Cost Accounting

Unit-I

Gunjan Dwivedi
Assistant Professor Finance
Department of Management
 Topics Covered
Cost Concept & Classifications,
Meaning of Cost Accounting
Objectives and Advantages of Cost Accounting,
Difference Between Financial, Cost & Management
Accounting
Role of a Cost Accountant in an Organization.

Limitations of Cost Accounting

Methods & Techniques of Cost Accounting
 Cost: Meaning & Concept
Cost denotes the amount of money that a company
spends on the creation or production of goods or
services.

It does not include the markup for profit.

In accounting, the term cost refers to the monetary

value of expenditures for raw materials, equipment,
services, labor, products, etc.
 Definition
 According to Institute of Cost and Work Accountants
(ICWA), cost implies “Measurement in monetary
terms of the amount of resources used for the purpose
of production of goods or rendering services.”

* In terms of manufacturing, costs refer to sum total -of

monetary value of resources used in producing or
manufacturing a product. These resources can be raw
material, labor, and land.
 Elements of Cost

Cost

Material Labour Expenses

Direct Indirect Direct Indirect Direct Indirect

 Material Cost
The cost of commodities and materials used by the
organization.
Direct Material Cost – all raw materials, either
purchased from outside or manufactured in house.

Indirect Material Cost – material which assist the

manufacturing process and does not become an
integral part of finished goods like lubricants oils and
grease used in manufacturing machines.
 Labour Cost
The cost of remuneration paid to the employees of the
organization.

Direct Labour Cost – all labour directly engaged in

converting raw material into finished goods.

Indirect Labour Cost – those employees who are not

engaged in the manufacturing process but only assist.
Like security department, storekeeper , etc.
 Expenses Cost
All cost other then material and labour are treated as
expenses. This is the cost of services provided to all
undertaking and the notional cost of assets owned.

• Direct Expenses Cost – Hire charges of

machinery/equipment for particular job, architect’s
fees, etc.

• Indirect Expenses Cost – Rent, Telephone expenses,

Insurance, Depreciation, etc.
Direct Material Cost
+
Direct Labour Cost Prime Cost
+
Direct Expenses Cost
Indirect Material Cost
+
Overheads Indirect Labour Cost
+
Indirect Expenses Cost
 Classification of Cost

Cost

According to According to According to

According According to
Functions or Nature or Controllabilit
to Elements Normality
Operations Behaviour y
 According to Elements
Direct Cost- Direct costs are expenses that a company
can easily connect to a specific "cost object," which may
be a product, department or project.

Indirect Cost- Indirect costs extend beyond the

expenses incurred in creating a product to include the
costs involved with maintaining and running a company.
These overhead costs are the ones left over after direct
costs have been computed.
 According to Functions
Production/Manufacturing Cost

Administration Cost (Office & Administration Exp.)

Selling Cost

Distribution Cost
 According to Nature
Fixed Cost- A cost which tends to be unaffected by
variations in volume of output.

Variable Cost- A cost which tends to vary directly

with volume of output.

Semi-fixed or Semi-variable Cost- A part of the cost

tends to remain constant (fixed) and the other part
tends to change proportionately with change in
output.
 According to Controllability
Controllable Cost- the cost which can be controlled
by a specified member, head of a cost centre or a
department. Controllable costs are the variable costs.

Uncontrollable Cost- Generally fixed costs.

 According to Normality
Normal Cost- Normal Cost is the one which is
considered to be normal under the normal
circumstances.

Abnormal Cost- It is a cost which is beyond normal

cost.
According to Relevance to Decision Making
and Control
Shut Down Cost
Sunk Cost
Opportunity Cost
Imputed Cost
Replacement Cost
Marginal Cost
Differential Cost
Standard Cost
Relevant Cost
 Cont…
 Shut Down Cost- A cost which will still be required to
be incurred even though a plant is closed or shut down
for a temporary period.
For Example: Cost of Rent, Depreciation, Maintenance
Expenses.
 Cont…
Sunk Cost- A cost which has been incurred in the
past or sunk in the past is a sunk cost.

It refers to a cost that has already occurred and has no

potential for recovery in the future. For example, rent,
marketing campaign expenses or money spent on new
equipment can be considered sunk costs or irrevocable
cost.

Sunk cost are generally historical cost.

 Cont…
Opportunity Cost- The cost which are related to the
sacrifice made or the benefits forgone are opportunity
costs.

For example if a part of the factory building has been

let out on rent and now the owner wants to use that
portion for installing a plant, so the loss of rent is the
opportunity cost.
 Cont…
Imputed Cost- It is a hypothetical cost required to be
considered to make costs comparable.

