Cost Accounting Elements of Cost and Classification of Costs

MBA : FT103C
Accounting for Managers
Part II: Cost Accounting
Elements of Cost and Classification of Costs
There are broadly three elements of cost –
(1) material, (2) labour and (3) expenses.:
Material
The substance from which the product is made is known as material. It may be
in a raw state-raw material, e.g., timber for furniture and leather for shoe, etc. It
may j also be in manufactured state-components, e.g., battery for car, speaker for
radio, etc, Materials can be direct and indirect.
Direct Material:
All materials which become an integral part of the finished j product, the cost of
which are directly and completely assigned to the specific physical units and
charged to the prime cost, are known as direct material.
Indirect Material:
All materials, which cannot be conveniently assigned to specific physical units,
are termed as 'indirect material'. Such commodities do not form part of the
finished products. Consumable stores, lubrication oil, stationery and spare parts
for the machinery are termed as indirect materials.
Labour
Human efforts used for conversion of materials into finished products or doing
various jobs in the business are known as labour. Payment made towards the
labour is called labour cost. It can also be direct and indirect.
Direct Labour:
Direct labour is all labour expended and directly involved in altering the
condition, composition or construction of the product. The wages paid to skilled
FT103C/Accounting for Managers/Prof. Sachin Sarda
http://studymaterial.sapientindore.org c
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MBA : FT103C
Accounting for Managers
and unskilled workers for manual work or mechanical work for operating
machinery, which can be specifically allocated to a particular unit of production,
is known as direct wages or direct labour cost. Hence, 'direct wage' may be
defined as the measure of direct labour in terms of money.
Indirect Labour:
Labour employed to perform work incidental to production of goods or those
engaged for office work, selling and distribution activities are known as 'indirect
labour'. The wages paid to such workers are known as 'indirect wages' or indirect
labour cost.
Example: Salary paid to the driver of the delivery van used for distribution of the
product.
Expenses
All expenditures other than material and labour incurred for manufacturing a
product or rendering service are termed as 'expenses'. Expenses may be direct or
indirect.
Direct Expenses:
Expenses which are specifically incurred and can be directly and wholly allocated
to a particular product, job or service are termed as 'direct expenses'. Examples
of such expense are: hire charges of special machinery hired for the fob, carriage
inward, royalty, cost of special and specific drawings, etc. These are also known
as 'chargeable expenses'.
Indirect Expenses:
All expenses excluding indirect material and indirect labour, which cannot be
directly and wholly attributed to a particular product, job or service, are termed
as 'indirect expenses'. Some examples of such expenses are: repairs to
machinery, insurance, lighting and rent of the buildings.
FT103C/Accounting for Managers/Prof. Sachin Sarda
http://studymaterial.sapientindore.org c
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MBA : FT103C
Accounting for Managers
Unit Cost:
The cost incurred by a company to produce, store and sell one unit of a
particular product. Unit costs include all fixed costs (i.e. plant and equipment)
and all variable costs (labor, materials, etc.) involved in production.
Batch Cost:
Batch costing is used for calculating total cost of each batch. Batch is small
group of units which is produced for production purposes. We also identify batch
of units in our production. All raw materials is supplied on batch basis and other
expenses are also paid on the basis of each batch.
Job order cost:
The job order cost system is used when products are made based on specific
customer orders. Each product produced is considered a job. Costs are tracked
by job. Services rendered can also be considered a job.
Contract Cost:
Contract costing is a type of job costing and it applies to
Civil construction works like: building contractors, dam, roads,
Civil Engineering firms like building repairing firms, landscaping firms etc.
Mechanical Engineering firms ship building, aircraft building and the like.
Process Cost:
Process costing is a type of operation costing which is used to ascertain the cost
of a product at each process or stage of manufacture. CIMA defines process
costing as "The costing method applicable where goods or services result from a
sequence of continuous or repetitive operations or processes.
Joint Product Cost:
A joint product cost can be defined as that cost which arises from the common
processing or manufacturing of products produced from a common raw material.
Whenever two or more different products are created from a single cost factor, a
FT103C/Accounting for Managers/Prof. Sachin Sarda
http://studymaterial.sapientindore.org c
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MBA : FT103C
Accounting for Managers
joint product cost results. A joint cost is incurred prior to the point at which
separately identifiable products emerge from the same process.
By-Product Cost:
The term "by product" is generally used to denote one or more products of
relatively small total value that are produced simultaneously with a product of
greater total value. The product with the greater value, commonly called the
"main product", is usually produced in greater quantities than the byproducts.
Cost Control and Cost Reduction:
Cost control and reduction refers to the efforts business managers make to
monitor, evaluate, and trim expenditures. These efforts might be part of a formal,
company-wide program or might be informal in nature and limited to a single
individual or department. In either case, however, cost control is a particularly
important area of focus for small businesses, which often have limited amounts
of time and money. In a small business the focus is often on selling and servicing
the customer.
Target Costing and Activity Based Costing:
Target Costing is a method to measure the allowable amount of cost that can be
incurred on a product and still earn the required profit from that product.
Activity-Based Costing (ABC):
is a method to measure the cost and performance of activities, resources, and
cost objects. Resources are assigned activities and activities are assigned to cost
objects based on their use.
FT103C/Accounting for Managers/Prof. Sachin Sarda
http://studymaterial.sapientindore.org c
4