Cost and Session 1: Introduction

Managem
ent Prof. Pradeep Mishra,
CMA (IMA, NJ), Fellow (IRMA)
Accountin
g MBA-RM 2024-26 batch, XIM University, Bhubaneswar
Session objectives

Distinguish financial
Understand the role of
accounting from
management accountant
management accounting

Explain the decision- Appreciate the link of

making framework and management accounting
application of cost and in the larger strategic
management accounting framework
Textbook

• Horngren’s Cost Accounting: A Managerial

Emphasis by Datar and Rajan (16th Edition),
Pearson
 Course content (2.0 credit) & evaluation
Module/ Session Topics
Module -I Introduction
1 Introduction to cost and management
accounting
2 Terminology
3 Review of inventory valuation Sl. No. Component Weightage
(%)
Module – II Costing and Decision making
1 Quiz 20
4 Job costing
5 Process Costing 2 Assignment 25
6 Joint and byproduct costing
7 Activity based costing 3 Class participation 15
8 Cost Volume Profit Analysis
Module – III Budgeting 4 End term exam 40

8 Master Budget and Budgeting process

Total 100
9 Flexible budgets
10 Variance Analysis
Module - IV Managerial Decisions
11 Transfer Pricing
12 Strategic Cost Management
13 Pricing Decisions
14 Internal control
An overview of Accounting discipline

Management accounting measures, analyzes, and reports financial and nonfinancial information that
helps managers make decisions to fulfill organizational goals. Management accounting need not be
GAAP compliant.

Develop, communicate and implement strategies

Managers use management accounting
Coordinate product design, production, and marketing decisions
information to: and evaluate a company’s performance

Financial accounting focuses on reporting financial information to external parties such as investors,
governmental agencies, banks, and suppliers, based on GAAP.

Cost Accounting measures, analyzes and reports financial and nonfinancial information related to the
costs of acquiring or using resources in an organization.
Financial vs Management accounting
Strategy and
Management
Accounting
• 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.
Management accountant
in strategic decisions
Management accounting information helps managers formulate
strategy by answering questions such as the following:
• Who are our most important customers and what critical
capability do we have to be competitive and deliver value to
our customers?
• What is the bargaining power of our customers?
• What is the bargaining power of our suppliers?
• What substitute products exist in the marketplace and how
do they differ from our product in terms of features, price,
cost and quality?
• Will adequate cash be available to fund the strategy, or will
additional funds need to be raised?
Value chain
CRM and Supply Chain

• CRM: Customer Relationship Management (CRM) is a strategy that integrates people and
technology in all business functions to deepen relationships with customers, partners and
distributors. CRM initiatives use technology to coordinate all customer-facing activities and
design and production activities necessary to et products to customers.
• SCM: Supply Chain Management. The supply chain describes the flow of goods, services and
information from the initial sources of materials, services and information to their delivery
regardless of whether the activities occur in one organization or in multiple organizations.
 Customers want companies to use the value chain
and supply chain to deliver ever-improving levels of

Key
performance when it comes to several (or even all)
of the following:
• Cost and efficiency
success •
•
Quality
Time
factors •
•
Innovation
Sustainability
Decision-making framework

Identify Identify the problem/uncertainties

Obtain Obtain information

Make Make predictions about the future

Make Make decisions by choosing among alternatives

Implement Implement the decision, evaluate performance and learn.

 Planning Planning consists of Control comprises
1. selecting an organization’s 1. taking actions that
and control goals and strategies implement the planning
systems 2. predicting results under decisions
various alternative ways of 2. evaluating past
achieving those goals performance, and
3. deciding how to attain the 3. providing feedback and
desired goals, and learning to help future
decision making.
4. communicating the goals
and how to achieve them
to the entire organization.
The most important planning
tool when implementing
strategy is a budget.
 The four standards of ethical conduct for management accountants
as advanced by the Institute of Management Accountants (IMA) are:
• Competence

Ethical • Confidentiality
• Integrity

standards • Credibility

and legal The Sarbanes-Oxley legislation was passed in 2002 in response to a

requiremen series of corporate scandals. The act focuses on improving:
 Internal controls

ts  Corporate governance
 Monitoring of managers
 Disclosure practices of public companies
Thank you
Cost
concepts
and
Terminology

Chapter 2
Horngren’s Cost Accounting
 Cost
Terminology….. Object Illustration
Product A BMW X6 sports activity vehicle

Telephone hotline providing

• Cost – a sacrificed or forgone resource Service information and assistance to BMW
dealers
to achieve a specific objective.
• Actual cost – a cost that has occurred R&D project on DVD system
Project enhancement in BMW cars
• Budgeted cost – a predicted cost
Herb Chambers Motors, a dealer
• Cost object – anything for which a cost Customer that purchases a broad range of
measurement is desired BMW vehicles

Setting up machines for production

Activity or maintaining production
equipment

Departmen Environmental, Health and Safety

t department
 Cost Accumulation – the collection of
cost data in an organized way by means
Terminology…. of an accounting system

Cost Assignment – a general term that

encompasses the gathering of
accumulated costs to a cost object in two
ways:
• Tracing costs with a direct relationship to the cost
object, and
• Allocating accumulated costs with an indirect
relationship to a cost object.
Direct and Indirect Direct costs can be conveniently and
economically traced (tracked) to a cost
object.

Indirect costs cannot be conveniently or

economically traced (tracked) to a cost
Costs

object. Instead of being traced, these

costs are allocated to a cost object in a
rational and systematic manner.
 Cost Sheet
• Prime cost= Direct Material + Direct Labour
• Factory Cost = Prime cost + Factory Overhead
• Cost of production= Factory cost + Admin cost
• COGAS = Cost of Prodn + Op. stock of finished
goods
• COGS= COGAS – closing stock for finished
goods
• Total cost = COGS + Selling and distribution OH
• Sales=Total cost + profit
Cost Assignment to a Cost
Object (BMW Example)

21
Multiple Classifications of Costs
• Costs may be classified as:
• Direct/Indirect, and
• Variable/Fixed
• These multiple classifications give rise to important cost combinations:
• Direct and variable
• Direct and fixed
• Indirect and variable
• Indirect and fixed
Cost Direct Costs • Factors affecting cost
classification
Material (steel or • The materiality of the
Allocation tires for a car, as an example) cost in question.
• The available
Labor (Assembly line
Challenge wages) information-gathering
technology.
s Indirect Costs • Design of operations.
Electricity NOTE: a specific cost may be
both a direct cost of one cost
Rent object and an indirect cost of
another cost object.
Property taxes
The direct/indirect classification
Plant administration depends on the choice of the cost
expenses object.
Cost behaviour patterns:
Variable vs fixed cost
Variable costs change, in total, in proportion to changes in the related level
of activity or volume of output produced.
Fixed costs remain unchanged, in total, for a given time period, despite
changes in the related level of activity or volume of output produced.
Costs are fixed or variable for a specific activity and/or for a given time
period.
Variable costs are constant on a per-unit basis. If a product takes 5 pounds
of material each, it stays the same per unit regardless if one, ten or a
thousand units are produced.
Fixed costs per unit change inversely with the level of production. As more
units are produced, the same fixed cost is spread over more and more units,
reducing the cost per unit.
 PANEL A: Variable Costs of Steering Wheels at
$60 per BMW X6 Assembled

Cost Behavior Summarized

- TOTAL DOLLARS COST PER UNIT

VARIABLE Change in proportion Unchanged in

COSTS with output relation to output
(more output = more
cost)
PANEL B: Supervision Costs for the BMW X6
Assembly Line (in Millions)
FIXED Unchanged in relation Change inversely with
COSTS to output (within the output
relevant range) (more output = lower
cost per unit)
Other cost
concepts
• Mixed costs have both fixed and variable elements
• Cost driver – a variable, such as the level of activity or
volume, that causally affects costs over a given time
span.
• Relevant range – the band or range of normal activity
level (or volume) in which there is a specific relationship
between the level of activity (or volume) and the cost in
question.
• Fixed costs are considered fixed only within the relevant
range.
Examples of the Multiple
Classifications Of Costs

27
Use Unit Costs Cautiously
Although unit costs are regularly used in
financial reports and for making product mix
and pricing decisions, managers should think
in terms of total costs rather than unit costs
for many decisions.
Different Types of Firms

Manufacturing-sector Merchandising-sector
Service-sector companies
companies purchase companies purchase and
provide services
materials and components then sell tangible products
(intangible products) like
and convert them into without changing their
legal advice or audits.
various finished goods. basic form.
Types of inventory

Direct materials – resources in-stock and available for use

Work-in-process (or progress) – goods partially worked on but not yet

completed, often abbreviated as WIP

Finished goods – goods completed but not yet sold

Note: Merchandising-sector companies hold only one type of inventory:

merchandise inventory
Commonly Used Classifications of
Manufacturing Costs
Also known as inventoriable costs:
Direct materials – acquisition costs of all material that will become part of the
cost object.
Direct labor – compensation of all manufacturing labor that can be traced to the
cost object.
Indirect manufacturing – all manufacturing costs that are related to the cost
object but cannot be traced to that cost object in an economically feasible way.
Inventoriable Costs
VS. Period Costs
• Inventoriable costs are all costs of a product that
are considered assets in a company’s balance
sheet when the costs are incurred and that are
expensed as cost of goods sold only when the
product is sold. For manufacturing companies, all
manufacturing costs are inventoriable costs.
• Period costs are all costs in the income statement
other than cost of goods sold. They are treated as
expenses of the accounting period in which they
are incurred.
Cost Flows
The Cost of Goods Manufactured and the cost of goods sold section of the income
statement are accounting representations of the actual flow of costs through a
production system.
Note how inventoriable costs go through the balance sheet accounts of direct
materials, work-in-process and finished goods inventory before entering the cost of good
sold in the income statement.
Cost Flows Illustrated
EXHIBIT 2.7 Flow of Revenue and Costs for a
Manufacturing-Sector Company, Cellular Products (in
thousands)
Multiple-Step Income Statement,
Part Exhibit
One 2.8 Income Statement and Schedule of Cost of Goods
Manufactured of a Manufacturing-Sector Company, Cellular Products
Multiple –Step Income Statement, Part Two
Exhibit 2.8 Income Statement and Schedule of Cost of Goods
Manufactured of a Manufacturing-Sector Company, Cellular Products
Flow Of Revenues
and Costs for a
Merchandising
Company

Exhibit 2.10 Flow of

Revenues and Costs for
a Merchandising
Company (Retailer or
Wholesaler)
Other cost consideration
• Prime cost is a term referring to all direct manufacturing costs (materials and labor).
• Conversation cost is a term referring to direct labor and indirect manufacturing costs.
• Overtime premium labor costs are considered part of indirect overhead costs.
• Idle time refers to the wages paid for unproductive time caused by lack of orders,
machine or computer breakdown, work delays, poor scheduling, and the like.
Measurin Because there are alternative ways for management

g Costs to define and classify costs, judgment is required.

Managers, accountants, suppliers and others should

Requires agree on the classifications and meaning of the cost

terms introduced in this chapter and throughout the
book.
Judgment
Different Pricing and product-mix decisions – decision about
Product pricing and maximizing profits
Contracting with government agencies – very specific
Costs for definitions of allowable costs for “cost plus profit”
contracts

Different Preparing external-use financial statements – GAAP-

driven product costs only

Purposes
Different Product Costs for Different Purposes (2 of 2)
Management
accounting framework
The following three features of cost accounting and
cost management can be used for a wide range of
applications (for helping managers make decisions):
1. Calculating the cost of products, services, and
other cost objects
2. Obtaining information for planning and control,
and performance evaluation
3. Analyzing the relevant information for making
decisions
Thank you
Inventory
Management
Source

Chapter 7
Financial ACCT: A South Asian Perspective
By Godwin, Alderman and Sanyal
(Cengage) 2e.
Illustration
Assume that Nell Farms sells a specialty maple syrup
that it purchases from Waverly Manufacturing. The
following is Nell’s inventory activity for September.
Net Income Units Unit Cost Total
in INR
Sep.1 Begin Inventory 40 12 480
Sep.4 Purchase 60 13 780
Sep.10 Sale (65)
Sep.15 Purchase 30 14 420
Sep.23 Purchase 45 15 675
Sep.30 Sale (50)
Specific Identification
Cost of Goods Sold

Ending Inventory
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First-in-First-Out (FIFO)
Cost of Goods Sold

Ending Inventory
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Last-in-First-Out (LIFO)
Cost of Goods Sold

Ending Inventory
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Moving Average
Cost of Goods Sold

Ending Inventory
© 2016 Cengage Learning India Pvt Ltd. All rights reserved.
 Comparing Inventory
Costing Methods
Because inventory costing methods affect both income
statement and balance sheet accounts, a company must
disclose the method that it uses. It must also use the same
method consistently.

© 2016 Cengage Learning India Pvt Ltd. All rights reserved.

Relationships Summarized

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Thank You
Cost
Volume
Profit
Analysis
Chapter 3 (Horngren’s
Cost Accounting)
CVP Analysis
• Managers want to know how profits will change as the units sold of a product
or service changes.
• Managers like to use “what-if” analysis to examine the possible outcomes of
different decisions so they can make the best one.
• In chapter 2, we discussed total revenues, total costs and income.
• In this chapter, we take a closer look at the relationship among the elements
(selling price, variable costs, fixed costs)
Foundational Assumptions Used in
CVP Analysis
• Changes in production/sales volume are the sole cause for cost and
revenue changes.
• Total costs consist of fixed costs and variable costs.
• Revenue and costs behave and can be graphed as a linear function (a
straight line).
• Selling price, variable cost per unit and fixed costs are all known and
constant.
• In many cases, only a single product will be analyzed. If multiple products
are studied, their relative sales proportions are known and constant.
• The time value of money (interest) is ignored.
Basic CVP Equations
Contribution Margin = Total Revenue - Total Variable Costs
Contribution Margin per unit = Selling price - Number of units sold
Operating Income = Contribution margin - Fixed costs
Contribution Margin Ratio (or Percentage) = Contribution Margin / Revenue
More CVP Relationships
Manipulation of the basic equations (prior slide) yields an extremely important
and powerful tool called Contribution Margin.
Contribution margin equals revenue less variable costs.
Contribution margin per unit equals unit selling price less unit variable costs, but
can also be determined by taking contribution margin divided by number of units
sold
Cost-Volume-Profit
Equation and Contribution
Margin Methods
EQUATION METHOD: REVENUE - VARIABLE COSTS - FIXED COSTS
= OPERATING INCOME

CM METHOD: WHERE: [(SP X Q) - (VC X Q)] - FC = OI

REVENUE = SELLING PRICE (SP) * QUANTITY OF UNITS SOLD (Q)

VARIABLE COSTS (VC) = UNIT VARIABLE COSTS * QUANTITY OF UNITS SOLD

CONTRIBUTION MARGIN (CM) = REVENUE - VARIABLE COSTS

OPERATING INCOME (OI) = CONTRIBUTION MARGIN - FIXED COSTS

Cost-Volume-Profit – You Try It!
Problem
REVENUE - VARIABLE - FIXED = OPERATING
COSTS COSTS INCOME
Tiny’s Cabinets sells cabinets for $600 each
Variable cost is $350 each
Annual fixed costs are $20,000
If Tiny sells 100 cabinets, what it his operating income?
Cost-Volume-Profit – You Try It!
Solution
Tiny’s Cabinets sells cabinets for $600 each
Variable cost is $350 each
Annual fixed costs are $20,000
If Tiny sells 100 cabinets, what it his operating income?
Solution: [(SP X Q) - (VC X Q)] - FC = OI
($600*100) - ($350*100) = Contribution Margin
CM - $20,000 = Operating Income
$60,000 - $35,000 - $20,000 = $5,000
Breakeven Point
The breakeven point (BEP) is that quantity of output sold at which total revenue
equals total cost - that is, the quantity of output sold results in $0.00 of operating
income.
Recall our contribution margin method equation:
[(SP x Q) - VC x Q)] - FC = OI
If we set OI to 0 and solve, we’ll get the BEP.
 Breakeven Point-Example (1 of 2)

Let’s try this for Tiny’s Cabinets. Recall that his SP = $600, VC = $350 and Fixed
Costs are $20,000, annually.
[(SP x Q) - (VC x Q)] - FC = OI
($600 x Q) - ($350 x Q) - $20,000 = 0
$250 x Q = 20,000
Q = 80
Here’s another way to find the answer:
Breakeven revenues = FC / CM%
Breakeven units = FC / CM per unit
Breakeven Point-Example (2 of 2)

Let’s try this for Tiny’s Cabinets. Recall that his SP = $600, VC = $350 and Fixed
Costs are $20,000
Here’s another way to find the answer:
Breakeven revenues = FC / CM per unit
Tiny’s CM per unit = $600 - $350 = $250
Tiny’s CM % = $250/$600 = 41.67%
$20,000 / $250 = 80
Or, in revenues $20,000/41.67% = $47,996 which is equal to 80 x $600, allowing
for rounding
Breakeven Point-Extended:
Profit Planning/Target Income
The breakeven formula can be modified to become a profit planning tool by
adding target operating income to fixed costs in the numerator.
Let’s say that Tiny wants to make $30,000 Operating Income:
Qty of Units = (FC + Target Operating Income)/CM per unit
Q = ($20,000 + $30,000)/$250
Q = 200
CVP: Graphically
EXHIBIT 3.3 Profit-Volume Graph for GMAT Success
CVP and Income Taxes
After-tax profit (Net Income) can be calculated by:
Net Income = Operating Income * (1-Tax Rate)
Net income can be converted to operating income for use in the CVP equation
Operating Income = I I Net Income I
(1-Tax Rate)
Note: the CVP equation will continue to use operating income. We’ll use this
conversion formula to obtain the operating income value when provided with
Net Income.
CVP and Income Taxes – Tiny’s
Cabinets
Net income can be converted to operating income for use in the CVP Equation Operating Income
= II Net Income I
(1-Tax Rate)
What if Tiny wanted to earn $30,000 Net Income instead of Operating Income? His tax
rate is 35%.
Quantity of Units = (FC + Target Operating Income)/CM per unit
Q = ($20,000 + [$30,000/(1-35%)]/$250
Q = ($20,000 + $46,154)/$250 = 265
Using CVP Analysis for Decision
Making (1 of 3)
Remember Tiny? As is, he expects to sell 100 cabinets. What if Tiny spent
$5,000 on advertising and estimated that it would increase his sales by 10%.
Should he do it?
To find out, we can use CVP analysis as follows:

Blank Sales without Sales with Advertising

Advertising
Units Sold 100 110
Revenues (SP $600) $60,000 $66,000
Variable Cost ($350) $35,000 $38,500
Fixed Costs $20,000 $25,000
Operating Income $ 5,000 $ 2,500
Using CVP Analysis for Decision
Making (2 of 3)
As we see from the prior screen, though Tiny’s sales increase with the advertising expenditure, his
Operating Income decreases by $2,500.
Tiny will be better off if he doesn’t advertise.
What if I told you that a more detailed analysis indicated that Tiny’s sales would increase by 25%
instead of 10%. Should he do it?
Here’s a quick way to check that. If sales increase 25%, they’ll increase by 25 units. 25 units X
Contribution Margin per unit of $250 ($600 - $350) = $6,250.
That is $1,250 greater than the $5,000 Tiny would have to spend. So, in this case, Tiny will be better
off spending money on the advertising.
Using CVP Analysis for Decision
Making (3 of 3)
The concept of using CVP analysis for decision making works just as well if you are thinking about
decreasing prices. If you decrease your price, you’d expect more unit sales. To determine if the
combination of lower price with higher unit sales will improve Operating Income, use CVP analysis.
This type of strategic decision entails risk. We use CVP to evaluate how the Operating Income will
change but we cannot be certain that our estimates of increased sales will occur.
Managers use electronic spreadsheets to systematically and efficiently conduct CVP-based
sensitivity analysis to test how sensitive their conclusions are to different assumptions.
Sensitivity Analysis
• CVP provides structure to answer a variety of “what-if” scenarios.
• “What” happens to profit “if”:
• Selling price changes
• Volume changes
• Cost structure changes
• Variable cost per unit changes
• Fixed costs change
As an example, if a company determines that an ad campaign costing $15,000 is expected to
increase sales 25%, should they proceed? This is very similar to the analysis we did for Tiny’s
Cabinets. The question cannot be properly answered without doing this type of analysis.
Margin of Safety-Defined
• The margin of safety calculation answers a very important question:
• If budgeted revenues are above the breakeven point, how far can
they fall before the breakeven point is reached.
• In other words, how far can they fall before the company will begin to
lose money.
 Margin of Safety – An Indicator of Risk

• The margin of safety (MOS) measures the distance between budgeted

sales and breakeven (BE) sales:
• MOS = Budgeted Sales - BE Sales
• The MOS ratio removes the firm’s size from the output and expresses
itself in the form of a percentage:
• MOS Ratio = MOS / Budgeted Sales
 Cost Structure

• Managers make strategic decisions that affect the cost structure of the company
• The cost structure is simply the relationship of fixed costs and variable costs to
total costs.
• We can use CVP-based sensitivity analysis to highlight the risks and returns as
fixed costs are substituted for variable costs in a company’s cost structure.
• The risk-return trade-off across alternative cost structures can be measured as
operating leverage.
Operating Leverage = CM/Operating
Income
• The risk-return tradeoff across alternative cost structure can be measured as
operating leverage.
• Operating leverage describes the effects that fixed costs have on changes in
operating income as changes occur in units sold and contribution margin.
• Organizations with a high proportion of fixed costs in their cost structures have
high operating leverage.
• In the presence of fixed costs, the degree of operating leverage is different at
different levels of sales.
Using Operating Leverage to
Estimate Changes to Operating
Income
• We can use Operating Leverage to estimate changes to Operating Income that
will result from a percentage change in sales.
• Operating Leverage X % Change in Sales = Percentage change in Operating
Income
• For example, if sales increase 50% and operating leverage is 1.67, you should
expect operating income to increase 83.5% (50% x 1.67)
Effects of Sales Mix on CVP
• Sales Mix is the quantity or proportion of various products or services that
constitute a company’s total unit sales. It is often the case that the various
products or services have different contribution margins.
• Up to this point, we’ve assumed a single product; more realistically, we’ll have
multiple products with different costs and different margins.
• We can use the same formula in our CVP calculations but must use an average
contribution margin for the products.
• This technique assumes a constant mix at different levels of total unit sales.
CVP for Service and Not-For-Profit
Organizations
• CVP isn’t just for merchandising and manufacturing companies.
• Service and Not-For-Profit businesses need to focus on measuring their output
which is different from the units sold that we’ve been dealing with.
• For example, a service agency might measure how many persons they assist or an
airline might measure how many passenger miles they fly.
• What measure might a hotel use? A restaurant?
Contribution Margin versus Gross
Margin
• Recall from Chapter 2 that Gross Margin = Revenue – Cost of Goods Sold
• In Chapter 3, we learned about Contribution Margin which is Revenue – All Variable Costs
• Gross Margin measures how much a company charges for its products over and above the cost of
acquiring or producing them.
• Contribution Margin indicates how much of a company’s revenue is available to cover fixed costs.
• This is especially significant in the manufacturing sector where businesses carry inventory
Contribution Margin and Gross Margin for
Tiny’s Cabinets (Produced 100 cabinets, sold
90;SP $600; VC $350; FC $20,000 (15,000
Mfg))
Line Item Contribution Line item Gross Margin
Margin
Sales (90 * $600) $54,000 Sales (90 * $600) $54,000
Variable Costs (90*$350) $31,500 Cost of Goods Sold $45,000
(VCU $350; FCU $150)

Contribution Margin $22,500 Gross Margin $ 9,000

Fixed Mfg Costs $15,000 Non-Manufacturing $ 5,000
Costs
Fixed Non-Mfg Costs $ 5,000 Blank Blank
Operating Income $ 2,500 Operating Income $4,000
Thank You