Cost accounting

Introduction
 COST - MEANING
Cost means the amount of expenditure
( actual or notional) incurred on, or
attributable to, a given thing.
 COST ACCOUNTING -
MEANING
Cost accounting is concerned with
recording, classifying and summarizing
costs for determination of costs of products
or services, planning, controlling and
reducing such costs and furnishing of
information to management for decision
making
Objectives of Cost Accounting
•Determining Selling Price
•Determining and Controlling Efficiency
•Facilitating Preparation of Financial and Other Statements
•Providing Basis for Operating Policy
• Determination of a cost-volume-profit relationship
• Shutting down or operating at a loss
• Making for or buying from outside suppliers
• Continuing with the existing plant and machinery or replacing
them by improved and economic ones
 ELEMENTS COST
OF
COST

OTHER EXPENSES
MATERIALS LABOUR

DIRECT INDIRECT
DIRECT INDIRECT INDIRECT
DIRECT

OVERHEADS

SOH DOH
FOH AOH
MATERIAL: The substance from which the
finished product is made is known as
material.

Direct material is one which can be directly

or easily identified in the product Eg: Timber
in furniture, Cloth in dress, etc.

Indirect material is one which cannot be

easily identified in the product.
 Examples of Indirect material
At factory level – lubricants, oil, consumables,
etc.
At office level – Printing & stationery,
Brooms, Dusters, etc.
At selling & dist. level – Packing materials,
printing & stationery, etc.
 LABOUR: The human effort required to convert the
materials into finished product is called labour.

DIRECT LABOUR is one which can be conveniently

identified or attributed wholly to a particular job, product or
process.
Eg: wages paid to carpenter, amount paid to tailor,etc.

INDIRECT LABOUR is one which cannot be conveniently

identified or attributed wholly to a particular job, product or
process.
 Examples of Indirect labour
At factory level – foremen’s salary, works
manager’s salary, gate keeper’s salary, etc
At office level – Accountant’s salary, GM’s
salary, Manager’s salary, etc.
At selling and dist.level – salesmen salaries,
Logistics manager salary, etc.
 OTHER EXPENSES are those expenses other
than materials and labour.

DIRECT EXPENSES are those expenses which

can be directly allocated to particular job, process
or product. Eg : Excise duty, royalty, special hire
charges, etc.

INDIRECT EXPENSES are those expenses which

cannot be directly allocated to particular job,
process or product.
 Examples of other expenses
At factory level – factory rent, factory insurance,
lighting, etc.
At office level – office rent, office insurance, office
lighting, etc.
At sales & dist.level – advertising, show room
expenses like rent, insurance, etc.
 How to treat the following?

• Carriage

• Packaging expenses
 COST SHEET - ADVANCED

OPENING STOCK OF RAW MATERIALS

+PURCHASES
+CARRIAGE INWARDS
-CLOSING STOCK OF RAW MATERIALS

VALUE OF MATERIALS CONSUMED

+DIRECT WAGES
+DIRECT EXPENSES

PRIME COST
+FACTORY OVERHEADS
+OPENING STOCK OF WIP
-CLOSING STOCK OF WIP

FACTORY COST
(CONT.)
 FACTORY COST

+ADMINISTRATIVE OVERHEADS

COST OF PRODUCTION
+OPENING STOCK OF FINISHED GOODS
-CLOSING STOCK OF FINISHED GOODS

COST OF GOODS SOLD

+SELL. & DIST. OVERHEADS

COST OF SALES
+PROFIT

SALES
COST CLASSIFICATION – ON THE BASIS OF
Nature
Function
Direct & indirect
Variability
Controllability
Normality
Financial accounting classification
Time
Planning and control
Managerial decision making
 ON THE BASIS OF NATURE
• MATERIALS

