Module 1

Conceptual framework of Cost

Accounting:
PROF DR INDU MAZUMDAR
[email protected]
Contents….
• Basic Concepts of Cost Accounting, Objectives, Importance and
Advantages of Cost Accounting,
• Cost Centre, Cost Unit, Elements of Cost,
• Classification and Analysis of Costs,
• Relevant and Irrelevant Costs,
• Differential Costs, Sunk Cost, Opportunity Cost.
• Unit & Output Costing
• Preparation of Cost Sheet and Tender/Quotations.
Basic Concepts of Cost Accounting
• Cost Accounting is a method of accounting wherein all the costs involved in
performing any process, project or product are noted and analyzed. Such analysis
helps the management in taking strategic decisions. Cost accounting uses various
techniques to make an organization cost effective.
• For a standard manufacturing unit the various costs involved can be segregated into
the following :
Material
Labour
Other expenses
• These can be further segregated into the following:
Direct
Indirect
TYPES OF COST
 
• Fixed Costs: The costs that remain constant despite changes in production,  process or
projects are referred to as fixed costs. For example, in a manufacturing unit the salaries of
the office staff will remain fixed irrespective of the production. 
• Variable costs: These costs vary with the production,  process or project changes. For
example, in an organization manufacturing toy the material and labour cost will be
dependent on the production. 
• Opportunity cost: The cost incurred in selecting one option over another is called
opportunity cost. For example in a toy manufacturing unit with limited labour hours and
material, the decision to produce one particular toy say ‘Dancing Monkey’ will result in non-
production of an other toy say ‘Spinning top’. So while considering the profitability of toy
‘Dancing Monkey’ the organization has to consider the profit of ‘Spinning top’ that it
forgoes. 
• Sunk cost: Certain costs are incurred and cannot be recovered these are sunk costs.
 Continuing with our example of toy manufacturing unit, sunk costs would refer to
machinery cost that has been incurred.
Techniques in Cost Accounting
• Marginal Costing: As per this technique, the management may decide the number of units
to be produced.  Suppose a toy unit is already producing 100 units of ‘Dancing Monkey’ toy,
this technique will help the management understand that if the production is increased to
150, will it be profitable.  In this technique, only the variable costs for additional units
produced will be considered. Fixed costs are not taken into consideration as they do not
vary with changes in production. 
• Standard Costing: In this technique of costing the costs incurred are compared to the
predetermined cost of the product,  process or project. The variances are analyzed to bring
about cost-effectiveness. 
• Direct Costing: In this technique all the direct costs incurred for a particular product,
 process or project are charged to it and the indirect costs are written off to profit and loss. 
• Historical Costing: It is comparison of all costs incurred after the process is performed.
• Uniform Costing: In this technique same costing practices are followed across certain units
to facilitate comparison. 
• Absorption costing: This is a method of full costing.  In this all costs are charged to the
product,  process or project.
Objectives of Cost Accounting

• Ascertainment of cost
• Determination of selling price
• Cost control & Cost reduction
• Ascertaining the profit of each activity
• Assisting management in decision
making
• Matching cost with revenue
• Preparation of financial statements
P& L A/c and Balance Sheet
Importance of Cost Accounting

• Control of Material Cost

• Control of Labor Cost
• Control of Overheads
• Measuring Efficiency
• Budgeting
• Price Determination
• Expansion
Advantages of Cost Accounting

