Costng accounting

Q.01
What is Cost?
An amount that has to be paid or given up in order to get something. In business, cost is usually a
monetary valuation of (1) effort, (2) material, (3) resources, (4) time and utilities consumed, (5)
risks incurred, and (6) opportunity forgone in production and delivery of a good or service. All
expenses are costs, but not all costs (such as those incurred in acquisition of an income
generating asset) are expenses.
What is accounting?
The American Institute of Certified Public Accountants (AICPA) defines accounting as: the art
of recording, classifying, and summarizing in a significant manner and in terms of money,
transactions and events which are, in part at least of financial character, and interpreting the
results thereof.
What is Cost Accounting?
Cost accounting is a process of recording, classifying, analyzing, summarizing, allocating and
evaluating various alternative courses of action for the control of costs.
Basic Cost Concepts
Term cost is used in this very form. In reference to production/manufacturing of goods and
services cost refers to sum total of the value of resources used like raw material and labour and
expenses incurred in producing or manufacturing of given quantity.
Elements of cost
Cost of production/manufacturing consists of various expenses incurred on
production/manufacturing of goods or services. These are the elements of cost which can be
divided into three groups : Material, Labour and Expenses.
Elements of cost
Material Labour Expenses

Material
To produce or manufacture material is required. For example to manufacture shirts cloth is
required and to produce flour wheat is required.
All material which becomes an integral part of finished product and which can be conveniently
assigned to specific physical unit is termed as “Direct Material”. It is also described as raw
material, process material, prime material, production material, stores material, etc. The
substance from which the product is made is known as material. It may be in a raw or
manufactured state. Material is classified into two categories:
1. Direct Material
2. Indirect Material
Direct material
Direct Material is that material which can be easily identified and related with specific product,
job, and process. Timber is a raw material for making furniture, cloth for making garments,
sugarcane for making sugar, and Gold/ silver for making jewellery, etc are some examples of
direct material.
Indirect material
Indirect Material is that material which cannot be easily and conveniently identified and related
with a particular product, job, process, and activity. Consumable stores, oil and waste, printing
and stationery etc, are some examples of indirect material. Indirect materials are used in the
factory, the office, or the selling and distribution department.
Labour
Labour is the main factor of production. For conversion of raw material into finished goods,
human resource is needed, and such human resource is termed as labour. Labour cost is the main
element of cost in a product or service. Labour can be classified into two categories:
1. Direct Labour, and
2. Indirect labour

Direct labour
Labour which takes active and direct part in the production of a commodity. Direct labour is that
labour which can be easily identified and related with specific product, job, process, and activity.
Direct labour cost is easily traceable to specific products. Direct labour costs are specially and
conveniently traceable to specific products. Direct labour varies directly with the volume of
output. Direct labour is also known as process labour, productive labour, operating labour, direct
wages, manufacturing wages, etc. Cost of wages paid to carpenter for making furniture, cost of a
tailor in producing readymade garments, cost of washer in dry cleaning unit are some examples
of direct labour.
Indirect labour
Indirect labour is that labour which can not be easily identified and related with specific product,
job, process, and activity. It includes all labour not directly engaged in converting raw material
into finished product. It may or may not vary directly with the volume of output. Labour
employed for the purpose of carrying out tasks incidental to goods or services provided is
indirect labour. Indirect labour is used in the factory, the office, or the selling and distribution
department. Wages of store-keepers, time-keepers, salary of works manager, salary of salesmen,
etc, are all examples of indirect labour cost.
Expenses
All cost incurred in the production of finished goods other than material cost and labour cost are
termed as expenses. Expenses are classified into two categories:
1. Direct expenses, and
2. Indirect expenses (An item of overheads)
Direct expenses
These are expenses which are directly, easily, and wholly allocated to specific cost center or cost
units. All direct cost other than direct material and direct labour are termed as direct expenses
Direct expenses are also termed as chargeable expenses. Some examples of the direct expenses
are hire of special machinery, cost of special designs, moulds or patterns, feed paid to architects,

surveyors and other consultants, inward carriage and freight charges on special material, Cost of
patents and royalties.
1. Cost center means a location, person, or item of equipment or group of these for which costs
may be ascertained and used for the purpose of cost control.
2. Cost object is anything for which a separate measurement of cost is desired. It may be a
product, service, project, or a customer
Indirect expenses
These expenses cannot be directly, easily, and wholly allocated to specific cost center or cost
units. All indirect costs other than indirect material and indirect labour are termed as indirect
expenses. Thus,
Indirect Expenses = Indirect cost – Indirect material – Indirect labour.
Indirect expenses are treated as part of overheads. Rent, rates and taxes of building, repair,
insurance and depreciation on fixed assets, etc, are some examples of indirect expenses.
Q.02
Overheads:

The term overhead has a wider meaning than the term indirect expenses. Overheads include the
cost of indirect material, indirect labour and indirect expenses. This is the aggregate sum of
indirect material, indirect labour and indirect expenses.
Overhead = Indirect material + Indirect labour + Indirect expenses
Overheads are classified into following three categories:
1. Factory/works/ production overheads
2. Office and administrative overheads
3. Selling and distribution overheads
Factory/works overheads
All indirect costs incurred in the factory for production of goods is termed as
factory/works overheads. Such costs are concerned with the running of the factory or
plant. These include indirect material, indirect labour and indirect expenses incurred in
the factory. Some examples are as follows:
Indirect materials:
(i) Grease, oil, lubricants, cotton waste etc.
(ii) Small tools, brushes for sweeping, sundry supplies etc.
(iii) Cost of threads, gum, nails, etc.
(iv) Consumable stores
(v) Factory printing and stationery
Indirect wages
(i) Salary of factory manager, foremen, supervisors, clerks etc.
(ii) Salary of storekeeper
(iii) Salary and fee of factory directors and technical directors
(iv) Contribution to ESI, PF., Leave pay etc. of factory employee.
Indirect expenses
(i) Rent of factory buildings and land
(ii) Insurance of factory building, plant, and machinery

(iii) Municipal taxes of factory building
(iv) Depreciation of factory building, plant and machinery, and their repairs and maintenance
charges
(v) Power and fuel used in factory
(vi) Factory telephone expenses.
Office and administrative overheads
These expenses are related to the management and administration of the business. They are
incurred for the direction and control of an undertaking. These represent the aggregate of the cost
of indirect material, indirect labour, and indirect expenses incurred by the office and
administration department of an organisation. Some examples are as follows: Office printing and
stationery, Cost of brushes, dusters etc. for cleaning office building and equipments, Postage and
stamps. Salary of office manager, clerks, and other employees, Salary of administrative directors,
Salaries of legal adviser, Salaries of cost accountants and financial accountants, Salary of
computer operator. Rent, insurance, rates and taxes of office building, Office lighting, heating
and cleaning, Depreciation and repair of office building, furniture, and Equipment etc., Legal
charges, Bank charges, Trade subscriptions, Telephone charges, Audit fee etc.
Selling and distribution overheads
Selling and distribution overheads are incurred for the marketing of a commodity, for securing
order for the articles, dispatching goods sold or for making efforts to find and retain customers.
These expenses represent the aggregate of indirect material, indirect labour, and indirect
expenses incurred by the selling and distribution department of the organisation. These
overheads have two aspects (i) procuring orders (ii) executing the order. Based upon this concept
the selling and distributions are studied separately.
I. Selling overheads
Indirect costs incurred in relation to the procurement of sale orders are termed as selling
overheads. Some of the examples of selling overheads are as follows:

