MSC NCBAE Management

4th Semester West Canal Campus Accounting

Cost concepts and classification
Cost: (also known as expenditure) :

Cost represent the amount invested in acquisition of goods and services which have yet not
been expired or benefits or services which have yet not been received or which have yet not
been consumed or utilised in connection with realisation of revenue.

Expense:

Expense refers to the amount invested in the acquisition of goods and services which have
been fully utilised or the benefit of which is received.

Or

It refers to all expired cost which is deductible from revenue.

Example:

Plant and machinery purchased on 1st January 1996 for Rs. 3,00,000 represents the cost but
suppose charge 10% depreciation on 31st December 1996 represents the Expense.

Classification of cost
There are many ways to classify cost but we discuss one of the best in detail.

Element /composite/ ingredient/ break up of cost:

Factory cost Head office cost

Direct material Marketing expenses

Direct labor 1) Selling expenses

FOH. 2) Distribution expenses

General and Administration expenses

Product cost= Direct Material + Direct labor + FOH

Period cost = Marketing expenses + administrative expenses

Prime cost = Direct material cost + Direct labor cost

Conversion cost = Direct labor + FOH

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4th Semester West Canal Campus Accounting
Direct Material:

It refers to the cost of all materials that forms an integral part of finished product and that can
be directly included in calculating the cost of that product. We can say that it is major
contributor of product and its cost easily identified.

Example:

 Wood in furniture.

 Cloth in garments.

 Leather in shoes.

 Bricks in construction of house.

 Wheat in flour.

Indirect material:

It refers to the material which cannot be directly and conveniently measured and charged to a product,
process or order but the cost of which have to be apportioned buy some logical and equitable method.

Example:

 Nail and polish in furniture.

 Ketchup and salad in burger.

 Buttons and thread in shirt.

Direct labor: (Touch labor)

It is all the labor expanded in converting the raw material into finished articles or in altering the
construction, composition and condition of product.

Example:

In garments factory the labor spent in tailoring a particular suit.

Indirect labor:

It is that labor cost that does not directly work on the construction or composition of finished product.

Example:

Labor of security officers, supervisor, forman, cleaners, store keepers etc.

Factory overheads (FOH):

All the expenses which are incurred in the factory up to manufacturing other than direct materials and
in direct labor are called FOH or Manufacturing expenses or factory expenses.

Prof. Faisal Shehzad (M.Com / M. Phill) Page 2

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MSC NCBAE Management
4th Semester West Canal Campus Accounting
Example:

 Indirect material

 Indirect labor

 Rent of factory

 Repairs of building and machinery

 Factory taxes

 Electricity Cost

 Depreciation of factory assets

 Insurance of factory assets

Head office expenses

Marketing expenses:(order getting and order filling cost)

The cost which is incurred in introducing a product or in increasing sale e.g. advertisement.

Selling expenses:

Cost which is incurred in selling a product is called selling expense e.g. salary and
commission of salesman.

Distribution expenses:

The cost which is incurred in delivering a product, from its production place to ultimate
consumer.e.g. carriage, freight outward, insurance etc

Administrative expenses:

All cost connected with office and it's conduct and related to the controlling and good office
management e.g. office salaries, director salaries, office rent, auditor and legal advisor fee,
postage and telegram etc.

Costs on basis of behaviour:

Fixed cost:

The cost which remains constant or fixed in total but it varies inversely as production
increases. Fixed cost decreases per unit as production increases.

Example:

Factory rent is Rs. 2000 in total if it produces 100 units of a product then fixed cost per unit
will be Rs. 20 but if it produces 200 units it will be Rs. 10 per unit.

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4th Semester West Canal Campus Accounting
Variable Cost:

The cost which remains same per unit but in total it varies as production varies.

Example:

Material cost in manufacturing one bench is Rs.500 but the cost for 4 such benches will be Rs.
2000 so as production increases variable cost increases and vice versa.

Semi variable cost:

The cost in which some portion of cost is fixed and some is variable is called semi variable
cost.

Example:

A car is taken on rent on daily basis so the rent would be fixed portion of cost while the patrol
expense on basis of mileage coverage will be variable expense.

Costs on basis of decision making

Differential cost:

The cost difference between the cost of two articles or projects is known as differential cost.

It is used for decision making in selection of a commodity or project between the range of two
or more options.

Example:

let's suppose project A costs Rs.20000 to company and project B costs Rs. 23000 the
differential cost is Rs. 3000 so the company will go for the project A.

