UNIT-I

Cost Accounting
It is a process via which we determine the costs of goods and
services. It involves the recording, classification, allocation of
various expenditures, and creating financial statements. This data is
generally used in financial accounting.

This helps us calculate the costs of the various goods. It also involves
a suitable presentation of this data for the purposes of cost control
and guidance to the management.

It deals with the cost of every unit, job, process, order, service, etc,
whichever is applicable and includes the cost of production, cost of
selling and cost of distribution.
A BRANCH OF ACCOUNTING
Cost Accounting is a branch of accounting that deals specifically with the determination of
costs of the products and services being manufactured. It deals with those techniques, tools,
processes and methods which are associated with the determination of costs, their
classification and analysis. It is an accounting which is done internally to the organization
and is optional.

BRANCH OF KNOWLEDGE
It is an important branch of knowledge and emerges as a discipline in itself. It is an organize
body of knowledge which has its own tools and techniques like
 Job costing
 Process costing
 Standard costing
 Marginal costing
 Variance analysis
 Unit costing
 Batch costing
 Activity based costing
 Budgetary control
 Contract costing etc.
COST ACCOUNTING IS SCIENCE AND AN ART
Cost accounting is both science and an art but not a perfect science.

It is science as it is a body of systematic knowledge relating to not only accounting but

also to a wide variety of subjects such as law, office practices, data processing, production
and material control etc.
It is an art as it involves the use of the skills and experience of cost accountant in
collection, classification and analysis of the costs of the products.
COST ACCOUNTING IS A PROFESSION
Cost accounting is not a pure profession by nature but it is emerging as a profession. The set
up of various specialized institutions like
 Institute of Cost and Management Accountants in UK
 Institute of Cost and Work Accountants in India
Is a way long to make cost accounting as a profession.

BASED ON DOUBLE ENTRY SYSTEM

Cost accounting is based on the double entry system. It is follows the rule of ‘every debit has
equal credit.’ All transactions that are recorded in the cost accounting records have two fold
aspect.

A PROCESS IN NATURE
Cost accounting is a process in nature. It is a process that involves the following steps:
 Identification of costs
 Recording of costs
 Classification of costs
 Analyzing the costs
 Interpreting the results
 Communicating the results to the management.
It is a forward looking approach that aims at improving the efficiency of the manufacturing
activities.

TOOLS AND TECHNIQUES

Cost accounting has its own tools and techniques of standard costing and variance analysis,
contract costing, process costing, job costing, unit costing, batch costing, marginal costing
etc. cost accounting make use of such techniques in preparing the accounting records with
full accuracy and also fix the standards of performance for future.

INTERNAL ACCOUNTING
Costing accounting is an internal accounting. There is no compulsion on the organization to
prepare the cost accounting records and publish them. It is totally option to prepare the cost
accounting records. These are prepared to provide for the internal use by the management and
manufacturing departments.

Scope of Cost Accounting

Cost accounting is being widely applied by the production units to modify the
process and maximise the profit.

Following are the various applicabilities of the cost accounting techniques:

 Cost Analysis: Cost accounting determines the deviation of the

actual cost as compared to the planned expense, along with the
reason for such variation.
  Cost Audit: To verify the cost sheets and ensure the efficient
application of cost accounting principles in the industries, cost
audits are done.
 Cost Report: Cost reports are prepared from the data acquired
through cost accounting to be analysed by the management for
strategic decision making.
 Cost Ascertainment: To determine the price of a product or
service, it is essential to know the total cost involved in generating
that product or service.
 Cost Book Keeping: Similar to financial accounting; journal
entries, ledger, balance sheet and profit and loss account is prepared
in cost accounting too. Here, the different cost incurred is debited,
and income from the product or service is credited.
 Cost System: It provides for time to time monitoring and evaluation
of the cost incurred in the production of goods and services to
generate cost reports for the management.
 Cost Comparison: It examines the other alternative product line or
activities and the cost involved in it, to seek a better opportunity for
generating high revenue.
 Cost Contol: Sometimes, the actual cost of a product or service
becomes higher than its standard cost. To eliminate the difference
and control the actual cost, cost accounting is required.
 Cost Computation: When the company is engaged in the
production of bulk units of a particular product or commodity, the
actual per-unit cost is derived through cost accounting.
 Cost Reduction: It acts as a tool in the hands of management to
find out if there is any scope of reducing the standard cost involved
in the production of goods and services. Its purpose is to obtain
additional gain.

