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Basics of Cost Accounting

The document provides an overview of cost accounting, highlighting its importance in addressing the limitations of financial accounting. It covers key concepts such as cost definitions, objectives, various costing methods, and the classification of costs and overheads. Additionally, it discusses the significance of cost units and cost centers in managing and controlling costs within an organization.

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0% found this document useful (0 votes)
32 views20 pages

Basics of Cost Accounting

The document provides an overview of cost accounting, highlighting its importance in addressing the limitations of financial accounting. It covers key concepts such as cost definitions, objectives, various costing methods, and the classification of costs and overheads. Additionally, it discusses the significance of cost units and cost centers in managing and controlling costs within an organization.

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AnamicaMahajan
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UNIT:1

BASICS OF COST ACCOUNTING

Topics:
1. Basics Concept of Cost.
2. Limitations of Financial Accounting
3. Origin of Costing
4. Objectives of Cost Accounting
5. Advantages and Limitations of Costing
6. Difference between Financial Accounting and Cost Accounting
7. Cost Unit and Cost Centers

 INTRODUCTION
In today's competitive environment, the nature and functioning of business organizations have
become very complicated. Various parties like owners, creditors, employees, government
agencies, tax authorities, investors, management of the business etc. are interested to do business
activities. Accounting provides required and important information to all these parties, In order
to satisfy their needs, a sound organization of accounting system is essential. The needs of the
majority of the users of accounting information can be satisfied by Financial Accounting.
Financial Accounting is mainly concerned with preparation of two important statements, like
Statement of Profit and Loss and Balance Sheet. This information provides the needs of all those
who indirectly associated with the management of business. To carry out the functions of
planning, decision-making and control more efficiently, the management require more analytical
information relating to cost. The Financial Accounting system fails to some extent to provide all
these required information to management and hence a new system of accounting necessitates,
which fulfils all the needs of management. Thus, Cost Accounting is developed to offset the
limitations of Financial Accounting, Broadly speaking, there are three branches of like Financial
Accounting, Cost Accounting and Management Accounting which are concerned with presenting
analytical business data to the users. The following example clearly indicates the need and
importance of Cost Accounting as a separate branch of accounting, which has emerged mainly
because of the limitations of Financial Accounting.
Cost is something which is incurred to produce a product or rendering of services.

Eg:1. Cost of an ice-cream is the amount incurred for milk, cream, sugar, labour, packing charges, etc.

2. Cost for a patient for illness is a fee of a doctor.

COST: Total of expenses incurred to manufacture a product or rendering a services is called cost.
Example

For the manufacturing of a pen: Material expenses (Plastic + Ink+ Nib)

Labour expenses (manpower use to prepare pen)

Any other expenses (selling and distribution, packing, etc)

For rendering of a services: Fee of doctor, salary of a teacher etc

When the margin of profit is included in a cost it is called price, therefore cost is the total of all
expenses whereas price is the total of expenses and profit.

According to ICMA, London, “Cost is the amount of expenditure actual or notional) incurred on, or
attributable to, a specified thing or activity or cost unit.”

PROF. MUBINA ATTARI www.dacc.edu.in


Meaning and Definition of costing

Different techniques and process used to determine the cost of a product is called costing. Example:
Process costing techniques is used in the dairy industries for the manufacturing of different dairy
products like, ice- cream, paneer, ghee, curd. etc.

According to ICMA, London, has defined costing as the ascertainment of costs. Costing include, “the
techniques and process of ascertaining costs.”. the techniques refers to principles and rules which are
applied for ascertainment cost of product manufactured and services rendered.

Different Costing Methods

1. Job Costing
2. Marginal costing
3. Standard costing
4. Operational costing

PROF. MUBINA ATTARI www.dacc.edu.in


DNYANSAGAR ARTS AND COMMERCE COLLEGE, BALEWADI, PUNE – 45

Subject: Basics of Cost Accounting Subject code: 204 Class: FY BBA

5. Process Costing

Purpose of Costing

1.. To ascertain the exact cost of a product.

