BBA SEM II

Study Material: Cost Accountin

Basics of Cost Accounting Unit 1 - Cost Accounting

1.1 Introduction:
Costing is a branch of accounting. It helps us to classify, record, and allocate the expenditure for the determination of costs of product. Expenditure involved in business has to be ascertained to fix the price of a product produced. The expenditure is to be understood in terms of material, labour and other direct and indirect expenses. The major purpose of such classification is to estimate the profit and to understand its relationship with costs and price. The three elements of a transaction i.e., cost, profit and price are necessary components of any business activity. Example: A Calculator factory introduces a new device. The factory incurs Rs. 400 for material, Rs.400 for la our and Rs.!00 for overhead on every Calculator produced and supplied in the mar"et. The total cost comes around Rs.#000. $f the price of the device is Rs. #%00, the profit per device is Rs. %00 &#%00'#000(.

The management requires all information as seen in the example for each product produced. The above estimation is done for the purpose of planning, cost control and decision ma!ing. The existing system of financial accounting does not provide the necessary information to do similar estimation. "uch deficiency of financial accounting has given rise to the need of cost accounting. 1. 2 Define cost accounting: The word #Costing$ refers to the technique and process of ascertaining costs. There have been certain rules and principles in the field of costing developed over years by our forefathers. These rules and principles help us to ascertain the cost of products produced. The term %Cost &ccounting$ refers to the recording of all incomes and expenditures and ends with the preparation of periodical statements and reports for ascertaining and controlling costs.

Prepared By: Mahendra Patel, Faculty. Parul Institute of Business Administration

BBA SEM II
Costing is "ystem of computing cost of production or

Study Material: Cost Accountin

of running a business, by

allocating expenditure to various stages of production or to different operations of a firm. )efinitions of Cost Accountin*: Accordin* to the Terminolo*y used y the $nstitute of Cost and +ana*ement Accountants, ,Cost accountin* is the part of mana*ement accountin* which esta lishes ud*ets and standard costs and actual costs of operations, processes, departments or products and the analysis of variances, profita ility or social use of funds.-

2. Objective of Costing
1. Ascertainment of Cost: The first and foremost objective of cost accounting is to find out cost of a product, process or service. The other objectives which have been mentioned hereafter scan be achieved only when the costs have been ascertained. The primary objectives of the cost accounting are to ascertain cost of each product, process, job, operation or service rendered. 2. Ascertainment of Profitabi it!: Cost accounting determines the profitability of each product, process, job, operation or service rendered. The statement of profit or losses and 'alance "heet also submitted to the management periodically. ". C assification of Cost: Cost accounting classifies cost in to different elements such as materials, laborer and expenses. It has further been divided as direct cost and indirect cost for cost control and recording. #. Contro of Cost: Cost accounting aims at controlling cost by setting standards and compared with the actual, the deviation or variation between two is identified and necessary steps are ta!en to control them. $. %i&ation or 'e ing Prices or Determining 'e ing Price: Cost accounting guides management in regard to fixation of selling prices of the products. It is also helpful for preparing tender and quotations. (. )easuring and Increasing *fficienc! ( Cost accounting involvers a study of the various operations used in manufacturing a product or providing a services. The study facilitates measuring of the efficiency of the organisation as a whole as well as of the departments besides devising means of increasing the efficiency. +. Cost )anagement( The term #Cost )anagement$ includes the activities of managers in &s a matter of fact cost short run and long run planning and control of costs. Cost management has a broad focus. It includes both cost control and lost reduction. management is often invariably lin!ed with revenue and profit planning. *or instance, to enhance revenue and profits, the management often deliberately incurs additional costs for advertising and product modifications.

Prepared By: Mahendra Patel, Faculty. Parul Institute of Business Administration

BBA SEM II
,. Providing Basis for )anageria following matters( +i, +ii, +iii, Decision - )a.ing (

Study Material: Cost Accountin

Costs accounting helps the

management in formulation operative policies. These policies may relate to any of the -etermination of cost . volume . profit relationship. "hutting down or operating at a loss. )a!ing or buying from outside supplies.

". Advantage/ Im0ortance of Cost Accounting

1. Costing 1e 0s in 0eriods of trade de0ression and trade com0etition: - In periods of
trade depression the business cannot afford to have lea!ages which pass unchec!ed. The management should !now where economies may be sought, waste eliminated and efficiency increased. The business has to wage a wax for its survival. The management should !now the actual cost of their products before embar!ing on any scheme of reducing the prices on giving tenders. &dequate costing facilitates this.

2. 2e 0s in 0rice fi&ation:- Though economic law / supply and demand and activities of
the competitors, to a great extent, determine the price of the article, cost to the producer does play an important part. The producer can ta!e necessary guidance from his costing records.

