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CHAPTER
CHAPTER

INTRODUCTION
Cost- Cost is the amount of resource given up in exchange of some goods or services. It can be
defined as the amount of expenditure (actual or notional) incurred on or attributable to a
specified article, product, or activity. Overall expenditure in producing an article or
rendering the services is termed as cost.
Cost accounting - CIMA Official Terminology defines cost accounting as the process of gathering
of cost information and its attachment to cost objects, 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.
Costing- Costing is defined as “the technique and process of ascertaining costs”. CIMA Official
Terminology specifically states that the use of the term costing is not recommended except with a
qualifying adjective, for example standard costing.
Cost Accountancy: - Cost Accountancy is the academic discipline of cost accounting and is defined
as ‘the application of costing and cost accounting principles, methods and techniques to the science
and art and practice of cost control and the ascertainment of profitability as well as presentation
of information for the purpose of managerial decision making.

OBJECTIVE OF COST ACCOUNTING

The main objectives of Cost and Management accounting are explained as below:
(i) Ascertainment of Cost: The main objective of Cost Accounting is accumulation and
ascertainment of cost. Costs are accumulated, assigned and ascertained for each cost
object. This cost object may be aunit, job, operation, process, department or service.
(ii) Determination of Selling Price and Profitability: The cost accounting system helps in
determination of selling price and thus profitability of a cost object. Though in a
competitive business environment selling prices are determined by external factors but
cost accounting system provides a basis for price fixation and rate negotiation.
(iii) Cost Control: Maintaining discipline in expenditure is one of the main objectives of a
good cost accounting system. It ensures that expenditures are inconsonance with
predetermined set standard and any variation from these set standards is noted
and reported on continuous basis.
(iv) Cost Reduction: It may be defined" as the achievement of real and permanent
reduction in the unit cost of goods manufactured or services rendered without
impairing their suitability for the use intended or diminution in the quality of the
product."
(v) Decision making: Cost and Management Accounting by providing relevant information,
assist management in planning, implementing, measuring, controlling and evaluating of
various activities.

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OBJECTIVE OF COST ACCOUNTING
The scope of cost accounting is broad and is directed into the operations of the organisation. Thus a
proper functioning
cost accounting system ensures the strategic success/ failure of the organisation.
🖸 Cost book-keeping11 - It involves maintenance of records of all costs incurred from their
incurrence to their charge to departments, products and services. Such recording is done on the
basis of double entry system.
🖸 Cost ascertainment - Ascertaining cost of products, processes, jobs, services, etc., is the
important function of cost accounting. Cost ascertainment becomes the basis of managerial decision
making such as pricing, planning and control.
🖸 Cost Analysis - It involves the process of finding out the causal factors of actual costs varying
from the budgeted costs and fixation of responsibility for cost increases.
🖸 Cost Comparisons - Cost accounting also encompasses comparisons between cost from
alternative courses of action such as use of technology for production, cost of making different
products and activities, and cost of same product/ service over a period of time.
🖸 Cost Control - Cost accounting also includes the utilization of cost information for exercising
control. It involves a detailed examination of each cost in the light of benefit derived from the
incurrence of the cost. Thus, cost is analyzed to recognize whether the current level of costs is
satisfactory in the light of standards set in advance.
🖸 Cost Reports - Presentation of cost is the ultimate function of cost accounting. These reports
are primarily for use by the management at different levels. Cost Reports forms the basis for
planning and control, performance appraisal and managerial decision making.
🖸 Cost Audit - Cost Audit is the verification of correctness of Cost Accounts and check on the
adherence to the Cost Accounting plan. Its purpose is not only to ensure the arithmetic accuracy
of cost records but also to see the principles and rules have been applied correctly.
FINANCIAL ACCOUNTING VS COST ACCOUNTING
Basis of
Financial Accounting Cost Accounting
Comparison
Purpose It is prepared for providing information The main purpose of Cost Accounting is to
about the results of the business provide information to the management
activities as a whole for a particular for the proper planning, control and
period to the users. decision making.
Need Financial Accounts are maintained as per Cost accounts are maintained to meet
the requirements of Companies Act and the requirement of the Management.
Income Tax Act.
Recording Transactions are classified, recorded In cost accounting, transactions are
and classified, recorded and analysed
analysed subjectively. objectively according to the purpose for
which costs are incurred.
Analysis of Financial accounting reveals the profit of Cost Accounting shows the profit made on
profit a business as a whole. each product, job or process.

