Chapter one

Introduction to Cost Accounting

Costing Accounting

Cost accounting is the process of determining and accumulating the cost of product or activity. It

is a process of accounting for the incurrence and the control of cost. It also covers classificatio n,

analysis, and interpretation of cost. In other words, it is a system of accounting, which provides

the information about the ascertainment, and control of costs of products, or services. Internal

aspect of the organization. Cost Accounting is accounting for cost aimed at providing cost data,

statement and reports for the purpose of managerial decision making. The Institute of Cost and

Management Accounting, London defines “Cost accounting is the process of accounting from the

point at which expenditure is incurred or committed to the establishment of its ultimate relations hip

with cost centers and cost units. In the widest usage, it embraces the preparation of statistical data,

application of cost control methods and the ascertainment of profitability of activities carried out

or planned”.

Objectives of cost accounting

There is a relationship among information needs of management, cost

Accounting objectives, and techniques and tools used for analysis in cost

Accounting. Cost accounting has the following main objectives to serve:

1. Determining selling price,

2. Controlling cost

3. Providing information for decision- making

4. Ascertaining costing profit

5. Facilitating preparation of financial and other statements.

1. Determining selling price

The objective of determining the cost of products is of main importance in cost accounting. The

total product cost and cost per unit of product are important in deciding selling price of product.

Cost accounting provides information regarding the cost to make and sell product or services.

Other factors such as the quality of product, the condition of the market, the area of distributio n,

the quantity which can be supplied etc., are also to be given consideration by the manageme nt

before deciding the selling price, but the cost of product plays a major role.

2. Controlling cost

Cost accounting helps in attaining aim of controlling cost by using various techniques such as

Budgetary Control, Standard costing, and inventory control. Each item of cost [viz. material,

labor, and expense] is budgeted at the beginning of the period and actual expenses incurred

are compared with the budget. This increases the efficiency of the enterprise.

Providing information for decision-making

Cost accounting helps the management in providing information for Managerial decisions for

formulating operative policies. These policies relate to the following matters:

(i) Determination of cost-volume-profit relationship.

(ii) Make or buy a component

(iii) Shut down or continue operation at a loss

(iv) Continuing with the existing machinery or replacing them by

improved and economical machines.

4. Ascertaining costing profit

Cost accounting helps in ascertaining the costing profit or loss of any activity on an objective

basis by matching cost with the revenue of the activity.

5. Facilitating preparation of financial and other statements

Cost accounting helps to produce statements at short intervals as the management may require.

The financial statements are prepared generally once a year or half year to meet the needs of the

management. In order to operate the business at high efficiency, it is essential for management

to have a review of production, sales and operating results. Cost accounting provides daily, weekly

or monthly statements of units produced, accumulated cost with analysis. Cost accounting system

provides immediate information regarding stock of raw material, semi finished and finished goods.

This helps in preparation of financial statements

 The main differences between Financial and Cost Accounting are as follows:

Financial Accounting Cost Accounting

(a) It provides the information about the business in(a)

a It provides information to the management for

general way. i.e Profit and Loss Account, proper planning, operation, control and decision

Balance Sheet of the business to owners and making.

other outside partners.

(b) It classifies, records and analyses the transactions

(b) It records the expenditure in an objective manner,

in a subjective manner, i.e according to the nature i.e according to the purpose for which the costs

of expense. are incurred.

(c) It lays emphasis on recording aspect without

(c) It provides a detailed system of control for

attaching any importance to control. materials, labour and overhead costs with the

help of standard costing and budgetary control.

(d) It reports operating results and financial position

(d) It gives information through cost reports to

usually at the end of the year. management as and when desired.

(e) Financial Accounts are accounts of the whole

(e) Cost Accounting is only a part of the financ ia l

business. They are independent in nature. accounts and discloses profit or loss of each

product, job or service.

(f) Financial Accounts records all the commercia

(f)l Cost Accounting relates to transactions connected

transactions of the business and include all with Manufacturing of goods and services, means

expenses i.e Manufacturing, Office, Selling etc. expenses which enter into production.
(g) Financial Accounts are concerned with external
(g) Cost Accounts are concerned with interna l

transactions i.e. transactions between business transactions, which do not involve any cash

concern and third party. payment or receipt.

(h) Only transactions which can be measured (h)

in Non-Monetary information likes No of Units /

monetary terms are recorded. Hours etc are used.

(i) Financial Accounting deals with actual figures and

(i) Cost Accounting deals with partly facts and figures

facts only. and partly estimates / standards.

(j) Financial Accounting do not provide informa tio(j)

n Cost Accounts provide valuable information on the

on efficiencies of various workers/ Plant & efficiencies of employees and Plant &

Machinery. Machinery.

