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Cost Concepts

Cost of Product
Cost is an expenditure attributable to a product, item, or service to secure an economic benefit Cost per unit is a ratio and is expressed as Rs per unit

Cost, Expense, Loss

Cost
Expense which is incurred after deriving the benefit

Expense
All explicit (not hidden) costs which are deductible from revenue eg., wages paid to workers, rent paid for using building

Cost, Expense, Loss

Deferred Cost Cost before deriving the benefit Eg. Prepaid insurance, restructuring expenses, and promotion cost for product launch Written off to expense over their estimated useful economic lives. Loss When no benefit derived by the incurrence of cost. Ex. materials destroyed by fire, salary paid for a period of strike.

Cost Object
An entity or a part of an entity Product, group of product, a plant, territory Cost objective represents the overall objective for which cost collection, cost analysis, cost control is being attempted Cost objective can be a cost unit or cost center

Cost Unit

Cost Unit
Unit of finished product, service or time or a combination of these in relation to which cost is ascertained or expressed

Industry or Product Automobile Cement Hospital Brickworks Steel Hotel Electricity

Cost Unit Per no of vehicle produced Per tonne Per patient-day Per 1000 bricks made Per tonne Per guest-room, guest-day, per plate, meals Per kWh

Production/ Service Production Production Service Production Production Service Service


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Cost Unit

Methods of Costing
Method Name or Industry Furniture Final Cost unit Per unit

Job Costing
Batch Costing Contract Costing Single or Output Costing Multiple Costing

Ship building Books Ready made garments Building Road Construction


Brickworks, Chemicals Automobile industry

Per ship Per book Per batch of dozen or 100 Per Contract Per km
Per 1000, Per litre Each part by batch costing, Assembling cost by single or output costing
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Cost Unit

Methods of Costing
Method Name or Industry Cement Paints Oil Refinery Transport Powerhouse Final Cost unit Per tonne Per litre Per litre Passenger-km or tonne-km kWh Patient-day Per meal, per cup of tea or coffee, per room or bed

Process Costing

Operation Costing Hospitals Hotels

Cost Center

Cost center
Location, person or an item of equipment for which cost may be ascertained for the purpose of cost control

Types of Cost Center

Personal Cost center


Consists of a person or a group of persons for which costs are analysed and accumulated Eg. Sales managers office

Impersonal Cost center


Consists of a location or an item of equipment or a group of these. May represent a region of sales, assembling operations of a computer manufacturer, etc.

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Types of Cost Center

Operation Cost center


Consists of those group of machines which carry out same type of operation Eg. Grinding, weaving

Process Cost center


Specific process or a continuous sequence of operations is carried out Eg. Printing industry, colour and dye industries
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Types of Cost Center

Production Cost center


Where actual production processes are carried out, either specific operation Center where raw materials are converted into finished products Eg. Fabrication, machining

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Types of Cost Center

Service Cost center


Where services to other production cost centers are provided Eg. Boiler house, machine shop

Staff Cost center


Output cannot be quantified uniformly Eg. Accounts deptt, production planning deptt

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Classification of cost

By Nature or element
Material Cost
Direct material
Raw materials, semi-finished parts Material passing from one process to another Physically traced in some form of finished product Packing materials, eg. Cartons, card board boxes

Indirect Material
Material required for production process but do not become an integral part of finished or saleable product Cotton waste, lubricating oil

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Classification of cost

By Nature or element
Labour cost
Cost of personnel work Direct labour
Wages of operators, workers, weavers

Indirect labour who do not work directly on the product but whose services are quite essential for manufacturing process
Production deptts supervisors, security guards, maintenance employees

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Classification of cost

By Nature or element
Expenses
Incurred for business activities Not in nature of material or labour Direct Expenses
linked with a specific saleable product or service, but may not be physically traceable in finished product Expenses on making automobile design Fees of consultants

Indirect Expenses
Factory rent, expenses for handling stores
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Classification of cost

By Nature or element
Expenses
Chargeable Expenses
Directly chargeable to cost centers, cost unit or jobs are called chargeable expenses Cost of patents, license fees, traveling expenses to sites

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Classification of cost

By Function
Production or Manufacturing Cost
Cost of converting raw materials into finished goods thro the use of labour, service and other facilities

Administration Cost
Related to general administration activities, management which cannot be directly related to production, marketing, R&D and financing of the business

