COST & MANAGEMENT ACCOUNTING

Prof. Ranjan Kumar Bal

UTKAL UNIVERSITY

COST & MANAGEMENT ACCOUNTING

(COMA)
Provides information to managers for
planning, controlling & decision making.
The controller : The Chief Management Accountant

The Controller is compared to a ships

navigator, with the President (CEO) being
the ships captain.

ROLE OF THE ACCOUNTANT

TO MANAGE INFORMATION
An Information Technologist

SCORE KEEPING
ATTENTION DIRECTING
PROBLEM SOLVING

CUSTOMER DRIVEN FOCUS IN

MANAGEMENT ACCOUNTING SYSTEM
VISION STATEMENT OF MANAGEMENT ACCOUNTING
GROUP AT JOHNSON & JOHNSON

Delight our customers.

Develop alternative measurement system.
Keep it simple.
Utilize 20% of time on Accounting & 80% on
analysis.
Be the best.

ABILITIES & SKILLS for

Management Accountants A Survey
Communication (oral, written &
presentation) skills
Ability to work on a team
Analytical / problem-solving skills
Solid understanding of accounting
Understanding of how a business functions.
Computer skills

THE MANAGEMENT ACCOUNTANT AND

STRATEGIC DECISIONS
The management accountant helps to formulate
strategy by answering questions such as :

Who are our most important customers ?

How sensitive are their purchases to prices, quality,
and service ?
Who are our most important suppliers ?
What substitute products exist in the market place,
and how do they differ from our product?
Is the industry demand growing or shrinking ?
Is there overcapacity ?

IMPORTANCE OF COMA
Helps in achieving the main objective of the

organization
Identifies unprofitable activities.
Improves efficiency/Facilitates cost control.
Helps in planning & preparation of budgets.
Helps in inventory control.

Facilitates decision making.

COMA Vs. FINANCIAL ACCOUNTING

Similarities
Both are branches of Accounting.
Are concerned with systematic recording
and presentation of financial data.
Both follow same principles of Dr. and Cr.
Both have the same source of recording
transactions.
Both have the common goal of assisting
the organization they serve.
Both are complementary to each other.

COMA Vs. FINANCIAL ACCOUNTING :

Differences

Purpose
Periodicity of reporting
Customers served
Audit
Accounts prepared
Tax assessment
Actual and standard
Profit and Loss
Monetary and Non-monetary
Relative efficiency
Constrained by GAAP

COST AND MANAGEMENT

INFORMATION SYSTEM
COST ACCOUNTING INFORMATION SYSTEM
OPERATIONAL CONTROL SYSTEM
OBJECTIVES OF CMIS:
To provide information for costing out services,
products and other objects of interest to management.
To provide information for decision making.
To provide information for planning and control.

COST MANAGEMENT
Identifies, collects, measures,
classifies, & reports information
Useful to managers in costing,
planning, controlling, & decision
making.
Cost Accounting : Evolving into Cost Mgt.
It is associated with Mgt. Accounting

THE VALUE CHAIN OF THE BUSINESS FUNCTION

R&D
Design
Production
Marketing
Distribution
Customer service

Accounting helps managers:

To administer each of the business functions.
To coordinate the functions of value chain.

ENHANCING THE VALUE OF COMA SYSTEM

Customer Focus
Value Chain & Supply Chain Analysis
Key Success Factors Cost & efficiency,
Quality, Time, Innovation, etc.
(Distinct or Extinct)
Continuous Improvement (Kaizen) &
Benchmarking

We are running harder

just to stand still.
If youre not going forward,
you are going backward.

QUESTIONS

Management Accounting should not fit the

straightjacket of Financial Accounting.
Explain.
A leading management observer stated,
The most successful companies are those that
have an obsession for their customers.
Is this statement pertinent to management
accountants? Explain.

CHANGE
Change is the only constant
in todays world.

MANAGEMENT AND COMA

Provides adequate, timely and reliable information.
Helps management in managing and controlling costs.
Provides cost-benefit approach for resource allocation.
Helps in decision making:

Pricing

Product-mix
Profit-volume decisions
Helps: Formulation & execution of budgets & standards.
Helps in making special studies and investigations.

Without proper cost and management accounting,

decision would be like taking a jump in the dark.

COST TERMINOLOGY

Cost : Resources sacrificed or

Amount of expenditure incurred
Costing : Process of cost accumulation &
cost assignment
Cost Object : Anything for which a measurement of
cost is desired.
Cost Accumulation : Collection of cost data in some
organized way.
Cost Assignment : Cost Tracing & Cost Allocation.
Cost Tracing : Assigning direct cost.
Cost Allocation : Assigning indirect costs.
Cost Driver : A variable that causally affects /
influences costs over a given time span

COST CLASSIFICATION
WHY ?
To Achieve a Purpose / Objective
Control, Decision Making
To Facilitate Communication /
Reporting

COST CLASSIFICATION

Behaviour
Elements
Control
Decision Making
Functions
Nature

ELEMENTS OF COST
MATERIAL : Direct Vs. Indirect
LABOUR : Direct Vs. Indirect
EXPENSES : Direct Vs. Indirect
Direct cost of a cost object : Traced in an
economically feasible (cost effective) way.

OVERHEADS
Manufacturing or Factory
Office & Administration
Selling & Distribution

OTHER CONCEPTS OF COST

Fixed, Variable & Semi-variable

Controllable & Uncontrollable
Relevant & Irrelevant
Incremental & Decremental
Shutdown & Sunk cost
Traceable & Untraceable
Joint cost & Conversion cost

RELATIONSHIP OF COSTS
Direct & Variable
Direct & Fixed
Indirect & Variable
Indirect & Fixed

METHODS & TECHNIQUES

METHODS
- Job Costing
- Process Costing
TECHNIQUES
- Marginal Vs. Absorption Costing
- Standard Vs. Historical Costing

COST ACCOUNTING
OBJECTIVES :
To determine product costs
To facilitate planning & control
To supply information for decision
making
IN GOD WE TRUST,
EVERYBODY ELSE BRINGS DATA TO THE TABLE.
INFOSYS

COST ESTIMATION
Statement of Cost : For each cost object
or cost centre.
Different Columns : Total cost / Cost per
unit / Previous period costs / Budgeted
costs / Variable & Fixed costs ..
Sources of Data : F.A. & C.A.
Time Period : A month or week

WHY A COST SHEET ?

