BBF, PSM, BBA 121

COST ACCOUNTING AND BUDGETING.

INTRODUCTION:-

Accounting:-

Accounting is a discipline which provides accounting information to interested users to

enable them make economic decisions.

The interested users may include the internal management, potential investors,

shareholders, employees, financial institutions, government departments etc.

The users of financial accounting information always make different decisions and hence

require different types /forms of accounting information because of that reason, it’s

important to have different branches of accounting.

These include:-

 Financial accounting

 Cost accounting

 Management accounting.

FINANCIAL ACCOUNTING

This is a branch of accounting which specializes in the maintenance of accounting records

and preparation of financial reports.

Financial reports include the balance sheet which shows the financial position of the firm,

the income statement which reports on the level of performance of the firm, the sources

of funds and how you have utilized it in a given period.

COST ACCOUNTING

This is also a branch of accounting which provides cost information which can be used in

valuation of stock and profit measurement. It’s the cost accumulation discipline which

aggregates different cost elements so as to provide the cost of different products,

services activities, processes etc.

The system helps/specializes in the maintenance of cost accounts.

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The cost information helps managers to achieve the following objectives:-

1. Setting of selling prices especially where the cost oriented pricing approaches are

used e/g cost + make up= selling price.

2. The cost information helps you in controlling costs.

3. The cost information helps you in controlling costs

4. It helps in stock valuation and profit measurement

5. It helps in planning –planning involves the analysis of costs.

DIFFERENT BETWEEN FINANCIAL ACCOUNTING AND COST AND ACCOUNTING

1. Parties interested in the information provided.

Management accounts provide information to internal users (its inward looking

information) it serves manager, employees and B.O.D members who are the ones to make

decision, plan and control the organization.

Financial accounts are made fir external users e.g. public, govt financial analysts etc who

are interested in different information.

2. Information of reports

Financial accounting statements are prepared once a year (at the end of every accounting

period.

Management accounts can be prepared when need arises hence they can be prepared at

any time.

3. Information provided by the two systems.

Management accounting provide the predetermines information or future information.

Financial accounting reports on what has ready been existing. It is backward looking

4. Statutory requirements.

Financial statement preparation is a statutory requirement i.e. with financial is accounting

it’s a must that reports are prepared.

Management accounting may or may not prepare financial statements i.e. it’s optional that

why some organizations don’t have cost or management accountants.

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5. Rules and policies followed

Financial accounting has specific standards and rules e.g. ASC, concepts and principles

that are expected to be followed when preparing financial statements.

For management accounting there are no specific formats that showed be followed for

the preparation of reports

1. Audit requirement

All financial reports must be audited before they are relied on by the users to satisfy

whether they portray whats on the ground.Potray a true and fair view)

For management information, since it’s an internal issue there is no requirement of an

auditors report.

7.coverage

Financial accounting covers a wider scope as compared to management accounting since its

reports are made to be used by a wide range of users (public)

Management accounting also may cover a wider coverage in terms of planning.

Since planning involves different aspects of the organization they it may be considered to

have a wide range as compared to financial accounting.

However management accounts also cover specific aspects.

8. Accurancy

Financial accounting produces estimations where as management accounting information

provides information which is accurate and detailed e.g. considering materiality in

financial accounts is open ones willingness i.e. what material to one person may be

immaterial to the other.

You can’t base of f/s to make decisions since they provide data and not information

THE ROLE OF COST AND MGT ACCOUNTANT IN THE MANAGERIAL PROCESS

To provide information which can be used by managers ?

a) Planning: This is where objectives are set setting up of strategies that will enable you

achieve these objectives, identification of markets to be sensed etc.

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b) Controlling of costs and other business activities

You can only control if there standards and policies in place you find that you are going

beyond what is planned then you have revise year decision.

Control cycle

Set objectives that must be achieved

Measure actual performance will give you actual results.

Compare actual performance with the set standards (variance) should exist which be

favourable or un favourable)

Take collective action

c) Decision making: managers are expected to take decisions and hence the relevant

information must be provided to decision makers who are managers by a management

accountant.

Managers take different decisions i.e. buy or make outsource or employ one permanent

basis rotability or viability of the product (product mix) decisions may also be made.

