Elements of cost

SYLLABUS TO BE COVERED 10
ELEMENTS OF COSTS
(a) Materials Costs: - Materials purchasing,
receiving, storing and issuing
including pricing of issues.
(b) Labour Costs and Labour Turnover.
(c) Overheads- Identifying the overheads with
cost centre. Allocation,
Apportionment and Absorption – Accounting
treatment of Under and Over
Absorption.
(d) Preparation of Cost Sheet, items to be
excluded while preparing cost sheet.
 WHAT IS COST ?
• COST IS THE AMOUNT OF EXPENDITURE
INCURRED OR ATTRIBUTABLE TO A
SPECIFIED THING OR AN ACTIVITY.
• IT IS THE AMOUNT OF RESOURCES
(FORM OF MONEY) SACRIFICED TO
ATTAIN A PARTICULAR OBJECTIVE.
• COST IS TOTAL OF ALL EXPENSES
INCURRED PAID OR OUTSTANDING IN
MANUFACTURING OR SALE OF PRODUCT
OR FOR GIVING A SERVICE
• THE PROCESS OF FINDING OUT THE
COST IS COST ACCOUNTING
• PROCESS, TECNIQUES USED OR
PROCEDURE FOR ASCERTAINING THE
COSTS.
• Costing is simply finding the cost which is done
through application of principles and rules for
ascertaining the costs of products
MANUFACTURED and services RENDERED.
• Cost accounting is an extended branch of financial
accounting. It deals with classification, accumulation
and ascertainment and control of costs.
• It is a formal system of accounting by which costs of
products or services are ascertained.
• Features of costing :
– Cost classification
– Cost recording
– Cost allocation
– Cost determination’
– Cost reporting
• Cost Accounting is classifying , recording and
appropriate allocation of expenditure for the
determination of the costs of products or services and
for presentation of suitably arranged data for the
purpose of control and guidance of management.
• The features of cost accounting are
– Process of accounting
– Records income and expenditure relating to production of
goods and services
– Provides statistical data on basis of which estimates are
prepared
– Concerned with cost ascertainment and control
– Establishes budgets and standards to find out variances
LIMITATATIONS OF FINANCIAL
ACCOUNTING
• SHOWS OVERALL PERFORMANCE
• PROVIDES HISTORICAL DATA
• DATA IS STATIC CANNOT INCORPORATE
CHANGES NOT DYNAMIC
• FAILS TO PROVIDE INFORMATION ON FIXATION
OF SELLING PRICE
• NO PROPER CLASSIFICATION OF COSTS
• DOES NOT PROVIDE BASIS FOR COSTS
COMPARISON
• FAILS TO ASCERTAIN THE BREAK EVEN POINT.
• Objectives of cost accounting :
– Ascertainment of cost per unit of different products
manufactured
– Analysis of costs
– Identify the wastage material, time or expenses
– Determining the selling price
– Ascertain profitability
– Exercise control of material , WIP, finished goods
– Advise management on future expansions
 Advantages of cost accounting
• Profitable and unprofitable activities disclosed
• Provides information on which estimates and
tenders are based
• Guiding for future production
• Periodical determination of profits
• Efficiencies and inefficiencies in workers
identified
• Helps management in providing vital
information of taking control and better
decisions.
• Limitations of cost accounting :
– Lacks uniform procedure unlike financial accounting
– Large number of estimates
– Expensive hence only big concerns can use
– Lack of accuracy
– Confusion related to non cost items
– Complex – too many steps.
 Difference between Financial and
cost accounting
• It covers all commercial • Covers transactions related
transactions of business to specific activities,
• The purpose mainly for production, sales and service
external reporting to • The purpose is for internal
owners creditors, reporting mainly to
government, investors etc management
• These have to be prepared • Mainly prepared for mgt
as per requirements of of • Records historical and
companies and IT act estimated costs
• Records historical costs • Cost accounting shows
• Shows profitability of the profitability of product,
business as whole. process, job etc
 Difference between Financial and
cost accounting
• Prepares statements • No such specific
of accounts like profit statements are prepared
and loss account and • Adequate data provided
balance sheet. for price fixation
• Does not guide in • Costs classified into
formulation of pricing fixed variable etc
fixation
• Costs are not
classified
• Cost Unit : is the unit of product, service of time in relation to
which the costs can be ascertainment. It must be defined
and selected before the process of cost finding is started. It
is a unit of cost measurement. E.g.: tonne, hours, kgs , metre
etc
• Cost Centre : a location, a person, or an item of equipment or
a group of these for which cost may be ascertained and used
for the purpose of cost control. It refers to a section of an
organization to which costs are accumulated.
• Cost centres are classified into:
– Personal and impersonal : e.g.; finance manager, works
manager, sales manager. Impersonal – department – HR
dept, A/c Dept etc.
– Production cost centre and service : production activity
carried on such as paint shop, assembly shop etc and
service is where the activities re complementary to
production – stores, Labour office, time office etc
– Operation cost centre – machines and persons carrying
similar operations and process cost centre : continuous
 COST CONCEPT, ANALYSIS
COMPONENTS OF TOTAL COST,
COST SHEET
• The constituents which build up the cost comprises of
materials – supplied in manufacturing, labor which is
the most essential factor of production or service and
is a significant part, and expenses – which are all
costs other than material and labor costs.
• All the above are further classified into direct or
indirect categories
• the total cost is analyzed by elements of costs i.e. by
the nature of expenses.
• THERE ARE THREE MAIN ELEMENTS OF COST :
– MATERIALS
– LABOUR
– EXPENSES
– Classified further into direct or indirect
 ELEMENTS OF
COST

