Cost and Management Accounting PDF

Cost and Management Accounting DEACC205 Edited by: Dr. Lalit Bhalla Cost and Management Accounting Edited By Dr. Lalit Bhalla  CONTENTS Unit 1: Introduction to Cost Accounting...

Cost and Management Accounting DEACC205 Edited by: Dr. Lalit Bhalla Cost and Management Accounting Edited By Dr. Lalit Bhalla  CONTENTS Unit 1: Introduction to Cost Accounting 1 Dr. Arpit Sidhu, Lovely Professional University Unit 2: Cost Sheet 23 Dr. Arpit Sidhu, Lovely Professional University Unit 3: Material Costing 42 Dr. Arpit Sidhu, Lovely Professional University Unit 4: Techniques of Inventory Control 61 Dr. Arpit Sidhu, Lovely Professional University Unit 5: Pricing Material Issues 83 Dr. Arpit Sidhu, Lovely Professional University Unit 6: Marginal Costing 103 Dr. Arpit Sidhu, Lovely Professional University Unit 7: CVP Analysis 118 Dr. Arpit Sidhu, Lovely Professional University Unit 8: Standard Costing 137 Dr. Arpit Sidhu, Lovely Professional University Unit 9: Variance Analysis 152 Dr. Arpit Sidhu, Lovely Professional University Unit 10: Introduction to Management Accounting 179 Dr. Arpit Sidhu, Lovely Professional University Unit 11: Analysis of Financial Statements 191 Dr. Arpit Sidhu, Lovely Professional University Unit 12: Ratio Analysis 214 Dr. Arpit Sidhu, Lovely Professional University Unit 13: Cash Flow Statement 243 Dr. Arpit Sidhu, Lovely Professional University Unit 14: Budgetary Control 264 Dr. Arpit Sidhu, Lovely Professional University  Notes Dr. Arpit Sidhu, Lovely Professional University Unit 01:Introduction of Cost Accounting Unit 01: Introduction of Cost Accounting CONTENTS Objectives Introduction 1.1 Concept of Cost 1.2 Evolution of Cost Accounting 1.3 Definitions of Important Concepts 1.4 Features of Cost Accounting 1.5 Importance of Cost Accounting 1.6 Objectives of Cost Accounting 1.7 Advantages of Cost Accounting 1.8 Limitations of Cost Accounting 1.9 General Principles of Cost Accounting 1.10 Classification of Costs 1.11 Distinction between Financial Accounting and Cost Accounting Summary Keywords Self Assessment Answer for Self Assessment Review Questions Further Readings Objectives After studying this unit, you will be able to:  Understand the nature, scope and utility of cost accounting.  Familiarize with costing terminology.  Understand how cost accounting arises out of the need to make business decisions.  Difference between cost accounting and financial accounting.  Classify the components of cost. Introduction Accounting is an ancient science that seeks to keep track of various transactions. Accounting is thought to be necessary for keeping track of all receipts and payments, as well as revenue and expenditures. Accounting is usually classified into three types; viz; financial accounting, cost accounting and management accounting. Financial accounting seeks to determine an accounting year's profit or loss, as well as the assets and liabilities position, by recording various transactions in a methodical manner. LOVELY PROFESSIONAL UNIVERSITY 1 Notes Cost and Management Accounting Cost accounting assists businesses in determining the cost of production/services provided by the firm, as well as providing essential information for various decisions, cost control, and cost reduction. Cost accounting is an important discipline of accounting that provides correct information to management in order to properly discharge its tasks such as planning, organising, controlling, directing, coordinating, and decision making. In this sense, Financial Accounting is concerned with record keeping for the purpose of preparing Profit and Loss Accounts and Balance Sheets. It gives general information about the company. As a result, Financial Accounts are prepared in accordance with the requirements of the Companies Act and the Income Tax Act. The primary goal of financial accounting is to determine a company's overall profit or loss for a given time. Thus, financial accounting does not meet management's needs for effective control, pricing setting, establishing effective plans for future operations, and devising various policy judgments. To address the limits of financial accounting, cost accounting is a recent concept that was formed in response to management's demand for specific information about the cost of a product or a unit of services. Every business is expected to produce a profit in the long run while keeping expenditures under control. The company Act has made the maintaining of expense records in some manufacturing companies mandatory. As a result, large manufacturing and nonmanufacturing operations are increasingly utilizing Cost Accounting at large. Concept of Cost The amount of resource given up in exchange for particular goods or services is referred to as the cost. Money or money's equivalent expressed in monetary units is given up as a resource. The Chartered Institute of Management Accountants, London defines cost as “the amount of expenditure (actual or notional) incurred on, or attributable to a specified thing or activity”. This activity of a firm may be the production of a product or the provision of a service, both of which include expenditures under numerous headings, such as materials, labour, miscellaneous expenses, and so on. A manufacturing organisation is interested in determining the cost per unit of the product created, whereas a service organisation, such as a transportation undertaking, canteen, electrical company, municipality, and so on, is interested in determining the expenses of the service it provides. In its most basic form, the cost per unit is calculated by dividing the total expenditure by the total number of units produced or the amount of service delivered. However, this strategy is only effective if the manufacturer only manufactures one product. If the company produces more than one product, the total expenditure must be divided across the numerous items so that the cost of each product may be determined independently. Even if just one product is produced, it may be required to examine the cost per unit of each item of expenditure that contributes to the total cost. When a large number of products are created, the situation gets more complicated, and it is important to break down the cost per unit of each product into several components of expenditure that make up the entire cost. For a customer, cost equals price. For management, cost refers to the 'expenditure incurred' for producing a specific product or providing a specific service. Costing is the process of determining the cost. It is made up of concepts and rules that control the process of determining the costs of goods and services. Its goal is to determine the total cost as well as the cost per unit. For example, in transportation businesses, the entire cost for the period is calculated and used to calculate the cost per passenger/mile. i.e. the cost of transporting one passenger one mile. It allows for spending analysis in such a way that management has a thorough understanding of even the smallest cost item. It is vital to define the term "cost" precisely. When used precisely, the phrase is amended with terminology such as prime cost, fixed cost, sunk cost, and so on. Each description suggests a certain quality that aids in cost analysis. It aids cost accounting in attaining its three primary goals: cost ascertainment, cost control, and cost presentation. A cost must always be considered in connection to its purpose and circumstances. Different costs can be calculated for various purposes and under various conditions. Work-in-progress is valued at the factory cost, whereas finished goods stock may be valued at the cost of production. Even if the goal of the cost research is the same, different factors may cause cost difference. The cost per unit of a product is bound to vary as the volume of output increases, because the amount of fixed expenses absorbed by each unit of output reduces. 2 LOVELY PROFESSIONAL UNIVERSITY  Notes Unit 01:Introduction of Cost Accounting It is also vital to remember that there is no such thing as an exact or genuine cost because no cost figure is correct in all circumstances and for all reasons. The majority of the costing information is estimated; for example, the amount of overheads is often estimated in advance; it is divided over cost units, again on an estimated basis using various ways. Many aspects of production cost are handled in an optional manner, which may result in varying costs for the same product without violating any established standards. Depreciation is one such factor, the amount of which varies depending on the form of depreciation utilised. As a result, arriving at an exactly correct cost may be impossible unless one waits a lengthy time, during which time the costing information may lose all of its usefulness. Evolution of Cost Accounting Accounting has existed from the dawn of time. It is the process of discovering, measuring, documenting, and disseminating economic data that can be expressed in monetary terms. Accounting information's utility stems from its capacity to eliminate ambiguity. The data must be meaningful, verifiable, quantitative, and free of bias. Businesses were tiny and defined by basic market trades between individuals and groups prior to the industrial revolution. There was a need for proper bookkeeping back then, but not so much for cost accounting. However, the 18th-century industrial revolution produced large-scale process industries that performed single tasks (e.g. textiles, railways etc.). Because there was a dearth of a market for intermediary items during this time period, cost information became important as a tool for analysing the efficiency of various