Naresh Cost and Management Accounting MBA III Sem UNIT- I INTRODUCTION TO COSTING “Cost accounting is the process

of accounting for costs from the point at which the expenditure is incurred of committed to the establishment of its ultimate relationship with cost units. In its widest sense, it embraces the preparation of statistical data, the application of cost control methods and the ascertainment of the profitability of the activities carried out or planned is defined as the application of accounting and costing principles, methods and techniques in the ascertainment of costs and the analysis of saving and/or excess as compared with previous experience or with standards.” Institute of Cost and !anagement "ccountants of #ondon “Cost accounting is defined as the application of costing and cost accounting principles, methods and techniques to the science, art and practice of cost control and the ascertainment of profitability. It includes the presentation of information derived therefore for the purposes of managerial decision ma$ing. %heldon

Cost accounting thus provides information to the management for decision of all sorts. It serves multiple purposes on account of which it is generally indistinguishable from management accounting or so&called internal accounting. %ilmot has summari'ed the nature of cost accounting as “the analysing, recording, standardi'ing, forecasting, comparing, reporting and recommending” and the role of a cost account as that of “a historian, news agent and rophet” Cost: (enerally cost may be explained as the amount of expenditure, actual or notional, relating to a specific thing or activity such as product, )ob, service, process etc. It may also be expressed as a sacrifice which may be defined in the terms of money means it is the amount of resources given up in exchange for some goods and services. Cost and expenses are different but relative terms.%here *costs+ includes the cost of material and labour in addition to expenses, the term expenses is widely applied in financial accounts for various types of historical cost. In cost accounting, it is used for costs other than cost of raw material and wages. ,o understand the meaning of cost, it is necessary to define themeaning of expenses. Expenses: (enerally expenses are called expired costs means those costs which have been used up totally in generating revenue. ,hey are not capitalised but only shown as expenses in income

Naresh Cost and Management Accounting MBA III Sem statement. ,here are so many examples of expenses such as costs of goods sold expenses, selling expenses and administrative expenses. -or expenses, there is no need to be paid in cash immediately, even a promise to pay could be made f or the profits received. ,he manufacturing costs are capitali'ed in the form of finished goods inventory and when a sale is incurred, they expire becoming expenses. ,he cost of unsold stoc$ which was an asset prior now converts expenses of cost of goods sold as it has contributed to the generation of revenue. !anufacturing expenses may be expressed as cost because this is included in the cost of fished goods stoc$ which is an asset unless sale is made. -or example, depreciation of a factory machine increases the utility of goods manufactured which are therefore included in wor$&in&progress and finished goods inventory. .elling and administrative expenses, when not included in the cost of finished goods stoc$, are deemed only as expenses, not cost /asset0 and are deducted from revenues whenever obtained. .imilarly, depreciation of a factory building is a cost but depreciation of an office building is an expense. ,he term cost itself is without any significant meaning and therefore, it is always advisable to use it with an ad)ective or phrase that will convey the meaning intended such as prime, direct, indirect, fixed, variable, controllable, opportunity, imputed, sun$, differential, marginal, replacement and the li$e. -uture costs are also considered in cost accounting but not in financial accounting. Loss: ,o understand the concept of cost, the term *loss+ should be defined. #oss is lost cost. It is applied to define two accounting events. In financial accounting, it is used to describe a circumstance where expenses exceed revenues for an accounting period, that is, the reverse of net income /earnings0 for the accounting period. 1n the other hand, a loss arises due to the cost of an asset being more than the sale proceeds when the asset is sold. ,his unfavorable event does not arise from a normal business activity but from non&operating transactions or events. ,his meaning of loss is used to recogni'e the reverse of gain. ,hat is, if no gain is achieved from the cost incurred or it becomes definite that no benefits accrue, the cost becomes a lost cost, i.e., loss on sale of fixed asset, loss of stoc$ Cost :- Cost can be defined as the expenditure /actual or notional0 incurred on or attributable to a given thing. It can also be described as the resources that have been sacrificed or must be scarifies to attain a particular ob)ective. In other words, cost is the amount of resources used for something which must be measured in terms of money. -or example Cost of preparing one cup of tea is the amount incurred on the elements li$e material, labor and other expenses2 similarly

Naresh Cost and Management Accounting MBA III Sem cost of offering any services li$e ban$ing is the amount of expenditure for offering that service. ,hus cost of production or cost of service can be calculated by ascertaining the resources used for the production or services. Costing :- Costing may be defined as *the technique and process of ascertaining costs+. "ccording to %heldon, *Costing is classifying, recording, allocation and appropriation of expenses for the determination of cost of products or services and for the presentation of suitably arranged data for the purpose of control and guidance of management. It includes the ascertainment of every order, )ob, contract, process, service units as may be appropriate. It deals with the cost of production, selling and distribution. If we analy'e the above definitions, it will be understood that costing is basically the procedure of ascertaining the costs. "s mentioned above, for any business organi'ation, ascertaining of costs is must and for this purpose a scientific procedure should be followed. *Costing+ is precisely this procedure which helps them to find out the costs of products or services. Cost Accounting :- Cost "ccounting primarily deals with collection, analysis of relevant of cost data for interpretation and presentation for various problems of management. Cost accounting accounts for the cost of products, service or an operation. It is defined 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+. Cost Accountancy :- Cost "ccountancy is a broader term and is defined as, *the application of costing and cost accounting principles, methods and techniques to the science and art and practice of cost control and the ascertainment of profitability as well as presentation of information for the purpose of managerial decision ma$ing.+
Objectives of Cost Accounting: - 1b)ectives of Cost "ccounting can be summari'ed as

under 3. ,o ascertain the cost of production on per unit basis, for example, cost per $g, cost per meter, cost per liter, cost per ton etc. 4. Cost accounting helps in the determination of selling price. Cost accounting enables to determine the cost of production on a scientific basis and it helps to fix the selling price. 5. Cost accounting helps in cost control and cost reduction. 6. "scertainment of division wise, activity wise and unit wise profitability becomes possible through cost accounting.

Naresh Cost and Management Accounting MBA III Sem 7. Cost accounting also helps in locating wastages, inefficiencies and other loopholes in the production processes/services offered. 8. Cost accounting helps in presentation of relevant data to the management which helps in decision ma$ing. 9ecision ma$ing is one of the important functions of !anagement and it requires presentation of relevant data. Cost accounting enables presentation of relevant data in a systematic manner so that decision ma$ing becomes possible. :. Cost accounting also helps in estimation of costs for the future. Advantages of Costing; " good system of costing is the technique of controlling the expenditure and helps bringing economy in production, so it serves the needs of a large section of people in the following ways. (a)Benefits to the Management; ,he information revealed by cost accounting aims at mainly assisting the management in decision ma$ing and optimi'ing profits. <esides this there are certain advantages of cost accounting to the management i.e. it helps in price fixation, in revealing profitable and unprofitable activities, idle capacity, in controlling cost and also helps in inventory control. (b)Benefits to the Employees; Cost accounting introduces wage scheme, bonus to the efficient = sincere employees which in turn increasing productivity, profitability and lowering cost. (c) Benefits to Creditors; ,he better management of finance through cost accounting leads to timely debt servicing by company in the form of repayment of loan and payment of interest. ,o stay and grow in competition and for )udging soundness of present and perspective borrower and cost reports give better picture of efficiency profit prospectus and capacity. (d) Benefits to the Government; price, ceiling granting subsidy etc. (e)Benefits to Consumers !ublic: Cost accounting helps consumers in getting goods of better quality at reasonable price ,he important branches of accounting are; 1. inan!ia" A!!o#nting: ,he purpose of "ccounting is to ascertain the financial results i.e. profit or loss in the operations during a specific period. It is also aimed at $nowing the financial position, i.e. assets, liabilities and equity position at the end of the period. Cost accounting enables the (ovt. to prepare plans for economic development of the country, to ma$e policies regarding taxation, excise duty, export,

Naresh Cost and Management Accounting MBA III Sem It also provides other relevant information to the management as a basic for decision& ma$ing for planning and controlling the operations of the business. $. Cost A!!o#nting: ,he purpose of this branch of accounting is to ascertain the cost of a product / operation / pro)ect and the costs incurred for carrying out various activities. It also assists the management in controlling the costs. ,he necessary data and information are gatherr6ed form financial and other sources. %. &anage'ent A!!o#nting: Its aim to assist the management in ta$ing correct policy decision and to evaluate the impact of its decisions and actions. ,he data required for this purpose is drawn accounting and cost&accounting. Diffe(en!e )et*een Cost A!!o#nting and &anage'ent A!!o#nting ,he terms Cost "ccounting and !anagement "ccounting are considered to be interchangeable. ,his is accepted since the two fields are interrelated. !oreover, one is a part of the other. <esides this, cost and management accounts are utili'ed in the same context. ,he information available from cost accounts are needed by the management also, especially for stoc$ valuation, order assessment and pricing decisions. ,echnically spea$ing, the cost function is complementary to the management function. >owever, one must not confuse between these two divisions of accounting. ,he difference between cost accounting and management accounting. C1., "CC1?@,I@( !"@"(A!A@, "CC1?@,I@( Cost accounting is more specifically related to !anagement accounting incorporates all the cost determination, budget creation and levels and functions of management variance analysis. ,he data utili'ed for costing could be both of !anagement accounts utili'e the information financial and non&financial type provided by costing and encompass financial as well as non&financial data Cost accounting utili'es specified techniques. !anagement data can include specified $nowledge and s$ills Cost accounts offer a large amount of !anagement information needs less detail as information and data for management compared to cost information accounting ,he cost accounting function/department is !anagement accounting is involved in involved in collection of cost data, analysis of preparing financial statements and attributing cost behavior, preparing financial statements costs to units/ob)ects/departments and attributing costs to units/ob)ects/departments.

