ZeePedia buy college essays online


Cost and Management Accounting

COST CLASSIFICATION AND COST BEHAVIOR INTRODUCTION:COST CLASSIFICATION, Next >>>
 
img
Cost & Management Accounting(MGT-402)
VU
LESSON# 1
COSTCLASSIFICATION AND COSTBEHAVIOR
INTRODUCTION
Cost Accounting
CostAccounting is an expanded phase of financial accounting which provides management
promptlywith the cost of producingand/or selling each productand rendering a particularservice.
Management Accounting
Management accounting is application of professional knowledge and skill in the preparation and
presentation of financial information in such a way as to assist management in decision making and
in the planning and control of operations of the entity
Objectives
Objective of cost accounting is computation of cost perunit, whereas the objective of management
accountingis to provide information to themanagement for decision making purposes.
Users
Users of cost & management accountingare the decision makersand the managers of the
entity/organizationfor which all thisexercise is undertaken.
Uses of Cost and Management Accounting
1. It determines total cost of production and cost of sales
2. It determines appropriate selling price
3. It discloses the profitableproducts, areas andactivity/capacity levels
4. It is used to decide whether to manufacture or purchase for outside
5. It helps in planning andcontrolling the cost of production
Elements of Cost
Anyproduct that is manufactured is the result of consumption of some resources. The
management,for its planning andcontrolling functions, mustknow the cost of using these
resources.The constituent elements of cost are broadly classifiedinto three distinctelements:
1  Direct Material Cost
2  Direct LaborCost
3  Other ProductionCost
a) Direct Cost
b) Indirect Cost
COSTCLASSIFICATION
Elements of cost (Direct Material, DirectLabor, Other Productioncosts) can be classified as direct
cost or indirect cost.
DirectCost
A direct cost is a cost thatcan be traced in full to theproduct or service for whichcost is being
determined.
Coststhat can be economically identifiedwith a specific saleableproduct or service (cost unit).
a) Direct material costs arethe costs of materials thatare known to have beenused in
producingand selling a product or rendering a service.
1
img
Cost & Management Accounting(MGT-402)
VU
b) Directlabor costs arethe specific costs of theworkforce used to produce a product or
rendering a service.
c) Otherdirect production costs are those expenses that havebeen incurred in full as a
direct consequence of producing a product, or rendering a service.
IndirectCost/Overhead Cost
An indirect cost or overheadcost is a cost that is incurred in the course of producing product or
rendering service, but which cannot be traced in the product or service in full.
Expenditureincurred on labor, material or otherservices which cannot be economically identified
with a specific cost product or service (cost unit).
Examples include:
Wages of supervisor, cleaning material, workshop insurance.
MaterialCost Labor Cost Other Production Cost  TotalProduction Cost
PriceCost
Direct
Direct
Direct
FactoryOverhead Cost
Indirect
Indirect
Indirect
1. Prime Cost
Direct Material
+DirectLabor
+Other direct production cost
Prime cost
.
2. Total Production Cost
Prime Cost
+Factoryoverhead cost
Totalproduction cost
.
3. Conversion Cost
Directlabor cost
+Factoryoverhead cost
Conversioncost
.
COSTBEHAVIOR
Costbehavior is the way in whichtotal production cost is affected by fluctuations in theactivity
(production)level.
Activitylevel
Theactivity level refers to theamount of work done, or thenumber of events that have occurred.
Depending on circumstances, the level of activity may refer to thevolume of production in a
period, the number of items sold, the value of items sold, thenumber of invoices issued,the
number of invoices received, the number or units of electricity consumed, thelabor turnover etc.
etc.
Basicprinciple
Thebasic principle of costbehavior is that as thelevel of activity rises,costs will usually raise.For
example; it will cost more to produce 500 units of output than it will cost to produce 100units; it
willusually cost more to travel 10 km than to travel 2 km.Although the principle is based on the
commonsense, but the costaccountant has to determine, foreach cost elements, whetherwhich
costrises by how much by thechange in activitylevel.
