Introduction to Cost Accounting

27/10/2023
1
COST
ACCOUNTING
UNIT-1
INTRODUCTION TO COST
ACCOUNTING

27/10/2023
2
Classification of Accounting
Introduction to Cost Accounting

27/10/2023
3
Reason for Introducing Cost Accounting

27/10/2023
4
Meaning of Cost Accounting
Cost Accounting is classifying, recording an
appropriate allocation of expenditure for the
determination of the costs of products or services,
and for the presentation of suitably arranged data for
the purpose of control and guidance of management.
Definition of Cost Accounting
1. According to I.C.M.A. London –
“Cost Accounting is the technique and process of ascertainment of cost.”
2. Walter W. Bigg -
“Cost Accounting is the provision of such analysis and classification of
expenditure as will enable the total cost of any particular unit.

27/10/2023
5
Features of Cost Accounting
 Specialized Branch of Accounting
 Art and Science Both
 Recognized as a Profession
 Determination of various Components of Total Cost
 Provides data to management for decision making and budgeting for the future
 Provides costing data that helps in fixing prices of goods and services
Objectives of Cost Accounting
1.Cost ascertainment.
2.Cost Control.
3.Cost Reduction.
4.Ascertainment of Profitability.
5.Determination of Selling Price.
6.Providing a Basis for Business Policy and Decision Making.
7.Compliance to Statutory Requirements.

27/10/2023
6
Uses/Advantages of Cost Accounting
I. Management and its Functions:-
(i) Planning.
(ii)Organisation.
(iii)Motivation.
(iv)Control.
II. Other Advantages:-
(i) Control and wastage of material and labour.
(ii)Economy in cost.
(iii)Proper Utilisation of Plant.
(iv)Budgetary control.
(v)Cost Comparison.
Continuation……
III. Advantages to employees.
IV. Advantages to Consumers.
V. Advantages to the Government.
VI. Advantages to Investors.

27/10/2023
7
Difference between Financial
Accounting and Cost Accounting

27/10/2023
9
Elements of Cost Accounting
Material Cost

27/10/2023
10
Material Cost:
• Material cost is the cost of material of any nature used for the
purpose of production of a product or a service.
• It includes cost of materials, freight inwards, taxes & duties,
insurance ...etc directly attributable to acquisition, but
excluding the trade discounts, duty drawbacks and refunds
on account of GST etc.
Direct materials are those materials which can be identified in the product and can be
conveniently measured and directly charged to the product. Thus, these materials directly
enter the product and form a part of the finished product. For example, timber in furniture
making, cloth in dress making, bricks in building a house. The following are normally
classified as direct materials :-
(i) All raw materials, like jute in the manufacture of gunny bags, pig iron in foundry and
fruits in canning industry
(ii) Materials specifically purchased for a specific job, process or order, like glue for book
binding, starch powder for dressing yarn
(iii) Parts or components purchased or produced, like batteries for transistor-radios
(iv) Primary packing materials like cartons, wrappings, card-board boxes, etc.

27/10/2023
11
Indirect Material Cost
Indirect materials are goods that, while part of the overall manufacturing process, are not
integrated into the final product. For example, disposable gloves, personal protective
equipment, tape, etc., may be essential to a production line, but they are not part of the
actual product created on that line.
These are:
(i) Stores used in maintenance of machinery, buildings, etc., like lubricants, cotton waste,
bricks and cements
(ii) Stores used by the service departments, i.e., non-productive departments like Power
House, Boiler House and Canteen, etc., and
(iii) Materials which due to their cost being small, are not considered worthwhile to be
treated as direct materials.

