CONTOL THROUGH COSTINGCONTOL THROUGH COSTINGByByABDUL MUEEDABDUL MUEED

14N2-10802314N2-108023MUDASSIR ALIMUDASSIR ALI

14N2-10803014N2-108030ASAD MEHMOODASAD MEHMOOD

14N2-10803114N2-108031

Cost Accounting:Cost Accounting:

Cost covers many aspects.Cost covers many aspects.Valuation of materials drawn from stock to Valuation of materials drawn from stock to determine the overall cost of the product determine the overall cost of the product being made.being made.Costing of labour.Costing of labour.Costing of overheads.Costing of overheads.Product marginal cost to compare the Product marginal cost to compare the contribution made to cost recovery by contribution made to cost recovery by different products.different products.

Traditional Techniques of Costing :Traditional Techniques of Costing :

Total Absorption CostingTotal Absorption Costing In this method all the costs, direct and indirect, In this method all the costs, direct and indirect,

associated with the product are absorbed into the associated with the product are absorbed into the units.units.

Marginal CostingMarginal CostingThe primary purpose of this method is to help The primary purpose of this method is to help

in management decision making.in management decision making.

Standard costingStandard costingIn this method targets are first set for future In this method targets are first set for future

cost and then actual costs are measured, as they cost and then actual costs are measured, as they occur, using historical costing methods.occur, using historical costing methods.

Principles of CostingPrinciples of Costing

There are several principles associated with costing.There are several principles associated with costing.Costs must be associated as closely as possible with Costs must be associated as closely as possible with the cause or item.the cause or item.Costs should only be charged when they are Costs should only be charged when they are incurred, even if they are expected to occur in the incurred, even if they are expected to occur in the future.future.If the event causing the cost has passed and costs If the event causing the cost has passed and costs were not recovered at that time, then they should were not recovered at that time, then they should not be moved forward and charged to another item not be moved forward and charged to another item that was not responsible for the cost.that was not responsible for the cost.

CONTN’DCONTN’D

Costs allocated must be as accurate as Costs allocated must be as accurate as possible.possible.

Costs which are atypical should not be Costs which are atypical should not be included or they will give false managements included or they will give false managements information. information.

Key Cost ConsiderationsKey Cost Considerations

There are several key cost considerations for any There are several key cost considerations for any business.business.The company must ensure that costs, adjusted for The company must ensure that costs, adjusted for inflation, are continually decreasing. It must strive inflation, are continually decreasing. It must strive to be low-cost supplier.to be low-cost supplier.The company must know the true costs and profit The company must know the true costs and profit associated with each product, cost center, market of associated with each product, cost center, market of customer, so that it can take effective management customer, so that it can take effective management decisions.decisions.The company must manage its costs so as to The company must manage its costs so as to manage cash flow, which is crucial to any business. manage cash flow, which is crucial to any business.

Product Costing:Product Costing:

Product are usually costed on the basis of Product are usually costed on the basis of job costing or process costing.job costing or process costing.

Job CostingJob Costing

Job costing applies to a product that is Job costing applies to a product that is built on a batch basis.built on a batch basis.

Process CostingProcess Costing

Process costing applies when products Process costing applies when products are being built for stock.are being built for stock.

Classification of Costs:Classification of Costs:

There are several classifications used to define There are several classifications used to define costs. Generally they can be summarized as direct and costs. Generally they can be summarized as direct and indirect costs.indirect costs.Direct CostDirect Cost

Direct costs relate only those items that are Direct costs relate only those items that are associated closely with the product being made or associated closely with the product being made or costed and are not shared with any other product.costed and are not shared with any other product.Indirect CostIndirect Cost

Indirect costs are those items which are not Indirect costs are those items which are not dependent only on the products being made or costed.dependent only on the products being made or costed.

