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Cost Accounting and
Control
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Define cost, Accounting,Costing?
Cost may be defined as the amountof expenditure incurred on, orattributable to, a given thing. Cost is
a sacrifice of resources.
Accounting may be defined as the artand science of recording businesstransaction in a methodical mannerso as to show
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Financial Accounting
Its focus is on reporting to external
parties.
It measures and records businesstransactions.
It provides financial statements basedon generally accepted accountingprinciples.
Management Accounting
It measures and reports financial and
nonfinancial information that helpsmana ers make decisions to fulfil the33
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Costing involves,
Classifying, recording and
appropriate allocation of expenditurefor the determination of the costs ofproducts or services.
The relation of these costs to salesvalues; and
The ascertainment of profitability.
Element of Cost: 44
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Material cost it is the cost ofcommodities supplied to anundertaking
Direct material cost which goes intoa saleable product or it is directlyused for the completion of that
product e.g., HSS bit for lathe.
Indirect material cost which isnecessary but not directly used e.g.,
cotton waste 55
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Expense refers to all charges otherthan incurred as direct results ofMaterials and labourers.
Direct expenses - Other expenseswhich are incurred for the specificproduct or service and are directly
charged to them. Eg: Expenses onSpecial Tools and Consumablespurchased.
Indirect expenses - All those66
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Opportunity cost
It is the cost of any activity
measured in terms of the value ofthe best alternative that is notchosen (that is foregone)
Sunk cost It is the costs that have already been
incurred and cannot be recovered.
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Overheads defined as the cost ofindirect material, indirect labour andsuch other indirect expenses,
including services, as cannotconveniently be charged direct tospecific cost units.
Production or manufacturingoverheads all indirect expensesincurred from receipt of the
production order until its completion88
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Prime cost = Direct material cost +Direct labour cost + directexpenses
Factory cost = prime cost + factoryoverhead
= Direct material cost+ direct labour cost+ (variable) directexpenses + factory overhead.
Total cost = Factor cost + sellin99
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Depreciation
A noncash expense that reduces thevalue of an asset as a result of wearand tear, age, or obsolescence. Most
assets lose their value over time (inother words, they depreciate), andmust be replaced once the end of
their useful life is reached.There are several accounting
methods that are used in order to
write off an asset's depreciation cost1010
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COST VOLUME PROFIT ANALYSIS
CVP analysis shows the relationship between costs (bothvariable and fixed), volume (the number of units producedand sold), and profit or loss.
CVP is a useful management tool; it allows managers to
understand and predict how changes in sales prices, salesvolumes, and expenses will affect an organizationsprofitability.
CVP analysis is an examination of
the relationships of prices, costs,volume, and mix of products. Itinvolves the separation of costs intotheir variable and fixed categories atthe outset of the analysis.
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Assumptions of CVP:
Revenues and costs are linear throughout therelevant range.
Costs can be identified as either fixed orvariable.
Changes in activity levels are the only factorsaffecting costs.
The number of units produced and sold is thesame.
In companies with more than one product, thesales mix is constant.
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COST VOLUME PROFIT ANALYSIS
There are three main tools offered by CVP analysis:
breakeven analysis,
contribution margin analysis,
operating leverage,
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BREAK EVEN ANALYSIS In economics & business, specifically cost accounting, the break-even point (BEP) is the point at
which cost or expenses and revenue are equal: there is no net loss or gain, and one has "brokeneven". A profit or a loss has not been made, although opportunity costs have been paid, and capitalhas received the risk-adjusted, expected return.
Break-Even Analysis is used to calculate the break-even point where total revenue equals totalcosts. This point results in zero profit or in other words at this point the business recovers thevariable and fixed costs of doing business at a certain revenue level. In order to perform Break-EvenAnalysis the following variables are required:
- Total Revenue (TR) which is calculated as number of products sold times unit price
- Total Fixed Costs (TFC) generally this number will not change unless the analysis is for a largerange / changes in the
revenue
- Total Variable Cost (TVC) which varies directly with the number of products sold
The Profit (P) is calculated as total revenue minus total cost:
P = TR TC
Where: 1414
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Total Revenue (TR) Total Fixed Costs(TFC) Total Variable Cost (TVC) Profit(P) 1515
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For example, if a business sells fewerthan 200 tables each month, it willmake a loss, if it sells more, it will be
a profit. With this information, thebusiness managers will then need tosee if they expect to be able to make
and sell 200 tables per month.
If they think they cannot sell that
many, to ensure viability they could:1616
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Breakeven Analysis
A second tool for management decisionmaking
breakeven point can be determined by
using the following formulas: Sales Price per Unit Variable Costs per
Unit = Contribution Margin per Unit.
Contribution Margin per Unit divided bySales Price per Unit = Contribution MarginRatio.
