Limitations of financial
Due to the following limitations of financial accounting
,the cost accounting got its origin:
only provides past data.
does not show profit or loss of each product, job,
Fails to exercise control over resources
Does not measure organizational efficiency.
Fail to provide adequate data for price fixation.
Does not provide data for comparison of cost
Fails to take into account the impact of price level
Simply it is the price paid for something
In cost accounting:
It is the amount of resources consumed to
produce a product or service.
The institute of management accountants , U.S.A,
defines cost as “a measurement in monetory terms
of the amount of resources used for some
Objectives of Cost Accounting
Ascertainment of cost
Control of cost
Guide to business policy such as make or
buy, introduction of new product etc
Determination of selling price
Cost centre: is a location, person, or item of
equipment (or group of these) for which costs
may be ascertained and used for the purpose
It refers to a section of the business to
which costs can be charged.
Personal and Impersonal cost centre
Production and Service cost centre
Cost units are the things, that the business is
set up to provide, of which cost is ascertained.
Unit of product, service or time in relation to
which cost may be ascertained or expressed
Units of production :such as a ream of paper, a
tonne of steel, a meter of cable etc.
Units of services: such as passenger miles,
consulting hours, room per day, bed per day
Methods of costing
It refers to the techniques and processes employed in
the ascertainment of costs
Choice of the method depends upon the type and
nature of manufacturing activity
The methods of costing are:
JOB ORDER COSTING – Applies where work is
undertaken to customers special requirements.
CONTRACT COSTING or terminal costing:
It is same as Job order costing; however, job
is small and contract is big contract.
Contract is of long duration and may
continue for more than a financial year.
Cost of a batch or group of identical products
is ascertained; each batch of products is a
cost unit for which costs are ascertained.
PROCESS COSTING :
Applies to a context where there is a continuous
process. Costs are accumulated for each process.
And then total cost of a process is divided by the
number of units produced to arrive at cost per
Involves cost ascertainment for each operation.
OPERATING OR SERVICES COSTING:
It is applied to services; cost units are passenger –
kilometer, room per day, bed per day.
MULTIPLE OR COMPOSITE COSTING
Application of more than one method of costing in
respect of the same product.
Used in industries where a number of components
are separately manufactured and then assembled
into a final product.
SINGLE, OUTPUT OR UNIT COSTING:
Applied to a context where output produced are
identical, the cost per unit is found by dividing the
total cost by the number of units produced.
E.g. Steel output is identical but differentiated by
Techniques of costing – Types…..
Standard cost is predetermined as target of performance
and actual performance is measured against the
By comparing actual with planned / budgeted
Only variable cost is allocated to individual cost centers
or cost units
TOTAL ABSORPTION COSTING :
Both fixed and variable costs are charged to
It is not a technique but a situation wherein several
undertakings use the same costing principle and
Process of charging all direct costs to products,
services, job etc..
Technique of comparing cost of two alternatives for
the purpose of deciding which alternative is best.
Classification of cost
Classification can be done in the following ways:
to the functions
According to the variability
According to the identifiability
According to time and period
According to managerial decisions
According to functions
These are the costs associated with
the production of goods.
These are the costs associated with
the firm’s general management
Costs of creating and stimulating
demand and securing orders
Costs incurred in moving the
goods from the factory to the
Costs incurred for raising and
According to variability
Those costs which do not change with
changes in the level of activity.
When production increases or decreases, fc
will remain fixed.
Eg,rent&rates, salaries, insurance, tax,etc
Those costs which change in direct proportion
to changes in the level of activity.
When volume of output increases, total
variable cost also increases proportionately.
But the per unit remains fixed
Eg;direct material, direct labour,etc
These costs are Partly fixed and partly
eg:telephone charges, power charges,
According to identifiability
All costs which can be
conveniently identified with a
particular cost centre or cost
These are directly chargeable to
a product, activity or department.
Eg:Direct material, direct
The costs which cannot
conveniently be identified with a
particular cost unit or cost
The total of indirect costs is
Eg:factory rent, depreciation,
factory mgr’s salary, etc
According to time & period
These are the costs which are
incurred after the event takes
They are nothing but actual
These are the costs which are
directly associated with the
These are the costs of making
Eg: manufacturing costs
These are the costs charged
as an expense in the profit and
loss account of the period in
which they are occurred.
They are incurred on the
basis of time.
eg:deprciation, rent, salaries,
It is the cost which is
computed in advance of
According to managerial decisions
•Past costs, which have been
incurred as a result of a
decision made in the past.
