Introduction

Cost accounting is the application of accounting and costing principles, methods,

and techniques in the ascertainment of costs and the analysis of saving or excess
cost incurred as compared with previous experience or with standards.

Cost:
There is a cost involved to purchase or produce anything. Costs may be different
for the same product, depending upon the stages of completion. The cost changes
according to the stage a product is in, for example, raw material, work in progress,
finished goods, etc. The cost of a product cannot be perfect and it may vary for the
same product depending upon different constraints and situations of production
and market.
Classification of Costs
Classification of Costs essentially means the grouping of costs according to their
similar characteristics. Now, in costing there are a dozen ways to classify costs as per
their nature, functions, traceability etc. Here we will be focusing on five such
classifications. Let us learn this in detail.

1. Classification by Nature
This is the analytical classification of costs. Let us divide as per their natures. So
basically there are three broad categories as per this classification, namely Labor Cost,
Materials Cost and Expenses. These heads make it easier to classify the costs in a cost
sheet. They help ascertain the total cost and determine the cost of the work-in-
progress.

 Material Costs: Material costs are the costs of any materials we use in the
production of goods. We divide these costs further. For example, let’s divide
material costs into raw material costs, spare parts, costs of packaging material
etc.
 Labor Costs: Labor costs consists of the salary and wages paid to permanent and
temporary employees in the pursuit of the manufacturing of the goods
 Expenses: All other expenses associated with making and selling the goods or
services.
2. Classification by Functions
This is the functional classification of costs. So the classification follows the pattern
of basic managerial activities of the organization.

The grouping of costs is according to the broad divisions of functions such as

production, administration, selling etc.

 Production Costs: All costs concerned with actual manufacturing or construction

of the goods
 Commercial Costs: Total costs of the operation of an enterprise other than the
manufacturing costs. It includes the admin costs, selling and distribution costs
etc.
3. Classification by Traceability
This aspect one of the most important classification of costs, into direct costs and
indirect costs. This classification is based on the degree of traceability to the final
product of the firm.

 Direct Costs: So these are the costs which are easily identified with a specific
cost unit or cost centers. Some of the most basic examples are the materials used
in the manufacturing of a product or the labor involved with the production
process.
 Indirect Costs: These costs are incurred for many purposes, i.e. between many
cost centers or units. So we cannot easily identify them to one particular cost
center. Take for example the rent of the building or the salary of the manager.
We will not be able to accurately determine how to ascertain such costs to a
particular cost unit.
4. Classification by Normality
This classification determines the costs as normal costs and abnormal costs. The
norms of normal costs are the costs that usually occur at a given level of output, under
the same set of conditions in which this level of output happens.

 Normal Costs: This is a part of the cost of production and a part of the costing
profit and loss. These are the costs that the firm incurs at the normal level of
output in standard conditions.
 Abnormal Costs: These costs are not normally incurred at a given level of output
in conditions in which normal levels of output occur. These costs are charged to
the profit and loss account, they are not a part of the cost of production.
ADVANTAGES OF COST ACCOUNTING:
The extent of advantages derived from the cost accounting is based on the type,
adequacy and efficiency of cost accounting system installation. Moreover, the
management at the maximum should accept the advises given by the cost
accounting system. If so, the following advantages may be available to an
organization.

1. Elimination of Wastes, Losses and Inefficiencies

A good cost accounting system eliminates wastes, losses and inefficiencies by
fixing standard for everything.

2. Cost Reduction
New and improved methods of production are followed under cost accounting
system. It leads to cost reduction.

3. Identify the reasons for Profit or Loss

A good cost accounting system highlights the reasons for increasing or decreasing
profit. If so, the management can take remedial action to maintain profitability of
the concern. There is no possibility of shutting down of any product or process or
department.

4. Advises on Make or Buy Decision

On the basis of cost information, the management can decide whether make or buy
a product in open market. The management can rightly choose the best out of many
alternatives. Sometimes, spare capacity can be used profitably.

5. Price Fixation
The total cost of a product is available in the costing records. It is highly useful for
price fixation of a product.

6. Cost Control
Budgets are prepared and standards are fixed under cost accounting system. The
expenses are not permitted beyond the budget amount. The actual performance is
compared with standard to find the variation. If there is any variation, reasons are
find out and the management can exercise control. Period to period cost comparison
also helps cost control.

7. Assist the Government

Government can collect reasonable tax from the company and exercise price
control.

8. Help the Trade Union

Bonus calculation is very easy to the trade union. Reasonable remuneration is also
fixed on the basis of cost accounting information.
9. Marginal Analysis of Cost
It is done for facilitating the short-term decisions especially during depression
period.

10. Fixation of Responsibility

Responsibility centers is fixed under cost accounting system. If responsibility is
fixed, it becomes difficult to evade responsibility of performance and leads to
effective performance.

11. Helps to Prepare Financial Accounts

The information like value of closing materials, work in progress and finished
goods are necessary to prepare financial accounts. This information is supplied by
the costing records and helps to prepare financial accounts without any further
delay.

12. Prevention of Frauds

Introducing cost audit can prevent frauds. If so, correct and reliable data was
available from the costing records which are highly useful to the government, share
holders, the creditors and the like.

DISADVANTAGES OF COST ACCOUNTING:

1. Only past performances are available in the costing records but the management
is taking decision for future.

2. The cost of previous year is not same in the succeeding year. Hence, cost data are
not highly useful.

3. The cost is ascertained on the basis of full utilization of capacity. If capacity is

partly utilized, the cost may not be true.

4. Financial character expenses are not included for cost calculation. Hence, the
calculated cost is not correct always.

5. In cost accounting, costs are absorbed on pre-determined rate. It leads to over

absorption or under absorption of overheads.

6. Cost Accounting fails to solve the problems relating to work study, time and
motion study and operation research.

7. Installation of Cost Accounting System requires the maintenance of many costing

records. If results in heavy expenditure.
8. Delay in receiving costing information does not result in taking quality decision
by the management.

9. Rigid Cost Accounting System does not serve all purposes.

 COST SHEET OR STATEMENT OF COST
Total Units…….

Opening Stock of Raw material xxx

Add: Purchases xxx

Xxx

Less: Closing Stock xxx

Cost of material Consumed → Xxx

Add: Direct Labor/Wages xxx

Prime Cost Xxx

Add: Works overheads xxx

Works Cost Xxx

Add: Administration overheads xxx

Cost of Production Xxx

Add: Selling and distribution overheads xxx

Total Cost or Cost of Sale Xxxx