Module 1

Introduction to Cost Accounting

Cost
Cost is the total of expenses incurred for manufacturing a product or rendering a
service. It represents the sources that have been or must be sacrificed attain a
particular objective.

Expense
Expense is that portion of the cost which has been consumed during the current
accounting period and has contributed to the revenue

Loss
Loss is that portion of the cost which has been consumed during the current
accounting period but has not contributed anything to the revenue

Expenditure
The term 'expenditure generally means capital expenditure. It is the amount of
resources consumed for the acquisition of assets, the benefit from which is
derived over a period which extends beyond the accounting year. Capital
expenditure is the amount spent for acquiring an asset or for increasing the
value of an existing asset or for increasing the earning capacity of the business.
Eg: cost of purchase of machinery, cost of construction of building, carriage
paid on purchase of machinery, etc.

COST ACCOUNTING - Meaning and Definition

Cost accounting is the recording of the expenses incurred in manufacturing a

product or rendering a service. It is done in such a manner that the expenses are
analysed and classified so that the actual cost of any particular process or unit of
production or service rendered can be determined with a desired level of
accuracy.

J.M. Fregman defines cost accounting as "the process of recording, classifying,

allocating and reporting various costs incurred in the operations of an
enterprise"

COST ACCOUNTANCY - Meaning and Definition

Cost accountancy is the accounting of cost and revenue by applying the cost
accounting principles and methods for controlling the cost and ascertaining the
profitability. The term cost accountancy is wider and broader in coverage than
cost accounting. It includes cost control, cost reduction, cost audit and
presentation of information to managerial personnel for the purpose of decision
making.

The Institute of Cost and Management Accountants (ICMA) London defines

Cost accountancy as "the application of cost accounting principles, methods and
techniques to the science, art and practice of cost control and ascertainment of
profitability as well as presentation of information for the purpose of managerial
decision making."

1.COSTING- Meaning and Definition.

Costing is the technique of ascertaining the cost of a product or rendering a

service. It is the process of classification, recording and appropriate allocation
of expenditure for the determination of the cost of the product or service.

ICMA defines, costing as "the techniques and process of ascertaining costs".

The term 'techniques' consists of a body of principles and rules by which the
cost is ascertained.

Objectives/Functions/Purposes / Need of Cost Accounting

1. Cost ascertainment

3. Cost presentation

2. Cost estimation

4. Cost control

5. Cost reduction

6. Planning and control

7. Decision making
1.Cost ascertainment

Cost ascertainment refers to the collection and analysis of expenses, the

measurement of production of different products at different stages of
manufacture and the linking up of production with expenses.

2. Cost estimation

Cost accounting is mainly meant for cost estimation. Cost estimation is the
process of predetermining the cost of a product or service.

3. Cost presentation

Cost presentation refers to a system of reporting cost data to various levels of

management to suit their requirements.
4. Cost Control

Cost control is the process of controlling the cost by eliminating wastage. It is

effected through controlling the cost of materials, cost of labour and other
expenses.
Cost control is defined by ICMA, London as The guidance and regulation by
executive action, of cost of operating an undertaking

Steps for cost control

1. Setting up standards or targets for expenses and production performance
2. Comparing the actuals with the standards to find out variation, if any.
3. Analysing reasons for variation in the actual cost from standard cost.
4. Taking up corrective action to eliminate the variation and thus bringing
up actual performance to the predetermined standards.

5. Cost Reduction

Cost reduction is concerned with reducing the cost.Cost reduction can be

achieved through permanent elimination of all wastages. It is effected through
reducing the cost per unit by increasing the productivity.

6. Planning and Control

Planning and control are very important functions of every management. The
entire activities of the concern need to be controlled. This could be achieved
only through planning the activities and its continuous monitoring
7. Decision-making

The success of an organisation depends on effective management which in-turn

depends on timely decisions. Timely decisions can be taken only with the help
of analysed data. Cost accounting helps in providing the required data for taking
managerial decisions.

