Cost Accounting –

Meaning and Scope

Meaning of Cost Accounting
 Cost- Cost is the amount of resource given up in exchange
of some goods or services. It can be expressed as a noun as
well as a verb. As a noun, it can be defined as the amount
of expenditure (actual or notional) incurred on or
attributable to a specified article, product or activity.
 The Chartered Institute of Management Accountants
(CIMA) of UK has defined costing as, “the techniques and
processes of ascertaining costs”.
 Cost Accounting is concerned with recording, classifying
and summarizing costs for determination of costs of
products or services ;planning, controlling and reducing
such costs and furnishing information to management for
decision making.

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•Cost Accounting-
• Cost Accounting is defined as "the process of
accounting for cost which begins with the recording of
income and expenditure or the bases on which they are
calculated and ends with the preparation of periodical
statements and reports for ascertaining and
controlling costs."
•Cost Accountancy
• theapplication of costing and cost accounting principles,
methods and techniques to the science, art and practice
of cost control and the ascertainment of profitability. It
includes the presentation of information derived
therefrom for the purposes of managerial decision-
making.” Cost accountancy is thus the science, art and
practice of a cost accountant.
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 Activities of Cost Accounting

 Cost Determination for specific product or activity.

 Cost Recording
 Cost Analysis : concerned with the critical evaluation of cost
information to assist the management in planning and
controlling the business activities.
 Cost Reporting :Concerned with reporting cost data both for
internal and external reporting purposes.

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 Financial Accounting Vs. Cost Accounting
 Aims at safeguarding the
interest of the business, its
proprietors and others
connected with it.
 Financial Accounts are
prepared according to some
accepted accounting concepts
and conventions.
 Reveals the profit of business
as a whole
 Prepared and submitted
usually at the end of the
accounting period.
 Provides information useful to
outsiders,
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hence high degree
 Renders information for
guidance of the management
for proper planning,
operational control & decision
making.
 Maintenance of cost records
are voluntary and there are no
statutory forms regarding
their presentation.
 Reveals the profit made on
each product, job or process.
 Prepared more frequently,
sometimes even weekly.
 Provides information useful to
insiders, degree of accuracy
5
is
Cost Accounting and Cost Accountancy
The term Cost Accountancy has a wider meaning as compared to
the term cost accounting.
Cost Accountancy includes the following:
 Cost Accounting : It is the process of accounting for costs.
 Costing : It is the technique and process of ascertaining costs.
 Cost Control: Cost Control is a technique which provides the
necessary information to the management that actual costs
are aligned with the budgeted costs or not
 Cost Reduction: Cost Reduction is a technique used to save
the unit cost of the product without compromising its quality.
 Cost Audit: It is the verification of cost accounts and a check
on the adherence to the cost accounting plan.

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Objectives of Cost Accounting
i. Ascertainment of cost : Involves computation of cost incurred
ii. Estimation of costs : As compared to ‘what has been the cost’ it
emphasizes on ‘what is likely to be the cost’ or ‘what should be
the cost’.
iii. Cost Control : Involves i) determination of standard costs and ii)
analyzing the cause of variations between standard and actual
cost.
iv. Cost Reduction
v. Determining selling price
vi. Facilitating preparation of financial and other statements: A
developed cost accounting system provides immediate
information regarding stock of raw materials, work-in-progress
and finished goods. This helps in speedy preparation of financial
statements.
vii. Provides basis for operating policy: ex. make or buy, Shut down
or operate at loss etc.
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Importance of Cost Accounting
To the Management:
 Aids in price fixation
 Costing makes comparison possible.
 Provides data for periodical profit and loss account.
 Wastages are eliminated: Cost of the article can be known
at every stage and hence it is possible to check various
forms of waste.
 Aids in determining and enhancing efficiency: Losses due
to wastage are minimized thus enhancing efficiency.
 Helps in Inventory Control
 Helps in determining break even point:
Break Even Point = Fixed Costs / Contribution per unit
where, Contribution = Selling price – Variable cost.
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Importance of Cost Accounting ( Contd. )
vii. Helps in determining the level of output for a desired profit :
Level of Output = (Fixed Cost + Desired Profit)/ Contribution
per unit

