Cost Accounting

Notes 71 Pages

Savitribai Phule Pune University

Bachelor of Business Administration

AYK

Contributed by

Alpa Yash Khare

COST ACCOUNTING

SANJANA
Assistant Professor
MES INSTITUTE OF MANAGEMENT
Rajajinagar Bengaluru

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UNIT 1
INTRODUCTION TO COST ACCOUNTING
An external stakeholder of business enterprise makes decisions based on financial statements of
the entity, the preparation of which is based on the principles of financial accounting. While
financial accounting is inevitable and forms basis for many decisions of a business, it does not
completely facilitate internal decision making on account of various limitations. Such limitation
of financial accounting has led to the development of another form of accounting, i.e., cost
accounting.
LIMITATION OF FINANCIAL ACCOUNTING
1. Financial accounting provides the results and financial position of the business, but does
not provide reasons for change in results.
2. It provides results of the past period and hence offers a post mortem analysis of the
performance of the performance of the enterprise, which might not facilitate any
corrective action.
3. It provides only the overall performance of the business and does not offer any
information about performance of each product, division, department, individual, etc.,
thereby hindering any related decision and corrective measures.
4. Financial accounting is not helpful in managerial decisions like
a. Pricing of product
b. Making or buying a component
c. Adding a new product to the existing product line
d. Discontinuing an existing product or line
e. Profitable product mix
f. Choice of marketing channels
5. Financial accounting does not provide any basis for future estimations and planning.
APPLICATION OF COST ACCOUNTING
Cost accounting can be adopted and applied in every form of business entity viz., manufacturing
or non-manufacturing, wholesale or retail, product related or service related, government or
private, and profit oriented or non-profit oriented. Even entities which are not engaged in
business activities can also and apply cost accounting.
PURPOSES/OBJECTIVES OF COST ACCOUNTING
1. The foremost purpose of cost accounting is cost ascertainment. It involves collecting cost
information, recording them under suitable heads and ascertaining cost – product wise,
process-wise, function-wise, etc.
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2. Cost accounting determines the selling price. Although many factors influence selling price,
cost being the prominent factor, forms the base for selling price.
3. Contributing to profitability is another objective of cost accounting and it can be achieved
through and cost reduction. That is possible only when cost is accounted for, hence, cost
control and cost reduction is another major objective of cost accounting.
4. For enabling appropriate decision making, it is essential to know the result of each product,
process and activity. Cost accounting ascertains the profits of each products, process activity,
function department and division.
5. Providing the management with necessary inputs for decision making.
SOME TERMS AND COCEPTS IN ACCOUNTING FOR COSTS
1. Cost: Cost refers to the expenditure incurred for producing a product or for rendering a
service. It is expressed from the viewpoint of producer or service provider.
2. Costing: Costing refers to the methods and process of ascertaining cost.
3. Cost Accounting: It refers to the process of accounting for cost which begins with recording
of income and expenditure or the bases of which they are calculated. It ends with the
preparation of periodical statements and reports for ascertaining and controlling cost.
4. Cost Accountancy: Cost accountancy refers to the application of costing and cost accounting
principles, methods and techniques to the science, art and practice of cost control and the
ascertainment of profitability. It includes the presentation of information derived there from
for the purpose of managerial decision making.
5. Cost Unit: A Cost unit refers to the unit of production, service or time or combination of
these, in relation to which costs may e ascertained or expressed. It differs from business to
business.
For Example, Cost per kg, cost per labour hour, cost per kilometer, cost per seat one way,
cost per ticket per show, cost per plate, cost per square feet, cost per ton, cost per 1000
bricks, cost per bed per day, cost per room per night, etc.
6. Responsibility Center: A responsibility center is an activity center of a business organization
entrusted with a special task. Responsibility center may be of different type’s viz., cost
center, revenue center, profit center and investment center.
7. Cost Center: Cost center is defined as a location, a person, an item of equipment or a group
of these, for which cost may be ascertained and used for the purpose of cost control. It refers
to a section of the business to which costs can be charged. The primary responsibility of cost
center is cost control and reduction.
8. Revenue center: it is a center devoted to raising revenue but has no responsibility of
production. The main responsibility of a revenue center is generation of sales revenue.
9. Profit Center: Profit Center’s performance is measured in terms of income earned and cost
incurred (i.e., profit earning) the primary responsibility of a profit center is profit earning.
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10. Investment Center: Investment center is responsible for earning profits and also for asset
utilization. The primary responsibility of an investment center is earning return on
investment.
11. Methods of costing: Methods of costing are used ascertaining costs. They include, job
costing, output, contract costing, process costing and operating costing.
12. Techniques of Costing: Techniques of costing help in cost control and cost reduction. They
include, budgetary control, standard costing, marginal costing, differential costing, target
costing, life cycle costing, activity based costing, etc.
ADVANTAGES OF COST ACCOUNTING
1. It enables objective cost and profit measurement and also provides for an objective analysis
of the same.
2. It facilitates cost control and cost reduction, and thereby contributes to improved and
enhanced profitability.
3. It enables cost comparison period-wise, product-wise and function-wise, thereby facilitating
better cot control.
4. It helps in identifying unviable, unfeasible and unprofitable products and activities, thereby
making managerial decision making easier and simpler.
5. It provides sufficient and meaningful inputs for all managerial decision and thereby helps in
avoiding any financial mis-implications
6. It helps in appropriate price determination and helps in maintaining profits along with
capturing better market share.
7. It also supplies information to settle disputes with government and government bodies.
DIFFERENCE BETWEEN FINANCIAL ACCOUNTING AND COST ACCOUNTING
Element of Difference
Financial Accounting
Cost Accounting
Purpose
The main purpose of financial
accounting is recording business
transactions and ascertainment of
profitability and financial
position.
The main purpose of cost
accounting is accounting for cost
for enabling cost control and cost
reduction.
Nature
Subjective, since the recording is
based on policies.
Objective, since the recording is
based on facts.
Users of information
It mainly caters to the
requirements of external
stakeholders of the business
enterprise.
It is mainly for the use of
management for decision making
purposes.
Time period
Financial statements (the outcome
Cost reports are prepared on
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of financial accounting) are
prepared in periodic intervals,
generally, once in a year. Hence,
the information is not
contemporary
continuous basis. Hence, the
information is contemporary in
nature.

