VShree

on

COST AND MANAGEMENT ACCOUNTING

UNIT I: INTRODUCTION

Faculty of Undergraduate Studies

United Institute of Management
Prayagraj
 Semester IV
BBA – Paper 404
Cost and Management Accounting

Syllabus (Rephrased)
Objective: To familiarize students with the various concepts and element of cost.

Unit Title Contents as per Syllabus Additional Contents

I Introduction (1) Nature & Scope of Cost Accounting (1) Objectives
(2) Concepts of Cost (2) Cost vs. Loss
(3) Classification of Cost (3) Normal v. Abnormal Loss
(4) Methods and Techniques (4) Cost Unit
(5) Installation of Costing System (3) Cost Centre
II Element of Cost (1) Accounting for Material (1) EOQ
(2) Accounting for Labour & Overheads, (2) ABC Analysis
(3) Assessment of Cost (3) VED Analysis
(4) Preparation of Cost Sheet, (4) Bin System
(5) Statement of Cost (5) CS with RM,WIP & FG
III Management Accounting (1) Meaning, Nature, Scope and Functional (1) Profit Variance Analysis:
Relationship of Management Accounting, Cost vs. Financial Account
(2) Financial and Cost Accounting
IV Decision Based Costing (1) Marginal Costing, (1) Standard Costing – Brief
(2) Absorption Costing (better - decision making)

Author’s Note: About the course-contents

1. The syllabus has been rephrased here topic-wise to develop understanding of the scope of every unit.
2. Additional topics will compliment to the recommended concepts and make the subject complete.
3. Unit I – Covers basics of cost accounting
4. Unit II – Emphasis on preparation of Cost Sheet (for which concepts of Unit I will contribute a lot)
5. Unit III – Covers Management-accounting theoretically. Additional coverage will add numerical flavor to it.
6. Unit IV – Covers only two Costing Techniques that helps in taking managerial-decisions.

Author’s Note: About the handouts/notes

1. This is Author’s original piece of work and thus meant for private circulation among the students of UIM only.
2. Notes have been made exclusively for the UG-course, reserving certain topics that subject ideally demands.
3. Notes are to be considered exhaustive only when it is read along with the live lecture notings.
4. Notes are prepared in a very lucid manner covering every topic of the syllabus and additional topics too.
5. Every possible effort has been made to shun errors in these notes.
6. Any type of error or discrimination, if noted, may be brought to Author’s knowledge, for the correction.
 For private circulation only – BBA – FUGS, UIM

UNIT I: INTRODUCTION
S. No. Topic Page No.
1. Meaning of Cost 01
2. Meaning of Costing 01
3. Meaning of Cost Accounting 01
4. Salient Features of Cost Accounting 01
5. Objectives of Cost Accounting 02
6. Importance of Cost Accounting 02
7. Cost Unit 03
8. Cost Centre 03
9. Concept of Cost, Loss and Types of Losses 04
10. Classification of Cost - I: Through Cost-sheet
(a) Elements of Cost Basis: Material, Labour and Expenses
(b) Functional Basis: Production, Administrative and Market 05
(c) Traceability Basis: Direct Cost and Indirect Cost
Concept & Numerical Exercise – Simple Cost Sheet
11. Classification of Cost - II: Other Bases
(a) Variability Basis: Variable Cost and Fixed Cost
(b) Controllability Basis: Controllable Cost and Uncontrollable Cost
11
(c) Time Basis: Historical Cost and Pre-determined/Standard Cost
(d) Normality Basis: Normal Cost and Abnormal Cost
(e) Decision Making Basis: Sunk, Opportunity, Relevant, Marginal
12. Methods of Costing:
(1) Job Costing, (2) Contract Costing, (3) Batch Costing, (4) Unit Costing 13
(5) Process Costing, (6) Operating Costing
13. Techniques of Cost:
(1) Standard Costing, (2) Marginal Costing, (3) Direct Costing, (4) Absorption 14
Costing, (5) Uniform Costing, (6) Budgetary Control, (7) Historical Costing
14. Installation of Costing System: Factors to be considered 15

