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Cost Accounting

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 PROGRAMMES

 PROFESSIONAL PROGRAMMES

 CERTIFICATE PROGRAMMES

 PRE-UNIVERSITY PROGRAMMES

 UNDERGRADUATE STUDIES TUTORIALS

 POSTGRADUATE STUDIES TUTORIALS

 UNIVERSITY MATURE TUTORIALS

FIC SCHOOL OF PROFESSIONAL STUDIES

Pentoawala Commercial Complex, Opposite MetroMass Transit,

Adjacent SIC Building, Office Number: P29 & P30,
Koforidua, Ghana

Phone: (+233) 0544575991/0266 429270

Website: www.ficspsedu.org
Email: info@ficspsedu.org

1
 LECTURE NOTES

COST ACCOUNTING

LECTURER: MR. FRANCIS AYENSU

TEL: 0544575991/026 6429270

Email: francis.ayensu@gmail.com

If you need help with the course, call the number shown above or
email us

2
 CONTENT OUTLINE

Chapter 1: Introduction to Cost Accounting

Section 1: Financial Accounting, Management Accounting and Cost Accounting
Section 2: Purpose of cost accounting
Section 4: Value Chain Analysis and Management Accounting
Section 5: Cost terminologies and concepts

Chapter 2: Cost sheet or Statement of cost

Section 1: Definition of cost sheet
Section 2: Format of Cost sheet
Section 3: Illustration: Applications/Case Study/Questions/Assignment

Chapter 3: Accounting for Direct costs

Section 1: Ascertainment of Cost of Material Purchased
Section 2: Stock Control Level & Economic Order Quantity
Section 3: Pricing Material Issues
Section 4: Material Losses

Chapter 4: Accounting for Labour Cost

Section 1: Labour Cost
Section 2: Remuneration & Incentives
Section 3: Premium & Bonuses
Section 4: Illustration: Applications/Case Study/Questions/Assignment

Chapter 4: Accounting for Indirect costs (“Overheads”)

Section 1: Definitions
Section 2: Treatment of overheads
Section 3: Illustration: Applications/Case Study/Questions/Assignment

Chapter 5: Costing Methods

Section 1: Job costing
Section 2: Process costing
Section 3: Illustration: Applications/Case Study/Questions/Assignment

References

3
 CHAPTER 1: INTRODUCTION TO COST ACCOUNTING

Learning Outcomes

After completing this chapter, you should be able to answer the following questions:

LO1: What are the relationships among financial, management, and cost accounting?
LO2: What are the sources of authoritative pronouncements for the practice of cost
accounting?
LO3: How do management accountants support strategic decisions?
LO4: What is a value chain, and what are the major value chain functions?
LO5: How do companies add value, and what are the dimensions of performance that
customers are expecting of companies?
LO6: Where does the management accounting function fit into an organization’s
structure?

Introduction

Cost accounting provides key data to managers for planning and controlling, as well as
determining cost of products, services, and even customers. Managers use cost
accounting information to make decisions related to strategy formulation, research and
development, budgeting, production planning, and pricing, among others. The study of
modern cost accounting yields insights into how managers and accountants can
contribute to successfully running their businesses.

All types of business entities—manufacturing, merchandising, and service

businesses—require cost accounting information systems to track their activities.

Manufacturers convert purchased raw materials into finished goods by using labor,

technology, and facilities. Merchandisers purchase finished goods for resale. They

may be retailers, who sell products to individuals for consumption, or wholesalers,

who purchase goods from manufacturers and sell to retailers. For-profit service

businesses, such as health clubs, accounting firms, and sport clubs sell services rather

than products. Not-for-profit service agencies, such as charities, governmental

4
agencies, and some health care facilities, provide services at little or no cost to the

user.

The chapter seeks to dwell into general issues concerning cost accounting as a
discipline and as a profession. The chapter is organized into six sections each treating
an aspect of cost accounting.

Section 1: Financial Accounting, Management Accounting and

Cost Accounting
There are many definitions of accounting but one that is retained for the purpose of
this discussion is the definition given by the American Accounting Association.

Accounting is the process of identifying, measuring and communicating economic

information to permit informed judgments and decisions by users of information.

