2 COST AND MANA 6£M£.

NT Accou

Where as financ ial accou nting mainl y restric ts itself in determ ining
the result of tradin g du .
accou nting period and stating the financ ial positio n as at the end
of the accou nting peri~n g IQ:
accou nting takes the respon sibilit y of ascert aining cost of a produ
ct, proces s or operat i '
genera ting inform ation for contro lling operat ions with a view to maxim
ising profit throug h ef:~ alld
and manag ement accou nting takes the duty of assisti ng the manag ement
makin g by provid ing all inform ation they need.
in planni ng and
SJ
d:;.
DI Cost Accountancy =:J
Cost accou ntancy is define d as "the applic ation of costin g and cost accou
nting princip les, m~
and techni ques to the scienc e, art and practic e of cost contro l and the
ascert ainme nt of profita bi~
as well as presen tation of inform ation derive d theref rom for the purpo
se of manag erial decisi ity
makin g." It is the scienc e, art nnd practic e of a cost accoun tant. It is a
wide term, and it inclu des:
accoun ting, costin g, cost contro l, budge tary contro l and cost audit.

Ill Cost Accounting J

Cost accou nting is define d as the "proce ss of accoun ting for cost from
the point at which expenditure
is incurr ed or comm itted to the establ ishme nt of its ultima te relatio nship
with cost centre s and cost
units." Broad ly speaki ng, cost accoun ting covers the activit ies like
prepar ation of statistk al data,
applic ation of cost contro l metho ds and ascert ainme nt of profita bility
of the work carri,•J out or
planne d. It is the forma l mecha nism by means of which costs of produ
cts or servic es are ,t-.certained
and contro lled.

Ill Costing
While cost accoun tancy is define d as "the applic ation of costin g and
cost accou nting principles,
l
metho ds and techni ques to the scienc e, art and practic e of cost contro
l and the ascerta inment of
profita bility' ' includ ing the "prese ntatio n of inform ation derive d
theref rom for the purpos e of
manag erial decisio n-mak ing"; costin g refers to the techni que and proces
s of ascert aining cost. (Cost,
again, is define d as the actual or notion al expen diture incurr ed on, or attribu
table to, a given process,
produ ct or servic e.)
The techni que of costin g involv es mainly : (a) Collec ting expen diture ;
(b) Recor ding and classifying
the expen diture accord ing to the elemen ts of cost; (c) Alloca tion and apport
ionme nt of the expenditure
to the proces s, operat ion, produ ct or service .

Ill Cost ]
Accord ing to Cost Accou nting Standa rd-I (CAS- 1) cost is a measu remen
t, in monet ary terms, of the
amoun t of resour ces used for the purpo se of produc tion of goods or render
ing service s. Manufacturing
of goods or render ing service s involv es consu mptio n of resour ces. Cost
is measu red by the sacrifice
made in terms of resour ces or price paid to acquir e goods and service s.
Costs are ascerta ined by cost centre s or by cost units or by both.
ElI Cost Object ]
The term 'cost object' is used to denote any activit y for which costs are
requir ed to be determ ined
separa tely. Cost object may be define d as a functio n, organi sation al sub-di
vision , contra ct or other
work unit for which cost data are requir ed and for which provis ion
is made to accum ulate and
measu re the cost of proces ses, project s, jobs, capital ised projec ts and
so forth. Thus anythi ng for
INTRODUCTION 3

which c~st is determined is a cost object such as a department, a product, a sales territory, passenger-
km., patient-day etc. It covers both cost centre and cost unit.

111 Cost Centre /

A cost centre is a location, person or item of equipment (or group of persons or equipment) for which
cost m~y be ascertained and used for the purpose of cost control. Thus, when a cost centre refers to
a location or equipment (or group thereof) it is an impersonal cost centre and when it refers to
a person (or group of persons) it is a personal cost centre.
In organisations having manufacturing activities, cost centres are determined according to the pattern
of the layout_ of the factory. In this case, cost centres may be broadly dassified into : (a) Production
cos! ce_ntres (1.e., those engaged in production work like machine shop, welding shop, grinding shop,
pohshmg shop, painting shop, assembly shop etc.), and (b) Service cost centres (i.e., those engaged in
rendering services to the production cost centres). In production cost centres both direct and indirect
costs are incurred but in service cost centres only indirect costs are incurred. Examples of service
cost centres are: (i) Material service centres (such as stores, internal transport), (ii) Personnel service
centres (such as labour office, labour bureau, canteen), (iii) Plant maintenance centres (such as tool-
room, carpentry, smithy), (iv) Administration centres (such as general office, accounts office, cash
section) etc.
In manufacturing organisations there may be two other types of cost centres. These are : (a) Operation
cost centres consisting of machines and/or persons carrying out similar operations, and (b) Process
cost centres consisting of those engaged on a specific process of manufacture. The cost of a particular
operation or process, irrespective of location, equipment or person in the factory, can be known
through these cost centres.
It may be noted that, in case of personal cost centres, the cost may be analysed and related to any
level of management according to the pattern of organisation. For example, cost may be analysed
and related to works manager, sales manager etc. or at lower level to foreman, store-keeper etc.
The purposes of cost centres are as follows :
Firstly, cost centres locate the responsibility. The manager of a cost centre is responsible for the
control of costs of that centre. Costs are controlled with relation to cost centres and hence, cost
centres are often called 'responsibility centres.'
Secondly, cost centres facilitate recovery of overhead expenses. For example, a number of similar
machines performing similar type of work may be constituted into an equipment type of cost centre.
Expenses may be analysed and related with this cost centre so that hourly rate of recovery on the
basis of machine hours can be ascertained.

