Unit: Cost Concepts and Classification

Table of Contents
Objective 3

Learning Outcome 3

2.1 Introduction 3

2.2 Concept of Cost 3

2.3 Classification of Costs 3

2.3.1 Classification of Cost based on Nature of expense 4
2.3.2 Classification based Traceability and Cost centers 4
2.3.3 Classification of Cost based on Functionality 6
2.3.4 Classification based on Behaviour 7
2.3.5 Classification based on Controllability 7
2.3.6 Classification based on Normality 7
2.3.7 Classification based ON Relevance in Managerial Decision-making 8

2.4 Cost Behaviour with the help of Graphs 9

2.4.1 Fixed cost 9
2.4.2 Variable cost 9
2.4.3 Semi-Variable cost 10
2.4.4 Fixed cost, Variable cost, and Semi-Variable cost 12

2.5 Meaning of Cost Objects 12

2.6 Cost units 12

2.7 Cost centers 13

2.8 Cost Sheet/Statement 13

2.8.1 Prime Cost 14
2.8.2 Cost of Production 14
2.8.3 Cost of Goods Sold 15
2.8.4 Cost of Sales 15

2.9 Preparation of Cost Sheet 15

2.10 Tenders and Quotations 16

Conclusion 17

Glossary 17

Short answers 18

Questions for discussion forum 18

Case study 18

Multiple choice questions 19

Objective
In this unit you will learn –
● Concept of cost.
● Classification of cost based on nature, function, and variability.
● Cost behavior with the help of graphs.
● Meaning of cost objects, cost units, and cost centers.
● Preparation of Cost sheets/statements, Tender, and quotation.

Learning Outcome
Prepare a cost sheet/ cost statement in accordance with cost behavior.

2.1 Introduction
The goal is to ensure a consistent and standard classification of cost for determining the cost
of a good or service and preparing cost statements in order to make the reports of an
organization comparable to those of previous periods and other organizations. The
classification of costs is intended to improve the recording and allocation of cost data,
making it more useful for informed managerial decision-making.

2.2 Concept of Cost

Cost is a monetary measurement of the resources utilized in the manufacturing of goods or

the provision of services.  Resource consumption occurs when things are manufactured or
services are rendered. The cost is determined by the resources sacrificed or the price paid to
obtain products and services. The costing system frequently refers to the type of cost, which
is determined by the purpose for which the cost is incurred. Labor cost per unit, for
example, is the wages paid for the production of a product.

2.3 Classification of Costs

The process of organizing cost components under a generic term based on nature,
characteristics, or relationships is known as cost classification. It is the method for
identifying each element and organizing like items together based on their shared
characteristics. Items that are put together under common categories might be categorized
further based on their key distinctions. Depending on the classification's purpose, the same
expenses may occur in numerous different classes.
Normally, the cost is defined in terms of a managerial goal. Its presentation usually
necessitates sub-categorization. This sub-categorization could be based on the nature of the
cost components, functional divisions, centers of responsibility, or any other appropriate
classification. The respective sub-classification is based on the use of cost reports for
managerial decision-making.
The costs are classified on the following basis:
⮚ Based on Nature of expense
⮚ Based on Functionality
⮚ Classification based on cost centers
⮚ Based on Variability or Behaviour
⮚ Based on Controllability
⮚ Based on Normality
⮚ Based on Relevance in Managerial decision making

2.3.1 Classification of Cost based on Nature of expense

There are three elements of cost based on natural grouping: Material, labor, and Expense.
1) Material cost -The cost of any material used to manufacture goods or services is
referred to as the material cost. These costs can be direct, such as basic raw materials,
components, and consumables, or indirectly such as packing material, spares, etc.
When computing material costs, purchase costs, transportation charges, taxes & tariffs,
insurance, and other acquisition-related costs are all included in the material cost, and
trade discounts, rebates, duty drawbacks, tax refunds, and other similar items are
excluded.

2) labor cost - The compensation provided to employees, whether permanent or

temporary, for their services in the production of goods or services is referred to as labor
cost. Salaries and wages paid to all permanent or temporary employees and contractor
personnel are included in labor costs. 
 Salaries and wages include all additional benefits such as Provident Fund contributions,
gratuities, Employee state insurance payment, overtime, incentives, bonuses, leave
encashment, and compensation for vacations and idle time, among others.
3) Expense - Other than material and labor costs, the cost is incurred to support production
or related activity or to assure the smooth operation of the business. Expenses include
elements like electricity bills, payments for outsourced services, service charges, finance
charges, etc.

