Cost & management Accounting

C o u r s e : S Y B BA -C
S u b je c t C o d e : 2 0 3

Unit 1: Basic Cost Concepts

Cost Concept & Classification
Objective of Cost Accounting
Cost Accounting v/s Management Accounting
Cost Accounting v/s Financial Accounting
Cost Centers & Activities

Classification of Costs
In the words of Herald J. Wheldon, a classification

has to made to arrive at the detailed costs of

departments, process or other cost units.
Important basis of cost classification:
1.
2.
3.
4.

Classification by nature or element.

Functional Classification
Classification on the basis of behavior
Classification for managerial decision & control

1. Classification by nature or Element

Elements of Cost

Direct Cost

Direct
Material

Direct
Labour

Indirect Cost

Direct
Expenses

Indirect
Material

Indirect
labour

Indirect
Expenses

Direct Cost
Direct cost are the cost which can be conveniently

identified with & allocated to a particular unit of final

product.
Such cost are treated as the cost of the unit

produced.
It is also known as prime cost or first cost

Cont
Direct Material:

All material which become an integral part of the finished

product and which can be conveniently assigned to specific
physical unit is called direct material.

Ex. All primary packaging material

Cont
Direct Labour:

Direct labour cost consist of wages paid to workers directly

engaged in manufacturing or handing product, job or process.

Direct Expenses( Chargeable Expenses):

All expenses other then the direct material or direct labour that
has specifically incurred for particular job, product or process
are called direct expenses.
Ex. Cost of special tools, hire charges for a special equipment,
insurance on special material.

Indirect Cost
Indirect cost are those cost which can not be assign

to any particular cost unit.

Indirect cost are usually incurred for business as a

whole.

Cont
Indirect Material

Ex. Fuel, Lubricating oil, Small tools etc.

Indirect Labour

Wages of general supervisor, inspectors, workshop cleaner,

store keeper, watchmen etc.

Indirect Expenses

Rent, insurance, canteen, lighting, hospital etc.

Cont
A. Factory overheads
It includes all indirect expenses connected with the
manufacturing of all product
Ex: lubricants, oil, works mangers salary, factory rent, insurance
B. Office & administration overheads
It includes all indirect expenses relating to administration &
management of an office
Ex: office rent, office lighting, insurance, salary of clerical &
executive staff.
C. Selling & distribution overheads
It includes all indirect cost connected with marketing & sales
Ex: advertising expenses, salary of salesmen.

Functional Classification
Prime /first /direct cost:

Direct Material + Direct Labour + Direct Expenses

Factory /work /production /manufacturing cost:

Prime Cost + Factory overheads

Cost of production/office/administration/gross cost of

production:

Factory cost + office & administrative expenses

Total Cost/cost of sales:

Office cost + selling & distribution overheads

Classification on the basis of behaviour

Basis of
Behaviour
Variable
Cost

Fixed
Cost

Semi-Variable
Cost

Cont...
Variable Cost

Costs that may vary almost in direct proportion to the volume of

production are called variable cost.
Ex: Direct material, Direct Labour, Direct Expenses such as electric
power, fuel etc.

Fixed Cost

Cost which do not vary with the level of production are known as
fixed cost.
These cost remain constant irrespective of the level of output.
However, be noted that fixed costs do not remain constant for all
time
In fact , in the long run all costs have a tendency to vary.
Fixed cost remain fixed up to a certain level of production.

Cont...
Semi-variable cost

Those cost which are partly fixed and partly variable are called
semi-variable costs.

These cost vary with the level of production but not in direct
proportion to the level of production.

Ex: salary of salesmen

Classification of costs for managerial decision & control

Controllable & uncontrollable costs
Normal & abnormal Costs
Avoidable & unavoidable costs
Shut down & sunk cost
Product cost & period cost
Differential, incremental & decremental costs
Out of pocket cost
Marginal cost
Opportunity cost
Conversion cost
Budget and standard cost
Imputed or hypothetical cost

Controllable & uncontrollable costs

Controllable cost

Controllable cost are those cost which can be controlled or

influenced by a specified person or a level of management.

