Cost

Accounting

Introduction
 Difference
Difference
Cost and between cost The need and The
between cost
Accounting management and role of cost classification
and financial
accounting management accounting of cost
accounting
accounting
Accounting

It is a systematic process of identifying, recording, measuring,

classifying, verifying, summarizing, interpreting and communicating
financial information.

Internal parties within the organization

external parties such as shareholders,
Users of accounting information: creditors, and regulatory agencies outside the
organization
Usually the terms, Cost accounting and Management accounting, are used
interchangeably and are used in one and the same sense. However, there
are differences between these two terms conceptually and in application.

Cost accounting deals with calculation and measurement of resources

utilized for different business activities usually production. It relates to
calculation of per unit cost using different costing techniques

On the other hand, Management accounting relates to the use of all such
information gathered and processed by cost accounting by management.
Management accounting is about getting the information from cost
accountants and then use it for decision making purposes.
Financial Accounting
• Users: Aimed at providing financial
information to parties outside the
organization.(external)
• Regulation: must conform to certain
standards, such as generally accepted
accounting principles (GAAP)
• Time period:
• It deals with historical data, what has
happened in the past.
• Frequency: well structured , must be
prepared annually
• Organizational consideration:
organization as a whole
Managerial Accounting
• Aimed at helping managers within the
organization make well-informed
business decisions.(internal)
• No restrictions. It can be modified to
meet the needs of its intended users.
• For future plans and decision making.
• Can be made anytime. No restriction
• Measure and shows data segment wise
 Cost Accounting Management Accounting
• 1. It precedes management accounting • 1. It starts where cost accounting ends

• 2. It deals with calculation of cost per unit using • 2. It gathers information from cost accounting to
various cost techniques take decisions

• 3. It focus mainly on cost control keeping within • 3. It focus mainly on decision making from the
budgeted and standard limits given set of courses of action

• 4. It does not use much financial accounting • 4. It uses both financial and cost accounting

• 5. Application of statistics and operation research

• 5. Application of statistics and operation research
towards control is very much limited in use
towards control is very much used in wider scope
as compared to cost accounting
• 6. Calculation of cost of production dominates cost
accounting
• 6. Planning and control for decision making
• dominates management accounting
Cost Accounting

Cost accounting can be viewed as the

intersection between financial and
management accounting , It addresses the
informational demands of both financial and
management accounting by providing
product cost information to external parties
(stockholders, creditors, and various
regulatory bodies) for investment and credit
decisions and for reporting purposes, and
internal managers for planning, controlling,
decision making, and evaluating
performance.
 • Cost accounting is a large subset of managerial
Cost accounting that specifically focuses on capturing a
Accounting company's total costs of production by assessing the
variable costs of each step of production, as well as fixed
costs.

• It allows businesses to identify and reduce unnecessary

spending and maximize profits.

• The information obtained by employing all the methods

is used for controlling, planning and evaluation and
making decisions .
 Cost is defined as “the value of the sacrifice made to
acquire goods or services
COST: Concepts,
Definition and its
Classification
Cost reflects the monetary measure of resources
used to attain an objective such as making a good or
performing a service.

The balance sheet value of an asset is an unexpired

cost, but the portion of an asset’s value consumed or
sacrificed during a period is an expense or expired
cost, which is shown on the income statement.
Cost Object: A cost object is anything for which
management wants to collect or accumulate costs.
Production operations and product lines are common
cost objects.

For example, Toyota’s Princeton, Indiana, plant makes

Tundra trucks, Sequoia SUVs, and Sienna minivans.
Company managers could define the plant as the cost
object and request information about production
costs for a specific period; in this case, production
costs of all types of vehicles would be included in the
information report

