Cost Accounting Lesson 1 PDF

Lesson 1: Cost Accounting CPA Board Exam in the Philippines Financial Management Auditing Accounting and Advisory Services Reporting...

Lesson 1: Cost Accounting CPA Board Exam in the Philippines Financial Management Auditing Accounting and Advisory Services Reporting Regulatory Advanced Financial Framework for Accounting and Taxation Business Reporting Transactions Cost Accounting may be defined as “Accounting for costs, classification, and analysis of expenditure as will enable the total cost of any particular unit of production to be ascertained with reasonable degree of accuracy and at the same time to disclose exactly how such total cost is constituted”.  Cost Accounting is a branch of accounting that deals with the process of recording and summarizing the amount of cost that is spent of the company’s activities. It includes all cost of process, product, service used, provided, and sold. What is Cost Accounting? Differences Between Financial and Managerial Accounting Concepts of Costs Cost is the amount of resource given up in exchange for some goods or services. The resources given up are money or money’s equivalent expressed in monetary units. The Chartered Institute of Management Accountants, London defines cost as “the amount of expenditure (actual or notional) incurred on, or attributable to a specified thing or activity”.  1. To analyze 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 Objectives of the use of machinery, equipment and tools. Cost 4. To provide data for periodical profit and loss accounts and balance sheets at such intervals, e.g., weekly, monthly or quarterly, as may Accounting be desired by the management during the financial year, not only for the whole business but also by departments or individual products. Also, to explain in detail the exact reasons for profit or loss revealed in total, in the profit and loss account. 5. To reveal sources of economies in production having regard to methods, types of equipment, design, output and layout. Daily, weekly, monthly or quarterly information may be necessary to ensure prompt and constructive action.  6. 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. 7. 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. Objectives of 8. To present comparative cost data for different periods and various volumes of output. Cost 9. To provide a perpetual inventory of stores and other materials so that interim profit and loss account and balance sheet can be Accounting prepared without stock taking and checks on stores and adjustments are made at frequent intervals. Also to provide the basis for production planning and for avoiding unnecessary wastages or losses of materials and stores. 10. 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 Ascertainment: The main function of cost accounting is the ascertainment of cost of product or services rendered. It includes collection, analysis of expenses and measurement of production at different stages of manufacture. Control of Costs: In the era of competition, the goal of every business is to sustain Scope of Cost Accounting Proper matching of cost with revenue: In cost accounting manager prepares monthly or quarterly statements to reflect the cost and income data identified with the sale of that period. Aid to Management Decision-making: Decision-making is a process of choosing between two or more alternatives, based on the resultant outcome of the various alternatives. Classification of Costs  CLASSIFICATION OF COSTS (BY TIME) (a) Historical Costs: These costs are ascertained after they are incurred. Such costs are available only when the production of a particular thing has already been done. They are objective in nature and can be verified with reference to actual operations. (b) Pre-determined Costs: These costs are calculated before they are incurred based on a specification of all factors affecting cost. Such costs may be: ◦ (i) Estimated costs: Costs are estimated before goods are produced; these are naturally less accurate than standards. ◦ (ii) Standard costs: This is a particular concept and technique. This method involves: ◦ (a) setting up predetermined standards for each element of cost and each product; ◦ (b) comparison of actual with standard to find variation; ◦ (c) pin-pointing the causes of such variances and taking remedial action. CLASSIFICATION OF COSTS (BY NATURE OR ELEMENT)  CLASSIFICATION OF COSTS (BY DEGREE OR TRACEABILITY TO THE PRODUCTS) Direct Costs: The direct costs are those which can be easily traceable to a product or costing unit or cost center or some specific activity, e.g. cost of wood for making furniture. It is also called traceable cost. Indirect Costs : The indirect costs are difficult to trace to a single product or it is uneconomic to do so. They are common to several products, e.g. salary of a factory manager. It is also called common costs.  