COST Accounting AND Estimation

11/30/23, 2:18 PM COST Accounting AND Estimation
COST ACCOUNTING AND ESTIMATION

The Institute of Cost and Works Accountants, India defines cost
accounting as, “The technique and process of ascertainment of costs.
Cost accounts the process of accounting for costs, which begins with
the recording of expenses or the bases on which they are calculating
and ends with the preparation of statistical data.” Thus, the process
of accounting for cost from the point at which expenditure incurs or
commit to the establishment of its ultimate relationship with cost
centres and cost units. In its wider usage, it embraces the
preparation of statistical data, the application of cost control
methods and the ascertainment of the profitability of activities carry
out or plan.
TERMS:
Costing: technique and process of ascertaining costs.
Determining the cost of a product and making the various
budgets and standards when assisting the management or
business.
This is a reasonable definition, but it only addresses the
dimensions of technique and process. To elaborate on this, costing
can also be defined as a systematic process for determining the
unit cost of output produced.
Cost accounting: records and aims to capture a company’s

total cost of production by assessing the variable costs of each
step of production as well as fixed costs such as least expenses.
Overhead: ongoing business expenses.it is important for

budgeting purposes but also for determining how much a company
much charge for its products or services to make a profit.
Classification of Overheads:
 Direct Overheads
 Factory Overheads
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 Indirect Office Overheads

 Indirect Selling and distribution Overheads
Budget: process of creating a financial plan and budget using cost

estimation .it is a financial tool that professionals can use to manage
their funds. It is the involvement of totalling all expected costs for a
set period.
Estimation: technique of calculating or competing the various
quantity and expenditure computing of a project.
Cost estimation: statement that gives the value of the cost
incurred in the manufacturing of finished goods. Cost estimation
helps in fixing the selling price of the final product after charging
appropriate overheads and allowing a certain margin for profits.
Quantity survey: it is the scheduled of all items of work in a
building. These quantity are calculated from the drawing of the
building .thus quantity survey gives quantities of work done in
each case of items. When priced gives the total cost. Calculations
of quantities of materials required to complete the wok concerned.
Specifications: detailed specification gives the nature quality and
class of work materials to be used in the various parts of work quality
of the materials their proportions, methods of preparations,
workmanship and descriptions of the execution of work are required.
Rate: rate of various items of works materials to be used in the
construction and the wages of different categories of labour should
be available for preparing an estimate. The cost of transportation
charges should also be known.
Supplement estimate: when additions are done in the original
work, freshly detailed estimate is prepared to supplement the
original work.
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Indirect Indirect costs are not directly accountable to a cost object,

cost : such as a particular function or product. Indirect costs may be
either fixed or variable. Indirect costs can be tax,
administration, personnel, and security costs and are also
known as overhead costs.
Direct Direct costs are the costs that can be directly allocated to a
cost: cost object, for example, material purchase for a specific
product.
Fixed cost : Costs are the costs that are not dependent on the level of
goods or services produced by the company. They tend to be
time-related, such as salary or rent being paid per month. They
are in contrast to variable costs, which are volume-related, and
are paid per quantity produced.
Operational Operational costs are the recurring expenses which are

cost : related to the operation of a business, a device, and a
component.
Variable Variable costs are expenses that change in proportion to the

cost : activity of a business. Variable costs are the sum of marginal
costs over all units produced. Fixed costs and variable costs
make up the two components of total costs.
Allocation : The allocation key is the basis that is used to allocate costs. It
key is typically a quantity, such as square meters occupied, number
of employees, or man-hours used. For example, two
departments, with 20 and 10 employees respectively, share
canteen costs.
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Lump sum items: sometimes while preparing an estimate for

certain small items like front architecture or decoration work of a
building it is not possible to workout detailed quantities so far such
as lump sum items a lump sum rate is provided.
Marginal Cost: It is the aggregate of variable costs, i.e., prime cost
plus variable overheads.
Replacement Cost: It is the cost of replacing a material or asset in

the current market.
Variable Variable costs are expenses that change in proportion to the

cost : activity of a business. Variable costs are the sum of marginal
costs over all units produced. Fixed costs and variable costs make
up the two components of total costs.
Cost reduction: Cost reduction refers to real or genuine savings

