COST ACCOUNTING

Session Delivered By:

Dr. Kavitha Desai
 Chapter 1:
Introduction to Cost Accounting
• One of the most successful and largest furniture retailers in the
world, which sells self-assemble furniture, home decoration and
daily necessities.
• It was founded in Sweden

What were the strategies they used to maintain the success?

• Follows the “Cost Leadership Strategy”.

• Seeks for suppliers who could manufacture well-designed sub
assemblies at the lowest costs
• Customers need to assemble the products themselves. This method
could save delivery costs for both producers and customers.
• It allows manufacturers reducing a lot of costs
• Customers pay for the products lower price with high quality
• Market Leader
• Any company operating in the airline industry must maintain and
strengthen a set of competitive advantages that differentiate it from its
competitors.

• Southwest Airlines' business model is based on extremely efficient

operations, low-cost pricing, and innovative logistics solutions.

• Furthermore, their strategy also includes a deep focus on customer

experience and looking ahead.

• Finally, none of this would be possible without a motivated team of

employees.

• Through this sound strategy, Southwest achieved multiple

competitive advantages that have allowed it to stay relevant in a
rapidly changing world.
• Southwest is the only large U.S. airline that is also a low-cost carrier
 McDonald’s is a cost leader in the fast food industry.
• Cost leadership is a generic strategy (one of Porter’s strategies) employed by firms
to achieve competitive advantage.
• The heart of this strategy is to produce goods or services at a lower cost than your
competitors.
• By doing so, cost leadership can lead to lower prices, which can attract more
customers and generate more sales.
• Cost control is key to a cost-leadership strategy, which enables a company to earn
above-average returns.
• McDonald’s is the king of fast food because they know how to run a lean operation
and keep its costs down.
There are a few key things to keep in mind when pursuing a cost leadership strategy:
1.First, you must have a clear understanding of your costs. It means knowing what goes
into your product or service and how much it costs to produce.
2.Second, you must continually strive to find ways to reduce your costs. It could involve
improving your processes, using cheaper materials, or finding new suppliers.
3.Third, you must be able to pass on some of the cost savings to your customers. Adding
value or lowering prices are two ways to do this
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Introduction to Accounting
• Accounting serves the purpose of providing financial information
relating to activities of a business.
• Information is provided to shareholders, managers, creditors,
debenture holders, bankers, tax authorities and others.
• On the basis of type of accounting information and the purpose for
which such information is used, accounting may be divided into
three categories:

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• Financial Accounting: mainly concerned with recording business

transactions in the books of account and preparation of financial
showing the financial position of the company at a point of time.

• Cost Accounting: is a branch of accounting which specialises

in the ascertainment of cost of products and services. It is for
use by management.

• Management Accounting: is the modern concept of accounts

used as a tool of management. It is concerned with all such
accounting information that is useful to management.

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 Accountants
• Financial accountants provide information to external
parties
– Investors
– Creditors
– Regulators
• Managerial accountants provide information to internal
users
– Managers
• Cost accountants provide information to both internal and
external users
– Product cost information

Accounting is the language of business.

