Costing Principles

Prof. Ralph Dimaala, CPA,MBA

1
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

2
Functions of managerial
accounting
Determining the cost
Providing relevant information for
better decision-making
Providing information for planning,
control, decision-making and
application

3
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
4
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
5
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

6
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

9
Cost
It is the amount of expenditure
incurred on a specific cost object
Total cost = quantity used * cost
per unit (unit cost)

10
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

11
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

12
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

13
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
15
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

16
Direct labour
The cost of remuneration for
working time
E.g. assembly workers wages in
toy assembly

17
Direct expenses
Other costs which are incurred for
a specific product or service
E.g. royalties

18
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

19
Indirect materials
Such as stationery, consumable
supplies, spare parts for machine
that assist to the production of
final products

20
Indirect labour
Such as salaries of factory
supervision and office staff that do
not directly involve in production of
the final product

21
Indirect expenses
Such as rent, rates, depreciation,
maintenance expenses that do not
have instant relationships with the
manufacturing processes

22
 Cost accumulation
Prime cost = direct materials + direct labour + direct exp

Production cost = Prime cost + factory overhead

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

Total cost = Prime cost + Overheads (admin, selling,distribut

OR
= Production cost + period cost (administrative, sel
distribution and finance cost)
Period cost is treated as expenses and matched against sales for cal
profit, e.g. office rental
23
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

25
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

28
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
32
Expired costs
Expired costs are the expenses
attributable to the generation of
revenue in the current period

33
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

34
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

35
Comparison of cost,
management and financial
accounting

36
Meanings
Financial accounting
Cost accounting
Management accounting

37
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
38
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
39
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
40
Cost and management
accounting
Vs.
Financial accounting

41
 Management Financial
(cost)accountin accounting
g
Nature Records Records company

material, labour transaction events

and overhead External financial
costs in product statements are
or job produced
Reports

produced are for

internal
management and
contol
Accountin Not based on the Follows the double
g system double entry entry system
system 42
 Management Financial
(cost)accounting accounting
Accountin No need to use Use Generally
g accounting Accepted Accounting
principles principles Principles for
Adopt any recording
accounting transactions
techniques that
generates useful
accounting
information
Users of Used by different Used by external
informati levels of parties:
management or shareholders,
on
departments creditors,
responsible for government, etc 43
 Management Financial
(cost)accountin accounting
g
Operation Based on Conforms to
guideline management company
instructions and Ordinances, stock
s or
requirements exchange rules,
standards HKSSAPs
Time Reports are Reports are
span prepared prepared for a
whenever needed definite period,
They may be usually yearly and
prepared on a half yearly
weekly or daily
basis
44
 Management Financial
(cost)accountin accounting
g
Time Future Past orientation:
focus orientation: use of historic data
forecasts, for reporting and
estimates and evaluation
historic data for
management
actions
Perspecti Detailed analysis Financial summary
ve of parts of the of the whole
entity, products, orgainisation
regions, etc

45
 Cost accounting
vs.
Management accounting

46
 Management Cost accounting
accounting
Objective To provide To ascertain and
information for control cost
planning and
decision making
by the
management
Basic of Concerned with Based on both
recording transactions present and future
related to the transactions for cost
future ascertainment

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 Management Cost accounting
accounting
Coverage Covers a wider Covers matters
area: financial relating to
accounts, cost ascertainment and
accounts, control of cost of
taxation, etc. product or service

Utility Only the needs The needs of both

of internal internal and external
management interested groups

48
 Management Cost accounting
accounting
Types of Deals with both Deals only with
transactio monetary any monetary
non-monetary transactions,
ns
transactions, covering only
covering both quantitative aspect
quantitative and
qualitative
aspects

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