In other words, accounting is concerned with providing both financial and non-
financial information that will help decision makers to make good decisions.

Accounting information addresses three different functions:

(1) It provides information to external parties (stockholders, creditors, and various

regulatory bodies) for investment and credit decisions. This is financial accounting;
(2) It estimates the cost of products produced and services provided by the
organization. This is cost accounting; and
(3) It provides information useful to internal managers who are responsible for
planning, controlling, decision making, and evaluating performance. This is
management accounting.

Financial accounting focuses on reporting to external parties such as investors,

government agencies, banks, and suppliers. It measures and records business

5
transactions and provides financial statements that are based on generally accepted
accounting principles (GAAP).

Management accounting measures, analyzes, and reports financial and nonfinancial

information that helps managers make decisions to fulfill the goals of an organization.
Managers use management accounting information to develop, communicate, and
implement strategy. They also use management accounting information to coordinate
product design, production, and marketing decisions and to evaluate performance.
Management accounting information and reports do not have to follow set principles
or rules.

Cost accounting measures, analyzes, and reports financial and nonfinancial

information relating to the costs of acquiring or using resources in an organization. For
example, calculating the cost of a product is a cost accounting function that answers
financial accounting’s inventory-valuation needs and management accounting’s
decision-making needs (such as deciding how to price products and choosing which
products to promote). Modern cost accounting takes the perspective that collecting
cost information is a function of the management decisions being made. Thus, the
distinction between management accounting and cost accounting is not so clear-cut,
and we often use these terms interchangeably in this book.

1.1. Difference between Financial Accounting and Management Accounting

Table 1.1 summarizes the major differences between management accounting and
financial accounting. Note, however, that reports such as balance sheets, income
statements, and statements of cash flows are common to both management accounting
and financial accounting.

Table 1.1:Differences Between Financial Accounting and Management

Accounting
Financial Accounting Management Accounting

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1. Purpose of information Communicate
organization’s financial
position to investors, banks,
regulators, and other
outside parties
2. Primary users External users such as
investors, banks, regulators,
and suppliers
3. Focus and emphasis Past-oriented (reports on
past years performances )
Help managers make decisions
to fulfill an organization’s goals
Internal such as managers of the
organization
Future-oriented (report for next
years)

4. Rules of measurement Financial statements must Internal measures and reports

and reporting be prepared in accordance
with GAAP and be certified
by external, independent
auditors
5. Time span and type of Annual and quarterly
reports financial reports, primarily
on the company as a whole
6. Primary organizational Whole (aggregated) i.e
focus Entire business
do not have to follow GAAP but
are based on cost-benefit analysis
Varies from hourly information to
15 to 20 years, with financial and
nonfinancial reports on
products, departments, territories,
and strategies
Parts (segmented)i.e Segment of
business

7. Information Must be May be

characteristics • Historical • Current or forecasted
• Quantitative • Quantitative or qualitative
• Monetary • Monetary or nonmonetary
• Verifiable • Timely and, at a minimum,
reasonably estimated
8. Recordkeeping Formal Formal and Informal

1.2. Difference between Financial Accounting and Cost Accounting

The distinction between financial accounting and cost accounting are summarized in
the Table 1.2

Table 1.2: Differences between Financial Accounting and Management

Accounting
Financial Accounting Cost Accounting
1. Objective Financial Accounting is to prepare Cost accounting is provide
financial statements (Balance cost information to
sheet, Income statement, etc) to management for decision
shareholders and outside users making

7
2. Legal Financial accounting records are Cost accounts are maintained
requirement maintained as per requirement of to satisfy internal needs of
law the company. No legal
requirement
3. Reporting Financial reports are normally Cost reports are continuous
period prepared annually prepared as when needed and
may be hourly, daily,
weekly, etc. There is no set
4.Emphasis Emphasis is laid on recording Emphasis is on ascertaining
transactions and analyzing cost for cost
control purposes
5. Focus Financial accounting focused on Cost accounting focused on
the past events both past and future events
6. Scope of Financial reports covers entire Cost reports concerns a
reports organization activities product, department or
business segment.