111 Cost Unit

A cost unit refers to the unit or quantity of product, service or time (or combination of these) in
relation to which costs may be ascertained or expressed. According to CAS-1 cost unit is a form of
measure of volume of production". Cost unit is generally adopted on the basis of convenience and
practice in the industry concerned. Cost centres help ascertaining costs by location, person, equipment,
operation or process; but cost units help the subdivision of such costs as attributable to products or
services.
The following are the usual cost units in various industries :
1. Ton: in industries like mining, iron nd steel, cement, sugar etc.
2. Metre or Kilometre : in industries like cable, rope, road construction, wire etc.
4 COST ANO MANAG£M£lfr

Litre Kilogram, Ton : in chem ical indus tries. .

3. ' er t
indus tries ec
g
Cubic Metre : in gas indus tries, castin . indus tries, lumb
4.
5. Thousand : in brick fields.
6. Kilo-watt (or Mega-watt) Hour: in powe r indus try.
7, Ton-kilometre or Passenger-kilometre : in transp ort indus tries.
c
s. Bags (of standard weight) : in nuts and bolts indus tries, in mint (manufacturing
. ~
9. Square Metre: in indus tries like nickel platin g, fabric printi ng etc.
IJ Objects of Cost Accounting
The objects of cost accou nting may be stated as unde r :
of a unit of output
1. To record and analy se the expen ses with a view to know the cost
diture . .,
a process or of an opera tion. It involves; therefore, allocation of expen
r are controIJed, :ma
2. To exercise control over cost. Idle time of mach ine and labou
lled so that th
controlled so that wasta ge is minim ised and expen ses are also contro
with the stan
unreasonably inflate cost. Stand ards are set and actua ls are. comp ared
for prope r acti
differences detected are broug ht to the notice of the mana geme nt
ng exerts contra
purpose of control, costs of differ ent perio ds are also comp ared. Costi
.
elements of cost in detail in order to minim ise cost and maxim ise profit
unles s costing
3. To help mana geme nt in fixing the selling price. It is obvio us that,
addin g the mar ~
cost of sales, the selling price canno t be fixed. Selling price is fixed by
fixed just to cov
to cost. Sometimes durin g depression, selling price may have to be
to expand
costs. In that case, the concern runs at a loss for the time being. In order
price contributes a
selling price may be fixed a little over variable costs so that the sellin g
out the competito
sum towards the fixed costs. In this way the concern attem pts to fight
increase the price afterw ards so as to cover the past losses.
4. To help management in its effort to maximise outpu t and profit
. By break-even analysis,
of profit. To achie
can ascertain the appro priate outpu t that gives a desire d amou nt
ation regarding th
output, costing helps the mana geme nt by provi ding neces sary inform
ct-mi x, develop
points of the organisation, possibilities of impro veme nt, desire d produ
by-products etc. ·
probl ems of price nego
5. To help cost negotiation. The basic indus tries may have to face
for such.negotiati
with the Government authorities. Costing system lays the found ation
6- To ~~Ip fore~asting. Long-term forecast requir es the consi derati on of factors like salesi
overall guiding fa
position, capital expenditure, marke t variation, profit expected etc. The
the return on capital. Costing helps forecasting in appro priate mann er.
7 g the period of dep
· T~ h~lp facing depression. Cost accounting grows in impor tance durin
costing personq
It is nghtly s.aid that depression in indus try creates boom in emplo ymen t of
ing new produ
an attempt. to face depression, steps like cost control, cost reduc tion, select
s diverting to new
p:°d~c~-?11x, searching for new sales areas, creating cost-consciousnes
0
activities, discriminating price policy etc. are taken. Witho ut assistan'ce from a good
t h II . p
system the manag emen s a not be able to decide as to which step or steps shall be appro
at th
e moment.
8 To provide a basis f t' · ch
· to provi de inform ation enabl ing estima tes to be
after production. or es imatm g, and
INTRODUCTION 5
9. To provide a basis for determining operating policies. The policies may relate to:
(i) introduction of a new product or new line of production;
(ii) making or buying from outside suppliers;
(iii) s h utting down or operating a department running at a loss ;
(iv) utilisation of spare.capacity ;
(v) future expansion policies;
(vi) continue with the existing plant or replacing them by automatic plant ; and
(vii) determination of cost-volume-profit relationship.

111 Advantages of Cost Accounting

The nature and extent of the advantages that may be expected from a costing system depends upon
the type, .adequacy and efficiency of costing system installed and also upon the preparedness of
management, at all levels, to accept and act upon the advices given by the costing system. A properly
designed system of cost accounting will provide the following benefits to management:
1. Elimination of wastes, losses, inefficiencies: Idle time, lost time, idle facilities, wastage of materials
in the form of spoilage, excessive scraps etc. can be eliminated by employing a good costing
system.
2. Cost reduction: By operational research new and improved methods of production are invented
by a good costing system so as to reduce cost.
3. Detection of reasons for profit or loss: A costing system finds out the actual reasons for reduction
in profit or increase in profit. It identifies the product that runs at a loss and suggests to the
management the ways of its improvement or possibility of shutting it down.
4. Advices on various matters: Cost accountant, on the basis of cost information, can advise the
management in such a way that the management can rightly choose the best out of many
alternatives. Management, without appropriate advice from the cost accountant, cannot decide
whether to buy or make, whether to accept orders below cost or not.
5. Fixation of price: Cost accounting helps the management to fix price and to prepare estimates for
submission of tenders etc.
6. Cost control : Cost accounting, by fixing standards and budgets and comparing the actuals with
standards or budgeted figures and finally analysing the variances, points out to the management
the weak and strong points so that the management can exercise control. Period-to-period cost
comparison also helps control.
7. Assisting the government, trade unions etc. : The Government uses cost information for maximum
price fixation, price control, tariff protection, minimum wage fixation etc. Trade unions also use
cost information for solving trade disputes etc.
8. Marginal analysis of cost: It is done for facilitating short-term decisions, particularly in times of
trade depression. ·
9. Fixation of responsibility: For appropriate cost accounting, cost centres and responsibility centres
are determined. When responsibilities are properly defined and fixecf on individuals, it becomes
difficult to evade responsibility of performance and as a result, overall efficiency improves.
10. Helping preparation of final accounts under financial accounting system: Cost accounts readily
supplies the figures for closing materials, work-in-progress and finished goods. So, final accounts
can be prepared without any delay for ascertaining such values.
r
6 COST AND MANA6£M£NT ACCou

