Professional Documents
Culture Documents
SEMESTER-I
FINANCIAL ACCOUNTING
MBA-DA-105
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CONTENT
STRUCTURE
5.2 Introduction
5.3 Meaning
5.10 Summary
The theory of accounting dates back to the times when money came into existence.
He compares the actual performance with planned performance. He has to report and
interpret the results to all management levels in addition to the owners of the business.
As he performs these duties, he has to use different accounting techniques, and the one that
precedes other techniques is the cost technique. It is because the accounting treatment of
costs is usually financially significant and complex.
5.3 MEANING
Accountants use cost accounting as a conscious and rational procedure for accumulating
costs and relating them to specific departments or products for proper management action.
Through the technique of standard costing, cost accounting facilitates cost control, and
through the technique of marginal costing, it helps the management in profit planning.
In simple terms, cost accounting helps analyze past, present, and future data to assist in
managerial decision-making.
5.4 DIFFERENCE BETWEEN FINANCIAL ACCOUNTING AND COST
ACCOUNTING
The main differences between the two important branches of accounting are explained
below:
i) Objectives: The prime objective of financial accounting is to look after the interests of a
business and those connected to it by providing essential information to several parties like
partners or shareholders, creditors, etc. This is not exactly the case with Cost Accounting. It
provides information intending to guide the management regarding planning, decision-
making, and organizational control.
For example, when materials are purchased, we get to know about their proper accounting
and payment through Financial Accounting, whereas, Cost Accounting helps us learn if the
quantity purchased by us was reasonable, the purchase was necessary, and if we were able to
utilize it most efficiently or not.
ii) Periodicity of Reporting: Since Financial Accounting is concerned with the transactions
taking place between the company and third parties, it has to follow the conventional
accounting period of one year. Due to this reason, balance sheets and the income statement
are prepared and presented to the members annually. Cost accounting, on the contrary, is
concerned with the people within the organization and hence, is not bound by the
conventional accounting period. Cost reports can be prepared anytime as frequently as a
week.
iii) Recording: The preparation of financial accounts stresses the profits or losses incurred
by a firm. Based on this the classification, recording, and analysis of transactions are done. In
the case of cost accounting, the stress is on planning and control leading to the recording of
transactions based on the reason for incurring costs.
iv) Mode of Presentation: Accepted accounting concepts and conventions are used in the
preparation of Financial Accounts and they are stored keeping in mind the provisions of the
Income Tax Law, Companies Act, and other similar statutes. The maintenance of Cost
Accounts is not compulsory for they are not mandated under any law, leading to their
presentation having no statutory forms. But, the central government can demand the cost
records of any business engaged in mining, production, processing, or manufacturing
activities through a notification.
v) Analysing Profits: Financial Accounting helps reveal the firm’s profit while cost
accounting helps find the profit earned on a particular product, process, or job, which makes
it easier for a firm to get rid of the products that are less profitable and focus on those that
earn more profits.
1. Materials: The substance used in making a product is known as Material. There are two
types of materials, Direct and Indirect.
i) Direct Material: It includes the materials that are an integral part of the final product and
can be easily traced to specific physical units. The following fall under the category of Direct
Materials:
ii) Indirect Material: It includes the materials used for purposes ancillary to the business
and that cannot easily be assigned to specific physical units. Examples of them include
grease, oil, printing and stationery material, consumable stores, etc. Indirect material can be
used in the office, factory, or the selling and distribution division.
2. Labour: The human effort required in the conversion of materials into finished goods is
known as labor. It can be direct and indirect.
i) Direct Labour: It includes the labor that actively and directly participates in the
production of a particular commodity. Therefore, it can be concluded that direct labor costs
can be conveniently traced to specific products. It is also known as productive labor,
manufacturing labor, process labor, direct wages, etc.
ii) Indirect Labour: It is the labor employed to undertake tasks incidental to the production
of goods or services. Indirect labor cannot alter the composition, condition, or construction of
a product. Unlike direct labor, its cost cannot be conveniently traced to specific products.
