course code 462

COST ACCOUNTING
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COST ACCOUNTING 462 SPRING 2023
​Q1 SOLVED QUESTIONS
In a payroll system, what purpose is served by a labor time record?
How is the information that is recorded on labor time records used?
ANS
Labor time records serve a crucial purpose in payroll systems as they
provide accurate information about employee working hours, which
is then used to calculate their pay and ensure compliance with labor
laws ¹. The recorded information includes details such as regular and
overtime hours worked, leaves taken, and special payments or
exceptions ². This data is used for various purposes, including ¹:
1. Accurate payroll calculation
2. Compliance with labor laws
3. Identifying trends in labor costs
4. Employee self-service and access to pay information
5. Configuring employee schedules and shifts
6. Generating reports and analytics for workforce management.

Q2
From the books of Ali Brothers, the following transactions were
extracted related to January 2022, you are required to pass joumal
entries to record above transaction in the general and factory ledger
. Purchased material and directly delivered to production order No
305 Rs. 13,500

b. Depreciation on factory building and equipment Rs 8.000

c. Finished goods returned for credit Rs. 14,300, which cost was Rs.
12,800.

d. Miscellaneous factory overhead armounting to Rs. 10,800 was

vouched and paid by the home office

e. The raw material book inventory at the end of the month contains
the balance Rs. 5.64.548. A physical inventory taken at that time
showed a cost of Rs. 5,64,248
ANS
Here are the journal entries to record the transactions in the general
and factory ledger:

a. Purchased material and directly delivered to production order No

305:

General Ledger:
Debit: Purchases (Rs. 13,500)
Credit: Accounts Payable (Rs. 13,500)

Factory Ledger:
Debit: Work-in-Progress (Production Order No. 305) (Rs. 13,500)
Credit: Raw Materials (Rs. 13,500)

b. Depreciation on factory building and equipment:

General Ledger:
Debit: Depreciation Expense (Rs. 8,000)
Credit: Accumulated Depreciation (Rs. 8,000)

Factory Ledger:
No entry required, as depreciation is not directly related to
production costs.

c. Finished goods returned for credit:

General Ledger:
Debit: Sales Returns (Rs. 14,300)
Credit: Accounts Receivable (Rs. 14,300)

Factory Ledger:
Debit: Finished Goods (Rs. 12,800)
Credit: Work-in-Progress (Rs. 12,800)

d. Miscellaneous factory overhead:

General Ledger:
Debit: Factory Overhead (Rs. 10,800)
Credit: Cash (Rs. 10,800)

Factory Ledger:
Debit: Factory Overhead (Rs. 10,800)
Credit: Miscellaneous Factory Overhead (Rs. 10,800)

e. Raw material book inventory discrepancy:

General Ledger:
No entry required, as the discrepancy is already reflected in the raw
materials account.

Factory Ledger:
Debit: Raw Materials (Rs. 300)
Credit: Inventory Adjustment (Rs. 300)

Note: The raw material book inventory discrepancy of Rs. 300 (Rs.
5,64,548 - Rs. 5,64,248) is adjusted in the factory ledger to reflect the
correct physical inventory balance.

Q3
Normal operating capacity of Zeeshan Chemical Industries is 250,000
machine hours per month. At this level of activity the fixed factory
overhead cost is estimated at Rs 500,000 and variable overhead is
estimated at Rs.250,000. During March 2016, the actual production
consumed 240,000 machine hours and actual factory overhead cost
amounted to Rs. 730,000. You are required to:
. Determine the fixed portion of the factory overhead application
rate.

Determine the variable portion of the factory overhead application

rate. iii. Compute the amount of over or under applied factory
overhead cost.

iv. Calculate the amount of favourable or unfavorable Spending

Variance and Capacity Variance.
ANS
Here are the answers:

i. Determine the fixed portion of the factory overhead application

rate:

Fixed Factory Overhead Cost per Machine Hour = Rs 500,000 ÷ 250,000

machine hours = Rs 2 per machine hour

ii. Determine the variable portion of the factory overhead application

rate:

Variable Factory Overhead Cost per Machine Hour = Rs 250,000 ÷

250,000 machine hours = Rs 1 per machine hour

iii. Compute the amount of over or under applied factory overhead

cost:

Total Factory Overhead Cost = Rs 480,000 (fixed) + Rs 240,000

(variable) = Rs 720,000
Actual Factory Overhead Cost = Rs 730,000
Over-applied Factory Overhead Cost = Rs 730,000 - Rs 720,000 = Rs
10,000 (over-applied)

iv. Calculate the amount of favourable or unfavorable Spending

Variance and Capacity Variance:
Spending Variance = Actual Factory Overhead Cost - (Fixed Factory
Overhead Cost + Variable Factory Overhead Cost)
= Rs 730,000 - (Rs 480,000 + Rs 240,000)
= Rs 10,000 (unfavourable)

Capacity Variance = (Normal Capacity - Actual Production) × Fixed

Factory Overhead Cost per Machine Hour
= (250,000 - 240,000) × Rs 2
= Rs 20,000 (favourable)

Note: The favourable Capacity Variance indicates that the actual

production was less than the normal capacity, resulting in a lower
fixed factory overhead cost. However, the unfavourable Spending
Variance indicates that the actual factory overhead cost exceeded the
estimated total factory overhead cost.

Q4
Red producer uses process costing in its two producing Department.
Matena's are added at the end of the process after quality control
inspection, no abnormal spoilage occurred during the month Spoilage
is recovered at the end of process. During May 2.500 units were
received from Department-l at a cost of Rs. 625,000. Costs incurred by
Department-Il during May were: Materials Rs. 80,000, Conversion
Costs Rs. 360,000

A total of 2,000 units were transferred to finished goods inventory.

The 300 units still in process at the end of 2/3 complete as to
conversion cost. You are required to prepare Cost of Production
Report of Department-Il for May
Ans
Cost of Production Report of Department-II for May

Units Received from Department-I: 2,500

Cost of Units Received: Rs. 625,000
Costs Incurred by Department-II:

Materials: Rs. 80,000

Conversion Costs: Rs. 360,000
Total Costs Incurred: Rs. 440,000

Total Cost of Production: Rs. 625,000 (cost of units received) + Rs.

440,000 (costs incurred) = Rs. 1,065,000

Units Transferred to Finished Goods Inventory: 2,000

Units Still in Process: 300 (2/3 complete as to conversion cost)

Cost per Unit:

Total Cost of Production: Rs. 1,065,000

Total Units Produced: 2,500 (2,000 transferred + 300 in process)
Cost per Unit: Rs. 1,065,000 ÷ 2,500 units = Rs. 426 per unit

Cost of Units Transferred to Finished Goods Inventory: 2,000 units ×

Rs. 426 per unit = Rs. 852,000

Cost of Units Still in Process: 300 units × Rs. 426 per unit × 2/3
(complete as to conversion cost) = Rs. 85,320

Note: The cost of units still in process is calculated based on the

proportion of completion (2/3) and the cost per unit.

Q5
Patriot Company predicts that it will use 350,000 gallons of material
during the year. The material is expected to cost Rs. 5

per gallon. Patriot anticipates that it will cost Rs. 72 to place each
order. The annual carrying cost is Rs. 4 per gallon. You
are required to (a) Determine the most economical order quantity by
using the EOQ formula. (b) Determine the total cost of ordering and
carrying at the EOQ point.
ANS
(a) Determine the most economical order quantity (EOQ) using the
EOQ formula:

EOQ = √(2 × Annual Usage × Ordering Cost) / Carrying Cost

= √(2 × 350,000 × Rs. 72) / Rs. 4
= √(504,000) / 4
= 224.49 (round up to 225 gallons, as it's a more feasible order
quantity)

(b) Determine the total cost of ordering and carrying at the EOQ
point:

Total Cost = (Annual Usage / EOQ) × Ordering Cost + (EOQ / 2) ×

Carrying Cost
= (350,000 / 225) × Rs. 72 + (225 / 2) × Rs. 4
= 1,555.56 × Rs. 72 + 112.5 × Rs. 4
= Rs. 112,000 + Rs. 450
= Rs. 112,450

Therefore, the most economical order quantity (EOQ) is 225 gallons,

and the total cost of ordering and carrying at the EOQ point is Rs.
112,450.

Q6
What are the various methods used for allocating and proration of
Servicing Department's overhead costs to Producing Departments
etc.? Which method provides more accurate and realistic information
of cost of overheads?
ANS
There are several methods used for allocating and prorating
servicing department overhead costs to producing departments:

1. Direct Method: Allocates costs based on direct usage or benefit

received by each producing department.

