BASIC CONCEPTS
SYNOPSIS :
Cost Accountancy
Cost Accounting
2.1 Definition of Cost Accounting
2.2 Objectives of Cost Accounting
2.3 Importance of Cost Accounting
2.4 Advantages of Cost Accounting
2.5 Limitations of Cost Accounting
2.6 Reports Generated by Cost Accounting Department
Installation of Cost Accounting System
3.1 Basic Considerations
3.2 Steps in Introduction
3.3 Essentials of a Good Cost Accounting System
3.4 Difficulties in Introduction
4. Role of a Cost Accountant
Cost Accounting, Financial Accounting & Management Accounting
5.1 Cost Accounting and Financial Accounting
5.2 Cost Accounting and Management Accounting
6.1 Cost
6.2 Pre-determined Cost
6.3 Standard Cost
6.4 Estimated Cost
6.5 Marginal Cost
6.6 Differential Cost
6.7 Discretionary Cost
6.8 Decision Driven Cost
6.9 Managed / Policy Cost
6.10 Postponable Cost
6.11 Imputed / Notional Cost
6.12 Inventoriable / Product Cost
6.13 Opportunity Cost
6.14 Out-of-pocket Cost
6.15 Joint Cost
6.16 Period Cost
6.17 Sunk Cost
6.18 Committed Cost
6.19 Shut down Cost
6.20 Relevant Cost
6.21 Replacement Cost
6.22 Absolute Cost
6.23 Cost Centre
6.24 Cost Unit
6.25 Cost Allocation
6.26 Cost Apportionment
6.27 Cost Absorption
6.28 Responsibility Centre
7. Elements of Costs
7.1 Material Cost
7.2Labour Cost
7.3 Expenses
7.4 Overheads
8. Classification of Costs
8.1 By Nature
8.2 By Behaviour
8.3 By Element
8.4 By Function
8.5 By Controllability
8.6 By Normality
8.7 By Time When Computed
9. Types / Techniques of Costing
9.1 Historical Costing
9.2 Uniform Costing
9.3 Standard Costing
9.4 Direct Costing
9.5 Marginal Costing
9.6 Absorption Costing
9.7 Difference Between Various Types of Costing
10. Methods of Costing
10.1 Job Costing
10.2 Batch Costing
10.3 Contract Costing
10.4 Process Costing
10.5 Operating Costing
10.6 Single Output or Unit Costing
10.7 Multiple Costing
11. Analysis of Last Questions
11.1 Scanning of Questions Asked in Past Examinations
11.2 Frequency Table Showing Distribution of Marks
The Institute of Cost and Management Accountants of England
defines Cost Accountancy as follows:
"The application of costing and cost accounting principles, methods and
techniques to the science, art and practice of cost control and the
ascertainment of profitability. It includes the presentation of information,
derived therefrom for the purpose of managerial decision making."
Thus cost accountancy is a very comprehensive term.
2.1 Definition of Cost Accounting :
Based on the terminology published by the Institute of Cost and Management
Accountants of England, Cost Accounting is defined as the process of accounting
for cost. This process begins with the recording of income and expenditure or
the bases on which they are calculated and ends with the preparation of
periodical statements and reports for the purpose of ascending and controlling
costs.
2.2 Objectives of Cost Accounting :
Following are the main objectives of Cost Accounting -
(i) Ascertainment of Cost:
It can be done in two ways, namely,
(a) Post Costing, where the ascertainment of cost is done based on actual
information as recorded in financial books.
(b) 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.
(ii) Determination of Selling Price:
Though there are various other considerations for fixing the selling price of
a product (like the market conditions etc.), cost of the product is an important
factor which cannot be sidelined.
(iii) Ascertainment of Profit :
The purpose of any business activity is to earn a profit and profit can be
computed by matching the revenue and cost of that particular product/activity.
(iv)Cost Control and Cost Reduction:
Cost Control and Cost Reduction are two different concepts.
Cost Control aims at maintaining the costs in accordance with
established standards. It involves the following steps -
a.
Determination of target cost
b.
Measurement
of actual cost
c.
Analysis of
variation with respect to target cost
d.
Initiation
of corrective action.
Cost Reduction on the other hand aims at improvement established targets. It
is defined as "the achievement of real and permanent reduction in the unit cost
of goods manufactured or services rendered without impairing their suitability
for the use intended or diminution in the quality of the product."
The difference between Cost Cost Control and Cost Reduction can be summarized
as under:
[May'94]
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Cost Control
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Cost Reduction
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1. It represents efforts made ds towards achieving a target or a
goal.
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1. It represents achievement of reduction of cost .
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2. The process of cost control is to Set-up a target, investigate the
variations and take remedial action.
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2. Cost reduction is not contended merely with the maintenance of
performance with standards.
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3. It assumes existence of norms or Standards which are not
challenged.
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3. It assumes that the standards can be improved.
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4. It is preventive function.
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4. It is a corrective function.
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5. Sometimes, it lacks a dynamic approach.
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5. It is continuous process of analysis of all the factors affecting
cost.
