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Introduction to Cost Accounting Definition of Cost Cost may be defined as the price of any asset when one company purchases it or it may be the expenses for getting services . So, we can say that cost is total amount which is sacrificed for getting the goods , services and assets . In general, cost is calculated on production of goods. Total cost represents cost of raw material, cost of labour and cost of overheads after adding above we can find total cost and if we divide total numbers of units, then we can find cost per unit. Definition of Costing & Cost Accounting Definition of Costing: Costing is technique to determine the cost. It involves the process and method to classify and analysis of different expenditures. Definition of Cost Accounting: Cost accounting is science of recording, classify , analyzing and allocation of cost to cost centers or cost unit . It also include cost control. Objective of Cost Accounting 1. To determine the cost: It is the objective of cost accounting that cost accountant has to determine the cost because, after this cost per unit, price per unit can be calculated and product can be sold in market . 2. To analyze of cost: Under this objective , cost is calculated after analyze which is done in cost sheet by knowing different elements and writing in specific head . 3. To reduce the Wastage: Cost accountings main objective is to reduce the wastage , Wastage may be in material , labour cost or overhead cost . Cost accountant makes cost sheet and after this he compares it with standard cost and with this can find at where wastage are incurred and after this he can reduce it by making proper control . 4. Provide cost data: There are large no. of previous records of cost of different products are available, if cost accounting is maintained by accounting department. It can be given to other department for taking decision. It is the another objective of cost accounting. 5. Ascertain the profitability: We know that cost accounting is to determine cost and with this cost we can find profit margin 6. Control the cost: Cost accountings objective is to control the cost . For example Over stocking and under stocking is loss of money by using cost control techniques in stock maintaining , we can keep optimum level of stock to control the cost of stock . 7. Advicing the management: Cost accountants can advice to management for achieving the objectives of cost accounting At what cost , should any asset show in books of company ? He will suggest how many cost centers are needed for effective control over cost . He can solve different cost related problems in the company. Cost Accounting as a tool of Decision Making Decision making in today business is one of most difficult work of manager. Decision making is the process to select best alternative out of different alternative for solving

business problems. A prudent cost accountant can use different techniques of cost accounting and make it the best tool of decision making in business. We can see most common problems in business are to fix the price of product, to reduce the cost of product and to increase overall profitability of business. Cost accounting provides cost sheet, statement of material and labour utilization and some other reports like budget which can be used immensely for comparing the standard cost. After this, businessman can decide best price of products. We can also compile the following information of cost accounting which can be used for business decision making. 1. Cost Sheet: Cost Sheet is very helpful to find the cost of each unit. By comparing it with previous year or previous month's cost sheet, manager can take the decision regarding reducing the cost of product. If our costs are increasing which has been shown in cost sheet , then manager can identify the place of production or sales where company is wasting its money. After this, manager to reduce the wastage by using quality product techniques, to drop useless production processes and also standardization of raw material. 2. Labour Cost Reports: Labour cost reports are helpful to reduce labour turnover and idle time cost. In the off season, some of workers are free and doing nothing. This time can be calculated from statement of time utilization of each worker in production purpose and by studying its statement, manager can take decisions to transfer some of workers to other busy departments for effective utilization of human resources for business purposes. 3. Overhead Utilization Reports: These reports are helpful to pay only genuine overheads and distribute it on the product according to valid basis. These reports are helpful to calculate the correct cost of overhead and to control indirect expenses of business. Techniques of Cost Accounting for Decision Making Process Marginal Costing : To solve the linear programming problems, we need to linear variables. In marginal cost, we have two variables and both production level and variable cost are linears. So by creating their relationship, we can decide the production level by maximizing our profitability or minimizing our cost. In other words, we can find equilibrium production point under marginal costing technique. Analysis of Variance : To reduce the deviation after study the analysis of variance in cost accounting. Cost Benefit Analysis or Break Even Point Analysis: To purchase the fixed assets at minimum cost after studying cost benefit analysis of cost accounting. We can also use this tool for production purposes also. We can check the level of production where total cost is equal to total revenue and this level will be break even point. We must produce up to this level for securing our business from losses. So, it indicates our business to decide best. Activity Base Costing: In ABC costing we calculate the each unit's total cost on the basis of different activities. It reduce indirect cost after assigning it on product directly. Eventually, cost accounting is helpful to check each and every point of business where money is misusing and due to this our cost is increasing. By reducing this cost, cost accounting is helpful to increase the return on investment.

Scope of Cost Accounting There are lots of techniques, tools, procedures, processes, programs are used in cost accounting for calculating cost and its control. But basically, we divide its scope within three major parts. 1. Cost Ascertainment: In this region of cost accounting, cost accounting collects product's material, labor and overhead cost and try to calculate total and per unit cost of product. This total cost calculation will be based on historical or standard or estimated basis. After this, cost accountant will use any method of costing like specific order costing, operation costing, and direct costing technique. These techniques and methods may be used for calculating different nature products in same organization. 2. Cost Record: In this part of cost accounting, cost accountant maintains cost books, vouchers, ledgers, reports and other cost related documents for future comparison and reference. It will also be under the scope of cost accounting. 3. Cost Control: This is the end boundary of cost accounting scope. In this division, cost accountant used different techniques and methods for controlling the cost. Save One Rupees in the cost of product means we have earned one rupees in the production of goods. So, Cost accountant uses budgetary control, standard costing, break even point analysis and many other techniques for controlling the cost. Elements of Cost and Cost Sheet ELEMENTS OF COST A diagram as given below shows the elements of cost described as under : ELEMENTS OF COST

Raw materials are converted into finished products by a manufacturing concern with the help of labor, plants etc. The elements that constitute the cost of manufacturing are known as elements of cost. The elements of cost include the following: Material Labor Expenses Each of these elements is again subdivided into direct and indirect material.

