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21 views9 pagesCost Accounting
cost accounting
Uploaded by
shivam748806Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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/ 9
General PRINCIPLES
| 23
CLASSIFICATION OF Costs
fore ee semi-variable and step cost:
fe cost which increases or ee
r lecrease: i
|| output increases or decreases is known = eee in the same proportion in which the yolume of
oT 7 © Cos:.’ The cost which rema or cor
; f i i : t which remains static or constai
espective of Changes in output is regarded as fixed cost $ a matter of fact this concept of
pt
| fixed and variable costs holds goods in short ru at
| practice, no cost increases or decreases ropértion ial ee eee cea nee
10| ino cost remains static for all volumes of out nately with the increase or decrease in output and
| to vary with output or those which havea mafor‘elation lft at end eae ne
A0| costs’ and those costs whick {or relation with output should be termed as ‘variable
s ich tend to be constant at different volumes of out vhich hi
09) significant relation with output should be termed as" ied costs The ned cots have relationship
Op| with time. The costs which neither very as fixed costs.’ The fixed costs have relationship
j ene ater neither very proportionately nor remain stationary are called ‘semi-
00, variable’ or ‘semi-fixed costs.” Ifa cost varies more than proportionately, then also itis a sem:
[00 Variable cost. Depreciation repairs supervision costs etc. are good examples of semi-variable
509) $688. Rent, insurance charges, management salaries—which are examples of fixed costs, also vary”
with inflationary trends in the economy and change in market forces. Volume of output may, also.
affect them but these are not the main influencing factors and hence such costs shall be termed as
600| “xed costs’. Variable costs like wages of labourers, cost of direct material, power etc. also vary
000| disproportionately with output because of the same reasons but here volume of output is the
000) major influencing factor and hence these costs shall be termed as ‘variable costs’.
000) Theoretically speaking, variable cost remains constant per unit of output and fixed cost
i fant in total or per unit of time.
inthe system of direct costi Fixed costs can be further classified into (i) committed Fino cons
and (ij) discretionary fixed costs. Committed xed casts 2 unavoidable in short um ifthe
5, 400| 274 (HD) discret ort snction, Examples of such fixed Costs a tee a moun an
5,600) oi to Fane ecretinary fixed costs are those which are set at a fixed amount for
000, ee ic by management in the budgeting process. Examples of such costs are research
5.00 Sprfetine erie mete and re rae exes, Cea a
: "level as activity changes. Such costs are
old 2d eriind then jump to a new level 2 anges.
s solt| fixed over a range of activity a eeman is in a position to supervise a given number of
ef 7 le, :
bE treated as “step Costs- eet i be necessary t0 hire a second, then a third and so on.
Z| aaah Beyond aelivery He ieles will also follow a similar pattern. These costs may also
000, Similarly, rental CoS variable costs. :
15,00 betaken asa 1yPe Ota semi-variale costs if depicted on a graph paper will appear as follows :
0 ‘The fixed, vari a
74,00' 1
14,000 — costs z
5.000 - ae
000| 8
| 3 2 ef
Fot\ sf z 4
0 i é
4,00" 8 0
oe Coo
0 jon in thousand units Production in thousand units
28 Production 2,000) donot increase _(b) Toll variable costs (Rs. 50 per ui) increase
“gs (2) Toa foe no of production increases ‘as volume of production increases
a ee Fig. Fig. 1.2 24 GENERAL Princy
7 4
@ SEMI-VARIABLE COSTS o TEP.
g B 3
2 3 eae
2 R !
8 5 2 '
g g rr
£ 2 '
£ See
8 6 ‘pL 1 1,
ae gee Orca rece Sareea
Production in thousand units
(c) Semi-variable costs contain a fixed and
a variable element
Fig. 1.3 Fig. 1.4
Production in thousand units
(a) Step costs remain constant over a
range of activity
Product costs and period costs
Costs which become part of the cost of the product rather than a expenses of the period
which they are incurred are called as “Product costs”. They are included in inventory values,
financial statements such costs are treated as assets until the goods they are assigned to aré sol
They become an expense at that time. These costs may be fixed as well as variable e.g. cost|
raw-materials and direct wages, depreciation on plant and equipment etc.
