ELEMENTS

OF COST
 • Cost Accounting is a method of accounting –

COST • wherein all the costs involved in performing any

ACCOUNTING process, project or product are noted and
analyzed.

• Such analysis helps the management in taking

strategic decisions.

• Cost accounting uses various techniques to

make an organization cost effective.
 • For a standard manufacturing unit the various costs involved can
be segregated into the following :
• Material
ELEMENTS • Labour
• Other expenses
OF COST
• These can be further segregated into the following:
• Direct
• Indirect

• Illustration
Say a toy manufacturing unit procures plastic as a raw material. The cost
of plastic is direct material cost. The costs incurred in the packing and
transportation of the same is the indirect material cost. Similarly, the
labour cost for the production of toys is the direct labour cost whereas
the salary of the production supervisor will be indirect labour cost.
DIFFERENT TYPES OF COST

Fixed Costs
The costs that remain constant despite changes in production, process or projects are referred to as
fixed costs. For example, in a manufacturing unit the salaries of the office staff will remain fixed
irrespective of the production.

Variable costs
These costs vary with the production, process or project changes. For example, in an organization
manufacturing toy, the material and labour cost will be dependent on the production.
 Opportunity cost
The cost incurred in selecting one option over another is
DIFFERENT called opportunity cost.
For example in a toy manufacturing unit with limited labour
TYPES OF hours and material, the decision to produce one particular
COST toy say ‘Dancing Monkey’ will result in non-production of an
other toy say ‘Spinning top’. So while considering the
profitability of toy ‘Dancing Monkey’ the organization has to
consider the profit of ‘Spinning top’ that it forgoes.

Sunk cost
Certain costs are incurred and cannot be recovered are sunk
costs. Continuing with our example of toy manufacturing
unit, sunk costs would refer to machinery cost that has been
incurred.
 It was born to fulfill the needs of manufacturing
companies. Its a mechanism of accounting through
which costs of goods or services are ascertaining and
control for different purposes. It helps to ascertain
the true cost of every operation.
OBJECTIVES The main objectives of cost accounting are as follows:-
OF COST ➢ Cost Ascertainment
ACCOUNTING ➢ Cost Control
➢ Cost Reduction
➢ Fixation of Selling Price
➢ Framing Business Policy
 OBJECTIVES OF COST ACCOUNTING
The main objectives of cost accounting are as follows:-
• Cost Ascertainment : The main objective of cost accounts to find out the cost of product, process, job,
contract, service or any unit of production. It is done through various methods and techniques.
• Cost Control : The very basic function of cost accounts to control costs. A comparison of actual costs with
standards reveals the discrepancies (Variances). The variances reveal whether the cost is within the control or
not. Remedial actions are suggesting to control the costs which are not within control.
• Cost Reduction: Cost reduction refers to the real and permanent reduction in the unit cost of
goods manufactured or services rendered without affecting the use intended. It can be done with the help of
techniques called budgetary control, standard costing, material control, labor control, and overheads control.
• Fixation of Selling Price: The price of any product consists of total cost and the margin required. Cost data are
useful in the determination of selling price or quotations. It provides detailed information regarding various
components of cost. It also provides information in terms of fixed cost and variable costs, so that the extent of
price reduction can be decided.
• Framing Business Policy: It helps management in formulating business policy and decision making. Break-even
analysis, cost volume profit relationships, differential costing, etc help make decisions regarding key areas of
the business.
ADVANTAGES OF COST ACCOUNTING

Elimination of Wastes, Losses and Inefficiencies

A good cost accounting system eliminates wastes, losses and inefficiencies by
fixing standard for everything.
Cost Reduction
New and improved methods of production are followed under cost accounting
system. It leads to cost reduction.
Identify the reasons for Profit or Loss
A good cost accounting system highlights the reasons for increasing or
decreasing profit. If so, the management can take remedial action to maintain
profitability of the concern. There is no possibility of shutting down of any
product or process or department.
 ADVANTAGES OF COST ACCOUNTING

Advises on Make or Buy Decision

On the basis of cost information, the management can decide whether make or buy a
product in open market.
Price Fixation
The total cost of a product is available in the costing records. It is highly useful for price
fixation of a product.
Cost Control
Budgets are prepared and standards are fixed under cost accounting system. The
expenses are not permitted beyond the budget amount.
Marginal Analysis of Cost
It is done for facilitating the short-term decisions especially during depression period.
 DISADVANTAGES / LIMITATIONS OF COST ACCOUNTING
➢ It is based on Estimation :based on predetermined data
➢ No Uniform Procedure in cost accounting: with the same information different results
may arrive
➢ A large number of conventions and estimates: material to be issued on average or
standard price , Overheads are charging on % basis etc.
➢ Formalities are more: more formalities to obtain benefits, not apply to small and
medium firms
➢ Expensive: requires reconciliation with FS
➢ Secondary Data: Depends on financial statements (error or shortcomings)
COST
CLASSIFICATION
Definition: Cost classification
is the logical process of
categorizing the different
costs involved in a business
process according to their
type, nature, frequency and
other features to fulfil
accounting objectives and
facilitate economic analysis
BASIS OF COST
CLASSIFICATION
 BASIS OF COST CLASSIFICATION

Labour: Labour cost is the Material: Material cost is the

salary and wages paid to the cost of the raw material and
employees, i.e. permanent, its related cost such as
temporary or contractual procurement cost, taxes,
employees working in an insurance, freight inwards,
organisation. It also etc.
includes PF contribution,
bonus, commission, incentives,
allowances, overtime pay, etc.

