1

Cost Accounting
2
Definition

Chartered Institute Of Management
Accountants ( CIMA London )

Costing is the technique and process of
ascertaining cost


3
Cost Accounting
Cost accounting measures and reports information
relating to the cost of acquiring and utilizing
resources
Cost accounting provides information for
management and financial accounting

Cost management describes the approaches and
activities of managers in short-run and long-run
planning and control decisions
These decisions increase value of customers and
lower costs of products and services
Cost management is an integral part of a companys
strategy
4
Cost Accounting
It provides information for both management
accounting and financial accounting.
It measures and reports from financial
and non financial data.
5
Financial Accounting
Financial accounting measures and records business
transactions and provides financial statements that
are based on generally accepted accounting
principles (GAAP)
Managers are responsible for the financial statements
issued to investors, government regulators, and other
parties outside the organization
Financial accounting focuses on external parties
Financial accounting reports on what happened in the
past
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An Introduction to Cost Terms
7
Costs and Cost Objects
Cost
a resource sacrificed or foregone to achieve a specific
objective

Cost Object
any product, machine, service or process for which
cost information is accumulated
cost objects can vary in size from an entire company,
to a division or program within the company, or down
to a single product or service
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Direct and Indirect Costs
Direct Cost
a cost which is related to a particular cost objective
and can be traced to it in an economically feasible way
Indirect Cost
a cost which is related a particular cost objective but
cannot be traced to it in an economically feasible way
indirect costs are allocated to cost objectives
Direct
Cost
Indirect
Cost

Cost
Object

Trace
Allocate
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Cost Drivers and Cost Management
Cost driver (cost generator or cost determinant)
a factor which causes the amount of cost incurred to
change
production costs are driven by the number of
products produced, labour costs, number of setups
required, and the number of change orders
Cost Reduction Programs focus on two things:
1. Doing only value-added activities
2. Efficiently manage the use of cost drivers in those
value-added activities
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Variable and Fixed Costs
Variable Cost
a cost which is constant per unit
but changes in total in proportion
to changes in the output
materials (parts), fuel costs for a
trucking company
R
s
Volume
R
s
Volume
Fixed Cost
a cost which does not change in
total as volume changes but
changes on a per-unit basis as the
cost driver increases and decreases
amortization, insurance
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Total Costs and Unit Costs
Unit Cost (or Average Cost)
Total cost / some number of units
Average cost
= Total manufacturing costs / Number of units produced
= Rs980,000 / 10,000
= Rs98 per unit
Unit or average costs must be interpreted with caution
As volume increases, the unit or average cost falls as
the fixed costs are spread over a larger number of
units
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Types of Inventory

Direct material inventory (stock awaiting use in the
manufacturing process)

Work-in process inventory (partially completed goods
on the shop floor)

Finished goods inventory (goods completed but not
yet sold)
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Period and Product Costs
Period Costs
are expensed on the income statement as they are
incurred
also called operating costs (excluding cost of goods
sold)
examples: selling, general and administrative costs

Product Costs
are inventoried on the balance sheet and expensed
only when the product or service is sold
also called inventoriable costs
Examples: materials and labour (manufacturing)
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Costing System Terminology
Cost Object
anything for which a separate measurement of costs
is desired

Cost Pool
a grouping of individual cost items

Cost Allocation Base
a factor that is the common denominator for
systematically linking an indirect cost or group of
indirect costs to a cost object
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Alternative Classifications of Costs
1. Business function
a. R&D
b. Design
c. Production
d. Marketing
e. Distribution
f. Customer service

2. Assignment to a cost
object
a. Direct costs
b. Indirect costs
3. Behaviour pattern
a. Variable costs
b. Fixed costs

4. Aggregate or average
a. Total costs
b. Unit costs

5. Assets or expenses
a. Inventoriable costs
b. Period costs
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Costs in a Manufacturing Company
Inventoriable
(Product)
Costs
Direct
Material
Purchases
Work in
Process
Inventory
Cost of Goods Sold
Revenue
Gross Margin
Marketing and
Administrative Costs
Operating Income
Period
Costs
Income
Statement
Balance Sheet
Materials
Inventory
Direct
Labour