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 For private circulation only

1. MEANING OF COST:

- Amount of Expenditure incurred on:

(a) Production of goods (e.g. Milk by Amul)
(b) Manufacturing of goods (e.g. Car by Hyundai)
(c) Provisioning of services (e.g. Movers & Packers - Plying)
- It simply refers to the resources sacrificed in exchange of some goods or services.
- Resources sacrificed in the form of - Material, Machine, Man-power, Money/Expenses.
- Cost is measurement, in monetary terms, of the amount of resources used for the purpose of
production of goods and rendering of services – by the Institute of Cost Accountants of India.
- The cost can be actual (cost incurred) or notional (expected/projected/budgeted cost).

2. MEANING OF COSTING:

- Costing is a technique and process of ascertaining or determining cost – by CIMA London.

- Costing means determining the cost by using principles and rules for goods and services.
- For example – hotel service costing technique in comparison to a goods manufacturing costing

3. MEANING OF COST ACCOUNTING:

- Cost Accounting is a specialized branch of accounting

- Popularly branches – Financial Accounting, Cost Accounting and Management Accounting
- In simple terms the process of accounting for cost is called as Cost Accounting
- Cost accounting process begins with the incurrence of cost and ends with the control of cost.
- Thus involves, calculation, classification, allocation, controlling & presentation of costing data.

4. SALIENT FEATURES (NATURE) OF COST ACCOUNTING:

1. A specialized branch of accounting – Financial, Cost Accounting and Management Accounting

2. It’s a science – alike sciences it involves principles, observation, experiments
3. It’s an art – alike it involves creativity and volatility
4. Determines various components of Total Cost (material, labour, expenses)
5. Does pricing – freezes selling price
6. Application of costing data for computing profit
7. Helpful to management (helps the management to draw decisions)
8. An internal accounting (for firm’s own-sake)
9. Establishes budgets and standards (to reduce & control the cost – adversity/favorability)
10. Measures performance and evaluates efficiency
11. Only accounting that considers notional costs
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Notes are exhaustive only along with the live lectures
 For private circulation only – BBA – FUGS, UIM

5. OBJECTIVES OF COST ACCOUNTING:

1. Ascertainment of cost (of production/manufacturing of goods and provisioning services)

2. Determination of Selling price (and profit margin)
3. Controlling cost (actual cost going beyond to standard cost)
Case study: what action should be taken if actual cost in comparison to standard?
Standard/Notional Cost Rs. 100 Rs. 100 Rs. 100
Actual Cost Rs. 100 Rs. 75 Rs. 150
Comment Standard Favorable Adverse
Action Required To be maintained To be maintained Reduction & Control

4. Reducing cost (without compromising in quality and reduction should be of permanent nature)
Case Study: Decide – raw material to be bought or to manufactured, suggest the technique.
Raw Material Technique I Technique II Technique III
Market Buying Rs. 100 per unit Rs. 100 per unit Rs. 100 per unit
Own-production Rs. 100 per unit Rs. 120 per unit Rs. 60 per unit
Quality of own production (80%) (100%) (100%)
Action Required Reject – low quality Reject – high cost To be accepted
Note: A brief difference between - Cost Control and Cost Reduction
Cost Control Cost Reduction
Maintaining the costs as per standards Bringing the increased cost to minimal level
Study past and present facts Study present and future facts

5. Assisting manager to take decisions by analyzing the cost data (Action required’ - point 3 & 4)
- Costing accounting facts & figures – Drawing managerial decisions = Management accounting
Note: All points are numerically explained in the live lecture with important notings

6. IMPORTANCE (ADVANTAGES) OF COST ACCOUNTING:

1. Helps in measurement of various components of total cost

2. Helps in fixing prices (selling prices)
3. Helps in inventory/stock control
4. Helps in labour control (labour v. machine or piece-rated v. time-rated, idle-time analysis)
5. Helps in guiding the cost reduction and cost control
6. Helps in measuring the performance and efficiency
7. Helps in identifying irrelevant and unprofitable activities
8. Helps in improving productivity
9. Helps in taking managerial decisions
10. Helps in checking accuracy of financial accounting (reconciling profits - cost v. final accounts)

