COST ACCOUNTING

MODULE 1 (NEP)
INTRODUCTION TO COST ACCOUNTING

Introduction-
Cost accounting is branch of accounting. It has been developed because of the limitations of
financial accounting. Financial accounting is mainly concerned with keeping of records to show
the financial information about the profit or loss of business for a year and the financial position
of the business at the end of the year. It fails to provide cost related information to the
management to take effective decisions regarding production and sales aspects. It plays crucial
role in the success of every enterprise.

Definition to Cost:
According to ICMA, London – “The amount of expenditure (actual or notional) incurred onor
attributable to a specified thing or activity”
According to ICWA, India – “Cost is a measurement, in monetary terms, of the amount usedfor
the purpose of production of goods or rendering services”

Meaning
Cost means the total amount of expenditure, actual or notional, paid or outstanding, incurred on
a particular thing or service or on the completion of some work. In other words, Cost is the sum
of all the expenditure incurred in producing and selling a product, rendering a service or in
performing a job.

Definition to Costing:
According to ICMA, London – “The technique and process of ascertaining costs”

Meaning
Costing is the technique and process for determining the cost of a product, service or job.
In short, costing is the systematic procedure of ascertaining the cost of a product, service or job.

Cost Accounting
According to ICMA, London – “The process of accounting for cost form the point at which
expenditure is incurred or committed to the establishment of its ultimate relationship with
cost centers and cost units.”

Meaning
Cost accounting is the formal system of accounting for costs by means of which costs of products
or services are ascertained and controlled. It begins with the recording of costs and ends with
the preparation of cost report for managerial decisions.

Objectives of Cost Accounting:

1. Ascertaining Costs: The first objective of cost accounting is to find out cost of a product,
process or service. The other objectives which have been mentioned hereafter scan be achieved
only when the costs have been ascertained.
2. Determining Selling Price: After ascertaining the cost of product add certain percentage of
profit to cost to determining selling price. Thus, necessary that the revenue should be greater
than the costs incurred in producing goods and services from which the revenue is to be derived.
3. Measuring and Increasing Efficiency: Cost accounting involves a study of the various
operations used in manufacturing a product or providing services. The study facilitates
measuring of the efficiency of the organization as a whole as well as of the departments besides
devising means of increasing the efficiency.
4. Cost Control and Cost Reduction: Cost accounting assists in cost control it uses techniques
such as budgetary control, standard costing etc. for controlling costs. Cost is required to be
reduced also constant research and development activities help in reduction of costs without
compromising with the quality of goods or services.
5. Ascertaining Profits: Cost accounting also aims at ascertaining the profits of each and every
activity. It produces statements at such intervals as the management may require
6. Providing Basis for Managerial Decision-Making: Costs accounting helps the management
in formulation operative policies.

Importance/Scope of Cost Accounting:

1. Cost Ascertainment: It includes collection, analysis of expenses and measurement of
production at different stages of manufacture. The collection, analysis and measurement requires
different methods of costing for different types of production such as Historical costs, Standard
costs, Actual cost, Process cost, Operation cost etc.
2. Cost Records: In this part of cost accounting, cost accountant maintains cost books, vouchers,
ledgers, reports and other cost related documents for future comparison and reference. It will
also be under the scope of cost accounting. It is also the process of accounting for cost which
begins with the recording of expenditure and ends on the preparation of statistical data.
3. Cost Control: Cost control is the guidance and regulation by executive action. In this division,
cost accountant used different techniques and methods for controlling the cost. Cost accountant
uses budgetary control, standard costing, breakeven point analysis and many other techniques
for controlling the cost. This is the end boundary of cost accounting scope.

Significance/uses of Cost Accounting

a. It is useful for the internal working of an organization.
b. It enables to measure the qualitative aspects of a business concern. It gives information
on which estimates and tenders are based.
c. It helps in detecting the wastages or losses involved in the usage of stock. The exact cause
of a decrease or increase in profit or loss can be detected.
d. The efficient workers can be distinguished from that of inefficient workers.
e. It helps the government in the assessment of tax and the formulation of policiese.
regarding the export trade or import trade.
f. It is helpful to the consumers in knowing the price levels of the products or services. Costing
plays an important role to the public at large.

