This document provides an introduction to cost accounting, including its purpose and key concepts. It discusses the limitations of financial accounting and how cost accounting addresses these. The main objectives of cost accounting are to ascertain costs, determine selling prices, set efficiency standards, value inventory, and provide information for decision making. Key cost accounting concepts covered include cost elements, cost classifications, cost sheets, costing methods, and the installation of cost accounting systems. The relationship between cost and financial accounting is also explained.

2. Introduction
 Cost Accounting is a branch of accounting and has been
developed due to limitations of financial accounting.
Financial accounting is primarily concerned with record
keeping directed towards the preparation of Profit and Los
Account and Balance Sheet. It provides information
regarding the profit and los that the business enterprise is
making and also its financial position on a particular date.
 The financial accounting reports help the management o
control in a general way the various functions of the
business but it fails to give detailed reports on the
efficiency of various divisions.

3. Limitations of Financial Accounting
 No clear idea of operating efficiency
 Weakness not spotted out by collective results
 Does not help in fixing the price:
 No classification of expenses and accounts
 No data for comparison and decision making
 No control on cost
 Provides only historical information
 No analysis of loses

4. Cost Accounting
 Cost Accounting may be regarded as “a specialized branch
of accounting which involves classification, accumulation,
assignment and control of costs.”
 The costing terminology of C.IM.A, London defines cost
accounting as “the process of accounting for costs from the
point at which expenditure is incurred or committed to the
establishment of its ultimate relationship with cost centres
and cost units. In its widest usage, it embraces the
preparation of statistical data, the application of cost
control methods and the ascertainment of profitability of
activates carried out or planed”.

5. Costing
 The costing terminology of C.IM.A ., London defines
costing as the “the techniques and processes of
ascertaining costs”.
 These techniques consist of principles and rules which
govern the procedure of ascertaining cost of products
or services. The techniques to be followed for the
analysis of expenses and the processes by which such
an analysis should be related to different products or
services differ from industry to industry. These
techniques are also dynamic and they change with
time.

6. General Principles of Cost
Accounting
 A cost should be related to its causes
 A cost should be charged only after it has been
incurred
 The convention of prudence should be ignored
 Abnormal costs should be excluded from cost accounts
 Past costs not o be charged to future period

7. Objectives of Cost Accounting
The following are the main objectives of Cost Accounting:-
 (a) To ascertain the Costs under different situations using
different techniques and systems of costing
 (b) To determine the selling prices under different circumstances
 (c) To determine and control efficiency by setting standards for
Materials, Labour and Overheads
 (d) To determine the value of closing inventory for preparing
financial statements of the concern
 (e) To provide a basis for operating policies which may be
determination of Cost Volume relationship, whether to close or
operate at a loss, whether to manufacture or buy from market,
whether to continue the existing method of production or to
replace it by a more improved method of production....etc

8. Advantages of Cost Accounting
(i) A cost system reveals unprofitable activities, losses or
inefficiencies occurring in any form such as
(a) Wastage of man power, idle time and lost time.
(b) Wastage of material in the form of spoilage, excessive
scrap etc., and
(c) Wastage of resources, e.g. inadequate utilization of plant,
machinery and other facilities.
(ii) Cost Accounting locates the exact causes for decrease or
increase in the profit or loss of the business.
(iii) Cost Accounting is useful for price fixation purposes.

9. Limitations of Cost Accounting
 (i) Classification of costs into its elements.
 (ii) Materials issue pricing based on average or
standard costs.
 (iii) Apportionment of overhead expenses and their
allocation to cost units/centres.
 (iv) Arbitrary allocation of joint costs.
 (v) Division of overheads into fixed and variable.

10. COST ACCOUNTING CONCEPTS
 Cost: Cost is a measurement, in monetary terms, of
the amount of resources used for the purpose of
production of goods or rendering services.
 Cost in simple, words, means the total of all expenses.
Cost is also defined as the amount of expenditure
(actual or notional) incurred on or attributable to a
given thing or to ascertain the cost of a given thing.
 Thus it is that which is given or in sacrificed to obtain
something.

