Introduction to Cost Accounting
Introduction:
Financial Accounting is the father of accounting system. Cost Accounting is a branch of
accounting and has been developed due to the limitations of financial accounting. Cost
accounting provides the specific and detailed information about finance, administration,
production & distribution and operating efficiency about the various individuals, sections,
departments and divisions in an organization. It plays the key role in data feeding and
processing the business transactions.
Definition of Cost: “It is the amount of expenditure (actual or notional) incurred on or
attributable to a given thing”. ICMA LONDON
Costing: “The technique and process of ascertaining the cost of a given thing”. ICMA
LONDON
Meaning of Cost Accounting: It is a branch of accounting which specializes in the
ascertainment of cost of products and services.
Definition: It is defined as “the process of accounting for cost from the point at which
expenditure is incurred or committed to the establishment of its ultimate relationship with
cost centers and cost units”. CIMA UK
Objectives of Cost accounting:
1. Cost Ascertainment
2. Cost Control
3. Determination of selling price
4. Guide to business policy
5. Determination of profit
Comparison between Financial accounting and Cost accounting:
Basis Financial Accounting Cost accounting
Purpose The main purpose of financial The main purpose of Cost
accounting is to prepare profit & Loss accounting is to provide detailed
Account & Balance sheet for reporting cost information to management,
to owners or shareholders & others i.e., internal users.
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outside agencies, i.e., external users.
Format of presenting It has a single uniform format of It has varied forms of
information presenting information,i.e., P/L a/c, presenting cost information
Balance sheet & cash flow statement which are tailored to meet the
needs of management and thus
lacks a uniform format.
Statutory requirements These accounts are obligatory to be Maintenance of these accounts
prepared according to the legal is voluntary except in certain
requirements of companies Act and industries where it has been
Income Tax Act. made obligatory to keep cost
records under the companies
act.
Analysis of cost and It shows the profit or loss of the It provides detailed information
profit business as a whole. about cost and profit data.
Control aspect It lays emphasis on the recording of It provides for a detailed
financial transactions and does not system of controls with the help
attach importance to control aspect. of certain special techniques
like standard costing &
budgetary control.
Periodicity of reporting Financial reports are prepared usually Cost reporting is a continuous
on a year to year basis process and may be on daily
weekly, monthly basis, etc.
Historical and It is concerned almost exclusively It is concerned not only with
predetermined costs with historical records. historical costs but also with
predetermined costs.
Types of Statements Financial Accounting prepares profit It generates special purpose
prepared & loss a/c and Balance sheet which statements and reports. Ex:
are used by external users. Report on loss of materials
Types of transactions It records only external transactions It records both internal &
recorded. like sales, purchase receipts, etc., external transactions.
with outside parties.
Designing and Installing a Cost Accounting System
The following aspects in relation to setting up a cost accounting system must be understood:
i. Features of a good accounting system.
ii. Precautions for installing an effective cost accounting system
iii. Practical difficulties or challenges in installing cost accounting system
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I Features of a good accounting system.
The system should be practical, simple and capable of meeting the requirements of a
business concern.
The data required for the system must be accurate and authentic.
The outcome of the system must provide relevant data for managerial decision
making.
Complete participation from all employees
System must be cost effective.
II Precautions for installing an effective cost accounting system
The objective of the system
The quality of information required
The structure of the organization must be supportive
The attitude and behavior of the people involved in the process must be well studied
and the need for installation of cost accounting system must be well oriented to them.
III Practical difficulties or challenges in installing cost accounting system
Lack of support from top management
Resistance from accounting staff
Lack of co-operation levels
Shortage of trained staff
Costs of operating the system.
Classification of Costs
1) Classification into Direct and Indirect Costs:
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a) Direct Cost: refers to the cost which is identified easily with a particular product,
process, department or Centre etc.
b) Indirect cost: refers to the cost which is incurred for the benefit of cost unit, cost
center & they are not identified easily with a particular product, process, department or
Centre etc.
2) Classification according to Cost variability & behavior:
a) Fixed Cost: These cost remains constant irrespective the decrease or increase in
volume of production.
b) Variable Cost: These costs are fluctuate according to the volume or output of
production.
c) Semi Variable Cost: These cost is partly fixed & partly variable.
3) Classification according to Controllability:
a) Controllable Cost: is regulated at a given level of management authority.
b) Uncontrollable Cost: cannot be regulated by the management.
