Cost Accounting

E-MBA 3
rd
Semester (Section A) Institute of Business Administration
Muhammad Vaseem Azam University of The Punjab, Lahore.
Cost Accounting Lecture# 1 &2
Business & Cost Classification Concepts
Business
Any legal activity engaged for the sake of or/and with the intension of earning profit is called business.
Key Notes
Regular activity / ongoing concern
Legal activity (Smuggling shall not be termed as a legal activity, and thereof Business )
Regular intension to earn profit (Personal goods sale even to earn profit would not be termed
as a business activity)
Example
Telecommunication services, Food & Beverage, and Sports wear productions etc

Types of Business
1. Manufacturing
2. Trading
3. Services

Manufacturing Business
Manufacturing business is the type of business in which raw material converted into final
product through some manufacturing process.
Example
ICI Paints,

Trading Business
Buying, and then selling of ready made products/services with out any alteration is referred as
trading business. Wholesaler and retailing business collectively termed as trading business.
Example
Makro Cash and Carry, Metro Cash and Carry etc

Services Business
All the business set ups engaged in the business of intangible products are called as services
business.
Example
Banks,
Insurance Companies,
Lodging business units such as Pearl Continental, Lahore
Consultants etc

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Transaction
Any legal business dealing between two or more than two Persons, Objects, or/and Entities with some
monetary exchange is called Transaction. Or
A transaction can be defined as an exchange of goods or services between two parties, and therefore
represent some sort of change to one's assets, liabilities or owner's equity.
Key Notes
Regular activity / ongoing concern
Should include monetary ingredients (Exchange of goods is not termed as transaction)
Should not be a social dealing
Mr.B says to Mr. A that I will pay you Rs.1, 000 if you fetch me a class of water.
If a Father says to his son that if you will pass your exams with a distinction, I will buy you a
car etc.
Represents change in the assets, liabilities and/or owners equity of the involved parties.
Example
Mr. Ali purchase 100 units of Air conditions from LG electronics @ Rs.32000 each, and paid half of the
amount in cash, and rest on 30 days credit note.
Accounting
Accounting in simplest words termed as Language of Business which convey certain monetary
information about the business records. I.e. Profit & Loss, Assets, and liabilities of the companies etc
Key Notes
Business language
Convey certain useful monetary information about business records.
An effective and standardized language of businesss monetary records which interpret the
concerned records in a common understanding all over the world.
Need of Accounting System
Companies of all sizes need to implement a streamlined accounting system in order to accurately
record and report business transactions, keep track of invoices and reduce problems with tax
authorities and the IRS. Accounting procedures are typically coordinated by a CPA or financial manager
who is responsible for recording all incoming and outgoing transactions, maintaining consistent records
and creating financial statements at the end of each financial period. A well-implemented accounting
system also makes it easier to access financial statements such as the Balance Sheet, Income
Statement, Statement of Retained Earnings and Statement of Cash Flows.

E-MBA 3
rd

Branches of Accounting
1. Financial Accounting
2. Cost Accounting
3. Management Accounting
Financial Accounting
Financial Accounting satisfies the need of external stakeholders I.e. shareholders, creditors, Lenders,
Government, investors, and Tax authorities.
Main Objectives
o Records Business monetary transactions
o Financial interpretation of the business records
o Useful information use for external stakeholders
Cost Accounting, and Management Accounting are most often interchangeable terms which are not
correct. Cost accounting is the part Management Accounting, and it provides the bank of data for the
management accounting for further decisions.
Cost Accounting
It determine the total cost, and per unit cost of the products, and services.
Main Objectives
o To attain the costing measures
o To define quality adjustments in the products/services.
Management Accounting
Managerial accounting is concerned with providing information to managers - that is, people inside an
organization who direct, and control its operation. Managerial accounting provides the essential data
with which the organizations are actually run. Additionally, the Managerial Accounting is also termed
as cost accounting.
Main Objectives
o To prepare quality reports for business management.
o To help the management decision making process.
o To smooth managerial perspective based upon the decisions extracted.
o To attain the perfect combination of the product/services quality, and profit maximization.

