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Cost Accounting

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Published in: B.Com Tuition
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Basics and Classification of Costs

Manas M / Lucknow

7 years of teaching experience

Qualification: CA (ICAI - 2011)

Teaches: CA - CPT, CA - IPCC, CMA Intermediate, Direct Tax Laws, Accountancy, Commerce Subjects, Economics, Costing, Direct Tax, Indirect Tax, Company Laws, Tax Laws, BBA Entrance, BBA Subjects, Management Subjects

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  1. COST ACCOUNTING Iatroduction Cost accounting is a branch of accounting, it is younger than finadcial accounting and has dcve!oped because financial accounting alonc could not scrvc all the purposes of modern business. Financial accounting plays a very useful role, specially in indicating the results Of operations during a p:riod and also portraying the financial position of a concern. But for carrying on day-to-day work, the management or any undertaking will need much more infor- mation than financial accounting can as such give. Questions mentioned below will always be occurring to thc management of a industrial conccrn : 1. 2. 3. 5. Is there any wastage of material or time? Is the level of cfliciency what it should be? What should bc the selJing price of an article or what should be the price to bc quoted to a customer for whom a job is to be done? Additional sales can be made al concessional price. How much concession in price should be offcrcd? Whcn times arc difTlcult and sales acc not easy, prices have to be reduced. Should goods be sold at cven below cost? These are only some ot- the questions which management will have to answer. For the purpose of solving the problems indicated above, the ordinary Profit and Loss Account and the Balance Sheet will not serve any useful purpose. What is rcquircd is that all the accounting information should bc analysed according to each type of activity. If such an analysis is made gay for each article produced or for each job donej the management would have good deat of It is because of nccd to information on the basis of Which some good decisions can bc made. handle the sort of problems indicated by thc questions put above that the need of cost account* was felt and this branch of accounting emerged. Cost accounting is concerned with analysis of all the expenses and costs incurred so that the cost of completing each job or producing each product. ot for that matter completing any identifiable activity, is known. Not only the total cost has to be ascertained; the figure has also to be fully analysed into all its components. Take the example of this lesson which is in your hand. It would be desirable to know the cost of paper and the cost of printing it as It is with the hclp of such well as the cost of getting it prepared before it is sent to thc press. an analysis only that useful information would be available to the management for its purposes. Dennition The Institutg of Cost and Bfanagement Accountants. London has defined Cost Accoun- tancy as
  2. 2 application of costing and cost accounting principles, methods and techniques to science , art and practice o, cost control and lhc ascertaintnent profitability. It includes the presentation or information derived therefrom for the purpose of mana- gertal dectstons making,' Costing has defined by the Wtitute as : •The techntqu:e and process or ascertaining costs: And Cost Accounting as " T he process of the accounting for cost from the point at which expenditure is incurred or committcd to the establishmcnt or its ultimate relationship v,ith cost centrcs and cost In Its wide usage it embraces the preparation of statistical data, the application units. of cost control methods and the ascertainment cf the profitability of activities carried out or planned." The definitions given by the Institute bring out the point that the processes and techni- ques of ascertaining costs have the following aims : (i) Cost control, i,c.. kccping cost under check ; (ii) ascertaining profitability and profits came], including ascertaining causes that lead to a particular figure ; and (iii) collection and presentation of such information as is required by thc managemcnt in making decisions. The decisions to be madc may bc of various types some exam- ples of which hayc been mentioned on the pre. ious page. Adytntages of Cost Accounting If a good system of cost accounting is installed, i.he undetmentioned advantages should be available. 0) With the help or cost accounting. it would bccome possible to measure and then improve efficiency. Thi; is done by comparing costs in one period with those in another period or cost of one firm '*ith that of another etc. in the month of July 1993 the labour cost pet unit comes to Rs. 6 whereas in the month of June 1993, the figure was Rs- 5.70 ; it would indicate that to some extent there is ineff- ciency in the use or labour. One should notc that really speaking, cost accounting is the only way of an objective measurement of efficiency. This is specially so when actual costs are compared against what are known as standard costs which may be thought of as target costs. (ti) When prices are within the control of the firm. it would be posssib!e to fix proper if costs are known. For examp!e, when a contractor sends tcndcr to prices only the prospective contractee, he can do so only on the basis of costing information in his possession. (iii) Even when it is not possible for the firm to control -priccs, it has still to decide whether cettatn products should be produced or not, hay:ng regard to the price which is available. Suppose, the princ in the market is only Rs. 7 whereas the cost of producing the article comes to Rs. 7.50 ; the firm will have to decide whether this product Bhould be sold or whether its production ghould stoned.
