Introduction to Cost and Management Accounting: Basic Cost Concepts | Cost and Management Accounting for CA Intermediate PDF Download

 Page 1


 
         1 
  
BASIC COST CONCEPTS 
 
 
I.  MEANING OF COST 
? The monetary value of all sacrifices made to achieve an objective. (i.e. to produce goods and 
services). 
? Cost refers to the expenditure incurred in producing a product or in rendering a service. 
? It is expressed from the producer or manufacturer?s viewpoint. (not from consumer?s 
viewpoint). 
 
II.  DEFINITIONS 
'Costing' is defined as - “The techniques and processes of ascertaining costs”.  
Cost Accounting' is the classifying, recording and appropriate allocation of expenditure for the 
determination of the costs of the product or services". 
‘Cost Accountancy' is defined as “The application of costing and cost accounting principles, 
methods and techniques to the science, art and practice of cost control, and the ascertainment of 
profitability. It includes the presentation of information derived there from for the purpose of 
managerial decision-making”. 
'Management Accounting' is defined by CIMA as "Management Accounting is the application of 
the principles of accounting and financial management to create, protect, preserve and increase 
value of the stakeholders of for-profit and not-for-profit enterprises in the public and private 
sectors." 
'Cost Management' - It is an application of management accounting concepts, methods of 
collections, analysis and presentation of data to provide the information needed to plan, monitor 
and control costs. 
Inception - It started as a branch of financial accounting but developed soon as a specialised 
field distinct from financial accounting. The limitations of Financial Accounting gave birth to the 
Cost Accounting Methods and Techniques. 
For example - Financial records revealed that the total profit made during the financial year is Rs. 
50,000/- which is 20% of sales i.e. Rs. 2,50,000/-. It is a good performance. But the cost records 
revealed the following facts. 
Products A 
Rs. 
B 
Rs. 
C 
Rs. 
Total 
Rs. 
Sales 
Costs 
1,25,000 
1,30,000 
75,000 
50,000 
50,000 
20,000 
2,50,000 
2,00,000 
Profit / (Loss) (5,000) 25,000 30,000 50,000 
% of profit / (Loss) to sales (4%) 33.33% 60% 20% 
 
The above example clearly explains the importance and need of cost accounting as a separate 
branch from financial accounting. 
 
 
Page 2


 
         1 
  
BASIC COST CONCEPTS 
 
 
I.  MEANING OF COST 
? The monetary value of all sacrifices made to achieve an objective. (i.e. to produce goods and 
services). 
? Cost refers to the expenditure incurred in producing a product or in rendering a service. 
? It is expressed from the producer or manufacturer?s viewpoint. (not from consumer?s 
viewpoint). 
 
II.  DEFINITIONS 
'Costing' is defined as - “The techniques and processes of ascertaining costs”.  
Cost Accounting' is the classifying, recording and appropriate allocation of expenditure for the 
determination of the costs of the product or services". 
‘Cost Accountancy' is defined as “The application of costing and cost accounting principles, 
methods and techniques to the science, art and practice of cost control, and the ascertainment of 
profitability. It includes the presentation of information derived there from for the purpose of 
managerial decision-making”. 
'Management Accounting' is defined by CIMA as "Management Accounting is the application of 
the principles of accounting and financial management to create, protect, preserve and increase 
value of the stakeholders of for-profit and not-for-profit enterprises in the public and private 
sectors." 
'Cost Management' - It is an application of management accounting concepts, methods of 
collections, analysis and presentation of data to provide the information needed to plan, monitor 
and control costs. 
Inception - It started as a branch of financial accounting but developed soon as a specialised 
field distinct from financial accounting. The limitations of Financial Accounting gave birth to the 
Cost Accounting Methods and Techniques. 
For example - Financial records revealed that the total profit made during the financial year is Rs. 
50,000/- which is 20% of sales i.e. Rs. 2,50,000/-. It is a good performance. But the cost records 
revealed the following facts. 
Products A 
Rs. 
B 
Rs. 
C 
Rs. 
Total 
Rs. 
Sales 
Costs 
1,25,000 
1,30,000 
75,000 
50,000 
50,000 
20,000 
2,50,000 
2,00,000 
Profit / (Loss) (5,000) 25,000 30,000 50,000 
% of profit / (Loss) to sales (4%) 33.33% 60% 20% 
 
The above example clearly explains the importance and need of cost accounting as a separate 
branch from financial accounting. 
 