Other Expenses: All the other overheads

excluding material and labour comes under
this head. Some of these are packaging,
promotion, job processing charges, etc.
 BASIS OF COST CLASSIFICATION

Direct Cost: Direct cost is the Indirect Cost: Indirect cost is

significant cost immediately the cost which cannot be
associated with a production directly allocated to a particular
process. It can be seen as a process of production. It is a
prime cost for any business. It is secondary cost and is majorly
sub-divided into direct material seen as of three types – indirect
cost, direct labour cost and other material cost, indirect labour
direct expenses. cost and other indirect expenses.
 BASIS OF COST CLASSIFICATION

Selling: The indirect costs Research and Development:

Production: Production Research is essential to develop
cost comprises of all the incurred on the sales function
of the goods and services like an a new product or modify an
direct and indirect costs existing one. The cost incurred
incurred in the advertisement, promotion,
research, customer service, etc. on the research team, research
production of goods and implementation, findings, etc.
services. are clubbed under selling cost.
comes under this category.
Administration: The costs Distribution: Distribution cost
involved in the management refers to the cost incurred for
activities of an organisation making the goods or services
like electricity, stationery, available to the customers.
telephone expenses, rent etc. These are warehousing, delivery
These are also known as service, transportation, etc.
administrative overheads.
 BASIS OF COST CLASSIFICATION
Fixed Cost: The cost which
is hardly affected by the
temporary change taking
place in business activity is
known as a fixed cost. It
includes, rent, depreciation,
lease, salary, etc.

Semi-Variable Cost: The cost Variable Cost: The cost which

which is moderately influenced changes proportionately with
by the change in business the change in production
activity is called semi-variable quantity or other business
cost. It includes power activity is termed under variable
consumption, maintenance cost, cost. Raw material, packaging,
management cost, supervision sales commissions, wages, etc.
cost, etc are variable costs.
 BASIS OF COST CLASSIFICATION
Normal Cost: The routine cost
associated with the
Differential Cost: When there
manufacturing of goods or
is an increment or decrement
services under usual
in the cost of bulk production,
circumstances is called a normal
the change in the cost of a single
cost. .
unit is also determined which is
known as differential cost. Abnormal Cost: The cost that
arises suddenly and unknowingly
Replacement Cost: When under unfavorable situations is
machinery or any other asset known as abnormal cost. For
becomes obsolete or involve instance; workers go on strike, theft
high maintenance cost, and or robbery, fire in the premises, etc.
simultaneously a better asset Imputed Cost: is also called as implied/
is available in the market Opportunity/ Implicit Cost. For instance;
which can replace it, then the a teacher decides to go back to school to
cost involved in such earn a master's degree. During the
substitution is known as period when she is at school, the
replacement cost. imputed cost of this decision is the
wages she would otherwise have earned
if she had continued to work as a
teacher.
 BASIS OF COST CLASSIFICATION
Batch Cost: The cost incurred Operating Cost: Operating cost
while producing a whole lot refers to the day to day expenses
comprising of identical products incurred by an organisation to
(batch) is known as batch ensure uninterrupted functioning
cost. Examples: Pharmaceuticals, of the business is known as an
automobiles, electronic products operating cost.
Operation Cost: The cost
Joint Cost: The combined cost involved in a particular business
involved in the production of two function contributing to the
or more useful products production process is known as
simultaneously is known as the operation cost.
joint cost. For example; the cost of
processing milk to get cottage
cheese and buttermilk. Process Cost: The cost incurred
Contract Cost: The cost of entering on performing different
into a contract with a buyer or operations in a streamlined
seller by mutually agreeing to the production process is termed as
terms and conditions so mentioned is a process cost.
called a contract cost.
 BASIS OF COST CLASSIFICATION
Pre-determined Cost: The cost
Historical Cost: Any actual cost which can be identified and
ascertained and evaluated after it calculated before the production
has been incurred, is termed a of goods and services based on
historical cost. the cost factors and data is called
a pre-determined cost.

Estimated Cost: The cost of

business operation presumed on
Standard Cost: An actual cost the grounds of experience is
which is pre-determined as per known as an estimated cost. It is
certain norms and guidelines to merely based on assumptions and
provide as a base for cost control, therefore considered to be less
is termed as a standard cost. accurate to determine the actual
cost.