What is Cost Accounting in A/L Examination (Sri Lanka)?

Cost Accounting is a topic in the Commerce Stream syllabus of A/L Examination (Sri Lanka). It carries a weight of 3% in the exam. Our notes cover the key concepts, formulas, and problem-solving approaches you need to master this topic.

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Cost Accounting

🟢 Lite — Quick Review (1h–1d)

Rapid summary for last-minute revision before your exam.

Cost Accounting — Key Facts for Sri Lanka A/L Examination

Cost Classification:

Type	Description	Example
Direct Costs	Traceable to specific product	Raw material, direct labour
Indirect Costs	Cannot be traced directly	Factory rent, supervisor salary
Fixed Costs	Total constant regardless of output	Rent, salaries
Variable Costs	Changes with level of output	Raw materials, power
Semi-Variable	Has both fixed and variable elements	Electricity bills

Elements of Product Cost:

Product Cost = Direct Material + Direct Labour + Manufacturing Overhead

Overhead Allocation:

Allocation base (machine hours, labour hours, units)
Overhead absorption rate = Estimated Overhead / Estimated Base
Overhead rate × Actual base = Overhead absorbed

⚡ A/L Exam Tip: In A/L questions, a common trap is forgetting that indirect costs must still be included in product cost. Always ask: “Can I trace this directly to the product?”

🟡 Standard — Regular Study (2d–2mo)

Standard content for students with a few days to months.

Cost Accounting — Detailed Study Guide

Cost Classification Deep Dive

By Nature/Element:

Element	What it includes	Sri Lankan Example
Direct Material	Raw materials that form part of the product	Fabric in garment manufacturing
Direct Labour	Workers directly involved in production	Wages of machine operators in a shoe factory
Direct Expenses	Expenses directly traceable to specific products	Cost of specific dies/moulds
Indirect Labour	Labour not directly traceable	Salary of factory supervisor
Indirect Material	Items that cannot be traced to specific products	Nails, glue, oil for machinery

By Behaviour:

Cost Type	Definition	Example
Fixed Cost (FC)	Total cost stays constant; per unit cost changes	Factory rent of Rs. 500,000/month
Variable Cost (VC)	Total changes with output; per unit stays constant	Material cost Rs. 50 per unit
Semi-Variable	Part fixed, part varies with output	Electricity: fixed charge + usage

Cost Equations:

Total Cost (TC) = Fixed Cost + Variable Cost
TC = FC + (Variable cost per unit × Number of units)
TC = FC + VC

Average Cost = Total Cost / Units produced
Marginal Cost = Change in TC from producing one more unit

Overhead Allocation

Steps in Overhead Allocation:

Step 1: Identify Cost Pool

Group all indirect costs together
e.g., All factory overhead costs form one cost pool

Step 2: Select Allocation Base

Base	Appropriate when
Machine hours	Capital-intensive production
Labour hours	Labour-intensive production
Units produced	Simple, homogeneous products
Direct material cost	Material-intensive products

Step 3: Calculate Overhead Absorption Rate (OAR)

OAR = Estimated Overhead Costs / Estimated Allocation Base

Example:
Estimated overhead = Rs. 1,000,000
Estimated machine hours = 10,000 hours
OAR = Rs. 1,000,000 / 10,000 = Rs. 100 per machine hour

Step 4: Absorb Overhead to Products

Overhead absorbed = OAR × Actual base used by product

Example:
Product X used 200 machine hours
Overhead absorbed = Rs. 100 × 200 = Rs. 20,000

Under/Over Absorption:

Situation	Meaning	Action
Under absorption	Absorbed overhead < Actual overhead	Underhead recovered → Add to cost
Over absorption	Absorbed overhead > Actual overhead	Overhead recovered → Reduce cost or treat as income

Under/Over Absorption Formula:

Under/(Over) = Actual Overhead - Absorbed Overhead
If positive = Under absorption (cost needs to be added)
If negative = Over absorption (income/credit to P&L)

Example (Sri Lankan Factory):

Actual overhead incurred: Rs. 1,150,000
Overhead absorbed based on OAR: Rs. 1,080,000
Under absorption: Rs. 1,150,000 - Rs. 1,080,000 = Rs. 70,000
This Rs. 70,000 must be added to the product cost

