Elements of Cost CBCAT4T06

Syllabus topics (RTMNU)

• Meaning, Objectives and Advantages of Cost Accounting
• Difference between Cost Accounting and Financial Accounting
• Cost Concepts
• Cost Classification
• Elements of Cost
• Role of Cost Accountant in an Organization
• Direct and Indirect Material Cost
• Functions of Purchase Department
• Essential Requisites of Storing of Materials
• Preparation of Bin Card
• Issue of Material for Production
• Pricing Methods: LIFO, FIFO, Simple Average & Weighted Average

Meaning, Objectives and Advantages of Cost Accounting

Definition: Cost Accounting is the process of recording, classifying, allocating and analysing all expenses so that the cost of each product, job, process or service can be found and controlled.

Cost means the amount of expenditure (actual or notional) incurred on a given thing. Costing is the technique of finding cost.

Objectives:

1. Ascertain cost – find the cost per unit of each product or service.
2. Fix selling price – price = cost + profit margin.
3. Control cost – compare actual cost with standard and reduce waste.
4. Help management – give data for decisions like make or buy, accept a special order.
5. Value stock – value closing stock of materials, work-in-progress and finished goods.

Advantages:

1. Shows profitable and unprofitable products.
2. Reduces wastage of material, labour time and machine time.
3. Helps in preparing tenders and quotations.
4. Helps in budgeting and planning.
5. Gives a check on financial accounts through reconciliation.
6. Helps the government in price fixing (e.g. cost audit under the Companies Act 2013).

Difference between Cost Accounting and Financial Accounting

Cost Concepts and Cost Classification

Important cost concepts:

• Cost centre – a location, person or machine for which cost is found (e.g. machine shop, packing department).
• Cost unit – a unit of product or service in which cost is expressed (e.g. per tonne for steel, per km for transport, per bed for hospital).
• Opportunity cost – benefit lost by not choosing the next best option.
• Sunk cost – past cost that cannot be recovered and is not relevant for decisions.
• Notional cost – cost not actually paid, e.g. rent of own building.

Classification of cost:

Elements of Cost

Total cost is made of three elements: Material, Labour and Expenses. Each is divided into direct and indirect.

• Direct Material + Direct Labour + Direct Expenses = Prime Cost
• Indirect Material + Indirect Labour + Indirect Expenses = Overheads
• Overheads are of three types: Factory (Works), Office & Administration, Selling & Distribution.

Role of Cost Accountant in an Organization

1. Designs and runs the costing system.
2. Collects material, labour and overhead data and finds unit cost.
3. Prepares cost sheets, tenders and budgets.
4. Reports wastage, idle time and cost variances to management.
5. Suggests cost reduction and pricing.
6. Reconciles cost and financial profits; helps in cost audit.

Direct and Indirect Material Cost

Direct material is material that becomes part of the product and can be traced to it, e.g. cotton in cloth, steel in a car, wood in furniture, packing material for the product.

Indirect material cannot be traced to one product, e.g. lubricating oil, cotton waste, small nails, glue, stationery. It is part of overheads.

Functions of Purchase Department

1. Receive purchase requisitions from stores or departments.
2. Find suppliers and collect quotations.
3. Select the best supplier (price, quality, delivery time).
4. Issue purchase orders.
5. Follow up delivery and check goods received with the order.
6. Pass suppliers’ bills for payment.
7. Keep purchase records and maintain good supplier relations.

Essential Requisites of Storing of Materials

1. Proper location – stores near the production area to reduce handling.
2. Proper layout – racks, bins and codes so every item is easily found.
3. Safety – protection from fire, theft, rain and damage.
4. Stock levels – fixing maximum, minimum, re-order and danger levels.
5. Records – Bin Card in stores and Stores Ledger in the costing department.
6. Trained storekeeper and regular physical checking (perpetual inventory).

Preparation of Bin Card

Bin Card is a quantity record kept by the storekeeper for each item, attached to the bin or rack. It shows receipts, issues and balance in quantity only (no value). The Stores Ledger is kept by the costing department and shows both quantity and value.

Illustration 1 (Bin Card): Item: Steel rods. 1 March opening balance 200 units; 5 March received 300 units (GRN 12); 10 March issued 400 units (MRN 31); 18 March received 400 units (GRN 19); 25 March issued 300 units (MRN 42). Prepare a Bin Card.