1.3.Differences between Cost Accounting and Management Accounting

The distinction between cost accounting and management accounting are summarized
in the Table 1.3

Table 1.3: Differences between Cost Accounting and Management Accounting

Cost Accounting (CA) Management Accounting (MA)
1. Cost Accounting is concerned with 1. Management Accounting is concerned
cost computation, analysis and control with providing relevant information to
formulate policies and make decisions
2. Cost Accounting suggests to 2. Management Accounting considers
management the best of alternatives to both cost and non-cost information for
controlling cost decision making
3. Cost Accounting provides cost 3. Management Accounting uses cost
information to management for decision information provided by Cost
making Accounting to help in decision making
4. Cost Accounting use cost techniques 4. Management Accounting uses cost
such as full costing, standard costing, techniques such as budgets, balanced
marginal cost, etc. scorecard, etc.

1.4. Relationship of Cost Accounting to Financial and Management Accounting

Central to a cost accounting system is the process for tracing various input costs to an
organization’s outputs (products or services). This process uses the traditional
accounting form of recordkeeping—general and subsidiary ledger accounts. Accounts
containing cost and management accounting information include those dealing with
sales, procurement (materials and plant assets), production and inventory, personnel,

8
payroll, delivery, financing, and funds management. Not all cost information is
reproduced on the financial statements, however. Correspondingly, not all financial
accounting information is useful to managers in performing their daily functions. Cost
accounting creates an overlap between financial accounting and management
accounting. Cost accounting integrates with financial accounting by providing product
costing information for financial statements and with management accounting by
providing some of the quantitative, cost-based information managers need to perform
their tasks.

Figure 1.1: Relationship of Financial, Management and Cost Accounting

COST ACCOUNTING
determines
PRODUCT COST

FINANCIAL MANAGEMENT
ACCOUNTING ACCOUNTING

Cost accounting can be viewed as the intersection between financial and management
accounting (see Figure 1.1). Cost accounting addresses the informational demands of
both financial and management accounting by providing product cost information to:

 external parties (stockholders, creditors, and various regulatory bodies) for

investment and credit decisions and for reporting purposes, and;
 internal managers for planning, controlling, decision making, and evaluating
performance.

9
Section 2: Purpose of Cost Accounting
The information produced by a cost accounting system provides a basis for
determining product costs and selling prices, and it helps management to plan and
control operations.

2.3.1. Enable cost ascertainment, analysis, control and reduction

Cost accounting procedures provide the means to determine product costs that enable
the preparation of meaningful financial statements and other reports needed to manage
a business. The cost accounting information system must be designed to permit the
determination of unit costs as well as total product costs.

Unit cost information is also useful in making a variety of important marketing

decisions such as:

1. Determining the selling price of a product: Knowing the manufacturing cost of a

product aids in determining the desired selling price. It should be high enough to cover
the cost of producing the item and the marketing and administrative expenses
attributable to it, as well as to provide a satisfactory profit to the owners.
2. Meeting competition: If a product is being undersold by a competitor, detailed
information regarding unit costs can be used to determine whether the problem can be
resolved by reducing the selling price, by reducing manufacturing and selling expenses
attributable to the product, or by some combination of the above that will still result in
profitable sales.
3. Bidding on contracts: Many manufacturers must submit competitive bids in order to
be awarded contracts. Knowledge of the unit costs attributable to a particular product
is of great importance in determining the bid price.
4. Analyzing profitability: Unit cost information enables management to determine the
amount of profit that each product earns, thereby allocating the company’s scarce
resources to those that are most profitable.

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2.3.2. Enable decision making (Planning and Control)

One of the most important aspects of cost accounting is the preparation of reports that
management can use to plan and control operations.

Planning and Forecasting is the process of establishing objectives or goals for the
firm and determining the means by which they will be met. Cost accounting
information enhances the planning process by providing historical costs that serve as a
basis for future projections. Management can analyze the data to estimate future costs
and operating results and to make decisions regarding the acquisition of additional
facilities, any changes in marketing strategies, and the availability of capital.

Performance management: costing accounting provide a basis for performance

management by comparing actual results with targeted results. Managers need cost
accounting information to help them make decisions that are aimed at keeping the
business on course by trying to ensure that plans are met. Budgets are typically
expressed in full cost terms. This means that periodic reports that compare actual
performance with budgets need to be expressed in the same full cost terms.

