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INTRODUCTION
1 Cost Accounting - Introduction 2
2 Concepts of Cost Accounting 2

3 Cost accounting –Advantages 5

4 Cost Accounting vs Financial 6

Accounting

5 Cost Accounting - Classification of 6

Cost
6 Cost Accounting - Elements of Cost 7
7 Cost Accounting - Cost Sheet 8
8 Cost Accounting - Cost Control 10
9 Cost Accounting - Cost Reduction 11
10 Cost Accounting - Budgeting Analysis 11
11 Cost Accounting - Marginal Costing 13
12 Cost Accounting - Standard Costing 15
13 Cost Accounting - Variance Analysis 16
14 Cost Accounting - CVP Analysis 16
 1.Cost Accounting - Introduction
Cost accounting is the application of accounting and costing principles,
methods, and techniques in the ascertainment of costs and the analysis of
saving or excess cost incurred as compared with previous experience or with
standards.
…Wheldon.

2. Concepts of Cost Accounting

 Cost

There is a cost involved to purchase or produce anything. Costs may be different

for the same product, depending upon the stages of completion. The cost changes
according to the stage a product is in, for example, raw material, work in
progress, finished goods, etc. The cost of a product cannot be perfect and it may
vary for the same product depending upon different constraints and situations of
production and market.

 Expenses

Some costs are actual, such as raw material cost, freight cost, labor cost, etc.
Some expenses are attributable to cost. To earn revenue, some expenses are
incurred like rent, salary, insurance, selling & distribution cost, etc. Some
expenses are variable, some are semi-variable, and some of fixed nature.

 Loss

Expenses are incurred to obtain something and losses are incurred without any
compensation. They add to the cost of product or services without any value
addition to it.

 Cost Center

Cost center refers to a particular area of activity and there may be multiple cost
centers in an organization. Every cost center adds some cost to the product and
every cost center is responsible for all its activity and cost. A cost center may also
be called a department or a sub-department.
  Profit Center

Profit centers are inclusive of cost centers as well as revenue activities. Profit
centers set targets for cost centers and delegates responsibilities to cost centers.
Profit centers adopt policies to achieve such targets. Profit centers play a vital role
in an organization.

 Cost Drivers

Cost of any product depends upon cost drivers. There may be different types of
cost drivers such as number of units or types of products required to produce. If
there is any change in cost driver, the cost of product changes automatically.

 Conversion Cost

The cost required to convert raw material into product is called as conversion
cost. It includes labour, direct expenses, and overhead.

 Carrying Costs

Carrying cost represents the cost to maintain inventory, lock up cost of inventory,
store rent, and store operation expenses.

 Out of Stock Cost

Sometimes loss is incurred due to shortage of stock such as loss in sale, loss of
goodwill of a business or idle machine. It is called out of stock cost.

 Contribution Margin

Contribution margin is the difference between sale price and variable cost.

 Ordering Costs

Ordering costs represent the cost to place an order, up to to stage until the
material is included as inventory.

 Development Cost

To develop new product, improve existing product, and improved method in

producing a product called development cost.
  Policy Cost

The cost incurred to implement a new policy in addition to regular policy is called
policy cost.

 Idle Facilities Cost and Idle Capacity Cost

If available facilities remain idle and some loss incurred due to it, it is called idle
facilities cost. If capacity is unused due to repair, shut down or any other reason,
it is called capacity cost.

 Expired Cost

When the cost is fully consumed and no future monetary value could be
measured, it is called expired cost. Expired cost relates to current cost. Suppose
the expenses incurred in an accounting period do not have any future value, then
it is called an expired cost.

 Incremental Revenue

Incremental revenue implies the difference in revenues between two alternatives.

While assessing the profitability of a proposed alternative, incremental revenues
are compared with incremental costs.

 Added Value

Added value means value addition to any product. Value addition of the product
may be due to some process on product or to make the product available or there
may be other reasons; but it also includes the profit share on it.

 Urgent Cost

There are some expenses that are to be incurred on an immediate basis. Delaying
such expenses may result in loss to business. These expenses are called urgent
cost. Urgent costs are not be postponed.

 Postponable Cost

Without avoiding any expenses, if we are able to defer some expenses to future,
then it is called a postponable cost.
  Pre-production Cost

The cost incurred before commencing formal production or at the time of

formation of new establishment or project is called pre-production cost. Some of
these costs are of capital nature and some of these are called deferred revenue
expenditure.

 Research Cost

Research costs are incurred to discover a new product or to improve an existing

product, method, or process.