2.COST CONCEPTS

1.Cost unit-Meaning and Definition

A cost unit is a unit of product or service or time in relation to which costs may
be ascertained or expressed It is also known as a cost base. Costs may be
expressed in terms of unit, quantity, a group of identical products, units of
services, jobs, etc)
Cost unit may be eliber Simple Unit' or 'Composite' unit. A simple unit is one
where the unit is expressed in a single base such as per kilogram, per tonne, per
litre, etc. A compartite or compound cost unit is a combination of two simple
units like tonne and kilometre called "tonne kilometre", passenger and kilometre
called 'passenger kilometre, etc.
ICMA London defines cost unit as a quantitative unit or product or service in
relation to which costs are ascertained.

2.Cost Centre - Meaning and Definition

It is an organisational sub-unit or smallest segment of an activity for which cost

is ascertained for cost control and cost reduction. A cost centre may be a
location, a department, a machine,such as departments, sections, divisions,
machines, persons, etc. Cost centre is an a person, a process, a job, etc. for
which cost can be ascertained.

3.Cost objects

4.Profit Centre -

Meaning and Definition

A profit centre is an organisational sub-unit or smallest segment of an activity

for which profit is clearly ascertained. Profit centres are created to delegate
responsibility to Individuals and to measure their performance. In a profit
centre, both cost and revenue are capable of being measured in financial terms.

According to Fragman, "a profit centre is a department or division for which

expenses and revenues are accumulated and profit is ascertained".
5.Responsibility Centre

Meaning and Definition

A responsibility centre is a unit of function of an organisation, headed by a

manager having direct responsibility for its performance.

It may be defined as "the segment of a business with reference to which

information will be communicated to pin-point responsibility.
Opportunity Cost

6.Opportunity cost
It is the benefit foregone or sacrificed on rejecting a particular alternative to
another competing alternate choice.

Chartered Institute of Management Accountants (CIMA) England defines

opportunity cost, as "the value of a benefit sacrificed in favour of an alternative
course of action".
7.Imputed Cost/Notional Charges

Notional Charges are the imaginary charges, such as, rent on own building,
interest on own capital, etc. charged in the cost books but are not to be paid to
any one. These are charged on the notion that such payments are made by other
concerns of same industry who do not have such facilities. This helps in cost
comparison.
8.Estimated Cost

Estimated costs are the costs determined in advance, after considering all the
factors that may influence cost. These are computed in advance of production,
after taking into consideration the cost of previous period and the factors likely
to affect such costs in the future.

9.Standard Cost

Standard cost is a scientifically estimated cost, after taking into account all the
factors affecting and influencing the cost. Standard cost provides a yardstick
against which actual costs are compared. Standards may be used for measuring
efficiency of different cost centre.

10.Historical Cost

The historical cost is the actual cost determined after the production is over. The
costs which are ascertained after their incurrence are called historical costs.

11.Conversion Cost

It refers to the cost of converting direct materials into partly or fully finished
products or from one stage of production to the next. In conversion cost, the
cost of raw materials is left out. Therefore, conversion cost is the sum of direct
wages, direct expenses and overhead expenses for converting raw materials into
work-in-progress and finished products.

12.Differential Cost

Differential cost is the difference in cost between two levels of activities. If the
change increases the cost, it is known as incremental cost and if the change
decreases the cost it is known as decremental cost.

13.Sunk Cost

It is the irrecoverable cost incurred by an enterprise in the past which has no

influence in its future decision making. For example, when replacement of an
asset is under consideration, the undepreciated value of existing asset is the
sunk cost.
14.Development Cost

Development cost is the additional cost incurred inconnection with development

of a new product or the manufacture of a product under improved method.

15.Marginal Cost

Marginal cost is the additional cost incurred for the production of an additional
unit. It is the total of variable cost which includes, cost of material, cost of
labour and variable expenses.

