Costing Basics

8/8/2019 Costing Basics

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Cost Accounting

Definition

The process of identifying the costs of the business and of breaking them down and relating

them to the various activities of the organization.

OR

An activity that involves calculating how much it costs to make and sell a product or a

service.

Advantages of Cost Accounting

1. Fixation of responsibility: Whenever a cost center is established, it implies

establishing a kind of relationship between superior and subordinates. Thus

responsibilities are fixed on every individual who is concerned with incurrence of

cost.

2. Measures economic performance: By applying cost control techniques such as

budgetary control and standard costing it helps in assisting the performance of the

business.

3. Fixation of price: By providing the cost data it helps management to fix the selling

price in advance. Hence, quotations can be supplied to prospective customers to

secure orders.

4. Helps in minimizing wastage and losses: Cost accounting system enables to locate

the losses relating to materials, idle time and under utilization of plant and machinery.

5. Aids in decision-making: It helps management in making suitable decisions such as

make or but, replace manual labour by machines, shut down or continue operations

based on cost reports.

Advantages to Employees

1. Enables employees to earn better wages through overtime wages and incentive

systems of wage payment.

2. It ensures job security.

3. Employees benefit by merit rating techniques which is conducted by scientific

process.

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Advantages to Creditors

1. It increases the confidence of creditors in the capital employed in the business.

2. The frequent preparation of reports and statements help in knowledge solvency

position of the business.

Advantages to Government

1. It helps the government in formulating policies regarding export, import etc.

2. It helps in assessing excise duty, sales tax and income tax of the business.

3. It helps in preparing national plans.

Advantages to society

1. It offers employment opportunities in the cost accounting department in the capacity

of cost accountants and cost clerks.

Limitations of Cost Accounting

1. It is expensive: The system of cost accounting involves additional expenditure to be

incurred in installing and maintaining.

2. Inapplicability of same costing method and technique: All business enterprises

cannot make use of a single methods and technique of costing. It all depends upon the

nature of business and type of product manufactures by it.

3. Not suitable for small scale units: A cost accounting system is applicable only to a

large-sized business but not to a small-sized one. Hence, there is limitation to its

application to all types of business.

4. Lack of accuracy: The accuracy of cost accounts gets distorted owing to the use of

national cost such as standard cost, estimated cost, etc.

5. It lacks social accounting: Cost accounting fails to take into account the social

obligation of the business. In other words, social accounting is outside the purview of

cost accounts.

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Costing Methods:

Specific order costing1. Job costing

2. Batch costing

3. Contract costing

4. Cost plus contract

Operation costing

1. Single to output costing

2. Process costing

3. Service or operating costing

4. Departmental costing

5. Composite costing

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OPERATING OR SERVICE COSTING

Definition:

The ICMA terminology defines operating cost as the cost of providing a service and

operating costing as that form of operation costing which applies where standardized

services are provided either by an undertaking or by a service cost-centre within an

undertaking. The method may be used where the service is not completely standardized but it

is convenient to regard it as such, and to calculate average costs per period in relation to the

standardized unit of measurement. From these definitions it is clear that the cost of providing

a service is known as operating cost and the method employed to ascertain cost of such

service is known as operating costing.

Characteristic Features of Operating Costing:

The characteristic features of operating costing are as follows:

1. The industries which adopt this method of costing do not produce any tangible goods.

Instead they are concerned with rendering the services to public at large. They render

uniform service to all those who apply for such services.

2. The cost unit used by such undertakings is known as composite unit as compared to

the use of simple cost unit by rest of the undertakings. Some of the examples of

composite units used by the u8ndertakings are as follows:

Railways - Passanger-kilometer or ton-kilometer

Hospitals - Patient-day

Hotel (Lodging) - Room-day

Hotel (Boarding) - Plate-meals

Gas distribution - Cubic-meter

3. Classification of expenses into fixed and variable plays an important role. The cost of

rendering additional service is affected by variable cost.

4. In most of the cases, it involves many stages and processes in converting basic

materials to the ultimate service.

