COST AND MANAGEMENT ACCOUNTING

Unit-I

Cost

Cost may be defined as a total of all expenses incurred in the manufacture and
sale of a product. Example- We say that the cost of a table is Rs.2,000,which
means we have spent an amount of Rs 2,000 in making the Table. We can say
that we spent Rs.2,000 towards the cost of materials, labour and other
expenses.

Costing

Costing is the technique and process of ascertaining cost. Costing consists of

principles and rules which are used for determining

1.the cost of producing a product, Example. Computer, Car.

2.the cost of providing a service e.g. hotel ,hospital, transport.

3.the cost of performing an activity e.g. placing purchase orders, receiving

deliveries of materials.

Cost Accounting

Cost Accounting is the process of accounting foe cost which begins with the
incurrence of cost and ends with the control of cost.

It is a formal system of accounting by means of which costs of products,

services or activities are ascertained and controlled.

Definition
CIMA ,London defines cost accounting as the process of accounting 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 the ascertainment of the profitability of activities
carried out or planned.

Thus cost accounting embraces-

1.Collecting , classifying, recording, allocating and analysing the costs.

2.Preparation of periodical statement and reports for ascertaining and

controlling costs.

3.Application of cost control methods.

4.Ascertainment of profitability of activities carried out or planned.

Difference Between costing and cost Accounting

Costing means determining the cost of products or services by any technique or

process like formal record based on double entry system.

Cost accounting is a formal system of accounting by means of which costs of

products or services are ascertained and controlled.

Objectives of Cost Accounting

The main objectives of cost accounting are cost ascertainment furnishing of cost
data for decision making and control of cost. The objectives are listed below

1.To find out the total cost and cost per unit of various products manufactured.
To disclose the proportion of different elements (such as material, labour and
overheads ) in the total cost.

3.To provide necessary data for fixing the selling price.

4.To ascertain the profitability of each product and advise the management as to
how these profits can be maximised.

5.To supply estimates of cost data ,on the basis of historical data for the
preparation of tenders ,quotations etc.

6.To present important cost data to the management for decision making
planning and control.

7.To adopt a suitable system of inventory control to avoid excessive locking up

of working capital in stocks.

8.To identify the sources of wastages and losses in the business.

9.To formulate incentive bonus plans and implement them to improve labour
productivity and reduce costs.

10.To exercise effective control on the idle times of men and machines.

11.To help in the preparation of budgets and implementation of budgetary

control.

12.To compare the actual cost with the standard cost and analyse the cause of
variance.

13.To supply useful data to the management to take vital decisions such as
introduction of new products, replacement of labour and machines.

14.To advise the management on future expansion policies and proposed capital
projects.
Scope of Cost Accounting

Cost accountancy is broader in scope and comprises Costing, Cost Accounting,

Cost Control, Cost Reduction and Cost Audit

1.Costing

Costing is the technique and process of ascertaining costs.

2.Cost Accounting

Cost Accounting is the process of accounting for cost which begins with the
incurrence of cost and ends with the control of cost.

3.Cost Control

Cost control involves the establishment of target performance, measuring actual

performance, comparing actual performance against target performance and
taking corrective action.

4.Cost Reduction

Cost reduction is the achievement of real and permanent reduction in the unit
cost of products manufactured or services rendered without imparing their
suitability for the use intended or diminution in the quality of the product.

5.Cost Audit

Cost Audit is the verification of cost accounts and a check on the adherence to
the cost accounting plan. Thus it involves-

(i) verification of cost accounting records and

(ii) examining these records to ensure that they adhere to the cost accounting
principles, plans, procedure and objectives.
ADVANTAGES OF COST ACCOUNTING

Cost accounting is a very valuable tool of planning and control. It offers a

number of advantages to the management. The following are the important
advantages of cost accounting.

Advantages:

1) Helps in decision making : Cost accounting helps in decision making. It

provides vital information necessary for decision making. For instance,
cost accounting helps in deciding :

a) Whether to make a product or buy a product?

b) Whether to accept or reject an export order?
c) How to utilise the scarce materials profitably?

2) Helps in fixing prices : Cost accounting helps in fixing prices. It

provides detailed cost data of each product (both on the aggregate and
unit basis) which enables fixation of selling prices. Cost accounting
provides basic which enables fixation of selling price. Cost accounting
provides basic information for the preparation of tenders, estimates and
quotations.

3) Formulation of future plans : Cost accounting is not a post-mortem

examination. It is a system of foresight. On the basis of past experience, it
helps in the formulation of definite future plans in quantitative terms.
Budgets are prepared and they give direction to the enterprise.

4) Avoidance of wastage : Cost accounting reveals the sources of losses or

inefficiencies such as spoilage, leakage, pilferage, utilisation of plant etc.
 By appropriate control measures, these wastages can be avoided or
minimised.

5) Highlights causes : The exact of an increase or decrease in profit or loss

can be found with the aid of cost accounting. For instance, it is possible
for the management to know whether the profits have decreased due to an
increase in labour cost or materials cost or both.

6) Reward to efficiency : Cost accounting introduces bonus plans and

incentive wage systems to suit the needs of the organisations. These plans
and systems to suit the needs of the organisation. These plans and
systems reward efficient workers and improve the productivity as well
improve the morale of the work force.

7) Prevention of fraud : Cost accounting envisages sound system of

inventory control. Budgetary control and standard costing. Scope for
manipulation and fraud is minimised.

8) Improvement in profitability : Cost accounting reveals unprofitable

products and activities . Management can drop those products and
eliminate unprofitable activities. The resources released from unprofitable
products can be used improve the profitability of the business.

9) Preparation of final accounts :Cost accounting provides for perpetual

inventory system. It helps in the preparation of interim profit and loss
account and balance sheet without physical stock verification.
 10)Facilities control : Cost accounting includes effective tools such as
inventory control, budgetary control and variance analysis. By adopting
them, the management can notice the deviation from the plans. Remedial
action can be taken quickly.

