UNIT 2 COST CONCEPTS AND ITS

ASCERTAINMENT
Structure
2.0 Objectives
2.1 Introduction
2.2 Meaning of Cost
2.3 Classification of Costs
2.3.1 Functional Classification
2.3.2 On the Basis of Identifiability with Products
2.3.3 On the Basis of Variability
2.4 Cost Unit
2.5 Cost Centre
2.6 Elements of Cost
2.6.1 Materials
2.6.2 Labour
2.6.3 Expenses
2.7 Components of Total Cost
2.8 Cost Sheet
2.9 Methods of Costing
2.10 Types of Costing
2.11 Role of Cost Accountant
2.12 Let Us Sum Up
2.13 Key Words
2.14 Answers to Check Your Progress
2.15 Terminal Questions

2.0 OBJECTIVES
After studying this unit, you should be able to:
●● define the term cost,
●● explain the concepts of cost unit and cost centre,
●● classify costs,
●● describe the elements of cost,
●● give a proforma of cost sheet and identify the components of total
cost, and
●● describe different methods of costing and identify the industries to
which each method is applicable.

2.1 INTRODUCTION
In Unit 1 you have learnt about the nature and scope of costing, the difference
between Cost Accounting and Financial Accounting, and the advantages
of installing a costing system in an organisation. You learnt that costing is
18

BCOC-138 (E).indd 18 17-02-2021 15:48:27

 the technique and process of ascertaining cost. In order to understand this Cost Concepts and Its
process, one must gain familiarity with certain concepts like cost, cost unit, Ascertainment
cost centre, classification of costs, elements of cost and components of total
cost. This unit mainly covers these aspects and gives a proforma of cost sheet
prepared for ascertaining cost and profit of each product manufactured by
an organisation during a particular period. This unit also discusses various
methods of costing and identifies the industries for which each method is
considered suitable.

2.2 MEANING OF COST

Cost means the amount of expenditure: (actual or notional) incurred on, or
attributable to, a given thing. In other words, cost indicates: (i) an actual
or estimated expenditure, (ii) a direct or indirect expenditure, and (iii) it is
related to a job, process, product or service. Examples of expenses which
constitute cost are:
(a) materials, (b) labour, (c) factory overheads, (d) administrative overheads,
and (e) selling and distribution overheads.
Cost is a wide concept. It does not give an exact meaning unless it is properly
qualified. It is necessary, therefore, that both who ascertain cost and who
use it as a base for certain decisions, interpret the meaning and contents of
cost in a similar manner. The main characteristics of cost are:
1) The term ‘cost’ is not complete unless it is fully identified with its
nature and category.
2) Costs do not represent the same contents under every situation.
3) No cost is true, exact or accurate. It is a flexible concept; it does not
mean the same thing under all circumstances.
4) Cost may be ascertained in different ways by different persons.
5) Costs vary with time, volume, firm, method or purpose.
Thus, cost has no fixed, certain or definite meaning. This may change according
to its interpretation and the manner in which, or the purpose for which, it is
ascertained. Cost must indicate its purpose and the conditions under which
it is computed. If not, it may be vague, giving different meaning to different
people. Hence, it must be related to a particular activity or commodity and
expressed for a given quantity or unit of goods produced or services performed.
Cost and Loss: You should be able to distinguish between the terms ‘cost’
and ‘loss’. Cost actually signifies an expenditure incurred for securing some
benefit to the business. If no benefit is derived from a particular expenditure,
it is regarded as a loss. Cost of materials destroyed by fire or salary paid to
a foreman during the period of strike are not regarded as cost. These are
examples of loss to the business.

2.3 CLASSIFICATION OF COSTS

We often come across a wide variety of costs. Unless we are fully familiar
with their meaning and utility, we may not be effective in their computation,
analysis comparison and control.
There are various bases according to which costs have been classified.
These are: (1) according to functions to which they relate, (2) according to
their identifiability with jobs, products, or services, (3) according to their
variability with changes in output, (4) according to their association with

