Professional Documents
Culture Documents
1. Introduction
2. Types of Cost
3. Elements of Cost
4. Components of Cost
5. Methods of Cost Estimate
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1. INTRODUCTION
• Cost Accounting : Is the branch of
accounting responsible for controlling the
cost of a product, service or an operation.
• Measures and reports financial and non-
financial information relating to the cost of
making products, offering services, or
acquiring or utilizing resources in an
organization.
• It is responsible for controlling the cost of a
product, service of an organization
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Cost Accounting
• Managers use cost accounting to support
decision-making to cut a company’s cost and
improve profitability.
• Costs accounting facilitates pricing
• Cost accounting is a component of
management accounting
Branches of Accounting
• Financial Accounting
• Management Accounting
– Cost Accounting
• Social Responsibility Accounting
– Social Responsibility Accounting: Accounts for
social responsibility of a business to social,
ecology and environmental aspects.
Management accounting
• Management accounting or managerial
accounting is concerned with the provisions
and use of accounting information to
managers within organizations, to provide
them with the basis to make informed
business decisions that will allow them to be
better equipped in their management and
control functions.
Management accounting
Management accounting information is:
• designed and intended for use by managers
within the organization, instead of being intended
for use by shareholders, creditors, and public
regulators;
• usually confidential and used by management,
instead of publicly reported;
• forward-looking, instead of historical;
• computed by reference to the needs of
managers, often using management information
systems, instead of by reference to general
financial accounting standards.
Services provided by management
accounting
• Rate & Volume Analysis
• Business Metrics Development
• Price Modeling
• Product Profitability
• Cost Analysis
• Cost allocation
• Cost Benefit Analysis
• Cost-Volume-Profit Analysis
• Life cycle cost analysis
Services provided by management
accounting
• Capital Budgeting
• Buy vs. Lease Analysis
• Sales and Financial Forecasting
• Annual Budgeting
Management vs cost accounting
• In management accounting, cost accounting
establishes budget and actual cost of
operations, processes, departments or
product and the analysis of variances,
profitability or social use of funds.
• Managers use cost accounting to support
decision-making to cut a company's costs and
improve profitability.
Management vs cost accounting
• As a form of management accounting, cost
accounting need not to follow standards,
because its primary use is for internal
managers, rather than outside users, and
what to compute is instead decided
pragmatically.
Cost accounting
• Costs are measured in units of nominal
currency by convention.
• Cost accounting can be viewed as translating
the value chain (the series of events in the
production process that, in concert, result in a
product or service) into financial values.
Cost accounting
• Cost accounting has long been used to help
managers understand the costs of running a
business.
• Modern cost accounting originated during the
industrial revolution, when the complexities of
running a large scale business led to the
development of systems for recording and
tracking costs to help business owners and
managers make decisions.
Cost accounting
• In the early industrial age, most of the costs
incurred by a business were what modern
accountants call "variable costs" because they
varied directly with the amount of production.
• Money was spent on labour, raw materials,
power to run a factory, etc. in direct proportion
to production.
• Managers could simply total the variable costs
for a product and use this as a rough guide for
decision-making processes.
Cost accounting
• Some costs tend to remain the same even
during busy periods, unlike variable costs,
which rise and fall with volume of work.
• Over time, the importance of these "fixed
costs" has become more important to
managers.
• EXAMPLES OF FIXED COSTS?
Cost accounting
• Examples of fixed costs include the
depreciation of plant and equipment, and the
cost of departments such as maintenance,
tooling, production control, purchasing, quality
control, storage and handling, construction
supervision and engineering.
• In the early twentieth century, these costs were
of little importance to most businesses.
• WHY ARE THEY IMPORTANT NOW?
Cost accounting
• However, in the twenty-first century, these
costs are often more important than the
variable cost of a product, and allocating them
to a broad range of products can lead to bad
decision making.
• Managers must understand fixed costs in
order to make decisions about products and
pricing.
Classification of costs
• Classification of cost means, the grouping of
costs according to their common characteristics.
Office Overheads
TOTAL/SELLING COST
SELLING PRICE
Factory Overheads
FACTORY/PRODUCTION COST
OFFICE/GROSS COST
Direct Expenses
PRIME/DIRECT COST
Direct Wages
Direct Material
TYPES OF COSTING
Types of costing refers to various accounting
systems used for ascertaining and analyzing
costs. It includes the following:
• Absorption Costing
• Marginal Costing
• Standard Costing
• Direct costing
• Historical Costing
• Uniform Costing
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Absorption costing
• Sometimes referred to as Full Costing;
• This is the practice of charging all costs
both variables and fixed, to operations,
processes or products;
• No distinction is made between fixed
costs and variable costs;
• All costs, whether fixed or variable are
taken into account to ascertain the costs
of production.