11. Preven tion of frauds etc. thereby helping the manage ment, the govern ment and othersconn
.h h . ti' B . d . d
wit t e orgarus. a don : y mtro ucmg cost audit, frauds can be preven ted, correct an rel
data can_be obtame , not only by the manag ement but a.Jso by the Govern ment, the shareho
_ I
~~~~

m Management Accou nting and Cost Accounting

The accoun ting service throug h which manag ement is assisted , at all levels, in respect
of
making, plannin g, control ling the executi on of plans and apprais ing of perform ances,
is 1cn!:
l accoun .
manage ment accounting. Manag ement accoun ting utilises the inf~rmatior, of both financia
and cost accoun ting in the best interes t of the busines s. It is primar ily concern ed with
suppl)
efficient]
informa tion to the manag ement so that the manag ement can manag e the busines s
ry co
order to maximi se profit. Manag ement accoun ting employ s many techniq ues like budgeta
project account ing, in
margin al analysis, uniform costing, standar d costing, ratio accoun ting,
tion to
audit, fund flow analysi s, cash flow analysi s etc. Cost accoun ting also supplie s·informa
·of,
manage ment and it utilises most of the above techniq ues also. So, the princip al object
consid
manage ment accoun ting and cost accoun ting is similar. Thus, cost accoun ting may be
a part of manage ment accoun ting or manage ment accoun ting may be conside red as the
mana~
aspect of cost accoun ting. . ·
deinarca
Contrasting manage ment accoun ting and Cost accoun ting is somew hat difficul t as the
tely and talk of cost
line betwee n the two is rather blurred . Some avoid the issue comple
two mciy.
manage ment accoun ting. Howev er, the followi ng points of di~tinction betwee n the
noted: · · ·
1. The main object of cost accoun ting is the ascerta inment of cost, cost control and cost
m
The main objective of manage ment accoun ting is to render assistan ce to all levels of manage
d ··
so that produc tivity and efficiency can be improv ed throug h better plannin g, improv ed
making and more effective control. ,
. When
2. Cost accoun ting makes availab le cost data by operati ng a cost-re cording system
ermine d co
inform ation is availab le it is often compa red with an estima ted or pre-det
m
Manage ment accoun ting uses both cost and financial inform ation to advise manage
planning and control ling the organis ation.
manage m
3. Cost accoun ting is concer ned mostly with the curren t year's activiti es while
accounting is concern ed with short-r ange and long-ra nge plannin g. . . _
4. Traditional cost accoun ting is mostly historic al in its appro~ ch and. it proje~t
s th~ 'past b
management accoun ting is futuristic in its approa ch. It is more predict ive i,n 1_1ature
than co
accounting. ,
almost
5. Cost accoun ting operate s in restrict ed areas while manag ement accoun ting has
unrestricted area of operati on, since it is concern ed with the system as a whole, and th~ .'
over
vitality of the organisation. ' · · · ·

m Installation of a Good Costin g System . .. .

an industri
Different industrial underta kings have different problem s. To suit the specific needs of
nd ble :
u ertaking, ~he system of costing should be develop ed and applied . Thus, a system applica
system I[)
one und ertakmg may not be suitable in another underta king. While designi ng a costing
··
any undertaking the following broad principles' should be.born e in mind:
d . . .· ., . .. . . n
1. Least disturbance . B . system the presen t workin g of the orgams atio
h ld . · Y mtro ucmg a costmg
st time, the specific require ments of the
~r ou . b~ di urbed as little as possible. At the same .
gamsation must also be fulfilled .
INTRODUCTION 7

2 , Crea~on of faith: The executives and the work ers shoul d have faith in the syste m in order to create
ted benefits know n to them and
bene~ ts out of that. Faith can be creat ed by maki ng the expec
leads to the prosp ect of all connected
al~ow ~g them to believ e that prosp ect of the organisation
with 1t.
3· Simplicity : The syste m shou ld be simp le to unde rstan d, so that the perso ns place d to work on
the syste m can have a clear idea abou t the syste m.
4 · Easy applicability: Some times the syste m may be simpl e to under stand , but difficult to apply. The
y with sincere appli cation leads to
system must be easy to apply also, becau se easy applicabilit
success.
5 · Gradual application: The syste m shoul d be appli ed step by step i.e., in phase s. Hasty appli cation
cause s disru ption in work and ultim ately ends in failure.
shoul d be so desig ned as to invol ve
6. E~o~omy: The perso nnel patte rn, recor ds and forms etc.
ndere d to economy. So, essential
mmim um cost. It does not mean that efficiency shoul d be surre
and unnec essar y detail s shoul d be
forms and recor ds as well as perso nnel must be main taine d
elimi nated .

m Prer equi sites of a Goo d Cost ing Syst em

The point s that are to be caref ully consi dered before installing
a costing syste m may be descr ibed as
order to deriv e the best benef it out of the
the prere quisi tes and these prere quisi tes must be fulfilled in
syste m. The point s are as below :
ng : The size, layou t and natur e of
1. Consideration of the size, layout and nature of the undertaki
sed costin g syste m shoul d suit such
the unde rtaki ng shall decid e the requi reme nts and the propo
eigh the expec ted benefits. On the
requi reme nts. The cost of the costin g syste m must not outw
cost invol ved. Indus tries whic h
other hand , the bene fits shou ld be much more than the
ng concerns whic h purch ase and
manu factu re good s and servic es requi re cost accounting. Tradi
big manu factu ring concern, with
sell finish ed good s requi re little cost accou nting service. A
costin g syste m desig ned for a simp le
comp licate d manu factu ring activities, canno t do well with a
small manu factu ring conce rn.
e of produ ction , the meth ods of
2. Study of the production nature, methods and stages : The natur
meth od of costing to be appli ed. The
produ ction and the stage s of produ ction shall deter mine.the
every stage of produ ction can be built
system of costing is to be devel oped in such a way that cost at
up.
ties relati ng to the contr ol of mater ials
3. Study of the organisational activities: The prese nt activi
ully studi ed. If there is any defect
and wage s and also to the contr ol of expen ditur e shoul d be caref
g syste m.
or looph ole they shou ld be modi fied so as to suit the costin