Direct material, direct labor and direct expenses are those which can be traced in relationship with a particular process, job, operation or product. Indirect material, indirect labor and indirect expenses are those which are of general nature and cannot be traced in relationship with a particular process, operation, job or product. Direct material + Direct labor + Direct Expenses = prime cost. Indirect material + Indirect labor + Indirect expenses (of the factory)= factory (or works). Prime cost + Factory (or works) overhead = Factory cost or works cost Factory cost + Administration overhead = Cost of production Cost of production + Selling and distribution overhead = Total cost or cost of sales While working out the cost of sales, following details are to be kept in mind: Opening stock of raw material Add: Purchasing of raw materials Less: Return to suppliers Less: abnormal loss of materials Rs.************Rs. Less: Closing stock of raw materials Raw material consumed Direct wages Direct expenses Prime cost Factory overhead expenses Add: Opening work in process Less: sales of scraps Less: closing work in process Factory cost or works cost Office and administration overhead Cost of production Add: Opening finished stock Less: closing finished stock Cost of production of goods sold Selling overhead Distribution overhead Total cost or cost of sales Profit Selling price Direct Material Direct material is the material which can be conveniently identified with or allocated to cost centers and cost units. It refers to the material out of which a product is manufactured. For example, leather shoes are produced out of leather, butter is produced out of milk, steel utensils are produced out of stainless steel and so on. Thus, leather, milk and stainless steel are the direct materials for the manufacture of shoes, butter and steel utensils respectively. Like direct material, another kind of material may be required for manufacturing but not directly. For example, machines used for production require lubricants, jute and cotton wastes etc. Which are indirect materials?

Direct material is a component of prime cost and indirect material is a component of factory overhead. Direct material directly varies with the output whereas indirect material does not so.

Direct Wages Direct wages are the wages which can be conveniently identified with or allocated to cost centers and cost units. It refers to the wages paid to the workers who actually produce goods. In case of manual work, it is not difficult to locate direct worker because he is the one who produces goods. In case of the work done by a machine, the person who collects input and output and in whose account the output is credited for the purpose of payment of wages is direct worker. There are several other workers in a factory who help direct workers in connection with their work with regard to supply of materials, power etc. and in respect of supervision and maintenance. These are indirect workers and wages of indirect workers at different stages of production are indirect wages. Direct wage is a component of prime cost whereas indirect wage is a component of factory overhead. The former directly varies with the output whereas the latter may not vary so. Direct Expenses Besides direct material and direct layout, certain expenses may be wholly and exclusively necessary for a particular production. This expense is referred as direct expense and it can be easily identified with or allocated to cost centers or cost units. For example, if an order is received, a manufacturer will have to prepare a mould exclusively for this purpose. The cost of the mould may be regarded as direct expense of the production. Similarly, the charge for hiring a special plant for production is also direct expense and it can be easily identified with and allocated to cost centers or cost units. The cost of preparing blue print for a production is another example of direct expense. Overhead Overhead is an indirect expense incurred at various levels of activities of an enterprise. These expenses cannot be conveniently identified with or allocated to cost centers or cost units. According to functions, classification of overhead expenses may be done as follows: Factory or Works Overhead Factory or works overhead refers to all indirect expenses of a factory. It includesthe following: Wages of all factory staff excluding those of direct workers Indirect material Rent Rates Taxes of factory Depreciation of factory assets Excise duty Canteen expenses Labor welfare expenses Administration Overhead It refers to all the expenses incurred in connection with general administration. In administrative building, following things are included: Salary of administrative staff Rent

Rates Taxes of administrative accommodation Postage Telegram and telephone Stationery Lighting of administrative building Depreciation of office appliances Selling Overhead Selling overhead refers to all expenses incurred in connection with sales. In selling overhead, following things are included: Salary of sales staff Travelers commission Advertisement Rent Rates Taxes of sales office Depreciation of sales office appliances Cost of participation in industrial fares and exhibitions Cost of free gifts Cost of free after sales service Normal bad debt Distribution Overhead Distribution overhead refers to all the expenses incurred in connection with the delivery of a product after the sale is affected. In distribution overhead, following things are included: Delivery van expenses Fright and insurance Packing for delivery loading and unloading Salary of the deliverymen Customs duty According to behavior, classification of overhead expenses may be done as follows: a. Variable Overhead The overhead expenses that vary proportionately with the output are variable overhead. b. Semi-Variable or Semi-Fixed Overhead Indirect materials : Materials which do not normally form part of the finished product (cost object) are known as indirect materials. These are Stores used for maintaining machines and buildings (lubricants, cotton waste, bricks etc.) Stores used by service departments like power house, boiler house, canteen etc. Indirect labour : Labour costs which cannot be allocated but can be apportioned to or absorbed by cost units or cost centres is known as indirect labour. Examples of indirect labour includes - charge hands and supervisors; maintenance workers; etc. Indirect expenses : Expenses other than direct expenses are known as indirect expenses. Factory rent and rates, insurance of plant and machinery, power, light, heating, repairing, telephone etc., are some examples of indirect expenses.

Definition of Costing, Cost Accounting and Cost Accountancy: Costing is defined as the technique and process of ascertaining costs. Cost Accounting is defined as "the process of accounting for cost which 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 ascertaining and controlling costs." Cost Accountancy has been defined as 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 there from for the purpose of managerial decision making. OBJECTIVES OF COST ACCOUNTING The main objectives of Cost Accounting are as follows : (i) Ascertainment of cost. (ii) Determination of selling price. (iii) Cost control and cost reduction. (iv) Ascertaining the profit of each activity. (v) Assisting management in decision-making. Ascertainment of Cost: There are two methods of ascertaining costs, viz., Post Costing and Continuous Costing. Post Costing means, analysis of actual information as recorded in financial books. It is accurate and is useful in the case of Cost plus Contracts where price is to be determined finally on the basis of actual cost. Continuous Costing, aims at collecting information about cost as and when the activity takes place so that as soon as a job is completed the cost of completion would be known. This involves careful estimates being prepared of overheads. In order to be of any use, costing must be a continuous process. Cost ascertained by the above two methods may be compared with the standard costs which are the target figures already compiled on the basis of experience and experiments. Determination of selling price: Though the selling price of a product is influenced by market conditions, which are beyond the control of any business, it is still possible to determine the selling price within the market constraints. For this purpose, it is necessary to rely upon cost data supplied by Cost Accountants. Cost control and cost reduction: as The guidance and regulation, by executive action of the cost of operating an undertaking. The word guidance indicates a goal or target to be guided; regulation indicates taking action where there is a deviation from what is laid down; executive action denotes action to regulate must be initiated by executives i.e. persons responsible for carrying out the job or the operation; and all this is to be exercised through modern methods of costing in respect of expenses incurred in operating an undertaking. Cost Reduction, may be 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."

Ascertaining the profit of each activity : The profit of any activity can be ascertained by matching cost with the revenue of that activity. The purpose under this step is to determine costing profit or loss of any activity on an objective basis. Assisting management in decision making : Decision making is defined as a process of selecting a course of action out of two or more alternative courses. For making a choice between different courses of action, it is necessary to make a comparison of the outcomes, which may be arrived under different alternatives. Such a comparison has only been made possible with the help of Cost Accounting information. RELATIONSHIP BETWEEN COST ACCOUNTING, FINANCIAL ACCOUNTING, MANAGEMENT ACCOUNTING AND FINANCIAL MANAGEMENT Cost Accounting is a branch of accounting, which has been developed because of the limitations of Financial Accounting from the point of view of management control and internal reporting. Financial accounting performs admirably, the function of portraying a true and fair overall picture of the results or activities carried on by an enterprise during a period and its financial position at the end of the year. Also, on the basis of financial accounting, effective control can be exercised on the property and assets of the enterprise to ensure that they are not misused or misappropriated. To that extent financial accounting helps to assess the overall progress of a concern, its strength and weaknesses by providing the figures relating to several previous years. Data provided by Cost and Financial Accounting is further used for the management of all processes associated with the efficient acquisition and deployment of short, medium and long term financial resources. Such a process of management is known as Financial Management. The objective of Financial Management is to maximise the wealth of shareholders by taking effective Investment, Financing and Dividend decisions. Investment decisions relate to the effective deployment of scarce resources in terms of funds while the Financing decisions are concerned with acquiring optimum finance for attaining financial objectives. The last and very important Dividend decision relates to the determination of the amount and frequency of cash which can be paid out of profits to shareholders. On the other hand, Management Accounting refers to managerial processes and technologies that are focused on adding value to organisations by attaining the effective use of resources, in dynamic and competitive contexts. Hence, Management Accounting is a distinctive form of resource management which facilitates managements decision making by producing information for managers within an organisation. CLASSIFICATION OF COSTS It means the grouping of costs according to their common characteristics. The important ways of classification of costs are : (1) By nature or element (2) By functions (3) As direct and indirect (4) By variability (5) By controllability (6) By normality 1. By Nature of Element - Under this classification the costs are divided into three categories i.e., materials cost, labour cost and expenses. This type of classification is useful to determine the total cost.

2. By Functions - Under this classification, costs are divided according to the function for which they have been incurred. Some of the examples are : Production cost - The cost of sequence of operations which begins with supplying materials, labour and services and ends with primary packing of the product. Selling cost - The cost seeking to create and stimulate demand (sometimes termed marketing) and of securing orders. Distribution cost - 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. Administrative cost - The cost of formulating the policy, directing the organisation and controlling the operations of an undertaking which is not related directly to a production, selling and distribution, research or development activity or function. Research cost - The cost of researching for new or improved products, new applications of materials, or improved methods. Development cost - The cost of the process which begins with the implementation of the decision to produce a new or improved product or to employ a new or improved method and ends with commencement of formal production of that product or by that method. Pre-production cost - The part of development cost incurred in making a trial production run preliminary to formal product. Conversion cost - The sum of direct wages, direct expenses and overhead cost of converting raw materials to the finished stage or converting a material from one stage of production to the next. 3. By Variability - According to this classification costs are classified into three groups viz., fixed, variable and semi-variable. Fixed costs - These are the costs which are incurred for a period, and which, within certain output and turnover limits, tend to be unaffected by fluctuations in the levels of activity (output or turnover). They do not tend to increase or decrease with the changes in output. Variable costs - These costs tend to vary with the volume of activity. Any increase in the activity results in an increase in the variable cost and vice-versa. For example, cost of direct labour, etc. Semi-variable costs - These costs contain both fixed and variable components and are thus partly affected by fluctuations in the level of activity. Examples of semi variable costs are telephone bills, gas and electricity etc.

