What is retention money

What is retention money

Retention money is concept related to contract payment when a portion of payment is retained from the certified amount. This is very much international practice

Purpose of retention money

The money is retained for two reason.

1. Completion of work

The first reason to retain money is to require the contractor to complete the work. this contract may not be interested to complete the project if he is given the full payment of work performed if he get some other opportunity of investment or for any other reason.

2. Quality

The other reason is to retain money to maintain the quality in remaining work to be performed by the contractor.

Example of anticipated Contract Loss

Example of Anticipated Contract Loss
Material Issued			50,000
Labour			40,000
Plant value Begning			100,000
Ovehreads			40,000
Matrial at Site			5,000
Plant at Closing			80,000
Toal estimated Cost			230,000
Contract Price			190,000
Work Certified			120,000
Solution
Contract Cost Profit & Loss
Work Certified			120,000
Material Used	(50,000-5000)		45,000
Labour			40,000
Plant value Begning	(100,000-80,000)		20,000
Ovehreads			40,000
Less: Cost of Good Sold			145,000
Loss for the year			(25,000)
Total Loss
Loss for the year			(25,000)
Future Loss			(15,000)
Total Loss	(230,000-190,000)		(40,000)

Contract Profit

There are number of way where the profit can be calculated from the contract. The following are important consideration for profit recognition in contract costing. There are number of practices are available in the industry to recognized but those practices must not be confused with the international accounting standard criteria of profit.

1. Expected Loss

The expected loss of contract is immediately recognized in full.

2. Initial Activity

The contract in very early stage and the cost incurred for mobilization the activity . Then no profit should be recognized this is a situation where 1 to 5 % cost is incurred.

3. Cost of completion

A very famous method of profit recognition and this method is also supported by international accounting standard.

= cost of work done/estimated total cost x estimated profit

4. Work Certified

= value of work certified / contract Price x estimated profit

5. Work certified - Cost of work certified

How Depreciation Charged Contract Costing

How Depreciation Charged Contract Costing

There are there method of charging cost of plan to a contract.

1. Deprecation

The depreciation may be charged by using straight line or reducing balance method. both these method have predetermined rate of utilization and therefore site manager give little attention for careful utilization and maintenance of asset.

2. Book Value Difference

The book value difference is charged as depreciation. The book value at the start and at the end is calculated and the difference is charged as depreciation. The book value is determined by the condition of the plant. This method improve the responsibility of site manager for effective and careful utilization of asset.

3. Plant Account method

Depreciation and Repair and maintenance is charged to an account and then a notional rent is charged to contract on the bases of utilization.

What is Contract Costing

What is Contract Costing

Contract costing is basically a type of job costing and normally apply to a long term assignment.

Characteristic of Contract Costing

1. Formal Agreement

The contract involve long duration and high cost therefore a formal contract is made between contractor and contractee.

2. Job costing Methodology

Contract costing apply the job costing methodology and cost are collected at a single point which is known as contract account.

3. Direct Cost

Majority of cost in contract costing are direct cost and most of the cost are incurred in direct relation of the contract due to the nature of the job.

What are internal Service Departments

What are internal Service Departments

The internal service department does not directly participate in the production process but provide vital support to the production department. for example maintenance department. The cost of internal service department is apportioned to the production department.

Job costing for Internal Service Department

Job costing may be used to charge the service department cost on to the user department on the bases of usage of service instead of apportionment of total cost to different production department.

Advantages of Internal Job Costing

1.Rational

Expenses charges on the bases of utilization is a rational way of apportionment.

2. Careful utilization

user department will exercise care for using the service department as expenses are being charged and monitored by the management. This serve as important cost control tool.

3. Service Department Efficiency

Service is being charged to the department therefore the department will require more quality and efficient services from the service department and this would automatically improve the service quality level of the service department.

What is Job Cost Card

What is Job Card

Job Cost Card or Job sheet is document where all cost of a job is collected.

How many sections of Job card

The job card has typically two section .

1.one section carry the details of each transaction carried out with respect of a job.

2. 2nd section carry the summary of those transaction plus some additional information like
    a administration expenses charged to job , sale price and profit.

