1st chapter

COST • Cost is the resources foregone or sacrificed in order to accomplish a specified objective. • Generally the cost is measured in terms of  money. • Incidentally, cost which do not give rise to actual cash outlay namely imputed or notional cost are also considered during decision making.

“ The foregoing, in monetary terms, incurred or potentially to be incurred in the realization of the objective of  management which may be manufacturing of a product or rendering of a service” service”

• Thus cost is that which is given or is sacrificed to obtain something. • The cost of an article consists of  actual outgoings or ascertained charges incurred in its production and sale.

• The objective for which the costs are computed is also important. • For example- If the purpose is to fix selling price, then total cost is considered. • For valuation of stock, cost means cost of  production only. • So the term cost has different interpretations.

COSTING

“ The technique and process of  ascertaining cost”

COST ACCOUNTING “The process of accounting for cost which begins with the recording of  income and expenditure or the bases on which they are calculated and ends with the preparation of  periodical statements and reports for ascertaining and controlling cost ”.

COST ACCOUNTANCY • COST ACCOUNTANCY is the application of  costing and cost accounting principles, methods and techniques to the science, art and practice of cost control and ascertainment of profitability. • It includes presentation of information derived therefrom for the purpose of  managerial decision making”

ELEMENTS OF COST

OTHER EXPENSES MATERIALS

DIRECT

LABOUR 

INDIRECT DIRECT

INDIRECT

DIRECT

INDIRECT

OVERHEADS

FOH

AOH

SOH

DOH

MATERIAL The substance from which the finished product is made is known as material.

Direct Material Indirect Material

Direct Material • Direct material is one which can be identified in the product and can be conveniently measured and directly charged to the product. • Thus, these materials directly enter the production and form a part of the finished product. • Eg: Timber in furniture making, Cloth in dress making, bricks in building a house, etc….

The following are normally classified as direct material • All raw materials like jute in the manufacture of  gunny bags, pig iron in foundry, etc • Materials specifically purchased for a specific job, process or order like glue for book-binding, starch powder for dressing yarn etc. • Parts or components purchased or produced like batteries for transistor radios, tyres for cycles. • Primary packing materials like cartons, wrappings etc used to protect finished product from climate conditions or for easy handling inside the factory

Indirect Materials • Indirect materials are those materials which cannot be classified as direct materials. • Materials which do not normally form part of the finished product. • Eg;- consumables like cotton waste, lubricants, brooms, cleaning materials, materials for repairs and maintenance of fixed assets etc…..

Examples of Indirect material • At factory level – lubricants, consumables, etc. • At office level – Printing & stationery, Brooms, Dusters, etc. • At selling & dist. level – Packing materials, etc.

• However in some cases a material may be direct but it is treated as indirect, because it is used in small quantities and it is not economically feasible to identify.. • Eg:-sewing thread in dress making, nails in furniture making etc

LABOUR

• The human effort required to convert the materials into finished product is called labour.

DIRECT LABOUR • It is that labour which can be conveniently identified or attributed wholly to a particular job, product or process or expended in converting raw materials into finished goods. • wages of such labour are known as direct wages. • Eg: wages paid to carpenter, fees paid to tailor, etc.

• The wages paid to supervisors, inspectors etc, though not direct labour can be treated as direct labour if they are directly engaged on specific product or process and the hours they spend on it can be directly measured without much of  an effort.

Direct labour-payment made to the following:• Labour engaged on the actual production of the product carrying out an operation or process. • Labour engaged in aiding the manufacture by way of supervision, maintenance, tools setting, transportation of material etc. • Inspectors, analysts etc specially required for such production.

INDIRECT LABOUR

• INDIRECT LABOUR is one which cannot be conveniently identified or attributed wholly to a particular job, product or process.

Examples of Indirect labour  • At factory level – foremen’s salary, works manager’s salary, gate keeper’s salary, etc • At office level – Accountant’s salary, GM’s salary, Manager’s salary, etc. • At selling and dist.level – salesmen salaries, Logistics manager salary, etc.

OTHER EXPENSES

• These are those expenses other than materials and labour. • Direct expenses • Indirect expenses

DIRECT EXPENSES

• DIRECT EXPENSES are those expenses which can be directly allocated to particular job, process or product. Eg : Excise duty, royalty, hire charges, etc.

