COST ANALYSIS, CONCEPTS

& CLASSIFICATIONS
 CONCEPT OF COST

1. Cost means the total of all expenses.

3. Cost is defined as the amount of expenditure(
actual or notional) incurred on or attributable to
a given thing or to ascertain the cost of a given
thing.
4. The cost of an article consists of actual
outgoings or ascertained charges incurred in
its production and sale.
 ELEMENTS OF COST
For proper control and managerial decisions,
the total cost is analysed by elements of cost.
i.e,by the nature of expenses.

The elements of cost are

1. Materials
2. Labour
3. Other expenses
These elements of cost are further analysed into
different elements as
 Elements of cost

Labour Other expenses

Materials

Direct Indirect Direct Indirect Direct Indirect

Overheads

Production or
Administration Selling Distribution
Works
Overhead Overheads Overheads
Overhead
By grouping the above elements of cost, the following divisions
of cost are obtained.

1. Prime cost = Direct Materials + Direct Labour +

Direct Expenses

2. Work or Factory cost = Prime cost + Works or Factory

Overheads

3. Cost of Production = Works Cost + Administration

Overheads

4. Total cost or = Cost of production+ Selling &

Cost of sales Distribution Overheads
 DIRECT MATERIAL
Those materials which can be identified in the product and
can be conveniently measured and directly charged to the
product.
Eg: cloth of dress making, bricks for building

The following are normally classified as direct materials:

5. All raw materials
6. Materials specifically purchased for a specific job, process
or order
7. Parts or components purchased or produced
8. Primary Packing materials
Certain materials which are parts of
finished products but used in small
quantities are treated as indirect
material

Thus the ease and the feasibility with

which a material can be traced into
the composition of a finished product
will determine what is to be treated
as direct material.
 DIRECT LABOUR
All labour expended in altering the
construction, composition, confirmation or
condition of the product.

It is that labour which can be conveniently

identified or attributed wholly to a
particular job, product or process or
expended in converting raw materials into
finished goods.
Direct labour includes payment made to

3. Labour engaged on the actual

production of the product or in carrying
out of an operation or process.
4. Labour engaged in aiding the
manufacture by way of supervision,
maintenance, tools setting,
transportation of material etc.,
5. Inspectors, analysts etc., specially
required for such production
 DIRECT OR CHARGEABLE
EXPENSES
All expenditures other than direct material or
direct labour that are specifically incurred for a
particular product or process.

Such expense is charged directly to the

particular cost centre as part of the prime cost.

Eg: Excise duty, Royalty on production,

surveyor’s fees, designing or drawing expenses
etc
 OVERHEADS
The aggregate of the cost of indirect materials,
indirect labour and such other expenses
including services as cannot conveniently be
charged direct to specific cost units.

All expenses other than direct expenses

The cost of operating supplies and services

used by the undertaking and including the
maintenance of capital assets.
 The main groups into which overheads may be
sub-divided are

3. Manufacturing overheads
4. Administration overheads
5. Selling overheads
6. Research and Development overheads

Overheads can also be classified as

9. Indirect materials
10. Indirect labour
11. Indirect expenses
 EXPENSES EXCLUDED
FROM COSTS
Total cost of a product should include only those
items of expenses which are a charge against
profit.

