MPA 602: Cost and

Managerial Accounting

Introduction
DEFINITION OF ACCOUNTING
• Accounting is the process of identifying,
measuring and communicating economic
information about an entity to permit informed
judgments and decisions by users of the
information (Anthony et al, 1995)
What economic information?
Examples
• Assets of the entity
• Liabilities of the entity
• Expenses & income of the entity
• Performance of the entity
• Financial position of the entity
• Liquidity position of the entity
Users of accounting information

• Management
• Investors: Shareholders/owners & lenders
• Creditors/ suppliers
• Debtors/customers
• Government
• The public/ Community
• Financial analysts
• Employees
Branches of Accounting
• Financial Accounting
• Cost Accounting
• Management Accounting
 Accounting:
• Financial Accounting: (Stewardship Accounting)
• limits its activities in recording business transaction and
determining financial results and position.

• Cost Accounting: (Control Accounting)

• takes the responsibility of determining cost of products and
services and controlling costs with a view to maximizing
profit.

• Management Accounting: (Decision making Accounting)

• takes the duty of helping management in planning and
decision making.
 Functions:
• Fin. Acc.
• Recording business transaction.
• Determining the end results of the business.
• Determining the financial position on the closing date of the
accounting period.
• Cost Acc.
• Determining cost of product or services.
• Controlling cost of product or services.
• Measuring efficiency.
• Supplying financial and cost data.
• Mgt. Acc.
• Assisting management in planning.
• Assisting management in taking decisions in special situation
Relationship of Financial, Management, and Cost
Accounting
Product
Costs

FINANCIAL COST MANAGEMENT

ACCOUNTING ACCOUNTIN ACCOUNTING
G
Cost Accounting
 Cost Accounting
• “Cost Accounting is the identification, accumulation, assignment
and analysis of production and activity cost data to provide
information for external reporting, internal planning and control
of ongoing operations and special decisions.”
• Cost accounting is concerned with providing information for
financial accounting and management accounting purposes.
Cost accounting provides the product cost data needed for
inventory valuation in the statement of financial position and for
income determination in the Income Statement. It also provides
the cost data needed for budgeting, the control of operation
and special decisions e.g. pricing decision.
1959- Committee of Mgt Acc. of the AAA
• “ The application of appropriate techniques & concepts in processing
the historical & projected income data of an entity to assist
management in establishing plans for reasonable economic objectives
& in the making of rational decisions with a view toward achieving
these objectives. It includes the method & concepts necessary for
effective planning, for choosing among alternatives business actions &
for control through the evaluation & interpretation of performance. Its
study involves consideration of ways in which accounting information
may be accumulated, synthesized, analyzed & presented in relation to
specific problems, decisions & day to day task of business
management.”
 Limitations of Financial Accounting:
 Improper classification of accounts.
 Control of material and supplies.
 Recording of labor and wages.
 Improper classification of costs.
 Absence of standard of efficiency.
 Closure of accounts.
 Product pricing.
 Absence of control over the use of physical facilities.
 Decision relating to long term investment.
 Absence of adequate reporting
Advantages of Cost Accounting:
• Cost determination
• Cost control
• Identification and elimination of wastage.
• Identification of causes resulting in increase or decrease in profit or
losses.
• Identification of variances.
• Identification of causes of variation within departments and over the
period.
• Measuring the effects of capacity utilization at different levels.
• Development of cost reduction program.
• Identification of responsibility center.
• Material control.
• Management information
• A cost accountant may furnish data relating to managerial decision in
respect of buy or make, acceptance of order below cost etc.
• A cost accountant may help fixation of product price by supplying
necessary financial and cost data.
• Use of managerial costing may help the management taking short run
decision.
• Miscellaneous advantage
• A cost accounting system may supply information for use by various
outside agencies.
• The operation of cost audit may prevent fraud pr manipulation in cost
accounts.
• Cost of closing stock i.e. material, work-in-process and finished goods
may be derived automatically.
The Role of Cost Accounting:
• Establishing costing methods & procedures that permit control & if
possible reduction or improvement of costs.
• Aiding & participation in the creation & execution of plans & budgets.
• Creating inventory value for costing & pricing as described by law & at
times controlling physical quantities.
• Determining company costs & profit for an annual & shorter
accounting period in total or by segment, as determined by mgt. or
required by governmental regulations.
• Providing mgt. with cost information in connection with problems that
involve a choice among alternative courses i.e. decision making. The
decision may be to enter into a new market, develop the costs of a
new product, discontinue a product line, buy or lease equipment, or
take other action to increase profit or solve problems.
 What is Managerial Accounting?
• It is the process of identifying, measuring, accumulating, analyzing,
preparing, interpreting, and communicating information that managers
use to fulfill organizational objectives.
• The branch of accounting that produces information for managers within
an organization is termed as Managerial Accounting.
• The term Managerial accounting refers to accounting for the
management, i.e., accounting which provides necessary information to
the management for discharging its functions. The functions of the
management are planning, organizing, directing and controlling.
• Thus, Managerial accounting provides information to management so that
planning, organizing, directing and controlling g of business operation
can be done in an orderly manner.
16
 1-17

Comparison of Financial and Managerial Accounting

 Distinction between Cost Accounting and
Managerial Accounting

Cost Accounting:

Cost Accounting is the process of a accounting for costs which begins with
recording of income and expenditure or the bases on which they are
calculated and ends with the preparation of statistical data.