through permanent reduction in cost of a product or service
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without impairing the quality and affecting its purpose for which
it was intended to be used. In the competitive market situations,
it is utmost important for the organisations to look for activities
and search for new technology through research and
development activities that can reduce the cost of a product.
Cost reduction can be attainable in almost all the areas of
business activities. The area covered for cost reduction are like
product design, plant layout, production methods, material
substitution, reduction in wastages, innovation marketing
strategies, purchasing and material control etc.
Cost ascertainment: The primary objective of cost accounting is to

determine the cost of production of every unit, job, operation,
process, department or service. The technique of ascertaining cost is
known as „Costing‟. In order to determine cost, all the expenses are
accumulated, classified and analysed. It not only determines the cost
at completion stage but also determines cost at various stages of
production.
Objectives of Costing:
1. Ascertainment of Cost
Ascertainment of cost is the first and most important objective of

costing.
The aim is to determine the cost of each product, process, or

operation, and to ensure that all expenses are absorbed into the cost
of the products, the techniques, and the process of costing used.
2. Cost Control
Ascertaining costs alone is not sufficient. Naturally, it is not enough

because it is the cost that determines the selling price and, in turn,
the profitability. As such, the norm that everyone attempts to follow
is “the lower the cost, the greater to profit.”
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3. Guidelines for Management
Costing is a faithful servant for managers within an organization. It

aids managerial decision-making from all practical points of view.
For example, the use of cost data can guide the introduction of a new
product line, lead to the identification of unused capacity, or
highlight expansion opportunities.
Advantages of Costing:
 Costing provides valuable cost data. Therefore, it plays a vital role
in managerial decision-making.
 To deliver good services, it is also necessary to have a sound

costing system.
 An important advantage of costing is that it provides cost data for
managerial decisions. Costing also provides information that may
help in making estimates and then in calling for tenders.
 Costing reveals the losses that a particular unit is incurring. It

reveals the inefficiencies at various levels, and it also helps to
identify the exact cause of a decrease or increase in the profit or
loss of a business
 A final advantage of costing is that it helps managers within an

organization make decisions about wages.
Scope of cost accountancy:
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The scope of Cost Accountancy is very wide and includes the

following:-
Cost Ascertainment: The main objective of Cost Accounting is to find
out the Cost of product / services rendered with reasonable degree
of accuracy
Cost Accounting: It is the process of Accounting for Cost which
begins with recording of expenditure and ends with preparation of
statistical data.
Cost Control: It is the process of regulating the action so as to keep
the element of cost within the set parameters.
Cost Reports: This is the ultimate function of Cost Accounting. These
reports are primarily prepared for use by the management at
different levels. Cost reports helps in planning and control,
performance appraisal and managerial decision making.
Cost Audit: Cost Audit is the verification of correctness of Cost
Accounts and check on the adherence to the Cost Accounting plan.
Its purpose is not only to ensure the arithmetic accuracy of cost
records but also to see the principles and rules have been applied
correctly.
Differences b/w financial accounting and cost accounting:
Financial accounting:
 It provides the information about the business in a general
way. I.e. Profit and Loss Account, Balance Sheet of the business
to owners and other outside partners.
 It classifies, records and analyses the transactions in a
subjective manner, i.e. according to the nature of expense.
 It lays emphasis on recording aspect without attaching any
importance to control.
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 It reports operating results and financial position usually at the

end of the year.
 Financial Accounts are accounts of the whole business. They
are independent in nature.
 Financial Accounts records all the commercial transactions of
the business and include all expenses i.e. Manufacturing,
Office, Selling etc.
 Financial Accounts are concerned with external transactions
i.e. transactions between business concern and third party.
 Only transactions which can be measured in monetary terms
are recorded.
Cost accounting:
 It provides information to the management for proper
planning, operation, control and decision making.
 It records the expenditure in an objective manner, i.e
according to the purpose for which the costs are incurred.
 It provides a detailed system of control for materials,
labour and overhead costs with the help of standard costing

and budgetary control.
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 It gives information through cost reports to management
as and when desired.
 Cost Accounting is only a part of the financial accounts
and discloses profit or loss of each product, job or service.
 Cost Accounting relates to transactions connected with
Manufacturing of goods and services, means expenses which