INDIRECT EXPENSES

• INDIRECT EXPENSES are those expenses which cannot be directly allocated to particular job, process or product.

Examples of other expenses • At factory level – factory rent, factory insurance, lighting, etc. • At office level – office rent, office insurance, office lighting, etc. • At sales & dist.level – advertising, show room expenses like rent, insurance, etc.

COST CENTRE •

For the purpose of ascertaining cost, the whole organization is divided into small parts or sections. • Each small section is treated as a cost centre of which cost is ascertained. • CIMA- “ a location, person or item of  equipment  (or group of these) for which cost may be ascertained and used for the purpose of  control”.

• Thus cost centre refers to a section of the business to which cost can be charged. • It may be a location( a department, a sales area), an item of equipment (a machine, a delivery van), a person ( a sales man, a machine operator) or a group of these (two automatic machines operated by one workman). • Purpose - cost control

• Personal cost centre- which consists of a person or a group of persons.

• Impersonal cost centre- which consists of a location or an item of  equipment or group of these.

Functional point of view• Production cost centre- these are those cost centres where actual production work takes place. • Eg- weaving department in textile mill. Melting shop in a steel mill. Cane crushing shop in a sugar mill. • Service cost centre- these are those cost centres which are ancillary to and render services to production cost centres. • Eg- power house, tool room, stores department, repair shop, canteen etc.

• Helps the cost accountant to ascertain the costs he needs to know. • A cost centre is charged with all the costs that relate to it. • Eg- cost centre- machine • It will be charged with the costs of  power, light, depreciation and its share of rent.

COST UNIT • A cost unit goes a step further by breaking up the cost into smaller sub-divisions, thereby helping in ascertaining the cost of saleable products or services. • CIMA-Unit of product or service in relation to which costs are ascertained.

• For example – in sugar mill cost per tonne of sugar may be ascertained, in a textile mill the cost per metre of  cloth may be ascertained. • Thus, “tonne” of sugar, and “metre” of cloth are cost units .

• Cost unit is unit of measurement of cost

• Units of production- a ream of paper, a tonne of steel, a metre of cable. Etc

• Units of service-passenger miles, cinema seats, consulting hours etc.

Industry/business

Cement

Cost unit

tonne

Shoes

pair or dozen pairs

Hotel

Room per day

Paper Petroleum Printing press Carpet

Ream Barrel / litre Copies Square foot

COST OBJECT • Anything for which a separate measurement of cost may be desired. • A cost accountant may want to know the cost of a particular “thing” and  such a thing is called a cost object. • The cost object may be a product, service, activity or process etc.

Examples • Product-car, shaving razor • Service-telephone hotline, taxi service • Process-melting process in a steel mill, weaving process in a textile mill • Activity-developing a website on the internet, purchasing raw material.

cost

Unexpired cost

Expired cost

Expenses

Shown in P&L account On debit side

Loss

Shown in Balance sheet As an asset

• Costs used up in producing revenues are said to have expired and are called expenses. Such expenses are deducted in each period to produce profits. • A Loss is a cost that expires without producing any revenue benefit. • Example: The cost of uninsured inventory destroyed by fire would be classified as a loss on the income statement.

• Costs that do not produce any benefit during a given period, are classified as Assets in the Balance Sheet of the period.

What is Cost Sheet? 

Cost sheet is a statement of cost.



In other words, when costing information are set out in the form of  a statement, it is called cost sheet.

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 Cost

sheet may be prepared for a week, monthly, quarterly or yearly indicating various components of cost as prime cost, works cost, cost of  production, cost of goods sold, total cost and also profitability on a production.

COST SHEET DIRECT MATERIAL DIRECT LABOUR DIRECT EXPENSES

PRIME COST FACTORY OVERHEADS

FACTORY COST OFFICE OVERHEADS

COST OF PRODUCTION SELL & DIST OVERHEADS

COST OF SALES PROFIT

SALES

COST SHEET - ADVANCED OPENING STOCK OF RAW MATERIALS +PURCHASES +CARRIAGE INWARDS -CLOSING STOCK OF RAW MATERIALS VALUE OF MATERIALS CONSUMED +DIRECT WAGES +DIRECT EXPENSES PRIME COST +FACTORY OVERHEADS +OPENING STOCK OF WIP -CLOSING STOCK OF WIP FACTORY COST (CONT.)