2. Step Method: Allocates costs in a sequential manner, with each

servicing department receiving a share of the costs before allocating
the remaining costs to the producing departments.

3. Reciprocal Method: Considers the interdependencies between

servicing departments and producing departments, allocating costs
based on the services provided and received.

4. Algebraic Method: Uses mathematical equations to allocate costs,

considering the relationships between departments.

5. Repeated Distribution Method: Allocates costs in a cyclical manner,

distributing costs from one department to another until all costs are
allocated.

The Reciprocal Method provides more accurate and realistic

information about overhead costs, as it considers the
interdependencies between departments and allocates costs based on
the services provided and received. This method recognizes that
servicing departments often provide services to each other, in
addition to the producing departments, and allocates costs
accordingly.

The Reciprocal Method is more accurate because it:

- Accounts for interdepartmental services

- Recognizes the complexity of departmental relationships
- Provides a more detailed understanding of overhead costs
- Helps managers make informed decisions about resource allocation
However, it's important to note that the choice of method depends on
the specific organization, its structure, and the nature of its
departments. The most appropriate method will depend on the
specific circumstances and the level of accuracy required.

Q7
Raza Trader discloses the following information related to purchase
and sales of goods during the month of March 2022:
March 01 Balance of 600 Articles at Rs 400/each
March 02

1500 Articles bought at Rs. 4.5/each

March 05.

800 Articles sold

March 07,

2000 Articles bought at Rs 4.10/each

March 10.

1200 Articles sold

March 10.

500 Articles sold

March 04

500 Articles bought at Rs. 4. 80/each

Raza sold all units at Rs. 6.00 each You are required to calculate the
cost of ending inventory and Gross profit by using the FIFO Method

ANS
To calculate the cost of ending inventory and gross profit using the
FIFO method, we need to follow these steps:

1. Calculate the total number of units sold:

800 (March 5) + 1200 (March 10) + 500 (March 10) = 2500 units

2. Calculate the total number of units purchased:

1500 (March 2) + 2000 (March 7) + 500 (March 4) = 4000 units

3. Calculate the total cost of units purchased:

1500 x Rs. 4.5 = Rs. 6750
2000 x Rs. 4.1 = Rs. 8200
500 x Rs. 4.8 = Rs. 2400
Total cost = Rs. 67350

4. Calculate the cost of units sold using FIFO:

First, 600 units from the opening balance (Rs. 400 each) = Rs. 240000
Next, 1500 units from the March 2 purchase (Rs. 4.5 each) = Rs. 6750
Next, 400 units from the March 4 purchase (Rs. 4.8 each) = Rs. 1920
Total cost of units sold = Rs. 266670

5. Calculate the cost of ending inventory:

Total units purchased = 4000
Total units sold = 2500
Units remaining = 4000 - 2500 = 1500 units
Cost of ending inventory = 1500 units x Rs. 4.1 (last purchase price) =
Rs. 6150
6. Calculate the gross profit:
Total sales revenue = 2500 units x Rs. 6 each = Rs. 15000
Total cost of units sold = Rs. 266670
Gross profit = Total sales revenue - Total cost of units sold = Rs. 15000 -
Rs. 266670 = Rs. 123330

Therefore, the cost of ending inventory is Rs. 6150, and the gross
profit is Rs. 123330.

Q8
From the following information, compute the ending balances of the
Materials Inventory, Work in Process Inventory, and Finished Goods
Inventory accounts Materials Inventory, beginning balance

Work in Process Inventory, beginning balance

Finished Goods Inventory, beginning balance

Direct materials purchased

Rs. 25,000

Direct materials placed into production

Rs. 74,000

85,000

Cost of goods manufactured

25,750

Direct labor costs

38,000

Overhead costs

Cost of goods sold

97,000

35,000

123,000

95,000
ANS
Here are the computations for the ending balances:

Materials Inventory:
Beginning balance = Rs. 25,000
Add: Direct materials purchased = Rs. 25,000
Total = Rs. 50,000
Less: Direct materials placed into production = Rs. 74,000
Ending balance = Rs. 50,000 - Rs. 74,000 = Rs. (-24,000)

Work in Process Inventory:

