Cost Accounting Study material - Unit I

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Cost Accounting
Study material - Unit I
UNIT-I
Cost Accounting – Definition – Meaning and Scope – Concept and Classification –
Costing an aid to Management – Types and Methods of Cost – Elements of Cost -
Preparation of Cost Sheet and Tender.
What is Cost Accounting?
• Cost accounting comes down to two words – “cost” and “accounting”. First, let’s
understand what “cost” is. Then we will look at “accounting”.
What is “Cost”?
Cost is an expense incurred by a particular unit. In another way, the cost is what the
business sacrifices in order to produce one unit of product.
Eg: Pen production (what are the various brands of pen available in the market?)
What is “Accounting”?
Accounting is the art and science of recording, classifying, summarizing, and analyzing
inputs to make a sense of the information related to financial, management, or cost.
Meaning
• Goal of Cost Accounting is to advise the management on how to optimize business
practices and processes based on cost efficiency and capability.
Optimize business practices

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Optimize means to make the best possible use of something. If you optimize your
home storage capacity, you clean and organize your closets and drawers to be able to fit
the most in.
• Cost accounting provides the detailed cost information that management needs to
control current operations and plan for the future.
Eg: How much pens produced at present whether it could be expended
• Can the company go for mechanization?
• How to reduce cost of production
Definition
• Cost Accounting Definition –According to the Institute of Cost and Management
Accountants (I.C.M.A) ”Cost accounting is the art and science of recording,
classifying, summarizing, and analyzing costs to help the management to
make prudent business decisions”.
Need for Cost Accounting
• Fixation of selling prices (best price)
• Control of costs (improve the quality and efficiency and reduce cost)
• Decision making from alternative choices
• Can go in for expansion
• Can go for export
• Can reduce the labour cost
• Make or buy
Objectives or purposes or functions or aims of Cost Accounting
• Cost finding or cost ascertainment
• Control of cost

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• Reduction of cost
• Fixation of selling price
• Providing information for framing business policy
• Cost finding or cost ascertainment
To ascertain the cost per unit of each product manufactured or service rendered
by an organization.
• Control of cost
Information regarding cost of each product or service would enable the
management to know where to economize on costs, to fix prices, how to
maximize profits and so on.
• Reduction of cost
• Discloses sources of wastage
• Whether material, time or expense
Helps in cost reduction through various techniques such as budgetary control,
material control, labour control and overheads control.
Fixation of Selling Price
To provide requisite data on and serve as a guide for fixing prices of products
manufactured or services rendered.
(Market price or competitive price and so on…)
Providing information for framing business policy
• Production or discontinuation of product
• Utilization of idle capacity
• The most profitable sales mix A sales mix is the collection of all of the products
and services a company offers

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• Alternatives based on key factor
Key factor is the limiting factor is one which is short in supply or constraint or
not available in abundance (material or labour or capital)
Providing information for framing business policy
• Export decisions
• Make or buy decisions
• Advise management on future expansion policies
• To help in the preparation of budgets
SCOPE OF COST ACCOUNTING
• The scope of Cost Accountancy is very wide and includes the following:-
• Cost Ascertainment:
The main objective of Cost Accounting is to find out the Cost of product / services
rendered with reasonable degree of accuracy.
• Initial stages of evolution:
Cost accounting was confined itself to cost ascertainment and presentation.
• With the development of business activity and introduction of large scale
production :
The scope of cost accounting was broadened to cost control and cost reduction
along with finding out cost of production.
Area of application of Cost Accounting:
Initial period:
Cost accounting was applied only in manufacturing sector.
Recent Years:

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Now it is applied in service organisations (education, hospital, transportation, etc.),
government organisations, local authorities (Municipality, Town Panchayat,
Corporation), farms, extractive industries (Oil and gas extraction, mining, etc.)
Objections of Cost Accounting
1. Cost Accounting is costly to operate
 Installation involves heavy expenditure
 But the benefits are higher than the expenses
 Hence it is necessary
2. Cost Accounting is unnecessary
Few experts feel that
 Cost accounting is of recent origin
 Enterprise can survive without cost accounting
 Financial Accounts ascertains the P&L A/C and Balance sheet
 But in turn Cost Accounting increases the efficiency and profitability in long run
3. Cost Accounting involves many forms and statements
 Monotony in filling up forms
 Increase in paper work
4. Costing may not be applicable in all types of industries
 Only for manufacturing and service not for trading
5. It is based on estimates
 Costing is based on assumptions and pre determined data
 Hence it is not reliable
Limitations of Cost Accounting