What is purpose of Job Cost card

Job card is basically a memorandum record for the management for the decision making and controlling the cost. It is quiet complex to use job account for the decision making purposes and therefore the concept of cost sheet has been introduce.

1. Readily Information 

The cost sheet provide the readily available information about the cost incurred on a job. Material are recorded on bases on material requisition , Labor is recorded on ticket number and overhead rate is used to charge the overhead to a job.

2. Effective Tool cost control

The information provided in job card is effective tool to control the cost as per estimation.

3. Accuracy of Job account

Job account may be reconciled with job card information to check the accuracy of job account.

Accounting of Job Costing

Accounting of Job Costing

1.Unique Job Account

Each work is assigned a unique code and all expenditure are charged to that job.

2.Job under Process

Job under process is maintained in work in progress ledger with a unique account and all related expenditure to that job is charged to that account.

3.Job Finished

Finished job is transferred to finished Good. The amount transferred to finished good indicate the cost incurred on a job.

4.Sale

Job are transferred to cost of good sold on sale and sale transaction is also entered in books of account.

What is Job Costing

What is Job Costing

Job costing is costing method used where a work is performed as per requirement of customer.

What is procedure of Job Costing

1. Customer Requirement

Customer specify it requirements. the famous example of job costing is furniture industry where every order is different from other order in term of requirement.

2. Detail Information

Production department will take precise details about the job. These details includes product features , quality of material used etc. Details about deadline for completion  of job and number of unit is to be produced is also important aspect of job costing.

3. Prepare Estimate

Estimation department prepare an estimate of the required work. The estimation department calculate the total cost of the job . A desired percentage of profit is added to such cost and the price is quoted to customer.

4. Intimate Customer

Customer is intimated about the price and a formal agreement is signed where it is required. usually some amount is paid by the customer in advance.

Minimum Product Pricing

Minimum Product Pricing

The minimum price is charged to cover the following cost.

1. Incremental cost of unit produced
2. Opportunity cost of alternative sacrificed, however ,no opportunity cost is charged where there is spare capacity and no scarcity or resources.

Why Minimum Price Charged

There is no concept of charging the minimum price but this concept is used for the two main reason.

1. Know the Minimum Price

The management would like to know the minimum price of the product so that management would be careful in pricing decisions. 

2. Incremental Profit

Minimum price will help to determine the incremental profit would be obtained from setting a certain price.

Imputed interest in Opportunity Costing

Imputed interest in Opportunity Costing

The interest is charged to the resources tied up in a project. The interest charged is equal to the borrowing cost of the entity.

Example of Imputed Interest

A asset is employed at a project costing 1 million and the interest rate is 18% pa. then an amount of $ 180,000 will be charged as imputed interest to the project.

Opportunity Costing

What is Opportunity Costing

Opportunity cost is the value of benefit sacrificed. In opportunity costing system the cost are charged on the bases of benefit sacrificed and not on the bases of cost actually incurred. The opportunity costing has a great use in decision  making.

When Opportunity Cost is Zero

There are two situation where the opportunity cost will be treated as zero.

1. There is no alternative use of resources.

2. There is no scarcity of resources and therefor there is no question of sacrificing.

What are limitation of Opportunity Costing

1. Not Easy Establish Alternative use

It is not easy to determine the alternative use of resources in many cases.

2. Valuation of Alternate use

The valuation of alternate use of resources is also a very challenging task.

Absorption Costing and Manipulation of Profit

Absorption Costing and Manipulation of Profit

The profit can easily be manipulated in absorption costing by changing the value of closing stock . The stock valuation consist of overhead element which can easily be manipulated by management for the stock valuation purposes.

The overhead absorption rate is very much at the discretion of the management and management can change the absorption rate to get the desired results. Whereas in case of Marginal costing management does not have this opportunity because overheads are charged as period cost.

1.Increase in Stock

If more value of closing stock is increased then it will increase the profit of the entity because some portion of the cost in current period will be stored in closing stock and will be charged next year.

2. Decrease in Stock

Similarly if the closing stock is valued at less amount then maximum expenses are charged in this period and this will reduce the current year profit.

Marginal Costing as Decision Making tool

Marginal Costing as Decision Making tool

Marginal costing is consider to provide more information to management for decision making.

