Subject : Cost Accounting

UNIT- I : INTRODUCTION

Cost Accounting: Definition- Features- Objectives – Functions – Scope – Advantages

and Limitations- Essentials of a good cost accounting system- Difference between Cost
Accounting and Financial Accounting – Cost concepts – Cost Classification

Short Answer Questions

1. What is Cost Accounting?

Ans: Cost Accounting is a branch of accounting, has primarily developed to help

managers understand the costs of running a business. Cost accounting provides
detailed cost information to various levels of management for efficient performance
of their functions. The information supplied by the cost accounting acts as a
management tool for decision making, to optimize the utilisation of scarce resources
and ultimately add to the profitability of the business by controlling expenditure. It is
defined by CIMA London as “the presentationof accounting information in such a way
as to assist management in creation of policy and day-to-day operations of an
undertaking.”

2. State the features of Cost Accounting.

Ans: Cost accounting is the science, art and practice of cost accounting. There is no
ready-made system of cost accounting that is suitable to a given type of business.The
following are the important features of cost accounting:- (a) It is a process of
accounting for costs (b) It records income and expenditure about production of goods
and services (c) It provides statistical data on the basis of which future estimates are
prepared and quotations are submitted (d)It is concerned with cost ascertainment and
cost control (e It Provides data to the management for decision making and budgeting
for the future

3. Explain in brief the Scope of Cost Accounting

Ans: The scope (field of activity or domain) of Cost Accountancy is very wide and
includes the following:- (a) Cost Ascertainment:- The main objective of Cost
Accounting is to find out the Cost of product /services rendered with reasonable
degree of accuracy. (b) Cost Accounting:- It is the process of Accounting for Cost which
begins with recording of expenditure and ends with preparation of statistical data. (c)
Cost Control:- It is the process of regulating the action so as to keep the element of
cost within the set parameters. (d) Cost Reduction:- Cost reduction is the act of
bringing about a permanent reduction in the elements of cost. (e) Cost Audit:- Cost
Audit is the verification of correctness of Cost Accounts and check on the adherence
to the Cost Accounting plan.

4. What is a Cost unit?

Ans: Cost unit is defined as a ‘Unit of product or service in relation to which costs are
ascertained or expressed’. Cost units are the things that the business is set up to
provide of which cost is ascertained. For example, in a sugar mill, the cost per tonne
of sugar may be ascertained, in a textile mill the cost per metre of cloth may be
ascertained.

5.What is a Cost Centre?

Ans: CIMA of UK defined a cost centre as “a location, a person, or an item of equipment

(or a group of these) for which costs may be ascertained and used for the purpose of
control Thus,a cost centre refers to a section of the business to which costs can be
charged. These cost centres are the departments and sub - departments of an
organisation with reference to which cost is collected for cost ascertainment and cost
control.

6.What are the Objections of Cost Accounting?

Ans: The main objections against cost accounting system are as follows: (a)
Unnecessary:-It is argued that maintenance of the costing records for the purpose of
operating the cost accounting system, is unnecessary and involves duplication of work
(b) Inapplicable:- Modern method of costing is not applicable to many types of
industries. There is no readymade system of cost accounting applicable to all
industries. Therefore a costing system must be specially designed to meet the needs
of a business.(c) Expensive:- Installation of cost accounting system involves additional
expenditure which leads to an increase in cost of production and reduces the
profitability of the business concern.(d)Failure in many cases:- It is argued that costing
system adopted in many concerns has not produced the desired results. Hence, it is
ineffective.

7. What do you mean elements of Cost?

Ans: Elements of cost refers to the essential components of the total cost of a cost
unit. The total cost of manufacture is classified under three elements called the
elements of cost. This element wise classification of cost is based on the nature of the
cost itself. A cost is composed of three elements :– Material, Labour and Expenses.
Each of these three elements can be direct and indirect, i.e., direct materials and
indirect materials, direct labour and indirect labour, direct expenses and indirect
expenses.

Long Answer questions

Q1.Define Cost Accounting and Explain its objectives.

Ans: Cost accounting is the process of classifying, recording and appropriate allocation
of expenditure for the purpose of determining the costs of products or services, It also
helps in presentation of suitably arranged data for the purposes of control and
guidance of the management. It includes the ascertainment of the cost of every order,
job, contract, process, service or unit as may be appropriate. It deals with the cost of
production, selling and distribution.

CIMA of UK defined cost accounting as “Cost accounting is the process of accounting

for cost from the point at which expenditure is incurred or committed to the
establishment of its ultimate relationship with cost centres and cost units. In its widest
usage, it embraces the preparation of statistical data, the application of cost control
methods and ascertainment of profitability of activities carried out or planned”.

