Cost

• In general word ,Cost means price; the price that is paid for
something.
• But, in Cost accounting, cost refers to expenditure and not to
price.
• It is an expenditure (Actual or notional) incurred on particular
thing or activity.
For example:
For manufacturing of cotton fabrics, the expenditure incurred on the
purchase of cotton yarn,
wages paid to weavers,
salary paid to foreman ,
depreciation on machinery
used in manufacture of fabrics etc are the items of cost.
 Elements of cost

Materials Labour Expenses

Direct Indirect Direct Indirect Direct Indirect

Overheads

Production or Administration Selling & Distribution

works overheads overheads overheads
 Material

• The substance/commodities from which the finished product is made

is known as material.
(a) DIRECT MATERIAL: Direct material is the material which can
be directly or easily identified in the product .
• Eg: Timber/wood is raw material for making furniture, Cloth
in dress, etc.

(b) INDIRECT MATERIAL: It is the cost of material which do not

form the part of product but which help the production.
Eg: Threads for manufacturing garments, oil and grease for the
maintenance of machinery, Nails for making furniture etc.
 Labour
• The human effort required to convert the materials into finished
product is called labour.
• Direct Labour/wages: It refers to the amount paid to the workers
who are directly engaged in the production of goods.
• It varies directly with the output.
Eg: wages paid to carpenter, fees paid to tailor, wages paid to the
driver etc
• Indirect Labour /wages: It refers to the amount paid to the
workers who are indirectly engaged in the production of goods.
• It does not vary directly with the output.
e.g. Security Guards, salary paid to managers or supervisor
 Expenses
• These are those expenses other than materials and labour.
a. DIRECT EXPENSES: are those expenses which can be directly
allocated to particular job, process or product.
Eg : Excise duty, carriage and freight charges, special hire
charges, etc.
b. INDIRECT EXPENSES: are those expenses which cannot be
directly allocated to particular job, process or product.
Example: Rent ,insurance of showroom building, factory
lighting, telephone charges etc
.
 Overhead
• Sum /aggregate of all indirect cost(Indirect
material,labour and expenses) is known as
overhead.
Indirect material + indirect labour + Indirect
expenses= Overhead
• Indirect cost or overhead may again be classified on
the basis of function as follows;
• Factory overhead
• Office and administration overhead
• Selling and distribution overhead
 FACTORY OVERHEAD :- These are indirect expenses which are incurred for
running of the factory or plant.
Eg: cotton waste for cleaning the machinery, wages of storekeeper, factory
rent ,repairs to factory building etc.

 OFFICE/ADMINISTRATIVE OVERHEAD :- These are indirect expenses which

are incurred for administration and control of organization are known as
administrative costs.
Eg: costs are office salaries, printing and stationery, office telephone, office
rent, office insurance audit fée and légal charges etc.

 SELLING AND DISTRIBUTION COSTS :-

a)Selling overheads :These are indirect expenses which are incurred to create
and maintain demand for the product..
b) Distribution overheads: these are expenses which are incurred for delivery
of finished goods to the customers
Eg. Cost of advertisement, salary of sales manager running and
maintenance of delivery vans, packaging charges etc
 COST CLASSIFICATION – ON THE BASIS OF

 Nature / Elements
 Function
 Direct & Indirect
 Variability
 Controllability
 Normality
Time
 Planning and Control
 Managerial Decision Making
 ON THE BASIS OF ELEMENTS

• Materials
• Labour
• Expenses
 ON THE BASIS OF FUNCTION
 Production Costs :- All costs incurred for production of goods are known
as production costs.
 Administrative Costs :- Costs incurred for administration are known as
administrative costs.
Examples of these costs are office salaries, printing and stationery, office
telephone, office rent, office insurance etc.
 Selling and Distribution Costs :- All costs incurred for procuring an order
are called as selling costs while all costs incurred for execution of order
are distribution costs.
Market research expenses, advertising, sales staff salary, sales promotion
expenses are some of the examples of selling costs.
Transportation expenses incurred on sales, warehouse rent etc are
examples of distribution costs.
 Research and Development Costs :- In the modern days, research and
development has become one of the important functions of a business
organization. Expenditure incurred for this function can be classified as
Research and Development Costs.
 ON THE BASIS OF VARIABILITY
• Fixed costs / Period Costs: Out of the total costs, some costs
remain fixed irrespective of changes in the production volume. The
feature of these costs is that the total costs remain same while per
unit fixed cost is always variable.
Examples of these costs are salaries, insurance, rent, etc.
• Variable costs: These costs are variable in nature, i.e. they change
according to the volume of production.
• Semi-Variable Cost / Semi-Fixed cost:
These costs are partly fixed and partly variable.
Examples of variable costs are telephone rent. It includes partly
fixed charge up to a certain level and then varies according to the
calls. These costs are also called as ‘stepped costs’.
 ON THE BASIS OF NATURE