1. Direct Relationship

Marginal costing establish a direct relationship between sales volume and profit as one additional unit sold will bring additional contribution. This relationship can be used by management to determine the profit level.

2. Expected Cash flow

Marginal costing provides vital information about the expected cash flow from the sales and cash availability for meeting the fixed cost and other operation.

3. Less Manipulation of Profit

Marginal costing there are less chances of profit manipulation as compared to absorption costing where the profit can be manipulated by valuation of stock.

4. Decision Making tools

Marginal costing concept of contribution can be used in various quantitative techniques of decision making like break even analyses.

Reasons for under and over absorbed overheads

 Reasons for under and over absorbed overheads

The production overhead are charged on predetermined rate which is based on budgeted overheads and budgeted level of activity. Therefore actual expenditure may differ from that rate. The main reason for that difference due to following reasons.

1. Actual expenditure differ from the budgeted expenditure
2. Budgeted level activity differ from actual level of activity

What is Absorption Rate

What is Absorption Rate

The absorption rate is rate used to charged the overheads to the production . The rate is based on the budgeted level of activity and budgeted overheads. The absorption rate is calculated by dividing the budgeted overheads by the budgeted level of activity.

What is use of Absorption Rate

Absorption rate is basically used to overhead during the year and based on historical data ( i.e budgeted overhead and budged location). The data of the actual overheads are available at the year end therefore predetermined rate is used.

What is under absorption and over absorption

The under absorption is the less amount charged to production than actual amount . The overhead absorption is the more amount charged to the production than actual amount. 

The reason for the under absorption and over absorption is due to use absorption rate for charging the overhead to the production and  which may differ from actual overheads.

Reasons for using absorption Costing

Reasons for using absorption Costing

There are mainly three reasons for using the absorption costing methods

1. Stock Valuation

Accurate Stock valuation is possible under absorption costing.

2. Financial Statements

Accurate financial statement can be prepared under the absorption costing system because under this method stock which is an important part of balance sheet and profit and loss account can only be accurately calculated under this system.

3.Product Pricing

Product pricing decision making can be made with the help of absorption costing.

What are methods of apportionment

What are methods of apportionment

There are basically four methods of apportionment of service department costs.

1.Direct 

If service department do not work for each other then overheads are only charged to production department using appropriate bases. This method of apportionment is called Direct apportionment.

However if it is assumed that service department is providing service to production department and other service department as well then there are three method to deal the situation.

1. Repeated Distribution

under this method cost are distributed among the service department repeadly unless the value of service department becomes negligible.

2. Algebraic method

Algebraic method is used for apportionment.

3.Step-wise Elimination

Under this method firstly one service department is allocated to all departments including serviced department then other service department cost are allocated only to production department.

How Absorption costing Works

How Absorption costing Works

The absorption costing build a product cost by allocation , apportionment and overhead absorption.

1.Direct Allocation

in first place direct expenditure are allocated to appropriate cost center. The examples of direct allocation is direct material and direct labour and direct overheads.

2. Apportionment

Apportionment involves two steps . in first place the general overhead which are charged to production and service department cost centers by using appropriate bases.

in second place the service department general overheads are charged to production department.

3. Absorption

Finally the general heads are charges to production cost by an absorption rate.

What are overheads

What are overheads

Product cost is primarily consist of three element i.e Direct material , Direct Labour and production overheads. Production overheads basically are indirect cost.

What are Examples of Production overheads

The famous examples of Production overheads are factory rent, supervision cost, Depreciation of plant and Machinery , Factory Lightening.

How Factory overhead are Charged 

Factory overheads charged to the product on the bases of absorption rate which is calculated by the management based on the historical data and experience of management.

Why variances are calculated

What are Variance analyses

Concept variance analyses to compare the standard performance with the actual performance. The actual performance is better than expected /standard performance then it is called favorable situation and expressed as favorable variance and if the actual performance is worst than standard performance than it is called adverse situation and expressed as adverse variance.

Why variances are calculated

There are number of advantages of variances

1. Control Expenditure

When variance is calculated during the period it provides management to take appropriate action to control the expenditure.