 Relationship of Financial, Management, and Cost
Accounting
There is a close relationship between various disciplines like Cost Accounting,
Management Accounting, Financial Accounting and Financial Management.
Sometimes these disciplines are interrelated and dependent on each other also.
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 Limitations of Financial Accounting
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Historical in Nature: Financial accounting is based upon the
historical cost method
Overall Profitability: In other words, it provides information
concerning the entity’s business as a whole; it does not give
financial information per product, department, or job.
Segmental Reporting: An entity could also be doing business under
several different segments. Financial Accounting does not provide
any information, i.e., the profit margin per segment and the costs
specific to those segments.
Inflation Impact: Financial accounting requires recording assets on
a historical cost basis. In an economy with relatively high inflation,
financial accounting entails risk by not adjusting such assets towards
inflation changes
Fixed Period Financial Statements Information: Financial
accounting requires the preparation of financial statements for a
specific period.
Fraud and Window Dressing: To showcase a powerful
financial net worth, the accountant or the management may resort to
window dress the financial statements.
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 Limitations of Financial Accounting Christ University
Non-Financial Aspects: It records only those transactions which can
be measured in monetary terms. It has no scope for recording
transactions, which, although non-monetary, have an important effect
on running the business.
Intangible Assets: Financial accounting does not recognize many
intangible assets. Intangible assets such as brand value and the
development of new assets find no place in financial statements.
Audit Concerns: Various business entities are working on a small
and medium level. The audit is not mandatory to avoid unnecessary
hardships, provided they fall under the specified category.
Future Prediction: In simple words, all the financial data is based
on past transactions and provides no scope for analyzing what shall
be the expected or future viability of the business.
Comparability: To compare the financial statements of different
companies, the accounting policies followed by the companies must
be the same.
Personal Bias: Although the books of accounts are prepared keeping
in mind the accounting principles, many of these principles require
the accountant to use his judgment and experience in practical cases.
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Cost, Costing, Cost Accounting and Cost Accountancy
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Cost:
• Cost is the amount of actual or notional expenditure relating
to a product, job, service, process or activity
• Cost is a resource sacrificed or foregone to achieve a specific
objective

Costing:
• The Chartered Institute of Management Accountants (CIMA) has
defined costing as, “techniques and processes of ascertaining
costs”.
• The ‘Technique’ refers to principles which are applied for
ascertaining costs of products, jobs, processes and services
• The `process’ refers to day to day routine of determining costs

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Cost Accounting
• Cost accounting is a formal system of accounting for costs in the books of
account by means of which costs of products and services are ascertained
and controlled.
• CIMA of UK defines: “Cost accounting is the process of accounting for
costs from the point at which expenditure is incurred or committed to the
establishment of its ultimate relationship with cost centres and cost units.
Cost Accountancy
• It is defined by CIMA of UK, as “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 purposes of
managerial decision-making.”
• Cost accountancy is a wide term and includes costing, cost accounting, cost
control and cost audit

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Objectives of Cost Accounting
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Cost Control Vs Cost Reduction
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Scope of Cost Accounting
Cost Accounting: It is the process of Accounting for Cost
which begins with recording of expenditure and ends
with preparation of statistical data.

Cost Analysis: It is the process of finding out the factors

responsible for variance in the actual costs from budgeted
costs and fixation of responsibility for cost differences
Cost Comparisons: Comparison of costs involved in
alternative courses of action
Cost Control: It is the process of regulating the action so as
to keep the element of cost within the set parameters
Cost Reports: These reports are primarily prepared for use
by the management at different levels. Cost reports helps
in planning and control, performance appraisal and
managerial decision making.
Statutory Compliances: Maintaining cost Accounting
records as per the rule
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Users of Cost & Management Accounting

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 Advantages of Cost Accounting Christ University
Advantages to management
• Reveals profitable and unprofitable activities
• Helps in cost control: with special techniques –budgetary control,
standard costing
• Helps in decision making: cost data helps in decision making –
introduce a new product etc
• Guides in fixing selling prices
• Helps in inventory control: perpetual inventory system ; inventory
control techniques – ABC control, JIT etc
• Aids in formulating policies: formulate production, pricing policies
and preparing estimates of contracts and tenders.
• Helps in cost reduction
• Reveals idle capacity
• Checks the accuracy of financial accounts
• Prevents fraud and manipulation

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Advantages to Workers:
Workers are benefited by introduction of incentive plans of wage
payment which is an integral part of a cost system.

Advantages to Society: An efficient cost system is bound to lower the

cost of production. The benefits of cost reduction and cost control
accrue to the public at large in the form of lower prices of products
and services.

Advantages to Government Agencies and Others: A cost system

produces ready figures for use by government, wage tribunals, trade
unions, etc., for use in problems like price fixing, wage level fixation,
settlement of industrial disputes, etc.

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 Limitations Cost Accounting Christ University

Lack of uniformity: Procedures of cost accounting followed by different

organizations are different for different products

Duplication: Many entries have to be made twice; once in the final accounts
and then in the cost accounts, which is a tedious process.

