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COST AND MANAGEMENT ACCOUNTING

BBA-III Semester
Total Hrs: 49 Faculty: Rachna Chawla

UNIT –II

COST:
Cost is defined as the ‘value’ of the sacrifice made to acquire goods and services. It’s the
expenditure, actual (outlay of cash or other property) or notional (incurring of a liability),
incurred on, or attributable to a product, a service or any activity.

At the time of acquisition, the cost incurred is for the present or future benefits. When
these benefits are utilized, the costs become expense. An expense is defined as a cost that
has given a benefit and is now expired.

COSTS

Expired Unexpire
Costs d Costs

Appear
in P& L Appear in
Account Balance Sheet
in the form of
Assets
COST OBJECT:
All costs incurred or likely to be incurred can be attributed to the firm. This general
identification of costs with the firm is, however of not much managerial use. For planning
and control purposes, costs should be measured for and associated with the segments or
components of the firm: they should be attributed to products or services or other cost
objects. The purpose or object for which costs are measured is called a cost object. A cost
object may be a single unit of a product, a group/batch of products, a department,
division, machine, a sales territory, an order, a job, and so on.

In selecting a cost object it should be seen that it is significant as well as feasible to


attribute cost to it. Cost objects may be tangible goods such as automobile, shoes,
machine etc. or services such as treating patients, repairing a car, stitching a garment etc.
The cost object should be clearly stated whenever cost is measured.

COST UNIT:

CIMA London defines a unit of cost as ‘a unit of quantity of product, service or time in
relation to which costs may be ascertained or expressed.’

It is a form of physical measurement, like a number, weight, area, volume length, time,
area etc.
COST OBJECT- COST UNIT
 Advertising : Each job
 Bridge Construction: Each Contract
 Gas: Cubic Meter, Kg
 Nursing Home: Per Bed/ Per Day
 Sugar: Quintal/ Tonne
 Machine: Per Hour
 Labour: Per Hour
 Canteen: Per meal, Per dish
 Nickel Plating: Per square meter
 Fencing: Per square feet

COST CENTER:
Cost center refers to one of those convenient units into which the whole factory is being
appropriately divided for costing purposes. It is the segment of an activity or the area of
responsibility for which costs are accumulated. It may be a location (department or a sub
department), a person or a group of persons, or an item of equipment or machinery or a
combination of these for which costs are ascertained and used for cost control.

The determination of a suitable cost center as well as analysis of costs under cost centers
is very helpful for periodical comparison and control of costs. In order to obtain the cost
of a product or services, expenses should be suitably segregated to cost centers. The
manager of a cost center is held responsible for control of cost of his cost center. The no.
of cost centers and size of each cost center may vary from one undertaking or another and
are independent upon the expenditure involved and requirements of the management for
the purpose of cost ascertainment and cost control. Too many cost centers tend to be
expensive but having too few cost centers defeats the very purpose of cist ascertainment
and cost control.

COST CENTERS

Productive Unproductive
Cost Centers Mixed cost Centers
Cost
Centers

Actually These are


engaged in essential aids
making the to productive
products centers
Engaged
sometimes in
Administration,
productive
Repairs &
activities n
maintenance
Shop Floor sometimes in
Drawings
provision of
department
services

Tool Shop
(Sometimes in
production of dies
n sometimes in
Repairs)
Cost Center

Process
Personal Cost Operation Impersonal Cost
Cost
Center Cost Center Center
Center

Cost
center
which
A cost
consists
One which center
of
consists of a which
persons
person or a consists of
or
group of continuous
machines
persons sequence of
that carry
operations
out the
same
operation

Impersonal Cost Centre

Location Equipment
Marketing Department Conveyor Belt
Reception Blast Furnace
Finance Department Welding Machine
Shop Floor etc etc
Centre

Profit Center
It is that segment of the Cost Center
activity of a business in A cost center is
which case both the created for
revenues and expenses accounting
are identified and P& L convenience for
made by that particular ascertaining and
segment of activity is controlling costs.
determined.