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 Accounting Financial accounts are prepared for a Cost reports are prepared frequently and
period definite period. submitted to the management according to
their requirement which may be daily,
weekly, etc.
Stock valuation In financial accounts, stocks are valued as Cost accounting stocks are valued at cost
per the relevant Accounting Standard
(for example, AS 2 specifies that closing
inventory should be valued at cost
[carrying amount] or net realisable value
whichever is lower.
Relative Financial accounts do not reveal the Cost account provides information on the
Efficiency relative efficiency of each department or relative efficiencies of various plant and
section. Machinery

MANAGEMENT ACCOUNTING VS COST ACCOUNTING

Basis of Cost Accounting Management Accounting
Comparison
Meaning The recording, classifying and The accounting in which the both
summarising of cost data of an financial and non-financial
organisation is known as cost information are provided to
accounting. managers is known as Management
Accounting.
Information Quantitative. Quantitative and Qualitative.
Type
Objective Ascertainment of cost of production. Providing information to managers to
make decisions, and forecast
strategies.
Scope Concerned with ascertainment, Managerial decision making.
allocation, distribution and accounting
aspects of cost.
Specific Yes No. Thus the scope of management
Procedure accounting is much broad.
Target Recording of cost data (past and It gives more stress on the analysis of
present). future projections.
Interdepende Can be installed without management Cannot be installed without cost
ncy accounting. accounting.

IMPORTANT TERMS RELATED TO COST

Historic Cost

COST

Economic Cost

Historical cost is the factual cost incurred for the production of goods or services, encompassing

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direct material costs, direct labour costs, and manufacturing overhead costs. It emphasizes the
retrospective nature of the cost, reflecting the real expenditures made in the past to produce a
particular unit of output.
🖸 Out-of-Pocket Cost – this refers to the actual expenditures or payments made by an individual
or a business for goods, services, or resources. These costs are tangible and represent real cash
outlays. Out-of-pocket costs can include expenses such as direct payments for goods, services,
wages, and other tangible items. It is often historical in nature but is pertinent to decision
making.
In the next few lines economic costs along with the other costs pertinent to the managerial
decision-making process are discussed.
Economic cost – This is also referred as opportunity cost. It is the value of the best alternative
course of action that was not chosen. In other words, it is what could have been accomplished with
the resources used in the course of action if they were employed in the next best alternative. It
represents opportunities forgone.
Example:
If a person has a job offer that pays Rs 25 for an hour’s work. But instead, he chooses to take a nap
for an hour then the historical cost of the nap is zero as the person did not dash out any money in
order to take the nap. However, the economic cost of the nap is Rs 25. This is what he could have
been earned if he worked and did not take the nap. Thus, Rs 25 is a cost of the decision of taking
the nap as it is the benefit foregone in taking the nap.
Sunk Cost – Cost that has been irreversibly incurred or committed and cannot therefore be
considered relevant to a decision. Sunk costs may also be termed irrecoverable costs.
Imputed Costs – Imputed costs are hypothetical or notional costs, not involving cash outlay
computed only for the purpose of decision making. In this respect, imputed costs are similar to
opportunity costs. Interest on funds generated internally, payment for which is not actually made
is an example of imputed cost.
Relevant Costs: Relevant costs are costs which are relevant for a specific purpose or situation.
In the context of
decision making, only those costs are relevant which are pertinent to the decision at hand.
Since we are concerned with future costs only while making a decision, historical costs, unless
they remain unchanged in the future period are irrelevant to the decision-making process.
Avoidable Costs & Unavoidable Costs – Avoidable Costs are those which under given conditions
of performance efficiency should not have been incurred. Unavoidable Costs which are
inescapable costs, which are essentially to be incurred, within the limits or norms provided for.
It is the cost that must be incurred under a programme of business restriction. It is fixed in
nature and inescapable.
Controllable and Non-Controllable Costs – Controllable Cost is that cost which is subject to
direct control at some level of managerial supervision. Non-controllable Cost is the cost which is
not subject to control at any level of managerial supervision.
COST OBJECT and COST UNIT
A cost object is any item for which cost measurement is required, for example, a product or
a customer.
Examples of cost objects include:
🖸 A product
🖸 A service to a hotel guest
🖸 A sales territory
CIMA Official Terminology states, A cost object is, for example, a product, service, centre, activity,
customer or distribution channel in relation to which costs are ascertained.

