COST AND

MANAGEMENT
ACCOUNTING
INSTRUCTOR:KENNETH MBURUGU
Email: [email protected]
Mobile: 0715705533
Introduction cost Accounting
DEFINATIONS
• Cost Accounting - Cost accounting is that branch of the accounting
information system, which records, measures and reports information
about costs.
• Cost accounting is concerned with recording, classifying and appropriate
allocation of expenditure for the determination of the costs of products
or services, and for the suitably arranged data for purposes of control and
guidance of information to management for decision making.
• Cost means “the price paid for something”
• Cost ascertainment is computation of actual costs incurred
• Cost estimation is a process of predetermining costs of goods and service.
The Scope of Cost Accounting
• Cost accounting techniques arise because of specific information requirements by
management. Examples of information required by management and information
provided by a typical costing system are shown below.
• · Cost accounting comprises a range of techniques for the purpose of:
a) Cost ascertainment,
b) Cost control and cost reduction.
c) Cost accounting systems and financial accounting systems are different.
d) Cost accounting is in effect for internal use. Financial accounting forms the basis of external
reporting and is for stewardship purposes.
e) Cost accounting systems provide information to management for planning, control and
decision making.
f) Financial accounting is concerned with types of expenditure for the purpose of an overall
profitability statement and statement of assets and liabilities.
g) Cost accounting is dealt with in this text within three broad headings of product costing,
budgeting and appraisal. They arise primarily out of the need to address the information
needs of the organization.
Application of Cost Accounting
• Cost control is one of the most important functions in a company and
that it is crucial not only for the price choice but also in order to
understand what really succeed in the company (Giancarlo B., 2009)
Cost accounting system is a powerful management instrument that can
help to:
1) control costs
2) control prices
3) control efficiency
4) plan company activities
5) control activities development
6) give information
• Cost Accounting system helps management of the company to take
efficient and effective decisions.
Expected learning outcomes
• Determine the cost of products or services
• Interpret cost data
• Evaluate performance and financial position of organizations
• Formulate plans for objective strategic planning.
Costing Principles

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Cost and management accounting
• 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-range decisions

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Functions of managerial accounting
• Determining the cost
• Providing relevant information for better decision-making
• Providing information for planning, control, decision-making and
application

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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, analysing
cost behavior with changes in levels of activity

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Control
• Deals with the maintenance of product costing record, comparison of
actual performance with standards or budgets, anlaysis of variances,
recommendation of corrective actions, controlling cost to ensure
operational efficiency and effectiveness

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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

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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

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COSTING METHODS AND TECHNIQUES
• There are different methods and techniques that allow to quantify the
amount of resources used during the production process and so the
cost of the output.
• The method to be adopted by business organization will depend on
the nature of the production and the type of out put.
• There are different methods :
1) Process costing (PC);
2) Operation costing;
3) Job order costing (JOC);
4) Activity based costing (ABC);
METHODS OF COSTING
• Job Costing:
Job costing is concerned with the finding of the cost of each job or work order. This method is
followed by these concerns when work is carried on by the customers request, such as printer general
engineering work shop etc. under this system a job cost sheet is required to be prepared find out
profit or losses for each job or work order.
• Contract Costing:
Contract costing is applied for contract work like construction of dam building civil engineering
contract etc. each contract or job is treated as separate cost unit for the cost ascertainment and
control.
• Batch Costing:
A batch is a group of identical products. Under batch costing a batch of similar products is treated as a
separate unit for the purpose of ascertaining cost. The total costs of a batch is divided by the total
number of units in a batch to arrive at the costs per unit. This type of costing is generally used in
industries like bakery, toy manufacturing etc.
• Process Costing:
This method is used in industries where production is carried on through different stages or processes
before becoming a finished product. Costs are determined separately for each process. The main
feature of process costing is that output of one process becomes the raw materials of another process
until final product is obtained. This type of costing is generally used in industries like textile, chemical
paper, oil refining etc.
• Service (Operating) Costing:
This method is used in those industries which rendered services instead of producing goods. Under this
method cost of providing a service is also determined. It is also called service costing. The organization
like water supply department, electricity department etc. are the examples of using operating costing.
• Operation Costing:
This is suitable for industries where production is continuous and units are exactly identical to each
other. This method is applied in industries like mines or drilling, cement works etc. Under this system
cost sheet is prepared to find out cost per unit and profits or loss on production.
• Multiple Costing:
It means combination of two or more of the above methods of costing. Where a product comprises
many assembled parts or components (as in case of motor car) costs have to be ascertained for each
component as well as for the finished product for different components, different methods of costing
may be used. It is also known as composite costing. This type of costing is applicable to industries
producing motor vehicle, aeroplane radio, T.V. etc.
TECHNIQUES OF COSTING:
The following are the main types or techniques of costing for ascertaining cost
• Uniform Costing:
It is the use of same costing principles and practices by several undertakings for
common control or comparison of costs.
• Marginal Costing:
It is the ascertainment of marginal cost by differentiating between fixed and variable
cost. It is used to ascertain the effect of changes in volume or type of output on profit.
• Standard Costing:
A comparison is made of the actual cost with a pre-arranged standard cost and the cost
of any deviation (called variances) is analyzed by causes. This permits the management
to investigate the reasons for these variances and to take suitable corrective action.
• Historical Costing:
It is ascertainment of costs after they have been incurred. It aims at
ascertaining costs actually incurred on work done in the past. It has a
limited utility, though comparisons of costs over different periods may
yield good results.
• Direct Costing:
It is the practice of charging all direct costs, variable and some fixed costs
relating to operations, processes or products leaving all other costs to be
written off against profits in which they arise.
• Absorption Costing:
It is the practice of charging all costs, both variable and fixed to
operations, processes or products. This differs from marginal costing
where fixed costs are exclude.
Steps in Installation of a Costing System

• 1. Determination of objectives: Clearly lay down the objectives of the costing system.
If the objective is only to ascertain the cost, a simple system will be sufficient.
However, if the objective is to get information for decision making, planning and
control, a more elaborate system of costing is necessary.
• 2. Study of the nature of business: Carefully analyze the nature of the business and
other technical aspects like nature of the products, methods and stages of production
cycle. This helps to decide the method of costing to be adopted. i.e, contract costing is
suitable for large construction projects while Operating costing is adopted by service
industries like transport.
• 3. Study of the nature of the organization: The costing system designed must meet
the requirements of the organization. Hence, it is necessary to study the nature, size
and layout of the organization. Consider factors such as: the size of the departments,
Hierarchy of command in an organization and the levels of management.
• 4. Deciding the structure of cost accounts: TA suitable costing system can be
developed on the basis of the study of the nature of business and organization. The
structure of cost accounts should be simple and in accordance with the natural
production process.
• 5. Determination of cost rates: This step involves a thorough study of the following
points for developing an integrated costing system: 
a) Classification of costs into direct and indirect costs.
b) Grouping of indirect costs (overheads) into production, administration, selling and distribution
etc.
c)  Methods of pricing issues.
d)  Treatment of wastes of all types.
e) Absorption of overheads.
f) Calculation of overhead rates.
• 6. Organization of the cost office: The cost office is responsible for the efficient
operation of the costing system. The cost office, with adequate staff must be located a
close as possible to the factory. The following are the major functions of the cost
office. i. Stores accounts. ii. Labour accounting, iii. Recording of cost data and iv. Cost
control.
• 7. Clearly define the roles and responsibilities of the cost
accountant: He must have the necessary authority to discharge his
duties effectively.
• 8. Introducing the system: After completion of the above steps, the
costing system may be formally introduced. should be done gradually.
Before introduction, the feature of the systems, its working and
advantages must be explained to the concerned employees to secure
their co-operation.
COST CONCEPTS & CLASSIFICATION
Element of cost
• Cost object
• Cost
• Cost unit
• Cost centre
• Profit centre

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Cost object
• It is an activity or item or operation for which a separate
measurement of costs is desired
• E.g. the cost of operating the personnel department of a company,
the cost of a repair fob, and the cost for control

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Cost
• It is the amount of expenditure incurred on a specific cost object
• Total cost = quantity used * cost per unit (unit cost)

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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

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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 strorekeepers

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Profit centre
• It is location or function where managers are accountable for sales
revenues and expenses
• E.g. division of a company that is responsible for the sales of products

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Cost classification
• Direct cost
• Indirect cost (overhead)

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Direct cost
• Cost that can be identified specifically with or traced to a given cost
object
• The direct costs consist of the following three elements:
• Direct materials
• Direct labour
• Direct expenses

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Direct materials
• The cost of materials – the cost of materials used entering into and
becoming the elements of a product or service
• E.g. fabrics in garments

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Direct labour
• The cost of remuneration for working time
• E.g. assembly workers’ wages in toy assembly

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Direct expenses
• Other costs which are incurred for a specific product or service
• E.g. royalties

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Indirect cost (overhead)
• Cost that cannot be identified specifically with or traced to a given
cost object
• They are identified with cost centres as overheads
• Indirect materials
• Indirect labour
• Indirect expenses

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Indirect materials
• Such as stationery, consumable supplies, spare parts for machine that
assist to the production of final products

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Indirect labour
• Such as salaries of factory supervision and office staff that do not
directly involve in production of the final product

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Indirect expenses
• Such as rent, rates, depreciation, maintenance expenses that do not
have instant relationships with the manufacturing processes

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 Cost accumulation
•Prime cost = direct materials + direct labour + direct expenses

•Production cost = Prime cost + factory overhead

OR
= Direct materials + Conversion cost
*Conversion cost is the production cost of converting raw materials into
finished product

•Total cost = Prime cost + Overheads (admin, selling,distribution cost)

OR
= Production cost + period cost (administrative, selling,
distribution and finance cost)
•Period cost is treated as expenses and matched against sales for calculating
profit, e.g. office rental 39
Cost coding
• A code is a system of symbols designed to be applied to a classified
set of items to give a brief, accurate reference, facilitating entry,
collation and analysis
• Coding is important in modern computerised accounting systems for
catergories various composite accounting items

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Reasons
• To reducing error owing to descriptions
• Enable easy recalling
• Reduce computer file size as a code

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Cost behaviour
• Costs can be classified into variable, fixed, semi-variable, or step-costs
according to how they behave with respect of changes in activity
levels

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Variable cost
• It increases or decreases in direct proportion to levels of activity, but
the unit variable cost remains constant
• E.g. cost of food served in a restaurant

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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

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Semi-variable cost
• It processes characteristics of both fixed and variable cost
• It increases or decreases with activity level but not in direct
proportion

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Step cost
• It remains constant for a range of activity levels, then, on further
increase in activity, the cost jumps to a new level and remains
constant over a certain range until the next jump occurs

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Cost for stock valuation
• Unexpired and expired cost
• Product and period cost

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Unexpired cost
• Unexpired costs are the resources that have been acquired and are
expected to contribute to the future revenue
• They will be recorded as assets in current period
• They will be charged as expenses when they have been consumed in
the generation of revenue

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Expired costs
• Expired costs are the expenses attributable to the generation of
revenue in the current period

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Product cost
• Product cost are related to the goods purchased or produced for
resale
• If the products are sold, the product cost will be included in the cost
of goods sold and recorded as expenses in current period
• If the products are unsold, the product costs will be included in the
closing stock and recorded as assets in the balance sheet

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Period cost
• Period cost related to the operation of a business
• They are treated as fixed cost and charged as expenses when they are
incurred
• They should not be included in the stock valuation

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 Comparison of cost,
management and financial
accounting

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Meanings
• Financial accounting
• Cost accounting
• Management accounting

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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

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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

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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

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Cost and management accounting
Vs.
Financial accounting

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 Management Financial accounting
(cost)accounting
Nature Records material, Records company

labour and overhead transaction events

costs in product or External financial
job statements are
Reports produced produced
are for internal
management and
contol
Accounting Not based on the Follows the double
system double entry system entry system

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 Management Financial accounting
(cost)accounting
Accounting No need to use Use Generally


principles accounting principles Accepted Accounting

Adopt any Principles for recording
accounting techniques transactions
that generates useful
accounting
information
Used by different Used by external
Users of
information levels of management parties: shareholders,
or departments creditors, government,
responsible for etc
respective activities

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 Management Financial accounting
(cost)accounting
Operation Based on Conforms to company
guidelines management Ordinances, stock
instructions and exchange rules,
or
requirements HKSSAPs
standards

Time span Reports are Reports are prepared

prepared whenever for a definite period,

needed usually yearly and half
They may be yearly
prepared on a
weekly or daily basis

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 Management Financial accounting
(cost)accounting
Time focus Future orientation: Past orientation: use
forecasts, estimates of historic data for
and historic data for reporting and
management evaluation
actions

Perspective Detailed analysis of Financial summary of

parts of the entity, the whole orgainisation
products, regions,
etc

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 Cost accounting
vs.
Management accounting

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 Management Cost accounting
accounting
Objective To provide To ascertain and
information for control cost
planning and
decision making by
the management

Basic of Concerned with Based on both present

recording transactions related and future transactions
to the future for cost ascertainment

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 Management Cost accounting
accounting
Coverage Covers a wider Covers matters
area: financial relating to
accounts, cost ascertainment and
accounts, taxation, control of cost of
etc. product or service

Utility Only the needs of The needs of both

internal internal and external
management interested groups

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 Management Cost accounting
accounting
Deals with both Deals only with
Types of 

transactions monetary any non- monetary transactions,

monetary covering only
transactions, quantitative aspect
covering both
quantitative and
qualitative aspects

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