What is Costing: An Overview

Costing means evaluating or assessing the cost of a product or job in monetary terms.

It is the process of identifying and analysing the expenses involved in producing a product.

Production involves multiple expenses that vary in nature. So, the cost accountant should identify the expenses directly related to the product's manufacturing.

For example, there are raw materials, power and fuel, buildings, machinery, tools and equipment, salaries and wages, expenses incurred in administration and marketing, etc.

The costing department tries to accurately identify the costs directly related to the product by setting aside expenses that are not a part of the direct cost.

Definition of Costing

Based on the above facts, costing can be defined as "an accurate and systematic process of computing the cost of a product or service".

How to Calculate the Cost

To put it in simple terms, Costing is done by adding the value of all the factors of production directly related to the production and then dividing the total cost by the quantity produced. 

For example, consider the simple case of going to a movie. It could be a wonderful example.

Here, the cost of the movie does not comprise only the ticket price. 

• To watch the movie, you have to travel there by public transportation or your own vehicle. So you incur round-trip fare charges or fuel for your vehicle. 
• Then, if you have to eat there, the cost of food is also incurred. This is because eating out is costlier than home-cooked food. 
• Then the value of your time spent watching it may also be added if you are a very busy person and your other work is hampered if you get stuck in traffic jams, etc.
• Any other costs can also be added, like financial disturbance, mental disturbance, deterioration of health due to the movie.
•  So all these factors can add up to the cost of your movie, and literally it will become a great price paid for watching that movie. 
• This is how costing is to be done

Stages Involved in Costing

Bifurcate Direct Costs and Indirect Costs

Trace and Allocate

Aggregate & Divide to obtain Unit Price 

• First, you will need to identify and locate all the elements that affect the cost of your object. Thereafter, bifurcate the expenses into Direct and Indirect.
• Then you will need to determine the actual quantity of each element that affects your particular object. It involves tracing which cost impacts the production process. Allocate that cost to the product's cost.
• If there are four elements used to make, say, 100 units of a particular product, your cost per unit will be one-hundredth of the sum of the values of those 4 elements.
• When there are many stages of production, you can calculate the cost for each stage by considering the expenses incurred for that stage separately. This is known as process-wise cost.
• When there are many products with the same elements of expenses or factors involved, you will calculate the cost by identifying the proportionate share of expenses for each product. This is known as product-wise cost.

Need for Good Relationship Between Finance and Accounts Fields

Finance and accounting are deeply interconnected business disciplines. While finance focuses on sourcing and managing corporate capital, accounting handles the systematic recording and tracking of funds secured or utilized. Because of this interdependence, seamless collaboration between both departments is essential.

The Finance Department relies heavily on data recorded by accounting personnel to prepare its financial statements and strategic reviews. Conversely, the accounting department utilizes the frameworks and guidelines established by financial managers to record transactions in a very concise format for the overall benefit of their company.

So, Finance and Accounts are the dual pillars of any organisation.

Better administration is possible through linking of Finance & Accounts
Finance and Accounts need to work together for better administration of the company. In many companies, the Finance Manager is entrusted with the responsibilities of both the Finance and Accounts departments, in which case he needs to be both an MBA and a Chartered Accountant. He will supervise or work alongside the Accounts Managers and Accounts Officers in controlling the Accounts and Finance wings. He will guide them in the proper maintenance of account books and records and in the preparation of the company's final accounts and financial statements. He can prescribe various formats for providing accurate information and work out the financial ratios and other inputs to the management for better governance of the business. So, a good relationship between Finance and Accounts is necessary.

Efficient management of Working Capital is possible
Finance professionals can manage the company's funds and working capital efficiently if they are closely linked to the accounts department. Because the accounts department maintains records of all expenses, it can provide the information in whatever form the finance manager may require, enabling finance professionals to gather accurate, concise information when preparing various statements for management. As a result, the finance department will be better positioned to determine how much funding each process and activity of the business requires and to procure the necessary working capital for the company in a timely manner.