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(v) Facilitation of Inventory Valuation :
As per the Accounting Standard 2 on Valuation of Inventories, Inventories are
to be valued at "lower of cost and net realisable value". Costing accounting
determines the ascertainment of this "cost" based on which the inventory is
valued.
(vi) Assisting Management in Decision-making :
Decision-making is a process of choosing between two or more alternatives,
based on the resultant outcome of the various alternatives. A Cost Benefit
Analysis also needs to be done. All this can be achieved through a good cost
accounting system.
2.3 Importance of Cost Accounting :
The importance of cost accounting can be highlighted through the following
benefits which accrue to any business concern:
(i) Control of Material Cost :
Normally, material cost constitutes a major portion of the cost of the
product. Hence control of material cost can ensure a good amount of benefit.
Control of material cost can be exercised as follows :
a.
Maintaining
optimum level of stock to avoid unnecessary locking up of capital
b.
Maintaining
an uninterrupted supply of materials
c.
Use of
techniques like value analysis, standardisation etc.
(ii) Control of Labour Cost :
Labour cost control can be exercised as follows:
a.
Setting
standard time for each activity and keeping adverse variance to the minimum
b.
Laying down
proper remuneration schemes
c.
Control
over labour turnover
d.
Control
over idle time, overtime
(iii) Control of Overheads :
Overheads are nothing but indirect expenses incurred at the factory, office
and sales depots. Again control over overheads will ensure a control over the
total cost of the product and a higher profit margin.
(iv) Determination of Selling Price :
Refer 2.2 (ii) above.
(v) Budgeting :
Any commercial activity begins with the preparation of budgets for the same.
A budget serves as a guideline against which the actual performance can be
measured and continuous corrective action can be taken to ensure that the budget
is adhered to.
(vi) Measuring Efficiency :
Efficiency can be measured by comparing actuals against standards and
corrective action can be taken.
(vii) Strategic Decision-making:
Cost accounting enables the management to take up various strategic decisions
like "Make or Buy", "Shut down or Continue", "Replace or Continue", " Status quo
or Expansion" etc.
2.4 Advantages of Cost Accounting :
(i) Helps optimum utilization of men, materials and machines
(ii) Identifies areas requiring corrective action
(iii) Identifies unprofitable activities, losses, inefficiencies
(iv) Helps price fixation
(v) Facilitates cost control and cost reduction
(vi) Facilitates use of various cost accounting techniques, like, variance
analysis, value analysis etc.
(vii) Helps management in formulation of policies
(viii)Helps management in making strategic financial decisions. For eg: the
technique of marginal costing helps the management in making various short term
decisions.
(ix) Helps in formation of cost centres and responsibility centres to
exercise control
(x) Marginal Cost having a linear relationship with production volume enables
in formulation and solution of "Linear Programming Problems".
(xi) Provides a data-base for reference by government, wage tribunals and
trade unions etc.
2.6 Limitations of Cost Accounting :
i.
It is not
an exact science and involves inherent element of judgement.
ii.
Cost varies
with purpose. Therefore cost collected for one purpose will not be suitable for
another purpose.
iii.
Cost
accounting presents the base for taking the best decisions. It does not give an
outright solution .
iv.
Most of the
cost accounting techniques are based on some pre-assumed notions.
v.
The
apportionment of common costs comes under a lot of criticism.
vi.
There are
different views held by different experts on the treatment of certain items of
cost.
2.6 Reports Generated by Cost Accounting Department :
The Cost Accounting Department generates the following reports as a routine,
for use of its executives:
i.
Expen
ii.
Cost Sheet
giving details as to component wise break-up of each element of cost as compared
with previous year’s data, competitors data.
iii.
Material
Consumption Statement, showing total quantity and types of material issued and
used, wastage’s if any. Comparison of actual v/s standard.
iv.
Labour
Utilization statement showing total number of hours, budgeted & actually worked,
types of labour utilised, idle time etc.
v.
Labour
Turnover , cost of recruitment and training of new employees.
vi.
Overheads
Statement giving break-up of various types of overheads, the actual overheads
incurred as against the budgeted and the over/under absorption, if any
vii.
Sales
Statement giving product wise break-up of unit realisation, volume achieved as
against the targets.
viii.
Inventory
Analysis Sheet giving break-up of inventories into materials, work-in-progress
and finished goods, their number of months holding as against the normal holding
period in the industry.
ix.
Statement
of Abnormal wastages / losses / spoilages
x.
ses
incurred on research and development as compared with the budget.
xi.
Any other
report pertaining to any cost centre (explained later).
3. INSTALLATION OF COST ACCOUNTING SYSTEM
[May'96, Nov'99]
3.1 Basic Considerations in Installation of Cost Accounting System :
A system is an established set of procedures for the purpose of achieving
specific objectives at minimum cost. A lot of problems can be avoided if the
cost accounting system is introduced carefully. Before setting up a system of
cost accounting, the under mentioned factors should be studied :
i.
The
objective of costing system i.e whether it is for price fixation or for cost
control or for a particular management decision.
ii.
Size of the
organisation, general organisation of the business with a view to finding out
the manner on which the system could be introduced
iii.
Areas of
functioning wherein the management's action will be most beneficial.
iv.