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4. By Controllability - Costs here may be classified into controllable and uncontrollable costs. Controllable costs - These are the costs which can be influenced by the action of a specified member of an undertaking. A business organisation is usually divided into a number of responsibility centres and an executive heads each such centre. Controllable costs incurred in a particular responsibility centre can be influenced by the action of the executive heading that responsibility centre. Direct costs comprising direct labour, direct material, direct expenses and some of the overheads are generally controllable by the shop level management. Uncontrollable costs - Costs which cannot be influenced by the action of a specified member of an undertaking are known as uncontrollable costs. For example, expenditure incurred by, say, the Tool Room is controllable by the foreman incharge of that section but the share of the tool-room expenditure which is apportioned to a machine shop is not to be controlled by the machine shop foreman. The distinction between controllable and uncontrollable costs is not very sharp and is sometimes left to individual judgement. In fact no cost is uncontrollable; it is only in relation to a particular individual that we may specify a particular cost to be either controllable or uncontrollable. 5. By Normality - According to this basis cost may be categorised as follows: 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. 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. It is charged to Costing Profit and loss Account. Material costing Materials constitute a very significant proportion of total cost of finished product in most of the manufacturing industries. A proper recording and control over the material costs is essential because of the following : (a) The exact quality of specification of materials required should be determined according to the required quality of the finished product. If too superior quality of material is purchased, it would mean higher cost due to high prices; if the quality of materials purchased is too low, the product will be of inferior quality.

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(b) The price paid should be the minimum possible otherwise the higher cost of the finished products would make the product uncompetitive in the market. (c) There should be no interruption in the production process for want of materials and stores, including small inexpensive items like lubricating oil for a machine. Sometime their out of stock situation may lead to stoppage of machines. d) There should be no over stocking of materials because that would result in loss of interest charges, higher godown charges, deterioration in quality and losses due to obsolescence (either due to manufacture of certain articles being given up or the material previously required for the production not being required any longer due to a change in methods of production). (e) Wastage and losses while the materials are in store should be avoided as far as possible; and (f) Wastage during the process of manufacture should be the minimum possible. INVENTORY CONTROL The main objective of inventory control is to achieve maximum efficiency in production and sales with the minimum investment in inventory. Inventory comprises of stocks of materials, components, work-in-progress, and finished products and stores and spares. The techniques commonly applied for inventory control are as follows: Techniques of Inventory control : (i) Setting of various stock levels. (ii) ABC analysis. (iii) Two bin system. (iv) Establishment of system of budgets. (v) Use of perpetual inventory records and continuous stock verification. (vi) Determination of economic order quantity. (vii) Review of slow and non-moving items. (viii) Use of control ratios. VALUATION OF MATERIAL ISSUES Several methods of pricing material issues have been evolved in an attempt to satisfactorily answer the problem. These methods may be grouped and explained as follows : Cost Price Methods: (a) Specific price method. (b) First-in First-out method. (c) Last-in-First-out method. (d) Base stock method. a) Specific Price Method - This method is useful, specially when materials are purchased for a specific job or work order, and as such these materials are issued subsequently to that specific job or work order at the price at which they were purchased. To use this method, it is necessary to store each lot of material separately and maintain

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its separate account. The advantages and disadvantage of this method are : Advantages : 1. The cost of materials issued for production purposes to specific jobs represent actual and correct costs. 2. This method is best suited for non-standard and specific products. Disadvantage : This method is difficult to operate, specially when purchases and issues are numerous. (b) First-in-First out Method (FIFO) - It is a method of pricing the issues of materials, in the order in which they are purchased. In other words, the materials are issued in the order in which they arrive in the store or the items longest in stock are issued first. Thus each issue of material only recovers the purchase price which does not reflect the current market price. This method is considered suitable in times of falling price because the material cost charged to production will be high while the replacement cost of materials will be low. But, in the case of rising prices, if this method is adopted, the charge to production will be low as compared to the replacement cost of materials. Consequently, it would be difficult to purchase the same volume of material (as in the current period) in future without having additional capital resources. The advantages and disadvantages of the method may be stated as follows : Advantages : 1. It is simple to understand and easy to operate. 2. Material cost charged to production represents actual cost with which the cost of production should have been charged. 3. In the case of falling prices, the use of this method gives better results. 4. Closing stock of material will be represented very closely at current market price. Disadvantages : 1. If the prices fluctuate frequently, this method may lead to clerical error. 2. Since each issue of material to production is related to a specific purchase price, the costs charged to the same job are likely to show a variation from period to period. 3. In the case of rising prices, the real profits of the concern being low, they may be inadequate to meet the concerns demand to purchase raw materials at the ruling price. (c) Last-in-First out method (LIFO) - It is a method of pricing the issues of materials. This method is based on the assumption that the items of the last batch (lot) purchased are the first to be issued. Therefore, under this method the prices of the last batch (lot) is used for pricing the issues, until it is exhausted, and so on. If however, the quantity of taken into consideration. During inflationary period or period of rising prices, the use of LIFO would help to ensure that the cost of production determined on the above basis is approximately the current one. This method is also useful specially when there is a feeling that due to the use of FIFO or average methods, the profits shown and tax paid are too high. Advantages : 1. The cost of materials issued will be either nearer to and or will reflect the current market price. Thus, the cost of goods produced will be related to the trend of the market price of materials. Such a trend in price of materials enables the matching of cost of

