THE FUNDAMENTAL OF COSTING and CALCULATION OF UNIT COSTS

S M Rahmatul Mujeeb, FCA
KL_MI—Synopsis_Chapter 1,2 & 3_ The Fundamental of Costing and Calculation of Unit Costs 1 | P a g e
Chapter 1, 2 and 3
THE FUNDAMENTAL OF COSTING and CALCULATION OF UNIT COSTS
Cost Accounting: Cost Accounting identifies, defines, measures, reports and analyzes the various elements of direct and
indirect costs associated with producing and marketing goods and services. Originally cost accounting dealt
 Establish inventory valuations, profits or losses and balance sheet items.
 Planning
 Control and
 Decision making
The Cost Accountant: The cost accountant or a person having access to cost information should be able to provide the
following information:
• Assess the profitability of a product, a service, a department, or the whole organization.
• Determine appropriate selling prices with due regard to the costs of sale and target profit margins.
• Determine the value on inventory (raw materials, work in progress, or finished goods)
• future costs of goods and services
• information to make sensible decisions about future profits and costs
Financial Accounting vs Cost accounting:
Point of
Difference
Financial Accounting Cost Accounting
Meaning
Recoding of transactions is part of financial
accounting. We make financial statements through
these transactions. With the help of financial
statements, we analyze the profitability and financial
position of a company.
Cost accounting is used to calculate cost of the product
and also helpful in controlling cost. In cost accounting,
we study about variable costs, fixed costs, semi-fixed
costs, overheads and capital cost.
Purpose
Purpose of the financial statement is to show correct
financial position of the organization.
To calculate cost of each unit of product on the basis of
which we can take accurate decisions.
Recording
Estimation in recording of financial transactions is not
used. It is based on actual transactions only.
Actual transactions and compare it with the estimation.
Hence costing is based on the estimation of cost as well
as on the recording of actual transactions.
Controlling
Correctness of transaction is important without taking
care of cost control.
Cost accounting done with the purpose of control over
cost with the help of costing tools like standard costing
and budgetary control.
Period
Period of reporting of financial accounting is at the
end of financial year.
Reporting under cost accounting is done as per the
requirement of management or as-and-when-required
basis.
Reporting In financial accounting, costs are recorded broadly.
In cost accounting, minute reporting of cost is done per-
unit wise.
Fixation of
Selling Price
Fixation of selling price is not an objective of financial
accounting.
Cost accounting provides sufficient information, which is
helpful in determining selling price.
Relative
Efficiency
Relative efficiency of workers, plant, and machinery
cannot be determined under it.
Valuable information about efficiency is provided by
cost accountant.
Valuation of
Inventory
Valuation basis is ‘cost or market price whichever is
less’
Cost accounting always considers the cost price of
inventories.
Process
Journal entries, ledger accounts, trial balance, and
financial statements
Cost of sale of product(s), addition of margin and
determination of selling price of the product.

Cost Accounting vs Management accounting:
Point of
Difference
Cost Accounting Management Accounting
Meaning
Cost accounting is used to calculate cost of the
product and also helpful in controlling cost. In cost
accounting, we study about variable costs, fixed
costs, semi-fixed costs, overheads and capital cost.
The accounting in which the both financial and non-
financial information are provided to managers is known
as Management Accounting.
Purpose
To calculate cost of each unit of product on the basis
of which we can take accurate decisions.
Providing information to managers to set goals and
forecast strategies.
Controlling
Cost Accounting provides quantitative information only. Management Accounting provides both quantitative and
qualitative information
Reporting
The main objective of the Cost Accounting is the
ascertainment of cost of producing a product,
The main objective of the management accounting is to
provide information to managers for setting goals and
future activity.
Fixation of
Selling Price
There are specific rules and procedure for preparing
cost accounting information
There are no specific rules and procedures in case of
management accounting information.
Relative
Efficiency
The scope of Cost Accounting is limited to cost data Management Accounting has a wider area of operation
like tax, budgeting, planning and forecasting, analysis
etc.
Cost
Any present sacrifice in the form of cash or any other form for obtaining future benefit is called cost
Cost vs Expenses
 The paper goods that were purchased had a cost of $500, and only $400 of the paper items were used at today's
event. The remaining $100 was put in your company's store room for use at the events to be catered in the next few
weeks. In this example, the cost of $500 consisted of a $400 expense and a $100 asset.
 Purchase Cost of Car BDT 2M (Cost) and depreciation for the year BDT 200K (expenses)
Cost objects
A cost object is anything for which cost is incurred
Cost unit vs Unit cost
Cost unit is the standard unit for buying the minimum of any product or service. Unit cost is the minimum cost for buying any
standard unit of product or service
Element of cost
 Material
 Labour
 Overhead
 Production overhead
 Admin overhead
 Selling and distribution overhead
Expenses Loss
Cost
Expired portion of cost
for which benefit is
already has derived
Expired portion of cost
for which benefit has
not derived or will not
derived
Assets
Unexpired portion of
cost for which benefit
will be derived in future

