Cost Accounting

1. Introduction
As compared to the financial accounting, the focus of cost accounting is different. In the modern days of
cut throat competition, any business organization has to pay attention towards their cost of production.
Computation of cost on scientific basis and thereafter cost control and cost reduction has become of
paramount importance. Hence it has become essential to study the basic principles and concepts of
cost accounting. These are discussed in the subsequent paragraphs.

1.1 Cost :- Cost can be defined as the expenditure (actual or notional) incurred on or attributable
to a given thing. It can also be described as the resources that have been sacrificed or must be
sacrificed to attain a particular objective. In other words, cost is the amount of resources used for
something which must be measured in terms of money. For example – Cost of preparing one cup
of tea is the amount incurred on the elements like material, labor and other expenses, similarly
cost of offering any services like banking is the amount of expenditure for offering that service.
Thus cost of production or cost of service can be calculated by ascertaining the resources used for
the production or services.

1.2 Costing :- Costing may be defined as ‘the technique and process of ascertaining costs’. According
to Wheldon, ‘Costing is classifying, recording, allocation and appropriation of expenses for
the determination of cost of products or services and for the presentation of suitably arranged
data for the purpose of control and guidance of management. It includes the ascertainment of
every order, job, contract, process, service units as may be appropriate. It deals with the cost of
production, selling and distribution.
If we analyze the above definitions, it will be understood that costing is basically the procedure
of ascertaining the costs. As mentioned above, for any business organization, ascertaining of costs
is must and for this purpose a scientific procedure should be followed. ‘Costing’ is precisely this
procedure which helps them to find out the costs of products or services.

1.3 Cost Accounting :- Cost Accounting primarily deals with collection, analysis of relevant of cost
data for interpretation and presentation for various problems of management. Cost accounting
accounts for the cost of products, service or an operation. It is defined as, ‘the establishment of
budgets, standard costs and actual costs of operations, processes, activities or products and the
analysis of variances, profitability or the social use of funds’.

1.4 Cost Accountancy :- Cost Accountancy is a broader term and is defined as, ‘the application of
costing and cost accounting principles, methods and techniques to the science and art and practice
of cost control and the ascertainment of profitability as well as presentation of information for the
purpose of managerial decision making.’
If we analyze the above definition, the following points will emerge,
A. Cost accounting is basically application of the costing and cost accounting principles.
B. This application is with specific purpose and that is for the purpose of cost control, ascertainment
of profitability and also for presentation of information to facilitate decision making.
C. Cost accounting is a combination of art and science, it is a science as it has well defined rules
and regulations, it is an art as application of any science requires art and it is a practice as it
has to be applied on continuous basis and is not a onetime exercise.
1.5 Objectives of Cost Accounting:- Objectives of Cost Accounting can be summarized as under
1. To ascertain the cost of production on per unit basis, for example, cost per kg, cost per meter,
cost per liter, cost per ton etc.
2. Cost accounting helps in the determination of selling price. Cost accounting enables to
determine the cost of production on a scientific basis and it helps to fi x the selling price.
3. Cost accounting helps in cost control and cost reduction.
4. Ascertainment of division wise, activity wise and unit wise profitability becomes possible
through cost accounting.
5. Cost accounting also helps in locating wastages, inefficiencies and other loopholes in the
production processes/services offered.
6. Cost accounting helps in presentation of relevant data to the management which helps in
decision making. Decision making is one of the important functions of Management and it
requires presentation of relevant data. Cost accounting enables presentation of relevant data
in a systematic manner so that decision making becomes possible.
7. Cost accounting also helps in estimation of costs for the future.

2. Classification of Costs :- An important step in computation and analysis of cost is the classification
of costs into different types. Classification helps in better control of the costs and also helps
considerably in decision making. Classification of costs can be made according to the following basis.

A. Classification according to elements :- Costs can be classified according to the elements. There
are three elements of costing, viz. material, labor and expenses. Total cost of production/
services can be divided into the three elements to find out the contribution of each element in
the total costs.

