Cost Accounting

Cost
Cost is the measurement, in monetary terms, of the amount of the resources used for the purpose of production of goods or rendering services.

3 important factors
Identification of cost centers

Cost unit Classifying the cost.

Cost Center
Any unit of cost accounting selected with a view to accumulating all cost under that unit.

The unit can be product, a service, a department, a division, a group of plant and machinery, a group of employees.

Types of Cost Center

May be of two types personal and impersonal cost centers. Personal cost center consists of person or a group of persons . Cost centers which are not personal cost centers are Impersonal cost centers.

Types of Cost Center

May be further classified as Production cost centers and service cost centers . Production cost center are those which are engaged in production like machine shop, welding shop, assembling shop etc. Service cost centers are for rendering services to the production cost centers like power house, maintenance, stores purchase office.

Cost Unit
Cost unit is a form of measurement of volume of production or service. The unit is generally adopted on the basis of convenience and practice in the
industry concerned.
Industry Cost unit MW MT Number Industry Steam production Textile Transport Cost unit Cubic Meter KM Tonne km/ passenger km

Power Cement/steel Automobile

Classification of cost

Basis of classification
Nature of expense. Relation of cost center traceability. Functions / activities. Behaviour wise. Management decision making. Production process. Time period

Classification by Nature of expense

COST Material Labour Expenses

Classification by Nature of expense (Contd.)

Material cost includes cost of procurement.
Freight inward, taxes & duties, insurances etc directly attributable to the acquisition should be included. Similarly trade discount, rebates, duty drawback, sales tax refund should be deducted in determining the cost of material.

Classification by Nature of expense (Contd.)

Labour cost means the payment made to the employees, permanent or temporary, for their services Salaries + wages (both permanent & temporary) + payment to the employees of contractors. Include fringe benefit like gratuity, ESI, overtime, bonus, incentive, leave encashment etc.

Classification by Nature of expense (Contd.)

Expenses are other than material cost or labour cost which are involved in an activity. Expenditure on account of utilizes, payment for bought out services, job processing charges etc. can be termed as expenses.

Classification by Relation of cost center

If an expenditure an be allocated to a cost center or cost object in an economically feasible way then it is called direct or otherwise the cost component is called indirect. According to this classification material, labour and expenses are divided in to direct/ indirect material, direct/ indirect labour & direct/indirect expenses. All direct costs are called prime cost and indirect costs are known as overheads

Classification by Relation of cost center (Contd.) cost

MATERIAL LABOUR EXPENSES
PRIME COST

DIRECT

DIRECT

DIRECT

INDIRECT

INDIRECT

INDIRECT

OVERHEADS

Classification by Relation of cost center (Contd.)

Direct material cost is the cost of material which can be directly allocated to a cost center or cost object in a economically feasible way. Direct labour cost is the cost of wages of those workers who are readily identified or linked with a cost center or cost object. Direct expenses are those other than direct material or direct labour which can be identified or linked to a cost center or cost object

Classification by Relation of cost center (Contd.)

Indirect material cost is the cost of material which can not be directly allocated to a cost center or cost object. Ex 1. consumable spares and parts 2. Lubricants for machinary Indirect labour cost is the cost of wages of those workers who are not directly allocated to a particular cost center or cost object. Ex 1. Salaries to staff in the administration and accounts department. 2. Salaries to the security staff.

Classification by Relation of cost center (Contd.)

Indirect expenses are the expenses other than of the nature of material or labour which can not be directly allocated to a particular cost center. EX insurance , taxes , duties etc.

Classification by Functions / Activities

Cost should be classified according to the major function for which elements are used into the following four major functions : 1. Production; 2. Administration; 3. Research and Development; 4. Selling; and 5. Distribution

Classification by Functions / Activities (Contd.)

Production Cost is the cost of all items involved in the production of a product or service. It includes all the direct costs ( prime cost ) and all indirect costs involved in the production ( Production Overhead ). Production Cost = Prime cost ( direct material + direct labour + direct expenses ) + Production overhead

Classification by Functions / Activities (Contd.)

Production overhead is also termed as Factory overhead or Manufacturing overhead. EXSalaries for production planning, technical supervision, factory administration etc. Expenses for stores management Security expenses for the factory Labour welfare expenses Dispensary and canteen expenses Depreciation of plant and machinery , repairs and maintenance expenses Insurance and quality control

Classification by Functions / Activities (Contd.)

Administration cost are expenses incurred for general management of an organization. These are in the nature of indirect costs and are also termed as Administration overhead. EXSalaries of administrative and accounts staff. General Expenses like rent, lighting, rates and taxes, telephone, stationary etc. Bank charges Audit fees Legal expense Depreciation and repairs and maintenance of office building etc.

Classification by Functions / Activities (Contd.)

Selling cost are the indirect costs related to the selling of product or service and include all indirect cost in sales management for the organisation. EXSalaries, commission and travel expenditure of sales personal. Advertisement cost. Legal expenses for debt realisation Market research cost Royalty on sale After sale service cost

Classification by Functions / Activities (Contd.)

Distribution cost are the costs incurred in handling a product from the time it is completed in the works until it reaches the ultimate customer. EXTransport cost. Cost of warehousing saleable products. Cost of delivering the products to the customer. Market research cost

Classification by Functions / Activities (Contd.)

Notes 1. Primary packing cost is included in the production cost whereas Secondary packing cost is distribution cost 2.In case of heavy industries equipment supply, installation cost at the delivery site for heavy equipments which involves assembling of parts, testing etc is included in the production cost but not in the distribution cost. 3.Installation cost of Gas turbine at plant site is included in the cost of production of Gas turbine.

