Accounting: The information system that identifies transactions, records, classifies, summarizes

period cost is related to level of production and sale rises, interprets, and reports transactions of
an enterprise for a certain period through preparation of financial statements to different users for
taking important decisions is known as accounting.

Types of accounting:
Financial accounting -The accounting system that identifies, records, classifies, summarizes,
interprets, and reports transactions of an enterprise for a certain period through preparation of
financial statements to different users for taking important decisions.

Cost accounting – The accounting system that accumulates cost information for manufacturing
a product of offering a service to different external users for taking important decisions is known
as cost accounting.

Management accounting – The accounting system that provides important information to

different internal users mainly managers for taking important intellectual decisions for achieving
goal of the enterprise is known as management accounting.

Tax accounting – The accounting system that determines taxable income of an enterprise for an
accounting period and tax burden on that income is known as tax accounting.

Types of accountants:
Private accountant – The accountant provides accounting related services to a particular
enterprise for long time as a regular job in exchange of monthly salary is known as private
accountant.

Public accountant – The accountant provides accounting related services to different enterprises
in different periods through different contracts in exchange of fee is known as public accountant.

Government accountant – The accountant provides accounting related services to the

government or government agencies as a regular job in exchange of monthly salary is known as
government accountant.

Financial accounting vs Management accounting:

I. Practice of financial accounting is mandatory for all company form business enterprises, but
practice of management accounting is optional.
Ii. Financial accounting reports important information to both internal and external parties,
whereas management accounting provides important information only to internal managers for
taking intellectual decisions.
Iii. Financial accounting emphasizes on past transactions, whereas management accounting
emphasizes on future actions.
Iv. Financial accounting focuses on objectivity and verifiability, but management accounting
focuses on relevancy.
V. Precision is important in case of financial accounting whereas timeliness is more important in
case of management accounting.
Vi. Areas of financial accounting is companywide reporting, but area of management accounting
is segment reporting.
Vii. Financial accounting follows ifrss, but management accounting does not follow ifrss.

Costing: Costing is the classifying, recording and appropriate allocating of expenditure for the
determination of the costs of products or services, and for presentation of suitably arranged data
for the purposes of control, and guidance of management.
A sunk cost is an expense that has been already done and cannot be recovered.

Objectives of costing:
1. To determine the exact cost of each article.
2. To determine the cost incurred during each operation to keep control over workers’ wages.
3. To provide information to ascertain the selling price of the product.
4. To supply information for detection of wastage.
5. It helps in reducing the total cost of manufacture.
6. It suggests changes in design when the cost is higher.
7. To help in formulating the policies for charging the prices of the product.
8. To facilitate preparation of estimate for submitting the rates in tenders or quotations.
9. To compare the actual cost with the estimated cost of the component.

Costing classifications:

1. Activity based costing - It’s a costing method that identifies activities in an organization and
assigns the cost of each activity to all products and services according to the actual consumption
by each related to the costing and monitoring of activities which involves tracing resource
consumption and costing final outputs where resources are assigned to activities, and activities to
cost objects based on consumption estimates and finally utilize cost drivers to attach activity
costs to outputs.
2. Target costing- Target costing is a system under which a company plans in advance for
the price points, product costs, and margins that it wants to achieve for a new product. If it
cannot manufacture a product at these planned levels, then it cancels the design project
entirely. With target costing, a management team has a powerful tool for continually
monitoring products from the moment they enter the design phase and onward throughout
their product life cycles.
3. Life cycle costing (LCC) - The total cost throughout its life including planning, design,
acquisition and support costs and any other costs directly attributable to owning or using the
asset. It represents the total cost of its ownership and includes all the cots that will be incurred
during the life of an item to acquire it, operate it, support it and finally dispose it. Life Cycle
Costing adds all the costs over their life period and enables an evaluation on a common basis for
the specified period (usually discounted costs are used).
4. Throughput costing - It’s a costing approach under which only direct materials are recorded
as inventory costs while all other manufacturing costs (including direct labor
and variable factory overhead) are expensed as period costs. Selling and administrative costs are
expensed as period costs as well.
5. Environmental costing - It means costs incurred in connection with acquiring and
maintaining all environmental permits and licenses for the product, and the product’s compliance
with all applicable environmental laws, rules and regulations, capital costs for pollution control
equipment, all operating and maintenance costs for operation of pollution mitigation or control
equipment, costs of permit maintenance fees and emission fees as applicable, and costs
associated with the disposal and clean-up of hazardous substances introduced to the site, and the
decontamination or remediation, on or off the site, necessitated by the introduction of such
hazardous substances on the site.

