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Presenter’s Introduction:
Muhammad Atif Saeed (Material Cost)
Muhammad Kamran (Labor & FOH)
Imran Bhatti (Total Cost)
M. Zia ur Rehman (Methods of Costing)
M. Mumtaz (Summary & Conclusion)

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Cost Concepts

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Outline:
Topics:
Meaning of Cost Accounting
Objective of Cost Accounting
Elements of Cost Accounting
Material Cost
Classification of Material Cost
Labor Cost
Classification of Labor Cost
Factory Overhead cost
Types of FOH
Total Cost
Component of Total Cost
Topics:
Relevant & Irrelevant Cost
Fixed & Variable Cost
Semi-Variable Cost
Per Unit Cost
Methods of Costing
Techniques of Costing
Other Costing Concepts
Application of Cost Concepts
Summary

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Meaning of Cost
Accounting
• According to the Chartered Institute of Management
Accountants, London, cost accounting is the process
of accounting for costs from the point at which its
expenditure is incurred or committed to the
establishment of the ultimate relationship with cost
units. In its widest sense, it embraces the preparation
of statistical data, the application of cost control
methods and the ascertainment of the profitability of
the activities carried out or planned.

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Objectives of Cost Accounting
• The main objectives of cost accounting can be summarized as
follows:
Determine Selling Price
Determining and Controlling Efficiency
Facilitating Preparation of Financial and Other
Statements
Providing Basis for Operating Policy

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Elements of Cost:

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Cost: Material Cost
• To produce or manufacture material is required. For
example to manufacture shirts cloth is required and to
produce flour wheat is required.
• All material which becomes an integral part of finished
product and which can be conveniently assigned to
specific physical unit is termed as “Direct Material”. It
is also described as raw material, process material,
prime material, production material, stores material,
etc. The substance from which the product is made is
known as material. It may be in a raw or manufactured
state. Material is classified into two categories.

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Classification of Material:
• Direct material
Direct Material is that material which can
be easily identified and related with specific
product, job, and process. Timber is a raw
material for making furniture, cloth for
making garments, sugarcane for making
sugar, and Gold/ silver for making
jewellery, etc are some examples of direct
material.
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Direct Material:

Beginning
Beginning inventory
inventory ++ Purchases
Purchases == Goods
Goods Available
Available for
for Sale
Sale

Goods
Goods Available
Available for
for Sale
Sale –– Ending
Ending inventory
inventory == Cost
Cost of
of goods
goods sold
sold
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Computing Direct Material Cost:

Beginning Balance + DM purchase - Ending DM Balance

EI: Direct Materials Used:

Materials Inventory, Dec.31, 2005 $100,000
Direct Materials Purchase 200,000
Cost of Direct Materials available for use 300,000
Less:Materials inventory, Dec. 31, 2006 50,000
Cost of direct materials used $250,000

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Cost: Indirect Material
Indirect Material is that material which cannot
be easily and conveniently identified and
related with a particular product, job, process,
and activity. Consumable stores, oil and waste,
printing and stationery etc, are some examples
of indirect material. Indirect materials are used
in the factory, the office, or the selling and
distribution department.

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Cost: Labour Cost
Labor is the main factor of production. For
conversion of raw material into finished goods,
human resource is needed, and such human resource
is termed as labor. Labor cost is the main element of
cost in a product or service. Labor can be classified
into two categories:
• Direct Labour
• Indirect labour

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Cost: Direct Labour Cost
Labour which takes active and direct part in the
production of a commodity. Direct labour is that
labour which can be easily identified and related with
specific product, job, process, and activity. Direct
labour cost is easily traceable to specific products.
Direct labour costs are specially and conveniently
traceable to specific products. Direct labour varies
directly with the volume of output. Direct labour is also
known as process labour, productive labour, operating
labour, direct wages, manufacturing wages, etc. Cost
of wages paid to carpenter for making furniture, cost
of a tailor in producing readymade garments, cost of
washer in dry cleaning unit are some examples of
direct labour.
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Cost: Indirect Labour
Indirect labour is that labour which can not be easily
identified and related with specific product, job,
process, and activity. It includes all labour not directly
engaged in converting raw material into finished
product. It may or may not vary directly with the
volume of output. Labour employed for the purpose of
carrying out tasks incidental to goods or services
provided is indirect labour. Indirect labour is used in
the factory, the office, or the selling and distribution
department. Wages of store-keepers, time-keepers,
salary of works manager, salary of salesmen, etc, are
all examples of indirect labour cost.
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Cost: Factory Overhead
• Expenses
• Expenses may be direct or indirect.
Direct Expenses
These are the expenses that can be directly, conveniently and
wholly allocated to specific cost centers or cost units.
Examples of such expenses are as follows:
• Hire of some special machinery required for a particular contract
• Cost of defective work incurred in connection with a particular job
or contract etc.
• Direct expenses are sometimes also described as chargeable expenses.
Indirect Expenses
• These are the expenses that cannot be directly, conveniently
and wholly allocated to cost centers or cost units. Examples of
such expenses are rent, lighting, insurance charges etc.

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Cost: Factory Overhead
• Overhead
• The term overhead includes indirect material,
indirect labor and indirect expenses. Thus, all
indirect costs are overheads.
• A manufacturing organization can broadly be
divided into the following three divisions:
– Factory or works, where production is done
– Office and administration, where routine as well as
policy matters are decided
– Selling and distribution, where products are sold and
finally dispatched to customers

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Cost: FOH Types
– Factory Overheads
• They include the following things:
• Indirect material used in a factory such as lubricants,
oil, consumable stores etc.
• Indirect labor such as gatekeeper, timekeeper, works
manager’s salary etc.
• Indirect expenses such as factory rent, factory
insurance, factory lighting etc.

