PUNJAB COLLEGE CHAKWAL

BASIC CONCEPTS OF COST ACCOUNTING

Main branches of Accounting:

Accounting has three main branches:
 Financial Accounting
 Cost Accounting
 Management Accounting
Limitations of Financial Accounting:
Limitations from which financial accounting suffers may be summarized as follow:
 Historical and monetary nature
 Control over cost is not possible
 Does not reveal relative profitability of products
 Does not assist in pricing
Cost Accounting:
As J.W. Neuner has pointed out
“Cost accounting is an expanded phase of the general or financial accounting of
a business concern which provides management promptly with the cost of
producing or selling each article or of rendering a particular service.”
Objectives (Importance) of Cost Accounting
Cost accounting is essential for every business concern because it makes for greater knowledge
of costs and therewith for possible control and reduction of costs. Following are the main
objectives of cost accounting:
 Cost computations
 Cost analysis and control
 Testing adequacy of selling prices
 Special cost studies for management decisions
 Planning and decision making
 Optimum utilization of resources
Difference between Cost Accounting and Financial accounting

Sr.No Financial Accounting Sr.No. Cost Accounting

.
1. Produces general purpose financial 1. Produces special purpose statements
statement. and reports.
2. Provides information to external 2. Provides information to internal
users. users.
3. Must conform to generally accepted 3. Must conform to information needs of
accounting principles. management.
4. Provides accounting data in 4. Provides accounting data in monetary
monetary terms. and non-monetary terms.
5. Financial statements are prepared on 5. Cost statements and reports are
yearly or half yearly basis. prepared more frequently i.e., weekly
and daily basis.
Cost:
A cost is an unexpired expenditure and is defined as
“Cost is foregoing, measured in monetary terms incurred or potentially to be
incurred to achieve a specific cost objective”
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(OR)
“Resources sacrificed or forgone to achieve a specific objective.”
Expense:
Expense is an expired portion of cost. Actually when resources given up have no future potential
benefit we call them an expense.
Classification of Costs
Costs can be classified by:
 Function or operation
o Manufacturing cost
o Selling cost
o Administrative cost
 Elements of cost
o Material
o Labor
o Factory Overhead
 Product identification
o Direct cost
o Indirect cost
 Relationship to volume
o Fixed cost
o Variable cost
o Semi-variable cost
Manufacturing cost
Product costs or manufacturing costs are the cost incurred for manufacturing or, as the case may
be, for purchasing goods. Product costs are said to be “attached to” the units produced. These are
also called ‘Inventoriable Costs’.
Selling cost
Marketing or selling costs include all costs of marketing research, getting orders and distribution
of finished product to consumers.
Administration cost
Administrative costs include costs of planning, policy making and controlling the operations of
enterprise.
Direct cost:
A direct cost is a cost that can be traced in full to the product, service of department that is being
costed.
Indirect cost:
An indirect cost is a cost that is incurred in the course of making product, providing service or
running a department, but which cannot be traced directly and in full to the product, service or
department.
Fixed cost:
Fixed costs are costs which do not respond to changes in activity level within a limited range,
called ‘relevant range’. These costs remain constant in total regardless of changes in activity
level but the per unit fixed cost react inversely to changes in activity level.
Variable cost:
Variable cost are cost which change in total in direct proportion to changes in activity level. It is
important to note that total of variable cost vary with activity level but per unit variable cost
remain constant.
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Semi-variable cost:
Semi-variable costs are composed of both fixed costs and variable costs. These costs respond to
changes in activity level, but due to the presence of fixed cost they do not change in direct
proportion to production volume.
Period Cost:
Costs which are not related to production and are matched against the revenues on time period
basis are called period costs, non-manufacturing costs or non-Inventoriable costs. Selling costs
and administrative costs are examples of period costs.
Differential Cost:
According to CIMA Terminology
“Differential cost is the difference in total cost between two alternatives”.
Opportunity Cost:
According to CIMA Terminology
“The value of benefit sacrificed when one course of actions chosen, on preference to an
alternative.”
Standard Cost:
Standard cost means what the cost should be’
According to ACCA Terminology
“A standard cost is a planned unit cost”
Sunk Cost:
A cost that has already been incurred and now cannot be avoided or changed and consequently it
is irrelevant for the current decision making situation.
Controllable cost:
A controllable cost is one that can be controlled by a specified manager in the organization.
Uncontrollable cost:
Where a specified manager cannot control a particular item of cost, it is an uncontrollable cost
for that manager.
Cost object or cost objective:
It means an item or activity or division for which we make a separate measurement of costs. Cost
objectives are developed to guide the decision makers and to form the basis of classification of
cost.
(OR)
“Any activity for which a separate measurement of costs is desired”.
Cost Accounting System;
The system of recording, classification of costs under the rules of double entry system and finally
presentation in the form of income statement and balance sheet.
Integrated system

