Cost & Management Accounting

IQRA University Gulshan Campus

By Raheel Bhagar
[email protected]
[email protected]
 Course Introduction
Recommended Books:
1. Matz, A., & Usry, M.F. Cost Accounting: Planning and Control
(7th Ed.)
Grading policy and general guidelines:
Final term: 60;
Hourly Quizzes 20; (I am dicey about it)
Assignments 20;
Total: 100;

Cost & Management Accounting 2

 Accounting

It is a language about financial information (which is measurable in terms

of money) commonly used in business.

Branches of Accounting

Accounting

Financial Management
Cost Accounting
Accounting Accounting

Fed by Financial
For External For Internal
& Cost
Reporting Reporting
Accounting
 User Group

User Group

Financial Accounting Cost & Management Accounting

Investors Managers

Lenders Directors

Govt Agencies

Suppliers

Management

Employees
 Branches Of Accounting

Financial Accounting is an art of recording (Journal), classifying

(Ledger), summarizing (Trial balance), reporting (Profit & Loss A/c &
Balance Sheet) and analysis (Interpretation) the financial
information.

Cost Accounting deals with ascertainment, measurement,

accumulation, budgeting and evaluating cost structure of the entity.

Management Accounting deals with decisions relating to the

generation and effective utilization of the financial resources of an
entity.
 Cost Accounting
Cost Accounting means: Accounting for cost.

Question arises what is cost?

cost is expenditure incurred
Next question arises expenditure incurred for what ?
Expenditure incurred for a product
Next question arises what is product?
Production of a article
Rendering of services
 Cost Accounting

So Cost accounting is a specialized branch of accounting which

provide processed set of information / statements to the
management which assist them in decision making.

In cost accounting cost of product or a process is;

Ascertained
Measured
Accumulated
 Management Accounting

Management is central coordinating body in an entity

Management is concerned with the maximization of wealth through

Minimization of cost
Maximization of profit

For this purpose information provided by cost accounting is analyzed

by the management for decision making and management control
function.
 Management Accounting

Reports generated through management accounting are used

internally.
Major function of management accounting:
Planning & Forecasting
Controlling
Decision making

Pricing
Make or Buy
Shut down or Continued operation
Equipment Replacement
 Purpose Of Cost Accounting

Provides information relating to cost of production.

Determines the appropriate selling price.
Discloses profitable products, areas and activity level.
Helps in make or buy decision.
Budgeting relating to production function.
Controls production variances.
Provides information to financial accountant.
 Classification Of Cost

Cost
Classification

Direct Cost Indirect Cost

Direct Other Direct Factory

Direct Labor
Material Expenses Overhead
 Direct Cost

Cost that can be traced in full to the

product or services is direct cost
 Types Of Direct Cost

Direct material costs are those cost of material that are traceable in
full in the cost of a product or services

For example wood in manufacturing of table

Direct labor cost are the specific cost of the worker in producing a
or service

For example labor involve in cutting wood

 Types Of Direct Cost

Other Direct Expenses These are expenses other than direct

material and direct labor which have been incurred in full as direct
consequences of producing product or services

Royalty on production, Cost of jigs / moulds

 Indirect Cost

The cost that is incurred in producing product or services but which can not traced
in full

Factory overhead (FOH)

FOH means all expenses of factory other than direct material, direct labor and
other direct production expenses.

Indirect material
Indirect Labor
Deprecation of machinery
Factory utility bills
 Cost classification

Direct Material + Direct Labor + Other Direct Cost = Prime cost

Direct Labor + Other Direct Cost + FOH = Conversion cost

Prime Cost + FOH = Total factory cost

 Summary

Material cost Labor cost Other production Total production

cost cost

Direct = Prime cost

Direct Direct

Indirect Indirect Indirect = FOH cost

Total Factory
Total Total Total =
Cost
 Cost classification

Direct material Rs 12,000

Direct labor 8,000
Other direct cost 2000
Prime cost 22,000
FOH
Indirect material 3000
Indirect labor 2000
Electricity bill 1500
Rent of factory 3500
Depreciation 1000
11000
Total factory cost 33000
 Behavior Of Cost

Fixed cost Step fixed cost

Variable cost Semi variable cost

 Fixed cost
Fixed cost is a cost that do not vary with the level of production.
Simple means the variation in production has no impact on fixed
cost. For example rent of building and accountant salary etc

3000

Fixed cost
2000

1000

100 200 300

No. of units
 Fixed Cost Per Unit Reaction

Fixed cost per unit decreases as the number of units produced

increases and vice versa

For example rent of building is Rs. 10,000 and number of units

produced is 5000.

Per unit fixed cost = 10000 / 5000 = 2 per unit

If the number of units produced increases to 10000

Per unit fixed cost = 10000 / 10000 = 1 per unit

 Step Fixed Cost
Costs which are constant for a relevant range of activity and rise
to new constant level once that range exceeded.
For example rent.

Fixed cost

No. of units
 Variable Cost

The expenses that vary in direct proportion to volume of product. For

example Prime cost.

Variable cost

No. of units
 Variable Cost Per Unit Reaction

Variable cost per unit remain constant

Units of Labor Total wages Per labor wage rate

10 10,000 1,000
20 20,000 1,000
 Semi Variable Cost

The cost that is partly fixed and partly variable cost. For
example electricity bills, salesman salary.

3000

Semi variable 2000

cost
1000

100 200 300

No. of units
 Summary

If the production volume increases

Per unit Total

Fixed cost Decreases Constant

Variable cost Constant Increases

Total cost Decreases Increases

 Summary

If the production volume decreases

Per unit Total

Fixed cost Increases Constant

Variable cost Constant Decreases

Total cost Increases Decreases

 Total cost

Total cost include both fixed cost and variable cost

As VC added in FC shifts upward

Total cost

Variable cost

3000
Total cost
2000 Fixed cost
1000

100 200 300

No. of units
 Exercise
ABC Company has the following data required
for the production data:
PC Direct Material 25000 VC
Direct Labor 15000
VC
Electricity Bill 2000
FC
Building Rent 5000
Indirect Material 7000 FC
FOH Indirect Labor 3000 FC
Depreciation 2000 FC
Selling Expense 7000
Salary to Plant supervisor 4000 FC

Cost & Management Accounting 29

 Test your knowledge
Which of the following is most likely to be a variable
cost?
a. Depreciation
b. Cost of materials
c. Rent
d. Advertising

Answer:
b. Cost of materials
 Test your knowledge

Which of the following is most likely to be a fixed cost?

a. Cost of materials
b. Rent
c. Assembly labor cost
d. Commissions

Answer:
b. Rent
 What we have discussed so Far

Branches of accounting
Cost Classification
Direct material
Direct Labor
Other direct production cost
Factory overhead

Cost Behavior
Fixed cost
Variable cost
Semi variable cost
Step Fixed
Second Part of Todays Lecture

IMPORTANT TERMINOLOGIES

Cost & Management Accounting 33

 Important terms

Cost unit Historical cost

Cost center
Revenue center Standard cost
Profit center Implicit cost
Opportunity cost Explicit cost
Investment center
Relevant cost Differential cost
Irrelevant cost Cost accumulation
Sunk cost
Product cost
Period cost
 Cost unit

It is a cost of a product or services in relation to which the cost is

ascertained, in simple words the cost of producing the units.

Example

Ball point for a Ball point manufacturing concern.

Bottle for Beverage producing concern.
Fan for a Fan manufacturing concern.
 Cost centre

Cost centre is a production or service location where costs are

incurred and may be attributed to cost units.

Examples

Workshop in a manufacturing concern

Auto service department
Electrical service department
Packaging department
Janitorial service department
 Revenue Center

It is part of the entity that earns sales revenue. Its manager is

responsible for the revenue earned not for the cost of operations.

Examples:

Sales department
Factory outlet
 Profit Center

Profit centre is a section of an organization where the manager

responsible for producing profit by utilizing resources assigned by
the organization

Examples:

A branch
A division
 Opportunity Cost

Opportunity cost is the value of a benefit sacrificed in favor of

alternate decision.

Example

Building already let out at a rent of Rs. 10,000

that can be utilized at the palace of business.
Rs 10,000 is opportunity cost for the business.
 Investment Center

An investment centre is a segment which is a profit centre where

the manager has a responsibility for making capital investment
decision.

Examples:

A branch
A division
 Relevant Cost

Relevant cost changes with a change in decision. These are future

costs that affect the current decision.

Examples

Variable cost
Fixed cost which changes with in an alternatives
Opportunity cost
 Irrelevant Cost

Irrelevant costs are the costs that would not effect the current
decision.

Examples:

Building Rent
Machine Depreciation
 Sunk Cost

Sunk cost is the cost of resource already required that cannot be

changed with the change in decision.

Examples:

Research Cost
Architect consultation fee
 Test your knowledge

Costs incurred in the past are:

a. Opportunity costs
b. Direct costs
c. Sunk costs
d. Variable costs

Answer:
c. Sunk costs
 Product Cost

Product cost is a cost that is incurred in producing goods and

services.

Example

Direct material, direct labor and factory overhead

 Period Cost

The cost are not related to production and are matched against
on a time period basis are period cost

Example

Selling and administrative expenses

 Historical cost

Historical cost is an actual cost that is borne at the date of

transaction .

Example

A building was purchased for Rs 400,000,

it is historical cost of building.
 Standard Cost

Standard cost is a Predetermine cost of the units.

Example

Budgeted cost = Rs 400

Budgeted hours = 10 hours
Standard cost per hour is Rs. 40
 Implicit Cost

Implicit cost is an opportunity cost.

Example

Uses its own capital

Uses its owner's time
and/or financial resources
 Explicit cost

The actual cost incurred is an explicit cost . The cost where you
make physical payments

Example

Wage
Rent
Materials
 Differential Cost or Incremental cost

It is the difference of the costs of two levels.

Example

Cost at producing 1,000 units is 15,000

Cost at producing 3,000 units is 60,000

Difference between differential cost and marginal cost

 Test your knowledge
In the past year, Williams Mold & Machine had sales of
$8,000,000 and total production costs of $6,000,000. In the
coming year, the company believes that production can be
increased by 30%, but this will require adding a second shift
to work from 4:00 pm to 1:00 am.

1. Indicate three production costs that are likely to

increase because of adding a second production
shift.

Material costs, workers salaries, and indirect

materials are all likely to increase.
 Test your knowledge
In the past year, Williams Mold & Machine had sales of
$8,000,000 and total production costs of $6,000,000. In the
coming year, the company believes that production can be
increased by 30%, but this will require adding a second shift
to work from 4:00 pm to 1:00 am.

2. What production cost most likely will not

increase when the second shift is added?

Rent of the building will not increase.

Depreciation of the building will not increase.
 Cost Accumulation

Cost accumulation are the various ways in which the information

in a set of cost accounts may be aggregated to produce report.

Cost
Accumulation

Job Order
Process Costing
Costing

It is a method of cost accounting Generally, it is the allocation

applied to production carried out of all time, material and
by a series of chemical or expenses to an individual
operational stages or processes. project or job
 Job Order Vs Process Costing
Job Order Costing
Companies produce goods to a customers unique
specifications
Cost of job accumulated on job cost sheet
Process Costing
Companies produce large quantities of identical items
Cost accumulated by each operation
Unit cost of items determined dividing costs of
production by number of units produced

55
Thats All Folks!

Cost & Management Accounting 56