Breakeven Sales Volume = Fixed Costs
divided by Contribution Margin Ratio.1717
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Contribution Margins
which compares the profitability of differentproducts, lines, or services we offer
contribution margin is simply the percentage ofeach sales dollar that remains after the
variable costs are subtracted. CM = Selling price - Variable cost
CM may be shown as a per unit amount or a totalamount at a specific level of sales.
The contribution margin is the amount available tocover fixed costs (below the break even point) andthe amount to add to profit (above the break evenpoint).
The contribution margin may be expressed as a1818
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Contribution margin ratio
CMR = Contribution margin / sellingprice
The contribution margin ratio is the
percent of each sales dollar that isavailable to cover fixed costs (belowthe break even point) and theamount to add to profit (above thebreak even point).
The contribution margin ratio isusually expressed as a percentage.
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Contribution margin
Sales = CMRatio
Fixed expense
CM Ratio
Break-even
point(in sales dollars)
=
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Contribution Margin Ratio
Total Per Unit Percent
Sales ( 400 surf boards) 200,000$ 500$ 100%
Less: variable expenses 120,000 300 60%Contribution margin 80,000$ 200$ 40%
Less: fixed expenses 80,000
Net income -$
$80,00040%
$200,000
sales
=
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All costs
Product costs(Manufacturing costs)
Period costs(Non-manufacturing
costs)
Direct materials
Direct labour
Manufacturingoverhead
Selling expenses
Administrativeexpenses
Primecosts
Conversioncosts
COST
OF
PROD
UCTIO
N
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Product Costs costs that are necessary andintegral part of producing the finished product.
Direct labour and manufacturing overhead areincurred in converting raw materials intofinished goods, these costs elements are oftenreferred to as conversion costs.
Period costs costs that are identified with aspecific time period rather with a salable
product. These costs relate to non-manufacturin costs and therefore are not2323
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Manufacturing Costs in FinancialStatements
Format Manufacturing Accounts
ABC Manufacturing CompanyManufacturing account for the year ended December
2007
Direct Materials RM RM
Raw material as at 1 January 2007 xx
Add: Purchases of Raw Material xx
Carriage Inward xx
Import Duty xxTotal Raw Material Available for Use xxx
(-) Raw material as at 31 December 2007(xx)
DIRECT MATERIAL USED xxx2424
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Continue..
PRIME COSTS xxx
Overhead Costs
Indirect Labor xx
Factory repairs xx
Depreciation factory machine xx
TOTAL OVERHEAD COSTS xxx
TOTAL MANUFACTURING COSTS xxx
Add: WIP Opening xx
Less: WIP Closing (xx)
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ABC Manufacturing Company
Income Statement for the year ended December 2007
RM RM
Sales xxx
Less: Cost of Goods Sold:
Finished goods 1 Jan xx
Add:Cost of goods manufactured xx
Goods Available for Sale xx
Less: Finished goods 31 Dec (xx)
COST OF GOOD SOLD xx
GROSS PROFIT XX
Less: Operating Expenses
Selling and Distribution Expenses xx2626
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Excercise
Mutiara Ltd incurs the following manufacturing costs andexpenses during the month of May.
1. Assembly line wages
2. Raw materials used directly in product
3. Depreciation on office equipment
4. Property taxes on factory building
5. Rent on factory building
6. Sales commissions
7. Depreciation on factory equipment
8. Factory utilities
9. Wages for factory maintenance workers
10. Advertising
11. Indirect materials used in production 2727
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Complete the following matrix by placing an X markunder the appropriate headings.
Cost item Direct
material
Directlabour
Manufact.
overhead
Prime costs Conversioncosts
Period costs
Wages
Raw material
Depreciation officeequip.
Property taxes
Sales commissions
Depreciation onfactory equipment
Factory utilities
Wages for factorymaintenanceworkers
Advertising
Indirect materials
Factory manager'ssalary 2828
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operating leverage, whichexamines the degree to which ourbusiness uses fixed costs, which
magnifies our profits as salesincrease, but also magnifies ourlosses as sales drop.
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What is a budget ?
A budget is a written plan aboutwhat is to be done in future.
It is a financial statement relatingto future. Budget is a method ofestimating the likely revenues and
expenses.Budget: It is a financial and / orquantitative statement, prepared
and approved prior to defined
Budget
and
Budget
ary
contro
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BUDGETING
it is a whole process of designing,implementing and operating budget
Process of preparing budgets,
Study of business situations,
Understanding the management
objectives, Understanding the capacity of
enterprise.
The entire process of preparing the3131
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Budgetary control
Budgetary control is a system ofcontrolling costs which includespreparation of budgets, coordinatingthe department, establishingresponsibilities, comparing actualperformance with the budgeted, andacting upon the results to achieve
maximum profitability-BROWN &HOWARD
it is establishment of budget relating
the responsibilities of executives to the3232
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What is a budget key factor?
