Presenter :

Md. Maksodur Rahman FCA

Deputy Head of FAD
Standard Bank Limited
 Topic List:
1. What is cost accounting?
Management 2. Basic cost accounting
concepts
Information 3. Cost classification for
inventory valuation and profit
Chapter: 1 measurement
4. Cost classification for
planning and decision-making
The fundamentals of 5. Cost classification for
control
costing
 In the examination, candidates may be required to:

 Understand the purpose of a cost unit

 Classify costs as fixed, variable and semi-variable (or
semi-fixed)
 Understand what is meant by the elements of cost
 Understand the difference between a direct cost and an
indirect cost, between a controllable cost and an
uncontrollable cost and between a product cost and a
period cost
 1. What is cost accounting?

 Cost accounting is the process of recording,

classifying, analyzing, summarizing, and
allocating costs associated with a process, and
then developing various courses of action to
control the costs. Its goal is to advise
the management on how to optimize business
practices and processes based on cost efficiency
and capability. Cost accounting provides the
detailed cost information that management needs
to control current operations and plan for the
future.
 The cost accountant
The cost accountant or a person having access to cost information should be
able to provide the answers to questions such as the following :
What was the cost of goods produced or services provided last period?
What was the cost of operating a department last month?
What revenues were earned last week?
Knowing about costs incurred or revenues earned enables management to do
the following :
Assess the profitability of a product, a service, a department, or the
whole organisation.
Determine appropriate selling prices with due regard to the costs of
sale and target profit margins.
Put a value on inventory (whether raw materials, work in progress, or
finished goods) that is still held at the end of a period, for preparing a
balance sheet of the company's assets and liabilities, and determining the cost
of materials (goods) used or sold in a period.
Cost accounting and management accounting

Originally cost accounting dealt with ways of

accumulating historical costs and of charging these
costs to units of output, or to departments, in order
to establish inventory valuations, profits or losses
and balance sheet items. It has since been extended
into planning, control and decision making.
In today's environment the role of cost accounting in
the provision of management information is
therefore almost indistinguishable from that of
management accounting, which is basically
concerned with the provision of information
to assist management with planning, control
and decision making.
 Cost accounting systems

The managers of a business have responsibility for planning and

controlling the resources used. To carry out this task effectively they
must be provided with sufficiently accurate and detailed
information, and the cost accounting system should provide this.
Indeed, a costing system provides the foundations for an
organisation's internal financial information system for
managers.
Cost accounting systems are not restricted to manufacturing
operations.
Cost accounting information is also used in service industries,
government departments and not-for- profit organizations,
including charities.
Within a manufacturing organization itself, the cost
accounting system should be applied not only to manufacturing
operations but also to administration, selling and distribution,
research and development and so on.
 Cost Accounting

Cost accounting is concerned with providing

information to assist the following :
Establishing inventory valuations,
profits or losses and balance sheet items
Planning (for example the provision of forecast
costs at different activity levels)
Control (such as the provision of actual and
standard costs (see Chapter 9) for comparison
purposes)
Decision making (for example, the provision of
information about actual unit costs for the period
just ended for pricing decisions).
 Financial accounting versus cost accounting

The financial accounting and cost accounting systems in a business

both record the same basic data for income and expenditure, but
each set of records may analyze the data in a different way. This is
because each system has a different purpose.
Financial accounts are usually prepared for stakeholders
external to an organisation, eg shareholders, banks, customers,
suppliers, HM Revenue and Customs and employees.

Management accounts are usually prepared for internal

managers of an organisation.

The data used to prepare financial accounts and management

accounts are the same. The differences between the financial
accounts and the management accounts arise because the data is
usually analyzed differently.
Financial accounts Management accounts

Financial accounts detail the performance of an Management accounts are used to aid management to record, plan and
organisation over a defined period, including its cash control the organisation's activities and to help the decision-making
flows and the state of affairs at the end of that period. process.

In Bangladesh, limited companies must, by law, There is no legal requirement to prepare management accounts.
prepare financial accounts.
The format of published financial accounts is The format of management accounts is entirely at management
determined by IFRS, relevant Acts and Rules as discretion: no strict rules govern the way they are prepared or presented.
applicable. In theory the accounts of different Each organisation can devise its own management accounting system
organisations can therefore be easily compared. and format of reports.

