COST
ACCOUNTIN
G
Team No.8
Definition of Cost Accounting
◈ The total cost can be found out from financial accounting. But, problem arises
when the manufacturer produces more than one type of product. When more than
one type of product is manufactured, it becomes necessary to split up the total
cost among the various products. Then only the cost per unit of each category of
product can be ascertained. Only now the manufacturer can fix the selling price of
each category of product. As already stated, from financial accounts, we get only
the aggregate cost of all categories of products. Here arises the need for cost
accounting. Cost accounting helps in splitting up the aggregate cost (especially
indirect cost) among the various categories of products. Thus, a manufacturing
enterprise requires cost accounting in addition to financial accounting.
◈ Cost accounting is the process of accounting for costs. It is the accounting
for cost for preparing statements and reports for the purpose of managerial
decision making. According to the latest terminology published by CIMA,
"Cost accounting is that part of management accounting which establishes
budgets and standard costs and actual costs of operations, processes,
departments, or products and the analysis of variances, profitability or
social use of funds" Thus, cost accounting may be defined as a formal
accounting system set up for recording analysing, and estimating costs. In
short, cost accounting is the formal system for recording costs.
Difference Between Cost & Cost
Accounting
Importance of Cost Accounting
A. To Management:
❖ Cost accounting system identifies profitable and unprofitable activities. This
helps to reduce or eliminate unprofitable activities.
❖ Cost accounting system helps in minimizing losses and wastages relating
to materials, idle time, idle capacity etc.
❖ Cost accounting helps the management in fixing the selling price.
❖ Cost accounting system enables to measure organizational efficiency.
B. To Employees:
❖ Cost accounting facilitates the introduction of incentive schemes and bonus
plans. In this way it offers better wages to employees.
❖ Cost accounting helps in introducing a good wage system.
❖ Cost accounting minimizes the possibilities of misunderstanding between
workers and employers.
❖ A good costing system helps in increasing the productivity, profitability and
prosperity of firms. On account of this, workers get better wages, job
security etc.
C. To Creditors and Investors:
❖ Cost data helps the creditors to ascertain the solvency, profitability and
future prosperity of an enterprise before they lend.
❖ Cost accounting enables the creditors to ascertain whether the capital
employed effectively utilized in the business.
❖ Cost data helps the creditors to ascertain the solvency, profitability and
future prosperity of an enterprise before they lend.
❖ Cost accounting enables the creditors to ascertain whether the capital
employed effectively utilised in the business.
D. To Government:
❖ Cost accounting helps government in formulating policies relating to export,
import, taxation, price control measures, wage fixation etc.
❖ Cost information helps in preparing national plans and budgets.
❖ Cost accounting helps in levying excise duty, sales tax etc.
❖ Government can run public sector enterprises efficiently with the help of
cost accounts.
E. To Society:
❖ Cost accounting conducts a war against all kinds of waste. Therefore,
consumers get quality products at reasonable prices.
❖ Cost accounting brings stability by improving managerial and operating
efficiency.
❖ Cost saving and cost reduction efforts carried out by various organizations
help in curbing inflationary tendencies in the economy.
❖ Cost accounting provides continuous employment opportunities to various
sections of society.
Objectives
❖ To ascertain cost per unit of each product / service
❖ To control cost.
❖ To determine selling price.
❖ To ascertain the profit of each activity.
❖ To prepare financial statements
❖ To assist management in decision-making.
❖ To ascertain the profitability of different products, jobs or work orders.
❖ To measure efficiency
❖ To control and reduce wastages.
Principles
1. A cost should be related to its causes: Cost should be related as closely as possible to their causes so
that cost will be shared only among the cost units that pass thorough the department of which the
expenses are related.
2. A cost should be charged only after it has been incurred: While determining the cost of individual units
those costs which have actually been incurred should be considered.
3. The convention of prudence should be ignored: Usually accountants believe in historical costs and while
determining cost, they always attach importance to historical cost. In Cost Accounting this convention
must be ignored, otherwise, the management appraisal of the profitability of the projects may be vitiated.
4. Abnormal costs should be excluded from cost accounts: Costs which are of abnormal nature (eg.
Accident, negligence etc.) should be ignored while computing the cost, otherwise, it will distort costs
figures and mislead management as to working results of their undertaking under normal conditions.
5. Past costs not to be charged to future period: Costs which could not be recovered or charged in full during
the concerned period should not be taken to a future period, for recovery. If past costs are included in the
future period, they are likely to influence the future period and future results are likely to be distorted.
6. Principles of double entry should be applied wherever necessary: Costing requires a greater use of cost
sheets and cost statements for the purpose of cost ascertainment and cost control, but cost ledger and
cost control accounts should be kept on double entry principle as far as possible.
Cost identification
Costs in business and economics can be categorized into various types
based on their characteristics and behavior. Here's a distinction between
different types of costs: direct, indirect, variable, and fixed :
1. Direct Costs: Direct costs are expenses that can be directly attributed to
producing a specific product or service. These costs vary with the level of
production and are directly linked to the production process. Examples include
raw materials, labor directly involved in production, and manufacturing
equipment.