• Direct costs:- Direct costs that can be easily and

conveniently traced to a unit of product .
• Examples: direct material and direct labor

• Indirect costs:- Indirect costs cannot be easily and

conveniently traced to a unit of product.
• Example: manufacturing overhead
 ON THE BASIS OF CONTROLLABILITY
• Controllable costs: These costs are regulated or controlled by
specified member of an organisation. Most of the variable
costs are controllable.
• Generally direct material, direct labor and direct expenses are
controlled by the lower level of the management.

• Uncontrollable costs: These costs can not be regulated or

controlled by specified member of an undertaking. Most
of the fixed costs are uncontrollable.
• Example of uncontrollable costs are, factory rent,
managers salary etc.
 ON THE BASIS OF NORMALITY

• Normal costs: It is the cost which is normally incurred at a given

level of output. These costs are part of cost production.
• Example: repairs, maintenance, salaries paid to employees.

• Abnormal costs:
It is the cost which is not normally incurred at a given level of
output. These costs are not charged to the cost of production. It
is transferred to the costing profit and loss account.
Example: destruction due to fire, shut down of machinery, lock
outs, etc.
 ON THE BASIS OF TIME:

• Historical costs: These are the costs which are

incurred in the past, i.e. in the past year, past month
or even in the last week or yesterday.
• The historical costs are ascertained after the period
is over. In other words it becomes a post-mortem
analysis of what has happened in the past.

• Pre determined costs: These costs relating to the

product are computed in advance of production, on
the basis of a specification of all the factors affecting
cost and cost data.
 ON THE BASIS OF MANAGERIAL DECISION
MAKING
• Marginal costs: Marginal cost is the change in the aggregate costs
due to change in the volume of output by one unit.
• For example, suppose a manufacturing company produces 10,000
units and the aggregate costs are Rs. 25,000, if 10,001 units are
produced the aggregate costs may be Rs. 25,020 which means that
the marginal cost is Rs. 20.

• Differential costs: refers to the difference in total costs between

two alternatives. In case, the choice of an alternatives results in all
adding or dropping a product, make or buy decisions, accepting an
export offer and so on.
 ON THE BASIS OF MANAGERIAL DECISION MAKING
contd….

• Opportunity costs: It is the value of benefit sacrificed

in favor of an alternative course of action. It is the
maximum amount that could be obtained at any
given point of time if a resource was sold or put to
the most valuable alternative use that would be
practicable.

• Replacement cost: This cost is the cost at which

existing items of material or fixed assets can be
replaced. Thus this is the cost of replacing existing
assets at present or at a future date.
 ON THE BASIS OF MANAGERIAL DECISION MAKING
contd….
• Sunk costs:
sunk costs are historical or past costs. They have already been
incurred in past and cannot be changed by any decision in future.
Example: If management wants to replace an old machinery in
the past is now sunk cost and cannot be changed and will also not
affect in any way the decision on cost of new machine.
• Shutdown costs:
These are the costs which will still be incurred although a plant is
shut down temporarily. Due to shortage of raw materials, non
availability of labour etc.
During this period though no work is done yet certain fixed costs
such as rent and insurance of buildings, depreciation etc. for the
entire plant will have to be incurred. Such costs of the idle plant
are known as shut down costs.
 ON THE BASIS OF MANAGERIAL DECISION MAKING
contd….