E-MBA 3
rd

The Concepts of Business and Cost Classification
Introduction
The term Cost carries no particular meaning until assigned a relevant scope of understanding. Such
we can better understand what may be Fixed Cost, Variable Cost, and Product Cost instead of Cost.
Basic Understanding of the Cost Classification concepts
Following are the some the basic classification concepts of the cost
Controllable Cost
A cost which can be influenced/affected by a manager is a controllable cost for that particular
manager. We can further expand the concept that the cost, for which a concerned manager can be
accountable, shall be also being termed as Controllable cost.
Uncontrollable Cost
A cost which can not be influenced/affected by a manager is an uncontrollable cost for that particular
manager. (Whenever, we will talk about the controllable, and uncontrollable costs, these will be
referred to same managerial aspect)
Example
A Purchase manager can be held accountable for the purchasing costs considering the competitive
negotiation advantages of Price, Quality, quantity, and other relevant attribute of purchasing costs.
Relevant cost
A cost which changes between the alternatives is called a relevant cost or a cost which does not varies
between different options is called relevant cost. The term is used with reference to the decision
making process.
irrelevant Cost
A cost which does not change between the alternatives is called a relevant cost or a cost which varies
between different options is called relevant cost.
Example
School (A) School (B)
Admission Fee Rs.10,000 Rs.10,000 (IRC)
Monthly Fee Rs.8,000 Rs.10,000 (RC)

Key Note: The marginal difference of Rs.2,000 in the monthly fee would be termed Differential Cost

E-MBA 3
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1. Direct cost /Prime Cost
A direct cost is the one which is fully traceable to the product, service, or department that is
being costed.
Example
o Direct Material cost (For making, selling a product or/and even providing a service)
o Direct Labor (For direct production work time consumed)
o Other Direct Expenses

2. Indirect Cost/ Overheads
A direct cost is the one which is not fully traceable to the product, service, or department that
is being costed and such cost incurred in the course of making a product, providing a service or
department.
Example
o Indirect Material cost (For making, selling a product or/and even providing a service)
o indirect Labor (For indirect production work time consumed)
o Other indirect Expenses

3. Product Cost
The cost of making something is called as Product cost. This cost is charged to the product,
and therefore, becomes the part of the inventory.
Example
Product Cost = Total Overheads

4. Fixed Cost
A fixed cost is the one which is incurred for a particular period of time, and which, within
certain activity levels, is unaffected by the changes in the activity levels.
Example
o The rental cost for a certain time period is fixed therefore, by that condition it is termed
as Fixed cost.

5. Variable Cost
A variable cost is the one which is incurred for a particular period of time, and which, within
certain activity levels, is get affected /changes by the changes in the activity levels.
Example
o The sales commission is often a fixed percentage of sales turn over, and so is a variable
cost.
o Telephone calls cost which will vary along with the business volume.

E-MBA 3
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6. Mixed Cost/Semi variable Cost
A hybrid combination of fixed, and variable costs is termed as Mixed Cost. We can say that
cost which is neither fixed nor variable is always termed as Mixed cost.
Example
o Telephone call charges are likely to increase with the level of business expands, but its
line rent is fixed. Thus, such combination of the cost is termed Mixed cost.

7. Sunk Cost
A cost which has already been incurred in the past before a decision or action taken is called
sunk cost. Moreover, such cost becomes irrelevant for future decision making.
Example
Lets say if a research department of any organization expenses an idea to be launched in future
but somehow the idea catch pre launch expiry due to any reason. So in this case all the cost
incurred on the research of the idea will be termed as Sunk cost.

8. Differential Cost
The marginal difference of the alternative cost is called as Differential cost which is often
known as Incremental cost.
Example

9. Opportunity Cost
The marginal benefit foregone/scarified/ given up or/and not earned is known as opportunity
cost.
Example
Mr.Faraz start a business preferring over a Rs.25,000 per month salary job, and he get the first
month return from the business Rs.15,000. So in this event Rs.10, 000 which is foregone by
opting business will be reckoned as Opportunity cost.

10. Functional Cost/Departmental Cost
The cost of performing a particular function or activity is called as a Function cost.
Example
Marketing Development (All the costs incurred for performing marketing
development functions)
Finance Department (All the costs incurred for performing Finance
departments functions)
11. Step cost
Every fix cost, in its long run is known as step cost due to its increasing behavior. In short words,
we can say that every fix cost has an increasing in the long run period therefore considering this
behavior it is referred as Step cost

E-MBA 3
rd

Example In the chart we can see
that first year rent of the factory
was Rs.10, 000, and then in the
consequent years it kept on
increasing. Therefore, these steps
up increasing behavior of fixed
cost tend it to be reckoned as
Step cost.