Examples include wages of foremen, store-keepers, time-keepers, salesmen's salary,
directors' fees, etc. Indirect labor can be used in the office, factory, or the selling and
distribution division.
i) Direct Expenses: Such expenses can be conveniently, directly, and wholly assigned to
particular cost units or cost centers. Another name for direct expenses is 'chargeable
expenses'. Some examples include the cost of defective work incurred on a specific job, hire
of special machinery needed for a particular contract, cost of drawings or designs, etc.
ii) Indirect Expenses: Such expenses cannot be conveniently, directly, and wholly assigned
to particular cost units or cost centers. Examples of indirect expenses include rates and taxes,
rent, insurance, power, repairs and maintenance, depreciation, etc.
4. Overheads: It includes the cost of indirect labor, indirect expenses, and indirect material,
terms that you studied in the above paragraphs. It means that all the indirect costs are
overheads. It is classified into three categories:
Some examples of the costs falling under it are power used in the factory premises,
lubricants, gatekeeper’s salary, etc.
ii) Office and Administrative Overheads: They contain expenses related to the
administration and management of the business and exclude the expenses falling under the
manufacturing overheads. Examples include lighting and heating, office rent, printing, and
stationery; salaries of the clerk, office accountant, manager, etc.; depreciation of office
building, equipment, and furniture, legal charges, audit fee, bank charges, etc.
iii) Selling and Distribution Overheads: Falling under it are the expenses incurred for the
promotion and marketing of a commodity, for despatching goods sold, for making efforts to
find new customers and retaining the existing ones, and for securing orders for the products.
Examples include the cost of preparing tenders, advertisement expenses, bad debts, traveling
expenses, packing and loading charges, warehouse charges, collection charges, carriage
outwards, etc.
i) Fixed Costs: These are the costs that remain constant or static regardless of any change in
the output. For example, insurance charges, rent, management salary, etc. They do not
change and stay constant per unit of time. Fixed costs do not have a major relationship with
output and remain constant per unit of time. Changes in market forces and inflationary trends
in the economy impact these costs. They are also known as period costs. Fixed costs are
further divided into Committed Fixed costs and Discretionary fixed costs:
Committed fixed costs: These are the costs that cannot be avoided in the short run and are
imperative for the functioning of the organization. For example depreciation, pay and
allowances of staff, rent, etc.
Discretionary Fixed Costs: The fixed costs set aside by the management, during the
budgeting process, for a short period and at a fixed amount are known as discretionary fixed
costs. They do not share a particular relationship with the level of output and reflect the
policies of the top management. For example, advertisement and market research expenses,
research and development costs, etc.
ii) Variable costs: The costs that change exactly in the same proportion in which the volume
of output changes are known as variable costs. They have a significant relationship with
output, which has the biggest influence on them. Examples of variable costs include the cost
of direct material, wages of labourers, etc. Variable costs remain constant per unit of time.
They are also known as direct costs.
iii) Semi-variable costs: These are the costs that neither remain stationary nor very
proportionately. Costs varying more than proportionately also fall under this category.
Examples include repairs, depreciation, supervision costs, etc.
iv) Step costs: Costs that remain fixed over a range of activities and then jump to a new level
are called step costs. They can be considered as a type of semi-variable cost. Take the
example of a foreman supervising some employees. With an increase in the number of
employees, it would become necessary to hire another foreman. Similarly, more foremen
would be required with a further increase in the number of employees.
Fixed, variable, semi-variable, and step costs can be graphically represented in the following
manner:
v) Product Costs: These are the costs that become part of the product’s cost and not of the
expenses of the period in which they are incurred. They are a part of the inventory values and
are treated as assets until the goods they are assigned to get sold become expenses. Product
Costs can be both fixed and variable. Depreciation on plant and machinery, cost of wages
and raw materials, etc., are some of the examples of such costs.
vi) Period Costs: These are the costs that are charged to the period in which they are
incurred and are not associated with production. Unlike product costs, period costs are
treated as expenses. They can be both fixed and variable. Generally, they are incurred for
various products at a time, and cannot be assigned directly to a product. Salaries, rent,
insurance, general administrative costs, commission, etc., are some of the examples of period
costs.
vii) Direct Costs: Under this fall those expenses on material and labor can be easily and
economically traced to a service, product, or job. When the process of production or
manufacture takes place, labourers are employed, materials are purchased, wages are paid,
and several other expenses are incurred directly. Since such expenses take a direct and active
part in the manufacturing process, they are known as direct costs.
