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Cost (Costing)
February 3, 2019 - by admin - Leave a Comment

Classi cation Of Costing

Elements Of Costing

1) Meaning Of Cost :-

The term cost means total amount of expenditure did by manufacturer or factory for producing
or making any goods and services.  The term ‘cost’ is most widely used as the ‘money cost’ of
production which relates to the money expenditure of a rm on: (i) Wages and salaries paid to
the labour. (ii) Payment incurred on machinery and equipment. (iii) Payment for materials, power,
light, fuel, transportation etc. (iv) Payments for rent and insurance. (v) Payments to Government
by way of taxes. Money costs therefore relate to money outlays by a rm or factors of a
production which enable the rm to produce and sell a product. It should be remembered that
every producer is interested in money costs. Besides money cost there are other costs that are
equally important to take decisions on various matters.

This activity of a rm may be the manufacture of a product or the rendering of a service which
involves expenditure under various heads, e.g., materials, labour, other expenses, etc. A
manufacturing organisation is interested in ascertaining the cost per unit of the product
manufactured while an organisation rendering service, e.g., transport undertaking, canteen,
electricity company, municipality, etc., is interested in ascertaining the costs of the service it
renders. In its simplest form, the cost per unit is arrived at by dividing the total expenditure
incurred by the total units produced or the quantum of service rendered. But this method is
applicable if the manufacturer produces only one product. If the manufacturer produces more
than one product, it becomes imperative to split up the total expenditure between the various
products so that the cost of each product can be ascertained separately. Even if only one product
is manufactured, it may be necessary to analyse the cost per unit of each item of expenditure
that goes to make up the total cost. The problem becomes more complicated where a
multiplicity of products is produced and it is necessary to analyse the cost per unit of each
product into various items of expenditures that make up the total cost.

De nition Cost-

The Chartered Institute of Management Accountants, London de nes cost as “the

amount of expenditure (actual or notional) incurred on or attributable to a speci ed
thing or activity”.
cost means ‘expenditure incurred’ for producing a particular product or rendering a
particular service

1. Meaning and de nition of costing –

The process of ascertaining the cost is known as costing.

It consists of principles and rules governing the procedure of nding out the costs of goods/
services. It aims at ascertaining the total cost and also per unit cost. For instance, in transport
companies the total cost for the period is ascertained and used to nd out the cost per
passenger/mile. i.e. the cost of carrying one passenger for one mile. It provides for analysis of
expenditure in such a way that the management gets complete idea about even the smallest item
of cost.

Scope or Objectives or functions of costing

Cost Ascertainment
Cost Control
Determining Selling Price
Cost Audit
Providing information for decision-making
Ascertainment of pro t
Facilitating preparation of nancial and other statements

Cost Ascertainment

To ascertainment of cost means to know and calculate how much cost has been incurred for
particular article or product. The main function of cost accounting is the ascertainment of cost of
product or services rendered. It includes collection, analysis of expenses and measurement of
production at different stages of manufacture. The collection, analysis and measurement
requires different methods of costing for different types of production such as Historical costs,
Standard costs, Process cost, Operation cost etc.

It can be done in two ways, namely

(i) Post Costing, where the ascertainment of cost is done based on actual information as
recorded in nancial books.

(ii) Continuous Costing, where the process of ascertainment is of a continuous nature i.e. where
cost information is available as and when a particular activity is completed, so that the entire
cost of a particular job is available the moment it is completed.

Cost Control:

Cost Control is the guidance and regulation by executive action of the costs of operating an
undertaking. It aims at comparing the actual performance towards the standard; regulates or
corrective action taken the actual if they deviate or vary from the targets or standard; this
guidance and regulation is done by an executive action. T0 exercise cost control, following steps
should be observed

1. Determine the standard or target

2. Measure the actual performance
3. Compare the actual performance with standard, nd the deviation
4. Find out or investigate the causes of failure of deviation
5. Institute or implement  corrective action

Determination of selling price

The scope of costing is to determination of selling cost of the product. Generally rm adding
certain percentage of margin or pro t in total cost and xing price of any article.  Price of any
article is depending upon total cost incurred on product. If cost is more selling price will be more,
so control the cost means increase the pro t of the rm. Price and demand have inverse
relationship.

 Cost Audit

Cost Audit is the veri cation of the correctness of cost accounts and a check on the adherence
to the cost accounting plan. Its purpose is not only to ensure that cost accounts and other
records are arithmetically correct but also to see that the principles and rules have been applied
correctly.

