Hawassa University College of Business & Economics

Department of Accounting
CHAPTER ONE
INTRODUCTION TO COST AND MANAGEMENT ACCOUNTING
1.1 Meaning of Cost and Management Accounting
Meaning of Cost Accounting
Cost accounting is the process of determining and accumulating the cost of
product or activity. It is a process of accounting for the incurrence and the
control of cost. It also covers classification, analysis, and interpretation of cost.
In other words, it is a system of accounting, which provides the information
about the ascertainment, and control of costs of products, or services. It
measures the operating efficiency of the enterprise. It is an internal aspect of the
organization. Cost Accounting is accounting for cost aimed at providing cost
data, statement and reports for the purpose of managerial decision making. The
Institute of Cost and Management Accounting, London defines “Cost accounting
is the process of accounting from the point at which expenditure is incurred or
committed to the establishment of its ultimate relationship with cost centers and
cost units. In the widest usage, it embraces the preparation of statistical data,
application of cost control methods and the ascertainment of profitability of
activities carried out or planned”.
Costing includes “the techniques and processes of ascertaining costs.” The
‘Technique’ refers to principles which are applied for ascertaining costs of
products, jobs, processes and services. The `process’ refers to day to day routine
of determining costs within the method of costing adopted by a business
enterprise.
Costing involves “the classifying, recording and appropriate allocation of
expenditure for the determination of costs of products or services; the relation of
these costs to sales value; and the ascertainment of profitability”.
Scope of Cost Accounting
The terms ‘costing’ and ‘cost accounting’ are many times used interchangeably.
However, the scope of cost accounting is broader than that of costing. Following
functional activities are included in the scope of cost accounting:
1. Cost book-keeping: It involves maintaining complete record of all costs
incurred from their incurrence to their charge to departments, products and
services. Such recording is preferably done on the basis of double entry
system.
2. Cost system: Systems and procedures are devised for proper accounting for
costs.
3. Cost ascertainment: Ascertaining cost of products, processes, jobs, services,
etc., is the important function of cost accounting. Cost ascertainment
becomes the basis of managerial decision making such as pricing, planning
and control.

Cost & Management Accounting I (Acct 3031) - Handout # 01 - February 2, 2025 Page 1
Hawassa University College of Business & Economics
Department of Accounting
4. Cost Analysis: It involves the process of finding out the causal factors of
actual costs varying from the budgeted costs and fixation of responsibility for
cost increases.
5. Cost comparisons: Cost accounting also includes comparisons between cost
from alternative courses of action such as use of technology for production,
cost of making different products and activities, and cost of same product/
service over a period of time.
6. Cost Control: Cost accounting is the utilization of cost information for
exercising control. It involves a detailed examination of each cost in the light
of benefit derived from the incurrence of the cost. Thus, we can state that
cost is analyzed to know whether the current level of costs is satisfactory in
the light of standards set in advance.
7. Cost Reports: Presentation of cost is the ultimate function of cost accounting.
These reports are primarily for use by the management at different levels.
Cost Reports form the basis for planning and control, performance appraisal
and managerial decision making.
Objectives of cost accounting
There is a relationship among information needs of management, cost
accounting objectives, and techniques and tools used for analysis in cost
accounting. Cost accounting has the following main objectives to serve:
1. Determining selling price,
2. Controlling cost
3. Providing information for decision-making
4. Ascertaining costing profit
5. Facilitating preparation of financial and other statements.
1. Determining selling price
The objective of determining the cost of products is of main importance in cost
accounting. The total product cost and cost per unit of product are important in
deciding selling price of product. Cost accounting provides information regarding
the cost to make and sell product or services. Other factors such as the quality of
product, the condition of the market, the area of distribution, the quantity which
can be supplied etc., are also to be given consideration by the management
before deciding the selling price, but the cost of product plays a major role.
2. Controlling cost
Cost accounting helps in attaining aim of controlling cost by using various
techniques such as Budgetary Control, Standard costing, and inventory control.
Each item of cost [viz. material, labor, and expense] is budgeted at the beginning
of the period and actual expenses incurred are compared with the budget. This
increases the efficiency of the enterprise.
3. Providing information for decision-making
Cost accounting helps the management in providing information for managerial

