Cost Accounting-Introduction

Chapter 1 -
Overview
Meaning- Cost
• Cost means the amount of expenditure (actual
or notional) incurred on, or Attributable to, a
given thing.
2
Meaning - 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 of information to management for
decision making
3
Cost Accounting - Objectives
1. Ascertainment of Cost
2. Cost Control and Cost Reduction
3. Guide to Business Policy
4. Determination of Selling Price
4
8. A Comparison –
Financial Accounting and Cost Accounting
Sr No Difference Financial Accounting Cost Accounting
1 Purpose P&L and BS for Cost information for internal users
owners/shareholders outsiders
2 Statutory requirements Under Companies Act and IT Act Optional, except in specified industries as per Companies
Act
3 Analysis of cost and profit Profit/loss of business as whole Detailed information about cost and profit data of
individual products, processes, plants etc.
4 Periodicity of Reporting Prepared periodically usually Continuous, daily, weekly, monthly ..
annually
5 Control Aspect Emphasis on recording rather Detailed system of control
than control
6 Historical and predetermined Historical Historical + Budgeted
cost
7 Format of presentation Uniform Tailored as per requirement
8 Types of transactions External External + internal or inter-departmental

recorded
9 Types of statements General purpose statements P&L Special purpose reports with tailored informations
prepared , BS. Caters to all with no
explicitly defined needs.
5
Cost Center - Meaning
“A location, person, or item of equipment(or group
of these), for which costs may be ascertained and
used for the purpose of control”
6
Cost Center - Types
Primarily
• Personal Cost Center - person, group of persons
• Impersonal Cost Center – location or an item of equipment or group of these
From Functional point of view
• Production Cost Center – where actual production work takes place
• Service Cost Center – ancillary to and render services to production cost center
7
Cost Unit - Meaning
“Cost unit is a form of measurement of volume of
production or service. This unit is generally adopted
on the basis of convenience and practice in the
industry concerned”
8
Cost Unit - Types
Broadly
• Units of production – a tonne of steel, or a metre
of cable, MW of power
• Units of service – cinema seats or consulting
hours, Room per day of hotel
9
Cost Object - Meaning
“Anything for which a separate measurement of
cost may be desired”
10
Cost Object - Examples
Examples
• Product - car, computer etc
• Service - Taxi service, Telephone service
• Process – Melting process in steel mill
• Activity – Website development, Raw material
purchase
• Department – Personnel department, stores
department
11
Cost Classification – Material, Labour, Others
Cost
Materials Labour Other Expenses
Direct Indirect Direct Indirect Direct Indirect
Overheads
FOH AOH SOH DOH

12
Cost Classification basis nature - Materials
 Material: The substance from which the finished product is made is

known as material.
 Direct material: one which can be directly or easily identified in the

product Eg: Timber in furniture, Cloth in dress, etc.
 Indirect material: one which cannot be easily identified in the

product.
1. Small & relatively inexpensive items which may become part of
finished product e.g. pins, screws, nuts and bolts, thread
2. Items which do not physically become a part of the finished product
e.g.coal, lubricating oil and grease, sand paper used for polishing
etc. 13
Cost Classification basis nature - Labour
 Labour: The human effort required to convert the materials into

finished product is called labour.
 Direct Labour: One which can be conveniently identified or

attributed wholly to a particular job, product or process.
Eg:wages paid to carpenter, fees paid to tailor,etc.
 Indirect Labour: One which cannot be conveniently identified or

attributed wholly to a particular job, product or process.
14
Cost Classification basis nature – Other Expense
 Other expenses are those expenses other than materials and labour.
 Direct expenses: Those expenses which can be directly allocated to

particular job, process or product. Eg : Excise duty, royalty, special
hire charges,etc.
 Indirect expenses: Those expenses which cannot be directly

allocated to particular job, process or product. Eg. Rent and rates,
Depreciation, lighting & power, Advertising, Insurance, Repairs.
15
Cost Classification basis nature – Overheads
Production/Factory/Works/Manufacturing Overheads: Includes expense

related to production function
 Indirect Material: Coal, oil, grease, stationary used in factory office

 Indirect Labour: Factory manager’s salary, salary of factory office
staff, salary of inspector or supervisor, wages of factory sweeper,
wages of factory watchman etc.
 Indirect Expenses: Factory rent, depreciation of plant, repair &
Maintenance of plant, insurance of factory building, factory lighting &
power etc.
16
Office and administration overheads: Includes expenditure incurred in

general administrative function & having no direct connection with
production or sales activities
 Indirect Material: Stationary used in general administrative office,

postage etc.
 Indirect Labour: Office staff salary, salary of Managing director etc.
 Indirect Expenses: Office building rent, Legal expenses, Office
lighting & power, telephone expense, depreciation on office furniture
& equipment etc.
17
Selling & distribution overheads: Includes expenditure incurred in

promoting sales & retaining customer.
 Indirect Material: Packing material, stationary used in sales office,

cost of samples, price list, catalogues, oil, grease for delivery van etc.
 Indirect Labour: Salary of sales manager, salary of sales office staff,
salary of warehouse staff and salary of drivers of delivery vans etc.
 Indirect Expenses: Advertising, travelling expenses, showroom
expenses, rent of warehouse etc.
18
Cost Classification – Direct Vs Indirect
Cost
Direct Indirect Cost

