Fundamentals of Costing Explained

The Fundamentals of Costing
AFZAL AHMED, ACA

FINANCE CONTROLLER
NAGAD
Cost Accounting Vs Financial Accounting
Basis for
Cost Accounting Financial Accounting
Comparison
Financial Accounting is an
Cost Accounting is an accounting system that
accounting system, through captures the records of
which an organization keeps financial information about the
Meaning
the track of various costs business to show the correct
incurred in the business in financial position of the
production activities. company at a particular date
Records the information

related to material, labor and Records the information which
Information Type
overhead, which are used in the are in monetary terms.
production process.
Both historical and pre-
Cost type Only historical cost.
determined cost
Basis for
Comparison
Information provided by the

Users of information provided
cost accounting is used only by
by the financial accounting are
the internal management of the
Users internal and external parties
organization like employees,
like creditors, shareholders,
directors, managers,
customers etc.
supervisors etc.
Cost or Net Realizable Value,

Stock valuation At cost
whichever is less.
No, except for manufacturing
Mandatory Yes for all firms.
firms it is mandatory.
Details provided by cost Financial statements are
accounting are frequently reported at the end of the
Reporting time
prepared and reported to the accounting period, which is
management. normally 1 year.
Basis for
Comparison
Income, expenditure and profit

Generally, the profit is analyzed
Profitability are analyzed together for a
for a particular product, job,
Analysis particular period of the whole
batch or process.
entity.
Keeping complete record of the

Purpose Reducing and controlling costs.
financial transactions.
Forecasting is possible through Forecasting is not at all

Forecasting
budgeting techniques. possible.
Key Differences Between
Cost Accounting and Financial Accounting
Cost Accounting aims at maintaining cost records of an

Organisation. Financial Accounting aims at maintaining all
the financial data of an organisation.
Cost Accounting Records both historical and per-determined

costs. Conversely, Financial Accounting records only
historical costs.
Users of Cost Accounting is limited to internal management of

the entity, whereas users of Financial Accounting are internal
as well as external parties.
In cost, accounting stock is valued at cost while in financial

accounting, the stock is valued at the lower of the two i.e. cost or
net realisable value.
Cost Accounting is mandatory only for the organisation which is

engaged in manufacturing and production activities. On the other
hand, Financial Accounting is mandatory for all the organisations,
as well as compliance with the provisions of Companies Act and
Income Tax Act is also a must.
Cost Accounting Records both historical and per-determined

costs. Conversely, Financial Accounting records only historical
costs.
 Cost Accounting information is reported periodically at frequent

intervals, but financial accounting information is reported after
the completion of the financial year i.e. generally one year.
 Cost Accounting information determines profit related to a

particular product, job or process. As opposed to Financial
Accounting, which determines the profit for the whole
organisation made during a particular period.
 The purpose of Cost Accounting is to control costs, but the

purpose of financial accounting is to keep complete records of
the financial information, on the basis of which reporting can be
done at the end of the accounting period.
Cost Object
A cost object is anything for which we are trying to ascertain the
cost.
Examples of cost objects include:

 A unit of product (eg a car)
 A unit of service (eg a valet service of a car)
 A department or function (eg the accounts department)
 A project (eg the installation of a new computer system)
 A new product or service (eg to enable the cost of
development to be identified)
Cost Unit
A cost unit is the basic measure of product or service for which costs
are determined.
Before measuring the cost, we should determine the cost unit. It should
be different according the nature of products and nature of business.
1. We measure coal in ton. So, ton is the cost unit. One metric ton will
be equal to 1000 kgs but our cost unit will be ton.
If you want to buy coal, you buy coal at prices range between Tk 2000
and Tk 2,500 a tonne.
2. We know that wall bricks are measured in one thousand. So, cost
unit will thousand bricks. These days, one thousand bricks cost is Tk.
10,000
Cost Unit Vs Unit Cost

Cost unit is the standard unit for buying minimum quantity of
any inventory.
Unit cost is the minimum price for buy any standard unit of any
inventory.
Suppose X purchased 20 Kgs of material A for Tk 5 per Kg.