Indirect
Manufacturing
Costs
Finished
Goods
Inventory
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Costing Systems
Job-Costing
System
Costs are assigned to a
distinct unit or batch
Resources are
expended to bring a
distinct product or
service to market for a
specific customer
advertising campaign,
audit, aircraft assembly
Process-Costing
System
Costs are assigned to
a mass of similar units
Resources are used to
mass-produce a
product or service and
not for any specific
customer
Postal delivery, oil
refining
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Job Costing Approach
1. Identify the cost object(s)
2. Identify the direct costs for the cost object(s)
3. Select cost-allocation bases to use in allocating the
indirect costs to the cost object(s)
4. Identify the indirect costs associated with each
cost-allocation base
5. Compute the rate per unit of each cost-allocation
base to allocate indirect costs to the cost object(s)
6. Compute the indirect costs allocated to the cost
object(s)
7. Determine the cost of the cost object(s) by adding
the direct and indirect costs
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Job Costing Overview
Indirect
Cost Pool
Manufacturing Overhead
Rs1,215,000
Rs45 per direct
Manufacturing Labour Hours

Cost Object:
Direct + Indirect Costs
Direct Material
Direct Labour
Cost
Allocation Base
27,000 Direct Manufacturing
Labour-Hours
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Job Costing System in Manufacturing
Cost of
Goods Sold
Finished Goods
Inventory
Work-In-Process
Inventory
Materials
Inventory
Buy
Materials
Use
Materials
Incur Labour
Costs
Incur Overhead
Costs
Complete
Production
Sell
Goods
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Cost Sheet
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Cost Sheet
It is a statement designed to show the output of a
particular accounting period along with
breakup of cost.
It is a memorandum statement
It does not form part of double entry cost
accounting records.
It discloses the total cost and cost per unit.
It helps
To fix Selling Price.
To submit quotation price.
To Control cost.
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COST SHEET

Total Cost Cost Per unit
Direct Materials
Direct Labour
Prime Cost
Add: Works Overheads
Works Cost
Add: Administration overheads
Cost of Production
Add: Selling & Distribution Overheads
Total Cost or Cost of Sales
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Elements of Cost

Direct Material :-
Identify in the product
Easily measure & directly charge to the product
e.g. Timber in furniture making
Categories
raw material
Specifically purchased for specific job or process
Parts or components purchased.
e.g. tyres for cycles
Primary Packing material
to protect finished product
for easy handling inside the factory.

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Direct Labour :-
Labour engaged in
converting raw material into finished goods
Altering the construction
Actual Production
Composition of Product
i.e labour which can be attributed to a particular job,product
or process
Exception :- Where the cost is not significant like
wages of trainees- their labour though directly
spent on product is not treated as direct Labour
Test:-
Easily Identify
Feasible to Identify
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Overheads :- It may be defined as the aggregate of the cost of
indirect materials, indirect labour and such other expenses
including services as cant conveniently be charged direct
to specific cost unit.
Categories:-
Manufacturing Overheads
Administration of machines
Selling & distribution of machines
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Standard Costing
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Why is Standard Costing Used?
A standard is a preestablished
benchmark for desirable performance.
A standard cost system is one in which a
company sets cost standards and then
uses them to evaluate actual performance.
A variance is the difference between
actual performance and the standard.
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Favorable versus Unfavorable
An unfavorable variance occurs when actual
performance falls below the standard.
A standard is a preestablished
benchmark for desirable performance.
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. Standard cost is the Predetermined cost
based on a technical estimate for material, labor and
overhead for a selected period of time
and for a specified set of working conditions.


Standard costing is the preparation of standard cost and
applying them to measure the variations from actual
costs and analyzing the causes of variations with a view
to maintain maximum efficiency in production