Naresh Cost and Management Accounting MBA III Sem ,he process of cost method of accounting, !anagement accounting is consider the overall considers per unit cost. -or example in a steel cost and revenue of the organi'ation mill, the cost of production of one tone of steel is computed. Cost information is useful to both internal and ,he Information provided by the management external parties accounting is useful only to the management Diffe(en!e )et*een Cost A!!o#nting and inan!ia" A!!o#nting C1., "CC1?@,I@( ,he process can also be dynamic and is often continuously implemented, that is it costing ta$es place throughout the process of production and sales ,he process of cost method of accounting, considers per unit cost. -or example in a steel mill, the cost of production of one tone of steel is computed Cost accounting ta$es into consideration all macro and micro details that contributed to the production cost accounting is micro derivation of cost that is required to ma$e one unit of goods and services Cost "ccounting voluntary Cost "ccounting discloses the profit/ loss -I@"@CI"# "CC1?@,I@( ,he process of financial accounting on the other hand is )ust a one time process that ta$es place post the production schedule and post the sales process ,he process of financial accounting on the other hand records the comprehensive cost. -or example it may record the cost of steel that is produced for a month. financial accounting records, the total salary paid to foremen, total cost of machinery, sale cost of that one tone of steel -inancial accounting has a more macro approach and records multiple transactions and costs on the basis of their value and time constraint. -inancial accounting compulsory

-inancial accounting discloses the net profit/net loss of the firms In the cost accounting stoc$ is valuated at cost In the financial accounting stoc$ is valuated at price only cost or mar$et price Cost accounting is the part of financial -inancial accounting is the accounts of whole accounting Cost accounting is concerned with manufacture -inancial accounting is related to commercial of goods and services transactions -ollowing ,echniques of costing are usually used;& a0 +isto(i!a" Costing; In this technique, ascertainment of cost is done after they have been incurred but the utility of this technique is limited b0 Unifo(' Costing;

Naresh Cost and Management Accounting MBA III Sem ,he practice in which common methods of costing for different underta$ings in the same industry are used is $nown as uniform costing. c0 Di(e!t Costing; ,he practice of charging all direct costs to operations, processes or products leaving all indirect costs to be written off against profit+s in which they arise are called as direct costing. d0"bsorption Costing; In this all costs, both variable and fixed are charged to production, operations or processes. e0&a(gina" Costing: ,he method of ascertaining marginal cost by differentiating between fixed and variable costs. ,his technique is used to ascertain effect of changes in volume or type of output over the profits. f0 Standa(d Costing; ,he preparation of standard costs and applying them to measure the variations from actual cost and analy'ing the causes of variations with a view to maintain maximum efficiency in production is $nown as standard costing. g0 A!tivit, -ased Costing; "<C is a system that focuses on activities as fundamental cost ob)ects and utili'es the cost of these activities as building bloc$s or compiling the costs of other cost ob)ects T./ES O COST; ,here are many different types of costs that a firm may consider relevant for decision ma$ing under varying situations the manner in which costs are classified or defined is largely dependent on the purpose for which the cost data are being outlined. ixed Cost;& -ixed Cost are those costs which in total do not vary which changes incorrupt fixed costs are associated with the very existence of a firm+s plant and therefore must be paid even if the firm+s rate of output is 'ero such cost as interest on borrowed capital. apportion of depreciation, changes on equipment and buildings. 0a(ia)"e Cost; & 1n the other hand variable costs are those costs which increase with the level of output. ,hey include payments for raw materials. Changes as fuel, and electricity. %ages and salaries of temporary staff, depreciation charges, based upon the production. Croduction is increases the cost also increases, if production decreases cost also decreases. Bental payments,

