Cost and Management Accounting

Financial Accounting

Financial accounting tracks two things: assets/debts and income/expenses. The first is tracked by the balance sheet and the second by the income statement.

Financial Accounting

It is concerned with providing information of the business with the help of financial statements to investors, creditors, financial analyst, government agencies and others. Financial statements summaries the result of operations for selected period of time and show financial positions of the business at particular dates. These are generally the basis for investment decisions by the shareholders, lending decisions by banks and credit decisions by vendors.

Contents: The end product of the financial accounting processes are the financial statements , such as Profit and loss account, Balance sheet. Accounting system: Journals, ledgers and other techniques are used in the preparation of financial statements. Users: owners, creditors, employees, customers etc

Sheet
Details Direct Material: Material Consumed Direct Labour: Productive wages Direct Expenses Prime cost Add : Factory overheads Indirect Material: Consumable stores Oil grease/lubricants Indirect Labour: Unproductive wages Salary of a factory Manager Indirect Expenses: Factory rent Repair and Depreciation on Machine Factory cost Amount (Rs.) 60,000 20,000 5,000 85,000

2,000 500
1,000 6,000

2,500

7,000

2,000 600

2,600 97,100

Cost Accounting

Initially used by agriculturist or craftsman who desired to establish a price to be charged of his product. Cost accounting tracks manufacturing costs and allocates them to various products. This information helps them set prices so that they can make a profit on their goods.
Cost are resources sacrificed or foregone to achieve a specific objective. These are the benefits given up to acquire goods and services.

Accounting is the financial information system. It measures and communicates the financial effects of transactions and events. Cost Accounting is the branch of accounting dealing with the classification, recording, allocation, summarization and reporting of current and prospective costs. It refers to determining the process of determining the price of some product.

Cost accounting and management

Management requires adequate, systematic and useful cost data and reports to manage a business.
Cost accounting helps the management in the following manner

Eg:
Particular SALES Materials Wages Direct Exp PRIME COST Work exp Selling Exp Distribution Exp General & Admin OVERHEAD COST Total cost A 60,000 30,000 12,000 2,000 44,000 16,00 400 1,000 1,000 4,000 48,000 B 60,000 22,000 8,000 2,000 32,000 2,000 1,600 400 4,000 8,000 40,000 C 40,000 26,000 12,000 3,000 41,000 500 2,000 3,500 1,000 7,000 48,000 D 40,000 24,000 8,000 1,000 33,000 200 400 200 200 1,000 34,000 20,000 1,70,000 TOTAL 2,00,000 1,02,000 40,000 8,000 1,50,000

Profit
% profit/ loss

12,000
20%

20,000
33.33%

-(8000)
(-)20%

6,000
15%

30,000
15%

Cost statements produced at regular, short intervals which are not prepared in financial accounting, enables the firm to take prompt action to overcome the problems of producing and selling product C. The firm may decide to discontinue the product C, but cost structure is referred to find out whether or not more efficient manufacturing, selling and distribution is possible. Also selling price of the product can be increased to a profitable level.

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2.

Cost accounting helps the management in controlling cost and budgeting. Cost accounting helps in making revenue decisions Pricing- cost data are vital in pricing new products, and to make a decision in whether to lower or raise price. Product mix- long and short term product mix decisions

Cost Acc v/s Financial Acc

Cost Accounting

Cost v/s Financial Accounting

PURPOSE Fin Acc- the main purpose of financial accounting is to prepare profit and loss account and balance sheet for reporting to creditors, shareholders, IT dept, Govt etc. Cost Acc- its main purpose is to provide detailed cost information to management for proper planning, decision making and control.
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2. NATURE

Fin Acc- it classifies, records, presents and interprets, transactions and events that are of financial character for the preparation of financial statements.
Cost Accounting- it classifies, records, presents and interprets, the material, labor and overhead costs involved in manufacturing and selling each product.

Accounting system

Fin Acc- it follows double entry system for recording, classifying and summarizing business transactions.

As an example of :if I buy a truck for the company with the company's money, one asset (money) goes down, but another asset (the truck) is added. Financial accounting is essentially a measure of "how well are we doing?"

