Cost Accounting

Cost accounting is the system of accounting which is concerned with determining costs of doing
something, which can be manufacturing or producing an article or rendering some service or even
conducting any activity or function.

Definitions of Cost Accounting:

1. The amount of expenditure, actual or notional, incurred on or attributable to a given thing

2. Technique and process of ascertainment of costs, which begins with recording of expenses or the
basis on which they are calculated and ends with preparation of statistical data
3. Classifying recording and appropriate allocation of expenditure for determination of costs of
products or services and for the presentation of suitably arranged data for purpose of control and
guidance of management

Functions of cost accounting:

1. Ascertainment of costs
1) Ascertainment
2) Analysis
3) Allocation
4) Apportionment (Distribution/ allotment)
5) Absorption
2. Control over costs
 Tool for guidance and regulation by executive action for cost of operating an undertaking
 Example: Production, Sales
3. Reporting/ presentation
 Concerned with presentation of information obtained through cost methods and techniques of
costing to the management

Objectives of cost accounting:

1. To ascertain cost of product or services rendered and enable measurement of profit by proper
valuation of inventory
2. To analyse the data and provide suitable information to assist management in decision making
Achieved by using several techniques of costing, involving classification of cost on different basis
such as marginal costing, absorption costing, direct costing
3. To provide information for planning and control through the techniques of standard costing and
budgetary control
4. To indicate to the management any inefficiencies and the extent of various forms of waste,
whether of materials, time, expenses or in the use of machinery, equipment and tools
This may indicate appropriate remedial action
5. To provide data for periodical profit and loss accounts and balance sheets
6. To reveal sources of economies in production
7. To assist the management in fixation of selling price
8. To present comparative cost data for different periods
9. To provide a perpetual inventory of stores
10. To provide the basis for production planning
11. To provide information to enable management to take decisions of various types

Elements of costing

 Cost classification is the process of grouping costs according to their common features.
 Costs are to be classified in such a manner that they are identified with cost centre or cost unit.
 Classification is done:
1. On the basis of behaviour
1) Fixed cost
 That portion of the total cost which remains constant irrespective of output up to the
capacity limit
 Called as a period cost as it is concerned with period
 Tends to be unaffected by variations in output
  Example: rent of premises, taxes and insurance, staff salaries
2) Variable cost
 Varies according to the output
 Tends to vary in direct proportion of output
 If output is decreased, variable cost will also decrease
 Example: direct material, direct labour, direct expenses and variable overheads
3) Semi-variable cost
 Also referred to as semi-fixed or partly variable cost
 Remains constant up to a certain level and registers change afterwards
 Vary in some degree with volume but not in direct or same proportion
 Example: repairs and maintenance of machinery, telephone charges, maintenance of
building supervision, professional tax
2. On the basis of elements of cost
 Elements mean nature of items
 A cost is composed of three elements: Material, Labour, Expenses
 Each of these elements can be direct and indirect
1) Direct cost
 Cost which is directly chargeable to the product manufactured
 Easily identifiable
1. Direct material
 Cost of basic material used for manufacturing a product
 Becomes a part of the product
 No finished product can be manufactured without basic raw materials
 Example: leather in leather wares, pulp in paper, steel in steel furniture,
sugarcane for sugar
2. Direct labour/ direct wages
 Amount of wages paid to those workers who are engaged on the manufacturing
line for conversion of raw materials into finished goods
 Can be easily identified and directly charged to the product
 Example: paid to workers operating lathes, drilling, cutting machines
3. Direct expenses/ chargeable expenses
 Amount of expenses which is directly chargeable to the product manufactured or
which may be allocated to the product directly
 Easily identified with the product
 Example: hire charges of a special machine used for manufacturing a product,
cost of designing the product, cost of patterns, architect’s fees/ surveyor’s fees
2) Indirect cost
 That portion of the total cost which cannot be identified and charged direct to the
product
 Has to be allocated, apportioned and absorbed over the units manufactured on a
suitable basis
1. Indirect material
 Cost of material other than direct material which cannot be directly charged to the
product directly
 Cannot be treated as part of the product
 Also known as expenses materials
 Material which cannot be allocated to the product but which can be apportioned
to the cost units
 Example: lubricants, cotton waste, grease, oil, stationery
2. Indirect labour
 Amount of wages paid to those workers who are not engaged on the
manufacturing line
 Example: wages of workers in administration department, watch and ward
department, sales department, general supervision
3. On the basis of time
1) Historical cost
 Costs which are ascertained after they are incurred
2) Predetermined cost
 Costs that are decided in advance before they are incurred
 Calculated on the basis of a speculation of all factors influencing cost
  May be either estimated cost or standard cost
4. On the basis of functions
1) Manufacturing cost
 Cost of operating the manufacturing department of an organisation
 Includes cost of direct materials, direct labour, direct expenses, packing (primary) cost
and overheads expenses relating to production
2) Administrative cost
 Cost which is incurred for formulating the policy, directing the organisation and
controlling operations
3) Selling and distribution cost
 Cost of stimulating demand
 Includes advertisement, market research
 Distribution cost is incurred for distribution of product
 Includes warehousing, cartage
4) Research and development cost
 Costs incurred to discover new ideas, processes, products by experiment
 Includes cost of the process which begins with the implementation of the decision to
produce a new or improved product
5) Pre-production cost
 Costs incurred when a new product is introduced
 These costs are incurred for trial run
 Treated as deferred revenue expenditure
 Charged to the cost of future production
5. On the basis of controllability
1) Controllable cost
 Cost which can be influenced by the action of a specific member of an organisation
 This can further be analysed with reference to a particular person
2) Uncontrollable cost
 Cost which cannot be influenced by the action of a specific member of an organisation
6. Other basis
1) Conversion cost
 Cost of converting raw material into finished goods
 Comprises direct labour and manufacturing overheads
2) Normal cost
 Cost which is incurred normally at a given level of output, in the conditions in which
that level of output is normally attained
3) Abnormal cost
 Cost which is not normally incurred at a given level of output, in the conditions in which
that level of output is normally attained
4) Avoidable cost
 Cost which can be avoided under the present conditions
5) Unavoidable cost
 Cost which cannot be avoided under the present conditions