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1. Lack of uniformity
 No similar system is followed for all industries
2. Second hand data
 Cost accounts depend on financial accounts for data
 Any error in that will also reflect in cost accounts
3. Conventions
 Cost accounting is based on many assumptions
 It may not be applicable in all situations
4. Uncertainty
 Since various assumptions are used on pricing, absorption and allocation of
overheads
 The results may be uncertain
5. Costly
 Costly for small and medium enterprises
6. Applicability
 Applicable only for manufacturing and service firms and not for trading firms
Classification of cost
I. According to elements
II. According to functions
III. According to nature or behavior
IV. According to controllability
V. According to normality

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VI. According to relevance to decision making and control
I. According to elements
• Material (Direct and indirect), labour and expenses
• Total direct cost – Prime cost
• Indirect material, indirect labour & indirect expenses - Indirect cost or Overheads
• Overheads – Factory overhead, Office overhead and selling and distribution
overhead
II. According to functions
1. Production cost
• Manufacturing or factory cost
• Incurred in converting raw material into finished products
2 . Administration Cost
• Not directly related with production, selling, distribution, research and
development.
• Related with planning, organizing and control of the enterprise.
3. Selling cost
• Demand creation or marketing cost
• Product promotion and advertising
• Incurred for securing orders
4. Distribution Cost
• Distribution expenses or overheads (transportation)
• Packing and warehouse expenses
5. Research cost

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Cost of searching of
• New or improved products
• New or improved methods
• New application of materials
6. Development cost
• Cost on Managements decision to produce new or improved product.
• Cost on Managements decision to employ new or improved technology.
III. According to nature of costs
1. Fixed cost
• Cost which does not change with increase or decrease in quantum of production
(eg. Factory Rent)
2. Variable cost
• Cost which increase or decrease in direct proportion to increase or decrease in
production. (eg. raw material)
IV. According to controllability
1. Controllable cost
• These are controlled by management like material , labour and direct expenses.
2. Uncontrollable cost
• They are not influenced by management or any group of people. They include rent
of a building, salaries, and other indirect expenses.
V. According to normality
1. NORMAL COST
• Cost which is normally incurred at the given level of output

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• It is a part of cost of production.
2. ABNORMAL COST
• Cost which is not normally incurred at the given level of output. (eg. Unexpected
raise in onion prices)
• It is not a part of cost of production & charged to costing profit and loss account.
VI. According to relevance to decision making and control
1. Shut-down cost:
• Cost incurred irrespective of plant is in operation or not
• Eg. Rent, rates, depreciation, maintenance expenses etc.
2 . Sunk cost
• Cost incurred in the past which is not relevant to the current decision making.
• Eg. Written down value of machinery is irrelevant for replacement of machinery.
3. Opportunity cost
• Cost related to the sacrifice made or the benefits foregone by choosing other
alternative
4. Imputed cost
• It is the notional or imaginary cost
• Eg. Rent of own building, interest on own capital are not actually paid but can be
taken as costs notionally.
5. Out –of-Pocket cost
• Cost which is payable in cash as against costs which do not involve cash payment
• Eg. Depreciation
6. Replacement cost

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• Cost at which an asset or material is replaced
• It reflects the present market price of the asset or material.
7. Conversion cost
• Cost of converting raw material into finished goods.
8. Product cost
• Product cost is identifiable in any product.
• It includes direct material, direct labor and direct overheads.
9. Time/Period cost
• Period cost affect the income irrespective of sales.
• Selling expenditure and Administrative expenditure, both are time or period based
expenditures.
• For example, rent of a building, salaries to employees are related to period only.
CONCEPTS OF COSTING
(1) COST:
It is the amount of resources given up in exchange for some goods or services.
The resources given up are expressed in monetary terms. Cost is 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”.
Cost is also different from value as cost is measured in terms of money whereas
value is measured in terms of usefulness or utility of an article.
COST CENTRE:
• A cost centre is the smallest segment of activity or area or responsibility for which
costs are accumulated.

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• Typically cost centers are departments but in some instances, a department may
contain several cost centers.
• These cost centers are the departments or sub- departments of an organization
with reference to which cost is collected for cost ascertainment and cost control.
Types of Cost Centers:
i) Personal and impersonal cost centers.
ii) Operation and process cost centers.
iii) Production and service cost centers.
Profit Centre:
• A profit centre is that segment of activity of a business which is responsible for
both revenue and expenses and discloses the profit of a particular segment of
activity.
• Profit centers are created to delegate responsibility to individuals and measure
their performance. Profit centre is different from cost centre.
• Conversion Cost:
• Conversion Cost is the sum of direct wages, direct expenses and manufacturing
overhead costs of converting raw material from one stage of production to the
next. In other words, conversion cost is works cost minus the cost of direct
materials.
• Contribution Margin:
• This is the excess of sales price over variable costs.
• This can be expressed in total or ratio of sales or percentage of sales.

