1 Cost Accounting
May 06, 2015
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Cost Accounting
Introduction- Meaning Cost accounting is concerned with
recording, classifying and summarizing costs for determination of costs of products or services, planning, controlling and reducing such costs and furnishing of information to management for decision making
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COST ACCOUNTING
The Institute of Cost and Management Accountant, England (ICMA) has defined Cost Accounting as –
“the process of accounting for the costs from the point at which expenditure incurred, to the establishment of its ultimate relationship with cost centers and cost units. In its widest sense, it embraces the preparation of statistical data, the application of cost control methods and the ascertainment of the profitability of activities carried out or planned”.
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Cost Accounting = Costing + Cost Reporting + Cost Control.
Cost Accounting and Accountancy
Cost Accountancy means : “the application of costing and cost
accounting principles, methods and techniques to the science, art and practice of cost control”
It includes the presentation of information derived therefrom for the purpose of managerial decision making.
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Cost Accountancy includes… Cost Accounting Cost Control Cost Reduction Cost Audit
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Objectives of Cost Accounting Ascertainment of cost Estimation of cost Cost Control Cost reduction Determination of selling price Facilitating preparation of financial
and other statements Providing basis for operating policy
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Functions of managerial accounting Determining the cost Providing relevant information for
better decision-making Providing information for planning,
control, decision-making and application
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Application Cost accounting has extended
from manufacturing operations to a variety of service industries such as hotels, bands, airline, etc
Cost accounting system should be flexible and adaptable to meet the new business environment and the changing nature of the company
Cost - Concept Cost refers to the amount of resources
given up in exchange for some of goods or services
The resources given up are always expressed in terms of money.
CIMA defines “ the amount of expenditure (actual or notional) incurred on or attributable to a given thing or activity”.
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Important concepts Cost object Cost Cost unit Cost centre
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Cost object It is an activity or item or operation
for which a separate measurement of costs is desired
E.g. the cost of operating the personnel department of a company, the cost of a repair machine, and the cost for control
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Cost It is the amount of expenditure
incurred on a specific cost object Total cost = quantity used * cost
per unit (unit cost)
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Cost unit It is a quantitative unit of product
or service in which costs are ascertained, e.g. cost per table made, cost per metre of cloth
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Cost centre It is a location or function of an
organisation in respect of which costs are ascertained
E.g. the rent, rates and maintenance of buildings; the wages and salaries of strorekeepers
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Main Elements of Cost Material Labour Expenses
Material The substance from which the product
is made is known as material. It may be in raw, semi- manufactured
or a manufactured state. It can be Direct as well as Indirect.
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Direct materials All material which becomes an integral part of the
finished product and which can be conveniently assigned to specific physical unit is called as ‘direct material’.
The cost of materials – the cost of materials used entering into and becoming the elements of a product or service
E.g. fabrics in garments, crude oil in refinery, bricks, iron and cement in Building.
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Indirect materials All material which is used for purpose
ancillary to the business and which cannot be conveniently assigned to specific physical unit is termed as ‘indirect material’.
Such as stationery, consumable supplies, spare parts for machine that assist to the production of final products.
Labour For conversion of materials into
finished goods, human effort is needed
Such human effort is called Labour. Labour can be direct labour as well
indirect labour.
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Direct labour Labour which takes an active and direct part in
the production of a particular commodity or rendering service is called direct labour.
Direct labour costs are, therefore, specifically and conveniently traceable to specific product or service.
The cost of remuneration for working time E.g. assembly workers’ wages in toy assembly. It is also known as process labour, productive
labour, operating labour etc.
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Indirect labour Labour employed for the purpose of carrying out
tasks incidental to goods or service provided, is indirect labour.
Such labour does not alter the construction, composition or conditions of the product. It cannot be particularly traced to specific units of output.
Such as salaries of factory supervision and office staff that do not directly involve in production of the final product.
Indirect labour may relate to the factory, the office or the selling and distribution divisions
Expenses Any other cost, beside material
and labour cost, is termed as expense.
Expenses may be direct or indirect.
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Direct expenses These expenses which can be directly,
conveniently and wholly allocated to specific cost centres or cost units.