#. Cost Classification
Element of Product
Cost behavior
Relationship of production
Traceability
Functional Department
Association with the Product
Planning, Controlling and decision making
ELEMENT OF PRODUCT
#. Manufacturing Costs:
 Direct Material – consist of all materials that can be identified with specific product that becoming part of the cost
unit (unless used in negligible amounts and/or having negligible cost).
 Component parts or other materials purchased for a particular product, service, job, order or process.
 Primary packing materials like cartons and boxes.
 Direct Labor – consist of labour that can be specifically identified or traced with a specific product (either as basic
hours or as overtime) that can be identified with the cost unit.
 Workers engaged in altering the condition, conformation or composition of the product.
 Inspectors, analysts and testers specifically required for such production.
 Direct Expenses – consist of expenses that are incurred on a specific cost unit other than direct material cost and
direct wages.
 The cost of special designs, drawings or layouts for a particular job
 The hire of tools or equipment for a particular job
 Production (or manufacturing or factory) Overhead – consist of indirect material and or indirect labour and other
indirect manufacturing cost that can be directly identified with specific product
#. Non-manufacturing Costs:
 Admin Overhead – all indirect material costs, wages and expenses incurred in the direction, control and
administration of an undertaking
 Selling & Distribution Overhead – all indirect materials costs, wages and expenses incurred in promoting sales and
retaining customers and packing cost for dispatch and delivering
Production overhead including:
Indirect materials, which cannot be traced to units of the finished product.
 Consumable stores, e.g. material used in negligible amounts or across several different products, factory supplies,
lubricant
Indirect wages, meaning all wages not charged directly to a unit of product.
 Salaries of non-productive personnel in the production department, eg supervisor, inspec
Indirect expenses (other than material and labour) not charged directly to units of production
 Rent, rates and insurance of a factory
 Depreciation, fuel, power and maintenance of plant and buildings
Administration overhead including:
 Depreciation of office equipment
 Office salaries, including the salaries of secretaries and accountants
 Rent, rates, insurance, telephone, heat and light cost of general offices
Selling overhead including:
 Printing and stationery, such as catalogues and price lists
 Salaries and commission of sales representatives
 Advertising and sales promotion, market research
 Rent, rates and insurance for sales offices and showrooms
Distribution overhead including:
 Cost of packing cases
 Wages of packers, drivers and dispatch clerks
 Depreciation and running expenses of delivery vehicles

Variable Factory overhead including:
 Supplies
 Fuel
 Power
 Tools and accessories
 Spoilage
 Overtime premium
Fixed Factory overhead including:
 Salary of Production executives
 Depreciation
 Insurance – factory premises
 Wages of security guard
 Rent of factory
 Maintenance of factory building
Semi Variable/Fixed overhead including:
 Supervision
 Inspection
 Factory office services
 Repair and maintenance of plant and machineries
 Heat, light and Power
 Insurance
COST BEHAVIOR
 Fixed Cost - costs that is not affected by increases or decreases in the level of activity within a certain relevant range.
Fixed cost is in total fixed but per unit variable.
 Variable Cost - cost that increases or decreases as the level of activity increases or decreases. Variable cost is in
total variable but per unit fixed.
 Semi-Fixed/Variable Cost (mixed cost) - costs that are part-fixed and part-variable and are therefore partly affected
by changes in the level of activity
RELATIONSHIP OF PRODUCTION
 Prime Costs – Direct material + direct labour + direct expense (if any)
 Conversion Costs – Cost concerned with transforming direct materials into finished product
TRACEABILITY
Direct and indirect costs
Direct costs are costs identified with a cost object. Indirect costs cannot be identified with a particular cost object. For example
if a chair is a cost object then certain costs such as materials and the labour required to assemble the chair would be classed
as direct costs for an individual chair. Factory rent could not be associated with an individual chair so would be classed as an
indirect cost of the chair. However, if the cost object were the factory itself then the rent is a direct cost of the factory.
FUNCTIONAL DEPARTMENT
Classification under Production department cost (directly attributable to the production) and service department cost (not
directly attributable to the production rather to provide service to the other department)

