Introduction to Cost Accounting: formula sheet

Key formulas

Cost accounting in one line

Cost accounting = recording + classifying + allocating + reporting of costs

Use this to define the term in a sentence. Add 'for ascertainment and control' to earn full marks.

Hierarchy of terms

Cost → Costing → Cost accounting → Cost accountancy

Each term is wider than the one before. Cost is the amount; cost accountancy is the widest practice.

Core objectives

Ascertainment, control, reduction, pricing, decision support, reporting

List these in your answer. Give one line of explanation for each.

Cost control vs cost reduction

Control = keep to a target; Reduction = lower the target itself

Control compares actual with standard. Reduction is a real, permanent saving without loss of quality.

Purpose

Financial: report overall results | Cost: ascertain and control cost | Management: plan and decide

Start every comparison with purpose. All other differences follow from it.

Users

Financial: mainly external (shareholders, lenders, regulators), also read by management | Cost: internal management | Management: internal management

Financial statements also serve owners, lenders, regulators and tax authorities.

Time focus

Financial: mostly past | Cost: past, present and estimates | Management: mainly future

Cost accounting also deals with standard and budgeted costs, so do not call it purely historical.

Format and rules

Financial: statutory format and standards | Cost: guided by CAS, no single statutory statement format | Management: no prescribed format

Company financial statements follow Schedule III and the applicable AS or Ind AS.

Unit of reporting

Financial: the whole entity | Cost: product, job, process, department | Management: any segment, decision or project

Cost accounting reports at cost-unit and cost-centre level.

Total cost

Total cost = Fixed cost + Variable cost

Fixed cost holds constant in total within the relevant range.

Semi-variable cost

Total cost = Fixed element + (Variable rate per unit × Activity)

Use it to split a mixed cost into its two parts.

Variable cost per unit by high-low method

Variable cost per unit = (Cost at high activity − Cost at low activity) ÷ (High activity − Low activity)

Fixed element = Total cost at either level − Variable rate × activity at that level.

Fixed cost per unit

Fixed cost per unit = Total fixed cost ÷ Units produced

This falls as output rises; total fixed cost does not change.

Prime cost

Prime cost = Direct material + Direct labour + Direct expenses

Direct costs are those traceable to the cost unit.

Relevance rule

Relevant cost = future, avoidable cash cost that differs between alternatives

Sunk costs and committed costs already incurred are ignored.

Method vs technique

Method = HOW costs are collected for a type of work; Technique = HOW cost data is analysed or used

Use this one-line test to classify any costing term in an MCQ.

Job costing

Cost of job = Direct material + Direct labour + Direct expenses + Overheads absorbed

Used where work is done to customer order, each order being distinct.

Batch costing

Cost per unit = Total batch cost ÷ Number of units in the batch

A batch is a group of identical units treated as one job.

Process costing (normal loss only)

Cost per unit = (Total process cost − Scrap value of normal loss) ÷ Expected output

Used for continuous or mass production through stages. This formula applies where there is normal loss only. Abnormal loss or abnormal gain is valued separately at the same cost per unit, and does not change the cost per unit of good output.

Contract costing

Each contract is a separate cost unit with its own contract account

Used for long-term construction and engineering projects at the customer's site.

Marginal cost equation

Contribution = Sales − Variable cost; Profit = Contribution − Fixed cost

Technique that values stock at variable cost only.

Standard cost variance

For cost items: Variance = Standard cost − Actual cost (positive = favourable). For sales or profit items: Variance = Actual − Standard (positive = favourable)

Technique that compares actual with predetermined standards. The sign convention differs for costs and for sales or profit, so check which type of item you are dealing with.

Direct material consumed

Opening stock of raw material + Purchases + Carriage inward (and other purchase costs) − Closing stock of raw material

Deduct trade discount and add freight and duty on purchases. Do not add carriage outward here.

Prime cost

Direct material consumed + Direct labour + Direct expenses

Includes only direct costs.

Gross factory cost

Prime cost + Factory overheads

Factory overheads include indirect material, indirect labour, factory rent, power and depreciation of factory assets.

Factory cost (works cost)

Gross factory cost + Opening WIP − Closing WIP

Adjust WIP only at this stage.

Cost of production

Factory cost + Office and administration overheads

Adjust for scrap or by-product credit if the question gives it.

Cost of goods sold

Cost of production + Opening finished goods − Closing finished goods

Value finished goods at cost of production, not selling price.

Cost of sales

Cost of goods sold + Selling and distribution overheads

This is the full cost. Profit is added to this figure.