2.  Adjust budget estimates

When there is no appropriate reason for adverse variance then it is assumed that budgeted estimate were in correct and appropriate correction is made in budget.

3. Evaluate performance

Variance is important tool to evaluate performance of individual and especially the controlling manager.

  

Break-even Point

Contribution

Sale unit price is constant and variable cost is also constant therefore each unit sold result in a unit profit which is known as contribution and the formula of calculating unit contribution.

Contribution = Sales – Variable cost

Conceptually the fixed cost is a period cost and therefore we must generate enough contribution to cover fixed cost. This situation where we able to cover over fixed cost are known as break-even point. This point is also known as no profit no loss situation.

Example of Break even

Sale Price = 20

Variable Cost = 16

Fixed Cost = 40,000

What is break-even point?

Solution

Unit contribution = 20-16

Unit contribution = 4

Required level =                      fixed Cost/unit Contribution

                          =          40,000/4

                         =           10,000 units

Desired Level Profit

The concept of break even may be further extended to get the desired level of profit and the formula is amended as below

Desired level of profit = (Fixed Cost + Desired Level of profit)/unit contribution

Example of Desired level of Profit

Example of Break even

Sale Price = 20

Variable Cost = 16

Fixed Cost = 40,000

Desired level of profit = 70,000

What is required contribution?

Solution

Unit Contribution = 20-16

                              = 4

Required level of contribution:    (40,000+70,000)/4

                                                         = 110,000/4

                                                         = 27,500 units

Margin of Saftey

What is Margin of safety

Margin of safety is difference between the budget unit and break even. This difference may be  expressed in term of unit, revenue or percentage of budgeted figure.

What is formula of Margin of Safety

Formula =      i) Budgeted (units) – Break even (unit)

                = ii )  Budgeted (Revenue) – Break Even (Revenue)

Purpose of calculating the margin of Safety

The main purpose of calculating the margin of safety is to determine the risk factor. In simple term margin of safety tell what margin you have before the profit fall down at a level of break even a situation and that margin can be express either in terms of unit, revenue or as percentage of budgeted .

Example of Margin Safety

Sale Price = 20

Variable Cost = 16

Fixed Cost = 40,000

Budgeted unit are 25,000

What is Margin of Safety in terms of unit and percentage?

First place we will calculate the break even

= 40,000/(20-16)

= 10,000 units

Margin of safety = 25,000-10,000

                              = 15,000 units

Margin of safety in % = 15,000 units/ 25,000 units

                                      = 60%

Techniques of budget preparation

Techniques of budget preparation

There are mainly two types of budget preparation techniques used

1. Participation Budget
2. Imposed Budget

1. Participatory Budget

Under this technique the lower management effectively participates in the budget preparation process and mainly their recommendation is incorporated in the budget. The participatory technique of budget preparation is suitable in relatively medium scale organization.

Advantages of participatory Budget

1. Commitment

The manager will shoe more commitment to achieve the target set by them. The participation will act as motivating factor for the junior management and it will have a positive impact on the performance of the junior management.

2. Improve communication

This method will improve bottom to up communication. This will help top management to understand the problem at lower level. This technique will also identify the potential of junior management and junior management talent may be utilized effectively in future.

3. Confidence

This method will improve the confidence of the lower management and give him a motivation to work harder for achieving the organization objective. This technique will also have positive psychological effects on the junior management.

4. Accuracy

The lower manager can project the figures more accurately because they are more related to operations and they have more detail knowledge of operations. They will prepare a budget after considering all the relevant facts and figures. Therefore the budget would be more appropriate.

Disadvantages of participative budget Technique

1. Overall Direction is lost

The lower tier management has little idea about overall direction of the organization. The focus only on operational level issues in budgets preparation. For example the junior management may be interested in more efficient methods and dot care about the cost of acquiring those methods while on other hand top management is pursuing a cost saving policy.

2. Conflict

The rejection of budgets by the senior management may create resentment and conflict in the organization. The rejection may be considered as de motivating factor for the junior management and it will adversely affect the performance.

2. Imposed Budget

The budgets are prepared by the senior Management and junior management is informed to achieve the targets. There is no effective involvement of junior management in decision making process.