27/10/2023
13
Labour Cost:
Labour cost means the payment made to the employees, permanent
or temporary for their services. Labour cost includes salaries and
wages paid to permanent employees, temporary employees and
also to the employees of the contractor. Here salaries and wages
include all the benefits like provident fund, gratuity, ESI, overtime,
incentives...etc
Direct Labour / Employee Cost
Direct labor in manufacturing businesses includes employees who work directly in
production, while direct labor in service-based businesses includes employees who
provide services.
Example of such labour are:
(i) Labour engaged on the actual production of the product or in carrying out of an
operation or process
(ii) Labour engaged in adding the manufacture by way of supervision, maintenance, tool
setting, transportation of material etc.
(iii) Inspectors, analysts etc., specially required for such production

27/10/2023
14
Indirect Labour/ Employee Cost
The workers who are not directly involved in producing goods or supplying
services, or the cost of paying those workers: Indirect labour includes all
labour not directly engaged in converting raw material into finished product.
Example of such labour are:
charge-hands and supervisors; maintenance workers; men employed in
service departments, material handling and internal transport; apprentices,
trainees and instructors; clerical staff and labour employed in time office and
security office.

27/10/2023
15
Expense/Overhead Cost

27/10/2023
16
Expenses / Overhead Cost:
• Expenses are other than material cost or labour cost
which are involved in an activity.
• Expense is the operational cost that is paid to earn
business revenues. It means the outflow of cash in return
for goods or services. Expenses can also be written as
the sum of all the operations that usually bring profit.

27/10/2023
17
Direct expense is an expense incurred that varies directly with changes in
the volume of a cost object. A cost object is any item for which you are
measuring expenses, such as products, product lines, services, sales
regions, employees, and customers.
Here are several examples of direct expenses:
•The materials used to construct a product for sale
•The cost of the freight needed to transport goods to and from a
manufacturing facility
•The labor incurred to produce hours billable to a client
•Labor and payroll taxes paid based on the number of units produced
•Production materials consumed during the manufacture of goods
•The commission and payroll taxes related to the sale of goods or services
Indirect expenses are those that a company or organization
incurs from daily business operations. You can't assign
them to the cost or selling price of any products, programs
or services.
Indirect costs usually include those associated with
insurance, rent, salaries and other expenses, such as bank
charges, interest on loans and audio fees. You can't link a
direct cost to a specific cost object, which is the main
differentiator between direct and indirect costs.

27/10/2023
18
Classification of Costs
COSTS ARE CLASSIFIED ON THE FOLLOWING BASIS:
1. Elements of cost
2. Functions
3. Relationship
4. Behaviour
5. Time period
6.Controllability
7. Normality
8. Attributability
9. Cash outflow
10. Relevance to decision making

27/10/2023
19
A. ON THE BASIS OF ELEMENTS OF COST
Elements of cost refer to 'on what the cost is incurred. Based on the elements
of cost, cost is into the following:
(a) Material Cost:-
It refers to the cost of inputs used in production. It includes cost of raw cost
of consumable stores, etc.
(b) Labour Cost:-
It refers to the cost incurred in relation to people or human resources of the
organization. It includes wages paid for converting raw material into
finished goods, salary. incentives, benefits, perquisites, training and
development expenses, etc.
(c) Other Expenses:-
All other expenses, other than material and labour, incurred for operating the
business are included in these expenses. They include rent of factory,
maintenance expenses, sales promotion expenses, freight charges, etc.
B. ON THE BASIS OF FUNCTIONS
On the basis of the purpose for which it is incurred, cost is classified into the following:
(a) Production Cost- It refers to the cost of producing the product till the primary
packing. It includes material cost, cost of converting material into finished goods
(i.e., labour cost and other expenses for production and related to factory).
(b) Administration Cost -It refers to the cost incurred to administer and manage the
business. It includes all expenses which are not directly relating to production, selling,
distribution, research development activities. Examples of Administration cost are office
rent, office stationery, legal expenses, accounting expenses, audit t expenses, directors'
remuneration, etc.
(c) Selling Cost- It refers to the expenses incurred to promote sales, increase demand and
generate revenues. These are also called marketing costs. Selling cost includes
advertisement expenses, salesman salary and commission, cost of samples, cost of
promotional offers, etc.

