Business Studies Year 1

SECTION

8 INTRODUCTION TO
COST ACCOUNTING

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SECTION 8 INTRODUCTION TO COST ACCOUNTING

Cost Accounting
Controlling Cost to Improve Organisational Performance

Introduction
In this section, we will explore the essential concepts of Cost Accounting, which is
crucial for effective management and decision-making. We will cover the purpose and
basic terminologies such as direct costs, indirect costs, fixed costs and variable costs.
Understanding these concepts is key to developing cost management strategies. We
will also classify costs based on common characteristics to understand cost structures
better and examine the composition of costs in services and operations. By the end of
the section, you should understand the importance of cost management and control in
enhancing organisational performance.

At the end of this section, you will be able to

• Explain the purpose and basic terminologies used in cost accounting.

• Explain the composition of the cost of products, services and operations.

Key Ideas:
1. Cost Accounting is a branch of accounting that focuses on recording, classifying and
analysing the costs associated with producing goods or providing services. Its main
objective is to control and reduce costs, enhance decision-making and determine product
profitability.
2. Cost Centre is a segment or area within an organisation where costs are incurred and
tracked. It may be a department, machine, a person, time or specific activity.
3. Cost Unit is a unit of output or service to which costs can be allocated or measured. It
represents the measure of quantity, such as a single product, service, or job, for which
cost is calculated.
4. Unit Cost is the total cost incurred to produce a single unit of output. It is calculated by
dividing the total cost by the number of units produced.
5. Cost Classification is the process of grouping costs based on their nature or purpose,
such as direct and indirect costs, fixed and variable costs or product and period costs, to
facilitate decision-making and control.
6. Element of Cost are the basic categories of costs that make up the total cost of production,
typically classified into three elements: materials, labour and expenses
7. Direct Costs are made up of costs that can be directly traced to a specific product, service
or cost object. These include expenses like direct materials and direct labour which are
linked with the production of a particular good or service.

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SECTION 8 INTRODUCTION TO COST ACCOUNTING

8. Indirect Cost are costs that cannot be directly traced to a single product or service
and so are typically allocated across various products or departments. These costs
support multiple cost objects and include expenses like factory overheads, utilities and
administrative expenses

COST ACCOUNTING AND BASIC

TERMINOLOGIES USED IN COST ACCOUNTING

Meaning and definition of cost accounting

Cost accounting is a form of management accounting and is the process by which all
the costs of a business activity or production are examined to support effective decision
making
Cost accounting records all incurred costs associated with the production of goods or
provision of a service and enables businesses to track costs over time.

Functions of cost accounting

Cost accounting is used by business to:
1. Provide relevant information to management to support decision-making.
2. Assist management in planning, measuring and controlling business activities.
3. Allocate cost to products and services.
4. Help in the collection and accumulation of cost.
5. Set budgets and standards.
6. Evaluate the performance of departments.

Activity 8.1

1. In pairs, discuss the meaning of cost accounting and record your agreed
definition.
2. Identify the functions of cost accounting.
You could use a table such as the one below to record your responses.

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SECTION 8 INTRODUCTION TO COST ACCOUNTING

Definition of cost accounting

Functions of cost accounting

3. Compare your answers with another pair for discussion and feedback.

Basic Cost Accounting Terminologies

To understand cost accounting, it is necessary to explain the terminology used in the
process. Some basic terms are defined below:
Cost Centre
Cost centres allow businesses or departments to organise their accounts based on
their specific activities. Each cost is assigned to a cost centre to enable monitoring or
performance and control over expenditure.
• A cost centre could be a location, e.g. a department or a sales area of the business;
• a person e.g. a salesman or machine operator;
• an item of equipment e.g. a delivery van or a machine;
• a group of these.

Cost Unit / Cost Object

A cost unit is defined as a product, service or time to which cost may be expressed. Cost
unit refers to the product or service that a company produces for example: a tin of milk,
a car, a bag of rice, etc.
Unit Cost
A unit cost refers to the cost incurred per unit of output. It is the cost price of a product.
It is measured as total cost divided by the total number of units produced.

Cost Classification
This refers to the process of grouping costs according to their common features or
characteristics. This ensures effective reporting and communication of costs.