• Advantages to the management • Advantages to the Employees

• Facilitates planning
• Helps in formulating policies
• Ensures fair incentive wage
• Useful in setting up objectives and standards schemes
of performance • Facilitates job security,
• Facilitates cost comparison
recognition and promotion
• Leads to effective cost control
• Determines the selling price • Useful in measuring operating
• Ascertains profit of each activity efficiency of the employees
• Assists the Management in decision making
• Facilitates cost reduction
• Measures performance.
• Advantages to the Creditors • Advantage to the Government
• 1)Measures the financial strength • It helps to formulate business policies and
and creditworthiness of the business. national plans for industrial development.
• 2) Attract investors for extending • It facilitates assessment of taxation, and
establishment of indexes.
their credit facilities.
• It assists in effective utilization of resources,
• 3) Creates trustworthiness among
i.e. materials, labor and machines etc.
the creditors, debenture holders,
banks etc. • It assists the government for cost reduction,
price fixation, export and import and
• Advantage to the public granting subsidy etc.
• It helps in elimination of wastages and
inefficiencies.
• It facilitates the consumers to pay fair price for
products.
• It leads to progress of national economic growth.
• Creates employment opportunities.
• Increases the living standards of the people
Cost Center, Cost Unit: A cost unit is the measurement medium
whereas a cost center refers to a subdivision, location, department, or other institution.
• COST CENTER
• COST UNIT
The marketing department, Research &
Development department, and other cost Metre, kilometre, gallon, and other
centres are examples of cost centres cost units are examples of cost
The first phase in the cost analysis process is to units.
identify the cost centres
Cost centres are primarily developed to assist the second phase is to assess the
management in operations like budgeting, costs of those departments using
strategic planning, decision-making, and control the cost units determined by top
cost centre can be defined as the one or more management.
units of the firm that don’t contribute directly
to the process of revenue generation in an Cost unit, on the other hand, serves
organisation but incur expenses no such purpose because it is
A cost centre, in other words, is any location, simply a way of expressing cost.
person, machine, section, part, activity, or
function inside an organisation or enterprise
where expenses are gathered or aggregated
and assigned.
 • Element # 1 Materials:
• “The material cost is the cost of commodities
ELEMENTS OF COST supplied to an undertaking”- I.C.M.A.
• Materials cost is of two types, viz.:
• (i) Direct materials cost, and
• A cost is composed of three elements – • (ii) Indirect materials cost.
Material, Labour and Expenses. Each of
• (i) Direct Materials Cost:
these three elements can be direct and
indirect, i.e., direct materials and indirect • Direct material cost is “The cost of materials
materials, direct labour and indirect entering into and becoming constituent
elements of a product or saleable service”.
labour, direct expenses and indirect Thus, materials which can be identified with
expenses. units of output or service are known as direct
• The elements of cost are: materials.
• 1. Materials • (ii) Indirect Materials:
• “Materials used for the product other than the
• 2. Labour,
direct materials are called indirect materials.
• 3. Expenses and In other words, materials cost which cannot
be identified with a specific product, job,
• 4. Overheads
process is known as indirect material cost.
• Element # 2 Labour: • Element # 3 Expenses:
• Labour is the remuneration paid for physical or mental • Expenditure other than material and labour is the third element of
cost.
effort expended in production and distribution.
• It is defined by I.C.M.A. as- “The cost of service provided to an
• “The labour cost is the cost of remuneration (wages, undertaking and the notional cost of the use of owned assets”.
salaries, commissions, bonus, etc.) of the employees of • Expenses are of two types:
an undertaking” – I.C.M.A. • (i) Direct expenses, and
• Labour cost is also divided into direct and indirect • (ii) Indirect expenses.
portions: • (i) Direct Expenses:
• (i) Direct Labour Cost: • These are the expenses which can be directly identified with a unit
• It is also called ‘Direct-wages’. Direct labour cost is the of output, job, process or operation. They are specifically incurred
for a job, or unit or process and in no way they are connected with
cost of labour directly engaged in production operations. other jobs or processes. The direct expenses are also known as
E.g., workmen engaged in assembling parts, carpenters chargeable expenses.
engaged in furniture making, etc. • Some examples are:
• (ii) Indirect Labour Cost:Indirect labour cost is the • (a) Hire charges of special plant used for a job.
remuneration paid for labour engaged to help the • (b) Royalty on products.
production operations, e.g., inspectors, watchmen, • (c) Cost of special patterns, designs or plans for a particular job or
sweepers, store keepers, etc. The remuneration paid to work order, etc.
these persons cannot be traced to a job, process or • (ii) Indirect Expenses:
production order. The labour costs of idle time,
• Indirect expenses are expenses other than indirect material and
overtime, holidays, etc., are also taken as indirect costs. indirect labour, which cannot be directly identified with units of
Similarly, clerical and managerial staff, salesmen, output, job, process or operation. These expenses are incurred
distribution employees are also included in the orbit of commonly for jobs and processes. E.g., rent, power, lighting,
‘indirect labour’. depreciation, bank charges, advertising, etc.
• Direct and Indirect Costs: • Indirect Cost or ‘Overhead’ or ‘On
• Direct Cost or Prime Cost: Cost’ or ‘Burden’:
• The aggregate of all the direct costs • The aggregate of all the indirect
