COST CONCEPTS

Course Instructors:
Prof. Surbhi Gupta
LEARNING OUTCOMES

1. Students should be able to understand the concepts of

i. Cost
ii. Cost objects
iii. Cost centres
iv. Cost units
2. Students should be able to differentiate between
i. Costing methods
ii. Costing techniques
iii. Different types of cost classifications
WHAT IS COST?

 The price paid for something. – Oxford Dictionary

 Cost is the amount of expenditure, actual (incurred) or
notional (attributable), relating to a specific thing or
activity such as a product, job, service, process or any
other activity.
COST VS EXPENSE AND LOSS

 Expense is defined as "an expired cost resulting from a productive usage of an

asset.“
 An expense is that portion of the revenue earning potential of an asset which
has been consumed in the generation of revenue.
 Unexpired or unconsumed part of the cost is recorded as an asset in the
balance sheet.
 For example, when a plant is purchased, depreciation on plant (expired cost) is
charged to profit and loss account as an expense and cost of plant remaining
after providing depreciation (unexpired cost) is shown as an asset in the
balance sheet.
 Loss - expired cost resulting from the decline in the service potential of an asset
that generated no benefit to the firm. (Obsolescence or destruction of stock by
fire)
RELATION OF COST, EXPENSE AND LOSS

COST

UNEXPIRED
EXPIRED COST
COST

SHOWN IN
EXPENSE BALANCE SHEET
SHOWN IN PROFIT AS AN ASSET

AND LOSS
ACCOUNT ON
DEBIT SIDE LOSS
6 COST CENTRE

 Location, person, or an item of equipment or a group of these for which

costs may be ascertained and used for the purpose of cost control.
 Each sub-unit of an organization where costs are incurred is known as a
cost centre.
 It is the smallest segment of activity or the area of responsibility for which
costs are accumulated.
 The costs incurred by the cost centres form part of cost of output.
 Objective of cost centres:
 Cost control: It helps in controlling expenditure by making the manager
responsible for the costs.
Types of cost centre
7

Two
automatic
machines
operated by Impersonal Personal Production Service
one workman

Location or item of
Person or group of Production or Provide service to the
equipment (or a
persons manufacturing area company
group of these)

A department, A salesman, a Weaving department Power house, tool

a sales area/ a machine in a textile mill, cane room, stores
machine, a operator crushing shop in a department, repair
delivery van sugar mill shop, canteen
8 COST UNIT
 Cost unit it a quantity of product, service or time (or a combination of these) in relation to which
costs may be ascertained or expressed.
 The unit of output in relation to which cost is incurred by cost centre.
 The selection of suitable cost unit relates to the natural unit of the product and service. It also
depends on nature of business, process of information, requirements of costing system etc.

Per kilowatt-hour Per kilogram Per passenger-kilometer

Per meter Per patient-day Per tonne-kilometer

Per piece
 It can be a single cost unit or a composite cost unit, i.e., a combination of two units.
9
COST OBJECT

A cost object is any item, product, service, or activity for which costs are
accumulated or measured.

COST OBJECT EXAMPLES

PRODUCT Phone, Car, Bag
SERVICE Cab ride, Legal advice, fitness classes
ACTIVITY Machine setup, Product design, customer service calls
 Cost object in healthcare organization – Fortis hospitals

Different medical services can be a cost object,

like consultation, surgeries, diagnostic tests.

Different departments can be cost objects, like

emergency room, pharmacy, radiology.
 Cost object in manufacturing company – Adidas

Each product line can be a cost object, like shoes,

apparels, accessories

Individual products can be cost objects, like

“adidas samba”, “ultraboost”, “yeezy”
COSTING
METHODS
AND
TECHNIQUES
JOB COSTING
 Cost accounting method used to allocate costs to individual jobs or projects.
 It is commonly employed in industries where products or services are customized or
produced in small batches.