Fixing selling price

Submitting quotations
Planning & control of cost
To know relative efficiency of products
Decision making

STATEMENT OF COST
COST SHEET
Prime Costs or Direct Costs
DM + DL + DE = PC
Production or Works or Factory Costs
PC + P. OH. = FC
Office Costs or Cost of Production*
FC + O. OH. = COP
Total Cost or Cost of Sales
COP + S. OH. = TC
*Assumption : Office & Admn. Overheads relate to production.

TREATMENT OF STOCK
Raw Material
WIP
Finished Goods

Treatment of the amount realized from the

sale of scraps / wastes ?

ITEMS NOT AFFECTING COST SHEET

Income Tax
Dividends to Share Holders
Interest on Loans
Capital Loss
Donations
Capital Expenditure
Discount on Shares & Debentures
Underwriting Commission
Writing off Goodwill
Commission to MD

ESTIMATED COST SHEET

Considers all probable changes in cost

Preparation :
- Prepare a Cost Sheet
- Establish relationship
- Estimate OH costs
- Prepare Estimated Cost Sheet

CASE
The following information are obtained from the
records of AB cycles for the month of August:
Direct materials
: Rs. 19, 80, 000
Direct labour
:
18, 00, 000
Factory overheads :
5, 80,
000
Administrative overheads : 3, 90, 000
Outputs for the month : 2,000 cycles.
What price the company should quote for an
order of 100 cycles?
Note: Factory overheads are absorbed on the
basis of direct labour and administrative
overheads on the basis of works cost.

THE FOLLOWING DATA RELATE TO A COMPANY:

Expected sales
: 50,000 units
Direct material cost
: Rs. 2.50 per unit
Direct labour cost
: Rs. 2.00 per unit
Variable Overhead
: Rs.1.50 per unit
Fixed cost
: Rs. 1.50 per unit
Selling price
: Rs.10 per unit
The firm expects to get a special export order for 10,000
units at a price of Rs. 7.25 per unit.
Advise whether the export order should be accepted or not.

The company has a capacity to produce 60,000 units.

INFERENCES:
An organization has different costs having
different nature.
Example: Fixed, Variable, Mixed Cost
These costs behave differently to changes in
the level of business activity.
Understanding this relationship helps in
planning, control and developing successful
business strategies.

Cost of a product / process can be ascertained by :

1. Absorption costing
2. Marginal costing

ABSORPTION COSTING
Traditional or full cost method :
Cost of a product = V. C. + F. C.
Variable costs are directly charged to the product.
Fixed costs are apportioned on suitable basis.
DISADVANTAGES:

It assumes that prices are simply a function of costs.

It includes past costs which may not be relevant to the
pricing decision at hand.

MARGINAL COSTING
- Direct Costing / Variable Costing
- A Technique of Costing

Meaning :
Ascertainment of marginal cost by differentiating
between F.C. and V.C. and of the effect on profit of
changes in volume or type of output.
Cost of a product : Only VCs are considered
: Product cost
FCs : Charged against the revenue of the period.
FC = Period costs
Valuation of inventory at M.C.
Contribution = C = S - V = F + P
Price = M.C. + Contribution

MARGINAL COST
Economists : The cost of producing
one additional unit of output is the
marginal cost of production.
Include an element of FC

Accountants : MC is equal to the

increase in total VC.

SEGREGATION OF SEMI-VARIABLE COSTS

Levels of output compared to levels of expenditure Method :
The variable element in semi- vc = Change in amt. of exp.
Change in activity/qnty.
High-low method (Range Method) : Similar to the previous
method

Methods of least squares

Y = a + bx, where
Y = Semi-VC, a = FC, b = VC, x = Production in units

ABSORPTION COSTING Vs. MARGINAL COSTING

1. Recovery of F.OH.
Abs. Costing : Both F. OH. and V. OH. are charged to
production
Mar. Costing : Only V. OH. is charged to production
and F.OH. transferred to P. & L. A/C.
2. Valuation of Closing Stock
Abs. Costing : WIP at works cost and F. goods at
cost of production.
Mar. Costing : WIP and F. Goods -- Only VCs are
considered.
3. Profit Vs. Opening and Closing Stock

UTILITY OF MARGINAL COSTING

Helps in determining the volume of
production.
Helps in selecting production lines.
Helps in deciding whether to shutdown or
continue.

MARGINAL COSTING Vs. ABSORPTION COSTING

The following information relates to ABC Company for the
year 2011-12:
Sales 10,000 units at Rs. 5 each;
Production 15,000 units at the following costs:
Rs.
Direct materials
15,000
Direct labour
30,000
Variable expenses
6,000
Fixed expenses
12,000
Determine net profit.

Income Statement for the year 2011-12

Sales

Cost of Production:
Direct materials
Direct labour
Variable overhead
Fixed overhead

Less Closing Stock

50,000

50,000

Marginal

Absorption

costing Rs.

Costing Rs.

15,000
30,000
6,000
_

51,000
17,000

15,000
30,000
6,000
12,000

63,000
21,000

Cost of goods sold

42,000
Contribution
(50,000- 34,000)

34,000
16,000

4,000
Net profit

Less Fixed Overhead

8,000

12,000

Valuation of closing stock:

Marginal costing = (5000/15,000) x 51,000
= Rs. 17,000
Absorption costing = (5000/15,000) x 63,000
= Rs. 21,000
Note: Difference in profit is due to the difference in
stock valuation.