Cost Acc- it may not be based on double entry system

Accounting principles

Fin Acc- it is based on GAAP generally accepted accounting principles Cost Acc- it may or may not use GAAP for recording transactions.

Analysis of profit

Fin Acc- it gives the account of the whole business and discloses the net profit or loss of the whole business. Cost Acc- it discloses profit or loss of each product

Unit of measurement

Fin Acc- all information is in terms of money.

Cost acc- besides monetary unit, cost accounting involves measures such as machine hours, labor hours, product units for the purpose of decision making.

Time Span

Fin Acc- here data and statements are developed for a definite period usually yearly, half yearly, quarterly. Cost Acc- reports and statements are made whenever needed.

Control Aspect

Fin Acc- it does not provide adequate control over material, wages and overhead cost. Cost Acc- it takes control over all elements of cost.

Area of management accounting

Budgeting, planning, forecasting Calculating the profitability of products, service and operations. Measuring organizational, departmental performances Comparing results and performance within and between organizations Advising on decision on whether to outsource a products, components Assisting in making a wide range of strategic decision

Management Accounting

It is not only confined to the area of product costing, cost and price data. In management accounting the objective is to have a data pool which will include any and all information, the management would need. Eg : if management decides to depend on the equity capital for expansion of business, it may be investigated as to what extent it will effect companys share prices. Also study of growing competition, economic influences on

Thus management accounting is concerned with data collection from internal and external sources, analyzing, processing and interpreting the information for the use within the organization, so that management can more effectively plan, &make decisions

It makes use of information that is drawn from financial accounting and other disciplines such as economics, finance, statistics etc.

Cost v/s Management Accounting

Definition : Cost Acc- it is concerned with the techniques of product costing and deals with only cost and price data. Management Acc- it is a system of accounting which is concerned with internal reporting of information to management for planning and controlling operations and decision making.
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2. Historical v/s Predetermined cost

Cost Acc- cost is determined on the basis of past data. Management Acc- uses primarily present and future information.

3. Decision making v/s Control

Cost Acc- the focus is on cost control,i.e keeping the cost in a limit or budgeting it. Management Acc- its primary function is to aid the management in decision making.

4. Use of financial acc

Management accounting uses financial accounting techniques such as ratio analysis, fund flow analysis.
Cost accounting does not use financial accounts as such.

5. Wider scope

For planning and control, management accounting employs many quantitative models from statistics, operations research, research findings. Cost accounting does not have such scope.

Financial Accounting v/s Managerial Accounting Financial Acc - Reports to those outside the organization owners, lenders, tax authorities and regulators. Managerial Acc - Reports to those inside the organization for planning, directing and motivating, controlling and performance evaluation.

Financial acc- Emphasis is on summaries of financial consequences of past activities. Management Acc- Emphasis is on decisions affecting the future.

Financial acc- Objectivity and verifiability of data are emphasized. Management Acc- Relevance of items relating to decision making is emphasized.

Financial acc- Only summarized data for the entire organization is prepared. Management Acc-Detailed segment reports about departments, products, customers, and employees are prepared.

Financial acc- Must follow Generally Accepted Accounting Principles (GAAP) & Mandatory for external reports.
Management acc- Need not follow Generally Accepted Accounting Principles (GAAP) & Not mandatory for external reports.

Cost classification
Cost

Variability Behavioral cost

Functi onal

Controllable and uncontrollab le

Traceabilit y- direct and indirect cost

Product cost and period cost

Relevant and irrelevant cost

Variability Behavioral cost

Fixed cost It is a cost which remains unaffected by changes in the level of activity during a given time period. Eg: rent, insurance, taxes, salaries
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2. Variable cost
It is that cost which vary with the changes in the level of activity. It increases/decreases in the same proportion with the output.
For example, a company may have variable costs such as labour associated with the packaging of one of its products. As the company moves more of this product, the costs for packaging will increase. Conversely, when fewer of these products are sold the costs for packaging will consequently decrease.

