13  Cost and Management Accounting

13.1 Meaning of Cost and Management Accounting

Cost accounting is the branch of accounting concerned with the ascertainment, recording, allocation, control and reporting of costs. The CIMA Official Terminology defines it as “the application of accounting and costing principles, methods and techniques in the ascertainment of costs and the analysis of savings and/or excesses as compared with previous experience or with standards” (cima2024?).

Management accounting extends cost accounting toward decision-support. The Institute of Chartered Accountants of India describes it as “the presentation of accounting information in such a way as to assist management in the creation of policy and in the day-to-day operation of an undertaking” (icai2024?).

TipThree Branches Compared

Dimension	Financial Accounting	Cost Accounting	Management Accounting
Primary user	External	Internal	Internal
Time horizon	Past	Past and present	Past, present, future
Statutory?	Mandatory	Mandatory for specified industries (Sec. 148)	Voluntary
Unit of measure	Money only	Money and physical units	Money, physical units, ratios
Reporting frequency	Annual / quarterly	Continuous	As needed
Standardisation	High (Ind-AS / Sch. III)	Cost Accounting Standards (CAS)	None

13.2 Elements of Cost

The classical decomposition of cost has three elements — material, labour and expenses — each split further into direct and indirect parts.

TipElements of Cost

Element	Direct portion	Indirect portion
Material	Material directly traceable to a product	Consumables, lubricants, factory supplies
Labour	Wages of workers directly producing the product	Salaries of supervisors, store-keepers, security
Expenses	Royalty, hire charges of special equipment	Rent, rates, insurance, depreciation

The standard cost-classification chart aggregates these into:

• Prime Cost = Direct Material + Direct Labour + Direct Expenses
• Factory / Works Cost = Prime Cost + Factory Overheads
• Cost of Production = Works Cost + Office and Administration Overheads
• Cost of Sales = Cost of Production + Selling and Distribution Overheads
• Sales = Cost of Sales + Profit / − Loss

13.3 Classification of Cost

Costs are classified along several intersecting axes (arora2021?; horngren2021?).

TipClassification of Cost

Basis	Categories
By traceability	Direct vs Indirect
By behaviour	Fixed, Variable, Semi-variable, Stepped
By function	Production, Administration, Selling, Distribution, R&D
By controllability	Controllable vs Uncontrollable
By relevance	Relevant vs Irrelevant; Sunk; Opportunity; Imputed
By time	Historical vs Predetermined (Standard / Budgeted)
By inventory	Product cost vs Period cost

A fixed cost (factory rent) does not change with output in the short run; a variable cost (raw material) changes proportionately; a semi-variable cost (telephone bill) has a fixed and a variable component. Sunk costs are irrecoverable and irrelevant for future decisions. Opportunity cost is the value of the next best alternative foregone.

13.4 The Cost Sheet

A cost sheet (or statement of cost) lays out the build-up of cost from elements to total. It is the standard output of an external-cost-record system.

TipFormat of a Cost Sheet

Item	Cost (₹)
Direct Material Consumed	xxx
Direct Labour	xxx
Direct Expenses	xxx
Prime Cost	xxx
Add: Factory Overheads	xxx
Works / Factory Cost	xxx
Add: Office and Administration Overheads	xxx
Cost of Production	xxx
Add: Opening Stock of Finished Goods − Closing Stock	xxx
Cost of Goods Sold	xxx
Add: Selling and Distribution Overheads	xxx
Cost of Sales	xxx
Add: Profit (or − Loss)	xxx
Sales	xxx

Direct Material Consumed = Opening Stock of RM + Purchases + Carriage Inward − Returns − Closing Stock of RM.

13.5 Methods of Costing

A method of costing is the system used to ascertain cost; it depends on the nature of the production process.

TipSix Methods of Costing

Method	Used in	Cost unit
Job costing	Tailoring, printing, repair shops	Each individual job
Batch costing	Pharmaceuticals, spare parts	A batch (a group of identical units)
Contract costing	Construction, civil engineering	A contract (a large job)
Process costing	Cement, oil refining, sugar, chemicals	Output of a process per period
Operation costing	Toy making, garment making	Each operation in the process
Service / Operating costing	Transport, hospitals, hotels, electricity	Composite unit (passenger-km, bed-day)

13.6 Techniques of Costing

A technique of costing is the analytical lens applied to cost data — orthogonal to the method.

TipFive Techniques of Costing

Technique	Working principle
Marginal / Variable Costing	Charges only variable costs to product; fixed costs are period costs
Absorption / Full Costing	Charges all (variable + fixed) manufacturing costs to product
Standard Costing	Compares actual costs against pre-set standards; analyses variances
Activity-Based Costing (ABC)	Allocates overheads on activities rather than volume
Budgetary Control	Establishes budgets; compares against actuals; takes corrective action

13.7 Marginal Costing and CVP Analysis

Marginal cost is the change in total cost when output changes by one unit; in practice, it is the variable cost per unit. Marginal costing uses contribution as the focus of analysis.