Cost & Management Accounting I (Acct 3031) - Handout # 01 - February 2, 2025 Page 2
Hawassa University College of Business & Economics
Department of Accounting
decisions for formulating operative policies. These policies relate to the following
matters:
i. Determination of cost-volume-profit relationship.
ii. Make or buy a component
iii. Shut down or continue operation at a loss
iv. Continuing with the existing machinery or replacing them by improved and
economical machines.
4. Ascertaining costing profit
Cost accounting helps in ascertaining the costing profit or loss of any activity on
an objective basis by matching cost with the revenue of the activity.
5. Facilitating preparation of financial and other statements
Cost accounting helps to produce statements at short intervals as the
management may require. The financial statements are prepared generally once
a year or half year to meet the needs of the management. In order to operate the
business at high efficiency, it is essential for management to have a review of
production, sales and operating results. Cost accounting provides daily, weekly or
monthly statements of units produced, accumulated cost with analysis. Cost
accounting system provides immediate information regarding stock of raw
material, semi-finished and finished goods. This helps in preparation of financial
statements
Meaning of Management Accounting
Management Accounting can be defined as the process of identification,
measurement, accumulation, analysis, preparation, interpretation, and
communication of financial as well as non financial information used by
management to plan, evaluate, control within the organization and to assure
appropriate use and accountability for its resources. Management accounting
consists of accounting techniques and procedures of gathering and reporting
financial data in order to meet management’s information needs. The
management accountant is expected to provide timely, accurate information
-.including budgets, standard costs, variance analysis, support day-to-day
operating decisions, and analyses of expenditures. Management accounting
measures and reports financial information as well as other type of information
that assists managers in fulfilling the goals of the organization.
Management accounting enables the organization to understand and identify
weakness in terms of efficiency and quality improvement of its products and
services compared to the major competitors and suggest cost effective
measures to improve organizational flexibility and innovative potential to meet
competitive pressure. As well, it gives the organization the capacity to grow with
minimum volatility in its profitability and performance. The management
accounting system is a cost control system as well as a tool for planning and
controlling operations and suggests solutions to improve organizational

Cost & Management Accounting I (Acct 3031) - Handout # 01 - February 2, 2025 Page 3
Hawassa University College of Business & Economics
Department of Accounting
efficiency and productivity of the organization as a whole. It also gives the
manager the importance of non financial factors, which can be crucial factor that
determines the innovative capacity of the organization particularly, the human
factor in all organizations. Therefore, it is important to design a management
accounting system to be profitable in short term as well as in the long term in a
dynamic and unpredictable global market. Specifically, the followings are some
of the purposes of Management accounting:
 Formulating over all strategies and long range plans
 Resource allocation decision such as product and customer emphasis
pricing.
 Cost planning and cost control operations and activities.
 Performance measurement and evaluation.
1.2 Functions of the Management Accountant
Management accountant provides a staff function. He/she gives advice and
assistance to line managers. Management accountants contribute to the
company’s decision about strategy, planning and control by Scorekeeping,
Attention directing, and Problem solving.
1. Score keeping function- is a function of accumulating data and reporting
reliable result to all levels of the management describing how the organization is
doing and how well it is implementing its strategies. The collection, classification,
and reporting of scorekeeping information is the task that dominates day to day
accounting. The followings are some of the scorekeeping functions an
accountant will provide.
 Recording sales, purchase and payroll data
 Preparing financial reports
 Preparing depreciation schedules
2. Attention directing function: is reporting and interpreting information that
helps managers to focus on operating problems, imperfections, inefficiency and
opportunities. This aspect of accounting helps managers to concentrate on the
importance of operation promptly enough for effective action. Attention
directing is commonly associated with current planning and control, and with the
analysis and investigation of recurring routine internal accounting reports. What
opportunities and problems should managers focus on? Making visible both
opportunities and problems on which managers need to focus. For example, the
followings are attention directing functions provided by an accountant.
 Highlighting rapidly growing market opportunity
 Variance analysis and interpretation
 Explaining performance report
3. Problem solving function: The problem solving aspect of accounting
quantifies the likely results of possible courses of action and often recommends