Analysis and decision
making
The analysis based on financial
statement is post mortem and
might not be useful for all
managerial decisions.
The analysis based on cost
information are concurrent and
facilities most decision of the
management
Performance of
individual products,
division, etc.
Financial accounting does not
provide performance of each
product, process, division,
function, etc. it only provides the
overall results of the organization.
Cost accounting provides the
performance of each and every
product, process, division,
function, etc., and thereby
facilitates, etc., and thereby
facilitates better decision making.
Inventory valuation
Inventory is valued on the
convention of conservatism i.e.,
at cost price or net realizable
value whichever is less.
Inventory is valued at cost price,
projection more realistic data.
Statutory
Requirements
Financial accounting is
mandatory for most business
enterprise
Cost accounting is voluntary in
most cases, other than cases
where cost accounting record
rules are applicable.

CLASSIFICATION OF COST
Cost accounting deals with accounting of cots. However, the accounting of costs depends upon
the nature and type of cots. Hence, it is essential to understand the types of costs, on different
bases.

Costs are classified on the following basis:
1. Elements of cost
2. Functions
3. Relationship
4. Behavior
5. Time period
6. Controllability
7. Normality
8. Attributability
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9. Cash outflow
10. Relevance to decision making

A. ON THE BASIS OF ELEMENTS OF COST

a. Material Cost: it refers to the cost of inputs used in production. It includes cost of raw
materials, cost of consumable stores, etc.
b. Labour Cost: It refers to the cost incurred in relation to people or human resources of the
organization. It includes wages paid for converting raw material into finished goods,
salary, incentives, benefits, perquisites, training and development expenses, etc.
c. Other Expenses: All other expenses other than material and labour, incurred for
operating the business are included in these expenses. They include rent of factory,
maintenance expenses, sales promotion expenses, freight charges, etc.