Cost
 Direct cost : incurred for and easily identified with a particular cost object like raw
material or wages for machine operator
 Indirect Cost : General cost and for a number of cost objects. Can not be identified
with a particular cost object like depreciation.
19
Cost Classification – Variability
Cost
Fixed Variable Semi Variable

Cost Cost Cost
20
Cost Classification basis nature – Fixed Costs
 Cost that remains constant irrespective of the output
 This doesn’t increase or decrease when the volume of production
changes.
 Eg. Building Rent, Managerial Salaries, Building insurance, Municipal
taxes
21
22
*Fixed cost remains constant in total but varies per

unit
Units Produced Total Fixed Cost Fixed Cost per unit

100 6000 60
200 6000 30
500 6000 12
1000 6000 6
1500 6000 4
23
Cost Classification basis nature – Fixed Costs Per
Unit
24
Cost Classification basis nature – Variable Costs
 The costs that Varies with the increase/decrease in the output.
 If the output increases the cost increases and vice-versa.
25
26
Per Unit
27
Cost Classification basis nature – Semi Variable
Costs
 These cost includes both fixed and variable component.
 These are partially fixed and partially variable
28
Cost Classification – Product vs Period
Cost
Product Period Cost

Cost
 Important from the view point of profit determination
 Product costs are carried forward from one accounting period to next
 As stock of finished goods is sold in the next year.
 Period costs expires when the period expires (year ends)
29
Cost Classification basis nature – Product cost
 These are those costs that are necessary for production
 These will not be incurred if there is no production
 This means that these costs are attached to units produced
 Examples:
 Direct Materials
 Labour
 Some of the factory expenses
30
Cost Classification basis nature – Period cost
 These are costs which are not necessary for production.
 They are incurred even if there is no production
 They are written off as expenses after the end of the period.
 Examples:
 Rent of Factory
 Depreciation
 Salary of Executive and managerial personnel
31
Cost Classification – Controllable vs Non Controllable Cost
Cost
Controllable Cost Non Controllable

Cost
 Classification from the view point of controllability
 Important to define scope of authority
 All costs are controllable in long run provided authority is given
32
Cost Classification – Historical Vs Predetermined
Cost
Historical Cost Pre Determined

Cost
 Historical cost are ascertained after being incurred , these are actual costs
 Predetermined costs are , those which are ascertained in advance of production.
33
Cost Classification – Normal Vs Abnormal
Cost
Normal Cost Abnormal Cost
 Normal costs : normally incurred at given level of out put.
 These are expected costs
 Abnormal Costs: Can not be assumed and are not normally incurred at the given level
of output
34
Cost Classification – Committed Vs Discretionary
Cost
Discretionary
Committed Cost
Cost
 Committed Cost : Once decision to incur them has been made by management, they
are unavoidable & invariant in the short run.
 Examples : Managing director’s salary, Depreciation of plant & equipment
 Discretionary Cost: Those cost which can be avoided or reduced in short run by
management decisions, and are not permanent in nature.
 Examples: Advertising, Research & Development costs etc.

35
Special Costs - Relevant and Irrelevant Costs:
Relevant Costs:
 All costs are not relevant for managerial decision making
 Relevant Costs: the magnitude or amount of expense will be affected by a decision
being made hence relevant costs are future costs that will differ depending on the
action of the management
 Though which cost is relevant or irrelevant depends upon circumstances.
36
Special Costs - Relevant and Irrelevant Costs:
Irrelevant Costs:
 These cost are not affected by decision being taken.
37
Special Costs – Sunk Costs
 Sunk cost is the cost incurred in past, It can not be changed
 Management has no control over it now
 These are not relevant for any decision making now
 Example : Plant & Machinery purchased in 1995 is irrelevant for taking decision
now for purchase of new plant & Machinery.
 That means “ All sunk costs are irrelevant costs”
 But is “All irrelevant costs are sunk costs??”
 Ans.: NO
38
Special Costs – Marginal costs
 Cost of producing one additional unit
 Same as variable costs
39
Special Costs – Differential/Incremental costs
 Increase or decrease in total costs that results from an alternative course of action
 Examples : Make or buy decision, change in product mix
 Together with differential cost we also need to derive differential revenue for decision
making.
40
Special Costs – Imputed Costs
 Imputed means hypothetical or notional costs which is not actually incurred, but still
relevant for decision making.
 For Example: Project A requires a capital investment of Rs.50,000 and Project B
Rs.40,000, Both the projects are expected to yield Rs.10,000 as profit. As project B
requires less investment hence it should be preferred.
41
Special Costs – Opportunity Costs
 Opportunity cost is value/benefit of alternatives foregone by adopting a particular
strategy/alternative.
 For Example: A company deposited Rs.1 lakh in bank at 8% interest p.a., now it is
considering proposal to invest in debentures where the yield is 12% p.a., if the
company decides to invest in debentures then it will forego bank interest, which will
become opportunity cost.
42
Special Costs – Replacement cost
 Replacement cost is current market cost of replacing an asset
43
Special Costs – Out of pocket cost
 Cost which require cash payment is called out of pocket cost or explicit cost
 Example : Wages, Raw material, insurance & power, Manager’s salary etc.
 Cost which do not require cash outlay is not out of pocket cost or implicit cost
 Example : Depreciation
44
Special Costs – Future cost
 Only relevant cost for decision making are predetermined or future cost.
 But base of historical cost will be taken to project future cost.
45
Special Costs – Conversion cost
 It is total cost of converting raw material into finished goods.
 Conversion cost = Factory cost – Direct material
46
Homework
 Installation of costing system in organisation
 Practical Difficulties:
 Lack of support from top management
 Resistance from accounting staff
 Non-cooperation of working and supervisory staff
 Shortage of trained staff
47
Homework
 Advantages of cost accounting
 Reveals profitable and unprofitable activities
 Helps in cost control & cost reduction
 Helps in decision making
 Guides in fixing selling prices
 Helps in inventory control
 Aids in formulating policies
 Reveals ideal capacity
 Check accuracy of financial accounts
 Prevent frauds & manipulation