27/10/2023
20
(d) Distribution Cost- It refers to the expenses incurred for making available
the final product to the customer. It includes expenses incurred to deliver the
finished product to customer's location, expenses incurred to deliver the
goods to point-of-sale, expenses incurred on delivery vehicles, salary of
delivery personnel, etc.
(e) Research Cost- It refers to the cost of researching for new or improved
products, new application materials or improved methods.
(f) Development Cost -It refers to the cost of the process which begins with
the implementation of the decision to produce a new or improved product, or
to employ a new or improved method and ends with commencement of
formal production of that product or by that method. For Example: Software
Development, Product Development, Infrastructure Development etc.,
(g) Conversion Cost -It refers to the cost of converting raw material into
finished goods. It includes Direct Wages (i.e., wages paid for labour involved
in production process), direct expenses (i.e. other expenses directly
attributable to the final product) and factory expenses (i.e., expenses incurred
at the point of production in relation to the product).
(h) Pre-production Cost- It refers to the cost incurred in making a trial
production run prior to formal production.

27/10/2023
21
C. ON THE BASIS OF RELATIONSHIP
On the basis of the relationship of cost with the final product, cost is
classified into the following:
(a) Direct Cost -It refers to the cost which is directly related to identified
with/attributable to a cost center or a cost unit. It includes raw material
used in the finished product, wages paid to worker engaged in
conversion of raw material to finished product and any other expenses
which can be directly attributed to the product.
(b) Indirect Cost -These are not directly identified with a cost center or a
cost unit. They are costs which are apportioned over different cost centers
using appropriate basis. Indirect costs are popularly called 'overheads".
Factory expenses, administration expenses, selling expenses, distribution
expenses are some examples of indirect costs.
D. ON THE BASIS OF BEHAVIOUR
On the basis of "how cost behaves for change in production, it is classified
into the following
(a) Fixed Cost- It refers to the cost which remains the same in total but varies
inversely per unit with production. Ex: Rent, Taxes, Licenses and
Permits.
(b) Variable Cost -It refers to the cost which remains the same per unit but
the total varies proportionately with production or sales. Ex: Utilities,
Maintenance.
(c) Semi-variable Cost- This cost refers to the cost, a portion of which is
fixed in nature and the units, remaining portion is variable with production or
sales. For example, electricity bills, water bills, internet bills, etc., have a
fixed charge for a certain period and additional charges based on usage.

27/10/2023
22
E. ON THE BASIS OF TIME-PERIOD
On the basis of the period to which the cost incurred belongs to, it is
classified into the following:-
(a)Historical Costs -These refer to the costs relating to the past
period. They are the costs which have already been incurred.
(b) Current Costs- Current costs refer to the costs relating to the
present period.
(c) Pre-determined Costs -These costs refer to the costs relating to
the future period. These are computed in advance on the basis of
specification of all factors affecting them.
F. ON THE BASIS OF CONTROLLABILITY
On the basis of the ability to control costs, they are classified into the
following:
(a) Controllable Costs- These costs can be influenced and controlled by
management action; for example, a long-term agreement with a supplier
for supply of raw-materials at a pre-determined price.
(b) Non-controllable Costs -These costs cannot be influenced and controlled
by any specific management action or by any specific member of the
organization.
for example, Insurance, Depreciation, Building Rent, Interest Rates etc.,

27/10/2023
23
G. ON THE BASIS OF NORMALITY
On the basis of the conditions under which costs are incurred, they
are classified into the following:
(a)Normal Costs -These refer to the costs which are reasonably
expected to be incurred under normal, routine and regular
operating conditions. for example, Employee Salary, raw
material cost, utilities, rent, etc.
(b) Abnormal Costs -These refer to the costs over and above
normal costs which are not incurred under the normal operating
conditions and its unusual, for example, Equipment's breakdowns,
fines and penalties, wages for idle hours, etc.
H. ON THE BASIS OF ATTRIBUTABILITY
On the basis of the assignment of costs to the product, they are classified into
the following:
(a)Period Costs -These costs are not assigned to the products but are charged
as expenses against revenues of the period in which they are incurred. These
are the costs which are not included in inventory valuation.
For example, general administration costs, depreciation of office premises,
Insurance Premium, Software Subscriptions etc.
(b)Product Costs -These costs are assigned to the product and included in
inventory valuation.
For example, cost of raw materials, Direct Wages, depreciation of plant,
equipment, Packing, Marketing and sales Expenses etc.

