Documente Academic
Documente Profesional
Documente Cultură
CONTENT
1. Definition
2. Cost Classification
3. Costing & Cost Measurement
4. Cost Accumulation Methods
5. Cost Assignment
6. Other definitions
7. Cost Allocation Techniques
8. Relevant Cost for Specific Decision Making
RukshiCA 1
PART 1 LESSON 6
COST MANAGEMENT CONCEPTS
SUBDISCPLINES OF ACCOUNTING
Financial Accounting
Financial accounting focuses on external reporting and is guided by GAAP. The reporting
is constrained by GAAP which prescribe the revenue and cost measurement rules and
types of items that are classified as assets, liabilities or equity in balance sheets.
Cost Accounting
Cost Accounting measures and reports financial and other information related to
organization’s acquisition and consumption of resources. The information in cost
accounting system is used both by financial and management accounting. In India Cost
Accounting Record rules prescribe the cost accounting books to be maintained in
prescribed industries.
Cost Management:
Accounting systems help managers in Cost Management which involves actions by the
management to satisfy customers while continuously reducing and controlling costs.
RukshiCA 2
PART 1 LESSON 6
COST MANAGEMENT CONCEPTS
DEFINITIONS
Expenses:
The International Accounting Standards Board defines expenses as decreases
in economic benefits during the accounting period in the form of outflows or
depletions of assets or incurrence of liabilities that result in decreases in equity, other
than those relating to distributions to equity participants.
Thus an expense results in decrease in assets either because of cash outflow,
or incurrence of a liability or using up of an asset.
Costs:
Costs are the amount of expenses incurred in production of a goods or
service. Cost is a resource sacrificed or foregone to achieve a specific objective. In
simple words an expense becomes a cost of a specified cost objective when that
expense is associated with that cost objective.
RukshiCA 3
PART 1 LESSON 6
COST MANAGEMENT CONCEPTS
an asset. When the benefits of the acquisition (the goods or services) expire, the cost
becomes an expense or loss.
Cost objects:
Management is interested in knowing how much it would cost to make a
specific item or to run a specific department. That specific item or entity is called a
cost object.
Any product, service, customer, contract, project, process or other work unit
for which a separate cost measurement is desired.
Cost Accounting:
It means classification, recording, allocation, summarization, and reporting of
current and prospective costs. Included in the field of cost accounting are the design
and operation of cost systems and procedures; the methods of determining costs by
departments, functions, responsibilities, activities, products, territories, periods and
other units; the methods of determining forecasted future costs, desired or standard
costs, and historical costs; the comparison of costs of different periods, and of actual
with estimated, budgeted or standard costs; the comparison of alternative costs; and the
presentation and interpretation of cost data to help management control current and
future operations.
Cost drivers:
It is a factor that causes a change in the cost of an activity. There are two kinds of
cost drivers.
Resource cost driver:
It is a measure of the quantity of resources used for an activity. It is used to assign
the cost of a resource to an activity or cost pool.
RukshiCA 4
PART 1 LESSON 6
COST MANAGEMENT CONCEPTS
Cost driver
Research & development -No. of. Research projects
-No. of. Hrs spent for each project
-Length & complexity of each project
RukshiCA 5
PART 1 LESSON 6
COST MANAGEMENT CONCEPTS
I IV
Standard Costs/Flexible Cost Estimation and
Budgets/Activity Based Performance
Costs/Forecasts Evaluation
II III
Budgeting Responsibility
Accounting
OPERATIONS/MARKETING
(Value Addition Activities)
Direct Costs
(Traced)
Inputs
Cost Outputs
Cost
Object Goods/Services/Sales
(expenses associated with
cost object)
Indirect Costs (Allocated)
(Cost Pools)
Costs are
classified
depending on
the objective
Planning Control
RukshiCA 6
PART 1 LESSON 6
COST MANAGEMENT CONCEPTS
Cost Classification:
Management seeks information on different aspects like:
1. Products
2. Services
3. Volume of production/sales
4. Prices
5. Make or buy
6. Cost control- standard costs, variances
7. Capital budgeting- Investments in new equipment/capital expenditure
8. Operational efficiency
9. Improvements required in the manufacturing process
The answers to these questions can be very easily determined if management has
cost data available.
