1.

Introduction
2. Types of Cost
3. Elements of Cost
4. Components of Cost
5. Methods of Cost Estimate

July 3, 2024 1
• Cost Accounting : Is the branch of
accounting responsible for controlling the
cost of a product, service or an operation.
• Measures and reports financial and non-
financial information relating to the cost of
making products, or acquiring or utilizing
resources in an organization.
• It is responsible for controlling the cost of a
product, service of an organization
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 Cost Accounting
• Managers use cost accounting to support
decision-making to cut a company’s cost and
improve profitability.
• Cost accounting is a component of
management accounting
 Branches of Accounting
• Financial Accounting
• Management Accounting
– Cost Accounting
• Social Responsibility Accounting
– Social Responsibility Accounting: Accounts for
social responsibility of a business to social,
ecology and environmental aspects.
 Management accounting
• Management accounting or managerial
accounting is concerned with the provisions
and use of accounting information to
managers within organizations, to provide
them with the basis to make informed
business decisions that will allow them to be
better equipped in their management and
control functions.
 Management accounting
Management accounting information is:
• designed and intended for use by managers within
the organization, instead of being intended for use
by shareholders, creditors, and public regulators;
• usually confidential and used by management,
instead of publicly reported;
• forward-looking, instead of historical;
• computed by reference to the needs of managers,
often using management information systems,
instead of by reference to general financial
accounting standards.
Services provided by management
accounting
• Rate & Volume Analysis
• Business Metrics Development
• Price Modeling
• Product Profitability
• Cost Analysis
• Cost allocation
• Cost Benefit Analysis
• Cost-Volume-Profit Analysis
• Life cycle cost analysis
Services provided by management
accounting
• Capital Budgeting
• Buy vs. Lease Analysis
• Sales and Financial Forecasting
• Annual Budgeting
 Management vs cost accounting
• In management accounting, cost accounting
establishes budget and actual cost of
operations, processes, departments or
product and the analysis of variances,
profitability or social use of funds.
• Managers use cost accounting to support
decision-making to cut a company's costs and
improve profitability.
 Management vs cost accounting
• As a form of management accounting, cost
accounting need not to follow standards,
because its primary use is for internal
managers, rather than outside users, and
what to compute is instead decided
pragmatically.
 Cost accounting
• Costs are measured in units of nominal
currency by convention. Cost accounting can
be viewed as translating the value chain (the
series of events in the production process
that, in concert, result in a product or service)
into financial values.
 Cost accounting
• Cost accounting has long been used to help
managers understand the costs of running a
business.
• Modern cost accounting originated during the
industrial revolution, when the complexities
of running a large scale business led to the
development of systems for recording and
tracking costs to help business owners and
managers make decisions.
 Cost accounting
• In the early industrial age, most of the costs
incurred by a business were what modern
accountants call "variable costs" because they
varied directly with the amount of production.
• Money was spent on labour, raw materials,
power to run a factory, etc. in direct proportion
to production.
• Managers could simply total the variable costs
for a product and use this as a rough guide for
decision-making processes.
 Cost accounting
• Some costs tend to remain the same even
during busy periods, unlike variable costs,
which rise and fall with volume of work.
• Over time, the importance of these "fixed
costs" has become more important to
managers.
• EXAMPLES OF FIXED COSTS?
 Cost accounting
• Examples of fixed costs include the
depreciation of plant and equipment, and the
cost of departments such as maintenance,
tooling, production control, purchasing, quality
control, storage and handling, construction
supervision and engineering.
• In the early twentieth century, these costs
were of little importance to most businesses.
• WHY ARE THEY IMPORTANT NOW?
 Cost accounting
• However, in the twenty-first century, these
costs are often more important than the
variable cost of a product, and allocating them
to a broad range of products can lead to bad
decision making.
• Managers must understand fixed costs in
order to make decisions about products and
pricing.
 Classification of costs
• Classification of cost means, the grouping of
costs according to their common characteristics.