". 2e 0s in estimate:- &dequate costing records provide a reliable basis upon which tenders
and estimates may be prepared. The chances of losing a contract on account of over . rating or losing in the execution of a contract due to under . rating can be minimi0ed. Thus, 1ascertained costs provide a measure for estimates, a guide to policy, and a control over current production2.

#. 2e 0s in c1anne ing 0roduction on rig1t ines:- Costing ma!es possible for the
management to distinguish between profitable and non profitable activities profit can be maximi0ed by concentrating on profitable operations and eliminating non profitable ones.

$. 3astages are e iminated:- &s it is possible to !now the cost of the article at every stage,
it becomes possible to choc! various forms of waste, such as time, expenses etc. or in the use of machine, equipment and tools.

(. Costing ma.es com0arison 0ossib e:- If the costing records are regularly !ept,
comparative cost data for different periods and various volumes of production will be available. It will help the management in forming future lines of action.

+.

Provides data for 0eriodica 0rofit and oss accounts:- A dequate costing records supply to the management such data as may be necessary for preparation of profit and loss account and balance sheet, at such intervals as may be desired by the management.

Prepared By: Mahendra Patel, Faculty. Parul Institute of Business Administration

"

BBA SEM II

Study Material: Cost Accountin

It also explains in detail the sources of profit or loss revealed by the financial accounts thus helps in presentation of better information before the management.

,. Aids in determining and en1ancing efficienc! ( 3osses due to wastage of material, idle
time of wor!ers, poor supervision etc., will be disclosed if the various operations involved in manufacturing a product are studied by a cost accountant. The efficiency can be measured and costs controlled and through it various devices can be framed to increase the efficiency.

4. 2e 0s in inventor! contro :- Costing furnishes control which management requires in

respect of stoc! of materials, wor! in progress and finished goods. +This has been explained in detail under the chapter 1)aterials2,

15. 2e 0s in cost reduction:- Costs can be reduced in the long run when alternatives are
tried. This is particularly important ion the present day context of global competition cost accounting has assumed special significance beyond cost control this way.

11. Assists in increasing 0roductivit!:- 4roductivity of material and labour is required to

be increased to have growth and more profitability in the organisation costing renders great assistance in measuring productivity and suggesting ways to improve it.

#. %unction of Cost Accountant

The cost accountant is an important person in an organi0ation5especially manufacturing organi0ation. The responsibility of discharging the cost accounting functions of the organi0ation lies on the cost accountants$ shoulders. Their role has attained a significant position, now. They are a part of senior management team. The role of a cost accountant can be understood from the following important functions to be performed by them.

1.

)aintenance of records: The basic function is to maintain cost accounting records as per section 678+9,+d, of the Companies &ct 98:;. In pursuance of this provision, the <overnment of India has notified Cost &ccounting =ecord =ules for more than >7 industries. These rules prescribe the manner in which cost accounting records have to be maintained. They specify the particulars that should be entered in the boo!s of accounts. "ome of the records are to be maintained under the following heads( "tores and raw materials? salaries and wages? overheads? wor! in progress? production +finished goods, sales? depreciation. These records should be !ept in such a way so as to reveal the business operations and valuation of stoc!s are determined accurately. =econciliation of the results from these cost records should be made with those of financial accounts. In case, if the firms are not governed by the statutory provision,

Prepared By: Mahendra Patel, Faculty. Parul Institute of Business Administration

BBA SEM II
to the management for ta!ing decisions.

Study Material: Cost Accountin

the cost accountant himself has to maintain records in such a way that they are useful

2.

%inancia

0 anning: The cost accountant$s role in financial planning cannot be

minimi0ed. The cost accountant assists the line and staff managers in the preparation of budgets, ma!ing changes as and when necessary, ensuring consistency, and final compilation of the budget and master budget.

3.

Product 0ricing: This is an important function to be performed by a cost accountant. The cost accountant assists the management in pricing a product by providing valid information after analysing and interpreting various cost data relating to fixing the price of a product.

4. 5.

Cost ascertainment: &scertainment of the cost of a product or service is another important function of a cost accountant. Cost contro : Controlling the costs of business operations is the prime function of a cost accountant. Cost accountants have to exercise cost control by using a variety of techniques such as budgetary control, standard costing, quality control. They have to assist the management by submitting periodical reports to facilitate cost control function. *or example, statement of inventory valuation with relevant ratios will help the management to appraise the level of stoc!.

6.

Cost reduction: This is another important area in which a cost accountant$s role has gained much importance. )anufacturing quality goods and rendering prompt services at the minimum cost is the goal of any organi0ation. The cost accountant aims at achieving reduction on the unit cost of goods produced or services rendered and at the same time maintaining quality.

7.