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Quantity and Price Standards
Quantity used
Price paid
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Ideal versus Practical Standards
A standard that allows for the normal
inefficiencies of production is
called a practical standard.
A standard that allows for no inefficiencies
of any kind is an ideal standard.
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The Standard Costing Process
Gather information
and set standards.
Compare actual
performance to
standard and prepare
performance reports.
Determine which
variances to investigate.
Investigate the
cause of variances.
Take corrective action.
Determine if
corrective action
is needed.
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Problems With Standard Costing
Employees may try to set low standards
to make them easier to achieve.
Using historical data to set standards
may build in past inefficiencies.
Managers might focus on the
numbers to the exclusion
of other important factors.
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Problems With Standard Costing
Focus on unfavorable variances
may result in ignoring the
favorable variances.
Managers may lose
sight of the big picture.
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Comparison of Cost Systems
Cost
Classification
Actual
Cost
System
Normal
Cost
System
Standard
Cost
System
Direct
Material
Direct
Labor
Manufacturing
Overhead
Actual
Actual
Actual
Actual
Actual
Estimated
Estimated
Estimated
Estimated
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Analysis of variance
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Analysis of Variance may be done in
respect of each element of cost and sales:
1.Direct Material Variance
2.Direct Labor Variance
3.Overhead Variance
4.Sales Variance
Analysis of Variance
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Material Variances
(Standard Price x Standard Rate)
- ( Actual quantity x Actual Rate )
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Direct Materials Variances
There are two variances calculated
for material cost variance.
The material quantity variance
(also called the usage variance) is a
measure of the amount of materials used.
The material price variance
is a measure of the cost to buy the
various materials that were purchased.
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Material Variances
( Standard material price
Actual material price)
Actual material quantity
( Standard material quantity
Actual material quantity)
Standard unit price
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Direct Materials Variances
Again Material Qt variances can be
divided into two varainces
The material mix variance
.
The material Yield variance
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Material Mix Variances
Standard Cost of Standard Mix
Standard Cost of Actual Mix
Std. Unit cost (SQ AQ)
Actual weight do not differ
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Material Mix Variances
Actual weight differ
Total wt. Of actual mix X Std. Cost - Std. Cost
Total wt. Of standard of Std. Mix of actual mix
mix

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Material Variances
Standard Rate (Actual Yield
Standard Yield )
{If std. & actual mix are same}
Standard Rate = Std. Cost of Std. Mix
Net Std. Output
(Gross output Standard loss)
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Material yield Variances
{Standard Rate (Actual Yield
Revised Standard Yield )
If std. & actual mix are not same}
Standard Rate = Std. Cost of Revised Std. Mix
Net Std. Output
(Gross output Standard loss)
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Labor Variances
The labor cost variance is the
difference between actual cost of hour
worked and the standard cost allowed.
The labor rate variance is the
difference between the actual direct
labor cost incurred and the standard
cost for the actual hours worked.
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St. Cost of labor Actual cost of labor

Rate variance =Actual Time
Taken (Standard Rate
Actual Rate)
Labor Cost Variance
Labor Rate Variance
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Standard Rate (Standard time for actual
Output - Actual time Paid for)

Total Labor Efficiency Variance
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Labor Variances
Total Labor efficiency variance are of two types
Labor Efficiency Variance
Labor Idle Time variance
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Labor Variances
Labor Efficiency Variance
Labor Efficiency Variance = Standard rate(Standard time
for actual output - Actual time worked)
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Labor Variances
Labor Idle Time variance = Abnormal Idle Time x
Standard Rate
Labor Idle Time variance
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St. Cost of St Composition
(Actual time taken) Standard cost of actual
Composition ( Actual time worked)

Labor Mix Variance
Labor Variances
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Standard Rate
(Actual Yield Revised
Standard Yield)
Labor Yield Variance
Labor Variances
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Overhead cost variance can be
defined as the difference between
the Standard cost allowed for the
actual output achieved and the
actual overhead cost incurred.
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Overhead :- According to terminology of
cost Accountancy (ICWA London)
Overhead is defined as The aggregate of
indirect material cost, indirect wages
(indirect Labor Cost) and indirect
expenses.

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Overhead Costs
Overhead costs are significant for most
organizations
Variable Overhead
Recall that variable overhead is allocated to
products and services using a budgeted variable
overhead rate
Fixed Overhead
Recall that fixed overhead is allocated to products
and services using a budgeted fixed overhead rate
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Overhead Cost Variances
Variable Overhead
Fixed Overhead
How the
Cost is
Planned
and
Controlled
How Costs
are
Allocated
to
Products
Rs
Volume
Rs
Volume
Rs
Volume
Rs
Volume
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Overhead cost Variance:-




Overhead Cost Variance

Variable overhead variance Fixed overhead
variance


Expenditure Efficiency Expenditure Volume
variance variance variance variance



Capacity Calendar Efficiency
variance variance variance

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Overhead Cost Variance :-


Overhead Cost Variance

( Actual output x Standard overhead Rate per unit )
Actual overhead cost
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Overhead Cost Variances
Overhead Cost variances can be
divided into two varainces

