introduction to cost accounting

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Costing Principles

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Cost and management accounting Provides management with costs

for products, inventories, operations or functions and compares actual to predetermined data

It also provides a variety of data for many day-to-day decision as well as essential information for long-range decisions

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Functions of managerial accounting Determining the cost Providing relevant information for

better decision-making Providing information for planning,

control, decision-making and application

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Planning Deals with the estimation of

product costs, setting up of costing system to record cost data, preparation of cost standards and budgets, planning of materials and manpower resources, analysing cost behavior with changes in levels of activity

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Control Deals with the maintenance of

product costing record, comparison of actual performance with standards or budgets, anlaysis of variances, recommendation of corrective actions, controlling cost to ensure operational efficiency and effectiveness

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Decision-making Deals with whether it is more

profitable to make or buy a component, determine the economic order quantity and production batch size, replace fixed asset, add or drop products, decide pricing

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Application Cost accounting has extended

from manufacturing operations to a variety of service industries such as hotels, bands, airline, etc

Cost accounting system should be flexible and adaptable to meet the new business environment and the changing nature of the company

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Element of cost Cost object Cost Cost unit Cost centre Profit centre

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Cost object It is an activity or item or operation

for which a separate measurement of costs is desired

E.g. the cost of operating the personnel department of a company, the cost of a repair fob, and the cost for control

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Cost It is the amount of expenditure

incurred on a specific cost object Total cost = quantity used * cost

per unit (unit cost)

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Cost unit It is a quantitative unit of product

or service in which costs are ascertained, e.g. cost per table made, cost per metre of cloth

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Cost centre It is a location or function of an

organisation in respect of which costs are ascertained

E.g. the rent, rates and maintenance of buildings; the wages and salaries of strorekeepers

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Profit centre It is location or function where

managers are accountable for sales revenues and expenses

E.g. division of a company that is responsible for the sales of products

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Cost classification Direct cost Indirect cost (overhead)

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Direct cost Cost that can be identified

specifically with or traced to a given cost object

The direct costs consist of the following three elements: Direct materials Direct labour Direct expenses

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Direct materials The cost of materials – the cost of

materials used entering into and becoming the elements of a product or service

E.g. fabrics in garments

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Direct labour The cost of remuneration for

working time E.g. assembly workers’ wages in

toy assembly

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Direct expenses Other costs which are incurred for

a specific product or service E.g. royalties

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Indirect cost (overhead) Cost that cannot be identified

specifically with or traced to a given cost object

They are identified with cost centres as overheads Indirect materials Indirect labour Indirect expenses

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Indirect materials Such as stationery, consumable

supplies, spare parts for machine that assist to the production of final products

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Indirect labour Such as salaries of factory

supervision and office staff that do not directly involve in production of the final product

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Indirect expenses Such as rent, rates, depreciation,

maintenance expenses that do not have instant relationships with the manufacturing processes

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Cost accumulation

•Prime cost = direct materials + direct labour + direct expenses

•Production cost = Prime cost + factory overheadOR

= Direct materials + Conversion cost*Conversion cost is the production cost of converting raw materials into finished product

•Total cost = Prime cost + Overheads (admin, selling,distribution cost)OR

= Production cost + period cost (administrative, selling, distribution and finance cost)

•Period cost is treated as expenses and matched against sales for calculating profit, e.g. office rental

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Cost coding A code is a system of symbols

designed to be applied to a classified set of items to give a brief, accurate reference, facilitating entry, collation and analysis

Coding is important in modern computerised accounting systems for catergories various composite accounting items

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Reasons To reducing error owing to

descriptions Enable easy recalling Reduce computer file size as a

code

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Cost behaviour Costs can be classified into

variable, fixed, semi-variable, or step-costs according to how they behave with respect of changes in activity levels

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Variable cost It increases or decreases in direct

proportion to levels of activity, but the unit variable cost remains constant

E.g. cost of food served in a restaurant

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Fixed cost Total fixed cost remains constant

over a relevant range of activity level but unit fixed cost falls with an increase in activity volume

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Semi-variable cost It processes characteristics of both

fixed and variable cost It increases or decreases with

activity level but not in direct proportion

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Step cost It remains constant for a range of

activity levels, then, on further increase in activity, the cost jumps to a new level and remains constant over a certain range until the next jump occurs

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Cost for stock valuation Unexpired and expired cost Product and period cost

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Unexpired cost Unexpired costs are the resources

that have been acquired and are expected to contribute to the future revenue

They will be recorded as assets in current period

They will be charged as expenses when they have been consumed in the generation of revenue

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Expired costs Expired costs are the expenses

attributable to the generation of revenue in the current period

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Product cost Product cost are related to the goods

purchased or produced for resale If the products are sold, the product cost

will be included in the cost of goods sold and recorded as expenses in current period

If the products are unsold, the product costs will be included in the closing stock and recorded as assets in the balance sheet

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Period cost Period cost related to the

operation of a business They are treated as fixed cost and

charged as expenses when they are incurred

They should not be included in the stock valuation

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Comparison of cost, management and financial accounting

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Meanings Financial accounting Cost accounting Management accounting

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Financial accounting Provides information to users who

are external to the business It reports on past transactions to

draw up financial statements The format are governed by law

and accounting standards established by the professional accounting policies

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Cost accounting Is concerned with internal users of

accounting information, such as operation managers

The generated reports are specific to the requirement of the management

The reporting can be in any format which suits the user

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Management accounting Comprises all cost accounting

functions The accounting for product and

service costs, management accounting extends to use various internal accounting reports for planning, control and decision making

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Cost and management accounting

Vs.Financial accounting

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Management (cost)accounting

Financial accounting

Nature Records material, labour and overhead costs in product or jobReports produced are for internal management and contol

Records company transaction eventsExternal financial statements are produced

Accounting system

Not based on the double entry system

Follows the double entry system

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Management (cost)accounting

Financial accounting

Accounting principles

No need to use accounting principlesAdopt any accounting techniques that generates useful accounting information

Use Generally Accepted Accounting Principles for recording transactions

Users of information

Used by different levels of management or departments responsible for respective activities

Used by external parties: shareholders, creditors, government, etc

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Management (cost)accounting

Financial accounting

Operation guidelines or standards

Based on management instructions and requirements

Conforms to company Ordinances, stock exchange rules, HKSSAPs

Time span

Reports are prepared whenever neededThey may be prepared on a weekly or daily basis

Reports are prepared for a definite period, usually yearly and half yearly

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Management (cost)accounting

Financial accounting

Time focus

Future orientation: forecasts, estimates and historic data for management actions

Past orientation: use of historic data for reporting and evaluation

Perspective

Detailed analysis of parts of the entity, products, regions, etc

Financial summary of the whole orgainisation

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Cost accountingvs.

Management accounting

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Management accounting

Cost accounting

Objective To provide information for planning and decision making by the management

To ascertain and control cost

Basic of recording

Concerned with transactions related to the future

Based on both present and future transactions for cost ascertainment

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Management accounting

Cost accounting

Coverage Covers a wider area: financial accounts, cost accounts, taxation, etc.

Covers matters relating to ascertainment and control of cost of product or service

Utility Only the needs of internal management

The needs of both internal and external interested groups

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Management accounting

Cost accounting

Types of transactions

Deals with both monetary any non-monetary transactions, covering both quantitative and qualitative aspects

Deals only with monetary transactions, covering only quantitative aspect