Providing information for decision-making

 Cost accounting helps the management in providing information for managerial decisions for
formulating operative policies. These policies relate to the following matters:

Determination of cost-volume-pro t relationship.

 Make or buy a component
Shut down or continue operation at a loss
Continuing with the existing machinery or replacing them by improved and economical
machines.

Ascertaining costing pro t

 Cost accounting helps in ascertaining the costing pro t or loss of any activity on an objective
basis by matching cost with the revenue of the activity. Generally when we minus the total cost
from total sale or revenue rm get pro t.

Facilitating preparation of nancial and other statements

Cost accounting helps to produce statements at short intervals as the management may require.
The nancial statements are prepared generally once a year or half year to meet the needs of the
management. In order to operate the business at high ef ciency, it is essential for management
to have a review of production, sales and operating results. Cost accounting provides daily,
weekly or monthly statements of units produced, accumulated cost with analysis. Cost
accounting system provides immediate information regarding stock of raw material, semi
nished and nished goods. This helps in preparation of nancial statements.

4.) Classi cation Of Costs

By element or nature
By Variability
As Direct and Indirect (Element of cost)
By Time
By Controllability
By Normality
By functions
Other cost classi cation

1. By element or Nature

Costs should be gathered together in their natural grouping such as Material, Labour and Other
Direct expenses. Items of costs differ on the basis of their nature. The elements of cost can be
classi ed in the following three categories.

Cost Classi cation by nature

 1.Material Cost             2. Labour Cost              3. Expenses/Overheads Cost

Material Cost: Material cost is the cost of material of any nature used for the purpose of
production of a product or a service. It includes cost of materials, freight inwards, taxes & duties,
insurance …etc directly attributable to acquisition, but excluding the trade discounts, duty
drawbacks and refunds on account of excise duty and vat.

Labour Cost: Labour cost means the payment made to the employees, permanent or temporary
for their services. Labour cost includes salaries and wages paid to permanent employees,
temporary employees and also to the employees of the contractor. Here salaries and wages
include all the bene ts like provident fund, gratuity, ESI, overtime, incentives…etc

Expenses: Expenses are other than material cost or labour cost which are involved in an activity.
Like transportation payment, electricity payment etc

By Variability

Fixed cost – It mainly relates to time or period. It remains unchanged irrespective of volume of
production like factory rent, insurance, etc. The cost per unit uctuates according to the
production. The cost per unit decreases if production increases and cost per unit increases if the
production decreases. That is, the cost per unit is inversely proportional to the production. For
example, if the factory rent is Rs 25,000 per month and the number of units produced in that
month is 25,000, then the cost of rent per unit will be Rs 1 per unit. In case the production
increases to 50,000 units, then the cost of rent per unit will be Rs 0.50 per unit.

Variable cost – Variable cost directly associates with unit. It increases or decreases according to
the volume of production. Direct material and direct labor are the most common examples of
variable cost. It means the variable cost per unit remains constant irrespective of production of
units.

Semi-variable cost – A speci c portion of these costs remains xed and the balance portion is
variable, depending on their use. For example, if the minimum electricity bill per month is Rs
5,000 for 1000 units and excess consumption, if any, is charged @ Rs 7.50 per unit. In this case,
xed electricity cost is Rs 5,000 and the total cost depends on the consumption of units in excess
of 1000 units. Therefore, the cost per unit up to a certain level changes according to the volume
of production, and after that, the cost per unit remains constant @ Rs 7.50 per unit.

As direct and indirect cost- 

The elements of cost can be studied under the classi cation direct and indirect costs. If the
object of interest for identifying and measuring cost is to determine how much sacri ces
involved in manufacturing a particular product, then initially one can de ne the three elements
of total cost i.e., materials, labor, and expenses.
i. Direct Costs: The direct costs are those which can be
identi ed easily and indisputably with a unit of operation or
costing unit or cost centre. Costs of direct material, direct
labour and direct expenses can be directly allocated or
identi ed with a particular cost centres or a cost unit and can
be directly charged to such cost centre or cost unit. These
costs are also called ‘traceable costs’.

ii. Direct Material: The direct material costs are those which
can be identi ed easily and indisputably with a unit of
operation or costing unit or cost centre. The direct material
cost can be directly allocated or identi ed with particular cost
centres or cost units and can be directly charged to such cost
centres or cost units.
Raw materials are directly identi able as part of the nal product and are classi ed as direct
materials. For example, wood used in production of tables and chairs, steel bars used in steel
factory etc. are the direct materials that becomes part of the nished product.

