Cost Accounting- meaning, methods, techniques, types

1
Bhagwan Mahavir College of Commerce and Management Studies
Course : S.Y. B. COM. Sem 3
Subject : Cost Accounting
Chapter : Introduction to Cost Accounting
Prepared By : Dr. Harshita Bhatia

1.1 Meaning, Definition, Cost Concept, Cost Accounting and Cost Accountancy :
1.1.1. Meaning of Cost
1.1.2. Meaning and Definition of Cost Accounting :-
1.1.3. Cost Accountancy :
1.1.4. Costing
1.2 Objectives and Functions of Cost Accounting and Cost Unit :-
1.2.1. Objectives of Cost Accounting :-
a) Cost Reduction
b) Performance evaluation
c) Decision making
d) Budgeting and forecasting
e) To examine the costs
f) Per unit cost of different types of products
g) Helps cost auditor in easily analysing the data
h) Acts as a backup in soft copy instead of hard copy
i) Helps in finalisation of financial statements
CONTENTS OF UNIT 1 :-
BMCCMS

1.2.2. Functions of Cost Accounting :
a) Ascertainment of Costs
b) Controlling Costs
c) Aid to management
d) Setting up selling prices
e) Inventory Control
f) Discloses profitable and non profitable activities
g) Measurement of efficiencies
1.3 Cost Centre, Responsibility Centre, Profit Centre, Cost Control, Cost
Reduction :-
1.3.1. Cost Centre
1.3.2. Responsibility Centre
1.3.3. Profit Centre (Importance, Characteristics, Advantages, Disadvantages, Types,
Cost Centre vs. Profit Centre)
1.3.4. Cost Control (Factors, Tools, Advantages and Disadvantages)
1.3.5. Cost Reduction (Cost Control vs. Cost Reduction)
1.4 Distinction between Cost Accounting and Financial Accounting, Essentials of a
good costing system, Installation of costing system, Methods and Techniques of
Cost Accounting :
1.4.1 Distinction between Cost Accounting and Financial Accounting :
h) Meaning
i) Information type
j) Which type of cost is used for recording?
k) Valuation of stock
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e) Users
f) Mandatory
g) Forecasting
h) Purpose
i) Profit Analysis
j) Reporting time
1.4.2. Essentials of a good costing system :
a) Suitable to Business
b) Economical
c) Simplicity
d) Accuracy and Timeliness
e) Flexibility
f) Reconcilable
g) Cooperation of other departments
h) Adequate wage procedure
i) Comparability
1.4.3. Installation of a costing system :-
(A) Matters to be considered before installing the system
•minimum disturbance
•not be undue economy
•least resistance
•simple to operate
•attention of higher level management to important matters. BMCCMS

(B) Preliminary Investigation
•Product
•Manufacturing methods
•Organisation
•Selling system
(C) Steps for installation of costing system
•To know objectives
•To study existing information
•Determining cost accounting structure
•To determine cost rates
•Installing the system
•Setting up the cost office
•Cooperation with other departments
•Clarification of authority and responsibility
(D) Characteristics of a good costing system
a) Suitable to Business
b) Economical
c) Simplicity
d) Accuracy and Timeliness
e) Flexibility
f) Reconcilable
g) Cooperation of other departments
h) Adequate wage procedure
i) Comparability BMCCMS

(E) Practical difficulties in the way of Installation
a) Resistance
b) Lacks of support of top management
c) Shortage of trained staff
d) Involves heavy cost
1.4.4. Methods of Cost Accounting :-
a) Unit / Single / Output Costing
b) Job Costing
c) Contract / Terminal Costing
d) Batch Costing
e) Process Costing
f) Operating / Service Costing
g) Multiple Costing
1.4.5. Techniques of Cost Accounting :-
a) Uniform Costing
b) Historical Costing
c) Standard Costing
d) Marginal Costing
1.5 Advantages and Disadvantages of Cost Accounting, Cost Concept and
Classification, Element of Cost :-
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(A) Advantages to Management
i) Facilitates comparison
ii) Measures economic performance
iii) Fixation of prices
iv) Aids in decision making
v) Helps in minimising wastages and losses
vi) Assists in increasing profitability
vii) It guides future production policy
(B) Advantages to Employees
i) Earn better wages
ii) Job security
iii) Merit rating techniques
(C) Advantages to Creditors
i) Increases confidence
ii) To know solvency position
(D) Advantages to the Government
i) Helps in formulating policies
ii) Helps in assessing tax
iii) Helps in prepare national plans
(E) Advantages to Society
i) Pay less price for goods and services
ii) Offers Job opportunities
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1.5.2 Limitations of Cost Accounting :
i) It is expensive
ii) The system is more complex
iii) Not suitable for small scale units
iv) It lacks social accounting
v) Lack of Uniformity
vi) Does not include all items of expense and income
vii) Involves many forms and documents
viii) Conventions
1.5.3. Cost Concepts :
a) Cost
b) Cost Driver
c) Cost Unit
d) Cost Centre
• Basic Classification
• Personal Cost Centre
• Impersonal Cost Centre
• Functional Classification
• Production Cost Centre
• Service Cost Centre
• Other
• Operational Cost Centre
• Process Cost Centre BMCCMS

