COST ACCOUNTING Cost: It is an expenditure incurred on Producing good or services.

Costing: Costing is technique and process of ascertaining cost Cost Accounting is the process or methodology of accounting for cost. It includes recording of expenditure and providing information on various parameters. Definition of Cost accounting: Cost Accounting refers the process of classifying, recording and appropriate allocation of expenditures for the determination of costs of products or services. OBJECTIVES OF COST ACCOUNTING To ascertain the cost per unit of different products manufactured or services rendered by the undertaking. To maintain a systematic record of the cost incurred by analyzing and classifying the cost information so that necessary cost data and information is available. To point out how wastage of time, money, machinery, equipment occurs and to prepare such reports which may be necessary to control such wastage. To help management in formulation and implementation of incentive plans, internal audit systems perpetual inventory system. Elements of Costs The following Pictures clearly depicts the elements of costs COST Material Labour General Expenses

Direct

Indirect

Direct

Indirect

Direct

Indirect

Over heads Note: All Indirect expenditures are called as Over heads

Cost Audit: Cost audit is the verification of the correctness of cost accounts. It is a check to ensure adherence to the cost accounting plan. It ensures that accounts and records are correctly compiled and maintained. Types of Costing There are different types or techniques of costing are used in cost accounting. The following are the important techniques or methods in costing. Marginal Costing: In Marginal costing, it allocates only variable costs, i.e. direct material, direct labour and other direct expenses and variable overheads to the production. It does not take into account the fixed cost of production. This type of costing emphasizes the distinction between fixed and variable costs. Absorption costing: the technique of absorbing fixed and variable cost to production is called absorption costing. Under absorption costing full cost. I.e. fixed and variable costs are absorbed to the production. Standard Costing: When costs are determined in advance on certain predetermined standards under a given set of conditions, it is called standard costing. Standard costing is to be compared with the actual costs periodically to analyze the changes in the costs to revise the standards to avoid any loss due to outdated costing. Historical Costing: When costs are determined in terms of actual costs and not in terms of predetermined standards cost is called historical costing. In this type of cost accounting, cost is determined only after they have been incurred. Majority of organizations use historical costing system of accounting for costs. Cost Classification: Cost classification is the process of grouping cost according to their common characteristics. The following are the important types of Cost classifications. Classification Based on Identity: According to this classification, the costs are divided into three categories. Material costs: It refers total cost incurred on purchasing material for production unit. Labour cost: It refers total amount paid for labour and workers. General expenses: It refers the all management and administration expenses. On the basis of Function: Production, administration, selling & distribution are three important functions of a business concern. Taking threes functions into consideration costs have been classified by

Production Cost: Which are incurred in the course of manufacture. It includes cost of raw material, cost of labour, other direct cost and factory indirect cost. Ex. Heating, lighting etc. Administration Cost: These costs incurred for the general administration of the enterprise. It included office cost as well as administration cost. Ex. Salaries. Selling & Distribution cost: It includes both selling cost as well as distribution cost. Selling cost are those costs which are incurred in connection with the selling of goods. Distribution costs are those costs which are incurred on dispatch of finished goods to the consumers. Ex: Pecking charges, carriage etc On the basis of Variability: The cost varies from one another as production increases, some cost remains constant or varies indirect proportion to the volume of out put or others may vary partially, Thus on the basis of variability costs can be classified into the following categories. Fixed cost: Fixed costs are those costs which remain fixed irrespective of the change in the volume of out put. Ex: Office manger salary, Rent etc. Variable cost: Variable costs are those costs which varies indirect proportion to the volume of out put. If production increases variable costs are increases if production cost decreases production cost decreases. Ex: raw material, labour Semi variable Cost: These costs are partly fixed and partly variable. Example, Telephone rent. It includes partly fixed charge up to a certain level and then varies according to the calls. On the basis of controllability: based on controllability the cost has been classified into two categories they are Controllable costs: These costs are regulated or controlled by specified member of an organisation. Example material, labour Uncontrollable cost: These costs can not be regulated or controlled by specified member of an undertaking, Example tax etc.

Cost sheet: Cost sheet is a statement of cost, is a statement that is prepared to present information regarding the various elements to cost incurred in production during a defined period of time. The cost sheet is generally prepared at short intervals (weekly or monthly) and presents the total cost as well as cost per unit of product manufactured during the period.