Opportunity cost:

It is the benefit which one has to forgo for selecting other option.

Example:

Mr.Ali got job in a school as well as in college for the pay Rs. 20000 and Rs.30000
respectively. If he opts job at college then he has to forgo Rs. 20000 so this is opportunity cost
which he has to bear for choosing job at college.

Sunk cost:

The cost which has been incurred in past and which cannot be recovered is called sunk cost.

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4th Semester West Canal Campus Accounting
FINANCIAL STATEMENTS
Q #1. The following information has been extracted from the books and records of Rawal
Manufacturing Company

Material purchased Rs. 240,000

Total payroll Rs. 100,000

Direct labour Rs. 84,000

Factory office salaries Rs. 10,000

Heat and light Rs. 5,000

Power cost Rs. 3,000

Insurance (fire and other) Rs. 1,000

Indirect materials purchased and used Rs. 8,000

Superintendence Rs. 1,000

Depreciation of building Rs. 1,000

Depreciation of equipment Rs. 3,000

Factory taxes Rs. 2,000

Employer’s provident fund contribution Rs. 10,000

(94% factory, 4% selling and 2% administrative)

Tool expenses Rs. 600

Miscellaneous factory overhead costs Rs.1100 Rs. 45,700

The beginning and ending inventories were January 1 December 31

Materials Rs. 24,000 Rs. 30,000

Work in process Rs. 12,000 Rs. 8,000

Finished goods Rs. 36,000 Rs. 42,000

Required From the foregoing information prepare the cost of goods manufactured and
sold statement. On the statement the cost at normal should be indicated with
adjustment of over or under applied overhead.

Prof. Faisal Shehzad (M.Com / M. Phill) Page 5

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4th Semester West Canal Campus Accounting
Q#2. Kareem Hosiery House presents you the following data relating to the operations for the
year ended on June 30, 2011

Purchase of materials Rs. 374600

Purchases returns and allowances Rs. 7900

Direct labour cost incurred Rs. 295400

Factory overhead cost incurred Rs. 166200

Inventories

Materials inventory, July 1, 2010 Rs. 54000

Materials inventory, June 30, 2011 Rs. 34800

Work in process inventory increased by Rs. 22450

Finished goods inventory decreased by Rs. 28650

Required: Prepare cost of good manufactured and sold statement.

Q#3. Following data pertains to the operations of Sahil Ceramics Limited from May 1, 2010
to April 30, 2011

Changes in inventory Rs.

Finished goods decreased by 25,080

Work in process decreased by 21,200

Raw materials increased by 17,120

Raw materials purchased 287,360

Purchase returns and allowances 4,940

Purchase discounts 16,700

Transportation in 32,580

Direct labour cost 146,240

Manufacturing overhead incurred 129,460

Required: Prepare Cost of Goods Sold Statement.

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4th Semester West Canal Campus Accounting
Q#4. In an accounting conference, discussion turned to the possibility of preparing financial
statements from a few accounts together with financial ratios. The Assistant Controller
provided the following data.

Net income before tax for the year Rs. 1,200,000

Rate of return (income) 10% of sales

Gross profit rate 40% of sales

Rate of marketing expenses 15% of sales

5% bonds payable represent 37.5% of total liabilities Rs. 2,000,000 (two million)

Required: An Income Statement for the year based on the above information.

Q#5. The books and records of a manufacturing Co. present the following data for the
month of February

Direct labor Cost Rs. 16,000 (160% of factory overhead)

Cost of goods sold Rs. 56,000

Inventory accounts showed three opening and closing balances-

Feb. 1st (Rs.) Feb. 28 (Rs.)

Raw material 8,000 8,600

Work-in-process 8,000 12,000

Finished Goods 14,000 18,000

Other data

Marketing expenses 5% of sale.

General & Admin Expense 10% of sale

Sale for the month Rs. 75,000

Required An Income statement with supporting schedule.

Q#6. Arslan & Co. has presented the following data for the month of March

Material Purchased Rs. 110,000

Cost of goods sold Rs. 345,000

Factory Overhead was 50% of Direct Labour Cost

Inventory accounts showed opening and closing balances-

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4th Semester West Canal Campus Accounting
Opening (Rs.) Closing (Rs.)

Finished Goods 102,000 105,000

Work-in-process 40,000 36,000

Raw Material 20,000 26,000

Other data

Marketing expenses 7.5 % of sale.

General & Admin Expense 12.5 % of sale

Sale for the month Rs. 800,000

Required: Prepare an Income statement with supporting schedule.

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