19

BCOC-138 (E).indd 19 17-02-2021 15:48:27

 Basic Concepts product or period, (5) according to their controllability, and (6) according
to their relevance to decision making. The first three bases are considered
important at the introductory stage and, therefore, have been discussed here
in detail.
2.3.1 Functional Classification
The most common classification of costs in a manufacturing establishment is on
the basis of functions to which they relate because costs have to be ascertained
for each of these functions. On this basis, costs are classified into four categories:
(i) manufacturing costs (production costs), (ii) administrative costs, (iii)
selling costs, and (iv) distribution costs.
Manufacturing Costs: Manufacturing costs refer to all expenditure incurred
in the course of production from acquisition of materials to primary packing
(packaging) of the finished product. It includes cost of materials, cost of
labour, other direct expenses and factory overheads. These are also termed
as ‘production costs’.
Administrative Costs: Administrative costs include all costs that are
incurred for general administration of the organisation and for the operational
control. Some examples of such costs are salaries of the office staff, rent of
the office building, depreciation and repairs of the office furniture, etc. In
fact, any expenditure which is not related directly to production, selling,
distribution, research or development forms part of the administrative costs.
Selling Costs: Selling costs are those costs which are incurred in connection
with the sale of goods. Some examples of such costs are: cost of warehousing,
advertising, salesmen salaries, etc.
Distribution Costs: Distribution costs are those costs which are incurred on
despatch of the finished products to customer including transportation. Some
examples of such Ascertainment costs are : packing, carriage, insurance,
freight outwards, etc.
2.3.2 On the Basis of Identifiability with Products
On this basis costs are divided into (i) direct costs, and (ii) indirect costs.
Direct Costs: Direct costs refer to expenses which can be directly identified
with a product, job or process. For example, in case of materials used and
labour employed, we can easily ascertain as to which product or job or
process they relate. The same thing is not true of expenditure like rent of the
building which is a common cost for various products manufactured in the
factory and will have to be allocated to all products on some rational basis.
Indirect Costs: Indirect costs refer to those expenses which cannot be
easily identified with a particular product, job or process. These are of a
general, common or collective nature which are to be allocated to various
products manufactured in the factory. Some examples of such costs are:
rent of the factory building, salary of the production manager, wages paid to
chowkidar, etc. These costs have to be apportioned among different products
on some rational basis. These are known as ‘overheads’ or ‘on costs and can
be subdivided into factory overheads, administrative overheads, selling and
distribution overheads.
2.3.3 On the Basis of Variability
On this basis costs are classified into (i) fixed costs, (ii) variable costs, and
(iii) semi-variable (or semi-fixed) costs.
Fixed Costs: Costs which remain unaffected by changes in volume of output
are termed as ‘fixed costs’. For example, whether we produce 10,000 units
or 15,000 units of a particular product during a particular period, the rent
of the factory building or salary of the production manager will remain the
20

BCOC-138 (E).indd 20 17-02-2021 15:48:27

 same. Hence, the rent or salary is regarded as fixed cost. It should, however, Cost Concepts and Its
be noted that fixed costs do not remain fixed for all times to come. They Ascertainment
remain fixed only upto a certain level of production capacity. If there is a
change in the production capacity which require additional building and
equipment, such costs will also increase.
Variable Costs: Costs which increase or decrease in direct proportion
to changes in the volume of output are termed as ‘variable costs’. For
example, for 10,000 units of output, cost of materials consumed comes to
Rs. 1,50,000. If the production is increased to 12,000 units (increase of
20%) the cost of materials will increase to Rs.1,80,000 (increase of 20%). It
should be noted that the cost of material per unit of output has not changed.
It remains the same i.e., Rs. 15 per unit. But, it is the total cost of materials
which changes because of the change in the volume of output.
Semi-Variable Costs: Costs which increase or decrease with a change in
volume of output but not in the same proportion as the change in the volume
of output are termed as ‘semi-variable costs’. In other words, these costs
are partly variable and partly fixed and, as such, are also known as ‘semi-
fixed costs’. Depreciation and repairs of machinery are the best examples of
such costs. Depreciation on machinery is caused partly by passage of time
and partly by its usage. Hence, when production is increased the amount of
depreciation also increases, but not in the same proportion as the increase
in the volume of output. Take another example. If the quantity of goods
sold increases, the remuneration of salesman may also increase. But, such
increase will not be in direct proportion to the increase in sales because his
commission on sales will increase while his salary remains the same.
The classification of costs into fixed, variable and semi-variable is very
helpful in estimating the total cost at various levels of activity and also in
various managerial decisions.
Check Your Progress A
1) What do you mean by the term ‘cost’.
2) Distinguish between ‘cost’ and ‘loss’.
3) Give three examples of semi-variable costs.
4) Distinguish between direct costs and indirect costs.
5) State whether the following statements are True or False and justify
your answer.
i) Costs may be ascertained in different ways by different persons.
ii) The term ‘cost’ has a fixed, certain and definite meaning.
iii) Rent of a factory building is a variable cost.
iv) Salesmen salary is a fixed cost.
v) All factory expenses can be identified directly with the products
manufactured by a factory.
vi) Bad debts are selling costs.