Limitations of Cost Accounting

1.Lack of Uniformity

There is no uniform system of costing applicable to all industries. Even for the
same firm, two different cost accountants may arrive at two different cost
figures.

2.Second Hand Data

Costing depends on financial accounts for a lot of information, which is second

hand .Any errors or short comings in that data creep into cost accounts also.

3.Conventions

Several conventions are routinely applied or used in costing which may not be
appropriate in all situations. For example classifying overheads into variable
and fixed , recovery of overheads on machine hour or labour hour basis etc.

4.Uncertainty

Estimates are used in different contexts like Tenders and Quotations, Contracts
etc. Different methods of pricing of materials are available. Several methods of
absorption and apportionment of overheads can be used. All these factors lead
to uncertainty and fluidity in costing. It becomes difficult to derive correct costs.
Actual costs may differ from estimated costs, rendering quotations etc,
5.Costly

The need to observe several formalities to derive benefits of costing makes it

costly for small and medium enterprises.

6.Applicability

Costing is applicable primarily in manufacturing and service firms.It is not

useful for trading firms.

7.Some items of costs and incomes are fully ignored in cost accounts where as
they are shown in financial accounts.
 Elements of cost Accounting

Chart

Elements of Cost

Materials Labour Expenses

Direct Indirect Direct Indirect Direct Indirect

Material Material Labour Labour Expenses Expenses

Prime cost

Overheads

Production Administration Selling and Distribution

Overheads Overheads Overheads
1.Material

The term materials refer to all commodities supplied to an undertaking. For

costing purposes, materials may be classified into two broad categories
(a)Direct Materials (b) Indirect Materials.

(a)Direct Materials

1.Meaning Direct materials are those materials which can be

conveniently identified with and can be directly allocated
to a particular product, job or process

2.Features The main features of direct materials are:

1.It can be easily identified with a specific job, contract or

work order.

2.It varies directly with the volume of output.

3.Examples Some examples of direct materials are as follows:

Basic Raw - Materials Primary Packing Materials

1.Timber in furniture 1.Can for tinned food and

drink.

2.Bottles for water ,wine

2.Cloth in Garments.
&whisky.
3.Milk &cream in Ice
3.Plastic packing for
cream
Milk,Ghee &Oil.
4.Paper in Books
4.Tin packing for Ghee &Oil
5.Bricks or cement in
5.Bag for cement
Building Construction.
 4.Treatment Direct material cost
forms part of prime cost.

(b)Indirect Materials

1.Meaning Indirect materials are those materials which can not be

conveniently identified with and cannot directly allocated to a
particular product, job or process.

2.Features 1.It cannot be easily identified with a specific job, contract or

work or work order.

2.It may or may not vary directly with the volume of output

3.Examples 1.Stores used for maintaining machines such as lubricant oil &
grease, cotton waste, consumable stores.

2.Stores used by service departments like power house, boiler

house.

3.Materials of small value which cannot be conveniently

identified with a particular product ,job or process. For
example, nails used in furniture, thread used in stitching
garments.

4.Treatment Indirect Material cost is treated as part of overheads.

2.Labour

Labour is an essential factor of production. It is a human resource and

participates in the process of production. Labour cost is a significant element of
cost of a product or service. For costing purposes labour may be classified into
two broad categories (a) Direct Labour and (b) Indirect Labour.

(a)Direct Labour

1.Meaning Direct labour is that labour which can be easily can be

identified with a specific job, contract or work order. It
includes:

1.All labour directly engaged in converting raw materials

into finished goods or in altering the construction,
composition or condition of the product.

2.Any other form of labour which is incurred wholly or

specifically for any particular job, contract or work order.

2.Features The main features of direct labour are

1.It can be easily identified with a specific job, contract

or work order

2.It varies directly with the volume of output.

3.Examples Some examples of direct labour are

1.Weaver in weaving unit.

2.Carpenter in furniture unit

3.Tailor in Readymade wears unit

 4.Labour employed on construction contract.

4.Treatment Wages paid to direct labour are termed as direct labour

cost and form part of prime cost.

(b) Indirect Labour

1.Meaning Indirect labour is that labour which cannot be readily

identified with a specific job, contract or work order. It
includes all labour not directly engaged in converting raw
materials into finished goods or in altering the
construction, composition or condition or the product.

2.Features 1.It cannot be easily identified with a specific job, contract

or work order.

2. It may or may not vary directly with the volume of

output.

3.Examples 1.Labour employed in Personnel Department.

2.Labour employed in Time keeping department.

3.Labour employed in Repairs and maintenance

department.

4.Labour employed in stores department.

4.Treatment Wages paid to indirect labour are termed as indirect labour

 cost and are treated as part of overheads.

3.Expenses

All costs other than material costs and labour costs are termed as expenses. For
costing purpose, expenses may be classified into two broad categories;(a)Direct
Expenses and(b)Indirect Expenses.

(a) Direct Expenses

1.Meaning All direct costs other than direct material costs and
direct labour costs are termed as direct expenses. These
can be readily identified with and thus can be directly
allocated to a particular product ,job or process.

2.Features The main features of direct expenses are

(a)It can be easily identified with a specific job,

contract or work order.

(b)It varies directly with the volume of output.

3.Examples Excise Duty based on output produced .

Job processing charges

Cost of special Moulds, designs and patterns

Hiring charges for machines, tools and equipments.

4.Treatment Direct expenses forms part of prime cost

(b) Indirect Expenses.

1.Meaning All indirect costs other than indirect material costs

and indirect labour costs are termed as indirect
expenses. These cannot be readily identified with and
thus,cannot be directly allocated to a particular
product, job or process.

2.Features 1.It cannot be easily identified with a specific job,

contract or work order.

2.It may or may not vary directly with the volume of

output.

3.Examples Rent ,Rates and taxes of Building

Repairs, Insurance and Depreciation of Building

,plant and Machinery ,Furniture.

