Cost Accounting and Control

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Define cost, Accounting, Costing?

Cost may be defined as the amount of expenditure incurred on, or attributable to, a given thing. Cost is a sacrifice of resources. Accounting may be defined as the art and science of recording business transaction in a methodical manner so as to show
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Financial Accounting

Its focus is on reporting to external parties. It measures and records business transactions. It provides financial statements based on generally accepted accounting principles. It measures and reports financial and nonfinancial information that helps 10/30/12 33 managers make decisions to fulfil the

Management Accounting

Costing involves,

Classifying, recording and appropriate allocation of expenditure for the determination of the costs of products or services. The relation of these costs to sales values; and The ascertainment of profitability.
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Element of Cost: 10/30/12

Material cost it is the cost of commodities supplied to an undertaking Direct material cost which goes into a saleable product or it is directly used for the completion of that product e.g., HSS bit for lathe. Indirect material cost which is necessary but not directly used e.g., 10/30/12 55 cotton waste

Expense refers to all charges other than incurred as direct results of Materials and labourers. Direct expenses - Other expenses which are incurred for the specific product or service and are directly charged to them. Eg: Expenses on Special Tools and Consumables purchased. Indirect expenses - All those66

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Opportunity cost It is the cost of any activity measured in terms of the value of the best alternative that is not chosen (that is foregone) Sunk cost It is the costs that have already been incurred and cannot be recovered.
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Overheads defined as the cost of indirect material, indirect labour and such other indirect expenses, including services, as cannot conveniently be charged direct to specific cost units. Production or manufacturing overheads all indirect expenses incurred from receipt of the production order until its completion 10/30/12 88

Prime cost = Direct material cost + Direct labour cost + direct expenses Factory cost = prime cost + factory overhead = Direct material cost + direct labour cost + (variable) direct expenses + factory overhead.
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Total cost = Factory cost + selling

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Depreciation

A noncash expense that reduces the value of an asset as a result of wear and tear, age, or obsolescence. Most assets lose their value over time (in other words, they depreciate), and must be replaced once the end of their useful life is reached. There are several accounting methods that are used in order to write off an asset's depreciation cost 10/30/12 1010

COST VOLUME PROFIT ANALYSIS

CVP analysis shows the relationship between costs (both variable and fixed), volume (the number of units produced and sold), and profit or loss. CVP is a useful management tool; it allows managers to understand and predict how changes in sales prices, sales volumes, and expenses will affect an organizations profitability.

CVP analysis is an examination of the relationships of prices, costs, volume, and mix of products. It involves the separation of costs into their variable and fixed categories at the outset of the analysis. 10/30/12 1111

Assumptions of CVP:

Revenues and costs are linear throughout the relevant range. Costs can be identified as either fixed or variable. Changes in activity levels are the only factors affecting costs. The number of units produced and sold is the same. In companies with more than one product, the sales mix is constant.

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COST VOLUME PROFIT ANALYSIS There are three main tools offered by CVP analysis:

breakeven analysis, contribution margin analysis, operating leverage,

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BREAK EVEN ANALYSIS

In economics & business, specifically cost accounting, the break-even point (BEP) is the point at which cost or expenses and revenue are equal: there is no net loss or gain, and one has "broken even". A profit or a loss has not been made, although opportunity costs have been paid, and capital has received the risk-adjusted, expected return.

Break-Even Analysis is used to calculate the break-even point where total revenue equals total costs. This point results in zero profit or in other words at this point the business recovers the variable and fixed costs of doing business at a certain revenue level. In order to perform Break-Even Analysis the following variables are required:

- Total Revenue (TR) which is calculated as number of products sold times unit price - Total Fixed Costs (TFC) generally this number will not change unless the analysis is for a large range / changes in the revenue - Total Variable Cost (TVC) which varies directly with the number of products sold The Profit (P) is calculated as total revenue minus total cost:

P = TR TC

10/30/12 Where:

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Total Revenue (TR)Total Fixed Costs (TFC) Total Variable Cost (TVC) Profit 10/30/12 1515 (P)

For example, if a business sells fewer than 200 tables each month, it will make a loss, if it sells more, it will be a profit. With this information, the business managers will then need to see if they expect to be able to make and sell 200 tables per month.

If they think they cannot sell that 10/30/12 many, to ensure viability they1616 could:

Breakeven Analysis

A second tool for management decision making breakeven point can be determined by using the following formulas: Sales Price per Unit Variable Costs per Unit = Contribution Margin per Unit. Contribution Margin per Unit divided by Sales Price per Unit = Contribution Margin Ratio.
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Breakeven Sales Volume = Fixed Costs divided by Contribution Margin Ratio.