Different methods of costing:

1. Unit costing
 Method of costing based on units of production
 Known as output or single costing
 Output is measured in convenient physical units
 A simple method of costing employed in industries where the production is continuous,
uniform and is of only a single product or of essentially one product in two or more grades
 Units of output being identical, costs are measured by a common unit
 Industries employing unit costing: collieries, quarries, brick works, diaries, breweries, sugar
mills, cement works, paper mills and iron foundries

Cost per unit = Total Cost .

Number of units produced
  Unit cost is arrived at by dividing the total cost during a period by the number of units
produced
2. Batch costing
 A type of job costing
 Cost unit is not a single product but some specific quantity of like products at the same time
 A cost unit consisting of a group of identical items which maintain their identity throughout
the stages of production
 The items manufactured are held for stock and sold on demand
 Industries employing batch costing: shoe industry, biscuit factories, toy manufacturing
companies
 Example: Consider a pen industry. It is costly to produce one pen. Hence, it is economically
viable to produce pens in batches of 20,000 to 50,000 of particular design.
 Each batch is given a batch order number.
 Cost per unit is decided by dividing the cost of production by the number of units in a batch
3. Job costing
 Also known as specific order costing or production-order costing or job-lot costing
 Applicable where the work consists of separate, contract jobs or batches each of which is
authorised by specific order or contract
 Followed by manufacturing and non-manufacturing concerns
 Industries employing job costing are those in which:
1) Production is done on the basis of customer’s own specifications
2) Products are manufactured in distinguishable lots
3) Products are not uniform
4) It is practical to maintain a separate record of each lot from the time production is begun
until it is completed
 Applicability of job costing: job printing, manufacturers of special types of equipments,
design engineering concerns, repair works, engineering concerns, construction companies,
ship building companies, furniture makers, hardware industry, machine manufacturing
industry, automobile garage, interior decoration
 Features of job costing:
1)
 Advantages and disadvantages:
4. Contracting costing

5. Processing costing

6. Operating costing


Job Costing Process Costing

1. Production is against specific orders
2. Costs are determined for each job separately
3. Each job is separate and independent of
others
4. Total cost of job is divided by the number of
units in order to calculate unit cost of a job
5. Costs are calculated when a job is completed
6. There are usually no transfers from one job to
another unless there is a surplus work of
excess production
7. There may or may not be work in progress at
the end of the accounting period
8. Proper control is comparatively difficult as
each product unit is different and the
production is not continuous
9. It involves more paperwork
Production is in continuous flow, the products
being homogeneous
Costs are compiled for each process or
department on time basis, i.e. for production of a
given accounting period
Products lose their individual identity as they are
manufactured in a continuous flow
The total cost of each process is divided by the
total production for the process to calculate the
average cost per unit for the period
Costs are calculated at the end of cost period
Transfer of costs from one process to another is
made, as the product moves from one process to
another
There is always work in progress at the beginning
and at the end of the accounting period
Proper control is comparatively easier, as the
production is standardised and is more stable
It involves less paperwork