COST ACCOUNTING

What is Cost ??
➢ ‘Cost’ is the amount of expense (actual or notional)
incurred for obtaining certain benefits.
➢ Actual cost means there is cash outflow (explicit cost)
e.g. raw material, salary, rent, commission paid etc.
➢ In notional cost there is no cash outflow (implicit cost)
e.g. depreciation, amortization, opportunity cost etc.
➢ Basically, cost represents revenue expenditure,
incurred for day-to-day operations of a business.
➢ ‘Cost’ is always related to a particular object, i.e.
difficult to assess any cost in isolation. E.g. – cost per
dozen, ticket cost, exam fees etc.
Costing, Cost Accounting
and Cost Accountancy
➢ ‘Costing’ is the technique and process of cost
ascertainment.
➢ ‘Cost Accounting’ is the collection and recording
of costs and preparation of periodical reports.
➢ ‘Cost Accountancy’ is the application of cost
accounting principles, methods and techniques
for the purpose of managerial decision making.
Objectives of Cost Accounting
o Ascertainment of costs
o Fixing selling price
o Profitability analysis
o Cost Control & Cost Reduction
o Ascertainment of profits of
various products / activities
o Various Mgt. decision making
o Variance analysis
(actual vs. budgeted data)
o Measuring use of resources
Classification of Cost
Basis of Classification
Decision
Elements Functions Identity Nature
Making

Material Cost Factory Cost Direct Cost Fixed Cost Sunk Cost

Indirect Cost Relevant

Labour Cost Office Cost Variable Cost
Cost

Semi-Fixed
Opportunity
Expenses S & D Cost or Semi-
Cost
Variable

Out of Pocket
R & D Cost
Cost
Based on Elements
• Material Cost are the tangible articles / items used in
a business. Example - raw material, spares, cleaning
material, oil, fuel, consumables etc.

• Labour Cost are the costs related to workers and

employees of an organization. Example - salary,
wages, staff welfare, bonus etc.

• Expenses are the costs related to services and

facilities availed by a business. Example – rent,
electricity, telephone, legal charges, marketing,
commission, printing, postage etc.
Based on Functions
• Factory Cost are the costs incurred for production of
goods, i.e. related to Manufacturing, Technical, Works
or Production.
• Example – raw material, wages, power, fuel,
insurance premium of machinery, heating,
supervisor, depreciation of equipment etc.

• Office Cost are the costs incurred for office purposes

i.e. related to administration activities.
• Example - office rent, salary of accountant,
electricity of office, stationery, legal fees, audit fees,
depreciation of furniture etc.
Based on Functions (contd.)
• Selling Cost are the costs incurred to create demand
for the product / services, i.e. finding customers
• Example - advertisement, promotion, commission to
agent, showroom rent etc.

• Distribution Cost are the costs incurred to deliver the

product / service to the customer
• Example - diesel, petrol, depreciation of delivery
vehicle, salary of delivery boys, warehouse rent etc.

• Research & Development Cost are costs incurred for

conducting research and developing new products.
• Example - laboratory rent, salary of scientist etc.
Based on Identification
• Direct Cost are the costs which are directly related
or directly identifiable with a product / service (also
known as Product Cost).
Example – milk, sugar, coffee powder is a direct cost
in coffee. Total Direct Costs are known Prime Cost.
• Indirect Cost are the costs which are not directly
related or not directly identifiable with a product /
service (also known as Period Cost).
Example – salary of waiter in a coffee shop,
electricity cost, rent of premises etc.
Total Indirect Costs are known as Overheads.
Based on Nature
• Fixed Cost are the costs which do not change as per
the level of output / activity
• Total Fixed Cost depends on the 'Installed capacity' of
factory or office etc. They remain constant within the
installed capacity
• Fixed Cost per unit changes as per the actual level of
output / activity.
• Total Fixed Costs are not considered for decision
making, since it is not affected by the decision.
• Example – Factory Rent, Accountant Salary,
Insurance premium
Based on Nature (contd.)
• Variable Cost are the costs which change as per the
level of output / activity
• Total Variable Costs depends on the actual capacity
used in factory or office etc.
• Total Variable Cost always changes as per level of
activity, i.e., higher output – more total variable costs
• Variable Cost per unit is remains constant
• Total Variable Cost is very important for decision
making, since it changes as per our decision
• Example – Raw Material, Wages, Petrol, Royalty etc.
Based on Nature (contd.)
• Semi-Fixed Cost or Semi-Variable Cost are the costs
which is a combination of fixed cost and variable
cost. (i.e., fixed cost + variable cost)
• In this case, some part is of fixed nature and some
part is of variable nature.
• Here, the total costs are fixed upto a certain level,
and thereafter it changes on the basis of activity.
• Example - post-paid mobile bill, electricity bill,
salesman salary (10,000 fixed + based on numbers of
units sold etc.)
Based on Decision Making
• Sunk Cost are the costs that are incurred in the past (also
known as historical costs).
• Since the cost is already paid in the past, it is not going to
be affected by our decision today. Hence, sunk cost is not
considered for decision-making.
• Example - demand survey expenses, exam fees etc.

