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Financial Accounting, Cost Accounting and Management Accounting
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1.1 Introduction
Accounting is a very old science which aims at keeping records of various transactions. The accounting is
considered to be essential for keeping records of all receipts and payments as well as that of the income
and expenditures. Accounting can be broadly divided into three categories.
Financial Accounting, aims at fi nding out profi t or losses of an accounting year as well as the assets and
liabilities position, by recording various transactions in a systematic manner.
Cost Accounting helps the business to ascertain the cost of production/services offered by the organization
and also provides valuable information for taking various decisions and also for cost control and cost
reduction.
Management Accounting helps the management to conduct the business in a more effi cient manner.
The scope of management accounting is broader than that of cost accounting. In other words, it can be
said that the management accounting can be considered as an extension of cost accounting. Management
Accounting utilises the principles and practices of fi nancial accounting and cost accounting in addition
to other modern management techniques for effi cient operation of a company. The main thrust in
management accounting is towards determining policy and formulating plans to achieve desired
objectives of management. Management Accounting makes corporate planning and strategies effective
and meaningful.
In the present chapter all these concepts are discussed in detail in order to make the concepts more clear.
1.2 Financial Accounting
Financial Accounting aims at fi nding the results of an accounting year in terms of profi ts or losses and
assets and liabilities. In order to do this, it is essential to record various transactions in a systematic
manner. Financial Accounting is defi ned as, ‘Art and science of classifying, analyzing and recording
business transactions in a systematic manner in order to prepare a summary at the end of the year to fi nd
out the results of the concerned accounting year.’ The defi nition given above is self explanatory, however
for understanding clearly, the following terms are explained below.
A Business transactions :- A transaction means an activity, a business transaction means any activity
which creates some kind of legal relationship. For example, purchase and sale of goods, appointing
an employee and paying his salary, payment of various expenses, purchase of assets etc.
B Classifi cation of transactions :- Before recording any transaction, it is essential that it is to be classifi ed.
A transaction can be classifi ed as cash transaction and credit transaction. Similarly transactions
of receiving income and payment of expenditure can be segregated. Even in case of expenditure,
transactions involving revenue expenditure and capital expenditure can be segregated.
C Recording of transactions :- The essence of fi nancial accounting is recording of transaction. In
accounting language, recording of the transaction is known as entry. There are well defi ned rules
for recording various transactions in books of accounts. As per the rules of fi nancial accounting,
each and every transaction is recorded at two places and hence it is called as ‘Double Entry’ system
of accounting.
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Cost and Management Accounting
D Summary of transactions :- After recording all transactions, it is essential to prepare a summary of
them so as to draw meaningful conclusions. The summary will help in fi nding out the Profi t/Loss
of a particular year and also ascertaining Assets and Liabilities on a particular date. In fact, the very
purpose of fi nancial accounting is to know the results of a particular year. From this angle, the process
of preparing the summary is extremely important.
1.2.1 Concepts and conventions of Financial Accounting :- There are some well defi ned concepts and
conventions of fi nancial accounting system. Concepts can also be termed as ‘principles’ while
conventions are those which have been followed over a period of time and are accepted as
norms to be followed in fi nancial accounting systems. The concepts and conventions of fi nancial
accounting are explained in the following paragraphs.
1.2.2 Concepts of Financial Accounting:- The following are the concepts of fi nancial accounting.
A. Separate Entity :- This concept implies that the businessman is different from business. Thus
if X starts his business known as X and Sons, X as a person shall be different from his fi rm,
i.e. X and Sons. Actually in Law, separate entity concept is recognized only in the case of
joint stock companies registered under Companies Act, 1956. In case of partnerships and sole
proprietorship business, separate entity concept is not recognized under Law. However in
accounting, separate entity concept is recognized and the accounting entries are passed in
the books of the business and not in the books of the proprietor as such. Thus when X starts
his business and invests his own money as capital, it is shown as liability in the Balance Sheet
of the business. On the other hand, if the proprietor incurs any private expenditure from the
resources of the business, it is shown as recoverable in the books of accounts of the business.
Thus the principle of separate entity is applied in practice.
B. Double Entry :- This principle can be called as ‘Heart’ of the entire accounting mechanism.
Double entry means a transaction is recorded at two places in the books of accounts, the
reason being that any transaction has two fold effects and hence it is to be recorded at two
places. The following example will clarify the point.
1. If goods are purchased for cash, the cash goes out and goods come in. Thus one effect is
the cash going out and the second effect is that goods come in.
