Cost Accounting – An Introduction

IPCC Paper 5: Cost Accounting Chapter 1

BY
CA. B.N. Pattabhi, M.Com, FCA
Salutations
DEDICATED TO MY
NOBLE,
EVER LOVING,
EVER INSPIRING
MOTHER

LALITAMMA
Learning Objectives
Introduction to Cost Accounting

Cost Accounting is basically a MIS i.e.

• A Management Information System

It’s an aid to the Management in its Primary

Function of Decision Making

It aims at Ascertainment of Cost for the purpose

of Cost Analysis and Control
Evolution of Cost Accounting
An Intro.
Before Industrial Revolution

 Seller’s Market since Skilled

Labourers were very few and Buyers
were unlimited i.e
 Low Production High Demand
 Price was determined by Sellers
 No Competition because of High
Demand
 Hence cost was not relevant
Industrial Revolution - Initial Stage

Automation of Production Process

Limited Production but still short of Demand

Whatever was produced was Sold

Prices were still high and unrelated to cost

Progression towards Large Scale Production and increase in efficiency

Developments in the Field of
Management

 Different concepts evolved in the field of

Management like

1
• Scientific Management Theory

2
• Time & Motion Study

3
• Functional Departmentalisation

4
• Specialisation etc
Industrial Revolution - Maturity Stage
Oragnisations mastered Efficient Processes

Scaled up production to derive Economies of Large Scale Operation

For the First Time Supply was more than Demand

• In fact there was a glut in the market

Organisations Started Competing for Market Share

Price Competition crept in based on Financial Statements

Price Competition turned into a cut throat price competition based on historical Info

Organisations survived for a year or two based on reserves

Industrial Revolution-Maturity Stage 2
Organisations started going Bankrupt

Even though the efficiency levels were high i.e. upwards of 99% and Production Processes were
highly efficient still Organisations went bankrupt

Management scientists or Managers started searching for the reasons of bankruptcy

Managers zeroed in on the reasons for bankruptcy i.e

• Fixing the price based on earlier periods Financial Statements

• The information based on which pricing decisions were taken were old and not up to date

Managers started realising that the basis of their decisions were incorrect

The need for an efficient MIS was being felt by managers across the cadres

An MIS in tune with the changes / trends in the management was the need of the hour
Financial Accounting System Limitations

It’s a post mortem of transactions

No mechanism to consider the future trend i.e. no mechanism for precise estimates

No mechanism for considering the present trends / changes in the situations

Information presented is historical and based on historical cost basis

Stock Records do not form part of Financial Records

Concept of Work in progress does not exist

Concept of issue and consumption does not exist

The time gap between recording and reporting is very long

Evolving Cost Accountancy

The New MIS had all

To meet the changing
the mechanisms and
needs of the Managers Cost Accountancy is
techniques to overcome
a new system of MIS Forward Looking,
the shortcomings of
emerged known as Analytical and Current
Financial Accounting
Cost Accountancy
System
Definitions
Cost Accounting
Cost
 It is the sum total of expenditure
“Incurred” or “Attributable” to
produce an article or thing or
render a Service.
 The expenditure may be real or
implied
 The payment is not a criteria
 To Sum up it’s the aggregate of
value of all factors of productions
used to produce an article or a
thing or render a Service
Costing
 Costing is a term used to
collectively refer to all those
techniques, Processes and
activities that are used to
ascertain cost
 It is the process of ascertainment
of cost
 It includes all those activities
which are performed to collect
information for the ascertainment
of cost
Cost Accounting

 It is the process of accounting

for costs or the physical
process of collecting and
recording of expenditure &
income, identifying the bases
for collecting of information
and culminates in preparation
of reports and statements that
are used for ascertainment
and control of costs
Cost Accountancy
 It is the process of applying
costing and cost accounting
principles, methods, techniques
and processes to the Science art
and practice of Ascertainment of
cost for the purpose of analysis
and control of cost.
 It deals with preparation of MIS
reports that form the basis of
managerial decision making
Scope and Objective
Of Cost Accounting
Scope
Cost Book Keeping

Cost System

Cost Ascertainment

Cost Analysis

Cost Comparison

Cost Control

Cost Reports
Objectives & Scope

 The Primary objective of Cost

Accounting is to provide the
management with analytical,
accurate and reliable reports &
information (MIS Report) based on
which management can take
informed decisions
 In a nutshell Cost Accounting is an
Aid or tool in the hands of
Management which facilitates
decision making
Objectives & Scope - 2