  3. 3 (iv) In special times and for special customers, sp:cial concessions have to be given. This also can be decided only by reference to the figures of costs. (v) Cost accountiag necessitates a number or record; to be maintain:d ; good deal of tnformation then antomatically available. For e.xarnplc, availability
  4. 4 SELF CHECK TEST State which of the following statement* are true : (ii) (iii) (iv) (vii) (viii) (ix) (x) Joint stock companies must instal a system of cost accounting just as they must have a good financial accounting system. The chief aim of cost accounting is to help in firtng price. hence if prices ate the control of a firm, it will be useless for it to have cost accounting. Cost arcounting should enable one to know not only the Iota! cost of a or job but atso an analysis of it, One can easily measure on's efi*ency and che€k was! ages and losses on the basis of the Profit and Loss Account. Cost accounting help in determining pnees under spe:ial catcumstances. Measurement of efficiency is possible through comparision of costs in one with those In another, Cost Accounting requires records in quanti!auve and monetary terms regarding matenals and stores. Costing information Will be useless unless it is fully correct. Each fitm muft fashion its own cost accounting system, no ready made system available Cost Account;ng should be installed bv a!t firms since it is faqhionab!e to do so, ( True : (iii), (v) to (vil) & (in) ) EWCDts of Cost Take this lesson again and tel u, try list th2 c 'its wtlich wi!t be incurred to make it •ready for you to read it. The cost wöl-dd comprise the following (i) the on which it is printed; (ii) the amount paid to the press for printing the lesson and also for folding bindmg it; (iii) the proportionate amount of the exp2TtES of the salaries paid to the of staf of the Commeree Department of the School to write and read through the lesson and edit it; (iv) the proportion of the salary paid to the proof reader by tbe Schoo%; (y) the proprtionate amount of the genera! expenses incurred in the omce to pay attention to the preparation, printing and despatch of this *esson It can easily be noticed that the first two items have been incurred only for this lesson and the amounts will be different from lesson to lesson—it one lesson IS mgget Chan another. qbe cost of the paper consumed and the cost of printing it would naturally be higher. In some lesson, there may even be graphs fot which blocks have to be pcepared, lhese blocks would oot be useful Cor apiy other Sä:h cöyts or expetF•.'-s whi-:h are p:culiar a particular tesm, are kaown as direct cons. One can define direct cost; as etpenscs which can be convcni•
  5. 5 catty associated with a particular job or product er unit of cost. Note the word •conveniently* is because we must not spend cn cost accounts more than the b:nctits which expect to get from it. Hence, wc should not devote teo much time and etrort to the definite allocation of expenses to different units or costs. Ordinarily, for any product, maten.lls used and the wages paid and in some cases. some expenses will be ditcet expenses. The other type of listed above are common to the various lessons which are being prepared. The staff of the Commercc Departtncnt of the School has prepated net only this lesson but others also ; besides. it does other '*Ork also like attending to students and to their Response Sheets. The proof readers also have to make corrections not only in lessons written in the Commerce Department Hut also ia other deprtrtments. Further, the office is paying attention to a most of problems of which prep2ration tessrlns is only one. Such expenses are kno'rvn as indirect expenses because they are incurred net for a particular product It is '1 Ather iraconu•aient to allocate exactly or job or unit of cost but for work in eeneral. It ts more convenient to treat them in lump sum these expenses to individual units of cost; and have a sort of rough and ready method apportioning them over various units of cost. For industrial concerns, in direct expenses usually can be di'e {ded into the undermen- tioaed categories:— (i) factory expenses , (if) office and administrative expenses ; and (iii) selling and distribution expenses. Expenses incurred for purposcs of producticn arc factor expenses expenses incurred for obtaining orders from customers and despatching thc goods to them are kno'.yn as selling and distribution cxpenses ; expenses incurred for the general Otlice ate knowa as and Edministrative expenses. From the above, cae can say that the total cost can be analysed under the six under- mentioned elements : (i) direct materials ; (ii) direct wag:s (iii) direct charges (iv) factory expenses . (v) OIT1ce and ad:ninistrative expcases ; and (Yi) selling and distribution expenses. T hest ate as elements or cost. When costing informaticn is prescntcd. it should be analysed under tne six heads mentioned above so that one can the relative importance of each etement, One should note, however, that if a conccm is 'Very small, It may have only one category of expense instead of three or, if it is bigger but not 'very big, it may have If a concern category for factory expenses and only one for both office and seiting expenses. i' very big. each of •the three types of •indirect expcns.es can be further subdivided. For example many concerns make a distinction beween selling exvxnscs, i.e. expenses inearred to obtain orders, and distribution i.e., expenses incurred tot complvwith the orders.
