CHAPTER ONE

Overview of Cost and

Management Accounting
 Objectives of Cost & Management
Accounting
• Management accounting measures analyzes,
and reports financial and nonfinancial
information that helps managers make
decisions to fulfill the goals of an organization.
• Used by management
• To develop, Communicate and
implement strategy
• To coordinate product design and
production
 Cont…

• Management accounting information and

reports do not have to follow set principles or
rules.
• The key questions are always
• How will this information help
managers do their jobs better, and
• Do the benefits of producing this
information exceed the costs?
 Cont…

• Cost accounting is the process of determining

and accumulating the cost of product or
activity.
• Cost Accounting is accounting for cost aimed
at providing cost data, statement and reports
for the purpose of managerial decision
making
 Objectives of Cost Accounting

• There is a relationship among information needs of

management, cost accounting objectives, and
techniques and tools used for analysis in cost
accounting. Cost accounting has the following main
objectives to serve:
• Determining selling price,
• Controlling cost,
• Providing information for decision-making,
• Ascertaining costing profit,
• Facilitating preparation of financial and other
statements.
 Cont…

• Determining selling price –

• The objective of determining the cost of
products is of main importance in cost
accounting. The total product cost and cost
per unit of product are important in deciding
selling price of product. Cost accounting
provides information regarding the cost to
make and sell product or services.
 Cost…

• Controlling cost - Cost accounting helps in

attaining aim of controlling cost by using
various techniques such as Budgetary Control,
Standard costing, and inventory control.
• Each item of cost [viz. material, labor, and
expense] is budgeted at the beginning of the
period and actual expenses incurred are
compared with the budget. This increases the
efficiency of the enterprise.
• Ascertaining costing profit - Cost accounting helps in
ascertaining the costing profit or loss of any activity on an
objective basis by matching cost with the revenue of the activity.
• Facilitating preparation of financial and other statements - Cost
accounting helps to produce statements at short intervals as the
management may require.
– In order to operate the business at high efficiency, it is
essential for management to have a review of production,
sales and operating results. Cost accounting provides daily,
weekly or monthly statements of units produced,
accumulated cost with analysis.
– Cost accounting system provides immediate information
regarding stock of raw material, semi-finished and finished
goods. This helps in preparation of financial statements.  
 Financial Accounting, Management Accounting, and
Cost Accounting
• How is management accounting different from financial accounting?
• Financial Accounting aims at finding out profit or losses
of an accounting year as well as the assets and liabilities
position, by recording various transactions in a
systematic manner.
• Cost Accounting helps the business to ascertain the cost
of production/services offered by the organization and
also provides valuable information for taking various
decisions and also for cost control and cost reduction.
• Management Accounting helps the management to
conduct the business in a more efficient manner.
 Cont…

• The scope of management accounting is

broader than that of cost accounting.
• Management Accounting utilizes the principles
and practices of financial accounting and cost
accounting in addition to other modern
management techniques for efficient operation
of a company.
• The main thrust in management accounting is
towards determining policy and formulating
plans to achieve desired objectives of
management.
Major Differences between Management and Financial Accounting
 Cont…

• Cost accounting provides information for both

management accounting and financial accounting.
• Cost accounting measures, analyzes, and reports
financial and nonfinancial information relating to
the costs of acquiring or using resources in an
organization.
• For example, calculating the cost of a product is a
cost accounting function that answers financial
accounting’s inventory-valuation needs and
management accounting’s decision-making needs
(such as deciding how to price products and
choosing which products to promote).
Figure 1-2 shows how cost accounting intersects both financial
and management accounting.
•
Cont…
 Cost classification concepts and terms

• Cost: According to Carl .S. Warren the term cost refers

to all payments of cash for the purpose of generating
revenues.
• Costs can be either expensed or capitalized. Expensed
costs are treated as expenses in the period cash is
paid. Capitalized costs are treated as assets in the
period cash is paid. The asset is recognized as
expenditure in future periods.
• According to J. Horngren cost refers as resource
scarified or foregone to achieve a specific objective. It
is usually measured as the monetary amount that
must be paid to acquire goods and services.
 Cont…

• Cost object: A cost object is anything for which a separate

measurement of costs is desired. Examples include a product,
service, project, customer, brand category, activity, department,
etc
• There are two stages for accounting of costs
1. Cost accumulation is the collection of cost data in some
organized way by means of an accounting system.
2. Cost assignment means tracing accumulated costs to cost
object and allocating accumulated costs to a cost object.
• Tracing Assigning accumulated costs with a direct relationship to the
cost object
• Allocating Assigning accumulated costs with an indirect relationship
to a cost object
 Direct Costs and Indirect Costs

• Direct costs are costs that can be conveniently or

economically traced to a cost object.
• For example, the cost of bottles is a direct cost of a
Pepsi soft drink.
• Indirect costs are costs that cannot be conveniently
or economically traced to a cost object.
– Instead of being traced, these costs are allocated
to a cost object in a rational and systematic manner.
• Examples include nails in furniture
BMW: Assigning Costs to a Cost Object
 Cost behavior Patterns: Variable, Fixed and Mixed
Costs
• Variable cost: Variable cost changes in total in
proportion to changes in the related level of
total activity or volume.
• Example, If Ford buys a steering wheel at $
100 for each of its Ford Explorer vehicles, then
the total cost of steering wheel should be
$100 times the number of vehicles assembled.
 Cont…

To summarize,
.as activity changes, total variable cost increases or
decreases proportionately with the activity change,
but unit variable cost remains the same.
 Cont….

