Module 1- Basics of Costing

7/31/2019 Module 1- Basics of Costing

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Concept of Cost

Cost is price paid for something.

The amount of expenditure (actual or notional) incurred for

production of goods and services.

Cost represents the resources that have been or must besacrificed to attain a particular objective.

Resource may be tangible(money, materials, machinery) or they

may take form of services(wages, rent, power).

Cost is composed of three elements; Material, Labour, Expenses

Interpretation of cost depends upon;

The nature of business or industry

The context in which it is used

Cost


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Deferred Cost Deferred costs are the expenses, incurred but the economic

benefit is received for more than one accounting period.

Eg: Acquistion of Plant & Machinery, Building, Equipment,

Prepaid rent and Insurance.

They are shown on the asset side of the Balance Sheet.

Expired Cost or Expenses Amount spent in generating revenues. IOW when the amt is

spent and the economic benefit is received immediately is

called expenses.

Ex: Selling expenses, Administrative exp. Distribution exp.

Expired cost are deducted from revenues to calculate the net

income.


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Loss

Actual expenses exceed the income. No benefit is received from the cost incurred.

It is charged to profit or loss.

Cost

Unexpired Cost

Expired CostDeferred Cost

Expenditure

Balance Sheet

LossExpenses

Profit & Loss A/c


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Classification of Costs

Elements BehaviorFunctions

Material Labour Expenses

DM IM DL IL DE IE

Overheads

Factory

OH

Administrative

OH

Selling

OH

Distributive

OH


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Production Cost or

Works Cost or

Factory cost or

Manu. Cost.

Administrative

CostSelling Costs

Distribution

Cost



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Variable Cost Fixed CostsSemi-Variable or

Semi-Fixed Cost



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Elements of Cost

Material Cost: Cost of commodities supplied to an undertaking.

Material Cost includes;

Cost of procurement, freight inwards, taxes, insurance etc.

Direct Material Cost: DMC is that which can be conveniently identified with and allocated to

cost units. DMC becomes a part of finished product.

Ex: Clay in bricks, Leather in shoes, Steel in machines, cloth in garment,

timber in furniture.

Indirect Material Cost: Cost incurred on those materials which cannot be conveniently identified

with individual cost units.

These are small and relatively inexpensive items which may or may not

physically become a part of finished product.

Eg: pins, screws, nuts & blots, grease, lubricating oil etc.


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Elements of Cost Labour Cost:

This the the cost of remuneration (wages, salaries, commission, bonuses)

of the employees of an undertaking.

It includes all fringe benefits like: PF, Gratuity, ESI, overtime pay,

incentive bonus, wages for holiday, idle time.

Direct Labour Cost: DLC consists of wages paid to workers directly engaged in converting raw

materials into finished product. DLC can be identified with a particular

product, job or process.

Eg: Machine Operator, Shoe-maker, carpenter, weaver, Tailor.

Indirect Labour Cost:

Indirect labour is not directly engaged in the production operations but

only to assist or help in production operations.

Ex: Supervisor, Inspector, Cleaner, Clerk, Peon, Watchmen.


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Elements of Cost Expenses:

Allcosts other than material and labour are termed as Expenses.

Expenses is defined as the cost of services provided to an

undertaking and the notional cost of the use of owned assets

Direct Expenses/Chargeable Expenses:

Direct Expenses are those expenses that can be identified with and

allocated to cost centers or units

These expenses are particularly incurred in connection with a

particular job or cost unit.

Indirect Expenses:

All Indirect costs other than indirect materials and indirect labor

costs are termed as Indirect Expenses.

Expenses which cannot be directly identified with a particular job,

process or work order and are common to cost units or cost centers.


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Direct Expenses

Hire of special plant for aparticular job.

Tarvelling expenes in

securing a particular contract.

Cost of patent rights

Experimental costs

Cost of special drawings,

designs and layouts.

Job processing charges

Royalty paid in mining

Depreciation or hire of a

plant used on a contract at

site.

Indirect Expenses

Rent and Rates

Depreciation

Lighting and Power

Insurance

Repairs


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Classification of Cost based on Function

Production Cost/Factory Overhead/Works Overhead or

manufacturing Overhead

These are the overheads which are concerned with the

production function. It includes indirect materials, Indirect labor and Indirect

expenses in producing goods and services.

Indirect Materials: pins, screws, nuts & blots, grease, lubricating oil etc.