  6. 6 One should also note, some of (be important terms which are often use costing tctminology. Ihe total of the first three elemcnts namely. direct material, direct wages and direct charges is khovm as prime cost. When factory expenses are added to the prime cost, it factory cost, or works cost. When omce and administrative exrenscs are added to the works cost, v.e call it as ofüce cost or cost Of production. Selling cost or cost of sales arrived at by adding to Offcc Cost, the selling and distributiön expenscs. Of course. when cost Of salcs is comparcd *itb sales. the profit Ot loss witl be ascertained. Costing information is usually set out in the form of a statement called cost sheet. A chart sh0*ing Total Cost divided into Elements of cost is given below : Total Cost Materials Ditcct L 2 bour laditect Dirwt indirect Direct Factory Elgxnses Office & Adminstratioa Expenses Indirect 'l Selling and Distribution
  7. L In a factory 30,COJ units were manufactured in the menth of June, 1994 Prepare Cost Sheet from the O*ntng Stock of Raw Materials Purchases Of Raw Materials Closing stcck of Raw Materials Direct Wages Factory Overheads Ofticc and AdmiaistratÅe overheads SoiatEoa Sheet for the moath or 82,sco Totai C13t Raw Materials O*ning •4- Putcbases —Closing 79) 82,m 15,coo Material Conusumcd Direct Wages Prime CO,st 04 Factory Overhcads Works on Factory Cost +0ffce & Admn. Overheads Cost of PrclucGon Example From the f0110'ving information, prcparc Cost Sheet for 1993 Cost per unit 1.25 3.75 6.75 Raw Materials Oxaing Pu rchases Closing Carriage inwards Wage—Direct —Indito:t Direct Rent and Rates—Factory —O itce Rse 40
  8. 8 tidirect cosumption of materials Deptæiation—Plant Office furniture Salary—Office —Salesmen Forcmants Salary Other offce expenses Managtng Director's remuneration Other selling expenses Travelling expenses of Salesmen Carriage and freight outwards Dividends Sales Advance income-tax paid Advertisement Interest Managing Director's remuneration is to be allocated Rs. offce aad Rs. 6,000 to selling department. Cost SEcet ror the year 1993 Riw Materials Opening + Purchases —Closing Stock Material Consuned Dircct Wages Carriage inwards expenses Factory Expenses— Indirect Wages Rents and Rates Indirect Materials Depreciation Of Plants Foreman's Salary Mg. Dircctor•s remuneration WGB bmcc and Administrative Expcases . Rent and Rates on office furniture Salary Other omce Mg. Dirwtot'$ cnweratim Prime 'Cost 1,500 100 2,500 2,ocn 12,000 1,000 li100 5,000 2uo 1,000 4,000 to factory, RE. tc Total 15,0 5,cm 26.7m Cost or 10,ü) smo 1,500 Factory Cost soo 10) 2,500
  9. Cost of Productioa or ONce Cost Selling and Distributive Expenses— Salary—Salcsmen Nfg. Director's remuneration Other selling expenses Advertisement Travellwng expenses Carriage & freight outwards Cost of Sales Profit Sales 9 6,oco 2,000 1,1C0 1,000 13,100 2, 10.8m 39,2Ø NCI' : Dividends, Advance Income-tax and interest are excluded from Cost•Shect. Illasfrat Ion 3 The Metal Products Company Ltd. manufactured and sold 1.000 Ceiling Fans during ycar cnded 3 1st December, 1992 The summarised accounts of the Company are given belov M',nuractoring Tr:dEzg cod Pront and Loss Account for the year coded 31st December, 1992 Rss To Material used . Direct wages i, Manufacturing Cost Gross Profits To Salaries . Rent Rates and Insurance General Expenses Selling Expcnscs Net Profit so,ooo• so,ooo 60,C00 10.030 20,000 30,oco By Sales By Gross Profit For the year ending 31st December. 1993 it is proposed that (i) Output and Safes v.ilt be 1,2CO FpAz ; (ii) of materials will rie by 20% ca the previou year Inel ; (Ei) Waves +3 by 5'/:•: (iY) Me-aufc.ct±3 vill