2
img
Cost & Management Accounting(MGT-402)
VU
Division of cost by its behavior
Basicallythe cost of production hastwo behaviors:
1. Fixed Cost
2. Variable Cost
FixedCost
It is a cost which tends to be constant by increases or decreases in the activity level.
Graph of Fixed Cost
Rs
5000
4000
3000
2000
1000
100
200 300
400
500
Volume of output
This graph shows that the costremains fixed regard less of the volume of output.
Examples include:
a. Salary of the productionmanager (monthly/annual)
b. Insurance premium of factorywork shop
c. Depreciation on straight linemethod
VariableCosts
A variable cost is a costwhich tends to very directlywith the change in activitylevel. The variable
costper unit is the sameamount for each unit produced whereas total variablecost increases as
volume of output increases.
Graph of Variable Cost
Rs.
Cost
4000
3000
2000
1000
Volume of output
100
200
300
400
500
This graph shows a proportionate increase in the cost by the increase in the activity level.
Examples include:
a. Cost of raw-material consumed
b. Direct labor cost
c. Selling commission
3
img
Cost & Management Accounting(MGT-402)
VU
Further division of cost behavior
1. Step fixed cost
2. Semi variable cost
Stepfixed cost
A step fixed cost is thecost which is constant for a specific range of activityand rises to a new
constantlevel once the rangeexceeds. The range overwhich the fixed costremains constant is
known as the relevantrange.
Forexample; the depreciation of a machine may be fixed if productionremains below 100number
of units per month, but if the production exceeds 100number of units, a second machine may
now be required, and the cost of depreciation would go up a step.Other examplesinclude:
a. Rent of workshop (in case of increase in the production one needs to rent one
moreworkshop)
b. Salary of supervisor (increase in outputwill be supervised by increasednumber of
supervisors)
Graph of Step fixedCost
Rs.
Cost
4000
3000
2000
1000
Units
100
200
300
Volume of output
This graph shows a stepwise increase in the total cost. Relevant range in this graph is of 100
numbers of units.
Semi Variable Cost
It is also known as mixed cost. It is the cost which is partfixed and par variable. It is in fact the
mixture of both behaviors.
Examples include: Utility bills ­ there is a fixed line rentplus charges for units consumed.
Salesman'ssalary ­ there is a fixedmonthly salary plus commission per units sold.
Thegraph of semi variable cost is as follow:
4
img
Cost & Management Accounting(MGT-402)
VU
Rs.
Cost
4000
Variable cost portion
3000
2000
1000
Fixed cost portion
100
200
300
400
500
Volume of output
This graph shows a fixed cost of Rs. 2,000 and thereafter the cost is variable.
COSTBEHAVIOR PER UNIT OF PRODUCTION
Costper unit behaves differentlythan the total cost of production. Following tablesshow the
difference in behavior.
Increasing Production VolumeSituation
DecreasingProduction VolumeSituation
PerUnit
Total
FixedCost
Increase
Constant
VariableCost Constant
Decrease
TotalCost
Increase
Decrease
Increase or decrease in production volumecauses no change to thevariable cost per unit it remains
constant,assuming there is not rebate in case of bulk purchase andthe labor receives constantrate
despitechange in productionvolume.
Whereas,increase in production volumecauses a decrease in fixedcost per unit and in the same
way a decrease in production volumecauses an increase in fixedcost per unit.
Followingexample helps understanding this concept.
Totalfixed cost
= Rs. 4,000
Perunit variable cost
= Rs. 3
Costper unit at differentactivity levels 1000, 2000,4000, and 5000units
1000 units
2000 units
4000 units
5000 units
Rs.Per  Total  Rs.Per  Total  Rs.Per  Total  Rs.Per  Total
Unit
Rs.
Unit
Rs.
Unit
Rs.
Unit
Rs.
