Cost Accounting-Introduction

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    Managing Resources, Activities, and
                     An organization . . .

Acquires Resources                                       Decision
                          Organized set                  Making
                           of activities

                                           Controlling   Planning
    Hires People
  Accounting Discipline Overview
• Managerial Accounting – measures, analyzes and
  reports financial and nonfinancial information to
  help managers make decisions to fulfill organizational
  goals. Managerial accounting need not be GAAP /
  IFRS compliant.

• Financial Accounting – focus on reporting to external
  users    including    investors,   creditors,    and
  governmental agencies. Financial statements must
  be based on GAAP / IFRS.
         Managerial versus Financial
                    Accounting System
                (accumulates financial and
                managerial accounting data)

 Managerial Accounting                 Financial Accounting
Information for decision                Published financial
 making, planning, and                statements and other
     controlling an                      financial reports.
             Internal                              External
              Users                                 Users
A Typical Organizational Structure and
    the Management Accountant
The chief managerial and financial accountant
responsibility for:
 – Supervising accounting personnel
 – Preparation of information and reports, managerial
   and financial
 – Analysis of accounting information
 – Planning and decision making
      Responsible for raising capital and safeguarding the
      organization’s assets.
       – Supervises relationships with financial institutions.
       – Work with investors and potential
       – Manages investments.
       – Establishes credit policies.
       – Manages insurance coverage

               Internal Auditor
Responsible for reviewing accounting procedures, records,
and reports in both the controller’s and the treasurer’s area
of responsibility.
 – Expresses an opinion to top
    management regarding the
    effectiveness of the
    organizations accounting
              Cost Accounting
• It is the method of accounting for cost which
  begins with incurrence of costs & ends with
  control of cost.

• It is the process of accounting for costs.

• It includes the accounting procedures relating to
  recording of all income and expenditure and the
  preparation of periodical statements and reports
  with the objective of ascertaining and controlling
  Objectives of Cost Accounting
– To ascertain cost
– To control cost
– To provide information for decision making
– To determine selling price
– To ascertain profit
– To facilitate cost reduction
 Advantages of Cost Accounting
• Helps in ascertainment of cost
• Helps in control of cost
• Helps in decision making (make or buy, retain or replace,
  continue or shut down, accept or reject orders, etc)
• Helps in fixing selling prices
• Helps in inventory control
• Helps in cost reduction
• Helps in preparation of budgets
• Helps in identifying unprofitable activities
• Helps in identifying material losses
• Helps in improving productivity
• Helps in cost comparison
       Financial & Cost Accounting
No.   Basis               Financial Accounting                Cost Accounting
                          Financial     performance     and
1.    Objective                                               Ascertain cost and cost control
                          Shows overall costs and profit /    Shows details for each product,
2.    Costs and profits
                          loss                                process, job, contract, etc
                                                              Emphasis      on    control    and
3.    Control / Report    Emphasis on reporting
4.    Decision making     Limited use                         Designed for decision making
5.    Responsibility      Does not fix responsibility         Can effectively fix responsibility
6.    Time frame          Focus on historical data            Focus on present and future
                          General   reports  like  P&L
                                                              Can generate special reports
7.    Type of reports     Account, Balance Sheet, Cash
                                                              and analysis
                          Flow Statement
                                                              Voluntary,    except   for    some
8.    Legal need          Statutory requirement
                                                              Records internal and external
9.    Transactions        Records external transactions
10.   Reader              Everybody                           Internal management
11.   Formats             Standard, as per law                Tailor made
12.   Access              Everybody, except for some          Very limited access
13.   Unit of value       Monetary                            Monetary and physical
      Cost Management Systems
Measure the cost of
 resources consumed.
Identify and eliminate
 non-value-added costs.      Cost
       Cost Management Systems
Determine efficiency
 and effectiveness of
 major activities.
Identify and evaluate
 new activities that can      Cost
 improve performance.        System
                   Costing System
• An accounting system established to monitor a
  company's costs, providing management with
  information on operations and performance.

