costing concept

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Cost & Management Accounting

Cost ConceptsPrepared By Vishal Goel

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The basic approach to cost accounting is distinct

from financial accounting.

It is oriented to relating the expenditures to products

in addition to analyzing the expenditures on the basisof natural classification of material, labour, etc.

The cost of a product is taken as the final outcome of manufacturing activities.

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Concept of Cost Accounts


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The fundamental element of cost accounting system is costwhich is defined as the amount of expenditure (actual ornotional) incurred on or attributable to a produced item or aservice unit

The term cost connotes different meanings to differentpeople, but in cost accounting, it is used in a special sense.Cost represents an expenditure made to secure an economicbenefit, generally on the uses of resources that promise toproduce revenue.

The resources may have tangible substance (e.g. manpower,material, machine, etc.), or they may take the form of services(e.g. wages, rent, power, etc.).

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Cost of Product


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The term cost is denoted by expense which is incurred after

deriving the benefit. A resources sacrificed or forgone to achieve aspecific objectives.

Expenses are defined as all explicit costs which are deductible fromrevenue.

When the cost is incurred before deriving the benefit, it is termedas deferred cost,

When no benefit is derived by the incurrence of cost, it is termed asloss,

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Cost, Expense, and Loss


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Cost ascertainment : is related to computation of actual costs incurred.It means the methods and process employed in ascertaining costs.

Different methods are employed for ascertaining cost in different organizations. Job costing, contract costing, batch costing, process costing, unit costing and multiple costing are some methods .Each method is chosen according to its suitability with the organization concerned.The ascertainment of actual cost has a small impact because of the followingpossible reasons:

Actual cost cannot be used for the purpose of price quotations and filingtenders.

Actual cost has practically no utility for control purposes. Actual cost is ineffective as means of measuring performance efficiency.Ascertainment of actual costs proves to be important though there are limitationsas shown above. Ascertainment of actual costs tells us unprofitable activities andlosses and inefficiencies occurring in the form idle time, excessive scrap etc.,

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Cost ascertainment


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It is the process of pre-determining costs of goods or services.The costs are determined in advance of production and precede theoperations.Estimated costs are future costs and are based on the average of pastactual costs adjusted for anticipated changes in future.

Uses:In making price quotations and bidding for contracts.Helpful in preparation of budgets.Helpful in evaluation performance.

Helpful in preparing financial statements.Serve as targets in controlling the costs.

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Cost Estimation


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Cost assignment a general termthat includes gathering accumulatedcosts to a cost object.

This includes: Tracing accumulated costs with a direct

relationship to the cost object and

Allocating accumulated costs with anindirect relationship to a cost object

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Cost is generally ascertained by cost centres. Let us understand about costcentre A cost centre is a location, person or item of equipment (or group of

these) for which costs may be ascertained and used for the purposes of cost control. (I.C.M.A. London)

The entire organisation may be divided into specified cost centres, which jointly contribute to the total cost. A cost centre is primarily identified in twmajor ways. They are

Personal cost centre: It consists of a person or a group of persons. Impersonal cost centre: It consists of a location or an item of equipment

group of these.

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What is cost centre? How is it identified? List its uses.


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A cost centre is a location, a person, or an itemof equipment (or a group of these) for whichcosts may be ascertained and used for thepurpose of cost control.

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Cost centre


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Personal and impersonal cost centre Operation and process cost centre Production, service and staff cost centre

Whatever may be the type of cost centre, it isdetermined by taking into consideration thefollowing factors:

the value of the work to be performed, the extent of cost control that can be exercised, responsibilities to be identified, and the uses of cost centre wise data by the costing

department, etc.

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Types of Cost Centres


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Cost unit is defined as a quantitative unit of a product, a service, or anitem, in relation to which costs are measured.

A cost unit, simply stated, is a unit of finished product, service or time, ora combination of these in relation to which cost is ascertained andexpressed.