Beginning balance = Rs. 85,000
Add: Direct materials placed into production = Rs. 74,000
Add: Direct labor costs = Rs. 38,000
Add: Overhead costs = Rs. 35,000
Total = Rs. 232,000
Less: Cost of goods manufactured = Rs. 95,000
Ending balance = Rs. 232,000 - Rs. 95,000 = Rs. 137,000

Finished Goods Inventory:

Beginning balance = Rs. 123,000
Add: Cost of goods manufactured = Rs. 95,000
Total = Rs. 218,000
Less: Cost of goods sold = Rs. 97,000
Ending balance = Rs. 218,000 - Rs. 97,000 = Rs. 121,000

Note: The negative balance in Materials Inventory indicates that the

company has used more materials than it has purchased, and it needs
to replenish its inventory.
ALLAMA IQBAL OPEN UNIVERSITY ISLAMABAD

COURSE CODE: 5410-462-8408

SOLVED BY KHAN BHAI 03259594602

Spring 2023

Q4: Explain various types of incentive schemes available to molivale

workers for enhancement in productivity and for greater earnings.
Describe and narrate the advantages and disadvantages of (a) The
hourly rate wage plan and (b) The piece-rate wage plen.

Answer

Incentive schemes play a significant role in enhancing worker productivity and ensuring greater
earnings. These schemes are carefully designed to motivate employees by linking their wages to
their performance. Let’s discuss the types of incentive schemes available for workers and then
dive into a detailed explanation of two common wage plans: the hourly rate wage plan and the
piece-rate wage plan.

Types of Incentive Schemes for Workers

Incentive schemes can be broadly categorized into:

1. Time-Based Incentives: These are wages paid based on the number of hours a
worker spends on the job, irrespective of the output. Examples include the hourly
rate wage plan.
2. Performance-Based Incentives: These schemes reward workers for the quantity of
work produced. The piece-rate wage plan is a typical example.
3. Group Incentives: These are designed for teams, where incentives are distributed
based on the collective performance of a group.

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4. Bonus Schemes: Additional financial incentives provided when specific
performance targets or productivity milestones are met.
5. Profit Sharing: Workers receive a share of the company’s profits, which motivates
them to contribute towards the overall profitability.
6. Commission-Based Plans: Commonly used in sales, workers earn a percentage of
the sales they generate.

Now, let’s discuss the advantages and disadvantages of two specific incentive schemes: the
hourly rate wage plan and the piece-rate wage plan.

(a) The Hourly Rate Wage Plan

Definition:
The hourly rate wage plan compensates workers based on the number of hours worked,
regardless of the amount of work produced during that time. It ensures a fixed hourly wage, and
workers are paid based on their total hours spent on the job.

Advantages:

1. Stable and Predictable Income: Workers are assured of a consistent income,

which provides financial security and stability.
2. Reduced Pressure: Since the wage is not linked to the amount of work done,
employees experience less stress and pressure compared to performance-based
plans.
3. Focus on Quality: Workers can concentrate on maintaining high-quality standards
without feeling rushed to complete tasks quickly.
4. Easier for Complex Tasks: Suitable for work that requires careful execution,
creativity, or tasks where productivity cannot be easily measured by output.

Disadvantages:

1. Lack of Incentive for Productivity: Workers might be less motivated to work

efficiently, as their earnings do not increase with the amount of work they complete.
2. Potential for Time Wastage: Employees might misuse working hours or perform at
a slower pace since their pay is guaranteed by the hour.
3. Higher Labor Costs: Employers may face higher labor costs, especially if
productivity is low, as they are obligated to pay for every hour worked.
4. Supervisory Challenges: Close monitoring might be necessary to ensure that
workers are productive, leading to increased management oversight.

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(b) The Piece-Rate Wage Plan

Definition:
The piece-rate wage plan compensates workers based on the number of units they produce or
tasks they complete. The wage per piece is predetermined, encouraging workers to produce more
in order to earn higher pay.

Advantages:

1. Direct Link to Productivity: Workers are highly motivated to increase their output
because their earnings are directly tied to their performance.
2. Reduced Supervisory Needs: Since workers are self-motivated to complete more
work, employers may require less supervision.
3. Efficient Workforce: Workers strive to maximize their productivity, which can lead
to overall higher output for the company.
4. Lower Labor Costs per Unit: Companies can manage labor expenses more
efficiently since they only pay for work that has been completed.