 Training Cost

The costs incurred on teaching, training, apprentice of staff or worker inside or

outside the business premise to improve their skills is called training cost.

3. Cost Accounting – Advantages

 Guidance for future production policies
 Periodical determination of profit and losses
 To find out exact cause of decrease or increase in profit
 Control over material and supplies
 Relative efficiency of different workers
 Reliable comparison
 Helpful to government
 Helpful to consumers
 Classification and subdivision of costTo find out adequate selling price
 Proper investment in inventory

 Correct valuation of inventory

 Decision on manufacturing or purchasing from outside
 Reliable check on accounting
 Budgeting
 4.Cost Accounting Vs Financial
Accounting
Both cost accounting and financial accounting help the management formulate
and control organization policies. Financial management gives an overall picture
of profit or loss and costing provides detailed product-wise analysis.

No doubt, the purpose of both is same; but still there is a lot of difference in
financial accounting and cost accounting. For example, if a company is dealing in
10 types of products, financial accounting provides information of all the products
in totality under different categories of expense heads such as cost of material,
cost of labor, freight charges, direct expenses, and indirect expenses. In contrast,
cost accounting gives details of each overhead product-wise, such as much
material, labor, direct and indirect expenses are consumed in each unit. With the
help of costing, we get product-wise cost, selling price, and profitability.

5. Cost Accounting - Classification of

Cost

 By Nature

In this type, material, labour and overheads are three costs, which can be further
sub-divided into raw materials, consumables, packing materials, and spare parts
etc.

 By Degree of Traceability of the Product

Direct and indirect expenses are main types of costs come under it. Direct
expenses may directly attributable to a particular product. Leather in shoe
manufacturing is a direct expenses and salaries, rent of building etc. come under
indirect expenses.

 By Controllability

In this classification, two types of costs fall:

  Controllable - These are controlled by management like material labour and
direct expenses.
 Uncontrollable - They are not influenced by management or any group of
people. They include rent of a building, salaries, and other indirect expenses.
 By Relationship with Accounting Period

Classifications are measured by the period of use and benefit. The capital
expenditure and revenue expenditure are classified under it. Revenue expenses
relate to current accounting period. Capital expenditures are the benefits beyond
accounting period.

 By Association with the Product

There are two categories under this classification:

 Product cost - Product cost is identifiable in any product. It includes direct

material, direct labour and direct overheads.
 Time/Period base cost - Selling expenditure and Administrative
expenditure, both are time or period based expenditures.

6. Cost Accounting - Elements of Cost

The following chart shows the various elements of cost and how they are
classified.
  Direct or Indirect Materials

The materials directly contributed to a product and those easily identifiable in the
finished product are called direct materials. For example, paper in books, wood in
furniture, plastic in water tank, and leather in shoes are direct materials. They are
also known as high-value items. Other lower cost items or supporting material
used in the production of any finished product are called indirect material. For
example, nails in shoes or furniture.

 Direct Labour

Any wages paid to workers or a group of workers which may directly co-relate to
any specific activity of production, supervision, maintenance, transportation of
material, or product, and directly associate in conversion of raw material into
finished goods are called direct labour. Wages paid to trainee or apprentices does
not comes under category of direct labour as they have no significant value.

 Overheads

Indirect expenses are called overheads, which include material and labor.
Overheads are classified as:

 Production or manufacturing overheads

  Administrative expenses
 Selling Expenses
 Distribution expenses
 Research and development expenses

7. Cost Accounting - Cost Sheet

A cost sheet is prepared to know the outcome and breakup of costs for a
particular accounting period. Columnar form is most popular. Although cost
sheets are prepared as per the requirements of the management, the information
to be incorporated in a cost sheet should comprise of cost per unit and the total
cost for the current period along with the cost per unit and the total cost of
preceding period. Data of financial statement is used for preparation of cost
sheet. Therefore, reconciliation of cost sheet and financial statement should be
done on a regular interval.

 Format
 COST SHEET OR STATEMENT OF COST
Total Units………

Opening Stock of Raw material ... ... ... ... ... ... ... ...

Add: Purchases ... ... ... ... ... ... ... ...

... ... ... ... ... ... ... ...

Less: Closing Stock ... ... ... ... ... ... ... ...

Cost of material Consumed → ... ... ... ... ... ... ... ...

Add: Direct Labor/Wages ... ... ... ... ... ... ... ...

Prime Cost → ... ... ... ... ... ... ... ...

Add: Works overheads ... ... ... ... ... ... ... ...

