Introduction and basic concepts of Costing

In any manufacturing activity understanding the nature and behavior of costs is of fundamental significance. The success of an enterprise in a highly competitive world depends on the ability of the organization to ascertain and control its costs.

There are three important terms: i.e., costing, cost accounting and cost accountancy. The Institute of Cost and Works Accountants in England and Wales (now known as Cost and Management Accountants) has defined costing as “the technique of ascertaining costs”.

Cost accounting has been defined as “the process of accounting for cost from the point at which expenditure is incurred or committed to the establishment, of its ultimate relationship with cost centers and cost units. In its widest usage it embraces the preparation of statistical data, the application of cost control methods and the ascertainment of profitability of activities carried out or planned”.

Cost accountancy has been defined as “the application of costing and cost accounting principles, methods and techniques to the science, art and practice of cost control and the ascertainment of profitability”.

Basic Concepts of Cost Accounting

1. The classification of costs can be according to their nature or purpose. According to their nature, they can be classified as materials cost, labor costs, overhead costs etc. and further more. According to purpose it can be classified as period costs, product costs, indirect and direct costs, normal and abnormal costs etc. and further more.

2. Costs can be variable, fixed or semi-variable/semi-fixed. Example: Say a manufacturing company has various expenses relating to producing a product. We need to classify these as fixed and variable and find the total in each.

Total units produced: 1000
Direct materials $5,000
Direct Labor: $3,000
Manufacturing overheads: $4,000 (50% variable)
Rent of the factory: $7,000
Insurance of factory building: $1,000
Variable expenses: Direct materials = $5,000
Direct Labor = $3,000
Variable manufacturing overheads = $2,000
Total variable expenses = $10,000
Fixed expenses:
Fixed manufacturing overheads = $2,000
Rent of the factory = $7,000
Insurance of factory building = $1,000
Total fixed expense = $10,000
Thus we can classify various costs as fixed and variable. Some expenses can be semi-variable too.

3. Variable costs vary with the volume of output, fixed costs remain the same irrespective of output and semi-variable costs consists of both fixed and variable cost elements and will be partly affected by the changes in the volume of activity. Semi-variable costs can be identified using high-low method.

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