The important ways of classification of costs are:

• By nature or element: materials, labor, expenses
• By functions: production, selling, distribution,
administration, R&D, development,
• As direct and indirect
• By variability: fixed, variable, semi-variable
• By controllability: controllable, uncontrollable
• By normality: normal, abnormal
 Elements of costs
• In the context of an organization of your
choice:
• List down all types of costs you know
• Indicate whether they are variable or
fixed
• Direct or indirect
Elements of costs
1. Material (Material is a very important part of
business)
– A. Direct material
– B. Indirect material
2. Labor
– A. Direct labor
– B. Indirect labor
3. Overhead
– A. Indirect material
– B. Indirect labor
– C. Other overheads such as cost of utilities
Elements of costs
• Over heads are further grouped based on
their functions as,
• Production or works overheads
• Administration overheads
• Selling overheads
• Distribution overheads
 Elements of costs
• Cost is defined as the amount of
expenditure incurred on a given process,
product or service.
• The analysis and classification of cost is
basically made with reference to factors on
which expenditure is incurred.
• Elements of cost include material cost,
labour cost or wages and expenses.
 Material costs
• Material cost refers to cost of commodities
supplied to an undertaking. Material cost may be
further subdivided into:
• Direct Material Costs: enter into and form part
of the finished product e.g. Cost of wood
incase of furniture.
• Indirect Material Costs: material cost which
cannot be allocated but can be apportioned to
or absorbed by cost centers or cost units. e.g.
Lubricating Oil or grease in maintaining the
machinery.
• In the construction sector can we identify
indirect material costs?
 Labour costs
• Refers to the cost of remuneration of the
employees of an undertaking, e.g. wages,
salaries, commission, etc. labour cost may
be subdivided into:
• Direct Labour Costs or Direct Wages;
• Refers to labour cost which can be
identified with and allocated to cost
centers or cost units. E.g. remuneration
paid for converting a raw material to
finished product.
• They are incurred where production
process or service delivery takes place
 Labour costs
• Indirect Labour Costs or Indirect
Wages;
• Refers to labour cost or wage which can
not be allocated but can be apportioned to
or absorbed by cost centers or units. E.g.
salary paid to factory manager and officers.
• These are costs of labour incurred in
providing a supporting role to the
production process or service delivery
• Give examples related to the construction
sector
 Expenses
• Refers to the cost of services provided to
an undertaking and the notional cost of
the use of owned assets e.g. depreciation
of owned factory building. Hiring of
assets, rent, etc. Expenses are sub divided
into:
• Direct expenses or Chargeable Expenses.
• Indirect Expenses.
 Components of cost
• A component of cost is the cumulative or
aggregate of different elements of cost.
The components of cost are:
– Prime cost/ Direct cost: Is the aggregate of
Direct material cost, Direct labour cost and
Direct expenses. Is also known as flat or first
cost.
– Factory Cost: is the prime cost plus factory
overhead(or works overhead)
– What would factory overhead include in a
road construction project?
 Components of cost
• Gross cost or cost of production: Is the
aggregate of factory cost plus office and
administration overhead.
• Total Cost/ selling cost: is made up of
gross cost plus selling and distribution
overhead, also known as cost of sales.
– Total cost includes all elements of cost
or all the items of expenditure till the
commodity has finally sold.
Types of costing refers to various accounting
systems used for ascertaining and analyzing
costs. It includes the following:
• Absorption Costing
• Activity based costing
• Marginal Costing
• Standard Costing
• Direct costing
• Historical Costing
• Uniform Costing
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 Absorption costing
• Sometimes referred to as Full Costing;
• This is the practice of charging all costs
both variables and fixed, to operations,
processes or products;
• No distinction is made between fixed
costs and variable costs;
• All costs, whether fixed or variable are
taken into account to ascertain the costs
of production.
 Absorption costing – Categorization of costs
Product cost
• Direct materials
• Direct Labor
• Variable Manufacturing overhead
• Fixed manufacturing overhead

Period cost
• Variable selling and administrative expenses
• Fixed selling and administrative expenses
 Unit Cost Computation - Example
• To illustrate the computation/calculation of
unit product costs under absorption costing
consider the following example.
• A small company that produces a single
product has the following cost structure
 Absorption costing - example
Number of units produced
6,000
per year
Variable costs per unit (units of money):
Direct materials 2
Direct labor 4
Variable manufacturing
1
overhead
Variable selling and
3
Administrative expenses
Fixed costs per year:
Fixed manufacturing
30,000
overhead
Unit product Cost - Absorption Costing Method
Direct materials 2
Direct labor 4
Variable manufacturing overhead 1
--------
Total variable production cost 7
Fixed manufacturing overhead 5
--------
Unit manufacturing cost 12
Variable selling and Administrative expenses 3
Fixed selling and Administrative expenses 2