Cost & Management Accounting I (Acct 3031) - Handout # 01 - February 2, 2025 Page 4
Hawassa University College of Business & Economics
Department of Accounting
the best course to follow. Problem solving is commonly associated with non
recurring decisions, situations that require special accounting analysis or report.
Comparison and analysis to identify the best alternatives in relation to the
organizations objectives is a problem solving function. The followings are some
of the decision area in which the management accountant gives problem solving
function.
 Make or buy decision
 Add or drop decision
 Sell at split off or process further decision
Scorekeeping is a general purpose data collection function without knowing
whether the data is used for internal or external reporting. However, the
scorekeeping and attention directing functions are closely related. The same
information may serve as scorecard function for a manger and an attention
directing function for the managers’ superior.
The accounting or finance department in an organization is usually lead by a
finance officer. A finance officer is a senior officer empowered with overseeing
the financial operations of an organization. If the organization is large, the
finance officer can be supported by a controller and a treasurer both of whom are
usually accountants. A controller is responsible for preparing the information and
report used in both managerial and external reporting where as the treasurer is
concerned mainly with the company’s financial matters. The following table
summarizes the roles and responsibilities of the Controller and the Treasurer
Controller Treasurer
 Planning & control  Provision of capital
 Reporting and interpreting  Investors relation
 Evaluating and consulting  Short term financing
 Government reporting  Banking and custody
 Tax planning and administration  Credits and collections
 Protection of assets  Investment
 Economic appraisal  Risk management and insuranc

1.3 Financial, Cost and Management Accounting

Accounting system takes economic events and transactions, such as sales and
purchases, and processes the data into information helpful to managers, sales
representatives, production supervisors and others. Processing any economic
transaction means collecting, categorizing, summarizing and analyzing. For
example, costs are collected by category, such as materials, lobar and overhead.
These costs are then summarized to determine total cost by month, quarter, or
year. The results are analyzed to evaluate, say, how costs have changed relative
to revenue from one period to the next. Managers use this information to
administer the activities or functional areas they oversee and to coordinate those

Cost & Management Accounting I (Acct 3031) - Handout # 01 - February 2, 2025 Page 5
Hawassa University College of Business & Economics
Department of Accounting
activities or functions within the frame work of the organization.
Individual managers often require the information in an accounting system to be
presented and reported differently. Consider, for example, sales order
information. A sales manager may be interested in the total birr amount of sales
to determine the commission to be paid. A distribution manager may be
interested in sales order quantities by geographical regions and by customers
requested delivery dates to ensure timely delivery. This indicates that the
financial information required by different bodies is not the same.
Financial accounting includes all the principles that regulate the accounting and
reporting for financial information that must be disclosed to people outside the
company, to stockholders, bankers, creditors, and brokers. In contrast,
management accounting exists primarily for the benefit of those inside the
company, the people who are responsible for its operations.
Management and financial accounting have differing goals. Management
accounting measures analyzes, and reports financial and non financial
information that helps managers make decision to fulfill the goals of an
organization. Managers use management accounting information to choose,
communicate, and implement strategies. They also use management accounting
information to coordinate product design, production, and marketing.
Management accounting focuses on internal reporting. Financial accounting
focuses on reporting to external parties such as, investors, government agencies,
banks and suppliers. It measures and records business transactions and
provides financial statement that are based on Generally Accepted Accounting
Principles (GAAPs). A manager’s compensation can be affected by the numbers
in this financial statement. Consequently, managers are interested in both
management accounting and financial accounting.
Many of the procedures and principles that stem from financial accounting can
also apply to management accounting. Depreciation techniques, cash collection
and disbursement procedures, inventory valuation methods, and the recognition
of what is an asset or a liability are all essential to the study of management
accounting. The reports such as balance sheet, income statement and statement
of of cash flow are common to both management accounting and financial
accounting. But, because their output is communicated to different audiences for
different reasons, financial accountants and management accountants follow
different rules. The rules of management accounting are somewhat less defined
and place fewer restrictions on the accountant’s day-to-day activities where as
financial accounting strictly follows GAAP. The following table summarizes the
major difference between Management accounting and financial accounting.
Areas of
Financial Accounting Management Accounting
Comparison

Cost & Management Accounting I (Acct 3031) - Handout # 01 - February 2, 2025 Page 6
Hawassa University College of Business & Economics
Department of Accounting
1. Primary users of Persons and organizations outside Various levels of internal
information the business entity management
2.Purpose of the Communicate organization’s financial Help managers make decisions to
Information and operating information to fulfill an organizations goal
investors, banks, regulators and other
outside parties
3. Types of Double entry system Not restricted to double entry
accounting systems system; any useful system can be
used
4. Restrictive Adherence to GAAP No formal guidelines or restrictions,
guidelines only criterion is usefulness

5. Units of Historical (past) Monetary unit Any useful monetary (historical and
measurement future) or physical measure such as
machine hours, labor hours etc
6. Focal point for Business entity as a whole Various segments of the business
analysis entity.