4) Functional Classification:
a) Manufacturing Cost (Factory Cost): Cost which begins with supply of raw materials
till completion of production.
b) Administration Cost: Includes all expenditure incurred in connecting to salaries, audit
fees, remuneration, office or legal expenses.
c) Selling & distribution Cost: Which includes expenses belongs to advertising, salaries
of salesman, commission, upkeep and operating charges, showroom rent & rates.
5) Classification of Cost for decision making:
a) Sunk cost: is a cost that has already been incurred & that cannot be changed by any
decision made now or in the future.
b) Differential or incremental cost: It is the difference between the cost of two
alternative decisions, or of a change in output levels.
c) Marginal cost: It is the additional cost of producing one additional unit.
d) Imputed or Notional cost: These are hypothetical costs which are specially computed
outside the accounting system for the purpose of decision making.
e) Opportunity cost: It is the profit lost when one alternative is selected over another.
f) Replacement cost: It is the current market cost of replacing an asset.
g) Out of pocket cost: Out-of-pocket expenses are costs that an individual is responsible
for paying that may or may not be reimbursed later
h) Future cost: An estimated quantification of the amount of a perspective expenditure.
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i) Conversion cost: It is the total cost of converting a raw material into finished product.
Elements of Cost:
1) Material Cost
a) Direct materials
b) Indirect materials
2) Labour Cost
a) Direct labour
b) Indirect labour
3) Expenses
a) Direct expenses
b) Indirect expenses
Prime Cost = Direct materials + Direct labour + Direct expenses
4) Overhead
Overhead= Indirect materials + Indirect labour + Indirect expenses
a) Production Overhead
b) Office & administration Overhead
c) Selling & administration Overhead
Cost Unit: It is defined by CIMA as “unit of product, service or time in relation to which
cost may be ascertained or expressed”
Cost Center: It is defined by CIMA of UK as “ a location, person, or item of equipment( or
group of these) for which costs may be ascertained and used for the purpose of control”.
Advantages of Cost Accounting
1. Reveals profitable & unprofitable activities
2. Helps in cost control
3. Helps in decision making
4. Guides in fixing selling prices
5. Helps in inventory control
6. Aids in formulating policies
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7. Helps in cost reduction
8. Checks the accuracy of financial accounts
9. Prevents frauds & manipulation.
Disadvantages of Cost Accounting
• It is Expensive:
• Only past performances are available in the costing records but the management
is taking decision for future.
• The cost of previous year is not same in the succeeding year. Hence, cost data are not
highly useful.
• Not suitable for small scale organizations
• Use of secondary data.
Proforma or format of Cost Sheet
Particulars Amount Amount
Opening stock of raw materials XX
Add: Purchase of raw materials and carriage inward XX
Less: Closing stock of raw materials XX
Cost of materials consumed XX
Direct wages/Direct labour (productive wages or labour) XX
Direct expenses/productive expenses/chargeable XX
expenses ………….
Prime Cost XXX
…………...
Add: Works/ factory/ manufacturing over heads:
Rent and rates, works manager salary, cleaning charges, light,
gas and water, haulage, fuel, lubricating oil, depreciation on
plant & machinery, loose tools written off, motive power,
grease, cotton waste, indirect wages, drawing office salaries,
technical directors fees, R & D expenses and other works
expenses XXX XXX
Total work cost (Before Scrap) …………… …………..
XXX
Less: Scrap XX
Total work cost (After Scrap) …………
Add: Opening stock of work in progress XXX
XX
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Less: Closing stock of work in progress ………….
XXX
XX
Work/factory cost …………..
XXX
Add: Office and administrative overheads: …………..
Staff salaries, depreciation on office furniture, legal expenses,
general manager salary, rent, rates and taxes insurance,
managing director remuneration, directors’ fees, printing and
stationery, postage and telegrams, establishment charges, audit
fees and any other office expenses
XXX XXX
Total cost of production/Total cost of goods sold …………… ………..
Add: Opening stock of finished goods
XXX
XX
Less: Closing stock of finished goods …………...
XXX
Cost of production/ cost of goods sold XX
…………..
XXX
Add: Selling and distribution overheads:
Advertisements, rent of showrooms or sales depots, salesmen
salaries and commission, publicity, packing, rent of warehouse,
upkeep charges of delivery van, depreciation of delivery van,
bad debts, free gifts and samples and any other selling and
distribution expenses
XXX XXX
…………… ………….
Total Cost/ Cost of Sales
Profit/ Loss XXX
XX
Sales or Selling price ………….
XXX
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