Classification by Functions / Activities (Contd.)

Research and Development Costs are the cost for undertaking research to improve quality of a present product or improve process of manufacture, develop a new product, market research etc. and commercialization thereof . Research cost includes cost of development of new product and manufacturing process; improvement of existing product or process. Development cost includes the cost incurred for commercialization / implementation of research findings.

Direct materials consumed Direct labour cost Direct expenses Prime cost Add: production overhead Factory cost Add: Adminstration overhead Add: Research and development cost Cost of Production Add: Selling & Distribution Cost Cost of Sales

Classification by Behaviour

Fixed Variable Semi variable

Classification by Behaviour (Contd.)

Fixed cost is the cost which does not vary with the changes in the production volume of activity in the short run. These costs are not affected by temporary function in activity of an enterprise. These are also known as period costs. Ex - salaries, rent, audit fees, depriciation

Classification by Behaviour (Contd.)

Variable cost is the cost of elements which tends to directly vary with the volume of activity . Ex materials consumed, direct labour, sales commission, freight, packing etc. variable cost has two parts (a) Variable direct costs; (b) Variable indirect costs. Variable indirect costs are termed as variable overheads.

Classification by Behaviour (Contd.)

Semi variable costs contain both fixed and variable elements. They are partly affected by the fluctuation in the level of activity Ex factory supervision, maintenance, power etc.

Classification by Behaviour (Contd.)

Characteristics of Fixed cost - (1) fixed amount within output of range (2) fixed cost per unit decreases with increased output. fixed cost
6,00,000 5,00,000 4,00,000 3,00,000 fixed cost 2,00,000 1,00,000 0 0 10,000 20,000 30,000 40,000 50,000 60,000

Classification by Behaviour (Contd.)

Characteristics of Variable cost - (1) varies with production (2) Variable cost remains constant per unit within range of activity. variable cost
6,00,000 5,00,000 4,00,000 3,00,000 variable cost 2,00,000 1,00,000 0 0 10,000 20,000 30,000 40,000 50,000 60,000

Classification by Behaviour (Contd.)

Total cost
12,00,000 10,00,000 8,00,000 6,00,000 4,00,000 2,00,000 0 0 10000 20000 30000 40000 50000 60000 fixed cost variable cost Total cost

Classification for management decision making

Marginal cost Opportunity cost Relevant cost Sunk cost Abnormal cost Differential cost Replacement cost Imputed cost Normal cost Avoidable cost

Unavoidable cost

Classification for management decision making (contd.)

Marginal cost per unit is the change in the amount at any given volume of output by which aggregate cost changes if the volume of output is increased or decreased by one unit. MARGINAL COST = PRIME COST + VARIABLE OVERHEADS

Differential cost is the change in the cost due to change in the activity from one level to another.

Classification for management decision making (contd.)

Opportunity cost is the value of the alternative foregone by adopting a particular strategy or employing resources in specific manner. Ex a machine is currently used to produce the product p. It can also be used to produce the product Q which can fetch Rs 60,000 profit . So the opportunity cost of using the machine is Rs 60,000. Replacement cost is the cost of an asset in the current market for the purpose of replacement

Classification for management decision making (contd.)

Relevant cost are costs relevant for a specific purpose or situation. Ex depreciated value of a machine is relevant in case of decision of its sale, but is irrelevant in case of its decision of its replacement. Impute cost are hypothetical or notional costs, not involving cash outlay , computed only for the purpose of decision making Ex Salary or wages of owner or interest on generated fund

Classification for management decision making (contd.)

Sunk cost are historical cost which are incurred i.e. sunk in the past and are not relevant to the particular decision making problem being considered. Ex book value of assets

Classification for management decision making (contd.)

Normal cost is a cost that is normally at a given level of output in the conditions in which that level of output is achieved.

Abnormal cost is an unusual or a typical cost whose occurrence is usually irregular and unexpected and due to some abnormal situation of the production. Ex- idle time for some heavy breakdown or abnormal process loss.

Classification for management decision making (contd.)

Avoidable cost are those costs which under conditions of performance efficiency should not have incurred. Ex when spoilage occurs in the manufacture in excess of normal limit, the resulting cost of spoilage is avoidable cost. Unavoidable cost are inescapable costs which are essentially to be occurred, within the limits or norms provided for. It is fixed in nature and inescapable.

Classification by nature of production process

Job costing

Batch costing

Contract costing

Unit costing

Process costing

Operating costing

Classification by nature of production process(contd.)

Job costing when work performed against individual order from customers . Ex - printing press, Car repair shop Batch costing factories which has to produce large no of parts in order to make the product undertake production of each part in batches. Bicycle factory may produce 100000 handles at one time and then take up the manufacture of other parts

Classification by nature of production process(contd.)

contract costing The term applies to the system of costing which relates to the business concentrating on big contracts only. Very similar to the job costing. A job is a small contract while contract is a big job. Unit costing This method applies when there is production of one product only, as in case of brewery or colliery.

Classification by nature of production process(contd.)

Process costing When a product passes through different stages or processes, each having a bearing on the total cost of production or each yielding valuable by product. Ex in case of oil three distinct processes - crushing, refining, finishing. Operating costing followed by business which renders services . Ex transport industries, hospitals.

Classification by time

Historical cost

Standard cost cost Predetermined cost Estimated cost

Classification by time(contd.)
Historical cost The actual cost of producing goods or services. These are postmortem costs and ascertained after incurred. Pre-determined costs the predetermined costs are computed in advance of production, on the basis of specification of all factors affecting cost. Predetermined cost can be either standard or estimated.