Cost Accounting

Introduction
 Cost means the amount of expenditure (actual
or notional) incurred on or attributed to a given
thing.

 Cost Accounting is concerned with recording,

classifying & summarizing costs for
determination of costs of products or services,
planning, controlling & reducing such costs &
furnishing of information to management for
decision making.
 Objectives
 Cost determination
 Cost Control
 Help in decision making. (Buy or make
decision, price fixation, marginal costing)
 Other objectives (supply information to
Govt. & other agency, prevention of fraud)
Difference between Cost Accounting
and Financial Accounting
 Objectives
 Users
 Outcome
 Limitations
 Basis of valuation
 Scope
 Time period
 Role of Cost Accounting
 Creation and execution of plans and budget.
 Establishing costing method and procedures.
 Creating inventory values and controlling
physical quantities.
 Determining company cost and profit.
 Providing cost information.
Characteristics of a good/ideal cost
accounting system
 Suitable for manufacturing unit.
 Flexible.
 Proper internal checking should be
implemented.
 Minimum of clerical work.
 Outcome should be reached to all level
 Ensure control.
 Proper reconciliation between cost and financial
accounts.
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 Proper allocation of duties and
responsibility.
 Provide accurate and timely information.
 Logical and simple.
 Economical.
Cost accounting methods, Systems
and Techniques
 Methods
Cost are accumulated to find out total cost.
 Job Order Costing
 Process Costing
 System
Cost are allocated to products and services.
 Historical/ Actual Cost
 Standard Costing
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 Techniques
Present cost information to management
 Direct Costing
 Absorption costing
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Job Order Costing:
Cost are accumulated by job or specific
customer order. This method is used when
the products manufactured within a
department or cost centre are
heterogeneous. This method presupposes
the possibility of physically identifying the
jobs produced and of charging each job
with its own cost.
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 Job order costing is applicable to job order

work in factories, workshops and repair
shops as well as to work by builders,
construction engineers and printers
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Process Costing:
In Process costing cost are accumulated by
production, process or by department.
This method is used when all units
manufactured within a department or cost
centre essentially homogeneous.
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The following conditions may exist:

1. The product of one process becomes the

material of the next process.
2. Different products or even by-products
are produced by the same process.
The process cost is applicable mainly for
industries such as flour mills, chemical
plants and textile factories.
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Example-
Cloth manufacturing process

Process 1 Process 2 Process 3

Finished
goods
Cotton is Threads are Cloths are
processed processed colored
System
 Historical cost:
In an actual or historical cost system, cost are
allocated as they occur and their actual cost.
 Standard Cost:

In standard cost system, products, operations and

processes are costed using standards for both
quantities and dollar amounts. These standards
are predetermined in advance of production.
Actual cost are also recorded and variances or
differences between actual costs and standard
costs are collected in separate accounts.
Techniques
 Direct Costing
Also referred to as variable or marginal costing;
charges products only those manufacturing cost
that vary directly with volume.

Under direct costing, only variable costs are

treated as product cost, fixed manufacturing
costs are totally expensed in the current period,
such as depreciation, insurance and taxes.
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 Absorption Costing:
It is a process of allocating both fixed and
variable production cost to units of
production.
 Cost, Expense and Loss
Cost

“An exchange price, a forgoing, the value of

sacrifice made to acquire goods and
services.”
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Expense
Defined as a measured outflow of goods or
services, which is matched with revenue to
determine income.

“All expired costs which have given benefit”.

At the time of acquisition the cost incurred for

present or future benefit. When this
benefits are utilized the cost become
expense.
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Loss

When assets are given up for nothing in

return in those cases the value of the
assets given up treated as loss.
 Cost Concept
 Cost concept is the process of evaluating
historical data to determine the cost of
such elements as materials, goods, labor,
overhead and other expenses.
Determining how much it "costs: to
produce a product or service aids
management in planning future
investments.
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 Four Cost Concepts:
1. Cost composition Concept
2. Cost Attachment Concept
3. Cost Flow Concept
4. Cost Formulation Concept
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1. Cost composition Concept
Cost are additive in nature. In arriving at
total cost of goods and services several
cost components are added.

2. Cost Attachment Concept

The cost attachment concept emphasis the
fundamental idea that direct and indirect
cost of manufacturing are assigned to
product as manufacturing operations are
performed
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3. Cost Flow Concept:
The Cost Flow Concept expresses the idea
that all costs proceeds towards and
ultimate destination as expense in the
income statement.
4. The Cost Formulation Concept:
It indicates that cost must identified,
measured and analyzed according to one
or more particular characteristics.
Cost Unit, Cost Center & Cost Object
Cost Unit
While preparing cost accounts, it becomes
necessary to select a unit with which
expenditure may be identified.

The quantity upon which cost can be conveniently

allocated is known as a unit of cost or cost unit.