CLASSIFICATION OF COSTS (Association with the Product) Product Costs: Product costs are those which are traceable to the product and included in inventory values. In a manufacturing concern it comprises the cost of direct materials, direct labor and manufacturing overheads. Product cost is a full factory cost. Product costs are used for valuing inventories which are shown in the balance sheet as asset till they are sold. The product cost of goods sold is transferred to the cost of goods sold account. Period Costs: Period costs are incurred on the basis of time such as rent, salaries, etc., include many selling and administrative costs essential to keep the business running. Though they are necessary to generate revenue, they are not associated with production, therefore, they cannot be assigned to a product. They are charged to the period in which they are incurred and are treated as expenses.  CLASSIFICATION OF COSTS (by Changes in Activity or Volume) Fixed Costs: “ the cost which is incurred for a period, and which, within certain output and turnover limits, tends to be unaffected by fluctuations in the levels of activity (output or turnover)”. a. Committed Costs: These costs are incurred to maintain certain facilities and cannot be quickly eliminated. The management has little or no discretion in this cost, e.g., rent, insurance etc. b. Policy and Managed Costs: are incurred for implementing management policies such as executive development, housing, etc. Such costs are often discretionary. Managed costs are incurred to ensure the operating existence of the company e.g., staff services. c. Discretionary Costs: These are not related to the operations and can be controlled by the management. These costs result from special policy decisions, new researches etc., and can be eliminated or reduced to a desirable level at the discretion of the management. d. Step Costs: Such costs are constant for a given level of output and then increase by a fixed amount at a higher level of output.  CLASSIFICATION OF COSTS (by Changes in Activity or Volume) Variable Cost: Variable costs are those costs that vary directly and proportionately with the output e.g. direct materials, direct labour. It should be kept in mind that the variable cost per unit is constant but the total cost changes corresponding to the levels of output. It is always expressed in terms of units, not in terms of time. Semi-fixed (Semi-Variable) costs: Such costs contain fixed and variable elements. Because of the variable element, they fluctuate with volume and because of the fixed element; they do not change in direct proportion to output. Semi-variable costs change in the same direction as that of the output but not in the same proportion.  CLASSIFICATION OF COSTS (Functional Classification) Manufacturing/production Costs: It is the cost of operating the manufacturing division of an undertaking. It includes the cost of direct materials, direct labor, direct expenses, packing (primary) cost and all overhead expenses relating to production. Administration Costs: They are indirect and covers all expenditure incurred in formulating the policy, directing the organization and controlling the operation of a concern, which is not related to research, development, production, distribution or selling functions. Selling and Distribution Cost: Selling cost is the cost of seeking to create and stimulate demand e.g. advertisements, market research etc. Distribution cost is the expenditure incurred which begins with making the package produced available for dispatch and ends with making the reconditioned packages available for re-use e.g. warehousing, cartage etc. Research and Development Costs: They include the cost of discovering new ideas, process, products by experiment and implementing such results on a commercial basis. Pre-production Cost: When a new factory is started or when a new product is introduced, certain expenses are incurred. There are trial runs. Such costs are termed as pre-production costs and treated as deferred revenue expenditure. They are charged to the cost of future production.  CLASSIFICATION OF COSTS (Relationship with Accounting Period) a. Capital expenditure provides benefit to future period and is classified as an asset. b. Revenue expenditure benefits only the current period and is treated as an expense.  CLASSIFICATION OF COSTS (Controllability) a. Controllable Cost: The Chartered Institute of Management Accountants defines controllable cost as “cost which can be influenced by its budget holder”. b. Non-Controllable Cost: It is the cost which is not subject to control at any level of managerial supervision.  CLASSIFICATION OF COSTS (for Analytical and Decision Making) a. Opportunity Costs: Opportunity cost is the cost of selecting one course of action and the losing of other opportunities to carry out that course of action. b. Sunk Costs: A sunk cost is one that has already been incurred and cannot be avoided by decisions taken in the future. As it refers to past costs, it is called unavoidable cost. c. Differential Cost: Differential cost has been defined as “the difference in total cost between alternatives, calculated to assist decision making”. d. Joint Costs: The processing of a single raw material results in two or more different products simultaneously. e. Common Costs: Common costs are those costs which are incurred for more than one product, job, territory or any other specific costing object. They are not easily related with individual products and hence are generally apportioned.  