Absorption costing – Categorization of costs
Product cost
• Direct materials
• Direct Labor
• Variable Manufacturing overhead
• Fixed manufacturing overhead
Period cost
• Variable selling and administrative expenses
• Fixed selling and administrative expenses
Unit Cost Computation - Example
• To illustrate the computation/calculation of
unit product costs under absorption costing
consider the following example.
• A small company that produces a single
product has the following cost structure
Absorption costing - example
Number of units produced per year 6,000
Variable costs per unit (units of money):
Direct materials 2
Direct labor 4
Unit cost 17
Multi product example
Unit product Cost - Absorption Costing Method
Direct materials $2
Direct labor $4
--------
$10,000
Fixed selling and administrative expenses
The $30,000 fixed manufacturing overhead will be charged off in total against income as
a period expense along with selling and administrative expenses)
Marginal Costing cont’d…(Example
PRODUCT
A B C Total (TZS)
(c) Sales 20,000 30,000 50,000 100,000
Direct 5,000 15,000 10,000 30,000
materials
Direct Wages 6,000 4,500 5,000 15,500
Variable factory 2,600 4,500 13,000 20,100
Overhead
Variable Selling 1,400 3,000 10,000 14,400
Overhead
(d) Marginal 15,000 27,000 38,000 80,000
Costs
Contrbtn. (c) – 5,000 3,000 12,000 20,000
(d)
Less fixed 10,000
overhead
Net profit 10,000
Marginal costing
• There are different phrases being used for this
technique of costing.
• In UK, marginal costing is a popular phrase
whereas in US, it is known as direct costing
and is used in place of marginal costing.
• Variable costing is another name of marginal
costing.
Marginal costing
• Marginal costing technique has given birth to
a very useful concept of contribution where
contribution is given by: Sales revenue less
variable cost (marginal cost)
• Contribution may be defined as the profit
before the recovery of fixed costs.
• Thus, contribution goes toward the recovery
of fixed cost and profit, and is equal to fixed
cost plus profit (C = F + P).
Marginal costing
• In case a firm neither makes profit nor suffers
loss, contribution will be just equal to fixed
cost (C = F). this is known as break even point.
• The concept of contribution is very useful in
marginal costing.
• It has a fixed relation with sales.
• The proportion of contribution to sales is
known as P/V ratio which remains the same
under given conditions of production and
sales.
Marginal costing
• It should be clearly understood that marginal
costing is not a method of costing like
absorption costing.
• Rather it is simply a method or technique of
the analysis of cost information for the
guidance of management which tries to find
out an effect on profit due to changes in the
volume of output.
• Marginal costing information is used in profit
volume analysis
Cost Volume relationships
• Cost-Volume-profit analysis examines the
behaviour of total revenue, total costs, and
operating income as changes occur in the
output level, the selling price, the variable
cost per unit, and/or the fixed costs of a
product.
CVP Assumptions
• Changes in the level of revenue and costs arise
only because of changes in the number of
product units produced and sold; i.e., the
number of units is only the revenue driver and
the only cost driver.
• The total cost (TC) can be separated into total
fixed cost (TFC) that does not vary with the
output level and total variable cost (TVC) (total
marginal cost) that changes with the output
level. Mathematically, TC = TFC+ TVC
CVP Assumptions
• When represented graphically, the behaviors
of total sales revenue (TSR) and TC are linear
in relation to output level within a relevant
range (and time period).
• Demand will always accommodate what is
produced or offered
• The unit selling price (USP), unit variable cost
(UVC) and unit fixed cost (UFC) are known and
constant within a relevant range and time
period.
CVP Assumptions
• The analysis covers a single product but can
be extended to a given proportion of different
products.
• All revenues and costs can be added and
compared without taking account the time-
value of money (see later)
Profit volume analysis - example
• A condensed income statement of a certain
manufacturing company as of Dec. 31, 2011 is
given below
‘000’shs %
Manufacturing
50% 35% 5% 10% 100%
overhead
Selling and
administrative 10% 45% 25% 20% 100%
overhead
Total activity
100
measure 1,000 units 250 orders -- --
customers
value
Single product ABC
The allocation of overhead costs to the activities
Manufacturing
250,000 175,000 25,000 50,000 500,000
overhead(TZS)
Selling
30,000 135,000 75,000 60,000 300,000
overhead(TZS)
Assembling units TZS 280,000 1,000 units TZS 280 per unit
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PURPOSES OF PRODUCT COSTING
• To facilitate budgeting
• To enable measurement of
performance efficiency
• For preparation of financial
statements(financial accounting)
• To help decide on make or buy
decisions
• To determine prices of products
.
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