Overview of cost & Management Accounting

Lesson 1: Overview of cost & Management Accounting

Prepared by: Niruja R11th August 2017

Cost accounting

• Cost accounting is a system for recording data and producing information about costs for the products produced by an organization.

• It is also used to establish costs for particular activities or responsibility centers.

• The Chartered Institute of ManagementAccountants, U.K. (CIMA) defines costing as‘the technique and process of ascertainingcosts.’

• Wheldon has defined Costing as “the properallocation of expenditure and involves thecollection of costs for every order, job,process, service or unit”

Cost accounting

Why organization need costing systems

Type of information provided by a costing system and its need:

1. Actual unit cost:

used for cost control,

planning future unit cost,

pricing and production level decisions.

Provide information that management needs to plan and control



2. Actual cost of operating a department:

used for cost control by comparing with a predetermined,

budget planning future budget cost.




3.Forecast costs:

planning,

decision making,

cost control by comparing actual cost with the

forecast.


Terms in cost accounting

Cost

• ‘the amount of expenditure incurred or attributed ona given thing’

- CIMA Definition-

• the amount of cash or cash equivalent paid or thefair value of other consideration given to acquire anasset at the time of its acquisition or construction(IAS 16)

• More simply, it can be defined as that which is givenor scarified to obtain something.

Cost units

• The CIMA Terminology defines a cost unit as a unit of product or service in relation to which costs are ascertained.

• Examples:

– A room in a hotel

– A litre of paint

– In-patient in a hospital

• A cost centre is a production or servicelocation, a function, an activity or an item ofequipment for which costs are accumulated.

• Examples:

– A department

– A machine

– A project

– A ward

Cost centers

• A cost object is any activity for which aseparate measurement of cost is undertaken.

• Examples:

– Cost of a product

– Cost of a service

– Cost of running a department

– Cost of running a regional office

Cost objects

Classification of costs

• Cost classification is the arrangement of items in logical groups. Costs can be classified in a number of different ways. Those ways are,

– Element

– Nature

– Function

– Behaviour

By nature: grouping costs according to whether they

are materials, labour or overhead cost.


Direct Materials

Raw materials that become an integral part of the product and

that can be easily traceable

Example: Tyres in an automobile

Direct Labor

Those labor costs that can be easily traced to individual units of product.

Example: Wages paid to automobile assembly workers

Manufacturing Overhead

Manufacturing costs that cannot be easily traced directly to specific units produced.

Examples: Indirect materials and indirect labor

Wages paid to employees who are not directly

involved in production work.

Examples: maintenance workers and security guards.

Materials used to support the production process.

Examples: lubricants and cleaning supplies used in the automobile assembly plant.

By purpose: grouped according to the reason for

which they have been incurred.


Direct Cost

• a cost which is related to a particular cost objective and can be traced to it in an economically feasible way

Indirect Cost

• a cost which is related a particular cost objective but cannot be traced to it in an economically feasible way

• indirect costs are allocated to cost objectives

By purpose: Direct cost vs. Indirect cost


Direct

Cost

Indirect

Cost

Cost

Object

Trace

Allocate

By functions: this is based on the costs incurred in

various function of an organization.

Examples: Production,

Administration,

Selling and distribution.


Selling

Costs

Costs necessary to

secure the order and

deliver the product.

Administrative Costs

All executive, organizational, and clerical

costs.

Classification of costsBy functions:

By changes in activity or volume:


it is based on how a cost will react to

changes in the level of activity. The most

common classifications are:

– Variable costs.

– Fixed costs

– Mixed costs.

Variable Cost

A variable cost varies, in total, in direct proportion to changes in thelevel of activity.Example:

Your total texting bill is based on how many texts you send.

Number of Texts Sent

Tota

l Tex

tin

g B

ill

Fixed Cost

A fixed cost is constant within the relevant range. Or, cost whichremain fixed in total; with changes in the volume of the outputfor a given period of time.

Example: Your monthly contract fee for your cell phone is fixed forthe number of monthly minutes in your contract. The monthlycontract fee does not change based on the number of calls youmake.

Number of Minutes UsedWithin Monthly Plan

Mo

nth

ly C

ell

Ph

on

e

Co

ntr

act

Fee

Semi variable cost

Semi variable costs are those which are partly fixed and partly variable.

By functions:• Product costs:

– are manufacturing costs which are accumulated as inventories

– It includes direct material, direct labor and direct overheads.

– Up to sale, these products are shown and valued as inventory and they form a part of balance sheet.

• Period costs:– are all other costs of operating the business, expensed in

the accounting period they are incurred.– e.g. general administrative, selling and financial.


By Controllability: • Controllable - These are controlled by management

like material labour and direct expenses.

• Uncontrollable - They are not influenced bymanagement or any group of people. They includerent of a building, salaries, and other indirectexpenses.


By Normality• Normal Cost are the normal or regular costs which are

incurred in the normal conditions during the normaloperations of the organization. They are the sum of actualdirect materials cost, actual labour cost and other directexpense.

Example: repairs, maintenance, salaries paid to employees.

• Abnormal Cost are the costs which are unusual or irregular which are not incurred due to abnormal situation s of the operations or productions.

Example: destruction due to fire, shut down of machinery, lock outs, etc.


By relationship with accounting period:• The capital expenditure and revenue expenditure are

classified under it.

