BASIC CONCEPTS-COST, COSTING AND COST ACCOUNTING

What is Cost? The term cost indicates the amount of expenditure (actual or notional) incurred on, or attributable to, a specified thing or activity or cost unit. Elements of Cost

Materials Cost

Labour Cost

Other expenses

Direct Material

Indirect Material

Direct Labour

Indirect Labour

Direct Expenses

Indirect Expenses

Overheads

Production or Works O/H

Administrative Or office O/H

Selling O/H

Distribution O/H

Total Cost = Material + Labour + other Expenses Prime Cost = DM + DL + DE Total Cost = Prime Cost + Overheads What is Costing? Costing is the technique and process of ascertaining costs. What is Cost Accounting? Cost accounting is the process of accounting for costs, which begins with 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.

Classification of Costs: The important ways of classification of costs are: 1. By Nature or Element: Costs are divided into three categories viz., Material Costs, Labour Costs and Other Expenses. This classification is useful in determining total cost. 2. As Direct and Indirect: Direct costs are those costs that can be identified with or allocated to either cost centre or a cost unit. Costs, which are not direct, are termed as Indirect. For instance, wages of the maintenance department is direct cost of the maintenance deptt., but it is an indirect cost as regards the production departments and production units are concerned. This is because of the fact that the maintenance departments cost is apportioned to different production departments and finally absorbed by the cost units on some realistic basis. 3. By Functions: Cost may be divided into Production Cost, Administration Cost, Selling Cost, Distribution Cost, and R&D Cost. Here, costs are categorized according to the purpose for which they are incurred. 4. By Variability: Under this, costs are divided as per their behavior in relation to changes in volume of production. Costs are classifies as Fixed, Variable and Semi-Variable (or Semi-Fixed). 5. By Controllability: Costs may be Controllable or Uncontrollable. A cost, which may be influenced by a member of an undertaking, is controllable. Controllability of an item of cost will depend upon the area of managerial responsibility and the time factor involved. An expenditure, which is uncontrollable by one individual, may be controllable so far as another individual is concerned. More over, expenditure, which is uncontrollable on a short-term basis, may be controlled on a long term basis. 6. By Normality: Here, costs are categorized as Normal Cost and Abnormal Cost. Normal cost is the cost that is normally incurred at a given level of output in the conditions in which that level of output is normally attained. Abnormal cost is the cost that is not normal. 7. By Time: On the basis of time costs may be categorized as Historical Cost and Predetermined Cost. The cost, which is ascertained after its incurrence is Historical Cost. Predetermined costs are estimated costs. Predetermined cost determined on scientific basis is Standard Cost. 8. For Decision Making: For managerial decision making costs may be sub-divided into Relevant Costs and Irrelevant Costs. Relevant costs are those costs, which are relevant for decision-making. Irrelevant Costs are those, which have no bearing on decision-making. Relevant Costs may be further sub-divided into following categories: Marginal Cost - It is the total variable cost i.e., prime cost plus variable overheads. Differential Cost It is the change in costs due to change in the level of activity or method of production. Differential cost resulting out of such change may be incremental or decremental. Opportunity Cost It is the possible maximum alternative earning that might have been obtained if the productive goods, services or capacity

have been applied to alternative use. For instance, if the owner of a building proposes to use it for a particular project, the likely rent of the building is the opportunity cost, which should be taken into consideration while evaluating the profitability of the project. Replacement Cost It is the cost at which there could be purchase of an asset or material identical to that which is being re4placed or revalued. Imputed Costs These are notional costs appearing in the cost accounts only e.g., notional rent, intt. On capital for which no interest has been paid.

Irrelevant costs are: Sunk Cost It is past cost. Foe e.g., WDV of abandoned plant is a past cost which is irrelevant for decision making. Committed Cost It is the cost that has been committed by the management. Absorbed Fixed Cost Fixed cost which do not change due to increase or decrease in activity is irrelevant for decision making. Statement of Total Cost:
(Assuming no opening and closing stocks of raw material, WIP and finished goods)

Particulars Direct Materials Direct Wages Direct expenses Prime Cost Production Overheads Administration Overheads Cost of Production Selling & Distribution Overheads Total Cost or Cost of Sales

Amount (Rs.) xx xx xx xx xxx xx xx xx xxx

What is Cost Centre? A cost centre is a location, person or item of equipment in respect of which costs may be ascertained and related to cost units for control purposes. The manager of a cost centre is held responsible for control of costs of his cost centre. In a factory, cost centres may be production cost centres or service cost centres. An example of production cost centres can be tablet, capsule, injection and ointment departments in a pharmaceutical factory. Service cost centres render service to production cost centres such as raw material stores, finished goods stores, plant maintenance department, canteen, etc. It may be mentioned that cost centres are the building block of a costing system. What is Cost Unit? A cost unit is a unit of production, service or time in relation to which costs may be ascertained or expressed. Since costing is measuring, the unit of measurement must be

clearly defined and selected before the process of cost finding can be started. The following are the examples of cost units in different industries: Name of Industry Automobile Brickworks Cement Chemicals Furniture Gas Paints Power Shipbuilding Steel Transport Cost Unit Umber Thousand Tonne Litre, Kg, Tonne Number Cubic meter Litre Kwh Number Tonne Tonne-Km Passenger-Km

Procedure of linking Cost with Cost Centre and Cost Units: The main stages involved in linking process are 1. Cost Classification Discussed above 2. Cost Allocation and Apportionment Cost allocation is the allotment of whole items of costs to cost centre or cost units. Cost apportionment is the allotment of proportion of item of cost to cost centre or cost units. E.g., wages of powerhouse workers can be wholly charged to powerhouse service department. On the other head rent charges should be distributed to different department on the basis of effective area of each department. 3. Overhead Absorption Overhead absorption is the procedure involved in the allotment of total cost of a cost centre to the products or services on a suitable basis. METHODS OF COSTING: Different methods of cost finding are used because businesses vary in their nature, methods of production, types of products/services they render and the unit of cost used. The various methods of costing are discussed below: 1. JOB COSTING: this method is applied where the items of prime cost are traceable to specific jobs or orders, as shipbuilding, machinery repair, furniture construction, etc. Here each job is separately identified and prime cost and overhead is charged to it. 2. BATCH COSTING: A batch of similar products is regarded as one job, and the cost of this complete batch is collected. This method is applicable to factories, which produce in convenient economical batches, e.g., biscuits, drug formulations, etc. 3. CONTRACT COSTING: In building construction industry, a contract is treated as a whole job and is costed in total. Contract costing is used where the job is big and spread over the long periods of time.