Basics of Cost Accounting
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.
COST: Total of expenses incurred to manufacture a product or rendering a services is called cost.
Example
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.”
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.
1. Job Costing
2. Marginal costing
3. Standard costing
4. Operational costing
5. Process Costing
Purpose of Costing
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:
1. Uniform Costing
2. Absorption Costing
3. Historical Costing
4. Batch Costing
5. Unit Costing
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”
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
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.
It records incomes and expenditures, required for manufacturing of product and rendering
services.
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.
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.
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:
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.
Where direct material is calculated with the help of the following formula:
Direct Material = Material Purached + Op. stock of Raw material – Closing Stock
of Raw Material
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:
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
UNIT:3
OVERHEADS
Topics:
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
“All overheads are the costs, but all costs are not the overhead’’.
Composition of Overhead
Classification of overheads
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.
Apportionment of Overheads
3. Efficiency Method
4. Survey 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.
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
UNIT:4
Topics
Contract costing
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.
5. The specific order costing principles are applied in contract costingThe size
of a contract is usually large or bigger than jobs.
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
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.
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.
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.
Case 4
When work certified is 90% or more of the contract price than entire notional profit is
transferred to P & L A/c.
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
all the expenses relating to the process for the period is charged to the respective process
account.
DIAGRAMATIC PRESENTATION
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.
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.
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
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.