Topics:

Definition

Fundamental
Principles

Chapter 1 Scope, Functions

and Objectives

Merits and Demerits

Methods and
Techniques

Cost Accounting Vs

Introduction to Financial
Accounting

Elements of Cost

Cost Accounting Cost Vs. Expenses

Cost Centre, Cost

Unit and Cost
Object

Classification of
Cost

Costs for Decision

Making

Installation of
Costing System

Cost Sheets,
Tenders and
Quotations

Cost Accounting
Jerlin Jose, Asst. Professor, CHRIST (Deemed to be University)
Bengaluru
Introduction
In todays business world, business entities are functioning in a highly competitive environment
with high degree of risk and uncertainty. Consequently, they are required to function more
efficiently and effectively and thereby able to offer their products at a comparatively lower
price. In order to get a competitive advantage in the industry, business organizations need to
adopt three strategic dimensions, and ‘cost leadership’ is one among them (other dimensions
are product differentiation and focus or niche). Cost leadership implies producing goods or
provision of services at lowest cost while maintaining quality to have better competitive price.
So, it is essential for business organizations to have a robust costing system. Information is the
key resource for business decision making. Cost accounting provide a comprehensive cost and
revenue evaluation report to the management for appropriate decision making.
Accounting information’s required for a business entity is classified in to three categories;

Financial
Accounting

Accounting Cost Accounting

Management
Accounting

Financial Accounting: Concerned with recording of business transactions in the books of

accounts for the purpose of preparing the final accounts. The objective of financial accounting
is to present a true and fair view of company’s income and financial position at regular intervals
of one year.

In spite of new accounting device, improved techniques and eloborative subsidiary records,
financial accounting is limited with regard to information requirements of various stake
holders, such limitations of financial accounting led to the development of cost accounting.

Cost Accounting
Jerlin Jose, Asst. Professor, CHRIST (Deemed to be University)
Bengaluru
Such limitations are as follows;

• Reveals only overall performance : The approach of financial accounting is totalitarian

in nature and therefore, it does not make any attempt to evaluate the performance, more
particularly the cost effectiveness of departments, processes, products, functions, sales
territories etc., which is essential for cost control and to improve the segmental and
overall performance.
• Historical in nature: Financial accounting is basically a post-mortem excersise. Which
means, it summerizes the data and ascertain the results and financial position only after
the completion of the accounting period. Hence, there is no scope for taking timely
action.
• Comparison of performance not made: Under Financial accounting, no norms/standards
agaist which actual cost and performnce can be compared are developed.
• No cost control, no classificaiton of cost and no analysis of losses

However, the importance and utility of financial accounting system cannot be underrated. It
may be noted that cost accounting is not a substitute for fiancial accounting.

Cost, Costing, Cost Accounting and Cost Accountancy – Meaning and

Definitions

Cost: The amount of expenditure (actual or notional) incurred on or attributable to a specified

article, product or activity.

Costing: The technique and process of ascertaining cost of products and services.

Cost Accounting: Coast accounting is a broader term than costing, though both ascertain cost.
Cost accounting as the boady of concepts, methods and procedures used to measure, analyse
or estimate costs, profitability,and the performance of individual products, departments and
other segements of a company’s operations, for either internal or external use or both, and
report to the interested parties.

Cost Accounting = Costing (by formal mechanism) + Application of cost control methods +
Assessment of profitability

Cost Accounting
Jerlin Jose, Asst. Professor, CHRIST (Deemed to be University)
Bengaluru
Cost Accountancy: Comprehensive term which includes costing and const accounting as it
aims at not only the ascertainment and control of cost and asessment of profitability, but also
serving mangerial personnel in their decision making process by furnishing relevant cost
information obtained from their cost books of account. Cost Accountancy has, therefore, been
viwed as the science, art and practice of a cost accountant.

Cost Accountancy = Costing Accounting + Presentation of relevant information for mangerial

decision making.

Objectives and Functions of Cost Accounting

The main objectives and functions are as follows;

• Ascertainment of Cost: This is the primary objective of cost accounting. For cost
ascertainment different methods and techniques are used under different circumstances.
• Control of Cost: Cost accounting aims at improving effeciency by controlling and
redusing cost. This objective is becoming increasingly important because of growing
competition.
• Guide to Business Policy: Cost accounting aims at serving the needs of mangement in
conducting the business with utmost efficiency. Cost data provide guidelines for various
mangerial decisions like make or buy, selling below cost, utilisation of idle plant
capacity, introduction of new product, etc.
• Determination of Selling Price: Cost accounting provides cost estimation on the basis of
which selling prices of products or services my be fixed.
• Easuring and improving Performance: Cost accounting measures efficiency by
classifying and analysing cost data and then suggest various steps in improving
performance so that profitability is increased.

