Professional Documents
Culture Documents
Origins
All types of businesses, whether service, manufacturing or trading, require cost accounting to track
their activities. Cost accounting has long been used to help managers understand the costsof running
a business. Modern cost accounting originated during the industrial revolution, when the
complexities of running a large scale business led to the development of systems for recording and
tracking costs to help business owners and managers make decisions.
In the early industrial age, most of the costs incurred by a business were what modern accountants
call "variable costs" because they varied directly with the amount of production. Money was spent
on labor, raw materials, power to run a factory, etc. in direct proportion to production. Managers
could simply total the variable costs for a product and use this as a rough guide for decision-making
processes.
Some costs tend to remain the same even during busy periods, unlike variable costs, which rise and
fall with volume of work. Over time, these "fixed costs" have become more important to managers.
Examples of fixed costs include the depreciation of plant and equipment, and the cost of
departments such as maintenance, tooling, production control, purchasing, quality control, storage
and handling, plant supervision and engineering. In the early nineteenth century, these costs were of
little importance to most businesses. However, with the growth of railroads, steel and large scale
manufacturing, by the late nineteenth century these costs were often more important than the
variable cost of a product, and allocating them to a broad range of products lead to bad decision
making. Managers must understand fixed costs in order to make decisions about products and
pricing.
For example: A company produced railway coaches and had only one product. To make each coach,
the company needed to purchase $60 of raw materials and components, and pay 6 laborers $40
each. Therefore, total variable cost for each coach was $300. Knowing that making a coach required
spending $300, managers knew they couldn't sell below that price without losing money on each
coach. Any price above $300 became a contribution to the fixed costs of the company. If the fixed
costs were, say, $1000 per month for rent, insurance and owner's salary, the company could
therefore sell 5 coaches per month for a total of $3000 (priced at $600 each), or 10 coaches for a
total of $4500 (priced at $450 each), and make a profit of $500 in both cases.
Financial accounting aims at finding out results of accounting year in the form of Profit and
Loss Account and Balance Sheet. Cost Accounting aims at computing cost of production/service
in a scientific manner and facilitate cost control and cost reduction.
Financial accounting reports the results and position of business to government, creditors,
investors, and external parties.
Cost Accounting is an internal reporting system for an organizations own management for
decision making.
Financial accounting aims at presenting true and fair view of transactions, profit and loss
for a period and Statement of financial position (Balance Sheet) on a given date. It aims at
computing true and fair view of the cost of production/services offered by the firm.[3]
lean accounting
activity-based costing
throughput accounting
environmental accounting
Target costing
Elements of cost
Basic cost elements are:
1. Raw materials
2. Labor
3. Indirect expenses/overhead
Labor
Overhead (Variable/Fixed)
Administration overheads
Selling overheads
Distribution overheads
Supplies
Utilities
Salaries
Occupancy (Rent)
Depreciation
(In some companies, machine cost is segregated from overhead and reported as a separate element)
Classification of costs
Classification of cost means, the grouping of costs according to their common characteristics. The
important ways of classification of costs are:
1. By Element: There are three elements of costing i.e. material, labor and expenses.
2. By Nature or Traceability:Direct Costs and Indirect Costs. Direct Costs are Directly
attributable/traceable to Cost Object. Direct costs are assigned to Cost Object. Indirect Costs
are not directly attributable/traceable to Cost Object. Indirect costs are allocated or
apportioned to cost objects.
3. By Functions: production,administration, selling and distribution, R&D.
4. By Behavior: fixed, variable, semi-variable. Costs are classified according to their behavior
in relation to change in relation to production volume within given period of time. Fixed
Costs remain fixed irrespective of changes in the production volume in given period of time.
Variable costs change according to volume of production. Semi-variable Costs costs are
partly fixed and partly variable.
5. By control ability: controllable, uncontrollable costs. Controllable costs are those which can
be controlled or influenced by a conscious management action. Uncontrollable costs cannot
be controlled or influenced by a conscious management action.
6
6. By normality: normal costs and abnormal costs. Normal costs arise during routine day-today business operations. Abnormal costs arise because of any abnormal activity or event not
part of routine business operations. E.g. costs arising of floods, riots, accidents etc.
7. By Time: Historical Costs and Predetermined costs. Historical costs re costs incurred in the
past. Predetermined costs are computed in advance on basis of factors affecting cost
elements. Example: Standard Costs.
8. By Decision making Costs: These costs are used for managerial decision making.
Marginal Costs: Marginal cost is the change in the aggregate costs due to change in the
volume of output by one unit.
Differential Costs: This cost is the difference in total cost that will arise from the selection of
one alternative to the other.
Relevant Cost: The relevant cost is a cost which is relevant in various decisions of
management.
Replacement Cost: This cost is the cost at which existing items of material or fixed assets
can be replaced. Thus this is the cost of replacing existing assets at present or at a future date.
Shutdown Cost:These costs are the costs which are incurred if the operations are shut down
and they will disappear if the operations are continued.
Capacity Cost: These costs are normally fixed costs. The cost incurred by a company for
providing production, administration and selling and distribution capabilities in order to perform
various functions.
Other Costs
For example: if the railway coach company normally produced 40 coaches per month, and
the fixed costs were still $1000/month, then each coach could be said to incur an Operating
Cost/overhead of $25 =($1000 / 40). Adding this to the variable costs of $300 per coach
produced a full cost of $325 per coach.
This method tended to slightly distort the resulting unit cost, but in mass-production industries that
made one product line, and where the fixed costs were relatively low, the distortion was very minor.
For example: if the railway coach company made 100 coaches one month, then the unit cost
would become $310 per coach ($300 + ($1000 / 100)). If the next month the company made
50 coaches, then the unit cost = $320 per coach ($300 + ($1000 / 50)), a relatively minor
difference.
An important part of standard cost accounting is a variance analysis, which breaks down the
variation between actual cost and standard costs into various components (volume variation,
material cost variation, labor cost variation, etc.) so managers can understand why costs
were different from what was planned and take appropriate action to correct the situation.
Marginal costing
The cost-volume-profit analysis is the systematic examination of the relationship between selling
prices, sales, production volumes, costs, expenses and profits. This analysis provides very useful
information for decision-making in the management of a company. For example, the analysis can be
used in establishing sales prices, in the product mix selection to sell, in the decision to choose
marketing strategies, and in the analysis of the impact on profits by changes in costs. In the current
environment of business, a business administration must act and take decisions in a fast and
accurate manner. As a result, the importance of cost-volume-profit is still increasing as time passes.
8
CONTRIBUTION MARGIN
A relationship between the cost, volume and profit is the contribution margin. The contribution
margin is the revenue excess from sales over variable costs. The concept of contribution margin is
particularly useful in the planning of business because it gives an insight into the potential profits
that can generate a business. The following chart shows the income statement of a company X,
which has been prepared to show its contribution margin:
Sales
$1,000,000
$600,000
Contribution Margin
$400,000
$300,000
$100,000
The contribution margin ratio measures the effect on operating income of an increase or a decrease
in sales volume. For example, assume that the management of Fusion, Inc. is studying the effect of
adding $80,000 in sales orders. Multiplying the contribution margin ratio (40%) by the change in
sales volume ($80,000) indicates that operating income will increase $32,000 if additional orders
are obtained. To validate this analysis the table below shows the income statement of the company
including additional orders:
Sales
$1,080,000
Contribution Margin
$300,000
$132,000
Variable costs as a percentage of sales are equal to 100% minus the contribution margin ratio. Thus,
in the above income statement, the variable costs are 60% (100% - 40%) of sales, or $648,000
($1'080,000 X 60%). The total contribution margin $432,000, can also be computed directly by
multiplying the sales by the contribution margin ratio ($1'080,000 X 40%).
TYPE OF COST:
Up-front costs comprise the initial investments and expenses necessary to implement MSW
services. These include public education and outreach, land acquisition, permitting, and building
construction or modification.
Operating costs are the expenses of managing MSW on a daily basis, including operations and
maintenance, capital costs, debt service, and any unexpected costs.
Back-end costs include expenditures to properly wrap up operations and take proper care of
landfills and other MSW facilities at the end of their useful lives. Costs include site closure,
building/equipment decommissioning, postclosure care, and retirement/health benefits for current
employees.
Remediation costs at inactive sites include investigation, containment, and cleanup of known
releases and closure and postclosure care at inactive sites. Many local governments have inactive
MSW landfills that require "corrective action" for known contamination of ground water, soil, or
surface water. These remediation costs can be relatively well estimated, though with somewhat
more uncertainty than other types of engineering projects such as road building.
Including these costs in FCA is a matter of choice. The decision to include remediation costs
depends on the intended use of the FCA information. For example, if you are using FCA to
document the revenue needs of an MSW program, you might want to include costs entailed by
inactive sites. However, if you intend to use FCA to reveal the current economics (e.g., cost per ton)
of current MSW management or compare your performance to other communities or state
benchmarks, you might want to exclude inactive sites from such calculations.
10
Contingent costs are costs that might or might not be incurred at some point in the future.
