Rajarshi Shahu Mahavidyalaya, Latur (Autonomous)

Department Of Commerce
Cost Accounting I
B.Com II (Sem III)
Dr. S. N. Bagwan
M.Com, NET, SET.

I. Introduction to Cost Accounting

❖ Origin of Cost Accounting
• Originated during the earlier years of world war II.
• Evolved during Industrial Revolution.
• Institute of Cost Accountants in India was first established in 1944.
• On 28th May 1959, the Institute was established by a special act of Parliament,
namely, the Cost and Works Accountants Act, 1959.
• The head office is situated at Kolkata.
• Four regional councils are at Kolkata, Chennai, Delhi and Mumbai.

❖ Meaning of Cost, Costing, Cost Accounting OR Basic Concepts of Cost

1. Cost
“The amount of expenditure incurred on a given thing”.
“The price paid for something.”
2. Costing
“Costing is simply cost finding by using any method like arithmetical process”.
“Costing means finding out the cost of product or service”.
3. Cost Accounting
“Cost accounting means Costing with double entry system”.
“It is formal system of recording cost in the books of accounts”.
4. Cost Centre
It is a part of an enterprise to which cost can be charged.
A cost Centre can be-
1. A location, i.e., a department, store yard, or sales area.
2. An item or equipment , i.e., a machine, delivery vehicle
3. A person, i.e., salesman, foreman.
A purpose of ascertaining cost by cost centres is to control the cost.
The size and number of cost centres vary from concern to concern and are dependent
upon the amount of Expenditure and requirements of Management for cost control.
➢ Types of Cost Centre
i. Impersonal Cost Centre
ii. Personal Cost Centre
iii. Operation Cost Centre
iv. Process Cost Centre

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 i. Impersonal Cost Centre
It is a cost Centre which consists location or item or group of these.
ii. Personal Cost Centre
It is a cost Centre which consists of a person or a group of persons.
iii. Operation Cost Centre
It is a cost Centre which consists of machines and or persons carrying out similar
operations.
iv. Process Cost Centre
It is a cost Centre which consists of specific process are continuous sequence of
operations.
5. Cost unit
A cost unit is “a unit of product or service or time in relation to which cost may be
ascertained or expressed.”
It is a unit of quantity in terms of which cost can be calculated.
The cost units can be a number, length, area, volume, weight, time, and value.
The cost unit can be changes according to nature of business operations.
➢ Examples of Cost unit

Industry Cost Unit

Steel Per Tonne
Cement Per Tonne
Sugar Per Quintal
Cable Per Metre or Kilometre
Textile Per Metre
Paper Per Kg. Or Per Tonne
Chemical Kg., Litre or Tonne
Power Kilowatt Hour (KWH)
Transport Passenger Kilometre, or Tonne
Kilometre.
Automobile Per Automobile, (Number)

➢ Types of Cost Unit

i. Simple or Single Cost Unit
ii. Composite or Compound Cost Unit
i. Simple or Single Cost Unit
These are used in manufacturing industries.
For Example- a tonne a kilometre, a litre, a metre, per passenger etc.
ii. Composite or Compound Cost Unit
These are used in service industries.
For Example- Per Passenger Per Kilometre, Per Bed Per Day, Per Tonne Per
Kilometre, Kilowatt-Hour etc.

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 6. Cost Ascertainment
Cost Ascertainment refers to methods used to find out the cost.
It is concerned with computation of actual cost after cost has been incurred.
7. Cost Estimation
Cost estimation is the process of pre- determining the cost of product or services.
Estimated costs are definitely future costs and are based on the average of past actual
figures adjusted for anticipated changed in future.
8. Cost Journal
Cost journal is a book in which cost transactions are recorded.
9. Cost Ledger
Cost ledger is a subsidiary ledger account open for posting transactions of cost Journal.
10. Cost Allocation or Allotment
All those expense which can be directly charged to cost Centre or cost unit is known as
cost allocation.
11. Cost Apportionment
When indirect expenses or overheads are charged then it is called as cost
apportionment.
12. Cost Manual
The document in which Costing information is recorded is known as cost manual.
13. Cost Audit
Cost audit means Verification and critical examination of Costing records.