Indirect material
(i) Catalogues, price list (ii) Printing and stationery
(iii) Postage and stamps (iv) cost of sample
Indirect wages
(i) Salaries of sales managers, clerks and other employees
(ii) Salaries and commission of salesmen and technical representatives
(iii) Fees of sales directors
Indirect expenses
(i) Advertising
(ii) Bad debts
(iii) Rent and insurance of showroom
(iv) Legal charges incurred for recovery of debts
(v) Travelling and entertainment expenses
(vi) Expenses of sending samples
(vii) Market research expenses.
II. Distribution overheads
Indirect costs incurred in relation to the execution of the sales order is termed as distribution
overheads. Some of the examples of distribution overheads are as follows:
Indirect material
(i) Cost of packing material
(ii) oil, grease, spare parts etc. for maintaining delivery vans
Indirect wages
(i) Salaries of godown employees
(ii) Wages of drivers of delivery vans
(iii) Wages of packers and dispatch staff.
Indirect expenses
(i) Packing expenses

(ii) Godown rent, insurance, depreciation, and repair etc.
(iii) Freight carriage outwards and other transport charges.
(iv) Running expenses of delivery vans, repair, and depreciation.
(v) Insurance in transit etc.
Q.03
1. Cost behavior basis
(a) Fixed Cost
A cost that remains constant within a given period of time and range of activity in spite of
fluctuations in production. Per unit fixed cost varies with the change in the volume of
production. If the production increases fixed cost per unit decreases and as there is decrease in
production, the fixed cost per unit increases. Rent and insurance of building, depreciation on
plant and machinery, salary of employees etc., are some examples of fixed costs.
(b) Variable cost
Variable costs are those cost which vary directly in proportion to change in volume of
production/output. The cost which increases or decreases in the same proportion in which the
units produced is termed as variable cost. Direct material, direct labour, direct expenses, variable
overheads are some examples of variable cost.
(c) Semi-variable cost
A cost contains both fixed and variable component and which is thus partly affected by
fluctuations in the level of activity. Semi-variable costs is that cost of which some part remains
fixed at the given level of production and other part varies with the change in the volume of
production but not in the same proportion of change in production. For example, expenses may
not change if output is upto 50% capacity but may increase by 5% for every 20% increase in
output over 50% but up to 70%. For example, Telephone expenses of which rent portion is fixed
and call charges are variable.

Segregation of semi-variable cost
Semi-variable costs are segregated into fixed and variable cost by using the following formula :
Semi-variable cost = Fixed cost + variable cost
Variable cost per unit = change in cost/change in output
For example, if the cost of production of 2000 units is Rs.26,000 and 25000 units is Rs.30,000
Variable cost per unit = (30000 – 26000)/(2500 – 2000)
= 4000/500
= Rs.8 per unit.
Verification :
Variable cost of 2000 units = 2000 × 8 = Rs. 16,000
Fixed cost = Total cost- variable cost
= Rs.26,000-Rs. 16,000
= Rs.10,000
Alternatively :
Variable cost of 2500 units = 2500 × 8 = Rs.20,000
Fixed cost = Total cost – variable cost
= Rs.30,000 – Rs.20,000
= Rs.10,000
For example,
Semi variable cost Rs.150000 are constant upto 70 % capacity [7,000 units] But increase by 10%
over 70 % but upto 80% and then increase by 20% over 80% but upto 100% capacity.
2. Costs by inventory : Product cost and period cost

Product costs are those cost which are charged and identified with the product and included in
stock value. In other words, the costs that are the cost of manufacturing a product are called
product cost. Product cost includes direct material, direct labour, direct expenses, and
manufacturing overheads.
Period costs are those costs which are not charged to products but are written off as expenses
against revenue of the period during which these are incurred. They are not transferred as a part
of value of stock to the next accounting year. They are charged against the revenue of the
relevant period. Period costs include all fixed costs and total administration, selling and
distribution costs.
3. Cost Relation to Cost Centre : Direct and Indirect costs
All costs are subdivided into direct and indirect costs. The concept of direct and indirect cost is
of basic importance in costing. Costs which are easily and directly allocated to products or units
are termed as direct cost. Direct costs include all traceable costs. In the process of manufacturing
of a product, materials are purchased, wages are paid to labour, and certain other expenses are
also incurred directly. All these expenses are called as direct costs.
The expenses incurred on those items which are not directly charged to a single product because
they are incurred for many products are termed as indirect Costs. The example of indirect costs
are Oil and scrap materials, [indirect materials], salary of factory supervisors [indirect
labour],rent rates and depreciation [indirect expenses]. Indirect costs, often referred to as
overheads have to be apportioned to different products on suitable criterion/criteria.

