MODULE-8

Cost Accounting, Introduction,

Classification of costs, Methods of Costing,
Techniques of Costing, Cost sheet and
preparation cost sheet, Breakeven Analysis,
Meaning and its application, Limitation.
The word cost does not have a definite meaning. For common people, cost

means the amount spent on purchasing an article. Cost is commonly defined

as Sacrificed resource for a particular thing.

According to ICWA Cost is a measurement, in monetary terms, of the amount

of resources used for the purpose of production of goods or rendering

services.
Cost Accounting : Cost Accounting may be defined as
“Accounting for costs classification and analysis of
expenditure as will enable the total cost of any particular
unit of production to be ascertained with reasonable degree
of accuracy and at the same time to disclose exactly how
such total cost is constituted”. Thus Cost Accounting is
classifying, recording an appropriate allocation of
expenditure for the determination of the costs of products or
services, and for the presentation of suitably arranged data
for the purpose of control and guidance of management.
Objectives of Cost Accounting The following are the main objectives of Cost
Accounting :-
(a) To ascertain the Costs under different situations using different techniques and systems of
costing
(b) To determine the selling prices under different circumstances
(c) To determine and control efficiency by setting standards for Materials, Labour and Overheads
(d) To determine the value of closing inventory for preparing financial statements of the concern
(e) To provide a basis for operating policies which may be determination of Cost Volume
relationship, whether to close or operate at a loss, whether to manufacture or buy from market,
whether to continue the existing method of production or to replace it by a more improved
method of production....etc
Financial Vs Cost Accounting
CLASSIFICATION OF COST
Classification of cost is the process of grouping the components of cost under a common

designation on the basis of similarities of nature, attributes or relations. It is the process

of identification of each item and the systematic placement of like items together

according to their common features. As per Cost Accounting Standard 1 (CAS-1), the

basis for cost classification is as follows:

(a) Nature of expense (e) Production Process
(b) Relation to Object – Traceability (f) Time Period
(c) Functions / Activities
(d) Behavior–Fixed, Semi-variable or Variable
Classification by Nature of Expense

Costs should be gathered together in their natural grouping such as Material, Labour and Other

Direct expenses. Items of costs differ on the basis of their nature. The elements of cost can be

classified in the following three categories. 1. Material 2. Labour 3. Expenses

Classification by Relation to Cost Centre or Cost Unit:
If expenditure can be allocated to a cost centre or cost object in an economically feasible way then it is
called direct otherwise the cost component will be termed as indirect. According to this criteria for
classification, material cost is divided into direct material cost and indirect material cost, Labour cost is
divided into direct labour and indirect labour cost and expenses into direct expenses and indirect
expenses. Indirect cost is also known as overhead.
Classification by Functions: A business enterprise performs a number of functions like
manufacturing, selling, research...etc
Classification based on Behaviour – Fixed, Semi-variable or Variable Costs are classified based on
behaviour as fixed cost, variable cost and semi-variable cost depending upon response to the
changes in the activity levels.
Classification by nature of Production or Process
Classification by Time:
A cost item is related to a specific period of time and cost can be classified
according to the system of assessment and specific purpose as indicated in the
following ways :-
Techniques of Costing:

A. Marginal Costing

B. Standard Costing

C. Budgetary Control

D. Uniform Costing
A. Marginal costing
Marginal Costing is the ascertainment of marginal costs and of the effect on profit
of changes in volume or type of output by differentiating between fixed costs and
variable costs. Several other terms in use like Direct Costing, Contributory Costing,
Variable Costing, Comparative Costing, Differential Costing and Incremental
Costing are used more or less synonymously with Marginal Costing.
The term direct cost should not be confused with direct costing. In absorption
Costing, direct cost refers to the cost which is attributable to a cost centre of cost
unit (e.g., direct labour, direct material and direct expenses including traceable
fixed expenses, i.e., the fixed expense which are directly chargeable). In Direct
Costing (or Marginal Costing), factory variable overhead is taken as a direct cost
while in the Absorption Cost Method, it is Indirect Cost.
B. Standard Costing

Standard Costing is defined as the preparation and use of standard cost, their

comparison with actual costs and the measurement and analysis of variances to

their causes and points of incidence. Standard Cost is a predetermined cost unit

that is calculated from the management’s standards of efficient operation and

the relevant necessary expenditure. Standard Costs are useful for the cost

estimation and price quotation and for indicating the suitable cost allowances

for products, process and operations but they are effective tools for cost control

only when compared with the actual costs of operation.

C. Budgetary Control
Budgetary Control may be defined as the process of continuous comparison of
actual costs and performance with the pre-established budgets in relation to the
responsibilities of the executives to the specific budgets for the achievement of a
target in accordance with the policy of the organisation and to provide a basis for
revision of budget. Therefore, Budgetary Control involves mainly establishment of
budgets, continuous compassion of actual with budgets for achievement of
targets, revision of budgets in the light of changed circumstances.
The classification of budgets into various categories certainly helps to make the
budgetary control more effective because the maximum use is made of the
functional budgets. Functional Budgets over the goals to be attained by the
functional executives and thus assume the greatest significance.
D. Uniform Costing
Uniform Costing may be defined as the application and use of the same costing principles and
procedures by different Organizations under the same management or on a common
understanding between members of an association. It is thus not a separate technique or
method. It simply denotes a situation in which a number of organizations may use the same
costing principles in such a way as to produce costs which are of the maximum comparability.
From such comparable costs valuable conclusions can be drawn. When the Uniform Costing is
made use of by the different concerns the same management it helps to indicate the strengths
and/or weaknesses of those concerns. By studying the findings, appropriate corrective steps may
be taken to improve the overall efficiency of the organizations. When used by the member
concerns of a trade association Uniform Costing helps to reduce expenditure on a comparative
marketing, to determine and follow a uniform pricing policy, to exchange information between
the members for comprised and improvement and so on.
COST SHEET Cost sheet is defined as “a document which provides for the assembly of the

detailed cost of a cost centre or cost unit.”