Cost and cost classification:

A: cost in relation to a product – manufacturing cost (direct materials, direct labor and factory
overhead) and nonmanufacturing cost or commercial cost (administrative and marketing cost).
B: Assigning cost to objects – direct cost and indirect cost
C: Cost in relation to preparing financial statement – product cost and period cost
D: Cost in relation to activity – variable cost, fixed cost and mixed cost
E: Cost in relation to making decisions – differential cost, sunk cost and opportunity cost
F: Cost in relation to manufacturing departments – producing departments and service
departments

♦ Costs classification based on financial statements:

(a) Income statement – Cost of goods manufactured and cost of goods sold.
(b) Balance sheet – Raw materials, work-in-process and finished goods inventory.

♦ Costs classification from controlling viewpoint:

(a) Controllable cost: The cost that’s controlling power remains within the authority of an
individual is called controllable cost. The entertainment cost for the purchase department
is controllable cost for the purchase manager. Because the manager can increase or
decrease this cost by applying his power.
(b) Noncontrollable cost: The cost that’s controlling power does not remain within the
authority of an individual is called noncontrollable cost. The depreciation cost of the
equipment is noncontrollable cost for the purchase manager. Because the manager cannot
increase or decrease this cost by applying his power.
(c) Incremental cost: The additional cost incurred for producing additional one unit of a
particular product is called incremental or differential cost.
(d) Opportunity cost: The cost of the second-best alternative that is sacrificed for choosing
the first best alternative is called opportunity cost. For example–an individual can deposit
his savings in a bank account or purchase shares of a company. If the individual purchase
shares of a company, then his opportunity cost is to sacrifice to deposit in a bank account.
(e) Step cost: The cost that remains fixed up-to a certain level and changes with respect to
changes the level of activity is called step cost. Income tax is an example of step cost.
(f) Mixed/ Semi-variable cost: The cost that includes both fixed and variable portion is
called mixed cost. The mobile bills electricity bills are examples of mixed cost.
Committed fixed cost:
(g) The fixed cost in which there is no opportunity to make adjustment is called committed
fixed cost. The remuneration of the managing director of the business is an example of
committed fixed cost.
 (h) Discretionary fixed cost: The fixed cost in which there is opportunity to make
adjustment is called discretionary fixed cost. Research and development cost is an
example of discretionary fixed cost.

Cost-volume-profit analysis is a technique for evaluating the effect of changes in cost and
volume on profit.
Costs include variable and fixed costs that are expenses of the period.
Volume represents the level of sales activity, either in units or in dollars.
Profit for the firm may be net income or operating income. The role of this analysis is to help
managers answer questions that relate to certain decisions. For example, given the selling price,
fixed costs and variable costs of the products, management can determine how many units must
be sold to break even – to have a net income of zero.
The break-even point is that level of volume at which the firm earns zero profit. Analyzing
costs and volume in order to determine the break-even point is referred to as break-even analysis.

Uses of CVP analysis:

CVP enables the management to reach planning and policy making decisions more intelligently.
This analysis is used in the following cases:
1. Determination of profit which will result from any given volume of sales.
2. Analysis of effect of changes in selling price.
3. Effect of changes in product mixture.
4. Additional sales volume needed to support an additional expenditure.
5. Lowest price at which business may be accepted to utilize facilities and contribute something
towards net profit.
6. The particular products to be emphasized to reflect the highest net profit.
7. Determination of unit costs at various volume levels.
8. Determination of probable effect of investment in new plant and equipment.
9. Determination of most profitable use of scarce materials.
10. Determination of how many units must be sold to earn a specific net income or a minimum
desired rate of return.
11. Determination the necessary selling price of a product, given expected volume, costs and
desired profit.