ally, every manu factu ring organ isatio n
4. Study of the present departments and their work: Norm
sellin g depa rtmen t and distri butio n
has manu factu ring depar tmen t, admi nistra tive depar tmen t,
tmen ts, their co-or dinat ion etc. are
depar tmen t. The prese nt work ing efficiency of all these depar
and impr ovem ent there of shou ld be
to be studi ed. Inefficiency at any stage shoul d be point ed out
suggested.

mI Methods of Cost ing

princ iples unde rlyin g all these meth ods
There are vario us meth ods or types of costing, but the basic
se the expe nditu re accor ding to the
or types are the same. The basic princ iples are to collect and analy
8 COST AND MANA6£M£Nt It

and to dete rmin e the cost for each cost cent re and/
lements of cos ts or cost unit 'T'L
e . pera tion carr ied out or t h e natu re o f t h e serv ices
. d . ,nena
manufacturing o . ren ered by a cone
th
met hod s of costingern .
.cable to it. Broa dly spea king , ther e are ree mam .
method app1l h
f g and farm costing, the othe rs are e1t er vana nts
. . f th
o ese t h ree meth ods or - Jo
procdefss cos marticular purp ose und er part icula r cond
use or a p ition s. The met hod s whic h combinareth
. b .d
of basic costing syste ms are, acco rdin g to J. Batty, hy rt cost.mg syst ems . e e
• Job Costing . · ·
Under this method, the cost unit is take n to be a job,
sma ll or big, com pris ing of a definite
a product man ufac tured . So, the a_pproach is ~r.od
uct appr oach . Job co~ti~g syst em is use
is desired to ascertain the cost of a JOb or a spec1f1c orde
r or of a batc h of fm1shed good s and a
or loss on each such job. Thu s, prin ters, publ ishe
rs, mac hine tool man ufac ture rs, cat
foundries, painters, buil ders etc. use job cost ing syst
em.
d'lot1. : The approach of job costing system is product approach i.e.,
emphasis is given on the job and costsot
in a job are ascertained. The approach of process costi
ng and farm costing is period approach i.e.,
given on the period or time and costs incurred during a perio
d are ascertained and are divided by the
units produced to obtain unit cost.
The variants of job cost ing are the follo wing :
1. Batch costing: Here the cost of a grou p of prod
ucts is asce rtain ed. A grou p or batch ofi
prod uctio n unit s is take n as a cost unit . (Und er pure
job costing, a sing le job or orde r is
a cost unit.) Batch cost ing is used by engi neer ing facto
ries prod ucin g com pone nts or sp
in economical batc hes and also by factories whic h
prod uce a sma ll num ber of items, b
item on mass scale (furn iture , med icine , garm ents ,
toys , pack ed food , bisc uits etc.). Thea
is prod uct appr oach .
2. Terminal or contract cost ing: Here the cost unit
is a cont ract. The cost of the contract an
or loss there on are asce rtain ed. The exec ution peri
od of the cont ract may exte nd over an:
of years. Buil ding and .cons truc tion engi neer ing
conc erns and ship -bui lder s use COllJ
terminal costing. The appr oach is prod uct appr oach
.
3. Multiple or composite cost ing : Indu strie s whic
h prod uce a num ber of com pone nts an
assemble them into a final com plete prod uct use mult
iple or com posi te costing. The appr
prod uct appr oach . Cos t of each com pone nt is asce
rtain ed and the cost of assembly i
ascertained sepa ratel y. In batc h costing, the cost of
asse mbly is not to be ascertained, beca
assembly is done . Mul tiple or com posi te cost ing is
used by indu strie s like automobile, bi
aeroplane, radi o receiver, television, locomotive,· air-c
ondi tione rs, etc.
1111 Pro cess Cos ting
Where man ufac turin g is carr ied out as a cont inuo us
process, proc ess cost ing is used . The app_
of process costing is peri od appr oach . Cost duri ng
a peri od, depa rtme ntwi se or processW.lS
determined. This cost bein g divi ded by the num ber
of unit s of outp ut duri ng the sam e period .
the unit cost. Indu strie s like refineries, chemical, cem
ent, suga r, phar mac eutic al, gas and ele .
generating concerns, steel indu strie s, soap indu strie
s, leath er indu strie s etc. use process costirt
Variants of process cost ing are the following :
1 · Single or outp
ut costing : Indu strie s whic h prod uce only a sing
le unif orm prod uct or a v
small num ber of simi lar prod ucts or a single prod
uct of diffe rent grad es, use single or oUJ
INTRODUCTION 9

being divided by the numb er of

co~ting. Here the appro ach is period approach. The period cost
breweriesI collieriesI mines and
umts ,produ ced, gives the unit cost. Iron and steel industriesI
quarries etc. use single or outpu t costing.
2 tion is taken as the cost centre. In
· ?perati~n costi ng: Here, instead of the process, each opera
st of distinct operations, operation
md~ n~s w~er e the produ ction is carried out by a number
produ ct there are four distinct
cost m~ is smtabry used. If in the manufacture of a particular
of the finished unit is determined
opera tions and the operation unit costs are a, b, c and d, the cost
by a+ b + c+ d.
3 . Operating costing : The appro ach of operating costing is period approach. It is used in those
goods. Educational institutions,
conce rns whic h rende r 'services' and do not manufacture
operating costing. The respective
hospitals, trans port companies, railways, powe r houses etc. use
lometre, a kilowatt-hour etc. The
cost units are - a stude nt, a bed, a passenger-kilometre/ton-ki
and is divided by the numb er of
cost of an educational institution during a period is ascertained
rns is determined. Operating
stude nts to obtai n unit cost. Similarly, unit cost of other conce
ct natur e, but it may also be
costing may be regar ded as a separate type owing to its distin
regar ded as a varia nt of process costing.

1111 Farm Costing ring indus tries in many respects.

The agric ultur al farms are quite different from the manufactu
ard output. Plant of a farm is the
Manu factu ring indus tries use stand ard plants which give stand
ure. Produ ce of a farm is highly
land whic h varies wide ly from place to place and in soil struct
natur e of labou r used at different
influenced by climate, rainfall, irrigation, nature of manuring,
cts of a manufacturing indus try are
stages from sowin g to harvesting, natur e of seeds used etc. Produ
is that, outpu t of a period, in part at
not influenced by these factors. Another peculiarity of a farm
, onions etc. produ ced in one year are
least, is used as the input of the perio d fo1lowing. Padd y, potato
preserved for using them as seeds in the next year.