CLASSIFICATION OF COSTS (for Analytical and Decision Making) f. Imputed Costs: Some costs are not incurred and are useful while taking decision pertaining to a particular situation. These costs are known as imputed or notional costs and they do not enter into traditional accounting systems. g. Uniform Costs: They are not distinct costs as such. Uniform costing signifies common costing principles and procedures adopted by a number of firms. They are useful in inter- firm comparison. h. Marginal Costs: It is the aggregate of variable costs, i.e., prime cost plus variable overheads. Thus, costs are classified as fixed and variable. i. Replacement Costs: This is the cost of replacing an asset at current market values e.g. when the cost of replacing an asset is considered, it means the cost of purchasing the asset at the current market price is important and not the cost at which it was purchased. j. Out of Pocket Cost: It involves payment to outsiders i.e. gives rise to Cash Expenditure as opposed to such costs as depreciation which don’t involve any cash expenditure.  CLASSIFICATION OF COSTS (Other Costs) Conversion Cost: It is the cost of a finished product or work-in-progress comprising direct labor and manufacturing overhead. It is production cost less the cost of raw material but including the gains and losses in weight or volume of direct material arising due to production. Normal Cost: This is the cost which is normally incurred at a given level of output in the conditions in which that level of output is achieved. Traceable Cost: It is the cost which can be easily associated with a product, process or department.  CLASSIFICATION OF COSTS (Other Costs) Avoidable Costs: Avoidable costs are those costs which under the present conditions need not have been incurred. Example: (a) Spoilage in excess of normal limit; (b) Unfavorable cost variances which could have been controlled. Unavoidable Costs: Unavoidable costs are those costs which under the present conditions must be incurred. Total Cost: This is the sum of all costs associated to a particular unit, or process, or department or batch or the entire concern. It may also mean the sum total of material, labor and overhead. Value Added: It means the selling price of the product/service less the cost of materials used in the product or the service. Often depreciation is also deducted for ascertaining “value added”.  According to the Chartered Institute of Management Accountants, London, cost center means, “a production or service location, function, activity or item of equipment whose costs may be attributed to cost units”. Cost center is the smallest organizational sub-unit for which separate cost collection is attempted. Cost Center and Cost Unit The Chartered Institute of Management Accountants, London, defines a unit of cost as “a unit of product or service in relation to which costs are ascertained”. A cost unit is a devise for the purpose of breaking up or separating costs into smaller sub-divisions.  Job Costing It refers to a system of costing in which costs are ascertained Methods of in terms of specific jobs or orders which are not comparable with each other. Industries where this method of costing is Costing generally applied are printing press, automobile garage, repair shop, ship-building, house building, engine and machine construction, etc.  Contract Costing Methods of Although contract costing does not differ in principle from job costing, it is convenient to treat contract cost accounts Costing separately. The term is usually applied to the costing method adopted where large scale contracts at different sites are carried out, as in the case of building construction.  Batch Costing This method is also a type of job costing. A batch of similar products is regarded as one job and the cost of this complete batch is ascertained. It is then used to determine the unit cost of the articles produced. Terminal Costing Methods of This method is also a type of job costing. This method Costing emphasizes the essential nature of job costing, i.e. the cost can be properly terminated at some point and related to a particular job. Operation Costing This method is adopted when it is desired to ascertain the cost of carrying out an operation in a department, for example, welding.  Process Costing This method is used where it is difficult to trade the item of prime cost to a particular order because its identity is lost in volume of continuous production. Process costing is generally adopted in textile industries, chemical industries, oil refineries, soap manufacturing, paper manufacturing, tanneries, etc. Methods of Costing Unit or Single or Output or Single-output Costing This method is used where a single article is produced or service is rendered by continuous manufacturing activity. This method is suitable in industries like brick-making, collieries, flour mills, cement manufacturing, etc. This method is useful for the assembly department in a factory producing a mechanical article e.g., bicycle.  