NAME SURNAME

Cost and Management

Accounting

Dr. Sachin Mittal

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 It is an interesting but quite challenging world!

Welcome to the world of Cost & Management

Accounting 3
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What is the motivating force for me?
Why Cost and
Management
Accounting?
NOW, LET’S
LOOK AT
SOME OF THE
CHALLENGES
…

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READ &
THINK!!!

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What do you think?

What is the most

important job of a
CFO in a Company?

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Mc Donald, a burger fast food restaurant, incurs the
following costs:

a. Cost of oil for deep fryer

b. Wages of the counter help who give customers the food they order
c. Cost of the television commercials
d. Cost of the children’s toys free with kids’ meal
e. Cost of the promotional posters
f. Cots of the frozen onion and French fries
g. Salary of the food specialists who create new varieties
h. Cost of the additional services to customers

Classify each of the items of the value chain

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Financial Accounting
The art of recording, classifying and summarizing in a significant manner and in
terms of money, transactions and events, which are in part at least, of a
financial character and interpreting the results thereof.

Financial Accounting is summarized in the following three statements at the end

of the period generally one year:

• Profit and Loss Account

• Balance Sheet
• Cash flow Statement
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Limitations of Financial Accounting

1. Shows only overall performance 7. No analysis of losses
Does not furnish classified data in terms of products, processes, Does not analyses losses due to idle time, plant idle capacity,
sales territories, departments etc. inefficient labor, sub- standard material, etc. Thus exact cause of
losses are not known.
2. Historical in nature
Data is summarized only at the end of the accounting period. 8. Inadequate information for price fixation
There is no system of computing day to day cost. Costs are not available as an aid in determining prices of products,
services or production orders.
3. No performance appraisal
No norms to appraise the efficiency of use of material, labor by 9. No cost comparison
comparing actual to industry standards. Does not provide data for comparison of costs of different periods,
different jobs or departments, sales territories etc.
4. No material control system
To track losses in the form of obsolescence, deterioration, 10. Fails to supply useful data to management
excessive scrap, misappropriation etc. For taking various decisions like replacement of labor by machines,
introduction of new products, make or buy, operate or shutdown,
5. No labor cost control selection of the most profitable product mix, etc.
No system of recording labor idle time. Labor cost is not recorded
by jobs, processes or departments.

6. No proper classification of costs

Cost are not classified into fixed and variable, controllable and
uncontrollable, direct and indirect. These help in management
decision making.
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Cost and Management Accounting

Management accounting measures, analyzes, and
reports financial and nonfinancial information that helps
managers make decisions to fulfill organizational goals.
Management accounting need not be GAAP compliant.

Cost Accounting measures, analyzes and reports

financial and nonfinancial information related to the costs
of acquiring or using resources in an organization.
 Cost Accounting and its Features
A specialized application of general principles of accounting in order to
ascertain the cost of producing and marketing any unit of manufacture or of
carrying out any particular job or contract.

Objectives are:
• Ascertainment of cost
• Cost control and cost reduction
• Guide business policy
• Determining selling price

1. Calculating the cost of products, services, and other cost objects

2. Obtaining information for planning & control, and performance
evaluation
3. Analyzing the relevant information for making decisions
 Major Differences
Management Accounting Financial Accounting
Purpose Decision making Communicate financial position to outsiders
External users – investors, banks, suppliers,
Primary Users Internal managers
govt.
Focus/Emphasis Future-oriented Past-oriented
Voluntary maintenance except certain industries Companies Act and Income Tax Act
Rules
wherein its obligatory. compliant
Ultra current to very long
Time Span Historical monthly, quarterly reports
time horizons
Indirect effects on
Behavioral Issues Designed to influence employee behavior
employee behavior
Analysis of cost & profit For each product, process, department For business as a whole

Control Aspect Emphasis on detailed system control Emphasis on recording transactions

Format of presenting Lacks uniform format, tailored as per
Uniform format
information management requirement

Special purpose statements and reports like

P & L A/c, Balance Sheet, Cash flow
Types of statements prepared Report on loss of material, Idle time report,
statement
Variance report, etc.
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Cost & Cost Centre

Cost is the measurement, in monetary terms, of the amount of resources used
for the purpose of production of goods or rendering of services.

