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UNIT 2 COST CONCEPTS AND ITS
ASCERTAINMENT
Structure
2
...
1 Introduction
2
...
3 Classification of Costs

2
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1 Functional Classification


2
...
2 On the Basis of Identifiability with Products



2
...
3 On the Basis of Variability

2
...
5 Cost Centre
2
...
6
...
6
...
6
...
7 Components of Total Cost
2
...
9 Methods of Costing
2
...
11 Role of Cost Accountant
2
...
13 Key Words
2
...
15 Terminal Questions

2
...


2
...
You learnt that costing is
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BCOC-138 (E)
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In order to understand this
process, one must gain familiarity with certain concepts like cost, cost unit,
cost centre, classification of costs, elements of cost and components of total
cost
...
This unit also discusses various
methods of costing and identifies the industries for which each method is
considered suitable
...
2 MEANING OF COST
Cost means the amount of expenditure: (actual or notional) incurred on, or
attributable to, a given thing
...
Examples of expenses which
constitute cost are:
(a) materials, (b) labour, (c) factory overheads, (d) administrative overheads,
and (e) selling and distribution overheads
...
It does not give an exact meaning unless it is properly
qualified
...
The main characteristics of cost are:
1) The term ‘cost’ is not complete unless it is fully identified with its
nature and category
...

3) No cost is true, exact or accurate
...

4) Cost may be ascertained in different ways by different persons
...

Thus, cost has no fixed, certain or definite meaning
...
Cost must indicate its purpose and the conditions under which
it is computed
...
Hence, it must be related to a particular activity or commodity and
expressed for a given quantity or unit of goods produced or services performed
...
Cost actually signifies an expenditure incurred for securing some
benefit to the business
...
Cost of materials destroyed by fire or salary paid to
a foreman during the period of strike are not regarded as cost
...


2
...
Unless we are fully familiar
with their meaning and utility, we may not be effective in their computation,
analysis comparison and control
...

These are: (1) according to functions to which they relate, (2) according to
their identifiability with jobs, products, or services, (3) according to their
variability with changes in output, (4) according to their association with
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BCOC-138 (E)
...
The first three bases are considered
important at the introductory stage and, therefore, have been discussed here
in detail
...
3
...
On this basis, costs are classified into four categories:
(i) manufacturing costs (production costs), (ii) administrative costs, (iii)
selling costs, and (iv) distribution costs
...
It includes cost of materials, cost of
labour, other direct expenses and factory overheads
...

Administrative Costs: Administrative costs include all costs that are
incurred for general administration of the organisation and for the operational
control
...
In
fact, any expenditure which is not related directly to production, selling,
distribution, research or development forms part of the administrative costs
...
Some examples of such costs are: cost of warehousing,
advertising, salesmen salaries, etc
...
Some
examples of such Ascertainment costs are : packing, carriage, insurance,
freight outwards, etc
...
3
...

Direct Costs: Direct costs refer to expenses which can be directly identified
with a product, job or process
...
The same thing is not true of expenditure like rent of the
building which is a common cost for various products manufactured in the
factory and will have to be allocated to all products on some rational basis
...
These are of a
general, common or collective nature which are to be allocated to various
products manufactured in the factory
...
These costs have to be apportioned among different products
on some rational basis
...

2
...
3 On the Basis of Variability
On this basis costs are classified into (i) fixed costs, (ii) variable costs, and
(iii) semi-variable (or semi-fixed) costs
...
For example, whether we produce 10,000 units
or 15,000 units of a particular product during a particular period, the rent
of the factory building or salary of the production manager will remain the

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BCOC-138 (E)
...
Hence, the rent or salary is regarded as fixed cost
...
They
remain fixed only upto a certain level of production capacity
...

Variable Costs: Costs which increase or decrease in direct proportion
to changes in the volume of output are termed as ‘variable costs’
...
1,50,000
...
1,80,000 (increase of 20%)
...

It remains the same i
...
, Rs
...
But, it is the total cost of materials
which changes because of the change in the volume of output
...
In other words, these costs
are partly variable and partly fixed and, as such, are also known as ‘semifixed costs’
...
Depreciation on machinery is caused partly by passage of time
and partly by its usage
...
Take another example
...
But, such
increase will not be in direct proportion to the increase in sales because his
commission on sales will increase while his salary remains the same
...


Cost Concepts and Its
Ascertainment

Check Your Progress A
1)
2)
3)
4)
5)

What do you mean by the term ‘cost’
...

Give three examples of semi-variable costs
...

