Meaning of Cost Accounting

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.

According to Chartered Institute of Management Accountants, London, cost accounting is ‘the

process of accounting for costs from the point at which the expenditure is incurred or committed
to the establishment of its ultimate relationship with cost units. In its widest sense, it embraces
the preparation of statistical data; the application of cost control methods and the ascertainment
of the profitability of the activities carried out or planned.’

Cost Accounting Activities

Cost accounting provides useful data for both internal and external reporting. Internal report
presents details of cost information regarding cost of specific products or services while external
reports contain cost data in a summarized and aggregate form.

To satisfy requirements of both internal and external reporting, the following activities are
undertaken by 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.

Cost Accounting and Cost Accountancy

The term Cost Accountancy has a wider meaning as compared to the term cost accounting.
According to CIMA, London, cost accountancy means ‘the application of costing and cost
accounting principles, methods and techniques to the science, art and practice of cost control. It

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includes the presentation of information there from, for the purpose of managerial decision
making’. Cost accountancy is thus the science, art and practice of the cost accountant.

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 Reduction

 Cost Audit: It is the verification of cost accounts and a check on the adherence to the cost
accounting plan.

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.

Importance/ Advantage/ Significance of Cost Accounting

To the Management:

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  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

To the Employees:

Workers are benefited indirectly through increase in consumer goods and directly through
continuous employment and larger remuneration.

Branches of Accounting

 Financial Accounting
 Management Accounting
 Cost Accounting

Financial Accounting Vs. Cost Accounting

Financial 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.

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  Provides information useful to outsiders, hence high degree of accuracy.

Cost Accounting

 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 is less.

Cost concepts and classifications

The term cost refers to the amount of resources given up in exchange for some goods or services.
The resources so given up are always expressed in terms of money.

According to CIMA, London, the term cost in general means, ‘the amount of expenditure (actual
or notional) incurred on or attributable to a given thing or activity.

Cost refers to the total resources foregone, which may or may not bring matching economic
benefits.

CLASSIFICATIONS OF COST
By Elements By Functions By Nature By Accounting Treatment By Control By Managerial Decision Making
Materials Production Cost Fixed Product cost Controllable Sunk cost
Labour Administrative Cost Variable Period cost Non-controllable Shut down cost
Overheads Marketing and distribution cost Semi-variable Differential cost
Financing cost Step up Opportunity cost

Elements of Cost

Material: Substance from which the product is made. It can further be divided as:

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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.

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

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.

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
cannot be traced to specific units of output ex. wages for store keeper, foremen, time keepers,
directors’ fee, and salaries for sales men etc.

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 cannot be directly, conveniently or wholly allocated to

specific cost centres or cost units ex. rent, insurance, salaries etc.

Fixed, variable, Semi-variable and step costs:

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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 semi variable costs.

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.

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:

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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.

COMPONENTS OF TOTAL COST

 PRIME COST/DIRECT COST/ FIRST COST/ FLAT COST

 WORKS COST/FACTORY COST

 OFFICE COST

 TOTAL COST

 SELLING PRICE

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.

Main Considerations

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  The product: Nature of product determines the type of costing system to be
adopted e.g a product requiring high value of material content requires an
elaborate system of material control.

 The organization: The existing organization should be disturbed as little as

possible.

 The objective: The objective and information that the management wants to
acquire should also be cared for while adopting a costing system.

 The technical details: The system should be adopted after a detailed study of the
technical aspect of the business.

 Informative and simple

 Elastic: Should be capable of adapting to changing requirements of the business.

Functions of the Cost Accountant

 Determining cost and analyzing income: Analyses and classifies costs according
to different cost elements viz. material, labour and expenses. Advises the
management about the profitability or otherwise of each job, product or process.

 Providing cost data for planning and control: Collects, classifies and presents in
appropriate form, suitable data to the management for planning and controlling
the operations of the business.

 Undertaking special cost studies for managerial decision making : Studies

regarding -

 Introduction of new products, replacement of manual labour with machines etc.

 Make or buy decisions, accepting orders below cost etc.

 Expansion plans, Utilization of idle capacity etc.

 Installation of cost audit system

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MATERIAL

In various elements of cost, material has an important place. The term material generally used in
manufacturing concerns refers to raw materials used for production, sub-assemblies and
fabricated parts. However, both the terms are different. Stores are wider term in comparison to
materials. For our discussion, the term material shall mean and include:

i. Raw material
ii. Spare parts and components
iii. Factory supplies; and
iv. Packaging materials.

