COST ANALYSIS, CONCEPTS &

CLASSIFICATIONS

CONCEPT OF COST
1. Cost means the total of all expenses.
2. Cost is defined as the amount of
expenditure(
actual
or
notional)
incurred on or attributable to a given
thing or to ascertain the cost of a
given thing.
3. The cost of an article consists of actual
outgoings or ascertained charges
incurred in its production and sale.

ELEMENTS OF COST
For proper control and managerial
decisions, the total cost is analysed by
elements of cost. i.e,by the nature of
expenses.
The elements of cost are
1. Materials
2. Labour
3. Other expenses
These elements of cost are further
analysed into different elements as

Elements of cost
Labour

Materials
Direct

Indirect

Direct

Indirect

Other expenses
Direct

Indirect

Overheads

Production or
Works
Overhead

Administration
Overhead

Selling
Overheads

Distribution
Overheads

By grouping the above elements of cost, the following divisions

of cost are obtained.
1. Prime cost

= Direct Materials + Direct Labour +

Direct Expenses

2. Work or Factory cost = Prime cost + Works or Factory

Overheads
3. Cost of Production

= Works Cost + Administration

Overheads

4. Total cost or
= Cost of production+ Selling & Cost of
sales
Distribution Overheads

DIRECT MATERIAL
Those materials which can be identified in the product
and can be conveniently measured and directly charged
to the product.
Eg: cloth of dress making, bricks for building

1.
2.
3.
4.

The following are normally classified as direct materials:

All raw materials
Materials specifically purchased for a specific job,
process or order
Parts or components purchased or produced
Primary Packing materials

Certain materials which are parts of finished products but used

in small quantities are treated as indirect material
Thus the ease and the feasibility with which a material can be
traced into the composition of a finished product will
determine what is to be treated as direct material.

DIRECT LABOUR
All labour expended in altering the
construction, composition, confirmation or
condition of the product.
It is that labour which can be conveniently
identified or attributed wholly to a
particular job, product or process or
expended in converting raw materials into
finished goods.

Direct labour includes payment made to

1.

2.

3.

Labour engaged on the actual production of

the product or in carrying out of an
operation or process.
Labour engaged in aiding the manufacture
by way of supervision, maintenance, tools
setting, transportation of material etc.,
Inspectors, analysts etc., specially required
for such production

DIRECT OR CHARGEABLE EXPENSES

All expenditures other than direct
material or direct labour that are
specifically incurred for a particular
product or process.
Such expense is charged directly to the
particular cost centre as part of the
prime cost.
Eg: Excise duty, Royalty on production,
surveyors fees, designing or drawing
expenses etc

OVERHEADS
The aggregate of the cost of indirect
materials, indirect labour and such other
expenses including services as cannot
conveniently be charged direct to
specific cost units.
All expenses other than direct expenses
The cost of operating supplies and
services used by the undertaking and
including the maintenance of capital
assets.

The main groups into which overheads

may be sub-divided are
Manufacturing overheads
2. Administration overheads
3. Selling overheads
4. Research and Development overheads
1.

Overheads can also be classified as

5. Indirect materials
6. Indirect labour
7. Indirect expenses

EXPENSES EXCLUDED FROM

COSTS
Total cost of a product should include
only those items of expenses which are
a charge against profit.
Items of expenses which are relating to
capital assets, capital losses, payments
by way of distribution of profits and
matters of pure finance should not form
a part of the costs
Eg: Dividend, abnormal wastage of
material, abnormal idle time, interest on
capital, loss on sale of assets etc

COST SHEET OR STATEMENT OF

COST
Cost sheet is a statement designed to
show the output of a particular
accounting period along with break-up
of costs.
1. It is a memorandum statement
2. It does not form part of double entry
cost accounting records.
3. But derives its data for financial
accounting

ADVANTAGES OF COST
SHEET
It discloses the total cost and the cost
per unit of the units produced during
the given period.
2. It enables a manufacturer to keep a
close watch and control over the cost
of production.
3. By providing a comparative study of
the various elements of current cost
with the past results and standard
costs, it is possible to find out the
causes of variations in costs and to
eliminate the adverse factors and
conditions which go to increase the
1.

4.

5.
6.

7.

It acts as a guide to the manufacturer and

helps him in formulating a definite useful
production policy.
It helps in fixing up the selling price more
accurately
It helps the businessman to minimise the
cost of production when there is a cut throat
competition
It helps the businessman to submit
quotations with reasonable degree of
accuracy against tenders for the supply of
goods.