Cost Which are not associated with production are called “Period costs”. They are wel
as an &Xpense of the period in which they are incurred, They may also be fixed as well as Varia
Such costs include general administrative costs, salesmen salaries and commission, depreciat
on office facilities etc. They are charged against the revenue of the relevant period. Difference
“opinion exist regarding whether certain costs should be considered as product costs or per
costs. Some accountants are of the opinion that fixed manufacturing costs are more closely relal
to the passage of time than to the manufacturing of the product costs, while fixed manufactur
and other costs are period costs. However, their view does not seem to have been yet wid)
accepted.
‘The above explanation shows that the difference between the period and product costs
the accountants is made depending upon the purpose for which the information is required by!
accountants as explained below :
While calculating the marginal cost of a product, all variable manufacturing costs of
product are treated as product costs. However, while computing the cost of a product u
absorption costing, all manufacturing costs whether fixed or variable are treated as product c
In case a firm is following direct cost method, only direct costs will be considered as pro
costs while indirect cost will be taken as period costs.
In financial accounting, all costs whether fixed or variable which become part of
inventory values are considered as product costs, While all costs which do not become part of
inventory values are treated as product costs. The product costs are treated as assets until
products to which they are assigned are sold, While in period costs, the costs are treated as
expense in the period they are incurred
irect and indirect costs - :
ati The expenses on material and labour economically and easily traceable to a product, serv
job are considered as direct costs. In the process of manufacture or production of a
ae is are purchased. labourers are employed and the wages are paid to them, certain o!
materia " General PRINCIPLES
25
expenses are also incurred direct!
: : ly. All oft
ofa particular commodity, hence are ier take an active and direct part in the manufacture
rect cr
Decision making costs and accountin,
Decision making costs are special Pieces i ; =
which they are constructed. They have no uni ie costs that are applicable only in the situation in
Fnancial accounts. They do not and should versal application. “They need not tie into routine
‘oats are compiled primarily from financial not conform to the accounting rules”.' Accounting
fe used for'decision making, Mi statements. They have to be altered before they can
Asan aking. Moreover, they are historical costs and show what has happened
under an x ‘ing set of circumstances. While, decision making costs are future costs, they represent
what is expected to happen under an assumed set of conditions. For example, accounting costs
may show the cost of the product when the operations are manual. While, decision making costs
might be calculated to show the costs when the operations are mechanised.
_ Relevant and irrelevant costs
Relevant costs are those which would be chi
evant costs are those which would not be affected by the decision. For example, if a
‘wn of an unprofitable retail sales shop, wages payable to
the workers of the shop are relevant in this connection since they will disappear on closing down
ofthe shop. But prepaid rent for the shop of unrecovered costs of any equipment which will have
to be scrapped will be irrelevant costs which must be ignored. #
Illustration 1.10. A company is considering a contract which requires among other things,
50 Kgs. of material M. 80 Kgs. of material IM are in stock which were purchased for € 2 per Kg.
The replacement price is € 2.15 per Kg. The material is in stock as a result of buying error and the
company has no other use for it. If not used on this contract, it could be sold for € 1.80 per Kg.
What isshe relevant cost of the material to be used in this contract. [B.Com (Pass), Delhi, 2004]
Solution : '
The relevant cost of material is % 1.80 per unit,
Similarly the repl
purchase cost of € 2 is a sunk cost. Ff
since the management cannot sell it at that price.
anged by the managerial decision. While
irre]
manufacturer is considering closing do
ive. the price at which it can be sold. The old
lacement price of & 2.15 is also irrelevant
Shut-down and sunk costs :
‘A manufacturer or an organisation renderin
period on account of some temporary difficu
Nalability of requisite labour ete. During this period th
sts, such as, rent and insurance of buildings, depreciation,
Willhave te ke imourred, Such costs ofthe idle plant are Knot
Sunk costs are historical or past costs. These are costs which have been created by.a decision
that was made in the past that cannot be changed by any decision that will be made in the future.