enter into production.
 Cost Accounts are concerned with internal transactions,
which do not involve any cash payment or receipt.
 Non-Monetary information likes No of Units / Hours etc.
are used.
Elements of Cost the elements of costs are the essential part

of the cost.
There are broadly three elements of cost, as explained below:
(A) Material the substance from which the produce is made is
called material. It can be direct as well as indirect.
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I) Direct Material: it refers to those materials which become an

integral part of the final product and can be easily traceable to
specific physical units.
Direct materials, thus, include:
1. All materials specifically purchased for a particular job or
process.
2. Components purchased or produced.
3. Primary packing materials (e.g., carton, wrapping, card-
board boxes etc.).
4. Material passing from one process to another.
II) Indirect Material:

All materials which are used for purpose ancillary to the
business and which cannot conveniently be assigned to specific
physical units are known as `indirect materials‟.
Oil, grease, consumable stores, printing and stationery material
etc. are a few examples of indirect materials.
(B) Labour In order to convert materials into finished products,

human effort is required. Such human effort is known as
labour. Labour can be direct as well as indirect.
Direct Labour: It is defined as the wages paid to workers who are
engaged in the production process and whose time can be
conveniently and economically traceable to specific physical units.
When a concern does not produce but instead renders a service, the
term direct labour or wages refers to the cost of wages paid to those
who directly carry out the service, e.g., wages paid to driver,
conductor etc. Of a bus in transport service.
II) Indirect Labour: Labour employed for the purpose of carrying out
tasks Incidental to goods produced or services provided is called
indirect labour or indirect wages. In short, wages which cannot be
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directly identified with a job, process or operation, are generally

treated as indirect wages.
Examples of indirect labour are: wages of store-keepers, foremen,
supervisors, inspectors, internal transport men etc.
(C) Expenses Expenses may be direct or indirect.
I) Direct Expenses: These are expenses which can be directly,
conveniently and wholly identifiable with a job, process or operation.
Direct expenses are also known as chargeable expenses or productive
expenses.
Examples of such expenses are: cost of special layout, design or
drawings, hire of special machinery required for a particular contract,
maintenance cost of special tools needed for a contract job, etc.
II) Indirect Expenses: Expenses which cannot be charged to
production directly and which are neither indirect materials nor
indirect wages are known as indirect expenses. Examples are rent,
rates and taxes, insurance, depreciation, repairs and maintenance,
power, lighting and heating etc.
2. Cost Classification by Time
On the basis of the time of computing costs, they can be classified
into historical and predetermined costs
. I) Historical Costs: These costs are computed after they are incurred.
Such costs are available only after the production of a particular thing
is over.
II) Pre-Determined Costs: These costs are computed in advance of
production on the basis of a specification of all factors influencing
cost. Such costs may be:
1. Estimated costs: estimated costs are based on a lot of guess work.
They try to ascertain what the costs will be based on certain factors.
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They are less accurate as only past experience is taken into account
primarily, while computing them.
2. Standard costs: standard costs is a pre-determined cost based on a
technical estimate for material, labour and other expenses for a
selected period of time and for a prescribed set of working
conditions. It is more scientific in nature and the object is to find out
what the costs should be.
3. Cost Classification by Traceability As explained previously, costs
which can be easily traceable to a product are called direct costs.
Indirect costs cannot be traced to a product or activity. They are
common to several products (e.g., salary of a factory manager,
supervisor etc.) And they have to be apportioned to different
products on some suitable basis. Indirect costs are also called
`overheads‟
4. Cost Classification by Association with Product Costs can also be
classified (on the basis of their association with products) as product
costs and period costs.
 Product Costs: product costs are traceable to the product and
include direct material, direct labour and manufacturing
overheads. In other words, product cost is equivalent to
factory cost.
 Period Costs: period costs are charged to the period
in which they are incurred and are treated as expenses. They

are incurred on the basis of time, e.g., rent, salaries, insurance
etc. They cannot be directly assigned to a product, as they are
incurred for several products at a time.
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Marginal cost equation:

The algebraic expression of contribution is known as marginal
cost equation. It can be expressed thus:
 S–V=F+P
S–V=C
=F+P
 And In Case Of Loss
C=F–L
Where:
S = Sales
V = Variable Cost
C = Contribution
F = Fixed Cost
P = Profit
L = Loss
Profit volume ratio:

Contribution P/V Ratio = contribution divide by sales multiply
by 100
C/ S or s-v /s
Or f+ p/s
Or 1- variable cost / sales
The ratio can also be shown by comparing the change in
contribution to change in sales, or change in profit to change
in sales.
P/v ratio = change in contribution / change in sales.

