Jimma University

College/Faculty of Business & Economics

Department of Accounting and Finance
Course Title: Cost & management Accounting I

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 Chapters of the course
 Overview of Cost and Management Accounting
 Cost determination: The costing of resource inputs
 Costing methods: The costing of resource outputs
 The Process and Operation or service costing methods:
 Cost Allocation
 Activity-Based Costing and Management
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 Cost & management Accounting I

CHAPTER 1
OVERVIEW OF COST ACCOUNTING

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 CHAPTER 1 - OVERVIEW OF COST ACCOUNTING
Cost and Management Accounting
Cost Accounting - refers to the measurement and reporting of financial and
non-financial information relating to the cost of acquiring or utilizing
resources in an organization.
It includes those parts of both Management accounting and Financial
accounting in which cost information is collected and analyzed.
• It provides the detailed information that management needs to control
current operations and plan for the future.
 Management Accounting -
Measures and reports financial and non-financial information
that helps managers make decisions to fulfill organizational goals.
Mangers use management accounting information to choose,
communicate, and implement strategy.
Therefore, management accounting focuses on internal reporting.
For example;

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 Cont...
 Determining the cost of providing a service or making a good
 Assist management in profit planning and formalizing the plans
into budgets
 Determine the behavior of costs and how profit will change as sales
and production volumes change
 Compare actual costs and financial results with budgeted costs and
results
 Providing cost and sales information necessary for management to
use to make a decision.
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 Cont...
Managers are responsible for financial statements issued to investors (potential
investors who want to invest in the concerned company), government regulatory
institutions and other outsider institutions which are interested on the status of
the firm (Suppliers and Banks for instance).

Hence, managers are interested in both management accounting and

financial accounting.

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 Cont...
• Cost accounting can be viewed as the intersection b/n financial and
management accounting.
Financial Cost Management
Accounting Accounting Accounting
• Cost accounting addresses the informational demands of both financial and
management accounting by providing product cost information to external
parties and internal managers for planning, controlling, decision making and
evaluating performnce.
 Therefore cost accounting is a bridge between financial and managerial
accounting. One of such concepts is that of product costing for a
manufacturing company.
e.g. should a company make or buy a component used in manufacturing a product?),
 Cont...
 Cost accounting is a branch of accounting and has been developed due to
limitions of financial accounting.
 Limitations of financial accounting;
 No clear idea of operating efficiency (the reason of profit or loss).
 We get the total cost of production but it does not aid in determining
prices of the products, services, production order and lines of
products.
 Expenses are not classified as direct or indirect, controllable or
uncontrollable.
 No data for comparison and decision making: As introduction of
new product or not, replacement of labor by machine or not,
producing a part in the factory or buying it from outside market,
investment to be made in new products or not etc.
 Objectives of Cost & Management Accounting
 To ascertain the cost of production on per unit basis, for example,
cost per kg, cost per meter, cost per liter, cost per ton etc.
 It helps in the determination of selling price on the basis of cost of
production.
 Cost accounting helps in cost control and cost reduction.
 Ascertainment of division wise, activity wise and unit wise
profitability becomes possible through cost accounting.

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 Cont...
 Helps in locating wastages, inefficiencies and other loopholes in
the production processes/services offered.
 Helps in presentation of relevant data to the management decision
making.
 Helps in estimation of costs for the future.