Section 3: Value Chain Analysis and Management Accounting

Customers demand much more than just a fair price; they expect quality products
(goods or services) delivered in a timely way. These multiple factors drive how a
customer experiences a product and the value or usefulness a customer derives from
the product. How then does a company go about creating this value?

3.1. Value-Chain Analysis

Value chain is the set of activities that transforms raw resources into the goods and
services end users (households, for example) purchase and consume. It also includes
the treatment or disposal of any waste generated by the end users. As an example, the
value chain for gasoline stretches from the search and drilling for oil, through refining

11
the oil into gasoline, to the distribution of gasoline to retail outlets such as convenience
stores, and, finally, to the treatment of the emissions produced by automobiles.

In much of our discussion about cost accounting, we will be concerned with the part of
the value chain that comprises the activities of a single organization (a firm, for
example). However, an important objective of modern cost accounting is to ensure that
the entire value chain is as efficient as possible. It is necessary for the firm to
coordinate with vendors and suppliers and with distributors and customers to achieve
this objective.

The value-added activities that the firms in the chain perform are those that customers
perceive as adding utility to the goods or services they purchase. The value chain
comprises activities from research and development through the production process to
customer service. Managers evaluate these activities to determine how they contribute
to the final product’s service, quality, and cost.

Table 1.4 identifies the individual components of the value chain and provides
examples of the activities in each component, along with some of the costs associated
with these activities. Although the list of value chain components in Table 1.4 suggests
a sequential process, many of the components overlap. For example, the R&D and
design processes might take place simultaneously. Feedback from production workers
on existing products might be incorporated in the development of new models of a
product.

Table 1.4: Value Chain Components, Example Activities, and Example Costs
Component Example Activities Examples Cost
Research and development The creation and  Research personnel
(R&D) development of ideas  Patent applications
related to new products,  Laboratory facilities
services, or processes.
Design The detailed development  Design center
and engineering of  Engineering facilities
products, services, or used to
processes.  develop and test
prototypes
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 Purchasing The acquisition of goods
and services needed to
produce a good or service.
Production The collection and
assembly of resources to
produce a product or
deliver a service.
Marketing and sales The process of informing
potential customers about
the attributes of products
or services that leads to
their sale.
Distribution The process for delivering
products or services to
customers.
Customer service The support activities
provided to customers for
a product or service.
 Purchasing department
personnel
 Vendor certification
 Machines and equipment
 Factory personnel
 Advertising
 Focus group travel
 Product placement
 Trucks
 Fuel
 Web site creation,
hosting,
 and maintenance
 Call center personnel
 Returns processing
 Warranty repairs

In addition to the above primary business functions, Figure 1.2 shows an

administrative function, which includes functions such as accounting and finance,
human resource management, and information technology that support the primary
business functions.

Figure 1.2: Different Parts of the Value Chain

ADMINISTRATION

Research & Design of Product Purchasing Production Marketing Distributi Customer

Development & Processes on Service

Section 5: Cost terminologies and concepts

5.1. Definition of cost

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Cost may be defined as the amount of resources, usually measured in monetary terms,
sacrificed to achieve a particular objective. The objective might be to retain a car, to
buy a particular house, to make a particular product or to render a particular service.

5.2. Costing Techniques: Absorption (Full) costing versus Marginal costing

Full (absorption) costing is a widely used approach to costing that takes account of
all of the cost of producing a particular product or service. The logic of full costing is
that the entire cost of running a facility, say an office, is part of the cost of the output
of that office. For example, the rent may be a cost that will not alter merely because
we provide one more unit of the service. If the office were not rented, however, there
would be nowhere for the staff to work, so rent is an important element of the cost of
that service.

Absorption costing is the practice of charging all cost, both fixed and variable costs to
a product, job, process and operation. This definition explains why absorption costing
is also called full costing. The full cost includes prime cost, factory overheads,
administration overheads, selling and distribution overheads.

Marginal costing charges only variable cost, including any variable indirect elements,
as part of the cost of the goods or service. Fixed cost, both direct and indirect
elements, is treated as a cost of the period in which it is incurred.