Valuation of StockValuation of Stock

FIFO (First in first out)FIFO (First in first out)In the FIFO method of stock In the FIFO method of stock

valuation the earliest purchase price valuation the earliest purchase price is used to determine the value of the is used to determine the value of the material being withdrawn from material being withdrawn from stores, until all the stock at this level stores, until all the stock at this level is used up, and then the next is used up, and then the next purchase price is used.purchase price is used.

LIFO (last in, first out) LIFO (last in, first out) The LIFO (last in, first out) method The LIFO (last in, first out) method

of stock valuation uses the latest purchase of stock valuation uses the latest purchase price paid for the stock until that is used price paid for the stock until that is used up, and then the earlier price is usedup, and then the earlier price is used Weighted AverageWeighted Average

In the weighted average pricing In the weighted average pricing system of store valuation, the average system of store valuation, the average price of the store contents at the time of price of the store contents at the time of issue is used to cost the job.issue is used to cost the job.

Replacement Price MethodReplacement Price Method

In the replacement price method the In the replacement price method the withdrawals from stores are valued at the actual withdrawals from stores are valued at the actual market price that exist at that time. Clearly this is the market price that exist at that time. Clearly this is the best method to use at times of violently fluctuating best method to use at times of violently fluctuating prices, and it is also simple to calculate.prices, and it is also simple to calculate.

Standard Price MethodStandard Price Method

The standard price method uses the initial The standard price method uses the initial standard price calculated for the material as the price standard price calculated for the material as the price for all subsequent withdrawals. The standard price for all subsequent withdrawals. The standard price may be periodically reviewed and changed, but this may be periodically reviewed and changed, but this would be done relatively infrequently.would be done relatively infrequently.

Allocation Of OverheadsAllocation Of Overheads

Overheads are generally taken to Overheads are generally taken to include all costs that cannot be identified include all costs that cannot be identified exclusively with a specific product or exclusively with a specific product or service, and therefore cannot be easily service, and therefore cannot be easily allocated to individual units. Overheads allocated to individual units. Overheads are ‘recovered’ by charging out a are ‘recovered’ by charging out a proportion of the overhead to the various proportion of the overhead to the various items that shared in causing it to occur.items that shared in causing it to occur.

MethodsMethods

Generally overheads are allocated to items Generally overheads are allocated to items of production according to six methods.of production according to six methods.

By the number of units made.By the number of units made.

By the cost of the material used.By the cost of the material used.

By the labour costs associated with making the By the labour costs associated with making the units.units.

By the labour hours used in production.By the labour hours used in production.

By the machine hours.By the machine hours.

By the prime cost of the units By the prime cost of the units

Standard CostingStandard Costing

There are two basic method for costing the product or There are two basic method for costing the product or service.service.Historical CostingHistorical Costing

Determining the cost after the activity has been Determining the cost after the activity has been completed.completed.Standard CostingStandard Costing

Estimating the costs that are likely to occur Estimating the costs that are likely to occur before the activity is started. This method is known as before the activity is started. This method is known as standards costing because it sets standards for the standards costing because it sets standards for the costs involved. costs involved.

Standard Costing SystemStandard Costing SystemStandard costing system involves the followingStandard costing system involves the following

1.1. Establishing cost centres. These may be Establishing cost centres. These may be product, person and location and so on, for which product, person and location and so on, for which cost can be determined and completed.cost can be determined and completed.

2.2. Clearly establishing the responsible person Clearly establishing the responsible person for each standard cost.for each standard cost.

3.3. Preparing a classification system for cost Preparing a classification system for cost collection. Usually this will be on the basis of collection. Usually this will be on the basis of direct materials, direct labour and so on the direct materials, direct labour and so on the product or service.product or service.

CONT’DCONT’D

4.4. Determining the type of standard to be set up. Determining the type of standard to be set up. There are three type There are three type Ideal Ideal Expected Expected BasicBasic5.5. Determining standard costs for each activity. Determining standard costs for each activity. This involves a considerable amount of work, This involves a considerable amount of work, and key personnel must be involved in this, and key personnel must be involved in this, especially if they are to be measured against especially if they are to be measured against these standards.these standards.

Advantages of Standard CostingAdvantages of Standard Costing

It provides a yardstick or standard against It provides a yardstick or standard against which cost performance can be measured.which cost performance can be measured.It clearly defines responsibility for each It clearly defines responsibility for each standard and provides a target, which can act standard and provides a target, which can act as an incentive, for improvement.as an incentive, for improvement.The activity involved in setting standards The activity involved in setting standards requires a detailed analysis of the processes requires a detailed analysis of the processes being used within the organization.being used within the organization.Standard costs help to identify problem areas, Standard costs help to identify problem areas, which can then be investigated using variance which can then be investigated using variance analysisanalysis

Knowledge Required For Standard Knowledge Required For Standard Material CostsMaterial Costs

To set the standard material costs To set the standard material costs requires a knowledge of several items requires a knowledge of several items such as:such as:1.1.The standard material specification.The standard material specification.2.2.The standard material price.The standard material price.3.3.The standard material usage on the The standard material usage on the product or service being considered.product or service being considered.

Standard Labour CostsStandard Labour Costs

The standard labour costs are those which are The standard labour costs are those which are used in the manufacture of the product. These are used in the manufacture of the product. These are subdivided into rate cost and time cost.subdivided into rate cost and time cost.Rate CostRate Cost

Which is the standard rate of pay for each class Which is the standard rate of pay for each class of labour employed, and time cost.of labour employed, and time cost.Time CostTime Cost

Which is the standard time for each grade of Which is the standard time for each grade of labour needed to make the product when the job is labour needed to make the product when the job is carried out in the most efficient way.carried out in the most efficient way.

Information Required to Set the Information Required to Set the Standard Labour CostsStandard Labour Costs

Some of the information required to set Some of the information required to set the standard labour costs are:the standard labour costs are:

The standard skills needed to make the The standard skills needed to make the product or provide the service.product or provide the service.

The standard labour rates.The standard labour rates.

The standard labour hours needed to produce The standard labour hours needed to produce the produce the product or service must be the produce the product or service must be forecast.forecast.

VariancesVariances

The differences between The differences between standard costs and actual costs are standard costs and actual costs are computed as the job progresses. computed as the job progresses. These differences are known as These differences are known as variances.variances.

Type of VariancesType of Variances

There are two basic types of variances.There are two basic types of variances.

PricePrice

VolumeVolume

PricePrice

A price variances related to such items as A price variances related to such items as the price materials.the price materials.

VolumeVolume

Volume variances relate to the amount of Volume variances relate to the amount of raw material used.raw material used.

Direct Material VarianceDirect Material Variance

The direct material variance is due The direct material variance is due to the actual cost of materials used in to the actual cost of materials used in production differing from those predicted production differing from those predicted in the standard costs. It is given by in the standard costs. It is given by equationequation

Material cost variance = Actual material cost – Standard material costMaterial cost variance = Actual material cost – Standard material cost

Overhead VarianceOverhead Variance

Overhead variance occurs when the Overhead variance occurs when the overhead absorbed is less than that originally overhead absorbed is less than that originally planned. Overhead absorption is usually planned. Overhead absorption is usually determined following equationdetermined following equation

Overhead absorbed = OSH × Overhead absorption rateOverhead absorbed = OSH × Overhead absorption rate

Overhead variance = Actual overheads – OSH (Fixed Overhead variance = Actual overheads – OSH (Fixed overhead absorption rate + Variable overhead absorption rate)overhead absorption rate + Variable overhead absorption rate)

Selling and Distribution Selling and Distribution VariancesVariances

The selling and distribution variances The selling and distribution variances arise when the selling and distribution costs arise when the selling and distribution costs differ from those planned. They are based on differ from those planned. They are based on the volume of sales, not production, and are the volume of sales, not production, and are given by Equationgiven by Equation

Variance = Actual costs – (Units sold ×Standard cost per unit)Variance = Actual costs – (Units sold ×Standard cost per unit)

Sales VarianceSales Variance

The sales margin variance is the difference The sales margin variance is the difference between the actual margin from sales and the between the actual margin from sales and the budgeted margin (profits).budgeted margin (profits).Sales margin variance = (Actual sales – Cost of sales) –Budgeted marginSales margin variance = (Actual sales – Cost of sales) –Budgeted margin

The sales margin variance can be analyzed into The sales margin variance can be analyzed into the sales margin price variance and the sales the sales margin price variance and the sales margin quantity variance. margin quantity variance. Price variance = (Actual margin – Standard margin) × Units soldPrice variance = (Actual margin – Standard margin) × Units sold

Quantity variance = (Units sold – Budgeted margin) × Standard marginQuantity variance = (Units sold – Budgeted margin) × Standard margin

Marginal CostingMarginal Costing

Marginal costing differentiates between fixed and Marginal costing differentiates between fixed and variable costs and it prime use is in decision making. variable costs and it prime use is in decision making. Costs and DistributionCosts and DistributionCosts can be broadly divided into two categories:Costs can be broadly divided into two categories:Those related to the level of activity ,such as production Those related to the level of activity ,such as production or sales.or sales.Those that are fixed, that is, not related to the level of Those that are fixed, that is, not related to the level of activity.activity.Figure (on next slide) graphically illustrates those two Figure (on next slide) graphically illustrates those two costs, it is assumed that over the time frame being costs, it is assumed that over the time frame being considered the fixed costs are truly fixed and the considered the fixed costs are truly fixed and the variable costs vary linearly with the level of activity variable costs vary linearly with the level of activity

Breakdown of Total Costs as Fixed Breakdown of Total Costs as Fixed Cost and Variable CostsCost and Variable Costs

Break Even ChartBreak Even ChartThe break-even point for any product is the volume beyond The break-even point for any product is the volume beyond

which profit is realized and below which profit turns into loss. The which profit is realized and below which profit turns into loss. The break even point is illustrated graphically by the break even chart.break even point is illustrated graphically by the break even chart.

Advantages of Marginal CostingAdvantages of Marginal Costing

There are several advantages to marginal costing There are several advantages to marginal costing techniques ,compared with standard costing:techniques ,compared with standard costing:Fixed costs ,which are time related rather than Fixed costs ,which are time related rather than product related, are kept separates from product related, are kept separates from production costs. This prevents misleading result production costs. This prevents misleading result being obtained regarding profitability of being obtained regarding profitability of products.products.Marginal costing avoids the false results that can Marginal costing avoids the false results that can arise if fixed costs are absorbed into products arise if fixed costs are absorbed into products which later cannot be sold, for example they are which later cannot be sold, for example they are spoilt.spoilt.

CONT’DCONT’D

Marginal costing avoids the situation of Marginal costing avoids the situation of over or under absorption of fixed costs, over or under absorption of fixed costs, which can arise with standard costing.which can arise with standard costing.Contribution in a much better indicator of Contribution in a much better indicator of profitability of individual product lines profitability of individual product lines than profit obtained from total absorption than profit obtained from total absorption costing. It is therefore a more effective costing. It is therefore a more effective decision making method.decision making method.

DisadvantagesDisadvantages of Marginal of Marginal CostingCosting

The main disadvantages of The main disadvantages of marginal costing is that if fixed costs marginal costing is that if fixed costs are totally ignored, and too much are totally ignored, and too much sales if taken at marginal costs plus a sales if taken at marginal costs plus a margin of profit, it will result in margin of profit, it will result in lower overall profit or even a loss.lower overall profit or even a loss.

THANK THANK YOU SIRYOU SIR