CASE

From the following cost, production and sales data of AB Motors Ltd., prepare
comparative income statement for three years under
(i) Absorption costing method, and (ii) Marginal costing method.
Indicate the unit cost for each year under each method. Also evaluate closing
stocks. The company produces a single article for sale.
PARTICULARS
Selling price per unit
Variable Mfg. Cost per unit
Total fixed manufacturing cost
Opening stock
Units produced
Units sold
Closing stock

YEARS
2010
2011
Rs
Rs.
20
20
10
10
5000 5000
1000 1500
1000 1000
500

2012
Rs.
20
10
5000
500
2000
1500
1000

BREAK-EVEN ANALYSIS
Narrow Sense :
Determination of that level of activity where
total cost equals selling price.
Broad Sense :
The system of analysis which determines the
probable profit at any level of activity.
Refers to Cost-Volume-Profit Analysis

BEP - Represents a minimum acceptable

level of operation

- Level of activity : Income equals Expenditur

- No profit no loss point

C=S-V=F+P
At BEP,

P = 0;

Thus, C = F

Or, Units at BEP x Contribution per unit = F

Or, BEP(units) = F / Contribution per unit
BEP (sales) = (F / Cont. per unit) x S.P. per
unit
= (F/C) x S = F/c/s
= F / p/v ratio

Contribution Margin Ratio =

P/V ratio =
Contribution / Sales = C / S
= Change in Profit / Change
in
Sales
MOS = Total Sales BEP

BREAKEVEN ANALYSIS FOR

MULTIPLE PRODUCTS

A multi products Company has a sales ratio of 2: 3: 5

for models X, Y and Z respectively.
Total fixed cost for the year are Rs. 2,00,000.
The other information are as follows:
Model X
Sales Price
Rs. 50
Variable Costs
Rs. 30
Contribution Margin Rs. 20
WHAT IS ITS BEP ?

Model Y
Rs. 25
Rs. 15
Rs. 10

Model Z
Rs. 10
Rs. 8
Rs. 2

BREAKEVEN ANALYSIS FOR MULTIPLE PRODUCTS

A market basket approach is used to compute the
breakeven point in units.
The average market basket is based on the sales ratio and
consists of 10 units with a total contribution of
Rs. 80 = { (2 x Rs. 20) + (3 x Rs.10) + (5 x Rs.2) }
BEP in market baskets = FC / Contribution of one baskets
= Rs.200,000 / Rs.80 = 2,500 baskets.
To fill 2,500 baskets : The following units for each model.
Model X : 5000 units ( 2,500 x 2)
Model Y : 7500 units (2,500 x 3)
Model Z : 12500 units (2,500 x 5)

COST VOLUME PROFIT ANALYSIS

Examines the behaviour of total revenues, 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.
One of the decision models
One aspect of CVP Analysis : BEP Analysis
A useful technique for planning profits
(budgeting), pricing decisions, sales-mix
decisions and production capacity decisions.

CVP Analysis evaluates the effects of:

Price changes on Net Profit (NP)

Volume changes on NP
Price and volume changes on NP
Changes in VC on NP
Changes in FC on NP
All four factors, viz., price, volume,
VC and FC on NP.

Sensitivity Analysis & Uncertainty

A what-if technique
Analyze the sensitivity of their decisions to
changes in underlying assumptions.
Managers use this technique to examine How a result will change : If the original
predicted data are not achieved or
if an underlying assumption changes.

C-V-P ANALYSIS
INCOME TAX
I.T. : No effect on BEP
S VC FC = Op. Income
=Target Net Income / (1-T)
Desired Sales in Units = ?
Desired Sales in Rupees = ?

DO-ALL SOFTWARE
SP = Rs.2,000 per unit
VC = Rs.1,200 per unit
FC = Rs.20,000
The organisation anticipates selling 40 units.
1. Decision to Advertise
Proposed Advertisement = Rs.5,000
Effect : Increase in Sales by 10%
DECISION ?

2. Decision to reduce S.P.

Proposal : Reduce SP to Rs.1,750
Effect : Increase in Sales by 10 units
Purchase from Whole-seller
at Rs.1,150 per unit.
DECISION ?

RELEVANT COSTS & REVENUES

Expected future costs
Expected future revenues
Differ among the alternative courses of action
Insourcing or Outsourcing products or services.
Accepting or Rejecting special order.
Shutdown or Continue.
Qualitative & Quantitative Relevant Information

COST ALLOCATION / APPORTIONMENT

An inescapable problem in every organization.

How should the costs of service

departments be allocated among production
departments ?
How should the manufacturing overhead be
allocated to individual products in a multiproduct company ?
The answers are seldom clearly right
or clearly wrong.

PURPOSES OF COST ALLOCATION

To provide information for economic decision :
Pricing decisions; Make or buy decisions.
To motivate managers and employees :
To push high margin products or services
To justify costs or compute reimbursement :
Reimbursement for a consulting firm that is paid a
percentage of the cost savings
To measure incomes and assets for external
reporting :
- valuation of inventory

SURVEY OF COMPANY PRACTICE

Why allocate corporate and other support costs to

divisions and departments ?
U. S. A.
To remind profit-center managers that indirect costs exist and
that profit-center earnings must be adequate to cover those costs
To encourage use of central services.
To stimulate profit-center managers to control service costs
U. K.
To acknowledge that divisions would incur such costs if they
were not provided centrally.
To make division managers aware that central costs exist.
To stimulate divisional managers to put pressure on central
support managers to control costs.
To stimulate divisional managers to economize in usage of
central services.

CRITERIA FOR COST ALLOCATION

DECISION

CAUSE AND EFFECT:

Rent- Floor area occupied
BENEFITS RECEIVED:
FAIRNESS OR EQUITY:
Government contracting
ABILITY TO BEAR:
Corporate executives salaries on the
basis of divisional operating income.

COST POOL

POSSIBLE ALLOCATION BASE

Corporate executive
salaries :
Legal Department :
Marketing Department :
Payroll Department

Personnel Department :

Sales; Assets employed;

Operating income
Estimated time or usage;
Sales; Assets
Sales; No. of sales
personnel
No. of employees;
Payroll Rupees
No. of employees;
Payroll Rupees

ACCOUNTING AND CONTROL OF OH COSTS

Classification
Codification
Collection
Allocation and apportionment
to cost centers
Absorption in costs of products,
services etc.

WHY TO CLASSIFY?

Effective cost control :

Flexible Budgets

Absorption of cost

Decision Making :

CVP Analysis

CODIFICATION
Numeral method : Numbers
Mnemonic Method :
Symbols / Letters
Mixed

COLLECTION OF MANUFACTURING OHs

Material Issue Analysis Sheet / Material

Abstract
Wages Analysis Sheet
Cash Book
Subsidiary Records
Plant Register : Depreciation
Asset Register : Depreciation
Journal : Outstanding expenses

DISTRIBUTION OF OVERHEAD COSTS

Primary Distribution:
Departmentalization of overhead to
Production and service departments.
Secondary Distribution:
Re-distribution of service departments costs among
production departments.
Re-apportionment
Final Distribution: Absorption
Overhead costs of production departments are
distributed among the units produced.