2.4 COST UNIT

You know one of the main functions of costing is to ascertain cost per unit
of output. This means that each economic activity has to be measured in
identifiable units which may serve as the basis of costing. Such units for the
purpose of costing may be as follows:
1) unit of product (e.g., cost per book)
21

BCOC-138 (E).indd 21 17-02-2021 15:48:27

 Basic Concepts 2) unit of time (e.g., cost of generating electricity per hour)
3) unit of weight (e.g., cost per kilogram of biscuits)
4) unit of measurement (e.g., cost per metre of cloth or per square foot of
construction),
5) operating unit of service (e.g., cost of running a bus per kilometer).
Thus, a cost unit is a unit of product, service or time in terms of which
costs are ascertained or expressed. Cost unit will normally be the quantity
of a product for which price is quoted to the customers.
Selection of a cost unit, however, must be appropriate. Firstly, it should
offer convenience in cost ascertainment. Secondly, it should be easier to
associate expenses with cost units. Thirdly, it should be according to the
nature and practice of the business.
Some examples of cost unit for different products and services are given
below:
Product/Activity Cost Unit
Wire per metre
Power per kilowatt hour
Telephone per call
Iron per tonne/quintal
Transport per passenger per kilometer/
per kilogram per kilometer
Bricks per thousand
Cement per bag/per tonne
Paper per ream/per kilogram
Computer per hour
Printing per thousand impressions
Cars per car
Petrol per litre
Television per set
Pencils per dozen
Gold per gramme
Ship-building per ship
Nursing Home per bed per day

2.5 COST CENTRE

A Cost Centre is a location, person or item of equipment (or group of these)
for which costs may be ascertained and used for the purposes of cost control.
In other words, a cost centre may consist of either or a combination of the
following:
LOCATION : Factory, Office, Warehouse, Stores, Sales Depot, etc.
PERSON : Foreman, Salesman, Customer, etc.
EQUIPMENT : Machine, Car, Truck, Crane, etc.
In fact, the entire organisation may be divided into specified cost centres which
jointly contribute to the total cost. Identification of cost centres helps us in
1) ascertaining the centre-wise costs,
2) comparing the centre-wise costs periodically,
22

BCOC-138 (E).indd 22 17-02-2021 15:48:27

 3) finding out the major trends of variance, and Cost Concepts and Its
Ascertainment
4) applying the techniques of control to check undue, undesirable or
unexpected movements in costs.
A cost, centre is a convenient unit of the organisation. It segregates
operations, demarcates activities, and distributes expenses. This helps in
fixing responsibilities for every cost centre.
Types of Cost Centres: Cost centres may be divided into the following four
types:
1) Prices Cost Centre (based on sequence of operations)
2) Production Cost Centre (for regular production in a factory)
3) Operation Cost Centre (where various operations are involved in the
production process)
4) Service Cost Centre (for activities supporting the main production)
Thus, identification or selection of cost centres depends on the nature and
type of industry.
Check Your Progress B
1) Match the cost unit appropriate to the activity/product.
i) Transport a) per sq. centimeter
ii) House Construction b) per job
iii) Furniture c) per contract
iv) Advertising d) per piece
v) Nursing Home e) per ton kilometer
vi) Ice Cream f) per bed per day
vii) Shirt g) per kilogram
2) Define Cost Unit.
3) What do you mean by Cost Centre?
4) State the objectives of identifying cost centres.
2.6 ELEMENTS OF COST
There are three main elements of cost : (1) materials, (2) labour, and (3)
expenses.
2.6.1 Materials
The term ‘materials’ refers to those commodities which are used as raw
materials components, or consumables for manufacturing a product.
Materials can be direct o indirect.
Direct Materials: All materials used as raw-materials or components for
a finished product are known as ‘direct materials’. Sugarcane for sugar,
cloth for ready-made garments, tyres for car are some examples of direct
materials. Packaging is also an item of direct materials cost.
Indirect Materials: Consumables like lubricating oil, stationery, spare
parts for machinery are termed as indirect materials. Such commodities do
not form part of the finished product.
2.6.2 Labour
The workers employed of converting material into finished product or for
doing various odd jobs in the business are known as ‘labour’. Labour can
also be direct or indirect.
23