PROFORMA OF COST SHEET

PARTICULARS Opening Stock of Raw Material Add: Purchase of Raw materials Add: Purchase Expenses Less: Closing stock of Raw Materials Raw Materials Consumed Add: Direct Wages (Labour) Add: Direct Charges

Amount **** **** **** **** **** **** ****

Amount

PRIME COST (1) Add :- Factory Over Heads: Factory Rent Factory Power Indirect Material Indirect Wages Supervisor Salary Drawing Office Salary Factory Insurance Factory Asset Depreciation

**** **** **** **** **** **** **** **** ****

WORK COST INCURRED Add: Opening Stock of WIP Less: Closing Stock of WIP WORK COST (2) Add:- Administration Over Heads:Office Rent Asset Depreciation General Charges Audit Fees Bank Charges Counting house Salary Other Office Expenses COST OF PRODUCTION (3) Add: Opening stock of Finished Goods Less: Closing stock of Finished Goods COST OF GOODS SOLD (4) **** **** **** **** **** **** **** **** **** **** ****

****

****

****

****

Add:- Selling and Distribution OH:Sales man Commission Sales man salary Traveling Expenses

**** **** **** ****

Notes:1) Factory Over Heads are recovered as a percentage of direct wages 2) Administration Over Heads, Selling and Distribution Overheads are recovered as a percentage of works cost. The following formulas drawn from the Cost sheet 1. Prime cost = Direct Material + Direct Labour + Direct Expenses 2. Work Cost = Prime cost + Works or Factory overheads 3. Cost of production = Works cost + Administration overheads 4. Total cost or Cost of sales = Cost of production + selling and Distribution overheads 5. Sales = Total cost + Profit ( balancing figure)

Marginal Costing: The CIMA (Charted institute of Management Accountants), London, defines the term marginal cost as follows Marginal cost is the amount at any given volume of output by which aggregate costs are changed if the volume of output is increased or decreased by one unit. In this context a unit may be a single article, a batch of articles, an order, a stage of production capacity or department. It relates the change in output in the particular circumstance under consideration. In general marginal costing is the ascertainment of marginal costs and of the effect on profit of changes in volume or type of output by differentiating between fixed costs and variable costs. In this technique of costing only variable costs charged to operations, process or products, leaving all indirect costs to be written off against profits in the period in which they arise. Marginal costing is difference from direct costing. Direct costing is the practice of charging all direct costs operations, processes or products, leaving all indirect costs to be written-off against profit in the period in which they arise. Thus, in direct costing some fixed costs could be considered to be direct costs in appropriate circumstances but fixed cost in never taken in marginal cost. Features of marginal costing: The following are the features of the marginal costing It is the technique of costing used to ascertain the marginal cost and to know the impact of variable cost on the volume of output. All costs are classified into fixed and variable cost on the basis of variability; even semi fixed is segregated into fixed and variable cost. Valuation of stock of work in progress and finished goods is done on the basis of marginal costing. CVP or BEP is one of the integral parts of Marginal costing. Break Even Analysis or Cost, volume, Profit (CVP) Analysis Break even analysis is a logical extension of marginal costing. It is based on the principles of classifying operating cost into fixed and variable. Now days it has become a powerful instrument in the hands of policy makers to maximize profits. Definition of BEP Analysis: Is a calculation of the approximate sales volume required to just cover cost, below which production would be unprofitable and above which it would 8

be profitable. BEP analysis focuses on relationship between fixed cost, variable cost and profit. Break even point: It represents point where total revenue equals to total cost. OBJECTIVES OF BEP/CVP ANALYSIS: This analysis helps to forecast profit fairly accurately as it is essential to know the relationship between profits and costs on one hand and volume on the other. This analysis is useful in setting flexible budgets which indicates costs at various levels of activity This analysis also assists in formulating price policies. This analysis helps the management in policy making Graphical representation of BEP analysis

CVP analysis establishes the relationship between costs, volume of output and profits; it studies the effect on profit or changes in volume of output and cost. In order to understand mathematical relationship between cost, volume and profit, it is required to understand the following concepts which can be treated as elements of cost volume profit analysis. 1. Marginal Cost Equation 2. Contribution Margin 3. Profit/volume (P/V) Ratio 4. Break even point 5. Margin of safety Marginal Cost Equation