Examples include the costs of remediating unknown or future releases of pollutants, such as leaks
from currently operating municipal landfills. Contingent costs also include the liability costs of
compensating for undiscovered or future damage to property or persons adversely affected by MSW
services. Both of these types of contingent costs can be projected, but not very precisely. (In
contrast, where there is a known need to remediate, costs can be projected much more precisely.)
Environmental costs are the costs of environmental degradation that cannot be easily measured or
remedied, are difficult to value, and are not subject to legal liability. To truly capture all of the
important life-cycle cost elements, some people advocate assessing the upstream and downstream
environmental costs of resource use, pollution, and waste generated by providing goods and
services.
Social costs are adverse impacts on human beings, their property and welfare that cannot be
compensated through the legal system. Social costs (also termed "social externalities") might
include the impacts of MSW transport on neighborhoods along the routes taken, as well as the
impacts of MSW facilities themselves. Adverse effects on property values, community image, and
aesthetics, as well as the increase of noise, odor, and traffic all contribute to social costs.
Operating cost
Operating costs are costs that are incurred on a day-to-day basis related to the business operations.
It can also be related to the operation of a device, component, and piece of equipment or facility.
Operating costs are also known as operating expenses. For example sales and administration costs
are operating costs. Operating costs are referred to as cost per unit of a product or service, or the
annual cost incurred on a continuous process. The operating costs are those that do not
11
include capital outlays or the costs incurred in design and implementation phases of a new
process.
Operating costs are divided into two categories. They are fixed costs and variable costs. Fixed
costs are those which are fixed and do not vary with the changes in the level of output. They do not
change whether the business is inactive or operating at full capacity. Variable costs are those costs
which vary with the changes in the level of output. Flexible expenditures are also known as the
variable operating costs. The expenses fluctuate on the basis of a variety of factors.
Operating expenses differ in every country. The actual expenses vary in every location. The
calculation of operating costs is essential for sound business planning. These costs should be
properly budgeted; otherwise it will adversely affect the business. The lack of planning in a business
increases the risk that a business will not maintain adequate funds to operate properly. When the
operating costs are fixed, the likely business interruptions or economic declines should be taken
into consideration. The business generally cannot be deferred until a business finds it convenient to
pay them. Fixed operating costs are set on a payment schedule and need to be paid accordingly for
the company to maintain good credit.
Operation costing is an accounting method used to allocate costs of similar products that are
manufactured in batches. It combines two other popular costing methods to get a more accurate
picture of how a particular company's manufacturing process works. It simplifies the accounting
process by only differentiating activities that cause a variation in cost between products. Similar
items are allocated in batches that reflect the actual cost involved in creating that group. Here is a
basic guide to the operation costing accounting method.
(7) documents like the daily log sheet, cost sheet etc. are used for the collection of cost data.
Operating characteristic
14
Classical statistical hypothesis testing [Montgomery 1996] uses percent risk tools such as the socalled operating characteristic or power curve. This is obtained by calculating the risk of
incorrect decisions associated with either measurement uncertainty or entity dispersion in terms of
the area of the probability distribution function extending beyond the specification limit, for
instance, in the case of consumer risk, the tail (figure (a)) above the upper specification limit. This
risk is calculated as the location of the uncertainty interval of fixed width is swept across the
specification limit, USL, of interest, as illustrated.
Customer and supplier can use such curves to agree on:
a maximum level, , of consumer risk say, 10% where the uncertainty interval is located
at the value LQL (limiting quality level) of the quality characteristic. Characteristic entity
values further away from (below) the (upper) specification limit, will have probabilities of
in-correctly accepting a non-conforming entity less than .
a minimum level, , of supplier risk say, 95% where the uncertainty interval is located
at the value AQL (acceptable quality level) of the quality characteristic. Characteristic entity
values further away from (above) the (upper) specification limit, will have probabilities of
correctly rejecting a non-conforming entity greater than .
15
Transport Costing:
In transport undertakings most of the statistical data required for cost finding and cost control
purposes are obtained from Daily Log Report.
All repairing and maintenance work are recorded on repair tickets and are then costed.
In order to prepare a Transport Cost Sheet for a transport undertaking the costs may be
subdivided as under:a) Wages and running costs: - These include cost of petrol, oil, grease, wages of assistants and
16
drivers, etc.
b) Maintenance charges: - These include repairs and overhauling of vehicles, garage charges,
tyres, etc.
c) Fixed charges: - These fixed expenses include insurance, license, depreciation, etc.
The statistical data regarding costs, maintenance and performance are helpful in preparing a
performance in respect of each vehicle.