 Theoretically the objectives are

 Ascertainment of Cost
 Determination of Selling Price
 Cost Control and Cost Reduction
 Ascertaining the profit of each
activity
 Assisting Management in Decision
Making
Objectives & Scope - 3
 Ascertainment of cost
Post Costing
Ascertainment of cost based on or by
analysing Financial Information is called as
post costing, it is helpful in Cost Plus
Contracts, wherein the price will have to be
determined based on cost plus an agreed
rate of profit on cost
Objectives & Scope - 4
 Continuous Costing
It is a process which aims at collecting costs
as and when they are incurred. It’s a process
which involves a careful estimation of certain
Implied costs such as overheads etc. This
system of costing aims at ascertainment of
cost of completion simultaneously with the
completion of the production/job
Objectives & Scope - 5
 Determination of Selling Price
Cost of Production is one of the factors for
determining the price of a product or service.
Cost Accounting helps in determining the
Selling Price of a product or Service
It is pertinent to note here that the market
maxim is “Cost is a fact, Price is a policy”
Objectives & Scope - 6
 Cost Control
One of the objectives of Cost Accounting is
cost control. Once the cost is ascertained
the next step is to analyse such costs with a
view to exercise control over them by clearly
establishing objectives & achieving optimum
efficiency and comparing the performance
with the objectives set
Objectives & Scope - 7
 Cost Reduction
It’s defined as achieving real and permanent
reduction in the unit cost of manufacturing a
product or rendering a service without
compromising on either the Quality of the
product or impairing the suitability of the
product for the intended use
Objectives & Scope - 8
 Cost Reduction – Continued
It also implies retaining of the essential
characteristic features & quality of the
product or service. It is achieved through
constant innovation and improvisation of
processes, so that there is a permanent and
real reduction in cost
Cost Control & Cost Reduction
Cost Control Cost Reduction
It maintains cost Aims at reducing the cost
Aims at achieving lowest Aims at optimising the
possible cost cost
Focuses on past & by challenging the
Present practices
It is preventive in nature Focuses on present &
future
It has a limited target It is corrective in nature
It is a continuous process
Objectives & Scope - 9
 Ascertainment of Profit of each activity
Since cost information is collected activity
wise ascertainment of profit activity wise
becomes easier. In financial accounting
system it may not be possible to identify the
profit of each activity.
In fact profit can be ascertained for each
activity level.
Objectives & Scope - 10
 Assisting Management in Decision Making
This is one of the most important & relevant
objectives of Cost Accounting. In fact it is
the genesis of Cost Accounting.
It is this need of the management for reliable
and accurate information for basing its
decision that gave birth to a separate system
of accounting called Cost Accounting
Cost Centre
A Cost Centre is defined as a person,
location or an item of equipment or a
combination of these for which cost is
ascertained for the purpose of analysis and
control.
Cost Centre can be Personal or Impersonal
Cost Unit
 It is a physical measure or unit of product, Service
or Time or a combination of these for which costs
may be ascertained.
 The cost unit may differ from product to product and
service to service depending on the inherent nature
of the product or service or the process
Cost Object
Anything for which a separate measurement
of cost is intended is called as a cost object.
The cost object may be a Product, Service,
Project, Customer, an Activity etc
A Cost object is used to ascertain the selling
price of the Product or Service
Elements of Cost
 These are akin to heads of account in financial
accounting
 Elements of cost are those items of cost which form
a significant portion of the total cost, which deserve
to be mentioned separately.
 In a nutshell elements of cost are those expenses
incurred which are separately identified in
ascertaining the cost
Cost Accounting System
Installation of a Costing System
The prime considerations for installation of a costing
system are
 Economic Viability i.e. whether the cost
incurred on installing a costing system justify
the benefits derived there from.
 Managements attitude towards having a
sound MIS. If the management is averse to
using an MIS report, then installing a costing
system doesn’t make sense
Factors to be considered
 Objective
 Type of Business
 General Organisation
 Technical Details
 Change in Operations
 Method of Maintenance of Cost Records
 Information
 Accuracy
 Informative and Simple
Essentials of a Good Costing System
 Informative and Simple
 Accuracy
 Support from Management
 Cost Benefit
 Precise Information
 Procedure
 Trust
Cost Accounting - Relationship
An Intro.
Relationship of Cost Accounting
 With Financial Accounting, Management Accounting
and Financial Management
Cost Accounting is a branch of accounting, while
Financial Accounting aims at preparation and
presenting General Purpose Financial Statements,
Cost Accounting aims at preparation and
presentation of MIS reports which are for the
exclusive use of Management.
Relationship Continued
 Management Accounting Aims at analysing the
Financial Statements and providing inputs to the
management based on the analysis and focuses on
certain set parameters such as Gross Profit,
Operating Margin, etc
 Whereas cost accounting is a real time exercise
which furnishes information on income &
Expenditure as and when it is incurred
Relationship Continued
 Financial Management aims at maximising the
wealth of an organisation through profit
maximisation whereas cost accounting aims at
ascertainment of cost for the purpose of Analysis,
control and reduction.
To sum up cost accounting is an additional
supplementary and indispensible source of
information for the management in its decision
making process
Classification of Cost
 On the basis of elements Viz
 Material Direct & Indirect
 Labour Direct & Indirect
 Expenses Direct & Indirect
 Overheads Production/works/Factory
Administration, Selling & Distribution
Classification of Cost continued
By Function
 Prime Cost
 Factory Cost
 Cost of Production
 Cost of Goods Sold
 Cost of Sales
Classification of Cost continued
On the basis of variability or behaviour
Fixed Cost
Variable Cost
Semi variable Cost
By Controllability
Controllable Cost
Uncontrollable Cost
Classification of Cost continued
 By Normality
Normal Cost
Abnormal Cost
Lesson Summary
Thank You