Cost and Management Accounting

II Sem MBA Faculty : Dr Roshna Varghese E-mail : roshnavarghese@gmail.com

Syllabus

Cost and Management Accounting Outline

Syllabus Modules
Module 1 - Introduction Module 2 - Methods and Techniques of Costing Module 3 - Pricing Policies Module 4 Cost control & reduction methods Module 5 Cost audit

Internal Assessment Policy

(1)Marks for Tests
One Mid Sem Exam (2 hours) End semester exam (3 hours) : 6 marks : 9 marks

15 marks

(2) Assignments, Seminars and Discussions

(3) Class Participation

..15 marks .10 marks

Attendance : 5 marks Class Interaction : 5 marks

Max. marks ---------------------------------------- 40

Reference Books
Maheshwari, S.N. (2003). Principles of Cost and Management Accounting. (2nd ed). New Delhi : Sulthan Chand & Sons. Tulsian, P.C. (2008). Cost Accounting. (1st ed.). New Delhi : Sulthan Chand & Sons Jain, S.P. & Narang, K.L. (2008). Cost and Management Accounting (10th ed.). New Delhi Sikka, T.R. (2003). Fundamentals of cost accounting. (1st ed.). New Delhi : Viva Books.

Module 1
Introduction to Cost and Management Accounting

Module 1
Basic concepts
Concept of cost centers profit centers and investment centers Cost units Classification of costs Cost analysis for management decision making

Cost and management accounting is it important?

All businesses are concerned with costs
Automobiles, fast food or cement industry

Managers use cost accounting information to make decisions

Strategy formulation, R&D, budgeting, production planning, pricing

Source : Horngren., Datar., Foster., Rajan and Ittner (2009) Cost Accounting. (13th ed). New Delhi : Prentice Hall of India. pp. 2-3

Cost and Management Accounting

Cost Accounting Management Accounting

Accounting classification
o Financial Accounting
The branch of accounting that develops information for external decision makers such as shareholders, suppliers, banks, and government regulatory agencies.

o Management Accounting
The branch of accounting that produces information for managers within an organisation

Cost accounting supports management accounting and financial accounting

Source : Horngren, Sundem and Stratton. (2006). Introduction to Management Accounting, 13th ed., New Delhi : Prentice Hall of India, p.5.

Users of Accounting Information

Management Accounting Financial Accounting
External Users

Internal managers
Investors: Stockholders Day-toDay-to-day operating decisions LongLong-range strategic decisions Creditors: Suppliers Bankers Government Authorities

Management accounting and financial accounting

Point of comparison 1. Objectives 2. Analysing performance 3. Data used 4. Monetary management 5. Periodicity of reporting 6. Precision 7. Nature 8.Legal Compulsion Financial Accounting Management Accounting External reporting process Internal reporting process Overall business performance Post mortem analysis of past activity Interested only in monetary events Long period 1 year/6 months/3 months Emphasis on precision Based on measurement, more objective Compulsory due to legal provisions Performance of various divisions/departments/product Supplies data for present and future Interested in non monetary economic events Short time periods Less emphasis on precision Based on judgment, more subjective No legal compulsion

Source : S.N. Maheshwari & S.K. Maheshwari . (2004). Advanced Accountancy, Vol II, 9th ed. New Delhi : Vikas Publishing House Pvt Ltd, p.3.8

Cost accounting & Management accounting

Cost accounting
Formal mechanism by which costs of products or services are ascertained and controlled.

Management Accounting
Accounting and reporting of information to management
To assist management in efficient decision making, planning and control Detailed operations of the company Blending of financial accounting and cost accounting
Source : B.K. Bhavar. (2008). Cost accounting : Methods and problems. 17th ed., Kolkata : academic Publishers, p.1.2 M A Sahaf. (2000). Management Accounting, New Delhi : Vikas Publishing House, pp.3-4

Management Accounting and cost accounting

Point of comparison Cost Accounting Management Accounting To provide information to management for planning and coordinating business activities Deals with projections and plans on the basis of past and present cost data No principles and procedures. Information is prepared and presented as per the requirement of the management Both quantitative and qualitative information Information useful only to the management To determine and record the 1. Objective cost of producing a product or providing a service 2. Nature Based on past and present facts and information Certain principles and procedures are followed in Cost accounting Quantitative information Information useful to both internal as well as external parties

3. Principles

4. Data used 5. Interested Groups

H. V. Jhamp. (2008). Management Accounting. New Delhi : Ane Books India, pp.5-6

Costs and Types of costs

Meaning of Cost
Measurement, in monetary terms, of the amount of resources used for the purpose of production of goods or rendering services ICWA, India

Costs
Anything incurred during the production of the goods or service to get the output into the hands of the customer. The customer could be the public (the final consumer) or another business Controlling costs is essential to business success
Not always easy to pin down where costs are arising!

Cost vs Expenses vs Loss

Cost
o Amount of expenditure actual (incurred) or notional (attributable) relating to a specific thing or activity
Can be product, job, service, process etc

Expenses
Expired costs, incurred and totally used up in generation of revenue

Loss
Lost cost e.g. loss due to theft, fire etc.