viii.It helps in periods of trade depression and competition: In

periods of depression, a firm may have to sell its product even
below the total cost. While deciding whether to shut down or
sell, the firm should keep operating as long as the fixed costs
are being recovered.
To the Employees:
Workers are benefited indirectly through increase in consumer
goods and directly through continuous employment and larger
remuneration.
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Installation of Costing System
Practical Difficulties
 Lack of Support from Top Management: This due to
resistance to the additional work involved. The difficulty
can be overcome by instilling a sense of cost
consciousness in the minds of the top management.
 Resistance from the existing staff : They should be
explained that the costing system would not replace
but strengthen the existing system and open to them
new areas of development.
 Non-cooperation at other levels
 Heavy Costs: Unnecessary sophistication and
formalities should be avoided .

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Basic Cost Concepts
Cost Unit
• “unit of product, service or time in relation to which
cost may be ascertained or expressed”. By CIMA
London
• Cost units are the ‘things’, that the business is set up
to provide of which cost is ascertained. For example,
in a sugar mill, the cost per tonne of sugar may be
ascertained, in a textile mill the cost per metre of
cloth may be ascertained. Thus ‘a tonne’ of sugar and
‘a metre’ of cloth are cost units

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 Cost Object
•Cost object may be defined as “anything for which a separate
measurement of cost may be desired”. A cost accountant may want to
know the cost of a particular ‘thing’ and such a ‘thing’ is called a cost
object. A cost object may be a product, service, activity, department or
process etc. Examples of cost objects are given below:
•Cost object Examples
•Product Car, shaving razor, TV
•Service Telephone hotline, taxi service, electricity
•Process Melting process in a steel mill, weaving process in a
textile mill. Activity Developing a webside on the Internet,
Purchasing raw material. Department Purchasing department,
Personnel department, Production department
•

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 Cost Driver
• A cost driver is the unit of an activity that causes
the change in activity's cost.
• Number of set-ups
• Number of machine hours
• Number of processed orders
• Number of orders completed
• Number of labor hours
• Number of orders packed and delivered

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 Cost Centre
•A cost centre is defined by CIMA of UK 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”. Thus,
a cost centre refers to a section of the business to which costs can be charged. Cost centres
are primarily of two types:
(a) Personal cost centre—which consists of a person or a group of persons,
(b) Impersonal cost centre—which consists of a location or an item of equipment or
group of these.
From functional point of view, cost centres may be of following two types:
(c) Production cost centre—This is that cost centre where actual production work takes
place. Examples are melting shop, machine department, welding department, finishing
shop, etc.
(d) Service cost centre—This is that cost centre which are ancillary to and render
services to production cost centres. Examples of service cost centres are power house,
tool-room, stores department, repair shop, canteen, etc. Costs incurred in service cost
centres are of indirect type.

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 CLASSIFICATION
OF COST

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On the basis of Nature
• Direct Cost: These are those costs which are incurred for and
conveniently identified with a particular cost unit, process or department.
Cost of raw materials used and wages of machine operator are common
examples of direct costs. To be specific, cost of steel used in manufacturing
a machine can be conveniently ascertained. It is, therefore, a direct cost.
• Indirect Cost: These are general costs t of a trouser. and are
incurred for the benefit of a number of cost units, processes or
departments. These costs cannot be conveniently identified with a
particular cost unit or cost centre. Depreciation of machinery, insurance,
lighting, power, rent, managerial salaries, materials used in repairs, etc.,
are common examples of indirect costs