RukshiCA 7
PART 1 LESSON 6
COST MANAGEMENT CONCEPTS
2. Any cost not directly identified with a single final cost object, but identified with two or
more final cost objects or with at least one intermediate cost object (CASB)
An overhead cost pool aggregates overhead costs and distributes them as a group
to all products or production runs on some basis, such as direct labor hours, machine
hours, or number of parts. For example, an organization could use separate cost pools for
general overhead, set up costs and material handling costs and apply each to production
on a different basis. It could also place all manufacturing overhead costs in a common
cost pool and use a single application rate to assign manufacturing overhead to
production runs or products.
Under traditional Normal costing or “peanut butter” costing all the indirect costs
are pooled into one category and allocated on a uniform predetermined rate to the cost
objects The concept of cost pools is unique to Activity Based costing where indirect costs
RukshiCA 8
PART 1 LESSON 6
COST MANAGEMENT CONCEPTS
are further segregated into separate pools depending on the cost drivers that drive these
costs.
Factors Affecting Direct/Indirect Cost Classifications:
a) Whether the cost tracing is material?
Tracing is recommended for high costs items. Because higher the cost, the
more is the economic feasibility of tracing that cost than to allocate.
b) Available information gathering technology:
Use of high tech like bar codes, RFID etc has made it easier to gather cost data
which were not possible before. Improvements in information gathering
technologies make it easier to trace costs and reduce the need for allocation
c) Design of operations:
If an operation is exclusively for a particular product or service then it can be
directly traced to that product or service
d) Contractual arrangement:
Where the contract is for procuring an input that is exclusively used in
production of a particular product or rendering a service then its cost can be
directly traced to that product/service.
RukshiCA 9
PART 1 LESSON 6
COST MANAGEMENT CONCEPTS
Merchandising and manufacturing companies differ from service companies in that they
hold inventories. The capitalized costs of merchandising and manufacturing companies are
classified as:
• Capitalized costs which are assets and depreciated over the life of the asset.
• Product cost or capitalized inventoriable costs: The cost of inventories held
for resale.
• Period costs or non capitalized costs: All costs that are not product costs are
period costs. Period costs are recognized as an expense during a specific
period and do not create assets. Administrative and Selling/Distribution
overheads are charged to period rather than the product.
3. Manufacturing Companies:
• Manufacturing sector companies provide tangible products that have been
converted to a different form from that of the products purchased from
suppliers
Calculation of Cost of Goods Sold and Cost of Goods Manufactured:
• Cost of goods sold is simple for merchandising company because
merchandizing companies have only single class of inventory which is
finished goods. In case of merchandising company cost of goods sold is
calculated as:
Beginning Inventory + Purchases – Ending Inventory = Cost of Goods Sold
• In case of manufacturing companies there are three different kinds of
inventories. So in case of manufacturer cost of goods sold is calculated as:
Beginning work in process inventory + manufacturing costs – ending work
in process = Cost of Goods Manufactured
a. Manufacturing cost:
RukshiCA 10
PART 1 LESSON 6
COST MANAGEMENT CONCEPTS
i. Direct materials costs: costs used in the acquisition of all materials that
eventually become part of the cost object
RukshiCA 11
PART 1 LESSON 6
COST MANAGEMENT CONCEPTS
C. Prime Costs:
Prime cost equals Direct Material plus Direct Labor i.e. those costs
directly attributable to the product
D. Conversion costs
Conversion cost equals direct labor plus manufacturing overhead i.e. the
cost of converting raw materials into the finished product
• Selling costs
• Distribution expenses
• Administrative expenses
Selling Costs:
Distribution Expenses:
Generally, any expense incurred in moving a product from the factory to the
customer, including transportation and warehousing expenses. In some
industries, it may also include the expense of selling and advertising.