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production with current sales revenues. 2. The use of the method during the period of rising prices does not reflect undue high profit in the income statement as it was under the first-in-first-out or average method. In fact, the profit shown here is relatively lower because the cost of production takes into account the rising trend of material prices. 3. In the case of falling prices profit tends to rise due to lower material cost, yet the finished products appear to be more competitive and are at market price. 4. Over a period, the use of LIFO helps to iron out the fluctuations in profits. 5. In the period of inflation LIFO will tend to show the correct profit and thus avoid paying undue taxes to some extent. Disadvantages : 1. Calculation under LIFO system becomes complicated and cumbersome when frequent purchases are made at highly fluctuating rates. 2. Costs of different similar batches of production carried on at the same time may differ a great deal. 3. In time of falling prices, there will be need for writing off stock value considerably to stick to the principle of stock valuation, i.e., the cost or the market price whichever is lower. 4. This method of valuation of material is not acceptable to the income tax authorities. (d) Base Stock Method - A minimum quantity of stock under this method is always held at a fixed price as reserve in the stock, to meet a state of emergency, if it arises. This minimum stock is known as base stock and is valued at a price at which the first lot of materials is received and remains unaffected by subsequent price fluctuations. Thus, this is more a method of valuing inventory than a method of valuing issues because, with the base of stock valued at the original cost some other method of valuing issues should be adopted. The quantity in excess of the base stock may be valued either on the FIFO or LIFO basis. This method is not an independent method as it uses FIFO or LIFO. Its advantages and disadvantages therefore will depend upon the use of the other method viz., FIFO or LIFO. TREATMENT OF NORMAL AND ABNORMAL LOSS OF MATERIALS Whichever method may be adopted for pricing materials, certain differences between the book balance and the value of physical stock are bound to occur. These differences, which may be a gain or loss, should be transferred to Inventory Adjustment Account pending investigation. If, upon investigation, they are regarded as normal, they should be transferred to Overhead Control Account; if abnormal, they should be written off to the Costing Profit and Loss Account. In the case of normal losses, an alternative method used to price per unit of material so as to cover the normal loss can be understood with the help of the example considered. ACCOUNTING AND CONTROL OF WASTE, SCRAP, SPOILAGE AND DEFECTIVES Waste - It represents the portion of basic raw materials lost in processing having no recoverable value. Waste may be visible - remnants of basic raw materials - or invisible; e.g., disappearance of basic raw materials through evaporation, smoke etc. Shrinkage of material due to natural causes may also be a form of a material wastage.

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Normal waste is absorbed in the cost of net output, whereas abnormal waste is transferred to the Costing Profit and Loss Account. For effective control of waste, normal allowances for yield and waste should be made from past experience, technical factors and special features of the material process and product. Actual yield and waste should be compared with anticipated figures and appropriate actions should be taken where necessary. Responsibility should be fixed on Scrap - It has been defined as the incidental residue from certain types of manufacture, usually of small amount and low value, recoverable without further processing. Scrap may be treated in cost accounts in the following ways:(i) Where the value of scrap is negligible, it may be excluded from costs. In other words, the cost of scrap is borne by good units and income scrap is treated as other income. (ii) The sales value of scrap net of selling and distribution cost, is deducted from overhead to reduce the overhead rate. A variation of this method is to deduct the net realisable value from material cost. This method is followed when scraps cannot be aggregated job or process-wise. (iii) When scrap is identifiable with a particular job or process and its value is significant, the scrap account should be charged with full cost. The credit is given to the job or process concerned. The profit or loss in the scrap account, on realisation, will be transferred to the Costing Profit and Loss Account. Control of scrap really means the maximum effective utilisation of raw material. Scrap control does not, therefore, start in the production department; it starts from the stage of product designing. Thus the most suitable type of materials, the right type of equipment and personnel would help in getting maximum quantity of finished product from a given raw material. A standard allowance for scrap should be fixed and actual scrap should be collected, recorded and reported indicating the cost centre responsible for it. A periodical scrap report would serve the purpose where two or more departments or cost centres are responsible for the scrap; the reports should be routed through the departments concerned. Spoilage - It is the term used for materials which are badly damaged in manufacturing operations, and they cannot be rectified economically and hence taken out of process to be disposed of in some manner without further processing. Spoilage may be either normal or abnormal. Normal spoilage (i.e., which is inherent in the operation) costs are included in costs either charging the loss due to spoilage to the production order or by charging it to production overhead so that it is spread over all products. Any value realised from spoilage is credited to production order or production overhead account, as the case may be. Defectives - It signifies those units or portions of production which can be rectified and turned out as good units by the application of additional material, labour or other service. For example, some mudguards produced in a bicycle factory may have dents; or there may be duplication of pages or omission of some pages in a book. Defectives arise due to sub-standard materials, bad-supervision, bad-planning, poor workmanship, inadequate-equipment and careless inspection. To some extent, defectives