• Imputed costs: These are the cost which donot

involve cash expenditure. They are not included in
cost accounts but are important for taking into
consideration while making management decisions.
Examples: Interest on capital, salaries of the proprietor
or partner of a partnership firm etc
 Cost Accounting
• Cost accounting is the branch of accounting that deals
with the classification, allocation, recording,
summarization and reporting of costs. It is the
accounting process for cost ascertainment, cost
allocation, cost distribution and accounting aspects. It
is an internal reporting system by the means of which
costs of products and services are controlled.
• Cost accounting aims to assist the management in
planning and decision-making processes.
• Its emphasis is primarily on collection, analysis,
interpretation and presentation of cost for managerial
decision makings.
 Functions and Objectives of Cost
Accounting
• To ascertain cost:
It is the main objective of cost accounting. Costs are the expenses that incur during
the production of goods and services and it is the major objective of cost
accounting to ascertain their costs. Material, labour, direct expenses, etc. are some
of the examples of cost.

• To analyze cost and loss:

Another objective of cost accounting includes the analysis of the cost of each
activity. It is important to analyze the cost in order to classify the costs’ variability,
profitability or loss chances, relevancy, etc. Similarly, breakdown or machine
damage, idle time, the effects of misuse of material, etc. are further analyzed.

• To control cost:
Cost accounting uses cost control as the technique to minimize the cost of product
and services, without any compromise on their quality. Standard costing and
budgetary control are some of the techniques that helps in controlling the cost.
• To aid the management:
Cost accountancy provides essential costing information to the
management which helps in the planning and its implementation.
This helps in the evaluation of both past activities and future
planning.

• To help in selling price fixation: Almost all the above functions are
performed in order to reach the objective to determine the selling
price of the products or services in per unit term. After ascertaining
the cost per unit of products, selling price per unit is calculated with
the addition of a certain profit on the total cost amount. Various
techniques such as job costing, batch costing, service costing,
multiple costing, contract costing, etc. are used to fixate the selling
price.
 Advantages and Importance of Cost
Accounting
• Helps in controlling cost:
Cost accounting controls the cost by comparing the actual cost with the standard or
budgeted cost under techniques like Standard Costing and Budgetary Control. If
there is the deviation in existence, the corrective actions are to be taken.

• Helps in increasing profit:

From the introduction and implementation of various cost reduction techniques to
increase profit and to the disclosure of the profitability of activities helps the
management in the decision making of contract continual and expansion or
contract elimination, Cost accounting helps in every way possible to gain profit.

• Helpful in fixing selling price:

By ascertaining the cost per unit of products and services, Cost accounting helps in
the determination of selling price by adding certain profit amount on the total cost.
• Provides essential cost information:
Cost accounting helps the management by providing necessary cost
information for planning, implementation and controlling purposes.
Further, it also provides some other necessary costing information to the
outsiders like the suppliers, investors, the government, tax authority, etc.

• Helps to compare costs:

Comparison of costs between periods, processes, departments and
volumes of output is important to take corrective actions. For this, cost
accounting provides the management with reliable data and information.

• Helps to compare costs:

Comparison of costs between periods, processes, departments and
volumes of output is important to take corrective actions. For this, cost
accounting provides the management with reliable data and information.
•

• Advantages to customers:
Because the cost accounting makes sure in the rational usage of material, labour
and technology, as well as different cost reduction and controlling programs,
customers are provided with quality goods and services at reasonable prices.

• Advantages to government:
Fixation and control of price, formulation of foreign trade policies, determination of
tax, settling minimum wages and labour disputes, etc. are some of the issues that
cost accounting helps the government with.

• Advantages to the workers:

As cost accounting emphasizes on the rational use of labour and wage payment
system, it is very beneficial to the workers too.

• Helpful to the investors: Cost accounting is very beneficial to the investors as well
as financial institutions because it shows the financial position and profitability of
the possible investments.
 Limitations of Cost accounting
• The system is more complex.
• It is expensive.
• Inapplicability of costing method and technique.
• Not suitable for small scale units.
• Lack of Accuracy.
• Lacks social Accounting.
• Need preparation of frequent reconciliation to verify accuracy.
• Duplication of Work.
• Use of Secondary Data.
• Lack of cooperation of employees.
• Does not control Cost by itself.
• It is based on estimation and previous data.
• It only bring out the cost of goods or services.
• It serves the information need of the management.
• Not useful for determining the tax liabilities.