Introduction to Cost Accounting
Concepts
Costing
The technique and process of ascertaining the cost
Technique and Process Ascertainment of Cost
• Collection • Collection and Analysis of Expenses
• Classification • Measurement of production at different
• Allocation stages
• Apportionment • Linking production to expenses
Cost Accounting
Branch of accounting that deals with
• Classification
• Recording
• Allocation
of the costs of products and services,
their relation to sales and the related
profitability
Cost Accounting Focuses on:
• Cost Classification
• Cost Recording
• Cost Allocation
• Cost Determination
• Cost Reporting
Cost Accountancy Costing
• Concerned with formulation of • Concerned with
ascertainment of cost
principles, methods, and • Begins where Cost
techniques to be adapted by the Accountancy ends
•business
Is the starting point
• Persons involved are • Persons involved are
Management Accountants Cost Accountants
Cost Accounting
• Concerned with
recording
of cost
• Begins where Costing
ends
• Persons involved Cost
Clerks
OBJECTIVES OF COST ACCONTING
1) Ascertainment of cost: Is normally calculated on the basis of actual information collected from the financial
books
2) Determination of selling price: Business enterprises work for profits. The cost accounting provides information
regarding cost of a product or service. Though the selling price is also influenced by market conditions, which
are beyond the control of any business, it is possible to determine selling price within market constraints by
keeping appropriate profit margin.
3) Cost control: To exercise cost control following steps be observed
i. Predetermine the desired results i.e. set the standards
ii. Measure the actual performance
iii. Compare the actual with the standards
iv. Find the causes of variations
v. Take corrective action
4) Cost reduction: Is real and permanent reduction in unit cost of product manufactured or service rendered
without impairing the quality of product or service
5) Determine costing profit or loss of any activity
6) Assisting management in decision making
Advantages of Cost Accounting:
1) Data on products and activities
2) Minimize losses and wastages
3) Changes / improvement in production methods
4) Comparison with industry standards
5) Price fixation
6) Negotiations with labour and government
7) Selecting the most optimum cost structure
8) Maximum utilization of resources
Criticism against Cost Accounting:
1) Duplication of efforts
2) Expensive
3) External factors influencing prices render data useless
4) Other factors affecting decision-making reduce utility
5) Applicable to limited industries
6) Based on estimates
7) Desired results not always attained due to changing environment
Classification By nature or element Material cost Direct
Indirect
of Costs Labour cost Direct
Indirect
Expenses Direct
Indirect
By function Manufacturing cost
Office and administrative cost
Selling and distribution cost
By behaviour Fixed cost
Variable cost
Semi-variable cost
By controllability Controllable cost
Non-controllable cost
By normality Normal cost
Abnormal cost
COST ACCOUNTING STANDARDS
The Institute of Cost Accountants of India, recognizing the need for structured approach to the
measurement of cost in manufacture or service sector and to provide guidance to the user
organizations, government bodies, regulators, research agencies and academic institutions to achieve
uniformity and consistency in classification, measurement and assignment of cost to product and
services, has constituted Cost Accounting Standards Board (CASB) with the objective of formulating
the Cost Accounting Standards.
Cost Accounting Standard Board (CASB) was set up by the Institute of Cost and Works Accountants
of India (ICWAI) to develop Cost Accounting Standards on important issues/topics relating to Cost
and Management Accounting.
These standards aim to
i. assist the cost accountants in preparation of uniform cost statements
ii. assist the management to follow the standard cost accounting practices
iii. help Indian industry and the government towards better cost management
COST ASCERTAINMENT - ELEMENTS OF COST:
Material Costs: (i) Procurement of Materials, (ii) Inventory Management and Control, (iii) Inventory
Accounting & Valuation (iv) Physical Verification, treatment of losses (v) Scrap, spoilage,
defectives and wastage.
Employee Costs: (i) Time keeping, Time booking and payroll, (ii) Labour Turnover, Overtime and
idle time (iii) Principles and methods of remuneration and incentive schemes (iv) Employee cost
reporting and measurement of efficiency.
