Introduction to cost accounting

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Information about Introduction to cost accounting
Business & Mgmt

Published on March 6, 2014

Author: faltufocat


Cost Accounting 1

Introduction- Meaning  Cost accounting is concerned with recording, classifying and summarizing costs for determination of costs of products or services, planning, controlling and reducing such costs and furnishing of information to management for decision making 2

COST ACCOUNTING  The Institute of Cost and Management Accountant, England (ICMA) has defined Cost Accounting as –  “the process of accounting for the costs from the point at which expenditure incurred, to the establishment of its ultimate relationship with cost centers and cost units. In its widest sense, it embraces the preparation of statistical data, the application of cost control methods and the ascertainment of the profitability of activities carried out or planned”. Cost Accounting = Costing + Cost Reporting + Cost Control. 3

Cost Accounting and Accountancy  Cost Accountancy means :   “the application of costing and cost accounting principles, methods and techniques to the science, art and practice of cost control” It includes the presentation of information derived therefrom for the purpose of managerial decision making. 4

Cost Accountancy includes…     Cost Accounting Cost Control Cost Reduction Cost Audit 5

Objectives of Cost Accounting        Ascertainment of cost Estimation of cost Cost Control Cost reduction Determination of selling price Facilitating preparation of financial and other statements Providing basis for operating policy 6

Functions of managerial accounting    Determining the cost Providing relevant information for better decision-making Providing information for planning, control, decision-making and application 7

Application   Cost accounting has extended from manufacturing operations to a variety of service industries such as hotels, bands, airline, etc Cost accounting system should be flexible and adaptable to meet the new business environment and the changing nature of the company 8

Cost - Concept    Cost refers to the amount of resources given up in exchange for some of goods or services The resources given up are always expressed in terms of money. CIMA defines “ the amount of expenditure (actual or notional) incurred on or attributable to a given thing or activity” . 9

Important concepts     Cost object Cost Cost unit Cost centre 10

Cost object   It is an activity or item or operation for which a separate measurement of costs is desired E.g. the cost of operating the personnel department of a company, the cost of a repair machine, and the cost for control 11

Cost   It is the amount of expenditure incurred on a specific cost object Total cost = quantity used * cost per unit (unit cost) 12

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 13

Cost centre   It is a location or function of an organisation in respect of which costs are ascertained E.g. the rent, rates and maintenance of buildings; the wages and salaries of strorekeepers 14

Main Elements of Cost    Material Labour Expenses 15

Material   The substance from which the product is made is known as material. It may be in raw, semi- manufactured or a manufactured state. It can be Direct as well as Indirect. 16

Direct materials       All material which becomes an integral part of the finished product and which can be conveniently assigned to specific physical unit is called as ‘direct material’. The cost of materials – the cost of materials used entering into and becoming the elements of a product or service E.g. fabrics in garments, crude oil in refinery, bricks, iron and cement in Building. 17

Indirect materials   All material which is used for purpose ancillary to the business and which cannot be conveniently assigned to specific physical unit is termed as ‘indirect material’. Such as stationery, consumable supplies, spare parts for machine that assist to the production of final products. 18

Labour    For conversion of materials into finished goods, human effort is needed Such human effort is called Labour. Labour can be direct labour as well indirect labour. 19

Direct labour      Labour which takes an active and direct part in the production of a particular commodity or rendering service is called direct labour. Direct labour costs are, therefore, specifically and conveniently traceable to specific product or service. The cost of remuneration for working time E.g. assembly workers’ wages in toy assembly. It is also known as process labour, productive labour, operating labour etc. 20

Indirect labour     Labour employed for the purpose of carrying out tasks incidental to goods or service provided, is indirect labour. Such labour does not alter the construction, composition or conditions of the product. It cannot be particularly traced to specific units of output. Such as salaries of factory supervision and office staff that do not directly involve in production of the final product. Indirect labour may relate to the factory, the office or the selling and distribution divisions 21

Expenses   Any other cost, beside material and labour cost, is termed as expense. Expenses may be direct or indirect. 22

Direct expenses      These expenses which can be directly, conveniently and wholly allocated to specific cost centres or cost units. Such expenses are also described as ‘chargeable expenses’ Other costs which are incurred for a specific product or service E.g. royalties Hiring of some special machinery, required for a particular construct; cost of defective work etc. 23