•Such cost cannot be
reversed by future decision.
•Eg: investment in fixed
assets, as the amount
invested in fixed assets is
It is the value of a benefit
sacrificed in favour of an
alternative course of action.
It is the cost of the best
The difference between total
costs between two alternatives
is called differential cost.
It is the increase or decrease
in total cost that result from
an alternative course of
Increase in cost incremental
Decrease in cost decremental
These costs are not
These are expenses which
an entrepreneur pays himself
Costs considered at time of
Eg: rent of owned building,
salary of owner, etc
Those costs that involve
cash outflow immediately
or in the future.
Eg: material costs, labour
costs, repairs, rents, etc,
These are the costs which
will be incurred even if the
plant is closed down
temporarily due to raw
material shortage, labour
Eg: rent, depreciation,
maintenance of plant ,etc
It is the additional cost
of producing an
It is the cost of converting raw
materials into finished goods.
It is the total of direct labour, direct
expenses, and factory overheads.
Costs which have direct influence on
the decision making are called
These are future costs that will
change due to managerial decision.
Elements of costs
In order to interpret the term cost correctly and to
ascertain the cost with respect to the cost centers,
the cost attached with the manufacturing process
may be subdivided, known as Elements of Costs.
Elements of Cost
The cost of commodities and materials used by the
Direct Material Cost –
all raw materials, either purchased from outside or
manufactured in house.
Indirect Material Cost –
material which cannot be identified with the individual
cost centre, assist the manufacturing process and does not
become an integral part of finished goods.
Consumable stores, Cotton waste, oils and lubricants,
stationary material etc.
The cost of remuneration paid to the employees of the
Direct Labour Cost –
identified with the individual cost centre and is incurred for
those employees who are engaged in the manufacturing
Indirect Labour Cost –
cost which cannot be identified with the individual cost
centre and is incurred for those employees who are not
engaged in the manufacturing process but only assist.
wages paid to foreman/storekeeper, salary of works manager,
Accountant/Personnel dept. salaries etc.
This is the cost of services provided to the organization
and the notional cost of assets owned.
Direct Expenses Cost –
Expenses identified by individual cost centers.
Hire charges of machinery/equipment for particular job,
cost of defective work etc.
Indirect Expenses Cost –
Expenses which cannot be identified by individual cost
Rent , Telephone expenses, Insurance, Lightening etc.
Direct Material Cost
Direct Labour Cost
Direct Expenses Cost
Indirect Material Cost
Indirect Labour Cost
Indirect Expenses Cost
Factory / Works Overheads
Consist of all overhead costs incurred from the stage of
procurement of material till the production of finished goods.
Indirect material such as Consumable stores, Cotton waste,
oils and lubricants, stationary material etc.
Indirect labour such as wages paid to foreman/storekeeper,
salary of works manager, Accountant/Personnel dept. salaries
Indirect Expenses such as Carriage inward cost, Factory
lightening/power expenses, rent/ Insurance /repairs for
factory building/machinery, depreciation on factory building
or machinery etc.
Office and Administrative Overheads
These overheads consists of all overheads costs
incurred for the overall administration of the
organisation. They include :
Indirect material such as stationary items, office
Indirect labour such as salaries paid to account and
administrative staff, Directors’ remuneration etc.
Indirect expenses such as postage/telephone,
depreciation on office building, legal/audit charges,
Bank charges . Rent/insurance / repairs in offices etc.
Selling and Distribution Overheads
These overhead consist of all overhead costs
incurred from the stage of final manufacturing of
finished goods till the stage of sale of goods in the
market and collection of dues from customers.
Indirect material such as packaging material,
Indirect labour like salaries paid to sales
personnel, commission paid to sales manager.
like carriage outward,
warehouse charges, advertisement, bad debts,
repairs and running of distribution van, discount
offered to customers etc.
A. Direct Material
B. Works Expenses,
Rent & taxes of factory
Repairs, Fuel & power etc.
C. Office Expenses
Office Rent, Rates,
Directors fees etc.
Works or Factory cost
i.e. A + B
(Also often Production Cost)
i.e. A + B + C
Or Cost of Production
D. Selling Expenses, such as
Sales staff salaries
Show room expenses
E. Plus Profit
Cost of Sales,
i.e. A + B + C + D
i.e. A + B + C + D +
Expenses excluded from Costs
Item of expenses which are apportionment of profit
should not form a part of the costs. These are Income tax
Dividend to share holders
Commission to partners, managing agents etc.
Interest on Capital
Interest paid on debentures
Capital expenses etc.