1. Variable Overhead variance

.
2. Fixed Overhead variance

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Variable Overhead Variance

1. Variable Overhead variance

(Actual output x Standard variable overhead rate)
(Actual variable overheads)

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Variable Overhead Variances
Variable Overhead variances can be
divided into two variances

1. Variable Overhead Expenditure variance

.
2. Variable Overhead Efficiency variance


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(A) Variable overhead (spending) expenditure
variance
= (Actual hours worked x standard variable
overhead rate) Actual variable overheads

(B) Variable overhead efficiency variance
= Standard variable overhead rate(standard
Hours for Actual output Actual Hours)


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2. Fixed overhead variance

Fixed overhead variance
(Actual output x standard fixed overhead rate)
Actual fixed overheads

Fixed overhead variance can be categorized into:-

a) Expenditure variance = Budgeted Fixed overheads
Actual fixed overheads

b) Volume variance = actual output x Standard rate
Budgeted fixed overheads
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b) Capacity variance= standard rate( Revised
Budgeted units Budgeted units)

c) Calendar variance
= (Decrease or increase in number of units
produced due to the difference of budgeted and
actual days x standard rate per unit)

e) Efficiency Variance = Standard Rate (Actual
Production Standard Production)

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Using Standard Cost Variances
A performance report should be prepared
on a periodic basis for the managers
who are responsible for the
standard cost variances.
The management by exception concept
would then be used by the managers
to focus their attention on the most
significant cost variances.
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Marginal Costing

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Marginal Costing:-

Chartered Institute of Management Accountant,
England-

Marginal costing is the ascertainment of
marginal cost and of the effect on profit of
changes in volume or type of output by
differentiating between fixed cost and variable
costs.
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Features of Marginal Costing:

Cost is classified into :
Fixed Cost
Variable Cost
Variable cost is only charged to production
Fixed cost is recovered from contribution
Valuation of stock of WIP and F.G. is done on the basis
of marginal cost.
Selling price is based on marginal cost and contribution
It is technique used to ascertain the marginal cost & to
know the impact of V.C. on volume of output
Profit is calculated by deducting marginal cost and
fixed cost from sales
C-V-P analysis is one of integral part of marginal costing

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Costs
Fixed (Indirect/Overheads) are not influenced by the
quantity produced but can change in the long run e.g.,
insurance costs, administration, rent, some types of
labour costs (salaries), some types of energy costs,
equipment and machinery, buildings, advertising and
promotion costs.
Variable (Direct) vary directly with the quantity
produced, e.g., raw material costs, some direct labour
costs, some direct energy costs.
Semi-fixed Where costs not directly attributable to
either of the above, for example some types of energy
and labour costs.
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Costs
Total Costs (TC) = Fixed Costs (FC)+ Variable
Costs (VC)

Average Costs = TC/Output (Q)
AC (unit costs) show the amount it costs to produce
one unit of output on average

Marginal Costs (MC) the cost of producing one
extra or one fewer units of production
MC = TC
n
TC
n-1

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Revenue
Total Revenue also known as turnover,
sales revenue or sales = Price x
Quantity Sold
TR = P x Q
Price may be a variety of different
prices for different products in the
portfolio
Quantity Units sold
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Profit
Profit = TR TC
Normal Profit the minimum amount
required to keep a business in a
particular line of production
Abnormal/Supernormal Profit the amount
over and above the amount needed to
keep a business in its current line of
production

75
Marginal Cost Equation

Sales = Variable Cost + Fixed Cost + Profit/Loss

Sales - Variable Cost = Fixed Cost + Profit/Loss

Sales - Variable Cost = Contribution

Therefore,
Contribution = S.P. V.C. or
Contribution = Fixed Cost + Profit

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Cost-Volume-Profit
(CVP) Analysis
77
Cost volume Profit Analysis

Cost volume Profit Analysis is a logical
extension of marginal costing
C.V.P. analysis examines the relationship
of cost & profit to the volume of business
to maximize profits
Indicates direct relationship between
volume & profit
Indicates Indirect relationship between
volume & cost per unit (Inverse)


