost ledger because all control accounts are maintained in the financial ledger.

(b) There is no need to open a Cost Ledger Control Account because both the aspects (i.e., debit and credit) of all transactions are recorded in respective accounts.

(c) Subsidiary ledgers i.e., Stores Ledger, Work-in-Progress Ledger and Finished goods ledger are maintained as is done in non-integrated accounting. In addition, a Sales Ledger (containing personal accounts for each customer) and a Purchase Ledger (containing personal accounts for each supplier) are also maintained. Overhead ledger is maintained to contain separate accounts for factory, administration and selling and distribution overhead.

(d) A control account for each subsidiary ledger is maintained in the general ledger.

The important control accounts are as follows:

(i) Stores Ledger Control Account;

(ii) Work-in-Progress Ledger Control Account;

(iii) Finished Goods Ledger Control Account;

(iv) Wages Control Account;

(v) Factory Overhead Control Account;

(vi) Administrative Overhead Control Account;

(vii) Selling and Distribution Overhead Control Account;

(viii) Sales Ledger Control Account;

(ix) Purchase Ledger Control Account.

(e) The balances of overheads Control Accounts represent under or over absorption of overheads which are transferred to Profit and Loss Account.

(f) The profit or loss as per Profit and Loss Account is transferred to Profit and Loss Appropriation Account.

(g) The degree of integration must be determined in advance. Some business firms may integrate the cost and financial accounts up to the stage of prime cost or factory cost while other firms integrate the two completely.

(h) A suitable coding system is generally developed to serve the purposes of both cost accounts as well as financial accounts.

(i) There should be an agreed accounting procedure in respect of treatment of provision for accruals, prepaid expenses and other adjustments necessary for preparing interim accounts.

Q9) Explain essential prerequisites for integrated system?

A9) The essential prerequisites for integrated system include the following:

(a) Degree of Integration:

The degree of integration of the two sets of accounts should be determined. It is the management which has to decide on full or partial integration. Full integration changes the entire accounting records.

(b) Suitable Coding System:

A suitable coding system must be developed to serve the accounting purposes of both financial and cost accounts.

(c) Accounting Policy:

An agreed routine with regard to the treatment of provision for accruals, pre-paid expenses, other adjustments necessary for the preparation of interim accounts.

(d) Co-ordination:

Prefect co-ordination should exist between the staff responsible for the financial and cost aspects of the accounts and an efficient processing of various accounting documents should be ensured.

Q10) What is non integral system?

A10) Non-integral system is a system of accounting under which two separate sets of account books are maintained—one for cost accounts and the other for financial accounts. In other words, cost accounts are maintained separately from financial accounts.

Since separate ledgers are maintained for cost and financial accounts in this system, the cost accountant is responsible for recording of the cost accounting transactions and the financial accountant is responsible for financial transactions.

Non-integral system of accounting is also known as non-integrated system or Interlocking system or Cost Ledger Accounting system. CIMA, London defines Nonintegral system as a system in which the cost accounts are distinct from financial accounts, the two sets of accounts being kept continuously in agreement by the use of control accounts or made readily reconcilable by other means.

Basic Features of Non-Integral System:

(i) Separate ledgers are maintained for cost and financial accounts.

(ii) Like financial accounting, it is also based on double entry system.

(iii) There are no personal accounts because cost accounts do not show relationship with outsiders.

(iv) Cost accounts are concerned with impersonal accounts i.e., real and nominal accounts.

(v) In real accounts, only stocks are shown in cost accounts.

(vi) Transactions affecting the nominal accounts are recorded separately in detail. Thus cost accounting department is concerned mainly with the ascertainment of income and expenditure of business,

(vii) Under this system one main ledger (i.e., Cost Ledger) and various subsidiary

Ledgers are maintained,

(viii) Since the system is not properly integrated, some items may appear in financial ledgers only, while some other items appear only in cost ledger,

(ix) The profit or loss disclosed by the two sets of accounts for a particular period will never be the same and as such a reconciliation of costing profit or loss with that of financial accounts is essential.

Q11) Explain the features of non integral system?

A11) Non-integral system is a system of accounting under which two separate sets of account books are maintained—one for cost accounts and the other for financial accounts. In other words, cost accounts are maintained separately from financial accounts.

