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BASIC CONCEPTS

OF
COST ACCOUNTING

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 10 - 1


COSTING:

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.
©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 10 - 2
COST ACCOUNTING vs
FINANCIAL ACCOUNTING
 COST ACCOUNTING: The accumulation &
analysis of cost information for internal use to aid
management in planning, control & decision
making.

 FINANCIAL ACCOUNTING: It is the branch of


accounting which is concerned primarily with
financial reports for external use.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 10 - 3


NATURAL CLASSIFICATION OF COSTS

1. Manufacturing Costs also called


Product Cost.
2. Commercial Expenses
Distribution & Selling Expenses
General & Administrative Expenses

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 10 - 4


COSTS WITH RESPECT OF
ACCOUNTING PERIOD

 Capital Expenditure: Classified as


an asset.
 Revenue Expenditure: Classified as
an expense. Also called period
cost.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 10 - 5


COSTS WITH RESPECT OF
VOLUME OR ACTIVITY

1. Fixed Overhead
2. Variable Overhead
3. Semi Variable Overhead.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 10 - 6


COSTS WITH RESPECT OF
VOLUME OR ACTIVITY
FIXED OVERHEAD:
 It refers to those expenses which do not vary with
the increase or decrease in production level. Total
amount of the fixed overhead remains constant with
all the level of production.
 Fixed cost per unit changes with increase or
decrease of production level.
 Example: Factory Building Rent, Salary of Plant
Manager, Insurance Premium, Depreciation etc.
©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 10 - 7
COSTS WITH RESPECT OF
VOLUME OR ACTIVITY
 VARIABLE OVERHEAD: It refers to those
expenses which vary with the increase or decrease in
production level. Total amount of variable overhead
changes with all levels of production.
 Variable cost per unit remains constant irrespective
of the increase or decrease of production level.
 Example: Power, Overtime, Maintenance cost etc.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 10 - 8


COSTS WITH RESPECT TO
VOLUME OR ACTIVITY
SEMI-VARIABLE OVERHEAD:
 A part of such expenses is fixed & a part is
variable.
 Example: Telephone Expense Bill

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 10 - 9


Categories of
Manufacturing Costs
 All costs which are eventually allocated
to products are classified as either…
1 direct materials,
2 direct labor, or
3 indirect manufacturing.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 10 - 10


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.
– Example: Timber in chair or table, cloth in shirt,
Basic or essential packing materials like cartons,
boxes, papers etc.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 10 - 11


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.
– The cost of wages paid to skilled or unskilled
workers and assignable to the unit produced is
termed direct labor.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 10 - 12


Indirect Manufacturing Costs or
Factory Overheads...
– or factory overhead, include all costs ( indirect
material, indirect labor & other indirect expenses )
associated with the manufacturing process that
cannot be traced to the manufactured goods in an
economically feasible way.
– Simply stated factory overhead includes
all manufacturing cost except direct materials &
direct labor.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 10 - 13


Indirect Manufacturing Costs or Factory
Overheads ( Cont’d )
 Indirect Material: Material cost which can not be allocated or
identified, but which are to absorbed by the units produced.
 Example: Lubricants, factory supplies, tacks, tools for general use,
glue, thread in shirt, nails in furniture.
 Indirect Labor: Labor cost which can not be allocated or identified,
but which are to be absorbed by the units produced.
 Example: Idle time wages, Maintenance & Repair Wages, Salary of
peon, guard, general helpers, cleaners etc.
 Indirect Expenses: All indirect cost other than indirect material &
indirect labor which can not be allocated or identified, but which are
to absorbed by the units produced.
 Example: Canteen, Depreciation, Insurance, Taxes, Rent, Heat &
Light etc.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 10 - 14


EXAMPLE ( Direct vs Indirect Cost)
 For example, if a company produces artisan furniture, the
cost of the wood and the cost of the craftsperson are direct
costs—they are clearly traceable to the production
department and to each item produced—no allocation was
needed. On the other hand, the rent of the building that
houses the production area, warehouse, and office is not a
direct cost of either the production department or the items
produced. The rent is an indirect cost—an indirect cost of
operating the production department and an indirect cost of
crafting the product.
 To calculate the total cost of the production department or
to calculate each product’s total cost, it is necessary to
allocate some of the rent (and other indirect costs) to the
department and to the product.
©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 10 - 15
COMPONENTS OF
TOTAL COST
 Prime Cost: Direct Material + Direct Labor +
Direct Expenses
 Prime Cost + FOH = Manufacturing Cost

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 10 - 16