The following are the major objectives of cost accounting:-

The objective of cost accounting is to determine the methods by which expenditure

on materials, wages and overhead are recorded classified and allocated. This is
necessary so that the cost of the product and services, may be accurately ascertained.
The following are the main objectives of cost accounting.

1.Ascertainment of Cost:- The basic objective of cost accounting is to ascertain the

cost of a product, job or service. Expenses relating to a product are collected from
different sources. In addition to direct expenses relating to a product, indirect
expenses related to several products are also taken into consideration (apportioned
on some equitable basis) while ascertaining the cost of a product.

2. Cost control:-The second objective of cost accounting is to control the cost so that
the maximum and better production at minimum cost may be made possible. To
achieve this objective, the techniques of budgetary control and standard costing are
adopted.

3. Cost Reduction:-To survive in the world of competition, it is necessary to keep the

prices of products or services as low as possible. It is only possible when cost of
production is less. So the management has to make continuous efforts to reduce the
cost. To provide data for cost reduction is one of the important objectives of Cost
Accounting. It helps the management in finding out new and improved methods to
reduce costs.

4. Determination of Selling Price:-Cost accounting provides cost information on the

basis of which selling prices of products or services can be determined. In the event of
depression or recession, cost accounting guides the management in deciding the
extent to which the selling price may be reduced to meet special situations.

5. Matching Costs with Revenue:- The profit of any activity can be ascertained by
matching cost with the revenue of that activity. The purpose of this step is to
determine profit or loss of any activity on an objective basis.

6. Providing Basis for Operating Policy:-Cost accounting is an essential tool for the
management to formulate operating policies and to take business decisions like
determination of cost-volume-profit relationship; whether to buy or to make an
article, replacement of labour by machine whether to close or continue operations, in
spite of losses, selling at below cost, introduction of new products etc.

7. Measuring Efficiency:For measuring the performance of various business activities,

management requires some base for evaluating the performance. Standard Cost is one
of the means for evaluating the performance. So the development of Standard Cost is
also an important objective of Cost Accounting.

8.To prepare periodic statements:- Under cost accounting system Cost statements are
prepared periodically i.e. monthly or quarterly, half yearly, annually to review the
operating results.

Q2. Explain the Advantages and Limitations of Cost Accounting.

Ans: Cost accounting has many Advantages but the extent of the advantages obtained
will depend upon the efficiency with which cost system is installed and also to the
extent to which the management is prepared to accept the system.

The main Advantages of Cost Accounting are as follows.

I. Advantages to Management:-

1.Ascertainment of Cost:-Cost accounting serves the main purpose of ascertaining the

cost of products. It records detailed information regarding all expenditures associated
with production processes of business which enables manufacturers to determine the
right cost.

2.Measures And Improves Efficiency:-It collects and records the data with respect to
cost, time and expenses. This data is used for analysis or comparison with industry
which evaluates the overall efficiency and improves the performance of the
organization.

3 Helps in identifying Unprofitable Activities:-Cost accounting assists the

management in determining the profitable and unprofitable activities of the business.
It supplies all information regarding product cost, selling price, and profitability of
products, which helps managers in choosing the products which are profitable for
business and which are not.

4.Helps in Fixing selling price:- Fixing the selling price of products is a crucial decision
to be taken by every business. The total cost of a product is available in the costing
records, which is highly useful for fixingselling price of a productor a service.

5.Inventory Control:-Cost accounting maintains a systematic record of inventories. It

helps in avoiding overstocking or under stocking of inventory and helps in always in
maintaining an ideal stock level within the organization.

6.Cost Control:-Cost accounting helps in controlling cost with special techniques like
standard costing and budgetary control. Under cost accounting, budgets are prepared
and standards are fixed for each activity. Performance of every activity is compared
with standards, to find out the deviations and to take necessary action.

7. Identifies Reasons For Losses:-Cost accounting evaluates and reveals the exact
causes for losses suffered by the business. It evaluates the output level of every
department of business and helps in finding out whether it is efficient in accordance
with the capacity of the firm.

8.Reliable check on accounting:-Cost accounting is more reliable and accurate system

of accounting. It is helpful to check results of financial accounting with the help of
periodic reconciliation of cost accounts with financial accounts.

II. Advantages to Workers:-

Workers are benefited by introduction of incentive plans of wage payment. Which is

an integral part of cost system. This results not only in higher productivity but also
higher earnings for workers.