Issue of Material for Production

Material is issued only against a Material Requisition Note (MRN) signed by the foreman. It shows the job number, item, quantity and department. Excess material is returned with a Material Return Note; material moved from one job to another uses a Material Transfer Note. This ensures no unauthorised issue and correct charging to jobs.

Pricing Methods: LIFO, FIFO, Simple Average and Weighted Average

• FIFO (First In First Out) – material received first is issued first. Closing stock is at the latest prices. Good when prices are falling (issues at older prices are realistic) but in rising prices it shows higher profit.
• LIFO (Last In First Out) – latest purchases are issued first. Issues are at current prices; closing stock at old prices. Note: LIFO is not allowed for financial statements under Ind AS 2 / AS 2, but it is studied in cost accounting.
• Simple Average – issue price = total of unit prices of lots in stock ÷ number of lots (quantity is ignored).
• Weighted Average – issue price = total value of stock ÷ total quantity in stock. A new rate is found after every receipt.

Illustration 2: Using the data of Illustration 1 with rates – opening 200 units @ ₹10, Mar 5 receipt @ ₹12, Mar 18 receipt @ ₹13 – prepare Stores Ledger under FIFO and LIFO.

FIFO:

LIFO:

Check: Opening + receipts = 2,000 + 3,600 + 5,200 = ₹10,800. FIFO: issues 4,400 + 3,800 + closing 2,600 = 10,800. LIFO: 4,600 + 3,900 + 2,300 = 10,800.

Illustration 3 (Weighted and Simple Average), same data:

Simple Average: Mar 10 issue rate = (10 + 12) ÷ 2 = ₹11, issue = 400 × 11 = ₹4,400, balance 100 units = 5,600 − 4,400 = ₹1,200. Mar 18 balance 500 units = ₹6,400. Mar 25 lots in stock @ ₹12 and ₹13, rate = ₹12.50, issue = 300 × 12.50 = ₹3,750, closing 200 units = 6,400 − 3,750 = ₹2,650.

Likely exam questions

1. (Long, 8/16 marks) What is Cost Accounting? Explain its objectives and advantages, and distinguish between Cost Accounting and Financial Accounting.
2. (Long, 8/16 marks) From the following, prepare the Stores Ledger under FIFO and Weighted Average methods: 1 Jan opening stock 500 kg @ ₹20; 6 Jan purchased 1,000 kg @ ₹22; 12 Jan issued 800 kg; 20 Jan purchased 600 kg @ ₹24; 28 Jan issued 900 kg.
3. (Short, 4 marks) Explain the elements of cost with a chart.
4. (Short, 4 marks) What is a Bin Card? How is it different from the Stores Ledger?
5. (Short, 4 marks) State the functions of the Purchase Department.

Syllabus topics (RTMNU)

• Direct and Indirect Labour Cost
• Methods of Payment of Wages: Time Basis and Piece Basis
• Incentive Plans: Halsey Plan, Rowan Plan and Taylor’s Differential Piece Rate System
• Classification of Overheads
• Need and Importance of Allocation, Apportionment and Absorption of Overheads
• Basis of Apportionment of Overheads
• Principles of Apportionment
• Methods of Absorption of Overheads: Percentage on Direct Material Cost, Percentage on Direct Labour Cost, Percentage on Prime Cost, Direct Labour Hour Rate, Machine Hour Rate

Direct and Indirect Labour Cost

Labour cost is the wages paid to workers for converting raw material into finished goods.

• Direct labour – wages of workers directly engaged in making the product, traceable to it (e.g. a tailor stitching shirts, a machine operator in a job). It is part of prime cost.
• Indirect labour – wages of workers not directly making the product (e.g. supervisor, storekeeper, watchman, cleaner, maintenance staff). It is part of overheads.

Methods of Payment of Wages: Time Basis and Piece Basis

Time rate system: wages = hours worked × rate per hour. Payment does not depend on output.

Piece rate system: wages = units produced × rate per unit. Payment depends on output.

Incentive Plans: Halsey Plan, Rowan Plan and Taylor’s Differential Piece Rate System

Incentive plans pay a bonus to efficient workers for saving time or producing more. Time wages are guaranteed in Halsey and Rowan.