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Notes are exhaustive only along with the live lectures
 For private circulation only

7. COST UNIT:

- A cost unit refers to the unit of quantity of product, service or time (or combination of these) in
terms of which costs may be ascertained or expressed
- It simply, a scale of measuring, using which cost is to be calculated and presented.
- Cost units can be divided as: (a) units of manufacturing of goods and (b) units of services
- Selection of a cost unit depends on the nature and type of industry
Types of Industries Cost Unit
Automobile Per automobile/numbers
Road Construction Per kilometer
Building Construction Per Square foot
Iron, Steel, Sugar, Chemical, Cement, Mines/Quarries Per tonne
Gas, Casting Per cubic meter
Metal Plating, Fabric Printing Per square meter
Paper Per ream/roll/bundle
Bricks Per thousand bricks
Nursing Home Per bed per day
Hotels Per room per day
Goods Transport Per Tonne-per Kilometre
Passenger Transport Per Passenger or Per Kilometre

8. COST CENTRE:

- A location, a person, or an item of equipment in or connected with an undertaking, in relation

to which costs ascertained and used for the purpose of cost control – by CIMA.
- The main purpose of ascertaining the cost of a cost centre is to control the cost and to fix the
responsibility of person-in-charge of any particular cost centre.
- Cost centres can be classified into three broad categories:
1. Production and Service Cost Centre: Cost center which is engaged in actual and regular
production (RM into FG) is a production cost centre. And a center which is not engaged
actually in a regular production (assists production cost centres) is known as service cost
centre, for example stores, maintenance, personnel departments.
2. Personal and Impersonal Cost Centre: When the plant/machine is taken as a unit it is the
impersonal and when the persons are a unit it is the personal cost center.
3. Operation and Process Cost Center: Operation cost center is a center which consists of those
machines and/or persons which carry out the same operations and “process cost center is a cost
center which consists of a continuous sequence of operations.
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Notes are exhaustive only along with the live lectures
 For private circulation only – BBA – FUGS, UIM

9. CONCEPT OF COST, LOSS AND TYPES OF LOSSES

- Cost: The amount of expenditure incurred on production/manufacturing of goods or

provisioning of services
- Cost vs. Loss: Loss: Cost that goes worthless/sacrifice of resources for no value (Loss of goods
due to theft/destruction of machine)
- Resources coming to an end: Is either utilized or destroyed. Utilization value becomes Cost.
Destruction value to be called as Loss.
- For example - 2.5 meter cloth piece of Rs. 2,500 used for making a shirt
a. If shirt is made then, Cloth piece Rs. 2,500 + Tailoring Rs. 500 = Rs. 3,000 Total Cost
b. If shirt is not made (cloth piece get torn) then, Amount of cloth piece Rs. 2,500 is a loss
- Losses are generally of two types: Normal and Abnormal Losses
- In the above example, whole 2.5 meter of cloth piece cannot be used in making a shirt
- Say 10% goes scrap (amounting Rs. 250) & 90% used (balance amounting Rs. 2,250)
- 10% of scrap is said to be a Normal Loss – that is an inevitable (it remain as a part of the cost)
- Loss mentioned above (point ‘b’) is also a loss but an Abnormal Loss, arising due to abnormal
some abnormal reasons - say theft, destruction.
- Final Noting:
a. Cost is the amount of resources used
b. If resources are not used and goes worthless, it is a loss
c. Loss that is inevitable – Normal Loss
d. Loss other than normal reasons – Abnormal Loss

10. CLASSIFICATION OF COSTS - I: THROUGH COST-SHEET

- Basic Classification of costs covers:

(a) Elements of Cost Basis: Material Cost, Labour Cost and Expenses
(b) Functional Basis: Production Cost, Administrative Cost and Market Cost
(c) Traceability Basis: Direct Cost and Indirect Cost
- To develop a better understanding of above three lets began with the first basis i.e. on the basis
of elements of cost and with the same lets gain the concept of a basic Cost Sheet.
- Understanding for rest of the two classifications will get naturally developed during the session
Note: Notes are compiled exclusively considering the flow of the live lecture and notings.