Advantages

1. Time Saved

Because the decision making is in few hands therefore immediate decision can be made.

2. Overall Direction

This technique helpful to achieve the overall direction of the organization as senior management set the overall direction and they prepare the budget keeping in mind the strategic objective.

Disadvantages

1. Challenging Targets

The target set may be too challenging to achieve. This situation may create resentment in junior management. This situation will also create un due pressure on junior management to achieve un realistic target set by budget.

2. Demoralization

The junior management will have low moral over due to non consultation. The junior management will feel powerless and this will adversely affect the performance.

3. Poor communication

This technique there will be very little communication process between top management and the top management would not be able to incorporate the operational aspect in the budget. There will be over focused on strategic objective and importance of operation in achieving the overall objective is ignored.

Labour Ratios

Labour Ratios

Labor efficiency

Labour efficiency ratio tell us about how efficiently labour are working  the efficiency ratio is calculated on the concept what is expected from labour and how is actual performance. If the result are below the 100% then we say that labour are under performing when the result are above 100% we say that labour performance is beyong the expectation and if the result is 100% the labour performance is upto expectation.

Labour efficiency is important because labour involve a high production cos therefore the labour should be working efficiently and efficiency ration provide effective information for controlling the labour performance.

Labour efficiency ratio is an important factor while calculating the bouns for the employees. The bonus is also an important tool to improve the efficiency of the worker.

Efficiency is very important because low efficiency mean that you are paying for wasted time. The some worker have tendency to waste time and efficiency ratio can be used to identify those worker or group of worker. The low efficiency is effectively mean that you are paying more and getting less.

 formula for efficiency

E efficiency Ratio =expected time/Actual time *100

Capacity utilization = (total hour spend / Total hour available) X 100

Production Volume = (Expected Time/total time available) X100

Example

There are 30 days in a month and 10 hour and number of employee are 10 there is idle time of 300 hours and standard time per unit 1 hour. Unit produced 6000 and expected time per unit produced was 20 minute.

Solution

Total hour available ( 30 days @ 10 * employee) =3000 hour

Total Productive hour ( 3000 hour – 300 idle ) = 2700 hour

Expected hour = 6000 X 20/60 = 2000 standard hour

Efficiency ratio =  2000/2700 X100 = 74%

Capacity utilization =  (Total hour spend / Total hour available) X 100

                                 =( 2700/3000)* 100 = 90 %

Labour capacity ratio

The purpose of calculating to identify that at what level the entity operating and how much of the capacity is being utilized. Capacity utilization is important factor because under utilization of capacity is a loss for the entity and specially in case of labour under utilization of capacity means that there are some over employment.

If there is over employment and the money is being paid it technically shows a poor management and the management should review the number of labour required and make appropriate decision in this regard.

The under utilization may also be due to the shortage of demand especially in case of season based industries. Some industries are not willing to reduce the staff due to shortage of demand because losing the employee and hiring again also involve cost moreover it requires training and experience is not an visible option.

Under utilization is possible but over utilization of capacity is not possible unlike efficiency ratio where the over efficiency is possible. Technically saying the answer of capacity ratio would be always equal or less than 100%.

Production volume

Production volume =( Expected Time/ Time Available ) X 100

This ration is basically an further interpenetration of efficiency and capacity ratio and explain what would be the production volume in case of efficient and non efficiency environment. If the capacity is being utilized and it is being utilized effectively then this production volume will show a positive sign if the capacity is being under utilized and efficiently then this production volume will improve.

Simple word it can be said if people are working and working with focus and integrity then you will have good production but if the people are wasting time and not working properly then this will be reflected in production volume ratio.

Processing Costing and Equivalent Units

Processing Costing and Equivalent units

Process costing is an average cost of the units but we have partly completed units in the opening and closing balance it is difficult to calculate the average cost. Therefore the concept of equivalent unit is introduced in the processing cost.

The average cost is calculated by dividing the total cost with the equivalent unit.

Formula of equivalent unit

Physical unit X % of completion

The physical units are multiplied with percentage degree of completion to get the equivalent units.

Example of equivalent unit

We have work in progress which is 100% complete with respect of material and only 40% complete with respect of conversion cost and number of units are 1200.

