Cost Accounting

Accounting

◼ Accounting is a specialized information

system that provides economic information
to different groups of people.
Branches of Accounting…

◼ Financial Accounting

◼ Cost Accounting

◼ Management Accounting
Financial Accounting..
◼ Financial accounting is the field of
accounting concerned with the
summarizing, analyzing and reporting of
financial transactions pertaining to a
business.

◼ Financial accounts provide information to

“inside users (Management)” and “Outside
users (shareholders, investors, trade
unions, general public etc.)”
Management Accounting:
◼ The application of professional knowledge
and skill in the preparation and
presentation of accounting information in
such a way as to assist management in
the formulation of policies and in the
planning and control of operations of the
undertaking.
Cost Accounting:
Institute of Cost and Management
Accountants of U.K.

◼ “The application of accounting and costing

principles, methods and techniques in the
ascertainment of costs and analysis of
savings or excesses as compared with
previous experience or with standards”.
 Cost Accounting
◼ Cost means the amount of expenditure (actual
or notional) incurred on or attributed to a given
thing.

◼ Cost Accounting is concerned with recording,

classifying & summarizing costs for
determination of costs of products or services,
planning, controlling & reducing such costs &
furnishing of information to management for
decision making.
 Objectives
◼ Cost determination
◼ Cost Control
◼ Help in decision making. (Buy or make
decision, price fixation, marginal costing)
◼ Other objectives (supply information to
Govt. & other agency, prevention of fraud)
Contributions of Cost
Accounting:
◼ Planning
◼ Controlling
◼ Evaluation of Alternatives
◼ Inventory Management
◼ Pricing
◼ External Reporting
Planning
◼ Process of setting objectives and steps
needed to attain them.

◼ The plans are numerically expressed in

the form of budgets.

◼ Budgeting is the area where contribution

of cost accounting is most visible.
Controlling:
◼ It is the process by which management
makes sure that intended and desired
results are consistently and continuously
achieved. It consists of three steps:
i. Establishment of standards
ii. comparison of results against standards
iii. correction of deviation
Evaluation of Alternatives:
◼whether it is less expensive to make or
buy a product.
◼ whether to continue or discontinue a
product.
◼ cost accounting provides information as to
how future costs and revenues will be
affected under each alternative and help
management to take decisions.
Inventory Management:
◼ complete record of materials from entering
time to time they are sold in the form of
finished product.
◼ Stock Evaluation.
◼ valuation of work in process inventory.
◼ quantitative models for material planning
and management developed by cost
accounting.
Pricing of products and
Services:
◼ determination of price of new products as
well as adjustment of price of existing
products.
◼ determination of bid price
External Reporting
◼ Detailed cost reports are prepared and
presented in front of users.
 Difference between Cost
Accounting and Financial
Accounting
◼ Objectives
◼ Users
◼ Outcome
◼ Limitations
◼ Scope
◼ Time period
Cost accounting methods and
Techniques
◼Methods
The term method of costing refers to cost
ascertainment.

▪ Broadly two types:

➢ Job Order Costing
➢ Process Costing
Methods of costing..
◼Job Order Costing:
Cost are accumulated by job or specific
customer order. This method is used when
the products manufactured within a
department or cost centre are
heterogeneous. This method presupposes
the possibility of physically identifying the
jobs produced and of charging each job
with its own cost.
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◼ Job order costing is applicable to job order

work in factories, workshops and repair
shops as well as to work by builders,
construction engineer.s and printers
Continue….

Process Costing:
In Process costing cost are accumulated by
production, process or by department.
This method is used when all units
manufactured within a department or cost
centre essentially homogeneous.
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The following conditions may exist:

1. The product of one process becomes the

material of the next process.
2. Different products or even by-products
are produced by the same process.
The process cost is applicable mainly for
industries such as flour mills, chemical
plants and textile factories.
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For example..
Cloth manufacturing process
Raw
Yarning waving Yarn dying
materials