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may be unavoidable but Depreciation : Depreciation is the diminution in the intrinsic value of an asset due to use and/or the lapse of time. Depreciation is thus the result of two factors viz., the use, and the lapse of time. We know that each fixed asset loses its intrinsic value due to their continuous use and as such the greater the use the higher is the amount of depreciation. The loss in the intrinsic value may also arise even if the asset in question is not in service. In Cost Accounting depreciation is charged to the cost of production. The various reasons for including the depreciation charge in Cost Accounting are as follows : (a) To show a true and fair picture of Balance Sheet. (b) To ascertain the true cost of production. (c) To keep the asset intact by distributing losses in its value over a number of years. (d) To keep the capital intact and to make a provision of the resources for the replacement of asset in future. (e) To provide for depreciation before distribution of profit as required under the Companies Act. Labor costing INCENTIVE SYSTEM Important factors necessary for introducing an incentive system : An incentive can be defined as the stimulation for effort and effectiveness by offering monetary inducement or enhanced facilities. It may be monetary in the form of a bonus or non-monetary tending to improve living and working conditions. It may be provided individually or collectively. In the first case, the employee gets a reward for his efforts directly and in the second, a group of employees share the reward arising out of their combined effort in equitable production. The main factors that should be taken into account before introducing a scheme of incentives are stated below : (i) The need for producing goods of high quality or those having very good workmanship or finish and the manner this can be ensured. Only if a system of quality control can be relied upon to maintain the quality of goods of the standard required, an incentive scheme should be introduced; otherwise, workers should be paid on time basis. (ii) The need to maximise productionthus required incentives to be given to workers. But sometimes workmanship is more important than quantity of output; in such cases, incentive schemes of wage payment are not suitable. (iii) Where the quantity of work done cannot be measured precisely, incentive schemes cannot be offered. (iv) The role of management and workers in achieving greater efficiency, if it is unnecessary for the management to constantly plan work for example, when the work is repetitive, workers should be offered good incentives to achieve high efficiency; but in case management is constantly required to plan the work, as in the case of job work, the management should share the fruits of extra efficiency achieved. This factor determines the choice of a particular incentive scheme. (v) Whether the quantity of output is within the control of the worker and if so, to what extent.

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Sometimes, as in the case of chain assembly work the output is not dependent on the effort put in by workers; incentive schemes in such cases are not suitable. (vi) The exactitude with which standards of performance can be laid down. Fixation of standard is necessary for the introduction of a scheme of incentives. When this requires heavy expenditure, incentive schemes may be rather costly. (vii) The effect of an incentive scheme for one set of workers on other workers. If for instance, an incentive scheme makes it possible for unskilled workers to earn high wages, the wage rates for skilled workers must also be raised (if they are paid on time basis) to avoid dissatisfaction among them. In that event, the incentive scheme may raise labour cost instead of lowering it. (viii) The system of wage payment prevailing in other areas and industries or similar occupations. If possible, there should be uniformity. (ix) The attitude of labour and trade unions towards incentive schemes. Workers usually like to have a certain guaranteed time-basis wage but also like to earn extra through an incentive scheme. On the whole, the system of wage payment should be such as would increase production without lowering quality. This will increase the surplus and will enable the employer to pay higher wages which, in turn, will lead to higher output. Overheads CLASSIFICATION OF OVERHEADS Classification of overheads by function : Overheads principally are of four types: (i) Factory or Manufacturing Overheads; (ii) Office and Administrative Overheads; (iii) Selling and Distribution Overheads; (iv) Research and Development. Whether an expense belongs to one class or another depends entirely on the benefit derived from it. For instance, salaries of clerks will be (i) factory or manufacturing expenses, when the clerks concerned work in the factory office; (ii) office and administrative expense when the clerks work in the general office; and (iii) selling and distribution expense when the clerks work in the sales office. Small concerns may not distinguish between office and selling expenses and still smaller concerns may treat all overhead, of whatever class, together. Big concerns may have even a more detailed classification to be able to exercise better control. A detailed classification of such expenses is given below: (i) Factory or Manufacturing Expenses: (a) Stores overheads (expenses connected with purchasing and handling of materials); (b) Labour overheads (expenses connected with labour); and (c) Factory administration overheads (expenses connected with administration of the factory). (ii) Office and Administration Expenses: (a) Administrative expenses (expenses incurred on managerial personnel - their salaries, costs of facilities provided to them and salaries of their personal staff); and (b) Office expenses (expenses on the routine office work). (iii) Selling and Distribution Expenses : (a) Selling expenses (expenses incurred to persuade customers to purchase the firms products and, or engage its services, that is to maintain and expand the market); and

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(b) Distribution expenses are those which are incurred to execute orders. One should note that many people use the two terms selling and distribution as synonymous. Cost allocation : The term allocation implies relating overheads directly to the various departments. The estimated amount of various items of manufacturing overheads should be allocated to various cost centres or departments. The salary of the works manager cannot be directly allocated to any one department since he looks after the whole factory. It is, therefore, obvious that many overhead items will remain unallocated after this step. Cost apportionment : At this stage, those items of estimated overheads (like the salary of the works manager) which cannot be directly allocated to the various departments and cost centres are apportioned. Apportionment implies the allotment of proportions of items of cost to cost centres or departments. It implies that the unallocable expenses are to be spread over the various departments or cost centres on an equitable basis. After this stage, all the overhead costs would have been either allocated to or apportioned over the various departments. Prime cost Method of costing JOB COSTING According to this method costs are collected and accumulated according to jobs, contracts, products or work orders. Each job or unit of production is treated as a separate entity for the purpose of costing. Job costing is carried out for the purpose of ascertaining cost of each job and takes into account the cost of materials, labour and overhead etc. The job costing method is also applicable to industries in which production is in batches since batch production basically is of the same character as the job order production, the difference being mainly one in the size of different orders. The method then may also be described as Batch Costing. The job costing method of costing may be regarded as the principal method of costing since the basic object and purpose of all costing is to analyse and ascertain cost of each unit of production so that it may be possible to control and regulate cost and to determine the profitability or otherwise of each work order or product line. The basic principles enunciated for the job costing method are, therefore, valid essentially for all types of industry. For example, printing; furniture; hardware; ship-building; heavy machinery; interior decoration, repairs and other similar work. The job costing method essentially involves preparation of a separate cost sheet for each job, disclosing cost of material issued for the job, labour charges incurred (on the basis of bill of material and time cards respectively); when the job is completed, overhead charges are added for ascertaining total expenditure BATCH COSTING This is a form of job costing. Under job costing, executed job is used as a cost unit, whereas under batch costing, a lot of similar units which comprises the batch may be used as a cost unit for ascertaining cost. In the case of batch costing separate cost sheets are maintained for each batch of products by assigning a batch number. Cost per unit in a batch is ascertained by dividing the total cost