Such expenses are also described as ‘chargeable expenses’
Other costs which are incurred for a specific product or service
E.g. royalties Hiring of some special machinery, required for a
particular construct; cost of defective work etc.
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Indirect expenses Such as rent, rates, depreciation,
maintenance expenses that do not have instant relationships with the manufacturing processes
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Direct cost Cost that can be identified
specifically with or traced to a given cost object
The direct costs consist of the following three elements: Direct materials Direct labour Direct expenses
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Indirect cost (overhead) Cost that cannot be identified
specifically with or traced to a given cost object
They are identified with cost centres as overheads Indirect materials Indirect labour Indirect expenses
Overhead Factory or Works where production
is done Indirect material used in factory such
as oil, lubricants and consumables. Indirect labour such as gatekeeper
salary and works’ manager’s salary Indirect exp. such as factory rent,
insurance and factory lighting
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Office and Administration Overheads Indirect material used in office such as
printing & stationary Indirect labour such as salaries to
office managers, Director, CFO, CEO etc.
Indirect exp. such as insurance, ret and lighting of office
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Selling and Distribution overheads Indirect material used such as packing
material, printing and stationary material
Indirect labour such as salaries of salesman and sales manager
Indirect expenses such as rent insurance and advertising exp.
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Cost accumulation
•Prime cost = direct materials + direct labour + direct expenses
•Production cost = Prime cost + factory overheadAlso known as Factory Cost
•Total cost = Prime cost + Overheads (admin, selling,distribution cost)OR
= Production cost + period cost (administrative, selling, distribution and finance cost)
•Period cost is treated as expenses and matched against sales for calculating profit, e.g. office rental
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Cost Sheet Costs sheet is a document which
provides for the assembly of the estimated detailed cost in respect of a cost centre or a cost unit.
It analyses and classifies in a tabular form, the expenses incurred on different items for a particular period.
COST SHEET
DIRECT MATERIALDIRECT LABOURDIRECT EXPENSES
PRIME COSTFACTORY OVERHEADS
FACTORY COSTOFFICE OVERHEADS
COST OF PRODUCTIONSELL & DIST OVERHEADS
COST OF SALESPROFIT SALES
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Example.. From the following particulars compute the cost of production of
product:Amount
Material Used 12,000
Labour Employed 8,000
Salary of inspector engaged in the product 1,000
Propionate lighting and heating (factory and office 3:2)
500
Proportionate of deprecation, repairs and rent (50% is related to factory)
1,000
Municipal tax and insurance (40% related to office) 800
Trade subscription 100
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Cost Sheet..Particulars Amount
Direct Material: Material Consumed 12,000
Direct Labour: Labour Employed 8,000
Direct Exp: Salary of inspector engaged in the product
1,000
PRIME COST 21,000
Add: Factory overheads lighting and heating deprecation, repairs and rentMunicipal tax and insurance
300500480
FACTORY COST (Prime cost + Factory overheads)
22,280
Add: Office and Administrative overheads lighting and heating deprecation, repairs and rentMunicipal tax and insurance Trade subscription
200500320100
Total Cost of Production (Factory cost+ office exp)
23,400
Exercise.. Calculate total cost Material Used in manufacturing: 5,500 Material Used in packing: 1,000 Material Used in selling the product: 150 Material Used in factory: 75 Material Used in office: 125 Labour required in producing: 1,000 Labour required for supervision of mgt. of factory: 200 Expenses- Direct- Factory: 500 Expenses- Indirect- Factory:100 Expenses- office: 125 Deprecation- office building and equipment: 75 Depreciation- factory: 175 Selling expense: 350 Freight : 500 Advertising : 125
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Classification of Cost Fixed Variable Semi-variable and Step cost
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Variable cost It increases or decreases in direct
proportion to levels of activity, but the unit variable cost remains constant
E.g. cost of food served in a restaurant, raw material, labor (per unit paid)
Also known as product cost. Wages of labour, power and material
cost are example of variable cost.
Variable cost- Total and per unit
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Fixed cost Total fixed cost remains constant
over a relevant range of activity level but unit fixed cost falls with an increase in activity volume.