TipKey Marginal-Costing Formulas

Term	Formula
Contribution	Sales − Variable Cost
Profit-Volume (P/V) ratio	(Contribution ÷ Sales) × 100
Break-even point (units)	Fixed Cost ÷ Contribution per unit
Break-even point (value)	Fixed Cost ÷ P/V ratio
Margin of safety	Actual Sales − Break-even Sales
Sales for desired profit	(Fixed Cost + Desired Profit) ÷ P/V ratio

13.7.1 Worked example

Selling price ₹50, variable cost ₹30, fixed cost ₹2,00,000. Contribution = ₹20 per unit; P/V ratio = 40 per cent. Break-even = 2,00,000 ÷ 20 = 10,000 units (or ₹5,00,000 in value). Sales required for a profit of ₹1,00,000 = (2,00,000 + 1,00,000) ÷ 0.40 = ₹7,50,000.

flowchart LR
  TR[Total Revenue<br/>= Price × Q] --> M[Margin of Safety<br/>region]
  TC[Total Cost<br/>= FC + VC × Q] --> BE[Break-Even Point<br/>TR = TC]
  BE --> M
  style TR fill:#E3F2FD,stroke:#1565C0
  style TC fill:#FFEBEE,stroke:#C62828
  style BE fill:#E8F5E9,stroke:#2E7D32

13.8 Standard Costing and Variance Analysis

A standard cost is a pre-determined cost set under specified working conditions. A variance is the difference between actual and standard cost. The total cost variance breaks down into material, labour and overhead variances (arora2021?).

TipStandard Material and Labour Variances

Variance	Formula
Material Cost Variance	(SQ × SP) − (AQ × AP)
Material Price Variance	AQ × (SP − AP)
Material Usage Variance	SP × (SQ − AQ)
Labour Cost Variance	(SH × SR) − (AH × AR)
Labour Rate Variance	AH × (SR − AR)
Labour Efficiency Variance	SR × (SH − AH)

(SQ = Standard Quantity; SP = Standard Price; AQ = Actual Quantity; AP = Actual Price; SH = Standard Hours; SR = Standard Rate; AH = Actual Hours; AR = Actual Rate.)

A variance is favourable if actual cost is less than standard, and adverse if actual cost exceeds standard.

13.9 Budgeting and Budgetary Control

A budget is a quantitative expression of a plan. Budgetary control uses budgets to plan, coordinate and control operations.

TipTypes of Budgets

Basis	Types
Time	Long-term, Short-term, Current
Function	Sales, Production, Materials, Labour, Overheads, Cash, Master
Flexibility	Fixed (one level of activity) vs Flexible (range of levels)
Method	Incremental vs Zero-Based Budgeting (ZBB)

The master budget is the consolidated summary; the cash budget projects cash inflows and outflows; zero-based budgeting (developed by Peter Pyhrr at Texas Instruments) requires every expense to be justified afresh each period.

13.10 Activity-Based Costing (ABC)

Traditional absorption costing distributes overhead on volume-based allocators (machine hours, labour hours), which can mis-cost low-volume, complex products. Activity-Based Costing, popularised by Robin Cooper and Robert Kaplan, traces overheads to activities (the actual drivers of cost) and then from activities to products (kaplan1988?).

The four steps:

• Identify activities (e.g. set-up, inspection, scheduling).
• Compute the cost of each activity (the cost pool).
• Identify a cost driver for each activity (e.g. number of set-ups, number of inspections).
• Charge each product the activity rate × its consumption of the driver.

ABC reveals the cross-subsidy hidden inside traditional cost systems: high-volume simple products often subsidise low-volume complex ones.

13.11 Decision-Making Applications

Marginal costing supplies the lens for several recurring decisions (khan2022?).

TipFive Decision Settings

Decision	Decision rule
Make-or-buy	Buy if buying price < relevant (variable) cost of making
Accept-special-order	Accept if price > variable cost (when there is spare capacity)
Drop-or-retain product	Retain if it makes a positive contribution toward fixed cost
Optimum product mix (one constraint)	Rank by contribution per unit of limiting factor
Sell-or-process-further	Process further if incremental revenue > incremental processing cost

13.12 Cost-Audit and CAS

Section 148 of the Companies Act 2013 empowers the Central Government to require cost records and a cost audit in specified industries (notified through the Companies (Cost Records and Audit) Rules, 2014). The Institute of Cost Accountants of India (ICMAI) issues Cost Accounting Standards (CAS-1 onward) governing terminology, measurement and disclosure of costs.

13.13 Exam-Pattern MCQs

Q 01

Which of the following is not an element of cost?

• ADirect material
• BDirect labour
• CIndirect expenses (overheads)
• DSales revenue

View solution

Correct Option: D

Sales revenue is income, not a cost element. Cost is built from material, labour and expenses (each split into direct and indirect).