Indirect Labour: Supervisor, Inspector, Cleaner, Clerk, Peon, Watchmen.

Indirect Expense: Rent and Rates,Depreciation,Lighting and Power,

Insurance,Repairs


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Administrative Cost/Overhead It is the indirect expediture incurred in general administrative

function.

These overhead are of general character and have no direct

connection with production or sales activities. Indirect Materials: Stationery used in general administrative office, postage,,

printing etc.

Indirect Labour: Salary of office staff, managing director, remuneration to

directors etc.

Indirect Expense: Rent of office building, office lighting and power,

telephone expenses, depreciation on office furniture etc.


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Selling and Distribution Cost/Overhead Selling overhead is the cost of promoting sales and retaining

customers.

It is defined as the cost of sekking to create and stimulate demand

and of securing orders Eg: Advertisements, samples and free gifts, salaries of salesmen etc.

Distribution cost includes all expenditure incurred from the time the

product is completed until it reaches its destination.

Eg: Carriage outwards, insurance of goods in transit, upkeep of

delivery vans, warehousing etc.


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Classification of Cost based on Behavior Cost behave differently when level of production rise or falls.

Certain costs changes with production level while other costs remain

unchanged.

On basis of behavior or variabiltiy costs are classified into

Fixed Cost Variable Cost

Semi-Variable Cost


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Fixed Cost

These costs remain constant in total amount over a specific range ofactivity for a specified period of time.

Fixed cost do not increase or decrease when the volume of production

changes.

Ex: Rent and lease, Managerial Salaries, Building Insurance, Salaries

& Wages of permanent Staff, Municipal Tax.

1 2 3 4 5

No. of Units Purchased 1 2 20 200 2000

Total Fixed Cost Rs. 20000 20000 20000 20000 20000

Fixed Cost per unit Rs. 20000 10000 1000 100 10

0

5000

10000

15000

20000

25000

FixedCostPerUnitRs.

Fixed Cost


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Variable Cost

These costs tend to vary in direct proportion to the volume of output. Variable Cost per unit remains fixed.

Variable cost can be controlled by functional managers.

Ex: Direct Materials, Wages, Power, Commission on Salesmen etc.


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Semi-Variable or Semi-Fixed costs

These costs include both a fixed and a variable component.

These costs are partly fixed and partly variable.

Semi-variable cost has a fixed element below which it will not

fall at any level of output. Variable element in semi-variable costs changes either at a

constant rate or in lumps.

Ex: Introduction of an additional shift in the factory will

require additional supervisors. Telephone expense, Power etc.


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Cost Centre Acc to ICMA (The chartered Institute of Management Accountant),

London define cost centre as a location, person or item ofequipment(or group of these) for which costs may be ascertained and

used for the purpose of control.

IOW Cost centre refers to a section of the business to which costs

can be charged. The purpose of ascertaining the cost of cost centre is to control cost.

A cost centre is charged with all the costs that relate to it.

Eg: If a cost centre is a machine, it will be charged with the cost of

power, light, depreciation and its share of rent etc.

Types of Cost Centres:

Personal Cost Centre

Impersonal Cost Centre


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Cost Unit

Cost unit is the unit of measurement of cost.

Cost unit is defined as a unit of product or service in

relation to which costs are ascertained

Cost units are of two types: Units of Production: a tonne of steel, a metre of cable, a

ream of paper etc.

Units of Service : Passenger miles, cinema seats, consulting

hours etc.


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Cost Object

Cost object is defined as anything for which a separatemeasurement of cost may be desired.

A cost object may be a product, service, activity or

process.

Cost Object Examples Product Car, Shaving Razor

Service Telephone hotline, taxi service

Process Weaving process in textile mill

Activity Developing a website, Purchasing a rawmaterial


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Component of Total Cost


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Cost Sheet

For determination of total cost of production a statement

showing the various elements of cost is prepared. This

statement is called as a statement of cost or cost sheet.

Cost sheet is a document that provides for the assembly of an

estimated detailed cost in respect of cost centers and cost units.

It analyzes and classifies in a tabular form the expenses on

different items for a particular period.