Summary
The term ‘cost’ means the amount of expenses [actual or notional] incurred on or attributable to
specified thing or activity.
Elements of cost are divided into three groups: Material, Labour, and Expenses.
The term overhead has a wider meaning than the term indirect expenses. Overheads include the
cost of indirect material, indirect labour and indirect expenses. Overheads are classified into
following three categories:
1. Factory/works/ production overheads
2. Office and administrative overheads
3. Selling and distribution overheads
Costs are classified into following categories:
1. Cost behavior basis
(a) Fixed Costs
(b) Variable costs
(c) Semi-variable costs
2. Cost inventory basis
(a) Product costs and period costs
3. Cost Relation to Cost Centre basis
(a) Direct and indirect costs

Q.04
Difference Between Financial and Managerial Accounting.
Accounting , refers to the process of recording, classifying and summarizing in monetary terms,
the business transactions and events and interpreting the results. It is used by entities to keep a
track of their financial transactions.
Financial Accounting and Management accounting are the two branches of accounting. Financial
accounting stresses on giving true and a fair view of the financial position of the company to
various parties.
On the contrary, management accounting aims at providing both qualitative and quantitative
information to the managers, so as to assist them in decision making and thus maximizing the
profit. This article excerpt is created to help you learn the significant differences between
financial accounting and management accounting.
Definition of Financial Accounting
Financial Accounting is an accounting system which is concerned with the preparation of
financial statement for the outside parties like creditors, shareholders, investors, suppliers,
lenders, customers, etc. It is the purest form of accounting in which proper record keeping and
reporting of financial data are done, to provide relevant and material information to its users.
Financial Accounting is based on various assumptions, principles and convention like going
concern, materiality, matching, realisation, conservatism, consistency, accrual, historical cost,

etc. The financial statement consists of a Balance Sheet, Income Statement and Cash flow
statement which are prepared as per the guidelines provided by the relevant statute.
Normally, the statements based on the financial accounting are prepared for one accounting year,
to enable the user to make comparisons regarding the financial position, profitability and
performance of the company in a specific period. Not only external parties but internal
management also gets information for forecasting, planning, and decision making.
Management Accounting
Management Accounting, also known as Managerial Accounting is the accounting for managers
which helps the management of the organisation to formulate policies and forecasting, planning
and controlling the day to day business operations of the organisation. Both the quantitative and
qualitative information are captured and analysed by the management accounting.
The functional area of management accounting is not limited to providing a financial or cost
information only. Instead, it extracts the relevant and material information from financial and
cost accounting to assist the management in budgeting, setting goals, decision making, etc. The
accounting can be done as per the requirement of the management, i.e. weekly, monthly,
quarterly, etc. and there is no format set on the basis of which it is to be reported.
Key Differences Between Financial Accounting and Management Accounting
The following points explain the major differences between financial accounting and managerial
accounting:
• Financial Accounting is the branch of accounting which keeps track of all the financial
information of the entity. Management Accounting is that branch of accounting which
records and reports both the financial and nonfinancial information of an entity.
• Users of financial accounting are both the internal management of the company and the
external parties while the users of the management accounting are only the internal
management.