12. Period cost
All the cost other than the factory mainly including the selling, distributing, and advertising cost
are termed as Period cost. Such costs are also reckoned as Operational costs which are not
charged to product/services, and therefore, are adjusted to the Gross Profit.
Example
o Anything at corporate headquarters, anything related to selling the product, shipping
costs, administrative salaries, executive salaries, administrative office expenses, sales
commissions, advertising, research and development, etc.
o Warehouse costs and people who move inventory are period costs
o Selling Costs all cost associated with marketing the finished products and getting the
product to the customer
o Administrative Costs costs incurred for the general administration of the organization

Difference Between Period and Product Costs

Key Note:
In sum, product costs are inventoried on the balance sheet before being expensed on the income
statement. Period costs are just expensed on the income statement.
0
10,000
20,000
30,000
40,000
Year 1 Year 2 Year 3 Year 4 Year 5
F
a
c
t
o
r
y

R
e
n
t
Years
Rent (PKR)
Product costs are applied to the products the
company produces and sells. Product costs refer to
all costs incurred to obtain or produce the end-
products. Examples of product costs include the
cost of raw materials, direct labor, and overhead.
Before the products are sold, these costs are
recorded in inventory accounts on the balance
sheet. They are treated like assets. Product costs
are sometimes referred to as inventorable costs.
When the products are sold, these costs are
expensed as costs of goods sold on the income
statement.
Period costs are the costs that cannot be
directly linked to the production of end-
products. Essentially, any cost that is not a
product cost is a period cost. Examples of period
costs include sales costs and administrative
costs. Period costs are always expensed on the
income statement during the period in which
they are incurred.

E-MBA 3
rd
Cost Accounting Lecture# 4

Classification of Costs By Function
1. Production Cost
2. Direct material
3. Direct Wages
4. Direct Expenses
5. Prime Cost
6. Production overheads
7. Full Factory Cost
8. Administration Costs
9. Selling and Distribution Cost
10. Full Cost of Sales

1. Production Cost
The costs which are incurred by the sequence if operations beginning with the supply of raw material,
and ending with the completion of the product ready for warehousing as a finished goods item.
Key Note:
Since there are two types of the Packaging I.e. Primary Packaging and Secondary Packaging. The
Primary packaging is always treated as part of the production cost unlike secondary packaging cost.
Example:
Products wrapped in the large cartins, deliverance boxes, and despatchment box are not to be treated
as production cost unlike products such as Soap, Toothpaste, washing powder, deodorants spray, and
artificial juices.
2. Administration Cost
Administration costs are the costs of managing an organization, that us, planning, and controlling its
operation, but only insofar as such administration costs are not related to the production, sales,
distribution or research, and development.
3. Selling cost
Sometimes also known as Marketing Costs, are the costs of creating demand for the production, and
securing firm orders from customers.
Example:
Sales promotion cost is the example of selling cost.

E-MBA 3
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4. Distribution Cost
Distribution costs are the cost of the sequence of the operations with the receipt of the finished goods
from the production department, and making them ready for the dispatch, and ending with the
reconditioning for reuse of the empty containers.
Example:

5. Research & Development Cost
The costs of searching for new or improved products are known as research and development costs.
Since at times, it becomes difficult to distinguish between research and development costs individually
therefore, collectively known as R&D costs.
6. Financing cost
Financing costs are those costs which incurred due to business financing.
Example:
Interest on the loan obtained for the business is called as financing cost.
Difference Between Financial and Management Accountants
Financial Accounts Management Accounts
For External reporting For internal reporting
It is the legal requirement for the companies to
prepare, and maintain Financial accounts. (All the
Limited Liability companies )
It is not the legal requirement for the companies
to prepare, and maintain Management accounts
but to be beneficial of the informative decision
making such accounts are to be prepared on
advisory note.
It only deals for the past records.
It deals with past as well futuristic decision
making.
Financial accounts detail the over all business
performance of a particular organization starting
from a particular period, and ending on it.
Management accounts are used to aid the
management record, plan, and control the
organizations activities.
Financial accounts concentrate on business as a
whole, aggregating revenues, and cost from
different operations, and are end in themselves.
I.e. P&L reports, and Financial Statements.
Managerial accounts can focus on specific areas of
an organizations activities to facilitate, and aid
decision making process.
Formats for Financial accounts are prescribed by
Intentional Accounting Standards and
International Financial Reporting Standards.
Since the format of the companies is entirely at
their own discretion so every company has its
own formatting of informative record for the
required decision making.