BCOC-138 (E).indd 23 17-02-2021 15:48:27

 Basic Concepts Direct Labour : The workers who are directly involved in the production
of goods are known as ‘direct labour’. They may be labourers producing
manually or workers operating machinery. The wages paid to such workers
are known as ‘direct wages’ or ‘manufacturing wages’.
Indirect Labour: The workers employed for carrying out tasks incidental
to production of goods or those engaged for office work and selling and
distribution activities are known as ‘indirect labour’. The wages paid to
such workers are known as ‘indirect wages’.
2.6.3 Expenses
All expenditure other than material and labour are termed as ‘expenses’.
Expenses can also be direct and indirect.
Direct Expenses : Other expenses which are incurred specifically for a
particular product, job or service are termed as ‘direct expenses’. Some
examples of such expenses are : carriage inwards, production royalty, hire
charges of special equipment, cost of special drawings, etc. These are also
known as ‘chargeable expenses’.
Indirect Expenses : All expenses other than indirect materials and labour
which cannot be directly attributed to a particular product, job, or service
are termed as ‘indirect expenses’. Rent of building, repairs of machinery,
lighting and heating, insurance are some examples of indirect expenses.
The various elements of cost have been presented in the form of a chart in
Figure 2. 1.
Figure 2.1 : Elements of Cost

Concept of Overheads : All material, labour and expenses which cannot be

identified as direct costs 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’.
Overheads are grouped into three categories : (1) factory (or manufacturing)
overheads, (2) office (or administrative) overheads, and (3) selling and
distribution overheads as shown in Figure 2.2.
Figure 2.2 : Categories of Overheads

Conversion Cost: The cost of converting raw materials into finished goods
is termed as ‘conversion cost’. This includes direct wages, direct expenses
and factory overheads.
24

BCOC-138 (E).indd 24 17-02-2021 15:48:27

 Cost Concepts and Its
2.7 COMPONENTS OF TOTAL COST Ascertainment

Total cost of a product is the combination of direct costs (also known as

prime cost) and indirect costs (also known as overheads).
Thus, the two main components of total cost are: (1) Prime Cost, and (2)
Overheads. The prime cost which represents all direct costs, therefore,
consists of direct materials, direct labour and other direct expenses.
Overheads, on the other hand, consists of factory overheads, office
overheads, and selling and distribution overheads.
Total Cost Build Up
If we add various costs step by step, we get the following framework of total
cost build-up.
1) Direct Material + Direct Labour + Other Direct Expenses = PRIME
COST
2) Prime Cost + Factory Overheads = WORKS COST
3) Works Cost + Office and Administrative Overheads = COST OF
PRODUCTION
4) Cost of Production + Selling and Distribution Overheads TOTAL
COST or COST OF SALES
The above framework of total cost build-up is shown in Figure 2.3.
Figure 2.3 : Total Cost Build-up
Cost of 
Direct Materials  
Prime Cost  Factory Cost  Production 
Direct Labour    
 Factory  Office  Selling &  Cost of Sales
Other Direct   Distribution 
Overheads  Overheads 
Expenses  
Overheads 

Thus, we get the following components of total cost:

1) Prime Cost (also known as Direct Cost or First Cost)
2) Works Cost (also known as Factory Cost)
3) Cost of Production (also known as Office Cost)
4) Cost of Sales
Check Your Progress C
1) Give four examples of other direct expenses.
2) Give four examples of indirect expenses.
3) Distinguish between direct and indirect wages.
4) Fill in the blanks.
i) Direct Materials + ……+ Other Direct Expenses = Prime Cost
ii) Prime Cost + ……………..= Works Cost
iii) Works Cost + Office Overheads = ……………..
iv) Prime Cost +………… +………… + = ……….Cost of Sales

2.8 COST SHEET

A Cost Sheet is a statement showing various components of total cost which
acts a guide to pricing decisions and a basis for cost control.

