Cost accounting

Limitation of financial accounting (FA)

1. historical data
2. summarized result
3. does not satisfy the information needs

Accounting information is critical containing of a business organization, their

dependence on accounting information has widely increased and hence is recognized
as an essential resource for managing an organization
FA achieves the objectives of

a. identifying financial events and transaction that occurs in an organization

b. measures the value of such occurrence in terms of money
c. organizes the data into meaningful information
d. analyses and communication of information to as broad range of persons
within the organization and outside organization is enable

Limitation of FA
i. It provides only part data: FA provides out of data information to management.
The management is more interested in current data than part data. It is rightly
said that financial accounts provides only postmortem analysis of part activities
ii. it reveals only over all result for the business: fa does not provide data for
each and every product process department or operation separately instead it
provides the financial information in a summary form for the whole
organization
iii. it is stasis in nature: modern business is dynamic but financial accounts do not
incorporate the changes a that takes place within the business
iv. it fails to take into account the impact of price level changes : under fa asset
are shown at the actual or the historical cost consequently deprecation is also
charged on the actual cost their will distort the profit. In modern inflationary
condition the price level have significant impact over the financial statement
v. it fails to exercise control over resources ie labor material and other expenses,
as a result losses and wastage go uncheck under this system
vi. it does not provide basis for cost comparison , cost comparison over a period
of time are between 2 jobs or 2 operations is not feasible
 vii. it fails to ascertain break even point ie the sales or output where the revenue
equals the cost
viii. possibility of manipulation of fa the chief form of manipulation fa are in the
area of valuation of inventory, provision of deprecation , creation of secretes
reserves

Definition of cost accounting

The charted institute of management account of U.K has defined costing as the
techniques and process of ascertaining cost.

Weldon has defined costing as classifying recording and appropriate allocation of

expenses for the determination of cost, the relation of these cost too sales value and
the ascertainment of the profitability.

Cost accounting and financial accounting comparison

FA CA
Purpose The main aim of FA is to The main purpose of CA is to
prepare P & L a/c and balance provide detailed cost information
sheet to reporting to to management ie insider
shareholder and outside
agencies ie external user
Statutory The FA are required to be Maintenance of CA are voluntary
requirement prepared according to the expect in certain industries
requirements of companies act where it has been made
and income tax obligatory to keep cost recorded
under the companies act
Periodically Financial reports are prepared Cost reporting is a continuous
reporting periodically usually on annual process at an interval of daily
basis weekly monthly instance etc
Control aspect FA emphasis on the recording of CA provides detailed system of
financial transaction and does control with the help of special
not attach important to control techniques of like standard
aspect costing and budgetary control

Historical and FA exclusively concerned with It is concerned not only with

pre determined historical records; the historical historical cost but also with
cost nature of FA can be understood predetermined cost because cost
 in the context of the purpose for accounting doesn’t end with
which it is designed what happened in the past it
extends to planning and
improves performance in the
future
Format FA has a single uniform format CA has various forms of
presenting of presenting information ie P & presenting cost information
information L a/c balance sheet which are tailored to meet the
needs of management and thus
lacks in uniform format
Type of FA records only transaction with CA records not only external
transaction outside parties ie sales, transaction but also internal and
recorded purchase receipt etc interdependent transaction like
issue of materials by store
keeper to production department
analysis of cost FA reveals the P & L of the CA shows detail cost and profit
and profit business as a whole for a period for each product line department
it doesn’t show the fig of cost process etc
and profit for the individual
products department and
process

Objectives and functions of cost accounting

1. ascertainment of cost :this is the primary objective accounting .cost
ascertainment is achieved by different techniques and system of costing which
are used under different circumstance
2. Control of cost: cost control aims at improving efficiency by controlling and
reducing the cost. This objective has become increasingly important because of
growing competition
3. determination of selling price: on the basis of cost information provided by cost
accounting selling price of product or serviced may be fixed in period of dippers
ion cost accounting guide in deciding the extent to which selling price may be
reduced to meet the situation

4. Guide to business policy: it aims at serving needs of management at conducting

the business with at most efficiency. Cost data provides guide lines for various
 managerial decision like make or buy selling below cost, utilization of ideal
capacity, introduction of new product etc..
5. measuring and improving performance: ca measures efficiency by classifying and
analysis cost data and then suggest various steps in improving performance so
that profitability is increased

Cost: cost is the amount of resources given up in exchange for some goods or
services. Resources given up are money money’s equalient expressed in monitory
unit.

