UNIT ONE

INTRODUCTION TO COST AND MANAGEMENT ACCOUNTING

Cost Accounting
What is cost accounting? We have different definitions for cost. Some of them are:

Cost accounting is an accounting that provides cost information not only for determination of
cost of something but also for controlling of costs of activities (products, services, projects,
departments, processes, etc) and for decision making.

Cost accounting measures and reports financial and other information related to the acquisition
or consumption of an organization’s resources. Cost accounting provides information to both
management accounting and financial accounting.

Objectives of Cost Accounting

 Ascertainment product unit cost

 Controlling cost
 Stimulating cost consciousness
 Determining selling price
 Determining profit and loss for various products and services and inventory valuation &
 Providing basis for formulating operating policies.

Advantage of cost accounting

 Helps in optimum utilization of resources

 Identifies the areas requiring corrective action
 Helps management in formulation of policies and making short term decisions
 Helps to face difficulties in setting prices and improving efficiency.
 Focuses on the profitability of each product or service.

Limitations of cost Accounting

 It is not an exact science and involves inherent element of judgment
 Cost varies with purpose
 It does not give any outright solution to a problem
 Most of its techniques are based on some pre-assumed notions
 It uses arbitrary apportionment of common costs

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Techniques of Costing

Historical data: it is ascertainment of cost after they have been incurred based on recorded data
Standard Costing: is the control technique which compares budgets costs and revenue with
actual results to obtain variances which are used to stimulate improved
performance.
Variable costing: is an accounting system in which variable costs are charged to units produced,
service or activities performed and fixed costs of the period are written off in full
against the aggregate contribution margin.
Direct Costing: it is the practice of charging all direct costs to operations, processes or products
leaving all indirect costs to be written off against profits in the period in which
they arise.
Absorption or full Costing: it is the practice of charging all costs both variable and fixed to
operations, products or processes.
Uniform costing: here standardized principles and methods of cost accounting are employed by
a number of different corporations and firms.

MANAGEMENT ACCOUNTING
Definition: it is an accounting which provides necessary information to the management for
discharging its functions. The functions of management are planning, organizing, directing and
controlling. Thus management accounting provides information to management so that
planning, organizing, directing and controlling of business operations can be done in an orderly
manner.

Objectives of Managerial Accounting Activity

 Providing managers with information for decision making and planning
 Assisting managers in directing and controlling operational activities
 Motivating managers and other employees toward the organizational goals
 Measuring the performance of sub-units, managers and other employees within the
organization

Advantage of Management Accounting

 Planning
 Controlling
 Coordinating
 Organizing
 Motivating and
 Communicating.

Limitations of management accounting

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  Limitations of basic records
 Persistent effort to convince people at all levels about the decisions being made
 It has very wide scope incorporating many disciplines
 Top heavy structure (high cost, numerous rules and regulations)
 Opposition to change by the peoples involved

Management Accounting Guidelines (Directives)

a) Cost benefit Approach- It is concerned with allocation of resources. The expected
benefit from spending resources of an organization should exceed their expected costs.
b) Behavioral and Technical consideration: A management accounting system should
have two simultaneous missions for providing information:
 To help managers make wise economic decisions, &
 To motivate mangers and other employees to strive for organizational
goals.
c) Different costs for different purposes: A cost concept used for the external reporting
purpose may not be appropriate concept for internal routine reporting to managers.

Management philosophies of continuous improvement

a. Just in time operating technique (JIT)- the JIT requires that all resources including
materials, personnel and facilities be acquired and used only as needed. Its objective is to
improve productivity and eliminate wastage.
b. Total quality management (TQM): it is a philosophy that requires all functions work
together to build quality in to the organization product and service. Improved quality of
work environment and the product or service is a goal of TQM.
c. Activity based management (ABM): it is an approach to manage an organization that
identifies all major operating activities, determines what resources are consumed by each
activity, and categorizes the activities as either adding value to a product or service or
not adding value.
d. Theory of constraints: It is concerned with the limiting factors or bottle necks, occurs
during the production of any product or service. Once the managers identify such
limitation or constraint, they can focus attention and resources on it and thus achieve
significant improvements.

FINANCIAL ACCOUNTING

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Definition – it is an art of recording, classifying, measuring and summarizing in a significant
manner and in term of money, transactions and events, which are n part at least, of a
financial character and interpreting the result thereof.

The advantages and Objectives of financial accounting: it includes;

 Summarizing the operational result of a business entity for a particular specified period
showing a profit or loss (income statement)
 Presenting the net in the net asset of that enterprise (statement of owners equity)
 Reflecting the financial position of the business entity at a specific date (balance sheet).
 Presenting economic (financial) information based on historical data to external users for
decision makers

Limitations of Financial Accounting

 It shows only overall performance
 It is historical in nature
 It has no performance appraisal
 It has no material control system
 It has no labor cost control mechanism
 It has no proper classification of costs
 It has no sufficient analysis of losses

Distnictions among the accounting disciplines

Cost accounting and financial accounting
 Financial accounting is primarily concerned with the preparation of financial statement
where as Cost accounting is primarily concerned with determination of cost of
something.
 A cost accountant unlike financial accountant has an obligation to both external
reporting and internal reporting.
 Cost accounting primarily helps management in planning, controlling and decision making
while financial accounting provides external reporting for outside users.

Cost accounting and management accounting

 Cost accounting is all about the ascertainment and control of costs on the other hand,
management accounting involves collecting, analyzing, interpreting and presenting all
accounting information, which is useful to the management.
 Management accounting has a wider scope than cost accounting
 Cost accounting primarily deals with cost data while management accounting involves
the considerations of both cost and revenue.

Management accounting and financial accounting

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Areas of comparison Management accounting Financial accounting

Report format Flexible Acc. To GAAP

Purpose of report Provide information for planning, Report on past performance

control, and decision making
Primary users As a whole business or aggregate External users
employees, mangers, etc
Units of measurement Historical or future dollars Historical dollars

Nature of information Future oriented Historical oriented

Frequency of report Prepared as needed Prepared on regular basis

Legal compulsion Not compulsory (at the discretion of Compulsory (obligatory)

the management)

The value chain of business function

The value chain refers to the sequence of activity (business functions) in which usefulness is
added to the products or services of an organization. The value chain of business function
includes the following:
 Research and development- the generation of, and experimentation of ideas related to
new products or services or process
 Design of products, services or process
 Production – acquisition and assembly of resources
 Marketing – promotion and sell of products
 Distribution -the delivery of products or service to the customers
 Customer service- after sale support activity provide to customers