DIFFERENCES BETWEEN FINANCIAL ACCOUNTING AND COSTACCOUNTING

Basis Financial accounting Cost accounting

It serves the interest of business and It renders information to the management
other interested parties by providing for the proper planning control and decision
1. Purpose suitable information in the financial making
statements.
FA are required to be kept as per the CA are voluntary kept to serve the
2. Options requirements of the company act and management in the discharge of its
income tax act. functions.
FA reveal the profit of the business as a CA shows the profit result of eachoperation
3. Analysis whole. process and product.
 It consists of classification recording It records in an objective manner i.e.,
and analysis of transactions in a according to which cost are incurred.
4. Recording subjective manner i.e., according to the
nature of expenditure.
It lays emphasis on the recording It provides for a detailed system of control
5. Control aspect, no consideration is given to with the help of standard costing and
control aspect. budgetary control.
It involves reporting of business There is a continuous flow of data
6. Reporting performance at the end of the information of cost report to management.
accounting year.
7. Obligation This is to be maintained compulsorily. This is to be maintained voluntarily.
8. Audit Audit of FA is statutory Audit of CA is not compulsory.
FA provides financial information once CA furnishes reporting cost data at
9. Duration a year. frequent intervals.
It fails to guide the formulation of It provides adequate data for formulating
10. Pricing pricing policy. pricing policy.
11. Valuation Stock is valued at cost or marked rice Stock is always valued at cost price.
of stock whichever is less.
Cost Concept
• Cost Classification
• Cost Unit
• Cost Center
• Elements of Cost

I. Cost Classification
On the basis of the Nature or Elements of Costs
• On the basis of the Functions or Operations of Costs
• On the basis of the Allocation or Identity of Costs
• On the basis of the Variability or Behaviour Costs
• On the basis of the Controllability of Costs
• On the basis of the Normality of Costs
• On the basis of the Time of Ascertaining the Costs
• On the basis of the cost analysis for decision making

1. On the basis of the Nature or Elements of Costs

a. Material Costs– Refers the costs of various items of materials used by an undertaking. Ex:
Cost of Raw Material, Components, Consumable stores, Packingetc.
b. Labour Costs– Refers to the various items of remuneration, such as wages, salaries,
commission, bonus, etc paid to the employees.
c. Expenses– Refers to the cost of services enjoyed by an undertaking. In other words, expenses
refers to all costs except the material cost and labour cost. Ex: Factory rent, lighting, power,
depreciation of plant, printing and stationery, postage, advertisement etc.

2. On the basis of the Functions or Operations of Costs

a. Production Costs (Manufacturing or Factory Cost) – Refers to the costs of sequence of
operations which begins with the acquisition of raw material and ends with the completion of
the finished goods. Ex: Material Costs and Labor Costs
b. Administration Costs – Refers to the costs incurred in formulating the policy, directing, the
organist ion and controlling the operations of an undertaking.
Ex: Office rent, Depreciation of office building, GM Salary, Office staff salaries, office lighting
and heating, Printing and stationery etc.
b. Selling and Distribution Costs– Refers those costs which are incurred after the goods are
converted into saleable condition until they are sold and delivered to the consumers. These
cost again divided into two heads such as Selling costs and Distribution costs. Selling costs
referred as marketing cost and Distribution cost referred as transportation and storage cost
of product.

3. On the basis of the Allocation or Identity of Costs

a. Direct Costs– Refers to costs which can be identified with the cost center or cost unit
b. Indirect Costs– Refers to cost which cannot be identified and allocated to anyparticular cost
center or cost unit.