Decision’s concerning segmentation of product i.e. should use past power or delete the

production of product B or not.

d) Helps in budget formulation and budget management.

A budget is a control tool that expresses ones intentions or plans in qualitative terms.

To have a budget you must desire cost information that will enable you to value some of

the items that will be incorporated in the budget.

e) Organisations. The information provided van help managers to organize firms

resources to coordinate different activities and ever coming up with organization

structure.

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INTRODUCTION TO COSTS

COST CONCEPTS AND TERMS

1. A cost can be defined as an exchange price, OR expenditure incurred to produce a

product, or represented by decrease in assets or increase in liabilities. A cost could be a

loss, an expense or a production or a production cost.

2. Cost unit.

A cost unit is a unit of measurement of costs or a unit in which costs can be expressed

e.g. kilogram, kilometer, tonne etc.

3. Cost centres

These are divisions or sections within organizations to which cost can be related or

attributed. Cost Centre’s could be departments, machines employees so long as they can

attribute or relate to specific costs.

WHY DO WE HAVE COST CENTRES IN ORGANIZATIONS?

It is to have an incentive control ie provide accountability of the resources provided to

the department. It applies to responsibility accounting (who is supposed to give an

answer)

2. Cost objectives

These try to explain why cost information is desired or required. Managers need

information for different purposes.

There are 3 main cost objectives

i) Cost for stock valuation and profit measurement

Information should enable a manager to value what he has produced (this information can

be got from manufacturing costs)

ii) Costs for decision making.

There are relevant costs and irrelevant costs. Relevant costs and irrelevant costs don’t

change and hence do not influence decision making.

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 iii) Costs for controlling and planning

Identify controllable and uncontrollable costs

Information meant to achieve a given objective can not be used to achieve another

objective.

CLASSIFICATION OF COSTS

Classification of costs is the grouping of costs basing on their common characteristics or

attributes. Costs are classified different ways to answer questions asked by managers/

management.

Management want different information for different purposes, cost must be grouped

and arranged to serve the purpose of management.

Costs are classified because of the following reasons:-

1. Evaluate /measure ones performance

2. controlling of costs

3. Decision making

4. budget preparation

5. Preparation of final accounts /file.

CLASSIFICATION OF COSTS.

The table below is a summary of costs classification.

NO CATEGORY Explanation EXAMPLES

1 Nature/elements Cost of goods and services -Material costs

provided to an undertaking. -Labour costs.

2 Traceability Cost that are easily identified in -Direct costs

production. Can be attached to -Indirect costs.

cost centers.
3 Functions /operations Costs classified by functions as -Manufacturing cost

manufacturing. -Indirect production

costs

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 -Direct labour costs

-Indirect production

costs.

-Direct material

costs.

-Administration

costs.
4 Behavior Costs classified in terms of -Variable costs.

changes in activity / volume of -Semi-variable costs.

work. -Fixed costs.

5 Controllable Costs which can be influenced by -Direct material

the action of a specified member -Direct labaour.

of an undertaking. Can reduce

such costs as to his level of

functioning.
6 Managerial purpose Costs classified for decision -Opportunity costs.

making purposes. -Relevant costs.

-Incremental costs

-Differential costs

-Average costs.

-Sunk costs.

-Out of pocket costs.

Costs can be classified basing on costs objectives and the following classification can be

analyzed.

A.) Classification of costs under the objective of stock

Valuation and profit measurement

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Here we talk about production costs. These costs should be measured in order to know

the level of productivity is profitability

Under this cost objective we have the following classification:-

i) Product costs of period costs

Product costs

These are manufacturing or production costs which are always incurred in producing

goods and services and they are always part of the cost of the unit produced.

Manufacturing costs could be direct or indirect manufacturing costs.

Direct manufacturing costs are costs that can be directly or provided by the

organization i.e. the cost is attached directly to the product e.g. direct material costs,

direct labour costs and direct expenses.

The sum of all direct manufacturing costs are known as prime cells.

