Cost Accounting

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 Introduction- Meaning
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 of
information to management for decision
making

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 COST ACCOUNTING

The Institute of Cost and Management Accountant, England

(ICMA) has defined Cost Accounting as
the process of accounting for the costs from the point at which

expenditure incurred, to the establishment of its ultimate relationship

with cost centers and 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 activities
carried out or planned.

Cost Accounting = Costing + Cost Reporting + Cost Control.

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 Cost Accounting and Accountancy
Cost Accountancy means :
the application of costing and cost accounting
principles, methods and techniques to the
science, art and practice of cost control
It includes the presentation of information
derived therefrom for the purpose of
managerial decision making.

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Cost Accountancy includes
Cost Accounting
Cost Control
Cost Reduction
Cost Audit

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Objectives of Cost Accounting
Ascertainment of cost
Estimation of cost
Cost Control
Cost reduction
Determination of selling price
Facilitating preparation of financial and
other statements
Providing basis for operating policy
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Functions of managerial
accounting
Determining the cost
Providing relevant information for better
decision-making
Providing information for planning,
control, decision-making and application

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Application
Cost accounting has extended from
manufacturing operations to a variety of
service industries such as hotels, bands,
airline, etc
Cost accounting system should be
flexible and adaptable to meet the new
business environment and the changing
nature of the company
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 Cost - Concept
Cost refers to the amount of resources given up
in exchange for some of goods or services
The resources given up are always expressed in
terms of money.
CIMA defines the amount of expenditure
(actual or notional) incurred on or
attributable to a given thing or activity.

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Important concepts
Cost object
Cost
Cost unit
Cost centre

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Cost object
It is an activity or item or operation for
which a separate measurement of costs
is desired
E.g. the cost of operating the personnel
department of a company, the cost of a
repair machine, and the cost for control

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Cost
It is the amount of expenditure incurred
on a specific cost object
Total cost = quantity used * cost per
unit (unit cost)

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Cost unit
It is a quantitative unit of product or
service in which costs are ascertained,
e.g. cost per table made, cost per
metre of cloth

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Cost centre
It is a location or function of an
organisation in respect of which costs
are ascertained
E.g. the rent, rates and maintenance of
buildings; the wages and salaries of
strorekeepers

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Main Elements of Cost
Material
Labour
Expenses

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 Material
The substance from which the product is
made is known as material.
It may be in raw, semi- manufactured or a
manufactured state. It can be Direct as well
as Indirect.

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 Direct materials
All material which becomes an integral part of the finished
product and which can be conveniently assigned to specific
physical unit is called as direct material.
The cost of materials the cost of materials used entering
into and becoming the elements of a product or service
E.g.
fabrics in garments,
crude oil in refinery,
bricks, iron and cement in Building.

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Indirect materials
All material which is used for purpose
ancillary to the business and which cannot be
conveniently assigned to specific physical unit
is termed as indirect material.
Such as stationery, consumable supplies,
spare parts for machine that assist to the
production of final products.

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Labour
For conversion of materials into finished
goods, human effort is needed
Such human effort is called Labour.
Labour can be direct labour as well
indirect labour.

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Direct labour
Labour which takes an active and direct part in the
production of a particular commodity or rendering
service is called direct labour.
Direct labour costs are, therefore, specifically and
conveniently traceable to specific product or service.
The cost of remuneration for working time
E.g. assembly workers wages in toy assembly.
It is also known as process labour, productive labour,
operating labour etc.

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Indirect labour
Labour employed for the purpose of carrying out
tasks incidental to goods or service provided, is
indirect labour.
Such labour does not alter the construction,
composition or conditions of the product. It cannot
be particularly traced to specific units of output.
Such as salaries of factory supervision and office staff
that do not directly involve in production of the final
product.
Indirect labour may relate to the factory, the office or
the selling and distribution divisions
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Expenses
Any other cost, beside material and
labour cost, is termed as expense.
Expenses may be direct or indirect.

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Direct expenses
These expenses which can be directly, conveniently
and wholly allocated to specific cost centres or cost
units.
Such expenses are also described as chargeable
expenses
Other costs which are incurred for a specific product
or service
E.g. royalties
Hiring of some special machinery, required for a
particular construct; cost of defective work etc.

