INTRODUCTION TO COST ACCOUNTING

ACC116
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DHANYA NAIR SUGUKUMARAH

INTRODUCTION
1. 2. 3.

Cost Accounting, Management and Financial Accounting Cost, Cost Unit and Cost Centres Classification and Types of Costs

AT THE END OF THIS CHAPTER, STUDENT MUST BE ABLE TO:

1.

2.

3.

Differentiate between Cost Accounting and Financial Accounting. Explain and differentiate between cost, cost unit and cost center. Classify cost according to function, traceability and behavior.

COST ACCOUNTING

CIMA defines cost accounting as the establishment of budgets, standard costs and actual costs of operations, processes, activities or products; and the analysis of variances, profitability or the social use of funds

Costing involves the classifying, recording and appropriate allocation of expenditure for the determination of costs of products or services; the relation of these costs to sales value; and the ascertainment of profitability.
COST + PROFIT = SALES
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OBJECTIVES OF COST ACCOUNTING

1. 2. 3. 4. 5.

6.

7.

Cost accounting has the following main objectives to serve: Determining selling price, Controlling cost Providing information for decision-making Ascertaining costing profit Facilitating preparation of financial and other statements. Allocate costs between cost of goods sold and inventories for internal and external profit reporting. Provide information for planning, control and performance measurement.
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FINANCIAL ACCOUNTING

Financial accounting can be defined as the process of identifying, measuring, and communicating economic information to permit informed judgments and decisions by users of information.

MANAGEMENT ACCOUNTING
Management accounting in the words of Robert S. Kaplan, is a system that collects, classifies, summaries, analyses and reports information that will assist managers in their decision making and control activities. Management accounting is largely concerned with providing economic information to managers for achieving organisational goals. Management accounts are prepared for internal managers of an organisation.

FINANCIAL ACCOUNTING AND MANAGEMENT ACCOUNTING

Financial accounts are prepared for external users:

1.
2. 3. 4.

5.

Shareholders Customers Suppliers The Inland Revenue Employees

The data used to prepare financial accounts and management accounts are the same. The differences between the financial accounts and the management accounts arise because the data is analysed differently.
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DIFFERENCES BETWEEN FINANCIAL ACCOUNTING AND COST ACCOUNTING

Basis Objective Financial Accounting It provides information about the financial performance and financial position of the business. It classifies records, presents and interprets transactions in terms of money. Cost Accounting It provides information of ascertainment of cost to control cost and for decision making about the cost. It classifies, records, presents, and interprets in a significant manner the material, labour and overheads cost.
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Nature

DIFFERENCES BETWEEN FINANCIAL ACCOUNTING AND COST ACCOUNTING

Basis Recording of data Financial Accounting It records Historical data. Cost Accounting It also records and presents the estimated/budgeted data. It makes use of both the historical costs and predetermined costs..
The cost accounting information is used by internal management at different levels.

Users of information

The users of financial accounting statements are shareholders, creditors, financial analysts and government and its agencies, etc.

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DIFFERENCES BETWEEN FINANCIAL ACCOUNTING AND COST ACCOUNTING

Basis
Analysis of costs and profits Time period

Financial Accounting
It shows the profit/ loss of the organisation. Financial Statements are prepared for a definite period, usually a year.

Cost Accounting
It provides the details of cost and profit of each product, process, job, contracts, etc. Its reports and statements are prepared as and when required.

Presentatio A set format is used for n of presenting financial information. information

There are not any set formats for presenting cost information.

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DIFFERENCES BETWEEN FINANCIAL ACCOUNTING AND MANAGEMENT ACCOUNTING

Financial Accounting
Financial accounts detail the performance of an organisation over a defined period and the state of affairs at the end of the period.

Management Accounts
Management accounts are used to aid management record, plan and control the organisations activities and to help the decision-making process.

Limited companies must, by law, There is no legal requirements to prepare financial accounts. prepare management accounts.

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DIFFERENCES BETWEEN FINANCIAL ACCOUNTING AND MANAGEMENT ACCOUNTING

Financial Accounting
The format of published financial accounts is determined by law (mainly the Companies Acts), by Statements of Standard Accounting Practice and by Financial Reporting Standards. In principle the accounts of different organisations can therefore be easily compared.