Cost sheet may be prepared on the basis of actual data

(historical cost sheet) or on the basis of estimated data

(estimated cost sheet)


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Items excluded from cost sheet or Non-Cost Items

Non-cost items are those items which do not form part of cost of a product.Such items should not be considered while ascertaining the cost of a

product. These are items included in the Profit & Loss A/c.

a) Income tax

b) Interest on capital

c) Interest on loan

d) Profit on Sale of fixed assets

e) All the assets

f) Donations

g) Capital Expenditure

h) Discount on shares & Debentures

i) Commission to Partners, Managers etc

j) Brokerage

k) Preliminary Expenses Written off.

l) Wealth tax etc


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Cost Ascertainment and Cost Estimation(Historical Cost & Future Cost)

Cost Ascertainment

It is concerned with computation of actual costs incurred.

It refers to the methods and processes employed in

ascertaining costs.

Cost ascertainment is the process of determining costs on

the basis of actual data.

Ascertained cost may be compared with the pre-determined

costs on a continuing basis and proper and timely steps be

taken for controlling costs and maximizing profits.


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Cost Estimation

Cost estimation is the process of pre-determining the cost

of a certain product job or order.

Costs are determined in advance of production and

precede the operations. Estimated costs are future costs.

Purpose of Cost Estimation;

Budgeting

Measurement of performance efficiency

Preparation of financial statements (valuation of stocks etc.)

Make or buy decisions

Fixation of the sale prices of products


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Cost Allocation and Cost Apportionment

Cost Allocation

Cost allocation refers to

the allotment of all the

items of cost to cost

centers or cost units.

IOW it is the process of

charging direct

expenditure to cost centers

or cost units

The cost of labor engaged

in a service department

Cost Apportionment

Cost Apportionment refers

to the allotment of

proportions of items of cost

to cost centers or cost units

It is the process of charging

indirect expenditure to cost

centers or cost units in

certain proportion.

Canteen Expenses of the

factory


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Product Costs & Period Costs

Product Costs

These are the costs which are

necessary for production.

These are absorbed by or

attached to the units produced. These are inventoriable costs.

Product cost is carried forward

to next accounting period.

Direct Materials, direct labor,

some of the factory overheads.

Period Costs

These are those costs which are

not necessary for production and

are incurred even if there is no

production. These costs are written off as

expenses in the period in which

these costs are incurred.

These are not inventoried.

Showroom rent, salary ofcompany executives, travel

expenses. Administration exp.

Etc.

Classification of cost into product & period cost is from the

point of view of profit determination.


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Controllable & Non-Controllable Cost

Controllable

These are the costs which may

be directly regulated at a given

level of mgt. authority.

Variable costs are generallycontrollable by dept. heads.

Eg: Cost of raw materials.

Non - Controllable

These are those costs which

cannot be influenced by the

action of a specified member of

an enterprise. Ex. Factory Rent, Managerial

salaries etc.

Classification of cost into product & period cost is not possible

without specifying the level and scope of mgt. authority


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Normal Cost and Abnormal Costs

Normal

Normal cost includes those items

of cost which occur in the

normal situation of production

process or in the normalenvironment of the business.

It is considered to be a part of

cost of production.

Abnormal Costs

Abnormal Cost is an unusual or a

typical cost whose occurrence is

usually irregular and unexpected

and due to some abnormalsituation of the production.

Heavy break down of machinery

or abnormal process loss.

It is charged to costing profit &

loss account.


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Cost Accounting

CIMA, London defines Cost Accounting as

it is the process of accounting for costs from the point of which

expenditure is incurred or committed to the establishment of its

ultimate relationship with cost centers and cost units.

Difference between costing and Cost Accounting:

Costing is basically finding out cost of products or services by

any technique or method.

Cost Accounting is application of double entry system for

recording costs.


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Objectives & Functions of Cost Accounting

Ascertainment of Cost

Cost control and cost reduction

Guide to business policy Determination of selling price


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Method of Costing The principles in every method of costing are same but the

methods of analyzing and presenting the costs differ with the

nature of business.

Job Costing

Contract Costing

Cost plus Costing

Batch Costing

Process Costing

Operation Costing

Unit Costing (Output Costing or Single Costing)

Operating Costing

Departmental Costing

Multiple Costing (Composite Costing)


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SummaryConcept of Cost

Cost v/s Expense and Loss


Cost CentreCost Unit

Cost Object

Cost Sheet

Cost Ascertainment and Cost Estimation

Types of Costs

Meaning of Costing and Cost Accounting

Objectives of Cost Accounting

Methods of Costing

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Module 1- Basics of Costing

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