e) Expense
f) Loss
g) Conversion Cost
h) Contribution
1.5.4. Classification of Cost Accounting :
(A) According to Element or Cost
i) Direct Costs
ii) Indirect Costs
(B) According to Functions or Operations
i) Factory / Works / Production overheads
ii) Administrative / Office overhead
iii) Selling and Distribution overheads
iv) Research and Development overheads
(C) According to Nature / Behaviour
i) Fixed overheads
ii) Variable overheads
(D) According to Time
i) Historical Costs
ii) Pre-determined Costs
(E) According to Period or Product
i) Product Costs
ii) Period Costs
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(F) According to Managerial Decision Making
i) Marginal Costs
ii)Relevant Costs
iii) Differential Costs
iv) Sunk Cost
v) Opportunity Cost
1.5.5. Elements of Cost Accounting :
A) Direct Costs
i) Direct Material
ii) Direct Labour
iii) Other Direct Expenses
B) Indirect Costs
i) Factory overheads
ii) Administrative overheads
iii) Selling and Distribution overheads
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UNIT 1 : Introduction to Cost
Accounting -
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1.1 Meaning, Definition, Cost Concept, Costing, Cost Accounting
and Cost Accountancy :-
• 1.1.1. Meaning of Cost :-
• 1.1.2. Meaning and Definition of Cost Accounting :-
Cost Accounting is a system
of accounting
Which helps in determining
cost of production of goods
or services
With reasonable accuracy
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• Cost Accounting is a process of collecting, recording, classifying, analyzing,
summarizing, allocating and evaluating various alternative course of action and
control of costs.
• Its goal is to advise the management on the most appropriate course of action
based on the cost efficiency and capability.
• Cost Accounting provides the detailed cost information that management
needs to control current operations and plans for the future.
• According to CIMA (Chartered Institute of Management Accountants), Cost
Accounting is defined as a system put in place by the management to generate
the amount incurred in the production of goods and services so as to determine
the cost of production and profit generated in the organization.
• For example, It is not sufficient to know that the cost of one pen is Rs. 25/- but
the management is also interested to know the cost of material used, the
amount of labour and other expenses incurred so as to control and reduce its
cost. It establishes budgets and standard costs and actual cost of operations,
processes, departments or products and the analysis of variances, profitability
and social use of funds. Thus Cost Accounting is a quantitative method.BMCCMS

1.1.3. Cost Accountancy :
•It is a wider term than Cost Accounting.
•CIMA, London defines Cost Acountancy as “the application of costing and cost
accounting principles, methods and techniques to the science, art and practice of cost
control and ascertainment of profitability. It includes the presentation of information
derived there from the purpose of managerial decision making.
•Cost Accountancy includes :
Cost Accounting :- It is the process of accounting for costs.
 Costing :- It is the technique and process of ascertaining costs.
 Cost Control
 Cost Reduction
 Cost Audit :- It is the verification of cost accounts and a check on the
adherence to the cost accounting plan.
1.1.4. Costing :
CIMA London has defined Costing as “The technique and process of ascertaining
costs. ”
BMCCMS

1.2 Objectives and Functions of Cost Accounting and Cost
Unit :-
1.2.1. Objectives of Cost Accounting :-
Cost
Reduction
• Cost accounting helps in controlling the costs of production, identifying the
cost of each process and identifying the inefficiencies in each process.
• Cost reduction is important for the survival of the business, especially in the
current competitive business environment.
Performance
Evaluation
• Cost accounting helps in evaluating the performance of different
departments, processes, and products.
• Performance evaluation helps the management to understand the efficiency
of each process and take necessary actions to improve efficiency.
Decision
Making
• Cost accounting provides accurate and reliable information that
management can use to make informed decisions by providing accurate data
on the costs of different alternatives..
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Continue….
Budgeting and
Forecasting:
• Budgeting involves planning the future business operations and allocating
resources to achieve the goals of the business.
• Forecasting involves estimating future trends in the market and the impact of
those trends on the business.
To Examine the
Costs
• Sometimes, the management wants to decide whether to produce the
product in-house or outsource the same.
• For making such a decision, management has to thoroughly examine the
costs associated with the production of the product in-house.
Per Unit Cost
of Different
Types of
Product
• Various entities produce many types of products within a factory, and
purchasing the required product.
• Then by correctly analyzing all the costs for the respective products, one can
quickly determine the per-unit cost of production for different products.
BMCCMS

Helps Cost
Auditor in
Easily
Analyzing the
Data
• As per the policies and regulations of the Government, companies fulfill
the criteria to maintain records in a prescribed manner and get them
audited by the person authorized to do. i.e., Cost Auditor.
• Properly maintained accounts and allocation of records positively affect
the auditor’s mind.
Acts as a
backup in Soft
copy Instead of
Hard Copy
• When records are maintained properly, it helps the management easily
to check the records as and when required from any remote location.
• In addition, it serves as a backup of all the physical records maintained
in digital form and can be easily kept over the years.
Helps in
Finalization of
Financial
Statements
• At the time of preparation of financial statements, the properly
maintained accounts help the financial analysts easily understand the
costs and expenses that an enterprise incurred over some time and
could also save time.
Continue…..
BMCCMS

