Cost and Management Accounting I
Introduction
Cost & Managemet Accounting 1
Cost accounting
• Is the process of accounting or recording all attributable
and allocable costs for a product or service, beginning with
recording of income and expenditure relating to the
product and ending with preparation of statistical data.
• Costing is essentially an activity of assigning the
appropriate costs to a product and creating a data for
future references as regards the cost relating to it.
Cost & Managemet Accounting 2
Cost Terms
• Cost : The amount of expenditure/expenses incurred on or attributable
to a specified article, product or activity.
• Cost Unit: unit of product with which cost is attached. Examples:
Marker, Bike, Watch, etc.
• Cost Per Unit: Cost of one unit of a product is called cost per unit”.
• Cost Center: A cost center is a production or service location, function,
activity or item of equipment for which costs are accumulated and
analyzed”.
• Cost Object: A cost object is any activity or item for which a separate
measurement of cost is desired”. It could be a cost unit or cost center.
Objectives of Cost Accounting
• Ascertainment of Cost: This is the main objective of cost accounting, Costs are accumulated,
assigned and ascertained for each cost object.
• Determination of Selling Price and Profitability: In a competitive business environment,
selling prices are determined by external factors but cost accounting system provides a basis
for price fixation and rate negotiation.
• Cost Control. It ensures that expenditures are in accord with predetermined set standard and
any variation from these set standards is noted and reported on continuous basis.
• Cost Reduction: this is the achievement of real and permanent reduction in the unit cost
of goods manufactured or services rendered without impairing their suitability for the use
intended or diminution in the quality of the product.”
• Assisting management in decision making: Cost accounting provides relevant
information, assists management in planning, implementing, measuring, controlling
and evaluation of various activities.
Cost & Managemet Accounting 4
Cost Control includes…
a. Determination of pre-determined standard or results: Standard cost or performance targets
for a cost object or a cost center is set before initiation of production or service activity.
These are desired cost or result that need to be achieved.
b. Measurement of actual performance: Actual cost or result of the cost object or cost center
is measured. Performance should be measured in the same manner in which the targets
are set i.e. if the targets are set operation-wise, and then the actual costs should also be
collected and measured operation- wise to have a common basis for comparison.
c. Comparison of actual performance with set standard or target: The actual performance so
measured is compared against the set standard and desired target. Any deviation (variance)
between the two is noted and reported to the appropriate person or authority.
d. Analysis of variance and action: The variance in results so noted are further analyzed to
know the reasons for variance and appropriate action is taken to ensure compliance in
future. If necessary, the standards are further amended to take developments into account.
Cost & Managemet Accounting 5
Difference bt’n Cost Control and Cost Reduction
Cost Control Cost Reduction
Cost control aims at maintaining the costs in Cost reduction is concerned with reducing
accordance with the established standards. costs. It challenges all standards and
endeavors to better them continuously
Cost control seeks to attain lowest possible Cost reduction recognizes no condition as
cost under existing conditions. permanent, since a change will result in lower
cost.
In case of cost control, emphasis is on past In case of cost reduction, it is on present
and present and future.
Cost control is a preventive function Cost reduction is a corrective function. It
operates even when an efficient cost control
system exists.
Cost control ends when targets are achieved. Cost reduction has no visible end.
Cost & Managemet Accounting 6
Scope of Cost Accounting
• Costing
• Cost Accounting
• Cost Analysis
• Cost Comparisons
• Cost Control
• Cost Reports
• Statutory Compliances
Cost & Managemet Accounting 7
Management Accounting
• Is concerned with providing information to managers for use within the
organization.
• It deals with the processing of data in financial accounting and cost accounting for
managerial decision making.
• It also deals with the application of managerial economic concepts for decision making
for the efficient running of the business, thus maximizing profits.
• In other words, it is accounting for the management.
• Management accounting is useful to the management to provided necessary
information for decision making and creation of suitable policies within the
organization.
• The aim of management accounting is the efficient running of the business, and
thus, maximizing profits.
Cost & Managemet Accounting 8
Financial accounting
• Is the process of recording, analyzing and reporting (in
the form of statement of profit or loss and statement of
financial position) the financial affairs of business.
• Concerned with reporting financial information to
external parties, such as
– Stockholders
– Creditors
– regulators.