The result requires reconciliation: Information and results provided by

financial accounting and cost accounting may be different

Expensive: Cost accounting is expensive. For medium and small size concern,
the benefit derived from a costing system may not justify the cost involved.

Dependent: It is not an independent system of accounting. It depends on

other accounting systems.

Based on estimates: Indirect costs are not charged fully to a product or

process. It is charged to all the products and processes on the basis of
estimates. Actual cost varies from the estimated cost

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 Cost Accounting and Financial Accounting- Comparison
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Suppose a company is manufacturing three products – A, B and C.

Under Financial Accounting:

Amount Amount (Rs.)
(Rs.)

To Materials 75,000 By Sales 1,50,000

To Wages 20,000

To Other expenses 25,000

To Profit (Balancing figure) 30,000

1,50,000 1,50,000

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• Under Cost Accounting

Total (Rs.) Product A Product B Product C (Rs.)
(Rs.) (Rs.)
Materials 75,000 40,000 12,000 23,000

Wages 20,000 10,000 5,000 5,000

Other Expenses 25,000 20,000 3,000 2,000

Total Cost 1,20,000 70,000 20,000 30,000

Sales 1,50,000 96,000 28,000 26,000

Profit/Loss 30,000 26,000 8,000 (-) 4,000

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 Concept of Cost, Expense and Loss
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Cost means “the price paid for something”.

Cost is “the amount of expenditure (actual or notional)

incurred or attributable to a given thing”. (CIMA, UK)

“Cost is a measurement, in monetary terms, of the amount of

resources used for the purpose of production of goods or
rendering services “. (Cost Accounting Standards of ICWA of
India)
• Expense: is that portion of revenue earning potential of an
asset which has been consumed in the generation of revenue.

• Loss: Obsolescence or destruction of stock by fire

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 Cost Object Christ University

• Cost object is the technical name for a product or a service, a

project, a department or any activity to which a cost relates.
• A cost object is any activity for which a separate measurement of
cost is undertaken.
• The Cost object could be defined broadly or narrowly.
• At a broader level a cost object may be named as a Cost Centre,
where as at a lowermost level it may be called as a Cost Unit

Cost object Examples

• Product Car, TV
• Service Taxi service, electricity
• Process Melting process in a steel mill
• Activity Purchasing a raw material
• Department Purchasing dept, Production dept

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 Cost Unit Christ University

• A cost unit is defined by CIMA as a “unit of product, service or time

in relation to which cost may be ascertained or expressed”.
• For example, in a sugar mill, the cost per tonne of sugar may be
ascertained, in a textile mill the cost per metre of cloth may be
ascertained. Thus ‘a tonne’ of sugar and ‘a metre’ of cloth are cost
units.
• In short, cost unit is unit of measurement of cost

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 Cost Centre Christ University

• It refers to a section of the

business in which the costs
can be charged.
It may be:
A location
( a department, sales area)
An item of equipment
( machine)
A person (a salesman)
A group of these (two
automatic machines operated
by one workman)
• Purpose of ascertaining the
cost of a cost centre – To
control the cost

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 Types of Cost centres Christ University

• Personal Cost Centre: A cost centre which consists of a person or group of

persons is called ‘personal cost centre’. Example: sales manager, works
manager, etc.
• Impersonal Cost Centre: An impersonal cost centre consists of a location or
item of equipment, production department, a machine or a group of machines.
• Production Cost Centre: ‘Production cost centres’ are engaged in production
activity by conversion of raw material into finished production. Ex. welding
shops, machine shops, grinding shops, painting shops, polishing shops,
assembly shops, etc.
• Service Cost Centre: ‘Service cost centres’ are those which are ancillary to
and render service to other production and service cost centres. Ex.
maintenance department
• Operation Cost Centre: It represents such machines or persons which
undertake the same operations. The aim is to determine the cost of each
operation regardless of the location within the unit.
• Process Cost Centre: A cost centre in which a specific process or a
continuous sequence of operations is carried out.