✔ "Total cost" or "full cost" refers to the sum of all material, labor, and other expenses incurred in
the production of goods or provision of services.
✔ "Conversion costs" refer to the sum of labor and other expenses which aid in the
transformation of raw materials into finished goods.

2.3.2 Classification based Traceability and Cost centers

Material costs are split into direct and indirect material costs, labor costs into direct and
indirect labor costs, and expenses into direct and indirect expenses, according to this
classification criterion.
Based on Traceability:
⮚ Direct Cost - Direct costs are those that can be easily linked to the output unit. The
implication is that these costs are directly related to the number of units produced. As a
result, any costs could be classified as direct costs if there is a direct link between them
and the unit produced or service provided. Direct costs might include direct materials,
direct labor, and direct expenses.
⮚ Indirect Cost - Indirect costs are those that are difficult to link directly to a cost unit or
cost center. Indirect costs include elements like indirect material costs, indirect labor
costs, and indirect expenditures. Due to the lack of a direct link between cost unit and
end product, such costs are either assigned or apportioned to the finished product on
some defined basis.
Based on Cost centers
1) Direct Material cost -The cost of material that can be immediately assigned to a cost
center or a cost object in a cost-effective manner is referred to as direct material cost.
Procurement costs, freight or carriage inward, duties and taxes, insurance, and other
costs directly related to the purchase of direct material are included in the direct
material cost. When calculating direct material costs, trade discounts or cash
discounts, duty drawbacks, tax refunds, and other comparable items are excluded.
2) Direct labor cost -It is defined as the pay given to workers who participate in the
manufacturing process. The cost of remuneration for those workers who can be easily
identified or associated with a cost center or cost item is known as direct labor cost. For
the purpose of calculating direct labor cost, the remuneration of the workers includes all
additional benefits such as Provident fund, gratuities, employee insurance, overtime,
incentive schemes, bonus, leave encashment, paid leave, and so on.
3) Direct Expense - Direct Expenses are expenses that can be identified or attributed to a
cost center or cost object, other than direct material or direct labor. These costs are
associated with a certain cost unit and can be linked directly to it. Examples of direct
expense are: Cost of special designs or molds required for the production.
4) Indirect Material cost - The material cost that is not immediately allocable to a certain
cost center or cost item is known as indirect material. All material that is utilized for non-
production or ancillary purposes and that cannot be easily assigned to a specific cost
center are indirect materials. Example: Oils, grease, and other lubricants.
5) Indirect labor cost - Indirect labor is labor that is used to perform tasks that are not
directly related to the production of goods or provision of services. It is not possible to
link it to specific output units. The salaries of such employees who are not immediately
attributable to a cost center are referred to as indirect labor costs. Example: Factory
guard, supervisor, etc.
6) Indirect Expense - Indirect expenses are those that aren't directly related to materials or
labor. These are expenses that cannot be assigned to a cost center or cost unit in a
direct, efficient, and complete manner. Example: Electricity and other utility cost, rent,
rates, and taxes.

Important note
✔ The Prime Cost is the sum of the Direct Costs (material plus labor plus expense).
✔ Overheads refer to all indirect costs (materials plus labor plus expenses).
2.3.3 Classification of Cost based on Functionality
1) Production cost - The cost of all material, labor, and other expenses used in the
production of goods or services is referred to as the production cost. It comprises all
direct and indirect costs incurred during the production process. Example: Raw material,
oils, and other lubricants.
⮚ Concept of Production overheads - The indirect costs incurred in manufacturing
process are known as production overheads. Factory overhead or manufacturing
overhead are other terms for production overhead. Example: Primary packaging
cost, warehouse or storage cost of raw materials, etc.
2) Administration cost - Expenses incurred for the overall management of an organization
are known as administration costs. These are indirect costs that are also referred to as
administrative overhead. It includes all costs associated with the formulation of policies
and strategies, managing an organization, and overseeing a company's operations,
excluding operations such as research and development, manufacturing, or selling and
distribution. Example: Legal charges, Audit fees, etc.
3) Selling cost - Selling costs are all indirect costs associated with selling goods or services
and include costs related to the organization's sales management. All expenditures
associated with sales and marketing activities are included in selling costs. In other terms,
the cost of attempting to create and stimulate demand for the product or service is
known as the selling cost. Example: Cost of after-sales services, selling commissions, etc.
4) Distribution cost - The cost of handling goods from the time of leaving the factory till it
reaches the final customer is known as distribution costs. The costs of distributing a
product to clients are known as distribution costs. Example: Transportation cost, Cargo
or transit insurance, secondary packaging, etc.
5) Research and Development cost - The costs of conducting research to enhance the
quality and performance of a current product or improve the manufacturing process,
innovate a new product, conduct market research and identify opportunities, and
commercializing it is known to research and development cost.
Important note
✔ Installation costs at the delivery location for heavy equipment, which include part
assembly, testing, and other services, are included in the production cost but not the
distribution cost.
✔ The cost of primary packaging for example bottle of water, is included in the cost of
manufacturing, but the cost of secondary packaging for example corrugated boxes used
for transportation is included in the distribution cost.

