SARASWATI INSTITUTE

(The School of Commerce)

COST ACCOUNTING
By. Sukesh Sir
class-xii

Address: College Square ,Ctc (In front of Ravenshaw University

Contact: Sukesh Sir -(8093390691)
Office -(8658570258)
(For more details, visit our website: http://saraswatiinstitutecuttack.com)

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 CLASSIFICATION OF COST AND
UNIT PREPARATION OF COST SHEET

Cost:-The amount of resources given up is exchanging some goods or services

expressed in monetary forms. Or anything which is sacrificed to obtain something
POINTS TO REMEMBER
is known as cost. The cost is always studied with reference to its purpose and
➢ Cost conditions. In cost accounting there are different types of cost; such as prime cost,
factory cost etc.
❖ Meaning
❖ Definition Acc.to CIMA,” Chartered Institute of Management Accountants”, London”, cost
means the amount of expenditure incurred or attributable to a given thing.
❖ Classification
Classification of Cost:-The process of grouping costs according to their
➢ Cost sheet common characteristics is called classification of cost. Cost classification is
necessary in order to identify cost with which cost centre or cost unit. The following
❖ Meaning are the different ways of classification of cost:-
❖ preparation
1. By nature and elements:-As the name suggests according to these
classification, the costs are classified based on the nature or the purpose for which
they are incurred. The costs are divided into 3 categories, i.e. material, labour, other expenses. All the above 3
elements of cost are subdivided into 2 categories:-direct and indirect. Generally material means raw materials,
components, spare parts, consumable stores, packing material etc. Labour is incurred for converting the raw
material into finished goods. Besides raw marerial and labour some other expenses are incurred while producing
a product

2. By functions or functional classification:-Grouping of costs according to the main function of an enterprise is

called functional classification. The main functions of a business are manufacturing, administration and selling.
So under this method costs are grouped as manufacturing cost, administration cost and selling and distribution
cost.
i. Manufacturing cost:- The cost incurred to manufacture a product and to bring it into a saleable form are
termed as manufacturing cost. It includes direct material, direct labour and other manufacturing costs.
ii. Administrative cost:- The administrative costs are those costs which are incurred in general in the general
administration of an enterprise. It includes office rent, office stationary, manager’s salary, telephone expenses,
postage, etc.
iii. Selling and distribution cost: The costs incurred to secure order, to boost sale and to deliver the goods to
consumers come under selling and distribution costs. It includes carriage-outward, advertisement, salesmen
commission, show room expenses, etc.

3. On the basis of identity:-It is classified into 2 categories:-

i. Direct cost:-Those cost which can be easily identified, conveniently measured and directly charged to the
product. For example – direct material, direct labour etc.
ii. Indirect cost:-Those cost which cannot be directly charged to the particular product or process or job are
called indirect cost. Ex-Rent of building, salary of office staff etc.
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4. On the basis of variability:-Nature of cost varies to each other, on the basis of variability cost can be classified
into 3 categories:-
i.Fixed cost:-The cost which remains fixed and unchanged with the change in volume of output. Fixed cost
per unit increase if production decreases and vice versa. Ex-Manager salary.
ii.Variable cost:-The cost which vary with the change in the volume of output. Variable cost per unit always
remains constant but the total cost increases with the increase in the volume of output and vice versa.
iii.Semi-variable cost:-The cost which is partly fixed and partly variable that means they are fixed up to a
certain level and then vary accordingly to the change in production. Ex-Telephone expenses, depreciation
etc.

5. On the basis of controllability:-

i. Controllable costs:
ii. Un controllable costs: The costs which cannot be influenced by executive actions are termed as
uncontrollable costs. For example, it is difficult to control factory rent or manager salary. Generally fixed
costs are uncontrollable.

6. On the basis of Normality:-

i. Normal Costs: The costs which should be incurred under normal situations at a given level of output are
called normal costs. These costs form a part of cost of production.
ii. Abnormal costs: The costs which are incurred because of certain abnormal situations are called abnormal
costs. These costs do not form a part of cost of productions. These are charged to costing profit and loss
account.

7. On the basis of time:-It can be classified into 2 ways.

i. Historical cost:-The past costs or the costs which have already been incurred are termed as historical costs.
These costs are recorded after they have been incurred. Thus these costs are not much useful for control
purposes.
ii. Predetermined cost:-The cost which are estimated or computed in advance before a dual production takes
place based on the cost of the previous periods are known as pre-determined cost. After production of the
goods dual costs are compared with the predetermined cost to find the variance of any and to take remedial
action to avoid its recurrence in future. The historical and predetermined cost work together in accounting
system of organization.