2. When goods are sold for cash, the fi rst effect is that the cash comes in and the second one
is that the goods are going out.
3. In case of credit transactions like purchase of goods, one effect is that goods come in and
the person from whom the goods are purchased becomes the creditor of the business.
Thus in double entry system, each and every transaction has the two fold effects. There is
another system of recording the transactions, which is known as single entry system. In single
entry system, every transaction is recorded only once and hence no double effect is given.
There are very few organizations where single entry system is still implemented. However
the double entry system is now being accepted everywhere.
C. Money Measurement Concept :- Another important concept of fi nancial accounting is the
money measurement concept. This concept means that only the transactions which are
capable of being expressed in monetary terms will be recorded in the books of accounts. In
other words, transactions which cannot be expressed in monetary terms cannot be recorded
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in the books of accounts. For example, in books of accounts monetary value of assets or goods
will be recorded and not the quantity of the same. Furniture will not be recorded as 1 table
or 12 chairs or 100 cupboards, but the values of the same in monetary terms will be recorded.
This principle means that items like Human Resources will not be recorded in the books of
accounts as they cannot be converted into monetary terms. This principle is important as it
brings uniformity in recording transactions in the books of accounts.
D. Going Concern Concept :- As per Glossary of terms, International Accounting Standards,
1999, the defi nition of ‘Going Concern’ is as follows
‘That enterprise is normally viewed as a going concern, that is as continuing in operation
for the foreseeable future. It is assumed that the enterprise has neither the intention nor the
necessity of liquidation or curtailing materially the scale of its operations.’
The implications of this concept is that the fi nancial statements, fi xed assets are shown at the
cost of acquisition less depreciation accumulated up to the date of closure. The reason is that it is
assumed that the enterprise is going to continue for a long period of time and there is no intention
to close it down in the near future. Therefore the market values of the same are not relevant at all,
the cost prices are relevant and hence the assets should be shown at the cost value.
E. Matching Concept :- Matching of costs and revenues concept is explained below in the
International Accounting Standards
‘Expenses are recognized in the income statement on the basis of a direct association between
the costs incurred and the earnings of specifi c items of income. This process involves the
simultaneous or combined recognition of revenues and expenses that result directly and
jointly from the same association or other events. However, the application of the matching
concept does not allow the recognition of items in the Balance Sheet which do not meet the
defi nition of assets or liabilities.’
In other words, matching concept means that it is necessary to periodically match the costs
and revenues in order to fi nd out the results of a particular period. This period is called as
accounting year. For any business it is essential to fi nd out the profi t or loss after periodic
intervals. Actually, real profi t or loss can be found out only after the business is closed down.
But in the earlier concept we have seen that any business organization is a going concern and
not likely to shut down in the near future. Therefore it is necessary to match the revenue and
expenditure on periodic basis. This period is normally for one year and is called as accounting
year. In case of limited companies established under the Companies Act, 1956, fi rst accounting
year in case of a company can be of 18 months but subsequent accounting years must be of 12
months duration. A business organization is free to choose the accounting year, i.e. a calendar
year can be adopted as accounting year or fi nancial year starting from 1st April to 31st March
can be an accounting year. The assessment year for income tax purpose is always from 1st April
to 31st March and hence many organizations adopt this period as accounting year.
1.2.3 Accounting Cycle : It is essential to describe the accounting cycle in brief. The cycle commences
with the happening of a transaction and ends with the preparation of fi nal accounts, i.e. Profi t and Loss
Account and Balance Sheet. The following chart will show the accounting cycle.
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5
Cost and Management Accounting
Transaction
|
Entry
|
Books of Prime Entry – Journal and Subsidiary Books
|
Posting in Ledger – Book of Secondary Entry
|
Trial Balance
|
Final Accounts – Profi t and Loss Account and Balance Sheet
As mentioned above, the accounting cycle starts with a transaction. As soon as a transaction takes place, it
is recorded in the books of Prime Entry, i.e. either Journal or subsidiary books. After recording the same in
these books, the transaction is posted in the ledger which is called as book of secondary entry. All ledger
accounts are closed and a list of the same is prepared which is called as ‘Trial Balance’. From the trial
balance, fi nal accounts, Profi t and Loss Account and Balance Sheet are prepared.
1.2.4 Utility of Financial Accounting : The utility of fi nancial accounting can be explained in the
following manner.
A. Financial Accounting provides well defi ned rules and principles of recording business transactions.
This provides uniformity in recording the transactions and thus results of various organizations
become comparable.