2.3.4 Classification based on Behaviour

Fixed cost, variable cost, and semi-variable cost are the three types of costs based on how
they respond to variations in levels of activity.
1) Fixed cost - A cost that is incurred over a period of time and is unaffected by variations
in activity level. They are expressed in terms of time and arise with the passage of time
 rather than with production so these charges are also referred to as Period costs.
Example: Rent, depreciation, etc.
2) Variable cost - The cost of items that tend to directly and proportionately vary with the
volume of activity is referred to as variable cost. Direct materials and direct labor are
examples of variable costs. The variable cost per unit remains constant while the overall
cost varies with output levels. It is always stated in terms of units rather than time.
Example: Material cost per unit, labor cost per unit, etc.
3) Semi-Variable cost - These costs are made up of both fixed and variable charges. They
are influenced in part by changes in activity levels. They vary with volume due to the
variable component, and they do not alter in direct proportion to output due to the
fixed component. Example: Electricity bill, telephone bill, etc.

2.3.5 Classification based on Controllability

1) Controllable cost - A cost that can be changed based on a business choice or

requirement is referred to as a controllable cost. Example: The salary and commission of
salespeople are under the supervision of the sales manager.
“Belkaoni” has mentioned the following fallacies about controllable costs:
✔ All variable costs are controllable and fixed are not.
✔ All direct costs are controllable and indirect costs are not.
✔ All long-term costs are controllable.
2) Non-Controllable cost - Uncontrollable cost, on the other hand, is a cost that cannot be
changed based on a personal management decision or requirement. Example: The
departmental heads have no authority over a company-wide marketing budget that is
distributed by the top management to several departments.

2.3.6 Classification based on Normality

1) Normal cost - The term "normal cost" refers to costs that arise in the usual course of a
manufacturing process or in the typical working environment of a company. The
calculation of normal cost must take into account regular idle time. It is a cost that is
incurred at a particular level of production under the circumstances within which the
level of productivity is usually achieved.
2) Abnormal cost - Abnormal Expense is an unusual expense that occurs infrequently and
unexpectedly as a result of a production condition that is out of the ordinary. They are
not factored into the production cost when making decisions and are instead charged to
the profit and loss account. Example: Idle time caused by machine breakdown.

2.3.7 Classification based on Relevance in Managerial Decision-making

1) Opportunity cost - The value of the options foregone by choosing a given strategy or
allocating resources in a specific way is called opportunity cost. The opportunity cost is
taken into account when deciding on a project or justifying an investment, as well as
when determining the viability of a particular investment opportunity. Example: When a
 building leased on rent to a party is vacated for personal use or to expand production,
the rent that is forgone is known as the opportunity cost.
2) Relevant cost - Expenses that are appropriate for a given purpose or scenario are known
as relevant costs. Only those costs that are relevant to the decision-making are
considered as part of decision-making. For example, the current depreciation cost of a
machine is relevant while deciding whether or not to sell it, but it is meaningless when
deciding whether or not to replace it.
3) Replacement cost - This is the cost of replacing an asset in today's market. The cost of
an asset in the present market for the purpose of replacement, taking into account the
existing machine's maintenance costs and productivity, is known as replacement cost.
4) Differential cost - The differential cost is the arithmetic difference between the relevant
costs at two activity levels. It refers to the cost shift that occurs as an activity shifts from
one level to the next.
5) Marginal cost - The total of variable costs, that is the prime cost + variable overhead +
variable part of semi-variable overheads is known as marginal cost. The variation in the
cost at any given quantity of output by which overall cost changes if the quantity of
output is increased or lowered by a unit is known as marginal cost per unit. In the
Marginal Costing system, marginal cost is used.
6) Sunk cost - Sunk costs are expenses that have already been incurred for a project but
will not be reimbursed if the project is discontinued. Sunk Expenses are historical costs
that have been incurred in the past but are unrelated to the decision-making.
7) Shut down cost - Shut down costs include expenses that must be paid even if the plant is
only temporarily shut down. They are all fixed costs that cannot be avoided while the
plant is temporarily closed. Example: Rent, depreciation, etc.
8) Imputed cost - Imputed costs are imaginary or notional costs that are evaluated only for
the purpose of making a decision. Example: interest on money generated internally that
is not paid. Imputed costs are similar to opportunity costs.
9) Avoidable cost - Cost variations that can be controlled are referred to as avoidable costs.
The Costs that should not have been incurred under given conditions of performance
efficiency are known as avoidable costs. Example: When wastage occurs in excess of the
standard limit during manufacturing, the expense of wastage is avoidable.
10) Unavoidable cost - Unavoidable Costs are inevitable expenses that must be incurred
within the limitations or standards set. It is the expenditure that must be incurred as
part of business operations, being fixed in nature.