Management’s policies and expectations. The system of costing should be designed
after a careful study of the management's polices and expectations.
v.
Methods &
procedures in vogue for purchase, receipts, storage and issue of material,
methods of wage payment etc.
vi.
Technical
aspects of the business should be studied thoroughly by the designers. They
should also make an attempt to seek the assistance and support of the
supervisory staff and workers of the organisation for the system.
vii.
The maximum
amount of information that would be sufficient and how the same should be
secured without too much burden on the existing system of the organisation.
viii.
Forms
standardisation - various forms to be used by costing system for various data
collection and dissemination.
ix.
The degree
of accuracy of data to be supplied by the system and how verification of such
data can be brought about.
x.
Benefits of
system to be explained - the manner in which the benefits of installation of the
cost accounting system should be explained and how an awareness of the utility
of the same should be created.
xi.
The manner
in which an integral system of accounts can be devised so as to automatically
reconcile financial profit with costing profit with the help of control
accounts.
xii.
Information
requirements of management, the nature of reports to be generated through the
cost accounting system
3.2 Steps in Introduction of Cost Accounting System : [Nov'93]
The introduction of a cost accounting system will involve the following
steps:
i.
Codification and classification
ii.
Establishment of cost centres
iii.
Guidelines
for separation of fixed and variable costs
iv.
Guidelines
for allocation of indirect costs
v.
Introduction of standard formats
vi.
Specification of reports and their periodicity
vii.
Preparation
of Cost Accounts Manual
viii.
Guidelines
for post-installation appraisal of costing system
3.3 Essentials of a Good Cost Accounting System : [Nov'93, May'96]
i.
It should
be simple and practical.
ii.
It should
be tailor-made for the requirements of the organisation.
iii.
The data to
be used by the cost accounting system should be accurate or else the output will
suffer.
iv.
The system
of costing should not sacrifice the utility by introducing meticulous and
unnecessary details.
v.
The cost of
installation should justify the results.
vi.
Active
co-operation and participation of executives from different departments ensures
in developing a good cost accounting system.
vii.
A carefully
phased program should be prepared by using network analysis for the introduction
of the system.
3.4 Difficulties Likely to be Experienced in the Introduction of a Cost
Accounting System :
Following initial difficulties are likely to be experienced when a new
costing system is introduced :
i.
Lack of
support from other departmental heads
ii.
Resistance
from accounting staff
iii.
Non
co-operation from the supervisory staff
iv.
Shortage of
trained staff
4. ROLE OF A COST ACCOUNTANT IN A MANUFACTURING ORGANISATION
A cost accountant in a manufacturing organisation plays several important
roles
i.
He
establishes a cost accounting department in his concern.
ii.
He
ascertains the requirement of cost information which may be useful to
organisational managers at different levels of the hierarchy.
iii.
He develops
a manual, which specifies the functions to be performed by the cost accounting
department. The manual also contains the format of various forms which would be
utilised by the concern for procuring and providing information to the concerned
officers. It also specifies the frequency at which the cost information would be
supplied to a concerned executive.
Usually, the functions performed by a cost accounting department includes
-cost ascertainment, cost comparison, cost reduction, cost control and cost
reporting.
a.
Cost
ascertainment, requires the classification of costs into direct and indirect.
Further it requires classification of indirect costs (known as overheads) into
three classes viz., factory overheads; administration overheads and selling and
distribution overheads. Cost accountant suggests the basis which may be used by
his subordinates for carrying out the necessary classifications as suggested
above.
b.
Cost
comparison is the task carried out by cost accountant for controlling the cost
of the products manufactured by the concern. Cost accountant of the concern
establishes standards for all the elements of cost and thus a standard cost of
the finished product. The standard cost so determined may be compared with the
actual cost to determine the variances. Cost accountant ascertains the reasons
for the occurrence of these variances for taking suitable action.
c.
Cost
analysis may also be made by cost Accountant for taking decisions like make or
buy and for reviewing the current performance.
d.
Cost
accountant also plays a key role in the preparation of cost reports. These
reports help the executives of a business concern in reviewing their own
performance and in identifying the weak areas, where enough control measures may
be taken in future.
In brief, one may say that there is hardly any activity in a manufacturing
organisation with which a cost accountant is not directly associated in some
form or the other.
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5 COST ACCOUNTING, FINANCIAL ACCOUNTING AND MANAGEMENT ACCOUNTING
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5.1 Cost Accounting And Financial Accounting :
Financial Accounting is concerned with the preparation of financial
statements, which summarise the results of operations for a selected period of
time and show the financial position of the organisation as at a particular
date. It helps to assess the overall progress of an organisation, its strength
and weakness. It facilitates effective control over the assets of the
organisation.
However, there are serious limitations of financial accountancy from the
point of view of the management. It is on account of these limitations that
"Costs Accounting" has been developed for the purpose of management control and
internal reporting.
The limitations of financial accounting together with procedures that over
come the limitations are given below:
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Limitations of Financial Accounting
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Overcome By Cost Accounting
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Forecasting and Planning
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Financial accounts cannot provide information required for future
planning.
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Budget technique of cost accounting overcomes this
hurdle.