CHALLENGE YOUR CURRENT

PRACTICES AND ENHANCE
YOUR HORIZON
IIMB

ACTIVITY BASED COSTING

REFINING A COSTING SYSTEM:

Intense competition
Advances in IT

WHY?

ABC system
Calculates the costs of individual
activities:
Assign costs to cost objects
such as products and services
On the basis of the activities
needed to produce each
product or service.

A SIMPLE COSTING SYSTEM:

A single indirect cost rate to
allocate cost to products
Weak cause-and-effect relationship

Cost Smoothing : Under-costing &

Over-costing
Product cost cross-subsidization

ABC : BENEFITS
Obtaining true product cost
Cost Management
Better decision making

PROCESS : ABC
Direct cost tracing
Indirect-cost pools
Cost-allocation bases

IMPLEMENTING ABC: Steps

Identify the Products : Cost Objects

Identify Direct Cost of the products
Select the Cost Allocation Bases : For allocating
indirect costs to the products
Identify the Indirect Costs : Associated with each
cost-allocation base.
Compute the Rate per unit of each cost- allocation
base : Used to allocate indirect costs to the products
Compute the Total Indirect Costs allocated to the
products
Compute the Total Costs of the products : Adding
all direct and indirect costs assigned to the product

PLASTIM CORPORATION
Manufactures lenses for the rear lamps
(tail lights) of automobiles
Contract with G Motors : To supply
CL5, a complex lens ($137 per lens)
S3, a simple lens ($63 per lens)
Operating at full capacity & incurs very low
marketing costs.
Minimal customer-service costs.
Business Environment : Very competitive with
respect to S3.

Process : Plastim Corporation

Design products and processes
Manufacturing operations
Shipping and distribution
G. Motors purchasing manager :
A new competitor offering to supply the S3 lens
at a price of $53.
Plastims management is worried.

Options for Plastim:

Lower

its selling price.

Give up G. Motors business.
Reduce cost.

Existing Costing System

60,000
S3
Total($)
Direct Material
Direct labour
Total Direct
Cost
Indirect cost
Allocated
Total Cost

Actual indirect
cost rate

1125,000
600,000
1725,000
1800,000
3525,000

15,000
CL5
Per Unit($)

Total($)

18.75
10.00

675,000
195,000

Per Unit($)
45.00
13.00

28.75

870,000

58.00

30.00
58.75

585,000
1455,000

39.00
97.00

Actual total cost in indirect cost pool

=

Actual total quantity of cost allocation base

= 2385,000 / 39750(Labour Hours)
= $60 per Labour hour
S3 : Uses 30,000 labour hours = $1800,000
CL5 : Uses 9,750 labour hours = $585,000

Possible Reasons :
Plastims technology and process
are inefficient in manufacturing
and distributing S3 lens.
Ineffective cost management.
Is costing system over-costing the
S3 lens ?

SEVEN ACTIVITIES OF PLASTIM

Design products and processes : $ 450,000

Set up of molding machines : $ 300,000
Manufacturing operations : $ 637,500
Cleaning and Maintenance : $ 270,000
Shipment set up : $ 81,000
Distribution : $ 391,500
Administration : $ 255,000

Guidelines for refining the costing system :

Direct Cost Tracing

To identify some costs or cost pools that can be reclassified
as direct costs instead of indirect costs (improves cost
accuracy)
Example: Cleaning and maintenance activity

Indirect Cost Pools

To create smaller cost pools linked to the different activities:
Plastim : Subdivides- One direct activity cost pool & Six
indirect activity cost pool

Cost Allocation Bases

A measure of activity performed serves as the cost
allocation base for each activity-cost pool

Activity Cost Rates for IndirectCost pools

Activity
Design

Total
Cost
$ 450,000

Setups of
Molding
Machines
Manufacturing
operations

$ 300,000

Shipment

$ 81,000

$ 637,500

Cost-allocation
Base
100 partssquare feet
2000
Setup-hours

OH allocation
Rate
$ 500 per partsquare foot
$ 150 per setuphour

12,750
Molding
machine hours
200

$ 50 per molding
machine-hour
$ 405 per

shipment
Setup
Distribution

$ 391,500

Administration

$ 255,000

67,500
Cubic feet
39,750
Direct manuf.
Labour hours

$ 5.80 per cubic

foot shipped
$ 6.4151 per
Direct manuf.
labour hour

Product Cost using ABC

S3(60000)
CL5(15,000)
Total($) Per unit($) Total($) Per unit

Direct Costs :
Direct Materials1125,000 18.75
675,000 45.00
Direct Labour 600,000
10.00 195,000 13.00
Direct Mold Cleaning120,000 2.00 150,000 10.00
Total Direct Costs1,845,000 30.75 1,020,000 68.00

Indirect Costs :
Design activity costs:
S3, 30 parts-sq.ft.*$4,500 135,000
CL5, 70 parts-sq.ft.*$4,500
Setup activity costs:
S3, 500 setup-hours*$150
75,000
CL5, 1,500 setuphours*$150
Manufacturing operations
Activity costs:
S3,9,000 moulding
Machine hours*$50
450,000
CL5,3,750 moulding
Machine hours* $50

2.25
315,000

21.0

225,000

15.00

1.25

7.50
187,500

12.50

Shipping setup activity:

S3, 100 shipments*$405 40,500
CL5, 100 shipments*$405
Distribution activity:
S3,45,000 cubic feet
Shipped*$5.80
261,000
CL5, 22,500 cubic
feet shipped*$5.80
Administration activity:
S3,30,000 dir. Manuf.
Labour-hours*$6.4151
192,453
CL5,9,750 Dir. Manu.
Labor-hours*$6.4151
Total indirect costs: 1,153,953

Total Costs

$ 2,998,953

0.67
40,500

2.70

4.35
130,500

8.70

3.21

19.23

$49.98

62,547
961,04

$1,981,047

4.17
64.07

$132.07

WHO SAID THESE WORDS ?

A managers job is to pursue the
interests of society.
Customer is the only valid reason for
the existence of a business.
Entrepreneurship and innovation are
not inborn characteristics.
Management is neither an art nor
a science, but a practice.