Telephone Expenses

Lighting, heating and Cleaning Expenses

4.Treatment Indirect expenses Are treated as part of overheads

4.Overheads or On cost or Indirect Cost

All material , labour, and expenses which cannot be readily identified with a
particular product ,job or process are termed as Indirect costs. The three
elements of indirect costs viz. Indirect materials, indirect labour and indirect
expenses are collectively known as overheads or on costs or Burden. Thus,

Overheads= Indirect Material Cost+ Indirect Labour Cost +Indirect Expenses.

1.Production/Manufacturing /Factory Overheads

Production overheads represent all the indirect costs incurred in connection with
the production of product or services. These represent the aggregate of indirect
material cost ,indirect labour cost and indirect expenses incurred by production
department.

Examples

1.Indirect Material Cost of consumable stores and supplies like

Cost cotton waste, lubricating oil etc.

2.Cost of printing, postage & stationery used in

production Department.

2.Indirect Labour Cost 1.Salary of supervisor, works manager and

department superintendants.

2.Contributions to ESI, PF, leave pay, maternity

pay.
 3.Indirect Expenses 1.Rent ,rates and taxes of factory building.

2.Repairs, insurance & depreciation of factory

building, plant and machines and furniture.

3.Factory telephone expenses

4.Lighting, heating &cleaning of factory.

2.Administration Overheads

Administration overheads represent the cost of formulating the policy ,directing

the organisation and controlling the operations of an undertaking which is not
related directly to production, selling, distribution ,research or development
activity or function. These represent the aggregate of material cost ,labour cost
and expenses incurred by Administration Department for the general
management of an organisation.

Examples

1.IndirectMaterial 1.Cost of printing &Stationery used in Administration

Cost department.

2.Cost of dusters

2.Labour Cost 1.Salary of managing director, whole time director,

general manager, finance manager, accounts manager
and other staff working in Administration department.

2.Remuneration of internal and statutory cost and

financial auditors, Legal advisors.
 3.Expenses 1.Rent ,rates &taxes of office building, equipment and
furniture.

2.Administration office telephone expenses.

3.Lighting & cleaning of Administration office.

3.Selling Overheads

Selling overheads represent the cost of seeking to create and stimulate demand
and of securing order.Thus this is the cost of promoting sales and retaining
customers.These represent the aggregate to materials cost ,labour cost and
expenses incurred by sales department for the sales management of an
organisation.

Examples

1.Indirect Material 1.Cost of printing &stationery used ui sakes

Cost department.

2.Cost of catelogues, list prices etc.

2.Indirect Labour cost 1.Salary of sales director, sales manager, sales officers,
salesmen and other staff working in sales department.

2.Commission to agents.

3.Indirect Expenses 1.Rent ,rates &taxes of sales office/showroom.

2.Repairs, insurance &depreciation of sales office

building, equipment and furniture.
 3.Sales office, telephone expenses.

4. Lighting and cleaning of sales office.

5.Advertising

6.Baddebts

7.Debt collection charges

8.Sales men travelling expenses.

4.Distribution Overheads

Distribution overheads represent the cost of the sequence of operations which

begins with making the packed product available for despatch which begins
with making the packed product available for despatch and ends with making
the reconditioned returned empty package, if any available for reuse. They also
include expenditure incurred in moving articles to central or local storage or in
moving articles to and from prospective customers as in the case of goods on
sale or return basis. In the gas ,electricity and water industries Distribution
means pipes ,mains and service which may be regarded as equivalent to packing
and transportation. These represent the aggregate of material cost, labour cost
and expenses incurred by distribution department for the distribution
management of the organisation.

Examples

1.Indirect Materials 1.Cost of printing ,postage & stationary used

in distribution office.

2.Cost of secondary package.

 3.Cost of materials used in reconditioning of
the empty containers returned by customers for
reuse.

2.Indirect Labour 1.Salary of staff attached to distribution office

like packers, despatch (staff).

2.Salary of distribution vehicle driver

3. Indirect Expenses 1.Rent, rates & taxes of distributing office/go-

down /storage/warehouse.

2.Repair, insurance & depreciation of

distribution office building, equipment &
furniture, delivery van of distribution office.

3.Distribution office telephone expenses.

4.Freight and carriage outwards.

Methods of Costing

1.Job Costing-It means and applies to an industry which produces a definite

article against individual orders from out and each job moves through the
process as a continuously identical product. Where the cost of separate job is
wanted ,job costing method can be applied. Each job involves different
operations. The object of job costing is to ascertain the cost of each job
separately .This type of costing is suitable to printing press, automobile
garages, repair shops ,building yards, furniture manufacture, heavy machine etc.
2.Contract Costing- The method of contract costing is applied where the job is
big and of longer duration. For each individual contract, separate accounts have
to be kept. Basically this type of costing is similar to job costing, but takes
longer time It is also known as Terminal Costing. Each contract is given a
number for identification. It applies to a concern like constructional work,
roads, bridges, buildings etc.

3.Batch Costing-A batch may represent a number of small orders passed in

batches through the factory .The unit of cost is a batch or group of identical
products. ICMA defines as that form of specific order costing, which applies
where similar articles are manufactured in batches either for sale or for use
within the undertaking. In most cases ,this costing is similar to job costing. The
total cost of a batch is ascertained, the same is divided by the number of units in
the batch so as to know the cost per unit. All the units of a particular batch are
uniform in nature and in size. This type of costing is adopted by industries
producing ,medicines ,biscuits, spare parts and components etc.

4.Multiple Costing-It means combination of two or more of the above

methods. This system of costing is adopted on manufacturing, concerns where a
variety of parts are produced separately and later assembled into a final
product. It is also known as composite costing. It is a system of different
methods such as job costing, unit costing, operation costing etc. This type of
costing is in force in industries where cycles, radios, typewriters and other
complex items are produced.

5.Process Costing-It applies to industries where production is carried on

through different stages(process)before becoming a finished product. The
output of each process becomes input of the next process, i.e., finished product
of one process becomes the raw material of the subsequent process. This is
particularly important where by products arise or wastage occurs at any stage.
Finished products are obtained at the end of each process. It is necessary to
ascertain the cost of each process and the cost per unit at each process. Each
process has an account to which all expenditure is charged. The process cost per
unit in different processes is added to find the total cost per unit.

