Course Name: Cost and Management
Accounting
Module 2: Cost Concepts
Introduction
• Cost is the amount of resource given up in exchange for some goods or
services. The resources given up are money or money’s equivalent expressed
in monetary units.
• The process of ascertaining the cost is known as costing. It consists of
principles and rules governing the procedure of finding out the costs of
goods/ services.
• Cost accounting may be regarded as “a specialised branch of accounting
which involves classification, accumulation, assignment and control of costs.”
• The Costing terminology of C.I.M.A. London defines cost accounting as “The
establishment of budgets, standard costs and actual costs of operations,
processes, activities or products, and the analysis of variances, profitability or
the social use of funds.”
Objectives of cost accounting
• To analyse and classify all expenditures with reference to the cost of products
and operations.
• To arrive at the cost of production of every unit, job, operation, process,
department or service and to develop cost standard.
• To indicate to the management any inefficiencies and the extent of various
forms of waste.
• To provide data for periodical profit and loss accounts and balance sheets at
intervals as may be desired by the management.
• To reveal sources of economies in production having regard to methods, types
of equipment, design, output and layout.
• To provide actual figures of cost for comparison with estimates and to serve
as a guide for future estimates or quotations and to assist the management in
their price-fixing policy.
Objectives of cost accounting
• To show, where standard costs are prepared, what the cost of production
ought to be and with which the actual costs which are eventually recorded
may be compared.
• To present comparative cost data for different periods and various volumes of
output.
• To provide a perpetual inventory of stores and other materials so that interim
profit and loss account and balance sheet can be prepared without stock
taking and checks on stores and adjustments are made at frequent intervals.
• To provide information to enable management to make short-term decisions
of various types, such as quotation of price to special customers or during a
slump, make or buy decision, assigning priorities to various products, etc.
Importance of cost accounting
• Cost accounting provides detailed costing information to the management to
enable them to maintain effective control over stores and inventory, to
increase efficiency of the organisation and to check wastage and losses.
• Investors, banks and other money lending institutions can base their
judgment about the profitability and future prospects of the enterprise on the
costing records.
• Employees are benefited, through continuous employment and higher
remuneration by way of incentives, bonus plans, etc. that is possible by an
efficient system of costing.
• Control of costs, elimination of wastages and inefficiencies led to the progress
of the industry and, in consequence of the nation as a whole.
Scope/functions of cost accounting
• Cost Ascertainment: Ascertainment of cost of product or services
rendered includes collection, analysis of expenses and measurement of
production at different stages of manufacture.
• Control of Costs: It is essential to examine each individual item of cost in
the light of the services or benefits obtained so that either the cost may
be utilised to the fullest or it may be recovered.
• Management decision making: A good cost accounting system helps in
Cost Benefit Analysis, thus making decision making easy.
Cost classification - On the basis of time
• Historical cost: Ascertained after they are incurred, these are available
only when the production of a particular thing has already been done.
• Pre-determined cost: These costs are calculated before they are
incurred on the basis of a specification of all factors affecting cost.
Cost classification - On the basis of nature or elements
• Direct material is the material which becomes a major part of the
finished product and can be easily traceable to the units.
• Indirect material is that which is used for purposes ancillary to
production and which can be conveniently assigned to specific physical
units is termed as indirect materials.
• Direct labour is the wages paid to workers who are engaged in the
production process whose time can be conveniently and economically
traceable to units of products.
• Indirect labour is the labour employed for the purpose of carrying tasks
incidental to goods or services provided.
Cost classification - On the basis of nature or elements
• Direct expenses are incurred on a specific cost unit and identifiable with
the cost unit.
• Indirect expenses cannot be directly, conveniently and wholly allocated
to cost centre or cost units.
• Overheads: It is the aggregate of indirect material costs, indirect labour
costs and indirect expenses.
Cost classification - On the basis of degree of traceability
• Direct cost: The direct costs are those which can be easily traceable to a
product or costing unit or cost center or some specific activity.
• It is also called traceable cost.
• Indirect cost: The indirect costs are difficult to trace to a single product
or it is uneconomic to do so.
• It is also called common costs.
Cost classification - On the basis of functions
• Production cost: Total cost incurred from the production.
• Administration cost: Cost incurred for formulating policy, directing the
organization, the controlling the operation of a firm, production and selling
function.
• Selling cost: The expenditure related in seeking of demand and stimulating
the demand.
• Distribution cost: The cost related to packing of product available for dispatch
and the cost incurred for the returned empty containers if any.
Cost classification - On the basis of variability
• Fixed cost: A cost which tends to be unaffected by variations in volume
of output.
• Variable cost: A cost which tends to vary directly and proportionately
with the volume of output.
• Semi-fixed cost: The cost, which is partly fixed and partly variable, is
semi-fixed or semi-variable cost.
Cost classification - On the basis of controllability
• Controllable cost: The cost, which is influenced, by the action of a given
person of the firm is controllable cost.
• Sometimes the time factor and the decision making authority can make
a cost controllable. If the time period is long enough, all costs can be
controlled.
• Uncontrollable cost: The cost, which is not influenced, by the action of
any given person of the firm is uncontrollable cost.
Cost classification - On the basis of relationship with accounting
period
• Capital cost: The cost that is incurred in purchasing of asset either to cash
income or to increase the earning capacity is the capital cost.
• Capital expenditure provides benefit to future period and is classified as an
asset.
• Revenue cost: Any expenditure is done in order to maintain the earning
capacity of the concern is the revenue cost.
• Revenue expenditure benefits only the current period and is treated as an
expense.
Cost classification - On the basis of managerial decisions
• Marginal cost: Marginal cost is the aggregate of variable cost. Variable cost
varies with the volume of output.
• Differential cost: Differential cost has been defined as “the difference in total
cost between alternatives, calculated to assist decision making”.
• Imputed cost: Costs that are not incurred and are useful while taking decision
pertaining to a particular situation.
• Replacement cost: Replacement cost is the cost of replacement of an asset at
the current market price.
Cost classification - On the basis of managerial decisions
• Opportunity cost: Opportunity cost is the cost of selecting one course of
action and the losing of other opportunities to carry out that course of
action.
• Sunk cost: A sunk cost is one that has already been incurred and cannot
be avoided by decisions taken in the future.
• Shut down cost: These are costs which continue to occur even if there is
temporary stoppage of production activities.
Cost classification - On the basis of managerial decisions
• Conversion cost: It refers to cost of converting raw material into partly
or fully finished product.
• Avoidable cost: Avoidable costs are those costs which can be avoided by
discontinuation of a product or department.
• Unavoidable cost: Unavoidable costs are those costs which cannot be
avoided by discontinuation of a product or department.
T h a n k Yo u … .
