What is Cost Accounting?

COST ACCOUNTING
INTRODUCTION

Cost Accounting provides the detailed

information that management needs to

control current operations and plan for the
future.

Management uses this information to decide

how to allocate resources to the most

efficient and profitable areas of the business.

Definition COST ACCOUNTING

Kohler in his dictionary for Accountants defines cost

accounting as that branch of accounting dealing with

the classification, recording, allocation, summarisation

and reporting of current and prospective costs.
Mr. Wheldon defines cost accounting as the
classifying, recording and appropriate allocation of
expenditure for the determination of the costs of
products or services, the relation of these costs to sales
values, and the ascertainment of profitability.

ASPECTS COST ACCOUNTING

The above definitions reveal the following aspects of

cost accounting:

(a) Cost classification

(b) Cost recording
(c) Cost allocation
(d) Cost determination or cost finding
(e) Cost reporting

ASPECTS OF COST ACCOUNTING

ASPECTS OF COST ACCOUNTING

Cost classification: This refers to grouping of

Cost determination or cost finding: This

like items of cost into a common group.

Cost recording: This refers to posting of cost
transactions into the various ledger
maintained under cost accounting system.
Cost allocation: This refers to allotment of
costs to various products or departments.

refers to the determination of the cost of

goods or services by informal procedure, i.e.,
procedures that do not carry on the regular
process of cost accounting on a continuous
basis.
Cost reporting: This refers to furnishing of
cost data on a regular basis so as to meet the
requirements of management.

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NATURE OF COST ACCOUNTING

Cost accounting is a branch of
knowledge.
Cost accounting is a science.
Cost accounting is an art.
Cost accounting is a profession.

NATURE OF COST ACCOUNTING

Cost accounting is a science. Cost accounting

is a science as it is a body of systematic knowledge

relating to not only cost accounting but relating to a
wide variety of subjects such as law, office practice
and procedure, data processing, production and
material control, etc. It is necessary for a cost
accountant to have intimate knowledge of all these
field of study in order to carry on his day-to-day
activities. But it is to be admitted that it is not a
perfect science as in the case of natural science.

NATURE OF COST ACCOUNTING

Cost accounting is a profession. In recent years

cost accounting has become one of the important

professions which has become more challenging. This
view is evidenced by the setting up of various
professional bodies such as National Association of
Accountants (NAA) in USA, the Institute of Cost and
Management Accountants in UK, the Institute of
Cost and Works Accountants in India and such other
professional bodies both in developed and developing
countries have increased the growing awareness of
costing profession among the people.

NATURE OF COST ACCOUNTING

Cost accounting is a branch of

knowledge. Though considered as a branch

of financial accounting, cost accounting is one
of the important branch of knowledge, i.e., a
discipline by itself. It is an organised body of
knowledge consisting of its own principles,
concepts and conventions. These principles
and rules of course vary from industry to
industry.

NATURE OF COST ACCOUNTING

Cost accounting is an art. Cost accounting

is an art in the sense that it requires the ability

and skill on the part of cost accountant in
applying the principles, methods and
techniques of cost accountancy to various
management problems. These problems include
the ascertainment of cost, control of costs,
ascertainment of profitability, etc.

Types of Businesses that use Cost

Accounting
All types of business entities manufacturing, merchandising, and service
businesses - require cost accounting
information systems to track their activities.
Manufacturers convert purchased raw

materials into finished goods by using labor,

technology, and facilities.

Types of Businesses that use Cost

Accounting
Merchandisers purchase finished goods for

resale.

For-profit service businesses, such as beauty spa

and accounting firms, sell services rather than

products.
Not-for-profit service agencies, such as
charities, governmental agencies, and some
health care facilities, provide at little or no cost
the user.

Relationship of Cost Accounting to

Financial and Management Accounting
Financial accounting meets the needs of
investors, creditors, and other external
users of financial information.
Management accounting seeks to
provide information to managers which will
be used for decision making purposes (e.g.
pricing, investment) for planning and
control.

Relationship of Cost Accounting to

Financial and Management Accounting
Cost accounting includes those parts of
financial and management accounting that
collect and analyze cost information. It is
concerned with cost accumulation for stock
valuation to meet the requirements of
external reporting.

Relationship of Cost Accounting to

Financial and Management Accounting

Relationship of Cost Accounting to

Financial and Management Accounting

Relationship of Cost Accounting to

Financial and Management Accounting

Trading VS Manufacturing

Uses of Cost Accounting Information

When an entrepreneur contemplates in going into a business

Principles of cost accounting have been developed

of selling goods, he has to decide either to buy them from

outside suppliers or to manufacture them. Should he buy the
goods and sell them at a profit, he will then be engaged in a
trading concern. Should he decide to purchase goods in a
form which is to be converted into another and when
completely finished, be offered for sale, he will then be
embarking on a manufacturing business.
The primary concern of both types of business operations is
to earn revenue by selling goods. It will be noted that the
main difference between a trading and a manufacturing
concern is the manufacturing process.

Uses of Cost Accounting Information

Cost Accounting Information is used for:
-Determining Product Costs and

Pricing

to enable manufacturers to process the many

different costs associated with manufacturing and
to provide built-in control features.
The information produced by a cost accounting
system provides a basis for determining product
costs and selling prices, and helps management to
plan and control operations.