Investments in plant and machinery are prime examples of such costs. Since sunk costs cannot be
i ee
+ (Englewood cliffs, New Jersey, Prentice Hall, Inc. 1951)
to. 1 Reanomics
g service may have to suspend its operations
Ities e.g. shortage of raw-material, non-
hough no work is done yet certain fixed
maintenance etc. for the entire plant
wn as shut-down costs. ee
6 Genera Prncrues
altered by later decision, they are irrelevant for decision making, For example, a departmental
store ts considering selling a fleet of trucks it owns. It wants te buy delivery services from 4
outside firm in their place. The sunk costs of the investment in delivery equipment (present book
value minus present market value) is irrelevant in making this decision, Relevant costs in the
decision are operating costs such as gasoline, repairs, and maintengn nd the salaries of truck
drivers that would be eliminated if a decision to buy delivery services is made,
Controllable and uncontrollable costs
Controllable costs are those costs which can be influ ction of a specified
member of an undertaking. Costs which cannot be so influenced are termed as uncontrollable
cach of which is in
Foreman-in-charge of that section but the share of the tool room expenditure which is apportioned
toamachine shop cannot be controlled by a machine shop foreman. Thus, the difference between
controllable and uncontrollable costs is only in relation to a particular individual or level of
Management. An expenditure which is controllable by one individual may be uncontrollable so
far as another individual is concerned,
Avoidable or escapable costs and unavoidable or inescapable costs
<__-Avoidable costs are those which will be climinated, if a segment of the business (e.g. a
Product or department) with which they are directly related, is disco nued. Unavoidable costs
are those which will not be eliminated withthe segments, Such costs are merely reallocated if the
Segment is discontinued. For example, in case a product is discontinued, the salary of the factory
manager or factory rent cannot be eliminated. It will simply mean that certain other products will
have to absorb a higher amount of such overheads, However, salary of clerks attached to the
Product or bad debts traceable to the product would be climinated. Certain costs are partly
avoidable and partly unavoidable e.g closing of one department of a store might result in decrease
in delivery expenses but not in their altogether elimination,
I isto be noted that only avoidable costs are relevant for deciding whether to continue or
eliminate a segment of the business,
Imputed or hypothetical costs
These are costs which do not involve Eh oui They are not included in cost accounts
but are important for taking into consideration While mal ng management decisions. For example,
interest on capital is ignored in cost accounts though itis considered in,financial accounts, In
Case two projects require wiiequal outlays of cash, the management must take into consideration
interes on capital to judge the relative profitability ofthe projects
Differential, incremental or decremental costs
The difference in total costs between two altematives is termed as differenti
case the choice of an alternative results in increas
as incremental costs. While assessing the pro
costs are matched with incremental revenue,
costs. In
in total costs, such increased costs are known
ability of a proposed change the incremental
his is ilustrated with the following. example: eeititg Sitgiion | 5 = 4 2 fo vneenen
—_—_———_+____
z Cost Revenue
Sales z z z z
é 12,000 2,000,
Fi costs 000
4,000 9,000 4,000 10,000 1,000
1,000 2,000 | 1,000
Proposed situation there will be a net increase in revenue of
ion is acceptable,
decrease
% 1,000. Hence, the proposed situati
In case the choice results in
decremental costs.
in total costs, such decreased costs are termed as
Out-of-pocket costs
: Out-of- pocket Costs means the present or future cash expenditure regarding a certain decision
which will vary depending upon the nature of decision made. For example, a company has its
own truck for transporting raw-materials and finished products from one place to another. It
seeks to replace these trucks by employment of public carriers of goods, In making this decision,
ofcourse, the depreciation of the trucks is not to be considered, but the management must take
into account the present expenditure on fuel, salary to drivers and maintenance. Such costs are
termed as out-of-pocket costs.
Opportiinity costs
Opportunity costs refers to the advantage, in measurable terms, which has been foregone
onaccount of not using the facilities in the manner originally planned. For example, if an owned
building is proposed to be utilised for housing a new project plant, the likely revenue which the
building could fetch, if rented out is the opportunity cost which should be taken into account
while evaluating the profitability of the project. Similarly, if a manufacturer is confronted with
thé problem of selecting any one of the following two alternatives :
(a) selling a semi-finished product at € 2 per unit, and
(6) introducing it into a further process to make it more refined and valuable; alternative
(will prove to be remunerative only when after paying the cost of further processing the amount
Tealised by the sale of the product is more than & 2 per unit-the revenue which could have been
Otherwise realised. The revenue of € 2 per unit is foregone in case alternative (b) is adopted. The
term ‘opportunity cost” refers to this alternative revenue foregone.