11. Elements of Cost
Elements
of Cost
Material Labour Expenses
•Direct Material
•Indirect Material
•Direct Labour
• Indirect Labour
•Direct Expenses
•Indirect Expenses

12. Components of Total Cost
1.Prime Cost: It consists costs of direct material, direct labour
and direct expenses. It is also known as basic, first or flat
cost.
2. Factory Cost: It comprises of prime cost and in addition,
works or factory overheads which include costs of
indirect labour and indirect expenses. This cost is also
known as works cost, production or manufacturing cost.
3. Office Cost: If office and administration overheads are
added to factory cost office cost is arrived at. This is also
termed as administration cost or total cost of production.
4. Total Cost: Selling and distribution overheads are added to
the total cost of production to get the cost of sales.

13. Cost Sheet
 Cost sheet is an analytical statement of expenses relating to
production of an article which informs regarding total cost, per
unit cost and quantity of production.
 According to Wheldon, “Cost sheets are prepared for the use of
management and consequently, they must include all the
essential details which will assist the manager in checking the
efficiency of production.”
 In the words of C.I.M.A., London, “Cost sheet is a cost schedule
or document which provides for the assembly of the estimated
detailed cost in respect of a cost centre or cost unit”
 When cost per unit of production is not necessary to calculate
then a statement of cost is prepared to ascertain total cost and
profit or loss on production.

14. Methods and Techniques of
Costing
 Job costing
a) Contract Costing b) Bach Costing c) Operation
Costing
 Process Costing
 Unit Costing
 Operating Costing
 Uniform Costing
 Departmental Costing
 Multiple or Complete Costing

15. Techniques of costing
 Historical Costing
 Direct Costing
 Absorption Costing
 Marginal Costing
 Standard Costing
 Activity Based Costing

16. Installation of Cost Accounting
System
Essential Factors for Installing a Cost Accounting
System:
 Nature of Industry
 Background of Business Unit
 Selling & Distribution Method
 Flexibility and Uniformity
 Product Range
 Organizational Factors

17. Procedure for Installation
 Nature of Business
 Determination of Cost Centres
 Determination of Process
 Nature and Quality of Product
 Determination of Extent and Way to Control
 Records to be Maintained

18. Cost Accounting and Financial
Accounting
 Financial accounting reveals profits and loses of the
business as a whole during a particular period, while cost
accounting shows, by analysis and localization, the unit
costs and profits and loses of different product lines.
1. Purpose
2. Coverage
3. Scope
4. Parties Involved
5. Final Statement
6. Valuation of Stock
7. Classification of cost
8. Legal requirements

19. Various Cost Concepts
 Fixed Cost: Fixed cost is a cost which does not vary in total
for a given time period in spite of wide fluctuation in
production or volume of activity. These costs are also
termed as standby costs, capacity costs or period costs. For
example fixed costs are rent, property taxes, supervising
salaries etc.
 Variable Cost: Variable Cost is those costs that change
directly and accordingly with the production. There is a
fixed ratio between the variation in the cost and variation
in the level of output. Direct materials cost and direct
labour cost are the costs which are generally variable costs.

20. Various Cost Concepts
 Semi-variable/Fixed Cost (Mixed Cost): Mixed costs are costs
made up of fixed and variable items. They are a combination of
semi-variable costs and semi-fixed costs. Because of the variable
element, they vary with volume; because of the fixed element,
they do not fluctuate in direct proportion to output. Semi-fixed
costs are those costs which remain fixed up to a certain level of
production after which they become variable.
 Direct Cost: It may be defined as the term of direct materials,
direct labour and direct overheads. That means it is a cost which
can be directly identified to a unit of output or the segment of a
business operation.
 Indirect Cost: Indirect costs are those costs which cannot be
associated with or chargeable to a single product because they
are incurred for more products.

21. Materials- Introduction
 Successful operations of any of the business depend to a
large extent on the availability of goods and services of the
right quality in the right quantity at the right time, from
the right source at the right prices. Out of three elements of
cost (material, labour, overheads), material cost account for
nearly 50% of the cost of production, it is therefore
essential to establish suitable procedure for proper control
of materials from the time of placing order with suppliers
and vendors until they have been consumed. Material
control is a system which ensures the provision of Five
Rights as discussed above in the first two lines of this
paragraph.