RukshiCA 12
PART 1 LESSON 6
COST MANAGEMENT CONCEPTS
Administrative Expenses:
The range of economic activity within which estimates and predictions are
valid. This range is normally viewed in the context of variable budgets and
Relevant range is same as “short term” for economists. Costs are fixed or
variable in a relevant range. Economists and management accounts consider all
costs to be variable in long run.
• Fixed cost
• Variable costs
• Mixed costs
• Step costs
RukshiCA 13
PART 1 LESSON 6
COST MANAGEMENT CONCEPTS
• Marginal costs
i. Fixed Cost:
Fixed cost is cost or expense element that does not vary with the volume of
activity in the short term. Also called Nonvariable Cost or Constant Cost.
Contrast with.
• If the organization ceases to exist or its activities are scaled down, fixed
costs associated with those activities may be avoidable.
ii. Variable cost:
An operating expense, or operating expenses as a class, that varies directly, and
proportionately, with sales or production volume, facility utilization, or some
other measure of activity. Examples include materials consumed, direct labor,
power, factory supplies, depreciation (on a production basis), and sales
commissions.
iii. Mixed costs/Semi Fixed Cost/Semi variable cost
A cost composed of fixed and variable elements.
In case of Mixed Costs, the fixed and variable portion in the total cost is
separated using different techniques like high low method or regression
method.
iv. Step Cost:
A cost that is constant for a volume of demand within a specified range, but
those changes once demand volume moves outside that range. Step increase
may occur both in fixed costs and variable costs.
v. Marginal costs
RukshiCA 14
PART 1 LESSON 6
COST MANAGEMENT CONCEPTS
a. Marginal cost: The cost incurred by a one unit increase in the activity level of
a particular cost driver. Marginal cost remains constant across the relevant
range
d. Sunk cost
RukshiCA 15
PART 1 LESSON 6
COST MANAGEMENT CONCEPTS
e. Opportunity cost
RukshiCA 16
PART 1 LESSON 6
COST MANAGEMENT CONCEPTS
1. Cost accumulation:
Cost accumulation refers to collection of cost data. Cost accumulation is the process of
collecting and recording cost data of historic cost.
2. Cost Assignment:
The accumulated cost data is assigned to “Cost Object”. Sometimes assignment is made
on the basis of BUDGETED COSTS rather than HISTORIC COSTS.
Cost Assignment involves two activities:
(i) Cost Tracing: Direct costs are traced to cost object
(ii) Cost allocation: Indirect costs are allocated to cost object
Cost Measurement is: An assignment and accumulation of monetary amounts for the
recognition, classification, and assignment of costs to goods and services acquired or used.
RukshiCA 17
PART 1 LESSON 6
COST MANAGEMENT CONCEPTS
Thus Cost Accounting system adopts a two step process for ascertaining costs.
o The first step is costing where the accumulated (or budgeted) costs are
assigned to the cost objects through tracing and allocation.
o The second step involves cost measurement where the assigned cost is
accumulated to determine the cost of goods and services acquired or used.
RukshiCA 18
PART 1 LESSON 6
COST MANAGEMENT CONCEPTS
3. Process Costing:
A method of cost accounting that first collects costs by cost centers and
then allocates the total costs of each cost center equally to each unit flowing
through it during an accounting period.
The accumulation of costs for activities that occur over the entire life cycle
of a product, from inception to abandonment by the consumer. It is a
measure of the total costs over the product’s life including design and
development, acquisition, operation, maintenance, and service. Service
costs include marketing, distribution, administration, and after-sales service
costs.
Cost Assignment:
Assignment means to attribute a cost item to one or more cost objects that presumably
caused it. Direct costs are assigned directly; indirect costs are allocated.
1. Cost Tracing:
RukshiCA 19
PART 1 LESSON 6
COST MANAGEMENT CONCEPTS
Indirect costs are allocated to cost objects on some basis. Indirect costs are first
collected in cost pools and then allocated to cost objects using costing
techniques.