Unit cost 17
 Example: Refer to the income statement below:
Products

A B C Total (TZS)
Units 10,000 15,000 25,000 50,000
(a) Sales 20,000 30,000 50,000 100,000
Direct materials 5,000 15,000 10,000 30,000
Direct Wages 6,000 4,500 5,000 15,500
Variable factory 2,600 4,500 13,000 20,100
Overhead
Variable Selling 1,400 3,000 10,000 14,400
Overhead
Fixed Overhead
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10,000 35
 Marginal costing
• This method is used particularly for short-term
decision-making. Its principal tenets are:
• Revenue (per product) − variable costs (per
product) = contribution (per product)
• Total contribution − total fixed costs = (total
profit or total loss)
• Thus, it does not attempt to allocate fixed
costs in an arbitrary manner to different
products.
 Marginal costing
• The short-term objective is to maximize
contribution per unit.
• If constraints exist on resources, then
Managerial Accounting dictates that marginal
cost analysis be employed to maximize
contribution per unit of the constrained
resource.
 Marginal costing
• The costs that vary with a decision should only
be included in decision analysis.
• For many decisions that involve relatively small
variations from existing practice and/or are for
relatively limited periods of time, fixed costs are
not relevant to the decision.
• This is because either fixed costs tend to be
impossible to alter in the short term or managers
are reluctant to alter them in the short term.
 Marginal costing
• Marginal costing distinguishes between fixed
costs and variable costs as conventionally
classified.
• The marginal cost of a product –“ is its
variable cost”. This is normally taken to be;
direct labour, direct material, direct expenses
and the variable part of overheads.
 Marginal costing
• Marginal costing is formally defined as:
‘the accounting system in which variable costs
are charged to cost units and the fixed costs of
the period are written-off in full against the
aggregate contribution.
• The term ‘contribution’ mentioned in the
formal definition is the term given to the
difference between Sales and Marginal cost.
 Marginal costing
Thus
• MARGINAL COST =
DIRECT LABOUR
+
DIRECT MATERIAL
+
DIRECT EXPENSE
+
VARIABLE OVERHEADS
 Marginal costing
• The term marginal cost sometimes refers to
the marginal cost per unit and sometimes to
the total marginal costs of a department or
batch or operation.
• The meaning is usually clear from the context.
• Alternative names for marginal costing are the
contribution approach and direct costing In
this course, we will study marginal costing as a
technique quite distinct from absorption
costing.
 Unit product Cost Marginal Costing Method
ITEM COST
Direct materials $2
Direct labor $4
Variable manufacturing overhead $1
--------
Unit product cost $7
Fixed costs per year:
Fixed manufacturing overhead $30,000
Fixed selling and administrative $10,000
expenses
The $30,000 fixed manufacturing overhead will be charged off in
total against income as a period expense along with selling and
administrative expenses)
 Marginal Costing cont’d…(Example
PRODUCT
A B C Total (TZS)
(c) Sales 20,000 30,000 50,000 100,000
Direct 5,000 15,000 10,000 30,000
materials
Direct Wages 6,000 4,500 5,000 15,500
Variable 2,600 4,500 13,000 20,100
factory
Overhead
Variable 1,400 3,000 10,000 14,400
Selling
Overhead
(d) Marginal 15,000 27,000 38,000 80,000
Costs
 Marginal costing
• There are different phrases being used for this
technique of costing.
• In UK, marginal costing is a popular phrase
whereas in US, it is known as direct costing and
is used in place of marginal costing.
• Variable costing is another name of marginal
costing.
 Marginal costing
• Marginal costing technique has given birth to
a very useful concept of contribution where
contribution is given by: Sales revenue less
variable cost (marginal cost)
• Contribution may be defined as the profit
before the recovery of fixed costs.
• Thus, contribution goes toward the recovery
of fixed cost and profit, and is equal to fixed
cost plus profit (C = F + P).
 Marginal costing
• In case a firm neither makes profit nor suffers
loss, contribution will be just equal to fixed
cost (C = F). this is known as break even point.
• The concept of contribution is very useful in
marginal costing.
• It has a fixed relation with sales.
• The proportion of contribution to sales is
known as P/V ratio which remains the same
under given conditions of production and
sales.
 Marginal costing
• It should be clearly understood that marginal
costing is not a method of costing like
absorption costing.
• Rather it is simply a method or technique of
the analysis of cost information for the
guidance of management which tries to find
out an effect on profit due to changes in the
volume of output.
• Marginal costing information is used in profit
volume analysis
 Cost Volume relationships
• Cost-Volume-profit analysis examines the
behaviour of total revenue, total costs, and
operating income as changes occur in the
output level, the selling price, the variable
cost per unit, and/or the fixed costs of a
product.
 CVP Assumptions
• Changes in the level of revenue and costs arise
only because of changes in the number of
product units produced and sold; i.e., the
number of units is only the revenue driver and
the only cost driver.
• The total cost (TC) can be separated into total
fixed cost (TFC) that does not vary with the
output level and total variable cost (TVC) (total
marginal cost) that changes with the output
level. Mathematically, TC = TFC+ TVC
 CVP Assumptions
• When represented graphically, the behaviors
of total sales revenue (TSR) and TC are linear
in relation to output level within a relevant
range (and time period).
• Demand will always accommodate what is
produced or offered
• The unit selling price (USP), unit variable cost
(UVC) and unit fixed cost (UFC) are known and
constant within a relevant range and time
period.
 CVP Assumptions
• The analysis covers a single product but can
be extended to a given proportion of different
products.
• All revenues and costs can be added and
compared without taking account the time-
value of money (see later)
 Break Even Sales(BES)
• In order to compute the BES we need to first to
determine the profit – volume or pv ratio
• The pv ratio is obtained by deducting the total
variable costs from total sales and diving the
result to the latter
• The BES is then obtained by diving the total fixed
cost to the pv ratio
• This process should be elaborated by the
instructor
• The break even Quantity or Break even volume is
obtained by diving the BES by the unit price
Profit volume analysis - example
 Profit volume analysis - example
• Determine the BEV – sales
• Draw break even chart and profit volume
chart
 DISCUSSION QUESTION
A) What assumptions guide the use of profit volume analysis?
B) A certain manufacturing company had Tshs 50,000,000 of sales
and Tshs 8,000,000 of before tax profits in 2017. An analysis of
the company’s sales revealed the following:
• Fixed costs = 10,000,000
• Variable costs = 20,000,000
• Semi variable costs(assume 50% variable) = 10,000,000
1. What contribution does each shilling of sales make to fixed cost
and profit?
2. What is the break even sales?
3. What is the break even quantity?
4. What would be the effect on profit if prices are increased 30%
but customers who currently account for 10% of sales are lost as
a result?
 Activity-based costing
• Activity-based costing (ABC) is a system for
assigning costs to products based on the
activities they require.
• In this case, activities are those regular actions
performed inside a company.
• "Talking with customer regarding product
features" is an example of an activity inside
most companies.
 Activity-based costing
• Accountants assign 100% of each employee's
time to the different activities performed
inside a company (many will use surveys to
have the workers themselves assign their time
to the different activities).
• The accountant then can determine the total
cost spent on each activity by summing up the
percentage of each worker's salary spent on
that activity.
 Activity-based costing
• A company can use the resulting activity cost
data to determine where to focus their
operational improvements.
• For example, a job-based manufacturer may
find that a high percentage of its workers are
spending their time trying to figure out a
hastily written customer order.
Differences between ABC and tradition costing methods
1. Consumption of resources versus
consumption of activities
• ABC acknowledges that you cannot manage
costs, you can only manage what is being
done and then costs will change as a
consequence.
• In traditional cost accounting, however, the
underlying assumption is that costs can be
managed, but as most managers have found
out the hard way - managing costs is almost
impossible.
 Differences between ABC and tradition costing
methods