Job Costing and Process Costing

Job Costing:

Each job is a separate cost unit
Used in printing, construction, tailoring
Job cost sheet maintained

Job Cost Sheet Format:

Job No: 101 | Customer: XYZ Ltd
Product: 500 custom shirts

                   Rs.
Direct Material      75,000
Direct Labour       45,000
Direct Expenses      5,000
                    -------
Prime Cost         125,000
Add: Overhead
  (OAR: Rs. 80 per labour hour × 900 hrs) = 72,000
                    -------
Total Cost         197,000
                    =======
Cost per unit = 197,000 / 500 = Rs. 394 per unit

Process Costing:

Continuous mass production
Costs averaged over units
Used in flour mills, sugar, cement, textile spinning

Process Account Format:

Process 1 Account for January

Dr.                                    Cr.
                            | Units | Rs.   |                       | Units | Rs.
Opening WIP (40% complete) | 200   | 40,000 | Completed to Process 2 | 1,800 | 270,000
Direct Material           | 2,000  | 200,000| Closing WIP (60% complete)| 400 | 48,000
Direct Labour             |        | 60,000 |
Overhead                  |        | 18,000 |
                          |       |---------|
                          | 2,200 | 318,000|                           | 2,200 | 318,000
                          |       |========|                            |       |=======

Equivalent Units (for incomplete work):

Equivalent Units = Physical Units × Percentage Complete

Example:
Opening WIP: 200 units, 40% complete = 80 equivalent units
Units started and completed: 1,600 units = 1,600 equivalent units
Closing WIP: 400 units, 60% complete = 240 equivalent units
Total equivalent units = 1,920
Cost per equivalent unit = Rs. 270,000 / 1,920 = Rs. 140.63

🔴 Extended — Deep Study (3mo+)

Comprehensive coverage for students on a longer study timeline.

Cost Accounting — Complete Notes for A/L Sri Lanka

Marginal Costing and Contribution Analysis

Key Concepts:

Marginal Cost: Cost of producing one additional unit (usually = variable cost)

Contribution: Revenue minus Variable Costs

Contribution = Selling Price - Variable Cost
Contribution = Fixed Costs + Profit

Per Unit Contribution = Selling Price per unit - Variable Cost per unit

Break-Even Analysis:

Break-Even Point (Units):

BEP (units) = Fixed Costs / Contribution per unit

Example:
Fixed Costs = Rs. 200,000
Selling Price = Rs. 500 per unit
Variable Cost = Rs. 300 per unit
Contribution = Rs. 500 - Rs. 300 = Rs. 200 per unit

BEP = 200,000 / 200 = 1,000 units

Break-Even Point (Rs.):

BEP (Rs.) = Fixed Costs / Contribution Margin Ratio
Contribution Margin Ratio = Contribution / Selling Price

Example:
CM Ratio = 200 / 500 = 0.40 (40%)
BEP (Rs.) = 200,000 / 0.40 = Rs. 500,000

Margin of Safety:

Margin of Safety = Actual Sales - Break-Even Sales
Margin of Safety % = (MOS / Actual Sales) × 100

Example:
Actual Sales = Rs. 800,000
BEP Sales = Rs. 500,000
MOS = Rs. 300,000
MOS % = 37.5%

⚡ A/L Exam Tip: Break-even questions frequently appear in A/L! Students often forget that BEP in rupees needs the CM ratio, not just the per-unit contribution.

Profit-Volume (P/V) Ratio:

P/V Ratio = (Contribution / Sales) × 100
          = (Fixed Cost + Profit) / Sales × 100

A higher P/V ratio indicates better profitability

Target Profit Analysis:

Units for Target Profit = (Fixed Costs + Target Profit) / Contribution per unit

Example: Target profit = Rs. 100,000
Units needed = (200,000 + 100,000) / 200 = 1,500 units

Costing Methods

Absorption Costing vs. Marginal Costing:

Feature	Absorption Costing	Marginal Costing
Fixed overhead	Absorbed into product cost	Written off to P&L
Inventory valuation	Includes fixed overhead	Excludes fixed overhead
Profit (when production > sales)	Higher profit	Lower profit
Fixed overhead recovery	Uses pre-determined OAR	Not allocated to products

Why the Difference?: When production > sales in absorption costing, some fixed overhead remains in inventory (not yet expensed). In marginal costing, ALL fixed overhead goes to P&L immediately.

