COST ACCOUNTING

In general, cost accounting is a field of accounting that measures, records and reports
information about costs. It involves the comprehensive set of principles, methods and techniques
to determine an appropriate analysis of costs to suit the various parts of organizational structure
within the enterprise. There is, however, no watertight definition for cost accounting. Various
authorities and scholars have gone ahead to give their definitions. Some of the definitions
include:
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. (Chartered Institute of Management Accountants - CIMA).
That which identities, defines, measures, reports and analyzes the various elements of direct
and indirect costs associated with producing and marketing goods and services. Cost accounting
also measures performance, product quality and productivity. (Letricia Gayle Rayburn).
A systematic process of collecting, summarizing and recording data regarding the various
resources and activities in a firm so as to calculate the basis of production costs used in financial
accounting or making other relevant decisions in a firm. (Horngren C.T)
The main objective of cost accounting is communicating financial information to management
for planning, evaluating and controlling performance, and to assist management to make
decisions that are more informed. Its data are used by managers to guide their decisions.
Cost accounting aims at providing useful information to decision makers to enable them make
better decisions. It helps them in preparing various statements such as cash budgets and
performance reports, cost data collection and application of costs to products and services.
Purpose of cost accounting
Cost ascertainment: the costs of producing different commodities or providing services must be
ascertained accurately. These costs consists of material cost, labour cost and overheads. The costs
must be kept at minimum possible level. The detailed information about cost helps the
management to make some important decisions and to evaluate performance of the organization.

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KeMU

Disclosure of wastes: the costs incurred for production of any commodity can be determined in
advance in view of the past experience. If actual costs are higher than the expected or standard
costs then the excessive cost may be due to wastage of raw materials or idle labour time.
Decision making: the management is responsible to make decision regarding what goods should
be produced and in how much quantity. Cost accounting provides necessary information to the
management for making the decisions.
Cost control: it is an important function of the management. Material cost, labour cost and
overheads must be maintained at desirable levels. Cost accounting principles are used to
eliminate unnecessary costs.
Planning: the management prepares plans for the expansion of business activities. The
installation of new machinery and plant is needed to increase the production capacity of the
manufacturing concern in view of greater demand for its products. The past experience and cost
data are used to prepare and implement future plans.
Measurement of efficiency: cost data are used to measure the efficiency of the organization. If
there are various department of a business enterprise then it is important to determine the relative
performance of these departments. More efficient departments must be given greater incentives
and appropriate steps must be taken to improve the performance of less efficient departments.
Comparison between cost accounting and financial accounting
Cost Accounting

Financial accounting

Cost accounting is not governed by any Financial Accounting is highly regulated and
principles or concepts.

is governed by the Generally Accepted

Accounting Principles.
Cost accounting is not mandatory, the Financial accounting

is

management may practice it or not

requirement. It is mandatory.
Cost accounting looks at segments of the Financial
accounting
looks
organization and the organization as a whole.

statutory
at

the

organization as a whole. It is less concerned

with segmental performance.

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KeMU

Cost accounting is futuristic; it places more Financial accounting is historical in that it

emphasis on the future.
reports what has already taken place.
Cost accounting places less emphasis on Financial accounting places more emphasis
precision and more emphasis on non- on monetary data and precision
monetary data.
Cost accounting draws heavily from other Financial accounting draws little if any from
disciplines such as economics, finance, other disciplines. It is governed by the
statistics and operation research.

statutes

and

the

Generally

Accepted

Accounting Principles
Cost and management accounting provides Financial accounting provides data for
data for internal use by management.
external uses.
Cost accounting emphasizes the relevance Financial accounting emphasizes more on
and flexibility of data.

objectivity and verifiability of data.

COST TERMS AND CONCEPTS

Cost
A cost is the value of economic resources used as a result of production of any commodity or
performing any service. E.g if ksh. 5000 are spent to produce 100 units of cloth then this amount
is referred as cost. The main elements of cost are: Raw materials, labour and overheads.
Classification of cost
i) Fixed and variable cost
Fixed cost is the cost which remains the same at various levels of output. This cost does not
change with the change in output. This cost is incurred mostly on periodic basis e.g rent. Fixed
cost remains the same even at zero level of output.
Variable cost is the cost which changes with the level of production. When production increases,
variable cost also increases and vice versa e.g. lighting and heating charges.
ii) Direct and indirect cost
Direct cost is that cost which can be identified for the production of some specific goods. Raw
materials and labour cost are direct costs because these can be charged and identified to the
production of some specific output of goods.

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KeMU

Indirect cost is that cost which cant be identified to the production of some specific goods.
These costs are incurred for the activities as a whole in case of any department or organization.
E.g. indirect materials, wages, electricity, water charges, rent and rates.
iii) Cost classification by function
It consists of:
a) Production cost: This consists of raw material cost, labour cost, factory rent and so on.
b) Administration cost: Consists of office rent, postage and telephone, salaries of office staff,
depreciation of office machines and so on.
c) Selling and distribution costs: Are costs which are incurred to promote the sale of goods and
deliver these goods to the customers. They include advertisement, salesmens commission, and
depreciation of delivery vans and so on.
Total cost analysis
The total cost incurred by a manufacturing concern may be analyzed as:
Direct Material
It consists of the raw materials used in a product and some components which are incorporated
into the finished product.Opening stock + purchases + carriage inwards purchase returns
closing stock = direct material
Direct wages
Are the remuneration paid to the factory workers for converting the raw materials into finished
goods. They are also called direct labour cost.
Direct expenses
Include any expenditure other than direct material and direct wages incurred on the production of
some specific product. E.g. cost of drawings or designs, royalties paid per unit for a copyright
design e.t.c.

