COSTING

Prepared by:
Dr. B. K. Mawandiya
Costing
Cost may be defined as the amount of expenditure incurred on, attributable to a given thing.

Accounting may be define as the art and science of recording business transaction in a
methodical manner so as to show.
 The true state of affairs of business at a particular instant of time
 Deficiency or surplus which has occurred during a specific time period.
 Costing or Cost Accounting
Costing may be define as “ The technique and process of ascertaining costs of given thing
or items”.
Or “Costing is the classifying and recording the appropriate allocation of expenditure for
the determination of the costs of products or services and for presentation of suitably
arranged data for the purpose of control and guidance of management”.

It is the determination of an actual costs of an article after adding different expenses incurred in various
departments.
It may also be defined as the system which systematically records all the expenditure to determine the
cost of manufactured products.
Costing differs from estimating that costing is a determination of cost after knowing the expenditure
incurred in various department on the product, while estimating is the pre-determination of cost based on
the assumptions and previous experiences.
 Aim and Need of Costing
1. To determine the cost of each article.
2. To determine the cost incurred in each operations, to keep control over worker’s
wages.
3. To provide information to ascertain the selling process of the product.
4. To supply information for detection of wastages.
5. It helps in reducing the cost of manufacture.
6. It suggests changes in design, when the cost is higher.
7. To help in formulating the policies for charging the pieces of the products.
Elements of Cost
The total costs of a product may be divided into three principle elements.
1. Material cost.
2. Labor cost.
3. Expenses cost.
Material Cost
a) Direct material cost
b) Indirect material cost
Direct Material cost: These are those material which when operated or processed in
the factory shops through various stages, form the final useful shape of the main
product or component part of the main product. These are also known as
“PRODUCTIVE MATERIALS”.
The amount paid for or the money spent on direct materials is known as “DRIECT
MATERIAL COST”.
Indirect material cost: This is one which is necessary in the production process but is
not directly used in product it self. e.g. cotton waste, oil, grease, sand paper etc.
The cost associated with indirect material is called “INDIRECT MATERIAL COST”.
The same material may be direct material for one producer and indirect material for
another.
LABOUR COST
Cost of remuneration (wages cost, salaries, commissions, bonus etc.)
Classified into
a) Direct Labor cost
b) Indirect labor cost.

Direct Labor cost : The cost of labor that can be Identified directly with the manufacture of product
and allocated to, cost centers or cost units.
A direct labour is one who convert the material into salable product , the wages etc. of such employees
constitute “Direct Labor cost ”. Wages of welder for fabricating a structure is the direct labor cost.
The labor cost may be apportioned to the unit of cost or job either on the basis of time spent by worker
on job or as a price for same physical measurement (quantity of the product).
Direct labor are also called “Productive Labor.”
 Labor cost
Indirect labor cost : it is that labor cost which cannot be allocated but which can be
apportioned to, or absorbed by, cost centers or cost units.
Cost Centers. : A person, location or an equipment (or group of these) for which
costs may be ascertained and used for the purpose of cost control.
Cost Units. : A unit or quantity of product, services or time (or a combination of
these) in relation to which costs may be ascertained.

This is the cost of labor that does not alter the constructions, conformations,
composition or condition of the direct material but is necessary for the progressive
movement and handling of product to the dispatch. E.g. maintenance men, helper,
machine setters, supervisors and foremen etc.
Expenses
It is a collective title which refers to all charges other than those incurred as direct result of employing
workers or obtaining material.
Expenses include the cost of services provided to an undertaking and the notational cost of the use of
owned assets. These are two types:-
a) Direct expenses
b) Indirect expenses
Direct expenses: Theses are those expenses which can be charged directly to a particular job and are
incurred for that specific job only. E.g. costs of special jigs and fixtures, costs for some special patterns,
costs for special layout, costs of design/drawing for specific job etc.
Indirect expenses: These are the expenses which cannot be allocated but which can be apportioned to, or
absorbed by cost centers or cost units. E.g. rent of building, Telephone bills, Insurance premium etc.
Fixed expenses: Cost remain relatively constant regardless of the volume of production. E.g. Taxes on land
and building, Depreciation arising from time rent etc.
Variable expenses: Costs tend to vary directly with volume of production. E.g. Royalties paid on a volume
basis .
Overheads
Overheads are all expenses other than direct expenses.

