Course Title:

Cost & Management Accounting

Course Code:ACC 205
Introduction to Cost Accounting (Unit-I)

Learning Outcomes:
Meaning and Definition of Cost Accounting
Scope and Uses of Cost Accounting
Difference between Financial Accounting and
Cost Accounting
Role of Cost Accounting in Decision Making
Elements of Cost
Classification of Cost
 What is Accounting?
The importance of accounting for the successful
running of business has been long recognized.
The two basic objectives of accounting system in
any business organization are:
1. Basically, it is used to classify and record
business transactions .
2. To provide financial information regarding the
activities of an enterprise to a diverse group of
people such as managers, creditors, debtors, tax
authorities, bankers, Government etc.
Branches of Accounting

Financial Accounting

Cost Accounting

Management Accounting
 Cost
According to Oxford Dictionary, cost means,
“the price paid for something.”

Cost is a measurement in monetary terms of

the amount of resources used for the purpose
of production of goods or rendering of services

ICWA of India
 Cost Accounting
Cost accounting is the classifying, recording and appropriate
allocation of expenditure for the determination of the costs of
products and services, and for the presentation of suitably arranged
data for the purpose of control and guidance of management.

“Basically, it is a process of ascertaining costs.”

 In brief, cost accounting is a system of determining the costs of

products or services.

 It has primarily developed to help managers to understand the

costs of running a business
 Costing & Cost Accounting
Though the two terms ‘costing’ and ‘cost accounting’ are used
interchangeably , there is a difference between the two.
 Costing enables the total cost of any particular unit of production or
service to be ascertained with reasonable degree of accuracy and at
the same time to disclose exactly how such total cost is constituted,
i.e.
• the value of materials used,

• the amount of labour and

• other expenses incurred.

 Cost accounting on the other hand is a formal system of accounting

Scope and Use of Cost Accounting
Ascertainment
of Cost

Technique and
Budgetary
Process of
Control
Costing

Cost Audit Cost Control

 Relationship between Cost
Accounting and Financial Accounting
• Both cost accounting and financial accounting are concerned with the
systematic recording and presentation of financial data.

• The two systems rest on the same principles concerning debit and
credit and have the same sources of recording the transactions.

• But cost accounting is much more detailed than financial accounting.

This is because in financial accounting profit or loss is ascertained
for the business as a whole whereas in cost accounting, detailed cost
and profit data for various parts of business, like departments,
products etc. are shown.
 Difference between Financial
and Cost accounting
Basis Financial Accounting Cost Accounting

1.Purpose The purpose is to prepare The main purpose is to prepare

profit and loss account and detailed cost information to
balance sheet. management.

2.Statutory These account have to be Maintenance of these account is

requirement prepared according to legal voluntary.
(Maintenance requirement.
of Accounts)
3.Periodicity/ Financial reports are Cost reporting is a continuous
Duration of prepared usually on annual process.
reporting basis.

4.Control This does not attach any It provide for a detailed system of
aspect importance to control aspect. control with the help of certain
special techniques.
 Difference between Financial
and Cost accounting
Basis Financial Accounting Cost accounting

5. Profit & Financial accounting discloses Cost accounting shows the profit for
Loss profit/loss for the entire each product, process or operation.
business as a whole.

6. Recording It classifies, records and Cost accounting records the

analyses the transactions in a expenditure in an objective manner,
subjective manner, i.e., i.e., according to purpose for which
according to the nature of costs are incurred.
expenses.

7. Pricing It fails to guide the It provides adequate data for

Policy formulation of pricing policy. formulating of pricing policy.