viii) Indirect Costs: These costs include the expenses on material and labor that cannot be
easily and economically traced to a service, product, or job. For example, salaries of
timekeepers, foremen, storekeepers, etc. Since such expenses do not take a direct and active
part in the manufacturing process, they are known as indirect costs.
ix) Decision-making costs: These are special-purpose costs applicable only in situations in
which they are constructed. There is no universal application of these costs. They are future
costs. For example, if the operations of a firm were mechanized for a certain period,
decision-making costs would show the costs incurred during that time.
x) Accounting costs: They are primarily compiled from financial statements and need to be
altered before getting considered for decision making. For example, the recorded cost of a
product when the operations were manual and not mechanized. They help a firm in knowing
about past decisions taken during a particular business situation and are hence, also known as
historical costs.
xi) Relevant costs: The costs that can be changed by managerial decisions are known as
relevant costs. For example, during the closure of a shop, the wages payable to the workers
are relevant costs for they won’t occur in the future.
xii) Irrelevant costs: The costs unaffected by managerial decisions are known as irrelevant
costs. For example, if a manufacturer decides to shut down his shop, any prepaid rent would
be considered an irrelevant cost.
xiii) Shut-down Costs: A manufacturer or a company might have to suspend its operations
due to any reasons, for a period of time. Even with zero work during the closure period,
certain fixed costs like depreciation, rent, and insurance of machinery, maintenance of
equipment, etc., are incurred. Such costs are called shut-down costs.
xiv) Sunk costs: These are the costs that are incurred on account of such past decisions that
cannot be changed by decisions made in the future. The most common examples of sunk
costs are plants and machinery. They are not relevant in the process of decision-making
because they cannot be altered by later decisions.
xv) Controllable costs: The costs that can be influenced by the action of a particular
member of an undertaking are called controllable costs. For example, the Foreman-in-charge
of a particular section has control over the expenditure incurred by that section.
xvi) Uncontrollable costs: Costs that are not influenced by the action of a particular member
of an undertaking are called uncontrollable costs. For example, rent, insurance, etc.
xix) Imputed Costs: Costs that do not involve any cash outlay are called imputed costs. For
example, interest in Capital. Though they are not a part of cost accounting, imputed costs are
important to be considered for making managerial decisions.
xx) Differential costs: The difference in total costs between two alternatives is called
differential costs. For example, if the cost of producing 1000 units of a product by automated
operations is Rs.20000 and the same by using manual labor is Rs.30000, then the differential
cost is Rs.10000.
xxi) Incremental costs: When the choice of alternative results in an increase in total costs,
the increased costs are known as incremental costs. Consider the example used in the
previous point, if the chosen alternative leads to an increase in total cost, the increased cost
will be known as incremental cost. Incremental costs are matched with incremental revenue
to assess the profitability of a proposed change.
xxii) Out-of-pocket costs: These are the cost expenditure of the present and future about a
certain decision. Such expenditures vary based on the nature of the decision made. For
example, if a new machine is to be set up, the wages of the worker setting it up are an out-of-
pocket cost.
xxiii) Opportunity costs: The advantage foregone by not using the facilities in the originally
planned manner refers to opportunity costs. For example, if someone owns a building and
decides to use it for storing a new project plant then the likely revenue it would have earned
through rent is the opportunity cost.
xxiv) Traceable costs: These are the costs that are easy to identify with a process,
department, or product, for example, the cost of direct labor, direct material, etc.
xxv) Untraceable costs: These are the costs that cannot be identified with a process,
department, or product. They are also known as common costs and are incurred collectively
for various cost centers. To determine the cost of individual cost centers, they need to be
suitably apportioned. An example of untraceable cost can be the overhead cost incurred for
the factory as a whole.
xxvi) Joint costs: These are the costs incurred on the production of two or more products out
of the same material or process. For example, the cost of producing cottonseed and cotton
fiber from the same raw materials.
xxvii) Expired costs: The costs relating to the current period as a loss or expense are known
as expired costs. For example, rent paid for the current period is an expired cost.
xxviii) Unexpired costs: These are the costs relating to the future period. They are charged
as a loss or expense in the future period. For example, the cost of materials purchased for
consumption in the next month is an unexpired cost for the current month.
xxix) Conversion costs: The cost of transforming direct materials into the finished products,
exclusive of direct material cost is called conversion cost. For example, equipment
depreciation, maintenance, etc.
