Cost Accounting is a method of recording, analysing, and controlling costs so that management can make decisions regarding production, pricing, budgeting, and efficiency.
📌 Meaning
Cost Accounting is the process of identifying, recording, classifying and controlling costs involved in manufacturing goods or providing services.
📌 Features
- Deals with costs only (not complete financial accounts)
- Helps in control of expenses
- Helps in fixing price
- Focuses on internal management
- Cost is collected by cost centres & cost units
📌 Objectives of Cost Accounting
| Objective | Simple Meaning |
|---|---|
| Cost ascertainment | Find cost per product/service |
| Cost control | Reduce wastage & expenses |
| Cost reduction | Increase efficiency |
| Price fixation | Help set selling price |
| Decision making | Make or buy, product mix decisions |
| Profit planning | Helps prepare costing & budgets |
📌 Importance / Advantages
- Helps find actual cost
- Detects wastage & leakage
- Helps maintain optimal cost
- Improves profitability
- Used for tendering/quotation
- Helps in inventory valuation
COST SHEET
A cost sheet is a statement showing detailed cost of production per unit and total, for a period.
Elements of Cost
| Cost Element | Examples |
|---|---|
| Direct Material | Raw material used |
| Direct Labour | Wages to workers directly engaged |
| Direct Expenses | Royalty based on production |
| Prime Cost | DM + DL + DE |
| Factory OH | Indirect material, supervisor salary |
| Factory / Works Cost | Prime Cost + FOH |
| Office OH | Admin salary, office rent |
| Cost of Production | Works Cost + Office OH |
| Selling OH | Advertisement, packing |
| Cost of Sales | Cost of production + Selling OH |
Cost Sheet Format
Direct Material
+ Direct Labour
+ Direct Expenses
= PRIME COST
+ Factory OH
= WORKS COST
+ Office OH
= COST OF PRODUCTION
+ Selling & Distribution OH
= COST OF SALES
+ PROFIT
= SELLING PRICE
✔ EXAMPLE – Cost Sheet
A company produces 1,000 units.
| Particulars | Amount (₹) |
|---|---|
| Raw Material | 50,000 |
| Direct Wages | 25,000 |
| Direct Expenses | 5,000 |
| Factory OH | 20,000 |
| Office OH | 10,000 |
| Selling OH | 6,000 |
| Profit | 14,000 |
SOLUTION:
| Cost Items | Amount |
|---|---|
| Direct Material | 50,000 |
| Direct Labour | 25,000 |
| Direct Expenses | 5,000 |
| Prime Cost | 80,000 |
| + Factory OH | 20,000 |
| Works Cost | 1,00,000 |
| + Office OH | 10,000 |
| Cost of Production | 1,10,000 |
| + Selling OH | 6,000 |
| Cost of Sales | 1,16,000 |
| + Profit | 14,000 |
| Selling Price | 1,30,000 |
Cost per unit = 1,30,000 / 1,000 units = ₹130/unit
Cost Centre & Cost Unit
📌 Cost Centre
A location, department, or person where costs are collected.
Examples:
- Workshop, Machine section
- Department A/B
- Supervisor, Machine No.2
📌 Cost Unit
A unit of product/service for which cost is measured.
Examples:
- 1 kg of sugar
- 1 litre of milk
- 1 passenger-km in bus service
Difference (Easy):
| Cost Centre | Cost Unit |
|---|---|
| Where cost is incurred | What cost is calculated per unit |
| Eg. Department | Eg. 1 product |
Classification of Costs
- By Nature – Material, Labour, Expenses
- By Function – Production, Office, Selling
- By Behaviour – Fixed, Variable, Semi-variable
- By Traceability – Direct & Indirect cost
- By Time – Historical cost & Standard cost
- By Decision Making – Relevant & Irrelevant cost
Relevant & Irrelevant Cost
| Type | Meaning | Example |
|---|---|---|
| Relevant | Affects decision | Cost of material for new order |
| Irrelevant | Does not affect | Past cost, depreciation already charged |
Differential Cost
Extra cost between two alternatives.
Example:
Make cost = ₹10 each
Buy cost = ₹12 each
Difference = ₹2 → differential cost.
Sunk Cost
Cost already incurred & cannot be recovered.
Example: Machine purchased last year = sunk cost.
Opportunity Cost
Benefit lost when one alternative is chosen.
Example:
Use factory for product A → Miss profit from product B.
✔ Summary of Unit 3 (Part-1)
| Topic | Must Write in Exam |
|---|---|
| Cost Accounting | Meaning + Objectives + Importance |
| Cost Sheet | Format + Example (easy marks) |
| Cost Classification | Fixed/Variable + Relevant/Irrelevant etc. |
| Cost Centre/Cost Unit | 2 marks favourite |
| Opportunity vs Sunk cost | Write example |
🔷 1. Meaning of Marginal Costing
Marginal costing is a technique where only variable costs are considered for deciding cost and price, while fixed costs are kept separate and treated as period cost.
Marginal Cost = Variable Cost only
Fixed cost is constant & does not change with production.