 
 
        2 
III.  OBJECTIVES OF COST ACCOUNTING  
Following are the basic objectives of Costing : 
1. Cost Ascertainment – This involves collection of cost information, by recording them under 
suitable heads of account and reporting such information on a periodical basis. It simply 
means calculation of cost. Cost calculation also helps in ascertainment of profit. 
2. Cost Estimation : In many business situations, we need to quote a price to the customer 
before accepting his order.  In such case you need to first estimate the cost and then add 
profit to provide the price quotation to the customer. 
3. Cost Control : Cost has an inherent tendency to go up, hence cost control becomes a very 
important feature of Cost Accounting.  Cost accounting provides data for comparison 
between standard cost and actual cost to note down the variances.  This variance analysis 
helps us in doing cost control.  We will study this in the chapter of 'Standard Costing'. 
4. Assisting management in decision-making :  Business decisions are taken after 
conducting Cost-Benefit Analysis. Hence cost and benefits of each option are analysed and 
the Manager chooses the least cost option. Thus cost accounting and reporting system assist 
managers in their decision making process. We will study this in the chapter of 'Marginal 
Costing'. 
5. Determination of Selling Price and Profitability :  the cost accounting system helps in 
determination of selling price and thus profitability of a cost object.  Though in a competitive 
business environment, selling prices are determined by external factors but cost accounting 
system provides a basis for price fixation and rate negotiation. 
6. Cost Reduction : It is defined as the achievement of real and permanent reduction in the 
unit cost of goods manufactured or services rendered, without affecting its utility and quality.  
By conducting continuous research and study, we can find better ways to do the things at a 
lower cost, which helps in cost reduction. 
 
IV.  Elements of Cost:  
Basically there are three elements of costs - 
1. Material Cost : It is the cost of tangible items, which gets consumed in the process of 
manufacture. 
2. Labour Cost : It is the cost of human efforts i.e. manpower cost. E.g. salary & wages paid 
to employees. 
3. Expenses : It is the cost, which is neither material nor labour. E.g. rent, electricity, 
depreciation etc. 
These cost elements can be further divided into as : 
Direct Material    Indirect Material 
+ Direct Labour   + Indirect Labour 
+ Direct Expenses   + Indirect Expenses 
Prime Cost       +           Overheads           = Total Cost 
 
In practice, however, the elements of costs are better known as –  
1. Material Cost 
2. Labour Cost and 
3. Overheads Cost 
Page 3


 
         1 
  
BASIC COST CONCEPTS 
 
 
I.  MEANING OF COST 
? The monetary value of all sacrifices made to achieve an objective. (i.e. to produce goods and 
services). 
? Cost refers to the expenditure incurred in producing a product or in rendering a service. 
? It is expressed from the producer or manufacturer?s viewpoint. (not from consumer?s 
viewpoint). 
 
II.  DEFINITIONS 
'Costing' is defined as - “The techniques and processes of ascertaining costs”.  
Cost Accounting' is the classifying, recording and appropriate allocation of expenditure for the 
determination of the costs of the product or services". 
‘Cost Accountancy' is defined as “The application of costing and cost accounting principles, 
methods and techniques to the science, art and practice of cost control, and the ascertainment of 
profitability. It includes the presentation of information derived there from for the purpose of 
managerial decision-making”. 
'Management Accounting' is defined by CIMA as "Management Accounting is the application of 
the principles of accounting and financial management to create, protect, preserve and increase 
value of the stakeholders of for-profit and not-for-profit enterprises in the public and private 
sectors." 
'Cost Management' - It is an application of management accounting concepts, methods of 
collections, analysis and presentation of data to provide the information needed to plan, monitor 
and control costs. 
Inception - It started as a branch of financial accounting but developed soon as a specialised 
field distinct from financial accounting. The limitations of Financial Accounting gave birth to the 
Cost Accounting Methods and Techniques. 
For example - Financial records revealed that the total profit made during the financial year is Rs. 
50,000/- which is 20% of sales i.e. Rs. 2,50,000/-. It is a good performance. But the cost records 
revealed the following facts. 
Products A 
Rs. 
B 
Rs. 
C 
Rs. 
Total 
Rs. 
Sales 
Costs 
1,25,000 
1,30,000 
75,000 
50,000 
50,000 
20,000 
2,50,000 
2,00,000 
Profit / (Loss) (5,000) 25,000 30,000 50,000 
% of profit / (Loss) to sales (4%) 33.33% 60% 20% 
 
The above example clearly explains the importance and need of cost accounting as a separate 
branch from financial accounting. 
 