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Indirect expenses
Such as rent, rates, depreciation,
maintenance expenses that do not have
instant relationships with the
manufacturing processes

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Direct cost
Cost that can be identified specifically
with or traced to a given cost object
The direct costs consist of the following
three elements:
Direct materials
Direct labour
Direct expenses

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Indirect cost (overhead)
Cost that cannot be identified
specifically with or traced to a given
cost object
They are identified with cost centres as
overheads
Indirect materials
Indirect labour
Indirect expenses

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Overhead
Factory or Works where production is
done
Indirect material used in factory such as
oil, lubricants and consumables.
Indirect labour such as gatekeeper salary
and works managers salary
Indirect exp. such as factory rent,
insurance and factory lighting

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 Office and Administration Overheads
Indirect material used in office such as
printing & stationary
Indirect labour such as salaries to office
managers, Director, CFO, CEO etc.
Indirect exp. such as insurance, ret and
lighting of office

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 Selling and Distribution overheads
Indirect material used such as packing
material, printing and stationary material
Indirect labour such as salaries of
salesman and sales manager
Indirect expenses such as rent insurance
and advertising exp.

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 Cost accumulation
Prime cost = direct materials + direct labour + direct expenses

Production cost = Prime cost + factory overhead

Also known as Factory Cost

Total cost = Prime cost + Overheads (admin, selling,distribution cost

OR
= Production cost + period cost (administrative, selling,
distribution and finance cost)
Period cost is treated as expenses and matched against sales for calculating
profit, e.g. office rental
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 Cost Sheet
Costs sheet is a document which provides
for the assembly of the estimated detailed
cost in respect of a cost centre or a cost
unit.
It analyses and classifies in a tabular form,
the expenses incurred on different items for
a particular period.

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 COST SHEET

DIRECT MATERIAL
DIRECT LABOUR
DIRECT EXPENSES

PRIME COST
FACTORY OVERHEADS

FACTORY COST
OFFICE OVERHEADS

COST OF PRODUCTION
SELL & DIST OVERHEADS

COST OF SALES
PROFIT

SALES
 Example..
From the following particulars compute the cost of production of product:

Amount
Material Used 12,000
Labour Employed 8,000
Salary of inspector engaged in the product 1,000
Propionate lighting and heating (factory and office 3:2) 500
Proportionate of deprecation, repairs and rent (50% is 1,000
related to factory)
Municipal tax and insurance (40% related to office) 800
Trade subscription 100

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 Cost Sheet..
Particulars Amount
Direct Material: Material Consumed 12,000
Direct Labour: Labour Employed 8,000
Direct Exp: Salary of inspector engaged in the product 1,000
PRIME COST 21,000
Add: Factory overheads
lighting and heating 300
deprecation, repairs and rent 500
Municipal tax and insurance 480
FACTORY COST (Prime cost + Factory overheads) 22,280
Add: Office and Administrative overheads
lighting and heating 200
deprecation, repairs and rent 500
Municipal tax and insurance 320
Trade subscription 100

Total Cost of Production (Factory cost+ office exp) 23,400

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 Exercise.. Calculate total cost
Material Used in manufacturing: 5,500
Material Used in packing: 1,000
Material Used in selling the product: 150
Material Used in factory: 75
Material Used in office: 125
Labour required in producing: 1,000
Labour required for supervision of mgt. of factory: 200
Expenses- Direct- Factory: 500
Expenses- Indirect- Factory:100
Expenses- office: 125
Deprecation- office building and equipment: 75
Depreciation- factory: 175
Selling expense: 350
Freight : 500
Advertising : 125
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Classification of Cost
Fixed
Variable
Semi-variable and
Step cost

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 Variable cost
It increases or decreases in direct
proportion to levels of activity, but the
unit variable cost remains constant
E.g. cost of food served in a restaurant,
raw material, labor (per unit paid)
Also known as product cost.
Wages of labour, power and material cost
are example of variable cost.
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Variable cost- Total and per unit

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Fixed cost
Total fixed cost remains constant over a
relevant range of activity level but unit
fixed cost falls with an increase in
activity volume.
Salary, rent, insurance are example of
fixed cost

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Fixed cost- Total and Per unit

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Semi-variable cost
It processes characteristics of both fixed
and variable cost
It increases or decreases with activity
level but not in direct proportion