processes. However, several industrialists exploited the concept of prime cost around 1875. The period 1880 AD-1925 AD saw the development of complicated product designs as well as the creation of multi-activity diversified organisations such as Du Pont, General Motors, and others. During this time, scientific management was developed, leading accountants to turn physical standards into cost standards, which were then used for variance analysis and control. In the year 1913, J.L. Nicholson's book "Cost Accounting Theory and Practice" was published in New York. During World War I and II, the social value of cost accounting increased in tandem with the expansion of the teaching country's defence budget. In the lack of competitive marketplaces for the majority of the items required to fight a war, governments in various nations entered into cost-plus contracts in which the price to be paid was the cost of production plus an agreed-upon rate of profit. The parties to defence contracts continued to rely on cost information after World War II. Even today, the majority of government contracts are awarded on a cost-plus basis. Definitions of Important Concepts The definitions of the following important Cost Accounting concepts are provided below: (a) Cost (b) Costing (c) Cost Accounting (d) Cost Accountancy (e) Cost Control (f) Cost Reduction (g) Cost Allocation (h) Cost Absorption (i) Cost Audit (j) Cost Unit (k) Cost Centre (a) Cost:The term "cost" is used in a variety of contexts. Cost can be defined as the sum of all expenses involved in the production of a certain item. A cost is defined as "the amount measured in money or cash expended or other property transferred, capital stock issued, services performed, or a liability incurred in consideration of goods or services received or to be received" by the AICPA. W.M. defines the term 'cost.' Harper, in his own words "Cost is the monetary value of economic resources utilised as a result of the cost of creating or doing the thing" (b) Costing: ICMA London defines costing as "the technique and process of ascertainingcosts." As a technique, it refers to costing as the body of principles and procedures concerned with appropriate expenditure allocation for the determination of the cost of products and services. (c) Cost Accounting:Cost accounting is a way of accounting for cost. Cost accounting is defined by the ICWA as the technique and process of determining costs. Cost accounting starts with recording all income and expenses and finishes with the display of statistical data. LOVELY PROFESSIONAL UNIVERSITY 3 Notes Cost and Management Accounting (d) Cost Accountancy: According to the Chartered Institute of Management Accountants London,cost accountancy means "the application of costing and cost accounting principles, methods andtechniques to the science, art and practice of cost control and the ascertainment of profitability. It includesthe presentation of information derived therefore for the purpose of managerial decision making. Thus,cost accountancy is the science, art and practice of a cost accountant." (e) Cost Control:Cost control is the direction and regulation of an undertaking's operating costs through executive action. It entails determining the intended costs in beforehand, measuring the actual costs, investigating the causes of deviations, and implementing corrective action. (f) Cost Reduction:The phrase "cost reduction" refers to the attainment of a true and permanent reduction in the unit cost of items manufactured or services supplied without compromising their appropriateness or product quality. Cost reduction entails a reduction in unit cost; such a reduction is permanent, and the utility and quality of the goods and services remain unaffected. (g) Cost Allocation:Cost allocation is the assignment of entire cost items to cost centres. Cost Allocation refers to the practise of charging all overhead expenses to a cost centre. (h) Cost Absorption:The process of absorbing all overhead costs is referred to as 'Cost Absorption.' The costs allotted to or apportioned across a specific cost centre or manufacturing department based on the units generated. Cost Ascertainment: The word 'Cost Ascertainment' refers to the process of determining the cost of each product. process or operation and guarantee that all costs have been absorbed in the product cost One of the most important goals of cost accounting is cost determination. (i) Cost Audit:According to I C M A, a 'Cost Audit' is a detailed review or verification of cost accounts and a check on conformity to the cost accounting plan. The goal of a cost audit is to determine whether or not the procedures established for determining costs and other decisions are being effectively executed, as well as whether or not the cost accounting plan is being followed. The goal could be (i) Protective and (ii) Constructive:The protective goal is to ensure that there is no unnecessary waste or loss, and that the cost accounting system accurately reflects the right and actual cost of production. Based on the findings of the cost audit, the constructive purpose intends to provide management with information useful in controlling production, selecting economic methods of operation, decreasing operational expenses, and so on. (j) Cost Unit:A 'Cost Unit' is a unit of goods, service, or time against which costs can be calculated. It is a monetary unit that can be used to calculate costs. Cost Units can be chosen as (a) single, (b) composite, or (c) commonly used. Here are some examples of Cost Units used in various industries: Name of Industry Cost Units used Paper Per Tonne (or) Per Kg Steel Per Tonne Sugar Per Quintal Cement Per Tonne Textile (cloth) Per Metre Transport Passenger Kilometre Electricity Per Kilo Watt-hour Bricks Per 1000 bricks 4 LOVELY PROFESSIONAL UNIVERSITY  Notes Unit 01:Introduction of Cost Accounting (k) Cost Centre: According to the Chartered Institute of Management Accountants, London, Cost Centre is defined as a location, person or items of equipment (or group of these) for which costs may be ascertained and used for purposes of cost control. In other words, cost centre is a part of an organization which includes location, processes, equipment, (or) machine centres, various departments, persons etc. in relation to which costs can be charged or ascertained. Cost Centres can be classified into the following types :  Personal Cost Centre: : It is made up of a single person or a group of people, such as a salesperson, a marketing manager, and so on.  Impersonal Cost Centre: An impersonal Cost Centre is one that comprises of a place or pieces of equipment.  Operation Cost Centre: It is made up of machines and/or people who perform comparable tasks.  Process Cost Centre: A Process Cost Centre is a Cost Centre that comprises of a single process or a continuous sequence of operations. Features of Cost Accounting a) It is a process of accounting for costs. b) It keeps track of income and expenses related to the production of goods and services. c) It supplies information from which future estimations and quotations are generated. d) It is concerned with cost estimation, control, and reduction e) It establishes budgets and standards so that actual cost may be compared to find out deviations/variances Importance of Cost Accounting Because of the limits of financial accounting, management has recognised the need of cost accounting. Whatever form of business it is, it entails spending money on labour, materials, and other items needed for creating and disposing of the product. At each level, management must avoid the possibility of waste. It must ensure that no machine is idle, that efficient labour is adequately rewarded, that byproducts are correctly utilised, and that expenses are accurately calculated. Aside from management, the installation of a competent costing system benefits creditors and employees in a variety of ways. Cost accounting boosts an organization's total production and acts as a key instrument in bringing wealth to the nation. As a result, the value of cost accounting can be addressed under the following headings: A. Costing as an Aid to Management Management benefits greatly from cost accounting. It gives thorough costing information to management in order for them to keep effective control over stores and inventory, boost organisational efficiency, and reduce waste and losses. It makes it easier to delegate responsibility for essential tasks and rate staff. For all of this, management must be capable of properly utilising the information provided by cost accounts. B. Costing as an Aid to Creditors Investors, banks and other money lending institutions have a stake in the success of the business concern and are, therefore, benefited immensely by the installation of an efficient system of costing. They can base their judgment about the profitability and future prospects of the enterprise on the costing records. C. Costing as an Aid to Employees LOVELY PROFESSIONAL UNIVERSITY 5 Notes Cost and Management Accounting Employees have a vested stake in the success of their employer's business. They profit in a variety of ways from the implementation of an effective costing system. They profit from ongoing employment and increased remuneration through incentives, bonus programmes, and so on. D. Costing as an Aid to National Economy A costing system that is efficiently delivers prosperity to the company enterprise, which increases government revenue. The overall economic development of a country occurs as a result of increased production efficiency. Controlling costs and eliminating waste and inefficiencies aided the advancement of the industry and, as a result, the nation as a whole. Did you know? State whether the following statement is “True” or “False” Costing and Cost Accounting are the same thing: True False Correct answer: False Objectives of Cost Accounting  To determine the cost of manufacturing per unit, such as cost per kilogramme, cost per metre, cost per litre, cost per tonne, and so on.  