Sales

Cost of sales + Profit

If profit is given as a percentage of sales, then profit = % ÷ (100 − %) of cost of sales.

Conversion cost

Direct labour + Direct expenses + Factory overheads

Excludes direct material. Use the question's definition if it states one.

Cost per unit

Total cost at that level ÷ Units

Units produced for cost of production, units sold for cost of sales.

Essentials of a good costing system

Suitable to the business + Simple + Economical + Accurate + Flexible + Timely reports + Integrated with financial records + Management support

Write these as headed points with one line of explanation each. The exact wording can vary, but cover the ideas.

Steps to install a costing system

Study business → Decide objectives → Fix cost centres and codes → Design records and forms → Define procedures and responsibilities → Train staff → Run and review

Keep this order. It runs from understanding to implementation to follow-up.

Role of a cost accounting standard

Standard = Uniformity + Comparability + Reliability of cost data

Use this as the one-line answer to a question on why standards are needed.

Cost system building blocks

Cost centres + Cost codes + Cost records and forms + Cost reports

These are the practical parts you design during installation.

Quick revision

• Cost accounting ascertains, controls and helps reduce cost, and supports pricing and decision-making.
• Financial accounting reports to outsiders on the whole business; cost accounting focuses on cost of products and services for internal use.
• Prime cost = direct materials + direct labour + direct expenses.
• Factory cost = prime cost + factory overheads, adjusted for opening and closing work-in-progress.
• Cost of production = factory cost + administration overheads (production-related), adjusted for finished goods where required.
• Cost of sales = cost of goods sold + selling and distribution overheads.
• Fixed cost stays constant in total over the relevant range; variable cost changes in total with activity.
• Variable cost per unit is constant; fixed cost per unit falls as output rises.
• Controllable costs can be influenced by a manager at that level; uncontrollable costs cannot.
• Methods of costing suit the type of industry; techniques such as marginal costing and standard costing are used for particular purposes.
• Items of pure finance or appropriation, such as interest on loans and income-tax, are generally excluded from a cost sheet.
• Cost Accounting Standards issued by ICMAI aim to bring uniformity and consistency in cost practice.

Common mistakes

• Treating costing, cost accounting and cost accountancy as the same thing Fix: Remember the order: technique, then system, then wide practice including control, reduction and audit. State the difference when the question asks for it.
• Saying cost control and cost reduction mean the same Fix: Control keeps cost within a fixed target. Reduction lowers the target itself through better methods, without loss of quality.
• Writing that cost accounting deals only with past data. Fix: State that cost accounting also uses standard costs, budgets and estimates for control and pricing.
• Saying management accounting is governed by Accounting Standards. Fix: Write that management accounting has no prescribed format and serves internal needs only.
• Treating cost unit and cost centre as the same thing. Fix: A cost unit is the measure (per tonne, per bed-day). A cost centre is the place or person where costs are collected (a department).
• Saying fixed cost per unit is constant. Fix: Total fixed cost is constant within the relevant range. Per-unit fixed cost falls as output rises. Variable cost is the reverse.
• Calling marginal costing or standard costing a method of costing. Fix: Remember that marginal, standard and absorption costing are techniques. Methods are tied to the type of work.
• Saying a company must choose either a method or a technique. Fix: State that a method gives the base and a technique is applied over it. For example, process costing with standard costing.
• Including non-cost items such as interest paid, income tax, donations or loss on sale of assets in the cost sheet. Fix: Cost sheets show costs of production and sale only. Exclude purely financial items and appropriations unless the question says to include them.
• Adjusting WIP and finished goods at the wrong stage. Fix: WIP is adjusted after factory overheads. Finished goods are adjusted after cost of production. Raw material is adjusted in the consumption working.

Exam tips

• Section A MCQs on this topic usually test definitions and the difference between terms. There is no negative marking, so attempt all 15.
• In written answers, number your points and give one line of explanation each. Examiners award marks per point.
• For 'distinguish' questions, compare on stated bases such as scope, nature and use, rather than writing two paragraphs.
• Add a short example from a business or service. It shows application and lifts a plain answer.
• Do not spend more than the marks justify. A 5-mark note needs about 5 clear points.
• Present comparison answers as a table with at least five rows; it is quick to read and earns marks per point.
• In MCQs, spot the key word: statutory format and Schedule III mean financial accounting; cost unit and cost centre mean cost accounting; decisions and forecasts mean management accounting.
• Always add a one-line linkage statement at the end of a comparison answer.