Cost & Managemet Accounting 9
Management accounting
• Managerial accounting helps managers perform
three vital activities
• Planning
• Controlling and
• decision making
Cost & Managemet Accounting 10
Differences Between Financial and Managerial
Accounting
Financial Managerial
Accounting 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. Requirements Must follow GAAP Need not follow GAAP
and prescribed formats or any general format
Pillars of managerial accounting
• Planning
• Directing and Motivating
• Controlling
• Feedback
Cost & Managemet Accounting 12
Work of Management
Planning
Directing and
Motivating
Controlling
Cost & Managemet Accounting 13
Planning
• Planning involves selecting a course of action and
specifying how the action will be implemented.
• An important part of planning is to identify alternatives
and then to select from among the alternatives the one that
best fits the organization’s strategy and objectives.
• The basic objective of any organization is to earn profits for
the owners of the company by providing superior service
at competitive prices in as many markets as possible
Cost & Managemet Accounting 14
Directing and Motivating
• Involves mobilizing people to carry out plans and run
routine operations
• Managers oversee day-to-day activities and try to keep the
organization functioning smoothly.
• Managers assign tasks to employees, arbitrate disputes,
answer questions, solve on-the-spot problems, and make
many small decisions that affect customers and employees
Cost & Managemet Accounting 15
Controlling
• Controlling involves ensuring that the plan is
actually carried out and is appropriately modified
as circumstances change
• managers seek to ensure that the plan is being
followed
Cost & Managemet Accounting 16
Feedback
• Signals whether operations are on track, is the key to
effective control.
Cost & Managemet Accounting 17
Planning and controlling circle
Formulating long and short-term plans
(Planning)
Comparing actual to Decision Implementing plans
planned performance (Directing and
Making Motivating)
(Controlling)
Measuring performance (Controlling)
Cost & Managemet Accounting 18
Purpose of management accounting
• Decision making • Performance measurement and
• Formulating overall strategies evaluation of people:
and long-range plans (Planning • Meeting external regulatory and
for future) legal reporting requirements
• Resource allocation decisions • Control of resources and cost of
such as product and customer production
emphasis and pricing
• Cost planning and cost control of
operations and activities
Cost & Managemet Accounting 19
Quiz
• With a relevant example, Describe the five-
step decision-making process?
Cost & Managemet Accounting 20
Role of management accountant
• Planning and controlling
• Performance measurement
• Allocation of costs between cost of goods sold
and inventories
• Decision making
Cost & Managemet Accounting 21
Cost Classification
• General classification of cost
• Classification of costs by nature
• Classification of costs by function
• Cost classification by behavior
• Cost Classifications for Decision Making
Classification of costs by nature
• Costs are classified into direct and indirect by nature.
• The distinction of costs into direct and indirect is necessary
because they need different treatments for cost computation and
control.
• This classification is based on the principle of traceability of costs
to the final product or service
• Direct costs consist of all the direct materials, direct labor and direct
expenses.
• Indirect costs consist of indirect materials, indirect labor and
indirect expenses
General Cost Classifications
• Manufacturing Costs/ Product cost
• Period cost
• Prime Cost and Conversion Cost
Manufacturing Costs/ Product cost
• The production process generally involves processing
raw materials into the final product,
• All the costs incurred in a factory, until the stage
when the goods can be marketed as final products
are considered product or manufacturing costs
Manufacturing costs
• Direct material
• Direct labor
• Direct expense
• Production overheads (factory overheads)
Direct Materials
• Direct materials refer to any materials that are used
in the producing the final product; and the finished
product of one company can become the raw
materials of another company
• For example, the Timber wood produced by XX Ltd
are a raw material used by YY Furniture Company in
producing sofa set.
Material costs may include costs of:
• The ingredients from which the product is manufactured
• The spares and parts used for completion of the product
• Materials transferred from one process to another as
input to the other process (work in process).
• Primary packing wherever essential in order to sell the
product
Direct Labor
• The remuneration paid to workers who are directly involved in the
production process or the provision of a service is termed labor
costs.
• Direct labor costs are computed either on the basis of the hours of
work put in by the workers or the number of units produced by
them.
• Labor costs include:
– The cost of labor engaged in the actual production activity.
– Charges paid to special labor engaged in any production activity.
Direct expenses
• Direct expenses include all expenses other than direct
material or direct labor that are specifically incurred for a
particular product or process.