6.Single output or Unit costing-Under this method production is continuous

and units are identical. Producing a single article or a few articles, choosing the
cost unit depends upon the nature of the product .By preparing a cost sheet , the
cost per unit is arrived at by dividing the total cost by the total number of units
produced. This method is suitable to industries producing pencils, cigarettes,
dairy products, brick works, mines, steel works etc.

7.Operation Costing-|This method is used where there is a mass production

and process are repetitive in nature and there is a detailed application of
processes costing. The procedure of costing is broadly the same as per process
costing. Each manufacturing process can be distinguished as a seperate
operation. Operation costing is confined to every minute operation of each
accuracy and better control of costs. Hence ,the cost of each operation per unit
and cost per unit upto each stage of operation can be found out. Therefore it
facilitates in solving problems whether all the operations are profitable or not, in
case of unprofitable operations it can be given to outsiders.

8.Operating Costing-It is suitable to those industries which render services

instead of producing goods. This system is adopted where expenses are incurred
for provision of services for example, transport companies, electricity
companies, railways, hospitals, canteens etc. The cost is based on a specified
unit or composite unit like tonne-kilometre, passenger-kilometre, bed-days,
kilo-watt hours etc.

9.Departmental Costing-It is a method of cost finding adopted to ascertain the

cost of operating a department or a cost centre separately. Where the factory is
divided into a number of departments, this method is adopted. The total cost for
each department is found out and divided by the total units produced in that
department and this will give cost per unit. For example, departmental stores,
sellers, publishers etc.

Types of Costing

Costing is the technique and process of ascertaining costs. The objective of cost
accounting is the determination of all cost. The cost may be allocated on the
basis of actual cost incurred or costs may be assigned on a standard cost basis.
A system of cost accounting implies that there is a planned and coordinated
arrangement of all matters relating to costing, i.e., a systematic and planned
procedure is to be followed. The following are the systems generally in use.

1.Historical Costing-Batty says that ,Historical costing ,the ascertaining and

recording of actual costs when or after they have been incurred, was one of the
first stages in the growth of the cost accountants work. It refers to the
ascertainment of costs after they have been incurred. It is also known as
Traditional Costing. It is also known as Traditional costing.

2.Standard Costing-Standard cost is pre-determined cost. The costs are

determined in advance of production. Standard performance is set in terms of
costs and actual costs are compared with the standards. The difference between
the actual cost and the standard one is known as variations, which are recorded
and causes there of are investigated and remedial steps are taken. |This system
enables control of costs and also measuring the efficiency of operation.

3.Uniform Costing It is not a distinctive form of costing, but the cost system
is designed by trade associations followed by several undertakings. This system
enables inter-firm comparisons.
4.Marginal Costing-This system of costing differentiates between fixed costs
and variable costs. Under this system, fixed costs are not treated as product
costs. |The cost is thus the aggregate of direct material, direct wages, direct
expenses and variable overhead. This type of costing is useful in taking
important policy decisions- price fixing during competition time, make or buy
decisions, product mix etc. It is also known as variable for direct costing.

DISTINCTION BETWEEN FINANCIAL ACCOUNTING AND COST

ACCOUNTING

The main differences between financial accounting and cost accounting are
given below :

FINANCIAL ACCOUNTING COST ACCOUNTING

1)Objective 1)The main objective of cost
The main objective of financial accounting is to provide cost
accounting is to prepare profit and information to the management for
loss account and balance-sheet to decision making.
report to the owners and the outsiders
2)Legal Compulsion 2) Cost accounting is compulsory
Financial accounting is compulsory only for certain industries. In other
cases it is optional.
3)Recording of costs 3) Costs are recorded on unit basis
Costs are recorded in aggregate also

4) Data used Both monetary and non-monetary

Only monetary data are used. (units) data are used.
5) Periodicity of reporting It gives information to the
It reports operating results and management as and when required.
financial position at the end of the
year
6) Scope It deals with facts as well as estimates
It deals with actual facts and figures.
7)Stock valuation Stocks are valued at cost.
Stocks are valued at cost price or
market price whichever is less
8) Analysis of costs & profit It shows the detailed cost and profits
It shows the overall profit and loss of of each product, job or process
the organisation

9) Classification of expenses Distinction is made between fixed

No distinction is made between fixed and variable cost.
and variable costs.
10)Control Its emphasis only on control-control
Its emphasis is on reporting and not of material, labour and overheads.
on control

CHARACTERISTIC OF GOOD COSTING SYSTEM

A good costing system is one which effectively achieves the objectives of the
system. It should bring all advantages of costing to the business. The following
are the characteristics of a sound costing system.

1) Suitability : A good costing system is one which is designed to suit the

requirements of the business. It should be capable of providing necessary
information to the management for running the business efficiently.
 2) Simplicity : The system of costing should be simple and easy to
understand. It must facilitate the flow of information to the right person at
the right time.
3) Economy : The costing system must be economical. That is, it should not
be expensive. The expenditure must be less than the benefits derived from
the system adopted.
4) Flexibility : Modern business conditions are fast changing. Hence the
costing system must be flexible. In other words, the system must be easily
adaptable to the changes in business conditions.
5) Comparability : The management must be able to make comparison of
the facts and figures with the past figures, of other concerns or other
departments of the same concern.
6) Minimum changes : When introducing a costing system, it may cause
minimum disturbance to the existing setup of the business.
7) Minimum clerical work: The clerical work of the costing system must
be kept as low as possible.
8) Material control : Materials generally account for a higher proportion of
cost. The costing system should therefore, have fool proof method of
material control. This is necessary to ensure efficient utilisation of
materials and to avoid losses, pilferage etc.
9) Sound system of wage payment : A sound system of wage and incentive
payment is necessary to reward the efficient workers and motivate them
to improve productivity. It will also help reduce labour cost. Hence a
good costing should incorporate definite and clear procedures for the
following:
a) Recording of time spent by workers on their jobs
b) Preparation of wage sheets
c) Payment of wage, incentive and bonus
 10) Allocation of overheads : A sound basis should be developed for
collection, allocation, apportionment and absorption of overheads. Such
clear allocation would help to ascertain cost accurately.
11) Reconciliation : The costing system should provide for periodic
reconciliation of cost accounts and financial accounts
12) Role of the cost accountant: The cost accountant plays a key role in the
operation a costing system. Hence, his role, duties and responsibilities
must be clearly defined. He must have the requisite authority and facilities
to discharge his duties effectively.