• Halsey Premium Plan – Earnings = (Time Taken × Rate) + 50% × (Time Saved × Rate). Time saved = Time Allowed − Time Taken. (The bonus percentage may be 33⅓% in the Halsey-Weir plan.)
• Rowan Plan – Earnings = (Time Taken × Rate) + (Time Saved ÷ Time Allowed) × Time Taken × Rate. Bonus can never reach 100% of time wages, so a worker cannot gain by rushing too much.
• Taylor’s Differential Piece Rate – two piece rates: a low rate for output below standard and a high rate for output at or above standard. No guaranteed time wage. It rewards efficient workers and penalises slow ones.

Illustration 1: Time allowed for a job 10 hours, time taken 8 hours, rate ₹50 per hour. Calculate earnings under (a) Time rate (b) Halsey (50%) (c) Rowan.

Illustration 2 (Taylor): Standard output 100 units per day. Normal piece rate ₹2 per unit. Low rate ₹1.60 (80%) below standard; high rate ₹2.40 (120%) at or above standard. Worker A produces 90 units, Worker B 110 units.

Classification of Overheads

Overheads are the total of indirect material, indirect labour and indirect expenses.

• By function: Factory/Works overheads (factory rent, power, depreciation of machinery), Office & Administration overheads (office salaries, audit fees), Selling overheads (advertisement, salesmen’s commission), Distribution overheads (carriage outward, warehouse rent).
• By behaviour: Fixed (rent, insurance), Variable (power, fuel), Semi-variable (repairs, telephone).
• By element: Indirect material, indirect labour, indirect expenses.
• By control: Controllable and uncontrollable.

Need and Importance of Allocation, Apportionment and Absorption of Overheads

• Allocation – charging a whole overhead item to one cost centre that alone caused it (e.g. salary of the machine shop foreman to the machine shop).
• Apportionment – sharing a common overhead among several cost centres on a fair basis (e.g. factory rent shared by floor area).
• Absorption – charging the overheads of a cost centre to the units produced, using a pre-determined rate.

Importance: gives the correct total cost of each product; helps fix selling price and tender price; shows overhead cost of each department for control; ensures no overhead is left out of product cost.

Basis of Apportionment of Overheads and Principles of Apportionment

Principles of apportionment:

1. Service or benefit received – share in proportion to benefit (e.g. canteen by number of workers).
2. Survey method – technical survey estimates each department’s share (e.g. supervision time).
3. Ability to pay – share in proportion to sales or profit of the department.
4. Efficiency – based on achieved vs planned production.

Methods of Absorption of Overheads

The labour hour rate is best when work is done mainly by hand; the machine hour rate is best when work is done mainly by machines, because most overheads (power, depreciation) depend on machine time.

Illustration 3: Factory overheads ₹30,000; direct material ₹50,000; direct labour ₹25,000; direct labour hours 10,000; machine hours 5,000. Job No. 7 used material ₹2,000, labour ₹1,500, 400 labour hours and 250 machine hours. Find overheads for Job 7 under each method.

Illustration 4 (Machine Hour Rate): Cost of machine ₹5,00,000; scrap value ₹50,000; life 10 years; working 2,000 hours a year. Repairs ₹20,000 a year. Power 10 units per hour @ ₹8. Shop rent ₹60,000 and supervisor salary ₹1,20,000 a year, shared equally by 4 machines. Insurance 1% of cost a year.

Likely exam questions

1. (Long, 8/16 marks) Explain the meaning of allocation, apportionment and absorption of overheads. State the bases and principles of apportionment of overheads.
2. (Long, 8/16 marks) Time allowed for a job is 40 hours, time taken is 30 hours and the rate is ₹60 per hour. Calculate the earnings and effective hourly rate under the Time Rate, Halsey Plan and Rowan Plan.
3. (Short, 4 marks) Distinguish between time rate and piece rate systems of wage payment.
4. (Short, 4 marks) Explain Taylor’s Differential Piece Rate System.
5. (Short, 4 marks) What is Machine Hour Rate? When is it used?

Syllabus topics (RTMNU)

• Cost Sheet
• Need of Cost Sheet
• Preparation of Cost Sheet
• Tender and Quotations

Cost Sheet

Definition: A Cost Sheet is a statement that shows the various elements of cost of a product step by step – prime cost, works cost, cost of production, cost of goods sold and cost of sales – for a given period, in total and per unit.