Apart from the costs mentioned above, a firm incurs other important costs as well while
performing functions like administration, production, research, and development, selling and
distribution, etc. They are defined below.
i) Administration cost: It is the cost incurred while formulating policies, controlling the
operations of an undertaking, directing the organization, and other costs not directly related
to production, research and development, selling, and distribution functions of the firm. For
example, rent, insurance, etc.
ii) Production cost: It is the cost of the sequence of operations beginning with the supply of
materials and ending with the primary packaging of the product. Therefore, production cost
includes the cost of direct labor, direct material, factory overheads, and direct expenses.
iii) Selling cost: It is the cost of seeking to generate and stimulate demand and secure orders.
For example, advertisement expenses incurred for a product.
iv) Distribution cost: It is the cost of the sequence of operations beginning with the
availability of a packaged product for despatch and ending with the reusability of the
reconditioned returned empty package if any. Logistics or transport costs can be examples of
Distribution costs.
v) Research cost: It is the cost of improving current products or searching for new products,
new methods, new applications, etc.
vi) Development cost: It is the cost of that process that begins with the implementation of
the decision to produce a new or improved product or to employ a new or improved method
and ends with the commencement of formal production of that product or by the method.
vii) Pre-production cost: That part of the development cost which is incurred in making a
trial production run preliminary to formal production. For example, the cost of conducting
trial production.
5.7 COMPONENTS OF TOTAL COST
i) Prime cost: It consists of the cost of direct labor, direct material, and direct expenses.
Other names of prime costs are flat cost, first cost, etc.
ii) Factory cost: Under this, Prime cost and factory overheads are included. Factory
overheads contain the costs of indirect labor, indirect material, and indirect expenses of the
factory. Other names of factory costs are production cost, works cost, manufacturing cost,
etc.
iii) Total cost: It is arrived at by adding selling and distribution overheads to the total cost of
production.
Direct Material Direct Labour Direct (1)Prime Cost
Expenses
Figure 5.6
While calculating the different components of cost, the following adjustments may be
required for inventories of raw materials, work-in-progress, and finished goods:
ii) Works Cost = Gross Works Cost + Opening Work-in-Progress - Closing Work-in-
Progress
iii) Cost of Production of Goods sold = Cost of Production + Opening Stock of Finished
Goods - Closing Stock of Finished Goods
5.8 PREPARATION OF COST SHEET
A cost sheet is a statement containing the items that become a part of the cost of products or
services. It shows the components of the total cost through stages and cost per unit of output
during a period. A cost sheet has three objectives:
iii) to help in a comparative analysis of costs with cost sheets of previous times
Direct materials
Direct Wages
Direct Expenses
Prime Cost
Add Factory Overheads
Indirect Wages
Indirect Materials
Expenses
Building
Defective Work
Works cost
● Audit Expenses
Cost of Production
Cost of Sales
Sales
Contractors or manufacturers have to look into the figures corresponding to the previous year
from the cost sheet of that year to prepare tenders or quotations. Such figures need to be
modified suitably considering expected changes in the prices of labor, materials, etc. and the
tender or quotation has to be submitted accordingly.
Example 5.1 Prepare the cost sheet to show the total cost of production and cost per unit of
goods manufactured by a company for July 2019. Also, find out the cost of sales.
The stock of finished goods was 200 and 400 units on 1-7-2019 and 31-7-2019 respectively.
The total cost of units on hand on 1-7-2019 was Rs.2,800. All these have been sold during
the month.
Solution:
4500
Factory overheads:
Factory Cost
Office and administrative overheads: 900 0.30
Office rent
400
Cost of Production
---------
41,700
--------
Example 5.2 From the following particulars, prepare a cost sheet for the year ending 31-12-
2019.
General 20,000
Chargeable expenses 40,000
Advertisement 30,000
Sales 4,60,000
Management expenses should be allocated in the ratio of 2:1:3 to factory, office, and sales
departments.
