COST AND MANAGEMENT ACCOUNTING

Module-1

Mrs. Anita Sahoo

Associate Professor
Faculty of Management Sciences
Siksha ‘O’ Anusandhan (Deemed to be University)
Bhubaneswar, Odisha, India
 Contents
• Meaning, definition, scope, objectives of cost
accounting
• Cost concepts
• Elements of cost
• Cost centre, cost unit
• Classification of cost
• Relationship between financial accounting and
cost accounting
• Self study: Role of cost accounting in decision
making
 Meaning of Cost Accounting
• Cost accounting is the classifying, recording, and
appropriate allocation of expenditure for the
determination of the costs of products or services,
and for the presentation of suitably arranged data
for purposes of control and guidance of
management.
• Cost accounting is the application of accounting
and costing principles, methods and techniques in
the ascertainment of costs and the analysis of
saving or excess cost incurred as compared with
previous experience or with standards.
 Features of Cost Accounting
• It is a process of accounting for costs.
• It records income and expenditure relating to production
of goods and services.
• It provides statistical data on the basis of which future
estimates are prepared and quotations are submitted.
• It is concerned with cost ascertainment, cost control and
cost reduction.
• It establishes budgets and standards so that actual cost
may be compared to find out deviations or variances.
• It helps the preparation of right information to the right
person at the right time so that it may be helpful to
management for planning, evaluation of performance,
control and decision making.
 Scope of Cost Accounting
• Cost ascertainment: it deals with the collection
and analysis of expenses, the measurement of
production of the different products at the different
stages of manufacture and the linking up of
production with the expenses.
• Cost accounting: it is the process of accounting for
cost which begins with recording of expenditure
and ends with the preparation of statistical data.
• Cost control: it aims at guiding the actual towards
the line of targets; regulates the actual if they
deviate or vary from targets.
 Objectives of cost accounting
• To ascertain the cost per unit of the different
products manufactured by a business concern.
• To provide a correct analysis of cost by different
elements of cost.
• To disclose sources of wastage whether of material,
time or expense or in the use of machinery,
equipment and tools and to prepare such reports
which may be necessary to control such wastage.
• To provide requisite data and serve as a guide for
fixing prices of products manufactured or services
rendered.
• To ascertain the profitability of each of the
products and advice management as to how these
profits can be maximised.
• To exercise effective control of stocks of raw
materials, work in progress, and finished goods in
order to minimise the capital locked up in these
stocks.
• To help in the preparation of budgets and
implementation of budgetary control.
• to guide management in the formulation and
implementation of incentive bonus plans based on
productivity and cost savings.
• To provide specialised services of cost audit in
order to prevent the errors and frauds and to
facilitate prompt and reliable information to
management.
Broadly speaking the above objectives can be
regrouped under the following three heads:
• Ascertainment and analysis of cost and income by
product, function and responsibility.
• Accumulation and utilisation of cost data for
control purposes to have the minimum possible
cost consistent with maintenance of quality.
• Providing useful data to management for taking
decisions.
 Advantages of cost accounting
• Advantages to Management:
 Reveals profitable and unprofitable activities
 Helps in cost control
 Helps in decision making
 Guides in fixing selling prices
 Helps in inventory control
 Aids in formulating policies
 Helps in cost reduction
 Reveals idle capacity
 Checks the accuracy of financial accounts
 Prevents frauds and manipulation
• Advantages to workers:
Workers are benefited by introduction of incentive plans
which is an integral part of cost system.
• Advantages to society:
An efficient cost system is bound to lower the cost of
production, the benefit of which is passed on to the
public at large in form of lower prices of products or
services.
• Advantages to Government agencies and others:
A cost system produces ready figures for use by
Government, wage tribunals, chambers of commerce
and industry trade unions, etc., for use in problems like
price fixing, wage level fixation, settlement of industrial
disputes, policy matters, etc.
 Cost Unit
• It is a device for the purpose of breaking up
separating cost into smaller sub-divisions
attributable to products and services.
• It is the unit of product, service or time in relation
to which costs may be ascertained, e.g., tonne in
case of coal.
• In case of brick kiln, the unit should not be each
brick but 1000bricks ; normally it is the same unit
by which wholesale transactions are entered into.
• In case of goods transport the unit will be tonne-
km- the effort involved in carrying one tonne of
goods for a distance of one kilometer.
 Difference Between Cost & Financial
Accounting
Financial accounting Cost accounting
• Its main purpose is to prepare • Its main purpose is to provide
financial statements for detailed cost information to
reporting to users of its management i.e., internal
information. users.
• It reveals the profitability of • It shows the detailed cost and
the business as a whole not profit data for each product
for individual products, line, department, process, etc.
departments and processes.
• Financial reports are prepared • Cost reporting is a continuous
periodically, usually on an process and may be daily,
annual basis. weekly, monthly, etc.
 Financial accounting Cost accounting
• It does not attach any • It provides for a detailed system
importance to the control of controls with the help of
aspect. certain special techniques like
standard costing and inventory
control etc.
• It extends to plans and policies
• It is concerned almost
to improve performance in the
exclusively with historical future.
records.
• It generates special purpose
• It prepares general purpose statements and reports like
statements to produce report on loss of materials, idle
information that is used by time report, variance report, etc.
many classes of people. it identifies the user, discusses
his problems and needs and
provides tailored information.
 Difference between Cost & Management
Accounting
Cost Accounting Management Accounting
• It deals with ascertainment,
• It deals with the effect and
allocation, apportionment and
impact of costs on the
accounting aspect of costs.
business.
• It provides a base for
• It is derived from both cost
management accounting
and financial accounting.
• Cost accountant has a narrow
• Management accountant
approach. He has to refer to
reports the effect of cost on the
economic and statistical data
business along with cost
for analysing cost effects.
analysis.
• It has standard costing,
• It has funds and cash flow
variable costing, break even
statements, ratio analysis etc
analysis etc as the basic tools
as tools and techniques.
and techniques.
 Material Cost
• Material is any substance (Physics term) that forms part of
or composed of a finished product. i.e material refers to the
commodities supplied to an undertaking for the purpose of
consumption in the process of manufacturing or of
rendering service or for transformation into products.