Cost Accounting and Financial Accounting – Comparison

BASIS FOR FINANCIAL

COST ACCOUNTING
COMPARISON ACCOUNTING
Meaning Cost Accounting is an Financial Accounting is an
accounting system, through accounting system that
which an organization keeps captures the records of
the track of various costs financial information about

Cost Accounting
Jerlin Jose, Asst. Professor, CHRIST (Deemed to be University)
Bengaluru
 incurred in the business in the business to show the
production activities. correct financial position of
the company at a date.
Types of transactions Records the information Records the information
recorded (both internal and external) which are external only like
related to material, labour sales, purchase, receipts etc..
and overhead, which are
used in the production
process.
Which type of cost is used Both historical and pre- Only historical cost.
for recording? determined cost
Users Information provided by the Users of information
cost accounting is used only provided by the financial
by the internal management accounting are internal and
of the organization like external parties like
employees, directors, creditors, shareholders,
managers, supervisors etc. customers etc.
Control aspect Emphosise on control aspect Emphosise on recording
aspect
Statutory Requirement No, except for Yes. Obligatory to prepare
manufacturing firms it is as per Companies Act and
mandatory. Income Tax Act.
Frequency of Reporting Details provided by cost Financial statements are
accounting are frequently reported at the end of the
prepared and reported to the accounting period, which is
management. normally 1 year.
Profit Analysis Generally, the profit is Income, expenditure and
analysed for a particular profit are analysed together
product, job, batch or for a particular period of the
process. whole entity.
Purpose Reducing and controlling Keeping complete record of
costs. the financial transactions.

Cost Accounting
Jerlin Jose, Asst. Professor, CHRIST (Deemed to be University)
Bengaluru
 Forecasting Forecasting is possible Forecasting is not at all
through budgeting possible.
techniques.

Merits and Demerits of Cost Accounting

Cost accounting as its merits and demerits as given belwo;

Merits

• Reveals Profitable and Unprofitable Activities: Costing helps management to identify

the activities/products which are profitable or not and thereby enable to take necessary
mesures to reduce or eliminate wastages and inefficiencies occuring in the form of idle
time, under-utilisation resources etc.
• Helps in Cost Control: Cost accounting helps in cost determination and thereby cost
control with the help of special techniques like standard costing, budgetary control etc.
• Helps in Decision Making: The Ultimate aim of cost accountancy is to present the
suitable information to the top level management for efficient and effective decision
making like introduction of a new product line, make or buy etc.
• Guides in Fixing Selling Price: Cost is one of the most important factors to be
considered for fiixng the price. Cost ccounting helps in determining the cost and thereby
fixing the price.
• Helps in Inventory Control: Cost accounting performs various techniques like ABC
analysis, level setting etc. for inventory control in the organisation.
• Aids in Formulating Policy: Production and pricing policies of an organisation is based
on the cost information provided with the help of various cost accounting techniques.
• Reveals idle Capacity: Cost accounting helps the management in identifying the cost
of idle capacity and enable for a immediate corrective action.
• Prevents Fraud and Manipulation: Cost audit, a system of cost accounting helps in
prevenitng manipulation and frauds.

Cost Accounting
Jerlin Jose, Asst. Professor, CHRIST (Deemed to be University)
Bengaluru
Demerits

• It is Unnecessary: It is argued that maintenance of cost records is not necessary and

invloves duplication of Work and a good number of concerns are working without any
system of costing.
• It is Expensive: Installation of a costing system is quite expensive which only large
concerns can afford.
• It is Inapplicable: Costing sytem will be inapplicable if its not customised according to
the nature and requirement of the organisation.
• It is a failiure: The failiure of costing system in some concerns is quoted as an argument
against the introduction in other undertkaings.

Basic Cost Concepts

Cost: The amount of expenditure (actual or notional) incured or attributable to a given thing.

Cost Vs. Expense and Loss:Often the terms ‘cost’ and ‘expenses’ are used interchangably.
But cost should be differentiated from expenses and losses.

Expense is defined as “an expired cost resulting from a productive usage of an asset”. It is that
cost which has been applied against revenue of a particular accounting period in accordance
with the principle of matching costs to revenue. In other words, an expense is that portion of
the revenue earning pottential of the cost of an asset which has been consumed in the generation
of revenue. Unexpired cost of an asset is recored as an asset in the balance sheet. Ex.
Depreciation -Expired cost, Prepaid insurance – Unexpired cost.

Loss is defined as “reduction in firms equity, other than from withdrawal of capital for which
no compensating value has been received”. A loss is an expired cost resulting from the decline
in the service potential of an asset that generated no benefit to the firm.

Cost Centre, Cost Unit and Cost Object

Cost is ascertained by cost centre, cost unit or cost object

Cost Centre

ACCORDING TO CIMA (UK) as “ a location , person , or item of equipment (or group of

these ) for which cost may be ascertained and used for the purpose of control .”

