Cost Accounting

Escorted by : Abdul Sattar

Muhammad Zeeshan
Submitted to : Sir- Shahid Iqbal

Table of Contents
Acknowledgement and
Dedication3
Introduction4
Product Cost5
Two-Stage7
Cost of Complexity.9
Comprehensive Cost System..11
Conclusion...12

Acknowledgement
All the praise is for ALLAH, the most merciful
and beneficent, who blessed me with the
knowledge, gave me the courage and allowed
me to accomplish this task. I am especially
indebted to all my teachers for instilling in me
enough knowledge to be able to carry myself
efficiently during my project

Dedication
I dedicate this report to my parents and friends in
recognition of their worth and to my teachers who are
the guiding force for me and it is their effort and hard
work that showed me the path of success and
prosperity which would be there for me for the rest of
my life.
My thanks to all those who have generously
contributed their theoretical knowledge to this report
without their understanding and support, completion
of this work would not have been possible. I hope
people find this report useful and the subject matter
adds to their knowledge.

INTRODUCTION

The recent management accounting literature provides several case

studies of multi-product firms whose product costs are distorted
because they allocate overhead costs to products on the basis of a
single volume related variable. Most of the Firms that they have
personally studied use simple cost accounting systems that assign
overhead costs to products based on the direct labor hours
expended on each product.
Cost concept and terms have developed according to the need of
Accountant, Economist & Engineers. It is defined as:
AN EXCHANGE PRICE, A FORGOING OR SECRIFICE
MADE TO SUCCESS BENEFIT. IN FINANACIAL
ACCOUNTING, THYE FORGIVING OR SECRIFICE AT DATA
OF ACQUISITION IS REPRESENTED BY A CURRENT OR
FUTURE DIMINUTION IN CASH OR OTHER ASSETS.

Classification Of Costs
Cost classification are needed the development of cost data that
will aid management in achieving its objectives. These
classifications are based on the Relationship of Cost to:
The Product
The Volume
Manufacturing Departments
An Accounting Period

The Product
The process of classifying costs & expenses may begin by relating
costs to the operations of a business. Total operating cost consists
of
Manufacturing cost
Commercial Cost

The Volume
Costs vary directly in relation to exchange in the volume of
production or output, while other remains relatively fixed in
amount.
Variable costs
Fixed Costs
Semi variable Cost

Manufacturing Department
The division of a factory into department, cost centre or cost pools
also serves as the basis for classifying and accumulating product
cost and assigning responsibility for cost control. As a product
passes through a department or cost centre, it is charged with direct
materials, direct labour and factory overhead (FOH)

Accounting Period
Cost may be classified as capital expenditures or as revenue
expenditures
A capital expenditure is intended to benefit future periods and is
recorded as an asset.
A revenue expenditure benefits the current period and is recorded
as an expense.

Accounting distorts product cost

Disagreement persists about whether product costs should be
assessed by using full or variable costs. Academic accountants and
economists have argued that variable costs are most relevant in
product decision-making, arguing that the highest profits can be
gained by setting marginal revenues equal to marginal costs.
Accountants in practice report full costs in their cost accounting
systems. It is suggested that a comprehensive product cost system
that incorporates long-term, variable marketing and manufacturing
costs for each product or product line be the basis for management
decisions in introduction, price, continuance, or re-engineering of
product lines.

Product Cost
In order to make sensible decision concerning the products they
market, managers need to know what their product cost.
Product design. New product decision and the amount of effort
expended on trying to market a given product or product line will
be influenced by the anticipated cost and profitability of the
product. Conversely, if product profitability appears to crop, the
question will be raised. Product cost also plays an important role in
setting prices particularly for customized product s with low sales
volumes & without readily available market prices.

Two-Stage
TWO-STAGE Cost allocation systems are:
The cost system of all companies had many common
characteristics. Most important was the use of two stage cost
allocation system: In the first stage, cost were assigning to cost
pools (often called cost centers) and in second stage cost were
allocated from the cost pools to the products.
The companies used many different allocation bases in the first
stage to allocate cost from plant overhead accounts to cost centers.
Despite the variation in allocation bases in the first stage, however
all companies used direct labour hours in the second stage to
allocate over head from the cost pools to the product. Direct labour
hours were used in the second allocated stage even when the
production process was highly automated so that burden rates
extended 1,000%.
Firms used only one cost system even through cost were collected
and allocated for several purposes including product costing,
operational control and inventory valuation. The cost system
seemed to be design primarily to perform the inventory valuation
function for financial reporting because the had serious
deficiencies for operational control (too delayed & too aggregate)
and for product costing (too aggregate).