• The term ‘Stores’ is often used synonymously with

materials, however, stores has a wider meaning and it
covers not only raw materials consumed or utilized in
production but also such other items as sundry supplies,
maintenance stores, fabricated parts, components, tools,
jigs, other items, consumables, lubricants......etc.
• Finished and partly finished products are also often included
under the term ‘Stores’. Materials are also known as
Inventory. The term Materials / Inventory covers not only
raw materials but also components, work-in-progress and
finished goods and scrap also.

• Material cost is the significant constituent of the total cost

of any product. It constitutes 40% to 80% of the total cost.
The percentages may differ from industry to industry. But
for manufacturing sector the material costs are of greatest
significance.

• Inventory also constitutes a vital element in the Working

Capital. So it is treated as equivalent to cash. Therefore the
 Objectives of Material Control System:

• To make continuous availability of materials so that there

may be uninterrupted flow of materials for production.
Production may not be held up for want of materials.
• To purchase requisite quantity of materials to avoid
locking up of working capital and to minimise risk of
surplus and obsolete stores.
• To make purchase competitively and wisely at the most
economical prices so that there may be reduction of
material costs.
• To purchase proper quality of materials to have minimum
possible wastage of materials.
• To serve as an information centre on the materials knowledge
for prices, sources of supply, lead time, quality and
specification.
“Material cost is defined as cost of material of
any nature used for the purpose of production of
a product or service”
The principles to be followed for
valuation of materials are:
 Valuation of Receipts of Materials: Inclusions and Exclusions:

The following items are to be ‘included’ for the purpose of

determining valuation of receipt of materials:
• Purchase price;
• Duties and Taxes ;
• Freight Inwards ;
• Insurance ;
• Other expenditure directly attributable to procurement that
can be quantified with reasonable accuracy at the time of
procurement ;
• Self-manufactured packing materials shall be valued
including direct material cost, direct employee cost, direct
expenses, job charges, factory overheads and other directly
related overheads.
 The following items are to be ‘excluded’ for
the purpose of determining valuation of receipt
of materials:
• Trade Discounts (Cash Discount being a
financial income is not to be netted off against
cost of materials)
• Rebates
• Taxes and duties refundable or credited by tax
authorities
 Valuation and Cost of Materials: Inclusions and Exclusions:

The following items are to be ‘included’ for the purpose of

determining valuation of materials:
• Normal loss or spoilage prior to receipt at factory gate net of
amounts recoverable from suppliers, insurers, carriers or
recoveries from disposal
• Normal losses due to shrinkage or evaporation or gain due to
elongation or absorption of moisture before receipt of material
• Foreign exchange component of material cost converted at the rate
on the date of transaction
• Subsidy/Grant/Incentive and any similar payments received or
receivable which can be ascertained with certainty shall be
reduced.
• Price Variances when materials are accounted
for at standard cost
• Self-manufactured components and sub-
assemblies to be valued inclusive of direct
material cost, direct employee cost, direct
expenses, factory overheads and share of
administrative overheads relating to production
• Material cost of normal scrap/defectives to be
included in the material cost of manufactured
goods
 The following items are to be ‘excluded’ for the purpose
of determining valuation of receipt of materials:
• Finance costs
• Abnormal losses due to shrinkage or evaporation or gain due to
elongation or absorption of moisture before receipt of material
• Changes in foreign exchange rate from the rate on date of
transaction till date of payment
• Demurrage or detention charges or penalty levied by transport
or other authorities
• Imputed costs
• Cost of self-manufactured components and sub-assemblies shall
not include share of other administrative overheads, finance
cost and marketing overheads
• Material cost of abnormal scrap/defectives not to be included
 Employee Cost
• Labour Cost is also called as Employee Cost. However, for
control and reduction of Labour Cost, it is essential to compute
the Labour Cost in a scientific manner and hence there should
be proper systems and processes and documentation, which
will help computation of Labour Cost in a scientific manne
• It should be remembered that Labour is not like material as
there is a human aspect involved in it. Therefore, there should
be a comprehensive study of all related aspects of Labour Cost
and then only computation and control over the same will be
possible.
• Attention should also be paid to the productivity aspect. Low
productivity results in higher Labour Cost per unit while
higher productivity will reduce the Labour Cost per unit.
Study of Labour or Employee Cost can better be explained as follows:
• Employee Cost is ‘The aggregate of all kinds of
consideration paid, payable and provisions made for
future payments for the services rendered by employees
of an enterprise (including temporary, part time and
contract employees). Consideration includes wages,
salary, contractual payments and benefits, as applicable
or any payment made on behalf of employee. This is also
known as Labour Cost.’
 Measurement of Employee Cost: Inclusions and Exclusions:

• The following items are to be ‘included’ for the purpose of

measuring employee cost:
• Any payment made to an employee either in cash or kind
• Gross payments including all allowances payable and includes all
benefits
• Bonus, ex-gratia, sharing of surplus, remuneration payable to
Managerial personnel including Executive Directors and other
officers
• Any amount of amortization arising out of voluntary retirement,
retrenchment, termination, etc
• Variance in employee payments/costs, due to normal reasons (if
standard costing system is followed)
• Any perquisites provided to an employee by the employer
 The following items are to be ‘excluded’ for the purpose of
measuring employee cost:
• Remuneration paid to Non-Executive Director
• Cost of idle time [ = Hours spent as idle time x hourly rate]
• Variance in employee payments/costs, due to abnormal reasons
( if standard costing system is followed)
• Any abnormal payment to an employee – which are material
and quantifiable
• Penalties, damages paid to statutory authorities or third parties
• Recoveries from employees towards benefits provided – this
should be adjusted/reduced from the employee cost
• Cost related to labour turnover – recruitment cost, training cost
and etc
• Unamortized amount related to discontinued operations.
 Direct Expenses

• Direct expense or chargeable expense is that which can be

allocated to a cost centre or cost unit and indirect expense
is that which needs to be apportioned.
• There may be items of expense direct in relation to some
cost centre. Thus rent and rates, heating & lighting,
depreciation & insurance are often allocated or charged
directly to the appropriate service cost centre, the totals of
service department cost are however, apportioned to other
cost centres before being absorbed by cost units as
overheads.
• These costs are direct costs of the first cost centre, but
indirect costs of other production cost centres, as well as
being indirect cost of cost units.
• Direct expenses as defined in CAS-10,
‘Expenses relating to manufacture of a product
or rendering a service, which can be identified
or linked with the cost object other than direct
material cost and direct employee cost’
• The following expenses may be treated as direct
expenses:-
• Cost of patents, royalty payment;
• Hire charges in respect of special machinery or
plant;
• Cost of special patterns, cores, designs or tools;
• Experimental costs and expenditure in connection
with models and pilot schemes;
• Architects, surveyors and other consultants fee;
• Travelling expenses to sites;
• Inward charges and freight charges on special
material.
 Measurement of Direct Expenses: Inclusions and Exclusions:

The following items are to be ‘included’ for the purpose of measuring direct
cost:
• Costs which are directly traceable/identifiable with the cost object
• Expenses incurred for the use of bought in resources
• Price variance if such expenses are accounted for at standard cost
The following items are to be ‘excluded’ for the purpose of measuring direct
cost:
• If not traceable/identifiable should be considered as overheads
• Finance cost is not a direct expense
• Imputed cost ( example, if the owner of a company engages himself for
facilitating the production or gets actively engaged in production or
rendering of services, this would be an imputed cost)
• Recoveries, credits, subsidy, grant, incentive or any other which reduces the
cost
•
 Overheads

• An overhead is the amount which is not identified

with any product. The name overhead might have
come due to the reason of over and above the
normal heads of expenditure.
• It is the aggregate of indirect material, indirect
labour and indirect expenditure. The generic term
used to denote indirect material, indirect labour
and indirect expenses. Thus overheads forms a
class of cost that cannot be allocated or absorbed
but can only be apportioned to cost units.
Study of Overheads can be better understood from the following diagram:
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