Solution:
80000
Prime Cost
General wages
8000
Salary 5000
Cost of Production
Advertising 4000
4,20,400
Sales
39,600
Profit
Example 5.3 The following particulars relate to a company for three months:
Sales 1,54,000
Solution:
35000
1,54,000
Particulars Rs.
46,750
Price to be quoted
Example 5.4 The following information has been taken from a factory:
Materials 50,000
You are required to fix the selling price of a machine costing rs.4,200 in materials and
rs.3,000 in wages so that it yields a profit of 25% on the selling price.
Solution:
Particulars Rs.
Materials 50,000
Materials 4200
Wages 3000
Particulars Rs.
Advertising 1000
Cost Sheet
Storekeeper wages
Factory rent
Machinery 400
Indirect Material:
Manager’s Salary
2,000
Telephone charges
Advertising
Warehouse charges
Carriage Outwards
Cost of Sales
The focus of accountants, during the evolutionary stage of costing, was only on computing
actual cost i.e., the actual cost of production. It led to the non-availability of cost control
measures with the management. To meet these contingencies, cost accountants developed
standard costing.
The technique of using standards for revenues and costs for controlling through variance
analysis is called standard costing. It involves setting predetermined cost estimates to provide
a basis for comparison with actual costs. For cost control in industries, standard costing is
universally accepted as an effective instrument.
ii) Enable the practice of ‘management by exception’ at the detailed operational level.
ii) Increase in efficiency of the firm with best methods and resources being set based on
standards.
iii) Standard Costing helps in highlighting the areas of strengths and weaknesses.
iv) Performance can be evaluated by comparing actual costs with standard costs.
v) By highlighting performance that did not meet the set standards, it acts as a form of
feedback.
iv) Subjective judgments and forecasting are involved in standard costing which makes it
possible for ambiguity and error to creep in.
v) Firms without uniform and standard production programs cannot adopt standard costing.
Cost variance is the difference between standard cost and actual cost. A variance is said to be
favourable when the actual cost is less than the standard cost and is said to be unfavourable
when the actual cost is more than the standard cost. Efficiency is indicated by a favourable
variance while an unfavourable variance points to inefficiency. Both the variances need to be
analyzed thoroughly to ensure cost control and find the contributory factors. Only then it
would be possible to find the amenability of the variances.
Variance analysis can be defined as the resolution into constituent parts and the explanation
of variances. It is of two types, cost variance, and sales variance.
We will limit our discussion only to Material and Labour cost variances in this unit.
i) Direct Material Cost Variance (DMCV): It is the difference between the standard cost for
actual output and the actual cost of materials used. We can obtain the standard cost for actual
output by multiplying the standard price with the standard quantity for actual output. The
actual cost can be ascertained by multiplying the actual price with the actual quantity.
The formula for DMCV = Standard Cost For Actual Output – Actual Cost
Or
DMCV = (Standard Price × Standard Quantity For Actual Output) – (Actual Price ×
Actual Quantity)
Example 5.6 16 kg of raw materials @ Rs. 1 per kg was consumed. On completion of the
unit, it was found that 20 kg. of raw material costing rs. 1.50 per kg. have been consumed.
Compute material cost variance.
= Rs. 14 (Adverse)
ii) Direct Material Price Variance (DMPV): It is the difference between the specified
standard prices and the actual paid price. Various possible reasons behind this variance are
inefficient buying, change in price, non-availability of favourable discounts, non-purchase of
standard quality materials, etc.
The variance would be adverse if the actual price is more than the standard price and it would
be favourable if the standard price is more than the actual price.
Example 5.7 16 kg of raw materials @ Rs. 1 per kg was consumed. On completion of the
unit, it was found that 20 kg. of raw material costing rs. 1.50 per kg. have been consumed.
Compute material price variance.
Solution:
= 20 (1 – 1.50)
The formula for DMUV = Standard Price (Standard Quantity For Actual Output –
Actual Quantity)
= SP (SQ – AQ).
Example 5.8 16 kg of raw materials @ Rs. 1 per kg was consumed. On completion of the
unit, it was found that 20 kg. of raw material costing rs. 1.50 per kg. have been consumed.