Non-integrated or interlocking system

chart of Accounts
 PUNJAB COLLEGE CHAKWAL
Chapter 1
FINANCIAL STATEMENTS

Financial statements
Financial statements are the final product of an accounting cycle or accounting system. These
predict the financial strength of a business at a particular date. These include:
 Income statement
 Balance sheet
 Cash flow statement
 Statement of changes in equity
 Notes to the accounts
Income statement
It is the summary of revenues and expenses for an accounting period. It measures the results of
an entity in terms of profit or loss for the period covered.
Balance sheet
Balance sheet is the statement of assets and a liability which is prepared to present the financial
position of business at a particular date.
Cash flow statement
Cash flow statement is prepared to show the entity’s current cash position and its ability to
generate future cash flows.
Statement of changes in equity
This statement shows all changes in capital and reserves of an entity during an accounting period
through normal operation of business and further issue of shares.
Prime cost
It is the total of direct material cost and direct labor cost. It is the short form of primary cost.
Prime cost = Direct material cost + Direct Labor cost
Conversion cost
It is the total of direct labor cost and factory overhead.
Conversion cost = Direct Labor cost + Factory overhead
Applied Factory overhead
In absence of actual factory overhead when FOH are estimated on the basis of a predetermined
rate then these factory overhead are known as applied factory overhead.
Under or over applied Factory overhead
If applied factory overheads are less than actual factory overhead the balance will be known as
under applied factory overhead otherwise over applied factory overhead.
Parts of cost of goods sold statement
There are three major parts of cost of goods sold statement:
 Current manufacturing cost
 Cost of goods manufactured
 Cost of goods sold

Disposal of Under or over applied FOH

Under or over applied FOH variance can be disposed off by any of the following two ways:
 It can be closed to cost of goods sold
 It can be closed to entire production of the period
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Computational Questions
i. Sales = Rs. 500,000 , Sales return = Rs. 10000 Discount on sales = 5000
Net sales =?
ii. Material inventory (opening) = Rs. 50000 Material purchased = Rs. 200000 Material
inventory (Ending) = Rs.30000 Material used =?
iii. Direct Labor cost = Rs. 75000, FOH rate = 25% of Direct Labor cost, FOH =?
iv. Sales = Rs. 100000 Gross profit = 20% of sales, Gross profit =?
v. Sales = Rs. 100000 Gross profit = 20% of cost, Gross profit =?
vi. Cost = Rs. 50000 Gross profit is cost plus 10%, Sale =?
vii. Cost = Rs. 100000 Gross profit = 20% of sale, Gross profit =?
viii. Sale =Rs. 100000 Gross profit = 25% of cost, GP ratio =?
ix. Cost = Rs. 50000 Sales Rs. 100000, Cost to sale ratio =?
x. Factory overhead Rs. 32000 Direct Labor cost = Rs. 40000 FOH rate based on labour
cost =?
 PUNJAB COLLEGE CHAKWAL
Chapter 2
COST ACCOUNTING CYCLE