4. On the basis of the Variability or Behavior Costs

Under this available cost classified into three categories
a. Fixed Cost – The cost which do not vary with the change in the level of activity or output
and remain fixed for all volume of production for a given period of time .
b. Variable Cost- The cost which vary with the change in the level of activity or output.Under
this costs increases in total when the output increases and vice-versa
c. Semi-Variable Cost- Refers to those costs which remain fixed upto a certain level of
production, and tend to vary beyond that level. In short, these costs which are party fixed and
partly variable

5. On the basis of the Controllability of Costs

a. Controllable Costs– Refers to those costs which can be controllable by the specified
executive in charge of the concerned cost centre.
b. Non-Controllable Costs- Refers to those costs which cannot be controllable by the
specified executive in charge of the concerned cost centre.

6. On the basis of the Normality of Costs

a. Normal Costs – Refers to those costs which are normally incurred at a given level of
output in the normal conditions. Ex: Costs of Production.
b. Abnormal Costs– Refers to those costs which are incurred under exceptionalcircumstances
at a given level of output and not change against cost of prouction.

7. On the basis of the Time of Ascertaining the Costs

a. Historical Costs or Post Costs – Refers those costs which are ascertained after theyhave
been incurred. The costs are available only after the completion of production
b. Pre-determined Costs– Refers those costs which are determined in advance ofproduction.
These costs may be either estimated or standard costs.

Other types of Cost

a. Actual Cost or Expenditure: The expenses in the form of cash and the same are shown
in accounting records. For Ex: cost of material purchased, wages paid to workers, any
expenses in cash etc
b. Notional Cost or Expenditure: The expenses not in the form of cash and not consider for the
purpose of comparison and managerial decisions. For Ex: cost of land and building, labour,
capital owned by the proprietor and supplied to the business at free of change.
c. Expired Cost: The cost which incurred or paid by the organization to generate the revenue
and recorded in the profit and loss account in the debit side. For Ex: Depreciation, Salary,
Interest and tx,
d. Unexpired Cost: The cost which unconsumed or yet incurs by the organization and should
be shown as an asset in the balance sheet. For Ex: Prepaid Expenses (Insurance, Advances) etc.
e. Expense – “An expired or unexpired cost resulting from a productive usage of an asset” and
it should be compensating the value in terms of revenue for an organization
f. Loss – “An expired cost resulting from the decline in the service potential of an asset that
generated no benefit to the firm. It should not be compensating the value. For Ex: Destruction of
stock by fire

ELEMENTS OF COST:
Elements are related to the process of manufacture that is the conversion of raw materials
into finished products. Cost are normally classified into three basic elements namely
materials, labor and expense.
Material cost: According to CIMA, UK material cost is ―The cost of commodities supplied
to an undertaking. material may be direct or indirect.
 Direct Material: direct material cost is that which can be conveniently identified with and
allocated to cost units. Direct materials generally become a part of finished product .for e.g.
clay used in bricks, leather in shoes, cloth in garment, steel in machine.
 Indirect Material: These are those materials which cannot be conveniently identified with
individual cost units.

Labour Cost: Labour cost is the cost of remuneration (wages, salaries, commission bonus
etc.) of the employees of an undertaking‖.
 Direct Labour: direct labour cost consists of wages paid to workers directly engaged in
converting raw materials into finished product.
 Indirect Labour: it is of general character and cannot be conveniently identified with a
particular cost unit. Foreg: wages paid to supervisor, clerk, peon, watchman etc.

Expenses: All costs other than material and labour are termed as expenses. It isdefined as
―the cost of services provided to an undertaking
 Direct Expenses: According to CIMA, UK, ―direct expenses are those expenses which
can be identified with and allocated to cost centres or units.‖
 Indirect Expenses: All indirect cost, other than indirect materials and indirect labour costs
are termed as indirect expenses.