Indirect expenses  Such as rent, rates, depreciation, maintenance expenses that do not have instant relationships with the manufacturing processes 24

Direct cost   Cost that can be identified specifically with or traced to a given cost object The direct costs consist of the following three elements:    Direct materials Direct labour Direct expenses 25

Indirect cost (overhead)   Cost that cannot be identified specifically with or traced to a given cost object They are identified with cost centres as overheads    Indirect materials Indirect labour Indirect expenses 26

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 27

 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 28

 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. 29



Cost accumulation •Prime cost = direct materials + direct labour + direct expenses •Production cost = Prime cost + factory overhead Also known as Factory Cost •Total cost = Prime cost + Overheads (admin, selling,distribution cos 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 32

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. 33


Example..  From the following particulars compute the cost of production of product: Amount Material Used 12,000 Labour Employed 8,000 Salary of inspector engaged in the product 1,000 Propionate lighting and heating (factory and office 3:2) 500 Proportionate of deprecation, repairs and rent (50% is related to factory) 1,000 Municipal tax and insurance (40% related to office) 800 Trade subscription 100 35

Cost Sheet.. Particulars Amount Direct Material: Material Consumed 12,000 Direct Labour: Labour Employed 8,000 Direct Exp: Salary of inspector engaged in the product 1,000 PRIME COST 21,000 Add: Factory overheads lighting and heating deprecation, repairs and rent Municipal tax and insurance FACTORY COST (Prime cost + Factory overheads) 300 500 480 22,280 Add: Office and Administrative overheads lighting and heating deprecation, repairs and rent Municipal tax and insurance Trade subscription 200 500 320 100 Total Cost of Production (Factory cost+ office exp) 23,400 36

Exercise.. Calculate total cost                Material Used in manufacturing: 5,500 Material Used in packing: 1,000 Material Used in selling the product: 150 Material Used in factory: 75 Material Used in office: 125 Labour required in producing: 1,000 Labour required for supervision of mgt. of factory: 200 Expenses- Direct- Factory: 500 Expenses- Indirect- Factory:100 Expenses- office: 125 Deprecation- office building and equipment: 75 Depreciation- factory: 175 Selling expense: 350 Freight : 500 Advertising : 125 37

Classification of Cost     Fixed Variable Semi-variable and Step cost 38

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. 39

Variable cost- Total and per unit 40

Fixed cost   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 41

Fixed cost- Total and Per unit 42

Semi-variable cost   It processes characteristics of both fixed and variable cost It increases or decreases with activity level but not in direct proportion 43

Semi- Variable Cost 44

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 45

Step costs 46

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 47

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 48

Relevant and Irrelevant Cost   Relevant cots 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. 49

  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. 50

Shutdown and Sunk 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 cots 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 51

    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 52

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. 53

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. 54

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. 55

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 . 56

Comparison of cost, management and financial accounting 57

Meanings    Financial accounting Cost accounting Management accounting 58

Financial accounting    Provides information to users who are external to the business It reports on past transactions to draw up financial statements The format are governed by law and accounting standards established by the professional accounting policies 59

Cost accounting    Is concerned with internal users of accounting information, such as operation managers The generated reports are specific to the requirement of the management The reporting can be in any format which suits the user 60

Management accounting   Comprises all cost accounting functions The accounting for product and service costs, management accounting extends to use various internal accounting reports for planning, control and decision making 61

Cost and management accounting Vs. Financial accounting 62

Management (cost)accounting Nature Records material, labour and overhead costs in product or job  Financial accounting Records company transaction events  External financial statements are produced  Reports produced are for internal management and contol Accounting Not based on the Follows the double double entry system entry system system  63

Management (cost)accounting Accounting No need to use principles accounting principles Financial accounting Use Generally Accepted Accounting Principles for recording transactions  Adopt any accounting techniques that generates useful accounting information Used by different Used by external Users of information levels of management parties: shareholders, or departments creditors, government, responsible for etc respective activities  64

Management (cost)accounting Operation guidelines or standards Time span Based on management instructions and requirements  Reports are prepared whenever needed  They may be prepared on a weekly or daily basis  Financial accounting Conforms to company Ordinances, stock exchange rules, SEBI , MCA rules etc.  Reports are prepared for a definite period, usually yearly and half yearly  65