• LABOUR

• EXPENSES
ON THE BASIS OF FUNCTION
• MANUFACTURING COSTS OR
FACTORY COST

• COMMERCIAL COSTS –
ADMINISTRATIVE AND SALES &
DISTRIBUTION COSTS
 ON THE BASIS OF DIRECT
AND INDIRECT
• DIRECT COSTS

• INDIRECT COSTS
 ON THE BASIS OF VARIABILITY
•FIXED COSTS: Fixed Cost is the cost which remains constant or
unaffected by variations in the volume of output within a given period of
time. Example: Rent or rates, Insurance charges, etc.
•VARIABLE COSTS: Variable Cost is the cost which varies directly in
proportion with every increase or decrease in the volume of output with a
given a period of time. Example: Wages paid to labours, cost of direct
material, consumable stores, etc.
•SEMI VARIABLE COSTS: Semi-variable Cost is the cost which is
neither fixed nor variable in nature. These remain fixed at certain level of
operations while may vary proportionately at other levels of operations.
Example: maintenance cost, repairs, power, etc.
 ON THE BASIS OF CONTROLLABILITY

• CONTROLLABLE COSTS: They are those which can be controlled

if one pays attention.
Example: For making a product only 2 labors are required but 3 are
working then you can control the cost of 1 labor.

• UNCONTROLLABLE COSTS: They are those which cannot be

controlled and company has to pay it no matter what happens.
Example: if company has taken a place on rent for production then if it
produces 100 units or 1000 units or no units the rent will remain the
same.
ON THE BASIS OF NORMALITY
• NORMAL COSTS: The loss expected or anticipated prior to
production is a normal process loss. It is thus called a standard
loss. A provision for such a loss is made before starting
production. Weight losses, shrinkage, evaporation etc. are the
examples of normal loss. Normal loss increases the cost of
production of the usable goods realized
• ABNORMAL COSTS: The loss realized over the normal loss is
called an abnormal loss. Abnormal loss arises because of
abnormal working conditions, bad working condition,
carelessness, rough handling, lack of proper knowledge, low
quality raw material, machine breakdown, accident etc. Therefore
an abnormal loss is an unanticipated loss. Abnormal loss is a
controllable loss and thus can be avoided if corrective measures
are taken. Therefore, abnormal loss is also called an avoidable
loss.
ON THE BASIS OF INVESTMENT

CAPITAL COSTS: Capital Expenditure is that expenditure which is

incurred
a) For acquiring or bringing into existence an asset or advantage of an
enduring benefit or
b) For extending or improving a fixed asset or
c) For substantial replacement of an existing fixed asset. The benefit on
such expenditure is going to accrue for more than one year.
Examples: Cost of land and building, plant and machinery, furniture and
fixtures, etc. Such expenditure normally yields benefits which extend
beyond the current account period
REVENUE COSTS: Revenue Expenditure is that expenditure which is
incurred for maintaining productivity or earning capacity of a business.
Such expenditure yields benefits in the current accounting period. The
examples of revenue expenditure include office and Administrative expenses
such as Salaries, Rent, Insurance, Telephone Expenses., Electricity Charges
etc.
DEFERRED REVENUE EXPENDITURE: Sometimes expenditure is of
Revenue nature but benefit of expenditure is available for more than a year,
in such a case it is not fair that total expenditure should be debited to profit
& loss a/c only in one year. It is to be charged over the period over which
the
benefit is available. Such expenditure is known as deferred revenue
expenditure.
Example: Heavy advertisement expenditure
ON THE BASIS OF TIME

• HISTORICAL COSTS: Historical cost is the amount that is

originally paid to acquire the asset and may be different from the
current market value of the asset.

• PRE DETERMINED COSTS: Predetermined cost means that

estimation which is made by a manufacturing company in advance; it is
done even before the production of a product starts. The calculation for
predetermined cost is done on the basis of various variables affecting
the production like raw material, labor, factory expense and so on.
ON THE BASIS OF PLANNING AND CONTROL

• BUDGETED COSTS: A budgeted cost is a forecasted future

expense that the company is expected to incur in the future. In other
words, it's an estimated expense that management anticipates will be
incurred in a future period based on projected revenues and sales. ...
These estimated expenses are considered budgeted costs.

