Cost and Management Accounting 309

Browse more Topics under Fundamentals of Cost Accounting

 Origin and Evolution of Cost Accounting

 Meaning of Cost, costing and cost accounting
 Importance of Cost Accounting
 Financial Account vs Cost Account
 Meaning of Management Accounting
 Objectives of Cost Accounting
 Advantages of Cost Accounting
 Costing – an aid to management
 Characteristics of an Ideal Costing System
 Classification of Cost
 Methods of Costing
 Techniques of Costing
 Cost Unit and Cost Centre
 Cost Control and Cost Reduction
 Elements of Cost
 The format of the Cost Sheet
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Assignment# 1
Elements of Cost Accounting
The elements of cost are those elements which constitute the cost of
manufacture of a product. We can broadly divide these elements of cost into
three categories. In a manufacturing organization, we convert raw materials into
a finished product with the help of labor and other services. These services are
Material, Labour and Expenses.

Elements of Cost
Again, we can bifurcate these elements of cost into two categories such as
Direct Material and Indirect Material, Direct Labour and Indirect Labour, Direct
Expenses and Indirect Expenses. We need to add all direct material, direct
labor, and direct expenses to calculate the prime cost.
Likewise, we add all indirect material, indirect labor, and indirect expenses to
calculate the overhead cost. Again, we can bifurcate the overheads into four
categories. They are factory overhead, administrative overhead, selling
overhead and distribution overhead.
1. Direct Material
It represents the raw material or goods necessary to produce or manufacture a
product. The cost of direct material varies according to the level of output. For
example, Milk is the direct material of ghee.
2. Indirect Material
It refers to the material which we require to produce a product but is not directly
identifiable. It does not form a part of a finished product. For example, the use
of nails to make a table. The cost of indirect material does not vary in the direct
proportion of product.
3. Direct Labour
It refers to the amount which paid to the workers who are directly engaged in
the production of goods. It varies directly with the level of output.
4. Indirect Labour
It represents the amount paid to workers who are indirectly engaged in the
production of goods. It does not vary directly with the level of output.
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5. Direct Expenses
It refers to the expenses that are specifically incurred by the enterprises to
produce a product. The production cannot take place without incurring these
expenses. It varies directly with the level of production.

6. Indirect Expenses
It represents the expenses that are incurred by the organization to produce a
product. These expenses cannot be easily identified accurately. For example,
Power expenses for the production of pens.

7. Overhead
It refers to all indirect materials, indirect labour, or and indirect expenses.

8. Factory Overhead
Factory overhead or Production Overhead or Works Overhead refers to the
expenses which a firm incurs in the production area or within factory premises.

Indirect material, rent, rates and taxes of factory, canteen expenses etc. are
example of factory overhead.

9. Administration Overhead
Administrative or Office Overhead refers to the expenses which are incurred in
connection with the general administration of the organizations.

Salary of administrative staff, postage, telegram and telephone, stationery

etc.are examples of administration overhead.

10. Selling Overhead

All expenses that a firm incurs in connection with sales are selling overheads.
Salary of sales department staff, travelers’ commission, advertisement etc.are
example of selling overhead.
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11. Distribution Overhead

It represents all expenses incurred in connection with the delivery or
distribution of finished goods and services from the manufacturer to the
consumer. F Delivery van expenses. loading and unloading, customs duty, the
salary of deliverymen are examples of distribution overhead.

Solved Example for You

Specify items which are generally classified as direct materials?

Ans:
Following are normally classified as direct materials:

(i) All raw materials like plastic in the manufacture of bottles, yarn in clothes,
and iron in the steel industry.

(ii) Materials specifically acquired for a specific job, process or order like
adhesives for bookbinding, starch powder for dressing yarn.

(iii) Parts or components acquired or produced like cartage for printer and tires
for cars.

(iv) All materials used in primary packing like cartons, wrappings, cardboard
boxes, etc. to protect finished goods from climatic conditions or for easy
handling inside the factory.

From the above discussion, it becomes clear that indirect materials are those
materials which cannot be treated as direct materials. Consumables, like the
cotton waste, lubricants, brooms, rags, cleaning materials, materials for repairs
and maintenance of fixed assets, are examples of indirect materials.
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2. Evaluate
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Topic: Quality and future of a good cost accounting system

1. Relevance- cost accounting information must be relevant for the purpose
for with the information is needed.
2. Understandable / simplicity
3. Clarity
4. Timeliness
5. Adequacy
6. Reliability
7. Economical
8. Objectivity
9. Comparability
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TOPIC: BASIC CALCULATION IN COST ACCOUNTING

There are algebraic or arithmetic tools used for processes in analyzing and
presenting costing quantative data.
Example: franctions, ratio, percentage, simple interest, compound interest,
present value, discounting series, mark up, margin, mark down, discount
Cost and Management Accounting 309

Assignment # 2
1. The difference between Cost Accounting and Managerial Accounting
2. Difference between Finance Accounting and Cost Accounting
3. List some advantages and disadvantages of Cost Accounting
4. Name 10 functions of Cost Accounting
5. List 10 activities undertaken by Cost Department

Q# 1 The difference between Cost Accounting and Managerial

Accounting

Cost Accounting and Management Accounting:

Management Accounting is primarily concerned with management. It involves
application of appropriate techniques and concepts, which help management in
establishing a plan for reasonable economic objective. It helps in making
rational decisions for accomplishment of these objectives. Any workable
concept or techniques whether it is drawn from Cost Accounting, Financial
Accounting, Economics, Mathematics and Statistics, can be used in
Management Accountancy. The data used in Management Accountancy should
satisfy only one broad test. It should serve the purpose that it is intended for. A
Management Accountant accumulates, summarizes and analysis the available
data and presents it in relation to specific problems, decisions and day-to-day
task of management. A Management Accountant reviews all the decisions and
analysis from management’s point of view to determine how these decisions
and analysis contribute to overall organizational objectives. A Management
Accountant judges the relevance and adequacy of available data from
management’s point of view.
The scope of Management Accounting is broader than the scope of Cost
Accountancy. In Cost Accounting, primary emphasis is on cost and it deals with
its collection analysis relevance interpretation and presentation for various
problems of management. Management Accountancy utilizes the principles and
practices of Financial Accounting and Cost Accounting in addition to other
management techniques for efficient operations of a company. It widely uses
different techniques from various branches of knowledge like Statistics,
Mathematics, Economics, Laws and Psychology to assist the management in its
task of maximizing profits or minimizing losses.
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The main thrust in Management Accountancy is towards determining policy and

formulating plans to achieve desired objective of management. Management
Accounting makes corporate planning and strategy effective.
From the above discussion we may conclude that the Cost Accounting and
Management Accounting are interdependent, greatly related and inseparable.

Q# 2 Difference between Finance Accounting and Cost

Accounting

Financial Accounting and Cost Accounting: Financial Accounting is primarily

concerned with the preparation of financial statements, which summaries the
results of operations for selected period of time and show the financial position
of the company at particular dates. In other words, Financial Accounting reports
on the resources available (Balance Sheet) and what has been accomplished
with these resources (Profit and Loss Account). Financial Accounting is mainly
concerned with requirements of creditors, shareholders, government,
prospective investors and persons outside the management. Financial
Accounting is mostly concerned with external reporting

Cost Accounting, as the name implies, is primarily concerned with

determination of cost of something, which may be a product, service, a process
or an operation according to costing objective of management. A Cost
Accountant is primarily charged with the responsibility of providing cost data
for whatever purposes they may be required for.
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The main differences between Financial and Cost Accounting are as

follows:

Financial Accounting Cost Accounting

(a) It provides the information about the (a) It provides information to the
business in a general way. i.e Profit and management for proper planning,
Loss Account, Balance Sheet of the operation, control and decision making.
business to owners and other outside
partners.
(b) It classifies, records and analyses the (b) It records the expenditure in an
transactions in a subjective manner, i.e objective manner, i.e according to the
according to the nature of expense. purpose for which the costs are incurred.

