Cost is a resource sacrificed to achieve a

specific objective
Actual cost is what is incurred
Cost object anything for which separate
measurement of cost is desired
product/service/project/brand/Department
 Cost Accounting
Procedures for recording income and expenditure
with objective of ascertaining and controlling
costs
Objectives-
Ascertain costs-control/reduce
Determine selling price
Measure efficiency-improve/control
Ascertain profitability of activity/ product/ division
Decision making-make or buy/cost-vol-profit etc
 Cost Accountancy
Cost Accountancy includes the following:
Cost accounting;(the process of accounting for costs)
Costing;(technique and process of ascertaining costs)
Cost control;(comparing actual performance against
target performance and taking corrective actions)
Cost reduction;(achievement of real and permanent
reduction without impairing their suitability for the use)
Cost audit; (verification of cost accounts and a check on
the adherence to cost accounting plan)
Financial Accounting Cost Accounting

According to acctg stds for For internal management

business as a whole, also Mainly voluntary unless notified
for external parties- by Govt., eg paper, cement,
shareholders/ creditors aluminum, fertilizer
By objective-product wise,
Statuatory reqt-companies
direct/indirect cost
act, income tax etc
According to decision
Record expenses by requirement
nature-eg total wages
According to need-even daily
Analysis- whole business Advantage-various decisions-
Periodicity-qtrly/yearly productivity, incentive
schemes, cost & profit
Limitation-not useful for planning &control
may types of decisions Limitation-more accounting
work, needs to be used
Items in Fin Accts-not in Cost Accts
Appropriation of profits-dividend, sinking fund,
income tax, preliminary expenses, donations etc.
Pure Financial Charges -interest on loans,
penalties/fines, loss on scrapping of m/c, loss on
sale of investments
Pure financial income -interest on deposits,
dividends, profit on sale of investments,
brokerage, commission
Abnormal gains /losses -theft, fire, gain on sale of
assets
 Classification Direct/Indirect
Direct
Costs that can be directly traced to the cost object
Easy- the requisition slip says so

Indirect
Costs that need to be allocated to the cost object
Challenge- on what basis ?
Elements of Cost- material, labour, expenses
Material-
Direct material (RM, Process Material, Prime material)- which
becomes part of finished product including packing
Indirect Material -which cannot be assigned to individual units eg
grease, stationary
Labour-
Direct Labour- specifically traceable to product
Indirect Labour -common to many products eg store, admn, selling
Expenses-
Direct Expenses- product specific payment-eg hire of special
machinery for a particular contract ,electricity for electroplating
Indirect Expenses – common to many eg rent, electricity for lighting
OVERHEADS- indirect(material, labour,expenses)
Manufacturing OH -
Related to Production Management and
administration - factory rent, salaries, grease,
insurance, power, depreciation
Office and Administrative OH-
Office rent, salaries, stationary, electricity, legal,
audit
Selling & Distribution OH-
Sales salaries, rent, advertisement, travel, bad
debts, warehouse, loading, freight
Components of Total Cost (Contd.)
Adjustment for Scrap : If some materials are found
defective before use, and hence sold, their value should
be subtracted from the cost of materials.
Adjustment for Work-in-progress :Work-in progress
means units which are not yet complete but on which
some work has been done. Generally, such goods bear a
proportionate part of factory overheads, apart from raw
material and direct wages. Thus, opening and closing
stock of work-in progress is kept in mind while computing
works cost of goods manufactured.

9
 Elements of cost
Direct Material
Direct labour
Direct Expenses
Prime Cost

Overhead
-Factory-Indirect mat/Lab/exp
-Office- Indirect mat/Lab/exp
-Sell & Distt-Indirect mat/Lab/exp
 Question 1
The following manufacturing items are for a construction
company working on several custom homes. Identify whether
each item should be categorized as direct materials , direct
labor, or manufacturing overhead.
1. Nails 5. Supervisor responsible
for three homes
2. Lumber
6. Light bulbs
3. Drywall
7. Cabinets
4. Workers building the
house frame 8. Depreciation of
construction equipment
Answer 1
1. Manufacturing overhead
2. Direct materials
3. Direct materials
4. Direct labor
5. Manufacturing overhead
6. Manufacturing overhead (You might call this a direct material, but the
benefit of tracking this item as a direct material probably does not
outweigh the cost.)
7. Direct materials
8. Manufacturing overhead
Question 2
Identify whether each item listed below should be categorized as direct
materials, direct labor, manufacturing overhead, selling cost, or general
and administrative cost.

