Costing Principles

Cost and management

accounting

Provides management with costs for

products, inventories, operations or
functions and compares actual to
predetermined data
It also provides a variety of data for
many day-to-day decision as well as
essential information for long-range
decisions
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Functions of managerial
accounting

Determining the cost

Providing relevant information for
better decision-making
Providing information for planning,
control, decision-making and
application

Planning

Deals with the estimation of

product costs, setting up of costing
system to record cost data,
preparation of cost standards and
budgets, planning of materials and
manpower resources, analysing
cost behavior with changes in
levels of activity
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Control

Deals with the maintenance of

product costing record, comparison
of actual performance with
standards or budgets, anlaysis of
variances, recommendation of
corrective actions, controlling cost
to ensure operational efficiency
and effectiveness
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Decision-making

Deals with whether it is more

profitable to make or buy a
component, determine the
economic order quantity and
production batch size, replace
fixed asset, add or drop products,
decide pricing

Application

Cost accounting has extended from

manufacturing operations to a
variety of service industries such
as hotels, bands, airline, etc
Cost accounting system should be
flexible and adaptable to meet the
new business environment and the
changing nature of the company
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Element of cost

Cost object
Cost
Cost unit
Cost centre
Profit centre

Cost object

It is an activity or item or operation

for which a separate measurement
of costs is desired
E.g. the cost of operating the
personnel department of a
company, the cost of a repair fob,
and the cost for control
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Cost

It is the amount of expenditure

incurred on a specific cost object
Total cost = quantity used * cost
per unit (unit cost)

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Cost unit

It is a quantitative unit of product

or service in which costs are
ascertained, e.g. cost per table
made, cost per metre of cloth

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Cost centre

It is a location or function of an
organisation in respect of which
costs are ascertained
E.g. the rent, rates and
maintenance of buildings; the
wages and salaries of
strorekeepers
12

Profit centre

It is location or function where

managers are accountable for
sales revenues and expenses
E.g. division of a company that is
responsible for the sales of
products

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Cost classification

Direct cost
Indirect cost (overhead)

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Direct cost

Cost that can be identified

specifically with or traced to a
given cost object
The direct costs consist of the
following three elements:

Direct materials
Direct labour
Direct expenses
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Direct materials

The cost of materials the cost of

materials used entering into and
becoming the elements of a
product or service
E.g. fabrics in garments

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Direct labour

The cost of remuneration for

working time
E.g. assembly workers wages in
toy assembly

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Direct expenses

Other costs which are incurred for

a specific product or service
E.g. royalties

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Indirect cost (overhead)

Cost that cannot be identified

specifically with or traced to a
given cost object
They are identified with cost
centres as overheads

Indirect materials
Indirect labour
Indirect expenses
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Indirect materials

Such as stationery, consumable

supplies, spare parts for machine
that assist to the production of
final products

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Indirect labour

Such as salaries of factory

supervision and office staff that do
not directly involve in production of
the final product

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Indirect expenses

Such as rent, rates, depreciation,

maintenance expenses that do not
have instant relationships with the
manufacturing processes

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Cost accumulation

Prime cost = direct materials + direct labour + direct exp

Production cost = Prime cost + factory overhead
OR
= Direct materials + Conversion cost
*Conversion cost is the production cost of converting raw
materials into finished product

Total cost = Prime cost + Overheads (admin, selling,distribut

OR
= Production cost + period cost (administrative, sel

distribution and finance cost)

Period cost is treated as expenses and matched against sales for cal
profit, e.g. office rental
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Cost coding

A code is a system of symbols

designed to be applied to a classified
set of items to give a brief, accurate
reference, facilitating entry, collation
and analysis
Coding is important in modern
computerised accounting systems for
catergories various composite
accounting items
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Reasons

To reducing error owing to

descriptions
Enable easy recalling
Reduce computer file size as a
code

25

Cost behaviour

Costs can be classified into

variable, fixed, semi-variable, or
step-costs according to how they
behave with respect of changes in
activity levels

26

Variable cost

It increases or decreases in direct

proportion to levels of activity, but
the unit variable cost remains
constant
E.g. cost of food served in a
restaurant