The cost of Complexity

The complexity costs of a full line can be illustrated as follows.
Consider two identical plants. One plant produces 1,000,000 units
of product A. The second plant produces 100,000 units of product
A and 900,000units of 199 similar products. (The similar product
have sales volume that vary from 100 to 100,000units)
The first plant has a simple production environment and requires
limited manufacturing support facilities. Few steps, expediting and
scheduling activities are required.
The other plant presents a much more complex production
management environment. Its 200 products have to be scheduled
through the plant, requiring frequent setups, inventory movements,
purchases, receipts and inspections. To handle this complexity, the
support departments must be larger and more sophisticated.
The traditional cost accounting system plays an important
role in obfuscating the underlying relationship between the range
of products and the size of support department. First, the costs of
most support departments are classified as fixed, making it difficult
to realize that these costs are systematically varying. Second the
use of volume related allocation bases makes it difficult to
recognize how these support department costs vary.
Support department costs must vary with something because they
have been among the fastest growing in the overall cost structure
of manufactured products. As the e.g. demonstrate. Support
department costs vary not with the volume of product item
manufactured; rather they vary with the range of item produce. i.e.
the complexity of the production process. The traditional definition
of variable cost with its monthly or quarterly perspective, views
such costs are fixed because complexity related cost do not vary
significantly in such a short time frame. The increase complexity
of the production process places additional demands on support
department and their costs eventually and inevitably rise.

The output of a support department consists of the activities its

personal perform, these includes such activity as Setup, Material
handling and Scheduling. The output of the department can be
represented by the n.o of distinct activities that are performed or
the n.o transaction handled. Most of the output of theses
departments consists of human activities; however output can
increase quite significantly before an immediate deterioration in
the quality of service detected. Eventually the maximum output of
the department is reached an additional personal are requested. The
requests typically come some time after the initial increase in
diversity and output. Thus support department while varying the
diversity of the demanded output, grow intermittently. The practice
of annual budgeted the size of the department further hides the
underlying relation b/t the mix and volume of demand and the size
of the department. The support departments often are constrained
to grow only when budgeted to do so.

Comprehensive Cost System

The notions of fixed and variable are meaningful only with respect
to a particular time period; they immediately discard this warning
and teach from the perspective of one-month decision horizons.
The short-term focus for product costing has led all the
companies growing proportion of their total manufacturing cost as
FIXED. Costs have been the most variable and rapidly
increasing costs.
The thinking of cost behavior is: The allocation of cost from the
cost pools to the product should be achieved using bases that
reflect cost drivers. Because many overhead cost are driven by the
complexity of production, not the volume of production, nonvolume related bases are required. Second many of these overhead
costs are some what discretionary, while they vary with changes in
the complexity of the production process. These changes are
intermittent. A traditional cost system that define Variable cost are
varying in the short term with production volume will misclassify
these cost are fixed.
The misclassification also arises from an inadequate
understanding of the actual cost drivers for most overhead cost.
Many overhead cost vary with transactions. Transaction to order,
schedule and pay for shipments to move, tracks and count
inventory to schedule production work to setup machine to
perform quality assurance to implement engineering change order
and to expedite and ship orders. The cost of these transactions is
largely independent of the size of the order being handled. The cost
does not vary with the amount of input or outputs. It does vary,
however with the need for the transaction itself. If the firm
introduce more products. If its need to expedite more orders or fit
need to inspect more components then it will need larger overhead
departments to perform these additional transactions.

Conclusion
Product costs are almost all variable cost. Some of the sources of
variability relate to physical volume of items produced. These
costs will vary with units produced. Or in a varied, multiproduct
environment with surrogate measures such as labour hour, machine
hour & quantities or elapsed time of production. Other cost
however those are arising from overhead support. The variability
of these costs is best explained by the incidence of transactions to
initiate the next stage in the production, logistics or Distribution
process.
A comprehensive product cost system, incorporating the long
term variable costs of manufacturing product line. The cost system
may even become strategically important for running the business
and creating sustainable competitive advantages for the firm.