Control account
A control account is a major single account which covers a wide range of related transactions in
summary form.
(OR)
A control account is a summary account, where entries are made from totals of transactions for a
period. (Colin Drury)
Subsidiary account
A control account is summary of different related accounts. Each individual account in relation
to control account is known as subsidiary account.
General Ledger
A ledger which contains the accounts of control accounts is called general ledger.
Subsidiary Ledger
A ledger which contains the details of transactions posted to control accounts is known as
subsidiary ledger.
Cost accounting cycle
The activities connected with verification or preparation of source documents, their journalizing,
and then posting to control accounts and subsidiary ledger, closing of accounts and presenting
results of operations of accounting period in the form of income statement are known as cost
accounting cycle.
Debit memorandum
A document which specifies the amount which is to be debited to the supplier account and reason
for the return is known as debit memorandum.
Credit memorandum
A document which specifies the amount which is to be credited to the customer against sales
return is known as credit memorandum.
Material requisition summary
A document which contains the description of materials quantities and cost charged to
production.
Purchase requisition
A document which serves as a request by storekeeper for purchase of material in favor of
purchasing department.
Payroll register
A register which contains separate columns for gross earnings, deductions and the net pay. It
provides data for preparing pay envelop of employees and also serves as a journal to record gross
earning, deductions and net pay.
Payroll distribution sheet
It is a document which shows department wise and/or job wise distribution of direct and indirect
labour as well as the amount of payroll chargeable to marketing overhead control account and
administrative overhead control account.
Transfer voucher
A transfer voucher is a document by which communication between head office and factory
office is affected on account of that transaction which affects both the ledgers at the same time.
Voucher payable
It is document which serves as a written authorization of a payment made by head office on
behalf of factory, selling and administrative department.
 PUNJAB COLLEGE CHAKWAL
Chapter 3
PROCESS COSTING

Define Job Costing.

The costing system that separately accumulates cost incurred to produce each job in a situation
where each job is distinguishable from the other throughout the production process.
What are the special features of production using job costing?
(1) Production is generally in response of customer’s orders.
(2) Every order has its own manufacturing specifications.
(3) each job is clearly distinguishable from the other at all stages of production process.
What are the different types of job costing?
Job costing may be any one of the following three types.
(i) Job order costing
(ii) Batch costing
(iii) Contract costing
What is job order costing?
Job order costing refer to that type of job costing which is employed to accumulate separately
cost incurred to produce each job in a situation where each job consists of a single unit and
production is against customer’s orders.
What is Batch Costing?
Batch costing is employed in such situation where the job consists of a group of identical units
and the job is separately identifiable throughout the production process examples include shoes
industry, readymade garments, toys manufacturing etc.
What is contract costing?
Contract costing is employed by such concerns as firms of builders and public works e.g.
construction of roads, bridges, dams and ship builders etc. The contract generally takes more
than one accounting year for completion and it may involve sub-contracts.
What is job number?
Before preparing production order, a code number is assigned to each job. This code number is
called job number which acts as an easy reference to identify the job.
What is a production order?
Production order is a written authorization for the production of job. It also serves as a document
to communicate to production people exact specifications of a job.
What is job cost sheet?
Job cost sheet is a document used for accumulating costs incurred to produce a job.
What purpose a job cost sheet serves?
It serves as subsidiary record for work in process, finished goods and cost of goods sold in
respect of incomplete jobs, completed jobs and sold jobs. It also serves as source document to
transfer cost from work in process to finished goods and to cost of goods sold.
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What is a cost center?
Cost center means a department, or segment for which a separate individual is made responsible
for incurrence of cost.
Define process costing.
The costing system that collects department wise data of quantities. Produced and product costs
incurred during the costing period and reports an average unit cost of mass production of
homogeneous articles by the performance of uniform manufacturing operations.
What are special features of production using process costing?
(1) There is mass production of a single or two or more products.
(2) All units of output are exactly similar and produced by the same manufacturing process
(3) Entire production is divided into departments.
(4) Completed output of each department, except the last one is the input for the next department.
(5) Production is not in response to customers odder but in anticipation of demand.
Give a brief comparison of process costing and job costing?
Points of
Process Costing Job Costing
Difference
(1) Production Continuous for stock As and when required
(2) Customer General public Specific
Through various process Usually site based, work
(3) Operating product moves from one normally remain
department to another stationary.
Output of one process Job started, completed
(4) Input/Output becomes becomes the and handed over to
output of other process. customer.

What is a cost of production report?