- Elements of Cost Basis: means the basic elements or physical elements involved in a
production process i.e. (1) Material Cost, (2) Men - Labour Cost and (3) Money – Expenses,
(other than Material and Labor – to be considered simply as expenses, like electricity, rent)
- Total Cost = Material Cost + Labour Cost + Expenses (in generic terms)

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Case Study - Imagine a firm manufacturing a Mobile Phone

CLASSIFICATION ON THE BASIS OF ELEMENTS OF COST:
1. Material Used: Physical Input Cost
Electronic Circuit/Metal-Copper/Steel, Grease, Stationary, Packing-material
a. Direct Material – Electronic circuit/metal-copper/steel
b. Indirect Material – Grease, Stationary, Packing material
2. Labour Employed: Human Input Cost
Software and Hardware Engineering, Gatekeeper, Peon, Sales Manger
a. Direct Labour - Software Engineer, Hardware Engineer, Labour Handling Machine
b. Indirect Labour – Gatekeeper, Peon, General & Sales Manager, Sales Executives
3. Expenses Incurred: Residual Cost
(Other than material/labour) Power, Royalty, Floor-cleaning, Electricity, Fule/Petrol
a. Direct Expenses – Power, Royalty, Depreciation of Plant & Machinery
b. Indirect Expenses – Floor-clean, Electricity, Stationary, Fuel/Petrol, Van Depreciation

CLASSIFICATION ON THE BASIS OF IDENTIFIABILITY/TRACEABILITY:

- Thus, all three ‘Elements of Cost’ (material, labour and expenses) have been sub-divided as to
their connectivity to manufacturing of mobile-phones.
- Direct Cost: Elements of cost which are readily identified with the production are termed so.
- Conveniently and indisputably identifiable for calculating a cost of production of goods.
- Is it feasible to calculate cost of a cloth piece, tailoring charge and royalty paid for manufacturing of
each shirt? Or Metal & Circuit used, engineering and royalty paid for each piece of mobile? Ans. - Yes
- Direct Material + Direct Labour + Direct Expenses = Prime Cost
- Indirect Cost: Elements of costs which are not directly connected or incidental, termed so.
- Will it be that ease to calculate, oil used for overhauling machines, manager’s salary and
advertisement expenses incurred on manufacturing of each shirt/mobile? Answer is - NO
- Indirect Material + Indirect Labour + Indirect Expenses = Overheads
-
Elements of Costs

Material Cost Labour Cost Expenses

Direct Indirect Direct Indirect Direct Indirect

Material Material Labour Labour Expenses Expenses

Prime Cost Overheads

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Notes are exhaustive only along with the live lectures
 For private circulation only – BBA – FUGS, UIM

CLASSIFICATION ON FUNCTIONAL BASIS:

- An enterprise mainly performs functions like manufacturing, administrative, selling & distribution.
- Costs may be required to be determined for each of these functions
- (i) Factory/Production Costs, (ii) Office/Administrative Costs, (iii) Market/Sell. & Dist. Cost
- Other than, Direct Material + Direct Labour + Direct Expenses (sum as PRIME COST)
- Indirect Material + Indirect Labour + Indirect Expenses (sum as OVERHEADS) is now to be
re-classified as costs involved in Production, Administrative, Selling & Distribution functions.
- Indirect Material (IM) + Indirect Labour (IL) and Indirect Expenses (IE) = Overheads
(a) Production/Factory Overheads:
- IM + IL + IE, incurred in a Factory/Production = Production/Factory Overheads
- For example = Grease (IM) + Gatekeeper’s salary (IL) + Floor Cleaning (IE)
(b) Office & Administrative Overheads:
- IM + IL + IE, incurred in an Office/Administration = Office & Administrative Overheads
- For example = Stationary (IM) + Peon/General Manager’s salary (IL) + Electricity (IE)
(c) Selling & Distribution Overheads:
- IM + IL + IE, incurred in a Market = Selling & Distribution Overheads
- For example = Packaging Material Cost (IM) + Sales Manager (IL) + Petrol Expenses (IE)
Total Overheads = Factory (Indirect MLE) + Off. & Admin. (Indirect MLE) + S&D (Indirect MLE)