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Contribution Margins

which compares the profitability products, lines, or services we offer

of

different

contribution margin is simply the percentage of each sales dollar that remains after the variable costs are subtracted. CM = Selling price - Variable cost CM may be shown as a per unit amount or a total amount at a specific level of sales. The contribution margin is the amount available to cover fixed costs (below the break even point) and the amount to add to profit (above the break even point).
10/30/12 The contribution 1818 margin may be expressed as a

Contribution margin ratio

CMR = Contribution margin / selling price The contribution margin ratio is the percent of each sales dollar that is available to cover fixed costs (below the break even point) and the amount to add to profit (above the break even point). The contribution margin ratio is usually expressed as a percentage.
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Contribution margin Sales Fixed expense CM Ratio

= CM Ratio

Break-even = point (in sales dollars)

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Contribution Margin Ratio

Sales ( 400 surf boards) Less: variable expenses Contribution margin Less: fixed expenses Net income

Total $200,000 120,000 $ 80,000 80,000 $ -

Per Unit $ 500 300 $ 200

Percent 100% 60% 40%

$80,000 40%
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$200,000 sales 2121

OF I O ST UCT CO OD PR N
Product costs (Manufacturing costs)

All costs

Period costs (Non-manufacturing costs)

Direct materials Prime costs Conversio n costs

Selling expenses

Direct labour

Manufacturing overhead

Administrative expenses

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Product Costs costs that are necessary and integral part of producing the finished product. Direct labour and manufacturing overhead are incurred in converting raw materials into finished goods, these costs elements are often referred to as conversion costs. Period costs costs that are identified with a specific time period rather with a salable product. These costs relate to non10/30/12 2323 manufacturing costs and therefore are not

Format Manufacturing Accounts

Manufacturing Costs in Financial Statements

ABC Manufacturing Company

Manufacturing account for the year ended December 2007 Direct Materials RM RM xx xx

Raw material as at 1 January 2007 Add: Purchases of Raw Material Carriage Inward Import Duty xx xx

Total Raw Material Available for Use (-) Raw material as at 31 December 2007 (xx) DIRECT MATERIAL USED 10/30/12 xxx 2424

xxx

Continue.. PRIME COSTS xxx

Overhead Costs Indirect Labor Factory repairs xx xx xxx

Depreciation factory machine xx TOTAL OVERHEAD COSTS

TOTAL MANUFACTURING COSTS xxx Add:

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WIP Opening

xx (xx)
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Less: WIP Closing

ABC Manufacturing Company Income Statement for the year ended December 2007 RM Sales Finished goods 1 Jan Goods Available for Sale COST OF GOOD SOLD GROSS PROFIT Less: Operating Expenses
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RM xxx xx xx (xx) xx XX xx

Less: Cost of Goods Sold: Add: Cost of goods manufactured xx Less: Finished goods 31 Dec

Selling and Distribution Expenses

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Excercise
Mutiara Ltd incurs the following manufacturing costs and expenses during the month of May. 1. Assembly line wages 2. Raw materials used directly in product 3. Depreciation on office equipment 4. Property taxes on factory building 5. Rent on factory building 6. Sales commissions 7. Depreciation on factory equipment 8. Factory utilities 9. Wages for factory maintenance workers 10. Advertising
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Complete the following matrix by placing an X mark under the appropriate headings.
Cost item Wages Raw material Depreciation office equip. Property taxes
Sales commissions

Direct material

Direct labour

Manufact. overhead

Prime costs

Conversion costs

Period costs

Depreciation on factory equipment Factory utilities Wages for factory maintenance workers Advertising Indirect materials Factory manager's 10/30/12 salary

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operating leverage, which examines the degree to which our business uses fixed costs, which magnifies our profits as sales increase, but also magnifies our losses as sales drop.

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and get tary Bud dge Bu ntrol co

What is a budget ?

A budget is a written plan about what is to be done in future. It is a financial statement relating to future. Budget is a method of estimating the likely revenues and expenses.