3. Semi- Variable cost

(Fixed+ variable cost) eg: telephone charges, here rental element is fixed, and call charges are variable depending on the number of calls. Also some variable cost changes, but not due to change in the level of activity . Eg: increase cost of AC in summer.

Functional classification
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Manufacturing cost cost related to production of an item and covers all cost incurred up to the stage when the goods are ready to dispatch. It is inclusive of all direct material, direct labour, direct expenses and manufacturing expense. Eg: salary of factory manager, rent of factory, depreciation, power and fuel used in factory.

2. Administrative cost

It includes cost of policy formulation and its implementation to attain the objectives of organization. Eg: salaries of management and clerical staff, rent of offices, office power bill, depreciation of office building.

3. Selling and distribution cost

Selling cost- cost of activities relating to create demand of companys product and to secure orders. Eg: travelling expenses of salesmen, depreciation and maintenance of delivery van. Distribution cost- cost incurred in moving goods from source to destination. Eg: warehouse exp, wage of packers, van drivers. 4. Research & development cost.

Controllable and uncontrollable cost

Eg: excessive scrap may arise from inadequate supervision or from defect in purchasing material. The controllable cost can be regulated during a given time span by a particular individual. Eg: physical hazards like flood, fire. Political change like change in govt policy, Economic change like increase in competition. These are uncontrollable cost.

Direct and Indirect cost

Direct (traceable cost)An expense that can be traced directly to (or identified with) a specific cost center or cost object such as a department, process, or product. Eg: labor, material, fuel or power
Indirect Cost(common cost)- An expense such as advertising, computing,maintenance, security, supervision) incurred in joint usage and, therefore, difficult to assign to or identify with a specific cost object or cost center (department, function, program).

Relevant and irrelevant cost

Relevant costs are those costs which are relevant for decision making.
Relevant cost

Differential

opportunity

Out- of pocket

Differential cost
Eg: If you have a decision to run a fully automated operation that produces 100,000 widgets per year at a cost of $1,200,000, or of using direct labor to manually produce the same number of widgets for $1,400,000, then the differential cost between the two alternatives is $200,000. In making a decision, management compares the cost of alternatives. A difference in the cost of alternatives is called differential cost.

Description

Retailer (Present) Revenue (variable) $700,000 Cogs (V) 350,000 Advertising (V) 80,000 Commissions (F)* -0Warehouse (V)** 50,000 Depreciation Other Expenses (F) 60,000 Total 540,000 Net Operating Income$160,000 *F = Fixed

Direct Sale (Proposed) $800,000 400,000 45,000 40,000 80,000 60,000 625,000 $175,000

Differential Costs and Revenues $100,000 50,000 (35000) 40,000 30,000 -0 85,000 $15,000

According to the above analysis

The differential revenue is $100,000 and the differential cost is $85,000,leaving a positive differential net operating income of $15,000 under the proposed marketing plan. The net operating income under the present distribution is $160,000, whereas the net operating income under door to door direct selling is estimated to be $175,000. Therefore the door to door direct distribution method is preferred, since it would result in $15,000 higher net operating income.

Opportunity cost

It is the potential benefit that is given up when one alternative is selected over another. Eg: if product A is estimated to generate a profit 0f Rs.56,000and product B Rs.71,000. the company chooses product B and the opportunity cost of selecting product B is the sacrifice of Rs. 56,000 that could be earned by product A.

Out- of pocket cost

The relevant cash expenditure which is involved in a particular situation. Eg: if the company decides to deliver the goods by public carrier, instead of companys delivery truck, then cost of fuel, drivers salary and maintenance expenditure are the cost in cash or out of pocket costs.

Irrelevant cost
These cost may be ignored while decision making. Eg: Sunk Cost -A sunk cost is a cost that has already been incurred and that cannot be changed by any decision made now or in future.

Jolly Ltd. purchased a machine for $. 30,000. The machine has an operating life of five yea$ without any scrap value. Soon after making the purchase, management feels that the machine should not have been purchased since it is not yielding the operating advantage originally contemplated. It is expected to result in savings in operating costs of $. 18,000 over a period of five years. The machine can be sold immediately for $.

assume that a company paid $50,000 several years ago for a special purpose machine. For this reason, such costs are said to be sunk costs and should be ignored in decision making.

