Every rupee that Maruti Suzuki spends making a car — steel, paint, factory wages, electricity, on robots — must be tracked, classified, and allocated before management can answer the most fundamental business questions: How much does it cost to make one car? Which model is most profitable? Should we accept a bulk order at a lower price? Cost accounting provides the answers. Cost accounting is a branch of accounting concerned with classifying, recording, analysing, and reporting costs to aid management decision-making, planning, and control. Unlike financial accounting (which reports to outsiders), cost accounting is primarily an internal tool. The ICAI CA Intermediate paper tests both the theoretical framework (definitions, classifications, objectives) and the computational skills (preparing cost statements, computing cost per unit). This chapter lays the essential foundation.
Before You Start
🎯 Why learn this?
Cost accounting concepts underpin every subsequent topic — material, labour, overheads, standard costing, marginal costing. Getting the classification right from the start is essential.
📚What you'll learn
- •Objectives and scope of cost accounting
- •Classification of costs — by nature, function, behaviour, controllability, normality
- •Cost concepts: cost unit, cost centre, cost object
- •Cost accounting vs financial accounting vs management accounting
- •Elements of cost and their components
✅ After this chapter, you can…
- ✓Classify a given cost using multiple classification bases
- ✓Distinguish between product costs and period costs
- ✓Define cost unit, cost centre, and cost driver
- ✓Explain the relationship between cost, management, and financial accounting
💼 Real problems this solves at work
- →Setting up a cost accounting system for a manufacturing company
- →Identifying cost centres for responsibility reporting
- →Providing management with relevant cost data for pricing decisions
01Classification of Costs
| Basis of Classification | Categories | Examples |
|---|---|---|
| By Nature / Element | Material, Labour, Expenses (overheads) | Steel (material), wages (labour), rent (expenses) |
| By Function | Production, Administration, Selling & Distribution, R&D | Factory wages (production), office salaries (admin), advertising (selling) |
| By Behaviour (Variability) | Fixed, Variable, Semi-variable (mixed) | Rent (fixed), direct material (variable), electricity (semi-variable) |
| By Controllability | Controllable, Uncontrollable | Department labour cost (controllable by dept manager), apportioned head office cost (uncontrollable) |
| By Normality | Normal, Abnormal | Planned scrap (normal), flood damage (abnormal) |
| By Relevance | Relevant, Irrelevant (sunk), Opportunity cost | Future variable costs (relevant); past costs already paid (sunk) |
| Product vs Period | Product costs (inventoriable), Period costs (expensed) | DM, DL, variable overhead (product); selling, admin costs (period) |
02Key Cost Concepts
| Term | Definition |
|---|---|
| Cost Unit | The unit of product or service in relation to which costs are ascertained. E.g., per tonne of steel, per patient-day, per 100 bricks. |
| Cost Centre | A location, person, or item of equipment for which costs are collected. E.g., machine shop, welding department. |
| Profit Centre | A cost centre that is also responsible for generating — manager controls both costs and revenues. |
| Investment Centre | A centre where the manager controls costs, , AND investment. |
| Cost Driver | Any factor that causes a change in the cost of an activity. E.g., number of setups drives setup costs; machine hours drive power costs. |
| Opportunity Cost | The value of the next best alternative foregone. Not recorded in books but relevant for decisions. |
| Sunk Cost | A cost already incurred and unrecoverable — irrelevant for future decisions. |
03Elements of Cost
| Element | Sub-elements |
|---|---|
| Material | Direct Material (DM) — identifiable with product; Indirect Material — cannot be traced (lubricating oil, cleaning supplies) |
| Labour | Direct Labour (DL) — directly engaged in production; Indirect Labour — supervisors, maintenance staff |
| Expenses / Overheads | Direct Expenses — expenses other than DM/DL that can be traced to cost unit (sub-contractor cost); Indirect Expenses — rent, , insurance |
Prime Cost = Direct Material + Direct Labour + Direct Expenses. Works Cost = Prime Cost + Factory/Works Overhead. Cost of Production = Works Cost + Administration Overhead. Total Cost (Cost of Sales) = Cost of Production + Selling & Distribution Overhead.
Chapter Summary
- 1Cost classified by: nature (M/L/E), function (production/admin/selling), behaviour (fixed/variable/semi-variable), controllability, normality.
- 2Prime Cost = DM + DL + Direct Expenses. Works Cost = Prime Cost + Factory Overhead. Total Cost = Works Cost + Admin + Selling overhead.
- 3Cost unit: measure per which costs are computed. Cost centre: location for which costs are collected.
- 4Product costs: inventoriable (DM, DL, manufacturing overhead). Period costs: expensed immediately (selling, admin).
- 5Sunk costs: irrelevant for decisions. Opportunity costs: relevant but not recorded in books.
Key Terms
Cost Unit
Unit in relation to which costs are ascertained — per kg, per litre, per tonne, per unit.
Cost Centre
Location/department for which costs are collected — used for cost control and responsibility.
Prime Cost
DM + DL + Direct Expenses — the directly traceable manufacturing costs.
Fixed Cost
Cost that remains constant in total regardless of activity level — rent, depreciation, salaries.
Variable Cost
Cost that changes proportionally with activity level — direct material, direct labour (if paid per unit).
Semi-variable Cost
Contains both fixed and variable elements — electricity bill with a fixed standing charge plus per-unit consumption.
Sunk Cost
Past cost already incurred — irrelevant for future decisions.
Opportunity Cost
Benefit foregone from the next best alternative — relevant for decision-making, not recorded in accounts.