1.2.2 Functions of Cost Accounting :-
Ascertainment
Of Cost
• Cost Accounting records each and every element relating to production
activity systematically like fixed and variable cost, direct and indirect cost.
• The data collected by cost accounting is analyzed by managers in
determining the true and actual cost of products
Controlling
Cost
• Cost accounting supplies detailed information related to the cost of each
step of production.
• Information collected is then compared with standards and if any
deviation is found, necessary steps are taken. Therefore it helps in the
detection of deviations in cost and time controlling them.
Aid To
Management
• Cost Accounting supplies them all relevant data to the managers
periodically that may be monthly, quarterly or half-yearly.
• Managers analyze the detailed cost information, framed and implement
policies and taking strategic decisions in the organization.
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Continue….
Setting Up
Selling
Prices
• Cost accounting helps in the ascertainment of the accurate cost of production of
products by adding the profit margin to the real cost, company can easily fix the
selling cost for its products.
• Businesses use different techniques like batch costing, job costing, service, and
output costing for determining the selling price of its products.
Inventory
Control
• Cost Accounting maintains complete records of all raw materials so that timely
proper order for raw materials can be made. It avoids all situations like over-
ordering and under-ordering of raw materials.
• It avoids wastages of resources and the occurrence of losses for the organization.
Discloses
Profitable
And Non-
Profitable
Activities
• Cost accounting gives clear details of each activity of business to managers that
which one is profitable and which one not.
• Managers by comparing the cost of the product with demand in the market can
decide whether to continue its production or not.
Measurement
Of Efficiency
• Managers can easily acquire information regarding production cost which can be
analyzed to find out how efficiently a business is running.
• It uses a standard cost method in measuring the efficiency of each process,
product and department.
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1.3 Cost Centre, Responsibility Centre, Profit Centre, Cost
Control, Cost Reduction :-
1.3.1. Cost Centre :-
Cost
Centre
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1.3.2. Responsibility Centre :-
A responsibility center is an operational unit or entity within an organization,
that is responsible for all the activities and tasks structured for that unit.
Examples of responsibility centers are a sales office, a purchasing department for
several locations, and a plant planning office.
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Cost Centre vs. Profit Centre :-
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1.3.4 Cost Control :-
•Cost control is the practice of identifying and reducing business expenses to
increase profits, and it starts with the budgeting process.
•Cost control is an important factor in maintaining and growing profitability.
Several factors that are involved in monitoring the cost control of a project:
•Cost of labor.
•Cost of materials.
•The actual cost.
•The cost variance.
•Return on investment (ROI).
•Planning the budget properly.
•Monitoring all expenses using checkpoints.
•Using change control systems.
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Tools of Cost Control :-
a) Cost Estimate
b) Budget
c) Cost Monitoring
d) Financial Evaluation
Advantages :-
•It enhances the creditworthiness of a company.
•It helps in enhancing the return on capital employed for an organization.
•It helps the management in increasing productivity with the available resources.
•This mechanism helps an organization in enhancing the volume of profits with
minimum sales and output.
•This system helps the employees in sourcing jobs continuously.
•This system helps the employees in earning reasonable remuneration and incentives.
Disadvantages :-
•It can sometimes lead to mismanagement, which can further lead to some severe and
adverse problems for an organization.
•The probabilities of human errors in the cost control system can lead to serious
inaccuracies, and the management might end up making certain decisions that can
ultimately impact the profitability of an organization.
BMCCMS

1.3.5 Cost Reduction :-
•Cost reduction is the process of decreasing a company's expenses to
maximize profits.
•It involves identifying and removing expenditures that do not provide
added value to customers while also optimizing processes to improve
efficiency.
•Cost reduction typically focuses on generating short-term savings.
•The goal of cost reduction is to lower the overall costs of operating the
business without compromising quality or negatively impacting other
areas of the company.
•Cost reduction has a significant role in reducing the per unit costs of
products and are thus essential for firms to maximise their profits.
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1.4 Distinction between Cost Accounting and Financial
Accounting, Essentials of a good costing system, Installation of
costing system, Methods and Techniques of Cost Accounting :-
Basis for
Comparison
Cost Accounting Financial Accounting
a) Meaning Cost Accounting is an
accounting system, through
which an organization keeps
the track of various costs
incurred in the business in
production activities.
Financial Accounting is an
accounting system that
captures the records of
financial information about the
business to show the correct
financial position of the
company at a particular date.
b) Information
type
Records the information
related to material, labor and
overhead, which are used in
the production process.
Records the information which
are in monetary terms.
1.4.1. Distinction between Cost Accounting and Financial Accounting :-
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Basis for
Comparison
c) Which type of
cost is used for
recording?
Both historical and pre-
determined cost
Only historical cost.
d) Valuation of
Stock
At cost Cost or Net Realizable Value,
whichever is less.
e) Users Information provided by the
cost accounting is used only
by the internal management
of the organization like
employees, directors,
managers, supervisors etc.
Users of information provided
by the financial accounting are
internal and external parties
like creditors, shareholders,
customers etc.
f) Mandatory No, except for
manufacturing firms it is
mandatory.
Yes for all firms.
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Basis for
Comparison
g) Forecasting Forecasting is possible
through budgeting
techniques.
Forecasting is not at all
possible.
h) Purpose Reducing and controlling
costs.
Keeping complete record of
the financial transactions.
i) Profit Analysis Generally, the profit is
analyzed for a particular
product, job, batch or
process.
Income, expenditure and
profit are analyzed together
for a particular period of the
whole entity.
j) Reporting
Time
It is frequently prepared and
monitored accordingly.
It is reported mostly at the
end of an accounting period.
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1.4.2. Essentials of a good costing system :-
An ideal costing system is one that offers the organization the most advantages
and benefits of cost accounting.
a)Suitable to
Business
The costing system must suit the organization. The system should be devised so that it
suits the nature, conditions, manufacturing methods, size of the company etc.
Of course, the basic principles of costing remain the same for any type of business.
• But the methods and techniques to be adopted differ from industry to industry.
b)Economical
• Any system to be introduced should yield more benefits than its cost.
• E.g. if the business is a small scale one, elaborate costing system is not required.
c)Simplicity
• The system should be simple and easy to understand and operate.
• The data presented in the cost reports must not be complicated and can be easily
understood by the executive to whom it is to be presented.
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d)Accuracy
and
Timeliness
• The data presented in cost reports and statements must be accurate and
correct.
• Secondly, the reports must be submitted at right time, otherwise it would
lose its utility. Sometimes, even with less accuracy, the reports presented in
time, so that the management may be able to take corrective steps in time.
e)Flexibility
• The costing system should be flexible in the sense that it should be able
to do changes according to changes in conditions and circumstances.
• Otherwise it would become rigid and would lose it utility.
f)Reconcilable
If possible, the cost and financial accounts should be integrated.
• If this is not possible, then, the cost accounts may be so devised that it
can be easily reconciled with figures of financial accounts.
Continue….
BMCCMS

