Cost and Management Accounting

Financial Accounting

Financial accounting tracks two things: assets/debts and income/expenses. The first is tracked by the balance sheet and the second by the income statement.

These are generally the basis for investment decisions by the shareholders. financial analyst. creditors. lending decisions by banks and credit decisions by vendors.Financial Accounting    It is concerned with providing information of the business with the help of financial statements to investors. . government agencies and others. Financial statements summaries the result of operations for selected period of time and show financial positions of the business at particular dates.

such as Profit and loss account. Accounting system: Journals. Users: owners. ledgers and other techniques are used in the preparation of financial statements. customers etc .   Contents: The end product of the financial accounting processes are the financial statements . creditors. Balance sheet. employees.

) 60.000 6.000 5.000 20.100 .500 7.000 600 2.Sheet Details Direct Material: Material Consumed Direct Labour: Productive wages Direct Expenses Prime cost Add : Factory overheads Indirect Material: Consumable stores Oil grease/lubricants Indirect Labour: Unproductive wages Salary of a factory Manager Indirect Expenses: Factory rent Repair and Depreciation on Machine Factory cost Amount (Rs.600 97.000 85.000 2.000 2.000 500 1.000 2.

 . This information helps them set prices so that they can make a profit on their goods. These are the benefits given up to acquire goods and services.Cost Accounting   Initially used by agriculturist or craftsman who desired to establish a price to be charged of his product. Cost accounting tracks manufacturing costs and allocates them to various products. ―Cost‖ are resources sacrificed or foregone to achieve a specific objective.

―Cost Accounting‖ is the branch of accounting dealing with the classification.   ―Accounting‖ is the financial information system. allocation. summarization and reporting of current and prospective costs. recording.‖ It refers to determining the process of determining the price of some product. It measures and communicates the financial effects of transactions and events. .

Cost accounting helps the management in the following manner  . systematic and useful cost data and reports to manage a business.Cost accounting and management  Management requires adequate.

000 15% .000 12.Eg: Particular SALES Materials Wages Direct Exp PRIME COST Work exp Selling Exp Distribution Exp General & Admin OVERHEAD COST Total cost A 60.000 4.000 1.000 12.50.000 1.000 33.500 1.00.000 1.000 2.000 16.000 1.000 1.000 1.70.000 32.000 Profit % profit/ loss 12.00 400 1.000 30.000 C 40.600 400 4.000 48.000 20.000 8.000 22.000 44.000 8.000 200 400 200 200 1.000 3.000 41.000 26.000 34.33% -(8000) (-)20% 6.02.000 20% 20.000 15% 30.000 D 40.000 TOTAL 2.000 24.000 7.000 2.000 2.000 8.000 3.000 500 2.000 40.000 40.000 8.000 33.000 48.000 B 60.

The firm may decide to discontinue the product C. enables the firm to take prompt action to overcome the problems of producing and selling product ―C‖. Also selling price of the product can be increased to a profitable level. but cost structure is referred to find out whether or not more efficient manufacturing. selling and distribution is possible. short intervals which are not prepared in financial accounting.  Cost statements produced at regular. .

cost data are vital in pricing new products. Product mix.  1.long and short term product mix decisions . Cost accounting helps the management in controlling cost and budgeting. and to make a decision in whether to lower or raise price. Cost accounting helps in making revenue decisions— Pricing. 2.

Cost Acc v/s Financial Acc Cost Accounting .

shareholders.its main purpose is to provide detailed cost information to management for proper planning. . 1. IT dept. Cost Acc. decision making and control.the main purpose of financial accounting is to prepare profit and loss account and balance sheet for reporting to creditors. Govt etc.Cost v/s Financial Accounting PURPOSE Fin Acc.

NATURE  Fin Acc. presents and interprets. the material.2. records. records.  . transactions and events that are of financial character for the preparation of financial statements. presents and interprets. labor and overhead costs involved in manufacturing and selling each product.it classifies.it classifies. Cost Accounting.

but another asset (the truck) is added. Financial accounting is essentially a measure of "how well are we doing?"  Cost Acc. As an example of :if I buy a truck for the company with the company's money.Accounting system  Fin Acc. one asset (money) goes down.it follows double entry system for recording.it may not be based on double entry system . classifying and summarizing business transactions.

