Introduction to Cost Accounting

Prof. Abhay Kumar

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Learning Objective
What is cost accounting

Objective of cost accounting

Forms of Accounting Role of cost accounting Advantages of cost accounting Factors affecting cost accounting Cost classification Preparation of Cost sheet
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Cost Accounting
Cost is a resource sacrificed or forgone to achieve a specific objective. Costing- Ascertainment of cost. Cost Accounting refers to the methods and process of determining the cost of some particular product or activity. Cost Accountancy- It includes costing, cost accounting, cost control and cost audit.

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Objective of cost accounting

To determine product cost

To facilitate planning and control of regular

business activity. To supply information for short and long term decision.

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Financial Accounting Versus Management Accounting

Financial accounting is devoted to providing

information for external users; these users include investors, government agencies, and banks. Cost Accounting identifies, collects, measures, classifies, and reports information that is useful to managers in costing (determining what something costs), planning, controlling, and decision making.

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Financial Accounting Versus Management Accounting

Cost accounting attempts to satisfy costing

objectives for both financial and management accounting. Management accounting is concerned specifically with how cost information and other financial and nonfinancial information should be used for planning, controlling, and decision making.

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Role of cost accounting

It helps the management

To determine and analyze product cost To control cost To determine price, product mix and profit volume To establish profit goal Determining departmental goal by formation and execution of budget Measuring and controlling performances Taking corrective action In decision making when alternatives are available

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Advantages of cost accounting

Provides data about profitable and

unprofitable product. Provides data and information to determine price of the product. Provides data regarding cost of different alternatives Ensures maximum utilization of resources More accurate and reliable financial accounts can be prepared Helps to negotiate with government and labour union

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Cost classification
Different bases for cost classification

Elements/ Natural Characteristics Behaviour/ activity Functions Traceability Association with the product Relationship with Accounting Period Decision Making
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Elements/ Natural Characteristics

Material Cost

Labour Cost
Overhead Cost

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Material
Those materials that become an integral part

of the product. Example: For manufacturing an apparel Cloth, collar, buttons, thread, Primary packing material (e.g., carton, wrapping, cardboard, boxes, etc.)

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Labor
The aggregate of all human physical and

mental effort used in creation of goods and services. Such as.. Workers Inspectors Supervisors Internal transport staff Storekeeper, maintenance staff

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Overhead
Resource consumed or lost in completing a

Process, that does not contribute directly to the end product. It is also known as manufacturing expenses or factory burden. It comprises of indirect materials, indirect labour and indirect expenses. Expenses leading to a job or contract Traveling expenses for negotiation Special pattern, design Special tools for executing the contract Rent, Insurance, Canteen, hospital, power, lighting, maintenance

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Behaviour/Activity
Fixed costs: remain unchanged at any level

of activity. Variable costs : Varies with volume and remains constant per unit Semi-variable : A cost could be variable for one level of activity whereas it could be fixed for another.

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Function
Production/Manufacturing Cost

Administration Cost
Selling & Distribution Cost

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Production/Manufacturing Cost
It includes the costs of direct material, direct

labor and manufacturing overhead. manufacturing overhead include:

Salaries and wages for quality assurance, industrial engineering, materials handling, factory management, and equipment maintenance personnel. Equipment repair parts and supplies Factory utilities Depreciation on factory assets Factory-related insurance and property taxes
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Administration Cost
It includes costs incurred in planning,

directing, controlling and operating a company. Such as salary paid to the managers and other staff.

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Selling & Distribution Cost

It includes costs incurred to stimulate

demands and of securing orders, distribution cost, cost of insurance on goods in transit and cost of warehousing etc,

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Traceability
Direct costs
Costs that can be easily and conveniently

traced to a unit of product or other cost object. Examples: direct material, direct labor and direct expenses

Indirect costs
Costs that cannot be easily and conveniently

traced to a unit of product or other cost object. Example: manufacturing overhead

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Association with the product

Inventoriable cost/ product cost is that cost

which is regarded as asset when incurred, but becomes a part of cost of goods sold when the product is sold. Period costs (non-product cost): all costs in P&L account except cost of goods sold. So, in a mfg. sector unit, all non-manufacturing costs are period costs. (Ex. Distribution cost, design cost, R&D costs, Marketing costs, customer-service costs, etc.)

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Relationship with Accounting Period

Capital Cost

Revenue Cost

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Decision Making
Budgeted/Standard Cost

Sunk cost (Irrelevant cost)

Opportunity Cost Incremental/Differential Avoidable & Unavoidable Controllable/Uncontrollable Normal Cost/Abnormal Cost

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Planning & Control

Budgeted Cost: Estimate of expenditure for

different business operations Standard Cost: For prescribed set of operating conditions, labour, material and overheads are predetermined; budget translated into actual operation through standard costs.

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Sunk costs
Sunk costs-Costs that have already been

incurred and cannot be changed now or in the future. They should be ignored when making decisions. Also known as irrelevant cost.
Example: You bought an automobile that

cost Rs 1000,000 two years ago. The Rs 1000,000 cost is sunk because whether you drive it, park it, trade it, or sell it, you cannot change the Rs 1000,000 cost.
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Relevant cost- relevant for decision making

Opportunity cost
The potential benefit that is given up when

one alternative is selected over another. The opportunity cost is the monetary amount associated with the next best use of the resource.

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Incremental / Differential Cost

Incremental Cost- The encompassing change

that a company experiences within its balance sheet due to one additional unit of production. Also referred to as "marginal cost". Differential Cost- it refers to both cost increase and cost decrease between alternatives.

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Avoidable and unavoidable cost

Avoidable and unavoidable cost: Cost that

can be avoided by eliminating a product or department is avoidable and that which cannot be, is unavoidable. Ex. Rent of factory is unavoidable if a product is discontinued

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Other costs
Programmed cost: Cost incurred as per policy of top

management. Ex.- Donation to charity. Joint cost: cost of joint or by-products incurred before separation, which cannot be traced to particular products. Conversion cost: cost of converting raw material to finished goods = Production cost- direct material. Imputed (Notional cost): Actually not incurred (interest on own capital, rent on owned building, etc.) Taken into account in capital budgeting decisions. Replacement cost: Cost of replacing at current market price

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Cost sheet
Cost sheet is a statement of cost. In other

words, when costing information are set out in the form of a statement, it is called cost sheet.

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The main purposes or advantages of cost sheet

It discloses the total cost and the cost per unit of the

units produced during the given period. It enables a manufacture to keep a close watch and control over the cost of production. It acts as guide to the manufacturer and helps him in formulating a definite useful production policy. It helps in fixing up the selling price more accurately. It helps the businessman to minimize the cost of production when there is a cut throat competition. It helps the businessman to submit quotations with reasonable degree of accuracy against tenders for the supply of goods.
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What we learnt?
What is cost accounting

Objective of cost accounting

Forms of Accounting Role of cost accounting Advantages of cost accounting Factors affecting cost accounting Cost classification Preparation of Cost sheet
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Any Question
Thanks

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