Basic Cost Concepts

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Basic Cost Concepts

Meaning of Cost Accounting – Cost accounting is concerned with ➢ recording, classifying and summarizing costs for determination of costs of products or services, ➢ planning, controlling and reducing such costs and

➢ furnishing of information to management for decision-making. Cost accounting, thus, provides information to the management for decision of all sorts. It serves multiple purposes on account of which it is generally indistinguishable from management accounting.

Objectives of Cost Accounting
1. Determining selling price
2. Determining and controlling efficiency
3. Facilitates the preparation of financial and other statements 4. Providing basis for operating policy
a. Determination of cost-volume-profit relationship
b. Shutting down or operating at a loss
c. Making or buying from outside suppliers
d. Continuing with the existing plant and machinery or replacing them by improved and economic ones.

Concept of Cost
Cost – the amount of expenditure (actual or estimated) incurred on, or attributable to, a given thing.” However, the term cost cannot be exactly defined. Its interpretation depends upon – ➢ The nature of the business, or industry, and

➢ The context in which it is used

Cost Classification
1. Fixed, Variable and Semi-variable costs –
a) Fixed Costs – costs which do not change with changes in volume of output/activity within a specified (relevant) range for a given budget period. There is an inverse relationship between volume and fixed cost per unit ↑ No. of Units produced → Fixed cost per unit ↓ Hence, Fixed Costs are constant on aggregate basis but are variable on a unit basis.

b) Variable costs – costs that tend to vary in direct proportion or in a one-to-one relationship to changes in production activity, sales activity or some other measure of volume, within relevant range for a given budget period. There is a direct relationship between volume and variable cost. However, variable cost per unit remains constant within relevant range. ↑ No. of Units produced → Total Variable Cost ↑

c) Semi-variable Costs (Mixed Costs) – costs which consist of partly fixed costs and partly variable costs. Fixed component – the cost of providing capacity – not affected by the changes in the level of activity Variable Component – the cost of using the capacity – influenced by the changes in the level of activity. Thus, semi-variable costs change in the same direction as volume but not in direct proportion thereto.

2. Product costs and Period costs –
(a) Product costs –
➢ which become part of the cost of the product ➢ included in inventory values
➢ Are shown as assets until goods are sold
➢ Become an expense at the time of sales
➢ May be fixed as well as variable
➢ Example – cost of raw material, direct wages, depreciation etc. (b) Period costs –
➢ Costs, which are not associated with production ➢ Are treated as an expense of the period in which they are incurred. ➢ May also be fixed as well as variable

➢ Example – general administration expenses, salesman salaries, commission, depreciation of office facilities etc.

3. Direct and indirect costs –
➢ Direct costs are costs which can be identified logically and practically in their entirety to a particular department/product. ➢ Indirect costs are costs which are not practically identifiable exclusively and wholly to a particular product, division or segment. ➢ Indirect costs are frequently called “common costs” as they are allocated between two or more products / divisions of a business. ➢ Thus, the distinction between a direct cost and indirect cost depends upon...
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