Cost and

Management
Accounting
 UNIT – 1

Management Accounting
 What is Management Accounting?
• “Management Accounting is the term used to describe accounting
methods, system and techniques which coupled with special
knowledge and ability, assists management in its task of
maximising profits or minimising losses.”
- J Batty
• “Management accounting is an integral part of management
concerned with identifying, presenting and interpreting
information used for: (a) formulating strategy; (b) planning and
controlling activities; (c) decision taking; (d) optimising the use of
resources; (e) disclosure to shareholders and others external to
the entity; (f) disclosure to employees; (g) safeguarding assets
- CIMA, London
 Main users of accounting
information relating to business
Importance of Management
Accounting
 Informed Decision-Making
 Strategic Planning
 Performance Measurement
 Resource Optimization
 Cost Control
 Enhanced Operational Efficiency
 Risk Management
 Budgeting and Forecasting
 Nature of Management
Accounting

 Management accounting is a decision

making system
 Management accounting is futuristic
 Management accounting is a technique of
selective nature
 Management accounting analyses
different variables
 Management accounting does not set particular
formats for information
Function of Management
Accounting
Role of Management
Accounting
 Real- World Example
Company: Tesla, Inc.Tesla, a leader in the electric vehicle (EV) and clean
energy sector, relies heavily on management accounting to make
decisions regarding product pricing, production cost management, and
performance evaluation. For example:

• Cost-Volume-Profit (CVP) Analysis

• Budgeting and Forecasting
• Performance Metrics
• How Management Accounting Helps Tesla:
• Strategic Decision Making
• Cost Control
• Investment Decisions

Management accounting techniques provided valuable insights that

were crucial for optimizing operations, enhancing profitability, and
ensuring long-term sustainability.
Financial v/s Management
Accounting
Cost v/s Management
Accounting
BASIC CONCEPTS OF
COSTING
 Cost Term And Concepts
Costing is a branch of accounting that deals with the
recording, classification, allocation, and analysis of costs
associated with a process, product, or service.
Here are the fundamental cost terms and concepts:
• Cost
Definition: The amount of expenditure (actual or notional)
incurred on or attributable to a specified thing or activity.
Example: Cost of raw materials, labor, rent, etc.
• Costing
Definition: The technique and process of ascertaining
costs.
Purpose: Helps in determining the cost of production and
setting the price of goods or services.
• Cost Accounting
Definition: The process of recording, classifying, analyzing,
summarizing, and allocating costs.
Goal: To help in decision-making, cost control, and cost reduction.
• Cost Centre
Definition: A location, person, or item of equipment for which costs
are ascertained and used for control purposes.
Types: Personal (e.g., an employee), Impersonal (e.g., a machine or
department).
• Cost Unit
Definition: A unit of product, service, or time in relation to which costs
are ascertained.
Example: Per ton (cement), per km (transport), per unit (electricity).
• Direct Cost
Definition: Costs that can be directly attributed to a product or service.
Examples: Direct materials, direct labor, direct expenses.
• Indirect Cost
Definition: Costs that cannot be directly traced to a
single product or service.
Examples: Factory rent, manager salary, electricity.
• Fixed Cost
Definition: Costs that remain constant irrespective of
output levels.
Examples: Rent, insurance, salaries.
• Variable Cost
Definition: Costs that vary in direct proportion to the
level of production.
Examples: Raw materials, power consumption in
machines.
• Semi-Variable Cost
Definition: Costs that have both fixed and variable components.
Example: Electricity bills (fixed connection charges + variable usage).
• Marginal Cost
Definition: The additional cost incurred for producing one more unit
of output.
Used in: Decision-making related to pricing, output levels.
• Standard Cost
Definition: Predetermined cost based on technical estimates for
materials, labor, and overhead.
Purpose: Used for budgeting and cost control.
• Opportunity Cost
Definition: The cost of the next best alternative foregone.
Example: If you use a machine for one product, the opportunity cost
is the profit lost from not using it for another product.
• Sunk Cost
Definition: Past costs that cannot be recovered
and should not affect current decisions.
Example: Cost of obsolete inventory.
 Types and Elements of Cost
The elements of cost refer to the broad categories under
which costs are classified. There are three main elements:
1. Material Cost
• Direct Material: Raw materials that can be directly identified
with the finished product.
– Example: Steel in car manufacturing.
• Indirect Material: Materials that cannot be directly traced to
the product.
– Example: Lubricants, cleaning supplies.
2. Labour Cost
• Direct Labour: Wages paid to workers directly involved in
production.
– Example: Assembly line workers.
• Indirect Labour: Wages of workers not directly
involved in production.
– Example: Supervisors, maintenance staff.
3. Expenses
• Direct Expenses: Costs that can be directly allocated
to a specific job or product.
– Example: Cost of special tools or designs.
• Indirect Expenses: Costs not directly linked to a
product.
– Example: Rent, depreciation, utility bills.
 Types of Cost