• Revenue expenses relate to current accounting period. Capital expenditures are the benefits beyond accounting period.


By time:HISTORICAL COST:

a cost computed after production from records made concurrently with various steps of production —contrasted with predetermined cost and standard cost

PREDETERMINED COST:

estimated cost that they are computed in advance of production taking into consideration the previous periods.


Element of cost

Exercise

1. The wages of employees who build the sailboats

2. The cost of advertising in the local newspapers

3. The cost of an aluminum mast installed in a sailboat

4. The wages of the assembly shop’s supervisor

5. Rent on the boathouse

6. The wages of the company’s bookkeeper

7. Sales commissions paid to the company’s salespeople

8. Depreciation on power tools: manufacturing overhead cost

Cost accounting and Cost accountancy

COST ACCOUNTING

• The Institute of Cost and Management Accountant, England (ICMA) hasdefined Cost Accounting as –

– “the process of accounting for the costs from the point at which expenditureincurred, to the establishment of its ultimate relationship with cost centersand cost units. In its widest sense, it embraces the preparation of statisticaldata, the application of cost control methods and the ascertainment of theprofitability of activities carried out or planned”.

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Cost Accounting = Costing + Cost Reporting + Cost Control.

Cost Accountancy

• Cost Accountancy means :

– “the application of costing and cost accounting principles, methods and techniques to the science, art and practice of cost control”

– It includes the presentation of information derived there from for the purpose of managerial decision making.

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Cost Accountancy includes…

• Cost Accounting

• Cost Control

• Cost Reduction

• Cost Audit

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Features of Cost Accounting1. It is a process of accounting for costs;

2. It records all expenditure relating to production of goods and

services ;

3. It provide statistical data on the basis of which future estimates are

prepared and quotations are submitted;

4. It is concerned with cost ascertainment, cost control, and cost

reduction;

5. It establishes budgets and standards;

6. It gives right information to right person at the right time;

7. It is concerned with classification, accumulation, distribution and

control of costs.

Management accounting

• Management accounting is the sourcing, analysis,communication and use of decision-relevant financialand non-financial information to generate andpreserve value for organisations.

• Management accounting is the process ofidentification, measurement, accumulation, analysis,preparation, interpretation and communication ofinformation that assists managers in specific decisionmaking within the framework of fulfilling theorganizational objectives.

Management accounting

• The Report of the Anglo-American Council ofProductivity (1950) "Management accounting is thepresentation of accounting information in such away as to assist the management in creation ofpolicy and the day to day operation of anundertaking".

Characteristics of Management Accounting

• Useful in decision making

• Derived from Financial and Cost Accounting information

• Exclusively for internal use

• Purely optional

• Concerned with future

• Flexibility in presentation of information

Functions/ Objectives of Management Accounting

• Planning

• Coordinating

• Controlling

• Communication

• Financial analysis and interpretation

• Qualitative information

• Decision making

Cost Accounting vs Management Accounting

Basis Cost Accounting Management Accounting

Scope Limited to providing costinformation for managerial uses

Broader scope as it provides all types ofinformation

Emphasis Mainly on cost ascertainment andcost control to ensure maximumprofit

Mainly on planning, controlling anddecision making to maximize profit

Techniquesemployed

Standard costing and varianceanalysis, marginal costing and costvolume profit analysis, budgetarycontrol, uniform costing etc.

All the techniques of cost accountingbut in addition it also uses ratioanalysis, fund flow statement,statistical analysis, operation research,mathematics, economics etc.,whatsoever help management in tasks

Evolution Its evolution is mainly due to thelimitations of financial accounting

Its evolution is due to the limitations ofcost accounting

Statutoryrequirement

Maintenance of cost records hasbeen made compulsory in selectedindustries as notified by the govt.from time to time

It is purely voluntary and its usedepends upon the utility ofmanagement

Cost Accounting vs Management Accounting

Basis Cost Accounting Management Accounting

Data base It is based on data derived from financial accounts

It is based on data derived from financial accounting, cost accounting and other sources

Status in organisation

In an organisational setup, cost accountant is placed at a lower level in hierarchy than the management accountant

In an organisational setup, management accountant is placed at a higher level in hierarchy than the cost accountant

Installation Cost accounting can be installed without management accounting

Management accounting cannot be installed without a proper system of cost accounting

Scope of cost accountancy

(i) Cost Ascertainment: It deals with the collection andanalysis of expenses, the measurement of production ofthe different products at the different stages ofmanufacture and the linking up of production with theexpenses.

(ii) Cost Accounting: It is the process of accounting for costwhich begins with recording of expenditure and endswith the preparation of statistical data.

(iii) Cost Control:Cost Control is the guidance andregulation by executive action of the costs of operatingan undertaking. It aims at guiding the actualperformance towards the line of targets

Scope of cost accountancy

Objectives of Cost Accounting

• To ascertain the cost per unit.

• To provide a correct analysis of cost.

• To disclose sources of wastage of time, material , machine etc.

• To fix price.

• To ascertain the profitability.

• To exercise effective control of stocks.

• To advice management on future expansion

• To present interpret for mgt. planning.

• To helps in preparation of budgets

• To provide information to right person at right

time.

• To organise internal audit system.

• To formulate & implement incentive bonus plans.

• To organise cost reduction programmes

• To find out costing & profit and loss .

Objectives of Cost Accounting

Business

Overview of cost & Management Accounting