Cost of production report also called process cost sheet prepared at the end of each costing
period, summarizes the data of quantities produced and cost incurred by producing department. It
also serves as source documents for passing entries of departmental work in process control
account.
What are different sections of cost of production report?
A cost of production report is divided into four sections. Each section is meant to provide
specific information.
Section 1 - Quantity Schedule
Section 2 - Cost charged to Departments.
Section 3 - Cost Accounted for as follows.
Section 4 - Computations Explained.
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What is normal loss in process costing?

It is usual, unavoidable, and customary to the nature of process like evaporation in chemical
industries waste or scrap in food processing industries. These losses are uncontrollable and
treated as a part of process cost and absorbed in the cost of good units.
What is Abnormal loss in process costing?
Such loss is unusual, avoidable and controllable and incurred due to some accident or
carelessness. Cost of abnormal loss is not absorbed by good units. It is treated as separate
unfavorable item.
 PUNJAB COLLEGE CHAKWAL
Chapter 4

MATERIALS - COSTING AND CONTROL

Material
Goods or items used as inputs for production of finished goods are known as material. There are
two types of material.
 Direct material
 Indirect material
Direct material
Material that becomes the integral part of the finished output and the cost of each unit can be
traced easily or economically.
Indirect material
Material that becomes part of finished output but the cost cannot be traced in each unit easily.
Material control
Material control includes all those activities, processes procedures, which make possible for the
organization to safeguard against the risk of stock out and excessive costs relating to material.
Costing of Material
Costing means to determine the cost. Costing of material includes the computation of cost of
receipts and issue and returns. According to IAS 2 there are two recommended methods of costing
of Material
 First in first out (FIFO)
 Last in first out (LIFO)
FIFO Method
The costing method where the first cost received in store is the first cost that goes out from
storeroom. In simples words cost of material is charged to production in sequence of purchase.
LIFO Method
The costing method where the last cost received in store is the first cost the goes out from store. In
simple words cost of material is charged to production in reciprocal order of the purchase.
According to IAS 2 this method of costing has become outdated.
\AVCO Method
Under the weighted average costing method unit cost is used for charging material cost to
production. Weighted average unit cost is computed by dividing total units of the item into their
total cost.
Rule of LCM for Inventory
According to IAS 2 relating to inventories state that inventories must be valued at lower of cost
and market value (Net realizable value or Replacement cost).
Defective goods
Defective goods are those faulty units that can be re-worked after incurring additional reworking
cost to bring them fit for customer’s specifications.
Spoiled goods
Spoiled goods are faulty units, which cannot be re-worked to bring them up to the requirements of
customer.
Economic order quantity
Economic order quantity is an economical order size or quantity at which the ordering cost and
carrying cost of material remains equal with minimum total cost.
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Carrying cost
All costs incurred on holding stock of material are known as carrying cost. It may include storage
expenses, interest cost, insurance premium of inventory etc.
Ordering cost
It includes the expenses of purchase department from placing an order to receipt of goods. Examples
are cost of advertising, postage etc.
Order level
Order level is the inventory level at which the storekeeper must issue a purchase requisition so that
fresh supply of material can be secured before the existing inventory is exhausted,
Minimum stock level
Minimum inventory level is the inventory level below which the inventory should not fall. It is, in fact,
a safety stock that management intends to keep all the times as caution against any delay in receipt of
the material or against above normal consumption.
Maximum Stock level
Maximum stock level indicates the upper limit and any inventory above this limit is an indication of
overstocking.
Danger level
In normal circumstances inventory does not fall below minimum level but sometimes due to delay in
delivery from supplier inventory falls below the minimum level then the next caution is set at danger
level. Inventory at danger level means it is near to depletion.
Re-working cost
Any cost incurred for bringing defective production Upto the specifications of customers is known as
re-working cost.
Bin card
Bin cards are inventory records, maintained by storeroom, containing only the quantities because bin
means a place where a material is stored.
Purchase requisition
When materials are to be purchased a document, which is sent to purchase department, or purchasing
agent, it will be known as purchase requisition.
Purchase order
When purchase requisition is received by purchase department quotations are called for supply of
material. After selection of appropriate quotation a formal document is prepared for specifications of
material called purchase order.
Goods received note(GRN)
Receiving department after checking the materials received against the Purchase order and the
supplier’s invoice prepares a Receiving Report, which is also called Goods Received note.
Debit Memorandum
If goods are not according to the specifications or damaged then Receiving department prepares a
document specifying the description of goods and amount of goods returned. This document is known
as Debit Memorandum.
 PUNJAB COLLEGE CHAKWAL
Chapter 5