With full costing, both fixed and variable costs are included in product cost and
treated as expenses when the product is sold while with marginal costing, only the
variable product cost is linked to the products in this way, fixed cost is treated as an
expense of the period in which it was incurred.

5.3. Cost classification

Cost classification is the process of grouping costs according to common

characteristics. Figure 1.3 shows the basis of classification and resulting type of cost

14
Figure 1.3: Cost Classification Categories
Basis of classification Types of Cost Included
Material cost
Nature Labour cost
Expenses

Direct (conveniently and economically traceable)

Association with
cost object Indirect (nontraceble; must be allocated)

Variable (fluctuates in total)

Fixed (remains constant in total)
Mixed (is part variable, part fixed)
Step (increases at certain activity levels)
Cost behaviour

Production cost
Selling & Distribution cost
Functions Administration cost
Research & Development cost
Financing cost

5.3.1. Classification based on nature of cost

To manufacture a product, one needs materials, human force and other resources.
These elements also constitute the cost component of manufactured products. These
cost components are material cost, labour cost and other expenses.

Material cost: represents expenditure on raw materials required to manufacture a

product. Example is wood used in the production of chairs or tables. These materials
are subdivided into direct or indirect materials. Direct materials are directly involved
in the production process while indirect materials are not directly traceable to the
production process

15
Labour cost: represent wages and salaries paid to workers and employees engaged by
the organization.

Expenses: are expenditures other than material and labour cost.

5.3.2. Relationship to cost object

To provide full cost information, we need to have a systematic approach to

accumulating the elements of cost and then assigning this total cost to particular cost
units on some reasonable basis. Where cost units are not identical, the starting point is
to separate cost into two categories: direct cost and indirect cost.

Direct cost: This is the type of cost that can be identified with specific cost units. That
is to say, the effect of the cost can be measured in respect of each particular cost unit.
The main examples of a direct cost are direct materials and direct labour. Thus, in
determining the cost of a motor car repair by a garage, both the cost of spare parts used
in the repair and the cost of indirect cost is a simple matter of having a cost-recording
system that is capable of capturing the cost of direct materials used on each job and the
cost, based on the hours worked and the rate of pay, of direct workers.

Indirect cost (or overheads): This is all other elements of cost, that is, those items
that cannot be directly measured in respect of each particular cost unit (job). Thus, the
rent of the garage premises would be an indirect cost of a motor car repair.

5.3.3. Cost behaviour

The notions of fixed and variable cost are concerned with cost behaviour in the face of
changes in the volume of activity. The notions of direct and indirect, on the other hand,
are concerned with the extent to which cost elements can be measured in respect of
particular cost units (jobs). The two sets of notions are entirely different. Though it
may be true that there is a tendency for fixed cost elements to be indirect (overheads)

16
and for variable cost elements to be direct, there is no link, and there are many
exceptions

The costs incurred by a business may be classified in various ways and one important
way is according to how they behave in relation to changes in the volume of activity.
Costs may be classified according to whether they:

 fixed cost
 variable cost
 Semi-fixed, semi-variable or mixed cost
 Stepped fixed cost

Relevant range is the band of normal activity level or volume in which there is a
specific relationship between the level of activity or volume and the cost in question.

Fixed Costs: are costs that remain constant within a relevant range and only change
after beyond the relevant range. Examples are rent and rates, the managing director’s
salary etc.

Variable costs are costs that vary in direct proportion with activity levels. For
example, the cost of raw materials, direct wages and direct expenses such as royalties.

Mixed cost (semivariable cost) are costs that have both a variable and a fixed
component.

Step cost (semifixed cost) shifts upward or downward when activity changes by a
certain interval or “step.” A step cost can be variable or fixed.

Step variable costs have small steps and Step fixed costs have large steps.