State whether the following statements are True or False and justify
your answer
...

ii) The term ‘cost’ has a fixed, certain and definite meaning
...

iv) Salesmen salary is a fixed cost
...

vi) Bad debts are selling costs
...
4 COST UNIT
You know one of the main functions of costing is to ascertain cost per unit
of output
...
Such units for the
purpose of costing may be as follows:
1) unit of product (e
...
, cost per book)
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BCOC-138 (E)
...
g
...
g
...
g
...
g
...

Thus, a cost unit is a unit of product, service or time in terms of which
costs are ascertained or expressed
...

Selection of a cost unit, however, must be appropriate
...
Secondly, it should be easier to
associate expenses with cost units
...

Some examples of cost unit for different products and services are given
below:
Product/Activity
Wire
Power
Telephone
Iron
Transport

Bricks
Cement
Paper
Computer
Printing
Cars
Petrol
Television
Pencils
Gold
Ship-building
Nursing Home

Cost Unit
per metre
per kilowatt hour
per call
per tonne/quintal
per passenger per kilometer/
per kilogram per kilometer
per thousand
per bag/per tonne
per ream/per kilogram
per hour
per thousand impressions
per car
per litre
per set
per dozen
per gramme
per ship
per bed per day

2
...

In other words, a cost centre may consist of either or a combination of the
following:

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BCOC-138 (E)
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PERSON : Foreman, Salesman, Customer, etc
...

In fact, the entire organisation may be divided into specified cost centres which
jointly contribute to the total cost
...

A cost, centre is a convenient unit of the organisation
...
This helps in
fixing responsibilities for every cost centre
...


Cost Concepts and Its
Ascertainment

Check Your Progress B
1)







2)
3)
4)

Match the cost unit appropriate to the activity/product
...
centimeter
ii) House Construction
b) per job
iii) Furniture
c) per contract
iv) Advertising
d) per piece
v) Nursing Home
e) per ton kilometer
vi) Ice Cream
f) per bed per day
vii) Shirt
g) per kilogram
Define Cost Unit
...


2
...

2
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1 Materials
The term ‘materials’ refers to those commodities which are used as raw
materials components, or consumables for manufacturing a product
...

Direct Materials: All materials used as raw-materials or components for
a finished product are known as ‘direct materials’
...
Packaging is also an item of direct materials cost
...
Such commodities do
not form part of the finished product
...
6
...
Labour can
also be direct or indirect
...
indd 23

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Basic Concepts

Direct Labour : The workers who are directly involved in the production
of goods are known as ‘direct labour’
...
The wages paid to such workers
are known as ‘direct wages’ or ‘manufacturing wages’
...
The wages paid to
such workers are known as ‘indirect wages’
...
6
...

Expenses can also be direct and indirect
...
Some
examples of such expenses are : carriage inwards, production royalty, hire
charges of special equipment, cost of special drawings, etc
...

Indirect Expenses : All expenses other than indirect materials and labour
which cannot be directly attributed to a particular product, job, or service
are termed as ‘indirect expenses’
...

The various elements of cost have been presented in the form of a chart in
Figure 2
...

Figure 2
...
The three elements
of indirect costs viz
...

Overheads are grouped into three categories : (1) factory (or manufacturing)
overheads, (2) office (or administrative) overheads, and (3) selling and
distribution overheads as shown in Figure 2
...


Figure 2
...
indd 24

Conversion Cost: The cost of converting raw materials into finished goods
is termed as ‘conversion cost’
...


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Cost Concepts and Its
Ascertainment

2
...

Thus, the two main components of total cost are: (1) Prime Cost, and (2)
Overheads
...

Overheads, on the other hand, consists of factory overheads, office
overheads, and selling and distribution overheads
...

1) Direct Material + Direct Labour + Other Direct Expenses = PRIME
COST
2) Prime Cost + Factory Overheads = WORKS COST
3) Works Cost + Office and Administrative Overheads = COST OF
PRODUCTION
4) Cost of Production + Selling and Distribution Overheads TOTAL
COST or COST OF SALES
The above framework of total cost build-up is shown in Figure 2
...

Figure 2
...

Give four examples of indirect expenses
...

Fill in the blanks
...
= Works Cost
iii) Works Cost + Office Overheads = ……………
...
Cost of Sales

2
...

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BCOC-138 (E)
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In view of its valuable contents, a cost sheet should be
prepared properly and at frequent intervals (weekly or monthly)
...
4
...
4 : Proforma of Cost Sheet
COST SHEET OF ……………
...


Output units……………
...