SCRAP:
• Scrap results when some part of the raw material is not usable in making the
product.
• This happens when the raw material being processed is not of the exact length,
width, or thickness required for the product being made
• Scrap has minor economic value
Accounting for Scrap:
• There are two methods of accounting for scrap.
o Under method I the sales proceeds of the scrap are deducted from the cost
of the job that yielded the scrap.
o Under method II the sales proceeds of the scrap are deducted from actual
overhead.
WASTE:
• The term waste is used to refer to the portion of material inputs that
o either disappears in the production process
o Or has no economic value.
SPOILAGE:
RukshiCA 20
PART 1 LESSON 6
COST MANAGEMENT CONCEPTS
• Spoilage results when either the material being processed or the finished products
is discovered are unusable because of defects in workmanship or material.
• Like scrap, the spoilage occurs after the raw material has entered the production
process.
RukshiCA 21
PART 1 LESSON 6
COST MANAGEMENT CONCEPTS
Discrete Spoilage:
• The cost of normal discrete spoilage is assigned only to the good units that
have passed the inspection points.
• Normal, discrete spoilage is assumed to occur precisely at inspection point;
the units past this point should be good units, while the units prior to this
point may be good or may be spoiled.
Thus we may have two kinds of situations here as shown in the figures below:
Ending
Work in
Process
RukshiCA 22
PART 1 LESSON 6
COST MANAGEMENT CONCEPTS
Ending
Work in
Process
Abnormal Spoilage:
RukshiCA 23
PART 1 LESSON 6
COST MANAGEMENT CONCEPTS
REWORKED UNITS:
• Reworked units are those that do not initially meet product quality specifications
but have subsequently been reworked so that they may be sold as good units
RukshiCA 24
PART 1 LESSON 6
COST MANAGEMENT CONCEPTS
• As in case of accounting for normal spoilage under job order costing, there are two
methods of accounting for reworked units:
o Under method I, the costs of rework are added to the cost of particular job
from which the reworked units came
o Under method II, the costs f rework are added to actual overhead
2) In a standard cost system, both standard costs and actual costs are recorded in the
accounting records.
a. This dual recording enables exercise of control by facilitating comparison
of standards with actual.
3) Standard cost systems make use of standard costs, which are budgeted or estimated
costs to manufacture a single unit of product or perform a single service.
a. Almost all products can be manufactured with a variety of inputs that would
generate the same basic output.
b. Even after the product design has been selected, wide spectrums of input
factors are available.
RukshiCA 25
PART 1 LESSON 6
COST MANAGEMENT CONCEPTS
Material Standards:
1) The first step in developing material standards is to identify the specific direct material
components used to manufacture the product.
2) In making quality decisions, managers seek the advice of materials experts, engineers,
cost accountants, marketing personnel and suppliers.
3) Physical quantity estimates is made in terms of weight, size, volume or other measures.
These estimates are based on result of engineering tests, opinions of managers and
workers using the materials.
4) Information about product material components, their specifications and quantities are
compiled on a document called bills of materials.
Labor Standards:
RukshiCA 26
PART 1 LESSON 6
COST MANAGEMENT CONCEPTS
1) After bill of materials and the operations flow document have been developed, a
standard cost card is prepared.
2) A standard cost card is a record of the direct material and direct labor standard
quantities and costs needed to complete one unit of product.
1. Appropriateness:
a. Standards are developed from past and current information, but they must
reflect technical and environmental factors expected during the period when
the standards are applied.
b. Material quality, ordering quantities, expected employee wage rates, degree
of plant automation, facility layout, and mix of employee skills etc must be
taken into account
2. Attainability:
a. Standards are targets for performance and they can be set at different levels
and rigor. Standards can be classified as
i. Ideal standards: also called theoretical standards. Ideal standards
encompass the highest level of rigor and do not allow for operating
delays or human limitations such as fatigue, boredom, or
misunderstanding.
ii. Practical standards: these standards allow for normal, unavoidable time
problem or delays such as machine downtime and worker breaks.