Since separate ledgers are maintained for cost and financial accounts in this system, the cost accountant is responsible for recording of the cost accounting transactions and the financial accountant is responsible for financial transactions.

Non-integral system of accounting is also known as non-integrated system or Interlocking system or Cost Ledger Accounting system. CIMA, London defines Nonintegral system as a system in which the cost accounts are distinct from financial accounts, the two sets of accounts being kept continuously in agreement by the use of control accounts or made readily reconcilable by other means.

Basic Features of Non-Integral System:

(i) Separate ledgers are maintained for cost and financial accounts.

(ii) Like financial accounting, it is also based on double entry system.

(iii) There are no personal accounts because cost accounts do not show relationship with outsiders.

(iv) Cost accounts are concerned with impersonal accounts i.e., real and nominal accounts.

(v) In real accounts, only stocks are shown in cost accounts.

(vi) Transactions affecting the nominal accounts are recorded separately in detail. Thus cost accounting department is concerned mainly with the ascertainment of income and expenditure of business,

(vii) Under this system one main ledger (i.e., Cost Ledger) and various subsidiary

Ledgers are maintained,

(viii) Since the system is not properly integrated, some items may appear in financial ledgers only, while some other items appear only in cost ledger,

(ix) The profit or loss disclosed by the two sets of accounts for a particular period will never be the same and as such a reconciliation of costing profit or loss with that of financial accounts is essential.

Q12) Explain the ledger under non integral system?

A12) Ledgers under Non-Integral Accounts:

(a) The principal financial ledgers are:

(i) General Ledger:

It contains all real, nominal and personal accounts except trade debtors and trade creditors account.

(ii) Debtors Ledger:

It has personal accounts of trade debtors.

(iii) Creditors Ledger:

It has personal accounts of trade creditors.

(b) The principal cost ledgers are:

(i) Cost Ledger:

It is the principal ledger in cost books which controls all other ledgers in the costing department. It contains all impersonal accounts and is similar to General Ledger of financial accounts.

(ii) Stores Ledger:

It is a subsidiary ledger. It contains all stores accounts.

(iii) Work-in-Progress Ledger:

It is a subsidiary ledger. It contains a separate account for each job in progress. Each such account is debited with the materials costs, wages and overheads chargeable to  the jobs and credited with the cost of work completed. The balance in this account shows the cost of uncertified work.

(iv) Finished Goods Ledger:

It is a subsidiary ledger. It contains accounts of completely finished goods and jobs. The cost ledger is made self-balancing by opening a control account for each of the above subsidiary ledgers.

Q13) What is the difference between integral and non integral system?

A13) Difference Non-Integral System:

Two separate sets of account books are maintained—one to record cost transactions and the other to record financial transactions.

Cost Ledger is maintained.

Control Accounts are opened in the Cost Ledger.

There are two figures of profit or loss—one as per cost accounts and another as per financial accounts.

There is need for reconciliation of cost accounts and financial accounts because there are two figures of profit or loss as there are two sets of account books.

Balances of Overheads Control Accounts which represent under or over absorption of overheads are transferred to costing Profit & Loss Account.

There is duplication of recording the transactions in two sets of account books. It requires more manpower, time and money.

Difference Integral System:

Only one set of account books is maintained to record both the cost transactions and financial transactions.

Cost Ledger is not maintained.

Control Accounts are opened in the General Ledger.

There is only one figure of profit or loss because only one set of account books is maintained.

There is no need for reconciliation because there will be only one figure of profit or loss as there is only one set of account books.

Balances of Overhead Control Accounts which represent under- or over-absorption of overheads are transferred to Profit and Loss Account.

It is economical because it avoids the duplication of recording the transactions in two sets of account books.

Q14) State the importance of reconciliation statement?

