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BY: Mohammad Amer Qais Abro Submission Date: 09/01/12




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When properly implemented, the cost accounting function can have a pervasive influence in the modern manufacturing companies. Unfortunately, it is not always properly implemented because management often is not completely aware of all the uses to which the cost accounting function can be put. This report describes the main categories of activities in which this function can become involved. The definition of accounting according to Colin Drury is the process of classifying, measuring and sharing economic information to allow for educated decisions and choices by users of the information. Users of accounting information can be divided into two categories (i) External parties outside the organization (financial accounting); (ii) Internal parties within the organization (management accounting). Accounting information is significant secretaries must use accounting skills to manage the company check-book and orders, auditors have to study financial statements to evaluate the accuracy and integrity of the business, and executives need to judge the success of their business using accounting statements from the past and present. These are just a few of the many possible positions where an understanding of accounting is necessary. Another reason for the importance in accounting is because in recent years, people in the business world have been held more accountable for their financial practices. Since the Enron and WorldCom crisis when independent auditor Arthur Anderson failed to report illegal accounting practices, the SEC has been monitoring public corporations more closely. Thus, companies require some basic knowledge of accounting to avoid any future misstatements unintentionally occurring.


There are differences between management accounting and financial accounting include such as management accounting provides information to people within an organisation while financial accounting is mainly for those outside it, such as shareholders. Financial accounting is required by law while management accounting is not. Specific standards and formats may be required for statutory accounts such as International Financial Reporting Standards. Financial accounting covers the entire organisation while management accounting may be concerned with particular products or cost centres. Managerial accounting is used primarily by those within a company or organization. Reports can be generated for any period of time such as daily, weekly or monthly. Reports are considered to be "future looking" and have forecasting value to those within the company. Financial accounting is used primarily by those outside of a company or organization. Financial reports are usually created for a set period of time, such as a fiscal year or period. Financial reports are historically factual and have predictive value to those who wish to make financial decisions or investments in a company. Management Accounting is the branch of Accounting that deals primarily with confidential financial reports for the exclusive use of top management within an organization. These reports are prepared utilizing scientific and statistical methods to arrive at certain monetary values which are then used for decision making. Such reports may include: Sales Forecasting reports, Budget analysis and comparative analysis, Feasibility studies and Merger and consolidation reports. Financial Accounting, on the other hand, concentrates on the production of financial reports, including the basic reporting requirements of profitability, liquidity, solvency and stability. Reports of this nature can be accessed by internal and external users such as the shareholders, the banks and the creditors. This contrast in basic orientation results in a number of major differences between financial and managerial accounting, these differences are discussed in the following paragraphs. Emphasis on the Future: Since planning is such an important part of the manager's job, managerial accounting has a strong future orientation. In contrast, financial accounting primarily provides summaries of past financial transactions. These summaries may be useful in planning, but only to a point. Relevance of Data: Financial accounting data are expected to be objective and verifiable. However, for internal use the manager wants information that is relevant even if it is not completely objective or verifiable. By relevant, we mean appropriate for the problem at hand. For example, it is difficult to verify estimated sales volumes for a proposed new store at a new location, but this is exactly the type of information that is most useful to managers in their decision making. The managerial accounting