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Cost-Volume-Profit Assumptions
and Terminology
1. Changes in the level of revenues and costs arise
only because of changes in the number of product
(or service) units produced and sold.
2. Total costs can be divided into a fixed component
and a component that is variable with respect to
the level of output.
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Cost-Volume-Profit Assumptions
and Terminology
3. When graphed, the behavior of total revenues
and total costs is linear (straight-line) in relation
to output units within the relevant range
(and time period).
4. The unit selling price, unit variable costs, and
fixed costs are known and constant.
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Abbreviations
SP = Selling price
VCU = Variable cost per unit
CMU = Contribution margin per unit
CM% = Contribution margin percentage
FC = Fixed costs
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Abbreviations
Q = Quantity of output units sold
(and manufactured)
OI = Operating income
TOI = Target operating income
TNI = Target net income
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Breakeven Point
Sales
Variable
expenses
Fixed
expenses

=
Total revenues = Total costs
83
Break Even

Point of No Profit and No Loss

Occurs where Total Costs = Total Revenue

Fixed Costs
Break-Even Point = ---------------
Contribution
84
Break even point ( Rs ) =Fixed Cost / P/V ratio

Break Even point (Units) = Fixed Cost (Total)
-----------------------------
(S.P per unit M.C per unit)
or( Contribution per Unit)
Cost-Volume-Profit Assumptions
and Terminology
P/V Ratio = Profit / Sales
P/V Ratio = Contribution / Sales
85
Value of sales to earn desired amount of
profit:-

(Fixed Cost + Desired Profit)
------------------------------------------
P/ V ratio

Cost-Volume-Profit Assumptions
and Terminology
86
Variable Cost = Sales (sales x P/V ratio)

Profit= (sales x P/V ratio) Fixed Cost

Fixed Cost= (sales x P/v ratio) Profit

Margin of safety =
(Rs) = Profit/ P/V ratio or
= Actual sales Break Even Sales
(Units) = Profit / Contribution per unit


Cost-Volume-Profit Assumptions
and Terminology
87
Essentials of Cost-Volume-Profit
(CVP) Analysis Example
Assume that the Furniture Shop can purchase
Chairs for Rs32 from a local factory; other
variable costs amount to Rs10 per unit.
The local factory allows the Furniture Shop to
return all unsold Chairs and receive a full Rs32
refund per pair of Chairs within one year.
The average selling price per pair of Chairs is Rs70
and total fixed costs amount to Rs84,000.
88
Essentials of Cost-Volume-Profit
(CVP) Analysis Example
How much revenue will the business receive if
2,500 units are sold?
2,500 Rs70 = Rs175,000
How much variable costs will the business incur?
2,500 Rs42 = Rs105,000
Rs175,000 105,000 84,000 = (Rs14,000)
89
Essentials of Cost-Volume-Profit
(CVP) Analysis Example
What is the contribution margin per unit?
Rs 70 Rs 42 = Rs 28 contribution margin per unit
What is the total contribution margin when
2,500 pairs of Chairs are sold?
2,500 Rs 28 = Rs70,000
90
Essentials of Cost-Volume-Profit
(CVP) Analysis Example
Contribution margin percentage (contribution
margin ratio) is the contribution margin per
unit divided by the selling price.
What is the contribution margin percentage?
Rs28 Rs70 = 40%
91
Essentials of Cost-Volume-Profit
(CVP) Analysis Example
If the business sells 3,000 pairs of Chairs,
revenues will be Rs 210,000 and contribution
margin would equal 40% Rs 210,000
= Rs 84,000.
92
Equation Method
Rs70Q Rs42Q Rs84,000 = 0
Rs28Q = Rs 84,000
Q = Rs84,000 Rs28 = 3,000 units
Let Q = number of units to be sold to break even
(Selling price Quantity sold) (Variable unit cost
Quantity sold) Fixed costs = Operating income
93
Contribution Margin Method
Rs84,000 Rs28 = 3,000 units
Rs84,000 40% = Rs210,000
94
Graph Method
0
42
84
126
168
210
252
294
336
378
0 1000 2000 3000 4000 5000
Units
$
(
0
0
0
)
Breakeven
Fixed costs
95
Target Operating Income
(Fixed costs + Target operating income)
divided either by Contribution margin
percentage or Contribution margin per unit
96
Target Operating Income
Assume that management wants to have an
operating income of Rs 14,000.
How many pairs of Chairs must be sold?
(Rs84,000 + Rs14,000) Rs 28 = 3,500
What sales are needed to achieve this income?
(Rs84,000 + Rs14,000) 40% = Rs245,000
97
Target Net Income
and Income Taxes Example
Proof:
Revenues: 4,822 Rs70 Rs337,540
Variable costs: 4,822 Rs42 202,524
Contribution margin Rs135,016
Fixed costs 84,000
Operating income 51,016
Income taxes: Rs51,016 30% 15,305
Net income Rs 35,711
98
Alternative Fixed/Variable Cost
Structures Example
What is the new contribution margin?
Decrease the price they charge from Rs32 to Rs25 and
charge an annual administrative fee of Rs30,000.
Suppose that the factory the Chairs Shop is using to
obtain the merchandise offers the following:
99
Alternative Fixed/Variable Cost Structures
Example
Rs70 (Rs25 + Rs10) = Rs35
Contribution margin increases from Rs28 to Rs35.
What is the contribution margin percentage?
Rs35 Rs70 = 50%
What are the new fixed costs?
Rs84,000 + Rs30,000 = Rs114,000
100
Alternative Fixed/Variable Cost Structures
Example
Management questions what sales volume
would yield an identical operating income
regardless of the arrangement.
28x 84,000 = 35x 114,000
114,000 84,000 = 35x 28x
7x = 30,000
x = 4,286 pairs of Chairs
101
Alternative Fixed/Variable Cost Structures
Example
Cost with existing arrangement
= Cost with new arrangement
.60x + 84,000 = .50x + 114,000
.10x = Rs30,000 x = Rs300,000
(Rs300,000 .40) Rs 84,000 = Rs36,000
(Rs300,000 .50) Rs114,000 = Rs36,000
102
.
Financial accounting income statement
emphasizes gross margin.
Contribution income statement emphasizes
contribution margin.
103
Application Of Marginal Costing

