By: Dr. Pankaj Chaudhari Assistant Professor, Ph. D., M. Com., MBA (Finance & HR), B. Ed., GDC&A Department of Commerce and Business Management

2. Cost Accounting

3. COST ACCOUNTING
Unit 01
Conceptual framework of Cost Accounting:
Basic Concepts of Cost Accounting:
Cost accounting involves determining fixed and variable costs. Fixed costs are expenses that
recur each month regardless of the level of production. Examples include rent, depreciation, interest on
loans and lease expenses. Variable costs are expenses that fluctuate with changes in production level,
such as supplies, labor, and maintenance expenses. These costs are related to production in that the
more units of a product produced the more expense there is associated with the materials and labor that
went into making the product.
Cost accounting determines both fixed and variable costs associated with a product line to
determine the break even point, and then ultimately the profit. The break even point represents the
point at which expenses are covered by sales. Profit is determined by using the break-even point as the
starting point for calculating profit. All sales beyond the break even point are profit. Determining the
number of units that need to be sold to reach the break even point and then achieve profit is know as
cost-volume-profit analysis.
While most cost accountants work in government organizations or large companies,
some will work as consultants either through public accounting firms or their own independent
practice. Private consultants will often be called upon to perform services for small or mid-sized
businesses that cannot substantiate the full-time employment of a cost accountant. Those who are
employed full-time will perform a wide variety of duties:
• Providing data for stable budget developments
• Using software to allocate indirect costs to internal processes
• Detailed analysis on suitable cost drivers
• Evaluation of potential business ventures
Cost accountants should be familiar with all of the methods of cost accounting, as well as the
software programs that support cost accounting functions. There are four primary methods of
cost accounting, each of which allocates indirect costs to individual product lines and / or
services:
• Standard Costing System assigns an average cost to each direct cost (labor, material,
overhead, etc) associated with a product so as to standardize the cost accounting system.
This is one of the more popular methods of cost accounting used by small and medium
sized businesses because of its simplicity.
• Activity-based Costing determines fixed and variable costs in proportion to the direct cost
associated with a product line.
• Throughput Accounting focuses on the expansion of an organization’s efficiency, by
reducing production bottlenecks and/or limitations and thereby maximizing throughput.
• Cost-Volume-Profit (CVP) Analysis determines total fixed and variable costs based on
the total quantity of products produced. It uses this information to calculate a company’s
breakeven point, or the production level at which it will begin to earn a profit.

4. Objectives
Following are the main objectives of cost accounting:
1. To ascertain the cost per unit of the different products manufactured by a business
concern;
2. To provide a correct analysis of cost both by process or operations and by different
elements of cost;
3. To disclose sources of wastage whether of material, time or expense or in the use of
machinery, equipment and tools and to prepare such reports which may be necessary to control
such wastage;
4. To provide requisite data and serve as a guide for fixing prices of products manufactured
or services rendered;
5. To ascertain the profitability of each of the products and advise management as to how
these profits can be maximised;
6. To exercise effective control if stocks of raw materials, work-in-progress, consumable
stores and finished goods in order to minimize the capital locked up in these stocks;
7. To reveal sources of economy by installing and implementing a system of cost control for
materials, labour and overheads;
8. To advise management on future expansion policies and proposed capital projects;
9. To present and interpret data for management planning, evaluation of performance and
control;
10. To help in the preparation of budgets and implementation of budgetary control
Importance
1] Classification of Costs
Cost is a very generic term, it needs to be classified to be of further use. Cost accounting
involves the recording and classification of such costs.
Some costs are prime cost, direct cost, factory cost, selling cost etc. Such classification allows
the management to control the costs and ascertain the profitability of any such processes and
activities. It also helps in calculating efficiency.
2] Cost Control