1. Advertising 10. Caretaker provided for production

2. Shipping costs for raw materials facility
coming from a supplier 11. Supplies used by human resources
3. Shipping costs for goods shipped to personnel
a customer 12. Utility costs for retail store
4. Chief executive officer’s salary 13. Insurance costs for production
5. Production supervisor’s salary facility
6. Depreciation on production 14. Assembly line workers
equipment 15. Clerical support for chief executive
7. Raw materials used in production officer
8. Paper used by the accounting staff 16. Maintenance of production
9. Commissions paid to salespeople equipment
Answer 2
1. Selling 8. General and administrative
2. Direct materials or manufacturing 9. Selling
overhead, depending on if the 10. Manufacturing overhead
materials are easily 11. General and administrative
traced to the product (direct) or not 12. Selling
(indirect manufacturing overhead) 13. Manufacturing overhead
3. Selling 14. Direct labor
4. General and administrative 15. General and administrative
5. Manufacturing overhead 16. Manufacturing overhead
6. Manufacturing overhead
7. Direct materials or manufacturing
overhead, depending on if the
materials are easily traced to the
product (direct) or not (indirect
manufacturing overhead)
Cost Behaviour-Variable vs Fixed

Depends on the Cost driver-activity that

generates cost-
Volume-variable costs eg RM

Relevant range
-maybe step function related to volume-production
shift classroom, truck
-maybe time related- lighting cost/per month
in long run even fixed costs change
 Classification of Costs (not mutually exclusive)
1. Fixed-committed for short run(rent, insurance,
mgt salary)-discretionary(R&D, Mkt Research)
Variable -direct material, labour, power
Semi variable- depreciation, repairs
Step (w.r.to vol)-supervisor, classroom, trucks
2. Product costs-are included in inventory cost
Upto factory cost-absorbtion costing
Only variable cost-marginal costing
All direct costs
Useful for inventory valuation in fin acctg, price
fixation, cost plus contracts
Period -Gen Admn and selling
Product Costs on the
Balance Sheet
Raw Materials
The raw materials inventory account records the cost of materials not yet put into production. For
Furniture Company, this account includes items such as wood, brackets, screws, nails, glue, lacquer, and
sandpaper.
Work in Process
The work-in-process (WIP) inventory account records the costs of products that have not yet been
completed. Suppose Furniture Company has eight tables that are still in production at the end of the year.
All manufacturing costs associated with these incomplete eight tables— direct materials, direct labor, and
manufacturing overhead—are included in the WIP inventory account. Once goods in WIP inventory are
completed, they are transferred into finished goods inventory. The cost of completed goods that are
transferred out of WIP inventory into finished goods inventory is called the cost of goods manufactured.
Finished Goods
The finished goods inventory account records the manufacturing costs of products that are completed
and ready to sell. Suppose Furniture Company has five completed tables at the end of the year (in
addition to the eight partially completed tables in work-in-process inventory). The manufacturing costs of
these five tables—direct materials, direct labor, and manufacturing overhead—are included in the
finished goods inventory account until the tables are sold. (For the purposes of this example, assume the
tables are “sold” when delivered to the customer.)
3. Direct & Indirect
4. Decision making &accounting
5. Relevant & irrelevant for a particular decision
6. Shut down-when plant idle & sunk-already
incurred
7. Controllable & Uncontrollable-short run,
responsibility level
8. Avoidable & unavoidable – can be eliminated w
r to a particular product and co as whole
9. Imputed or hypothetical- proprietor salary,
interest not normally taken, but for 2 projects
with different cash reqt maybe included
10.Differential/incremental/decremental- match
increase in cost with increased revenue
11. Out of pocket -cash outflow for a certain
decision
12. Opportunity cost- when more alternatives
available-sell now or process further
13. Traceable(Direct) untraceabale/common-
indirect including joint costs-eg refinery, oil and
soap
14. Expired (period)& unexpired- c/f next period
eg RM purchased but not used
15. Classify by function- prodn, admn, sell, disttn,
research, devt, pre prodn (trial run)
16. Conversion cost- factory cost minus direct
material
 Relevant Costs
Costs are relevant if they guide the executive towards a
decision that harmonizes with the top management’s
objectives. Their two fundamental characteristics are:
▪They are future costs: Past costs are the result of past
decisions and no current or future decision can change
what has already happened. In forward decision making,
data regarding historical or standard cost is useful only as a
basis for estimating future costs.
▪They differ between alternatives: Only such future costs
(fixed or variable) are relevant which may be expected to
be different between alternatives. Similar costs are to be
ignored.