Fixed
4
4,000
2
4,000
1
4,000
0.8
4,000
Cost
5
img
Cost & Management Accounting(MGT-402)
VU
Variable
3
3,000
3
6,000
3
1,200
3
15,000
Cost
Total
7
7,000
5
10,000
4
16,000
3.8
19,000
Cost
IMPORTANT TERMINOLOGIES
CostUnit
It is a unit of a product or service in relation to which the cost is ascertained, i.e. it is theunit
of the out put or product of the business. In simplewords the unit forwhich cost of
producingthe units is identified/allocated.
Example
Ballpoint for a Ball pointmanufacturing entity
Bottlefor Beverage producingentity
Fanfor a Fan manufacturingentity
Cost Center
Cost centre is a location where costs areincurred and may or maynot be attributed to cost
units.
Examples
Workshop in a manufacturing concern
Autoservice department
Electricalservice department
Packagingdepartment
Janitorial service department
Revenue Centre
It is part of the entity thatearns sales revenue. Itsmanager is responsible forthe revenue
earnednot for the cost of operations.
Examples
Salesdepartment
Factoryoutlet
Profit Centre
Profit centre is a section of an organizationthat is responsible forproducing profit.
Examples
A branch
A division
Investment Centre
An investment centre is a segment or a profit centre where the managerhas significantdegree
of control over his/herdivision's investmentpolicies.
Examples
A branch
A division
Relevant Cost
Relevant cost is which changes with a change in decision. Theseare future costs thateffect the
currentmanagement decision.
Examples
Variable cost
Fixed cost which changes with in an alternatives
Opportunitycost
6
img
Cost & Management Accounting(MGT-402)
VU
IrrelevantCost
Irrelevantcosts are those costs thatwould not affect thecurrent managementdecision.
Example
A building purchased in lastyear, its cost is irrelevant to affect managementdecisions.
SunkCost
Sunk cost is the cost expended in the past that cannot be retrieved on product or service.
Example
Theentity purchase stationary in bulklast moth. This expensehas been incurred andhence
willnot be relevant to themanagement decisions to be taken subsequent to thepurchase.
OpportunityCost
Opportunitycost is the value of a benefitsacrificed in favor of an alternative.
Example
An investor invests in stock exchange he foregoes the opportunity to invest further in his
hotel.The profit which theinvestor will be getting fromthe hotel is opportunitycost.
Product Cost
Productcost is a cost that is incurred in producing goodsand services. This costbecomes part
of inventory.
Example
Direct material, direct labor and factoryoverhead.
Period Cost
Thecost is not related to production and is matched against on a time period basis. This cost is
considered to be expired during the accounting period and is charged to theprofit & loss
account.
Example
Sellingand administrative expenses
HistoricalCost
It is the cost which is incurred at the time of entering into the transaction. This cost is
verifiablethrough invoices/agreements. Historicalcost is an actual cost that is borne at the
time of purchase.
Example
A building purchased for Rs 400,000, has market value of Rs.1,000,000. Its historicalcost
is Rs. 400,000.
StandardCost
Standardcost is a Predetermine cost of the units.
Example
Standardcost for a unit of product`A' is set at Rs 30. It is compared with actualcost
incurredfor control purposes.
ImplicitCost
Implicitcost imposed on a firm includes cost when it foregoes an alternative action but doesn't
make a physical payment. Such costsare related to forgone benefits of any single transaction,
andoccur when a firm:
Example
Uses its own capital or
7
img
Cost & Management Accounting(MGT-402)
VU
Uses its owner's time and/orfinancial resources
ExplicitCost
Explicitcost is the cost that is subject to actual payment or will be paid for in future.
Example
Wage
Rent
Materials
DifferentialCost or Incrementalcost
It is the difference of the costs of two or more alternatives.
Example
Differencebetween costs of raw material of two categories or quality.
Costing:
Themeasurement of cost of a product or service is called costing; however, it is not a
recommended terminology.