Management Accounts
The format of management accounts is entirely at management discretion; no strict rules govern the way they are prepared or presented. Each organisation can devise its own management accounting system and format of reports.

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DIFFERENCES BETWEEN FINANCIAL ACCOUNTING AND MANAGEMENT ACCOUNTING

Financial Accounting
Financial accounts concentrate on the business as a whole, aggregating revenues and costs from different operations, and are an end in themselves.
Most financial accounting information is of a monetary nature.

Management Accounts
Management accounts can focus on specific areas of an organisations activities. Information may be produced to aid a decision rather than be an end product of a decision.
Management accounts incorporate non-monetary measures. Management may need to know, for example, tons of aluminium produced, monthly machine hours, or miles travelled by salesmen.
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DIFFERENCES BETWEEN FINANCIAL ACCOUNTING AND MANAGEMENT ACCOUNTING

Financial Accounting

Management Accounts

Financial accounts present in an Management accounts are both essentially historic picture of past an historical record and a future operations. planning tool.

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COST, COST UNIT AND COST CENTRES

CIMA Terminology defines cost as resources sacrificed or forgone to achieve a specific objective. Cost is generally measured in monetary terms. Cost is the amount of expenditure (actual or notional) incurred on or attributable to, a specified thing or activity. The cost of an item can be divided into the following cost elements: 1. Materials 2. Labour 3. Expenses

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EACH ELEMENT CAN BE SPLIT INTO TWO, AS FOLLOWS:

MATERIALS + LABOUR = = DIRECT MATERIALS + DIRECT LABOUR + + INDIRECT MATERIALS + INDIRECT LABOUR

+
EXPENSES = TOTAL COST = =

+
DIRECT EXPENSES = DIRECT COST +

+
INDIRECT EXPENSES = OVERHEAD
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COSTS
Important

1.

2.

points: Costs are either variable or fixed, depending upon whether they change when the volume of production changes. Costs are either direct or indirect, depending upon how easily they can be traced to a specific unit of production.

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EXAMPLE OF UNIT COST CARD

RM
Direct Materials: Yellow plastic Ink xx xx

RM

Metal
Direct Labour: Machine operators wages Manual assembly staff wages Direct Expenses: Moulding machinery operating costs Total direct cost or Prime cost Overheads production Manufacturing cost or Factory cost

xx

xx

xx xx xx

xx

xx XXX xx XXX

Overheads Administration, distribution and selling

Total cost

xx
XXXX

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COST UNIT
Cost

unit is a unit of product, service or a combination of them in relation to which costs are ascertained or expressed. The selection of suitable cost unit depends upon several factors, such as, nature of business, process of information, requirements of costing system, etc. but usually relates to the natural unit of the product or service.

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EXAMPLES OF COST UNITS:

lndustry or product Automobile Biscuit Bread Bricks Chemical Hospital Power and electricity Cost unit Number Kilogram Thousand loaves Thousand bricks Litre, gallon, kilogram Patient day Kilowatt-hour
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COST CENTRES

1.

2.

Cost centre is defined as a location, person or item of equipment (or group of them) in respect of which costs may be ascertained and related to cost units for the purposes of cost control. Impersonal cost centre consisting of a location or item of equipment (or group of these) such as machine shop, and Personal cost centre consisting of a person or a group of persons such as factory manager, sales manager, etc.
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COST CENTRES
Cost centres are also classified in manufacturing concerns into production and service cost centres. 1. Production cost centres relate to those centres where production or manufacturingactivities take place. 2. Service cost centres are those, which are ancillary and render services to the production cost centres, so that manufacturing activities can take place. In a biscuit manufacturing company, making, baking and packing are production cost centres while personnel, purchase, stores, canteen, accounts are service cost centres

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CLASSIFICATION OF COSTS
Cost classification refers to the process of grouping costs according to their common characteristics, such as nature of expense, function, variability, controllability and normality. Thus, classification is essential for identifying costs with cost centres or cost units for the purpose of determination and control of cost : 1. By nature of expenses: Costs can be classified into material, labour and expenses.

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CLASSIFICATION OF COSTS
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3.

