Cost Accounting Principles and Manufacturing Applications
Q1. Define Cost Accounting and State Its Main Objects
Cost Accounting is the process of recording, classifying, analyzing, summarizing, and allocating all the costs incurred in the production process. It helps management in understanding and controlling costs so that efficient and profitable operations can be maintained. Cost accounting not only deals with the costs of production but also helps in pricing, budgeting, and decision-making processes. It includes both fixed and variable costs, and applies to all aspects of a business — from raw material procurement to finished goods distribution. The key purpose of cost accounting is to provide detailed cost information that management needs to control current operations and plan for the future. Unlike financial accounting, which provides historical data primarily for external stakeholders, cost accounting focuses on internal users such as managers and executives.
Main Objectives of Cost Accounting:
- Cost Control: One of the primary objectives is to control the costs of production by identifying avoidable and unnecessary expenditures. It uses tools such as standard costing and variance analysis.
- Cost Ascertainment: Cost accounting aims to ascertain the exact cost of each product, service, job, or operation through various costing techniques like job costing, batch costing, and process costing.
- Pricing Decisions: Cost data is essential in determining the selling price of a product. Knowing the exact cost ensures that the pricing covers costs and includes profit margins.
- Budgeting and Planning: With accurate cost information, management can create more realistic budgets and strategic plans. It allows for forecasting based on cost behavior patterns.
- Decision Making: Whether to accept a special order, discontinue a product line, or make or buy a product — all these managerial decisions require cost analysis.
- Profitability Analysis: It helps in identifying the profit earned from each product, department, or process. This ensures that unprofitable areas can be corrected or eliminated.
- Inventory Valuation: Cost accounting helps in the correct valuation of inventory, which impacts the balance sheet and profit & loss statement. It ensures that stocks are neither overvalued nor undervalued.
- Performance Measurement: With techniques like responsibility accounting and performance budgeting, managers can evaluate their team’s cost efficiency.
- Detection of Wastage and Losses: Cost accounting helps identify losses due to theft, spoilage, or inefficiencies and allows management to take corrective actions.
- Compliance with Government Policies: In certain industries, cost accounting records are mandatory to comply with regulations and laws, especially where prices are controlled.
Q1. What are the main features of cost accounting? Explain its role in a manufacturing concern.
Cost accounting is a specialized branch of accounting that focuses on recording, classifying, analyzing, and allocating all costs associated with a business process. Its primary goal is to determine the cost of production and ensure cost control and cost reduction. It plays a crucial role in decision-making within manufacturing concerns by offering precise data regarding costs involved in production, labor, materials, overheads, and other operational areas.
Main Features of Cost Accounting:
- Systematic Recording: It involves the systematic recording of costs for each process, job, or product.
- Classification and Allocation: Costs are classified into various categories (fixed, variable, direct, indirect) and allocated accordingly.
- Cost Determination: Helps in determining the total cost of production and the per-unit cost.
- Control and Reduction: Through techniques like standard costing and variance analysis, it helps control and reduce unnecessary expenses.
- Decision-Making Tool: It provides critical data for decisions related to pricing, outsourcing, budgeting, etc.
- Budgeting: Helps in preparing budgets and estimating future costs.
Role in Manufacturing Concern:
Manufacturing companies use cost accounting to track the costs involved in turning raw materials into finished goods. It supports:
- Product Costing: Helps in calculating the exact cost incurred to produce each unit, aiding in pricing decisions.
- Inventory Valuation: Cost accounting determines the value of closing stock of raw materials, work-in-progress, and finished goods.
- Budgetary Control: Manufacturers can prepare realistic budgets and compare actual results with budgeted figures.
- Operational Efficiency: By analyzing cost data, areas of inefficiency and wastage can be identified and corrected.
- Profitability Analysis: It helps identify the most profitable product lines and processes.
- Cost Reports: Provides reports for internal use which help in production planning, cost control, and optimization.
Q2. Discuss any two methods of costing and the industries to which they can be applied.
Costing methods are techniques used by businesses to determine the cost of their products or services. These methods help in cost control, setting prices, and making informed managerial decisions. There are several methods of costing, but here we will discuss Job Costing and Process Costing, along with their applicable industries.
