Basic Cost Term and Concepts

Coverage
(A) Introduction
(B) Types of Cost
(C) Cost Units and Cost Centers
(D) Characteristics of Cost Information
(E) Cost for Financial Reporting Purpose
(F) Cost Behavior & Cost Estimation
(G) Statement of Cost Sheet
 (A) Introduction

Cost means “ The price paid for something”

According to CIMA, London “ The amount of expenditure (Actual
or Notional) incurred or attributable to a given thing”
 Types of cost

1.By Nature 2.By 3.By 4.By

of Element Function Traceability Variability

5.By 7.By
6.By
controllabilit Capital / 8.By Time
Normality
y Revenue

9.By 10.According 11.For

Identification to Planning Managerial 12.Others
as part of and Control. Decisions
inventory
 1. By Nature of Element

By Nature of
Element

(a) Material (b) Labor (c) Overheads

 (a) Material

(i) Direct (ii) Indirect

 (b) Labor

(i) Direct (ii) Indirect

 (3)Overheads

Indirect

(ii) Office & (iii)Selling &

(i) Factory
Administrative Distribution
Overhead
Overhead Overhead
 2. By Function

By Function

(a) Manufacturing
(b) Administrative (c) Selling &
and Production
Costs Distribution Costs
Costs
 a) Manufacturing and Production Costs

 Production cost include the total of cost incurred in manufacture,

construction and fabrication of units of production.
 The manufacturing and production costs comprise direct materials,
direct labor and factory overheads.
 (b) Administrative Costs

 This cost include cost incurred in planning, directing,

controlling and operating a company.
 For example Salaries paid to Mangers and Other
administrative staff
 (c) Selling and Distribution Costs

 Selling costs are defined as ‘the cost of seeking to create and

stimulate demand and of securing orders’
 Ex: Advertisement, Sales man salary, Sales man commission
etc.
 Distribution costs are defined as ‘the cost of sequence of
operations which begin with making the product available for
dispatch and ends with the making the reconditioned,
returned empty packages, if any, available for re-use’
 Ex: Insurance on goods-in-transit, ware housing, carriage
outwards, etc.
 3. By Traceability

Cost Direct
Indirect
Direct cost are incurred for and may be conveniently identified or
easily traceable with particular cost center or cost unit
Indirect cost are incurred for benefit of a number of cost centers
and cannot be conveniently identified with particular cost center
Ex: Rent of building, management salaries, depreciation of
machinery, etc.
For example the hire charges of mobile crane is a direct cost if it is
used in the site or project.
If the same crane is used as part of the service inside the factory,
then the hire charges are regarded as indirect cost
4. By Variability

Fixed Cost

Variable Cost

Semi-Variable
Cost
 5. By Controllability

(a) Controllable Cost (b) Un Controllable Cost

• Which are controllable by
respective cost centre
• Ex: Direct Costs &
Overheads
• Which cannot be
controlled
• Ex: Rent, Salaries,
Overhead cost incurred
by one Department and
apportioned to other
departments
 6. By Normality

Normal Cost Abnormal Cost

 repairs, maintenance,
destruction due to fire,
salaries, etc.
shut down of
machinery, lock outs,
etc.
 7. By Capital or Revenue Costs

Capital Costs Revenue Costs

• Cost incurred in purchase • It is a cost to maintain the
of asset either to earn earning capacity of the
income or increase concern such as cost of
earning capacity of maintaining
business asset/running the
• Cost is incurred at one business
point of time, but • Ex: Raw material, labour,
benefits spread over the salaries, etc.
years.
 8. By Time

Historical cost accounting

involves reporting assets and
liabilities at their historical costs,
which are not updated for
changes in the items' values.
Standard Cost

Historical Cost
Pre-determined Cost
 By Identification as a part of inventory

(A) Product Cost : Carried forward to next

accounting year in the form of unsold stock.
Associated with unit of out put. Ex: Direct Material,
Direct Labour and Factory Overhead

(B) Period Cost: Written off in the

accounting year in which they have
incurred. Ex: Selling & Distribution,
Adminstration Expenses, etc.
 For Management Decision Making

7.
1. Marginal
4. Sunk Cost Replacement
Cost
Cost

8. Avoidable
2. Out of 5. Imputed or and
Pocket Cost Notional Cost Unavoidable
Cost
6.
3. Differential
Opportunity
Cost
Cost
 Marginal Cost

It is the additional cost incurred for additional unit is produced

In other words marginal cost is variable cost i.e. prime cost plus
variable overhead
 Out-of-Pocket Costs

It is that portion of the cost which involves payment, i.e. gives rise to
cash expenditure as opposed to such costs as depreciation, which do
not involve any cash An out-of-pocket expense is a payment you make
with your own money, whether or not it is reimbursed.
It could be a business expense, such as paying for a flight that is
reimbursed by your employer, or a health expense that you pay before
your total outlay reaches the insurance deductible.
 Sunk Cost