information system should be flexible enough to provide whatever data are relevant for a particular decision. Less Emphasis on Precision: Timeliness is often more important than precision to managers. If a decision must be made, a manager would rather have a good estimate now than wait a week for a more precise answer. A decision involving tens of millions of dollars does not have to be based on estimates that are precise down to the penny, or even to the dollar. In fact, one authoritative source recommends that, "as a general rule, no one needs more than three significant digits, this means, for example, that if a company's sales are in the hundreds of millions of dollars, than nothing on an income statement needs to be more accurate than the nearest million dollars. In addition, managerial accounting places considerable weight on non-monitory data, for example, information about customer satisfaction is tremendous importance even though it would be difficult to express such data in monitory form. Segments of an Organization: Financial accounting is primarily concerned with reporting for the company as a whole. By contrast, managerial accounting forces much more on the parts, or segments, of a company. These segments may be product lines, sales territories divisions, departments, or any other categorizations of the company's activities that management finds useful. Financial accounting does require breakdowns of revenues and cost by major segments in external reports, but this is secondary emphasis. In managerial accounting segment reporting is the primary emphasis. Generally Accepted Accounting Principles (GAAP): Financial accounting statements prepared for external users must be prepared in accordance with generally accepted accounting principles (GAAP). External users must have some assurance that the reports have been prepared in accordance with some common set of ground rules. These common ground rules enhance comparability and help reduce fraud and misrepresentations, but they do not necessarily lead to the type of reports that would be most useful in internal decision making. Managerial Accounting Not Mandatory: Financial accounting is mandatory; that is, it must be done. Various outside parties such as Securities and Exchange Commission (SEC) and the tax authorities require periodic financial statements. Managerial accounting, on the other hand, is not mandatory. A company is completely free to do as much or as little as it wishes. Since managerial accounting is completely optional, the important question is always, "Is the information useful?" rather than, "Is the information required?" Advantages of Financial Accounting Systems Financial accounting is the field of accountancy concerned with the preparation of financial statements for decision makers such as stockholders, suppliers, banks, employees, government agencies, owners, and other stakeholders. In direct contrast to financial accountancy, managerial

accountancy is for internal decision making and does not have to follow any rules enforced by standard setting authorities. All activities carried out by financial accountancy bodies are regulated by Generally Accepted Accounting Principles guidelines (GAAP). Those in favour of financial accounting for a business or company, large or small, point to a number of factors which they feel are advantageous. Firstly, it allows people to measure the profitability and value of a business, rather like having a dossier of the businesss transactions you can see how well or how poorly the company is doing. It also helps when attempting to compile a company report for those outside the company, this might be for prospective buyers or investors, who wish to see a full and detailed account before becoming involved. Financial accounting and the information it generates can act like a barometer for an organization, allowing achievements and losses to be measured against rivals and competitors and produce a clear picture of where a firm stands in its particular field. Disadvantages of Financial Accounting Systems Corporate financial statements also exclude estimates of social costs beyond those directly impacting the bottom line. However, there are guidelines on the reporting of environmental liabilities - these pertain to likely remediation and liability issues, rather than long-term social issues. These liabilities are often reported in the statement footnotes since their magnitude is unknown. Advantages of Managerial/Cost Accounting Systems Business owners often use management accounting to track a record and report financial information for managerial review. Management accounting does not usually follow any national accounting standards. Business owners can design management accounting systems according to their company business operations or management need for business information. Management accounting has several advantages. These advantages usually coincide with the ability for companies to improve operations and overall profitability. Business owners can also create a competitive advantage by developing cost allocation processes in their management accounting function. Reduce Expenses Management accounting can help companies lower their operational expenses. Business owners often use management accounting information to review the cost of economic resources and other business operations. If overall product quality would not suffer by using a cheaper raw material, business owners can make this change to reduce production costs. Improve Cash Flow Budgets are a major part of management accounting. Business owners often use budgets so they have a financial road map for future business expenditures. Many budgets are based on a companys historical financial information. Management accountants will comb through this information and create a master budget for the entire company. Larger business organizations may use several smaller budgets for divisions or departments. These individual budgets usually roll up into the companys overall master budget. The main purpose of budgets is to save the company money through careful analysis of necessary and unnecessary cash expenditures.

Business Decisions Management accounting often improves the business owner decision-making process. Rather than making business decisions based solely on qualitative analysis, business owners or managers can use management accounting information as a decision-making tool. Management accounting usually provides a quantitative analysis for various decision opportunities. Business owners can review each opportunity through the prism of quantitative analysis to assure they have a clear understanding relating to business decisions. Increase Financial Returns Business owners can also use management accounting to increase their company financial returns. Management accountants can prepare financial forecasts relating to consumer demand, potential sales or the effects of consumer price changes in the economic marketplace. Business owners will often use this information to ensure they can produce enough goods or services to meet consumer demand at current prices. Companies also pay close attention to the amount of competition in the economic marketplace. Competition can reduce the company financial returns from business operations.