Here, Cost Object: Material A
Cost Unit: Kg
Unit Cost: Tk 5
Direct Cost
A direct cost is a cost that can be traced in full to the cost unit.
There are three types of direct cost.
1. Direct material costs are the costs of materials that are

known to have been used in making and selling a unit of
product (or providing a service).
Examples are components and packing materials.
2. Direct labour costs are the specific costs of the workforce

used to make a unit of product or provide a service. Direct
labour costs are established by quantifying the cost of the time
taken for a job, or the time taken in 'direct production work'.
For example, the wages paid to an employee sewing buttons on
a coat is a direct cost of that cost unit .
3. Other direct expenses are those expenses that have been

incurred in full as a direct consequence of making a unit of
product, or providing a service, or running a department.
For example, the cost of hiring a special machine for a job is a
direct cost of that job.
Total direct costs can be termed as Prime cost.
Prime Cost = Total Direct Cost

= Direct material cost
+ Direct labour cost
+ Direct expenses
Indirect Cost or Overhead

A cost that is incurred which cannot be traced directly and in
full to the cost unit.
Examples of indirect costs, where the cost object is a unit of

output, might be the cost of supervisors‘ wages on a
production line or cleaning materials and buildings
insurance for a factory.
These costs cannot be traced directly and in full to the cost

unit
Production Overhead
Indirect Material
Consumable stores, e.g material used in negligible amounts
or across several different products
Indirect Wages
Salaries of non-productive personnel in the production
department, eg supervisor
Indirect Expences
 Rent, rates and insurance of a factory
 Depreciation, fuel, power and maintenance of plant and
buildings
Administration Overhead
Administration overhead is all indirect material costs, wages
and expenses incurred in the direction, control and
administration of an undertaking,
including:
 Depreciation of office equipment
 Office salaries, including the salaries of secretaries and
accountants
 Rent, rates, insurance, telephone, heat and light cost of
general offices
Selling Overhead
Selling overhead is all indirect materials costs, wages and
expenses incurred in promoting sales and retaining
customers,
including:
 Printing and stationery, such as catalogues and price lists
 Salaries and commission of sales representatives
 Advertising and sales promotion, market research
 Rent, rates and insurance for sales offices and showrooms
Distribution Overhead
Distribution overhead is all indirect material costs, wages and
expenses incurred in making the packed product
ready for despatch and delivering it to the customer,
including:
 Cost of packing cases
 Wages of packers, drivers and despatch clerks
 Depreciation and running expenses of delivery vehicles
Product Cost Vs Period Cost

Costs are classified into product costs and period costs on the
basis of whether they are capitalized to the cost of products
produced or not.
Product Cost
Costs that become part of the cost of goods manufactured are
called product costs. Such costs are incurred on
manufacturing process either directly as material and labor
costs or indirectly as overheads.
Examples of products costs are raw material, labor, factory

depreciation, fuel and packaging costs.
Period Cost
Period costs are basically all costs other than product costs.
These are not incurred on the manufacturing process and
therefore these cannot be assigned to cost goods
manufactured. Period costs are thus expensed in the period in
which they are incurred.
Example of period costs are advertising, sales commissions,

office supplies, office depreciation, legal and research and
development costs.
Costs can be classified according to how they vary in

relation to the level of activity.
A knowledge of how the cost incurred varies at different
activity levels is essential to planning and decision-making.
Fixed Costs
A fixed cost is a cost that, within a relevant range of activity
levels, is not affected by increases or decreases in the level of
activity.
Fixed costs are a period charge
Cost (CU)
Fixed Cost
Volume Output (level of activity)
Examples of fixed costs include the following.
 The salary of the managing director (per month or per annum)

 The rent of a single factory building (per month or per annum)
 Straight line depreciation of a single machine (per month or per
annum)
Variable Costs
A variable cost is a cost that increases or decreases as the
level of activity increases or decreases.
A variable cost tends to vary directly with the level of
activity. The variable cost per unit is the same amount for
each unit produced whereas total variable cost increases as
volume of output increases.
Cost (CU)
Variable Cost

Semi Variable or Mixed Costs

A Semi-variable or mixed costs are costs that are part-fixed
and part-variable and are therefore partly affected by changes
in the level of activity.
Cost (CU)
Variable Cost
Fixed Cost