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 Cost and management accounting in comparison
with financial accounting
• Both Cost Accounting and Financial Accounting are concerned with
systematic recording and presentations of financial data.
• Cost and Management Accounting is concerned with determination of costs of
products or services for planning, controlling and reducing.
• Financial accounting includes all the principles that regulate the accounting for
and reporting for financial information that must be disclosed to people outside
the company, to stockholders, bankers, creditors, and brokers.
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 Comparison of Financial and Managerial Accounting
Basis of Cost Accounting Financial Accounting
comparison
1.Purpose Provide detailed cost information Prepare financial statements for reporting to persons &
to management. i.e. internal users organizations outside the business entity
2.Primary users Various levels of internal Persons and organizations outside the business entity
ofInformation management
3.Analysis of cost Detailed cost and profit data for Provide the profit & loss of theBusiness as a whole for
and profit each product line, department, etc. a particular period. It does not show figure of cost and
profit for individual products, departments and
processes
4.Types of Not restricted to double entry; any Use double entry system
accounting system useful system can be used
used
5.Periodicity of Use a continuous process Reports are prepared periodically, usually an
reporting reporting, and may be daily, annual basis
weekly, and monthly, etc.
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6.Unit of Any useful monetary (historical Historical (past) monetary unit
measurement &future) or physical measure such as
machine hours, labors, etc
7.Format of Has various forms of presenting the Has a single uniform format for
presenting cost information & thus lacks a presenting information. i.e. income
information uniform formats statement & balance sheet
8.Types of Recorded not only external Records only the external
transactions transactions but also internal or transactions like sales , purchase,
recorded interdepartmental transaction like receipts, with outside parties
issue of materials ,idle time variance
report, etc.
9.Types of Generates special purpose statements Prepare general purpose financial
statement & reports like reports on loss of statement like income statement
prepared materials ,idle time, variance report, and balance sheet
etc

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 1-15

Summary Comparison of Financial and Managerial

Accounting
Financial Accounting Managerial Accounting
1. Users External persons who Managers who plan for
make financial decisions and control an organization
2. Time focus Historical perspective Future emphasis
3. Verifiability Emphasis on Emphasis on relevance
versus relevance verifiability for planning and control
4. Precision versus Emphasis on Emphasis on
timeliness precision timeliness
5. Subject Primary focus is on Focuses on segments
the whole organization of an organization
6. Principle Must follo IFRS Need not follow IFRS
and prescribed formats or any prescribed format
7. Requirement Mandatory for Not
external reports Mandatory
 Cost classification concepts and terms
Costs are assigned to cost objects for a variety of purposes including
pricing profitability studies, and control of spending. For purposes of
assigning costs to cost objects, costs are classified as either direct or
indirect.
Direct Costs
A direct cost is a cost that can be easily and conveniently traced to the
particular cost objects under consideration in an economical feasible
way.
Direct costs - are expenses incurred on material and labor which are
economically and easily traceable for a product, service or job.
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 Cont...
Indirect cost: - is a cost that cannot be easily and conveniently traced
to the particular cost object under consideration.
Indirect costs- are expenses incurred on those items which are not
directly chargeable to production.
For example: Cost of electricity, Depreciation of equipment, indirect
labor, indirect material, Cost of different utilities, Cost of repair and
maintenance, Insurance for the factory.
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Cost Classifications for Predicting Cost Behavior(Another aspect)

Quite frequently, it is necessary to predict how a certain cost will behave in

response to a change in activity
For planning purposes, a manager must be able to anticipate which of these
will happen; and if a cost can be expected to change, the manager must know by
how much it will change.

To help make such distinctions, costs are often characterized as variable
or fixed.
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  Variable Cost

 A variable cost is a cost that varies in total in direct proportion

to changes in the level of activity. The activity can be expressed
in many ways, Such as units produced, units sold, miles driven,
beds occupied, hours worked and so forth. Direct material is a
good example of variable cost.

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  Fixed Cost
 is a cost that remains constant, in total, regardless of changes in
the level of activity. Unlike variable costs, fixed costs are not
affected by changes in activity.
 Consequently, as the activity level rises and falls, the fixed costs
remain constant in total amount unless influenced by some
outside forces, such as price changes.
 Rent is a good example of fixed cost.
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 Summary of Cost Behavior
Behavior of the cost (within the relevant range)
Cost
In Total Per Unit
Variable Cost Total variable cost increases and Variable cost remains constant
decreases in proportion to changes in the per unit
activity level.