Disadvantages of Managerial/Cost Accounting Systems Most corporate managerial accounting systems do not track costs closely. Easily identifiable costs, such as labour or raw materials, are often finely tracked and allocated to particular product or process lines, but many costs - such as administration costs and environment, health, and safety costs, are considered to be indirect or overhead costs and are allocated broadly across product and process lines. Placing a cost in an overhead account allows it to be shared across activities, but generally removes cost responsibility from any one particular product line or manager. If no one is responsible for a cost, it is likely to be ignored, or in the worst case, may increase as a result of efforts to reduce other costs.


Accounting information also needs to provide relevant information to help managers make better decisions such as Profitability analysis, Product pricing, Make or buy (Outsourcing) and Product mix and discontinuation


EXTERNAL REPORTING The key task for the cost accounting information is contributing information to a companys external financial reports. In many cases where the main accounting function is perceived to be financial reporting (such as in a publicly held company), the other tasks of the cost accounting information may very well be subordinated to providing various types of information for these external reports. A key piece of information provided by the cost accounting information is inventory valuation, which in turn impacts the cost of goods sold. Several tasks are involved here, such as deciding on the type of cost layering technique, ensuring that inventory quantities and costs are accurate, and compiling the resulting data into the formats required for external reporting. Other related work may also be needed, such as compiling profitability levels for various product lines, or profit levels by division. The cost accounting information may also become involved in the compilation or updating of a few footnotes to the financial statements, though most of these are handled by the financial accounting staff. INTERNAL REPORTING The advantage of having cost accounting information create reports strictly for internal consumption is that they are not restricted to generally accepted accounting principles (GAAP) when preparing these reports. GAAP requires the use of full-absorption costing in the creation of external reports, which may not be necessary or may even be counterproductive for internal reporting purposes. Accordingly, the cost accounting information is free to use any costing paradigm that will result in the most informative reports for the management teamjob costing, process costing, direct cost costing, activity-based costing, direct costing, throughput costing, and so on. For example, direct costing can be used for an internal report that focuses specifically on activities in the extreme short term, where there is no impact associated with overhead costs. Alternatively, a report can be based on throughput costs if the issue is how to push the correct product mix through a bottleneck operation in order to derive the highest possible profit. Further, full-absorption costing can be used for reports that focus on long-term decisions. The accounting method can therefore be precisely tailored to the use to which the report will be put. Some examples of different reporting structures include: Corporate-level reports. These reports may include only trend lines of information about a few critical success factors that senior managers are most interested in influencing, bottom-line profits and return on assets for each production facility or store, and perhaps forecasts at the product line level. The exact format used varies not only by company but also over time within each company, as different reporting items become less or more important to the senior management team. There is certainly no reason to include deeply detailed reports in the reporting package that goes to senior managersthey do not have the time to wade through such a morass of information. Business unit-level reports. These reports must include a much larger quantity of information, for the recipient (the plant manager) needs to know about the operation of each department, as well as a host of operational issues such as the cost of quality, inventory turnover, machine utilization, profitability, and cash