PETER F. DRUCKER
Father of Modern Management.
The most enduring Management Thinker of our
Time : Business Week
Born in Austria:1909; Died in Los Angeles:2005
Studied Law in Germany at Hamburg University
Received Ph.D. from Frankfurt University in
International Law.
Moved to London & Taught Economics.
Married Doris & Moved to America as a
Correspondent for several British Newspapers.
Professor of Management at New York University.

Without proper cost and

management accounting,
decision would be like
taking a jump in the dark.

COST ACCOUNTING SYSTEM

Determines per unit cost.
Helps management in planning and
controlling costs.
Provides information for decision making
Used to develop timely information about:
- Cost of producing specific products.
- Cost of performing specific functions / services.

CAS
Most widely used in manufacturing companies
Also used in services sector:
Banks
Accounting firms
IT sector
Govt. agencies

US congress has passed legislation requiring

hospitals to measure and report the average
unit cost of their product.

Why to find unit cost?

Basis for inventory valuation.

Measurement of cost of goods sold.
Useful in fixing selling prices.
Deciding : Products to manufacture.
Evaluating the efficiency of operations
Controlling costs.

DESIGNING COSTING SYSTEM

Cost-benefit Approach
Tailored to fit the operations/functions
Facilitate decision making
Costing System : Only one source of
information for Managers combine noncost information & non-financial
performance measures

BUILDING-BLOCK CONCEPTS
Cost Object
Direct Costs of a Cost Object
Indirect Costs of a Cost Object
Cost Tracing
Cost Allocation
Cost Pool & Cost Allocation Base

CAS
DELL COMPUTER
WIPRO
Will they have same CAS ?

Two basic types of CA system:

Two extremes of product costing :

JOB ORDER COST SYSTEM

PROCESS COST SYSTEM

JOB ORDER COST SYSTEM

Used by companies:
Producing one-of-a-kind products
Tailor products to the specifications
of individual customers

APPLICATIONS

Ship / Aircraft Building, Printing,

Defense Contractors, Hospitals,
Motion Picture Studios, Furniture Makers,
Accounting Firms, Advertising Industries,
Consultancy Firms, Construction Firms.

JOB
Represents the goods manufactured at
one time to fill a particular order
Unique Feature : Cost are accumulated
separately for each job.
JOB COST SHEET : JOB-COST RECORD
Heart of JOCS

JOB COSTING
A method of ascertaining cost.
Also known as Specific Order Costing .
Production : Always against customers orders
and not for stock.
Each Job : Different characteristics and needs special
treatment.
Each job undertaken : A cost unit or cost object.
A separate job cost sheet : To ascertain
profit or loss for each job .
No uniformity in the flow of production from one
department to another in respect of jobs.

GENERAL APPROACH TO J.C.

Identify the Job : Cost Object

Identify the Direct Costs of the Job
Select Cost-Allocation Bases
Identify the Indirect Costs
Compute the Rate per Unit of Base
Compute the Indirect Costs allocated
Compute Total Cost of the Job

ACTUAL COSTING Vs. NORMAL COSTING

Direct Cost : Actual Rates
Indirect Cost : Actual Rates

Actual Rates
Budgeted Rates

Both Methods Use :

Actual Quantities of Inputs for

Tracing Direct costs

Actual Quantities of Allocation Bases

for Allocating Indirect Costs
Some organizations use budgeted rates to assign
both direct costs & indirect costs, to jobs.

JOB COST SHEET

Job Number ---------- Product -------------Date Started ------------Date Completed -------------Number of units -----------DIRECT MATERIAL
Date Requisition Number Quantity Unit Price Cost
DIRECT LABOUR
Date Time Card Number
Hours
Rate
Cost
MANUFACTURING OVERHEAD
Date
Activity Base
Application Rate

Cost

COST SUMMARY
Cost Item
Total Cost Unit Cost
Total Direct Material used
Total Direct Labour
Manufacturing Overhead applied
Cost of Finished Goods manufactured
Job costing is a compromise between
actual costing and standard costing.

ACCOUNTING : Job Costing

ACCOUNTING FOR DIRECT MATERIALS

End of each week or month : Summary entry
WIP Inventory Rs. 50,000
Materials Inventory
Rs. 50,000
ACCOUNTING FOR DIRECT LABOUR
End of each month or week
WIP Inventory Rs.20,000
Direct labour
Rs. 20,000
ACCOUNTING FOR OH COSTS
End of each week or month:
WIP Inventory
Rs. 10,000
Manufacturing overhead
Rs. 10,000
ACCOUNTING FOR COMPLETED JOB
Finished goods Inventory
Rs. 80,000
WIP Inventory
Rs. 80,000
ABC Furniture (S. Drs.) Rs. 100,000
Sales
Rs 1,00,000
Cost of goods sold
Rs 80,000
Finished goods Inventory
Rs. 80,000

CONTRACT COSTING
One type of specific order costing
Used in civil engineering works
Each contract : Separate accounts for each
contract

AS 7 : Construction Contracts
Fixed Price Contracts
Cost Plus Contracts

COSTS
Materials
Labour
Direct Expenses
Indirect Expenses
Plant and machinery :
Depreciation

WIP : Presented in the Balance Sheet

Balance Sheet as at..

Assets
Amount
Work in progress :

Value of work certified

Cost of work uncertified
Less Reserve for unrealized profit
Less Amount Received from contractee

Profit on Incomplete Contracts:

Work Completed : Less than 1/4th :

Work Certified : More than 1/4th but less than half :

Profit = 1/3 x Notional Profit x (Cash Received / Work
Certified)

Work Certified : Half or more than half :

Profit = 2/3 x Notional Profit x (Cash Received / Work
Certified)

Contract is almost complete :

Profit = Estimated Profit x (Work Certified / Contract Price)
or, Estimated Profit x (Cash Received / Contract Price)

No profit

PHARMACEUTICAL INDUSTRY

Multi-Products
Production in batches
Identical products in a batch
Use Process Costing

PROCESS COSTING
A method of costing
Costing of process : Converting raw
materials into finished products.
Find Out : Cost of operating each
process.

