Introdustion to Cost

Management

Costing Principles

Chapter 1- Introduction to Cost

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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 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,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 Chapter 1- Introduction to Cost
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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 Financial accounting
(cost)accounting
Nature Records material, Records company

labour and overhead transaction events

costs in product or External financial
job statements are
Reports produced produced
are for internal
management and
contol
Accounting Not based on the Follows the double
system double entry system entry system

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 Management Financial accounting
(cost)accounting
Accounting No need to use Use Generally


principles accounting principles Accepted Accounting

Adopt any Principles for recording
accounting techniques transactions
that generates useful
accounting
information
Users of Used by different Used by external

information levels of management parties: shareholders,

or departments creditors, government,
responsible for etc
respective activities
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 Management Financial accounting
(cost)accounting
Operation Based on Conforms to company
guidelines management Ordinances, stock
instructions and exchange rules,
or
requirements HKSSAPs
standards

Time span Reports are Reports are prepared

prepared whenever for a definite period,

needed usually yearly and half
They may be yearly
prepared on a
weekly or daily basis

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 Management Financial accounting
(cost)accounting
Time focus Future orientation: Past orientation: use
forecasts, estimates of historic data for
and historic data for reporting and
management evaluation
actions

Perspective Detailed analysis of Financial summary of

parts of the entity, the whole orgainisation
products, regions,
etc

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 Cost accounting
vs.
Management accounting

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 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 present

recording transactions related and future transactions
to the future for cost ascertainment

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

Utility Only the needs of The needs of both

internal internal and external
management interested groups

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

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