Institute of cost and work accounting in India (ICWAI)

Defines cost as the amount of expenses (actual and national) incurred or attributed
to a specified thing or activity

American accounting association (AAA)

Defines cost as a foregoing measured in monetary terms incurred or potentially to be
incurred to achieve a specific objective
Shilling law defined cost as “cost represents benefit given up to acquire goods or
service

Cost unit: ascertainment of cost is the central activity of the ca the ascertainment of
the cost necessities the determination of unit in terms of which cost can be
ascertained and expressed

The unit of product or service in relation to which cost are ascertained is known as a
cost unit. Cost unit varies from industry to industry and from concern to concern. A
no of cost units maybe used within an organization for different purpose. Cost unit is
the basis of measuring cost and making comparison between actual cost and
predetermined standards
The forms of ascertainment used as cost units are usually the units of physical
measurement like number, weight, area, length, value, time etc.. Cost unit is a
device for the purpose of breaking up or separating up into smaller sud-divisions,
these smaller sub-divisions are attributed to product or services to determine.
Product or service or costs of time spend for a particular job etc.
Advantages
a. Revel profitable and unprofitable activities: on this information management
may take step reduce or emulate wastage and ineffenciey occurring in the
form of ideal time, under utilization of planned capacity spoilage of material
etc.
b. helps in cost control by using of techniques of std costing and budgeting
control
c. helps in decision making: ie provides related information for decision such as
introduction of new products replacement of old machinery, make or buy etc
d. Guides in fixing selling price: cost is one of the most important factor to be
considered while fixing price especially at times of deprecation. The price may
have to be fixed below total cost.
e. Helps in inventory control: perpetual inventory is an integral part of ca and
helps in preparation of entire p&l a/c. cost accounting also uses inventory
control techniques like ABC analysis etc
f. Helps in cost reduction : ca helps in finding out new improved ways to reduce
cost through the introduction of cost reduction programme
g. Revels idle capacity: the concerned may not be working to full capacity due to
reasons sudden shortage of demand , machine breakdown or other bottle
neck (experiment) in production a cost accounting system can easily work out
the cost of idle capacity so that management can take immediately steps to
improve the position
h. Aids in formulating policies: it provides such information that enables
management to formulate pricing policies preparing estimates of contracts
and tenders
i. Prevent frauds and manipulation : cost audit system helps in preventing
manipulation and fraud and thus gives reliable cost data to management and
others
j. Check the accuracy of financial accounts: with the help of reconciliation
between financial accounting and ca at the end of the accounting period

Cost centre
Cost centre is the smallest segment of activity or area or responsibility for which
costs are accumulated cost centre is defined as by “CIMA” of 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” it may be a location ie a sales area, an item of
equipment ie a machinery or a delivery van, a person ie as sales man or a machine
operator or a group of these

The determined of a suitable cost centre is very important for ascertainment and
control of cost. It enables accumulation of all such causes at one place for which a
common base of recovery may be used.

Types of cost centre

i. Personnel cost centre: it consist of person or a group of persons
ii. Impersonal cost centre: it consists of locator or an items of equipment or a group
or a group of these
iii. Operation cost centre: it consists of those persons and 1 or machine carrying out
the same kind of operation
iv. Process cost centre: it is one which has a continues sequence of operation
v. Product cost centre: it refers to a centre through which a product passed and
generally corresponds to a product department. In such centre raw material are
converted into finished products eg: repairs-melting shop, welding shop.
vi. Service cost centre: it is a department which incurs cost not direct on making the
product these cost centre area ancillary to and render service to production cost
centre eg: store department repair shop canteen

Classification is the process of grouping like facts under a common destination on the
basis of similarities of nature attributes or relations.