If the owner of the factory charges rent of the factory

to the cost of production to make cost comparable
with that of those undertakings which run production
in rented factories.

It is an imputed cost as the rent has actually not been

paid.
 Cont…
Replacement Cost- Replacement cost is the amount
of money required to replace an existing asset with an
equally valued or similar asset at the current market
price.

In other words, it is the cost of purchasing a substitute

asset for the current asset being used by a company.
 Cont…
Marginal Cost- Marginal Cost refers to the increase
or decrease in total cost caused due to increase or
decrease in output by one single unit.

It comprises of direct material, direct labour, direct

expenses and variable overheads.
 Cont…
Differential Cost- The difference in total costs
between two alternatives is termed as differential cost.

The Change in total cost due to the change in method

or technique of production or charge in level of
production is called differential cost.

In case, if the choice of an alternative results in increase

in total cost, then this increase is termed as incremental
cost and if the cost decrease due to change in
alternative then it is known as decremental cost.
 Cont…
Standard Cost- Standard cost is a predetermined cost
or estimate which is compared with the actual cost in
order to determine variance and carry out an analysis
of variance for cost control.
 Cont…
Relevant Cost- The relevant costs are those cost
which aids to makes specific management decisions.
The cost is said to be relevant if it help managers in
taking a right decision in furtherance of company’s
objectives.

The concept of relevant cost is used to eliminate

unnecessary data that could complicate the decision-
making process.

As an example, relevant cost is used to determine

whether to sell or keep a business unit.
 Concept of Cost Accounting
Cost Accounting is the art of recording, analyzing and
classifying of expenditure incurred in order to
ascertain total cost and per unit cost of a product or
service.

The accounting of cost which is incurred on

manufacturing a product or rendering a service is
known as cost accounting.
 Definition of Cost Accounting
The Institute of Cost and Management Accountant,
England (ICMA) has defined Cost Accounting as –

“The process of accounting for the costs from the point

at which expenditure incurred, to the establishment of
its ultimate relationship with cost centres and cost
units. In its widest sense, it embraces the preparation
of statistical data, the application of cost control
methods and the ascertainment of the profitability of
activities carried out or planned”.
Cost Centre- Cost centre is a location or person or
place or machine or item or equipment or thing for
which cost can be ascertained and used for the
purpose of cost control.

For example, production department, machine

workshops, service department or a work force can be
considered as a cost centre.
Cost Unit- Cost unit is a unit of product or unit of
service for which costs are ascertained through means of
costing process.

It is a quantitative unit of product or service in relation

to which costs are ascertained.

Cost unit differ from industry to industry. It can be

expressed as cost per thousand bricks, cost per
passenger-kilometre, cost per ton, etc.
Objectives & Functions
of Cost Accounting
Cost Ascertainment
Cost Control
Cost Reduction
Ascertainment of Profitability
Determination of Selling Price
Providing A Basis for Business Policy
 Cont…
Cost Ascertainment- The primary objective of cost
accounting is to determine the cost of production of
every unit, job, operation, process, department or
service.

The technique of ascertaining cost is known as

‘Costing’.

The cost may be ascertained by Historical Costing,

Standard Costing or Marginal Costing.
 Cont…
Cost Control- It is one of the important function or
objective of cost accounting.

To measure the efficiency of the organization or of the

cost centres, the various operations involved in the
manufacture of products are to be carefully studied.

In this, the standard consumption of material, labour

and expenditure are compared with the actual
performance to find out that the cost is within control
or not.
 Cont…
Cost Reduction- Cost reduction refers to real or
genuine savings through permanent reduction in cost
of a product or service without impairing the quality
and effecting its purpose for which it was intended to
be used.

The area covered for cost reduction are like product

design, plant layout, production methods, material
substitution, reduction in wastages, innovation
marketing strategies, purchasing and material control.
 Cont…
Ascertainment of Profitability- It is the object of
cost accounting to ascertain the profitability of the
activities carried out or planned.

If a new product or activity introduced, the

management generally tries to find out the profits that
can be earned from it.

The profit making capacity of product/activity is

compared on the basis of actual profits with their
profitabilities.
 Cont…
Determination of Selling Price- The selling price of
the product depends upon its total cost plus a margin
of profit which the businessman wants to make
depending upon the factors of demand and supply.