17
Figure 1.4: Four Cost Behavior Patterns
Variable Costs (a) Fixed Costs (b) Mixed Costs (c) Step Costs (d)

Volume Volume Volume Volume

5.3.4. Cost classification based on Functions

Production cost: is the cost associated to the conversion of raw materials into finished
products.
Administration cost: is the cost associated with the management of an enterprise
Selling & Distribution cost: is cost associated with marketing and selling of products
by the company
Research & Development cost: is the cost associated with research and development
of new product or services of the company
5.3.5. Classification as Product Costs or Period Costs

Product Costs: These are the costs that are identified with goods produced or
purchased for resale. These usually are the production or manufacturing costs. They
are the costs used for the valuation of stocks and work in progress. Examples of
product costs are:

 Cost of raw materials

 Production wages
 Production overheads such as electricity, depreciation of plant, factory rent, etc

Period Costs: These are the costs incurred and charged against profit for a period, and
not included in cost for stock valuation purposes. These usually are non-manufacturing
costs. Examples are selling and distribution overheads and administrative overheads.

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5.4. Cost Accounting System

To provide management with the data needed for effective cost control, two basic
types of cost accounting systems have been developed: the process cost system and the
job order cost system. Both systems are used to gather cost data and to allocate costs to
goods manufactured. The selection of one method or the other depends on the type of
manufacturing operation used by a given company. To determine the appropriate
method, manufacturing operations are classified into two types: special order and
continuous or mass production.

5.4.1. Special Order: Job order cost system

In a job order cost system the output consists of special or custom-made products; in
other words, each product is made to order. Special-order industries include those
manufacturing or producing ships, aircraft, custom- built homes, machine tools,
engines, structural steel, books and magazines, directories and catalogs, and specialty
shops producing custom-made products such as clothing, shoes, and hats

A job order cost system provides a separate record for the cost of each special-order
job, as illustrated by the block for ‘‘Job Cost Sheets’’ in Figure 1.5. Each job would
have its costs tracked on a separate cost sheet or computer file. Job order cost
accounting techniques are also used by firms, such as accounting, architecture, and law
that provide a service rather than a product. It is important for these firms to be able to
track the various costs of serving different clients. For example, a law firm would
expend many more resources defending a client in a capital murder case than it would
in defending another client against petty theft charges.

Figure 1.5: Flow of Costs in a Job Order Cost System

Direct Materials Job Cost Sheets Finished Goods

Direct Labour

Factory Overheads
Work in Process

19
5.4.2. Continuous or Mass Production: Process cost system

This type of operation produces a continuous output of homogeneous products. Such a

factory may produce a single product, such as a Toyota automobile, or many different
products, such as Pepsi, Diet Pepsi, and Pepsi One soft drinks. The factory generally is
departmentally organized. Continuous or mass production industries include those
manufacturing automobiles, tires, cement, chemicals, canned goods, lumber, paper,
candy, foodstuffs, flour, glass, soap, toothpaste, chewing gum, petroleum products,
textiles, plastics, paints, and firms engaged in such processes as rubber compounding
and vulcanizing. A process cost system accumulates costs for each department or
process in the factory as illustrated in Figure 1.6.

Figure 1.6: Flow of Costs in a Process Cost System

Work in Process Work in Process Finished

Dept 1 Dept 2 Goods

Direct Direct Factory Direct Direct Factory

material Labour Overheads material Labour Overheads

Process cost accounting is appropriate for manufacturing situations in which all units
of the final product are substantially identical. Finished units are placed in stock and
removed as needed to fill customer orders. There are no separate jobs presenting
substantially different characteristics. Rather, the company (or a department within the
company) produces large numbers of virtually identical items that are sold (or
transferred to other departments) as orders are received. Process cost accounting
techniques also may be used by organizations that provide a service such as for
determining the cost per passenger-mile for an airline.

5.4.3. Combination of Systems

Some companies use both a job order cost and a process cost system. For example, a
company that manufactures equipment on specific order but also produces, on a
continuous basis, a number of small motors that are component parts of many of the

20
equipment orders, may benefit from combining the systems. The costs of making these
motors would be accumulated on a process cost basis, while the costs for each unique
piece of equipment would be gathered using job order costing.

5.5. Costing Methods

Costing method refers to the technique or approach adopted in ascertaining cost. The
method of cost ascertainment depends on nature of industry. Costing methods can be
grouped into two main categories which are:

5.5.1. Specific order costing

This method is applicable where production takes place based on specific orders or job
or batch of jobs or contract. Costing method under this categories are job costing,
batch costing and contract costing.