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Decision-making
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Day-to-day decision making like -
- Which product mix is the most profitable ?
- When to shut down the activity ?
- When will the break-even point be achieved?
Cannot be facilitated by financial accounting.
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The technique of marginal costing overcomes the decision-making
limitation. The management can make accurate decisions by analysis
of the cost incurred / to be incurred.
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Control and Assessment
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Financial accounting does not provide management with the information
required to assess the performance of various departments / persons.
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The techniques of budgeting and standard costing enable management to
perform this function.
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Thus the important limitations of financial accountancy namely, lack of
analysis of data and absence of yardsticks is very well overcome by cost
accountancy.
5.2 Cost Accounting and Management Accounting :
The scope of management accounting is broader than that of cost accounting.
In cost accounting, the main emphasis is on cost and it deals with its
collection, analysis, relevance, interpretation and presentation for various
problems of the management. Management accountancy utilizes the principles and
practices of financial accounting in addition to other modern management
techniques for efficient operation of the organisation.
The main emphasis in management accountancy is towards determining policy and
formulating plans to achieve the desired objective of the management.
Management accountancy has been defined by CIMA as under :
"An internal part of concerned with identifying, presenting and interpreting
information used for:
a.
Formulating
strategy
b.
Planning
and controlling activities
c.
Decision
making
d.
Optimising
the use of resources
e.
Disclosure
to shareholders and others external to the entity
f.
Disclosure
to employees
g.
Safeguarding assets".
6. COST - CONCEPTS AND TERMS
6.1 Cost - Cost represents the amount of expenditure (actual or notional)
incurred on or attributable to a given thing. It represents the resources that
have been or must be sacrificed to attain a particular objective.
6.2 Pre-determined cost - It is the cost which is computed in advance, before
the production starts, on the basis of specification of all the factors
affecting the cost.
6.3 Standard cost - It is a pre-determined cost which is arrived at,
assuming a particular level of efficiency in utilisation of material, labour and
other indirect services. It is the planned cost of a product and is expected to
be achieved under a particular production process under normal conditions. It is
often used as a basis for price fixing and cost control.
6.4 Estimated Cost - It is an approximate assessment of what the cost will
be. It is based on past data adjusted to anticipated future changes.
(Note : Standard cost Vs Estimated cost [Nov'92]
Although pre-determination is the essence of both standard cost and estimated
cost, they differ from each other in the following respects:
a.
Difference
in computation
b.
Difference
in emphasis
c.
Difference
in use
d.
Difference
in records
e.
Difference
in applicability
6.5 Marginal cost - It is the amount at any given volume of output by which
aggregate cost changes if the volume of output changes increases/decreases) by
one unit.
6.6 Differential cost - It is the difference in the total cost between
alternatives calculated to assist decision making Thus, it represents the change
in total cost (both fixed and variable) due to a change in the level of
activity, technology, process or method of production, etc.
6.7 Discretionary cost - It is an "escapable" or "avoidable" cost. In other
words, it is that cost which is not essential for the accomplishment of a
particular objective.
6.8 Decision-driven cost - It is that cost which is incurred following a
policy decision and continues to be incurred till that decision is altered. It
does not vary with changes in output or with operational activities.
6.9 Managed / Policy cost - It is that cost which is incurred as a matter of
policy eg: R & D cost. This cost has two important features :
a.
It arises
from periodic (usually annual) decisions regarding the maximum outlay to be
incurred
And
b.
This cost
is not tied to a cause and effect relationship between input and output.
(Note : Decision-driven cost Vs Managed / Policy cost while
managed / policy cost arises from periodic decisions (usually annual),
decision-driven cost has no such fixed frequency).
6.10 Post-ponable cost - It is that cost which can be shifted to the future
with little or no effect on the efficiency of the current operations.
6.11 Imputed / Notional cost - CIMA defines notional cost as "the value of
benefits where no actual cost is incurred". Thus, imputed cost is that cost
which does not involve any cash outlay. Though it is a hypothetical cost, it is
relevant for decision making. Interest on capital, the payment for which is not
actually made, is an example of imputed cost.
6.12 Inventoriable / Product cost - It is the cost which is
assigned to the product. For eg : Under marginal costing ® variable
manufacturing cost. Under absorption costing ® total manufacturing cost (fixed
and variable) constitute product or inventoriable cost.
6.13 Opportunity cost - It refers to the value of sacrifice made or
benefit of opportunity forgone in accepting an alternative course of action. For
e.g. If Mr. A works in his brother’s firm instead of working in X Ltd., then the
loss of salary Mr. A suffers by foregoing employment in X Ltd., is the
opportunity cost of working in his brother's firm.
6.14 Out of pocket cost - It is that portion of total cost which
involves cash outlay. It is a short term cost concept and is used in short- term
decision making like make or buy, price fixation during recession. Out of pocket
cost can be avoided if a particular proposal under consideration is not
accepted.
6.15 Joint cost - It is the cost of the process which results in
more than one main product.
6.16 Period cost - It is the cost which is not assigned to the product but is
charged as an expense against the revenue of the period in which it is incurred.