flow projections. This tends to be the most voluminous of all reporting packages, as well as the one that includes the greatest mix of financial and operational information. Function-level reports. These reports can be issued to individual departments or at lower levels, for example, to the supervisors of individual machines. Such reports are custom-designed for each recipient, with some requiring more financial data (e.g., for the sales manager who wants to know about customer bad debts or orders booked) and others including almost entirely operational information (e.g., for the warehouse manager who is interested in inventory turnover, kiting percentages, and receiving accuracy). Project-specific reports. A project report is slanted more toward just those costs being incurred for a specific purpose and so tends to be heavy on direct costs and light on most other allocations. This report usually compares incurred costs against budgeted costs expected to have been incurred at various stages of the project. If a project is already bringing in revenues, the reporting structure can be converted to a profit center format. This format tends to have few operational statistics besides percentages of completion and lists of to-do items that must be finished in order to ensure conclusion of the project. Decision-specific reports. Many times the cost accounting information is called on to report on a specific issue that occurs only once, after which the report is discarded. For example, a report may be needed that describes the particular quality costs associated with the selection of three prospective production processes the management team is considering installing. Once the decision is made and the installation completed, there is no longer a need for the report. Another example is a review of waste in a production processthe report may cover such information as times elapsed when moving products between manufacturing stations, setup times, cycle times, and the amount of space occupied by idle work in process; this report is concerned less with financial issues than with process efficiency, but it is still the cost accounting informations job to complete it. Clearly, these reports can cover virtually any topic and can include any type of information financial, operational, or a mix. An enormous range of topics can be covered by internal reports. Because they lack the amount of structure imposed on external reports, they are much more interesting to prepare, giving the cost accounting information free rein to express creativity in designing the perfect format that will result in easy readability and effective management decision making.

CHAPTER 5: COST CLASSIFICATIONS Direct versus indirect costs Direct costs are easy to match with a process or product, whereas indirect costs are more distant and have to be allocated to a process or product Fixed versus variable costs If business sells more units of a certain item, some of the costs increase accordingly (variable costs), but some costs remain the same (fixed costs).

Relevant versus Irrelevant costs Relevant costs: Costs that should be considered and included in analysis when deciding on a future course of action. Relevant costs are future costs that would incur, or bring upon itself, depending on which course of action will be taken Irrelevant costs: Costs that we should disregard when deciding on a future course of action; if brought into the analysis, these costs could cause us to make the wrong decision. An irrelevant cost is a vestige of the past that money is gone. Actual, budgeted, and standard costs The actual costs a business incurs may differ (though hopefully not significantly) from its budgeted and standard costs. Actual costs: Historical costs, based on actual transactions and operations for the period just ended, or going back to earlier periods. Budgeted costs: Future costs, for transactions and operations expected to take place over the coming period, based on forecasts and established goals. Standard costs: Costs, primarily in the area of manufacturing, that are carefully engineered based on detailed analysis of operations and forecast costs for each component or step in an operation.


Product Costs; for financial accounting purposes, include all the costs that are involved in acquiring or making product. In the case of manufactured goods, these costs consist of direct materials, direct labor, and manufacturing overhead. Period Costs are all the costs that are not included in product costs. These costs are expensed on the income statement in the period in which they are incurred, using the usual rules of accrual accounting that we learn in financial accounting. Sunk cost are costs that were incurred in the past. Sunk costs are irrelevant for decisions, because they cannot be changed. Sunk costs are costs that were incurred in the past. Committed costs are costs that will occur in the future, but that cannot be changed. As a practical matter, sunk costs and committed costs are equivalent with respect to their decision-relevance; neither is relevant with respect to any decision, because neither can be changed. Sometimes, accountants use the term sunk costs to encompass committed costs as well. Plant wide overhead rate is a single overhead rate that a company uses to allocate all of its manufacturing overhead costs to products or cost objects. Using a plant wide overhead rate is acceptable in circumstances like the total amount of overhead to be allocated is so small that using multiple allocation rates to achieve a higher level of allocation accuracy is unnecessary, the services provided by the various company departments are relatively similar (a rarity); or the single allocation base used is acceptable for allocating all of the overhead costs. Conversely, a single plant-wide overhead rate is not acceptable if a company has a large amount of overhead to allocate, services provided by the various departments are highly differentiated, or it is apparent that a number of different allocation bases should be used Cost objects are tangible input for a product manufactured/Service provided, like labour or material. Manufacturing companies requires some amount of predetermined labour and predetermined raw material for any amount of cloth being manufactured. The cost of employing labour can be directly fixed as "per man per hour" or "per man per day per hour per minute per annum", so the labour is a cost object as one can directly associate cost with it. Similarly the raw material like cotton or threads or fabric can be another cost object. Traditional Costing Method A traditional costing system does not divide cost by function or allocation or by each part of the manufacturing process. It takes a total cost and divides it by each part of the process. so essentially each part of the manufacturing process is assigned an equal estimated cost. The strengths of traditional costing systems are: simplicity the calculation of overhead rates is relatively straightforward; they are widely understood in the business; they are not expensive to operate. They are still being used after many decades. The weaknesses of traditional costing systems are: their reliance on arbitrary rather than cause-and-effect allocation of overheads; their inability to give accurate product costs in multiproduct companies; their failure to analyse nonmanufacturing costs. Activity-Based Costing Method Activity-Based Costing (ABC) is a method of allocating costs to products and services. It is generally used as a tool for planning and control. It was developed as an approach to address problems associated with traditional cost management systems, that tend to have the inability to