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COSTING AN AID TO MANAGEMENT
• It provides detailed costing information to the management to enable them to
maintain effective control over stores and inventory, to increase efficiency of
the organization and to check wastage and losses.
• It facilitates delegation of responsibility for important tasks and rating of
employees. For all these the management should be capable of using the
information provided by cost accounts in a proper way.
• The various advantages derived by the management from a good system of
costing are as follows:
1. Cost accounting helps in periods of trade depression and trade competition.
 In periods of trade depression, the organization cannot afford to have
wastages which pass unchecked. The management must know areas where
economies may be sought, waste eliminated and efficiency increased.
 The organization must wage a war not only for its survival but also
continued growth.
 The management should know the actual cost of their products before
embarking on any scheme of price reduction. Adequate system of costing
facilitates this.
2. Cost accounting aids price fixation.
 Although the law of supply and demand determines the price of the product, cost
to the producer does play an important role.
 The producer can take necessary guidance from his costing records in case he
is in a position to fix or change the price charged.
3. Cost accounting helps in making estimates.
 Adequate costing records provide a reliable basis
for making estimates and quoting tenders.

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Cost accounting helps in channelizing production on right lines.
• Proper costing information makes it possible for the management to
distinguish between profitable and non-profitable activities; profits can be
maximized by concentrating on profitable operations and eliminating non-profitable
ones.
5. Cost accounting eliminates wastages.
• As cost accounting is concerned with detailed breakup of costs, it is possible to
check various forms of wastages or losses.
6. Cost accounting makes comparisons possible.
• Proper maintenance of costing records provides various costing data for
comparisons which in turn helps the management in formulating future lines
of action.
Cost accounting provides data for periodical Profit and Loss Account.
• Adequate costing records provide the management with such data as may be
necessary for preparation of Profit and Loss Account and Balance Sheet at such
intervals as may be desired by the management.
8. Cost accounting provides data for periodical Profit and Loss Account.
• Adequate costing records provide the management with such data as may be
necessary for preparation of Profit and Loss Account and Balance Sheet at such
intervals as may be desired by the management.
Cost accounting helps in determining and enhancing efficiency.
• Losses due to wastage of materials, idle time of workers, poor supervision etc.,
will be disclosed if the various operations involved in the production are studied
carefully. Efficiency can be measured, cost controlled and various steps can be
taken to increase the efficiency.

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10. Cost accounting helps in inventory control.
Cost accounting furnishes control which management requires, in respect of
stock of materials, work in progress and finished goods.
b) Costing as an aid to Creditors.
Investors, banks and other money lending institutions have a stake in the
success of the business concern are therefore benefitted immensely by the
installation of an efficient system of costing. They can base their judgment about the
profitability and future prospects of the enterprise on the costing records.
c) Costing as an aid to employees.
• Employees have a vital interest in their employer’s enterprise in which they are
employed. They are benefited by a number of ways by the installation of an efficient
system of costing. They are benefited, through continuous employment and
higher remuneration by way of incentives, bonus plans, etc.
d) Costing as an aid to National Economy
• An efficient system of costing brings prosperity to the business enterprise
which in turn brings prosperity to the business enterprise which in turn results
in stepping up of the government revenue. The overall economic development
o f a country takes place as a consequence of increase in efficiency of
production. Control of costs, elimination of wastages and inefficiencies led to
the progress of the industry and, in consequence of the nation as a whole.
11. Cost units-
• The Chartered Institute of Management Accountants, London, defines a unit of
cost as “a unit of quantity of product, service or time in relation to which
costs may be ascertained or expressed”.

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• The forms of measurement used as cost units are usually the units of physical
measurements like number, weight, area, length, value, time etc.
Following are some examples of cost unit.
Industry/product Cost unit basis
Automobile Numbers
Brick works per 1000 bricks
Cement per Tonne
Chemicals Litre, gallon, kilogram, ton
Steel Tonne
sugar Tonne
Transport
Passenger-kilometer, tonne kilometer
LIMITATIONS OF FINANCIAL ACCOUNTING:
1. No clear idea of operating efficiency:
• Sometimes profits in an organization may be less or more because of inflation or
trade depression and not due to efficiency or inefficiency. But financial accounting
does not give a clear reason for profit or loss.
2. Weakness not spotted out by collective results:
• Financial Accounting shows the net result of an organization. When the profit
and loss account of an organization, shows less profit or a loss, it does not give
the reason for it or it does not show where the weakness lies.

