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Cost and Management AccountingSemester II
MBA
RKU
Dr. DS Raval, RKU
2
Business Accounting System
1. Financial Accounting
2. Cost Accounting
3. Management Accounting
Dr. DS Raval, RKU
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Financial Accounting
• Recording the transactions.• Legal and Formal Accounting.• For outsiders to know about the firm and its financial
position.• Basic three financial statements
• Trading Account• Profit and Loss Account• Balance Sheet
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Limitations of Financial Accounting
• Historical Nature.• Provides information about the concern as a whole.• Not helpful in price fixation.• Cost control not possible.• Chances for manipulations.
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Management Accounting
• CIMA London has defined Management Accounting as, “ the presentation of accounting information in such a way as to assist management in the creation of policy and in the day to day operation of an undertaking.”
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Management Accounting
• In the words of Board and Carmichael, Management accounting, “covers all those services by which the accounting department can assist the top management and other departments in the formation of policy, control of execution and appreciation of effectiveness.”
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Management Accounting
• In the words of Horngren and Charles, “Management Accounting is concerned with the accumulation, classification and interpretation of information that assists individual executives to fulfill organizational objectives.”
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Management Accounting
• Management accounting includes all those accounting services by means of which assistance is rendered to management at all levels in formulation of policy, fixation of plan, and control of their execution and measurement of performance
• The accounting information should be recorded and presented in the form of reports at such frequent intervals as the management may want.
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Objectives of management accounting
• Management Accounting is management oriented• Is concerned with the supply of operative data to management
at all levels in planning and administration. • Its basic objective is to enhance the managerial understanding
regarding the concerned organization in terms of environment, activities and people.
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Tasks of Management Accounting1. Replace “management by hunch” with “management by
information”.2. Professionalize management3. Organize a systematic flow of intelligence within the
organization.4. Apply an objective approach to management5. Increase managerial effectiveness by viable decision
making.6. Cost Determination7. Cost Control8. Performance Evaluation9. Supplying information for planning and decision making
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11Cost
• Viewpoint of Market / Customer• Viewpoint of Business / Seller
“The amount of expenditure incurred on or attributable to a given thing.”
• Thus cost refers to something that must be sacrificed to obtain a particular thing.
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12Costing
• Costing is the technique and process of ascertaining costs.
• It consists of the principles and rules which are used for ascertaining the costs of products and services.
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13Cost Accounting
• It includes 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 lays down the principles to be followed in evolving different methods by which expenses are analyzed and related to the product produced.
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Purposes of Cost Accounting
1. Cost Ascertainment• Recording ( classification and reclassification)• Allocation and apportionment amongst the respective
products, process or department, etc
2. Fixation of Selling Price
3. Basis for estimating• For quotations• For estimates
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4. Matching costs with revenue
5. Cost control
6. Decision making
7. Presentation of comparative cost data
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16Cost Accounting
• Cost accounting lays down the principles to be followed in evolving different methods by which expenses are analyzed and related to the product produced.
• One of the primary purpose of cost accounting is the ascertainment of cost per unit of production and also the cost of each element of expenditure.
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17Elements of cost
• A manufacturing organization is concerned with conversion of raw materials into finished products with the help of labour and certain other services.
• Elements of costs are the primary classification of costs according to the factors upon which expenditure is incurred.
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18Elements of cost
1. Material Cost : Cost of commodities supplied to the undertaking
2. Wages or labour cost: Cost of remuneration of the employees of the undertaking
3. Expenses: The cost of services provided to the undertaking and the notional cost of the use of owned asset.
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Further classification of elements of cost
1. Materials1. Direct materials (timber in furniture, cloth in garments)
2. Indirect materials (lubricating oil, nuts and bolts)
2. Labour1. Direct Labour (machine operator, carpenter, tailor)2. Indirect Labour (supervisor, inspector, clerk)
3. Expenses1. Direct expenses (traveling ,cost of patent rights, experiment)
2. Indirect expense (rent,lighting,adv.,insurance,repairs)
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20Cost Unit…
• Cost unit is the unit of output for which a separate cost is ascertained.
• Cost unit is defined as unit of quantity of output in relation to which cost are ascertained or expressed.
• The forms of measurement used as cost units are usually the units of physical measurements like number, weight, area, length, value, time, etc.
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Simple Cost Unit
• When any single criteria is chosen for measurement of output. This cost unit is referred to as a Simple Cost unit.
• For example cost per ton of steel, per ton of transport service, per kilometer of a transport service or cost per machine hour, etc.