In order to compare the operating efficiency for each period, the total costs thus arrived at are
divided by the bases such as number of hours or days, number of kilometers run, number of
commercial ton-kilometers, etc. Costs per unit thus obtained are compared with the past result. A
monthly Vehicle Cost Sheet and Performance Statement are generally used in many transport
undertakings.
Cost control is always possible by means of comparison of actual performance with the budgeted
performance. Various control measures, viz., securing the optimum use of vehicles, regular
maintenance as a planned operation, avoidance of loading and unloading delays prevention of
overlapping and duplicated journeys, planned replacement of vehicles, etc., may be instituted.
Where transport department is treated as service department all costs are collected and
apportioned to other departments on the basis of commercial ton-kms. The haulage of incoming
material might be charged as an addition to cost of raw material, and the haulage of fabricated
goods to customers becomes a part of distribution overhead.
Generally, commercial ton-km, is obtained by multiplying the total tonnage carried by the
kilometers traveled and dividing the product by two. This is done where the vehicles return empty
as is found in most cases.
17
ILLUSTRATION 1:
Adhunik Transport Organization Limited
The visit was made to Adhunik Transport Organization Limited. The company was established in
the year 1988 as an organization. In 1991, it got the status of a limited company after reaching the
minimum turnover level. The company currently has a turnover of approximately Rs. 10 Crores.
The company is a member of Bombay Goods Transport Association (BGTA) AND Indian Bank
Association (IBA), which is very essential for the smooth conduct of their business activities.
BGTA checks all business malpractices and IBA is needed for regulating payments within
different states. The company has its 17 branches all over the country, along with 3 agencies in
certain remote areas. The company also provides warehousing facilities to companies like PhilipsIndia and Colgate. The company is involved in delivery of goods all over the country.
Number of vehicles:
The company has owned as well as dedicated trucks and trailers.
Owned Vehicles
8 HCVs- Heavy Commercial Vehicles
4 Trailers
Dedicated Vehicles
25 LCVs- Light Commercial Vehicles
Dedicated Vehicles are delivery trucks, which are made according to certain specifications,
operated under the name of another company for which they give a minimum amount of business
and certain running costs are borne by that company.
The company has its LCVs dedicated to ELBEE Delivery Services. They are used for delivering
goods given by ELBEE. The driver charges and maintenance charges are borne by Adhunik
Transport. Other expenses are borne by Elbee. The advantage to Elbee is that its capital is not
blocked. The advantage to the company is that it does not have to look for customers and keeps
getting a minimum amount of business.
No. of Employees:
The company has on an average 8 office staff members per branch. There are 30 staff members in
the head office in Mumbai. The salaries of these employees vary from Rs. 2,000- Rs. 10,000
depending upon the nature of the job they do.
Measurement of Materials is done in tons.
COSTS:
18
FIXED COSTS
Salaries
54,00,000
Insurance
8,00,000
1,00,000
Administrative Overheads
2,11,00,000
Taxes
Depreciation
30,00,000
Interests
34,00,000
TOTAL
3,38,00,000
VARIABLE COSTS
Maintenance (Per Vehicle)
HCV
10,000
LCV
6,000
TRAILERS
15,000
Drivers
2,000
Cleaners
1,200
Wages
Transit Expenses
TOTAL
500-1,500
35,000
Approx
Notes:
There are 2 drivers and 1 cleaner for every long journey.
In case of short journeys, there is only 1 driver and 1 cleaner.
The maximum distance covered in a day is 300kms. The average distance covered 225-280kms.
THE CUSTOMERS ARE CHARGED:
Rs. 1.20 PER KM PER TON (For HVC)
Rs. 1.00 PER KM PER TON (For LVC)
The Profit-Margin is between 10%-20%
19
IILUSTRATION 2:
Costing Club Transport Limited is running 4 buses between two towns, which are
180 kilometers apart. Seating capacity of each bus is 45 passengers. The
following particulars are obtained from their books for January 2013.
Particulars
Wage of drivers, conductors and cleaners
Salaries
Diesel
Repairs and Maintenance
Taxation and Insurance
Depreciation
Interest
Total
Amount (Rs.)
5,20,000
1,50,000
6,30,000
1,20,000
2,20,000
3,20,000
3,00,000
22,60,000
Passenger carried were 75% of seating capacity. All buses ran on all day of the month. Each bus
made one round trip per day.
Find out the cost per passenger kilometer.
Solution:
Costing Club Transport Limited
January 2012
Vehicle No. xxxxxxx
Registration No.xxxxxxxx
operated: 31 days
Particulars
A) Standing Charges/Fixed charges
Wages of drivers, conductors and cleaners
Salaries
Taxation and Insurance
Interest
Depreciation
Total
B) Running Charges/Variable Expenses
Petrol/Diesel
Total
C) Maintenance Charge/Semi- Variable
Repairs & Maintenance
Total
Days
Amount (Rs.)