8. On the basis of planning and control:-

i. Budgeted cost:- Budgeted cost is a total concept. It states the total budgeted cost of an item at a given level
of output. For example- total budgeted material cost for this year will be Rs 10,000 for the production of
2,000 units. Budgeted cost is simply an estimate of expenditure to be incurred in the coming year

ii. Standard cost:- The pre-determined cost based on technical estimates of material, labour and overhead is
called standard cost

9. Association with the product:-Costs can be classified into product cost and period cost on the basis of their
association with the product.
i. Product cost: The costs which can be identified with a product and are included in the inventory value are
called product costs. In other words, the factory cost is the product cost. It includes direct material, direct
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 labour, direct expenses and factory overhead. Product costs are used for inventory valuation and are shown
in the Balance Sheet as an asset until they are sold. When finished goods are sold, the product costs are
transferred from inventory account to the cost of goods sold, thus becoming an expense. Thus, these costs
are recovered and income is derived only after sale.
ii. Period costs: The costs which are not identified with a product but are incurred on time basis are called
period costs. Generally, the administrative and selling overheads are period costs. They are not carried
forward to the next year as a part of inventory value. They are charged to the period in which they occur.
Rent , salary, insurance, stationery, legal charges, selling expenses are some examples of period costs. These
costs, even if not associated with production, are necessary to generate revenue.

10. By capital and revenue: - The costs which are incurred in order to increase the earning capacity of a business
are called capital costs. The whole benefit of such expenditure is not consumed in the year of occurrence itself
rather they provide benefit for future period. For example, purchase price of machinery and equipments are
called capital cost as they provide benefit for future accounting periods. A part of such cost is charged to profit
and loss account and the balance is shown as an asset in the Balance Sheet.

The cost incurred to keep the business running and to maintain the earning capacity of a business are
termed as revenue costs. These costs are necessary for day to day management. The benefit of revenue costs
are consumed in the year of their incurrence. Labour cost, repairs and maintenance, salary stationery, etc. are
some examples of revenue costs. Revenue costs are charged to profit and loss account.

Cost of Managerial Decision Making

i. Marginal Cost:- Cost of producing one additional unit is called marginal cost. When one extra unit is produced,
fixed costs being constant, only variable costs are to be incurred. Therefore, marginal cost is same as variable
cost.
Marginal costing is a technique that charges variable costs to products and fixed costs are treated as
period cost to be written off to costing profit and loss account. Under this system, only variable costs are taken
into account for determining the cost of product, work-in –progress and finished goods.

ii. Differential cost: difference in total cost between two alternatives is called differential cost. It includes
additional variable costs incurred for additional output plus increase in fixed costs.

iii. Out of Pocket Cost: The costs which require cash payment are called out of pocket cost or explicit cost. Rent,
salary, stationery, cartage, material cost are some examples of out of pocket costs. Out of pocket cost may be
fixed such as rent, manager’s salary, etc. or variables such as direct material, direct wages, etc.
iv. Imputed or Notional Cost: The costs which are notional in nature (not actual) and do not involve cash
payment are termed as notional cost or imputed costs. These are sometimes referred to as implicit cost.
Example- Interest on internally generated fund and rent of the company owned property are the example’s of
notional cost.

v. Opportunity Cost: The benefit lost by rejecting the next best alternative is termed as opportunity cost. For
example, capital invested in a project could have been invested in shares and debentures. The loss of dividend
and interest that could have been earned by investing in shares and debentures is the opportunity cost of
investment in the project. Opportunity costs are not recorded in the accounting system as they relate to the
opportunity lost.
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vi. Sunk Cost: It is the cost incurred in the past which cannot be reversed or avoided by a decision in future. The
book value (depreciated value) of an asset previously purchased less scrap value If any is a sunk cost. These
costs are irrelevant in decision making.

vii. Relevant Cost: The costs which are relevant in decision making are called relevant costs. Differential cost,
opportunity cost and out of pocket costs, etc. are some examples of relevant cost. These costs can be influenced
by management decisions. While taking decisions management has to find out which costs are relevant . For
example, in pricing a competitive bid differential costs are relevant . similarly, while taking a decision affecting
short-term solvency position, the existing short-term liability and the out of pocket costs are relevant.

viii. Irrelevant cost: The costs which are not relevant in managerial decision making are called irrelevant cost.
These costs are not influenced by managerial decisions. For example sunk cost is an irrelevant cost.

