Management AccountingManagement Accounting

Management AccountingManagement AccountingManagement Accounting is "the process

of identification, measurement, accumulation, analysis, preparation, interpretation and communication of information used by management to plan, evaluate and control within an entity and to assure appropriate use of and accountability for its resources.

Management accounting also comprises the preparation of financial reports for non-management groups such as shareholders, creditors, regulatory agencies and tax authorities.

Cost accounting is a central element of managerial accounting.

MEANING OF COST MEANING OF COST ACCOUNTINGACCOUNTING• 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.

Scope of Cost Scope of Cost AccountingAccounting• Cost book-keeping: It involves maintaining

complete record of all costs incurred from their incurrence to their charge to departments, products and services.

• Cost system: Systems and procedures are devised for proper accounting for costs.

• 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 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.

• 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.

• 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.

• 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 Objectives of cost accountingaccountingDetermining selling price,Controlling costProviding information for

decision-makingAscertaining costing profitFacilitating preparation of

financial and other statements.

Importance of Cost Importance of Cost accountingaccounting1. Importance to Management• Helps in ascertainment of cost• Aids in Price fixation• Helps in Cost reduction Elimination of

wastage• Helps in identifying unprofitable activities• Helps in checking the accuracy of

financial account• Helps in fixing selling Prices• Helps in Inventory Control• Helps in estimate

2. Importance to Employees : Worker and employees have an interest in which they are employed. An efficient costing system benefits employees through incentives plan in their enterprise, etc.

3 Creditors : They can base their judgement

about the profitability and prospects of the enterprise upon the studies and reports submitted by the cost accountant.

4. Importance to National Economy : An

efficient costing system benefits national economy by stepping up the government revenue by achieving higher production. The overall economic developments of a country take place due to efficiency of production.

LIMITATIONS OF COST LIMITATIONS OF COST ACCOUNTINGACCOUNTING

• It is expensive• The results shown by cost accountant differ

from those shown by financial accountant.• It is unnecessary because it involves

duplication of work.• Costing system itself does not control

costs. If the management is alert and efficient, it can control cost without the help of the cost accounting. Therefore it is unnecessary.

What is cost? What is cost? Cost is foregoing or sacrifice ,

measured in monetary terms, incurred or potentially to be incurred , to achieve a specific purpose.

Thus it has three features:i. Sacrifice : it is current or future decrease in

cash or other asset or increase in liabilities.ii. Money value : it is always in monetary

terms.iii. Stated objective : it is some benefit in the

future.

Important terminologiesImportant terminologiesCost object : the purpose or object

for which cost is measured is called cost object or cost unit. It may be unit of product, a machine, a job ,a department ,an order and so on.

Cost centre : When costs are accumulated for an organizational unit or department it is called cost centre.

Types of costTypes of cost

1 Manufacturing Cost• Direct cost : Cost associated directly

with the final product.eg. Leather used for manufacturing shoes.It may be Direct Material : cost of raw material used to produce finished product.Direct Labor : cost of labor used for converting raw material into finished product.

• Indirect cost : Cost which cannot be directly identified with the cost object. Eg Salary of the watchman.

It may be Indirect Material : cost of material which do not become a part of finished product.eg. Grease.Indirect Labor : cost of labor not used for converting raw material into finished product.eg salary of clerk.

• Factory overhead : All manufacturing cost except direct material and labour are included in factory overhead.Indirect material and labor cost are included in Factory overhead.Other Eg. Rent, power, taxes etc.

2 Non Manufacturing costDistribution cost : cost incurred to

perform marketing functions.Also known as selling cost or marketing cost.

General and administrative costs : cost not covered under any of the categories.eg salary of the administrators , accounting cost etc.

Cost ConceptCost Concept

Classification of Cost Concept according to management needs:

Income Measurement Profit PlanningCosts ControlSpecial Situations requiring

special decisions

Cost Concept relating to Cost Concept relating to income measurementincome measurementProduct cost and period costAbsorbed and unabsorbed costExpired and Unexpired costJoint product cost and separable

cost

Product cost and period Product cost and period costcostProduct cost : These cost are

identified with goods produced or purchased for resale.