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Types of Cost on the basis of Identification
1. Direct Costs: which are incurred for and conveniently identified with
particular cost unit, process or department.
Eg. Cost of raw materials, Wages of machine operator
2. Indirect Costs : These are general costs and are incurred for the
benefit of a number of cost units processes or departments.
Eg. Depreciation of machinery etc
Types of Cost on the basis of the behaviour of Cost

1. Fixed costs: Remain constant in total amount even when the

volume of production changes.
Eg. Building rent, managerial salaries
2. Variable costs: Tends to vary in direct proportion to the
volume of output.
3. Semi Variable costs: Includes both fixed and variable.

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Types of Cost on the basis of Controllability
1. Controllable costs: costs which may be directly
regulated at a given level of management authority. Eg. Cost
of raw material may be controlled by purchasing in larger
quantities.
2. Uncontrollable costs: costs which cannot be influenced
by the action of specific member of an enterprise.
Eg. Factory rent, managerial salaries etc
Types of Cost on the basis of Functions

1. Manufacturing Costs
2. Administration Costs
3. Selling and Distribution Costs
4. Research and Development Costs

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Types of Cost on the basis of Time
1. Historical costs: These are past costs which are ascertained
after these have been incurred. Historical costs are thus
nothing but Actual costs.
2. Pre-determined costs: Predetermined costs are future costs
determined in advance on the basis of standards or estimates.
These costs are extensively used for the purpose of planning
and control.
Types of Cost on other Basis
1. Normal costs: Normally incurred on expected
lines at a given level of output. It is a part of cost
of production.
2. Abnormal costs: Cost which is not normally
incurred at a given level of output. Such cost is
over and above the normal cost.
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• Avoidable Cost: The cost which can be avoided under the present
condition is an avoidable cost.

• Unavoidable Cost: The cost which can not be avoidable under the
present condition is an unavoidable cost.

• Product Costs: Product costs are the direct costs involved in

producing a product.
for example: Direct labor, Raw materials

• Period Costs: Period costs are all costs not included in product costs.
Period costs are not directly tied to the production process. Overhead
or sales, general, and administrative costs are considered period costs.

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Types of Cost on the basis of Identification
1. Direct Costs: which are incurred for and conveniently identified with
particular cost unit, process or department.
Eg. Cost of raw materials, Wages of machine operator
2. Indirect Costs : These are general costs and are incurred for the
benefit of a number of cost units processes or departments.
Eg. Depreciation of machinery etc
Types of Cost on the basis of the behaviour of Cost

1. Fixed costs: Remain constant in total amount even when the

volume of production changes.
Eg. Building rent, managerial salaries
2. Variable costs: Tends to vary in direct proportion to the
volume of output.
3. Semi Variable costs: Includes both fixed and variable.

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Types of Cost on the basis of Controllability
1. Controllable costs: costs which may be directly
regulated at a given level of management authority. Eg. Cost
of raw material may be controlled by purchasing in larger
quantities.
2. Uncontrollable costs: costs which cannot be influenced
by the action of specific member of an enterprise.
Eg. Factory rent, managerial salaries etc
Types of Cost on the basis of Functions

1. Manufacturing Costs
2. Administration Costs
3. Selling and Distribution Costs
4. Research and Development Costs

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Types of Cost on the basis of Time
1. Historical costs: These are past costs which are ascertained
after these have been incurred. Historical costs are thus
nothing but Actual costs.
2. Pre-determined costs: Predetermined costs are future costs
determined in advance on the basis of standards or estimates.
These costs are extensively used for the purpose of planning
and control.
Types of Cost on other Basis
1. Normal costs: Normally incurred on expected
lines at a given level of output. It is a part of cost
of production.
2. Abnormal costs: Cost which is not normally
incurred at a given level of output. Such cost is
over and above the normal cost.
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• Avoidable Cost: The cost which can be avoided under the present
condition is an avoidable cost.

• Unavoidable Cost: The cost which can not be avoidable under the
present condition is an unavoidable cost.

• Product Costs: Product costs are the direct costs involved in

producing a product.
for example: Direct labor, Raw materials

• Period Costs: Period costs are all costs not included in product costs.
Period costs are not directly tied to the production process. Overhead
or sales, general, and administrative costs are considered period costs.