Cost accounting provides detailed information about

the composition of total cost for the determination of
the selling price.
 Cont…
Providing A Basis for Business Policy & Decision
Making- It helps the management in profit-planning
and in deciding crucial matters like:

 Introduction or Discontinuance of a Product,

 Utilization of Idle Plant Capacity,
 Selection of Most Profitable Sales Mix,
 Dumping of Goods in a Foreign Market at a Cheaper Price,
 Make or Buy,
 Purchase of New Plant or Continuance with the Old Plant at
the Cost of Heavy Repairs, etc.
 Advantages of Cost Accounting
1. Measurement and Improvement of Efficiency
2. Profitable and Unprofitable Activities
3. Fixation of Prices
4. Guide in Reducing Prices
5. Information for Proper Planning
6. Control over Materials
7. Decision Regarding Machine vs. Labour
8. Helps in Taking Decisions
 Limitations of Cost Accounting
Based on Estimates
Lack of Uniformity
Many Conventions
Expensive
Dependent
Does Not Include All Items of Expense and Income
Not An Exact Science
 Differences Between Financial, Cost &
Management Accounting
Basis Financial Cost Accounting Management
Accounting Accounting
Objects Record transactions Ascertainment, allocation, To assist the
& accumulation management
determine financial and accounting for cost in decision-making
& policy
position & profit or
formulation.
loss.
Nature Concerned Concerned with both past Deals
with historical and with
data. present projection of data for
recorded(historical the future (futuristic
in in nature)
nature).
Principle Governed Certain No set principles are
by GAAP principles followed for followed in it.
Followed recording costs.
Data Qualitative Only quantitative aspect is Uses
aspects are not recorded. both
 Differences Between Financial, Cost &
Management Accounting
Basis Financial Cost Accounting Management
Accounting Accounting
Reporting Generally at As & when desired by As & when desired by
end of year management management
frequency
Publication Published in case NOT published NOT published
of companies
Informatio Monetary Both and Both and
n recorded transactions monetary non- monetary non-
ONLY monetary monetary
information. information
Forms of Accounts are These are generally These are generally
Account prepared to meet kept Voluntarily to kept Voluntarily to
the meet the requirements meet the requirements
legal of the management. of the management.
requirements.
 Role of Cost Accountant
Develop and maintain the cost accounting system,
documents and records of the organization.

Analyze and recommend costs and cost savings.

Prepare and complete internal cost audits.

Comply with Generally Accepted Accounting Principles

(GAAP) for financial statements.

Analyze the data collected and log a detailed record of the

results.
 Cont…
Analyze any changes in goods or services provided in order to
determine what effect it has on the cost.

Analyze manufacturing costs and prepare regular reports comparing

standard costs to actual production costs.

Make estimates of new and proposed product costs.

Provide management with reports that specify and compare factors

that affect prices and profitability of products or services.

Assist in audits and general ledger preparation.

Conduct physical inspection of inventories and monitor the cycle

count program.
 Methods & Techniques of Costing
Costing Methods are use to ascertain the cost of
product or services.
For Example- Job Costing, Contract Costing, Process
Costing, etc.

While Costing Techniques are used to control and

minimize the cost.
Examples of costing techniques are -Activity Costing,
Marginal Costing etc.
 Methods of Costing
Costing methods refers to the methods of ascertaining
cost of a product manufactured or service rendered.

Various methods are used by the industries to

ascertain cost.

Selection of Costing Method is depending upon the

nature of industry.
Costing Methods can be classified into two categories:

●
Job Costing
Specific Order ●
Contract Costing
Costing Method
●
Batch Costing
●
Target Costing

Continuous ●

●
Process Costing
Single or Output Costing
Operation Costing
Operation Costing
●

●
Operating Costing
●
Departmental Costing
Method ●
Composite or Multiple Costing
 Specific Order Costing Method

Specific Order Costing Methods are used by

those business concerns which take on any
manufacturing activity or render services to individual
customers on receipt of specific orders.

In other words, these costing methods are

applicable where the work consists of separate
contracts, job or batches, each of which is
authorized by a special order or contract.
 Cont…
1. Job Costing- It is a system of costing in which costs are
ascertained in terms of specific jobs or orders which are not
comparable with each other and non repetitive in nature.

 This method is applied where work is undertaken on the

request of customer’s special requirements and each order is
comparatively of shorter time period.

 It is applicable where the manufacturing unit is one and

complete in itself.

 For example, Printers, Job foundries, Tool Manufacturers,

Contractors, etc. and in services like Plumbering Job, Sanitary
Job, etc.
 Cont…
2. Contract Costing- Contract costing is a costing
method which applies where work is executed under
customer’s specific requirements and each order is of
long duration which may cover or go into several
accounting years.