Direct Expenses
Overheads: (i) Collection, classification and apportionment and allocation of overheads (ii)
Absorption and treatment of over or under absorption of overheads (iii) Reporting of overhead costs
Cost Allocation
When items of cost are identifiable directly with some products or departments such costs are charged to such cost
centres. This process is known as cost allocation. Wages paid to workers of service department can be allocated to
the particular department. Indirect materials used by a particular department can also be allocated to the
department. Cost allocation calls for two basic factors - (i) Concerned department/product should have caused the
cost to be incurred, and (ii) exact amount of cost should be computable.
For example, depreciation of a particular machine should be allocated to a particular cost centre if the machine is
directly attached to the cost centre
Cost Apportionment
When items of cost cannot directly charge to or accurately identifiable with any cost centres, they are prorated or
distributed amongst the cost centres on some predetermined basis. This method is known as cost apportionment.
Thus we see that items of indirect costs residual to the process of cost allocation are covered by cost
apportionment. The predetermination of suitable basis of apportionment is very important and usually following
principles are adopted - (i) Service or use (ii) Survey method (iii) Ability to bear. The basis ultimately adopted
should ensure an equitable share of common expenses for the cost centres and the basis once adopted should be
reviewed at periodic intervals to improve upon the accuracy of apportionment.
For example, Rent and other building expenses can be apportioned on the basis of floor area, Lighting expenses
can be apportioned on the basis of number of light points, etc..
Cost Absorption
Ultimately the indirect costs or overhead as they are commonly known, will have to be distributed
over the final products so that the charge is complete. This process is known as cost absorption,
meaning thereby that the costs absorbed by the production during the period. Usually any of the
following methods are adopted for cost absorption - (i) Direct Material Cost Percentage (ii) Direct
Labour Cost Percentage (iii) Prime Cost Percentage (iv) Direct Labour Hour Rate Method (v)
Machine Hour Rate, etc.. The basis should be selected after careful maximum accuracy of Cost
Distribution to various production units. The basis should be reviewed periodically and corrective
action whatever needed should be taken for improving upon the accuracy of the absorption.
Cost Centre
CAS-1 by ICWA, defines cost centre as any unit of Cost Accounting selected with a view of accumulating
all costs under that unit. It may be a product, a service, division, department, section, a group of
machineries, a group of employees or a combination of several units. Cost centres may be of different
types:
i. Personal Cost Centre consists of a person or a group of persons, e.g. Production Manager, Finance
Manager, etc..
ii. Impersonal Cost Centre consists of a location or an equipment, e.g. Production Centres like Machine
shop, Assembly shop or Service Centres like Stores, Transport etc..
iii. Production Cost Centre is that engaged in production e.g. Machine shop, Welding shop, Assembly
shop etc..
iv. Service Cost Centre is for rendering service to production cost centre e.g. Power house, Maintenance,
Stores, Purchase office etc..
Cost Unit
CAS-1 by ICWA, defines cost unit as a form of management of volume of production or service. This unit
is generally adopted on the basis of convenience and practice in the industry concerned.
Example: Power-MW , Cement-MT, Automobiles-No. etc.
METHODS OF COSTING
Contract costing
Special features
A. Specific jobs, activities requiring special skills, knowledge and experience are performed on contract
basis e.g. Construction, Civil work, Installation of plant, Setting up refinery, Oil exploration etc..