Controllable and uncontrollable costs
A controllable cost is a cost that can be influenced by

management decisions and actions.
An uncontrollable cost is a cost that cannot be affected by

management within a given time span.
Unit Cost Calculation
The pricing of issues of inventory items and the valuation of

closing inventory have a direct effect on the calculation of
profit.
Several different methods can be used in practice.
With FIFO all issues are priced at the cost of the earliest
delivery remaining in inventory.
With LIFO all issues are priced at the cost of the most
recent delivery remaining in inventory.
The cumulative weighted average pricing method
calculates a weighted average price for all units in inventory
whenever a new delivery of materials is received into store.
Illustrative Problem
Quantity Quantity Unit Cost Total Unit MV

Cost @ T date
units CU CU CU
1 May Opening Balance 100 2.00 200
3 May Receipts 400 2.10 840 2.11
4 May Issues 200 2.11
9 May Receipts 300 2.12 636 2.15
18 May Receipts 100 2.40 240 2.40
31 May Closing Balance 200 2.45
Illustrative Problem
Date Receipts Issues Inventory

Q P T Q P T Q P T
Exam Questions
1. (a) “Over time or over a specific range of activity, some

costs tend to be unaffected by the level of output, whereas
others will change as output changes” – Briefly explain
with the support of example, each of the following three
cost classifications: 3x3=9
i. Variable cost
ii. Fixed cost
iii. Mixed cost (semi variable/semi fixed cost)
Exam Questions
(b) ABC Limited has provided following information to you:
8th March Purchase 500 Units Valued at BDT 5,000

17th March Sales 400 Units Valued at BDT 8,000
27th March Sales 250 Units Valued at BDT 5,000
There was an opening stock of 250 Units valued at BDT 2,000 on 1st March.
Calculate the gross profit for the month of March using each of the following methods of
inventory valuation: 4x3=12
i. FIFO
ii. LIFO
iii. Weighted average
iv. Which inventory valuation is most relevant for the decision making purpose. Explain
your answer. (3x4)
Exam Questions
2. (a) A wholesaler had an opening inventory of 750 units of

item X valued at Tk. 80 each on 1 March.
The following receipts and sales were recorded during March.
4 March Received 180 units at a cost of Tk. 85 per unit
18 March Received 90 units at a cost of Tk. 90 per unit
24 March Sold 852 units at a price of Tk. 110 per unit
Using the weighted average cost method of valuation, what
was the cost of item X sold on 24 March? (5)
Thank you

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The Fundamentals of Costing

AFZAL AHMED, ACA

Records the information

Information provided by the

Cost or Net Realizable Value,

Income, expenditure and profit

Keeping complete record of the

Forecasting is possible through Forecasting is not at all

Cost Accounting aims at maintaining cost records of an

Cost Accounting Records both historical and per-determined

Users of Cost Accounting is limited to internal management of

In cost, accounting stock is valued at cost while in financial

Cost Accounting is mandatory only for the organisation which is

Cost Accounting Records both historical and per-determined

 Cost Accounting information is reported periodically at frequent

 Cost Accounting information determines profit related to a

 The purpose of Cost Accounting is to control costs, but the

Examples of cost objects include:

Cost Unit Vs Unit Cost

Suppose X purchased 20 Kgs of material A for Tk 5 per Kg.

There are three types of direct cost.

1. Direct material costs are the costs of materials that are

2. Direct labour costs are the specific costs of the workforce

3. Other direct expenses are those expenses that have been

Total direct costs can be termed as Prime cost.

Prime Cost = Total Direct Cost

Indirect Cost or Overhead

Examples of indirect costs, where the cost object is a unit of

These costs cannot be traced directly and in full to the cost

Product Cost Vs Period Cost

Examples of products costs are raw material, labor, factory

Example of period costs are advertising, sales commissions,

Costs can be classified according to how they vary in

Volume Output (level of activity)

Examples of fixed costs include the following.

 The salary of the managing director (per month or per annum)

Volume Output (level of activity)

Semi Variable or Mixed Costs

Volume Output (level of activity)

Controllable and uncontrollable costs

A controllable cost is a cost that can be influenced by

An uncontrollable cost is a cost that cannot be affected by

The pricing of issues of inventory items and the valuation of

Quantity Quantity Unit Cost Total Unit MV

Date Receipts Issues Inventory

1. (a) “Over time or over a specific range of activity, some

(b) ABC Limited has provided following information to you:

8th March Purchase 500 Units Valued at BDT 5,000

2. (a) A wholesaler had an opening inventory of 750 units of

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