B. For any organization, whether it is profi t making or non-profi t making, it is essential to fi nd out
the results of a particular accounting period, i.e. accounting year. Financial accounting mechanism
enables them to prepare Profi t and Loss Account and Balance Sheet at the end of the fi nancial year.
C. Financial Accounting helps the taxation authorities for determining the tax liability in a fair manner.
Income Tax is levied on the profi ts and fi nancial accounting helps to disclose true and fair view of the
business as regards to profi ts. Thus the assessment of tax liability becomes rational and free from any
controversies.
D. Financial Accounting is also helpful for the investors who are interested in fi nding out the profi tability
of the business in which they want to invest the money. Financial accounting information helps in
ascertaining profi tability so that decision-making is easier.
E. In the course of the business, a fi rm has to borrow money for various objectives such as expansion,
diversifi cation, modernization and so on. The lenders have to ensure that the money lent by them
will be repaid back. For this, they study fi nancial statements viz. Profi t and Loss Account and Balance
Sheet to ascertain the fi nancial condition of the business. Thus the fi nancial accounting helps them in
decision-making regarding granting of loan.
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F. Financial accounting also provides useful information for the purpose of valuation of business during
merger and acquisition process.
1.3 Cost Accounting
As compared to the fi nancial accounting, the focus of cost accounting is different. In the modern days of
cut throat competition, any business organization has to pay attention towards their cost of production.
Computation of cost on scientifi c basis and thereafter cost control and cost reduction has become of
paramount importance. Hence it has become essential to study the basic principles and concepts of cost
accounting. These are discussed in the subsequent paragraphs.
1.3.1 Cost :- Cost can be defi ned as the expenditure (actual or notional) incurred on or attributable
to a given thing. It can also be described as the resources that have been sacrifi ced or must be
sacrifi ced to attain a particular objective. In other words, cost is the amount of resources used for
something which must be measured in terms of money. For example – Cost of preparing one cup
of tea is the amount incurred on the elements like material, labor and other expenses, similarly
cost of offering any services like banking is the amount of expenditure for offering that service.
Thus cost of production or cost of service can be calculated by ascertaining the resources used for
the production or services.
1.3.2 Costing :- Costing may be defi ned as ‘the technique and process of ascertaining costs’. According
to Wheldon, ‘Costing is classifying, recording, allocation and appropriation of expenses for
the determination of cost of products or services and for the presentation of suitably arranged
data for the purpose of control and guidance of management. It includes the ascertainment of
every order, job, contract, process, service units as may be appropriate. It deals with the cost of
production, selling and distribution.
If we analyze the above defi nitions, it will be understood that costing is basically the procedure
of ascertaining the costs. As mentioned above, for any business organization, ascertaining of costs
is must and for this purpose a scientifi c procedure should be followed. ‘Costing’ is precisely this
procedure which helps them to fi nd out the costs of products or services.
1.3.3 Cost Accounting :- Cost Accounting primarily deals with collection, analysis of relevant of cost
data for interpretation and presentation for various problems of management. Cost accounting
accounts for the cost of products, service or an operation. It is defi ned as, ‘the establishment of
budgets, standard costs and actual costs of operations, processes, activities or products and the
analysis of variances, profi tability or the social use of funds’.
1.3.4 Cost Accountancy :- Cost Accountancy is a broader term and is defi ned as, ‘the application of
costing and cost accounting principles, methods and techniques to the science and art and practice
of cost control and the ascertainment of profi tability as well as presentation of information for the
purpose of managerial decision making.’
If we analyze the above defi nition, the following points will emerge,
A. Cost accounting is basically application of the costing and cost accounting principles.
B. This application is with specifi c purpose and that is for the purpose of cost control, ascertainment
of profi tability and also for presentation of information to facilitate decision making.
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Cost and Management Accounting
C. Cost accounting is a combination of art and science, it is a science as it has well defi ned rules
and regulations, it is an art as application of any science requires art and it is a practice as it
has to be applied on continuous basis and is not a one time exercise.
1.3.5 Objectives of Cost Accounting :- Objectives of Cost Accounting can be summarized as under
1. To ascertain the cost of production on per unit basis, for example, cost per kg, cost per meter,
cost per liter, cost per ton etc.
2. Cost accounting helps in the determination of selling price. Cost accounting enables to
determine the cost of production on a scientifi c basis and it helps to fi x the selling price.
3. Cost accounting helps in cost control and cost reduction.
4. Ascertainment of division wise, activity wise and unit wise profi tability becomes possible
through cost accounting.
