Cost Accounting

Indroduction

 Definition

Generally Cost accounting is a systematic set of procedures for recording, classifying and
summarizing the cost of manufacturing goods and finding out results and interpretation of
cost sheets and cost control.

According to Bhabatosh Banerjee, “Cost accounting is a quantitative method that

accumulates, classifies, summarizes and interprets financial and non-financial information for
three major purposes, viz,

a. Ascertainment of cost of a product or service;

b. Operational planning and control;
c. Decision making;

According to D. Batty, “Cost accounting may be defined as the systematic to the

measurement recording and control of the sacrifice involved in the transformation of
resources materials labor and fixed assets”.

The Certified Institute of Management Accountant of England (CIMAE) defines "cost

accounting as “that part of management accounting which establishes budgets and standard
costs and actual costs of operations, processes, departments or products and the analysis of
variances, profitability or social use of funds”.

 Purposes/ Advantages of Cost Accounting:

Cost accounting meets the following purposes-

1) Ascertainment of Cost: - It will make possible ascertainment of cost.

 By products , process, cost control or departments in manufacturing functions

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  By services and departments in administrative function and
 By products, group of products salesmen or areas in the selling and distribution
function.

2) Inventory Management:-
a) Systematic recording of materials.
b) Determination of stock levels
c) Ascertainment of optimum amount of materials to be ordered. Each time an order is
placed.
d) Materials stores are properly controlled and as a result loss due to misappropriation,
deterioration, obsolescence, scrap and defectiveness can be reduced.

3) Labor Cost Control

a) A sound system of remuneration.
b) An analysis of time lest in production.
c) Introduction to incentive scheme to reduce labor turnover.

4) Cost Control: - With the aid of standard costing in conjunction with budgetary control
cost may be predetermined and actual cost may be compared with standard cost to develop
variances according to originating causes. This will reveal operating efficiency or
inefficiency so that right action may be taken by right person at the right moment.

5) Managerial Decision Making: - Cost data will be readily available and this will facilitate
many vital technical decisions such as -

a) Introduction of new product

b) Selection of most profitable sales product.
c) Exploration of additional markets
d) Whether to make or buy
e) Utilization of spare capacity
f) Replacement of existing assets
g) Appraisal of proposed investment to meet expansion programme, etc.

6) Reports to Various Users: - Adequate information is available for reports to various

interested parties such as
a) Trade associations
b) Customers
c) Shareholders

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 d) Government
e) Insurance companies
f) Creditors
g) Banks
7) Cost Comparison: - Interfirm and Intrafirm cost comparison is facilitated.

 Types of Costs:

1) Historical cost
2) Standard cost
3) Estimated cost
4) Direct cost
5) Prime cost
6) Opportunity cost
7) Sunk cost
8) Relevant cost
9) Policy cost
1. Historical Cost:- It represents the actual cash payments or their equivalent at the time of
outlay for acquisition of assets. One of the mentionable limitations of historical cost is that it
ignores market price. It is not usually helpful in managerial decision making.

2. Standard Cost:- It is one of the most important control devices used in cost accounting. It
is most scientifically predetermined cost. Here standard is set for each element of cost in
accordance with past experience and future expectation for one unit of output.

This standard will be compared with actual cost later on to develop variances according to
originate causes. It involves no cash outlet.

3. Estimated Cost: It is predetermined cost. It doesn’t involve any cash outlay. It plays a
vital role in managerial decision making. It is estimated or predetermined based on past
experiences and future expectation.

Suppose in 2002, a firm used 1,000 kgs of raw materials for taka 10,000 @ taka 10 per
kg. It is past experience. Now if it is assumed that the cost of raw materials will increase
by 5%, then the amount for raw materials will be taka 10,500 for 2003.

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4. Direct Cost: It includes direct material, direct labor and direct expenses. Direct means that
which can be identified with and allocated to cost units.

5. Prime Cost: The sum of DM, DL and DE is known as prime cost and is found as follows:

Opening stock of R/M xx

Add- Purchase of R/M xx
Carrying cost xx
__________ x x x
Less: Closing stock of R/M xx
R/M Consumed xx
Add: Direct Labor xx
Direct Expenses xx
Prime Cost xx
6. Opportunity Cost: Opportunity is a hypothetical cost. It is the measurable advantage
forgone as a result of the rejection of alternative uses of resources, whether of materials, labor
or facilities. This cost does not involve any cash outlay and is computed only for the purpose
comparison in the context of managerial decision. Hence doesn’t find place in finances.