Elements of Costs

Material Cost Labour Cost Expenses

Direct Indirect Direct Indirect Direct Indirect

Material Material Labour Labour Expenses Expenses

Prime Cost Overheads

Classification on Functionality Basis

Production Office & Administrative Selling & Distribution

Overheads Overheads Overheads

IM IL IE IM IL IE IM IL IE
Factory Factory Factory Office Office Office Market Market Market

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SIMPLE COST SHEET # 1

[Clubbing all above three classifications altogether]
A Direct Material Xx
B Add: Direct Labour Xx
C Add: Direct Expenses Xx
D Prime Cost = A + B + C **
E Add: Production/Factory Overheads Xx
F Works Cost = D + E **
G Add: Office and Administrative Overheads Xx
H Cost of Production = F + G **
I Add: Selling & Distribution Overheads Xx
J Total Cost = H + I **
K Add: Profit Xx
L Total Sales = J + K **

SIMPLE COST SHEET # 2

Adjustment of Raw Material
A Direct Material (Consumed) Xx
Opening RM + Net Purchases + Carriage-in – Closing RM
B Add: Direct Labour Xx
C Add: Direct Expenses Xx
D Prime Cost = A + B + C **

SIMPLE COST SHEET # 3

Adjustment of Semi Finished Goods/Work-in-progress (WIP)
A Direct Material Consumed Xx
B Add: Direct Labour Xx
C Add: Direct Expenses Xx
D Prime Cost = A + B + C **
E Add: Production/Factory Overheads Xx
Add: Opening WIP
Less: Closing WIP
F Works Cost = D + E **

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Notes are exhaustive only along with the live lectures
 For private circulation only – BBA – FUGS, UIM

SIMPLE COST SHEET # 4

Adjustment of Finished Goods
A Direct Material Xx
B Add: Direct Labour Xx
C Add: Direct Expenses Xx
D Prime Cost = A + B + C **
E Add: Production/Factory Overheads Xx
F Works Cost = D + E **
G Add: Office and Administrative Overheads xx
H Cost of Production = F + G **
I Add: Opening Finished Goods
xx
Less: Closing Finished Goods
J Cost of Goods Sold = H + I **
K Add: Selling & Distribution Overheads xx
L Cost of Sales = J + K **
M Add: Profit xx
Total Sales = L + M **

Points to ponder for Simple Cost Sheet

1. Cost Sheet Equations: Direct Material Cost + Direct Labour + Direct Expenses = Prime Cost
Prime Cost + Factory overheads = Works Cost+ Office & Admin overheads = COP
Cost of Production + Selling & Distribution overheads = Total Cost
2. Direct Material Cost = Raw Material Consumed
Raw Material Consumed = Open RM + Net Purchases + Carriage – Net Scrap – Close RM
3. Direct Labour Cost = Piece Rated or Time Rated
No. of units produced x Piece rate per unit
No. of hours taken x Time rate per hour
4. Opening & Closing WIP to be adjusted with Factory overheads to calculate Works Cost.
Prime Cost + Factory overheads + Opening WIP – Closing WIP = Works Cost
5. Opening & Closing Finished Goods (FG) to be adjusted in COP to calculate COGS.
Works Cost + Office overheads = COP + Opening FG - Closing FG = Cost of goods sold
6. If no open/close FG: Cost of Production + Selling & Distribution overheads = Total Cost
7. If opening and closing FG exists:
Cost of Production + Opening FG – Closing FG = Cost of Goods Sold
Cost of Goods Sold + Selling & Distribution overheads = Cost of Sales
8. Cost sheet is basically known as Unit Costing (Method)

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 For private circulation only

Class Exercises on Simple Cost-Sheet

Exercise 1. Calculate a prime cost

Direct Material 2,00,000
Direct Labour 75,000
Direct Expenses 25,000 [Hint - DM + DL + DE]