• The benefit of the ABC mindset is that it opens

up for a much wider array of measures when
it comes to improving productivity.
• By investigating systematically what is being
done, i.e. the activities, one will not only be
able to identify surplus capacity if it occurs,
but also lack of capacity and misallocation of
capacity.
Differences between ABC and tradition costing methods
2. Volume related allocation bases versus drivers at
many levels
• Due to the historic background of traditional cost
accounting methods, they tend to use direct labor - or
other volume related allocation bases - for cost
assignment purposes.
• But as overhead has grown and new technologies
have come, it goes without saying that assigning costs
based on only 5 - 15% (in most companies) of total
costs is highly risky.
• In fact, the incurred errors are up to several hundred
percent
Differences between ABC and tradition costing methods

• In ABC, however, costs are assigned according

to the 'cause and effect' relationship between
activities (the actual process) and cost objects,
which is captured using drivers.
• Because the drivers are related to the actual
processes, they occur on several levels. The
four most common levels are;
 Differences between ABC and tradition costing
methods

• Unit level. Unit level drivers are triggered for

every unit that is being produced.
• For example, for a man and a machine that
produces one unit at a time, the associated
direct labor will be a unit level cost driver.
• This is therefore a volume related driver
similar to the traditional allocation bases.
 Differences between ABC and tradition costing
methods

• Batch level. Batch level drivers are triggered

for every batch produced.
• A good example of that is production
planning, because the planning is done for
each and every batch regardless of the size of
the batch.
• Here, number of batches can be a good driver.
Differences between ABC and tradition costing methods
• Product level. Product level drivers are
triggered for every product regardless of the
number of units and batches produced.
• These drivers occur by the sole existence of a
product.
• A good example of a driver is the number of
product development hours per product so that
the more product development hours a product
triggers, the more product development costs
should be assigned to that product.
Differences between ABC and tradition costing methods

• Facility level. Facility level driver are drivers

that are not related to the products at all.
• Costs that are traced by such drivers will
therefore be allocated to products.
• The difference between allocation and tracing
is that allocation is quite arbitrary whereas
tracing is based on 'cause and effect' relations
Differences between ABC and tradition costing methods
• Hence, we see that the traditional usage of fixed
and variable costs is totally meaningless. In ABC,
all costs are included.
• However, ABC employs a different usage and
definition of fixed and variable costs.
• A fixed activity cost is a cost that exists due to
the very existence of the activity whereas a
variable activity cost changes as the output of
the activity changes.
• This distinction is very helpful in various
improvement efforts.
 Activity-based costing
• Activity-based management includes (but is
not restricted to) the use of activity-based
costing to manage a business.
• While ABC may be able to pinpoint the cost of
each activity and resources into the ultimate
product, the process could be tedious, costly
and subject to errors.
 Process of ABC
• ABC can be used to establish the cost of a
single product or many products produced by
a company
• The procedure is essentially similar in the two
approaches
• Lets us first consider the process of costing a
single product
 Single product costing procedure
Step 1: Get diect cost data related to the
product i.e. direct costs of material
and labour
Step 2: Get overhead cost data
Step 3: Get a list of activities and their measures
Step 4: Allocate overhead costs to the activities.
Step 5: Compute activity overhead rates for the

activities
Step 6: Compute product cost based on costs of
the activities
 Examples of ABC
• XYZ Company makes a single product – a filing
cabinet - that it sells to office furniture
distributors.
• The company has a simple ABC system that it
uses for internal decision making.
• The company has two overhead departments
whose costs are listed below:
 Examples of ABC
Step 1: Direct costs of material
and labour
• Direct materials (TZS 180 per unit)
• Direct labour (TZS 50 per unit)
 Single product ABC
Step 2: Overhead cost data
• Manufacturing overhead = TZS 500,000
• Selling and administration overhead = TZS 300,000
• Total overhead costs = TZS 800,000

• The company's activity based costing system

has the following activities and activity
measures
 Single product ABC
Step 3: A list of activities and their measures