2.4 Cost Behaviour with the help of Graphs

2.4.1 Fixed cost

A cost that is incurred over a period of time and is unaffected by variations in activity level.
They are expressed in terms of time and arise with the passage of time rather than with the
level of production units.
Fixed Cost or Fixed Overhead behaves differently at total expense level and per unit level.
The graphs below depict the behavior of fixed costs at both the overall and per-unit levels.
We know that fixed overheads will remain constant in the long run. However, if production
quantities rise, these expenses will be distributed across a larger number of units. As a
result, as output increases, the fixed cost per unit will decrease. Similarly, as output levels
are reduced, fixed costs per unit will rise.

Overall Fixed cost

60000 50000 50000 50000 50000 50000
50000
40000
30000
Cost

20000
10000
0
200 units 400 units 600 units 800 unit 1000 units
Units

Overall Fixed cost

Per unit fixed cost

300 250
250
Cost per unit

200
150 125
100 83.33 62.5 50
50
0
200 units 400 units 600 units 800 units 1000 units
Units

Per unit fixed cost

2.4.2 Variable cost

The cost of items that tend to directly and proportionately vary with the volume of activity is
referred to as variable cost. The variable cost per unit remains constant while the overall
cost varies with output levels. It is always stated in terms of units rather than time.
Variable cost or Variable Overhead constantly behaves at the per unit level but differently
at the overall expense level.
The graphs below depict the behavior pattern of variable costs or overheads. It shows while
total variable expenses are expected to rise with change in activity level, the variable
overhead per unit is expected to remain unchanged. Every increase in output level leads to a
proportionate increase in overall variable cost while per unit cost remains constant at all
levels.
 Overall Variable cost
120000
100000
100000
80000
80000
60000
60000
Cost

40000
40000
20000
20000
0
200 units 400 units 600 units 800 units 1000 units
Units

Variable cost Linear (Variable cost)

Per unit variable cost

120 100 100 100 100 100
100
Cost per unit

80
60
40
20
0
200 units 400 units 600 units 800 units 1000 units
Units

Per unit variable cost

2.4.3 Semi-Variable cost

These costs are made up of both fixed and variable charges. They are influenced in part by
changes in activity levels. They vary with volume due to the variable component, and they
do not alter in direct proportion to output due to the fixed component. Consider the cost of
a phone call. It features a monthly rental fee as well as per-call fees. These overhead
expenses remain constant at first but grow as volume increases.
It's hard to ascertain whether they should be considered fixed or variable. These expenses
are divided into fixed and variable categories for appropriate cost analysis.
The graph below shows the behavior of such costs at different levels of outputs based on
overall cost and per unit cost.
 Overall Semi Variable cost
100000 90000
90000
80000 70000
70000
60000 50000
50000
Cost

40000 40000
40000
30000
20000
10000
0
200 units 400 units 600 units 800 units 1000 units
Units

Semi Variable cost

Per unit semi-variable cost

250
200
150
100
50
0
200 units 400 units 600 units 800 units 1000 units

Per unit semi-variable cost

Certain statistical and other methods can be used to separate the fixed and variable aspects
of these costs.
⮚ Simultaneous Equation Method - The straight-line equation y = m x + c is used, with y
representing total cost, m representing variable cost per unit, x representing
production level, and c representing fixed expenses. These are solved numerically for
the values of m and c based on the total expenses at two distinct levels.
⮚ Graphical Method - Expenses are charted on graph paper, and a line is drawn and
expanded to meet the 'Y' axis, passing through the maximum points. The spot where
it crosses the 'Y' axis represents the fixed part of the costs, while the rest is variable.
2.4.4 Fixed cost, Variable cost, and Semi-Variable cost

Chart Title
120000

100000

80000

60000
Cost

40000

20000

0
200 unit 400 units 600 units 800 units 1000 units
Units

Fixed cost Variable cost Semi-Variable cost

2.5 Meaning of Cost Objects

Any element for which a cost must be determined independently is referred to as a cost
object. A product, a service, a process, an activity, a program, or a department can all be
considered cost objects.
For example:
● Purchase department, finance department, sales department are all different cost
objects under the Departmental costing method.
● Printing of Visiting cards, and invitation cards are different cost objects under the job
costing method used in the Printing press.