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 Methods of Costing Christ University

• Job order costing: Cost unit is a job or work order for which costs are
collected. (Printing press , painters, repair shop)
• Contract costing: Cost unit is a contract. (construction of buildings,
bridges, dams)
• Batch costing: Cost unit – batch, producing group of identical
products. (Readymade garments, toys, shoes )
• Process costing: Raw material has to pass through a no of processes
in a particular sequence. The finished product of one process is passed
on to the next process as raw material. (Textile mills, chemical works,
sugar mills)

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• Operation costing: This method is adopted when it is desired to ascertain the cost of
carrying out an operation in a department, for example, welding. For large
undertakings, it is frequently necessary to ascertain the cost of various operations.
• Unit or Single or Output Costing: When production is uniform and consists of
single or two or three varieties of the same product. This method is used where a
single article is produced or service is rendered by continuous manufacturing activity.
Eg. steel production, flour mills, mines etc
• Service costing or Operating costing: This method is applicable where services are
rendered rather than goods produced. Ex. Transport undertakings, hotels, hospitals etc.
• Multiple or composite costing: It is used where there are a variety of components
separately produced and subsequently assembled in a complex production. Eg.
scooters, cars, air conditioners

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 Techniques of costing
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• Historical (or Conventional) Costing: Determination of costs after they
have been actually incurred. Not useful for exercising any control over
costs.
• Absorption costing: The practice of charging all costs both variable and
fixed to operation, process or products.
• Marginal Costing: It refers to the ascertainment of marginal costs by
differentiating between fixed costs and variable costs and the effect on
profit of the changes in volume or type of output.
• Budgetary Control: Budget – is an expansion of firm’s plan in financial
form.
• Standard costing: It refers to the preparation of standard costs and
applying them to measure the variations from standard costs and analysing
the variations
• Uniform Costing: A technique where standardized principles and methods
of cost accounting are employed by a number of different companies. This
helps in comparing performance of one firm with that of another.
• Activity Based Costing: Method of assigning the costs through activities to
the products and services provided to its customers. ABC involves
identification of costs with each cost driving activity and making it as the
basis of apportionment of costs over different products or jobs on the basis
of the number of activities required for their completion.
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Elements of Cost:
1. Materials
2. Labour Cost
3. Other Expenses

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• Direct Materials: They are those materials which can be
identified and can be measured and directly charged to a
particular product.
Example: Timber in furniture making, bricks in building a
house, paper used in note books, leather in shoe making
Direct Labour cost: They are those Labours which can be
conveniently identified or attributed wholly to a particular
job, product or process expended in converting raw
materials into furnished goods.
Eg. Wages paid to machine operator
• Direct expenses or chargeable expenses: Include all
expenditure other than direct material or direct labour that
are specifically incurred for a particular product or Process.
Example : Excise duty, Carriage paid for materials
purchased, surveyor's fee, Expenses of designing or
drawing a model.
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Division of overheads: Overheads are divided into 3 groups.
1. Production overhead
2. Administration overhead
3. Selling and Distribution overhead.
Production overhead or works overhead or factory overhead: It includes all
indirect cost which is connected with the manufacture of a product.
It consists of 3 elements:
Indirect Materials: materials which cannot be conveniently identified with
individual cost units. Eg. Nuts and bolts, threads
Indirect Labour Cost: It is of general character and which cannot be
conveniently identified with a particular cost unit.
Eg. Wages of supervisor, Salary of works manager, Foreman salary.
Indirect expenses: Factory rent, Rates, Deprecation on Machinery, Power light,
heat, Insurance of factory building.

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Office and administration overheads
• Indirect material: Office stationery, postage etc.
• Indirect labour: Salary of office staff
• Indirect expenses: Rent of office building, legal
expenses, office lighting and power, depreciation of
office furniture etc.

Selling and distribution overheads

• Indirect material: Packing material, stationery used in
sales office etc.
• Indirect labour: Salary of sales manager, salary of
warehouse staff, salary of drivers of delivery vans etc
• Indirect expenses: Advertising, Travelling expenses,
showroom expenses, rent of warehouse etc.

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