Accounting principles   Fin Acc.it is based on GAAP ― generally accepted accounting principles‖ Cost Acc. .it may or may not use ―GAAP‖ for recording transactions.

it gives the account of the whole business and discloses the net profit or loss of the whole business.Analysis of profit   Fin Acc.it discloses profit or loss of each product . Cost Acc.

 . product units for the purpose of decision making. Cost acc. cost accounting involves measures such as machine hours. labor hours.besides monetary unit.all information is in terms of money.Unit of measurement  Fin Acc.

here data and statements are developed for a definite period usually yearly.Time Span   Fin Acc. .reports and statements are made whenever needed. half yearly. Cost Acc. quarterly.

Control Aspect  Fin Acc.it does not provide adequate control over material.  .it takes control over all elements of cost. wages and overhead cost. Cost Acc.

Measuring organizational.Area of management accounting       Budgeting. forecasting Calculating the profitability of products. service and operations. planning. departmental performances Comparing results and performance within and between organizations Advising on decision on whether to outsource a products. components Assisting in making a wide range of strategic decision .

economic influences on . In management accounting the objective is to have a data pool which will include any and all information. it may be investigated as to what extent it will effect company’s share prices. Also study of growing competition. Eg : if management decides to depend on the equity capital for expansion of business. the management would need. cost and price data.Management Accounting   It is not only confined to the area of product costing.

so that management can more effectively plan. &make decisions . Thus management accounting is concerned with data collection from internal and external sources. analyzing. processing and interpreting the information for the use within the organization.

finance. . It makes use of information that is drawn from financial accounting and other disciplines such as economics. statistics etc.

Cost v/s Management Accounting Definition : Cost Acc. .it is a system of accounting which is concerned with internal reporting of information to management for planning and controlling operations and decision making. 1.it is concerned with the techniques of product costing and deals with only cost and price data. Management Acc.

Historical v/s Predetermined cost Cost Acc. Management Acc. .cost is determined on the basis of past data.uses primarily present and future information.2.

Management Acc. Decision making v/s Control Cost Acc.e keeping the cost in a limit or budgeting it. .the focus is on cost control.its primary function is to aid the management in decision making.i.3.

Use of financial acc Management accounting uses financial accounting techniques such as ratio analysis. .4. fund flow analysis. Cost accounting does not use financial accounts as such.

5. management accounting employs many quantitative models from statistics. Cost accounting does not have such scope. operations research. research findings. . Wider scope   For planning and control.

Reports to those inside the organization for planning. directing and motivating. tax authorities and regulators.Financial Accounting v/s Managerial Accounting Financial Acc . Managerial Acc . .Reports to those outside the organization owners. controlling and performance evaluation. lenders.

.Emphasis is on decisions affecting the future.Emphasis is on summaries of financial consequences of past activities.Financial acc. Management Acc.

Management Acc. .Objectivity and verifiability of data are emphasized.Relevance of items relating to decision making is emphasized.  Financial acc.

Management Acc-Detailed segment reports about departments. . and employees are prepared. customers.Only summarized data for the entire organization is prepared.  Financial acc. products.

 Financial acc.  .Must follow Generally Accepted Accounting Principles (GAAP) & Mandatory for external reports. Management acc.Need not follow Generally Accepted Accounting Principles (GAAP) & Not mandatory for external reports.

direct and indirect cost Product cost and period cost Relevant and irrelevant cost .Cost classification Cost Variability – Behavioral cost Functi onal Controllable and uncontrollab le Traceabilit y.

. taxes. insurance.Variability – Behavioral cost Fixed cost It is a cost which remains unaffected by changes in the level of activity during a given time period. salaries 1. Eg: rent.

For example. As the company moves more of this product. the costs for packaging will increase. when fewer of these products are sold the costs for packaging will consequently decrease. a company may have variable costs such as labour associated with the packaging of one of its products. Variable cost It is that cost which vary with the changes in the level of activity. It increases/decreases in the same proportion with the output. Conversely. .2.