Continue…
g)Co-operation
of other
Departments
• Since cost accounting pervades all departments, it should be designed in such
a way that the cooperation of all others departments can be obtained.
• The cost accountant should try to explain to them the benefits of the system
available to them.
h)Adequate
Wage
Procedure
• In order to control wage cost, a well- defined system of time keeping,
time booking and wage system should be introduced.
• The procedure of preparation of wage sheets and wage payments should
be efficient.
i)Comparability
• The ideal costing system provides the management facts and data in such a way,
that it can be compared with the data from the previous year and also with the
data of other organizations of the same industry.
• This comparison helps the management evaluate the performance of the
organization, hence it is an important aspect.
BMCCMS

1.4.3. Installation of a costing system :-
• a) minimum disturbance
• b) not be undue economy
• c) Least resistance
• d) simple to operate
• e) attention of higher level management to important
matters.
(A) Matters to be
considered before
installing the system
• a) Product
• b) Manufacturing methods
• c) Organisation
• d) Selling system
(B) Preliminary
Investigation
• a) To know objectives
• b) To study existing information
• c) Determining cost accounting structure
• d) To determine cost rates
• e) Installing the system
• f) Setting up the cost office
• g) Cooperation with other departments
• h) Clarification of authority and responsibility
(C) Steps for
installation of
costing system
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• a) Suitable to Business
• b) Economical
• c) Simplicity
• d) Accuracy and Timeliness
• e) Flexibility
• f) Reconcilable
• g) Cooperation of other departments
• h) Adequate wage procedure
• i) Comparability
(D) Characteristics
of a good costing
system
• a) Resistance
• b) Lacks of support of top management
• c) Shortage of trained staff
• d) Involves heavy cost
(E) Practical
difficulties in the
way of Installation.
BMCCMS

•We discuss the installation of costing system from the viewpoint of various angles.
•They are:
(A) Matters to be considered before installing the system
(B) Preliminary Investigation
(C) Steps necessary for Installation
(D) Characteristics of a good costing system
(E) Practical difficulties in the way of Installation.
(A) Matters to be Considered :
•There should be minimum disturbance in the existing organisation.
•Care should be taken that there are not too many forms and registers; Also, there
should not be undue economy at the cost of efficiency.
•This system should be introduced gradually so that there is least resistance and its
introduction is smooth.
•The method must be simple to operate and understand.
•The system should be able to draw the attention of higher level management to
important matters.
BMCCMS

(B) Preliminary Investigations :
a) Product : In order to determine which method of costing is to be applied, the
cost accountant should know the nature of product or products
manufactured by the company. If one product is produced, the method will
be simple. If the product contains materials of high value, it would require
elaborate system of material control.
b) Manufacturing Methods : Various industries employ different methods of
manufacturing. If the method depends mainly on manual labour, more
attention should be paid to labour costs. If it uses sophisticated machines, the
question of allocation of overhead becomes important.
c) Organisation : The cost accountant needs to study the organisation structure
of the company. This will help him in determining the extent of authority
given to each executive, his responsibilities and the types of reports required
at each managerial level.
d) Selling System : The system adopted by the company for selling and
distribution of its products should be studied by the cost accountant. This
requires that the cost accountant should discuss the matter with the sales
manager or marketing manager. BMCCMS

(C) Steps necessary for Installation :
a) To Know Objectives : If the objective is to determine only the cost, it may be
simple. But an elaborate system is required, if the objective is to control cost
and to assist in managerial decision making.
b) To Study Existing Organisations : Next step for installation is to study the
existing organization structure by the cost accountant, so that he may know
the cost data needs of various managerial personnel. This study will help
them to determine the authority and responsibility of each executive, what
information can be accessed from whom, etc.
c) Determining Cost Accounting Structure : The cost accounting system suited
to the type of business being carried on by the company has to be adopted.
The cost system has to be so structured that cost data is made available at
every important stage of manufacture.
d) To Determine Cost Rates : Cost rates for each element of cost have to be
determined. For this purpose, the cost has to be classified into direct and
indirect and has also into functional groups like factory overheads,
administrative overheads, selling and distribution overheads etc.
BMCCMS