Need for cost classification: arises due to use of cost data for a verity of purpose the
same cost data can’t serve all purpose equally hence cost must be arranged and
classified in such a way that they can be combined in different ways to serve
different purpose. The following are the list of purpose the following are the list of
purpose that cost classification serves
1. ascertainment of profits periodically: profit can be ascertained only when the
relevant revenue is compared with the relevant cost
2. preparation of budget ; the classification helps in preparation of budget for
instance when flexible budget are prepared for different levels of activity , the
 fixed cost remains constant at all levels of activity were as variable cost varies
according to level of output
3. cost control: fixed cost are mostly uncontrollable and if at all any control can be
exercised it can be done by the top level management , variable cost on the other
hand are mostly controllable when cost are classified s controllable cost and
uncontrollable
4. fixed selling price: in case of classification for the purpose of fixing selling price
the information needed will vary with the situation in which selling price is fixed
(marginal costing)
5. Observation of overheads (indirect cost) by classifying cost into fixed and variable
separate rates of absorption of overheads may be used the under observation or
over absorption arising out of the overhead are different in nature and need
different managerial action.
6. Other uses while planning cap. Expenditure: effect of proposed project on fixed
and variable cost should be studied more over differential and comparative cost
analysis are bases on classification of cost as fixed or variable

Basis of classification (nature analytical classification)

a. Material cost: ICMA defines material cost as “the cost of commodities other
than fixed cost introduction into product or consumed in the operation of an
organization. material cost may be direct or indirect material, the cost of
material entering into becoming a constituent part of the product or saleable
service is known as direct material cost
b. labor cost : it is defined as “ the cost of remuneration for employees efforts
and skills applied directly to the product or saleable service” labor consist of
both direct and indirect labor cost the above mentioned direct labor cost
inclusive of the indirect labor cost constitute the total labor cost
c. expenses : expenses may relate to direct expenses or indirect expenses cost
other than wages material cost , good constitute expenses
On the basis of viability
a. fixed cost: a cost which accurse in relation to the passage of time and which
within certain output or turnover limits tense to be unaffected by flotation in
volume of output or turn over the following are characteristics of the fixed cost
• total amount of fixed cost remains constant for varying levels of output
• fixed cost per unit is indirectly proportionate to the output
 • control of fixed cost lies in the hands of top management rather than the
departmental heads
b. variable cost: a cost which is aggregate tends to vary indirect proposition to
changes in volume of output or turn over its characteristics are
• the variable cost per unit remains constant
• the total variable cost varies in direct proportion to output
• it is easy to assign variable cost 2 product or department
• Control of variable cost lies in the hands of departmental heads eg; direct
material cost direct labor cost etc..
c. semi variable cost : a cost containing both fixed and variable elements is a semi
variable cost and is partly effected by flotation in volume of output or turn over
eg: tele charges, rental based on min rent supervision charges, maintenance and
repair

On the basis of identifiably

a. direct cost: are those which may be conveniently identified with a particular cost
centre or cost unit
b. indirect cost: are those cost which are incurred for the benefit a no of cost centre
or cost unit
eg: rent of a building ,salaries of mgt etc
Indirect costs have to be apportioned on certain assumption as regards this volume.

On the basis of function

a. production cost: cost of fabrication assembling units of products
b. administration cost: sum of cost of general mgt ,secretarial accountable and
administrative services which can be directly related to production marketing
research and development function of enterprise
c. selling and distribution cost : the cost of seeking to create and stimulate demand
and of securing orders ie cost of efforts to find and retain customers .distribution
– maling the packed products available for dispatch ie facilities the movement of
goods into the hands of the purchases
d. finance cost; cost of external source of funds
e. r&d : cost of seeking new or improved products

On the basis of controllability

 Cost are classified according to what they are influenced by the action of a given
member of the organization
a. controllable cost : are those costs which can be influenced by the action of
specified members of the organization ie cost which are at least partly within the
control of mgt controllable cost generally include all direct cost and ae
controllable by the person responsible for the cost centre(production manager)
b. uncontrollable cost : are those which cant be influenced by the action of a
specified members of the organization fixed cost are uncontrollable cost

On the basis of time

a. Historical cost: Costs which are ascertained after been incurred ie such cost cost
are available only when the production has already been done. Their
characteristics
• they are based on recorded facts
• they can be verified and they are always supported by evidence of their
occurrence
• they are mostly objectives because they related to happening which have
already taken place
b. Pre determined cost: such cost are estimated cost ie computed in advance of
production taking into consideration the pervious.. cost and the factors efficiently
such cost pre determined cost which will result in the identification of a variance
which helps the mgt in the purpose of control

