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Introduction to Cost Accounting

Unit 1: Introduction to Cost Accounting

1. Introduction to Accounting

Accounting provides financial information related to the activities of a business. This information is provided to shareholders, management, creditors, debenture holders, bankers, etc.

Accounting can be divided into:

  • Financial Accounting: It is mainly concerned with recording business transactions in the books of accounts in order to prepare:
    1. P&L A/c: Shows the net profit/loss.
    2. Balance Sheet: Shows the financial position of the company.
  • Cost Accounting: It is a branch of accounting that specializes in the ascertainment of the cost of goods and services.
  • Management Accounting: It is the modern concept of accounting and acts as a guiding tool for management. It is concerned with all such accounting information that is useful to management.

2. Key Terminology 📝

  • Cost: The price paid for something.
  • Costing: The techniques, methods, and practices to ascertain a cost.
  • Cost Accounting: The process of recording, classifying, summarizing, analyzing, interpreting, and communicating information to management in order to control the cost.
  • Cost Accountancy: This is a wider term. It includes principles, conventions, techniques, and systems which are used in business to plan and control the utilization of resources. It is a science, art, and practice.
    • Science: It is a systematic body of knowledge.
    • Art: It requires the skills of a cost accountant.
    • Practice: It is an ongoing process.

3. Difference Between Financial Accounting & Cost Accounting

Basis Financial Accounting Cost Accounting
1. Purpose To prepare an Income Statement & Balance Sheet for external users. To prepare a cost statement (for goods & services) to provide to management for internal usage.
2. Statutory Requirement These accounts are obligatory to be prepared according to the legal requirements of the Companies Act & Income Tax Act. Maintenance of these accounts is optional, except in certain industries where it is obligatory under the Companies Act.
3. Periodicity of Report Financial reports are prepared at the end of the financial year. Costing reports are a continuous process and are prepared anytime (daily, weekly, monthly, etc.).
4. Control Aspect It focuses on recording financial transactions and does not attach the cost control aspect. It provides detailed information about the cost control aspects (budgetary control, marginal costing, etc.).
5. Historical vs. Predetermined It is concerned with historical records. It is concerned with both historical and predicted costs.
6. Fixation of Selling Price Financial accounts are not maintained with the object or purpose of fixing the selling price. Cost accounting provides sufficient data for the fixation of the selling price.
7. Analysis of Profit Financial a/cs are prepared for the whole business and disclose the net profit or loss of the business as a whole. Cost accounting discloses the profit or loss of each product, department, and job.
8. Facts and Figures Financial a/c deals mainly with actual facts and figures. Cost accounting deals partially with facts and figures and also deals with estimates.

4. Elements of Cost 🧱

The elements of cost can be broken down as follows:

  • Prime Cost = Direct Material + Direct Labour + Direct Expenses
  • Overhead Cost = Indirect Material + Indirect Labour + Indirect Expenses

Material Cost

This is the cost of commodities supplied to an undertaking.

  • Direct Material: Cost of material which is directly attributed to a cost object. It is the physical appearance of the product.
    • Examples: Clay in a manufacturing pot, batteries in a radio.
  • Indirect Material: Cost of material which cannot be directly attributed to a cost object. It is not present in the final product.
    • Examples: Hand gloves used in manufacturing, lubrication used in machines.

Labour Cost

This is the cost of remuneration (wages, salary, incentives) paid to employees.

  • Direct Labour Cost: Cost of labour who are directly involved in the conversion of raw materials into finished products.
    • Example: Labour engaged in the actual production.

5. Cost Sheet Format

The cost sheet is a statement designed to show the total cost and cost per unit of a product for a given period.

7. Practical Problem Example ⚙️

Bharat Engineers & Company manufactured and sold 1000 sewing machines in 2021. The cost details were as follows:

  • Cost of Materials: ₹80,000
  • Wages Paid: ₹1,20,000
  • Manufacturing Expenses: ₹50,000
  • Salaries: ₹60,000
  • Rent, Rates & Insurance: ₹10,000
  • Selling Expenses: ₹30,000
  • General Expenses: ₹20,000
  • Sales: ₹4,00,000

The company plans to make 1200 sewing machines in 2022. You are asked to submit a statement. (The task is to prepare a cost sheet for 2021 and an estimated cost sheet for 2022).

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