Cost Accounting, Meaning and Objective of Cost Accounting, Elements of Cost, Methods of Cost

Accounting – Unit Costing, Contract Costing.

Cost Accounting is the process of recording, classifying and analysing the costs of products
or services. It helps in the presentation of suitably arranged data for the purpose of control
and guidance of management.
Costing is the technique and process of ascertaining costs.
Cost Accountancy is the knowledge and application of the principles, methods and
techniques in Costing and Cost Accounting.
The Institute of Cost and Works Accountants of India (Now, The Institute of Cost
Accountants of India) was established at Kolkata with the enactment of the Cost and Works
Accountants of India Act, 1959.
Main objectives of Cost Accounting:
➢ To ascertain cost
➢ To determine the selling price
➢ To determine and control efficiency in Materials, Labour and Overheads
➢ To determine the value of closing inventory
➢ To provide basis for operating policies and decisions
➢ To achieve real and permanent reduction in the cost

Scope of Cost Accountancy:

➢ Cost Ascertainment
➢ Cost Accounting
➢ Analysis of Cost
➢ Cost Control
➢ Cost Reports
➢ Cost Audit

Cost: Total of all expenses made, for the production of goods or rendering services.
Elements of Cost:
➢ Material: Direct Material and Indirect Material
➢ Labour: Direct Labour and Indirect Labour
➢ Expenses: Direct Expenses and Indirect Expenses

Prime Cost = Direct Material + Direct Labour + Direct Expenses

Overheads = Indirect Material + Indirect Labour + Indirect Expenses
Direct materials: can be identified in the product and can be conveniently measured and
directly charged to the product.
Indirect materials: do not normally form a part of the finished product.
Direct Labour: can be conveniently identified or attributed wholly to a particular job,
product or process.
Indirect Labour: cannot be directly attributed to a particular cost object.
Direct Expenses: expenses relating to manufacture of a product or rendering a service which
can be identified or linked with the cost object.
Cost Object: technical name for a product or a service, a project, a department or any
activity to which a cost relates.
➢ At a broader level a cost object may be named as a Cost Centre.
➢ At a narrow level a cost object may be named as a Cost Unit.

Cost Centre: a location, a person, or an item of equipment in relation to which costs

ascertained and used for the purpose of cost control.
Cost Unit: A Unit of product or service in relation to which costs are ascertained.
Cost Allocation: It is a process, thorough which, items of cost are identified directly with
some products or departments, and are charged to specific cost centres.
Cost Apportionment: When items of cost cannot be directly charged to or accurately
identifiable with any cost centres, they are prorated or distributed amongst the cost centres on
some predetermined basis.
Classification of cost: The arrangement of items of costs in logical groups having regard to
their nature or purpose.
Conversion Cost: The sum of direct wages, direct expenses and overhead costs of converting
raw material to the finished products.
Manufacturing Costs: The cost of all items involved in the production of a product or
service.
Administration costs: Expenses incurred for general management of an organization.
Selling & Distribution Costs:
➢ Selling costs are indirect costs related to selling of products or services.
➢ Distribution costs are the costs incurred in handling a product from the time it is
produced until it reaches the ultimate consumer.

Fixed Cost: Fixed cost is the cost which does not vary with the change in the volume of
activity. These are also known as period cost.
Variable Cost: Variable cost is the cost which tends to vary with the volume of activity.
Semi-Variable Costs: Semi variable costs contain both fixed and variable elements.
Marginal cost: The change in the amount if the volume of output is increased or decreased
by one unit.
Sunk Cost: Sunk Cost is the cost incurred in purchasing a capital asset.
Opportunity Cost: Opportunity cost is the value of alternatives foregone
Replacement Cost: This is the cost in the current market of replacing an asset.
Differential cost: It refers to the difference between the cost of two alternative decisions.
Relevant Costs: Relevant costs are costs which are relevant for a specific purpose or
situation.
Imputed Costs: Imputed costs are hypothetical or notional costs, not involving cash outlay.