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By function: production or manufacturing cost, administration cost, selling and distribution cost, research and development cost. By variability: Costs are classified into fixed, variable and semi-fixed / semi-variable costs according to their tendency to vary with the volume of output. By controllability: Costs can be classified under controllable cost and uncontrollable cost. By normality : Costs can be divided into normal cost and abnormal cost.
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CLASSIFICATION OF COSTS
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On the basis of time : Costs, may be classified into historical or actual cost and predetermined or future cost. In relation to the product : Costs may be classified into direct and indirect costs. Cost analysis for decision making: Here costs are classified under relevant costs (e.g. marginal cost, additional fixed cost, incremental cost, opportunity cost) and irrelevant costs (e.g. sunk cost, committed costs, etc.)
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TYPES OF COSTS
1.

2.

Direct cost is a cost that can be traced to full to saleable costs units (products or services) that are being costed. Indirect cost or overhead is a cost that is incurred in the course of making a product or providing a service, but which cannot be traced directly and in full to the product or service.
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EXAMPLE: DIRECT COST VS INDIRECT COST

Example : Manufacture of desk. Wood would be the direct cost as it can be specifically and exclusively identified with a particular desk. In addition to it, salary of factory workers also can be identified as the direct cost for the manufacture of desk. However, the factory supervisors salary is not part of direct cost and will be classified as indirect cost. Nails used to manufacture a particular desk can be identified specifically with the desk but the cost is likely to be insignificant as the expense of tracing such items does not justify the possible benefits from calculating more accurate product costs.
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DIRECT COSTS VS INDIRECT COSTS

Important note: The distinction between direct and indirect costs also depends on the cost object. A cost can be treated as direct for one cost object but indirect in respect of another.
Cost object Maintenance department Direct costs Salary of the workers in that department Operators salary Indirect costs

Product

Warehouse rental Supervisors salary

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RELEVANT COSTS AND REVENUES

3.

Relevant costs and revenues are those future costs and revenues that will be changed by a decision, whereas irrelevant costs and revenues are those that will not be affected by the decision. Example: If one has to decide whether to make a journey by car or public transport. Irrelevant cost car tax and insurance costs since they will remain the same whatever alternative is chosen. Relevant cost petrol costs for the decision making.
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SUNK COST
4.

Sunk cost is a cost that has been incurred and cannot be reversed. Also referred to as "stranded cost." Example of the written down values of assets previously purchased are sunk costs. Machine purchased four years ago for RM100,000 with an expected useful life of five years and nil scrap then the written value will be RM20,000 if straight line depreciation is used. This written down value will have to be written off, no matter what possible alternative future action might be chosen. If the machine was scrapped, the RM20,000 would be written off; if the machine was used for productive purposed, the RM20,000 would still have to be written off. This cost cannot be changed by any future decision and therefore classified as sunk cost.
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OPPORTUNITY COST
5.

Opportunity cost is a cost that measures the opportunity that is lost or sacrificed when the choice of action requires that an alternative course be given up. Example: A company has an opportunity to obtain a contract for the production of a special component. This component will require 100 hours of processing on machine X. Machine X is working at full capacity on the production of product A, and the only way in which the contract can be fulfilled is by reducing the output of product A. This mean a loss of revenue of $200. The contract will also result in additional variable costs of $1000.
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OPPORTUNITY COST
If the company takes on the contract, it will sacrifice revenue of $200 from the lost output of product A. This represents an opportunity costs and should be included as part of the cost when negotiating for the contract. The contract price should at least cover the additional costs of $1000 plus $200 opportunity cost to ensure that the company will be better off in the short term by accepting the offer.

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INCREMENTAL COSTS AND REVENUES

6.

Incremental costs and revenues are the difference between costs and revenues for the corresponding items under each alternative being considered. Example: The incremental costs of increasing output from 1000 to 1100 units per week are the additional costs of producing an extra 100 units per week.

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COST BEHAVIOR
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2.

3.

Fixed costs tend to remain unaffected by the variation or change in the volume of output, such as supervisory salary, rent, taxes, etc. Variable costs tend to vary directly with volume of output, such as direct material, direct labour and direct expense. Semi-fixed/semi-variable cost is partly fixed and partly variable, such as telephone expense, electricity charges, etc.

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THANK YOU
A journey of a thousand miles begins with a single step.

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