Ex: Salary of Employee

Uncontrollable Cost

Cost which cannot be controlled or influenced by the action of

a specified person are known as uncontrollable costs.

Ex: taxation policy by government

Normal & abnormal Costs

Normal Cost

Costs which are normally incurred at a given level of output are

called normal cost.

Ex: labour welfare expenses or cost

Abnormal Cost

The cost which are not normally incurred at a given level of

output are called abnormal cost.

Ex: compensation paid to the employees due to any accidents

Avoidable & unavoidable costs

Avoidable cost

Avoidable cost are those costs which can be escaped or avoided

Ex: Refreshment expenses

Unavoidable cost

Unavoidable costs are those which cannot be escaped or

eliminated

Ex: Tax

Shut down & sunk cost

Shut down cost

Those fixed costs which Have to be incurred even if production

are discontinued temporary due to strike, shortage of raw
material, etc

Ex: Factory Rent, Fix Salary to employee

Sunk cost

Costs which have been incurred and are irrelevant in a

particular situation are called sunk cost.

Amount paid to Local Painter

Product & period cost

Product Cost

Costs which are associated with production and which become

part of the product are called product cost.

Ex: raw material, direct wages, etc

Period Cost

Costs which are associated with period for which they incurred
are called period cost.

Ex: rent, insurance, salesmen salary, etc.

Differential, incremental, decremental cost

Differential cost

The difference in costs due to change in the level of activity or

method of production is known as differential cost

Incremental cost

If that changes increase the cost, it is called incremental cost.

Decremental cost

The change decreases the cost, it is called decremental cost.

Out of pocket cost

It is that cost which gives rise to costs expenditure.
Out of pocket cost are important for price fixation

during recession and where make or buy decision is

involved

Ex: Personal use of Company landline phone

Marginal Cost
Marginal cost is the cost of producing one additional

unit.
Marginal cost is the total of variable cost only and

not fixed cost.

The concept of marginal cost is very useful in making

many managerial decisions such as price fixation,

make or buy decisions, etc.

Opportunity cost
Opportunity cost refer to the advantages foregone as

a result of adopting one course of action and not the

other.

Ex: if an building is proposed to be used for a project, the

expected rent of the building is the opportunity cost.

Conversion cost
It is the cost of converting raw materials into

finished products.
Conversion cost can be calculated as the total of

direct labour, direct expenses and factory overheads.

Budget & standard cost

Budget cost

Budget cost are estimated costs prior to a defined period of time.

Ex: cash budget

Standard cost

Standard cost is a predetermined cost based on technical estimate

for materials, labour and overheads for selected period of time and
for a prescribed set of working conditions

Standard cost are based upon technical assessments where as

budget are based on historical costs adjusted future trends.

Imputed or hypothetical cost

These cost do not involve any expenditure in real

sense.
They are included in cost accounts only for taking

managerial decisions.

Ex: the rent of owned building or interest on owned capital

should consider while evaluating the profitability of a project.

These costs are also called notional costs

Objective of cost accounting

1.

To determine product costs.

2. To facilitate planning and control of regular

business activities.
3. To supply information for short & long run

decisions.

Cont...
To determine product costs:

1.

The objective of determining the cost of product is of prime

importance in cost accounting.

The total product cost and cost per unit of product are
important in making inventory valuation, deciding price of the
product and managerial decision making.

Cont...
2. To facilitate planning & control:

Useful cost data and information for the purpose of planning

and control by management

The different alternative plans are evaluated in terms of

respective cost and associated benefits.

The management control over business operations aims to

establish balance between actual and budgeted peformances

Cont...
3. Information for decisions:

An important purpose of the cost accounting system is to

provide data and special analyses for short & long run decision.

Appropriate cost information must be accumulated to make a

wide variety of short & long run decisions.

Cost Centres
The ICMA, London defines cost centres as A

location, person, or item of equipment for which

costs may be ascertained and used for the purpose of
cost control
A cost centre is an organizational segment or area of

activity considered to accumulate costs.

Types of cost centres

Impersonal cost centre
Personal cost centre
Cost Centre
Operational cost centre
Process cost centre