DIRECT AND INDIRECT MATERIALS

Direct material means material which becomes the integral part of the finished goods and which
can be easily recognized in manufactured goods. The material which is though used in
production yet cannot be related to a particular job or product is called indirect material.

MATERIALS CONTROL

The financial statements of various public and private companies show that expenses on
materials are 40 to 70 percent of the total cost. According to an estimate 40 to 45 percent of the
total cost in steel and newspaper productions, 45 to 50 percent in chemical, tyre and cement
industries, 50 to 60 percent in engineering units and 60 to 65 percent in bakeries is spent on
materials. As significant part of the cost of a product is spent on material, control on cost without
appropriate control on material is not possible.

OBJECTIVES OF MATERIAL CONTROL

The main objectives of material control may be described as follows:

1. To check possible wastages and leakages of material

2. To check theft of material
3. To check unnecessary purchases
4. To check the excess storage of material
5. To maintain flow of production

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 6. To reduce the cost of storage

SCOPE OF MATERIALS CONTROL

The main activities included in material control are as follows:

1. Determination of stock levels

2. Purchase of materials
3. Storing of materials
4. Issue of material
5. Verification of materials

Determination of stock levels: For material control, it is necessary to maintain each item of
material at an appropriate level. It depends on the demand and supply of material.

1. Rate of Material Usage: It is necessary to know the rate of material usage in

production in an organization. Generally this rate is find out as usage rate per day, per
week or per month.
(a) Maximum Usage rate: the quantity of material which is consumed at maximum
capacity production is called maximum usage rate.
(b) Minimum Usage rate: The quantity of material which is used at minimum capacity
production, in unusual business conditions, is called minimum usage rate.
(c) Normal or Average Usage Rate: The quantity of material which is used to run the
manufacturing activity properly under the normal conditions of business, is called
average or normal usage rate.
2. Delivery, Lead or Procurement Time: The period from the time taken in preparing
the order for the material purchase to the time taken in getting the delivery of the
material supplied is called delivery time.
3. Reserve Stock: Sometimes the material usage rate and the delivery time may be
more than the pre-estimated rates or time so the reserve stock of material is necessary.

Types of Stock Levels

i. Minimum stock level

ii. Maximum stock level

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iii. Re-order level or Re-order point
iv. Average Stock level

Purchase of materials

(i) Receipt and Analysis of Purchase Requisitions: Purchase requisition slip is a slip
which contains full details relating to kind, quantity, date of delivery etc. of the material
desired.

PURCHASE REQUISITION

Store Ledger No…………… Dated…………………………………

Please Purchase for………… Department/ works order No…………

…………..Materials

Serial No. Stock Code No. Description Qty. Remarks

(ii) Finding out the sources of Supply: After the receipt of purchase requisition slips and
their analysis, the possible suppliers of the desired material are find out.
(iii) Invitation of quotations/ tenders: After finding out the sources of supply, the purchase
department invites quotations from the suppliers.
(iv) Preparing a comparative statement: the tenders received till the last date is opened and
a comparative statement is prepared so that the order for the purchase of material on the
best conditions may be sent.
(v) Selection of the best supplier: After analyzing the comparative statement of tenders, the
best supplier is selected.
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 (vi) Placing of purchase order: After selecting the best suppliers, the order for the supply of
desired material is given to the concerned suppliers.
(vii) Follow Up of the Purchase order: The position of supply of material is known
through the follow-up action.
(viii) Receiving, Inspecting and Verifying the Material: Record by material received
note.

MATERIALS RECEIVED NOTE

ABC Ltd., Mumbai

Indent No……. Date…………….

Purchase order No. and Date……………

Supplier’s Challan No. and Date………..

Material Received Note No……………..

No. Description Code No. Qty. Rate (Rs.) Amount (Rs.) Remarks

Signature of Checker Signature of Receiving Clerk

(ix) Payment Arrangement: Arrangement for payment to the supplier.

(x) Maintaining of Records: The last step where proper record keeping takes place.

Storing of materials

i. Place of store: Proper and adequate place for storing the material.
ii. Safe Place: No risk of theft or fire.

