Chapter one

Fundamental
of
Cost Accounting
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Definition of Cost & Management Accounting

 Accounting is major means of helping managers

a) to administer each of the activities

b) to coordinate those activities

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Definition of Cost & Management Accounting

 Accounting provides information for three purposes

1. Routine internal reporting for the decisions of
managers.
2. Non routine internal reporting for decisions of
managers.
3. External reporting to external users on the
organization’s financial position, operations and
related activities.

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Definition of Cost & Management Accounting

Management Accounting
 It measures and reports financial and nonfinancial
information that helps managers make decisions to fulfill
the goals of an organization.
 Concerned with providing information to managers.
 Focuses on internal reporting
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Definition of Cost & Management Accounting

Financial Accounting
 Its focus is on reporting to external parties.
 It measures and records business transactions.
 It provides financial statements based on
international financial reporting standard(IFRS)
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Definition of Cost & Management Accounting

Cost Accounting
 It provides information for both management
accounting and financial accounting.
 It measures and reports financial and nonfinancial
data.
 Managers are responsible for the financial statements
issued for external users. Therefore, managers are
interested in both management accounting and
financial accounting. 6
Management Accounting VS Financial Accounting
Features
Users of Information
Level of Aggregation
Information type
Regulation
Information Characteristics
Time Horizon
Reporting Frequency
Sources of data
Report Requirement
Managerial Accounting Financial Accounting
Managers at various levels within the Interested parties outside the
organization. organization.
Detailed information on subunits within the Summarized information on the company
organization as a whole
Economic any physical data as well as Financial data
financial data
Unregulated, limited only by the value- Regulated by IFRS.
added principle.
Estimates that promote relevance and Factual information that is characterized
enable timeliness. by objectivity, reliability, consistency,
and accuracy.
Past, present, and future Past only, historically based
Continuous reporting Delayed with emphasis on annual reports
The organization’s basic accounting system The organization’s basic accounting
plus various other sources. system.
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Not mandatory Mandatory for external reports
Cost Accounting

 costaccountancy is regarded as the science, art and

practice of cost accountant.
 Cost Accounting primarily deals with collection,
analysis of relevant cost data for interpretation and
presentation for various problems of management.
 Cost accounting is a management information
system, which analyses past, present, and future data
to provide the basis for managerial decision making.

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Cost Accounting

 According to Charles T. Horngren Cost Accounting is “a Quantitative

method that accumulates, classifies, summarizes, and interprets
information for three major purposes:
(i) Operational planning and control
(ii) Special decisions and
(iii) product decisions.
 In general, cost accounting is thus concerned with recording,
classifying and summarizing costs for determination of costs of products
or services, planning, controlling and reducing such costs and furnishing
of information to management for decision making.
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 MATCHING COST FLOW WITH WORK FLOW

Procurement------------production-------------ware housing----------selling
-Raw materials -work process -finished goods -COGS

-Factor payroll clearing

-Manufacturing overhead control

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RECORDING THE COST FLOW AT EACH STAGE
OF WORK FLOW

 Purchase of raw materials

Raw materials xxxx
Vouchers payable (accounts payable) xxxx
 Raw material used
Work in process xxxx
Manufacturing overhead control xxxx
Raw materials xxxx

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RECORDING THE COST FLOW AT EACH STAGE
OF WORK FLOW

 Wages and salaries incurred

Factory payroll clearing xxxx
Salaries and wages payable xxxx

 An analysis of records indicates that labor costs allocated

as follows:-
Work in process xxxx
Manufacturing over head control xxxx
Factory payroll clearing
xxxx
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RECORDING THE COST FLOW AT EACH STAGE
OF WORK FLOW