Eg: increase cost of AC in summer. . Semi. here rental element is fixed.3. but not due to change in the level of activity .Variable cost (Fixed+ variable cost) eg: telephone charges. Also some variable cost changes. and call charges are variable depending on the number of calls.

. direct labour.Functional classification 1. It is inclusive of all direct material. depreciation. rent of factory. Eg: salary of factory manager. power and fuel used in factory.   Manufacturing cost – cost related to production of an item and covers all cost incurred up to the stage when the goods are ready to dispatch. direct expenses and manufacturing expense.

depreciation of office building. office power bill. . Administrative cost   It includes cost of policy formulation and its implementation to attain the objectives of organization. Eg: salaries of management and clerical staff.2. rent of offices.

cost of activities relating to create demand of company’s product and to secure orders. van drivers. Research & development cost. Selling and distribution cost Selling cost.cost incurred in moving goods from source to destination.3.  Distribution cost. Eg: warehouse exp. wage of packers.  . depreciation and maintenance of delivery van. 4. Eg: travelling expenses of salesmen.

These are uncontrollable cost. The controllable cost can be regulated during a given time span by a particular individual.Controllable and uncontrollable cost Eg: excessive scrap may arise from inadequate supervision or from defect in purchasing material. fire. . Political change like change in govt policy. Eg: physical hazards like flood. Economic change like increase in competition.

program). therefore.An expense such as advertising.Direct and Indirect cost   Direct (traceable cost)An expense that can be traced directly to (or identified with) a specific cost center or cost object such as a department. material. function. fuel or power Indirect Cost(common cost). security. computing. or product. supervision) incurred in joint usage and.  . difficult to assign to or identify with a specific cost object or cost center (department. process.maintenance. Eg: labor.

Relevant and irrelevant cost  Relevant costs are those costs which are relevant for decision making.of pocket . Relevant cost Differential opportunity Out.

Differential cost
Eg: If you have a decision to run a fully automated operation that produces 100,000 widgets per year at a cost of $1,200,000, or of using direct labor to manually produce the same number of widgets for $1,400,000, then the differential cost between the two alternatives is $200,000. In making a decision, management compares the cost of alternatives. A difference in the cost of alternatives is called differential cost.

Description

Retailer (Present) Revenue (variable) $700,000 Cogs (V) 350,000 Advertising (V) 80,000 Commissions (F)* -0Warehouse (V)** 50,000 Depreciation Other Expenses (F) 60,000 Total 540,000 Net Operating Income$160,000 *F = Fixed

Direct Sale (Proposed) $800,000 400,000 45,000 40,000 80,000 60,000 625,000 $175,000

Differential Costs and Revenues $100,000 50,000 (35000) 40,000 30,000 -0— 85,000 $15,000

According to the above analysis

The differential revenue is $100,000 and the differential cost is $85,000,leaving a positive differential net operating income of $15,000 under the proposed marketing plan. The net operating income under the present distribution is $160,000, whereas the net operating income under door to door direct selling is estimated to be $175,000. Therefore the door to door direct distribution method is preferred, since it would result in $15,000 higher net operating income.

Opportunity cost

It is the potential benefit that is given up when one alternative is selected over another. Eg: if product A is estimated to generate a profit 0f Rs.56,000and product B Rs.71,000. the company chooses product B and the opportunity cost of selecting product B is the sacrifice of Rs. 56,000 that could be earned by product A.

then cost of fuel. driver’s salary and maintenance expenditure are the cost in cash or out of pocket costs.of – pocket cost   The relevant cash expenditure which is involved in a particular situation. Eg: if the company decides to deliver the goods by public carrier.Out. . instead of company’s delivery truck.

 . Eg: Sunk Cost -A sunk cost is a cost that has already been incurred and that cannot be changed by any decision made now or in future.Irrelevant cost These cost may be ignored while decision making.

. Jolly Ltd. purchased a machine for $. It is expected to result in savings in operating costs of $. 30. The machine can be sold immediately for $. Soon after making the purchase. management feels that the machine should not have been purchased since it is not yielding the operating advantage originally contemplated. The machine has an operating life of five yea$ without any scrap value.000 over a period of five years. 18.000.

such costs are said to be sunk costs and should be ignored in decision making. assume that a company paid $50. For this reason.000 several years ago for a special purpose machine. .

