Costing Concepts & Terms

Prof. Nand Dhameja

17/9/12

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Financial Statements
Balance Sheet Total assets Rs 90 Crore Profit & Loss A/c Sales Rs. 60 crore Profit for the Year 20 cr Profit Margin = 33% Need for Costing ?

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Accounting Information-Needed

a).Score Keeping : Historical, GAAP, Mandatory b).Attention Directing c).Problem Solving Financial Accounting : is concerned Partly with (a) above; Management Accounting serves (b) & (c)
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Cost Accounting
A branch of accounting A process of accounting for Costs In broader terms covers:
Management Accounting & Budgeting Financial Accounting : concerned with Costs Cost accounting : Concerned with Break-up of Costs
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Cost Accounting
Ascertainment of Costs Accumulation of cost Elements
Material Labour Other Expenses

Concerned with Money as a Measure of Economic Performance

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Cost Accounting: Purposes

Inventory Valuation & Pricing

Cost control & Cost Reduction

Decision Making
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Cost: Meaning
Cost refers to Sacrifice or Forbearance Cost involves Exchange Process Relates to a Purpose or Activity or Job Measured in Monetary Terms Cost measured in monetary terms: Actual Cost- Cost Incurred A Historical Cost
Budgeted Cost or forecasted cost
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Cost Accumulation & Cost Object

Cost Accumulation is the Collection of Cost Data in a systematic way for a purpose Cost Object Cost Objects : Illustrations Paper cost : Magazine, A particular issue, A Publishing House, Macro-level use Supervision : Magazine Issue, Publication Dept., Publishing House Rent of Premises:Magazine Issue, Publication Dept. Company Canteen Expenses : for a batch of production, Production Dept., Enterprise
Training Expenses : for a batch of production, training division. HR dhameja 8 Dept., Enterprise

Financial Accounting VS Management Accounting

Financial Accounting Management Accounting Scope: Concerned with money Concerned with money as measure as economic resource of economic performance Purpose: One purpose- exhibit More than one purpose- mgt. needs financial results of enterprise Coverage : Entire Business Requirement : Time Span : Governing Factor Emphasis: Parties Interested Statutory One activity/dept./ Optional

Historical; Annual Forward Looking; periodical GAAP Objectives for which inf. needed Accuracy; Presentation Prompt & Analysis of data External
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Internal
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Cost Accounting : Principles

Costs should be Related as closely as possible to their causes Profit appropriations are excluded from costs Abnormal Costs are excluded from costs Past costs are not charged to future period. Past costs are those from which no benefit is expected A Cost is not charged until it is incurred Measuring Costs requires Judgement Greater the proportion of prime costs in cost structure, more confident are managers about cost accuracy dhameja 10

Cost Accounting
Cost Elements:
Material Labour Other Expenses

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Cost Terms
Direct & Indirect Cost Traceability Total Costs & Unit Cost Units Fixes Costs &Variable Costs Level of Activity Product & Period Costs Controllable & Uncontrollable Costslevel of authority Actual & Budget Costs Prime cost & conversion costs Managed Cost & Engineered Costs Opportunity costs Separate costs; Common Costs; Joint Costs; ByProduct Costs Variable Cost; marginaldhameja costs; differential costs

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Cost Sheet
Direct Cost
Direct Material Direct Labour Other Direct Expenses

Indirect Costs:
Factory Overheads Office Overheads Marketing Overheads Profits Selling Price
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Cost Sheet
A).Direct Cost
Direct Material Direct Labour Other Direct Expenses

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Prime Cost Works Cost or

Factory Cost (A + B1))

B). Indirect Costs: B1. Factory Overheads

Indirect Materials Factory Supervision Factory rent, rate Factory Depreciation

B2. Office Overheads

Office Rent Directors Fees

B3. Marketing Overheads Sales Staff expenses packing carriage outward Advertising C).

