Basic Cost Concepts
Define Terms 1) Cost :
Expenditure incurred in producing a product or in rendering a service
measurement, in monetary terms, of the amount of resources used for the purpose of production of goods or rendering services.
2) Costing :The technique and process of ascertaining costs.
3) Cost Accounting : Begins with recording of
income and expenditureends with the preparation of
periodical statements and reports
4) Cost Accountancy :The application of costing and
cost accounting principles, methods and techniques
practice of cost controlthe ascertainment of profitability
List the Objetives of Cost Accounting
The primary objective of study of cost is to contribute to profitability through Cost Control and Cost Reduction.1. Ascertainment of Cost:
Collection of cost information 2. Determination of Selling Price3. Ascertaining the profit of each activity4. Assisting Management in decision-making5. Cost Control and Cost Reduction
Distinguish between Cost Reduction and Cost Control.
1) PermanencePermanent, Real and genuine savings in
cost. Temporary saving
2) Saving Focus
Saving in Cost per unit Saving either in Total Cost or Cost per unit
3) Product Quality
Retained Not a guarantee
4) Nature of Standards
Continuous process of critical examination Control is achieved through compliance with standards
5) Dynamic
Full Dynamic Less Dynamic
6) CoverageUniversally applicable to all areas of
business. Does not depend upon standards, though target amounts may be
set.
Limited applicability to those items of cost for which standards can be set.
7) Nature of CostsPartly on present costs and largely on
future costs. present and past behavior of costs
8) Nature of Function
Corrective Action - operates even when efficient cost control systems exist. There
is room for reduction in the achieved costs.
Preventive Function - costs are optimized before they are incurred.
9) Tools & Techniques
(a) Value Engineering, (b)Standardisation and
Simplification, (c) Work Study, (d) Variety Reduction, (e) Quality Measurement &
Research, (f) Operations Research, (g) Market Research, (h)Job Evaluation and Merit
Rating, (i)Improvement in Product
Design, (j)Mechanisation and
Automation, etc.
Budgetary Control and Standard Costing.
Bring out the importance of Cost Accounting to Business Concerns.
1. Decision Making: Business decision-making requires analysis of statements indicating the likely effect of various cost control and revenue generation measures on the profits.
2. Cost Control:For example, Material Costs may be controlled by –
(a) ensuring un-interrupted supply of material and spares for production,
(b) avoiding excessive locking up of funds / capital in stocks of materials and stores, and
(c) use of techniques like Value Analysis, Standardization, etc.
3) Budgeting:Budget Estimates are drawn up by Cost Accounting Department, before the start of each activity, to ensure that a practicable course of action is identified, and the actual performance corresponds with the estimated.
4) Measuring Efficiency: Cost Accounting Department can provide information about standards and actual performance of the concerned activity.
5) Price Determination : 6) Curtailment of Loss during off-season:7) Expansion:
Distinguish between Cost Accounting and Financial Accounting.
1) Users of InformationInternal Management & External
ManagementInternal Management for proper planning,
decision making & cost control
2) Statutory Compliance
Companies Act, Income Tax ActCost Accounting is voluntary, except in cases
where Cost Accounting Records Rules mandatorily apply to the enterprise
3) Nature/ObjectivityAccounting Policies may differ from one
Firm to another Firm.Techniques are generally uniform to all
Firms.
4) Focus
Recording the transactions. Control Cost
5) Nature of Cost
Historical Cost Historical Cost & Standard Cost i.e. Pre determined cost
6) Stock Valuation
Cost or NRV whichever is less. Cost
7) Cost AnalysisCost / Expenditure and Profits are generally shown as a whole for the
period.
Costs are analysed product-wise, department-wise, activity-wise, etc.
8) Time Period
F.S. are prepared at the end of the Year Cost data & reports are prepared on continuous basis.
9) Forecasting & PlanningLimited Use. Parameters like GP, NP, ROI,
EPS, etc. can be laid down.Specific and detailed plan for each
product/Useful for Budgeting
10) Utility for decisions
Helps only for future decisions with respect to product pricing, make or buy, asset retainment vs replacement, etc.
Helps current & future decisions, e.g. product price reduction and higher volume in order to earn target profit, resource re-allocation, etc.
Note: Cost Accounting supplements Financial Accounting for analysis and decision-making purposes, as described above.
Financial Accounting suffers from limitations of lack of analysis of information, and absence of detailed control and assessment parameters.
Better tools of control, analysis and assessment are available. Some examples are Variance Analysis, Budgetary Control, & Marginal Costing.
11) Control & Assessement
Cost
Functions-basedProduction
AdministrationS&DR&D
Pre ProductionConversion
Relationship based
• Direct• Indirect
Controllability based
• Controllable• Non-
Controllable
Normality basedNormal
Abnormal
Attributability based
• Product• Period
Decision—making based
• Relevant• Irrelevant
Cause & Effect based
• Engineered• Discretionary
Payment-based
• Explicit• Implicit
List the various items of costs on the basis of relevance to decision-making.
(A) Relevant Costs:
1) Marginal Cost:
Total Variable Cost, Prime Cost plus Variable Overheads.
(Marginal Cost is relevant for decision-making, as this cost will be incurred in future for additional units of production.)
2) Differential Cost:
• It is the change in costs due to change in the level of activity or pattern or method of production.
• Where the change results in increase in cost it is called Incremental Cost
• If costs are reduced due to decrease of output, the difference is called decremental Costs.
3) Opportunity Cost:
• The value of sacrifice made or benefit of opportunity foregone in accepting an alternative course of action.
• For example, a Firm may finance its expansion plan by withdrawing money from its bank deposits. Then, interest lost on the Bank Deposit is the opportunity cost for carrying out the expansion plan.
4) Out-of-pocket Cost:
• Current or near future outlays of cash for the decision at hand
• relevant for decision-making• short-run concept• avoided or saved, if a particular proposal under
consideration is not accepted.
5) Replacement Cost:
• It is the cost at which there could be purchase of an asset or material identical to that which is being replaced or revalued.
• It is the cost of replacement at current market price and is relevant for decision-making.
6) Imputed Costs:
• notional costs appearing in the cost accounts only• e.g. notional rent charges, interest on capital for
which no payment has been made.• Where alternative capital investment projects are
being evaluated, it is necessary to consider.
(B) Irrelevant Costs: Not useful for decision making
1) Sunk Cost:
• Has already been incurred or sunk in the past.• It is not relevant for decision making
• Firm has obsolete stock of materials originally purchased for Rs.50,000 which can be sold as scrap now for Rs.18,000 or can be utilised in a special job, the value of stock already available Rs.50,000 is a sunk cost and is not relevant for decision-making.
2) Absorbed Fixed Costs:
• Fixed Costs do not change due to increase or decrease in activity
• Fixed Costs are absorbed in cost of production at a normal rate, they are irrelevant for managerial decision-making.
• However if Fixed Costs are specific, they become relevant.
3) Committed Costs:
• Cost in respect of which decision has already been taken, and such decision cannot be altered.
• e.g. entering into irrevocable agreements for Rent, Technical Collaboration, etc.
• should be contrasted with Discretionary Costs, which are avoidable costs.
Cost Classification for presentation purpose
Total Cost
Direct Cost i.e. Prime Cost
Direct
Material
Direct
Labour
Direct
Expnese
Indirect Cost (OH)
Production OH
Administration OH
Selling &
Distribution OH
Cost Sheet? What are its uses?Meaning:
1. shows the break-up and build-up of costs2. document which provides the consolidation of the
detailed cost of a Cost Centre or a Cost Unit.Uses:1. Presentation of Cost information.2. Determination of Selling Price.3. Ascertainment of profitability.4. Preparation of Budgets.
5) Inter-Firm and Intra-Firm Cost Comparison.6) Preparing Cost Estimates for submitting tenders /
quotations.7) Product-wise and Location-wise Cost Analysis.8) Disclosure of operational efficiency for Cost Control
Items that are not regarded as "Cost" and not included in the Cost Sheeta) Non-Operating Incomes, e.g. Rent, Interest and
Dividends received.b) Losses or Profits of capital nature, e.g. Profit or Loss on
sale of Investments, Plant and Equipment, etc.c) Items not representing actual costs but dependent on
arbitrary decisions and policies of the management, e.g. an unreasonably high salary to the Managing Director, providing for depreciation at a rate exceeding the economic rate.
d) Appropriation of Profits, e.g. Payment of Dividends, Transfers to Reserves, etc.
e) Profit based Outflows, i.e. Income-Tax. [Note: Bonus paid to workers is treated as Cost].
f) Amounts representing loss on account of inefficiency of a particular activity, e.g. Bad Debts as a result of inefficient credit management, Penalties & Fines due to non-compliance with law, abnormal wastages and losses, etc.
g) Items which may distort comparison, e.g. financial items like interest, discount, etc. and other similar items.
h) Imputed items that are not actually incurred by the firm but constitute arbitrary charges against profit, e.g. interest on own capital at an arbitrary rate.
i) Write-offs of Goodwill, Preliminary Expenses, etc.
Particulars Production / Manufacturing A/c Cost Sheet 1. Basis It is prepared on the basis of double-entry system of book-keeping. It is only a statement and hence double-entry system is not applicable. 2. Purpose The primary objective of preparation is Reporting. The primary objective is decision-making. 3. Parts It has two parts - one showing the cost of manufacture and the other part showing Sales and Gross Profit. It is a step-by-step presentation of total cost and shows Prime Cost, Works Cost, Cost of Production, Cost of
Goods Sold, Cost of Sales and Profit. 4. Analysis Total Cost is shown in aggregate. Product-wise or Location-wise analysis is not generally given. Cost Sheet shows costs in a detailed and analytical manner, which facilitates cost comparison. 5. Quotations This is not useful for preparing tenders or quotations. Estimated Cost Sheets can be prepared based on past experience, and useful for submitting quotations.
Production / Manufacturing A/c Cost Sheet
1) Basis
double-entry system of book-keeping only a statement and hence double-entry system is not applicable.
2) Purpose
Reporting decision-making.
2) Purpose
Reporting decision-making.
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