It is the critical factor which is responsible for
the budget to work properly (as planned). It isto be identified carefully and properlyestimated.
Example : demand of products could be abudget key factor
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What is a zero base
budgeting ?It is a system of budgeting, whereall activities are re-evaluated eachtime a budget is set. It is superiorto traditional method, as we are
evaluating each iterm and findingits rationale. As against zero base
budgeting, in traditionalbudgeting, a budget is preparedjust on the basis of last year's
data. We try to add a little bit in' a s per ormance
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a s per ormancebudgeting ?
In this system, there is a budget,
which is linked to performance. Itinvolves evaluation of
performance of an organization inthe context of both specific as well
as overall objectives of theorganization.
What is a master budget?
It is a consolidated budgetprepared by combining the
summaries of all the functionalbudgets
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CLASSIFICATION OF BUDGETS
ACCORDING TO ACCORDING TOACCORDING TO
TIME FUNCTIONFLEXIBILITY
1. Long term budget 1. Sales budget1. Fixed budget
2. Short term budget 2. Production budget2. Flexible budget
3. Current budget 3. Cost of Production budget4. Rolling budget 4. Purchase budget
5. Personnel budget6. R & D budget7. Capital Expenditure budget8. Cash budget9. Master budget
1. SALES BUDGET:
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1. SALES BUDGET:
Sales budget is the most important budget basedon which all the other budgets are built up. Thisbudget is a forecast of quantities and values of sales
to be achieved in a budget period.
2. PRODUCTION BUDGET:
Production budget involves planning the level ofproduction which in turn involves the answer to thefollowing questions:
a. What is to be produced?
b. When is it to be produced?c. How is it to be produced?
d. Where is it to be produced?
3 COST OF PRODUCTION BUDGET:
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3. COST OF PRODUCTION BUDGET:
This budget is an estimate of cost of outputplanned for a budget period and may be
classified into Material Cost Budget
Labour Cost Budget
Overhead Cost Budget
4. PURCHASE BUDGET:
This budget provides information about the
materials to be acquired from the marketduring the budget period.
5. PERSONNEL BUDGET:
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5. PERSONNEL BUDGET:
This budget gives an estimate of therequirements of direct labour essential to meet
the production target.This budget may be classified into
a. Labour requirement budget
b. Labour recruitment budget
6. RESEARCH AND DEVELOPMENT BUDGET:
This budget provides an estimate ofexpenditure to be incurred on R & D during the
budget period.A R&D budget is prepared taking into
consideration the research projects in hand andnew R & D projects to be taken up.
7. CAPITAL EXPENDITURE BUDGET:
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7. CAPITAL EXPENDITURE BUDGET:
This is an important budget providing foracquisition of assets necessitated by the
following factors:a. Replacement of existing assets.
b. Purchase of additional assets to meetincreased production
c. Installation of improved type of machinery toreduce costs.
8. CASH BUDGET:
This budget gives an estimate of theanticipated receipts and payments of cash duringthe budget period.
Cash budget makes the provision for
minimum cash balance to be maintained at all
9. MASTER BUDGET:
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9. MASTER BUDGET:
CIMA defines this budget as The summary budgetincorporating its component functional budget and
which is finally approved, adopted and employed.Thus master budget is a summary of all functionalbudgets in capsule form available in one report.
10. FIXED BUDGET:
This is defined as a budget which is designed toremain unchanged irrespective of the volume ofoutput or turnover attained.
This budget will, therefore, be useful only when theactual level of activity corresponds to the budgetedlevel of activity.
11. FLEXIBLE BUDGET:
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11. FLEXIBLE BUDGET:
CIMA defines this budget as one which, byrecognising the difference in behaviour between
fixed and variable costs in relation to fluctuationsin output, turnover or other variable factors suchas number of employees, is designed to changeappropriately with such fluctuations.
Fixed budget Flexible budget
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g g
Cost are not classified according totheir variability
Cost are classified according to thenature of their variability
It remains the same irrespective ofthe volume of business activity
It can be suitably recasted quickly tosuit the changed conditions
It assumes that conditions wouldemain static
It is designed to change according to achange in the level of activity
Actual and budgeted performancecannot be correctly compared if thevolume of activity differs
Comparison are realistic since thechanged plan figure are placed againstactual ones
Budget has limited application Budget has more application
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Capital Budgeting...
is a formal means of analyzing long-range capital investment decisions.
The term describes budgeting for theacquisition of capital assets.
Capital assets are assets used for along period of time.
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Capital Budgeting
Capital budget models using net cashinflow from operations are:
payback
accounting rate of return
net present value
internal rate of return