STEPS TO BE TAKEN FOR THE INSTALLATION OF A COSTING

SYSTEM

The costing system of an organisation should be carefully planned in order to

achieve its objectives, The important steps for the installation of a costing
system are discussed below:

1) Determination of objectives : The first and foremost step is to clearly

lay down the objectives of the costing system. If the objective is only to
ascertain the cost, a simple system will be sufficient. However, if the
objective is to get information for decision making, planning and control,
a more elaborate system of costing is necessary.
2) Study of the nature of business : The nature of the business and other
technical aspects like nature of the products, methods and stages of
production cycle should be carefully analysed. Such an analysis is
necessary to decide the method of costing to be adopted. For example,
contract costing is suitable for large construction projects. Operating
costing is adopted by service industries like transport.
3) Study of the nature of the organisation : The costing system should be
designed to meet the requirements of the organisation. Hence, it is
necessary to study the nature, size and layout of the organisation. The
factors to be considered are :
a) Size of the organisation and the size of the department
b) The physical layout of the organisation
c) The different levels of management
d) The extent of decentralisation
e) The nature of authority relationships

4) Deciding the structure of cost accounts: A suitable costing system can

be developed on the basis of the study of the nature of business and
organisation. The structure of cost accounts should be simple and in
accordance with the natural production process.

5) Determination of cost rates : This step involves a thorough study of the

following points for developing an integrated costing system.
a) Classification of costs into direct and indirect costs.
b) Grouping of indirect costs (overheads) into production, administration,
selling and distribution etc.
c) Methods of pricing issues.
d) Treatment of wastes of all types
e) Absorption of overheads
f) Calculation of overhead rates

6) Organisation of the cost office : The cost office is responsible for the
efficient operation of the costing system.. The cost office, with adequate
staff must be located as close as possible to the factory. The following are
the major functions of the cost office.
 a) Stores accounts
b) Labour accounting
c) Recording of cost data and
d) Cost control

Further, the role and duties and responsibilities of the cost accountant
must be clearly defined. He must have the necessary authority to
discharge his duties effectively.

7) Introducing the system : After completion of the above steps, the

costing system may be formally introduced. Introduction of the system in
an existing organisation should be done gradually. Before introduction,
the feature of the systems, its working and advantages must be explained
to the concerned employees to secure their co-operation.

EXPLANATION OF THE TERMS

A) Cost Unit : A cost unit refers to a unit of product, service or time in

relation to which costs may be ascertained or expressed. In other words,
cost units is the unit of output for which cost is ascertained. For example,
the cost of air-conditioner is ascertained per unit.
The selection of cost unit is important in cost accounting. It should be
carefully selected to suit the nature of business corporation. The selected
unit should be neither too small nor too big, but ideal for cost
ascertainment. Cost unit may be expressed in terms of number(units),
weight , per Km, per tonne K.m .,etc. The following are the cost units in
various industries.
 Industry Cost Unit
Refrigerators, Cars, Scooters Per unit
Television sets, Motor cycles Per unit
Watches, Radios Per unit
Sugar Per quintal
Cement, Steel, Coal Per tonne
Paper Per tonne
Textiles Per metre
Chemicals Per kg/tonne/litre
Electricity Per kilowatt hour (kwh.)
Passenger Transport Per passenger K.m
Goods Transport Per tonne K.m
Ceramic tiles Per square feet or per unit
Bricks Per 1,000 Nos.
Road Contract Per K.m
Thus, cost units may vary from industry to industry. An enterprise
which produces more than one type of product may have more than one
cost unit.

Cost Centre : A large business is divided into a number of functional

departments (such as production, marketing and finance) for administrative
convenience. These departments are further divided into smaller divisions for
cost ascertainment and control. These smaller divisions are called cost centre.

A cost centre is a location, person or item of equipment (group of these)

for which cost may be ascertained and used for the purpose of cost control. In
simple words, it is a sub-division of the organisation to which costs can be
charged.
 A cost centre can be: (a) location i.e. an area such as works department,
store yard (b) a person such as supervisor, salesman (c) an item of equipment
e.g. delivery van or a particular machine.

The determination of suitable cost centre is very important for the

purpose cost ascertainment and control. The manager of a cost centre is held
responsible for control of cost of his cost centre. The number and the size of the
cost centre vary from organisation to organisation. The selection of a suitable
cost centre depends on the following factors :

a) Nature and size of business

b) Layout and organisation of the factory
c) Availability of various cost data and information
d) Management policy regarding cost ascertainment and control.

TYPES OF COST CENTRES : Cost centre may be of the following types:

1) Production Cost Centre : A cost centre in which production is carried on is

known as production centre. Eg. Machine shop, welding shop, assembly shop
etc.

2) Service Cost Centre : A cost centre which renders service to production cost
centre is known as service cost centre. Eg. Power house, stores department,
maintenance department etc.

3) Personal Cost Centre : It consists of a person or a group of person Eg. Sales

manager, works manager etc.
4) Impersonal Cost Centre : It consists of a location or a machine or a group
of machines. Eg. Canteen

5) Operation Cost Centre : It consists of machines and/ or persons carrying

out similar operations. Eg. Machines and operators engaged in welding or
turning

6) Process Cost Centre : It consists of a specific process or a continuous

sequence of operations Eg. Ginning, spinning, weaving etc.