Cost Object: A cost object is often a product or department for which costs are accumulated
or measured. For example, a product is the cost object for direct materials, direct labor and
manufacturing overhead. The factory maintenance department is a cost object for the cost of
the maintenance employees and the maintenance supplies. Later the factory maintenance
department costs will be assigned to products, which are also cost objects. A cost object can
also be a customer, a machine, a group of machines, a group of employees, etc

Cost Centre
A cost center is a location, person or item of equipment (or group of these) for which cost
may be ascertained and used for the purpose of cost control. In simple words, cost centre is a
part of an undertaking in relation to which costs are changed and ascertained. Each cost center
is given charge under a personal for controlling the cost, accumulation of cost and its
allocation. The sub divisions of cost centers are:
a) The personal Cost Centre: It consist a person or group persons. For Ex: Works
Managers, Store Keepers, and Sales Managers Etc.
b) Impersonal Cost Centre: It consists of a location or items of equipment
c) Operational Cost Centre: It consists of machines and/or person carrying out similar
operations. For Ex: Machines and People engaged in welding, turning, machinery etc.
d) Process Cost Centre: It consists of specific process or a continuous sequence of
operations.

Profit Centre: It is a segment of a business that is responsible for all activities involved inthe production
and sales of products, systems and services. It is created by the top management for evaluating
performance of a division. It enjoys autonomy in decisions making.

Cost Unit
According to I.C.M.A London, “A cost unit is a unit of production, service or type in relationto
which costs may be ascertained and expressed”
Therefore, a cost unit is a unit of quantity, service or type in terms of which costs can be
conveniently computed. Example: For Steel industry the cost unit is per tonne, for paper
industry the cost unit is per kg. Etc.

Cost Control and Cost Reduction

Cost control can be defined as the comparative analysis of actual cost with appropriate standard
budgets. The objective of cost control is the performance of the same job at lower cost or a better
performance for the same cost.
Cost control aims at reducing inefficiency and wastages and setting up predetermined costs and
in achieving them
Cost control techniques:
The techniques of the cost control are
 Managerial control * Control of capital and expenditure
 labor control * Profitability and accounting ratio
 Overhead control
 Standard costing
 Budgetary control

Cost Reduction:
As per CIMA-“cost reduction is to be understood as the achievement of real and permanent
reduction in the unit cost of goods manufactured or service rendered without impairing their
suitability for the use intended”
The above definition brings to light the following characteristics of cost of reduction.
 The cost reduction should be real one in the course of manufacture or servicerendered. Real
cost reduction comes through greatest productivity.
 The reduction must be permanent. The reduction should be through improvement in
methods of production from research work
 The reduction should not be at the cost of essential characteristics, such as quality ofthe
product or services rendered
Cost reduction must be genuine one and should aim at eliminating wasteful elements in methods
of doing things. It should not be at the cost of quality. Cost reduction is a continuous process of
critically examining various elements cost and each aspect of the business.

LIMITATIONS OF COST ACCOUNTING

It is expensive: The system of cost accounting involves additional expenditure to be
incurred in installing it and maintaining it.
The system is more complex: As the cost accounting system involves number of steps in
ascertaining cost, it is considered to be complicated system of accounting.
 Inapplicability: All business cannot make use of a single method and technique of
costing. It all depends upon the nature of business and type of product manufactured by it.
Not suitable for small organizations: A cost accounting system is applicable only to a
large organization but not suitable for small organization.
Lack of social accounting: Cost account fails to take into account the social obligation of
the business. In other words, social accounting is outside the preview of cost account.

Cost Sheet
A cost sheet is a statement of cost showing different elements of cost of a product produced, or
service rendered or job done during a period in total as well as cost per unit. It is prepared at
regular intervals. For Ex: Weekly, Monthly, Quarterly, Yearly etc.
A cost sheet is prepared by classifying costs according to elements such as Materials, labor and
Overheads.
Specimen of Cost Sheet