B. ON THE BASIS OF FUNCTIONS

a. Production cost: It refers to the cost of producing the product till the primary packing. It
includes material cost, cost of converting material into finished goods (i.e., labour cost
and other expenses for production and related to factory).
b. Administration Cost: It refers to the cost incurred to administer and manage the
business. It includes all expenses which are not directly relating to production, selling,
distribution, research or development activates. Examples of administration cost are
office rent, office stationery, legal expenses, accounting expenses, audit expenses,
director’s remuneration, etc.
c. Selling Cost: its refers to the expenses incurred to promote sales, increase demand and
generate revenues. These are also called marketing cost. Selling cost includes
advertisement expenses, sales man salary and commission, cost of samples, cost of
promotional offers, etc.
d. Distribution Cost: It refers to the expenses incurred for making available the final
product to the customer. It includes expenses incurred to deliver the finished product to
customer’s location, expenses incurred to deliver the goods to point-of-sales, expenses
incurred on delivery vehicles, salary of delivery personnel, etc.
e. Research Cost: It refers to the cost of researching for new or improved products, new
application of materials or improved methods.
f. Development Cost: it refers to the cost of the process which begins with the
implementation of the decision the produce a new or improved product, or to employ a
new or improved method and ends with commencement of formal production of that
product or by that method.
g. Conversion Cost: It refers to the cost of converting raw material into finished goods. It
includes Direct wages (i.e., wages paid for labour involved in production process), direct
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expenses (i.e., other expenses directly attributable to the final product) and factory
expenses (i.e., expenses incurred at the point of production in relation to the product)
h. Pre-production cost: it refers to the cost incurred in making a trial production run prior
to formal production.

C. ON THE BASIS OF RELATIONSHIP

a. Direct Cost: it refers to the cost which in directly related to/ identified with/ attributable
to a cost center or a cost unit. It includes raw material used in the finished product, wages
paid to worker engaged in conversion of raw material to finished product and any other
expenses which can be directly attributed to the product.
b. Indirect Cost: These are not directly identified with a cost center or a cost unit. They are
cost which are apportioned over different cost centers using appropriate basis. Indirect
costs are popularly called ‘overheads’. Factory expenses, administration expenses, selling
expenses, distribution expenses are some examples of indirect costs.

D. ON THE BASIS OF RELATIONSHIP

a. Fixed Cost: It refers to the cost which remains the same in total but varies inversely per
unit with production. For example, let us say the monthly rent for factory building is Rs.
10000. The total rent remains the same each month, irrespective of the quantum of
production. However, the rent per unit will vary inversely with production.
For a production of one unit in a month, the rent per unit would be Rs. 10000. For a
production of 100 units in a month, the rent per unit would be Rs. 100. For a production
of 1000 units in a month, the rent per unit would be Rs. and so on.
b. Variable Cost: it refers to the cost which remains the same per unit but the total varies
proportionately with production or sale. For example, let us say the raw material
requirement per unit of finished product is 2 kg and each kg costs Rs. 5. So, the per unit
raw material cost is Rs.10.
For a production of 10 units, the total raw material cost is Rs. 100. For a production of
1000 units, the total raw material cost is Rs. 1000 and so on.
c. Semi variable Cost: This cost refers to the cost, a portion of which is fixed in nature and
the remaining portion is variable with production or sales. For example, electricity bills,
water bills, internet bills, etc., have a fixed charge for certain period and additional
charges based on usage.

E. ON THE BASIS OF TIME-PERIOD

a. Historical Costs: These refer to the costs relating t other past period. They are the costs
which have already been incurred.
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b. Current Costs: Current costs refer to the costs relating to the present period.
c. Pre-determined Costs: These costs refer to the costs relating to the future period. These
are computed in advance on the basis of specification of all factors affecting them.

F. ON THE BASIS OF CONTROLLABILITY

a. Controllable Costs: These costs can be influenced and controlled by management
action, for example, a long term agreement with a supplier for supply of raw materials at
a pre-determined price.
b. Non-controllable Costs:These costs cannot be influenced and controlled by any specific
management action or by any specific member of the organization.