Fixed cost Total fixed cost is not affected by changes fixed cost per unit decreases as
in the activity level within the relevant the activity level rises, and
range. increases as the activity level
falls
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 Cont…
Example of variable costs products per unit birr 10 and total fixed
cost birr 10,000:
Units cost per Total variable Total Unit Fixedcost
produced unit (birr) Cost (birr) Fixedcost

100 10 1000 100 10,000

200 10 2000 50 10,000
300 10 3000 33.33 10,000

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 1-23

Variable Cost
Total variable cost increases and decreases in proportion to changes
in the activity level.

Total Variable cost

Number of Unit produced

 1-24

Variable Cost Per Unit

• Variable cost remains constant per unit

Variable Cost Per Number of Production

 1-25

Fixed Cost
Total fixed cost is not affected by changes in the activity level within the
relevant range.
Total Fixed cost

Number of Unit produced

 1-26

Fixed Cost Per Unit

•Fixed cost per unit decreases as the activity level rises, and increases as the
activity level falls

Fixed cost per

Number of Unit
 Classification of costs as product and period costs
 For financial accounting purposes report as Product and Period costs
• Product / Manufacturing costs - Are capitalized as assets (inventory) until they are sold
and transferred to COGS (E.g. DMC, DLC and IDMC).
Product Costs: Product costs include all the costs that are involved in
acquiring or making product . In the case of manufactured goods, these costs
consist of DM,DL and MOH.
 Product costs are assigned to an inventory account on the balance sheet.
 When the goods are sold, the costs are released from inventory as expense
(typically called Cost of Goods Sold) and matched against sales revenue
 Since product costs are initially assigned to inventories, they are also
known as inventoriable cost.
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
Period Costs:
 Period / Non manufacturing costs - Are expensed on income statement as
they are incurred Are all the costs that are not included in product costs.
 These costs are expensed on the income statement in the period in which
they are incurred using the usual rules of accrual accounting.
 Period costs are not included as part of the cost of either
purchased or manufactured goods.
 Sales commissions and office rent are good examples of period costs. Both
items are expensed on the income statement in the period in which they are
incurred. Thus they are said to be period costs.
Other examples of period costs are:
 selling
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, administrative expenses, marketing, distribution.
 Prime and Conversion costs
• Prime costs - Is a term referring to all direct manufacturing costs (labour and
materials), PC = DMC + DLC + DEX
• Conversion costs - Is a term referring to direct labour and factory over head
costs, CC = DLC + MOHC
 Cont....
 Types of Manufacturinng Inventories
• Direct Materials - Resources in stock and available for use to make product.
• Work-In-Process - Products started but not yet completed.
• Finished Goods - Products completed and ready for sale or not yet sold.
 Different types of firms
• Manufacturing sector companies - Create and sell their own products.
• Merchandising sector companies - purchase and then sell tangible products
without changing their basic form and They hold only one type of inventory.
• Service sector companies - provide services (intangible products) and do not hold
inventories of tangible products.
 Manufacturing cost flow and Financial statements
Manufacturing cost flows
• The Cost of Goods Manufactured and the Cost of Goods Sold section of the income statement
are accounting representations of the actual flow of costs through a production system.

Raw materials available Balance sheet items

Direct materials cost Not in put production Raw materials inventory
Direct labor cost Still in production Work in process inventory
Factory overhead cost Work in process Finished goods Unsold Finished goods inventory
Income statement items