A manufacturer or an organization may have to suspend its operations for a period on account of some temporary difficulties, e.g., shortage of raw material, non-availability of requisite labor etc. During this period, though no work is done yet certain fixed costs, such as rent and insurance of buildings, depreciation, maintenance etc., for the entire plant will have to be incurred. Such costs of the idle plant are known as shutdown costs.

15. Conversion Cost The cost of transforming direct materials into finished products excluding direct material cost is known as conversion cost. It is usually taken as an aggregate of total cost of direct labor, direct expenses and factory overheads.

Cost Sheet
The statement of cost according to element-wise is known as cost sheet. It encloses the following: 1. Prime cost 2. Work cost 3. Cost of production 4. Total cost

ELEMENT-WISE CLASSIFICATION

COST COMPONENTS

DIRECT COST (PRIME COST)

Direct Material Direct Labor Direct expenses

PRIME COST

WORK COST COST OF PROD UCTIO N

TOTAL COST

INDIRECT COST (OVERHEADS)

Manufacturing Exp Administration Exp Selling Exp

Distribution Exp
R&D exp

COST SHEET

DIRECT MATERIAL + DIRECT LABOR + DIRECT EXPENSES PRIME COST

PRIME COST + MANUFACTURING EXPENSE/ FACTORY COST

WORK COST WORK COST + ADMINISTRATIVE EXPENSES COST OF PRODUCTION

COST OF PRODUCTION + SELLING & DISTRIBUTION EXP TOTAL COST

1.MATERIAL

The substance from which a product is made is known as material. Such as cotton, jute etc
Materials Direct materials Indirect materials

All materials directly used in production, which can be measured. 1. Material (primary and raw) purchsed for a particular job. 2. Primary packing material e.g., carton, wrapping, cardboard, boxes etc 3. Components purchased or produced

The material which is used for purposes ancillary to the business and which cannot be conveniently assigned to specific physical units is termed as indirect material. Glue, thread, oil and waste, printing and stationery material etc. are some of the examples of indirect material. These are part of manufacturing overheads

It is not necessary that all the material purchased in a particular period is used in production. There is some stock of raw material in balance at opening and closing of the period. Hence, it is necessary that the cost of opening and closing stock of material is adjusted in the material purchased.

Opening stock of material is added and closing stock of raw material is deducted in the material purchased and we get material consumed or used in production of a product. It is calculated as : Material Consumed = Material purchased + Opening stock of material Closing stock of material.

2.Labour

For conversion of materials into finished goods, human effort is needed and such human effort is called labor.
Labour Direct Labour Indirect Labour Wages paid to such labor that does not alter the construction, composition or condition of the product

The labor which actively and directly takes part in the production of a particular commodity is called direct labor. Direct labor can also be described as process labor, productive labor, operating labor

Wages of storekeepers, foremen, timekeepers, commission of salesmen etc,

Direct Expenses
Expenses Direct Expenses Indirect Expenses

Expenses other than direct materail and direct labour, directly incurred on a specific cost unit.

Expenses incurred for the business as a whole rather than for a particular job.

1. Hire of some special machinery required for a particular contract 2. Maintainance expenses on such machinery

Rent, lighting, insurance charges.

OVERHEADS

The term overhead includes indirect material, indirect labor and indirect expenses. Thus, all indirect costs are overheads.
OVERHEADS FACTORY 1. Indirect material used in a factory such as lubricants, oil, consumable stores etc. 2. Indirect labor such as gatekeeper, timekeeper, works managers salary etc. 3. Indirect expenses such as factory rent, factory insurance, factory lighting etc. ADMINISTRATIVE 1. Indirect materials used in an office such as printing and stationery material, brooms and dusters etc. 2. Indirect labor such as salaries payable to office manager, office accountant, clerks, etc. 3. Indirect expenses such as rent, insurance, lighting of the office SELLIND & DIST

1. Indirect materials used such as packing material, printing and stationery material etc. 2. Indirect labor such as salaries of salesmen and sales manager etc 3. Indirect expenses such as rent, insurance, advertising expenses etc.

