What is Cost Accounting?

Cost accounting is that part of the

accounting system that measures costs for the purposes of management decision making and financial reporting.

Cost Accounting System

Cost Accumulation

Collecting costs by some natural classification such as materials or labor

Tracing costs to one or more cost objectives

Cost Allocation

Cost

A cost may be defined as a sacrifice or giving up of resources for a particular purpose. Costs are frequently measured by the monetary units that must be paid for goods and services.

Direct Costs
What are direct costs? Direct costs can be identified Specifically and exclusively with a given cost objective (cost centre)

Indirect Costs
What are indirect costs? Indirect costs cannot be identified specifically and exclusively with a given cost objective (Cost Centre)

What Distinguishes Direct and Indirect Costs?

Managers prefer to classify costs as direct rather than indirect whenever it is economically feasible or cost effective. Other factors also influence whether a cost is considered direct or indirect. The key is the particular cost objective.

Categories of Manufacturing Costs

Any raw material, labor, or other input used by any organization could, in theory, be identified as a direct or indirect cost depending on the cost objective.

There are 3 major categories of manufacturing costs:

Direct Materials Raw material, parts, and components that can be observed being used to make a specific product.

Manufacturing Overhead

Direct Labor The cost of paying employees who convert direct materials into finished product.

Indirect material Other overhead

Direct Material Costs...

include the acquisition costs of all materials that are physically identified as a part of the manufactured goods and that may be traced to the manufactured goods in an economically feasible way.

Direct Labor Costs...

include the wages of all labor that can be traced specifically and exclusively to the manufactured goods in an economically feasible way.

Prime Costs include:

Direct Material s
Direct Labor Manufacturing Overhead

Indirect Manufacturing Costs...

or factory overhead, include all costs associated with the manufacturing process that cannot be traced to the manufactured goods in an economically feasible way.

ELEMENTS OF COSTS_

Broadly there can be three elements of costs. (A) Material: (B) Labour : (C) Expenses:

(A) Material

This is the cost of commodities and materials used by the organization. It can be direct or indirect. Direct Material indicates that material which can be identified with the individual cost center and which becomes an integral part of the finished goods. It basically consists of all raw materials, either purchased from outside or manufactured in house. Indirect Material indicates that material which cannot be identified with the individual cost center. This material assists the manufacturing process and does not become an integral part of finished goods. The examples of this type of material may be consumable stores, cotton waste, oils and lubricants, stationery material etc.

(B) Labour :

This is the cost of remuneration paid to the employees of the organisation. It can be direct or indirect. Direct Labour Cost indicates that labour cost which can be identified with the individual cost center and is incurred for those employees who are engaged in the manufacturing process. Indirect Labour Cost indicates that labour cost which cannot be identified with the individual cost center and is incurred for those employees who are not engaged in the manufacturing process but only assist in the same. The examples of this type of cost are wages paid to foreman/storekeeper, salary of works manager, Accounts/Personnel department salaries etc.

(C) Expenses:

This is the cost of services provided to the organization (and the notional cost of assets owned). It can be direct or indirect. Direct Expenses are those expenses, which can be identified with the individual cost centers. The examples of these expenses are

hire charges of machinery/ equipments required for a particular job, cost of defective work for a particular job etc.

Indirect Expenses are those expenses, which cannot be identified with the individual cost centers. The examples of these expenses are

rent, telephone expenses, insurance, lighting etc

Prime costs & Overheads

The aggregate of Direct Material Cost, Direct Labour Cost and Direct Expenses is termed as Prime Cost. The aggregate of Indirect Material Cost, Indirect Labour Cost and Indirect Expenses is termed as Overheads.

Classification of Overheads

(a) Factory Overheads (Also termed as production/works/manufacturing overheads) (b) Office and Administration Overheads. (c) Selling and Distribution Overheads.

(a) Factory Overheads:

These overheads consist of all overhead costs incurred from the stage of procurement of material till the stage of production of finished goods. They include : Indirect Material such as consumable stores, cotton waste, oil and lubricants etc. Indirect Labour Cost such as wages paid to foreman/storekeeper, works managers salary etc. Indirect Expenses such as carriage inward cost, cost of factory lighting/power expenses, rent/insurance/repairs for factory building/machinery, depreciation on factory building or machinery etc.

(b)

Office and Administration Overheads:

These overheads consist of all overhead costs incurred for the overall administration of the organization. They include : Indirect Material such as stationery items, office supplies etc. Indirect Labour cost such as salaries paid to Accounts and Administration staff, Directors remuneration etc. Indirect Expenses such as postage/telephone, rent/insurance/repairs/depreciation on office building, general lighting, legal/audit charges, bank charges etc.

(c)

Selling and distribution Overheads:

These overheads consist of all overhead costs insured from the stage of final manufacturing of finished goods till the stage of sale of goods in the market and collection of dues from the customers. They include : Indirect Material such as packing material, samples etc. Indirect Labour like salaries paid to sales personnel, commission paid to sales manager etc. Indirect Expenses like carriage outwards, warehouse charges, advertisement, bad debts, repairs and running of distribution van, discount offered to customers etc.

classification of overheads can be shown as below :

Factory

Indirect Material Indirect Labour Indirect Expense Indirect

Indirect Labour Indirect Indirect material Indirect Labour Indirect

material Office/Administration Expense Selling & Distribution Expense

Cost Sheet:

The various elements/components of the cost is presented in the form of a statement, popularly known as Cost Sheet or Cost Statement. The cost sheet may be prepared separately for each cost centre and may have the columns like cost per unit or cost of previous period etc.

Performa cost sheet

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PRIME COST : Factory Overheads FACTORY/WORKS COST : Office and Administration Overheads TOTAL COST : Selling and Distribution Overheads COST OF SALES : Profit SALES

Direct Material Cost Direct Labour cost Direct Expenses