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Office Cost or Cost of Production (A+B1+B2)

Profits

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Cost of Sale or Total Cost ( A+B1+B2+B3)

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(Selling Price) (A=B1+B2+B3+C)

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Cost Terms
Direct Costs & Indirect Costs- Traceability
Direct Costs: Costs which can be Traced to cost OBJECT conveniently & economically Indirect Costs: Costs which cannot be traced conveniently & economically Cost Object Direct Indirect Magazine paper Rent Publishing House rent Factors Affecting Direct & Indirect Distinction: Materiality: Larger the cost, easier to trace - Courier charge & paper cost Information gathering technology: Design of operations: exclusive use of specific cost

Rule: Broader the definition of Cost Object, higher % costs are Direct Costs & more confidence MGT has in accuracy of cost estimation dhameja 15

Cost Terms
Variable Costs & Fixed Costs- Variability in relation to specific cost object & time period Variable Cost changes in % to level of output Fixed cost remains unchanged in total for a given period. Fixed costs always focus on total costs Cost Driver: level of activity affects costs Variable cost Total Costs & Unit Costs: Total costs rather unit costs are more meaningful as fixed cost per unit changes with change in level of output
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Cost Terms
Inventoriable costs & Period Costs Inventory cost: all costs incurred to put the product in location & condition of sale =prime cost + factory overhead Period Costs: costs not associated with inventories Marketing & Office cost Prime Costs & Conversion Costs: Prime Costs = DM +ML + Other Direct Expenses Conversion Costs = Manufacturing costs other than DM = DL + Other Direct Expenses + Factory O/H
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Cost Terms: Controllable & Noncontrollable Costs

Controllable and Non-controllable Costs:

Controllable at a level of managerial authority & given time period Controllable Costs attributes:
a) Vary in size at management discretion b) manager responsible fo cost is identifiable c) time period is appropriate for the costs

material quantity used is influenced by production manager material purchased price influenced by production manager/market conditionss
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Cost Terms: Engineered & Managed Costs

Engineered Costs
Effectively & objectively measured Input-output relationship

Managed Costs
* Arise as result of management judgment * No scientific way of deciding

exits

Right or proper amount can be estimated e.g. Qty of coal per ton of cement * e.g cost of legal dept.; personnel dept; advertisement cost

right amount * also called Discretionary cost

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Cost Terms
Opportunity Costs:Benefit foregone on the immediate next best alternative in a given situation Situation of two or more alternatives-best alternative is chosen & next best alternative foregone is the opportunity cost E.g. from timber we can manufacture two chairs or one table; we decide for table & the opportunity cost is the value of two chairs A notional cost; is not actually incurred E.g Two job alternatives: Rs. 8 lakh or Rs 7 lakh ?
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Cost Terms
Book cost & Out-of Pocket Cost Allocated cost & * Apportioned Cost Costs which can be directly *Costs which can not be booked or traced to activity directly booked or or division traced to activity/ division e.g. Direct material, or direct *also called common costs labour

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Cost Terms
Joint Cost and By-product cost:
When group of products are produced simultaneously from the same raw material- products are not identifiable until split-off point Joint Products Products having significant value are Joint Products & products of less significant value are by-products Costs prior to split-off point are called joint costs Management Decision Petroleum Industry: Petrol, diesel, aviation fuel, kerosene Sugar industry: sugar; baggasse & molasses
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Cost Terms
Standard- Budgeted- Actual Costs Standard costs- what the costs should be Budgeted cost- what costs would be Actual costs- what costs are or what cost has been Standard Costs- ideal costs irrespective environment; normally per unit Budgeted Costs- in the prevailing environment for planning; cost budgeted for an activity or dept.

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Cost Terms
Sunk Costa) Purpose for which cost is incurred, is not to be served; & b) cost incurred is irrecoverable Not relevant for decision - making e.g. research cost, when decided that not to be useful, becomes sunk cost, before such decision it is a development cost Oil well exploration cost- development cost; but when decided not to pursue further & well will not fructify, cost incurred will not be recovered, it becomes sunk cost
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Cost Terms
Marginal and Incremental Costs No difference in these concepts- basically mean cost of extra production Marginal Cost=> cost at margin; cost of one unit more capital intensive products i.e. ship, airplane, turbine produced in units & not in batches Incremental cost => cost of producing a batch of additional units consumer/consumer durables- production in batches
For example: Output 100 units 101 units 120 units Total cost (Rs) X X+ i.e. cost of one extra unit is marginal cost X ++ i.e. cost of 20 more units 25 is dhameja incremental cost