Costs are classified based on nature, function,

behavior, and purpose.
 Based on Nature or Traceability

• Direct Cost: Directly attributable to a cost unit (e.g.,

direct material, direct labour).
• Indirect Cost: Not directly attributable (e.g., indirect
labour, factory overheads).
 Based on Function

• Production/Manufacturing Cost: Cost incurred in the

production process.
• Administrative Cost: Related to office and
management.
• Selling and Distribution Cost: Incurred to market and
deliver products.
• Research & Development Cost: For innovation and
product development.
 Based on Behavior
• Fixed Cost: Remains constant regardless of output
(e.g., rent).
• Variable Cost: Varies directly with output (e.g., raw
materials).
• Semi-variable Cost: Has both fixed and variable
components (e.g., electricity bill)
 Based on Decision-Making Need

• Relevant Cost: Affects a specific decision.

• Irrelevant Cost: Doesn’t affect the decision.
• Opportunity Cost: Cost of the next best alternative
foregone.
• Sunk Cost: Already incurred and not recoverable.
• Marginal Cost: Cost of producing one additional unit.
 Introduction to Cost Allocation
• Definition: Cost allocation refers to the
process of identifying, aggregating, and
assigning costs to cost objects such as
departments, products, or projects.
• Objective: To determine the accurate cost of
products/services for pricing, profitability, and
decision-making.
 What is Absorption Costing?
• Also called Full Costing.
• A method where all manufacturing costs
(fixed and variable) are absorbed by the units
produced.
Includes:
• Direct Costs (Direct Material, Direct Labor)
• Indirect Costs (Factory Overheads)
 Features of Absorption Costing
• Follows GAAP and accounting standards.
• Required for external financial reporting.
• Fixed factory overhead is included in the cost
per unit.
• Profit is affected by production volume.
Components of Product Cost in Absorption
Costing

Cost Type Included in Absorption Costing?

Direct Material ✅ Yes

Direct Labor ✅ Yes

Variable Manufacturing Overhead ✅ Yes

Fixed Manufacturing Overhead ✅ Yes

Selling & Administrative Expenses ❌ No

 Benefits of Absorption Costing
• Complies with accounting standards.
• Provides a complete picture of product cost.
• Better inventory valuation (includes fixed
cost).
• Useful for external reporting.
Limitations of Absorption Costing
• Can overstate profits when production >
sales.
• Not suitable for internal decision-making.
• May lead to overproduction to absorb more
fixed cost.
Formulas in Absorption Costing
Numerical Example of Absorption Costing

Particulars Amount (₹)

Direct Material per unit ₹ 40

Direct Labour per unit ₹ 20

Variable Overhead per unit ₹ 10

Fixed Manufacturing OH (Total) ₹ 30,000

Units Produced 5,000 units

Units Sold 4,000 units

Selling Price per unit ₹ 100

 Introduction to Marginal Costing
• What is Marginal Costing?
• Marginal costing is a costing technique where only
variable costs are charged to products, and fixed
costs are treated as period costs.
Key Concepts:
• Marginal Cost = Cost of producing one additional
unit.
• Fixed costs remain unchanged regardless of output.
• Used for decision-making like pricing, profitability,
and production level decisions.
Important Formulas in Marginal Costing

Concept Formula

Contribution Selling Price – Variable Cost

Profit Contribution – Fixed Cost

P/V Ratio (Profit/Volume) Contribution / Sales × 100

Break-Even Point (units) Fixed Cost / Contribution per unit

Break-Even Point (₹) Fixed Cost / P/V Ratio

Margin of Safety Actual Sales – Break-Even Sales

 Example – Break-Even Analysis
• Given:
• Selling Price per unit = ₹50
• Variable Cost per unit = ₹30
• Fixed Cost = ₹40,000
Solution:
• Contribution per unit = ₹50 – ₹30 = ₹20
• Break-Even Point (units) = ₹40,000 / ₹20 =
2,000 units
• Break-Even Sales (₹) = 2,000 × ₹50 =
₹1,00,000
• P/V Ratio = ₹20 / ₹50 × 100 = 40%
 Applications of Marginal Costing
Used for:
• Make or Buy Decisions
• Profit Planning
• Determining Break-Even Point
• Fixing Selling Price in Competitive Markets
• Evaluating Impact of Changes in Cost or
Volume
 Example: Make or Buy