5. Cost accounting also helps in locating wastages, ineffi ciencies and other loopholes in the
production processes/services offered.
6. Cost accounting helps in presentation of relevant data to the management which helps in
decision making. Decision making is one of the important functions of Management and it
requires presentation of relevant data. Cost accounting enables presentation of relevant data
in a systematic manner so that decision making becomes possible.
7. Cost accounting also helps in estimation of costs for the future.
1.3.6 Essentials of a good Costing system :- For availing of maximum benefi ts, a good costing system
should possess the following characteristics.
A. Costing system adopted in any organization should be suitable to its nature and size of the
business and its information needs.
B. A costing system should be such that it is economical and the benefi ts derived from the same
should be more than the cost of operating of the same.
C. Costing system should be simple to operate and understand. Unnecessary complications
should be avoided.
D. Costing system should ensure proper system of accounting for material, labor and
overheads and there should be proper classifi cation made at the time of recording of the
transaction itself.
E. Before designing a costing system, need and objectives of the system should be identifi ed.
F. The costing system should ensure that the fi nal aim of ascertaining of cost as accurately
possible should be achieved.
1.3.7 Certain Important Terms :- It is necessary to understand certain important terms used in cost
accounting.
A. Cost Center :- Cost Center is defi ned as, ‘a production or service, function, activity or item
of equipment whose costs may be attributed to cost units. A cost center is the smallest
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organizational sub unit for which separate cost allocation is attempted’. To put in simple
words, a cost center is nothing but a location, person or item of equipment for which cost
may be ascertained and used for the purpose of cost control. For example, a production
department, stores department, sales department can be cost centers. Similarly, an item of
equipment like a lathe, fork-lift, truck or delivery vehicle can be cost center, a person like
sales manager can be a cost center. The main object of identifying a cost center is to facilitate
collection of costs so that further accounting will be easy. A cost center can be either personal
or impersonal, similarly it can be a production cost center or service cost center. A cost center
in which a specifi c process or a continuous sequence of operations is carried out is known as
Process Cost Center.
B. Profi t Center :- Profi t Center is defi ned as, ‘a segment of the business entity by which both
revenues are received and expenses are incurred or controlled’. (CEMA) A profi t center is
any sub unit of an organization to which both revenues and costs are assigned. As explained
above, cost center is an activity to which only costs are assigned but a profi t center is one
where costs and revenues are assigned so that profi t can be ascertained. Such revenues
and expenditure are being used to evaluae segmental performance as well as managerial
performance. A division of an organization may be called as profi t center. The performance
of profi t center is evaluated in terms of the fact whether the center has achieved its budgeted
profi ts. Thus the profi t center concept is used for evaluation of performance.
1.3.8 Costing Systems :- There are different costing systems used in practice. These are described
below.
A. Historical Costing :- In this system, costs are ascertained only after they are incurred and that
is why it is called as historical costing system. For example, costs incurred in the month of
April, 2007 may be ascertained and collected in the month of May. Such type of costing system
is extremely useful for conducting post-mortem examination of costs, i.e. analysis of the costs
incurred in the past. Historical costing system may not be useful from cost control point of
view but it certainly indicates a trend in the behavior of costs and is useful for estimation of
costs in future.
B. Absorption Costing :- In this type of costing system, costs are absorbed in the product units
irrespective of their nature. In other words, all fi xed and variable costs are absorbed in the
products. It is based on the principle that costs should be charged or absorbed to whatever is
being costed, whether it is a cost unit, cost center.
C. Marginal Costing :- In Marginal Costing, only variable costs are charged to the products and
fi xed costs are written off to the Costing Profi t and Loss A/c. The principle followed in this
case is that since fi xed costs are largely period costs, they should not enter into the production
units. Naturally, the fi xed costs will not enter into the inventories and they will be valued at
marginal costs only.
D. Uniform Costing :- This is not a distinct method of costing but is the adoption of identical
costing principles and procedures by several units of the same industry or by several
undertakings by mutual agreement. Uniform costing facilitates valid comparisons between
organizations and helps in eliminating ineffi ciencies.
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Cost and Management Accounting
1.3.9 Classifi cation of Costs :- An important step in computation and analysis of cost is the
classifi cation of costs into different types. Classifi cation helps in better control of the costs and
also helps considerably in decision making. Classifi cation of costs can be made according to the
following basis.
A. Classifi cation according to elements :- Costs can be classifi ed according to the elements. There
are three elements of costing, viz. material, labor and expenses. Total cost of production/
services can be divided into the three elements to fi nd out the contribution of each element in
the total costs.