  10. proportion (o the c0ifibined cost of materia!s and wages ; (v) Selling expenses per unit will remain unchanged ; and (Yi) Other expenses witl remain unaffected by the rise in output. Prepare a statement of Cost. showing the price at which the fans should be marketed so as to earn a profit of on the selling price. Solutioa : Statement ot Cost Proat for the Maoafacture of Fa.as for 31st Dec ember 1992 Matettals used Direct Labour PRIME cost Add Factory Overheads FATORY COST Add Offce Overbeads Sataties Rent, Insurance General Expenscs COST OF PRODUCTION dd.å Selling Ovetheads SELLING COST Profit 20,030 Total Cost ( l,Üunits ) 80.coo so,cco 2.so,ooo •90.000 30.cco 30.0co Cost per unit 80.00 1200 2W.oo 250.00 90.Ø 340.00 30.00 370.00 30m 400m
  11. 11 Estimate for the Manufacture or i .200 Fans during 1993 blate;ials 20 x 80 Add increase 11k) Direct Labour Add 5% incrcasc PRIME COST Add Factory Overheads 25% on Prime Cost FACTORY COST Add Officc Overheads Salaries Ren t General cxpenses COST OF PRODUCr10N 120) 80 16 120 6 unaffected by increase ia output Add Selling Overheads (remains unchanged) COST OF SALES Add Profit (10% oa sates or 1/9thpst) Cost per 96 126 222 277.50 75,00 352.50 30.00 382.50 42.50 425.00 Total cost Rss 5,200 66,600 90,000 4i23,ooo 36,000 459,000 51,000 S, IOTÅ}O SELLING PRICE 3Vorkiog Notes : profit is 10 oh Sclling Price i.e. on cost 9 100 . Profit 100 100xto X % on cost 90
  12. Classification of Cost The cost can be classified into the following : l. 2, 3 4. 5. 6. l. According to Elemenls, According to Functions, According to Nature oc Behav:our, According to Controllability, According to Normality, ,According to Relevance to decision-making and control. According 10 : The cost is classified into (i) Direct Cost and (ii) Indirect Cost according to elenunts viz., Matcrial, Labour and Expenses '*'hicli wc have studied earlicr in Q)is Chapter. 2. According 'o Function : The cost is classified into the following : (i) Production Cost or N[unufacturing Cost (ii) Administration Cost (iii) Selling Cost, and (iv) Disttibution Cost. (i) Production COSI : The Cost of sequence of operation which begins with supplying materials. labour and services and ends with primary packing oÜ the product—I. C.M.A. (ii) ifdnlinistratioti Cost : ' 'The cost of formu\ating the policy, direéting the Organist- tion and controlling the operations of an undertaking. Which is not related directly to a production, selling, distribution, research or development activity or function." I. C. NIA. (iii) Selling Cost : "The cost of selling to create and stimulate demand sometimes tetmcd marketing and of securing of order." I.C.NI.A. (iv•) Distribution Cost : "The cost or sequence of operaticns, which begins with making the packed product available for despatch and end with making the re-conditioned returned empty packaget f any, available for re-use.' • I.C.M.A. The following terms of cost are also included in the 'classificaticn of cost' as per I.C.M.A. l. 2. Research Cost The cost of searching ror•new or Improved products, new applica- lion ot materials or improved methods. Deve!opment Cost : The cost of the process which begins with the implementati0A of the decision to produce a new or improved product or to employ a new or improved method and ends with the commencement of formal production of that product or by that method. Pre-production Cost That part of deyelopment cost which is incurred in making a trial production preliminary to formal production.
