Overview of Cost Accounting

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Cost Accounting

Cost accounting involves recording, controlling estimating and reporting for costs.

Cost accounting process begins with the recording of expenditure or the bases on which they are
calculated and ends with the preparation of statements for ascertaining and controlling costs.

Objectives:

The main objectives of Cost Accounting are as follows:

1. Ascertainment of cost.
2. Cost control and cost reduction.
3. Assisting management in decision-making including pricing, profit planning, budgeting.

Advantages
1. Helps in identifying unprofitable activities, losses or inefficiencies in any form.
2. Application of cost reduction techniques, operation research techniques and value analysis
technique.

WHAT IS COST?

COST
Anything incurred during the production of the good or service to get the output into the hands of the
customer. e.g. Material cost, Labour cost, electricity cost, fuel cost etc.

Capitalised Cost: The cost incurred on fixed assets are capitalised cost. E.g. cost incurred to purchase
machineries. These cost are not covered here, except which is subsequently treated as expenses
(depreciation).

Cost Classification
• By elements.
• By function.
• As direct and indirect.
• By variability.
• By controllability.
• By normality.
• By relevance.

By Nature or Element

Under this classification the costs are divided into three categories i.e. material cost, labour cost and
expenses.

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Material
The cost which is incurred on physical substance or thing. e.g. Components or raw materials purchased.
Labour

The cost incurred on human efforts. e.g. Salary, Wages, Bonus, Incentives, Retirement Benefits,
Perquisites.

Expenses
The cost incurred for services. Expenses are other than material and labour are covered here. e.g.
Electricity expenses, Rent, Telephone.

By Function In this classification costs are divided according to the function for which they have been
incurred. E.g. production cost, office & administration cost, selling & distribution costs

Production cost: materials, direct labour, stores overheads etc.

Office & administration cost: cost of formulating policy, directing the organization and controlling the
operations. E.g. Rent of Office, Depreciation of Office equipment’s, Salary to Office staff, Director Fees,
Remuneration to CEO.

Selling and distribution expenses or marketing cost: expenditure incurred generating demand, on moving
articles to prospective customers etc.

DIRECT COST Direct costs are costs which can be easily attributed to a particular cost center/ product.
e.g.- the cost of hard disks while assembling an PC.

INDIRECT COST Cost that must be allocated in order to be assigned to a product or department. This
cannot be assigned directly to any particular cost centre. Eg. Costs incurred by the computer maintenance
and support group, wages paid to security staff, storage cost of units produced.

By Variability According to variability classification cost are classified into three groups viz. fixed, variable
and semivariable.

VARIABLE COST Variable Costs are those costs that vary directly and proportionately with the output.
There is a constant ratio between the change in cost and change in the level of output. Examples Examples
of variable cost are direct wages, direct material, Petrol cost for vehicle.

FIXED COST Fixed Cost is a cost which does not change in total for a given time period despite wide
fluctuations in output or volume of activity. Examples Fixed Cost Examples are rent, property, taxes.

Semi-variable Cost
These costs contain both fixed and variable components and thus partly affected by fluctuation in the
level of activity.

By Controllability
Costs here may be classified as controllable and un- controllable cost. Controllable costs are the cost which
can be influenced by an action of the specified member of the undertaking. Uncontrollable cost are those
which are not controllable. The distinction between controllable and uncontrollable costs is not very
sharp. Infact no cost is uncontrollable; it is only in relation to a particular individual that we may specify a
particular to be either controllable or uncontrollable. For example, expenditure incurred by tool room is
controllable by foreman in- charge of that section but share which is apportioned to machine shop can
not to be controlled by machine shop foreman.

By Normality
According to this basis cost may be categorized as normal Cost and abnormal cost. Normal cost is normally
incurred at a given level of output under the conditions in which that level of output is normally attained.
And cost which is abnormally incurred is called as abnormal cost. e.g. cost of material which is evaporated
is normal loss whereas goods lost by fire or theft is treated as abnormal loss.

By relevance
Relevant costs are those future costs which differ between alternatives. Relevant costs may also be
defined as the cost which are affected and changed by a decision. Sunk costs are all costs incurred in the
past that cannot be changed by any decision made now or in the future. Sunk costs should not be
considered in decisions. e.g. cost incurred on research of a product will be irrelevant while making decision
whether to undertake production or not, in make or buy (the raw materials) decision cost of the material,
wage rate will be relevant on the other hand factory rent will be irrelevant.

DIFFERENTIAL COSTS
Differential cost is the difference between any two alternatives. Differential costs are equal to the
additional variable expenses incurred in respect of the additional output, plus the increase in fixed costs
if any.

OPPORTUNITY COSTS
Opportunity cost is the cost of opportunity lost. It is the cost of selecting one course of action in terms of
opportunity which are given up to carry out that course of action. Opportunity cost is the benefit lost by
rejecting the best competing alternative to one chose. The benefit lost is usually the net earnings or profit
that might have been earned from rejected alternative. For example if we invest 1 lakh in a business then
the opportunity cost would be the amount of interest that money would have earned if it was in bank. An
individual is earning Rs. 2.5 lakhs in year, now if he think to start his own proprietary business of computer
maintenance, his opportunity cost will be 2.5 lakhs per annum.

MARGINAL COSTS
Marginal cost is the extra cost incurred to produce one additional unit

AVERAGE COSTS
Average cost is the total cost to produce a quantity divided by the quantity produced.