Is equal to change in profit / change in sales.
Budgeting:
According to batty “the entire process of preparing the
budgets is known as budgeting “
Objectives of budgeting:
 to obtain more economical use of capital
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 to prevent waste and reduce expenses

 to fix responsibilities on different departmental heads
 to ensure availability of working capital
 To co -ordinate the activities of various departments.
Cost audit: the terminology of ICMA London, defines cost audit as

the “verification of the correctness of cost accounts and the
adherence to the cost accounting plan”
Nature of cost accounting:

The nature of cost accounting can be brought out under the
following headings:
Cost accounting is branch of knowledge
Cost accounting is science
Cost accounting is an art
Cost accounting is a profession
Objectives of cost accounting:

 Determining selling price
 Determining and controlling efficiency
 Facilitating preparation of financial and other statements
 Providing basis for operating policy
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Budgetary Control and Standard Costing:

The systems of budgetary control and standard costing have
the common objective of controlling business operations by
establishing pre-determined targets, measuring the actual
performance and comparing it with the targets, for the
purposes of having better efficiency and of reducing costs.
These two systems are said to be interrelated but they are not
inter-dependent. The budgetary control system can function
effectively even without the system of standard costing in
operation but the vice-versa is not true. Usually, the two are
used in conjunction with each other to have most fruitful
results. The distinction between the two systems is mainly on
account of the field or scope and technique of operation.
Budgeting standard costing:
Budgeting:
 Budgetary control is concerned with the operation of the
business as a whole and hence it’s more extensive
 Budget is a projection of financial accounts
 It does not necessarily involve standardization of products.
 Budgetary control can be adopted in part also
 Budgeting can be operated without standard costing.
 Budgets determine the ceilings of expenses above which
actual expenditure should not normally rise.
Standard costing:
 Standard Costing is related with the control of the expenses
and hence it is more intensive
 Standard cost is the projection of cost accounts
 It requires standardization of products.
 It is not possible to operate this system in parts
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 Standard costing cannot exist without budgeting

 Standards are minimum targets which are to be attained by
actual performance at specific efficiency level.
Accounting terms:
Account: refers to a summarize records of all the business

transactions relating to particular person thing or services
which have taken place during a given period of time.
Debit: Latin word ‘debere’ which means’ to owe’ debit means
the amount owed by an account for benefit received by that
account for the benefit received by the account.
Credit: Latin word ‘credere’ which means ‘to believe ‘credit
means amount owed to an account for the benefit given by
that account in the belief that its value will be returned at a
later date.
Business transactions: a business transaction refes to any
activity , dealing or event which has value measurable in
terms of many and which involves exchange of money or
money’s worth between the business the business and any
other person including the proprietor of the business dealing
with business.
Goods: goods refer to merchanchise commodities, products,
articles or things in which a trader deals. In other words they
refer to commodities or things meant for resale.
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Assets: French word ‘assez’ meaning enough. So asset means

enough or sufficient thing of value owned by a concern for
carrying on the business.
Liabilities: the word liabilities is derived from French word
‘lier’ means ‘to bind’.so liabilities means clime of others
against a business which bind the business to others.
Capital or owners’ equity: this refers to the amount with
which the proprietor or owner has started his business .in
other words it is the amount at which the owner has invested
in business.
Debtor: person who owes money to business. He owes
money to the business because he has received some benefit
from the business.
Creditor: person to whom the business owes money to him
because he has given some benefits to the business.
Expenses: it refers to an expenditure in return for which
some benefit is received and the benefit received is enjoyed
and exhausted immediately
Cost concepts and methods of costing:
Concept of cost:
Cost accounting is concerned with cost and therefore is
necessary to understand the meaning of term cost in a
proper perspective.
Elements of cost:
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Material: the substance from which a product is made is