Thus, cost sheet is a periodical statement of cost designed to show in detail the various

elements of cost of goods produced like prime cost, factory cost of production and total cost. It

is prepared at regular intervals, e.g., weekly, monthly, quarterly, yearly, etc. Comparative figures

of the previous period may also be shown in the cost sheet so that assessment can be made

about the progress of the business.

Purposes. Cost sheet serves the following purposes:

1. It reveals the total cost and cost per unit of good0s produced.

2. It discloses the break-up of total cost into different elements of cost.

3. It provides a comparative study of the cost of current period with that of the corresponding

previous period.

4. It acts as a guide to management in fixation of selling prices and quotation of tenders.

Cost sheet (or Statement of Cost) for the period………..
Cost sheet (or Statement of Cost) for the period………..
Cost sheet (or Statement of Cost) for the period………..

Sales 1,16,000
 Break-Even Point
In a business scenario, the break-even point is a perimeter at which the total expenses of the

enterprise equals the total revenue generated. Reaching this point indicates that a business has

overcome all the expenses and no more in a state of loss.

Break-even analysis is of vital importance in determining the practical application of cost func-

tions. It is a function of three factors, i.e., sales volume, cost and profit. It aims at classifying the

dynamic relationship existing between total cost and sale volume of a company.

Hence it is also known as “cost-volume-profit analysis”. It helps to know the operating condition

that exists when a company ‘breaks-even’, that is when sales reach a point equal to all expenses

incurred in attaining that level of sales.

• The Point which breaks the total cost & Selling price
evenly to show the level of output or sales at which there
shall be neither profit not loss
• At this point, Income of the business exactly equals its
expenditure

• At BEP
Total Cost = Total Sales
Income = Expenditure

• If Production > BEP= Business earns Profit

• If Production < BEP = Business suffers Loss
Calculation of Break-Even Analysis
Profit/Volume Ratio (P/V Ratio
• Important for studying the Profitability of Operation of a business
• Also establishes a relationship between the contribution and the sale
value
• It is also called as Contribution/Sales ratio
• It is important for management to find out which product is profitable.
 DESIRED PROFIT
• At BEP the desired profit is Zero
• In case the volume of output/sales is to be computed
for a desired profit. The amount of desired profit
should be added to fixed cost in formula.
Applications of Break-Even Analysis
•Planning in New Businesses
New businesses have a lot to plan before they introduce a facility and start manufacturing goods for
sale. To ensure the plans regarding cost and pricing of goods are done right, break even analysis is a
necessity. One will be able to analyze and state if the new business idea is productive or not.
•Introduction of New Products
For cases, a company wishes to introduce the production of new products in its business unit; the
study of break-evens can emerge very significant. Before they start producing the goods, analyzing
break-even will help them understand the cost and pricing strategy.
•Business Model Modification
Change in a business model may have an impact on your businesses productivity. The change of
model doesn’t necessarily mean it will affect the costs and expenses, but if that’s the case, it will help
you change your selling price accordingly. Hence, analyzing break-even in this scenario is both feasible
and important.
Further, while discussing, the term marginal costing and break even analysis may appear frequently.
Marginal cost is the extra cost incurred in producing one extra unit of a good. This can help determine
how variable costs can affect the volume of production in a business unit.
Limitations of Break-Even Analysis:

1. In the break-even analysis, we keep everything constant. The selling price is assumed to be constant

and the cost function is linear. In practice, it will not be so.

2. In the break-even analysis since we keep the function constant, we project the future with the help of

past functions. This is not correct.

3. The assumption that the cost-revenue-output relationship is linear is true only over a small range of output.

It is not an effective tool for long-range use.

4. Profits are a function of not only output, but also of other factors like technological change, improvement in

the art of management, etc., which have been overlooked in this analysis.
5. When break-even analysis is based on accounting data, as it usually happens, it may suffer from various

limitations of such data as neglect of imputed costs, arbitrary depreciation estimates and inappropriate

allocation of overheads. It can be sound and useful only if the firm in question maintains a good accounting

system.

6. Selling costs are specially difficult to handle break-even analysis. This is because changes in selling costs are

a cause and not a result of changes in output and sales.

7. The simple form of a break-even chart makes no provisions for taxes, particularly corporate income tax.

8. It usually assumes that the price of the output is given . In other words, it assumes a horizontal demand

curve that is realistic under the conditions of perfect competition.

9. Matching cost with output imposes another limitation on break-even analysis. Cost in a particular

period need not be the result of the output in that period.

10. Because of so many restrictive assumptions underlying the technique, computation of a break-

even point is considered an approximation rather than a reality.

BREAK EVEN CHART
Illustration: From the following particulars, Break even point in terms of units and

volume and also prepare Break Even Chart:

1.Sales = Rs. 400

2. Material = Rs. 40

3.Labor = Rs. 100

4.Variable Over Heads = Rs. 100

5.Fixed Cost = Rs. 60,000

From the following particulars, calculate:
(i) Break-even point in terms of sales value and in units.
(ii) Number of units that must be sold to earn a profit of Rs. 90,000.
Fixed Factory Overheads Cost = Rs. 60,000
Fixed Selling Overheads Cost = Rs. 12,000
Variable Manufacturing Cost per unit = Rs.12
Variable Selling Cost per unit = Rs.3
Selling Price per unit = Rs.24
From the following particulars, find out the break-
even-point:

What should be the selling price per unit, if the break-even

point should be brought down to 6,000 units?
Illustration: