COST · 2018-10-17 · Mr. Wheldon defines cost accounting as “The classifying, recording and appropriate allocation of expenditure for the determination of cost of products or

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COSTACCOUNTING-I

[As per New CBCS Syllabus for 3rd Semester B.Com,Tumkur University w.e.f. 2016-17]

Prof. S.V. HalappaM.Com., M.Phil., PGDBM

Associate Professor & Head, Department of Commerce & Management, Pallagatti Adavappa Arts & Commerce First Grade College, Tiptur.

Prof. S. Krishna MurthyM.Com., M.Phil., MBA

Associate Professor & Head, Department of Commerce & Management,Sri Siddhartha First Grade College, Tumakuru.

Dr. S.T. RangappaM.Com., Ph.D.,

Associate Professor & Head, Department of Commerce & Management,Government First Grade College of Arts, Science & Commerce, Sira.

© AUTHORSNo part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by anymeans, electronic, mechanical, photocopying, recording and/or otherwise without the prior written permission of theauthors and the publisher.

First Edition : 2017Second Revised Edition : 2018

Published by : Mrs. Meena Pandey for Himalaya Publishing House Pvt. Ltd.,Ramdoot, Dr. Bhalerao Marg, Girgaon, Mumbai - 400 004

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DTP by : Sneha

Printed at : M/s. Sri Sai Art Printer, Hyderabad. On behalf of HPH.

Indeed, much benefit could be derived from centralizing the teaching of basic accountingin one course in one department, which, in most colleges, would be either the managementor commerce department. If only one such course is offered much needless duplication canbe avoided and a single standard of achievement can be maintained. It is for such a coursethat this book is designed.

This book entitled as a “Cost Accounting-I” is written for degree students of UG courses.The related matters are written in a simple and easily understandable. While writing thisbook, an attempt has been made to present the concepts briefly with examples. The presentwork of us has sincerely tried to highlight the practical areas of accounting. The languageused is very lucid and more informative to both a beginner as well as a professional.

This book aims to provide required course content of the cost accounting which is dividedin six units. Each and every unit is explained with structure and illustrations. Review questionsand practical problems at the end of each unit and carefully selected the view of examinationand practice of assignments.

We wish, this book will be of immerse value to the students who have interest in costaccounting. It is also handly for facilitators of the course, corporates and other interested inthis area. Though the present work is the result of regressiv effort in the area of cost accountingstill expect and accept valuable suggestions from students and fellow professionals in thesame field. May this work of us be useful and flourish to greater heights, We sincerelyacknowledge the earlier works in the area of cost accounting.

We offer our gratitude to Himalaya Publishing House Pvt. Ltd., who is leader in Commerceand Management publications. Our sincere regards to Mr. Niraj Pandey and Mr. Vijay Pandeyfor interest shown and for the best effort put forth by the matter of publication of this book.

Finally, we express our sincere thank to SPS, Bengaluru for their excellent computertypesetting work and the printing.

Any suggestions regarding improvement and errors, if any, will be gratefullyacknowledged.

Bengaluru Authors

June, 2018

Preface

UNIT-I: INTRODUCTION

Meaning and definition of cost, costing and cost accounting, objectives of costing,comparison between cost accounting and financial accounting, cost units andcost centers, advantages and limitations of cost accounting, installation of costaccounting system.

UNIT-II: ANALYSIS AND CLASSIFICATION OF COST

Elements of cost – Classification of cost – Proforma of cost sheet – Problemson detailed cost sheet including tenders and quotations.

UNIT-III: ELEMENT OF COST MATERIAL

Meaning–Types: Direct Material, Indirect Material, Material control – Purchaseprocedure, E-Tenders and E-quotations, Store keeping – Techniques of Inventorycontrol – Setting of stock levels – EOQ, ABC Analysis, VED Analysis – Just– in–time – Perpetual Inventory System – Documents used in Material costing– Methods of pricing Material Issues: FIFO, LIFO, simple and weighted averagemethod– Problems.

UNIT-IV: ELEMENTS OF COST LABOUR

Meaning, Types: Direct labour, Indirect labour; Time keeping – Time booking– Idle time, overtime, Labour turnover, Methods of Labour remuneration, Timerate system, piece rate system, incentive system – Halsey plan, Rowan plan,Emerson’s efficiency plan and Taylor’s differential price rate system – Problems.

