BAF Cost Accounting Notes

Costing - Meaning

Cost accounting is the process of determining and accumulating the cost of product
or activity. It is a process of accounting for the incurrence and the control of cost. It also
covers classification, analysis, and interpretation of cost. In other words, it is a system of
accounting, which provides the information about the ascertainment, and control of costs of
products, or services. It measures the operating efficiency of the enterprise.

Cost Accounting is an essential part of accountancy which has been developed to

meet the managerial needs of business organizations.

Present Age is the Age of Competition. The success of a business to the large extent
depends to a great extent upon his ability to reduce the cost of a production to the minimum.
This would require a vigilant control of all expenses. Costing Accounting serves as a means
in this direction. It indicate the cost of production, item wise and profit per unit. It helps the
management in cost and control reduction.

Cost Management has been developed because of the limitations of financial

accounting and needs of management. The main objective of Financial Accounting is
recording of business transactions and ascertaining the results. It does not give importance
to cost control aspects. Where as costing, costing gives most importance to cost control
aspects. In short, cost accounting deals with the cost of production, selling and distribution.

Cost Accounting: It is a formal system of accounting for costs by means of which cost of
products and services are ascertained and controlled
Cost Accountancy: This is the widest of all the terms. It is the application of costing and cost
accounting principles, methods and techniques to the science, art and practice of cost
control and ascertainment of profitability.
Costing – Definitions: The following are some of the important definitions regarding
costing. Costing is the classifying, recording and appropriate allocation of
expenditure for the determination of the costs of products or services. – Wheldon.
Cost accounting is the science of recording and presenting the business transactions
pertaining to; the production of goods and services, where by these records become
a method of measurement and a means of control.
Objectives of Cost Accounting
The objectives of Cost Accounting may be classified into two categories namely a)
Primary Objectives and b) Subsidiary Objectives.

A) Primary Objectives
1. Cost Ascertainment
2. Cost Presentation
3. Cost Control

B) Subsidiary Objectives
A) Primary Objects: The main advantage of Cost Accounting is cost
ascertainment
1. Cost Ascertainment: It implies
i) Collection and analysis of expenses
ii) Measurement of production and
iii) Linking of production to expenses.
i) Collection of expenses: There are various systems of Costing like
historical Costs, estimated costs, standard costs for collection of
expenses.
ii) Measurement of production: There are various methods of costing like
process costing, job costing, output costing for measuring the quantity
of production.
iii) Linking the production to expenses: There are various techniques like
absorption costing and marginal costing, for linking production with the
expenses.
2. Cost Presentation: The second object of costing is Cost reporting.
Appropriate cost information should be sent to right persons in right time in
proper form. Different printed forms are used for efficient reporting.
3. Cost Control: Another important object of Costing is Cost Control. There are
various methods to ensure cost control. They are:
1. Setting up of standards and budgets for expenses and production
performance.
2. Comparing the actual with standards to find out variations.
3. Analysing the reasons for such variation
4. Taking corrective action to eliminate variations.
B) Subsidiary Objectives:
1. To assists the management in determining the selling price.
2. To helps the Management to prevent the wastage in material, men and
machinery.
3. To help the management to carry on production with utmost efficiency.
4. To facilitate the presentation of financial and other statements very quickly.
5. To helps the management for formulating the operational policies such as
a) Determination of cost volume profit relationship.
b) Shutting down or operating at loss.
c) Making a buying from outside suppliers.
d) Replacing the old production methods by improved methods.

Nature and Scope of Cost Accounting

There is no ready made system of Cost Accounting suited to all business concerns.
Hence it is necessary to devise a system suited to each type of business. As such, the
benefits to be derived from Cost Accounting depend upon the need for it, suitability of the
system designed and it efficient working.

Cost accounting is an organized boy of knowledge. As such it consists of certain

principles and rules subject to which the technique of Cost Accounting should be applied.
Although Cost Accounting is an organized body of knowledge, principles of Cost Accounting
cannot be verified with experiments. Hence, this discipline is not an exact science.