1. Job Costing:
Definition: Job costing is a method used when work is undertaken as per specific orders from customers. Each job is treated separately, and costs are collected and recorded for each job individually.
Features:
- Every job is assigned a unique job number.
- Materials, labor, and overhead costs are recorded for each job.
- It is suitable where work is not standardized and jobs vary in terms of requirements.
Industries Using Job Costing:
- Construction Industry: Each construction project like a building, road, or bridge is treated as a separate job.
- Printing Presses: Every printing order has different design, pages, and quantity.
- Interior Decoration: Custom-made interior work varies for each client.
- Shipbuilding: Each ship is a large project, different from another.
- Repair Workshops: Every repair job is different depending on the nature of damage.
Advantages:
- Helps determine the profit or loss of individual jobs.
- Effective control over job-wise cost elements.
- Better customer pricing through accurate job costing.
Limitations:
- Can be time-consuming to track each job individually.
- Not suitable for mass production.
2. Process Costing:
Definition: Process costing is used in industries where production is continuous and products pass through multiple processes or departments. Costs are accumulated for each process for a given period and then averaged over the number of units produced.
Features:
- Suitable for homogeneous products produced in large quantities.
- Costs are collected process-wise.
- Each process has its own cost sheet.
Industries Using Process Costing:
- Chemical Manufacturing: Like paints, fertilizers, and pharmaceuticals.
- Food and Beverages: Dairy, biscuit, soft drinks, and oil industries.
- Textiles: Yarn and fabric production go through multiple processing stages.
- Cement Industry: Raw materials go through kiln, grinding, packing, etc.
- Soap and Detergents: Where mixing, molding, and packing are sequential.
Advantages:
- Easy to determine average cost per unit.
- Simplifies accounting for large-scale production.
- Helps in controlling wastage in each process.
Limitations:
- Not suitable for customized products.
- Cost allocation between processes may sometimes be inaccurate.
Q2. What are the different methods of costing? State the industries to which they can be applied.
Costing methods are techniques used to ascertain the cost of a product, service, job, or activity. These methods help in analyzing and evaluating costs for decision-making and control. The selection of a method depends on the nature of the industry, type of product, and production process.
1. Job Costing:
In this method, costs are ascertained for each specific job, work order, or project. It is suitable for customized or non-repetitive production.
Industries Using Job Costing:
- Construction companies
- Shipbuilding
- Repair workshops
- Printing presses
- Interior designing firms
2. Batch Costing:
Under batch costing, a group of identical units is treated as one batch. The cost of the entire batch is calculated and divided by the number of units to determine per unit cost.
Industries Using Batch Costing:
- Pharmaceutical companies
- Shoe manufacturing
- Ready-made garment industries
- Electronic parts production
3. Process Costing:
This method is used where production is carried out through a series of processes or stages, and the product is homogeneous. Costs are collected for each process or department.
Industries Using Process Costing:
- Oil refineries
- Paint manufacturing
- Cement industry
- Chemicals and fertilizers
- Sugar and paper mills
4. Unit Costing (or Output Costing):
Here, cost per unit is calculated for a single product that is manufactured in large quantities and is homogeneous in nature.
Industries Using Unit Costing:
- Brick making
- Mining
- Cement manufacturing
- Beverage bottling
- Steel production
5. Operating Costing (or Service Costing):
This method is applied where services are rendered instead of tangible goods. The cost of providing a service per unit (per passenger, per km, etc.) is calculated.
Industries Using Operating Costing:
- Transport services (bus, railways, airlines)
- Hospitals
- Hotels and restaurants
- Power generation companies
- Educational institutions
6. Contract Costing:
Used for long-term, large-scale construction contracts. Each contract is treated as a cost unit, and costs are tracked accordingly.
Industries Using Contract Costing:
- Building and civil construction
- Road and bridge construction
- Large infrastructure projects
7. Multiple Costing (or Composite Costing):
Used where the final product is made up of many components, each of which may require a different costing method.
Industries Using Multiple Costing:
- Automobile manufacturing
- Aircraft manufacturing
- Electronics and machinery
Q1. Why is costing necessary in the modern system of economy? Explain various advantages of cost accounting.