. A manufacturer or an organization may have to suspend its operations for a period on account of some temporary difficulties.. such as rent and insurance of buildings. depreciation.g. though no work is done yet certain fixed costs. During this period. non-availability of requisite labor etc.. maintenance etc. Such costs of the idle plant are known as shutdown costs. for the entire plant will have to be incurred. shortage of raw material. e.

. direct expenses and factory overheads. Conversion Cost The cost of transforming direct materials into finished products excluding direct material cost is known as conversion cost. It is usually taken as an aggregate of total cost of direct labor.  15.

Cost Sheet The statement of cost according to element-wise is known as cost sheet. It encloses the following: 1. Total cost . Prime cost 2. Work cost 3. Cost of production 4.

ELEMENT-WISE CLASSIFICATION COST COMPONENTS DIRECT COST (PRIME COST) Direct Material Direct Labor Direct expenses PRIME COST WORK COST COST OF PROD UCTIO N TOTAL COST INDIRECT COST (OVERHEADS) Manufacturing Exp Administration Exp Selling Exp Distribution Exp R&D exp .

COST SHEET DIRECT MATERIAL + DIRECT LABOR + DIRECT EXPENSES PRIME COST PRIME COST + MANUFACTURING EXPENSE/ FACTORY COST WORK COST WORK COST + ADMINISTRATIVE EXPENSES COST OF PRODUCTION COST OF PRODUCTION + SELLING & DISTRIBUTION EXP TOTAL COST .

boxes etc 3. printing and stationery material etc. which can be measured. 2. jute etc Materials Direct materials Indirect materials All materials directly used in production.MATERIAL  The substance from which a product is made is known as material. Such as cotton. Material (primary and raw) purchsed for a particular job.. Components purchased or produced The material which is used for purposes ancillary to the business and which cannot be conveniently assigned to specific physical units is termed as indirect material. Primary packing material e. thread. are some of the examples of indirect material. carton.1. wrapping. Glue.g. 1. cardboard. oil and waste. These are part of manufacturing overheads .

 . There is some stock of raw material in balance at opening and closing of the period. Hence. It is not necessary that all the material purchased in a particular period is used in production. it is necessary that the cost of opening and closing stock of material is adjusted in the material purchased.

  Opening stock of material is added and closing stock of raw material is deducted in the material purchased and we get material consumed or used in production of a product. . It is calculated as : Material Consumed = Material purchased + Opening stock of material – Closing stock of material.

timekeepers. productive labor.2. composition or condition of the product The labor which actively and directly takes part in the production of a particular commodity is called direct labor.Labour  For conversion of materials into finished goods. human effort is needed and such human effort is called labor. Direct labor can also be described as process labor. Labour Direct Labour Indirect Labour Wages paid to such labor that does not alter the construction. . commission of salesmen etc. operating labor Wages of storekeepers. foremen.

Maintainance expenses on such machinery Rent.Direct Expenses Expenses Direct Expenses Indirect Expenses Expenses other than direct materail and direct labour. . 1. lighting. directly incurred on a specific cost unit. Hire of some special machinery required for a particular contract 2. insurance charges. Expenses incurred for the business as a whole rather than for a particular job.

Indirect labor such as salaries of salesmen and sales manager etc 3. Indirect labor such as salaries payable to office manager. clerks. Thus. 2. Indirect expenses such as rent. oil. works manager’s salary etc. etc. Indirect materials used in an office such as printing and stationery material. brooms and dusters etc. 3. factory insurance. 3. Indirect expenses such as rent. 2. factory lighting etc. Indirect expenses such as factory rent. consumable stores etc. advertising expenses etc. OVERHEADS FACTORY 1. lighting of the office SELLIND & DIST 1. printing and stationery material etc. insurance. office accountant. timekeeper. Indirect labor such as gatekeeper. Indirect materials used such as packing material. 2. indirect labor and indirect expenses. . Indirect material used in a factory such as lubricants. ADMINISTRATIVE 1.OVERHEADS  The term overhead includes indirect material. insurance. all indirect costs are overheads.