Example – raw material and direct labor cost

Period cost : they vary with passage of time and not volume of production.

Example – Rent, insurance premium, salary.Thus these cost are matched against the revenue of the current period.

Absorbed and unabsorbed Absorbed and unabsorbed costcost• Fixed cost add value to the product

and this value is well taken into account in determining the selling price.

• Therefore, these costs must be absorbed by the revenue of the period in which the product have been sold and not necessarily in the year in which they have been incurred.

• Let us understand this concept with the help of Example and graph.

Suppose that the fixed coat are Rs. 30000 normal production is 15000 units.it means every unit of product absorbs Rs. 2 of Fixed cost.Thus absorbed cost is the which is charged to production.

Now if company produce only 10000 units then cost incurred is Rs.20000 and Rs. 10000 constitute unabsorbed cost.Thus unabsorbed cost is cost which remains uncharged to production.(This happens when production is below normal production)

Now if company produce 16250 units then cost incurred is Rs.32500 and Rs. 2500 constitute over absorbed cost.(This happens when production is above normal production)

Expired and unexpired Expired and unexpired costcostAn Expired cost is one which cannot

contribute to the production of the future revenues. It is a cost that has been recognized as an expense. When an entity fully consumes or receives benefit from a cost it is an expired cost.

Unexpired cost is one which has capability of contributing to the production of revenue in the future.

Joint Product cost & Joint Product cost & Separable costSeparable costJoint product cost are the cost of

a single process or a series of processes that simultaneously produce two or more products of significant sales value.

Separable cost refers to any cost that can be attributed to particular product or process.

Cost concept relating to Cost concept relating to profit planningprofit planningFixed , variable and semi-

variable/mixed costFuture cost and budgeted cost

Fixed , variable and semi- Fixed , variable and semi- variable costvariable costFixed cost are costs associated with those

inputs which do not vary with changes in the volume of output or activity within specified range of activity or output for a given budget period. Eg. Rent of factory.

Variable cost tend to vary in total in the direct proportion or in a one to one relationship to changes in production activity. Eg. Material cost , direct labor cost.

Semi-variable or mixed cost are neither perfectly fixed nor perfectly variable . Eg Telephone bill has both component

Future cost and Budgeted Future cost and Budgeted costcostFuture cost are reasonably expected

to be incurred at some future date as a result of a current decision.

Budgeted costs when an operating plan involving future costs is accepted and incorporated formally in the budget for a specific period , such cost get converted to what is called budgeted costs.

Cost concept for Decision Cost concept for Decision makingmakingRelavant and irrelivant costIncremental cost/ differential costOut of pocket cost and sunk costOpportunity cost and imputed

cost

Relevant CostRelevant CostIt is a cost that differs between

alternatives being considered.Cost which is influenced by decisions is a

relevant cost and hence it is important for decision makers.

Examples are Incremental cost/Differential cost which are the cost which will be incurred if management chooses one course of action as opposed to another.

It is the difference in cost between any two available and acceptable alternatives.

Irrelevant CostIrrelevant CostIrrelevant cost are not affected by a

decision, regardless of the choice that is made.

Sunk costs are the examplesSunk cost are the cost which have already

been incurred in past and will not require current cash expenditure.

Depreciation , cost of issue of new shares and debentures are the examples of Sunk cost.

As they are made in past they will be ignored in future decision making

Out of Pocket costOut of Pocket costThese are the costs which will be required

currently or in near future in cash are out of the pocket costs.

It is wrong to say that all fixed cost are sunk cost and all variable cost are out of pocket cost

Salary of CEO is fixed but it is not sunk because it will be paid in near future so it is out of pocket

If manufacturing process change and there is no change in variable cost then it will not affect future decision thus it is sunk and not out of pocket.

Opportunity costOpportunity costOpportunity cost represents the benefits

foregone by not choosing the second best alternative in favor of the best one.

These are associated only with feasible alternatives.

An imputed cost is any cost that results from using an asset instead of renting, selling, or lending it. The term also applies to forgone income from choosing not to work.