alternatively, managers could define the Tundra truck

as the cost object and request information about
production costs during the same period, in such
case production costs for the SUVs and minivans
would be excluded from the information report.
 Association with Cost Object
• Costs related to the making of a product or performance of a service are appropriately labeled product
or service costs.
• The costs associated with any cost object can be classified according to their relationship to the cost
object.
• Direct costs are conveniently and economically traceable to the cost object. If management requested
cost data about the Tundra, direct costs would include tires, fiberglass, CD player, leather, paint, and
production line labor.
• Indirect costs cannot be economically traced to the cost object but instead are allocated to the cost
object. For example, Toyota uses glue in manufacturing Tundra trucks but tracing that material would not
be cost effective because the cost amount is insignificant.
• The clerical and information-processing costs of tracing the glue cost to products would exceed any
informational benefits that management might obtain from the information. Th us, glue cost for each
truck would be classified as an indirect cost.
• Classification of a cost as direct or indirect depends on the cost object specification. For example, if the
Princeton plant is specified as the cost object, then the plant’s depreciation is directly traceable. However,
if the cost object is specified as the Tundra, the plant’s depreciation cost is not directly traceable, in
which case the depreciation is classified as indirect and must be allocated to the cost object
Reaction to Changes in • Accountants need to understand how total costs change in response
to changes in activity measures, such as production volume, service
and sales volumes, machine hours, material usage, and purchase
orders.

• Costs can change over time or due to extreme shifts in activity levels,
so it's important to specify a time frame for cost analysis and assume
a specific range of activity levels.

• For example, if the cost of Tundra tires is expected to increase by $25

next year and $80 in 2015, only the $25 increase is relevant for
Activity

estimating production costs for the upcoming year.

• The relevant range is the range of activity levels that reflects a

company's normal operations. Within this range, costs can be
classified as either variable or fixed.
Variable Cost
• Variable costs change in proportion to the level of activity or
production. They are constant per unit of output.
• Examples of variable costs include material costs, hourly
wages, and sales commissions.
• Variable costs are crucial for a company's profitability
because they are incurred each time a product is made, or a
service is provided.
• Economists see variable costs as curvilinear, with costs
increasing at a consistent rate until a certain production
volume is reached, beyond which costs rise steeply due to
inefficiencies.
• Accountants simplify this curve by defining a relevant range
where variable costs are assumed to behave linearly.
• Within the relevant range, you can calculate total variable
costs by multiplying the cost per unit (e.g., $50 per battery)
by the number of units produced (e.g., 15,000 Tundras),
resulting in a total variable cost of $750,000.
Fixed Cost
• Fixed costs are those that remain constant in total within a
certain range of activity, known as the relevant range.
• Examples of fixed costs include salaries (not hourly wages),
depreciation (calculated using the straight-line method), and
insurance.
• On a per-unit basis, fixed costs change inversely with activity
level. As activity increases, the per-unit fixed cost decreases,
and vice versa.
• To determine the total and per-unit amounts of a fixed cost, you
can use an example: Suppose Toyota rents manufacturing
equipment for $12,000,000 annually, with a capacity of 150,000
Tundras.
• If Toyota produces 120,000 Tundras, its annual equipment
rental cost remains fixed at $12,000,000, resulting in a per-unit
cost of $100 per Tundra ($12,000,000 divided by 120,000).
• If Toyota increases production to 125,000 TundMras, the total
equipment rental cost still remains at $12,000,000, but the per-
unit cost decreases to $96 per Tundra ($12,000,000 divided by
125,000).
• Within the relevant range, the total fixed cost remains
unchanged, while the fixed cost per unit varies inversely with
changes in production levels.
 • Some costs are neither strictly variable nor fixed
but have both variable and fixed components.
Semi variable/ Mixed cost These are referred to as mixed costs.
• Mixed costs do not change proportionately with
changes in activity, nor do they remain constant.
• An example of a mixed cost is an electric bill, which
consists of a fixed component (a flat charge for
basic service) and a variable component (a rate per
kilowatt hour of usage).
• For instance, assume a firm's monthly electric bill is
$5,000 as the fixed component plus $0.018 per
kilowatt hour (kWh) consumed as the variable
component.
• When the firm uses 80,000 kWh of electricity in a
month, the total bill is $6,440 ($5,000 + ($0.018 *
80,000)).
• If the firm uses 90,000 kWh, the total bill increases
to $6,620 ($5,000 + ($0.018 * 90,000)).
• Mixed costs can vary depending on the level of
activity, making them different from purely variable
or fixed costs.
Classification on the Financial Statements
• Balance Sheet and Income Statement:
• The balance sheet is a financial statement that lists assets, liabilities, and owners' equity,
representing unexpired costs.
• The income statement lists revenues and expenses (expired costs) and is used to match
revenues with expenses.
• Matching revenues and expenses is central to financial accounting, determining when an
unexpired cost becomes an expense or a loss
• Expenses vs. Losses:
• Expenses are intentionally incurred in generating revenues, while losses are unintentional
costs in business operations.
• Examples of expenses include cost of goods sold, depreciation, and estimated product
warranty costs. Losses include fire damage, abnormal production waste, and selling assets
below book value.
Product vs. Period Costs:

