Fundamentals of Cost Accounting

Fundamentals of Cost Accounting

Usually costs are collected under general ledger accounting headings, which follow natural classifications, such as materials, labor, power, electricity, fuel etc. Cost assignment is a general term used to cover 1 . Tracing of costs to cost objects, 2. Apportionment of costs to cost objects, and 3. Application of costs to cost objects Often termed as cost absorption. 3. Define Cost apportionment and Cost absorption. Cost apportionment is “The allotment to two or more cost centers of proportions of the common items of cost on the estimated basis of benefit received. Cost Absorption is a method of assigning cost to cost units. Cost which Anton be allocated to cost units are assigned to them on some equitable basis. Normally it shall be assigned at a predetermined basis like machine hour rate, labor cost etc. 4. How the cost is classified? The costs are classified according to the basis of relationship to the production unit as direct cost and indirect cost. The cost incurred direct in manufacture Of a product in respect Of each and every unit is called direct costs. These include direct material cost; direct labor cost and direct chargeable expenses.

The expenses that are normally incurred to a production centers irrespective of production are called indirect costs. These include indirect materials, indirect labor and other indirect expenses. Based on the variability of the costs they are classified as fixed costs, Variable cost and semi-variable cost. The expenses, which are constant for a particular period or for a particular level of productivity, are fixed costs. These costs have no-direct relationship to the actual production and incurred irrespective of actual production.

Semi-variable costs include an element, which is directly proportionate to the production, and other element, which has no relation to the production. Normally these expenses assumes the unction y = a+box or a + box + ex.. Based on the financial accounting principle these can be classified as capital costs or revenue cost. Capital cost is those expenses that result in increase in productivity. E. G. Purchase of machinery. The cost incurred in producing or aids in such production are the revenue costs. E. G. Materials, rent, power, electricity etc. 5.

Define the term cost driver. A cost driver is a factor, which influences the cost of a cost object. It is often used to describe the factors, events of forces that are the significant determinants of the cost object. For example, cost of issuing materials is determined by the number of times materials being issued to production cost centers and also by the size of the and the weights of materials. Similarly the cost of operating the purchases department is determined by the variety of materials being used and also the number of purchased orders being issued. . What do you mean by step costs? Step costs are those which increase in Steps. These costs remain constant over various levels of small ranges of output. These cost increase by discrete amounts as activity moves from one range to next. Example: the amount of depreciation will remain constant till 100% productivity is achieved and will increase considerably where the output increases above 100%. 7. Define notional cost. Notional cost is one, which is not actually incurred but ascertained and allocated on some basis.

For example the rent for one premise can be charged which is not actually incurred but ascertained based on actual rental value etc. These costs will not result in outflow of cash. 8. Define imputed cost, sunk cost and relevant cost. Imputed cost – It is a historical cost and does not involve actual cash outlay, and, as a consequence does not appear in the financial records. Imputed cost is similar to the notional cost and is considered only in cost accounts in ascertaining the cost of a product. Sunk cost – It represents historical cost which is irrecoverable in a given situation.

For example, while considering the replacement of asset the capital loss or depreciated book value of the existing asset may not be taken into account on the ground that this portion of the cost having been already incurred in the past and has no relevance to the present decision. Relevant cost – Costs appropriate to aiding the making of specific management decisions are called relevant cost. These are expected future costs that will differ under alternatives. Future variable costs generally become relevant in a decision context while fixed costs may be irrelevant if they do not change in total.

However the fixed cost will also be relevant if there is a change in value immediately or in future. 9. Define controllable cost and policy cost. Controllable cost- costs which can be influenced by the action of an individual enterprise with in a given time of span. But few costs are clearly under the influence of one person in any organization and few items of cost are susceptible to control at all levels. Another major aspect in controllability is the time factor. With enough time virtually all cost are controllable by somebody or by some means in an organization. Logic cost- the costs incurred as a result of policy decisions is called policy cost. For example, purchase of assets will create a charge for depreciation. 10. What are the essentials Of a good costing system? An ideal system of cost accounting must posses some characteristics, which will bring the advantages to the business. He main features of an ideal costing system are: a. Simplicity – It must be simple, flexible and adaptable to the changing conditions. The information must be provided in proper order, at the right mime and to the right persons so as to be utilized fully. . Flexibility and adaptability – The costing system must be flexible to adjust to the changing conditions and circumstances. The expansion, contraction or changes must be adopted in the existing system with minimum changes. C. Economy – The costing system must suit the availability of finance. The expenditure must be less than the benefits derived from the system adopted. D. Comparability – The management must be able to compare the facts and figures with past figures, figures of other concerns or other departments of the same concern. E.