❖ Definition of Cost Accounting

According to C.I.M.A., London Terminology, cost accounting is “the process of
accounting for costs from the point at which expenditure is incurred or committed to the
establishment of its ultimate relationship with cost centres and cost units. In its widest usage,
it embraces the preparation of statistical data, the application of cost control methods and
ascertainment of profitability of activities carried out or planned.”

❖ Objectives of Cost Accounting

1. Ascertainment of cost
This is the primary objective of cost accounting. For cost ascertainment different
techniques and system of Costing are used under different circumstances.
2. Control of cost
Cost control aims at improving efficiency by controlling and reducing the cost. This
objective is becoming increasingly important because of growing competition.
3. Guide to business policy
Cost Accounting aims at serving the needs of management in conducting the business
with utmost efficiency. Cost data provide guidelines for various managerial decisions like make
or buy decision, selling below cost, utilisation of resources, introduction of new product etc.

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 4. Determination of selling price
Cost accounting provides cost information on the basis of which selling price of a
product or services may be fixed. In periods of depression, cost accounting guided in deciding
the extent to which the selling price may be reduced to meet the special situation.

❖ Advantages of Cost Accounting

1. Advantages to Management
2. Advantages to Workers
3. Advantages to Creditors
1. Advantages to Management
i. Reveals Profitable and Unprofitable Activities.
ii. Helps in Decision Making.
iii. Helps in Inventory Control
iv. Checks the Accuracy of Financial Accounts.
v. Facilitates Cost Comparison.
2. Advantages to Workers
i. Introduction of Incentive Plans
3. Advantages to Creditors
i. To know the Financial Soundness.

❖ Objections Against Cost Accounting OR Limitations of Cost Accounting

1. It is Unnecessary.
2. It is an Expensive.
3. It is inexplicable.

Financial Accounting Vs. Cost Accounting

Basis of Difference Financial Accounting Cost Accounting
1. Purpose The main purpose of financial The main purpose of cost
accounting is to prepare Profit accounting is to provide details
and Loss Account and Balance of cost information to
Sheet management.
2. Statutory Financial Accounting is Recently, the Companies Act
requirements required to be kept as per the has made obligatory the
requirements of companies Act keeping of Costing records in
and Income Tax Act. some manufacturing
companies.
3. Periodicity of Financial accounting reports are Cost accounting aims at
Reporting prepared at the end of continuous reporting of cost
accounting period. and the related information at
short intervals. Cost reporting
maybe daily, weekly,
fortnightly, monthly etc.
4. Control Financial accounting does not Cost accounting provides
provide control over the cost. control over all elements of
cost.
5. Recording It records information about all In cost accounting different
kind of income and expenditure types of cost or recorded.
of a business.

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 6. Analysis of Financial accounts disclose the Cost accounting provides
profit profit of a business, but it is not information about the profit
possible to analyse the profit as along with analysis of profit of
per department, processes, and separate department, process,
products. products etc.

❖ Elements of Cost
An element of cost means essential part of a cost according to the factors upon which
expenditure is incurred namely called as-
I. Material
II. Labour
III. Expenses
The term cost is made-up of three elements that is material cost, labour costs and
expenses.
Material cost is the cost which is incurred on commodities supplied to an undertaking.
Labour cost is the cost of remunerating our employees.
Expenses is the cost of services provided to an undertaking. It also include the cost of
using our own assets that is depreciation, royalty, etc. (Indirect Expenses)
I. Material
For manufacturing goods there is a requirement of raw material. If cost of material is
not correctly ascertain then the cost of production also cannot be calculated properly. In the
absence of material no production can be carried out. Material includes-
1. Direct material
2. Indirect material
1. Direct material
While producing a product the raw material is used is called as a direct material.
For example, for constructing building cement, bricks, and iron are the direct material,
is also called as raw material.
2. Indirect material
The material which is not directly related to production process is known as indirect
material.
It is required for smooth performance of production activity.
For Example, lubricant oil and grease used in machinery.
II. Labour
Labour is a second important element of cost. The conversion of raw material into final
product is done with the help of workers. So, the expenses incurred on labour to be recorded
correctly. If the labour are not paid accordingly it may results into conflicts and also affect the
production process. Labour may include-
1. Direct Labour
2. Indirect Labour