1. Cost book-keeping: It involves maintaining complete record of all costs incurred

from their incurrence to their charge to departments, products and services. Such
recording is preferably done on the basis of double entry system.
2. Cost system: Systems and procedures are devised for proper accounting for costs.
3. Cost ascertainment: Ascertaining cost of products, processes, jobs, services, etc.,
is the important function of cost accounting. Cost ascertainment becomes the basis
of managerial decision making such as pricing, planning and control.
4. Cost Analysis: It involves the process of finding out the causal factors of actual
costs varying from the budgeted costs and fixation of responsibility for cost
increases.
5. Cost comparisons: Cost accounting also includes comparisons between cost from
alternative courses of action such as use of technology for production, cost of
making different products and activities, and cost of same product/ service over a
period of time.
 6. Cost Control: Cost accounting is the utilisation of cost information for exercising
control. It involves a detailed examination of each cost in the light of benefit derived
from the incurrence of the cost. Thus, we can state that cost is analysed to know
whether the current level of costs is satisfactory in the light of standards set in
advance.
7. Cost Reports: Presentation of cost is the ultimate function of cost accounting.
These reports are primarily for use by the management at different levels. Cost
Reports form the basis for planning and control, performance appraisal and
managerial decision making.

The importance of cost accounting.

The importance of cost accounting are as follows:

1. Importance to Management
Cost accounting provides invaluable help to management. It is difficult to indicate where the
work of cost accountant ends and managerial control begins. The advantages are as
follows:
Helps in ascertainment of cost
Cost accounting helps the management in the ascertainment of cost of process,
product, Job, contract, activity, etc., by using different techniques such as Job costing
and Process costing.
Aids in Price fixation
By using demand and supply, activities of competitors, market condition to a great
extent, also determine the price of product and cost to the producer does play an
important role. The producer can take necessary help from his costing records.
Helps in Cost reduction
Cost can be reduced in the long-run when cost reduction programme and improved
methods are tried to reduce costs.
Elimination of wastage
As it is possible to know the cost of product at every stage, it becomes possible to
check the forms of waste, such as time and expenses etc. are in the use of machine
equipment and material.
Helps in identifying unprofitable activities
With the help of cost accounting the unprofitable activities are identified, so that the
necessary correct action may be taken.
Advantages of Costing
Primarily Costing is developed to meet the necessities of Management. It is an
important tool in the hands of Management to run the business efficiently. But there are
various other agencies also who are benefited by cost accounting. The advantage of costing
of various agencies can be summarized as under.
1. Advantages to the Management:
a) Cost Accounts enable the Management to ascertain the true cost of each
article, process or contact or any other unit of production.
b) They help in fixing price and in forming the price fixation policy particularly
when an industry produces several commodities.
c) They provide a reliable basis upon which tenders and estimates may be
prepared.
d) They assist the management in developing cost calculations for new products
and designs and to determine the profitableness or otherwise of the proposed
changes.
2. Advantages to Creditors
Cost Accounts help the creditors to study the financial position and strength of the
business concerns to which they desire to give loans. It has become a policy of many
banks that no loans will be made to industrial units unless such concerns have
complete cost accounting systems which produce cost reports showing satisfactory
trends.
3. Advantages to employees
The personnel of many business enterprises have benefited by the establishment of
incentives in the form of piece rates and bonus plans which may be used to
compensate all classes of workers, including supervisors, clerks, departments heads
and major executives.
4. Advantages to the Public
Cost accounts aid in reducing and controlling costs which means supplying of goods
to the consumers at lower prices.
5. Advantages to the public enterprises: Cost accounts play an important role in
public enterprises i.e., enterprises owned by the Government. Efficiency of Public
Enterprises can be measured and maintained only through a systematic collection of
costing data and its study.
6. Advantages to the Government
Cost Accounts enable the assessment of Income Tax, Excise duty etc. It facilitates
the formulation of policies with regard to public finance, Industry, business,
commerce, foreign, trade etc.
Distinguish between Cost Accounting and Finance Accounting
The main differences between financial accounting and cost accounting are given as under:
Point of
Financial Accounting Cost Accounting
Distinction
Purpose It provides information about the It provides information to
business in a general way. It tells management for proper planning,
about the profit and loss and operation, control an decision-
financial position of the business to making.
owners and other outside parties
Form of These accounts are kept in such a These accounts are generally kept
Accounts way as to meet the requirements of voluntarily to meet the
Companies Act and Income Tax requirements of management. But
Act. now Companies Act has made it
obligatory to keep cost records in
some manufacturing industries.
Recording It classified, records and analyses It records the expenditure in an
the transaction in a subjective objective manner i.e., according to
manner i.e. according to the nature the purposes for which the costs
of expense are incurred
Control It lays emphasis on the recording It provides a detailed system of
aspect without attaching any control for materials, labour and
importance to control overhead costs with the help of
standard costing and budgetary
control
Periodicity of It reports operating results and It gives information through cost
Reporting financial position usually at the end reports to management as and
of the year when desired
Analysis of Profit Financial accounts are the Cost accounting is only a part of
accounts of the whole business. the financial accounts and
They independent in nature and discloses profit or loss of each
disclose the net profit or loss of the product, job or service
business as a whole
Reporting of The costs are reported in The costs are broken down on a
Costs aggregate in financial accounts unit basis in cost accounts
Nature of Financial accounts relate to Cost accounts relate to
Transactions commercial transactions of the transactions connected with the
business and include all expenses manufacture of goods and services
viz., manufacturing, office, selling and include only those expenses
and which enter into the production.
 Cost accounts are concerned with
internal transactions which do not
form the basis of payment or
receipt of cast.
Information Monetary information is only used Non-monetary information like units
(i.e., only monetary transactions is also used (i.e., it deals with
are recorded0 monetary as well as non-monetary
information)
Fixation of Financial accounts are not Cost accounting provides sufficient
Selling Price maintained with the object of fixing data for fixation of selling prices.
selling prices