2. To determine the cost incurred during each operation and process

3. To decide the selling price of a product.

4. To prevent the excessive loss during manufacturing process.

5. Suggest better and low cost design.

Choice of costing method depends on following factors:

(i) Nature of Industry,

(ii) Class of products manufactured,

(iii) Quantity of goods produced, and

(iv) Types of labour required for production.

Meaning and Definition of Cost Accounting

Cost accounting is a process of recording, analysing and reporting a cost of a product. This is a formal
system of cost records so that ascertainment of cost became easy and reliable. Cost accounting
determines fixed and variable element of cost associated with the product. Example:

Techniques of cost Accounting:

1. Uniform Costing

2. Absorption Costing

3. Historical Costing

4. Batch Costing

5. Unit Costing

PROF. MUBINA ATTARI www.dacc.edu.in


DNYANSAGAR ARTS AND COMMERCE COLLEGE, BALEWADI, PUNE – 45

Subject: Basics of Cost Accounting Subject code: 204 Class: FY BBA

According to ICMA, London, “Cost accounting means a specialized application of the general principles
of accounting in order to ascertain the cost of producing and marketing any unit of manufacture or of
carrying out any particular job or contract”

Meaning and Definition of Cost Accountancy

Cost Accountancy is the process of applying the costing principles, methods, and techniques. It also
helps in decision making process of management. Cost accountancy is characterised as arts, science and
practice.

Cost accountancy as an art: Arts include special techniques and skill to do a work, here cost accountant
need special skills to ascertain a cost of a product, therefore we can conclude that cost accountancy as
an art.

Cost accountancy as a science: science involve organised body of knowledge, principles, techniques and
procedures, Cost accountancy also need organised body of knowledge, it required special techniques
and procedures.

Cost accountancy as a practice: Practice required regularity in a field, Cost accountancy need regular
practice in order to achieve effective result and proper cost management

Origin of Cost Accounting

Cost accounting is incredibly previous conception. it's needed for all businesses and organization to stay
track of their activities and prices. it's a really useful in higher cognitive process activity.

The age of the economic revolution resulted within the beginning of enormous businesses and
organizations. therefore these organizations were a lot of complicated and dynamic.

So the origin and evolution of accounting is copied back to the economic revolution. the thought was to
assist the businessmen to record and keep a track of their prices and expenses.

During the early industrial era ,cost accountant think about all business value as “variable cost”

However, once manufacture took off, these businesses had a lot of ‘fixed costs’. These are prices that
don't seem to be directly associated with the assembly of products or services. Some samples of
fastened prices are rent, depreciation, storage prices etc.

PROF. MUBINA ATTARI www.dacc.edu.in


DNYANSAGAR ARTS AND COMMERCE COLLEGE, BALEWADI, PUNE – 45

Subject: Basics of Cost Accounting Subject code: 204 Class: FY BBA

Objectives of Cost Accounting

Following are the objectives of cost Accounting:

 To ascerain the cost of a product

 To ascertain the profits.

 To find the selling price of a product

 To regulate the Business policy.

 Help the management in decision making process.

 To help in cost reduction.

Features of cost Accounting

 It is a process of accounting to determine costs and price of a product.

 It records incomes and expenditures, required for manufacturing of product and rendering
services.

 It provides statistical data for preparing estimates and budgets

 It is the basis for cost control and cost reduction policies of a company.

 It evaluates efficiency by comparing actual with standard and find the reasons for variance.

 It involves recording, analysis, comparison and reporting of data in order to ascertain cost.

Conceptual analysis of cost unit and cost centre

COST UNIT: Total expenditure incurred to produce, store, and sell one unit of a product or service is
called as cost unit. Unit cost of a product include variable cost and fixed cost.

