COST ACCOUNTING STANDARD ON “CLASSIFICATION OF COST” PART 1

COST ACCOUNTING STANDARD ON

“CLASSIFICATION OF COST”

The following is the text of the COST ACCOUNTING STANDARD 1 (CAS 1) issued by the Council of the Institute of Cost and Works Accountants of India on “Classification of Cost”. The standard deals with the principle of classifying costs in the cost statements. In this Standard, the standard portions have been set in bold italic type. These should be read in the context of the background material which has been set in normal type.

1. Introduction

The standard on classification of costs deals with the basis of classification of costs and the practice to be adopted for classification of cost elements in regard to its nature and management objective. The statement aims at providing better understanding on classification of cost for preparation of various cost statements required for statutory obligations or cost control measures.

2. Objective

2.1 The objective of this Standard is to prescribe the classification of costs for ascertainment of cost of a product or service and preparation of cost statements on a consistent and uniform basis with a view to effect the comparability of the same of an enterprise with that of previous periods and of other enterprises.

2.2 The classification and its disclosure are aimed at providing better transparency in the cost statement.

2.3 The standard is also for better adoption of Uniform Costing and Inter-firm Comparison.

3. Scope

3.1 The standard on classification of cost should be applied in assessment of cost of a product or service, application of costing technique and in case of management decision making by the manufacturing industries in India.

3.2 The standard is to be followed by an enterprise, whether covered under section 209(1)(d) of the Companies Act,1956 or not, to classify cost in order to prepare cost statement on uniform basis to make it relevant and understandable for effective cost management.

3.3 The standard has also to be followed for the purpose of assessment of cost of production or valuation of product or the valuation of stock to be certified for calculation of duties and taxes, tariffs and other purposes as the case may be. The cost statement prepared based on standard will be used for assessment of excise duty and other taxes, anti-dumping measures, transfer pricing etc.

4. Definitions:

4.1 Cost : Cost is a measurement, in monetary terms, of the amount of resources used for the purpose of production of goods or rendering services.

4.2 Manufacturing of goods or rendering services involves consumption of resources. Cost is measured by the sacrifice made in terms of resources or price paid to acquire goods and services. The type of cost is often referred in the costing system depends on the purpose for which cost is incurred. For example material cost is the price of materials acquired for manufacturing a product.

4.3 Cost Centre : Any unit of Cost Accounting selected with a view to accumulating all cost under that unit. The unit may be a product, a service, division, department, section, a group of plant and machinery , a group of employees or a combination of several units. This may also be a budget centre.

4.4 Cost Centre or Cost Object is the logical sub-unit for collection of cost. Cost Centre may be of two types – personal and impersonal cost centers. Personal cost centre consists of a person or a group of persons. Cost centres which are not personal cost centres are impersonal cost centers. Again Cost centers may be divided into broad types i.e. Production Cost Centres and Service Cost Centres. Production Cost Centres are those which are engaged in production like Machine shop, Welding shop, Assembly shop etc. Service Cost centers are for rendering service to production cost centre like Power house, Maintenance, Stores, Purchase office etc.

4.5 Cost unit is a form of measurement of volume of production or service. This unit is generally adopted on the basis of convenience and practice in the

industry concerned.

4.6 Examples of Cost Units :

Power - MW

Cement - MT

Automobile - Number etc

5. Basic Rules for Classification of Costs

5.1 Classification of cost is the arrangement of items of costs in logical groups having regard to their nature (subjective classification) or purpose (objective classification).

5.2 Items should be classified by one characteristic for a specific purpose without ambiguity.

5.3 Scheme of classification should be such that every item of cost can be classified.

5.4 Basis of classification :

i) Nature of expense

ii) Relation to object – traceability

iii)Functions / activities

iv) Behaviour fixed, semi-variable or variable

v) Management decision making

vi) Production Process

vii) Time period

5.5 Classification of cost is the process of grouping the components of cost under a common designation on the basis of similarities of nature, attributes or relations. It is the process of identification of each item and the systematic placement of like items together according to their common features. Items grouped together under common heads may be further classified according to their fundamental differences. The same costs may appear in several different classifications depending on the purpose of classification.

5.6 Cost is classified normally in terms of a managerial objective. Its presentation normally requires sub-classification. Such sub-classification may be according to nature of the cost elements, functional lines, areas of responsibility, or some other useful break-up. The appropriate sub-classification depends upon the uses to be made of the cost report.