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5. Costs are usually computed period-wise. However, under special circumstances costs

are computed order-wise as in the case of utilization of vehicles, use of road-roller,

etc.

6. The demand for the services of industries adopting this method of costing fluctuates.

Hence, it is difficult to estimated the cost accurately.

7. There is no difficulty faced in respect of valuation of work-in-progress or closing

stock when compared to other industries.

8. Only medium and large sized undertakings deal in manufacturing and rendering

services. Such industries assume the portion of monopolistic undertakings or public

utility undertakings.

Applications:

Operating costing is applied to those organizations which render service externally (i.e., to

public at large) or internally (i.e., to various departments of the same organization). Some

examples of services rendered to outsiders are electricity supply, water supply, gas supply,

boarding and lodging and so on. While services such as repairs and maintenance, purchasing

and storage, internal transport, etc. constitute services rendered internally. There is a point of

difference in respect of accounting of services rendered. Whereas the objective of accounting

external service is to know the total cost of manufacturing and profit on provision of such

service , the object of internal service to facilitate apportionment of service department cost to

various other departments.

Operating costing is applied to the following undertakings:

1. Transport undertakings such as Roadways, Railways, Tramways and Airways.

2. Municipal services such as supply of water, street lights, etc.

3. Stream and electricity undertakings.

4. Hotels covering boarding and lodging.

5. Hospitals.

6. Educational Institutions.

7. Public libraries.

8. Service departments in big factories.

9. Cinemas.

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10. Distribution of gas, air compressor, air-conditioning.

11. Sports and recreational clubs.

12. Services such as supply cranes, road roller, water pumping, fire extinguishers, etc.

Components Of Total Cost In Operating Costing

As compared to other methods of costing, where the total cost comprises of prime cost,

factory cost, the total cost under operating costing is classified under the following headings :

1. Capital Expenditure : This includes:

(a) Buildings

(b) Plant

(c) Vehicles

(d) Equipments from the use of which service is provided.

2. Direct or variable cost : This includes :

(a) Expenses on medicines (in hospitals)

(b) Fuel (in railways, buses, trucks, taxies)

(c) Pilot salaries (in hotels)

(d) Provisions (in hotels)

3. Fixed cost : This includes :

(a) Depreciation

(b) Rent and taxes

(c) Taxes and insurance

(d) License fee.

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Transportation Costing

The Transport Costing System provides a means to calculate the current operating

costs for road transport operations. The relevant "input costs" that are currently applicable in

the transport industry (for example license fees, fuel costs, capital costs, tire costs, etc) are

updated in the system on a regular basis. Therefore the results from the Transport Costing

System are not 3, 6 or 12 months behind. They are current!

The main objects of transport costing are (a) to ascertain the cost of operating a vehicle and

(b) to fix up a fair for carrying passengers or goods for a certain distance.

Advantages of Transport Costing:

The advantages of operating costing are as follows:

1. To decide whether to own a vehicle or to hire a vehicle

2. To provide a basis for apportioning service departments expenses to production

departments

3. To enable the owner of a vehicle to charge fair to the clients, including concessional

and special rates

4. To know efficiency by comparing the cost of maintaining and running one vehicle

with similar type of vehicle; car vs. matador

5. To choose between two modes of transport, as for example between lorry or railway

in order to deliver goods to customers.

Components of Transport Costing:

The total cost of operating service by a transport company is as follows:

1. Standing charges or fixed cost: these include

a. Administrative expenses such as salaries of manager, accountant, mechanic, etc

b. Garage rent

c. Taxes and insurance of vehicles

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d. Wages of drivers, conductors, and cleaners

e. Depreciation of vehicles

2. Running charges or variable cost: these include:

a. Petrol

b. Diesel, oil

c. Lubricant

3. Maintenance cost:

a. Repeirs and maintenance charges

b. Tyres, tubes, batteries, etc

Recording of Cost Under Transport Costing:

Two important documents are used under transport costing. They are as follows:

1. Daily report sheet or log sheet:

This document is used when an owner owns a fleet of vehicles. This report is prepared either

by a driver, foreman or a clerk at the garage or depot. The purpose of this document is to

enable the accumulation and control cost. This document contains particulars about each

journey made by the vehicle. These particulars enable the owner to utilize the vehicle without

allowing for idle running capacity. Besides this, the data

In this report also enables to apportion expenses to other vehicle. The proforma of this

document is shown below:

Daily report sheet or log sheet

Vehicle No.............. No. Of Sheet.................