CLASSIFICATION OF COSTS

Classification of costs is the grouping of costs basing on their common characteristics/

attributes are classified because of the following reasons:-

1. evaluate/measure ones performance

2. controlling of costs

3. decision making

4. budget preparation

5. preparation of final accounts

Costs can be classified basing on cost objectives and the following classifications

COST MANAGEMENT
INDIRECT MANUFACTURING COSTS represents costs which can not be easily
identified with a specific product or service because two or more products have
benefited from such costs. Examples include indirect labour costs to represent salaries

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and wages paid to staff who is not directly involved in producing the product e.g. salaries
paid to a factory guard, the cleaners etc, indirect expenses e.g. electricity. The total sum
of indirect costs provide what we take to be overhead costs
Period costs
These are on manufacturing costs that are usually treated as operating expenses. They
can not be part of the product or services produced.
They are costs incurred in the period and are debated to P& L a/c. They are incurred in
marketing distributing and administrative.
ii) Expired and unexpired costs.
Unexpired costs
These represent the monetary values of unutilized / unused resources that can be used in
future to generate more revenue. They are service potential not yet utilized in generating
revenue e.g. all prepayment, book values of assets are utilized resources. They are
represented in the balance sheets.
Expired costs
These represent the monetary values of resources that have already been utilized in
generating revenue and they no longer have a potential of generating revenue in future.
These costs could be operating expenses or losses and are all debated to P & L a/c at the
end of the year.
Unexpired items are in the balance sheet as prepayments while the expired items help in
measuring profits (p & l a/c)
b) Classification of cost under the objective of decision making.
This is to enable one make economic decisions. Information is meant for manager to make
economic decisions.
Under this we have the following classification
1. Classification according to cost behaviour
2. Classification according to relevant and irrelevant
Classification according to cost behaviour
This classification tries to explain how the costs behave at the volume of output or level
of activity is changed or adjusted.
Behaviour of costs will guide you know how much you should produce.
In attempt to explain from this behaviour, the following terms must be analyzed
a) variable costs
b) fixed costs
c) semi variable costs
d) semi fixed costs
a) Variable costs
These are costs that change in direct proportion with the level of activity. There is a
direct relationship between the output and total variable costs.
Increase in out put leads to increase in variable costs.

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 The variable cost per unit remains statue i.e. it doesn’t change under the same
manufacturing environment or methods. If you change the methods then it will also
change e.g. fuel consumed under the same driver road or vehicle remains constant but
the more the distance covered the more the costs (fuel) required.
In manufacturing costs, variables could be direct material costs, direct labour costs
part to casual labourers.

E.g. rent doesn’t depend on the no of units produced i.e. doesn’t depend on the no of
people. Also salaries paid to permanent staff are also fixed costs.
The fixed cost per unit depends/varies according to the level of activity e.g. if one is
operating at 10,000 units FC= 1000000
Fixed cost per unit will be 1000000 = 100/=
If units are increased to 20, 000, FC per unit will be 1000, 000= 50/=
20,000

C Semi-variable costs
These have both attributes of variable and fixed costs. They begin as fixed costs and at
a certain level of activity (output) they tend to be variable in nature.

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Extra costs depend on extra units produced beyond 100, you are paying per extra unit
e.g. making an announcement on radio they say that the first 40 words the costs are
fixed and above towards, the costs are variable.
If a person is permanently employed he gets a salary that is fixed but beyond a certain
limit he may qualify for a bonus.
e) Semi –fixed costs.
These are costs which remain static or which are fixed according to ranges of activities
or level of output. I.e. they are static between given ranges of production i.e. between
100 costs is 200, between 100-200 cost is 300 etc.

They are sometimes called

step-up costs e.g. transport
costs like from tax park to
Wandegeya is 500 and from
Tax Park to Bwaise is 600
etc.

ii) Classification according to relevant and irrelevant costs.

These are costs which usually influence the decisions to be made by managers and they
usually change or vary according to alternatives under consideration.
Relevant costs that can influence someone using his own car may include fuel, parking fee,
risks etc.but road licenser fee is irrelevant since it’s fixed.
Here you have to consider variable costs and not fixed costs since they don’t influence
ones decisions.

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Irrelevant costs
These are costs that do not influence the decisions and are always common under all
considerations for decision making e.g. insurance road licence etc.
These are junk costs/past costs/expired costs.
The costs that you have already incurred are irrelevant. In the short run fixed costs are
irrelevant though they can be influenced by external factors.
Opportunity costs is also a relevant cost what can influence ones decisions
C .Classification according to controllability of costs.
Information should give the manager ability to control costs. It tries to explain the
extent to which costs must be manipulated or influenced by the actions of the persons in
charge of these costs i.e. can you reduce or increase them.
Basing on the above you can have
Controllable and uncontrollable
Controllable costs
These are costs that can be contained and influenced by the person in charge e.g. you can
say am spending a lot on fuel; let me control by reducing it. These may include materials,
wages, and power.
Uncontrollable costs
These are costs that can not be influenced or manipulated by the actions of the person in
charge of such costs e.g. rent, road license
As a manager if you want to make decisions you should base on the controllable costs and
not the uncontrollable costs.

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PROCESS COSTING METHODS
This is a processing approach applied in ascertaining the cost of the product or service
that passes through a series of sequential stages/processes. At every process an
operation/activity is always carried out and aims at improving on the condition of the
product to be processed.
Such a method is applied in industry including breweries, soap making industries, chemical
processing, oil refinery etc.
Main features of process costing
1. There must be mass production
2. Products must be homogenous
3. Continuous flow of items
4. Processes accumulate costs
5. The cost of each unit is the average cost which can be ascertained by having
total processed cost minus scrap value over expected output
6. There is always closing and opening work in progress
7. As the product passes through different stages, its unit cost increases because
of operations carried out at different stages.
Process costs
Because of activities carried out at every process, the processor is bound to register a
process loss. The loss could be as a result of chemical reactions, evaporation,
inefficiency, carelessness etc. A process loss can be represented by a reduction in
weight, volume or unit and where there is a process loss; inputs are not always equal to
the outputs.
Process losses can be classified into 2 forms
1. Normal process losses
2. Abnormal process losses.
Normal process losses
These are inevitable losses, uncontrollable losses that are always expected to be incurred
whenever there is a process of item. Such losses are caused by factors which are beyond
the control of a processor and they include:-
Evaporation, chemical reactions etc.
Since normal loss can’t be controlled, it’s always incorporated in the cost of the product
produced and its later passed on to customers through the selling price.
If normal loss is represented by scrap that can be sold, the realized amount (scrap sales)
is offset from total process costs while computing the cost of each unit. The scarp value
in cost accounts should be debited to scrap sales account and credited to ----

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PROCESS COSTING.

Process costing is a method of allocating manufacturing cost to products to determine

an average cost per unit. It is used by companies which mass produce identical or similar
products. Since every unit is essentially the same, each unit receives the same
manufacturing input as every other unit. Refineries, paper mills, and food processing
companies are examples of businesses which use process costing.

Similarities between job order and process costing include:

Both systems have the same basic purpose—to calculate unit cost

Both systems use the same manufacturing accounts

The flow of costs through the manufacturing accounts is basically the same.

However, there are some important differences between job order and processing costing as described
below.

Job Order Costing Process Costing

Each job is different
Costs are accumulated by job
Costs are captured on a job cost sheet
Unit costs are computed by job
All products are identical
Costs are accumulated by department
Costs are accumulated on a department
production report
Unit costs are computed by department

When the products are completed they are transferred from the final processing
department to Finished Goods.

A complication arising in process costing is that not all units may be completed at the
balance sheet date. To calculate unit costs, it will be necessary to compute equivalent
units of production. Equivalent units can be defined as the product of the number of
partially completed units times the percentage completion of these units.

If there are 300 of partially completed units at year-end which are 40% complete, then
there are 120 equivalent units. If say 5000 units were completed during the period, the
managerial accountant would add 5000 and 120 to arrive at 5120 equivalent units
completed during the period.

Then total department costs for the period (direct material, direct labor, and overhead)
would be divided by the 5120 equivalent units to arrive at cost per unit.

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 Equivalent units can be computed in two different ways, the weighted average method
and the FIFO method.

Companies using process costing prepare departmental production reports .

Note that the production report consists of three parts as follows:

1. A quantity schedule which shows the flow of units through the department and a
computation of equivalent units

2. A computation of costs per equivalent unit

3. A reconciliation of all cost flows into and out of the department

Also note that the equivalent unit totals are different for material costs and for
conversion costs. This frequently happens as all material is input at the start of the
production process but the direct labor and overhead costs are incurred sometime later.

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