• A cost accounting system may said to be a system which:
    Accumulation of costs
    Assigns them to cost objectives.
    Reports cost information
    Ascertain the product profitability
    It helps the management in planning and controlling activities of
     the organization.
       Installation of costing system
• Mostly employed in manufacturing industries
  (including mining, construction etc).
• Factors to be considered while designing a costing
   –   Objective of the system
   –    Objective of the management
   –   Nature of business
   –   Nature of product
   –   Manufacturing Process
   –   Types of cost information desired and required by the management
   –   Flexibility and Accuracy of data
   –   Key personnel and employees of the organization
   –   Availability of qualified technical personnel
   –   Materiality of the cost items
   –   Selection of suitable unit of cost
   –   Statutory and other legal provisions to be complied with
      Practical Difficulties in installing
               costing system

•   Lack of support from the Head of the Departments
•   Inadequate trained personnel
•   Heavy costs
•   Resistance from the staff
•   Non co-operation at the other levels of organizations
Cost Concepts
                Cost Control
• It is the Prime function of Cost Accountant.

• “The act of controlling costs through the
  application of management tools and
  techniques keeping in mind the most
  predetermined objectives of quality, quantity,
  value and time at an optimum outlay.”
             Cost Reduction
• Cost reduction is concerned with achieving
  real and permanent reduction on the unit cost
  of goods produced or services rendered
  without impairing their quality or suitability.
                 Cost Audit
• Cost Audit is the verification of cost accounts
  and a check on the adherence to the Cost
  Accounting plan.

• It involves checking up the arithmetical
  accuracy of cost accounts and verifying
  whether the principles laid down have been
  followed or not.
            Elements of Cost
• Three broad elements of costs:

     • Material
     • Labour
     • Expenses
1. Material:
• The substance from which a product is made
  is known as material.
• It may be in a raw or a manufactured state.
• It can be:
          Direct Material
          Indirect Material
Direct Material:
The material which becomes an integral part of a finished
  product and which can be conveniently assigned to specific
  physical unit is termed as direct material.

Following are some of the examples of direct material:
   • All material or components specifically purchased, produced or
     requisitioned from stores
   • Primary packing material (e.g., carton, wrapping, cardboard, boxes
   • Purchased or partly produced components

   Direct material is also described as process material,
    prime cost material, production material, stores
    material, constructional material etc.
Indirect Material:
  – The material which is used for purposes ancillary
    to the business and which cannot be conveniently
    assigned to specific physical units is termed as
    indirect material. Consumable stores, oil and
    waste, printing and stationery material etc. are
    some of the examples of indirect material.

  – Indirect material may be used in the factory, office
    or the selling and distribution divisions
• For conversion of materials into finished
  goods, human effort is needed and such
  human effort is called labour.

• Labour can be:
         Direct Labour
         Indirect Labour
Direct Labour:
 • The labour which actively and directly takes part
   in the production of a particular commodity is
   called direct labour.

 • Direct labour costs are specifically           and
   conveniently traceable to specific products.

 • Direct labour can also be described as process
   labour, productive labour, operating labour, etc.
Indirect labour:
 – The labour employed for the purpose of carrying out tasks
   incidental to goods produced or services provided, is indirect

 – Such labour does not alter the construction, composition or
   condition of the product. It cannot be practically traced to
   specific units of output.

 – Wages of storekeepers, timekeepers, directors’ fees, salaries
   of salesmen etc, are examples of indirect labour costs.

 – Indirect labour may relate to the factory, the office or the
   selling and distribution divisions
3. Expenses:
• All costs other than material and labour are
  termed as expenses.

• Expenses may be:
           Direct Expenses
           Indirect Expenses

• Expenses which are directly identified with a
  particular job, process, or operation.

• These are expenses incurred on one particular
  job or task.

• E.g. Cost of transportation of raw material,
  cost of hiring a machine.