5. An efficient business focuses on controlling the cost of inventory, labor, and various other
overhead costs. Cost accounting allows them to do so.
For example to achieve maximum efficiency in their inventory management the can adopt the
EOQ technique which is a costing technique.
Similarly, by analyzing costs of labor and capacity of machinery their efficiency can be
improved also. Cost accounting also classifies overheads into fixed, variable or controllable,
uncontrollable to achieve cost control.
3] Price Determination
Cost accounting makes the basic distinction between fixed and variable costs. This is then used
by management to fix the prices of products, according to the costs of the product.
This allows the management to find the most ideal price for the product or the service, not too
high and not too low. Take for example a case where the economy suffers depression.
The businessman has to lower the prices of his products to survive these circumstances. So he
can begin by trying to control his variable costs allow him to fix his prices.
4] Fixing of Standards
Organizations use standards to make estimates and budgets for the future. They use these as a
basis to measure the actual efficiency of the process or department.
There is an entire branch in cost accounting known as Standard Costing dedicated to this process.
5] Importance of Cost Accounting to Others
• Workers: One of the biggest uses of cost accounting is that it helps us calculate efficiency.
This will help the company come up with an incentive scheme for workers who show
efficiency in their work, and thus they will be awarded accordingly. It is also an incentive
for workers with lower efficiency to do better.
• Government: Costing helps the government when assessing for income tax or any other
such government liabilities. It also helps set industry standards and helps with price
fixing, tariff plans, cost control etc.
• Customers: The main aims of costing are cost control and improvement in efficiency.
Both of these are very beneficial to the company. And ultimately this benefit passes on to
the customers of the products or services.

6. Advantages of Cost Accounting
1] Measuring and Improving Efficiency
Cost accounting allows for data that enables the firm to measure efficiency. This could be
efficiencies with respect to cost, time, expenses etc.
Standard costing is then used to compare actual numbers with the industry or economy standards
to indicate changes in efficiency.
2] Identification of Unprofitable Activities
Just because a firm is making overall profits, it does not mean all activities are profitable. Cost
accounting will help us identify the profitable and unprofitable activities of the firm.
So activities that cause the firm losses can be made profitable or eliminated. This can happen due
to the cost ascertainment done in cost accounting.
3] Fixing Prices
This is one of the important advantages of cost accounting. Many businesses price their products
based on the cost of production of these products.
To enable this, we first need to calculate the actual cost of production of these products. Costing
makes the distinction between fixed cost and variable cost, which allows the firm to fix prices in
different economic scenarios. Prices that we fix without the help of cost accounting can be too
high or low, and both cause losses to the business.
4] Price Reduction
Sometimes during tough economic conditions, like depression, the prices have to be reduced. In
some cases, these prices are reduced to below the total cost of the product.
This is to help the company survive this tough period. Such decisions the management has to
take are guided by cost accounting.
5] Control over Stock
Another important advantage of cost accounting is that it helps with restocking and control over
materials. Cost accounting will help us calculate the most ideal and economic re-order level and
quantities.
This will ensure that the firm is never overstocked or under stocked. Also costing allows the
management to keep a check over these raw materials, WIP etc.

7. 6] Evaluates the Reasons for Losses
Every firm has to deal with periods of profits and losses. But now they must always evaluate or
investigate the reasons for the losses suffered.
This will help to tackle the problem or overcome the cause by some other means necessary. So if
you cannot eliminate the reason you can at least minimize the losses.
Cost accounting plays a huge role in determining the cause of any losses. Say, for example, your
cost of production is low, and prices are high but yet losses persist. This can be due to low output
levels due to inefficiency. Cost accounting helps us determine this.
7] Aids Future Planning
One of the biggest advantages of cost accounting is that it will help the management with future
plans they may have. For any production or selling plans, it is important to have detailed data
about the machines, the labour capacity, output levels, levels of efficiency of each process etc.
Cost Centre
A cost center is a business unit that is only responsible for the costs that it incurs. The manager of
a cost center is not responsible for revenue generation or asset usage. The performance of a cost
center is usually evaluated through the comparison of budgeted to actual costs. The costs
incurred by a cost center may be aggregated into a cost pool and allocated to other business units,
if the cost center performs services for the other business units. Examples of cost centers are as
follows:
• Accounting department
• Human resources department
• IT department
• Maintenance department
• Research & development
A cost center can be defined at a smaller level than a department. It could involve a particular job
position, machine, or assembly line. However, this more detailed view of cost centers requires
more detailed information tracking, and so is not commonly used.
The management focus in a cost center is usually on keeping expenditures down to a minimum
level, possibly by using outsourcing, automation, or capping pay levels. The main exception is
when a cost center indirectly contributes to profitability (such as R&D), in which case a certain
minimum expenditure level will be needed to support sales.
Cost Unit