• Examples of Direct Expenses
– Royalties paid to authors while publishing books
– Freight, or carriage inwards
– Hire charges paid by a construction contractor for
hiring a hot mix plant. (cement mixing machine)
Overheads
• Overheads are all the indirect costs (material, labor and expenses) which are
not directly identifiable with a product. Overheads in the context of production
are production overheads.
• Production overhead costs include:
• Indirect materials
• Indirect labor
• Indirect expenses
• Examples of Overheads
– Indirect materials - lubricants for machines, fuel used in a factory
– Indirect labor – factory supervisor’s salary, support technicians‟ wages,
material handlers‟ wages
– Indirect expenses - factory utilities, factory depreciation, factory
maintenance and repairs
Prime Cost and Conversion Cost
• Prime cost is the sum of direct materials
cost and direct labor cost.
• Conversion cost is the sum of direct labor
cost and manufacturing overhead cost.
Prime Cost and Conversion Cost
• Manufacturing costs are often classified as follows
Direct Direct Manufacturing
Material Labor Overhead
Prime Conversion
Cost Cost
Period Costs
• Period costs are all the costs that are not product
costs.
• All selling and administrative expenses are treated as
period costs.
• Administration costs, commission cost, selling costs,
distribution costs, finance costs and research and
development costs
Cost for preparing financial statements
• Product costs – Includes all the costs that are involved in
acquiring or making a product. More specifically, it includes
direct materials, direct labor, and manufacturing overhead
– Product costs are expensed in the income statement when
the products are sold.
• Period costs – Includes all selling and administrative costs.
– These costs are expensed in the income statement in the
period incurred.
Merchandising Company income statement
Sales $1,000,000
Cost of goods sold:
Beginning merchandise inventory $100,000
Add: Purchases 650,000
Goods available for sale 750,000
Deduct: Ending merchandise inventory 150,000 600,000
Gross margin 400,000
Selling and administrative expenses:
Selling expense 100,000
Administrative expense 200,000 300,000
Net operating income $ 100,000
Manufacturing Company Income statement
Sales $1,500,000
Costs of goods sold:
Beginning finished goods inventory $125,000
Add: Cost of goods manufactured 850,000
Goods available for sale 975,000
Deduct: Ending finished goods inventory 175,000 800,000
Gross margin 700,000
Selling and administrative expenses:
Selling expense 250,000
Administrative expense 300,000 550,000
Net operating income $ 150,000
Cost of Goods Sold in a Merchandising Company
• Beginning merchandise inventory + Purchases = Ending
merchandise inventory + Cost of goods sold
• or
• Cost of goods sold = Beginning merchandise inventory +
Purchases – Ending merchandise Inventory
Cost of Goods Sold in a Manufacturing Company
• Beginning finished goods inventory + Cost of goods
manufactured =Ending finished goods inventory
+Cost of goods sold
Or
• Cost of goods sold = Beginning finished goods
inventory + Cost of goods manufactured ¬-Ending
finished goods inventory
Schedule of Cost of Goods Manufactured
Beginning raw materials inventory* $ 60,000
Add: Purchases of raw materials 400,000
Raw materials available for use 460,000
Deduct: Ending raw materials inventory 50,000 Direct Material
Raw materials used in production $410,000
Insurance, factory 6,000
Indirect labor 100,000
Machine rental 50,000 Manufacturing
Utilities, factory 75,000 OHD
Supplies 21,000
Depreciation, factory 90,000
Property taxes, factory 8,000
Total manufacturing overhead cost 350,000
Schedule of Cost of Goods Manufactured
• Direct labor 60,000
• Cost of good Manufactured
Total manufacturing cost 820,000
Add: Beginning work in process inventory 90,000
910,000
Deduct: Ending work in process inventory 60,000
Cost of goods manufactured $850,000
Cost classification by behavior
• Cost behavior refers to how a cost reacts to changes
in the level of activity. As the activity level rises and
falls, a particular cost may rise and fall as well—or it
may remain constant
• This category include
– Variable Cost
– Fixed cost
Variable Cost
• A variable cost varies, in total, in direct proportion to changes
in the level of activity.
• Common examples of variable costs include
Examples
• Direct material and labor cost
• Indirect material and labor cost
• Power and fuel
• Lubricants
• Tools and spares
Fixed Cost
• 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..