There are various factors which should be considered while selecting cost unit.

Example: milk is quantified as per litres, per gallon, whereas power and electricity is measured as
Kilowatt-hours.

PROF. MUBINA ATTARI www.dacc.edu.in


DNYANSAGAR ARTS AND COMMERCE COLLEGE, BALEWADI, PUNE – 45

Subject: Basics of Cost Accounting Subject code: 204 Class: FY BBA

Single cost unit:

It involves the use of a single standard or unit of measurement of the goods manufacture e.g. Product
per piece, per kilogram, per quintal, per tonne, per gallon, per meter etc.

Composite Unit or Complex Unit: It is a combination of two simple units e.g., per passenger-kilometer,
per tonne-kilometre , per kilowatt-hour etc.

COST CENTRE

A cost centre is a division within a company. The manager and employees of different cost centre are
responsible for its costs but are not directly responsible for sales or profit decisions. Some of the cost
centre are Research and development centre, marketing centre, Customer Care centre.

According to CIMA “a production or service, function, activity or item of equipment whose costs may
be attributed to cost units. A cost centre is the smallest organizational sub-unit for which separate
cost allocation is attempted.”

Cost Centre is a location, person or item of equipment for which cost may be ascertained and used for
the purpose of cost control. From Practical approach a cost centre may be relatively easy to establish,
because a cost centre is a unit of the organization to which costs can be separately assigned

A cost centre is an individual activity or group of similar activities for which costs are accumulated.

Example:

1) An item of equipment e.g., a machine, forklift, truck or delivery van.

2) A person e.g., a sales person, Marketing representative, Financial advisor etc.

PROF. MUBINA ATTARI www.dacc.edu.in


DNYANSAGAR ARTS AND COMMERCE COLLEGE, BALEWADI, PUNE – 45

Subject: Basics of Cost Accounting Subject code: 204 Class: FY BBA

Unit-2
Elements of cost and Cost Sheet

Topics
1. Material, Labour and other Expenses
2. Classification of Cost &
3. Types of Costs
4. Preparation of Cost Sheet

A cost sheet is a statement which represents the various costs incurred at different
stages of business operations, in a tabular format. It determines the total cost or
expenditure made by the organization, along with the cost incurred on each unit of
a product or service in a particular period.

A. Prime Cost

The initial cost made for manufacturing a product, i.e., raw material,
labour wages and other production-related expenses, is termed as
prime cost.

Following is the equation for computing the prime cost:

Prime Cost = Direct Labour + Direct Material + Direct Expenses

Where direct material is calculated with the help of the following formula:

Direct Material = Material Purached + Op. stock of Raw material – Closing Stock

PROF. MUBINA ATTARI www.dacc.edu.in


DNYANSAGAR ARTS AND COMMERCE COLLEGE, BALEWADI, PUNE – 45

Subject: Basics of Cost Accounting Subject code: 204 Class: FY BBA

of Raw Material

B. Works Cost or Factory Cost

The works cost is calculated by summing up the prime cost with the factory overheads
and simultaneously adjusting the opening and closing stocks of work in progress. It can
be denoted as:
Work Cost = Prime Cost + Factory Overheads + Op. Stock of WIP – Closing stock
of WIP Where –
WIP ( Work in Process )

C. Cost of Production

The cost of production includes all the direct and indirect cost, including the material, labour
andotherexpenses, i.e., productioncost, factorycostandofficeoradministrationcost.
The following formula denotes the computation of cost of
production: Cost of Production = Factory Cost + Administrative
Expenses
After making an adjustment of the openingfinished goods and the closing finishedgoods
to the cost of production, we acquire the cost of production of goods sold.
D. Total Cost

The final value of a product or service can be determined after adding all the selling
and distribution expenses to the cost of production of goods sold. The formula to find
out the total cost or cost of sales is:

TOTAL COST = Cost of Goods Sold + Selling And Distribution Expenses

If the sales price of the products or service is known, the following method can be used to
determine the profit:
Profit = Cost – Selling Price

PROF. MUBINA ATTARI www.dacc.edu.in


DNYANSAGAR ARTS AND COMMERCE COLLEGE, BALEWADI, PUNE – 45

Subject: Basics of Cost Accounting Subject code: 204 Class: FY BBA

PROF. MUBINA ATTARI www.dacc.edu.in


DNYANSAGAR ARTS AND COMMERCE COLLEGE, BALEWADI, PUNE – 45

Subject: Basics of Cost Accounting Subject code: 204 Class: FY BBA

UNIT:3

OVERHEADS
Topics:

1. Meaning and Definitions


2. Classification of Overheads
3. Collection, allocation, apportionment and reapportionment of overheads
4. Under and over absorption – Definition and Reasons

Meaning and definition of overheads

Overhead is those costs required to run a business, but which cannot be directly attributed to any
specific business activity, product, or service

Overhead includes activities that are not directly related to the products or services that the firm offers,
but they support the firm’s profit-making activities. For example, paying the rent is not a profit-making
activity, but it allows the firm to maintain a building and manufacture its products.

EXAMPLES: Employee salaries, Office equipment and supplies, External legal and audit fees

OVERHEADS= Indirect Material + Indirect wages+ Indirect Expenses

Features of overhead expenses

 Overheads are indirect costs.

 They are common costs.

 Overhead comprises of both cash expenses and non-cash expenses.

 Overhead consist of both Production and non-production expenses.

 Overhead are both variable and fixed.

 They include both escapable and inescapable.

“All overheads are the costs, but all costs are not the overhead’’.

PROF. MUBINA ATTARI www.dacc.edu.in


DNYANSAGAR ARTS AND COMMERCE COLLEGE, BALEWADI, PUNE – 45

Subject: Basics of Cost Accounting Subject code: 204 Class: FY BBA

Composition of Overhead

Indirect Material Indirect Labor Indirect


Expenses

Cleaning materials. Technical director’s Coal and coke.


Lubricants. Store keepers wages Audit fees.
Consumables stores. Foremen salary Publicity
charges
Oils. Wages of packers warehouse
charge
Cotton waste. Salary of office staff Legal charges

Classification of overheads

Classification of overheads

Functional Elementwise Behavioural control wise normali

classification classification classification classification classificat

Factory Indirect Fixed Controllable Norma


overheads Material overheads overheads overhea

Administration Indirect Variable Uncontrollable Abnorm


overheads Labour overheads overheads overhea

Selling &Distribution Indirect Semi-variable


overheads Expenses overheads

PROF. MUBINA ATTARI www.dacc.edu.in


DNYANSAGAR ARTS AND COMMERCE COLLEGE, BALEWADI, PUNE – 45

Subject: Basics of Cost Accounting Subject code: 204 Class: FY BBA

Steps involve in overheads Accounting.

1. Collection and Classification of overheads.

2. Allocation of overheads.

3. Apportionment of overheads.

4. Re-apportionment of overheads.

5. Absorption of Overheads.

Collection of Overheads.

The collection of overhead is the process of recording each item of cost in the book of accounts
maintained for the purpose of ascertainment of cost of each cost Centre or cost unit.

Allocation of overheads

Overheads are common costs incurred for the benefits of a number of costs centers or cost units.
Therefore, they can not be identified and allocated directly to a particular unit of output. As such, they
are to be allocated among the units of output of a particular department or a number of departments or
cost centers.

“Allocation of Overheads is always direct’’

Apportionment of Overheads

Distribution of an overhead cost to several departments or cost centers is known as apportionment of


overheads. It is the process of charging or apportioning costs to a number of cost centers or cost units. If
a given cost is common to two or more departments or cost centers, such cost should be apportioned or
divided among these departments on an equitable basis. For example, the amount of factory rent
should be apportioned to all the departments.