APPLICATIONS
Manufacturing Industries : Iron and
Steel, Cement, Textiles, Soap
Making, Biscuits, Food Products
Mining Industries : Oil, Coal
Chemical Industries : Drugs & Medicines
Public Utility Services : Electricity, Water
Supply

CHARACTERISTICS : Process Costing

Production : Continuous
Products : Processed in one or more processes.
Products: Homogeneous, Identical and Standardized.
The Finished Product of one process : Raw Material of
the next process.
Costs : Collected process-wise.
Unavoidable wastage : Generally arises at different
stages.
Different products with or without by-products :
Simultaneously produced.

JOB COSTING VS. PROCESS COSTING

Job costing: Production is by specific orders.

Process costing: Products are homogeneous.
Costs are determined by jobs or batches.
Costs are complied on time basis.
Each job is separate and independent.
Products lose their identity : continuous flow.
There may or may not be any WIP.
There is WIP as production is continuous.

There is normally no transfers from one job to another.

Products move from one process to another.

Control is difficult. More managerial attention is required.

Proper control is comparatively easier.

Unit cost of a job is calculated.

Unit cost of a process is calculated.

AUSTRALIA : COSTING SYSTEM

Textiles
%

Chemicals Refining
%
%

Printing
%

Process

91

75

100

20

Job

18

25

25

73

Other

12

13

Normal Loss
Inherent in the processing operation; Unavoidable.
Cost of Normal Loss : Absorbed by good units
produced.

Abnormal Loss
Caused by unexpected or abnormal conditions viz.,
carelessness, accident, bad plant design
Value of Abnormal Loss
=( Normal cost of Normal output / Normal output) x
Units of Abnormal Loss

Abnormal Gain
Actual Loss < Expected
Calculation : Similar to Abnormal Loss.

Joint Products or Co-products

Represent two or more products,
Separated in the course of the same processing
operation,
Usually requiring further processing.
Example : Oil Industry : Gasoline, Fuel Oil,
Lubricants, Kerosene.

By- product
Recovered from materials discarded in a main process
or from the production of some major products.

WHY ALLOCATE JOINT COSTS?

Computation of cost of goods sold,
Cost reimbursement under contracts,
Insurance-settlement computations.

APPROACHES FOR ALLOCATING

JOINT COSTS

Using market based data : Revenue

Using physical measures : Weight

INTER PROCESS PROFIT

Out put of one process is transferred to a
subsequent process at a price.
WHY ?
To show cost of production in relation to
the market price.
To make each process stand on its own
efficiency and economies.
To induce competition amongst different
processes : Leads to cost
control.

BALANCE SHEET: ADJUSTMENTS

Adjust : The closing balance of inventories
as it includes unearned profit.
Create : A provision to reduce the stock to
actual cost price.

EQUIVALENT FULL UNITS OR

EQUIVALENT PRODUCTION
EP : Production of a process in terms of
completed units
WIP : Creates problem to find out cost per unit.
To overcome this problem : Express the
partially completed units in equivalent
full units of completed product.
Material Cost per unit = Total cost of direct
materials used / Equivalent full units produced

Work done by a Manufacturing Department :

Completing opening WIP units.

Working on units started and
completed.
Working on closing WIP units.

STATEMENT OF EQUIVALENT PRODUCTION

Units

Opening WIP :
(60% completed in June)
Unit s started &
Completed :
Total units completed :

Portion
completed
in July

Equivalent
full
units

5,000

40%

2,000

37,000
42,000

100%

37,000

25%

1,000

Closing WIP :
(25% completed)
Total Equivalent Units :

4,000 `

40,000

STATEMENT OF EQUIVALENT PRODUCTION

Estimate : The percentage of completion of opening WIP

State : Opening WIP in equivalent completed units
( Apply the % work required to complete)
Units completed during the period :
Units representing opening WIP
Units introduced and completed
Closing WIP : State in equivalent completed units
(apply the % work done)
Normal Loss : Not taken for calculation of EP
Abnormal Loss & Abnormal Gain : Treated like units
finished and transferred to next process.

HMT
Five Divisions :

Machine Tools;
Tractors;
Industrial Machinery;
Engineering and Components;
Consumer Products .

SEGMENT PERFORMANCE ANALYSIS

AS- 17 : SEGMENT
Business Segment
Geographical Segment

Segment :
A distinguishable component of an organization:
Engaged in providing products and services
Subject to risks and returns that different from
other segments.

SEGMENT / DIVISION
A sub-unit
Headed by a man fully responsible
for its operation.
A Responsibility Center
A Decision Unit

WHY DIVISIONALIZATION?

Decentralization
Measurement & evaluation of
performance
Training ground for top mgt. personnel
Planning and allocation of resources.
Controlling operations

RESPONSIBILITY ACCOUNTING
--A Control Device
R. A. collects and reports
planned and actual accounting
information about the input and
output of responsibility centers.

Process of R.A.

Identify : Responsibility Centers (Decision

Units).
Define : Extent of Responsibility for each R.C.
Specify : Controllable and Uncontrollable
Activities at Various Levels of Responsibility.
Accounting system: To Accumulate Information
of R. C.

Prepare : Performance Reports.

Why responsibility Centers?

Defines the corporate objectives and goals of R.C.

Determines the contribution of a R. C.
Provides a basis for evaluation.
Motivates the managers.
Provides a system of closer control.
Helps Management by exception.
Facilitates decentralization.
Sets realistic plans and budgets for R.C..
Creates a sense of cost consciousness.

Requirements of effective R. A.

A sound organization structure.

Dividing the organization into RCs.
Accurate and acceptable budgets.
Top management support.
Healthy organizational environment

COST CENTRE
Manager : Accountable only for costs incurred.
Output of cost center : Not measured in monetary
terms.
Evaluation : Actual cost vs. Budgeted cost
Employed in : Legal Dept, Accounting Dept, Public
Relation Dept, HR Dept.

REVENUE CENTRE
Manager : Accountable for revenues only.
Evaluation : Actual Revenue Vs. Budgeted Revenue
Employed in : Sales Dept., Product Centre.

PROFIT CENTRE
Manager : Held responsible for both costs (inputs) and
revenues (outputs), i.e., profits
Inputs & outputs :Capable of financial measurement.
Measures effectiveness and efficiency and motivates
managers.
Employed in: Production Dept., production centers.