 
 
        2 
III.  OBJECTIVES OF COST ACCOUNTING  
Following are the basic objectives of Costing : 
1. Cost Ascertainment – This involves collection of cost information, by recording them under 
suitable heads of account and reporting such information on a periodical basis. It simply 
means calculation of cost. Cost calculation also helps in ascertainment of profit. 
2. Cost Estimation : In many business situations, we need to quote a price to the customer 
before accepting his order.  In such case you need to first estimate the cost and then add 
profit to provide the price quotation to the customer. 
3. Cost Control : Cost has an inherent tendency to go up, hence cost control becomes a very 
important feature of Cost Accounting.  Cost accounting provides data for comparison 
between standard cost and actual cost to note down the variances.  This variance analysis 
helps us in doing cost control.  We will study this in the chapter of 'Standard Costing'. 
4. Assisting management in decision-making :  Business decisions are taken after 
conducting Cost-Benefit Analysis. Hence cost and benefits of each option are analysed and 
the Manager chooses the least cost option. Thus cost accounting and reporting system assist 
managers in their decision making process. We will study this in the chapter of 'Marginal 
Costing'. 
5. Determination of Selling Price and Profitability :  the cost accounting system helps in 
determination of selling price and thus profitability of a cost object.  Though in a competitive 
business environment, selling prices are determined by external factors but cost accounting 
system provides a basis for price fixation and rate negotiation. 
6. Cost Reduction : It is defined as the achievement of real and permanent reduction in the 
unit cost of goods manufactured or services rendered, without affecting its utility and quality.  
By conducting continuous research and study, we can find better ways to do the things at a 
lower cost, which helps in cost reduction. 
 
IV.  Elements of Cost:  
Basically there are three elements of costs - 
1. Material Cost : It is the cost of tangible items, which gets consumed in the process of 
manufacture. 
2. Labour Cost : It is the cost of human efforts i.e. manpower cost. E.g. salary & wages paid 
to employees. 
3. Expenses : It is the cost, which is neither material nor labour. E.g. rent, electricity, 
depreciation etc. 
These cost elements can be further divided into as : 
Direct Material    Indirect Material 
+ Direct Labour   + Indirect Labour 
+ Direct Expenses   + Indirect Expenses 
Prime Cost       +           Overheads           = Total Cost 
 
In practice, however, the elements of costs are better known as –  
1. Material Cost 
2. Labour Cost and 
3. Overheads Cost 
 
         3 
V.  DIFFERENT METHODS OF COSTING : 
Job Costing - In this case each job is treated as distinct from other and the cost of each job is 
calculated separately. e.g. Scooter Servicing, fabrication workshop, furniture manufacturing, etc. 
Batch Costing - It is a variation of job costing. A batch is considered as a job and the cost of 
each batch is calculated separately. e.g., Pharmaceutical Companies, toothpastes, spare parts 
etc. 
Contract Costing - It is another variation of job costing, but the job is of a big size relating to civil 
construction or mechanical erection etc. and involves a longer period to complete. Say more than 
a year. e.g. Construction of Bridges, Dams, Housing Complexes, Road Building, etc. 
Process Costing/Operation Costing - This method is applied where different processes are 
involved in a sequence to manufacture a particular product. Cost for each such process is 
required to be calculated separately. e.g., Sugar factories, paper industries, cement industry etc. 
It gets connected to Joint Product & By-Product Costing for multiple products. 
Unit/Single/Output Costing - This method is applied where a continuous production of 
identical items is done. e.g., News paper Printing, Electricity generation, coal mining etc. This is 
the simplest form of costing method. 
Operating Costing - It is applied to service industries like transportation of goods & passengers, 
hospitals, hotels, health clubs and other service centers. 
Multiple Costing - A combination of above different methods of costing may be used as per the 
need and suitability of the organisation. It is called as " Multiple Costing".   It is not a separate 
method of costing but use of a combination of different methods of costing.  
 