iii. Direct Labour: The labour cost incurred on the employees

who are engaged directly in making the product, their work
can be identi ed clearly in the process of converting the raw
materials into nished product is called ‘direct labour cost’.
For example, wages paid to the workers engaged in machining department, fabrication
department, assembling department etc.

iv. Direct Expenses: The direct expenses refers to expenses that are speci cally incurred and
charged for speci c or particular job, process, service, cost unit or cost centre. These expenses
are also called ‘chargeable expenses’.

Some of the examples of direct expenses include the following:

(1) Cost of drawings, designs and layout.

(2) Royalties payable on use of patents copyrights etc.

(3) Hire charges of special tools and equipment for a particular job or work.
(4) Architects, surveyors and other consultation fees of particular job or work.

Sometimes, if the direct expenses are negligible or small amount, it will be treated as overhead.

v. Indirect Costs: Indirect costs cannot be allocated but which

can be apportioned to cost centres or cost units. These costs
are also called as ‘common costs’. The indirect costs are not
traceable to any plant, department, operation or to any
individual nal product. All overhead costs are indirect costs.
Costs of indirect material, indirect labour and indirect expenses in aggregate constitute the
overhead costs and are the indirect component of the total cost. Indirect costs cannot be directly
allocated to cost units or cost centres and have to be absorbed or recovered into cost units.

vi. Indirect Material: The costs incurred on materials used to

further the manufacturing process, which cannot be traced
into the end product and the material required in the
production process but not necessarily built into the product
are called ‘indirect material’.
For example cutting oil used in cutting surface, threads and buttons used in stitching clothes,
lubricants used in maintenance of plant and machinery, cotton waste used in cleaning the
machinery etc. are considered as indirect materials.

Sometimes indirect materials like coal, fuel used in kilns etc. are considered as part of the prime
cost and some materials which are contained in small quantities in the end product like gums and
threads used in binding the books even though forming part of direct material cost, but is
considered not worth analyzing to cost units and may be categorized as indirect material cost.

vii. Indirect Labour: The cost of indirect labour consist of all

salaries and wages paid to the staff for the purpose of carrying
and tasks incidental to goods or services provided which will
not form part of salaries and wages paid in working directly
upon the product.
For example, salaries and wages paid to store keepers, watch and ward, supervisors,
timekeepers, quality control, managers, clerical staff, salesmen etc. These indirect labour costs
cannot be identi ed with any particular job, process, cost unit or cost centre.
viii. Indirect Expenses: Indirect expenses are those which are
incurred by the organization in carrying out their total
business activities and cannot be conveniently allocated to job,
process, cost unit or cost centre. Rent, rates, taxes, insurance,
lighting, telephone, postage and telegrams, depreciation etc.
are the examples of indirect expenses.
The concepts of direct and indirect costs are meaningless without identi cation of the relevant
cost unit or cost centre. Segregation of costs into direct and indirect costs is essential for proper
accounting and control of costs and also for managerial decision making purpose.

Advanced manufacturing technologies such as Robotics, Computer Aided Design and

Manufacture, Flexible Manufacturing Systems, Optimized Production Technology, Just-in-Time
etc., are revolutionizing the manufacturing process at shop- oor, quality and creating areas for
improved opportunities. They have dramatically changed the manufacturing cost behaviour
patterns.

The direct cost component of product cost is decreasing while depreciation, engineering and
information processing costs are increasing. These changes have resulted in higher overhead
rates and a shrinking base of direct costs over which to allocate those costs.

4. Cost Classi cation by Time:

i. Historical Cost: The historical cost is the actual cost,

determined after the event. Historical cost valuation states
costs of plant and materials, for example, at the price originally
paid for them. Costs reported by conventional nancial
accounts are based on historical valuations. But during periods
of changing price levels, historical costs may not be correct
basis for projecting future costs. Naturally historical costs
must be adjusted to re ect current or future price levels.