Let us assume S Sales, V Variable Cost, F Fixed cost, P Profit and C Contribution The Basic form of Marginal cost equation is Sales Variable cost = Fixed cost + Profit 1. S V = F + P 2. C = S V, then 3. C = F + P Contribution Margin: Contribution is the difference between the sales and the marginal cost of sales and it contribute towards fixed expenses and profit. Contribution = Selling price Marginal cost Contribution = Fixed expenses + Profit/Loss Contribution Fixed expenses = Profit In marginal costing contribution is very important as it helps to find out the profitability of a product, department or division, to have better product mix, for profit planning and to maximize the profits and a concern. Profit / Volume (P/V) Ratio The profit/volume ratio is one of the most important ratios for studying the profitability of operations of a business and establishes the relationship between contribution and sales. This ratio is calculated as under Contribution P/V Ratio = Sales Fixed expenses + profit = Sales = SV S or or (i.e. C/S) or OR OR

Changes in profits or Contributions = 10

Change in sales Break even point: A business is said to be break even when its total sales are equal to its total cost. It is a point of no profits no loss. At this point contribution equal to fixed cost. The BEP can be calculated by the following formula Total fixed expenses BEP (in units) = Selling price per unit Marginal cost per unit Total Fixed expenses = Contribution per unit F XS BEP (in total sales volume) = = P/V Ratio Calculation of out put or sales value at which a profit is earned The formula for the calculation of output to earn a certain amount of profit is as follows Fixed expenses + desired profit Sales = Selling price per unit Marginal cost per unit Fixed expenses + desired profit = Contribution per unit Fixed expenses + desired profit = P/V ratio Margin of safety: Margin of safety is the difference between the actual sales and the sales at break even point. One of the assumptions of marginal costing is that output will coincide sales, so margin of safety is also the excess production over the break even point's output. Sales or output beyond the break even point is known as margin of safety because it gives some profit, at break even point only fixed expenses are recovered. Formula for calculating M/S OR OR OR SV Fixed cost OR

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Margin of safety (M/S) = Actual sales Break even sales OR Profit = P/V Ratio Profit = Contribution per unit PROBLEMS IN MARGINAL COSTING Problem 1 From the following data, calculate: 1. BEP Sales 2. No. of units that must be sold t earn a profit of Rs. 60,000 per year. Selling price Variable Manufacturing cost Variable selling cost Fixed factory over head Fixed selling cost Sol: Fixed cost BEP (Sales) = P/V Fixed cost = Fixed Factory Overhead + Fixed selling Cost = 5, 40,000+2, 52,000 = 7, 92,000 Contribution per unit P/V Ratio = Sales Price per unit Variable cost p.u =1Selling Price p.u Variable cost per unit = Variable Manufacturing cost p.u + Variable selling cost p.u = 11 +3 = 14 Rs There fore, P/V = 1 14/20 = 1-0.7 = 0.3= 30% Fixed cost + desired profit 2. No of units to be sold to earn desired profit = Contribution per unit Contribution p.u = selling p.u variable cost p.u = 20-14 = 6 There fore, 7, 92,000 + 60,000 = 1, 42, 00 units Rs 20 per unit Rs 11per unit Rs 3 per unit Rs 5, 40,000 per year Rs 2 52,000 per year OR

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Unit required to be sold =

Problem 2: Assuming that the cost structure and selling price3s remain the same in periods I and II fin out: a) P/V ratio b) Fixed cost c) BEP for sales d) Profit when sales are of Rs. 1, 00,000 e) Sales required earning a profit of Rs. 20,000 f) Margin of safety at a profit or Rs. 15,000 g) Variable cost in Period II

Period I II Sol: a).

Sales in Rs 1,20,000 1,40,000

Profit in Rs 9,000 13,000

Changes in Profit P/V Ratio = X 100 Changes in Sales 13,000 - 9,000 = X 100 1, 40,000 - 1, 20,000 4, 0000 = X 100 = 0.2 or 20 % 20,000

b). Fixed cost = (Sales X P/V ) Profit = (1, 00,000 X 20/100) 9,000 = 15,000 Rs Fixed Cost C). Break even point ( in sales) = P/v ratio 15, 000 = 20% d). Profit = (Sales X P/V ) Fixed cost = (1,00,000 X 20/100) 15,000 = Rs 5,000 Fixed expenses + desired profit e). Sales = P/V ratio = 75,000 Rs

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15, 000 + 20,000 = 20 % Profit f). Margin of safety = P/V Ratio 15,000 = 20 % g). Variable cost in Period II = (1 P/V Ratio) X Sales 80 = X 1 40, 000 = 1, 12, 000 20 % = 75,000 Rs

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