Cost accounting aids in determining the selling price. Cost accounting allows for the accurate determination of production costs and the fixing of selling prices.  Accounting for costs aids in cost control and cost reduction.  Cost accounting enables the determination of divisional, activity-based, and unit-based profitability.  Cost accounting also aids in the identification of waste, inefficiencies, and other flaws in the manufacturing processes/services provided.  Cost accounting aids in the presenting of pertinent data to management, which aids in decision making. Decision making is a crucial function of management, and it necessitates the presentation of pertinent facts. Cost accounting allows for the systematic display of pertinent facts, allowing for decision making.  Cost accounting also aids in the forecasting of future costs. Advantages of Cost Accounting Cost accounting assists management in determining the true cost of each operation by establishing objectives and standards of operation, comparing actual performance to standards, and identifying gaps or variances. If the deviations are negative, management takes remedial action to eliminate the variances. The following are the benefits of cost accounting to management, employees, creditors, the government, and the general public: Advantages to the Management (1) Makes planning easier. (2) Aids in policy formulation. (3) Helpful in establishing performance objectives and standards. (4) Makes cost comparison easier. (5) Contributes to successful cost control. (6) Establishes the selling price. 6 LOVELY PROFESSIONAL UNIVERSITY  Notes Unit 01:Introduction of Cost Accounting (7) Determines the profit of each action. (8) Assists management in making decisions. (9) Aids in cost-cutting. (10) Tracks performance. Advantages to the Employees (1) Ensures equitable incentive wage systems (2) Promotes employment security, recognition, and advancement. (3) Useful for determining staff operational efficiency. Advantages to the Creditors (1) Assesses a company's financial soundness and creditworthiness. (2) Persuade investors to extend their credit lines. (3) Builds trust among creditors, debentureholders, banks, and others Advantages to the Government (1) It helps to formulate business policies and national plans for industrial development. (2) It makes it easier to assess taxation and create indexes. (3) It assists in effective utilization of resources, i.e., materials, labour and machines etc. (4) It assists the government for cost reduction, price fixation, export and import and granting subsidy etc. Advantages to the Public (1) It aids in the removal of waste and inefficiency. (2) It makes it easier for customers to pay a reasonable price for things. (3) It contributes to the advancement of national economic growth. (4) Generates new job opportunities. (5) Improves people's living conditions. Limitations of Cost Accounting  There is a lack of consistency in its procedures and processes.  Costs are classified and interpreted in such a variety of ways that, despite having the same title, they are computed on different bases.  When projections are made beyond the recorded cost data, the lack of consistency becomes more pronounced.  Inherent limitations of cost accounting objections raised by different sections of business societies against the introduction of cost accounting.  For newly founded industries, cost accounting is unnecessary. Furthermore, modern costing procedures are not appropriate for all businesses.  Cost accounting system involves considerable amount of expenditure at the installation stage. Thus costing system is not economical for a small concern. LOVELY PROFESSIONAL UNIVERSITY 7 Notes Cost and Management Accounting  Cost accounting necessitates the use of accounting techniques and record-keeping. These are far more detailed and difficult to complete than those required for financial accounting. General Principles of Cost Accounting 1. Cause-Effect Relationship: Each cost item should have a cause-and-effect link identified. Each expense item should be as closely tied to its cause as feasible, and the impact on the various departments should be determined. A cost should be shared exclusively by units that transit through the departments that incurred the cost. 2. Charge of Cost Only after its Incurrence: Only costs that have been incurred should be included in the unit cost. For example, while the product is still in the manufacturing, the unit cost should not be paid along with the selling price. 3. Past Costs Should not Form Part of Future Costs: Past costs should not be recovered from future costs since it would mislead not only the genuine results of the future period but also other assertions. 4. Exclusion of Abnormal Costs from Cost Accounts: All costs incurred because of abnormal reasons (like theft, negligence) should not be taken into consideration while computing the unit cost. If done so, it will distort the cost figures and mislead management resulting in wrong decisions. 5. Principles of Double Entry Should be Followed Preferably: To reduce the likelihood of a mistake or error, cost ledgers and cost control accounts should be kept on double entry principles as much as feasible. This will assure the accuracy of cost sheets and cost statements created for cost estimation and cost control. Classification of Costs The different bases of cost classification are:  By time (Historical, Pre-determined).  By nature, or elements (Material, Labour and Overhead).  By degree of traceability to the product (Direct, Indirect).  Association with the product (Product, Period).  By Changes in activity or volume (Fixed, Variable, Semi-variable).  By function (Manufacturing, Administrative, Selling, Research and development, Pre- production).  Relationship with accounting period (Capital, Revenue).  Controllability (Controllable, Non-controllable).  Cost for analytical and decision-making purposes (Opportunity, Sunk, Differential, Joint, Common, Imputed, Out-of-pocket, Marginal, Uniform, Replacement).  Others (Conversion, Traceable, Normal, Avoidable, Unavoidable, Total). (1) Classification on the Basis of Time (a) Historical Costs: These expenses are calculated after they have been incurred. Such expenses are only available once the production of a certain item has been completed. They are objective in character and may be validated using actual operations. (b) Pre-determined Costs: 8 LOVELY PROFESSIONAL UNIVERSITY  Notes Unit 01:Introduction of Cost Accounting These expenses are computed before they are incurred based on a characterization of all cost- influencing elements. Such expenses could include: (i) Estimated costs: Costs are estimated before goods are produced; these are naturally less accurate than standards. (ii) Standard costs: This is a particular concept and technique. This method involves: (a) establishing predetermined norms for each cost factor and product; (b) a comparison of the actual to the standard to determine variation; (b) determining the reasons of such variations and taking corrective action. (2) By Nature or Elements There are three broad elements of costs: (a) Material: The substance from which the product is made is known as material. It can be direct as well as indirect. Direct material: It refers to those materials which become a major part of the finished product and can be easily traceable to the units. Direct materials include: (i) All materials specifically purchased for a particular job/process. (ii) All material acquired and latter requisitioned from stores. (iii) Components purchased or produced. (iv) Primary packing materials. (v) Material passing from one process to another. Indirect material: All material which is used for purposes ancillary to production and which can be conveniently assigned to specific physical units is termed as indirect materials. Examples, oil, grease, consumable stores, printing and stationary material etc. (b) Labour: Labour cost can be classified into direct labour and indirect labour. Direct labour: It is defined as salaries paid to workers involved in the manufacturing process whose time can be conveniently and cheaply traced to units of product. Wages paid to compositors in a printing press, workers in a foundry in a cast iron plant, and so on. Indirect labour: it is defined as labour performed for the purpose of carrying out tasks ancillary to the provision of products or services. It is not practicable to link it to particular units of output. Wages of storekeepers, foremen, timekeepers, supervisors, inspectors, and so on are examples. (c) Expenses: Expenses may be direct or indirect. Direct expenses: These expenses are incurred on a specific cost unit and identifiable with the cost unit. Examples are cost of special layout, design or drawings, hiring of a particular tool or equipment for a job; fees paid to consultants in connection with a job etc. Indirect expenses: These are expenses which cannot be directly, conveniently and wholly allocated to cost centre or cost units. Examples are rent, rates and taxes, insurance, power, lighting and heating, depreciation etc. The various elements of cost can be illustrated by the following chart: LOVELY PROFESSIONAL UNIVERSITY 9 Notes Cost and Management Accounting (3) By Degree of Traceability to the Products Cost can be distinguished as direct and indirect. Direct Costs:Direct