Cost Centre is a location, person or item of equipment (or a group of these) for
which cost may be ascertained and used for the purpose of control.

❖ Personal cost centre: person or a group of persons

❖ Impersonal cost centre: location or an item of equipment or group of these
❖ Production cost centre: actual production takes place like weaving department in a textile mill, melting shop in a
steel mill, cane crushing shop in a sugar mill etc.
❖ Service cost centre: these are ancillary to and render services to production cost centre like power house, tool
room, stores department, repair shop, canteen etc.

Cost Unit of product or service in relation to which cost are ascertained

Units of production: ream of paper, a tone of steel, a meter of cables, etc.
Units of service: passenger miles, cinema seats, consulting hours, etc.
 Cost Object

Anything of interest for which cost may be desired. A manager may want to
know the cost of a particular ‘thing’ and such a ‘thing’ is called a cost object.

Cost Object Illustration

Product Honda City car
Service Dealer-support telephone hotline
Enhancement of ERP system implementation at shop floor
Project

Sai Motors, a dealer that purchases a broad range of Honda

Customer
vehicles
Activity Setting up production machines
Department Purchase of ancillary spare parts
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Direct & Indirect Costs

• Traceability is the ability to assign a cost to a cost object in an economically
feasible way by means of a cause-and-effect relationship.

• Direct costs – can be conveniently and economically traced (tracked) to a

cost object.
E.g. cost of steel used in manufacturing a machine, wages paid to tailor in a readymade garment company to stitch a
trouser can be easily identified in the cost of that garment.

• Indirect costs – cannot be conveniently or economically traced (tracked) to a

cost object. Instead of being traced, these costs are allocated to a cost
object in a rational and systematic manner.
E.g. rent of a building, nails used in furniture, sewing thread, etc.
Cost Behavior
●Variable costs: Changes in total in proportion to changes in the related level of activity or
volume
Variable costs are constant on a per-unit basis. If a product takes Rs.5/gm of
materials each, it stays the same per unit regardless of one, ten or a thousand
units are produced

●Fixed costs: Remains unchanged in total regardless of changes in the related level of
activity or volume
Fixed costs – change inversely with the level of production. As more units are
produced, the same fixed cost is spread over more and more units, reducing the
cost per unit

●Semi variable or Semi fixed: Remains fixed up to a certain level of activity

■E.g. telephone expenses, light and power etc.

Costs are fixed or variable only with respect to a specific activity or a given time period
Cost Behavior Summarized

Total Rupees Cost Per Unit

Change in Unchanged in
Variable Costs proportion with relation to output
output
More output = More cost

Change inversely
with output
Fixed Costs Unchanged in More output = lower cost
per unit
relation to output
Other types of cost

❖ Sunk Cost: Cost that has already been incurred and cannot be recovered. When
you make a decision in the future, sunk costs must be avoided in this decision.

❖ Opportunity Cost: is the cost of the next best alternative of a product of service

❖ Controllable Cost: are expenses that a business has the power to change.

❖ Non- Controllable Cost: the costs are not under control of a specified manager
and the manager does not have influence in the decisions. For example,
advertisement costs from the central office, depreciation, insurance, security
costs

❖ Incremental Cost: is the difference in total costs as the result of a change in

some activity, so the extra cost associated with manufacturing one additional
unit of production
Exercise
Classify the cost data as either ……sunk cost, fixed cost, controllable cost, incremental cost,
semi-variable cost, non-controllable cost, variable cost, semi-fixed cost or opportunity cost

(1) A company is considering selling an old machine. The machine has a book value of
20,000. In evaluating the decision to sell the machine, the 20 000 is a ...

(2) As an alternative to the old machine, the company can rent a new one. It will cost 3000 a
year. In analyzing the cost–volume behavior the rental is a ...

(3) To run the firm’s machines, here are two alternative courses of action. One is to pay the
operator a base salary plus a small amount per unit produced. This makes the total cost of
the operators a ....

(4) As an alternative, the firm can pay the operators a flat salary. It would then use one
machine when volume is low, two when it expands, and three during peak periods. This
means that the total operator cost would now be a ...
Exercise contd.
(5) The machine mentioned in (1) could be sold for 8000. If the firm considers retaining and
using it, the 8000 is a ...