e) Installing the System : Once, the structure is determined, the system has to be
introduced. the cost accountant should try to obtain co-operation of all officials, and
the benefits of system available to all departments and to the business should be
discussed with them.
f) Setting up the Cost Office : It is desirable that the office should be located near the
factory, so that necessary cost data is easily available. Staff members of the costing
departments should be allowed to visit the factory to collect necessary information.
Sufficient staff members should be appointed so that necessary reports are accurately
prepared in time. He should have adequate staff for :
•Stores accounts = including recording of receipts and issues of stores, preparation of
stores book etc.
•Wages Accounts = which includes preparation of pay sheets from time cards and job
cards,
•Cost Accounts = which includes preparation of accounts and details of each job or
batch, contract and income accounts.
•Cost Control Accounts.
g) Co-operation with Other Departments : Cost Accounts Department occupies an
important position in the organization and the Cost Accountant should be directly
responsible to the Managing Director. However, he has to meet the needs of
managerial personnel at all levels and hence he has to co-operate with all the
departments. BMCCMS

h) Clarification of Authority and Responsibility : Authority and responsibility of
various officials should be clearly understood. The management should also
clarify the relationship so that no conflict develops and the cost accountant is
able to devise his reports accordingly.
(D) Characteristics / Essentials of a good costing system : Already Discussed
(E) Practical difficulties in the way of Installation :
a) Resistance : Wherever a new system is adopted, it is bound to meet with
resistance from the existing staff. They feel their importance would be
reduced.
b) Lack of support of Top Management : No system can be successful unless it
has the whole hearted support of top management.
c) Shortage of Trained Staff : There is a shortage of trained staff for operating a
costing system, particularly in India.
d) Involves heavy cost : Any new system to be introduced requires money.
BMCCMS

a) Unit / Single / Output Costing
b) Job Costing
c) Contract / Terminal Costing
d) Batch Costing
e) Process Costing
f) Operating / Service Costing
g) Multiple Costing
a) Uniform Costing
b) Historical Costing
c) Standard Costing
d) Marginal Costing
Methods of Cost Accounting : Techniques of Cost Accounting :
BMCCMS

1.4.4. Methods of Cost Accounting :-
a) Unit Costing :- It is also known as single or output costing. It is applicable in a
manufacturing unit where manufacturing is continuous, all the units of the product
are similar. It is a system of costing in which the cost per unit of output is
determined. The method is generally used in brick-making, paper mills, dairies,
cement industry, mines and quarries, flour mills, steel plants, etc. Cost per unit =
Total cost / Total number of units.
b) Job Costing :- It is a costing method used to determine the cost of specific jobs,
which are performed according to the customer's specifications. Each job is
assigned job name or number to ascertaining the actual costs. It is of short
duration. It is used in industries where the work is not of repetitive nature but
undertaken on receiving orders from customers. The method is generally used in
Printing press, Garage and repairs shops, Painting and Interior decorating,
Production of made to order articles, etc.
c) Contract Costing :- Another variant of Job Costing is known as Contract or Terminal
Costing. It is of long duration. Under this method, Contract Account for each
contract is separately prepared. It is generally used in Construction of building,
road, bridge etc. Ship-Building industry, Manufacture of large and complicated
machines, etc. BMCCMS

Continue….
d) Batch Costing :- Another variant of Job Costing is Batch Costing. It is
calculating the total cost of each batch. Batch is small group of units which is
produced for production purposes. It is employed where orders are arranged
in batches convenient for production. It is useful to determine economic
batch quantity. It is generally used in Pharmaceutical industry, Hardware
making (bolts, nuts, screw etc), Bicycle parts, Toy manufacturing etc.
e) Process Costing :- Process costing is a method of costing used mainly in
manufacturing where units are continuously mass-produced through one or
more processes. It is desirable to ascertain the cost of production at each
stage or process. The method is used in chemical works, petroleum, sugar,
cotton textiles industries, soap making, oil refineries, paint manufacturing,
etc.
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Continue….
f) Operating or Service Costing :- Operating costing is a process and technique of
accumulating and ascertainment of cost for providing a standardized service to
the public or to an undertaking. Operating costs are the day-to-day expenses of
running the business. It is used in power house, transport companies, water
works, hospitals, railways , airlines companies, road transport, electricity
companies, gas supply companies, hotels, etc.
g) Multiple Costing :- It is also known as composite costing. When two or more
methods of costing are used in the same business unit, it is used. This method is
generally used in automobile industry, bicycle making industry, radio and
television industry, sewing machine making industry, typewriter making industry,
manufacture of motor cars, etc.
BMCCMS

1.4.5. Techniques of Cost Accounting :-
a) Uniform Costing :- Where several undertakings of the same industry use the same
costing principles and practices, then it is uniform (same) costing. A trade association or
an Industry may laid down costing practices to be followed by all its members. CIMA
London defines Uniform Costing as, “the use by several undertakings of the same
costing principles and/or practices”.
b) Historical Costing :- When costs are ascertained after they are already incurred, it is
termed as Historical Costing. For example, Cost of production per unit produced in
January is ascertained in February.
c) Standard Costing :- It's a branch of cost accounting that's used by a manufacturer, for
example, to plan their costs for the coming year on various expenses such as direct
material, direct labor or overhead. It is pre-determined costs relating to manufacturing
process. It is estimated and recorded in the beginning of the financial year. It promotes
efficiency. It is very useful in controlling costs.
d) Marginal Costing :- Marginal costing is used to know the impact of variable cost on the
volume of production or output. It is a technique of decision making. It is a costing
technique that focuses on segregating costs into fixed and variable components. It is a
technique of cost and management accounting which is used to analyse relationship
between cost, volume and profit. It is the variable cost which arise only when
production continues. BMCCMS