i.e., Direct Materials, Direct Labour costs i.e., Indirect Material, Indirect
or wages and Direct expenses is labour and Indirect expenses is
termed as- ‘Prime Cost’ or ‘Direct variously termed as ‘On cost’ or
cost’. Thus prime cost or direct cost ‘overhead’ or ‘Burden’. Over heads
is the sum of all the elements of or on cost or indirect cost cannot be
costs which can be specifically identified with specific products or
identified with particular products jobs. So it is apportioned to the
or jobs and allocated to such output on some reasonable basis
output.
• Elements # 4. Overhead: • (ii) Administration or Office Overhead:
• On the basis of functions overhead is • All the indirect administration expenses,
classified as: come under this category. Salaries of
• (i) Factory overhead office staff, accountants, directors’ fees,
rent of office building, stationery
• (ii) Administration or office overhead, expenses incurred in the office lighting
and and bank charges, etc., are the examples.
• (iii) Selling and Distribution overhead. • (iii) Selling and Distribution Overhead:
• (i) Factory Overhead: • This includes indirect selling and
distribution expenses. Examples are
• This is the aggregate of indirect salaries of salesmen, selling commission,
material, indirect wages and indirect advertising, warehouse rent,
expenses incurred in the factory. maintenance of delivery vans,
Examples of indirect factory expenses warehouse staff expenses, warehouse
are rent, power, depreciation lighting lighting, etc.
and heating incurred in the factory.
Expenses Excluded from Costing:
• a) Capital Costs and Capital Losses- Purchase of fixed assets, plant
and machinery, building, etc. Loss on sale of fixed assets, abnormal
losses, preliminary expenses, patents written off, etc.
• (b) Transfer to reserves, income tax, dividend, bonus to
shareholders, etc.
• (c) Financial items like, cash discount, interest on debentures,
interest on loans, interest on own capital, etc.
ITEMS EXCLUDED FROM COST
• The following items are of • Income-tax paid
financial nature and thus not • Goodwill written off
included while preparing a cost
sheet: • Dividend paid
• Cash discount • Provision for taxation
• Transfer to reserves • Profit/ loss on sale of fixed
assets
• Interest paid
• Provision for bad debts
• Donations
• Damages payable at law, etc.
• Preliminary expenses written off
 Cost Sheet:All costs incurred or expected to be incurred during a given
period are presented in the form of a statement, popularly called cost sheet
or statement of cost or production statement
• The basic features of cost sheet
• Objectives of Cost Sheet
are as follows:
(1) It reveals the total cost and cost per
unit of goods produced. • (i) This statement is usually
prepared under the output
(2) It discovers the break-up of total costing method, where the
cost into different elements of cost. object is to ascertain the per unit
(3) It provides a comparative study of cost of production.
the cost of current period with that of
the corresponding previous period. • (ii) A cost sheet is prepared for a
specified period of time,
(4) It acts as a guide to management in generally for a month, quarter,
fixation of selling prices and quotation half year or year.
of tenders.
The total expenditure consisting of material, labour
and expenses can further be analysed as under:
• Prime Cost = Direct materials + Direct Labour + Direct expenses
• Works Cost (Factory) = Prime Cost + Factory overhead
• Cost of Production = Factory Cost + Administration overhead
• Total Cost (Cost of sales) = Cost of production + Selling and distribution
overhead
 The cost sheet generally contains the following information –
• Element # 1. Prime Cost:Prime cost is
(a) Period, the addition of all direct costs. It
(b) Total Output, includes direct material cost, direct
labour cost and other direct costs. Other
(c) Cost of raw materials consumed, direct expenses may include patterns,
(d) Cost of direct labour, designs, power expenses etc
Material consumed =
(e) Details of chargeable expenses
Opening stock of Raw material
(f) Details of overheads namely factory,
+ Purchases made during the year
office and administration and selling
and distribution, and + Carriage in words
(g) Aggregate of elements of cost at – Materials returned
various stages e.g., Prime Cost, Works – Scrap of raw materials
Cost, Office Cost and Total Cost. – Closing stock of raw material at end
• Element # 2. Gross Factory Cost: • Element # 3. Cost of
Factory cost is obtained by adding factory related expenses to
the direct costs.
Production/Officer Costs:
Various factory related expenses are: • Where office and administration
i. Indirect materials like oil, lubricants expenses may include:
ii. Indirect labour like foreman, factory manager, clerks
iii. Factory lighting, heating, rent, insurance of factory building • i. Office salaries
iv. Repairs and maintenance of plants, machine tools, factory • ii. Rent, rate, taxes, depreciation of
building
v. Factory stationery, welfare expenses of the workers etc.
insurance of office building
In addition to that adjustments in respect of cost of opening • iii. Lighting, heating of the office
and closing WIP is also adjusted to calculate net
factory/work cost as given below:
building
Net factory/work cost – • iv. Stationary, printing, telephone
Gross factory cost expenses and other expenses
+ Opening stock of WIP related to office building
– Closing stock of WIP
WIP – WIP is that part of production at which same work has • v. Director and management
been done but it is still not complete. So WIP is semi-finished salaries.
stock.
• Element # 4. Cost of Goods Sold: • The value of opening stock is
generally given in the question.
• Cost of production is adjusted with
The value of closing stock can be
the value of opening and closing
obtained by dividing the total cost
stock of finished goods to obtain
of production by number of units
value of cost of goods sold, as given
produced multiplied by no. of units
below –
in closing stock as shown below –