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Cost Unit: Cost Unit is a device for the purpose of breaking up or separating costs into smaller sub
divisions attributable to products or services. CIMA official Terminology defines a cost unit as a
unit of product or service in relation to which costs are ascertained. Cost unit should be
appropriate to the type of business. It is important to note that once costs are traced to cost
centres, they are further analysed in order to establish the cost per cost unit. Alternatively, some
items of costs may be charged directly to a cost unit, for example direct materials and direct labour
costs.
Business Appropriate Cost Unit
Car manufacturer Particular brand of car
Cigarette manufacturer Packet/ piece of cigarette
Builder Particular building /Flat
Audit company Audit File / Chargeable hour
Composite Cost Unit – The cost units for services are intangible and often comprise of two parts.
Thus, they are referred as composite cost units. For example, if costs of a delivery service are being
monitored and controlled by measuring the cost per tonne delivered then ‘tonne delivered’ is not
an appropriate cost unit because it would not be valid to compare the cost per tonne delivered from
place A to place B with the cost per tonne delivered from place M to place N. This is due to the
simple fact that the distance is a major factor and delivering one tonne over a distance of one KM
is not the same as delivering one tonne over a distance of 10 KM. Thus, Composite cost units.
Composite cost units help to improve cost control in service organisations.
Business Composite Cost Unit
Hospital Patient – Day
Transport (Freight) Tonne – kilometre
Transport (Passenger) Passenger -KM

COST CENTRE and RESPONSIBILITY CENTRE

Cost Centre - Cost centres are collecting places for costs before they are further analysed. For cost
accounting purposes, departments are termed cost centres and the product produced by an
organisation is termed the cost unit.
CIMA Official Terminology defines a cost centre as a production or service location, function,
activity or item of equipment for which costs are accumulated.
GACAP23 defines a cost unit as any unit of an entity selected with a view to accumulating all cost
under that unit. The unit can be division, department, section, group of plant and machinery, group
of employees or combination of several units. This definition is also corroborated in paragraph
4.6 of CAS 1.
Cost Centre and Cost Object is the logical sub-unit for collection of cost. Cost Centre may be of two
types personal and impersonal cost centres. Personal cost centre consists of a person or a group
of persons. Cost centres which are not personal cost centres are impersonal cost centres. Again Cost
centres may be divided into broad types i.e. Production Cost Centres and Service Cost Centres.
🖸 Production Cost Centres are those which are engaged in production like Machine
shop, Welding shop, Assembly shop etc.
🖸 Service Cost centres22 are for rendering service to production cost centre like Power house,
Maintenance, Stores, Purchase office etc.
Cost centre is often referred as a responsibility centre whose managers are normally accountable
for only those costs that are under their control, also known as expense centres.
Responsibility Centre - Responsibility Center refers to a particular segment or unit of an
organization for which a particular manager, employee, or department is held responsible and
accountable for its business goals and objectives. It refers to the part of the company where a
manager has authority and responsibility. A responsibility center is a functional entity within a

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business that tends to have its own goals and objectives, policies, and procedures, thereby giving
managers specific responsibility for revenues, expenses incurred, funds invested, etc.
CIMA official terminology defines responsibility centre as departmental or organisational function
whose performance is the direct responsibility of a specific manager.
There are usually four types of responsibility center which are identified as under.
(a) Cost Centre – Under the cost center , the manager is held responsible only for the costs,
including a production department, maintenance department, human resource department,
etc. this is discussed in previous section.
(b) Profit Centre – Under the profit center the manager is responsible for all costs and revenues.
Here the manager would have all of the responsibility to make decisions that would affect
both the price and the revenue.
CIMA official terminology defines profit centre as part of a business accountable for both
costs and revenues.
(c) Revenue Centre – This segment is primarily responsible for attaining sales revenue. The
performance would be evaluated by comparing the actual revenue attained with the
budgeted revenue.
(d) Investment Centre - Apart from looking into the profits, this center looks into returns on the
funds invested in the group’s operations during its time.