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SECTION 8 INTRODUCTION TO COST ACCOUNTING

1. Classification according to Nature of Cost.

Under this classification, cost can be described as Direct or Indirect.
Direct costs are those costs that are traced or conveniently identified with a
particular cost centre or cost unit. For example, the cost of wood used in making
a table.
Indirect costs are those costs which cannot be traced to any particular cost
centre. They are general costs that are incurred for the benefit of a number of
cost centres. Examples are insurance, rent and salaries.
2. Classification according to Behaviour.
Here, cost can be classified as Fixed or Variable.
Fixed costs are those costs that remain constant over a range of activities for
a period of time. That is, a fixed cost does not change as output changes. For
example, rent, depreciation, insurance on vehicles.
Variable costs are those costs that usually vary in direct proportion to output.
That is, as output rises, variable cost also increases and vice versa. E.g. cost of raw
materials.
3. Classification according to Management Function.
A cost item can be described on the basis of the functional areas of the business.
In this regard, cost may be classified as:
Production/Factory cost e.g. cost of raw materials, direct labour
Administration cost e.g. salaries of management, stationery.
Selling & distribution cost e.g. advertising and promotions cost, salaries of
salesmen, warehouse rent.
4. Classification according to Profit Determination
Under this, a cost can be classified as a product cost or a period cost.
Product costs are costs that are necessary for production of goods. Such costs are
not incurred when there is no production. They include the cost of raw materials
and direct labour.
Period costs are those costs that are made even when there is no production.
They include rent, insurance, salaries of management, etc. Period costs are
written off as expenses in the period in which they are incurred.

In addition to these cost classifications, costs may be

seen as follows.
1. Relevant Cost refers to any cost is incurred in direct response to a decision. It
can therefore be altered, or will be dependent upon the nature of that decision.
2. Irrelevant Cost is any cost that does not change in the decision-making process.
For example, in deciding to increase the number of goods in the warehouse,
the salary of the storekeeper is an irrelevant cost, but the price of the product is
relevant.

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SECTION 8 INTRODUCTION TO COST ACCOUNTING

3. Sunk Cost is a past or previous cost that cannot be changed by any decision. It
refers to the cost of resources already acquired and is unaffected by the choice
between two alternatives. For example, the cost of a machine purchased five
years ago.
4. Opportunity Cost is the value of the option not taken when a business makes
a decision, in other words the potential benefit that a business sacrifices when
choosing one alternative over another. Where there is no alternative use for a
resource, then the opportunity cost is zero.
5. Avoidable Cost is any cost that management can choose not to incur. Examples
are advertising, overtime allowances, medical bills of staff, etc.
6. Incremental / Differential Cost is the difference in total relevant cost between
two alternatives. It is a cost that differs as a result of changing levels of activity.
7. Marginal Cost refers to the additional cost of producing one extra unit of a
product.
8. Conversion Cost is the cost of transforming raw materials, direct labour and
overheads into finished goods. It is the amount of direct labour and overheads
that are required to turn raw materials into finished products.

Activity 8.2

1. In groups, complete the table below by writing the appropriate costings term
for the following definitions.

s/n Definition Appropriate

terminology

1 The expense incurred per unit of output. It is calculated by

dividing the entire cost by the total quantity produced.

2 The additional cost of producing one additional unit of a

product.

3 Any cost that can be changed by a management decision.

4 A person, place, or piece of equipment for which a cost may be

calculated and used for control.

5 The price of converting raw materials, direct labour and

overhead into final items. It is the total amount of labour and
overhead needed to convert raw resources into final goods.

6 Expenses incurred even in the absence of productivity. They

include things like rent, insurance, management pay, etc. `

7 Costs that typically change in direct proportion to production. In

other words, costs that increases with output and vice versa.

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SECTION 8 INTRODUCTION TO COST ACCOUNTING

2. Make a presentation of your responses using a flip chart to share with the
wider class.

Extension task 1

Analyse three classifications of cost and explain how they are applied to cost
accounting. Include examples in your answer.

Extension task 2

Answer at least one of the following questions to support the review of your
learning in this area.
• Outline the functions of cost accounting.
• Outline the basic cost accounting terminologies.
• Describe the different ways by which cost can be classified.

ELEMENTS OF COST OF SERVICES AND

OPERATIONS

Elements of Cost
Elements constitute the components that make up the cost of a product or service.
The main elements of cost are materials, labour and other expenses.
1. Materials are all the ingredients, raw materials or inputs that go into the
production of the final product or service. Material cost is made up of direct
materials and indirect materials.
a. Direct material cost – the cost of raw materials that go into production to
be transformed, through the manufacturing process, to become finished
products or saleable services. For example, leather used for shoes, cement
used for building, palm oil used for soap and cassava used for gari.
b. Indirect material cost – the cost incurred on physical components that do not
form part of the final product. Indirect materials cannot be easily traced to
a particular product or service. For example, cleaning materials, lubricants
used in machines and packaging materials.

