Chapter Review MACS

On

Cost concept and classification

Submitted By: Ravikumar Ananthpur 1PT10MBA32 Sec c

Book name : Cost and management accounting Introduction about the Author : S.P.Jain : Professor in the department of commerce at Shaheed Bhagat Singh College (university of New Dehli).He is also a faculty member of N.I.R.C of institute of company secretaries. K.L.Narang : Formerly he was the head of the department of commerce at the Government college of Chandigarh and Principle of the Government college , Kapurthara (Punjab).

Title of the Chapter: Cost concept and classification Contents :

1. 2. 3. 4. 5. DEFINITION OF COST ELEMENTS OF COST COST CONCEPTS CLASSIFICATION OF COST CONCLUSION

Review/ Information :
CONCEPT OF COST

y y y

Cost means the total of all expenses. Cost is defined as the amount of expenditure( actual or notional) incurred on or attributable to a given thing or to ascertain the cost of a given thing. The cost of an article consists of actual outgoings or ascertained charges incurred in its production and sale.

ELEMENTS OF COST For proper control and managerial decisions, the total cost is analysed by elements of cost. i.e,by the nature of expenses. The elements of cost are

By grouping the above elements of cost, the following divisions of cost are obtained. Prime cost Work or Factory cost Cost of Production Total cost or = Direct Materials + Direct Labour + Direct Expenses = Prime cost + Works or Factory Overheads = Works Cost + Administration Overheads = Cost of production+ S & D Overheads

DIRECT MATERIAL Those materials which can be identified in the product and can be conveniently measured and directly charged to the product.Eg: cloth of dress making, bricks for building The following are normally classified as direct materials: y y y y All raw materials Materials specifically purchased for a specific job, process or order Parts or components purchased or produced Primary Packing materials

Certain materials which are parts of finished products but used in small quantities are treated as indirect material.Thus the ease and the feasibility with which a material can be traced into the composition of a finished product will determine what is to be treated as direct material.

DIRECT LABOUR All labour expended in altering the construction, composition, confirmation or condition of the product. 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. Direct labour includes payment made to y y Labour engaged on the actual production of the product or in carrying out of an operation or process. Labour engaged in aiding the manufacture by way of supervision, maintenance, tools setting, transportation of material etc.,

DIRECT OR CHARGEABLE EXPENSES All expenditures other than direct material or direct labour that are specifically incurred for a particular product or process. Such expense is charged directly to the particular cost centre as part of the prime cost. Eg:Excise duty, Royalty on production, surveyor s fees, designing or drawing expenses etc OVERHEADS The aggregate of the cost of indirect materials, indirect labour and such other expenses including services as cannot conveniently be charged direct to specific cost units. All expenses other than direct expenses The cost of operating supplies and services used by the undertaking and including the maintenance of capital assets. The main groups into which overheads may be sub-divided are y y y y Manufacturing overheads Administration overheads Selling overheads Research and Development overheads

Cost concepts

COST CENTRE It is the smallest segment of activity or area or responsibility for which costs are accumulated.These cost centres are departments or sub departments of an organisation with reference to which cost is collected for cost ascertainment and cost control.The cost centres may be product centre or service centre Eg: In engineering industry, cost centres may be machine shop, welding shop, assembly shop, maintenance dept etc. PROFIT CENTRE It is that segment of activity of a business which is responsible for both revenue and expenses and discloses the profit of a particular segment of activity.Profit centres are created to delegate responsibility to individuals and measure their performance CONVERSION COST It is the sum of direct wages, direct expenses and overhead costs of converting raw material from one stage of production to the next. Conversion cost = Works cost Cost of direct materials ORDERING COST Costs incurred each time an order for the purchase of material is placed and are expressed as rupee cost per order and include cost of getting an item into the firm s inventory CARRYING COST It is basically the costs incurred on the maintenance of inventory and include cost of the money locked up in the inventory, inventory obsolescence, storage space, rent and cost of stores operations. It is also known as holding cost. CLASSIFICATION OF COST Cost classification is the process of grouping costs according to their common characteristics.A suitable classification of costs is important, in order to identify the cost with cost centres or cost units.The same cost figures are classified according to different ways of costing depending upon the purpose to be achieved and requirements of a particular concern. By nature or Element: The costs are divided into three categories, Materials, Labour and Expenses. Materials can be further classified as raw material, spare parts, consumable stores, packing material etc.This classification is important as it helps to find out the total cost and valuation of WIP.