III. Advantages to Government:-

It helps the Government in planning and policy making about imports, exports,
industry and taxation. It is helpful in assessment of excise duty, service tax and income
tax, etc. It provides readymade data to Government in price fixation, price
control,extending subsidies, tariff protection, etc.

IV. Advantages to Society:.

Reduction of selling price due to reduction in cost price passes on to customers

ultimately. Application of Cost accounting builds confidence in customers about
fairness of price.

Limitations of Cost Accounting

1.Lack of Uniformity:-Cost Accounting has a lack of a uniform principles and

procedure. It is possible that two equally competent cost accountants may arrive at
different conclusions in the same situation.

2.Estimates:-It is argued that the costing system depends on predetermined data and
therefore it is not reliable. The user does not receive the time or exact cost.

3. Expensive:-It is pointed that installation of a costing system is expensive which only

large concerns can afford. It is also argued that installation of the system will involve
additional expenditure which will lead to diminution of profits..

4.Uses Secondary Data:- Cost Accounting uses secondary data from financial
statements for various calculations like standard cost. It does not include primary data
or short term data. That’s why cost accounting does not provide effective results.

5. Unable To Determine Tax Liability:-Cost Accounting will not help in calculating the
tax liability of a company.Cost records information cannot be taken as a basis for
calculating tax. Financial accounting is required for finding out the tax liability.

Q3. What are the essentials of good Cost Accounting system?

Ans: The essential features, which a good Cost Accounting System should possess, are
as follows:

1.Suitability:-The method of costing adopted should be suitable to the business and

serve its objectives. Different industries have different processes. A suitable cost
accounting system should be adopted to give the desired result.

2.Specially designed:- A readymade cost accounting system cannot be suitable to

every business. Therefore the costing system should be tailor made according to the
requirements of the business
3.Simple and informative:-The cost accounting system should be simple so that it may
be easily understood even by a person of average intelligence. The information
provided by the cost accounting must be presented in the right format at the right
time to the right person.

4.Flexible and adaptive:- The cost accounting system should be flexible enough to
make necessary amendments and modifications in the system to incorporate changes
in technological, reporting, regulatory and other requirements.

5. Accurate and authentic:- The data to be used by the cost accounting system should
be accurate and authenticated, otherwise it may distort the output of the system and
a wrong decision may be taken.

6.Comparability:-The costing system must admit of easy comparison with

predetermined estimates and with costs of similar jobs previously performed. It is the
comparison which point out the areas of strengths and weakness.

7.Support from executives:- If a cost accounting system is to be successful, it must

be fully supported by executives of various departments and everyone should
participate in it.

8.Integration with financial accounts:-Integration of Financial Accounting and Cost

Accounting Systems will avoid duplication of work. The financial and cost accounts
should be interlocked together and should be reconciled periodically.
9. Uniformity and consistency:-There should be uniformity and consistency in
classification, treatment and reporting of cost data and related information. This is
required for benchmarking and comparability of the results of the system for both
horizontal and vertical analysis.

10.Continuous education:-Well trained and educated staff should be employed to

operate the system. In order to educate the staff, written manuals and meetings
should be arranged on a continuous basis.

11. Trust on the system:-Management should have a faith in the Costing System and
should also provide a helping hand for its development and success.

Q4.Distinguish between Financial Accounting and Cost Accounting.

Ans: Financial accounting is the process of recording, classifying and summarising in a

significant manner and in terms of money transactions and events. These have to be,
in part or at least, of financial character. on the other hand, Cost accounting is the
method that records, collects, classifies and allocates appropriately expenditures, for
the determination of costs of products and services. The definition of the two branches
of accounting, therefore, reveals a large common area between the two .But the
emphasis of the two widely differs. Some points of difference between Cost
accounting and financial accounting are as follows:

S.no. Basis Financial Accounting Cos Accounting

1. Purpose It provides consolidated The focus of cost
information to the parties accounting is essentially
external to the business internal. It tends to provide
firm regarding its information about costs
operational and financial and cost estimates to the
conditions. Such parties parties within the firm for
include shareholders, decision making.
bankers, creditors,
,government etc.
2. Statutory These accounts are Maintenance of these
requirement obligatory to be prepared accounts is voluntary
according to the legal except in certain industries
requirements of where it has been made
Companies Act and obligatory to keep cost
Income Tax Act. records under the
Companies Act.

