Cost Accounting

Download as pdf or txt
Download as pdf or txt
You are on page 1of 11

UNIT 1

COST ACCOUNTING
INTRODUCTION
Every businessman tries to reduce the cost of manufacture to the minimum in the stage of complexity
and competition more particularly in the large-scale production. Therefore, the businessman looks for
information to study the cost of a manufacture in the past and on this basis, he assesses what it will cost
in the future. Therefore, more importance is given to profit and loss account, which is prepared on the
cost principle.

1. DEFINE OF COST? (2Marks)


W.M.Harper in this cost accountancy defined cost as follows: “cost is the value of economic resources
used as a result of producing or doing the thing costed”.
2. WHAT DO YOU MEAN BY COSTING? (2Marks)
Costing is the body of principal and rules for ascertaining the costs of products and service. It is the day-
to-day routine of ascertaining costs.
The I.C.M.A., London has defined costing as the ascertainment cost. “It refers to the techniques and
processes of ascertaining costs and studies the principles and rules concerning the determination of cost
of products and services”.

MEANING OF COST ACCOUNTING:


It is the method of accounting for cost. The process of recording and accounting for all the elements of
cost is called cost accounting.
1. DEFINE OF COST ACCOUNTING? (2Marks)
The Institute of cost and works Accounts, India defines “cost accounting is the technique and process
of ascertainment of costs. Cost accounting is the process of accounting for costs. Which begins with
recording of expenses or the bases on which they are calculated and ends with preparation of statistical
data”.

Q. EXPLIAN THE SCOPE OF COST ACCOUNTING? (5Marks)


SCOPE OF COST ACCOUNTING:
The term scope refers to field of activity. Cost ascertainment and control of costs. The information
provided to the management is helpful for cost control and cost reduction through functions of planning,
decision making and control.
In the initial stages of evolution, cost accounting confined itself to cost ascertainment and presentation
of the same with the main objective of finding the product cost. With the development of business
activity and introduction of large-scale production the scope of cost accounting was providing
information for cost control and cost reduction has assumed equal significance along with finding out
cost of production.
In addition to enlargement of scope the area of application of cost accounting has also widened. Initially
cost accounting was applied in manufacturing activities only. Now it is applied in service organization,
government organization, local authorities, forms, extractive industries.

OBJECTIVES OF COST ACCOUNTING:


Main objectives of cost accounting are;
a) Finding (or) ascertainment of cost
b) Control of cost
c) Reduction of cost
d) Fixation of selling price
e) Providing information for framing business policy
a. Ascertainment of cost
The primary objective of cost accounting is ascertainment of cost. It is done through the methods and
techniques of costing. Costing is the process of collection, classification and analysis of costs or
expenses.
b. Control of cost
A basic function of cost accounting is to control costs. The object is to minimize the cost of
manufacturing. Comparison of actual cost with standards cost. If the variances are adverse, the
management enters into investigation so as to adopt corrective action immediately.
c. Cost reduction
Cost accounting is helpful to management in cost reduction through the techniques of budgetary control,
standard costing, material control, labour control and overhead control.
d. Fixation of selling price
Cost data are useful in the determination of selling price. Apart from cost ascertainment, the cost
accountant analyses the total cost into fixed and variable costs. This will help the management to fix the
selling price.
e. Forming business policy
Cost accounting helps the management in formulating business policy and decision making. Break even
analysis, cost-volume-profit relationship differential costing etc. are helpful to the management in taking
decisions regarding:
1) Production or discontinuation of a product.
2) Utilization of ideal capacity.
3) The most profitable sales mix.
4) Export decision.
5) Make or buy decision.

METHODS OF COST ACCOUNTING (10Marks)


Different methods of cost findings are used because industries vary in their nature in the types of
products, service. The following are important methods of costing.
1) Job costing
Job costing means an industry which produces a definite article against individual order from customers.
This type of costing is suitable to printing press, furniture manufacture, and heavy machine.
2) Contract costing
The method of contract costing is applied where the job is big and of longer duration. For each
individual contract, separate accounts have to be kept. It applies to concern like constructional work,
roads, bridges, buildings.
3) Batch costing
A batch may represent a number of small orders passed in batches through the factory. This type of
costing is adopted by industries producing medicines, biscuits, spare parts and components.
4) Multiple costing
It means combination of two or more of the above methods. This system of costing is adopted in
manufacturing concerns where varieties of parts are produced separately and later assemble into a final
product. This type of costing is adopted by industries produce cycles, radios, typewriters.
5) Process costing
It applies to industries where production is carried on through different stages before becoming a
finished product. Finished product of one process becomes the raw material of the subsequent process.
This type of cost accounting is suitable for industries such as chemical, oil paint, rubber, glass.
6) Unit costing
Under this method production is continuous and units are identical. This method is suitable to industries
producing pencils, dairy products, and steel work.
7) Operation costing
This method is used where there is a mass production and processes are repetitive in nature. This
method is adopted by industries like toy-making, leather and spare parts.
8) Operating costing
It is suitable to those industries which render services instead of producing goods. This system is
adopted where expenses are incurred for provision of service; for example transport companies,
electricity companies, railways, hospitals and canteen.
9) Department costing
It is a method of cost finding adopted to ascertain the cost of operating a department or a cost centre
separately. Where the factory is divided into a number of departments this method is adopted.