ii. Predetermined Cost: These costs relating to the product are

computed in advance of production, on the basis of a
speci cation of all the factors affecting cost and cost data.
Predetermined costs may be either standard or estimated.
iii. Standard Cost: It is a predetermined calculation of how
much costs should be under speci ed working conditions. It is
built up from an assessment of the value of cost elements and
correlates technical speci cations and the quanti cation of
materials, labour and other costs to the prices and/or usage
rates expected to apply during the period in which the
standard cost is intended to be used.
Its main purpose is to provide basis for control through variance accounting for the valuation of
stock and work-in-progress and in some cases, for xing selling prices. A standard cost is a
planned cost for a unit of product or service rendered.

iv. Estimated Cost: It is a predetermined cost based on past

performance adjusted to the anticipated changes. No minute
appraisal of each individual component cost. It can be used in
any business situation or decision making which does not
require accurate cost.
It is used in budgetary control system and historical costing system. Its emphasis is on the level
of costs not to be exceeded. It is used in decision making and selection of alternative with
maximum pro tability. It is also used in price xation and tendering. It is determined generally
for the period.

5.  By Normality

Normal Cost: The normal cost is normally incurred at a given level of output in the conditions in
which that level of output is achieved. Normal cost includes those items of cost which occur in
the normal situation of production process or in the normal environment of the business. The
normal idle time is to be included in the ascertainment of normal cost.

 Abnormal Cost: It is an unusual or a typical cost whose occurrence is usually irregular and
unexpected and due to some abnormal situation of the production. Abnormal cost arises due to
idle time for some heavy break down or abnormal process loss. They are not considered in the
cost of production for decision making and charged to Pro t and Loss Account.

By Controllability

Controllable Cost: The controllable cost is a cost chargeable to a budget or cost centre, which
can be in uenced by the actions of the person in whom control of the centre is vested. It is
always not possible to predetermine responsibility, because the reason for deviation from
expected performance may only become evident later.

For example excessive scrap may arise from inadequate supervision or from latent defect in
purchased material. The controllable cost is a cost that can be in uenced and regulated during a
given time span by the actions of a particular individual within an organization.

Uncontrollable Cost:  These costs cannot be in uenced by the action of a speci ed member of
the organization. The controllability of cost depends upon the level of responsibility under
consideration. Direct costs are generally controllable by the shop level management. The
uncontrollable cost is a cost that is beyond the control (i.e., unin uenced by actions) of a given
individual during a given period of time.

By functions

A company performs a number of functions. Functional costs may be classi ed as follows:

Manufacturing/production Costs: It is the cost of operating the manufacturing division of an

undertaking. It includes the cost of direct materials, direct labour, direct expenses, packing
(primary) cost and all overhead expenses relating to production.

Administration Costs: They are indirect and covers all expenditure incurred in formulating the
policy, directing the organisation and controlling the operation of a concern, which is not related
to research, development, production, distribution or selling functions.

 Selling and Distribution Cost: Selling cost is the cost of seeking to create and stimulate demand
e.g. advertisements, market research etc. Distribution cost is the expenditure incurred which
begins with making the package produced available for dispatch and ends with making the
reconditioned packages available for re-use e.g. warehousing, cartage etc. It includes
expenditure incurred in transporting articles to central or local storage. Expenditure incurred in
moving articles to and from prospective customers as in the case of goods on sale or return basis
is also distribution cost.

Research and Development Costs: They include the cost of discovering new ideas,

Process, products by experiment and implementing such results on a commercial basis.

Pre-production Cost: When a new factory is started or when a new product is introduced,
certain expenses are incurred. There are trial runs. Such costs are termed as pre-production
costs and treated as deferred revenue expenditure. They are charged to the cost of future
production.
 Other costs

Opportunity Costs: Opportunity cost is the cost of selecting one course of action and the losing
of other opportunities to carry out that course of action. It is the amount that can be received if
the asset is utilized in its next best alternative.

Example: Capital is invested in plant and machinery. It cannot be now invested in               shares or
debentures or banks. The loss of interest and dividend that would be earned is the opportunity
cost. Another example is when the owner of a business foregoes the opportunity to employ
himself elsewhere. Opportunity costs are not recorded in the books. It is important in decision
making and comparing alternatives.

Replacement Costs: This is the cost of replacing an asset at current market values e.g. when the
cost of replacing an asset is considered, it means the cost of purchasing the asset at the current
market price is important and not the cost at which it was purchased.

Shutdown Cost: The shutdown costs are the costs incurred in relation to the temporary closing
of a department / division / enterprise. Such costs include those of closing, as well as, those of
reopening. The shutdown costs are de ned as those costs which would be incurred in the event
of suspension of the plant operation and which would be saved if the operations are continued.

