Concept of cost

the price paid for something The amount of expenditure incurred or attributable to a given thing (CIMA, UK) A measurement in monetary terms of the amount of resources used for the purpose of production of goods

Cost Accounting
Mr. Kohler: that branch of accounting dealing with the classification, recording, allocation, summarization and reporting of current and prospective costs. Mr. Wheldon: the classifying, recording and appropriate allocation of expenditure for the determination of the costs of products or services, the relation of these costs to sales values, and the ascertainment of profitability.

Cost Accountancy
Institute of Cost and Management Accountants(ICMA), London: the application of costing and cost accounting principles, methods and techniques to the science, art and practice of cost control and the ascertainment of profitability. It includes the presentation of information derived there from for the managerial decision-making. Scope of cost accountancy is broader and includes (1) Costing, (2) Cost Accounting, (3) Cost Control Techniques, (4) Budgeting and (5) Cost Audit.

Cost centre
Cost ascertainment is made by cost centers and cost units or by both. A cost centre is a production or service location (department/sales area), a function, an activity, a person (salesman/machine operator) or an item of equipment (machine/delivery van) or a group of these (two machines operated by one workman) for which costs are accumulated. A cost center refers to a section of the business to which costs can be charged.

Types of cost centre

Personal person/group of persons Impersonal: a) Production: where actual production takes place. Ex.melting shop/welding department. b) Service: where services are rendered to production cost centers (indirect costs). Ex. Power house, tool-room, stores department, canteen, etc.

Cost unit & Types

It is a unit of measurement of cost. a unit of product or service in relation to which costs are ascertained. Cost unit may be a) unit of production - Ex. A kg of chemical, a ream of paper, a tonne of steel, a meter of cable b) unit of service Ex.Room per day (hotel), hospital (bed per day),transport (passenger-km)

Cost classification
CIMA Terminology defines classification as the arrangement of items in logical groups by nature, purpose or responsibility.

Cost classification Nature

Direct costs costs identified conveniently with a particular cost unit/process/ department. Ex. Wages paid to a tailor in a readymade garment shop for stitching a shirt. Indirect costs general and are incurred for the benefit of a number of cost units. They cannot be identified conveniently with a particular cost unit/process/ department. Ex.depreciation of machine for stitching a particular shirt.

Cost classification

Behaviour

Fixed cost is a cost incurred for an accounting period, that, within certain output or turnover limits, tends to be unaffected by fluctuations in the levels of activity (output or turnover). Ex. Rent, salaries of managers. Variable cost is a cost that varies with a measure of activity or volume of output. Ex.Direct material/labour, commission to salesmen.

Contd..
Semi-variable cost: ,"A semi-variable cost is also referred to as a semi-fixed or mixed cost. It is a cost containing both fixed and variable components and thus partly affected by a change in the level of activity. Ex. Telephone expenses, electricity charges, depreciation, etc.

Cost classification Product Vs. Period

Product costs are those which are necessary for production and which will not be incurred if there is no production.Ex. Direct material/labour. Period costs are those which are not necessary for production and are written off as expenses in the period in which these are incurred and are charged to P&L account. Ex.Rent, salary of executives, other administration & selling expenses.

Cost classification Controllable vs. Uncontrollable

Controllable costs are the costs which may be directly regulated at a given level of management authority. Ex. Variable costs. Uncontrollable costs are the costs which cannot be influenced by the action of a specific member of an enterprise. Ex. Factory rent, management salaries. However, all costs are controllable in the long run.

Cost classification Historical vs. Predetermined

Historical: These are the past costs ascertained after these have been incurred. They are actual costs and are available only after the completion of manufacturing operations. Predetermined: Future costs ascertained in advance of production on the basis of a specification of all the factors affecting cost. They are extensively used for planning and control.

Cost classification Normal vs. Abnormal

Normal cost is the cost normally incurred on expected lines at a given level of output. It is treated as a part of production. a) Abnormal cost is the cost not normally incurred at a given level of output. b) It is over and above the normal cost and is treated as a part of production. c) It is charged to Profit & Loss account.

Special costs for management decision-making

Sunk cost expenditure made in the past that cannot be changed and management has no control. Differential cost Difference in total cost due to change in the level of activity or the method of production. If the change increases (or decreases)the cost, it is called incremental (or decremental)cost.