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of a batch by number of items produced in that batch. Such a method of Costing is used in the case of pharmaceutical or drug industries, ready-made garments, industries manufacturing electronic parts of T.V., radio sets etc. METHODS OF COSTING Different industries follow different methods of costing because of the differences in the nature of their work. The various methods of costing are as follows: Job Costing: In this case the cost of each job is ascertained separately. It is suitable in all cases where work is undertaken on receiving a customers order like a printing press, motor workshop, etc. In case a factory produces a certain quantity of a part at a time, say 5,000 rims of bicycle, the cost can be ascertained like that of a job. The name then given is Batch Costing. Batch Costing: It is the extension of job costing. A batch may represent a number of small orders passed through the factory in batch. Each batch here is treated as a unit of cost and thus separately costed. Here cost per unit is determined by dividing the cost of the batch by the number of units produced in the batch. Contract Costing : Here the cost of each contract is ascertained separately. It is suitable for firms engaged in the construction of bridges, roads, buildings etc. Single or Output Costing : Here the cost of a product is ascertained, the product being the only one produced like bricks, coals, etc. Process Costing : Here the cost of completing each stage of work is ascertained, like cost of making pulp and cost of making paper from pulp. In mechanical operations, the cost of each operation may be ascertained separately ; the name given is operation costing. Operating Costing : It is used in the case of concerns rendering services like transport, supply of water, retail trade etc. Multiple Costing : It is a combination of two or more methods of costing outlined above. Suppose a firm manufactures bicycles including its components; the parts will be costed by the system of job or batch costing but the cost of assembling the bicycle will be computed by the Single or output costing method. The whole system of costing is known as multiple costing. Direct Costing A direct cost is a cost that is directly associated with changes in production volume. This usually restricts the definition of direct costs to direct materials and direct labor (and a strong case can be made for not using direct labor, since this costs tends to be present even when production volumes vary). For example, the materials used to create a product are a direct cost, whereas the machine used to convert the materials into a finished product is not a direct cost, because it is still going to be sitting on the factory floor, irrespective of any changes in production volume. Thus, direct costing assumes that fixed costs are period costs, and so should be recognized as expenses during the period when they occur

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Absorption costing It is costing system which treats all manufacturing costs including both the fixed and variable costs as product costs Activity-based costing Activity-based costing (ABC) is a special costing model that identifies activities in an organization and assigns the cost of each activity with resources to all products and services according to the actual consumption by each. This model assigns more indirect costs (overhead) into direct costs compared to conventional costing models Markup and Markdown Markup is the amount of money above their cost of a product or service that a business will charge for that product or service, while markdown is the reduction in price of a product or service based on a percentage of the original price. Incoterms The Incoterms rules or International Commercial terms are a series of pre-defined commercial terms published by the International Chamber of Commerce (ICC) widely used in international commercial transactions. A series of three-letter trade terms related to common sales practices, the Incoterms rules are intended primarily to clearly communicate the tasks, costs and risks associated with the transportation and delivery of goods. The Incoterms rules are accepted by governments, legal authorities and practitioners worldwide for the interpretation of most commonly used terms in international trade. They are intended to reduce or remove altogether uncertainties arising from different interpretation of the rules in different countries EXW Ex Works (named place of delivery) The seller makes the goods available at its premises. This term places the maximum obligation on the buyer and minimum obligations on the seller. The Ex Works term is often used when making an initial quotation for the sale of goods without any costs included. EXW means that a seller has the goods ready for collection at his premises (works, factory, warehouse, plant) on the date agreed upon. The buyer pays all transportation costs and also bears the risks for bringing the goods to their final destination. The seller doesn't load the goods on collecting vehicles and doesn't clear them for export. If the seller does load the good, he does so at buyer's risk and cost. If parties wish seller to be responsible for the loading of the goods on departure and to bear the risk and all costs of such loading, this must be made clear by adding explicit wording to this effect in the contract of sale. FCA Free Carrier (named place of delivery) The seller hands over the goods, cleared for export, into the disposal of the first carrier (named by the buyer) at the named place. The seller pays for carriage to the named point of delivery, and risk passes when the goods are handed over to the first carrier. CPT - Carriage Paid To (named place of destination) The seller pays for carriage. Risk transfers to buyer upon handing goods over to the first carrier. CIP Carriage and Insurance Paid to (named place of destination)