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iii. Efficient and Honest employees: The employees of the store should be efficient and
honest.
iv. Store Accounting and Recording: For control on store, proper recording and accounting
f material received, issued, returned and transferred should be made.
a) Bin card: In the store, a card on every almirah, rack or drawer is hanged
which is called as bin card.

BIN CARD

ABC Ltd., Mumbai

Material………. Bin No……….

Code No……….. Max. level……….
S.L. Folio………. Min. level……….
Ordering level……
Receipts Issues Balance
Date Remarks
Challan No. Qty. Req. No. Qty. Qty.

b) Material inward book: Material received in the store is entered in the

material inward book.

MATERIALS RECEIVED NOTE

ABC LTD., MUMBAI

NO………. Purchase order No………. Date……….

Date………. Supplier……….

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 No. Description Unit Quantity Condition For Cost Accounting Use
Rate (Rs.) Amount (Rs.)

Received by………. Store – keeper………

Inspected by………. Purchase Officer………

Material issue book: this book is prepared with the help of materials requisition slip.

ABC LTD.

STORES REQUISITION

TO, ………. No………..

Deliver the following material to………. Date……….

For order No………..& Dept……….

Code For Office use

Quantity Unit Description Remarks
No. only
Rate Amount

Stores Ledger Folio Cost Office

Sanctioned Issued Received
by No….. by by Ref. No.
Bin No…. Priced by

c) Material return book: This book is prepared with the help of materials return
note.

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 ABC CO. LTD.

MATERIAL RETURN NOTE

From…….. No……….

Dept…… Date……

Job No……….

Order No……..

Quantity Description Code No. For Office use only Remarks

Rate Amount

Cost
Returned by Cost Office
Authorized Office
Received by
by Ref. No. Ref. No.
Priced by Priced by..
d) Material transfer book: this book is prepared on the basis of materials
transfer note.

ABC LTD.

MATERIAL TRANSFER NOTE

Serial No……….

Date……….

From Job No………. To Job No……….

From Deptt………. To Deptt……….

Description of Code Rate Amount

S.No. Qty. Remarks
Material No. (Rs.) (Rs.)

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 ……….…. …………. ……….

Transferor Receiver Cost Clerk

e) Store ledger account: In this book separate account of each material is

maintained.

ABC CO. LTD.

Store Ledger Account
Description………. Folio No……….
Code No………. Maximum level……….
Location………. Minimum level……….
Bin No……….. Ordering level……….
Pricing Method……….
Receipts Issues Balance
Date Invoice No. Qty. Rate Amount Material Req. No. Qty. Rate Amount Qty. Rate Amount
Rs. Rs. Rs. Rs. Rs. Rs.

Issue of material

Pricing of Material Issued

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1. Cost Price Method

 FIFO
 LIFO
 HIFO

2. Average Rate Methods

 Simple Average Method

 Weighted Average Method

3. Other Methods

 Replacement Price Method

 Standard Price Method
 Inflated Price Method (Treatment of Material Loss)

Verification of materials

Periodic Inventory System: Under this system, after a certain period i.e. 3 months, 6 months, or
a year, all the material is physically counted.

Perpetual Inventory System: The system of continuous physical stock taking is known as
perpetual inventory system.

SOME OTHER TECHNIQUES OF MATERIAL CONTROL

(i) ABC Analysis technique: Always better control is also known as control by
importance and exception. It is an analytical method of inventory control which aims
at concentrating efforts in those areas where attention is required most. This
technique classifies the various inventory items according to their importance. A class
consists on only small percentages of total number of items handled but are most
important in nature. B class items include relatively less important items. C class
items consist of a very large number of items which are less important.

Inventory surveys in general have shown the following trends regarding the components of
inventories in manufacturing organizations:

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Category % of total value % of total quantity

A 70 to 75 5 to 10

B 15 to 25 15 to 25

C 5 to 10 70 to 75

(ii) Material Turnover Ratio = Material Consumed/ Average stock of raw material

Where in: - Material Consumed = Opening stock of material + purchase - closing stock

Average stock of raw material = Opening stock + closing stock / 2

e.g., if opening stock of material is Rs. 200, purchases are Rs. 160 and closing stock is Rs. 120
then material turnover ratio would be =

Material consumed = 200 + 160 – 120 = 240

Average stock of raw material = 200 + 120 / 2 = 160

Material turnover ratio = 240/ 160 = 1.5: 1

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