Module1Introduction to Cost

Management

Introduction Financial accountants provide information to

external parties Investors Creditors Regulators

Managerial accountants provide information to internal users Managers

Cost accountants provide information to both internal and external users Product cost information

Relationship of Financial, Management, and Cost Accounting

FINANCIALACCOUNTING

MANAGEMENTACCOUNTING

COSTACCOUNTIN

G

Product Costs

Accounting Information System

5

Accounting Information SystemFinancial accounting system

Follows established rules and conventions to provide information (financial statements) to external users such as investors, government agencies, and banks.

Cost management systemIdentifies, collects, measures, classifies, and reports information that is useful to managers in costing (determining what something costs), planning, controlling, and decision making.

Management AccountingModern concept of accounts as a tool of management. Any form of accounting which enables a business to be conducted more efficiently can be regarded as Management Accounting

7

Subsystems of theAccounting Information System

8

Cost Management System

Cost accounting systemAssigns costs to individual products and services and other cost objects as specified by management; satisfies financial reporting and management decision-making needs

Operational control systemProvides accurate and timely feedback concerning performance; concerned with what activities should be performed and assessing those activities.

Factors AffectingCost Management Global Competition Growth of the Service Industry Advances in Information Technology Advances in Management Environment Consumer Orientation New Product Development Total Quality Management Time as a Competitive Element Efficiency

Components of the Value Chain

Limitations of Financial Accounting Shows only overall performance Historical in Nature No performance appraisal No material control system No labour cost control No proper classification of costs No analysis of losses Inadequate information for price fixation No cost comparison Fails to supply useful data to management

Objectives and Functions of Cost Accounting

Ascertainment of Cost Cost Control and Cost Reduction Guide to Business Policy Determination of selling price

Contd.

1. To analyse and classify all expenditures with reference to the cost of products and operations.

2. To arrive at the cost of production of every unit, job, operation, process, department or service and to develop cost standard.

3. To indicate to the management any inefficiencies and the extent of various forms of waste, whether of materials, time, expenses or in the use of machinery, equipment and tools.

4. To provide data for periodical profit and loss accounts and balance sheets at such intervals, e.g., weekly, monthly or quarterly, as may be desired by the management during the financial year, not only for the whole business but also by departments or individual products.

5. To provide actual figures of cost for comparison with estimates and to serve as a guide for future estimates or quotations and to assist the management in their price-fixing policy.

6. To show, where standard costs are prepared, what the cost of production ought to be and with which the actual costs which are eventually recorded may be compared.

7. To present comparative cost data for different periods and various volumes of output.

8. To provide information to enable management to make short-term decisions of various types, such as quotation of price to special customers or during a slump, make or buy decision, assigning priorities to various products, etc

Cost Accounting vs. Financial Accounting

Basis Financial A/C Cost A/c

Purpose External Users Internal Users

Statutory Requirements

Legal requirements of Companies Act and Income tax Act

Maintenance of these accounts is voluntary

Analysis of cost and Profit

Reveal the P/L of the business as a whole for a particular period

Shows the detailed cost data for each product, department etc

Periodicity of reporting

Annual basis Reporting is a continuous basis

Control Aspect Lays emphasis on recording of financial transactions

Provides detailed system of controls

Contd.

Basis Financial A/C Cost A/c

Historical and Predetermined Cost

It is concerned exclusively with historical records

It extends to plans and policies to improve performance in the future

Format of presenting Information

Uniform format of presenting the information

It has varied form of presenting information which are tailored to meet the needs of management

Types of transactions recorded

External transactions like Sales, purchases etc.. With outside parties

Records not only external transactions but also internal and inter departmental transactions.

Types of statements prepared

General purpose statementsP& L a/cBalance Sheet

Special Purpose StatementsReport on loss of materialsIdle time reportVariance report

Cost Centre For the purpose of cost ascertainment the

whole organization is divided into small parts or sections

Each small section is treated as a cost centre for which cost is ascertained

It may be a location (a department, sales area), equipment(a machine, delivery van) a person (machine operator)

E.g.: 1.Weaving department in textile mill, melting shop in a steel mill, cane crushing shop in a sugar mill.

2. Service cost centers are power house, stores department, repair shop etc.

Cost Unit Unit of product or service in relation to which

costs are ascertained

E.g.: In a sugar mill the cost per tonne of sugar may be ascertained, In a textile mill the cost per metre of cloth may be ascertained.

Thus ‘a tonne ’ of sugar and ‘a metre’ of cloth are cost units

Methods of Costing

Job order costing: Applies where work is undertaken to customers special requirements

E.g.: Interior Decoration, Painting etc

Contract Costing: Applies for a longer duration and may continue for more than a yeare.g.: Constructions of buildings, Dams, Ship Buildings etc

Batch Costing: Cost of a batch or group of identical products is ascertained

E.g.: Production of readymade garments, Tyres and tubes, Component parts etc

Contd.

Process Costing: Applied in mass production industries

manufacturing standardized products in continuous

processes of manufacturing

E.g.; Textile mills, Chemical works etc.

Unit Costing: Applied when production is uniform, the

cost per unit is found by dividing the total cost by number

of units produced.

E.g.: Mines, Steel production

Service Costing: Applied in service undertakings

E.g.: Transport undertakings, Electricity companies

Contd. Multiple or Composite Costing: Applied

where a number of components are separately manufactured and then assembled into a final product

E.g.: Television set manufacturing, Refrigerators, cars etc

Techniques of Costing Standard Costing Budgetary Control Marginal Costing- Only Variable Costing Total absorption costing- Total costs

Classification Of Costs1. By time (Historical, Pre-determined). 2. By nature or elements (Material, Labour and Overhead). 3. By degree of traceability to the product (Direct, Indirect). 4. Association with the product (Product, Period). 5. By Changes in activity or volume (Fixed, Variable, Semi-

variable). 6. By function (Manufacturing, Administrative, Selling, Research

and development, Pre-production). 7. Relationship with accounting period (Capital, Revenue). 8. Controllability (Controllable, Non-controllable). 9. Cost for analytical and decision-making purposes

(Opportunity, Sunk, Differential, Common, Out-of-pocket, Marginal, Replacement).

10. Others (Conversion, Traceable, Normal, Avoidable, Unavoidable, Total).

Importance and Advantages of CAI. To the Management• It discloses profitability of activities• It helps in cost control• Helps in Inventory control• It aids in formulating policies• Helps in decision making• It guides in fixation of selling price• It discloses idle capacityII To the workers• Helps for fixing the standard of efficiency for

workers• Rewards the efficient workers.

Contd.III. To the Creditors• Cost reports are useful to the creditors for

ascertaining the future prospects and profitability of the enterprise

IV To the Society• Quality goods at a reasonable price• Curbing inflationary trend in the economy

Elements of Cost

Meaning Element of cost means the essential parts/

components of goods or services. It is the total cost and includes the main item of expenditure incurred for production of goods and services

1. Element wise Classification• Material cost• Labour Cost• Expenses

2. Function wise Classification• Production cost/ works cost/ factory cost• Administrative cost• Selling cost• Distribution cost

3. According to Behavior• Variable cost• Fixed cost• Semi variable

Elements Of CostCost

Material Labour Expenses

Direct Materi

al

Indirect

Material

Direct Labou

r

Indirect

Labour

DirectExpens

es

Indirect Expens

es

Overheads

FactoryAdministrati

veSelling

Distribution