(k) Stocks are valued at Cost or Market price

(k) Stocks are valued at Cost only.

whichever is lower.

(l) Financial Accounting is a positive science as it (l)

is Cost Accounting is not only positive science but

subject to legal rigidity with regarding to also normative because it includes techniques of

preparation of financial statements. budgetary control and standard costing.

(m) These accounts are kept in such away to meet the

(m) Generally Cost Accounts are kept voluntarily to

requirements of Companies Act 2013 as per Sec meet the requirements of the management, only

128 & Income Tax Act, 1961 Sec 44AA. in some industries Cost Accounting recor
COST SHEET: MEANING AND ITS IMPORTANCE

Cost sheet is a statement, which shows various components of total cost of a product. It classifies

and analyses the components of cost of a product. Previous period’s data is given in the cost sheet

for comparative study. It is a statement which shows per unit cost in addition to Total Cost. Selling

price is ascertained with the help of cost sheet. The details of total cost presented in the form of a

statement is termed as Cost sheet. Cost sheet is prepared on the basis of is prepared on the basis of :

1. Historical Cost 2. Estimated Cost

Historical Cost

Historical Cost sheet is prepared on the basis of actual cost incurred. A statement of cost prepared

after incurring the actual cost is called Historical Cost Sheet.

Estimated Cost

Estimated cost sheet is prepared on the basis of estimated cost. The statement prepared before the

commencement of production is called estimated cost sheet. Such cost sheet is useful in quoting

the tender price of a job or a contract

Importance of Cost Sheet The importance of cost sheet is as follows:

Cost ascertainment

The main objective of the cost sheet is to ascertain the cost of a product. Cost sheet helps in ascertainment

of cost for the purpose of determining cost after they are incurred. It also helps to ascertain the actual cost

or estimated cost of a Job.

Fixation of selling price

To fix the selling price of a product or service, it is essential to prepare the cost sheet. It helps in fixing

selling price of a product or service by providing detailed information of the cost. Help in cost control For
controlling the cost of a product it is necessary for every manufacturing unit to prepare a cost sheet.

Estimated cost sheet helps in the control of material cost, labour cost and overheads cost at every point of

production

. Facilitates managerial decisions

It helps in taking important decisions by the management such as: whether to produce or buy a component,

what prices of goods are to be quoted in the tender, whether to retain or replace an existing machine etc.

Prime Cost

Prime Cost

It consists of direct material, direct wages and direct expenses. In other words “Prime cost

represents the aggregate of cost of material consumed, productive wages, and direct expenses”. It

is also known as basic, first, flat or direct cost of a product.

Prime Cost = Direct material + Direct Wages + Direct expens es

Direct material

Direct material means cost of raw material used or consumed in production. It is not necessary

that all the material purchased in a particular period is used in production. There is some stock of

raw material in balance at opening and closing of the period. Hence, it is necessary that the cost

of opening and closing stock of material is adjusted in the material purchased. Opening stock of

material is added and closing stock of raw material is deducted in the material purchased and we

get material consumed or used in production of a product. It is calculated as :

Direct material

Direct material = Material purchased + Opening stock of material – Closing stock of material.
Example 1

Calculate prime cost from the following particulars for a production unit:

. Cost of material purchased 30,000

Opening stock of material 6,000

Closing stock of material 4,000

Wages paid 3,000

Rent of hire of a special machine for production 5,000

Solution
Opening stock of material 6,000 6,000

Add : Material Purchased 30,000

Material available for consumption 36,000

Less : Closing stock of material 4,000

Direct material 32000

Direct Labour : Wages

Direct Expenses: Rent of hire a special machine 3000

5000

Prime Cost 40000

Factory Cost In addition to prime cost it includes works or factory overheads. Factory overheads

consist of cost of indirect material, indirect wages, and indirect expenses incurred in the factory.

Factory cost is also known as works cost, production or manufacturing cost.

Exercise

1) Compute the cost of material consumed from the following data:

Opening stock of raw material 9,000

Purchases of raw material 1, 27,000

Closing stock of raw material Rs 12,000

 2. Compute Prime cost from the data given below:

Direct Material 180,000

Expenses on purchases 20,000

Rent of special machine taken on hire for production 40,000

Productive wages 65,000

Cost of glue 6700

Factory Cost = Prime cost + Factory overheads

Illustration 2

Calculate factory cost from the following particulars:

Material consumed 60,000

Productive wages 20,000

Direct Expenses 5,000

Consumable stores 2,000

Oil grease/Lubricating 500

Salary of a factory manager 6,000

Unproductive wages 1,000

Factory rent 2,000

Repair and Depreciation on Machine 600

Solution