All the non-manufacturing costs like administrative, selling and distribution
expenses are treated as period costs.
6.17 Sunk cost - Historical cost which is incurred in the past is known as
sunk cost. This cost is not relevant in decision making in the current period.
For eg. In the case of a decision relating to the replacement of a machine, the
written down value of the existing machine is a sunk cost and hence irrelevant
to decision making.
6.18 Committed cost - It is a fixed cost which results from
decisions of prior period and is not subject to managerial control in the
present. Examples of committed cost are depreciation, insurance premium and
rent.
6.19 Shut down cost - The fixed cost which cannot be avoided during
the temporary closure of a plant is known as shut down cost. Examples of shut
down cost are depreciation and rent.
6.20 Relevant cost - CIMA defines relevant cost as " cost appropriate to a
specific management decision".
6.21 Replacement cost - It is the cost of replacement in the
current market.
6.22 Absolute cost - It is the total cost of any product or
process. For e.g.: in a cost sheet, both absolute cost and cost per unit are
depicted.
6.23 Cost centre - [May'95, May'97]
Meaning - For the installation of a cost accounting system, the organization
is divided into sub-units. Cost centre is the smallest organisational sub-unit
for which separate cost collection is attempted. It is defined as a location, a
person or an item of equipment (or group of these) for which cost may be
ascertained and used for the purpose of cost control.
Types – Primarily , there are two types of cost centres, namely:
a.
Personal
cost centre - consisting of a person or a group of persons
b.
Impersonal
cost centre - consisting of a location or an item of equipment (or a group of
these).
Functionally, there are two types of cost centres, namely:
a.
Production
cost centre - It is a cost centre where both direct and indirect expenses are
incurred for the production. Following are the examples of production cost
centres- machine shop, milling and turning shop, assembly shop.
b.
Service
Cost Centre - A cost centre which renders services to production cost centres is
termed as service cost centre. It serves as an ancillary unit to the production
cost centre.
Powerhouse, boiler plant, repair shop, material service centre, all are examples
of service cost centres.
Considerations - Formation of appropriate cost centres is very important for
the purpose of cost control. Important considerations for the formation of cost
centres are as follows:
a.
Organisation of the factory
b.
Conditions
prevalent for incurrence of cost
c.
Management’s decision needs
6.24 Cost unit - Meaning - Once the cost of various cost centres is
ascertained, the need arises to express the cost of output (product / service).
A cost unit is defined as a unit of quantity of product, service or time (or a
combination of these) in relation to which costs may be ascertained or
expressed.
Cost units are usually units of physical measurement like number, weight, time,
area, length, volume etc.
Examples - A few typical examples of cost units are given below :
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Industry
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Cost Unit Basis
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Automobile
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Number
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Bicycle
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Number
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Transport
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Tonne-kilometer
Passenger-kilometer
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Furniture
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Each article
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Bridge construction
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Each contract
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Interior decoration
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Each job
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Advertising
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Each job
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Nursing home
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Bed or day
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Power
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Kilowatt hour
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Bricks
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Number
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Cement
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Tonne, bag
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Steel
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Tonne
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Chemical
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Litre, gallon, tonne,kilogram
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Sugar
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Tonne
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Coal
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Tonne
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6.25 Cost allocation - Cost allocation refers to the allotment of whole items
of costs to cost centres. For example, if a worker is employed in department
"A", then the wages paid to the worker are allocated or charged to department
"A". This process of charging the entire wages (being ‘cost’) of the worker to
department "A" is termed as cost allocation.
6.26 Cost apportionment - It is the process of distributing an item of cost
over several cost centres or cost units. Thus, one item of cost is charged to
two or more cost centres or cost units. Normally overheads (indirect costs) are
charged to cost centres or cost units by way of apportionment in proportion to
the anticipated benefits.
( Note : Cost allocation Vs Cost apportionment. The former involves the
process of charging direct expenditure to cost centres or cost units while the
latter involves the process of charging indirect expenditure to cost centres or
cost units.)
6.27 Cost absorption - It is the process of absorbing the overhead costs
(indirect costs) allocated to or apportioned over a particular cost centre. Thus
cost absorption follows cost allocation and cost apportionment. Selection of
correct method of overhead absorption is very important for pricing policies,
tenders and other managerial decisions. Overhead absorption is accomplished
through overhead rates. For eg. the overhead costs of a ‘grinding centre’ may be
absorped by using a rate per " grinding" hour.
6.28 Responsibility centre - Meaning - When an organisation is divided into
different sub-units according to the responsibility and for each sub-unit, a
specified individual is made responsible, then the sub-unit thus formed is
termed as a responsibility centre. Thus, a responsibility centre is defined as
an activity centre of a business organisation entrusted with a special task.
The specified individual is held accountable only for those activities which
he directly affects. Under modern budgeting and control, finance executives tend
to apply the concept of responsibility centres for the purpose of control.
Types -
Responsibility centres can be classified as under:
a.
Cost
centres - Refer 6.23 above
b.
Profit
centres - Centres, which have the responsibility of generating and maximising
profits , are called profit centres. [Nov'97]
c.
Investment
centres - Centres which are responsible for earning an optimum return on
investments are termed as investment centres.
d.
