Cost accounting is concerned with
recording, classifying and summarizing
costs for determination of costs of
products or services, planning, controlling
and reducing such costs and furnishing of
information to management for decision
The Institute of Cost and Management Accountant, England
(ICMA) has defined Cost Accounting as –
“the process of accounting for the costs from the point at which
expenditure incurred, to the establishment of its ultimate relationship
with cost centers and cost units. In its widest sense, it embraces the
preparation of statistical data, the application of cost control methods
and the ascertainment of the profitability of activities carried out or
Cost Accounting = Costing + Cost Reporting + Cost Control.
Cost Accounting and Accountancy
Cost Accountancy means :
“the application of costing and cost accounting
principles, methods and techniques to the
science, art and practice of cost control”
It includes the presentation of information
derived therefrom for the purpose of
managerial decision making.
Objectives of Cost Accounting
Ascertainment of cost
Estimation of cost
Determination of selling price
Facilitating preparation of financial and
Providing basis for operating policy
Functions of managerial
Determining the cost
Providing relevant information for better
Providing information for planning,
control, decision-making and
Cost accounting has extended from
manufacturing operations to a variety of
service industries such as hotels,
bands, airline, etc
Cost accounting system should be
flexible and adaptable to meet the new
business environment and the changing
nature of the company
Cost - Concept
Cost refers to the amount of resources given up
in exchange for some of goods or services
The resources given up are always expressed in
terms of money.
CIMA defines “ the amount of expenditure
(actual or notional) incurred on or
attributable to a given thing or activity” .
It is an activity or item or operation for
which a separate measurement of costs
E.g. the cost of operating the personnel
department of a company, the cost of a
repair machine, and the cost for control
It is the amount of expenditure incurred
on a specific cost object
Total cost = quantity used * cost per
unit (unit cost)
It is a quantitative unit of product or
service in which costs are ascertained,
e.g. cost per table made, cost per metre
It is a location or function of an
organisation in respect of which costs
E.g. the rent, rates and maintenance of
buildings; the wages and salaries of
Main Elements of Cost
The substance from which the product is
made is known as material.
It may be in raw, semi- manufactured or a
manufactured state. It can be Direct as well
All material which becomes an integral part of the finished
product and which can be conveniently assigned to specific
physical unit is called as ‘direct material’.
The cost of materials – the cost of materials used entering
into and becoming the elements of a product or service
fabrics in garments,
crude oil in refinery,
bricks, iron and cement in Building.
All material which is used for purpose
ancillary to the business and which cannot be
conveniently assigned to specific physical
unit is termed as ‘indirect material’.
Such as stationery, consumable supplies,
spare parts for machine that assist to the
production of final products.
For conversion of materials into finished
goods, human effort is needed
Such human effort is called Labour.
Labour can be direct labour as well
Labour which takes an active and direct part in the
production of a particular commodity or rendering
service is called direct labour.
Direct labour costs are, therefore, specifically and
conveniently traceable to specific product or service.
The cost of remuneration for working time
E.g. assembly workers’ wages in toy assembly.
It is also known as process labour, productive labour,
operating labour etc.
Labour employed for the purpose of carrying out
tasks incidental to goods or service provided, is
Such labour does not alter the construction,
composition or conditions of the product. It cannot be
particularly traced to specific units of output.
Such as salaries of factory supervision and office
staff that do not directly involve in production of the
Indirect labour may relate to the factory, the office or
the selling and distribution divisions
Any other cost, beside material and
labour cost, is termed as expense.
Expenses may be direct or indirect.
These expenses which can be directly, conveniently
and wholly allocated to specific cost centres or cost
Such expenses are also described as ‘chargeable
Other costs which are incurred for a specific product
Hiring of some special machinery, required for a
particular construct; cost of defective work etc.
Such as rent, rates, depreciation,
maintenance expenses that do not have
instant relationships with the
Cost that can be identified specifically
with or traced to a given cost object
The direct costs consist of the following
Indirect cost (overhead)
Cost that cannot be identified
specifically with or traced to a given
They are identified with cost centres as
Factory or Works where production is
Indirect material used in factory such as oil,
lubricants and consumables.
Indirect labour such as gatekeeper salary
and works’ manager’s salary
Indirect exp. such as factory rent,
insurance and factory lighting
Office and Administration Overheads
Indirect material used in office such as
printing & stationary
Indirect labour such as salaries to office
managers, Director, CFO, CEO etc.