COST CLASSIFICATION:

It is the process of grouping costs according to their nature or common characteristics. As


the name suggests, cost classification entails the grouping the costs under heads –
material, labour and overheads. Grouping of costs may be on the basis of function,
variability, controllability and normality of costs.
COST
CLASSIFICATION

Nature
Materials/ Wages/
or Expenses
Elemen
t

Direct Material / Indirect


Material
Direct or
Indirect Direct Labor/ Indirect Labor

Direct Expenses / Indirect


Expenses

Function Production Cost/


Administrative Cost/
Selling and Distribution
Cost etc
Variabilit Fixed / Semi Variable/
y Variable

Controllabilit Controllable/ Uncontrollable


y

Normality
Normal Cost/ Abnormal Cost

Time Historical/ Predetermined


Decisio
n
Relevant/ Irrelevant Cost
Making
Incremental Cost/ Differential Cost

Out of Pocket Costs / Sunk Costs

Opportunity Costs and Imputed Costs

One of the most important inputs in managerial decision-making is cost data. There is
however no single concept of cost which can cater to all management needs. The “needs”
concept of cost depends on the conditions under which the costs are required to be
measured and the purpose for which measurement is required. In other words cost data
which is relevant in one situation may be irrelevant in other situation. Developing the
data on the required lines can be designated as “concept of cost relevancy”. This concept
implies the needed of different set of cost data for different objectives, purposes and
situations. Ass such various concepts of cost related to management needs are:

ON THE BASIS OF INCOME MEASUREMENT


(i) Product Costs:- Product costs are costs which can be identified with goods produced
for sale. They vary with production. Raw Material and direct labour are examples of
product costs. In a variable costing system, only variable costs are recognized as product
costs as only the variable costs are ones which are affected by the production volume.

(ii) Period Costs:- Period costs are costs which are matched against the revenue of the
current period. Period costs vary with passage of time and not with volume of production.
Rent, Insurance, Salary of work’s manager are example of fixed costs.

(iii) Absorbed Costs:- Absorption is defined as charging of overheads to cost units.


Absorbed costs are those costs which are absorbed by the revenues of the period in which
product has been sold.

(iv)Unabsorbed Costs
(v)Expired Costs:- Expired cost is a cost which cannot contribute to the production of
future revenues. Eg. Electricity Bill, Telephone Bill, Rent etc. Expired Costs are written
in P& L account against revenues.

(vi)Unexpired Costs:- Unexpired cost has the capacity to contribute to the production of
revenue in future. Inventory constitutes a good amount of unexpired costs as it can be
sold in subsequent years and will influence total future revenues. Unexpired costs are
written in Balance Sheet.

(2)ON THE BASIS OF PROFIT PLANNING


(i)Fixed costs

TOTAL FIXED COST

1
Fixed Cost Line

0
1 2 3 4 5
Production (in thousand units)

Fixed Costs are those costs that do not vary directly with the volume or rate of output.
They are period costs and are recoverable if firm is shut down. Eg. Rent, Property taxes,
supervisor’s salary, insurance, depreciation etc.
Fixed cost per unit varies due to change in output. If production increases fixed cost per
unit declines and if production declines fixed cost per unit increases. There are
two types of fixed costs:

Committed fixed Costs- These are unavoidable in short run and must continue to
be paid to ensure the operating existence of the company. Eg. Rent,
depreciation, pay and allowances of management etc.

Discretionary fixed costs- These are not related to current operations or activities
and are subject to management discretion and control. Eg. New Researches,
Management Programmes etc These are set at a fixed amount for specific
time periods by management in budgeting process.

(ii)Variable Costs:

TOTAL VARIABLE COST

3
TVC Line
Total
2
Variable
Cost
1

0
1 2 3 4 5
Production (in thousand units)
VARIABLE COST PER UNIT

1
Variable Cost Line

0
1 2 3 4 5
Production (in thousand units)

Variable costs are those costs that vary directly with the volume or rate of output. They
are product costs.

Eg. Direct Material, Direct Labour

Variable cost per unit does not vary due to change in output. If production increases total
variable cost increases but variable cost per unit remains the same.

(iii) Semi- Variable Costs-

SEMI VARIABLE COSTS

1
Semi -Variable Cost
Line

0
1 2 3 4 5
Production(inthousandunits)
Semi variable costs are also known as mixed costs. These are those costs which consist of
partly fixed costs and partly variable costs. The fixed component of mixed costs
represents the cost of providing capacity, whereas the variable component is caused by
using the capacity.

(iv) Step Costs


STEP COSTS

Steps Cost Line

0
1 2 3 4 5
Production (in thousand units)

Step Cost remains constant over a range of activity

(V)Future costs: Future costs are relevant costs in profit planning function of
management. Those costs which are reasonably expected to be incurred at some
future date as a result of current decision are known as Future costs. These costs
are of paramount importance to management as they are the only costs which it
can control. If they are too high resources can be [planned to meet the high costs
and efforts can be made if possible to reduce them.

(VI)Budgeted costs: When an operating plan involving future costs is accepted, and
incorporated formally in the budget for a specific period, such costs get converted
to what may be referred to as Budgeted costs. Budgeted costs are important
elements in that they provide the basis for measuring the actual performance of
different cost centers and therefore they are of utmost importance for
management.