8. What is Cost Unit?
A cost unit refers to the unit of quantity of product, service or time (or combination of these) in
relation to which costs may be ascertained or expressed.
Measurements used as Cost units
The forms of measurement used as cost units are usually the units of physical measurement.
Such physical measurement along with the type of industry applied is presented below.
Table: Forms of measurements used as Cost units and Industries where commonly used.
Home » Accounting » Cost Accounting » What is Cost Unit | Measurements used as cost units
What is Cost Unit | Measurements used as cost units What
is Cost Unit?
A cost unit refers to the unit of quantity of product, service or time (or combination of these) in
relation to which costs may be ascertained or expressed.
COST UNITS
HHAI IS COST UMITF
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Cost Units - What is Cost unit, Forms of measurements
Measurements used as Cost units
The forms of measurement used as cost units are usually the units of physical measurement.
Such physical measurement along with the type of industry applied is presented below.

9. Table: Forms of measurements used as Cost units and Industries where commonly used.
Sl.
No Cost Unit Basis Types of Industries
1 Number Automobile
2 Metre or Kilometre Cable, Rope, Road Construction, Wire
3 Tonne Iron and steel, Sugar, Cement, Mines and Quarries
4 Litre, Kilogram, Tonne Chemicals
5 Cubic Metre Gas, Casting
6 Square Metre Metal Plating, Fabric Printing
7 Grors or Bag of Standard Weight Nuts and Bolts
8 Kilo-watt hour Power (Electricity)
9 Tonne-Kilometre, Passenger Kilometre Transport
10 Thousand Bricks
Elements of Cost
What are the Elements of Cost in Cost Accounting?
The elements that constitute the cost of manufacture are known as the elements of cost. Such
element of cost is divided into three categories. In a manufacturing concern, raw materials are
converted into a finished product with the help of labour and other service units. They are
Material, Labour and Expenses.
. Direct Material: It refers to material out of which a product is to be produced or manufactured.
The cost of direct material is varying according to the level of output. For example: Milk is the
direct material of butter.
2. Indirect Material: It refers to material required to produce a product but not directly and
does not form a part of a finished product. For example: Nails are used in furniture. The cost of
indirect material is not varying in direct proportion of product.
3. Direct Labour: It refers to the amount paid to the workers who are directly engaged in the
production of goods. It varies directly with the output.

10. 4. Indirect Labour: It refers to the amount paid to the workers who are indirectly engaged in the
production of goods. It does not vary directly with the output.
5. Direct Expenses: It refers to the expenses that are specifically incurred by the company to
produce a product. A product cannot be produced without incurring such expenses. It varies
directly with the level of output.
6. Indirect Expenses: It refers to the expenses that are incurred by the organization to produce
a product. But, these expenses cannot be easily found out accurately. For example: Power used
for production.
7. Overhead: It is the combination of all indirect materials, indirect labour and indirect
expenses.
8. Factory Overhead: It is otherwise called Production Overhead or Works Overhead. It refers
to the expenses that are incurred in the production place or within factory premises. For example:
Indirect material, rent, rates and taxes of factory, canteen expenses etc.
9. Administration Overhead: It is otherwise called Office Overhead. It refers to the expenses
that are incurred in connection with the general administration of the company. For example:
Salary of administrative staff, postage, telegram and telephone, stationery etc.
10. Selling Overhead: It refers to all expenses incurred in connection with sales. For example:
Salary of sales department staff, travelers’ commission, advertisement etc.
11. Distribution Overhead: It refers to all expenses incurred in connection with the delivery or
distribution of goods and services from the producer to the consumer. For example: Delivery van
expenses. loading and unloading, customs duty, salary of deliverymen etc.
Classification and Analysis of Costs
Classification of Cost:
Classification of costs implies the process of grouping costs according to their common
characteristics. A proper classification of costs is absolutely necessary to mention the costs with
cost centres. Usually, costs are classified according to their nature, viz., material, labour,
overhead, among others. An identical cost figure may be classified in various ways according to
the needs of the firms.
However, the classification of cost may be depicted as given:
(a) According to Elements:
Under the circumstances, costs are classified into three broad categories Material, Labour and
Overhead. Now, further subdivision may also be made for each of them. For example, Material
may be subdivided into raw materials, packing materials, consumable stores etc. This