8. Facts and Financial accounting deals Cost accounting deals partly with
Figures mainly with actual facts and facts and figures and partly with
figures. estimates.
 Role of Cost Accounting in Decision
Making
The cost accounting plays an important role in the following
decisions making:
1. Determination and Analysis of Cost: The main object of cost
accountaning is to determine cost per unit or per job or per
contract.
2. Cost Control and Cost Reduction: Cost control and cost
reduction is an important factor to be considered to know the
best result obtained by each department. For this purpose, the
standards are fixed and in case the efficiency of each department
is more than the anticipated standard, the result will be
considered as favourable and vice-versa.
3. Planning and Decision-making: This is possible when policies
that are framed are properly implemented.
 Role of Cost Accounting in Decision
Making
A good system of costing will be of varied benefits to the
management:
 Profitable and unprofitable activities can be disclosed by taking
necessary steps periodically.
 Costing enables a concern to measure the efficiency maintained
and prove it.
 Costing provides such information upon which estimates and
tenders are based.
 Costing guides future production policies.
 An efficient check is provided on stores and materials.
 An efficient check on labour and machines is also possible by
providing incentives to workers.
 Role of Cost Accounting in Decision
Making
 It helps increase profits.
 It enables a periodical determination of profits or
losses without resort to stock taking.
 It furnishes reliable data for comparing costs in
different periods for different volumes of output.
 The fixation of price cannot be properly done unless
proper figures of costs are available.
 The exact cause of increase or decrease in profit or
loss can be detected.
 Some Important Cost Concepts
Cost Units
 “Cost unit is a form of measurement of volume of production or
service. This unit is generally adopted on the basis of convenience and
practice in the industry concerned.” CAS-I*
 As defined by the ICMA “a quantitative unit of product or service in
relation to which costs are ascertained”.
 Basically, a cost unit is a device used for the purpose of splitting total
cost into smaller sub-divisions attributable to products or service.
Simply stated it is a unit of finished product, service of these in
relation to which cost is ascertained and expressed.
Example -
1. Power Industry
• Electricity - Per kilo-watt hour
2. Cement Industry
 Cost Centre
A cost centre is defined as a “ location, person or item of equipment (or
group of these), for which costs may be ascertained and used for the
purpose of control”.

 For the purpose of ascertaining cost, the whole organization is

divided into smaller parts or section. Each small sector is treated as a
cost centre of which cost is ascertained.
 The sections of business to whom cost can be charged may be a
location (department), an item of equipment (machine), a person
(salesman) or group of these (two machines operated by one
workman).
 The main purpose is control of cost.
 Types of Cost centre

Operation and Process Cost Center

Production and Service Cost Center

Personal and Impersonal Cost Center

 Types of Cost centre

1. Operation and Process Cost Centre:

• Operation cost centre consists of those machines which carry
out the same operation.
• A process cost centre is a cost centre in which a specific process
or a continuous process of operation is carried out.
2. Production and Service
• Production cost centre: where the products are manufactured or
processed.
• Service cost centre: where services are provided to other cost
centres.
3. Personal and Impersonal
• Personal cost centre: person or group of persons
• Impersonal cost centre: location such as production centre.
 Cost Object

Cost object may be defined as anything for which a

separate measurement of cost may be desired. A cost
object may be a product, service, activity or process etc.
For example:
• Product: Car, Computer, etc.
• Service: Telephone, Internet service
• Activity or process: Melting process in a steel mill
etc.
 Elements of Cost

OTHER EXPENSES
MATERIALS LABOUR

DIRECT INDIRECT
DIRECT INDIRECT INDIRECT
DIRECT

OVERHEADS
MATERIAL: The substance from which
the finished product is made is known as
material.

Direct material is one which can be

directly or easily identified in the product
Eg: Timber in furniture, Cloth in dress, etc.

Indirect material is one which cannot be

easily identified in the product.
 Examples of Indirect material
• At factory level – lubricants, oil,
consumables, etc.

• At office level – Printing & stationery,

Brooms, Dusters, etc.

• At selling & dist. level – Packing

materials, printing & stationery, etc.
LABOUR: The human effort required to convert
the materials into finished product is called labour.

DIRECT LABOUR is one which can be

conveniently identified or attributed wholly to a
particular job, product or process.
E.g. : wages paid to carpenter, fees paid to tailor,
etc.

INDIRECT LABOUR is one which cannot be

conveniently identified or attributed wholly to a
particular job, product or process.
 Examples of Indirect labour
• At factory level – foremen’s salary, works
manager’s salary, gate keeper’s salary, etc.

• At office level – Accountant’s salary,

GM’s salary, Manager’s salary, etc.

• At selling and distribution level– salesmen

salaries, Logistics manager salary, etc.
OTHER EXPENSES are those expenses other
than materials and labour.

DIRECT EXPENSES are those expenses

which can be directly allocated to particular job,
process or product. Eg : Excise duty, royalty,
special hire charges, etc.

INDIRECT EXPENSES are those expenses

which cannot be directly allocated to particular
job, process or product.
 Examples of Other expenses
• At factory level – factory rent, factory
insurance, lighting, etc.

• At office level – office rent, office insurance,

office lighting, etc.