Overheads : Overheads are defined as the cost of indirect material, indirect labor and
other such indirect expenses, including services, as cannot be conveniently charged
directly to specific cost units.
These are subdivided into
1. Production or manufacturing overheads, including services.
2. Administration overhead.
3. Selling overhead.
4. Distribution overhead.
5. R & D overhead.
 Production or manufacturing over head
It includes all indirect expenses incurred by the concern from the receipt of the production
order until its completion. (I.e. it being ready for dispatch to customer.) examples are:
1. Building Expenses
a) Rent, Insurance.
b) Repairs.
c) Heating and lighting etc.
2. Indirect labor
a) Supervision and foreman.
b) Machine setters and General workers.
c) Maintenance men etc.
3. Water, fuel and power .
4. Consumable stores such as cotton waste, grease etc.
5. Plant maintenance and deprecation
6. Sundry expenses such as (employment office, security, all form of welfare, recreation or
rest rooms etc.)
 Administration Overheads
Administration overheads consists of expenses incurred in the direction, control and
administration of an enterprises.
The expenses of providing general management and clerical service. E.g. office rent,
salaries and wages of clerks, director, general manager, insurance, legal cost, taxes,
postage, audit fee etc.

Selling Overheads
In order to maintain and increase the volume of sales.
covers all expenses direct or indirect which are necessary to persuade consumers to buy.
E.g. advertising, salaries and commission of sale manager, travelers, agents, rent of sale
room and offices
Distribution overheads
Connected with transporting products to consumers and storing them when necessary.
E.g. ware house charge, cost of transporting goods, loading and unloading charges,
upkeep and running of delivery vehicles,

R & D Overheads
Expenses incurred related to all research and development activities.
It depends upon the nature of product or services being produced.
Nature of Cost
a) “Fixed cost” , “Policy cost” or “period cost”: it tends to remains constant
irrespective of the volume output or sales, eg. staff salary, administration
expenses, rent and establishment charges etc.

b)Variable cost: It tends to vary directly with the volume of output. Eg. direct
production labor cost, direct materials cost, direct expenses.

c) Semi Variable costs: These are partly fixed and partly variable. Eg. Oil &
Grease, water and electricity.
Types of Costs
1. Predetermined cost: It is computed in advance of production on the basis of
specification of all the factors affecting cost.

2. Standard cost :
Standard cost is predetermined cost which is calculated from management’s standards
of efficient operation and the relevant necessary expenditure.
Standard costs are build upon a theoretically desired standards that is capable of
attainment under practical operating condition.
Standard cost is estimated cost per unit of output for labour, materials and overheads
based on that prediction of materials prices, labour rates and overheads expenses for a
given future period.
Standard costs represent the best estimate that can be made of what cost should be for
material, labour and overhead after eliminating inefficiency and waste.
Types of Costs

Any deviation from the standard of material will be tend to produce a deviation from
the standard cost.

Variation from predicted performance can be accurately determined and action taken
to prevent their recurrence.
ADVANTAGES OF ESTABLISHING STANDARD COST:
Tend to bring about a more systemic and thorough analysis of costs and discourage
reliance on separate job-by-job studies as basis for cost estimation for new products.
Tend to reduced to a minimum the variations in price.
Represents management’s best measure of efficient plant operation.
May be used as a basis for price fixing and for Cost control through variance
analysis.
Types of Costs
3.Marginal, Differential, Incremental Costs

Differential costs also frequently described as marginal costs and incremental costs.

This is the increase or decrease in total costs that result from producing and distributing
an additional or fewer unit of a product.

It is assumed that the fixed cost remain unchanged by increasing output by one more unit,
then the marginal cost of a product will consist of the variable cost only.

