Cost Accounting

Escorted by : Agha Zubair Ali khan Submitted to : Sir- Danish Naqvi Table of Contents

Acknowledgement and Dedication3 Introduction4 Product Cost5 Two-Stage7 Cost of Complexity.9 Comprehensive Cost System..11 Conclusion...12

Acknowledgement

All the praise is for Allah, the most merciful and beneficent, who blessed me with the knowledge, gave me the courage and allowed me to accomplish this task. I am especially indebted to all my teachers for instilling in me enough knowledge to be able to carry myself efficiently during my project

Dedication
I dedicate this report to my parents and friends in recognition of their worth and to my teachers who are the guiding force for me and it is their effort and hard work that showed me the path of success and prosperity which would be there for me for the rest of my life. My thanks to all those who have generously contributed their theoretical knowledge to this report without their understanding and support, completion of this work would not have been possible. I hope people find this report useful and the subject matter adds to their knowledge.

INTRODUCTION

The recent management accounting literature provides several case studies of multi-product firms whose product costs are distorted because they allocate overhead costs to products on the basis of a single volume related variable. Most of the Firms that they have personally studied use simple cost accounting systems that assign overhead costs to products based on the direct labor hours expended on each product. Cost concept and terms have developed according to the need of Accountant, Economist & Engineers. It is defined as: AN EXCHANGE PRICE, A FORGOING OR SECRIFICE MADE TO SUCCESS BENEFIT. IN FINANACIAL ACCOUNTING, THYE FORGIVING OR SECRIFICE AT DATA OF ACQUISITION IS REPRESENTED BY A CURRENT OR FUTURE DIMINUTION IN CASH OR OTHER ASSETS.

Classification Of Costs

Cost classification are needed the development of cost data that will aid management in achieving its objectives. These classifications are based on the Relationship of Cost to: The Product The Volume Manufacturing Departments An Accounting Period

The Product
The process of classifying costs & expenses may begin by relating costs to the operations of a business. Total operating cost consists of Manufacturing cost Commercial Cost

The Volume
Costs vary directly in relation to exchange in the volume of production or output, while other remains relatively fixed in amount. Variable costs Fixed Costs Semi variable Cost

Manufacturing Department

The division of a factory into department, cost centre or cost pools also serves as the basis for classifying and accumulating product cost and assigning responsibility for cost control. As a product passes through a department or cost centre, it is charged with direct materials, direct labour and factory overhead (FOH)

Accounting Period
Cost may be classified as capital expenditures or as revenue expenditures A capital expenditure is intended to benefit future periods and is recorded as an asset. A revenue expenditure benefits the current period and is recorded as an expense.

Accounting distorts product cost

Disagreement persists about whether product costs should be assessed by using full or variable costs. Academic accountants and economists have argued that variable costs are most relevant in product decision-making, arguing that the highest profits can be gained by setting marginal revenues equal to marginal costs. Accountants in practice report full costs in their cost accounting systems. It is suggested that a comprehensive product cost system that incorporates long-term, variable marketing and manufacturing costs for each product or product line be the basis for management decisions in introduction, price, continuance, or re-engineering of product lines.

Product Cost
In order to make sensible decision concerning the products they market, managers need to know what their product cost. Product design. New product decision and the amount of effort expended on trying to market a given product or product line will be influenced by the anticipated cost and profitability of the product. Conversely, if product profitability appears to crop, the question will be raised. Product cost also plays an important role in setting prices particularly for customized product s with low sales volumes & without readily available market prices.

Two-Stage

TWO-STAGE Cost allocation systems are: The cost system of all companies had many common characteristics. Most important was the use of two stage cost allocation system: In the first stage, cost were assigning to cost pools (often called cost centers) and in second stage cost were allocated from the cost pools to the products. The companies used many different allocation bases in the first stage to allocate cost from plant overhead accounts to cost centers. Despite the variation in allocation bases in the first stage, however all companies used direct labour hours in the second stage to allocate over head from the cost pools to the product. Direct labour hours were used in the second allocated stage even when the production process was highly automated so that burden rates extended 1,000%. Firms used only one cost system even through cost were collected and allocated for several purposes including product costing, operational control and inventory valuation. The cost system seemed to be design primarily to perform the inventory valuation function for financial reporting because the had serious deficiencies for operational control (too delayed & too aggregate) and for product costing (too aggregate).