Disadvantages:

1. Compromised Quality: Workers might rush to produce more units, potentially

leading to lower quality output and increased errors.
2. Physical and Mental Strain: The constant push to produce more can lead to worker
fatigue, burnout, and reduced overall well-being.
3. Inconsistent Earnings: Worker income can fluctuate based on production levels,
creating financial instability, especially in cases of equipment failure or supply
shortages.
4. Unsuitable for Complex Tasks: The plan is not ideal for jobs that require precision,
creativity, or where the output is not easily quantifiable.

Conclusion

Both the hourly rate wage plan and the piece-rate wage plan have their own advantages and
disadvantages. The hourly rate wage plan provides stability and is suitable for roles where
quality is more important than quantity. However, it lacks incentives for boosting productivity.
On the other hand, the piece-rate wage plan promotes efficiency and higher output but can lead
to quality concerns and worker burnout. Employers need to carefully evaluate their
organizational needs and the nature of the work to select the most appropriate wage plan for their
workforce.

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Q5: What is cost accounting? What are its objectives? In what
respects, does cost accounting diller from financial accounting?

Answer

Cost accounting is a branch of accounting that focuses on capturing, recording, and analyzing all
the costs associated with the production or operations of a business. The primary aim is to
determine the cost of producing goods or services, assist in cost control and cost reduction, and
facilitate decision-making within an organization. It provides valuable insights for internal
management, helping improve efficiency and profitability.

Objectives of Cost Accounting

1. Ascertainment of Cost: The fundamental objective is to ascertain the cost of

production or service provided by the business. This involves identifying the costs of
materials, labor, and overheads and allocating them appropriately.
2. Cost Control: By analyzing the various costs and comparing them with established
standards, cost accounting helps in identifying areas where savings can be made. It
promotes efficient use of resources and prevents wastage.
3. Cost Reduction: Through continuous analysis, cost accounting aims to find ways to
minimize costs without compromising on quality or efficiency. This can be achieved
through the use of alternative materials, improved production processes, or
efficient resource utilization.
4. Profitability Analysis: Cost accounting helps in assessing the profitability of
different products, services, or business segments. This enables management to
make informed decisions about product pricing, discontinuing unprofitable lines, or
investing in more profitable ventures.
5. Assisting in Managerial Decision-Making: Cost accounting provides crucial data
to management for strategic planning and operational decisions, such as budgeting,
pricing strategies, make-or-buy decisions, and financial forecasting.
6. Inventory Valuation: It aids in the accurate valuation of inventory, which is critical
for determining the cost of goods sold and reporting the value of inventory on the
balance sheet.

Differences Between Cost Accounting and Financial Accounting

Cost accounting and financial accounting are two distinct branches of accounting, each serving
different purposes and audiences. Here’s how they differ:

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1. Purpose and Focus:
o Cost Accounting: Primarily concerned with providing information to internal
management to aid in decision-making, cost control, and improving
operational efficiency. It focuses on detailed cost data of specific processes,
products, or services.
o Financial Accounting: Aimed at providing financial information to external
stakeholders such as investors, creditors, regulators, and the public. It
focuses on summarizing financial data to present the financial health of the
entire organization.
2. Users:
o Cost Accounting: Used mainly by internal management for strategic
planning, performance evaluation, and cost management.
o Financial Accounting: Used by external parties, such as shareholders,
creditors, and regulatory authorities, for assessing the financial performance
and position of the company.
3. Reporting:
o Cost Accounting: Reports are prepared frequently (daily, weekly, monthly)
and can be customized to meet the needs of the management. They are not
governed by any statutory regulations.
o Financial Accounting: Reports are prepared periodically (quarterly,
annually) and must adhere to generally accepted accounting principles
(GAAP) or International Financial Reporting Standards (IFRS). These reports
are standardized and regulated.
4. Scope:
o Cost Accounting: It deals with the costs of specific products, departments,
or projects. The scope is more detailed and specific, providing insights into
areas where cost improvements can be made.
o Financial Accounting: It deals with the financial position of the whole
organization. The scope is broader, covering the overall financial results and
position of the business.
5. Flexibility:
o Cost Accounting: Offers flexibility and is tailored to meet the internal
requirements of the organization. There are no strict rules governing its
methods.
o Financial Accounting: Highly structured and bound by legal and regulatory
requirements, ensuring consistency and comparability of financial
statements.
6. Nature of Information:
o Cost Accounting: Provides detailed information on the cost of production
and operations, which helps in cost control and internal decision-making.
o Financial Accounting: Provides summary-level information about the
financial performance and position of the business, which is used by external
stakeholders to make investment and lending decisions.
7. Emphasis:

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o Cost Accounting: Emphasizes cost analysis, cost reduction, and efficiency
improvements.
o Financial Accounting: Emphasizes profitability, liquidity, and solvency of the
business.