of manu factu ring concerns, a new
Thus, owing to the peculiar natur e of farms, as distinct from that
se and it is know n as farm costing.
costing meth od has been applied to farms so as to suit their purpo
oping agriculture throu gh organised
The countries which depen d on agriculture mainly, and are devel
is perio d approach. When only one
farms, suitably use farm costing. The approach of farm costing
of units produ ced gives the unit cost.
crop is produced the perio d cost being divid ed by the numb er
on of crops, unit cost is ascer taine d
When more than one crop is produ ced or where there is rotati
after proper allocation of expenses to different crops.

mI Techniques of Cost ing

for ascertaining cost. These techniques
Within the methods of costing, different techniques may be used
may be group ed unde r the following heads :
1. Historical or absorption costi ng: Costs which are ascer
tained after they have been incur red are
ar to diagn osing a disea se by
historical costs. Historical costing may be found to be simil
control is conce rned, historical
postmortem analysis. This is the traditional costing. So far as cost
costing does not bear much value .
 COST AND MANAG£M£NT AC
10
determined cost: Costs which are ascertained before they have been actua])y in
2
· Pred t mined costs This is like writing the Ramayana much before the birth of Ra cu
pre e er · . ina,,
0 the basis of specification of all the factors affectmg costs, cost of each element is ascerta
a;vance, before the actual productio~. This is, in other ':ords, the cos~ that should be. Th
COS/ t after it is incurred, is compared with the corresponding predetermmed
,
cost and the .
is analysed with reasons, s? that management may take remedial measureg in time.
Predetermined cost may be ascertained under : (a) Estimated costi~g, or under (b) S
costing. Under the former, cost of each element is determined, in advance, on the basis of .
while in the case of standard costi~g, standards ~re set for eac~ element and for each p
process or service, and actual cost 1s compared with predetermined standard and the
(i.e., differences) with reasons are worked out so as to enable the management to take
action. Estimated cost is less accurate than standard cost.
3. Marginal costing: Under this costing technique, costs are classified into two types: (aJ
costs, and (b),Variable costs. Total of variable costs of a unit is called marginal cost. Fix
are recovered from contribution which is the excess of selling price over marginal cost.
costing is very useful for managerial decision, particularly in times of acute competiti
taking 'make or buy' decision, selecting appropriate product-mix, taking 'shut-down'
etc.
4. Uniform costing: Costing principles and or practices being uniformly followed by a
undertakings under common control may be known as uniform costing. Different factories
one management use the same principles and or practice of costing so as to facilitate
comparison of efficiency. Uniform costing is, therefore, a technique for studying comp
efficiency and for promoting efficiency. Factories under different ownership, but under ind
combination, may also follow uniform costing for the same benefit. Even, the scope of
costing may be extended to firms in different countries.
5. Incremental or differential cost: \\Then a change is made in the level of output or in produ
or in pattern of production or in method of production, the resulting increase in total
called incremental cost. It is important to ascertain incremental cost in order to judg
desirability of effecting the change from the point of view of cost, revenue and profit.
6. Out-of-pocket cost : It is that part of the cost which involves cash payment to third parti
opposed to cost that does not require any cash outlays, such as depreciation. This is impo
for the purpose of price fixation during trade depression, for takiJ:'g 'make or buy' decision
7· ~mputed or notional cost : Imputed
costs are hypothetical notional costs not involving pa .
m cash or kind. For example, interest on own capital, rent of own building, salary to the propn
manager etc. are not required to be paid. But these costs are taken into consideration for
purpose of comparison. Imputed cost does not find place in accounts, but is considered fo
purpose of comparison, as in case of opportunity cost. · ·
8
· Oppo~nity cost: Men, material, finance etc. may be used in different ways. When us
a _particular way they give a particular return. If the same are used in different ways the~
give the ~ame or a different return. The original return which is no longer obt~inable 15
~pportumty cost. For example, t 10,000 invested in some investment gives an annual inCO
~ l,OOO: The investment is realised at par and put into a business. The opportunity COS
l,OO~ 1.e., the interest lost. Opportunity cost never finds place in the books of accounts, but
taken into cons1'd erahon · f or the purpose of comparison.
INTRODUCTION 11
9. Sunk cost: Sunk cost is the cost which is incurred (i.e., 'sunk') in the past and as such, irrelevant
for considering a particular decision making problem. The depreciated book value of an old plant
is not relevant while considering replacement of the same because the amount is a sunk cost
which is to be written off at the time of replacement. Sunk costs are not affected by increase or
decrease in volume of production.

Ill Classification of Cost 1

In order to provide useful information for management, it is necessary to classify (or analyse) costs
appropriately as the analysed details will provide much more information for management than
can be derived from the total information alone. Total cost can be classified in several ways and the
following are examples of the more usual forms of classification :
A. Element-based Classification :
The basic elements of cost are materials, labour and expenses. Costs can be classified into three
groups on the basis of these basic elements.
Materials are those substances from which products are made by an undertaking. They may be
raw materials, e.g. steel and timber, or components upon which some work has already been carried
out, e.g. electrical switches.
Labour is the human effort involved in transforming materials into finished products, selling the
finished products or managing the undertaking's operations.
Expenses is the classification which includes all costs which are not of a materials or labour nature.
