Grade 12 Account Note

Introduction to Cost Accounting

Concept of cost accounting

There are three branches of accounting. i.e Financial Accounting, cost accounting and management accounting. Cost accounting is one of the branches of accounting, which has been developed due to the limitation of financial accounting. Financial accounting communicates economic information of an organization as a whole and that is used for external reporting purpose. The reporting of financial accounting may not be sufficient for internal reporting i.e for the formulation of policy and strategy, decision making and control.

According to C.Gilespie “cost accounting is a set of producers for determining the cost of a product and various activities involved in its manufacture and sales and for planning and measuring performance.

FEATURES OF COST ACCOUNTING

The following are the main features of cost accounting

Nature: Cost accounting is a branch of accounting. It is concerned with recording and reporting costs of output to the firm’s management.

Objective: Its main objectives are to accumulate costs of output, job, process, unit and department and report them for different uses.

Status: It is complementary to financial accounting as it provides cost data of different kinds of stock for preparing financial statements.

Basis: It is the basis for cost estimate, cost control, and price determination of output.

Usefulness: It is useful for decision making and performance evaluation as it uses absorption or valuation costing technique in preparing income statements.

 

Objectives of cost accounting

There can be several objectives of cost accounting. However, the following are its important objectives:

To ascertain cost:

The important objective of cost accounting is to ascertain cost of a product or services or jobs. Ascertainment of cost is process of determining cost after they have been incurred. Generally, there are two methods of determining the cost i.e job costing and process costing. Due to the different in the nature of activity of industry, different methods of cost may be applied.

To control cost:

The objectives of cost accounting is to control over the cost by using various techniques such as standard costing, inventory control, marginal costing etc.

To provide information for decision making:

Cost accounting is the formal system of accounting and provides information for various managerial decisions like

i.Whether to accept or reject the offer
ii.Whether to make or buy a product
iii.Whether to continue or replace the existing machine and
iv.Whether to drop or continue the product or services

To fix the selling price:

Cost accounting can beprovide the detailed information about the cost of a product or service to determine the selling price.

To ascertain costing profit or loss:

Cost accounting ascertains total cost and total revenue of every product or services or job and calculates profit or loss by comparing with revenue and cost.

To provide information in preparation of financial statements:

Inventory should be valued for preparation of financial statements by comparing cost price and market price.

 

Importance and advantages of cost accounting

Cost accounting provides immense advantages to a firm. It also can be explained in terms of importance:

Helping in ascertaining of cost:

Cost accounting uses different methods of costing such as job costing, process costing etc. applying this costing method cost of each product, process or job is ascertained.

Helps in inventory control:

It helps in inventory control using various techniques like ABC analysis, economic order quantity, stock level etc.

Helps in measurement of efficiency:

It helps in measurement of efficiency of operations through establishment if standards and various analysis.

Helps in preparation of budget:

It helps in preparation of various budgets such as sales budget, production budget, material purchase budget, flexible budget etc.

 

 

LIMITATIONS OF COST ACCOUNTING

Cost accounting also suffers from a number of limitations such as follows:

Unnecessary: It is unnecessary because it involves duplication of work, many good enterprise are functioning without any costing system.

Expensive: It is expensive because the installation of cost accounting system involves additional cost.

Inapplicable to many industries: It is inapplicable to many industries. A single costing system may not be applicable to all industries because the costing system may be specially designed to meet the need of a specific industry.

Lack of uniform procedure: it is possible that two equally competent cost accounts may arrive at different result from the same information.

Result shown by cost and financial accounting may not be equal to each other: In cost accounting certain incomes such as interest, dividend, share transfer fee etc. are not recorded and certain expenses such interest paid, dividend, loss on sale of fixed assets are not shown but these items are shown in financial accounting.

