BBA305 COST AND MANAGEMENT ACCOUNTING LECTURE NOTES

These notes are to be read before the lectures take place. They do not replace additional text readings to be done by each student. Your involvement in this unit would decide your grades in this course. LAST MINUTE CRAMMING IS INJURIOUS TO YOUR HEALTH. In this unit this is a prescription for definite fail. PLEASE NOTE, AS ADVISED ON DAY 1, THIS UNIT INOLVES 80-90% COMPUTATIONAL TYPE QUESTIONS.

Module I: Introduction to Cost Accounting

Meaning, nature and scope of cost accounting.

Modern business needs frequent cost information about business activities to plan accurately for the future, to control business results, and to make a proper appraisal of the performances of persons working in the organization. The fulfillment of these goals requires details about the costs incurred and benefits(revenues) obtained which are provided by what is known as `cost accounting. In comparison, financial accounting does not provide management with detailed cost and revenue information relevant to its needs. Briefly, Financial accounting is concerned with providing information to external users such as shareholders (existing and potential0, creditors, financial analysts, labor unions and government authorities. Financial accounting is oriented towards the preparation of financial statements which summarise the results of operations for selected periods of time and show.

Scope of Cost Accounting

Cost Ascertainment Cost Accounting Cost Control

Cost Acertainment Deals with the collection and analysis of expenses, the measurement of production of the different products at the different stages of manufacture and the link up of production with expenses. Cost Accounting

Its the process of accounting for cost beginning with recording of expenditure and ends with the preparation of statistical data. Cost Control Deals with the guidance and regulation by executive action of the costs of operating an undertaking.

Differentiate cost accounting from accounting and financial accounting.

management

Cost accounting is a branch of accounting and has been developed due to limitations of financial accounting. Financial accounting is primarily concerned with record keeping directed towards the preparation of profit and loss account and balance sheet. Cost accounting is a tool of management that provides management with detailed records of the costs relating to products, operations or functions. It refers to the process of determining and accumulating the cost of some particular product or activity. It covers classification, analysis and interpretation of costs. Cost accounting is also distinguished from cost accountancy, whereby, cost accountancy refers to costing, cost accounting, budgetary control, cost control and cost audit. Cost accounting and Costing also differs. Costing is the determining of costs. It includes the techniques and processes of determining costs. Here technique refers to the principles and rules which are applied for determining costs of products manufactured and services rendered. FEATURES OF COST ACCOUNTING
cost accounting establishes budget and actual cost of operations, processes, departments or product and the analysis of variances, profitability or social use of funds. Managers use cost accounting to support decision-making to cut a company's costs and improve profitability. As a form of management accounting, cost accounting need not follow standards such as GAAP, because its primary use is for internal managers, rather than outside users, and what to compute is instead decided pragmatically.

Cost accounting can be viewed as translating the supply chain (the series of events in the production process that, in concert, result in a product) into financial values. Supply chain activities transform natural resources, raw materials and components into a finished product that is delivered to the end customer.

Cost accounting has long been used to help managers understand the costs of running a business. Modern cost accounting originated during the industrial revolution, when the complexities of running a

large scale business led to the development of systems for recording and tracking costs to help business owners and managers make decisions. In the early industrial age, most of the costs incurred by a business were what modern accountants call "variable costs" because they varied directly with the amount of production. Money was spent on labor, raw materials, power to run a factory, etc. in direct proportion to production. Managers could simply total the variable costs for a product and use this as a rough guide for decision-making processes. Some costs tend to remain the same even during busy periods, unlike variable costs, which rise and fall with volume of work. Over time, the importance of these "fixed costs" has become more important to managers. Examples of fixed costs include the depreciation of plant and equipment, and the cost of departments such as maintenance, tooling, production control, purchasing, quality control, storage and handling, plant supervision and engineering. In the early twentieth century, these costs were of little importance to most businesses. However, in the twenty-first century, these costs are often more important than the variable cost of a product, and allocating them to a broad range of products can lead to bad decision making. Managers must understand fixed costs in order to make decisions about products and pricing. For example: A company produced railway coaches and had only one product. To make each coach, the company needed to purchase $60 of raw materials and components, and pay 6 laborers $40 each. Therefore, total variable cost for each coach was $300. Knowing that making a coach required spending $300, managers knew they couldn't sell below that price without losing money on each coach. Any price above $300 became a contribution to the fixed costs of the company. If the fixed costs were, say, $1000 per month for rent, insurance and owner's salary, the company could therefore sell 5 coaches per month for a total of $3000 (priced at $600 each), or 10 coaches for a total of $4500 (priced at $450 each), and make a profit of $500 in both cases.

What Does Cost Accounting Mean?

A type of accounting process that aims to capture a company's costs of production by assessing the input costs of each step of production as well as fixed costs such as depreciation of capital equipment. Cost accounting will first measure and record these costs individually, then compare input results to output or actual results to aid company management in measuring financial performance. While cost accounting is often used within a company to aid in decision making, financial accounting is what the outside investor community typically sees. Financial accounting is a different representation of costs and financial performance that includes a company's assets and liabilities. Cost accounting can be most beneficial as a tool for management in budgeting and in setting up cost control programs, which can improve net margins for the company in the future.

Cost Accounting features include the following:

It is a process of accounting for costs. 3

It records income and expenditure relating to production of goods and services. Provides statistical data on the basis of which future estimates are prepared and quotations are submitted. Concerned with cost ascertainment, cost control and cost reduction. Establishes budgets and standards so that actual cost may be compared to find out variances. Involves preparation of right information to the right person at the right time so that it may be helpful to management for planning , evaluation of performances, control and decision-making.

Management accounting
Management accounting or managerial accounting is concerned with the provisions and use of accountinginformation to managers within organizations, to provide them with the basis to make informed business decisions that will allow them to be better equipped in their management and control functions. In contrast to financial accountancy information, management accounting information is:

designed and intended for use by managers within the organization, instead of being usually confidential and used by management, instead of publicly reported; forward-looking, instead of historical; computed by reference to the needs of managers, often using management information

intended for use by shareholders, creditors, and public regulators;

systems, instead of by reference to general financial accounting standards.

According to the Chartered Institute of Management Accountants (CIMA), Management Accounting is "the process of identification, measurement, accumulation, analysis, preparation, interpretation and communication of information used by management to plan, evaluate and control within an entity and to assure appropriate use of and accountability for its resources. Management accounting also comprises the preparation of financial reports for nonmanagement groups such as shareholders, creditors, regulatory agencies and tax authorities" (CIMA Official Terminology). The Institute of Management Accountants(IMA)[1] recently updated its definition as follows: "management accounting is a profession that involves partnering in management decision making, devising planning and performance management systems,and providing expertise in

financial reporting and control to assist management in the formulation and implementation of an organizations strategy."

Financial accounting.
The process of Preparing management reports andaccounts that provide accurate and timely financial andstatistical information required by managers to make dayto-day and short-term decisions.

1) Unlike financial accounting, which produces annual reportsmainly for external

stakeholders, management accounting generates monthly or weekly reports for an organization'sinternal audiences such as department managers and thechief executive officer. These reports typically show theamount of available cash, sales revenue generated, amount of orders in hand, state of accounts payable and accounts receivable, outstanding debts, raw material and inventory, and may also include trend charts, variance analysis, and other statistics. Also called managerial accounting.

Cost accounting helps in determination and analysis of cost of departments, processes, jobs, products, sales territories, sales orders. An example is given to point out how Cost accounting by products reveal facts and data which cannot be developed in financial accounting, since cost statements produced at

FINANCIAL ACCOUNTING VS. COST ACCOUNTING

Both financial and cost accounting are the branches of accounting whose main object is to provide information by recording the business transactions systematically and scientifically so that it may serve the purpose of the management for policy formulation and controlling. Financial accounting involves recording of transactions, classification and analysis in a subjective manner according to the nature of the expenditure. They do not provide the information on the relative effectiveness of products, processes, human resources. Thus financial accounting treats costs very broadly, while cost accounting does this in much greater detail. Lets see the following two statements: Under Financial Accounting Direct materials 1,50,000 Rs. 5

Wages Other expenses TOTAL EXPENSES Sales Profit (10% of Sales)

70,000 50,000 2,70,000 3,00,000 30,000

Here, the financial accountant is just happy to report a profit of Rs30,000 which represents 10% of Sales, but isnt the info very general? How would the management make better use of this info?

Under Cost Accounting Product A Direct 48,000 materials Wages 15,000 Other 15,000 expenses TOTAL COSTS 78,000 Sales Profit Profit (%) 1,02,400 24,400 23.8

Product B 37,000 25,000 18,000 80,000 1,08,000 28,000 25.9

Product C 65,000 30,000 17,000 1,12,000 89,600 (22,400) -

Total 1,50,00 0 70,000 50,000 2,70,00 0 3,00,00 0 30,000 10

Now in this statement it clearly reveals to management that products (A) and (B) are obtaining approximately 24% and 26% but the product (C) is pulling down the total profit to 10%. Thus management may: a) b) c) d) Investigate thoroughly product (C) to find out possible economies Stop production of (C) Increase selling price of (C) Produce (C) as a loss and sell in the hope of encouraging consumers also to buy A and B provided there are no changes in plant capacity, plant utilization, volume of sales. The cost accountant under this scenario points out the fact and where possible, suggests remedies thus management must make the final decision on policy.