• Expenses which are not directly identified
  with a particular job, process, but common for
  many jobs or processes.

• These include factory expenses, administrative
  expenses, selling and distribution expenses.
• The term overhead includes indirect material,
  indirect labor and indirect expenses.

• Thus, all indirect costs are overheads.
Types of Overheads:

1. Factory Overheads
2. Office and Administration Overheads
3. Selling and Distribution Overheads
1. Factory Overheads:

     • Indirect material used in a factory such as lubricants,
       oil, consumable stores etc.

     • Indirect labour such as gatekeeper, timekeeper, works
       manager’s salary etc.

     • Indirect expenses such as factory rent, factory
       insurance, factory lighting etc.
      2. Office and Administration

     • Indirect materials used in an office such as printing and
       stationery material, brooms and dusters etc.

     • Indirect labor such as salaries payable to office
       manager, office accountant, clerks, etc.

     • Indirect expenses such as rent, insurance, lighting of
       the office
 3. Selling and Distribution Overheads

     • Indirect materials used such as packing material etc.

     • Indirect labour such as salaries of salesmen and sales
       manager etc.

     • Indirect expenses such as advertising expenses etc.
        Components of Total Cost
1. Prime Cost :

• Prime cost consists of costs of direct materials,
  direct labours and direct expenses.

• It is also known as basic, first or flat cost.
2. Factory Cost:

• Factory cost comprises prime cost and, in
  addition, works or factory overheads that
  include costs of indirect materials, indirect
  labors and indirect expenses incurred in a

• It is also known as works cost, production or
  manufacturing cost.
3. Office Cost:

• Office cost is the sum of office and
  administration overheads and factory cost.

• This is also termed as administration cost or
  the total cost of production.
              Components of total cost
Direct material                             Prime cost or direct cost or first cost
Direct labour
Direct expenses

Prime cost plus works overheads             Works or factory cost or production cost or
                                            manufacturing cost

Works cost plus office and administration   Office cost or total cost of production

Office cost plus selling and distribution   Cost of sales or total cost
               COST SHEET

• The components of cost can be presented in
  the form of a statement. Such a statement of
  cost giving total cost is known as Cost sheet.
         Basic Cost Terminology
• Cost – sacrificed resource to achieve a specific

• Actual cost – a cost that has occurred

• Budgeted cost – a predicted cost

• Cost object – anything of interest for which a cost is
 Cost Centre:
• “It is defined a location, person, or item of equipment (or group
  of these) for which costs may be ascertained and used for the
  purpose of control.”

• Cost centre refers to a section of the business to which costs can
  be charged.

• It may be a location( a department, a sales area), an item of
  equipment (a machine, a delivery van), a person (a salesman, a
  machine operator), or a group of these (two automatic machines
  operated by one workman).

• Purpose of ascertaining cost of a cost centre is control of cost.
Types of cost centre:
• Personal cost centre: which consists of a person or a
  group of persons.

• Impersonal cost centre: which consists of a location
  or an item of equipment or group of these.
Cost unit
• Cost unit is unit of measurement of cost.

• Cost unit is defined as “unit of product, service, or time in
  relation to which cost may be ascertained or expressed.”

• E.g. Chemicals – tonne, kilogram, litre, gallon
       Bricks – 1,000 bricks or 500 bricks
       Soft drink – crate of 24 bottles or 12 bottles
       Cotton or jute – Bale
       Timber – cubic foot
Classification of Cost
    1. Fixed, Variable and Semi-Variable
• The cost which varies directly in proportion with every increase or
  decrease in the volume of output or production is known as
  variable cost. E.g. Wages of laborers, Cost of direct material,
• The cost which does not vary but remains constant within a given
  period of time and a range of activity inspite of the fluctuations in
  production is known as fixed cost. E.g. Rent, Insurance charges,
  Management salary
• The cost which does not vary proportionately but simultaneously
  does not remain stationary at all times is known as semi-variable
  cost. It can also be named as semi-fixed cost. E.g. Depreciation,
     2. Product Costs and Period Costs
• Product cost :
 The costs which are a part of the cost of a product rather
  than an expense of the period in which they are incurred are
  called as “product costs.