Compute material usage variance.
Solution:
= 1 (16 – 20)
= Rs. 4 (Adverse)
As you can observe in the above examples, the total of DMPV and DMUV is equal to the
Material Cost Variance. Therefore,
Example 5.9 A manufacturing concern that had adopted standard costing furnishes the
following information.
Standard:
Material 70 kgs.
Actual:
Calculate:
Solution:
For an output of Rs.70 kgs. of finished products, the standard quantity of material output is
100 kgs.
(a) Material usage variance = Standard Price (Standard Quantity – Actual Quantity)
(b) Material price variance = Actual Quantity (Standard Price – Actual Price)
(c) Material cost variance = Standard Quantity × Standard Price – Actual Quantity ×
Actual Price
= (3,00,000 × 1) – (2,52,000)
Verification:
Standard Actual
Solution:
Total Standard Cost = Rs. 2,325 Total actual cost = Rs. 2,702
(ii) Material Price Variance = Actual Quantity (Standard Price – Actual Price)
(iii) Material Usage Variance = Standard Price (Standard Quantity – Actual Quantity)
Example 5.11 From the following particulars, compute material cost variance, price
variance, and usage variance.
Solution:
Quantity)
Verification:
Example 5.12 Given that the cost standards for material consumption are 40 kgs. At rs. 10
per kg., compute the variances when actuals are:
Solution:
The formula for DLCV = Standard Cost For Actual Output – Actual Cost
Or
Actual Time)
Solution:
= 20,000 – 21,000
ii) Direct Labour Rate Variance (DLRV): It is the difference between the standard specified
rate and the actual paid rate. It can arise due to employment of the wrong type of labor,
excessive overtime, etc. Other names it is known by are wage rate variance and rate of pay
variance.
The formula for DLRV = Actual Time (Standard Rate – Actual Rate)
iii) Direct Labour Efficiency Variance (DLEV): It is the difference between the standard
specified labor hours and the actual hours spent on work. It is concerned with the standard
wage rate. There will be no labor efficiency variance where piece wage payment is in force.
It can arise due to poor working conditions, lack of supervision, the inefficiency of workers
because of inadequate training, use of high standard or substandard materials, higher labor
turnover, lack of proper machinery equipment and tools, etc.
The formula for DLEV = Standard Rate (Standard Time for Actual Output – Actual Time)
Idle Time Variance (ITV): It is a component of labor efficiency variance. It is the standard
cost of the actual hours for which the workers remain idle due to abnormal circumstances, for
example, power cut, breakdown of machinery, non-availability of raw materials, etc. ITV is
always adverse. The total labor rate, idle time and efficiency variances would be equal to
labor cost variance.
(i) labor cost variance, (ii) labor rate variance and, (iii) labour efficiency variance.
Solution:
(ii) Labour Rate Variance = Actual Time (Std. Rate – Actual Rate)
= 200 (10 – 12) = 400 (Adverse)
(iii) Labour Efficiency Variance = Standard Rate (Standard Time – Actual Time)
Verification:
Example 5.15 Standard hours for manufacturing two products, m, and n, is 15 hours per unit
and 20 hours per unit respectively. Both products require similar kinds of labor and the
standard wage rate per hour is Rs. 5. In the year 2011, 10,000 units of m and 15,000 units of
n were manufactured. The total of labor hours worked was 4,50,500 and the actual wage bill
came to Rs. 23,00,000. This included 12,000 hours paid for @ Rs. 7 per hour and 9,400
hours paid for @ Rs. 7.50 per hour, the balance having been paid at Rs. 5 per hour. You are
required to compute the labor variances.
Solution:
Labour Cost Variance = Standard Cost For Actual Output – Actual Cost
Standard cost:
4,50,000 Hours
= 50,000 (A)
= Rs.2,500 (A)
Verification:
Example 5.16 100 workers are working in a factory at a standard wage of rs. 4.80 per hour.
During a month there are four weeks of 40 hours each. The standard performance is set at
360 units per hour. The following is the summary of the wages paid during the month:
Power failure stopped production for 2 hours actual production of 57,960 units. Calculate
labor variances.