Route...................... Date....................

Driver.................... Starting Time..................

Registration No..

Particulars of Trip

Trip no. From To Passenger/

goods

Distance time

Out In

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Out Enroute

Employee Name: Delays: Supplier:

Driver................... Loading.............. Petrol............

Cleaner............... Traffic............... Oil.................

Conductor........... Accident........... Grease...........

Mechanic............. Breakdown........ Tire..........

2. Operating cost sheet or cost summery performance statement:

this document helps in calculating cost per carrying passenger or goods for one kilometer.

The cost of operating the vehicles helps the owner in the following ways:

a) To avoid waste of oil, fuel etc

b) To know the efficiency by comparing with other vehicle

c) Facilitates in quoting hire charges

d) Cost of idle vehicle and lost running time can be known

e) Helps in apportioning overheads to other departments

f) Helps in controlling cost by comparing operating cost of one year with previous year

The operating cost sheet is prepared on a periodical basis. The information for this

purpose is collected from log sheets.

A specimen of this document is shown below:

Cost Summery and Performance Statement

Registration no month ended.

Capacity

Monthly charges

A- Operating Cost B- Maintenance Charges C- Fixed Charges

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1. Petrol 1. Tires 1. Insurance

2. Oil 2. Repairs 2. Interest

3. Grease 3. Overhead 3. Depreciation

4. Driver 4. Garage 4. Tax, License5. Assistant 5. Others

6. Mechanics

_________ __________ _____________

Total _________ __________ _____________

Monthly Cost Sheet

1. Total capital cost

Performance record

2. Days operated

3. Days idle

4. Days maintained

5. Total hours operated

6. Total kilometers covered

7. Total trip made

Performance Averages

8. Averages kilometers per day maintained 6/4

9. Averages kilometers per day operated 6/2

10. Average kilometers per trip 6/7

Costs for the Month

11. Total expences for the month(A+B+C)

12. Cost per day operated 11/2

13. Cost per day maintained 11/4

14. Cost per kilometer operated 11/6

15. Cost per hour 11/5

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Units of Costs in Transport Costing

There are various different cost units, which are used to measure the efficiency of running

vehicles. Important among them are as follows.

The tone-kilometer:

This can be divided in to two types:

1. The absolute tone-kilometer:

It refers to unit cost of carrying one tone of goods over a distance of 1 kilometer.

Absolute tone-kilometer = Weight carried x Kilometer run (for each section of the trip)

2. Commercial tone-kilometer:

This unit is used to overcome the limitation of calculating the unloaded capacity at

various distance covered. This method is based on the assumption of an average, wherein

it is assumed that the vehicle runs with half load throughout the distance covered (after

having unloaded part of the goods at different places).

Commercial tone-kilometer = Average load x Total kms travelled

Problem:

A truck starts with a load of 10 tones of goods from stationP. It unloads 4 tones at station

Q and rest of the goods at stationR. It reaches back directly to stationafter getting

reloaded with 8 tones of goods at stationR. The distance between-

P to Q = 40 kms, Q to R = 60 kms & R to P = 80 kms.

Calculate Absolute tone-kilometer & Commercial tone-kilometer.

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Solution:

Absolute tone-km = (10 x 40)+ (6x60)+ (8 x 80)

= 1400 tone-kms

Commercial tone-km = Average load x Total km travelled

= 10 +6 +8 x 180 kms

3

= 8 x 180

= 1440 tone-kms

Cost Per Passenger Kilometer:

It helps in identifying unit cost of carrying one passenger over a distance of 1 kilometer.

