Dr.Kaustubh A.

Sontakke

Notes on Cost Accounting

Chapter 01
Introduction to Cost Accounting and Cost Concepts
Meaning
It is very difficult to define the term cost, cost accounting, and cost management as these
are skill oriented management sciences. According to Oxford Dictionary the term cost;
means the price paid for something.
According to CIMA (London), cost is the amount of expenditure, actual or notional
incurred or attributed to a given thing.
Further, cost accounting in straight words consists of records, reports and analyses cost of
each cost centre such as product or process or contract. It has its own cost recording
system under costing ledgers. Under cost accounting the records are prepared for specific
cost centre. It uses current data for future estimations. Cost accounting records are
optional except for certain corporate entities where government orders the maintenance
of cost accounting records.

Distinguishing Cost accounting from other branches of accounting

Cost accounting is one of the branches of accounting discipline. There are other branches
of accounting such as financial accounting; management accounting etc. Each of these
branches performs the specific function appropriate to the purpose of its existence. Hence
it is appropriate to distinguish the cost accounting from the other specific branches of
accounting. Following are the points of distinction.
Sr.
Financial accounting
Cost accounting
Management
No
accounting
01
Nature
It records, reports and It records, reports and It analyses and interprets
analyses the financial analyses cost of each accounting information
transactions
of
a cost centre such as for further decision
concern.
product or process or making by management
contract.
of a concern.
02
System
It uses double entry It has its own cost It generates statements
system of entering the account
recording as per the requirements
transaction in the books system under costing and forms suitable for
of accounts.
ledgers.
analysis and decision
making.
03
Period
Records are prepared Records are prepared Records are free lanced

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04

05

06

for a specific period i.e.

a financial year.
Nature of data used
It uses past data
(occurred transactions)
for recording into the
system.
Publication of records
Financial accounting
records are required to
be published as per the
legal requirement (in
case
of
corporate
entity)
Compulsion
Financial accounting
records are required to
be
maintained
compulsorily by every
business organizations.

Notes on Cost Accounting

for specific cost centre.

and can be prepared as

per requirement.

It uses current data for It is more of futuristic

future estimations.
nature and develops
records for decision
making.
Cost
accounting
records
are
not
published. It may be
submitted
to
government in certain
cases.

Management
accountings records are
generated purely for
internal decision making
and hence do not require
any publication.

Cost
accounting Management accounting
records are optional records
are
purely
except
for
certain optional.
corporate
entities
where
government
orders the maintenance
of costing records.

Cost Concepts
There are various cost concepts as regards to the cost accounting in particular and the
business organization in general. In order to understand these cost concepts it is very
pertinent to understand classification of such costs into various categories on certain
predefined base. Cost classification is the process of grouping costs according to their
common characteristics. Thus, following are the various types of costs categorized on
certain predefined basis.
A) On the basis of nature/ element of cost

Material
Material is the principle substance that goes into the production process and then
processed and converted into finished goods. Materials are further classified as
direct and indirect. Direct material can be easily and directly identified with the
production of finished goods. All the material other than direct material that goes
into the process of production is called as indirect material. For example in the
production of furniture, wood is direct material and the adhesive used in
production of such furniture is indirect material.

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Notes on Cost Accounting

Labour
Labour is the physical and mental human efforts that go into the process of
production. As like material, even labour is further classified as direct and indirect.
For example the efforts of the workers (carpenters) actually working towards
making the furniture are called as direct labour and the efforts of the supervisors
supervising their production of furniture are categorized as indirect labour.

Overheads
All the costs incurred in the business other than cost of material and labour are
called as overheads. Overheads are further classified as factory overheads, office
and administration overheads, selling and distribution overheads, etc.
B) On the basis of functions

Manufacturing cost
Manufacturing cost consists of direct materials, direct labour and factory
overheads. In totality it is also referred to as factory on-cost.

Administrative cost
Administrative cost includes cost incurred in planning, directing, controlling and
operating a company. For example salaries paid to managers, accountants, office
staff, etc.

Selling and distribution cost
Selling costs are the costs incurred in stimulating market demand for the product
and developing business through enhancing sales revenue. Distribution cost is all
the cost incurred from the point of packing the product to delivering it to
customers and even return or exchange if any.
C) On the basis of variability

Variable cost
The cost that varies in a direct proportion to the volume of output/production is
called as variable cost. Variable cost per unit remains unchanged. Further, the
variable cost per unit may be impacted due to economies of scale.

Fixed cost
Fixed cost has a tendency to remain unchanged in spite of change in volume of
output/production. Further, fixed cost per unit changes inversely with the volume
of output.

Mixed cost
Mixed cost is also called as semi0variable or semi-fixed cost. This cost has a
tendency to remain fixed upto certain point and then changes like a variable cost in

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Notes on Cost Accounting

direct proportion to the volume of production. For example telephone bill which
has certain minimum fixed amount for predetermined usage and then over and
above such usage its amount of bill increases in direct proportion to the use.
D) On the basis of controllability

Controllable cost
The costs that are influenced by the action of specified members of the
undertaking are called controllable costs. These costs are at least in part within the
control of the management. Generally direct costs are of this category and within
the control of lower level of management.