Items of expenses which are relating to capital

assets, capital losses, payments by way of
distribution of profits and matters of pure finance
should not form a part of the costs
Eg: Dividend, abnormal wastage of material,
abnormal idle time, interest on capital, loss on
sale of assets etc
 COST SHEET OR STATEMENT
OF COST
Cost sheet is a statement designed to show
the output of a particular accounting period
along with break-up of costs.
2. It is a memorandum statement
3. It does not form part of double entry cost
accounting records.
4. But derives its data for financial accounting
 ADVANTAGES OF COST SHEET
1. It discloses the total cost and the cost per unit
of the units produced during the given period.
2. It enables a manufacturer to keep a close
watch and control over the cost of production.
3. By providing a comparative study of the
various elements of current cost with the past
results and standard costs, it is possible to find
out the causes of variations in costs and to
eliminate the adverse factors and conditions
which go to increase the cost.
1. It acts as a guide to the manufacturer
and helps him in formulating a definite
useful production policy.
2. It helps in fixing up the selling price more
accurately
3. It helps the businessman to minimise the
cost of production when there is a cut
throat competition
4. It helps the businessman to submit
quotations with reasonable degree of
accuracy against tenders for the supply
of goods.
Prepare a cost sheet from the following
particulars
Rs.
Direct materials 1,00,000
Direct wages 25,000
Direct expenses 5,000
Wages of foreman 2,500
Electric power 500
Lighting: factory 1,500
Office 500
Depreciation:
Factory plant 500
Office premises 1,250
Consumable stores 2,500
Manager’s salary 5,000
Director’s fees 1,250
Office stationery 500
Storekeeper’s wages 1,000
Oil & water 500
Rent: Factory 5,000
Office 2,500
Repairs and renewals:
Factory plant 3,500
Office premises 500
Carriage outward 375
Transfer to reserves 1,000
Discount on shares written off 500
Telephone charges 125
Postage 250
Salesmen’s salaries 1,250
Travelling expenses 500
Advertising 1,250
Warehouse charges 500
Sales 1,89,500
Income tax 10,000
Dividend 2,000
 COST SHEET OR STATEMENT OF COST
Rs. Rs.
Direct material 100000
Direct wages 25000
Direct expenses 5000
Prime cost 130000
Add: Factory overheads:
Wages of foreman 2500
Electric power 500
Storekeeper’s wages 1000
Oil and water 500
Factory rent 5000
Repairs and renewals
Factory 3500
Factory lighting 1500
Depreciation- factory 500
Consumable stores 2500 17500
Factory cost 147500
 Rs. Rs.
Add: Admn overheads:
Office rent 2500
Repairs and renewals
Office 500
Office lighting 500
Depreciation-office 1250
Manager’s salary 5000
Director’s fees 1250
Office stationery 500
Telephone 125
Postage 250 11875

Cost of production 159375

 Rs. Rs.
Add: Selling & Dist. overheads:
Carriage outwards 375
Salesmen’s salaries 1250
Travelling expenses 500
Advertising 1250
Ware house expenses 500 3875
Cost of Sales 163250
Cost of Sales : Rs. 163250
Profit Rs. 26250

Sales Rs. 189500

 TREATMENT OF STOCK
1. Stock of Raw materials

If the opening stock of raw materials,

purchases and closing stock of raw materials
are given then the cost of raw materials
consumed must be calculated as

Cost of raw materials consumed = Opening

stock of raw materials + purchases during the
year – closing stock or raw materials
1. Stock of Work in progress
Work in progress is valued at prime cost
or works cost.
If is valued at works cost then the
adjustment will be

Factory or Manufacturing or Works cost

=Prime Cost + Factory overheads+
opening WIP- Closing WIP
3. Stock of Finished Goods

If the opening and closing stocks of finished

goods are also given, then these must be
adjusted before calculating cost of goods sold
as under:

Cost of goods sold = Cost of production +

Opening stock of Finished goods – Closing
stock of Finished goods.
 COST CENTRE
It is the smallest segment of activity or area or
responsibility for which costs are accumulated.

These cost centres are departments or sub departments

of an organisation with reference to which cost is
collected for cost ascertainment and cost control.

The cost centres may be product centre or service

centre
Eg: In engineering industry, cost centres may be
machine shop, welding shop, assembly shop,
maintenance dept etc.,
 PROFIT CENTRE
It is that segment of activity of a business
which is responsible for both revenue and
expenses and discloses the profit of a
particular segment of activity.

Profit centres are created to delegate

responsibility to individuals and measure
their performance
 CONVERSION COST
It is the sum of direct wages, direct
expenses and overhead costs of
converting raw material from one stage of
production to the next.

Conversion cost = Works cost – Cost of

direct materials
 ORDERING COST &
DEVELOPMENT COST
Ordering cost: Costs incurred each time an
order for the purchase of material is placed and
are expressed as rupee cost per order and
include cost of getting an item into the firm’s
inventory
Development cost: It is the cost of process
which begins with the implementation of the
decision to produce a new or improved method
and ends with the commencement of formal
production of the product by that method
 CONTRIBUTION MARGIN &
CARRYING COST
Contribution margin: This is the excess of
sales price over variable costs. This can be
expressed as total or ratio of sales or
percentage of sales.

Carrying cost: It is basically the costs incurred

on the maintenance of inventory and include
cost of the money locked up in the inventory,
inventory obsolescence, storage space, rent and
cost of stores operations. It is also known as
holding cost.
 POLICY COST &
DISCRETIONARY COSTS
Policy cost: It is the cost which is in
addition to normal requirement, incurred in
accordance with the policy of an
undertaking.
Discretionary costs: Include fixed costs
that arise from periodic appropriate
decision that directly reflected top
management policies. It is also known as
managed cost or programmed costs.
CLASSIFICATION OF COST
Cost classification is the process of grouping
costs according to their common characteristics.