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3. Does not help in fixing the price:
• In Financial Accounting, we get the total cost of production but it does not
aid in determining prices of the products, services, production order and lines of
products.
4. No classification of expenses and accounts:
• In Financial Accounting, we don’t get data relating to costs incurred by
departments, processes separately or per unit cost of product lines, or cost
incurred in various sales territories. Further expenses are not classified as direct
or indirect, controllable and uncontrollable overheads and the value added in each
process is not reported.
5. No data for comparison and decision making:
• It does not supply useful data to management for comparison with
previous period and for taking various financial decisions as introduction of new
products, replacement of labour by machines, price in normal or special
circumstances, producing a part in the factory or buying it from outside
market, production of a product to be continued or given up, priority accorded to
different products, investment to be made in new products or not etc.
. No control on cost:
• Financial Accounting does not help to control materials, supplies, wages,
labor and overhead costs.
7. Does not provide standards to assess the performance:
• Financial Accounting does not help

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in developing standards to assess the performance of various persons or departments .
It also does not help in checking that costs do not exceed a reasonable limit for a given
quantum of work of the requisite quality.
8. Provides only historical information:
• Financial Accounting records only the historical costs incurred. It does not
provide day-to-day cost information to the management for making effective
plans for the future.
9. No analysis of losses:
• It does not provide complete analysis of losses due to defective
material, idle time, idle plant and equipment etc.. In other words, no distinction is
made between avoidable and unavoidable wastage.
10.Inadequate information for reports:
• It does not provide adequate information for reports to outside agencies such as
banks, government, insurance companies and trade associations.
. No answer for certain questions:
 Financial Accounting will not help to answer questions like:-
(a) Should an attempt be made to sell more products or is the factory operating to
capacity?
(b) if an order or contract is accepted, is the price obtainable sufficient to show a profit?
(c) if the manufacture or sale of product A were discontinued and efforts make to increase
the sale of B, what would be the effect on the net profit?
(d) Why the profit of last year is of such a small amount despite the fact that output was
increased substantially? Etc.
TYPES OF COSTING
Uniform Costing:

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• It is not a distinct method of costing.
• It is the adoption of identical costing principles and procedures by several units
of the same industry or several undertakings by mutual agreement.
• It facilitate valid comparisons between organizations and helps in elimination of
inefficiencies.
Marginal Costing:
• Under marginal costing, costs are classified into fixed and variable costs.
• Variable costs are charged to unit cost and the fixed costs attributable to the
relevant period are written-off in full against the contribution for that period.
• Contribution margin indicates the recovery of fixed cost before contributing
towards the operational profit.
• This technique is widely used for internal management purpose for decision
making rather than for external reporting.
Historical Costing:
• In this type of costing system, the costs are ascertained only after they have been
incurred.
• The main objective of it is to ascertain costs that have been incurred in past. It is
the process of accumulation of costs after they are incurred in a systematic
manner.
• The historical costs are used only for postmortem examination of actual costs
incurred and it would be too late to control.
• The actual figures can be compared only when the standards of performance
exists.
Direct Costing:
• It is a method of costing in which the product is charged with only those costs
which vary with volume.

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• Variable or direct costs such as direct material, direct labour and variable
manufacturing expenses are examples of costs charged to the product.
• All indirect costs are charged to profit and loss account of the period in which they
arise.
• Indirect costs are disregarded in inventory valuation.
Standard Costing:
• Under standard costing system, the ascertainment and use of standard costs and
the measurement and analysis of variances is done for control purpose.
• Standard cost is a predetermined cost which is computed in advance of
production on the basis of a specification of all the factors affecting costs and used
in Standard Costing.
• Its main purpose is to provide a base for control through Variance Accounting,
for valuation of stock and work-in-progress and, in some cases, for fixing selling
prices.
Absorption Costing:
• Under the ‘absorption costing system’ all fixed and variable costs are allotted to
cost units and total overheads are absorbed according to activity level.
• In absorption costing system, fixed manufacturing overheads are allocated to
products, and these are included in stock valuation.
• Therefore, valuation of inventories of finished goods and WIP includes
manufacturing fixed cost and transferred to next period. Unlike manufacturing fixed
overhead, the administrative overhead, selling and distribution overheads are
treated as fixed cost and recorded only when they incurs.
• It is a traditional form of cost ascertainment. It is based on the principle that costs
should be charged or absorbed to whatever is being costed – be it cost unit, cost
centre – on the basis of the benefit received from these costs.
METHODS OF COSTING

