ACOF014

Trimester 1 2022/2023

CHAPTER 1: INTRODUCTION TO COSTING AND COST CLASSIFICATION

Learning Objectives:
After study this topic, students should be able to:
1. Differentiate between Financial Accounting & Managerial Accounting.
2. Identify key concepts in Managerial Accounting.
3. Understand the roles of Managerial Accounting.
4. Classify costs into: Costs for stock valuation and profit measurement, Costs for
decision making and planning and Costs for control.

1.1 Difference Between Financial Accounting and Management Accounting

i.
In relation
Financial Accounting Management Accounting
to…
Users  Concerned with the  Concerned with the
or provision of information to provision of information to

Audience external parties outside the people within the

organisation
 I.e. For external reporting
such as to owners,
investors, creditors,
bankers, regulators (stock
exchange, tax)
Purpose  Financial reporting
Type of  Financial measurements
Information  Financial statements
 Backward-looking; past
information
organisation to help them
make better decisions
 Internal decision-making
 Financial and non-financial
information
 Various internal reports
 Future-oriented

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Report  Issued periodically  Issued as needed; can be

Frequency quarterly, monthly, weekly,
daily, even hourly
Precision or  Accurate, objective,  Subjective, relevant,
Nature of reliable, auditable involves

Information estimation/approximations,
flexible
Scope  Highly aggregated;  May be more detailed; less
or summarised summarised

Segment  Whole of organisation  May focus on smaller parts

of organisation as well (e.g.
Individual products,
activities, departments)
Legal  Subject to public &  No restrictions, upon
Requirement regulatory scrutiny request/necessity

or  Must comply with MASB,  Optional, and not subject to

Restrictions securities commission, regulations

company act rules &  Not required by law
regulations

ii. Cost Accounting

a. Is concerned with the cost accumulation for stock valuation to meet the
requirements of external reporting and internal profit measurement
(Drury)
b. "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" (Lucey)

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c. The application of accounting and costing principle, methods and

technique in the ascertainment of costs and analysis of savings and/ or
excess as compared with previous experience or with standards (CIMA)
iii. Management Accounting
a. Is a method of providing information to management in order to assist in
planning and control activities.
b. Is a method in providing of appropriate information for decision making,
planning, control and performance evaluation (Drury).
iv. Financial Accounting
c. Is a method of analyzing, classifying and recording financial position,
financial performance and change in financial position.
d. Is a rule requiring matching costs with revenues to calculate profit
(Drury)

1.2 Theory and Practice of Cost Accounting

i. The roles of Management Accountant
Management accountant performs the task of management accounting in the
managerial process to achieve the company’s objectives. Below are the
functions performed by the management accountant:
a. Assist in setting up information system relating to cost accounting
matters. This system is a service to the managers.
b. Advises and monitors the system.
c. Use their expertise to analyse raw data and present to the management.
d. Interprets the figures reported and explain how the data and information
can be made useful.

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ii. Purpose/role of Cost Accounting

a. Foundation of the internal financial information system.
b. Management needs a variety of information to plan, to control, and to
make decisions.
 Cost accounting and planning:
 Calculation of costs that will be incurred in the future and also
the analysis of past costs will assist managers in planning
 Cost accounting and control:
 To ensure that operations, departments, processes and costs
are under control – organisation as a whole are working
efficiently towards agreed objectives
 Costing system provides a sound basis of information for
financial control – monitors the results of all activities.
 E.g. budgeting and standard costing
 Cost accounting and decision making:
 Decision making – making a choice between alternatives
 Financial implications (information provided by the costing
system) of the various alternatives is essentially a critical
factor in making such decision