B. It is normally a long term activity carried on over a period of time
C. Separate contract account is maintained for each contract
D. Contract is performed on site
E. Most of the expenses incurred on site are directly charged to contract
F. Plant and equipments required are either purchased or hired for the duration of the contract
G. Normally contractor pays advance to contractor on the basis of stage of completion certified by an
architect or value
H. Sub-contractor may be appointed to perform part of the contract
Important terms in contract costing
1. Contractor: Is a person or company who is appointed by another person or
company to perform a specific job or activity
2. Contractee: Is a person or company who appoints contractor to perform the job or
activity on his behalf
3. Contract price : Is the amount agreed to be paid by contractee to the contractor for
the job to be performed
4. Certified work : Is the value of work completed as certified by an architect
5. Uncertified work : Is the cost of work completed after the date of architect
certificate before the end of the accounting year. It is valued at cost
6. W.I.P. : Represents value of work certified by an architect and cost of uncertified
work
Treatment for profit on incomplete contract:
Since contract is completed over a period of time it is necessary to give special treatment to account
for the profit at the end of the accounting year .It is accounted for in the following manner
A. When the contract is up to 25% complete: Entire profit is transferred to reserve
B. When contract is > 25% complete but < 50% or equal to 50% complete then Profit = 1/3 (Notional
profit )(cash received /work certified ) is credited to profit and loss account and balance to
reserve
C. When contract is > 50% complete but <90% or equal to 90% complete then Profit = 2/3 (Notional
profit) (cash received / work certified) is credited to profit and loss account and balance to
reserve
D. When contract is more than 90% complete ,the contract is considered almost complete in such case
estimated total profit on completion of the contract is determined by taking into account estimated
additional cost necessary to complete the contract .Then Profit = Estimated profit (cash
received /work certified) OR = Estimated profit (work certified /contract price ) is credited to
profit and loss account and balance to reserve
E. In case of loss on incomplete contract entire loss is transferred to profit and loss account
irrespective of stage of completion of the contract
Type of contracts
A. Fixed price contract :
In which contract price is fixed at the time of signing the contract .Incase of escalation in cost
contractor will suffer financial loss unless an escalation clause is included in the contract .In
case of escalation clause the contractor is entitled to receive additional compensation as per
agreement for increase in cost of material and labour beyond certain percentage .
B. Cost plus contract :
Is a contract in which value of contract is determined by adding margin of profit to the total cost
of the contract as per agreed terms and conditions .It is normally done costs of contract cannot
be accurately determined due to unstable and fluctuating conditions
Process costing:
Is a method of costing used where standardized product is manufactured in large volume on continuous
basis. It is used in industries like chemicals, plastic, textiles, steel fertilizers, oil, food etc..
Special features
A. Entire manufacturing activity is divided into no of stages known as process .All the process are
carried on in the factory .The sequence of process is predetermined and normally cannot be
changed .The output of first process becomes the input of next process.
B. Separate process account is maintained for each process
C. All cost related to concerned process are debited to process account it consist of mainly four
elements material , labour, direct expenses ,production overheads
D. At the end of last process the cost of completed units is transferred to finished goods
E. Production of a product may give rise to Joint and /or By -products
Important terms in process costing
A. Normal loss: Represent loss which is caused by inherent quality of material or product .It is
unavoidable or uncontrollable .It is recorded in process account at scrap value, if no scrap value is
given it is taken as zero. It is calculated at predetermined rate on the basis of input entering the
process.
B. Abnormal loss: Represent loss arising from external factors ,it can be reduced or avoided by taking
precautionary measures such as loss by accident ,fire, labour strike, natural calamity, power failure,
break down of machinery etc.. In process costing abnormal loss is valued at cost and credited to
concerned process account
C. Abnormal gain: Represents excess of actual output over expected output. In other words when
actual loss of process is less than expected normal loss it is called abnormal gain .In process costing
abnormal gain is valued at cost and is debited to concerned process account
Joint products:
Represent two or more products separated in course of same processing operation usually
requiring further processing ,each product being in such proportion that no single product
can be designated as a major product .In other words two or more products of equal
importance produced simultaneously from the same process are called joint products .For
example in oil industry gasoline, fuel oil, lubricants, kerosene etc.. are all produced from
crude oil
Byproducts : Are products recovered as result of processing operation of another product or
they are produced from the scrap or waste of materials of the process .It is a secondary or
subsidiary product which arises as result of manufacture of main product .The point at which
they are separated from main product is known as split off point .The expenses of processing
are joint till the split off point .Examples of byproduct are molasses in manufacture of sugar,
glycerin obtained manufacture of soap, etc.
