Cost Accounting Methods and Cost Classification

Absorption costing, is also termed as Traditional or full costing method , it includes everything that is a direct cost in producing a good in its cost centre.

 A direct cost is a cost that can be completely attributed to the production of specific goods or services.

Cost may be classified as fixed cost and variable cost.  

Employees who are involved directly in to the production activity are direct labor. The cost of labor is directly associated to a specific unit or cost or product.

This is the situation in which the overheads applied to a product is less than the actual overhead incurred. This results in the overheads having a debit balance.

A flexible budget requires careful study and classification of expenses into Fixed, semi-variable and variable expense. A flexible budget is a budget which changes with the change in level of activity. 

A period cost is any cost that cannot be capitalized into prepaid expenses, inventory, or fixed assets. A period cost is more closely associated with the passage of time than with a transactional event.

In accounting, a standard costing system is a tool for planning budgets, managing and controlling costs, and evaluating cost management performance. A standard costing system involves estimating the required costs of a production process.

All costs are controllable in long run. In long run all costs are controllable because of the time period. Controllable costs are those cost which can be controlled if taken care of. 

Expected or attainable Standards: This standard is a compromise between extremes of normal standard & extremes of idle standard. The main features of these standards are:  (a) for the purpose of providing for operating inefficiencies which are unavoidable, these standards are set; (b) conditions prevailing in the period for which use of standards are made are taken into account; (c) for the purpose of evaluation of performance, these standards provide best criterion & are very realistic in nature; (d) as all requirements of good standards are fulfilled by these standards, i.e., these standards are consistent, are attainable, realistic & provide incentive for improvement; they have got the maximum usage. Level of performance expected in these standards is higher than level of performance expected in normal standard. 

A standard cost is a pre-determined or pre-established cost to make a unit of finished product.

Direct labour rate variance is the difference between the standard rate of labour and the actual labour rate on standard ouput/hour.

The following preliminaries are to be carefully considered before introducing standard costing system in any firm:

A. Setting up or Establishment of Cost Centres;

B. Classification and Coding of Accounts;

C. Types of Standards; and

D. Setting up or Establishment of Standards.

Product cost includes direct materials, direct labor, and overhead. These are the costs that are included in the cost of goods sold and inventory. Only these costs can be included in the inventory.

Total fixed cost remains constant in total (b). Total variable cost increases in proportion to output (a). Unit variable cost remains constant per unit (d). Unit fixed cost decreases with a rise in output (c). Thus, the correct sequence is b, a, d, c.

 Companies that produce identical units such as lumber, tile, brick manufacturers, cereal makers, or pharmaceutical companies utilize process costing. Generally, companies utilize process costing when: Mass production of identical products. Output of products is of low value.

In every production activity, a predetermined % is considered as normal loss. If the actual loss is more than the predetermined loss, difference is considered as abnormal loss. 

Packing material is the cost of material which is incurred to bring the product in salable condition. 

In a special order situation with idle capacity, fixed costs like depreciation are considered sunk or irrelevant because they do not change regardless of whether the order is accepted. Materials, direct labour, and variable overhead are incremental costs that must be considered.

Expected capacity is the most appropriate base for computing overhead application rates when the goal is to reflect anticipated fluctuations in sales over several years, as it incorporates the actual expected production levels.

Sales is completed only when the legal title of the goods passed to the buyer. 

The sunk cost is that cost which has already been incurred and can not be recovered. Sunk cost is considered irrelevant in future decision making as this has already been incurred. 

Sundry overhead expenses may be apportioned in the ratio of labour hours. Sundry expenses are expenses that are small in amount and rare in occurrence. For these rare and insignificant expenses, a company might use a general ledger account entitled Sundry Expenses for these items.

Material control involves the systematic management of purchasing, receiving, storing, and accounting for materials. Using materials is an operational activity, not a control step.

Direct expenses are costs directly attributable to the production of a specific product or service. Wages, carriage inward, and local taxes are directly linked to production or procurement.

A joint venture is typically formed for a specific project or purpose, but it is not strictly limited to a fixed period of time by definition; it can continue until the project is completed.

Controllable Costs are the costs that can be influenced by the manager or head responsible for it. It is a cost that the management at its discretion increase or decrease. These are raw material cost, labour cost and some amount of fixed costs also.

Sunk costs are the costs which have been created by a decision that was made in the past and cannot be changed by any decisions that will be made in the future. A sunk cost cannot be recovered and are considered irrelevant for future decision making. They are he past expenditures and are also known as retrospective costs.

Opportunity cost is concerned with the cost of the next best alternative opportunity which was forgone in order to pursue a certain action. In other words it is cost of the next best alternative forgone. 

Under- or over-absorption occurs when actual overheads or activity levels differ from budgeted rates. Actual cost of direct labour (a financial value) does not affect the absorption rate calculation, which is based on units or hours.

Variable costs are the costs which vary with the change in the level of production. Fixed costs are the costs which do not vary with the level of production. Variable cost are fixed per unit whereas fixed cost vary per unit.