• At sales & distribution level – advertising,

show room expenses like rent, insurance, etc.
 CLASSIFICATION of COST

Cost Classification is the process of grouping

costs according to some of their common
characteristics.
It is a systematic placement of like items
together according to their common features.
A suitable classification of costs is of utmost
importance in order to identify the cost with
cost centers or cost units.
 Classification of Cost
1. By Nature Classification:

(a) Materials

(b) Labour

(c) Expenses

2. By Functions:

(a) Manufacturing and Production Cost

(b) Commercial Costs

3.By Degree of Traceability:

(a) Direct cost

 Classification of Cost
4. By Change in Activity or Volume/ Behavior

(a) Fixed Costs

(i) Committed Costs an investment that a business entity has already made

(ii) Discretionary Costs or Managed Costs

(iii) Step Costs fixed cost within certain boundaries, outside of which it will change.

(b) Variable Costs

(c) Semi-Variable Costs

5. By Controllability:

(a) Controllable Costs

(b) Non- Controllable Costs

 Classification of Cost
6. By Normality:

(a) Normal Cost

(b) Abnormal Cost

7. By Relationship with Accounting Period:

(a) Capital Cost

(b) Revenue Cost

8. By Time:

(a) Historical Costs

(b) Predetermined Costs

9. According to Planning and Control:

(a) Budgeted Costs

(b) Standard Costs

 Classification of Cost
10. For Managerial Decisions:
(a) Marginal Cost: It is the cost of producing an additional unit. Same thing as
variable cost. It is a technique of charging only variable costs to the products.

(b) Out Of Pocket Costs: These costs require cash payments to be done. Also
known as explicit cost. Example: wages, material cost - either fixed or variable
(c) Differential Costs: It is the increase or decrease in total cost that results from
an alternative course of action.
(d) Sunk Costs: Historical expense
(e)Imputed costs/Notional Costs/Opportunity Cost/Implicit Cost: Computed
outside the accounting system
(f) Replacement Cost
(g) Avoidable and Unavoidable Costs
PREPARATION OF COST
SHEET
 Meaning
Cost sheet is a statement of cost. In other words,
when costing information are set out in the form
of a statement, it is called cost sheet. For
determination of total cost of production a
statement showing the various elements of cost
is prepared. This statement is called as a
‘statement of cost’ or ‘cost sheet’.
 ELEMENTS
• Material consumed.

• Direct wages & salaries.

• Direct expenses.

• Work overhead.

• Administration overhead.

• Cost of production.

• Selling overhead.

• Distribution overhead.

• Valuation of stock of WIP & finished goods.

• Treatment of scrap & waste.

• Miscellaneous income.

• Interest & financial charges.

•
 PREPARATION OF COST SHEET
• Calculation of Materials Consumed:
Materials Consumed = (Opening stock of raw materials + Purchase of raw
material + carriage inward) - (closing stock of raw material).
• Calculation of Prime Cost:
Prime Cost = Materials consumed + direct wages + direct expenses.
• Calculation of Factory cost:
Factory Cost = Prime cost + sum of all factory overheads.
• Calculation of Production Cost
Cost of Production = Factory cost + office and administration overheads.
• Calculation of Sales Cost or Total Cost
Total Cost = Cost of production + selling and distribution overheads.
• Calculation of Total Sales
Total Sales = Total cost + net profit.
FORMAT OF COST SHEET
Particulars Amount Amount

Opening Stock of Raw Material ***

Add: Purchase of Raw materials ***
Add: Purchase Expenses ***
Less: Closing stock of Raw Materials ***
Raw Materials Consumed ***
Less;- Sale of Material Scrap (if any) ***
Direct Wages (Labor) ***
Direct Charges ***

Prime cost (1) ***

Add :- Factory Over Heads:
Factory Rent ***
Factory Power ***
Indirect Material ***
Indirect Wages ***
Supervisor Salary ***
Drawing Office Salary ***
Factory Insurance ***
Factory Asset Depreciation ***
Less:- Sale of Factory Scrap ( If any)

Works cost Incurred ***

Add: Opening Stock of WIP ***
Less: Closing Stock of WIP ***
Continued
Works cost (2) ***
Add:- Administration Over Heads:-
Office Rent ***
Asset Depreciation ***
General Charges ***
Audit Fees ***
Bank Charges ***
Counting house Salary ***
Other Office Expenses ***

Cost of Production (3) ***

Add: Opening stock of Finished Goods ***
Less: Closing stock of Finished Goods ***
Cost of Goods Sold ***
Add:- Selling and Distribution OH:-
Sales man Commission ***
Sales man salary ***
Traveling Expenses ***
Advertisement ***
Delivery man expenses ***
Sales Tax ***
Bad Debts ***

Cost of Sales (5) ***

Profit (balancing figure) ***
Sales ***