ASSOCIATION WITH THE PRODUCT
Product Costs - costs that are involved in the acquiring or making product and can be identifiable with goods purchased or
produced, i.e. Direct material, direct labor, manufacturing overhead. This cost also called inventorial costs
Period Costs - costs that are not included in the inventory valuation and treated as expenses in the period that in which
cost is incurred. These costs depends on the period basis, i.e. Office rent
PLANNING, CONTROLLING AND DECISION MAKING
i. Relevant and irrelevant
ii. Controllable and Non-controllable
iii. Avoidable and Unavoidable
iv. Shut down cost
v. Differential cost
vi. Incremental and decremented Cost
vii. Opportunity Cost
viii. Sunk Cost
Opportunity Cost - the potential benefit that is given up when one alternative is selected over another. To illustrate this
important concept, consider the following examples:
Example 1 Vicki has a part-time job that pays 2k per week while attending college. She would like to spend a week at the
beach during spring break, and her employer has agreed to give her the time off, but without pay. The 2k in lost wages would
be an opportunity cost of taking the week off to be at the beach.
Example 2 Suppose that Neiman Marcus is considering investing a large sum of money in land that may be a site for a future
store. Rather than invest the funds in land, the company could invest the funds in high-grade securities. If the land is acquired,
the opportunity cost is the investment income that could have been realized by purchasing the securities instead.
Example 3 Steve is employed by a company that pays him a salary of 38k per year. He is thinking about leaving the company
and returning to school. Since returning to school would require that he give up his 38k salary, the forgone salary would be
an opportunity cost of seeking further education.
Sunk Cost - A sunk cost is a cost that has already been incurred and that cannot be changed by any decision made now or in
the future. Because sunk costs cannot be changed by any decision, they are not differential costs. And because only differential
costs are relevant in a decision, sunk costs can and should be ignored.
REVIEW PROBLEM 1
Required: Classify the above cost
REVIEW PROBLEM 2
For manufacturing a ball following costs are required:
 Material Tk.5 per ball
 Labour cost Tk. 3.5 per ball
 Other indirect material cost Tk. 2 per ball
 Factory rent - 10k, Salary – 8k, Others – 2K
Required: Total cost and per ball cost for the order considering below no:
a. 10k b. 50K c. 100K d. 5k

Method of Costing – two types of method of costing, Process costing and Job costing
Techniques of Costing
 Marginal Costing
 Absorption/full costing
 Uniform coting
 Standard costing
 Historical costing
 Direct costing
Inventory valuation - inventories are valued at the lower of cost and net realisable value.
Pricing method in Inventory valuation
 FIFO (First in, First Out)
 LIFO (Last in, First Out)
 Weighted Average
Work Example:
Required: Closing inventory valuation under FIFO
Work Example:
X company I trader of PQS product. The following information collected fromrecord:
January 1, 2015 (beginning inventory) 16,000 @ Tk.18.00
Purchases:
January 5, 2,600 units @ Tk.20.00
Issued:
January 2, 8,000 units
Required: Prepare schedules to compute the ending inventory at January 31, 2013 under each of the following inventory
methods: (a) FIFO, (b) LIFO, (c) Weighted‐average.