Job Order Costing applies where work is undertaken to customers' special requirements
•Interior decorations, painting, custom furniture manufacturing

the cost of a batch or group of identical products is ascertained and

therefore each batch of products is a cost unit for which costs are
Batch Costing ascertained.
•Production of ready-made garments, toys, shoes, bags, bakery producing cakes in Batches etc.

used when the production is for a long-term contract or project, and costs
Contract Costing are accumulated for the duration of the project.
•Most suited to construction of buildings, dams, bridges and roads, ship-building, etc.
PROCESS COSTING
 Cost accounting method used in mass production industries manufacturing standardised
products in continuous processes of manufacturing.
 Textile mills, chemical works, sugar mills, refineries, soap manufacturing, etc.,
production is uniform and consists of a single or two or three varieties of the
Unit Costing same product
•mines, steel production, flour mills, etc.

involves cost ascertainment for each operation; provides minute analysis

Operation Costing of costs and ensures greater accuracy and better control.

Operating or Service used in undertakings which provide services instead of manufacturing

Costing products
•transport undertakings (road transport, railways, airlines, costing, shipping companies), electricity
companies, hotels, hospitals, cinemas, etc.,
COSTING TECHNIQUES

 Standard Costing - standad cost is pre-determined as target of

performance, and actual performance is measured against
the standard
 Budgetary Costing - applied to control of total expenditure on
materials, wages and overheads by comparing actual
performance with planned performance
 Marginal Costing – separates costs into fixed and variable
(marginal); it regards only variable costs as the cost of the
products. Fixed cost is treated as period cost and no attempt is
made to allocate this cost to individual cost centres or cost
units
 Total Absorption Costing - total costs (fixed and variable) are
charged to products
 Uniform Costing- It simply denotes a situation in which a
number of firms adopt a uniform set of costing principles.
Classification of costs

Process of grouping costs according to their common characteristics.

It is a systematic placement of like items together according to their common
features.
Function

Variability Controllability

Classification
of costs

Identifiability Time

Normality
Classification of costs
By Variability:
i. Fixed costs:
 These costs remain constant in ‘total’ amount over a specific range of activity for a specific period
of time.
 They do not increase or decrease when the volume of production changes.
 For eg.: Rent of the building and managerial salaries
 Fixed cost per unit decreases when volume of production increases and vice versa.
Classification of costs
By Variability:
ii. Variable costs:
 These costs tend to vary in direct proportion to the volume of output.
 When volume of output increases, total variable cost also increase, and vice versa.
 For example: Direct material, direct wages, direct expenses
 Variable cost per unit remains same.
Classification of costs
By Variability:
iii. Semi-variable or semi-fixed costs (Mixed costs):
 These costs include both a fixed and a variable component.
 They have a fixed element below which it will not fall at any level of output. The variable element
changes either at a constant rate or in lumps.
 For e.g.:
TRUE OR FALSE

[Link] cost per unit remains unchanged when output is increased or

decreased.
2. Cost accounting is a branch of financial accounting.
3. Cost accounting is used in manufacturing and non-manufacturing undertakings.
4. Cost means expired cost while expense means expired as well as unexpired cost.
5. Main purpose of cost accounting is to maximise profit.
6. Contract costing is used in the supply of tyres and tubes for a long term contract
with a car manufacturing company.
7. Contract costing is used in ship building.
8. Variable cost per unit varies with increase or decrease in the volume of output.
9. Fixed cost per unit remains fixed.
10. Fixed cost does not change in the same proportion in which output change.
Classification of costs
1. By function:
i. Production cost: From raw material to primary packing of finished product
ii. Administration cost: Formulating policy and controlling operation. Not directly related to production,
selling, distribution, and R&D.
iii. Selling cost: Promoting sales and retaining customers.
iv. Distribution cost: From making the packed product available for dispatch to returning the empty
package for reuse.
v. R&D cost: Researching new or improved products, methods, processes.
vi. Pre-production cost: Making trial production run preliminary to formal production.
Classification of costs
2. By controllability:
i. Controllable costs: Costs which may be directly regulated at a given level of management authority. For
example: cost of raw may be controlled by purchasing in larger quantities.
ii. Uncontrollable costs: Costs which cannot be influenced by the action of a specified member of an
enterprise. For example: it is difficult to control costs like factory rent, managerial salaries etc.