It is used under unit (single/output) costing, where a business makes one product or a few similar products in uniform units, e.g. cement (per bag), bricks (per 1,000), sugar (per quintal), steel (per tonne).

Need of Cost Sheet

1. Shows total and per unit cost of each element.
2. Helps fix selling price and prepare tenders/quotations.
3. Comparison – cost of this period can be compared with last period to find increase or decrease.
4. Cost control – shows which element is rising.
5. Stock valuation – work-in-progress and finished stock can be valued at cost.
6. Decision making – e.g. whether to accept an export order at a lower price.

Preparation of Cost Sheet

Items NOT included in a cost sheet (pure financial items): interest on capital/loans, income tax, dividend, donations, goodwill written off, preliminary expenses written off, loss on sale of fixed assets, discount on issue of shares, interest received, rent received.

Illustration 1: From the following particulars of Sai Industries, Nagpur, for the year 2025-26, prepare a Cost Sheet showing total and per unit cost. Units produced and sold: 10,000.

Solution: Cost Sheet of Sai Industries for 2025-26 (Output 10,000 units)

Note: Interest on loan ₹5,000 is a financial charge and is excluded from the cost sheet.

Tender and Quotations

Tender / Quotation: A tender (or quotation) is a price offered in advance to a customer for supplying a given quantity of goods or doing a job. Since the work is not yet done, the cost is estimated from the previous period’s cost sheet.

Steps to prepare a tender:

1. Prepare the cost sheet of the last period.
2. Find the overhead rates: factory overheads as % of direct wages (or prime cost), office overheads as % of works cost, selling overheads as % of cost of production.
3. Estimate direct material and direct labour for the new order, adjusting for expected price changes.
4. Apply the overhead rates to the estimated figures.
5. Add the required profit. Note: 20% profit on sales price = 25% on cost; 25% on sales = 33⅓% on cost.
6. The total is the tender price; also show price per unit.

Illustration 2: Last year’s records of Shree Ganesh Works: direct material ₹2,00,000; direct wages ₹1,50,000; factory overheads ₹90,000; office overheads ₹44,000; selling overheads ₹24,200. Prepare a tender for 500 units requiring material ₹60,000 and wages ₹40,000, to earn a profit of 20% on the selling price.

Working notes (last year): Works cost = 2,00,000 + 1,50,000 + 90,000 = ₹4,40,000; Cost of production = 4,40,000 + 44,000 = ₹4,84,000.

• Factory overheads % of direct wages = 90,000 ÷ 1,50,000 × 100 = 60%
• Office overheads % of works cost = 44,000 ÷ 4,40,000 × 100 = 10%
• Selling overheads % of cost of production = 24,200 ÷ 4,84,000 × 100 = 5%
• Profit 20% on sales = 20 ÷ 80 = 25% on cost of sales

Statement of Tender Price for 500 units

Check: 20% of ₹1,79,025 = ₹35,805, which equals the profit.

Likely exam questions

1. (Long, 8/16 marks) What is a Cost Sheet? Explain its need and give the format of a Cost Sheet showing the various stages of cost.
2. (Long, 8/16 marks) From the following, prepare a Cost Sheet showing prime cost, works cost, cost of production, cost of sales and profit: raw material consumed ₹1,20,000; direct wages ₹80,000; direct expenses ₹10,000; factory overheads 50% of direct wages; office overheads 10% of works cost; selling overheads ₹15,000; sales ₹3,20,000.
3. (Short, 4 marks) What is a tender? How is it prepared?
4. (Short, 4 marks) Write a short note on items excluded from a cost sheet.
5. (Short, 4 marks) Last year direct wages were ₹50,000 and factory overheads ₹30,000. For a job with material ₹8,000 and wages ₹5,000, find works cost (factory overheads as % of wages).

Syllabus topics (RTMNU)

• Need of Reconciliation of Profit
• Reason for the difference between Profits of Cost Accounts and Financial Accounts
• Objectives of Reconciliation Statement
• Preparation of Reconciliation Statement

Need of Reconciliation of Profit

When a business keeps cost accounts and financial accounts separately (non-integrated system), the profit shown by the two sets of books is usually different. Profit Reconciliation Statement is a statement prepared to explain the reasons for this difference and to agree (match) the two profits.