Management (cost)accounting Time focus Perspectiv e Future orientation: forecasts, estimates and historic data for management actions Detailed analysis of parts of the entity, products, regions, etc  Financial accounting Past orientation: use of historic data for reporting and evaluation  Financial summary of the whole orgainisation  66

Cost accounting vs. Management accounting 67

Management accounting Objective Basic of recording To provide information for planning and decision making by the management Concerned with transactions related to the future  Cost accounting To ascertain and control cost  Based on both present and future transactions for cost ascertainment  68

Management accounting Coverage Utility Covers a wider area: financial accounts, cost accounts, taxation, etc. Only the needs of internal management  Cost accounting Covers matters relating to ascertainment and control of cost of product or service The needs of both internal and external interested groups  69

Management accounting Deals with both Types of transactions monetary any non- monetary transactions, covering both quantitative and qualitative aspects Cost accounting Deals only with monetary transactions, covering only quantitative aspect  70

Methods of Costing   Costing is “the technique and process of ascertaining cost”. There are various methods of costing:       Job Costing Contract Costing Batch Costing Process Costing Operation Costing Operating Costing 71

Job Costing     Job costing is used when the production is not highly repetitive and, in addition, consists of distinct jobs or lots . Each product produced in the job are identified by order number. This method is followed by these concerns when work is carried on by the customers request. Commercial foundry, printing press, specialized industrial equipments are example where job costing is applied. 72

Contract Costing   Contract  costing is applied for contract work like construction of dams, buildings, roads, civil engineering contract etc. each contract or job is treated as separate cost unit for the cost ascertainment and control. A contract costing in principle differ from job costing, A contract is a big job while a job is a small contract. 73

Batch costing    A batch is a group of identical products. Under batch costing a batch of similar products is treated as a separate unit for the purpose of ascertaining cost. The total costs of a batch is divided by the total number of units in a batch to arrive at the costs per unit. This type of costing is generally used in industries like bakery, toy manufacturing, pharmaceutical etc. 74

Process Costing    This method is used in industries where production is carried on through different stages or processes before becoming a finished product. Costs are determined separately for each process. The main feature of process costing is that output of one process becomes the raw materials of another process until final product is obtained. This type of costing is generally used in industries like textile, chemical  paper, oil refining etc. 75

Service (Operating) Costing   This method is used in those industries which rendered services instead of producing goods. Under this method cost of providing a service is also determined. It is also called service costing. The organisation like water supply department, hotels, Railway, transportation, electricity department etc. are the examples of using operating costing. 76

Operation Costing    This is suitable for industries where production is continuous and units are exactly identical to each other. This method is applied in industries like mines or drilling, cement works etc. Under this system cost sheet is prepared to find out cost per unit and profits or loss on production. 77

Techniques of Costing  Following types of techniques are used by management only for controlling costs and making some important managerial decisions.      Marginal Costing Direct Costing Absorption or Full Costing Uniform Costing Standard Costing 78

Marginal Costing    It is a technique of costing in which allocation of expenditure to production is restricted to those costs which arise as a result of production i.e. costs which vary with production (material, labour and direct expensesvariable only and variable overheads) Fixed costs are excluded on the ground that in cases where production varies, the inclusion of fixed costs may give misleading results. It is the ascertainment of marginal cost by differentiating between fixed and variable cost. It is used to ascertain the effect of changes in volume or type of output on profit. 79

Direct Costing   It is the practice of charging all direct costs, variable and some fixed costs relating to operations, processes or products leaving all other costs to be written off against profits in which they arise. This technique is different from marginal because some fixed costs can be considered as direct costs in appropriate circumstances. 80

Absorption or Full Costing   It is the practice of charging all costs, both variable and fixed to operations, processes or products. This differs from marginal costing where fixed costs are exclude. 81

Uniform Costing   It is the use of same costing principles and practices by several undertakings for common control or comparison of costs. This facilitates inter firm comparison, establishing of realistic pricing policies etc. 82

Standard Costing   A comparison is made of the actual cost with a pre-arranged standard cost and the cost of any deviation (called variances) is analyzed by causes. This permits the management to investigate the reasons for these variances and to take suitable corrective action. 83

Historical Costing    It is ascertainment of costs after they have been incurred. It aims at ascertaining costs actually incurred on work done in the past. It has a limited utility, though comparisons of costs over different periods may yield good results. 84

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