Uncontrollable cost
If the cost cannot be influenced by the action of specified members of the
undertaking then it is called as uncontrollable cost. These costs are not within the
control of the management. Generally, fixed costs are of this category.
E) On the basis of normality

Normal cost
It is the cost which normally incurred at a given level of output. This cost forms
the cost of production of the product.

Abnormal cost
It is the cost incurred at a given level of output in a condition which is not
favourable for that level of output. It is generally accounted for as a part of cost
over and above cost of production of the product.
F) On the basis of capital or revenue

Capital cost
If the cost is incurred in purchase of fixed assets either to earn income or to
enhance earning capacity of the business then it is called as capital cost. For
example cost of purchasing machinery in the factory. Its benefits last for a longer
period of time.

Revenue cost
Revenue cost is any expenditure incurred in normal course of business for
generating or earning revenue in the business such as wages paid in the process of
production or salaries paid to the office staff.

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Notes on Cost Accounting

G) On the basis of time

Historical cost
The costs that are ascertained after being incurred are called as historical costs.
These costs are recorded for the purpose of accounting and then further used for
analysis and estimation of future costs.

Estimated cost
These costs are computed in advanced before-hand on the basis of analysis and
interpretations about future course of action for business and market. Estimated
costs play very vital role in future-oriented decision making as regards to cost
reduction, cost control and effective cost management.
H) On the basis of inclusion

Product cost
Product cost is associated with the unit of output. These costs are attached to the
units produced. These costs are counted with the output and considered as a cost
of production.

Period cost
Period costs are associated with the period of time rather than the units of
production. For example salary paid to the employee or rent paid for office
premises is associated with the period of employment and usage respectively.

I) On the basis of planning and control

Budgeted cost
Budgeted costs represent an estimate of expenditure for different departments of
business operations such as manufacturing, administration, sales, research and
development, etc. for a certain period of time in future which generally a year but
it may be long-term. Generally, various budgets for different types of revenues and
expenses are prepared which in turn helps in preparing master budget.

Standard cost
Standard cost is the predetermined cost based on a technical estimate for material,
labour and overheads for a selected period of time under a prescribed set of
working conditions. Predominantly, budgeted costs are projection of financial
accounting estimates based on historical financial accounting records whereas
standard costs are projection of cost accounting estimates based on past records of
cost accounting estimations. Further, primary objective of budget preparation is
planning and standards cost estimation is controlling.

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Notes on Cost Accounting

J) On the basis of managerial decision

Marginal cost
It is an additional cost incurred for producing an additional unit of production. It is
basically computed on variable costs i.e. prime cost plus variable overheads.

Out-of-pocket cost Vs Non-cash expenditures
Out-of-pocket cost is that portion of cost that involves payments and it is also
called as cash expenditure like salary to office staff. Non-cash expenditures are
those which are recorded through book entry and need no actual cash payment for
example depreciation of fixed assets.

Differential cost
If there is a change in cost due to change in level of activity or pattern or method
of production then it is called as differential cost. If such change is an increase in
cost then it is referred to as incremental cost and if it is decrease in cost then it is
referred to as decremental cost.

Sunk cost
Sunk cost is other name for historical cost. It is cost that already has been incurred.
Generally, sunk cost does not help much in recent future decision making. For
example even if we charge depreciation on fixed assets every year but the cost of
fixed asset is already spent at the time of its purchase and it can be considered as
sunk cost.

Imputed / notional cost
These costs are recorded in cost accounts only. For example notional rent charged
on business premises owned by the proprietor.

Opportunity cost
Opportunity cost is opportunity lost. It is the cost of that all alternative benefits of
a particular resource which are forgone because of usage of that particular
resource for a particular purpose.

Replacement cost
It is the cost at which there could be purchase of an asset or material identical to
that which is replaced. It is cost of replacement at current market price.

Avoidable and Unavoidable cost
Avoidable costs can be eliminated if a particular product or department, with
which they are directly related to, is discontinued. For example salary of a clerk
employed in particular department can be eliminated if particular department is
closed. Unavoidable costs will not be eliminated with the discontinuation of a
product or department. For example a factory rent cannot be avoided even if one
of the products is discontinued.

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Notes on Cost Accounting

K) Other costs

Future cost
It is the cost that is expected to be incurred at a later date or future date. For
example the cost of machinery which a company is planning to buy after two
years.

Programmed cost
Certain costs are incurred as per the policy of the top management for carrying out
or undertake some program. For example a higher management has decided to go
for ISO compliance program or Credit rating etc.

Joint cost
Joint cost is the common cost of processing joint products or by-products till the
point of separation which cannot be traced to a particular product before the point
of its split-off.

Conversion cost
It is a cost of converting raw material into the finished product. It is the production
cost other than cost of direct material.

Discretionary cost
The cost that is incurred at the discretion of management of the company and has
no direct relation to the level of activity or output is called discretionary cost. For
example advertisement expenditure, research and development expenditure, etc.

Committed cost
It is a fixed cost which is a result of past decision of the management and is not
subject to the control of the management in short-run. For example depreciation
on plant and machinery which has already been purchased and will be used for
next five years and hence depreciation will be continued for next five years.
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