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Introduction to Costing.

Topic 1: Introduction and cost classification.

1. Differences between financial, management and cost accounting:

In relation to... Financial accounting Management accounting


(external information) (internal information)

Users/audience • Concerned with the • Concerned with


provision of provision of
information to external information to
parties outside of the people within the
organisation. organisation to help
• External reporting to in better decision
owners, investors, making.
creditors, bankers and
regulators.

Purpose Financial reporting Internal decision making

Types of information • Financial • Financial and non-


measurements. financial info.
• Financial statements. • Various internal
• Backward-looking, past reports.
info. • Future oriented.

Report frequency • Issued periodically • Issued monthly,


quarterly, weekly,
daily or hourly

Precision/nature of • Accurate, objective, • Subjective,


info. reliable, auditable. relevant, involves
estimation, flexible.

Scope/segment • Highly aggregated, • Detailed, less


summarised. summarised.
• Whole of organisation. • May focus on
smaller parts of
organisation.

Legal • Subject to public • No restrictions.

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requirements/restric scrutiny. • Upon
tions • Must comply with request/necessity.
MASB, Securities • Optional, and not
Commission, Company subjective to
Act rules & regulations.
regulations. • Not required by
law.

Cost accounting:

• Drury - Concerned with the cost accumulation for stock valuation to meet
the
requirements of external reporting.

• Lucey - The establishment of budgets, standard costs and actual costs of


operations,
processes, activities of products, and the analysis of variances,
profitability,
or the social use of funds.
1. Role of costing:
➢ Foundation of the internal financial info. system.
➢ Management needs a variety of info. to plan, to control & make
decisions.

a) Cost accounting and control:


• To ensure that operations, departments, processes and costs are
under control – organisation as a whole are working efficiently
towards agreed objectives.
• Provides a sound basis of information 4 financial controls – monitors
the results of all activities.
• Budgeting and standard costing.
b) Cost accounting & decision making:
• Decision making – making a choice between alternatives.

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• Financial implications of the various alternatives is essentially a
critical in decision making.
c) Cost accounting & planning:
• Calculation of costs that will be incurred in the future and also the
analysis of past cost will assist managers in planning.
1. Several key concepts in costing:
a. Cost:
i. The amount of expenditure incurred on , or attributable to, a
specified thing or activity.
b. Cost units:
i. Related 2 some objects or activities.
ii.A unit of product or service in relation to which costs are
ascertained.
iii.May be units of production/service, consultation hrs, number
of invoice processed.
c. Direct costs:
i. Can be directly identified with a job, batch, product or
service.
ii.Consists of:
1. Direct materials
2. Direct labour
3. Direct expenses
iii.Do not have to be spread between various categories – the
whole cost can be attributed directly to a production unit or
saleable service.
iv.It is also known as prime cost.
d. Indirect costs:
i. Defined as all material, labour and expense costs that cannot
be identified as direct costs.
ii.The 3 elements:
1. Indirect materials.
2. Indirect labour.
3. Indirect expenses/ overheads.
2. Classification of costs:
a. Cost objectives:

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i. Any activity 4 which a separate measurement of costs is
desired.
ii.Users of accounting information want to know the cost of
something.
iii.Cost of a product, cost of rendering a service to a bank or
hospital patient.

b. Cost objectives are divided into 3 broad categories:


i. Cost 4 stock valuation.
ii.Cost 4 planning & decision making.
iii.Cost 4 control.
c. Examples:
i. Cost of operating an existing machine is a cost objective that
may be required 4 a comparison with the costs of operating a
replacement machine – cost 4 decision making.
ii.Cost of operating a department is a cost objective that may
be required for a comparison with the budgeted costs – costs
4 control.

Cost Objective Possible methods of cost classifications

1. Costs 4 stock valuation • Period & product costs.


• Element of manufacturing costs.
• Job & process costs.

1. Cost 4 planning decision • Cost behaviour.


making • Relevant & irrelevant costs.
• Avoidable and unavoidable costs.
• Sunk costs.
• Opportunity costs.
• Marginal costs & incremental costs.

1. Costs 4 control • Controllable & uncontrollable costs.


(budgeting)

5.1 Classification of costs 4 Stock valuation & profit measurement.

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a) Period and product costs.
a. For stock valuation, only manufacturing costs should be included in
the calculation of product costs.
b. Therefore, they have product costs and period costs:
i. Product costs – Costs which are identified with goods
purchased or produced for resale. Stock valuation for finished
goods, or for work-in-progress.
• Prime costs – Direct costs of the product
a. Direct materials – all those materials that can
be physically identified with a specific product.
b. Direct labour – Those labour costs that can be
specifically traced or identified with a particular
product.
c. Direct expense – Expenses incurred
specifically 4 a particular product.
• Manufacturing overhead – All manufacturing costs
other than direct labour, direct materials & direct
expenses.
a. Indirect materials – Materials that cannot be
directly traced to a particular unit of product.
b. Indirect labour – Labour costs that cannot be
physically identified with a particular product.
c. Indirect expense – Expenses that cannot be
traced to the item being manufactured.
ii.Period costs – Costs which are not included in the stock
valuation. Treated as an expense in the period in which they
are incurred (non-manufacturing costs) :
• Financial expenses – Bank charges, interest on loan,
discounts allowed.
• Selling & distribution – Salesmen’s salaries,
commission.
• Administrative – Salaries or office staff.

5.2 Classification of Costs 4 Planning & Decision-Making.

Cost accounting – The calculation of actual product costs 4 stock valuation &
profit measurement.

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Management accounting – The provision of information 2 help people within
the organisation make good decisions.

1. Cost behaviour...
a. Fixed costs:
i. Remain constant over wide ranges of activity for a specified
time period.
ii.E.g. Depreciation of the factory machine, supervisor’s
salaries, rent.
iii.Graph:

• Unit fixed costs decreases proportionally with the level of activity.


○ E.g. If the total of the fixed costs is RM 5,000 for a month, the fixed
cost per unit will be as follows:

Units produced Fixed cost per unit (RM)

1 5,000

10 500

100 50

1,000 5

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• Therefore, the graph will look like:

a. Variable costs:
i. Variable in direct proportion to the volume of activity –
doubling the level of activity will double the total variable
cost.
ii.Total variable costs are linear & unit variable cost is constant.

b. Semi-fixed or step fixed costs:


i. Fixed within specified activity levels but they are eventually
increased or decreased by a constant amount at various
critical activity levels.

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ii.E.g. Labour costs. If production capacity expands to some
critical level, & therefore additional workers will be employed,
labour costs should be semi-fixed.

c. Semi-variable costs:
i. Include both a fixed & a variable component.
ii.These are costs that change with production, but not in direct
proportion to the volume.
iii.E.g. Telephone charges which has a fixed charge 4 line
rental of RM 68 per month & a variable change per minute 4
call charges of RM 0.30 per minute.

2. Sunk costs:
a. The cost of resources already acquired where the total will be
unaffected by the choice between various alternatives.
b. Created by the decision made in the past & that cannot be changed
by any decision that will be made in the future.
3. Incremental & marginal costs/revenues:
a. The additional costs or revenues which arise from the production or
sale of a group of additional units.

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