Cost of goods sold

Non - manufacturing or Selling, general and administrative
Period costs expense
Note:
 DMU = BDMI + DMP - EDM
 COGM = BWIPI + DMU + DLC + MOHC - EWIPI
 COGS = BFGI + COGM - EFGI
Preparation of financial statements
Income Statement
Revenue...................................................................................................xxx
(Cost of Goods Sold) (COGS)................................(xxx)
Gross Profit (GP).....................................................................................xxx
(Operating Expense) (OEX)....................................(xxx)
Operating Income (OI)...............................................................................xxx
(Tax, x%)..................................................................(xxx)
Net Income.......................................................................xxx
Illustration1 : Assume DM cost 15,000 birr, DL cost 35,000 birr and MOH cost
40,000 birr.
Requered (determine): Total manufacturing cost, Prime cost and Conversion cost.
Solution: ?
Illustation 2 : XYZ Textile factory purchased direct materials of birr 440,000 and incurred
direct labor of birr 320,000 during the year ended june 30, 2023. Total factory overheads for
the year were birr 280,000. The inventory balances are as follows:
July 1, 2023 June 30, 2023 Other information
Finished goods birr 90,000 birr 105,000 Revenue.........1,500,300
Work in process birr 121,000 birr 110,000 Period cost......63,000
Materials birr 100,000 birr 105,000 Tax..................30%
Determine: Direct material used, Cost of goods manufactured, Cost of goods sold, GP, OI &
NI
 Solution:
1. DMU = BDMI + DMP = (CDMAFU) - EDM
= 100,000 + 440,000 = 540,000 - 105,000 = 435,000
2. COGM = BWIPI + DMU + DLC + MOHC = (TMC) - EWIP
= 121,000 + 435,000 + 320,000 + 280,000 = 1,156,000 - 110,000 = 1,046,000
3. COGS = BFGI + COGM = (COGAFS) - EFGI
= 90,000 + 1,046,000 = 1,136,000 - 105,000 = 1,031,000
4. Gross Profit (GP) = Revenue - COGS
= 1,500,300 - 1,031,000 = 469,300
5. Operating Income (OI) = GP - Period costs
= 469,300 - 63000 = 406,300
6. Net Income (NI) = Operating Income - Tax (406,300*30%)
406,300 - 121,890 = 284,410
 Classification of costs on the basis of controllability
 Cost estimates for decision making are based on forecasts of the
resources that would be consumed under the various alternatives.
 Controllable and uncontrollable costs
• Controllable cost:- is costs incurred in a particular
responsibility center can be influenced by the actions of the
executive head of the responsibility center.
• A manager can control influence the level of cost.
• Uncontrollable costs: - is the costs which cannot be influenced
by the action of a specified member of an undertaking are
known as uncontrollable cost.
• A manager cannot influence or control significantly
Classification of costs on the basis of Avoidable cost and
Unavoidable
 Avoidable cost and Unavoidable costs
• Avoidable cost :- a cost that is not incurred if the activity is not
performed.
• These costs are often identified as variable costs.
• Example labor, material cost.
Unavoidable costs: - is a cost that is still incurred even if the activity is
not performed.
• It is an expenditure for which there is firm spending commitment in
the short term.
 Classification of costs on the basis of controllability

 Costs controllability on the basis of Economic Characteristics of

Costs Classification as Opportunity cost (Incremental costs),Sunk
Costs,Differential Cost and Marginal and Average costs
 Opportunity cost - Is defined as the benefit that is sacrified when the choice of
one action precludes taking an alternative course of action.
• It is an asset in a specific alternative is the net benefit that would be
received if the asset were utilized in its best alternative use.
• The change in costs will occur as the result of a charge in activity from base or
reference level to another level.
 Classification of costs on the basis of controllability

Sunk Costs - Such costs are past or historical costs. These are costs, which
have been created by a decision that was made in the past that cannot be
changed by any decision that will be made in the future.
• Differential Cost - The difference in total cost between alternatives.
• Marginal and Average costs - Marginal cost is the extra cost incurred when
one additional unit is produced. The average cost per unit is the total cost of
quantity manufactured divided by the number of units manufactured.
 Budgeted, standard, actual costs and their
comparisons and analyses
• Budgeted use as performance evaluation tool focuses on determining
the discrepancies between the planned and actual performance at the
end of the operating cycle.
• Variance is the difference between an amount on an actual result
and the corresponding budgeted amount. The budgeted amount is a
point of reference from which comparison may be made.
• The difference between budget and actual result can be favorable or
unfavorable based upon the impact of the discrepancy on the overall
profitability of the firm.
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 Cont…
• If the variance has an increasing effect on the operating income as
compared to the budgeted amount, it is said to be favorable
variance. On the other hand unfavorable or adverse variance
occurs when the variance has a decreasing effect on the operating
income relative to the budgeted amount.
• Standard costs are predetermined costs that are usually expressed
on per unit basis. In other word, standard cost is a predetermined
calculation of how much costs should be incurred under specified
working condition.
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 Cont…
• A standard cost system has three basic functions:
• collecting the actual costs of a manufacturing operation, determining the
achievement of that manufacturing operation, and evaluating performance
through the reporting of variances from standard.”
• Budgetary control and standard costing are comparable system of cost
accounting in that they are both predetermined of forward – looking.
• The common objective is of controlling business operations by establishing
predetermined targets.