Financial accounts often concentrate on the business as Management accounts can focus on specific areas of an organisation's
a whole, aggregating revenues and costs from different activities such as operating departments, individual sites or business
operations, and are wholly historical. streams. Information may be produced to aid a decision rather than to be an
end product of a decision.
Most financial accounting information is of a Management accounts incorporate non-monetary measures. Management
monetary nature. may need to know, for example, tonnes of product produced, monthly
machine hours, or miles travelled by sales representatives. These are
often called 'Key Performance Indicators'
Financial accounts present an essentially historical Management accounts are both a historical record and a future planning
picture of past operations. tool, linking to budgets and forecasts.
 Basic Cost Accounting Concepts
Cost objects : A cost object is anything for which
we are trying to ascertain the cost. Examples of cost
objects include:
A unit of product (eg a car)
A unit of service (eg a valet service of a car)
A department or function (eg the accounts
department)
A project (eg the installation of a new
computer system)
A new product or service (eg to enable the
cost of development to be identified)
 Basic Cost Accounting Concepts

Cost units : A cost unit is the basic measure of product or service

for which costs are determined.
Businesses are often interested in one particular cost object – the
cost unit – and the cost per
 Composite cost units

Notice that some of the cost units in the above table are made
up of two parts, for example the patient/day cost unit for
the hospital. These two-part cost units are known as
composite cost units and they are used most often in
service organizations.
Composite cost units help to improve cost control. For
example, the measure of 'cost per patient' might not be
particularly useful for control purposes. The cost per
patient will vary depending on the length of the patient's
stay, therefore monitoring costs using this basis would be
difficult.
The cost per patient/day is not affected by the length of the
individual patient's stay. Therefore it would be more useful
for monitoring and controlling costs. Similarly, in a
freight organization the cost per tonne/kilometre (the
cost of carrying one tonne for one kilometre) would be more
meaningful for control than the cost per tonne carried, which
would vary with the distance travelled.
 Interactive question 1: Cost units

Identify which of the following cost objects would be

suitable cost units for an hotel. Tick the boxes to
indicate which would be suitable :
 Bar

Restaurant

Room/night

Meal served

Conference delegate

Fitness suite

Conference room/day
Direct vS indirect costs and cost objects

Direct costs are costs identified with a cost object.

Indirect costs cannot be identified with a particular
cost object. For example if a chair is a cost object
then certain costs such as materials and the labour
required to assemble the chair would be classed as
direct costs for an individual chair.
Factory rent could not be associated with an
individual chair so would be classed as an indirect
cost of the chair. However, if the cost object were
the factory itself then the rent is a direct cost of the
factory.
 Cost elements
For the purposes of inventory valuation and profit
measurement, the cost of one unit must be
determined. The total cost of a cost unit of product
or service is made up of the following three
elements of cost.
Materials
Labour
Other expenses (such as rent and rates, interest
charges and so on)
Cost elements can be classified as direct costs or
indirect costs as far as cost units are concerned.
 Direct cost and prime cost

A direct cost is a cost that can be traced in full to the cost unit.
There are three types of direct cost.

Direct material costs are the costs of materials that are known to have been used
in making and selling a unit of product (or providing a service). Examples are
components and packing materials.

Direct labour costs are the specific costs of the workforce used to make a unit of
product or provide a service. Direct labour costs are established by quantifying the
cost of the time taken for a job, or the time taken in 'direct production work'. For
example, the wages paid to an employee sewing buttons on a coat is a direct cost of
that cost unit.

Other direct expenses are those expenses that have been incurred in full as a
direct consequence of making a unit of product, or providing a service, or running
a department. For example, the cost of hiring a special machine for a job is a direct
cost of that job.
Another term used to describe the total direct cost is prime cost.