Exercise 2. Calculate a prime cost

Opening stock of raw material 50,000
Closing stock of raw material 20,000
Purchases of raw material 1,60,000
Purchase returns of raw material 10,000
Carriage on purchases 20,000
Direct Labour 75,000
Direct Expenses 25,000 [Hint - DM Consumed + DL + DE]

Exercise 3. Calculate a prime cost

Direct Material 2,00,000 (5,000 Units)
Direct Labour Rs. 15 per unit
Direct Expenses 25,000 [Hint - DM + DL @ Piece Rate + DE]

Exercise 4. Calculate a prime cost

Direct Material 2,00,000
Direct Labour Rate Rs. 50 per hour
Total Direct Labour 1500 hours
Direct Expenses 25,000 [Hint - DM + DL @ Hour Rate + DE]

Exercise 5. Calculate prime cost

Opening stock of raw material 100 units @ Rs. 5
Closing stock of raw material 200 units @ Rs. 10
Purchases of raw material 4,000 units @ Rs. 10
Purchase returns of raw material 500 units
Carriage on purchases Rs. 5 per unit
Direct labour hours 2000 hours
Direct labour rate Rs. 10 per piece
Direct expenses Rs. 60,000 [Hint – DM Consumed + DL @ Piece Rate + DE]

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 For private circulation only – BBA – FUGS, UIM

Exercise 6. Calculate works/factory cost

Direct Material 2,00,000
Direct Labour 75,000
Direct Expenses 25,000
Factory overheads 1,00,000 [Hint - Prime Cost + Factory Overheads]

Exercise 7. Calculate works/factory cost

Direct Material 1,00,000
Direct Labour 75,000
Direct Expenses 25,000
Machine Hour Rate Rs. 50
Total Machine Hours 1,000 [Hint – Total Machine Hours = Factory Overheads]

Exercise 8. Calculate works/factory cost

Direct Material 1,00,000
Direct Labour 75,000
Direct Expenses 25,000
Factory overheads 25% of prime cost [Hint – ¼ Prime Cost = Factory Overheads]

Exercise 9. Calculate works/factory cost

Direct Material 2,00,000
Direct Labour 75,000
Direct Expenses 25,000
Factory overheads 20% of works cost [Hint - Factory Overheads = 1/5 Works Cost]

Exercise 10. Calculate cost of production

Prime Cost 3,00,000
Factory overheads 20% of works cost
Office & Admin overheads 50% of works cost [Ans. – COP 5, 62, 500]

Exercise 11. Calculate cost of goods sold

Prime Cost 3,00,000
Factory overheads 20% of works cost
Office & Admin overheads 50% of works cost
Selling & Distribution overheads 25% of COP
Mark the assumption? [Ans. – COS 7,03,125]

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11. CLASSIFICATION OF COSTS - II:

CLASSIFICATION ON VARIABILITY BASIS:

Fixed Cost:
- Cost that remains stagnant irrespective of the volume of production
- For example - rent, insurance, depreciation, manager’s salary
Variable Cost:
- Cost that is directly proportional to the volume of production and also, known as a Product Cost.
- For example - cost of raw material consumed, direct wages, direct expenses.
Semi Variable Cost or Semi Fixed Cost:
- Cost, the one part of which is fixed (minimum charge) and another is proportional to the volume of
usage. In a simple equation, Fixed (Minimum Rent) + Variable (Usage)
- For example – electricity bill, first portion caries a fixed rent and balance depends on consumption.

CLASSIFICATION ON CONTROLLABILITY BASIS:

Controllable Cost:
- A cost that can be controlled by its budget-holders/management
- Generally, almost all direct costs such as material cost, labor costs, and certain overhead expenses are
controllable by the actions of the lower levels of management.
- For example - Raw material buying option or to get it manufactured. Similarly, labour wage can be
reduced or controlled by employing machines
Un-controllable Cost:
- A cost that cannot be controlled by the action of management/authority is known as uncontrollable.
- For example – Factory rent, managerial remunerations

CLASSIFICATION ON NORMALITY BASIS:

