UNIT 1

CLASSIFICATION OF COSTS & COST SHEET

1.1 Introduction

A manufacturing organisation converts raw materials into finished products. For the purpose, it employs labour and provides other facilities. While compiling production cost, amounts spent on all these facilities are required to be ascertained. Thus, cost ascertainment involves:

(a) Collection and classification of costs according to cost elements

(b) Its allocation or apportionment to cost centers or units

(c) Choice of an appropriate method of costing and

(d) Selection of an appropriate costing technique.

Costs are primarily classified into various elements for accounting and control

1.2 Concept of Cost

Cost represents a sacrifice, a foregoing or a release of something of value. It is reckoned in money and usually appears as payment of money. It is money outlay for productive factors.

Costs are expenditure incurred in doing something.  Costing is the process of determining the cost of doing something i.e. cost of manufacturing an article, rendering service or performing a function.

Cost is composed of three elements- material, labour and expenses or overheads. Each of these costs can be further classified as (a) Direct and (b) Indirect.

Direct costs are costs which can be easily identified with a particular Product, Process or Department. Indirect costs refer to costs which cannot be conveniently identified with a particular product. Process or Department. Indirect costs are common costs like rent, repairs salaries, which are incurred for the benefit of a number of cost units or cost centres.

1.3 Cost Classification

Cost items are analysed or grouped according to their common characteristics which is some independent factor.  There are many objectives of cost classifications depending on the requirements of management. The different cost classifications are as follows:-

Cost Classification by Elements:

The constituent elements of costs are broadly classified into three distinct elements i.e. materials, labour and expenses. These three elements of cost can be further grouped into direct and indirect categories. Direct materials refer to the cost of materials which are conveniently and economically traceable to specific units of output. For example: Raw cotton in textiles, crude oil in making diesel. The indirect materials refer to materials that are needed for the completion of the product but whose consumption with regard  to the product is either so small or so complex that it would not be appropriate to treat it as a direct material. For example: stationery lubricants, cotton waste etc.

Cost Classification by Function:

A business organisation has to perform several functions such as Manufacturing, Administration, Selling and Distributing and Research and Development. Functional classification of cost implies that the business performs many functions for which costs are incurred. Expenses or Costs are usually classified by function and grouped under the headings of Manufacturing, Selling and Administrative costs in measuring net income.

Manufacturing costs are all check costs incurred to manufacture the products and to bring them to a saleable condition. This includes direct material, direct labour and indirect manufacturing costs or overheads. Administration costs are incurred for formulation of policy, directing the organisation and controlling the activities excluding the cost of research, development, production, selling and distribution. These costs include salary of executives, office, staff, office rent, stationery, postage etc. Selling costs include the cost of creating and stimulating demand and getting customers. For example: advertisement, salary and commission to salesmen, packing. Distribution costs include the cost of warehouse, freight, cartage etc.

Research and Development costs are incurred in the process of finding out new ideas, new processes by experiments or other means of putting the results of such experiments on a commercial basis. Functional classification of cost is important because it provides an opportunity to the management to evaluate the efficiency of departments performing different functions in an organisation.

Cost Classification by variability:

Cost can be classified as (i) fixed (ii) variable and (iii) semi - fixed or semi variable in terms of their variability or changes in cost behaviour in relation to changes in output or activity or volume of production. Activity may be indicated in any form such as units of output, hours worked, sales, etc. The separation of costs into variable and fixed categories is the most difficult part of the costing operation. Certain costs are easily identifiable as variable or fixed while other costs can be segregated only after careful consideration of their nature and an examination of their behaviour.

Fixed costs:

Fixed cost is a cost which does not change in total for a given time period despite wide fluctuations in output or volume of activity.  These costs must be met by the organisation irrespective of the volume level. These costs are also known as capacity costs, period costs or stand - by costs; for example, rent, property taxes, supervisor’s salary, advertising, insurance etc.

Variable costs:

Variable costs are those costs which vary directly and proportionately with the output. There is a constant ratio between the change in the cost and the change in the level of output. Direct materials and labour are the examples of variable costs. Thus, all these costs which tend to vary directly with variations in volume of output are variable costs. However, it must be remembered that variable costs remain the same or approximately the same in amount per unit of production regardless of increase or decrease in volume.

Semi variable or semi fixed costs:

There is another group of costs in between the fixed and variable costs. It is semi variable or semi fixed costs. These costs vary in some degree with volume but not in direct proportion. Such costs are fixed only in relation to specified constant conditions.  Semi fixed costs are those costs which remain constant up to a certain level of output after which they become variable. For example: maintenance of building, depreciation of plant, supervisor’s salary, telephone expenses etc.

1.4 Cost Sheet

Cost sheet is a statement prepared to present the detailed costs of total output during a period. It provides information relating to cost per unit at different stages of total cost of production. The preparation of cost sheet is one of the important and primary function of cost accounting. Cost sheet is not an account. There is a prescribed form for preparation of cost sheet. A cost sheet is a statement of cost prepared for a given period of time in such a manner that it indicates various elements of cost as clearly as possible. A cost sheet is useful in ascertaining the total cost of production per unit, formulation of production plan, fixing up the selling price and minimizes the production cost. Sometimes standard cost data are provided to facilitate comparison with the actual cost increased. The preparation of the cost sheet requires understanding of the treatment of the following items:-

Stock of raw materials: The opening and closing stock of raw materials are to be adjusted with purchase of Raw materials in order to determine the value of raw materials consumed for the output produced. Carriage/Freight inward and Octroi on purchase etc. also to be added to purchases. This is a part of Prime Cost.