Examples of such costs are costs of sheltering the plant and equipment and construction of
sheds for storing exposed property. Further, additional expenses may have to be incurred when
operations are restored e.g., reemployment of workers may involve cost of recruitment and
training.

Marginal Cost: The term ‘marginal cost’ is de ned as the amount at any given volume of output
by which aggregate costs are changed if the volume of output is increased or decreased by one
unit. It is a variable cost of one unit of a product or a service i.e., a cost which would be avoided if
that unit was not produced or provided

6. Techniques of Costing:

A. Marginal Costing

B. Standard Costing

C. Budgetary Control

D. Uniform Costing

A. Marginal costing
Marginal Costing is the ascertainment of marginal costs and of the effect on pro t of changes in
volume or type of output by differentiating between xed costs and variable costs. Several other
terms in use like Direct Costing, Contributory Costing, Variable Costing, Comparative Costing,
Differential Costing and Incremental Costing are used more or less synonymously with Marginal
Costing.

The term direct cost should not be confused with direct costing. In absorption Costing, direct
cost refers to the cost which is attributable to a cost centre of cost unit (e.g., direct labour, direct
material and direct expenses including traceable xed expenses, i.e., the xed expense which are
directly chargeable). In Direct Costing (or Marginal Costing), factory variable overhead is taken
as a direct cost while in the Absorption Cost Method, it is Indirect Cost.

B. Standard Costing

Standard Costing is de ned as the preparation and use of standard cost, their comparison with
actual costs and the measurement and analysis of variances to their causes and points of
incidence. Standard Cost is a predetermined cost unit that is calculated from the management’s
standards of ef cient operation and the relevant necessary expenditure. Standard Costs are
useful for the cost estimation and price quotation and for indicating the suitable cost allowances
for products, process and operations but they are effective tools for cost control only when
compared with the actual costs of operation. The techniques of standard costing may be
summarised as follows :-

(i) Predetermination of technical data related to production. i.e., details of materials and labour
operations required for each product, the quantum of inevitable losses, ef ciencies expected,
level of activity, etc.

(ii) Predetermination of standard costs in full details under each element of cot, viz., labour,
material and overhead.

iii) Comparison of the actual performance and costs will the standards and working out the
variances, i.e., the differences between the actual and the standards.

(iv) Analysis of the variances in order to determine the reasons for deviations of actuals from the
standards.

(v) Presentation of information to the appropriate level of management to enable suitable action
(remedial measures or revision of the standard) being taken.

C. Budgetary Control
Budgetary Control may be de ned as the process of continuous comparison of actual costs and
performance with the pre-established budgets in relation to the responsibilities of the
executives to the speci c budgets for the achievement of a target in accordance with the policy
of the organisation and to provide a basis for revision of budget. Therefore, Budgetary Control
involves mainly establishment of budgets, continuous compassion of actual with budgets for
achievement of targets, revision of budgets in the light of changed circumstances.

The classi cation of budgets into various categories certainly helps to make the budgetary
control more effective because the maximum use is made of the functional budgets. Functional
Budgets over the goals to be attained by the functional executives and thus assume the greatest
signi cance.

D. Uniform Costing

Uniform Costing may be de ned as the application and use of the same costing principles and
procedures by different Organizations under the same management or on a common
understanding between members of an association. It is thus not a separate technique or
method. It simply denotes a situation in which a number of organizations may use the same
costing principles in such a way as to produce costs which are of the maximum comparability.
From such comparable costs valuable conclusions can be drawn. When the Uniform Costing is
made use of by the different concerns the same management it helps to indicate the strengths
and/or weaknesses of those concerns. By studying the ndings, appropriate corrective steps
may be taken to improve the overall ef ciency of the organizations. When used by the member
concerns of a trade association Uniform Costing helps to reduce expenditure on a comparative
marketing, to determine and follow a uniform pricing policy, to exchange information between
the members for comprised and improvement and so on.

Inter- rm Comparison as the name denotes means the techniques of evaluating the
performances, ef ciencies, de ciencies, costs and pro ts of similar nature of rms engaged in
the same industry or business. It consists of exchange of information, voluntarily of course,
concerning production, sales cost with various types of break-up, prices, pro ts, etc., among the
rms who are interested of willing to make the device a success. The basic purposes of such
comparison are to nd out the work points in an organization and to improve the  ef ciency by
taking appropriate measures to wipe out the weakness gradually over a period of time.

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