VI.  DIFFERENT CLASSIFICATION OF COSTS 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Time based 
 
? Historical  
? Current 
? Budgeted  
Payment based 
? Explicit 
? Implicit  
Controllability based 
? Controllable 
? Non-controllable 
Elements based 
? Materials  
? Labour 
? Expenses 
Normality based 
? Normal 
? Abnormal 
Association based 
? Period 
? Product 
Decision making based 
 
? Relevant  
? Irrelevant  
Nature based 
 
? Variable  
? Fixed  
? Semi-variable  
Function based 
,,, 
? Production  
? Administration  
? Selling 
? Distribution 
? R & D 
? Conversion 
? Pre-production 
 COST 
Page 4


 
         1 
  
BASIC COST CONCEPTS 
 
 
I.  MEANING OF COST 
? The monetary value of all sacrifices made to achieve an objective. (i.e. to produce goods and 
services). 
? Cost refers to the expenditure incurred in producing a product or in rendering a service. 
? It is expressed from the producer or manufacturer?s viewpoint. (not from consumer?s 
viewpoint). 
 
II.  DEFINITIONS 
'Costing' is defined as - “The techniques and processes of ascertaining costs”.  
Cost Accounting' is the classifying, recording and appropriate allocation of expenditure for the 
determination of the costs of the product or services". 
‘Cost Accountancy' is defined as “The application of costing and cost accounting principles, 
methods and techniques to the science, art and practice of cost control, and the ascertainment of 
profitability. It includes the presentation of information derived there from for the purpose of 
managerial decision-making”. 
'Management Accounting' is defined by CIMA as "Management Accounting is the application of 
the principles of accounting and financial management to create, protect, preserve and increase 
value of the stakeholders of for-profit and not-for-profit enterprises in the public and private 
sectors." 
'Cost Management' - It is an application of management accounting concepts, methods of 
collections, analysis and presentation of data to provide the information needed to plan, monitor 
and control costs. 
Inception - It started as a branch of financial accounting but developed soon as a specialised 
field distinct from financial accounting. The limitations of Financial Accounting gave birth to the 
Cost Accounting Methods and Techniques. 
For example - Financial records revealed that the total profit made during the financial year is Rs. 
50,000/- which is 20% of sales i.e. Rs. 2,50,000/-. It is a good performance. But the cost records 
revealed the following facts. 
Products A 
Rs. 
B 
Rs. 
C 
Rs. 
Total 
Rs. 
Sales 
Costs 
1,25,000 
1,30,000 
75,000 
50,000 
50,000 
20,000 
2,50,000 
2,00,000 
Profit / (Loss) (5,000) 25,000 30,000 50,000 
% of profit / (Loss) to sales (4%) 33.33% 60% 20% 
 
The above example clearly explains the importance and need of cost accounting as a separate 
branch from financial accounting. 
 
 
 
        2 
III.  OBJECTIVES OF COST ACCOUNTING  
Following are the basic objectives of Costing : 
1. Cost Ascertainment – This involves collection of cost information, by recording them under 
suitable heads of account and reporting such information on a periodical basis. It simply 
means calculation of cost. Cost calculation also helps in ascertainment of profit. 
2. Cost Estimation : In many business situations, we need to quote a price to the customer 
before accepting his order.  In such case you need to first estimate the cost and then add 
profit to provide the price quotation to the customer. 
3. Cost Control : Cost has an inherent tendency to go up, hence cost control becomes a very 
important feature of Cost Accounting.  Cost accounting provides data for comparison 
between standard cost and actual cost to note down the variances.  This variance analysis 
helps us in doing cost control.  We will study this in the chapter of 'Standard Costing'. 
4. Assisting management in decision-making :  Business decisions are taken after 
conducting Cost-Benefit Analysis. Hence cost and benefits of each option are analysed and 
the Manager chooses the least cost option. Thus cost accounting and reporting system assist 
managers in their decision making process. We will study this in the chapter of 'Marginal 
Costing'. 
5. Determination of Selling Price and Profitability :  the cost accounting system helps in 
determination of selling price and thus profitability of a cost object.  Though in a competitive 
business environment, selling prices are determined by external factors but cost accounting 
system provides a basis for price fixation and rate negotiation. 
6. Cost Reduction : It is defined as the achievement of real and permanent reduction in the 
unit cost of goods manufactured or services rendered, without affecting its utility and quality.  
By conducting continuous research and study, we can find better ways to do the things at a 
lower cost, which helps in cost reduction. 
 