Raw Materials Consumed:
Opening stock of raw materials
Add: Purchases of raw materials
Less: Closing stock of raw materials
Direct Labour
Other Direct Expenses

xx
xx
xxx

PRIME COST
Factory Overheads:
Indirect Material
Indirect Labour
Insurance on factory building &
equipments
Other expenses of factory
Gross Factory/Works Cost
Add : Opening Work-in-Progress
Less : Closing Work-in-Progress
Factory Cost or Works Cost
Office & Administrative Overheads:
Office Rent, Insurance, Salaries,
office Expenses
COST OF PRODUCTION/
OFFICE COST
( ………
...


x
x
x

xx
xx
xx
xx
xxx
xx
xx

xx
xxx
xx
xx
xxx

x
xx

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BCOC-138 (E)
...
units)
Less: Closing Stock of Finished
Goods
( ……………
...
units)
Selling & Distribution Overheads :
Packing, Showroom,
Advertisement, Sale, Staff
Salaries/Travelling Expenses
COST OF SALES
( ……………
...

Illustration 1:
From the following particulars of a manufacturing firm, prepare the Cost
Sheet showing (i) Prime Cost, (ii) Works Cost, (iii) Cost of Production,
and (iv) Cost of Sales
...

Stock of materials on 1
...
2018
40,000
Purchase of Materials

Stock of finished goods on 1
...
2018 (5,000 units)
Productive wages

11,00,000
50,000
5,00,000

Finished goods sold (1,74,000 units)

24,36,000

Works overheads

1,50,000

Office expenses

1,00,000

Selling and Distribution expenses

1,74,000

Stock of materials on 31
...
2018
Stock of finished goods on 31
...
2018 (6,000 units)

1,48,000
60,000

Solution :
Before preparing the Cost Sheet, we should work out the number of units
produced during the year
...
12
...
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Output 1,75,000 units

Basic Concepts

Raw Materials Consumed:
Opening Stock
Add:

Purchases

Per Unit

Rs
...


40,000
11,00,000
11,40,000
1,40,000

Less : Closing Stock
Direct Wages
Other Direct Expenses

Total

10,00,000
5,00,000

PRIME
COST

15,00,000

Works Overheads
WORKS COST
Office Overheads
COST OF PRODUCTION
(1,75,000 units)
Add : Opening stock of Finished
Goods (5,000 units)
Less : Closing stock of Finished
Goods (6,000 units)
Cost of Goods Sold (1,74,000
units
Selling and Distribution
Overheads

1,50,000
16,50,000
1,00,000
17,50,000

COST OF SALES
PROFIT
SALES

10
...
00

1,74,000
19,14,000

1
...
00

5,22,000

3
...
00

2
...
These methods can be summarised as follows :
Job Costing: Under this method, costs are ascertained for each job or
work-order separately
...

Contract Costing: This method is used in case of big jobs described
as ‘contracts’
...
Hence, each
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BCOC-138 (E)
...
Contract costing (also termed as Terminal Costing) is most suited to
industries like ship-building, construction of buildings, roads and bridges
...
In such a
situation, the method of costing adopted is known as ‘batch costing
...

Unit Costing: Under this method costs are ascertained for convenient
units of output
...

It is suitable for industries like brick making, mining, cement manufacturing,
dairy, flour mills, etc
...

Process Costing: In case of some industries, a product passes through
different stages of production called ‘processes’ and each process is distinct
and well-defined
...
Take the case
of cotton textile mill where the finished product (cloth) passes through
three distinct processes viz
...
The output
of spinning process is yarn, which is used as a raw material for the weaving
process and the output of weaving process (coarse cloth) is transferred to
finishing process
...
In such
a situation, it becomes necessary to ascertain the cost at each stage
...
The
method employed for ascertaining the cost at each stage of production is
termed as ‘Process Costing’
...

Operating Costing: This method is used for ascertaining the cost of
operating a service such as bus, railways, water supply, nursing home, etc
...
g
...
According to the latest Terminology, this is called ‘Service
Costing’
...
, costs have to be ascertained for each component as well as for the
finished product
...

Uniform Costing : The practice of using a common method of costing by a
number of firms in the same industry is known as ‘Uniform Costing’
...
It simply refers to a common system
using agreed concepts, principles and standard accounting practices
...

It should be noted that the two basic methods of costing are: (1) Job
Costing, and (2) Process Costing
...
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Basic Concepts

simply variants of these two methods
...
10 TYPES OF COSTING
While method of costing refers to the process and practice of ascertaining
costs of products and services, the type of costing refers to the technique
of analysing and presenting costs for purposes of control and managerial
decisions
...

Absorption Costing: It refers to the technique of costing under which
full costs are charged to production i
...
, both fixed and variable costs are
included in the cost of products
...
In other words, the
accounting is done in terms of actual costs and not in terms of predetermined
or standard costs
...

