COST ACCOUNTING - INTRODUCTION

Accounting for determination and control of costs.

 COST ACCOUNTING: The Institute of Cost and Management Accountant,

England (ICMA) has defined Cost Accounting as – “the process of
accounting for the costs from the point at which expenditure incurred, to the
establishment of its ultimate relationship with cost centers and cost units. In
its widest sense, it embraces the preparation of statistical data, the
application of cost control methods and the ascertainment of the profitability
of activities carried out or planned”.

Cost Accounting = Costing + Cost Reporting + Cost Control .

 Cost Accounting
 CA is a formal system of accounting for costs in
the books of accounts by means of which costs of
products and services are ascertained and
controlled.
 Cost means the amount of expenditure ( actual or
notional) incurred on, or attributable to, a given
thing.
 Cost ascertainment is computation of actual costs
incurred
 Cost estimation is a process of predetermining
costs of goods and service.
 OBJECTIVES OF COST ACCOUNTING

 Ascertainment of costs

 Estimation of costs

 Cost control

 Cost reduction

 Determining selling price

 Facilitating preparation of financial and other statement

 Providing basis for operating policy

 Comparison of cost,
management and financial
accounting
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 Meanings
 Financial accounting
 Cost accounting
 Management accounting

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 Financial accounting
 Provides information to users who are external to
the business
 It reports on past transactions to draw up
financial statements
 The format are governed by law and accounting
standards established by the professional
accounting policies

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 Cost accounting
 Is concerned with internal users of accounting
information, such as operation managers
 The generated reports are specific to the
requirement of the management
 The reporting can be in any format which suits
the user

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 Management accounting
 Comprises all cost accounting functions
 The accounting for product and service costs,
management accounting extends to use various
internal accounting reports for planning, control
and decision making

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 CA and FA - Comparison
 Purpose
 Statutory requirements
 Analysis of cost and profit
 Periodicity of reporting
 Control aspect
 Historical and predetermined costs
 Format of presenting information
 Types of transactions recorded
 Differences Between Financial and
Managerial Accounting
Financial Managerial
Accounting Accounting
1. Users External persons who Managers who plan for
make financial decisions and control an organization

2. Time focus Historical perspective Future emphasis

3. Verifiability Emphasis on Emphasis on relevance

versus relevance verifiability for planning and control

4. Precision versus Emphasis on Emphasis on

timeliness precision timeliness
5. Subject Primary focus is on Focuses on segments
the whole organization of an organization

6. Requirements Must follow GAAP Need not follow GAAP

and prescribed formats or any prescribed format
 Cost accounting
vs.
Management accounting

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 Management Cost accounting
accounting
Objective To provide To ascertain and
information for control cost
planning and
decision making by
the management

Basic of Concerned with Based on both

recording transactions related present and future
to the future transactions for cost
ascertainment

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 Management Cost accounting
accounting
Coverage Covers a wider Covers matters
area: financial relating to
accounts, cost ascertainment and
accounts, taxation, control of cost of
etc. product or service

Utility Only the needs of The needs of both

internal internal and external
management interested groups

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 Management Cost accounting
accounting
Types of Deals with both Deals only with
transactions monetary any non- monetary transactions,
monetary covering only
transactions, quantitative aspect
covering both
quantitative and
qualitative aspects

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Cost concepts

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 Element of cost
 Cost object
 Cost
 Cost unit
 Cost centre
 Profit centre

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KMoC&pg=SA6-
PA1&dq=cost+ledgers&hl=en&sa=X&ei=NLL_Up
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 Cost object
 It is an activity or item or operation for which a
separate measurement of costs is desired
 E.g. the cost of operating the personnel
department of a company, the cost of a repair
fob, and the cost for control

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 Cost
 It is the amount of expenditure incurred on a
specific cost object
 Total cost = quantity used * cost per unit (unit
cost)

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 Cost Unit
 Cost units are the things, that the business is set
up to provide, of which cost is ascertained.
 Unit of product, service or time in relation to
which cost may be ascertained or expressed

 Types:
 Units of production such as a ream of paper, a tonne of
steel, a meter of cable etc.
 Units of services such as passenger miles, consulting
hours, room per day, bed per day
 Responsibility centre
 Responsibility centers are identifiable segments
within a company for which individual managers
have accepted authority and accountability.
Responsibility centers define exactly what assets
and activities each manager is responsible for.
 http://www.dummies.com/how-to/content/
managerial-accounting-types-of-responsibility-
cent.html