Objectives of Cost Accounting

Cost accounting aims at eliminating the loopholes in the production process and
ensures manufacturing of goods at the lowest possible cost.

Other than this, there are multiple objectives of the cost accounting practices.
Let us now discuss its importance in detail:
 Control and Reduce Cost: Cost accounting continuously focuses
on managing the cost of production per unit to improve profitability
without compromising with the quality of the product.
 Determine Selling Price: It provides the total cost incurred in the
product or service, which is the base for fixing an appropriate
selling price.
 Assist Management in Decision Making: The reports and cost
sheets generated based on cost accounting back the managerial
decisions of the organization.
 Ascertain Closing Inventory: It determines the closing inventory
value at the end of the financial year.
 Ensure Profit from Each Activity: Cost accounting reviews the
cost and takes corrective actions at each level to ensure profitability
from all business activities.
 Budgeting: It generates the estimated cost of products or services to
assist in budget planning, implementation and control.
 Setting Performance Standards: It provides a standard cost of
goods or services to sets a level for the future course of action.
 Business Expansion: It estimates the cost of production at different
stages, based on this analysis, the management can plan for
expansion of the business.
 Minimizing Wastage: Cost control and reduction so attained helps
in reducing the wastage during the manufacturing process.
 Improves Efficiency: Cost accounting assures cost management,
profit appreciation and less wastage which ultimately enhances the
overall production and manufacturing process of products.
Classification of Costs
1] Classification by Nature
This is the analytical classification of costs. Let us divide as per their
natures. So basically there are three broad categories as per this
classification, namely Labor Cost, Materials Cost and Expenses.
These heads make it easier to classify the costs in a cost sheet. They
help ascertain the total cost and determine the cost of the work-in-
progress.

1. Material Costs: Material costs are the costs of any materials

we use in the production of goods. We divide these costs
further. For example, let’s divide material costs into raw
material costs, spare parts, costs of packaging material etc.
2. Labor Costs: Labor costs consists of the salary and wages
paid to permanent and temporary employees in the pursuit
of the manufacturing of the goods
3. Expenses: All other expenses associated with making and
selling the goods or services.

2] Classification by Functions
This is the functional classification of costs. So the classification
follows the pattern of basic managerial activities of the organization.
The grouping of costs is according to the broad divisions of functions
such as production, administration, selling etc.

 Production Costs: All costs concerned with actual

manufacturing or construction of the goods
 Commercial Costs: Total costs of the operation of an
enterprise other than the manufacturing costs. It includes
the admin costs, selling and distribution costs etc.
3] Classification by Traceability
This aspect one of the most important classification of costs, into
direct costs and indirect costs. This classification is based on the
degree of traceability to the final product of the firm.

 Direct Costs: So these are the costs which are easily

identified with a specific cost unit or cost centers. Some of
the most basic examples are the materials used in the
manufacturing of a product or the labor involved with the
production process.
 Indirect Costs: These costs are incurred for many purposes,
i.e. between many cost centers or units. So we cannot easily
identify them to one particular cost center. Take for example
the rent of the building or the salary of the manager. We will
not be able to accurately determine how to ascertain such
costs to a particular cost unit.
4] Classification by Normality
This classification determines the costs as normal costs and abnormal
costs. The norms of normal costs are the costs that usually occur at a
given level of output, under the same set of conditions in which this
level of output happens.