3. Analysis of cost and Financial accounts It discloses the detailed

profit disclose the net profit or cost and profit data for
loss of the firm as a whole each product line,
department, process, job
etc.
4. Periodicity of Financial reports are Cost reporting is a
reporting prepared periodically, continuous process and
usually on an annual may be on daily, weekly,
basis. monthly basis, etc.
5. Control aspect It lays emphasis on the It lays emphasis on control
recording of financial or various elements of
transactions and does not material, labour and
attach importance to overhead . standard
control part. costing and budgetary
control are the main
techniques of control.
6. Historical and It is concerned almost It is concerned not only
predetermined with historical records. with historical but also
costs The historical nature of with predetermined costs.
 financial accounting can
be easily understood in
the context of the
purpose for which it was
designed
7. Format of Financial accounting has a It has varies forms of
presenting single uniform format of presenting cost
information presenting information, information which are
i.e. P&L account, Balance made to meet the needs of
Sheet and Cash Flow the management.
Statement.

8. Types of Financial accounting It records not only external

transactions records only external transactions but also
recorded transactions like sales, internal or inter –
purchases, etc. With departmental transactions
outside parties. like issue of materials by
store – keeper to
production departments.
9. Stock valuation Stocks are valued at cost In this system stocks are
or market price whichever valued at cost.
is less
10 Information It records only monetary It deals with monetary as
transactions well as non- monetary
information like units is
also used.

Q5.What are the different methods of Classification of Costs?

Ans: Classification of Costs is the process the grouping of costs according to their similar
characteristics. It is a systematic placement of like items together according to their
common features. There are various ways of classifying costs. Each classification serves
a different purpose.

1. Natural Classification:-According to this classification, the costs are divided into

three categories i.e. Materials, Labour, and expenses. It is a primary classification and
can be further sub classified . These heads make it easier to classify the costs in a cost
sheet and help to ascertain the total cost and determine the cost of the work-in-
progress.
2. Behavioural Classification-: According to this classification, costs are classified
according to their behaviour in relation to changes in the level of activity. On this basis
costs are classified into three groups viz., Fixed cost, Variable cost and semi –variable
cost.

a) Fixed Cost is the cost which does not vary with the change in the volume of activity
in the short run. For example, salaries, rent, audit fees, depreciation etc.

b) Variable Cost is the cost of elements which tends to directly vary with the volume
of activity. Examples of variable cost are materials consumed, direct labour, sales
commission, etc.

c) Semi Variable Costs contains both fixed and variable elements. They are partly
affected by fluctuation in the level of activity. Examples of semi-variable cost: Factory
supervision, maintenance, power etc.

3.By Traceability:- According to this classification, Total cost is divided into direct cost
and indirect cost. Direct costs are those which are incurred for and may be
conveniently identified with a particular cost centre or cost unit. Cost of raw material
and wages of machine operator are common examples of direct costs.

Indirect cost : These costs are incurred for the benefit of a number of cost units,
processes or departments. These costs cannot be conveniently identified with a
particular cost unit or cost centre.

4. By Functions:- According to this classification, costs are divided in the light of the
different aspects of basic managerial activities of the organization. The major functions
in an organization can be production, administration, selling, distribution, research,
and development.

• Production Costs: All costs concerned with actual manufacturing or

construction of the goods

• Commercial Costs: It is the total costs of the operation of an enterprise

other than the manufacturing costs. It includes the administrative costs,
selling and distribution costs etc.

5.By control-: According to this costs are classified into controllable costs and non –
controllable costs.

• Controllable costs: These are the costs which may be directly regulated at a
given level of management authority. Variable costs are generally controllable
by department heads.
 • Non – controllable costs: These are those costs which cannot be influenced by
the action of a specified member of an enterprise. For example, it is very
difficult to control costs like factory rent, managerial salaries, etc.

6.By Normality:- Costs can also be classified as Normal and Abnormal costs.

• Normal costs: Normal costs are costs incurred in the normal course of
activity for producing normal level of output under normal conditions.

• Abnormal costs: Costs incurred on account of abnormal conditions or

abnormal activity are abnormal costs.

7. By Relationship with Accounting Period :- Costs can be classified into capital cost
and Revenue costs.

Capital cost: The cost which is incurred in purchasing an asset either to earn income or
increasing the earning capacity of the business is called capital cost

Revenue cost: Costs incurred to maintain the revenue earning capacity of the
organisation is called Revenue cost.

8.By Time:-Costs can be classified as Historical cost and predetermined costs.

Historical costs: These are the past costs which are ascertained after these have been
incurred. Historical costs are nothing but actual costs.