ELEMENTS OF COST

Cost

Direct (traceable to Indirect (Overhead)

product)

Material (CAS 6) Administrative

Production Overhead
Ovehead
Labour Selling Overhead
/Employee
Cost (CAS 7)

Direct Expense (CAS 10) Distribution Overhead

It is important to note that all the traceable costs (direct material, direct labour and direct
expenses) are grouped together and is referred as prime cost.
Para 4.26 of CAS 1 define Prime cost is the aggregate of direct material cost, direct employee
cost and direct expenses.
Prime Cost = Direct Material + Direct Labour (Employee cost) + Direct Expenses
It is previously noted in this study note that the traditional cost accounting system is the
absorption costing system which is more frequently used. Under generally accepted accounting

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principles (GAAP), absorption costing is required for external reporting. This is an accounting
method that captures all of the costs involved in manufacturing a product when valuing inventory.
The method includes direct costs and indirect costs and is helpful in determining the cost to
produce one unit of goods32. thus, absorption costing also referred as full costing or traditional
costing is GAAP compliant.
CLASSIFICATION OF COST
The Cost Accounting Standard (CAS) 1 (Revised 2015) issued by the Council of the Institute of Cost
Accountants of India for determination of Classification of Cost. This section of the study note is in
tandem with the provisions of the said document.
Para 4.3 CAS 1 state that classification of cost is the arrangement of items of costs in logical groups
having regard to their nature (subjective classification) and purpose (objective classification).
Thus, two type of classification (logical groups) is recommended
🖸 Subjective classification (classification on the basis of nature) and
🖸 Objective classification (on the basis of purpose)

1. Classification by nature of expense (para 6.1) – on the basis of nature of the expense the
elements of cost can be classified in the following three categories:
a. Material – Material Costs are cost of materials used for the purpose of production of a
product or rendering of a service, net of trade discounts, rebates, taxes and duties
refundable that can be quantified with reasonable accuracy.
b. Employee - Employee Costs are consideration, including benefits paid or payable to
employees, permanent or temporary, for the purpose of production of a product or
rendering of a service.
c. Expenses - Expenses are costs other than material cost and employee cost for the purpose
of production of a product or rendering of a service. (example - cost of utilities, payment
for bought out services, job processing charge)
2. Classification by traceability of the cost to a cost object (para 6.2) – on the basis of
traceability costs are either direct cost or indirect cost.
a. Direct cost - If a cost can be assigned to a cost object in an economically feasible way, it
shall be termed as direct to that cost object. These are of three types
i. Direct material cost - Direct Material Costs are the cost of materials which can be
assigned to a cost object in an economically feasible way.
ii. Direct employee cost - Direct Employee Cost are employee costs, which can be assigned
to a cost object in an economically feasible way.
iii. Direct expenses - Direct Expenses are expenses except direct material and direct
employee cost which can be assigned to a cost object.
b. Indirect cost – if a cost is not identifiable as a direct cost then it is referred as indirect
cost. It comprises of the following.
i. Indirect material - Indirect Material Costs are cost of materials, which cannot be
directly assigned to a particular cost object in an economically feasible way
ii. Indirect employee cost - Indirect Employee costs are employee costs, which cannot be
directly assigned to a particular cost object in an economically feasible way.
iii. Indirect expenses - Indirect Expenses are expenses, which cannot be directly assigned
to a particular cost object in an economically feasible way.

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3. Classification by function (para 6.3) – costs can be classified according the functions which
are:
a. Production;
b. Administration;
c. Selling;
d. Distribution;
e. Research; and
f. Development
4. Classification by nature of behaviour of the cost (para 6.4) - Costs shall be classified based
on behaviour in response to the changes in the activity levels such as, fixed cost, variable cost and
semi-variable cost. Accordingly, costs are:
a. Fixed cost
b. Variable cost
c. Semi variable cost
5. Classification by nature of production or operation process (para 6.5) - Costs shall also be
classified on the basis of nature of production or operation process. Operation Cost shall be the
cost a specific operation involved in production of goods or rendering of services. Accordingly,
costs are:
a. Job cost
b. Batch cost
c. Contract cost
d. Process cost
e. Joint costs are the costs of common resources used for producing two or more
products or rendering two or more services simultaneously.
A diagram regarding the types of classification is presented for easy comprehension.

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