PRODUCT COST
Product Cost is the cost incurred to make or manufacture the product and sell it. These are also known as
inventoriable costs. Eg. Direct Material, Direct Labour, Direct Expenses, Power (if Identifiable to product)

PERIOD COSTS
Period Costs are the costs which are charged as expenses against the revenue of the period in which they
are incurred. These costs are not assigned to product/ project, but are treated as expenses of the period
in which they are incurred. Eg. Factory Rent, Security Charges, Maintenance, Factory Manager’s salary.
COST MANAGEMENT

Strategy – is a set of Policies, procedures and approaches to business that produce long-term success
while strategic management involves the development of sustainable competitive position. Strategic cost
management involves the development of cost management information to facilitate the principal
management function which is strategic management.2

Cost management information – is the information that the manager needs to effectively manage the
firm, profit-oriented as well as not-for-profit organization. This includes both financial information about
cost and revenues as well as relevant nonfinancial information about productivity, quality and other key
success factors for the firm or organization.3

Cost management – is the practice of accounting in which the accountant develops and uses cost
management information. For competitive success, it is not enough to emphasize only on financial
information. This could lead manager to stress cost reduction while ignoring or even lowering quality
standards.4

Management Functions and the Needs for Management Accounting Information:5

1. Planning – involves:
a) Setting of immediate, as well as long-range goals for the organization;
b) Predicting future conditions that are expected to prevail;
c) Considering the different means or strategies by which the goals set may be
achieved; and
d) Deciding which of the strategies should be used to attain such goals.

2. Directing and Motivating – involves overseeing the day-to-day activities, seeing to it that the
organization is functioning smoothly and the members of the organization are mobilized to carry
plans.

3. Controlling – involves checking the performance of activities against the plan or standards set and
deciding what corrective actions to take there be any deviation between the actual planned /
standard performance.

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Financial Accounting vs. Cost Accounting

Basis of Difference Financial Accounting Cost Accounting

1. Purpose Tells about the profit and loss Information to managers for
and financial position of planning, operating, control, and
business. decision making.
2. Form of Accounting Meets the requirements of To meet the requirement of the
Financial Reporting Standards. managers.
3. Recording Records the data in a subjective Records the data in an objective
manner (according to the nature manner (according to the
of expenses) purpose which the costs are
incurred)
4. Control Not giving emphasis on the It provides detailed system of
control control
5. Periodicity of Reporting Usually at the end of the given Provides information as and
period when it is desired by the
managers
6. Analysis of Profit Disclose the net profit and loss It discloses the profit and loss of
of the business as a whole each product, job or services.

Importance of Ethical Behavior for Management Accountants

Standards of Ethical Conduct for Management Accountant (From the American Institute of
Management Accountants)6

Management accountants have an obligation to the organizations they serve, their profession, the public,
and themselves to maintain the highest standards of ethical conduct. In recognition of this obligation, the
Institute of Management Accountants, formerly the National Association of Accountants, has
promulgated the following standards and ethical conduct for management accountants. Adherence to
these standards is integral to achieving the Objectiveness of Management Accounting. Management
accountants shall not commit acts contrary to these standards not shall they condone the commission of
such acts by others within their organizations.

COMPETENCE7
Management accountants have the responsibility to:
• Maintain an appropriate level of professional expertise by continually developing knowledge and
skills.
• Perform their professional duties in accordance with relevant laws, regulations, and technical
standards.
• Provide decision support information and recommendations that are accurate, clear, concise ad
timely.

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 • Recognize and communicate professional limitations or other constraints that would preclude
responsible judgment or successful performance of an activity.

CONFIDENTIALITY8
Management accountants have the responsibility to:
• Keep information confidential except when disclosure authorized or legally required.
• Inform all relevant parties regarding appropriate use of confidential information. Monitor
subordinates’ activities to ensure compliance.
• Refrain from using confidential information for unethical or illegal advantage.

INTEGRITY9
Management accountants have the responsibility to:
• Mitigate actual conflicts of interest. Regularly communicate with business associates to avoid
apparent conflicts of interest. Advise all parties of any potential conflicts.
• Refrain from engaging in any conduct that would prejudice carrying out duties ethically.
• Abstain from engaging in or supporting any activity that might discredit the profession.

CREDIBILITY10
Management accountants have the responsibility to:
• Communicate information fairly and objectively
• Disclose all relevant information that could reasonably be expected to influence an intended
user’s understanding of the reports, or recommendations.
• Disclose delays or deficiencies in information, timeliness, processing, or internal controls in
conformance with organization policy and applicable laws.

INTERNATIONAL CERTIFICATIONS11

The three certifications available to management accountants are as follows:

• Certificate of Management Accounting (CMA)
• Certificate in Public Accounting (CPA)
• Certificate in Internal Auditing (CIA)

CMA. A Certified Management Accountant is one who has passed the rigorous qualifying examination,
has met an experience requirement, and participate in continuing educations. The CMA Certificate is
granted by the Institute Management Accountants (IMA).

CPA. A Certified Public Accountant is one who has met the pre-qualification educational requirements,
passed the CPA licensure examinations given the Professional Regulatory Board of Accountancy and has
satisfied all other legal and regulatory requirements of public accountant.

CIA. Since one of the management control responsibilities of the management accountant is to develop
effective systems to detect and prevent errors and fraud in the accounting records, it is common for the

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management accountant to have strong ties to the control-oriented organization such as the Institute of
Internal Auditors (IIA) granting Certification in Internal Auditing (CIA). To attain the status of Certified
Internal Auditor and individual must pass a comprehensive examination designed to ensure technical
competence and have the required number of years of work experience.