OVERVIEW OF COST

ACCOUNTING
 CLASSIFICATION OF ACCOUNTING

1.Financial Accounting: It is defined as ‘the art of recording, classifying

and summarizing in a significant manner and in terms of money, transactions
and events, which are in part at least, of a financial character and interpreting
the results thereof.’
2.Cost Accounting: ‘Cost accounting is the process of accounting for costs from
the point at which expenditure is incurred or committed to the establishment of
its ultimate relationship with cost centres and cost units. In its widest usage, it
embraces the preparation of statistical data, the application of cost control
methods and ascertainment of profitability of activities carried out or
planned.’
3. Management Accounting: (CIMA), London has defined management
 OBJECTIVES AND FUNCTIONS OF
COST ACCOUNTING
Ascertainment of cost:
• In cost accounting, cost of each unit of production, job, process or department, etc., is
ascertained. Not only actual costs incurred are ascertained but costs are also pre-
determined for various purposes.
Cost control and cost reduction
• Cost accounting aims at improving profitability by controlling and reducing costs. For
this purpose, various specialized techniques, like standard costing, budgetary
control, inventory control, value analysis, etc., are used.

Guide to business policy

• Cost accounting aims at serving the needs of the management in conducting
the business with utmost efficiency. Cost data provide guidelines for various
managerial decisions, like making or buying, selling below cost, utilization of idle
plant capacity, introduction of a new product, etc.
Determination of selling price
• Cost accounting provides cost information on the basis of which selling prices of
products or services may be fixed. In periods of depression, cost accounting guides the
firms in deciding the extent to which the selling prices may be reduced to meet the
situation.
 MEANING OF COST
According to Cambridge International
Dictionary of English, cost means ‘the amount of
money needed to buy, do or make something.’
Some other definitions of cost are given below:
1. Cost is ‘the amount of expenditure (actual or
notional), incurred or attributable to a given
thing.’ (CIMA, London)
2. A cost is the value of economic resources
used as a result of producing or doing the things
costed.’ (W M Harper)
3. ‘Cost is a measurement, in monetary terms, of
the amount of resources used for the purpose of
production of goods or rendering of services.’
(ICWA of India)
Cost Centre: ‘A location,
person, or item of
Cost Unit: ‘Unit of Cost Object: ‘Anything for
equipment (or group of
product or service in which a separate
these), for which costs
relation to which costs measurement of cost may
may be ascertained and
are ascertained.’(CIMA) be desired.’
used for the purpose of
control.’ (CIMA)
 METHODS OF COSTING
Job order costing: Cost unit in job order costing is taken to be a job or work
order for which costs are separately collected and computed.
Batch costing: In this, cost of a
Contract costing or terminal
batch or group of identical
costing: The cost unit here is a
products is ascertained and
‘contract’ which is of a long
therefore each batch of products is
duration and may continue over
a cost unit for which costs are
more than one financial year.
ascertained.

Process costing: This method is used in mass production industries

manufacturing standardized products. Costs are accumulated for each
process or department.
Operation costing: A Single, output or unit
Operating or service
process may consist of a costing: This method is
costing: It is used in
number of operations and used when production is
undertakings which
operation costing involves uniform and consists of a
provide services instead
cost ascertainment for single or two or three
of manufacturing
each operation instead of varieties of the same
products.
a process. product.
METHODS OF COSTING( Contd.)
Costing Techniques

Marginal
costing

Cost
Data

Job Process
costing costing

Factory Batch Contract Unit Operation Operating

job costing costing costing costing costing costing

Multiple
costing
Costing Methods
TECHNIQUES OF COSTING
Standard costing
• In this technique, standard cost is predetermined as target of
performance, and actual performance is measured against the
standard.
Budgetary control
• It is a technique applied to the control of total expenditure by
comparing actual performance with planned performance.

Marginal costing
• In this technique, separation of costs into fixed and variable
(marginal) is of special interest and importance.

Total absorption Marginal costing

In this technique, separation of costs into fixed and variable
(marginal) is of special interest and importance. It is a traditional
method of costing whereby total costs (fixed and variable) are
charged to products.

Uniform costing
In this technique, separation of costs into fixed and variable
(marginal) is of special interest and importance.
 COST ASCERTAINMENT AND COST ESTIMATION
Cost Ascertainment: Cost ascertainment is concerned with computation of
actual costs incurred. It refers to the methods and processes employed in
ascertaining costs.