Cost per passenger km = __Total Expenses__

Total passenger kms

Problem:

A 40 seater tourist bus operates in a month as follows:

Capacity From To DistanceFirst 10 days 100% Hyderabad Khammam 160 kms

Next 15 days 75% Hyderabad Khazipet 250 kms

Next 5 days 60% Hyderabad Koppidi 100 kms

The total expenses are Rs. 3,77,000. Ascertain cost of one passenger km.

Solution:

No. of Passenger km = No. of Days x Capacity x Capacity used x Distance x To & From

First 10 days = 10 x 40 x 100/100 x 160 x 2 = 1,28,000

Next 15 days = 15 x 40 x 75/100 x 250 x 2 =2,25,000

Next 5 days = 5 x 40 x 60/100 x 100 x 2 =24,000

Total Passenger kms 3,77,000

Cost per passenger km = __Total Expenses__

Total passenger kms

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= __3,77,000__

3,77,000

= Re. 1 per passenger km

Cost Per Hour:

This unit is used when vehicles are hired out to customers at a certain rate per hour.

This unit covers all the costs of operating the vehicle along with a profit margin.

The hour for this purpose is taken as Hired-out hour.

Power, Electricity And Gas Supply Services

In these services- concerns, generation of power or electricity or gas is carried on and these

are made available to outsiders or to our production departments. A cost statement is prepared

to find out cost per unit. The unit may be per kwt (kilowatt) or kWH (kilo-watt hours).

Following is the statement of cost:

Statement of Electricity Generation Cost

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(A)Variable Charges:

Cost of steam used

Coal

Lubricants and Suppliers

Wages of operators

Total

(B) Maintenance Charges:

Repairs and Maintenance

Total

(C)Fixed Charges:

Depreciation

Supervision

Administrative overheads

Interest on capital

Total

Total A+B+C

Cost per unit = Total cost / Number of units or

Cost per kw = Total cost / kw or

Cost per kWH = Total cost / Kwh

Problem:

You are requested to prepare a cost sheet showing the cost of generation of power per kilo

watt-hours (kWH).

Total unit Generated 15,00,000 kilo watt-hours (kWH) per annum

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Rs.

Operating Labour 16,500 per annum

Plant Supervision 5,250 per annum

Lubricant and Supplies 10,500 per annum

Repairs and Maintenance 21,000 per annum

Adm. Overheads 9,000 per annum

Capital cost 1,50,000

Coal consumed per kWH is 1.5 lbs and cost of coal delivered to the power station is Rs.33.06

per metric ton. Depreciation rate chargeable is 4% per annum and interest on capital is to be

taken @ 7%. Take one metric ton = 2,205 lbs.

Solution:

Operating Cost sheet

(Power: Generated: 15,00,000 kWHs for the year )

Rs.

(A)Variable charges:

Operating Labour

Lubricant and Supplies

16,500

10,500

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Coal (15,00,000*1.5*33.06)/2,205

Total

(B) Maintenance charges:

Repairs and Maintenance

Total

(C)Fixed charges:

Depreciation(1,50,000*4/100)

Plant Supervision

Adm. Overheads

Interest on capital (1,50,000*7/100)

Total

Total A+B+C

(D)Cost per kWH = 1,12,485/15,00,000

= 0.07499

33,735

60,735

21,000

21,000

6,000

5,250

9,000

10,500

30,750

1,12,485

0.075

Canteen Or Hotel Costing

A canteen is established in most of the factories as a welfare facility. Canteens provide

wholesome food and snacks at subsidized rates. The real problem in canteen costing is use of

perishable provisions. This involves careful planning and controlling of various provisions to

be bought from time to time. The record problem is determination of menu which again

depends upon the canteen manager. Menu is sold against the purpose of coupons and

therefore the number of coupons sold in terms of value constitutes the sale value.

For enabling proper accounting three important records are maintained-

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1. Stock register which is maintained by canteen store keeper. As when issues are made

they are recorded to ascertain the cost of materials consumed in the canteen.

2. Wage analysis sheet is maintained by the personal department to record labour cost

and supervision of canteen.

3. Overhead analysis sheet, to calculate proportionate overhead charge.

Purpose

The purpose of canteen costing is to determine a price at which menu is to be sold. For this

purpose it involves classifying the expenses according to the following types:

(a) Provisions: such as rice, wheat flour, oil, sugar, vegetables, fruits, milk, coffee and tea

powder.