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Classification of cost

By Function
Selling Cost
Expenses incurred on selling activities Publicity, advertising, sales force wages, sales executives salary

Distribution Cost
Cost incurred on delivering products and other related activities Transporting articles from central to local storage Moving articles to and fro from the customer perspective on sales or return basis 19

Classification of cost

By Function
Finance Cost
Costs associated with borrowed funds Interest paid or accrued on capital borrowed

Research Cost
Cost incurred in discovering new ideas, new facts, new application of accepted facts, new interpretation of available information, improvement of existing products/ processes/ equipments

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Classification of cost

By Function
Development Cost
Begins with Implementation of the decision to produce a new or improved product Ends with commencement of formal production

Pre-Production Cost
Cost incurred in making trial production prior to regular and normal production Costs to cover all activities prior to production including R & D
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Classification of cost

By Conversion
Conversion Cost
Sum of direct wages, direct expenses and overhead cost for converting raw materials into finished product OR converting materials from one stage of production to the next stage

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Classification of cost

By Variability or Behaviour
Fixed or Constant Cost
Remain constant at all level of production Ex. Rent, insurance of factory building

Variable Cost
These costs tend to vary with the volume of output Cost of direct material and direct labour

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Classification of cost

By Variability or Behaviour
Stepped Fixed Cost
Which are fixed over a certain level of activity, but increase by a no of fixed amount when the activity rises above this level A doctor looks after 50 beds. For additional patient additional doctor is required to be appointed

Semi-variable Cost
Partly fixed and partly variable in relation to the output Ex. Telephone bill, electricity bill
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Classification of cost
Semi-Variable Cost Stepped fixed Cost Variable Cost

Amount in Rs

Fixed Cost

Level of Activity
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Classification of cost

By Controllability
Controllable Cost
Costs which can be influenced by action of specified member of an undertaking

Uncontrollable Cost
Costs which can not be influenced by the action of a specified member of an undertaking Ex. A technician can control the cost of his job but not the share in factory expenditure

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Classification of cost

By Normality
Normal Cost
Which is normally incurred at a given level of output under the normal condition of working

Abnormal Cost
Costs which is not normally incurred at a given level of output in the conditions in which that level of output is normally attained Charged to costing of P/L acct Ex. Wastage in excess of normal allowed wastage
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Classification of cost

By Capital and Revenue


Capital Cost
Cost is incurred in purchasing assets either to earn income or increasing the earning capacity of the business Ex. Cost incurred in purchasing gen set, boiler

Revenue Cost
Cost incurred to maintain the earning capacity of the concern such as cost of maintaining an asset or running a business Ex. Cost of materials used in production, salaries, depreciation, repair charges
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Classification of cost

By Time or Periodicity
Historical Cost
Cost is incurred in purchasing assets either to earn income or increasing the earning capacity of the business Ex. Cost incurred in purchasing gen set, boiler Key characteristics
Measurable in monetary terms Verifiable objective evidence in support of such cost

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Classification of cost

By Time or Periodicity
Future Cost
Cost expected to be incurred in future under uncertain circumstances Measurement of these future costs is in the form of estimates Required for planning and control

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Classification of cost

By Expiry
Expired Cost
Cost expected to be incurred in future under uncertain circumstances

Unexpired Cost
Are the resources which have been acquired and which have the capacity to generate revenue in the future

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Classification of cost

By Relationship
Direct or Identifiable Cost or Separable Cost
Separately identifiable Cost with the cost object Cost of a stabiliser when the cost object is a refrigerator

Indirect cost or common costs


Identifiable only partially, not fully with the cost object Rent of a factory where several products are manufactured
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Classification of cost

By Product or Period
Product Costs
Identified with goods manufactured Purchased for resale Till sold, they are recorded as asset When they are sold, recorded in P/L In mfg organisation, all mfg costs are treated as product cost

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Classification of cost

By Product or Period
Period Costs
Not included in the stock valuation Treated as expense in the period in which they are incurred Recorded as an expense in P/L in current acctg period In mfg organisation, non-mfg costs are regarded as period cost like administration, selling, distribution expenses

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Classification of cost

By Planning and Control


Marginal Cost
Additional cost to be incurred if an additional unit is produced

Out-of-Pocket costs
Which involves payment

Differential costs
Costs due to change in the level of activity or pattern or method of production If the change increases costs, it is incremental cost If the change decreases costs, it is decremental cost