• STANDARD COSTS: Standard costs are used as target costs (or basis
for comparison with the actual costs), and are developed from
historical data analysis.
ON THE BASIS OF MANAGERIAL DECISION MAKING
• MARGINAL COSTS: Marginal cost is the additional cost
incurred in the production of one more unit of a good or service.

• OUT OF POCKET COSTS: Out of pocket cost is the cost which

results in cash outflow from the business organization due to a
particular managerial decision.

• SUNK COSTS: A sunk cost is a cost that an entity has incurred,

and which it can no longer recover by any means. Sunk costs
should not be considered when making the decision to continue
investing in an ongoing project, since these costs cannot be
recovered. Instead, only relevant costs should be considered.
Example: Research and development.
IMPUTED OR NOTIONAL COSTS: Imputed cost is otherwise called
Notional Cost and Hypothetical Cost. A cost that has not involve cash
outflow from the business organization. It does not appear in the financial
records but relevant to the decision-making.
For example: Interest on Capital.
OPPORTUNITY COSTS: A benefit, profit, or value of something that
must be given up to acquire or achieve something else. Since every
resource (land, money, time, etc.) can be put to alternative uses, every
action, choice, or decision has an associated opportunity cost.
REPLACEMENT COSTS: Replacement cost is the price that an entity
would pay to replace an existing asset at current market prices with a
similar asset.
Points of Cost accountancy Costing Cost Accounting
differences

Scope Broadest in its Broader in its Narrow in its scope

scope scope

Function Concerned with the Concerned with Concerned

formulation of ascertainment of recording of cost
costing principles, cost
methods,
techniques

Periodicity of It is a starting point It begins where It begins where cost

functioning cost accounting accountancy ends
ends

Persons Experts in the field Cost accountant Cost clerks

involved of cost accountancy
TERMS IN COST ACCOUNTING

• COST UNIT
• COST CENTRE
• COST ESTIMATION
• COST ASCERTAINMENT
• COST ALLOCATION
• COST APPORTIONMENT
• COST REDUCTION
• COST CONTROL
Cost unit: The quantity upon which cost can be conveniently allocated
is known as a unit of cost or cost unit. The Chartered Institute of
Management Accountants, London defines a unit of cost as a unit of
quantity of product, service or time in relation to which costs may be
ascertained or expressed.

Cost Center: According to the Chartered Institute of Management

Accountants, London, cost center means “a location, person or item of
equipment (or group of these) for which costs may be ascertained and
used for the purpose of cost control.”