Job costing: It is applicable to an industry where goods are produced against

individual orders from customers. In job costing direct costs are traced to specific job
orders. Each of the job involves different operations. Basic object of job costing is to
ascertain the cost of each job separately.

Batch costing: is a variation of job costing where each job consists of a number of
identical cost units. The production of many types of goods and services (particularly
goods) involves producing in a batch of identical units of output, but where each batch
is distinctly different from other batches.

Contract costing: is used in industry where jobs are executed based on contract. For
each contract a separate account is opened and the total cost incurred is identified with
it.

5.5.2. Operation costing

21
This method is applicable where production of goods done on a mass scale and/or
standardization. This result in production process taking place in sequence of activities
called process. Costing methods under this category are Process costing andOperating
costing

Process costing: is applicable where inputs are transformed through several processes
to be converted into finished products. In process costing, a separate account is
maintained for each process.
Operating costing: is applicable to the service industries.

5.6. Glossary of cost terms

Actual costs : These are the cost actually incurred in the production process. Actual
costs are not estimates but are historical or past costs.
Budgeted costs are costs estimated and planned for a given activity level, function or
segment of the organisation within a specified time horizon.
Avoidable Costs are costs that may be saved by the adoption of a given alternative
option.
Non-Avoidable Costs are costs that cannot be saved or eliminated by the adoption of
a given alternative line of action.
Cost unit is a quantitative unit of a product or service in relation to which costs are
ascertained. For example, tonnes of cocoa, bags of maize, bags of rice, barrels of beer
or cartons of minerals, kilowatt hours, passenger per mile, ton per mile etc.
Cost centre is a location, a person, an item of equipment (or a group of these in
relation to which cost are ascertained and further related to cost units. For example, the
factory, canteen, maintenance section, the foreman, managing director, the plant, the
pool of computers etc. Cost centres are broadly classified into: Production cost centres
and service cost centres
Relevant Costs are those future costs that can be altered by a given decision.
Irrelevant Costs are those costs that will not be affected by a given decision.
Irrespective of what decision is taken, the cost will not alter.

22
Normal Costs : are costs planned for and expected to be incurred at given levels of
activity under specified conditions. For example, normal scrap and loss of materials
cost of expected idle time etc.
Abnormal Costs are costs not planned for and therefore not expected to beincurredat
a given level of activity under conditions in which that level of activity is normally
achieved, e.g. cost of excessive scrap and abnormal idle time pay etc.
Sunk Costs are the costs of resources already acquired. They are costs created by
decisions made in the past and cannot be altered by decisions to be made in the future.
For example the written down value of plant previously acquired.
Opportunity Costs are the values of benefits forgone or sacrificed in favour of
alternative courses of action.
Incremental Costs are the additional costs or revenues that arise from the production
or sale of a group of additional units. These are sometimes termed differential costs.
Marginal Costs are the additional costor revenue that arises from the production of
one additional unit of output or service.
Future cost are costs estimated and are reasonably expected to be incurred in the
future.
Replacement Costs are the estimated costs at which an identical item can be acquired
or produced.
Conversion costs are the cost of transforming raw materials into finished goods or the
cost of converting raw materials from one stage of production cycle to the next. It is
total cost of production less cost of bought in materials.
AttributableCosts are costs that could be avoided on average if a product or a
function is discontinued entirely.
Policy Costs are costs additional to normal requirement incurred in accordance with
the policy of an undertaking. They are also termed discretional costs.
DevelopmentCosts are costs of research into improving the production of goods and
services.
Pre-Production Costs are the part of development cost relating to making trial
production run preliminary to formal production

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 Committed Costs are costs that are expected to be incurred and for which resources
have been earmarked or allocated as a result of a contractual agreement or an earlier
decision to have the cost incurred.
Value Added is the increase in market value of a product as a result of changing the
form, location etc, of that product. It is the total market value of the product less cost
of bought in materials and services.
Pre-Determined Costs are costs estimated and computed in advance of production on
the basis of specifications of all the factors affecting cost.
Standard Costs are cost estimated and expected to be incurred per unit of activity
under efficient production conditions.

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