Fundamentals of Cost

Accounting
Prepared By Miss. Akshada Zurale (Assistant
Professor)

1
 Learning Objectives
 Define and understand the meaning of Basic Cost
Concepts
 Illustrate the Prime Cost & Overheads
 Understand Cost Allocation, Apportionment and
Absorption of Overheads
 Points of difference between
Points Cost & Management Accounting Financial Accounting

Recording Based on the data as obtained Based on the monetary transactions of

from Financial Accounting. the enterprise.
Main function To assist the management in the Recording and classifying monetary
process of its planning, controlling, transactions in the books of accounts and
performance evaluation and decision- preparation of financial statements at the
making by providing necessary end of every accounting period.
information to the management.
Reports It contain both objective as well It always contain relevant figures. It
Prepared as subjective figures. lays emphasis on the objectivity of the
data.
Reports Exclusively meant for the management Meant for the management as well as for
Users of the concern. shareholders and creditors of the
concern.
Timing of Reports are prepared as per Reports are prepared at the end of
Report the requirement of the every accounting period.
Preparatio management.
n
Statutory Reports are not subject to statutory Reports are always subject to statutory audit.
audit of audit.
Reports

Performanc Evaluates the sectional as well as Ascertains the results and exhibits the
e the entire performance of the financial strength of the business as a
Evaluation business. whole.
Success Success depends on the existence of Success does not depend, in any way, on
a sound Financial Accounting the existence of a sound Management
System. Accounting System.
We are going to learn…

Cost Accounting concepts, Cost Allocation,

Apportionment and Absorption of Overheads
 Cost Accounting
Advantages Limitations
 Profitable and unprofitable activities  Cost accounting lacks
are disclosed a uniform procedure
 Enables a concern to measure  There are a large number
the efficiency
 of conventions,
Provides information upon
estimates and flexible
which estimates
 and tenders are based factors
 Guides future production
policies
 Helps in increasing profits
 Enables a periodical
determination of profits or losses
 The exact cause of a decrease or an
increase in profits or loss can be
detected
 Discloses the relative efficiencies
of different workers
 Enables the creditors and
investors to judge the financial
strength
 Helpful to the government
 COST : MEANING AND ITS
ELEMENTS
 The term ‘cost’ means the amount of expenses [actual or
notional] incurred on or attributable to specified thing or
activity or specific object
 Total cost = quantity used * cost per unit (unit cost)

 Elements of Cost

 Material Labour Expenses

To produce or manufacture For conversion of raw All cost incurred in the
material is required. For material into finished production of finished
example to manufacture goods, human resource goods other than
shirts cloth is required and is needed, and such material cost and labour
to produce flour wheat is human resource is cost are termed as
required. termed as labour. expenses
 Elements of Cost

Direct Material Indirect Material

 Direct material is the material which can  Like direct material, another kind of
be conveniently identified with or material may be required for
allocated to cost centers and cost units. manufacturing but not directly.
 It refers to the material out of which a  Indirect is that
 product is manufactured. Material which material
 Example: cannot be
 Leather shoes are produced out of
conveniently easily
leather particular
 Butter is produced out of milk  identified product, job, process,and
and
 Steel utensils activity
and
are produced  Example related with a
out of stainless steel.  Machines used for
 Timber is a raw
for require production lubricants,
material furniture cotton
 Cloth for making making  Consumable jute stores,
and
garments oil and waste, printing and
 Sugarcane for making stationery
 Direct
sugar material is a component  Indirect material is a component of
 of prime
Gold/ cost
silver for making factory overhead.
 Direct material directly varies with the
jewellery  Indirect material does not
varies
 with the output.
 Elements of Cost
Direct Labour Indirect Labour
 Labour which takes active and 
direct part in the production of a Indirect labour is that labour
commodity. which can not be easily
 Direct labour is that labour which identified and related with
can be easily identified and related specific product, job, process,
with specific product, job, process,  and activity.
and activity. It includes all labour not
 Direct labour cost is easily directly engaged in converting
traceable to specific products. raw material into finished
 product.
Direct labour costs are specially and  It may or may not vary directly
conveniently traceable to specific
products. with the volume of output.
 Direct labour varies directly with  Labour employed for the
the volume of output. purpose of carrying out tasks
 Direct labour is also known as incidental to goods or services
process labour, productive labour, provided is indirect labour.
operating labour, direct wages, 
manufacturing wages, etc. Indirect labour is used in the
 Cost of wages paid to carpenter for factory, the office, or the
making furniture, cost of a tailor in selling and distribution
producing readymade garments, department.
cost of washer in dry cleaning unit
are some examples of direct  Wages of store-keepers, time-
labour.
keepers, salary of works
manager, salary of salesmen,
etc, are all examples of
indirect labour cost.
 Elements of Cost