22. Materials
 Material is any substance (Physics term) that forms
part of or composed of a finished product. i.e material
refers to the commodities supplied to an undertaking
for the purpose of consumption in the process of
manufacturing or of rendering service or for
transformation into products. Hence the total cost of a
product can be controlled and reduced by efficiently
using materials.

23. Objectives of Material Control
System
 Material Control: The function of ensuring that sufficient goods are
retained in stock to meet all requirements without carrying
unnecessarily large stocks.
The objectives of a system of material control are as following :-
 (a) To make continuous availability of materials so that there may be
uninterrupted flow of materials for production. Production may not be
held up for want of materials.
 (b) To purchase requisite quantity of materials to avoid locking up of
working capital and to minimise risk of surplus and obsolete stores.
 (c) To make purchase competitively and wisely at the most economical
prices so that there may be reduction of material costs.
 (d) To purchase proper quality of materials to have minimum possible
wastage of materials.
 (e) To serve as an information centre on the materials knowledge for
prices, sources of supply, lead time, quality and specification.

24. Requisites of Material Control
System
 (a) Coordination and cooperation between the various departments concerned
viz purchase, receiving, inspection, storage, issues and Accounts and Cost
departments.
 (b) Classification, coordination, standardization and simplification of
materials.
 (c) Planning of requirement of material.
 (d) Efficient purchase organization.
 (e) Budgetary control of purchases.
 (f) Planned storage of materials, physical control as well as efficient book
control through satisfactory storage control procedures, forms and documents.
 (g) Appropriate records to control issues and utilization of stores in
production.
 (h) Efficient system of Internal Audit and Internal Checks.
 (i) System of reporting to management regarding material purchase, storage
and utilization.

25. Purchase of Material
 Purchasing is a specialized activity in a manufacturing
concern because it has its bearing on every vital factor
concerning the manufacture like quantity, quality, cost,
efficiency, prompt delivery, and volume of production.
Quality of finished product ultimately depends upon
quality of raw materials used in it. High skill work can of
course help in improving the quality of product but it
cannot change the character of raw material, which is base
for the end product. A traditional housewife is a pace setter
when demand, price, consumption, source, money,
management comes into pictures. The purchases can be
 Centralized
 Decentralized.

26. Purchase Procedure
 1. Initiating the Purchase
 2. Purchase Requisition
 3. Deciding Important Factors
 4. Studying the Market and Sources of Supply
 5. Placing the Purchase Order
 6. Follow Up
 7. Receiving and Inspecting the Goods
 8. Passing Invoices for Payment

27. Purchase Requisition Form

28. Material Issue Procedure
 Issue of material must not be made except under
properly authorized requisition slip; usually it is the
foreman of a department who has the authority to
draw materials from the store. Issue of material must
be made on the basis of first in fist out, that is, out of
the earliest lot on hand. If care is not exercised in this
regard, qualify of earliest lot of material may
deteriorate for having been kept for a long period.

29. Material Issue Procedure
 Material Requisition Note: It is the voucher of the authority as
regards issue of materials for use in the factory or in any of its
departments.
 Bill of Material: It is also known as material specification list or
simply material list. It is a schedule of standard quantities of
materials required for any job or other unit of production.
 Transfer of Material: The surplus material arising on a job or
other units of production may sometime be unsuitable for
transfer to stores because of its bulk, heavy weight, brittleness or
some such reason. It may, however, be possible to find some
alternative use for such materials by transferring it to some other
job instead of returning it to the store Room.
 Return of Material: Sometimes, it is not possible before end to
make any precise estimate of the material requirements or units
of production. Besides, at times due to some technical or other
difficulty, it is not practicable to measure exactly the quantity of
material required by a department.