MATERIAL COST
Material refers to the commodities used for the purpose of consumption in the process of
manufacturing or of rendering service or for transformation into products.
Material cost is an important part of the total cost of any product.
Material Control: It is the function of ensuring sufficient material in the stock to meet all
requirements without carrying unnecessarily large stocks.
Economic Order Quantity (EOQ): The size of the order for which both ordering and
carrying cost are minimum.
Ordering Cost: The costs associated with the ordering of material. For example: cost of staff
involved in ordering, transportation expenses, inspection expenses, etc.
Carrying Cost: The costs for holding the inventories. For example: Cost of capital invested
in inventories, Cost of storage, Insurance, etc.
Assumptions of Economic Ordering Quantity (EOQ):
➢ Ordering cost and carrying cost are known and fixed.
➢ Anticipated usage of material is known.
➢ Cost per unit of the material is constant and is known.
➢ The quantity of material ordered is received immediately.

𝟐 × 𝑫𝒆𝒎𝒂𝒏𝒅 × 𝑶𝒓𝒅𝒆𝒓 𝒄𝒐𝒔𝒕

Economic order quantity = √ 𝑪𝒂𝒓𝒓𝒚𝒊𝒏𝒈 𝒄𝒐𝒔𝒕

Ex. The purchase price of a lock is Rs. 100 per unit, while the carrying cost comes to 5% and
consumption of raw material is 24000 units p.a. Ordering cost is Rs. 10 per order. What will
be the EOQ?
2 × 𝐷𝑒𝑚𝑎𝑛𝑑 × 𝑂𝑟𝑑𝑒𝑟 𝑐𝑜𝑠𝑡
Economic order quantity = √ 𝐶𝑎𝑟𝑟𝑦𝑖𝑛𝑔 𝑐𝑜𝑠𝑡

2 × 24,000 × 10
Economic order quantity = √ = 309.8386 or 310
5

Maximum Level: The maximum quantity of material that can be held in stock at any time.
Maximum Level = Re-Order Level + Re-Order Qty – (Minimum Rate of Consumption ×
Minimum Re-Order Period)
Minimum Level: The lowest quantity of material which must be maintained at all times.
Minimum Level = Re-Order level – (Normal Rate of Consumption × Normal Re-Order
Period)
Re-Order Level: The quantity of material, sufficient to meet the requirements of production
up to the time the fresh supply of material is received.
Re-Ordering level = Minimum Level + (Normal Rate of Consumption × Normal Re-order
Period)
Or
Re-Order level = Maximum Rate of Consumption × Maximum Re-Order period (lead time)
Ex. The weekly minimum and maximum consumption of material A in a company is 25 and
75 units respectively. The recurrence quantity fixed by the company is 300 units. Material
supply takes place between 4 to 6 weeks after the order is issued. Find the minimum and
maximum level of material A.
Re Order Level = Maximum Rate of Consumption × Maximum Re-Order period (lead time)
= 75 x 6 = 450
Minimum Level = Re-Order level – (Normal Rate of Consumption × Normal Re-Order
Period)
= 450 – (50 x 5) = 200
Maximum Level = Re-Order Level + Re-Order Qty – (Minimum Rate of Consumption ×
Minimum Re-Order Period)
= 450 + 300 – (25 x 4) = 650
Stores Records: The bin cards and the stores ledger are the two important stores records that
are generally kept for making a record of various items.
Bin Card: Bin Card is a quantitative record of receipts, issues and closing balance of items
of stores. It is also known as ‘Bintag’ or ‘Stock card’.
Stores Ledger: Stores Ledger is maintained by the costing department to record all receipts
and issues of materials with quantity, rate and amount.
ABC Analysis:
➢ It is an analytical method of stock control.
➢ It aims at concentrating efforts on those items where attention is needed most.
➢ It is based on the concept that a small number of the items in inventory may represent
the bulk money value of the total materials used, while a relatively large number of
items may present a small portion of the money value.
➢ The materials stocked may be classified into a number of categories according to their
importance.
VED Analysis (Vital, Essential and Desirable):
➢ VED analysis is used primarily for control of spare parts.
➢ The spare parts can be classified in to three categories i.e Vital, Essential and
Desirable- keeping in view the criticality to production.
➢ Vital: stock-out even for a short time will stop the production for quite some time,
and the stock out cost is very high.
➢ Essential: absence cannot be tolerated for more than few hours or a day and the cost
of lost production is high.
➢ Desirable: needed, but absence for even a week or more will not lead to stoppage of
production.
FSN Analysis:
➢ It is the process of classifying the materials based on their movement from inventory
for a specified period.
➢ All the items are classified in to F-Fast moving, S- Slow moving and N-Non-moving
items based on consumption and average stay in the inventory.
➢ This analysis helps the store keeper to keep the fast-moving items always available &
take necessary steps to dispose-off the non-moving inventory.
Just-in-Time (JIT):
➢ A strategy that strives to improve return on investment by reducing inventory and
associated carrying costs.
➢ This system focuses on “the right material, at the right time, at the right place, and in
the exact amount” without the safety net of inventory.
➢ It reduces the working capital requirements, as very little inventory is maintained.
➢ It minimizes storage space.
➢ It reduces the chance of inventory obsolescence or damage.
First in – First Out Method (FIFO):
➢ It is a method of pricing the issue of materials in the order in which they are
purchased.
➢ This method is considered suitable in times of falling price.