On the basis of planning

Budget and STD cost furnish information to mgt and helps in planning and control
a. Budget cost represent : an estimate of expenditure for different phase of business
operations such as mfting, administration ,R&D etc which are co-coordinated in a
foremen work for a period of time in future eg raw material cost budget, labor
cost budget , cost of production budget mfting overheads budget administration
overhead budget etc
b. Standard cost: is defined as the predetermined cost based on a technical estimate
for material for material, labor and overhead for a selected period of time and for
prescribed set working conditions.
Cost sheet is a statement designed to show the output of a particular period along
with break up of cost the data incorporated in cost sheet are collected from various
statements of accounts which have been written in cost a/c on a day to day bases or
regular records CIMA defines cost sheet as document which provides for assembly of
the detailed cost of a cost centre or a cost unit.
A cost sheet may be prepared on a weekly, quiterally, monthly or yearly bases

Methods of costing
Specific order costing Operation costing
Job order costing Single /operation/output
Contract costing Operating costing
Batch costing Process costing
Multiple
Departmental

Specific order costing is defined as the category of basic costing method applicable
were work consist of separate contracts, job or batches each of which is authorized
by a special order or contract this method is adopted in made –to-order, type of
products which depends entirely on specification of customers as such there is known
standardization in production process for want of uniformity

Job order costing:

Is defined as that form of specific order costing which applies were work is
undertaken to customers requirement
Work is carried out within a factor or work shop were each job moves through
operations as a continuously identifiable unit
Building repair carried out in customer premises also constitute job costing
Costing for each job is dissimilar in nature & is identified separately by a job order no
Profit or loss is ascertained for each job separately
Eg ; interior deco, repair work shop , printing press etc..

Contract costing:
A work usually a constructional nature and is that form of specific order costing for
which customer requirements are taken and each order is off a long duration
Work is performed at the premises of the contractee
Most of the expenses are chargeable are direct in nature
Eg: building, road, dams, bridge etc...
Batch costing:
Is defined as that form of specific order costing which applies were similar articles
are manufactured in batches either for sale or for use within the under taking
It is similar to job costing
A convenient batch of production is rated as a job
Eg: bakery, hardware like bolts scores &Pharma industries

Operation costing
Is defined as basic costing method applicable were stdised goods or services result
from a sequence or repetitive and more less continuous operation or process to
which cost are charged before doing average over the units produced during the
period

Single output/unit costing: it is a method of costing by the unit of production where

manufacturing is continues & the units are identified. In some case the units may
differ I size, shape and quality. This method is called single costing as only a single
type of product is manufacturing
Eg; brick making industry, textile mills, paper mill, flour mills, quarries and collieries

Process costing: is that form of operation costing which applies where stdized goods
are produced. It is that method of costing where cost is ascertained at every stage of
the process

Features:
 Out put of one process is passed as input of the subsequent process unit
production is complete
 The cost of every process is transferred to the subsequent process
 The process industries incase normal and abnormal losses usually
 In a majority of process industries by products are obtained in addition to the
main the product
 The cost of semi-finished goods are generally expressed in terms of fully
finished goods and this process is called equivalent production
Eg : sugar industry, breweries petroleum , paints

Service or operating costing: it is applicable where stdized service are provided

either by an undertaking or by a service cost centre
Features:
 They render uniform service to all those who depends on it
 It involves heavy cap. Expenses in the mfting and supply of service
 The cost of production is classified into fixed and variable as economy of
operation affect the service cost unit
 They make use of composite unit to express the cost per unit

Eg ; transport undertaking, service supplier supply’s of gas, electricity water, canteen

hospital service library etc..

Departmental costing: under this method of costing the cost incurred in mft of
particular department is ascertained

The two main reasons being

• To control the cost of a dept eg :a dispensary belonging to a factory or cost of
running a research department
• To charge the cost of a dept to the finished product eg: charging the cost of
maintained dept to the production dept.

Multiple costing/hybrid costing: it is used in those industries which ascertain various

component parts
Eg; automobiles industry, aero planes, refrigerator industry etc.