20
Cost Allocation and Cost
Apportionment
Cost Allocation and Cost Apportionment
Cost allocation and cost apportionment are the two procedures
which describe the identification and allotment of cost centres
or cost units. Cost allocation refers to ‘the allotment of whole
items of costs to cost centres or cost units’ while cost
apportionment refers to ‘the allotment of proportions of items
of costs to cost centres or cost units’. Thus the former involves
the process of charging direct expenditure to cost centres or cost
units while the latter involves the process of charging indirect
expenditure to cost centres or cost units.
 Cost Ascertainment
Collect and classify by cost elements -material, labour,
exp, direct/ overheads etc
Allocate(whole item) & apportion(divide cost item) to cost
centres & cost units
Cost unit- qty on which cost can be allocated-car factory-
cars, crude oil-barrels, painter-square ft
Cost centre- for cost control-person, location, equipment,
department
Productive cost center- makes product
Service /unproductive-helps productive cost center
Personal-people group, Impersonal-machine group
Process-sequence of operations
Profit Centre to set targets-sales may be notional or real-
be careful of notional price
Cost estimation (future)- for budgets, decisions etc
Cost ascertainment (historical) -to compare actuals
Cost Absorption from cost centres to cost units
Cost reduction -work study, R&D,
Cost control vs standards &
Cost Management costs and revenues from overall
company point of view
 Methods of Costing (JOB and PROCESS)
Job Costing- special orders tracked-like Machine shop
Contract Costing-like a big shop-eg ship
Cost Plus Costing-Define costs -normally upto prodn +%
for OH
Batch Costing- like job grouped into batches

Process Costing-various stages where we need to know

cost-eg refinery
Operation Costing- more detail – to track various types
of components that can be combined to give a variety
of finished goods
Unit Costing/ single/output costing- single output from a
continuous prodn
Operating Costing -for services
Multiple/composite costing-mix job & process
 Techniques of Costing -for decisions and control

Marginal Costing- when output varies and OH may

mislead
Direct Costing- period costs written off , not in inventory
Absorption Costing-all costs incl prodn and admn
Uniform Costing -for inter firm comparison
Activity Based Costing- apportion OH based on cost
drivers- eg no of purchase orders, no of store slips etc
 Installing a Costing System
Requires top Mgt support, all deptts staff, trained staff
and involves expenditure!
Design according to requirements and organisation
structure-
What needs control? (eg ABC analysis)
Who needs what info for planning & control
Simple , standardised forms for complete and reliable
data collection. Yet possible to adapt for
expansion/new product/new decision
Reconcile with Fin Accts OR have one set of books
 Certain Cost Acctg Terms
Prime Cost (basic, first, flat cost)=Direct
material+labour+expenses
Factory Cost (works cost, prodn cost,
mfgcost)=Prime Cost+Factory OH
Office Cost/ Total Cost of Production=
Factory Cost +Office /Admn OH
Total Cost/Cost of Sales=Total cost of
Production+Sell & Disttn OH
Just as done in Fin Acctg adjust inventory at each
stage-
Direct Material=op+purch-cl
Processed=op+works cost-cl
Finished goods=op+cost of prodn-cl
Opening Raw Material 10200 Depn-plant & m/c 200

Opening WIP 1000 consumable stores 700

Opening Finished goods 2000 Office Mgr salary 2000

Raw material Purchased 35000 Director's fee 500

Wages 10000 Printing & stationary 500

Direct expenses 2000 Phone 100

Oil 100 Postage 50

Foreman Wages 1000 Salesman 500

Store Keeper 500 Sales travel exp 200

Power 200 Advertisement 500

Factory Lighting 500 Warehouse 200

Office lighting 200 Carriage out 150

Factory rent 2000 Closing Raw Material 5000

Office rent 1000 Closing WIP 1000

Repairs Plant,M/c 1500 Closing Finished Goods 2000

Office repairs 200 Sale of wasted RM 200

Depreciation-office 500 Sales 85000

Classify as prodn, admn, sell and direct , indirect

Opening Raw Calc 10200 Depn-plant & m/c Prod I E 200
Material
consumable stores Prod IM 700
Opening WIP Calc 1000
Office Mgr salary Adm IL 2000
Opening Calc 2000
Finished goods Director's fee Adm IL 500
Raw material Calc DM 35000 Printing & stationary Adm IM 500
Purchased
Phone Adm IE 100
Wages Prod DL 10000
Postage Adm IE 50
Direct expenses Prod DE 2000
Salesman Sales IL 500
Oil Prod IM 100
Sales travel exp Sales IE 200
Foreman Wages Prod IL 1000
Advertisement Sales IE 500
Store Keeper Prod IL 500
Warehouse Sales IE 200
Power Prod IE 200
Carriage out Sales IE 150
Factory Lighting Prod IE 500
Closing Raw Material Calc DM 5000
Office lighting Adm IE 200
Closing WIP Calc 1000
Factory rent Prod IE 2000
Closing Finished Goods Calc 2000
Office rent Adm IE 1000
Sale of wasted RM Calc DM 200
Repairs Prod I E 1500
Plant,M/c Sales 85000
 Systems of Costing

Job Costing and Process Costing- can be done using

Historical Costing-Post Costing (after completion of cost

accounts) or Continuous Costing
Standard Costing-predetermined standards- compare
actuals and analyse variances