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On the basis of behaviour
Fixed, variable, Semi-variable and step costs:
Fixed Cost : A cost which tends to be unaffected by variations in
volume of output. Depend mainly on passage of time and do
not vary directly with volume or rate of output ex. rent,
insurance.
Variable Cost : the cost which varies directly in proportion to every
increase or decrease in the volume of output or production ex.
wages of labourers, cost of direct material.
Semi- Variable Cost: The cost which does not vary proportionately
but simultaneously cannot remain stationery at all times . Also
called semi-fixed cost ex. Depreciation, repairs.
Step up costs : Costs which remain fixed over a range of activity and
then jump to a new level as activity changes. They are a type of
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On the basis of controllability
• Controllable cost: Cost that can be controlled, typically by a
cost, profit or investment centre manager is called controllable
cost. Controllable costs incurred in a particular responsibility centre
can be influenced by the action of the manager heading that
responsibility centre. For example, direct costs comprising direct
labour, direct material, direct expenses and some of the overheads
are generally controllable by the shop floor supervisor or the
factory manager.
• Uncontrollable cost: Costs which cannot be influenced by the
action of a specified member of an undertaking are known as
uncontrollable costs. Forexample, expenditure incurred by, say, the
tool room is controllable by the foreman in-charge of that section
but the share of the tool-room expenditure which is apportioned to
a machine shop is not controlled by the machine shop foreman
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 On the basis of managerial
decision making
Shut down and sunk costs:
Shut down Cost :If a plant is idle due to temporary difficulties,
certain fixed costs have to be incurred even if no work is being
done ex. rent, insurance of building, depreciation etc. Such
costs of the idle plant are known as shut down costs.
Sunk Cost :Historical or past costs. Created by a decision that was
made in the past and cannot be changed by any decision that
will be made in the future ex. Investment in building, plant and
machinery. Such costs are irrelevant for decision making.
Differential, Incremental or Decremental cost :
Differential Cost :Difference in total cost between two alternatives.
Incremental Cost: increase in total cost as a result of choice of
alternative.
Decremental Cost : Decrease in total cost as a result of choice of
alternative.
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Classification Of Costs ( Contd )
Opportunity Cost: The advantage which has been foregone on
account of not using the facilities in the manner originally
planned. It is the alternative revenue foregone. Ex. If an owned
building is proposed to be utilized for housing a new project
plant, the likely revenue which the building could fetch, is the
opportunity cost.
Product Costs and Period Costs :
Costs which become part of the cost of the product rather than an
expense of the period in which they are incurred are called
‘Product costs’. They are included in inventory values. They can
be fixed or variable ex. Cost of raw material, direct wages.
Costs which are not associated with production are called ‘ Period
costs’. They are treated as an expense of the period in which
they are incurred. They can be fixed or variable ex. general
administration costs, salesmen salaries etc.
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Classification Of Costs ( Contd )
Explicit Cost: Out-of-pocket costs, also known as explicit
costs, are those costs that involve cash outlays or
require the utilisation of current resources. Examples
of out-of-pocket costs are wages, material cost,
insurance, power cost, etc. Out-of-pocket cost may be
either fixed (manager’s salary) or variable (raw
materials and direct wages).
Implicit Cost: Depreciation on plant and machinery does
not involve any cash outlay and therefore is not an
out-of-pocket cost. Such costs are also known as
implicit costs.

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 Elements of Cost
Material : Substance from which the product is made. It can further be
divided as :
 Direct Material : All material which becomes an integral part of the
finished product and which can be assigned to specific physical units
ex.
i. All material components specifically purchased, produced or
requisitioned from the stores
ii. Primary packing material (carton, wrapping, cardboard box)
iii. Purchased or partly produced components.

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• Indirect Material: All material which is used for
purpose ancillary to the business and which can
not be assigned to specific physical units ex.
Consumable stores, oil and waste, printing and
stationery material etc.