27/10/2023
24
I. ON THE BAS OF CASH OUTFLOW
On the basis of cash outflow involved, costs are classified into the following:
(a) Explicit Costs- These are the costs which involve cash payment and are actually
incurred. They are also called out-of-pocket costs. Since they are actually incurred,
they are easily and objectively measured. They are recorded in the books of accounts
and are used for the purpose of ac counting, reporting, cost control and decision-
making. For example, material costs, labour costs, salaries, rent, advertisement
expenses, etc.
(b) Implicit Costs- These costs do not involve cash payment and are not actually incurred.
They are also called economic costs or notional costs or imputed costs. They cannot be
easily measured and involve subjective estimation. They are not recorded in the books but
are used for the purposes of decision making. For example, interest on owner's capital,
rent of own premises, proprietor's salary, etc.
J. ON THE BASIS OF RELEVANCE TO DECISION-MAKING
(A) RELEVANT COSTS- These costs are relevant and useful for decision-making
purposes. They include the following:
(i) Marginal Cost: It refers to the cost of producing one additional unit. It is the total of
variable cost, specific fixed cost and opportunity cost.
(ii) Differential Cost: It refers to change in costs due to change in the level of activity or
pattern or method of production. Where the change results in increase in cost, it is called
incremental costs and where the change results in decrease in cost, the difference in cost is
called decremental cost. Ex: financial scenarios, such as pricing decisions, make-or-buy
decisions, special order decisions
(iii) Opportunity Cost: It refers to the value of benefit forgone by accepting an alternative
course of action. For example, if a business enterprise carries out its operations in its
own premises, so the rent which could have been earned if the premises was let out is
the opportunity cost.

27/10/2023
25
(iv) Out-of-pocket Cost: It refers to the cost which involves cash outflow.
These costs are recorded in the books and they form the basis for all decisions
of the enterprise.
(v) Replacement Cost: It is the costs at which there could be purchase of an
asset or material identical to that which is being replaced or revalued.
(vi) Imputed Cost: These are notional costs which do not involve any cash
outflow, but are relevant for making decisions. Examples: notional rent,
notional salary, notional interest, etc.
(vii) Discretionary Cost: These are "escapable' or 'avoidable costs. These are
essential for accomplishment of a managerial objective. They can be avoided
if a particular course of action is not chosen. For example, foremen have to
be appointed if the enterprise decides to produce a component on its own,
instead of outsourcing; then, foremen salary is discretionary in nature..
(B) IRRELEVANT COSTS- These costs are not relevant or useful for
decision-making. They include the following:
(i) Sunk Cost: It is a cost which has already been incurred or sunk in the past.
It is not relevant for decision-making. For example, the employees are
trained in operation of a particular machine. The expenses for training are
sunk costs for decision on whether to hire the employees or not.
(ii) Absorbed fixed Cost: It refers to common fixed cost which does not
change with any alternative course of action. For example, depreciation on
factory building, salary to accountants, etc., will not change irrespective of
whether a component is produced in the factory or bought out from the
market.

