Notes on Cost Accounting Concepts

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Cost Concepts
Semester II

Basic Terms
• Cost is the amount of expenditure, actual (incurred) or
notional (attributable), relating to a specific thing or
activity. The specific thing or activity may be a
product, job, service, process or any other activity
• Expenses are expired costs, incurred and totally used
up in generation of revenue
• Loss is lost cost. The term ‘loss’ is used to describe mainly two accounting events. In traditional financial
accounting it is used to denote a situation where
expenses exceed revenues for an accounting period.
Secondly, a loss arises due to the cost of an asset being
more than the sale proceeds when the asset is sold.
Loss is unrelated to revenue generation and is only
offset against revenue of the period in which the loss

Classification of Costs
• The achievement of the objectives of cost accounting
requires that cost should be ascertained, classified and
• Cost classification may be defined as the process of
grouping costs according to their common
• There are many objectives of cost classifications
depending on the requirements of managementDetermining product costs for stock valuation and profit measurement
Decision Making

Natural classifications of costs
1. Direct material refers to the cost of
materials which are conveniently and
economically traceable to specific units of
output. Examples of direct materials are:
raw cotton in textiles, crude oil to make
diesel, steel to make automobile bodies.
Items, such as import duties, dock charges,
transport cost of materials, storing of
materials, cost of purchasing and receiving
materials are properly added to their
invoiced price and thus, the materials are
charged out at this increased cost.

• Direct labour - Direct labour is defined as the
labour of those workers who are engaged in
the production process. Examples are the
labour of machine operators and assemblers.
• Direct expenses - These include any
expenditure other than direct material and
direct labour directly incurred on a specific
product or job. Such special necessary
expenses can be identified with product or
job and are charged directly to the product as
part of the prime cost. Examples of direct
expenses are fees paid to architects,
surveyors and other consultants, cost of
special moulds, designs and patterns.

• Factory overhead also called manufacturing overhead
or factory burden, may be defined as the cost of
indirect materials, indirect labour and indirect
expenses. Relation with the product is so small or
complex that it would not be appropriate to treat it as
prime cost
• Selling and distribution and administrative
overheads are generally incurred when the product is
in saleable condition. Selling and distribution
overheads covers the cost of making sales and
delivering/despatching products. These costs include
advertising, salesmen salaries and commissions,
Administrative overhead
includes costs of planning and controlling the general
policies and operations of a business enterprise.

Total Cost
• Direct Material + Direct Labour + Direct
Expenses = Prime Cost
• Indirect Materials + Indirect Labour +
Indirect Expenses = Factory Overhead
• Prime Cost + Factory Overhead = Factory
• Factory Cost + Selling and Distribution
and Administrative overhead = Total Cost

Cost behaviour
1. Fixed cost - Fixed cost is a cost which does
not change in total for a given time period
and capacity despite wide fluctuations in
output or volume of activity. They accrue or
are incurred with the passage of time and
not with the production of the product or
the job. Examples of fixed costs are rent,
depreciation on office facilities, advertising,
insurance, etc.

2. Variable cost - Variable costs are those costs that...
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