Principles of Apportionment of Overhead Costs

1. Service or Use or Benefit Derived

2. Ability to Pay Method

3. Efficiency Method

PROF. MUBINA ATTARI www.dacc.edu.in


DNYANSAGAR ARTS AND COMMERCE COLLEGE, BALEWADI, PUNE – 45

Subject: Basics of Cost Accounting Subject code: 204 Class: FY BBA

4. Survey Method

Methods for re-apportionment of overhead

 Direct Redistribution Method

 Non-Reciprocal or Step Ladder Method

 Simultaneous Equation (Reciprocal) Method

 Repeated Distribution (Reciprocal) Method

Absorption: Meaning

Overhead absorption is the amount of indirect costs assigned to cost objects. Indirect costs are costs that are not
directly traceable to an activity or product. Cost objects are items for which costs are compiled, such as products,
product lines, customers, retail stores, and distribution channels.

Over and Under absorption of overheads

If the absorbed overheads at predetermined rates are greater than actual overheads, this is known as OVER-
ABSORPTION. Conversely, if absorbed overheads are less than the actual overheads, this is known as UNDER-
ABSORPTION

PROF. MUBINA ATTARI www.dacc.edu.in


DNYANSAGAR ARTS AND COMMERCE COLLEGE, BALEWADI, PUNE – 45

Subject: Basics of Cost Accounting Subject code: 204 Class: FY BBA

UNIT:4

Contact and Process Cost and Methods of Costing

Topics

1. Contract Costing – Meaning And Features Of Contract Costing,


2. Works Certified And Uncertified,
3. Escalation Clause,
4. Cost Plus Contract,
5. Work In Progress, Profit On Incomplete Contract ,
6. Process Costing - Meaning, Features Of Process Costing,
7. Preparation Of Process Costing Including Normal And Abnormal
Loss/Gains

Contract Costing – Meaning And Features Of Contract Costing


In this method costing is done for jobs that involve heavy expenditure and stretches over long
period and across different sites. It is also called as terminal costing.

Example: Construction of roads and bridges, buildings etc.

Contract costing

Contract costing is a specialized system of Job costing applies to long-term


contracts as distinct from short-term jobs. Contract costing is mainly applied in
civil construction and engineering projects, ship building, road and railway line
contracts, construction of bridges etc.

The contract costing method is used mostly by builders, civil contractors, ship
builders, and construction and mechanical engineering firms. Generally, the
contract is undertaken at the site of contract i.e. customer and according to the
specifications of customer. Moreover, the period inquired to complete a
contract is fairly long time or usually more than one year.

PROF. MUBINA ATTARI www.dacc.edu.in


DNYANSAGAR ARTS AND COMMERCE COLLEGE, BALEWADI, PUNE – 45

Subject: Basics of Cost Accounting Subject code: 204 Class: FY BBA

The main purpose of preparing contract account is the ascertainment of cost of


each contract separately and profit on each contract.

Features of contract costing

1. A contract is undertaken according to the specific requirements of


customers.

2. Generally, the duration of a contract is long period.

3. The contract is undertaken only at the site of the customer.

4. Contract work mainly consists of construction activities.

5. The specific order costing principles are applied in contract costingThe size
of a contract is usually large or bigger than jobs.

6. It requires a long time to complete a contract.

7. Each contract is an independent one, quite distinct from another.

8. A distinctive number is assigned to each contract to differentiate the contract


from one another.

9. A separate account is maintained and prepared for each contract to find out
the profit earned from each contract separately.

IMPORTANT TERMS
1.Work certified: It is that part of the contract work which is being completed by the
contractor for which a completion certificate has been issued by the contractee’s architect.
The amount of work certified is debited to contractee’s Account and credited to contract
account.