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 Cost Centre
Cost center is a location, person, or item of
equipment (or group of these) for which costs
may be ascertained and used for the purpose of
control

It refers to a section of the business to

which costs can be charged.
Types:
Personal and Impersonal cost centre
Production and Service cost centre
 Profit centre
 It is location or function where managers are
accountable for sales revenues and expenses
 E.g. division of a company that is responsible for
the sales of products

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 Revenue centre
 A revenue center is the business operation
responsible for generating a company’s sales
revenue.
 These centers may be departments, divisions or
business units that have direct interaction with
consumers to sell goods and services.
 For example, a hotel might add a snack bar or a coffee counter to generate
extra sales. Companies usually break down their business operations into
revenue centers to determine the profitability of each good or service it
produces. Company size, the number of product or service lines and
industry standards are all factors companies use when choosing or adding
additional centers for their operations.

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COST CLASSIFICATION – ON THE BASIS
OF
 Nature
 Function
 Direct & indirect
 Variability
 Controllability
 Normality
 Financial accounting classification
Time
 Planning and control
 Managerial decision making
 ON THE BASIS OF NATURE – Module 2

 Materials

 Labour

 Expenses - Direct expenses

 ON THE BASIS OF FUNCTION

 Manufacturing costs
 Commercial costs – ADM and S&D Costs

ON THE BASIS OF DIRECT AND INDIRECT

 Direct costs

 Indirect costs
 Classifications of Costs

Manufacturing costs are often

classified as follows:

Direct
Direct Direct
Direct Manufacturing
Manufacturing
Material
Material Labor
Labor Overhead
Overhead

Prime Conversion
Cost Cost
 Nonmanufacturing Costs
Marketing and selling costs . . .
 Costs necessary to get the order and deliver the
product.
Administrative costs . . .
 All executive, organizational, and clerical costs.
 Direct Costs and Indirect Costs

Direct costs Indirect costs

 Costs that can be  Costs cannot be easily
easily and conveniently and conveniently traced
traced to a unit of to a unit of product or
product or other cost other cost object.
objective.  Example:
 Examples: direct manufacturing
material and direct overhead
labor
 ON THE BASIS OF VARIABILITY

 Fixed costs

 Variable costs

 Semi variable costs

Cost Classifications for Predicting Cost
Behavior

How
How aa cost
cost will
will react
react to
to
changes
changes in
in the
the level
level of
of
business
business activity.
activity.
 Total
 Totalvariable
variablecosts
costs
change
changewhen
whenactivity
activity
changes.
changes.
 Total
 Totalfixed
fixedcosts
costsremain
remain
unchanged
unchangedwhen
whenactivity
activity
changes.
changes.
 Total Variable Cost

Your total long distance telephone bill is based on

how many minutes you talk.
Total Long Distance
Telephone Bill

Minutes Talked
 Variable Cost Per Unit

The cost per long distance minute talked is constant.

For example, 10 cents per minute.

Telephone Charge
Per Minute

Minutes Talked
 Total Fixed Cost

Your monthly basic telephone bill probably does not

change when you make more local calls.
Telephone Bill
Monthly Basic

Number of Local Calls

 Fixed Cost Per Unit

The average cost per local call decreases as more local

calls are made.

Monthly Basic Telephone

Bill per Local Call
Number of Local Calls
Cost Classifications for Predicting Cost
Behavior

Behavior of Cost (within the relevant range)

Cost In Total Per Unit

Variable Total variable cost changes Variable cost per unit remains
as activity level changes. the same over wide ranges
of activity.
Fixed Total fixed cost remains Fixed cost per unit goes
the same even when the down as activity level goes up.
activity level changes.
 Semi-variable cost
 It processes characteristics of both fixed and
variable cost
 It increases or decreases with activity level but
not in direct proportion

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ON THE BASIS OF CONTROLLABILITY

 Controllable costs

 Uncontrollable costs

ON THE BASIS OF NORMALITY

 Normal costs

 Abnormal costs

*Cost accounting – Arora TB

 ON THE BASIS OF TIME:

 Historical costs

 Pre determined costs

ON THE BASIS OF PLANNING AND CONTROL:

 Budgeted costs

 Standard costs

*Cost accounting – Arora TB

 ON THE BASIS OF MANAGERIAL
DECISION MAKING - *Cost accounting
– Arora TB

Marginal costs
Out of pocket costs
Sunk costs
Imputed costs
Opportunity costs
Replacement costs
Avoidable costs
Unavoidable costs
Relevant and irrelevant costs
Differential costs
 Opportunity Costs
The potential benefit that is
given up when one alternative
is selected over another.