costs are those that can be easily traced back to a product, costing unit, cost centre, or specific activity, such as the cost of wood used to make furniture. It is also known as traceable cost. Indirect Costs: Indirect costs are difficult or impossible to link to a single product. They are common to various items, such as a plant manager's compensation. It is also known as common costs. Costs may be direct or indirect in relation to a specific division or department. For example, all of the expenditures incurred in the Power House are indirect in terms of the main product, but the fuel cost or supervisory wages are direct in terms of the Power House itself. It is vital to understand why the cost is being calculated and whether it is related with a product, department, or activity. Direct costs can be assigned to a costing unit or cost centre. Indirect costs, on the other hand, must be allocated to other items if proper measurement techniques are not available. These may include a formula or base that is not quite right or exact. (4) Association with the Product Costs can be divided into two categories: product costs and period costs. Product Costs: Product costs are those that can be traced back to the product and are included in inventory values. It includes the cost of direct materials, direct labour, and manufacturing overheads in a manufacturing company. The product cost is the total factory cost. Product costs are used to value inventories, which are recorded as an asset on the balance sheet until they are sold. The cost of goods sold for the product is transferred to the cost of goods sold account. Period Costs: Period costs are incurred on a time basis, such as rent, salaries, and so on, and include numerous selling and administrative expenditures necessary to keep the business going. They are required to produce money, but they are not related with production and hence cannot be assigned to a product. They are charged to the time in which they occur and are classified as expenses. Selling and administrative expenses are classified as period expenses for the following reasons: (i) Most of these expenses are fixed in nature. (ii) It is difficult to apportion these costs to products equitably. 10 LOVELY PROFESSIONAL UNIVERSITY  Notes Unit 01:Introduction of Cost Accounting (iii) It is difficult to determine the relationship between such cost and the product. (iv) The benefits accruing from these expenses cannot be easily established. A company's net income is determined by both product and period costs. Product costs are included in the product price and have no effect on income until the product is sold. Period costs are billed to the period in which they occur. (5) By Changes in Activity or Volume Fixed, variable, and semi-variable costs are the three types of costs. Fixed Costs: The Chartered Institute of Management Accountants, London, defines fixed cost as “the cost which is incurred for a period, and which, within certain output and turnover limits, tends to be unaffected by fluctuations in the levels of activity (output or turnover)”. These expenses are incurred in order to offer physical and human facilities required for business operations. These expenses are incurred as a result of contractual obligations and management decisions. They emerge with the passage of time rather than with the production of goods and are expressed in terms of time. Rent, property taxes, insurance, supervisory pay, and so forth are examples. It is incorrect to assert that fixed expenses never vary. Depending on the circumstances, these costs may vary. Fixed refers to non-variability in relation to the relevant range. For the purposes of analysis, fixed costs can be divided into the following categories: (a) Committed Costs: These are costs incurred to maintain specific facilities and cannot be eliminated quickly. The management has little or no control over these costs, such as rent, insurance, and so on. (b) Policy and Managed Costs: Policy costs are incurred for implementing particular management policies such as executive development, housing, etc. Such costs are often discretionary. Managed costs are incurred to ensure the operating existence of the company e.g., staff services. (c) Discretionary Costs: These are unrelated to operations and are under management's control. These costs are the consequence of unique policy decisions, new research, and so on, and they can be avoided or reduced to an acceptable level at the discretion of management. (d) Step Costs: These are costs that are constant at one level of output and then increase by a fixed amount at a higher level of output. Variable Cost: Variable costs are those that vary directly and proportionally with production, such as direct materials and direct labour. It should be noted that the variable cost per unit is constant, but the total cost varies with output levels. It is always expressed in terms of units rather than time. Management decisions might have an impact on cost-behavior patterns. Variability is a relative concept. If the conditions under which the variability was calculated change, the variability must be calculated again. LOVELY PROFESSIONAL UNIVERSITY 11 Notes Cost and Management Accounting Semi-fixed (Semi-Variable) costs: Such costs contain fixed and variable elements. Because of the variable element, they fluctuate with volume and because of the fixed element; they do not change in direct proportion to output. Semi-variable costs change in the same direction as that of the output but not in the same proportion. Depreciation is an example; for two shifts working the total depreciation may be only 50% more than that for single shift working. They may change with comparatively small changes in output but not in the same proportion. (6) Functional Classification of Costs A firm serves several purposes. The following are some examples of functional costs: (a) Manufacturing/production Costs:It is the cost of operating the manufacturing division of an undertaking. It includes the cost of direct materials, direct labour, direct expenses, packing (primary) cost and all overhead expenses relating to production. (b) Administration Costs: They are indirect and covers all expenditure incurred in formulating the policy, directing the organisation and controlling the operation of a concern, which is not related to research, development, production, distribution or selling functions. (c) Selling and Distribution Cost:The selling cost is the cost of attempting to create and increase demand, such as through marketing, market research, and so on. The distribution cost is the expense incurred that begins with making the package manufactured ready for dispatch and concludes with making the reconditioned packages available for re-use, such as warehousing, cartage, and so on. It includes the cost of transferring items to central or local storage. The expense involved in transporting things to and from prospective clients, as in the case of goods for sale or return, is also considered distribution cost. (d) Research and Development Costs: These are the costs of discovering new ideas, processes, and products through experimentation and commercialising the results. (e) Pre-production Cost:Certain expenses are spent when a new factory is established or a new product is introduced. There are practise runs. Such expenses are known as pre-production expenditures and are classified as delayed revenue expenditure. They are deducted from future production costs. (7) Relationships with Accounting Period Capital and revenue can both be considered costs. Capital expenditure is classified as an asset since it provides benefits in the future. Revenue spending, on the other hand, benefits just the current period and is classified as an expense. When an asset is written off, capital expenses become cost to that extent. Only when capital and revenue are properly differentiated can the income of a specific period be accurately determined. Under all circumstances, it is impossible to discern between the two. 12 LOVELY PROFESSIONAL UNIVERSITY  Notes Unit 01:Introduction of Cost Accounting (8) Controllability Costs are both controllable and uncontrollable. Controllable Cost: The Chartered Institute of Management Accountants defines controllable cost as “cost which can be influenced by its budget holder”. Non-Controllable Cost:This is a cost that cannot be controlled at any level of managerial oversight. The distinction between the words is critical for cost accounting, cost control, and responsibility accounting. A person at a specific organisational level can influence a controllable cost. Costs that are manageable are not completely controllable. Some costs can be controlled in part by one person and in part by another, for example, maintenance costs can be controlled by both the production and maintenance managers. The word "controllable costs" is frequently used to refer to variable costs, while non-controllable costs are defined as fixed. Belkaoni has mentioned the following fallacies about controllable costs: (i) All variable costs are controllable and fixed are not. (ii) All direct costs are controllable and indirect costs are not. (iii) All long-term costs are controllable. The time factor and decision-making authority can sometimes make a cost manageable. All costs can be controlled if the time period is long enough. Delegation that is done correctly aids in the establishment of unambiguous responsibility and controllability. However, all costs can be handled by one or more people. The authority and responsibility for cost control are transferred at several levels, with the managing director ultimately liable for all costs. (9) Costs for