ELEMENTS AND

CLASSIFICATION OF COST
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 OBJECTIVE OF STUDY

Meaning of Cost
Cost terminology
Elements of Cost
Material
Labour
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Other Expenses
Overheads
Components of Total Cost
Cost Sheet and its Advantage.
Specimen of Cost Sheet.
Practical problem
COST TERMINOLOGY
Cost Allocation : Cost allocation is the allotment of the whole items of costs to
cost centres or cost units. A cost which is allocated to a cost centre is a direct cost
of that cost. Thus, direct costs are allocated, since they can be directly identified
with a cost centre or cost unit.
Cost Apportionment: Cost apportionment refers to the allotment of proportions of
item of cost to cost centres or cost Units .The cost which is apportioned to
different cost centres on suitable basis is an indirect cost of that cost centre.
Cost Centre: Cost centre is defined as a location, person or item of equipment (or
group of them) in respect of which costs may be ascertained and related to cost
units for the purposes of cost control. It is the smallest segment of activity or

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area of responsibility for which costs are accumulated. Thus cost centres can be
of two kinds, viz.
IMPERSONAL AND PERSONAL COST CENTRE
(a) Impersonal cost centre consisting of a location or item of equipment (or group
of these) such as machine shop, and
(b) Personal cost centre consisting of a person or a group of persons such as
factory manager, sales manager, etc.
OPERATION AND PROCESS COST CENTRE
(a) Operation cost centre is a cost centre which combines both person and
machine for doing same type of work. Such as a machine being operated by
group of person
Process cost centre is a cost centre where men and machine are working for a
specific process or sequence of operation as crushing, refining and finishing in
an oil mill
PRODUCTION AND SERVICE COST CENTRE:
Production cost centre is a place where actual production take place. Raw
material is converted into finished goods. Such as machine shop, welding shop,
boring shop, polishing shop etc
Service cost centre is a centre which provides services to production centre or
other department of organization. Such as power supply, house repair shop,
store department, telephone room.

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Cost Unit: cost unit is a unit of product, service or a combination of them in
relation to which costs are ascertained or expressed. For example ,
Industry Cost unit Industry Cost unit

Coal , iron ore Per tonne Paper per KG

sugar Quintal Automobile Per automobile

cable meter hospital bed per day

gas Per cubic meter aircraft Number

MEANING AND DEFINITION OF COST
The dictionary meaning of cost is “a loss or sacrifice”, or “an amount paid or
required in payment for a purchase or for the production or upkeep of something,
often measured in terms of effort or time expended”.
The term “Cost” may be used in different senses. Cost depends basically on
1. The nature of the business
2. The context in which it is used.

According to Institute of Cost and Management Accountants, London defines cost

as “ the amount of expenditure( Actual or notional) incurred on or attributable to a
given thing.” The given thing may be a product( Chair, pen, car, scooter etc ) or a

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service ( electricity, telephone, transport etc )

EVOLUTION OF COST ACCOUNTING

 Accounting is a very old profession. Financial accounting is in use with the dawn
of civilisation.
 The cost accounting concepts was used in beginning of the First World War.
The ‘cost plus’ concept was introduced during the war time in order to avoid delay
in executing urgent supplies.
 This led to increase in demand for cost accountant and more and more people
got interested in the profession. In 1919, the Institute of Cost and Works
Accountants was established in U.K., which is now known as the Chartered
Institute of Management Accountants (CIMA) at London
In U.S.A. the National Association of Cost Accountants, which is now known
as the National Association of Accountants, was also established at New York.
Under the leadership of these two institutes, the profession and the concepts of
cost accounting developed significantly.
 In India, prior to independence, there were a few cost Accountants, and they
were qualified mainly from I.C.M.A. (now CIMA) London.
 Costing profession was in an embryonic stage at that time. However, with the
enactment of the Cost and Works Accountants of India Act, 1959, the Institute of
Cost and Works Accountants of India was established in Kolkata.
The Institute has grown in stature, having Fellow, Associate and Student
Members. The Institute controls its function through its Head Office at Kolkata

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and four Regional Offices at Mumbai, Kolkata, Delhi and Chennai. Each of the
Regional Offices has several chapter Offices to look after the interest of the local
members and the profession.

ELEMENTS OF COST AND ITS CLASSIFICATION.

For the purpose of identification, accounting and control, breakup of cost into its
elements is essential. Elements are related to the process of manufacture i.e. the
conversion of raw materials into finished products. Costs are normally broken
down into three basic elements, namely,
 DIRECT

MATERIAL
INDIRECT

DIRECT
ELEMENTS
OF COST LABOUR
INDIRECT

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DIRECT
OTHER
EXPENSES
INDIRECT

ELEMENTS OF COST
MATERIAL COST

The substance from which products are manufactured are called material. The
material may be in raw shape , e.g., timber for furniture and leather for shoe, etc.
or in manufactured state, .g., battery for car, speaker for radio, etc.