ix. Replacement cost: The market price of an asset that is to be replaced now is the replacement cost of that
asset. While replacing an asset, management must consider the market value of a similar asset and not the
cost at which it was purchased.

x. Shut-down cost: The costs which are still incurred even after closing down a plant or division are termed as
shut-down cost. Such costs are generally fixed in nature. Various shut-down costs are rent, rates , light
watchman salary, etc. payable even after closure of a branch.

xi. Conversion cost: The sum of direct labour, direct expenses and factory overhead is called conversion cost.
It is the cost incurred in converting the raw material into finished goods. Thus , conversion cost= Direct
labour+ Direct expenses+ Factory overhead.

xii. Target Cost: Deriving the cost price of a product from a competitive market price is known as target cost.
This technique is used to reduce cost through continuous improvement.

xiii.Avoidable and Un avoidable Cost: The costs which can be avoided by discontinuing certain product or
activity are called avoidable cost. When a product is deleted from the product line, the cost that are not going
to incurre are avoidable cost. Similarly, by closing a branch office certain costs such as rent, light, etc. can be
avoided.

Conversely the costs, the occurrence of which cannot be prevented are unavoidable. These are fixed
in nature. The shut –down costs are unavoidable.

COST ANALYSIS AND PREPARATION OF COST SHEET

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What is cost sheet

It is a memorandum statement or a statement of cost which is prepared to calculate total cost as well as cost per
unit for a given period .i.e. a week, a month, a quarter, a year. In this statement total cost is calculated in a logical
order under proper division of cost, such as prime cost, work cost, cost of production, cost of goods sold and total
cost. When cost sheet is prepared in ”T” form it is known as production account.

Advantages of cost sheet

i) It shows total cost and unit cost of output
ii) It reflects the break up figures of the total cost i.e different elements of cost.
iii) It facilitates comparison between two consecutive periods. That is to say the previous year’s figure can be
compared with current year’s figures.
iv) It enables a manufacturer to keep a close watch and control over the cost of production.
v) By providing a comparative study of the various elements of current cost with the past results and standard
costs.
vi) It helps in fixing up the selling price more accurately.
vii) It helps in minimizing the cost of production at the time of tough competition,

What are the expenses excluded from cost?

Generally the items of expenses relating to capital assets, capital losses, distribution of profits, matters of pure
finance should not form a part of the cost which are as follows:-

a. Purely financial charges

b. Appropriation of profit
c. Writing off intangible and fictitious Assets
d. Purely financial incomes
e. Abnormal gains and losses

ELEMENTS OF COST

Cost of a product is composed of three elements i.e material, labour and expense. Each of these elements may
be direct or indirect.

Direct Costs Indirect Cost

Direct material Indirect material

Direct labour Indirect labour
Direct expenses Indirect expenses

Elements of Cost
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 Material Labour Expenses

Direct Indirect Direct Indirect Direct Indirect

Material Material Labour Labour Expenses Expenses
1. Direct Material:- The materials which can be conveniently measured, easily identified & can be directed
charged to the product are known as direct material. Example- jute in manufacturing of gunny shirts; timber
in making furniture.

2. Indirect material:- Some other materials of minor importance are also used in making a finished product.
These are termed as indirect material. For example, in shoe making besides leather lace, gum, etc. are used.
Similarly in furniture making gum, nail and polish are also used. These are called indirect materials. The
material which can not be conveniently identified with finished products is termed as indirect material
3. Direct Labour:-The labour which is directly engaged in converting the raw materials into finished goods can
be conveniently identified and attributed wholly to a particular job or product are known as Direct Labour.
Ex-wages given to workers, tailor, carpenter etc.

4. Indirect Labour:- The labour who is engaged indirectly in production process. It cann’t be allocated but can
be apportioned or absorbed by cost centers or cost units is known as indirect labour. i.e. wages of repairer,
departmental coolies, instructor, watchman etc.

5. Direct Expenses:- The expenses which are directly charged to the product & can be directly identified to a
particular cost center are known as direct expenses. i.e royalty, exercise duty, hire charges of specific plant &
equipment, cost of patent rights, special drawings & designs.

6. Indirect Expenses:- The expenses which cannot be charged to the product neither can be allocated to a
particular cost center are known as indirect expenses. i.e. general manager’s salary, rent, taxes, & rates,
insurance- power & fuel, canteens & welfare expenses.
7. Raw material consumed:-It means the total cost of the raw material used in the production process which
is calculated considering the opening stock, closing stock and purchase of raw material.

8. Stock of Work-in-progress:-It means those units of material on which some work has been progressed or
done but the work hasn’t been completed yet. It is valued either of prime cost basis or work cost basis.