Finished Cloths
goods processing
Methods

◼ Other methods:
➢ Contract Costing
➢ Batch Costing
➢ Operating or service Costing
➢ Multiple Costing
Contract Costing:
◼ Under this method costing is done for big
jobs which involves heavy expenditure and
stretches over a long period and often it is
undertaken at different sites. Each contract is
treated as a separate unit for costing. This is
also known as Terminal Costing.
Construction of bridges, roads, buildings, etc.
comes under contract costing.
Batch Costing
◼ This methods of costing is used where the
units produced in a batch are uniform in
nature and design. For the purpose of
costing each batch is treated as a job or
separate unit.
◼ Industries like Bakery, Pharmaceuticals
etc. usually use batch costing method.
Operating Costing or Service
Costing:
◼ This method of costing is used to ascertain
the cost of particular service such as nursing
home, Bus, railway or chartered bus etc.
Each particular service is treated as separate
units in operating costing.
◼ In the case of a Nursing Home, a unit is
treated as the cost of a bed per day per
patient and for buses operating cost for a
kilometer is treated as a unit.
Multiple Costing:
◼ Application of more than one method of
costing in respect of the same product.
Used in industries where a number of
components are separately manufactured
and then assembled into a final product
Cost accounting techniques
◼ Different types of costing techniques are
used in different industries to analyze and
presenting costs for the purposes of control
and managerial decisions.
➢ Standard costing
➢ Historical costing
➢ Marginal Costing
➢ Absorption costing
 Continue..

◼ Historical costing:
Historical costing is the ascertainment and
recording of actual costs when, or after, they
have been incurred and was one of the first
stages in the growth of the Cost Accountant's
work. Actual costs refer to material cost, labour
cost and overhead cost.
◼ In this technique of cost accounting, costs are
determined only after they have been incurred.
◼ Almost all organizations use historical costing
system.
Continue…
Standard Costing:
◼ When costs are determined in advance on
certain predetermined standards under a
given set of operating conditions, it is
called standard costing.
◼ Standard Costing compares the standard
cost of each product or service with actual
cost to determine the efficiency of the
operation, so that any remedial action may
be taken immediately.
Techniques
◼ Marginal Costing
Also referred to as variable costing, charges
products only those manufacturing cost that vary
directly with volume.

Under direct costing, only variable costs are

treated as product cost, fixed manufacturing
costs are totally expensed in the current period,
such as depreciation, insurance and taxes.
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Absorption Costing:
◼ It is a process of allocating both fixed and
variable production cost to units of
production.
◼ Under absorption costing full costs, i.e.
fixed and variable manufacturing costs are
absorbed to the production.
 Cost, Expense and Loss
Cost

“An exchange price, a forgoing, the value of

sacrifice made to acquire goods and
services.”
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Expense
Defined as a measured outflow of goods or
services, which is matched with revenue to
determine income.

“All expired costs which have given benefit”.

At the time of acquisition the cost incurred for

present or future benefit. When this
benefits are utilized the cost become
expense.
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Loss

When assets are given up for nothing in

return in those cases the value of the
assets given up treated as loss.
 Cost Unit & Cost Center
◼Cost Unit
While preparing cost accounts, it becomes
necessary to select a unit with which
expenditure may be identified.

The quantity upon which cost can be conveniently

allocated is known as a unit of cost or cost unit.

The Chartered Institute of Management

Accountants, London defines a unit of cost as a
unit of quantity of product, service or time in
relation to which costs may be ascertained or
expressed.
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Following are the examples of cost units:

Brick works per 1000 bricks made

Textile mills per yard of cloth
manufactured
Electrical per unit of electricity
companies generated
Transport per passenger km.
companies
Steel mills per ton of steel made
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◼Cost Center
Cost center means “a location, person or item
of equipment (or group of these) for which
costs may be ascertained and used for the
purpose of cost control.”
Each such unit consists of a department, a
sub-department or an item or equipment or
machinery and a person or a group of
persons.
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◼ Cost Centre may be-
✓ Production Cost Centre
✓ Service Cost Centre
✓ Operation Cost Centre
✓ Process Cost Centre
Elements of costs
There major Elements of Costs.
(A) Material

(B) Labor

(C)Expenses
Elements of Cost

Material Labor Expenses

Direct Indirect Direct Indirect Direct Indirect

Factory / Selling
Administration & Distribution
Works
Overheads Overheads
Overheads
 Material Cost
The cost of commodities and materials used
by the organization.

Direct Material Cost –

Those costs which are incurred for and
conveniently identified with a particular cost
unit, process or department.
Ex: cost of raw material
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Indirect Material Cost –
Material which cannot be identified with
the individual cost centre, assist the
manufacturing process and does not
become an integral part of finished goods.
Ex: Consumable stores, Cotton waste, oils
and lubricants, stationary material etc.
Labor Cost
The cost of remuneration paid to the
employees of the organization.