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Composite Cost Unit
• When two criterion are chosen for measurement of output. This cost unit is referred to as a Composite Cost unit.
• For example cost per ton kilometer in transport services, cost per passenger kilometer in transport services, cost per bed day in hospitals, etc
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Examples Industry/ Product Cost Unit
Automobile Number
Brick works 1000 bricks
Cement Ton
Transport Ton – kilometerPassenger kilometer
Chemicals Liter, gallon, kg., ton
Steel Ton
Medicine One batch
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Industry/ Product Cost UnitFurniture ArticleHospital Per bed or per dayBridge construction Each contractPower Kilowatt hour
Gas Cubic foot or cubic meter
Interior decoration Each jobAdvertising Each job
Carpets Square foot
Hotel Room per day
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Cost Centre• “A production or service location, function, activity or
item of equipment whose costs may be attributed to cost units.”
• A location, person, equipment, operation, process for which cost may be ascertained and used for the purpose of cost control.
• Cost centre refers to one of the convenient unit into which the whole factory organization has been appropriately divided for costing purposes.
• Cost centre is the organizational sub unit for cost collection.
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Classification of cost centres
1. Productive and unproductive cost centres:
Examples:
Productive: Machine shops, welding shops and assembly shops in a factory.
Unproductive/Service: Administration, repairs and maintenance, canteen, etc.
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2. Personal and impersonal cost centres:• Personal cost centre which consists of a person or a
group of persons• Impersonal cost centre which consists of a location or
item of equipment (dept., equip)
3. Operation and Process cost centres:• Cost centre consists of those machines and/or persons
which carry out the same operation is operation cost centre.
• Cost centre consisting continuous sequence of operations is called process cost centre.
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Example
• A cost accountant sets up cost centres to enable him to ascertain the costs he needs to know. A cost centre is charged with all the costs that relate to it; if a cost centre is machine, it will be charged with the cost of power, light, depreciation and its share of rent, etc.
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29Example
• In a laundry, activities such as collecting, sorting, marketing and washing of clothes are performed. Each activity may be considered as a separate cost centre and all costs relating to a particular cost centre may be found out separately.
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Purposes of cost centres
• Cost centres are created for ascertainment of the cost of that cost centre.
• Cost ascertainment is required for cost control for that cost centre.
• The manager in charge of a cost centre is assigned the responsibility for the control of costs of that centre.
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Advantages of cost accounting
1. Supplies detailed cost information
2. Enable price fixation
3. Discloses operating efficiency
4. Helps reveal idle capacity
5. Facilitates planning
6. Guides decision making
7. Assists managerial control of costs
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8. Facilitates cost comparison
9. Facilitates cost plus contracting
10. Facilitates inter period comparison
11. Identifies the areas requiring corrective action.
12. Negotiations with government and labour unions can be easily made with the information provided by the cost accounting system.
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Limitation of cost accounting
1. Absence of readymade system
2. Cost accounting provides base for taking decisions, it does not give outright solution of the problems.
3. Conclusions from the results can be subjective.
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Different Methods of Costing
• Cost ascertainment is accomplished by adopting a method of cost accumulation and measurement of production, depending upon the nature of the undertaking and nature of the product produced.
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Methods of costing1. Unit or Single Output Costing
1. Homogeneous units
2. As the units of output are identical, the cost per unit is found by dividing the total cost by the no. of units produced.
3. Per unit cost
4. Examples: Production of radios, cameras, typewriters, pencils, cigarettes, etc
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2. Job costing
1. Production as per customers’ specification.
2. Each job is separate and distinct.
3. Cost unit is a job or work order.
4. Examples :Printing press, interior decorators, painters, etc
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3. Contract costing or Terminal costing
1. Variation of job costing.
2. A contract is a “Big” job.
3. Cost unit here is a contract itself.
4. Contract can be of long duration and may continue for more than one accounting year.
5. Examples: Construction of buildings, dams, bridges and roads, etc
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4. Batch costing
1. Cost of group of identical products is ascertained.
2. Production consists of group and not individual units.
3. Each batch of product is cost unit.
4. Examples: Readymade garments, toys, shoes, etc
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5. Process costing
1. Used in mass production industries.2. Costs are accumulated for each process.3. Raw material passes through a number of processes in a
particular sequence.4. The finished product of one process is passed on to the next
process as raw material.5. Examples: Textile mills, chemical works, sugar mills, soap
manufacturing, etc
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6. Operating or service costing
1. Used in undertakings which provides services.
2. Examples: Transport undertakings, Electricity companies, hotels, hospitals, cinemas, etc.
3. Cost units are passenger km., a room per day in hotel, a seat per show in cinema, etc
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7. Operation costing
1. Refinement and more detailed application of process costing.2. A process may consist of a number of operations.3. Operation costing involves cost ascertainment for each
operation instead of a process.4. This method provides minute analysis of costs and ensures
greater accuracy and better control.