➢ The material cost charged to production will be high while the replacement cost of
materials will be low.
Last-in-First Out Method (LIFO):
➢ It is a method of pricing the issue of materials at the prices of last received batch, until
it is exhausted and so on.
➢ During the inflationary period, this method is considered suitable.

➢ Stocks would be valued at old prices.

Simple Average Price Method:
➢ Under this method materials issued are valued at average price.
➢ Average price is computed by dividing the total of all units’ rate by the number of
units.
➢ This method is useful, when the materials are received in uniform lots of similar
quantity and prices do not fluctuate considerably.
Price = Total of unit prices of each purchase / Total No of Units

Weighted Average Price Method

➢ This method removes the limitation of Simple Average Method.
➢ It takes into account the quantities which are used as weights in order to find the issue
price.
➢ This method uses total cost of material available for issue divided by the quantity
available for issue.
Price = Total Cost of Materials in stock/Total Quantity of Materials in stock

Labour Cost
Labour cost is the amount paid or payable in all forms of consideration, to the employees for
their services.
✓ Labour Cost is also called as Employee Cost.
✓ Labour cost can be direct labour cost and indirect labour cost.
✓ Direct labour cost can be identified with a product unit.
✓ Indirect Labour Cost cannot be identified with a product unit.
✓ Low productivity - higher Labour Cost per unit
✓ Higher productivity - low Labour Cost per unit

Major Issues:
Idle Time:
➢ Idle Time is ‘The difference between the time for which the employees are paid and
the employees time booked against the cost object’.
➢ Idle Time Cost represents the wages paid for the time lost during which the worker
does not work.
Taylor’s Differential Piece Rate Plan:
➢ According to F. W. Taylor, there are two classes of workers, efficient and inefficient.
➢ Efficient workers should be encouraged by giving wages at a higher rate.
➢ Inefficient workers should be penalized by giving wages at a lower rate.
➢ According to Taylor, if the workers are efficient, they should be paid @ 120% of the
normal piece rate and if they are inefficient, they should be paid @ 80% of the normal
piece rate.
Merrick’s Differential Piece Rate System:
➢ Merrick’s system is modification of Taylor’s system and is comparatively less harsh
on the workers.
Remuneration is given as follows:
➢ Up to 83% of production - Normal piece rate
➢ 83% to 100% of production - 110% of ordinary piece rate
➢ Above 100% of production - 120% of ordinary piece rate
Gantt Task Bonus Plan:
➢ This method assures minimum wages for all workers.
➢ It also offers good incentive to efficient workers.
➢ Main limitation is that the method is complicated to understand by the workers and
hence may create confusion amongst them.
➢ In this method, there is a combination of time rate, bonus and piece rate plan.

The remuneration is computed as follow:

➢ Production below standard - Guaranteed time rate
➢ Production at standard - Time Rate + 20% Bonus
➢ Production above standard - High piece rate for the entire output
Emerson’s Efficiency System:
➢ Under this system minimum time wages are guaranteed.
➢ Bonus is given to the worker beyond a certain efficiency level.
➢ The scheme provides for payment of bonus at various levels of efficiency in the following
manner:
performance below 66.67% efficiency, only time rate wages is paid without any
bonus
performance between 66.67% and 100% efficiency, bonus varies between 0.01% and
20%
above 100% efficiency level, bonus of 20% of basic wages + 1% for each 1% increase
in efficiency is admissible
Points Scheme−Bedaux System:
➢ Under this system the quantum of work that can be performed by a worker is
expressed in Bedaux Points or B’s.
➢ B’s points represent the standard time expressed in terms of minutes that are
necessary to perform a job.
➢ The standard numbers of points in terms of minutes are determined after analysing
each operation or job in detail.
➢ The workers who are not able to complete the tasks allotted to them within the
standard time are paid only the normal daily rate of wages.