Value of work certified: Contract price X work certified as %of contract price

OR

Cash Received / Cash received as %of work certified

PROF. MUBINA ATTARI www.dacc.edu.in


DNYANSAGAR ARTS AND COMMERCE COLLEGE, BALEWADI, PUNE – 45

Subject: Basics of Cost Accounting Subject code: 204 Class: FY BBA

2. Work uncertified: It is the coast of that part of the contract work which is being completed
by the contractor but not certified by the architects because of the faulty work or the work not
according to the specifications. In respect of such work there will be no payment from the
contractee. The cost price of each work is Debited to work -in -progress account and credited
to contract account.

Cost of work uncertified = Total cost incurred till date-cost of work certified.

OR

Total Cost incurred till date X %of work Uncertified / %of total work done till date.

PROF. MUBINA ATTARI www.dacc.edu.in


DNYANSAGAR ARTS AND COMMERCE COLLEGE, BALEWADI, PUNE – 45

Subject: Basics of Cost Accounting Subject code: 204 Class: FY BBA

Profit on incomplete contracts


Case 1

When work-certified is less than 25% of contract price- No profit should be transferred to P
& L A/c. The entire notional profit is kept in reserve for contingencies.

Case 2

When work certified is 25% or more but less than 50% of the contract- 1/3rd of the notional
profit, subject to the ratio of cash received to work certified, and is transferred to P & L A/c.

Profit credited to P/L= Notional profit X 1/3 X Cash received


work certified

Case 3

When work certified is 50% or more of the contract price- 2/3rd of the notional profit is
transferred to P & L A/c, after reducing it further in the ratio of cash received to work
certified.

Profit credited to P/L= Notional profit X 2/3 X Cash received


work certified

Case 4

When work certified is 90% or more of the contract price than entire notional profit is
transferred to P & L A/c.

Meaning of Process Costing

Process Costing is defined as a branch of operation costing, that determines the cost of a
product at each stage, i.e. process of production. It is an accounting method which is adopted
by the factories or industries where the standardized identical product is produced, as well as
it passes through multiple processes for being transformed into the final product.

In simple words, process costing is a cost accounting technique, in which the costs incurred
during production are charged to processes and averaged over the total units manufactured.
For this purpose, process accounts are opened in the books of accounts, for each process and

PROF. MUBINA ATTARI www.dacc.edu.in


DNYANSAGAR ARTS AND COMMERCE COLLEGE, BALEWADI, PUNE – 45

Subject: Basics of Cost Accounting Subject code: 204 Class: FY BBA

all the expenses relating to the process for the period is charged to the respective process
account.

DIAGRAMATIC PRESENTATION

Features of Process Costing

 The plant has various divisions, and each division is a stage of production.

 The production is carried out continuously, by way of the simultaneous, standardized and
sequential process.

 The output of a process is the input of another.

 The production from the last process is transferred to finished stock.

 The final product is homogeneous.

 Both direct and indirect costs are charged to the processes.

 The production may result in joint and by-products.

 Losses like normal and abnormal loss occur at different stages of production which are also
taken into consideration while calculating the unit cost.

 The output of one process is transferred to another one at a price that includes the profit of the
previous process and not at the cost.

PROF. MUBINA ATTARI www.dacc.edu.in


DNYANSAGAR ARTS AND COMMERCE COLLEGE, BALEWADI, PUNE – 45

Subject: Basics of Cost Accounting Subject code: 204 Class: FY BBA

 At the end of the period, if there remains the stock of finished goods, then it is also expressed in
equivalent completed units. It can be calculated as:
Equivalent units of semi-finished goods or WIP = Actual number of units in process × Percentage
of work completed

Preparation of process accounts including normal and abnormal loss/gain

Process Losses and Gains

It is usual that a certain amount of material introduced into the processes are lost, scrapped or wasted.
There are many ways in which losses may arise e.g., evaporation, shrinkage, breakages, spoilage for
various reasons.

PROF. MUBINA ATTARI www.dacc.edu.in

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