Managerial Accounting:
It is the process of identifying, measuring, accumulating, analyzing,
preparing, interpreting, and communicating information that managers use to
fulfill organizational objectives
 Difference Between Cost Accounting and Managerial Accounting
Base Cost Accounting Managerial Accounting

Cost Accounting is a process of Managerial accounting is one which enables

Meaning
ascertaining the cost management in doing its functions efficiently.

The primary object of Cost accounting is Managerial accounting is aims at representation of

Objects to determine the records, cost of products
and services.
The scope of Cost accounting is not wide,
Scope
it is apart of Managerial accounting
Under this system of cost accounting
Principles
certain principles are followed.
Both parties, internal and external have
Parties
interested in costing
Principles and Cost accountancy have some established
formats and set accounting principles and formats
cost data or accounting information for management
use.
Managerial accounting has wider scope. It includes
Financial accounting, Cost accounting an statistics
etc.
No principles is followed under the system of
managerial accounting.
Managerial accounting is specially designed for
management or internal use.
it is not so in the case of the management
accounting
Cost
 Cost
• Cost can be defined as the value of the sacrifice made to
acquire goods or services, measured in monetary units by the
reduction of assets or incurrence of liabilities at the time the
benefits are acquired. At the time of acquisition the cost
incurred for present or future benefits. When these benefits
are utilized, the cost becomes expense.
• An expense is defined as a cost that has given a benefit and is
now expired. Unexpired costs that can give future benefits are
classified as assets.
• When assets are given up for nothing in return in those cases
the value of the assets given up becomes a loss.
Cost Classification
 Classification of costs:
The achievement of the objective of cost accounting requires that cost should be
ascertain, analyzed and classified.
Classifications are based on the relationship of costs to:
• The product
• Volume of production/cost behavior pattern.
• Ability to trace.
• Departments where incurred.
• Functional areas.
• Timing of charges against revenue.
• Time when computed.
• Degree of averaging.
• Relationship with accounting period.
• Relationship to planning, controlling and decision making.
 1-24

Manufacturing Costs
Direct
Direct Direct
Direct Manufacturing
Manufacturing
Materials
Materials Labor
Labor Overhead
Overhead

The Product
1-25

Direct Materials
Raw materials that become an integral part of
the product and that can be conveniently traced
directly to it.

Example:
Example: A
A radio
radio installed
installed in
in an
an automobile
automobile
1-26

Direct Labor
Those labor costs that can be easily
traced to individual units of product.

Example:
Example: Wages
Wages paid
paid to
to automobile
automobile assembly
assembly workers
workers
 1-27

Manufacturing Overhead
Manufacturing costs cannot be traced directly to
specific units produced.

Examples:
Examples: Indirect
Indirect materials
materials and
and indirect
indirect labor
labor

Materials used to support the Wages paid to employees who

production process.
Examples: Lubricants and
cleaning supplies used in the
automobile assembly plant.
are not directly involved in
production work.
Examples: Maintenance workers,
janitors and security guards.
1-28

Classifications of Nonmanufacturing
Costs

Administrative
Selling Costs
Costs

Costs necessary to get All executive,

the order and deliver organizational, and
the product. clerical costs.
 Volume of Production:
• Fixed cost: are those in which total fixed cost remain constant over a
relevant range of output, while the fixed cost per unit varies with the
output. Beyond the relevant range of output, fixed cost will vary.
• The relevant range refers to that range of activities in which management
expects the firm to be operative in the next planning period.

• Variable cost: are those that in total will change proportionately as levels
of activities are changed. A variable cost can be viewed as a cost that is
constant as per unit.

• Mixed cost: contain both fixed and variable characteristics over relevant
ranges of operation. Mainly two types:
• Step cost
• Semi-variable cost
• Relationship between cost & volume within the relevant
range:
• Total variable cost change in proportion to change in
volume.
• Per unit variable cost remain constant when volume
changes.
• Total fixed cost remain constant when volume changes.
• Per unit fixed cost increase/decrease when volume
decrease/increase.
 1-31

Cost Classifications for Predicting Cost Behavior

Behavior of Cost (within the relevant range)

Cost In Total Per Unit

Variable Total variable cost changes Variable cost per unit remains
as activity level changes. the same over wide ranges
of activity.
Fixed Total fixed cost remains Average fixed cost per unit goes
the same even when the down as activity level goes up.
activity level changes.
 Ability to trace:

• Direct cost: cost that management is capable of tracing

to specific items or areas. e.g. direct material, direct
labor etc.