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Classification of cost

By Planning and Control


Imputed or Notional Cost
Costs appear only in the cost accounts Ex., Notional rent charged on business premises owned by proprietor, interest on capital for which no interest has been paid

Discretionary/ Managed/ Policy/ Programmed Costs


Fixed nature and incurred in accordance with certain policy decisions of the top mgmt May be in excess of current requirement like cost of employees training, cost of advtg

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Classification of cost

By Planning and Control


Sunk Costs
arise on account of commitments made in the past Ex., Depreciation Charges

Opportunity Costs
Cost which measures the opportunity which is lost or cancelled when choice is made on one course of action Profit or benefit foregone by not taking an alternative course of action
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Classification of cost

By Planning and Control


Replacement Costs
Cost of replacement at current market price Cost at which there could be purchase of an asset or material identical to that is being replaced or revalued

Avoidable Costs
Costs which can be eliminated with discontinuance of a product or department If any deptt is discontinued, salaries of clerks can be avoided
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Classification of cost

By Planning and Control


Unavoidable Costs
Cost which will not be eliminated with the discontinuation of a product or department

Programmed Costs
Decisions by mgmt to resulting in periodic appropriations, reflects policy of top mgmt Ex. Expenditure incurred under CSR in the form of maintenance of gardens, Village adoption
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Classification of cost

By Planning and Control


Joint Cost
Cost of manufacturing joint products up to prior to the split-off point Common to the processing of joint products and by-products till the point of seperation

Committed Costs
Fixed cost which results from the long-term decisions of the management which were taken in the past and is not subject to the management control
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Costing Principles
Relation of the causes costs should be related to their causes, ie cost centers, cost units Abnormal costs to be excluded Past costs not to be charged Future costs not to be charged

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Costing Principles

Expenses excluded from cost accounts Interest on debentures and loans Cash discount Loss on sale of assets or stores and other capital losses Abnormal losses Expenses written off Fines, penalties, donations, subscriptions, charities Discount on issue of shares and debentures
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Costing Principles

Expenses excluded from cost accounts


Income tax, dividends paid to shareholders and appropriation of profits such as reserves Loss on investment

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Costing Principles

Incomes excluded from cost accounts


Profit on sale of assets or stores and other capital profits Interest on investments, dividends received and interest gained on bank deposits Rent received Abnormal gains Fees received
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Costing Principles

Imputed costs included in cost accounts


Rent of the building Salary of owner or manager Depreciation

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Components of total costs

Prime Cost
Direct material + direct labour + direct expenses Highest percentage of total cost

Factory Cost or Works Cost


Denotes expenses incurred in converting raw materials into finished products Prime Cost + Factory overhead/ expenses Factory overhead consists indirect material, indirect labour and indirect expenses 46

Components of total costs


Office Cost Works Cost + Office and Admin expenses Total Cost or Cost of Sales Office cost + Selling and distribution Exp Direct material + direct labour + direct exp + Indirect material + Indirect labour + Indirect expenses + Office & Admin exp +SD exp Serves purpose of fixing the selling price by adding markup on total cost or a profit margin on total sale Margin is profit as %age of sales
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Types of Costing Systems

Uniform Costing
No of firms in an industry agree among themselves to follow the same system of costing in detail by adapting common terminology and calculation methods Comparison of the performance of each firm with one another or with the average performance of the industry

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Types of Costing Systems

Marginal Costing

Ascertainment of marginal cost by differentiating between fixed and variable cost Used to ascertain the effects of changes in volume or level of output on profit Standard Costing Technique where standard costs are predetermined and subsequently compared with recorded actual costs Technique can be used with any method of costing
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Types of Costing Systems

Historical Costing
Ascertainment of costs after they have been incurred Limited utility in real life

Direct Costing
Practice of charging all direct costs to operations, processes, or products and leaving all indirect costs to be written off

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Types of Costing Systems

Absorption Costing
Practice of charging all direct costs both variable and fixed to operations, processes or products.

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Characteristics of Cost Info

Cost Tracing
Attempt to assign costs on the basis of their cause

Cost Allocation
Allotment of whole items of cost to cost centres or cost units

Cost Apportionment
Allotment of proportions of items of cost to cost centers to cost units
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