These are the cost of services provided to an undertaking, e.g. electricity, rent and rates, and the
notional cost of the use of owned assets, e.g., depreciation.
B. Type-of-Cost-based Classification :
Costs can be classified into direct costs and indirect costs. Direct costs are those costs which can be
specifically identified with a particular product. Indirect costs are those costs which cannot be
specifically identified with a particular product. According to this criteria for classification, material
cost is divided into direct material and indirect material, labour cost into direct labour and indirect
labour and expenses into direct expenses and indirect expenses.
C. Function-based Classification :
Businesses can be split into various functional departments and costs can be classified in accordance
with these departments. The usual functional departments found in a business are: (a) Production,
(b) Administration, (c) Research and development, and (d) Selling and distribution.
Production cost is the cost of all items involved in the production of a product or service. It includes
all direct costs and indirect costs related to the production.
Production overhead are the indirect costs involved in the production process. Other names of
production overhead are works overhead and manufacturing overhead.
Administration costs are expenses incurred for general management of an organisation. These are in
the nature of indirect costs and are also termed as administrative overhead.
Selling costs are indirect costs relating to selling of products or services and include all indirect costs
in sales management for the organisation.
F
]2 COST AND MANA6£M£NT Acco

Distribution costs are the costs incurred in handling a product from the time it is complet
works until it reaches the ultimate customer.
Research and development_costs are the costs for undertaking research to improve qua
a present product or improve process of manufacture, develop a new product, market resear
and commercialisation thereof.
D. Behaviour-based Classification :
On the basis of behaviour, costs may be classified into fixed costs, v~riable costs and
variable/semi-fixed costs.
Fixed costs are commonly described as those costs of running a business which do not vary
level of production activity or volume of output varies - instead they remain constant or
Examples of fixed costs are rent, rates, insurance, management salaries and loan interest. Fix
are constant in total while the cost per unit varies with the change in output level. This
expenses is time-based, i.e., the expenses relate to a period of time rather than being based o
level of production activity.
The concept of a cost being 'fixed' pre-supposes that a time-scale of, say, up to si?c months is
envisaged. Over a longer time-scale than this, even fixed costs do not necessarily
.
remain co
'

because, for example, factories can be expanded or even shut down, thereby causing a change·
level of fixed costs.
Variable costs are those costs which increase or decrease in relation to the level of production a
If the production output is doubled, the cost of production materials use_d and the cost of
applied to the production will double. Variable costs per unit remain relatively constant with
in the level of product~on activity. Thus variable costs vary in total amount but tend to r
constant per uni! as production activity ch~ges.
The analysis of costs into the fixed and variable castegories is usually straight forward but
costs, called semi-variable (or semi-fixed) costs, contain both variable and fixed elements and
elements have to be separated and analysed accordingly. Thus, telephone costs would be anal}i
into the rental charge, which would be added to the fixed costs, and the total call charge, w
would be added to variable costs on the broad assumption that the number of telephone calls
would vary in relation to the production and sales activity of the business.
Distinction between Fixed Cost and Variable Cost :
The points of distinction between fixed cost and variable cost may be stated as under :
1. Fixed cost tends to remain unaffected by variations in the volume of output. Variable cost t
to vary more or less proportionately with variations in the volume of output.
2. Although total fixed cost remains constant within a particular range of production activity,
unit fixed cost varies with the change in output level. On the other hanµ, variable cost varies
total amount but tends to remain constant per unit as production activity changes.
3. Fixed cost is uncontrollable in the short-run. Variable cost is generally controllable.
 INTRODUCTION 13

CosT Accoum 1NG STANDA RD-I (CAS-1) ON CLASSIFICATION OF CosTs

CAS-l issued by the Council of the ICWAI deals with the principle of classifying costs in cost
statemen ts.
st rd
The anda on classification of costs deals with the basis of classification of costs and the practice
. .
.
to be adopted for class1·f1·cat1·on of cost e1ements m d .
regar to its nature and management ob1echve.
•
The statemen t on the sta n d ard aims .d. . .. .
. at prov1 mg better understanding of class1ficat1on of costs for
. .
preparat ion of various cost s tat ements un d er 1egal obhgaho
. . ns or for cost control purpose.
ObJectives:
1. st
The fir objectiv : of this standard is to prescribe the classification of costs for ascertaining cost
rod
of a p uct/service and for preparin g cost statements on a consistent and uniform basis so that
st
co of an enterpri se of a relevant year becomes comparable with that of previous year or with
that of other enterpri ses in respect of the same period.
2. The second objective is to provide better transparancy in the cost statements through classification
and its disclosure.
3. The third objective is to encourage better adoption of uniform costi~g and interfirm comparison.
Scope:

1. This standard on classification of cost should be applied in ascertaining cost of a product or

service, applicat ion of costing technique and in making management decision by the Indian
industri es.
2. All enterpri ses should follow this standard to classify costs in order to prepare cost statements
on an uniform basis to make it relevant and understandable for effective cost management.
3. The standard has to be followed for assessing cost of production, valuation of product or
valuatio n of stock to be certified for determining duties, taxes, tariffs and other purposes as the
case may be. Cost statemen ts prepared in accordance with this standard will be used for