7. Sunk Cost: It represents historical cost which is irrecoverable in a given situation. For
example, while considering the replacement of an asset, the capital loss or depreciated book
value of the existing asset may not be taken into account on the ground that this portion of the
cost having being already incurred in the past has no relevance to the present decision.

8. Relevant Cost: It represents cost which is relevant /appropriate to aiding the making of
specific management decisions. These are expected future cost that will differ under
alternatives. Future variable costs generally become relevant in a decision context while fixed
costs may be irrelevant if they do not change in total.

9. Policy Cost: These costs are incurred as a result of taking a particular policy decision. For
example, ownership of assets will create a charge for depreciation. Depreciation is, therefore,
a policy cost.

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  Methods of Costing

Cost May be ascertained by different methods. Mainly, the major groupings are:

a) Job Costing
b) Process Costing
c) Farm Costing

a) Job Costing: Many companies produce goods against orders. Job costing is suitable for
those enterprises where the world is under taken according to the order of the customer. In
this case each order is known as a job.

Classification-

i) Batch Costing- A batch of similar products is treated as a job. Costs are collected
according to batch order numbers and total costs are divided by total numbers in a
batch to arrive at unit cost of each job. Examples are pharmaceuticals, biscuit,
bakeries, etc.

ii) Contract Costing- It is that form of specific order costing which applies where work
is undertaken to customers’ special requirements and each order is of long duration.
The work is usually constructional and in general the method is similar to job costing.

b) Process Costing: It refers to costing of process or operation involved in converting

materials into finished products. Under this method, cost of operation of each process and the
cost of transfer are ascertained. Process costing is most often found in such industries as--
chemicals, oil, textiles, plastic, flour, rubber, cement and meat packing. The following
methods are included in process costing.

i) Output Costing/ Single output or Unit costing: This is used when the
manufacture is continuous and the products are identical. The total production cost is
divided by the number of units produced to get unit or single unit cost. This method is
generally used in steel works, brick-fields, mines and collieries, flour mills, cement
Industries and bakery.

ii) Operating Costing- It is suitable to those industries which render services instead
of producing goods. The Cost and Management Accounting Terminology replaces
operating costing by service/function costing and defines it as the costing of specific
services of functions. Under this method, cost of providing and operating service is

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 ascertained and unit cost is found out by dividing total cost by units of services
rendered. It is generally used in transport industries, canteen, hospital, educational
Institution, boiler houses etc.

iii) Departmental Costing- It refers to the method of ascertaining the cost of

operating a department. Total cost for each department is ascertained and this is
divided by total units produced in that department to arrive at unit cost.

iv)Operation Costing–Under this method, each operation in each stage of production

or process is separately ascertained. Thereafter the cost of finished unit is determined.
This is suitable to those industries which are connected with mass production of
repetitive nature.

C) Farm costing: Here, the cost of produce is determined instead of product and emphasis is
given on this period. It is known as period costing. Some of the contributors come from
natural agents like water, air and the sun and cost of them can’t be measured in terms of
money.

 Techniques of Costing

In each of the costing methods, various techniques may be used in ascertaining costs.
These techniques may be grouped according to their approaches as follows:

a. Absorption Costing- It refers to the ascertainment of costs after they have been
incurred. In absorption costing, fixed and variable costs are allotted to cost units and
total overheads are absorbed according to activity level. It is also termed as historical &
traditional costing. Since costs are ascertained after they have been incurred. It doesn’t
help to exercise control on costs.

b. Standard Costing- Control device, standard are most scientifically fixed for each
element of costs and for revenues and actual are compared with standard to develop
variance in accordance with originating causes. It is usually employed in conjunction
with budgetary control. B/C refers to the establishment of budgets relations to
responsibilities of executives to the requirements of a policy & the continuous
comparison of actual with budgeted results, either to secure by individual action.