UNIT-V: ELEMENTS OF COST OVERHEAD

Meaning, definition – Classification of Overhead – Procedure for accounting andcontrol of overhead – allocation and apportionment of overhead – primarydistribution – secondary distribution – Repeated distribution method andSimultaneous equation method – Problems. Absorption of overhead – methodsof Absorption (problems on machine Hour rate Only).

UNIT-VI: RECONCILIATION OF COST AND FINANCIAL ACCOUNTING

Meaning, Need for Reconciliation – Reasons for differences in profits – Problemson preparation of Reconciliation Statement.

SKILL DEVELOPMENT

1) Prepare a detailed Proforma of cost sheet.

2) Collect the formats of Job card and Time card.

3) Draw a material requisition note, Bin card and Store ledger.

4) Prepare primary distribution summary with imaginary figures.

5) Draw a Proforma of Reconciliation statement and prepare a reconciliation statement with imaginary figures.

Syllabus

Sl. No. Unit Name Page No.

UNIT - 1 INTRODUCTION TO COST ACCOUNTING 1 - 11

UNIT - 2 ANALYSIS AND CLASSIFICATION OF COST 12 - 61

UNIT - 3 ELEMENTS OF COST MATERIAL 62 - 119

UNIT - 4 ELEMENTS OF COST LABOUR 120 - 167

UNIT - 5 ELEMENTS OF COST OVERHEADS 168 - 213

UNIT - 6 RECONCILIATION OF COST AND FINANCIALACCOUNTING 214 - 241

Content

Unit-1INTRODUCTION TO COST

Accounting

Meaning, and definition of cost, costing and cost accounting, objectives of costing,comparison between cost accounting and financial accounting, cost units and costcenters, advantages and limitations of cost accounting, installation of Costaccounting system.

Unit Syllabus

Cost Accounting-I2

INTRODUCTIONIn the earlier times, the concept of costing was defined as the technique and process of

ascertaining costs of a given thing. In sixties, the definition of cost accounting was modifiedas, “the application of costing and cost accounting principles, methods and techniques to thescience, art and practice of cost control and ascertainment of profitability of goods or services”.It includes the presentation of information derived therefore for the purpose of managerialdecision-making. Today, the scope of cost accounting has widened enormously to help theorganosations to achieve its goals. Modern cost accounting is being termed as managementaccounting, since managers being the primary user of accounting information are increasinglyusing the data provided by the accounts, setting objectives and controlling the operations of thebusiness.

Today, the wide usage of cost accounting techniques has led to new concept ofinformation technology, operation control and performance measurement. The concept ofcosting activity-based on budgeting, strategic, flexible production systems etc., are the recenttrend in cost management, Target costing, Life Cycle Costing.

Meaning of CostThe simple word ‘cost’ has a variety of meanings according to the context. For a

common man, the word cost means the price. But in management terminology, the termcost refers to the amount of expenditure incurred or attributed to manufacture a productand render service.

Definition of CostingAccording to CIMA terminology, the term costing means, “The techniques and process

of ascertaining costs. As a technique costing follows certain principles in ascertaining thecost such as classifying, identifying, of cost into cost unit and cost centre. As a process, itfollows a definite procedure in ascertaining the costs. Apply job costing, process costing etc.ascertaining the cost.

Meaning of Cost AccountingCost accounting means the process of accounting for cost. It starts recording of income

and expenditure and ends with periodical cost reports to management for the purpose of costcontrol.

Definition of Cost Accounting

Mr. Wheldon defines cost accounting as “The classifying, recording and appropriateallocation of expenditure for the determination of cost of products or services. The relationof these cost to sale value and the ascertainment of profitability”.

According to Kohler, “Cost accounting deals with the classification, recording, allocation,summarization and reporting of current and prospective costs”.

Introduction to Cost Accounting 3

Meaning of Cost AccountancyCost accountancy is defined by CIMA of UK as “the application of costing and cost

accounting principles, methods and techniques to the science, art and practice of cost controland the ascertainment of profitability. It includes the presentation of information derivedtherefrom for the purposes of managerial decision-making”.

Similarities between Financial Accounts and Cost Accounts1. The fundamental principles of double entry is applicable in both the system of

accounts.

2. Both financial accounting and cost accounting are concerned with the accumulationand presentation of information to serve the needs of management.

3. The source of the two accounts for recording the transaction is the same.

4. Both are in monetary terms.

5. Accuracy of accounts is maintained under both the systems.

OBJECTIVES OF COST ACCOUNTINGThe following are considered to be most important objectives:

1. Ascertaining Costs: The first objective of cost accounting is to find out cost of aproduct, process or service. The other objectives which have been mentioned hereaftercan be achieved only when the costs have been ascertained.