Prepare a cost sheet from the following

particulars
Rs.
Direct materials
1,00,000
Direct wages
25,000
Direct expenses
5,000
Wages of foreman
2,500
Electric power
500
Lighting: factory
1,500
Office
500
Depreciation:
Factory plant
500
Office premises
1,250

Consumable stores
2,500
Managers salary
5,000
Directors fees
1,250
Office stationery
500
Storekeepers wages
1,000
Oil & water
500
Rent: Factory
5,000
Office
2,500
Repairs and renewals:
Factory plant
3,500
Office premises
500
Carriage outward
375
Transfer to reserves
1,000
Discount on shares written off
500

Telephone charges
125
Postage
250
Salesmens salaries
1,250
Travelling expenses
500
Advertising
1,250
Warehouse charges
500
Sales
1,89,500
Income tax
10,000
Dividend
2,000

COST SHEET OR STATEMENT OF COST

Rs.
Rs.
Direct material
100000
Direct wages
25000
Direct expenses
5000
Prime cost
130000
Add: Factory overheads:
Wages of foreman
2500
Electric power
500
Storekeepers wages
1000
Oil and water
500
Factory rent
5000
Repairs and renewals
Factory
3500
Factory lighting
1500
Depreciation- factory
500
Consumable stores
2500
17500
Factory cost
147500

Rs.
Rs.
Add: Admn overheads:
Office rent
2500
Repairs and renewals
Office
500
Office lighting
500
Depreciation-office
1250
Managers salary
5000
Directors fees
1250
Office stationery
500
Telephone
125
Postage
250
Cost of production

159375

11875

Rs.
Rs.
Add: Selling & Dist. overheads:
Carriage outwards 375
Salesmens salaries
1250
Travelling expenses
500
Advertising
1250
Ware house expenses 500
3875
Cost of Sales
163250

Cost of Sales :
Profit
Sales

Rs. 163250
Rs. 26250
Rs. 189500

TREATMENT OF STOCK
1. Stock of Raw materials
If the opening stock of raw materials,
purchases and closing stock of raw
materials are given then the cost of
raw materials consumed must be
calculated as
Cost of raw materials consumed =
Opening stock of raw materials +
purchases during the year closing
stock or raw materials

2.

Stock of Work in progress

Work in progress is valued at prime cost or
works cost.
If is valued at works cost then the
adjustment will be
Factory or Manufacturing or Works cost
=Prime Cost + Factory overheads+ opening
WIP- Closing WIP

3. Stock of Finished Goods

If the opening and closing stocks of
finished goods are also given, then these
must be adjusted before calculating cost
of goods sold as under:
Cost of goods sold = Cost of production
+ Opening stock of Finished goods
Closing stock of Finished goods.

COST CENTRE
It is the smallest segment of activity or area or
responsibility for which costs are accumulated.
These cost centres are departments or sub
departments of an organisation with reference
to
which
cost
is
collected
for
cost
ascertainment and cost control.
The cost centres may be product centre or
service centre
Eg: In engineering industry, cost centres may
be machine shop, welding shop, assembly
shop, maintenance dept etc.,

PROFIT CENTRE
It is that segment of activity of a business
which is responsible for both revenue and
expenses and discloses the profit of a
particular segment of activity.
Profit centres are created to delegate
responsibility to individuals and measure
their performance

CONVERSION COST
It is the sum of direct wages, direct
expenses and overhead costs of converting
raw material from one stage of production
to the next.
Conversion cost = Works cost Cost of
direct materials

ORDERING COST & DEVELOPMENT

COST
Ordering cost: Costs incurred each
time an order for the purchase of
material is placed and are expressed as
rupee cost per order and include cost of
getting an item into the firms inventory
Development cost: It is the cost of
process
which
begins
with
the
implementation of the decision to
produce a new or improved method and
ends with the commencement of formal
production of the product by that
method

CONTRIBUTION MARGIN &

CARRYING COST
Contribution margin: This is the
excess of sales price over variable costs.
This can be expressed as total or ratio
of sales or percentage of sales.
Carrying cost: It is basically the costs
incurred
on
the
maintenance
of
inventory and include cost of the money
locked up in the inventory, inventory
obsolescence, storage space, rent and
cost of stores operations. It is also
known as holding cost.

POLICY COST & DISCRETIONARY

COSTS
Policy cost: It is the cost which is in
addition to normal requirement, incurred in
accordance with the policy of an
undertaking.
Discretionary costs: Include fixed costs
that arise from periodic appropriate
decision
that
directly
reflected
top
management policies. It is also known as
managed cost or programmed costs.

CLASSIFICATION OF COST
Cost classification is the process of
grouping costs according to their
common characteristics.
A suitable classification of costs is
important, in order to identify the cost
with cost centres or cost units
The same cost figures are classified
according to different ways of costing
depending upon the purpose to be
achieved and requirements of a
particular concern.