7.Report Summarized report; concerned Detailed report; concerned about

primarily with the entity as a whole details of parts of the entity’s
products, departments, territories
8. Frequency of Periodical on a regular basis When ever needed; may not be on a
reporting regular basis

9. Degree of Demands objectivity; historical in Heavily subjective for planning

objectivity nature purposes, but objective data are
used when relevant and future in
nature.

Cost accounting is an accounting information system that records, measures

and reports information about cost. Every business operates with the objective of
making profit for its owners, which is revenue generated less cost of producing
that revenue. Cost accounting deals with accumulating cost of manufacturing a
product and other functional processes and identifying these costs with units
produced or some other cost object to enable the determination of profit. Cost
Accounting measures and reports financial and other information related to the
organization’s acquisition or consumption of resource. Cost accounting can be
applied in any type of organization but primarily applied in manufacturing
organization that combine and process raw material in to finished product.
Cost accounting provides information for both management accounting and
financial accounting. Cost accounting is required everywhere cost information
needs to be collected or analyzed. Cost information is required for financial
accounting to determine the cost of goods manufactured or sold and operational
costs while preparing the income statement and to determine the value of
inventories on the balance sheet. Management accounting requires cost

Cost & Management Accounting I (Acct 3031) - Handout # 01 - February 2, 2025 Page 7
Hawassa University College of Business & Economics
Department of Accounting
information to set product price, to identify potential areas that could be taken
care of, or area of possible cost reduction and the like. Hence, cost accounting is
important for both financial accounting and management accounting. It is a
subfield of managerial accounting that interfaces with both managerial and
financial accounting.
Classifications of Cost
There are several standard cost classifications and each classification has its
own unique terminology. In this subunit, we present a comprehensive list of ways
costs may be grouped, the concepts underlying each, and the terminology
commonly used. Remember that the same cost may be included in several or in
all of the following classifications.
1. Time Period for Which the Cost is computed
Time can be broadly classified in to past and future. Costs can also be classified
according to these time periods. Historical costs are those costs that were
incurred in past period. Future costs, generally called budgeted costs, are those
costs that are expected to be incurred in the future period. For example, the
Br.8,000 cost of a computer acquired in 2008 is a historical cost in the financial
statement of 2009. How ever, the Br.10, 000 cost to acquire a new computer in
2011 to replace the existing computer is a future cost.
2. Management Function
An organization may be separated into functional areas. A manufacturing
company’s functional areas generally include manufacturing, marketing, and
general administration. One individual, such as a vice president of manufacturing
or a vice president of marketing, has primary responsibility for a specific
functional area. To evaluate the effectiveness of the functional area and the
individual in charge of it, costs also must be grouped by functional area as
follows.
 Manufacturing Costs - include costs from the acquisition of raw materials
through production, until the product is turned over to the marketing
division to be sold. Manufacturing costs include the cost of the raw
materials, payroll costs for people working on the product, and incidental
costs such as taxes, power, depreciation, and repairs associated with
manufacturing the product.
 Selling Costs - are all costs associated with marketing and selling a
product. They include all costs incurred by the marketing division from the
time the manufacturing process is complete until the product is delivered
to the customer. These costs include advertising, promotional offers,
freight to deliver the product, and warehouse costs while the product is
waiting to be sold.
 Administrative Costs are all costs associated with the management of the