Cost Accounting
Jerlin Jose, Asst. Professor, CHRIST (Deemed to be University)
Bengaluru
It refers to section of business to which cost can be charged and the main purpose is cost
control .

• Location ( a department, sales area ).

• An item of equipment ( a machinery, delivery van )
• A person ( a salesman, machine operator )
• A group of these (two automatic machines opertated by one workman)

Cost center refers to a convenient segment into which organization is appropriately divided
for product costing .For the purpose of cost accumulation each of theses activities may be
treated as cost centre .

Types of Cost Center

• Personal cost Centre – which consist of person or group of person .

• Impersonal cost Centre – which consist of location or an item of equipment .

From functional point of view

• Production cost Centre - Cost centre where actual production work takes place. Ex.
work machine department, welding dept, finishing shop etc.

• Service cost Centre- Which are ancillary to and render services to production cost centre
Ex. repair shop , canteen , power house, tool room, stores etc.

Cost Unit

Cost unit helps the cost accountant to breaks up the cost of a cost centre into smaller sub-
divisions.

A cost unit is defined by CIMA as a “ unit of product , service or time in relation to which cost
may be ascertained or expressed .”

Cost unit are usually the unit of physical measurement like number , weight , area , volume ,
length , time ..etc.

Cost Unit is Unit of Measurement of Cost. Ex. Unit cost of Sugar mill – Cost per tonne of
sugar. Unit cost of Textile mill - Cost per metre of cloth.

Cost Accounting
Jerlin Jose, Asst. Professor, CHRIST (Deemed to be University)
Bengaluru
 Industry Normal cost unit

Cement Tonne

Chemicals Tonne , kilograms, liter .

Nursing home Bed per day

transport Passenger kilometer

Hotel Room per day .

Types of Cost Units

• Units of Production: Kg, tonne, metre etc.

• Units of Service: Km, Seat, hour etc.

Cost Object

Cost object may be defined as “anything for which a separate measurement of cost may be
desired”. Cost object may be a product, service, activity, department or process.

Cost Object Industry

Product Car, Shaving razor, Tv

Service Taxi service, Electricity

Process Melting process in steel mill, weaving process in a textile

mill

Activity Developing a website, purchasing raw material

Cost Accounting
Jerlin Jose, Asst. Professor, CHRIST (Deemed to be University)
Bengaluru
 Department Purchasing Department, Personnel, Production
department

Methods and Technique of Cost Accounting

Costing methods and techniques

Methods of Costing

The methods or types of costing refer to the methods employed in the ascertainment of costs.
several methods have been having been designed to suit the needs of different industries.

These methods of costing are as follows:

Cost Accounting
Jerlin Jose, Asst. Professor, CHRIST (Deemed to be University)
Bengaluru
!. JOB ORDER COSTING:
According to CIMA, UK this method “applies where work is undertaken to customers” special
requirements “cost unit in job order costing is a job or work order for which costs are separately
collected and accumulated. A job big or small, comprises a specific quantity of a product to be
manufactured as per customer’s specifications. The industries where this method is used
include printing press, repair shops, interior decorators, painters etc.

2. CONTRACT COSTING OR TERMINAL COSTING:

This is a variation of job costing and therefore principles of job costing apply to this method.
The difference between job and contract is that job is small and contract is big. It is well said
that a contract is a big job and a job is a small contract. The cost unit here is a contract which
is of a long duration and may continue over more than one financial year. Contract costing is
most suited to construction of buildings, dams, bridges and roads, ship building. Etc.

3. BATCH COSTING:
Like contract costing, this is also a variation of job costing. In this method, the cost of a batch
or group of identical products is ascertained and therefore each batch of products is a cost unit
for which costs are ascertained. This method is used in companies engaged in the production
of readymade garments, toys, shoes, tyres and tubes, component parts, etc .

4. PROCESS COSTING:
A distinct form job costing, this method is used in mass production industries manufacturing
standardized products in continuous processes of manufacturing. Costs are accumulated for
each process or department. Here raw material has to pass through a number of processes in a
particular sequence to completion stage. In order to arrive at the unit cost, the total cost of a
process is divided by the number of process is passed on to the next process as raw material.
Textile mills, chemical works, sugar mills, refineries, soap manufacturing, etc may be cited as
examples of industries which employ this method.

5. OPERATION COST:
This is nothing but a refinement and a more detailed application of process costing. A process
may consist of a number of operations and operation costing involves cost ascertainment for
each operation instead of a process.