Predetermined costs: These are the future costs which are ascertained in advance of
production on the basis of a specification of all the factors affecting cost. These costs
are extensively used for the purpose of planning and control.
Q6.Explain different Methods and techniques of Cost Accounting.
Ans: The methods or types of costing refer to the techniques and processes employed in
the ascertainment of costs. Different methods of costing are applied to different
industries depending upon the type of manufacture and their nature.
The following are the different methods of costing and the situations in which they are
applicable:

1. Unit or Output or Single Costing:

This method is applied where production is uniform and consists of only a single product
or two or three types of similar products with variations in size, shape, or quality. The
information is presented in the form of a statement known as cost sheet. This method is
suitable in industries like brick making, flour mills, cement manufacturing, etc.

2. Job Costing:
It is a method of costing used to ascertain the cost of making a single unit of customized
product. Under this method, a job cost sheet is prepared for each job and all costs
related to the specific job are recorded. The total cost of each job is determined by
aggregating all the expenses related to that specific job. This method is suitable for jobs
like making a wooden dinning table, designing a software, painting a house, repairing a
car, etc.

3. Batch Costing:
This method is also a type of job costing. A batch of similar products is regarded as one
job and the cost of this complete batch is ascertained. It is then used to determine the
unit cost of the articles produced. Batch costing is generally employed in industries
engaged in biscuit manufacturing, toy making, spare parts manufacturers etc.

4.. Process Costing:

It is a method where costs are collected and accumulated according to department or
processes and cost of each department or process is divided by the quantity of
production to arrive at cost per unit. This method is useful in industries such as paper,
soap, textiles, chemicals, sugar, and food processing products.

5.Operating costing:
This method is applicable where services are rendered rather than goods produced. The
procedure is same as in the case of unit costing. The total expenses of the operation are
divided by the units and cost per unit of service is arrived at. This is followed in transport
undertakings, municipalities, hospitals, hotels etc.

6.Operations Costing:
This method is adopted when it is desired to ascertain the cost of carrying out an
operation in a department, for example, welding. For large undertakings, it is frequently
necessary to ascertain the cost of various operations.

7.Contract Costing:
It is a method of costing used to ascertain the cost of executing a work involving heavy
expenditure and extending over a long period of time. The work is executed according to
customer specifications. Under this method, a separate account is opened for each
individual contract and the same is debited with expenses and credited with Closing
Stock of various items and the value of work completed. This method is suitable for
activities like construction of a building, construction of ship, etc.
8.Multiple Costing :
This method is followed where the final product consists of a number of separate parts,
e.g., radio set, motor car, bicycle etc. The cost of each part has to be ascertained and
then the cost of assembling the parts will be tabulated. The cost of the final product will
consist of the cost of all the parts plus the cost of assembling them.

Techniques of Costing:
Techniques of costing are those which help in cost control and cost reduction.
The following are the different techniques of costing:
1 Historical (or Conventional) Costing
It refers to the determination of costs after they have been actually incurred. It means
that cost of a product can be calculated only after its production. This system is useful
only for determining costs, but not useful for exercising any control over costs. It can
serve as a guidance for future production only when conditions continue to be the same
in future.

2.Marginal Costing :
It refers to the ascertainment of costs by differentiating between fixed costs and
variable costs. In this technique fixed costs are not treated as product costs. They are
recovered from the contribution (the difference between sales and variable cost of
sales). This technique helps management in taking important policy decisions.

3. Standard Costing :
It refers to the ascertainment and use of standard costs and the measurement and
analysis of variances. Standard cost is a predetermined cost which is computed in
advance of production on the basis of a specification of all factors affecting costs. The
standards are fixed for each element of cost. To find out variances, the standard costs
are compared with actual costs. It helps in measuring the efficiency of operations from
time to time. By focusing attention on critical variances, it helps the management in
controlling costs.

4. Uniform Costing :
A technique where standardized principles and methods of cost accounting are
employed by a number of different companies and firms, is termed as uniform costing.
This helps in comparing performance of one firm with that of another.

5.Absorption Costing :
Absorption costing is also referred to as full costing. It is a costing technique in which all
manufacturing cost (fixed and variable) are considered as cost of production and are
used in determining the cost of goods manufactured and inventories. The fixed
production costs are treated as part of the actual production costs.

6. Activity Based Costing:

Activity based costing refers to the technique of determining the cost of activities and
the cost of output that those activities produce. It is a process of identification of the
activities that have taken place in the organisation, assigning costs to cost pool for each
activity, spreading of support activities across the primary activities, determining cost
driver for each activity and managing the costs of activities.

7.Budgetary Control :
A Budget is used for controlling and co-ordination of business operations. A Budget is a
quantitative or financial statement prepared for definite period of time. Budgetary
control is a use of comprehensive system of budgeting to aid management in carrying
out its functions of planning, coordinating, and controlling operations. A budgetary
control is one of the important tools of control.