CostAccounting:
It is the establishment of budgets, standardcost and actual costs of operations, processes,
activities or products and the analysis of variances, profitability or socialuse of funds. It
involves a careful evaluation of theresources used within thebusiness. The techniques
employed are designed to providefinancial information aboutthe performance of a business
and possibly the direction whichfuture operations shouldtake.
PrimeCost:
Thetotal costs which can be directly identified with a job, a product or service is known as
Prime cost. Thus prime cost = direct materials + direct labor + other direct expenses.
ConversionCost.
This is the total cost of converting the raw materialsinto finished products. Thetotal of direct
laborother direct expenses andfactory overhead cost is known as conversioncost
CostAccumulation
Cost accumulations are the various ways in which the entries in a set of cost accounts(costs
incurred)may be aggregated to providedifferent perspectives on theinformation.
Methods of cost accumulation
Processcosting
It is a method of cost accountingapplied to production carriedout by a series of operational
stages or processes.
Joborder costing
Generally, it is the allocation of alltime, material and expenses to an individual project or job.
8
img
Cost & Management Accounting(MGT-402)
VU
Assignment Questions
Answer to each of the following question should not exceed fivelines.
1. Define CostAccounting
2. What are the three broad elements of cost?
3. Give any five examples of factory overhead cost. Also explain.
4. Give any two examples of distribution overheads.
5. Give any two examples of office overheads
6. Define direct cost and givetwo examples.
7. What is indirect cost? Givethree examples.
8. What is meant by step fixedcost and semi-variable cost?Also show graphs.
9. What is fixed cost? Givethree items of fixed cost,also show its graph.
ExamType Questions
1. What is a cost unit? Givetwo example
2. Define cost centre. How does it differ from costunit
3. What is the difference between direct and indirect materials? Givetwo examples of
each.
4. Fixed cost per unit remainsfixed. Do you agree?
5. How variable cost perunit behaves? Give twoexamples.
6. What are semi-variablecosts? Draw graph for such costs
MultipleChoice Questions
Choosethe correct answer in each of the following MCQ.
1. The main purpose of costaccounting is to
a  Maximize profits
b Help in inventoryvaluation
c   Provide information to managementfor decision making
d  Aid in the fixation of selling price;
2. Fixed cost per unitincreases when
a   Variable cost per unitincrease
b Variable cost per unitdecreases
c  Production volumeincreases
d  Production volumedecreases
3. Variable cost perunit
a  Varies when outputvaries
b Remains constant
c  Increases when outputincreases
d  Decrease when outputdecreases
4. Which of the followings is the reason of increase in total variable cost:
a  Increase in fixedcost
b Rise in interest on capital
c  Increase in direct material cost
d   Depreciation of machinery
5. Which of the followings is an example of fixedcost:
a  Direct material cost
b Works manager'ssalary
c   Depreciation of machinery
d  Chargeable expenses
9
img
Cost & Management Accounting(MGT-402)
VU
6. Cost accounting conceptsinclude all of the followingexcept
a  Planning
b Controlling
c  Sharing
d   Costing
7. The three elements of product cost are allbut
a  Direct material cost