Costing plays a significant role in the modern system of economy where competition is intense, resources are limited, and efficiency is key. Costing is the technique and process of ascertaining the costs of products or services. It enables businesses to understand their cost structures, reduce waste, and enhance decision-making.
In the modern economy, there is a continuous need to control production costs to survive in a competitive environment. Companies must offer quality products at reasonable prices, which is only possible through efficient cost management. Costing systems provide detailed information about production costs, overheads, and profitability, helping in strategic planning and price setting.
Advantages of Cost Accounting:
- Helps in Cost Control: It helps managers to identify wastages and inefficiencies by comparing actual costs with standard costs.
- Fixing the Selling Price: Accurate cost data enables a company to fix selling prices that cover costs and ensure profitability, especially in a competitive market.
- Measurement of Efficiency: Cost accounting assesses performance by comparing standard performance with actual results, thus identifying efficient and inefficient areas.
- Assists in Decision Making: It provides crucial data for decisions like make or buy, continue or discontinue a product line, or expand capacity.
- Inventory Control: Helps maintain an optimum level of inventory of raw materials, work-in-progress, and finished goods.
- Budgeting: Aids in preparing budgets and forecasts by providing cost data of previous periods and expected future trends.
- Improves Profitability: Through effective cost analysis and control, it helps businesses identify areas to cut costs and increase profits.
- Determining Break-Even Point: Cost accounting helps in finding the break-even point which indicates the level of sales where the company earns no profit or loss.
- Compliance and Reporting: It helps in reporting to the government, financial institutions, and for internal audits.
- Helps in Valuation: Assists in the valuation of inventories and work-in-progress for financial reporting.
- Encourages Cost Consciousness: Employees become more aware of cost implications, leading to improved performance.
- Facilitates Internal Control: Cost systems set standards and compare them with actuals, ensuring accountability and control.
Q2. What are the main characteristics of the cost? Describe different types of classifications of the cost.
Main Characteristics of Cost:
Monetary Value: Cost is always measured in monetary terms. It reflects the value of resources consumed in production or service delivery.
Purpose Oriented: Cost is always incurred with a specific objective — manufacturing, administration, selling, etc.
Relates to Past or Future: Cost can be historical (already incurred) or future (expected or budgeted).
Variable Nature: Costs vary with time, volume, activity, or management decisions — some are fixed, others variable.
Classification of Costs:
Costs can be classified based on different parameters:
1. By Nature (Element-wise Classification):
Direct Costs: Directly traceable to the product — e.g., direct materials, direct labor.
Indirect Costs (Overheads): Cannot be traced directly — e.g., factory rent, electricity, manager’s salary.
2. By Function:
Production/Manufacturing Cost: Costs associated with production — raw materials, wages, factory rent.
Administrative Cost: Expenses for general management — salaries, office rent, stationery.
Selling and Distribution Cost: Cost to promote and deliver the product — ads, salesmen salary, freight.
Research & Development Cost: Costs incurred to innovate or improve products.
3. By Behavior:
Fixed Costs: Do not change with output — e.g., rent, insurance.
Variable Costs: Change proportionally with output — e.g., raw material, piece-rate wages.
Semi-variable Costs: Partly fixed and partly variable — e.g., electricity bill with fixed meter rent and variable usage charges.
4. By Controllability:
Controllable Costs: Costs which can be influenced by a specific level of management — e.g., direct material wastage by production supervisor.
Uncontrollable Costs: Cannot be directly controlled — e.g., allocated corporate expenses.
5. By Time:
Historical Costs: Incurred in the past, recorded in books.
Pre-determined/Standard Costs: Expected or budgeted costs used for planning and control.
6. By Decision Making:
Relevant Costs: Affects decisions, e.g., incremental costs in choosing between alternatives.
Irrelevant Costs: Do not affect decisions, e.g., sunk costs.
Opportunity Cost: Value of next best alternative foregone.
Marginal Cost: Extra cost for producing one more unit.
Q1. Explain different steps involved in purchases in a manufacturing organization.
In a manufacturing organization, purchasing plays a vital role in ensuring uninterrupted production by procuring the right quality and quantity of materials at the right price and time. The process is systematic and involves several key steps to ensure efficiency, control, and cost-effectiveness.