Cost Accounting
Jerlin Jose, Asst. Professor, CHRIST (Deemed to be University)
Bengaluru
6. SINGLE OUTPUT OR UNIT COSTING:
This method of cost ascertainment is used when production is uniform and consists of a single
or two or three varieties of the same product. Where the product is produced in different grades.
Costs are ascertained grade wise. As the units of output are identical, the cost per unit is found
by dividing the total cost by the number of units produced. This method is applied in mine,
quarries, brick kilns, steel production, flour mills etc

7. OPERATING OR SERVICE COSTING:

This method should not be confused with operation costing. Operation costing is used in
undertakings which provide services instead of manufacturing products. For example transport
undertaking (road transport, railways, airways, shipping companies) electricity companies,
hotels, hospitals, cinema, etc use this method. The cost units are passenger-kilometer or ton-
kilometer, kilowatts hour, a room per day in a hotel, a seat per show in cinema, etc. This method
is a variation of process costing

8. MULTIPLE OR COMPOSITE COSTING:

It is an application of more than one method of cost ascertainment in respect of the same
product. This method is used in industries where a number of companies are separately
manufactured and assembled into a final product. For example in a television company,
manufacturer of different component parts may require different production methods and thus
different methods of costing may have to be used. Assembly of these components into final
product still requires another method of costing other examples of industries which make use
of this method are air conditioners, refrigerators, scooters, cars, locomotive works etc

Techniques of Costing

All the types of industries which determines which of the sight methods of costing discussed
above will be used in a particular business. However, in addition to these methods, there are
certain techniques of costing which are not alternatives to the methods discussed above. These
techniques may be used for special purpose of control and policy in any business irrespective
of the method of costing being used there. These techniques are briefly explained below.

1.STANDARD COSTING:
This is a very valuable technique to control the cost. In the techniques standard cost is
predetermined as a target of performance and actual performance is measured against the

Cost Accounting
Jerlin Jose, Asst. Professor, CHRIST (Deemed to be University)
Bengaluru
standard. The difference between the actual costs and analysed to know the reasons for the
difference so that corrective actions may be taken.

2.BUDGETRAY CONTROL:
Closely allied to standard costing is the technique of budgetary control. A budget is an
expression of a firms plan in financial form of budgetary control is a technique applied to the
control of total expenditure on materials, wages and overhead by comparing actual
performance with planned performance. Thus in an addition to its planning, the budget is also
used for control and co-ordination of business operations.

3.MARGINAL COSTING:
This is a technique of profit planning. In this technique, separation of cost into fixed and
variable is of special interest and importance. This is so because marginal costing regards only
variable costs as the cost of the products. Fixed cost is treated as period cost and no attempt is
made to allocate or appropriation this cost to individual cost centers or cost units. It is
transferred to costing profit and loss account of the period. This technique is used to study the
effect on profit of changes in volume or type of output.

4.TOTAL ABSORPTION COSTING:

It is a traditional method of costing whereby total costs are charged to products. This is in
complete contrast to marginal costing where only variable costs are charged to products. All
though until recently this was the only technique employed by cost accountants, it is now a
days considered to have only a limited application

5.UNIFORM COSTING:
This is not separate technique or method of costing like standard costing or process costing.
Uniform costing simply denotes a situation in which a number of firms adopt a uniform set of
costing principles. It has defined by CIMA as the use of several undertakings of the same
costing principles and/or practices. This helps to compare the performance of one firm that of
other firms and thus to derive the benefit of anyone’s better experience and performance.

Cost Accounting
Jerlin Jose, Asst. Professor, CHRIST (Deemed to be University)
Bengaluru
Classification of Costs

Classification of costs refers to a systematic process of grouping cost items into two or more
categories on the basis of their common characteristic features. There are a number of bases
for classification of costs. However , the selection and use of a particular base or method for
classification of costs depends upon a a numbers of factors including the objective of
classification. The important bases are nature or element, function, traceability or
identifiability, behavior , controllability, normality, time and relevancy. It may be noted here
that the items of cost classified on a basis can further be sub-classified on another basis.

A) Element – wise Classification of Costs: On the basis of nature or elements of costs, costs
can be classified into three broad categories as material cost, labour cost and other expenses

Material
Cost

Element-wise
classification
of cost

Other Labour
Expenses Cost

● Material cost denotes the cost of raw material consumed in the process of
manufacturing and marketing a commodity .
● Labour cost represents the wages , salaries , etc., payable to the employees of
a corporate entity .
● Expenses refers to the costs other than material and labour cost, of other
services provided and used in manufacturing and marketing the goods and
services of the company .These expenses include even the notional cost for
using owned assets and/or facilities.
B) Functional classification of costs: On the basis of the functions to which the cost items
relate or the purpose for which the costs are incurred , costs are classified into three
categories as production cost , administrative cost and selling and distribution costs.