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Different industries follow different methods to establish the cost of their product. This
varies by the nature and specifics of each business. There are different principles and
procedures for performing the costing. However, the basic principles and procedures
of costing remain the same. Some of the methods are mentioned below:
(1) Job Costing,
(2) Contract Costing
(3) Batch Costing
(4) Process Costing
(5) Operation Costing
(6) Unit Costing
(7) Operating Costing
(8) Multiple Costing.
Job Costing:
• Under this method costs are collected and accumulated for each job or work order
or project separately.
• Each job can be identified separately and hence becomes essential to analyze
the costs according to each job.
• Normally production consists of distinct jobs or lots so that order number can
identify costs. A job card is prepared for each job for cost accumulation.
• This method is suitable for Printers, Machine tool manufacturers, Foundries, and
general engineering workshops.
Contract Costing:
• Contract costing does not in principle differ from job costing. When the job is big
and spread over long period of time, the method of contract costing is used.

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• A separate account is kept for each individual contract. Civil engineering
contractors, constructional and mechanical engineering firms, builders, etc use this
method.
• In contracts, when it is agreed to pay an agreed sum or percentage to cover
overheads and profit to the contractors, it will be termed as ‘cost plus costing’. The
term cost here refers to the prime cost.
• Usually government contracts are assigned in this basis.
• Batch Costing:
• This is an extension of job costing. A batch may represent a number of small orders
or group of identical products passed through the factory in batch.
• Each batch is treated as a cost unit and cost is ascertained separately.
• The cost per unit is determined by dividing the cost of the batch by the number of
units produced in a batch.
• The manufacturers of biscuits, garments, spare parts and components mainly
use this method.
Process Costing:
• A process refers here to a stage of production. If a product passes through
different stages, each distinct and well defined, then in order to ascertain the cost
at each stage or process, the process costing is used.
• Under this method, a separate process account is prepared and all costs incurred
in that process are charged.
• Normally the finished product of one process becomes the raw material of the
subsequent process and a final product is obtained in the last process.
• As the products are manufactured in continuous process, this is also known as
continuous costing. Process costing method is generally followed in textile units,
chemical industries, refineries, tanneries, paper manufacture, etc.

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Operation Costing:
• It is a further refinement of process costing.
• It is suitable to industries where mass or repetitive production is carried out or
where the goods have to be stocked in semi-finished stage, to enable the
execution of special orders, or for the convenient use in later operations.
• In this method, the cost unit is an operation. It is used in cycle manufacturing,
automobile units, etc.
Unit Costing:
• This is also known as single or output costing. This method is suitable for
industries where the manufacture is continuous and units are identical. This
method is applied in industries like mines, quarries, cement works, brick works,
etc.
• In all these industries there is natural or standard unit of cost, for example, tonne
of coal in collieries, tonne of cement, one thousands of bricks, etc. The object of
this method is to ascertain the cost per unit of output and the cost of each element
of such cost.
• Here the cost account takes the form of cost sheet or statement prepared for a
definite period. The cost per unit is determined by dividing the total expenditure
incurred during a given period by the number of units produced during that period.
Operating Costing:
• This is suitable for industries, which render services as distinct from those, which
manufacture goods. This is applied in transport undertakings, power supply
companies, gas, water works, municipal services, hospitals, hotels, etc.
• It is used to ascertain the cost of services rendered.
• There is usually a compound unit in such undertakings, for example, tonne-
kilometer or passenger-kilometer in transport companies, kilo-watt-hour in power
supply, patient-day in hospitals, etc.

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Multiple Costing:
• It is also called as composite costing. It represents the application of more than
one method of costing in respect of the same product.
• This is suitable for industries where a number of component parts are separately
produced and subsequently assembled into a final product. In such industries each
component differs from others as to price, materials used, and manufacturing
processes.
• So it will be necessary to ascertain the cost of each component. For this purpose
process costing may be applied. To ascertain the cost of the final product batch
costing may be applied.
• This method is used in factories manufacturing cycles, automobiles, engines,
radios, typewriter, aero plane and other complex products.
Cost Accounting and Financial Accounting
 Both financial accounting and cost accounting are concerned with systematic
recording and presentation of financial data.
 Financial accounting reveals profits and losses of the business as a whole during
a particular period, while cost accounting shows, by analysis and localization, the
unit costs and profits and losses of different product lines.
 The main difference between financial accounting and cost accounting are
summarized below.
Financial accounting aims at safeguarding the interests of the business and its
proprietors and others connected with it.
This is done by providing suitable information to various parties, such as
shareholders or partners, present or prospective creditors etc.
Cost accounting on the other hand, renders information for the guidance of the
management for proper planning, operation, control and decision making.