Analytical and Decision Making Purposes (a) Opportunity Costs: Opportunity cost is the cost of selecting one course of action and the losing of other opportunities to carry out that course of action. It is the amount that can be received if the asset is utilised in its next best alternative. Edwards, Hermanson and Salmonson define it as “the benefits lost by rejecting the best competing alternative to the one chosen. The benefit lost is usually the net earnings or profit that might have been earned from the rejected alternative” Example: Capital is invested in plant and machinery. It cannot be now invested in shares or debentures. The loss of interest and dividend that would be earned is the opportunity cost. Another example is when the owner of a business foregoes the opportunity to employ himself elsewhere. Opportunity costs are not recorded in the books. It is important in decision making and comparing alternatives. (b) Sunk Costs: A sunk cost is one that has already been incurred and cannot be avoided by decisions taken in the future. As it refers to past costs, it is called unavoidable cost. The National Association of Accountants (USA) defines a sunk cost as “an expenditure for equipment or productive resources which has no economic relevance to the present decision making process”. This cost is not useful for decision making as all past costs are irrelevant. CIMA defines it as the past cost not taken into account in decision making. It has also been defined as the difference between the purchase price of an asset and its salvage value. (c) Differential Cost: Differential cost has been defined as “the difference in total cost between alternatives, calculated to assist decision making”. Differential cost is the increase or decrease in total costs resulting out of: (a) Producing and distributing a few more or few less of products; (b) A change in the method of production/distribution; (c) An addition or deletion of a product or a territory; and LOVELY PROFESSIONAL UNIVERSITY 13 Notes Cost and Management Accounting (d) The selection of an additional sales channel. (d) Joint Costs: The processing of a single raw material results in two or more different products simultaneously. The joint products are not identifiable as different types of product until a certain stage of production known as the split-off point is reached. Joint costs are the costs incurred upto the point of separation. One product may be of major importance and others of minor importance which are called by-products. Bierman and Djckman define it as: “Joint costs relate to a situation in which the factors of production by their basic nature result in two or more products. The jointness results from there being morethan one product, and these multi-products are the result of the methods of production or the natureof raw material and not of a decision by management to produce both”. (e) Common Costs: Common costs are those costs which are incurred for more than one product, job, territory or any other specific costing object. They are not easily related with individual products and hence are generally apportioned. The National Association of Accountants defines the term as “the cost of services employed in the creation of two or more outputs which is not allocable to those outputs on a clearly justified basis”. It should be kept in mind that management decisions influence the incurrence of common costs e.g. rent of the factory is a common cost to all departments located in factory. (f) Imputed Costs: Some costs are not incurred and are useful while taking decision pertaining to a particular situation. These costs are known as imputed or notional costs and they do not enter into traditional accounting systems. Examples: Interest on internally generated funds, salaries of owners of proprietorship or partnership, notional rent etc. (g) Uniform Costs: They are not distinct costs as such. Uniform costing signifies common costing principles and procedures adopted by a number of firms. They are useful in inter-firm comparison. (h) Marginal Costs: It is the aggregate of variable costs, i.e., prime cost plus variable overheads. Thus, costs are classified as fixed and variable. (i) Replacement Costs: This is the cost of replacing an asset at current market values e.g. when the cost of replacing an asset is considered, it means the cost of purchasing the asset at the current market price is important and not the cost at which it was purchased. (j) Out of Pocket Cost: It involves payment to outsiders i.e. gives rise to Cash Expenditure as opposed to such costs as depreciation which don’t involve any cash expenditure. Such costs are relevant for price fixation during recession or when make or buy decision is to be made. (10) Other Costs (i) Conversion Cost: It is the cost of a finished product or work-in-progress comprising direct labour and manufacturing overhead. It is production cost less the cost of raw material but including the gains and losses in weight or volume of direct material arising due to production. (ii) Normal Cost: This is the cost which is normally incurred at a given level of output in the conditions in which that level of output is achieved. (iii) Traceable Cost: It is the cost which can be easily associated with a product, process or department. (iv) Avoidable Costs: Avoidable costs are those costs which under the present conditions need not have been incurred. Example: (a) Spoilage in excess of normal limit; (b) Unfavourable cost variances which could have been controlled. (v) Unavoidable Costs: Unavoidable costs are those costs which under the present conditions must be incurred. (vi) Total Cost: This is the sum of all costs associated to a particular unit, or process, or department or batch or the entire concern. It may also mean the sum total of material, labour and 14 LOVELY PROFESSIONAL UNIVERSITY  Notes Unit 01:Introduction of Cost Accounting overhead. The term total cost however, is not precise, it needs to be made precise by using terms that indicate the elements of cost included. (vii) Value Added: Strictly, it is not cost. It means the selling price of the product/service less the cost of materials used in the product or the service. Often depreciation is also deducted for ascertaining “value added”. Did you know? A cost which does not involve any cash outflow is called_______ or____________ Correct answer: Notional cost, Imputed cost Distinction between Financial Accounting and Cost Accounting Both financial accounting and cost accounting are concerned with systematic recording and presentation offinancial data. Financial accounting reveals profits and losses of the business as a whole during a particularperiod, while cost accounting shows, by analysis and localization, the unit costs and profits and losses of differentproduct lines. The main difference between financial accounting and cost accounting are summarized below: Financial Accounting Cost Accounting a) It provides the information about the a) It provides information to the business in a general way. i.e Profit management for proper planning, and Loss Account, Balance Sheet of operation, control and decision the business to owners and other making. outside partners. b) It records the expenditure in an b) It classifies, records and analyses objectivemanner, i.e according to the thetransactions in a subjective purpose forwhich the costs are manner, i.eaccording to the nature of incurred. expense. c) It provides a detailed system of control c) It lays emphasis on recording aspect formaterials, labour and overhead withoutattaching any importance to costs withthe help of standard costing control. and budgetarycontrol. d) It gives information through cost d) It reports operating results and reports tomanagement as and when financialposition usually at the end of desired. the year. e) Cost Accounting is only a part of the e) Financial Accounts are accounts of financial accounts and discloses profit thewhole business. They are or loss of eachproduct, job or service. independent innature. f) Cost Accounting relates to f) Financial Accounts records all transactionsconnected with thecommercial transactions of the Manufacturing of goodsand services, businessand include all expenses i.e means expenses which enterinto Manufacturing,Office, Selling etc. production. g) Cost Accounts are concerned with g) Financial Accounts are concerned internaltransactions, which do not withexternal transactions i.e. LOVELY PROFESSIONAL UNIVERSITY 15 Notes Cost and Management Accounting transactionsbetween business concern involve any cashpayment or receipt. and third party. h) Non-Monetary information likes No of h) Only transactions which can be Units /Hours etc are used. measured inmonetary terms are recorded. i) Cost Accounting deals with partly i) Financial Accounting deals facts andfigures and partly estimates / withactualfigures and facts only. standards. j) Cost Accounts provide valuable j) Financial Accounting do not informationon the efficiencies of provideinformation on efficiencies of employees and Plant &Machinery. various workers/Plant & Machinery. k) Stocks are valued at Cost only. k) Stocks are valued at Cost or Market pricewhichever is lower. l) Cost Accounting is not only positive l) Financial Accounting is a positive sciencebut also normative because it science asit is subject to legal rigidity includestechniques of budgetary with regarding topreparation of control andstandard costing. financial statements. m) Generally Cost Accounts are m) These accounts are kept in such away keptvoluntarily to meet the tomeet the requirements of requirements of themanagement, only Companies Act2013 as per Sec 128 & in some industries CostAccounting Income Tax