*va uation of 0erformance: The cost accountant compares the actual results with the budget, and variances are ascertained. @ariances are analysed by causes and responsibility centres and communicated to appropriate level for corrective action. The performance of the responsibility centre is evaluated constantly which enhances the efficiency of an organi0ation.

8.

)anagement decision: Ane more important function of a cost accountant is to adopt as well as adapt cost accounting tools and techniques for management decision analysis such as ma!e or buy, to continue or shut down operation, to accept an order, to quote a price, to choose alternative proposal etc. and various problem solving situations.

9.

Communication: The cost accountant discloses the needed financial information to all needed centres.

10. Coordinator: The cost accountants$ role of coordination with other departments
cannot be underestimated. Their constant flow of cost information with production department, purchase department, personnel department, finance and accounts

Prepared By: Mahendra Patel, Faculty. Parul Institute of Business Administration

BBA SEM II

Study Material: Cost Accountin

department, mar!eting department is essential for the successful functioning of an organi0ation. They coordinate the activities of all the departments by way of exercising cost control and cost reduction.

11. 6e iab e ta& basis: &s costs are ascertained precisely and profits shown in cost records
are reliable and accurate, it facilitates the tax levying authorities to assess the tax without great difficulty. "o, the role of the cost accountant gains greater responsibility.

12. Customer re ations1i0 management: C=) initiatives use technology to coordinate all
customer facing activities +such as mar!eting, sales calls, distribution and post sales support, and the design and production activities necessary to get products to customers.

$. Cost Accounting and Ot1er Branc1es of Accounting

&ccounting is classified into( 9. 6. *inancial accounting and )anagement accounting

*irst, we shall loo! into the relationship between cost accounting and financial accounting. Botwithstanding the fact that both are concerned with systematic recording and presentation of data based on the same records and on the same principles of debit and credit rules, they differ widely in the aspects shown in Table.

$.1. Differences bet7een %inancia Accounting and Cost Accounting

Basis 1. Aim .inancial Accountin* *inancial business, 2. accounting proprietors aims and at strengthening the interests of the others associated with it. 'tatutor! These accounts have to comply with statutory requirements such as company act and income tax act. ". *m01asis This emphasi0es the measurement of profitability. Cost Accountin* Cost accounting planning, aims at strengthening the management for operation, control and decision ma!ing. Cost accounts have to comply with the requirements of management. Af late, certain industries have to meet the requirements of company act +only obligatory,. Cost accounting emphasi0es ascertainment of costs.

all proper

re8uirement

Prepared By: Mahendra Patel, Faculty. Parul Institute of Business Administration

BBA SEM II
#. ana !sis $. 9ature Profit This analyses accounts discloses the profit of the firm as a whole. of Transactions classified and are recorded, in

Study Material: Cost Accountin

and This discloses profit made on each product, process, job or service. Transactions are recorded and

recording transactions (. %acts

analysed

a analysed in an objective manner, which costs are incurred. Cost accounting deals with facts and figures besides estimates. "toc!s are valued at cost price. Costs are bro!en into unit basis in cost accounting. Cost accounting provides

subject manner, i.e., according to i.e., according to the purpose for the nature of expenditure. and *inancial accounts deal mainly with facts and figures only.

estimates

+. :a uation of "toc!s are valued at cost or stoc. ,. 9ature mar!et price whichever is less. of Costs are reported in aggregate in

re0ort of costs financial accounts. 4. 6e ative This does not provide information efficienc! 15. ;!0e on the relative efficiency of wor!ers, plant, machinery etc. of *inancial accounts are concerned with external transactions, which

information on relative efficiency of wor!ers, plant and machinery. Cost accounts are concerned with internal transactions, which do receipt of cash. Cost reports are prepared and reported it. These most frequently, whenever management requires are comparatively less

transactions and basis 11.

form the basis of payment or not form the basis of payment or

receipt of cash. Periodicit! *inancial statements are prepared and reported only at specified period, usually once in a year.

of re0ort

12. Degree of *inancial statements are more accurac! 1". C assification 1#. Information accurate as they are subject to scrutiny by statutory authorities. *inancial accounts do not classify accounts, expenses etc. 4roper and adequate information on each aspect of business is not provided to outsiders, though it extends information to outsiders.

accurate as they are intended mainly for the management. In cost accounting, they are

classified properly and analysed perfectly. 4roper and adequate information on each and every aspect of business is provided to outsiders.

Prepared By: Mahendra Patel, Faculty. Parul Institute of Business Administration

&

BBA SEM II

Study Material: Cost Accountin

$.2. Cost Accounting and )anagement Accounting

"ome accounting professionals are of the view that cost accounting is a branch of management accounting. "uch a close relationship exists between the two categories of accounting. 'oth are internal to the organi0ation. 'oth have the same objectives5for instance, both assist management in its functions of planning, controlling and decision ma!ing. 'oth use more or less similar techniques such as marginal costing and budgetary control. 'ut cost accounting and management accounting differ in certain areas. The main points of distinction between cost accounting and management accounting are shown in Table.