Need:

1. To find the reasons why the two profits differ.
2. To check the arithmetical accuracy of both sets of accounts.
3. To show that cost data used by management is reliable.
4. To find under- or over-absorption of overheads, which helps correct overhead rates.
5. Required in cost audit and for management confidence.

Reason for the difference between Profits of Cost Accounts and Financial Accounts

1. Items shown only in Financial Accounts (not in Cost Accounts)

• Purely financial incomes (increase financial profit): interest received on investments, dividend received, rent received, transfer fees received, profit on sale of fixed assets, discount received.
• Purely financial expenses (reduce financial profit): interest on loans/debentures, income tax, donations, goodwill/preliminary expenses written off, loss on sale of fixed assets, discount on issue of shares, fines and penalties.

2. Items shown only in Cost Accounts – notional costs such as interest on own capital and rent of own premises. They reduce costing profit only.

3. Under- or over-absorption of overheads – cost accounts charge overheads at pre-determined rates, while financial accounts show actual overheads.

• Under-absorbed (cost a/c charged less than actual) → costing profit is higher.
• Over-absorbed (cost a/c charged more than actual) → costing profit is lower.

4. Different methods of stock valuation – cost accounts value stock at cost (FIFO, weighted average etc.); financial accounts at cost or net realisable value, whichever is lower. A higher closing stock gives a higher profit; a higher opening stock gives a lower profit.

5. Different depreciation methods or rates in the two sets of books.

Objectives of Reconciliation Statement

1. Explain the difference between the two profits item by item.
2. Ensure accuracy and reliability of cost accounts.
3. Help management control overheads and improve overhead rates.
4. Help detect errors and frauds.
5. Promote co-ordination between the costing and financial departments.

Preparation of Reconciliation Statement

Steps:

1. Start with profit as per one set of books (usually Cost Accounts) as the base.
2. For each item, ask: “Is the other profit higher or lower because of this item?”
3. If the other profit is higher, add; if lower, less.
4. Total the additions and deductions; the result is the profit as per the other set of books.

Illustration 1: Profit as per Cost Accounts of Om Traders for 2025-26 is ₹1,50,000. Prepare a Reconciliation Statement from the following: (a) Factory overheads under-absorbed in cost accounts ₹8,000. (b) Office overheads over-absorbed in cost accounts ₹5,000. (c) Depreciation charged in financial accounts ₹30,000 and in cost accounts ₹25,000. (d) Interest received on investments ₹6,000. (e) Preliminary expenses written off ₹4,000. (f) Closing stock valued at ₹52,000 in cost accounts and ₹50,000 in financial accounts. (g) Dividend received ₹3,000.

Reconciliation Statement for the year ended 31 March 2026

Illustration 2 (starting from Financial Profit): Net profit as per financial accounts ₹80,000. (a) Goodwill written off ₹10,000. (b) Loss on sale of machinery ₹6,000. (c) Income tax provided ₹20,000. (d) Notional rent of own premises charged in cost accounts ₹12,000. (e) Transfer fees received ₹2,000. (f) Works overheads over-recovered in cost accounts ₹4,000. (g) Selling overheads under-recovered in cost accounts ₹3,000. Find costing profit.

Memorandum Reconciliation Account: The same adjustments can also be shown in a ledger-style account – start with the costing profit on the credit side, put additions on the credit side and deductions on the debit side; the balancing figure is the financial profit.

Likely exam questions

1. (Long, 8/16 marks) What is a Profit Reconciliation Statement? Explain its need and the reasons for the difference between the profits shown by Cost Accounts and Financial Accounts.
2. (Long, 8/16 marks) Profit as per Cost Accounts is ₹2,00,000. Factory overheads under-recovered ₹12,000; administration overheads over-recovered ₹6,000; interest on debentures ₹15,000 (not in cost accounts); bank interest received ₹4,000; closing stock valued ₹5,000 higher in cost accounts. Prepare a Reconciliation Statement and find the financial profit.
3. (Short, 4 marks) State the objectives of a Reconciliation Statement.
4. (Short, 4 marks) Give four items that appear only in financial accounts and not in cost accounts.
5. (Short, 4 marks) Profit as per financial accounts is ₹50,000; income tax ₹8,000 and donation ₹2,000 are shown only in financial accounts; notional interest on capital ₹5,000 is charged only in cost accounts. Find costing profit.