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2. Financial accounts are kept in such a way as to meet the requirements of the
Companies Act, Income Tax Act and other statues.
On the other hand cost accounts are generally kept voluntarily to meet the
requirements of the management.
But now the Companies Act has made it obligatory to keep cost records in some
manufacturing industries.
3. Financial accounting emphasizes the measurement of profitability, while cost
accounting aims at ascertainment of costs and accumulates data for this very
purpose.
4. Financial accounts disclose the net profit and loss of the business as a whole,
whereas cost accounts disclose profit or loss of each product, job or
service.
This enables the management to eliminate less profitable product lines and
maximize the profits by concentrating on more profitable ones.
5. Financial accounting provides operating results and financial position
usually gives information through cost reports to the management as and when
desired.
6. Financial accounts deal mainly with actual facts and figures, but cost accounts deal
partly with facts and figures, but cost accounts deal with facts and figures and
partly with estimates.
7. In case of financial accounts stress is on the ascertainment and exhibition of profits
earned or losses incurred in the business.
 On account of this reason in financial accounts, the transactions are recorded,
classified and analyzed in a subjective manner i.e. according to the nature of
expenditure.

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 In cost accounts the emphasis is more on aspects of planning and control and
therefore transactions are recorded in an objective manner.
 Financial accounts are concerned with external transactions i.e. transactions
between the business concern on one side and third parties on the other.
 These transactions form the basis for payment or receipt of cash. While
cost accounts are concerned with internal transactions which do not form the
basis of payment or receipt of cash.
9. The costs are reported in aggregate in financial accounts but costs are broken into
unit basis in cost accounts.
10. Financial accounts do not provide information on the relative efficiencies of
various workers, plants and machinery while cost accounts provide valuable
information on the relative efficiencies of various plants and machinery.
11. In financial accounts stocks are valued at cost or market price whichever is less,
whereas stocks are valued at cost price in cost accounts.
Elements of Cost
 The management of an organization needs necessary data to analyze and
classify costs for proper control and for taking decisions for future course of action.
 Hence the total cost is analyzed by elements of costs i.e. by the nature of
expenses. The elements of costs are three and they are materials, labor and other
expenses.
 These can be further analyzed as follows.

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By grouping the above elements of cost, the following divisions of cost are obtained.
1.Prime cost= Direct Materials + Direct Labor+ Direct Expenses
2.Works or Factory Cost= Prime Cost + Works or Factory Overheads
3.Cost of Production= Works Cost + Administration Overheads
4.Total Cost or Cost of Sales = Cost of Production + Selling and Distribution Overheads
The difference between the cost of sales and selling price represents profit or loss.
1. Direct Materials are those materials which can be identified in the product
and can be conveniently measured and directly charged to the product.
For example, bricks in houses, wood in furniture etc. Hence all raw materials,
materials purchased specifically for a job or process like glue for book making, parts
or components purchased or produced like batteries for radios and tires for cycles, and
primary packing materials are direct materials.

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2. Indirect Materials are those materials which cannot be classified as direct
materials.
 Examples are consumables like cotton waste, lubricants, brooms, rags, cleaning
materials, materials for repairs and maintenance of fixed assets, high speed diesel
used in power generators etc.
. Direct Labor is all labour expended in altering the construction, composition,
confirmation or condition of the product.
 Thus direct wages means the wages of labour which can be conveniently
identified or attributed wholly to a particular job, product or process or expended
in converting raw materials into finished goods.
 Thus payment made to groups of laborers engaged in actual production, or
carrying out of an operation or process, or supervision, maintenance, tools
setting, transportation of materials, inspection, analysis etc is direct labour.
 Direct Expenses are expenses directly identified to a particular cost centre.
Hence expenses incurred for a particular product, job, department etc are
direct expenses.
 Example royalty, excise duty, hire charges of a specific plant and equipment,
cost of any experimental work carried out especially for a particular job,
travelling expenses incurred in connection with a particular contract or job etc.
Overheads may be defined as the aggregate of the cost of indirect materials, indirect
labour and such other expenses including services as cannot conveniently be charged
direct to specific cost units.
 Overheads may be sub-divided into (i) Manufacturing Overheads; (ii)
Administration Overheads; (iii) Selling Overheads; (iv) Distribution Overheads; (v)
Research and Development Overheads.
Cost sheet or Statement of Cost:
 When costing information is set out in the form of a statement, it

28. 28
is called “Cost Sheet”.
 It is usually adopted when there is only one main product and all costs
almost are incurred for that product only.
 The information incorporated in a cost sheet would depend upon the
requirement of management for the purpose of control.
Specimen of Cost Sheet or Statement of Cost