2. Determining Selling Price: After ascertaing the cost of product add certainpercentage of profit to cost to determining selling price. Thus necessary that therevenue should be greater than the costs incurred in producing goods and servicesfrom which the revenue is to be derived.

3. Measuring and Increasing Efficiency: Cost accounting involves a study of thevarious operations used in manufacturing a product or providing a services. The studyfacilitates measuring of the efficiency of the organization as a whole as well as of thedepartments besides devising means of increasing the efficiency.

4. Cost Control and Cost Reduction: Cost accounting assists in cost control it usestechniques such as budgetary control, standard costing etc. for controlling costs. Cost isrequired to be reduced also constant research and development activities help in reductionof costs without compromising with the quality of goods or services.

5. Ascertaining Profits: Cost accounting also aims at ascertaining the profits of each andevery activity. It produces statements at such intervals as the management may require.

7. Providing Basis for Managerial Decision–Making: Costs accounting helps themanagement in decision-making and formulation operative policies.

Cost Accounting-I4

SCOPE OF COST ACCOUNTING1. Cost Ascertainment: It includes collection, analysis of expenses and measurement of

production at different stages of manufacture. The collection, analysis and measurementrequires different methods of costing for different types of production such as Historicalcosts, Standard costs, Actual cost, Process cost, Operation cost etc. After this, costaccountant will use any method of costing like specific order costing, operation costing,and direct costing technique. These techniques and methods may be used for calculatingdifferent nature products in same organization.

2. Cost Records: In this part of cost accounting, cost accountant maintains cost books,vouchers, ledgers, reports and other cost related documents for future comparison andreference. It will also be under the scope of cost accounting. It is also the process ofaccounting for cost which begins with the recording of expenditure and ends on thepreparation of statistical data. It is a formal mechanism by means of which cost ofproduct or services are ascertained and controlled.

3. Cost Control: Cost control is the guidance and regulation by executive action. In thisdivision, cost accountant used different techniques and methods for controlling the cost.Cost accountant uses budgetary control, standard costing, break even point analysis andmany other techniques for controlling the cost. This is the end boundary of costaccounting scope.

SIGNIFICANCE OF COST ACCOUNTING(i) It is useful for the internal working of an organization.

(ii) It helps in detecting the profitable and unprofitable activities of the business concern.

(iii) It enables to measure the qualitative aspects of a business concern. It gives informationon which estimates and tenders are based.

(iv) It helps in detecting the wastages or losses involved in the usage of stock. The exact causeof a decrease or increase in profit or loss can be detected.

(v) The efficient workers can be distinguished from that of inefficient workers.

(vi) It helps the creditors and the investors to know the financial position of the organization.

(vii) It helps the government in the assessment of tax and the formulation of policiesregarding the export trade or import trade.

(viii) It is helpful to the consumers in knowing the price levels of the products or services.Costing plays an important role to the public at large.

(ix) It measures the efficiency and profitability of the concern in specific and the interest ofthe public at large. Thus, cost accounting has a wider application in the modernsociety.

Introduction to Cost Accounting 5

DIFFERENCES BETWEEN FINANCIAL ACCOUNTING AND COST ACCOUNTING

Basis Financial accounting Cost accounting

1. Purpose It serves the interest of business It renders information on for theand other interested parties by guidance of the management for theproviding suitable information in proper planning control and decisionthe financial statements. making.

2. Options FA are required to be kept as CA are voluntary kept to serveper the requirements of the the management in the dischargecompany act and income tax act. of its functions.

3. Analysis FA reveal the profit of the CA shows the profit result of eachbusiness as a whole. operation process and product.

4. Recording It consists of classification It records in an objective mannerrecording and analysis of i.e., according to which cost aretransactions in a subjective incurred.manner i.e., according to thenature of expenditure.

5. Control It lays emphasis on the recording It provides for a detailed system ofaspect, no consideration is given control with the help of standardto control aspect. costing and budgetary control.

6. Reporting It involves reporting of business There is a continuousperformance at the end of the flow of data information of costaccounting year. report to management.

7. Obligation This is to be maintained This is to be maintained voluntarily.compulsorily.

8. Audit Audit of FA is statutory Audit of CA is not compulsory.

9. Duration of FA provides financial information CA furnishes reporting cost data atonce a year. frequent intervals.

10. Pricing It fails to guide the formulation of It provides adequate data forpricing policy. formulating pricing policy.