 Direct expenses  Indirect expenses

 These are expenses which are  These expenses cannot be directly,
directly, easily, and wholly easily, and wholly allocated to
allocated to specific cost center specific cost center or cost units.
or cost units.  All indirect costs other than
 All direct cost other than
indirect material and indirect
direct material and direct labour are termed as indirect
labour are termed as direct expenses.
expenses. 
 Direct expenses are also termed Indirect Expenses = Indirect cost –
Indirect material – Indirect labour.
as chargeable expenses.
 Examples:  Indirect expenses are treated as
 Hire of special machinery part of overheads.
 Cost of special designs,  Examples:
moulds or patterns  Rent, rates and taxes of
 Fees paid to architects, building
surveyors and other  Repair, insurance and
consultants depreciation on fixed assets
 Inward carriage and
freight charges on special
material
 Cost of patents and
royalties
 Factory Overhead
 Factory or Works where production is done
 Indirect material used in factory such as oil, lubricants and
 consumables.
 Indirect labour such as gatekeeper salary and works’
manager’s salary
 Indirect exp. such as factory rent, insurance and factory
lighting
 Grease, oil, lubricants, cotton waste etc.
 Small tools, brushes for sweeping, sundry supplies etc.
 Cost of threads, gum, nails, etc.
 Consumable stores
 Factory printing and stationery
 Insurance of factory building, plant, and machinery
 Municipal taxes of factory building
 Depreciation of factory building, plant and machinery, and their
repairs and maintenance charges
 Power and fuel used in factory
 Factory telephone expenses.
Office and Administration Overheads
 Indirect material used in office such as printing & stationary
 Indirect labour such as salaries to office managers, Director,
 CFO, CEO etc.
 Indirect exp. such as insurance, ret and lighting of office
 Office printing and stationery, Cost of brushes, dusters etc. for
cleaning office building and equipment's
 Postage and stamps.
 Salary of office manager, clerks, and other employees
 Salary of administrative directors,
 Salaries of legal adviser
 Salaries of cost accountants and financial accountants
 Salary of computer operator.
 Rent, insurance, rates and taxes of office building
 Office lighting, heating and cleaning
 Depreciation and repair of office building,
furniture, and Equipment etc.,
 Legal charges, Bank charges, Trade subscriptions, Telephone
charges, Audit fee etc.
Selling and Distribution overheads
 Indirect material used such as packing material, printing and
stationary material
 Indirect labour such as salaries of salesman and sales manager
 Indirect expenses such as rent insurance and
advertising exp.
 Salaries of sales managers, clerks and other
employees
 Salaries and commission of salesmen and technical
 representatives
 Fees of sales director
 Advertising
 Bad debts
 Rent and insurance of showroom
 Legal charges incurred for recovery of debts
 Travelling and entertainment expenses
 Expenses of sending samples
 Market research expenses.
 Cost Concepts & Terminology
Relationshi Relationship Ability
Cost Elements p to Functional Areas
to Volume to
Production trace
•Direct Materials
(Wood in furniture making, Fixed Costs Manufacturing
cloth in dress making, and (Factory rent, costs (Direct
bricks in building a house) property Material+ Direct
Labour+ Factory
•Indirect Materials Prime Costs insurance, lease Direct Costs Overhead)
(Office supplies, such as (Direct payments) (Direct
pens, paper, and staplers ) Material+ Material+