Classification of cost
Based on elements
Material, labour, expenses

Based on cost behaviour

Fixed, variable, semi variable cost

Based on function
Production, marketing cost, Administration

Elements of cost - material

o Material
o o The substance from which product is made Direct material cost
o o Materials which becomes integral part of the finished product and can be assigned to specific physical units. E.g. Timber in furniture; cloth in shirt

Indirect material cost

o o Material which can not be conveniently assigned to the specific physical units E.g. Oil, printing & stationery; consumable stores;

Elements of cost- Labour

o Labour
o o One of the conversion costs- human effort Direct Labour cost
o o Labour, which can be specifically and conveniently traceable to specific products. E.g. carpenter s work in furniture

Indirect Labour cost

o o Labour employed to carry out tasks incidental to goods/services; can not be traced to specific units of output. E.g. wages of store keeper, foremen; salaries of salesmen

Elements of cost- Expenses

o Expenses
o o Any other cost besides material and labour. Direct Expenses
o o Expenses, which can be wholly and conveniently traceable to specific cost centres or units E.g. Excise duty; Royalty; hiring charges of machinery;

Indirect Expenses
o o Expenses, which can not be directly, wholly and conveniently allotted to specific cost centres or units E.g. rent, rates, insurance, etc

Overhead
Overhead
Includes indirect material, indirect labour and indirect expenses All indirect costs are overheads Types
Factory OH indirect material/labour/expenses
E.g. lubricants, gate-keeper s salary, factory rent, insurance

Office & Admn OH

indirect material/labour/expenses

Printing & stationery, salary of accountant, office rent , insurance

Selling & Distbn OH

indirect material/labour/expenses

Special packing material*, salesmen s salary, advtsg expenses

* Packing material can be a part of direct material

Cost Sheet
Direct Material+ Direct Labour + Direct expenses Prime Cost Add Factory Overheads Works cost Add Office Overheads Cost of Production Add Selling & Distribution Overheads Total cost Add Profit Selling Price Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx xxxx

Types of Costs based on cost behaviour

Classification depends on behaviour of costs as the level (volume) of a particular product or service (cost driver) changes

1. Fixed Cost 2. Variable Cost 3. Semi-variable cost (mixed cost)

Source : Horngren, Sundem and Stratton. (2006). Introduction to Management Accounting, 13th ed., New Delhi : prentice Hall of India, p.46.

Variable cost
Cost that changes in direct proportion to changes in volume/activity
These costs vary in proportion to output. E.g. material cost, labour cost, expenses (direct and indirect)

Variable cost per unit remains constant

Total Variable Cost

Total variable costs change when activity changes. Variable costs per unit do not change as activity increases.
Variable costs

Number of units produced

Fixed Costs
The cost that tends to be unaffected by fluctuations in level of activity
E.g. Rent of factory building; interest on capital; salary of sales manager

Fixed cost does not change in total, but per unit fixed cost reduces as volume increases.

Total Fixed Cost

Total fixed costs remain unchanged when activity changes.
Monthly rent of factory building does not change when the company produces more units of product
Number of units produced Monthly rent on factory building

Semi-variable (Mixed) Costs

Contain fixed portion that is incurred even when facility is unused & variable portion that increases with usage. Example: monthly electric utility charge
Fixed service fee Variable charge per kilowatt hour used

Semi-variable (Mixed) Costs

Total Utility Cost

Variable Utility Charge Fixed Monthly Utility Charge Activity (Kilowatt Hours)

Other Classifications
By controllability
Controllable costs/uncontrollable costs

By Normality
Normal costs/abnormal costs

Cost, profit and investment Centres

Companies may choose to classify business units as
Cost centres Profit centers, or Investment centres

Cost centre
A location, person, or item of equipment (or a group of these) for which costs may be ascertained and used for the purposes of cost control. For example research and development department, production/HR/ IT/accounting department An organisation segment or area of activity Types
Personal/ Impersonal cost centre Operation/Process cost centre

Profit centre
Peter Drucker originally coined the term profit center around 1945 Profit center is a section of a company treated as a separate business. Thus profit or loss for profit center are calculated separately. Business organizations may be organized in terms of profit centers where
the profit center's revenues and expenses are held separate from the main company's in order to determine their profitability

Profit centre
Section of a company treated as a separate business A large corporation with diversified interests in paper manufacturing, trucking, and fast food may regard each of these three businesses as a profit center. Examples of typical profit centers are a store, a sales organization and a consulting organization whose profitability can be measured.

Investment centre
Investment centres are profit centres that are accountable for cost, revenues and net assets for capital investment. This unit is assessed by return on investment and is a cost centre. Managers in an investment centre are responsible for purchasing capital or non-current assets and making investment decisions with capital.

Cost Sheet
Total Per unit

Direct Material+ Direct Labour + Direct expenses Prime Cost Add Factory Overheads Works cost Add Office Overheads Cost of Production Add Selling & Distribution Overheads Total cost (Cost of sales) Add Profit Selling Price

Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx xxxx

Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx xxxx

Cost Sheet
Total Direct Material consumed: Raw material purchases Add opening stock of raw materials Less closing stock of raw materials Direct Labour + Direct expenses Prime Cost Add Factory Overheads Add opening WIP Less closing WIP Works cost Add Office Overheads Cost of Production Add opening stock of finished goods Less closing stock of finished goods Cost of goods sold Add Selling & Distribution Overheads Total cost (Cost of Sales) Add Profit Sales Xxxx Per unit Xxxx

Xxxx Xxxx Xxxx Xxxx

Xxxx Xxxx Xxxx xxxx

Xxxx Xxxx Xxxx

Xxxx Xxxx Xxxx

Xxxx Xxxx Xxxx Xxxx xxxx

Xxxx Xxxx Xxxx xxxx Xxxxx

Profit on sales or cost

If profit is 1/3rd of cost then,
Then on sales profit will be 1/4th

If 1/4th on cost, then 1/5th on sales if 1/5th on cost, then 1/6th on sales It can be the other way around
If 1/4th on sales, hen 1/3rd on cost If 1/5th on sales, then 1/4th on cost

Exercises
Sikka, p.34 Tulsian, illustration 9, p.1.44 Tulsian, illustration 10, p. 1.45

Certain adjustments
Adjustment for Raw material stocks
Direct Material means cost of direct materials consumed
DM Op. Stock + Purchases CL. Stock

Cost of goods sold = COP + Op stock of fin. goods -- clos. stock of finished goods

Cost of Sales = COGS +Selling and distribution OH

Certain adjustments
Adjustment for scrap
Sale of scrap deduct from works OH or works Cost If material found to be defective before using and therefore sold, value of material used should be reduced by cost of such materials & loss on sale be charged to costing P&L account

Methods of costing
Job costing
Job is carried out against specific order and customer specifications Not repetitive
E.g. engineering works; printing press; repair shops

Contract costing
Separate contracts of non repetitive nature A contract is a big job (while job costing is small)
E.g. Ship-building business., construction industries

Batch costing
Part of job costing Production is carried on in batches
E.g. Pharma industry, toy making, canned foods, ready made garments

Methods of costing
Process costing
Where a product passes through different stages, each distinct and well-defined
E.g. paper industry, chemical industries, sugar industries

Single (unit costing)

Where products can be expressed in identical units Method of process costing
E.g. Brick making; cement industry ; steel industry

Service (operating) costing

Orgns which render services
Transport industry(road, railway, airline); hotels; hospitals; electricty

Methods of costing
Operation costing
Refinement of process costing - consists of operations instead of process Cost of each operation are ascertained Operation costing is a hybrid costing system applied to batches of similar products Each batch is often a variation on a single design and proceeds through a sequence of selected activities or operations
E.g. bicycle manufacturing;

Multiple or Composite costing

Involves application of two or more methods of costing Where nature of product is complex
Motor cars, aero planes, air conditioners, refrigerators

Types or Techniques of Costing

Historical costing
Costs are determined after they have been incurred

Marginal costing
Charges only variable production costs to products or jobs Fixed production, administration, selling & distribution are written off against profits

Absorption or Full costing

All manufacturing expenses fixed and variable, are charged o products or jobs Selling and distribution against profit

Types or Techniques of Costing

Direct costing
Practice of charging all direct costs to products or jobs All indirect costs are written off against profit

Standard costing
Fixation of standards for each element of cost Comparison factual with the standard Analysis of variance

Uniform costing
Practice of using same costing principles by a number of firms in the same industry. Helps in inter-firm comparison, price fixation and cost control

Cost unit
A unit of quantity of product, service or time (or a combination of these), in relation to which cost may be ascertained or expressed.
Job costing a specific order Batch costing one batch Contract costing single product (contract)

Method of costing and cost unit

Industry Building Chemical Cement Automobile Steel Transport Sugar Method of costing Job costing Process costing Process costing Process costing Process costing Operating costing Process costing Cost unit House/square foot of area Tonne/pound/Kg Tonne Number Tonne Passenger KM Tonne/Kg

Source: Jawahar Lal & Seema Srivastava. (2009). Cost Accounting. (4th ed.) New Delhi : Tata McGraw-Hill. p.21.

Cost analysis for managerial decision making

Marginal cost
Increase in total cost resulting from increase in output by one unit Total variable costs

Differential costs
Difference in total costs between two alternatives Incremental costs or decremental costs

Sunk costs
Costs which have already been incurred and cant be altered by any decision in the future
Source : Jain, S.P., Narang, K.L. and Agrawal, Simi.(2007). Advanced Cost Accounting (11th ed.). New Delhi, pp.III 8-10.

Cost analysis for managerial decision making

Replacement cost
Cost of replacement of an asset at current market price

Imputed (notional) cost

Costs which do not involve any cash outflow. Rent of owned building

Out of pocket cost

Costs which involve cash outflow Wages of workers, purchase of materials,..

Cost analysis for managerial decision making

Opportunity costs
Value of sacrifice made in accepting an alternative course of action E.g.

Relevant and irrelevant costs

Relevant costs- Those costs which would be changed by the managerial decision Irrelevant costs- Those costs which would not be affected by the managerial decision