MATERIAL LABOUR EXPENSES

DIRECT INDIRECT
DIRECT INDIRECT INDIRECT DIRECT

OVERHEADS

PRODUCTION
ADMINISTRATION SELLING DISTRIBUTION
OR
OVERHEADS OVERHEADS OVERHEADS
WORKS OVERHEADS
MATERIAL COSTS
• MATERIAL COSTS DENOTES COST OF RAW
MATERIALS CONSUMED IN THE PROCESS
OF MANUFACTURING.
• MATERIAL COSTS ARE CLASSIFIED INTO
DIRECT AND INDIRECT MATERIAL COSTS.
• Direct Materials: are those materials which can be
identified in the product, conveniently measured and
charged to the finished product. They become a part
of the finished product. E.g.; timber in furniture making,
cotton in textile, bricks in building the house etc.
• The following are classified as direct materials
– Raw materials like jute in gunny bag, fruits in canning etc
– Materials purchased for specific jobs , process or order e.g.:
glue for book binding, starch powder for dress yarn etc
– Parts or components purchased like batteries for radio, tyre
for cycle etc
– Primary packing material like cartons, wrappings, cardboard
boxes used to protect finished product for easy handling.
• Indirect materials are those which cannot be
classified as direct. These are of minor
importance . These are a part of finished
goods but not treated as direct materials as
they are comparatively small quantities.
• E.g. : cotton waste, oil, lubricants cleaning
material, sewing thread ,nails, sandpaper, pins,
screws, grease etc.
 LABOR COSTS
• COSTS PAID TO THE EMPLOYEES OR
WORKERS TOWARDS REMUNERATION IN
THE FORM OF WAGES, SALARIES,
COMMISSION, NOMUS FOR EFFORTS
TAKEN IN MANUFACTURING OR
PROVIDING A SERVICE.
• IT IS A SIGNIFICANT COST
• CLASSIFIED INTO DIRECT LABOUR COSTS
AND INDIRECT LABOUR COSTS.
• Direct Labour : all the Labour expended in
construction, composition , altering the
product, which can be identified and
attributed to a job, product, process or for
converting the raw material into finished
products. Such expenses are known as
direct wages. Eg: wages paid to carpenter,
tailor, weaver etc.
• It includes the following
– Labour engaged on actual production
– Labour engaged in aiding the manufacture by
way of supervision, maintenance, tool setting,
transportation of material
– Inspector, analysts specifically required for
production
• Indirect Labour : cannot be identified with
a particular product , not directly engaged
in production but only to assist or help in
production operations
• E.g. clerk, peon, watchman, cleaner ,
trainee, works manager, salary of factory
officer, salary of inspector, wages of
factory sweeper etc.,
• Expenses : all the cost other than the direct
material and Labour are termed as expenses.
• Direct Expenses : are those expenses which
can be identified with and allocated to cost
centres . These are also known as chargeable
expenses.
• E.g.: hire of special plant for a job; traveling
expenses for securing a contract, special
drawings, designs, layout, moulds,architectfees,
surveyors fees etc.
• Indirect Expenses :all indirect costs other than
indirect material and indirect Labour. These
cannot be identified with a process or job.
• E.g.: rent, depreciation, lighting, advertising ,
insurance, repairs,etc.
• The aggregate of direct material + direct
labour + direct expense = PRIME COST
 overheads
• The aggregate of indirect material cost, indirect labour
cost and indirect expenses is known as overheads
• Indirect materials+indirect labour+indirect expenses=
overheads
• Overhead costs are the operating costs of a business
which cannot be identified with particular unit of
output
• Overheads Further segregated into
– FACTORY OR Production Overheads : also known as factory
overheads, works overheads, manufacturing overheads,
these are concerned with production function.
• It includes indirect material -E.g. : cotton waste, oil, lubricants
cleaning material, sewing thread ,nails, sandpaper, pins, screws,
grease etc.
• Indirect labour - E.g. clerk, peon, watchman, cleaner , trainee, works
manager, salary of factory officer, salary of inspector, wages of
factory sweeper etc.,
• Indirect expenses - E.g.: rent, depreciation, lighting, advertising ,
insurance, repairs etc.
– Office and Administration : indirect expenses
incurred in general administrative functions in
formulating policies of planning and controlling
functions , directing personnel in attaining
objectives. These are classified into
• Indirect material – stationary used, postage, sweeping
equipments etc
• Indirect labour – office staff salary, MD salary, directors
salary
• Indirect expenses – rent of office building, legal expenses,
office expenses and equipments, air conditioning
expenses etc.
– Selling and distribution expenses: cost of promoting
and retaining customers. Classified into
• Indirect material – packing material, stationary in sales
office, cost of samples, price list, catalogues
• Indirect labour – salary of sales manager, sales staff,
warehouse staff, driver of delivery van
• Indirect expenses – advertising, traveling, showroom
expenses, carriage outward, rent of warehouse, bad debts,
, insurance of goods in transit etc.
 Components of total cost
ELEMENTS MAY BE GROUPED AS
FOLLOWS :
• Prime cost = DIRECT MATERIAL + DIRECT
LABOUR + DIRECT EXPENSE
• Works cost = PRIME COST + FACTORY
OVERHEADS.
• Cost of production = WORKS COST +
ADMINISTRATION OVERHEADS
• Total cost or cost of sales = COST OF
PRODUCTION + SELLING DISTRIBUTION
OVERHEADS.
• ADD PROFIT TO FIX THE SELLING PRICE.
(DIFF BET SP-CP = PROFIT OR LOSS
 COST SHEET
• It is a statement which is prepared
periodically to provide detailed cost of a
cost centre.
• It shows the total cost and the
components of the total cost
• Period covered by a cost sheet mat be a
year, a month, a week etc.
• A cost sheet is a detailed statement which
shows the analysis of different elements of
cost of a job or a product
• Cost data incorporated is collected from
various statements of accounts.\
• Purposes of cost sheet :
– Discloses cost per unit s well as total cost of output
– Discloses various elements of costs
– Useful for calculation of tender price as selling price
may be fixed in advance
– Helps management to find out the causes of
variations take steps to eliminate the factors
increasing the costs.
– Management can formulate useful production
policy
 Format of simple cost sheet
Particulars Total Unit cost
cost Rs Rs
Direct materials
+ direct labour
+ direct expenses
PRIME COST
+ Factory overhead
FACTORY COST / WORKS COST
+ office and admn overheads
COST OF PRODUCTION
+ selling and distribution overheads
TOTAL COST
ADD PROFIT / LESS LOSS
SALES
 COST SHEET WITH STOCK ADJUSTMENTS