Cost Sheet
Particulars Amount Amount
Opening Stock of Raw Material
Add: Purchase of Raw materials
Add: Purchase Expenses
Less: Closing stock of Raw Materials
Raw Materials Consumed
Direct Wages (Labour)
Direct Charges
***
***
***
***
***
***
***
Prime cost (1) ***
Add :- Factory Over Heads:
Factory Rent
Factory Power
Indirect Material
Indirect Wages Supervisor Salary
Drawing Office Salary
Factory Insurance
Factory Asset Depreciation
***
***
***
***
***
***
***
***
Works cost Incurred ***
Add: Opening Stock of WIP
Less: Closing Stock of WIP
***
***
Works cost (2) ***
Add:- Administration Over Heads:-
Office Rent
Asset Depreciation
General Charges
Audit Fees
Bank Charges
Counting house Salary
Other Office Expenses
***
***
***
***
***
***
***
Cost of Production (3) ***
Add: Opening stock of Finished Goods
Less: Closing stock of Finished Goods
***
***
Cost of Goods Sold ***
Add:- Selling and Distribution OH:-
Sales man Commission
Sales man salary
Traveling Expenses
Advertisement
Delivery man expenses
Sales Tax
Bad Debts
***
***
***
***
***
***
***
Cost of Sales (5) ***
Profit (balancing figure) ***
Sales ***

#. Full or absorption cost of a cost unit--
The full or absorption cost per unit is made up as follows:
 Direct material xxx
 Direct labor xxx
 Direct expense (if any) xxx
 Total direct cost (prime cost) XXX
 Share of indirect/overhead cost xx
 Absorption (Full cost) XXX
#. Determining the share of overhead cost
Following are three stages in determining the share of overhead:
 Overhead allocation
 Overhead apportionment
 Overhead Absorption
 Overhead allocation
The first step in absorption costing is allocation. Allocation is the process by which whole cost items are
charged direct to a cost centre. A cost centre acts as a collecting place for costs before they are analyzed
further.
Cost centres may be one of the following types.
 A production department, to which production overheads are charged.
 A production service department, to which production overheads are charged.
 An administrative department, to which administration overheads are charged.
 A selling or a distribution department, to which sales and distribution overheads are charged.
 An overhead cost centre, to which items of expense which are shared by a number of departments,
such as rent and rates, heat and light and the canteen, are charged.
 Overhead apportionment
The next step in absorption costing is overhead apportionment. This involves apportioning general overheads
to cost centres (the first stage) and then reapportioning the costs of service cost centres to production
departments (the second stage).
First stage: apportioning general overheads
The first stage of overhead apportionment is to identify all overhead costs as production department,
production service department, administration or selling and distribution overhead. Overhead costs should
be shared out on a fair basis.
The common bases used for PRIMARY DISTRIBUTION of production overhead:
Item of Expenditure Basis of Distribution
Rent, Rates & Taxes Insurance of buildings Depreciation of
Buildings
Area occupied
Insurance and depreciation of plant and machinery, tax
(property tax)
Capital value
Insurance of stock (Fire insurance) Stock value
Power Horse power of machines H.P.x machine hours
Heating & lighting Floor area
Cubic content

Electricity Direct (If Metered)
Light points
Floor area
Supervision Wages of operations
Labor hours
Number of employees
Employers liability insurance Number of employees
Direct wages
Store keeping expense Weight or value of materials handled
Internal transport expense No. of requisitions
Value of materials
Establishment, pay-roll, time-keeping, hospital & dispensing,
transport, canteen etc. expenses
No. of employees
Also meals served
For canteen
Second stage: service cost centre cost apportionment
The second stage of overhead apportionment concerns the treatment of service cost centres. For example,
a factory is divided into several production departments and also a number of service departments, but
only the production departments are directly involved in the manufacture of the units.
In order to be able to add production overheads to unit costs, it is necessary to have all the overheads
charged to (or located in) the production departments. The next stage in absorption costing is, therefore,
to apportion the costs of service cost centres to the production cost centres. The common bases used for
SECONDARY DISTRIBUTION of production overhead:
Expense of service department Basis or redistribution
Stores Values or stores issued; quantity of stores issued or number
of materials requisitions.
Time keeping Number of employees; labour hours or machine hours.
Accounts, personnel & training & welfare Number of workers.
Canteen No. of worker; daily count of workers served.
Power house Heat-area or cubic content; electric energy & compressed
air production-metered consumption.
Maintenance Hours of maintenance work done for each cost centre
Production planning Direct labour hours worked in each production cost centre
Service cost centre cost can be apportioned in two ways:
1. Repeated Distribution Method
2. Equation Method
 Overhead absorption
Having allocated and/or apportioned all overheads, the next stage in absorption costing is to add them to,
or absorb them into, the cost of production or sales.
 Production overheads are added to the prime cost (direct materials, labour and expenses), the total
of the two being the factory cost, or full cost of production. Production overheads are therefore
included in the value of inventories of finished goods.
 Administration, selling and distribution overheads are then included. The aggregate of the factory
cost and these non-production overheads is the total cost of sales. These non-production overheads
are therefore not included in the value of closing inventory.