FACTORY COST +ADMINISTRATIVE OVERHEADS

COST OF PRODUCTION +OPENING STOCK OF FINISHED GOODS -CLOSING STOCK OF FINISHED GOODS COST OF GOODS SOLD +SELL. & DIST. OVERHEADS COST OF SALES +PROFIT

SALES

Factory overhead • All the costs incurred during the manufacturing process, minus the costs of direct labour and materials. • indirect materials, indirect labor, and all other overhead expenses related to factory other than direct materials and direct labor. • Factory overhead does not include direct materials and direct labor. also of course factory overhead does not include selling, general and administrative expenses.

• Examples of Factory overhead include: factory rent, factory insurance, maintenance of factory machines, oil and lubrications of  factory machines, depreciation of  factory machines.

Office/administrative overhead

• The indirect expenses (overheads) incurred within the administrative area are classified as administrative or office overheads.

• Selling Overheads • The indirect expenses (overheads) incurred in relation to the sales activities are classified as selling overheads. • Distribution Overheads • The indirect expenses (overheads) incurred in relation to the distribution of the product or service are classified as distribution overheads. • Selling and Distribution Overheads • The indirect expenses (overheads) incurred in relation to the sales activities as well as distributing the product or service are classified under a single head as "Selling and Distribution Overheads".

Classification of Cost • On • On • On • On • On • On • On • On

the the the the the the the the

basis basis basis basis basis basis basis basis

of of of of of of of of

Behaviour or Variability. Identifiability or Traceability. Controllability. Association with Product Normality Time Functions Managerial Decisions

On the basis of Behaviour or Variability.

• Variable cost • Fixed cost • Semi-variable cost

Variable Cost • Variable costs are those costs that vary directly and proportionately with the output. • There is a constant ratio between the change in the cost and change in the level of output.

• There are several costs of this type such as , for example, the material used to manufacture a product, the wages of  workers engaged in the manufacturing process, the power consumed while a machine is engaged in production.

Total Variable cost • To manufacture one unit product ‘X’ Direct material cost of Rs.10 has to be incurred. The existing volume of  production is 10,000 units p.a, so existing direct material cost is Rs.10 x 10,000=Rs.1,00,000

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Materials used

If the production increases to 15,000 units , the direct material cost would be Rs.10 x 15,000=Rs.1,50,000

Variable Cost Per Unit Per unit materials cost will remain constant

Direct material cost per unit remains constant. (Rs.10 per unit)

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Materials Cost

Fixed Cost • Fixed cost is the cost which does not change in total for a given time period despite wide fluctuations in output or volume of activity. • Examples of fixed costs are rent, property tax, supervising salaries, insurance, advertising etc.

• They accrue or are incurred with the passage of time and not with the production of the product or the job. • This is the reason why fixed costs are expressed in terms of time, such as per day, per month or per year and not in terms of unit.

Total Fixed Cost A factory manufacturing shoes incurs a fixed cost of  Rs.1,50,000( rent of building). The existing volume of production is 1000 shoes p.a. if the production increases to 1,500 units p.a, the fixed cost would remain fixed in total.

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Total production

Fixed Cost Per Unit The average fixed cost per unit decreases as more production is made.

The average fixed cost per unit would fall from Rs.150 per unit (1,50,000/1000) to Rs.100 per unit (1,50,000/1,500).

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production

Semi-variable or Semi-fixed Cost (Mixed cost) •

These costs include both a fixed and a variable component i.e, these are partly fixed and partly variable.

•

A semi variable cost often has a fixed element below which it will not fall at any level of output. •

The variable element in semi-variable costs changes either at a constant rate or in lumps.

Introduction of an additional shift in the factory will require additional supervisors

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Volume of production

On the basis of  Identifiability or Traceability. • Direct Cost • Indirect Cost

Direct Cost • Cost which are easily traceable or identifiable with a product are called direct costs. • If output units are the objects of  costing, then direct cost represent cost and resources that can be traced to or identified with the finished product . • Eg- direct material, direct labour, direct expenses

Indirect Cost • Indirect costs are those costs which cannot be identified with, or traced to a single product because they are incurred for several products. • Example- indirect material (lubricants), indirect labour (salary of factory supervisors), indirect expenses (rent).