Solution

                                                                     Equivalent units

Material   1200 X 100 %                                           1200

Conversion Cost  1200X 40%                                      480

Process Costing and Normal Loss

Process Costing

Process costing is used where there are homogeneous product of either the product cannot be separated from the other product or there are a large number of product with small value. The typical example is liquid product like oil industry, paint industry and stationary items etc.

The paint and oil industry are the examples where the product cannot be separated from each other and stationary industry is typical example of small items are produced with small cost.

Normal Loss with no scrape value

The normal is the expected loss in the process of production. This is a loss which is expected in industry. This loss cannot be avoided and therefore may be called as inherent loss. The accounting treatment the normal loss is not valued at output. The process costing is done to assign average value of per unit.in case of normal loss the average value is calculated by actual cost by normal out i.e an output does not include the normal loss. The normal output may also be called as expected output.

Example Normal Loss with no scrape value

Input (material) 3000 units        $ 5000

Labour                                        $ 500

Overheads cost                          $ 500

Actual output is 2700 units

Solution

Out put

                           Units      Cost      Total Cost

Material             2,700       2.2              6000

Loss                      300

Total                   3000                           6000

 Total input Cost/ Normal output

= 6000/2700

=  2.2

Normal with Scrape Value

When there is scrape value of normal loss than normal loss is valued at given value. The average cost of per unit is reduced by that value.

Average Cost per unit = Input Cost – Scrape value/Normal Output

Example of normal loss with scrape value

Example Normal Loss

Input (material) 3000 units   $ 5000

Labour                                        $ 500

Overheads cost                        $ 500

Actual output is 2700 units and normal loss is value at $ 3 per unit

Solution

=   (6000- 900)/2700

=  1.889 Average cost

= 2700 unit X 1.889

= 5,100 (Output)

=  300 units  X 3 = 900 (Normal Loss)

Direct labour can be a Period Cost

Direct labour can be a Period Cost

Theoretical saying direct labor can be paid on monthly instead of on hour bases or output bases. But it does not mean that direct labour will be charged as period cost and not as direct cost. Because the direct labour is directly associated with production and if there is no production , there is no reason to pay the labour.Direct labour is always hired when there is an activity.

Direct labour payment on periodically bases must be confused with its nature. and direct labour will remain the direct cost all the time by its nature i.e vary with level of activity. The monthly payment is just a way of payment and does not change the nature of cost. Therefore Direct labour can be paid on monthly bases but will be charged as production cost and not as period cost.


Example of Monthly payment to Direct Labour

10 people employed to by a factory and paid a monthly salary of 10,000. what be would direct labour cost for the month.

10 people X 10,000 = 100,000

Difference between product hour and Normal Hour

Difference between product hour and Normal Hour

Difference between productive hour and normal hour is idle time. The normal hour is very much the time spent by labour including the idle time while the productive hour is the only working hours. The productive hours are hours where labour is involved in producing Good.

Example of Product Hour

There are 10 employee and working hour per week are 30 . Due to strike the the labour could not work for one day what would be normal hour and productive hour. There are five working days in a week.


Normal Hours 10 employees X hour per day X  5 days = 300 Hours

Product Hours 10 X 6 hour per day X 4 days = 240 Hours

Different Types of Labour hour

Different Types of Labour hour

There are four types of labour hour term used in production process. These all types are different from each other and a deep understanding is required of these hour. These hour are usually confused with each other.

Basic Labour hour

Basic Labour hour is the number of minimum hour required from a labour to work. This is more like an office timing concept when a employee is required to attend the office.

Productive Labour Hour

Productive hours are the actual number of hour worked by the employee or worker. it is to be noted that productive hour may exceed the basic hour.

Paid Labour Hour

Paid hour is clearly from the terminology that worker paid for hour , sometime paid hour are more than productive hour because of idle time. simply you can say these are hour for which employee was available for work and therefore paid.

Standard Labour Hour

Standard hour is basically used to measure the efficiency of worker, The standard hour are calculated with reference to the unit produced by the employee. The efficiency is calculated for the purpose of bonus payment etc.

