Management Accounting 1

Class: SYBBA/SYBBA(T&T)
Term: 5 , Academic Year:2020-21
Don Bosco College, Panaji-Goa
Lecturer In-charge: Twinkle Fernandes, M.com ( Accounting &
Finance), MBA (HR), Inter CS , SET Qualified
Chapter 2: Introduction to Cost
Accounting
 Learning Objectives
• Meaning of Cost, Costing and Cost Accounting
• Objectives of Cost Accounting
• Importance of Cost Accounting
• Elements of cost
• Cost Sheet- Meaning, its uses and preparation of cost
sheets (Practical Problems)
• Costing methods and techniques
 Cost
• Expenditure incurred in producing a product or in rendering a service
• Measurement in monetary terms, of the amount of resources used for the
purpose of production of goods or rendering a service.
 Cost accounting
• Cost accounting is the process of accounting for costs.
• It embraces the accounting procedures relating to recording of all income
and expenditure and the preparation of periodical statements and reports
with the object of ascertaining and controlling costs.
• It is thus the formal mechanism by means of which costs of products or
services are ascertained and controlled.
 Objectives of Cost Accounting

• Ascertaining Costs
• Determining Selling Price
• Measuring and Increasing Efficiency
• Cost Control and Cost Reduction
• Cost Management
• Ascertaining Profits
• Providing Basis for Managerial Decision Making
1. Ascertaining Costs: - The first and foremost objective of cost accounting is
to find out cost of a product, process or service. The other objectives which
have been mentioned hereafter scan be achieved only when the costs have
been ascertained.

