COST

ACCOUNTING

Introduction

• In today’s business world, the resources available are very scarce.

• Hence, every business unit must strive hard to obtain maximum output with the available input in order to ensure the optimum utilization of scarce resources.

• The value of input is measured against the value of output.• In the present era of cut-throat competition, the need to study

this subject is growing very fast.• Every businessman makes a constant effort to improve his/her

business.

Cost Accounting

• Cost accounting is the process of accounting for cost.

• Cost accounting is generally concerned with internal reporting for management requirement.

• The development of cost accounting is of recent origin.

Definition

• The Chartered Institute of Management Accountants, U.K. (CIMA) defines costing as ‘the technique and process of ascertaining costs.’

• Costing is a tool to determine the cost of products or service.

• Cost accounting – analysis and classification of costs or expenditure.

• Cost accountancy – application of costing and cost accounting principles.

Functions of Cost Accounting

• ‘Cost Accounting is to serve management in the execution of policies and in the comparison of actual and estimated results in order that the value of each policy may be appraised and changed to meet the future conditions.’– To calculate cost per unit– To prepare a correct cost analysis– To ascertain the wastage in each process of manufacture– To provide necessary information for the determination of

selling price

Functions of Cost Accounting

– To compute product-wise profit

– To serve the management in the valuation of W-I-P

– To install and implement cost control systems

– To advice management for future expansion

– To establish an effective reporting system

– To guide the management in the preparation and implementation of incentive schemes based on productivity and cost savings.

Objects of Cost Accounting• To determine the actual cost of each article, process, operation, service, department or

segment of activity.• To reveal and report inefficiencies in the form of material wastage, loss of time in material

buying, storing, and issuing.• To provide actual figures of cost comparison with estimates of costs and price fixing.• To find out the degree of efficiency and productive capacity of men and machines and

ideal standard for their working.• To implement incentive wage plans for workers.• To reduce cost through budgetary control and standard costing.• To study trends at different volumes of output, and to determine production policies and

programs.• To ensure continuous check and adjustment of stores and materials with the help of

perpetual inventory.• To organize internal audit system, and interlocking of financial and cost accounts to verify

the accuracy of each other.• To furnish necessary data for the preparation of profit and loss account and balance sheet

at short intervals [e.g., monthly, quarterly, etc.] for each department or business as a whole.

Advantages of Cost Accounting

• Price Fixation• Control on Unprofitable Activities• Useful Information• Cost Control• Provides Valuable Data• Effective Check• Preparation of Budgets and Regulations of production• Fixation of Responsibilities• Independent Check• Prevention of Manipulation, misappropriation, and frauds

Objections against Cost Accounting

• Expensive

• Differences in Results

• Unnecessary

• Worthless

• Inapplicability

Principles of Costing

• Every concern must design its own costing system, keeping in view its peculiar problems.

• If financial books can afford the necessary information, separate costing system is not needed.

• Reasonable accuracy is enough, of course, this depends upon the nature of industry.

• As a rule, costing information should be collected as and when the work proceeds.

Importance of Costing

• To the Employees– Incentive Bonus– Higher earnings through time and motion

study– Overtime payments– Benefit of job evaluation– Continuous employment and job security

Contd..

• To the Management– Planning– Organizing– Controlling– Budgeting– Decision-making– Pricing– Evaluation of operating efficiency

Contd..

• To the creditors– Can access more information in comparison to

Financial accounts– To ascertain the solvency, profitability

• To the government– More taxes through higher production– Useful in preparing import and export policy

• To the society– Lower prices through cost reduction– Better quality of products and services

Concept of Cost Accounts

• The basic approach to cost accounting is distinct from financial accounting.

• It is oriented to relating the expenditures to products in addition to analyzing the expenditures on the basis of natural classification of material, labour, etc.

• The cost of a product is taken as the final outcome of manufacturing activities

Cost of Product

• The fundamental element of cost accounting system is cost which is defined as the amount of expenditure (actual or notional) incurred on or attributable to a produced item or a service unit

• The term ‘cost’ connotes different meanings to different people, but in cost accounting, it is used in a special sense. Cost represents an expenditure made to secure an economic benefit, generally on the uses of resources that promise to produce revenue.

• The resources may have tangible substance (e.g. manpower, material, machine, etc.), or they may take the form of services (e.g. wages, rent, power, etc.).

Cost, Expense, and Loss

• The term ‘cost’ is denoted by expense which is incurred after deriving the benefit.

• Expenses are defined as ‘all explicit costs which are deductible from revenue.’

• When the cost is incurred before deriving the benefit, it is termed as deferred cost,

• When no benefit is derived by the incurrence of cost, it is termed as loss,

Cost Object

• Cost object is an entity or a part of an entity• The cost object changes according to decision

needs of the management.• Costing objective represents the overall

objective for which cost collection, cost analysis, and cost control is being attempted.

• Cost objective is different from expenditure objective.

Cost Unit and Cost centre

• Cost unit is defined as a quantitative unit of a product, a service, or an item, in relation to which costs are measured.

• A cost unit, simply stated, is a unit of finished product, service or time, or a combination of these in relation to which cost is ascertained and expressed.

• A cost centre is a location, a person, or an item of equipment (or a group of these) for which costs may be ascertained and used for the purpose of cost control.

Types of Cost Centres

• Personal and impersonal cost centre• Operation and process cost centre• Production, service and staff cost centre• Whatever may be the type of cost centre, it is

determined by taking into consideration the following factors:– the value of the work to be performed,– the extent of cost control that can be exercised,– responsibilities to be identified, and– the uses of cost centre wise data by the costing

department, etc.

Classification of Costs

• Nature or element– Material cost– Labour cost– Expenses

• Function– Production cost or Manufacturing cost– Administration cost– Selling cost– Distribution cost– Finance cost– Research cost– Development cost– Pre-production cost

Classification of Costs

• Conversion– Conversion cost

• Variability or Behaviour– Fixed or Constant costs– Variable costs– Stepped Fixed cost– Semi-Variable costs

• Controllability– Controllable– Uncomtrollable

Classification of Costs

• Normality– Normal– Abnormal

• Capital and Revenue• Time or Periodicity

– Historical– Future

• Expiry• Relationship

Classification of Costs• Product or Period

– Products– Period

• Planning and Control– Marginal– Out-of-pocket– Differential– Imputed or Notional– Discretionary– Sunk– Opportunity– Replacement– Avoidable and unavoidable

Costing Principles

• Relation of the causes

• Abnormal costs to be excluded

• Past costs not to be charged

• Future costs not to be charged

• Expenses and incomes excluded from cost accounts

Components of Total Costs

• Prime costs

• Factory or Work costs

• Office or Cost of Production

• Total or Cost of Sales

Statement of Cost or Cost Sheet

• A cost sheet is a statement which shows the details regarding the total cost of a cost object, i.e. for the company as a whole, for a product or a job.

• A cost sheet not only shows the total cost but also the various components of total cost.

• It serves the following purposes:– It discloses the various elements of cost which make up the total

cost.– It discloses the cost per unit as well as the total cost of output.– It facilitates for preparation of tender price, and/or selling price in

advance.– It facilitates the comparison of current year’s total cost with the

estimated cost and with the previous year’s cost, and thereby helps the management in locating inefficiency in activities of an organization.