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Elements of Cost ( Contd )
Labour : Conversion of Material into finished goods requires
human effort which is called labour. It can further be
subdivided as :
 Direct Labour : Labour which takes an active and direct
part in the production of a particular commodity. It is
specifically and conveniently traceable to specific
products.

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• Indirect Labour : Labour employed for the purpose of carrying out
tasks incidental to goods or services provided. It does not alter the
construction, composition or condition of the product. It can not be
traced to specific units of output ex. wages for store keeper,
foremen, time keepers, directors’ fee, salaries for sales men etc.

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Elements of Cost ( Contd )
Expenses : Any other cost besides material and labour is termed
as expense.
 Direct Expense : Expenses which can be directly,
conveniently and wholly allocated to specific cost centers
ex. hire of special machinery for a particular contract, cost
of defective work incurred in connection with a particular
job.
 Indirect Expense : Expenses which can not be directly,
conveniently or wholly allocated to specific cost centres or
cost units ex. rent, insurance, salaries etc.

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Overheads : All indirect costs ( material, labour and
expenses ) are overheads. May be subdivided as :
 Production Overheads : They include Indirect
material used in factory such as lubricants, oil,
consumable store etc.
ii. Indirect labour ex. salary for gatekeeper , time
keeper etc.
iii. Indirect expenses ex. factory rent, factory insurance
etc.

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Elements of Cost ( Contd )
consumable store etc.
ii. Indirect labour ex. salary for gatekeeper , time keeper etc.
iii. Indirect expenses ex. factory rent, factory insurance etc.
 Office & Administration Overheads: They include:
i. Indirect material used in office ex. printing and stationery.
ii. Indirect labour ex. salaries payable to office manager, clerks.
iii. Indirect expenses ex. office rent, office insurance etc.
 Selling and Distribution Overheads : They include :
i. Indirect material used ex. packing material, printing and
stationery etc.
ii. Indirect labour ex. salaries of salesmen, sales manager etc.
iii. Indirect expenses ex. rent, insurance, advertising expenses
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etc.
Components of Total Cost
 Prime Cost : Also known as basic, first or flat cost.
Prime Cost =Direct material + Direct Labour + Direct Expenses
The term ‘ Direct Material’ means the cost of direct material
consumed, which equals : Opening Stock + Purchases – Closing
Stock
 Production Cost: Also called Works cost or manufacturing cost.
Production Cost = Prime Cost + Production Overheads.
Adjustment for Scrap : In case certain materials ( before being used )
are found to be defective and hence sold, the value of materials
used should be reduced by the cost of such materials
Adjustment for Work-in-progress :Work-in progress means units
which are not yet complete but on which some work has been
done. Generally such goods bear a proportionate part of factory
overheads, apart from raw material & direct wages. Thus,
opening and closing stock of work-in progress is kept in mind
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while computing works cost of goods manufactured.
Components of Total Cost ( Contd )
 Cost of production = Production cost + Op. WIP – Cl WIP
 Office & Administration overheads are included on the
presumption that they relate solely to production. The amount
of office and administration overheads relating to sales are a
part of selling overheads and must have already been included
in them
Adjustment for Finished Goods :
Cost of production of goods sold = Cost of production + Opening
Stock of Finished Goods – Closing Stock of Finished Goods.
 Total Cost or Cost of Sales:
Cost of Sales = Cost of Production of goods sold +
Administrative & Selling and distribution overheads.

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Cost Sheet
Cost Sheets may be of the following two types :
 Historical Cost Sheet: Prepared periodically and after the costs
have been incurred.
 Estimated Cost Sheet: Prepared before the actual
commencement of production. The estimation process is
repeated at regular intervals. The estimates are compared
with the actual costs so that costs can be effectively
controlled.
Importance of Cost Sheet:
 Ascertainment of Cost
 Controlling Costs
 Fixation of Selling Price
 Submitting of tenders: Preparation of an estimated cost sheet
about relevant product or job facilitates this.
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