 Normal Costs: This is a part of the cost of production and a

part of the costing profit and loss. These are the costs that
 the firm incurs at the normal level of output in standard
conditions.
 Abnormal Costs: These costs are not normally incurred at a
given level of output in conditions in which normal levels of
output occur. These costs are charged to the profit and loss
account, they are not a part of the cost of production.

Methods and Techniques of Costing

Methods of Costing:
Methods to be used for the ascertainment of cost of production
differ from industry to industry. It primarily depends on the
manufacturing process and also on the methods of measuring the
departmental output and finished products.

Basically, there are two methods of costing (as per CIMA

Terminology) viz.:
(i) Specific Order Costing (or Job/Terminal Costing) andJob
costing is a precise method of tracking all the costs and
revenue associated with a particular project. Projects might
include one-off customer undertakings, manufacturing new
products or delivering multiple products that will be developed
at the same time.

(ii) Operation Costing (or Process or Period Costing.)

Specific Order Costing is the category of basic costing methods

applicable where the work consists of separate jobs, batches or
contracts each of which is authorised by a specific order or contract.
Job costing, batch costing and contract costing are included in this
category.
Operation Costing is the category of basic costing methods
applicable where standardized goods or services result from a
sequence of repetitive and more or less continuous operations or
process to which costs are charged before being averaged over units
produced during the period.

All these methods are discussed briefly as under:

1. Job Costing:
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Under this method, costs are collected and accumulated for each
job, work order or project separately. Each job can be separately
identified; so it becomes essential to analyse the cost according to
each job. A job card is prepared for each job for cost accumulation.
This method is applicable to printers, machine tool manufacturers,
foundries and general engineering workshops.

2. Contract Costing:
When the job is big and spread over long periods of time, the
method of contract costing is used. A separate account is kept for
each individual contract. This method is used by builders, civil
engineering contractors, constructional and mechanical engineering
firms etc.

3. Batch Costing:
This is an extension of job costing. A batch may represent a number
of small orders passed through the factory in batch. Each hatch is
treated as a unit of cost and separately costed. The cost per unit is
determined by dividing the cost of the batch by the number of units
produced in a batch. This method is mainly applied in biscuits
manufacture, garments manufacture and spare parts and
components manufacture.

4. Process Costing:
This is suitable for industries where production is continuous,
manufacturing is carried on by distinct and well defined processes,
the finished products of one process becomes the raw material of
the subsequent process, different products with or without by-
products are produced simultaneously at the same process and
products produced during a particular process are exactly identical
As finished products are obtained at the end of each process, it will
be necessary to ascertain not only the cost of each process but also
cost per unit at each process. A separate account is opened for each
process to which all expenditure incurred thereon is charged.

The cost per unit is obtained by averaging the expenditure incurred

on the process during a certain period. Hence, this is known as
average costing. As the products are manufactured in a continuous
process, this is also known as continuous costing. Process costing is
generally followed in Textile Industries, Chemical Industries,
Tanneries, Paper Manufacture etc.

5. One Operation (Unit or Output) Costing:

This is suitable for industries where manufacture is continuous and
units are identical. This method is applied in industries like mines,
quarries, oil drilling, breweries, cement works, brick works etc. In
all these industries there is natural or standard unit of cost. For
example, a barrel of beer in breweries, a tonne of coal in collieries,
one thousand of bricks in brickworks etc.
The object of this method is to ascertain the cost per unit of output
and the cost of each item of such cost. Here cost accounts take the
form of cost sheets prepared for a definite period. The cost per unit
is determined by dividing the total expenditure incurred during a
given period by the number of units produced during that period.

6. Service (or Operating) Costing:

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This is suitable for industries which render services as distinct from

those which manufacture goods. This is applied in transport
undertakings, power supply companies, municipal services,
hospitals, hotels etc. This method is used to ascertain the cost of
services rendered.

There is usually a compound unit in such undertakings, e.g., tonne

kilometre (transport undertaking), kilowatt-hour (power supply)
and patient day (hospitals).