Technique or types of costing


The following are the main types of costing applied for cost ascertainment.
1.Historical costing
It is ascertainment of cost after they have been incurred. It aims at ascertaining the cost incurred
on the work done in he cost.
2.Marginal costing
This technique classifies the total cost of a product or operation into two class viz i) fixed cost
which do not change but remain constant for any level of production and ii) variable cost which
proportionately vary to the change in the volume.
3.Absorption costing
It is also known as total cost approach. It is defined as “the practice of charging all costs, both
variable and fixed to operations, process or products.
4.Standard costing
A standard costing is a predetermined cost. Standard costing is the ascertainment of the
standard cost and its comparison with the actual cost in order to ascertain variations.

5.Uniform costing
“The use by several undertakings of the same costing principles and /or practices”

ESSENTIAL CHARECTERISTICS OF COST ACCOUNTING:


The ideal system of cost accounting must posses some characteristics. The main characteristics are:
1) Simplicity
It must be simple, flexible and adoptable to the changing conditions. And it must be easily
understandable to the personal.
2) Flexibility and Adoptability
The costing system must be flexible to accommodate the changing conditions. The expansion or
changes must be adopted in the existing system with minimum changes.
3) Economy
The costing system must suit the finance available. The expenditure must be less than the benefits
derived from the system adopted.
4) Comparability
The management must be able to make comparison of the facts and figures with the past figures, figures
of other concerns or other departments of the same concern.
5) Suitability to the firms
Before accepting a costing system, the nature, requirements, size, conditions of a business must be
carefully considered.
6) Minimum changes to the existing one
When introducing a costing system, it may cause minimum disturbance to the existing set up of the
business.
7) Uniformity of forms
Forms of different colours can be used to distinguish them. Forms must be uniform in size and quality.
8) Less clerical works
Printed forms will involve less labour to fill in as the workers may be a little education, they may not
like to spend much time in filing the forms.
9) Efficient material control and wages system
There must be a proper procedure for recording the time spent on different jobs by workers for the
payment of wages. The systematic method of wage system will help in the control of labour cost.
10) A sound plan
There must be proper and sound plans to collect to allocate and the overhead expenses on each job or
each product in order to find out the cost accurately.

ADVANTAGES OF COST ACCOUNTING:


Cost accounting is useful to the management, to the employees, to the public and to the creditors. They
are discussed below:

a) To the Management
1. Effective decision making
Cost accounting provides information regarding individual products, departments, divisions and cost
centers. This facilitates the management to identify unprofitable operation and improve overall
profitability.
2. Measuring efficiency
With the help of cost accounting the management can set budgets and standards for various elements of
cost and compare them with actual to measure efficiency.
3. Cost reduction
Cost accounting is helpful to management in reduction of cost through its techniques by efficient and
effective utilization of raw materials, labour and optimum production of output.
4. Fixation of selling price
Cost accounting provides information in detail regarding variable and fixed costs helps in selling price
under different circumstance.
5. Effective cost control
The fundamental objective of cost accounting is to ascertain and control costs.
6. Increasing efficiency
Under an efficient cost accounting system, proper inventory control, labour utilization and proper
analysis of expenditure is possible. This results in increasing efficiency through out the organization.
7. Effective inventory control
An effective cost accounting system and check are provided on all materials and stores.
8. Reduction of wastages of materiel and labours
Cost accounting sets predetermined costs for different elements which are compared with actual to
reveal variances. The unfavourable variances are dealt with and controlled effectively.
9. Effective utilization of resources
Managerial costing helps in decision making regarding ‘make or buy’ of components, profit planning,
sales mix etc. Standard costing and budgetary control are also helpful in effective utilization of
resources.
10. Effective budgeting
Cost accounting records both historical cost and pre-determined costs, which are essential for the
technique of budgetary.