Contd..
Marginal cost is the additional cost of producing one additional unit. It is the total of variable cost only and fixed costs are ignored. This is useful in fixing the prices. Imputed/Hypothetical/Notional costs are those which do not involve any expenditure in the real sense. These are considered in cost accounts only. Ex. Rent of owned building for evaluating the profitability of a project. Opportunity cost is the sacrifice involved in accepting an alternative under consideration.

Contd..

Replacement cost is the cost at which there could be purchased an asset identical to that which is being replaced. It is the current market cost of replacing an asset. Out-of-pocket costs are those costs that involve cash outlays. Ex. Rent and wages. But, expenses like depreciation on plant & machinery are not out-of-pocket costs. Conversion cost is the total cost of converting a raw material into finished product. It includes direct labour, direct expenses and chargeable factory overheads.

Elements of cost Direct & Indirect

Direct costs Direct costs

Indirect costs Indirect costs

Direct material

Direct labour Direct expenses Indirect material

Indirect labour Indirect expenses

Material cost Direct Vs. Indirect

Direct Clay in bricks Leather in shoes Steel in machines Cloth in garments Timber in furniture Indirect Lubricating oil Sand paper Nuts & bolts Office stationery Small tools

Labour cost Direct Vs. Indirect

Direct Machine operator Shoe-maker Carpenter Weaver Tailor Indirect Supervisor Inspector Cleaner Clerk Peon Watchman

Expenses Direct Vs. Indirect

Direct Hire of special plant for a particular job Experimental costs Carriage paid for materials purchased for a specific job.
Indirect All indirect costs other than indirect materials and indirect labour costs. These cannot be conveniently identified with a particular job but are common to cost centers/cost units. Rent & Taxes,Depreciation, Advertising,Insurance and repairs.

Note:
Overheads = Indirect material + Indirect labour + Indirect expenses Overheads = Production overheads + Office & Administration overheads + Selling & Distribution overheads

Production (or Factory/ Manufacturing) overheads

Overheads concerned with the production function Coal,oil, grease, stationery in factory office, works managers salary, salary of factory office staff, factory rent, depreciation & repairs and maintenance of plant.

Office & Administration overheads

Indirect expenditure incurred in general administrative function and no direct connection with production/sales activities.

Stationery used in general administrative office, postage, salary of office staff, salary of managing director, rent of office building, legal expenses, office lighting & power and telephone expenses.

Selling & Distribution overheads

Selling overhead is the cost of promoting sales and retaining customers. Distribution cost includes all expenditure from the time the product is completed until it reaches its destination. Packing material, stationery used in sales office, cost of samples, oil and grease for delivery vans, advertising, travelling and showroom expenses and insurance of goods in transit.

Components of total cost

Prime cost = Direct material + Direct labour + Direct expenses Works/Factory cost = Prime cost + Factory overheads Cost of production = Works/Factory cost + Administration overheads Total cost or Cost of sales = Cost of production + Selling & Distribution overheads

Cost sheet / Cost statement

A statement prepared periodically, say, a month, year or a week to provide detailed cost of a cost center or cost unit. Both total cost and the components are shown.

Proforma of a Cost sheet

Cost sheet for the period..(production..units Particulars Total cost Rs. 1. Direct materials: Opening stock of raw materials Add: Purchases and carriage inwards Less: Closing stock of raw materials 2. Direct labour 3. Direct expenses A. Prime cost (1 + 2 + 3) xxx Add: Works/Factory overheads Add: Opening stock of Work-in-Progress (WIP) Less: Closing stock of Work-in-Progress (WIP) B. Works/Factory cost xxx Add: Office/Administration overheads C. Cost of production xxx Add: Selling and distribution expenses Add: Opening stock of finished goods Less: Closing stock of finished goods D. Total cost or Cost of sales xxx Cost Per unit Rs.

Items excluded from cost accounts

Pure financial expenses: Loss on investment Capital losses, Penalties/fines Interest on debentures/mortgage/bank loan Discount on debentures/bonds Damages payable

Contd..
Pure financial incomes Dividend/Brokerage, Commission or discount/ Rent received Interest on investment/bank deposits received Capital profits

Contd..
Appropriation of profit Transfer to general/specific reserve Taxes on income/profits Dividends paid Donations/charities Amount written off like goodwill, preliminary expenses, underwriting commission, discount on issues of shares/debentures

Contd..
Abnormal losses/expenses Cost of abnormal wastage of material Loss by fire/theft