Limitations of Cost Accounting

In spite of various advantages, costing suffers with the following limitations.
1. Lack of Uniform Procedure: As costing contains estimates, two cost
Accountants may arrive two different results from the same information. Hence Cost
accounting results can be taken as mere estimates.
2. Very expensive: As the installation cost of costing is very expensive only big
business concerns use costing.
3. Absence of a ready made system: There is no stereo typed costing system
applicable to all industries and even firms in the same industry.
4. Varied cost concepts: Since different costs are used for different purposes, no
one cost is suitable for all purposes. For example, actual costs are different from
standard costs and both are different from estimated costs.

Different Methods of Costing:

The following are the important methods of costing:
1. Job Costing: It refers to a system of costing in which costs are ascertained in terms
of specific job or orders. This is also known as terminal or contract costing. The unit
of cost is the job, order, or contract, and the accounts show the cost of each order.
This method is suitable for contractors, builders, constructional engineers, printers,
municipal engineers, garages, shipbuilding, repair shops, film studios, furniture
manufacturer, and road construction, books, pharmaceuticals etc.
2. Contract Costing: It is a method of costing applied to ascertain the costs incurred on
each contract and profit earned or less incurred on each sub-contract. This system is
suitable to all types of contractors and ship builders.
3. Batch Costing: It is a form of job costing in which a batch of identical products
constitutes the cost unit. Each batch is separately costed, from which unit costs are
determined for the units produced. It is useful for biscuit factories, bakeries,
confectionery, medicines, hardware, pottery and ready made garments etc.
4. Unit Costing (Output or Single Costing): It is a method of costing by the unit of
production where manufacture is continuous and the units are identical. When all the
units produced are identical, the cost per unit is ascertained by dividing the total
expenditure with the number of units produced in a given period. It may be employed
in conjunction with batch, operation or process costing. This method is suitable for
such industries as collieries, quarries, flour-mills, steel-works, paper mills, breweries,
cement and brick work, oil drilling etc.
5. Operating Cost: The method of costing applied in the costing of service rendered
like transport companies, power supply undertakings, municipal services, hospitals,
water-works, road carrier, hostels, railways, etc., is called operating costing.
Transport companies use a ton-KM, or passenger – KM as the unit of cost, while an
electricity supply undertaking measures costs per kilowatt hour.
6. Operation Costing: This is a method of unit costing by operations in connection
with mass production and repetitive production. It is particularly useful where the
production is put in hand in large quantities of standardized units, as is usually
necessary to ensure working at minimum cost.
7. Process Costing: This is sometimes referred to as Continuous or Average Costing.
This is a method of costing production by processes in which a) the product of the
process becomes the material of a subsequent process. B) the different products and
by products are produced simultaneously at the same process, or c) the products,
different only in shape, are not separately distinguishable from one another during
one or more processes of manufacture.
8. Multiple Costing: This is sometimes refereed to as composite costing. It is used
where there are a variety of component parts separately produced subsequently
assembled in a complex organization. The cost of each product will have to be
ascertained by adopting different types of costing. Eg., Job Costing from one product,
process costing for another, and some other method for a third.
9. Departmental Costing: This is a method of ascertaining the cost of operating a
department or cost centre. This is frequently necessary because of the need of
control of expenditure in a department e.g., the cost of running a Research
Department.

