Concept of Cost

Cost v/s Expense and Loss

Classification of Costs
Cost Centre
Cost Unit
Cost Object
Cost Sheet
Cost Ascertainment and Cost Estimation
Types of Costs
Meaning of Costing and Cost Accounting
Objectives of Cost Accounting
Methods of Costing
 Concept of Cost
Cost
Cost is “price paid for something”.
The amount of expenditure incurred for production of goods
and services.
Cost represents the resources that have been or must be
sacrificed to attain a particular objective.
Resource may be tangible(money, materials, machinery) or they
may take form of services(wages, rent, power).
Cost is composed of three elements;
 Material, Labour, Expenses
Deferred Cost
Deferred costs are the expenses, incurred but the economic
benefit is received for more than one accounting period.
Eg: Acquistion of Plant & Machinery, Building, Equipment,
Prepaid rent and Insurance.
They are shown on the asset side of the Balance Sheet.

Expired Cost or Expenses

Amount spent in generating revenues. IOW when the amt is
spent and the economic benefit is received immediately is
called expenses.
Ex: Selling expenses, Administrative exp. Distribution exp.
Expired cost are deducted from revenues to calculate the net
income.
Loss
Actual expenses exceed the income.
No benefit is received from the cost incurred.
It is charged to profit or loss.

Expenditure

Cost

Deferred Cost Expired Cost

Unexpired Cost
Expenses Loss

Balance Sheet

Profit & Loss A/c

 Classification of Costs

Elements Functions Behavior

 Classification of Costs

Elements Functions Behavior

Material Labour Expenses

DM IM DL IL DE IE

Overheads

Factory Administrative Selling Distributive

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 Classification of Costs

Elements Functions Behavior

Production Cost or
Works Cost or Administrative Distribution
Selling Costs
Factory cost or Cost Cost
Manu. Cost.
 Classification of Costs

Elements Functions Behavior

Semi-Variable or
Variable Cost Fixed Costs
Semi-Fixed Cost
 Elements of Cost
Material Cost:
 Cost of commodities supplied to an undertaking.
 Material Cost includes;
 Cost of procurement, freight inwards, taxes, insurance etc.
 Direct Material Cost:
 DMC is that which can be conveniently identified with and allocated to cost
units. DMC becomes a part of finished product.
 Ex: Clay in bricks, Leather in shoes, Steel in machines, cloth in garment,
timber in furniture.
 Indirect Material Cost:
 Cost incurred on those materials which cannot be conveniently identified
with individual cost units.
 These are small and relatively inexpensive items which may or may not
physically become a part of finished product.
 Eg: pins, screws, nuts & blots, grease, lubricating oil etc.
 Elements of Cost
Labour Cost:
 This the “the cost of remuneration (wages, salaries, commission, bonuses)
of the employees of an undertaking.
 It includes all fringe benefits like: PF, Gratuity, ESI, overtime pay,
incentive bonus, wages for holiday, idle time.
 Direct Labour Cost:
 DLC consists of wages paid to workers directly engaged in converting raw
materials into finished product. DLC can be identified with a particular
product, job or process.
 Eg: Machine Operator, Shoe-maker, carpenter, weaver, Tailor.
 Indirect Labour Cost:
 Indirect labour is not directly engaged in the production operations but
only to assist or help in production operations.
 Ex: Supervisor, Inspector, Cleaner, Clerk, Peon, Watchmen.
 Elements of Cost
Expenses:
 All costs other than material and labour are termed as Expenses.
 Expenses is defined as “the cost of services provided to an
undertaking and the notional cost of the use of owned assets”
 Direct Expenses/Chargeable Expenses:
 Direct Expenses are those expenses that can be identified with and
allocated to cost centers or units”
 These expenses are particularly incurred in connection with a
particular job or cost unit.
 Indirect Expenses:
 All Indirect costs other than indirect materials and indirect labor costs
are termed as Indirect Expenses.
 Expenses which cannot be directly identified with a particular job,
process or work order and are common to cost units or cost centers.
Direct Expenses Indirect Expenses
 Hire of special plant for a  Rent and Rates
particular job.  Depreciation
 Tarvelling expenes in
 Lighting and Power
securing a particular contract.
 Insurance
 Cost of patent rights
 Repairs
 Experimental costs
 Cost of special drawings,
designs and layouts.
 Job processing charges
 Royalty paid in mining
 Depreciation or hire of a
plant used on a contract at
site.
Classification of Cost based on Function
Production Cost/Factory Overhead/Works Overhead or
manufacturing Overhead
These are the overheads which are concerned with the
production function.
It includes indirect materials, Indirect labor and Indirect
expenses in producing goods and services.
 Indirect Materials: pins, screws, nuts & blots, grease, lubricating oil etc.
 Indirect Labour: Supervisor, Inspector, Cleaner, Clerk, Peon, Watchmen.
 Indirect Expense: Rent and Rates,Depreciation,Lighting and Power,
Insurance,Repairs
Administrative Cost/Overhead
It is the indirect expediture incurred in general administrative
function.
These overhead are of general character and have no direct
connection with production or sales activities.
 Indirect Materials: Stationery used in general administrative office,
postage,, printing etc.
 Indirect Labour: Salary of office staff, managing director, remuneration to
directors etc.
 Indirect Expense: Rent of office building, office lighting and power,
telephone expenses, depreciation on office furniture etc.
Selling and Distribution Cost/Overhead
 Selling overhead is the cost of promoting sales and retaining
customers.
 It is defined as “ the cost of seeking to create and stimulate demand
and of securing orders”
 Eg: Advertisements, samples and free gifts, salaries of salesmen etc.