Conclusion

Cost accounting and financial accounting are essential for the successful management of a
business. Cost accounting focuses on internal efficiency and cost control, aiding managerial
decision-making, whereas financial accounting serves external stakeholders by providing an
overview of the company’s financial status. Both types of accounting complement each other,
with cost accounting ensuring operational effectiveness and financial accounting ensuring
transparency and accountability.

Q6: The Yellow Company uses process costing system. The

department B received 14,000 units at the cost of Rs. 420,000. The
department E costs were Rs. 24,000 for direct labour and Rs. 89,250
for factory overheads, 8,000 unils were completed and ransferred to
Department C for further processing. At the end of the month, 6,000
units were still in process, estimated to be 80% complete as to the
conversion cost. You are required to prepare a cost of production
report or department B.

Answer

To prepare a Cost of Production Report for Department B using a process costing system, we
need to distribute the costs incurred over both the completed units and the units still in process.
The report involves several steps: calculating the cost per equivalent unit, determining the total
cost for completed units, and assigning costs to the work in process at the end of the period.

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Cost of Production Report for Department B
1. Units Flow Analysis
Description Units

Units received in Department B 14,000

Units completed and transferred out 8,000

Units still in process (80% complete) 6,000

2. Cost Analysis

1. Costs Transferred In: Rs. 420,000

2. Costs Added in Department B:
o Direct Labor: Rs. 24,000
o Factory Overheads: Rs. 89,250
o Total Costs Added: Rs. 24,000 + Rs. 89,250 = Rs. 113,250
3. Total Cost to Account For: Rs. 420,000 + Rs. 113,250 = Rs. 533,250

3. Equivalent Units of Production (EUP)

1. Units Completed and Transferred Out: 8,000 units (100% complete)

2. Units Still in Process: 6,000 units (80% complete)

Calculation of Equivalent Units for Conversion Costs:

6,000×80%=4,800 equivalent units6,000 \times 80\% = 4,800 \text{ equivalent

units}6,000×80%=4,800 equivalent units

Total Equivalent Units for Conversion Costs:

8,000+4,800=12,800 equivalent units8,000 + 4,800 = 12,800 \text{ equivalent

units}8,000+4,800=12,800 equivalent units

4. Cost per Equivalent Unit Calculation

1. Total Conversion Costs: Rs. 113,250

2. Cost per Equivalent Unit:

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113,25012,800=Rs.8.85 per equivalent unit\frac{113,250}{12,800} = Rs. 8.85 \text{ per
equivalent unit}12,800113,250=Rs.8.85 per equivalent unit

5. Cost Allocation

1. Cost of Units Completed and Transferred Out: 8,000×8.85=Rs.70,8008,000 \times

8.85 = Rs. 70,8008,000×8.85=Rs.70,800
2. Cost of Units Still in Process: 4,800×8.85=Rs.42,4804,800 \times 8.85 = Rs.
42,4804,800×8.85=Rs.42,480

6. Total Cost Assignment

1. Units Completed and Transferred Out: Rs. 420,000 (Transferred-in) + Rs. 70,800
(Conversion Cost) = Rs. 490,800
2. Units Still in Process: Rs. 42,480 (Conversion Cost)

Cost of Production Report for Department B

Description Units Cost per Unit (Rs.) Total Cost (Rs.)

Units Completed and Transferred Out 8,000 8.85 490,800

Units Still in Process (80% complete) 6,000 8.85 42,480

Total Costs 533,250

This Cost of Production Report details how the costs are distributed between the completed units
and the work in process in Department B.

Q7: Describe the terms, ordertig level, minimum level, maximum level, danger level
and Economic Order Quantity (EOQ) regarding material and supplies inventories in a
manufacturing industry.