IV.  Elements of Cost:  
Basically there are three elements of costs - 
1. Material Cost : It is the cost of tangible items, which gets consumed in the process of 
manufacture. 
2. Labour Cost : It is the cost of human efforts i.e. manpower cost. E.g. salary & wages paid 
to employees. 
3. Expenses : It is the cost, which is neither material nor labour. E.g. rent, electricity, 
depreciation etc. 
These cost elements can be further divided into as : 
Direct Material    Indirect Material 
+ Direct Labour   + Indirect Labour 
+ Direct Expenses   + Indirect Expenses 
Prime Cost       +           Overheads           = Total Cost 
 
In practice, however, the elements of costs are better known as –  
1. Material Cost 
2. Labour Cost and 
3. Overheads Cost 
 
         3 
V.  DIFFERENT METHODS OF COSTING : 
Job Costing - In this case each job is treated as distinct from other and the cost of each job is 
calculated separately. e.g. Scooter Servicing, fabrication workshop, furniture manufacturing, etc. 
Batch Costing - It is a variation of job costing. A batch is considered as a job and the cost of 
each batch is calculated separately. e.g., Pharmaceutical Companies, toothpastes, spare parts 
etc. 
Contract Costing - It is another variation of job costing, but the job is of a big size relating to civil 
construction or mechanical erection etc. and involves a longer period to complete. Say more than 
a year. e.g. Construction of Bridges, Dams, Housing Complexes, Road Building, etc. 
Process Costing/Operation Costing - This method is applied where different processes are 
involved in a sequence to manufacture a particular product. Cost for each such process is 
required to be calculated separately. e.g., Sugar factories, paper industries, cement industry etc. 
It gets connected to Joint Product & By-Product Costing for multiple products. 
Unit/Single/Output Costing - This method is applied where a continuous production of 
identical items is done. e.g., News paper Printing, Electricity generation, coal mining etc. This is 
the simplest form of costing method. 
Operating Costing - It is applied to service industries like transportation of goods & passengers, 
hospitals, hotels, health clubs and other service centers. 
Multiple Costing - A combination of above different methods of costing may be used as per the 
need and suitability of the organisation. It is called as " Multiple Costing".   It is not a separate 
method of costing but use of a combination of different methods of costing.  
 
VI.  DIFFERENT CLASSIFICATION OF COSTS 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Time based 
 
? Historical  
? Current 
? Budgeted  
Payment based 
? Explicit 
? Implicit  
Controllability based 
? Controllable 
? Non-controllable 
Elements based 
? Materials  
? Labour 
? Expenses 
Normality based 
? Normal 
? Abnormal 
Association based 
? Period 
? Product 
Decision making based 
 
? Relevant  
? Irrelevant  
Nature based 
 
? Variable  
? Fixed  
? Semi-variable  
Function based 
,,, 
? Production  
? Administration  
? Selling 
? Distribution 
? R & D 
? Conversion 
? Pre-production 
 COST 
 
         4 
1. Historical costs :  Costs relating to the past time period; cost which has already been 
incurred. 
2. Current costs : Cost relating to the present period. 
3. Budgeted Costs : Costs relating to the future period; Cost which is computed in advance, on 
the basis of specification of all factors affecting it. 
4. Controllable Costs :  Cost which can be influenced and controlled by managerial action. 
These are also known as avoidable cost or discretionary cost etc. 
5. Non-Controllable costs : These are costs that cannot be influenced and controlled by 
managerial decisions.  These are also known as unavoidable costs or non discretionary 
costs etc. 
6. Normal Cost : Costs which can be reasonably expected to be incurred under normal, routine 
and regular operating conditions. 
7. Abnormal Cost : Costs over and above normal cost; which is not incurred under normal 
operating conditions e.g. fines and penalties, goods lost due to fire, repairs cost due to major 
machine breakdown etc. 
8. Period Cost : These are costs which are not assigned to the products but are charged as 
expenses against the revenue of the period in which they are incurred. These costs vary 
according to period of time and not according to the number of units produced. Thus, they 
are fixed costs e.g. factory rent, fixed salary of office staff, insurance charges etc.  
9. Product Cost : These are costs which will change according to number of units produced. 
These costs are associated with the product we manufacture and not the period.  These are 
also known as variable costs e.g. direct material, direct labour etc. It can be called as the 
cost associated with the acquisition and conversion of material into finished product.  It is 
also known as Engineered Cost. 
10. Engineered Cost : These are the costs that result specifically from a clear cause and effect 
relationship between inputs and outputs.  The relationship is usually personally observable.  
Examples of inputs are direct material cost, direct labour cost etc.  (In my opinion, it is similar 
to Product Cost). 
11. Relevant Costs : Costs which are relevant for decision making i.e. avoidable cost or 
discretionary cost. 
12. Irrelevant Costs : Costs which are irrelevant for decision making i.e. unavoidable cost or 
non-discretionary cost. 
13. Variable Costs : These are costs which tend to vary or change in relation to volume of 
production. They increase in total as production increases and vice-versa e.g. cost of raw 
materials, direct wages etc. However, variable costs per unit are generally constant for every 
unit of the additional output.  
14. Fixed Costs :  These are costs which remain constant at various levels of production. They 
are not affected by volume of production e.g. Factory Rent, Insurance etc. Fixed Costs per 
unit vary inversely with volume of production, i.e. if production increases, fixed cost per unit 
decreases and vice-versa. Sometimes, these are also known as Capacity costs or Period 
Costs. 
15. Semi-variable Costs : These are costs which are partly fixed and partly variable. These are 
fixed upto a particular volume of production and become variable thereafter for the next level 
of production. Some examples are Repairs and Maintenance cost, Electricity bills, Telephone 
bills etc. 
16. Production Cost : It is the costs related to manufacturing activities. Thus it is equal to the 
total of Direct Materials, Direct Labour, Direct Expenses and Production Overheads. 
  