Revenue
centres - Centres which are devoted to raising revenue with no responsibility
for production are called revenue centres. Eg. Sales centre.
e.
Contribution centres - Profit centres whose expenditure are reported on a
marginal cost basis, are called contribution centres.
7. ELEMENTS OF COST
7.1 Material Cost :
i.
Direct
Materials - Materials which are present in the finished product or can be
identified in the finished product are called direct materials. For eg. coconuts
in case of coconut oil or wood in a wooden cupboard.
ii.
Indirect
Materials - Indirect materials are those materials which do not normally form
part of the finished products or which cannot be directly traced to the finished
product. For eg. stores, oil, grease, cotton wool etc.
7.2 Labour Cost :
i.
Direct
Labour - Labour which can be attributed wholly to a particular product, process
or job is called direct labour. It is the labour utilised in converting raw
materials into finished products. For eg. labour employed in the crushing
department of an oil mill.
ii.
Indirect
Labour - Labour which cannot be identified with a particular product, process or
job is called indirect labour. Indirect labour cost is apportioned to cost units
or cost centres. For eg. maintenance workers.
7.3 Expenses :
i.
Direct
Expenses - Expenses incurred (except direct materials and direct labour)
specifically for a product, process or job is known as direct expenses. They are
also called "chargeable expenses". For eg. hiring charges for a machine
specifically hired for a particular process, excise duty, royalty.
ii.
Indirect
Expenses - Expenses incurred other than direct expenses are called indirect
expenses. For eg. factory rent & insurance, power, general repairs.
7.4 Overheads :
Overheads is the sum total of indirect materials, indirect labour and
indirect expenses. Functionally overheads can be classified as under -
i.
Production
/ Works overheads
ii.
Administrative overheads
iii.
Selling
overheads
iv.
Distribution overheads
8. CLASSIFICATION OF COST
8.1 Classification By Nature :
i.
Direct cost
- Direct cost is that cost which can be identified with a cost centre or a cost
unit. For e.g. cost of direct materials, cost of direct labour.
ii.
Indirect
cost - Cost which cannot be identified with a particular cost centre or cost
unit is called indirect costs. For e.g. wages paid to indirect labour.
8.2 Classification By Behaviour :
i.
Fixed cost
- Fixed cost is that cost which remains constant at all levels of production.
For e.g. rent, insurance.
ii.
Variable
cost - The cost which varies with the level of production is called variable
cost i.e., it increases on increase in production volume and vice-versa. For
e.g. cost of materials, cost of labour.
iii.
Semi-variable cost - This cost is partly fixed and partly variable in relation
to the output. For e.g. telephone bill, electricity bill.
8.3 Classification By Element :
Refer 7 above.
8.4 Classification By Function :
i.
Production
cost - It is the cost of the entire process of production. In other words it is
nothing but the cost of manufacture which is incurred upto the stage of primary
packing of the product.
ii.
Administrative cost - It is the indirect cost pertaining to the administrative
function which involves formulation of policies, directing the organisation and
controlling the operations of an undertaking. This cost is not related to any
other functions like selling and distribution, research and development etc.
iii.
Selling
cost - Selling cost represents the indirect cost which is incurred for
(a) seeking to create and stimulate demand
and
(b) securing orders.
iv.
Distribution cost - It is the cost of the sequence of operations which begins
with making the packed product available for despatch and ends with making the
reconditioned returned empty package, if any available, for re-use.
v.
R&D cost -
"Research Cost" and "Development cost" are two different types of costs.
Research cost is the cost of researching for new products, methods and
applications. Development cost is the cost of the process which begins with the
implementation of the decision to produce the new product or apply the new
method and ends with the commencement of formal production of that product or by
that method.
vi.
Pre-production cost - It is that part of the development cost which is incurred
for the purpose of a trial run, before the commencement of formal production.
vii.
Conversion
cost - It is the cost incurred for converting the raw material into finished
product. It comprises of direct labour cost, direct expenses and factory
overheads.
viii.
Prime cost
- Prime cost is the aggregate of direct material cost, direct labour cost and
direct expenses. The term ‘direct’ indicates that the elements of cost are
traceable to a particular unit of output.
8.5 Classification By Controllability : [May'97]
i.
Controllable cost - The cost, which can be influenced by the action of a
specified person in an organisation, is known as controllable cost. In a
business organisation, heads of each responsibility centre are responsible to
control costs. Costs that they are able to control are called controllable costs
and include material, labour and direct expenses.
ii.
Uncontrollable cost - The cost which cannot be influenced by the action of the
person heading the responsibility centre is called uncontrollable cost. For e.g.
all the allocated costs and the fixed costs.
Note: It may be noted that controllable and uncontrollable cost concepts are
related to the authority of a person in the organisation. An expenditure which
may be controllable by one person may not be controllable by another. Moreover,
in the long run, all cost may be controllable.
8.6 Classification By Normality :
i.
Normal cost
- It is the cost which is normally incurred at a given level of output, under
the conditions in which that level of output is normally attained. Normal cost
is charged to the respective product / process.
ii.