• Indirect cost: cost that are common to many items and

are not therefore directly traceable to any one item or
area. Indirect costs are usually charged to items or areas
on the basis of allocation techniques.
 Departments where incurred:

• Production dept.: These contribute directly to the

production of the item and include departments in which
conversion and production processes take place. They
include manual and machine operations directly performed
on the product manufactured.
• Service dept.: These are departments which are not directly
related to the production of an item. Their function is to
provide services for other depts. The cost of service depts.
are usually allocated to production depts. since the benefit
from the service provided.
Functional areas:
• Manufacturing cost: they are related to the production of an item.
They are the sum of direct material cost, direct labor cost, other
direct expenses and factory overhead.
• Administrative cost: these are incurred for the overall
management of the enterprise which cannot be readily identified
with one of the major functional areas. It includes all expenses
necessary for the maintenance of an efficient management
administration.
• Selling & Distribution cost: are cost that incurred after the
manufacturing process. It includes all expenditure necessary for
the transition of the product from the manufacturing to the
immediate buyer.
Period charges to income:

• Product cost: relates to the product on hand, either

unsold finished goods or semi-finished goods. They are
inventoried and carried forward as assets until the
goods to which they relate are sold, then they are
matched against sales.
• Period cost: are cost that are associated with the
revenues of the current period. They are not assigned
directly to the products on hand because they do not
represent value added to any specific product.
 1-36

Product Costs Versus Period Costs

Product costs include Period costs are not
direct materials, direct included in product costs.
labor, and manufacturing They are expensed on the
overhead. income statement.
Cost of
Inventory Goods Sold Expense

Sale

Balance Income Income

Sheet Statement Statement
Time when computed:
• Historical cost: are past cost valued at the acquisition
cost of the asset. It has the basic advantage of
confirming to GAAP and so are assumed to be
objective , verifiable and free from bias.

• Standard/ Predetermine cost: express the future

trend of the historical cost and result from prediction
model. It is useful for planning & control. Standard
cost set yardstick for future performance.
 Relationship with Accounting period:

• Capital expenditure: provides benefits to future period

and is classified as an asset.

• Revenue expenditure: is assumed to the current period

and is classified as an expense.
• A capital expenditure will flow into the cost stream as
an expense when the asset is used up or written off.
Relationship with Planning, Controlling & Decision making
purposes:
• Controllable cost: are those which may be directly influenced by
unit managers in a given time period.
• Non-controllable cost: are those which are not directly
administered at a given level of management authority.
• Committed fixed cost: are those fixed unavoidable costs necessary
for maintaining a basic organization and a production capacity. Their
incurrence continues even if the volume of activity is zero.
• Discretionary fixed cost: arises from yearly appropriation. Decision
for repairs and maintenance costs, advertising costs, executive
training cost etc.
• Relevant cost: are expected future cost that differ among alternative
courses of action
• Irrelevant cost: are unaffected by management’s actions.
• Differential cost: a differential cost is the difference between the cost of
alternative courses of action on an item by item basis. If the cost is
increasing from one alternative to another it is called an incremental cost
and if the cost is decreasing from one alternative to another it is called
detrimental cost.
• Opportunity cost: it is the cost of next best alternative forgone. Where a
decision to pursue one alternative is made, the benefits of other options
are forgone. Benefits lost from rejecting the next best alternative are the
opportunity cost of the chosen action. Since opportunity costs are not
actually incurred they are not recorded in the accounting records. They
are however relevant cost fop decision making purposes and must be
considered in evaluating a proposed alternative.
• Sunk cost: irrevocable costs are called sunk cost. Sunk cost referred to
those cost that result from expenditure made in the past and can’t be
changed by present or future decisions.

• Imputed cost: are costs not actually incurred in some transactions

but which are relevant to the decision as they pertain to a particular
situation. This cost do not enter into traditional accounting system but
they are being related with economic reality help in making better
decision.

• Out of pocket cost: refers to cash outlay immediately or at some

future date. These costs are relevant cost. Sometime this cost is
termed as direct or variable cost. This cost concept is useful for
management decision making.
• Avoidable cost: are those cost which may not have been
incurred under expected condition. e.g. abnormal loss.
• Joint cost: is the cost of two or more products that are
produced simultaneously by a single process and are not
identifiable as individual types of products until a certain stage
of production known as the split off point is reached. In other
words, it is the total cost incurred up to the point of separation.
• Common cost: are those cost which are incurred for more than
one product, job, territory or any other specific costing object. It
is not easily identifiable with individual product and therefore
generally apportioned.