Normal Cost :
- Regular cost incurred in the normal conditions for normal operation of production is known as a
normal cost. Normal cost is the cost, which is normally incurred at a given level of output in the
conditions in which that level of output is normally attained.
- Any cost that is at par to the standard cost can be considered as a normal cost.
Abnormal Cost:
- Costs which are unusual/ irregularly incurred due to abnormal situations.
- For example – value of goods destroyed, cost of idle time of labour

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 For private circulation only – BBA – FUGS, UIM

CLASSIFICATION ON TIME BASIS:

Historical Cost:
- Costs incurred in the past. They are the original and actual cost.
- Such cost is only of historical value and not at all helpful for cost control purposes.
Predetermined Cost:
- For Decision Making – budgeted cost or standard
- Cost computed in advance on basis of factors affecting cost elements.
- Determined on scientific basis - keeping in view past costs and future trends

CLASSIFICATION ON MANAGERIAL DECISION BASIS:

Marginal Cost:
- A change in the total cost when the quantity is increased by one
- It is the cost of producing an additional unit and its impact on the total cost of production.
- It is also known as variable costing.
Out-of-Pocket:
- A potential future outlay of cash that management needs to decide whether or not to make.
- Said another way, it’s an expense that requires a future disbursement of cash.
- These can be avoided or saved.
- For example – rent, wages, purchases
Opportunity Cost:
- Loss of a chance to do something by choosing one activity over another.
- For example – rent of owned building proposed to be used for a new project
Sunk Cost:
- A cost incurred, which can no longer be recovered.
- Since such costs cannot be recovered therefore these have no relevance for decision making.
- For example – in replacement decision of an old machine, its WDV has no relevance.
Differential Costing:
- When there is an increment or decrement in the cost of bulk production.
- It refers to the difference between the costs of two alternative decisions.
- Total cost under alternative I and II as amounting to Rs, 5,00,000 and Rs. 4,00,000 respectively.
Replacement Cost:
- On any asset becoming obsolete or involve high maintenance cost, and at the same time
availability of a better asset option in the market for replacement, it is such substitution cost.
- For example- a transportation company needs to replace its trucks from time to time to avoid
excessive repairing expenses.

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12. METHODS OF COSTING:

- There are different methods of costing (almost half a dozen)

- But why to have so many methods?
- Reason: Every method is made to suit a particular kind of business/industry
- Logically, methods for goods and services will differ, a production involving process will
differ from a bear job costing and a time taking building construction will also have a different.
- The popular methods of costing are as follows: (1) Job Costing, (2) Contract Costing, (3) Batch
Costing, (4) Unit Costing (5) Process Costing, (6) Operating Costing

Exercise 1 (with examples) - Match the following

Methods Purpose Example
1. Job Costing a. To tackle a contract of constructing Construction contract of a
road/mall/building
2. Contract Costing b. Producing similar products in a lot/batch Medicine ‘X’ of 500 units
with 1 batch no.
3. Batch Costing c. Manufacturing with 2 or more processes Treading, weaving, coloring
& printing
4. Process Costing d. Product making with fixed unit cost Card/bricks per unit fixed
cost
5. Unit Costing e. To tackle costing of a specific order/job Mobile repair job –
hardware or software
6. Operating Costing f. Costing of services – hotels Hotels, Cinema, Transport
[Answer - 1(e), 2(a), 3(b), 4(c), 5(d), 6(f)]

CONCLUSION: METHODS OF COSTING

Methods Meaning Business

Job Costing The costs incurred for a particular job or a specific order Mobile Repair

Contract Costing Similar to job costing but the duration of assignment is longer Construction

Batch Costing Costs incurred for a fixed number of units forming a batch/lot Pharmacy

Process Costing Manufacturing involved two or more distinguished processes Textile Mills

Unit Costing The costs are incurred for a fixed quantity and rate Mining

Operating Costing The costs are incurred for services rendered Services

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 For private circulation only – BBA – FUGS, UIM

13. TECHNIQUES OF COSTING:

- Costing Methods: Methods are only the different presentation-modes applicable for different
industries, employed just for ascertaining the costs.
- Costing Techniques: These are the different ways of analyzing and presenting costs for the
purpose of controlling costs and drawing decisions (irrespective of the methods used).
- Costing Methods v. Costing Techniques: Method is essential to know the costing figures.
Costing Technique uses costing facts & figures to conclude on the performance and efficiency.
- The techniques are as follows: (1) Standard Costing, (2) Marginal Costing, (3) Direct Costing,
(4) Absorption Costing, (5) Uniform Costing, (6) Budgetary Control, (7) Historical Costing

COSTING TECHNIQUES DEFINED

Absorption Costing It is the practice of charging all costs, both variable and fixed. This
differs from marginal costing where fixed costs are excluded
Marginal Costing It is the ascertainment of marginal cost by differentiating between
fixed and variable. It is used to ascertain the effect of changes in
volume on profit.
Case – A marriage card upto 250 units will charge Rs. 5,000 and
thereafter every single unit will cost Rs. 10. Why so?
Standard Costing A comparison is made of the actual cost with a pre-arranged standard
cost. Cost deviations (called variances) are analyzed – Adverse or
Favorable. Followed to investigate the reason of variance and to take
corrective action
Uniform Costing It is the use of same costing principles and practices by several firms
under a same industry for common-control/inter-firm comparison of
costs
Direct Costing It is the practice of charging all direct costs, variable and some fixed
costs relating to operations, processes or products leaving all other
costs to be written off against profits in which they arise.
Historical Costing Ascertainment of incurred costs to compare costs over different
periods. This technique has a very limited usage.

Students’ Note: There are seven costing techniques, but in our syllabus (Unit 4) only two of
the techniques have been marked or to be studied – Marginal Costing and Absorption Costing.
So, academically and theoretically all techniques should get in this unit. And numerically in
Unit 4 we will exercise the above mention two techniques only.

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Notes are exhaustive only along with the live lectures
 For private circulation only

14. INSTALLATION OF COSTING SYSTEM

- Costing System means an overall system installed by an undertaking to monitor the costs
incurred, to report and to have control over.
- Thus, a system established having set of methods and techniques employed with objectives of
ascertaining, controlling and minimizing the costs.
- An ideal system of costing is that which achieves the objectives of a costing system and brings
all advantages of costing to the business.
- Following are the main characteristics which an ideal system of costing should possess or the
points which should be taken into consideration before installing a costing system.
1. Size, Layout and Nature of Business: The general nature of the business must be considered
by the costing system planner or designer to gain compatibility of outcomes with the business.
A trading concern requires little cost accounting in comparison to a manufacturing concern.
2. Objective: A costing system will naturally differ according to what exactly is expected from it.
If simply it requires determination of selling or it demands heavy cost control analysis,
accordingly a costing system should be shaped by the designer.
3. Suitability: A costing system should be tailor-made, practical and must be devised according
to the nature, conditions, requirements and size of the business.
4. Simplicity: A costing system should be plain and simple enough to make it facts and figures
easily understood and to draw a meaningful conclusion.
5. Flexibility: A costing system must be flexible so that it may cope-up with the change in the
conditions and circumstances.
6. Economical: A costing system costs money therefore it should not be expensive and must be
adapted according to the financial capacity of the business.
7. Comparability: A costing system must be such so that for evaluating the performance inter-
intra comparison can be done feasibly.
8. Timelines: A costing system must provide accurate and timely information so that it may be
helpful to management for taking decisions and suitable action for the purpose of cost control.
9. Effective Material Control: A costing system must be capable of having an effective stores
and stock control as materials usually account for a greater proportion of the total cost.
10. Adequate Wage Procedure: A costing system must be capable of introducing a well defined
wage system to control the cost of labour. Calculation of idle timing, placing incentives and
evaluating the performance should be nicely considered.
11. Allocation of Expenses: A costing system should have a sound plan to be devised for the
collection, allocation; apportionment and absorption of overheads in order have accuracy.

Notes Compiled by Dr. Vikas Singh (Contact – 9839943452) Page 15

Notes are exhaustive only along with the live lectures