Problem 01
Problem 02

Problem 03
Worked example: Service centre cost apportionment
#. Pre-determined overhead absorption rate--
The predetermined overhead absorption rate is calculated by dividing the budgeted overhead by the
budgeted level of activity. For production overheads, the level of activity is often budgeted direct labor
hours or budgeted machine hour.
#. Blanket absorption rate--
A blanket or single factory overhead absorption rate is an absorption rate used throughout a factory and
for all jobs and units of output irrespective of the department in which they were produced.

#. Under or Over absorption of overheads--
 Under absorption of overhead means that less overheads have been included in the cost of
production than the overhead actually incurred.
 Over absorption means that the overhead charged to the cost of production are greater than the
overhead actually incurred.
The reasons are-
 Actual overhead costs are different from budgeted overhead
 Actual activity level is different from budgeted activity level.
#. Activity Based Costing (ABC)--
Activity Based Costing (ABC) is an alternative approach to absorption costing. In activity based costing,
activity costs are assigned to products or services on the basis of the number of the activity cost drivers
that each product or service generates.
#. Cost drivers--
The cost of an activity are caused or driven by factor known as cost drivers.
Cost Pool: A group of individual costs that is allocated to cost objectives using a single cost driver.
#. The steps of calculating product costs using ABC--
 Identify an organization’s major activities
 Identify the factors(Cost drivers) which cause the costs of the activities
 Collect the costs associated with each activity into cost pools
 Charge the costs activities to product on the basis of their usage of the activities. A product’s
usage of an activity is measured by the quantity of the activities cost driver it generates.

Problem 04
Comparing ABC with traditional absorption costing
#.Different types of costing method--
 Specific order costing: Some organizations produce “one off” products or services to a
customer’s specific requirements. Where unit cost is separately identified from all other.
 Job costing: Job costing is appropriate where each separately identifiable cost unit or job is of
relatively short duration.
 Contact costing: Contact costing is appropriate where each separately identifiable cost unit or
job is of relatively long duration.
 Batch costing: Batch costing is similar to job costing except that each separately identifies cost
unit would be a batch of identical items.
 Process costing: Some organizations have a continuous flow of operations and produce a large
number of identical products.
 Life cycle costing: A product incurs costs over the whole of its life cycle, from the design stage
through development to market launch, production and sales, and its eventual withdrawal from
the market.

Component elements of a product’s cost over its life cycle include the following:
 Research & Development costs; Design, Testing
 Training costs; Including operational training
 Production costs; Materials, Labour
 Distribution costs; Transportation, handling, inventory cost
 Marketing costs; advertising, customer service
 Retirement & disposal costs; dismantling specialized equipments
 Target costing: Target costing works the other way round. It designs with a concept for a new
product and after considering the situation in the potential market for the product, a required
selling price s determined.
 Just- In-Time (JIT): It is an approach to operations planning & control based on the idea that
goods and service should be introduced when they are needed.
JIT consists of JIT purchasing and JIT production.
 JIT production is driven by demand for a product so that no items are produced until they
are needed by a customer or by the next stage in a production process.
 JIT purchasing requires that material is delivered by the supplier just as it is needed in
the production process.
#. Operational requirements for JIT--
The operational requirements are:
 High Quality
 Speed
 Reliability
 Flexibility
 Efficient production planning
 Reliable sales forecasting
#. Advantages of JIT cost approach--
 Warehouse cost
 Improved capacity utilization
 Reduction in waste
 Reduction in write- off due to obsolescence

THE FUNDAMENTAL OF COSTING and CALCULATION OF UNIT COSTS

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THE FUNDAMENTAL OF COSTING and CALCULATION OF UNIT COSTS