Preparation of Budgets and Fund Flow Statements
The finance department needs to prepare budgets and Fund Flow/Cash Flow statements on a monthly and annual basis to better administer the Company's funds. To do this, they need to study past trends and determine the amount of expenditure incurred for each activity. This information is available with the accounts departments, as they keep the accounts. With proper cooperation from the accounts personnel, the finance department can prepare more accurate budgets and Fund Flow statements, thereby providing management with more accurate knowledge for governing the business.

Profit maximization and growth are possible
Improved relations and cooperation between Finance and Accounts lead to the growth of the company and profit maximization. By keeping accurate records, the accounts team can provide more reliable information at every stage of the business, across different time periods and under varying circumstances, as required by the finance team for their studies. Together, these departments can produce highly detailed and sensitive information for management to control expenses at every stage of the product, thereby identifying wastage and excessive spending. This helps remove bottlenecks in activities, leading to efficient production and growth of the company, yielding profits.

There can be many more areas where both accounts and finance need to cooperate in their functioning. For example, investments by the company or the issue of shares and debentures for the raising of working capital, valuation of company property for any purposes, or facing legal suits and litigations - all these areas require cooperation and a good relationship between the finance and accounts departments.

So, it is evident that a good relationship between finance and accounts is crucial for the financial health and growth of a company.

What is Depreciation and How to Calculate Depreciation?

Definition and Meaning of Depreciation

Depreciation means a decrease in value. As and when we use goods, they undergo wear and tear. Thereby, their value begins decreasing gradually. Even with the passage of time alone, they can lose their value, whether put to use or not. This notion of loss in value needs to be added to expenses in the accounting books to recover/adjust the loss from sales.

Definition:

Depreciation is the portion of value that an asset loses each year due to wear and tear, usage, or obsolescence, irrespective of whether it is used.

It is the process of transferring the cost of the asset into expenses over its lifespan.

Need for Charging Depreciation

• As capital is invested in procuring the assets, it needs to be recovered through the sale price of your product. But it is a known fact that whenever you sell assets, they fetch lower prices. 
• So, the depreciation value is to be added to the cost of production in determining the sale price of the product. By charging depreciation, you are recovering the value of the assets proportionately each year throughout their expected lifespan. If the asset is sold within its lifespan, the difference between the remaining value of the asset and its sale proceeds is treated as a loss on sale of assets. 
• The written-off cost serves as an offset needed while replacing the asset after the completion of its useful life so as to project a good picture. 

How to calculate Depreciation

Depreciation is normally calculated by spreading 95% of the asset value throughout its estimated lifespan.

5% of the asset value is kept in books as salvage value, which supposes that you can recover at least 5% of the asset when you sell it in any future years. No asset can be reduced to zero value, as it is generally considered that it has some value even after complete erosion.

There are different methods of calculating depreciation as per practices prevalent in different countries and even in different companies.

In this article, I am dealing with the calculation as per the Companies Act in India

Depreciation as per Companies Act 2014 (Schedule XIV of 1956)

As per Schedule XIV of the Indian Companies Act, 1956, depreciation is to be calculated in two methods:

Either the straight-line method or the written-down value method.

Under this Act, all assets are classified into different groups and rates are fixed based on the lifespan of each group. The major classifications of assets are as follows:

• Land
• Roads
• Buildings
• Furniture
• Office Equipments
• Vehicles ( Light or Heavy)
• Plant & Machinery

Besides the above groupings, there are many subgroupings under each category with some variations in the rates. 

Further, under Plant & Machinery, calculations are to be made based on their single shift, double shift or triple shift workings using their corresponding rates.

The rate charts are available at Schedule XIV of the Companies Act, 1956 (amended in 2014), which get updated as and when changes are made to it.

Straight Line Method of Depreciation

Under the straight-line method of depreciation, depreciation is calculated each accounting year at the same amount as per the Depreciation Rates Schedule of the Companies Act applicable for that Assessment Year. Each accounting year, the depreciation is calculated on the original gross value of the asset. As rates are fixed, the depreciation amount will be the same for each and every accounting year (provided the Gross value of the asset remains the same and if no additions are made during that year). If additions are made, the amount will increase pro rata.