Difference bet7een Cost Accounting and )anagement Accounting

Basis of Distinction Cost Accountin* Cost accounting is concerned with 1. Objective the ascertainment, allocation, distribution and accounting aspects of costs. In an organi0ation, cost accountant is placed at a lower hierarchy level than management accountant. Cost accounting data are generally derived by using management accounting techniques. =elevance and objectivity of data is not higher in to cost accounting management & wide range of tools and techniques are used such as ratio analysis, cash flow in addition to tools and techniques used in cost accounting. )anagement account is concerned both with short term and with long term planning. It is concerned with both assisting management in its functions and in evaluating the performance of the management. It is generally approach. futuristic in its compared )anagement accountant is placed at a higher hierarchy level than cost accountant. )anagement derived from accounting cost data are and +ana*ement Accountin* This is mainly concerned with +i, the impact +ii, effect aspects of costs.

2. 2ierarc1! eve ". Accounting data

accounts

financial accounts. =elevance and objectivity of data is higher than cost accounting.

#. 6e evance and objectivit!

accounting. Tools and techniques used in cost $. Usage of too s and tec1ni8ues accounting are limited such as standard costing, budgetary control, brea! even analysis. Cost account is generally concerned with short term planning. It is mainly concerned with assisting +. *va uation of 0erformance in management functions and in the evaluation of performance. Cost accounting is generally historical in its approach. It projects the past.

(. Period of 0 anning

,. A00roac1

Prepared By: Mahendra Patel, Faculty. Parul Institute of Business Administration

'

BBA SEM II
4. Inc usion of ot1er branc1es of accounting. Cost accounting does not include financial accounting. accounting and

Study Material: Cost Accountin

It includes cost accounting as well as tax tax accounting.

(. Conce0ts of Cost
It is difficult to define the term 1cost2. The term 1cost2 is ambiguous and uncertain. In general, cost means the amount of resource used in exchange for goods or services. The resources used shall be money or money$s worth, which is usually expressed in monetary units. The terminology of CI)& defines cost as 1the amount of expenditure +actual or motional, incurred on, or attributable to, a specified thing or activity2. It may also be defined as Cost is a foregoing, measured in monetary terms, incurred or potentially to be incurred to achieve a specific objective. & cost has to be loo!ed in relation to +i, the nature of business +ii, purpose, +iii, different conditions and +iv, the context in which it is used. &s already said, cost is measured in terms of money. Cowever, costs which do not give rise to actual cash outlay, namely, imputed +actual, or notional cost, are to be considered while decision ma!ing. 'ut these are not available from accounting records5for instance, interest on capital invested by the owner in the firm in notional cost.

1.

9ature of business: & cost has to be studied in relation to its nature of business. *or example, a manufacturing organi0ation is interested in !nowing the cost per unit of its product, whereas the organi0ations rendering services such as electricity and transport are interested in ascertaining the costs of services they undertoo!. The cost per unit can be easily ascertained by dividing the total expenditure by number of units produced or quantum of services rendered. This is relatively easy if the organi0ation produces only a single product. 'ut if more than one product is produced, other factors have to be considered for determining the cost.

2.

Pur0ose: & cost has to be studied in relation to its purpose. *or example, the purpose is fixation of selling price cost. &ll items of expenditure relating to production, administration and selling will have to be included. 'ut if the purpose is valuation of inventories, only cost of production will have to be ta!en into account. Cence, the concept of cost varies according to the purpose. It differs from purpose to purpose and has different denotations.

3.

Conditions: & cost has to be ascertained under different conditions also. *or instance, while dealing with inventory, wor! in progress is valued at factory cost, whereas stoc! of finished goods is valued at production cost. -ifferent conditions lead to different modes of valuation of cost. Concept of cost varies thus.

Prepared By: Mahendra Patel, Faculty. Parul Institute of Business Administration

BBA SEM II 4.

Study Material: Cost Accountin

Conte&t: The term 1cost2 may not stand on its own and has to be qualified. It is a generic term. It is generally used to include all the various types of costs. Cowever, when the term is used specifically, it is always modified with reference to the context costed by such descriptions as prime cost, fixed cost, variable cost, opportunity cost and sun! cost. Each such modification implies a certain attribute which is important in computing and measuring the cost.

Concept of cost is not precise and cannot be pinpointed. It is ever widening. It has its own terminology. Cence, different costs are to be used for different purposes

(.1. Define t1e term cost.