Cost sheet format .

Interest received on bank deposit. Obsolescence loss 5. idle time of labour . Profit on sale of investment 5. Writing off good will. Interest on debenture.ITEMS EXCLUDED FROM COST SHEET PURELY FINANCIAL CHARGES PURELY FINANCIAL INCOME APPROPPRIATION(Di stribution OF funds from )PROFITS ABNORMAL GAIN/ LOSS 1. fix asst 2. 3. Income tax 3. Loss on sale of investment.Rent/interest/divi dend receivable 4. Damages received through a court of law 1. Dividend on shares 4.Discount. Damages payable through a court of law 1. fix deposit 4. commission received 3. bank loans. Transfer to reserve Abnormal loss of material. preliminary exp. Charitable donations 5. 2. capital raising exp 2. Fines and penalties.

METHODS OF COSTING  Different industries follow different methods of costing because of the differences in the nature of their work. The various methods of costing are as follows: .

Methods of Costing Costing Job costing BATCH CONTRACT MULTIPLE UNIT Process costing SERVICE OPERATION .

Users: manufacturing concerns where order is produced to a customers specifications.Job costing   It is a costing method applied to determine the cost of specific jobs or lots of production generally manufactured according to customers specification. .

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Job Costing Example   David. . is a small furniture manufacturing business making. and Co. all kids of furniture in Texas. Bryan. They received an order for 10 chairs from a customer in Kansas City.

hence it is beneficial Helps in identifying profitable and unprofitable jobs Helps in preparing estimates when submitting job quotations for similar jobs Helps in analyzing the job trend for different jobs Helps in fixing the selling price .Advantages      Here since there are different direct and indirect cost each time for different products.

Disadvantages  It is very expensive to operate because it involves detailed clerical work. hence the chances of errors are there .

A batch may represent a number of small orders passed through the factory in batch . the cost can be ascertained by Batch Costing. Eg.Batch Costing This method is used to determine the cost of a group of identical or similar products. In case a factory produces a certain quantity of a part at a time. medicines etc. production of nuts. bolts.000 rims of bicycle.  It is the extension of job costing. say 5.

4.  . It is suitable for firms engaged in the construction of bridges. aero planes. buildings etc. The whole system of costing is known as multiple costing.3.it is used in those industries where the nature of the product is complex. Suppose a firm manufactures bicycles including its components. the parts will be costed by the system of job or batch costing but the cost of assembling the bicycle will be computed by the Single or output costing method. In such case cost are accumulated for different components making the final product. Or It is a combination of two or more methods of costing outlined above. Contract Costing Here the cost of each contract is ascertained separately. roads. such as motor cars. Multiple/ composite Costing.

Job cost sheet .

Process Costing   1. gas. . 2. paper etc. This costing method is used in those industries where production is done continuously. Features of process costing: Manufacturing activity carried out continuously The output of one process becomes the input of another. oil. such as chemical.

the product being the only one produced like a thousand of brick. Single or Output Costing or unit costing  Here the cost of a product is ascertained. a tonne of a coal. etc.1. .

like cost of making pulp and cost of making paper from pulp. 3. the name given is operation costing. Operation Costing. retail trade etc.  Here the cost of completing each stage of work is ascertained. Operating Costing  It is used in the case of concerns rendering services like transport.2. In mechanical operations. the cost of each operation may be ascertained separately. supply of water. .

. Profit is effected by volume of output. price and product mix on profits. technology and efficiency of work force. Eg: cost of a product is effected by choice of plant. cost.Cost volume profit analysis   It measures the effect of changes in the volume.

   Thus CVP helps in finding the effect of changes in price. cost and volume on profits. It helps in determining the level of sales to earn a desired level of profit. Effect on profit by changes in sales mix. .

Model of CVP  Less Less Sales variable cost --------------Contribution Fixed cost ------------------Profit .

It is a point on which the total cost and revenue are just equal.Break even analysis     It is a technique to study cost-volume-profit relationship. If the production and sales are increased beyond this level. . the business will earn profit. It establishes relationship between revenues and cost with respect to volume.

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