*Variable costs are more prone to control than fixed costs.

Classification of costs
3. By time:
i. Historical costs: Based on actual expenses incurred during the period. They are ascertained after they
have been incurred. They are not available until after the completion of the manufacturing operations.
ii. Predetermined costs: Prepared in advance before the actual operation starts based on specification,
historical data, and other factors affecting costs. They are future costs and are extensively used for
planning and control.
Classification of costs
4. By normality:
i. Normal costs: Cost which is normally incurred at a given level of output. It is a part of cost of
production. They are a part of the regular, ongoing business operations.
ii. Abnormal costs: Cost which is not normally incurred at a given level of output. It is over and above the
normal cost and is not treated as a part of the cost of production. They arise due to unforeseen
circumstances. They are not anticipated in the budget.
Classification of costs
5. By their identifiability with cost units/ jobs/ cost centres:
i. Direct costs:
 These are those costs which can be easily and conveniently identified with a unit of product/service/project.
 They are critical for calculating the cost of goods sold.
 Cost of raw material used and wages of a machine operator are common examples of direct cost.
Classification of costs
5. By their identifiability with cost units/ jobs/ cost centres:
ii. Indirect costs:
 These are general costs and are incurred for the benefit of a number of units, processes or departments.
 They cannot be easily identified with a unit of product or other cost object.
 Depreciation of machinery, power, lighting, rent are common examples.
Classification of costs
6. Classification into product and period costs:
i. Product costs: These are the costs which are necessary for production, and
which will not be incurred if there is no production. These include direct
material, direct labour etc. They are ‘inventoriable’ costs as they are included in
the cost of product.
ii. Period costs: These are the costs which are not necessary for production and
are incurred even if there is no production. They are not inventoried, i.e., they
are not included in the value of stocks. They are incurred for a time period and
are charged to Profit and Loss account. Administration and selling expenses are
treated as period costs.
Product vs Period Cost
Classification of
costs
[Link] into Committed
and Discretionary costs:
• Fixed costs are further
classified into committed
and discretionary costs.
• Based on the degree to
which a firm is locked into
an asset or service that is
generating the fixed cost.
Classification of costs
8. By managerial decisions:
i. Marginal cost: Additional cost of one additional unit of product or service.
ii. Differential cost: Difference in total cost resulting from a contemplated change. It is the
increase/ decrease in total cost that results from an alternative course of action. The alternative
may arise due to change in method of production, change in product mix, make or buy
decisions etc.
iii. Imputed cost: Hypothetical cost to represent benefit enjoyed by an entity on which no
expense is explicitly incurred.
iv. Out of pocket cost: Actual cash outlay. They are explicit costs.
v. Sunk cost: Historical cost that are irrevocable in a given situation. Not relevant for decision
making.
vi. Replacement cost: Current market cost of replacing an asset.
vii. Opportunity cost: Value of benefit sacrificed in favour of an alternative course of action.
Classification of
costs
8. By managerial decisions:
viii. Relevant & Irrelevant cost:
• Relevant costs- future costs and
which differ under each alternative.
• Irrelevant costs- not affected by a
managerial decision
ELEMENTS OF COST
Elements of cost
1. Material cost
 Material is a substance from which the finished product is made.
a.) Direct Material: It is the acquisition cost of all materials that eventually become part of
the product and can be traced to that product in an economically feasible way.
 For eg.: Cotton used in garments, clay used in bricks.
b.) Indirect material: Materials that cannot be conveniently identified with individual cost
units. Includes (i) small and inexpensive items that may become a part of a finished product
like pins, screws, threads etc. (ii) items that do not physically become part of a finished
product like lubricating oil, coal, grease, sandpaper, bolts etc.
*It includes cost of procurement, freight inwards, insurance etc.
**Trade discounts, rebates, duty drawbacks etc. are deducted in determining the cost of
material.
 Identify the following as direct or indirect materials:
a. Sandpaper used in furniture making
b. Milk to make ice cream
c. Detergent used for factory cleaning
d. Battery to be installed in a car
e. Clay used to make ceramic mugs
f. Nuts and bolts used in fixing a table
g. Wood used in making a table
h. The glue used to paste the cushion on a chair
 What would be the direct and indirect materials in a burger?
Direct – bun, patty, cheese, lettuce, tomato, onion
Indirect – cooking oil, seasoning, packing material
 Prime cost = Direct material + Direct labour + Direct expenses
 Overhead = Indirect material + Indirect labour + Indirect expenses
 Types of overheads
a. Production overhead
b. Office and administration overhead
c. Selling and distribution overhead
 Works cost = Prime cost + Factory overhead
 Cost of production = Works cost + Administration overhead
 Total cost or Cost of sales = Cost of production + Selling and distribution
Elements of cost
2. Labour cost
 Labour is the human effort required to convert the materials into finished
product.
 Labour cost is the cost of remuneration (wages, salaries, commissions,
bonus etc.) of the employees of an undertaking.
a.) Direct Labour: It consists of wages paid to workers directly engaged
in converting raw materials into finished products.
For eg.:Wages paid to the machine operator or carpenter
b.) Indirect Labour: It is of general character and cannot be conveniently
identified with a particular unit. Indirect labour is not directly engaged in the
production operations but only to assist.
 For eg.: gatekeeper’s salary, foreman’s salary
Elements of cost
3. Expenses
 All the costs other than material and labour are termed as expenses.
a.) Direct expenses: Those expenses which are incurred in connection with a
particular job cost unit. They are also known as chargeable expenses.
 For eg.: cost of hiring a special machine for a particular cost object,
royalities/ patents cost.
b.) Indirect expenses: All indirect costs, other than indirect material and
indirect labour costs, are termed as indirect expenses. These cannot be
directly identified with a particular job or process and are common for several
cost centres.
 For eg.: Rent, depreciation, lighting, advertising.
COST SHEET
 It is a statement which is prepared periodically to provide detailed cost of a cost centre.
 It shows total cost as well as the various components of it.
 Period covered by a cost sheet may be a year, a month, a week etc.
TRUE OR FALSE