The terms #Cost$ and #expenditure$ are used interchangeably to mention same thing in the field of business. Cost means the amount of expenditure incurred on, or attributable to, a given thing. Accordin* to the committee on Cost Concepts and /tandards of the American Accountin* Association, ,Cost is fore*oin*, measured in monetary terms, incurred or potential to e incurred to achieve a specific o 0ectiveIt may be an actual cost or estimated expenditure. It also indicates a direct or indirect expenditure. It is also related to job, process, product or service. Examples of costs are material, labour, factory overhead, administrative overheads, and selling and distribution overheads. (.1.1. Cost Centre Cost is generally ascertained by cost centres. 3et us understand about cost centre. A cost centre is a location, person or item of e1uipment &or *roup of these( for which costs may e ascertained and used for the purposes of cost control. &$.C.+.A. 2ondon( The entire organi0ation may be divided into specified cost centres, which jointly contribute to the total cost. & cost centre is primarily identified in two major ways. They are a. 4ersonal cost centre( It consists of a person or a group of persons. b. Impersonal cost centre( It consists of a location or an item of equipment or group of these. Identification and establishments of cost centres depend on the nature and type of industry. Cost centres may be of the following types. i. 4rocess cost centre +based on sequence of operation, ii. 4roduction cost centre+for regular production in a shop, iii. Aperation cost centre+where various operations are involved in the production process,

Prepared By: Mahendra Patel, Faculty. Parul Institute of Business Administration

1)

BBA SEM II

Study Material: Cost Accountin

iv. "ervice cost centre+for activities supporting the main production, Identification and establishment of cost centres help us in i, ascertaining the centre wise costs, ii, comparing the centre wise costs periodically, iii, finding out the major trends of variance, iv, applying the techniques of control to chec! undue, undesirable or unexpected movements in costs. The concept of costing by cost centres may be applied to almost any industry. The number of cost centres and the si0e of each vary from one underta!ing to another. The main purpose of identification of cost centres is to fix responsibilities for every cost centres. & large number of cost centres tend to be expensive but having too few cost centres defeat the very purpose of control. (.1.2. Cost Unit

The cost centres help in ascertaining the costs by location, equipment or person. Cost unit is an extension of identification of cost centres. Cost unit helps in brea!ing up the cost into smaller sub divisions. It also facilitates in ascertaining the cost of saleable product or services. &ccording to I.C.).&. 3ondon 1A cost unit is a unit of product, service or time in relation to which cost may e ascertained or expressedCost units are the #things$ that the business is setup to provide of which cost is ascertained. Cost units will normally be the quantity of a product for which price is quoted to the customers. Cost units may be( i. unit of product +e.g., cost per boo!, ii. unit of time +e.g., cost of generating electricity per hour, iii. unit of weight +e.g., cost per !ilogram of sugar, iv. unit of measurement +e.g., cost per square foot of construction, v. operating unit of service +e.g., cost of running a car per !ilometre, "election of a cost unit must be appropriate. Convenience is the first criterion. "econdly, it should be easier to correlate expenses with cost units. Thirdly, it should be according to the nature and practice of the business. & few more examples of cost units in various industries are given(

Prepared By: Mahendra Patel, Faculty. Parul Institute of Business Administration

11

BBA SEM II
Industr! &utomobile 'ric!s Carpets Cars Cement Chemicals Cotton Electricity Cotel )ines 4encils 4rinting 4ress "hoes Timber Transport

Study Material: Cost Accountin

Cost Unit Bumber 9,777 bric!s "quare yard 4er Car Tonne Tonne, !ilogram, litre, gallon etc 'ale Dilowatt hour =oom per day Tonne -o0en or gross Thousand copies 4air or do0en pairs Cubic foot 4assenger Dilometre

(.2. Com0onents of ;ota Cost

The total cost comprises of direct costs +also !nown as prime cost, and indirect costs +!nown as overheads,. The prime cost consists of direct materials, direct labour and other direct expenses. Averhead consists of factory overheads, office overheads, and selling and distribution overheads. )ec1anism of Cost Bui d U0 Prime < 3or.s < Cost Direct = Cost Prime = Cost Office And Administrative Over1ead )ateria Direct = Cost %actor! Over1ead >abour Direct *&0enses

Cost of Production 3or.s < ;ota < =

Cost Cost of Production 'e ing And Distribution Over1ead =

+. * ements of Cost
There are three elements of Cost

Prepared By: Mahendra Patel, Faculty. Parul Institute of Business Administration

1!