b) To the employees
1. Sound wages policy
Cost accounting introduces incentive wages schemes, bonus plans etc, which bring better reward to
sincere and efficient workers.
2. Higher bonus plans
Cost accounting leads to an increase in productivity, lowering of cost and increasing in productivity,
workers get share in profits in the form of bonus. Higher profit naturally allows higher bonus
distribution.
3. Distinction between efficient and inefficient workers
Cost accounting provides standards for the measurement of efficiency of workers. This means
increasing in earnings, through the motion study and time study in doing jobs.
4. Security of job
Employees get better remuneration, security of job etc, due to the increasing prosperity of the industries.

c) To the creditors
Before the creditors offer the loan to a firm, they can have better understanding of the progress and
profitability of the firm through relevant reports.

d) To the government
Cost data of specific industries and general trend of cost can influence the Government to initiate
appropriate changes in granting of subsidies, formulating taxation policies, import and export legislation
etc,

e) To the public :Good costing system helps in proper utilization of resources. Cost reduction is helps
in fair price of products and profitability of organizations is helpful in prosperity of the industry through
more employment opportunities to the members of the public.

LIMITATION OF COST ACCOUNTING:


Cost accounting has becoming indispensable tool to management for exercising effective decision.
However the following are the limitation of cost accounting:
a) Cost accounting is costly to operate
Cost accounting involves heavy expenditure to operate. Double set of accounts books has to be
maintained and it is not economical for small concerns.
b) It is unnecessary
It is argued that costing is only recently originated and that many industries have prospered well and are
still prospering without cost accounting. Therefore the system is unnecessary.
c) Cost accounting involves many forms and statements
It is pointed against cost accounting that it involves usage of many forms and statements. This leads to
monotony in filling up of forms and increase of paper work.
d) Costing may not be applicable in all types of industries
Existing methods of cost accounting may not be applicable in all types of industries. Cost accounting
methods can be devised for all types of industries and services.
e) It is based on estimations
Some people claim that costing system relies on predetermined data and therefore it is not reliable.

GIVE THE SHORT NOTE ON COST UNIT, COST CENTRE, PROFIT CENTRE
a) Cost unit
The selection of cost unit is important is cost accounting system. A cost unit is a unit of product, service
or time in relation to which cost may be ascertained. The unit of measurement must be clearly defined
and selected before the process of process of cost finding can be started. For example in cotton spinning
mill, cost may be calculated in terms of a meter.
b) Cost centre
A cost centre is a location, person or item of equipment for which cost may be ascertained and used for
the purpose of cost control. The cost may be a department or a machine or a plant or a salesman or a
particular work etc.
c) Profit centre
Profit center is a segment of a business that is responsible for all activities involved in the production
and sales of products and services. It is thus a segment of the organization which has been assigned
control over both revenues and costs. A profit center is created by the top management of evaluating
performance of a division.

THE FUNCTIONS OF COST ACCOUNTING:


1. It helps in optimum utilization of men, material and machine.
2. Cost accounting identified the areas that require corrective action.
3. It helps management in the formulation of policies.
4. It provides appropriate solution to the various problem of management.
5. Costing helps management making short-term decision by the use of techniques managerial costing,
standard costing etc. 6. It provides useful data for the preparation of final accounts by giving cost of
closing stock of raw materials, work-in-progress and finished products
7. It provides a data-base for reference to Government, wage tribunals, trade union etc.
8. It helps in the formation of cost centre and responsibility centre to exercise control.
9. It helps in fixing prices of products and services.
10. Costing facilitates use of specialized techniques like cost prediction, value analysis etc.

EXPLAIN THE ELEMENTS OF COST (10Marks)


The total expenditure consisting of material, labour and expenses can further be analysed as under.
Prime cost = Direct materials +Direct labour + Direct expenses
Work cost = Prime cost + Factory overheads
Cost of production = Factory cost + Administration overheads
Total cost = Cost of production + selling and distribution overheads.
Each elements of cost is explained in detail as below:
The elements of cost are:
1) Materials
2) Labour and
3) Expenses.

1) Material:
“The materials cost is the cost of commodities supplied to an undertaking”.-I.C.M.A
Materials cost is of two types, vis i) Direct materials cost and indirect materials.
Direct materials cost:
Direct material is material that can be directly identified with each unit of the finished products. Cotton
used in production of cloth, leather used in the case of production of leather goods etc. any material
purchased and used for a specific job are also direct materials.
InDirect materials cost:
Materials used for the product other than the direct materials are called indirect material. In other words,
materials cost which cannot be identified with a product, job, process is known as indirect material cost.
Small tools, stationary used in works and office stationary etc.
2) Labour:
Labour is the remuneration paid for physical or mental effort expended in production and distribution.
Labour cost is also divided into direct and indirect portions.