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8. Multiple or composite costing
1. Application of more than one method of cost ascertainment in respect of the same product.
2. Used in industries where a number of components are separately manufactured and then assembled into a final product.
3. Examples: air-conditioners, refrigerators, scooters, cars, etc.
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Cost accounting techniques
In order to produce useful information for managerial purposes, cost data collected should be processed according to costing principles, using one or more costing techniques.
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Marginal costing
• CIMA has defined marginal cost as, “ the cost of one unit of product or service which would be avoided if that unit were not produced or provided.”
• Functions of marginal costing• Cost control• Profit planning• Performance evaluation• Decision making
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• Marginal costing is the ascertainment of marginal costs and of the effect on profit of changes in volume or type of output by differentiating between fixed costs and variable costs.
• It is a technique applying the existing methods in a particular manner in order to bring out the relationship between profit and volume of output.
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46Example
• Break Even Point.• Required sales for expected profit.• Entering into new market.• Accepting the export order.• Make or buy.• etc
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Uniform costing• This is not a separate technique of costing, it simply
denotes a situation in which a number of firms adopt a uniform set of costing principles.
• The use by several undertakings of the same costing systems, i.e., the same basic costing methods, principles and techniques.
• This helps to compare the performance of one firm with that of other firms and thus to derive the benefit of anyone’s better experience and performance.
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Standard costing
• One of the most important techniques of cost control.• Standard cost is predetermined as target of performance and
actual performance is measured against the standard.• The difference between standard and actual costs are analyzed
to know the reasons for the difference so that corrective actions may be taken.
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49Differential costing
• The difference in total cost between alternatives calculated to assist decision making.
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50Classification of costs
• Classification is the process of grouping costs according to their common characteristics.
• It is a systematic placement of like items together according to their common features.
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1. Direct & Indirect Costs
• Costs are classified into direct costs and indirect costs on the basis of their identifiability / traceability with cost units or jobs or processes or cost centres.
• Examples: Direct Material is a direct cost while indirect material is the indirect cost.
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2. Fixed & Variable Costs
• Costs behave differently when level of production rises or falls.
• Certain costs change in sympathy with production level while other costs remain unchanged.
• Factory rent and salary to office staff is a fixed cost. While raw material is a variable cost.
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3. Capital & Revenue Cost
• A capital expenditure provides benefit to future benefits and is classified as an asset.
• A revenue expenditure is assumed to benefit the current period and is classified as an expense.
• Purchasing machine is a capital expenditure while it would be revenue expenditure if the raw materials are purchased.
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4. Controllable & Uncontrollable Costs
• Controllable cost is a cost which can be influenced by the action of a specified member of an undertaking.
• A non-controllable cost is a cost which cannot be influenced by the action of a specified number of an undertaking.
• Normal loss is a non-controllable cost while abnormal loss is a controllable cost.
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5. Historical and Budgeted Costs
• Historical costs refers to costs that are already incurred and are of past.
• Budgeted refers to the costs of future or which are estimated in advance.
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Total cost & Unit cost
• The sum of all the costs refers to total cost.• When the total cost is divided by total output the unit cost
is available.
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Manufacturing, Administration & S&D Costs
• This classification is as per function• Total cost can be divided as per function.• Manufacturing costs include Raw Material, Direct Labour, and
other manufacturing costs.• Administration costs include all the office expenses.• Selling and Distribution cost include all the marketing,
distribution and selling expenses.
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Installation of cost accounting
1. Nature of business2. Nature of organization3. Methods and procedures4. Technical aspects5. Management’s expectations and policies6. Simplicity7. Co-operation and support of personnel8. Standardization of forms
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M.A. v/s F.A.
1. Structure or format of presenting information
2. Primary objective
3. Legal requirements
4. Orientation
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M.A. v/s C.A.1. When costs are used by outsiders it is said to be used for
financial accounting purpose.
2. When cost data are used inside the organization it is said to be used for management accounting purpose.
3. CA is confined to cost ascertaining and related information processing, while MA provides data which includes any and all information that management may need.
4. CA largely uses data about production, sales, wages ,etc while MA utilizes the same and more data to prepare budgets, performance reports, control reports, etc.
