UNIT 3

Cost Sheet: A cost sheet is a statement which represents the various costs incurred
at different stages of business operations, in a tabular format. It determines the total
cost or expenditure made by the organization, along with the cost incurred on each
unit of a product or service in a particular [Link] cost sheet of a business
organization provides an insight into its performance and efficiency. It helps in
competitive analysis and improvement of the business operations through cost
reduction.

Components of Cost

Prime Cost

The initial cost made for manufacturing a product, i.e., raw material, labour wages
and other production-related expenses, is termed as prime cost.
Following is the equation for computing the prime cost:

Where direct material is calculated with the help of the following formula:

Works Cost or Factory Cost

The works cost is calculated by summing up the prime cost with the factory
overheads and simultaneously adjusting the opening and closing stocks of work in
progress. It can be denoted as

The various indirect overheads incurred at the factory premises can be computed
with the help of the following formula:

Let us now go through each of the indirect overheads in detail below:

Indirect Material

The indirect material includes all the additional items used for manufacturing
products, but not directly contribute as a raw material for the finished goods. It can
be anything like the oil, fuel, coal, stationery items and other factory utilities.

Also, the items which are though directly used for making a product, but are
inexpensive and small, are considered as indirect material. These include thread,
pins, cello tape, nails, nuts, etc.

Indirect Labour

The labour or human resource engaged in all the activities other than
manufacturing of goods or services which are essential to carry out the business
and assist the production operations is called indirect labour.

It includes salary paid to managers, cleaning staff, security staff, drivers, etc.
Indirect Expenses

All the other overheads which are neither directly contributing to the production
operations, nor they can be termed as labour or material expense, are called
indirect expenses.

These are the expenses made for running the business operations smoothly. These
include advertisements, depreciation, rent, electricity, insurance, taxes, repairs and
maintenance, etc.

Cost of Production

The cost of production includes all the direct and indirect cost, including the
material, labour and other expenses, i.e., production cost, factory cost and office or
administration cost.

The following formula denotes the computation of cost of production:

After making an adjustment of the opening finished goods and the closing finished
goods to the cost of production, we acquire the cost of production of goods sold.

Further, to calculate the cost of production of goods sold, the opening and closing
stocks of finished products are adjusted with the cost of production. Its formula is:

Total Cost

The final value of a product or service can be determined after adding all the
selling and distribution expenses to the cost of production of goods sold. The
formula to find out the total cost or cost of sales is:

If the sales price of the products or service is known, the following method can be
used to determine the profit:
Cost Sheet Format

The companies which have their production or manufacturing units along with
office premises and also carry out sales and distribution of goods require a
systematic cost accounting procedure to determine the cost, profit and sales price.

Given below is a proforma of a cost sheet to provide you with a complete

understanding of cost accounting in business organizations:
Classification of Cost:

On the Basis of Time

 Historical Cost: refers to the original cost of an asset or liability when
acquired or incurred. Companies often use historical costs in accounting to
value assets and liabilities on a company’s balance sheet. This means we
record assets or liabilities at their original cost rather than their current
market value or replacement cost.
 Predetermined Cost
A predetermined cost is a budgeted or estimated cost established before producing
or purchasing goods or services. Companies typically use it in cost accounting
and managerial accounting to help them plan and control costs.
 Estimated Cost
Estimated cost refers to calculating or projecting the expected cost of a project,
product, or service. It is typically used in project management, construction,
manufacturing, and other industries where cost estimation is an important part of
planning and budgeting.
 Standard Cost
Standard cost refers to a predetermined cost established as a benchmark for
measuring actual costs in a manufacturing or production process. It is used in cost
accounting to help companies plan and control costs and identify areas for cost
savings.