The Chartered Institute of Management

Accountants, London defines a unit of cost as a
unit of quantity of product, service or time in
relation to which costs may be ascertained or
expressed.
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Following are the examples of cost units:

Brick works per 1000 bricks made

Textile mills per yard of cloth
manufactured
Electrical per unit of electricity
companies generated
Transport  per passenger km.
companies      
Steel mills per ton of steel made
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Cost Center
Cost center means “a location, person or item
of equipment (or group of these) for which
costs may be ascertained and used for the
purpose of cost control.”
Each such unit consists of a department, a
sub-department or an item or equipment or
machinery and a person or a group of
persons.
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 Cost Centre may be-
 Production Cost Centre
 Service Cost Centre
 Operation Cost Centre
 Process Cost Centre
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Cost object
Anything for which a separate measurement
of cost is desired is referred to as a Cost
Object. Example of cost object includes a
product, a service, a project, a customer, a
brand category, a department, a program
etc.
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 For example a cloth manufacturing firm
requires some amount of predetermined
labor and predetermined raw material for
any amount of cloth being manufactured.
The cost of employing labor can be directly
fixed as "per man per hour" or "per man per
day per hour per minute per annum", so the
labor is a cost object as you can directly
associate cost with it.
 Classification of Costs
 Classification of cost is the process of
grouping the components of cost under a
common designation on the basis of
similarities of nature, attributes or relations.
It is the process of identification of each
item and the systematic placement of like
items together according to their common
features.
Classification of Costs
 Basis of classification :
i) Nature of expense
ii) Relation to object – traceability
iii) Functions / activities
iv) Behavior of cost
v) Management decision making
vi) Time period
By Nature of expense:

Cost Classification by nature

Material Labor Expenses

 Material Cost
 Material Cost is the cost of material of any
nature used for the purpose of production
of a product or a service.

Material cost includes cost of procurement,

freight inwards, taxes & duties, insurance
etc directly attributable to the acquisition.
 Labor Cost
 The payment made to the employees,
permanent or temporary, for their services.

Labor cost include salaries and wages paid

to permanent employees, temporary
employees and also to employees of the
contractor.
 Expenses
 Expenses are other than material cost or
labor cost which are involved in an activity.

Expenditure on account of utilities, job

processing charges etc. can be termed as
expenses
 Relation to object – traceability

Direct Cost Indirect Cost

Material Expense
Material Expense
Labor
Labor
 Classification by Function

Production Administration
Cost Cost

Selling & Distribution

RD Cost
Cost
 Cost by Behavior

How a cost will react to changes in the level

of business activity.

1. Fixed cost
2. Variable Cost
3. Semi Variable Cost
 Fixed Cost:

Cost which does not vary with the change in

the volume of activity in the short run.
These costs are not affected by
temporary fluctuation in activity of an
enterprise.

Examples for fixed cost : salaries, rent,

audit fees, depreciation etc.
 Variable Cost
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, utilities, freight, packing, etc
 Semi Variable Cost
 Semi Variable Costs contain 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.
 Management decision making
 Opportunity Cost:
It is the cost of next best alternative forgone.
When a decision to pursue one alternative is
made the benefits of other alternative is
foregone. Benefits lost from rejecting the next
best alternative are the opportunity cost of the
chosen action.
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 Since opportunity costs are not actually
incurred, they are not recorded in the
accounting records. They are however
relevant cost for decision making purpose
and must be considered in evaluating a
proposed alternative.
 Relevant Cost
 Relevant Costs are costs relevant for a
specific purpose or situation.
In the context of decision making relating to
a specific issue, only those costs which
are relevant are considered. A particular
cost item may be relevant in a decision
making and may be irrelevant in some
other decision making situation.
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For example, present depreciated cost of
machine is relevant in case of decision of
its sale but it is irrelevant in case of
decision of its replacement.
 Sunk Cost
 Sunk Costs are historical costs which are
incurred i.e. ‘sunk’ in the past and are not
relevant to the particular decision making
problem being considered.
 Sunk costs are those that have been incurred
for a project and which will not be recovered if
the project is terminated. While considering the
replacement of a plant, the depreciated book
value of the old asset is irrelevant as the
amount is a sunk cost which is to be written off
at the time of replacement.
 Avoidable Cost
 Avoidable Costs are those costs which under
given conditions of performance efficiency
should not have been incurred.

 Avoidable costs are logically associated with

some activity or situation and are ascertained
by the difference of actual cost with the
happening of the situation and the normal
cost.
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 When spoilage occurs in manufacture in
excess of normal limit, the resulting cost of
spoilage is avoidable cost. Cost variances
which are controllable may be termed as
avoidable cost.
 Unavoidable Cost
 Unavoidable Costs are inescapable costs
which are essentially to be incurred, within
the limits or norms provided for. It is the
cost that must be incurred under a
program of business restriction. It is fixed
in nature and inescapable.
 Product Cost
 The costs which are a part of the cost of a
product rather than an expense of the period in
which they are incurred are called as “product
costs.” They are included in inventory values.

 In financial statements, such costs are treated

as assets until the goods they are assigned to
are sold. They become an expense at that time.
These costs may be fixed as well as variable,
i.e.cost of raw materials and direct wages,
depreciation on plant and equipment etc.
 Period Cost
The costs which are not associated with
production are called period costs. They are
treated as an expense of the period in which
they are incurred. They may also be fixed as
well as variable.
 Such costs include general administration
costs, salaries salesmen and commission,
depreciation on office facilities etc. They are
charged against the revenue of the relevant
period.
 Imputed Cost
 Imputed costs are not actually incurred in
some transactions but which are relevant to
the decision as they part into a particular
situation.
 This cost don’t enter into traditional
accounting system but they are being
related with economic reality help in making
better decision.
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 For example, The owner of a house have
not to pay rent but it should take into
consideration, otherwise cost will be
understated.