7. Farm Costing:
It helps in calculation of total cost and per unit cost of various
activities covered under farming. Farming activities cover
agriculture, horticulture, animal husbandry (i.e., rearing of live-
stocks), poultry farming, pisciculture (i.e., rearing of fish), dairy,
sericulture (i.e. silkworm breeding), nurseries for growing and
selling of seedlings and plants and rearing of fruits and flowers.

Farm costing helps to improve the farming practices to reduce cost

of production, to ascertain the profit on each line of farming activity
which ensures better control by management and to obtain loans
from banks and other financial institutions as they give loans on the
basis of proper cost accounting records.

8. (Multiple) Operation Costing:

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Multiple operation method of manufacture consists of a number of

distinct operations. It refers to conversion cost i.e., cost of
converting the raw materials into finished goods. This method takes
into consideration the rejections in each operation for calculating
input units and cost. The different operations in machine screw are
—stamps, knurl, thread and trim. The cost per unit is determined
with reference to final output.

9. Multiple Costing:
It represents the application of more than one method of costing in
respect of the same product. This is suitable for industries where a
number of component parts are separately produced and
subsequently assembled into a final product. In such industries
each component differs from the others as to price, material used
and process of manufacture undergone. So it will be necessary to
ascertain the cost of each component.

For this purpose, process costing may be applied. To ascertain the

cost of the final product batch costing may be applied. This method
is used in factories manufacturing cycles, automobiles, engines,
radios, typewriters, aeroplanes and other complex products. This
method has been dropped from the latest CIMA Terminology.

Types or Techniques of Costing:

Following are the main types or techniques of costing for
ascertaining costs:
1. Uniform Costing:
It is the use of same costing principles and/or practices by several
undertakings for common control or comparison of costs.

2. Marginal Costing:
It is the ascertainment of marginal cost by differentiating between
fixed and variable cost. It is used to ascertain the effect of changes
in volume or type of output on profit.

3. Standard Costing:
A comparison is made of the actual cost with a pre-arranged
standard cost and the cost of any deviation (called variances) is
analysed by causes. This permits management to investigate the
reasons for these variances and to take suitable corrective action.

4. Historical Costing:
It is ascertainment of costs after they have been incurred. It aims at
ascertaining costs actually incurred on work done in the past. It has
a limited utility, though comparisons of costs over different periods
may yield good results.

5. Direct Costing:
It is the practice of charging all direct costs, variable and some fixed
costs relating to operations, processes or products leaving all other
costs to be written off against profits in which they arise.

6. Absorption Costing:
It is the practice of charging all costs, both variable and fixed to
operations, processes or products. This differs from marginal
costing where fixed costs are excluded.
Any of the methods of costing like unit or output costing, service
costing, process costing etc. can be used under any techniques of
costing.

What is a cost sheet?

A cost sheet is a statement that shows the various components of total cost for a

product and shows previous data for comparison. You can deduce the ideal selling

price of a product based on the cost sheet.

A cost sheet document can be prepared either by using historical cost

or by referring to estimated costs. A historical cost sheet is prepared based on the

actual cost incurred for a product. An estimated cost sheet, on the other hand, is

prepared based on estimated cost just before the production begins.

Importance and objectives of cost sheet

Cost sheets help with a number of essential business processes:

1. Determining cost: The main objective of the cost sheet is to obtain an

accurate product cost. It gives you both the total cost and cost per unit of a product.

2. Fixing selling price: In order to fix the selling price of a product, you need to

create a cost sheet so you can see the details of its production cost.

3. Cost comparison: It helps the management compare the current cost of a

product with a previous per unit cost for the same product. Comparing the costs

helps management take corrective measures if costs have increased.

4. Cost control: The cost sheet is an important document for a manufacturing unit,

as it helps in controlling production costs. Using an estimated cost sheet aids in

monitoring labour, material and overhead costs at each step of production.

5. Decision-making: Some of the most important

decisions management makes are based on the cost sheet. Whenever a business

needs to produce or buy a component, or quote prices for its goods on a

tender, managers refer to the cost sheet.