Types of Costing:
 1. Uniform Costing: It is called as such when all or majority of the members of
the same industry adopt a particular method of costing.
2. Marginal Costing: It is the ascertainment of Marginal cost by differentiating
between fixed and variable cost. It is used to ascertain the effect of changes
in volume or type of output on profit.
3. Standard Costing: Standard Costing is a system of costing under which the
cost of a product is determined in advance on the basis of predetermined
standard.
4. Historical Costing: Historical costing is a costing under which costs are
ascertain after they have been incurred. Its aim is to ascertain the costs
actually incurred on work done in the past.
5. Absorption Costing: It is the practice of charging all costs both fixed and
variable to operations, processes, jobs or products.

Cost Control

Cost Control has been defined as the guidance and regulation by executive action of
the costs of operating and undertaking. It is regarded as an important derivative of cost
accounting. Cost accounting is inseparably connected with cost control with the help of cost
data. Cost Control may be classified under three broad divisions.
a) Physical Cost Control - Control over production and distribution
b) Managerial Cost Control - The use of Cost data for regulating current
operations
c) Mechanic Cost Control - The accounting techniques which are
involved in providing for cost control.

Cost Centre: A cost centre is a location, Pearson or item of equipment (or group of
these) for which costs may be ascertained and used for the purpose of cost control. Cost
centres may be production cost centres or service cost centres. Production cost centres
engage in regular production where as service cost centres engage in regular production
where as service cost centres serve as aids to production centres.

Unit of Cost: A unit of cost is a small unit which is natural to the business and with
which expenditure may most conveniently identified. It is important in determining the
method of costing that should be installed in a business concern. The unit adopted must be
practical i.e., neither tool small nor too big. Unit of production means the unit in which a
commodity or service is divided.

Cost Audit: Cost audit is the verification of the correctness of cost accounts and of
the adherence to the cost accounting plan. Cost audit is essential where cost accounting is
carried out on a large scale. It also assists the external auditor in the verification of the cost
records and statements.

Classification of Costs
Cost classification is the process of grouping costs according to their common
characteristics. There are various ways of classifying costs. Costs may be classified
according to
1. Elements: Costs are classified primarily according to the factors upon which
expenditure is incurred viz; Materials, labour or wages and expenses. In otherwords
the cost is composed of three elements namely material, labour and expenses.

2. Functions: A business perform a number of functions like manufacturing,

administration, selling and distribution. Costs are classified on the basis of these
functions.

3. Behaviour; With the increase or decrease in production, some costs will increase
or decrease, while some costs will change but not in direct proportion to the change
in the volume.
a) Variable Costs
b) Semi-variable Costs
c) Fixed Costs

4. Controllability: Under this, costs are classified according to whether they are capable
control or not. The broad divisions under this are
i) Controllable Costs: These costs are directly regulated by Management. All
variable cost are controllable cost.
ii) Uncontrollable Costs: Uncontrollable costs are those which cannot be
influenced by management action. All the fixed costs are generally
uncontrollable.
5. Normality: There are two types of costs, which display the Normality
characteristic. They are
 i) Normal Cost: It is cost which is normally incurred at given level of output I the
conditions in which that level of output is normally attained.
ii) Abnormal Costs: It is a cost which is not normally incurred at a given level
output in the conditions in which that level of output is normally attined.

