COST ACCOUNTING

UNIT 1:
INTRODUCTION TO
COST ACCOUNTING
Accounting

Accounting is the art of recording, classifying

and summarizing in a significant manner and
in term of money transactions and events
which are in part at least, of a financial
character and interpreting the results thereof .
 Classification

Managemen
Financial Cost
t
Accounting Accounting
Accounting
Cost: is the expenditure required to create and sell products and services

Costing: The techniques and process of ascertaining the cost

 ◦ (CIMA) has defined Cost Accounting as,
'the process of accounting for cost
from the point at which expenditure is
Cost incurred or committed to
Accounting establishment of its ultimate
relationship with cost centers and
cost units.
 Cost centre: A location, person or item of equipment for which cost
may be ascertained and used for the purpose of control
cost unit: unit of product , service time in relation to which cost may be
ascertained or expressed
Relation of cost, expense and loss
Expense: Expenses are cost which has been applied against revenue of
particular accounting period in accordance with the principle of matching cost
to revenue.

Loss: loss is defined as ―reduction in firm’s equity, other than from

withdrawals of capital for which no compensating value has been received
 BASIS FOR COMPARISON COSTING COST ACCOUNTING

Meaning Costing refers to the practice of Cost Accounting is a method of

identifying costs of any accounting that records,
product, service or activity, at classifies, allocate, summarize,
various times and stages of analyse, interpret and controls
production. the cost incurred on any product,
process, service or activity.

What is it? Process and techniques of Specialized branch of

determining costs. Accounting.

Decision making It is not used for decision It is used by management for

making. decision making.

Accounting principles Accounting principles are not Application of accounting

applied. principles is important.

Scope Narrow Comparatively wide

 Objectives/ functions of Cost
Accounting
1. Ascertainment of Cost

2. Fixation of Selling Price

3. Cost Control and reduction

4.Guide to business policy

5.Measuring and improving performance

 BASIS FOR COMPARISON COST ACCOUNTING FINANCIAL ACCOUNTING
Meaning Cost Accounting is an accounting Financial Accounting is an
system, through which an accounting system that captures
organization keeps the track of the records of financial information
various costs incurred in the about the business to show the
business in production activities. correct financial position of the
company at a particular date.
Analysis of cost and profit Reveal the profit or loss of the Reveals the detail of cost and profit
business for individual product

Statutory requirement Legal requirement under companies voluntary

act and income tax act
Users Information provided by the cost Users of information provided by
accounting is used only by the the financial accounting are internal
internal management of the and external parties like creditors,
organization like employees, shareholders, customers etc.
directors, managers, supervisors
etc.
Valuation of Stock At cost Cost or Net Realizable Value,
whichever is less.
 BASIS FOR COMPARISON COST ACCOUNTING FINANCIAL ACCOUNTING

Time of Reporting​ Details provided by cost Financial statements are reported

accounting are frequently prepared at the end of the accounting
and reported to the management.​ period, which is normally 1 year.​

Format of presenting information Various form of presentation Uniform format.​

Purpose​ Reducing and controlling costs.​ Keeping complete record of

the financial transactions.​

Forecasting​ Forecasting is possible Forecasting is not at all possible.​

through budgeting techniques.​
 1. Advantages to the Management

• Reveals profitable and unprofitable activities.

• Helps in cost control.
• Helps in decision making.

Advantages •
•
•
Guides in fixing selling prices.
Helps in inventory control.
Aids in formulating policies.
of Cost •
•
Helps in cost reduction.
Reveals idle capacity.

Accounting •
•
Checks the accuracy of financial accounts.
Prevents frauds and manipulation.
2. Advantages to Workers

3. Advantages to Society
4. Advantages to Government Agencies and
Others
LIMITATIONS OR OBJECTIONS
AGAINST COST ACCOUNTING
◦ There is no uniform or readymade system of cost accounting
◦ The nature of cost information required for decision making differs from
purpose to purpose, from place to place and from time to time
◦ Cost accounting is more suitable for manufacturing activities than for other
type of activities
o It is expensive
INSTALLATION OF A
COSTING SYSTEM
1. Preliminary investigations should be made relating to the technical
aspects of the business.

2. The organisation structure of the business should be studied to ascertain

the scope of authority of each executive.

3. The methods of purchase, storage and issue of materials should be

examined and modified as per the requirements.
 4. The existing methods of any incentive plans. remunerating Labour should be
examined for the purpose of introducing any incentive plans.

5. Forms and accounting records should be so designed so as to involve minimum

clerical Labour and expenditure.