Direct Labor Cost –

identified with the individual cost centre
and is incurred for those employees who
are engaged in the manufacturing process.
Continued…
Indirect Labor Cost –
cost which cannot be identified with the
individual cost centre and is incurred for
those employees who are not engaged in
the manufacturing process but only assist.
Example: wages paid to
foreman/storekeeper, salary of works
manager, Accountant/Personnel dept.
salaries etc.
Expenses
This is the cost of services provided to the
organization and the notional cost of assets
owned.

Direct Expenses –
Expenses identified by individual cost
centers or directly incurred for a particular
job other than material and labor.
i.e. Hire charges of machinery/equipment
for particular job, cost of defective work etc.
Continue.

Indirect Expenses –
Expenses which cannot be identified by
individual cost centers.
Rent , Telephone expenses, Insurance,
Lightening etc.
 Direct Material Cost
+
Direct Labour Cost Prime Cost
+
Direct Expenses Cost

Indirect Material Cost

+
Indirect Labour Cost
Overheads
+
Indirect Expenses
Cost

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 Overheads- Classification
Factory / Works Overheads
Consist of all overhead costs incurred from the
stage of procurement of material till the
production of finished goods.
◼ Indirect material such as Consumable stores,
Cotton waste, oils and lubricants, stationary
material etc.
Overheads- Classification
◼ Indirect labor cost such as wages paid to
foreman/storekeeper, salary of works
manager, Accountant/Personnel dept.
salaries etc.
◼ Indirect Expenses cost such as Carriage
inward cost, Factory lightening/power
expenses, rent/ Insurance /repairs for
factory building/machinery, depreciation
on factory building or machinery etc.
 Overheads- Classification
Selling and Distribution Overheads
These overhead consist of all overhead costs
incurred from the stage of final manufacturing
of finished goods till the stage of sale of
goods in the market and collection of dues
from customers.
◼ Indirect material such as packaging
material, samples etc.
Continue.
◼Indirect labor like salaries paid to sales
personnel, commission paid to sales
manager.
◼Indirect expenses like carriage outward,
warehouse charges, advertisement, bad
debts, repairs and running of distribution
van, discount offered to customers etc.
 Classification of Costs
◼ Classification of cost is the process of
grouping the components of cost under a
common designation on the basis of
similarities of nature, attributes or relations.
It is the process of identification of each
item and the systematic placement of like
items together according to their common
features.
Classification of Costs
◼ Basis of classification :
i) Nature of expense
ii) Relation to object – traceability
iii) Functions / activities
iv) Behavior of cost
v) Management decision making
vi) Relation of product
By Nature of expense:

Cost Classification by nature

Material Labor Expenses

 Relation to object – traceability

Direct Cost Indirect Cost

Material Expense
Material Expense
Labor
Labor
 Classification by Function

Manufacturing Administration
Cost Cost

Selling & Distribution

Cost
 Cost by Behavior

How a cost will react to changes in the level

of business activity.

1.Fixed cost
2. Variable Cost
3. Mixed Cost
 Fixed Cost:

Cost which does not vary in total with the

change in the volume of activity within a
relevant range. These costs are not
affected by temporary fluctuation in
activity of an enterprise.

Examples for fixed cost : salaries, rent,

audit fees, depreciation etc.
 Variable Cost
Variable Cost is the cost of elements which
tends to directly vary with the volume of
activity within a relevant range of activity.

Examples of variable cost are materials

consumed, direct labour, sales
commission, utilities, freight, packing, etc
Cost Classifications for
Predicting Cost Behavior
Behavior of Cost (within the relevant range)
Cost In Total Per Unit

Variable Total variable cost changes Variable cost per unit remains
as activity level changes. the same over wide ranges
of activity.
Fixed Total fixed cost remains Average fixed cost per unit goes
the same even when the down as activity level goes up.
activity level changes.
Total Variable and Fixed Costs

Total Variable Cost Total Fixed Cost

Number of units Number of units

Variable and Fixed Costs Per
Unit
Per Unit Variable Cost Per Unit Fixed Cost

Number of units Number of units

 Total Costs
To get total costs you need to add
variable costs and fixed costs
Total Cost

Fixed costs
The Slope is the
variable cost per
unit

Number of units
 Mixed Cost
◼ Mixed Costs contain both fixed and
variable elements. They are partly affected
by fluctuation in the level of activity.