➢ Those workers who are able to increase their efficiency rate are paid 75% of the time
saved.
Halsey Premium Plan:
➢ F.A. Halsey, an American engineer introduced this plan.
➢ Bonus is paid equal to wages of 50% of the time saved.
The formula is as follows:
Total Earnings = H X R + 50% [S – H] R
Where, H = Hours worked, R = Rate per hour, S = Standard time

Halsey – Weir Plan:

➢ This method is similar to Halsey’s plan, the only difference is that the rate of bonus for
1
the time saved is 33 3 % of the time saved.

Formula:
1
Total Earnings = H × R + 33 % [S-H] R
3

Where, H = Hours worked. R = Rate per hour, S = Standard time

Rowan Plan
➢ In this plan, bonus hours are calculated as the proportion of the time taken which the time
saved bears to the time allowed and they are paid for at time rate.
Formula:
Total Earnings = H × R + [S – H]/S × H × R
Where H = Hours worked, R = Rate per hour, S = Standard time,
Barth Variable Sharing Plan:
➢ In this system, the total earnings are calculated as follows:

Total Earnings = R × √𝑆 × 𝐻
H = Hours worked, R = Rate per hour, S = Standard time
Expenses
➢ In cost accounting the term ‘Expense’ is used to denote the expenses other than material
and labour.
➢ Expenses may be Direct Expenses and Indirect Expenses.
Direct Expenses:
As per CAS-10, “Direct expenses are the expenses relating to manufacture of a product or
rendering a service, which can be identified or linked with the cost object other than direct
material cost and direct employee cost”.
Common examples of direct expenses:
➢ Cost of patents, royalty payment;
➢ Hire charges in respect of special machinery or plant;
➢ Cost of special patterns, cores, designs or tools;
➢ Experimental costs and expenditure in connection with models and pilot schemes;
➢ Architects, surveyors and other consultants’ fee;
➢ Travelling expenses to sites;
➢ Inward charges and freight charges on special material.
Indirect Expenses:
➢ As per CAS-3, “Indirect Expenses are expenses, which cannot be directly attributed to
a particular cost object.”
➢ Common examples of Indirect Expenses are rent and taxes, printing and stationery,
power, insurance, electricity, marketing and selling expenses etc.
Overhead:
According to CIMA, overhead costs are defined as, ‘the total cost of indirect materials,
indirect labour and indirect expenses.’
Overheads are all indirect costs; hence it becomes difficult to charge them to the product
units.
Therefore, overheads are charged to the product units on some equitably basis which is called
as ‘Absorption’ of overheads.
Overhead Accounting:
Steps involved in Overhead Accounting:
(a) Collection, Classification and Codification of Overheads.
(b) Allocation, Apportionment and Reapportionment of overheads.
(c) Absorption of Overheads.
Collection of Overheads:
➢ Process of recording each item of cost in the records.
➢ Source documents for collection of overheads are Stores Requisition, Wages Sheet, Cash
Book, Purchase Orders, Invoices, Journal, etc.
Classification of Overheads:
➢ Classification of overheads is the arrangement of items in logical groups having
regard to their nature or the purpose.
➢ Classification according to Elements: Indirect Materials, Indirect labour and Indirect
expenses.
➢ Classification according to Functions: Manufacturing overheads, Administrative
overheads, Selling and Distribution overheads, Research & Development overheads.
➢ Classification according to Behaviour: Fixed Overheads, Variable Overheads & Semi
variable overheads.
Codification of Overheads:
➢ Codification is done to make easy identification of different items of overheads.
➢ A unique code number is given to each item of overhead.
➢ Codes can be numerical codes or alphabetical codes or a combination of both.
Allocation of Overheads:
➢ CIMA defines Cost Allocation as, ‘the charging of discrete, identifiable items of cost,
to cost centres or cost units.’
➢ Where a cost can be clearly identified with a cost centre or cost unit, then it can be
allocated to that particular cost centre or unit.
Apportionment of Overheads:
➢ Where it is not possible to charge the overheads to a particular cost centre or cost unit,
they are to be apportioned to various departments on some suitable basis.
➢ This process is called ‘Apportionment’ of overheads.
Re-Apportionment of Overheads:
➢ It refers to re-distribute the service department costs over the production departments.
➢ This also needs to be done on some suitable basis, as there may not be a direct linkage
between services and production activity.
Absorption of Overheads:
Absorption refers to recording of overheads in Cost Accounts on an estimated basis with the
help of a predetermined overhead rate.
Formula for overhead absorption rate:
Overhead Rate = Amount of Overhead / No of units
Under-absorption and Over-absorption of Overhead:
➢ In case a predetermined rate worked out on the basis of budgeted overhead and base
➢ is applied to the actual base,
➢ the amount absorbed may not be identical with the amount of overhead expenses
incurred
➢ if either the actual base or the actual expenses or both deviate from the estimates.
If the amount absorbed is less than the amount incurred - Under-absorption
if the amount absorbed is more than the expenditure incurred - Over-absorption
Causes of Under or Over Absorption of Overhead:
➢ Error in estimating overhead expenses
➢ Error in estimating the level of production
➢ Unanticipated changes in the methods of production
➢ Unforeseen changes in the production capacity
➢ Seasonal fluctuations in the overhead expenses
➢ Overhead rate applied to the Normal Capacity which may be less than the full
operating capacity
Cost Sheet:

Cost Sheet of M/s …… for the period……….

Particulars Total Cost Per Unit Cost
(Rs.) (Rs.)
Direct Material Consumed
Direct Labour
Direct Expenses
Prime Cost
Add: Works overhead
Work/Factory Cost
Add: Administration overhead
Cost of Production
Add: Selling and Distribution overhead
Total Cost/Cost of Sales
Add: Profit
Selling Price

Items Excluded from Cost Accounts:

Appropriation of profits: Dividends paid, Taxes on income, Transfers to general reserves,
Excess provision for depreciation of buildings, plant and for bad debts, Amount written off
for goodwill, preliminary expenses, underwriting commission, discount on debentures issued,
etc.
Matters of pure finance
Interest on bank loan, debentures, mortgages, Damages payable, Penalties and fines etc.
Abnormal gains and losses:
Losses or gains on sale of fixed assets, Loss to business property on account of theft, fire or
other natural calamities, etc.
Methods or Types of Costing

Costing methods are classified into:

Job costing, Batch costing, Contract costing, Process Costing, and Operating costing.
Job costing:
➢ Used by industries which manufacture products or render services against specific
orders as distinct from continuous production.
➢ Examples: Engineering concerns, construction companies, ship-building, furniture
making, hardware and machine manufacturing industries, repair shops, automobile
garages, etc.

➢ Comparatively more expensive as more clerical work is involved in identifying each

element of cost with specific departments and jobs.
Batch Costing:
➢ Used in those industries where the similar articles are produced in definite batches.

➢ Each batch is treated as a cost unit.

➢ Costs are accumulated and ascertained for each batch.
➢ A separate Batch Cost Sheet is used for each batch and is assigned a certain number
by which the batch is identified.
➢ Examples: Readymade Garments Manufacturing Industries, Pharmaceutical and Drug
Industries, Spare parts and Components Manufacturing Industries, Toys
Manufacturing Industries, Tyres and Tubes Manufacturing Industries, etc.

CONTRACT COSTING:
➢ Contract Costing or Terminal Costing is a variant of the job costing system.
➢ It is used in constructional activities such as construction of buildings, roads, bridges
etc.
➢ The person who takes contract is called the Contractor and the person from whom it is
taken is called the Contractee.
➢ Contracts may run for long periods, therefore profits on incomplete contracts at the
end of the accounting period are ascertained.
➢ Contractor prepares a nominal account called ‘Contract Account’.
➢ In this account, all the expenses are debited and the income i.e mainly work certified
is credited.
➢ The difference represents profit or loss.
➢ The profit earned on a Contract Account is primarily called Notional Profit.