2.6 Cost units

Cost unit is the unit of goods, services, or time in relation to which costs are ascertained and
allocated. Cost units are generally the units for physical measurement like quantity, weight,
numbers, duration, etc. A cost unit is a device for breaking down the costs into smaller sub-
divisions. These sub-divisions are assigned to goods and services in order to estimate the
cost of goods, services, or hours spent on a particular job, among other things.
For example: Calculating the cost per labor hour, cost per passenger kilometer, cost per bed
occupied, etc.

2.7 Cost centers

Cost centers are divisions of a company. Departments, segments, divisions, and units are
examples of the term that communicate the same concept as a cost center. Because costs
 are determined and controlled in relation to cost centers, accurate identification of these
sub-units is critical for deploying a cost accounting system. Cost centers are frequently
referred to as centers that increase the organization's costs while only incidentally
increasing its profit.
The following are the several types of cost centers:
i. Cost centers that are Productive, Unproductive, or Mixed: The cost centers that are
actually involved in producing the goods are called productive cost centers because here
is where the raw materials are processed and turned into marketable goods. The service
or unproductive cost centers do not produce the goods, but they constitute significant
support for the production centers. Mixed-cost centers are those that have part lines
engaged in productive work and others involved in unproductive work.
ii. Personal and Impersonal Cost centers: A personal cost center is comprised of one or
more workers. An impersonal cost center is comprised of a department, a plant, or a
piece of equipment, or a group of all these.
iii. Operation and Process Cost center: An operation cost center is made up of machines
and/or people who perform the same function. Process cost centers are cost centers
that consist of operations performed in a continuous sequential manner.
The selection of an appropriate cost center is critical for calculations and control. The
responsibility of cost control is the responsibility of the manager in charge of that cost
center.

2.8 Cost Sheet/Statement

A cost sheet, also known as a cost statement, is a document that contains detailed cost
data. Cost data is presented using a functional classification system or another classification
system dependent on the needs of the users. It is a statement that accumulates all of the
costs associated with goods or production processes and is prepared at regular intervals of
time. It's used to calculate the profit margin on goods or services and helps in the
determinization of prices for similar goods.
For the purpose of preparing a cost sheet, costs are classified according to functions and
organized under the following cost heads –
⮚ Prime Cost
⮚ Cost of Production
⮚ Cost of Goods Sold
⮚ Cost of Sales

2.8.1 Prime Cost

The total of direct materials costs, direct labor costs, and direct expenses involved in the
production of goods or services are referred to as prime cost. For each element, the total
cost is computed independently.
For Example: If the direct material cost is $20000, the Direct labor cost is $ 20000, and the
Direct expense is $10000, then calculate the prime cost.
 Particulars Amount

(+) Direct Material consumed 20000

(+) Direct labor Cost 20000

(+) Direct Expenses 10000

Prime Cost 50000

✔ Direct material consumed – It is the cost material used in the production of goods or
services. It is calculated as: Opening stock Raw material (+) Raw material purchased
during the year (-) Closing stock of Raw material.

2.8.2 Cost of Production

The cost of production comprises all the cost of materials used, cost of direct labor involved,
direct expenses incurred, production overheads, quality management costs, primary
packaging costs, research and development costs, and administration costs incurred in the
production of goods or services. It is a cumulation of Prime cost and Factory cost.

Particulars Amount

Prime Cost

(+) Factory Cost and Overheads

Gross Work Cost

(+) Opening stock of work-in-progress

(-) Closing stock of work-in-progress

Factory or Work Cost

(+) Quality Management/Control Cost

(+) Production related Research and

Development Cost

(+) Production related Administration

Overheads

(+) Primary Packaging Cost

Cost of Production

✔ Factory or Work Overheads - These are manufacturing overheads which include the cost
of drawing or designing, depreciation on machinery and equipment, cost of spare part
consumed, amortized cost of designs or molds used, etc.
✔ Administration Overheads – It excludes general administration cost.
2.8.3 Cost of Goods Sold
Cost of goods sold is the cost of production of goods sold produced and excludes closing
stock or the cost of goods unsold at the end of the year.

Particulars Amount

Cost of Production

(+) Opening stock of finished goods

(-) Closing stock of finished goods

Cost of Goods Sold

2.8.4 Cost of Sales

The combined total cost of production and other costs incurred to make the goods or
services available for use by the end users are referred to as Cost of Sales. It includes the
cost of producing the goods sold, general administration costs or office expenses, selling and
distribution costs, and marketing costs.