27/10/2023
26
COST OBJECT
• A cost object is a term commonly used in cost
accounting and managerial accounting to refer to any
item, project, department, or activity for which you
want to track costs.
• Cost objects are used to help organizations allocate and
assign costs to specific areas, products, or activities,
which is important for decision-making, budgeting, and
performance evaluation.
1.Product: In a manufacturing company, a product is a common cost object. The company
tracks all costs associated with producing a specific product, including materials, labor,
and overhead.
2.Project: For a construction company, each construction project is a cost object. Costs
associated with labor, equipment, materials, and other expenses are allocated to the
specific project to determine its profitability.
3.Department: Within a large organization, each department can be considered a cost
object. The organization tracks the costs incurred by each department to assess their
performance and allocate resources accordingly.
4.Customer: Some businesses track costs related to specific customers. This is especially
common in service industries. It helps the business understand which customers are most
profitable and which may need more attention.
5.Service Line: In a healthcare organization, different medical procedures or services can
be considered cost objects. Costs related to providing each service are tracked separately
for cost analysis and pricing decisions

27/10/2023
27
COST UNIT
A cost unit is a term used in cost accounting to represent a
specific unit of a product or service. It helps in allocating
and analyzing costs within a business.

27/10/2023
28
Let's say you own a small bakery, and you want to determine the cost of producing a
single loaf of bread. In this case:
1.Cost Unit: The cost unit would be one loaf of bread.
2.Cost Components: To calculate the cost of a single loaf of bread, you would need to
consider various cost components, such as:
1. Direct Materials: The cost of flour, water, yeast, and any other ingredients used in the bread.
2. Direct Labor: The wages or salaries of the bakers involved in making the bread.
3. Overhead Costs: This includes the cost of electricity for baking, depreciation on baking equipment,
rent for the bakery space, and other indirect costs.
3.Total Cost: You would calculate the total cost of producing a single loaf of bread by
adding up the direct materials cost, direct labor cost, and overhead costs. This total cost
is the cost of one cost unit.
4.Cost Analysis: Analyzing the cost per unit can help you make pricing decisions,
identify areas for cost reduction, and assess the profitability of your bakery.

27/10/2023
29
COST CENTRE
A cost center is a department, team, or individual
within an organization that is responsible for incurring
costs, but not directly generating revenue. Cost
centers are used for budgeting, cost control, and
expense tracking purposes. They help organizations
analyze and allocate their expenses to various
activities and functions.
Cost Center: IT Department
Description: The IT department of a company is responsible for managing all the
technology and information systems, providing technical support, and ensuring the
smooth functioning of the organization's digital infrastructure. This department incurs
various costs related to hardware, software, personnel, and other IT-related expenses.
Expenses Associated with the IT Department:
1.Salaries and Benefits: This includes the salaries and benefits of IT professionals, such
as network administrators, software developers, and helpdesk support staff.
2.Hardware and Software: The cost of purchasing and maintaining computers, servers,
networking equipment, and software licenses.
3.Maintenance and Repairs: Expenses for regular maintenance and occasional repairs
of IT equipment and infrastructure.

27/10/2023
30
Continuation……
4. Utilities: Costs for electricity, heating, and cooling in data centers and server rooms.
5. Training and Development: Budget for training IT staff and keeping them up to date with the
latest technologies.
6. Office Space: Rent or leasing costs for office space used by the IT department.
7. Telecommunications: Costs related to internet and phone services used by the IT department.
8. Software Licenses: Expenses for software applications used by the IT department, including
antivirus software, productivity tools, and development software.
9. Consulting and Outsourcing: If the company hires external IT consultants or outsourcing
services, these costs are associated with the IT department.
COST CONTROL
Cost control is the practice of identifying and reducing business expenses to
increase profits. It starts from Cost Management.
As an example, a company can obtain bids from different vendors that
provide the same product or service, which can lower costs.

27/10/2023
32
Tools of Cost Control
1.Cost Estimate: This tool is used in the initiation phase. In this phase, the
users are responsible for evaluating the financial viability of a particular
project.ost Estimate:
2.Budget: This tool is used in the planning phase. In this phase, the users plan
out the work by considering the overall cost estimates and converting the same
into a budget.
3.Cost Monitoring: This is used in the execution phase. In this phase, the
users monitor their costs in order to check if there is not any sort of
overspending or unnecessary spending so that they can keep the expenditures in
line with the budgets.
4.Financial Evaluation: This is used in the closing phase. In this phase, users
evaluate if a particular project has met the pre-determined financial targets or
not.