◼ Examples of Mixed cost : electricity bills,

telephone bills etc.
 On the basis of relation to
product
1. Product Cost
2. Period cost

1. 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.
 Product Cost
◼ In financial statements, such costs are treated
as assets until the goods they are assigned to
are sold. They become an expense at that time.
These costs may be fixed as well as variable,
i.e.cost of raw materials and direct wages,
depreciation on plant and equipment etc.
 Period Cost
◼The costs which are not associated with
product 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 and commission of salesmen,
depreciation on office facilities etc. They are
charged against the revenue of the relevant
period.
Product Costs Versus Period Costs

Product costs include

Period costs are not
direct materials, direct
included in product
labor, and
costs. They are
manufacturing
expensed on the
overhead.
Cost of
income statement.
Inventory Goods Sold Expense

Sale

Balance Income Income

Sheet Statement Statement
 Management decision making
◼ Opportunity Cost:
It is the cost of next best alternative forgone.
When a decision to pursue one alternative is
made the benefits of other alternative is
foregone. Benefits lost from rejecting the next
best alternative are the opportunity cost of the
chosen action.
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◼ Since opportunity costs are not actually
incurred, they are not recorded in the
accounting records. They are however
relevant cost for decision making purpose
and must be considered in evaluating a
proposed alternative.
 Relevant Cost
◼ Relevant Costs are costs relevant for a
specific purpose or situation.
In the context of decision making relating to
a specific issue, only those costs which
are relevant are considered. A particular
cost item may be relevant in a decision
making and may be irrelevant in some
other decision making situation.
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For example, present depreciated cost of
machine is relevant in case of decision of
its sale but it is irrelevant in case of
decision of its replacement.
Controllable Costs
◼ Controllable Costs are the costs which can
be influenced by the action of a specified
number of an undertaking. Controllable
Costs incurred in a particular responsibility
centre can be influenced by the action of
the executive heading that responsibility
centre. For example, direct materials and
indirect materials.
Uncontrollable Cost

◼ Uncontrollable Costs are those costs

which cannot be influenced by the action
of a specified number of an undertaking. In
fact, no cost is controllable, it is only in
relation to a particular individual that may
specify a particular cost to either
controllable or non-controllable. For
example, rent and rates.
 Sunk Cost
◼ Sunk Costs are historical costs which are
incurred i.e. ‘sunk’ in the past and are not
relevant to the particular decision making
problem being considered.
◼ Sunk costs are those that have been incurred
for a project and which will not be recovered if
the project is terminated. While considering the
replacement of a plant, the depreciated book
value of the old asset is irrelevant as the
amount is a sunk cost which is to be written off
at the time of replacement.
 Avoidable Cost
◼ Avoidable Costs are those costs which under
given conditions of performance efficiency
should not have been incurred.

◼ Avoidable costs are logically associated with

some activity or situation and are ascertained
by the difference of actual cost with the
happening of the situation and the normal
cost.
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◼ When spoilage occurs in manufacture in
excess of normal limit, the resulting cost of
spoilage is avoidable cost. Cost variances
which are controllable may be termed as
avoidable cost.
 Unavoidable Cost
◼ Unavoidable Costs are inescapable costs
which are essentially to be incurred, within
the limits or norms provided for. It is the
cost that must be incurred under a
program of business restriction. It is fixed
in nature and inescapable.
Conversion Cost
◼ Conversion Costs are those costs incurred
while converting materials into semi-
finished or finished goods. It is the
aggregate of direct wages, direct
expenses and overhead costs of
converting raw materials into finished
products.
 Imputed Cost
◼ Imputed costs are not actually incurred in
some transactions but which are relevant to
the decision as they part into a particular
situation.
◼ This cost don’t enter into traditional
accounting system but they are being
related with economic reality help in making
better decision.
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◼ For example, The owner of a house have
not to pay rent but it should take into
consideration, otherwise cost will be
understated.
Cost of Goods Sold Statement.
Material Opening inventory xxx Add Work in process (opening) xxx
Add Purchases xxx
Cost of goods to be manufactured
xxx
(Less Purchase return) (xxx) Less Work in process (Closing) xxx
Less purchase discount (xxx) xxx Cost of Goods Manufactured xxx
Material available for use xxx Add-opening finished good
Inventory xxx
Less-Closing material inventory xxx
Cost of goods available for sale
Direct material consumed xxx xxx
Add- direct labor xxx Less closing Finished good
Inventory xxx
Other direct expenses xxx
Cost of Goods Sold xxx
Prime cost xxx

Add- factory overhead expenses xxx

Total manufacturing cost xxx