Cost Accounting
Jerlin Jose, Asst. Professor, CHRIST (Deemed to be University)
Bengaluru
 Producti
on Cost

Functional
Classification
of cost

Selling
Administ
and
rative
Distributi
Cost
on Cost

• CIMA , London has defined production cost as the cost of the sequence of operations
which begins with supplying materials , labour and services , and ends with
primary packing of the product . The cost of materials introduced into the
manufacturing process , cost of converting the raw material into the finished goods are
the two important items of production cost . Therefore ;

Production cost = Prime cost + factory overhead expenses = direct material cost + Direct labour
cost + Direct expenses + factory overhead expenses = Direct material cost + conversion
cost
● Administration cost which is also called administrative overhead expenses or office-
on-cost has been defined by CIMA , London as the cost of formulating the policy , directing
the organization and controlling the operations of an undertaking which is not related
directly to a production , selling , distribution , R&D activity or function .
Remuneration of office and administrative staff, depreciation, rent etc., of office buildings,
telephone charges, directors’ and auditors’ fees, etc., are some of the examples of
administrative cost.

Cost Accounting
Jerlin Jose, Asst. Professor, CHRIST (Deemed to be University)
Bengaluru
 • Selling Cost has been defined by CIMA, London as the cost of seeking to create and
stimulate demand and of securing orders. Cost of advertisement, bad debts, salary of
sales staff, etc., are some of the examples of selling costs.
• CIMA, London defines distribution cost as the cost of the sequence of operations,
which begins with making the packed product available for dispatch and ends with
making the reconditioned returned empty package, if any, available for reuse.
Salary of warehouse staff, maintenance cost of delivery van, godown rent, etc. are
examples to distribution costs.

C) Classification on the Basis of Identifiability: On the basis of whether the cost items can
easily and conveniently be identified with the cost centre or cost unit, costs may be
classified into two broad categories as direct costs and indirect costs.

Classification
of cost based
on
identifiability

Direct Indirect
Cost Cost

• Direct costs are those costs that are incurred for and which may easily and conveniently
be identified with, a particular cost unit or cost centre. Direct costs include direct
material cost, direct labour cost and other direct expenses.
• Indirect costs, on the other hand, represent the costs that are of general nature and which
cannot easily and conveniently be identifies with a particular cost unit or cost centre.
The indirect costs are, therefore, called overhead expenses.

D) Behavior-wise Classification: On the basis of how the cost items behave or vary with the
changes in the levels of activity, costs may be classified into three broad categories as
variable costs, fixed costs and semi-fixed costs.

Cost Accounting
Jerlin Jose, Asst. Professor, CHRIST (Deemed to be University)
Bengaluru
 Variabl
e Cost

Behabiour-
wise
Classificatio
n of cost
Semi-
Fixed
variabl
Cost
e Cost

• Variable costs are those costs which vary with the levels of activity in the same direction
and more or less, in the same proportion. For example, direct material cost, salesmen
commission, etc.
• Semi-variable costs are partly variable and partly fixed costs. For example, telephone
charge, salesmen remuneration based on monthly salary plus commission, etc.
• Fixed costs, on the other hand, represent the costs which, in aggregate, tend to be unaffected
by the changes in the levels of activity. They remain constant irrespective of the levels of
activity (of course, within the relevant range). But they go on accumulating as the time
passes. For example, factory rent, salary of manager, factory insurance, etc.

E) Controllability: On the basis of whether the costs are controllable by a specified level of
managerial authority and during a specified period of time, costs can be classified into two
broad categories as controllable costs and uncontrollable costs.

Classificatio
n of cost
based on
Controllabili
ty

Controllabl Uncontrol
e Cost lable Cost

Cost Accounting
Jerlin Jose, Asst. Professor, CHRIST (Deemed to be University)
Bengaluru
 • Controllable cost has been defined by CIMA, London as a cost which can be
influenced by the action of a specified member of an undertaking.
• On the other hand, uncontrollable cost has been defined by CIMA, England as a cost
which cannot be influenced by the action of a specified member of an undertaking.
Items of variable costs are controllable costs and most of the items of fixed costs are
uncontrollable costs.

F) Normality: Costs can also be classified into normal and abnormal costs.

Classification
of cost based
on Normality

Normal Abnorm
Cost al Cost

• Normal cost has been defined by CIMA, London as a cost at given level of output in
the condition in which that level of output is normally attained. It, therefore, forms a
part of costs of production and/or sales.
• On the other hand, abnormal costs represent the costs which are not normally incurred
at a given level of activity(i.e., production and/or sales) in the conditions in which that
level of activity is normally attained. It is, therefore, excluded from cost of production
and/or sales. Normally, these abnormal costs are charged directly to the Costing Profit
and Loss Account.

G) Relevancy: On the basis of whether the cost items are relevant or irrelevant to the decisions
under the consideration of the management, costs may broadly be classified into two
categories as relevant costs or irrelevant costs.

