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Cost Accounting
Adolph Matz
Milton F. usry

What is Cost????
The total amount of money or other
resources foregone or sacrificed to procure
something or to achieve some objective.

Cost Objective or Cost object:

An item or activity or division for which we make
a separate measurement of costs.
Developed to guide the decision makers and to
form the basis of classification of cost (Direct or
Indirect).

Cost Vs Expense:
A cost is an unexpired expense.
Cost may be an expense or may be an asset
When benefit of resources can be realized in future.

Cost Vs Expense (cont..):

An Expense is Expired Cost deductible from revenues.

When resources have no future benefit
Example
Insurance paid in advance for six months $600, it is cost incurred but
not expired yet so it will be charged under prepaid insurance in
Balance sheet. After one month $100 is expired so it became our
Expense and remaining cost will be $500.

Total Cost:

Total Cost = Product cost + Period cost

Product or Manufacturing cost:

Cost incurred for manufacturing or as the case may be for
purchasing goods.
In Manufacturing Business product cost consists of direct material,
direct labor and factory overhead.
in Merchandising Business this cost involve purchase price plus
transportation in plus other costs associated with receiving.
Product cost is said to be attached to the units produced.
It is also called Inventoriable cost.

Period or Non-manufacturing cost:

cost which is not related to production.
It is also called non-inventoriable cost.
These costs include marketing or selling and administrative costs.

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Direct Material

Total cost of Manufacturing concern:

Direct Labor

Factory
Overhead

Marketing and
selling costs

Administrative
costs

Period cost

Product cost

Total Cost

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Purchase
price

Total cost of Trading concern:

Transportation
in

Receiving cost

Marketing and
selling costs

Administrative
costs

Period cost

Product cost

Total Cost

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Classification of cost:
On the basis of Product
Volume of Production
Manufacturing Departments

An Accounting Period

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Cost in Relation to Product:

Direct Material means various substances that become an integral part of
finished product and that can be economically identified with it.
Examples
Cloth for shirt

paper for book

rubber for Tyre etc.

Direct Labor is the labor cost of workers working on material to convert them
into finished product and the cost can be traced with units of output without
inconvenience.
Examples include labor cost of Carpenter or Tailor.

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Cost in Relation to Product (cont..):

Factory overhead referred to as all manufacturing cost other than direct
material and direct labor are collectively termed as factory overhead.
These are also called Manufacturing overhead, indirect manufacturing
expenses and factory burden.

Indirect Materials are those materials needed for the completion of a

product but the consumption of which is so minimal or so complex that
treating them as direct material.

Examples are Factory supplies, lubricating oil, grease etc.

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Cost in Relation to Product (cont..):

Indirect Labor means labor which does not directly affect the
construction or the composition of the finished product.

Examples include wages of supervisors, shop clerks, general helpers

and employees engaged in maintenance work that is not directly
related to production.

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Cost in Relation to volume of production:

i.

Variable Costs

ii. Fixed costs

iii. Semi variable cost

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Cost in Relation to volume of production:

i. Variable Cost:
Variability is directly proportion to volume
Relatively constant per unit as volume changes within a
relevant range
Controllable by a specific department head

Examples:
Fuel, supplies, power etc.

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Cost in Relation to volume of production(cont..)

:
ii. Fixed

cost

fixed total amount within relevant output range

decreases in per unit cost as volume increases

assignable to departments on the basis of managerial decisions or

cost allocation methods
control responsibility resting with executive management rather
than operating supervisors
Examples are Rent, Depreciation. Property tax etc.

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Examples of Fixed and Variable cost:

Fixed cost
Annual store rent
Rs. 100,000

no. of items stored

100

100,000

1,000

100,000

10,000

average fixed cost per item

Rs. 1000

100
10

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Examples of Fixed and Variable cost:

Variable cost
No. of bags of floor
10

cost of wheat per bag

Rs. 100

total cost of wheat

Rs. 1,000

100

100

10,000

1,000

100

100,000

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Cost in Relation to volume of production(cont..)

:
iii. Semi

variable cost

Amount that is fixed within a relevant range of output and an amount

that varies proportionately with output changes.
Examples are supervision, inspection, heat, light and power etc.

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Cost in Relation to Accounting Period:

i. Capital

Expenditure

It is intended to benefit future periods and is recorded as an asset.

Prepaid rent for 6 months, prepaid insurance etc.

ii. Revenue

Expenditure

It benefits the current period and is recorded as an expense.

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Conversion cost and Prime cost:

i. Prime

Cost

Prime cost = Direct Material + Direct Labor

ii. Conversion

cost

Conversion cost = Direct Labor + Factory overhead

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Other types of Cost:

i.

Controllable cost

Controllability of cost means the degree of influence that a specific

manager can exert over the cost item.

As we move upwards in organizational hierarchy more and more costs

become controllable and for chief executive there is no uncontrollable
cost.
A controllable cost for a specified manager is one, over which he has the
influence as the power to authorize.

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Other types of Cost (cont..):

ii. Un-controllable cost
An un-controllable cost is one, which is out of sphere of influence of a
specified manager by virtue of limited authority given to him.
Example:
For production manager cost of direct material and direct labor used in his
department is controllable cost, but cost of depreciation of plant is
uncontrollable for him.

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Other types of Cost (cont..):

iii. Opportunity Cost:
An opportunity cost is the net return that could be obtained from the second
best alternative that has been rejected.
Alternative 1: an investment with expected return of Rs. 250,000
Alternative 2: an investment with expected return of Rs. 200,000
Alternative 3: an investment with expected return of Rs. 150,000

Investor will choos Alternative 1 with high return, so his opportunity cost will be
Rs. 200,000 which is the expected return from second best alternative.

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Other types of Cost (cont..):

iv. Opportunity Loss:
The difference of net return between the best alternative and

the alternative chosen is called Opportunity Loss.

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Other types of Cost (cont..):

iv. Standard Cost:
Standard cost means what the cost should be.
It is predetermined cost of a unit of product or an operation or a
department or a process.
It is mainly used for evaluation of actual performance.
Standard cost also forms the basis of budgets and sales price
determination decisions.

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Other types of Cost (cont..):

v. Sunk Cost:
Cost that has already been incurred and can not be
recovered.
It is also called Embedded cost, prior year cost, Stranded cost or Sunk Capital.

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