Suitability to the firms – Before accepting a costing system, the nature, requirements, size, conditions of business etc. Must be carefully studied. The system must be capable of prompt and accurate reporting to different levels of management according to their requirements. F. Minimum change in the existing set up -” When introducing a costing system, it must cause minimum disturbance to the existing system of business. G. Uniformity of forms- Forms of different colors can be used to distinguish them forms must be uniform in size and quality.

Forms should contain instructions to fill, to use and for disposal. H. Less clerical work – Printed forms will involve less labor to fill in, as the workers may be a little educated. I. Effective material control and wage system – There must be a proper procedure for recording the time spent on different jobs, by workers for the purpose of payment of wages. A systematic method of wage system will help in control of labor cost. Since the cost of materials forms a greater part of the total cost there must be an efficient system of stores control. J.

Sound plan – There must be proper and sound plan to collect, allocate and absorption of overhead expenses on each job or each product in order to find UT the cost accurately. K. Reconciliation – The system of costing and financial accounting must facilitate reconciliation in an easy manner. L. Overall efficiency of cost accountant – The work of the cost accountant under a good system of costing must be clearly defined as his duties and responsibilities to the firm are very essential 11. You have been asked to design a system of cost accounting in a factory. Describe the various points that should be considered before you design a system. Installation of a costing system) It is very difficult to prepare a uniform method of cost applicable to each ND every kind of industry. The basic principles are fairly definite, but practical application varies from industry to industry because of the basic nature of industries. The installation of a costing system requires careful consideration of the following: a. Objectives of a costing system – The expectation of the management from the costing system should be carefully understood for a smooth adoption of costing system. One must decide the objectives to be achieved.

The system must suit the general nature of the business. The system must be well understood to the management and the personnel. B. Product and the business – The nature of the product and business determines the method of costing system to be adopted. E. G. Engineering industries adopt job costing, chemical industries process or batch costing etc. Some industries may require more labor than more materials; many industries may require more materials than labor, etc. Hence the cost components of the products are to be analyses into its various constituents and their relative importance must be studied carefully. . The organization – When a new system of costing is introduced, the existing organizational set up has to be modified. There should be minimum dislocation of existing set up. The size of the organization, levels of management, authority of each executive, sources of cost information, the reports to be sent to various managerial authorities, etc. Should be studied carefully. The whole organization must be geared to have full co-ordination and control and of course without overlapping and overlooking all functions. D.

Technical aspects – A careful study of manufacturing operations and process, material control, labor control, system of wage payment, factory layout, etc. Are of immense significance. These will enable to remove inefficiencies of labor, wastage of materials, etc. E. Standardization – The forms to be used must be standardized so that clerical work can be reduced to the minimum. The method of filling, the forms to be used etc. Should be simple and guidelines may be provided whenever necessary. F. Communication – Emphasis should be put on the system of communication.

A proper system must be drawn to ensure complete and reliable cost information in the field Of collection, transmission, report making and reaching the appropriate levels of management. G. Accounting system – Determination of unit of cost, classification of operating expenses, coding systems of material, developing the measures of inventory control, stores accounting system, preparation of charts, budgetary control, reconciliation of cost with financial accounts, preparation of cost reports to managerial levels for making decisions are the general problems to be dealt with.

When all these are adopted in an existing industry the personnel may give raise to problems because of the fact that the existing inefficiencies may be brought to light. The personnel should be convinced about the system and their co-operation is ensured. Only then the system will be successful. Instead of rapid introduction, gradual introduction of the cost system will reap the desired goal. H. Elasticity and economy – The system to be adopted must be capable of being flexible and adaptive to the changing circumstances. Care should be taken that the utility be more than the cost paid.

The system should not be complicated and expensive. I. Regularity- Cost data and costing information must reach the person concerned regularly and promptly. Otherwise significance of the costing system will be lost and expensive. A good system of communication will render the communication process attainable the objective. 2. What do you mean by cost centre and what are its subdivisions? A cost centre is a location, person or item of equipment or group of these for which cost may be ascertained and used for the purpose of control. The cost centre may be a department or a machine or a plant or a salesman or a particular work, etc.