The ascertainment of actual cost has very little utility because of the
following reasons:
1. Actual costs cannot be used for the purpose of price quotations and filling
tenders.
Cost Estimation:
2. Actual cost has Cost estimation
practically is thefor
no utility process of predetermining
cost control purposes. costs of
goods or services.
3. Actual Theineffective
costs are costs are as
determined
means of in advance performance
measuring of productionefficiency.
and
precede the operations.
Cost estimates may have the following uses:

1. Cost estimates are used in making price quotations and bidding for
contracts.
2. Cost estimates are used in the preparations of budgets.
3. They help in evaluating performance.
4. They are used in preparing projected financial statements.
5. Cost estimates may serve as targets in controlling the costs.
 CLASSIFICATIONS OF COST
Classification into Direct and Indirect Costs
Direct costs: Costs which are incurred
Indirect costs These are general costs
for and conveniently identified with a and are incurred for the benefit of a
particular cost object. number of cost object.

Fixed costs : These

Classification into Fixed , Variable and Semi-variable or
Semi-variable semi-
Costs
Variable costs :Cost
remain constant over a fixed costs (mixed
that tend to vary in direct
specific range of activity costs): These costs
proportion to the volume
for a specified period of include both a fixed and a
of output.
time. variable component.

Classification into Com mitted and Discretionary Costs

Committed costs: These are those
Discretionary costs: Costs which can
costs that are incurred in maintaining
be avoided by management decisions.
physical facilities and managerial set
Such costs are not permanent.
up.
CLASSIFICATIONS OF COST(Contd.)
Classification into include Period costs:
Product Costs and These
Periodare Costs
those costs
Product costs: These costs
which are not necessary for
all such costs that are involved in
production and are incurred even if
acquiring or making a product.
there is no production.

Classification into Controllable and Non- controllable

Controllable costs: Costs which may Non-controllable costs: Costs which
Costs
be directly regulated at a given level cannot be influenced by the action of a
of management authority. specified member of an enterprise.

Classification into Historical Costs and Predetermined

Historical costs: Costs which are Predetermined costs: Future costs
ascertained after these have been
Costs
which are ascertained in advance of
incurred. production.

Classification into Normal and Abnormal Costs

Normal cost: Cost which is incurred Abnormal cost: Cost which is not
on expected lines at a given level of normally incurred at a given level of
output. output.
SPECIAL COSTS FOR MANAGEMENT
DECISION MAKING
1. Relevant costs: Cost whose magnitude will be affected by decision being
made.
2. Irrelevant costs: These are those costs that will not be affected by a
decision.
3. Sunk Costs: A sunk cost is an expenditure made in the past that
cannot be changed and over which management no longer has control.
4. Differential (or Incremental) Cost: This cost may be regarded as the
difference in total cost resulting from a contemplated change.
5. Marginal Cost: Marginal cost is the additional cost of producing one
additional unit. Marginal cost is the same thing as variable cost.
6. Imputed Costs: These are hypothetical costs which are specially computed
outside the accounting system for the purpose of decision making.
7. Opportunity Cost: It is the sacrifice involved in accepting an alternative
under consideration.
8.Replacement Cost: This is the cost at which there could be purchased an
asset identical to that which is being replaced.
9. Out - of - pocket Cost (Explicit Cost and Implicit Cost ): These are
those costs that involve cash outlays or require the utilization of current
resources.
ELEMENTS OF COST
 ELEMENTS OF COST (Contd.)
Material Cost: ‘The cost of commodities supplied to an undertaking.’(CIMA)

• Direct material cost is that which can be conveniently identified with and
allocated to cost units.
• Indirect materials cost are those materials which cannot be conveniently
identified with individual cost units.

Labour Cost: This is ‘the cost of remuneration (wages, salaries, commissions,

bonuses, etc.) of the employees of an undertaking’ (CIMA).

• Direct labour cost consists of wages paid to workers directly engaged in

converting raw materials into finished products.
• Indirect labour cost It is of general character and cannot be conveniently
identified with a particular cost unit.

Expenses: ‘The cost of services provided to an undertaking and the notional cost of the
use of owned assets’ (CIMA).

• Direct expenses According to CIMA, London, ‘direct expenses are those

expenses which can be identified with and allocated to cost centres or units.’
• Indirect expenses All indirect costs, other than indirect materials and
indirect labour costs, are termed as indirect expenses.

Prime Cost: Aggregate of direct material cost, direct labour cost and direct
expenses.
 ELEMENTS OF COST (Contd.)
Material Cost: ‘The cost of commodities supplied to an
undertaking.’(CIMA)
1.Direct material cost is that which can be conveniently identified
with and allocated to cost units.
2.Indirect materials cost are those materials which cannot be
conveniently identified with individual cost units.
Labour Cost: This is ‘the cost of remuneration (wages, salaries,
commissions, bonuses, etc.) of the employees of an undertaking’
(CIMA).
1. Direct labour cost consists of wages paid to workers directly
engaged in converting raw materials into finished products.
2. Indirect labour cost It is of general character and cannot be
conveniently identified with a particular cost unit.
Expenses: ‘The cost of services provided to an undertaking and the notional cost
of the use of owned assets’ (CIMA).
1. Direct expenses According to CIMA, London, ‘direct expenses are those
expenses which can be identified with and allocated to cost centres or units.’
2. Indirect expenses All indirect costs, other than indirect materials and
indirect labour costs, are termed as indirect expenses.
Prime Cost: Aggregate of direct material cost, direct labour cost and direct
expenses.
 ELEMENTS OF COST(Contd.)
Overheads: These are the aggregate of indirect material cost,
indirect labour cost and indirect expenses. Thus,