Salary, rent, insurance are example of fixed cost
Fixed cost- Total and Per unit
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Semi-variable cost It processes characteristics of both
fixed and variable cost It increases or decreases with
activity level but not in direct proportion
Semi- Variable Cost
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Step cost It remains constant for a range of
activity levels, then, on further increase in activity, the cost jumps to a new level and remains constant over a certain range until the next jump occurs
Step costs
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Product cost Product cost are related to the goods
purchased or produced for resale. If the products are sold, the product cost
will be included in the cost of goods sold and recorded as expenses in current period
If the products are unsold, the product costs will be included in the closing stock and recorded as assets in the balance sheet
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Period cost Period cost related to the
operation of a business They are treated as fixed cost and
charged as expenses when they are incurred
They should not be included in the stock valuation
Relevant and Irrelevant Cost
Relevant cots are those costs which would be changed by the managerial decision.
For example, if a company is considering to close unprofitable retail sales shop, wages, salaries payable to the shop workers are relevant in this decision as they will disappear on closing of shop.
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These costs wages, salaries, electricity are relevant for decision making.
On the other hand, prepaid rent, insurance or any other uncovered cost of any equipment which will have to be scarped are irrelevant cost which must be ignored.
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Shutdown and Sunk Costs Shutdown costs are those costs which will
gave to be incurred when plant is closed due to temporary non availability of material, labour or any other key ingredients.
Some fixed cots like deprecation of building, rent, maintenance will have to incur during that period and are called Shutdown cost.
Thus cost which have to incur even if there is no production are called Shutdown costs
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Sunk costs are historical or past costs. These costs are costs which have been
created or incurred by a decision that was taken in past that cannot be changed by any decision that will be made in future.
Investment in plant, machinery, building etc are prime example of such costs.
Since sunk cost cannot be altered by later decision, they are irrelevant for decision making
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Controllable and Uncontrollable cots
Controllable costs are those can be influenced by the action of a specified member of the company.
Cost which can't be so influenced are uncontrollable costs.
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Imputed or Hypothetical costs Costs which don’t involve any cash
outlay . They are not included in the cost
accounts but are important for consideration while making management decisions.
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Differential, Incremental cost The cost difference between two
alternatives is termed as differential cost
Incremental is increase in the cost if increase the production by x number of units.
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Out of pocket costs Present or future cash expenditure
regarding a certain decision which varies depending upon on the nature of decision made.
Own truck verus taking transport company .
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Comparison of cost, management and financial accounting
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Meanings Financial accounting Cost accounting Management accounting
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Financial accounting Provides information to users who
are external to the business It reports on past transactions to
draw up financial statements The format are governed by law
and accounting standards established by the professional accounting policies
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Cost accounting Is concerned with internal users of
accounting information, such as operation managers
The generated reports are specific to the requirement of the management
The reporting can be in any format which suits the user
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Management accounting Comprises all cost accounting
functions The accounting for product and
service costs, management accounting extends to use various internal accounting reports for planning, control and decision making
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Cost and management accounting
Vs.Financial accounting
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Management (cost)accounting
Financial accounting
Nature Records material, labour and overhead costs in product or jobReports produced are for internal management and contol
Records company transaction eventsExternal financial statements are produced
Accounting system
Not based on the double entry system
Follows the double entry system
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Management (cost)accounting
Financial accounting
Accounting principles
No need to use accounting principlesAdopt any accounting techniques that generates useful accounting information
Use Generally Accepted Accounting Principles for recording transactions
Users of information
Used by different levels of management or departments responsible for respective activities
Used by external parties: shareholders, creditors, government, etc
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Management (cost)accounting
Financial accounting
Operation guidelines or standards
Based on management instructions and requirements
Conforms to company Ordinances, stock exchange rules, SEBI , MCA rules etc.
Time span
Reports are prepared whenever neededThey may be prepared on a weekly or daily basis
Reports are prepared for a definite period, usually yearly and half yearly
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Management (cost)accounting
Financial accounting
Time focus
Future orientation: forecasts, estimates and historic data for management actions
Past orientation: use of historic data for reporting and evaluation
Perspective
Detailed analysis of parts of the entity, products, regions, etc
Financial summary of the whole orgainisation
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Cost accountingvs.