Indirect exp. such as insurance, ret and
lighting of office
Selling and Distribution
Indirect material used such as packing
material, printing and stationary material
Indirect labour such as salaries of
salesman and sales manager
Indirect expenses such as rent insurance
and advertising exp.
•Prime cost = direct materials + direct labour + direct expenses
•Production cost = Prime cost + factory overhead
Also known as Factory Cost
•Total cost = Prime cost + Overheads (admin, selling,distribution cos
= Production cost + period cost (administrative, selling,
distribution and finance cost)
•Period cost is treated as expenses and matched against sales for calculating
profit, e.g. office rental
Costs sheet is a document which provides
for the assembly of the estimated detailed
cost in respect of a cost centre or a cost
It analyses and classifies in a tabular form,
the expenses incurred on different items for
a particular period.
COST OF PRODUCTION
SELL & DIST OVERHEADS
COST OF SALES
From the following particulars compute the cost of production of product:
Salary of inspector engaged in the product
Propionate lighting and heating (factory and office 3:2)
Proportionate of deprecation, repairs and rent (50% is
related to factory)
Municipal tax and insurance (40% related to office)
Direct Material: Material Consumed
Direct Labour: Labour Employed
Direct Exp: Salary of inspector engaged in the product
Add: Factory overheads
lighting and heating
deprecation, repairs and rent
Municipal tax and insurance
FACTORY COST (Prime cost + Factory overheads)
Add: Office and Administrative overheads
lighting and heating
deprecation, repairs and rent
Municipal tax and insurance
Total Cost of Production (Factory cost+ office
Exercise.. Calculate total cost
Material Used in manufacturing: 5,500
Material Used in packing:
Material Used in selling the product: 150
Material Used in factory: 75
Material Used in office: 125
Labour required in producing: 1,000
Labour required for supervision of mgt. of factory: 200
Expenses- Direct- Factory: 500
Expenses- Indirect- Factory:100
Expenses- office: 125
Deprecation- office building and equipment: 75
Depreciation- factory: 175
Selling expense: 350
Freight : 500
Advertising : 125
Classification of Cost
It increases or decreases in direct
proportion to levels of activity, but the unit
variable cost remains constant
E.g. cost of food served in a restaurant,
raw material, labor (per unit paid)
Also known as product cost.
Wages of labour, power and material cost
are example of variable cost.
Total fixed cost remains constant over a
relevant range of activity level but unit
fixed cost falls with an increase in
Salary, rent, insurance are example of
It remains constant for a range of
activity levels, then, on further increase
in activity, the cost jumps to a new level
and remains constant over a certain
range until the next jump occurs
Product cost are related to the goods
purchased or produced for resale.
If the products are sold, the product cost will
be included in the cost of goods sold and
recorded as expenses in current period
If the products are unsold, the product costs
will be included in the closing stock and
recorded as assets in the balance sheet
Period cost related to the operation of a
They are treated as fixed cost and
charged as expenses when they are
They should not be included in the
Relevant and Irrelevant Cost
Relevant cots are those costs which would
be changed by the managerial decision.
For example, if a company is considering
to close unprofitable retail sales shop,
wages, salaries payable to the shop
workers are relevant in this decision as
they will disappear on closing of shop.
These costs wages, salaries, electricity are
relevant for decision making.
On the other hand, prepaid rent, insurance
or any other uncovered cost of any
equipment which will have to be scarped
are irrelevant cost which must be
Shutdown and Sunk Costs
Shutdown costs are those costs which will
gave to be incurred when plant is closed due
to temporary non availability of material,
labour or any other key ingredients.
Some fixed cots like deprecation of building,
rent, maintenance will have to incur during
that period and are called Shutdown cost.
Thus cost which have to incur even if there is
no production are called Shutdown costs
Sunk costs are historical or past costs.
These costs are costs which have been created or
incurred by a decision that was taken in past that
cannot be changed by any decision that will be
made in future.
Investment in plant, machinery, building etc are
prime example of such costs.
Since sunk cost cannot be altered by later
decision, they are irrelevant for decision making
Controllable and Uncontrollable cots
Controllable costs are those can be
influenced by the action of a specified
member of the company.