1.5 Advantages and Disadvantages of Cost Accounting, Cost Concept
and Classification, Element of Cost :-
• i) Facilitates comparison
• ii) Measures economic performance
• iii) Fixation of prices
• iv) Aids in decision making
• v) Helps in minimising wastages and losses
• vi) Assists in increasing profitability
• vii) It guides future production policy
(A) Advantages to
Management
• i) Earn better wages
• ii) Job security
• iii) Merit rating techniques
(B) Advantages to
Employees
• i) Increases confidence
• ii) To know solvency position
(C) Advantages to
Creditors
BMCCMS

• i) Helps in formulating policies
• ii) Helps in assessing tax
• iii) Helps in prepare national plans
(D) Advantages to
the Government
• i) Pay less price for goods and services
• ii) Offers Job opportunities
(E) Advantages to
Society
Continue…..
BMCCMS

A) Advantages to Management :
i) Facilitates comparison :- It facilitates cost comparison in respect of jobs,
process, and departments, also between two periods. This reveals the
efficiency or otherwise of each job process or department.
ii) Measures economic performance :- By applying cost control techniques such
as budgetary control and standard costing it helps in assisting the
performance of business.
iii) Fixation of price :- By providing cost data it helps management to fix the
selling price in advance. Hence, quotations/tenders can be supplied to
prospective customers to secure orders.
BMCCMS
1.5.1. Advantages of Cost Accounting :-

Continue….
iv) Aids in decision-making :- It helps management in making suitable decisions
such as make or buys, replace manual labour by machines, shut down or
continue operations based on cost reports.
v) Helps in minimising wastages and losses :- Cost accounting system enables
to locate the losses relating to materials, idle time and under utilisation of
plant and machinery.
vi) Assists in increasing profitability :- Costing reports provide information
about profitable or unprofitable areas of operation. The management can
discontinue that product line or that department which are responsible for
incurring losses. Thereby only profitable lines of activities alone are retained.
vii) It guides future production policy :- Cost data help management in
determining future production policy. Any expansion or contraction of
production for the future is based on past cost data.
BMCCMS

Continue….
B) Advantages to Employees :
i) Earn better wages :- Cost accounting system enables employees to earn better
wages through overtime wages and incentive systems of wage payment.
ii) Job Security :- By providing better facilities it ensures job security to
employees.
iii) Merit Rating techniques :- Employees benefit by merit rating techniques which
is conducted by scientific process.
C) Advantages to Creditors :
i) Increases confidence :- It increases the confidence of creditors in the capital
employed in the business.
ii) To know solvency position :- The frequent preparation of reports and
statements help in knowing solvency position of the business.
BMCCMS

Continue….
D) Advantages to the Government :
i) Helps in formulating policies :- It helps government in formulating policies
regarding export, import, taxation, price control measures, wage fixation, etc.
ii) Helps in assessing tax :- It helps in assessing excise duty, sales tax and income tax of
the business.
iii) Helps to prepare national plans :- Costing information helps in preparing national
plans.
E) Advantages to Society :
iv) Pay less price for goods and services :- Cost reduction and cost control programmes
go to minimise cost of production of goods and services. A portion of the reduced
cost of production is shared by customers by paying less price for goods and
services.
v) Offers job opportunities :- It offers employment opportunities in the cost
accounting department in the capacity of cost accountants and cost clerks. BMCCMS

1.5.2 Limitations of Cost Accounting :
i) It is expensive
ii) The system is more complex
iii) Not suitable for small scale units
iv) It lacks social accounting
v) Lack of Uniformity
vi) Does not include all items of expense and income
vii) Involves many forms and documents
viii) Conventions
BMCCMS

i) It is expensive :- The system of cost accounting involves additional
expenditure to be incurred in installing and maintaining it.
ii) The system is more complex :- As the cost accounting system involves
number of steps in ascertaining cost such as collection and classification of
expenses, allocation and apportionment of expenses, it is considered to be
complicated system of accounts. Moreover the system makes use of several
documents and forms in preparing the reports. This will tend to delay in the
preparation of accounts.
iii) 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.
iv) 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.
BMCCMS

Continue….
v) Lack of Uniformity :- Due to a lack of formal structure cost accounting methods
can differ widely from business to business so that it is not comparable from
business to business. Businesses in the same industry may have markedly different
treatments of the same cost accounting information. The absence of a uniform
standard is the primary limitation of cost accounting.
vi) Does not include all items of expense and income :- Items of purely financial
nature such as interest, financial charges, discount and losses on an issue of
shares and debentures, etc., are not taken into consideration in Cost Accounting.
vii) Involves many forms and statements :- It involves usage of many forms and
statements which leads to increase of paperwork.
viii) Conventions :- Several conventions are routinely applied or used in costing
which may not be appropriate in all situations. For example, classifying overheads
into variable and fixed, recovery of overheads on machine hour or labour hour
basis etc.
BMCCMS