Example:
Variable cost per unit = ₹50
Fixed cost per month = ₹20,000
If company produces:
| Output | Total Variable Cost | Total Cost |
|---|---|---|
| 1,000 units | 1,000×50 = 50,000 | 50,000 + 20,000 = 70,000 |
| 2,000 units | 2,000×50 = 1,00,000 | 1,00,000 + 20,000 = 1,20,000 |
Fixed cost remains same, variable cost changes with units.
🔷 2. Key Concepts in Marginal Costing
🔹 Contribution
Contribution is the extra amount available to cover fixed cost & profit.
Contribution = Selling Price − Variable Cost
If SP = ₹100 and VC = ₹60
Contribution = 100 − 60 = ₹40 per unit
If FC = 20,000
Units needed to cover FC = 20,000 / 40 = 500 units (BEP)
🔹 Profit Formula
Profit = Contribution − Fixed Cost
or when units are involved,
Profit = (Contribution per unit × Units) − Fixed Cost
🔷 3. Basic Principles of Marginal Costing
| Principle | Meaning (Easy) |
|---|---|
| Variable cost changes with output | More units → more VC |
| Fixed cost remains constant | Even if production changes |
| Contribution is key | Contribution > Fixed cost → profit |
| Selling price should cover VC + FC + profit | If not → loss |
| Decision making based on contribution | Higher contribution alternative is better |
🔷 4. Advantages & Limitations
✔ Advantages
- Easy for decision making
- Helps in fixing selling price
- Best for make or buy decisions
- Helps calculate BEP & MOS
- Useful for profit planning
- Good for CVP analysis
✖ Limitations
- Ignores fixed cost in product cost
- Not suitable for long-term decisions alone
- Unrealistic to classify cost only as fixed or variable
- Not useful where inventory valuation is needed
📌 P/V Ratio (Profit/Volume Ratio)
Shows relationship between profit and sales.
Higher P/V ratio = better profitability.
P/V Ratio = Contribution / Sales × 100
Example:
Sales = 2,00,000
Variable cost = 1,20,000
Contribution = 2,00,000 − 1,20,000 = 80,000
P/V ratio = 80,000/2,00,000 ×100 = 40%
📌 Break-Even Point (BEP)
Point where no profit, no loss.
Contribution = Fixed cost.
Formulas
- BEP (Units) = Fixed Cost / Contribution per Unit
- BEP (₹ Value) = Fixed Cost / P/V Ratio
Example:
Selling price = ₹200
Variable cost = ₹120
Contribution = 80
Fixed cost = ₹40,000
BEP units = 40,000 / 80 = 500 units
P/V = 80/200×100 = 40%
BEP (value) = 40,000/0.40 = ₹1,00,000
📌 Margin of Safety (MOS)
Sales above BEP = Profit area.
MOS = Actual Sales − BEP Sales
Example:
Actual sales = ₹1,80,000
BEP Sales = ₹1,00,000
MOS = 80,000
Higher MOS = safer business
📌 CVP (Cost Volume Profit) Analysis
Shows relationship between cost, volume & profit to plan output levels.
Used to determine:
- How much to sell to earn target profit
- Impact of change in price, cost, volume
- Choice of best product mix
⭐ Numerical Example (Full)
A product has:
Selling price = ₹150
Variable cost = ₹90
Fixed cost = ₹60,000
Actual units sold = 2,000 units
1. Contribution per unit
= 150 − 90 = ₹60
2. P/V Ratio
= Contribution/SP ×100 = 60/150×100 = 40%
3. BEP Units
= FC / Contribution
= 60,000 / 60 = 1,000 units
4. BEP ₹ Value
= FC / P/V Ratio = 60,000/0.40 = ₹1,50,000
5. MOS
= Actual units − BEP units = 2,000 − 1,000 = 1,000 units
OR
Actual sales − BEP sales = ₹3,00,000 − ₹1,50,000 = ₹1,50,000
6. Profit
= Contribution − FC
= (2,000×60) − 60,000 = 1,20,000 − 60,000 = ₹60,000
📌 Decision Areas under Marginal Costing
| Decision | How to Decide | Basis |
|---|---|---|
| Fix selling price | Price ≥ VC & cover FC | Contribution |
| Accept special order? | If price ≥ VC | Extra profit |
| Make or Buy | Choose higher Contribution | Cost comparison |
| Shutdown decision | Continue if contribution > avoidable cost | Short-term loss minimization |
| Product mix | Choose product giving more Contribution per limiting factor | Contribution ranking |
EXAM STRATEGY FOR UNIT – 3
| Theory Questions | How to Write |
|---|---|
| Cost Accounting | Meaning + Objectives + Advantages |
| Cost Sheet | Format + 1 example compulsory |
| Marginal Costing | Meaning + Features + Advantages |
| Contribution + P/V Ratio | Write formula + example |
| BEP/MOS/CVP | Write formula + one diagram optional |
Numerical will be based on:
- Cost Sheet preparation
- Marginal Costing (BEP, P/V ratio, MOS)