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1.3 The Cost Terms and Concepts in Costing

i. Cost
a. The amount of expenditure (actual or notional) incurred on, or
attributable to, a specified thing or activity. i.e. cost = quantity x price.
i. Cost units
a. Costs are always related to some object or function or service
b. A unit of product or service in relation to which costs are ascertained
c. May be units of production (e.g. tonnes of cement, typewriters) or units
of service (e.g. consultation hours, number of invoices processed,
kilowatt-hours)
d. E.g. cost of making one unit of table (cost/unit), cost of producing ten
tonnes of iron ore (cost/tonne).
ii. Direct costs
a. Costs which can be directly identified with a job, batch, product or
service
b. Consists of direct materials, direct labour and direct expenses
c. Do not have to be spread between various categories – the whole cost
can be attributed directly to a production unit or saleable service
d. Total of direct costs is known as prime cost.
iii. Indirect costs
a. All material, labour and expense costs that cannot be identified as direct
costs are termed indirect costs.
b. The three elements of indirect costs: indirect materials, indirect labour
and indirect expenses are collectively known as overheads.
c. In practice, overheads are usually separated in categories such as
Production Overheads, Administrative Overheads and Selling
Overheads.

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iv. Cost Centre

a. A production or service location, function, activity or item of equipment
for which costs are accumulated.
b. Responsibility centre where managers are accountable for the expenses
that are under their control.
c. Normally consists of departments, but in some instances they consist of
smaller segments such as groups of machines within a department.
v. Cost allocation
a. To assign a whole item of cost, or of revenue, to a single cost unit,
centre, account or time period.
b. Applies to direct costs as well as indirect costs.
vi. Cost apportionment
a. To spread revenues or costs over two or more cost units, centres,
accounts or time periods. This may also be referred to as ‘indirect
allocation’.
b. The choice of an appropriate basis is a matter of judgement to suit the
particular circumstances of the organisation and wherever possible
there should be a cost-cause relationship.
c. The process of apportionment is an essential part of the build-up of
overheads, because many indirect costs apply to numerous cost centres
rather than just to one.

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1.4 Cost Objectives & Classification of Costs

i. Cost Objectives
a. Any activity for which a separate measurement of costs is desired.
b. In other words, if the users of accounting information want to know the
cost of something, this “something” is called a cost object/objective.
c. E.g. Cost of a product, the cost of rendering a service to a direct-selling
customer, the cost of operating a particular department or job.
d. Cost objectives are divided into 3 broad categories: (refer page 7 – 15)
 Costs for stock valuation
 Costs for planning and decision making
 Costs for control
e. E.g.
 Cost of operating an existing machine is a cost objective that may
be required for a comparison with the costs of operating a
replacement machine – costs for decision making.
 Cost of operating a department is a cost objective that may be
required for a comparison with the budgeted costs – costs for
control
f. Cost objectives and possible cost classifications
Cost Objective Possible methods of cost classifications
Costs for stock  Period and product costs
valuation  Elements of manufacturing costs
 Job and process costs
Costs for planning &  Cost behaviour
decision-making  Relevant and irrelevant costs
 Avoidable and unavoidable costs
 Sunk costs
 Opportunity costs
 Marginal and incremental costs
Costs for control  Controllable and uncontrollable costs

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g. Cost objectives are divided into 3 broad categories:

 Classification of Costs for Stock Valuation and Profit Measurement
costs
 Unexpired vs Expired costs
 Unexpired costs:
 Resources that have been acquired and that are
expected to contribute to future revenue.
 They are recorded as assets in the balance sheet.
 Expired costs:
 Unexpired costs that have been consumed in the
generation of revenue and have no future revenue-
producing potential.
 They are recorded as expense in the profit and loss
account.
 Example – stock (asset); becomes cost of goods sold
(expense); matched against sales (revenue).
 Period and product costs
 For stock valuation, only manufacturing costs should be
included in the calculation of product costs.
 Product costs – costs that are identified with goods
purchased or produced for resale. Product costs are
included in stock valuation for finished goods, or for
work-in-progress. (Manufacturing costs)
 Prime cost – direct costs of the product = direct
materials + direct labour + direct expenses.
– Direct materials – all those materials that can
be physically identified with a specific product.
E.g. Wood – direct materials in producing a
desk.