While making depreciation calculations on additions made during the year, if the addition is made in the first half of the year, the full amount of depreciation will be charged for the whole year on that item.

If the addition is made in the second half of the year, only half the amount of the depreciation will be charged for that asset in that year.

Illustration for Depreciation Calculated at SLM method

Asset	Value	Rate %	Depreciation (2011-12)	Depreciation  (2012-13)	Depreciation (2013-14)
Building	500000	5	25000	25000	25000
Furniture	100000	10	10000	10000	10000
Machinery	1000000	15	150000	150000	150000
Cars	300000	10	30000	30000	30000

In the example above, no additions are included. If there is an addition during the year, you will need to add additional columns for Addition and Total Value. Depreciation will be calculated separately for the opening balance and the addition, and the total depreciation will be shown in the depreciation column for that year.

Written Down Value Method of Depreciation (WDV method)

In this method, depreciation is calculated each accounting year based on the asset's net value. The net value of an asset is the amount remaining after subtracting its accumulated depreciation. Each year, you deduct the depreciation amount from the asset's value and then calculate depreciation on that net amount. So, you will be taking the asset's net value as your opening balance for calculating depreciation, as opposed to the SLM method, where you always take the asset's original gross value as your opening balance.

In this method of calculation, the depreciation amount will be higher in the beginning years and lower at the end period of the asset. The depreciation rates will be higher in this method, but the number of years of the asset's life will be the same. 

Since you are calculating the depreciation on a diminishing value basis, the total amount of depreciation charged on any asset during its lifespan will be the same as that charged on the SLM method. 

So, in both methods, the ultimate residual value will remain more or less the same at the end of its lifespan.

Calculation of Depreciation under WDV method

Asset	Value	Rate %	2011-12 Deprecn.	2011-12 WDV	2012-13 Depr.	2012-13 WDV	2013-14 Depr.
Building	500000	5	25000	475000	23750	453250	22663
Furniture	100000	10	10000	90000	9000	81000	8100
Machinery	1000000	15	150000	850000	127500	722500	108375
Car	300000	10	30000	270000	27000	243000	24300

I hope the concept is clear with the help of the above illustrations. You may express your doubts, if any, in the comments section so that I can clear them.

How to Prepare A Balance Sheet: Sample Balance Sheet

What is a Balance Sheet?

A Balance Sheet is one of the most important documents of any company. It is a summary of all the company's accounts and activities in monetary terms. It is a statement of an Organisation's assets and liabilities. It gives a complete picture of the financial position as on a particular date of the company in question, in a nutshell. 

Importance of Balance Sheet

Balance sheets are important for the many uses they provide to different sections of people. They are mandatory under the Company Law for any business organization.

Here are some of the advantages derived from Balance Sheets:

• Balance Sheets are used by governments and Company Law Boards to determine the performance and activities of companies and business entities for the purpose of Income Tax assessment, Corporate Tax, and other statutory compliance requirements. 
• Investors use information from Balance Sheets as a guide while investing their resources in the company. As the balance sheets are certified by licensed Chartered Accountants, they are deemed reliable sources in projecting a true picture of the company's financial position. 
• Owners and Shareholders use the balance sheets to understand the status of their company and to take authoritative decisions on management issues and running of the company.
• Even staff and workers should know the status and progress of their company to seek increments, promotions, and bonus payments. Even fresh applicants for a job should assess the company's financial status before applying for a job. 
• In the legal field, also. Balance sheets are used to file cases and seek compensation from the company. 

How to Prepare Balance Sheets

Balance Sheets are prepared using the Trial Balance and Profit and Loss Statement of the company.

• A simple Balance Sheet consists of two columns, just like the Trial Balance and Profit and Loss account.
• On your right side, you will show all the assets like Fixed Assets, Current Assets, Cash & Bank Balances, and Investments, etc.
• On the left side of the balance sheet, you will show all your liabilities such as Capital, long-term liabilities, current liabilities, etc.
• The order followed while showing assets, as to which item should appear first and which at the last, is based on their liquidity or non-liquidity nature. Hard assets which are not easily saleable are generally shown first, followed by the next hard item.
• For Liabilities, the order followed is based on the obligation of the liability to be met first while paying out.

