Business Accounting Tutorial | COSTING & AUDITING

The motive of an organization is always profit maximization (except non-profit organization (NGO)). This profit can be increased either by increasing the sale price or by reducing cost. In today’s competitive world it is difficult for a firm to manage price and any tendency to increase price may shift the customer base to its competitor’s. Therefore the firm has to accept the price prevailing in the market. In order to be in the league, the emphasis is on cost reduction, which requires having complete knowledge of the associated costs and their components.

In layman’s language cost is the price paid for a thing. In accounting terms, costing is defined as something of value, usually, an amount of money, given up in exchange for something else, usually goods or services. Costs are the prices paid for purchasing, processing, and delivery activities involved in turning raw materials into finished products. As a verb, cost means to estimate the amount of money needed to produce a product or perform a service. Example – Cost of machinery, building, etc. It must be noted that all expenses are costs, but not all costs are expenses.

Classification of Costs

Classification on the basis of production cost:

Material Cost
Labour Cost
Overhead Cost

Classification on the basis of the volume of activity:

Fixed Cost
Variable Cost

Classification on the basis of ease of traceability:

Direct Cost
Indirect Cost

The objective behind the classification of cost is to determine the unit cost of the product (used in inventory valuation, pricing, and profit determination.) and providing data needed for control of costs.

Definitions

Material Cost

Material Cost is the cost incurred during the manufacturing process of a product. It is a part of the raw material cost that can be specifically associated with or assigned to the manufacture of a product, a particular work order, or provision of a service. Therefore, material cost is considered an integral part of the product.

Labor Cost

Labor cost is the cost associated with employing people in an organization, who are directly or indirectly concerned with the production of the product/services. It is that part of the cost of goods and services attributable to wages, especially for direct labor.

Overhead cost

Overhead costs refer to the ongoing expense of operating a business such as rent, maintenance, electricity, wages, etc. The term overhead is usually used to group expenses that are necessary for the smooth functioning of the business but cannot be immediately associated with the products/services being manufactured. Therefore, overhead is the cost of the facilities surrounding production, which do not, however, directly become part of the product.