Answer

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Effective management of materials and supplies inventories is crucial for any manufacturing
industry. This involves maintaining the right quantity of inventory to ensure smooth operations
while minimizing holding and ordering costs. Key inventory management concepts include
ordering level, minimum level, maximum level, danger level, and Economic Order Quantity
(EOQ). Here is an explanation of each:

1. Ordering Level (Reorder Level)

The ordering level, or reorder level, is the inventory level at which a new order must be placed to
replenish stock before it runs out. This level is set to ensure that there is enough inventory on
hand to cover usage during the lead time—the period between placing an order and receiving it.
The reorder level is calculated using the formula:

Reorder Level=Maximum Consumption×Maximum Lead Time\text{Reorder Level} =

\text{Maximum Consumption} \times \text{Maximum Lead
Time}Reorder Level=Maximum Consumption×Maximum Lead Time

• Purpose: To avoid stockouts and ensure that production processes are not
interrupted due to a lack of materials.

2. Minimum Level

The minimum level is the lowest quantity of inventory that must be maintained in stock to avoid
the risk of stockouts. This level ensures that there is always a safety buffer of materials to meet
unexpected demand or delays in delivery.

Minimum Level=Reorder Level−(Normal Consumption×Normal Lead Time)\text{Minimum

Level} = \text{Reorder Level} - (\text{Normal Consumption} \times \text{Normal Lead
Time})Minimum Level=Reorder Level−(Normal Consumption×Normal Lead Time)

• Purpose: To maintain a safety stock that can be used in emergencies, ensuring

continuity in operations.

3. Maximum Level

The maximum level is the highest quantity of inventory that can be held in stock without
incurring excessive holding costs or the risk of material deterioration. This level is set to ensure

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that the company does not overstock materials, which can tie up capital and increase storage
expenses.

Maximum Level=Reorder Level+Order Quantity−(Minimum Consumption×Minimum Lead Ti

me)\text{Maximum Level} = \text{Reorder Level} + \text{Order Quantity} - (\text{Minimum
Consumption} \times \text{Minimum Lead
Time})Maximum Level=Reorder Level+Order Quantity−(Minimum Consumption×Minimum
Lead Time)

• Purpose: To control inventory holding costs and optimize warehouse space while
ensuring that there is no excessive buildup of materials.

4. Danger Level

The danger level is the inventory level below which immediate action must be taken to replenish
stock to avoid halting production. It indicates a critical situation where the available stock is
close to being depleted, and the risk of stockout is imminent.

Danger Level=Average Consumption×Emergency Lead Time\text{Danger Level} =

\text{Average Consumption} \times \text{Emergency Lead
Time}Danger Level=Average Consumption×Emergency Lead Time

• Purpose: To serve as a warning signal that stock levels are dangerously low and that
expedited measures are required to prevent production disruptions.

5. Economic Order Quantity (EOQ)

Economic Order Quantity (EOQ) is the optimal order quantity that minimizes the total cost of
inventory management, including both ordering and holding costs. The EOQ model helps
determine the most cost-effective quantity to order to minimize the costs associated with
purchasing and storing inventory.

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• Purpose: To achieve a balance between ordering frequently (which incurs higher
ordering costs) and holding large quantities of stock (which incurs higher holding
costs). By using EOQ, companies can optimize their inventory management
processes and reduce overall costs.

Summary of Importance

1. Ordering Level: Ensures timely replenishment to avoid stockouts.

2. Minimum Level: Maintains a safety buffer for emergencies.
3. Maximum Level: Controls overstocking and minimizes holding costs.
4. Danger Level: Warns of critical inventory shortages requiring urgent action.
5. Economic Order Quantity (EOQ): Balances ordering and holding costs to optimize
inventory management.

These inventory control measures are essential for efficient operations in a manufacturing
industry, helping to maintain optimal stock levels, minimize costs, and ensure a smooth
production flow.

Q8: The Normal annual caparity of Toyota Motor Company is 60,000 vehicles with
production being constant throughout the year. The March budget shows fixed factory
overheads of Rs. 2,500,000 and variable factory overhead rate of Rs. 2,500 per vehicle.
During March, actual output was 4,800 vehicles with total factory overheads cost of Rs.
15,500,000. It is required to (a) Compute the under or over applied factory overheads cost.
(b) Work out the Spending Variance. (c) Determine the Idle Capacity Variance.

Answer

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KHAN BHAI WHATSAPP NUMBER 03259594602
KHAN BHAI WHATSAPP NUMBER 03259594602
KHAN BHAI WHATSAPP NUMBER 03259594602