basics of costing

7/29/2019 Basics of Costing

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What is Cost Accounting?

Costaccountingis that part of the

accounting system that measurescostsfor the purposes of management

decisionmaking and financial reporting.


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Cost Accounting System

Cost

Accumulation

Collecting costs by somenatural classificationsuch as materials or labor

CostAllocation

Tracing costs to one ormore cost objectives


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Cost

A cost may be defined as a sacrifice orgiving up of resources for a particularpurpose.

Costs are frequently measured by themonetary units that must be paid forgoods and services.


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Direct Costs

Direct costs can be identifiedSpecifically and exclusively witha given cost objective (cost centre)

What are direct costs?


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Indirect Costs

Indirect costs cannot be identifiedspecifically and exclusively with agiven cost objective (Cost Centre)

What are indirect costs?


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What DistinguishesDirect and Indirect Costs?

Managers prefer to classify costs asdirect rather than indirect whenever itis economically feasible or costeffective.

Other factors also influence whether acost is considered direct or indirect.

The key is the particular cost objective.


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Categories ofManufacturing Costs

Any raw material, labor, or other inpuused by any organization could,in theory, be identified as a

direct or indirect costdepending on thecost objective.


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There are 3 major categories ofmanufacturing costs:

Direct MaterialsRaw material,

parts, andcomponents thatcan be observedbeing used to

make a specificproduct.

Direct LaborThe cost of

paying

employees whoconvert directmaterials into

finishedproduct.

Manufacturing

OverheadIndirect material

Other overhead


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Direct Material Costs...

include the acquisition costs of allmaterials that are physically identifiedas a part of the manufactured goodsand that may be traced to themanufactured goods in an economicallyfeasible way.


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Direct Labor Costs...

include the wages of all labor that canbe traced specifically and exclusively tothe manufactured goods in aneconomically feasible way.


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Prime Costs include:

DirectMaterial

s

Direct Labor ManufacturingOverhead


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Indirect Manufacturing Costs...

or factoryoverhead, include all costsassociated with the manufacturingprocess that cannot be traced to themanufactured goods in an economicallyfeasible way.


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ELEMENTS OF COSTS_

Broadly there can be threeelements of costs.

(A) Material: (B) Labour :

(C) Expenses:


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(A) Material

This is the cost of commodities and materials usedby the organization. It can be direct or indirect.

Direct Material indicates that material which canbe identified with the individual cost center and

which becomes an integral part of the finishedgoods. It basically consists of all raw materials,either purchased from outside or manufactured inhouse.

Indirect Material indicates that material whichcannot be identified with the individual costcenter. This material assists the manufacturingprocess and does not become an integral part offinished goods. The examples of this type ofmaterial may be consumable stores, cotton waste,oils and lubricants, stationery material etc.

(B) L b


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(B) Labour :

This is the cost of remuneration paid to theemployees of the organisation. It can be direct orindirect.

Direct Labour Cost indicates that labour costwhich can be identified with the individual costcenter and is incurred for those employees who

are engaged in the manufacturing process. Indirect Labour Cost indicates that labour cost

which cannot be identified with the individual costcenter and is incurred for those employees whoare not engaged in the manufacturing process but

only assist in the same. The examples of this typeof cost are wages paid to foreman/storekeeper,salary of works manager, Accounts/Personneldepartment salaries etc.


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(C) Expenses:

This is the cost of services provided to the

organization (and the notional cost of assetsowned). It can be direct or indirect. Direct Expenses are those expenses, which

can be identified with the individual cost

centers. The examples of these expenses arehire charges of machinery/ equipmentsrequired for a particular job, cost ofdefective work for a particular job etc.

Indirect Expenses are those expenses, which

cannot be identified with the individual costcenters. The examples of these expenses arerent, telephone expenses, insurance, lightingetc


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Prime costs & Overheads

The aggregate of Direct Material Cost,Direct Labour Cost and Direct Expensesis termed as Prime Cost.

The aggregate of Indirect MaterialCost, Indirect Labour Cost and IndirectExpenses is termed as Overheads.


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Classification of Overheads

(a) Factory Overheads (Also termed asproduction/works/manufacturingoverheads)

(b) Office and AdministrationOverheads.

(c) Selling and Distribution Overheads.


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(a) Factory Overheads:

These overheads consist of all overhead costsincurred from the stage of procurement ofmaterial till the stage of production of finishedgoods. They include :

Indirect Material such as consumable stores,cotton waste, oil and lubricants etc.

Indirect Labour Cost such as wages paid toforeman/storekeeper, works managers salary etc.

Indirect Expenses such as carriage inwardcost, cost of factory lighting/power expenses,rent/insurance/repairs for factorybuilding/machinery, depreciation on factory buildingor machinery etc.


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(b) Office and Administration Overheads:

These overheads consist of all overhead costsincurred for the overall administration of theorganization. They include :

Indirect Material such as stationery items,

office supplies etc. Indirect Labour cost such as salaries paid to

Accounts and Administration staff, Directorsremuneration etc.

Indirect Expenses such as postage/telephone,rent/insurance/repairs/depreciation on officebuilding, general lighting, legal/audit charges, bankcharges etc.

( ) ll d d b h d


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(c) Selling and distribution Overheads:

These overheads consist of all overhead costsinsured from the stage of final manufacturing offinished goods till the stage of sale of goods inthe market and collection of dues from thecustomers. They include :

Indirect Material such as packing material,

samples etc. Indirect Labour like salaries paid to sales

personnel, commission paid to sales manager etc. Indirect Expenses like carriage outwards,

warehouse charges, advertisement, bad debts,repairs and running of distribution van, discountoffered to customers etc.


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classification of overheads can beshown as below :

Indirect MaterialFactory Indirect Labour

Indirect Expense

IndirectmaterialOffice/Administration Indirect Labour

Indirect

Expense

Indirect materialSelling & Distribution Indirect Labour

IndirectExpense


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Cost Sheet:

The various elements/components ofthe cost is presented in the form of astatement, popularly known as Cost

Sheet or Cost Statement. The costsheet may be prepared separately foreach cost centre and may have the

columns like cost per unit or cost ofprevious period etc.

P f h


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Performa cost sheet

Direct Material Cost Direct Labour cost Direct Expenses PRIME COST Add : Factory Overheads FACTORY/WORKS COST Add : Office and Administration Overheads TOTAL COST Add : Selling and Distribution Overheads COST OF SALES

Add : Profit SALES

basics of costing

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