• When considering a product as the cost object, costs are classified as either product
or period costs.
• Product costs are linked to producing goods or services that directly generate
revenue. Direct material, direct labor, and overhead are components of product
costs. Th e sum of direct labor and overhead costs is referred to as conversion cost
—those costs that are incurred to convert materials into products. Th e sum of
direct material and direct labor cost is referred to as prime cost
• Period costs are associated more with specific time periods than with production.
Period costs with future benefits become assets, while those without future benefits
are expenses.
• Distribution costs, related to warehousing, transportation, and delivery, are
considered period costs. They must be controlled for profitability, even though they
are not technically product costs.
 Conversion Process in
Organizations:
• All organizations convert inputs into outputs. Inputs typically include material, labor, and
overhead costs.
• Product costs are incurred in the production or conversion area, while period costs are incurred
in non-production or non-conversion areas.
• Conversion process outputs can be products or services, depending on the type of organizations
• Types of Organizations
• Service companies often engage in a high degree of conversion. Professionals like accountants,
architects, and attorneys convert labor and resources into completed services, such as audit
reports or contracts.
• Organizations with low to moderate conversion levels may expense insignificant labor and
overhead costs related to conversion.
• Retail firms have lower degrees of conversion compared to service and manufacturing firms.
• High-conversion firms find it beneficial to accumulate material, labor, and overhead costs for
their outputs, as the informational benefits outweigh clerical accumulation costs.
(Manufacturing)
• In construction, for example, significant costs like direct labor are accumulated separately as
part of the product cost and are inventoried until the project (house) is completed. This allows
for better cost control and financial reporting.

Th e production or conversion process occurs in three
stages:
1. work not started (raw material),
2. work started but not completed (work in process), and
3. work completed (finished goods
Thus, manufacturers normally use three inventory accounts
to accumulate costs as goods flow through the
manufacturing process:
4. Raw Material Inventory,
5. Work in Process Inventory (for partially converted
goods), and
6. Finished Goods Inventory
1.Manufacturer: A manufacturer is
a company that heavily transforms
raw materials into tangible
products using a combination of
people and machines. The output is
physically tangible and can be
inspected.
2.Service Company: A service
company relies primarily on labor
to perform a high or moderate level
of conversion. The output of a
service company can be either
tangible (e.g., an architectural
drawing) or intangible (e.g.,
insurance protection).
 Components of Product Cost
• Direct Material: This includes readily identifiable parts of a product.
However, some material costs are treated as indirect if they are not
economically traceable or too insignificant to justify tracking.
• Direct Labor: Direct labor refers to the effort of individuals directly
involved in manufacturing or providing a service. It includes wages,
production efficiency bonuses, and related costs. Some labor costs may be
treated as indirect due to inefficiency or the potential for creating
inaccurate cost information.
• Overhead: Overhead encompasses all indirect factory or production costs.
This includes indirect material, indirect labor, and various other production
expenses. Overhead costs can be variable or fixed depending on their
behavior in response to production volume.
• Overhead Cost:
• Variable Overhead: Includes costs like indirect material, hourly-paid
indirect labor, lubricants for machine maintenance, and depreciation based
on machine usage
• Fixed Overhead: Encompasses expenses such as straight-line depreciation
on factory assets, license fees, insurance, property taxes, and salaries for
supervisory roles.
• Quality Costs: Quality costs are incurred to control or prevent quality
issues in products or services. They include prevention costs (e.g., training,
research, improved equipment) and appraisal costs (e.g., monitoring and
inspection). Failure costs can be internal (e.g., scrap, rework) or external
(e.g., product returns, warranty costs).
 Cost object , allocation and accumulations
.
A cost object is a managerial term for
a product, process, department, or
customer that costs originate from or
are associated with. In other words,
it’s something that costs can be
identified with and traced back to
Cost Accumulation is the process of collecting all costs
information about the business with the help of the cost
accounting system. It is a process of collection of all
relevant data regarding the various costs incurred by
the company at various stages of production.
cost allocation is the process of identifying, accumulating, and
assigning costs to costs objects such as departments, products,
programs, or a branch of a company. It involves identifying
the cost objects in a company, identifying the costs incurred
by the cost objects, and then assigning the costs to the cost
objects based on specific criteria