Definition of Cost Accounting

Cost accounting is one of the branches of accounting. Cost accounting is the process of
determining the cost of producing some of products, providing some of services or undertaking
some activities. So cost accounting as the branch of accounting deals with the classification,
recording, allocation, summarization and reporting of current and prospective cost. Therefore
identification, accumulation, assignment, and analysis of cost of products or activities are done in
cost accounting.

Why cost accounting?

Cost accounting is a recent development born in the response to the needs of managerial
personnel for detailed information about cost of a product or unit of service. In the initial stages
of its evolution, cost accounting confined to itself to accumulation of historical costs and
presentation of the same for sole purpose of cost finding or product costing. With the passage of
time, however, the scope of cost accounting was broadened and provision of information for cost
control and cost minimization became more important than product cost.

So cost accounting is necessary for the achievement of the following purposes:

 Cost ascertainment: Cost finding for product or service is, even today, the basic
objective of cost accounting. For the purpose of asserting the cost of a product, process or
operation, it is necessary to record the expenses incidental thereto, subjectively as well as
objectively. In the process of recording expenses are reclassified according to the purpose
for which they are incurred. After reclassification, these expenses are allocated and
apportioned amongst the respective products, process or operation for building up total
cost for each of these. Cost per unit is achieved at by dividing the total cost by the
number of units produced.

 Cost control: This is, in fact, the principal purpose of cost accounting. This objective is
achieved by setting standard of performance. Actual costs are compared with the pre-
determined standards. Deviation, if any, is immediately corrected. The controlling
function is performed by managers at different levels to ensure that operation or process
costs are under control.
 Decision making: Choosing amongst alternatives is also one of the objectives of cost
accounting. Cost information, presented to management regularly at stated intervals of
time .enables management to make short-term and long-term decisions. Thus cost
information is of immense use of formulating operating policies of a business enterprise.

 Fixation of selling price: Cost per unit facilities fixation of selling price. Unless the cost
is known, the required percentage of profit cannot be added to cost, since selling price is
equal to cost plus profit. The need for reliable cost data becomes apparent specially
during a period of depression when the selling price has to be fixed below the total cost.
 furthermore in the competitive world, to determine the selling price efficiently is needed,
so that customers get products in lower price than other competitor of the enterprise, that
will ensure to sell the more products and more profit.

Total cost and unit cost: Total cost is the cost for total units produced by an enterprise in an
operation. Example total cost of production. Unit cost is per unit of cost product or service in
relation to which cost is ascertained.

Cost object: cost object is anything to which cost measurement is desired. Example is products,
services, departments, processes and operations.

Mark up: Mark up is cost plus profit. That means profit is charged on cost. Example is 10%
profit on cost. In here cost will be 100%.

Margin: Margin is profit which is charged on sales value. Example is 10% profit on sales. In
here sales will be 100%.

Prime cost is direct materials plus direct labor costs that are needed to produce the finished
product.

Conversion cost is direct labor + manufacturing overhead that is used to "convert" raw materials
into product (finished).

Classification of cost

On the basis of manufacturing and non-manufacturing:

Cost

Manufacturing cost Non manufacturing cost

Direct materials Office and Administrative overhead

Direct labor Marketing and selling overhead

Manufacturing overhead

On the basis of elements of cost

 Material cost; material is the basic substance of the products. Cost of the basic commodities
supplied to the enterprise to convert into finished product of that enterprise. For Example cotton
will be the material for spinning mills.

Labor cost; cost of remunerating own employees who converts the raw material into finished
products. For example may be wages and salaries for factory employees.

Overhead cost; all the costs except materials and labor cost, are overhead costs that are needed
to produce the product but cannot be traced directly in an economic faceable way to the product
produced. For example indirect material cost, indirect labor cost, factory overhead cost.

On the basis of behavior of cost

Variable cost: Cost variable in total into proportion to the changes of volume or level of activity.
In variable cost, cost varies in total but constant in per unit. For example direct material cost,
direct labor cost.

Fixed cost: Cost fixed in total within a relevant range of short time period but varies in per unit.
Relevant range is the specific period of time when the relationship between cost and activity or
number of units is certainly known. For example depreciation expenses, rent expense, interest
expense.

Mixed cost: Mixed cost is the combination of fixed cost and variable cost. Mixed cost may be
semi-variables or semi-fixed cost. When the variable portion of cost is higher than fixed portion
of cost then it will be semi-variable cost. When the fixed portion is higher than the variable
portion of cost then that mixed cost will be semi-fixed cost. Example of mixed cost is
maintenance cost, cost of goods sold.

On the basis of decision making

Relevant cost: The cost which is relevant for decision making among the alternatives. Relevant
cost is future cost and varies among the alternatives. All variable costs are relevant.

Irrelevant cost: Cost which does not affect the alternatives. Such costs are common among the
alternatives. Most of the cases all the fixed costs are irrelevant.

Opportunity cost: opportunity cost is the forgone benefits from the second best alternative due
to rejecting this alternative and accepting the first alternative. When more than one option is
available but the options are mutually exclusive then the company has to accept one option that
gives highest financial benefits. So in this case company has to reject all other options and the
benefit of the best option from rejecting options is opportunity cost of that company. This is
opportunity cost as company cannot take all the opportunities at the same time due to resource
constraints or other factors.
Sunk cost: sunk cost is past cost which has already been incurred so does not directly affect on
the decision making. This type of cost is not altered as a result of managerial decision to change
the level or nature of business activities. Example is equipment purchased and if the decision is
changed so the newly equipment will not be in use. But as the equipment is purchased already so
this has no effect on further decision making.

On the basis of direct and indirect

Direct cost: direct cost is directly traceable to the product or service in an economic feasible
way. For example cost of timber for table chair, cost cloth for making shirt.

Indirect cost: indirect cost can’t be traced directly to the product or service in an economic
feasible way. For example cost of gum or iron that are needed to produced table, chair. Cotton
needed to stitch the shirt.

Cost Function

Y = MX + C

Where:

Y is total cost or mixed cost.

M is multiplier that is variable cost per unit and constant over the period.

X is number of units produced.

And C is fixed cost that is constant over the period whatever the number of units produced.

Problem: Behavioral classification of cost

Frankel limited is a merchandising company, is the distinguishing distributor of a product that is

gaining rapid market acceptance. The company’s revenues and expenses for the last three months
are below:

Ap J
ril May une
Sales units 3000 3750 4500
Sales revenue 420000 525000 630000
less: Cost of Goods Sold 168000 210000 252000
Gross Margin 252000 315000 378000
Less: Operating expenses;
Shipping expense 44000 50000 56000
Advertising expense 70000 70000 70000
Salaries & commission 107000 125000 143000
Insurance expense 9000 9000 9000
 Depreciation expense 42000 42000 42000
Total operating expenses 272000 296000 320000
Net Operating Income -20000 19000 58000

Requirement

A. Identify the behavioral classification of cost as variable, fixed and mixed cost.
B. Using High-low method separate the fixed and variable cost from mixed cost
C. Using contribution margin format provide the Income Statement for 4500units.
D. What is cost function for 5000 units? Determine the total cost for mixed items.