11. Valuation Stock is valued at cost or marked Stock is always valued at cost of stock rice which ever is less. price.

Cost Accounting-I6

OTHER SPECIFIC COST SYSTEMSOther specific cost systems are as follows:

(i) Imported or National CostIt is hypothetical cost taken into account in a particular situation to represent a benefit

enjoyed by an entity in respect of which no actual expense incurred. For example, Interest onown capital.

(ii) Out of Pocket CostIt is just the opposite of imputed cost. This is that point of cost which represents actual

cash outlay. It is very much relevant in price fixation during trade depression or when a makeor buy decision is to be made.

(iii) Replacement CostIt is the current market cost of replacing an asset or a material.

(iv) Policy Cost

Cost incurred as a result of particular policy decision are policy cost. For example,Ownership of assets will create a charge for depreciation.

(v) Discretionary Costs

It is a cost which arise from yearly budget appropriation and reflect management policyhaving no direct input output relationship between their costs and activity volume. Forexample, All training expenses.

(vi) Engineered Cost

It refers to any cost that has an explicit and specified physical relationship with theselected measure of activity. Such a relationship is established either through engineeringanalysis or analysis of past data. For example, All direct material, direct labour.

(vii) Common Cost

These are costs which are incurred collectively for a number of cost centers and arerequired to the suitably apportioned for determining the cost of individual cost centers. Forexample, Rent of the factory premises may be apportioned over production and service costcenters on the basis of area.

(vii) Traceable Cost

This is cost which is easily identifiable with a department process or a product.

(ix) Joint Cost

It is the cost incurred upto the split of point between individual joint products arisingout of a production process.

Introduction to Cost Accounting 7

(x) Step Cost

Step costs are those costs which increases in steps. These costs remain constant oversmall ranges of output but the cost increases by discrete amounts as activity moves from onerange to the next. For example, Supervisory expenses, light, heating etc.

METHODS OR TECHNIQUES OF COSTINGThe choice of a particular method of costing depends on the nature of business of the

concern. There are two basic methods of costing namely:

(a) Specific or Job Order CostingJob costing is the basic costing method applicable to those industries where the work

consist of separate contracts, jobs or batches each of which is authorized by a specific order orcontract.

(i) Contract Costing: Contract costing is a variant of job costing system applicableparticularly in the case of organizations doing construction work. It is also known asTerminal costing. Each contract, short term or long-term, is treated as a job. It isunderstood that construction work involves massive investment and labour employment.So it may take much time to complete the work and may extend more than year period.

(ii) Batch Costing: Batch Costing is defined as that form of specific order costing whichapplies where similar articles are manufactured in batches either for sale or for usewithin the undertaking. Batch Costing is used where articles are produced in batches andheld in stock for assembly of components to produce finished products or for sale tocustomers. Costs are collected against each batch. When the batch is completed cost perunit is computed by dividing total cost by the number of units in each batch.

(b) Process CostingProcess costing method is applicable where goods result from a sequence of continuous or

repetitive operations or processes and products are identical and cannot be segregated.For example, Chemical Manufacturing Industries.

(c) Service or Operating CostingThe cost of operating a service is known as the operating cost and the method of

ascertaining the operating cost is known as “Operating Costing”.

(d) Unit and Output CostingIn this method, cost per unit of output or production is ascertainedand the amount of

each element constituting such cost isdetermined. In case where the products can be expressedinidentical quantitative units and where manufacture is continuous,this type of costing isapplied. Cost statements or cost sheets are prepared in which various items of expense are

Cost Accounting-I8

classified and the total expenditure is divided by the total quantity produced in order toarrive at per unit cost of production. The method is suitable in industries like brick making,collieries, flour mills, paper mills,cement manufacturing etc.

(e) Multiple CostingUnder this system, the costs of different sections of production are combined after

finding out the cost of each and every part manufactured. The system of ascertaining cost inthis way isapplicable where a product comprises many assailable parts, e.g., motor cars,engines or machine tools, typewriter, radios, cycles etc.

COST UNITA cost unit is a unit of product, service or time in relation to which cost may be

ascertained or expressed.

According to CIMA as “a quantitative unit or product or service in relation to which costsare ascertained”. For example:

a) The cost of cement is associated in terms of per ton.

b) Cost of carrying a passenger in terms of per kms, the cost of sugar is ascertained interms of per quintal etc.