1. Cost Control
2. Profit planning
3. Evaluation of performance
4. Decision Making
Fixation of selling Price
Key or limiting factors
Make or Buy Decision
104
Selection of suitable product mix
Effect of change in price
Maintained a desired level of Profit
Alternative methods of Production
Diversification of Products
Closing down of activities
Alternative course of action
Level of activity planning

Application Of Marginal Costing
105
Typical Relevant Costing Decisions
One-Time-Only Special Order (Pricing)
Make or Buy Decisions (Outsourcing)
Opportunity Costs
Product Mix Decisions under Capacity Constraints
Add or Drop a Product Line or Customer
Equipment Replacement Decisions
106
One-Time-Only Special Order
Without With
Order Order Difference

Volume 30,000 35,000 5,000

Relevant revenues Rs600,000 Rs655,000 Rs55,000

Relevant costs:
Variable
manufacturing (225,000) (262,500) (37,500)

Incremental income Rs17,500

107
Outsourcing and Make/Buy Decisions
Make Buy Difference

Relevant costs:
Outside cost of parts Rs160,000 Rs160,000
Direct materials Rs80,000 (80,000)
Direct labour 10,000 (10,000)
Variable overhead 40,000 (40,000)
Fixed purchasing,
receiving and
setup overhead 20,000 (20,000)

Incremental difference
In favour of making Rs10,000
108
Outsourcing and Opportunity Costs
Make Buy

Relevant cost to make Rs150,000
Relevant cost to buy Rs 160,000
Opportunity cost:
Profit forgone because
Capacity cannot be used
to make another product 25,000
Total relevant costs Rs175,000 Rs160,000
Opportunity cost considers the profits lost by not
following the next best alternative course of action
109
Product Mix Decisions Under Constraint
Snowmobile Boat
Engine Engine

Contribution margin per unit Rs240 Rs375
Machine hours required per unit 2 5
Contribution margin per
machine hour Rs120 Rs75
If machine hours are constrained, maximize income
by first producing as many snowmobile engines as
can be sold and then shift production to boat engines
110
Customer Profitability Analysis
Keep Drop
Account Account Difference
Relevant revenue Rs1,200,000 Rs800,000 Rs(400,000)
Relevant costs:
Cost of goods sold 920,000 590,000 330,000
Material-handling labour 92,000 59,000 33,000
Marketing support 30,000 20,000 10,000
Order/delivery 32,000 20,000 12,000

Decline in operating income
if drop account Rs(15,000)