Particulars Amount

Cost of Goods Sold

(+) General Administration cost

(+) Packaging cost (secondary)

(+) Selling and Distribution cost

(+) Marketing cost

Cost of Sales

2.9 Preparation of Cost Sheet

The following is the presentation of different cost items based on the relevant classification
in a Cost Sheet -

Format of Cost Sheet/Statement

Particulars Total Cost per

Cost unit

1 Direct materials consumed

2 (+) Direct labor cost

3 (+) Direct expenses

 4 Prime Cost

5 (+) Factory/Work overheads

6 Gross Factory/Work Cost

7 (+) Opening work-in-progress

8 (-) Closing work-in-progress

9 Factory/Work Cost

10 (+) Primary packaging cost

11 (+) Quality control cost

12 (+) Administration cost (production related)

13 (+) Research and development (production related)

14 Cost of Production

15 (+) Opening stock of Finished goods

16 (-) Closing stock of Finished goods

17 Cost of Goods Sold

18 (+) General administration overheads

19 (+) Selling and distribution overheads

20 Cost of Sales

2.10 Tenders and Quotations

A tender sheet is a cost sheet in the context that it is a type of cost sheet. It is the formal
process of requesting suppliers to bid on the goods or services of the producer. The tender
price is determined based on an estimated cost.
A quotation is a document submitted by the contractor to the owner that contains
information about the estimated materials, cost of goods or services, the time required to
complete the project, and other financial details. It is the responses of the bidders where
suppliers quote their prices for goods and services.
The following details should be carefully examined when preparing a tender:
✔ Cost of material and the respective changes due to various factors.
✔ Cost of labor and the respective changes due to various factors.
✔ Works or factory overheads
✔ Office or administrative overheads
✔ Selling and distribution overheads
 ✔ Estimated profit
The steps involved are
I. Estimate Direct material cost - By multiplying the quantity needed for a unit of a product
by the likely cost of materials, the direct material cost may be predicted. The cost of
purchasing materials will be calculated in light of future market conditions.
II. Estimate Direct labor cost - Direct wages or labor costs can be calculated based on the
number of workers needed for the job and anticipated wage rate changes in the near
future.
III. Estimate Overheads – The Overheads should be estimated based on previous experience
as a percentage.
IV. On the basis of the above, the following percentages are calculated –
● Percentage of factory cost on direct wages:
(Factory overheads/Direct wages) *100
● Percentage of office expenses on work cost:
(Office or administration overheads/Work cost) *100
● Percentage of Selling and distribution overheads on work cost:
(Selling and distribution overheads/Work cost) *100
V. To determine the tender price, a certain percentage of profit is to be added to the cost.
For estimation of profit, there are two ways:
● Percentage on Total cost:
Profit = Total cost * (Profit% on cost / 100)
● Percentage on Selling/Tender price:
Profit = Total cost * [Profit% on sales/ (100 – Profit% on sales)]

Conclusion
Ascertainment of cost is essential for making managerial decisions.
The classification of cost items should be done using a 'basis of classification' that has been
defined with a specific goal in mind.
Cost item classification should be constant from period to period, and cost statements
should be prepared with reference to a certain time period.
Time, nature or elements, degree of traceability to the product, association with the
product, variations in activity or volume, function, controllability, the cost for analytical and
decision-making purposes, and so on have all been used to classify costs.
A production or service location, function, activity, or item of equipment whose costs may
be traced to cost units is referred to as a cost center.
A cost unit is a unit of product or service that is used to calculate costs.
Cost data is presented using a functional classification system or another classification
system dependent on the needs of the users. It is a statement that accumulates all of the
costs associated with goods or production processes
A producer is expected to provide an order quotation. It is essential to provide a competitive
quote or pricing in advance. The tender price is determined based on an estimated cost.
A tender is a request from the owner to the contractor to execute certain work at a defined
cost within a specified time frame.
Quotations and tenders both are responses to requests.

Glossary

● Cost - Cost is a monetary measurement of the resources utilized in the manufacturing of

goods or the provision of services. 
● Product cost - Product costs are costs that can be directly attributed to a product and
are included in the value of inventory. The cost of the product is the total cost of the
factory.
● Period cost - Costs that are incurred on a time basis such as rent, salaries, and so on.
They are required to produce revenue, but they are unrelated to production and hence
cannot be linked to a product.
● Cost object - Any element for which a cost must be determined independently is
referred to as a cost object.
● Cost unit - The cost unit is the unit of goods, services, or time in relation to which costs
are ascertained and allocated.
● Cost center - Cost centers are divisions of a company. Cost centers are frequently
referred to as centers that increase the organization's costs while only incidentally
increasing its profit.
● Cost sheet - A cost sheet is a statement that shows the various components of the total
cost for a product.
● Tender - Tender is an invitation presented by the owner to the contractor to perform
specific work at a specific cost in the given time.
● Quotation -A quotation is a special document presented by the contractor to the owner
that contains the details of the estimated materials, cost of goods or services, the time
required for the completion of the project, and other related financial information.