Cost & Management Accounting I (Acct 3031) - Handout # 01 - February 2, 2025 Page 8
Hawassa University College of Business & Economics
Department of Accounting
company and include expenditures for accounting, legal, and
administrative activities. Interest costs are also included among
administrative costs.
3. Generally Accepted Accounting Treatment
The alternatives in accounting for a cost are to expense it or to capitalize it.
 Periodic Costs are costs that are expensed in the period in which they are
incurred. Periodic costs possess no future benefit and are generally
associated with a non-manufacturing area of the business. Examples of
periodic costs include advertising, Interest, president’s salary and sales
commissions.
 Product Costs consist of all costs associated with the manufacturing
function of the business. They include materials, labor, and 0ther factory
overhead costs associated with assembling and processing the units.
Because the company still holds the product and its usefulness has not
yet expired, it is not appropriate to expense these costs. They are
capitalized as inventory and held as unexpired until they are sold.
 Capital Costs are similar to product costs in that they are also capitalized
as assets. However, capital cost is the term used to describe the
equipment, building and land held permanently for making business.
These items are capitalized as tangible fixed assets and are depreciated
over their useful lives. Product costs are reserved for inventorable costs
associated with the manufacturing process
4. Traceability to Products
From traceability point of view, cost is divided in to direct and Indirect cost:
 Direct Cost: is a cost that can be economically traced to a single unit of
finished product. For example; direct material & direct labor are direct costs
 Indirect Cost: is one that is not directly traceable to the manufactured
product.It is associated with the manufacture of two or more units of
finished product, or is an immaterial cost that cannot be economically traced
to single units of finished product. For example: Cost of electricity,
Depreciation of equipment, indirect labor, indirect material, Cost of different
utilities, Cost of repair and maintenance, Insurance for the factory are indirect
costs.
A comparison of the labor cost of an assembly worker and a repair person in a
cabinet shop will illustrate the difference between a direct and an indirect cost.
The assembly worker’s salary is typically classified as a direct cost because, it is
a significant portion of the cabinet’s total cost and because it is easy to trace the
assembly worker’s efforts to a particular set of cabinets. The machine repair
person’s salary would probably be classified as an indirect cost because; it is
difficult or impossible to trace that individual’s efforts to a unit of output. The
repairperson is responsible for keeping all machines running properly. Since he

Cost & Management Accounting I (Acct 3031) - Handout # 01 - February 2, 2025 Page 9
Hawassa University College of Business & Economics
Department of Accounting
or she work on several machines and the machines work on several different
cabinets each day, we cannot trace this person’s salary to a particular set of
cabinets. The lack of traceability requires that it should be classified as an
indirect cost. The economics of tracing a cost to a particular unit of finished
product is an important distinction between direct costs and indirect costs. Take
a table that requires a few screws and a little glue to complete the assembly.
Both of these items can be traced to a particular unit of finished product and
would, therefore, qualify as direct costs. However, these items are usually
classified as indirect costs if their amounts are immaterial when compared to the
other materials going into the product. Also, the cost involved in tracing and
recording the items as direct costs would be greater than the benefit of having
that information.
5. Cost Behavior
Cost behavior describes how a cost changes with time or with changes in
volume. Variable costs are costs that vary proportionately in total as the volume
of production or sales changes. For example, if it takes Br.100 of lumber to make
one unit of table and if five units are produced, the total cost of the lumber is Br.
50. The total variable cost increases in proportion with the number of unit’s
produced, but the cost of each unit remains the same. Fixed cost remains
constant in amount as volume of production or sales changes. Straight-line
depreciation on a plant asset is an example of a fixed cost. The amount of
depreciation is the same regardless of the number of units produced.
6. Decision Significance
A decision involves making choices among alternative courses of action. The
decision maker generally collects cost information to assist in making the
decision. Relevant cost is future costs that differ with the various decision
alternatives. They are costs that make a difference in a decision-making process.
Irrelevant Costs do not relate to any of the decision alternatives, are historical in
nature or are the same under all decision alternatives. Irrelevant costs are
generally excluded from the analysis.

7. Managerial Influence
Managerial influence refers to the ability of a manager to control a particular cost.
Remember that all costs are controlled by some one at some level in the
organization if the time period is long enough. However, when we see for a
particular manager at a particular level in the organization and for a short period
of time, there are some costs that can be influenced and some that cannot.
Controllable costs are subject to significant influence by a particular manager
within the time period under consideration. Uncontrollable costs are those costs