Elements of Costs
Cost is composed of three elements namely materials, labour and other expenses.
These elements of cost are further analysed into different elements as shown below.

From the above chart it is very clear that each element is classified into direct
expenditure and indirect expenditure.

Direct Expenditure: Direct expenditure comprises those expenses which can be

conveniently identified wholly with a particular unit of cost. Indirect expenditures includes all
other expenses incurred for the undertaking as a whole and not identifiable wholly with a
particular unit of cost.
Hence direct expenditure includes the elements of Direct Materials, Direct Labour
and direct chargeable expenses.

Indirect Expenditure: Indirect expenditure includes the elements of Indirect Material,

Indirect Labour and Indirect Expense.
Indirect Expenditure comprising the above three elements is referred to by cost
accountants as overhead. For the purpose of classification, Overhead is further sub-divided
into the following.

1. Works or factory overhead.

2. Office and Administrative Overhead.
 3. Selling and Distribution Overhead.

By grouping the above elements of cost, the following divisions of cost are obtained
1 Prime Cost or Flat Cost or Direct Cost This comprises Direct Materials, Direct
labour and Direct Expenses

2 Works Cost or Factory Cost or Production This consists of Prime Cost plus works or
Cost factory expenses

3 Office Cost or Cost of Production or This consists of works cost plus

Gross Cost administrative overhead

4 Total Cost or Cost of Sales or Selling This is made up of cost of production plus
Cost Selling and Distribution Overhead.

Prime Cost Direct Materials + Direct Labour + Direct

Expenses

Works Cost or Factory Cost or Production Prime Cost + Works or Factory Overhead
Cost

Office Cost or Cost of Production or Works or Factory Overhead +

Gross Cost Administrative Overhead

Total Cost or Cost of Sales or Selling Office Cost or Cost of Production +

Cost Selling and Distribution Overhead

The difference between the cost of sales and selling price represents profit or loss

1. Direct materials: Direct Materials are those materials which can be identified in
the product and can be conveniently measured and directly charged to the product.
Direct Materials directly enter the production and from a part of cost of production.
Example: Flour in the bread, clay in bricks, leather in bricks, wood in furniture etc.

2. Indirect Materials: Materials which do not form part of the product are called indirect
materials.
Example: Consumable Stores, Lubricants, Cotton Waste, Service Department,
materials.
3. Direct Labour: Direct Labour consists of wages paid to workers engaged in
converting raw-materials into finished products. These wages can be conveniently
charged to particular products or Jobs or Process.
Example: Wages paid to workers engage in the production of a particular article.
Salaries of Inspectors, Analysts etc., Specially required for such production.

4. Indirect Labour: Indirect Labour is not engaged in production process but only
assist production operations.
Example: Salaries paid to clerical staff. Wages of Foreman, Wages of Repairers,
Time Keepers etc.

5. Expenses: All the costs other than men and material is termed as expenses.
Expenses again divided into
i) Direct Expenses : Direct Expenses are those which can be identified and
allocated to cost centres and cost units.
Example: Patents, Royalties, Designs, Drawings etc.
ii) Indirect Expenses : Direct Expenses are those which can be identified and
allocated to cost centres and cost units.
Ex. Rent, Depreciation, Insurance etc.
6. Overheads: Overheads consists of all expenses than direct expenses. In general
terms, overheads comprise of all expenses incurred for or in connection with general
organization of the whole or part of the undertaking. Overheads may be sub-divided
into i) works or Factory Overheads, ii) Administrative Overheads, iii) Selling
Overheads, iv) Distribution Overheads, v) Research and Development Overheads.

Tenders, Quotations and Estimations:

Output costing is particularly employed when Tenders, Quotations and Estimations have to
be submitted. The manufacturer has to fix a competitive price keeping in view the likely
impact of the inflationary trends on the inputs. Before submitting a tender or fixing price, a
manufacturer must have a detailed information regarding cost of raw materials, wages
different overheads, and past profit. On the basis of this information, he can prepare an
estimated cost sheet. Such an estimate can incorporate the likely increase or decrease in price
levels of various components of production. It must, however, be noted here that the amount
of overheads in these cases is to be estimated on some basis.