Management accounting
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Management accounting
Cost accounting
Objective To provide information for planning and decision making by the management
To ascertain and control cost
Basic of recording
Concerned with transactions related to the future
Based on both present and future transactions for cost ascertainment
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Management accounting
Cost accounting
Coverage Covers a wider area: financial accounts, cost accounts, taxation, etc.
Covers matters relating to ascertainment and control of cost of product or service
Utility Only the needs of internal management
The needs of both internal and external interested groups
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Management accounting
Cost accounting
Types of transactions
Deals with both monetary any non-monetary transactions, covering both quantitative and qualitative aspects
Deals only with monetary transactions, covering only quantitative aspect
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Methods of Costing Costing is “the technique and
process of ascertaining cost”. There are various methods of
costing: Job Costing Contract Costing Batch Costing Process Costing Operation Costing Operating Costing
Job Costing Job costing is used when the production is not
highly repetitive and, in addition, consists of distinct jobs or lots .
Each product produced in the job are identified by order number.
This method is followed by these concerns when work is carried on by the customers request.
Commercial foundry, printing press, specialized industrial equipments are example where job costing is applied.
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Contract Costing
Contract costing is applied for contract work like construction of dams, buildings, roads, civil engineering contract etc. each contract or job is treated as separate cost unit for the cost ascertainment and control.
A contract costing in principle differ from job costing, A contract is a big job while a job is a small contract.
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Batch costing A batch is a group of identical products.
Under batch costing a batch of similar products is treated as a separate unit for the purpose of ascertaining cost.
The total costs of a batch is divided by the total number of units in a batch to arrive at the costs per unit.
This type of costing is generally used in industries like bakery, toy manufacturing, pharmaceutical etc.
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Process Costing This method is used in industries where
production is carried on through different stages or processes before becoming a finished product.
Costs are determined separately for each process. The main feature of process costing is that output of one process becomes the raw materials of another process until final product is obtained.
This type of costing is generally used in industries like textile, chemical paper, oil refining etc.
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Service (Operating) Costing
This method is used in those industries which rendered services instead of producing goods. Under this method cost of providing a service is also determined.
It is also called service costing. The organisation like water supply department, hotels, Railway, transportation, electricity department etc. are the examples of using operating costing.
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Operation Costing This is suitable for industries where
production is continuous and units are exactly identical to each other.
This method is applied in industries like mines or drilling, cement works etc.
Under this system cost sheet is prepared to find out cost per unit and profits or loss on production.
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Techniques of Costing
Following types of techniques are used by management only for controlling costs and making some important managerial decisions. Marginal Costing Direct Costing Absorption or Full Costing Uniform Costing Standard Costing
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Marginal Costing It is a technique of costing in which allocation of
expenditure to production is restricted to those costs which arise as a result of production i.e. costs which vary with production (material, labour and direct expenses-variable only and variable overheads)
Fixed costs are excluded on the ground that in cases where production varies, the inclusion of fixed costs may give misleading results.
It is the ascertainment of marginal cost by differentiating between fixed and variable cost. It is used to ascertain the effect of changes in volume or type of output on profit. 79
Direct Costing It is the practice of charging all direct costs,
variable and some fixed costs relating to operations, processes or products leaving all other costs to be written off against profits in which they arise.
This technique is different from marginal because some fixed costs can be considered as direct costs in appropriate circumstances.
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Absorption or Full Costing It is the practice of charging all costs,
both variable and fixed to operations, processes or products.
This differs from marginal costing where fixed costs are exclude.
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Uniform Costing It is the use of same costing
principles and practices by several undertakings for common control or comparison of costs.
This facilitates inter firm comparison, establishing of realistic pricing policies etc.
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Standard Costing A comparison is made of the actual cost
with a pre-arranged standard cost and the cost of any deviation (called variances) is analyzed by causes.
This permits the management to investigate the reasons for these variances and to take suitable corrective action.
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Historical Costing It is ascertainment of costs after they
have been incurred. It aims at ascertaining costs actually
incurred on work done in the past. It has a limited utility, though
comparisons of costs over different periods may yield good results.
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