Cost & Management Accounting I (Acct 3031) - Handout # 01 - February 2, 2025 Page
Hawassa University College of Business & Economics
Department of Accounting
over which a given manager does not have a significant influence.
8. Commitment to Cost Expenditure
Commitment to a cost expenditure focuses on fixed costs as opposed to
variable costs and on budgeted costs as opposed to historical costs. Budgeted
fixed costs can be broadly classified as committed costs and discretionary costs.
Committed cost is one that is an inevitable consequence of a previous
commitment. Property tax budgeted for the coming year is an example of a
committed cost. Suppose top management made the decision two years ago to
construct a new warehouse. After it was completed, the tax commission placed
an assessed value on it, and a property tax notice is now recapped annually
according to the tax law. The property tax must be paid or the warehouse will be
seized by the tax authority and sold to cover the unpaid taxes. Property tax is a
committed cost that resulted from the decision to construct the warehouse.
Discretionary Cost, also called a programmed cost or a managed cost, is one for
which the amount or the time of incurrence is a matter of choice. There are some
nonrecurring costs for which a final commitment has not yet been made and that
can be postponed until a future period or cancelled entirely. Replacing the carpet
in the demolished offices and repainting the walls of the factory are examples of
discretionary costs where the right timing is a matter of judgment. Even though
the carpet is beginning to show some wear, it could continue to be used for
several months without any interruption to normal operations.
9. Other Cost Classifications
Several other cost classifications are frequently used in discussing cost
accounting and management decisions. Their primary usefulness is in helping to
place correct perspective of the potential benefit of a possible course of action.
These classifications include marginal costs, out –of –pocket costs, sunk costs,
and opportunity costs.
Marginal Costs, also called incremental costs, are the costs that are associated
with the next unit or the next project. The term marginal cost is widely used in
economics to refer to the added cost associated with the production of an
additional unit of output.
Out- of – Pocket Cost: is a cost that must be met with a current expenditure.
Generally an out – of – pocket cost is a cash expenditure associated with a
particular decision alternative.
Sunk Costs: are defined as past costs that have already been incurred. Because
sunk costs are historical costs, they are generally irrelevant to decisions
affecting the current or future use of the asset.
Opportunity Cost: is defined as the cost or value of an opportunity forgone
when one course of action is chosen over another. Opportunity cost is not an out-
of –pocket cost, or even a future cost associated with the selected alternative,
but represents the lost opportunity associated with each of the alternatives that

Cost & Management Accounting I (Acct 3031) - Handout # 01 - February 2, 2025 Page
Hawassa University College of Business & Economics
Department of Accounting
are rejected.
MEANING AND DEFINITION OF STANDARD COSTING
Standard: The word ‘Standard’ means criterion. Standard is a predetermined
measurable quantity, under defined set conditions.
Standard Cost: Standard cost is a scientifically pre-determined cost, which is
arrived at assuming a particular level of efficiency in utilization of material, labour
and indirect services.
When the actual figure is compared against standard, one can measure the level
of efficiency achieved by seeing how much actual differs from the standard.
When costing is used for the purpose of cost control, the technique is known as
standard costing.
Through the standard costing system, management is able to control the
variances in materials, labor and controllable expenses on quantity, efficiency
and cost basis (in terms of money).
Standard costs are, widely, used as they serve as an effective management tool
for control.
Standard costing is a managerial device to determine efficiency and
effectiveness of cost performance.
Definition: The costing terminology of the institute of cost and management
accounts, London defines standard costing as“Standard costing is the
preparation of standard costs and applying them to measure the variances from
actual costs and analyzing the causes of variations, with a view to maintain
maximum efficiency in production”.
Standard cost has also been referred to a cost plan for a single unit. This thinking
is not merely an estimate or guess work. It is based on certain assumed
conditions of efficiency, economic and other factors.
When we break the definition, the technique of Standard costing can be broken
into the
following:
1. Determination of standard costs under each element of cost-material, labour
and overheads. In other words, preparation of standard cost sheet is the first
step.
2. Finding out the actual costs.
3. Comparison of the actual costs with standard costs to ascertain and measure
variances.
4. Analyze the variances.
5. Presentation of information to the appropriate levels of management for
remedial action to control costs for achieving improved or better performance.
Industries where standard costing is applied: Standard costing can be applied in
industries producing standardized products, which are repetitive in character.
Examples are fertilizers, bricks, sugar, cement etc.
In job industries, it is not worthwhile to develop and employ a full system of
standard costing. In such industries, jobs undertaken are different from one
another. Setting standards in such job industries may be expensive.
Implementation partial standard costing in such industries is a better idea.
Certain processes or operations may be repetitive and introduction of standard

Cost & Management Accounting I (Acct 3031) - Handout # 01 - February 2, 2025 Page
 Hawassa University College of Business & Economics
Department of Accounting
costing can be applied only to those areas.

