COST ACCOUNTING – ELEMENTS OF COST

Mrs. Dilshad D. Jalnawalla

Concept of Cost Accounting

Cost is the amount of resources given up in exchange for some goods or services.

CIMA, London defines cost as “the amount of expenditure (actual or notional) incurred on, or attributed to a specified thing or activity.”

The process or technique of ascertaining cost of activities, processes, products, or services is termed as costing.

CIMA defines cost accounting as “the process of accounting for cost from the point at which the expenditure is incurred or committed to the establishment of its ultimate relationship with cost centers and cost units. In its widest usage, it embraces the preparation of statistical data, the application of cost control methods and the ascertainment of the profitability of activities carried out or planned.”

Cost unit

Unit of quantity of product, service or time in relation to which cost are ascertained or expressed.’

Industry Cost UnitAutomobile No. of vehiclesBridge Contract Each ContractCement, Sugar TonneChemical units Litre, Gallon, Kilogram

Cost Center

CIMA defines a cost center as ‘a location, person or item of equipment (or group of these) for which costs may be ascertained and used for the purpose of cost control.’

Personal or Impersonal cost centers Production cost center or Service cost

center Operation and Process cost centers

What are the elements of cost?

CIMA defines the elements of cost as “the primary classification of costs according to the factors upon which expenditure is incurred, viz., material cost, wages (labour cost), and expenses.”

Thus there are three elements of cost: Material Labour Expenses

Elements of Cost

Material

Direct Material

Indirect Material

Labour

Direct labour

Indirect labour

Overheads

Factory Overhea

ds

Office Overhea

ds

Selling and distribution Overheads

Expenses

Direct expenses

Indirect Expenses

Direct Material

CIMA defines material cost as “the cost of commodities supplied to an undertaking ”.

All materials, which become an integral part of the finished product and which can be conveniently allocated to specific physical units is termed as direct material.

Example Spare part, primary packaging material, components etc.

Indirect Material

All material which is used for secondary purposes and cannot be allocated conveniently to specified physical units, is called as Indirect material.

Example consumable stores, oil and waste, printing and stationery material etc.

Direct Labour

Labour, which plays an active and direct part in the production of a particular product, is termed as direct labour.

CIMA defines labour cost as “the cost of remuneration(wages, salaries, commission, bonus etc) of the employees of an undertaking”.

Indirect Labour

Indirect labour cost cannot be practically traced to specific units of output.

Example wages of storekeeper, salaries of office staff and salesmen, directors fees etc.

Direct Expenses

CIMA defines expenses as “the cost of services provided to an undertaking and the notional cost of the use of owned assets”.

Direct expenses can be directly allocated to a particular job, product or unit of service.

Example hire charges paid to some special machinery required for a particular contract, mould incurred in toy manufacturing etc.

Indirect Expenses

These are expenses which cannot be conveniently and directly allocated to a particular job, product or a unit of service.

Example factory rent, lighting, insurance etc.

Overheads

The aggregate of indirect material cost, indirect labour cost and indirect expenses is termed as overheads. Thus all indirect costs are overheads. Factory or works overheads – Oil, factory

manager’s salary, factory lighting etc. Office and administration overheads –

stationery salary of office staff, rent, insurance etc.

Selling and Distribution overheads – packing material, printing and stationery, salary of sales staff, advertising, insurance etc.

Prime cost – it is the aggregate of direct material cost, direct wages and direct expenses.

Factory cost – it includes prime cost + all factory or works overheads. It is also known as works cost, production cost or manufacturing cost.

Cost of Production – it is arrived at after adding office and administration overheads to factory cost.

Cost of sales or total cost – it is arrived at after adding selling and distribution overheads to cost of production.

Methods of Cost Accounting

The methods primarily depend on the manufacturing process and also on the methods of measuring departmental and finished products.

Basically there are two methods of costing Job costing. Process costing. Other methods are improvements, extensions

or contributions of the above two methods.

Job Costing

Under this method costs are collected and accumulated for each job or work order or project separately.

This method is suitable for printers, machine tool manufacturers, foundries and general engineering workshops.

Contract Costing

When the job is big and spread over long period of time, the method of contract costing is used.

A separate account is kept for each individual contract.

Civil engineering contractors, constructional and mechanical engineering firms, builders etc use this method.

Cost + Costing.

Batch Costing

This is an extension of job costing. A batch may represent a number of small

orders or group of identical products passed through the factory in batch.

The cost per unit is determined by dividing the cost of the batch by the number of units produced in a batch.

The manufacturers of biscuits, garments, spare parts and components mainly use this method.

Process Costing

A process refers here to a stage of production.

Under this method, a separate process account is prepared and all cost incurred in that process are charged.

This is also known as continuous costing. Process costing method is generally

followed in textile units, chemical industries, refineries, tanneries, paper manufacture etc.

Operation Costing

It is a further refinement of process costing.

It is suitable to industries where mass or representative production is carried out or where the goods have to be stalked in semi-finished stage, to enable the execution or special orders or for the convenient use of later operations.