Prime cost = total direct cost = direct material cost + direct labour cost + direct
expenses
Indirect cost and overhead
 Production , Administration overhead :

 Production (or manufacturing or factory) overhead includes all indirect material costs,
indirect wages and indirect expenses incurred in the factory from receipt of the
order until its completion, including:
 Indirect materials, which cannot be traced to units of the finished product.
 Consumable stores, eg material used in negligible amounts or across several
different products
 Indirect wages, meaning all wages not charged directly to a unit of product.
 Salaries of non-productive personnel in the production department, eg
supervisor
 Indirect expenses (other than material and labour) not charged directly to units of
production
 Rent, rates and insurance of a factory

 Depreciation, fuel, power and maintenance of plant and buildings

Administration overhead :
Administration overhead is all indirect material costs, wages and expenses incurred in the
direction, control and administration of an undertaking, including:
 Depreciation of office equipment
 Office salaries, including the salaries of secretaries and accountants
 Rent, rates, insurance, telephone, heat and light cost of general offices
Selling overhead :
Selling overhead is all indirect materials costs, wages and expenses incurred
in promoting sales and retaining customers, including:
Printing and stationery, such as catalogues and price lists
Salaries and commission of sales representatives
Advertising and sales promotion, market research
Rent, rates and insurance for sales offices and showrooms

Distribution overhead :
Distribution overhead is all indirect material costs, wages and expenses
incurred in making the packed product ready for despatch and
delivering it to the customer, including:
Cost of packing cases
Wages of packers, drivers and despatch clerks
Depreciation and running expenses of delivery vehicles
 Product costs and period costs
For the preparation of financial statements, costs are often classified as either product
costs or period costs. Product costs are costs identified with goods produced or
purchased for resale. Period costs are costs deducted as expenses during a particular
period.

Consider a retailer who acquires goods for resale without changing their basic form. The
only product cost is therefore the purchase cost of the goods. Any unsold goods are held
as inventory. The inventory is valued at the lower of purchase cost and net realizable
value, which is the valuation basis stipulated in accounting standards, and included as an
asset in the balance sheet. As the goods are sold, their cost becomes an expense in the
form of 'cost of goods sold'. A retailer will also incur a variety of selling and
administration expenses. Such costs are period costs because they are deducted from
revenue without ever being regarded as part of the value of inventory.

Now consider a manufacturing firm in which direct materials are transformed into saleable
goods with the help of direct labour and factory overheads. All these costs, even the
factory overheads, are product costs because they are allocated to the value of
inventory until the goods are sold (See Chapter 3). As with the retailer, selling and
administration expenses are regarded as period costs.
 Cost classification for planning and decision-making

Fixed costs
A fixed cost is a cost that, within a relevant range of activity levels, is not affected by
increases or decreases in the level of activity. Fixed costs are a period charge, in that
they relate to a span of time; as the time span increases, so too will the fixed costs.
Examples of fixed costs include the following.
The salary of the managing director (per month or per annum)
The rent of a single factory building (per month or per annum)
Straight line depreciation of a single machine (per month or per annum)
Variable costs
A variable cost is a cost that increases or decreases as the level of activity increases or
decreases.
A variable cost tends to vary directly with the level of activity. The variable cost per unit
is the same amount for each unit produced whereas total variable cost increases as
volume of output increases. Examples of variable costs include the following.
The cost of raw materials (where there is no discount for bulk purchasing, since bulk
purchase discounts reduce the unit cost of purchases).
Direct labour costs, which are usually classed as a variable cost even though basic wages
are often fixed.
Sales commission that is variable in relation to the volume or value of sales.
 Cost classification for planning and decision-making

Semi-variable costs (or semi-fixed costs or mixed costs)

Semi-variable, semi-fixed or mixed costs are costs that are part-fixed
and part-variable and are therefore partly affected by changes in the level of
activity. Examples of semi-variable costs include the following.
Electricity and gas bills. There may be a 'standing' basic charge plus a
charge per unit of consumption.
Sales representative's salary. The sales representative may earn a basic monthly amount plus a commission based on the value of sales made.
 Cost behaviour and total and unit costs

If the variable cost of producing a unit is CU5 per unit then it will remain at
that cost per unit no matter how many units are produced (within the relevant
range).
However, if the business's fixed costs are CU5,000 then the fixed cost per unit
will decrease the more units are produced: for example, one unit will have fixed
costs of CU5,000 per unit; if 2,500 are produced the fixed cost per unit will be
CU2; if 5,000 are produced the fixed cost per unit will be only CU1. Thus as the
level of activity increases the total costs per unit (fixed cost plus variable cost)
will decrease.
 …………….