Direct labour cost


It is also called Direct Wages. Direct labour cost is the cost of labour directly engaged in
production operations. E.g. workmen engaged in assembling parts, carpenters engaged in furniture
making etc.

Indirect labour cost


it is the remuneration paid for labour engaged in helps the production operations. E.g. inspectors,
watchmen, sweepers, store keepers etc.
3) Expenses: Expenditure other than material and labour is the third element of cost. Expenses are of
two types- i) Direct expenses and ii) Indirect expenses.
i) Direct expenses:
These are the expenses which can be directly identified with a unit of output. The direct expenses are
also known as chargeable expenses.
ii) Indirect expenses

Indirect expenses are expenses other than indirect material and indirect labour, cannot be directly
identified with units of output, job, process or operation. For example, rent, power, lighting,
depreciation, advertising etc.
4) Overheads:
Overheads are the total of all indirect expenses.

CLASSIFICATION OF OVERHEADS;
On the basis of functions overhead is classified as i) factory overhead, ii) administration or office
overheads iii) selling and distribution overhead.

Factory overheads;
This is aggregate of indirect material, indirect wages and indirect expenses incurred in the factory.
Examples of indirect factory expenses are rent, power, depreciation, lighting and heating incurred in the
factory.

Administration or office overheads


All the indirect administration expenses come under this category. Salaries of office staff, accountants,
director’s fees, rent of office lighting and bank charge etc. are the example.

Selling and Distribution overheads:


This includes selling and distribution expenses. Examples are salaries of salesmen, selling commission,
advertising, warehouse rent, maintenance of delivery vans, warehouse staff expenses, warehouse
lighting etc.

Expenses excluded from costing


The following items are excluded from computation of total cost.
Purchase of fixed assets, plant and building, machinery etc. loss on sale of fixed assets, abnormal losses,
and preliminary expenses.
❖ Financial items like cash discount, interest on debentures, interest on loans, interest on own capital
etc.

CLASSIFICATION OF COST
Cost classification is the process of grouping costs according to their common characteristics. The
important classifications are:

1. Classification according to nature:


According to this classification, the costs are divided into three categories; i.e. material, labour and
expenses. Material cost means the cost of commodities supplied to an undertaking. Labour cost or
wages means the cost of remuneration such as wages, salaries, bonuses etc. of the employees of the
undertaking. Expense means cost of services provided to an undertaking and notional cost of the use of
owned asset.
2. Classification according to time:
Historical costs: Costs relating to the past time period which has already been incurred. It is known
as traditional costing.
Current costs: Cost relating to present period.
Pre-determined costs: Cost relating to the future period. Cost which is compute in advance
predetermined costs are also known estimated costs.

3. classification according to function:


Production cost: The cost of the set of operations are commencing with supply of materials, labours
and services, and ending with primary packing of products. Thus it is equal to the total of direct
materials, direct labour, direct expenses and production overheads.
Administrative cost: Administrative cost is “the cost of formulating the policy, directing the policy,
directing the organization and controlling the operations of the undertaking which is not directly related
to production, selling, distribution, research or development activity or function”-I.C.M.A. Some
examples are office rent, accounts department expenses audit and legal expenses, director’s
remuneration etc.
Selling cost: The cost of seeking to create and stimulate demand and of securing orders these are
sometimes called marketing costs. Some examples are advertisement, salesman remuneration,
showroom expenses etc.
Distribution cost: The cost of sequence of operations which begins with making the packed product
available for dispatch and ends with making the reconditioned returned empty package. Some examples
are maintenance of delivery vans, carriage outwards, transporting and storage expenditure incurred in
moving article to and from prospective customers.
Research cost: The cost of researching for new or improved products, new applications of materials
or improve methods.
Development cost: When new products have to be manufactured or an improved the method is to be
adopted. The costs are expected to be higher.
Pre-production cost: The part of development cost incurred in making a trial production run prior to
formal production.
Conversion cost: The sum of direct wages, direct expenses and overhead cost of converting raw
material into the finished stage or converting a material from one stage of production to another stage.

4. Classification according to variability:


Fixed cost: There are costs which remain constant at various levels of production. They are not
affected by volume of production. E.g. factory rent, insurance etc.
Variable cost: These are costs which tend to change in relation to volume of production. E.g. cost of
raw materials, direct wages etc. They increase in total as production increases and vice-versa.
Semi variable cost: These are costs which are partly fixed and partly variable. These are fixed up to
a particular volume of production and become variable thereafter for the next level of production. Some
examples are repairs and maintenance of electricity, telephone etc.

