Cost accounting: meaning, objectives, classification of costs and installing a costing system
Cost and Management Accounting · Foundations · Topic 1 of 18 · 5 min read
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1. Cost, costing and cost accounting
Cost is the amount of expenditure, actual or notional, incurred on or attributable to a given thing. CIMA defines it as “the amount of expenditure (actual or notional) incurred on, or attributable to, a specified thing or activity.” A cost is always cost of something: a unit, a job, a process or a department. That something is the cost object, and the unit in which it is measured (per tonne, per job, per kilowatt-hour) is the cost unit. A cost centre is a location, person or item of equipment for which costs are collected.
Costing is the technique and process of ascertaining costs. Cost accounting is the process of accounting for cost from the point at which expenditure is incurred to the establishment of its ultimate relationship with cost centres and cost units. In its wider sense it includes the use of the cost data for control and decisions, which is where cost accounting shades into management accounting.
2. Objectives of cost accounting
- Ascertainment of cost of each product, job, process or service.
- Fixing selling prices and preparing tenders and quotations.
- Cost control and cost reduction through standards, budgets and variance reports.
- Valuation of stock of raw materials, work-in-progress and finished goods.
- Locating waste and inefficiency: idle time, idle capacity, scrap, spoilage.
- Information for decisions: make or buy, shut down or continue, accept a special order, choose a product mix.
- Comparison between periods, departments and (through uniform costing) firms.
3. Cost accounting and financial accounting
| Point | Financial accounting | Cost accounting |
|---|---|---|
| Purpose | True and fair view to owners, lenders, tax authorities | Cost information to management for control |
| Legal position | Compulsory (Companies Act 2013, tax law) | Voluntary, except where cost records are prescribed under s.148 |
| Scope | Whole business, all transactions | Products, jobs, processes, departments |
| Data | Historical, actual | Historical and predetermined (standards, budgets) |
| Period | Yearly statements | Continuous; reports weekly or monthly |
| Stock valuation | Cost or net realisable value, whichever lower | At cost |
4. Elements of cost
Total cost is built from three elements, each split into direct and indirect:
- Material: direct material (raw material that becomes part of the product) and indirect material (lubricants, cotton waste, small tools).
- Labour: direct labour (wages of workers who convert the material) and indirect labour (supervisors, storekeepers, maintenance staff).
- Expenses: direct (chargeable) expenses such as hire of a special machine for a job, royalty per unit, and indirect expenses such as rent and power.
Direct material + direct labour + direct expenses = prime cost. All indirect material, labour and expenses together are overheads, grouped by function into factory (works), office and administration, and selling and distribution overheads.
5. Classification of costs
- By element: material, labour, expenses.
- By function: production, administration, selling, distribution, research and development.
- By traceability: direct and indirect.
- By behaviour: fixed (rent, salaries: constant in total, falling per unit as output rises), variable (direct material: constant per unit, rising in total), and semi-variable (electricity, telephone: a fixed charge plus a usage charge).
- By controllability: controllable and uncontrollable at a given level of management.
- By normality: normal costs (charged to production) and abnormal costs (charged to costing profit and loss).
- By time: historical costs and predetermined costs (estimated and standard).
- For decisions: marginal, differential, opportunity, sunk, out-of-pocket, imputed and replacement costs.
6. Installation of a costing system
The examiner wants two things: the preliminary study before the system is chosen, and the steps in putting it in.
Preliminary considerations. (a) The nature of the product and the process: a job-order shop needs job costing, a chemical plant needs process costing. (b) The organisation structure and the lines of authority. (c) The size of the firm and the cost the system will carry: the system must pay for itself. (d) The information management actually wants. (e) The existing financial accounting system, so that the two can be reconciled. (f) The attitude of staff and workers.
Steps.
- Decide the cost units and cost centres.
- Choose the method of costing (job, batch, contract, process, operating, unit) and the technique (historical, standard, marginal).
- Set up the material control procedure: purchase requisitions, goods received notes, bin cards, stores ledger, pricing of issues.
- Set up the labour procedure: time-keeping, time-booking, job cards, wage sheets.
- Fix the overhead procedure: collection, apportionment bases, absorption rates.
- Design the forms and reports, and the frequency of reports.
- Decide whether to keep an integrated or a non-integrated set of accounts, and the reconciliation procedure.
- Introduce gradually, train the staff, and win the co-operation of foremen and workers.
How this is examined
“Explain the steps involved in installation of cost accounting system” is the 10-mark essay in Unit I of the B.Com paper (January 2026, January 2025). Write the preliminary study as one paragraph, the eight steps as a numbered list, and close with the difficulties. “Define cost accounting and explain its objectives” is a 6-mark short answer: definition, then the seven objectives. The classification of costs feeds the cost sheet (next note) and the fixed/variable split feeds flexible budgets and marginal costing.
Now try the real questions: Cost and Management Accounting past question papers.