Interactive question 2: Fixed, variable or semi-variable cost? Tick the

appropriate box for each cost.
Fixed Variable Semi-variable
•Telephone bill
•Annual salary of the chief accountant
•Cost of materials used to pack 20 units of product X into a box
 The relevant range

The relevant range is the range of activity levels within which assumed cost behaviour patterns
occur.
For example, a fixed cost is only fixed for levels of activity within the relevant range, after which it
could 'step up'.
The relevant range also broadly represents the activity levels at which an organisation has had
experience of operating in the past and for which cost information is available. It can
therefore be dangerous to attempt to predict costs at activity levels that are outside the relevant range
(extrapolation).
For example, the rent of a factory is generally assumed to be a fixed cost. However, if the volume of
activity increases beyond the relevant range then it may be necessary to rent an additional factory. The
rent cost will then increase to a new, higher level.
 …………………….

Interactive question 3: Activity levels

Select the correct words in the following sentence.
In general, as activity levels rise within a relevant range, the variable cost per unit will (a)
rise/fall/stay the same, the fixed cost per unit will (b) rise/fall/stay the same and the
total cost per unit will (c) rise/fall/stay the same.

Interactive question 4: Cost behaviour graphs

Match the sketches (1) to (4) below to the listed items of expense. In each case the vertical
axis relates to total cost, the horizontal axis to activity level. Each graph may be used more
than once. Write the graph number in the space provided.
 Electricity bill: a standing charge for each period plus a charge for each unit of electricity
consumed.
 Supervisory labour, which is paid as a monthly salary.
 Sales commission, which amounts to 2% of sales revenue.
 Machine rental cost of a single item of equipment. The rental agreement is that CU10
should be paid for every machine hour worked each month, subject to a maximum monthly
charge of CU480.
 Photocopier rental costs. The rental agreement is that CU80 is paid each month, plus
CU0.01 per photocopy taken.
 Responsibility accounting

Responsibility accounting is a system of accounting that segregates revenue

and costs into areas of personal responsibility in order to monitor and assess the
performance of each part of an organization.

A responsibility centre is a department or function whose performance is the

direct responsibility of a specific manager.

Managers of responsibility centers should only be held accountable for costs over
which they have significant influence. From a motivation or incentivisation point of
view this is important because it can be very demoralizing for managers to have
their performance judged on the basis of something over which they have no
influence. It is also important from a control point of view that management
reports should ensure that information on costs is reported to the manager who is
able to take action to control them.
Responsibility accounting attempts to associate costs, revenues, assets and
liabilities with the managers most capable of controlling them. As a system of
accounting, it therefore distinguishes between controllable and uncontrollable
costs.
 Controllable and uncontrollable costs

A controllable cost is a cost that can be influenced by management decisions and actions.
An uncontrollable cost is a cost that cannot be affected by management within a given time span.
Most variable costs within a department are thought to be controllable in the short term because
managers can influence the efficiency with which resources are used, even if they cannot do anything to
raise or lower price levels.

A cost that is not controllable by a junior manager might be controllable by a senior

manager. For example, there may be high direct labour costs in a department caused by excessive
overtime working. The junior manager may feel obliged to continue with the overtime to meet production
schedules, but his senior may be able to reduce costs by hiring extra full-time staff, thereby reducing the
requirements for overtime.
A cost that is not controllable by a manager in one department may be controllable by a
manager in another department. For example, an increase in material costs may be caused by buying
at higher prices than expected (controllable by the purchasing department) or by excessive wastage
(controllable by the production department) or by a faulty machine producing rejects (controllable by the
maintenance department).
Some costs are non-controllable, such as increases in expenditure due to inflation. Other costs are
controllable, but in the long term rather than the short term. For example, production costs
might be reduced by the introduction of new machinery and technology, but in the short term,
management must attempt to do the best they can with the resources and machinery at their disposal.
Summary
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 Gratitude

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