Chapter One: Overview of Cost and Management Accounting PDF

CHAPTER ONE Overview of Cost and Management Accounting  Objectives of Cost & Management Accounting Management accounting measures analyzes, and reports financial and nonfinancial information that helps managers make decisions to fulfill the goals...

CHAPTER ONE Overview of Cost and Management Accounting  Objectives of Cost & Management Accounting Management accounting measures analyzes, and reports financial and nonfinancial information that helps managers make decisions to fulfill the goals of an organization. To develop, Communicate and Used by implement management strategy To coordinate product design and production  Cont… Management accounting information and reports do not have to follow set principles or rules. The key questions are always How will this information help managers do their jobs better, and Do the benefits of producing this information exceed the costs?  Cont… Cost accounting is the process of determining and accumulating the cost of product or activity. Cost Accounting is accounting for cost aimed at providing cost data, statement and reports for the purpose of managerial decision making  Objectives of Cost Accounting There is a relationship among information needs of management, cost accounting objectives, and techniques and tools used for analysis in cost accounting. Cost accounting has the following main Determining objectives to serve: selling price, Controlling cost, Providing information for decision- making, Ascertaining costing profit, Facilitating preparation of financial and other statements.  Cont… Determining selling price – The objective of determining the cost of products is of main importance in cost accounting. The total product cost and cost per unit of product are important in deciding selling price of product. Cost accounting provides information regarding the cost to make and sell product or services.  Cost… Controlling cost - Cost accounting helps in attaining aim of controlling cost by using various techniques such as Budgetary Control, Standard costing, and inventory control. Each item of cost [viz. material, labor, and expense] is budgeted at the beginning of the period and actual expenses incurred are compared with the budget. This increases the efficiency of the enterprise.  Ascertaining costing profit - Cost accounting helps in ascertaining the costing profit or loss of any activity on an objective basis by matching cost with the revenue of the activity. Facilitating preparation of financial and other statements - Cost accounting helps to produce statements at short intervals as the management may require. – In order to operate the business at high efficiency, it is essential for management to have a review of production, sales and operating results. Cost accounting provides daily, weekly or monthly statements of units produced, accumulated cost with analysis. – Cost accounting system provides immediate information regarding stock of raw material, semi-finished and finished goods. This helps in preparation of financial statements.  Financial Accounting, Management Accounting, and Cost Accounting How is management accounting different from financial accounting? Financial Accounting aims at finding out profit or losses of an accounting year as well as the assets and liabilities position, by recording various transactions in a systematic manner. Cost Accounting helps the business to ascertain the cost of production/services offered by the organization and also provides valuable information for taking various decisions and also for cost control and cost reduction. Management Accounting helps the management to conduct the business in a more efficient manner.  Cont… The scope of management accounting is broader than that of cost accounting. Management Accounting utilizes the principles and practices of financial accounting and cost accounting in addition to other modern management techniques for efficient operation of a company. The main thrust in management accounting is towards determining policy and formulating plans to achieve desired objectives of management. Major Differences between Management and Financial Accounting  Cont… Cost accounting provides information for both management accounting and financial accounting. Cost accounting measures, analyzes, and reports financial and nonfinancial information relating to the costs of acquiring or using resources in an organization. For example, calculating the cost of a product is a cost accounting function that answers financial accounting’s inventory-valuation needs and management accounting’s decision- making needs (such as deciding how to price products and choosing which products to promote).  Figure 1-2 shows how cost accounting intersects both financial and management accounting. Cont…  Cost classification concepts and terms Cost: According to Carl.S. Warren the term cost refers to all payments of cash for the purpose of generating revenues. Costs can be either expensed or capitalized. Expensed costs are treated as expenses in the period cash is paid. Capitalized costs are treated as assets in the period cash is paid. The asset is recognized as expenditure in future periods. According to J. Horngren cost refers as resource scarified or foregone to achieve a specific objective. It is usually measured as the monetary amount that must be paid to acquire goods and services.  Cont… Cost object: A cost object is anything for which a separate measurement of costs is desired. Examples include a product, service, project, customer, brand category, activity, department, etc There are two stages for accounting of costs 1. Cost accumulation is the collection of cost data in some organized way by means of an accounting Tracing system. Assigning accumulated costs with a direct 2. Costrelationship assignment means to the cost object tracing accumulated costs to cost object and allocating accumulated Allocating Assigning accumulated costs with an costs to a cost object. indirect relationship to a cost object  Direct Costs and Indirect Costs Direct costs are costs that can be conveniently or economically traced to a cost object. For example, the cost of bottles is a direct cost of a Pepsi soft drink. Indirect costs are costs that cannot be conveniently or economically traced to a cost object. – Instead of being traced, these costs are allocated to a cost object in a rational and systematic manner. Examples include nails in furniture BMW: Assigning Costs to a Cost Object Cost behavior Patterns: Variable, Fixed and Mixed Costs Variable cost: Variable cost changes in total in proportion to changes in the related level of total activity or volume. Example, If Ford buys a steering wheel at $ 100 for each of its Ford Explorer vehicles, then the total cost of steering wheel should be $100 times the number of vehicles assembled.  