2. Determining Selling Price: - Business enterprises are run on a profit

making basis. It is thus necessary that the revenue should be greater than the
costs incurred in producing goods and services from which the revenue is to
be derived
3. Measuring and Increasing Efficiency: - Cost accounting involvers a study
of the various operations used in manufacturing a product or providing a
services. The study facilitates measuring of the efficiency of the organisation
as a whole as well as of the departments besides devising means of increasing
the efficiency.
4. Cost Control and Cost Reduction: - Cost accounting assists in cost control it
uses techniques such as budgetary control, standard costing etc. for controlling
costs. Budgets are prepared will in advance. The standards for each item of
cost are determined, the actual costs are compared with the standard costs and
variances are found out as to their causes. This greatly increases the operating
efficiency of the enterprise. Besides it, cost is required to be reduced also
constant research and development activities help in reduction of costs without
compromising with the quality of goods or services.
5. Cost Management: - The term ‘Cost Management’ includes the activities
of managers in short-run and long-run planning and control of costs. Cost
management has a broad focus. It includes both cost control and lost
reduction. As a matter of fact cost management is often invariably linked
with revenue and profit planning. For instance, to enhance revenue and
profits, the management often deliberately incurs additional costs for
advertising and product modifications.
6. Ascertaining Profits: - Cost accounting also aims at ascertaining the
profits of each and every activity. It produces statements at such intervals
as the management may require. The financial statements prepared under
financial accounting, generally once a year or half – year, are spaced too
far apart in time to meet the needs of the management. In order to operate
the business at a high level of efficiency, it is essential for the
management to have a frequent review of production, sales and operating
results. Cost accounting provides daily, weekly or monthly volumes of
units produced, accumulated costs together with appropriate analysis so
that quantum of profit and profitability is known.
7. Providing Basis for Managerial Decision – Making: -
Costs accounting helps the management in formulation
operative policies. These policies may relate to any of the
following matters:-
 Determination of cost – volume – profit relationship.
 Shutting down or operating at a loss.
 Making or buying from outside supplies.
 Continuing with the existing plant and machinery or replacing
them by improved and economical means.
 Importance of Cost Accounting
• Costing helps in periods of trade depression and trade competition:- In
periods of trade depression the business cannot afford to have leakages
which pass unchecked. The management should know where economies
may be sought, waste eliminated and efficiency increased. The business
has to wage a wax for its survival. The management should know the
actual cost of their products before embarking on any scheme of reducing
the prices on giving tenders. Adequate costing facilitates this.
• Aids in price fixation:- Though economic law & supply and demand and
activities of the competitors, to a great extent, determine the price of the
article, cost to the producer does play an important part. The producer can
take necessary guidance from his costing records.
• Helps in estimate:- Adequate costing records provide a reliable basis upon
which tenders and estimates may be prepared. The chances of losing a
contract on account of over – rating or losing in the execution of a contract
due to under– rating can be minimized. Thus, “ascertained costs provide a
measure for estimates, a guide to policy, and a control over current
production”.
• Helps in channelling production on right lines:- Costing makes possible
for the management to distinguish between profitable and non-profitable
activities profit can be maximized by concentrating on profitable
operations and eliminating non-profitable ones
• Wastages are eliminated:- As it is possible to know the cost of the article
at every stage, it becomes possible to chock various forms of waste, such
as time, expenses etc. or in the use of machine, equipment and tools.
• Costing makes comparison possible:- If the costing records are regularly
kept, comparative cost data for different periods and various volumes of
production will be available. It will help the management in forming future
lines of action.
• Provides data for periodical profit and loss accounts:- Adequate costing
records supply to the management such data as may be necessary for
preparation of profit and loss account and balance sheet, at such intervals
as may be desired by the management. It also explains in detail the sources
of profit or loss revealed by the financial accounts thus helps in
presentation of better information before the management.
• Aids in determining and enhancing efficiency:- Losses due to wastage of
material, idle time of workers, poor supervision etc., will be disclosed if
the various operations involved in manufacturing a product are studied by
a cost accountant. The efficiency can be measured and costs controlled and
through it various devices can be framed to increase the efficiency.
• Helps in inventory control:- Costing furnishes control which
management requires in respect of stock of materials, work-in-progress
and finished goods.
• Helps in cost reduction:- Costs can be reduced in the long run when
alternatives are tried. This is particularly important in the present day
context of global competition cost accounting has assumed special
significance beyond cost control this way.
• Assists in increasing productivity: Productivity of material and labour is
required to be increased to have growth and more profitability in the
organisation costing renders great assistance in measuring productivity and
suggesting ways to improve it.
 Elements of Cost
There are three broad elements of cost:-
• (a) Material
• (b) Labour
• (c) Expenses
 Material
(a) Material: - The substance from which the product is made is known as
material. It may be in a raw or a manufactured state. It can be direct as
well as indirect.
Direct Material: - All material which becomes an integral part of the finished
product and which can be conveniently assigned to specific physical units is
termed as “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 , Cotton used in production of
cloth, leather used in the case of production of leather goods and lime in the
production of chalk, etc
• Indirect Material: - Materials used for the product other than the direct
materials are called indirect materials. In other words, materials cost which
cannot be identified with a specific product, job, process is known as
indirect material cost.
• Small tools, stationery used in works, office stationery, advertising posters,
and materials used in maintenance of plant and machinery are a few
examples of indirect materials.
 Labour
(b) Labour: - For conversion of materials into finished goods, human effort is
needed such human effort is called labour. Labour can be direct as well as
indirect.
• Labour is the remuneration paid for physical or mental effort expended in
production and distribution.
• “The labour cost is the cost of remuneration (wages, salaries, commissions,
bonus, etc.) of the employees of an undertaking” –
• Direct labour: - Labour which takes an active and direct part in the
production of a particular commodity is called labour. It is also called
‘Direct-wages’. Direct labour cost is the cost of labour directly engaged in
production operations. E.g., workmen engaged in assembling parts,
carpenters engaged in furniture making, etc.