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 1. Direct labour
The labours which are directly related to the production process is known as direct
labour.
All the labours which are related to production process or wages paid to the Baker,
tailor, carpenter shoe maker, etc. is known as direct labour.
It is also known as productive labour are productive wages.
2. Indirect labour
The labour or employees which are not directly related to production activity is known
as indirect labour.
It is also known as unproductive wages or labours.
For Example, wages paid to Inspector, cleaner, clerk watchman etc.
III. Expenses
The third element of cost besides the material and labour is expenses which are incurred
by the businesses. Expenses includes-
1. Direct Expenses
2. Indirect Expenses
1. Direct expenses
All those expenses which are directly related to production process are known as direct
expenses
2. Indirect expenses
Indirect expenses are also known as overheads. The expenses on material, labour
services which cannot be directly identified with specific saleable cost is known as overheads.
For Example, rent and rates, depreciation, insurance, carriage outward, advertising etc.

❖ Classification of Cost
The cost is classified on the basis of –
I. Function
II. Behaviour
III. Control
IV. Time
V. Nature
VI. Managerial Decisions
I. On the Basis of Function
On the basis of function the cost is classified into-
1. Manufacturing or Factory Cost
2. Office and Administrative Cost
3. Selling and Distribution Cost
4. Research and Development Cost
1. Manufacturing or Factory Cost
Those expenses which are required at the time of producing or manufacturing the
product is known as factory cost.

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 2. Office and administrative cost
All those expenses which are related with office and administration is known as office
and administration cost.
For Example, stationery.
3. Selling and Distribution Cost
Selling cost is the cost which is incurred on advertising, commission of salesman and
so on.
Distribution cost is nothing but the cost which is incurred on distributing the goods like
cost of delivery van, warehousing cost etc.
4. Research and Development Cost
Research cost is the cost of searching new or improved product or method.
Development cost is the cost of the process which begins with implementation of the
decision to produce a new product or to employ new or improved method for the development
of a product.
Pre-production cost is the part of the development cost which is incurred on making a
trial production.
II. On the Basis of Behaviour or Variability
On the basis of behaviour the cost is classified into-
1. Fixed Cost
2. Variable Cost
3. Semi-fixed and Semi-variable Cost
1. Fixed Cost
The cost which remains fixed irrespective of the volume of production is known as
fixed cost.
For Example, managerial salaries, rent, insurance on building, salaries of permanent
staff etc.
2. Variable Cost
The cost which changes according to change in production then it is known as variable
cost.
For Example, direct material cost, direct wages, normal wastage etc.
3. Semi-fixed or Semi-variable Cost
The cost which is partly fixed and partly variable it is known as semi-fixed or semi-
variable cost.
For Example, electricity bill.
III. On the Basis of Control
On the basis of control the cost is classified into-
1. Controllable Cost
2. Uncontrollable Cost
1. Controllable Cost
Those costs on which management can have a control is known as controllable cost

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 For Example, material cost, labour cost, and other expenses.
2. Uncontrollable Cost
The expenses on which management does not have a control is known as uncontrollable
cost
For Example, increase in cost of raw material, strike of workers, cut-off of power
supply, natural and manmade calamities.
IV. On the Basis of Period or Time
On the basis of time the cost is classified into-
1. Historical Cost
2. Future Cost
1. Historical Cost
The cost which is already incurred is known as historical cost.
2. Future Cost
The cost which is pre-determined before production takes place is known as future or
estimated or standard cost.
V. On the Basis of Nature
On the basis of nature the cost is classified into-
1. Direct Cost
2. Indirect Cost
1. Direct cost
All those expenses which are included directly on production process is known as direct
cost.
The direct cost may include-
✓ Direct Material,
✓ Direct Labour, and
✓ Direct expenses.
2. Indirect Cost
All the expenses which are included indirectly on the production process is known as
indirect cost.
The indirect cost may include-
✓ Factory Overheads
✓ Office and Administrative Overheads
✓ Selling and distribution Overheads
VI. On the Basis of Managerial Decisions
On the basis of managerial decisions the cost is classified into-
1. Sunk Cost
2. Opportunity Cost
3. Estimated Cost
4. Replacement Cost
5. Conversion Cost
6. Imputed Cost