(6) If the firm wishes to use the machine any longer, it must be repaired. For the decision to
retain the machine, the repair cost is a ...

(7) The machine is charged to the foreman of each department at a rate of 3000 a year. In
evaluating the foreman, the charge is a ...
Case-let no.1
J K Paper produces three different paper products – Supreme, Deluxe and Regular. Each product has its
own dedicated product line. It currently uses the following three-part classification for its manufacturing
costs: direct material, direct manufacturing labour and indirect manufacturing costs. The total indirect
manufacturing costs of the plant for the month of December are Rs 150 million (out of which Rs 20 million
are fixed). The total amount is allocated to each product line on the basis of direct manufacturing labour
costs of each line. Summary data (in millions) for December are as follows:

Particulars Supreme Deluxe Regular

Direct material cost (Rs.) 84.00 54.00 62.00
Direct manufacturing labour cost (Rs.) 14.00 28.00 8.00
Units produced 80 120 100

(i) Calculate the manufacturing cost per unit for each product produced in December.
(ii) Suppose that in January production was 120 million units of Supreme, 160 million units of
Deluxe and 180 million units of Regular. Why might the December manufacturing unit cost
information be misleading when predicting total manufacturing costs in January?
 Case-let no.1…

(iii) J K Paper employs a consultant to help them reduce energy costs at its plant. It does not trace energy
cost to each of its product line. The consultant observes that each production line at the plant has multiple
energy meters and that tracing of energy costs to each line is possible. Of the Rs 150 million of indirect
manufacturing costs in December, Rs 90 million is energy cost traceable to the product lines. The
remaining Rs 60 million of indirect manufacturing costs of the plant (including the Rs 20 million of fixed cost)
is allocated to each product line on the basis of direct manufacturing –labour costs at each product line.
Using this information, J. K Paper’s cost analyst reports the following numbers (in millions) for December:

Particulars Supreme Deluxe Regular

Direct material cost (Rs.) 84.00 54.00 62.00

14.00 28.00 8.00
Direct manufacturing labour cost (Rs.)
Direct energy cost (Rs.) 39.8 40.7 9.5
Units produced 80 120 100

Why might J K paper’s managers prefer energy costs to be a direct cost rather than an indirect
manufacturing cost? Re-calculate the manufacturing cost per unit for each of the product line.
Case-let
no.2
Campbell Company is a metal and woodcutting manufacturer, selling products to the home
construction market. Consider the following data for 20XX:
Rs.
Sandpaper 20,000
Material handling costs 7,00,000
Lubricants and coolants 50,000
Miscellaneous & indirect manufacturing labor 4,00,000
Direct manufacturing labor 30,00,000
Direct materials inventory Jan.1,20XX 4,00,000
Direct materials inventory Dec.31, 20XX 5,00,000
Finished goods inventory Jan.1, 20XX 10,00,000
Finished goods inventory Dec.31, 20XX 15,00,000
Work-in-progress inventory Jan.1, 20XX 1,00,000
Work-in-progress inventory Dec.31, 20XX 1,40,000
Plant leasing costs 5,40,000
Depreciation –Plant equipment 3,60,000
Property taxes on plant equipment 40,000
Case-let
no.2 Fire insurance on plant equipment 30,000
Direct material purchased 46,00,000
Revenues 1,36,00,000
Marketing promotions 6,00,000
Marketing salaries 10,00,000
Distribution costs 7,00,000
Customer-service costs 10,00,000
Required:
1. Prepare an income statement with a separate supporting schedule of cost of goods manufactured.
For all manufacturing items, classify costs as direct costs or indirect costs and indicate by V or F
whether each is basically a variable cost or a fixed cost (when the cost object is a product unit). If in
doubt, decide on basis of whether the total cost will change substantially over a wide range of units
produced.
2. Suppose that both the direct material costs and the plant leasing costs are for the production of
9,00,000 units. What is the direct material cost of each unit produced? What is the plant leasing cost
per unit? Assume that the plant leasing cost is a fixed cost.
3. Suppose Campbell Company manufactures 10,00,000 units next year. Repeat the computation in
requirement 2 for direct material and plant leasing cost.
4. As a management consultant, explain concisely to the company president why the unit cost for direct
materials did not change in requirement 2 and 3 but the unit cost for plant leasing costs did change.