(c) It lays emphasis on recording aspect (c) It provides a detailed system of

without attaching any importance to control for materials, labour and overhead
control. costs with the help of standard costing
and budgetary control.

(d) It reports operating results and (d) It gives information through cost
financial position usually at the end of the reports to management as and when
year. desired.
(e) Financial Accounts are accounts of (e) Cost Accounting is only a part of the
the whole business. They are independent financial accounts and discloses profit or
in nature. loss of each product, job or service.
(f) Financial Accounts records all the (f) Cost Accounting relates to
commercial transactions of the business transactions connected with
and include all expenses i.e Manufacturing of goods and services,
Manufacturing, Office, Selling etc. means expenses which enter into
production.
(g) Financial Accounts are concerned (g) Cost Accounts are concerned with
with external transactions i.e. transactions internal transactions, which do not
between business concern and third party. involve any cash payment or receipt.

(h) Only transactions which can be (h) Non-Monetary information likes No

measured in monetary terms are recorded. of Units /Hours etc are used.
(i) Financial Accounting deals with actual (i) Cost Accounting deals with partly
figures and facts only. facts and figures and partly estimates /
standards.
(j) Financial Accounting do not provide (j) Cost Accounts provide valuable
information on efficiencies of various information on the efficiencies of
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workers/ Plant & Machinery. employees and Plant & Machinery.

(k) Stocks are valued at Cost or Market (k) Stocks are valued at Cost only.
price whichever is lower.
(l) Financial Accounting is a positive (l) Cost Accounting is not only positive
science as it is subject to legal rigidity science but also normative because it
with regarding to preparation of financial includes techniques of budgetary control
statements. and standard costing.

(m) These accounts are kept in such a (m) Generally, Cost Accounts are kept
way to meet the requirements of voluntarily to meet the requirements of
Companies Act 2013 as per Sec 128 & the management, only in some industries
Income Tax Act, 1961 Sec 44AA. Cost Accounting records are kept as per
the Companies Act.

Q# 3 List some advantages and disadvantages of Cost Accounting

Advantages of Cost Accounting

Cost Accounting has manifold advantages, a summary of which is given below.
It is not suggested that having installed a system of Cost Accounting, a concern
will expect to derive all the benefits stated here, the nature and the extent of the
advantages obtained will depend upon the type, adequacy and efficiency of the
cost system installed and the extent to which the various levels of management
are prepared to accept and act upon the advice rendered by the cost system.

The Cost Accounting System has the following advantages: -

(i) A cost system reveals unprofitable activities, losses or inefficiencies

occurring in any form such as:

(a) Wastage of man power, idle time and lost time.

(b) Wastage of material in the form of spoilage, excessive scrap etc., and

(c) Wastage of resources, e.g., inadequate utilization of plant, machinery

and other facilities.
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(ii) Cost Accounting locates the exact causes for decrease or increase in
the profit or loss of the business. It identifies the unprofitable products or
product lines so that these may be eliminated or alternative measures may
be taken.
(iii) Cost Accounts furnish suitable data and information to the
management to serve as guides in making decisions involving financial
considerations.
(iv) Cost Accounting is useful for price fixation purposes. Although
sale price is generally related more to economic conditions prevailing in
the market than to cost, the latter serves as a guide to test the adequacy of
selling prices.
(v) With the application of Standard Costing and Budgetary Control
methods, the optimum level of efficiency is set.
(vi) Cost comparison helps in cost control. Comparison may be period
to period, of the figures in respect of the same unit or factory or of several
units in an industry by employing Uniform Costs and Inter- Firm
Comparison methods. Comparison may be made in respect of cost of
jobs, process or cost centers.
(vii) A cost system provides ready figures for use by the Government,
wage tribunals and boards, and labour and trade unions.
(viii) When a concern is not working to full capacity due to various
reasons such as shortage of demands or bottlenecks in production, the
cost of idle capacity can readily work out and repealed to the
management.

(ix) Introduction of a cost reduction programmes combined with operations

research and value analysis techniques leads to economy.

(x) Marginal Costing is employed for suggesting courses of action to be taken.