INVESTMENT CENTRE
Manager : Responsible for costs, revenues &
investment in assets used.
Evaluation : By profit and ROI
A measure of overall performance, and facilitates
comparison.

RESPONSIBILITY & CONTROLLABILITY

Controllability : Degree of influence that a
specific manager has over costs, revenues, &
related items for which he or she is responsible.
Manager should avoid over-emphasizing
controllability & fixing blames.
R.A. is more far-reaching : Emphasis on
human aspects
R.A. focuses on information, knowledge &
behaviour, not on control.

ASSIGNING REVENUE & COSTS

TO SEGMENTS

REVENUE :

Assigning revenue : Electronic Cash Register

COSTS : Two Approaches

Classify costs : Fixed & Variable
Contribution Margin Approach
Charge each segment :
Traceable V.C. & Traceable F.C.
Absorption Costing Approach

MEASUREMENT OF PERFORMANCE

ROI Approach : Popular Approach

Accounting Rate of Return
Pioneer : Du Pont Co.
Return on Sales x Investment
Turnover

RI Approach :

Pioneer : General Electric Co.

RI = Income Minimum Return
on Investment

EVA : A specific type of RI

= After-tax operating income
Weighted average cost of capital
(Total Assets Current Liability)

Return on Sales

Income to Revenue (or Sales) Ratio

A component of ROI
COMPARING PERFORMANCE MEASURES :
ROI
RI
EVA
ROS

DESIGNING ACCOUNTING-BASED
PERFORMANCE MEASURE(PM)
Choose PM that align with Top Mgt.s
Financial Goals.
Choose the Time Horizon of each PM
Choose Definition of components in each PM
Choose a Measurement Alternative for each
PM
Choose a Target Level Performance
Choose the Timing of Feedback.

FINANCIAL PERFORMANCE
MEASURES A Survey

COMPANY
COUNTRY
Ford Motors US
Guinness
UK
Krones
Germany
Mayne Nickless Australia
Mitsui
Japan
Pirelli
Italy
Swedish Match Sweden

PM
Income, ROS, ROI
Income, RI, EVA
Revenues, Income
ROI, ROS
Revenues, Income
Income, Cash-flow
ROI

SIX SIGMA
Pioneer: Motorola
A Management Philosophy
Setting extremely high objectives
Collecting data
Analysing results
Reduce defects in products &
services

STANDARD COSTING AND

VARIANCE ANALYSIS
Objective : Cost Control
Accounting system :
Historical Costing
Standard Costing

Standard
A measure of desired
performance.
A predetermined
criterion for evaluating
the actual performance

WHY STANDARDS ?

Cost Control
Pricing Decision
Performance Appraisal
Cost Awareness

Management by Objective

TYPES OF STANDARDS
Ideal standards
Expected standards
Current standards
Basic standards

PROCESS OF DEVELOPING
STANDARDS

Varies from company to company :

The standard committee
Technical input
Past experience
Other inputs
Coordination

Standard Costing
A control device
Not a separate method of product costing
Used with any method of product costing :
Job or Process Costing
Generally used in manufacturing concerns

Standard Costing involves :

Ascertainment of standard cost
Measurement of actual cost
Comparison
Analysis of variance and taking
appropriate action where desired

VARIANCES
Favourable Variance &
Unfavourable Variance
Controllable Variance &
Uncontrollable Variance

Variances:
Sales Variances
Cost Variances
Cost Variances:
Direct material cost variances
Direct labour cost variances
Overhead cost variances

DIRECT MATERIAL COST VARIANCES

1. Material Cost variance = Standard cost for actual output Actual cost of material used
= Qs. Ps Qa. Pa
2. Mat. Price var. = Qa (Ps Pa)
3. Mat. Quantity var. = Ps (Qs Qa) = Usage Variance
= Efficiency Variance
4. Mat. Mix var. = Ps (Smqa Qa) = Standard Price (Revised
standard mix Actual mix)
5. Mat. Yield var. = Ps (Qs Smqa) = Sub-usage variance
= (Actual yield Standard yield) x Standard
cost per unit of output

1 = 2 + 3, 3 = 4 + 5
Note : Qs = Standard Quantity;
Qa = Actual Quantity;
Ps = Standard Price;
Pa = Actual Price;
Smqa = Standard Mix in Actual Quantity.

DIRECT LABOUR COST VARIANCE

1. Labour Cost var. = Standard cost of labour for actual
output Actual cost of labour
= Hs.Rs Ha.Ra
2. Labour Rate of Pay var. = Ha (Rs Ra)
3. Labour Efficiency var.= Rs (Hs Ha)
4. L. Mix or Gang Composition var.= Rs (Smha Ha)
5. L. Net Efficiency var. = Rs (Hs Smha)
6. Idle Time var.= No. of Hours Lost (Abnormal) x Rs

1 = 2 + 3,

3=4+5+6

Note : Ha = Actual hours worked

VARIABLE OVERHEAD VARIANCES

Variable Overhead Cost Variance
= St. V. OH Ac. V. OH
= AO . SRO AO . ARO
= SH . SVRH AH . AVRH
Variable Overhead Spending Variance
= AH(SVRH AVRH)
Variable OH Efficiency Variance
= SVRH(SH AH)

FIXED OVERHEAD VARIANCES

Fixed Overhead Cost Variance
= Standard Cost Actual Cost
= AO . SRO AO . ARO
= SH . SFRH AH . AFRH

Fixed Overhead Expenditure Var.

= Budgeted Cost Actual Cost
= BO . SRO AO . ARO
= BH.SFRH - AH.AFRH

Fixed Overhead Volume Variance

= Standard Cost Budgeted Cost
= AO . SRO BO . SRO = SRO (AO BO)
=SFRH (SH BH)

SALES VARIANCES
Sales Value Var. = Actual Value of Sales
Budgeted Value of Sales
Sales Price Var. = Act. Quantity sold
(AP SP)
Sales Volume Var. = SP(AQ BQ)
Sales Mix Var. = SP(AQ- Smqa)

POSSIBLE CAUSES OF COST VARIANCES

Mat. Price Var. : Changes in actual price, Failure to

purchase anticipated quantity, Not taking
cash discounts, Changes in freight cost
Mat. Quantity Var. : Poor material handling, Inefficient
machine operator, Pilferage, Waste,
Labour Turnover.
Lab. Efficiency Var. : Defective machine and equipment,
Poor supervision, Inexperienced employee,
Insufficient training, Poor working condition
OH Volume Var. : Failure to use normal capacity, Lack of
sales order, Machine break down, Defective
materials, Labour troubles, Power failure
OH Expenditure/Efficiency Var. = Same cause as Labour
Efficiency Variance.