25

BCOC-138 (E).indd 25 17-02-2021 15:48:28

 Basic Concepts It is a presentation of cost data incorporating its various elements in a
classified manner. In view of its valuable contents, a cost sheet should be
prepared properly and at frequent intervals (weekly or monthly).
Possible information which may be incorporated into a cost sheet in
accordance with the requirements of the business are:
1) Name of the product cost centre or cost unit
2) Period to which the statement relates
3) Output for the period
4) Details of various components of total cost
5) Item-wise cost per unit
6) Changes in stock position
7) Cost of goods sold
8) Profit or loss position
Proforma of cost sheet is given in Figure 2.4.
Figure 2.4 : Proforma of Cost Sheet
COST SHEET OF ……………..
for the month ending……………..
Output units……………..
Total Per Unit
Rs. Rs.
Raw Materials Consumed:
Opening stock of raw materials xx
Add: Purchases of raw materials xx
Less: Closing stock of raw materials xxx
Direct Labour xxx
Other Direct Expenses xx
x
x
PRIME COST xxx x
Factory Overheads:
Indirect Material xx
Indirect Labour xx
Insurance on factory building & xx
equipments
Other expenses of factory xx
Gross Factory/Works Cost xxx xx
Add : Opening Work-in-Progress xx
Less : Closing Work-in-Progress xx
Factory Cost or Works Cost xxx
Office & Administrative Overheads:
Office Rent, Insurance, Salaries, xx
office Expenses
xx x
COST OF PRODUCTION/ xxx xx
OFFICE COST
( ………..units)

26

BCOC-138 (E).indd 26 17-02-2021 15:48:28

 Add: Opening Stock of Finished xx Cost Concepts and Its
Goods Ascertainment
xxx
( ……………..units)
xx
Less: Closing Stock of Finished
Goods
( ……………..units)
COST OF GOODS SOLD xxx xx
(…………….units)
Selling & Distribution Overheads :
Packing, Showroom,
Advertisement, Sale, Staff
Salaries/Travelling Expenses
COST OF SALES xxx xx
( ……………..units)
PROFIT (LOSS) x x
SALES/SELLING PRICE xxx xx
Look at Illustration 1 and see how cost sheet is prepared from given costing data.
Illustration 1:
From the following particulars of a manufacturing firm, prepare the Cost
Sheet showing (i) Prime Cost, (ii) Works Cost, (iii) Cost of Production,
and (iv) Cost of Sales.
Rs.
Stock of materials on 1.1.2018 40,000
Purchase of Materials 11,00,000
Stock of finished goods on 1.1.2018 (5,000 units) 50,000
Productive wages 5,00,000
Finished goods sold (1,74,000 units) 24,36,000
Works overheads 1,50,000
Office expenses 1,00,000
Selling and Distribution expenses 1,74,000
Stock of materials on 31.12.2018 1,48,000
Stock of finished goods on 31.12.2018 (6,000 units) 60,000
Solution :
Before preparing the Cost Sheet, we should work out the number of units
produced during the year.
Closing Stock 6,000
Number of units sold 1,74,000
1,80,000
Less: Opening Stock -5,000
Number of units produced 1,75,000

COST SHEET
For the year ending 31.12.2018
27

BCOC-138 (E).indd 27 17-02-2021 15:48:28

 Basic Concepts Output 1,75,000 units
Total Per Unit

Rs. Rs.
Raw Materials Consumed:
Opening Stock 40,000
Add: 11,00,000
Purchases
11,40,000
Less : Closing Stock 1,40,000 10,00,000
Direct Wages 5,00,000
Other Direct Expenses
PRIME 15,00,000
COST
Works Overheads 1,50,000
WORKS COST 16,50,000
Office Overheads 1,00,000
COST OF PRODUCTION 17,50,000 10.00
(1,75,000 units)
Add : Opening stock of Finished 50,000
Goods (5,000 units)
Less : Closing stock of Finished 18,00,000
Goods (6,000 units)
Cost of Goods Sold (1,74,000 60,000
units
Selling and Distribution 17,40,000 10.00
Overheads
1,74,000 1.00
COST OF SALES 19,14,000 11.00
PROFIT 5,22,000 3.00
SALES 24,36,000 14.00

2.9 METHODS OF COSTING

Though, in all cases, the basic principles and procedure of costing remain
the same, but on account of the nature and peculiarities of their business,
different industries follow different methods of ascertaining cost of their
products and services. These methods can be summarised as follows :
Job Costing: Under this method, costs are ascertained for each job or
work-order separately. It is suitable for industries like printing, car repairs,
foundries, painting and decoration, where each job has its own specifications.
Contract Costing: This method is used in case of big jobs described
as ‘contracts’. The contract work usually involves heavy expenditure,
stretches over a long period, and is undertaken at different sites. Hence, each