It is a useful tool for the management for making decisions.
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(xi) Determination of cost centres or responsibility centres to meet the needs of

a Cost Accounting system, ensures that the organizational structure of the
concern has been properly laid responsibility can be properly defined and fixed
on individuals.

(xii) Perpetual inventory system which includes a procedure for continuous

stock taking is an essential feature of a cost system.

(xiii) The operation of a system of cost audit in the organization prevents

manipulation and fraud and assists in furnishing correct and reliable cost data to
the management as well as to outside parties like shareholders, the consumers
and the Government.
Cost and Management Accounting 309

Advantages and Disadvantages of Cost Accounting: Today accounting plays

a major role in every business life. Every transaction, especially monetary one,
is recorded in the books of the organization and is analyzed to improve the
efficiency and forecast the future of the business. There are different branches
of accounting, namely Management accounting, Cost accounting, and financial
accounting. Now let us understand what accounting is?
Accounting is a process of classifying, summarizing, and recording transactions
or events which can be expressed in the form of money and can be interpreted
thereof. According to A. W. Johnson; “Accounting may be defined as the
collection, compilation and systematic recording of business transactions in
terms of money, the preparation of financial reports, the analysis and
interpretation of these reports and the use of these reports for the information
and guidance of management”. Now let us focus on the very topic that is cost
accounting.
Cost Accounting refers to the recording of the transaction related to the cost
incurred and income generated by the organization and also helps in making
different financial statements and controlling costs. Thus, this branch of
accounting helps the management to make the company efficient and adopt
cost-effective measures. But still, there are certain disadvantages of cost
accounting also. Let’s discuss the advantages and disadvantages of cost
accounting.
Advantages of Cost Accounting
Below are a few advantages of Cost Accounting. Let’s discuss the advantages
briefly
1. Assistance to the management: Cost accounting is an aid to
management as it helps them to understand the pattern of the cost
incurred and how to control it. It also provides information about the
income earned during the whole process thus helping them to forecast
and manage the resources.
2. Helps in reducing costs: As we already discussed it give a platform to
management to forecast, evaluate and decide how to control the cost,
therefore cost is reduced to a much extent. Also, reduced cost helps to
earn more profit.
3. 3. Helps in forecasting: The best part of cost accounting is it helps to
forecast and take decisions. Experts of accounting have to make certain
Cost and Management Accounting 309

accounts to get through with the situation of the organization and act
accordingly. They can compare and provide cost estimates that help
management to make a decision and also help in locating wasteful
activities.
4. Helps in preparation of financial accounts: Proper estimation of costs
helps in preparing the final accounts and estimates whether an
organization has profit or loss. Profit and loss accounts and balance sheets
are prepared with the historical costs thus financial accounts can easily be
made.
5. Fraud can be reduced: As there is continuous assessment of cost and
management is involved to control the cost therefore chances of fraud can
be reduced. Cost accounting runs on a certain principle if deviated the
chances of fraud can be detected.
6. Helps the government: Government needs information on the
company’s financial statement to assess the tax and charge the tax
according to the profit gained by the company. If the government finds
any error in the company’s financial statement then it may assess the
financial statement again and find the fault or fraud happening in the
company.
7. Helps in determining loss or profit: Cost accounting helps in
determining the profit of the company. It’s very essential to determine the
profit and losses of the company not only to assess tax but also to provide
various pending payments to people whose amount is due.

Disadvantages of Cost Accounting

Let’s discuss the disadvantages of cost accounting briefly.
1. Only past performance can be recorded: Cost accounting does not
show the current stature of the company as all the data recorded is a
historical valuation of transactions taking place. The structure of
decision-making relies on the records of a company. Thus, only past
performances are recorded.
2. Costs keep on changing every year: the cost of the raw material, labour,
and other materials keep on changing due to different factors thus only
estimation can be made regarding costs, and accordingly managers have
to make decisions. There are various other variable factors like
government policies, economy that make these changes in the cost.
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3. Proper maintenance is required: To calculate the cost of the company