On the Basis of Elements

 Direct Material
Cost of materials refers to the raw materials and components used to produce a
product or service. This includes the cost of any materials that companies purchase
from suppliers, as well as the cost of any materials that they produce or process in-
house.
 Direct Labour
Labour costs refer to wages, salaries, benefits, and other expenses associated with
the labour required to produce a product or service. This includes the cost of all
employees involved in the production process, such as direct labourers,
supervisors, and support staff.
 Direct Expenses
Expenses refer to the costs incurred by a business or individual to generate revenue
or achieve a particular objective. They are typically classified into two main
categories: operating and non-operating expenses.
On the Basis of Function
 Cost of Production
The cost of production refers to the total expense incurred by a business in creating
and selling its products or services. These expenses may include costs associated
with raw materials, labour, equipment, rent, utilities, marketing, and other
overhead expenses.
 Cost of Marketing
Marketing costs refer to the expenses incurred by a business or organization to
promote its products, services, or brand to potential customers or clients. These
costs can include advertising fees, promotional materials, public relations
expenses, and salaries or fees for marketing personnel.
 Cost of Selling
The cost of selling refers to the expenses incurred by a business or organization to
sell its products or services to customers. These costs can include salaries or
commissions for sales personnel, advertising and marketing expenses, travel and
entertainment costs associated with sales efforts, and any fees associated with
payment processing or shipping.
On the Basis of Traceability
 Direct Cost
Direct costs are expenses companies can directly attribute to producing a specific
product or service. These costs are typically associated with the materials, labour,
and equipment needed to create the product or service. Direct costs include:
 Raw materials.
 Wages for manufacturing personnel.
 The cost of equipment and machinery used in the production process.
 Indirect Cost
Indirect costs are expenses not directly related to the production of a specific
product or service but necessary for the business to operate. We typically associate
these costs with overhead and administrative expenses such as rent, utilities, and
office supplies. However, indirect costs can also include salaries for non-
production personnel such as management, marketing, and accounting staff.
 On the Basis of nature of behaviour
 Fixed Cost
Fixed costs remain constant regardless of the activity level or volume. These costs
only change slowly, even if production increases or decreases. Examples of fixed
costs include rent, property taxes, and salaries for non-production personnel.
 Variable Cost
Variable Costs: Variable costs are expenses that fluctuate based on activity level or
volume. They increase or decrease as production levels change. Examples of
variable costs include raw materials, direct labour, and sales commissions.
 Semi-Variable Cost
Semi-variable costs, also known as semi-fixed costs, are expenses that have both
fixed and variable components. These costs may have a fixed portion that remains
constant regardless of activity or volume and a variable portion that fluctuates
based on production levels. Semivariable costs include utilities, maintenance, and
some types of labour.
On the Basis of Normality
 Normal Cost
Normal costs are expenses typically incurred during the normal course of business
operations. These costs are considered predictable and expected and are included
in the cost of goods sold or operating expenses. Examples of normal costs include
raw materials, direct labour, and utilities.
 Abnormal Cost
Abnormal costs, also known as extraordinary costs, are not considered part of
normal business operations. These costs are unexpected and typically result from
unforeseen events or circumstances. Examples of abnormal costs include repairs
due to natural disasters, legal settlements, and expenses related to a sudden drop in
demand for a product or service.
Based on Analytical and Decision Making Purpose
 Opportunity Cost
Opportunity cost refers to the value of the best alternative forgone when deciding.
In other words, it’s the cost of the missed opportunity. Whenever a decision is
made, there are always choices that are not pursued. The opportunity cost is the
value of the benefits that would have been gained from the next best alternative
that was not chosen.
For example, a person has Rs. 10,000 to spend and is trying to decide whether to
buy a new jacket or go to dinner. If they choose to buy the coat, the opportunity
cost is the dinner value they didn’t go to. If they decide to go out to dinner, the
opportunity cost is the value of the jacket that they didn’t buy.
 Joint Cost
Joint cost is a type of cost that arises when a single production process generates
multiple products or outputs simultaneously. These products cannot be easily
separated or identified as individual products until a certain point in production.
Joint costs are incurred up to that point and allocated to the different products
based on some agreed-upon cost allocation method.
An example of joint cost can be seen in oil and gas production. When oil is
extracted from a well, it often comes out along with natural gas. Extracting oil and
gas incurs joint costs, such as drilling the well and operating the extraction
equipment. These joint costs must be allocated to the different products to
determine their costs and profitability.
 Sunk Cost
Sunk cost refers to a cost that has already been incurred and cannot be recovered or
changed, regardless of any future actions taken. In other words, it’s a cost that has
been spent and cannot be reversed.
An example of a sunk cost is a non-refundable airline ticket. Once the ticket has
been purchased, the cost is sunk and cannot be recovered, even if the traveller
decides not to use it.
 Differential Cost
Differential cost, also known as incremental cost, refers to the difference in cost
between two alternatives. In other words, it’s the additional cost incurred or saved
by choosing one option over another.
Differential cost can be calculated by subtracting one option’s cost from another’s.
For example, if a business decides whether to produce a product in-house or
outsource production to a third-party manufacturer, the differential cost would be
the difference in cost between producing the product in-house and outsourcing
production.
 Imputed Cost
Imputed cost refers to a cost that is not incurred but is assigned to a particular
activity or product to reflect its true economic cost. These costs are often used in
cost accounting to provide a more accurate picture of the true costs of an activity or
product.
An example of the imputed cost would be using a company-owned building or
equipment for a particular activity or project. While the company may not incur
any actual expenses for using the building or equipment, an imputed cost would be
assigned to the activity or project to reflect the true economic cost of using those
resources.
 Marginal Cost
Marginal cost is an important concept in economics and business, as it helps firms
determine the most efficient production level. Businesses can determine whether
producing additional output units is profitable by comparing the marginal cost to
marginal revenue. Suppose the marginal revenue generated by producing an
additional unit exceeds the marginal cost. In that case, the firm should continue to
produce more units until marginal revenue equals marginal cost.
 Replacement Cost
Replacement cost replaces an asset or item with a new or similar item of equal
value. It is the cost that would be incurred to replace an asset at its current market
value rather than the historical or original cost of the asset.
For example, if a business’s computer equipment is destroyed in a fire, the
replacement cost would be the amount of money needed to purchase new
equipment of the same or similar specifications rather than the cost of the original
equipment when it was purchased.
 Out-of-Pocket Cost
Out-of-pocket costs refer to expenses that an individual or business incurs for
goods or services not covered by insurance or other reimbursement forms. These
costs are paid directly by the individual or business and are not reimbursed by a
third party.
Examples of out-of-pocket costs may include deductibles, copayments,
coinsurance, and expenses for services not covered by insurance, such as elective
medical procedures. Out-of-pocket costs may include travel, lodging, and other
incidental expenses associated with medical care or other services.