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c. Uniform Costing- It means a same costing methods, principles and techniques used by
a number of firms. Uniform costing will promote operating efficiency by ensuring
inter-firm comparison.

d. Life Cycle Costing: Life cycle costing is a technique for evaluating the total costs of a
product over its economic life. For cost analysis, it takes into consideration the entire
economic or useful life from start to finish of a product.

e. Marginal Costing/Variable Costing:- It refers to a principle whereby variable cost

are charged to cost units and the fixed cost attributable to the relevant period is written
off in full against the contribution for that period. Fixed costs are not treated as product
costs. They are recovered from contribution. It is a valuable aid to management in
taking many important policy decisions, such as product pricing in terms of
competition where to buy or make. Marginal costing is also known as valuable or
direct costing.

f. Target Costing: It is a technique which are determined by-

Target costs= Target (market) Price - Target (desired) profit.

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 Distinguish between Financial and Cost Accounting

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  Distinguish between Financial, Cost and Management Accounting

 Features of a good costing system / Factors to be considered in

installation of a costing system?

1) Objective: A good costing system should be objective oriented. The system to be

introduced should be adopted to suit the general nature of the business.

2) Technical Aspects: All the technical aspects, e.g. nature of product, methods & stages of
production cycle etc. should be studied thoroughly in order to select the proper method of
costing.

3) Participation: The participation from all levels of management is a prerequisite to

successful operation of any costing system.

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4) Details of Records: Details of record to be maintained should be arranged. Complete
analyses of reasonable cost are desirable. The system to be introduced should cover all
important functions, such as production, administration and sales.

5) Standardization: Forms to be used by foreman, workers etc should be standardized as far

as practicable. It should involve only minimum clerical works at different stages.

6) Sound Communication: Information should be communicated as early as possible so

that necessary steps can be taken at leisure time.

7) Authorization: Every original entry should be authorized by responsible person. This will
ensure reliability of data to be used for decision making purpose in future.

8) If costs and financial accounts are to be maintained separately, arrangement should be

made for reconciliation of cost & financial profits.

9) Easy to understand

10) Application of scientific method & tools, standard costing & budgetary control.

11) Flexible

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  Classifications of Cost:

Cost classification is the process of grouping costs according to their common features or
characteristics. Cost can be classified according to:

1) Elements
2) Function
3) Behavior
4) Controllability
5) Normality
6) Time Basis
7) Decision making

1) Elements wise of Costs: Costs are classified primarily according to the factors upon
which expenditure is incurred, viz:

a. Material cost, i.e., the cost of commodities supplied to an #undertaking.

b. Labor costs or wages, i.e., the cost of remuneration, such as wages, salaries,
bonuses for the employees of an undertaking

c. Expenses, i.e., the costs of services provided to an undertaking and the

notional cost of the use of owned assets (e.g dependent on plant).

Two broad further sub-divisions of the elements of costs may be made as follows:
1. Direct expenditure in
Materials
Labor
Expenses
2. Indirect expenditure in
Materials
Labor
Expenses
Here, direct (MLE) means that which can be identified with and allocated to cost centers or
cost units.

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Indirect (MLE) means that expenditure which can not be identified with or allocated to but
can be apportioned to or absorbed by costs centers or cost units.

Direct Material: clay in bricks, wood in furniture, leather in shoes, used in industry.

Indirect Material: Sundry stores, small tools for general use, materials consumed for repair
and maintenance work, fuel and lubricating oil required for operating and maintaining plant
and machinery.

Direct Wages: Wages paid to manufacturing labors.

Indirect wages: Wages to supervisors, Idle time wages, allowances to labor, wages payable to
storekeeper, clerical etc

Direct Expenditure: Cost of special pattern, drawing or layout, expenditure leading to the
receipt of a contract.

Indirect expenditure: Rent, rates and taxes. Canteen exp. Hospital etc.

2) Function Wise Classification: Costs which are generally incurred can be traced to the
main functions & named as:

b. Production cost
c. Administrative cost
d. Marketing cost

Description

a. Production Cost: It represents prime cost plus absorbed production overhead. While
prime cost means the total cost of DM, DL & DE, absorbed production overhead refers to
production overhead such as depreciation of factory plant, indirect wages etc.

b. Administrative Cost: It refers to the cost mgt and of secretarial and administrative
services, which can not be directly related to production, marketing, R&D functions of
the enterprise. In short, administrative costs are in the nature of indirect cost and include
the following

i. Salaries of office staff, accountants & directors

ii. Maintenance of factory estate
iii. General administrative expenses
iv. Office supplies & it’s expenses

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 v. Postage, stationary & telephone
vi. Rent, sales and dept. office building

c. Marketing Cost: This is defined in the terminology of CIMAE as follows; “The cost
incurred in researching the potential market promoting products in suitably attractive
forms and at acceptable prices”.