 

MEANING OF FINANCIAL ACCOUNTING

Business firms for earning profit perform business activities. Each business activity involves financial transactions. Such financial transaction needs proper recording and systematic classification and analysis to know profit or loss and financial position usually at the end of each year. Financial accounting is the account, which keeps records of financial transaction. It shows profit or loss and financial position at the end of each year.

In other word, financial accounting is an art of recording, classifying and summarizing the financial transactions of a firm in such a manner that its profit or loss and financial position are ascertained at the end year an communicated to the user.

 

OBJECTIVES OF FINANCIAL ACCOUNTING

The main objectives of financial accounting are;

To keep systematic record of financial transaction:

The main objective of financial accounting is to record the financial transaction of a business in a systematically and scientific order. The need to record due to limitated memory power of human being.

To disclose the result of operation of business organisation: Profit is the main motive of every firm. Everyone who is related to the firm is keen to know its profit or loss at the end of each year. It is also one of the importance objectives of financial accounting.

To show financial position: The firm is not only keen to know its profit or loss at the end of each year, but also its financial health on that date. The firm’s financial health is judged on the basis of financial position.

To protect assets and properties: Financial accounting not only keeps records of all assets and properties acquired by the firm, but also records of their use and transfer from one place to another. Recording of the firm’s assets and properties and their audit helps to protect from misuse and misappropriation.

 

Limitations of financial accounting

Financial accounting also suffers from limitations. Some notable ones are as follows:

No detailed cost information:

Financial accounting does not provide detailed cost information for different department, processes, product, job, different services and functions. But, financial accounting does not make evaluation performances of units, departments, and processes.

No classification and analysis of cost:

Segregation of costs by nature and behaviour are essential for controlling cost and identifying responsibilities. Financial accounting does not segregate cost in terms of behaviour such as variable or fixed costs, nor does it classify in terms of nature such as direct and indirect costs.

No price determination:

Every firm must determine prices of its outputs in order to sell them. But, financial accounting does not determine the selling prices of the firms output.

No use of standards:

It does not provide any standard costing to measure the efficiency in the use of material, labour and expenses.

No control over cost:

No information over loss of productivity:

Historical data:

 

DIFFERENCE BETWEEN FINANCIAL ACCOUNTING AND COST ACCOUNTING

COST ACCOUNTING

FINANCIAL ACCOUNTING

The main objective of cost accounting is to record and report costs of output.

The main objectives of financial accounting areto report financial results in terms of profit or loss and financial position of a firm.

Cost accounting segregates cost into fixed and variable portion.

Financial accounting does not segregate costs into fixed and variable portion.

Its user are mainly managers who use the cost data for their decision making purpose.

Its users are owners, managers, creditors, employees, workers, consumers and government.

It is voluntarily required for the firm to keep cost accounts.

It is legally required for the firm to maintain financial accounts.

It is primarily applied in manufacturing concerns.

It is generally applied in all types of business concerns.

It values inventory on cost basis.

It values inventory based either on cost or market  price whichever is low.

 

 

 

METHODS OF ACCOUNTING

Methods of costing are the procedures of ascertaining costs of output, process or operation. Since the nature of industry differs from one another, the methods of costing also differ. Important methods of costing are as follows:

Job order costing: Thismethods is used to gathers and accumulates costs for each job order or work order received from customers. Since each job order is specific and terminates after it is completed, therefore all costs that are incurred in the job or order are accumulated after its termination.

Process costing: The costing method that ascertains the cost of each process or stage of producing output is called process costing. Under this method, a separate account is opened for each process to which all costs incurred thereon are charged.

Service costing: The method of costing which is used for ascertaining the costs of service rendered is known as service costing. Under this method, the cost of per unit of service rendered such as cost per passenger kilometre, cost per ton kilometre, cost per kilo-watt, or cost per patient day is determined. Therefore, this method is popular in industries and institutions that provide services instead of manufacturing products.

Contract costing: This costing refers to the form of specific order costing, which applies, where work is undertaken to customer requirements and each order is long duration as compared to job order costing. A job, which is big and spreads over long periods of time is known as a contract. The method of costing which is used in a contract is called contract costing. This method is used by builders, civil engineering contractors and construction firms.

Batch costing: A batch consists of a lot of common units. Therefore, a number of identical units/articles manufactured on lot basis is called batch. A uniform size of product is produced in each batch. The costing method used to determine cost of products produced on lot wise basis is called batch costing.

Multiple costing: An ascertainment of cost of product by using more than one costing method is defined as multiple costing. It is also called composite costing. It is adopted in those industries where several components are used to produce a final product.

 

CONCEPT OF COST

Cost is frequently used word. Since all use the word cost as per their own need and purpose, therefore the meaning of cost differs depending upon the need and purpose. An accountant, economist, engineer and a manager define it according to their need. Therefore, it is not easy to define the term “cost”. However, in simple words, cost is defined as an amount of money spent for obtaining any thing, goods or service. Cost is a resource foregone or sacrifice in monetary terms, to achieve particular objectives.

According to U.S.A., it is defined as an exchange price, the foregoing, a sacrifice made to source some benefits.

 

CONCEPT OF COSTING

The process of fixing costs of activity is defined as costing. The activity refers to manufacture products/articles or services rendered, or function performed. Each activity needs cost. The procedure applied to ascertain unit cost of product or service is costing. So, costing comprises of collection, classification and analysis of cost for ascertaining unit cost of product and services. Manufacturing and service industries follow costing to ascertain cost of products or services.

According to W.H. Wheldon, costing is the classifying, recording and appropriate allocation of expenditure for the determination of the costs of products or services, and for the presentation of suitability arranged data for purpose of control and guidance of management.

 

Classification of costs

Classification of cost refers to the division of cost on the basis of characteristics of costs. it is concerned with dividing cost into different types. it is fact grouping of cost according to their common characteristics. A suitable classification of cost is important to identify cost by product, process or operation. Cost can mainly be classified on the following bases:

1.Element/Nature

2.Functions or activities

3.Variability or behaviour

4.Controllability

 

Elements/ Nature

Cost of product of an industry comprises of material cost, labour cost and expenses. Therefore, cost appears into material cost, labour cost, expenses under the classification of costs based or physical characteristics. Cost has three main elements such as raw materials, labour and other expenses. It can be classified into materials, labour and expenses based on physical characteristics.

 

Material cost

Material cost represents the total of costs of main raw materials, components, consumable stores and packing materials. Materials cost also includes import duties, dock charges, transport cost, storing cost receiving and inspection cost, and other costs associated with the materials purchased.

 

Labour cost

Labour cost is the total of wages incurred for the effort or services made by labours in the productions of goods and services. Therefore, wages paid to the workers are termed as labour costs.

 

Expenses

Expenses are the total of costs incurred for production, administration and selling and distributing operations. Such expenses include the cost of drawing, cost of special tools, cost of trial production, royalties, rent, lighting and welfare expenses.

All the three elements of cost can further be divided or grouped into two types based on their nature such as direct and indirect costs.

 

Direct costs

Direct costs are those materials, labour and other expenses which can easily be attributed or identified with a unit of product, process or operation. The cost of raw materials, productive labour, and carriage of materials paid are the examples of direct cost. The total of direct cost is termed as prime cost.

 

Indirect costs

Indirect costs are those types of cost, which cannot easily be attributed to or identified with a unit of product, process or operation. Therefore, the total of costs of indirect materials, indirect labour and indirect expenses is referred to as indirect costs. They are also called overhead costs. The examples of indirect costs are repair charges, salaries, rent, telephone and water.

 

Direct materials cost: The cost of materials having physical identity with the end product is defined as direct materials cost. Main raw materials and necessary components are a few examples of direct materials.

Indirect materials cost: Materials are not used as inputs of product are called indirect materials. Cost of materials incurred for repair of a machine used for printing of textbook is defined as indirect materials cost.

Direct labour cost:Labour or wages incurred for the operative workers engaged in production process are categorized as direct labour cost. Wages paid to the workers involved in production and handling materials, workers engaged in productive operation by way of supervision and maintenance etc is direct labour costs.

Indirect labour cost: Smooth operation of an organization needs operation of account department, marketing department, and internal transport also besides production department. Indirect labour cost mean salary paid to staff.

Direct expenses: Direct expenses are charged directly to finished product like direct materials cost. It is also called designed chargeable expenses. These include special layout cost, drawing and designed charges, royalties and so on.

 

Indirect expenses:

The cost which is not directly connected with finished product but occur on account of operation are termed as indirect expenses. Indirect expenses are also more frequently called on cost or overheads and include expenses such as canteen expenses, lighting, heating charge, rent, insurance and so on.

Components of indirect materials: Production supplies and consumable stores, greases, waste, Non-durable tools and equipment, maintenance material and supplies, inspection and testing materials.

Components of indirect labour:  Managerial salary, supervisory salary, foremen salary, clerical salary, general labour, unallocated times wages, over-time wages and so on.

Components of indirect expenses: factory rent, electricity, lighting, conveyance and travelling, postage and telegrams, insurance, depreciation of plants and machinery.

 

Functions or activities

The classification of costs based on the functions like manufacturing, administrative, selling and distribution is called functional classification. Functional classification of cost focuses on the different activities and segregate costs accordingly. Production (manufacturing) and non-production (non-manufacturing) costs are the major costs division made after prime cost under this classification.

Prime cost known as Basic, Flat or Direct cost comprises direct material, direct labour, direct expenses. They are attributable to and are identified to particular finished goods.

 

Production Cost

Production cost is the sum of the cost incurred for realizing finished goods. It includes direct material cost and conversion cost needed to convert such direct material into finished goods. So, it is the sum of Prime cost plus manufacturing expenses or factory overhead or work overhead. It is also called manufacturing cost or factory cost or work cost.

Manufacturing expenses include indirect materials, indirect labour and indirect expenses associated with manufacturing operations. Conversion cost includes direct labour cost and manufacturing expenses need to convert input material into finished goods.

 

Process cost

Production cost depending upon the stage of production operation can be categorized into different costs.The output of one process becomes input cost of immediate next process. Costs of each individual process are collected separately and are term as cleaning process cost, cooking process cost and so on. Each process cost is divided by the number of units produced by the same process. It goes on cumulating and total manufacturing cost equals the sum of all cost accumulated at the final process. The cost so accumulated is divided but the number of units produced to ascertain cost per unit of finished goods.

 

Components of manufacturing overheads: Work manager’s salary, factory supervisory salary, Foremen salary, Work Clerks’ salaries, Provident fund contribution of factory employees, Leave and holiday wages of factory employees, Unallocated time wages, over-time wages, Production supplies and consumable stores, Non-durable tools and equipment, Maintenance material and supplies, Greases, Waste, Inspection and testing materials, Inspection and testing labour, Repairs of maintenance of factory plant and equipment, Depreciation of factory plant and machinery, Factory rent, Factory electricity, Factory lighting, Factory insurance.

 

Non-Production cost

Non-production cost refers to the expenses incurred for running administrative and selling and distribution works. So, non-production cost is known as operation cost or non-manufacturing cost that include administrative overhead and selling and distribution overheads. Such costs keep no direct link with production operation therefore defined as non-production cost.

However, cost of production comprises manufacturing cost and administrative expenses.

 

Administrative overheads

The expenses incurred for administrative work like planning, coordinating, directing, controlling, are called administrative overheads. It is also called office cost.

 

Components of administrative overheads:

Director's fees, office rent, rates and taxes, office repairs and maintenance general and miscellaneous, executive salary, staff salary telephone charges, postage and telegrams, printing and stationery, electricity, audit fee, office insurance and so on.

 

Selling and distribution expenses

The expenses paid for selling and distribution of finished goods are called selling and distribution overheads. It can be categorized into selling overheads and distribution overheads.

 

Selling overheads

The expenses incurred for selling finished goods to customers are termed as selling expenses.

 

Components of selling overheads: cost of catalogues/price lists, salaries of sales staff, Salesman’s commission, Training of salesmen, Travelling expenses of sales representatives, Commission, rent of sales office and showrooms, Warehouse expenses, Provident fund, Entertainment and treatment to customers, Samples products, Bad debts and collection charges, Neon light posts, Customers’ service and service after sales.

 

DISTRIBUTION OVERHEADS:  The expenses associated with transporting finished goods from warehouse to sales depot, showroom and customers are termed as distribution overheads.

 

Components of distribution overheads: Packing expenses, Freight outwards, Loading and unloading, Depreciation of delivery vans, Insurance outward.

Total Cost includes cost of production plus a reasonable proportion of selling and distribution expenses. It is normally called costof sales or selling cost.

 

Variability or Behaviour

Knowledge of variability or behaviour of cost is essential for decision making and forecasting of cost. This helps to study how costs react with volume changes. Management needs to identify costs from their behaviour to formulate forward planning and select profitable course of action.

 

Variable Cost

Cost which change proportionality with volume of output or services are called variable costs. They increase or decrease in total amount with the increase or decrease in volume of output. However, the per unit variable cost is constant. Variable manufacturing cost are also called product cost and include direct material, direct labour and fluctuating indirect materials, labour and manufacturing overheads.

 

Fixed Cost

Cost that does not change with output is cost. It remains fixed for a stipulated period and for a specific capacity output. Fixed cost is called constant or capacity cost. It is also called create cost as it remains unchanged for a stipulated period. Fixed cost in total amount remains constant whereas fixed cost per unit changes inversely with output changes. Therefore, increase in output decreases fixed cost per unit and decrease in output increases fixed cost per unit. For example: depreciation, rent and salaries.

 

Semi-variable cost

Those cost which do not change proportionately like variable costs but their increase will be less than proportionate unlike the variable costs is termed as semi-variable cost. The examples of semi-variable costs are salary of supervisors, travelling salesman salary, repair and maintenance costs etc. such costs contain fixed and variable portions. So, semi variable cost is also called mixed costs.

 

Step-fixed costs (semi-fixed/ moving fixed costs)

Fixed costs are fixed either to a capacity volume or to a period of time. Therefore, change in capacity volume or lapses of time create change in fixed cost.  It will changes by the original amount remaining constant for the specific relevant range. Changes take the shape of steps at the different levels so it is called the step fixed cost. Repairs and maintenance cost; depreciation of additional machine purchase are some examples of step fixed costs.

 

Controllability

Controllability may be defined in terms of change or alternation of costs. An effective cost control requires knowledge of cost controllability. A sharp division of cost into controllable and uncontrollability cost is a relative one and is influenced by the action of a person at management hierarchy. The term controllable cost should not be used as synonymous of variable cost and direct costs. Knowledge of controllability of cost is important to control cost.

Cost under controllability may be categorized into controllable and uncontrollable costs.

 

Controllable cost:  The cost subject to control or substantial influence of a particular manager or individual is called controllable cost. In controllable cost, the cost can be changed or altered by the action of a specific managers. Example; direct materials, direct labour, other overheads such as indirect labour, factory supplies, cutting tools, power costs, repair and maintenance etc are controllable costs.

 

Uncontrollable costs: Costs that are not subject to influence by the action of manager is called uncontrollable costs. These costs remain unchanged or unaltered. Example: managerial salaries, staff salaries, depreciation after purchase of equipment, rent. Some costs may be controllable in the short run but not in the long run.


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