1.5.3. Cost Concepts :
a) Cost
b) Cost Driver
c) Cost Unit
d) Cost Centre
e) Expense
f) Loss
g) Conversion Cost
h) Contribution
BMCCMS

a) Cost :- In ordinary meaning, cost means, the total amount of expenditure
incurred in producing goods or services. Technically it is the amount of
resources given up in exchange for some goods or services.
• When the value of these resources are expressed in monetary terms, it is
called "Cost."
• The Institute of Certified Management Accountants has defined Cost as
"the amount of expenditure (actual or notional) incurred on, or attributed
to, a specified thing or activity." .
• Cost is a general term and to know exactly what type of cost it is, it is
necessary to qualify it by some adjective e.g. Factory Cost, Cost of Sales,
Total Cost etc.
b) Cost Driver :- A cost driver is a unit that derives the expenses and sets a
basis on which a particular cost is to be allocated between the different
departments.
• For Example, Labor hours, Materials used, degree of automation, Number
of machine setups, number of units produced, number of orders received,
and overhead costs.
BMCCMS

c) Cost Unit :- Cost unit, also known as the cost per unit, the cost of goods
sold or the cost of sales, is the amount of money that a company invests in
manufacturing a single unit of a saleable product.
•The former Institute of Cost and Works Accountants of England (now CIMA)
had defined 'Cost Unit' as a unit of quantity of product. service or time, in
relation to which costs may be ascertained or expressed. Thus, cost unit is a
device by which total cost is broken into smaller sub- divisions.
BMCCMS

d) Cost Centre :- For ascertaining cost of production, the business enterprises
divided into different units and cost is determined with reference to each such
unit. Each of such units or sub-divisions is known as Cost Centre.
• Suppose, a business unit is divided into three departments and cost of each
department is separately ascertained, then department is the cost centre. It is a
location with reference to which cost is determined. Similarly, costs may be
ascertained, say, with regard to a group of operators. Here, a group of workers
is a cost centre.
Cost Centres
Basic
Classification
Personal Cost
Centre
Impersonal
Cost Centre
Functional
Classification
Production
Cost Centre
Service Cost
Centre
Other
Operational
Cost Centre
Process Cost
Centre
BMCCMS

e) Expense :- Expired cost is known as an expense. Expenses are costs which
are applied against revenue of a particular accounting period.
E.g. Salaries, Rent which are paid or become payable are expenses and so they
are called "Expired Costs."
f) Loss :- The excess of expenses over related revenues is known as loss.
Similarly, if some fixed asset is sold and the value realised is less than its book
value, then the difference is treated as a loss.
E.g., Cash or goods lost by theft or a fire accident, Loss on sale of assets, etc.
BMCCMS

g) Conversion cost :- Conversion Cost is the total of all cost incurred on labour,
direct expenses and factory overheads for converting raw materials into finished
goods.
• Conversion cost does not include cost of raw materials, because they are
purchased from outside.
h) Contribution :- The
excess of selling price over
variable or marginal cost is
called "Contribution." e.g.
if the selling price of a unit
is Rs. 100 and if the
variable cost incurred for
producing it is Rs. 60, then
the contribution is Rs. 40.
BMCCMS

1.5.4. Classification of Cost Accounting :
• i) Direct / Traceable Costs
• ii) Indirect / Common Costs
(A) According to
Element or Cost
• i) Factory / Works / Production / Manufacturing
overheads
• ii) Administrative / Office overhead
• iii) Selling and Distribution overheads
• iv) Research and Development overheads
(B) According to
Functions or
Operations
• i) Fixed / Unavoidable overheads
• ii) Variable overheads
• iii) Semi-Variable / Mixed overheads
(C) According to
Nature / Behaviour
BMCCMS

• i) Historical Costs
• ii) Pre-determined Costs
(D) According to
Time
• i) Product Costs
• ii) Period Costs
(E) According to
Period or Product
• i) Marginal Costs
• ii)Relevant Costs
• iii) Differential Costs
• iv) Sunk Cost
• v) Opportunity Cost
(F) According to
Managerial Decision
Making
Continue….
BMCCMS

(A) According to Elements or Costs :
i) Direct / Traceable Costs :- A direct cost is a price that can be directly tied to the
production of specific goods or services. Eg., Wood used in making wooden
furniture.
ii) Indirect / Common Costs :- Indirect costs are costs that are not directly
accountable to a cost object like direct costs. It may be either fixed or variable.
Indirect expenses, or overhead costs, are expenses that apply to more than
one business activity. Eg., Factory rent, Indirect materials, Indirect wages or
Other indirect expenses.
(B) According to Functions or Operations :
i) Factory / Works / Production / Manufacturing overheads :- Factory overhead is
the costs incurred during the manufacturing process, not including the costs of
direct labor and direct materials. It includes : Factory rent and rates, lighting
and heating, factory canteen and welfare expenses, store keeping and time
keeping expenses, drawing office and salary, repairs to plant and machinery,
salaries of work manager, supervisor, etc, power or fuel, cost of training new
workers, consumable stores like oil, grease etc, insurance of factory, building,
plant, etc, depreciation of plant and machinery.
BMCCMS

ii) Administrative / Office overheads :- These are the costs associated with
management and administration. It includes : Salaries of office staff, office rent
and rates, depreciation of office building, office lighting and heating, insurance
of office building and equipments, telephone and postage, printing and
stationery, audit fees, legal charges, director fees.
iii) Selling and Distribution overheads :- Selling and Distribution expenses are
incurred in connection with selling function, which includes the delivery of
goods to the customers. Selling overheads includes : Cost incurred to save
orders, Advertising, Catalogue, price lists etc, Salaries, commission and travelling
expenses of salesmen and agents, Show-room expenses, Bad debts, Legal
charges in connection with recovery to bad debts, Cash discount allowed.
Distribution overheads includes : Rent, rates and insurance of warehouse,
packing charges, cost of up keep and maintenance of delivery van, wages of
warehouse keeper, packers and delivery staff etc., carriage and freight outward.
iv) Research and Development overheads :- Research and development (R&D)
expenses are associated directly with the research and development of a
company's goods or services and any intellectual property generated in the
process. A company generally incurs R&D expenses in the process of finding and
creating new products or services. It includes the cost of raw material used in
research, staff cost indulged in Research, etc.
BMCCMS