A14) Importance of Reconciliation Statement:

1. If separate books are maintained for costing and financial transactions, there is usually a difference between the profits shown in costing and the profits shown in financial accounting. However, by chance, it is possible that the overall benefits of the two books are the same. Nevertheless, in all cases, the results presented by both sets of books should be adjusted to identify the cause of the difference (if any) and establish the accuracy of both sets of books.
2. For business concerns, costing and financial accounting can be maintained on the basis of non-integrated or integrated accounting systems. In a non-integrated accounting system, costing and financial accounting are managed separately. Costing is maintained by costing personnel in accordance with costing principles and reviews the total cost per unit of products and jobs at various stages of production or execution.
3. Financial accounting is maintained by a financial accountant in accordance with the principles of financial accounting and records the day-to-day transactions of a business with the aim of finding the net impact on the profitability and financial position of the business.
4. Therefore, the objectives, objectives, principles, and methods of maintaining costing and financial accounting are not the same. Therefore, the profits shown in costing may not match the profits shown in financial accounting. The inconsistent information provided by these two sets of accounts may not help you make the right policy decisions.
5. Therefore, the costing system must be able to coordinate with financial accounting. Costing is unreliable unless such an analysis is coordinated with financial accounting, as costing relies primarily on estimates and constitutes a detailed analysis of financial expenditures. In this regard, H.J.  "

Q15) Define reconciliation?

A15) Meaning of Reconciliation:

Adjustments can be represented as a process of aggregating performance or profits, as shown in Costing and Financial Accounting. The arithmetic accuracy of profits is  revealed by two different books. Efforts have also been made to determine this. "

Therefore, costing and financial accounting adjustment involves the process of identifying and accounting for the items that led to the difference in performance, as shown in Costing and Financial Accounting. Adjustments are made in the form of analytics presented in the form of statements (called adjustment statements) or memo accounts (called memorandum adjustment accounts).

Need for reconciliation:

The need to collate cost and financial accounts arises for the following reasons:

(I) Adjustments help ensure the accuracy and reliability of the various accounting books maintained by business concerns.

(II) Analytical disclosure of reasons for fluctuations in profits or losses facilitates internal control.

(III) We support cooperation and coordination between cost accounting firms and accounting firms.

(IV) Helps develop appropriate policies regarding overhead absorption, depreciation and stock valuation.

Q16) “If there is a difference between the work results disclosed in costing and the work results disclosed in financial accounting”. Explain the statement ?

A16) If there is a difference between the work results disclosed in costing and the work results disclosed in financial accounting, you need to perform the following steps to determine the reason for the difference.

1. You need to check the degree of difference between the actual overhead recorded in financial accounting and the cost recorded in costing.

2. You need to schedule all costs and losses that are included in your trading and profit and loss accounts but not in your cost accounts.

3. You need to schedule all revenues and profits that are credited to the P & L account but excluded from the cost account.

4. You need to schedule all items that are included in costing but excluded from financial accounting.

5. You need to review the criteria by which raw material, work in process, and finished product inventories were valued for balance sheet purposes and compare them to the value shown in costing to see their differences.

6. Finally, you need to see all the items that are included in the cost and finance accounts but have different values.

If you find a discrepancy, you should create an adjustment statement starting with the profit disclosed in costing.

Next, you need to add the following items to your profit according to costing:

(I) Overhead costs (factories, offices, management, sales and distribution) are either over-absorbed or over-recovered in cost accounting or under-absorbed in financial accounting.

(II) Receipt items that appear in the financial books but not in costing.

(III) Overvaluation of starting inventory (of raw materials, work in process, or finished products) in costing.

(IV) Undervaluation of end-of-term inventory (of raw materials, work in process, or finished products) in costing.

(V) An item of unusual efficiency (abnormal savings) that appears in the financial books but not in costing.

The following items should be deducted from your profit according to costing.

(I) Under absorption of overhead costs in the cost account or overabsorption in the financial account,

(II) The item of expense that appears in the financial account, not the cost account.

(III) Undervaluation of starting inventory (of raw materials, work in process, or finished products) in costing,

(IV) Overvaluation of closing inventory in cost accounts.

After making the above adjustments, the costing profit will match the financial accounting profit.

Q17) Draw the performa of reconciliation statement?

A17) Below shown are the performa of reconciliation and memorandum reconciliation statement:

Q18) From the following particulars prepare reconciliation statement

A18)

Q19) From the following Profit & loss account draw up a Reconciliation statement showing the Profit as per Cost Accounts:

The cost accountant has ascertained a Profit of Rs. 19636 as  per his books

A19)

Q20) The net profits of a manufacturing company appeared at 64,500 as per financial records for the year ended 31st December, 2016. The cost books however, showed a net profit of 86,460 for the same period. A careful scrutiny of the figures from both the sets of accounts revealed the following facts.

A20) Statement showing reconciliation of profit shown by cost and financial accounts as on 31-12-2016: