30
Basic Cost Concepts

Basic cost concepts

Embed Size (px)

DESCRIPTION

Basic cost concepts

Citation preview

Page 1: Basic cost concepts

Basic Cost Concepts

Page 2: Basic cost concepts

Define Terms 1) Cost :

Expenditure incurred in producing a product or in rendering a service

measurement, in monetary terms, of the amount of resources used for the purpose of production of goods or rendering services.

Page 3: Basic cost concepts

2) Costing :The technique and process of ascertaining costs.

3) Cost Accounting : Begins with recording of

income and expenditureends with the preparation of

periodical statements and reports

Page 4: Basic cost concepts

4) Cost Accountancy :The application of costing and

cost accounting principles, methods and techniques

practice of cost controlthe ascertainment of profitability

Page 5: Basic cost concepts

List the Objetives of Cost Accounting

The primary objective of study of cost is to contribute to profitability through Cost Control and Cost Reduction.1. Ascertainment of Cost:

Collection of cost information 2. Determination of Selling Price3. Ascertaining the profit of each activity4. Assisting Management in decision-making5. Cost Control and Cost Reduction

Page 6: Basic cost concepts

Distinguish between Cost Reduction and Cost Control.

1) PermanencePermanent, Real and genuine savings in

cost. Temporary saving

2) Saving Focus

Saving in Cost per unit Saving either in Total Cost or Cost per unit

3) Product Quality

Retained Not a guarantee

4) Nature of Standards

Continuous process of critical examination Control is achieved through compliance with standards

Page 7: Basic cost concepts

5) Dynamic

Full Dynamic Less Dynamic

6) CoverageUniversally applicable to all areas of

business. Does not depend upon standards, though target amounts may be

set.

Limited applicability to those items of cost for which standards can be set.

7) Nature of CostsPartly on present costs and largely on

future costs. present and past behavior of costs

8) Nature of Function

Corrective Action - operates even when efficient cost control systems exist. There

is room for reduction in the achieved costs.

Preventive Function - costs are optimized before they are incurred.

Page 8: Basic cost concepts

9) Tools & Techniques

(a) Value Engineering, (b)Standardisation and

Simplification, (c) Work Study, (d) Variety Reduction, (e) Quality Measurement &

Research, (f) Operations Research, (g) Market Research, (h)Job Evaluation and Merit

Rating, (i)Improvement in Product

Design, (j)Mechanisation and

Automation, etc.

Budgetary Control and Standard Costing.

Page 9: Basic cost concepts

Bring out the importance of Cost Accounting to Business Concerns.

1. Decision Making: Business decision-making requires analysis of statements indicating the likely effect of various cost control and revenue generation measures on the profits.

2. Cost Control:For example, Material Costs may be controlled by –

(a) ensuring un-interrupted supply of material and spares for production,

(b) avoiding excessive locking up of funds / capital in stocks of materials and stores, and

(c) use of techniques like Value Analysis, Standardization, etc.

Page 10: Basic cost concepts

3) Budgeting:Budget Estimates are drawn up by Cost Accounting Department, before the start of each activity, to ensure that a practicable course of action is identified, and the actual performance corresponds with the estimated.

4) Measuring Efficiency: Cost Accounting Department can provide information about standards and actual performance of the concerned activity.

5) Price Determination : 6) Curtailment of Loss during off-season:7) Expansion:

Page 11: Basic cost concepts

Distinguish between Cost Accounting and Financial Accounting.

1) Users of InformationInternal Management & External

ManagementInternal Management for proper planning,

decision making & cost control

2) Statutory Compliance

Companies Act, Income Tax ActCost Accounting is voluntary, except in cases

where Cost Accounting Records Rules mandatorily apply to the enterprise

3) Nature/ObjectivityAccounting Policies may differ from one

Firm to another Firm.Techniques are generally uniform to all

Firms.

4) Focus

Recording the transactions. Control Cost

Page 12: Basic cost concepts

5) Nature of Cost

Historical Cost Historical Cost & Standard Cost i.e. Pre determined cost

6) Stock Valuation

Cost or NRV whichever is less. Cost

7) Cost AnalysisCost / Expenditure and Profits are generally shown as a whole for the

period.

Costs are analysed product-wise, department-wise, activity-wise, etc.

8) Time Period

F.S. are prepared at the end of the Year Cost data & reports are prepared on continuous basis.

9) Forecasting & PlanningLimited Use. Parameters like GP, NP, ROI,

EPS, etc. can be laid down.Specific and detailed plan for each

product/Useful for Budgeting

Page 13: Basic cost concepts

10) Utility for decisions

Helps only for future decisions with respect to product pricing, make or buy, asset retainment vs replacement, etc.

Helps current & future decisions, e.g. product price reduction and higher volume in order to earn target profit, resource re-allocation, etc.

Note: Cost Accounting supplements Financial Accounting for analysis and decision-making purposes, as described above.

Financial Accounting suffers from limitations of lack of analysis of information, and absence of detailed control and assessment parameters.

Better tools of control, analysis and assessment are available. Some examples are Variance Analysis, Budgetary Control, & Marginal Costing.

11) Control & Assessement

Page 14: Basic cost concepts

Cost

Functions-basedProduction

AdministrationS&DR&D

Pre ProductionConversion

Relationship based

• Direct• Indirect

Controllability based

• Controllable• Non-

Controllable

Normality basedNormal

Abnormal

Attributability based

• Product• Period

Decision—making based

• Relevant• Irrelevant

Cause & Effect based

• Engineered• Discretionary

Payment-based

• Explicit• Implicit

Page 15: Basic cost concepts

List the various items of costs on the basis of relevance to decision-making.

(A) Relevant Costs:

1) Marginal Cost:

Total Variable Cost, Prime Cost plus Variable Overheads.

(Marginal Cost is relevant for decision-making, as this cost will be incurred in future for additional units of production.)

Page 16: Basic cost concepts

2) Differential Cost:

• It is the change in costs due to change in the level of activity or pattern or method of production.

• Where the change results in increase in cost it is called Incremental Cost

• If costs are reduced due to decrease of output, the difference is called decremental Costs.

Page 17: Basic cost concepts

3) Opportunity Cost:

• The value of sacrifice made or benefit of opportunity foregone in accepting an alternative course of action.

• For example, a Firm may finance its expansion plan by withdrawing money from its bank deposits. Then, interest lost on the Bank Deposit is the opportunity cost for carrying out the expansion plan.

Page 18: Basic cost concepts

4) Out-of-pocket Cost:

• Current or near future outlays of cash for the decision at hand

• relevant for decision-making• short-run concept• avoided or saved, if a particular proposal under

consideration is not accepted.

Page 19: Basic cost concepts

5) Replacement Cost:

• It is the cost at which there could be purchase of an asset or material identical to that which is being replaced or revalued.

• It is the cost of replacement at current market price and is relevant for decision-making.

Page 20: Basic cost concepts

6) Imputed Costs:

• notional costs appearing in the cost accounts only• e.g. notional rent charges, interest on capital for

which no payment has been made.• Where alternative capital investment projects are

being evaluated, it is necessary to consider.

Page 21: Basic cost concepts

(B) Irrelevant Costs: Not useful for decision making

1) Sunk Cost:

• Has already been incurred or sunk in the past.• It is not relevant for decision making

• Firm has obsolete stock of materials originally purchased for Rs.50,000 which can be sold as scrap now for Rs.18,000 or can be utilised in a special job, the value of stock already available Rs.50,000 is a sunk cost and is not relevant for decision-making.

Page 22: Basic cost concepts

2) Absorbed Fixed Costs:

• Fixed Costs do not change due to increase or decrease in activity

• Fixed Costs are absorbed in cost of production at a normal rate, they are irrelevant for managerial decision-making.

• However if Fixed Costs are specific, they become relevant.

Page 23: Basic cost concepts

3) Committed Costs:

• Cost in respect of which decision has already been taken, and such decision cannot be altered.

• e.g. entering into irrevocable agreements for Rent, Technical Collaboration, etc.

• should be contrasted with Discretionary Costs, which are avoidable costs.

Page 24: Basic cost concepts

Cost Classification for presentation purpose

Total Cost

Direct Cost i.e. Prime Cost

Direct

Material

Direct

Labour

Direct

Expnese

Indirect Cost (OH)

Production OH

Administration OH

Selling &

Distribution OH

Page 25: Basic cost concepts

Cost Sheet? What are its uses?Meaning:

1. shows the break-up and build-up of costs2. document which provides the consolidation of the

detailed cost of a Cost Centre or a Cost Unit.Uses:1. Presentation of Cost information.2. Determination of Selling Price.3. Ascertainment of profitability.4. Preparation of Budgets.

Page 26: Basic cost concepts

5) Inter-Firm and Intra-Firm Cost Comparison.6) Preparing Cost Estimates for submitting tenders /

quotations.7) Product-wise and Location-wise Cost Analysis.8) Disclosure of operational efficiency for Cost Control

Page 27: Basic cost concepts

Items that are not regarded as "Cost" and not included in the Cost Sheeta) Non-Operating Incomes, e.g. Rent, Interest and

Dividends received.b) Losses or Profits of capital nature, e.g. Profit or Loss on

sale of Investments, Plant and Equipment, etc.c) Items not representing actual costs but dependent on

arbitrary decisions and policies of the management, e.g. an unreasonably high salary to the Managing Director, providing for depreciation at a rate exceeding the economic rate.

d) Appropriation of Profits, e.g. Payment of Dividends, Transfers to Reserves, etc.

Page 28: Basic cost concepts

e) Profit based Outflows, i.e. Income-Tax. [Note: Bonus paid to workers is treated as Cost].

f) Amounts representing loss on account of inefficiency of a particular activity, e.g. Bad Debts as a result of inefficient credit management, Penalties & Fines due to non-compliance with law, abnormal wastages and losses, etc.

g) Items which may distort comparison, e.g. financial items like interest, discount, etc. and other similar items.

h) Imputed items that are not actually incurred by the firm but constitute arbitrary charges against profit, e.g. interest on own capital at an arbitrary rate.

i) Write-offs of Goodwill, Preliminary Expenses, etc.

Page 29: Basic cost concepts

Particulars Production / Manufacturing A/c Cost Sheet 1. Basis It is prepared on the basis of double-entry system of book-keeping. It is only a statement and hence double-entry system is not applicable. 2. Purpose The primary objective of preparation is Reporting. The primary objective is decision-making. 3. Parts It has two parts - one showing the cost of manufacture and the other part showing Sales and Gross Profit. It is a step-by-step presentation of total cost and shows Prime Cost, Works Cost, Cost of Production, Cost of

Goods Sold, Cost of Sales and Profit. 4. Analysis Total Cost is shown in aggregate. Product-wise or Location-wise analysis is not generally given. Cost Sheet shows costs in a detailed and analytical manner, which facilitates cost comparison. 5. Quotations This is not useful for preparing tenders or quotations. Estimated Cost Sheets can be prepared based on past experience, and useful for submitting quotations.

Page 30: Basic cost concepts

Production / Manufacturing A/c Cost Sheet

1) Basis

double-entry system of book-keeping only a statement and hence double-entry system is not applicable.

2) Purpose

Reporting decision-making.

2) Purpose

Reporting decision-making.