11. classification is very useful in order to ascertain the total cost and its components. Same
classification may also be made for labour and overhead.
(b) According to Functions:
The total costs are divided into different segments according to the purpose of the firm. That is
why costs are grouped as per the requirements of the firm in order to evaluate its functions
properly. In short, the total costs include all costs starting from cost of materials to the cost of
packing the product.
ADVERTISEMENTS:
It takes the cost of direct material, direct labour and chargeable expenses and all indirect
expenses under the head Manufacturing/Production cost.
At the same time, administration cost (i.e. relating to office and administration) and Selling and
Distribution expenses (i.e. relating to sales) are to be classified separately and to be added in
order to find out the total cost of the product. If these functional classifications are not made
properly, true cost of the product cannot accurately be ascertained.
(c) According to Variability:
Practically, costs are classified according to their behaviour relating to the change (increase or
decrease) in their volume of activity.
ADVERTISEMENTS:
These costs as per volume may be subdivided into:
(i) Fixed Cost;
(ii) Variable Cost;
(iii) Semi-variable Cost.
Fixed Costs are those which do not vary with the change in output, i.e., irrespective of the
quantity of output produced, it remains fixed (e.g., Salaries, Rent etc.) up to a certain limit. It is
interesting to note that if more units are product, fixed cost per unit will be reduced, and, if less
units are produced, obviously, fixed cost per unit will be increased.
Variable Costs, on the other hand, are those which vary proportionately with the volume of
output. So the cost per unit will remain fixed irrespective of the quantity produced. That is, there
is no direct effect on the cost per unit if there is a change in the volume of output (e.g. price of
raw material, labour etc.,).

12. On the contrary, semi-variable costs are those which are partly fixed and partly variable (e.g.
Repairs of building).
(d) According to Controllability:
Costs may, again, be subdivided into two broad categories according to the performance done by
any member of the firm.
They are:
(i) Controllable Costs; and
(ii) Uncontrollable Costs.
Controllable Costs are those costs which may be influenced by the decision taken by a specified
member of the administration of the firm or, it may be stated, that the costs which at least partly
depend on the management and is controllable by them, e.g. all direct costs, direct material,
direct labour and chargeable expenses (components of Prime Cost) are controllable by lower
management level and is done accordingly.
Uncontrollable Costs are those which are not influenced by the actions taken by any specific
member of the management. For example, fixed costs, viz., rent of building, payment for salaries
etc.
(e) According to Normality:
ADVERTISEMENTS:
Under this condition, costs are classified according to the normal needs for a given level of
output for a normal level of activity produced for such output.
They are divided into:
(i) Normal Costs; and
(ii) Abnormal Costs.
ADVERTISEMENTS:
Normal Costs are those costs which are normally required for a normal production at a given
level of output and which is a part of production.
Abnormal Costs, on the other hand, are those costs which are not normally required for a given
level of output to be produced normally, or which is not a part of cost of production.

13. (f) According to Time:
Costs may also be classified according to the time element in it. Accordingly, costs are
classified into:
(i) Historical Costs; and
(ii) Predetermined Costs.
Historical Costs are those costs which are taken into consideration after they have been incurred.
This is possible particularly when the production of a particular unit of output has already been
made. They have only historical value and cannot assist in controlling costs.
Predetermined Costs, on the other hand, are the estimated costs. Such costs are computed in
advanced on the basis of past experience and records. Needless to say here that it becomes
standard cost if it is determined on scientific basis. When such standard costs are compared with
the actual costs, the reasons of variance will come out which will help the management to take
proper steps for reconciliation.
(g) According to Traceability:
Costs can be identified with a particular product, process, department etc. They are divided
into:
(i) Direct (Traceable) Costs; and
(ii) Indirect (Non-Traceable) Costs.
Direct/Traceable Costs are those costs which can directly be traced or allocated to a product, i.e.
it includes all traceable costs, viz., all expenses relating to cost of raw materials, labour and other
service utilised which can be traced easily.
Indirect/Non-Traceable Costs are those costs which cannot directly be traced or allocated to a
product, i.e. it includes all non-traceable costs, e.g. salary of store-keepers, general
administrative expenses, i.e. which cannot properly be allocated directly to a product.
(h) According to Planning and Control:
Costs may also be classified into:
(i) Budgeted Costs; and (ii) Standard Costs.
Budgeted Costs refer to the expected cost of manufacture computed on the basis of information
available in advance of actual production or purchase. Practically, budgeted costs include