Works Cost → ... ... ... ... ... ... ... ...
 Add: Administration overheads ... ... ... ... ... ... ... ...

Cost of Production → ... ... ... ... ... ... ... ...

Add: Selling and distribution overheads ... ... ... ... ... ... ... ...

Total Cost or Cost of Sale → ... ... ... ... ... ... ... ...

8. Cost Accounting - Cost Control

Conceptually, accounting is the discipline that provides information on which

external and internal users of the information may base decision that result in the
allocation of economic resource in society.
...Slavin and Reynolds

 Cost Control Techniques

Costs can be controlling by employing the following methods:

 Material Control
 Labour Control
 Overheads Control
 Standard costing
 Budgetary Control
 Capital Expenditure Control
 Productivity and Accounting Ratios

 Requirements for Successful Cost Control

The following requirements are to be fulfilled to implement successful cost
control:

 A plan and a set of well-defined responsibilities to all executives are

essential.
 Highlights of good and bad, both performances to enable the management
to take corrective steps.
 Reward for good performances and Punishment for the poor ones.
 
 Clear definition of tasks for performance and cost to execute those tasks.
 A fixed responsibility, in case of deviation between targeted and actual.

9. Cost Accounting - Cost Reduction

Cost reduction is to be understood as the achievement of real and permanent

reduction in the unit cost of goods manufactured or services rendered without
impairing their suitability for the use intended or diminution in the quality of
product.
… The institute of Management Accountants, London

There are only two ways to maximize profit of any organization: either to increase
sale price of unit, or to reduce cost of that unit. Both above cases may result into
gaining good profit. As we are seeing today, most of the businesses are facing tough
competitive market situation where increase in sale price may result in to loss of
sale. Increasing sale price is possible only in case of those products where the
company is dealing in monopoly items and we all are aware that this situation
cannot prolong for any company and its products. Therefore, cost reduction is only
one scientific way to deal with this situation; provided it is real and permanent.
Cost reduction should not be the result of any temporary decrement in cost of raw
material, change in government polices etc. and most importantly, reduction of
cost should not be on price of quality of that product.
Tools and Techniques of Cost Reduction

The following tools and techniques are used to reduce costs:

 Budgetary Control
 Standard Costing
 Simplification and Variety Reduction
 Planning and Control of Finance
 Cost Benefit Analysis
 Value Analysis
 Contribution Analysis
 Job Evaluation and Merit Rating
 10. Cost Accounting - Budgeting Analysis
We are all well-familiar with the term budget. Budgeting is a powerful tool that
helps the management in performing its functions such as planning, coordinating,
and controlling the operations efficiently. The definition of budget is,

A plan quantified in monetary terms prepared and approved prior to a define

period of time usually showing planned income to be generated and/or
expenditure to be incurred during the period and the capital to be employed to
attain a given objective.
---CIMA, England
Budget, Budgeting, and Budgetary Control

Let us go through the terms sequentially.

 Budget

Budget represents the objectives of any organization that is based on the

implication of forecast and related to planned activities.

Budget is neither an estimate nor a forecast because an estimation is a

predetermination of future events, may be based on simple guess or any scientific
principles.

Similarly, a forecast may be an anticipation of events during a specified period of

time. A forecast may be for a specific activity of the company. We normally
forecast likely events such as sales, production, or any other activity of the
organization.

On the other hand, budget relates to planned policy and program of the
organization under planed conditions. It represents the action according to a
situation which may or may not take place.

 Budgeting

Budgeting represents the formation of the budget with the help and coordination
of all or the various departments of the firm.
  Budgetary Control

Budgetary control is a tool for the management to allocate responsibility and

authority in planning for future and to develop a basis of measurement to
evaluate the efficiency of operations.

A budget is a plan of the policy to be pursued during a defined time period. All the
actions are based on planning of budget because budget is prepared after
studying all the related activities of the company. Budget gives a communication
ground to the top management with the staff of the firm who are implementing
the policies of the top management.

Budgetary control helps in coordinating the economic trends, financial position,

policies, plans, and actions of an organization.

Budgetary control also helps the management to ensure and control the plan and
activities of the organization. Budgetary control makes it possible by continuous
comparison of actual performance with that of the budgets.