Operating Costing This method is applicable where services are rendered rather than goods produced. The procedure is same as in the case of single output costing. This method is employed in railways, road transport, water supply undertakings, telephone services, electricity companies, hospital services, municipal services, etc. Multiple or Composite Costing Methods of It is used where there are a variety of components separately produced and subsequently assembled in a complex Costing production. This method is applicable to manufacturing concerns producing motor cars, aeroplanes, machine tools, type-writers, radios, cycles, sewing machines, etc. Departmental Costing When costs are ascertained department by department, the method is called “Departmental Costing”. Usually, for ascertaining the cost of various goods or services produced by the department, the total costs will have to be analyzed, say, by the use of job costing or unit costing. TECHNIQUES OF COSTING Historical (or Conventional) Costing It refers to the determination of costs after they have been actually incurred. It means that cost of a product can be calculated only after its production. This system is useful only for determining costs, but not useful for exercising any control over costs. It can serve as a guidance for future production only when conditions continue to be the same in future. Standard Costing It refers to the preparation of standard costs and applying them to measure the variations from standard costs and analyzing the variations with a view to maintain maximum efficiency in production.  Marginal Costing It refers to the ascertainment of marginal costs by differentiating between fixed costs and variable costs and the effect on profit of the changes in volume or type of output. In this case, only the variable costs are charged to products or operations while fixed costs are charged to TECHNIQUES profit and loss account of the period in which they arise. OF COSTING Uniform Costing A technique where standardized principles and methods of cost accounting are employed by a number of different companies and firms, is termed as uniform costing. This helps in comparing performance of one firm with that of another. TECHNIQUES OF COSTING Direct Costing The practice of charging all direct costs to operations, process or products leaving all indirect costs to be written off against profits in the period in which they arise, is termed as direct costing. Absorption Costing The practice of charging all costs both variable and fixed to operation, process or products or process is termed as absorption costing. Activity Based Costing In a business organization, Activity-Based Costing (ABC) is a method of assigning the organization's resource costs through activities to the products and services provided to its customers. It is defined as a technique of cost attribution to cost units on the basis of benefits received from indirect activities, e.g. ordering, setting up, assuring quality. Activity-Based Costing ABC principles are used: ◦ (i) to focus management attention on the total cost to produce a product or service, and ◦ (ii) as the basis for full cost recovery. Support services are particularly suitable for activity-based resourcing because they produce identifiable and measurable units of output. Activity-Based Costing encourages managers to identify which activities are value added—those that will best accomplish a mission, deliver a service, or meet a customer demand. It improves operational efficiency and enhances decision-making through better, more meaningful cost information. INSTALLATION OF COSTING SYSTEM A cost accounting system is a system that accumulates costs, assigns them to cost objectives and reports cost information. It ascertains product profitability and helps management in planning and control of business operations. A system has to be designed to suit the needs of an organization. Costing can be employed in any industry whether it is manufacturing industry or other industries like public utility, public services, construction companies, agriculture, mining etc. ROLE OF COST ACCOUNTANT IN DECISION MAKING Cost Accountant performs action as under: 1. To analyze material, labor and the overhead expenses 2. To reconcile daily productions with accounting transactions 3. To coordinate with R&D for production of new items 4. To Assist the controller in developing cost improvement opportunities 5. To prepare the new product costing as well as do the gross profit analysis for the marketing in order to determine the feasibility and profitability before presenting the samples and pricing to the customers.  value chain represents all the activities and processes involved in creating a product or performing a service. As such, it encompasses every stage of the product's or service's lifecycle, from design to production and distribution. In seeking higher profit margins or a competitive advantage, companies can conduct a value-chain analysis to identify each step (or link) in the chain and look for ways to improve it.  A value chain represents every step that's involved in creating a product or delivering a service, from start to finish. A company's value chain can be divided into primary activities and secondary (or support) activities. Value chain analysis is the process of examining each of those activities in terms of what they cost, the value they deliver, and how they might be optimized in keeping with the company's competitive strategy. It also looks at how the various activities interrelate. Companies can compete on the basis of delivering a unique or superior product or one that is attractive primarily due to a lower price.