Page 5


 
         1 
  
BASIC COST CONCEPTS 
 
 
I.  MEANING OF COST 
? The monetary value of all sacrifices made to achieve an objective. (i.e. to produce goods and 
services). 
? Cost refers to the expenditure incurred in producing a product or in rendering a service. 
? It is expressed from the producer or manufacturer?s viewpoint. (not from consumer?s 
viewpoint). 
 
II.  DEFINITIONS 
'Costing' is defined as - “The techniques and processes of ascertaining costs”.  
Cost Accounting' is the classifying, recording and appropriate allocation of expenditure for the 
determination of the costs of the product or services". 
‘Cost Accountancy' is defined as “The application of costing and cost accounting principles, 
methods and techniques to the science, art and practice of cost control, and the ascertainment of 
profitability. It includes the presentation of information derived there from for the purpose of 
managerial decision-making”. 
'Management Accounting' is defined by CIMA as "Management Accounting is the application of 
the principles of accounting and financial management to create, protect, preserve and increase 
value of the stakeholders of for-profit and not-for-profit enterprises in the public and private 
sectors." 
'Cost Management' - It is an application of management accounting concepts, methods of 
collections, analysis and presentation of data to provide the information needed to plan, monitor 
and control costs. 
Inception - It started as a branch of financial accounting but developed soon as a specialised 
field distinct from financial accounting. The limitations of Financial Accounting gave birth to the 
Cost Accounting Methods and Techniques. 
For example - Financial records revealed that the total profit made during the financial year is Rs. 
50,000/- which is 20% of sales i.e. Rs. 2,50,000/-. It is a good performance. But the cost records 
revealed the following facts. 
Products A 
Rs. 
B 
Rs. 
C 
Rs. 
Total 
Rs. 
Sales 
Costs 
1,25,000 
1,30,000 
75,000 
50,000 
50,000 
20,000 
2,50,000 
2,00,000 
Profit / (Loss) (5,000) 25,000 30,000 50,000 
% of profit / (Loss) to sales (4%) 33.33% 60% 20% 
 
The above example clearly explains the importance and need of cost accounting as a separate 
branch from financial accounting. 
 
 
 
        2 
III.  OBJECTIVES OF COST ACCOUNTING  
Following are the basic objectives of Costing : 
1. Cost Ascertainment – This involves collection of cost information, by recording them under 
suitable heads of account and reporting such information on a periodical basis. It simply 
means calculation of cost. Cost calculation also helps in ascertainment of profit. 
2. Cost Estimation : In many business situations, we need to quote a price to the customer 
before accepting his order.  In such case you need to first estimate the cost and then add 
profit to provide the price quotation to the customer. 
3. Cost Control : Cost has an inherent tendency to go up, hence cost control becomes a very 
important feature of Cost Accounting.  Cost accounting provides data for comparison 
between standard cost and actual cost to note down the variances.  This variance analysis 
helps us in doing cost control.  We will study this in the chapter of 'Standard Costing'. 
4. Assisting management in decision-making :  Business decisions are taken after 
conducting Cost-Benefit Analysis. Hence cost and benefits of each option are analysed and 
the Manager chooses the least cost option. Thus cost accounting and reporting system assist 
managers in their decision making process. We will study this in the chapter of 'Marginal 
Costing'. 
5. Determination of Selling Price and Profitability :  the cost accounting system helps in 
determination of selling price and thus profitability of a cost object.  Though in a competitive 
business environment, selling prices are determined by external factors but cost accounting 
system provides a basis for price fixation and rate negotiation. 
6. Cost Reduction : It is defined as the achievement of real and permanent reduction in the 
unit cost of goods manufactured or services rendered, without affecting its utility and quality.  
By conducting continuous research and study, we can find better ways to do the things at a 
lower cost, which helps in cost reduction. 
 
