ASSIGNMENT FOR INTRODUCTION TO COST ACCOUNTING

 Cost classification is the logical process of categorizing the different costs involved in a
business process according to their type, nature, purpose and other features to fulfil accounting
objectives and facilitate economic analysis. Cost refers to the value sacrificed with the aim of
gaining something in return. Every business process involves some cost. It is the basis of profit
determination for an organization.
Basis of Classification
 Cost Classification by Nature
 Cost Classification by Relation to Cost Centre
 Cost Classification by Functions
 Cost Classification by Behaviour
 Cost Classification by Management Decision Making
 Cost Classification by Production Process
 Cost Classification by Time
Cost Classification by Nature
The cost can be differentiated by its nature or the purpose for which it has occurred.
It can be treated as an expense under this category and the expenses so incurred is divided as
follows:

Material: Material cost is the cost of the raw material and its related cost such as procurement
cost, taxes, insurance and freight inwards.
Labour: Labour cost is the salary and wages paid to the employees, permanent, temporary or
contractual employees working in an organization. It also includes PF contribution, bonus,
commission, incentives, allowances, overtime pay, etc.
Other Expenses: All the other overheads excluding material and labour comes under this head.
Some of these are packaging, promotion and job processing charges.
Cost Classification by Relation to Cost Centre
Another basis of differentiating the costs is categorising them by their allocation in the
production process of goods or services.
The points as mentioned earlier under the cost classification by nature are used under this
category to further sub-categorise the elements of this category. To get a better understanding of
it, let us read below:

Direct Cost: Direct cost is the significant cost immediately associated with a production process.
It can be seen as a prime cost for any business. It is sub-divided into direct material cost, direct
labour cost and other direct expenses.
Indirect Cost: Indirect cost is the cost which cannot be directly allocated to a particular process
of production. It is a secondary cost and is majorly seen as of three types – indirect material cost,
indirect labour cost and other indirect expenses.
Cost Classification by Functions
The cost can also be classified by the business functions for which the resources have been used.
There are five significant functions of a business which involves some expense and are essential
to the organisation in their way. The cost involved in such business operations are explained
below:

Production: Production cost comprises of all the direct and indirect costs incurred in the
production of goods and services.
Administration: The costs involved in the management activities of an organization like
electricity, stationery, telephone expenses and rent. These are also known as administrative
overheads.
Selling: The indirect costs incurred on the sales function of the goods and services like an
advertisement, promotion, research, customer service, etc. are clubbed under selling cost.
Distribution: Distribution cost refers to the cost incurred for making the goods or services
available to the customers. These are warehousing, delivery service and transportation.
Research and Development: Research is essential to develop a new product or modify an
existing one. The cost incurred on the research team, research implementation and findings
comes under this category.
Cost Classification by Behaviour
The cost involved in any business process can be differentiated on the grounds of its volatility
concerning the fluctuation in business activities in the short run
The following classification of cost by its behaviour will give a clear illustration of the above
statement.
Fixed Cost: The cost which is hardly affected by the temporary change taking place in business
activity is known as a fixed cost. It includes rent, depreciation, lease and salary.
Variable Cost: The cost which changes proportionately with the change in production quantity
or other business activity is termed under variable cost. Raw material, packaging, sales
commissions and wages are variable costs.
Semi-Variable Cost: The cost which is moderately influenced by the change in business activity
is called semi-variable cost. It includes power consumption, maintenance cost, management cost
and supervision cost.
Cost Classification by Management Decision Making
Cost is not just a price paid to generate some value, but it is also used as a tool by the
management for decision making.
Managerial decisions are framed depending upon the following types of cost involved in
carrying out of business.
Marginal Cost: Marginal cost is the cost of producing an additional unit and its impact on the
total cost of production.
Differential Cost: When there is an increment or decrement in the cost of bulk production, the
change in the cost of a single unit is also determined which is known as differential cost.
Opportunity Cost: The value of one or more products given up to acquire the desired product or
service is known as opportunity cost. For instance; while choosing green tea, a person has to give
up the value he must have derived from coffee or regular tea.
Replacement Cost: When machinery or any other asset becomes obsolete or involve high
maintenance cost, and simultaneously a better asset is available in the market which can replace
it, then the cost involved in such substitution is known as replacement cost. For example; a
transportation company needs to replace its trucks from time to time to avoid excessive repairing
expenses.
Sunk Cost:The cost which has been born by the organization in the past and cannot be recovered
at any stage of the business process is termed as a sunk cost. Freight inwards paid at the time of
buying machinery has to be written off at the time of selling it.
Normal Cost: The routine cost associated with the manufacturing of goods or services under
usual circumstances is called a normal cost. It includes all direct expenses such as salary,
material, rent, etc.
Abnormal Cost: The cost that arises suddenly and unknowingly under unfavourable situations is
known as abnormal cost. For instance; workers go on strike, theft or robbery, fire in the
premises, etc.
Avoidable Cost: Such costs are under the control of management and can be prevented as per
the organizational need. For example; an enterprise upgrades its technology by installing self-
operative machines to avoid the labor charges it pays.
Unavoidable Cost: The cost which is pre-determined and inevitable is called an unavoidable cost.
Cost Classification by Production Process
This basis of cost classification is significantly applicable in the manufacturing industries or
factories where goods are produced.
All production or manufacturing activities involve different types of costs. According to the
nature of the production process, these costs can be classified as below.
Batch Cost: The cost incurred while producing a whole lot comprising of identical products
(batch) is known as batch cost. Each batch differs from the other, and the units lying under a
batch are identified by their batch number. Pharmaceuticals, automobiles, electronic products are
some of the examples.
Process Cost: The cost incurred on performing different operations in a streamlined production
process is termed as a process cost. By dividing the total cost of a process with the number of
units produced, we can derive the process cost of a single unit or product.
Operation Cost: The cost involved in a particular business function contributing to the
production process is known as operation cost. It helps in regulating the mechanism of business
activities by monitoring the cost incurred on each business operation.
Operating Cost: Operating cost refers to the day to day expenses incurred by an organization to
ensure uninterrupted functioning of the business is known as an operating cost.
Contract Cost: The cost of entering into a contract with a buyer or seller by mutually agreeing
to the terms and conditions so mentioned is called a contract cost. It includes a bidding contract,
price escalation contract and tenders.
Joint Cost: The combined cost involved in the production of two or more useful products
simultaneously is known as the joint cost. For example; the cost of processing milk to get cottage
cheese and buttermilk.
Cost Classification by Time
The nature, importance and liability of a cost vary as per the time it takes place or has been
assessed.
A cost which is a priority today, may not be that important tomorrow or a cost which has been
overlooked today, may be considered as a relevant cost tomorrow.
Thus, depending upon the period a cost has occurred or assessed, it can be categorised under the
following heads.
Historical Cost: Any actual cost ascertained and evaluated after it has been incurred, is termed a
historical cost. It can be committed either on the production of goods and services or asset acquisition.
Pre-determined Cost: The cost which can be identified and calculated before the production of goods
and services based on the cost factors and data is called a pre-determined cost. It can be either a
standard cost or an estimated cost.
Standard Cost: An actual cost which is pre-determined as per certain norms and guidelines to provide as
a base for cost control, is termed as a standard cost.
Estimated Cost: The cost of business operation presumed on the grounds of experience is known as an
estimated cost. It is merely based on assumptions and therefore considered to be less accurate to
determine the actual cost.

Question Number 2
Using High/Low Method of cost estimation.We have to calculate Variable Cost and Fixed Cost per unit.
Volum
Cost     e      
Diffe
High Low Diffe High
Low r  
220
24800 19800 5000 3200 0 1000  
             
             
    5000     1000 5
             
Variable cost per per KG is 5:00MWk            
Fixed cost =Total cost -(volume x variable
cost per unit)            
  24800-          
(3200x5)=8800.0
 0
             
Cost Function y=a+bx            
  y=Total Cost          
  a=Fixed cost          
b=Variable cost
  per unit          
  x=Volume          
Cost Function y =8800+5X            
             
             
Total Cost for 2500Kgs =fixed cost
+Variable cost per unit xVolume.            
2130
Cost for 2500 =   0 Mwk      
             

Answer to question number 3

Inventory Valuation
There are four accepted methods of costing inventory items:
Next In First Out(NIFO)
first-in, first-out (FIFO);
last-in, first-out (LIFO); and
weighted-average.
Each method has advantages and disadvantages. Note that a manufacturing business’s inventory
will consist of work in process, or unfinished goods, and finished inventory; the costs of
unfinished and finished inventory contain a combination of costs related to raw materials, labor,
and overhead. On the other hand, a retailer’s inventory consists of all finished products
purchased from a wholesaler or manufacturers, the costs of their units are based on their
acquisition cost rather than the costs associated with manufacturing units.
NIFO – Next in, First out is an inventory valuation technique in which issues to the production
hall are valued at the current market price that is current cost or replacement cost instead of the
cost at which material was bought that is historical cost.
This valuation method attempts to keep the production cost accurate according to the prices
prevailing in the accounting period in which material was consumed and not on the basis of the
prices prevailing in the period when material was bought. This way the measurement of
production cost for internal use and cost of goods sold for external use is more accurate and the
users of information has the figures according to latest market position and can make better
decisions.
However, International Accounting Standards (IASs) and Generally Accepted Accounting
Principles (GAAPs) does not allow the use of current cost i.e. replacement cost and for majority
of the asset historical cost concept i.e. cost at which asset was bought is required to be used.
Therefore, use of Next in, First out is in contradiction to the principles of two of the major
Accounting Frameworks.
In addition to the that, under International Accounting Standard (IAS) 2 – Inventories, entities
are allowed to use either FIFO – First in, First out method or AVCO – Average value of cost
method for cost assignment purposes. Therefore, use of NIFO is ruled out altogether.
FIFO (first-in, first-out)
The FIFO (first-in, first-out) method of inventory costing assumes that the costs of the first goods
purchased are those charged to cost of goods sold when the company actually sells goods. This
method assumes the first goods purchased are the first goods sold. In some companies, the first
units in (bought) must be the first units out (sold) to avoid large losses from spoilage. Such items
as fresh dairy products, fruits, and vegetables should be sold on a FIFO basis. In these cases, an
assumed first-in, first-out flow corresponds with the actual physical flow of goods.
LIFO (last-in, first-out)
The LIFO (last-in, first-out) method of inventory costing assumes that the costs of the most
recent purchases are the first costs charged to cost of goods sold when the company actually sells
the goods.
Weighted-average
The weighted-average method of inventory costing is a means of costing ending inventory using
a weighted-average unit cost. Companies most often use the weighted-average method to
determine a cost for units that are basically the same, such as identical games in a toy store or
identical electrical tools in a hardware store. Since the units are alike, firms can assign the same
unit cost to them.
Refferences
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