In certain cases the cost unit and cost centre may be the same. Each cost centre is given charge under a personnel for controlling the cost, accumulation of cost and its allocation. The sub divisions of cost centre a. The personal cost centre -” It consists of a person or group of persons; cost eke salary of works manager, storekeeper, sales manager and others may be accumulated. B. Impersonal cost centre – It consists of a location or items of equipment. C. Process cost centre- It consists of a specific process or a continuous sequence of operations.

The cost accumulated by each of these categories of department is a production or a service, which can be considered as a cost centre. 13. What do you mean by ‘cost control’ and ‘cost Reduction’. Distinguish between them. Cost control is defined as “The guidance and regulation by executive action, by costs of operating an undertaking’. Cost control plays its part at the secretion of the management, who wish to maintain the cost within a specific limit. It aims at improving performance efficiency to achieve the target. Cost control can be secured through: a.

Setting up standards for expenses and production. B. Finding out differences of actual against standards. C. Analyzing the differences with reasons. D. Taking up corrective measures to eliminate variances. Cost reduction is concerned with reducing costs. It is concerned with reduction program, which is a continuous process. It strives to achieve permanent reduction which starts where cost control ends; cost can be reduced on account of saving in cost. Distinction between cost control and cost reduction s. No reduction reducing cost 2. Challenging standard 3. Is dynamic. 4. Cost control Aims at maintaining the cost in accordance with standard cost Seeks to attain the lowest possible cost cost It aims at Brings profit by under existing conditions through research The function is static. Emphasis is on the past and present the present and future 5. Corrective function. It is a preventive function The function Emphasis is on It is a 14. List out various methods of costing and explain their practical applications. The following are the various methods of costing. . Single or output costing, b. Process costing c. Multiple costing, d. Terminal costing, e. Marginal costing, e.

Operating costing f. Job costing, g. Batch costing and Standard costing. A. Single or output costing – This costing system is applied where a single product is manufactured. It requires no allocation of overheads between products. A costing per unit of product is ascertained for a product in respect off period. E. G. Brick-making b. Process costing – Process costing is designed to show the cost of each process through which raw materials pass through in their conversion into scalable products. This system is applied where the plants are laid out in process layout. E. G. Textile industries. C.

Multiple costing – It is a system adopted in a business producing a variety of products each of which differs from the others as to material, manufacturing process etc. The principle characteristic of multiple costing is that a separate method of costing may be employed in respect of each article. D. Terminal costing – terminal costing is also called as contract costing and is used by an undertaking which carries substantial contract the completion of which generally takes more than a year. Under this method a major part of he expenditure is charged direct to contracts and only the office expenses need to be allocated.

The amount of such expenditure will be very less when compared to the direct expenses charged to production, a more precise scientific method of allocation of such expenditure is not needed. E. G. Construction of building. E. Marginal costing – Marginal costing is a method of costing in which the allocation Of expenditure to production is restricted to those expenses which arise as a result of production. Fixed overheads are not allocated on the ground that frequently the apportionment to cost centers or jobs cannot be add on any scientific basis.

Marginal costing is useful in manufacturing industries with various levels of output. This system of differentiates between fixed costs and variable costs. This type of costing is useful in taking important policy decisions such as price fixing during competition, make or buy decisions, product mix etc. F. Operating costing- Operating costing is a system of costing applicable to industries in which end product is service. E. G. Transport service, power generation etc. The system is also applicable to utility services such as applications. The foil marginal casting, c. C Standard casting. Ingle or output co produce is manufacture products A costing of a period. Brick process through hi( sale e products TTL process ‘duty, E. G. T Multiple costing- of rare of I,’ malingering proceed used by an undertake the expenditure is chi need to be allocated. Compared to the dire science:fix method of of build allocation CB expends ground that frequent made an any scientific industries with various fixed and variant important policy decide buy decisions. Proud _ casting- industries in which el generation etc. The canteen, hospitals, distribution services such as sum: as etc. G.

Job costing -”Job order costing or specific c ascertainment of cost of each job, work order or prop adopted by many undertakings both manufacturing concerns. Manufacturing concerns adopting this met’ machine tool manufacturing units etc. Non-manful general engineering work shops, automobile repair SSL objective of this type of costing is to determine profit Before accepting a job an estimation of cost is made. H. Batch costing- batch costing is a system of costing facilities are arranged in such a way that a particular carried out. This system is best adopted where the p Anton be manufactured as one piece and the cost al per piece.

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