known as material. It may be in raw or a manufactured state.
It can be direct or indirect.
Direct material: the raw materials and components used to
create a product. The materials must be easily identifiable
with the resulting product (otherwise they are considered to
be joint costs).
Indirect material : It is an expense, which is included in
Overhead Cost of manufacturing cost, and consists of
subsidiary material cost, shop supplies cost, perishable tools
and equipment cost. Here the material means the one
indirectly or supplementary consumed.
Labour: for conversion of material into finished goods human
effort is needed and such human effort is called as labour.
Direct labour: salaries and wages paid to workers that can be
directly attributed to specific products or services. It includes
the cost of regular working hours, overtime hours worked,pay
Roll taxes, unemployment tax, Medicare, employment
insurance,
Indirect labour: employees who work on tasks that

contribute to the company's performance outside of
producing products and services. They work in areas such as
the administrative, accounting and engineering departments.
Expenses: may be direct or indirect
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Direct expenses: Direct expense is an expense incurred that

varies directly with changes in the volume of a cost object. A
cost object is any item for which you are measuring expenses,
such as products, product lines, services, sales regions,
employees, and customers.
Indirect expenses: Indirect Expenses are those expenses that
cannot be assigned directly to any activity since these are
completely incurred while operating a business or as a part of a
business, examples of which include business permits, rent,
office expenses, telephone bills, depreciation, audit, and legal
fees.
Overhead: the ongoing costs to operate a business but excludes the
direct costs associated with creating a product or service. Overhead
costs can be fixed, variable, or a hybrid of both.
Factory overheads: Factory overhead is the costs incurred during the
manufacturing process, not including the costs of direct labour and
direct materials.
Office and administration overheads: Administrative overhead is
those costs not involved in the development or production of goods
or services. This is essentially all overhead that is not included in
manufacturing overhead. Examples of administrative overhead costs
are the costs of: Front office and sales salaries, wages, and
commissions.
Selling and distribution overheads: Selling and distribution
overheads are the costs associated with selling and distributing your
product or service. This can include marketing, advertising, sales
commissions, shipping, and more.
Components of total cost:
Prime cost: the total direct costs of production, including raw
materials and labour.
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Factory cost: Factory Costs are the expenses incurred by the business
to manufacture goods intended to be sold to the customers in the
normal course of business and include all costs linked to production
like direct material, direct labour, and other manufacturing
overheads.
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.
Total cost: the costs incurred to make an investment, which includes
the cost of the investment, plus any broker commissions, taxes,
licenses, and fees related to the transaction. All of these costs should
be considered when deriving the return on investment.
Classification of cost on the basis of elements:
Production cost
Administration cost
Selling cost
Distribution cost
Research cost
Development cost
Pre-production cost
Commercial cost
Classification on the basis of changes of traceability to the product:
Direct and indirect cost
Classification on the basis of changes in activity or volume:
Fixed, variable and semi variable costs
Classification on the basis of controllability:
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Controllable and uncontrollable costs

Classification on the basis of time:
Historical costs and pre-determined costs
Cost unit: a unit of quantity of product, services or time in relation to

which costs may be ascertained or expressed.
Cost centre: cost centre means a location, person or item of
equipment’s for which costs may be ascertained and used for the
purpose of cost control.
Cost estimation and cost ascertainment:
It is the process of pre-determining the cost of a certain product job
or order.
 Budgeting
 Measurement of performance efficiency
 Preparation of financial statements
 Make or buy decision
 Fixation of the sale prices of products
Cost reduction and cost control:
Cost control is achieving the cost target as its objective whereas cost
reduction is directed to explore the possibilities of improving the
targets.
Specimen of cost sheet :
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Problems on cost sheet:
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Bin card:
Bin cards, which are sometimes referred to as inventory cards or
stock cards, are record-keeping documents used in retail and other
businesses that require a stock room. They keep a running balance of
a business's inventory.
Bin Cards helps to monitor the total inventory process. This Card is
Similar to library card that shows total movements of the library
books and keeps the tracking of that books. Bin Card is issued to
track the number of items held in a warehouse or stock rooms.
Cost price methods:
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 First in first out (FIFO)