• Direct Labour Direct Direct

(Workers at a salon who Variable Costs Selling & Marketing
Labour Labour
) )
actually perform haircuts) (Material costs, costs
•Indirect Labour direct labour costs, (Advertisement)
(Managers, accountants and office supplies)
maintenance staff.)
Factory overhead Administrative Cost
Conversio
(Indirect Material+ Indirect n Costs Semi- Indirect (Salaries to managers
(Direct Variable Costs &
Labour) Labour Costs (Factory workers)
(Supervisor salaries +Factory (Telephone Overhea
Overhea Charges, d)
d) Electricity
Materials managers salaries, bills) Financing Costs
Factory rent, Factory (Interest on loans,
building insurance, Fringe cost of credit to
benefits) customers)
 Cost Concepts

Cost center 14

• It means a location, person, or item of equipment or group of these for

which costs may be ascertained and used for the purpose of cost control.

Cost object
• It is anything (an activity or item or operation) for which a separate
measurement of cost is desired.
• It may be a product, service, project, or a customer
• E.g. the cost of operating the personnel department of a company, the cost of
a repair machine, and the cost for control

Cost Unit

• It is a quantitative unit of product or service in which costs

are ascertained, e.g. cost per table made, cost per metre of cloth
 Examples of Cost Unit
Industry / Product Cost Unit
Automobile Number of vehicles

Cable Metres / kilometres

Cement Tonne
Chemicals / Litre / Kilogram / tonne
Fertilizers

Gas Cubic Metre

Power - Electricity Kilowatt Hour
Transport Tonne-Kilometre,
Passenger- Kilometre

Hospital Patient Day

Hotel Bed Night
Education Student year
Telecom Number of Calls
BPO Service Accounts handled
Professional Service Chargeable Hours
 Cost accumulation (via Cost Sheet)
16 + direct labour +
 Prime cost = direct materials
direct expenses
 Production cost or Cost of production or
 Factory Cost = Prime cost + factory overhead
 Total cost or Cost of Sales= Prime cost + Overheads
(admin, selling, distribution cost) OR = Production cost
+ period cost (administrative, selling, distribution and
finance cost)
 Period cost is treated as expenses and matched
against sales for calculating profit, e.g. office rental
 Cost Sheet
 Costs sheet is a document which provides
for the assembly of the estimated detailed
cost in respect of a cost centre or a cost
unit.
 It analyses and classifies in a tabular form,
the expenses incurred on different items
for a particular period.
 COST SHEET
DIRECT MATERIAL
DIRECT LABOUR
DIRECT EXPENSES

PRIME
COST
Add: FACTORY
OVERHEADS
FACTORY COST
Add: OFFICE
OVERHEADS

COST OF PRODUCTION
Add: SELL & DIST
OVERHEADS

COST OF SALES
PROFIT

SALES
Costing Methods
 Job Costing

20
•The cost are
collected for each
job/work/projects
separately.
•Where production is not
Forging Shops Printing Foundries
repetitive and consists of
distinct jobs /lots with
which costs can be
identified
•The cost unit is
specific jobs

Engineering House Machine Tools

Workshops Buildings Manufacturers
 Batch Costing

• It is
a
extension of
job costing
•A batch
consists of Nuts & Bolts Medicines Biscuits
number of
similar
products
•The cost of a
group of products
constituting the
batch and the
single item within Garment Spare Parts Components
the s
 Contract Costing

• Under this method

costing is done for big
jobs which involves
heavy expenditure and
stretches over a long Builder Civil
Mechanical
period and often it is s Construction
Engineering
undertaken at different Contractor
sites.
• Each contract is treated
as a separate unit for
costing.
• This is also known as
terminal costing.
 Process Costing