Direct and Indirect Labour

Direct and Indirect Labour

Direct labour is a labour which is directly connected with the production process whereas the indirect labour is not directly connected with production process. The direct labour is the person who are producing the product and any other labour would be treated as indirect labour and would be treated as production overhead.

Example of Direct Labour

The basic rate of direct labour is the only direct labour cost and any other cost will be treated as indirect cost. There is once exception to the rule when there customer is ready to pay for overtime premium then overtime premium may be charged as direct labour.

Example of Indirect Labour

There are number of indirect labour involve in the production process like supervisor and managerial involvement in production. There are also some payment made to the direct labor but actually those payment would be treated as indirect labor cost. These include the overtime premium payment, bonus payment etc.

Concept of Idle time

Concept of Idle time

The idle time is the simply the difference between the difference between the hour paid and productive hours. There are number of reason for idle time which include the strike, machine break down, stock out.

Idle time and efficiency

The idle time concept will not be confused with the efficiency and if the worker work below the standard hour required it can not be treated as idle time. The difference between actual hour and expected hour is low efficiency and not idle time.

Types of Labour payment Systems

Types of Labour Systems

There are basically three type of labour payment system which includes Hourly Rate System, Piece work and bonus system.

Hourly Rate

The management identify a per hour work rate for the employee and also an overtime hour rate . The overtime rate is slightly above the normal hour rate. it is important to note that overtime is paid in addition to normal rate and therefore if it is stated that 50% overtime rate it mean that rate would be 150% of normal rate.

Piecework Rate

This rate is based on output. This is sometime is supported with guaranteed minimum payment. 

Bonus system

This system is based on the efficiency of the employee.The management described the standard hour of work and actual working hour. The standard hour is the expected hour of unit produced and the actual hour off course the actually hour spent on producing unit.

2 bin inventory reorder system

2 bin inventory system is a simple inventory management system. The management simple use two place for stock stores and use one of them when one stock warehouse is empty then it order the inventory and start using the second warehouse. when the second bin is empty then first bin was filled by fresh supply and this process continues.

Reorder level and Maximum level of stock

Reorder level and maximum level of stock are two different concept .The reorder level is the level where you place an order for the stock whereas the maximum level the maximum holding of the stock efficiently and any quantity above that level would cause inefficiency. The stock involve huge cost therefore it is necessary to determine the maximum efficient level.

There is a scientific formula to calculate the minimum level which is given below


Maximum Level = Re order level ( Minimum Usage * Minimum Lead time) + Reorder Quantity

Reorder Quantity and Reorder Level

reorder quantity is the management decision is to how much stock is to be order to minimize the cost. This is important to remember that mainly two cost are considered in deciding the the reorder quantity and these cost are holding cost and ordering cost. This is matter of fact that purchase cost remains the same and have no relationship with quantity ordered. The most common method of calculating the reorder quantity is EOQ.


Reorder level is total a different concept than reorder quantity and tell basically about that at what stage the order would be place to avoid stock out or shortage of stock. The reorder level is important concept because the shortage of stock has many disadvantages for the entity these advantages include the idle time of the labour , loss of revenue , damage to the entity image and loss of revenue.


There are two important concept for determining the reorder level one is the usage and the second is the lead time. The usage is the expected quantity which would be required for a production process . The second factor is lead time which is the time require to reach the stock at the warehouse.

The management has to define the maximum usage and maximum lead time and also minimum usage and minimum lead time. There can be three reorder level calculated one is the that there will be maximum usage and maximum lead time. The second level is the minimum usage and minimum stock level and third is average usage and average lead time.

Stock Shortage Costs

Stock shortage costs are not a financial cost but and can not be directly explained in terms of money but it is these cost related to reputation and smooth operations of the entity.

Production Stoppage

The stock shortage will result in stoppage of production process which is not a healthy thing for an organization. The stoppage off course is the wastage of many resources.

Order completion 

The shortage may result in delay the order completion which will bring a bad reputation to the organization.

Loss of Revenue

The stock shortage will impact the production process and the entity would not be able to meet the demands of customers and this will result in loss of revenue.

Stock related costs

Stock Related Costs

There are three main types of costs are related to stocks i.e ordering cost , purchase cost and holding cost . As stock involve a number of cost therefore a proper control must be in place to control and minimize those cost.