B. Classification according to nature :- As per this classification, costs can be classified into
Direct and Indirect. Direct costs are the costs which are identifiable with the product unit
or cost center while indirect costs are not identifiable with the product unit or cost center
and hence they are to be allocated, apportioned and then absorb in the production units. All
elements of costs like material, labor and expenses can be classified into direct and indirect.
They are mentioned below.
i. Direct and Indirect Material :- Direct material is the material which is identifiable with
the product. For example, in a cup of tea, quantity of milk consumed can be identified,
quantity of glass in a glass bottle can be identified and so these will be direct materials
for these products. Indirect material cannot be identified with the product, for example
lubricants, fuel, oil, cotton wastes etc cannot be identified with a given unit of product
and hence these are the examples of indirect materials.
ii. Direct and Indirect Labor :- Direct labor can be identified with a given unit of product,
for example, when wages are paid according to the piece rate, wages per unit can be
identified. Similarly wages paid to workers who are directly engaged in the production
can also be identified and hence they are direct wages. On the other hand, wages paid to
workers like sweepers, gardeners, maintenance workers etc are indirect wages as they
cannot be identified with the given unit of production.
iii. Direct and Indirect Expenses :- Direct expenses refers to expenses that are specifically
incurred and charged for specific or particular job, process, service, cost center or cost
unit. These expenses are also called as chargeable expenses. Examples of these expenses
are cost of drawing, design and layout, royalties payable on use of patents, copyrights
etc, consultation fees paid to architects, surveyors etc. Indirect expenses on the other
hand cannot be traced to specific product, job, process, service or cost center or cost
unit. Several examples of indirect expenses can be given like insurance, electricity, rent,
salaries, advertising etc.
It should be noted that the total of direct expenses is known as ‘Prime Cost’ while the total of
all indirect expenses is known as ‘Overheads’.

C. Classification according to behavior :- Costs can also be classified according to their behavior.
This classification is explained below.
i. Fixed Costs :- Out of the total costs, some costs remain fixed irrespective of changes in
the production volume. These costs are called as fixed costs. The feature of these costs is
that the total costs remain same while per unit fixed cost is always variable. Examples of
these costs are salaries, insurance, rent, etc.
Cost and Management Accounting
ii. Variable Costs :- These costs are variable in nature, i.e. they change according to the
volume of production. Their variability is in the same proportion to the production. For
example, if the production units are 2,000 and the variable cost is Tk. 5 per unit, the total
variable cost will be Tk. 10,000, if the production units are increased to 5,000 units, the
total variable costs will be Tk. 25,000, i.e. the increase is exactly in the same proportion
of the production. Another feature of the variable cost is that per unit variable cost
remains same while the total variable costs will vary. In the example given above, the
per unit variable cost remains Tk. 2 per unit while total variable costs change. Examples
of variable costs are direct materials, direct labor etc.
iii. Semi-variable Costs :- Certain costs are partly fixed and partly variable. In other words,
they contain the features of both types of costs. These costs are neither totally fixed nor
totally variable. Maintenance costs, supervisory costs etc are examples of semi-variable
costs. These costs are also called as ‘stepped costs’.
D. Classification according to functions :- Costs can also be classified according to the functions/
activities. This classification can be done as mentioned below.
i. Production Costs :- All costs incurred for production of goods are known as production costs.
ii. Administrative Costs :- Costs incurred for administration are known as administrative
costs. Examples of these costs are office salaries, printing and stationery, office telephone,
office rent, office insurance etc.
iii. Selling and Distribution Costs :- All costs incurred for procuring an order are called as
selling costs while all costs incurred for execution of order are distribution costs. Market
research expenses, advertising, sales staff salary, sales promotion expenses are some of
the examples of selling costs. Transportation expenses incurred on sales, warehouse rent
etc are examples of distribution costs.
iv. Research and Development Costs :- In the modern days, research and development has
become one of the important functions of a business organization. Expenditure incurred
for this function can be classified as Research and Development Costs.