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Fixed cost

Total fixed cost remains constant

over a relevant range of activity
level but unit fixed cost falls with
an increase in activity volume

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Semi-variable cost

It processes characteristics of both

fixed and variable cost
It increases or decreases with
activity level but not in direct
proportion

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Step cost

It remains constant for a range of

activity levels, then, on further
increase in activity, the cost jumps
to a new level and remains
constant over a certain range until
the next jump occurs

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Cost for stock valuation

Unexpired and expired cost

Product and period cost

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Unexpired cost

Unexpired costs are the resources

that have been acquired and are
expected to contribute to the future
revenue
They will be recorded as assets in
current period
They will be charged as expenses
when they have been consumed in
the generation of revenue
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Expired costs

Expired costs are the expenses

attributable to the generation of
revenue in the current period

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Product cost

Product cost are related to the goods

purchased or produced for resale
If the products are sold, the product cost
will be included in the cost of goods sold
and recorded as expenses in current period
If the products are unsold, the product costs
will be included in the closing stock and
recorded as assets in the balance sheet

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Period cost

Period cost related to the operation

of a business
They are treated as fixed cost and
charged as expenses when they
are incurred
They should not be included in the
stock valuation
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Comparison of cost,
management and financial
accounting

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Meanings

Financial accounting
Cost accounting
Management accounting

37

Financial accounting

Provides information to users who

are external to the business
It reports on past transactions to
draw up financial statements
The format are governed by law and
accounting standards established
by the professional accounting
policies
38

Cost accounting

Is concerned with internal users of

accounting information, such as
operation managers
The generated reports are specific
to the requirement of the
management
The reporting can be in any format
which suits the user
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Management accounting

Comprises all cost accounting

functions
The accounting for product and
service costs, management
accounting extends to use various
internal accounting reports for
planning, control and decision
making
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Cost and management

accounting
Vs.
Financial accounting

41

Management
Financial
(cost)accountin accounting
g
Nature

Records company
Records
material, labour
transaction events
and overhead
External financial
costs in product
statements are
or job
produced
Reports
produced are for
internal
management and
contol

Accountin Not based on the Follows the double

entry system
g system double entry
system

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Management
Financial
(cost)accounting accounting
Accountin No need to use
accounting
g
principles principles

Adopt any
accounting
techniques that
generates useful
accounting
information

Users of
informati
on

Used by different
levels of
management or
departments
responsible for

Use Generally
Accepted Accounting
Principles for
recording
transactions

Used by external
parties:
shareholders,
creditors,
government, etc

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Management
Financial
(cost)accountin accounting
g
Operation
guideline
s or
standards

Based on
management
instructions and
requirements

Time
span

Reports are
prepared
whenever needed
They may be
prepared on a
weekly or daily
basis

Conforms to
company
Ordinances, stock
exchange rules,
HKSSAPs
Reports are
prepared for a
definite period,
usually yearly and
half yearly

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Management
Financial
(cost)accountin accounting
g
Time
focus

Perspecti
ve

Future
orientation:
forecasts,
estimates and
historic data for
management
actions

Past orientation:
use of historic data
for reporting and
evaluation

Detailed analysis Financial summary

of parts of the
of the whole
entity, products,
orgainisation
regions, etc
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Cost accounting
vs.
Management accounting

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Management
accounting

Cost accounting

To provide
information for
planning and
decision making
by the
management

Concerned with
Basic of
recording transactions

Objective

related to the
future

To ascertain and
control cost

Based on both
present and future
transactions for cost
ascertainment

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Management
accounting

Cost accounting

Coverage

Covers a wider
area: financial
accounts, cost
accounts,
taxation, etc.

Utility

Only the needs

of internal
management

Covers matters
relating to
ascertainment and
control of cost of
product or service
The needs of both
internal and external
interested groups

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Management
accounting
Deals with both
Types of
transactio monetary any
non-monetary
ns

transactions,
covering both
quantitative and
qualitative
aspects

Cost accounting
Deals only with
monetary
transactions,
covering only
quantitative aspect

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