28

BCOC-138 (E).indd 28 17-02-2021 15:48:28

 contract is treated as a separate unit for purposes of cost ascertainment and Cost Concepts and Its
control. Contract costing (also termed as Terminal Costing) is most suited to Ascertainment
industries like ship-building, construction of buildings, roads and bridges.
Batch Costing: Where work-orders are arranged in batches and the units
produced in a batch are uniform in nature and design, each batch is regarded
as a job and treated as a separate unit for purposes of costing. In such a
situation, the method of costing adopted is known as ‘batch costing.’ It is
generally used in industries like pharmaceuticals, bakery, toy manufacturing,
etc.
Unit Costing: Under this method costs are ascertained for convenient
units of output. It applies to products which are turned out by continuous
manufacturing activity and can be expressed in identical quantitative units.
It is suitable for industries like brick making, mining, cement manufacturing,
dairy, flour mills, etc. This method is also called ‘Single Output Costing’.
Process Costing: In case of some industries, a product passes through
different stages of production called ‘processes’ and each process is distinct
and well-defined. The output of each process is used as a raw material for
the next process and may also be a marketable commodity. Take the case
of cotton textile mill where the finished product (cloth) passes through
three distinct processes viz., spinning, weaving and finishing. The output
of spinning process is yarn, which is used as a raw material for the weaving
process and the output of weaving process (coarse cloth) is transferred to
finishing process. Yarn and coarse cloth can also be sold to other textile
mills which may not have adequate spinning or weaving facilities. In such
a situation, it becomes necessary to ascertain the cost at each stage. This
helps in comparing cost with the market price as well as in cost control. The
method employed for ascertaining the cost at each stage of production is
termed as ‘Process Costing’. It is used in case of chemicals, paints, textile
and food products.
Operating Costing: This method is used for ascertaining the cost of
operating a service such as bus, railways, water supply, nursing home, etc.
In such organisations, the unit of cost is a service unit e.g., in case of buses
the unit of cost is passenger kilometer, in case of nursing home it is per
bed per day. According to the latest Terminology, this is called ‘Service
Costing’.
Multiple Costing: Where a produce comprises many assembled parts (or
components) as in cases of motor car, typewriter, television, refrigerators,
etc., costs have to be ascertained for each component as well as for the
finished product. This may involve use of different methods of costing for
different components and so it is known as ‘multiple’ or ‘composite’ costing.
Uniform Costing : The practice of using a common method of costing by a
number of firms in the same industry is known as ‘Uniform Costing’. Thus, it
is not a separate method of costing. It simply refers to a common system
using agreed concepts, principles and standard accounting practices.
This helps in making inter-firm comparisons and fixation of prices.
It should be noted that the two basic methods of costing are: (1) Job
Costing, and (2) Process Costing. The other methods discussed above are

29

BCOC-138 (E).indd 29 17-02-2021 15:48:28

 Basic Concepts simply variants of these two methods.

2.10 TYPES OF COSTING

While method of costing refers to the process and practice of ascertaining
costs of products and services, the type of costing refers to the technique
of analysing and presenting costs for purposes of control and managerial
decisions. The types of costing (also known as techniques of costing)
generally used are as follows:
Marginal Costing: It refers to the technique of costing which emphasises
the distinction between fixed and variable costs and calculates the cost of
a job or a product without taking fixed costs into account, It allocates only
variable costs (direct materials, direct labour, other direct expenses and
variable overheads) to production and is also known as ‘Variable Costing.
Absorption Costing: It refers to the technique of costing under which
full costs are charged to production i.e., both fixed and variable costs are
included in the cost of products.
Historical Costing: It refers to a system of cost accounting under which
costs are ascertained only after they have been incurred. In other words, the
accounting is done in terms of actual costs and not in terms of predetermined
or standard costs. Most organisations follow this system of accounting for
costs.
Standard Costing: It refers to the system of cost accounting under which
costs are determined in advance on certain predetermined standards. These
are known as standard costs which indicate the level of costs that should
be attained under a given set of operating conditions. The standard costs
are compared periodically with the actual costs and underlying causes
for variances are analysed so that corrective action may be taken where
necessary.
Thus, having adopted a method of costing suited to the nature of activity in
which the undertaking is engaged, there is then a choice open with regard
to .the way in which the costing information is to be presented for control
purposes. Either ‘marginal costing’ or ‘absorption costing’ may be employed
and either ‘actual costs’ or ‘standard costs’ may be adopted to ascertain and
account for costs.