14. standard costs, both are predetermined costs and their amount may coincide but their objectives
are different.
Standard Costs, on the other hand, is a predetermination of what actual costs should be under
projected conditions serving as a basis of cost control and, as a measure of product efficiency,
when ultimately aligned actual cost. It supplies a medium by which the effectiveness of current
results can be measured and the responsibility for derivations can be placed.
Standard Costs are predetermined for each element, viz., material, labour and overhead.
Standard Costs include:
(i) The cost per unit is determined to make an estimated total output for the future period
for:
(a) Material;
(b) Labour; and
(c) Overhead.
(ii) The cost must depend on the past experience and experiments and specification of the
technical staff.
(iii) The cost must be expressed in terms of rupees.
(i) According to Management Decisions: Under this, costs may also be classified as:
(a) Marginal Cost:
Marginal Cost is the cost for producing additional unit or units by segregation of fixed costs (i.e.,
cost of capacity) from variable cost (i.e. cost of production) which helps to know the
profitability. Moreover, we know, in order to increase the production, certain expenses (fixed)
may not increase at all, only some expenses relating to materials, labour and variable expenses
are increased. Thus, the total cost so increased by the production of one unit or more is the cost
of marginal unit and the cost is known as marginal cost or incremental cost.
(b) Differential Cost:
Differential Cost is that portion of the cost of a function attributable to and identifiable with an
added feature, i.e. the change in costs as a result of change in the level of activity or method of
production.
(c) Opportunity Cost:

15. It is the prospective change in cost following the adoption of an alternative machine, process,
raw materials, specification or operation. In other words, it is the maximum possible alternative
earnings which might have been earned if the existing capacity had been changed to some other
alternative way.
(d) Replacement Cost:
It is the cost, at current prices, in a particular locality or market area, of replacing an item of
property or a group of assets.
(e) Implied Cost:
It is the cost used to indicate the presence of arbitrary or subjective elements of product cost
having more than usual significance. It is also called notional cost, e.g., interest on capital —
although no interest is paid. This is particularly useful while decisions are taken regarding
alternative capital investment projects.
(f) Sunk Cost:
It is the past cost arising out of a decision which cannot be revised now, and associated with
specialised equipment’s or other facilities not readily adaptable to present or future purposes.
Such cost is often regarded as constituting a minor factor in decisions affecting the future.
Unit or Output Costing
Introduction
A manufacturing concern converts raw materials into finished products and sells them at a
certain price. In the manufacturing process, it incurs different types of expenses such as
manufacturing, administrative and selling and distribution expenses.
Concept and meaning
Output or unit costing is one of the important methods of costing under which cost of production
and in turn the selling price unit are determined. This costing method is used by the
manufacturing concern which produces homogeneous products such as sugar, cloth, cement and
so on. A costing method used to ascertain unit cost output is called output-costing method.
Importance of output costing
A cost sheet is used to determine total and unit cost of a product under the unit cost method. The
followings are the importance;
Simple: This method is very simple and easy to understand.
Determination of cost: It helps to determine the total and unit cost if production for a given
period of time.
Fixation of selling price: It helps to determine the selling price of the product.
Elements of cost: It provides the detail information of the cost under different heading
incorporating step-wise cost as well as total cost.
Comparison: It facilitates to compare the current cost with the previous period.

