Cost & Management Accounting:

An Introduction
Learning outcome of the course
• Understand the principles of various Costing methods viz., Activity
Based Costing (ABC) Method, Job and Process Costing Methods.

• Use the relevant cost in decision-making.

• Apply Cost-Volume-Profit Analysis in business decision making.

• Analyze Price and Cost Variances and use budgetary control

techniques to perform managerial functions.
Evaluation Scheme
• Class Participation/Attendance 5%
• Cases 20%
• Quiz 15%
• Mid-Term Exam 30%
• Term-End Exam 30%
• Total 100%
Learning Objectives
• Need for Cost accounting
• Functions of managerial accounting
• Distinguish Financial accounting from managerial accounting
• Cost and Cost objects
• Cost Classification
• Cost Sheet
• Flow of Cost
Need for Management Accounting
•SALES 1,65,000
•LESS: COST OF SALES 1,15,000
•GROSS PROFIT 50,000
•LESS:
•ADM EXP 20,000
•SELLG EXP 10,000
•DISTRB EXP 5,000 35,000
•NET PROFIT 15,000

TOTAL PRODUCT
A B C
SALES 1,65,000 70,000 25,000 70,000
LESS: COST OF SALES 1,15,000 46,000 18,000 51,000
GROSS PROFIT 50,000 24,000 7,000 19,000
LESS:
ADM EXP 20,000 7,000 4,000 9,000
SELLG EXP 10,000 2,000 3,000 5,000
DISTRB EXP 5,000 2,000 1,000 2,000
TOTAL 35,000 11,000 8,000 16,000
NET PROFIT (LOSS) 15,000 13,000 (1,000) 3,000
Management Accounting
• Management accounting is the process of identification,
measurement, accumulation, analysis, preparation, interpretation,
and communication of financial information used by management to
plan, evaluate, and control an organization.
• Source: Institute of Management Accounting, 1981

• Provides management with costs for products, inventories, operations

or functions and compares actual to predetermined data.
• It also provides a variety of data for many day-to-day decision as well
as essential information for long-term decisions.
Financial vs Managerial 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
 Management
(cost)accounting Financial accounting
1)Records material, labour 1)Records company
and overhead costs in product transaction events
or job 2)External financial
Nature 2)Reports produced are for statements are
internal management and produced
contol

Not based on the double Follows the double

Accounting system
entry system entry system
1)No need to use accounting Use Generally Accepted
principles Accounting Principles
Accounting 2)Adopt any accounting for recording
principles techniques that generates transactions
useful accounting information

Used by different levels of Mainly Used by external

management or departments parties: shareholders,
Users of
responsible for respective creditors, government,
information
activities etc

Future orientation: forecasts, Past orientation: use of

estimates and historic data for historic data for
Time focus
management actions reporting and
evaluation
Detailed analysis of parts of Financial summary of
Perspective the entity, products, regions, the whole orgainisation
etc
Management Accounting Information
• Examples of management accounting information include:
• The reported expense of an operating department, such as the assembly department
of an automobile plant or an electronics company
• The costs of producing a product
• The cost of delivering a service
• The cost of performing an activity or business process – such as creating a customer
invoice
• The costs of serving a customer
• Management accounting also produces measures of the economic
performance of decentralized operating units, such as:
• Business units
• Divisions
• Departments
Functions of managerial accounting
• Planning
• Deals with the estimation of product costs, setting up of costing system
to record cost data, preparation of cost standards and budgets, planning
of materials and manpower resources, analyzing cost behavior with
changes in levels of activity
• Control
• Deals with the maintenance of product costing record, comparison of
actual performance with standards or budgets, analysis of variances,
recommendation of corrective actions, controlling cost to ensure
operational efficiency and effectiveness.
• Long-term and short-term planning (budgeting)
• Periodic performance reports for feedback control
Functions of managerial accounting
• Decision-making
• Deals with whether it is more profitable to make or buy a component,
determine the economic order quantity and production batch size, replace
fixed asset, add or drop products, decide pricing
• Application
• Cost accounting has extended from manufacturing operations to a variety of
service industries such as hotels, bands, airline, etc
• Cost accounting system should be flexible and adaptable to meet the new
business environment and the changing nature of the company
Strategic Decisions and the Management
Accountant
• Strategy specifies how an organization matches its own capabilities
with the opportunities in the marketplace
• There are two broad strategies: cost leadership and product
differentiation
• Strategic cost management describes cost management that
specifically focuses on strategic issues.
The Five-step Decision-making Process
• Identify the problem/uncertainties

• Obtain information

• Make predictions about the future

• Make decisions by choosing among alternatives

• Implement the decision, evaluate performance and learn.

Element of cost
• Cost object

• Cost

• Cost unit

• Cost Drivers

• Cost centre
Cost object

• Cost object
• It is an activity or item or operation for which a separate measurement of
costs is desired.
• Cost object is an entity or a part of an entity.
• The cost object changes according to decision needs of the management.
• Costing objective represents the overall objective for which cost collection,
cost analysis, and cost control is being attempted.
• E.g. the cost of operating the personnel department of a company, the cost of
a repair fob, and the cost for control
Cost Objects
Cost
• The Committee on Cost Concepts and Standards of the American Accounting
Association wrote: "Cost is a foregoing measured in monetary terms,
incurred or potentially to be incurred to achieve a specific objective.”
• Cost - the amount of expenditure (actual or notional) incurred on or attributable to a
produced item or a service unit.
• Cost represents an expenditure made to secure an economic benefit, generally on the
uses of resources that promise to produce revenue.
• The resources may have tangible substance (e.g. manpower, material, machine, etc.),
or they may take the form of services (e.g. wages, rent, power, etc.).
• Cost accounting measures cost in accordance with the plans and needs of
management.
• Costs must be based on relevant facts, competently observed and
significantly measured to enable management to make valid decisions.
Cost
• Cost - expense which is incurred after deriving the benefit.
• Expenses are defined as ‘all explicit costs which are deductible from revenue
• When the cost is incurred before deriving the benefit, it is termed as
deferred cost.
• When no benefit is derived by the incurrence of cost, it is termed as loss
• Uses Of Cost Data
1. Planning profit by means of budgets
2. Controlling costs via responsibility accounting
3. Measuring annual or periodic profit, including inventory costing
4. Assisting in establishing selling prices and a pricing policy
5. Furnishing relevant cost data for analytical processes for decision making
Element of cost
• Cost unit
• It is a quantitative unit of product or service in which costs are ascertained,
e.g. cost per table made, cost per metre of cloth
• Cost centre
• It is a location or function of an organisation in respect of which costs are
ascertained
• E.g. the rent, rates and maintenance of buildings; the wages and salaries of
storekeepers
• Cost Driver
• A cost driver is a variable, such as the level of activity or volume that causally
affects cost over a given time span. E.g. the number of vehicle assembled is
the cost driver of the total cost of the steering wheel.
Classification of Costs
• Traceability
• Direct
• Indirect
• Variability or Behaviour
• Fixed costs
• Variable costs
• Conversion
• Prime cost
• Conversion cost
• Product or Period Cost
• Relevance
• Sunk
• Opportunity
• Differential
Cost classification
• Nature or element
• Material cost
• Labor cost
• Expenses
• Function
• Production cost or Manufacturing cost
• Administration cost
• Selling cost
• Distribution cost
• Finance cost
• Research cost
• Development cost
• Pre-production cost
Cost Classification by Behaviour
• Variable cost

• It increases or decreases in direct proportion to levels of activity, but the unit

variable cost remains constant

• Fixed cost

• Total fixed cost remains constant over a relevant range of activity level but
unit fixed cost falls with an increase in activity volume
Cost Classification by Degree of Traceability
• Direct if: • Indirect if:
• Causal relationship between cost • Causal relationship between cost and
and cost object, and cost object, and
• Tracing can be done cost effectively • Tracing cannot be done cost
• Example: If a hospital is cost object, effectively
cost of heating & cooling the • Example: Salary of a plant manager,
hospital is direct cost. where departments within the plant
are defined as the cost objects.
Cost Classification by Degree of Traceability

Prime Cost

Conversion Cost
Cost Classification by Degree of Traceability
Cost Classification by Degree of Traceability
• Direct or Indirect Costs can be fixed depending upon cost object or
nature of operation
Direct
Variable Fixed
Indirect

If the number of taxis If miles driven during

owned by a taxi company a year on a particular taxi
is the cost object, annual is the cost object,
taxi registration and registration and license
license fees would Fees for that taxi are
be variable costs. fixed costs.
Cost Classification by Relevance
• Sunk Costs
• Occurred in the past and cannot be altered by any current or future decision.
Irrelevant for decision making.
• Example: You bought an automobile that cost Rs12,000 two years ago. The
Rs12,000 cost is sunk because whether you drive it, park it, trade it, or sell it,
you cannot change the Rs12,000 cost.
• Differential Costs
• The difference in a cost item under two decision alternatives.
• A work center can produce 10,000 widgets for $29,000 or 15,000 widgets for
$40,000. The differential cost of the additional 5,000 widgets is $11,000.
• Opportunity Cost
• The potential benefit given up by choosing a decision alternative.
Cost Classification by Function
• Costs are classified into product costs and period costs on the basis of
whether they are capitalized to the cost of products produced or not.
• Product Cost (Inventoriable Cost)
• Costs that become part of the cost of goods manufactured are called product
costs. Such costs are incurred on manufacturing process either directly as
material and labor costs or indirectly as overheads.
• Period costs are basically all costs other than product costs. These are
not incurred on the manufacturing process and therefore these
cannot be assigned to cost goods manufactured. Period costs are thus
expensed in the period in which they are incurred.
Cost Classification by Function
All Costs

 Cost necessary part of producing finished

product
 Accumulated in inventory a/c (asset)
 Expensed when sold (COGS)

•An integral part of

Expensed in
finished production
specific
•Smallportion
portion period
of total
•Sig incurredof total
cost of
cost ofproduct
product (40-
•Factory
60%) employee
directly plastics,
•Steel, associated
tyreswith
converting
Also
& raw material
glass called
into finished
mfctg goods
ovhds.
Proprtionately
higher than in
the past

Cost of converting
material into finished
product
Cost Classification by Function
All Costs

Mixture of Fixed
& Variable Cost

Variable Cost

Generally
Variable Cost

Mixture of Fixed
& Variable Cost
 Cost Flow & Classification
Costs Sum of
Product Costs  direct materials
Balance Sheet  direct labor and
Materials
 Mftg overhd incurred
Purchases

Direct
Labor

Factory
Overhead Income Statement

Period Costs
Selling and
Administrative
 Cost Flow & Classification
Costs Sum of
Product Costs Balance Sheet  direct materials
 direct labor and
Materials Materials
 Mftg overhd incurred
Purchases Inventory

Direct
Labor

Factory
Overhead Income Statement

Period Costs
Selling and
Administrative
 Cost Flow & Classification
Costs Sum of
Product Costs Balance Sheet  direct materials
 direct labor and
Materials Materials
 Mftg overhd incurred
Purchases Inventory

Direct
Work in
Labor
Process
Inventory
Factory
Overhead Income Statement

Period Costs
Selling and
Administrative
 Cost Flow & Classification
Costs Sum of
Product Costs  direct materials
Balance Sheet
 direct labor and
Materials Materials
 Mftg overhd incurred
Purchases Inventory

Direct Cost of Goods

Labor Work in Manufactured
Process
Factory Inventory
Overhead Income Statement

Finished
Period Costs Goods
Inventory
Selling and
Administrative
 Cost Flow & Classification
Costs Sum of
Product Costs Balance Sheet  direct materials
 direct labor and
Materials Materials  Mftg overhd incurred
Purchases Inventory
Product costs flow
through the balance
Direct sheet to the income
Work in
Labor statement
Process
Inventory
Factory
Overhead Income Statement
Finished
Goods Cost of
Period Costs Inventory Goods Sold

Selling and
Administrative
 Cost Flow & Classification
Costs
Product Costs Balance Sheet

Materials Materials
Purchases Inventory
Period costs flow
Direct directly to the income
Work in statement
Labor
Process
Inventory
Factory
Overhead Income Statement
Finished
Goods Cost of
Period Costs Inventory Goods Sold

Selling and Selling and

Administrative Administrative
Cost Calculation
• Ascertainment
• is a process through which the actual or estimated cost is determined.
• Analysis:
• Classified appropriately to the various elements of costs (Material, labour or
Overheads)
• Allocation
• Allocation of a particular cost to a cost centre or activity centre.
• Apportionment
• How to distribute the overhead expense
• Absorption
• The charging off cost to the products or services
Types of Costing Systems
• Uniform
• Marginal
• Standard
• Historical
• Absorption
Cost Sheet
• A document which provides for the assembly of the detailed cost of a
cost centre or cost unit.
• Cost sheet is a statement, which shows various components of total
cost of a product. It classifies and analyses the components of cost of
a product.
• It is a statement which shows per unit cost in addition to Total Cost.
Selling price is ascertained with the help of cost sheet.