Types of Budgets
 Functional Budgets
 Sales Budget
 Production Budget
 Material Budget
 Manufacturing Budget
 Administrative Cost Budget
 Plant Utilization Budget
 Capital Expenditure Budget
 Research and Development Cost Budget
 Cash Budget

 Cash Budget
 Collection of Cash
 Cash Payments
 Selling Expenses and administrative expensive budget
Flexible Budget
Flexible budget provides logical comparison. The actual cost at the actual activity is
compared with the budgeted cost at the time of preparing a flexible budget.
Flexibility recognizes the concept of variability.

 Cost Accounting Techniques

 

11. Cost Accounting - Marginal Costing

Marginal cost is the change in the total cost when the quantity produced is
incremented by one. That is, it is the cost of producing one more unit of a good.
For example, let us suppose:

Variable cost per unit = Rs 25

Fixed cost = Rs 1,00,000
Cost of 10,000 units = 25 × 10,000 = Rs 2,50,000
Total Cost of 10,000 units = Fixed Cost + Variable Cost
= 1,00,000 + 2,50,000
= Rs 3,50,000
Total cost of 10,001 units = 1,00,000 + 2,50,025
= Rs 3,50,025
Marginal Cost = 3,50,025 – 3,50,000
= Rs 25

Income Statement under Marginal Costing

Income Statement
For the year ended 31-03-2014

Particulars Amount Total

Sales 25,00,000

Less: Variable Cost:

Cost of goods manufactured 12,00,000

Variable Selling Expenses 3,00,000

Variable Administration Expenses 50,000

15,50,000
 Contribution 9,50,000

Less: Fixed Cost:

Fixed Administration Expenses 70,000

Fixed Selling Expenses 1,30,000 2,00,000

7,50,000

o Advantages of Marginal Costing

The advantages of marginal costing are as follows:

 Easy to operate and simple to understand.

 Marginal costing is useful in profit planning; it is helpful to determine
profitability at different level of production and sale.
 It is useful in decision making about fixation of selling price, export decision
and make or buy decision.
 Break even analysis and P/V ratio are useful techniques of marginal costing.
 Evaluation of different departments is possible through marginal costing.

12. Cost Accounting - Standard Costing

Standard costing tells us what should be the cost of the product and if the actual
cost exceeds the projected cost, the standard costing system can point to the
reason of deviation.
Points Related to Standard Costing
 Standard costing includes pre-determination of costs under specific working
conditions.
 In this process, the standard quantity of machine time, labor time, and
material is calculated and the future market trend for price standards is
analyzed.
 Standard costing helps in variance analysis.
  Along with fixation of sale price, it also provides valuation of stock and work
in progress.
 Material, labor, and overheads cost are ascertained.
 Actual cost is measured.

13. Cost Accounting - Variance Analysis

When the actual cost differs from the standard cost, it is called variance. If the
actual cost is less than the standard cost or the actual profit is higher than the
standard profit, it is called favorable variance. On the contrary, if the actual cost
is higher than the standard cost or profit is low, then it is called adverse variance.

Each element of cost and sales requires variance analysis. Variance is classified as
follows:

 Direct Material Variance

 Direct Labor Variance
 Overhead Variance
 Sales Variance
Direct Material Variance

Material variances can be of the following categories:

 Material Cost Variance

 Material Price Variance
 Material Usage Variance
 Material Mix Variance
 Material Yield Variance
Direct Labour Variance

Direct labour variances are categorized as follows:

 Labour Cost Variance

 Labour Rate of Pay Variance
 Total Labour Efficiency Variance
 Labour Efficiency Variance
 Labour Idle Time Variance
 Labour Mix Variance or Gang Composition Variance
 Labour Yield Variance or Labour Efficiency Sub Variance
 Substitution Variance
 14. Cost Accounting - CVP Analysis

Cost-Volume-Profit (CVP) Analysis is also known as Break–Even Analysis. Every

business organization works to maximize its profits. With the help of CVP analysis,
the management studies the co-relation of profit and the level of production.

CVP analysis is concerned with the level of activity where total sales equals the
total cost and it is called as the break-even point. In other words, we study the
sales value, cost and profit at different levels of production. CVP analysis
highlights the relationship between the cost, the sales value, and the profit.

 Assumptions
Let us go through the assumptions for CVP analysis:

 Variable costs remain variable and fixed costs remain static at every level of
production.
 Sales volume does not affect the selling price of the product. We can assume
the selling price as constant.
 At all level of sales, the volume, material, and labor costs remain constant.
 Efficiency and productivity remains unchanged at all the levels of sales
volume.
 The sales-mix at all level of sales remains constant in a multi-product
situation.
 The relevant factor which affects the cost and revenue is volume only.
 The volume of sales is equal to the volume of production.