Short answers
1. What are the types of costs on the basis of Cost centers?
2. Explain any 5 costs which are based on Relevance in Managerial Decision-making.
3. What do you understand by the cost of production and cost of goods sold? How can you
calculate them?
4. Explain fixed cost, variable cost, and semi-variable with the help of graphs.
5. Define tender sheet. Explain the process of preparation of a tender/quotation.

Questions for discussion forum

1. In your opinion, how can executives/managers of a company make use of cost data?
2. How are cost behavior assumptions in Management Accounting different than that of
Microeconomics?

Case study
ABC Super Tiffin ltd. to be produced during the year was 1000 super tiffin including the stock
left unsold at the end of the year. All super tiffin produced by the company are uniform in
terms of size and quality. The following information is given related to production and sales.
Opening Stock of materials: Rs100000
Closing Stock of materials: Rs25000
Materials purchased: Rs75000
Direct wages: Rs120000
Direct expenses: Rs80000
Factory overheads: 100% direct wages
Office and administration expenses: 10% work cost (related to production)
Selling and distribution overheads: Rs25000
Sales: Rs300000
Opening finished goods stock: Rs120000
Closing stock of finished goods: Rs50000
Profit percentage on cost: 25%
Also, there is a likely rise expected in material cost by 10% and 15% in direct labor cost.
Prepare Cost sheet/Statement and Quote the tender price for 500 such pieces of tiffin.