STEPS INVOLVED IN IMPLEMENTING STANDARD COSTING

The following are the steps involved in standard costing for achieving the
planned results and efficiency:
(A) Determination of standard cost
(B) Recording of actual cost
(C) Comparison of standard cost and actual cost
(D) Finding out reasons for variance
(E) Reporting variance to the concerned for corrective action
UTILITY OF STANDARD COSTING
The system of standard costing is useful in all types of industries. But, it is
more, commonly, used in industries producing standardized products, which are
repetitive in nature. So, standard costing is more, widely, applied in process and
engineering industries. Examples of industries, where standard costing can be
usefully employed are: bricks, cement, fertilizers, paper, electronic lamps, sugar
and tobacco products etc.
Standard costing is a valuable aid in cost control.
In jobbing industries, jobs differ from each other in their nature. It is not possible
to apply standard costing in jobbing industries because each job undertaken is
different and setting standard for each job may be difficult.
The product in such industries may not be of a repetitive nature. Still, there are
several operations or processes in the jobbing industries, which are of a
repetitive nature or character. Standards can be set up for such repetitive-nature
of operations or processes. In this way, the benefit of standard costing can be
derived, even, in jobbing industries.
PRELIMINARIES FOR ESTABLISHMENT OF STANDARD COSTING
Standard costing is the most effective method available for controlling
performance and cost. The following preliminaries are necessary for the
establishment of standard costing:
(A) Study of Technical Aspects of Factory
(B) Organization Chart
(C) Establishment of Cost Centers
(D) Setting Right Standard
(E) Allocation and Apportionment of Overheads
(F) Training to Staff
It also pre-supposes there would be no power failures and breakdown in
machinery.
(A) Study of Technical Aspects of Factory: This involves study of various
methods of manufacture and different processes, involved. For setting the right
standard, understanding the process and ascertaining previous years’ defectives
and costs incurred for their rectification is very important. Previous years’
records are to be studied, carefully, to understand the normal efficiency in each
production process.
Study of the technical aspects of the factory is very important since standard

Cost & Management Accounting I (Acct 3031) - Handout # 01 - February 2, 2025 Page
Hawassa University College of Business & Economics
Department of Accounting
cost should be based on the actual situation in the factory and the areas of
improvement that can be expected in the existing conditions.

(B) Organization Chart: Lines of authority and responsibility have to be, clearly,
defined so that responsibility may be assigned, as and when required.
(C) Establishment of Cost Centers
A cost center is a location, person or item of equipment at which costs may be
gathered, ascertained and used for the purpose of cost control.
Costs can be gathered at the stage of each machine for control.
Establishment of cost center is necessary for fixing responsibilities for
unfavorable variances for corrective action and rewarding, where favorable
variances are shown.
(D) Setting Right Standard: Setting right standard is a big challenge. The
challenge set should be attainable and should give the spirit and enthusiasm
to achieve to all the staff in the organization. Different firms may fix different
standards. Even the same firm may fix different standards at different periods
of time. This is due to change in circumstances.
VARIANCE ANALYSIS
The Institute of Cost and Management Accountant terminology defines a
variance as “the difference between a standard cost and the comparable cost
incurred during a given period”. Variance is the difference between the actual
and standard fixed. Variance may be related to materials, labour and
overheads. Overheads relate to indict materials, indirect labour and other
expenses such as insurance, lighting, rent etc. Once the difference is found
out, the reasons are to be analyzed.
Finding out the difference between the standard and actual cost component
and analyzing the reasons for the difference is called variance analysis.
Purpose of Variance Analysis: Variance analysis is the process of analyzing
variances by subdividing the total variance in such a manner that the
management can assign responsibility for the departure from the standard
performance. Variance analysis is the foundation for Standard Costing.
The purpose of variance analysis is to enable the management to improve
operations, increase efficiency, utilize resources more effectively and
reduce cost.
Standard costing is very important in controlling the performance to achieve
planned profits. There are a number of reasons which give rise to variances and
the analysis will help to locate the reason and person or department responsible
for it. For the purpose of control, the reasons of variance must be calculated
immediately, causes must be inquired into and remedial measures are, quickly,
taken.
The deviation of total actual cost from total standard costs is known as total
cost variance. Analysis of variances may be done in respect of each element of
cost and sales namely
1. Direct Material Variances.
2. Direct Labour Variances.
3. Overhead Variances.