30. Material Storage
 Proper Storing of materials is of primary importance. It is
not enough only to purchase material of the required
quality. If the purchased material subsequently deteriorates
in quality because of bad storage, the loss is even more than
what might arise from purchase of bad quality materials.
 Apart from preservation of quality, the store-keeper also
must ensure safe custody of the material. It should be the
function of storekeeper that the right quantity of materials
always should be available in stock.

31. Store Record
 The record of stores may be maintained in three
forms:
 Bin Cards
 Stock Control Cards
 Stores Ledger
 The first two forms of accounts are records of
quantities received, issued and those in balance, but
the third one is an accounts of their cost also. Usually,
the accounts are kept in two forms, the quantitative in
the store and quantitative-cum-financial in the cost
department.

32. Inventory Control
 Inventory means “a schedule of items held at a
particular point of time.” Inventory comprises of
stocks of materials, components, work-in-progress, and
finished products and stores and spares. The main
objective of inventory control is to achieve maximum
efficiency in production and sales with the minimum
investment in inventory.
 Inventory control refers supervision of supply, storage and
accessibility of items of inventory in order to ensure
adequate supply without excessive oversupply. Material
control is an important managerial function which is
directed to ensure that required quantity and quality of
material is provided at the proper time with the minimum
amount of capital.

33. Scope of Inventory Control
 Production, Planning and Control
 Storage Exercises
 Inventory Planning and Control
 External Transport, Control for Efficient Usage of
External Transport Activities
 Internal Transport and Material Handling

34. Techniques of Inventory Control
 1. Setting of Various Stock Levels.
 2. ABC Analysis.
 3. Two Bin System.
 4. Establishment of System of Budgets.
 5. Use of Perpetual Inventory Records and Continuous
Stock Verification.
 6. Determination of Economic Order Quantity.
 7. Review of Slow and Non-moving Materials and
Stock Items.
 8. Use of Control Ratios.

35. Setting of Various Stock Levels
 To avoid over-stocking and under-stocking each item of the
inventory has the maximum levels, minimum levels and an order
point.
 (a) Minimum Level: The lowest figure of inventory balance,
which must be maintained in hand at all times, so that there is
no stoppage of production due to non-availability of inventory. It
is also known as ‘Buffer stock’, ‘Safety stock’ ‘minimum limit’
or ‘Minimum stock’.
 Minimum level of inventory = Re-order level – (average rate
of consumption x average time of inventory delivery)
 Maximum Level: It indicates the maximum quantity of
inventory quantity held in stock at any time. It is also known as
‘Maximum limit’ or ‘Maximum stock’.

36. Setting of Various Stock Levels
 Maximum level of inventory = Re-order-level + Re-
order quantity - (Minimum Consumption x Minimum
re-order period)
 Re-Order Level: It is also known as ‘Ordering level’,
‘Reorder point’. Order point is a point at which order
for supply of materials or goods is placed. This level lies
between minimum and the maximum levels in such a way
that before the material orders is received into the stores,
there is sufficient quantity on hand to cover both normal
and abnormal consumption situations.
 Re-order level = Maximum re-order period x
maximum Usage (or) = Minimum level + (average rate
of consumption x average time to obtain fresh
supplies).

37. Setting of Various Stock Levels
 Average inventory level = Minimum level + ½ Re-
order quantity Or
 = Maximum level + Minimum level 2
 Danger Level: It is the level at which normal issues of
the raw material inventory are stopped and emergency
issues are only made. As and when the danger level is
reached, the material has to be purchased at any price
at which available.
 Danger level = Average Consumption x Lead time
for emergency purchases

38. Economic Order Quantity(EOQ)
 Economic order quantity is an order size. The size of
the order for which both ordering and carrying cost are
minimum, is known as economic order quantity.
 Ordering Cost: The cost which is associated with the
purchasing or ordering of material. It includes costs of
staff posted for ordering for goods, expenses incurred
on transportation of goods purchased, inspection cost
of incoming material etc.
 Carrying Cost: The cost for holding the inventories. It
includes the cost of capital invested in inventories.
Cost of storage, insurance cost etc.