Multiple choice questions

1. Cost is a monetary measurement of the
a) Material cost
b) Resources utilized in the manufacturing.
c) labor cost
d) Other expenses
Explanation: Cost is a monetary measurement of all the resources utilized in the
manufacturing of goods or the provision of services. 
2. Based on nature, the cost is divided into:
a) Two categories
b) Three categories
c) Four categories
d) Five categories
Explanation: There are three elements of cost based on natural grouping: Material, labor,
and Expense.
3. Material cost includes ______ and excludes ________.
a) Carriage inward and trade discount.
b) Procurement Charges and finance charges.
c) Provident fund and gratuities
d) Duties and taxes and insurance
Explanation: Procurement costs, freight or carriage inward, duties and taxes, insurance, and
other costs directly related to the purchase of direct material are included in the direct
material cost. When calculating direct material costs, trade discounts or cash discounts, duty
drawbacks, tax refunds, and other comparable items are excluded.
4. Conversion cost is defined as
a) The sum of all material, labor, and other expenses incurred in the production of goods or
provision of services.
b) The cost of any material used in the manufacture of goods or services.
c) Other than material and labor costs, the cost is incurred to support production or
related activity
d) The sum of labor and other expenses which aid in the transformation of raw materials
into finished goods.
Explanation: Conversion costs refer to the sum of labor and other expenses which aid in the
transformation of raw materials into finished goods.
5. Salary paid Factory guard is referred to as
a) Direct expense
b) Direct labor cost
c) Indirect labor cost
d) Production overhead
Explanation: Indirect labor is labor that is used to perform tasks that are not directly related
to the production of goods or provision of services such as factory guard, supervisor, etc.
6. All costs associated with the formulation of policies and strategies, managing an
organization are referred to as
a) Production overheads
b) Administration overheads
c) Selling overheads
d) Distribution overheads
Explanation: Administration overheads include all costs associated with the formulation of
policies and strategies, managing an organization, and overseeing a company's operations.
7. Cost of a tube of toothpaste is an example of
a) Primary packaging
b) Secondary packaging
c) Selling and distribution cost
d) Administration cost
Explanation: The cost of primary packaging for example bottle of water, a tube of
toothpaste, etc and is included in the cost of manufacturing.
8. Installation costs at the delivery location for an air conditioner are classified as
a) Production overhead
b) Administration overhead
c) Selling overhead
d) Distribution overhead
Explanation: Installation costs at the delivery location for heavy equipment are included in
the production cost but not the distribution cost. Otherwise, all such costs are distribution-
related.
9. Based on behavior, which is not a category of classification
a) Fixed
b) Semi-Variable
c) Direct
d) Semi-fixed
Explanation: Fixed cost, variable cost, and semi-variable cost or semi-fixed cost are the
three types of costs based on how they respond to variations in levels of activity.
10. Abnormal losses are charged to
a) Units produced
b) Statement of profit/loss
c) Factory cost
d) Other expenses
Explanation: They are not factored into the production cost when making decisions and are
instead charged to the profit and loss account.
11. The regular idle time cost is _________ and included in
a) Abnormal cost and charged to profit and loss account
b) Controllable cost and included in production overhead
c) Uncontrollable cost and charged to profit and loss account
d) Normal loss and included in production overhead
Explanation: The calculation of normal cost must take into account regular idle time and is
added to production overhead.
12. Expenses that are appropriate for a given purpose or scenario are known as
a) Relevant costs
b) Replacement costs
c) Imputed costs
d) Sunk costs
Explanation: Expenses that are appropriate for a given purpose or scenario are known as
relevant costs.
13. Shut down costs are
a) Irrelevant for decision-making
b) Relevant for decision-making
c) Historical costs
d) Avoidable costs
Explanation: - Shut down costs include expenses that must be paid even if the plant is only
temporarily shut down. They are all fixed costs that cannot be avoided while the plant is
temporarily closed.
14. Fixed Cost or Fixed Overhead behaves
a) Constant at per unit level but differently at overall expense level.
b) Constant at per unit level and overall expense level.
c) Differently at total expense level and per unit level.
d) Similarly at total expense level and per unit level.
Explanation: Fixed Cost or Fixed Overhead behaves differently at total expense level and per
unit level.
15. Any element for which a cost must be determined independently is referred_________
a) Cost object
b) Cost center
c) Cost unit
d) Cost driver
Explanation: Any element for which a cost must be determined independently is referred to
as a cost object.
16. _______ is a cost head under cost sheet
a) Production overhead
b) Cost of goods sold
c) Cost of selling overheads
d) Cost of materials consumed
Explanation: For the purpose of preparing a cost sheet, costs are classified according to
functions and organized under the following cost heads – Prime Cost, Cost of Production,
Cost of Goods Sold and Cost of Sales.
17. Prime cost is equal to:
a) Direct materials consumed + direct labor cost + direct expenses
b) Indirect material + indirect labor + indirect expenses
c) Production overhead + administration overhead
d) Direct expenses + indirect expenses
Explanation: The total of direct materials costs, direct labor costs, and direct expenses
involved in the production of goods or services are referred to as prime cost.
18. The tender price is determined based on
a) Previous tender
b) Apportioned cost
c) Ascertained cost
d) 0pportunity cost
Explanation: The tender price is determined based on an estimated cost.
19. If total cost is Rs1000000 and profit percentage on sales is 25%, calculated profit is:
a) 250000
b) 150000
c) 200000
d) 100000
Explanation: Percentage on Selling/Tender price: Profit = Total cost * [Profit% on sales/
(100 – Profit% on sales)]
20. ________ is an invitation presented by the owner to the contractor to perform specific
work at a specific cost in the given time.
a) Cost sheet
b) Cost statement
c) Quotation
d) Tender
Explanation: A tender is an invitation presented by the owner to the contractor to perform
specific work at a specific cost in the given time.

Case Study (Answer)

Statement of cost

Particulars Total cost (1000

units)

Direct materials consumed 150000

+ Direct wages 120000

+ Direct expenses 80000

Prime cost 350000

+ Factory overheads (100% of direct wages) 120000

Work cost 470000

+ Office and administration overheads (10% of work cost) 47000

Cost of production 517000

+ Opening finished goods stock 120000

(-) Closing finished goods stock (50000)

Cost of goods sold 587000

+ Selling and distribution expense 25000

Cost of sales 612000

● Direct materials consumed: Opening stock of raw material + Raw materials purchased
during the year – Closing stock of raw materials
(100000+75000-25000) = 150000
Statement of cost for Tender (500 pieces)

Particulars Per unit cost

Direct materials 165

(150000*500/1000) and add 10% rise

+ Direct labor 138

(120000*500/1000) and add 15% rise

Prime cost 303

+ Factory overheads (138*100/100) 138

+ Office and administration overheads (470*10/100) 47

+ Selling and distribution overheads (470*5.32/100) 25

Total cost 513

+ Profit (513*25/100) 128.25

Selling price 641.25

● Percentage of factory overheads on direct wages

Factory overheads/direct wages*100 = (120000/120000*100) = 100%
● Percentage of office and administration overhead on work cost
Office and administration overheads/work cost*100 = (47000/470000*100) =10%
● Percentage of selling and distribution overheads on work cost
Selling and distribution overheads/work cost*100 = (25000/470000*100) = 5.32%
● Percentage of profit on cost = Total cost*Profit on cost/100