•This kind of costing is

used for the products
which go through
different processes.
•Each process is to be Textiles Chemicals Tanneries
evaluated separately as
the output of each
process can be treated
as a finished good as
well as consumed as a
Paper Paints
raw material for the Food
next process.
•Process costing is
used to ascertaining
the cost at each stage Explosives Soaps Petroleum
of production.
 Costing

•Single or output

costing is used Mining

when the
production is
uniform and
identical and a
Breweries
single good is
produced.
•The total
production cost is
Brick Making
divided by the
number of units
produced to get
unit or output
 Multiple Costing

• In multiple costing, a combination of two or

more methods of costing is used in
conjunction to determine the cost of final
product.
• This method is used by the industries
where different components are Motor car
separately manufactured and
subsequently assembled into the
finished product.
 Example: For ascertaining the cost of a
television, cost of each part will be
ascertained by using batch or job costing Television
method and, then the cost of assembling
the parts will be ascertained by following
the method of single or output costing.

Ships
 Operating Costing

• Where the cost of operating a service

such as nursing home, bus, railway or Nursing Home
chartered bus etc is used.

• This method of costing is used to

ascertain the cost of such particular Bus Services

service.
• Each particular service is treated as
separate units in operating costing.
Railway Services

In the case of a Nursing Home, a

unit is treated as the cost of a bed
per day and for buses operating
 27

Costing Techniques
 Uniform Costing
28 of costing.
• This is not a separate method
• This is a system of using the same method of
costing by a number of firms in the same industry.
• It is treated as a common system of using agreed
principles and standard accounting practices in the
identical firms or industry.
• This helps in fixation of price of the product and inter-
firm comparisons.
 Marginal Costing
29
 It is a technique of ascertaining cost used in any
method of costing.
 It arises due to change in volume of production,
 i.e. variable cost only.
 According to this technique, variable costs are
charged to cost units and the fixed cost attributable
to the relevant period is written off in full against the
contribution for that period.
 This technique is employed to ascertain the
effect of change in volume/product mix and so on
profit.
 Absorption Costing
30 manufacturing a particular
 It charges all costs associated with
product, all variable as well as all fixed to operations/products/
processes.
 It uses the total direct costs and overhead costs associated with
manufacturing a product as the cost base.
 Generally accepted accounting principles (GAAP) require absorption
costing for external reporting.
 Historical Costing
31 in which costs
 It is system of costing
are determined after they have been
incurred.
 It ascertains actual costs incurred in
the past.
 Standard Costing
 Rather than assigning the actual costs of direct
material, direct labor, and manufacturing overhead
to a product, many manufacturers assign the
expected or standard cost.
 This means that a manufacturer's inventories and cost
of goods sold will begin with amounts reflecting the
standard costs, not the actual costs, of a product.
 Manufacturers, of course, still have to pay the
actual costs.
 As a result there are almost always differences
between the actual costs and the standard costs, and
those differences are known as variances.
 Cost Ascertainment and Product Costing
Collection & Cost allocation/ Choice of Selection of
Classification of costs apportionmen Appropriate appropriate
according to cost t to cost Method of costing
elements centres/units Costing technique
 Elements of costs- • Productive, • Specific • Uniform
 Direct Material Unproductive order/Job/ter Costing
minal
 Direct Labour /service and Costing • Marginal
mixed cost • Job Costing
 Overheads
centres Costing
 Indirect material • Batch • Direct Costing
• Personal
cost and Costing • Absorption
 Indirect labour cost Impersonal • Contract Costing
 Indirect expenses cost Costing • Historical
centres • Operations
Indirect /process/ Costing
manufacturing • Operation and Period
expense Process Cost • Standard
Centres Costing
Office & • Process Costing
administrative costing
expenses • Unit/
Selling & distribution output/
expenses single
costing
• Operating
Costing
Installation of Cost Accounting System
Features Steps
 Suitability  Objectives
 Simplicity  Study of existing
 Flexibility organisation
 /routine
 Economical  Structure of Cost Accounts
 Comparability  Determination of Cost Rates
 Timelines  Introduction of system
 Organisational Set Up  Organisation of cost office
 Uniformity
 Stores accounts
 Efficient Material Control  Labour
Systems Accounting
 Adequate wage procedure  Cost Accounts
  Cost Control
Departmentalisation of
 Relationship with
Expenses