Jréceable, untraceable or common costs
‘osts which can be easily identified with a department, process or product are termed as
taceable costs, eg, the cost of direct material, direct labour ete. Costs which cannot be so
ientfied are termed as untraceable or common costs. In other words, common costs are costs
Neurred collectively for anumber of cost centres and are to be suitably apportioned for determining
Cost of individinal cost centres, @.g., overheads incurred for a factory as a whole, combined
Putchase cost for purchasing several materials in one consignment etc,
fe, Joint costs are a sort of common costs. When two oe products are produced out of
| ita the same material or process, the costs of such material or process are called joint costs,
| cag atttple, when cotton seed and cotton fibre are produced from the same ravy. :
curred till the splif off or separation point will be “joint costs”,
Tom
“materials, the GENERAL PRINCIPLES Gi
28
EN
i d unexpired cost aoe : ao
lent pore are those costs which relate to the current period as an expense or loss. Fol yires
xpi
he cost incurred for rent paid or materials consumed in the current period are expired cost
eae Will sired costs are those costs which relate to theuture period and therefore ‘will jndit
sane as aretse or loss in the future period. For example, the cost ofteteials prc
for consumption in the next month is an unexpired cost as far as the current month is conceme
Production, administration and selling and distribution, etc., costs
‘A business organisation performs a numberof functions, .g., production, administratio
selling and distribution, research and development. Costs are to be ascertained for cach of thes
functions. The Chartered Institute of Management Accountants, London has defined each of th a
above costs as follows : F f :
(i) Production cost. The cost of the sequence of operations which begins with prying
materials, labour and services and ends with the primary packing of the product. Thus, it included may
the cost of direct material, direct labour, direct expenses and factory overheads, oft
(ii) Administration cost. The cost of formulating the policy, directing the organisation ang fC
4 ; : i ing) Fe!
controlling the operations of an undertaking, which is not related directly to a production, sellin
distribution, research or development activity or function
(iii) Selling cost. The cost of seeking to create and stimulate demand (sometimes termed
marketing) and of securing orders.
(iv) Distribution cost. The cost of sequence of operations which begins with making th
packed product available for despatch and ends with maki
package, if any, available for re-use
() Research cost. The cost of searching for new or improved products, new application o
materials, or new or improved methods.
i the reconditioned returned empl
(vi) Development cost, The cost of the process which begins with the implementation
the decision to produce a new or improved product or to employ
anew or improved method and
ends with the commencement of formal production of that product or by the method, Cos
(oil) Pre-production cost. That part of development cost incurred in making atrial productiod
run preliminary to formal production,
mea
and
Conversion cost into
‘The cost of transforming direct materials into the finished products, exclusive of direc| Eael
material cost is known as the conversion cost ora,
ICs usually taken asthe aggregate ofthe cost of direct Iabour, direct expenses and factor)
overheads. for «
COST ASCERTAINMENT =
~ac|
The technique of costing involves: (* collection and classification of expenditure according} Cnt
to cost elements and (ii) allocation and apportionment of the expenditure to the cost objects which]
may be cost centres or cost units; or both. The elements of co:
sts have already been discussed in
the previous pages. The meanings of the terms ‘cost object’ ‘cost unit? and “cost eenive™ ares
follows :
Cost object 7 : omy
Cost object may be defined as any activity for which a separate measurement of cost i) enn
desired, It may be in the form of a cost unit or a cost centre, For example, cost may be calculated
fe product, a process, a machine hour, a social welfare project or any conceivable activity.
for a 2 2 ‘
2) i: |
|
indirect ene, 2. PS iM deciai,
irect or indirect costs, In case the «wns Wh
ther a parti i
0 ts he cost ite ther a particular cost item should be taken as a
ost will be taken as direct, However ifthe “an be directly identified with the cost objects, the
adirect of an overhead cost. “EONS Cannot be done, the cost item will be taken #6 an
The following are
© Products Piel e0st objects
© Services © Jobs
© Units © Projects
© Batches © Customers
®@ Cases © Customer groups
© Sales territories
Cost unit
In preparing cost wcunts, it becomes necessary to select a unit with which expenditure
may be identified. The quantity upon which cost can be conveniently allocated is known as au
ofcost or cost unit. The Chartered Institute of Management Accountants, London, defines SURi>
ofcostas “a unit of quantity of Product, service or time in relation to which costs may be ascertained
or expressed.” The examples of s
E ‘ome cost units are given below :
(Brick Works —per 1,000 bricks made
(ii) Collieries —per tonne of coal raised
(ii) Textile Mills ~Per yard or per Ib. of cloth manufactured or yarn spun
(iv) Electricity Companies — —per unit of electricity generated
(») Transport Companies —per passenger-km., per tonne-km.
(vi) Steel Mills —per tonne of steel made
(vii) Screws manufacturing —per 1,000 screws
(viii) Gas —per cubic metre
(ix) Car
—per unit manufactured
(x) Nickel plating —per square metre
Cost centre
According to the Chartered Institute of Management Accountants,
London, cost centre
means “a location, person or item of