Example: If you were

not attending college,
you could be earning
$15,000 per year.
Your opportunity cost
of attending college for one
year is $15,000.
 Sunk Costs
Sunk costs cannot be changed by any decision. They are not
differential costs and should be ignored when making
decisions.

Example: You bought an automobile that cost $10,000

two years ago. The $10,000 cost is sunk because
whether you drive it, park it, trade it, or sell it, you cannot
change the $10,000 cost.
 Differential Costs and Revenues

Costs and revenues that differ among alternatives.

Example: You have a job paying $1,500 per month in

your hometown. You have a job offer in a neighboring
city that pays $2,000 per month. The commuting cost
to the city is $300 per month.

Differential revenue is:

$2,000 – $1,500 = $500

Differential cost is:

$300
 COST TERMINOLOGY:
 COST: Cost means the amount of expenditure incurred on a particular thing.
 COSTING: Costing means the process of ascertainment of costs.
 COST ACCOUNTING: The application of cost control methods and the ascertainment of
the profitability of activities carried out or planned”.
 COST CONTROL: Cost control means the control of costs by management. Following are
the aspects or stages of cost control.
 Methods of costing and techniques of costing
 JOB COSTING: It helps in finding out the cost of production of every order and thus helps
in ascertaining profit or loss made out on its execution. The management can judge the
profitability of each job and decide its future courses of action.
 BATCH COSTING: Batch costing production is done in batches and each batch consists of a
number of units, the determination of optimum quantity to constitute an economical batch is
all the more important.
 Cost organization and other depts…

In the organization chart, the cost department occupies a very important

position. The cost department is responsible
For keeping records connected with material, labour and expenses,
For analyzing all costs of manufacturing, marketing and
administration, and
For issuing control reports and data for decision making to the
executives, department heads, section heads and foremen. When
management is provided with useful reports, they assist in controlling
and improving cost and operations. Such information data are, again,
used for making new decisions.

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 Cost organization and other depts…

The effectiveness of the control of cost depends upon proper

communication through control reports from the cost accountant to the
various levels of operating management. Accounting and control
reports are directed to these levels of management, i.e. top
management, middle management and lower level or shop floor level of
management. Each management level requires data for deciding and
solving various problems. The cost accountant must devise a cost
system into which data are marshalled to fit the numerous problems
confronting management. The cost department is intimately connected
with the other departments in the organization. Their relationship can
be briefly established as follows:–

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 Cost organization and other depts…
Manufacturing departments control the scheduling, manufacturing and
inspection of each job or processed products to their finished stage in terms of
efficiency norms established. Costs incurred at each stage are measured and compared
with the norms.
Production planning, research and design department involve cost department
for cost estimates needed for each type of material, labour and machine process
before a decision can be reached in accepting or rejecting a design.
Personnel department is interested to maintaining employee cost up-to-date. The
wage rate and methods of remuneration agreed with the employees form the basis for
computing payroll. Cost department provides all data.
Marketing department needs a good product at a competitive price. While cost
cannot determine price, it can influence fixation of price. Besides, accurate cost data
help sales manager distinguish profitable with nonp rofitable products and compare
cost of marketing against sales volume.
Public relation department establishes good relations with the public in general
and customers, creditors, shareholders, and47 employees in particular. The cost
department provides information concerning price, cost, etc.
 Cost organization and other depts

Legal department finds cost department helpful in keeping many

affairs of the company in conformity with the law, specially excise,
customs, sales tax and other legislation regarding maintenance of
accounts and cost records.
The finance department relies on the cost department for
accounting, valuation of inventory, cash flow statements, C.A.S. data
for banks, etc. Where finance department is composed of general
accounting and cost accounting, besides taxation and funds
management departments, it is usual to consider cost accounting
department providing unit cost of goods manufactured and sold to
general accounting department.

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 Cost accumulation

•Prime cost = direct materials + direct labour + direct expenses

•Production cost = Prime cost + factory overhead

OR
= Direct materials + Conversion cost
*Conversion cost is the production cost of converting raw materials into finished
product

•Total cost = Prime cost + Overheads (admin, selling,distribution cost)

OR
= Production cost + period cost (administrative, selling,
distribution and finance cost)
•Period cost is treated as expenses and matched against sales for calculating
profit, e.g. office rental 49