5. Classification according to controllability:


Controllable cost: Costs which can be minimized by the executive action are known as controllable
costs. Costs are which can be influenced and controlled by the management action.
Non- Controllable cost/ uncontrollable costs: Costs which cannot be minimized by the executive
action are known as uncontrollable costs.

6. Classification according to normality:


Normal cost: It is the cost which is not normally incurred at a given level of output under the
conditions in which that level of output is normally attained.
Abnormal costs: It is the cost which is not normally incurred at a given level of output, is normally
attained. It is charged to costing profit and loss account.

7. Classification according to relationship:


Direct costs: Costs which are directly related to the cost centre or the cost unit for example cost of
basic raw material use in the finished produce, wages paid to site labour in construction contract etc.
Indirect costs: Costs which are not directly identified with a cost centre or a cost unit for example
factory rent incurred over variour departments, salary of supervisor engaged in overseeing various
construction contracts etc.

DEFINITION OF COST SHEET


Walter & Bigg define cost sheet as follows “The expenditure which has been incurred upon production
for a period is extracted from the financial books and the stores records, and set out in a memorandum
or a statement, if this statement is confined to the disclosure of the cost of the units produced during the
period, it is termed as a cost sheet”.

PURPOSES OF COST SHEET


It provides details of total cost under logical classification.
It provides cost per unit in different stages.
It helps in comparison and control of cost.
Cost sheet is helpful in estimation of cost for preparation to tenders.
It acts as basis for fixation of selling price.

MEANING OF TENDER OR QUOTATION


The manufacturer of capital goods, Customer durable goods etc is required to quote the price at which
he can supply a particular article. The price at which the supplier offers his goods for sales is known as
tender or quotation. To prepare a tender the following details are carefully analyzed:
1) Cost of materials.
2) Cost of direct labour and chargeable.
3) Cost of works overhead.
4) Cost of office overheads.
5) Cost of selling overheads.
6) Estimated profit.

Estimated direct labour cost taking into account any proposed increase in wage rates. Overheads are
estimated on the basis of past experience and current extends and than absorbed are estimated as
percentage for example:
1) For percentage of factory overheads to direct wages=factory overheads x100 /Direct wages
2) For percentage of office overheads to works cost=office overheads x 100 / Works cost
3) For percentage of selling overheads=selling overheads x 100 / Works cost

ESTIMATING OF PROFIT FOR A TENDER (OR) QUOTATION:


Some time profit is given as percentage of cost. In that case profit for the tender is ascertained as given
below:
Profit= cost of sales x profit percentage /100
If profit is to be ascertained as a percent of selling price of the tender, the profit is to be calculated as
given below:
Profit= cost sales x rate of profit on sales /100- Rate percentage on sales.
GIVE THE SPECIMEN OF COST SHEET (5Marks)
SPECIMEN AND PREPARATION OF COST SHEET
Cost sheet of ……….for the month of Rs Total cost Cost per unit
………… particulars
Direct material xxx
Direct labour xxx
Direct expenses xxx
A) PRIME COST xxx xxx
Add: works overheads: xxx
Indirect material xxx
Indirect wages xxx
Factory rent and rates xxx
Factory lighting and heating xxx
Power and fuel xxx
Repairs and maintenance xxx
Drawing office expenses xxx
Depreciation of plant and machinery xxx
Factory stationary xxx
Insurance of factory xxx
Factory/works managers salary xxx
Water consumption in factory xxx xxx xxx
Total works overheads
B) WORKS COST / FACTORY xxx
OVERHEADS xxx
Add: office/administration xxx
overheads: xxx
Office rents and rates xxx
Office lighting xxx
Office stationary xxx
Office furniture depreciation and repairs xxx
Office salaries xxx
Legal charges xxx
Bank commission xxx

Telephone and postage xxx


Office cleaning xxx
Total administration overheads xxx
C) COST OF PRODUCTION xxx xxx
Add: selling and distribution overheads xxx
Salesmen’s salaries xxx
Salesmen’s commission xxx
Showroom rent xxx
Showroom expenses xxx
Advertisement xxx
Sales office rent xxx
Traveling expenses xxx
Warehouse rent and rates xxx
Warehouse staff and salaries
Repairs and depreciation of delivery
vans
Carriage outward
Total selling & distribution overheads xxx xxx
D) COST OF SALES xxx xxx
E) PROFIT / LOSS xxx xxx
SALES xxx xxx
xxx xxx

You might also like