16.Research Cost

Research cost is the cost incurred for seeking or searching for improved or new
products, new or improved methods, etc. In the modern complex industrial
world, such costs are to be incurred, inorder to improve the products, to cut
down the prices, to introduce new technological improvements etc.

17.Ordering Cost

Ordering cost is the cost of placing one order at a time to purchase a particular
material. It includes all the costs for getting an item into the firm's inventory.

18.Carrying Cost

Carrying cost is the cost incurred on carrying or storing or maintaining

inventory in the store. Interest on money locked up in the inventory, loss of
inventory obsolescence, storage space rent, cost of stores operation, etc. come
under carrying cost.
Essentials of a good Cost Accounting System

1. Informative and simple

2. Accurate and authentic
3. Uniformity and consistency
4. Integrated and inclusive
5. Flexible and adaptive
6. Trust on the system
7. Participation of executives
8. Benefits from the system

Methods of Costing

1. Job costing
Job costing is a method of costing applied in those industries where jobs are
executed against specific orders and each job is treated as a cost unit.

2. Batch costing
Batch costing is a method of costing applied in those industries where articles of
similar nature are manufactured in definite batches or lots of large numbers.

3. Contract costing
Contract costing is a method of costing applied in such concerns where large
sized contract works extending to a number of years are undertaken.

4. Process costing

Process costing is a method of costing applied in such concerns where the

product passes from one distinct process to the other till completion.
5. Service (operating) costing

Service costing or operating costing is the method of costing applied in such

concerns which render services, as distinct from those which manufacture
goods.

6. Operation costing

This is also known as single or output or unit costing. The method of costing is
applied in such concerns where the process of production is continuous and the
units produced are identical. This method is applied in industries like mines,
quarries, brick works, etc.

7. Multiple costing

It is the application of two or more methods of costing in respect of the same

product

8. Farm Costing

Farm costing is the application of costing principles and techniques to farming.

Farming constitutes the activities like agriculture, horticulture, nursery, raising
of fruits and flowers, dairy, poultry, rearing of sheep, seri-culture, etc.

Techniques of Costing

1. Marginal costing

It is a technique of costing, where only variable costs are charged to operations,

processes or products. Under the technique, all fixed costs are charged against
profit.

2. Direct costing

It is the practice of charging all direct costs to operations, processes or products

and writing off all indirect costs against profits in the period in which they arise.

3. Absorption costing

It is the practice of charging all variable manufacturing costs and fixed

production overheads to operations, processes or products and writing off
administration, selling and distribution overheads against profits in the period in
which they arise.

4. Standard costing

Standard costing is the preparation and use of standard costs and their
comparison with actuals so as to analyse their variances.

5. Uniform costing

Uniform costing is the application of same costing principles and practices by

several undertakings for common control and comparison of cost.

6. Historical costing

It is the ascertainment of costs after they have been incurred. It aims at

ascertaining costs actually incurred on work done in the past.

COST CLASSIFICATION

Cost Classification is the process of grouping the items of cost under different
categories based on common characteristics.

A. Classification according to traceability of cost

1. Direct cost
Direct cost refers to those costs which can be clearly and easily traced or
identified with a job, product, cost centre, cost unit, etc. The aggregate of all
direct cost i.e., direct material, direct labour and direct expenses is referred as
direct cost or prime cost. Direct material, direct labour and direct expenses are
briefly discussed below:

a. Direct material: Direct material cost is the cost of material which can be
clearly traced and identified in the product, job, cost centre or cost unit. It is the
cost of materials used for a specific product or service or department.
b.Direct labour: Direct labour is the labour which can be distinctly and clearly
identified to a job, product, cost centre or cost unit. It refers to the specific costs
of workers used to make a particular product or to provide a particular service.

c.Direct expenses: The direct expenses are those expenses which can be clearly
identified or traced to a job, product, cost centre or cost unit.

2. Indirect cost
Indirect costs are those costs which are of a general nature and are neither
identifiable nor traceable to a particular job, product, cost centre or cost unit. It
is not directly charged to the product or job or cost centre. Indirect cost consists
of indirect material cost, indirect labour cost and indirect expenses.

B. Classification according to function

a. Production cost: The production cost is the total of all cost of direct material,
direct labour, direct expenses and manufacturing expenses.

b. Administration cost: The administration cost is the cost incurred for carrying
the administrative function of the organisation. i.e., cost of policy formulation
and its implementation to attain the objectives of the organisation.

c. Selling and distribution cost: Selling costs represent costs of creating and
stimulating demand and securing orders for products and services. Salaries,
travelling expenses and commissions of sales staff, Sales office expenses,
Brokerage, Advertisement and show room expenses, etc.

d. Research and Development Costs: The research cost is the cost of searching
for new products, new manufacturing process, improvement of existing
products, processe or equipment and the development cost is the cost of
applying the results of research on commercial basis.

C. Classification according to variability or nature or behaviour

a. Fixed cost
Fixed costs are those costs which remain fixed or constant at any level of
activity upto a given range of activity.
b. Variable cost
Variable cost is that part of the total cost which tends to vary directly with
variation in the volume of output.
c. Semi-variable cost
A cost which is partly fixed and partly variable is called semi-variable cost. It
varies at certain levels and remains fixed at other levels of activity.
D. Element-wise classification of costs

a. Direct material

Direct material cost is the cost of material which can be clearly traced and
identified to a job, product, cost centre or cost unit.

b. Direct Labour
Direct labour is the labour which can be distinctly and clearly identified to a
job, product, cost centre or cost unit.

c. Direct Expenses or Chargeable Expenses

The direct expenses are those expenses which can be clearly identified or traced
to a job, product, cost centre or cost unit.

d. Indirect cost
Indirect costs are those costs which are of a general nature and are not
identifiable or traceable or directly chargeable to a particular product, job or
department.

E. Classification according to controllability of cost

a. Controllable cost: Controllable costs are those which can be influenced by the
action of a specified member of an undertaking. Generally speaking, all direct
costs including direct materials direct labour and some of the overhead expenses
are controllable by the lower level management.

b. Uncontrollable cost: These are the costs which cannot be influenced by the
action of a specified member of undertaking. Most of the fixed costs such as
rent on building,salary to managerial persons, wages of skilled workers, etc. are
uncontrollable.

F. Classification according to normality of cost

a. Normal cost: Normal cost is the cost normally incurred at a given level of
activity.
b. Abnormal cost: Abnormal cost is the additional cost incurred at a given level
of activity than the normal cost.
G. Classification based on financial nature

a. Financial cost:

(1) Cash costs: Cash costs are those sacrifices that are reflected in actual cash
outflows.
(ii) Non-cash costs: These are financial sacrifices that do not involve any cash
outflows at the time when the cost is recognised. These costs are found in
depreciation, opportunity costs, etc.

b. Non-financial costs

Non-financial costs are those costs that are not directly traceable through a
company's cash flow. Such costs lead to reduced cash inflow in the future. For
example, low morale of employees, labour turnover, competition, etc.

Advantages of Cost Accounting

1. Advantages to the management

a. Supplies detailed cost information
b. Facilitates Planning
C. Assists in price fixing
d. Discloses operating efficiency
e. Helps in decision making
f.Facilitates cost comparison
g. Facilitates inter-firm comparison
h. Helps in establishing standard cost
i. Helps in preparation of income statement
j.Leads to introduction of New or Improved Methods: In

2. Advantages to employees:

a. Helps to have a sound wage policy

b. Distinguishes efficient from inefficient workers
c. Offers higher bonus
d. Offers more security to job

3. Advantages to the Government

a. Provides reliable cost data

b. Helps to utilise scarce resources
c.Helps to prepare plans
4. Advantages to the public

a. Reduces wastage
b. Improves public confidence through cost audit
C. Improves employment opportunities
d. Helps to control inflationary trend

5. Advantages to stakeholders

Bankers, investors, creditors, etc. get a clear picture of the functioning of the
firm. It helps them to grant financial assistance and offer better credit terms on
the basis of the Financial health of the organisation.

Limitations of Cost Accounting

1. Expensive
2. Dependence on financial accounting
3. Lack of support from managemen
4. Problem of apportioning blame for inefficiency
5. Problem of reconciling cost and financial accounts
6. Cost Accounting lacks uniform procedure

Installation of Good Costing System

A costing system is an established set of procedures, rules, cost records, etc., for
the purpose of achieving specified objective at minimum cost. All types of
concerns canncx adopt a single system.

Steps for Installation of Costing

1. Fixing the objective to be achieved

2. Studying the nature of business
3. Studying the nature of the organisation
4. Deciding the structure of cost accounts
5. Determining the cost rates
6. Introducing the system
7. Organising the cost office
8. Relationship of cost office to other departments
COST ACCOUNTING STANDARS (CAS)

Inorder to achieve uniformity and consistency in cost accounting. Cost

Accounting Standards have been established. The Cost Accounting Standards
are the standards set by the Cost Accounting Standards Board, inorder to
achieve uniformity, consistency and transparency in cost accounting procedure
and in the preparation of cost statements.

The Cost Accounting Standards are set by the Cost Accounting Standards
Board. The Cost Accounting Standard Board has been set up by the Council of
the Institute of Cost and Management Accountants of India (ICMAI).

Objectives

i.To equip the profession with better guidelines on standard cost accounting
practices.

ii. To assist the Cost Accountants in the preparation of uniform cost statement.

iii. To provide guidelines to Cost Accountants to make standard approach

towards maintenance of Cost Accounting Record.

iv. To assist the management to follow the standard cost accounting practices in
the matter of compliance of statutory obligations.
v. To help Indian industry and the Government towards better cost management

CAS-1: Classification of Cost

This standard deals with the principles of classification of cost for determining
the cost of a product or service.The objective of this standard is to bring
uniformity and consistency in the principles of classification of cost for
disclosure and presentation in the cost statements of a product or service.

CAS-2: Capacity Determination

The resource of a concern should be properly utilised. Proper utilisation of

resources is achieved through better utilisation of capacity. It is an important
consideration for cost determination, cost control and cost reduction.
The objective of the standard is to prescribe the method of determination of
capacity to be applied uniformly and consistently. The standard is to help the
management to identify the boulenecks, imbalances and idle capacity for
effective use of various resources, It helps in proper allocation, apportionment
and absorption of cost.

CAS-3: Overheads

In cost accounting the analysis and collection of overheads, their allocation and
apportionment to different cost centres and absorption to products or services
play an important role in determination of cost as well as control purposes.

CAS-4: Cost of Production for Captive Consumption

The Cost Accounting principle for determining of cost of production is well

established. Similarly, rules for levy of excise duty on goods used for captive
consumption are also well defined. Captive Consumption means the
consumption of goods manufactured by one division and consumed by another
division(s) of the same organisation or related undertaking for manufacturing
another product(s).

The standard and its disclosure requirement will provide better transparency in
the valuation of excisable goods used for captive consumption.

CAS-5: Determination of Average (Equalised) Cost of Transportation

The cost accounting principles for tracing/identifying an element of cost, its

allocation/ apportionment to a product or service are well established.
Transportation cost is an Important element of cost for procurement of materials
for production and for distribution of product for sale. Therefore, Cost
Accounting Records should present transportation cost of material purchased
and transportation cost of materials sold separately.

CAS-6: Material Cost

This standard deals with principles and methods of determining the material
cost. Material for the purpose of this standard includes raw materials, process
materials, additives, manufactured/bought out components, sub-assemblies,
accessories, semi finished goods. consumable stores, spares and other indirect
materials.