RESPONSIBILITY FOR COST VARIANCES

Variance
Mat. Price Variance :

Persons Responsible
Purchase Agent or
Purchase Manager
Mat. Quantity Variance :
Plant Supt. , Dept. Supervisors,
Machine Operators, Quality
Control Dept.
Labour Rate of Pay Variance : Personnel Manager, Dept.
Supervisors, Plant Superintendent
Labour Efficiency Variance : Plant Superintendent
OH Expenditure Variance : Variable portion : Foremen or
Supervisor; Fixed portion: Top Mgt.
OH Volume Variance :
Top Mgt.

Few businesses plan to fail,

but many of those that flop,
failed to plan.

BUDGETARY CONTROL
BUDGETS AND PERFORMANCE REPORTS
MANAGER
Managers plan &
act using budgets

Feedback

PERFORMANCE
OPERATING PROCESS
Managers evaluate using
a report that compares
actual results with budgets

STRATEGY AND PLANS

LONG-RUN PLANNING
LONG-RUN BUDGETS
STRATEGY
SHORT-RUN PLANNING
SHORT-RUN BUDGETS

Budget

A financial and / or quantitative statement

prepared and approved prior to a
defined period of time , of the
policy to be pursued during that period for the
purpose of attaining a given objective.
Planning for the future activities
Survey of past events, present
happenings and the future things.

BUDGET Vs. STANDARD

Standard : A carefully determined price,
cost or quantity
Budget : A broader term
Budgeted Costs : Need not be based on
standard
Standard = Budget : When standards are
used to obtain budgeted inputs or outputs

Features of a budget:
Comprehensive and coordinated
plan of action based on the
objectives of the organization.
Plan for the operations and
resources
For a specified future period

Budgetary Control System:WHY?

A tool for strategic planning & control
Ensures economy in workings
Promotes co-ordination &
communication among subunits
Management by exception
Optimum utilization of resources
Continuous review of performance
Motivates managers & employees

BUDGETING PROCEDURE
Varies widely from company to company.

Common steps:
Obtaining estimates from each sub-unit
or division or department.
Co-coordinating estimates.
Communicating the budget to
responsible managers.
Implementing the budget plan.
Reporting interim progress: Performance
Report

Pre-requisite for Introduction of

Budgetary Control

BUDGET CENTRE
ORGANISATION CHART
BUDGET COMMITTEE
BUDGET MANUAL
BUDGET PERIOD
PRINCIPAL BUDGET FACTOR

FIXED BUDGET vs. FLEXIBLE BUDGETS

FIXED BUDGET
Remain unchanged irrespective of level of activity obtained.
Prepared for a particular level of activity
Acts as a target for the forthcoming period
Not adjusted with actual activity
FLEXIBLE BUDGETS
Designed to change in relation to the level of activity attained
Prepared for a range of activities
Recognizes the behavior of costs: fixed ~ semi-fixed ~ variable
Facilitates performance measurement and control

BEHAVIOURAL DIMENTIONS OF BUDGETING

Implications of Participative Budgeting

Excessive Pressure Created by Budget
Budgetary Slack (Cushion)
Top Management Support
Inter-Departmental Conflict

OPERATING AND FUNCTIONAL BUDGETS

Sales Budget
Production Budget
Production Cost Budget

Direct Materials Budget

Direct Labour Budget
Factory Overhead Budget

Cost of Goods Sold Budget

Selling Expense Budget
Administrative Expense Budget
Budgeted Income Statement

FINANCIAL BUDGETS

Capital Expenditure Budget

R & D Budget
Cash Budget
Budgeted Balance Sheet

NON-FINANCIAL BUDGETS
- Space, Equipments, Workers

MASTER BUDGET
A comprehensive budget:
A Tool for coordinating all budgets.
Summarizes : Planned activities of all
subunits of an organization.
Incorporates:
Summary of all functional budgets.

MASTER BUDGET
Normally comprises :
Budgeted P.& L. A/C ;
Budgeted Balance Sheet;
Budgeted Cash Flow Statement.
Reveals: Top management goals of
incomes, expenditure, cash
flows and financial position.

ELEMENTS OF MASTER BUDGET

Sales Forecast
Production Schedule
Manufacturing Cost Budget
Operating Expense Budget
Capital Expenditure Budget

Budgeted Income Statement

Budgeted Balance Sheet
Cash Budget

BUDGET PRACTICES: Master Budget

U.S. : 91%

U.K. : 100%
Japan : 93%
Holland : 100%
Australia : 100%

BUDGET GOALS :
U.S. : ROI
Japan : Sales

What reduces effectiveness of Budgeting?

SURVEY OF CFOs IN THE U.S. :
Lack of well-defined strategy
Linkage of strategy to operational goals
Lack of individual accountability for
results.
Lack of meaningful performance
measures
SAIL Vs. TATA STEEL

ROLLING BUDGET

A Continuous Budget
A Plan : Always available for a
specified future period
Adding a period in the future as the
period just ended is dropped
ELECTROLUX :
A four-quarter rolling budget

KAIZEN BUDGETING

Kaizen : Continuous Improvement

Continuous Improvement Goals
Incorporates continuous
improvement during the budget
period into the budget numbers
JAPANESE COMPANIES
Citizen Watch Co.

ACTIVITY-BASED BUDGETING

Incorporating Activity-based
Cost Drivers into Budgets
Focuses on the Budgeted
Cost of Activities
Budget for each Activity

ZERO BASE BUDGETING

A method of budgeting
All Activities : Evaluated
Every item of expenditure :
Fully Justified
Involves starting from scratch or zero

ZBB & GOVT.

STEPS OF ZBB
Identify each separate activity :
A decision package
Evaluate : Each decision package
Consider : Alternatives for each
decision package.
Rank : Decision packages - priority for
resource allocation.
Allocate :Resources to the packages .

Budgeting is the common

accounting tool companies use for
planning and controlling what
they must do to satisfy their
customers and succeed in the
market place.