Cost units may be: unit of product (e.g., cost per book) unit of time (e.g., cost of generating electricity per hour) unit of weight (e.g., cost per kilogram of sugar)

unit of measurement (e.g., cost per square foot of construction) operating unit of service (e.g., cost of running a car per kilometre)

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Cost Unit


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Selection of a cost unit must be appropriate. Convenience is the firstcriterion. Secondly, it should be easier to correlate expenses with costunits. Thirdly, it should be according to the nature and practice of thebusiness.

A few more examples of cost units in various industries are given:

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Industry Cost Unit Cars Per Car

Cement Tonne Chemicals Tonne, kilogram, litre, gallon etc

Bricks 1,000 bricks Shoes Pair or dozen pairs

Pencils Dozen or gross Electricity Kilowatt hour Transport Passenger Kilometre

Automobile Number Printing Press Thousand copies Cotton Bale Timber Cubic foot Mines Tonne

Carpets Square yard

Hotel Room per day


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Cost object is an entity or a part of an entity. Anything for which a separate measurement of cost may be

desired. Ex: a product, services, process, or activity The cost object changes according to decision needs of the

management. Costing objective : represents the overall objective for which

cost collection, cost analysis, and cost control is beingattempted.

Cost objective is different from expenditure objective. Ex purchase of office equipment may be the objective of expenditure need not to be cost objective

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Cost Object


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1 Product costs: the costs of manufacturingour products; or

2 Period costs: these are the costs otherthan product costs that are charged to,

debited to, or written off to the incomestatement each period.

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Product and Period Costs


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Inventoriable cost/ product cost is that cost which isregarded as asset when incurred, but becomes a part of costof goods sold when the product is sold.For all manufacturing cost is Inventoriable cost. (Raw materialto WIP to Finished goods) For a service sector unit, absence of inventory means all are period costs.

Period costs (non-product cost): all costs in P&L accountexcept cost of goods sold. So, in a mfg. sector unit, all non-manufacturing costs are period costs. (Ex. Distribution cost,design cost, R&D costs, Marketing costs, customer-servicecosts, etc.)

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INVENTORIABLE COSTS AND PERIOD COSTS


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Direct costs are generally seen to be variable costs and they are calleddirect costs because they are directly associated with manufacturing.

Direct costs can include: Direct materials: plywood, wooden battens, fabric for the seat and theback, nails, screws, glue.

Direct labour : sawyers, drillers, assemblers, painters, polishers,upholsterersDirect expense: this is a strange cost that many texts don't include; but(International Accounting Standard) IAS 2, for example, includes it. Directexpenses can include the costs of special designs for one batch, or run, of

a particular set of tables and/or chairs, the cost of buying or hiring specialmachinery to make a limited edition of a set of chairs.

Total direct costs are collectively known asPrime Costs

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Direct costs


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Indirect costs are those costs that are incurred in the factory but that cannot bedirectly associate with manufacture.

Again these costs are classified according to the three elements of cost, materials,labour and overheads .Indirect materials: Some costs that we have included as direct materials would beincluded here.Indirect labour: Labour costs of people who are only indirectly associated withmanufacture: management of a department or area, supervisors, cleaners,maintenance and repair techniciansIndirect expenses: The list in this section could be infinitely long if we were to tryto include every possible indirect cost. Essentially, if a cost is a factory cost and ithas not been included in any of the other sections, it has to be an indirect expense.Here are some examples include:

Depreciation of equipment, machinery, vehicles, buildingsElectricity, water, telephone, rent, Council Tax, insurance

Total indirect costs are collectively known as Overheads .

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Indirect Costs


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2. By variability :Costs are classified according to their behaviour inrelation to changes in the level of activity orvolume of production. On this basis, costs areclassifiedinto three groups namely fixed, variable and semi-

variable

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Costs which vary in total in direct proportionto the volume of output.These costs per unit remain relatively constant

with changes in production.They are also known as product costs as theydepend on the quantum of out put ratherthan time.

Eg: Direct material, direct labour, power,repairs etc.

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Variable costs

costing concept

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