The important ways of classification are:

1. By nature or Element: The costs are

divided into three categories, Materials,

Labour and Expenses.
Materials can be further classified as raw
material, spare parts, consumable stores,
packing material etc.
This classification is important as it helps
to find out the total cost and valuation of
WIP.
2. By Functions: The costs are divided on
the basis of managerial activities
involved in the operation of a business
undertaking.
Eg; Production, Administration, Selling
and Distribution

3. As Direct or Indirect:
Total cost is
divided into direct costs and indirect costs.
Direct costs are those costs
which are
incurred for and may be conveniently
identified with a particular cost centre or cost
unit.
Indirect costs are those costs which are
incurred for the benefit of number of cost
centres or cost units and cannot be
conveniently identified with a particular cost
centre or cost unit.
Eg: rent of building, management salaries

4. By variability:

Costs are classified

according to their behaviour in relation to
changes in the level of activity or volume
of production. On this basis, costs are
classified into three groups namely fixed,
variable and semi-variable
Fixed costs: Those which remain fixed
in total amount with increase or decrease
in the volume of output or productive
activity for a given period of time.
Eg; rent, insurance
Fixed cost per unit decreases as
production increases and increases as
production declines.

Variable costs: Costs which vary in total

in direct proportion to the volume of
output.
These costs per unit remain
relatively constant with changes in
production.
They are also known as product costs as
they depend on the quantum of out put
rather than time.
Eg: Direct material, direct labour, power,
repairs etc.
Semi variable costs: Costs which are
partly fixed and partly variable.
Eg: Telephone expenses include a fixed
portion of annual charge plus variable
charge according to calls.

5. By controllability: The costs are

classified according to whether or not

they are influenced by the actions of a
given member of the undertaking. On
this it is classified as controllable costs
and uncontrollable costs.
Controllable costs: Costs which can be
influenced by the action of a specified
member of an undertaking. i.e. costs
which are at least partly within the
control of management
Uncontrollable costs: costs which
cannot be influenced by the action of a
specified member of an undertaking.

6. By

normality: Costs are classified

according to whether these are costs
which are normally incurred at a given
level of output in the conditions in which
that level of activity is normally attained.
On this basis costs are classified as
normal cost and Abnormal cost.
Abnormal costs are not a part of cost of
production and are charged to Costing
P&L a/c.
7. By Capital and Revenue (Financial
Accounting Classification): The costs
which are incurred in purchasing assets
used to generate income or to increase
income earning capacity is called capital
cost. The benefit of such costs are spread
over a number of years.

Expenditure incurred to maintain the earning

capacity or to run the business is called revenue
expenditure.
By time: Costs are classified as
1. Historical costs: The costs which are
ascertained after their incurrence are called
historical costs. The basic characteristics of
such costs are (a) They are based on recorded
facts. (b) They can be verified (c) They are
mostly objective
2. Predetermined costs: Costs are estimated costs.
Computed in advance of production taking into
consideration the previous periods costs and
the factors affecting such costs. Such costs
determined on scientific methods become
standard cost.
8.

9. According to planning and control:

Budgeted costs: An estimate of expenditure
for different phases of business operations,
coordinated in a well conceived framework for
a period of time in future which becomes a
managerial targets to achieve.
Standard costs: It is the predetermined cost
based on a technical estimate for materials,
labour and overhead for a selected period of
time and for a prescribed set of working
conditions.

10. For managerial decisions: On this basis

costs are classified as

1.Marginal costs: It is the total of variable
costs. i.e., prime cost plus variable overheads.
It is based on the distinction between fixed and
variable cost.
2.Out of pocket costs: It is that portion of the
cost which involves payment to outsiders.
3.Differential costs: The change in cost due
to change in level of activity or pattern or
method of production.
4.Sunk costs: It is an irrecoverable cost and is
caused by complete abandonment of a plant.
i.e., costs which are not relevant for decision
making.
5.Imputed costs: Costs which appear in cost
accounts only. These costs are also known as
notional costs, which are considered for decision
making.

6.Opportunity cost: It is the advantage,

in measurable terms, which has been
foregone due to not using the facility in the
manner originally planned.
7.Replacement cost:It is the cost at
which an asset or material identical to that
which is being replaced or revalued, can be
purchased.
8.Avoidable and unavoidable cost:
Avoidable costs are those which can be
eliminated if a particular product or
department with which they are directly
related is discontinued.
Un avoidable costs are those which will
cannot
be
eliminated
with
the
discontinuation
of
a
product
or
department.