7)Profit Centre : Profit centre is a responsibility centre which accumulates both

costs and revenues. In other words, it is department or segment of the
organisation which has been assigned to have a control over both revenues and
cost. For instance, if there are two divisions in a textile company, say ready-
mades and clothing, each one may be regarded as a profit centre. The main
objective of profit centre is to maximize the centres profit. (i.e. difference
between revenues and expenses.)

Distinguish between cost centre and profit centre

Important difference between cost centre and profit centre are:

1. Cost centre is created by the cost accountant. On the other hand a profit
centre is created by the management
2. Cost centre is created for the purpose of cost ascertainment and control
but the profit centres created for the purpose of evaluation of
performance.
3. Cost centre is a small segment, whereas profit centre is a large segment
 4. Cost centres do not enjoy autonomy. But, profit centres enjoy autonomy
5. Cost centre does not have a target of costs. But a profit centre has a target
of profit for performance evaluation.

Essentials of Cost Accounting in Management

Cost accounting plays a very important role in modern management. It helps the
management in the formulation of business policies, organising and control of
day to day function of the organisation. Cost accounting serves the management
in the following ways.

1. Decision making: the management has to select a course of action out of

the several alternatives available. This involves decision making. Cost
accounting provides accounting information necessary for making
decision such as:
a. Whether to make a component or buy from outside?
b. Whether to accept an export order or not?
c. Which is the most profitable product mix?
d. Which is the most profitable level of capacity utilisation?
e. How to utilise the scarce resources profitability?
2. Planning: cost accounting is very useful to the management in the
formulation of plans. Through the process of budgeting. The goals are
expressed clearly in quantitative terms. This helps in directing the efforts
of the organisation towards achievement of concrete objectives
Standard costing establishes standard to attain in respect of ach element
of cost establishment of standards is based on a careful study of various
factors and planning. As result, plans are formulated clearly and
objectively
3. Organising: installation of a costing system helps to build up a formal
organisation structure consisting of departments, cost centre and
responsibility centres. The authority, duties and responsibilities of each
 departments/ centre are clearly defined. Further, communication channels
are set up for proper reporting. The creation of a sound organisational
structure facilities the smooth functioning of the organisation.
4. Controlling: cost accounting is absolutely essential for controlling. It
provides detailed mechanism for control of material, labour and overhead
costs. Perpetual inventory system is operated to control material supplies,
various levels of stock( maximum level, danger level) and the economic
order quantity are determined for the purpose of the material control.
Labour costs are controlled by maintaining time and job records.
Overhead are also classifies into controllable and uncontrollable.
Management can concentrate on a few items for effective control.
5. Pricing: cost is the most important factor is pricing. Cost accounting
provides accurate cost data. It facilitates the determination of price and
the preparation of estimates, quotations and tenders. Cost accounting
techniques enables the management to take special pricing decisions such
as pricing during depression, price at which additional orders can be
accepted
Thus, costing has become an essential tools of management. It helps the
management from the stage of decision making to the final stage of
executive and control.
COST SHEET

Meaning of Cost Sheet

A cost sheet is a statement showing various component of total cost of output of

a particular product or service produced during a particular period. It may be
prepared on actual basis or estimated basis.

Periodicity of Cost Sheet

Cost sheet may be prepared weekly, monthly, quarterly, half yearly or yearly .

Purposes or Uses of Cost Sheet

1.It gives the break up figures of the total cost under different elements.

2.It gives total cost as well as cost per unit.

3.It facilitates comparisons.

4.It helps in the preparation of cost estimates(for tenders, quotations).

5.It helps in fixing the selling price.

6.It facilitates cost control by disclosing the inefficiencies by comparing with

the previous years figures.

Types of Cost Sheet

Cost sheet may be prepared on the basis of actual or estimated figures.

1.Historical Cost Sheet- Cost sheet prepared is the basis of actual costs after
the actual costs have been incurred is called Historical Cost Sheet.

2.Estimated cost sheet - Cost sheet prepared on the basis of estimated costs
before the actual commencement of production is called Estimated Cost Sheet.
Cost Sheet of ----------------for the Month of July------

Particulars Total Cost

Cost per
Opening stock of material ***
Rs. UnitRs.
Add: Purchase of raw material ***

Less: Closing stock of raw material ***

-------------

***

Cost of raw material consumed

*** ***
Direct Labour
*** ***
Direct Expenses
*** ***

_______ _______
PRIME COST
*** ***
Add: Works Overheads
*** ***

_______ ______
WORKS OR FACTORY COST
*** ***
Add: General or Administration Overhead
*** ***

_______ ______
COST OF PRODUCTION
*** ***
Add: Selling and Distribution Overhead
*** ***
Total cost or Cost of Sales _______ ______

Add: Profit *** ***

*** ***

Sales Price _______ ______

*** ***

Prime Cost

Prime cost of any product comprises of all direct comprises of all direct
comprises of all direct costs, viz. direct material ,direct labour and direct
expenses, specially attributable to a job. Prime cost is also known as flat cost or
first cost or direct cost.

Work Cost

Work represents the total of all items of expenses incurred in the manufacturing
of an article, viz. ,direct material, direct labour, direct expenses and factory
expenses. In short, it is described as prime cist plus works on cost. It is also
known as Factory cost or cost of manufacture.

Cost of Production

Cost of production means and represents the factory cost plus administrative
expenses , i.e, prime cost plus works cost plus administrative expenses is cost
of production it is also known as office cost.

Total Cost

Total cost means the sum of all items of expenditure incurred in producing,
manufacturing and selling distribution. It comprises of cost of production plus
selling and distribution expenses. Prime cost and works cost and administrative
cost +selling and distribution expenses = Total Cost(final cost).