This standard deals with the principles and methods of classification,

measurement and assignment of material cost, for determination of the cost of
product or service, and the presentation and disclosure in cost statements.
The standard deals with the following issues

a. Principle of valuation of receipt of materials

b. Principle of valuation of issue of materials

c. Assignment of material cost to cost objects

The objective of this standard is to bring uniformity and consistency in the

principles and methods of determining the material cost with reasonable
accuracy.

CAS-7: Employee Cost

This standard deals with the principle and methods of determining the employee
cost.It is effected through the classification, measurement and assignment of
employee cost for determination of the cost of product or service, and the
presentation and disclosure in cost statements.

CAS-8: Cost of Utilities

This standard deals with the principles and methods of determining the cost of
utilities. It deals with the principles and methods of classification, measurement
and assignment of cost of utilities, for determination of the cost of product or
service, and the presentation and disclosure in cost statements.

CAS-9: Packing Material Cost

This standard deals with the principles and methods of determining the Packing
Material Cost. It deals with the principles and methods of classification,
measurement and assignment of Packing Material Cost, for determination of the
cost of product and the presentation and disclosure in cost statements. Packing
materials for the purpose of this standard are classified into primary and
secondary packing materials.

CAS-10: Direct Expenses

This standard deals with the principles and methods of classification,

measurement and assignment of Direct expenses, for determination of the cost
of product or service,and the presentation and disclosure in cost statements.
CAS-11: Administrative Overheads

This standard deals with the principles and methods of classification,

measurement and assignment of administrative overheads, for determination of
the cost of product or service and the presentation and disclosure in cost
statements.

CAS-12: Repairs and Maintenance Cost

This standard deals with the principles and methods of classification,

measurement and assignment of repairs and maintenance cost, for determination
of the cost of product or service, and the presentation and disclosure in cost
statements.

CAS-13: Cost of Service Cost Centre

This standard deals with the principles and methods of classification,

measurement and assignment of Cost of Service Cost Centre, for determination
of the cost of product or service, and the presentation of disclosure in cost
statement.

CAS-14: Pollution Control Cost

This standard deals with principles and methods of determining the Pollution
control costs. It deals with the principles and methods of classification,
measurement and assignment of pollution control costs, for determination of
Cost of product or service, and the presentation and disclosure in cost
statements.

CAS-15: Selling and Distribution Overheads

This standard deals with the principels and methods of determining the Selling
and Distribution Overheads. It deals with the principles and methods of
classification, measurement and assignment of Selling and Distribution
Overheads, for determination of the cost of sales of product or service, and the
presentation and disclosure in cost statements.

CAS-16: Depreciation and Amortisation

This standard deals with the principles and methods of measurement and
assignment of Depreciation and Amortisation for determination of the cost of
product or service, and the presentation and disclosure in cost statements.
CAS-17: Interest and Financing Charges

This standard deals with the principles and methods of classification,

measurement and assignment of Interest and Financing Charges.

CAS-18: Research and Development Costs

This standard deals with the principles and methods of determining the
Research,and Development Costs and their classification, measurement and
assignment for determination of the cost of product or service, and the
presentation and disclosure in cost statements.

CAS-19: Joint Costs

The standard deals with the principles and methods of measurement and
assignment of Joint Costs and the presentation and disclosure in cost statement.

CAS-20: Royalty and Technical Know-how Fee

This standard deals with the principles and methods of determining the amount
of Royalty and Technical Know-how Fee.

CAS-21: Quality Control

The standard deals with the principles and methods of measurement and
assignment of Quality Control Cost and the presentation and disclosure in cost
statement.

CAS-22: Manufacturing Cost

This standard deals with the principles and methods of determining the
Manufacturing Cost of excisable goods.

Cost Sheet

A cost sheet is a statement of cost elements connected with production and

distribution of specific products for a specific period. Though a detailed study of
cost sheet is required in Module 5, it is better to have an idea about a simple
cost sheet before studying the cost elements in details.