other departments
Reconciliation  Authority &
 Duties & Responsibilities
responsibilty
 External Factors
 Classification of Cost
 Fixed
 Variable
 Semi-variable and
 Step cost
 Variable cost

 It increases or decreases in direct proportion to levels

of activity, but the unit variable cost remains constant
 E.g. cost of food served in a restaurant, raw
material, labor (per unit paid)
 Also known as product cost.
 Wages of labour, power and material cost are
example of variable cost.
Variable cost- Total and per unit
Fixed cost
38
 Total fixed cost remains constant over a relevant range
of activity level but unit fixed cost falls with an
increase in activity volume.
 Salary, rent, insurance are example of fixed cost
Fixed cost- Total and Per unit
 Semi-variable cost
40 of both fixed and
 It processes characteristics
variable cost
 It increases or decreases with activity level but not
in direct proportion
Semi- Variable Cost
 Step cost
 It remains constant for a range of activity
levels, then, on further increase in activity,
the cost jumps to a new level and remains
constant over a certain range until the next
jump occurs
Product cost
 Product cost are related to the goods
purchased or produced for resale.
 If the products are sold, the product cost will be
included in the cost of goods sold and recorded as
expenses in current period
 If the products are unsold, the product costs will be
included in the closing stock and recorded as assets
in the balance sheet
 Product cost includes direct material, direct labour,
direct expenses, and manufacturing overheads.
Period cost
 Period cost related to the operation of a
business
 They are treated as fixed cost and charged
as expenses when they are incurred
 They should not be included in the
stock valuation
 Period costs include all fixed costs and
total administration, selling and
distribution costs.
 Relevant and Irrelevant Cost

 Relevant costs are those costs which would be changed by

the managerial decision.
 For example, if a company is considering to close
unprofitable retail sales shop, wages, salaries payable to
the shop workers are relevant in this decision as they will
disappear on closing of shop.
 These costs wages, salaries, electricity are relevant for
decision making.
 On the other hand, prepaid rent, insurance or any other
uncovered cost of any equipment which will have to be
scarped are irrelevant cost which must be ignored.
 Shutdown Costs
 Shutdown costs are those costs which will gave to be
incurred when plant is closed due to temporary non
availability of material, labour or any other key
ingredients.
 Some fixed costs like deprecation of building, rent,
maintenance will have to incur during that period and
are called Shutdown cost.
 Thus cost which have to incur even if there is no
production are called Shutdown costs
 Sunk costs

 Sunk costs are historical or past costs.

 These costs are costs which have been created or incurred by
a decision that was taken in past that cannot be changed by
any decision that will be made in future.
 Investment in plant, machinery, building etc are prime
example of such costs.
 Since sunk cost cannot be altered by later decision, they
are irrelevant for decision making
 Controllable and Uncontrollable cots
 Controllable costs are those can be
influenced by the action of a specified
member of the company.
 Cost which can't be so influenced
are uncontrollable costs.
 Imputed or Hypothetical costs
 Costs which don’t involve any cash outlay .
 They are not included in the cost accounts but are
important for consideration while making
management decisions.
 Differential, Incremental cost

 The cost difference between two

alternatives is termed as differential cost
 Incremental is increase in the cost if increase
the production by x number of units.
 Out of pocket costs
 Present or future cash expenditure regarding a certain
decision which varies depending upon on the nature of
decision made.
 Own truck verus taking transport company .
Thanks….