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

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

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

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

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
Accounting

Managerial
Accounting

External persons who

make financial decisions

Managers who plan for

and control an organization

Historical perspective

Future emphasis

3. Verifiability
versus relevance

Emphasis on
verifiability

Emphasis on relevance
for planning and control

4. Precision versus
timeliness

Emphasis on
precision

Emphasis on
timeliness

5. Subject

Primary focus is on
the whole organization

Focuses on segments
of an organization

6. Requirements

Must follow GAAP

and prescribed formats

Need not follow GAAP

or any prescribed format

1. Users
2. Time focus

Cost accounting
vs.
Management accounting

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Management
accounting
Objective To provide

information for
planning and
decision making
by the
management

Cost accounting
To ascertain and
control cost

Concerned with Based on both

Basic of
present and future
recording transactions
related to the
future

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transactions for cost

ascertainment

Management
accounting

Cost accounting

Coverage Covers a wider

area: financial
accounts, cost
accounts,
taxation, etc.

Covers matters
relating to
ascertainment and
control of cost of
product or service

Utility

Only the needs

of internal
management

The needs of both

internal and external
interested groups

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Management
accounting

Cost accounting

Deals with both Deals only with

Types of
monetary
transactio monetary any
non-monetary
transactions,
ns
transactions,
covering both
quantitative and
qualitative
aspects

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covering only
quantitative aspect

Cost concepts

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Element of cost

Cost object
Cost
Cost unit
Cost centre
Profit centre

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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/howto/content/managerial-accounting-types-ofresponsibility-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 companys 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
Material
Material

Direct
Direct
Labor
Labor

Prime
Cost

Manufacturing
Manufacturing
Overhead
Overhead

Conversion
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

easily and conveniently
traced to a unit of
product or other cost
objective.
Examples: direct
material and direct
labor

Costs cannot be easily

and conveniently traced
to a unit of product or
other cost object.
Example:
manufacturing
overhead

ON THE BASIS OF VARIABILITY

Fixed costs
Variable costs
Semi variable costs

Cost Classifications for Predicting Cost

Behavior
How
Howaa 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

Total Long Distance

Telephone Bill

Your total long distance telephone bill is based on

how many minutes you talk.

Minutes Talked

Variable Cost Per Unit

Per Minute
Telephone Charge

The cost per long distance minute talked is constant.

For example, 10 cents per minute.

Minutes Talked

Total Fixed Cost

Monthly Basic
Telephone Bill

Your monthly basic telephone bill probably does not

change when you make more local calls.

Number of Local Calls

Fixed Cost Per Unit

Monthly Basic Telephone

Bill per Local Call

The average cost per local call decreases as more local

calls are made.

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

as activity level changes.

Variable cost per unit remains

the same over wide ranges
of activity.

Fixed

Total fixed cost remains

the same even when the
activity level changes.

Fixed cost per unit goes

down as activity level goes up.

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
47 employees in particular. The cost
and customers, creditors, shareholders, and
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
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profit, e.g. office rental