3. Cost Sheet
Cost Sheet is a statement of cost showing the total cost of production and profit or loss from a
particular product or service. A Cost Sheet shows the cost in a systematic manner and element
wise. A typical format of the Cost Sheet is given below.

A glance at the above cost sheet will reveal that it works out the total cost of production/service
in a phased manner. In other words, total costs are segregated into elements like Prime Cost,
Factory or Works Cost, Cost of Production, Cost of Sales and finally the profit/loss is worked out
by comparing the total cost with the selling price. Appropriate adjustments are made for opening
and closing stock of Work in Progress and also opening and closing stock of finished goods. The
format of cost sheet may be suitably changed according to the requirements of each firm but the
basic form remains the same.

4. Cost Control and Reduction :- One of the important functions of cost accounting is cost control
and cost reduction. Cost control implies various actions taken in order to ensure that the cost
do not rise beyond a particular level while cost reduction means reducing the existing cost of
production. Both these concepts are discussed below.
4.1 Cost Control :- As mentioned above, cost control means keeping the expenses within limits or
control. Cost control has the following features.
A. Cost control is a continuous process. It involves setting standards and budgets for
deciding targets of different expenses and constant comparison of actual the budgeted and
standards.
B. Cost control involves creation of responsibilities center with clearly defi ned authorities and
responsibilities.
C. It also involves, timely cost control reports showing the variances between standard and
actual performance.
D. Motivating and encouraging employees to accomplish budgetary goals is also one of the
essential aspects of cost control.
E. Actually cost control not only means monetary limits on cost but it also involves optimum
utilization of resources or performing the same job at same cost.

4.2 Cost Reduction :- Cost control means attempts to reduce the costs. For example, if the present
costs are Tk. 1,000 per unit, attempts can be made to reduce it to bring it down below Tk. 1,000. For
doing this, all out efforts will have to be made for achieving this target. The goal of cost reduction
can be achieved in two ways, first is reducing the cost per unit and the second one is increasing
productivity. Reducing wastages, improving efficiency, searching for alternative materials, and
a constant drive to reduce costs, can effect cost reduction. The following tools and techniques are
normally used for cost reduction.
A. Value analysis or value engineering.
B. Setting standards for all elements of costs and constant comparison of actual with standard
and analysis of variances.
C. Work study
D. Job evaluation and merit rating
E. Quality control
F. Use of techniques like Economic Order Quantity
G. Classification and codification
H. Standardization and simplification
I. Inventory management
J. Benchmarking
K. Standardization
L. Business Process Re-engineering.
Problems
1. From the books of accounts of XYZ Company Ltd., the following details have been extracted for
the year ending March 31, 2018.

Particulars Taka Particulars Taka

Inventories on 1st April 2017: Freight of materials 10,000
Finished Stock 80,000 Purchase return 8,000
Raw Materials 30,000 Inventories on 31st March 2018:
Work-in-progress 40,000 Finished Stock 40,000
Material purchased during Raw Materials
the year 1,100,000 60,000
Direct labor paid 650,000 Work-in-progress 15,000
Chargeable expenses 100,000
Factory overhead @ 50% of direct labor; Administrative overheads @ 10% of works cost; Selling
overheads @ 10% of cost of goods sold; Profit 25% of sales.

From the above details you are required to prepare a cost sheet showing:
i) Prime cost;
ii) Net works cost;
iii) Cost of Goods Manufactured;
iv) Cost of Goods Sold and
v) Sales.