FACTORY OVERHEAD (FOH)

Factory overhead
All manufacturing costs other than direct material cost and direct Labour cost are collectively known
as factory overhead. There are two types of factory overhead:
 Fixed factory overhead
 Variable factory overhead
Fixed Factory overhead
Fixed factory overhead are those costs, which do not fluctuate, or change with increase or decrease in
production. Examples are depreciation, rent, insurance of plant and machinery.
Variable Factory overhead
Variable factory overhead are those, which tend to increase or decrease in proportion to the volume of
production. Examples of variable overheads are indirect material, fuel etc.
FOH absorption rate
When actual factory overheads are not available then estimated factory overhead are charged to
production through a predetermined rate, which is known as applied rate or FOH absorption rate.
Factory overhead absorption base
Estimated factory overhead are absorbed on a suitable base which can be any of the following:
 Direct Labour cost
 Direct Labour hours
 Machine hours
 Direct material cost
 Prime cost
Plant wide rate/ Blanket rate
When a single FOH absorption rate is used for all departments of business then this rate is known as
plant wide rate or Blanket rate.
Departmental rate
When different FOH absorption rate is used for all departments of business then this rate is known as
departmental factory overhead rate.
Departmentalization of factory overhead
The process of determining factory overhead cost of each department involved in production. For the
purpose of departmentalization departments are divided in two categories:
 Production department
 Service department
Production Department
Production departments are directly engaged in manufacturing of products.
Service Department
Service departments do not perform operations on products to be manufactured but provide auxiliary
services to support operations in production departments.
Allocation of Factory overhead
The term allocation is used when an item of factory overhead can be directly identified with and
charged to a particular department.
Apportionment of factory overhead
Many items of factory overhead are incurred for common benefit of more than one department then
these items of factory overhead are apportioned or distributed among the benefiting departments
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Reciprocal Apportionment
Reciprocal apportionment means the secondary apportionment in such a way that interdependence
among service departments is recognized while prorating the cost. Reciprocal apportionment can be
performed by the following two methods:
 Algebric apportionment method
 Repeated distribution method
Algebric Apportionment Method
Where the cost of interdependent service departments is determined by means of simultaneous
equations is called algebric apportionment method
Repeated Distribution Method
Where the cost of interdependent service departments are prorated again and again until amount
become insignificant or completely exhausted is known as repeated distribution method.
Non-Reciprocal apportionment
The secondary apportionment in such a way that once cost of a service department has been
apportioned cost of no other service department is then apportioned to it.
Capacity level
Capacity level means ability to produce. The term is synonymous as activity level or volume.
Theoretical capacity
It is the maximum capacity level that could be attained if there were 100% utilization of time.
Practical capacity
It is the maximum activity level that can be attained under efficient working conditions.
Expected actual capacity
It is the activity level expected to be attained during the accounting year for which the budget is being
prepared.
Normal capacity
Normal capacity is the average of expected actual capacity over a number of years.
 PUNJAB COLLEGE CHAKWAL
Chapter 6
LABOUR COSTING AND ACCOUNTING