Steps Involved in the Purchase Procedure:
- Identification of Need: The first step is identifying the need for raw materials, components, tools, or supplies. This requirement usually originates from various departments like production, maintenance, or stores when stock reaches reorder level or when new production plans are scheduled.
- Purchase Requisition: The concerned department (usually the stores or production department) prepares a purchase requisition form. This form contains details like the type of material, quantity, specifications, and required date. The form is sent to the Purchase Department for further action.
- Selection of Suppliers: After receiving the requisition, the Purchase Department looks for potential suppliers. It may use previous supplier data, online platforms, market surveys, or tenders. A list of qualified suppliers is shortlisted based on quality, price, reliability, and delivery record.
- Obtaining Quotations: The department sends out inquiries or request for quotations (RFQs) to selected suppliers. Quotations include details such as price, delivery time, payment terms, transportation cost, taxes, etc.
- Evaluation of Quotations: All quotations received are compared and evaluated based on price, quality, terms of delivery, payment conditions, and reputation of the supplier. This helps in selecting the most appropriate supplier.
- Purchase Order (PO): Once a supplier is selected, a formal purchase order is issued. The PO is a legally binding document and includes all agreed-upon terms like quantity, price, delivery date, mode of transport, and payment terms.
- Follow-up of Order: Sometimes, especially for critical items, a follow-up is necessary to ensure the supplier dispatches the goods on time. This avoids any delay in production due to material shortages.
- Receiving and Inspection of Materials: When goods are delivered, the Receiving Department or Stores Department inspects them for quantity and quality. A Goods Received Note (GRN) is prepared after verifying with the Purchase Order. Any discrepancy is reported to the supplier immediately.
- Checking and Passing the Bill: The supplier’s invoice is verified with the Purchase Order and GRN. If everything is in order, the bill is approved for payment.
- Payment to Supplier: The Accounts Department processes the payment as per the agreed terms. It could be through cheque, bank transfer, or other modes.
- Record Keeping and Feedback: All documents like PO, invoice, GRN, and payment records are filed for audit and reference. Feedback about the supplier is recorded for future dealings.
Material Control Concepts in Costing
(a) Activity-Based Costing (ABC)
Activity-Based Costing (ABC) is a modern costing method used to allocate overhead costs more accurately. Unlike traditional costing, which applies overhead using a single cost driver (like labor hours or machine hours), ABC assigns costs based on multiple activities that drive costs in the production process.
In ABC, the process includes:
- Identifying the major activities involved in production.
- Assigning costs to these activities.
- Identifying cost drivers for each activity (like number of machine setups, orders processed, etc.).
- Assigning activity costs to products based on their usage of those cost drivers.
Example: Suppose two products – A and B – are made. Product A requires frequent machine setups while B requires more inspection. ABC will assign setup costs more to A and inspection costs more to B, resulting in accurate product costing.
Advantages:
- More precise cost allocation.
- Helps in identifying non-value-adding activities.
- Useful in complex production environments.
Limitations:
- Time-consuming and costly to implement.
- Requires detailed data collection.
(b) Halsey Premium Plan
Halsey Premium Plan is a type of incentive wage system where workers are rewarded for completing their job in less time than the standard time allotted.
- A standard time for each task is predetermined.
- Workers are paid a guaranteed basic wage for actual time worked.
- If a worker finishes the job in less time, they get a bonus — usually 50% of the time saved multiplied by the hourly rate.
Formula: Total Earnings = (Time taken × Rate) + 50% of (Time saved × Rate)
Example: Standard Time = 10 hours, Actual Time = 8 hours, Rate = ₹100/hour
Earnings = (8×100) + 50% of (2×100) = ₹800 + ₹100 = ₹900
Benefits:
- Encourages higher efficiency.
- Worker earns more if productive.
- Easy to understand and apply.
Drawbacks:
- Partial benefit of efficiency goes to the worker.
- May compromise quality for speed.
(c) Store-Ledger Accounting
Store Ledger Accounting is a system used to record and monitor the movement of materials (receipts, issues, and balances) in a store or warehouse. It helps in keeping a proper check on inventory and is maintained by the storekeeper or inventory controller.