(b) Labour: cooks wage, salary of supervisor, wages of kitchen assistants, porters

wages.

(c) Service: such as water, gas, electricity, steam, light

(d) Consumable stores: such as table cloths, crockery, glassware materials, dustbins,

brushes etc.

(e) Overheads: such as rent and rates, insurance, depreciation etc

(f) Sales: this includes revenue from meals, tea and coffee, sale of snacks etc.

Format

Cost sheet of a canteen for the month..

Particulars This month This month last

year

Provisions:

Rice

Wheat flour

Oil

Sugar

Milk

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Coffee

Tea

Vegetables and fruits

Soft drinks

Wages and salaries:

Cooks

Supervisor

Counter helpers

Miscellaneous cost

Crockery and glassware

Maintenance and repairs

Table cloths

Consumable stores

Rent

Gas

Electricity and lighting

Profit

Income from sales

Hospital Costing

Hospital costing may relate to ascertaining the cost of medical service rendering by a

dispensary belonging to a factory or a hospital or a nursing home owned by government or

private doctors. The main object of hospital costing is to ascertain the cost of rendering

service per patient per day. For this purpose a cost sheet is prepared to record the various

expenses incurred in the hospital. Such costs are classified under the following headings:

(1) Medicines

(2) Cost of operation theater

(3) Cost of out-patient department

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(4) Cost of in-patient wards

(5) Salary of physicians, surgeons and nurses

(6) Cost of equipments and instruments

(7) Cost of blood bank

(8) Cost of X-ray and pathological services

Problem:

A public health care center runs an intensive care unit. For this purpose it has hired a building

at a rent of Rs.5000 per month with the understanding that it would bear the repairs and

maintenance charges also.

The unit consists of 25 beds and 5 more beds can be accommodated when the

occasion demands. The permanent staff attached to the unit are as follows:

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2 Supervisors, each at a salary of Rs.500 p.m.

4 Nurses, each at a salary of Rs.300 p.m

2 Wardways, each at a salary of Rs.150 p.m

Though the unit is open for patients all the 365 days in a year. Scrutiny of accounts in

1990 reveals that only for 120 days in the year the unit had the full capacity of 25 patients per

day and for another 80 days it had on an average 20 beds occupied per day. But there were

occasions when the beds were full, extra beds were hired at a charge of Rs.5 per bed per day

and this did not come to more than 5 beds extra above the normal capacity on any one day.

The total hire charges for extra beds incurred for the whole year amounted to Rs.2000.

The unit engaged doctors from outside to attend on the patients and the fee were paid

as basis of the number of patients attended and time spent by them which on an average

worked out to Rs.10000 p.m in 1990.

The other expenses for the year were as under:

Repairs and maintenance 3600

Food supplied to patients 44000

Janitor services 12500

Laundry charges for bed linen 28000

Medicines supplied 35000

Cost of oxygen, X-ray, etc 54000

General administration charges allocated to the unit 49550

If the unit recovered an overall amount of Rs.100 per day on an average from each patient,

what is the profit per patient made by the unit in 1990?

Solution:

Operating Cost Sheet

Rs.

A. Variable cost:

Food

Janitor Services

44,000

12,500

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Laundry

Medicines

Doctor fee 10,000 x 12

Hire charges for extra beds

Total

B. Fixed cost:

Salaries (2 x 500 + 4 x 300 + 2 x 150) 12

Rent 5,000 x 12

Repairs & maintenance

General administration

Cost of oxygen

Total

Total Cost (A+B)

Profit

Income Received

28,000

35,000

1,20,000

2,000

2,41,500

30,000

60,000

3,600

49,550

54,000

1,97,150

___________

4,38,650

61,350____

5,00,000

Profit per patient day = 61,350 = 12.27

5,000

Calculation of patient days: Total Patient Days

= (25 beds x 120 days) + (20 beds x 80 days) + (Extra bed days i.e. 2,000/5)

= 3,000 + 1,600 + 400

= 5,000 days

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