29. 29

30. 30
Problem 1.
Find the Prime Cost, Works Cost, Cost of production, total Cost and profit from
the following:- Direct Materials Rs.20000; Direct Labour Rs. 10000; Factory
Expenses Rs. 7000; Administration Expenses Rs. 5000; Selling Expenses Rs.
7000 and Sales Rs.60,000.
Solution:
Prime Cost = Direct Materials + Direct Labour = Rs.20,000 + Rs.10,000 =
Rs.30,000. Works Cost = Prime Cost + Factory Expenses = Rs.30,000 + Rs.7,000
= Rs.37,000.
Cost of Production = Works Cost + Administration Expenses=Rs.37000+ Rs.5, 000
= Rs.42, 000.
Total Cost or Cost of sales= Cost of Production + Selling Expenses = Rs.42, 000+
Rs.7, 000 = Rs.49, 000. Profit = Sales - Total Cost = Rs.60,000 - Rs.49,000=

31. 31
Rs.11, 000.
These terms can be explained as follows
1. Present a cost sheet from the following data
1. You are required to compile a statement showing cost and profit from the
information given, showing clearly (a): Material consumed (b) Prime cost (c) Works
cost (d) Cost of Production (e) Cost of Sales (f)Profit and (g) Sales
Factory overhead is absorbed at 20% on wages, Administration overhead is 25%
on works cost. Selling and distribution overheads are 20% on the cost of
production.
Profit is 20% on sales.
PARTICULARS Rs Rs
Direct material used
Direct wages paid
Chargeable expenses
Indirect materials:
Used in factory
Used in office
Used in selling
Used in distribution
Indirect Labour:
In factory
In office
In selling
In distribution
Indirect Expenses
Relating to factory
Relating to office
Relating to selling
8000
12000
6000
4000
15000
20000
18000
12000
6000
3000
1000
50000
40000
10000
30000
65000
10000

32. 32
3. During the year 2008, X Ltd, produced 50,000
units a product.
The following were the expenses:
You are required to prepare a cost sheet showing
cost per unit and total cost at each stage
Stock of raw materials as on
1.1.2008
Stock of raw materials as on
31.12.2008
Purchases
Direct wages
Direct expenses
Factory expenses
Office expenses
Selling expenses
10,000
20,000
1,60,000
75,000
25,000
37,500
62,500
25,000
Cost sheet of X Ltd. For the year ending 31.12.2008
(Output 50000 Units)
Particulars Total
Rs.
Per Unit
Opening Stock of raw material
Add: Purchase of raw material
Less: Closing stock of raw material
Raw materials consumed
Direct wages
Direct expenses
Prime Cost
10000
160000
170000
20000
150000
75000
25000
3.00
1.50
0.50
5.00
0.75
5.75
1.25

33. 33
Add: Factory overheads
Factory overhead
Add: Office overheads
Cost of Production
Add: Selling overheads
Cost of sales
250000
37500
287500
62500
350000
25000
375000
7.00
0.25
7.50
1. The following details have been obtained from the cost records of Raja
Sekhar Ltd.,
Prepare a Cost sheet giving the maximum possible break up of costs and profit.
Raja Sekhar Ltd.
Statement of Cost and Profit
For the month ending 31.12.2010
Particular Rs. Rs.
Stock of raw materials on 1st
dec 2010
Stock of raw materials on 31st
Dec 2010
Direct wages
Indirect wages
Sales
Work-in-progress 1st
Dec 2010
Work-in-progress 31st
Dec 2010
Purchases of raw materials
Factory rent, rates and power
Depriciation of plant and machinery
Expenses on purchases
Carriage outwards
Advertising
Office rent and taxes
Traveller’s wages and commission
Stock of finished goods(1st
Dec 2010)
Stock of finished goods(31st
Dec 2010)
75,000
91,500
52,500
2,750
2,11,000
28,000
35,000
66,000
15,000
3,500
1,500
2,500
3,500
2,500
6,500
54,000
31,000

34. 34
Opening stock of raw
material
Add: Purchase of raw
material
Add: Expenses on purchase
Less: Closing stock of raw
material
Raw material consumed
Direct wages
Prime Cost
75000
66000
1500
142500
91500
51000
52500
103500
21250
124750
28000
152750
35000
117750
2500
120250
54000
174250
31000
143250
12500
155750
55250
211000
Add: Factory overheads:
Indirect wages
Factory rent, rates and
power
Depreciation of plant and
machinery
Gross
factory cost
Add: Opening work-in-
progress
Less: Closing work-in-
progress
Factory
overhead
2750
15000
3500
Add: Administrative
overhead:
Office rent and taxes
Cost of
Production
2500
Add: Opening stock of
finished goods
Less: Closing stock of
finished goods
Cost of Production of
goods sold

