Fundamentals of Cost Accounting

Harshad S. Deshpande, Cost Accountant, Pune India 1

Cost Accounting & Costing Cost Accounting & Costing AnalysisAnalysis

-: Presentation on :--: Presentation on :-


Drivers of ChangeDrivers of Change

EconomicEconomicEnvironmentEnvironment

EconomicEconomicEnvironmentEnvironment

Technological Technological EnvironmentEnvironment

Technological Technological EnvironmentEnvironment

• Liberalization of the Indian economy - dismantling of License Raj

• Globalization• Increased competition

from both within and outside India

• Advent of WTO - Reduction in tariffs and QRs

• Increasing sickness in Indian industry

• Heightened M&A activity

Sociopolitical Sociopolitical EnvironmentEnvironment

Sociopolitical Sociopolitical EnvironmentEnvironment

• Rapid rise of information technology - Internet and e-commerce

• Cost reduction due to technological innovation

• Increased automation – Flexible Manufacturing Systems, JIT, etc.

• Organization-wide networking - online information systems

• Rise of Indian IT superpowers

• Reduced interference of politics in business

• Cultural shift towards westernization

• Increasing role of trade associations

• Increased focus on customer service and quality


Emerging Concepts For Cost Accountants…Emerging Concepts For Cost Accountants…

Continuous Innovation for Cost Reduction to Continuous Innovation for Cost Reduction to survive in the competitive environmentsurvive in the competitive environment

Cost + Profit

SALES

Sales - Profit

COST

Traditional Approach

New Approach

Business Process -Business Process -A Paradigm ShiftA Paradigm Shift


Purposes of Cost Accounting:-Purposes of Cost Accounting:-

1. Ascertainment of costs: The first and foremost Purpose of Cost accounting is to ascertain the cost using various costing methods.

2. Determining and controlling efficiency: A cost accountant must study the various operations in involved in the manufacture of products. This study will enable him to render the service of measuring the efficiency of the organisation and in doing so he will be able to devise means of exercising efficiency.

3. Determining the selling price: Cost accounting provides detailed and relevant cost figures for determining the selling price of products or services.

Cont…..


Purposes of Cost Accounting:-Purposes of Cost Accounting:-

4. Preparation of financial statement: Where cost accounts are kept, the ascertainment of the value of closing stocks of raw materials, work-in-progress and finished goods becomes easy and as such financial statements can be prepared monthly or even weekly.

5. Providing a basis for operating policy: Cost accounting plays an important part in the management as it is used as a basis for formulating operating policies


ADVANTAGES OF COST ACCOUNTINGADVANTAGES OF COST ACCOUNTING

1. Establishment 0f more accurate unit costs

2. Development of cost comparisons

3. Elimination of inefficiencies in plant operation

4. Presentation of more frequent and more accurate financial accounts

5. Establishment of increased operating efficiency

Cont…..


ADVANTAGES OF COST ACCOUNTINGADVANTAGES OF COST ACCOUNTING

6. Establishment of control over materials, labour & overhead expenditures

7. Assisting in developing cost calculations for new products.

8. Establishment of an effective costing system prevents manipulation and fraud.


ELEMENTS OF COSTELEMENTS OF COST

1. Direct materials cost: Direct materials cost is the cost of materials which can be identified with, and allocated to, cost centres or cost units. Direct material is that material which becomes a part of the product.

2. Direct wages: Direct wages (labour costs) are the wages which can be identified with and allocated to cost centres and cost units. Direct labour is the labour expended in altering the condition, conformation or composition of the product.

3. Direct expenses: Direct expenses are expenses (other than direct material cost or direct wages) which can be identified with and allocated to cost centres or cost units.

Cont…..



4. Production or factory overhead: Production or factory overhead includes all indirect material cost, indirect wages, and indirect expenses incurred in the factory from the receipt of the order until its completion ready for despatch.

a) Indirect materials b) Indirect wages c) Indirect expenses

5. Administration overhead: Administration overhead includes all indirect materials cost, indirect wages and indirect expenses incurred in the direction, control and administration of an undertaking.

Cont…..



6. Selling overhead: Selling overhead includes all indirect materials cost, indirect wages and indirect expenses incurred in promoting sales and retaining customers.

7. Distribution overhead: Distribution overhead includes all indirect material cost, indirect wages and indirect expenses incurred with making the packed product available for despatch and ends with making the reconditioned returned empty packages available for reuse.


Cost ClassificationCost Classification

Costs may be classified on the basis of various factors such as

Nature or element :- Material Cost Labour Cost Overheads

Function :- Production cost Administration cost Selling cost Distribution cost Research and Development cost Cont…..