11. Abnormal cost is uncontrollable.

12. Conversion cost is the aggregate of direct labour and manufacturing
overhead.
13. Supervisor's salary is a part of administration overhead.
14. Nails used in furniture manufacture is an indirect material cost.
15. All costs are controllable.
16. Depreciation is an out-of-pocket cost.
17. An item of cost that is direct for one business may be indirect for another.
Fill in the blanks

1. Aggregate of all direct costs is known as _______________

2. Fixed cost per unit _______________ with increase in the size of output.
3. Factory cost + administration overhead = _______________
4. _______________ is the technique/process of ascertaining costs.
5. _______________ is a unit of product, service or time in relation to which cost
may be ascertained.
6. Indirect material + Indirect Labour + _______________ = Overhead.
7. _______________and _______________are examples of fixed cost.
Match the following

(i) Total fixed cost 1. What cost should be

(ii) Total variable cost 2. Incurred cost
(iii) Unit variable cost 3. Increases with output
(iv) Unit fixed cost 4. Cost of conversion
(v) Standard cost 5. What costs are expected to be
(vi) Period cost 6. Decreases with rise in output
(vii) Actual cost 7. Remains constant in total
(viii) Labour and overhead 8. Remains constant per unit
(ix) Incremental cost 9. Cost not assigned to product
(x) Budgeted cost 10. Added value of a new product