 Distribution cost includes all expenditure incurred from the time the
product is completed until it reaches its destination.
 Eg: Carriage outwards, insurance of goods in transit, upkeep of
delivery vans, warehousing etc.
Classification of Cost based on Behavior
 Cost behave differently when level of production rise or falls.
 Certain costs changes with production level while other costs remain
unchanged.
 On basis of behavior or variabiltiy costs are classified into
 Fixed Cost

 Variable Cost

 Semi-Variable Cost
 Fixed Cost
These costs remain constant in total amount over a specific range of
activity for a specified period of time.
Fixed cost do not increase or decrease when the volume of production
changes.
Ex: Rent and lease, Managerial Salaries, Building Insurance, Salaries
& Wages of permanent Staff, Municipal Tax.
 Variable Cost
These costs tend to vary in direct proportion to the volume of output.
Variable Cost per unit remains fixed.
Variable cost can be controlled by functional managers.
Ex: Direct Materials, Wages, Power, Commission on Salesmen etc.
 Semi-Variable or Semi-Fixed costs
These costs include both a fixed and a variable component.
These costs are partly fixed and partly variable.
Semi-variable cost has a fixed element below which it will not
fall at any level of output.
Variable element in semi-variable costs changes either at a
constant rate or in lumps.
Ex: Introduction of an additional shift in the factory will
require additional supervisors.
Telephone expense, Power etc.
 Cost Centre
 Acc to ICMA (The chartered Institute of Management Accountant), London
define cost centre as “ a location, person or item of equipment(or group of
these) for which costs may be ascertained and used for the purpose of control.”
 IOW Cost centre refers to a section of the business to which costs can be
charged.
 The purpose of ascertaining the cost of cost centre is to control cost.
 A cost centre is charged with all the costs that relate to it.
 Eg: If a cost centre is a machine, it will be charged with the cost of power,
light, depreciation and its share of rent etc.
 Types of Cost Centres:
 Personal Cost Centre
 Impersonal Cost Centre
 Cost Unit
Cost unit is the unit of measurement of cost.
Cost unit is defined as a “unit of product or service in
relation to which costs are ascertained”
Cost units are of two types:
Units of Production: a tonne of steel, a metre of cable, a
ream of paper etc.
Units of Service : Passenger miles, cinema seats, consulting
hours etc.
 Cost Object
Cost object is defined as “anything for which a separate
measurement of cost may be desired”.
A cost object may be a product, service, activity or
process.
Cost Object Examples
 Product Car, Shaving Razor
 Service Telephone hotline, taxi service
 Process Weaving process in textile mill
 Activity Developing a website, Purchasing a raw
material
Component of Total Cost
Cost Sheet
For determination of total cost of production a statement
showing the various elements of cost is prepared. This
statement is called as a statement of cost or cost sheet.
Cost sheet is a document that provides for the assembly of an
estimated detailed cost in respect of cost centers and cost units.
It analyzes and classifies in a tabular form the expenses on
different items for a particular period.
Cost sheet may be prepared on the basis of actual data
(historical cost sheet) or on the basis of estimated data
(estimated cost sheet)
Items excluded from cost sheet or Non-Cost Items
 Non-cost items are those items which do not form part of cost of a product. Such items
should not be considered while ascertaining the cost of a product. These are items
included in the Profit & Loss A/c.
a) Income tax
b) Interest on capital
c) Interest on loan
d) Profit on Sale of fixed assets
e) All the assets
f) Donations
g) Capital Expenditure
h) Discount on shares & Debentures
i) Commission to Partners, Managers etc
j) Brokerage
k) Preliminary Expenses Written off.
l) Wealth tax etc
 Cost Ascertainment and Cost Estimation
(Historical Cost & Future Cost)