A Store Ledger is maintained for each type of material or item. It includes:
- Date of transaction
- Quantity and rate of materials received
- Quantity and rate of materials issued
- Balance in hand (both quantity and value)
Objectives:
- To maintain accurate stock records.
- To assist in inventory control.
- To help in valuing materials under various pricing methods like FIFO, LIFO, and Weighted Average.
Valuation Methods Used:
- FIFO (First-In, First-Out): Oldest stock issued first.
- LIFO (Last-In, First-Out): Latest stock issued first.
- Weighted Average: Average of all available stock values.
Benefits:
- Helps prevent theft, loss, and wastage.
- Provides real-time information on stock levels.
- Facilitates budgeting and purchase decisions.
Limitations:
- Needs to be updated regularly.
- Prone to human error if maintained manually
(d) Material Requisition Note (MRN)
A Material Requisition Note (MRN) is a document used by departments (usually production) to formally request the issue of materials from the store department. It acts as an authorization slip and ensures control over the movement of raw materials.
Contents of an MRN:
- Requisition Number and Date
- Department requesting material
- Description of materials required
- Quantity needed
- Signature of authorized personnel
Purpose:
- Acts as a record of material drawn from stores.
- Helps in tracking usage of materials.
- Avoids unauthorized material usage.
Process:
- The production department fills the MRN.
- It is verified and signed by a supervisor.
- The store department issues materials as per the note.
- One copy goes to accounts/costing for cost recording.
Benefits:
- Ensures accountability and internal control.
- Prevents wastage and misuse.
- Aids in maintaining updated store records.
Limitations:
- Delay in approval may slow production.
- Errors in MRN (like wrong quantity) can disrupt operations.
(a) Purchase Order (PO)
A Purchase Order (PO) is a formal, written document issued by a buyer to a supplier, indicating the intent to purchase specific goods or services under stated terms. It includes details like item description, quantity, price, payment terms, delivery date, and shipping address. It serves as a legal offer to buy.
Once the supplier accepts the PO, it becomes a legally binding contract between the buyer and the seller. This process ensures clarity in transactions, prevents misunderstandings, and establishes accountability on both sides.
In cost accounting and inventory control, purchase orders are very useful. They help organizations maintain records of procurement, track inventory movement, and control costs effectively. Purchase Orders also serve as proof of authorization, ensuring that purchases are made only with proper approval, thereby preventing fraud or unauthorized spending.
A copy of the PO is usually sent to the accounting department to match it with the invoice and delivery receipt for payment processing. Thus, it plays a critical role in the internal control system of any organization.
In large organizations or manufacturing units, where material is procured in bulk, the use of a purchase order system becomes essential for maintaining proper documentation and audit trails.
(b) FIFO Method
The FIFO (First-In, First-Out) method is a popular inventory valuation technique where it is assumed that the oldest stock or materials purchased first are the ones used or sold first. This method closely resembles the actual flow of goods in many businesses, especially those dealing with perishable items like food, chemicals, or medicine.
Under FIFO, when materials are issued, the cost of the oldest available inventory is charged to production. The closing stock is therefore valued at the most recent prices. This helps in accurate reflection of current asset values in the balance sheet.
In a period of rising prices, FIFO results in lower cost of goods sold and higher profits, because cheaper inventory is issued first. However, this also leads to higher tax liability due to increased profit. On the other hand, it reflects a better balance sheet position as ending inventory is shown at recent (higher) prices.
FIFO is easy to understand and widely accepted under accounting standards. It also simplifies inventory rotation and reduces the risk of spoilage or obsolescence, particularly in industries where goods have a shelf life.
However, during periods of inflation, FIFO may not reflect true cost of production, and cost comparisons may be distorted over time.
(c) Overtime
Overtime refers to the time worked beyond the normal working hours as fixed by law or organization policy. Usually, a standard workday is 8 hours, and any work beyond this is considered overtime. Employees working overtime are generally paid at a premium rate – often 1.5x or 2x the regular hourly rate.
In cost accounting, overtime is treated as an indirect cost unless it is directly attributable to a specific job or urgent production order. It increases labor costs and affects budgeting, so it must be carefully controlled.