On the basis of  Controllability.

• Controllable Cost • Non-controllable Cost

Controllable cost • A cost which can be influenced by the action of a specified member of  an undertaking. • These are the cost which may be directly regulated at a given level of  management authority. • Variable cots are generally controllable by department heads.

• Eg- cost of raw material may be controlled by purchasing in larger quantities.

Non-controllable cost • A cost which can not be influenced by the action of a specified member of an undertaking.

• Eg-it is very difficult to control costs like rent, managerial salaries..

On the basis of Association with Product

• Product cost • Process cost

Product Cost • These are those costs which are necessary for production and which will not be incurred if there is no production. • These consists of direct material, direct labour and some of the factory overheads. • Products cost can be attached to the units produced.

Period cost

On the basis of Normality

• Normal cost • Abnormal cost

Normal Cost • It is the cost which is normally incurred at a given level of output under the conditions in which that level of output is normally attained. • This cost is a part of cost of  production.

Abnormal Cost • It is the cost which is not normally incurred at a given level of output under the conditions in which that level of output is normally attained. • Such cost is over and above the normal cost and is not treated as a part of the cost of production. • It is charged to costing profit and loss account.

• Those costs which are incurred over and above the normal cost, due to abnormal factors like accident, inefficiency etc.

On the basis of Time

Historical Costs

Pre-determined Costs

Historical cost • These are the costs which are ascertained after these have been incurred. • Historical costs are nothing but actual cost. • These costs are not available until after the completion of the manufacturing operations.

Pre-determined cost • These are future costs which are ascertained in advance of production on the basis of a specification o all the actors affecting the cost. • These costs are extensively used for the purpose of planning and control.

On the basis of Functions • Manufacturing costs • Commercial costs – ADM AND S&D COSTS

Manufacturing and Production cost

• This is the total of costs involved in manufacture, construction and fabrication of units of production.

Commercial cost This is the total of costs incurred in the operation of a business undertaking other than the cost of manufacturing and production. • Administrative cost and selling and distribution cost

On the basis of Managerial Decisions • MARGINAL COSTS • OUT OF POCKET COSTS • SUNK COSTS • IMPUTED COSTS • OPPORTUNITY COSTS • REPLACEMENT COSTS • AVOIDABLE COSTS • UNAVOIDABLE COSTS • RELEVANT AND IRRELEVANT COSTS • DIFFERENTIAL COSTS

Opportunity Costs The potential benefit that is given up when one alternative is selected over another.

Example: If you were not attending college, you could be earning Rs.15,000 per year.

Your opportunity cost of attending college

Sunk Costs Sunk costs cannot be changed by any decision. They are not differential costs and should be ignored when making decisions.

Example: You bought an automobile that cost Rs.3.5 lakh two years ago. The Rs.3.5 lakh cost is sunk because whether you drive it, park it, trade it, or sell it, you cannot change the Rs 3.5 Lakh cost.

METHODS OF COSTING • JOB COSTING • CONTRACT COSTING • BATCH COSTING • PROCESS COSTING • UNIT COSTING • OPERATING COSTING • OPERATION COSTING • MULTIPLE COSTING

JOB COSTING • Job order costing • This method applies where work is under taken to customers special requirements and each order is of  comparatively short duration. • The work is usually carried out within a factory or workshop and moves through processes and operations as a continuously identifiable unit.

• A job consists of a single order or contract. • It is a cost unit by itself. • Under this method cost incurred are specifically identified with the item being manufactured for the customer. • Accordingly, each order is given a job number and costs are accumulated with reference to this.

• In this system cost object is a unit or multiple units of a distinct product or service called a job.

Eg-

•

•

A specialized machine made in Hitachi, •

A construction project managed by Bechtel corporation,

•

A repair job done at an Audi Service Centre

An advertisement campaign produced by Saatchi and Saatchi…

CONTRACT COSTING • Terminal costing • This is a variation of job costing. • The difference between job and contract is that job is small and contract is big. • A contract is a big job and a job is a small contract.

• The work is generally of constructional and repairs nature.