RukshiCA 27
PART 1 LESSON 6
COST MANAGEMENT CONCEPTS
Flexible budgets:
RukshiCA 28
PART 1 LESSON 6
COST MANAGEMENT CONCEPTS
1. Standard costs are useful for controlling direct costs. An overhead budget is useful
in controlling indirect costs.
2. In developing an overhead budget, managers estimate the overhead costs that
should be incurred at different levels of production activity.
3. This overhead budget is called flexible budget because it is adjusted to the actual
level of activity.
4. A flexible budget is a series of budgets that present costs at different levels of
activity. In a flexible budget, all costs are treated as either variable or fixed.
5. Flexible budget can be prepared for product or period costs
Under extended normal costing, direct costs are traced using budgeted rates instead of
actual rates. (In normal costing actual costs are used for tracing direct costs). Extended
Normal costing is also known as budgeted costing.
Extended normal costing method traces direct costs to a cost object by using the budgeted
direct cost rates times the actual quantity of the direct cost input and allocated indirect
costs based on budgeted indirect cost rates times the actual quantity of cost allocation base.
RukshiCA 29
PART 1 LESSON 6
COST MANAGEMENT CONCEPTS
The distinctive feature of extended normal costing is that it used budgeted rates for both
direct costs and indirect costs.
Relevant Costing:
1) One of management’s important tasks is to allocate resources effectively and
efficiently to accomplish company’s goals and objectives.
2) Accounting information can improve management’s understanding of
consequences of alternative resource allocations.
3) Relevant costing allows managers to disregard extraneous information about
economic alternatives and focus on decision’s relevant facts.
4) The costs which should be used for decision making are often referred to as
"relevant costs". CIMA defines relevant costs as 'costs appropriate to aiding the
making of specific management decisions'.
5) To affect a decision a cost must be:
a. Future: Past costs are irrelevant, as we cannot affect them by current
decisions and they are common to all alternatives that we may choose.
b. Incremental: Expenditure which will be incurred or avoided as a result of
making a decision. Any costs which would be incurred whether or not the
decision is made are not said to be incremental to the decision.
c. Cash flow: Expenses such as depreciation are not cash flows and are
therefore not relevant. Similarly, the book value of existing equipment is
irrelevant, but the disposal value is relevant.
RukshiCA 30
PART 1 LESSON 6
COST MANAGEMENT CONCEPTS
RukshiCA 31
PART 1 LESSON 6
COST MANAGEMENT CONCEPTS
1. One of the questions facing managers is whether the right components are available
at right time to assure production.
a. Components must also meet quality specifications.
b. Further, an important consideration is the cost of the component.
2. Managers must consider whether the firm has capacity to produce components
internally.
a. The cost of internal production must be compared with the cost of acquiring
the components from other producers or in the open market.
b. Management will invariably opt for lesser cost option. If it is cheaper to buy
rather than make, the firm will opt to buy and vice versa.
Relevant information for this decision includes both qualitative and quantitative.
1. In make or buy decision, variable production costs are relevant if they can be
avoided by discontinuing production.
2. The opportunity cost of the facilities being used by production is also relevant in
make or buy alternative.
a. If a company chooses to buy a product rather than make it, an alternative
purpose may exist for the facility now being used for manufacturing.
b. If a more profitable alternative is available, management should consider
diverting the capacity to this alternative use.
RukshiCA 32
PART 1 LESSON 6
COST MANAGEMENT CONCEPTS
1. Managers are confronted with short run problem of making the best use of scarce
resources.
a. Scarce resources create constraints on producing goods or providing
services and can include machine hours, skilled labor hours, raw materials,
and production capacity.
b. Determining the best use of a scarce resource requires recognition of
company objectives.
Compensation Changes:
1. Another factor that may cause shifts in the sales mix involves either adjusting the
advertising budgets respective to each company product or increasing the
company’s total advertising budget.
RukshiCA 33
PART 1 LESSON 6
COST MANAGEMENT CONCEPTS
RukshiCA 34