IPCC Paper 5: Cost Accounting Chapter 1

BY CA. B.N. Pattabhi, M.Com, FCA

Cost Accounting – An Introduction

Salutations DEDICATED TO MY

NOBLE, EVER LOVING,

EVER INSPIRING MOTHER

LALITAMMA

Learning Objectives

Introduction to Cost Accounting

Cost Accounting is basically a MIS i.e.

• A Management Information System

It’s an aid to the Management in its Primary Function of Decision Making

It aims at Ascertainment of Cost for the purpose of Cost Analysis and Control

Evolution of Cost Accounting

An Intro.

Before Industrial Revolution

Seller’s Market since Skilled Labourers were very few and Buyers were unlimited i.e Low Production High Demand Price was determined by Sellers No Competition because of High

Demand Hence cost was not relevant

Industrial Revolution - Initial Stage

Automation of Production Process

Limited Production but still short of Demand

Whatever was produced was Sold

Prices were still high and unrelated to cost

Progression towards Large Scale Production and increase in efficiency

Developments in the Field of Management

Different concepts evolved in the field of

Management like

1 • Scientific Management Theory

2 • Time & Motion Study

3 • Functional Departmentalisation

4 • Specialisation etc

Industrial Revolution - Maturity Stage Oragnisations mastered Efficient Processes

Scaled up production to derive Economies of Large Scale Operation

• In fact there was a glut in the market

For the First Time Supply was more than Demand

Organisations Started Competing for Market Share

Price Competition crept in based on Financial Statements

Price Competition turned into a cut throat price competition based on historical Info

Organisations survived for a year or two based on reserves

Industrial Revolution-Maturity Stage 2 Organisations started going Bankrupt

Even though the efficiency levels were high i.e. upwards of 99% and Production Processes were highly efficient still Organisations went bankrupt

Management scientists or Managers started searching for the reasons of bankruptcy

• Fixing the price based on earlier periods Financial Statements • The information based on which pricing decisions were taken were old and not up to date

Managers zeroed in on the reasons for bankruptcy i.e

Managers started realising that the basis of their decisions were incorrect

The need for an efficient MIS was being felt by managers across the cadres

An MIS in tune with the changes / trends in the management was the need of the hour

Financial Accounting System Limitations

It’s a post mortem of transactions

No mechanism to consider the future trend i.e. no mechanism for precise estimates

No mechanism for considering the present trends / changes in the situations

Information presented is historical and based on historical cost basis

Stock Records do not form part of Financial Records

Concept of Work in progress does not exist

Concept of issue and consumption does not exist

The time gap between recording and reporting is very long

Evolving Cost Accountancy

To meet the changing needs of the Managers a new system of MIS emerged known as Cost Accountancy

The New MIS had all the mechanisms and

techniques to overcome the shortcomings of Financial Accounting

System

Cost Accountancy is Forward Looking,

Analytical and Current

Definitions

Cost Accounting

Cost

It is the sum total of expenditure “Incurred” or “Attributable” to produce an article or thing or render a Service.

The expenditure may be real or implied

The payment is not a criteria To Sum up it’s the aggregate of

value of all factors of productions used to produce an article or a thing or render a Service

Costing Costing is a term used to

collectively refer to all those techniques, Processes and activities that are used to ascertain cost

It is the process of ascertainment of cost

It includes all those activities which are performed to collect information for the ascertainment of cost

Cost Accounting

It is the process of accounting for costs or the physical process of collecting and recording of expenditure & income, identifying the bases for collecting of information and culminates in preparation of reports and statements that are used for ascertainment and control of costs

Cost Accountancy It is the process of applying

costing and cost accounting principles, methods, techniques and processes to the Science art and practice of Ascertainment of cost for the purpose of analysis and control of cost.

It deals with preparation of MIS reports that form the basis of managerial decision making

Scope and Objective

Of Cost Accounting

Scope

Cost Book Keeping

Cost System

Cost Ascertainment

Cost Analysis

Cost Comparison

Cost Control

Cost Reports

Objectives & Scope

The Primary objective of Cost Accounting is to provide the management with analytical, accurate and reliable reports & information (MIS Report) based on which management can take informed decisions

In a nutshell Cost Accounting is an Aid or tool in the hands of Management which facilitates decision making

Objectives & Scope - 2

Theoretically the objectives are Ascertainment of Cost Determination of Selling Price Cost Control and Cost Reduction Ascertaining the profit of each

activity Assisting Management in Decision

Making

Objectives & Scope - 3 Ascertainment of cost Post Costing Ascertainment of cost based on or by analysing Financial Information is called as post costing, it is helpful in Cost Plus Contracts, wherein the price will have to be determined based on cost plus an agreed rate of profit on cost