While overtime helps meet production deadlines, fulfill urgent orders, or manage peak workloads, excessive or poorly managed overtime can lead to reduced worker efficiency, fatigue, and increased errors.
There are two types of overtime:
- Regular Overtime – when consistently planned due to demand.
- Emergency Overtime – due to breakdowns, urgent orders, or absenteeism.
Proper authorization and planning are crucial before assigning overtime. Cost accountants analyze overtime reports to identify if it’s due to poor planning or actual necessity. Companies often try to minimize overtime through shift planning or hiring temporary staff.
From a cost perspective, overtime premium (extra wages over normal rate) is either charged to factory overheads or treated as a separate expense for special jobs.
(d) Time Wage System
The Time Wage System is a traditional method of wage payment where workers are paid based on the amount of time they work, irrespective of the quantity or quality of output. It is the simplest and most commonly used wage system, especially in jobs where output is difficult to measure.
Under this system, wages are calculated by multiplying the time worked (hours, days, or weeks) by the fixed hourly or daily wage rate. For example, if a worker earns ₹100 per hour and works 8 hours, the total wage is ₹800.
This system ensures income security and is suitable for jobs requiring precision, creativity, or mental effort – such as supervisors, clerks, quality inspectors, or skilled craftsmen.
Advantages:
- Simple to calculate and administer.
- Ensures stable income for workers.
- Encourages better quality of work.
- Useful where quality is more important than quantity.
Disadvantages:
- No direct incentive to increase productivity.
- Possibility of time wastage or inefficiency.
- Requires strict supervision.
(e) Prime Cost Method
Prime Cost Method is a technique used in cost accounting to calculate the basic or direct cost involved in manufacturing a product. It includes all those costs that are directly attributable to the production process. These costs are:
1. Direct Materials – Raw materials used directly in the production.
2. Direct Labour – Wages paid to workers directly involved in production.
3. Direct Expenses – Any other direct cost like royalty, special tools, etc.
Formula: Prime Cost = Direct Materials + Direct Labour + Direct Expenses
The prime cost is also referred to as “Flat Cost” or “First Level Cost” because it excludes overheads like factory rent, administrative salaries, electricity, etc.
This method is useful for:
- Cost estimation for pricing decisions.
- Budgeting and controlling direct production costs.
- Comparing cost efficiency of different products or departments.
Prime cost is particularly important in industries like textiles, furniture, and food processing, where the direct cost forms a major portion of total cost.
However, since it doesn’t include overheads, it gives an incomplete picture of the total cost and profitability. For comprehensive costing, factory overheads and other indirect costs must also be added to arrive at the total or full cost.
Still, prime cost remains a vital starting point in any cost analysis or cost sheet preparation.
(f) Depreciation
Depreciation is the gradual reduction in the value of a fixed asset over its useful life due to wear and tear, obsolescence, or passage of time. It is a non-cash expense, but is important in cost accounting as it allocates the cost of an asset over its service period.
For example, a machine bought for ₹5,00,000 with a life of 10 years may depreciate at ₹50,000 per year.
Depreciation is charged to production cost to accurately determine the true cost of manufacturing, and to ensure that the asset’s cost is spread across the units it helps produce.
Common methods of calculating depreciation:
- Straight Line Method (SLM): Equal depreciation each year.
- Written Down Value (WDV): Depreciation on the reduced value every year.
- Machine Hour Method: Based on usage hours.
- Units of Production Method: Based on output generated.
Importance in cost accounting:
- Helps in pricing decisions.
- Maintains real book value of assets.
- Assists in equipment replacement planning.
- Ensures accurate profit reporting.
1. Difference between Cost Accounting and Financial Accounting
Cost Accounting and Financial Accounting are two major branches of accounting that serve different purposes within an organization. Financial accounting is mainly concerned with preparing financial statements such as the income statement, balance sheet, and cash flow statement to show the overall financial health of the company. It is mainly for external stakeholders like investors, government agencies, and creditors.
In contrast, cost accounting focuses on recording, analyzing, and controlling costs associated with production or services. It helps management in budgeting, cost control, and decision-making. One major difference is that financial accounting is historical, while cost accounting is both historical and future-oriented. Financial accounting follows specific standards like GAAP or IFRS, while cost accounting is more flexible and used for internal management needs.
