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Unit 2 of 4 · B.Com Sem 2

Unit 2: Material, labour & overhead costs

Cost Accounting notes · PTU syllabus (BCOM 201-18)

3 min read7 topics10 exam questions
On this page
  1. Unit summary
  2. Purchase, storage and control of material
  3. Inventory control techniques
  4. Methods of pricing material issues
  5. Labour cost: idle time and overtime
  6. Wage payment and incentive plans
  7. Labour turnover
  8. Overheads: collection, apportionment and absorption
  9. Key terms
  10. Quick revision
  11. Important questions

Unit summary

Material, labour and overheads are the three building blocks of cost. This unit covers purchase, storage and control of material, inventory control techniques, pricing of material issues, labour cost, idle time and overtime, wage and incentive plans, labour turnover, and collection, apportionment and absorption of overheads including the machine hour rate.

After this unit you can

  • Explain purchase and storage procedures and inventory control techniques
  • Price material issues under FIFO, LIFO and weighted average
  • Calculate wages under incentive plans and labour turnover
  • Apportion and absorb overheads and compute a machine hour rate

PTU syllabus topics

  • Purchase
  • storage and control of material
  • inventory control techniques
  • methods of pricing material issues
  • components of labour cost
  • idle time and overtime
  • wage payment and incentive plans
  • labour turnover
  • collection and absorption of overheads
  • machine hour rate
Key formulasMaterial and labour controls

  • Economic Order Quantity

    EOQ = √(2AO / C)

    A = annual demand, O = ordering cost, C = carrying cost

  • Reorder level

    Maximum usage × maximum lead time

  • Halsey bonus

    50% × time saved × rate

  • Rowan bonus

    (Time saved / time allowed) × time taken × rate

  • Labour turnover

    Separations / average workers × 100

1

Topic 1

Purchase, storage and control of material

ProcessPurchase procedure
  1. 1

    Purchase requisition

    From stores or department

  2. 2

    Selection of supplier

    Quotations, tenders

  3. 3

    Purchase order

  4. 4

    Receipt and inspection of goods

    Goods received note

  5. 5

    Checking and passing of invoice

  6. 6

    Payment

  • Centralised purchasing: one department buys for all — economies, uniform policy.
  • Storage: store-keeper receives, stores, issues and records material; bin card (quantity, kept by store-keeper) and stores ledger (quantity and value, kept by costing department).
  • Material requisition note: authorises issue of material; material return note for unused material.
2

Topic 2

Inventory control techniques

Key formulasStock levels and EOQ

  • Reorder level

    Maximum consumption × Maximum reorder period

  • Minimum level

    Reorder level − (Normal consumption × Normal reorder period)

  • Maximum level

    Reorder level + Reorder quantity − (Minimum consumption × Minimum reorder period)

  • Average level

    (Minimum + Maximum) ÷ 2, or Minimum + ½ Reorder quantity

  • Danger level

    Average consumption × Emergency delivery time

  • EOQ

    √(2AO ÷ C) — A annual usage, O ordering cost per order, C carrying cost per unit per year

Example

Normal usage 100 units/week, minimum 50, maximum 150; reorder period 4–6 weeks (normal 5); EOQ 600. Reorder level = 150 × 6 = 900; minimum level = 900 − 100 × 5 = 400; maximum level = 900 + 600 − 50 × 4 = 1,300 units.

  • ABC analysis: classify items by value — A (high value, few items, strict control), B (moderate), C (low value, many items, simple control).
  • VED analysis: vital, essential, desirable (spares).
  • Perpetual inventory system with continuous stock-taking; JIT inventory; inventory turnover ratio to spot slow-moving and dead stock.
3

Topic 3

Methods of pricing material issues

MethodBasisEffect when prices are rising
FIFOEarliest purchases issued firstLower cost of issues, higher closing stock and profit
LIFOLatest purchases issued firstHigher cost of issues, lower closing stock (not allowed under AS-2/Ind AS 2)
Simple averageAverage of prices, ignoring quantitiesRough results
Weighted averageTotal cost ÷ total units after each receiptSmooths fluctuations
Standard pricePredetermined priceVariances recorded separately

Example

Opening 100 units @ ₹10; purchase 200 @ ₹12; issue 250. FIFO cost of issue = 100 × 10 + 150 × 12 = ₹2,800; closing 50 @ ₹12 = ₹600. Weighted average rate = (1,000 + 2,400) ÷ 300 = ₹11.33; issue cost = 250 × 11.33 = ₹2,833.