b Factory overhead cost
c  Indirect laborcost
d  Direct laborcost
Answers:
Q1
Q2
Q3
Q4
Q5
Q6
Q7
c
d
b
c
c
c
c
10
Table of Contents:
  1. COST CLASSIFICATION AND COST BEHAVIOR INTRODUCTION:COST CLASSIFICATION,
  2. IMPORTANT TERMINOLOGIES:Cost Center, Profit Centre, Differential Cost or Incremental cost
  3. FINANCIAL STATEMENTS:Inventory, Direct Material Consumed, Total Factory Cost
  4. FINANCIAL STATEMENTS:Adjustment in the Entire Production, Adjustment in the Income Statement
  5. PROBLEMS IN PREPARATION OF FINANCIAL STATEMENTS:Gross Profit Margin Rate, Net Profit Ratio
  6. MORE ABOUT PREPARATION OF FINANCIAL STATEMENTS:Conversion Cost
  7. MATERIAL:Inventory, Perpetual Inventory System, Weighted Average Method (W.Avg)
  8. CONTROL OVER MATERIAL:Order Level, Maximum Stock Level, Danger Level
  9. ECONOMIC ORDERING QUANTITY:EOQ Graph, PROBLEMS
  10. ACCOUNTING FOR LOSSES:Spoiled output, Accounting treatment, Inventory Turnover Ratio
  11. LABOR:Direct Labor Cost, Mechanical Methods, MAKING PAYMENTS TO EMPLOYEES
  12. PAYROLL AND INCENTIVES:Systems of Wages, Premium Plans
  13. PIECE RATE BASE PREMIUM PLANS:Suitability of Piece Rate System, GROUP BONUS SYSTEMS
  14. LABOR TURNOVER AND LABOR EFFICIENCY RATIOS & FACTORY OVERHEAD COST
  15. ALLOCATION AND APPORTIONMENT OF FOH COST
  16. FACTORY OVERHEAD COST:Marketing, Research and development
  17. FACTORY OVERHEAD COST:Spending Variance, Capacity/Volume Variance
  18. JOB ORDER COSTING SYSTEM:Direct Materials, Direct Labor, Factory Overhead
  19. PROCESS COSTING SYSTEM:Data Collection, Cost of Completed Output
  20. PROCESS COSTING SYSTEM:Cost of Production Report, Quantity Schedule
  21. PROCESS COSTING SYSTEM:Normal Loss at the End of Process
  22. PROCESS COSTING SYSTEM:PRACTICE QUESTION
  23. PROCESS COSTING SYSTEM:Partially-processed units, Equivalent units
  24. PROCESS COSTING SYSTEM:Weighted average method, Cost of Production Report
  25. COSTING/VALUATION OF JOINT AND BY PRODUCTS:Accounting for joint products
  26. COSTING/VALUATION OF JOINT AND BY PRODUCTS:Problems of common costs
  27. MARGINAL AND ABSORPTION COSTING:Contribution Margin, Marginal cost per unit
  28. MARGINAL AND ABSORPTION COSTING:Contribution and profit
  29. COST VOLUME PROFIT ANALYSIS:Contribution Margin Approach & CVP Analysis
  30. COST VOLUME PROFIT ANALYSIS:Target Contribution Margin
  31. BREAK EVEN ANALYSIS MARGIN OF SAFETY:Margin of Safety (MOS), Using Budget profit
  32. BREAKEVEN ANALYSIS CHARTS AND GRAPHS:Usefulness of charts
  33. WHAT IS A BUDGET?:Budgetary control, Making a Forecast, Preparing budgets
  34. Production & Sales Budget:Rolling budget, Sales budget
  35. Production & Sales Budget:Illustration 1, Production budget
  36. FLEXIBLE BUDGET:Capacity and volume, Theoretical Capacity
  37. FLEXIBLE BUDGET:ANALYSIS OF COST BEHAVIOR, Fixed Expenses
  38. TYPES OF BUDGET:Format of Cash Budget,
  39. Complex Cash Budget & Flexible Budget:Comparing actual with original budget
  40. FLEXIBLE & ZERO BASE BUDGETING:Efficiency Ratio, Performance budgeting
  41. DECISION MAKING IN MANAGEMENT ACCOUNTING:Spare capacity costs, Sunk cost
  42. DECISION MAKING:Size of fund, Income statement
  43. DECISION MAKING:Avoidable Costs, Non-Relevant Variable Costs, Absorbed Overhead
  44. DECISION MAKING CHOICE OF PRODUCT (PRODUCT MIX) DECISIONS
  45. DECISION MAKING CHOICE OF PRODUCT (PRODUCT MIX) DECISIONS:MAKE OR BUY DECISIONS