Theory Cost and Management Accounting

COST AND MANAGEMENT ACCOUNTINGJeet R.Shah

M.Com , CFP CM

EVOLUTION OF COST ACCOUNTING

� 15th Century – Barter Exchange

� 1494 - Luca Pacioli, an Italian found out the double entry system of accounting

� The period 1880 AD- 1925 saw the development of

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The period 1880 AD- 1925 saw the development of complex product designs and the emergence of multi activity diversified corporations like Du Pont, General Motors etc. It was during this period that scientific management was developed which led the accountants to convert physical standards into Cost Standards, the latter being used for variance analysis and control

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Some Important Definitions

Cost

� Cost can be defined as the expenditure(actual or notional) incurred on orattributable to a given thing.

� In other words, cost is the amount ofresources used for something whichmust be measured in terms of money.

� Chai

Costing

� According Wheldon,

� Costing is classifying, recording, allocation andappropriation of expenses for thedetermination of cost of products or servicesand for the presentation of suitably arrangeddata for the purpose of control and guidanceof management. It includes the ascertainmentof every order, job, contract, process, service

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� Chai of every order, job, contract, process, serviceunits as may be appropriate. It deals with thecost of production, selling and distribution.


Cost Accounting

is defined as, ‘the establishment ofbudgets, standard costs and actual costsof operations, processes, activities orproducts and the analysis of variances,profitability or the social use of funds’.

Cost Accountancy is defined as, ‘the application of costing and costaccounting principles, methods and techniques tothe science and art and practice of cost controland the ascertainment of profitability as well aspresentation of information for the purpose ofmanagerial decision making.’

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Objectives of Cost Accounting

1. To ascertain the cost of production on per unit basis, for example, cost per kg, costper meter, cost per liter, cost per ton etc.

2. Cost accounting helps in the determination of selling price. Cost accounting enablesto determine the cost of production on a scientific basis and it helps to fix the sellingprice.

3. Cost accounting helps in cost control and cost reduction.

4. Ascertainment of division wise, activity wise and unit wise profitability becomespossible through cost accounting.

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4. Ascertainment of division wise, activity wise and unit wise profitability becomespossible through cost accounting.

5. Cost accounting also helps in locating wastages, inefficiencies and other loopholes inthe production processes/services offered.

6. Cost accounting helps in presentation of relevant data to the management whichhelps in decision making. Decision making is one of the important functions ofManagement and it requires presentation of relevant data. Cost accounting enablespresentation of relevant data in a systematic manner so that decision makingbecomes possible.

7. Cost accounting also helps in estimation of costs for the future.

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Essentials of a good Costing system

A. Costing system adopted in any organization should be suitable to itsnature and size of the business and its information needs.

B. A costing system should be such that it is economical and the benefitsderived from the same should be more than the cost of operating ofthe same.

C. Costing system should be simple to operate and understand.Unnecessary complications should be avoided.

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C. Costing system should be simple to operate and understand.Unnecessary complications should be avoided.

D. Costing system should ensure proper system of accounting formaterial, labor and overheads and there should be properclassification made at the time of recording of the transaction itself.

E. Before designing a costing system, need and objectives of the systemshould be identified.

F. The costing system should ensure that the final aim of ascertaining ofcost as accurately possible should be achieved.

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Management Accounting

� The scope of Management Accounting is broader than the scope of cost accounting.

� In cost accounting, as we have seen, the primary emphasis is on cost and it deals with collection, analysis,relevance, interpretation and presentation for various problems of management.

� Management Accounting is an accounting system which will help the Management to improve its efficiency.

� The main thrust of Management Accounting is towards determining policy and formulating plans to achievedesired objectives of management.

� The distinguishing features of Management Accounting are given below.

1. The Management Accounting data are derived from both, the financial accounting and cost accounting.

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1. The Management Accounting data are derived from both, the financial accounting and cost accounting.

2. The main thrust in management accounting is towards determining policy and formulating plans to achievedesired objectives of management.

3. Management Accounting makes corporate planning and strategy effective and meaningful.

4. It is concerned with short and long range planning and uses highly sophisticated techniques like sensitivityanalysis, probability techniques, decision tree, ratio analysis etc for planning, control and evaluation.

5. It is futuristic in approach and predictive in nature.

6. Management Accounting system cannot be installed without proper cost accounting system.

7. Management Accounting systems generate various reports which are extremely useful from the Managementpoint of view.

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The central theme to focus on is this: (1) business value results from good management decisions,(2) decisions must occur across a spectrum of activities (planning, directing, and controlling), and(3) quality decision making can only consistently occur by reliance on information

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What is Strategy?

� Strategy is the creation of a unique and valuable position, involving a different set of activities.

� “The essence of strategy is choosing what not to do.” – Michael Porter

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do.” – Michael Porter

� “Strategy can be viewed as building defensesagainst the competitive forces or finding a position in the industry where the forces are weakest.”

– Michael Porter

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What Creates a Successful Strategy?11


Strategic Positioning

Achieving Superior Performance

� Strategic positioningattempts to achievesustainable competitiveadvantage bypreserving what isdistinctive about a

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distinctive about acompany.

� It means performingdifferent activities fromrivals, or performingsimilar activities indifferent ways.