Methods of costing. o Job Costing

6

Is used in those business concerns where production is carried out as per specific order and customers specifications. Each job (or product) is separate and distinct from the other jobs or products. The method is popular in enterprises engaged in house building, ship building, repair jobs, printing. Job costing has the following options: Batch Costing Contract or Terminal costing and Multiple or Composite Costing

Process Costing

This costing method is used in those industries where production is done continuously, such as chemical, oil, gas refinery, paper, aeroplane and car manufacture. Its difficult to trace the costs to specific units(products0 and the total cost is averaged for the number of units manufactured. Process costing has the following options: Single output costing Operating or service costing Operation costing

Cost concepts
What is Cost? The amount of expenditure actual (incurred) or attributable to a specific thing or activity such as a product, job, service or any other activity. TYPES OF COSTS Fixed Costs These are costs that remain the same each month or year irrespective of nil activity. Eg: a firm leases a factory for production. The rent is Rs50,000 paid monthly so its a fixed cost. If there is a strike and the factory is closed for 3 months, the firm still has to pay 3 months rent totaling Rs1,50,000. Variable Costs These are costs that keep fluctuating. They increase/decrease/remain constant based on level of activity. Eg. if a factory makes 20,000 units of a particular product, its material cost would be Rs9,000 and as the production increases, the material cost also increases and vice-versa. 7

Mixed Costs These are costs that have both Fixed and Variable costs. Example would be the telephone bill of the factory. The Fixed cost would be for the equipment and line rental charges, while Variable cost would be the calls (units) made. Both the FC + VC gives the TOTAL COST of the bill. Direct Costs These costs can be directly traceable to the products. Eg a firm makes tables. Only Direct materials (such as timber, nails, screws, metal plates or rods used) and Direct wages (wage cost paid to joiners/carpenters) can be easily identified. In Direct Costs These costs cannot be directly traceable to the products. However, they have contributed to the manufacture of the product. These include indirect materials and labor, other factory expenses sometimes referred to as `overheads Product Costs These costs can be identified to the products. Eg. Direct materials+Direct wages+Direct expenses+Factory overheads Period Costs These costs cannot be identified with the products. These are deducted as expenses during the period. They also generate revenue but not directly associated with the product.

Classification of costs Direct materials(DM) Direct Labor(DL) PRIME COST(PC) : DM + DL Factory overhead(FOH) COST OF PRODUCTION(COP): PC + FOH Selling(SE)/Admin.(AE)/Financial Expenses(FE)

COST OF SALES(COS): COP + SE + AE + FE

Numerical on preparation of cost sheet.

Cost Sheet is a statement which is prepared usually to present the detailed costs of total production during the period in question. It provides information relating to cost per unit at different stages of the total cost of production or at different stages of completion of the product.

COST SHEET
(1) Direct Materials Opening stock +Purchases +Cartage Inwards -Closing stock =Cost of materials consumed (2) Direct Labor Wages PRIME COST = (1) + (2) (3) Factory Overheads All factory Production related costs + WORK IN PROGRESS (OPENING) - WORK IN PROGRESS (ENDING) (4) Factory Selling expenses Admin expenses Financial expenses = COST OF PRODUCTION + FINISHED GOODS (OPENING) - FINISHED GOODS = COST OF SALES

Relevant costs for decision-making.

Relevance is one of the key characteristics of good management accounting information. This means that management accounting information produced for each manager must relate to the decisions which he/she will have to make. Relevant costs are the costs that meet this requirement of good management accounting information. The Chartered Institute of Management Accounting defines relevant costs as: the costs appropriate to a specific management decision This definition could be restated as the amount by which costs increase and benefits decrease as a direct result of a specific management decision. Relevant benefits are the amounts by which costs decrease and benefits increase as a direct result of a specific management decision. Before the management of an enterprise can make an informed decision on any matter, they need to incorporate all of the relevant costs which apply to the specific decision at hand in their decision making process. To include any non-relevant costs or to exclude any relevant costs will result in management basing their decision on misleading information and ultimately to poor decisions being taken. While the topics examined in these notes deal exclusively with relevant and non-relevant costs, the ideas raised and discussed apply with equal force to the importance and identification of the relevant and non-relevant benefits of various decisions. Relevant costs and benefits only deal with the quantitative aspects of decisions. The qualitative aspects of decisions are of equal importance to the quantitative and no decision should be made in practice without full consideration being given to both aspects. Identifying relevant and non-relevant costs The identification of relevant and non-relevant costs in various decisionmaking situations is based primarily on common sense and the knowledge of the decision maker of the area in which the decision is being made. Armed with these two tools you should be able to sift through all the information that is available in respect of any decision and extract those costs (and benefits) which are appropriate to the decision at hand. In identifying relevant costs for various decisions, you may find that some costs not included in the normal accounting records of an enterprise are relevant and some costs included in such records are non-relevant. It is important that you realise that there is a substantial difference between 10

recorded accounting costs and relevant costs for decision making, and while the latter may be recorded in the former this is not always the case. Accounting records are used to record the incidence of actual costs and revenues as they arise. Decisions, on the other hand, are based only on the relevant costs and benefits appropriate to each decision while the decision is being made. This point is particularly appropriate when you come to examine opportunity costs and sunk costs that are dealt with below. In practice, you may also find that the information presented in respect of a decision does not include all the relevant costs appropriate to the decision but the identification of this omission is very difficult unless you are familiar with the area in which the decision is being made.

End of Module 1

11