• Fixed Cost: A fixed cost remains unchanged in total

for a given time period despite wide changes in the
related level of total activity or volume.
• Total fixed cost remains the same; but the per unit
fixed cost changes.
• A mixed cost has characteristics of both a variable
and a fixed cost.
• For example, for using rented machinery the rental
charge is $ 20,000 per year & $ 2 per each machine
hour used.
• If the machinery is used for 30,000 hours, the total
rental changes are $ 80,000 (20,000 + 30,000x2) and
of the machinery in use for 20,000 hours the rental
charges are $ 60,000 (20,000x(2000x2)) and so on.
• Cost driver—a variable that causally affects costs over a
given time span. For example,
– Mile driven for transport cost
– Length of time of call for telephone cost
– Metric cube of water consumed for water cost
– Unit sold for cost of goods sold
• Relevant range—the band of normal activity level (or
volume) in which there is a specific relationship between the
level of activity (or volume) and a given cost
– For example, fixed costs are considered fixed only within the
relevant range.
Relevant range visualized
 Period and product costs

• For financial reporting purposes, costs are often classified as

either product costs or period cost.
• Product costs
• are incurred in the production or acquisition of products
• For manufacturing companies this cost is composed of the
three elements of manufacturing cost:
1. Direct Material,
2. Direct Labor and
3. Factory overhead
For merchandising – sector companies, product costs are the
costs of purchasing the goods that are resold in the same
form including freight costs (inward).
 Cont..
• Period Costs
 

• Period costs are all Costs in the income statement

other than cost of goods sold.
• These costs are treated as expenses of the period in
which they are incurred because they are assumed
not to benefit future periods. Expensing these costs
immediately best matches to revenues.
• For manufacturing sector companies, period costs
include all non-manufacturing costs for example,
selling cost, administration cost and Research and
Development costs.
 Prime Cost and Conversion Costs:

• In manufacturing companies, the costs are

classified as Prime Cost and conversion costs.
 
• Prime costs are all direct manufacturing costs, i.e
all direct material costs and direct manufacturing
labor cost.
• Conversion costs are the costs incurred to convert
direct material into the final product, namely, costs
for direct labor and manufacturing overhead.
 Controllable and Uncontrollable Costs

 
• Controllable costs are those costs, which can be
influenced by the action of a specified member
of the undertaking. If a manager can control or
heavily influence the level of cost, then that
cost is classified as a controllable cost of that
manager.
• Costs that a manager cannot influence
significantly are classified as uncontrollable
cost of that manager.
 Avoidable and unavoidable costs

• Avoidable costs are costs that will not continue if

an ongoing operation is changed, deleted or
eliminated. These costs are relevant costs in
decision-making.
• Examples of avoidable costs include departmental
salaries and other costs that could be avoided by
not operating the specific department.
• Unavoidable costs are costs that continue even if
a subunit or an activity is eliminated and are not
relevant for decision
 Budgeted, standard and actual costs and their
comparisons and analyses
• Budgeted cost
• In business and other organizations, a 
budgeted cost often refers to a department's
or a company's projected total costs
• Standard cost
• In accounting, a standard is likely to mean an
expected amount of cost per unit of product,
per unit of input (such as direct materials,
factory overhead), or per unit of output.
 Cont…

• Examples of a Budget and a Standard cost

• Assume that the finishing department's budgeted cost for
the upcoming year is $400,000 and is expected to process
50,000 identical units of product.
• Some companies will develop standard costs for controlling
its operations.
• For example, the standard cost of processing all identical
units in the finishing department is $8 (based on its budget
of $400,000 divided by the expected 50,000 identical units).
• Therefore, if 54,000 units are processed, the standard cost
of the company's inventory will be increased by $32,000.
 Cont…

• Actual cost is an accounting term that means

the amount of money that was paid to acquire
a product or asset
 The concepts of cost units, cost centers and profit centers

• A cost center is a role or department that costs the

business money but does not generate revenue on its
own.
• They are often administrative, service and support roles.
These positions cannot be eliminated to cut costs because
they are vital to a smoothly operating organization.
• A cost center is a type of responsibility center that is
called accountable for the incurrence of the costs, which
are under its control.
• Example: ICT department, HR department, Assembling
and painting department
 Cont…
• Cost Unit: The cost unit is defined as the unit
of product, service, time, activity, or
combination in relation to which cost is
estimated
• Cost Unit Example- The cost unit of the hotel
industry is a room and the cost unit of the
steel industry would be a ton.
 Cont..
• Profit centre:
• A profit centre is any business segment whose
manager has control over both cost and revenue. Like a
cost centre, a profit centre generally does not have
control over investment funds.
• Profit centre managers are often evaluated by
comparing actual profit to targeted or budgeted
profit.
• Segmented income statements should be used to
evaluate the performance of profit centre managers.
 THE END
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