Sunk cost is another name for historical cost

It is the cost which has already been incurred and is
irrelevant for decision making.
A good example is depreciation of fixed assets because the
cost has already been incurred when it is purchased and
cannot be affected by any future action
 Imputed or Notional Cost

These cost appears in cost accounts only

For example notional rent charged on business premises owned by
the proprietor or interest on capital for which no interest has been
paid
At time of calculating alternative investment projects, imputed
interest on capital is considered for taking decisions. Income
foregone
You have an opportunity for getting the job but you opted for
higher studies.
 Opportunity Cost

It is the maximum possible alternative earnings that will be foregone if

the productive capacity or service are put to some alternative use
For example if the owned building is used for own project or as own
office, then likely hood of getting rent is opportunity cost which should
be taken for consideration for decision making
Another example putting retirement money in business rather than in
fixed deposit
 Replacement Cost

It is the cost at which there could be purchase of asset or

material identical to that which is being replaced or revalued
It is the cost of replacement at current market price
 Avoidable and unavoidable cost

Avoidable costs can be eliminated if a particular product or

department with which are directly related to, is discontinued.
For Example: Salary of employees in a department can be
eliminated if the department is discontinued
Unavoidable cost will not be eliminated with the discontinuation
of a product or department.
For example salary of factory manager or factory rent cannot be
eliminated even if a product is elminated
 Cost Unit

 It is a cost included in a product, activities, department, number

of patient treated, etc.
 For example if Ford company produces cars , then the cost unit
would be a car because the costs are all incurred for motor cars.
 Another example is marker pen, which are produced in bulk but
the cost per marker pen is unit cost or cost unit.
 Cost per K.M = Rs.80,000/1,00,000 KM = Re. 0.80
 Cost Centers

 The smallest segment of activity or area of responsibility for

which cost are accumulated is designated as cost center
 In the manufacture and sale of a product or in the rendering
of service, several activities may have to be performed
 These activities are usually carried out by different
department or sections of the company
 Manufacturing of Frooti
Purchase Deptt

Selling &
Distribution Mangoes
Deptt Purchased
Stores Deptt

Stocked up in
Sold
store

Packing Deptt Process Deptt

Packed Processed
Typically cost centers are departments, but in some instances a
department may contain several cost centers.
Ex: A machine department may be under one foreman but it may
contain various group of machines, such as lathes, milling
machine, etc.
The role of department manager is the key for department
performance and cost effectiveness
 Kyocera Cost Centers

Kyocera is a Japanese company that makes packages which hold silicon

chips in electronic computers. The packages or containers are made
from alumina powder.
The powder is first made into sheets and wiring patters are then
screen printed on the sheets. The sheets are next converted into inter
connected stacks and the stacks are baked in ovens. The final step is
quality control. Based on above description can you decide on the
main cost center of Kyocera’ factory
 Sheet making department
 Screen printing department
 Stack making department
 Baking department
 Quality control department
 Characteristics of Cost Information

Planning future oriented

Analysis and comparison of actual with budget

Decision making on future oriented activity

Determination of cost related to cost center

General or common cost like depreciation on factory

building have to distribute among const centers

Accumulated cost in each cost center are distributed

to cost units
 Cost for Financial Reporting Purposes

 GAAP determines how cost are to classified for financial

reporting.
 Financial statements are for users outside the organization
 The main problem with the financial reporting is the cost
becomes expenses
 Calculation of cost of product for planning and controlling
purpose is different in financial reporting
 Cost Behavior

Cost behavior enables managers to anticipate changes in cost when level

of activity changes
Cost predications, which are based on cost behavior patterns, facilitate
planning, control and decision making throughout the organization
Cost predictions are valid for a range of activity known as relevant range
Relevant range is the range of activity for which the fixed cost remain same
Cost behavior patterns exist, ranging from simple variable and fixed costs
to more complicated semi variable and curvilinear costs
 Cost Estimation

Several cost estimation methods are used to determine which

cost behavior patter is appropriate for a particular cost
By selecting marginal accounting technique the choice of a cost
estimation method involves a trade off of cost and benefits
More estimation methods provide the benefits of better
information, but they are often costly to apply
 Statement of Cost or Cost Sheet

 Cost sheet is a statement, which provides for assembly and depiction of

the detailed cost in respect of cost center and cost unit
 Data is collected from various sources to incorporate in the cost sheet
 Cost sheet is only a statement.
 It is not a part of double entry cost accounting records
 According to ICMA, London, the cost sheet is a statement which provides
for the assembly of the detailed cost of a cost center or a cost unit
 There is no specific format for cost sheet
 There are three columns in the cost sheet i.e. particulars, amount (Rs) and
cost per unit