Cost ClassificationCost Classification Direct or Indirect

Variability:- Fixed Cost Variable Cost Semi – Variable Cost

Decision Making:- Relevant Cost Irrelevant Cost


METHODS OF COSTINGMETHODS OF COSTING

Different methods of cost finding are used because businesses vary in their nature and in the type of products or services they produce.

The main systems of cost finding which have been evolved

1. Job costing2. Process costing.

3. Multiple or Composite CostingCont…..



1. Job costing: This method is applied where the items of prime cost are traceable to specific jobs or orders, as in house-building; shipbuilding; construction and repair. Contractors' work e.g. garage and repair shops. Here each job is separately identified and prime cost as well as overhead is charged to it.

Job costing may include the following terms: 1. Contract costing 2. Terminal costing3. Departmental costing4. Batch costing

Cont…..



2. Process costing: - This method of costing is used where it is impossible to trace the items of prime cost to a particular order because its identity is lost in volume of continuous production. The following additional terms are used instead of process costing, but each is basically process costing: (a) Single, output or unit costing (b) Operating or operative costing

Cont…..



3. Multiple or composite costing: Some products are so complex (e.g. a motorcar, aeroplanes, cycles, radios, etc.) that no single system of costing is applicable. Where total cost is ascertained by aggregating component costs which are collected by both job and process costing, the system is termed multiple or composite costing. Multiple costing applies to agricultural machineries, general hosiery, electrical accessories, etc.


TECHNIQUES OF COSTINGTECHNIQUES OF COSTING

There are certain costing techniques which may be adopted for the purpose of control and managerial decision-making.

1. Historical costing :-It is the ascertainment of costs after they have been incurred. It permits comparison of costs over different periods.

2. Direct costing :-It is the practice of charging all direct costs to jobs, operations, processes, leaving all indirect costs to be charged to profit and loss account of the period in which they arise.

3. Absorption costing :- It is the practice of charging all costs, both variable and fixed, to jobs, operations or processes

Cont…..



4. Standard costing :-

Standard costing is frequently employed in conjunction with budgetary control. It permits management to investigate the reasons for variances and to take suitable corrective actions.

5. Marginal costing :-

Here, variable costs are charged to products and total fixed costs are charged to costing profit and loss account of the period in which they arise

Cont…..



6. Activity based costing :- It is the attribution of costs to cost units on the basis of benefit received from indirect activities, such as ordering, setting-up, quality control, etc.

7. Uniform costing :-It is the use of the same costing principles and/ or practices by several undertakings to ensure inter-firm comparison.


Comparison between Financial Record Comparison between Financial Record and Costing Record. and Costing Record.

In order to show how valuable the presentation of cost accounting information is, let us consider the following example :

The financial records show that there is a profit of Rs. 6000 i.e. 15 % of the sales.This company produces three products X, Y and Z and the cost accountant has analysed cost and submitted the following product wise statement of profit or loss. In his statement the cost accountant has attributed the different cost to each individual product and as result profit has been arrived at for each product for the purpose of managerial decision making.

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Comparison between Financial Record and Costing Record.Comparison between Financial Record and Costing Record.

Debit Credit

Particulars Rs. Particulars Rs.

To Material consumed 10,000 By Sales 40,000

Wages 9,000

Chargeable exp. 1,000

Production exp. 5,000

Gross profit c/d 15,000

Total 40,000 Total 40,000

To Administration Exp. 2,000 By Gross Profit 15,000

Selling and Dist. Exp 7,000

Net Profit 6,000

(15% of sales)

Total 15,000 Total 15,000

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Statement showing Profit or Loss of X, Y and Z

Item

Total

Products(Rs.) X (Rs.) Y (Rs.) Z( Rs.)

Direct material cost 10,000 4,000 4,000 2,000

Direct wages 9,000 4,000 2,400 2,600

Direct expenses 1,000 600 400

Prime cost 20,000 8,000 7,000 5,000

Production overheads 5,000 2,000 1,500 1,500

Cost of Production 25,000 10,000 8,500 6,500

Administration overheads 2,000 1,000 500 500

Selling & Dist. Overheads 7,000 4,000 1,500 1,500

Total Cost 34,000 15,000 10,500 8,500

Sales 40,000 12,000 16,000 12,000

Profit/ Loss 6,000 (-)3,000 5,500 3,500

Profit (%) to Turnover 15% (-)25% 34.40% 29.20%


Application of CostingApplication of Costing

1. Make or Buy decision 2. Accepting or Rejecting an Order 3. Extra Shift Decision4. Profit Planning 5. Adding or deleting department or product 6. Exploring Foreign Market 7. Plant Replacement Decision 8. Shut Down Decision 9. Preventive vs. Breakdown Maintenance 10. Use of Break Even Point concept 11. Cost Control


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Fundamentals of Cost Accounting