Budget: It is a financial and / or

quantitative statement, prepared and approved prior to defined 10/30/12 3030

BUDGETING

it is a whole process of designing, implementing and operating budget Process of preparing budgets, Study of business situations, Understanding the management objectives, Understanding the capacity of enterprise.
3131 The entire process of preparing the

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Budgetary control

Budgetary control is a system of controlling costs which includes preparation of budgets, coordinating the department, establishing responsibilities, comparing actual performance with the budgeted, and acting upon the results to achieve maximum profitability-BROWN & HOWARD it is establishment of budget relating 10/30/12 3232 the responsibilities of executives to the

What is a budget key factor?

It is the critical factor which is responsible for the budget to work properly (as planned). It is to be identified carefully and properly estimated. Example : demand of products could be a budget key factor

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It is a system of budgeting, where all activities are re-evaluated each time a budget is set. It is superior to traditional method, as we are evaluating each iterm and finding its rationale. As against zero base budgeting, in traditional budgeting, a budget is prepared just on the basis of last year's data. We try to add a little bit in 10/30/12 3434

What is a zero base budgeting ?

What is performance budgeting is a budget, ? In this system, there

which is linked to performance. It involves evaluation of performance of an organization in the context of both specific as well as overall objectives of the organization. It is a consolidated budget prepared by combining the summaries of all the functional budgets
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What is a master budget?

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CLASSIFICATION OF BUDGETS

ACCORDING TO ACCORDING TO TIME FLEXIBILITY

1. 2. 3. 4.

ACCORDING TO FUNCTION

Long term budget 1. Fixed budget Short term budget 2. Flexible budget Current budget Rolling budget

1. Sales budget 2. Production budget 3. Cost of Production budget 4. Purchase budget 5. Personnel budget 6. R & D budget 7. Capital Expenditure budget 8. Cash budget 9. Master budget
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1.

SALES BUDGET:
Sales budget is the most important budget based on which all the other budgets are built up. This budget is a forecast of quantities and values of sales to be achieved in a budget period.

2. PRODUCTION BUDGET:
Production budget involves planning the level of production which in turn involves the answer to the following questions:
a. b. c. d.

What is to be produced? When is it to be produced? How is it to be produced? Where is it to be produced?

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3. COST OF PRODUCTION BUDGET: This budget is an estimate of cost of output planned for a budget period and may be classified into

Material Cost Budget Labour Cost Budget Overhead Cost Budget

4. PURCHASE BUDGET: This budget provides information about the materials to be acquired from the market during the budget period.

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5. PERSONNEL BUDGET: This budget gives an estimate of the requirements of direct labour essential to meet the production target. This budget may be classified into a. Labour requirement budget b. Labour recruitment budget 6. RESEARCH AND DEVELOPMENT BUDGET: This budget provides an estimate of expenditure to be incurred on R & D during the budget period. A R&D budget is prepared taking into consideration the research projects in hand and new R & D projects to be taken up.
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7. CAPITAL EXPENDITURE BUDGET: This is an important budget providing for acquisition of assets necessitated by the following factors: a. Replacement of existing assets. b. Purchase of additional assets to meet increased production c. Installation of improved type of machinery to reduce costs. 8. CASH BUDGET: This budget gives an estimate of the anticipated receipts and payments of cash during the budget period. Cash budget makes the provision for minimum cash balance to be maintained at all 4040 10/30/12

9. MASTER BUDGET: CIMA defines this budget as The summary budget incorporating its component functional budget and which is finally approved, adopted and employed. Thus master budget is a summary of all functional budgets in capsule form available in one report. 10. FIXED BUDGET: This is defined as a budget which is designed to remain unchanged irrespective of the volume of output or turnover attained. This budget will, therefore, be useful only when the actual level of activity corresponds to the budgeted level of activity.
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11. FLEXIBLE BUDGET: CIMA defines this budget as one which, by recognising the difference in behaviour between fixed and variable costs in relation to fluctuations in output, turnover or other variable factors such as number of employees, is designed to change appropriately with such fluctuations.

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Fixed budget

Flexible budget

Cost are not classified according to Cost are classified according to the their variability nature of their variability It remains the same irrespective of It can be suitably recasted quickly to the volume of business activity suit the changed conditions It assumes that conditions would remain static It is designed to change according to a change in the level of activity

Actual and budgeted performance Comparison are realistic since the cannot be correctly compared if the changed plan figure are placed against volume of activity differs actual ones Budget has limited application
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Budget has more application

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Capital Budgeting...

is a formal means of analyzing longrange capital investment decisions. The term describes budgeting for the acquisition of capital assets. Capital assets are assets used for a long period of time.

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Capital Budgeting

Capital budget models using net cash inflow from operations are: payback accounting rate of return net present value internal rate of return

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