B. Classifi cation according to nature :- As per this classifi cation, costs can be classifi ed into
Direct and Indirect. Direct costs are the costs which are identifi able with the product unit
or cost center while indirect costs are not identifi able with the product unit or cost center
and hence they are to be allocated, apportioned and then absorb in the production units. All
elements of costs like material, labor and expenses can be classifi ed into direct and indirect.
They are mentioned below.
i. Direct and Indirect Material :- Direct material is the material which is identifi able with
the product. For example, in a cup of tea, quantity of milk consumed can be identifi ed,
quantity of glass in a glass bottle can be identifi ed and so these will be direct materials
for these products. Indirect material cannot be identifi ed with the product, for example
lubricants, fuel, oil, cotton wastes etc cannot be identifi ed with a given unit of product
and hence these are the examples of indirect materials.
ii. Direct and Indirect Labor :- Direct labor can be identifi ed with a given unit of product,
for example, when wages are paid according to the piece rate, wages per unit can be
identifi ed. Similarly wages paid to workers who are directly engaged in the production
can also be identifi ed and hence they are direct wages. On the other hand, wages paid to
workers like sweepers, gardeners, maintenance workers etc are indirect wages as they
cannot be identifi ed with the given unit of production.
iii. Direct and Indirect Expenses :- Direct expenses refers to expenses that are specifi cally
incurred and charged for specifi c or particular job, process, service, cost center or cost
unit. These expenses are also called as chargeable expenses. Examples of these expenses
are cost of drawing, design and layout, royalties payable on use of patents, copyrights
etc, consultation fees paid to architects, surveyors etc. Indirect expenses on the other
hand cannot be traced to specifi c product, job, process, service or cost center or cost
unit. Several examples of indirect expenses can be given like insurance, electricity, rent,
salaries, advertising etc.
It should be noted that the total of direct expenses is known as ‘Prime Cost’ while the total of
all indirect expenses is known as ‘Overheads’.
C. Classifi cation according to behavior :- Costs can also be classifi ed according to their behavior.
This classifi cation is explained below.
i. Fixed Costs :- Out of the total costs, some costs remain fi xed irrespective of changes in
the production volume. These costs are called as fi xed costs. The feature of these costs is
that the total costs remain same while per unit fi xed cost is always variable. Examples of
these costs are salaries, insurance, rent, etc.
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ii. Variable Costs :- These costs are variable in nature, i.e. they change according to the
volume of production. Their variability is in the same proportion to the production. For
example, if the production units are 2,000 and the variable cost is Rs. 5 per unit, the total
variable cost will be Rs. 10,000, if the production units are increased to 5,000 units, the
total variable costs will be Rs. 25,000, i.e. the increase is exactly in the same proportion
of the production. Another feature of the variable cost is that per unit variable cost
remains same while the total variable costs will vary. In the example given above, the
per unit variable cost remains Rs. 2 per unit while total variable costs change. Examples
of variable costs are direct materials, direct labor etc.
iii. Semi-variable Costs :- Certain costs are partly fi xed and partly variable. In other words,
they contain the features of both types of costs. These costs are neither totally fi xed nor
totally variable. Maintenance costs, supervisory costs etc are examples of semi-variable
costs. These costs are also called as ‘stepped costs’.
D. Classifi cation according to functions :- Costs can also be classifi ed according to the functions/
activities. This classifi cation can be done as mentioned below.
i. Production Costs :- All costs incurred for production of goods are known as production
costs.
ii. Administrative Costs :- Costs incurred for administration are known as administrative
costs. Examples of these costs are offi ce salaries, printing and stationery, offi ce telephone,
offi ce rent, offi ce insurance etc.
iii. Selling and Distribution Costs :- All costs incurred for procuring an order are called as
selling costs while all costs incurred for execution of order are distribution costs. Market
research expenses, advertising, sales staff salary, sales promotion expenses are some of
the examples of selling costs. Transportation expenses incurred on sales, warehouse rent
etc are examples of distribution costs.
iv. Research and Development Costs :- In the modern days, research and development has
become one of the important functions of a business organization. Expenditure incurred
for this function can be classifi ed as Research and Development Costs.
E. Classifi cation according to time :- Costs can also be classifi ed according to time. This
classifi cation is explained below.
I. Historical Costs :- These are the costs which are incurred in the past, i.e. in the past year,
past month or even in the last week or yesterday. The historical costs are ascertained
after the period is over. In other words it becomes a post-mortem analysis of what has
happened in the past. Though historical costs have limited importance, still they can be
used for estimating the trends of the future, i.e. they can be effectively used for predicting
the future costs.
