Cost & Management Accounting Cost Concepts

Prepared By Vishal Goel

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Concept of Cost Accounts

The basic approach to cost accounting is distinct from financial accounting. It is oriented to relating the expenditures to products in addition to analyzing the expenditures on the basis of natural classification of material, labour, etc. The cost of a product is taken as the final outcome of manufacturing activities.

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Cost of Product
The fundamental element of cost accounting system is cost which is defined as the amount of expenditure (actual or notional) incurred on or attributable to a produced item or a service unit The term cost connotes different meanings to different people, but in cost accounting, it is used in a special sense. Cost represents an expenditure made to secure an economic benefit, generally on the uses of resources that promise to produce revenue.

The resources may have tangible substance (e.g. manpower, material, machine, etc.), or they may take the form of services (e.g. wages, rent, power, etc.).
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Cost, Expense, and Loss

The term cost is denoted by expense which is incurred after deriving the benefit. A resources sacrificed or forgone to achieve a specific objectives. Expenses are defined as all explicit costs which are deductible from revenue.

When the cost is incurred before deriving the benefit, it is termed as deferred cost,
When no benefit is derived by the incurrence of cost, it is termed as loss,

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Cost ascertainment
Cost ascertainment : is related to computation of actual costs incurred. It means the methods and process employed in ascertaining costs. Different methods are employed for ascertaining cost in different organizations. Job costing, contract costing, batch costing, process costing, unit costing and multiple costing are some methods. Each method is chosen according to its suitability with the organization concerned. The ascertainment of actual cost has a small impact because of the following possible reasons: Actual cost cannot be used for the purpose of price quotations and filing tenders. Actual cost has practically no utility for control purposes. Actual cost is ineffective as means of measuring performance efficiency. Ascertainment of actual costs proves to be important though there are limitations as shown above. Ascertainment of actual costs tells us unprofitable activities and losses and inefficiencies occurring in the form idle time, excessive scrap etc.,

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Cost Estimation
It is the process of pre-determining costs of goods or services. The costs are determined in advance of production and precede the operations. Estimated costs are future costs and are based on the average of past actual costs adjusted for anticipated changes in future.
Uses:

In making price quotations and bidding for contracts. Helpful in preparation of budgets. Helpful in evaluation performance. Helpful in preparing financial statements. Serve as targets in controlling the costs.

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 Cost assignment a general term that includes gathering accumulated costs to a cost object. This includes:
Tracing accumulated costs with a direct relationship to the cost object and Allocating accumulated costs with an indirect relationship to a cost object

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What is cost centre? How is it identified? List its uses.

Cost is generally ascertained by cost centres. Let us understand about cost centre A cost centre is a location, person or item of equipment (or group of these) for which costs may be ascertained and used for the purposes of cost control. (I.C.M.A. London) The entire organisation may be divided into specified cost centres, which jointly contribute to the total cost. A cost centre is primarily identified in two major ways. They are Personal cost centre: It consists of a person or a group of persons. Impersonal cost centre: It consists of a location or an item of equipment or group of these.
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Cost centre
A cost centre is a location, a 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.

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Types of Cost Centres

Personal and impersonal cost centre Operation and process cost centre Production, service and staff cost centre Whatever may be the type of cost centre, it is determined by taking into consideration the following factors:
the value of the work to be performed, the extent of cost control that can be exercised, responsibilities to be identified, and the uses of cost centre wise data by the costing department, etc.
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Cost Unit
Cost unit is defined as a quantitative unit of a product, a service, or an item, in relation to which costs are measured. A cost unit, simply stated, is a unit of finished product, service or time, or a combination of these in relation to which cost is ascertained and expressed. Cost units may be: unit of product (e.g., cost per book) unit of time (e.g., cost of generating electricity per hour) unit of weight (e.g., cost per kilogram of sugar) unit of measurement (e.g., cost per square foot of construction) operating unit of service (e.g., cost of running a car per kilometre)

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 Selection of a cost unit must be appropriate. Convenience is the first criterion. Secondly, it should be easier to correlate expenses with cost units. Thirdly, it should be according to the nature and practice of the business. A few more examples of cost units in various industries are given: Industry Cost Unit
Cars Cement Chemicals Bricks Shoes Pencils Electricity Transport Automobile Printing Press Cotton Timber Mines Carpets Hotel Per Car Tonne Tonne, kilogram, litre, gallon etc 1,000 bricks Pair or dozen pairs Dozen or gross Kilowatt hour Passenger Kilometre Number Thousand copies Bale Cubic foot Tonne Square yard Room per day

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Cost Object
Cost object is an entity or a part of an entity. Anything for which a separate measurement of cost may be desired. Ex: a product, services, process, or activity The cost object changes according to decision needs of the management. Costing objective : represents the overall objective for which cost collection, cost analysis, and cost control is being attempted.

Cost objective is different from expenditure objective. Ex purchase of office equipment may be the objective of expenditure need not to be cost objective
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Product and Period Costs

1 Product costs: the costs of manufacturing our products; or 2 Period costs: these are the costs other than product costs that are charged to, debited to, or written off to the income statement each period.

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INVENTORIABLE COSTS AND PERIOD COSTS

Inventoriable cost/ product cost is that cost which is regarded as asset when incurred, but becomes a part of cost of goods sold when the product is sold. For all manufacturing cost is Inventoriable cost. (Raw material to WIP to Finished goods) For a service sector unit, absence of inventory means all are period costs. Period costs (non-product cost): all costs in P&L account except cost of goods sold. So, in a mfg. sector unit, all nonmanufacturing costs are period costs. (Ex. Distribution cost, design cost, R&D costs, Marketing costs, customer-service costs, etc.)

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Direct costs
Direct costs are generally seen to be variable costs and they are called direct costs because they are directly associated with manufacturing. Direct costs can include: Direct materials: plywood, wooden battens, fabric for the seat and the back, nails, screws, glue. Direct labour: sawyers, drillers, assemblers, painters, polishers, upholsterers Direct expense: this is a strange cost that many texts don't include; but (International Accounting Standard) IAS 2, for example, includes it. Direct expenses can include the costs of special designs for one batch, or run, of a particular set of tables and/or chairs, the cost of buying or hiring special machinery to make a limited edition of a set of chairs.

Total direct costs are collectively known as Prime Costs

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Indirect Costs
Indirect costs are those costs that are incurred in the factory but that cannot be directly associate with manufacture. Again these costs are classified according to the three elements of cost, materials, labour and overheads. Indirect materials: Some costs that we have included as direct materials would be included here. Indirect labour: Labour costs of people who are only indirectly associated with manufacture: management of a department or area, supervisors, cleaners, maintenance and repair technicians Indirect expenses: The list in this section could be infinitely long if we were to try to include every possible indirect cost. Essentially, if a cost is a factory cost and it has not been included in any of the other sections, it has to be an indirect expense. Here are some examples include: Depreciation of equipment, machinery, vehicles, buildings Electricity, water, telephone, rent, Council Tax, insurance Total indirect costs are collectively known as Overheads.
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2. By variability: Costs are classified according to their behaviour in relation to changes in the level of activity or volume of production. On this basis, costs are classified into three groups namely fixed, variable and semivariable

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Variable costs
Costs which vary in total in direct proportion to the volume of output. These costs per unit remain relatively constant with changes in production. They are also known as product costs as they depend on the quantum of out put rather than time. Eg: Direct material, direct labour, power, repairs etc.

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