Managerial Accounting

Table of Content
Table of content .. 1 Introduction .... 2 Principal of Cost Benefit Analysis 3 Classification of Cost 4 Conclusion ..... 9 References ..10

Managerial Accounting

Introduction
Cost is a sacrifice of resources to obtain a benefit or any other resource. For example in production of a car, we sacrifice material, electricity, the value of machine's life (depreciation), and labor wages etc. Cost-Benefit Analysis (CBA) estimates and totals up the equivalent money value of the benefits and costs to the community of projects to establish whether they are worthwhile. These projects may be dams and highways or can be training programs and health care systems. CBA has its origins in the water development projects of the U.S. Army Corps of Engineers. The Corps of Engineers had its orgins in the French engineers hired by George Washington in the American Revolution. For years the only school of engineering in the United States was the Military Academy at West Point, New York. In 1879, Congress created the Mississippi River Commission to "prevent destructive floods." The Commission included civilians but the president had to be an Army engineer and the Corps of Engineers always had veto power over any decision by the Commission. In 1936 Congress passed the Flood Control Act which contained the wording, "the Federal Government should improve or participate in the improvement of navigable waters or their tributaries, including watersheds thereof, for floodcontrol purposes if the benefits to whomsoever they may accrue are in excess of the estimated costs." The phrase if the benefits to whomsoever they may accrue are in excess of the estimated costs established cost-benefit analysis. Initially the Corps of Engineers developed ad hoc methods for estimating benefits and costs. It wasn't until the 1950s that academic economists discovered that the Corps had developed a system for the economic analysis of public investments. Economists have influenced and improved the Corps' methods since then and cost-benefit analysis has been adapted to most areas of public decision-making.

Principles of Cost Benefit Analysis

1- There Must Be a Common Unit of Measurement 2- CBA Valuations Should Represent Consumers or Producers 3- Valuations As Revealed by Their Actual Behavior

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4-Benefits Are Usually Measured by Market Choices 5- Gross Benefits of an Increase in Consumption is an Area Under the Demand Curve 6- Some Measurements of Benefits Require the Valuation of Human Life 7-The Analysis of a Project Should Involve a With Versus Without Comparison 8- Cost Benefit Analysis Involves a Particular Study Area 9- Double Counting of Benefits or Costs Must be Avoided

Cost Classifications
Costs are usually classified as follows:

1- On the basis of identity a) Direct cost b) Indirect cost

Direct cost: Costs that can be easily and conveniently traced to a unit of product or other cost objective. Examples: direct material and direct labor Indirect cost : Costs cannot be easily and conveniently traced to a unit of product or other cost object. Example: manufacturing overhead

2- On the basis of nature / element

a) Direct Material b) Direct Labour c) Factory overhead Direct materials: Represents the cost of the materials that can be identified directly with the product at reasonable cost.
For example, cost of paper in newspaper printing, A radio installed in an automobile.

Direct labor: Represents the cost of the labor time spent on that product.
For example cost of the time spent by a petroleum engineer on an oil rig, Wages paid to automobile assembly workers etc.
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Factor overhead: Represents all production costs except those for direct labor and direct materials,
For example the cost of an accountant's time in an organization, depreciation on equipment, electricity, fuel, etc.

3- According to Association with Product

a) Product cost b) Period cost Product costs:- Product costs are costs assigned to the manufacture of products and recognized for financial reporting when sold.
For example direct materials, direct labor, factory wages, factory depreciation, etc.

Period costs:- Period costs are on the other hand are all costs other than product costs.
For Example:- marketing costs and administrative costs, etc.

4- According to Association with Product

a) Normal cost b) Abnormal cost Normal cost: It is the cost which is normally incurred at a given level of out put. These costs are part of cost production.
Example: repairs, maintenance, salaries paid to employees.

Abnormal cost: It is the cost which is not normally incurred at a given level of out put. These costs are not charged to the cost of production. It is transferred to the costing profit and loss account.
Example: destruction due to fire, shut down of machinery, lock outs, etc.

5- On the basis of Function

a) Factory cost b) Commercial Cost i) Office and Administration Cost
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Managerial Accounting ii) Selling and Distribution Cost

Factory Cost:- Total cost of making a product at the production location, and comprising of raw material, labor, and overhead costs. Example:- Direct labour, Direct Material, Factory overhead Commercial cost:- Total cost of distribute and sell the product is called commercial cost. Example:- Online advertisement T.V

6- On the basis of variability Cost

a) Variable Cost b) Fixed Cost c) Mixed Cost d) Step Fixed Cost Variable Costs:- Variable costs are costs which change with a change in the level of activity.
Examples include direct materials, direct labor, etc.

Fixed costs: Fixed costs are costs which remain constant within a certain level of output or sales. This certain limit where fixed costs remain constant regardless of the level of activity is called relevant range.
For example, depreciation on fixed assets, etc.

Mixed Cost Semi-Variable Cost / Semi-Fixed cost: These costs are partly fixed and partly variable.
Examples of variable costs are telephone rent. It includes partly fixed charge up to a certain level and then varies according to the calls.

Step Fixed Cost: It is fixed up to a certain level of volume, and then they increase to an even higher level of fixed cost to a certain level of volume. This process is repeated over and over with fixed costs increasing to higher levels.

Managerial Accounting

When dealing with step-fixed costs it is important to recognize at what points costs increase and to what levels they increase. Example :- One employee can operate equipment to produce 100 valves per day. If 320 valves need to be produced, Friends Company would hire four employees (three employees won't be enough because three employees can only produce 300 valves). If the valve production requirement is increased to 400 units, four workers will still be able to cope with the work load. However, for 410 valves, an additional, fifth employee would be needed. Thus, the company's payroll costs change in steps, from costs for four employees at 320 or 400 units, to payroll costs for five employees at 410 units.

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On the basis of Controllability

a) Control Cost b) Uncontrolled Cost Controllable Cost: These costs are regulated or controlled by specified member of an organisation. Most of the variable costs are controllable.
For example:- direct material, direct labor and direct expenses are controlled by the lower level of the management.

Uncontrollable Cost: These costs can not be regulated or controlled by specified member of an undertaking. Most of the fixed costs are uncontrollable.
Example of uncontrollable costs are, factory rent, managers salary etc.

8- On

the basis of Time

a) Historical cost b) Predetermined Cost Historical Cost: These costs are ascertained after they have been incurred such costs are available only when the production of a particular thing has already been done.
Example:- For example, say the main headquarters of a company, which includes the land and building, was bought for $100,000 in 1925, and its
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expected market value today is $20 million. The asset is still recorded on the balance sheet at $100,000. Not all assets are held at historical cost. For example, marketable securities are held at market value on the balance sheet.

Pre-determined Cost: Pre-determined costs are estimated costs which are set in advance on a scientific way. It becomes standard cost and compared with the actual for adopting controlling measures.
For example, the costs of heating and cooling a factory in Illinois will be highest in the winter and summer months and lowest in the spring and fall.

9- According to Relevance
a) Opportunity Costs b) Sunk Costs c) Managerial Cost d) Differential Cost Opportunity Costs:- Opportunity costs which are costs of a potential benefit foregone.
Example: If you were not attending college, you could be earningRs.15,000 per year. Your opportunity cost of attending college for one year is Rs.15,000.

Sunk Costs:- Sunk Costs are historical costs which means they have been incurred in past and cannot be avoided by our current decisions
Example: You bought an automobile that cost Rs.3.5 lacs two years ago. The Rs.3.5 lacs cost is sunk because whether you drive it, park it, trade it, or sell it, you cannot change the Rs 3.5 Lacs cost.

Managerial Cost :-A cost is variable or fixed depending on whether the amount of the cost changes as the volume of production changes. A cost is a

Managerial Accounting

variable cost if it increases (decreases) as the volume or production levels increase (decrease.) For example, the amount of a raw material used in the production process increases as more units of a product are produced (more corn is used to make more ethanol.)

Differential Costs: Cost that differ among alternatives.

Example: You have a job paying Rs.1,500 per month in your hometown. You have a job offer in a neighboring city that pays Rs.2,000 per month. The commuting cost to the city is Rs.300 per month.

10- Other Cost

a) Prime Cost b) Conversion Cost Prime costs: Prime costs are the sum of all direct costs such as direct materials, direct labor and any other direct costs.
For example, the prime costs for creating a can of soda would include raw materials such as the aluminum needed for the cans, ink to customize the cans with the products brand name and logo, soda ingredients (i.e. carbonated water, caramel coloring, caffeine, sugar or aspartame and preservatives), freight charges to transport the raw materials to the manufacturing plant and the wages, taxes and benefits paid to or on behalf of the employees involved in the soda manufacturing process.

Conversion Costs: Conversion costs are all costs incurred to convert the raw materials to finished products and they equal the sum of direct labor, other direct costs (other than materials) and manufacturing overheads. For example:- Factory supervisors salaries, depreciation on the machines producing plastic food storage bags, and insurance on the production facilities.

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Conclusion
An important business objective is to break-even i.e. exactly covering your total cost by sale revenue. It is even more desirable to make the profit. It is necessary to estimate the profit and the loss of the business.

Managerial Accounting

References
http://www.scribd.com http://www.publishyourarticles.org http://simplestudies.com http://www.investopedia.com/terms/h/historical-cost.asp#ixzz1oGi12Aa9 http://en.wikipedia.org/wiki/Pre-determined_overhead_rate

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