Abnormal
cost – It is the cost which is not normally incurred at a given level of output
in the conditions in which that level of output is normally attained.
This cost is charged to the costing profit and loss account i.e., the product
/ process does not bear the abnormal cost.
8.7 Classification By Time when Computed :
i.
Sunk cost -
Refer 6.17 above
ii.
Estimated
cost - Refer 6.4 above
9. TYPES / TECHNIQUES OF COSTING
Following are the techniques of costing used in industries for ascertaining
the cost of products / services:
9.1 Historical Costing - It is the ascertainment of costs after they
have been incurred. This costing is based on recorded data and the cost arrived
at are verifiable by past events. This type of costing has limited utility.
9.2 Uniform Costing - CIMA defines it as " the use by several undertakings of
the same costing system, i.e., the same basic costing methods, principles and
techniques."
9.3 Standard Costing - CIMA defines standard costing as " a control technique
which compares standard costs and revenues with actual results to obtain
variances which are used to stimulate improved performance."
9.4 Direct Costing - Under direct costing, a unit cost is assigned
only the direct cost, i.e., all the direct costs are charged to the relevant
operations, products or processes. The indirect costs are charged to the profit
and loss account of the period in which they arise. As a result, inventory is
valued at direct cost only.
9.5 Marginal Costing - Under marginal costing, marginal cost is ascertained
by differentiating between fixed and variable costs. In this type of costing,
variable costs are charged to cost units and fixed costs of the period are
written off in full against the aggregate contribution.
Marginal costing is of great importance in case of short-term decision
making.
9.6 Absorption Costing - It is the technique of assigning all costs i.e. both
fixed and variable, to the respective product/service.
9.7 Difference between various Types of Costing
Note : Please note the following distinctions
a.
Marginal
Costing V/S Absorption Costing
Marginal cost excludes fixed costs. Under absorption costing, even fixed costs
are charged to the product/service.
b.
Marginal
Costing V/S Direct Costing
Under marginal costing only variable cost (both direct and indirect) is charged
to the cost unit while under direct costing, only direct cost ( both fixed and
variable) is charged to the cost unit.
c.
Absorption
Costing V/S Direct Costing
Under absorption costing, all costs (both direct and indirect) are assigned to
the cost unit, whereas under direct costing only direct cost is assigned to the
cost unit. In both types of costing, variability of cost is ignored.
d.
Differential Costing V/S Marginal Costing
[May'94, Nov'97]
|
Differential Costing
|
Marginal Costing
|
Scope
|
Wider than marginal costing.
|
Narrower than differential costing.
|
Variability
|
Both fixed and variable costs are considered.
|
Only variable costs are considered.
|
Definition
|
Cannot be precisely defined except in terms of increase or decrease
in total costs.
|
Can be defined as prime cost plus variable overheads.
|
Basis of Decision Making
|
Comparison of differential cost with incremental / decremental
revenue.
|
Margin of contribution and profit volume.
|
Incorporation in Accounting System
|
This type of costing does not find a place in the accounting system
as it involves future course of action. However, it may be incorporated
in the budgets.
|
Marginal costs may be incorporated in the accounting system.
|
Applicability
|
Applicable to both, long term as well as short term decision making.
|
Applicable only to short term decision making.
|
|
10. METHODS OF COSTING & THEIR APPLICABILITY
|
The method of costing applied by a particular industry depends upon the
nature of the industry.
Following are the various methods of costing which are commonly followed :
10.1 Job Costing - The objective under this method of costing is to ascertain
the cost of each job order. A job card is prepared for each job to accumulate
costs. The cost of the jobs is determined by adding all the costs against the
job when it is completed.
This method of costing is used in printing press, foundaries, motor-
workshops, advertising etc.
10.2 Batch Costing - This method of costing is used where small
parts/components of the same kind are required to be manufactured in large
quantities. Here a batch of similar products is treated as a job and the cost of
such a job is ascertained as mention in (10.1) above
For e.g. in a cycle manufacturing unit, rims are produced in batches of 1,000
units each, then the cost will be determined in relation to a batch of 1,000
units.
10.3 Contract Costing - If a job is very big and takes a long time
for its completion, then the method appropriate for costing is called contract
costing. Here the cost of each contract is ascertained separately.
It is suitable for firms engaged in erection activities like construction of
bridges, roads, buildings, dams etc.
10 4 Process Costing - This method of costing is used in those industries
where the production comprises of successive and continuous operations or
processes. Here specific units lose their identity in the manufacturing
operation. Under this method of costing, costs are accumulated by ‘processes’
for a particular period regardless of the number of units produced.
This method of costing is followed by chemical industry, soap industry,
rubber industry, paints industry.
10.5 Operating Costing - The method of costing used in service
rendering undertakings is known as operating costing.
This method of costing is generally made use of by transport companies, gas
and water works departments, electricity supply companies, canteens, hospitals,
theatres, schools etc.
10.6 Single Output/Unit Costing - This method of costing is used
where a single product is produced. The total production cost is divided by the
total number of units produced to get the unit/single output cost.
This method of costing is normally used in marble quarrying, mining,
brick-kilns, breweries, etc.