16. Corrective measures: It enables to find out the causes of variation if any and take corrective
measures.
Tender sheet: It helps in the preparation of tender sheet for submitting tender price with fair
degree of accuracy and reliability.
Decision making: It facilitates for making different types of decisions and formulation policy of
the manufacturing concern.
Limitation of unit costing
Cost sheet is very importance method for determining the unit cost or total cost of production.
Not applicable for heterogeneous products: manufacturing concerns engaged in manufacturing
different types of product cannot apply this method.
Not applicable for service sector: Services oriented concern like school, college, and hospital
cannot apply this method.
Cost sheet or statement of cost
A cost sheet is a periodical statement, which is designed to show in detail all the elements of cost
of good manufactured. The elements of costs are prime cost, factory cost, cost of production and
total cost. In simple words, a statement which is designed to show the total cost as well as cost
per unit of output for the given period of time is called cost sheet.
Components of cost sheet
Cost sheet is a statement, which collects the detail information about the cost of different cost
centre for determining the total cost and unit cost of production. It is prepared for the specific
period of time.
The main components of statement of cost are as follows;
Prime cost
Prime costs of product are the sum of direct costs, which varies in proportion to volume of
production. Prime cost includes direct expenses like cost of materials, direct labour and direct
expenses. These costs are directly identifiable with the product and constitute the major part of
total cost of the product.
Factory cost
Factory cost are the total of prime costs and factory expenses. Factory expenses are also as
factory, manufacturing or works overheads. They includes indirect expenses which are incurred
inside the work place where manufacturing takes place.
Factory cost= prime cost + factory overhead
Cost of production
Cost of production includes factory costs and office and administrative overheads. Office
overheads include all expenses incurred in performing administrative activities like planning,
coordinating, staffing and controlling.
Cost of production = Factory cost +Office overheads
Total costs

17. Total costs are the sum of costs of production and selling and distribution overheads. Selling and
distribution overheads are necessary for the promotion of sales.
Treatment or adjustment of stock
There are three types of stock, which are adjusted in the process of preparing statement of cost.
They are as follows;
Stock of raw materials
Stock of work-in-progress or partly finished goods Stock of finished goods
Stock of raw materials
Opening stock of raw materials value is added to the raw materials purchased and closing stock
of raw materials value is subtracted therefrom in order to calculate cost of raw materials
consumed. Cost of materials consumed is then considered as direct material cost.
Stock of work-in-progress
The stocks of work-in-progress are those units of commodities on which some work has been
done but are in process of completion. These units can neither be treated as raw materials nor
finished product, because such units requires further process to be completely finished products.
Stock of work-in-progress may be both opening and closing.
Stock of finished goods
All types of overhead other than selling and distribution overhead are absorbed by finished
goods. Therefore, stock of finished goods is adjusted after calculating cost of production.
Tender or quotation price
It is the price to be quoted for the supply of the particular product or for executing the work order
as quotation invited. The manufacturer has to quote price of its product in advance. In the
preparation of tender sheet, direct materials, direct wages and overhead are predetermined on the
basis of the costs of the proceeding period. It takes into account the possible changes in price in
future.
The overhead costs can be estimated by taking labour hour or machine hour basis. The basis of
machine hour rate or labour rate is used for the absorption the overheads. In the preparation of
tender sheet, the following steps can be taken:
The direct materials direct wages, and overheads should be added along with any changes if any,
to determine prime cost.
The other overhead should be absorbed on the basis of percentage of various years’ cost.
1. Absorption of factory overhead:
The factory overhead may be absorbed as a percentage on direct materials, direct wages and
chargeable expenses.
% of factory overhead on direct wages =
2. Absorption of office and administrative overhead:
The office and administrative overhead is absorbed as the same percentage of office and
administrative overhead on factory cost

18. % of office and administrative overhead=
3.Absorption of selling and distribution overhead
% of selling and distribution overhead
Manufacturing account
Manufacturing account is the alternative method of determination of total cost and fixation of selling
price. The manufacturing needs to ascertain the cost of goods manufactured and manufacturing profit or
loss during the year. Therefore, an account is prepared for the purpose, which is known as manufacturing
account. Generally, it is prepared by such concerns which do not have cost office and maintain any cost
account.
Features of manufacturing account
The opening and closing stock of finished goods are not recorded because the purpose of preparation of
the account is, to determined cost of goods manufactured and manufacturing profit during the specified
period. This represent ledger account consisting of debit and credit side. the difference between two sides
will be cost of goods manufactured or manufacturing profit/loss based on the type of manufacturing
account.
Importance of manufacturing account
Cost of goods manufactured and manufacturing profit/loss can be determined. it helps to fix the selling
price .
It assists to reduce and control the cost on manufacturing process.
Performance of manufacturing department can be evaluated by comparing profit/loss of current year.
Preparation of manufacturing account
Preparation of manufacturing account would depend upon the purpose that is sought to be obtained
information therefrom. The purpose may be either to ascertain cost of manufactured or manufacturing
profit or loss. However it is prepared in two different formats:
For showing cost of production
For showing manufacturing profit of loss