Cost Accounting
Jerlin Jose, Asst. Professor, CHRIST (Deemed to be University)
Bengaluru
 Classificati
on of cost
based on
Relevancy

Releva Irrelev
nt Cost ant
Cost

• Relevant costs are those costs which have a bearing, or which have an effect, on the
decisions under the consideration of the management.
• On the other hand, irrelevant costs represent the costs which have no effect on the
decisions under the consideration of the management.

H) Classification of cost by Time: On the basis of the time computing the costs(i.e., whether
the costs are classified after or before their incurrence), costs can be classified into two
categories as historical and predetermined costs.

Classification
of cost based
on Time

Pre-
Historic determi
al Cost ned
Cost

• Historical costs are those costs which have already been incurred and therefore,
ascertained after their incurrence.
• On the other hand, predetermined costs are those costs which are computed in advance
of their incurrence and production on the basis of the past experience and other
projections about the factors affecting the cost items.

Cost Accounting
Jerlin Jose, Asst. Professor, CHRIST (Deemed to be University)
Bengaluru
Designing and Installation of a Costing System

As there is no single Costing System which suits all types of industries and organization, every
organization has to design an appropriate Costing System. If an organization succeeds in
designing and installing an appropriate Costing System, then it can avoid a number of
difficulties and the management is able to take its decisions as the relevant cost data will be
supplied by the Costing Department at the right time. It is, therefore, necessary on the part of
the Cost Accountants to have a comprehensive idea about the essentials of a good Costing
System, general considerations and steps for the installation of a Costing System, practical
difficulties in installing a Costing System, etc.

Essentials of a Good Costing System: Though it is very difficult to specify all the features or
essentials of a good Costing System, an attempt is made in the following paragraphs to identify
certain important and general features of a good Costing System.

(a) Accuracy: Costing System adopted by a business entity should ensure the preparation and
provision of cost reports and statements, as far as possible, accurately. Otherwise, the very
purpose of Costing System will be defeated as it misleads the management and encourages
them to take wrong decisions.
(b) Equity: Ascertainment of cost involves allocation and apportionment of indirect costs to
cost centers and/or cost units, and absorption of departmentalized overhead expenses by
the cost units. The Costing System should ensure, as far as possible, equitable distribution
of overhead expenses to the cost centers and cost units.
(c) Simplicity: The system should be, as far as possible, simple to understand and operate.
Because, complexity in the operation of costing system may vitiate the very purpose as the
management may not be able to understand and appreciate the contents of cost reports of
the right perspective.
(d) Flexibility: Continuous change in the factors affecting the Costing System is one of the
common features of industrial society. Hence, the Costing System should be flexible so
modifications, changes, improvements, etc., can be incorporated into the Costing System
in the light of the changes.
(e) Consistency and Comparability: Frequent changes in the Costing System and procedure
impair the comparative quality of the cost information. Therefore, there should not be
frequent changes in the Costing procedures, practices, etc., there is, therefore, a need for

Cost Accounting
Jerlin Jose, Asst. Professor, CHRIST (Deemed to be University)
Bengaluru
 consistent use of costing procedures, practices, etc., year after year unless the altered
circumstances demand a change in the costing practices, procedure, etc.
(f) Economy: The Costing System should involve the minimum cost for keeping and
maintaining cost books of accounts. Unnecessary cost records and reports should be
avoided.
(g) Timeliness in Reporting: The System should ensure prompt reporting to various levels of
the management on time for taking necessary timely decisions and actions.
(h) Suitability: The Costing System designed and adopted should suit the industry and serve
the objectives with which the Costing System was installed.
(i) Relevant Information: The Costing System should ensure the supply of only the relevant
information to the management for the purpose of enabling it to take right decisions.

Steps for Installation of Costing System: After having studied the essentials of a good costing
system and also the general but desirable conditions to be observed before installing a costing
system, it is necessary to have look at the steps to be followed for the installation of costing
system. The important steps are identified below:

a) Study of the nature of product, Production Methods, and Organization, etc.: The nature of
product and manufacturing methods and processes will normally determine the methods of
costing to be used. Decisions about the bases for apportionment of common costs over
different beneficiaries, absorption methods, inventory valuation methods, depreciation
methods ,amortization of research and development costs, treatment of idle time costs,
overtime premium etc. can be taken only after a comprehensive study of size, layout and
type of organization production methods, degree of mechanization, number and nature of
production departments and/or processes, remuneration methods, purchase procedure,
selling and distribution methods, sales branches, etc. Therefore, cost accountant must
undertake a preliminary investigation into the above before devising and installing a
suitable costing system.
b) For the purpose of accumulation of costs, it is necessary to divide the entire organization
into number of convenient segments called, cost centres. The cost accountant has to decide
the number and size of cost centres.
c) Cost accountant has to decide about the codification system and also the base on which the
cost can be classified.