Examples of fixed costs include
– straight-line depreciation, insurance, property taxes, rent,
supervisory salaries, administrative salaries, and advertising
Cost classification by behavior
Behavior of Cost (within the relevant range)
Cost In Total Per Unit
Variable Total variable cost changes Variable cost per unit remains
as activity level changes. the same over wide ranges
of activity.
Fixed Total fixed cost remains Average fixed cost per unit goes
the same even when the down as activity level goes up.
activity level changes.
The relevant range
• Is that range of activity within which the assumptions
made about cost behavior are valid.
• Assume office space is available at a rental rate of
$30,000 per year in increments of 1,000 square feet.
• Fixed costs would increase in a step fashion at a rate
of $30,000 for each additional 1,000 square feet.
Mixed Costs
• A mixed cost contains both variable and fixed cost
elements.
• Mixed costs are also known as semi variable costs
• An equation can be used to express the relationship
between mixed costs and the level of the activity. This
equation can be used to calculate what the total mixed
cost would be for any level of activity
• The equation is Y = a + bX
Classification by function
• Administrative
• Selling
• Distribution
• Research and Development.
– These are all a part of indirect expenses / overheads
– For the entire organizational activity, these costs are directly taken to
the SOPL
Administrative costs
• Administrative costs of an organization include the costs incurred in
formulating the policy, directing the organization and controlling its
activities. In a big organization, administrative costs are split into two
types:
• Costs incurred at the factory level that are incurred to provide the staff
with administrative support
• Costs incurred at head office level that are allocated to the factory.
Examples of Administrative cost
• Office rent
• Salary of office staff – cleaners, clerks
• Electricity and telephone costs of the office
Selling costs
• A product needs to be marketed and advertised so that the customers are
aware of it, thereby creating a demand for the product in the market. Selling
costs include all costs that help the sale of the product in the market place.
• Example of Selling costs
– Sales promotion expenses, showroom expenses
– Advertising costs such as catalogues, banners, brochures
– Salaries of sales and marketing personnel, commissions paid to salesmen
Distribution costs
• Costs incurred for the transport of goods from the factory or depot to the
customer and / or the costs incurred for maintaining the channel of
distribution are known as distribution costs. This cost also covers the cost of
recovering and reconditioning empty containers for reuse.
Examples of Distribution cost
– Transportation cost of goods between two points, namely there receipt
point of goods from production and the delivery point to the customer
– The insurance cost of the goods between this period
– Depreciation on vehicles used for the distribution of goods
– Fuel used by vehicles in the distribution department
– Repairs and maintenance cost of the above vehicles
Finance costs
• Costs incurred in relation to the provision of finance to
the business, mainly interest costs, are known as
finance costs.
– Interest paid on a fixed-term loan taken for the
construction of a building
– Interest paid on a fixed-term loan taken for the
purchase of plant and machinery
– Interest paid to debenture holders
Cost Classifications for Decision Making
• Every decision involves a choice between at least two
alternatives.
• Only those costs and benefits that differ between
alternatives are relevant in a decision. All other costs
and benefits can and should be ignored.
Differential Cost and Revenue
• Costs and revenues that differ among alternatives.
Example: You have a job paying $1,500 per month in
your hometown. You have a job offer in a neighboring
city that pays $2,000 per month. The commuting cost
to the city is $300 per month.
Differential revenue is:
$2,000 – $1,500 = $500
Differential cost is:
$300
Opportunity Cost
• The potential benefit that is given up when one
alternative is selected over another
• Example: If you were not attending college, you
could be earning TZS15000,000 per year.
• Your opportunity cost of attending college for one
year is TZS15,000,000.
Controllability
• Controllable Costs: - Cost that can be controlled by
ones action labor, material etc.
• Uncontrollable Costs - Costs which cannot be
influenced by the action of a specified member of
an undertaking e.g. Cost of expenditure of store
room allocated to machine department.
Sunk Costs
• costs that have already been incurred and cannot be
changed now or in the future. They should be
ignored when making decisions
• Example: You bought a car that cost TZS10,000,000
two years ago. The TZS10,000,000 cost is sunk
because whether you drive it, park it, trade it, or sell
it, you cannot change the TZS10,000,000 cost.
Thank you so much.........