Labour cost
The cost of services of personnel involved directly or indirectly in the production process or
other operating activities of the business.
Direct Labour cost
Payroll of workers who are directly involved in production process is known as direct labour
cost. These workers convert raw material into finished goods. The direct labour cost can be
traced easily with units of output.
Indirect Labour cost
The labour cost which either cannot be directly associated with units of finished goods or which
can be associated only at unreasonably high cost or inconvenience is termed as indirect labour.
Costing for Labour
The process of computing the labour cost is known as costing for labour. It includes various
methods such as flat time rate, piece rate system etc.
Accounting for Labour
Accounting for labour involves the study of collection, and processing of labour cost data with
the objectives of:
 Computation of wages and salaries payable
 Posting of salaries and wages to relevant control accounts and subsidiary accounts.
Techniques to control direct Labour cost
Techniques to control direct labour costs include production planning, a labour budget and use of
labour standards, labour performance reports and wage incentive schemes
Flat time rates
Flat time rates offered to workers give a fixed daily, hourly or weekly wage rate irrespective of
the output produced by the worker.
Incentive wage system
Incentive wage system is an output based remuneration method. Under this method a worker
who produces more units of product gets more wages and vice versa.
Standard production time
The normal time allowed for completing a specific job or task by an experienced worker. It is
determined by conducting time and motion study.
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Time rate method
Under time rate method, the employee is paid a specified amount for each hour worked and can
be computed as follows:
Wages = Hours worked x Rate per hour
Straight piece rate method
Under straight piece work plan, the employee is paid a specified amount for each unit of product
produced. It can be computed as follows:
Wages = Units produced x Rate per unit
Piece rate with guaranteed time rates
Under straight piecework plan, the worker is sometimes guaranteed his base rate and a standard
output is fixed, If his production exceeds the standard output, he is paid according to the piece
rate. If his production is below standard, he is given a guaranteed wages.
Differential piece rate system
A system where higher wage rates are offered to employees attaining desired level of
productivity is known as different piece rate system.
Taylor’s differential piece rate system
Under this system bonus is given but the day rate is not guaranteed as it is under the other plans.
There are two piece rates in this system the lower being in operation up to standard production
and the higher rate is paid to the workers who produce above standard. For example
 80% of piece rate when output is below standard
 120% of piece rate when output is at or above standard
Marrick’s multiple piece rate system
It is a variation of Taylor Differential rate system. Under Taylor’s Differential plan two different
rates are fixed whereas under Merrick Multiple Piece rate system three different rates are fixed.
For example
 Ordinary piece rate if output is up to 83% of standard output
 110% of ordinary rate if output is from 83% --100% of standard output
 120% of ordinary rate if output is above 100% of standard output
100% Bonus plan
Under 100% premium or bonus plan, the worker is paid a bonus equal to 100% of extra output or
100% of time saved
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Halsey premium plan
This American system created by F.A. Halsey gives the worker a bonus of 50% of the time saved
over the standard time for the job.
Features of Halsey premium plan
 Generally, the worker gets a guaranteed fixed hourly rate, even though he cannot
complete the work in less than the standard time.
 Worker can earn bonus on every job.
 Worker can easily understand the calculations of the bonus.
 Saving in time is equally divided between the worker and the employer.
Halsey weir premium plan
Under this scheme of remunerating workers a bonus of 30% of time saved is allowed to worker
over the standard time for the job.
Rowan premium plan
Under this scheme the worker’s day rate is guaranteed. A standard time is set by the rate fixer
after time and motion study of the operations concerned. If worker completes the job in less than
the allowed time a percentage equal to the percentage of saving is added to the time taken. In
other words, the bonus added to the regular wages is a percentage equal to the percentage by
which the allowed is reduced.
Bonus Percentage = Time saved x 100
Time allowed
Labour Turnover
It is the rate at which employees leave a company and this rate shold be kept as low as possible.
Methods of labour turnover calculation
Labour turnover can be calculated with the help of following methods:
According to Separation method
Labour Turnover = No. of separation in a period x 100
Average no. of workers

According to Replacement method

Labour Turnover = No. of replacements in a period x 100
Average no. of workers

According to Flux method

Labour Turnover = No. of separations +No. of replacements x 100
Average no. of workers
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Labour efficiency Rate

Labour efficiency rate indicates how much output actually attained by labour force against the
predetermined standard output. It can be computed as follows:
Labour efficiency rate = Actual output x 100
Standard output
Clock Cards
Clock cards are used to regulate in time arrival and departure of worker and to record IN and
OUT time of the workers.
Job ticket
Job tickets are used to record the time work on job or work. Worker time is recorded when he
starts the work and ended when he finishes the work.