Naresh Cost and Management Accounting MBA III Sem Exp"i!it Costs 1o(2 O#t of /o!3et Costs; & Cayment made for the purchases of factors of production, goods and services from other firms for the production of the commodity is $nown as explicit cost. ,here costs are also $nown as out of poc$et cost. -or ex; & %ages, Cay for raw material, Bent. I'p"i!it Costs 1o(2 -oo3 Costs; & Croducer uses his own factors, also in the process of production2 producers generally do not ta$e into account the cost of their own factors. %hile calculating the expenditures, of the firm, but they should definitely be included. ,heir cost should be calculated on the mar$et rate and that should be included. ,here are called implicit costs, because producers do not ma$e payments to others for them. Ax; & Bent to own land. Oppo(t#nit, Costs; & 1pportunity Cost refers, to .acrificing the next best alternative in order to attain that alternative. ,his is nothing but the revenue that is lost in not utili'ing the best alternative. In other words. ,he foregone 1pportunity is considered as cost and it termed opportunity cost. “1pportunity cost of a particular product that resources, used in its production could have produced. S#n3 Costs: .un$ cost refers to those cost which is not affected by change in level of business activity. ,here costs remains same at all levels of business activity. Ax; & Creliminary expenses. Ove(4eads: ,he ultimate aim of overhead accounting is to absorb them in the product units produced by the firm. "bsorption of overhead means charging each unit of a product with an equitable share of overhead expenses. In other words, as overheads are all indirect costs, it becomes difficult to charge them to the product units. In view of this, it becomes necessary to charge them to the product units on some equitably basis which is called as *"bsorption+ of overheads. ,he important steps involved in overhead accounting are as follows. ". Collection, Classification and Codification of 1verheads <. "llocation, "pportionment and Beapportionment of overheads C. "bsorption of 1verheads.

Naresh Cost and Management Accounting MBA III Sem "s mentioned above, the ultimate of overhead accounting is *"bsorption+ in the product units. ,his is extremely important as accurate absorption will help in arriving at accurate cost of production. 1verheads are indirect costs and hence there are numerous difficulties in charging the overheads to the product units. In view of this, lot of care is to be ta$en in the absorption of overheads. Classification of overhears "ccording to this classification overheads are divided according to their elements. ,he classification is done as per the following details. D "ndirect Materials :- !aterials which cannot be identified with the given product unit of cost center is called as indirect materials. -or example, lubricants used in a machine is an indirect material, similarly thread used to stitch clothes is also indirect material. .mall nuts and bolts are also examples of indirect materials. D "ndirect #abor :- %ages and salaries paid to indirect wor$ers, i.e. wor$ers who are not directly engaged on the production are examples of indirect wages. D "ndirect E$penses :- Axpenses such as rent and taxes, printing and stationery, power, insurance, electricity, mar$eting and selling expenses etc are the examples of indirect expenses. D Manufacturing %verheads :- Indirect expenses incurred for manufacturing are called as manufacturing overheads. -or example, factory power, wor$s manager+s salary, factory insurance, depreciation of factory machinery and other fixed assets, indirect materials used in production etc. It should be noted that such expenditure is incurred for manufacturing but cannot be identified with the product units. D Administrative %verheads :- Indirect expenses incurred for running the administration are $nown as "dministrative 1verheads. Axamples of such overheads are, office salaries, printing and stationery, office telephone, office rent, electricity used in the office, salaries of administrative staff etc. D &elling and 'istribution %verheads :- 1verheads incurred for getting orders from consumers are called as selling overheads. 1n the other hand, overheads incurred for execution of order are called as distribution overheads. Axamples of selling overheads are sales promotion expenses, mar$eting expenses, salesmen+s salaries and commission, advertising expenses etc. Axamples of distribution overheads are warehouse charges, transportation of outgoing goods, pac$ing, commission of middlemen etc.

Naresh Cost and Management Accounting MBA III Sem D (esearch and 'evelopment %verheads :- In the modern days, firms spend heavily on research and development. Axpenses incurred on research and development are $nown as Besearch and 9evelopment overheads. E )i$ed %verheads :- -ixed overheads are commonly described as those that do not vary in total amount with increase or decrease in production volume, for a given period of time, may be a year. .alaries, depreciation of fixed assets, property taxes, are some of the examples of fixed costs. ,otal fixed costs remain same irrespective of changes in volume of production but per unit of fixed cost is variable. It increases if production decreases while if production increases, it decreases. E *ariable %verheads :- Fariable overheads are those which go on increasing if production volume increases and go on decreasing if the volume decreases. .uch increase or decrease may or may not be in the same proportion. Fariable overheads are generally considered to be controllable as they are directly connected with the production. E &emi-variable %verheads :- ,hese types of overheads remain constant over a relatively short range of variation in output and then are abruptly changed to a new level. In other words, they remain same up to a certain level of output and after crossing that level, they start increasing. -or example, supervisor+s salary is treated as fixed but if a decision is ta$en to operate a second shift, additional supervisor may have to be appointed which results into increase in the salary of the supervisor. ,his indicates that it is a semi&variable overhead. .imilarly, maintenance expenditure, fire insurance are also semi&variable overheads

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