• Financial accounting is to be publicly reported whereas the Management Accounting is
for the use of the organisation and hence it is very confidential.
• Only monetary information is contained in financial accounting. As against this,
management accounting contains both monetary and non-monetary information such as
the number of workers, the quantity of raw material used and sold, etc.
• Financial Accounting is done in the prescribed format, whereas there is no prescribed
format for the Management Accounting.
• Financial Accounting focuses on providing information about the functioning of the
entity’s business to its users, whereas Management Accounting focuses on providing
information to help them in evaluating the performance and devising plans for the future.
• The Financial Accounting is mainly done for a specific period, which is usually one year.
On the other hand, the management accounting is done as per the needs of the
management say quarterly, half yearly, etc.
• Financial accounting is a must for any company for auditing purposes. On the contrary,
management accounting is voluntary, as no editing is done.
• Financial accounting information is required to be published and audited by statutory
auditors. Unlike, management accounting, which does not require information to be
published and audited, as they are for internal use only.
Q.05
Labour costing, different remuneration systems and incentives plans.
Introduction of Labour Costing

The cost of wages paid to workers during an accounting period on daily, weekly, monthly, or
job, basis, plus payroll and related taxes and benefits.
Method of Remuneration
• Time rate system
• Piece wage system
• Incentive plans
Time rate system
Under this system of wages payment, workers are paid according to the time for which they
work. Payment may be on hourly basis, weakly basis, or monthly basis.
Wages= No. of hours worked ×Rate per hour
Advantages of Time Rate System
• Simplicity
• Security to workers
• Quality of work
• Accepted by trade unions
• Unity in labour
Disadvantages of Time Rate System
• Lack of incentive
• Lower production
• More supervision
• Idle time
• Costing difficulties
Piece wage system

Under this method, workers are paid in proportion to the work done by them. The rate is fixed
per unit of output, per article, per commodity, etc. the worker is paid for the total units
manufactured.
Total earning= Units manufactured ×Rate per unit
Advantages Piece wage system
• Incentive to efficient worker
• Increase in production
• Decrease in production
• Equitable wages
• Simple and easy
Disadvantages Piece wage system
• Lack of secured wages
• Inferior quality of the product
• Injurious to health of workers
• Unsuitable in certain cases
• Difficulties in fixing piece rate
Incentive plans
It induce a worker to produce more to earn a higher wages. Naturally, producing more in the
same period of time should result in higher wages for the worker.
The primary purpose of an incentive plan is to induce a worker to produce more to earn a higher
wages.
Advantages of Incentive plans
• Motivation
• Increased earning

• Loyalty
• Reduced turnover
• Collaborative efforts
Disadvantages of Incentive plans
• Cash bonuses
• Non-cash incentive
• Group incentives
• Commission
Halsey Premium Plan
It is a simple combination of time and piece rate systems. A worker is paid a guaranteed base
rate and is rewarded when his performance exceeds standard.
The total wages payable is calculated as under: =(hourly rate × time taken)+(50% ×time saved
×hourly rate)
Advantages of Halsey Premium Plan
• Simple
• Efficient worker
• Shares benefits
• Minimum base-wage
Disadvantages of Halsey Premium Plan
• Quality suffers
• Fixed bonus
Rowan Premium Plan
A standard time is established in respect of each job or process. There is a guaranteed base rate.

The total wages payable is calculated as under:
= (hourly rate × time taken)+(time saved × time taken)× hourly rate time allowed
Advantages Rowan Premium Plan
• Minimum wage to worker
• Protect the employer
• Gain arising
• Reduction in labour
Disadvantages Rowan Premium Plan
• Not understandable
• Not easy to operate
• Incentive given to workers
• Time saved
Taylor's Differential Piece Rate System
This system was introduced by F. W. TAYLOR ,the father of scientific management.
Definition: Taylor’s Differential Piece-Rate System was introduced by F.W. Taylor, who
believed that the workers should be paid on the basis of their degree of efficiencies. Under this
method, with the help of Time and Motion Study, the standard time for the completion of a job is
fixed on the basis of which the performance of the workers is evaluated.
Taylor’s differential piece-rate system posits that the worker who exceeds the standard output
within the stipulated time must be paid a high rate for high production. On the other hand, the
worker is paid a low rate if he fails to reach the level of output within the standard time. Thus,
there are two piece-rates, one who reach the standard output or exceeds it, is paid 120 percent of
the piece rate. While the one who fails to reach the standard level of output, is paid 80 percent of
the piece-rate. The minimum wages of the worker are not guaranteed.