27/10/2023
33
COST REDUCTION
Cost reduction is to be understood as the achievement of real and
permanent reduction in the unit cost of goods manufactured or
services rendered without diminution in the quality of product.

27/10/2023
34
Cost Reduction Strategies
1. Modifying Sourcing
Organizations can modify sourcing resources and procurement, and this tends to be a time-consuming process.
This step can involve switching to cheaper alternatives or sourcing from local produce. Changing sourcing is
undertaken to reduce long-term costs. Instead of being dependent on one supplier, the company switches
suppliers periodically for cost advantage.
2. Improvising Processes
Many businesses sometimes decide to incorporate expensive processes which can be avoided. Improvising
techniques to eliminate costs is one essential strategy of cost reduction. Minor improvements in the
manufacturing processes, such as preventing wastes or waste management processes, can help save costs in the
long run.
3. Utilizing Energy-Saving Equipment
Businesses utilize a lot of energy which tends to increase costs. Finding energy-saving equipment or using
alternative sources of energy saves costs over time. So, for example, some companies can decide to substitute
office printers or stationery with cost-saving alternatives like going digital. This will not only save paper but
electricity as well.

27/10/2023
35
Continuation……
4. Hiring Processes
The more experienced an individual is, the higher the cost of hiring and maintaining them as an
employee. Hiring graduates or interns for specific frontline or baseline positions is much cheaper. The
company could then focus on strengthening its training and development processes to train recruits
better. This also gives the individuals opportunity and industrial exposure while saving a lot of money
on remuneration.
5. Expense Reduction
Another strategy that organizations use to reduce costs is to cut down on expenses. An example could
be the use of video conferencing instead of physical travel to bring down travel costs. Another great
example is promoting carpooling for the work commute.
6. Product Alternatives
Bringing out product alternatives that appeal to different income segments of the population can be
economical in the long run. However, businesses must not compromise on product quality while
developing the financial product alternative.
Disadvantages of Cost Accounting
i) Expensive
ii) More Complex
iii) Lack of Accuracy
iv) Limited Applicability
v) Not applicable to Small Concerns
vi) Lack of Uniformity

27/10/2023
36
Explanation
i) Expensive – Highly paid cost accountants and the organization of costing system
Involve additional expenditure. However, before installing it, care must be taken to
ensure that the benefits derived are more than the investment made on this system of
accounting.
ii) More Complex – Cost accounting system involves a number of steps in
ascertaining cost such as collection and classification of expenses, allocation and
apportionment of expenses etc. These steps are considered as complicated and
requires several forms and documents in preparing the reports. This will lead to delay
in the preparation of accounts.
iii) Lack of Accuracy – Accuracy in Cost Accounting is relative. Certain assumptions
are always made while ascertaining cost to suit a particular situation.
Continue..
iv) Limited Applicability – All business enterprises cannot make use of a
single method and technique of costing. It all depends upon the nature of the
business and type of product manufactured by it. If a wrong technique and
method is used, it misleads the results of the business.
v) Not applicable to Small Concerns – A cost accounting system is applicable
only to large sized business and not suitable for small sized business because it
is more expensive.
vi) Lack of Uniformity – This is the greatest limitation of cost accounting
system. It fails to confirm to any uniform procedure. It is possible that two
equally competent cost accountants may arrive at different results from the same
information. So it is said that all cost accounting results are mere estimates and
not reliable.

Introduction to Cost Accounting

Recommended

Recommended

More Related Content

What's hot

What's hot (20)

Similar to Introduction to Cost Accounting

Similar to Introduction to Cost Accounting (20)

More from Acharya Institute of Graduate Studies

More from Acharya Institute of Graduate Studies (20)

Recently uploaded

Recently uploaded (20)

Introduction to Cost Accounting