Indirect material + Indirect labour + Indirect expenses =

Overheads
Office and administration
overheads: These are the indirect
Production overheads: Also known
expenditures incurred in general
as factory overheads, works overheads
administrative function, i.e., in
or manufacturing overheads, these
formulating policies, planning and
are those overheads which are
controlling the functions, directing and
concerned with the production
motivating the personnel of an
function.
organization in the attainment of its
objectives.
Selling and distribution overheads: Selling
overheads are the costs of promoting sales and
retaining customers. They are defined as ‘the cost of
seeking to create and stimulate demand and of
securing orders.’ Distribution cost includes all
expenditure incurred from the time the product is
completed until it reaches its destination.
STEPS OF INSTALLATION
•
OF A COSTING SYSTEM
Preliminary investigations should be made
1
relating to technical aspects of the business.
• The organization structure should be studied
2
to ascertain scope of authority.
• Methods of purchase, storage or issue of
3
materials should be modified as required.
• Methods of remunerating labour should be
4
examined to introduce any incentive plans.
• Forms and accounting records should be
5 designed to involve minimum clerical
labour.
• The size and layout of the factory should be
6
studied.
• The system should be effective in cost
7
control and cost reduction.
• Costing system should be simple and easy to
8
operate.
• The installation and operation of the
9
system should be economical.

10 • The system should be introduced gradually.

ADVANTAGES OF COST ACCOUNTING
Advantages to Management: Reveals profitable and unprofitable
activities, Helps in cost control, Helps in decision making, Guides
in fixing selling prices, Helps in inventory control, Aids in
formulating policies, Helps in cost reduction, Reveals idle capacity,
Checks the accuracy of financial accounts, Prevents frauds and
manipulation.
Advantages to Workers: Workers are benefited by introduction of
incentive plans which are an integral part of a cost system bringing
higher productivity and higher earnings for them.

Advantages to Society: An efficient cost system is bound to lower

the cost of production, the benefit of which is passed on to the public
at large, in the form of lower prices of products or services.

Advantages to Government Agencies and Others: A cost system

produces ready figures for use by government, wage tribunals,
chambers of commerce and industry trade unions, etc., for use in
problems like price fixing, wage level fixing, settlement of industrial
disputes, policy matters, etc.
LIMITATIONS OR OBJECTIONS AGAINST COST ACCOUNTING
It is unnecessary

• It is argued that maintenance of cost records is not necessary and

involves duplication of work. It is based on the premise that a good
number of concerns are functioning prosperously without any system
of costing.
It is expensive

• It is pointed out that installation of a costing system is quite

expensive which only large concerns can afford. It is also argued
that installation of the system will involve additional expenditure
which will lead to a diminution of profits.
It is inapplicable

• Another argument sometimes put forward is that modern methods

of costing are not applicable to many types of industry.

It is a failure

• The failure of a costing system in some concerns is quoted as an

argument against its introduction in other undertakings.
 ESSENTIALS OF A GOOD COST ACCOUNTING SYSTEM

Suitability
•The method of costing adopted should be suitable to the
industry and serve the objectives of installing the system.

Specially •A readymade costing system cannot be suitable for every

business. The cost accounting system should be tailor-made
designed system according to the requirements of a business.

Support of •If a costing system is to be successful, it must be fully

supported by executives of various departments and everyone
executives should participate in it.

Cost of the •The cost of installing and operating the system

should be justified by the results produced.
system
Clearly defined •In order to derive maximum benefits from a costing system, well-
defined cost centres and responsibility centres should be
cost centres identified within the organization.
 ESSENTIALS OF A GOOD COST ACCOUNTING SYSTEM (Contd.)
Controllable • Controllable and non-controllable costs of each responsibility centre
costs should be separately shown.

Integration • There should be cooperation and coordination between cost

with accounting and financial accounting departments. In order to
financial avoid duplication of accounts, cost and financial accounts may be
integrated.
accounts
• Well-trained and educated staff should be employed to operate
Continuous the system. In order to educate the costing staff, written manuals
education and meetings, etc. should be arranged on a continuous basis.

Prompt and • The cost accounting department should prepare accurate reports
accurate and promptly submit the same to appropriate level of management
so that action may be taken without delay.
reports

Avoid • Resources should not be wasted on collecting and compiling cost

unnecessary data that is not required.
details