48
Homework
 Limitations :
 It is unnecessary
 It is expensive
 It is inapplicable
 It is a failure
49
Homework
 Essentials of good costing system:
 Suitability
 Specially designed system
 Support of executives
 Cost of the system
 Clearly defined cost centres
 Controllable costs
 Integration with financial accounts
 Continuous education
 Prompt & accurate reports
 Avoid unnecessary details

50
Homework
 Methods of costing:
 Job order costing
 Contract costing or terminal costing
 Batch costing
 Process costing
 Operating costing
 Single, output or unit costing
 Operating or service costing
 Multiple or composite costing

51
Homework
 Techniques of Costing:
 Standard costing
 Budgetary control
 Marginal costing
 Total absorption costing
 Unit costing
52
COST SHEET
Direct Material
Direct Labor
Direct Expenses
PRIME COST
Factory Overheads
FACTORY COST
Office Overheads
COST OF PRODUCTION
Sell & Dist. Overheads

COST OF SALES
Profit
SALES

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Chapter 1 -

2. Cost Control and Cost Reduction

3. Guide to Business Policy

4. Determination of Selling Price

8 Types of transactions External External + internal or inter-departmental

“A location, person, or item of equipment(or group

of these), for which costs may be ascertained and

used for the purpose of control”

• Personal Cost Center - person, group of persons

• Impersonal Cost Center – location or an item of equipment or group of these

From Functional point of view

• Production Cost Center – where actual production work takes place

“Cost unit is a form of measurement of volume of

production or service. This unit is generally adopted

on the basis of convenience and practice in the

“Anything for which a separate measurement of

cost may be desired”

Materials Labour Other Expenses

Direct Indirect Direct Indirect Direct Indirect

FOH AOH SOH DOH

 Material: The substance from which the finished product is made is

 Direct material: one which can be directly or easily identified in the

 Indirect material: one which cannot be easily identified in the

 Labour: The human effort required to convert the materials into

 Direct Labour: One which can be conveniently identified or

 Indirect Labour: One which cannot be conveniently identified or

 Direct expenses: Those expenses which can be directly allocated to

 Indirect expenses: Those expenses which cannot be directly

Production/Factory/Works/Manufacturing Overheads: Includes expense

 Indirect Material: Coal, oil, grease, stationary used in factory office

Office and administration overheads: Includes expenditure incurred in

 Indirect Material: Stationary used in general administrative office,

Selling & distribution overheads: Includes expenditure incurred in

 Indirect Material: Packing material, stationary used in sales office,

Direct Indirect Cost

material or wages for machine operator

with a particular cost object like depreciation.

Fixed Variable Semi Variable

 Cost that remains constant irrespective of the output

 This doesn’t increase or decrease when the volume of production

 Eg. Building Rent, Managerial Salaries, Building insurance, Municipal

*Fixed cost remains constant in total but varies per

Units Produced Total Fixed Cost Fixed Cost per unit

 The costs that Varies with the increase/decrease in the output.

 If the output increases the cost increases and vice-versa.

 These are partially fixed and partially variable

Product Period Cost

 As stock of finished goods is sold in the next year.

 Period costs expires when the period expires (year ends)

 These are those costs that are necessary for production

 These will not be incurred if there is no production

 This means that these costs are attached to units produced

 Some of the factory expenses

 These are costs which are not necessary for production.

 They are incurred even if there is no production

 Salary of Executive and managerial personnel

Controllable Cost Non Controllable

 Classification from the view point of controllability

 Important to define scope of authority

 All costs are controllable in long run provided authority is given

Historical Cost Pre Determined

 Predetermined costs are , those which are ascertained in advance of production.

Normal Cost Abnormal Cost

 Normal costs : normally incurred at given level of out put.