•It is imperative formanagers to understandthe nature of cost behaviorand how changes involume impactprofitability.•You will begin to thinkabout business models andthe ability (or inability) tobring them to profitabilityvia increases in scale

Taxes etc To build a brandrequires considerable investment with an uncertain payback

Budgets – Financial Plans

Operating Budgets

• A plan must provide definition of the anticipated revenues and expenses of an organization and more.

• These operating budgets can become fairly detailed, to the level of mapping specific inventory purchases, staffing plans, and so forth. .

• The budgets, oftentimes, delineate allowable levels of expenditures for various departments.

• Capital budgets will also reveal the need for capital expenditures relating to new facilities and equipment.

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Capital Budgets

equipment. • These longer term expenditure decisions must be evaluated logically to determine whether an investment can be justified and what rate and duration of payback is likely to occur.

Financial Budgets

• A company must assess financing needs, including an evaluation of potential cash shortages. • These tools enable companies to meet with lenders and demonstrate why and when additional support may be needed.

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Directing

Costing

Job Costing

Batch Costing

Production Analysis


Batch Costing

Process Costing

Activity Based

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•This costing method is used in firms which work on the basis of job work.•The main feature of some organizations is that they produce according to the requirements and specifications of the consumers•Production is only on specific order and there is no pre demand production•The job cost sheet helps to compute the cost of the job in a phased manner and finally arrives the total cost of production

Job Costing

•This method of costing is used in those firms where production is made on continuous basis. •Each unit coming out is uniform in all respects and production is made prior to the demand, i.e. in anticipation of demand. •One batch of production consists of the units produced from the time machinery is set to the time when it will be shut down for maintenance .•The total cost incurred during this period will be divided by the number of units produced and unit cost will be worked out.

Batch Costing

• Process 1 to Process 2 to Process 3 = FG


• Process 1 to Process 2 to Process 3 = FG• In process costing, cost per process is worked out and per unit cost is worked out by dividing the total cost by the number of units

Process Costing

Activity Based Costing

Achitectural firms that design homes

an allocation model can be used to attribute activities to jobs, enabling a reasonable cost assignment.

Such “activity-based costing” (ABC) systems can be used in many settings, but are particularly well suited to situations where overhead is high, and/or a variety of products and services are produced.

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Costing Concepts or Theories-Absorption concept

� Under the absorption concept, a product or service would beassigned its full cost, including amounts that are not easily identifiedwith a particular item.

� Overhead items (sometimes called “burden”) include facilitiesdepreciation, utilities, maintenance, and many other similar sharedcosts.

With absorption costing, this overhead is schematically allocated

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� With absorption costing, this overhead is schematically allocatedamong all units of output.

� In other words, output absorbs the full cost of the productive process.

� Absorption costing is required for external reporting purposes undergenerally accepted accounting principles.

� But, some managers are aware that sole reliance on absorptioncosting numbers can lead to bad decisions.

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Costing Concepts or Theories-Direct Costing

� As a result, internal cost accounting processes insome organizations focus on a direct costingapproach.

� With direct costing, a unit of output will be assignedonly its direct cost of production (e.g., direct

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only its direct cost of production (e.g., directmaterials, direct labor, and overhead that occurswith each unit produced).

� You will study the differences between absorptionand direct costing, and consider how they influencethe management decision process

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Directing

Costing

Job Costing

Batch Costing

Production Analysis


Batch Costing

Process Costing

Activity Based

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Production

� As you would suspect, successfully directing an organizationrequires prudent management of production.

� Managerial accounting provides numerous tools formanagers to use in support of production and productionlogistics (moving goods through the production cycle to acustomer).

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customer).

� To generalize, production management is about running a“lean” business model.

� This means that costs must be minimized and efficiencymaximized, while seeking to achieve enhanced output andquality standards.

� ERP , B2B system , M2M systems

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Responsibility Considerations

� Enabling and motivating employees to work at peak performance is animportant managerial role.

� For this to occur, employees must perceive that their productive efficiencyand quality of output are fairly measured.

� A good manager will understand and be able to explain to others how suchmeasures are determined.

� Your study of managerial accounting will lead you through various related

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� Your study of managerial accounting will lead you through various relatedmeasurement topics. For instance, direct productive processes must besupported by many “service departments” (maintenance, engineering,accounting, cafeterias, etc.).

� These service departments have nothing to sell to outsiders, but areessential components of operation.

� The costs of service departments must be recovered for a business tosurvive. It is easy for a production manager to focus solely on the areaunder direct control, and ignore the costs of support tasks.

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Responsibility Considerations

� Yet, good management decisions require full consideration of the costs of supportservices.

� You will learn alternative techniques that managerial accountants use to allocateresponsibility for organizational costs.

� A good manager will understand the need for such allocations, and be able toexplain and justify them to employees who may not be fully cognizant of whyprofitability is more difficult to achieve than it would seem.

In addition, techniques must be utilized to capture the cost of quality -- or perhaps

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� In addition, techniques must be utilized to capture the cost of quality -- or perhapsbetter said, the cost of a lack of quality.

� Finished goods that do not function as promised entail substantial warranty costs,including rework, shipping (back and forth!), and scrap.

� There is also an extreme long-run cost associated with a lack of customersatisfaction.

� A manager must be held accountable, but to do this requires the ability to monitorcosts incurred and deliverables produced by circumscribed areas of accountability(centers of responsibility).

Jeet R.Shah

Directing

Costing

Job Costing

Batch Costing

Production Analysis


Batch Costing

Process Costing

Activity Based

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Documents

Theory Cost and Management Accounting