The cost of Complexity

The complexity costs of a full line can be illustrated as follows. Consider two identical plants. One plant produces 1,000,000 units of product A. The second plant produces 100,000 units of product A and 900,000units of 199 similar products. (The similar product have sales volume that vary from 100 to 100,000units) The first plant has a simple production environment and requires limited manufacturing support facilities. Few steps, expediting and scheduling activities are required. The other plant presents a much more complex production management environment. Its 200 products have to be scheduled through the plant, requiring frequent setups, inventory movements, purchases, receipts and inspections. To handle this complexity, the support departments must be larger and more sophisticated. The traditional cost accounting system plays an important role in obfuscating the underlying relationship between the range of products and the size of support department. First, the costs of most support departments are classified as fixed, making it difficult to realize that these costs are systematically varying. Second the use of volume related allocation bases makes it difficult to recognize how these support department costs vary. Support department costs must vary with something because they have been among the fastest growing in the overall cost structure of manufactured products. As the e.g. demonstrate. Support department costs vary not with the volume of product item manufactured; rather they vary with the range of item produce. i.e. the complexity of the production process. The traditional definition of variable cost with its monthly or quarterly perspective, views such costs are fixed because complexity related cost do not vary significantly in such a short time frame. The increase complexity of the production process places additional demands on support department and their costs eventually and inevitably rise. The output of a support department consists of the activities its personal perform, these includes such activity as Setup, Material handling and Scheduling. The output of the department can be represented by the n.o of distinct activities that are performed or

the n.o transaction handled. Most of the output of theses departments consists of human activities; however output can increase quite significantly before an immediate deterioration in the quality of service detected. Eventually the maximum output of the department is reached an additional personal are requested. The requests typically come some time after the initial increase in diversity and output. Thus support department while varying the diversity of the demanded output, grow intermittently. The practice of annual budgeted the size of the department further hides the underlying relation b/t the mix and volume of demand and the size of the department. The support departments often are constrained to grow only when budgeted to do so.

Comprehensive Cost System

The notions of fixed and variable are meaningful only with respect to a particular time period; they immediately discard this warning and teach from the perspective of one-month decision horizons. The short-term focus for product costing has led all the companies growing proportion of their total manufacturing cost as FIXED. Costs have been the most variable and rapidly increasing costs. The thinking of cost behavior is: The allocation of cost from the cost pools to the product should be achieved using bases that reflect cost drivers. Because many overhead cost are driven by the complexity of production, not the volume of production, nonvolume related bases are required. Second many of these overhead costs are some what discretionary, while they vary with changes in the complexity of the production process. These changes are intermittent. A traditional cost system that define Variable cost are varying in the short term with production volume will misclassify these cost are fixed. The misclassification also arises from an inadequate understanding of the actual cost drivers for most overhead cost. Many overhead cost vary with transactions. Transaction to order, schedule and pay for shipments to move, tracks and count inventory to schedule production work to setup machine to perform quality assurance to implement engineering change order and to expedite and ship orders. The cost of these transactions is largely independent of the size of the order being handled. The cost does not vary with the amount of input or outputs. It does vary, however with the need for the transaction itself. If the firm introduce more products. If its need to expedite more orders or fit need to inspect more components then it will need larger overhead departments to perform these additional transactions.

Conclusion

Product costs are almost all variable cost. Some of the sources of variability relate to physical volume of items produced. These costs will vary with units produced. Or in a varied, multiproduct environment with surrogate measures such as labour hour, machine hour & quantities or elapsed time of production. Other cost however those are arising from overhead support. The variability of these costs is best explained by the incidence of transactions to initiate the next stage in the production, logistics or Distribution process. A comprehensive product cost system, incorporating the long term variable costs of manufacturing product line. The cost system may even become strategically important for running the business and creating sustainable competitive advantages for the firm.