Act, 1961Sec 44AA. records are kept as per theCompanies Act. Both cost accounting and financial accounting are concerned with systematic recording and presentation of financial data. The two system rest on the same principles concerning debit and credit and have the same sources of recording the transactions.But cost accounting is much more detailed than financial accounting. This is because in financial accounting, profit or loss is ascertained for the business as a whole whereas in cost accounting, detailed cost and profit data for various parts of business, like departments, products, etc., are shown. Example: Numerical Suppose a company is manufacturing three products- X,Y and Z. Under financial accounting and cost accounting, the following types of statements are prepared:Firstly, Under financial accounting- A profit and loss account is prepared to compute profit as shown: Profit and Loss account for the period………… Rs. Rs. To Materials 75000 By sales 150000 To Wages 20000 To Other expenses 25000 16 LOVELY PROFESSIONAL UNIVERSITY  Notes Unit 01:Introduction of Cost Accounting To Profit (Balance figure) 30000 150000 150000 The statement shows in last slide depict that the total profit is Rs. 30000 but it does not disclose the details of profit/loss of each of the products X,Y and Z in the total profit. This is revealed by cost accounting.Now, Under cost accounting- A detailed statement is prepared as follows: Statement of Cost and Profit for the period………… Total Product X Product Y Product Z Materials 75000 40000 12000 23000 Wages 20000 10000 5000 5000 Other expenses 25000 20000 3000 2000 Total Cost 120000 70000 20000 30000 Sales 150000 96000 28000 26000 Profit/Loss(-) 30000 26000 8000 (-) 4000 Conclusion The statement prepared under cost accounting shows that in total profit of Rs. 30000. Product X contributed Rs. 26000 and Product Y Rs 8000, whereas Product Z gave a loss of Rs. 4000. When the firm’s management gets this information, it will investigate to find out the reason for loss in Product Z. If product Z cannot be made profitable, its production should be stopped to improve the overall profit picture of company. However, this type of information is not revealed by financial accounting Summary  Cost is the amount of expenditure (actual or notional) incurred on, or attributable to a specified thing or activity.  Costing is the techniques and processes of ascertaining costs.  Cost accounting is the establishment of budgets, standard costs and actual costs of operations, processes, activities or products, and the analysis of variances, profitability or the social use of funds.  Principles of cost accounting are - cost should be related to its cause; cost should be charged only after it has been incurred; the convention of prudence should be ignored; abnormal costs should be excluded from cost accounts; past costs not to be charged to future period; principles of double entry should be applied wherever necessary.  Costing is an aid to management, creditors, employers and national economy.  Costs have been classified by - time, nature or elements, degree of traceability to the product, association with the product, changes in activity or volume, function, relationship LOVELY PROFESSIONAL UNIVERSITY 17 Notes Cost and Management Accounting with accounting period, controllability, cost for analytical and decision-making purposes, etc.  Cost centre means, a production or service location, function, activity or item of equipment whose costs may be attributed to cost units.  Cost unit is a unit of product or service in relation to which costs are ascertained.  Financial accounting and cost accounting are distinct from each other. Keywords  Cause – effect relationship  Cost accounting  Cost driver  Financial accounting  Product cost  Period cost  Sunk cost  Market Price: Price of a commodity in the market.  Physical Unit: A unit of measurement. Self Assessment 1. Cost Accounting is not needed by a non-profit organisation such as a hospital. A. True B. False 2. Notional costs and imputed costs mean the same thing. A. True B. False 3. Rent on owned building is included in cost accounts (June, 2009). A. True B. False 4. Notional costs are not included while ascertaining costs. A. True B. False 5. Conversion costs and overheads are interchangeable terms. A. True B. False 6. The method of costing used in a refinery is “operating costing”. (December,2010) A. True B. False 18 LOVELY PROFESSIONAL UNIVERSITY  Notes Unit 01:Introduction of Cost Accounting 7. Cost reduction is cost control. (December, 2008) A. True B. False 8. Cost accounting is a branch of financial accounting. (December, 2008) A. True B. False 9. In cost accounting, like financial accounting, absolute accuracy is aimed at. A. True B. False 10. All materials and stores such as lubricating oil, will be direct. A. True B. False 11. Opportunity cost is recorded in the books of account. (December,2010) A. True B. False 12. Differential cost is the change in the cost due to change in _____________ from one level to another. 13. Management accounting is primarily concerned with __________________. 14. In Cost Accounting stock are valued at ___________ only. 15. Profit is the resultant of two varying factors viz _______________ and _______________. 16. ___________ cost are historical costs which are incurred in the past. 17. Joint Cost is suitable for- A. Infrastructure Industry B. Ornament Industry. C. Oil Industry D. Fertilizer Industry 18. Cost units of Hospital Industry is- A. Tonne B. Student per year C. Kilowatt Hour D. Patient Day 19. Cost units of Automobile Industry is- A. Cubic meter LOVELY PROFESSIONAL UNIVERSITY 19 Notes Cost and Management Accounting B. Bed Night C. Number of Call D. Number of vehicle 20. Identify the Example/s of Non-Production costs includes: A. Administrative costs B. Selling and Distribution costs C. Finance costs D. All of the above 21. Out of the followings Production costs includes: i) Direct materials ii) Direct labour iii) Direct expenses iv) Variable production overheads v) Fixed production overheads Identify which of the above are included? A. (I) (II) (IV) B. (I) (II) (III) C. Only (I) and (II) D. All of the above 22. The cost per unit of variable costs ______________. A. Increases with increase in volume B. Remains constant C. Constant to a certain volume D. None 23. Sales and distribution costs include: A. The wages and salary costs of all employees working in the selling and distribution departments, including sales commissions for sales representatives B. Advertising costs and other marketing costs C. Operating costs for delivery vehicles D. All of the above Answer for Self Assessment l. B 2. A 3. A 4. B 5. B 6. B 7. B 8. B 9. B 10. B 11. B 12. Activity 13. Management 14. cost 15. Sales, 20 LOVELY PROFESSIONAL UNIVERSITY  Notes Unit 01:Introduction of Cost Accounting cost 16. sunk 17. C 18. D 19. D 20. D 21. D 22. D 23. D Review Questions 1. What do you understand by Cost Accounting? 2. Define the terms Cost Centre and "Cost Unit." 3. What are the important objectives of Cost Accounting? 4. What are the differences between financial account and cost accounting? 5. Distinguish between cost accounting and management accounting. 6. What are the factors to be considered for installation of good costing system? 7. Describe the practical difficulties in installation of costing system. 8. Cost Accounting has become an essential tool of management. Give your comments on this statement. 9. Indicate the various advantages of Cost Accounting. 10. Define costing and discuss briefly its objects and advantages. 11. What are the limitations of cost accounting? 12. Write short notes on : (a) Costing; (b) Cost Accountancy; (c) Cost Control; (d) Cost Reduction; (e) Cost Unit and Cost Centre. 13. Write short notes on the following: (a) Out of Pocket Cost. (b) Sunk Cost (c) Opportunity Cost (d) Imputed Costs 14. Cost may be classified in a variety of ways according to their nature and the information needs ofthe management” Discuss. 15. What methods of costing would you apply in the following industries ? State how cost should beascertained in each case ? (i) Building, (ii) Colliery, (iii) Soap works, (iv) Motor cars, (v) Radio sets, (vi) Ship building. LOVELY PROFESSIONAL UNIVERSITY 21 Notes Cost and Management Accounting Further Readings  Deepak Jain, Cost & Management Accounting Taxmann Publications Pvt. Ltd.  Khan and Jain, Management Accounting.  N.S. Zad, Cost & Management Accounting Taxmann Publications Pvt. Ltd.  Nitin Balwani, Accounting & Finance for Managers, Excel Books, New Delhi.  S.P. Jain & K.L. Narang, Cost and Management Accounting; Kalyani Publishers, 23, Daryaganj, New Delhi-110 002.  S.N. Maheswari, Management Accounting.  M.N. Arora, Cost and Management Accounting (Theory and Problems); Himalaya Publishing House, Ramdoot, Dr. BhaleraoMarg, Kelewadi, Girgaon, Mumbai-400 004.  Ravi M. Kishore, Advanced Management Accounting; Taxmann’s, Taxmann Publication (P) Ltd. 59/32, New Rohtak Road, New Delhi – 110 005. Web Links www.futureaccountant.com https://icmai.in/upload/Students/Syllabus2016/Inter/Paper-8-Sep-2021.pdf 22 LOVELY PROFESSIONAL UNIVERSITY  Notes Dr. Arpit Sidhu, Lovely Professional University Unit 02: Cost Sheet Unit 02: Cost Sheet CONTENTS Objectives Introduction 2.1 Meaning of Single or Output Costing 2.2 Industries Using Single or Output Costing 2.3 Features of Output Costing 2.4 Objectives of Output Costing 2.5 Important Items Regarding Preparation of Statement of Cost and Cost Sheet 2.6 Cost Collection or Cost Accumulation 2.7 Components of Cost and Treatment for Stock & Scrap 2.8 Cost Sheet Approach for Output Costing 2.9 Methods of Cost Presentation Under Unit Costing 2.10 Format and Illustrations of Cost Sheet Summary Keywords Self Assessment Answer for Self Assessment Review Questions Further Readings Objectives After studying this unit, you will be able to:  Understand the Concept of Single or Output Costing.  