Selling Price

Selling price is the price which includes cost of sales plus a margin of profit or
minus loss if any.
 SPECIMEN OF COST SHEET
Cost Sheet for the period_________________
Production --------------
Unit

Total Cost Cost Per

Rs. unit
Rs.
Direct Material Consumed:
Opening Stores
Add: Purchases
Less: Closing Stock
Cost of Drawings
Direct Expenses
Primary Packing Materials

PRIME COST
Add: Works/ Factory Overheads
Indirect Materials
Indirect Wages
Factory Rent and Rates
Factory Lighting and Heating
Power and Fuel
Repairs and Maintenance
Drawing Office Expenses
Research and Experiment cost
Depreciation of Factory Plant
Works Stationery
Insurance of Factory Works Managers Salary
Works Managers Salary
WORKS COST /FACTORY COST/MANUFACTURING
COST
Add: Office and Administration Overheads
Office salaries
Office Rent and Rates
Cleaning
Light and Heating
Telephone and Postages
Printing and Stationery
Depreciation of Office Furniture
Depreciation of office Equipment
Insurance
Legal Expenses
COST OF PRODUCTION
Add: Selling and Distribution Overheads
Advertising Salesmen Salaries
Samples and Free gifts
Sales Office rent
Sales Promotion Expenses
Packing and Demonstration
Showroom Rent and Rates
Commission
Travelling Expenses
Warehouse Rent and Rates
Repair of Delivery vans
Carriage freight Outwards etc.

COST OF SALES
Add: Profit

SELLING PRICE or SALES

Unit-1 -COST SHEET

Problems

1.Calculate Prime Cost, Factory Cost, Cost of Production, Cost of Sales

and Profit

Direct Materials - Rs.10,000

Direct Labour - Rs.4,000

Direct Expenses Rs.500

Factory Expenses Rs.1,500

Administrative Expenses Rs.1,000

Selling Expenses Rs.300

Sales Rs.20,000

2.During the year 2008, X Ltd, produced 50,000 units of a product. The
following were the expenses.

Stock of raw materials on 1.1.2008 Rs.10,000

Stock of raw materials on 31.12.2008 Rs.20,000

Purchases Rs.1,60,000

Direct Wages Rs. 75,000

Direct Expenses Rs.25,000

Factory Expenses Rs.37,500

Office Expenses Rs.62,500

Selling Expenses Rs.25,000

You are required to prepare a cost sheet showing cost per unit and total cost at
each stage.

3.You are required to compile a statement showing cost and profit from the
information given, showing clearly 1.Material consumed 2.Prime cost
3.Works cost 4.Cost of Production 5.Cost of Sales 6.Profit 7.Sales.

Materials purchased Rs.2,00,000

Wages- Rs.1,00,000

Direct Expenses Rs.20,000

Opening Stock of Raw Materials Rs.40,000

Closing stock of Materials Rs.60,000

Factory overhead is absorbed at 20% on wages. Administration overhead is

25% on the works cost. Selling and Distribution overheads are 20% on the cost
of production. Profit is 20% on sales.

4.Prepare a cost sheet from the following data

Direct Materials Consumed 50,000

Direct Wages paid 40,000

Chargeable Expenses 10,000

Indirect Materials:

Used in factory 8,000

Used in office 12,000

Used in selling 6,000

Used in Distribution 4,000

---------- 30,000

Indirect Labour:

In factory 15,000

In office 20,000

In selling 18,000

In Distribution 12,000

--------- 65,000

Indirect Expenses:

Relating to Factory 6,000

Relating to office 3,000

Relating to selling 1,000

---------- 10,000
5.Calculate Prime cost, Factory cost, Cost of Production, Cost of
Sales and Profit from the following particulars
Direct Materials-Rs.1,00,000 Depreciation:

Direct Wages Rs.30,000 Factory plant Rs.500

Wages of Foreman Rs.2,500 Office premises-Rs.1,250

Electric power-Rs.500 Consumable Stores-2,500

Lighting: Factory Rs.1,500 Managers Salary-Rs.5,000

Office Rs.500 Directors Fees-Rs.1,250

Storekeepers wages Rs.1,000 Office stationery-Rs.500

Oil and water Rs.500 Telephone charges Rs.125

Rent: Factory- Rs.5,000 Postage &Telegrams Rs.250

Office- Rs.2,500 Salesmens Salaries-Rs.1,250

Repairs and Renewals: Travelling ExpensesRs,500

Factory plant Rs.3,500 Advertising Rs.1,250

Office premises-Rs.500 Warehouse charges-Rs-1,250

Transfer to Reserves Rs.1,000 Sales- Rs.1,89,500

Discount on shares written off Carriage outward Rs.375

Rs.500
Income Tax-Rs.10,000
Dividend-Rs.2,000
6.Calculate cost of Raw materials consumed from the following data

Opening stock of Raw materials Rs.25,000

Closing stock of Raw materials Rs.1,50,000

Carriage on purchase Rs.1,500

Sale of normal scrap of raw materials Rs.4,500

7.Prepare a statement of cost giving the following information

1.Prime cost 2.Works cost 3.Cost of production4.Cost of sales and 5.Profit

Raw materials consumed 40,000

Indirect Materials 9,000

Wages traceable to jobs 15,000

Wages paid to maintenance worker 7,500

Lubricating oil 3,750

Consumable stores 4,250

Repairs to plant & Machinery 5,100

Repairs to office Building 1,500

Postage and Telegram 1,200

Audit fees 2,800

Directors fees 6,400

Legal Expenses 3,600

 General Expenses 1,250

Gas &Water 750

Advertising 4,900

Packing Charges 2,200

Managers salary 12,000

(2/3 rd for factory 1/3 rd for office)

Interest received 1,900

Loss on sale of plant-Rs.4,000 4,000

Payment of sales tax-Rs.3,100 3,100

Travelling expenses &commission Rs.1,50,000

8.In a factory two types of fans are produced namely, Popular and Orient.
Ascertain the cost and profit per unit sold from the following particulars

Popular Orient

Rs. Rs.

Material 8,200 9,450

Labour 4,450 4,900

Works overhead is 60% of labour and Office overhead is 20% on work cost.
The selling expenses per fan sold is Re.1.The selling price of Popular fan is
Rs.275 and Orient fan is Rs.400.