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 7. Marginal Cost
1. Sunk Cost
The expenses which are actually incurred is known as sunk cost.
All historical cost are sunk cost.
2. Opportunity Cost
Opportunity Cost means alternative cost.
For Example, purchase of delivery can instead of machinery, so here cost of
machinery is known as opportunity cost.
3. Estimated Cost
The cost which is pre-determined before production process takes place is known as
estimated cost.
4. Replacement Cost
The cost which is required to replace any asset is known as replacement cost.
5. Conversion Cost
The cost which is required to convert raw material into finished goods is known as
conversion cost. Conversion cost includes-
✓ Direct Material
✓ Direct Labour,
✓ Direct Expenses.
6. Imputed Cost
These are hypothetical cost which are specifically computed for the purpose of decision
making.
For Example, interest on capital.
7. Marginal Cost
The cost which is required to produce an extra unit of product is known as marginal
cost.

❖ Methods of Costing
1. Job Costing
In this method, costs are collected and accumulated separately for each job or work
order. this is because each job work is done according to customers specifications. each job has
a separate identity and makes a cost unit. the industries where this method of Costing is used
are- repair shops, printing press, painting and decorating, production of made-to-order articles
etc.
2. Contract Costing
This method is based on the principle of job costing. if a job is big, it is known as
contract. contract is a big job and job is a small contract. each contract is taken as a separate
cost unit for the purpose of cost ascertainment. contract costing is most suited to- construction
work, ship building, architect, constructional engineers etc.
3. Batch Costing

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 Like contract costing it is also a variation of job costing. in this method production of
identical products are arranged in convenient groups or batches. Each batch is treated as a cost
unit and cost are accumulated for each batch separately. it is used in the production of-
readymade garments, toys, bicycle parts, biscuits and confectionery etc.
4. Process Costing
In this method, costs are separately collected and accumulated for each process or
department in order to arrive at the cost per unit, the total cost of process or department is
divided by the quantity of production. this method is used in mass production Industries
manufacturing standardized products in continuous process of manufacturing. in such
Industries finished product of one process becomes raw material for the next process. examples
of such industries are- textile mills, chemical works, sugar mills, paper mills, soap
manufacturing etc.
5. Single, Output or Unit Costing
This method is used when production is uniform and consists of only a single product
or two or three types of similar products or different grades of the same product. this method
is applied in the industries like mines, oil drilling, Steel works, bricks works etc.
6. Operating Costing
Operating costing method of cost ascertainment is applicable to those undertaking that
renders services. they do not manufacture goods. undertakings are- transport companies,
electricity companies, Cinemas, schools, hospitals, gas and steam generating concerns etc. as
the activities of such undertakings are of diverse nature the cost system used is obviously
different from that of manufacturing concerns.
7. Multiple or Composite Costing
It is an application of more than one method of Costing in respect of the same product.
this method is used in the industries in which a number of components are separately
manufactured and assembled to produce a single unit of product. for example manufacture of
different types of components may require different production methods and hence different
methods of Costing may have to be applied. assembly of these components into one finished a
unit may require still another method of Costing. multiple costing is applicable to
manufacturing and assembling concerns like television, radio manufacturing, scooter and other
motor vehicles, refrigerator manufacturing, electric motor etc.
References:
1. S. P. Iyengar- Cost Accounting: Principles and Practices
2. M. N. Arora- Essentials of Cost Accounting

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