COST ACCOUNTING STANDARDS

CAS - 1

COST ACCOUNTING STANDARD ON

CLASSIFICATION OF COST

ISSUED BY

THE INSTITUTE OF COST AND WORKS ACCOUNTANTS

OF

INDIA

PREFACE TO COST ACCOUNTING STANDARD BOARD

1. Introduction

Due to open competition for globalization, the Cost Management has gained special importance in the business activities. Cost Accounting Standard Board ( hereinafter called CASB) set up by the Council of the Institute of Cost and Works Accountants of India ( ICWAI ) and following statements are issued to define the objectives, operating procedures, scope and applicability and authority of CASB.

2. Constitution

2.1 The CASB will have a Chairman as appointed and nominated by the Council of the Institute and other members will also be appointed and nominated by the Council.

2.2 The terms and period of appointment will also be decided by the council of the Institute.

2.3 The Director( Technical ) will be the Secretary of the CASB.

2.4 The CASB will prepare a report of its work each year and send it to the Council.

3. Objective

The work of CASB is to develop Cost Accounting Standard on important issues/topics relating to Cost and Management Accounting with the following objectives :

3.1 To equip the profession with better guidelines on standard cost accounting practices

3.2 To assist the Cost Accountants in preparation of uniform cost statements

3.3 To provide guidelines to Cost Accountants to make standard approach towards maintenance of Cost Accounting Record Rules and Undertaking Cost Audit under section 209 (1) (d) and section 233B of Companies Law respective and various other Acts like Income Tax Act, Central Excise Act, Customs Act, Sales Tax Act, etc.

3.4 To assist the management to follow the standard cost accounting practices in the matter of compliance of statutory obligations.

3.5 To help Indian industry and the Government towards better cost management

4. Operating Procedure and policies of CASB

4.1 Organizing and initiating discussion and deliberation at national level to identify the areas/topics in respect of which needs for standards are felt

4.2 Generating information on all alternative cost accounting practices in respect of selected practices

4.3 Preparation of draft on the standard cost accounting practices in respect of chosen areas/topic in cost accounting and circulate it to the members of the Institute, national accounting institute and other end user bodies like industry association, Chambers of Commerce and Industry, Government bodies etc

4.4 Allowing sufficient time for consideration and comments on the exposure draft

4.5 Pronouncement of the exposure draft as ‘standard’ after giving due consideration to the suggestions and modification generated on the circulated exposure drafts from such individuals and agencies as mentioned in 4..3 above.

4.6 To fix a date for the standard to be effective

4.7 To propagate and generate acceptance and commitment to follow the ‘standards’ prescribed by CASB

4.8 To revise the ‘standards’ once issued, if dictated by environment, government, legal authority and other situation.

5. Scope and Applicability

5.1 The ‘standards’ issued by CASB will be recommendatory in nature and every member of the institute is expected to honour the same.

5.2 A standards will always make sure that it complies with the legal regulations in respect of the matter covered by it. However, a standard by its vary nature will have to be more definite and specific than its legal requirements.

5.3 Any limitation in application of a ‘standard’ in specific circumstances must be spelt out in the ‘standard’ itself.

5.4 Every standard will broadly have two parts – (a) explanatory part and (b) the operative part. The explanatory section will set out topic covered, the premises, the need for standardization and methodology and rationale for practice recommended. The second part, the operative portion will be the definite direction on the matter.

5.5 Every standard will indicate the date from which it will be operative.

5.6 The standards will be applicable to preparation of cost statements and other documents where the concepts embedded in the standard will be applicable.

5.7 As far as maintenance of cost accounting record rules under section 209 (1) (d) is concerned, relevant matter covered under the standards , wherever applicable, will be followed.

5.8 Cost Auditors will adopt and encourage the adoption of the standards, wherever applicable, in maintenance of Cost Accounting Record Rules under section 209(1)(d) and report the deviations, if any, in the Cost Audit Reports under section 233B.

5.9 The Institute will take up the standards with National Accounting Standard Board to enforce them and to include in Companies Act, 1956.

6. Authority attaching to the standard

6.1 So long the standards are not enforced by National Accounting Standard Board or by Companies Act, the CASB does not possess the legal authority to impose its views as statutory regulations but it is by only persuasion the standard can be followed as normal practice by the members of the profession

6.2 ICWAI will be duty bound to protect its members who respect and adhere to the standard prescribed.

6.3 Disciplinary restriction may be imposed by the Council of the Institute at appropriate stages as may be felt necessary for not complying with or not honouring the standard.

COST ACCOUNTING STANDARD ON CAPACITY DETERMINATION

The following is the COST ACCOUNTING STANDARD 2 (CAS 2) issued by the Council of the Institute of Cost and Works Accountants of India on “CAPACITY DETERMINATION”. The standard deals with determination of capacity of a unit. In this Standard, the standard portions have been set in bold italic type. These are to be read in the context of the background material which has been set in normal type.

1. Introduction

Better utilization of capacity means better utilization of resources. It is an important consideration for cost determination and cost reduction. Thus, it is essential to establish the capacity of the plant. Cost Accounting Records Rules under section 209(1)(d) of Companies Act, 1956 and Cost Audit Report Rules, 2001 under section 233B of the said Act specify that comparative statement of installed capacity and actual capacity utilization is to be recorded and furnished in order to assess the operating level.

2. Objective

2.1 The objective of the standard is to prescribe the method of determination of capacity to be applied uniformly and consistently.

2.2 The standard is to help the management to identify the bottlenecks, imbalances and idle capacity for effective use of various resources.

2.3 The standard is to help in proper allocation, apportionment and absorption of cost.

3. Scope

3.1 The standard should be followed for capacity determination required to be carried out for any purpose or under provisions of any Act, Rules or Regulations except where capacity determination has been prescribed otherwise.

3.2 The standard shall also be followed for maintaining cost records under the Cost Accounting Records Rules or for furnishing information on Capacity Utilization under the Cost Audit Report Rules issued pursuant to Section 209(1)(d) and section 233B of Companies Act,1956 respectively.

3.3 The standard is applicable for an undertaking, whether existing or new, where there is expansion of more than 5% of the existing capacity due to introduction of new machines or productive resources. Similarly, the standard is also applicable where there is more than 5% reduction of the existing capacity due to disposal or withdrawal or impairment of old machines or productive resources.





4. Definitions

4.1 ‘Licenced Capacity’ is the production capacity of the plant for which licence has been issued by an appropriate authority.

4.2 ‘Installed Capacity’ is the maximum productive capacity according to the manufacturers’ specification of machines / equipment. Installed capacity of the unit/plant is determined after taking into account imbalances in different machines/ equipment in the various departments / production cost centres in the unit / plant and number of working shifts.

4.3 ‘Practical or Achievable Capacity’ is the maximum productive capacity of a plant reduced by the predictable and unavoidable factors of interruption pertaining to internal causes.

Thus, practical capacity is the installed capacity minus the inevitable interruptions due to time lost for preventive maintenance, repairs, set ups, normal delays, weekly off-days and holidays etc. Practical capacity does not consider the external factors causing reduction in production e.g. lack of orders.

4.4 ‘Normal Capacity’ is the production achieved or achievable on an average over a period or season under normal circumstances taking into account the loss of capacity resulting from planned maintenance.

Normal capacity is practical capacity minus the loss of productive capacity due to external factors.

4.5 ‘Actual Capacity Utilization’ is the volume of production achieved in relation to installed capacity.

4.6 ‘Idle Capacity’ is the difference between installed capacity and the actual capacity utilization when actual capacity utilization is less than installed capacity.

4.7 ‘Excess Capacity Utilization’ is the difference between installed capacity and the actual capacity utilization when actual capacity utilization is more than installed capacity.

4.8 ‘Abnormal idle capacity’ is the difference between practical capacity and normal capacity or actual capacity utilization whichever is higher.








5. Determination of Installed Capacity

5.1 Installed capacity is determined based on :

i) Manufacturers’ Technical specifications
ii) Capacities of individual or interrelated production centres.
iii) Operational constraints / capacity of critical machines
iv) Number of shifts
v) Any other factor

5.2 In case of manufacturers’ technical specifications are not available, the estimates by technical experts on capacity under ideal conditions may be considered for determination of installed capacity.

5.3 In case a product passes through different production processes and each process is having different capacity then the process which brings effective or ultimate production shall be considered for deciding installed capacity.

6. Determination of Practical / Achievable Capacity

6.1 Practical capacity or achievable capacity should be determined after adjustment of the following with the installed capacity.

(i) Available production hours taking into consideration holidays, normal shut down days and normal idle time.
(ii) Normal time loss in batch change over, break downs of machines, repairs etc
(iii) Loss in efficiency due to ageing of the machines/ equipment
(iv) Number of shifts
(v) Any other factor

7. Determination of Normal Capacity

7.1 Normal capacity is determined based on the productive capacity achieved over a period of time, say average of three normal years out of preceding five years or expected to be achieved over a period of time, say next three to five years .

7.2 This capacity is determined after adjustment of external factors with practical capacity.

7.3 Normal capacity of production process involved in the production of a product or the productive capacity of the plant as a whole should be taken into account to arrive at normal capacity for a product or plant, as the case may be .

7.4 The periods influenced by abnormalities should be excluded for this purpose.




Explanation :
1. In case the same products with different specifications and of different ranges in terms of size, type, variety etc are manufactured, then there is a need to determine equivalence among them in order to determine the capacity.

2. In case some intermediate products / components etc are also produced, they should be taken into consideration for determining equivalent capacity.

3. In case some machines are leased out/let out or some machines are taken on lease, resulting decrease / increase in capacity should also be considered.


8. Disclosure

8.1 The details of basis for arriving at the capacity, variables used and assumptions made should be disclosed.

8.2 Any change in the installed capacity due to modifications in the machines/ equipment or addition of balancing equipment or disposal or impairment of some machines/ equipment should be disclosed.

8.3 The licenced capacity and installed capacity should be disclosed in absolute term of production whereas practical capacity, normal capacity and actual capacity utilization should be disclosed in absolute term as well as in percentage of installed capacity.

8.4 In case the same products with different specifications and of different ranges in terms of size, type, variety etc are manufactured, then there is a need to determine equivalence among them and capacity should be established in terms of equivalent units.

8.5 In case some machines are taken on lease or some machines are leased out, their impact in terms of increase/ decrease in capacity should be disclosed separately.

8.6 In case of low capacity utilization as compared to the installed capacity, reasons for the same should be disclosed. Comments on the shortfall in production should also specify the factors which are controllable and uncontrollable in short term or in long term.

8.7 In case of excess capacity utilization, the same should be disclosed separately in absolute terms and in terms of percentage with reasons.









Exhibit 1

COST ACCOUNTING STANDARD ON

CAPACITY DETERMINATION

The following is the COST ACCOUNTING STANDARD 2 (CAS 2) issued by the Council of the Institute of Cost and Works Accountants of India on “CAPACITY DETERMINATION”. The standard deals with determination of capacity of a unit. In this Standard, the standard portions have been set in bold italic type. These are to be read in the context of the background material which has been set in normal type.

1. Introduction

Better utilization of capacity means better utilization of resources. It is an important consideration for cost determination and cost reduction. Thus, it is essential to establish the capacity of the plant. Cost Accounting Records Rules under section 209(1)(d) of Companies Act, 1956 and Cost Audit Report Rules, 2001 under section 233B of the said Act specify that comparative statement of installed capacity and actual capacity utilization is to be recorded and furnished in order to assess the operating level.

2. Objective

2.1 The objective of the standard is to prescribe the method of determination of capacity to be applied uniformly and consistently.

2.2 The standard is to help the management to identify the bottlenecks, imbalances and idle capacity for effective use of various resources.

2.3 The standard is to help in proper allocation, apportionment and absorption of cost.

3. Scope

3.1 The standard should be followed for capacity determination required to be carried out for any purpose or under provisions of any Act, Rules or Regulations except where capacity determination has been prescribed otherwise.

3.2 The standard shall also be followed for maintaining cost records under the Cost Accounting Records Rules or for furnishing information on Capacity Utilization under the Cost Audit Report Rules issued pursuant to Section 209(1)(d) and section 233B of Companies Act,1956 respectively.

3.3 The standard is applicable for an undertaking, whether existing or new, where there is expansion of more than 5% of the existing capacity due to introduction of new machines or productive resources. Similarly, the standard is also applicable where there is more than 5% reduction of the existing capacity due to disposal or withdrawal or impairment of old machines or productive resources.

4. Definitions

4.1 ‘Licenced Capacity’ is the production capacity of the plant for which licence has been issued by an appropriate authority.

4.2 ‘Installed Capacity’ is the maximum productive capacity according to the manufacturers’ specification of machines / equipment. Installed capacity of the unit/plant is determined after taking into account imbalances in different machines/ equipment in the various departments / production cost centres in the unit / plant and number of working shifts.

4.3 ‘Practical or Achievable Capacity’ is the maximum productive capacity of a plant reduced by the predictable and unavoidable factors of interruption pertaining to internal causes.

Thus, practical capacity is the installed capacity minus the inevitable interruptions due to time lost for preventive maintenance, repairs, set ups, normal delays, weekly off-days and holidays etc. Practical capacity does not consider the external factors causing reduction in production e.g. lack of orders.

4.4 ‘Normal Capacity’ is the production achieved or achievable on an average over a period or season under normal circumstances taking into account the loss of capacity resulting from planned maintenance.

Normal capacity is practical capacity minus the loss of productive capacity due to external factors.

4.5 ‘Actual Capacity Utilization’ is the volume of production achieved in relation to installed capacity.