(C) According to Nature or Behaviour :
i) Fixed / Unavoidable overheads :- Fixed overhead costs are costs that do not
change even while the volume of production activity changes. It includes : Rent
and rates of factory and office, Canteen expenses, Manager’s salary, Interest on
capital, Insurance premium, Audit fees, Bank charges, Office expenses, Legal
charges, pension charges, etc.
ii) Variable overheads :- Variable overhead costs are costs that change as the
volume of production changes or the number of services provided changes. For
example, energy bills, raw materials, or commissioned employees' pay.
iii) Semi-Variable / Mixed overheads :- It is a cost composed of a mixture of both
fixed and variable components. For example, Depreciation charge, Telephone
expenses.
(D) According to Time :
i) Historical Costs :- When costs are ascertained after they are already incurred, it
is termed as Historical Costing. For example, Cost of production per unit
produced in January is ascertained in February.
BMCCMS

ii) Pre-determined Costs :- The costs which are estimated and fixed before the
production starts are called predetermined costs. Generally they are based on
past experience. For example, rent payable, utilities payable, insurance
payable, salaries payable to office staff, office supplies, etc.
(E) According to Period or Product :
i) Product Costs :- The production cost or cost of manufacturing or factory
cost is product costs. Such cost consist of cost of direct materials, cost of
direct labour, direct expenses and factory overheads. Until the goods are
sold, such costs are included in the value of closing inventory and when
they are sold, they are transferred to cost of goods sold account.
ii) Period Costs :- These are the costs incurred on the basis of time and are
not identified with product. They are deducted as expense of the period
during which they are incurred. They are not included in inventory and are
not carried forward. Administrative and Selling expenses are treated as
period costs.
BMCCMS

(F) According to Managerial Decision-making :
i) Marginal Cost :- Marginal costing is used to know the impact of variable
cost on the volume of production or output. It is a technique of decision
making. It is a costing technique that focuses on segregating costs into
fixed and variable components. It is a technique of cost and management
accounting which is used to analyse relationship between cost, volume
and profit. It is the variable cost which arise only when production
continues.
ii) Relevant Cost :- Relevant cost is a managerial accounting term that
describes avoidable costs that are incurred only when making specific
business decisions. The concept of relevant cost is used to eliminate
unnecessary data that could complicate the decision-making process. For
example, A company decides to buy loading machinery for a factory
unit. This machine can save the wage expenses of 20 manual laborers.
These costs are relevant since these expenses change in the future due to
the buying decision.
PRESENTED BY – Ms. Niita Keshan
BMCCMS

iii) Differential Cost :- Differential cost refers to the difference in costs between two or
more business decisions. Specifically, a differential cost arises when there are multiple
similar options and it's necessary to select one at the forfeiture of others. When costs
increase due to a particular decision, it is called Incremental Cost. When the costs
decrease due to a particular decision, it is called Decremental Cost.
iv) Sunk Cost :- The costs which have been incurred in the past and which is
irrecoverable in a given situation, it is a sunk or historical cost. Such costs include the
future payments which are compulsorily to be made. Such costs are irrelevant for
decision making. For example, When a proposal for replacement of a machine is
considered, the capital loss or depreciated book value of the machine is a sunk cost
and is not to be taken into consideration, such costs have already been incurred in the
past and has no relevance to the present decision.
v) Opportunity Cost :- It is very useful concept in managerial decision-making. When a
manager is considering 2 alternatives and selects one, he has thus foregone the
income from the 2nd
alternative. Thus the income foregone from 2nd
alternative is the
opportunity cost.
BMCCMS

1.5.5 Elements of Cost Accounting :
Elements
of Cost
A) Direct
Costs
i) Direct
Material
ii) Direct
Labour
iii) Other
Direct
Expenses
B) Indirect
Costs
i) Indirect
materials
ii) Indirect
labour
iii) Other
Indirect
expenses
a) Factory
overheads
b) Administrative
overheads
c) Selling and
Distribution
overheads
BMCCMS

A) Direct Costs :
i) Direct Materials :- Direct material is all materials that becomes a part of
the product, the costs of which are directly charged as part of prime cost.
Timber used in making wooden furniture is an example of direct materials.
Moreover, certain expenses are also included in direct material i.e., import
duty, dock charges etc. which are added in original invoice.
ii) Direct Labour :- Direct labor refers to the salaries and wages paid to
workers that can be directly attributed to specific products or
services. Wages paid to carpenter preparing furniture is an example.
iii) Other Direct expenses :- It includes any expenditure other than direct
material or direct labor incurred on a specific cost unit. It includes : hire of
special tools or equipments for a particular order, cost of special design,
etc.
Continue….
BMCCMS

B) Indirect Costs :-
i) Indirect Materials :- It is an expense on materials used not for a specific unit
but for the whole production. Examples of indirect materials include tools,
office supplies, and protective gear.
Continue….
BMCCMS
PRESENTED BY – Ms. Nikita Keshan

ii) Indirect labour :-
iii) Other Indirect expenses :- They are all expenses other than indirect material
and indirect wages which are incurred for the benefit of production as a whole.
It includes : a) Factory / Works / Production / Manufacturing overheads b) Office
/ Administrative overheads c) Selling and Distribution overheads.
Continue….
BMCCMS

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