BBA SEM II

Study Material: Cost Accountin

&. )ateria s: The word 1)aterials2 refers to those commodities, which are used as raw materials, components, or consumables for manufacturing product. )aterials can be direct or indirect. i. -irect materials( &ll materials used as raw materials or components for a finished product are !nown as #direct materials$. Cotton for textiles, tyres for car are few examples of direct material. It also includes pac!age material. ii. Indirect )aterials( Consumable li!e lubricating oil, spare parts for machinery are called as indirect materials. "uch commodities do not form part of the finished product. '. >abour : The wor!ers are involved in converting raw material into finished goods. "uch involvement of wor!ers forms the word #labour$. The reward given to them for their involvement is called #wages$. Eages can be direct or indirect. i. -irect 3abour( The wor!ers who are directly involved in the production of goods are !nown as #direct labour$. The reward paid to them is called direct wages. ii. Indirect 3abour( The wor!ers employed for carrying out tas!s incidental to production of goods or those engaged for office wor! and selling and distribution activities are !nown as #indirect labour$. The reward given to them is called indirect wages. C. *&0enses :&ll expenditures other than material and labour are termed as #expenses$. Expenses can also be direct or indirect. i. -irect Expenses( Ather expenses, which are incurred specifically for a particular product, job or processes are termed as #direct expenses$. "ome examples are given below(

Direct *&0enses Carriage Inwards 4roduction royalty Cire Charges of equipment Cost of special drawings

special

ii. Indirect Expenses( &ll expenses other than indirect materials and labour which cannot be directly attributed to a particular product, job or service are termed as #indirect expenses$. "ome examples are given below(

Prepared By: Mahendra Patel, Faculty. Parul Institute of Business Administration

1"

BBA SEM II
Indirect *&0enses: =ent of building, =epair of )achinery 3ighting and heating Insurance

Study Material: Cost Accountin

-. Conce0t of Over1ead: &ll material, labour and expenses, which cannot be identified as direct costs, are termed as #indirect costs$. The three elements of indirect costs namely indirect materials, indirect labour and indirect expenses are collectively !nown as #Averheads$ or #An costs2. Averheads are grouped into three categories( i. factory +or manufacturing, overheads, ii. office +or administrative, overheads, and iii. selling and distribution overheads E. Conversion Cost: The cost of converting raw materials into finished goods is termed as #conversion cost$. It includes direct wages, direct expenses and factory overheads.

E3E)EBT"A* A*CA"T CA"T E3E)EBT"

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Prepared By: Mahendra Patel, Faculty. Parul Institute of Business Administration

1#

BBA SEM II

Study Material: Cost Accountin

Elements Elements ofcost cost of

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,.C assification of Costs

Costs have been classified according to various bases. ,.1. C assification based on functions: ;1is is a traditional classification. The cost may have to be ascertained according to the functions carried out by the organisation. The functions generally are manufacturing, administration, selling, distribution and research. )anufacturing Costs refer to all expenditure incurred in the course of production from purchasing of materials to pac!ing of the finished goods.

Prepared By: Mahendra Patel, Faculty. Parul Institute of Business Administration

1$

BBA SEM II
+anufacturin* Costs +aterial 2a our .actory Rent )epreciation 3ower 4 2i*htin* $nsurance Store Keeping

Study Material: Cost Accountin

&dministration Costs are incurred for general administration of the organisation and for the operational control. Administration Costs Accounts office expenses Legal charges Audit charges Office Rent Remuneration to Director Postage Expenses "elling Costs are incurred to create and stimulate the demand and to secure the demand Selling Costs Salaries Commission to Salesmen Advertising and promotion Expenses Samples Travelling Expenses

-istribution Costs are incurred on dispatch of the finished goods to customer including transportation. Distri ution Costs Pac!aging costs "arehousing Costs Carriage out#ards $nsurance %p!eep of &ans

Prepared By: Mahendra Patel, Faculty. Parul Institute of Business Administration

1%

BBA SEM II
,.2.

Study Material: Cost Accountin

C assification based on :ariabi it! or be1avior : Costs have a definite relationship with the volume of production. They behave differently when volume of production rises or falls. An this basis, costs are classified into fixed cost, variable costs and semi variable +semi fixed, costs. %i&ed Cost: Costs, which remain unaffected by changes in volume of production, are called as 1fixed Costs2. *or example, the rent and manager$s salary will not change when you increase the units of production from 9777 to 9677. 'ixed Costs Rent lease Salar( to )anagers *uilding $nsurance Salar( and "ages Taxes to local authorit( :ariab e Cost: The cost that tends to vary in direct proportion to the volume of production is called 1variable cost2. *or example, for 9777 units of output, cost of raw materials consumed comes to =s. 97,777. If the production is increased to 9677 units +67I, the cost of material will increase to =s.96,777 +increase of 67I,. &aria le costs Direct )aterial Direct La our Po#er Commission of Salesmen Ro(alties 'emi-variab e Costs: Costs, which increase or decrease with a change in volume of production but not in the same proportion as the change in the volume of production are called 1semi variable costs2. Semi+varia le Costs Supervision Repairs )aintenance Telephone Charges Light and Po#er Depreciation

Prepared By: Mahendra Patel, Faculty. Parul Institute of Business Administration

1&

BBA SEM II
,.".