There are different methods and formula are available to minimize the cost. Those method primarily focus the ordering and holding cost of the stock.

1.Ordering cost

These cost include the telecommunication cost involved in ordering , cost of ordering team , cost of goods confirmation team and processes.Ordering cost and quantity order has inverse relationship. The unit ordering cost  decreases with the increase of quantity ordered.

2.Purchase Cost

The purchase cost include the purchase invoice , transportation cost and goods handling cost.

3.Holding Cost

 Holding cost includes the warehouse rent cost ,insurance cost and deterioration of cost. The holding cost has a direct relationship with ordered quantity. The holding cost increase with the increase of quantity ordered.

Cost Classification

Cost classification can be performed in many ways but however there are four important ways of classifying the different cost which includes the classification by nature , classification by tractability and classification by cost behavior.

Classification By Nature

There are basically four types of costs involve in a production process and these cost include the material cost , labor cost and overheads cost.

Classification by Tractability

The other important way is to classify the cost is its tractability to the product. The cost is classified into direct and indirect cost. The direct cost is directly related or traceable to production process or product whereas the indirect cost not directly related to production process of product.

Classification by Cost behavior

in this type classification the cost behavior to level of activity is bases for classification. The cost is basically classified into variable cost and fixed cost. The cost which react to level of activity know as direct cost and the cost which remain unaffected with level of activity know as fixed cost.

Purpose of Budget

Purpose of Budget

1. Communicate the plans

The budgets may be a source of communication plans to the relevant manager. Because the budgets are formal documents of the organization and prepared in a formal and structure way. Therefore it is not possible for manager to ignore the budgets.

2. Budget Set Targets

Budget can set performance targets for the organization and budget can be used as source document to evaluate performance of the manager. The performance evolution is critical for the employees because usually it is linked with the reward announcement for the employee. Therefore budget can play important role for improving the performance of manager and employees.

3. Budget set Limits

When the budgets are formally approved then it becomes an authorized expenditure limits and any expenditure which does not fall under these limit require special approval. Furthermore any expenditure which is not mentioned in the budget will also go to management for approval. Therefore budget put an effective control over expenditure.

4. Set a Direction

Budget is basically linking different department in formal way. Budget is prepared in a structured way and it takes into account the every department and therefore budget set a direction of moving forward. The budget is a linkage between different departments. Each department can get an idea about other department direction and activities from the budget.

5. Budget is Medium Term

The budget is normally considered to be a medium term plan and it provides a linkage between short term and long term planning. The budget is normally prepared for one year keeping in view the long term objective of the organization. The budget gives a direction to short term plan for achieving the long term plan.

Stages of budget preparation

1. Identify the key budget Factor

The first step is to identify the key factor for budget. The normal key factor is sales

2. Prepare budget for key factor

The second step is to prepare sales budget. The sales budget provides bases for other functional budgets. Therefore a great care must be exercised while preparing the sales budget. If budgets of key factor are not accurately prepared the whole process of budget will be at stake.

3. Other function budget

The other functional budget will be prepared in logical sequence. The typical sequence would be budget for production, and then budget for inventories, labor .

4. Submit the budget

The budget is submitted to the budget approving authority for review. The budget is reviewed by the budget committee and budget is explained to budget committee. The committee may require the further explanation and may also recommends the changes in the proposed budgets. The budget is amended in accordance with recommendation of the budget committee.

5. Master Budget

The functional budgets are incorporated into master budget. The master budget is overall budeget for whole organization.

6. Approve the budget

Submit the budget to board of director for approval. The key objective is explained to board of directors and board of director approves the budget in principal. The budget may be approved by board of director without any change or may approve the budget after some changes and amendments.

7. Communicate the budget

The budget is communicated to the relevant manager for implementation. The manager has a formal approved document in their hands and this document provides a basic guideline for activities to be carried out and range of those activities especially in financial terms.

8. Monitor the budget

The budget may be divided into shorter budget. For example monthly and quarterly budget. It is necessary to sub divide the budget for control purpose. The management keeps a close eye on periodical budget. The variance is calculated and required adjustment is made to achieve the overall objective.