Thus, cost center refers to one of the convenient units into which the
whole factory or an organization has been appropriately divided for
costing purposes. Each such unit consists of a department, a
sub-department or an item or equipment or machinery and a person or a
group of persons.
Cost Estimation
Cost estimation is the process of pre-determining the cost of a certain
product job or order. Such pre-determination may be required for several
purposes such as :
•Budgeting
•Measurement of performance efficiency
•Preparation of financial statements (valuation of stocks etc.)
•Make or buy decisions
•Fixation of the sale prices of products
Cost Ascertainment
Cost ascertainment is the process of determining costs on the basis of
actual data. Hence, the computation of historical cost is cost
ascertainment while the computation of future costs is cost estimation
Cost Allocation Cost allocation refers to the allotment of all the
items of cost to cost centers or cost units. It involves the process of
charging direct expenditure to cost centers or cost units.
Cost Apportionment
Cost apportionment refers to the allotment of proportions of items
of cost to cost centers or cost units. It involves the process of
charging indirect expenditure to cost centers or cost units.
Cost Reduction and Cost Control
•Cost control aims at maintaining the costs in accordance with
established standards whereas cost reduction is concerned with reducing
costs. It changes all standards and endeavors to improve them
continuously.
•Cost control seeks to attain the lowest possible cost under existing
conditions whereas cost reduction does not recognize any condition as
permanent since a change will result in lowering the cost.
•In case of cost control, emphasis is on past and present. In case of cost
reduction, emphasis is on the present and future.
•Cost control is a preventive function whereas cost reduction is a
correlative function. It operates even when an efficient cost control
system exists.
METHODS OF COSTING
JOB COSTING: The system of job costing is used where production is
not highly repetitive and in addition consists of distinct jobs so that the
material and labor costs can be identified by order number. This method
of costing is very common in commercial foundries and in plants making
specialized industrial equipments. In all these cases, an account is opened
for each job and all appropriate expenditure is charged thereto.
CONTRACT COSTING: Contract costing does not in principle differ
from job costing. A contract is a big job whereas a job is a small contract.
The term is usually applied where large-scale contracts are carried out. In
case of ship-builders, printers, building contractors etc., this system of
costing is used. Job or contract is also termed as terminal costing.
BATCH COSTING: This method is employed where orders or jobs are
arranged in different batches after taking into account the convenience of
producing articles. The unit of cost is a batch or a group of identical
products instead of a single job order or contract. This method is
Particularly suitable for general engineering factories which produce
components in convenient economic batches and pharmaceutical
industries.
PROCESS COSTING: If a product passes through different stages, each
distinct and well defined, it is desired to know the cost of production at
each stage. In order to ascertain the same, process costing is employed
under which a separate account is opened for each process.
This system of costing is suitable for the extractive industries, e.g.,
chemical manufacture, paints, foods, explosives, soap making etc.
UNIT COSTING: (Output Costing or Single Costing)
In this method, cost per unit of output or production is ascertained and the
amount of each element constituting such cost is determined. In case
where the products can be expressed in identical quantitative units and
where manufacture is continuous, this type of costing is applied. Cost
statements or cost sheets are prepared in which various items of expense
are classified and the total expenditure is divided by the total quantity
produced in order to arrive at per unit cost of production. The method is
suitable in industries like brick making, collieries, flour mills, paper
mills, cement manufacturing etc.
 OPERATING COSTING: This system is employed where
expenses are incurred for provision of services such as those
tendered by bus companies, electricity companies, or railway
companies. The total expenses regarding operation are divided by
the appropriate units (e.g., in case of bus company, total number of
passenger/kms) and cost per unit of service is calculated.
MANAGEMENT ACCOUNTING :
Management Accounting is the presentation of accounting
information in such a way as to assist management in the creation of
policy and the day-to-day operation of an undertaking. Thus, it
relates to the use of accounting data collected with the help of
financial accounting and cost accounting for the purpose of policy
formulation, planning, control and decision-making by the
management.
Management Accounting is the term used to describe accounting
methods, systems and techniques which coupled with special
knowledge and ability, assists management in its task of
maximising profits or minimising losses. Management
Accountancy is the blending together into a coherent whole,
financial accounting, cost accountancy and all aspects of financial
management
Scope of Management Accounting
Financial Accounting
Cost Accounting
Revaluation Accounting
Budgetary Control
Inventory Control
Statistical methods
Interim Reporting
Taxation
Internal Audit
Points of Cost Accounting
differences
Object To ascertain and control
cost
Basis of recording Based on both present and
future transactions for cost
ascertainment
Scope Narrow scope as it covers
matters relating to
ascertainment and control
of cost
Utility It serves the needs of both
internal management and
external parties
Types of It covers only quantitative
transactions dealt aspects
with
Management Accounting
To provide useful information
to management for decision
making
It is concerned purely with the
transactions relating to future
Wide scope as it covers the
areas of financial accounts, cost
accounts, taxation, etc.
It serves the needs of only
internal management
It covers both quantitative &
qualitative aspects