Total Cost per

PARTICULARS
cost(Rs.) unit(Rs.)
Opening stock of Direct raw materials
Add: purchases ……… ………
Add: carriage inwards ……… ………
Add: Octroi, custom duty,& other expenses on purchases ……… ………
Less: closing stock of direct raw materials ……… ………
Cost of direct materials consumed ……… ………
Direct or productive wages ……… ………
Direct (or chargeable) expenses ……… ………
………
Prime cost ………
Add: Works Or Factory Overheads ……… ………
Indirect materials ……… ………
Indirect wages ……… ………
Leave wages ……… ………
Overtime premium ……… ………
Fuel & power ……… ………
Coal ……… ………
Factory rent & taxes ……… ………
Insurance ……… ………
Factory lighting ……… ………
Supervision ……… ………
Works stationary ……… ………
Canteen & welfare expenses ……… ………
Repairs ……… ………
Haulage ……… ………
Work salaries ……… ………
Depreciation on plant & machinery ……… ………
Works expenses ……… ………
Gas & water ……… ………
Drawing office salaries ……… ………
Technical director fees ……… ………
Laboratory expenses ……… ………
Works telephone expenses ……… ………
Internal transport expenses ……… ………
Less: sale of scrap ……… ………
Add: opening stock of working progress ……… ………
Less: closing stock of work in progress ……… ………
………
Works Cost ………
Add: Office And Administrative Overheads ……… ………
Office salaries ……… ………
Directors fees ……… ………
Office rent & rates ……… ………
Office stationery & printing ……… ………
Sundry office expenses ……… ………
Depreciation & repairs of office equipment ……… ………
Depreciation of office furniture ……… ………
Subscription to trade journals ……… ………
Office lighting ……… ………
Establishment charges ……… ………
Directors travelling expenses ……… ………
Postage ……… ………
Legal charges ……… ………
Audit fees ……… ………
………
Cost Of Production ………
Add: opening stock of finished goods ……… ………
Less: closing stock of finished goods ……… ………
………
Cost Of Goods Sold ………
Add: selling & distribution overhead ……… ………
Advertising ……… ………
Showroom expenses ……… ………
Bad debts ……… ………
Sales man salary & expenses ……… ………
Packing expenses ……… ………
Carriage outward ……… ………
Commission of sales agent ……… ………
Cost of catalogues ……… ………
Expenses of delivery vans ……… ………
Collection charges ……… ………
Travelling expenses ……… ………
Cost of tenders ……… ………
Warehouse expenses ……… ………
Cost of mailing literature ……… ………
Sales manager salary ……… ………
Sales director fees ……… ………
Sales office expenses ……… ………
Depreciation & repairs of delivery van ……… ………
Expenses of sales branches ……… ………
………
Cost Of Sales Or Total Cost ………
Add: Profit ……… ………
Sales ……… ………
Items Excluded from Cost/Cost Sheet
The following items are of financial in nature and not included while preparing a cost sheet.
• Cash Discount
• Interest Paid
• Preliminary Expenses
• Goodwill written off
• Provision for Taxation
• Provision for Bad Debts
• Transfer Service
• Donations
• Income Tax
• Dividend Paid

IMPORTANT QUESTIONS- SECTION A

1. Define Cost
2. Give the meaning of Cost
3. Define Cost Accounting.
4. Give the meaning of Cost Accounting
5. State the Objectives of Cost Accounting
6. What are the scope of Cost Accounting?
7. State the significance of Cost Accounting.
8. State any two differences between Cost Accounting and Financial Accounting.
9. State the cost classifications.
10. Give the meaning of- Controllable and Non Controllable cost, Normal Cost and Abnormal Cost,,
Historical Cost and Pre- determined Cost, Notional Cost, Expired Cost,
11. State the elements of Cost.
12. What is Cost Object?
13. What is Cost Center?
14. What is Cost Unit?
15. Give the meaning of Cost Control.
16. What are the Cost Control Techniques?
17. What is Cost Reduction?
18. State any 2 limitations of Cost Accounting.
19. What is Cost sheet?
20. State any 4 items which are not included in Cost sheet.

SECTION B
1. What is Cost Accounting? What are the objectives of Cost Accounting?
2. Explain the significance of Cost Accounting.
3. Differentiate between Cost Accounting & Financial Accounting.
4. State the different classifications of Cost Accounting.
5. Explain the limitations of Cost Accounting.

SECTION D
6. Prepare Cost Sheet with imaginary figures.