 They are included in inventory values.

 In financial statements, such costs are treated as assets until
  the goods they are assigned to are sold.

 e.g. cost of raw materials and direct wages, depreciation on
  plant and equipment etc.
• Period Costs :
 The 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 may also be fixed as well as variable.
 Such costs include general administration costs, salaries
  salesmen and commission, depreciation on office facilities
 They are charged against the revenue of the relevant period.
        3. Direct and Indirect Costs
• Direct Costs:
 The expenses incurred on material and labor which are
  economically and easily traceable for a product, service or job are
  considered as direct costs.

 these take an active and direct part in the manufacture of a
  particular commodity and hence are called direct costs.

 E.g. In the process of manufacturing of production of articles,
  materials are purchased, laborers are employed and the wages
  are paid to them, are all direct costs.
• Indirect Costs:
 The expenses incurred on those items which are not directly
  chargeable to production are known as indirect costs. For
  example, salaries of timekeepers, storekeepers and foremen.

 All of these cannot be conveniently allocated to production and
  hence are called indirect costs.
4. Decision-Making Costs & Accounting
• Decision-making costs are special purpose costs that are
  applicable only in the situation in which they are compiled.
• They have no universal application.
• They do not and should not conform the accounting rules.
• Decision-making costs are future costs. They represent what is
  expected to happen under an assumed set of conditions.

• Accounting costs are compiled primarily from financial
• Moreover, they are historical costs and show what has
  happened under an existing set of circumstances.

• Decision-making costs are future costs. They represent what is
  expected to happen under an assumed set of conditions.
  5. Relevant and Irrelevant Costs
• Relevant costs are those which are affected and changed by
  managerial decision.

• Irrelevant costs are those which do not get affected by the
      6. Shutdown and Sunk Costs
• Shutdown Costs:

 A manufacturer or an organization may have to suspend its
  operations for a period on account of some temporary
  difficulties, e.g., shortage of raw material, non-availability of
  requisite labor etc.
 During this period, though no work is done yet certain fixed
  costs, such as rent and insurance of buildings, depreciation,
  maintenance etc., for the entire plant will have to be incurred.
  Such costs of the idle plant are known as shutdown costs.
• Sunk costs:

 Sunk costs are historical or past costs.

 These are the costs which have been created by a
  decision that was made in the past and cannot be
  changed by any decision that will be made in the future.

 E.g. Investments in plant and machinery, buildings etc.
  7. Controllable and Uncontrollable
• Controllable costs are those costs which can be
  influenced by the action of a specified member of
  the undertaking.

• Controllable costs are the costs over which a
  manager has direct and complete decision authority.

• The costs that cannot be controlled are termed as
  uncontrollable costs.
    8. Avoidable or Escapable Costs and
     Unavoidable or Inescapable Costs
• Avoidable costs are those which will be eliminated if a segment of
  a business (e.g., a product or department) with which they are
  directly related is discontinued.

• Unavoidable costs are those which will not be eliminated with the
  segment. Such costs are merely reallocated if the segment is

• For example, in case a product is discontinued, the salary of a
  factory manager or factory rent cannot be eliminated.
 9. Imputed or Hypothetical Costs
• These are the costs which do not involve cash outlay.

• They are not included in cost accounts but are
  important for taking into consideration while making
  management decisions.

• For example, rent of owned building, interest of
  owned capital, etc.
          10. Opportunity Cost
• Opportunity cost is the cost related to the next-best
  choice available to someone who has picked among
  several choices.

• It refers to an advantage in measurable terms that
  have foregone on account of not using the facilities
  in the manner originally planned.
     11. Differentials, Incremental or
            Decremental Costs
• The difference in total cost between two alternatives
  is termed as differential cost.