Objectives & Scope - 4 Continuous Costing It is a process which aims at collecting costs as and when they are incurred. It’s a process which involves a careful estimation of certain Implied costs such as overheads etc. This system of costing aims at ascertainment of cost of completion simultaneously with the completion of the production/job

Objectives & Scope - 5 Determination of Selling Price Cost of Production is one of the factors for determining the price of a product or service. Cost Accounting helps in determining the Selling Price of a product or Service It is pertinent to note here that the market maxim is “Cost is a fact, Price is a policy”

Objectives & Scope - 6 Cost Control One of the objectives of Cost Accounting is cost control. Once the cost is ascertained the next step is to analyse such costs with a view to exercise control over them by clearly establishing objectives & achieving optimum efficiency and comparing the performance with the objectives set

Objectives & Scope - 7 Cost Reduction It’s defined as achieving real and permanent reduction in the unit cost of manufacturing a product or rendering a service without compromising on either the Quality of the product or impairing the suitability of the product for the intended use

Objectives & Scope - 8 Cost Reduction – Continued It also implies retaining of the essential characteristic features & quality of the product or service. It is achieved through constant innovation and improvisation of processes, so that there is a permanent and real reduction in cost

Cost Control & Cost Reduction

Cost Control Cost Reduction

It maintains cost Aims at achieving lowest possible cost Focuses on past &

Present It is preventive in nature

It has a limited target

Aims at reducing the cost Aims at optimising the

cost by challenging the

practices Focuses on present &

future It is corrective in nature It is a continuous process

Objectives & Scope - 9 Ascertainment of Profit of each activity Since cost information is collected activity wise ascertainment of profit activity wise becomes easier. In financial accounting system it may not be possible to identify the profit of each activity. In fact profit can be ascertained for each activity level.

Objectives & Scope - 10 Assisting Management in Decision Making This is one of the most important & relevant objectives of Cost Accounting. In fact it is the genesis of Cost Accounting. It is this need of the management for reliable and accurate information for basing its decision that gave birth to a separate system of accounting called Cost Accounting

Cost Centre A Cost Centre is defined as a person, location or an item of equipment or a combination of these for which cost is ascertained for the purpose of analysis and control. Cost Centre can be Personal or Impersonal

Cost Unit It is a physical measure or unit of product, Service

or Time or a combination of these for which costs may be ascertained.

The cost unit may differ from product to product and service to service depending on the inherent nature of the product or service or the process

Cost Object Anything for which a separate measurement of cost is intended is called as a cost object. The cost object may be a Product, Service, Project, Customer, an Activity etc A Cost object is used to ascertain the selling price of the Product or Service

Elements of Cost These are akin to heads of account in financial

accounting Elements of cost are those items of cost which form

a significant portion of the total cost, which deserve to be mentioned separately.

In a nutshell elements of cost are those expenses incurred which are separately identified in ascertaining the cost

Cost Accounting System

Installation of a Costing System The prime considerations for installation of a costing

system are Economic Viability i.e. whether the cost incurred on installing a costing system justify the benefits derived there from. Managements attitude towards having a sound MIS. If the management is averse to using an MIS report, then installing a costing

system doesn’t make sense

Factors to be considered Objective Type of Business General Organisation Technical Details Change in Operations Method of Maintenance of Cost Records Information Accuracy Informative and Simple

Essentials of a Good Costing System Informative and Simple Accuracy Support from Management Cost Benefit Precise Information Procedure Trust

Cost Accounting - Relationship

An Intro.

Relationship of Cost Accounting With Financial Accounting, Management Accounting

and Financial Management Cost Accounting is a branch of accounting, while

Financial Accounting aims at preparation and presenting General Purpose Financial Statements, Cost Accounting aims at preparation and presentation of MIS reports which are for the exclusive use of Management.

Relationship Continued Management Accounting Aims at analysing the

Financial Statements and providing inputs to the management based on the analysis and focuses on certain set parameters such as Gross Profit, Operating Margin, etc

Whereas cost accounting is a real time exercise which furnishes information on income & Expenditure as and when it is incurred

Relationship Continued Financial Management aims at maximising the

wealth of an organisation through profit maximisation whereas cost accounting aims at ascertainment of cost for the purpose of Analysis, control and reduction.

To sum up cost accounting is an additional supplementary and indispensible source of information for the management in its decision making process

Classification of Cost On the basis of elements Viz Material Direct & Indirect Labour Direct & Indirect Expenses Direct & Indirect Overheads Production/works/Factory Administration, Selling & Distribution

Classification of Cost continued By Function Prime Cost Factory Cost Cost of Production Cost of Goods Sold Cost of Sales

Classification of Cost continued On the basis of variability or behaviour Fixed Cost Variable Cost Semi variable Cost By Controllability Controllable Cost Uncontrollable Cost

Classification of Cost continued By Normality Normal Cost Abnormal Cost

Lesson Summary

Thank You