G. ON THE BASIS OF NORMALITY

a. Normal Costs: These refer to the costs which are reasonably expected to be incurred
under normal routine and regular operating conditions.
b. Abnormal Costs: These refer to the cost over and above normal costs which are not
incurred under the normal operating conditions, for example, fines and penalties, wages
for idle hours, etc.

H. ON THE BASIS OF ATTRIBUTABILITY

a. Period costs: These costs are not assigned to the products but are charged as expenses
against revenues of the period in which they are incurred. These are the costs which are
not included in inventory valuation. For example, general administration costs, salesmen
salary, depreciation of office premises, etc.
b. Product Costs: These costs are assigned to the product and included in inventory
valuation. These are also called as inventoriable costs. For example, cost of raw
materials, directs wages, depreciation of plant, equipment, etc.

I. ON THE BASIS OF CASH OUTFLOW

a. Explicit Costs: These are the costs which involve cash payment and are actually
incurred. They are also called out-of-pocket costs. Since they are actually incurred, they
are easily and objectively measured. They are recorded in the books of accounts and are
used for the purpose of accounting, reporting, cost control and decision making. For
example, material costs, labour costs, salaries, rent, advertisement expenses, etc.
b. Implicit Costs: These costs do not involve cash payment and are not actually incurred.
They are also called economic costs or notional costs or imputed costs. They cannot be
easily measured and involve subjective estimation. They are not recorded in the books
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but are used for the purpose of decision making. For example interest on owner’s capital,
rent of own premises, proprietor’s salary.

J. ON THE BASIS OF RELEVANCE TO DECISION MAKING

a. Relevant Cost: These costs are relevant and uses full for decision making purpose. They
include the following
 Marginal Cost: It refers to the cost of producing one additional unit. It is the total of
variable cost, specific fixed cost and opportunity cost.
 Differential Cost: it refers to the change in costs due to change in the level of activity or
pattern or method of production. Where the change results in increase in cost, it is called
incremental cost and where the change results in increase in cost, it is called incremental
costs and where the change results in decrease in cost, the difference in cost is called
detrimental cost.
 Opportunity Cost: It refers to the value of benefit forgone by accepting an alternative
course of action. For example, if a business enterprise carries out its operations in its own
premises, so the rent which could have been earned if the premises were let out is the
opportunity cost.
 Out of pocket cost: It refers to the cost which involves cash outflow. These costs are
recorded in the books and they form the basis for all decisions of the enterprise.
b. Irrelevant Cost: These costs are not relevant or useful for decision making. They include
the following.
 Suck Cost: It is a cost which has already been incurred or sunk in the past. It is not
relevant for decision-making. For example, the employees are trained in operation of a
particular machine. The expense for training are sunk costs for decision on whether to
buy or lease the machine.
 Absorbed fixed Cost: It refers to common fixed cost which does not change with any
alternative course of action. For example, depreciation on factory building, salary to
accountants, etc., will not change irrespective of whether a component is produced in the
factory or bought out from the market.
Practical Difficulties or Challenges in installing cost accounting system
1. Lack of support from top management
2. Resistance from accounting staff
3. Lack of co-operation at operating levels
4. Shortage of trained staff
5. Costs of operating the system

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Methods of Costing
1. Units or output or Single Costing
2. Job Costing
3. Batch Costing
4. Contract Costing
5. Process Costing or Operation Costing
6. Operation costing
7. Multiple costing or Composite Costing
COST SHEET
A Cost Sheet or Statement of Cost is a statement which shows the break up and builds up of
costs. It is a document which provides for the assembly of the detailed cost center or a cost unit.
It is prepared in timely intervals and shows the various elements of cost of products produced
during the period. It presents the total cost as well as per unit cost of the production during the
period.
OBJECTIVES OF A COST SHEET
 Cost Sheet enables ascertainment of total cost and per unit cost of output or production
during a given period.
 It enables determination of selling price.
 It helps in ascertaining the profitability of the enterprise during a given period.
 It also provides analysis of cost for each product, location and unit.
 It provides the basis for making estimates and thereby helps in preparation of tender and
quotations.

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Cost Accounting

Cost Accounting

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