By Functions: The costs are divided on the basis of managerial activities involved in the operation of a business undertaking. Eg; Production, Administration, Selling and Distribution As Direct or Indirect: Total cost is divided into direct costs and indirect costs. y y Direct costs are those costs which are incurred for and may be conveniently identified with a particular cost centre or cost unit. Indirect costs are those costs which are incurred for the benefit of number of cost centres or cost units and cannot be conveniently identified with a particular cost centre or cost unit.

By variability: Costs are classified according to their behaviour in relation to changes in the level of activity or volume of production. On this basis, costs are classified into three groups namely fixed, variable and semi-variable y y Fixed costs: Those which remain fixed in total amount with increase or decrease in the volume of output or productive activity for a given period of time.Eg; rent, insurance Variable costs: Costs which vary in total in direct proportion to the volume of output. These costs per unit remain relatively constant with changes in production.Eg: Direct material, direct labour, power, repairs etc. Semi variable costs: Costs which are partly fixed and partly variable. Eg: Telephone expenses include a fixed portion of annual charge plus variable charge according to calls.

By controllability: The costs are classified according to whether or not they are influenced by the actions of a given member of the undertaking. On this it is classified as controllable costs and uncontrollable costs. y y Controllable costs: Costs which can be influenced by the action of a specified member of an undertaking. i.e. costs which are at least partly within the control of management Uncontrollable costs: costs which cannot be influenced by the action of a specified member of an undertaking.

By normality: Costs are classified according to whether these are costs which are normally incurred at a given level of output in the conditions in which that level of activity is normally attained. On this basis costs are classified as normal cost and Abnormal cost. Abnormal costs are not a part of cost of production and are charged to Costing P&L a/c. By Capital and Revenue (Financial Accounting Classification): The costs which are incurred in purchasing assets used to generate income or to increase income earning capacity is called capital cost. The benefit of such costs are spread over a number of years. By time: y Historical costs: The costs which are ascertained after their incurrence are called historical costs. The basic characteristics of such costs are (a) They are based on recorded facts. (b) They can be verified (c) They are mostly objective

Predetermined costs: Costs are estimated costs. Computed in advance of production taking into consideration the previous periods costs and the factors affecting such costs. Such costs determined on scientific methods become standard cost.

According to planning and control: y Budgeted costs: An estimate of expenditure for different phases of business operations, coordinated in a well conceived framework for a period of time in future which becomes a managerial targets to achieve. Standard costs: It is the predetermined cost based on a technical estimate for materials, labour and overhead for a selected period of time and for a prescribed set of working conditions.

For managerial decisions: y y y y y y y y Marginal costs: It is the total of variable costs. i.e., prime cost plus variable overheads. It is based on the distinction between fixed and variable cost. Out of pocket costs: It is that portion of the cost which involves payment to outsiders. Differential costs: The change in cost due to change in level of activity or pattern or method of production. Sunk costs: It is an irrecoverable cost and is caused by complete abandonment of a plant. i.e., costs which are not relevant for decision making. Imputed costs: Costs which appear in cost accounts only. These costs are also known as notional costs, which are considered for decision making. Opportunity cost: It is the advantage, in measurable terms, which has been foregone due to not using the facility in the manner originally planned. Replacement cost:It is the cost at which an asset or material identical to that which is being replaced or revalued, can be purchased. Avoidable and unavoidable cost: Avoidable costs are those which can be eliminated if a particular product or department with which they are directly related is discontinued. Un avoidable costs are those which will cannot be eliminated with the discontinuation of a product or department

Conclusion Different industries follow different techniques of cost management as per the nature of the business, the whole aim is to trace the cost as and when it occurs and have proper accountability of the expenses which a process or product draws in order to determine what revenue has to be earned to cover the cost incurred.