4

Topic 4

Labour cost: idle time and overtime

  • Components of labour cost: wages, DA, bonus, employer's contribution to PF and ESI, leave pay, fringe benefits.
  • Time-keeping (attendance) and time-booking (time spent on each job).
  • Idle time: time paid but no work done. Normal idle time (tea breaks, change of shift) is included in labour cost or overheads; abnormal idle time (power failure, strikes, machine breakdown) is charged to the Costing P&L account.
  • Overtime premium: extra over normal rate — charged to the job if at the customer's request; to overheads if due to general pressure; to Costing P&L if abnormal.
5

Topic 5

Wage payment and incentive plans

ClassificationMethods of wage payment
Wage systems

  • Time rate

    Paid per hour or day — quality work, no incentive

  • Piece rate

    Paid per unit — straight, differential (Taylor, Merrick)

  • Incentive (premium bonus)

    Halsey, Rowan, Emerson, Gantt task and bonus

Key formulasIncentive plan formulas

  • Halsey

    Earnings = TW × R + 50% × (TA − TW) × R

  • Rowan

    Earnings = TW × R + (TA − TW) ÷ TA × TW × R

  • Taylor's differential piece rate

    Low rate (83% of piece rate) below standard; high rate (125%) at or above standard

Example

Time allowed (TA) 10 hours, time taken (TW) 8 hours, rate ₹50/hour. Halsey: 8 × 50 + 50% × 2 × 50 = 400 + 50 = ₹450. Rowan: 400 + (2 ÷ 10) × 8 × 50 = 400 + 80 = ₹480.

Exam tip

Rowan gives a higher bonus than Halsey when time saved is less than 50% of time allowed; at 50% saved both are equal.

6

Topic 6

Labour turnover

Labour turnover is the rate of change in the workforce during a period.

Key formulasLabour turnover rates

  • Separation method

    Separations ÷ Average number of workers × 100

  • Replacement method

    Replacements ÷ Average workers × 100

  • Flux method

    (Separations + Replacements) ÷ Average workers × 100

  • Causes: avoidable (low pay, poor conditions, bad supervision) and unavoidable (retirement, death, marriage, illness).
  • Costs: preventive costs (welfare, personnel department) and replacement costs (recruitment, training, lower output, scrap).
7

Topic 7

Overheads: collection, apportionment and absorption

ProcessOverhead accounting
  1. 1

    Collection and classification

    Standing order numbers, function-wise

  2. 2

    Allocation

    Whole overhead to one cost centre

  3. 3

    Apportionment

    Share common overheads on fair bases

  4. 4

    Re-apportionment

    Service departments to production departments (direct, step, repeated distribution, simultaneous equations)

  5. 5

    Absorption

    Charge to products using a rate

  6. 6

    Under/over-absorption

    Adjust via supplementary rate or Costing P&L

OverheadBasis of apportionment
Rent, rates, lighting, building depreciationFloor area
PowerHorsepower × machine hours
Supervision, canteen, welfareNumber of workers
Insurance and depreciation of machineryValue of machinery
Stores overheadsValue of material used

Absorption rates

  • Percentage of direct material, direct labour or prime cost.
  • Labour hour rate — overheads ÷ direct labour hours.
  • Machine hour rate — overheads ÷ machine hours (best for machine-intensive departments).

Machine hour rate

Example

Machine cost ₹2,00,000, scrap value ₹20,000, life 10 years, 1,800 working hours a year. Depreciation = 18,000 a year = ₹10/hour. Power 10 units/hour @ ₹6 = ₹60/hour. Repairs ₹9,000 a year = ₹5/hour. Share of rent and supervision ₹27,000 a year = ₹15/hour. Machine hour rate = 10 + 60 + 5 + 15 = ₹90.

Key terms

Reorder level
Stock level at which a fresh order is placed
EOQ
Order quantity that minimises total ordering and carrying costs
Idle time
Time paid for but not worked
Labour turnover
Rate of change in the composition of the workforce
Machine hour rate
Overhead cost of running a machine for one hour

Quick revision

  • Purchase: requisition → order → receipt → inspection → payment.
  • Stock levels: reorder, minimum, maximum, danger; EOQ = √(2AO/C).
  • FIFO, LIFO, weighted average pricing.
  • Halsey 50% of time saved; Rowan proportion of time saved.
  • Overheads: allocate → apportion → re-apportion → absorb.

Important exam questions

Practice questions written to the PTU exam pattern for this unit's syllabus: short answers (Section A style) and long answers (Sections B and C style).

Short-answer questions

  1. Q1.What is a bin card?
  2. Q2.Define reorder level.
  3. Q3.What is ABC analysis?
  4. Q4.Distinguish normal and abnormal idle time.
  5. Q5.Write the Rowan plan formula.
  6. Q6.What is a machine hour rate?

Long-answer questions

  1. Q1.Explain the purchase procedure and techniques of inventory control.
  2. Q2.Explain methods of pricing material issues with an illustration.
  3. Q3.Explain the Halsey and Rowan premium plans and the treatment of idle time and overtime.
  4. Q4.Explain the collection, apportionment and absorption of overheads.

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