39. Economic Order Quantity(EOQ)

40. Issue of Materials
 Pricing of Outgoing Material: Material issued from stores
should be priced at the value at which they are carried in stock
but there can be a situation where the material may have been
purchased at different times and at different prices with varying
discounts, taxes etc. Because of this the problem arises as to how
the material issues to production are to be valued. There are
several methods for tackle this situation. The cost accountant
should select the proper method based on following factors:
 1. The frequency of purchases, price fluctuations and its range.
 2. The frequency of issue of materials, relative quantity etc.
 3. Nature of cost accounting system.
 4. The nature of business and type of production process.
 5. Management policy relating to valuation of closing stock.

41. Pricing of Outgoing Material
 1. Cost Price Methods:
 (a) Highest –in first –out method.
 (b) Fist – in first – out method.
 (c) Last in – first – out method.
 (d) Base stock method.
 2. Average Price Methods:
 (e) Simple average price method.
 (f) Weighted average price method.
 (g) Periodic simple average price method.
 (h) Periodic weighted average price method.
 (i) Moving simple average price method.
 (j) Moving weighted average price method.
 3. Market Price Methods:
 (k) Replacement price method.
 (l) Realizable price method.

42. First –in – First Out Method (FIFO)
 It is a method of pricing the issues of materials. Under this
method, the materials first received in the store are the first
issued. In other words, the order in which the materials are
received in the store are first issued at their cost price in the
same order or the items longest in stock are issued first.
Thus each issue of material only recovers the purchase
price which does not reflect the current market price.
 This method is considered suitable in times of failing price
because the material cost charged to production will be
high while the replacement cost of materials will be low.
But in the case of rising prices, if this method is adopted,
the charge to production will be low as compared to the
replacement cost of materials (as in the current period) in
future without having additional capital resources.

43. Last – in – First Out Method (LIFO)
 It is a method of pricing the issues of materials. This
method is based on the assumption that the items of the
last batch (lot) purchased are the first to be issued.
Therefore, under this method the price of the last batch
(lot) is used for pricing the issues, until it is exhausted, and
so on. If however, the quantity of issue is more than the
quantity of the latest lot than earlier (lot) and its price will
also be taken into consideration.
 During inflationary period or period of rising prices, the
use of LIFO would help to ensure that the cost of
production determined on the above basis is approximately
the current one. This method is also useful specially when
there is a feeling that due to the use of FIFO or average
methods, the profits shown and tax paid are too high.

44. Base Stock Method
 A minimum quantity of stock under this method is always held
at a fixed price as reserve in the stock, to meet a state of
emergency, if it arises. This minimum stock is known as base
stock and is valued at a price at which the first lot of materials is
received and remains unaffected by subsequent price
fluctuations.
 Thus, this is more a method of valuing inventory than a method
of valuing issued because, with the base of stock valued at the
original cost some other method of valuing issues should be
adopted. The quantity in excess of the base stock may be valued
either on the FIFO or LIFO basis. This method is not an
independent method as it uses FIFO or LIFO. Its advantages and
disadvantages therefore will depend upon the use of the other
method viz., FIFO or LIFO.

45. Material Losses
 There is various types of losses possible in subject of material
such as waste, scrap, spoilage, and defectives. We are going to be
discussing in detail their meaning, precautions and treatments.
 Waste
 “The portion of basic raw materials lost in processing having no
recoverable value.” Waste may be visible – bits and pieces of basic
raw materials – or invisible; e.g., disappearance of basic raw
materials through evaporation, Smoke etc. Shrinkage of material
due to natural causes may also be a form of a material wastage.
 In case of normal Wastage -Normal waste is absorbed in the
cost of net output.
 In Case of Abnormal Wastage -The abnormal waste is
transferred to the costing Profit and loss Accounts.

46.  Scrap:“It has been defined as the incidental residue from
certain types of manufacture, usually of small amount and
low value, recoverable without further processing.”
 Spoilage:“It is the term used for materials which are badly
damaged in manufacturing operations and they cannot be
rectified economically and hence taken out of process to be
disposed of in some manner without further processing.”
 Defectives:“It signifies those units or portions of
production which can be rectified and turned out as good
units by application of additional material, labour or other
service.”