Standard Costing: It refers to the system of cost accounting under which
costs are determined in advance on certain predetermined standards
...
The standard costs
are compared periodically with the actual costs and underlying causes
for variances are analysed so that corrective action may be taken where
necessary
...
the way in which the costing information is to be presented for control
purposes
...


2
...
The role of cost accountant is entirely different from financial
accountant
...
He has to work out for determining
actual costs of manufacturing or providing service
...


Supporting top management is cost related decisions by providing

30

BCOC-138 (E)
...

2
...
Cost records
are different from financial accounts
...


Performing cost control functions as directed by senior management
...


Cost Concepts and Its
Ascertainment

In order to perform the above responsibilities in a service organisation or
in a manufacturing concern, cost accountant has to play several prominent
roles as stated below:
●●

Establishes a cost accounting department in his concern
...


●●

Develops a manual, which specifies the functions to be performed by
the cost accounting department
...
Usually, the
functions performed by a cost accounting department includes a) cost
ascertainment, b) cost comparison, c) cost reduction, d) cost control
and cost reporting
...
Further it requires classification of
indirect costs (known as overheads) into factory overheads;
administration overheads and selling and distribution overheads
...
Cost accountant of the concern establishes standards
for all elements of cost and thus a standard cost of the finished
product
...
Cost accountant
ascertains the reasons for the occurrence of these variances for
taking suitable action
...
, and for reviewing the current
performance
...
These
reports help the executives of a business concern in reviewing
their own performance and in identifying the weak areas, where
appropriate and most suitable control measures may taken in
future
...
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Basic Concepts

1)

Explain the two basic methods and types of costing
...




iii) Oil Refinery

…………………
...




v)



vi) Construction of Bridge …………………
...




viii) Furniture

…………………
...


Brick Making

…………………
...


2
...
Cost means an
amount of expenditure (actual or notional) incurred or attributable to a
product, job, process, or service
...
It may vary with
time, volume, firm, method or purpose
...

Costs can be classified in various ways
...
On the basis of their Identifiability
with products, costs can be classified into direct costs and indirect costs
...

The two concepts which serve as the basis for cost computation are: (i) cost
unit, and (ii) cost centre
...
g
...
per dozen, per piece, etc
...
It can be a department, a person or an item of equipment
...
They may be direct or indirect, Indirect costs including Indirect
materials, indirect labour and indirect expenses are known as ‘overheads’,
Overheads are usually classified into factory overheads, office overheads,
and selling and distribution overheads
...
These are actually the stages to determine the
total cost and facilitate controlThere are various method of costing
...

(v) process costing, (vi) operating costing, (vii) multiple costing, and (viii)
uniform costing
...
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nature of its products and the technique of production used
...
His/Her role starts from establishment of a cost department to
preparation of costing reports to control the costs and effective utilization
of costs
...
13 KEY WORDS
Conversion Cost: Cost of converting materials into finished products
...

Cost Centre: A convenient costing segment to which initial allocation and
apportionment of various expenses can be made
...

Cost Unit: The quantity in terms of which the cost of a product is ascertained
...

Semi-variable Cost: Expenses which change with changes in output, but not
in the same proportion
...

Works Cost: Prime cost plus factory overheads
...
14 ANSWERS TO CHECK YOUR PROGRESS
A) 5
...
(i) e (ii) c (iii) b (iv) a (v) f (vi) g (vii) d

C) 4
...




(iv) Factory Overheads, Office Overheads, Selling and Distribution
Overheads
(i) Contract Costing (ii) Batch Costing (iii) Process Costing
(iv) Process Costing (v) Unit Costing (vi) Contract Costing
(vii) Operating Costing (viii) Job Costing

2
...
Analyse the importance of selecting
suitable cost centres
...


3)

“Costs may be classified according to their nature and
characteristics
...


4)

What are the different methods of costing? State the industries to
which they can be applied
...
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and indicate in which industry each would be suitable
a) Process Costing; b) Job Costing; c) Output Costing
...

Rs
...

Answer: a) Rs
...
13,000;

c) Rs
...
24,000; e) Rs
...
6,000; g) Rs
...

Note: These questions will help you to understand the unit better
...
But do not submit
your answers to the University
...


SOME USEFUL BOOKS
Arora M
...
2003
...
Ltd
...
(Chapter 3-8)
...
K
...
Cost Accounting: Methods and Problems, Academic
Publishers: Calcutta
...

Iyenger, S
...
, Cost Accounting, Sultan Chand and Sons
...
N
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Mittal, 2018
...
(Chapter 2-3)
...
M
...
and G
...
Sharma, 2018
...
(Chapter 4-7)
...


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