assessing excise duty and other taxes, and for anti-dumping measures, transfer pricing etc.

DEFINITIONS GIVEN BY CAS-1

Ill Cost
Cost is a measurement, in monetary tenns, of the amount ofresources used for the purpose ofproduction
ofgoods or rendering services.
Background material : For manufac turing goods and services consumption of resou~ces is always
involved. Sacrifice made in terms of resources or price paid to acquire goods and services measures
the cost. The type of cost is often refered to in costing system in relation to the purpose for wh~ch cost
is incurred. For example, price paid for acquiring materials for manufacture of a product 1s often
called material cost.

Ill Cost Centre

Cost centre is any unit ofcost accounting selected with a view to accumulating all cost under tha~ unit.
The unit may be a product, a service, division, department, section, a group of plant and machinery,
a group ofemployees or a combination ofseveral units. This may also be a budget centre.
 COST AND MANA Ei~
14 4
Backcn'otmd Material: A logical sub-unit for collection of cost represent s a cost centre~
o· .
There may be two types of cost centres : (a) Personal cost centres ; and (b) Impersonal
A personal cost centre is represente d by a group of persons. A cost centre which is not
centre is an impersonal cost centre. Cost centres may be further divided into productj: P
and service cost centres. Centres engaged in productio n like machine shop, assemblyshn
shop etc. are productio n cost centres. Service cost centres are centres for rendering 8
production cost ce~tres, e.g, power house, maint~nance shop, stores, purchase office, quan
1
department etc. • ,

II Cost Unit
Cost unit is afonn ofmeasurement ofvolume ofproduction or service. This unit is generally
the basis ofconvenience and practice in the industry concerned.
Background materials: Examples of generally adopted cost units are: Transport industry-
kilometre{fon-kilometre; Cement/Suger industry - Metric ton; Brick industry - Thousan
Automobile - Number; Power - Mega Watt. etc.

II Basic Rules for Classification of Costs

(a) Classification ofcost is the arrangement of items of costs in logical groups havingrega
nature (subjective classification) or purpose (objective classification).
(b) Items should be classified by one characteristic for a specific purpose without ambiguity,
(c) Scheme of classification sh_ould be such that every item ofcost can be classified.
(d) Basis ofclassification: (i) Nature ofexpenses; (ii) Relation to object- traceability; (iii)
activities; (iv) Behaviour - fixed, semi-variable or variable; (v) Management decision
(vi) Production process; (vii) Time period.
Background material : Components of cost are grouped under a common head on th
similarities of nature, attributes or relations through a process called classification. The
identifies each item and according to common features, like· items are systematica
together. The items grouped under a common head may be further classified accordin
fundamental differences. Thus, same cost may appear in several different classifications d
upon the purpose for which classific~tion i~ done.
Normally cost classification is done in terms of managerial objective. Presentation
usually r~quires sub-classification. Sub-classification may be done according to na
cost element, functional line, areas of responsibi~ity or other useful break-up. Appr
sub-classification depends upon how the cost report is used.

CLASSIFICATION OF Cosrs

a Classification by Nature of Expense

Costs should be gathered together in their natural groupings such as material labour and other
Items ofcosts differ on the basis of their nature. The elements ofcost can b:classified in thefol
three categories of: (a) Material, (b) Labour, (c) Expenses.
INTRODUCTION 15

(a) Mat~a l co st is the cost ofmaterial ofany nahtre ttsed for the purpose ofproduction ofa product or
a service. i

Bac_kgr~mid material : Material cost includes cost of procurement, freight inwards, taxes and
rebates,
duties, insuran ce etc. that can be directly attributed to the acquisition. Trade discounts,
are
duty draw backs, refunds on account of modvat, cenvat, sales tax and similar other items
deduct ed while determ ining the cost of material. ·
(b) Labottr cost means the payment made to the employees, permanent or temporary/, for their services.
Background material: Labour cost includes salaries ~nd wages paid to perman ent and temporary
fringe
employees. It also includes paymen t to labour contractors. Salaries and wages include a1l
e
benefits like employ er's contribution to provide nt fund, gratuity, contribution to E.S.I., overtim
s
wages, incentives, bonus, ex gratia payments, cost of leave encashment, wages paid for hoJiday
and idle time etc.
(c) Expenses are other than material cost and labour cost which are involved in an activity.
Background material : Expenditure incurred on account of utilities, paymen t for bought out
services, job processing charges etc. are included in expenses.

II Classi ficatio n by relation to Cost Centre

(a) Classification should be on the basis ofmethod ofallocation ofcost to a cost unit. If an expenditure
can be allocated to a cost centre or cost object iii an economically feasible way, then it is called direct,
otherwise the cost component will be tenned as indirect. According to this criteria for classification,
material cost is divided into direct material cost and indirect material cost, labour cost into direct
labour cost and indirect labour cost and expenses into direct expenses and indirect expenses. Indirect
cost is also known as o'Qerhead.
(b) Direct cost has three components: direct material cost, direct labour cost and
direct expenses; and
indirect cost has three components : indirect material cost, indirect labour cost and
indirect expenses. Sum ofall direct costs is.ca~led prime cost.
(c) Direct material cost is the cos( ofmaterial which can be d~rectly allocated to a
cost centre or a cost
object in a econimicallyfeasible way. . __
Background material : Direct materials consumed for produc tion of a produc t or service being
s
identifiable in the produc t or service represe nt direct material cost. Direct material cost include
etc. in
cost of procure ment of such material and also freights inward , taxes and duties, insuran ce
cks,
connection with such procure ment subject to deducti on for trade discount, duty drawba
refunds on account of modvat , cenvat, sale tax and similar other items.