According to Institute of Cost and Management Accountants, London defines

Material Cost
“ The material cost is the cost of commodities supplied to an undertaking. “

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Material Cost may be
Direct Material
Indirect Material

DIRECT MATERIAL

Direct material are those material which are either specifically purchased for the
production of product or which are visible in the final product or which can be
easily identified in the finished product as leather in shoes, wood in furniture,
cloth in dress, plastic in pen, paper in book, bricks in house etc. These can be
measured and directly charged to the product. The direct material include the
following
i. All raw material such as jute in gunny bags, fruit in canning industry.
ii. Materials specifically purchased for specific job, process or order like glue for
book binding, starch powder for dressing yarn etc.
iii. Parts or components purchased or produced like batteries for transistor-radio
and tyres for car.
iv. Primary packing materials like cartons, wrapping, cardboard boxes, etc used to
protect finished product from climatic condition or easy handling inside the
factory.

Direct material are also known as Process Material, Prime cost material,

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Productive Material or Store Material. In order to calculate the cost of material,
expenses such as import duties, dock charges, transport cost of materials are added
to the invoice price.
Material considered direct at one time may be indirect on other occasion. Nail used
in manufacturing wooden box is treated as direct material, but treated as indirect
material when used to repair the factory building.

According to Institute of Cost and Management Accountants, London defines

Direct Material as, “ Material cost which can be identified with and allocated to
cost centre or cost unit .”
INDIRECT MATERIAL

Indirect material refer to those material which do not normally form a part of
the finished product. These material are not visible in final product as
lubricant in machine, adhesive in the furniture making, glue in book binding.
The cost of these material is so small in the final product that it is not easy to
calculate the cost per unit of product as gum in kite etc.

According to Institute of Cost and Management Accountants, London define

Indirect material cost as “ The material cost which cannot be allocated but
which can be apportioned to or absorbed by cost centre or cost unit. “

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Indirect material include
i. Stores used in maintenance of machinery, building etc.. Like lubricants,
cotton waste, brick and cement ;
ii. Stores used by the service departments i.e. non-productive departments
like power house, boiler house and canteen.
iii. Material which due to their cost being small, are not considered
worthwhile to be treated direct materials.
LABOUR COST

Human efforts used for conversion of materials into finished products or doing
various jobs in the business are known as labour. Payment made towards the
labour is called labour cost.

According to Institute of Cost and Management Accountants, London defines

labour cost as
“ The cost of remuneration( wages, salaries, bonus, commission etc. ) of an employee
of an organization. “

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Labour cost may be
Direct Labour Cost
Indirect Labour Cost

DIRECT LABOUR COST

Direct Labour is all labour expended in altering the construction, composition,

confirmation or condition of the product. In simple words, it is that labour which
can be conveniently identified wholly to a particular job, product or process or
expended in converting raw material to finished product. Wages paid to such
labour is called direct wages.
Direct labour cost includes payment made to following groups of labour
i. Labour engaged on the actual production of product or carrying out of an
operation or process.
ii. Labour engaged in aiding the manufacture by way of supervision,
maintenance, tools setting, transportation of material etc
iii. Inspectors, analysts etc. specially required for such production.

Direct labour is also known as Process Labour, Operating Labour or Productive

Labour.

According to Institute of Cost and Management Accountants, London defines

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Direct Labour Cost as “ Wages which can be identified with and allocated to cost
centre or cost unit. “

INDIRECT LABOUR

The wages of that labour which cannot be allocated but which can be apportioned
to or absorbed by cost centre or cost unit is called Indirect labour cost. The
wages paid to labour which is employed other than on production constitute
direct labour cost. These labour provide service to those who are operating the
machine as store keeper, watchman, cleaner, chokidar, electrician, gardener etc.
According to Institute of Cost and Management Accountants, London defines
Indirect Labour Cost as “ The wages which cannot be allocated but which can be
apportioned to or absorbed by cost centre or cost unit. “

OTHER EXPENSES
All expenditures other than material and labour incurred for manufacturing a
product or rendering service are termed as 'expenses'.

According to Institute of Cost and Management Accountants, London defines

Expenses as
“ The cost of services provided to an undertaking and the notional cost of use of

Expenses may be
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owner’s asset. “

Direct expenses
Indirect Expenses

DIRECT EXPENSES
All expenses which can be identified to a particular cost centre and hence directly
charged to centre is known as direct expenses. All expenses other than direct
material and direct labour incurred specifically for a particular product, job,
department etc are called direct expenses
Direct expenses are also known as Process Expense , Productive expense, Prime Cost
Expenses
Examples of Direct expenses
 Cost of special moulds, design and patterns for specific job
Cost of patent of product, Royalty, Excise duty..
Hire charges of a specific plant and equipments
Travelling expense incurred in connection with particular contract or job
Research and experimental expense related to a specific contract or job.

According to Institute of Cost and Management Accountants, London defines Direct

expenses as “ Expenses which can be identified with and allocated to a cost centre or
cost unit. “

INDIRECT EXPENSES
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Indirect Expenses are those which cannot be identified with a specific job, order, or
process but which are common and these are apportioned to all jobs on some
appropriate basis such as rent , rates, insurance, municipal taxes, general manager’s
salary, canteen and welfare expense, power and fuel cost, telephone expense etc.