Q 02

Match the costing method with the typical industry:

	Method		Industry
(i)	Job costing	(a)	Cement / oil refining
(ii)	Batch costing	(b)	Construction
(iii)	Contract costing	(c)	Pharmaceuticals
(iv)	Process costing	(d)	Tailoring / printing

• A(i)-(d), (ii)-(c), (iii)-(b), (iv)-(a)
• B(i)-(c), (ii)-(d), (iii)-(a), (iv)-(b)
• C(i)-(a), (ii)-(b), (iii)-(c), (iv)-(d)
• D(i)-(b), (ii)-(a), (iii)-(d), (iv)-(c)

View solution

Correct Option: A

Q 03

A product sells at ₹100. Variable cost is ₹60. Fixed cost is ₹80,000. The break-even point in units is:

• A1,000 units
• B1,500 units
• C2,000 units
• D2,500 units

View solution

Correct Option: C

Contribution per unit = ₹100 − ₹60 = ₹40. BEP = 80,000 ÷ 40 = 2,000 units.

Q 04

Match the marginal-costing term with its formula:

	Term		Formula
(i)	Contribution	(a)	(Contribution ÷ Sales) × 100
(ii)	P/V ratio	(b)	Sales − Variable Cost
(iii)	Break-even sales	(c)	Actual Sales − Break-even Sales
(iv)	Margin of safety	(d)	Fixed Cost ÷ P/V ratio

• A(i)-(b), (ii)-(a), (iii)-(d), (iv)-(c)
• B(i)-(a), (ii)-(b), (iii)-(c), (iv)-(d)
• C(i)-(c), (ii)-(d), (iii)-(b), (iv)-(a)
• D(i)-(d), (ii)-(c), (iii)-(a), (iv)-(b)

View solution

Correct Option: A

Q 05

Standard quantity for actual output is 1,000 kg at ₹10 per kg. Actual usage is 1,100 kg at ₹9 per kg. The Material Usage Variance is:

• A₹1,000 (Adverse)
• B₹1,000 (Favourable)
• C₹100 (Adverse)
• D₹900 (Favourable)

View solution

Correct Option: A

Usage Variance = SP × (SQ − AQ) = 10 × (1,000 − 1,100) = ₹1,000 Adverse.

Q 06

Which of the following is not a feature of Activity-Based Costing?

• AIdentifies activities as cost drivers
• BDistributes overhead in proportion to volume only
• CUses cost pools and cost-driver rates
• DReveals cross-subsidies between products

View solution

Correct Option: B

ABC was introduced precisely to move away from volume-only allocation. The other three are core features.

Q 07

Arrange the following items in the order in which they appear in a cost sheet: (i) Cost of Production (ii) Prime Cost (iii) Cost of Sales (iv) Works / Factory Cost

• A(ii), (iv), (i), (iii)
• B(i), (ii), (iii), (iv)
• C(iv), (i), (ii), (iii)
• D(iii), (iv), (i), (ii)

View solution

Correct Option: A

Prime → Works/Factory → Cost of Production → Cost of Sales.

Q 08

Match the technique with its proponent or distinguishing feature:

	Technique		Feature / Proponent
(i)	Marginal Costing	(a)	Cooper and Kaplan
(ii)	Standard Costing	(b)	Variance analysis from pre-set standards
(iii)	Activity-Based Costing	(c)	Charges only variable costs to product
(iv)	Zero-Based Budgeting	(d)	Peter Pyhrr at Texas Instruments

• A(i)-(c), (ii)-(b), (iii)-(a), (iv)-(d)
• B(i)-(a), (ii)-(b), (iii)-(c), (iv)-(d)
• C(i)-(b), (ii)-(d), (iii)-(c), (iv)-(a)
• D(i)-(d), (ii)-(a), (iii)-(b), (iv)-(c)

View solution

Correct Option: A

ImportantQuick recall

• Cost build-up: Prime → Works → Cost of Production → Cost of Goods Sold → Cost of Sales → Sales.
• Three elements: Material, Labour, Expenses — each Direct or Indirect.
• Method of costing depends on production process: Job, Batch, Contract, Process, Operation, Service. Technique depends on the analytical lens: Marginal, Absorption, Standard, ABC, Budgetary.
• Marginal costing identities: Contribution = Sales − VC; P/V = C/S × 100; BEP = FC ÷ Contribution per unit; Margin of Safety = Actual − BEP Sales.
• Standard variance signs: actual < standard → Favourable; actual > standard → Adverse.
• Material variances: Cost = (SQ × SP) − (AQ × AP); Price = AQ × (SP − AP); Usage = SP × (SQ − AQ).
• ABC traces overheads via activities → cost pools → cost drivers → products (Cooper & Kaplan).
• ZBB requires every expense to be justified afresh each period (Peter Pyhrr, Texas Instruments).
• Cost audit under Sec. 148 of Companies Act 2013; CAS issued by ICMAI.