 Indirect materials and indirect labors (other manufacturing

overhead costs) incurred
Manufacturing overhead control xxxx
Vouchers payable (accounts payable) xxxx
 It is estimated that over head costs are applied or charged
to jobs worked on during the month
Work in process xxxx
Manufacturing overhead control xxxx
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RECORDING THE COST FLOW AT EACH STAGE
OF WORK FLOW

 some jobs were completed and transferred to the finished

goods ware house.
Finished goods xxxx
Work in process xxxx
 Finished goods costing were sold to various customers.
Cost of goods sold xxxx
Finished goods xxxx

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 FINANCIAL STATEMENT IN A MANUFACTURING INDUSTRY
COST OF GOODS MANUFACTURED SCHEDULE
ABC Manufacturing Corporation
Statement of Cost of Goods Manufacturing
Year ended December xx, xxxx
Raw Material      
Raw material inventory, Jan-1     Xxx
Material Purchase   Xxx  
Less purchase return and allowance xxx    
Purchase discount xxx Xxx  
Net Purchase     xxx
Total Material Available     xxx
Less Raw Materials Inventory Dec 31     xxx
Raw material used     xxx
Direct labor     xxx
Manufacturing Overhead     xxx
Total current manufacturing costs     xxx
Add Work in process Jan 1     xxx
Sub total     xxx
Less Work in process Dec 31     xxx
Cost of Goods Manufactured     xxx
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FINANCIAL STATEMENT IN A MANUFACTURING
ABC Manufacturing Corporation
INDUSTRY Income statement
Year ended December xx, xxxx
Revenue      
Sales     xxx
Less Sales Return and Allowance     xxx
Net Sales     xxx
Cost of goods sold      
Finished Goods inventory Jan-1   Xxx  
Add Cost of goods manufactured   xxx  
Total Goods available for sale   Xxx  
Less Finished Goods inventory Dec 31   Xxx  
Cost of goods sold     xxx
Gross profit on sale     xxx
Less operating and admini. Expenses     xxx
Net Income from operations     xxx
Add Other Income     xxx
Subtotal     xxx
Less Other Expenses     xxx
Net Income Before Tax     xxx
Provision for Tax     xxx
Net Income After Income Tax     xxx
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Basic cost terms &
concepts

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Definition

 Cost is defined as the cash or cash equivalent value

required to attain an objective such as acquiring the
goods and services used, completing with the
contract, performing a function or distributing a
product.

 Cost is defined as the monetary value of goods and

services expended to obtain current or future
benefits.
 Expenses are expired costs for which benefits have
already been received in the current fiscal period.
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Cost Concepts

 A Cost object: is anything for which a separate

measurement of costs is desired.
Example; product, department, customer,
geographical area, process etc.

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 Cost accumulation: is the collection of costs in
some organized way by means of an accounting
system, i.e., by some natural or self descriptive
classification.
Eg. material cost, labor cost, fuel, Advertisement
cost etc.

 Cost assignment: is a general term that

includes:
A. Tracing accumulated costs: For direct costs
B. Allocating accumulated costs: For indirect
costs
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 Cost driver is a variable, such as an activity level or
volume, the change of which causally affect costs over a
given time span. That is, there is a specific cause-and-
effect relationship between change in level of activity or
volume and change in level of cost.

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Classification of costs:

 Different cost classifications are used to develop cost

information for a given purpose.
 Managers use this information to support product and
service decisions, enables cost control, provide historical
data for cost management.
 Thus, different classification of costs provide different
information that helps for decision making.

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Cont’d
Cost classification is the process of grouping costs according to
their common characteristics.
There are various criteria on the basis of which costs can be
classified.
The classification can be:

1. Natural/elements/ analytical: refers to essential components

or parts of the total costs of a cost unit.
Or based on physical characteristics
a. Direct materials
b. Direct labor
c. Manufacturing overheads(expenses)
Prime cost =DM+DL
Conversion cost=DM+MOH 23
2. By function/operation/purposes:
 Production(manufacturing):
direct materials, direct labor and manufacturing
overhead), and
 Non manufacturing costs
( selling, distribution, administration, R&D)
3. Based on their traceability to a particular cost object:
 direct: costs that have a relationship with the cost object and
can be traced to that cost object in an economically feasible
(cost effective) way. And
 indirect: costs that have a relationship with the cost object
but cannot be traced to that cost object in an economically
feasible way.
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4. Based on their behavior pattern  :
 fixed(are total costs that remain
constant regardless of the level of
activity up to a certain relevant range
but unit costs vary according to the
level of activity.),
 Variable (are total costs that changes
in direct proportion to changes in the
level of activity but unit costs remain
constant),
semi-variable or semi-fixed.
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5. By control ability:
 Controllable : costs that can be influenced
by management action
 Uncontrollable: cost beyond the control of
management.
6. By normality:
 normal: costs incurred in the normal
course of activity for producing normal level
of out put under normal circumstances.
 Abnormal: costs incurred on account of
abnormal conditions or abnormal activity.

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7. Based on timing they are charged against revenue

 Product costs (inventoriable cost): are costs that are

necessary and integral part of producing (acquiring)
the finished product. They are considered as an
asset/inventory when they are incurred. Under the
matching principle, these costs do not become
expenses until the finished goods inventory is sold.
Example: Cost of direct material
 Period Costs: are costs of income statement other
than cost of goods sold. They are treated as expense
of the period in which they are incurred because
they are expected to benefit revenue in the current
period.
Example: Advertising costs 27
Cost Classification for Decision Making
Decision Significance

A decision involves making choices among alternative courses of action

the decision maker generally collects cost information to assist in
making the decision.
I) Relevant costs are future costs that differ with the various decision
alternatives. They are costs that make a difference in a decision
making process.
II) Irrelevant costs do not relate to any of the decision alternatives,
are historical in nature, or are the same under all decision alternatives.
Irrelevant costs are generally excluded from the cost analysis
Costs are an important feature of many business decisions. In making
decisions, it is essential to have a firm grasp of the concepts of
differential cost, opportunity cost, and sunk costs.

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Cost Classification for Decision Making
 Differential Cost and Revenue
 A difference in cost between any two alternatives is known as a differential
cost. A difference in revenue between ant two alternatives is known as
differential revenue.
 A differential cost is also known as an incremental cost, although technically an
incremental cost should refer only to an increase in cost from one alternative to
another; decrease in cost should be referred to as decremental costs.
Differential cost is a broader term, encompassing both cost increases
(incremental cost) and cost decreases (decremental cost) between alternatives.
 The accountant’s differential cost concept can be compared to the economist’s
marginal cost concept. The revenue that can be obtained from selling one more
unit of product is called marginal revenue, and the cost involved in producing
one more unit of product is called marginal cost.
 Differential cost can be either fixed or variable.

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Cost Classification for Decision Making

 Opportunity Cost

 Opportunity cost is the potential benefit that is given up

when one alternative is selected over another.

 Opportunity cost is not usually entered in the

accounting records of an organization, but it is a cost
that must be explicitly considered in every decision a
manager makes.

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Cost Classification for Decision Making

 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 the
future. Since sunk costs cannot be changed by any decision,
they are not differential costs. Therefore, they can and
should be ignored when making a decision.

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Cost Classification for Decision Making
 Commitment to Cost Expenditure

 Commitment to a cost expenditure focuses on fixed costs as opposed to variable

costs and on budgeted costs as opposed to historical costs.
 Budgeted fixed costs can be broadly classified as committed costs and
discretionary costs.
 i. A committed costs: is one that is an inevitable consequence of a previous
commitment. Property tax budgeted for the coming year is an example of a
committed cost.
 ii. A discretionary costs: also called a programmed costs or a Managed cost, is
one for which the amount or the time of incurrence is a matter of choice. There
are some non- recurring costs for which a final commitment has not yet been
made and that can be postponed until a future period or cancelled entirely.
Replacing the carpet in the administrative offices and repainting the walls of the
factory are examples of discretionary costs where the right timing is a matter of
judgment
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End

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