• If making a part costs ₹8 (₹5 variable + ₹3

fixed) and buying it costs ₹6, marginal costing
will suggest:
• Since fixed cost is not incremental, compare
₹5 (variable) with ₹6 → Buy only if less than
₹5
 Advantages & Limitations
• Advantages:
• Simple and easy to understand
• Useful for short-term decision-making
• Helps in understanding cost-volume-profit
relationships
• ⚠️Limitations:
• Ignores fixed costs in product pricing
• Not suitable for long-term planning
• Assumes linear cost and revenue behavior
Q1.
A company sells a product for ₹100 per unit.
Variable cost per unit is ₹60.
Fixed cost is ₹40,000.
Sales during the month are 2,000 units.
👉 Calculate:
• Contribution per unit
• Total Contribution
• Profit
• Break-even point (units)
• Contribution per unit = Selling Price – Variable
Cost
= ₹100 – ₹60 = ₹40
• Total Contribution = Contribution per unit ×
Units sold
= ₹40 × 2,000 = ₹80,000
• Profit = Total Contribution – Fixed Cost
= ₹80,000 – ₹40,000 = ₹40,000
• Break-even point (units) = Fixed Cost /
Contribution per unit
= ₹40,000 / ₹40 = 1,000 units
• Q2.
Total Sales = ₹5,00,000
Total Variable Cost = ₹3,00,000
Fixed Cost = ₹80,000
Calculate:
• P/V Ratio
• Break-even sales (₹)
• Profit at sales of ₹6,00,000
• Contribution = Sales – Variable Cost
= ₹5,00,000 – ₹3,00,000 = ₹2,00,000
• P/V Ratio = Contribution / Sales × 100
= ₹2,00,000 / ₹5,00,000 × 100 = 40%
• Break-even Sales = Fixed Cost / P/V Ratio
= ₹80,000 / 0.40 = ₹2,00,000
• Profit at ₹6,00,000 Sales:
Contribution = 40% of ₹6,00,000 = ₹2,40,000
Profit = Contribution – Fixed Cost = ₹2,40,000
– ₹80,000 = ₹1,60,000
Q3.
Sales = ₹4,00,000
Break-even Sales = ₹2,50,000

Calculate:
• Margin of Safety (₹)
• Margin of Safety (%)
Solution:
• Margin of Safety (₹) = Sales – Break-even
Sales
= ₹4,00,000 – ₹2,50,000 = ₹1,50,000
• Margin of Safety (%) = (Margin of Safety /
Sales) × 100
= (₹1,50,000 / ₹4,00,000) × 100 = 37.5%
• Q4.
Variable Cost per unit = ₹150
Fixed Cost = ₹60,000
Desired Profit = ₹30,000
Expected Sales = 1,000 units

Find the Selling Price per unit needed

Solution:

• Total Contribution Required = Fixed Cost +

Desired Profit
= ₹60,000 + ₹30,000 = ₹90,000
• Contribution per unit required = ₹90,000 /
1,000 units = ₹90
• Selling Price per unit = Variable Cost +
Contribution
= ₹150 + ₹90 = ₹240
 Activity-Based Costing (ABC)
• Definition:
Activity-Based Costing (ABC) is a costing
method that identifies activities in an
organization and assigns the cost of each
activity to products and services based on
actual consumption.
• Purpose:
More accurate product costing by identifying
overhead costs for each activity.
 Why Use ABC?
• Traditional costing allocates overhead based
on volume (like labor hours), which may
distort true costs.
• ABC gives better insights by:
– Tracing overheads to specific activities.
– Using cost drivers to assign costs more accurately.
 Key Components of ABC
• Activities – Tasks or processes that consume
resources (e.g., machine setup, quality checks)
• Cost Pools – Grouping of all costs associated
with a single activity
• Cost Drivers – Factors that cause changes in
the cost of an activity (e.g., number of setups)
• Cost Objects – Products/services that
consume activities
 ABC vs Traditional Costing
Feature Traditional Costing Activity-Based Costing

Based on volume (e.g.,

Overhead Allocation Based on activities
labor hours)

Accuracy Less accurate More accurate

Complexity Simple Complex

Use Suits uniform products Suits diverse/multi-product

 Steps in Activity-Based Costing
• Identify major activities.
• Assign costs to activity cost pools.
• Determine cost drivers.
• Calculate cost driver rates.
• Assign costs to products using cost driver
rates.
 Formula for ABC
Step-by-step Formula:

• Cost Driver Rate =

Total Cost of Activity ÷ Total Cost Driver

• Cost Assigned to Product = Cost Driver Rate ×

Number of Cost Driver Units used by Product
 Numerical Examples

• Example:
• Machine setup costs = ₹50,000
• Total number of setups = 100
• Product A requires 5 setups
Given:

Product A
Activity Cost Driver Total Units
Usage

Machine Setup ₹60,000 No. of Setups 120 10

Quality Check ₹40,000 No. of Checks 200 20

Given:

Activity Total Cost Cost Driver Total Units Product A Product B

Machine No. of
₹100,000 200 50 150
Setup setups

Quality No. of
₹60,000 300 100 200
Inspection inspections

Packing ₹40,000 No. of packs 400 150 250

 Advantages of ABC
• More accurate product costing
• Helps eliminate non-value-adding activities
• Better decision-making on pricing and
outsourcing
• Supports continuous improvement
 Limitations of ABC
• Time-consuming to implement
• Costly and complex
• Requires detailed data collection
• May not be suitable for small firms