Basics of Cost

Accounting
 What is Cost?
• Cost may be defined as resources sacrificed to achieve
a specific objective.
• Cost is generally measured in monetary terms.
• Cost refers to expenses incurred for the various inputs
in the process of producing a product or delivering a
service.
• The Chartered Institute of Management Accountants
defines cost as “The amount of expenditure (actual or
notional) incurred or attributable to a specified thing or
activity”.
 Classification of Cost
By Nature or
By Element By Functions
variability

By As per
controllabilit By time planning &
y control

For
Direct &
Managerial
Indirect cost
decisions
By Nature or variability

Fixed

Cost Variable

Semi-variable
By Element

Material
Labour
Expenses
Direct & Indirect Costs
• Directly related to the
Direct manufacturing of a
Cost product or service

• Not related to the

Indirect manufacturing of a
Costs product or service
 By Functions

O Production cost
O Administrative cost
O Selling & Distribution cost etc
 By controllability

Controllable •All variable

cost
costs

Uncontrollable
cost •All fixed costs
By time

Cost
Historical

Pre-determi
ned
As per planning & control

Standard Budgetary
cost control
For Managerial decisions

Sunk Cost

Marginal cost
 Costing, cost accounting,
cost accountancy
• Costing : It is a technique and process of
ascertaining cost.
• Cost Accounting : It is regarded as a specialized
branch of accounting which involves
classification, accumulation, assignment and
control of cost.
• Cost Accountancy : It has been defined as the
application of costing and cost accounting
principle, methods and techniques to the science
art and practice of cost control and the
ascertainment of profitability.
Importance of cost accounting
Aid to
management

Aid to
Aid to
National Cost accounting Creditors
Economy

Aid to
Employees
 Objectives of cost accounting
• To analyse cost and all expenditure.
• To arrive at the cost of production.
• To indicate to the management any inefficiencies and
waste.
• To provide data for periodical profit and loss accounts.
• To reveal sources of economies in production.
• To provide actual figures of Cost for comparison with
estimates.
• To show where standard costs are prepared
• To present comparative cost data for different periods
 Differences between Financial & Cost Accounting
Cost Accounting
Financial Accounting
1. It aims at finding out results 1. It aims at computing cost of
of accounting year in the production /service in a
form of Profit and Loss scientific manner and then
Account and Balance Sheet. cost control and cost
2. It is more attached with reduction.
reporting the results and 2. 2. It is an internal reporting
position of business to system for an organization’s
persons and authorities own management for
other than management like
decision making.
government, creditors,
investors, owners etc. 3. It not only deals with
3. Financial Accounting data historical data but is also
is historical in nature. futuristic in approach.
Financial Accounting Cost Accounting
4. In cost accounting, classifi
4. In financial accounting, the
cation is basically on the basis of
major emphasis is in cost
functions, activities, products,
classification based on type of
process and on internal planning
transactions, e.g. salaries,
and control and information
repairs, insurance, stores etc.
needs of the organization.
5. In financial accounting, only
5. Cost accounting uses both
those transactions are recorded
monetary as well as quantitative
which can be expressed in
information.
monetary terms.
6. It aims at computing ‘true and
6. It aims at presenting ‘true and
fair’ view of the cost of
fair’ view of the profit and loss
production/services offered by
position as well as financial
the firm.
position.
7. Cost accounts are subject to cost
7. Financial Accounts are subject
audit which verifies whether the
to statutory audit to verify
cost accounts disclose true and
whether they disclose a true
fair view of the cost of
and fair view of the profit and
production of the company.
loss as well as financial
position
 Cost Unit
While preparing cost accounts, it becomes necessary
to select a unit with which the consumption of
resources may be identified.

The quantity upon which cost can be conveniently

allocated is known as a unit of cost or cost unit.

The Chartered Institute of Management Accountants,

London defines a unit of cost as a unit of quantity of
product, service or time in relation to which costs may
be ascertained or expressed.

Unit selected should be unambiguous, simple and

commonly used.
Following are the examples of units of
cost:
(i) Brick works - per 1000 bricks made
(ii) Collieries - per ton of coal raised
(iii) Textile mills - per yard of cloth manufactured or
per MT of yarn spun
(iv) Electrical companies - per unit of electricity
generated
(v) Transport companies - per passenger/ km.
(vi) Steel mills - per ton of steel made

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 Cost Center
According to the Chartered Institute of Management
Accountants, London, cost center means a location, person or
item of equipment (or group of these) for which costs may be
ascertained and used for the purpose of cost control.

❑ Cost center refers to one of the convenient units into which

the whole factory or an organization has been appropriately
divided for costing purposes.

❑ Each such unit consists of a department, a sub-department

or an item or equipment or machinery and a person or a
group of persons.

❑ Sometimes, closely associated departments are combined

together and considered as one unit for costing purposes. For
example, in a laundry, activities such as collecting, sorting,
marking and washing of clothes are performed.
 Cost centers may be classified as follows:
❑ Productive cost centers are those which are actually engaged
in making products.

❑ Service or unproductive cost centers do not make the

products but act as the essential aids for the productive
centers. The examples of such service centers are as follows:
· Administration department
· Repairs and maintenance department
· Stores and drawing office department

❑ Mixed costs centers are those which are engaged sometimes

on productive and other times on service works. For example,
a tool shop serves as a productive cost center when it
manufactures dies and jigs to be charged to specific jobs or
orders but serves as servicing cost center when it does repairs
for the factory equipments.
 Cost Engineering

Cost Engineering is a collection of the

following activities:

❑ Business and program planning;

❑ Cost estimating;
❑ Economic and financial analysis;
❑ Program and project management;
❑ Planning and scheduling;

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Cost driver
A Cost Driver is any element
that would cause a change in
the cost of an activity.

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 COST
ACCOUNTING

COST COST
MANAGEMENT REDUCTION

COST
CONTROL

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 Cost Control vs Cost Reduction
Cost Control:

❑ It is a technique which provides necessary information

to the management about whether actual costs are
aligned with the budgeted costs or not;

❑ Cost control focuses on the minimization of wastage

than the reduction of cost;

❑ Cost control is routinely applied on a continuous basis;

❑ Cost control heavily relies on accounting techniques;

 Cost Reduction:

❑ It is a technique used to save the unit cost of

the product without compromising its quality.

❑ It focuses on minimization of cost through

new production process, improved plant
layout, scientific material handling etc.

❑ It is applied when an opportunity for cost

reduction is identified which offers a
competitive advantage for a longer time.

❑ It may not involve the use of accounting

technique.
Basis for Comparison Cost Control Cost Reduction

A technique used to
A technique used for economize the unit cost
Meaning maintaining the costs without lowering the
as per the set standards. quality of the product

Cost Per Unit

Savings in Total Cost

Guaranteed
Retention of Quality Not Guaranteed

Permanent
Nature Temporary

Present and Future Cost

Emphasis on Past and Present Cost

The pre-determined
Ends when target is achieved. No end

Type of Function Preventive Corrective