• In case the choice of an alternative results in an
  increase in total cost, such increased costs are known
  as incremental costs.

• In case the choice results in decrease in total costs,
  this decreased costs will be known as decremental
         12. Out-of-Pocket Costs
• Cost which requires cash payments to be made to
  other parties.

• It means the present or future cash expenditure
  regarding a certain decision, that will vary depending
  upon the nature of the decision made.
       13. Traceable, Untraceable or
              Common Costs
• Traceable costs: The costs that can be easily identified with a
  department, process or product.
• For example, the cost of direct material, direct labor etc.

• Untraceable or common costs: costs that cannot be identified
  with a dept. process or product. These costs are incurred
  collectively for a number of operations.
• E. g. overheads incurred for a factory as a whole, combined
  purchase cost for purchasing several materials in one
  consignment etc.
     14. Production, Administration and
     Selling and Distribution, etc. Costs
• Production Cost The cost of sequence of operations which begins with
  supplying materials, labor and services and ends with the primary packing of
  the product. Thus, it includes the cost of direct material, direct labor, direct
  expenses and factory overheads.

• Administration Cost The cost of formulating the policy, directing the
  organization and controlling the operations of an undertaking.

• Selling Cost It is the cost of selling to create and stimulate demand (sometimes
  termed as marketing) and of securing orders.

• Distribution Cost It is the cost of sequence of operations beginning with
  making the packed product available for dispatch and ending with making the
  reconditioned returned empty package, if any, available for reuse.

• Research Cost It is the cost of searching for new or improved products, new
  application of materials, or new or improved methods.
             15. Conversion Cost

• The cost of transforming direct materials into finished
  products (excluding direct material cost) is known as
  conversion cost. It is usually taken as an aggregate of total
  cost of direct labor, direct expenses and factory overheads.
            Methods of costing:
1.   Job / job order costing
2.   Contract costing or terminal costing
3.   Batch costing
4.   Process costing
5.   Operation costing
6.   Single, output, or unit costing
7.   Operating or service costing
8.   Multiple or composite costing
         1. Job / job order costing
• This method “applies where work is undertaken
  to customers’ special requirements”.

• A job comprises a specific quantity of a product or
  service to be provided as per customer’s

• E.g. printing press, repairs       shop,   interior
  decorators, painters etc.
2. Contract costing or terminal costing

• This is a variation of job costing.

• Difference: job is small and contract is big.

• The contract is of a long duration and may
  continue over more than one financial year.

• e.g. construction of buildings, dams, bridges,
  roads etc.
                 3. Batch costing

• Also a variation of job costing.

• In this method, the cost of a batch or group of
  identical products is ascertained and therefore each
  batch of product is a cost unit for which costs are

• E.g. production of readymade garments, toys, shoes,
              4. Process costing

• This method is used in mass production industries
  manufacturing the standardized products in
  continuous processes of manufacturing.

• Here, raw material has to pass through a number of
  processes in a particular sequence to completion
• Costs are accumulated for each process or
             5. Operation costing

• This is a more detailed application of process costing.

• A process may consists of a number of operations
  and operation costing involves cost ascertainment
  for each operation instead of a process.

• This method provides minute analysis of costs and
  ensures greater accuracy and better control.
     6. Single, output, or unit costing

• This method is used when production is uniform and
  consists of a single or two or three varieties of the
  same product.

• Where the product is produced in different grades,
  costs are ascertained grade-wise.

• As the units of output are identical, the cost per unit
  is found by dividing the total cost by the number of
  units produced.
      7. Operating or service costing

• It is used in companies which provide services,
  instead of manufacturing products.

• E.g. transport co., hotels, hospitals, cinemas, etc.
     8. Multiple or composite costing

• It is the application of more than one method.

• It is used in industries where a no. of components
  are separately manufactured and then assembled
  into a final product.

• e.g. T.V., A.C., refrigerators, cars, etc.

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