Solution 1: XYZ Company Ltd

Statement of Cost
For the period Ended March 31, 2018
Particulars Taka Taka
Opening Stock of materials 30,000
Material purchased during the year 1,100,000
Less: Purchase Return (8,000)
Freight of materials 10,000
Rawmaterial available for use 1,132,000
Less: Closing Stock of materials (60,000)
Rawmaterial Used/Consumed 1,072,000
Add: Direct Expenses
Direct Labor 650,000
Chargeable Expenses 100,000 750,000
i. Prime cost 1,822,000
Add: Factory Overhead:
Factory Overhead @ 50% of Direct labor 325,000
ii. Works cost 2,147,000
Add: Opening Work in Progress 40,000
2,187,000
Less: Closing Work in Progress (15,000)
iii. Cost of Goods Manufactured 2,172,000
Add: Opening Finished stock 80,000
2,252,000
Less: Closing Finished Stock (40,000)
iv. Cost of Goods Sold 2,212,000
Add: Office and Administrative Overhead
214,700
Administrative overheads @ 10% of works cost
Add: Marketing and Selling Expenses:
Selling overheads @ 10% on cost of sales 221,200
Total Expenses 2,647,900
Profit 25% on sale or 33.33% on Total Expenses 882,545
v. Sales 3,530,445

2. From the books of accounts of XYZ Company Ltd., the following details have been extracted for
the year ending December 31, 2015.
Particulars Taka
Stock materials: Opening 188,000
Closing 200,000
Material purchased during the year 832,000
Direct wages paid 238,000
Indirect wages 16,000
Salaries to administrative staff 40,000
Freight: Inward 32,000
Outward 20,000
Cash discount allowed 14,000
Bad debts written off 18,000
Repairs to plant and machinery 42,000
Rent, rates, taxes: Factory 12,000
Office 6,400
Travelling expenses 12,400
Salesman salaries and commission 33,600
Depreciation written off: Plant and Machinery 28,400
Furniture 2,400
Director fees 24,000
Electricity charges (factory) 48,000
Fuel (for boiler) 64,000
General Manager's salary 48,000
From the above details you are required to prepare a statement showing:
i) Prime cost
ii) factory cost and
iii) total cost.
 Break Even Point

The concept of ‘Break Even Point’ is extremely important for decision making in various areas. This
concept is based on the behavior of costs, i.e. fixed cost and variable costs. As discussed earlier, fixed
costs are those costs that remain constant irrespective of the changes in the volume of production. On
the other hand, variable costs are the costs that vary with the level of production. While fixed cost per
unit is always variable, variable cost per units is always fixed. In addition to these two types of costs,
there are semi variable costs that are partially fixed and partially variable. Semi variable costs thus have
the features of both types of costs. They remain fixed up to a certain level of production and after
crossing that level, they become variable.
The Break Even Point is a level of production where the total costs are equal to the total revenue, i.e.
sales. Thus at the break even level, there is neither profit nor loss. Production level below the break-
even-point will result into loss while production above break-even point will result in profits.

Break even level can also be worked out with the help of the following formulae.

Fixed Cost
Break even point [in units] =
Contribution per Unit

Fixed Cost
Break even point [in Tk.] =
Profit Volume [P/V] Ratio
Break even point can also be shown on the graph paper as follows:

Explanation: On horizontal axis, production and sales volume is shown while on the vertical axis, sales
and costs in amount are shown.
Assumptions of Break Even Point: The concept of break even point is based on the following
assumptions.
1. Production and sales are the same, which means that as much as is produced is sold out in the
market. Thus there is no inventory remaining at the end.
2. Fixed cost remains same irrespective of the production volume.
3. Variable cost varies with the production. It changes in the same proportion that of the
production. Hence it has a linear relationship with the production. In other words, variable cost per
unit remains the same.
4. Selling price per unit remains same irrespective of the quantity sold.

Margin of Safety: Margin of Safety is the difference between the actual sales and the break even
sales. As we have discussed, at the break even point there is neither any profit nor loss. Hence any firm
will always be interested in being as much above the break even level as possible. Margin of safety
explains precisely this thing and the higher the safety margin the better it is. Margin of safety is
computed as follows.

Margin of Safety = Actual Sales – Break Even Sales.