5,20,000
1,50,000
2,20,000
3,00,000
3,20,000
Amount (Rs.)
15,10,000
6,30,000
6,30,000
1,20,000
1,20,000
20
D)
E)
F)
Total Cost
Total passenger kilometer ( shown below)
Cost per ton kilometer/passenger kilometer
=22,60,000/4,46,400
(A+B+C)
22,60,000
4,46,400
5.062
21
OVERVIEW
OPERATING COSTING
INTRODUCTI
ON
Pre paration of Cost Shee t unde r Ope rating Costing : For preparing a cost
COST SHEET
sheet under operating cost, costs are usually accumulated for a spe cified
period viz., a month, a quarter, or a year etc.
All of the accumulated costs should be classified under the following
three heads:
1. Fixed costs or standing charges,
2. Variable costs or running charges, ( Fuel, Driver Wages, Depreciation,
oil etc.)
3. Semi-variable costs or maintenance costs. (Supervision salary, Repairs
and Maintenance)
Particulars
Total
Cost
cost
km
per
22
Standing charge s
:-
License fees
Insurance
Premium Road tax
Garage rent
Drivers wages
23
Total
B
Running charge s
:-
No. Enterprise
1.
Per passenger-kilometer
2.
Hospital
3.
Canteen
4.
5.
Boiler House
1000 kg of steam
6.
Goods Transport
7.
Electricity Boards
8.
9.
10.
Hotel
Per room/day
BASIC
FORMULAS
Commercial Tonne Km =
EXAMPLE
A lorry starts with a load of 20 tonnes of goods from station A. It unloads 8
tonnes at station B and rest of goods at station C. It reaches back directly to
station A after getting reloaded with 16 tonnes of goods at station C. The
distance between A to B, B to C and then from C to A are 80 kms., 120
kms., and 160 kms., respectively. Compute Absolute tonnes-kms., and
Commercial tonnes-kms.
Solution
Absolute tonnes-kms. = 20 tonnes 80 kms + 12 tonnes 120 kms + 16
tonnes 160 kms. = 5,600 tonnes-kms.
25
IMPORTANT
Que stion 1:
QUESTION
S FOR
THEORY
The more the kilometre you travel with your own vehicle the cheaper it
becomes. Comment briefly on the statement.
Solution:
The given statement is based on the fact that when we travel more, the costs
which are fixed in nature or do not vary with output remain same. As we all
are aware of the fact that all the costs can be classified as fixed and variable
in nature. In the above case, the costs relating to cost of vehicle( i.e.
depreciation), wages of driver etc. are fixed costs and on the other hand,
fuel expenses, repairs and maintenance etc. are variable. As we travel more
and more, there is a proportionate rise in variable costs and fixed costs
remain the same. Thus, whe n we compute the cost pe r kil ome tre , i t kee ps
on de cli ni ng for more kil ome tre s and He nce , the trave lli ng be come s
che ape r.
Que stion 2:
Write a short note on operating costing?
Sol ution:
Operating Costing - The method of costing used in service rendering
undertakings is known as operati ng costing.
26
TREATMENT
OF
SOME
SPECIAL
ITEMS
REVSION
The Union Transport Company has been given a twenty kilomet er long
ILLUSTRATIO route to ply a bus. The bus costs the company ` 1,00,000. It has been
N
insured at 3% per annum. The annual road tax amounts to ` 2,000. Garage
rent is ` 400 per month. Annual repair is estimated to
cost ` 2,360 and the bus is likely to last for five yea` The salaries of the
driver and the conductor are ` 600 and ` 200 per month respectively in
addition to 10% of the takings as commission to be shared equally by them.
The managers salary is ` 1,400 per month and stationery will cost ` 100
per month. Petrol and oil will cost ` 50 per 100 kilometres. The bus will
make three round trips per day carrying on an
average 40 passengers in each trip. Assuming 15% profit on takings and
that the bus will ply on an average 25 days in a month, prepare operating
cost statement on a full year basis and also calculate the bus fare to be
charged from each passenger pe r kilometer.
Solution
Union Transport Company Statement showing operating cost of the bus
per annum:
A Standing Charges:
Managers salary (` 1,400 * 12) = 16,800
Drivers salary (` 600 * 12) = 7,200
Conductors salary (` 200 * 12) = 2,400
Road tax = 2,000
Insurance (3% of ` 1,00,000) = 3,000
Garage rent (` 400 * 12) = 4,800
Stationery (` 100 * 12) = 1,200
27
28