  13. 4, 5. 6. 3. Into 13 It is the sum of direct wages, direct expenses and overhead cost Conversion Cost • or converting raw matenals to the formed state or conserting a material from onc stage of production to the next. A cost incurred. in addition to the normal requirements. as a matter Policy Cost : or policy of the undertaking is the policy cost. Idle facilities cost : The cost of abnormal idleness of fixed assets or available services is the Idle Facilities Cost. According to nature or behaviour cost, cost is classificd 'i cccrdtng Zo Natare . (l) Fi'Cd cost, (n) Variable cost, and (iii) Semi fixed cr Semi-variable cost. 'A cost which tends to be' unutTected by variation in volutne of out. (v) Fixed cost put. Fl\ed cost depersd mainly en the effluxion of time and do not vary directly with volume er rale ef output. Fixed costs ate sometimes referred to as period costs tn systems of Di!cct Costing." M.A. Fixed costs or Fixed expenses arc those which do not change with the increase or decrease in production. 'A cost 'tends to vary directly Wit) volume ef output. (ii) Variable Cost : colts are sometimes referred to as direct costs in systems cf direct costing.' I.C.M.A. Variable costs or expenses are those vehich increase in direct proportion with the increase in production. (iii) Semi-fixed or Variob!e Cost: ' 'A cost which is partly fixed and partly variable." This is the cost which change but not in direct proportion to the increase or dccrease in the production output, e.g. Repairs and Maintenance, Dep:ectation etc. According to Controllability: The costs can be divided into . (i) Controllable cestr and {ii) Uncontrollable cost. (i) Controllable : The costs 'Shich can b: controlled by a 'sp:cified member' NIL variable who is an Important link in the management are conttollable cost. costs are controllable. (ii) Uncontrollable Costs: Uaconttollable Costs ate those costs which can not be minimised by a •specified member • '*ho is an important link in the management are uncontrollable costs. All uncontrollable costs are fixed costs. According to Normctity: Normal costs are those '*hich are incurred at given level Of output under normal conditions. are those are incurred a of eulput undec Abnorn:al Cost • abnormal conditions. They are incurred in exceptional circumsiap.ccs and as such they are not charged to the cost of production but to Costing Profit & Loss Account.