Cost & Management Accounting I (Acct 3031) - Handout # 01 - February 2, 2025 Page
Hawassa University College of Business & Economics
Department of Accounting
4. Sales Variances.
Favorable and Unfavorable Variance
When actual cost is less than the standard cost or actual profit is greater than
the standard profit, it known as Favorable Variance or Credit Variance.
When actual cost exceeds standard cost, it is called Unfavorable or Adverse
Variance or Debit Variance.

Cost Concepts and Terminologies

The following are some of the terms and concepts used in cost accounting
Cost, Expense and loss
One of the common confusion in accounting is the distinction between cost and
expense. Many people use cost and expense interchangeably. Thus, we start with
the definition of these terms.
Accountants usually define cost as resource sacrificed or forgone to achieve a
specific objective. It refers to an outlay or expenditure of money to acquire goods
and services in the course of generating revenue. For instance purchase of raw
martial represent a cost as the raw material is used to produce finished goods
that generate revenue when sold. However some disbursements are not costs.
For example, payment of dividend is disbursement but it does not help to
generate revenue, hence it is not a cost.
All costs initially represent an asset. As the asset is used in generating revenue,
the amount consumed becomes an expense.
The cost of the asset used should then be recognized as an expense to properly
match revenues and expenses in the process of determining the income of the
organization over a given period. For instance, insurance premium paid in
advance to serve the coming period are initially recognized as an asset (prepaid
insurance), but as time passes on, the asset is continually converted in to an
expense (Insurance expanse). Another example may be a motor vehicle bought
for use for the coming five years is an asset when initially purchased. However,
as the asset is used up in the process of generating revenue, the cost gradually
becomes an expense. Thus, expenses are expired costs or costs used up in the
course of generating revenue.
The distinction between cost and expenses is important for the preparation of
financial statement for service, merchandising and manufacturing firms. In fact,
it has more importance relatively for manufacturing enterprise. This is because,
costs incurred in the manufacturing process don’t become expense until the
product is sold and thus, items that are fully or partially manufactured represent
costs and should be recognized as assets on the balance sheet. Therefore,
financial reporting in manufacturing firms has some complication as compared
to financial reporting in the service and merchandising business.

Cost & Management Accounting I (Acct 3031) - Handout # 01 - February 2, 2025 Page
Hawassa University College of Business & Economics
Department of Accounting
Sometimes, a firm may incur a cost that produces neither immediate nor future
benefit. This is called a loss. For example damage caused by fire or flood on
property held is a loss.
Cost object: is anything for which a separate measurement of cost is desired. In
manufacturing company, the cost object is the unit of finished goods
manufactured.
Cost Accumulation and cost Assignment: A costing system typically account for
costs in two basic stages, accumulation followed by assignment. Cost
accumulation is the collection of cost data in some organized means of
accounting system and cost assignment is a general term that encompass both
(1) tracing accumulated cost that have direct relationship to the cost object and
(2) allocating accumulated costs that have an indirect relationship to the cost
object. For example, a publisher that purchase paper rolls for printing magazines
collect the cost of paper bought and used in any one month to obtain the total
monthly cost of paper used. Beyond accumulating costs, the cost accountant
assign cost to the different magazines the publisher publish to help decision
making
Cost driver: is any factor that affects total cost. That is a change in the cost
driver will cause a change in the level of the cost of a related cost object. For
example, the following are some of the cost drivers used for each types of costs
mentioned.
 Mile driven for transport cost
 Length of time of call for telephone cost
 Metric cube of water consumed for water cost
 Unit sold for cost of goods sold
Cost management: cost management is the essence of cost accounting. Cost
management refers to the planning and execution of activities both in the short
run and long run to control costs. Profoundly, cost management is about cost
reduction but it is not confined to it alone. Some times managers may incur
additional costs in order to increase their future sales. This activity is also a cost
management. It is the set of actions that a manager takes to satisfy customers
while continuously reducing and controlling cost. Cost reduction efforts
frequently focus on two key areas:
 Doing only value adding activities, that is, those activities that customers
perceive as adding value to the product or service they purchase
 Efficiently managing the use of the cost drivers in the value adding
activities.

Cost & Management Accounting I (Acct 3031) - Handout # 01 - February 2, 2025 Page