COST CONCEPTS AND

CLASSIFICATIONS

-Planning and Control

CLASSIFICATION OF COSTS
(Manufacturing)
I. Product Cost
A. Materials
a. Direct Materials
b. Indirect Materials
B. Labor
a. Direct Labor
b. Indirect Labor
C. Manufacturing Overhead
II. Period Cost
o Marketing and Selling Costs
o Distribution Cost
o Administrative Cost

CLASSIFICATION OF COSTS
(Manufacturing)
Product costs are those costs assigned to an inventory account

that eventually become part of cost of goods sold.

Examples: raw materials used, direct labor, factory supervisor's
salary, and factory utilities. In a manufacturing company, product
costs are also called manufacturing costs.
Period costs are those costs recorded as an expense in the period

they are incurred.

Examples: selling expenses such as sales salaries, sales commissions,
and delivery expense, and general and administrative expenses
such as office salaries, and depreciation on office equipment.
These costs are often referred to as nonmanufacturing costs.

CLASSIFICATION OF
Manufacturing COSTS
There are three categories of manufacturing costs:

direct materials, direct labor, and overhead.

Direct materials are those materials (including

purchased parts) that are used to make a product and can

be directly associated with the product. Some materials
used in making a product have a minimal cost, such as
screws, nails, and glue, or do not become part of the final
product, such as lubricants for machines and tape used
when painting. Such materials are called indirect
materials and are accounted for as manufacturing
overhead.

Elements of Manufacturing Cost:

CLASSIFICATION OF
Manufacturing COSTS
Direct labor is the cost of the workers who make the

product. The cost of supervisory personnel, management,

and factory maintenance workers, although they are
needed to operate the factory, are classified as indirect
labor because these workers do not use the direct
materials to build the product.
Manufacturing overhead/Factory Overhead costs
include indirect materials, indirect labor, and all other
manufacturing costs. Depreciation on factory equipment,
factory rent, factory insurance, factory property taxes,
and factory utilities are all examples of manufacturing
overhead costs.

CLASSIFICATION OF COSTS
DIRECT COST cost that can be directly,

completely and conveniently identified with or

traced to a manufacturing process, job or order,
business unit, segment or department. For example:
material used, labour employed and expenses
incurred for production can be easily identified with
the product.
INDIRECT COST cost related to a particular cost
object but cannot be traced to that cost object in an
economically feasible way. Examples of such cost are:
salary to managers, watchman, etc, which is a
common cost for various products manufactured.

CLASSIFICATION OF COSTS

CLASSIFICATION OF COSTS

Costs classified as to Variability

Costs classified as to their nature

Common Cost mutually beneficial costs, which

Fixed Costs items of cost which remain constant in total.

Ex. Salaries of production executives, depreciation, rent,

insurance
Variable Costs items of cost which vary directly, in total,
in relation to volume of production. Ex. Direct materials,
direct labor, royalties, commission of salesmen
Mixed Costs items of cost with fixed and variable
components.
Semi-variable cost the fixed portion represents the minimum fee

for making a particular item or service available and the variable

portion is the cost charged for actually using the service.
Step costs the fixed part changes abruptly at various activity levels

occur when the same resource is used in the output of

two or more services or products or simply the cost of
facilities or services employed in more than one
period, operations, commodities, or services.
Joint Cost costs incurred in a single process that
yields two or more products. Costs of materials, labor,
and overhead incurred in manufacturing two or more
products at the same time. These costs are indivisible
and are not specifically identifiable with any of the
products being simultaneously produced.

CLASSIFICATION OF COSTS

CLASSIFICATION OF COSTS

Costs classified as to relation to an accounting period

Costs for planning, control, and analytical processes:

Capital Expenditure intended to benefit more

Standard Cost a budget for the production of one

than one accounting period and is recorded as an asset.

Revenue Expenditure that will benefit the
current period only and is recorded as an expense.

Opportunity Cost benefit given up when one

unit of product or service

alternative is chosen over another
Sunk Cost a cost for which an outlay has already

been made and it cannot be changed by present or

future decision. This cost cannot be reversed or revised
by subsequent decisions.

CLASSIFICATION OF COSTS

CLASSIFICATION OF COSTS

Committed costs consist largely of those costs that arise from

Controllable Cost cost which can be identified and

the possession of plant, equipment and a basic organization

structure. For example, once a building is erected and a plant is
installed, nothing much can be done to reduce the costs such as
depreciation, property taxes, insurance and salaries of the key
personnel etc.
Discretionary costs are those which are set at fixed amount for
specific time periods by the management in budgeting process.
These costs directly reflect the top management policies and have
no particular relationship with volume of output. These costs can,
therefore, be reduced or entirely eliminated. Examples of such
costs are research and development costs, advertising and sales
promotion costs, donations, management consulting fees etc.
These costs are also termed as managed or programmed costs.

controlled by the action of the management or a specified

member of the organisation. For example, control on
electricity cost, raw material cost, fuel cost, etc. are possible
by the foreman or supervisor of the production department.
Uncontrollable Cost - costs which cannot be influenced
by action of the management or a specified member of the
organisation. For example, depreciation and cost of material
consumed. If the purchase manager purchases the fixed assets
and materials at a higher price, production manager cannot
control these costs.

CLASSIFICATION OF COSTS
Out of Pocket Cost cost which requires

immediate or future cash payment to outside parties

on the basis of an alternate decision. Refers to the cash
outlay required to complete a proposed project or
extend an activity undertaken.
Budgeted Costs planned or predetermined costs.