E-MBA 3
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Some Important Classification
1. Responsibility center
2. Cost center
3. Revenue Center
4. Profit Center
5. Investment Center
6. Cost object
7. Cost unit
1. Cost Center
Cost centre is accountable for the cost only.
Example:
If your performance is judged on the basis of the revenue generation
2. Cost Units
It means a unit of output for which cost determination is desired by the management.
Example:

o A rooms rent
o Mobile Phone
o Standard unit of Sugars Price (One Kg)
Key Note: All cost units will be cost objectives but all cost objectives cant be cost units

3. Cost Objects or cost objectives
Anything whose cost determination is desired by the management is called cost objective/Object
Example:

o If a company is willing to find the cost of an order (To fulfill that order )it will be known as Cost
objective
o If management of an organization is willing to know the running cost of a particular department
that department will be a cost objective.
o If management of an organization is willing to know the service offered cost, then it will
become the cost objective of that services provider.

Key Note: All cost units will be cost objectives but all cost objectives cant be cost units

E-MBA 3
rd

4. Profit Centres
Profit centres are similar to cost centres but are accountable for cost, and revenue
Example:

o A profit centre manager will want information regarding both revenue, and costs. He will be
judged on the profit margins achieved with in the combination of the cost incurred, and profits
earned. Practically fixed costs are beyond the normal control therefore, variable costs become
a judgment indicator.
5. Revenue Centres
Revenue Centres are similar to cost centers but are accountable for revenues only, Revenue centre
should normally have control over how revenues are raised. A revenue centres manager is not
responsible for the costs rather he will look after revenue performance indicators.
Example:

o How to raise sales.
o How to develop product, and/or markets.
6. Investment Centres
Investment centre is a profit centre where managers performance will be evaluated on the basis of
the Return on Investment or Return on the Capital Employed.
Key Note:
All the Investment Centres are Profit Centre but all the Profit Centre cant be Investment Centre.
7. Responsibility Centres
A department, an activity, or a project whose performance is the direct responsibility of a manager
is called Responsibility centres
Example:

o Purchase department is responsibility centre for the purchase manager.
o A project is a responsibility centre for the project head.
o Marketing department is the responsibility centre for the Marketing Head.
Key Note
Cost centres, revenue centres, profit centres and investment centres are also known as responsibility
centers.

E-MBA 3
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Analyzing Semi Variable Cost
(High Low Method)

This method is used to analyze mix cost into its parts so that we may estimate this cost for the future
period.
Formulas:
a vaiiable Cost Pei unit

b ixeu Cost Total cost at Bighest oi Lowest Activity vaiiable Rate units

c stimateu Total cost ixeu Cost vaiiable Rate 0nits

Example:

Months Activity (Units) Total Cost =(FC+VC)
August 100 180
September 120 210
October 160 270
November 150 255
December 140 ?

a vaiiable Cost P0
Pei unit

b ixeu Cost P0

c stimateu Total cost Becembei

Explanation:

o Total Cost $180 against 100 units for the month of august include Fixed, and variable cost.
o So in order to estimate Decembers Total cost we have to segregate Variable, and Fix cost
components from $180 cost.
o In step (a) we have calculated PU variable cost 1.5 $, and Step (b) we have calculated fixed cost
as $30 which will be same for all the activities/units consumptions.
o So composition of cost $ 180 against 100 units will be TC=FC+ VC 180=150+30 (100*1.5
cost=150, and we know $ 30 is fixed so altogether it sums up 180 as Total cost.
o So we can say that if in the month of December 140 units are produced there will be a total
estimated cost estimated of $ 240. (Variable cost= Total Units 140*Per Unit variable cost 1.5=
210, and Fixed Cost is $30 )

E-MBA 3
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Analyzing Semi Variable Cost
(High Low Method-when step up cost is included)

This method is used to analyze mix cost into its parts when there is inclusion of Step up cost so that
we may estimate this cost for the future period.
Formulas:

u vaiiable Cost Pei unit

e ixeu Cost Total cost at Bighest oi Lowest Activity vaiiable Rate units

f stimateu Total cost ixeu Cost vaiiable Rate 0nits

Example:

Months Activity (Units) Total Cost =(FC+VC)
October 10,000 70,000
November 20,000 125,000
December 18,000 ?
JANUARY 12,000 ?

Key Note:
There is a step-up in fixed cost of $ 5,000 when activity level increases by 14,000 units.
u vaiiable Cost P0
Pei unit

e ixeu Cost P0 C foi Lowei Level
ixeu Cost P0 C foi highei Level

f stimateu Total cost Becembei
ixeu Cost k as units
stimateu Total cost }anuaiy
ixeu Cost k as units

Note: The only disadvantage of this method is, it assumes that all the trends of past shall be happening
in the future as well.

Cost Accounting

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