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Semi- Variable Cost

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Step cost
It remains constant for a range of
activity levels, then, on further increase
in activity, the cost jumps to a new
level and remains constant over a
certain range until the next jump occurs

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Step costs

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Product cost
Product cost are related to the goods
purchased or produced for resale.
If the products are sold, the product cost will
be included in the cost of goods sold and
recorded as expenses in current period
If the products are unsold, the product costs
will be included in the closing stock and
recorded as assets in the balance sheet

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Period cost
Period cost related to the operation of a
business
They are treated as fixed cost and
charged as expenses when they are
incurred
They should not be included in the
stock valuation

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 Relevant and Irrelevant Cost
Relevant cots are those costs which would
be changed by the managerial decision.
For example, if a company is considering
to close unprofitable retail sales shop,
wages, salaries payable to the shop
workers are relevant in this decision as
they will disappear on closing of shop.

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 These costs wages, salaries, electricity are
relevant for decision making.
On the other hand, prepaid rent, insurance
or any other uncovered cost of any
equipment which will have to be scarped
are irrelevant cost which must be
ignored.

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Shutdown and Sunk Costs
Shutdown costs are those costs which will
gave to be incurred when plant is closed due
to temporary non availability of material,
labour or any other key ingredients.
Some fixed cots like deprecation of building,
rent, maintenance will have to incur during
that period and are called Shutdown cost.
Thus cost which have to incur even if there is
no production are called Shutdown costs
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 Sunk costs are historical or past costs.
These costs are costs which have been created or
incurred by a decision that was taken in past that
cannot be changed by any decision that will be
made in future.
Investment in plant, machinery, building etc are
prime example of such costs.
Since sunk cost cannot be altered by later
decision, they are irrelevant for decision making
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Controllable and Uncontrollable cots
Controllable costs are those can be
influenced by the action of a specified
member of the company.
Cost which can't be so influenced are
uncontrollable costs.

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Imputed or Hypothetical costs

Costs which dont involve any cash

outlay .
They are not included in the cost
accounts but are important for
consideration while making
management decisions.

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Differential, Incremental cost
The cost difference between two
alternatives is termed as differential
cost
Incremental is increase in the cost if
increase the production by x number of
units.

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Out of pocket costs
Present or future cash expenditure
regarding a certain decision which
varies depending upon on the nature of
decision made.
Own truck verus taking transport
company .

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Comparison of cost,
management and financial
accounting

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Meanings
Financial accounting
Cost accounting
Management accounting

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Financial accounting
Provides information to users who are
external to the business
It reports on past transactions to draw
up financial statements
The format are governed by law and
accounting standards established by the
professional accounting policies

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Cost accounting
Is concerned with internal users of
accounting information, such as
operation managers
The generated reports are specific to
the requirement of the management
The reporting can be in any format
which suits the user

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Management accounting
Comprises all cost accounting functions
The accounting for product and service
costs, management accounting extends
to use various internal accounting
reports for planning, control and
decision making

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Cost and management accounting
Vs.
Financial accounting

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 Management Financial accounting
(cost)accounting
Nature Records material, Records company

labour and overhead transaction events

costs in product or External financial
job statements are
Reports produced produced
are for internal
management and
contol
Accounting Not based on the Follows the double
system double entry system entry system

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 Management Financial accounting
(cost)accounting
Accounting No need to use Use Generally

principles accounting principles Accepted Accounting

Adopt any Principles for recording
accounting techniques transactions
that generates useful
accounting
information
Users of Used by different Used by external

information levels of management parties: shareholders,

or departments creditors, government,
responsible for etc
respective activities

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 Management Financial accounting
(cost)accounting
Operation Based on Conforms to company
guidelines management Ordinances, stock
instructions and exchange rules, SEBI ,
or
requirements MCA rules etc.
standards

Time span Reports are Reports are prepared

prepared whenever for a definite period,

needed usually yearly and half
They may be yearly
prepared on a
weekly or daily basis

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 Management Financial accounting
(cost)accounting
Time focus Future orientation: Past orientation: use
forecasts, estimates of historic data for
and historic data for reporting and
management evaluation
actions

Perspective Detailed analysis of Financial summary of

parts of the entity, the whole orgainisation
products, regions,
etc

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 Cost accounting
vs.
Management accounting