 This method is applied in undertakings erecting

buildings or carrying out constructional works like
House building, Ship building, Civil engineering
contracts, etc.

 It is also known as Terminal Costing.

 Cont…
3. Batch Costing- In this method, a batch of similar or
identical products is treated as a batch.

 Costs are collected and analyzed according to batch

numbers and the costs are ascertained batch-wise.

 This method is applied in pharmaceutical industries

where medicines or injections are manufactured
batch-wise.
 Cont…
4. Target Costing- In this method, before
commencement of job the cost of work is estimated
with the help of experts.

 This estimated cost is termed as Target Cost.

 This method is used mainly in Government

Construction Work.
 Continuous Operation
Costing Method
This method of costing is applied in those industries
where mass production is done on a continuous basis
and where production will accumulate in stock and
will then be sold from stock on demand later on.
 Cont…
1. Process Costing- Process Costing method is applicable
to those industries manufacturing a number of units of
output requiring processing.

 Here, an article or product has to undergo two or more

processes for reaching the stage of finished goods and the
finished goods of the preceding process are treated as raw
material for the succeeding process till completion.

 This method is applicable to chemical industries or

refineries, for example, soap, edible or non-edible oils,
paints, etc.
 Cont…
2. Single or Output Costing- This method is used
where the production is uniform and consists of only a
single product.

 The units are identical to each other and are the

standard ones.

 This method is applied to industries like mining,

quarries, flour mills, steel works, etc.
 Cont…
3. Operation Costing- In the operation costing method,
the cost of each operation in the process of production
is ascertained.

 Operation cost is generally termed as conversion cost

like cost of labour and variable overhead used in
converting the shape of raw material.

 This method can suitably be applied to those industries

where mass production of repetitive nature goes on.
 Cont…
4. Operating Costing- This method is applied to those
undertakings which do not manufacture goods but
which render services.

 For example, Transport Companies, Railways, Hotels

for Lodging, Canteens, Hospitals, Electricity & Water
Supply Companies.
 Cont…
5. Departmental Costing- This method is applicable
where the cost of a department or a cost-centre is
required to be ascertained.

 This is similar to operation costing.

 This method is good for a comparative study of the

identical costs of different departments.
 Cont…
6. Composite or Multiple Costing- Where more than one
method are used in conjunction, the method becomes a
Composite or Multiple Costing Method.

 In the production of radio, television, motor-cars,

aeroplanes, a variety of components- some based on one
method and the others on the different method of
costing- are produced and then assembled.

 Since more than one method of costing have been

applied.
 Techniques of Costing
Techniques are different from Methods. A technique is
the way of doing a certain work.

Costing techniques refer to the techniques of

presenting cost information to suit the need of
management.
 Cont…
1. Historical Costing
2. Standard Costing
3. Marginal Costing
4. Direct Costing
5. Absorption Costing
6. Uniform Costing
 Cont…
Historical Costing-
“The ascertainment of costs after they have been
incurred.” -I.C.M.A

Historical Costs are therefore, ‘Postmortem’ costs as

under this method all the expenses incurred on the
production are first incurred and then the costs are
ascertained.
 Cont…
Standard Costing-
“The preparation and use of standard costs, their
comparison with actual costs and the analysis of variances
to their causes and points of incidence.”
- I.C.M.A.
Here the standards are first set and then they are
compared with actual performances. The difference
between the standard and the actual is known as the
variance. The variances are analyzed to find out their
causes and also the points or locations at which they
occur.
 Cont…
Marginal Costing-
“The ascertainment of marginal costs and of the effect
on profit of changes in volume or type of output by
differentiating between fixed costs and variable costs.”
- I.C.M.A.
Marginal Costing is a technique to ascertain the effect
on profit by the change in the volume of output or by
the change in the type of output.
 Cont…
Direct Costing-
“The practice of charging all direct costs to operations,
processes or products, leaving all the indirect costs to be
written off against profits in the period in which they
arise.”
 Cont…
Absorption Costing-
“The practice of charging all costs, both variable and
fixed, to operations, processes or products.”
-I.C.M.A.
This is the traditional technique as opposed to
Marginal or Direct Costing Techniques. Here both the
fixed and variable costs are charged in the same
manner.
 Cont…
Uniform Costing-
“The use by several undertakings of the same costing
principles and/or practices.” -I.C.M.A.

When several similar undertakings join together to

adopt a common approach to costing problems. They
adopt the same method of costing and the same set of
books in order to compare the performance of one
with the other and thus to derive the benefit of one’s
performances by the other.