9. Statement of cost and profit:-If profit is calculated along with the statement of cost is called as statement of
cost and profit.

10. Tender:-An advertisement given in the press inviting the quotation to be supplied by the supplier for the
supply of specified commodities.

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 11. Quotations:-It is the reply in response to an advertisement of a tender in press mentioning the prices for the
supply of commodities or completing a job. The preparation of quotation means information regarding prime
cost, works, administration, selling overheads and profit; While preparing quotations, work overheads are
estimated as a percentage on wages and selling & distribution overheads and administration overheads as
percentage on work-cost basis.

12. Overheads:- The aggregates of cost of indirect cost such as indirect labour, indirect material, indirect
expenses, is known as overheads.

13. Prime cost:- The sum of all direct costs such as direct labour, direct material, direct expenses, is known as
prime cost.

14. Different types of overheads:-

i. manufacturing /production or work overheads
ii. office & administrative overheads
iii. selling Overheads
iv. Distribution overheads

Production Overhead: The indirect material, indirect wages and indirect expenses incurred in connection with the
production operations are termed as factory overhead or production overhead or works overhead. These are;

• Indirect materials: lubricants, cotton waste, glue, thread, nails, etc.

• Indirect wages: Salary and wages of foremen, supervisors, inspectors, labourer in charge of maintenance,
etc.
• Indirect expenses: Factory rent, insurance, depreciation, etc.

Administrative Overheads: All expenses incurred in the direction , control and administration of an undertaking are
called administrative overhead. These include;

• Indirect materials: Printing and stationery for administration.

• Indirect wages: Salary of directors, secretaries, accountant and other office staff.
• Indirect expenses: Rent and insurance of office building, telephone, cleaning charges, bank charges,
legal fees , etc.

Selling Overhead: Indirect costs incurred to create and stimulate demand for a product come under selling overhead.
These are;

• Indirect materials: Printing catalogues and price lists, gift, free samples, display materials, etc.
• Indirect wages: Salary and commission to salesmen and representatives, Salary of staff working in
selling departments, etc.
• Indirect expenses: Collection charges, advertisement, rent of show room, after sale service etc.

Distribution Overheads: All indirect cost incurred in sending the finished goods from godown to the ultimate
consumers are termed as distribution overhead. These include;

• Indirect materials: Packaging cases, oil , grease and spare parts used in delivery vans, etc.
• Indirect wages: Salary of dispatch clerk and packers, salary of delivery van driver etc.
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 • Indirect expenses: Carriage outward , rent , rate and insurance of warehouse, running expenses of
delivery van, etc.

FORMAT OF COST SHEET

There is no prescribed format to prepare cost . Its form, content and arrangement differ from firm to firm.
However, the generally accepted format is shown below.

COST SHEET FOR THE PERIOD........

(For production of _______ units)

Items of costs Cost/Unit(Rs) Total Cost(Rs)

Direct material xxx xxx
Direct labour xxx xxx
Direct expenses xxx xxx
Prime Cost xxx xxx
Add Factory overhead
[Indirect material, indirect labour and Indirect expenses of the
factory] xxx xxx
Factory Cost/Works Cost xxx xxx
Add Administrative overhead
[Indirect material, Indirect labour and indirect expenses of office] xxx xxx
Cost of Production xxx xxx
Add Selling and distribution overhead
[Indirect material, Indirect labour and Indirect expenses of the
selling and distribution department] xxx xxx
Cost of Sales/Total Cost xxx xxx
Add Profit xxx xxx

Sales xxx xxx

CLASS NOTES

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Specimen of Cost Sheet (With Stock Adjustment)

COST SHEET FOR THE PERIOD........

(For production of _______ units)

Items of Cost Amount(Rs) Total Cost(Rs)

Opening stock of raw materials xxx
Add: Purchase of raw materials xxx
Add: Carriage inward xxx
xxx
Less: Closing stock of raw material -(xx)
Raw materials consumed xxx
Add: Direct wages xxx
Add: Direct expenses xxx
Prime Cost xxx
Add: Factory overhead xxx
Factory cost incurred xxx
Add: Opening stock of W.I.P xxx
-(xxx) xxx
Less: Closing stock of W.I.P xxx
Works cost xxx
Add: Administrative overhead xxx
Cost of Production xxx
Add: Opening stock of finished good -(xxx)
Less: Closing stock of finished good xxx
Cost of Goods Sold xxx
Add: Selling and distribution overhead xxx
Cost of Sales/Total Cost xxx
Profit (or loss) xxx
Sales

CLASS NOTES

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