2. Indirect Costs: Indirect costs, also known as overhead costs, are expenses
that are necessary for the overall operation of a business but cannot be directly
linked to the production of a specific product or service. These costs do not vary
with production levels and are incurred regardless of the level of production.
Examples include rent, utilities, salaries of administrative staff, and depreciation of
office equipment.
3. Variable Costs: Variable costs are expenses that vary in direct proportion to
the quantity of goods or services produced. As production increases, variable
costs increase, and as production decreases, variable costs decrease. Examples
include raw materials, direct labor, packaging, and shipping.
1. 4. Fixed Costs: Fixed costs are expenses that remain constant regardless of
the level of production or sales. These costs do not change in the short term,
even if production volumes fluctuate. Examples include rent, salaries of
permanent staff, insurance, and depreciation of fixed assets.
◈ In summary, direct costs are directly tied to the production of goods or services,
while indirect costs are associated with the overall operation of the business.
Variable costs vary with production levels, while fixed costs remain constant
regardless of production levels. Understanding these cost types is crucial for
effective cost management and decision-making in business operations.
◈ Cost measurement involves the process of quantifying and assigning values to the
resources, expenditures, and expenses incurred by an organization in producing
goods, providing services, or conducting various business activities. It aims to
provide accurate and relevant information about the financial resources utilized in
the production and operation processes.
◈ Key aspects of cost measurement include:
1. Identification of cost.
2. Cost assignment.
3. Cost estimation.
4. Cost analysis.
5. Comparison and Benchmarking.
6. Documentation and Record keeping.
7. Cost reporting.
Cost Control
Cost control is the process of managing and reducing expenses to align with
budgeted levels while maintaining operational efficiency and quality. It involves
monitoring and taking corrective actions to ensure spending remains within defined
limits.
Importance of Cost Control
◈ It minimize wastage
◈ It leads to effective utilisation of funds
◈ It reduces blocking up of capital
◈ It reduce storage cost
◈ It maintain up-to-date records of inventory
◈ It enables the management to take inventory decision
COST CLASSIFICATION
◈ 1. Classification According to Functions:
◈ (a) Manufacturing cost (Production cost)
◈ (b) Administrative cost
◈ (c) Selling cost
◈ (d) Distribution cost
◈ (e) Financing cost.
◈ 2. Classification According to Behaviour or Variability:
◈ (a) Fixed cost
◈ (b) Variable cost
◈ (c) Semi variable cost
◈ (d) Step cost
◈ 3. Classification According to Identifiability or Traceability:
◈ (a) Direct costs
◈ (b) Indirect cost
◈ 4. Classification by Association with Time and Period:
◈ (a) Historical Cost
◈ (b) Product cost
◈ (c) Period cost
◈ (d) Pre-determined
◈ 5. Classification on the Basis of Managerial Decisions:
◈ (a) Sunk costs
◈ (b) Opportunity costs
◈ (c) Differential costs
◈ (d) Imputed cost
◈ (e) Out of pocket cost
◈ (f) Shut down cost
◈ (g) Marginal cost
◈ (h) Conversion cost
◈ (i) Relevant cost
Components of Cost
◈ 1. Prime cost
◈ 2. Factory cost
◈ 3. Cost of production
◈ 4. Total cost
◈ Prime cost
◈ Prime cost = Direct material + Direct labour + Direct expenses
◈ Factory cost: Factory cost or Works cost Prime cost + Factory or Works overhead
◈ Cost of production or office cost = Factory cost + Office and administration
overheads
◈ Total cost or cost of sales = Cost of production + Selling and distribution overheads
Understanding Cost Behaviour
◈ - Costs change with variations in production or activity levels.
◈ Variable Costs:
Variable costs are expenses that fluctuate in direct proportion to the level of
production or sales, including items like raw materials, labor, and production
supplies. These costs increase or decrease as the quantity of goods or services
produced changes.
Total Variable Costs = Cost Per Unit x Total Number
of Units
◈Fixed Costs
◈ Fixed costs are expenses that remain constant regardless of the level of
production or sales, including items like rent, salaries, and insurance.
These costs do not vary with changes in production volume.
◈Fixed cost = Total cost of production -
(Variable cost per unit x number of units
produced)
Cost-volume-profit (CVP) analysis
◈ Analyzing cost changes with changes in production or activity
levels involves employing cost-volume-profit (CVP) analysis. This
technique assesses how costs (both fixed and variable) and
revenues vary as production or activity levels fluctuate. By
understanding the cost behavior and its impact on profitability at
different activity levels, businesses can make informed decisions to
optimize operations and achieve desired financial outcomes.
◈ It is the Graphical representation of costs, volume, and profit.
Break-even Analysis
◈ Break-even analysis is a financial tool used to determine the point at
which total revenue equals total costs, resulting in no profit or loss. It
identifies the minimum level of sales or production required for a
business to cover all its costs, providing valuable insights for decision-
making and pricing strategies.
Conclusion
◈ Key Takeaways:
• Cost accounting provides essential insights into managing and optimizing costs
within a business.
• Understanding cost behavior helps in decision-making and financial planning.
• Cost sheets are valuable tools for analyzing production costs comprehensively..
THANK YOU!