Familiarize with Applicability of Single or Output Costing.  Understand Treatment for Raw Material, Work in Progress & Finished Goods, and Treatment for Scrap.  Explain the importance of cost sheet  Identify the various steps in the preparation of cost sheet. Introduction Cost in any organization plays an important role in determining its profitability. Cost ascertainment is essential for cost control and cost management. Cost ascertainment is the determination of cost for a unit, product, process or center based on actual data. There are various methods of costing like job costing, unit costing, batch costing, process costing, operating costing and contract costing which are helpful in as certaining the cost of a job, product, batch, process, service and contract respectively. The following chapter will emphasis on one of the methods of costing for a unit or product which is called as Single, Unit or Output Costing. LOVELY PROFESSIONAL UNIVERSITY 23 Notes Cost and Management Accounting 2.1 Meaning of Single or Output Costing In output costing method, the cost per unit of output or production is ascertained. The cost per unit is derived by dividing the total cost with the total quantity produced. This type of costing is applied where the output is in identical quantitative units and manufacturing process is continuous. In this method, the various cost elements like prime cost, work/factory cost, office cost and cost of sales are determined so as to arrive at the total cost of production. There are two approaches to output costing method, i.e. cost sheet and production account. A statement of cost or cost sheet describes various components of cost at various stages. Another alternative to present the cost elements in vertical form account is the production statement or account. Both cost sheet and production account presents the same information with one major distinction. The production account shows sales and profit or loss figures along with the cost of production. The output costing method is useful in ascertaining the total cost and per unit cost of production that can be compared with the past years figures, in the same cost sheet, by the management for decision making. Moreover, it helps the management in deciding the final selling price for the product. 2.2 Industries Using Single or Output Costing Output costing is widely used by the manufacturing units producing a single product or identical products on mass basis with the consistent manufacturing processes. Such concerns also have cost units that are physical and natural. The various major industries using output costing methods are Sugar Industry, Paper Industry, Mining Industry, Cement Industry, Breweries Industry and Flour Milling Industry etc. Name and Cost Unit of Specific Industries Following are the cost unit of some specific industries: Name of the industry Cost unit 1 Textile industry Per meter 2 Brick industry Per 1000 brics 3 Milk industry Per liter 4 Paper industry Per rim or kg 5 Sugar industry Per Quintal 6 Cement industry Per Ton 7 Wine industry Per Gallon 8 Mine industry Per Ton 9 Coal industry Per Ton 10 Steel industry Per Ton Definition Unit costing or output costing is that technique of cost accounting in which the cost of production of a unit of output and total cost of production is ascertained. This method is also called the single costing because the process of production comprises only one stage or a single operation. Walter W. Bigg, “Unit costing method is a method of costing applied to ascertain the cost per unit of a production where standard and identical products are manufactured.” J. R. Batliboi, “Unit costing or output costing may be defined as, Single or output cost system is used in business were a standard product is turned out and it is desired to find out the cost of a basic unit of production.” The Institute of Cost and Management Accountants, London“output costing is the basic costing method applicable where goods or services result from a series of continuous or repetitive operations or processes to which costs are charged before being averaged over the units produced during the period.” 24 LOVELY PROFESSIONAL UNIVERSITY  Notes Unit 02: Cost Sheet 2.3 Features of Output Costing (1) Output costing is the method of costing adopted in concerns where there is a production of single product or a few grades of the same product differing only in size, shape or quality by continuous process of manufacture. The units of production or output are identical and the costs of units are physical and natural. (2) Under this method, the cost per unit of output, say, per ton, per barrel, per kilogram, per meter, per quintal, per bag, etc. is ascertained. The cost per unit of output is ascertained by dividing the total cost incurred on a product during a given period of time by output produced during the period. (3) Equality of cost is an important feature of this method. That is, under this method, cost units, which are identical, will have identical cost. (4) Under this method, the cost of product is ascertained at the end of the accounting period. (5) cost information relating to a product may be presented in the form of either cost sheet or production account. (6) the cost collection and the cost ascertainment are quite simple. (7) The cost per unit of output, determined under single. Costing enables the management to make real comparison between different periods and between different firms within the same industry, as the unit of output is a common factor between different periods and between different firms within the same industry. 2.4 Objectives of Output Costing (1) To ascertain the total cost of the output as well as the cost per unit of output. (2) To ascertain the profit or loss on production. (3) To analyze the expenditure by nature, classify them into element of cost and know the extent to which each element of cost contributes to the total cost. (4) To facilitate comparison of the cost of one period with the cost of another period to know the efficiency or otherwise of the production. (5) To facilitate the preparation of tender or quotation. (6) To control the cost of the product through comparative study of the costs of any two periods or through the comparison of the actual costs with the pre-determined standard cost. 2.5 Important Items Regarding Preparation of Statement of Cost and Cost Sheet 1. Normal Loss of Materials This type of loss is unavoidable and arises due to the nature of material. For example – loss by evaporation of liquid materials, loss due to loading and unloading of materials, etc. This loss is not deducted from the cost of material rather it is charged to the output because it is a principle of costing that all normal expenses which are necessarily to be incurred should be included in the cost of production.Therefore, in order to absorb normal material losses in cost, the rates of usable materials are inflated so that such losses are covered. In other words, such normal loss should be ignored and this will get automatically charged to output. 2. Abnormal Loss of Materials LOVELY PROFESSIONAL UNIVERSITY 25 Notes Cost and Management Accounting Abnormal losses are those losses which arise due to abnormal reasons such as loss by theft, loss by fire, careless handling etc. The cost of materials abnormally lost should be deducted from the value of materials purchased so that output is charged only for the materials used in production. Abnormal losses are charged to Costing Profit and Loss Account. 3. Wages of Normal Idle Time Normal idle time is inherent in any work situation and cannot be reduced. The cost of normal idle labour time is charged to the cost of production. Hence, wages of normal idle time is not subtracted from the labour cost. 4. Wages of Abnormal Idle Time Abnormal idle time arises due to unanticipated causes such as strikes, lockouts, fire, accidents, major machine break-down, earthquakes, etc. Loss of time due to such abnormal causes cannot be planned. Such causes are sudden and non-frequent.The cost of abnormal idle time is not included in cost of production. The wages paid for abnormal idle time should be debited to Costing P/L A/c. Hence, wages of abnormal idle time is subtracted from the labour cost. 5. Sale of Scrap, Defective, Salvage or Residue If clear information is given, then adjustment of these sales will be made accordingly. But, if it is not clear that what the nature of scrap defective, etc., the sale value of scrap etc. is deducted before computing factory cost. 6. Defective or Rejected Work Sometimes, under production process there might be defective goods. The production not conforming to the standard set is known as defective. If such goods cannot be rectified, then it may be sold in the market at lower rate.Whatever the amount is collected from such sale is deducted from the factory cost. Similarly, the defective units are also deducted from the number of units produced. On the other hand, the defective units which can be rectified by incurring extra expenses, then such extra expenses incurred on such a rectification can be added in factory overhead as an extra factory overhead. After that the saleable units and their costs can be determined. 7. Cash Discount and Trade Discount Cash discount is not considered as the part of cost of production, since it is of financial nature.Whereas, trade discount is treated as sales promotion expense and is included in selling and distribution expenses or may be deducted from gross sales. 