A suitable classification of costs is important, in

order to identify the cost with cost centres or
cost units

The same cost figures are classified according

to different ways of costing depending upon the
purpose to be achieved and requirements of a
particular concern.
The important ways of classification are:

• By nature or Element: The costs are divided

into three categories, Materials, Labour and
Expenses.
Materials can be further classified as raw
material, spare parts, consumable stores,
packing material etc.
This classification is important as it helps to
find out the total cost and valuation of WIP.
• By Functions: The costs are divided on the
basis of managerial activities involved in the
operation of a business undertaking.
Eg; Production, Administration, Selling and
Distribution
3.As Direct or Indirect: Total cost is
divided into direct costs and indirect costs.
Direct costs are those costs which are
incurred for and may be conveniently
identified with a particular cost centre or
cost unit.
Indirect costs are those costs which are
incurred for the benefit of number of cost
centres or cost units and cannot be
conveniently identified with a particular
cost centre or cost unit.
Eg: rent of building, management salaries
• By variability: Costs are classified
according to their behaviour in relation to
changes in the level of activity or volume of
production. On this basis, costs are classified
into three groups namely fixed, variable and
semi-variable
Fixed costs: Those which remain fixed in total
amount with increase or decrease in the
volume of output or productive activity for a
given period of time.
Eg; rent, insurance
Fixed cost per unit decreases as production
increases and increases as production
declines.
Variable costs: Costs which vary in total in
direct proportion to the volume of output. These
costs per unit remain relatively constant with
changes in production.
They are also known as product costs as they
depend on the quantum of out put rather than
time.
Eg: Direct material, direct labour, power, repairs
etc.
Semi variable costs: Costs which are partly
fixed and partly variable.
Eg: Telephone expenses include a fixed portion
of annual charge plus variable charge according
to calls.
• By controllability: The costs are classified
according to whether or not they are influenced
by the actions of a given member of the
undertaking. On this it is classified as
controllable costs and uncontrollable costs.
Controllable costs: Costs which can be
influenced by the action of a specified member
of an undertaking. i.e. costs which are at least
partly within the control of management
Uncontrollable costs: costs which cannot be
influenced by the action of a specified member
of an undertaking.
• By normality: Costs are classified according
to whether these are costs which are normally
incurred at a given level of output in the
conditions in which that level of activity is
normally attained. On this basis costs are
classified as normal cost and Abnormal cost.
Abnormal costs are not a part of cost of
production and are charged to Costing P&L
a/c.
• By Capital and Revenue (Financial
Accounting Classification): The costs which
are incurred in purchasing assets used to
generate income or to increase income
earning capacity is called capital cost. The
benefit of such costs are spread over a
number of years.
 Expenditure incurred to maintain the earning capacity
or to run the business is called revenue expenditure.

• By time: Costs are classified as

1. Historical costs: The costs which are ascertained
after their incurrence are called historical costs. The
basic characteristics of such costs are (a) They are
based on recorded facts. (b) They can be verified (c)
They are mostly objective
2. Predetermined costs: Costs are estimated costs.
Computed in advance of production taking into
consideration the previous periods’ costs and the
factors affecting such costs. Such costs determined on
scientific methods become standard cost.
9. According to planning and control:
Budgeted costs: An estimate of
expenditure for different phases of
business operations, coordinated in a well
conceived framework for a period of time
in future which becomes a managerial
targets to achieve.
Standard costs: It is the predetermined
cost based on a technical estimate for
materials, labour and overhead for a
selected period of time and for a
prescribed set of working conditions.
• For managerial decisions: On this basis costs are
classified as
1.Marginal costs: It is the total of variable costs. i.e.,
prime cost plus variable overheads. It is based on the
distinction between fixed and variable cost.
2.Out of pocket costs: It is that portion of the cost
which involves payment to outsiders.
3.Differential costs: The change in cost due to
change in level of activity or pattern or method of
production.
4.Sunk costs: It is an irrecoverable cost and is caused
by complete abandonment of a plant. i.e., costs which
are not relevant for decision making.
5.Imputed costs: Costs which appear in cost
accounts only. These costs are also known as notional
costs, which are considered for decision making.
6.Opportunity cost: It is the advantage, in
measurable terms, which has been foregone
due to not using the facility in the manner
originally planned.
7.Replacement cost: It is the cost at which
an asset or material identical to that which is
being replaced or revalued, can be purchased.
8.Avoidable and unavoidable cost:
Avoidable costs are those which can be
eliminated if a particular product or department
with which they are directly related is
discontinued.
Un avoidable costs are those which will cannot
be eliminated with the discontinuation of a
product or department.