Used in cycle manufacturing, automobile units etc.

Unit Costing

It is also known as single or output costing. This is suitable for industries where the

manufacturing is continuous and units are identical.

This method is applied in industries like mines, quarries, cement works, brick works etc.

The object of this method is to ascertain the cost per unit of output and the cost of each element of such cost.

Operating Costing

Suitable for industries which render services as distinct from those which manufacture goods.

Applied in transport undertakings, powder supply companies, gas, water works, municipal services, hospitals, hotels etc.

It is used to ascertain the cost of services rendered.

Multiple Costing

It is also called as composite costing. This suitable for industries where a

number of component parts are separately produced and subsequently assembled into a final product.

This method is used in factories manufacturing cycles, automobiles, engines, radios, aero-planes and other complex products.

Classification of costs

Costs are classified into different categories depending upon the purpose of classification.

A suitable classification of costs is important to identify the cost with cost centres and cost units.

By Nature or Element

According to this classification cost are divided into three categories – Material, Labour and Expenses.

This classification is important as it helps to find out the total cost, how such total cost is constituted and valuation of work in progress.

By Functions

According to this classification cost is divided based on purpose for which they are incurred.

It leads to grouping of cost according to

broad division of activities i.e production, administration, selling and distribution.

As Direct and Indirect Cost

Direct cost are those which are incurred for and may be conveniently identified with a particular cost centre or cost unit.

Indirect cost are those which are incurred for the benefit of a number of cost centre of cost units and therefore cannot be conveniently identified with a particular cost centre or cost unit.

By Controlability

Controllable costs are those which can be influenced by the action of a specified member of an undertaking i.e. cost are partly within the control of management.

All direct costs including direct material, direct labour and some of the overhead expenses are controllable by the lower level of management.

Uncontrollable costs are those costs which cannot be influenced by the action of a specified member of an undertaking i.e. which are not under the control of management.

Rent of the building, managers salary, overhead costs incurred by one department and apportioned to another.

Normality

Normal cost is the cost which is normally incurred at a given level of output in the conditions in which that level of output is normally attained. It is part of cost of production.

Abnormal cost is the cost which is not normally incurred at a given level of output in the conditions in which that level of output is normally attained. It is charged to costing profit and loss account.

Capital and Revenue

The cost which is incurred in purchasing and asset either to earn income or increase the earning capacity of business is called capital cost. Example building machinery etc.

If any expenditure is incurred in order to maintain the earning capacity of business as cost of maintaining an asset or running a business is revenue expenditure.

In costing capital items are normally ignored.

By Time

Historical cost is the cost ascertained after it is incurred or passed cost. It does not help in cost control purpose.

Pre-determined cost are estimated cost. A pre-determined cost becomes standard cost.

By Variability

Fixed or Period Cost: which remain fixed or constant in total amount with increase or decrease in the volume of output or productive activity for a given period of time. Decreases as production increases and increases as

production decreases. Variable or Product Cost: These costs vary in total in

direct proportion with the volume of output. These cost per unit remain relatively constant with changes in production. Example Material cost, Power etc.

Semi-variable Cost: These are partly fixed and partly variable example telephone charges, depreciation etc.

Classification of costs for managerial decisions

MARGINAL COST: It is total of variable cost that is prime

cost + variable overheads.

Fixed cost are ignored and only variable cost are taken into consideration for determining the cost or products and value of work in progress and finished goods.

Out of Pocket Costs

These are the cost which involve the cash outflow due to particular management decision.

Such cost are relevant for price fixation during recession or when make or buy decision is to be made.

Differential Costs

The change in costs due to change in level of activity or pattern or method of production is known as differential cost.

If the change increases the cost it will be incremental cost.

If it decreases the cost resulting from decrease of output the difference is known as decrement cost.

Sunk Costs

A sunk cost is an irrecoverable and is caused by complete abandonment of a plant.

It is the written down value of the abandoned less its salvage value.

Such cost are not relevant for decision making and are not effected by increase or decrease in volume.

Imputed cost/notional cost

It is the cost which does not involve actual cash outlay. It is a hypothetical cost and does not appear in financial records.

Interest on capital and notional rent charged for owned premises are common examples.

When alternative investment projects are evaluated it is necessary to consider imputed interest on capital before a decision is arrived at as to which is the most profitable project.

Opportunity Cost

It is the maximum alternative earning that might have been earned if the productive capacity or services had been put to some alternative use.

It is the advantage, in measurable terms, which is been foregone due to not using the facility.

Example owned building is proposed to be used for a project, the likely rent of the building is the opportunity cost.

Replacement Costs

It is the cost at which there could be purchase of an asset or material identical to that, which is been replaced or revalued.

It is the cost of replacement at current market price.

Avoidable and Un-avoidable Costs

Avoidable costs are those which can be eliminated if a particular product or department with which they are related is discontinued. For example salary of a clerk employed in a particular department.

Un-avoidable cost is that cost which

cannot be eliminated with the discontinuation of a product or department. For example factory rent.

THANK YOU