Examples of cost units are given below:

Industry or Product Cost unit

Automobile Number

Biscuit Kilogram

Hospital Patient - day

Bricks Kiln

Coal Cement Tonne

Gas Cubic - foot or

Cubic - metre

Transport Passanger - Kilometer

COST CENTRECost centers is defined as a location, a person or an item of equipment or group of them

in respect of which costs may be ascertained and related to cost units for the purpose of costcontrol. It is the smallest segment of activity or area of responsibility for which costs areaccumulated.

Introduction to Cost Accounting 9

Thus cost centres can be of two kinds, namely:

1. Impersonal Cost Centre

2. Personal Cost Centre

The main purposes of cost centers are:

(i) Recovery of Cost: Costs are collected, classified and accumulated in respect of alocation, person or an item of equipment and then the costs are distributed over theproducts for recovery unincurred cost.

(ii) Cost Control: Cost centres assist in making a person responsible for the control ofexpenditure incurred by the cost center. Manager of each cost center shall control costsincurred in his area of responsibility.

The size of the cost center depends on the activity and operation and feasibility of costcontrol. Sub-cost centers are created if the size of the cost centers become too big from controlpoint of view.

ADVANTAGES OF COST ACCOUNTINGA sound system of cost accounting provides the following advantages:

1. Profitable and Unprofitable activities are disclosed.

2. Costing provides such information upon which estimates and tenders may be based.

3. It reveals losses on inefficiency occurring in any form such as idle time, idle capacity,spoilage etc.

4. Costing guides future production policies.

5. It helps in the preparation of interium final accounts with the help of perpectualinventory system.

6. It helps in controlling the cost with the application of standard costing and budgetarycontrol.

7. It provides an independent and reliable check on the accuracy of Financial Accountingwith the help of the reconciliation of the two at the end of the year.

8. The exact cause of a decrease or increase in the profit and loss of business can belocated.

9. Costing information helps the management in taking the decisions, such as a make orbuy, whether to accept orders below cost etc.

10 Costing system helps the government, wage boards and trade unions in providing datafor price fixation and price control tariff protection and wage fixation.

Cost Accounting-I10

LIMITATIONS OF COST ACCOUNTINGDespite several benefits offered by cost accounting, there are certain limitations also:1. It is expensive: The system of cost accounting involves additional expenditure to be

incurred in installing it and maintaining it.2. The system is more complex: As the cost accounting system involve number of steps

in ascertaining cost, it is considered to be complicated system of accounting.3. Inapplicability: All business cannot make use of a single method and technique of

costing. It all depends upon the nature of business and type of product manufacturedby it.

4. Not suitable for small organisations: A cost accounting system is applicable onlyto a large organisation but not suitable for small organisation.

5. Lack of social accounting: Cost account fails to take into account the socialobligation of the business. In other words, social accounting is outside the previewof cost account.

DESIGNING AND INSTALLING A COST ACCOUNTING SYSTEMInstalling of cost accounting system depends on the objectives of costing, the nature of

business and information flow system.Before designing and installing a cost accounting system the following

considerations have to be taken into account:

(i) To study the existing organization chart and layout of the factory.

(ii) To follow the nature of manufacture carried on.

(iii) To examine the working of the organization its documents and reports.

(iv) To interact with various levels of management to find out expect.While installing the cost accounting system the following factors should be kept

in mind:

(i) The system should be simple and easy to operate.

(ii) It should give correct, timely and adequate information.

(iii) The system should be flexible and capable of adapting to changed situation.

For installing the cost accounting system the following fundamentalrequirements are to be followed:(i) Organization chart which shows the line of authority and delegation of responsibility.

(ii) Departmentalization which divides the organization into production and service costcenters to which expenses are charged.

Introduction to Cost Accounting 11

(iii) Chart of accounts showing control accounts for the elements of cost as well as expenseitems, so as to enable collection and classification of cost both expense wise and costcenter-wise.

REVIEW QUESTIONSConceptual Type

1. What do you mean by cost?

2. Define the term cost.

3. What do you mean by cost accounting?

4. Define cost accounting.

5. What do you mean by costing?

6. Define the term costing.

7. Define cost accountancy.

8. What do mean by cost accountancy.

9. Define cost centre.

10. What are the types of cost centres?

11. What is cost unit?

12. What is cost object?

Analytical Type

1. State the objectives of cost accounting.

2. Mention the advantages of cost accounting?

3. What are the limitations of cost accounting?

4. Distinguish between cost accounting and financial accounting.

5. State the steps involved in the installation of costing system.

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