Cost Accounting
Jerlin Jose, Asst. Professor, CHRIST (Deemed to be University)
Bengaluru
d) Decisions about the bases for apportionment of indirect common costs, methods for
absorption of overhead expenses, guidelines and specifications for various types of reports
and their periodicity etc., are to be taken.
e) Decision about the location for cost office is to be taken considering the sources from which
cost data are to be collected. It is better if it is situated adjacent to the factory.
f) Define clearly the objectives to be accomplished through costing system.
g) Decide about the structures of cost account.
h) Determine the bases on which the difference overhead expenses are to be allocated
apportion and absorbed.
i) Decide about the organization of cost office.
j) Define the relationship of cost office with other offices and departments.

This way ,decisions are to be taken about each and every aspect of costing practices, polices,
procedures, etc., and necessary arrangements are to be made to recruit and/ or train the people
to take up the new assignment, and to get the necessary forms, records, etc., ready for use.
Even after the installation of the system, it is necessary to supervise the working of the system
for further improvements.

Difficulties in Installing Costing System: While installing a costing system, cost accountant
is expected to face any a number of problems and difficulties. A clear understanding of these
problems is prerequisite to take appropriate measures to overcome the same and for the smooth
installation of costing system. A few practical difficulties, other than the technical costing
problems, are identified below together with the suggestions to overcome the same.

a) Lack of Support from the Top Management and Other Departmental Heads: In
many a number of organizations, decisions to install costing system is taken by the
managing director or by some other authority without understanding the benefit of the
system. This creates an impression in the minds of the departmental heads that the
system is a device to check their activities and power, and therefore, they may feel it as
a direct interference in their activities. Consequently, they may not extend full
cooperation and support to the cost accountant which is a prerequisite for the purpose
of installing and operating costing system. In order to overcome this difficulty, it is
necessary on the part of the cost accountant to educate all those who resist the
installation of costing system about the benefits, advantages, etc. He has to convince

Cost Accounting
Jerlin Jose, Asst. Professor, CHRIST (Deemed to be University)
Bengaluru
 them that the system is for their benefit and for the system is for their benefit and for
the benefit of the whole organization.
b) Resistance from the Existing Financial Accounting Staff: Whenever the initiatives
are taken to install a new system, there will be a strong protest and resistance from the
staff. Because, they may feel that the installation of costing system may result in the
reduction in their importance, position and career improvement opportunities in their
organization. The cost accountant should, therefore, convince them that the new system
is in no way a substitute to the financial accounting and therefore, there is no threat to
their jobs, promotional opportunities, etc. Further, he has to educate them to the effect
that the new costing system works as a supplement to their financial accounting system
and it will create new opportunities to them.
c) Non Cooperation from the Supervisory Staff: The foremen, supervisors and their
staff may not extend their support and cooperation which is one of the prerequisites for
the successful installation and operation of the system. Because, provision of accurate
information is absolutely essential for successful installation and implement of the
system. Their non-cooperation and resistance may be on the ground that the installation
of costing system may result in additional paper work for them. In order to overcome
this difficulty, it is necessary to educate the supervisory staff by explaining the benefits
of the system and the role they have to play. This proper education is necessary to win
their confidence to the system.
d) Shortage of Qualified Trained Staff: At the initial stage of installation, normally there
will be a shortage of qualified and trained staff. But, this can be overcome by taking
steps to train the existing staff and recruiting additional qualified staff.

Elements of Cost

A cost is composed of three elements, i.e., material, labour and expenses. Each of these
elements may be direct or indirect.

Material Cost

According to CIMA UK, material cost is “the cost of commodities supplied to an undertaking”.
Materials may be direct or indirect.

Cost Accounting
Jerlin Jose, Asst. Professor, CHRIST (Deemed to be University)
Bengaluru
Direct Material. Direct material cost is that which can be conveniently identified with and
allocated to cost units. Direct materials generally become a part of the finished product. For
Example, Cotton used in a textile mill is a direct material . However in many cases though a
material form a part of the finished product , yet it is not treated as direct material, eg nails used
in furniture, thread used in stitching garments , etc. This is because value of such material is so
small that it is quite difficult and futile to measure it . Such materials are treated as indirect
materials.

DIRECT MATERIAL

• CLAY IN BICK

• LEATHER IN SHOES

• STEEL IN MACHINES

• CLOTH IN GARMENT

Indirect Material. These are those material which cannot be conveniently identified with
individual cost units. These are those material which cannot be conveniently identified with
individual cost units. These are minor in importance such as 1) small and relatively inexpensive
items which may become a part of the finished product; eg. pins, screws, nuts and bolts 2)
Those items which do not physically become a part of the finished products eg coal, lubricating
oil and grease, sand paper used in polishing, soap etc.