  14. According to releva,tce to dcci$ien making and control : The costs classified on basis are the following . Shut-doan Cost. A cost which will be requited to be incurred even through a plant is closed or shut-down for a temporary period e.g., . Depreciation, Repairs and Maintenance expenses , the cost of rent and tatCä etc. Sink Costs: These costs are incurrcd in the past and have no effect on future decision making e.g. when replacement of an asset is under consideration the undeprcciated value of existing assct it is sink cost and so irrelevant for decision making. Opportunity Cost : Costs which are related to benefits, sacrificed or forgone are human opportpulty costs. When the management adopts one course o? action, it may have to give up an alternative course. The b:ncfits which might accure from the alternative would bc rcgarded as the oppottumty cost of choosing the particular course. Intpure•.l Cost it is hypothetical cost required to be considered to make costs com. parable. For instance interest cn capitat is after required to be included in the cost of projects even though it is not actually payable. Out-of.Pockc,' Cort : A cost which will have to be paid to outsiders as against costs such as depreciation, which do not requite any cash payment. This cost •is relevant in fixation Of prices during trade recessioz or in make or buy decisions. Method< of Costing Since thc nature of work done by various firms is different. it naturally follows Ihat tbe exact method employed to ascertain costs per unit would depend on the nature of the business. The following are the ptincipal methods (l) Job Costing. Work may be performed against individual orders from the customer, as in the case of motor workshop undertaking rcpairs of cats oc in the case of a printing press undertaking printing jobs of different typ:s, A factory may also produce different types of goods against orders. The preduction may also be undertaken against 'stock' order. i.e. for keeping the goods in the stock for ready supply of customets• requirements. In all these cases the best [costing results can be obtained by giving a distinct job number to each order in the factory or workshop and by opening an account to which atl expenditure on the job is debited. This will enable us to know the cost of undertaking a particular job. Separate Cost Account. ing books ate necessary. (2) nmch Costing. Factories which have to produce a large number of parts in order to make a product undertake the production of each patt in batches. For example. a bicycle factory may produce 10,000 handles at one time and then Rake up the manufacture of other 9,'hen this supply -of handles is cxhaustcd another lot Of handles will be made. Thus parts. production is made in batches. The cost of each batch is ascertaiacd separately and the method is koown as batch costing. It is similar to job costs. (3) Contract or Terminal Costing. This term applies to the system of costing which relates to business concentrating on the completion of big contracts only. Since all energi< of the business arc devoted to one ot two contracts.. the compilation costs incurred is
  15. 15 comparatively simple although the nature of contract costs ts not different from job costs. i JOb• is a snull contract : a •cont:act• is a big iob. Costing information can be obtained from financial hooks themselves. if suitably modclled. (4) Single or Costing. This method is applicd where there is only one product as in the case of a brewery or a colliery. As in case cf contract costs, the financial books themselves can b: made te yield details to make up the cost sheets. No separate sct of book is generally required and costtng Information is prescatcd in the ferm of a statement as Cost Sheet. When a product passes through distinct stages or precesses, cach ( Process Costing. having a bearing the total cost of production or each yielding valuable by-products or each causing considerable wastage of materia!s, finding out tile cost of each process Wii! yield good results. For example. in case or oil. there •ye three distinct processes—crushing. refining and finishing. Altoc3tiag expenditure to each precess '*sill give valuable information. This method is knc»n as process costing. (5) Operation Costing, This is used in case or mechanical products. .GcneraIty, many operations are necessary to make an article, For example, cycle mud-guards are to be made thc steel sheets will first be cut into proper strips and thca shaped accorcfing to the designs and then machined and then polished. Pach one o:- these is an operation and it is pcssibåe to fir.d out the cost each op:ration separately. The cost or the mud-guard can be found out this is done It is knov.n x; operation costs. Thcre by adding the cost oC these operations. IS really not much difference between procese„ costing 2nd costing. (7) Operating Costing. business docs not produce tangible goods but renders somc service, the system costing-would be known as operating cost. A transport company It should know the cost per does not produce any article but It carries goods or passengers. tonne.kilometrc i.e. cost of carrying one tonne of goods one Qlom:tre; or the cost per passen- cost or carrying one passenger one km. In an electricity concern cost '+,ould be ascertained pet kilowatt hour. The system of finding the cost would b: similar to that of single or output costing (R) Departen:cntai Coffing. A factory may bc divided into number of departments and somettme« good results are obtained by allocating expenditure first to different depart- ments and then to the different products manufactured in that department. It will be sccn later that departmental costing. as this is known, is generally advantageous the-purpose of estimating and allocating e\pcnses correctly. Ifu!tiple Cosiinq. The method (a combination of two or more methods) is follow. (9) ed Wherc the final product consists of a number of sep:lratc parts, e g, , bicycle, radio set, motor car, etc. Tile cost of each part has to be ascertained (through batch or job costing) and then the cost or assembling the part will be 'tabulated. The ecst of the assembly dcpart• me-nt will be more or less On the lines of single or outpu_t costing. The total cost of the final product will consist of the cost of all the P{srtg plus the cost of assembling them.

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