Marketing cost is further classified into

1) Selling cost 2) Publicity cost 3) Distribution cost
Selling cost: The cost incurred in securing orders usually including salesman salaries and
traveling expenses, rent of sales room & offices, training of salesman and sales staff.

Publicity cost: Advertisement & promotion

Distribution cost: The cost incurred in warehousing saleable products and in delivering
products to customers. It includes rents, rates & dept. of warehouses. Cost of freight, export
duty, packing, shipping & maintenance of transport vans etc.

3) Behavior wise classification: It can be classified into-

b. Variable cost
c. Fixed cost
d. Semi variable or semi fixed cost
Description:

Variable cost: Cost which tends to follow the short term, in the level of activity. It will tend
to vary directly with output. Examples are, DM, DL, DE, Variable O/H i.e. power & fuel.

Fixed cost: It remains unaffected by fluctuations in volume within a relevant range and
during a defined period. Examples- Rent and rates of office, legal expense, bank charges,
interest on capital or debt, office expenditure

Semi-variable: It contains partly fixed and partly variable elements. These costs are partly
affected by fluctuations in the level of activity. Examples include- Maintenance of building
and plant, dept. of publicity and marketing, service dept wages, telephone charges.

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 ============

“Cost accounting is a mixed blessing"- Discuss.

“Cost accounting is a mixed blessing” because it offers certain benefits and it has certain
inherent limitations resulting as a concomitant.

Advantages:-

 Ascertainment of cost.

 Inventory management.

 Labour cost control.

 Cost control.

 Managerial decision making.

 Report to various parties.

 Cost comparison.

 Reduction and avoidance of inefficiency, wastages.

 Reduction of cost.

 Determination of price.

 Maintenance of quality.

 Sound production.

 Efficient utilization of resources.

Limitations

 The cost determination and analysis are done based on various assumptions .such
assumptions may vary from persons to persons and lead to produce different
information on similar items.

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  Various methods of costing are applied by various cost accountants and
consequently result may not be coincide.

 Usage of various methods of department valuation of raw materials

apportionment of overhead

 Application of cost accounting is very expensive because a separate set of books

are to be kept and at least an accountant is to be appointed for this purpose.

 Inspite of this above limitations cost accounting may be used as an effective

technique in deciding managerial decisions if it is applied deliberately carefully.

Distinguish between Cost Unit and Cost Centre.

Cost Unit: The expression of product or service into some measures. It is a quantitative unit
of product or service in relation to which costs are ascertained. For ascertainment of cost it is
necessary to express them in terms of physical measurement like number, weight, volume,
area, length or any other convenient units. A few examples of cost units applicable to
different industries are given below

Name of Industries Cost Unit Used

Printing Job
Mines ton
Chemicals Litres, gallons, kg
Electricity kwh
Paper Ream
Timber 100 ft

Cost Centre: Any part of an enterprise in respect of which costs are ascertained related to
cost units for control purpose. It may be a location, person or item of equipment. Broadly
speaking, a cost centre may be of two types: personal cost centre which consists of a person
or group of persons; impersonal cost centre which consists of a location or item of equipment.
For the standpoint of functions, a cost centre may be of two types: i) Production Cost Centre
and ii) Service Cost Centre/ Responsibility Centre.

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Question 6. Give a brief description of the following and mention the names
of industries in which each of these would be suitable applied.

a) Contract costing (b) Output costing (c) Process costing (d) Operating costing

a) Contract costing: It is that form of specific order costing which applies where work is
undertaken to customer’s special requirements and each order is of long duration. The work
is usually constructional in nature and hence undertaken in the premises of customer. It is
also referred to as Terminal Costing. In general the method is similar to job costing. Example
of industries where applicable:

 Housing Industries
 Construction of Bridge
 Ship-Building Industries
 Building

b) Output Costing (Single output/Unit costing): This is used when the manufacture is
continuous and the products are identical. The total production cost is divided by the number
of units produced to get unit or single unit cost. Examples, where this method is used:

i. Steel Works
ii. Breweries
iii. Brick Field
iv. Mines and collieries
v. Flour Mills
vi. Cement Industres
vii. Bakery

c) Process Costing: It refers to costing of process of operation involved in converting

materials into finished products. Under this method, cost of operation of each process and the
cost of transfer are ascertained. This suitable for those industries where product passes
through distinct stages or processes. For example in case of textile mill there are 3 distinct
processes via 1.spinning, 2.weaving & 3.Dyeing. Examples, where this method is used:

1. Chemicals 5. Flour 9. Mining

2. Oil 6. Canneries 10. Cement
3. Textile 7. Rubber 11. Meat packing

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 4. Plastics 8. Glass

d) Operating Costing: It is suitable to those industries which render services instead of

production goods. The management accounting terminology (MAT) replaces operating
costing by Service/Function costing. Under this method cost of providing and operating
service is ascertained and unit cost is found out by dividing total cost by units of services
rendered. Composite Units such as ton-miles, passenger-miles, Kilowatt-hours, bad-days etc
are generally used. Example:

i. Transport Industries
ii. Canteen.
iii. Hospital
iv. Educational Institution
v. Power Generation
vi. Railway

Question 7. Distinguish between Expense and Cost

In general, Expired expenditure is expense and unexpired expenditure is cost.

The AICPA (American Institute of Certified Public Accountants) committee on terminology

defines expense as including “all expired cost”. The committee also suggests to use term
“expense” in case of Financial Accounting.

In C/A we use the term Cost and not Expense. According to Finney & Miller, “Cost is the
measure of the expenditure”.

Question 9. Distinguish between Costing methods and Costing techniques.

Explain the different methods & techniques of costing.
Answer:

Methods mean the way of ascertaining some things.

Techniques mean a method used to perform a certain functions.

Question 10. Define Cost. Discuss the different types of Cost.

Cost: Cost is a sacrifice which is measurable in terms of money or money’s worth.

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According to CIMAE, “cost is the amount of expenditure (actual or nominal) incurred on, or
attributable to, a specified thing or activity.”

Cost is computably defined as a sacrifice, a forgoing or a release of something of value.

Total Cost: The sum of all cost (actual or nominal) incurred on or attributable to a given
volume under consideration.

Average Cost: Unit cost computed by dividing Total Cost by the volume involved.

Marginal Cost: is the rate of change in Total Cost per unit change in the volume of output.

Differential Cost: It represents change in Total Cost at a particular level of activity with
respect to another. It is also known as Incremental Cost. Say, for producing 2000 units, Total
Cost is tk 4000. For producing 5000 units, Total Cost is 9500. Here Tk5500 for additional
3000 units is differential cost.

Replacement Cost: This is current cost of replacing an asset.

Imputed Cost: It is a hypothetical cost and does not involve actual cash outlay and as a
consequence, does not appear in the financial records. Nevertheless, such costs involve a
forgoing on the part of the person whose costs are being calculated. For example, interest on
own capital, rent on own premises etc.

Discretionary Cost: They are fixed costs that arise from periodic, usually yearly
appropriation decisions that directly reflect top most policies. These costs may not have
particular relation with the volume of activity. Examples- advertising, R&D, employee
training etc. In contrast to committed costs, these costs could be reduced almost entirely for a
given year if circumstances demand.

Controllable Cost: It is one of the most important objectives of cost accounting. Costs which
can be influenced by the action of an individual in an enterprise within a given time span.

Question 11: States the method of costing applicable to the following

1) Ship building
2) Railway
3) Hospitals
4) Prints

1. Ship building → Contract Costing

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 Reasons
a. Undertaken to customers special requirement
b. Long duration
c. Construction
d. Contractual relationship
2. Railway- Operating costing- Rendering service
3. Hospitals- Operating costing- Rendering service
4. Printer- Job costing- customer order.
i. Prints/garments-job costing
ii. BRTC/ railway- operating
iii. Food processor/ confectionary/ drug- batch/units
iv. Watch/ motor car/ plane/ rail car/ cycle/ equipment
v. Sugar, milk, oil, butter, rubber process
vi. Housing, bridge…. Contract
vii. Coal, iron, mine unit costing
viii. Furniture process

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