10.7 Multiple Costing - It is a combination of two or more methods of costing
mentioned above. Suppose a firm manufactures bicycles, including its components,
the parts will be costed by way of batch costing but the cost of assembling the
bicycle will be done by unit costing. This method is also called composite
costing.
Some other industries using this method of costing are those manufacturing –
radios, automobiles, aeroplanes etc.
|
11.ANALYSIS OF PAST QUESTIONS
|
11.1 Scanning of Questions Asked in Past Examinations :
Nov'92 - Distinguish between : Standard costs and Estimated costs. (4 marks)
May'93 - Match the following : (1 mark each)
|
|
|
|
|
|
|
|
- Increases in proportion to output
|
|
|
|
|
|
- What costs are expected to be
|
|
|
- Decreases with rise in output
|
|
|
- Remains constant in total
|
|
|
- Remains constant per unit
|
|
|
- Cost not assigned to products
|
|
|
- Added value of a new product
|
May'93 - Indicate whether the following statements are True or False : All
costs are controllable.
i.
Conversion
cost is equal to direct wages plus factory overhead.
ii.
Variable
cost per unit varies with the increase or decrease in the volume of output.
iii.
Depreciation is an out of pocket cost.
iv.
An item of
cost that is direct for one business may be indirect for another.
v.
Fixed cost
per unit remains fixed. (1 mark each)
Nov'93 - Outline the steps involved in installing a costing system in a
manufacturing unit. What are the essentials of an effective costing system? (16
marks)
May'94 - Distinguish between:
Marginal costing and Differential costing
Cost control and Cost reduction (8 marks)
May’95 - Write short notes on : Cost centre. (4 marks)
May’96 - What are the essentials of a good cost accounting system? (6marks)
May’96 - Narrate the essential factors to be considered while designing and
installing a cost accounting system. (10 marks)
Nov’96 - A factory manufactures only one product in one quality and size. The
owner of the factory states that he has a sound system of financial accounting
which can provide him with unit cost information and as such he does not need a
cost accounting system. State your arguments to convince him the need to
introduce a cost accounting system. (4 marks)
May’97 - What is meant by ‘Cost Centre’ ? (4 marks)
May'97 - Distinguish between the following : Controllable costs and
Uncontrollable costs. (4 marks)
Nov’97 - What is meant by ‘Profit Centre’? (4marks)
Nov’97 - Distinguish between : Differential costing and marginal costing
May’98 - Name the various reports ( Elaboration not needed) that may be
provided by the Cost Accounting Department of a big manufacturing company for
the use of its executives. (5 marks)
Nov’98 - Specify the methods of costing and cost units applicable to the
following industries:
i.
Toy making
ii.
Cement
iii.
Radio
iv.
Bicycle
v.
Ship
building
vi.
Hospital.
(3 marks)
Nov’99 - Discuss the four different methods of costing along with their
applicability to concerned industry. (4 marks)
Nov’99 - Enumerate the factors which are to be considered before installing a
system of cost accounting in a manufacturing organisation. (5 marks)
|
11.2 Frequency Table Showing Distribution of Marks :
|
|
Exam
|
Descriptttive Questions
|
Practical Questions
|
Total Marks
|
|
May'95
|
4
|
-
|
4
|
|
Nov'95
|
-
|
-
|
-
|
|
May'96
|
16
|
-
|
16
|
|
Nov'96
|
4
|
-
|
4
|
|
May'97
|
8
|
-
|
8
|
|
Nov'97
|
4
|
-
|
4
|
|
May'98
|
5
|
-
|
5
|
|
Nov'98
|
3
|
-
|
3
|
|
May'99
|
-
|
-
|
-
|
|
Nov'99
|
9
|
-
|
9
|
*********************************************************************
END
********************************************************************
MATERIAL
Introduction :-
These Chapter deals with Calculation & Control of Material
Cost. Normally Stock of material is valued either at cost price or MKT Price
whichever is lower. Under the Cost Price criteria method like FIFO [First In
First Out], LIFO [Last In First Out], Weighted Average, Simple Average are used.
The Above Approach are related to calculation & valuation
of material stock. However it is equally important to control the material cost.
For controlling the cost , it is necessary to decide how much should be
purchased, when to purchased, what should be stock level, How much discount
should be demanded from the supplier etc. It is also necessary to keep check
over material turnover. For controlling the material cost .
[1] ECONOMIC ORDER QUANTITY (EOQ) OR REORDER QUANTITY (ROQ)
It
represent the quantity of material which should be purchased each time. These
quantity is economical from the angle of the storages & ordering cost.
Where
A
= Annual Consumption of Qty
B
= Buying cost OR cost of placing one order.
CS =
Cost of storing one unit of material for one year.
If the cost of the Investment is given then such cost also
will be part of CS
|
Note :- Whenever Discount Factor given in a problem. These Formula
will not be apply for calculating EOQ.
|
It
represent the time gap involves between placement of order & Actual Receiving of
the Delivery. Such Period is again divided into Maximum Period, Minimum Period,
Average Period & Emergency Period.
It
represents that level of stock of which fresh quantity of material should be
purchased. The Purchased Quantity will be EOQ.
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