 Last in first out (LIFO)
 Average cost
 Inflated price
 Specific price
 Base stock
 Highest in first out
Market price methods:

 Replacement price
 Realisable value
Standard price methods:

 Current standard price
 Basic standard price
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Labour cost:
It is a second major element of cost. Under the present
political conditions with a restive labour in organized
industry, it is very important to control labour cost.
Types of labour:
Direct and indirect labour
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Labour turnover: Labour turnover is the ratio of the number of

persons leaving in a period to the average number employed. It is the
change in the composition of the labour force in an organisation. It
can be measured by relating the engagements and losses in the
labour force to the total number employed at the beginning of the
period.
Different methods of calculating labour turnover:
Sums on labour turnover:
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Job order and contract costing:

Job order costing is a costing method which is used to determine the
cost of manufacturing each product. This costing method is usually
adopted when the manufacturer produces a variety of products
which are different from one another and needs to calculate the cost
for doing an individual job.
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The system of job costing is used where production is not highly

repetitive and addition consists of distinct jobs so that material and
labour costs can be identified by order number.
Contract costing:
Contract costing is the tracking of costs associated with a specific
contract with a customer. For example, a company bids for a large
construction project with a prospective customer, and the two
parties agree in a contract for a certain type of reimbursement to the
company.it constitutes a unit of cost.
Format of contract costing:
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Sums on contracting cost:
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11/30/23, 2:18 PM COST Accounting AND Estimation

COST ACCOUNTING AND ESTIMATION

Cost accounting: records and aims to capture a company’s

Overhead: ongoing business expenses.it is important for

 Indirect Office Overheads

Budget: process of creating a financial plan and budget using cost

Indirect Indirect costs are not directly accountable to a cost object,

Operational Operational costs are the recurring expenses which are

Variable Variable costs are expenses that change in proportion to the

Lump sum items: sometimes while preparing an estimate for

Replacement Cost: It is the cost of replacing a material or asset in

Variable Variable costs are expenses that change in proportion to the

Cost reduction: Cost reduction refers to real or genuine savings

Cost ascertainment: The primary objective of cost accounting is to

Ascertainment of cost is the first and most important objective of

The aim is to determine the cost of each product, process, or

Ascertaining costs alone is not sufficient. Naturally, it is not enough

3. Guidelines for Management

Costing is a faithful servant for managers within an organization. It

 To deliver good services, it is also necessary to have a sound

 Costing reveals the losses that a particular unit is incurring. It

 A final advantage of costing is that it helps managers within an

Scope of cost accountancy:

The scope of Cost Accountancy is very wide and includes the

 It reports operating results and financial position usually at the

 It provides information to the management for proper

planning, operation, control and decision making.

 It records the expenditure in an objective manner, i.e

according to the purpose for which the costs are incurred.

 It provides a detailed system of control for materials,

labour and overhead costs with the help of standard costing

 It gives information through cost reports to management

as and when desired.

 Cost Accounting is only a part of the financial accounts

and discloses profit or loss of each product, job or service.

 Cost Accounting relates to transactions connected with

Manufacturing of goods and services, means expenses which

 Cost Accounts are concerned with internal transactions,

which do not involve any cash payment or receipt.

 Non-Monetary information likes No of Units / Hours etc.

Elements of Cost the elements of costs are the essential part

I) Direct Material: it refers to those materials which become an

II) Indirect Material:

(B) Labour In order to convert materials into finished products,

directly identified with a job, process or operation, are generally

 Period Costs: period costs are charged to the period

in which they are incurred and are treated as expenses. They

Marginal cost equation:

Profit volume ratio:

P/v ratio = change in contribution / change in sales.

 to prevent waste and reduce expenses

Cost audit: the terminology of ICMA London, defines cost audit as

Nature of cost accounting:

Objectives of cost accounting:

Budgetary Control and Standard Costing:

Budgeting standard costing:

 Standard costing cannot exist without budgeting

Account: refers to a summarize records of all the business

Assets: French word ‘assez’ meaning enough. So asset means

Material: the substance from which a product is made is

Indirect labour: employees who work on tasks that

Direct expenses: Direct expense is an expense incurred that

Controllable and uncontrollable costs

Cost unit: a unit of quantity of product, services or time in relation to