Costing Principles

Cost and management accounting

 Provides management with costs for products, inventories, operations or functions and compares actual to predetermined data  It also provides a variety of data for many day-to-day decision as well as essential information for long-range decisions

Functions of managerial accounting

 Determining the cost  Providing relevant information for better decision-making  Providing information for planning, control, decision-making and application

Planning
 Deals with the estimation of product costs, setting up of costing system to record cost data, preparation of cost standards and budgets, planning of materials and manpower resources, analysing cost behavior with changes in levels of activity

Control
 Deals with the maintenance of product costing record, comparison of actual performance with standards or budgets, anlaysis of variances, recommendation of corrective actions, controlling cost to ensure operational efficiency and effectiveness

Decision-making
 Deals with whether it is more profitable to make or buy a component, determine the economic order quantity and production batch size, replace fixed asset, add or drop products, decide pricing

Application
 Cost accounting has extended from manufacturing operations to a variety of service industries such as hotels, bands, airline, etc  Cost accounting system should be flexible and adaptable to meet the new business environment and the changing nature of the company
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Element of cost
     Cost object Cost Cost unit Cost centre Profit centre

Cost object
 It is an activity or item or operation for which a separate measurement of costs is desired  E.g. the cost of operating the personnel department of a company, the cost of a repair fob, and the cost for control

Cost
 It is the amount of expenditure incurred on a specific cost object  Total cost = quantity used * cost per unit (unit cost)

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Cost unit
 It is a quantitative unit of product or service in which costs are ascertained, e.g. cost per table made, cost per metre of cloth

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Cost centre
 It is a location or function of an organisation in respect of which costs are ascertained  E.g. the rent, rates and maintenance of buildings; the wages and salaries of strorekeepers

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Profit centre
 It is location or function where managers are accountable for sales revenues and expenses  E.g. division of a company that is responsible for the sales of products

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Cost classification
 Direct cost  Indirect cost (overhead)

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Direct cost
 Cost that can be identified specifically with or traced to a given cost object  The direct costs consist of the following three elements:
 Direct materials  Direct labour  Direct expenses

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Direct materials
 The cost of materials the cost of materials used entering into and becoming the elements of a product or service  E.g. fabrics in garments

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Direct labour
 The cost of remuneration for working time  E.g. assembly workers wages in toy assembly

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Direct expenses
 Other costs which are incurred for a specific product or service  E.g. royalties

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Indirect cost (overhead)

 Cost that cannot be identified specifically with or traced to a given cost object  They are identified with cost centres as overheads
 Indirect materials  Indirect labour  Indirect expenses

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Indirect materials
 Such as stationery, consumable supplies, spare parts for machine that assist to the production of final products

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Indirect labour
 Such as salaries of factory supervision and office staff that do not directly involve in production of the final product

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Indirect expenses
 Such as rent, rates, depreciation, maintenance expenses that do not have instant relationships with the manufacturing processes

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Cost accumulation
Prime cost = direct materials + direct labour + direct expenses Production cost = Prime cost + factory overhead OR = Direct materials + Conversion cost
*Conversion cost is the production cost of converting raw materials into finished product

Total cost = Prime cost + Overheads (admin, selling,distribution cost) OR = Production cost + period cost (administrative, selling,
distribution and finance cost) Period cost is treated as expenses and matched against sales for calculating 23 profit, e.g. office rental

Cost coding
 A code is a system of symbols designed to be applied to a classified set of items to give a brief, accurate reference, facilitating entry, collation and analysis  Coding is important in modern computerised accounting systems for catergories various composite accounting items

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Reasons
 To reducing error owing to descriptions  Enable easy recalling  Reduce computer file size as a code

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Cost behaviour
 Costs can be classified into variable, fixed, semi-variable, or step-costs according to how they behave with respect of changes in activity levels

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Variable cost
 It increases or decreases in direct proportion to levels of activity, but the unit variable cost remains constant  E.g. cost of food served in a restaurant

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Fixed cost
 Total fixed cost remains constant over a relevant range of activity level but unit fixed cost falls with an increase in activity volume

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Semi-variable cost
 It processes characteristics of both fixed and variable cost  It increases or decreases with activity level but not in direct proportion

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Step cost
 It remains constant for a range of activity levels, then, on further increase in activity, the cost jumps to a new level and remains constant over a certain range until the next jump occurs

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Cost for stock valuation

 Unexpired and expired cost  Product and period cost

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Unexpired cost
 Unexpired costs are the resources that have been acquired and are expected to contribute to the future revenue  They will be recorded as assets in current period  They will be charged as expenses when they have been consumed in the generation of revenue
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Expired costs
 Expired costs are the expenses attributable to the generation of revenue in the current period

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Product cost
 Product cost are related to the goods purchased or produced for resale  If the products are sold, the product cost will be included in the cost of goods sold and recorded as expenses in current period  If the products are unsold, the product costs will be included in the closing stock and recorded as assets in the balance sheet

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Period cost
 Period cost related to the operation of a business  They are treated as fixed cost and charged as expenses when they are incurred  They should not be included in the stock valuation

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Comparison of cost, management and financial accounting

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Meanings
 Financial accounting  Cost accounting  Management accounting

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Financial accounting
 Provides information to users who are external to the business  It reports on past transactions to draw up financial statements  The format are governed by law and accounting standards established by the professional accounting policies

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Cost accounting
 Is concerned with internal users of accounting information, such as operation managers  The generated reports are specific to the requirement of the management  The reporting can be in any format which suits the user

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Management accounting
 Comprises all cost accounting functions  The accounting for product and service costs, management accounting extends to use various internal accounting reports for planning, control and decision making

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Cost and management accounting Vs. Financial accounting

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Management (cost)accounting Nature



Financial accounting

Records material, Records company labour and overhead transaction events costs in product or job External financial Reports produced are statements are produced for internal management and contol Follows the double entry system


Accounting Not based on the double entry system system

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Management (cost)accounting Accounting No need to use accounting principles principles

Adopt any accounting techniques that generates useful accounting information


Financial accounting
Use Generally Accepted Accounting Principles for recording transactions


Used by different Used by external parties: Users of information levels of management or shareholders, creditors,

departments responsible government, etc for respective activities

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Management (cost)accounting
Based on Operation guidelines management instructions and or standards

Financial accounting
Conforms to company Ordinances, stock exchange rules, HKSSAPs


requirements


Time span

Reports are prepared Reports are prepared for whenever needed a definite period, usually yearly and half yearly They may be prepared on a weekly or daily basis

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Management (cost)accounting Time focus

Future orientation: forecasts, estimates and historic data for management actions


Financial accounting
Past orientation: use of historic data for reporting and evaluation


Perspective

Detailed analysis of parts of the entity, products, regions, etc



Financial summary of the whole orgainisation



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Cost accounting vs. Management accounting

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Management accounting Objective



Cost accounting

To provide To ascertain and control information for cost planning and decision making by the management Concerned with transactions related to the future


Basic of recording

Based on both present and future transactions for cost ascertainment



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Management accounting Coverage

Covers a wider area: financial accounts, cost accounts, taxation, etc.


Cost accounting
Covers matters relating to ascertainment and control of cost of product or service


Utility

Only the needs of internal management



The needs of both internal and external interested groups



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Management accounting Types of transactions



Cost accounting

Deals with both Deals only with monetary any nonmonetary transactions, monetary transactions, covering only quantitative covering both aspect quantitative and qualitative aspects

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