Prime cost
Prime cost of a product is the total of its direct costs. It is direct material cost plus direct labour
cost plus direct expenses.

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KeMU

Overheads
Indirect costs are those costs which cant be identified to the production of any specific product.
These indirect costs are known as overheads. They can be classified as:
i)

Production and factory overheads

These are production or factory expenses other than direct costs. They include:
a) Indirect material: they cant be charged directly to the production of specific product e.g. spare
parts, lubricating oil e.t.c
b) Indirect wages: Are wages paid to those workers who are required to complete some processes
in respect of all the products. E.g. factory supervision, wages of clerical staff, wages of
maintenance staff like repairers and cleaners.
c) Rent, rates, insurance, water, power and electricity charges for the factory.
d) Sundry expenses like canteen, entertainment and medical facilities provided to the workers.
e) Depreciation of factory plant and machinery, depreciation of factory building, maintenance
and repairs of factory plant and buildings.
ii)

Administration Overheads

All the expenses incurred for providing control, direction and management of the enterprises.
They include:
a) Rent, rates, insurance, water and electricity for the office.
b) Salaries of office staff e.g. accountant, clerks
c) Depreciation of office furniture, office equipment and office buildings.
d) Legal expense e.g. interest on loans
iii)

Selling and distribution overheads

Selling overheads are those expenses which are incurred to secure orders and to increase sales of
the enterprise. E.g. advert expenses, salaries of salesmen.
Distribution overheads are those expenses which are incurred on the movement of finished goods
from factory to warehouse and then in delivering these goods to the customers. E.g. salaries of
delivery van drivers, warehouse rent, and electricity and water charges.

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KeMU

Cost Accounting Terms

Cost unit
It is the unit of quantity of produce, service or time in relation to which costs may be ascertained
or expressed. Cost unit will be different in different organization. E.g. it may be unit of
production like a litre of milk or a metre of cloth. It may be a unit of service like a patient bed, a
passenger seat. It may also be a unit of time like one labour hour and a consultation hour. Mostly
costs are ascertained in terms of cost units e.g. cost of providing service per patient bed in the
hospital.
Cost centre
It is any particular part of an enterprise. It may be a particular department in respect of which
costs may be ascertained and related to cost units for control purposes. Accounts department,
store department and administration department are regarded as cost centres.
Profit centre
A profit centre is that cost centre which not only incurs costs but also yields revenue. The costs
incurred by those cost centres which do not generate revenue are charged to the profit centres.
Cost behavior
Cost behavior means that pattern of change in cost as a result of change in level of activity or
production. When production increases, cost also increases and vice versa. Total cost can be
divided into two parts i.e. fixed cost and variable cost.
Cost statement
It is the presentation of cost data in the form of a statement. It is prepared to show production or
factory cost, total cost of sales, total profit and sales.
sh
Material cost

Labour cost

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Direct expenses

Prime cost

Production overheads

sh

Factory rent

Power

Supervision

Depreciation

Cost of goods manufactured

Administration overheads

Selling and distribution overheads

Total cost of sales

Profit

Sales

Question 1
Prepare a cost statement from the following information:
Raw materials

300,000

Direct labour

80,000

Factory rent

15,000

Power

5,000

Supervision salaries

20,000

Administration expenses

40,000

Selling and distribution expenses

15,000

Question 2
Prepare a cost statement from the following information:
Raw materials

80,000

Direct labour

35,000

Factory rent

5,000

Power

3,000

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KeMU

Indirect wages

2,000

Administration expenses

4,000

Selling and distribution expenses

3,000

Profit

25% of cost

Answer
Cost Statement
sh
Material cost

80,000

Labour cost

35,000

Prime cost

115,000

Production overheads

sh

Factory rent

5,000

Power

3,000

Indirect wages

2,000

10,000

Cost of goods manufactured

125,000

Administration overheads

4,000

Selling and distribution overheads

3,000

Total cost of sales

132,000

Profit

33,000

Sales

165,000

Work in progress
It is the cost of those items which remain incomplete at the end of a specific period. These are
semi-finished goods. For example thread in the textile industry is neither a raw material nor
finished good so it is considered as a w.i.p.
If opening figure of w.i.p. is greater than the closing figure then this difference is added to the
factory cost
Question 3
Prepare a cost statement from the following information:
Stocks in 1st January, 2010

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KeMU

Raw materials

45,000

Work in progress

22,000

Stocks in 31st December, 2010

Raw materials

65,000

Work in progress

19,000

Purchase of raw materials

670,000

Carriage inwards

25,000

Return of raw materials

15,000

Direct wages

280,000

Factory rent

60,000

Power

48,000

Depreciation of plant

35,000

Supervisors salaries

55,000

Office salaries

70,000

Office expenses

12,000

Depreciation of office equipment

5,000

Salesmen salaries

68,000

Delivery vans expenses

27,000

Depreciation of delivery vans

18,000

Advertisement

12,000

Answer
Cost Statement
Sh
Opening stock

sh
45,000

Purchases

670,000

Add carriage inwards

25,000
695,000

Less returns outwards

15,000

680,000
725,000

Less closing stock

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65,000

KeMU

Direct material consumed

660,000

Direct wages

280,000

Prime cost

940,000

Factory overheads
Factory rent

60,000

Power

48,000

Supervisors salaries

55,000

Depreciation of plant

35,000

198,000
1,138,000

Work in progress
Opening

22,000

Closing

(19,000)

3,000
1,141,000

Administration overheads
Office salaries

70,000

Office expenses

12,000

Depreciation of office equipment

5,000

87,000

Selling and distribution overheads

Sales men salaries

68,000

Delivery van expenses

27,000

Advertisement

12,000

Depreciation of delivery vans

18,000

Total cost of sales

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125,000
1,353,000

KeMU