Decision-Making using Marginal Costing:

Make or Buy Decision:

Relevant Cost for Make/Buy = Variable Cost of production
Plus: Any additional costs if buying
Less: Any costs saved if buying

Example:
Variable cost to make = Rs. 80 per unit
If buy from supplier = Rs. 95 per unit
Additional costs if buy = Rs. 5 (delivery)
Total cost to buy = Rs. 100

Decision: Make (Rs. 80 < Rs. 100)

Special Order Pricing:

Relevant Cost = Variable Costs + Opportunity Cost (if any)
Minimum acceptable price = Variable Cost (if no opportunity cost)
Add margin for contribution toward fixed costs and profit

Closing a Department Decision:

Costs saved if department closes = Variable costs + Avoidable fixed costs
Costs lost if department closed = Contribution from department

Decision: Keep department if Contribution > Avoidable Fixed Costs

Standard Costing and Variance Analysis

Standard Cost: A pre-determined cost for a unit of output under normal conditions

Variance: The difference between actual cost and standard cost

Types of Variances:

Material Variance:

Material Price Variance (MPV) = (Actual Price - Standard Price) × Actual Quantity
Material Usage Variance (MUV) = (Actual Usage - Standard Usage) × Standard Price

Total Material Variance = MPV + MUV

Example:
Standard: 2 kg at Rs. 50/kg = Rs. 100 per unit
Actual: Purchased 1,000 kg at Rs. 52/kg, used 980 kg for 480 units

MPV = (52 - 50) × 1,000 = Rs. 2,000 Unfavourable
MUV = (980 - 960) × 50 = Rs. 1,000 Unfavourable
Total = Rs. 3,000 Unfavourable
(Standard usage for 480 units = 480 × 2 = 960 kg)

Labour Variance:

Labour Rate Variance (LRV) = (Actual Rate - Standard Rate) × Actual Hours
Labour Efficiency Variance (LEV) = (Actual Hours - Standard Hours) × Standard Rate

Total Labour Variance = LRV + LEV

Example:
Standard: 3 hours at Rs. 100/hour = Rs. 300 per unit
Actual: Paid Rs. 105/hour for 1,500 hours for 480 units

LRV = (105 - 100) × 1,500 = Rs. 7,500 Unfavourable
LEV = (1,500 - 1,440) × 100 = Rs. 6,000 Unfavourable
Total = Rs. 13,500 Unfavourable
(Standard hours for 480 units = 480 × 3 = 1,440 hours)

Overhead Variance:

Fixed Overhead Variance = Budgeted Fixed Overhead - Actual Fixed Overhead
Volume Variance = (Actual Units - Budgeted Units) × OAR

Example:
Budgeted overhead = Rs. 500,000
Budgeted units = 10,000
OAR = Rs. 50 per unit
Actual overhead = Rs. 480,000
Actual units = 9,500

Fixed Overhead Variance = 500,000 - 480,000 = Rs. 20,000 Favourable
Volume Variance = (9,500 - 10,000) × 50 = Rs. 25,000 Unfavourable

⚡ A/L Key: Favourable variance = costs saved vs. standard (good) Unfavourable variance = costs exceeded standard (bad)

Sri Lankan Context: Manufacturing Costing

Typical Cost Structure in Sri Lankan Manufacturing:

Industry	Major Cost	Typical %
Garment manufacturing	Direct labour + material	Labour 20-30%, Material 50-60%
Tea processing	Variable (green leaf)	Green leaf 60-70% of cost
Rubber processing	Direct material	Latex 55-65%
SME manufacturing	Mixed	Labour 25%, Material 55%, Overhead 20%

Cost Reduction Techniques:

Value analysis/engineering
Batch production optimisation
Lean manufacturing principles
Energy efficiency (Sri Lanka electricity costs)
Waste minimisation

⚡ A/L Exam Tip: The most commonly tested areas in Cost Accounting A/L are: (1) Cost classification, (2) Overhead absorption, (3) Break-even analysis, and (4) Variance analysis. Master these four areas!

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