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 Management Cost accounting
accounting
Objective To provide To ascertain and
information for control cost
planning and
decision making by
the management

Basic of Concerned with Based on both present

recording transactions related and future transactions
to the future for cost ascertainment

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 Management Cost accounting
accounting
Coverage Covers a wider Covers matters
area: financial relating to
accounts, cost ascertainment and
accounts, taxation, control of cost of
etc. product or service

Utility Only the needs of The needs of both

internal internal and external
management interested groups

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 Management Cost accounting
accounting
Types of Deals with both Deals only with
transactions monetary any non- monetary transactions,
monetary covering only
transactions, quantitative aspect
covering both
quantitative and
qualitative aspects

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 Methods of Costing
Costing is the technique and process of
ascertaining cost.
There are various methods of costing:
Job Costing
Contract Costing
Batch Costing
Process Costing
Operation Costing
Operating Costing

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 Job Costing
Job costing is used when the production is not
highly repetitive and, in addition, consists of
distinct jobs or lots .
Each product produced in the job are identified
by order number.
This method is followed by these concerns when
work is carried on by the customers request.
Commercial foundry, printing press, specialized
industrial equipments are example where job
costing is applied.
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 Contract Costing

Contract costing is applied for contract work like

construction of dams, buildings, roads, civil
engineering contract etc. each contract or job is
treated as separate cost unit for the cost
ascertainment and control.
A contract costing in principle differ from job
costing, A contract is a big job while a job is a
small contract.
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 Batch costing
A batch is a group of identical products. Under
batch costing a batch of similar products is
treated as a separate unit for the purpose of
ascertaining cost.
The total costs of a batch is divided by the total
number of units in a batch to arrive at the costs
per unit.
This type of costing is generally used in
industries like bakery, toy manufacturing,
pharmaceutical etc.
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 Process Costing
This method is used in industries where production is
carried on through different stages or processes before
becoming a finished product.
Costs are determined separately for each process. The
main feature of process costing is that output of one
process becomes the raw materials of another process
until final product is obtained.
This type of costing is generally used in industries like
textile, chemical paper, oil refining etc.

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 Service (Operating) Costing
This method is used in those industries which
rendered services instead of producing goods.
Under this method cost of providing a service is
also determined.
It is also called service costing. The organisation
like water supply department, hotels, Railway,
transportation, electricity department etc. are the
examples of using operating costing.

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 Operation Costing
This is suitable for industries where production is
continuous and units are exactly identical to each
other.
This method is applied in industries like mines or
drilling, cement works etc.
Under this system cost sheet is prepared to find
out cost per unit and profits or loss on
production.

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 Techniques of Costing
Following types of techniques are used by
management only for controlling costs and making
some important managerial decisions.
Marginal Costing
Direct Costing
Absorption or Full Costing
Uniform Costing
Standard Costing

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 Marginal Costing
It is a technique of costing in which allocation of
expenditure to production is restricted to those costs
which arise as a result of production i.e. costs which vary
with production (material, labour and direct expenses-
variable only and variable overheads)
Fixed costs are excluded on the ground that in cases
where production varies, the inclusion of fixed costs may
give misleading results.
It is the ascertainment of marginal cost by differentiating
between fixed and variable cost. It is used to ascertain
the effect of changes in volume or type of output on
profit.
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 Direct Costing
It is the practice of charging all direct costs,
variable and some fixed costs relating to
operations, processes or products leaving all other
costs to be written off against profits in which they
arise.
This technique is different from marginal because
some fixed costs can be considered as direct costs
in appropriate circumstances.

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 Absorption or Full Costing
It is the practice of charging all costs, both
variable and fixed to operations, processes
or products.
This differs from marginal costing where
fixed costs are exclude.

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Uniform Costing
It is the use of same costing principles
and practices by several undertakings
for common control or comparison of
costs.
This facilitates inter firm comparison,
establishing of realistic pricing policies
etc.

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Standard Costing
A comparison is made of the actual cost with
a pre-arranged standard cost and the cost of
any deviation (called variances) is analyzed
by causes.
This permits the management to investigate
the reasons for these variances and to take
suitable corrective action.

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 Historical Costing
It is ascertainment of costs after they have
been incurred.
It aims at ascertaining costs actually
incurred on work done in the past.
It has a limited utility, though comparisons
of costs over different periods may yield
good results.

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