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The containerized transport/multimodal equivalent of CIF. Seller pays for carriage and insurance to the named destination point, but risk passes when the goods are handed over to the first carrier. DAT Delivered at Terminal (named terminal at port or place of destination) Seller pays for carriage to the terminal, except for costs related to import clearance, and assumes all risks up to the point that the goods are unloaded at the terminal. DAP Delivered at Place (named place of destination) Seller pays for carriage to the named place, except for costs related to import clearance, and assumes all risks prior to the point that the goods are ready for unloading by the buyer. DDP Delivered Duty Paid (named place of destination) Seller is responsible for delivering the goods to the named place in the country of the buyer, and pays all costs in bringing the goods to the destination including import duties and taxes. This term places the maximum obligations on the seller and minimum obligations on the buyer. FAS Free Alongside Ship (named port of shipment) The seller must place the goods alongside the ship at the named port. The seller must clear the goods for export. Suitable only for maritime transport but NOT for multimodal sea transport in containers This term is typically used for heavy-lift or bulk cargo. FOB Free on Board (named port of shipment) The seller must load the goods on board the vessel nominated by the buyer. Cost and risk are divided when the goods are actually on board of the vessel (this rule is new!). The seller must clear the goods for export. The term is applicable for maritime and inland waterway transport only but NOT for multimodal sea transport in containers The buyer must instruct the seller the details of the vessel and the port where the goods are to be loaded, and there is no reference to, or provision for, the use of a carrier or forwarder. CFR Cost and Freight (named port of destination) Seller must pay the costs and freight to bring the goods to the port of destination. However, risk is transferred to the buyer once the goods are loaded on the vessel (this rule is new!). Maritime transport only and Insurance for the goods is NOT included. This term is formerly known as CNF (C&F). CIF Cost, Insurance and Freight (named port of destination) Exactly the same as CFR except that the seller must in addition procure and pay for the insurance. Maritime transport only. Standard costing Standard costing is defined by the ICMA, London, as the preparation and use of standard costs, their comparison with actual costs and the analysis of variances to their causes and points of incidence. Standard costing, thus, is a system of costing which can be used in conjunction with any method of costing, like job costing, process costing, etc. Standard cost is defined as a pre-determined cost which is calculated from managements standards of efficient operation and the relevant necessary expenditure. It may be used as a basis for price fixing and for cost control through variance analysis. BREAKEVEN POINT The word contribution has been given its name because of the fact that it literally contributes towards the recovery of fixed costs and the making of profits. The contribution

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grows along with the sales revenue till the time it just covers the fixed cost. This point where neither profits nor losses have been made is known as a break-even point. This implies that in order to break even the amount of contribution generated should be exactly equal to the fixed costs incurred. Hence, if we know how much contribution is generated from each unit sold we shall have sufficient information for computing the number of units to be sold in order to break even. Mathematically, Break even point in units = Contribution per unit Fixed costs BREAKEVEN CHART A breakeven chart records costs and revenues on the vertical axis and the level of activity on the horizontal axis. The making of the breakeven chart would require you to select appropriate axes. Subsequently, you will need to mark costs/revenues on the Y axis whereas the level of activity shall be traced on the X axis.

Budget Budget: A financial and/or quantitative statement, prepared and approved prior to a defined period of time of the policy to be pursued during that period for the purpose of attaining a given objective. It may include income, expenditure and employment of capital. OBJECTIVES OF BUDGETING The process of budgeting is initiated with the establishment of specific targets of performance and is followed by executing plans to achieve such desired goals and from time to time comparing actual results with the targets of performances/goals. These targets include both the overall business targets as well as the specific targets for the individual units within the business. Establishing specific targets for future operations is part of the planning function of management, while executing actions to meet the goals is the directing function of management.

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TYPES OF BUDGETS Budgets may be classified by : Capacity, coverage they encompass, periods which they cover and conditions on which they are based. BUDGET Capacity Coverage Period Conditions Fixed Flexible Functional Master Long-term Short-term Basic Current Budgets Budgets Budgets Budgets Budgets Budgets Budgets Budgets Fixed budget - According to Chartered Institute of Management Accountants of England, a fixed budget, is a budget designed to remain unchanged irrespective of the level of activity actually attained. A fixed budget shows the expected results of a responsibility center for only one activity level. Once the budget has been determined, it is not changed, even if the activity changes. Fixed budgeting is used by many service companies and for some administrative functions of manufacturing companies, such as purchasing, engineering, and accounting. Fixed Budget is used as an effective tool of cost control. In case, the level of activity attained is different from the level of activity for budgeting purposes, the fixed budget becomes ineffective. Such a budget is quite suitable for fixed expenses. It is also known as a static budget. Flexible budget - Unlike static budgets, flexible budgets show the expected results of a responsibility center for several activity levels. You can think of a flexible budget as a series of static budgets for different levels of activity. Such budgets are especially useful in estimating and controlling factory costs and operating expenses. It is more realistic and practicable because it gives due consideration to cost behaviour at different levels of activity. Functional budgets - Budgets which relate to the individual functions in an organisation are known as Functional Budgets. For example, purchase budget; sales budget; production budget; plant-utilisation budget and cash budget. Master budget - It is a consolidated summary of the various functional budgets. It serves as the basis upon which budgeted P & L A/c and forecasted Balance Sheet are built up. Long-term budgets - The budgets which are prepared for periods longer than a year are called long-term budgets. Such budgets are helpful in business forecasting and forward planning. Capital expenditure budget and Research and Development budget are examples of long-term budgets. Short-term budgets - Budgets which are prepared for periods less than a year are known as short-term budgets. Cash budget is an example of short-term budget. Such types of budgets are prepared in cases where a specific action has to be immediately taken to bring any variation under control, as in cash budgets. Basic budgets - A budget which remains unaltered over a long period of time is called basic budget. Current budgets - A budget which is established for use over a short period of time and is related to the current conditions is called current budget.