Cost which can't be so influenced are
Imputed or Hypothetical costs
Costs which don’t involve any cash
They are not included in the cost
accounts but are important for
consideration while making
Differential, Incremental cost
The cost difference between two
alternatives is termed as differential
Incremental is increase in the cost if
increase the production by x number of
Out of pocket costs
Present or future cash expenditure
regarding a certain decision which
varies depending upon on the nature of
Own truck verus taking transport
Comparison of cost,
management and financial
Provides information to users who are
external to the business
It reports on past transactions to draw
up financial statements
The format are governed by law and
accounting standards established by
the professional accounting policies
Is concerned with internal users of
accounting information, such as
The generated reports are specific to
the requirement of the management
The reporting can be in any format
which suits the user
Comprises all cost accounting functions
The accounting for product and service
costs, management accounting extends
to use various internal accounting
reports for planning, control and
Cost and management accounting
overhead costs in
product or job
are for internal
Accounting Not based on the Follows the double
double entry system entry system
Accounting No need to use
principles accounting principles
Principles for recording
Used by different
Used by external
information levels of management parties: shareholders,
They may be
prepared on a
weekly or daily basis
Conforms to company
exchange rules, SEBI ,
MCA rules etc.
Reports are prepared
for a definite period,
usually yearly and half
and historic data for
Detailed analysis of
parts of the entity,
Past orientation: use
of historic data for
Financial summary of
the whole orgainisation
decision making by
to the future
To ascertain and
Based on both present
and future transactions
for cost ascertainment
Covers a wider
Only the needs of
control of cost of
product or service
The needs of both
internal and external
Deals with both
transactions monetary any non-
Deals only with
Methods of Costing
Costing is “the technique and process
of ascertaining cost”.
There are various methods of costing:
Job costing is used when the production is not
highly repetitive and, in addition, consists of
distinct jobs or lots .
Each product produced in the job are identified by
This method is followed by these concerns when
work is carried on by the customers request.
Commercial foundry, printing press, specialized
industrial equipments are example where job
costing is applied.
Contract costing is applied for contract work like
construction of dams, buildings, roads, civil
engineering contract etc. each contract or job is
treated as separate cost unit for the cost
ascertainment and control.
A contract costing in principle differ from job
costing, A contract is a big job while a job is a
A batch is a group of identical products. Under
batch costing a batch of similar products is
treated as a separate unit for the purpose of
The total costs of a batch is divided by the total
number of units in a batch to arrive at the costs
This type of costing is generally used in
industries like bakery, toy manufacturing,
This method is used in industries where production is
carried on through different stages or processes before
becoming a finished product.
Costs are determined separately for each process. The
main feature of process costing is that output of one
process becomes the raw materials of another process
until final product is obtained.
This type of costing is generally used in industries like
textile, chemical paper, oil refining etc.
Service (Operating) Costing
This method is used in those industries which
rendered services instead of producing goods.
Under this method cost of providing a service is
It is also called service costing. The organisation
like water supply department, hotels, Railway,
transportation, electricity department etc. are the
examples of using operating costing.
This is suitable for industries where production is
continuous and units are exactly identical to each
This method is applied in industries like mines or
drilling, cement works etc.
Under this system cost sheet is prepared to find
out cost per unit and profits or loss on production.
Techniques of Costing
Following types of techniques are used by
management only for controlling costs and making
some important managerial decisions.
Absorption or Full Costing
It is a technique of costing in which allocation of
expenditure to production is restricted to those costs
which arise as a result of production i.e. costs which vary
with production (material, labour and direct expensesvariable only and variable overheads)
Fixed costs are excluded on the ground that in cases
where production varies, the inclusion of fixed costs may
give misleading results.
It is the ascertainment of marginal cost by differentiating
between fixed and variable cost. It is used to ascertain
the effect of changes in volume or type of output on
It is the practice of charging all direct costs,
variable and some fixed costs relating to
operations, processes or products leaving all other
costs to be written off against profits in which they
This technique is different from marginal because
some fixed costs can be considered as direct
costs in appropriate circumstances.
Absorption or Full Costing
It is the practice of charging all costs, both
variable and fixed to operations,
processes or products.
This differs from marginal costing where
fixed costs are exclude.
It is the use of same costing principles
and practices by several undertakings
for common control or comparison of
This facilitates inter firm comparison,
establishing of realistic pricing policies
A comparison is made of the actual cost with
a pre-arranged standard cost and the cost of
any deviation (called variances) is analyzed
This permits the management to investigate
the reasons for these variances and to take
suitable corrective action.
It is ascertainment of costs after they have
It aims at ascertaining costs actually
incurred on work done in the past.
It has a limited utility, though comparisons
of costs over different periods may yield