• Relevant Cost are the costs that are affected by our

decisions. These cost will be incurred in the future.
• Since the cost will be incurred in the future, it is going to be
affected as per our decision.
• Relevant Cost is considered for decision-making purpose.
• Example – repairs to old machine, interest on loans etc.
Based on Decision Making (contd.)
• Opporutnity Cost are the costs is the value of benefit
sacrificed by selecting another alternative.
• Opportunity cost is very important for the purpose of
decision-making, since involves choice between
different alternatives
• There is no actual cash outflow in opportunity cost,
also known as Implicit cost / Notional cost.
• Out of Pocket Cost are cost which results in actual
cash outflow (also known as Explicit cost)
• Out-of-Pocket Cost is a short term concept and
useful for decision-making.
• Example - travelling cost
Cost Components–
Materials = Direct Matl. + Indirect Matl.
(+) Labour = Direct Lab. + Indirect Lab.
(+) Expenses = Direct Exp. + Indirect Exp.
Total Costs = Prime Cost + Overheads

OVERHEADS

Production, Selling &

Office, General,
Factory, Mfg, Distribution,
Administrative
Works, Technical Promotional

Total Cost = Prime Cost + Overheads (OH)

Total Cost = Prime Cost + Factory OH + Office OH +
Selling Distribution OH
Costing vs. Financial Accounting
Sr. Cost Accounting Financial Accounting
1 Purpose as a MIS tool for Purpose as a statutory
management decisions requirement
2 Reporting as required by Reporting as per statutory
management calendar
3 Audit not compulsory for Audit is compulsory for
every company every company
4 Provides product-wise/ Provides overall profits of
process-wise profits the company
5 Records/ reports for Reports, statements given
internal use only to shareholders, banks etc
6 Financial items not included in cost statements such as
donations, interest on loans, income tax, bad debts etc.
Cost Sheet
• Cost Sheet is a summary of all costs
ascertained for a product or a service.
• Cost Sheet document is prepared for
recording actual costs or estimated costs.
• Cost Sheet analyzes and classifies
different costs as per their functions.
• Cost Sheets may be prepared for two or
more periods for comparative studies
• Total Cost = Prime Cost + Overheads
 Particulars Rs. Rs.
Direct Material
Opening stock 70,000
(+) Purchases 400,000
(+) Direct Expenses on purchases 20,000
490,000
(-) Closing Stock 50,000
Hence, Material Consumed 440,000 440,000

(+) Direct Labour 200,000

(+) Direct Expenses 30,000

Hence, Prime Cost 670,000 670,000

(+) Factory Overheads 90,000

Hence, Gross Factory Cost 760,000 760,000

(+) Opening stock of Work in progress (WIP) 40,000
(-) Closing stock of Work in progress (WIP) 50,000
Hence, Net Factory Cost 750,000 750,000
(+) Office Overheads 100,000

Gross Office Cost (Cost of Production) 850,000 850,000

(+) Opening stock of Finished Goods (FG) 80,000
(-) Closing stock of Finished Goods (FG) 60,000
Net Office Cost (Cost of Goods Sold COGS) 870,000 870,000
(+) Selling Distribution Overheads 130,000
Hence, Cost of Sales 1,000,000
(+) Profit 250,000
Sales 1,250,000