• Indirect labour:- Indirect labour cost is the remuneration paid for labour
engaged to help the production operations, e.g., inspectors, watchmen,
sweepers, store keepers, etc. The remuneration paid to these persons
cannot be traced to a job, process or production order. The labour costs of
idle time, overtime, holidays, etc., are also taken as indirect costs.
Similarly, clerical and managerial staff, salesmen, distribution employees
are also included in the orbit of ‘indirect labour’.
 Other Expenses
(c) Expenses: - Expenditure other than material and labour is the third
element of cost. 
• Direct Expenses

• These are the expenses which can be directly identified with a unit of output, job,
process or operation. They are specifically incurred for a job, or unit or process and
in no way they are connected with other jobs or processes. The direct expenses are
also known as chargeable expenses.
• Some examples are:
• (a) Hire charges of special plant used for a job.
• (b) Royalty on products.
• (c) Cost of special patterns, designs or plans for a particular job or work order, etc.
• Direct expenses are sometimes also described as “chargeable expenses”. 

• Indirect expenses:- Indirect Expenses:

• Indirect expenses are expenses other than indirect material and indirect labour,
which cannot be directly identified with units of output, job, process or operation.
These expenses are incurred commonly for jobs and processes. E.g., rent, power,
lighting, depreciation, bank charges, advertising, etc.
 Overheads
• OVERHEADS:- It is to be noted that the term overheads has a wider
meaning than the term indirect expenses overheads include the cost of
indirect material, indirect labour besides indirect expenses. Indirect
expenses may be classified under the following three categories:-
• Factory overheads
• Office and administrative overheads
• Selling and distribution overheads
(a) Factory overheads

This is the aggregate of indirect material, indirect wages and indirect expenses
incurred in the factory or concerned with running of the factory or plant are
known as Factory overheads

• Examples of indirect factory expenses are rent, power, depreciation

lighting and heating incurred in the factory.
(b) Office and Administrative expenses/overheads
All the indirect administration expenses, come under this category. Salaries of
office staff, accountants, directors’ fees, rent of office building, stationery
expenses incurred in the office lighting and bank charges, etc., are the
examples.
(c) Selling and Distribution Expenses:-
This includes indirect selling and distribution expenses. Examples are salaries
of salesmen, selling commission, advertising, warehouse rent, maintenance of
delivery vans, warehouse staff expenses, warehouse lighting, etc.
 The total expenditure consisting of material, labour
and expenses can further be analysed as under:

• Prime Cost = Direct materials + Direct Labour + Direct

expenses
• Works Cost (Factory) = Prime Cost + Factory overhead
• Cost of Production = Factory Cost + Administration overhead
• Total Cost (Cost of sales) = Cost of production + Selling and
distribution overhead
• Profit/Loss= Sales- Cost of Sales/Total Cost
 Cost Sheet
• A cost sheet is a statement which represents the various costs incurred at
different stages of business operations, in a tabular format.
• It determines the total cost or expenditure made by the organization, along
with the cost incurred on each unit of a product or service in a particular
period.
• The cost sheet of a business organization provides an insight into its
performance and efficiency.
• It helps in competitive analysis and improvement of the business
operations through cost reduction.
• ..\Cost sheet format.docx
 Methods of Costing