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Cost: Other Overheads
– Office and Administration Overheads
• They include the following things:
• Indirect materials used in an office such as printing and stationery
material, brooms and dusters etc.
• Indirect labor such as salaries payable to office manager, office
accountant, clerks, etc.
• Indirect expenses such as rent, insurance, lighting of the office
– Selling and Distribution Overheads
• They include the following things:
• Indirect materials used such as packing material, printing and
stationery material etc.
• Indirect labor such as salaries of salesmen and sales manager etc.
• Indirect expenses such as rent, insurance, advertising expenses
etc.

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Cost: Factory Overhead

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Components of Total Cost
Prime Cost
Prime cost consists of costs of direct materials, direct labors and
direct expenses. It is also known as basic, first or flat cost.
Factory Cost
Factory cost comprises prime cost and, in addition, works or factory
overheads that include costs of indirect materials, indirect labors
and indirect expenses incurred in a factory. It is also known as
works cost, production or manufacturing cost.
Office Cost
Office cost is the sum of office and administration overheads and
factory cost. This is also termed as administration cost or the total
cost of production.
Total Cost
Selling and distribution overheads are added to the total cost of
production to get total cost or the cost of sales.
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Cost: Total Cost

Components of total cost

Direct material
Direct labor Prime cost or direct cost or first cost
Direct expenses
Works or factory cost or production
Prime cost plus works overheads
cost or manufacturing cost
Works cost plus office and
Office cost or total cost of production
administration overheads
Office cost plus selling and
Cost of sales or total cost
distribution overheads

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Relevant and Irrelevant Cost
Relevant costs are those which change by
managerial decision. Irrelevant costs are those
which do not get affected by the decision. For
example, if a manufacturer is planning to close
down an unprofitable retail sales shop, this will
affect the wages payable to the workers of a
shop. This is relevant in this connection since
they will disappear on closing down of a shop.
But prepaid rent of a shop or unrecovered costs
of any equipment which will have to be scrapped
are irrelevant costs which should be ignored.
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 Fixed Cost & Variable cost:
Fixed costs represent commitments that the jurisdiction has already
made and cannot avoid, at least in the short term. Examples
include rent required pursuant to a lease, depreciation
(colloquially, wear and tear) on government-owned structures or
equipment, and payments of interest on bonded debt. Because
they tend not to change with changes in service levels, fixed costs
are more difficult to reduce in the short run than variable costs,
which can be altered fairly quickly.
Variable costs are those costs which are responsive to changes in
levels of service or the number of units of production — changes
which generally can be achieved in the near term. Examples
include personnel expenses (individuals can be transferred to other
functions or laid off), the costs of supplies, fuel, and travel.

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Semi-Variable Cost:
A cost contains both fixed and variable component and
which is thus partly affected by fluctuations in the level
of activity. Semi-variable costs is that cost of which
some part remains fixed at the given level of
production and other part varies with the change in
the volume of production but not in the same
proportion of change in production. For example,
expenses may not change if output is upto50%
capacity but may increase by 5% for every 20%
increase in output over 50% but up to 70%. For
example, Telephone expenses of which rent portion is
fixed and call charges are variable.
Semi-variable Cost= Fixed Cost + Variable cost
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Per Unit Cost
While preparing cost accounts, it becomes necessary to select a unit with
which expenditure may be identified. The quantity upon which cost can
be conveniently allocated is known as a unit of cost or cost unit. The
Chartered Institute of Management Accountants, London defines a unit of
cost as a unit of quantity of product, service or time in relation to which
costs may be ascertained or expressed.

(i) Brick works per 1000 bricks made

(ii) Collieries per ton of coal raised
(iii) Textile mills per yard or per lb. of cloth
manufactured or yarn spun
(iv) Electrical companies         per unit of electricity generated
(v) Transport companies         per passenger km.

(vi) Steel mills per ton of steel made

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Method of Costing:
• Job Costing
• Contract Costing
• Cost Plus Costing
• Batch Costing
• Process Costing
• Operation Costing
• Unit Costing (Output Costing or Single Costing)
• Operating Costing
• Departmental Costing
• Multiple Costing (Composite Costing)
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Techniques of Costing:
• Marginal Costing
• Direct Costing
• Absorption or Full Costing
• Uniform Costing

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Other Costing Concept:
Production Cost
The cost of sequence of operations which begins with supplying materials,
labor and services and ends with the primary packing of the product.
Thus, it includes the cost of direct material, direct labor, direct expenses
and factory overheads.
Administration Cost
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, research or development activity or
function.
Selling Cost
It is the cost of selling to create and stimulate demand (sometimes termed
as marketing) and of securing orders.
Distribution Cost
It is the cost of sequence of operations beginning with making the packed
product available for dispatch and ending with making the reconditioned
returned empty package, if any, available for reuse.
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Other Cost Concepts:
Research Cost
It is the cost of searching for new or improved products, new application
of materials, or new or improved methods.
Development Cost
The cost of process which begins with the implementation of the decision
to produce a new or improved product or employ a new or improved
method and ends with the commencement of formal production of that
product or by the method.
Pre-Production Cost
The part of development cost incurred in making a trial production as
preliminary to formal production is called pre-production cost.
Conversion Cost
The cost of transforming direct materials into finished products excluding
direct material cost is known as conversion cost. It is usually taken as an
aggregate of total cost of direct labor, direct expenses and factory
overheads.

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