According to Institute of Cost and Management Accountants, London defines,

Indirect expenses as, “ expenses other than direct expenses.”
OVERHEADS

Overhead may be defined as the

aggregate of the cost of indirect
materials, indirect labour and PRODUCTION
OVERHEAD
indirect expenses. It is also
known as ‘on cost’ or ‘Burden’.

According to Institute of Cost

and Management Accountants,

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London defines Overheads as,
DISTRIBUTION ADMINISTRATIVE
OVERHEAD OVERHEADS OVERHEAD

“ The aggregate of indirect

material cost, indirect labour cost
and indirect expenses. “

SELLING
OVERHEAD
PRODUCTION OVERHEAD

Production overheads are those indirect expenses of operating the

manufacturing division of a concern. It is also known as Factory overhead,
work overhead , Manufacturing overhead. It also include wages of indirect
workers and indirect material.

Production Overhead includes the following

 Rent, rate and taxes of factory
 factory telephone charges

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Factory repair and maintenance
 Heating and Lighting expenses in factory
Insurance of factory building, machinery, workers etc
 Power and fuel
 Water charges in the factory
Cleaning charges in factory
Wages to chokidar, sweeper, waterman etc
Indirect material, nut, bolt, screw, nail, rags, thread and lubricants.
ADMINISTRATIVE OVERHEAD

It is the indirect expenditure incurred in operating administrative and office

work of production unit. It include expenditure incurred in formulating the
policy, directing the organization, controlling and managing the operations of
an undertaking. It is also known as Office overheads or Establishment
Overheads.

Administrative Overheads include the following

 Office salaries

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 Directors salaries
 Office rent, rate, taxes, lightening etc
 Office cleaning charges
 Office Insurance( building, staff, appliances etc )
 Printing, stationery, postage and stamp charges
 Legal charge
 Public relation expenses
 Office heating and lighting
 Repair and maintenance of office building, office furniture etc.
SELLING OVERHEAD

It is the cost of seeking to create and stimulate demand and of securing orders
and comprises the cost of soliciting orders and efforts to retain customers. It
refers to those indirect cost which are associated with marketing and selling
activities.

Sales Overhead includes the following

Sales office expenses
Salesmen’s salaries and commissions
Showroom expense
Sample and free gifts

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After sales service expenses
Cost of catalogues and price lists

DISTRIBUTION OVERHEAD

It comprises all expenditure incurred from the time the product is completed in
the works until it reach its destination.
Distribution Overhead includes
 Warehouse rent
 Warehouse Staff salaries
Expenses on delivery van and truck
COMPONENTS OF TOTAL COST
The components of total cost are as given below

Prime cost
Factory cost
Total cost of production
Cost of sales or Total Cost

PRIME COST

Prime cost is the sum total of the Direct Material cost, Direct Labour cost and

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Direct Expenses. It is also known as Direct cost.

Prime Cost = Direct Material + Direct Labour + Direct Expenses

FACTORY COST

Factory cost is sum total of Prime cost and factory Overheads. It is also known as
Work Cost or manufacturing Cost or Production Cost.

Factory Cost = Prime Cost + Factory Overhead.

COST OF PRODUCTION

It is sum total of Factory cost and Administrative overheads.

Cost of Production= Factory Cost + Administration Overheads.

COST OF SALES

It is sum total of Cost of Production and Selling and Distribution Overheads.

Cost of Sales= Cost of Production + Selling and Distribution Overheads

SELLING PRICE {
If profit added to the cost of sales the resulting amount will be Sales price

Selling Price= Cost of sales + Profit

COST SHEET
Cost sheet is statement which shows the output of a specified period along with the
break-up of cost per unit as well as total. The data taken in cost sheet are collected
from various records related to the job or order or production.
There is no fixed form for preparation of cost sheet . It is generally presented in
columnar form.

ADVANTAGES OF COST SHEET

It discloses the total cost and the cost per units produced during the given period.
It enables a manufacturer to keep a close watch and control over the cost of
production.

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By providing Comparative study of various elements of current cost with the past
results and standard cost, it is possible to find out causes of variation in cost and to
eliminate the adverse factors and conditions which go to increase the total cost.
It act as a guide to the manufacturer and helps him in formulating a definite
useful production policy.
It helps in fixing Selling price more accurately
It help businessman to minimize the cost of production when there is a cut throat
competition.
It helps businessman to submit quotation with reasonable degree of accuracy
against tender for supply for goods.
 SPECIMEN OF COST SHEET

Total Cost(Rs) Cost per Unit (Rs)

Direct Material
Direct Labour
Direct Expenses
Prime Cost
Add : Factory Overhead
Factory Cost
Add : Administration Overhead

{ Cost of Production
Add: Selling and Administration
Overhead
Cost of Sales /Total Cost
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