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SECTION 8 INTRODUCTION TO COST ACCOUNTING

2. Labour refers to all human effort (physical or mental) used in the production of
goods and services. Labour cost is made up of direct labour and indirect labour
and can be made up of wages, salaries, bonuses, overtime, etc.
a. Direct labour – this is the remuneration paid to workers whose services can
be linked directly with a particular product or service. For example, wages
of a mason building a house, salaries of a machine operator, carpenter or a
tailor.
b. Indirect labour – this is the remuneration paid for services that cannot be
easily traced to a product or service. Examples are salaries of supervisors,
cleaners and security men.
3. Other expenses refer to all costs incurred other than materials and labour. They
are costs of services paid or unpaid, rendered to an organisation.
a) Direct Expenses – these are expenses that can be easily traced to or identified
with a particular product or service. For example, royalties paid on patents
and mining, cost of hiring a special machine, fees of architects or consultants
and experimental cost.
b) Indirect expenses – these are expenses that cannot be easily traced or identified
with a particular product or service. For example, rent and rates, telephone
bills, depreciation and insurance
Note: The total of all direct cost is known as prime cost while the total of all indirect
cost is called overheads.
The diagram gives an overview of how cost is broken down

Elements
of Cost

Material Labour Other

Cost Cost Expenses

Direct Indirect Direct Indirect Direct Indirect

Material Material Labour Labour Expenses Expenses

Activity 8.3

1. Working in pairs, discuss the following elements of cost and write down your
agreed definitions.
a. Material cost
b. Labour cost
c. Other expenses
2. For each of these components of cost, give three examples of:
a. Direct costs
b. Indirect costs

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SECTION 8 INTRODUCTION TO COST ACCOUNTING

3. Present your responses on manila cards. You could use a table such the one
below to record your responses.
4. Share your response with another group for feedback and discussion.

Definition Type Examples

Materials Direct 1.
2.
3.
Indirect 1.
2.
3.
Labour Direct 1.
2.
3.
Indirect 1.
2.
3.
Other Direct 1.
expenses
2.
3.
Indirect 1.
2.
3.

Activity 8.4

1. Copy and complete the flow chart below. Complete your version in the
context of production of a particular product or service (i.e. a car, or cocoa
production). Include examples of the types of direct and indirect costs that
would be incurred.

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SECTION 8 INTRODUCTION TO COST ACCOUNTING

ELEMENTS
OF COST

Material
Cost

Direct Direct Indirect

Material Labour Expenses

2. Make a poster presentation to the larger class.

Extension task 3

Answer at least one of the following questions to support the review of your
learning.
1. Identify the elements of cost.
2. Summarise the elements of cost and their importance to production.
3. Give four examples of indirect cost and four examples of material costs

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Review Questions

1. How can cost accounting help a business identify and manage production costs
more effectively?
2. Define the following cost accounting terms:
a. Cost Centre
b. Cost Unit
c. Unit Cost
3. Explain how costs are classified.
4. What are overheads?

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SECTION 8 INTRODUCTION TO COST ACCOUNTING

EXTENDED READING
• Eric Oduro (2012), Principles of Cost Accounting for Senior High Schools 4th
Edition. Accra: Terror Publications. (Pages 1 – 30)
• Dadzie Barnabas (2013) Costing for “U”, 5th Edition. Obuasi: For U Printing
House (Pages 1-11)

REFERENCES
1. Burns, J., Quinn, M., Warren, L. & Oliveira, J. (2013) Management Accounting.
Maidenhead: McGraw Hill Education
2. Dadzie B. (2024) Costing for “U”, 13th Edition. Obuasi: For U Printing House.
3. Drury, C. (2015) Cost and Management Accounting: An Introduction. 8th Edition.
London: Cengage Learning EMEA.
4. Oduro E. (2012), Principles of Cost Accounting for Senior High Schools 4th Edition.
Accra: Terror Publications.
5. ICAG (2019), Study Text - Introduction to Management Accounting
6. ICAI, Study Text - Introduction to Cost and Management Accounting, India
7. NaCCa (2023), Business Studies Curriculum.

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SECTION 8 INTRODUCTION TO COST ACCOUNTING

GLOSSARY
Budget A financial plan that estimates income and expenditures for a
specific period, helping to allocate resources and control costs.
Cost This refers to the monetary value of resources (such as materials,
labour and overheads) used to produce goods or services.
Overheads Indirect costs incurred during production, such as rent, utilities
and administrative expenses that cannot be directly traced to
specific products or services.
Patents Legal rights granted to inventors, providing them exclusive
control over the use and sale of their invention for a specified
period, which can affect production costs if the patented
technology is used.
Prime Cost The sum of direct materials, direct labour costs and direct
expenses that are directly attributable to the production of
goods.
Remunerations Payments or compensation provided to employees or workers
for their labour, typically including wages, salaries and bonuses.
Royalties Payments made to the owner of intellectual property, such
as patents or trademarks, for the right to use that property in
production.
Trademarks This refers to legally protected symbols, names, or logos that
distinguish a company’s products or services from others. The
costs associated with trademarks, such as registration, legal fees
and brand development, are typically considered intangible
assets.

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ACKNOWLEDGEMENTS

List of Contributors
Name Institution

Sittu Ahmed Bolgatanga Technical University

Harriet Oduraa Idun Sagoe Nsaba Presby SHS, Agona Nsaba

Emmanuel Asante Koree St. Francis SHS, Akim Oda

Victoria Osei Nimako SDA SHS

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