2.11 ROLE OF COST ACCOUNTANT

After having understanding on the concept, classification, elements, methods
and types of costing, it is important to know the responsibilities of a cost
accountant. The role of cost accountant is entirely different from financial
accountant.
The Cost Accountant is supposed to take essential steps for cost control,
cost reduction and cost management. He has to work out for determining
actual costs of manufacturing or providing service.
Cost accountant is basically responsible for the following three major
activities which include:
1. Supporting top management is cost related decisions by providing

30

BCOC-138 (E).indd 30 17-02-2021 15:48:28

 cost reports like cost of various products, Profitability, breakdown, Cost Concepts and Its
variance analysis etc. Ascertainment

2. Prepare and maintain cost records for legal compliance. Cost records
are different from financial accounts.
3. Performing cost control functions as directed by senior management.
On the basis of reports provided by cost accountant the management
would want the costing department to identify/implement various
corrective measures.
In order to perform the above responsibilities in a service organisation or
in a manufacturing concern, cost accountant has to play several prominent
roles as stated below:
●● Establishes a cost accounting department in his concern.
●● Ascertains the requirement of cost information which may be useful
to organizational managers at different levels of the hierarchy.
●● Develops a manual, which specifies the functions to be performed by
the cost accounting department. The manual also contains the format
of various forms which would be utilized by the concern for procuring
and providing information to the concerned officers. Usually, the
functions performed by a cost accounting department includes a) cost
ascertainment, b) cost comparison, c) cost reduction, d) cost control
and cost reporting.
a) Cost ascertainment, requires the classification of costs
into direct and indirect. Further it requires classification of
indirect costs (known as overheads) into factory overheads;
administration overheads and selling and distribution overheads.
b) Cost comparison is the task carried out by cost accountant
for controlling the cost of the products manufactured by the
concern. Cost accountant of the concern establishes standards
for all elements of cost and thus a standard cost of the finished
product. The standard cost so determined may be compared
with the actual cost to determine the variances. Cost accountant
ascertains the reasons for the occurrence of these variances for
taking suitable action.
c) Cost reduction is the activity of different cost analysis are
to be done by the cost accountant based on the situations for
taking decisions like make or buy, market manpower & install
infrastructure or outsourcing etc., and for reviewing the current
performance.
d) Cost control and cost reporting is required to be done by the
cost accountant in making alternative strategies for cost control
to maximum extent and preparation of cost reports. These
reports help the executives of a business concern in reviewing
their own performance and in identifying the weak areas, where
appropriate and most suitable control measures may taken in
future.
Check Your Progress D

31

BCOC-138 (E).indd 31 17-02-2021 15:48:28

 Basic Concepts 1) Explain the two basic methods and types of costing.
2) Which method of Costing would you recommend for the following
industries?
i) Ship-building ………………….
ii) Toy Making ………………….
iii) Oil Refinery ………………….
iv) Sugar ………………….
v) Brick Making ………………….
vi) Construction of Bridge ………………….
vii) Road Transport ………………….
viii) Furniture ………………….
3) List out the responsibilities of a Cost Accountant.

2.12 LET US SUM UP

Cost ascertainment is an important process of accounting. Cost means an
amount of expenditure (actual or notional) incurred or attributable to a
product, job, process, or service. Cost is a flexible concept. It may vary with
time, volume, firm, method or purpose. It should also be distinguished from
the term ‘loss’ which refers an expenditure incurred without deriving any
benefit therefrom.
Costs can be classified in various ways. On the basis of functions to which
they relate, costs are classified into manufacturing costs, administrative
costs, and selling and distribution costs. On the basis of their Identifiability
with products, costs can be classified into direct costs and indirect costs.
On the basis of their variability in relation to nature of output, costs can be
classified into fixed costs, variable costs and semi-variable (or semi-fixed)
costs.
The two concepts which serve as the basis for cost computation are: (i) cost
unit, and (ii) cost centre. Cost unit refers to that quantity of a product in terms
of which costs are ascertained e.g., per kilogram. per dozen, per piece, etc.
Cost centre refers to the division of organisation into convenient segments
with defined responsibilities to which initial allocation and apportionment
of various costs can be made and which can be used for the purpose of cost-
control. It can be a department, a person or an item of equipment.
There are three basic elements of cost: (i) materials, (ii) labour, and (iii)
expenses. They may be direct or indirect, Indirect costs including Indirect
materials, indirect labour and indirect expenses are known as ‘overheads’,
Overheads are usually classified into factory overheads, office overheads,
and selling and distribution overheads.
The main components of total cost are prime cost, works cost, cost of
production and cost of sales. These are actually the stages to determine the
total cost and facilitate controlThere are various method of costing. These
are: (i) job costing, (ii) contract costing, (iii) batch costing, (iv) unit costing.
(v) process costing, (vi) operating costing, (vii) multiple costing, and (viii)
uniform costing. Every organisation adopts the method which suits the