4.6 ‘Idle Capacity’ is the difference between installed capacity and the actual capacity utilization when actual capacity utilization is less than installed capacity.

4.7 ‘Excess Capacity Utilization’ is the difference between installed capacity and the actual capacity utilization when actual capacity utilization is more than installed capacity.

4.8 ‘Abnormal idle capacity’ is the difference between practical capacity and normal capacity or actual capacity utilization whichever is higher.

5. Determination of Installed Capacity

5.1 Installed capacity is determined based on :

i) Manufacturers’ Technical specifications

ii) Capacities of individual or interrelated production centres.

iii) Operational constraints / capacity of critical machines

iv) Number of shifts

v) Any other factor

5.2 In case of manufacturers’ technical specifications are not available, the estimates by technical experts on capacity under ideal conditions may be considered for determination of installed capacity.

5.3 In case a product passes through different production processes and each process is having different capacity then the process which brings effective or ultimate production shall be considered for deciding installed capacity.

6. Determination of Practical / Achievable Capacity

6.1 Practical capacity or achievable capacity should be determined after adjustment of the following with the installed capacity.

(i) Available production hours taking into consideration holidays, normal shut down days and normal idle time.

(ii) Normal time loss in batch change over, break downs of machines, repairs etc

(iii) Loss in efficiency due to ageing of the machines/ equipment

(iv) Number of shifts

(v) Any other factor

7. Determination of Normal Capacity

7.1 Normal capacity is determined based on the productive capacity achieved over a period of time, say average of three normal years out of preceding five years or expected to be achieved over a period of time, say next three to five years .

7.2 This capacity is determined after adjustment of external factors with practical capacity.

7.3 Normal capacity of production process involved in the production of a product or the productive capacity of the plant as a whole should be taken into account to arrive at normal capacity for a product or plant, as the case may be .

7.4 The periods influenced by abnormalities should be excluded for this purpose.

Explanation :

1. In case the same products with different specifications and of different ranges in terms of size, type, variety etc are manufactured, then there is a need to determine equivalence among them in order to determine the capacity.

2. In case some intermediate products / components etc are also produced, they should be taken into consideration for determining equivalent capacity.

3. In case some machines are leased out/let out or some machines are taken on lease, resulting decrease / increase in capacity should also be considered.

8. Disclosure

8.1 The details of basis for arriving at the capacity, variables used and assumptions made should be disclosed.

8.2 Any change in the installed capacity due to modifications in the machines/ equipment or addition of balancing equipment or disposal or impairment of some machines/ equipment should be disclosed.

8.3 The licenced capacity and installed capacity should be disclosed in absolute term of production whereas practical capacity, normal capacity and actual capacity utilization should be disclosed in absolute term as well as in percentage of installed capacity.

8.4 In case the same products with different specifications and of different ranges in terms of size, type, variety etc are manufactured, then there is a need to determine equivalence among them and capacity should be established in terms of equivalent units.

8.5 In case some machines are taken on lease or some machines are leased out, their impact in terms of increase/ decrease in capacity should be disclosed separately.

8.6 In case of low capacity utilization as compared to the installed capacity, reasons for the same should be disclosed. Comments on the shortfall in production should also specify the factors which are controllable and uncontrollable in short term or in long term.

8.7 In case of excess capacity utilization, the same should be disclosed separately in absolute terms and in terms of percentage with reasons.

Exhibit 1

Illustration Manufacturers’ Specifications - capacity per hour = 500 units No of shifts ( each shift 8 hours ) = 3 shifts Holidays in a year : Sundays = 52 days Other holidays = 13 days Annual maintenance is done within these 13 hoildays Preventive Weekly Maintenance for the machine on Sunday. Normal idle capacity for batch change over, Lunch, personal need etc = 1 hr per shift Production based on sales expectancy in past 5 years = 30.1, 26.9, 29.7, 24.4 and 30.2 lakh units Actual Production for the year = 30.1 Calculation Installed Capacity for the machine = 365 * 8 *3 * 500 = 43.8 lakh units Practical Capacity = ( 365 – 52 - 13 ) * ( 8 - 1) * 3 * 500 = 31.5 lakh units Out of the past five years, normal capacity is average of 3 normal years. Normal Capacity = ( 30.1 + 29.7 + 30.2 ) / 3 = 30.0 lakh units Actual Capacity Utilization = 30.1 lakh units = 68.7 % Idle Capacity = ( 43.8 – 30.1) = 13.7 lakh unit = 31.3 % Abnormal idle capacity = 31.5 – 30.1 = 1.4 lakh units Sources : www.nirc-icwai.org/cas/cas2.doc ICWAI or ICMAI

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