Activities Activity Measures

Assembling units = Number of units
Processing orders = Number of orders
Supporting customers = Number of customers supported
Other = Not applicable
• Costs assigned to the "other" activity have no activity
measure; they consist of other costs or costs of unused
capacity neither of which are assigned to products, orders or
customers
 Single product ABC
Step 4: Allocate overhead costs to the activities
• XYZ distributes the costs of manufacturing
overhead and of selling and administrative
overhead to the activities based on employee
interviews, the results of which are reported
below
 Single product ABC
Distribution of Resource Consumption Across Activities
Assembling Processing Supporting
Other Total
Units Orders Customers

Manufacturing
50% 35% 5% 10% 100%
overhead

Selling and
administrative 10% 45% 25% 20% 100%
overhead

Total activity 100

1,000 units 250 orders -- --
measure customers
 Single product ABC
The allocation of overhead costs to the activities

Activity Cost Pools

Type of over
head Assembling Processing Supporting
Other Total
Units Orders Customers

Manufacturing
250,000 175,000 25,000 50,000 500,000
overhead(TZS)

Selling
30,000 135,000 75,000 60,000 300,000
overhead(TZS)

Total activity 280,000 310,000 100,000 110,000 800,000

 Single product ABC
Step 5: Compute activity overhead rates for the activities
Activity rates for the activities

Activities Total Cost Total Activity Activity Rates

Assembling units TZS 280,000 1,000 units TZS 280 per unit

TZS 1,240 per

Processing orders TZS 310,000 250 orders
order

Supporting TZS 1,000 per

TZS 100,000 100 customers
customers customer
 Single product ABC
Step 6: Compute product cost based on costs of

the activities
• RST placed four orders amounting to 80
cabinets from XYZ during the year. What is the
cost of a single cabinet?
• The overhead cost for the four orders of a
total of 80 filing cabinets would be computed
as follows:
 Single product ABC
Activity Cost
Total Cost Total Activity Activity Rate
Pools

Assembling units TZS 280 per unit 80 units TZS 22,400

Processing TZS 1,240 per

4 orders TZS 4,960
orders order

Supporting TZS 1000 per

Not applicable
customers customer
 Single product ABC
Total product cost:
• Assembling units overheads = TZS 22,400
• Processing orders over heads = TZS 4,960
• Direct materials (TZS 180 per unit x 80) = TZS 14,400
• Direct materials (TZS 50 per unit x 80) = TZS 4,000

TOTAL PRODUCT COST = TZS 45,760

Process for multi product costing
Step 1: Get details of volume, cost, hours, and
other relevant data related to the
products
Step 2: Get overhead cost data
Step 3: Compute rates of overheads
Step 4: Allocate overhead costs to the products
using the rates.
Step 5: Compute product costs by adding
marginal costs as well as overhead costs
 Process for multi product costing
EXAMPLE
• Refer to the given cost data
• Compute unit product costs using ABC
method
• Now use absorption method and compare the
results
 Historical costing
• Is the recording of costs after they
have been incurred. It is also known
as conventional or actual costing.
Historical Costs can be ascertained in
two ways namely:
Post Costing: ascertained after production
is completed;
Continuous or Concurrent Costing:
ascertained by recording expenditures and
allocating them to production as and when
they are incurred.
 Standard costing
• In this costing method, costs are
computed in advance on the basis of
probable expectations.
• Computed standard costs are compared
with actual costs when they are incurred,
so as to ascertain the variances or
differences.
 A system of costing under which several units of the
same industry adopt the common principles and
procedures of costing.

Normally the principle and methods adopted for

compilation, analysis, apportionment and absorptions of
overhead differ from one undertaking to the other in the
same industry.

The adoption of a common or uniform pattern by

different units in the industry facilitates comparisons of
costs, cost control and cost reduction.

July 3, 2024 87
• To facilitate budgeting
• To enable measurement of
performance efficiency
• For preparation of financial
statements(financial accounting)
• To help decide on make or buy
decisions
• To determine prices of products
.
July 3, 2024 88
 WORKED ACTIVITY 1
• SELECT ANY ORGANIZATION THAT
MANUFATURES MORE THAN ONE PRODUCT
OR OFFERS MORE THAN ONE SERVICE AND
COMPUTE BOTH THE UNIT COSTS USING
ABSORPTION COSTING AND ACTIVITY BASED
COSTING METHOD
• MAKE REALISTIC ASSUMPTIONS