➢ The profit to be transferred to Profit & Loss Account out of notional profit is
ascertained by taking into consideration the degree of completion of the work, cash
received etc.
Profit or Loss from Contract Account:
In case of Loss – Whole loss is transferred to Profit and Loss Account
In case of Profit – Profit is transferred to P & L Account as follow:
➢ When contract is complete: Whole profit
➢ When contract is incomplete
If work certified is less than ¼ -

No amount is transferred
If work certified is ¼ or more but less than ½ -

𝐶𝑎𝑠ℎ 𝑅𝑒𝑐𝑒𝑖𝑣𝑒𝑑 1
𝑇𝑜𝑡𝑎𝑙 𝑃𝑟𝑜𝑓𝑖𝑡 × ×
𝑊𝑜𝑟𝑘 𝐶𝑒𝑟𝑡𝑖𝑓𝑖𝑒𝑑 3

If work certified is ½ or more –

𝐶𝑎𝑠ℎ 𝑅𝑒𝑐𝑒𝑖𝑣𝑒𝑑 2
𝑇𝑜𝑡𝑎𝑙 𝑃𝑟𝑜𝑓𝑖𝑡 × ×
𝑊𝑜𝑟𝑘 𝐶𝑒𝑟𝑡𝑖𝑓𝑖𝑒𝑑 3

➢ When contract is almost complete- Profit to be transferred is calculated by using any of

the below formula:

𝑊𝑜𝑟𝑘 𝐶𝑒𝑟𝑡𝑖𝑓𝑖𝑒𝑑
𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑃𝑟𝑜𝑓𝑖𝑡 ×
𝐶𝑜𝑛𝑡𝑟𝑎𝑐𝑡 𝑃𝑟𝑖𝑐𝑒

Or
𝐶𝑎𝑠ℎ 𝑅𝑒𝑐𝑒𝑖𝑣𝑒𝑑
𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑃𝑟𝑜𝑓𝑖𝑡 ×
𝐶𝑜𝑛𝑡𝑟𝑎𝑐𝑡 𝑃𝑟𝑖𝑐𝑒

Or
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑤𝑜𝑟𝑘 𝑡𝑜 𝐷𝑎𝑡𝑒
𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑃𝑟𝑜𝑓𝑖𝑡 ×
𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑠𝑡
Or
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑤𝑜𝑟𝑘 𝑡𝑜 𝐷𝑎𝑡𝑒 𝐶𝑎𝑠ℎ 𝑅𝑒𝑐𝑒𝑖𝑣𝑒𝑑
𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑃𝑟𝑜𝑓𝑖𝑡 × ×
𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑠𝑡 𝑊𝑜𝑟𝑘 𝐶𝑒𝑟𝑡𝑖𝑓𝑖𝑒𝑑

Process Costing
➢ Process costing is used to ascertain the cost of the product at each process or stage of
manufacture.
➢ This method is used in industries where the process of manufacture is divided into
two or more processes.
➢ The finished product of one process becomes the raw material of the next process or
operation.
➢ Examples: textile industry, oil industry, cement industry, pharmaceutical industry, etc.

➢ In some industries more than one product emerge from the manufacturing process.
➢ These products are termed as Joint Products or By-products.
➢ Joint products are comparatively of equal importance, produced simultaneously by a
common process and may require further processing after the point of separation.
➢ The by-product is a secondary product, which incidentally results from the
manufacture of a main product.
➢ The main difference between the joint product and by-product is that there is no
intention to produce the by-product while the joint products are produced
intentionally.
Operating or Service Costing:
➢ Operating costing is used in service industries.
➢ The main objective is to compute the cost of the services offered by an organization.
➢ Examples: Banks, insurance companies, electricity generating companies, hospitals,
transport, hotels, educational institutions, canteens, etc.

COST ACCOUNTING TECHNIQUES

Cost Accounting Techniques:
➢ Marginal Costing
➢ Standard Costing
➢ Budgetary Control
Marginal Costing
Marginal costing is based on marginal cost.
➢ Marginal cost is the change in total cost due to change in output.
➢ According to CIMA, “Marginal cost means the amount at any given volume of output
by which aggregate costs are changed if the volume of output is increased or
decreased by one unit.”
Marginal Costing:
➢ Marginal costing is the technique of ascertainment of marginal costs and knowing the
effect on profit, of change in volume of output, by differentiating between fixed costs
and variable costs.
➢ In marginal costing only variable costs are considered.
➢ According to CIMA, “Marginal costing is a technique where only the variable costs
are charged to cost units, the fixed cost attributable being written off in full against the
contribution for that period.”
Contribution:
Contribution is the reward for the efforts of the entrepreneur.
Contribution = Sales – Variable Cost
Or
Contribution = Fixed Cost + Profit
Profit Volume Ratio or PV Ratio or Contribution Ratio:
PV Ratio is the ratio of Contribution to Sales.
PV Ratio = (Contribution/Sales) x 100
If data is given of two periods:
PV Ratio = (Change in Contribution/Change in Sales) x 100
Break Even:
➢ It is the volume of output at which there is no profit and no loss.
➢ In other words, we can say that the total costs are equal to total revenue.