The general fundamental principles of ascertaining costs are the same in every system
of cost accounting, but the methods of analysis and presenting the costs vary from
industry to industry. Different methods are used because business enterprises vary in
their nature and in the type of products or services they produce
or render.
• Job Costing
• It refers to a system of costing in which costs are ascertained in terms of
specific jobs or orders which are not comparable with each other.
• Industries where this method of costing is generally applied are printing
press, automobile garage, repair shop, ship-building, house building,
engine and machine construction, etc.
• Contract Costing
• Although contract costing does not differ in principle from job costing, it is
convenient to treat contract cost accounts separately.
• The term is usually applied to the costing method adopted where large
scale contracts at different sites are carried out, as in the case of building
construction
• Batch Costing
• This method is also a type of job costing. A batch of similar products is
regarded as one job and the cost of this complete batch is ascertained.
• It is then used to determine the unit cost of the articles produced. It should,
however, be noted that the articles produced should not lose their identity
in manufacturing operations
• Operation Costing
• This method is adopted when it is desired to ascertain the cost of carrying
out an operation in a department, for example, welding.
• For large undertakings, it is frequently necessary to ascertain the cost of
various operations
• Process Costing
• Where a product passes through distinct stages or processes, the
output of one process being the input of the subsequent process,
it is frequently desired to ascertain the cost of each stage or
process of production.
• This is known as process costing.
• This method is used where it is difficult to trade the item of
prime cost to a particular order because its identity is lost in
volume of continuous production. Process costing is generally
adopted in textile industries, chemical industries, oil refineries,
soap manufacturing, paper manufacturing, tanneries, etc.
• Unit or Single or Output or Single-output Costing
• This method is used where a single article is produced or service is rendered by
continuous manufacturing activity.
• The cost of whole production-cycle is ascertained as a process or series of
processes and the cost per unit is arrived at by dividing the total cost by the number
of units produced.
• The unit of costing is chosen according to the nature of the product. Cost
statements or cost sheets are prepared under which various items of expenses are
classified and the total expenditure is divided by total quantity produced in order to
• arrive at unit cost of production. This method is suitable in industries like brick-
making, collieries, flour mills, cement manufacturing, etc. This method is useful for
the assembly department in a factory producing a mechanical article e.g., bicycle.
• Multiple or Composite Costing
• Some products are so complex that no single system of costing is
applicable.
• It is used where there are a variety of components separately
produced and subsequently assembled in a complex production.
• Total cost is ascertained by computing component costs which
are collected by job or process costing and then aggregating the
costs through use of the single or output costing system.
• This method is applicable to manufacturing concerns producing
motor cars, aeroplanes, machine tools, type-writers, radios,
cycles, sewing machines, etc
• Departmental Costing
• When costs are ascertained department by department, the method is called
“Departmental Costing”.
• Usually, for ascertaining the cost of various goods or services produced by
the department, the total costs will have to be analysed, say, by the use of
job costing or unit costing.
 Techniques of costing
• Historical (or Conventional) Costing
• It refers to the determination of costs after they have been actually
incurred. It means that cost of a product can be calculated only after its
production.
• This system is useful only for determining costs, but not useful for
exercising any control over costs. It can serve as a guidance for future
production only when conditions continue to be the same in future.
• Standard Costing
• It refers to the preparation of standard costs and applying them to
measure the variations from standard costs and analysing the
variations with a view to maintain maximum efficiency in
production.
• What is done in this case is that costs of each article are determined
before-hand under current and anticipated conditions, but sometimes
they are determined before-hand under normal or ideal conditions.
• Then actual costs are compared with the pre-determined costs and
deviations known as variances are noted down. Thereafter, the
reasons for the variances are ascertained and necessary steps are
taken to prevent their recurrence.
• Marginal Costing
• It refers to the ascertainment of marginal costs by differentiating between
fixed costs and variable costs and the effect on profit of the changes in
volume or type of output.
• In this case, only the variable costs are charged to products or operations
while fixed costs are charged to profit and loss account of the period in
which they arise
• Uniform Costing
• A technique where standardized principles and methods of cost
accounting are employed by a number of different companies and
firms, is termed as uniform costing.
• This helps in comparing performance of one firm with that of
another.

• Absorption Costing
• The practice of charging all costs both variable and fixed to
operation, process or products or process is termed as absorption
costing. 
 
• Activity Based Costing
• In a business organization, Activity-Based Costing (ABC) is a method of
assigning the organizations resource costs through activities to the products
and services provided to its customers.
• It is defined as a technique of cost attribution to cost units on the basis of benefits
received from indirect activities, e.g. ordering, setting up, assuring quality.
• ABC involves identification of costs with each cost driving activity and number of
activities required for their completion.
• It is basically used for apportionment of overheads costs in an organisation having
products that differ in volume and complexity of production.
• Under this technique, the overhead costs of the organisation are identified with
each activity which is acting as a cost driver i.e. the cause for incurrence of
overhead cost.
 Review Questions
• State the meaning and objectives of Cost Accounting.
• State the meaning and significance of Cost Accounting.
• Which are the various elements of cost?
• What is cost sheet?
• List and explain the various methods of costing?
• List and explain the techniques of costing?