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– Direct labour – those labour costs that can be

specifically traced to or identified with a
particular product. E.g. – wages of operatives
who assemble parts into the finished products
(desk).
– Direct expense – expenses incurred
specifically for a particular product. E.g.
royalties paid per unit for a copyright design.
 Manufacturing overhead – all manufacturing costs
other than direct labour, direct materials and direct
expenses.
– Indirect materials – Those materials that
cannot be directly traced to a particular unit of
product. E.g. varnish
– Indirect labour – Those labour costs that
cannot be physically identified with a particular
product. E.g. salaries of factory supervisors.
– Indirect expense – expenses that cannot be
traced to the item being manufactured. E.g.
rent and rates of the factory
 Period costs – costs that are not included in the stock
valuation. Treated as expense in the period in which they
are incurred (Non-manufacturing costs)
 Financial expenses: bank charges, interest on loan,
discounts allowed
 Selling and distribution: salesmen’s salaries,
commission
 Administrative: salaries of office staff.

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 Job and Process Cost

 Job costing
 Refers to accounting system that determines the
cost of individual orders (jobs).
 It is suitable in a production environment where
each new order is different from the earlier or
succeeding order.
 E.g.
– Shoe manufacturing where each order differs
from the following due to different
specifications being required.
– Vehicle repair shops, where each vehicle
repair requires different parts replacement and
labour hours.
– Garment manufacturing, where orders
received could vary significantly from one
another.
 Process costing
 Helps to determine the cost per unit of product
produced in an environment where identical
products are produced for all customers.
 E.g.
– Electronic assembly line where all products
produced is identical.
– Biscuit manufacturing where although there
may be more than one product line, each line
is a separate, continuous process producing
identical products.

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 Classification of Costs for Planning & Decision-Making

 Cost accounting is concerned with the calculation of actual
product costs for stock valuation and profit measurement,
whereas management accounting is concerned with the
provision of information to help people within the organisation
make good decisions.
 Cost behaviour:
 Fixed costs
 Remain constant over wide ranges of activity for a
specified time period.
 E.g. depreciation of the factory building,
supervisors’ salaries, rent
 Graph:
Total fixed
cost (RM)

Activity level

 Unit fixed costs decrease proportionally with the

level of activity.
 E.g. if the total of the fixed costs is RM5,000 for a
month, the fixed costs per unit will be as follows:
Units Fixed cost per
produced unit (RM)
1 5,000
10 500
100 50
1,000 5

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 Therefore, the graph should look like:

Unit fixed cost

(RM)

 Variable costs
 Vary in direct proportion to the volume of activity –
Activitywill
doubling the level of activity level
double the total
variable cost.
 Total variable costs are linear and unit variable cost
is constant.
 E.g. sales commissions, raw materials, petrol
 Graph:
Total Variable Cost Unit Variable Cost
(RM) (RM)

5,000
10
4,000

3,000

2,000

1,000 100 200 300 400 500

100 200 300 400 500

Activity level (units of output) Activity level (units of output)

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 Semi-fixed or step fixed costs

 Costs that are fixed within specified activity levels
but they eventually increase or decrease by a
constant amount at various critical activity levels
 E.g. labor costs. If production capacity expands to
some critical level, and therefore additional workers
will be employed, labor costs could be semi-fixed.
Total fixed cost (RM)

Level of activity

 Semi-variable costs
 Include both a fixed and a variable component
 These are costs that change with production, but
not in direct proportion to the volume.
 E.g. telephone charge which has a fixed charge for
line rental of say RM68 per month and a variable
charge per minute for call charges of say RM0.30
per minute.

104

Total cost Variable cost

(RM) element
68
Fixed cost
elements
120 Minutes
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 Relevant and Irrelevant Costs and Revenues

 Past vs. future
 differ between alternatives
 For decision-making, costs and revenues can be
classified according to whether they are relevant to
a particular decision
 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
 E.g. Petrol costs is relevant in deciding whether to
have a journey by own car or public transport. But
the neither car insurance nor car tax costs are
relevant.
 Sometimes, the terms avoidable and unavoidable
costs might be replacing the terms relevant and
irrelevant costs.
 Sunk costs
 The cost of resources already acquired where the
total will be unaffected by the choice between
various alternatives
 They are the costs that have been created by the
decision made in the past and that cannot be
changed by any decision that will be made in the
future.
 E.g. Let say you want to conduct a project. You
have two alternatives whether using the old
machine or replacing it with a new machine. The
cost of purchasing the old machine is therefore