Where closing stock (units) = Production during year + opening stock – Sales during year
Treatment of Scrap
• In certain manufacturing industries, scrap arises in the form of cuttings,
trimmings, borings from metals or timber, etc. Scrap generally can be
sold at a price.
• The realisable value of scrap is deducted from factory overheads or
factory cost while preparing the cost sheet.
• Element # 5. Cost of Sales:
Various selling and distribution expenses are added to
obtain cost of sales. Selling and distribution expenses
may be fixed or variable in the nature.
Some examples of selling and distribution expenses
are:
i. Salesman salaries and commission
ii. Advertisement expenses
iii. Commission sales
iv. Warehouses rent, depreciation etc.
v. Depreciation, maintenance of delivery vans
vi. Expenses relating to showrooms.
Element # 6. Profit:
Difference of sales and cost of sales is known or
profit as shown below –
 Calculation of Profit
• After the total cost has been
estimated, a desired percentage of
profit is added to arrive at the price
to be quoted.
• Such profit may be given as a
percentage of cost or percentage of
selling price. In order to calculate the
amount of profit, it is easy to assume
that figure as 100 on which profit
percentage is given and then
calculate the amount of profit.
Additional problems
• The following are the costing records for the year 2021 of a manufacturer:
• Production 10,000 units; Cost of Raw Materials 2,00,000 Labour Cost 1,20,000
Factory Overheads 80,000 Office Overheads 40,000 Selling Expenses 10,000
• Rate of Profit 25% on the Selling Price.
• The manufacturer decided to produce 15,000 units in 2022. It is estimated that
the cost of raw materials will increase by 20%, the labour cost will increase by
10%, 50% of the overhead charges are fixed and the other 50% are variable.
• The selling expenses per unit will be reduced by 20%. The rate of profit will
remain the same.
• Prepare a Cost Statement for the year 2021 showing the total profit and selling
price per unit and also prepare estimated statement of cost for the year 2022