Financial accounting emphasizes a company as a whole, while cost accounting analyzes individual units, processes, and departments. Financial accounting is mandatory for regulatory purposes, whereas cost accounting is optional but crucial for internal efficiency. Also, financial accounting is periodic, typically quarterly or yearly, whereas cost accounting provides continuous and real-time data for better managerial control.
2. Classification of Costs According to Their Nature and Characteristics
Cost classification is essential in cost accounting for planning, controlling, and decision-making. Costs can be classified in the following ways:
1. By Nature or Element:
- Material Cost: The cost of raw materials used in production.
- Labour Cost: Wages paid to workers.
- Expenses: Other costs such as rent, power, and depreciation.
2. By Function:
- Production Costs: Costs incurred in manufacturing.
- Administration Costs: Costs for managing the organization.
- Selling and Distribution Costs: Costs for promoting and delivering products.
3. By Behavior:
- Fixed Costs: Do not change with output (e.g., rent).
- Variable Costs: Change directly with output (e.g., raw materials).
- Semi-variable Costs: Partly fixed, partly variable (e.g., electricity).
4. By Traceability:
- Direct Costs: Can be traced directly to a product (e.g., raw material).
- Indirect Costs: Cannot be traced directly (e.g., factory rent).
5. By Decision-Making Needs:
- Relevant Costs: Costs that influence decision-making.
- Sunk Costs: Already incurred and irrelevant to future decisions.
- Opportunity Costs: Income foregone from the next best alternative.
Understanding these classifications helps in analyzing and managing costs effectively, especially in cost control, budgeting, and profitability analysis.
(a) LIFO Method (Last-In, First-Out)
LIFO stands for “Last-In, First-Out”, which is an inventory valuation and material issue method in cost accounting. Under this method, it is assumed that the latest (most recent) items purchased or produced are issued or consumed first, and the older inventory remains in stock. This method is most suitable in times of inflation, as it charges the recent higher costs to production and leaves older lower costs in stock.
For example, if a company purchases 100 units at ₹50 and then 100 more units at ₹60, under LIFO, the next issue of 100 units will be valued at ₹60. One of the main advantages of LIFO is that it matches current costs with current revenues, thereby providing a more accurate reflection of profitability in inflationary conditions. However, it may not reflect the true value of closing stock and is not accepted under some accounting standards like IFRS. LIFO is beneficial for tax purposes in some cases, as it reduces reported profit and, hence, tax liability. But it can create inventory layers and make tracking more complex.
(b) Idle Time
Idle time refers to the time during which employees or machines are available for work but are not engaged in productive activities. It is the unproductive time that arises due to reasons such as power failure, machine breakdown, lack of materials, or waiting for instructions. Idle time results in extra labor cost without corresponding output and is treated as an expense in cost accounting.
Idle time is classified into two types – normal and abnormal. Normal idle time is inevitable and occurs due to routine reasons like tea breaks, maintenance, or setting up machines. This cost is usually treated as part of factory overheads. On the other hand, abnormal idle time arises due to unusual circumstances such as machine failure, strikes, or lack of planning. Such costs are usually charged directly to the costing Profit & Loss account.
Controlling idle time is essential for improving productivity and reducing unnecessary costs. Proper planning, preventive maintenance, and efficient scheduling of operations help minimize idle time in the organization.
(c) Halsey Premium Plan
The Halsey Premium Plan is a wage incentive system that encourages workers to improve their efficiency by offering them a share in the time saved. It was introduced by F.A. Halsey. Under this system, a standard time is fixed for each job. If the worker completes the job in less time, they are paid wages for the actual time worked, plus a bonus which is a fixed percentage (usually 50%) of the time saved.
Formula:
Total Earnings = Time Taken × Hourly Rate + 50% of Time Saved × Hourly Rate
For example, if the standard time is 10 hours, and the worker completes the job in 8 hours at ₹100/hour, the bonus will be 50% of 2 hours = 1 hour × ₹100 = ₹100. So, total earnings = ₹800 + ₹100 = ₹900.