Particulars Total cost Per unit

Rs Rs

Opening stock of raw material

Add purchases of raw material
Add Expenses on purchases of raw material
Less closing stock of raw material
Less purchase returns
Less sale of scrap or defectives of RM
COST OF MATERIAL CONSUMED
ADD DIRECT LABOUR
ADD DIRECT EXPENSES
PRIME COST
 COST SHEET WITH STOCK ADJUSTMENTS

Particulars Total cost Per unit

Rs Rs
Add Factory overheads
Add opening stock WIP
Less closing stock WIP
Less Sale of scrap / defectives WIP
FACTORY COST /WORKS COST
Add office overheads
COST OF PRODCUTION
Add opening stock of finished goods
Less closing stock of finished goods
COST OF GOODS SOLD
Add Selling and distribution overheads
TOTAL COST
Add Profit / less loss
SALES
• NON COST ITEMS – TO BE EXCLUDED FROM COST
SHEET
– Financial incomes – capital profit, dividend received ,
commission received, share transfer fees, interest on
investments, interest on bank deposits, rent received, bad
debts recovery, interest on loan given
– Financial charges – cash discount, trade discount, penalties,
share transfer fees paid, interest on loan , debentures
interest, preliminary expenses, underwriting commission,
discount on issue of shares , loss on investments, income
tax, interest on capital, wealth tax
– Appropriations – bad debt reserve, dividend paid, charitable
donations, transfer to reserve, sinking fun, debenture
redemption reserve
– Abnormal – abnormal idle time, loss by fire , theft, loss of
stock , insurance premium.