II. Predetermined Cost :- These costs relating to the product are computed in advance of
production, on the basis of a specifi cation of all the factors affecting cost and cost data. Pre
determined costs may be either standard or estimated. Standard Cost is a predetermined
calculation of how much cost should be under specifi c working conditions. It is based on
technical studies regarding material, labor and expenses. The main purpose of standard
Financial Accounting, Cost Accounting and Management Accounting
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Cost and Management Accounting
cost is to have some kind of benchmark for comparing the actual performance with the
standards. On the other hand, estimated costs are predetermined costs based on past
performance and adjusted to the anticipated changes. It can be used in any business
situation or decision making which does not require accurate cost.
F. Classifi cation of costs for Management decision making :- One of the important function
of cost accounting is to present information to the Management for the purpose of decision
making. For decision making certain types of costs are relevant. Classifi cation of costs based
on the criteria of decision making can be done in the following manner
I. Marginal Cost :- Marginal cost is the change in the aggregate costs due to change in
the volume of output by one unit. For example, suppose a manufacturing company
produces 10,000 units and the aggregate costs are Rs. 25,000, if 10,001 units are produced
the aggregate costs may be Rs. 25,020 which means that the marginal cost is Rs. 20.
Marginal cost is also termed as variable cost and hence per unit marginal cost is always
same, i.e. per unit marginal cost is always fi xed. Marginal cost can be effectively used for
decision making in various areas.
II. Differential Costs :- Differential costs are also known as incremental cost. This cost is
the difference in total cost that will arise from the selection of one alternative to the
other. In other words, it is an added cost of a change in the level of activity. This type of
analysis is useful for taking various decisions like change in the level of activity, adding
or dropping a product, change in product mix, make or buy decisions, accepting an
export offer and so on.
III. Opportunity Costs :- It is the value of benefi t sacrifi ced in favor of an alternative course
of action. It is the maximum amount that could be obtained at any given point of time if
a resource was sold or put to the most valuable alternative use that would be practicable.
Opportunity cost of goods or services is measured in terms of revenue which could have
been earned by employing that goods or services in some other alternative uses.
IV. Relevant Cost :- The relevant cost is a cost which is relevant in various decisions of
management. Decision making involves consideration of several alternative courses of
action. In this process, whatever costs are relevant are to be taken into consideration.
In other words, costs which are going to be affected matter the most and these costs
are called as relevant costs. Relevant cost is a future cost which is different for different
alternatives. It can also be defi ned as any cost which is affected by the decision on hand.
Thus in decision making relevant costs play a vital role.
V. Replacement Cost :- This cost is the cost at which existing items of material or fi xed
assets can be replaced. Thus this is the cost of replacing existing assets at present or at a
future date.
VI. Abnormal Costs :- It is an unusual or a typical cost whose occurrence is usually not
regular and is unexpected. This cost arises due to some abnormal situation of production.
Abnormal cost arises due to idle time, may be due to some unexpected heavy breakdown
of machinery. They are not taken into consideration while computing cost of production
or for decision making.
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VII. Controllable Costs :- In cost accounting, cost control and cost reduction are extremely
important. In fact, in the competitive environment, cost control and reduction are the
key words. Hence it is essential to identify the controllable and uncontrollable costs.
Controllable costs are those which can be controlled or infl uenced by a conscious
management action. For example, costs like telephone, printing stationery etc can be
controlled while costs like salaries etc cannot be controlled at least in the short run.
Generally, direct costs are controllable while uncontrollable costs are beyond the control
of an individual in a given period of time.
VIII. Shutdown Cost :- These costs are the costs which are incurred if the operations are shut
down and they will disappear if the operations are continued. Examples of these costs
are costs of sheltering the plant and machinery and construction of sheds for storing
exposed property. Computation of shutdown costs is extremely important for taking a
decision of continuing or shutting down operations.
IX. Capacity Cost :- These costs are normally fi xed costs. The cost incurred by a company for
providing production, administration and selling and distribution capabilities in order
to perform various functions. Capacity costs include the costs of plant, machinery and
building for production, warehouses and vehicles for distribution and key personnel
for administration. These costs are in the nature of long-term costs and are incurred as a
result of planning decisions.
X. Urgent Costs :- These costs are those which must be incurred in order to continue
operations of the fi rm. For example, cost of material and labor must be incurred if
production is to take place.