8. Allocation of Joint Expenses In absence of clear-cut information factory overhead is allocated on the basis of wages ratio and office and administration expenses and selling and distribution expenses on the basis of works cost ratio. 9. Packing Charges Treatment of packing charges depends upon its nature. If, in absence of packing, goods cannot be sold, then it should be treated as direct expense (i.e. packing of mustard oil etc.).Packing charges in respect of partly finished goods are considered as factory overhead. In the same way, packing expenses concerned with finished goods are included in selling and distribution expenses. Did you Know? State whether the following statement is “True” or “False” Cost figures in the cost sheet cannot be compared with the past year figures in thesame cost sheet for analysis purpose by the management. True False Correct answer: False 26 LOVELY PROFESSIONAL UNIVERSITY  Notes Unit 02: Cost Sheet 2.6 Cost Collection or Cost Accumulation 1. Materials: As materials both direct and indirect are issued to production against properly authorized material requisitions. The direct and indirect material costs can be ascertained through material requisitions.Through the analysis of material requisitions, the quantities of direct and indirect materials issued to production can be ascertained, and on the basis of the prevalent method of pricing material issues, the direct and indirect material costs can be ascertained. Accounting of Materials: Materials are dealt in cost accounting as follows: (i) The direct material costs are taken as a part of Prime Cost. (ii) Indirect material costs are charged to Factory Overheads. (iii) Normal loss of materials is adjusted by inflating the issue price of materials. 2. Labour: The labour costs are collected periodically through pay rolls kept separately for each section or type of work without the detailed job cards or chits required in job costing. Treatment of Labour Cost in Cost Accounting: Labour cost is dealt as follows: (i) Direct labour costs are treated as a part of Prime Cost. (ii) Indirect labour costs are charged to Factory Overheads. 3. Direct Expenses: Direct expenses or chargeable expenses are separately collected from the financial record where the actual direct expenses incurred are recorded. The main expenses under this head are: (i) Royalty (ii) Architect and surveyor’s fees (iii) Expenses of drawing and designs (iv) Excise duty etc. Treatment: It is treated as a part of Prime Cost. 4. Overheads: Where cost finding is undertaken at the end of long interval, i.e., at the end of the year, after the overheads incurred are actually recorded in the financial book, the actual overheads incurred during the year are collected from the financial records. The actual overheads collected from the financial records are analyzed into three broad categories, viz.: (1) Factory Overheads, (2) Office and Administration Overheads, and (3) Selling and Distribution Overheads and are treated as such for cost finding. 2.7 Components of Cost and Treatment for Stock & Scrap Components of Cost The total cost has been divided into sub components representing the cost at various stages. Following are the various components of cost shown in the cost sheet or production account: Prime Cost: Prime cost is also named as “Direct Cost”, “Flat Cost”, “Basic Cost” or “First Cost”. It is the summation of all direct costs relating to production, i.e. direct material, direct labour and direct expenses. Factory Cost: Factory cost is also named as “Work Cost”, “Manufacturing Cost” or “Production Cost”. It is the summation of prime cost and factory overheads that includes indirect material, indirect labour and indirect expenses of factory. Factory cost includes all the direct cost relating to product and the indirect cost relating to factory. Office Cost: Office Cost is also named as “Cost of Production” or “Administration Cost”. Office cost is the summation of factory or work cost and office & administrative overheads. Any cost LOVELY PROFESSIONAL UNIVERSITY 27 Notes Cost and Management Accounting related to sales and distribution is not the part of office and administrative cost as they form a separate category. This total cost of production is adjusted with the opening and closing stock of finished goods to get the cost of goods sold. Cost of Sales: It is also named as “Total Cost”. It is derived by adding selling and distribution overheads to the cost of goods sold. Example: Numerical Ashwani Industries is into assembling of chairs and has certain expenditures that are mentioned below. You are required to determine the prime cost. Particulars (Rs.) Cost of chair frames 1,20,000 Cost of cushions 75,000 Cost of nuts and bolts 20,000 Wages paid for the assembling of chairs 30,000 Ans: Cost of all Direct Material = Cost of chair frames + Cost of cushions + Cost of nuts and bolts= 1,20,000 + 75,000 + 20,000 = Rs. 2,15,000 Cost of Direct Labor = Wages paid for the assembling of chairs = Rs. 30,000 Prime Cost = Direct Material + Direct Labour = 2,15,000 + 30,000 = Rs. 2,45,000 Treatment for Raw Material:The actual value of the raw material consumed is to be included in the cost sheet. Thus, the determinationof value of raw material consumed becomes important. For the same, the opening and closing stockof raw material is adjusted with the raw material purchased during the year to arrive at the actual valueof raw material consumed. Value of raw material consumed = Opening stock of raw material + Purchase of rawmaterial – Closing stock of raw material Illustration 1: Following are the cost details of Tehran Industries. You are required to calculate the factory cost. Particulars (Rs.) Direct material 2,30,000 Labour cost for manufacturing products 1,25,000 Direct expenses 65,000 Rent for factory 1,00,000 General consumables 40,000 Salary of factory manager 32,000 Ans: Prime Cost = Direct material + Labour cost for manufacturing products + Direct expenses = 2,30,000 + 1,25,000 + 65,000 = Rs. 4,20,000 Factory Overheads = Rent for factory + General consumables + Salary of factory manager = 1,00,000 + 40,000 + 32,000 = 1,72,000 Rs. Factory Cost = Prime Cost + Factory Overheads = 4,20,000 + 1,72,000 = Rs. 5,92,000 Illustration 2: Calculate the office cost from the following cost data: Particulars (Rs.) Direct material 12,000 Direct Labor 5,000 Direct expenses 2,000 Power and Fuel 3,500 Office Stationary 1,100 Office Telephone charges 200 28 LOVELY PROFESSIONAL UNIVERSITY  Notes Unit 02: Cost Sheet Ans: Prime Cost = Direct material + Direct labour + Direct expenses = 12,000 + 5,000 + 2,000 = Rs. 19,000 Factory Cost = Prime Cost + Power and fuel = 19,000 + 3,500 = Rs. 22,500 Office Cost = Factory Cost + Office stationery + Office telephone charges = 22,500 + 1,100 + 200 = Rs. 23,800 Illustration 3: Find out the value of raw material consumed for M/s Sameer from the following given information: Particulars (Rs.) Opening stock of raw material 55,000 Closing stock of raw material 15,000 Purchase of raw material 80,000 Ans: Value of raw material consumed = Opening stock of raw material + Purchase of raw material – Closing stock of raw material= 55,000 + 80,000 – 15,000 = Rs. 1,20,000 Treatment for Work-in-Progress:Work-in-Progress is that part of stock which has not been completely manufactured. It requires somemore work to be done for becoming the finished goods. They are in such a form which is not yet readyto be sold. It is usually abbreviated as “WIP”. It can be valued at prime or factory cost basis. But it isincorrect to value it at prime cost as many of the work overhead expenses get incurred on such goods.Work in progress is to be adjusted before calculating the net factory or work cost. The opening stockof WIP is added and closing stock of WIP is subtracted from gross work cost before arriving at theactual or network or factory cost. Example: Numerical Show the treatment of Work-in-Progress in the cost sheet from the available given information: Particulars (Rs.) Prime cost 23,50,000 Factory Overhead 8,53,000 Opening WIP 2,10,000 Closing WIP 1,60,000 Ans: Gross Work Cost = Prime cost + Factory overheads = 23,50,000 + 8,53,000 = Rs. 32,03,000 Work or Factory Cost = Gross Work Cost + OpeningWIP – Closing WIP = 32,03,000 + 2,10,000 – 1,60,000 = Rs. 32,53,000 Treatment for Finished goods:Finished goods are the goods that have been manufactured completely from the production’s point ofview. It is valued at the cost of production as no further cost is to be added at the factory level. Theadjustment for finished goods is of key importance for determining the cost of goods sold. We canarrive at the cost of goods sold by adding opening stock of finished goods and subtracting closingstock of finished goods from cost of production. Cost of Goods Sold = Cost of production + Opening stock of finished goods – Closing stockof finished goods Illustration 4: Find out the Total cost and Factory overheads for Budhiraj& Sons from the following given information: Particulars (Rs.) Prime cost 45,400 Factory Cost 52,600 Office Overhead 12,500 LOVELY PROFESSIONAL UNIVERSITY 29 Notes Cost and Management Accounting Opening stock of finished goods 1,000 Closing stock of finished goods 1,500 Salesman salary 5000 Ans: Factory Overheads = Factory Cost – Prime Cost = 52,600 – 45,400 = Rs. 7,200 Cost of Production = Factory Cost + Office overheads = 52,600 + 12,500 = Rs. 65,100 Cost of Goods Sold = Cost of Production + Opening stock of finished goods – Closing stock of finished goods = 65,100 + 1,000 – 1,500 = Rs. 64,600 Factory Cost = Prime Cost + Factory Overheads Total Cost = Cost of Goods Sold + Salesman Salary = 64,600 + 5,000