IV.  Elements of Cost:  
Basically there are three elements of costs - 
1. Material Cost : It is the cost of tangible items, which gets consumed in the process of 
manufacture. 
2. Labour Cost : It is the cost of human efforts i.e. manpower cost. E.g. salary & wages paid 
to employees. 
3. Expenses : It is the cost, which is neither material nor labour. E.g. rent, electricity, 
depreciation etc. 
These cost elements can be further divided into as : 
Direct Material    Indirect Material 
+ Direct Labour   + Indirect Labour 
+ Direct Expenses   + Indirect Expenses 
Prime Cost       +           Overheads           = Total Cost 
 
In practice, however, the elements of costs are better known as –  
1. Material Cost 
2. Labour Cost and 
3. Overheads Cost 
 
         3 
V.  DIFFERENT METHODS OF COSTING : 
Job Costing - In this case each job is treated as distinct from other and the cost of each job is 
calculated separately. e.g. Scooter Servicing, fabrication workshop, furniture manufacturing, etc. 
Batch Costing - It is a variation of job costing. A batch is considered as a job and the cost of 
each batch is calculated separately. e.g., Pharmaceutical Companies, toothpastes, spare parts 
etc. 
Contract Costing - It is another variation of job costing, but the job is of a big size relating to civil 
construction or mechanical erection etc. and involves a longer period to complete. Say more than 
a year. e.g. Construction of Bridges, Dams, Housing Complexes, Road Building, etc. 
Process Costing/Operation Costing - This method is applied where different processes are 
involved in a sequence to manufacture a particular product. Cost for each such process is 
required to be calculated separately. e.g., Sugar factories, paper industries, cement industry etc. 
It gets connected to Joint Product & By-Product Costing for multiple products. 
Unit/Single/Output Costing - This method is applied where a continuous production of 
identical items is done. e.g., News paper Printing, Electricity generation, coal mining etc. This is 
the simplest form of costing method. 
Operating Costing - It is applied to service industries like transportation of goods & passengers, 
hospitals, hotels, health clubs and other service centers. 
Multiple Costing - A combination of above different methods of costing may be used as per the 
need and suitability of the organisation. It is called as " Multiple Costing".   It is not a separate 
method of costing but use of a combination of different methods of costing.  
 
VI.  DIFFERENT CLASSIFICATION OF COSTS 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Time based 
 
? Historical  
? Current 
? Budgeted  
Payment based 
? Explicit 
? Implicit  
Controllability based 
? Controllable 
? Non-controllable 
Elements based 
? Materials  
? Labour 
? Expenses 
Normality based 
? Normal 
? Abnormal 
Association based 
? Period 
? Product 
Decision making based 
 
? Relevant  
? Irrelevant  
Nature based 
 
? Variable  
? Fixed  
? Semi-variable  
Function based 
,,, 
? Production  
? Administration  
? Selling 
? Distribution 
? R & D 
? Conversion 
? Pre-production 
 COST 
 