Types of costs in cost accounting

Costs are broadly classified into four types: fixed cost, variable cost, direct cost,

and indirect cost. 

1. Fixed cost:  These are costs that do not change based on the number of items

produced. For example, the depreciating value of a building or the price of a piece

of equipment.

2. Variable cost: These costs are tied to a company’s level of production. For

example, a bakery spends $10 on labor and $5 on raw materials to produce each

cake. The variable cost changes based on the number of cakes the company bakes.

3. Operating costs: These are those expenses incurred by an organisation to

maintain the product on a day to day basis. Traveling cost, telephone

expenses, office supplies are some of things that come under operating costs.

4. Direct costs: These costs can be directly associated with production. For

example, if a furniture manufacturing company takes five days to produce a

couch, then the direct cost of the finished product includes the raw material cost

and labor charges for five days.

Components & elements of total cost

Components of total cost are constituted mainly of prime cost, factory cost, office

cost and cost of sales. Let us take a detailed look at each of these elements:

1. Prime cost: This comprises direct material, direct wages, and direct expenses. It

is also called basic cost, first cost, or flat cost. It can be defined as an aggregate

of the price of the material consumed, the wages involved in production, and the

direct expenses.  

Prime cost = Direct material + Direct wages + Direct expenses

Direct material cost usually refers to the cost of raw materials used or consumed

during a given period. To calculate the amount of raw material actually consumed

during a given period, you add the opening stock and the amount of material

purchased, and deduct the closing stock. Here is the formula for material

consumed: 

Material consumed = Material purchased + Opening stock of material –

Closing stock of material

2. Factory cost: This is made up of prime cost plus factory overhead, which

includes indirect wages, indirect material and indirect expenses. Factory cost is

also known as works cost, production cost, or manufacturing cost.

Factory cost = Prime cost + Factory overhead

3. Office cost: This is also called administration cost or total cost of production.

Office cost is equal to factory cost plus office and administration overhead.

4. Total cost or cost of sales: This is the sum of the total cost of production

and the total of selling and distribution overhead. 

Total cost = Cost of goods sold + Selling and distribution overhead

In the production process, some units of a product are scheduled to be finished at

the end of a period. Such incomplete units are called work-in-progress. In such

situations, while calculating the factory cost of a product unit, it is necessary to

make adjustment for opening and closing stock to arrive at net factory cost of the

product. Generally, the cost of these unfinished units include direct material, direct

expenses, and factory overheads.

Besides this, the adjustments for inventories need to be made in the following

manner

1. Direct material consumed = Opening stock of direct material + Purchases of

direct material – Closing stock of direct

2. Works cost = Gross works cost + Opening work in progress – Closing work in

progress

3. Cost of production of goods sold = Cost of production + Opening stock of

finished goods – closing stock of finished goods

Co.

Opening Stock:
(i) Raw Material 40,350,

(ii) Work-in-Progress 15,000 and

(iii) Finished Stock 35,590.

Cost incurred during the period:

Materials purchased 2,50,000, Wages paid 2,00,000, Carriage
inward 2,000, Consumable Stores 10,000, Wages of Storekeeper
7,000, Depreciation of Plant & Machinery 10,000, Materials
destroyed by Fire 5,000, Repairs & Renewals 5,010, Office
Manager’s Salary 10,000, Salary to Office Staff 20,500, Printing &
Stationary 10,000, Power 10,500, Lighting for Office Building
2,000, Carriage outward 3,000, Freight 5,000, Entertainment
2,500, Warehousing charges 1,500, Legal charges 2,000, Expenses
for participating in Industrial exhibition-6,000.

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Closing Stock:
(i) Raw material 35,000,

(ii) Work-in-Progress 14,500, and

(iii) Finished Stock 40,030. Profit 25% on cost.

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Solution:
Best Engineering Co.
 Cost Sheet:
for the year ended 31.3.86
The accounts of Basudev Manufactures Ltd. for the year
ended 31st December 1988 show the following:

Solution: