Elements of Costs

 Material: Material may be classified into direct material and indirect material.

 Direct Material: CIMA defines material cost as “the cost of commodities supplied to
an undertaking.” All materials, which becomes an integral part of the finished product
and which can be conveniently allocated to specific physical units is termed as direct
material. Some of the examples are all material components or spare parts specifically
purchased, produced or supplied from stores, primary packing materials, and
purchased or partly produced components. It is also called as process material or
production material.

 Indirect Material: All material, which is used for secondary purposes and cannot be
allocated conveniently to specified physical units, is called as indirect material. A few
examples are consumable stores, oil and waste, printing and stationery material, and
etc. Indirect material may be used at the factory, office or selling and distribution
divisions.

 Labour: Human effort required to convert materials into finished products is termed
as labour. It may be classified into direct labour and indirect labour.

 Direct Labour: Labour, which plays an active and direct part in the production of a
particular product, is termed as direct labour. CIMA defines labour cost as “the cost of
remuneration (wages, salaries, commission, bonus, etc.) of the employees of an
undertaking.” Direct labour cost can be conveniently and specifically charged to
specific products.

 Indirect labour: It is employed to carry out tasks incidental to goods produced or

services rendered. Indirect labour cost cannot be practically traced to specific units of
output. A few examples indirect labour costs are wages of storekeeper, salaries of
office staff and salesmen, directors’ fees, etc. It may be incurred in the factory, office,
and selling and distribution divisions.

 Expenses: CIMA defines expenses as “the cost of services provided to an undertaking

and the notional cost of the use of owned assets.” It may be classified into direct
expenses and indirect expenses.

 Direct Expenses: These are expenses, which can be directly allocated to a particular
job, product or unit of service; They are also called as ‘chargeable expenses.’
Examples of such expenses are hire charges paid to some special machinery required
for a particular contract, cost of designs or mould incurred in toy manufacturing, cost
of blocks needed in book publishing, etc.

 Indirect Expenses: These are expenses, which cannot be conveniently and directly
allocated to a particular job, product or unit of service. They are incurred in common
and can be apportioned to various cost centers or cost units proportionately on some
basis. Examples of such expenses are factory rent, lighting, insurance, office and
administration expenses, selling and distribution expenses, etc.

 Overheads: The aggregate of indirect material cost, indirect labour cost, and indirect
expenses is termed as overheads. Thus all indirect costs are overheads.

They may be classified broadly into types:

 Factory or Works Overheads: These are indirect costs incurred inside a factory or
works. Examples are factory supplies such as oil, consumable stores, lubricants,
indirect labour such as factory manager’s salary, timekeeper’s salary, etc., and
indirect expenses such as factory rent, factory lighting, factory insurance, etc.

 Office and Administration Overheads: These are indirect costs incurred in the
general and administrative office. Examples are indirect materials such as stationery,
brooms, dusters, etc, and indirect labour such as salaries of office staff, directors’ fees,
etc., and indirect expenses such as rent, insurance, lighting, etc., of the office.

 Selling and Distribution Overheads: These are indirect costs incurred in connection
with the selling and distribution of goods and services. Examples are indirect
materials such as packing materials, printing and stationery materials, etc., and
indirect labour such as salaries of sales staff and sales manager, commission, etc., and
indirect expenss such as advertising expenses, insurance, godown rent, etc.

Importance of cost accounting

1. Controlling costs: Cost accounting helps the management foresee the cost price and

selling price of a product or a service, which helps them formulate business policies. With

cost value as a reference, the management can come up with techniques to control costs with

an aim to achieve maximum profitability.

2. Determining the total per-unit cost: Cost accounting techniques help in determining the

total per-unit cost of a product or a service, so that the business can fix the selling price for it.

3. Showing profitable and non-profitable activities: This information helps the

management put an end to non-profitable activities while developing and expanding the

profitable ones.

4. Comparing costs over time: The data in the cost sheet prepared for various time periods

helps in comparing the cost for the same product or a service over a period of time.
COST OBJECT

A Cost Object is anything for which a cost is to be calculated or that makes you incur a cost.
It could be anything for which a company plans to calculate costs separately. A cost object
could be a part of the process to come up with the pricing of a product or service. Or, it could
be a separate task to find the cost for the cost objects.

For example, if the sales department is the cost object, then several expenses are traceable to
this department. These expenses include salaries to the sales staff, rent for the selling space,
stationery costs, marketing costs, and more. A company can then use this cost to set the price
of the final product.

COST UNIT

A cost unit is characterised as the unit of service, time, movement, product, or mix according
to which cost is assessed. At the time of setting up the cost proclamations, statements, and
records, a specific unit is needed to be chosen. It assists with distinguishing the expense
precisely and allot the different costs. It helps the expense estimation interaction of the
organisation and advances correlation.
For example the cost unit of the steel business would be a ton, and the expense unit of the
hotel business is a room.
COST DRIVER
A cost driver is the direct cause of a cost and its effect is on the total cost incurred. For
example, if you are to determine the amount of electricity consumed in a particular period,
the number of units consumed determines the total bill for electricity. In such a scenario, the
number of units of electricity consumed is a cost driver.

COST CENTRE

In simple terms, you can define the cost centre as the one or more units of the firm that don’t
contribute directly to the process of revenue generation in an organisation but incur expenses.
This is a type of responsibility centre that is accountable for incurring expenses that are under
their control. It indicates any section of the organisation’s product or service for which
specific cost collection is looked for. 

A cost centre, in other words, is any location, person, machine, section, part, activity, or
function inside an organisation or enterprise where expenses are gathered or aggregated and
assigned.

Example: company’s legal department, accounting department, research and development

department, marketing and customer service
COST CONTROL

Cost Control is a process which focuses on controlling the total cost through competitive
analysis. It is a practice which works to maintain the actual cost in agreement with the
established norms. It ensures that the cost incurred on an operation should not go beyond the
pre-determined cost.

COST REDUCTION

Cost Reduction is a process, aims at lowering the unit cost of a product manufactured or
service rendered without affecting its quality by using new and improved methods and
techniques. It ascertains substitute ways to reduce the cost of a unit. It ensures savings in per
unit cost and maximisation of profits of the organisation.

Cost Reduction aims at cutting off the unnecessary expenses which occur during the
production, storing, selling and distribution of the product.

LIMITATION OF COST ACCOUNTING

1. Based on estimates: Indirect costs are not charged fully to a product or

process. It is charged to all the products and processes on the basis of estimates.
Actual cost varies from the estimated cost. Due to these limitations, all cost
accounting results are taken as mere estimates.
2. Lack of uniformity: Procedures of cost accounting followed by different
organizations are different for different products. There is no uniformity. There
is also a possibility of difference in pricing material issues for production. All
these lead to different cost results for the same operation.
3. Many conventions: There are many conventions for classification of costs,
pricing of material issues, apportionment of indirect costs, adoption of marginal
or standard cost, etc. These create difficulty in determining the exact cost
because no one type of cost is suitable for all purposes and in all circumstances.
4. Expensive: Cost accounting is expensive. It involves lots of clerical won for
maintaining various costing records for different purposes. For medium and
small size concern, the benefit derived from a costing system may not justify
the cost involved.
5. The result requires reconciliation: Information and results provided b;
financial accounting and cost accounting may be different for them as an
activity. This requires reconciliation to find out the correctness of the two
before taking any decision.
6. Dependent: It is not an independent system of accounting. It depends on other
accounting systems.
7. Does not include all items of expense and income: Items of purely financial
nature such as interest, financial charges, discount and losses on an issue of
shares and debentures, etc., are not taken into consideration in Cost
Accounting.