Cont… To summarize,.as activity changes, total variable cost increases or decreases proportionately with the activity change, but unit variable cost remains the same.  Cont…. Fixed Cost: A fixed cost remains unchanged in total for a given time period despite wide changes in the related level of total activity or volume. Total fixed cost remains the same; but the per unit fixed cost changes.  A mixed cost has characteristics of both a variable and a fixed cost. For example, for using rented machinery the rental charge is $ 20,000 per year & $ 2 per each machine hour used. If the machinery is used for 30,000 hours, the total rental changes are $ 80,000 (20,000 + 30,000x2) and of the machinery in use for 20,000 hours the rental charges are $ 60,000 (20,000x(2000x2)) and so on.  Cost driver—a variable that causally affects costs over a given time span. For example, – Mile driven for transport cost – Length of time of call for telephone cost – Metric cube of water consumed for water cost – Unit sold for cost of goods sold Relevant range—the band of normal activity level (or volume) in which there is a specific relationship between the level of activity (or volume) and a given cost – For example, fixed costs are considered fixed only within the relevant range. Relevant range visualized  Period and product costs For financial reporting purposes, costs are often classified as either product costs or period cost. Product costs are incurred in the production or acquisition of products For manufacturing companies this cost is composed of the three elements of manufacturing cost: 1. Direct Material, 2. Direct Labor and 3. Factory overhead For merchandising – sector companies, product costs are the costs of purchasing the goods that are resold in the same form including freight costs (inward).  Cont.. Period Costs Period costs are all Costs in the income statement other than cost of goods sold. These costs are treated as expenses of the period in which they are incurred because they are assumed not to benefit future periods. Expensing these costs immediately best matches to revenues. For manufacturing sector companies, period costs include all non-manufacturing costs for example, selling cost, administration cost and Research and Development costs.  Prime Cost and Conversion Costs: In manufacturing companies, the costs are classified as Prime Cost and conversion costs. Prime costs are all direct manufacturing costs, i.e all direct material costs and direct manufacturing labor cost. Conversion costs are the costs incurred to convert direct material into the final product, namely, costs for direct labor and manufacturing overhead.  Controllable and Uncontrollable Costs Controllable costs are those costs, which can be influenced by the action of a specified member of the undertaking. If a manager can control or heavily influence the level of cost, then that cost is classified as a controllable cost of that manager. Costs that a manager cannot influence significantly are classified as uncontrollable cost of that manager.  Avoidable and unavoidable costs Avoidable costs are costs that will not continue if an ongoing operation is changed, deleted or eliminated. These costs are relevant costs in decision- making. Examples of avoidable costs include departmental salaries and other costs that could be avoided by not operating the specific department. Unavoidable costs are costs that continue even if a subunit or an activity is eliminated and are not relevant for decision  Budgeted, standard and actual costs and their comparisons and analyses Budgeted cost In business and other organizations, a budgeted cost often refers to a department's or a company's projected total costs Standard cost In accounting, a standard is likely to mean an expected amount of cost per unit of product, per unit of input (such as direct materials, factory overhead), or per unit of output.  Cont… Examples of a Budget and a Standard cost Assume that the finishing department's budgeted cost for the upcoming year is $400,000 and is expected to process 50,000 identical units of product. Some companies will develop standard costs for controlling its operations. For example, the standard cost of processing all identical units in the finishing department is $8 (based on its budget of $400,000 divided by the expected 50,000 identical units). Therefore, if 54,000 units are processed, the standard cost of the company's inventory will be increased by $32,000.  Cont… Actual cost is an accounting term that means the amount of money that was paid to acquire a product or asset  The concepts of cost units, cost centers and profit centers A cost center is a role or department that costs the business money but does not generate revenue on its own. They are often administrative, service and support roles. These positions cannot be eliminated to cut costs because they are vital to a smoothly operating organization. A cost center is a type of responsibility center that is called accountable for the incurrence of the costs, which are under its control. Example: ICT department, HR department, Assembling and painting department  Cont… Cost Unit: The cost unit is defined as the unit of product, service, time, activity, or combination in relation to which cost is estimated Cost Unit Example- The cost unit of the hotel industry is a room and the cost unit of the steel industry would be a ton.  Cont.. Profit centre: A profit centre is any business segment whose manager has control over both cost and revenue. Like a cost centre, a profit centre generally does not have control over investment funds. Profit centre managers are often evaluated by comparing actual profit to targeted or budgeted profit. Segmented income statements should be used to evaluate the performance of profit centre managers.  THE END THANK YOU