(d) Direct labour cost is the cost ofwages of those workers who are readily identified or linked with
a cost centre or cost object.
Background material: Wages of workers in this case include all the fringe benefits i.e., employ er's
time,
contribution to provide nt fund and E.S.I., gratuity, wages for overtim e work/h olidays /idle
incentives, bonus, exgratia paymen t, leave encashm ent etc.
(e) Direct expenses are the expenses other than direct material and direct labour which can be identified
or linked with the cost centre or cost object.
 16 COST AND MANA6£M£NT It

terial . Examples of direct expenses are : cost of special

Backgroun d ma · spec d ·
mou lds requt-..a..a
f hire of ial tool s an eqm pme nts f
centre, cos t O . . or a cost centre, royalties "4~

.
connect10n wi'th a prod uct, JOb proc essi ng cost etc. p
(f) Indirect material is the cost ofmaterial which cannot be dire
ctly allocable to a particular ca
or cost object.
Background material : Materials of small valu e not cap
able of bein g identified in or aU
a cost centre or cost
object are norm ally term ed as indi rect materials.
Examples are: co
spares and parts, lubricants, jute/cotton was tes
etc.
(g) Indirect labour cost is the wages ofthe employees whi
ch are not directly allocable to a pa •
centre.
Background material : Salaries ~£ staff in administration, I

security , accounts, canteen, ·

etc. are examples of indirect labour.
(h) Indirect expenses are the expenses other than of the natu
re of material or labour and
directly allocable to a particular cost centre.
Background material : Examples of indirect expenses are
: insurance, taxes, duties etc.
not allocable directly to a part icul ar cost centre.

II Classification by Fun ctio ns/Activities

(a) Costs should be classified according to the
major functions for which the elements are
followingfourmajor functions: Production; Administrat
ion; Research and development;
and distribution.
(b) Production cost is the cost of all items
involved in the production ofa product or service.I
all direct costs and all indirect costs related to the producti
on.
(c) Production overhead is the indirect costs
involved in the production process.
Background material : Pro duc tion overhead is also call
ed factory ove rhea d or man
overhead. Examples of pro duc tion ove rhea d are
: salaries for pro duc tion planning,
supervision, factory supervision, fire and acciden
t prec auti on ; nor mal idle time cost
stores man age men t; security expenses of factory;
labo ur welfare exp ens es; medical and
expenses ; depreciation of plan t and machine
ry ; insurance of factory assets ; rep
maintenance of factory assets ; cost of quality con
trol etc.
(d) Administration costs are expenses incurred for general man
agement ofan organisation. Thes
the nature of indirect costs and are also termed as adminis
trative overhead.
Background material: Examples of administrative ove
rhea d items are : sala ries of admini
and accounts staff; rent, rates, taxes, lighting, tele
phone, postage, and stationery of general
ban k charges; aud it fees; legal exp ense s; depreci
ation, repair and maintenance of office b
etc.
(e) Selling costs are indirect costs related to selling of products
or services and include all indited
sales management for the organisation.
Background material: Selling costs are costs incurred
in connection with regular sales an
promotion. Examples of selling costs are: salaries, commission and travellin
staff ; cost of advertisement ; cost of participation g expenses {i
in fairs and exhibition; legal expenses
realisation; cost of free sam ples ; cost of market
rese arch ; royalty on sale s; cost of aft
services etc.
INTRODUCTION 17
from the time it is completed in the
(f) Distribution costs are the costs incurred in handling a· prodi uct
works until it reaches the ultimate customer. , . · , .• , · . • .

ing to the distribution of prod uct to

Background material : Distribution costs are the costs relat the
portation cost ; cost for warehousing
customers. Examples of distribution costs are : trans ··
customer's place etc: · ·
saleable p~oducts ; cost of delivery of the prod uct to
cost bu·t secondary packaging cost is inclu de/in
d'lote.: Prim ary packaging cost is ;elud ed ·in· prod ucti~ ery site for
equipments, installation cost at deliv
d~stribution cost. In case of heavy industries supplying
testing etc. is inclu ded~ p~oduction cost and ~ot in
heav y equip ment s which involves assembling of parts,
a·g~s turbine at plant site is included in the cost of
distri butio n cost. For example, cost of installation of , - _
•
produ ction of gas turbine. _1 • • ,

(g) Research and development costs are the costs for undertaki
ng research to improve quality ofa-pr ;;~
product or improve process of manufacture,--deve lop a new pro·duct, market research etc. and
commercialisaticiti thereof. - - · ·' -- - - - --· - - ·- - - - · -·- ~-'-, ·~ ·
• ,- · ·3. . -
.
relating to deve lopment of a new product,
· - Background material : Cost of research includes cost nt, finding new ~ses for known
and equipme
,impr ovin g an·existing product, improving the process
ufacture and application of products etc.
products, .solving technical problems arising _in_man
isati on and implementation of r~search
Development cost includes cost incurred for co~e rcial ,
findings.
Cost Sheet using classification by Functions/Activities:
•
\ l • ._\ ~~

Direct material costt I ,' j _...:

Direct Jabour cost \ •

Direct expenses lL
1 I 'I ; , ............
Prime cost • i
., . ,
J

Production over head ,.

,j . ............
Works/Factory cost
Administrative over head
Research and deve lopm ent cost (apportioned)
Cost of productio~
Se1ling cost (for good s sold)
Distribution cost (for good s delivered) • J , ...

Total cost/Cost of sales

raw mater ials, work-in-progress and finished goods to
dVote. : Adjustments are necessary for opening and closing
1 , , ., , , ,
, arrive at value at different points.

DI Classification by .Behaviom: cost and semi-variable cos_tdepending

· ·' J

Costs are classified based on behaviour as fixed cost, variable , •, ,

upon response to the changes in the activity levels. r

(a) Fixed cost is the cost which does not vary with
the change in the volume ofactivity in the short run.
The,se costs are not affected by temporary fluctuation: in activity of an enterprise. These are also
known as period costs. . ' '' : 1
• : • • . • •

etc. are examples of fixed cost.

Background material: Salaries~ rent, depreciation, audi t fees
Cost (H) - 2