Assumptions in CVP Analysis:

1. Costs have been accurately distinguished as variable and fixed.
2. Fixed costs remain constant within the relevant range of analysis.
3. Total variable costs are affected only by changes in volume.
4. Revenues are linear
5. No change in inventory levels
6. Sales-mix is constant for multiple product firm

1. Equation Technique:
Sales = Fixed Costs + Variable Costs + Desired Net Income
2. Contribution margin technique :
Breakeven point = Fixed Costs / Contribution margin ratio
3. Graphical analysis: The relationship between costs, sales and profit at different levels of
activity can be presented diagrammatically by using a break-even chart. It is possible to seat a
glance the estimated results of trading at various levels of activity. The chart shows fixed and
variable costs and sales revenue so that profit or loss at any given level of production or sales can
be ascertained. The chart also shows quite clearly the break-even point and the margin of safety.
In a break-even graph, costs and sales revenues are shown on the vertical axis and volume either
in units or in amount on the horizontal axis. Three lines are required to draw for presenting
graphically such as total fixed cost line, total costs line and sales revenue line.

Margin of safety: It is defined as the excess of actual sales over the break-even level of sales.
The margin of safety is a particularly important measurement for management when they are
contemplating an expansion or new product line because it shows how safe the company is and
how much lost sales or increased costs the company can absorb
Operating leverage: Operating leverage represents a measurement of the effect on net income
of changes in sales volume. Operating leverage = Contribution margin / Net income. An
operating leverage of 3 means that the percentage change in net income will be three times the
percentage change in sales

Activity based costing (ABC) is a costing method that is designed to provide managers with
cost information for strategic and other decisions that potentially affect capacity and therefore
fixed as well as variable costs. It is ordinarily used as a supplement to, rather than as a
replacement for, a company’s usual costing system. Most organizations that use this costing have
two costing systems- the official costing system that is used for preparing external financial
reports and the activity-based costing system that is used for internal decision making and for
managing activities.
Its a costing method that identifies activities in an organization and assigns the cost of each
activity to all products and services according to the actual consumption by each relating to the
costing and monitoring of activities which involves tracing resource consumption and costing
final outputs where resources are assigned to activities, and activities to cost objects based on
consumption estimates. The latter utilize cost drivers to attach activity costs to outputs. With
ABC, a company can soundly estimate the cost elements of entire products, activities and
services, that may help inform a company's decision to either:

To identify and eliminate those products and services that are unprofitable and lower the prices
of those that are overpriced (product and service portfolio aim), or

To identify and eliminate production or service processes which are ineffective, and allocate
processing concepts that lead to the very same product at a better yield (process re-engineering
aim)

Activity cost pool: An activity cost pool is an aggregate of all the costs associated with
performing a particular business task, such as making a particular product. By pooling all costs
incurred in a particular task, it is simpler to get an accurate estimate of the cost of that task. One
example of the use of activity costs is in manufacturing. A manager may be asked to
evaluate production costs of each product produced by a factory. Activity-based costing (ABC)
is a common method for determining those production costs. ABC defines production as
consisting of a variety of activities, and it assigns costs to those activities. For example, machine
set-up might be one activity associated with the production of a particular product. The cost of
set-up would be one cost included in an activity cost pool. Purchasing materials might be another
cost assigned to the pool. Assigning costs accurately is important to determine the profitability of
products and subsequently to make rational production decisions.

Activity cost driver: A cost driver directly influences a business activity. There may be

multiple cost drivers associated with an activity. For example, direct labor hours are a driver of
most activities in product manufacturing. If the cost of labor is high, this will increase the cost of
producing all company products or services. If the cost of warehousing is high, this will also
increase the expenses incurred for product manufacturing or providing services. More
technical cost drivers are machine hours, the number of engineering change orders, the number
of customer contacts, the number of product returns, the machine setups required for production,
or the number of inspections. If a business owner can identify the cost drivers, the business
owner can more accurately estimate the true cost of production for the business.

Batch-level activities: Batch-level activities are work actions that are classified within
an activity-based costing accounting system, often used by production companies. Batch-level
activities are related to costs that are incurred whenever a batch of a certain product is produced.
However, these costs are accounted for regardless of the related production run’s size. Examples
of these batch-level cost drivers can often include machine setups, maintenance, purchase orders,
and quality tests.

Contribution margin (CM), or dollar contribution per unit, is the selling price per unit minus
the variable cost per unit

A period cost is any cost that cannot be capitalized into prepaid expenses, inventory, or
fixed assets

Product cost refers to the costs incurred to create a product. These costs include direct labor ,
direct materials, consumable production supplies, and factory overhead

Indirect costs are those costs not readily identified with a specific project or organizational
activity but incurred for the joint benefit of both projects and other activities

A direct cost is a price that can be directly tied to the production of specific goods or services.