Cost Ascertainment
It is concerned with computation of actual costs incurred.
It refers to the methods and processes employed in
ascertaining costs eg: Job costing, contract costing, batch
costing, process costing.
Cost ascertainment is the process of determining costs on
the basis of actual data.
Ascertained cost may be compared with the pre-determined
costs on a continuing basis and proper and timely steps be
taken for controlling costs and maximizing profits.
Cost Estimation
Cost estimation is the process of pre-determining the cost
of a certain product job or order.
Costs are determined in advance of production and
precede the operations.
Estimated costs are future costs.
Purpose of Cost Estimation;
Budgeting
Measurement of performance efficiency
Preparation of financial statements (valuation of stocks etc.)
Make or buy decisions
Fixation of the sale prices of products
 Cost Allocation and Cost Apportionment
Cost Allocation Cost Apportionment
Cost allocation refers to Cost Apportionment refers
the allotment of all the to the allotment of
items of cost to cost proportions of items of cost
centers or cost units. to cost centers or cost units
IOW it is the process of It is the process of charging
charging direct indirect expenditure to cost
expenditure to cost centers centers or cost units in
or cost units certain proportion.
The cost of labor engaged Canteen Expenses of the
in a service department factory
 Committed Costs & Discretionary Costs
Committed Costs Discretionary Costs
Cost incurred in Cost which can be avoided
maintaining physical by management decisions.
facilities and managerial These costs are not
set up. permanent & can be
These are unavoidable and avoided or reduced in the
invariant in the short run. short run, if desired by mgt.
Ex. Salary of MD, Advertising, R&D, Salaries
Depreciation of plant & of low level managers etc.
equipment.

Classification of cost into committed and Discretionary is from the

point of view of cost control & decision making
 Product Costs & Period Costs

Product Costs Period Costs

 These are the costs which are  These are those costs which are
necessary for production. not necessary for production and
 These are ‘absorbed by’ or are incurred even if there is no
‘attached to’ the units produced. production.
 These are inventoriable costs.  These costs are written off as
 Product cost is carried forward expenses in the period in which
these costs are incurred.
to next accounting period.
 These are not inventoried.
 Direct Materials, direct labor,
some of the factory overheads.  Showroom rent, salary of
company executives, travel
expenses. Administration exp.
Etc.
Classification of cost into product & period cost is from the
point of view of profit determination.
 Controllable & Non-Controllable Cost

Controllable Non - Controllable

 These are the costs which may  These are those costs which
be directly regulated at a given cannot be influenced by the
level of mgt. authority. action of a specified member of
 Variable costs are generally an enterprise.
controllable by dept. heads.  Ex. Factory Rent, Managerial
 Eg: Cost of raw materials. salaries etc.

Classification of cost into product & period cost is not possible

without specifying the level and scope of mgt. authority
 Normal Cost and Abnormal Costs

Normal Abnormal Costs

 Normal cost includes those  Abnormal Cost is an unusual or a
items of cost which occur in the typical cost whose occurrence is
normal situation of production usually irregular and unexpected
process or in the normal and due to some abnormal
environment of the business. situation of the production.
 It is considered to be a part of  Heavy break down of machinery
cost of production. or abnormal process loss.
 It is charged to costing profit &
loss account.
 Meaning of Costing
CIMA, London defines costing as, “the techniques and
processes of ascertaining costs.”
It consists of principles and rules which are used for
determining;
The cost of manufacturing a product Eg; motor car,
furniture, chemical, paper etc.
The cost of providing a service Eg: electricity, transport,
education etc.
 Cost Accounting
CIMA, London defines Cost Accounting as
“it is the process of accounting for costs from the point of which
expenditure is incurred or committed to the establishment of its
ultimate relationship with cost centers and cost units.”

Difference between costing and Cost Accounting:

Costing is basically finding out cost of products or services by
any technique or method.
Cost Accounting is application of double entry system for
recording costs.
Objectives & Functions of Cost Accounting

Ascertainment of Cost
Cost control and cost reduction
Guide to business policy
Determination of selling price
 Method of Costing
The principles in every method of costing are same but the
methods of analyzing and presenting the costs differ with the
nature of business.
 Job Costing
 Contract Costing
 Batch Costing
 Process Costing
 Operation Costing
 Unit Costing (Output Costing or Single Costing)
 Operating Costing
 Servicing Costing
 Multiple Costing (Composite Costing)
Summary
Concept of Cost
Cost v/s Expense and Loss
Classification of Costs
Cost Centre
Cost Unit
Cost Object
Cost Sheet
Cost Ascertainment and Cost Estimation
Types of Costs
Meaning of Costing and Cost Accounting
Objectives of Cost Accounting
Methods of Costing