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 Cont…
Budgetary control system
1. Budgetary control is related to all types of items
of revenue and expenditure, whether they belong
to the product or not, i.e. to all types of business
activities. Hence, it is more extensive.
2. Budget is based on past experience and in most
cases a projection of financial accounts.
3. Budgets are comparatively less rigid and ‘should
be’ estimates. They fix limits.
4. Budgetary control can be operated without a
standard costing system. It can be adopted in part.
5. The study of variances is not a subject of special
study as in the case of standard costing
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Standard costing system
1. Standard costing is related to production and
production costs. Hence, it is more rigorous
and intensive.
2. Standard is established on the basis of
technical estimates. It is the projection of
accounts.
3. Standard are very rigid and ‘ought to be’
estimates. They fix targets.
4. Standard costing system cannot operate well
without a budgetary control system. Also, it
is not possible to operate the system in parts
5. Variance analysis is a subject of special
study of standard costing.
 The use of linear, curvilinear and step functions and how their
calculations are used to analyze cost behavior
• Linear cost is function within the relevant range of the activity in which
there is a relationship between total cost and the level of activity.
• For a linear cost function represented graphically, total cost versus the level
of a single activity related to that cost is a straight line within the relevant
range.
• Variable costs is a cost that varies, in total, in direct proportion to changes
in the level of activity (cost driver).
• For instance, a 5% increase in the units’ production would produce a 5%
increase in variable costs. However, the variable cost per unit of cost driver
remains the same as activity changes.
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 Cont…
Example of variable costs include direct material costs, direct labor
costs, indirect materials costs, factory utilities, power to run machine,
shipping costs and sale commission.
• This idea is presented below, assuming that a company's products
cost birr 24:

Units produced cost per unit (birr) Total variable Cost (birr)
1 24 24
500 24 12000
1000 24 24000
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 Cont…
TVC
24,000

24 VC/U
12,000

500 1000 1500

500 1000 1500
Volume of cost driver Volume of cost driver

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 Cont…
• As the above graphs show, total variable cost increases
proportionately with activity. When the volume of activity (units
produced) doubles from 500 to 1000 total variable cost doubles
from birr 12000 to 24000.
• In contrast, a variable cost on a per unit basis remains constant
birr 24 as the volume of output increases.
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 Cont…
• Fixed costs
• A fixed cost is a cost that remains constant, in total regardless of
changes in the level of activity.
• Unlike variable costs, fixed costs are not affected by changes in
activity. Consequently, as the activity level rises and falls, the
fixed costs remain constant in total amount unless influenced by
some outside force, such as price changes.
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 Cont…
• Curvilinear is a function that measures how labour-hours per unit
decline as units of production increase because workers are
learning and becoming better at their jobs.
• Managers use learning curves to predict how labour-hours, or
labour costs, will increase as more units are produced.
• Curvilinear (A non-linear) cost is a cost that varies with the
volume of activity but not proportionally or consistently.
• Non-linear costs may increase at a decreasing rate or at an
increasing rate.
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The concepts of cost units, cost centers and profit centers
 Cost unit, also called an average cost, is calculated by dividing the total cost by
the related number of units produced.
 Cost Center: -

is the smallest organizational sub unit of a production or service, function, activity

or item of equipment whose costs may be attributed to cost units.
 Profit Center: - is any sub unit of an organization to which both revenues and
costs are assigned.
 Cost center is an activity to which only costs are assigned but a profit center is
one where costs and revenues are assigned so that profit can be ascertained.
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 Thank you !!!
End of
Chapter 1

Any ?