Study Material: Cost Accountin

C assification according to t1eir identifiabi it! 7it1 Cost units: Costs are classified into direct and indirect based on their identifiability with cost units and jobs or processes( Direct Cost: It refers to expenses, which can be directly identified with the product, job or process. *or example, in case of materials used and labour employed we can easily ascertain as to which product or job or process they relate. Indirect Cost: It refers to those expenses, which cannot be easily identified with a particular product, job or process. These are general, common or collective nature, which are to be allocated to various products manufactured in the factory. *ew examples are( wages paid to night watchman, salary to the production manager.

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C assification based on t1eir association 7it1 0roduct or 0eriod. Product Costs: These are those costs, which are necessary for production and which will not be incurred if there is no production. -irect material, direct wages and some of the factory overheads are examples of this !ind. Period Costs: Costs, which are not necessary for production and are written off as expenses in the period in which these are incurred are called period costs. =ent, salaries of company executives, travelling expenses are some examples of period costs.

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C assification based on t1eir contro abi it! : Contro ab e Costs: These are the costs, which may be directly regulated at a given level of authority. @ariable costs are generally controllable by department heads. Uncontro ab e Costs( Costs, which cannot be influenced by the action of a specified member of an organisation, are called uncontrollable costs. *actory rent is a good example.

Prepared By: Mahendra Patel, Faculty. Parul Institute of Business Administration

1'

BBA SEM II

Study Material: Cost Accountin

4. >imitations of Cost Accounting:

Cost &ccounting suffers from certain inherent limitations. i, There is not standard set of rules and regulations of cost accounting applicable to all industries and even the firms in the same industry. ii, The cost accounting principles themselves !eep on changing. iii, There are widely recognised cost concepts but understood and applied differently by different concerns.

iv, Cost accounting is not an exact science and its postulates cannot be verified by
controlled experiment, but only by application in actual practice.

15.

)et1ods of Costing:
The methods of costing refer to the techniques and processes employed in the ascertainment of costs. )any methods have been designed to suit the needs of different industries. These methods can be summarised as follows( It should be noted that two basic methods of costing are +9, Job costing, and +6, 4rocess Costing. The other methods discussed below are simply variants of these two methods.

15.1. ?ob Costing: Fnder this method, costs are ascertained for each job separately. &ccording to I.C.).& 3ondon 1The method of 0o order costin* applies where wor" is underta"en to e a 0o or wor"It is suitable for industries li!e car repairs, printing, foundries, painting and interior designing, where each job has its own specification. 15.2. Contract Costing: This method is used in case of big jobs described as #contracts$. "ince this is a variation of job costing, the principles of job costing are in general applied. The contract wor! usually involves heavy expenditure, spreaded over a long period. Each contract is treated as a separate unit for the purpose of cost ascertainment. "hipbuilding, construction of premises, roads and bridges are few examples suitable for contract costing.

Prepared By: Mahendra Patel, Faculty. Parul Institute of Business Administration

1(

BBA SEM II

Study Material: Cost Accountin

15.". Batc1 Costing: This is also another version of job costing. The cost of batch or group of uniform products is ascertained under this method. Each batch of products is a unit of cost for which costs are accumulated. It is generally used in industries li!e pharmaceuticals, readymade garments, shoes, toys, bicycle parts, ba!ery, etc. 15.#. Process costing: & product passes through various stages of production called #processes in some industries. Each process is different and well defined. The output of one process is used as a raw material for the next process. Costs are accumulated for each process. To arrive at the unit cost, the total cost of the process is divided by the number of units. Textile mills, chemical wor!s, sugar mills and food products may be cited as examples of industries which use this method. 15.$. O0erating Costing: This method is used in underta!ings, which provide services instead of manufacturing products. The unit cost is a service unit e.g., in case of buses, the unit of cost is passenger !ilometer, and in case of nursing home, it is per bed per day. It is also called #service costing$. 15.(. )u ti0 e costing: This method is an application of more than one method of cost ascertainment in respect of the same product. Ehere a produce comprises many assembled parts as in case of motor car, typewriter etc., costs have to be ascertained for each component as well as for the finished product. This may involve use of different methods of costing for different component. It is, therefore, called #multiple$ or #composite$ costing. 15.+. 'ing e@ out0ut or unit costing: This method of cost ascertainment is used when production is uniform and consists of a single or two or three varieties of the same product. Ehere the product is produced in different grades, costs are ascertained gradewise. "ince the units of output are identical, the cost per unit is found by dividing the total cost by the number of units produced. This method is used in mines, bric! !ilns, steel production, floor mills, etc.

11.