➢ In break Even point analysis Cost, Volume and Profit are used, hence it is also called
as Cost-Volume-Profit Analysis (CVP analysis).
Angle of Incidence:
➢ It is an angle formed at the intersection point of total sales line and total cost line.
➢ If the angle is larger, the rate of growth of profit is higher and if the angle is lower, the
rate of growth of profit is lower.
Margin of Safety:
➢ It is the sales beyond the breakeven point.
➢ It can be obtained by subtracting break even sales from Total sales.
Margin of Safety = Total Sales – Break Even Sales

Standard Costing
Standard costing is based on standard cost.
Standard Costs are the costs which are determined in advance on a scientific basis.
According to Brown and Howard, “The Standard cost is a pre-determined cost which
determines what each product or service should cost under given circumstances.”
Standard Costing:
According to H. J. Wheldon, “Standard costing is a method of ascertaining the costs
whereby statistics are prepared to show:
(a) the standards costs;
(b) the actual costs;
(c) the difference between these costs, which is termed as variance.”
Types of Standards:
Ideal Standard: can be achieved under optimum conditions, practically unattainable.
Normal Standard: can be achieved under normal operating conditions.
Basic Standard: likely to remain constant over a long period of time.
Current Standard: management’s anticipation of what actual costs will be for the
current period.
Steps in the Process of Standard Costing:
➢ Setting of standards
➢ Determination of actual costs
➢ Comparison of standard cost with the actual costs
➢ Finding out the reasons for variances
➢ Taking corrective action and disposal of variances
Variances: The deviation of actual from standard is called variance.
➢ Controllable variances - can be controlled
➢ Uncontrollable variances - beyond control
➢ Favourable (F) variances - profitable to business
➢ Adverse (A) variances - loss to business

Calculation of Variances:
Material Cost Variance = Standard Cost of Material – Actual Cost of Material
MCV = (SQ X SP) – (AQ X AP)
Where:
SQ = Standard Quantity,
SP = Standard Price,
AQ = Actual Quantity,
AP = Actual Price
Material Price Variance = Actual Quantity Used (Standard Price Per Unit – Actual Price
Per Unit)
MPV = AQ (SP – AP)
Material Usage Variance = Standard Price Per Unit (Standard Quantity – Actual Quantity)
MUV/MQV/MEV = SP (SQ – AQ)
Labour Cost Variance = Standard Cost of Labour – Actual Cost of Labour
LCV = (ST X SR) – (AT X AR)
Where:
ST = Standard Time,
SR = Standard Rate,
AT = Actual Time,
AR = Actual Rate
Labour Rate Variance = Actual Time Used (Standard Rate – Actual Rate)
LRV = AT (SR – AR)
Labour Efficiency Variance = Standard Rate (Standard Time – Actual Time)
LEV = SR (ST – AT)

BUDGETARY CONTROL
Budget is a statement of income and expenditure of a future certain period.
According to CIMA, “A budget is a financial and/or quantitative statement, prepared prior to
a defined period of time, of the policy to be pursued during that period for the purpose of
attaining a given objective.”
According to George R. Terry, “A budget is an estimate of future needs arranged according
to an orderly basis covering some or all of the activities of an enterprise for a definite period
of time”.
Types of Budget:
Capital Budget: prepared for capital receipts and expenditure.
Revenue Budget: prepared for revenue receipts and expenses.
Functional Budget: prepared for separate functions: Sales Budget, Production Budget,
Purchase Budget etc.
Master Budget/Summary Budget: integrated budget which covers all the functions.
Fixed/Rigid budget: prepared for a fixed or standard volume of activity.
Flexible Budget: prepared for different levels of activity.
Budgetary control:
According to J. Batty, “Budgetary control is a system which uses budgets as a means of
planning and controlling all aspects of producing and/or selling commodities or services.”
Zero-Based Budgeting (ZBB): A technique of budgeting which requires each cost element
to be specifically justified.
Performance Budgeting: Under this technique, the responsibility of various levels of
management is predetermined in terms of output or result keeping in view the authority
vested with them.