it is required ethical and proper maintenance is a must. Without
maintaining proper books of account like sales books, purchase books no
one could properly estimate the actual cost incurred and income
generated by the company.
4. Expertise is required to record: To record the books of account one
should have the proper knowledge and mastery in the recording of
transactions, identify and summarize in the best possible way so that the
user who requires the information from the account can easily understand
it. Therefore, no person can easily record the transaction if he/she does
not have any proper knowledge of the principles of accounting.
5. Complex system: The system to record the transactions is a complex
process. No one can easily understand the process if they have not
learned the steps or learned about accounting. Even for experts it
sometimes gets complex to estimate the correct cost.
6. Costly to maintain: It’s costly to maintain the books of accounts and
requires lots of clerical work to maintain various costing records. For
small-scale and medium-sized businesses maintaining the costing
account, books become an impossible task.

Comparative Table for Advantages and Disadvantages of Cost Accounting

Advantages of Cost Accounting Disadvantages of Cost Accounting

Only past performance can be

Assistance to the management
recorded

Helps in reducing costs Costs keep on changing every year

Helps in forecasting Proper maintenance is required.

Helps in preparation of financial accounts Expertise is required to record

Fraud can be reduced Complex system

Helps the government in determining loss or

Costly to maintain
profit
Cost and Management Accounting 309

Scope of Cost Accounting

The scope of cost accounting is actually quite wide. It mainly consists of three
main aspects. Let us take a brief look at them.
1 Cost Ascertainment
This is one of the main criteria for cost accounting. Cost ascertainment is the
process of collection of expenses and by analysis of these expenses. It links up
the production of various products at their different stages of production with
such expenses.
Over time we have seen the development of a variety of production processes,
and so different systems of costing were also developed.
Examples include historical cost, actual costs, standard costs etc. And linking of
these expenses with the manufacturing process occurs via many techniques such
as marginal cost technique, direct cost technique etc.
2 Cost Accounting
This is the process of accounting for the costs of a firm. Classifying and
recording of costs is the first step in the process. The end result is the
preparation and presentation of this statistical data in an acceptable format.
Cost accounting is almost as crucial to management as financial accounting. It
allows them to make decisions. And if the cost accounting and financial
recording statements are separate, they must be reconciled at year-end.
3 Cost Control
Cost control is the process by which action is taken to reduce the costs and
expenses to boost profitability and efficiency.
The idea is to bring the actual figures as close to the target or budgeted figures
as possible. This involves the regulation of any costs that deviate from the
target.

Q# 4 Name 10 Functions of Cost Accounting

To understand the entire cost structure of a firm, cost accounting is crucial. It

ascertains the costs of various products, processes etc.
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So, we can compare them to the sales and arrive at the true profitability of the
firm. This is one of the main objectives or functions of cost accounting. To
achieve this the actual functions of cost accounting change daily. Let us take a
look,

1. ascertain the cost per unit of every product that the company
manufactures
2. to identify any wastages whether in material, expense, time, tools and
spares etc. Also, suggest ways to minimize this wastage
3. also, provide data that helps in the process of price fixing
4. calculate with accuracy the profitability of each of the company’s
products. And figure out ways to maximize these profits
5. cost accounting is also responsible for the control of raw material and raw
material ordering. So, it must ensure that we are not overordering which
leads to capital being locked-up unnecessarily. And underordering will
lead to inefficiency in the manufacturing process,
6. also, perform the functions of cost control for materials, labor, and other
miscellaneous expenses
7. present data to the management that allows them to interpret the data and
make business decisions
8. help management with incentive plans that are based on efficiency
9. also, help the management with the preparation of budgets and setting up
budgetary controls
10. Economic use of limited resources of production
Cost and Management Accounting 309

Overview of account costing

Job costing
Contract costing Specific Costing
Batch costing

Process costing Operation Costing

Service

Costing techniques
Marginal costing
Absorption
Breakeven analysis
Standard costing
Budgeting/budgetary control
Uniform costing
Cost principles/procedures
Acct. for materials
Acct for overhead
Acct. labor
Manufacturing/cost classification
Control accounts/ cost ledger
Basic calculation