(3)ON THE BASIS OF PLANNING AND CONTROL


(i) Responsibility Costs:- Responsibility Costs are costs which are identified with the
person responsible for their occurrence. In a responsibility accounting system, costs are
classified/ identified/ accumulated with the persons responsible for their occurrence
commonly referred to as responsibility centers. This is done not only o indicate what
costs have been incurred but also who is responsible for them so that responsibility can
be localized in case actual costs exceed budgeted costs.

(ii) Controllable Costs- An item of cost is controllable if the amount of cost incurred in
a responsibility center is significantly influenced by the action of the manager of the
responsibility center.

Features of Controllable costs


(i) They are in relation to a particular responsibility center.
(ii) The head of the responsibility center has significant influence but not complete
influence on its controllability.
(iii) They are relevant for the time period under review.

(iii) Controllable Costs- It’s the vice-versa in case of uncontrollable costs.

The concept of controllable and costs is a relative concept in the sense that when a
company is viewed as a single entity, all costs are controllable at one level or another of
management. The office in charge of a cost center can control costs only of those matters
which come directly under his control but not of other matters.

(iv)Direct Costs- Direct costs are costs which can be identified logically and practically
in their entirety to a particular department/ product. They are controllable.

(v)Indirect Costs- The expenses incurred on those items which are not directly
chargeable to production are known as indirect costs.

Indirect costs are also called common costs as they are allocated between two units/
products/ divisions/ departments

ON THE BASIS OF DECISION MAKING

(i) Marginal costs: The incremental cost of producing an additional unit of output. In
cost accounting variable cost represents marginal cost. This cost concept is of great
relevance in managerial decision making.

(ii) Relevant costs: These are costs which are influenced by a decision. In taking a
decision, all costs are not relevant. For example, in a decision related to replacement of
old machinery, the written down value of an existing machine is not relevant but its sale
value is relevant.
(iii) Irrelevant costs: Cost which is not affected by a decision. For example Sunk costs
are not considered in decision making as they are irrelevant.

(iv) Incremental costs: Incremental costs are the additional costs which will be incurred
if management chooses one course of action as opposed to another. These are the extra or
incremental costs, caused by a particular decision. It represents the change (increase or
decrease) in total cost or in specific elements of cost that occurs due to change in activity
level, technology or method of production.

(v) Differential costs: It represents the change in total cost or in specific elements of cost
that occur due to adopting another alternative. This approach compares the two
alternatives directly by looking at the differences between them. Eg. Difference inn cost
between buying a component from outside or manufacturing the same in-house is a
differential cost.

Incremental and Differential are by far the most important concepts of cost
in decision making.

(vi) Out- of- pocket costs: A cost which requires current or future cash expenditure as a
result of a decision is called out of pocket costs. It is that portion of total cost which
involves cash outlay as against those costs which do not require any cash outlay, such as
depreciation.
(vii) Sunk costs: It is a historical cost incurred in the past. In other words sunk costs are
those costs that cannot be recovered- As such these costs do not play any role in decision
making.

(viii)Opportunity costs: Represents benefits foregone by not choosing the second best
alternate in favor of the best one.

(ix) Imputed Costs: These are notional costs and do not involve any cash outlay. These
costs are also computed and considered only for decision making purposes. Imputed costs
are similar to opportunity costs. Interest on capital, the payment for which is actually not
made, is an example. Rent of factory which is actually not paid in case the owner has his
own factory is a imputed cost.
COST SHEET

DIRECT MATERIAL
DIRECT LABOUR
DIRECT EXPENSES

PRIME COST

INDIRECT MATERIAL
INDIRECT LABOUR Factory overheads
INDIRECT EXPENSES

FACTORY/ WORKS COST

OFFICE OVERHEADS

COST OF PRODUCTION

+ OPENING STOCK OF FINISHED GOODS


(-) CLOSING STOCK OF FINISHED GOODS
COST OF GOODS SOLD

SELLING AND DISTRIBUTION EXPENSES


COST OF SALES

+ PROFIT
SALES
COST SHEET ADVANCED
DIRECT MATERIAL
(Opening stock of raw material+ net purchases + carriage inwards-abnormal
wastage of raw material - closing stock) XXXXXXXXXXXXXXX
DIRECT LABOUR
DIRECT EXPENSES

PRIME COST

INDIRECT MATERIAL
INDIRECT LABOUR Factory overheads
INDIRECT EXPENSES

(-) Sale of scrap if any

+ opening stock of work-in –progress


(-) closing stock of work-in-progress

FACTORY/ WORKS COST

OFFICE OVERHEADS

COST OF PRODUCTION

+ OPENING STOCK OF FINISHED GOODS


(-) CLOSING STOCK OF FINISHED GOODS
COST OF GOODS SOLD

SELLING AND DISTRIBUTION EXPENSES


COST OF SALES

+ PROFIT
SALES
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Exercise:

A company manufactures and retails clothing. You are required to group the costs which
are listed below and numbered 1 to 20 into the following classification.( each cost is
intended to belong to only one classification

(a) Direct Materials


(b) Direct Labor
(c) Direct Expenses
(d) Indirect Production Overhead
(e) Selling and Distribution costs
(f) R & D Costs
(g) Finance Cost
(h) Administrative Costs
1. Telephone rental plus metered calls
2. Wages of security guards for factory
3. Parcels sent to customers
4. Wages of operators in cutting department
5. Developing a new product in the laboratory
6. Wages of fork lift truck drivers who handle raw material
7. Wages of storekeepers in materials store.
8. Chief accountant’s salary
9. Cost of painting advertising slogans in delivery vans.
10. Auditor’s fee.
11. Cost of advertising on television
12. Lubricants for sewing machines
13. Floppy discs for general office computers.
14. Maintenance contract for office photocopying machine
15. Interest on bank overdraft
16. Market research undertaken prior to new product launch
17. Carriage on purchase of raw materials
18. Royalty paid on number of units of a particular product produced
19. Road licenses for delivery vehicles
20. Amount payable to a company for broadcasting music through out the
factory.

1. Prepare a cost sheet from the following data to find out profit and cost per unit.

Raw Material consumed 160000


Direct Wages 80000
Factory overheads 16000
Office Overheads 10% of Factory Cost
Selling Overhead 12000
Units Produced 4000
Units Sold 3600
Selling Price Rs. 100 per unit

(Profit- 94560, per unit profit- 26.27)


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2. The following data are related to the manufacture of standard product during the month
of July 2009
Rs.
Raw Material Consumed 15000
Direct Wages 9000
Machine Hours Worked 900
Machine Hour Rate 5
Administrative Overheads 20% on works cost
Selling Overheads 0.50 per unit
Units Produced 17100
Units Sold 16000 (at Rs. 4 per unit)

You are required to prepare a cost sheet from the above showing
(a) The cost per unit
(b) The profit per unit sold and profit for the period)

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3. Calculate
(I) Value of Raw Material Consumed
(II) Total cost of production
(III) Cost of goods sold
(IV) The amount of profit from the e following particulars:

Opening Stock:
Raw Materials 5000

Finished Goods 4000

Closing Stock
Raw Materials 4000
Finished Goods 5000
Raw Material Purchased 50000
Wages Paid to Laborers 20000
Chargeable Expenses 2000
Rent rates and Taxes 5000
Power 2000
Factory Heating and Lighting 2000
Factory Insurance 1000
Experimental expenses 500
Wastage of Materials 200
Office Management Salaries 4000
Office Printing and Stationary 200
Salaries of Salesmen 2000
Commission of Traveling Agents 1000
Sales 100000

Value of Raw Material Consumed-51000


Cost of Production-87700
Cost of Goods Sold-86700
Profit-10300
(Raw material consumed includes cost of the wastage of materials of Rs. 200 and
such wastage is normal)

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4. The books of Anand Manufacturing Company Present the following data for the month
of August:
Direct Labor Cost Rs. 16000 being 160% of work overheads
Cost of goods sold Rs. 56000
Inventory Accounts showed the following opening and closing balances

August 1 August 30th


Rs. Rs.
Raw Material 8000 8600
Work-in –Progress 8000 12000
Finished Goods 14000 18000

Selling Expenses 3400


Administrative Expenses 2600
Sale for the month 75000

(b) Prepare a cost statement showing the various elements of the cost- cost of goods
manufactured and sold also the profit earned.

Cost of goods Sold 56000, Works Cost 61400


Raw Material Consumed 33900, Value of Materials Purchased 35400

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5. The books of Adarsh Manufacturing Company present the following data for the
month of April:
Direct Labor Cost Rs. 17500 being 175% of work overheads
Cost of goods sold excluding administrative expenses administrative expenses 56000
Inventory Accounts showed the following opening and closing balances

April 1 April 30th


Rs. Rs.
Raw Material 8000 10600
Work-in –Progress 10500 14000
Finished Goods 17600 19000

Selling Expenses 3500


Administrative Expenses 2500
Sale for the month 75000
(c) Compute the value of materials purchased.
(d) Prepare a cost statement showing the various elements of the cost and also the
profit earned.

Cost of goods Sold 56000, Works Cost 61400

Raw Material Consumed 33900, Value of Materials Purchased


36500
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