35. 35
Add: Selling and
Distribution overhead:
Carriage outwards
Advertisement
Travelling wages and
commission
Cost of sales
Profit (Bal.Fig.)
Sales
2500
3500
6500
2. The following particulars have been extracted from the books of a manufacturing
company
Stock of a material on 1st
Jan 2010
Stock of a material on 31st
Jan 2010
Materials purchased
Office salaries (Drawings)
Counting house salaries
Carriage inwards
Carriage outwards
Cash discount allowed
Bad debts written off
Repairs to plant and machinery
Rent, Rates, etc., - Factory
47,000
50,000
2,08,000
9,600
14,000
8,200
5,100
3,400
4,700
10,600
3,000
3. From the details given below, prepare a comparative cost sheet for the first and
second half of the year 2010, showing cost per unit in each case, at all stages.

36. 36
HALF YEAR
ENDED
30.6.2010 31.12.2010
Direct materials consumed
Wages
Chargeable expenses
Depriciation of factory machines
Indirect wages on factory
Rent:
Factory
Office
Repairs:
Factory
Office
Sundry office expenses
Output during the period in units
50,000
60,000
10,000
16,000
20,000
5,000
8,000
6,000
9,000
16,000
20,000 units
70,000
80,000
12,000
20,000
30,000
4,000
8,000
4,000
2,000
20,000
25,000 units
7. M/s Indu Industries Ltd., are the manufacturers of moonlight Torches. The following
data relate to manufacture of torches during the month of March 2009.
Raw materials consumed
Direct wages
Machine hours worked
Machine hour rate
Office overheads
Selling overheads
Units produced
Units sold
20,000
12,000
9,500 hours
Rs.2
20% of works cost
50 paise per unit
20,000 units
18,000 @ Rs.5 per unit
Prepare Cost sheet showing the cost and the profit per unit and the total profit earned
9. From the following details extracted from the trial balance of New Era Ltd for the
financial year ending 31.3.2010, you are required to prepare :
(a) A statement of cost showing various elements of cost in detail.

37. 37
A separate statement of profit.
Credit Balance Debit Balance (Continued)
Particulars Rs. Particulars Rs.
Sales 8,00,000
Return of Materials 10,000
Sale of scrap of Raw material 8,000
Debit Balances
Opening Stocks:
Raw Material 30,000
W.I.P 40,000
Finished goods 60,000
Plants & Machinery 1,00,000
Buildings 8,00,000
Return Inwards 20,000
Raw material purchased 2,00,000
Carriage on Material 10,000
Direct Wages 1,20,000
Indirect Wages 40,000
Factory Expenses 30,000
Sundry Office Expenses 83,000
Power 50,000
Indirect materials in Factory 10,000
Sundry factory Expenses 20,000
Selling Expenses 60,000
Distribution Expenses 20,000
Interest on Bank Loan 10,000
Additional Information
(A)Closing Stock:
Raw Materials 40,000
W.I.P 25,000
Finished Goods 50,000
(B) Depriciation on plant &
Machinery at 10% P.A:
On buildings(50% factory
And 50% office) at 5% P.A

38. 38
2. The cost accounts department of a company has supplied the following data for
the supply of 2,000 units of product.
Direct materials: 40,000 tons at Rs.5 per ton.
Direct wages : 8,000 labour hours at Rs.50 per labour.
Overheads:
Variable : Factory Rs.10per labour hour
Selling Rs.20 per unit
Fixed : Factory Rs.1,00,000
Office Rs.2,00,000
Prepare a statement showing the price to be fixed which will fetch a profit of 25% on cost.
1. The cost structure of an article, the selling price of which is Rs.500 is an follows:
Direct materials: 50% of the total cost
Direct Labour : 30% of the total cost
Overhead : Balance Amount
Due to anticipated increase in existing material price by 20% and in the existing labour
rate by 10%, the existing profit would come down by 30%, if the selling price remains
unchanged.
Prepare a comparative statement showing the cost, profit and price under the
present conditions and with the increase expected for future, assuming the same
percentage of profit on cost as at present had to be earned.

39. 39
(Calculate may be made to the nearest rupee).
1. The accounts of a machine manufacturing company disclose the following
information for six months ending 31st December 1982.
Materials used
Direct wages
Factory overheads
Administrative expenses
1,50,000
1,20,000
30,000
15,000
Prepare cost sheet for the half year and calculate the price which the company
should quote for the manufacture of a machine requiring materials valued at Rs.1,250
and expenditure in productive wages Rs.750, so that the price might yield a profit of 20%
on the selling price.