But in my example below, I am providing a sample balance sheet in a simple format that I used to prepare for my company in a two-column statement.

Balance Sheet of XYZ Company as on 31^st March 2014

Liabilities	Amount ($)	Assets	Amount ($)
Authorised Capital CP shares 200000 Ordinary    50000 Total         250000 Issued & Paid-Up CP shares 180000 Ordinary     45000		Fixed Assets 200000
		Less: Depreciation                                                         30000	170000
		Inventories	80000
		Sundry Debtors	15000
		Prepaid expenses	5000
		Investments	5000
		Bank Balance	10000
Total Issued & Paid	225000	Cash Balance	2000
Long-term Liabilities	15000
Current Liabilities	30000
Cumulative Profit	17000
TOTAL	287000	TOTAL	287000

The above is only a sample for easy understanding of Balance Sheet preparation. All figures are to be taken from your Profit and Loss Statement and Trial Balance, as already mentioned.

You must attach to this Balance Sheet all the quantitative information and the details of each group of account shown here in the above statement. These sheets are to be enclosed as Annexures to the Balance Sheet.

Please Note:

Different countries follow different styles in presenting balance sheets. Some prefer a single-column statement that starts with assets, then proceeds to liabilities and capital. The asset total is inserted in the middle, and the liabilities total at the end. In any case, the totals for assets and liabilities will match. That is why it is known as a Balance Sheet.

Even in the same country, different companies can present their figures in different ways. For example, cash and bank balances and current assets may come first, followed by fixed assets. Current liabilities may come first, then long-term liabilities, and then share capital.

Manufacturing Account: How it Differs from A Trading Account

A manufacturing account is different from the trading account in the sense that it is uniquely designed for the manufacturing industries.

A manufacturing account is prepared to know the manufacturing cost of goods. This statement is generally prepared and used in manufacturing concerns to know the cost of production.

But a trading account is prepared in all business concerns, whether they are manufacturers or dealers in goods.

The trading account gives you the gross profit or loss of your business in selling your products. So it includes, for its cost, some elements of selling and stock-maintaining charges also in it. So, the trading cost is broader than the manufacturing cost.

In a Manufacturing Account Statement, you will consider only those expenses which are directly related to the manufacturing of your goods and only up to the production point.

So, it will not include the cost of maintaining your stocks in godowns or warehouses, or the cartage incurred in selling your products, and the wages of labour, etc., not directly related to production.

Manufacturing cost is carried on to the trading account to determine the gross profit or loss of your business concern. 

So, you can take the manufacturing cost directly in your trading account and add other expenses to calculate the gross profit instead of taking each item of cost separately in the trading account. 

For this, you will first calculate the manufacturing cost and then carry it to the Trading Account and add other items of trading activities one by one on the expenses side and deduct the total amount from the sales amount to arrive at the gross profit of your business.

A sample of Manufacturing Account and Trading Account are given below so that you can know the differences between those two statements.

Manufacturing Account for Cement Industry

Particulars	Amount in $
Limestone cost	100000
Gypsum	5000
Other ash, additives	15000
Crushing charges	10000
Direct labour	20000
Power	20000
Fuel	20000
Total manufacturing cost	190000

   

Trading Profit/Loss Account

Particulars	Amount ($)	Particulars	Amount ($)
Opening Stock	10000	Sales	280000
Manufacturing cost	190000	Closing Stock	20000
Wages & Salaries	20000
Rent and Electricity	10000
Cartage	10000
Depreciation	20000
Total Cost	260000
Trading Profit	40000
TOTAL	300000	TOTAL	300000

Trading Profit is the same as Gross Profit (before administration expenses and other costs)   

Summary:

From the above illustration, you can see that a Manufacturing Account is directly related to the calculation of the cost of goods produced up to the manufacturing stage only, whereas the trading account takes into account other costs also related to the trading or selling of goods, including the depreciation involved on plant and vehicles and storage building.