• A construction contract is a contract for the construction of an asset or a combination of assets which together constitute a single substantial project.

• This covers various activities as construction of plants (including site preparation), bridges, roads, dams, ships, buildings, complex pieces o equipments etc

• This method is mainly used by builders, civil engineering contactors, constructional and mechanical engineering firms etc.

BATCH COSTING • It is also an extension of job costing.

• Batch cost-aggregated costs relative to a cost unit which consists of a group of similar articles which maintains its identity through out one or more stages of production.

• Batching costing is used where items o identical nature are produced in a batch and each one keep its identity from the beginning to the end. • Under this method a, a batch is regarded as a cost unit and costs are accumulated against each batch. • Accordingly each batch is given a number and costs are collected with reference to this. • A separate cost sheet is prepared for each batch.

• The cost of each unit is calculated by dividing the total cost of the batch by the number of units produced.

PROCESS COSTING • As distinct from job costing, this method is used in mass production industries manufacturing standardized products in continuous processes of manufacturing. • Costs are accumulated for each process or department.

• Eg - Citibank provides the same service to all its customers when processing customer deposits. • Intel provides the same product (a Pentium 4 chip) to each of its customers . • Customers of General Chemicals all receive the same product (soda ash). •

• In order to arrive at cost per unit the total cost of a process is divided by the number of units produced.

Job-Costing system

Distinct units of  a product or service

Process-costing system

Masses of  identical Or similar units of a product

OPERATION COSTING • This is nothing but a refinement and more detailed application of process costing. • A process may consists of a number of  operation . • Operation costing involves cost ascertainment for each operation instead of a process.

• This method provides minute analysis of costs and ensures greater accuracy and better control.

SINGLE, OUTPUT OR UNIT COSTING • This method of cost ascertainment is used when production is uniform and consists of a single or two or three varieties of the same product. • Where the product is produced in different grades, costs are ascertained grade-wise.

• As the units of output are identical, the cost per unit is found by dividing total cost by the number of units produced.

• This method is applied in mines, quarries, brick kilns, steel production, flour mills etc.

OPEATING OR SERVICE COSTING • Variation of process costing • It is used in undertakings which provide services instead of manufacturing products. • Transport undertakings, electricity companies, hotels, hospitals, cinemas etc. use this method. • The cost units are passenger-kilometer, kilowatts hour, room per day in a hotel, a seat per show in a cinema hall etc.

MULTIPLE OR COMPOSITE COSTING • It is an application of more than one method o cost ascertainment with respect to the same product. • This method is used in industries where a number of components are separately manufactured and then assembled into a final product.

• Eg- in a television manufacturing company, manufacture of different component parts may require different production methods and thus different methods of costing may have to be used. • Assembly of these components into final product requires yet another method of  costing. • Examples- air conditioners, refrigerators, scooters, cars, locomotives

Techniques of costing standard costing Budgetary control Marginal costing Absorption costing Uniform costing

Standard Costing • In this technique, standard cost is predetermined as target of performance and actual performance is measured against the standard.

• The difference between standard and actual costs are analyzed to know the reason for the difference so that corrective action may be taken.

Budgetary Control • A budget is an expression of a firm’s business plan in financial form and budgetary control is a technique applied to the control of total expenditure on materials, wages, and overheads by comparing actual performance with planned performance.

Marginal Costing • In this technique, separation of costs into fixed and variable (marginal) is of special interest and importance. • This is so because marginal costing regards only variable costs, as the cost of  the product. • Fixed cost is treated as period cost and no attempt is made to allocate or apportion this cost to individual cost centers or cost units.

• It is transferred to costing profit and loss account of the period.

• This technique is used to study the effect on profit of changes in volume or type of output. •

Variable costing/direct costing

Absorption Costing • Conventional /full costing • It is a traditional method of costing whereby total cost are charged to products.

• This is in complete contrast to marginal costing where only variable costs are charged to products.

• This is a total cost technique under which total cost (Fixed + Variable) is charged as production cost. • In other words all manufacturing costs are absorbed in the cost of the products produced.

Uniform Costing • It simply denotes a situation in which a number of firms adopt a uniform set of costing principles. • CIMA- the use by several undertakings of the same costing principles and/or practices. • Helps to compare the performance