Solution:
Standard Cost = Standard Rate Per Hour × 100 × Units Produced / Standard Production per
hour
*For 91 workers, rate variance is not calculated because they are paid at std. Rate.
Standard Time = No. Of Employees × Quantity Produced / Std. Quantity Per Hour
= 15,800 Hours
Now, Labour Efficiency variance = Rs. 4.80 (16,100 Hours – 15,800 Hours)
Verification:
5.10 SUMMARY
Cost accounting helps in analyzing past, present, and future data to assist in managerial
decision-making. It is used by accountants as a conscious and rational procedure for
accumulating costs and relating them to specific departments or products for proper
management action. The substance used in making a product is known as Material. Direct
Material includes the materials that are an integral part of the final product and can be easily
traced to specific physical units. Indirect Material includes the materials used for purposes
ancillary to the business and that cannot easily be assigned to specific physical units.
The human effort required in the conversion of materials into finished goods is known as
labor. Direct Labour includes the labor that actively and directly participates in the
production of a particular commodity. Indirect Labour is the labor employed to undertake
tasks incidental to the production of goods or services.
Direct Expenses are the expenses that can be conveniently, directly, and wholly assigned to
particular cost units or cost centers. Indirect Expenses are the expenses that cannot be
conveniently, directly, and wholly assigned to particular cost units or cost centers.
Overheads include the cost of indirect labor, indirect expenses, and indirect material.
Manufacturing consists of the expenses incurred in the factory and is concerned with the
running of the plant or factory.
Office and Administrative Overheads contain expenses related to the administration and
management of the business and exclude the expenses falling under the manufacturing
overheads. Selling and Distribution Overheads are the expenses incurred for the promotion
and marketing of a commodity, for despatching goods sold, for making efforts to find new
customers and retaining the existing ones, and for securing orders for the products.
Fixed Costs are the costs that remain constant or static regardless of any change in the output.
Committed fixed costs are the costs that cannot be avoided in the short run and are
imperative for the functioning of the organization. The fixed costs set aside by the
management, during the budgeting process, for a short period and at a fixed amount are
known as discretionary fixed costs. The costs that change exactly in the same proportion as
the volume of output are known as variable costs. Semi-variable costs are the costs that
neither remain stationary nor vary proportionately.
Costs that remain fixed over a range of activities and then jump to a new level are called step
costs. Product Costs are the costs that become part of the product’s cost and not of the
expenses of the period in which they are incurred.
Period Costs are the costs that are charged to the period in which they are incurred and are
not associated with production.
Direct Costs contain the expenses on material and labor that can be easily and economically
traced to a service, product, or job.
Indirect Costs include the expenses on material and labor that cannot be easily and
economically traced to a service, product, or job. Decision-making costs are special-purpose
costs applicable only in situations in which they are constructed. Accounting costs are
primarily compiled from financial statements and need to be altered before getting
considered for decision making.
The costs that can be changed by managerial decisions are known as relevant costs. The costs
unaffected by managerial decisions are known as irrelevant costs. Shut-down costs are the
costs incurred even during the closure period of a firm. Sunk costs are the costs that are
incurred on account of such past decisions that cannot be changed by decisions made in the
future.
The costs that can be influenced by the action of a particular member of an undertaking are
called controllable costs. Costs that are not influenced by the action of a particular member of
an undertaking are called uncontrollable costs. If a cost is eliminated due to a segment of
business related to it getting discontinued, it is known as avoidable cost.
Unavoidable costs are the costs not eliminated when a segment of business related to them
gets discontinued. Costs that do not involve any cash outlay are called imputed costs. The
difference in total costs between the two alternatives is called differential costs.
When the choice of alternative results in an increase in total costs, the increased costs are
known as incremental costs. Out-of-pocket costs are the cost expenditure of the present and
future pertaining to a certain decision. The advantage foregone by not using the facilities in
the originally planned manner refers to opportunity costs.
Traceable costs: These are the costs that are easy to identify with a process, department, or
product. Untraceable costs are the costs that cannot be identified with a process, department,
or product. Joint costs are the costs incurred on the production of two or more products out of
the same material or process. The costs relating to the current period as a loss or expense are
known as expired costs.