         4 
1. Historical costs :  Costs relating to the past time period; cost which has already been 
incurred. 
2. Current costs : Cost relating to the present period. 
3. Budgeted Costs : Costs relating to the future period; Cost which is computed in advance, on 
the basis of specification of all factors affecting it. 
4. Controllable Costs :  Cost which can be influenced and controlled by managerial action. 
These are also known as avoidable cost or discretionary cost etc. 
5. Non-Controllable costs : These are costs that cannot be influenced and controlled by 
managerial decisions.  These are also known as unavoidable costs or non discretionary 
costs etc. 
6. Normal Cost : Costs which can be reasonably expected to be incurred under normal, routine 
and regular operating conditions. 
7. Abnormal Cost : Costs over and above normal cost; which is not incurred under normal 
operating conditions e.g. fines and penalties, goods lost due to fire, repairs cost due to major 
machine breakdown etc. 
8. Period Cost : These are costs which are not assigned to the products but are charged as 
expenses against the revenue of the period in which they are incurred. These costs vary 
according to period of time and not according to the number of units produced. Thus, they 
are fixed costs e.g. factory rent, fixed salary of office staff, insurance charges etc.  
9. Product Cost : These are costs which will change according to number of units produced. 
These costs are associated with the product we manufacture and not the period.  These are 
also known as variable costs e.g. direct material, direct labour etc. It can be called as the 
cost associated with the acquisition and conversion of material into finished product.  It is 
also known as Engineered Cost. 
10. Engineered Cost : These are the costs that result specifically from a clear cause and effect 
relationship between inputs and outputs.  The relationship is usually personally observable.  
Examples of inputs are direct material cost, direct labour cost etc.  (In my opinion, it is similar 
to Product Cost). 
11. Relevant Costs : Costs which are relevant for decision making i.e. avoidable cost or 
discretionary cost. 
12. Irrelevant Costs : Costs which are irrelevant for decision making i.e. unavoidable cost or 
non-discretionary cost. 
13. Variable Costs : These are costs which tend to vary or change in relation to volume of 
production. They increase in total as production increases and vice-versa e.g. cost of raw 
materials, direct wages etc. However, variable costs per unit are generally constant for every 
unit of the additional output.  
14. Fixed Costs :  These are costs which remain constant at various levels of production. They 
are not affected by volume of production e.g. Factory Rent, Insurance etc. Fixed Costs per 
unit vary inversely with volume of production, i.e. if production increases, fixed cost per unit 
decreases and vice-versa. Sometimes, these are also known as Capacity costs or Period 
Costs. 
15. Semi-variable Costs : These are costs which are partly fixed and partly variable. These are 
fixed upto a particular volume of production and become variable thereafter for the next level 
of production. Some examples are Repairs and Maintenance cost, Electricity bills, Telephone 
bills etc. 
16. Production Cost : It is the costs related to manufacturing activities. Thus it is equal to the 
total of Direct Materials, Direct Labour, Direct Expenses and Production Overheads. 
  
 
         5 
17. Administration Cost : The cost of formulating the policy, directing the organisation and 
controlling the operations of the undertaking, which is not directly related to production, 
selling distribution, research or development activity or function. Some examples are Office 
Rent, Accounts Department Expenses, Audit and Legal Expenses, Directors Remuneration, 
Printing & Stationery, Telephone & Postage etc. 
18. Selling Cost : It is the cost of generating demand. These are sometimes called marketing 
costs. Some examples are Advertisement, Salesmen remuneration, Show-room Expenses, 
Cost of samples etc. 
19. Distribution Cost : It is the cost of satisfying the demand. Some examples are : secondary 
packing of goods for the convenience of material handling and transportation, carriage 
outwards, maintenance of delivery vans, expenditure incurred in transporting articles to 
central or local storage, expenditure incurred in moving articles to and from prospective 
customers (as in Sale or Return) etc. 
20. Research Cost : The cost of researching for new or improved products, new applications of 
materials or improved methods. 
21. Development Cost : The cost of the process which begins with the implementation of the 
decision to produce a new or improved product, or to employ a new or improved method and 
ends with commencement of formal production of that product or by that method. 
22. Conversion Cost : It is the cost required to convert raw material into finished goods.  
Conversion cost = Direct labour + Factory overheads. 
23. Pre-production Cost : It is the cost incurred before starting actual commercial production. 
For example, cost incurred in making a trial production run, cost of moulds & designs, cost of 
training the workers etc. 
24. Materials : Cost of tangible, physical input used in relation to output / production, e.g., cost of 
raw materials, consumable stores, maintenance items etc. 
25. Labour : Cost incurred in relation to human resources of the enterprise; e.g. wages to 
workers, Salary to Office Staff, Training Expenses etc. 
26. Expenses : Cost of operating and running the enterprise, other than materials and labour; 
they are the residual category of costs. E.g. Factory Rent, Office Maintenance, Depreciation, 
Electricity etc. 
27. Direct Costs : Costs which are directly related to / identified with / attributable to a cost 
object or a Cost unit. E.g. Cost of basic raw material used in the finished product, wages paid 
to site labour in a contract etc.  In simple words, it is a specific cost. 
28. Indirect Costs : Costs which are not directly identified with a cost object or a cost unit. Such 
costs are apportioned over different cost centers using appropriate basis. E.g., Factory Rent 
incurred over various departments; Salary of supervisor engaged in overseeing various 
construction contracts etc. In other words, it is a common cost.