40 units of Popular and 50 units of Orient are sold. There is no opening or

closing stock.

9.The following data relate to the manufacture of a product during the

month of April.

Raw materials consumed Rs.80,000

Direct Wages Rs.48,000

Machine hours worked Rs.8,000

Machine hour rate Rs.4

Office overhead 10% on works cost

Selling overhead Rs.1.50 per unit

Units produced Rs.4,000

Units sold 3,600 at Rs.50 each

Prepare a cost sheet and show

1.Cost per unit 2.Profit for the period.

10.From the details given below ,prepare a comparative cost sheet for the
first and second half of the year 2010,showing cost per unit in each case ,at
all stages.

Particulars Half Year Ended

30.6.2010 31.12.2010

Direct Materials Consumed 50,000 70,000

Wages 60,000 80,000

Chargeable Expenses 10,000 12,000

Depreciation of Factory Machine 16,000 20,000

Indirect Wages in Factory 20,000 30,000

Rent:

Factory 5,000 4,000

Office 8,000 8,000

Repairs:

Factory 6,000 4,000

Office 9,000 2,000

Sundry office Expenses 16,000 20,000

Output during the period in units 20,000units 25,000units

11.From the following information prepare a cost sheet for the month of
Dec 1985.

Stock on hand-1st Dec 1985:Raw materials 25,000

Finished goods 17,300

Stock on hand- 31st Dec.1985:Raw materials 26,200

Finished goods 15,700

Purchase of raw materials 21,900

Carriage on purchasesd 1,100

Work-in-progress 1.12.85 at work cost 8,200

Work-in progress 31.12.85 at work cost 9,100

Sale of finished goods 72,300

Direct Wages 17,200

Non productive wages 800

Direct Expenses 1,200

Factory overheads 8,300

Administrative overheads 3,200

Selling and distribution overheads 4,200

Tenders and Quotations

Frequently the manufacturers of consumer durables and capital goods are asked
to quote the price at which they can supply their output. The price at which the
items of output are offered for sale is known as Tender or Quotation price. The
tender has to be prepared carefully since it may be accepted and goods have to
be supplied in future at the quoted rate.

In order to prepare the tender the following items are to be analysed :

1. Raw Materials
2. Direct Labour
3. Chargeable Expenses
4. Works Overheads
5. Selling Overheads
6. Office overheads
7. Estimated Profit

Estimation of different elements of cost has to be made. The following are the
accepted norms :

A. Estimation of Direct material and direct labour

Direct material and direct labour costs are generally estimated on the
basis of cost per unit of preceding period, subject to fluctuations in the
market, price of materials and labour rates.
B. Estimation of Overhead
Overhead is estimated in the basis of past experience as a percentage, has
given below :
1) Percentage of factory Overheads to Direct Wages :

= Factory overheads 100

Direct Wages
 2) Percentage of Office Overhead to works cost

= Office Overheads 100

Works Cost

3) Percentage of Selling and Distribution Overheads to Works Cost

= Selling and Distribution Overheads 100

Works Cost

(or)

The Percentage may be calculated on Cost of Production

= Selling and Distribution Overheads 100

Cost of Production

The above overhead percentages obtained on the basis of preceding

period cost sheet are used for preparation of tender after giving due regard to
likely changes anticipated.

Estimation of profit for a tender or quotation

Sometimes profit is given as percentage of cost. In that case profit for the
tenders is ascertained as given below.

Profit = Cost of sales Percentage of profit

100
Unit -I

TENDERS AND QUOTATION

Problem No -1

The accounts of a machine manufacturing company disclose the following

information for six months ending 31 st December 1982.

Materials used 1,50,000

Direct Wages 1,20,000

Factory overheads 30,000

Administrative overheads 15,000

Prepare cost sheet for the half year and calculate the price which the company
should quote for the manufacture of a machine requiring materials valued at
Rs.1,250 and expenditure in productive wages Rs. 750 ,so that the price might
yield a profit of 20% on the selling price.

Problem No -2

BPL Television Company find that in 2008, the cost to manufacture 200 T.V.
Sets was Rs.6,16,000 which it sold at Rs.4,000 each cost was made up of:

Materials Rs.2,00,000

Direct Wages Rs.3,00,000

Factory Expenses Rs.60,000

Office Expenses Rs.56,000.

For 2009, it estimates that

1. Each Television will require materials of the value of Rs.1,000 and wages
Rs.1,500.

2. Absorb factory expenses on the basis of direct wages

3. Absorb office expenses on the basis of works cost.

Prepare a statement showing the profit it should make per unit if it enhances the
price of television by Rs.80

Problem No-3

A Company has received an enquiry for the supply of 5000 steel pipes. The
costs are estimated as follows:

Raw materials 1,00,000 Kgs at Rs.1.00 per kg.

Direct wages 10,000 hours at Rs.4.00 per hour.

Variable overheads : Factory Rs.2.40 per labour hour

Selling and Distribution Rs.16,000.

Fixed overheads : Factory Rs.6,000

Selling and Distribution Rs.14,000.

Prepare a statement showing the price to be quoted which will result in a profit
of 20% on selling price.

Problem No-4

The following particulars relate to the manufacture of Electric Fans for a period
of 3 months ending 31.3.2008.

Completed stock on 1.1.2008 Nil

Completed stock on 31.3.2008 30,000

Stock of raw materials 1.1.2008 5,000

Stock of raw materials 31.3.2008 3,500

Direct wages 74,000

Factory overhead 8,000

Administration overhead 4,000

Purchase of raw materials 32,500

Sales 1,12,500

The number of fans manufactured during the month was 2,000.Prepare a

statement showing the cost per fan and the price to be quoted for 750 fans to
realise the same percentage of profit as was realised during the 3 months
referred to above assuming the same cost.

Note:

The Solutions for the problems in this document has been worked out in the
Class. Refer Class notes for Solutions.