;!0es of Costing
)ethod of costing refers to the process and practice of ascertaining costs of product and services. The type of costing refers to the technique of analysing and presenting costs for the purpose of control and managerial decisions. The types of costing also !nown as techniques of costing generally used are as follows(

Prepared By: Mahendra Patel, Faculty. Parul Institute of Business Administration

!)

BBA SEM II

Study Material: Cost Accountin

11.1. )argina costing: "eparation of costs into fixed and variable +marginal, is of special interest and importance. Fnder marginal costing, cost of a product is estimated with out considering fixed cost. This method allocates only variable costs +direct material, direct labour, direct expenses, and variable overheads, to production. It is also !nown as #variable costing$. 11.2. Absor0tion costing: It refers to the conventional technique of costing under which the total costs +fixed and variable, are charged to products. It is considered to have only a limited application today. 11.". 2istorica Costing: It refers to a system of cost accounting under which costs are ascertained only after they have been incurred. The accounting is done in terms of actual costs and not in terms of predetermined costs. It is widely applied by many organi0ations today. 11.#. 'tandard Costing: This technique connotes the setting up of definite standards of performance in advance. These standards are expressed in monetary terms. &ctual performance is measured against these standards. The differences are helping the management to initiate corrective actions. This is believed to be a valuable tool in cost control. 11.$. Budgetar! Contro : & budget is an estimated results expressed in numerical numbers. 'udgetary control is a technique applied to the control of total expenditure on materials, wages and overhead by comparing actual performance with planned performance. This technique is also believed to be another valuable aid in cost control and coordination.

12.

Insta ation of A Cost '!stem

There cannot be a ready made costing system for every organisation. In view of growing si0e and variety of organisations, a single system of costing cannot suit every business. The installation of a costing system requires a thorough study and understanding of all the aspects involved. Atherwise the system may be a misfit and the organisation may not be able to derive full advantage from it. In other words, it is only a properly designed system of costing suitable to the underta!ing, which can help its successful operations.

Prepared By: Mahendra Patel, Faculty. Parul Institute of Business Administration

!1

BBA SEM II

Study Material: Cost Accountin

The cost benefit analysis should be initiated to install a costing system. The benefit of establishing cost system must exceed the amount spent on it. The system should be justified because of its value to management. 12.1. Prob em Areas: The organisation must be aware of the difficulties in introducing the system of costing. The following are some difficulties i, ii, iii, iv, v, Inadequate support from top management, =esistance to change from staff involved in the operation of the financial accounting, =esentment at other levels in view of the additional wor! expected due to the costing system, "hortage of trained and qualified staff to handle the new system, Ceavy costs involved in the process of installation.

12.2. %actors to be considered: The following factors should be considered before installation of a system of costing( i, ii, iii, iv, v, vi, vii, Abjective of the costing system Bature of business Kuality of the management "i0e and type of organisation, scope of authority, sources of information and reports to be submitted Technical aspect of the business &ttitude and behaviour of the staff in extending co operation to the system and the organisation Impact of different operations on variable expenses

12.". 'te0s Invo ved in Insta ing a Costing '!stem( i, )anagement conducts a preliminary investigation. *or example, the nature of product and methods of production will help them to identify the right cost system. ii, The organisation structure should be studied to ascertain the scope of authority of each executive.

Prepared By: Mahendra Patel, Faculty. Parul Institute of Business Administration

!!

BBA SEM II
iii, iv, v, vi, vii, viii, ix, changed as per the requirements.

Study Material: Cost Accountin

The system of material procurement, issue and storage should be examined and )ethod of remuneration to the labour should be altered to the new system of remuneration. &ccounting system should be designed in such a way to involve minimum clerical labour and expenditure. The layout of the factory should be studied. Costing system should be simple and easy to operate. The installation and operation of the system should be economical. The system should be initiated gradually.

6evie7 Auestions
,- "h( should there e costing in the field of usiness. 6. -efine cost accounting. L. Ehat are the difference between financial accounting and cost accountingM >. 'ring out the difference between financial and management accounting :. Compare cost accounting with management accounting. ;. 3ist the advantages of cost accounting. N. -efine the term cost. O. Ehat are ascertainment costsM Cow does it differ from cost estimationM 8. Ehat is cost centreM Cow is it identifiedM 3ist its uses. 97. -escribe about cost unit 99. Explain the components of total costM 96. Cow will you classify costsM Explain 9L. Ehat is cost sheetM Explain the components of cost "heet with an example. 9>. -efine cost control. Ehat are the steps to be followed in cost controlM Ehat are the advantages of cost controlM 9:. Ehat are the limitations of cost accountingM 9;. Explain different methods of costing. 9N. -escribe the types of costing. 9O. Ehat are the preliminaries that are to be satisfied before installation of a cost systemM

Prepared By: Mahendra Patel, Faculty. Parul Institute of Business Administration

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