Cost sheet format

ITEMS EXCLUDED FROM COST SHEET

PURELY FINANCIAL CHARGES PURELY FINANCIAL INCOME

APPROPPRIATION(Di stribution OF funds from )PROFITS

ABNORMAL GAIN/ LOSS

1. Loss on sale of investment, fix asst 2. Fines and penalties. 3. Interest on debenture, bank loans, fix deposit 4. Obsolescence loss 5. Damages payable through a court of law

1. Interest received on bank deposit. 2.Discount, commission received 3.Rent/interest/divi dend receivable 4. Profit on sale of investment 5. Damages received through a court of law

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Writing off good will, preliminary exp, capital raising exp 2. Income tax 3. Dividend on shares 4. Charitable donations 5. Transfer to reserve

Abnormal loss of material, idle time of labour

METHODS OF COSTING

Different industries follow different methods of costing because of the differences in the nature of their work. The various methods of costing are as follows:

Methods of Costing
Costing

Job costing
BATCH CONTRACT MULTIPLE UNIT

Process costing
SERVICE OPERATION

Job costing

It is a costing method applied to determine the cost of specific jobs or lots of production generally manufactured according to customers specification. Users: manufacturing concerns where order is produced to a customers specifications.

Job Costing Example

David, Bryan, and Co. is a small furniture manufacturing business making, all kids of furniture in Texas. They received an order for 10 chairs from a customer in Kansas City.

Advantages

Here since there are different direct and indirect cost each time for different products, hence it is beneficial Helps in identifying profitable and unprofitable jobs Helps in preparing estimates when submitting job quotations for similar jobs Helps in analyzing the job trend for different jobs Helps in fixing the selling price

Disadvantages

It is very expensive to operate because it involves detailed clerical work, hence the chances of errors are there

Batch Costing

This method is used to determine the cost of a group of identical or similar products. Eg, production of nuts, bolts, medicines etc. In case a factory produces a certain quantity of a part at a time, say 5,000 rims of bicycle, the cost can be ascertained by Batch Costing.

It is the extension of job costing. A batch may represent a number of small orders passed through the factory in batch

3. Contract Costing
Here the cost of each contract is ascertained separately. It is suitable for firms engaged in the construction of bridges, roads, buildings etc. 4. Multiple/ composite Costing- it is used in those industries where the nature of the product is complex, such as motor cars, aero planes. In such case cost are accumulated for different components making the final product. Or It is a combination of two or more methods of costing outlined above. Suppose a firm manufactures bicycles including its components; the parts will be costed by the system of job or batch costing but the cost of assembling the bicycle will be computed by the Single or output costing method. The whole system of costing is known as multiple costing.

Job cost sheet

Process Costing

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2.

This costing method is used in those industries where production is done continuously, such as chemical, oil, gas, paper etc. Features of process costing: Manufacturing activity carried out continuously The output of one process becomes the input of another.

1. Single or Output Costing or unit costing

Here the cost of a product is ascertained, the product being the only one produced like a thousand of brick, a tonne of a coal, etc.

2. Operation Costing.

Here the cost of completing each stage of work is ascertained, like cost of making pulp and cost of making paper from pulp. In mechanical operations, the cost of each operation may be ascertained separately; the name given is operation costing.

3. Operating Costing It is used in the case of concerns rendering services like transport, supply of water, retail trade etc.

Cost volume profit analysis

It measures the effect of changes in the volume, cost, price and product mix on profits. Eg: cost of a product is effected by choice of plant, technology and efficiency of work force. Profit is effected by volume of output.

Thus CVP helps in finding the effect of changes in price, cost and volume on profits. It helps in determining the level of sales to earn a desired level of profit. Effect on profit by changes in sales mix.

Model of CVP

Less

Less

Sales variable cost --------------Contribution Fixed cost ------------------Profit

Break even analysis

It is a technique to study cost-volume-profit relationship. It establishes relationship between revenues and cost with respect to volume. It is a point on which the total cost and revenue are just equal. If the production and sales are increased beyond this level, the business will earn profit.