Basic Aspects of Cost Accounting

What is a “Cost” ?

The term “cost” can be defined as all expenses that are incurred in relation to a specific item or an activity. It is important to manage cost in order to recover the investment made on a specific activity or a product.

What is a “Cost Unit” ?

The term “Cost Unit” can be defined as a unit of product or service in relation to which costs are ascertained. As an example cost unit for a mobile telecommunication provider would be call minutes. The total cost has to apportioned/allocated based on the cost unit to arrive at the final price of a product.

What is a “Cost Center” ?

Cost center is a location, item or an activity where costs are accumulated. This can be identified as a collecting place for costs. As an example, production floor, warehouse, head office, cafeteria and shop floor can be used to explain the concept of a cost center.

Prime Cost

These are the costs that can be direnclty attributable for a cost object. (a product/service) Prime costs are commonly known as direct costs.

Prime cost for a manufacturing firm can be calculated as follows:

Prime Cost = Cost of raw material + Cost of production labor + Other direct expenses

As an example, prime cost for a casual clothing manufacturer would be:

Prime cost of a clothing manufacturer = cost of fabric + cost of production labor + cost of needles and buttons

Overheads

Overheads can be defined as any cost that can not be directly related to a product or a service. Overheads are commonly known as indirect costs. Overheads have to be allocated to the products to make make the pricing decisions.

There are 02 types of overheads:

• Production Overheads-

Production overheads are indirect costs that occur during the production process which can not be directly attributable to the output of the production process. As an example depreciation of machines, electricity consumed by the factory and rental of the factory floor are production overheads of a manufacturing organization.

• Selling and Distribution Overheads-

These are the indirect cost that occur during the process of selling and distributing goods. Salary of sales staff and transportation charges can be named as examples.

Cost Behavior

Cost behavior refeers to the way in which the costs are affected by the fluctuations in the level of activity.

There are 03 types of cost behaviors can be identified.

• Variable Costs-

Variable cost is the type of cost that varies with the fluctuations in the activity level. As an example the fabric usage at a apperal manufacturing firm would be a variable cost since level of fabric purchasing is directly affected by level of the activity level.

• Fixed Costs-

Fixed are the cost that are not affected the by the fluctuations in the level of activity. As an example the rent cost of a apperal manufacturing company would be a typical example of a fixed cost in short run as rental is not affected by the level of activity that is produced.

• Stepped Fixed Costs-

Stepped fixed cost is a cost containing both fixed & variable components & which is thus partly affected by change in the level of activity. As an exapmple the telephone charges are fixed up to certain level of usage and there after additional units consumed are charged at a certain rate. The variable and the fixed components of a stepped fixed cost can be identified using techniques such as scatter diagrams, high low method and least square method of regression analysis.

Tagged Accounting, CIMA