INDIRECT MATERIAL

• LUBRICATING OIL

• SAND PAPER

• NUTS AND BOLTS

• COAL

• SMALL TOOLS

Labour Cost: This is “the cost of remuneration (wages, salaries, commission etc) of the
employee of an undertaking” CIMA

Direct Labour: Direct labour cost consist of wages paid to workers directly engaged in
converting raw material into finished products. These wages can be conveniently identified
Cost Accounting
Jerlin Jose, Asst. Professor, CHRIST (Deemed to be University)
Bengaluru
with a particular product, job or process. Wages paid to a machine operator in case of direct
wages.

DIRECT LABOUR

• MACHINE OPERATOR

• SHOE – MAKER

• CARPENTER

• WEAVER

• TAILOR

Indirect Labour: It is of general character and cannot be conveniently identified with a

particular cost unit. In other words, indirect labour is not directly engaged in the production
operation but only to assist or help in production operation.

INDIRECT LABOUR

• SUPERVISOR

• INSPECTOR

• CLEANER

• CLERK

• PEON

• WATCHMEN

Expenses: All cost other than material and labour are termed as expenses. It is defined as the
cost of service provided to an undertaking and the notional cost of the use of owned assets
(CIMA)

Direct Expenses: According to CIMA, UK, direct expenses are those expenses which can be
identified with and allocated to cost centres or units. These are those expenses which are
specifically incurred in connection with a particular job or cost unit. Direct expenses are also
known as chargeable expenses.

DIRECT OR CHARGEABLE EXPENSES

Cost Accounting
Jerlin Jose, Asst. Professor, CHRIST (Deemed to be University)
Bengaluru
 • HIRE OF SPECIAL PLANT FOR A PARTIULAR CONTRACT

• TRAVELLING EXPENSES IN SECURING A PARTICULAR CONTRACT

• COST OF PATENTS RIGHTS

• EXPERIMENTAL RIGHTS

• COST OF SPECIAL DRAWING, DESIGN, AND LAYOUTS

• CARRIAGE PAID FOR MATERIALS PURCHASED FOR A SPECIFIC JOB

• ROYALTY PAID IN MINING

Indirect Expenses: All indirect costs other than indirect materials and indirect labour costs are
termed as indirect expenses. These cannot be conveniently identified with a particular job,
process or wok order and are common to cost units or cost centres.

INDIRECT EXPENSES

• RENT AND RATES

• DEPRECIATION

• LIGHTING AND POWER

• ADVERTISEMENT

• INSURANCE

• REPAIRS

PRIME COST

This is the aggregate cost of direct material cost, direct labour cost and direct expenses. Thus

PRIME COST = Direct material + direct labour + direct expenses

OVERHEAD

This is the aggregate of indirect material cost, indirect labour cost and indirect expenses.
Overhead is also known as on cost. Thus

Cost Accounting
Jerlin Jose, Asst. Professor, CHRIST (Deemed to be University)
Bengaluru
OVERHEAD = Indirect material + indirect labour + indirect expenses

Overheads are divided into production overhead office overhead and selling overhead as
follows:

1 Production Overhead. Also known as factory overhead, works overhead or manufacturing

overhead, these are those overheads which are concerned with the production goods or service.
Examples are already given below

2 Office and Administration Overhead. This is the indirect expenditure incurred in general
administrative function. I.e. in formulation policies and controlling the functions, directing and
motivating the personnel of an organisation in the attainment of its objectives. These overheads
are of general character and have no direct connection with production or sales activities. This
category of overheads is also classified into indirect material, indirect labour and indirect
expenses. For eg. office salaries, legal expenses, office lighting etc.

3. Selling and distribution overheads. Selling overhead is the cost of production sales and
retaining customer. It is defined as the cost of seeking to create and stimulate demand and of
securing orders. Eg. advertisement, samples and free gifts, salaries of salesmen etc.

Distribution cost includes all expenditure incurred from time the product is completed until it
reaches its destination. It is defined as the cost of sequence of operation which begins with
making the packed product available for despatch and ends with making the reconditioned
returned empty packages, if any available for re-use. Examples are carriage outward, insurance
of goods in transit, upkeep of delivery vans, warehousing, etc.

Selling and distribution overheads are also grouped into indirect material, indirect labour, and
indirect expenses. Examples are sales office stationery, Advertisement sales staff salaries etc.

Components of total cost – Elements of cost may be grouped as follows;

1 prime cost = Direct cost + labour + direct expenses

2 works cost or factory cost = prime cost + factory overhead

3 cost of production = works cost + administration overhead

4 total cost or cost of sales = cost of production + selling and distribution overhead

Cost Accounting
Jerlin Jose, Asst. Professor, CHRIST (Deemed to be University)
Bengaluru