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sunk cost. Whether you want to use it or you want

to buy a new one, the cost has already incurred
 Sunk costs are irrelevant for decision making.
 Distinguished from irrelevant costs because not all
irrelevant costs are sunk costs.
 Opportunity costs
 Cost that measures the opportunity that is lost or
sacrificed when the choice of one course of action
requires that an alternative course of action be
given up.
 E.g. if an asset such as capital is used for one
purpose, the opportunity cost is the value of the
next best purpose the asset could have been used
for. Acquiring or renting? Let say, you choose to
acquire a building. A saving of RM150 per month of
renting might be your opportunity cost.
 Incremental and marginal costs/revenues
 Incremental costs and revenues are the additional
costs or revenues that arise from the production or
sale of a group of additional units.
 E.g. You want to set up a branch in Muadzam Shah.
Therefore, you need the analysis on the
incremental costs and revenues by setting up such
a new branch (including sales, advertising, staff
salaries, travelling, rentals etc)
 Marginal cost/revenue represents the additional
cost/revenue of one extra unit of output. If let say
the cost of producing 1 unit of table is RM20, how
about two units?

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 Classification of Costs for Control

 Costs and revenues must be traced to the individuals who are
responsible for incurring them. This is called responsibility
accounting
 In an organisation, normally it has 3 responsibility centres:
 Cost centre – managers are accountable for the
expenses that under their control. E.g. advertising
department, purchasing department
 Profit centre – managers are accountable for sales
revenue and expenses. E.g. sales department
 Investment centre – managers are normally accountable
for sales revenue and expenses, but in addition are
responsible for some capital investment decisions.

 Controllable and non-controllable costs and revenues

 Costs and revenues allocated to responsibility centres
should be classified according to whether or not they are
controllable or non-controllable by the manager of the
responsibility centres.
 A controllable cost may be defined as a cost that is
reasonably subject to regulation by the manager with
whose responsibility that cost is being identified.

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TUTORIAL QUESTIONS

1. Describe FOUR (4) differences between management accounting and financial

accounting.
2. Define the meaning of the term ‘cost object’ and provide THREE (3) examples of
cost objects.
3. Distinguish between a direct and an indirect cost.
4. Provide examples of each of the following:
(a) Direct labour (d) Indirect materials
(b) Indirect labour (e) Indirect expenses
(c) Direct materials
5. Distinguish between product costs and period costs.
6. Explain the meaning and example for each of the following terms:
(a) Fixed costs (c) Semi-fixed costs
(b) Variable costs (d) Semi-variable costs
7. Classify each of the following as being usually fixed (F), variable (V), semi-fixed (SF)
or semi-variable (SV):
(a) Direct labour (e) Advertising
(b) Depreciation of machinery (f) Maintenance of machinery
(c) Factory rental (g) Factory manager’s salary
(d) Supplies and other indirect (h) Supervisory personnel
materials (i) Royalty payments
8. Which of the following costs are likely to be controllable by the head of the production
department?
(a) Price paid for materials (g) Insurance on machinery
(b) Charge for floor space (h) Share of cost of industrial
(c) Raw materials used relations department
(d) Electricity used for machinery
(e) Machinery depreciation
(f) Direct labour

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9. Classify each cost item by placing an “X” mark under the appropriate cost
category.
No. Cost Item Direct Direct Manufacturing Non-
Materials Labour Overhead Manufacturing
Overhead
1. Rent on factory
machinery
2. Insurance on
manufacturing building
3. Raw materials
4. Manufacturing utilities
5. Office supplies
6. Wages for workers
7. Depreciation on office
equipment
8. Manufacturing
supervisor’s salary
9. Advertising cost
10. Sales commissions
11. Depreciation on
manufacturing building
12. Lubricant for factory
machinery
13. Maintenance of
machinery
14. Cleaning service for
office
15. Depreciation for office
photocopying machine

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