Unexpired costs are the costs relating to the future period. The cost of transforming direct
materials into the finished products, exclusive of direct material cost is called conversion
cost. Prime Cost consists of the cost of direct labor, direct material, and direct expenses.
Other names of prime costs are flat cost, first cost, etc.
Under Factory Cost, Prime Cost and factory overheads are included. Total cost is arrived at
by adding selling and distribution overheads to the total cost of production. A cost sheet is a
statement containing the items that become a part of the cost of products or services. The
technique of using standards for revenues and costs for controlling through variance analysis
is called standard costing. Variance analysis can be defined as the resolution into constituent
parts and the explanation of variances.
It is of two types, cost variance, and sales variance. Direct Material Cost Variance (DMCV)
is the difference between the standard cost for actual output and the actual cost of materials
used. Direct Material Price Variance (DMPV) is the difference between the specified
standard prices and the actual paid price. Direct Material Usage Variance (DMUV) is the
difference between the standard specified quantity and the used quantity. Direct Labour Cost
Variance (DLCV) is the difference between standard direct wages specified for the activity
achieved and the actual direct wages paid.
Direct Labour Rate Variance (DLRV) is the difference between the standard specified rate
and the actual paid rate. Direct Labour Efficiency Variance (DLEV) is the difference
between the standard specified labor hours and the actual hours spent on work. Idle Time
Variance (ITV) is a component of labor efficiency variance. It is the standard cost of the
actual hours for which the workers remain idle due to abnormal circumstances.
1. All controllable costs are direct costs, not all direct costs are controllable. Explain with the
help of suitable examples.
B. Practical Questions
Raw Materials:
Purchases 1,00,000
Closing 40,000
(Hint: Cash discount and interest on capital are to be excluded from costs).
2. Calculate (a) Value of raw material consumed, (b) Total cost of production, (c) Cost of
production of goods sold, and (d) The amount of profit from the following particulars:
Opening Stock:
Closing stock:
Power 2,000
Advertising 300
Sales 1,00,000
3. A company has provided the following information to you in respect of 10,000 units of
output. Calculate the total cost for 12,000 units of output and the cost per unit with the
following information:
4. Prepare a cost sheet to show the total cost of production and cost per unit of goods
manufactured by a company for July 2010. Also, find out the cost of sales.
The cost of finished goods was 400 and 600 units on 1-7-2010 and 31-7-2010 respectively.
The total cost of units on hand on 1-7-2010 was Rs. 4800. All these have been sold during
the month.
5. A furniture manufacturer makes sun mica tops for tables. From the following information,
find out price variance, usage variance, and material cost variance.
Actual purchase price of sun mica per sq. Ft. Rs. 5.50
(a) Proportionally
(b) Industry
(c) Inversely
(d) Indirect
3. Imputed cost is a
A. each department.
C. each month.
D. each executive.
10. The cost expended in the past that cannot be retrieved on product or service
______________
Answers: 1(a), 2 (b), 3 (a), 4 (d), 5 (a), 6 (b), 7(a),8 (a), 9 (c), (10 (b)
Reference Books
● Lanen, W., Anderson, S., & Maher, M. (2019). Fundamentals of Cost Accounting
(6th ed.). McGraw-Hill Education.
● Publishers, V. (2020). Cost Accounting & Management Essentials You Always
Wanted To Know (Self-Learning Management) (4th ed.). Vibrant Publishers.
Textbook References
● Berger, A. (2011). Standard Costing, Variance Analysis and Decision-Making (1st
ed.). GRIN Verlag.
● Bragg, S. M. (2019). Cost Accounting: Second Edition: A Decision-Making Guide.
Accounting Tools, Inc.
● Horngren, C.T.; Datar Srikant M and Foster George M, 2002, Cost Accounting: A
Managerial Emphasis, Prentice Hall of India: New Delhi (Chapters 2 and 9)
Websites
● F. (2020, July 20). What Is Cost Accounting? It’s Cost Control | FreshBooks
Resource Hub. FreshBooks. https://www.freshbooks.com/hub/accounting/cost-
accounting
● B. (2021, January 29). Cost Accounting - Definition, What is Cost Accounting, and
How Cost Accounting works? Clear Tax. https://cleartax.in/g/terms/cost-accounting