32

BCOC-138 (E).indd 32 17-02-2021 15:48:28

 nature of its products and the technique of production used. Cost Concepts and Its
Ascertainment
The role and responsibility of a cost accountant is different from a financial
accountant. His/Her role starts from establishment of a cost department to
preparation of costing reports to control the costs and effective utilization
of costs.

2.13 KEY WORDS

Conversion Cost: Cost of converting materials into finished products. It
includes direct labour, direct expenses and factory overheads.
Cost Centre: A convenient costing segment to which initial allocation and
apportionment of various expenses can be made.
Cost of Sales: Total cost of a product including selling and distribution
expenses.
Cost Unit: The quantity in terms of which the cost of a product is ascertained.
Prime Cost: Cost of direct expenses including those of materials and wages.
Semi-variable Cost: Expenses which change with changes in output, but not
in the same proportion.
Standard Cost: A predetermined cost based on a technical estimate
or material, labour and overheads for a selected period of time and for
prescribed set of working conditions.
Works Cost: Prime cost plus factory overheads.

2.14 ANSWERS TO CHECK YOUR PROGRESS

A) 5. (i) True (ii) False (iii) False (iv) True (v) False (vi) True
1. (i) e (ii) c (iii) b (iv) a (v) f (vi) g (vii) d
C) 4. (i) Direct Wages (ii) Factory Overheads (iii) Cost of Production
(iv) Factory Overheads, Office Overheads, Selling and Distribution
Overheads
D) 2. (i) Contract Costing (ii) Batch Costing (iii) Process Costing
(iv) Process Costing (v) Unit Costing (vi) Contract Costing
(vii) Operating Costing (viii) Job Costing

2.15 TERMINAL QUESTIONS

1) Define the term ‘Cost Centre’. Analyse the importance of selecting
suitable cost centres.
2) Why do we need to qualify ‘cost’? Discuss.
3) “Costs may be classified according to their nature and
characteristics.” Elaborate on this statement and clarify the meaning
of fixed, variable and semi-variable costs with examples.
4) What are the different methods of costing? State the industries to
which they can be applied.
5) State the main characteristics of the following methods of costing

33

BCOC-138 (E).indd 33 17-02-2021 15:48:28

 Basic Concepts and indicate in which industry each would be suitable
a) Process Costing; b) Job Costing; c) Output Costing.
6) The following figures relate to Rising Star Co.
Rs.
Wages 3,000
Factory Expenses 4,000
Office Expenses 5,000
Materials 6,000
Selling Expenses 3,000
Distribution Expenses 3,000
Sales 24,000
Output 2,000 units
Number of units sold 1,500 units
You are required to compute
a) Prime Cost; b) Works Cost; c) Office Cost (Cost of Production);
d) Total Cost; e) Cost per unit; f) Profit during the period; g) Profit
per unit.
Answer: a) Rs. 9,000; b) Rs. 13,000; c) Rs. 18,000;
d) Rs. 24,000; e) Rs. 12; f) Rs. 6,000; g) Rs. 3.
Note: These questions will help you to understand the unit better. Try to
write answers for them and verify with the content. But do not submit
your answers to the University. These are for your practice only.

SOME USEFUL BOOKS

Arora M.N. 2003. A Text Book of Cost Accountancy, Vikas Publishing
House Pvt. Ltd.: New Delhi. (Chapter 3-8).
Bhar, B.K. 2018. Cost Accounting: Methods and Problems, Academic
Publishers: Calcutta. (Chapter 5-9).
Iyenger, S.P., Cost Accounting, Sultan Chand and Sons.
Maheshwari, S.N. and SN. Mittal, 2018. Cost Accounting: Theory and
Problems, Shree Mahavir Book Depot: Delhi. (Chapter 2-3).
Nigam,B.M.L. and G.L. Sharma, 2018. Theory and Techniques of Cost
Accounting,
Himalaya Publishing House: Bombay. (Chapter 4-7).
Rajiv Goel, Cost Accounting, International Book House.

34

BCOC-138 (E).indd 34 17-02-2021 15:48:28