This system can be further understood through the example given below:
Standard Output = 200 units
Rate per unit = Rs 10 paise
Case (1): Output = 220 units
Earnings = 220 x (120/200) x 0.1 = Rs 13.20
Case (2): Output = 180 units
Earnings = 180 x (80/200) x 0.1 = Rs 7.20
It is clear from the above example that the worker is paid a higher rate (Rs 13.20) for high
production (220 units) and low rate (Rs 7.20) for low production (180 units). Thus, Taylor’s
differential piece rate system works on the principle that the inefficient worker must be paid at a
low piece-rate for low production such that he is left with no other option but to leave the
organization.
ADVANTAGES
• Incentive to efficient workers.
DISADVANTAGES
• Not guarantee minimum wages
• Wide discrimination between efficient and inefficient workers.

Q.06
Classification of Cost
Costs can be classified based on the following attributes:
ByNature
In this type, material, labor and overheads are three costs, which can be further sub-divided into
raw materials, consumables, packing materials, and spare parts etc.
ByDegreeofTraceabilityoftheProduct
Direct and indirect expenses are main types of costs come under it. Direct expenses may directly
attributable to a particular product. Leather in shoe manufacturing is a direct expenses and
salaries, rent of building etc. come under indirect expenses.
ByControllability
In this classification, two types of costs fall:
• Controllable - These are controlled by management like material labour and direct expenses.
• Uncontrollable - They are not influenced by management or any group of people. They include
rent of a building, salaries, and other indirect expenses.
ByRelationshipwithAccountingPeriod
Classifications are measured by the period of use and benefit. The capital expenditure and
revenue expenditure are classified under it. Revenue expenses relate to current accounting
period. Capital expenditures are the benefits beyond accounting period. Fixed assets come under
category of capital expenditure and maintenance of assets comes under revenue expenditure
category.
ByAssociationwiththeProduct
There are two categories under this classification:
• Product cost - Product cost is identifiable in any product. It includes direct material, direct labor
and direct overheads. Up to sale, these products are shown and valued as inventory and they

form a part of balance sheet. Any profitability is reflected only when these products are sold.
The Costs of these products are transferred to costs of goods sold account.
• Time/Period base cost - 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. Profitability and costs are depends on both, product cost and time/period cost.
ByFunctions
Under this category, the cost is divided by its function as follows:
• Production Cost - It represents the total manufacturing or production cost.
• Commercial cost - It includes operational expenses of the business and may be sub-divided into
administration cost, and selling and distribution cost.
ByChangeinActivityorVolume
Under this category, the cost is divided as fixed, variable, and semi-variable costs:
• Fixed cost - It mainly relates to time or period. It remains unchanged irrespective of volume of
production like factory rent, insurance, etc. The cost per unit fluctuates according to the
production. The cost per unit decreases if production increases and cost per unit increases if the
production decreases. That is, the cost per unit is inversely proportional to the production. For
example, if the factory rent is Rs 25,000 per month and the number of units produced in that
month is 25,000, then the cost of rent per unit will be Rs 1 per unit. In case the production
increases to 50,000 units, then the cost of rent per unit will be Rs 0.50 per unit.
• Variable cost - Variable cost directly associates with unit. It increases or decreases according to
the volume of production. Direct material and direct labor are the most common examples of
variable cost. It means the variable cost per unit remains constant irrespective of production of
units.
• Semi-variable cost - A specific portion of these costs remains fixed and the balance portion is
variable, depending on their use. For example, if the minimum electricity bill per month is Rs
5,000 for 1000 units and excess consumption, if any, is charged @ Rs 7.50 per unit. In this case,
fixed electricity cost is Rs 5,000 and the total cost depends on the consumption of units in excess
of 1000 units. Therefore, the cost per unit up to a certain level changes according to the volume
of production, and after that, the cost per unit remains constant @ Rs 7.50 per unit.

Costng accounting

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