6. The size and layout of the factory should be studied.

7. The costing system should be effective in cost control and cost reduction.
8. Costing system should be simple and easy to operate.
9. The installation and operation of the system should be economical.
10. The system should be introduced gradually.
Characteristics of an
Ideal System of Cost
Accounting
◦ Simplicity: The costing system should be simple to operate and easy to understand. The facts, figures, and
other information revealed by cost accounts should be presented in a way that makes them easy to grasp.
◦ Simplicity: The costing system should be simple to operate and easy to understand. The facts, figures, and
other information revealed by cost accounts should be presented in a way that makes them easy to grasp.
◦ Economy: For the costing system to become a profitable investment for the business, the cost of installing
and operating the system must be within the organization's financial capacity.
◦ Elasticity: The costing system should be elastic and capable of adapting to changing conditions. As such, it
must not be rigid.
◦ Reconciliation of Results: The costing system should be maintained so as to make the task of reconciling
cost accounts with financial accounts easy and simple.
◦ Comparability: Costing records must be presented in a standardized form, enabling a comparative study of
costing results across different periods.
Fundamental
Prerequisites
1. organization chart which shows the line of authority and delegation of
responsibility
2. Identify the cost centers
3. Classification of cost
Classification of cost
 Cost Accounting

1. Classification Into Direct And Indirect Cost

2. Classification Into Fixed And Variable Costs
3. Classification into Controllable and non-controllable cost
4. Classification Into Historical Costs And Pre-Determined Costs
5. Classification into Normal and Abnormal Costs
6.classification of costs for decision making
 Cost Accounting

1. Classification Into Direct And Indirect Cost:

(a) Direct Cost - these are those costs which are incurred for and conveniently
identified with a particular cost unit, process or department.
(b) Indirect Costs: These Costs cannot be conveniently identified with a particular
cost unit or cost center.
2. Classification Into Fixed And Variable Costs:
(a) Fixed cost: These costs remain constant in total amount over a wide range of activity for a specified
period of time. i.e. these do not increase or decrease when the volume of production changes.
(b) Variable costs: these cost tend to vary in direct proportion to the volume of output in general, variable
costs shows the following characteristics.
(c)Semi - variable or semi fixed cost (Mixed Cost): These costs include both a fixed and a variable
component i.e. these are partly fixed and partly variable.
3. Classification into Controllable and non-controllable cost:
(a) Controllable costs: these are the cost which may be directly regulated at a given; level of management
authority.
(b)Non controllable cost - These are those costs which cannot be influenced by the action of a specified
member of an enterprise.
4. Classification Into Historical Costs And Pre-Determined Costs:
(a) Historical costs: these are past costs which are ascertained after these have been incurred.
(b) Pre-determined costs - these are future cost which are ascertained in advance of production on the basis
of a specification of all the factors affecting cost.
5. Classification into Normal and Abnormal Costs:
(a) Normal cost: Normal cost may be defined as cost which is normally incurred on expected lines at a
given level of output.
(b) Abnormal cost: Abnormal cost is that which is not normally incurred at a given level of output.
6.CLASSIFICATION OF COSTS FOR DECISION MAKING

a. Sunk Costs - A sunk cost is a cost that has already been incurred and that
cannot be changed by any decision made now or in the future.
b. Differential (or Incremental) Costs - This cost may be regarded as the
difference in total cost resulting from a contemplated change. In other words,
differential cost is the increase or decrease in total cost that results from an
change in the course of action.
c. Marginal Cost - Marginal cost is the additional cost of producing one
additional unit.
d. Opportunity Cost - An opportunity cost may be defined as the potential
benefit that is lost or sacrificed when the selection of one course of action makes
it necessary to give up competing course of action.
e. Replacement Cost - This is the cost at which there could be purchased an
asset identical to that which is being replaced.
f. Out-of-pocket Cost - (Explicit Cost and Implicit Cost) - Out-of-pocket costs,
also known as explicit costs, are those costs that involve cash outlays or require
the utilization of current resources. Implicit cost occurs when the company uses
resources belonging to the owner. It doesn't require an outflow of cash
g. Future Cost - Future costs involve forecasting for control of expenses,
appraisal of capital expenditures, decisions on new projects as well as
expansion programmes and profit-loss projections through proper costing under
assumed cost conditions. Policy decisions on pricing also depend
upon future costs.
h. Conversion Cost - are the labor and overhead expenses that convert raw
material into a completed unit
ELEMENTS OF COST:
A cost is composed of three elements i.e materials, labor and expenses. Each of these
elements may be direct or indirect.
Material cost: According to CIMA, UK material cost is ―The cost of commodities supplied
to an undertaking. material may direct or indirect.
(a) DIRECT MATERIAL: direct material cost is that which can be conveniently identified
with and allocated to cost units.
(b) INDIRECT MATERIAL: These are those materials which cannot be conveniently
identified with individual cost units.
Labour Cost: This is ―the cost of remuneration (wages, salaries, commission bonus etc) of
the employees of an undertaking‖.
(a) DIRECT LABOUR: direct labourcost consists of wages paid to workers directly engaged
in converting raw materials into finished product.
(b) INDIRECT LABOUR: it is of general character and cannot be conveniently
identified with a particular cost unit. Foreg: wages paid to supervisor,clerk,peon,
watchman, cleaner etc.
Expenses: All costs other than material and labour are termed as expenses. It is
defined as ―the cost of services provided to an undertaking
(a) DIRECT/ CHARGABLE EXPENSES: According to CIMA, UK, ―direct
expenses are those expenses which can be identified with and allocated to cost
centres or units.‖
(b) INDIRECT EXPENSES: All indirect cost , other than indirect materials and
indirect labour costs, are termed as indirect expenses.
 1. Cash discount

2. Interest paid

3. Preliminary exps

4. Goodwill written off

ITEMS 5. Provision for tax

6. Provision for bad debts

EXCLUDED 7. Transfer to reserves
FROM COST 8. Donations

9. Income tax paid

10. Dividend paid

11. Profit/loss on sale of fixed assets

12. Damages payable at law.