Stock of Work in Process: The value of stock of work in process is a part of Factory cost and therefore, it should be adjusted with factory overheads. Sale of scrap should be deducted from the factory overheads in order to determine the total factory cost.

Stock of Finished goods: Finished goods cover the products on which factory work has been completed. It is the cost of completed production. The opening and closing values of finished goods are to be adjusted with  the  total cost of production in order to arrive at cost of sales.

Expenses excluded from cost sheet:

There are certain expenses /costs which do not form a part of cost sheet. Some of these expenses are an apportionment of profit. Examples of these expenses are -

1. Dividend to shareholders
2. Income Tax
3. Interest on loan
4. Donations paid
5. Capital expenditure
6. Capital loss on sale of assets.
7. Commission to Partners / Managing Director
8. Discount on issue of shares/ debentures
9. Underwriting commission.
10. Writing of goodwill/ bad debts
11. Provision for Taxation, Bad Debts or any kind of Fund or reserves.

Specimen of Cost Sheet

Cost Sheet for the period

(Production ------ Units)

Elements of Total Cost

Costs are classified under different heads which represent the successive stages through which the cost flow.

Prime Cost

Prime cost is the basic cost of any product. It comprises of those expenses which could be traced directly to it. The prime cost consists of cost of direct materials, direct labour and direct expenses. Direct expenses include special expenses which can be identified with product or job and are charged directly to the product as part of the prime cost. For example cost of hiring special plant or machinery, cost of special moulds, design or patterns, Architect’s fees, Royalties, License fees etc.

Works cost:

Works cost of a Product consists of prime cost plus the portion of works or factory expenses chargeable against the Production. Works or factory expenses include indirect materials indirect labour and indirect expenses. Indirect materials refer to those materials that are needed for the completion of the product but the consumption of these materials is either so small or complex that it would not be appropriate to treat it as direct materials. These are supplies that cannot be conveniently and economically charged to a specific unit of output. For example, lubricants, cotton waste, works stationery etc.

Indirect labour is that labour which does not affect the construction or the composition of the finished product. This is the labour cost of production related activities that cannot be associated with or conveniently traced to specific product through physical observation. For example, Foremen’s salary and salary of employees engaged in maintenance or service work. Indirect expenses cover all expenditure incurred by the manufacturer from the time of production to its completion as delivery to customer by way of rate of product. Any expense that cannot be allocated but which can be apportioned to or absorbed by the cost centers/ cost units are known as indirect expenses. These expenses are incurred for the benefit of more than one product, job or activity and therefore, must be apportioned by appropriate bases to the various functions or products. For example, lighting and heating, maintenance factory manager’s salary, watch and ward department’s salary etc.

Cost of Production:

Cost of Production consists of works cost plus an additional amount of office and administrative expenses. It includes all expenses connected with the managerial functions such as planning, organizing, directing, coordinating and controlling the operations of the manufacturing business. For example, office rent, salary, lighting, stationery, repairs and maintenance and depreciation of office building, audit fees, legal expenses.

Cost of Sales:

Cost of sales consists of cost of production plus proportionate selling and distribution expenses of the product.  Selling expenses include the expenses incurred for creating demand for the product such as advertisement, salaries of salesmen, selling expenses and show room expenses. Distribution expenses are those expenses incurred in connection with the delivery of goods to the customers such as packing, carriage outwards, and warehouse expenses.

1.5 Solved Examples

Q.1. Bombay Manufacturing Company submits the following information on 31-3-2010.

Solution:

Bombay Manufacturing Company

Statement of cost for the year ended 31-3-2010.

Q.2.  From the following information prepare a statement showing (i) Prime cost (ii) Works cost (iii) Cost of Production (iv) Cost  of  Sales (v) Net profit of X Ltd. Which produced and sold 1000 units in June 2009.

Solution:

Cost Statement for June 2009

Q.3. NRC Ltd. Manufactured and sold 1000 Radio sets during the year 2009. The summarized accounts are given below:

Mfg. / Trading & Profit & Loss A/c

It is estimated that output and sales will be 1200 Radio Sets in the year 2010. Prices of Materials will rise by 20% on the previous year’s level. Wages per unit will rise by 5% Manufacturing expenses will rise in proportion to the combined cost of materials and wages. Selling and distribution expenses per unit will remain unchanged. Other expenses will remain unaffected by the rise in output. Prepare cost sheet showing the price at which the Radio Sets should be sold so as to earn a profit of 20% on the selling price.

Solution:

Cost Sheet

Q.4. A factory can produce 60,000 units per year at its 100% capacity. The estimated cost of production are as under:-

Direct Material- Rs. 3 per unit

Direct Labour- Rs. 2 per unit

Indirect Expenses:

Fixed- Rs. 1,50,000 per year

Variable- Rs. 5 per unit

Semi-variable- Rs.50,000 per year up to 50% capacity and an extra  expenses of Rs.10,000 for every 25% Increase in capacity or part thereof.

The factory produces only against order and not for stock. If the Production programme of the factory is as indicated below and the management desires to ensure a Profit of Rs. 1,00,000 for the year, work out the average selling price at which per unit should be quoted:

First 3 months of the year 50% of capacity remaining  9 months 80% of the capacity. Ignore selling, distribution and administration overheads.

Solution:

Q.5. In a factory two types of T.V sets are manufactured i.e. black & white + color. From the following particulars prepare a statement showing cost and profit per T.V Set sold. There is no opening or closing stock.

Works overhead is charged at 60% of Prime cost and Office overhead is taken at 20% at Works cost. The selling price of B & W is Rs.60,00 and that of color is 10000. During the period 200 B & W and 400 color T.V. Sets were sold.  The selling expenses are Rs. 50 per T.V.Set.

Solution:

Statement of Cost and Profit