Limitations of Break even Point: Break Even point is extremely useful in decision- making regarding
the production level. It indicates the level of production where there is neither any profit nor loss.
However this is based on the assumption that the variable cost per unit, sales price per unit and the
fixed cost remains the same. If there is any change in these variables, the break even point will give
misleading results.

Problems and Solutions:

1. A Company budgets for a production of 150000 units. The variable cost per unit is Tk.14 and fixed
cost per unit is Tk.2 per unit. The company fixes the selling price to fetch a profit of 15% on cost.
Required:
A. What is the break- even point?
B] What is the profit/volume ratio?
C] If the selling price is reduced by 5%, how does the revised selling price affects the Break Even Point
and the Profit/Volume Ratio?
D] If profit increase of 10% is desired more than the budget, what should be the sales at the reduced
price?
Solution:
Fixed Cost
A] Break Even Point =
Contribution per Unit
Tk.2 X 1,50,000 units
=
Tk.18.40 – Tk.14.00
Tk.3,00,000
=
Tk.4.40
= 68,182 units.
Note: Contribution per unit is computed as shown below.
Selling Price per unit = Total Cost + 15% Profit on cost
= [Tk.14 variable cost + Tk.2 fixed cost] + [15% of Tk.16]
= Tk. 16 + Tk.2.40
= Tk.18.40
Contribution = Selling Price – Variable Cost
= Tk.18.40 – Tk.14
= Tk.4.40

Contribution Per Unit

B] Profit/Volume Ratio: X 100
Selling Price Per Unit
Tk.4.40
= X 100
Tk.18.40
= 23.91%

C] Reduction in selling price by 5%:

Reduced selling price = Tk.18.40 – (5% of Tk.18.40)
= Tk.17.48
Revised contribution = Tk.17.48 – Tk.14.00 = Tk.3.48

Fixed Cost
Break Even Point =
Contribution per Unit
Tk.3,00,000
=
Tk.3.48
= 86,207 units

D] Desired profit per unit = Tk.2.40 + (10% of Tk.2.40)

= Tk.2.64 per unit
Total Desired Profits = Tk.2.64 X 1,50,000 units
= Tk.3,96,000

Desired Contribution = Total Desired Profits + Total Fixed Costs

= Tk.3,96,000 + Tk.3,00,000
= Tk.6,96,000
Total Contribution
Quantity to be sold =
Revised Contribution Per Unitt
Tk.6,96,000
=
Tk.3.48
= 2,00,000 units
Sales Value = 2,00,000 units X Tk.17.48
= Tk.34,96,000.
2. Menlo Company distributes a single product. The company’s sales and expenses for last Month
are following:

Total Tk. Per Unit Tk.

Sales 450,000 30
Variable expenses 180,000 12
Contribution margin 270,000 18
Fixed expenses 216,000
Net operating income 54,000

Required:
i. What is the monthly break-even point in units sold and in sales taka?
ii. Without resorting to computations, what is the total contribution margin at the break-
even point?
iii. How many units would have to be sold each month to earn a target profit of tk. 90,000?
iv. Refer to the original data. Compute the company’s margin of safety in both taka and
percentage terms.

3. Voltar Company manufactures and sells a specialized cordless telephone for high
electromagnetic radiation environments. The company’s contribution format income statement
for the most recent year is given below:
Total Per Unit Percent of Sales
Sales (20,000 units) .....................Tk.1,200,000 Tk.60 100%
Variable expenses .......................... 900,000 45 ?%
Contribution margin ........................ 300,000 Tk. 15 ?%
Fixed expenses .............................. 240,000
Net operating income .....................Tk. 60,000
Management is anxious to increase the company’s profit and has asked for an analysis of a
number of items.
Required:

i. Compute the company’s CM ratio and variable expense ratio.

ii. Compute the company’s break-even point in both units and sales Tk. Use the equation method.
iii. Assume that sales increase by Tk.400,000 next year. If cost behavior patterns remain
unchanged, by how much will the company’s net operating income increase? Use the CM ratio to
compute your answer.