USES OF DIFFERENTIAL COST:

In determining the selling price of the product.
In making decision regarding replacement of machinery.
In accepting an offer.
In submitting a bid.
Types of Costs
4. PROCESS COST
It is the cost for each of a number of distinct stages or process which are
performed to make a product.
The total time spent and materials used on each process as well as services
such as power, light and heating are all charged in calculating process cost.
An important objective in process costing is the evaluation of wastages.

COST OF PRODUCTION OR PRODUCTION COST

It is the cost of the sequence of operations which begins with supplying
materials, labour an services and ends with primary packing of the product.
 ALLOCATION of OVERHEAD COST
If an industry is making only one product, a uniform charge for overhead may be
possible, but if number of different products are being manufactured, an equitable base
must be sought out to charge, each product with a fair and reasonable share of the
overhead cost, so that the total cost (direct or indirect) of each product unit may be
calculated.
Most common methods for applying over heads to production are.
1. Percentage of direct labour cost.
2. Percentage of direct material cost.
3. Prime cost percentage rate.
4. Labour hour rate.
5. Machine hour rate.
6. Production unit method.
Percentage of Direct Labour Cost
% of direct labour costs =%of overhead cost
=(factory overheads for budget period)*100/(Direct labour cost for budget period)
This methods makes use of the cost of labour charged to a particular product as a basis
for setting the overhead rate for the product.
Advantages
1. This method is economical and easy to apply.
2. It reaches its highest degree of efficiency when there is uniformity in wages rates,
skill of workers, equipment used and work performed.
3. Proves to be very useful where the products are manufactured using manual
operations.
Disadvantages
4. Ignores variation in equipment used in different production operations.
5. This method is inequitable because it applies a greater amount of overheads to jobs
performed by workers receiving high wages.
 Percentage of Direct Material Cost
This method charges an overhead rate proportionate with either the weight or the cost
of direct material going into the product.
The method is useful where.
1. Material and method of manufacture are common to all products.
2. The expenses on direct material constitute the main factor determining total cost
(e.g. foundry).
Application: Cement, Paint, Sugar, industries etc.

% of direct material cost = % over head

= (factory overhead for budget)*100/(Direct material cost for budget period)
This method does not prove to be accurate, when applied where different types of
materials (having wide variations in their prices) go into a product.
Prime Cost Percentage Rate
Prime cost percentage rate=% over head
=(factory overhead for budget period)*100/(prime cost for budget period)
1. Here overhead is based on the summation of direct labour cost and direct material cost.
2. This methods does not account for the different rate of material and labour and
different equipment sizes and capacities used in manufacturing various products.
3. This method proves to be very useful where both material and labour cost are
prominent factors in determining total cost.
Labour Hour Rate
Rate per hour of direct labour=
(Factory overhead for budget period)*100/(Direct labour hours for budget period)
1. In this method, labour hours instead of direct labour cost from the basis for finding
percentage over heads .
2. Variations in pay that causes confusion in the direct labour cost method are eliminated in the
labour hour rate method
3. Labour hour method is more accurate than direct labour cost.
4. This is useful where hand labour method exists.
5. Labour hours rate method does not recognize variations in type and size of equipment.
6. This methods proves to be in accurate if the factory products involving both manual and
machine operation.
 Machine Hour Rate
In this method factory overheads costs are applied to production orders on the basis of the
number of machine hours required to complete the production.
Machine hour rate
=(Factory overhead for budget period)*100/(Machine hour for budget period)
This is an accurate and very relevant method because in modern age of mechanization
and automation, the factory overhead resulting from the use of machinery are far in
excess of costs from other sources.
• Study of the actual overheads expenses of machines used such as floor space, power,
repair are calculated.
•This method is very useful in concerns where machine constitute a more important and
costly elements than manual labour.
Production Unit Method
In this method overheads are charged on the basis of number of production units such as KG,
Tons ,FEET, LITERS etc.
Over head rate per unit
=(factory overhead for budget period)*100/(production in term of units for budget period)
It is simple and easy method.
This method is preferred for industries manufacturing one type of product. TV etc.
THANK YOU