accurately determine actual production and service costs, or provide useful information for operating decisions. With these defiencies managers can be exposed to making decisions based on inaccurate data. The higher exposure is for companies with multiple products or services.

The advantage of ABC method has evolved from a product cost tool to a performance enhancement tool that helps to compute a more accurate cost. This, of course, is of minimal value unless there is an associated effort to reduce cost and improve performance. On the other hand; ABC method has some limitations & disadvantages. For instance, an ABC information system method might be very expensive to implement and requires special expertise. It has lost ground to the economic value-added (EVA) analysis and the balance scorecard methodology as a strategic tool. Finally, gathering and maintaining accurate activity information has always been the Achilles heel of the ABC method.


Financial Accounting Systems Income Statement: The Income Statement presents the results of the operating activities of a company for a specific period of time - usually the fiscal year. The statement summarized the revenues and expenses and reveals the net income or earnings of the firm during the period of time covered. The income statement is an aggregated record of all sales and all corresponding expenses over a given past period typically a year. Example:

Firms that aimed to be successful in its business activities and expected to be in long term competitiveness are firms that are having the ability to produce relevant information of its internal and external sources. Generally, the significant information needed for making business decision is the financial information. This information helped the management to manage problems in supervising and controlling the areas in costing, expenditure and cash flow. Therefore, one of the most important tools to assist companies in processing and producing good financial information is by having suitable income statement.


Balance Sheet The balance sheet explains how the business is currently using its resources and how those uses have been financed. It balances the assets employed (all long-term resources in the business) against the capital employed (the long-term finance in the business). Example:


Cash Flow Statement: Cash flow statements and projections express a business's results or plans in terms of cash in and out of the business, without adjusting for accrued revenues and expenses. The cash flow statement doesn't show whether the business will be profitable, but it does show the cash position of the business at any given point in time by measuring revenue against outlays.



CHAPTER 6: SUMMARY & CONCLUSION Despite the large number of categories of work discussed here, it does not begin to reflect the full range of tasks that the cost accounting information may be involved. The cost accounting information can reliably expect to be assigned to tasks in every nook and cranny of a corporation, which is what makes the job such an interesting one, far more so than that of a financial accounting information, whose job is much more closely defined by external accounting reporting rules. The only common denominator among the various cost accounting tasks is that they focus on providing information for management decision making. Typically, the task is to conduct a short analysis of a specialized topic, draw conclusions, and make recommendations that will be acted on by management to make improvements. The responsibility here is great, for the cost accounting informations recommendations ultimately have a direct impact on company operations and overall profitability.

Drury, C. (2011) Management Accounting for Business 4th Edition Cengage Learning EMEA Ray H. Garrison, Eric W. Noreen, Peter C. Brewer, Managerial Accounting 12th Edition, McGraw Hill =en