TOPIC 1

INTRODUCTION TO COST ACCOUNTING

DEFINITION
Cost accounting is defined by Chartered Institute of
Management Accountants (CIMA) as “the application of
accounting and costing principles, methods and techniques in
the ascertainment of costs and analysis of savings and/or
excesses as compared with the previous experience or with
standards.”
Thus, basic concern is COST DETERMINATION.
(i.e. finding cost is the central activity in cost accounting)
OBJECTIVES OF COST ACCOUNTING
 To determine cost

 To plan and control

 To make decision

To determine cost: determine the classification of cost, amount of cost needed,

inventory valuation
To plan and control: Plan = long-term or short term plan – relate to budgeting.
Control = performance report, evaluate performance against the plan
To make decision: product pricing, make or buy, profitability analysis, product mix
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DIFFERENCES AND SIMILARITIES OF FINANCIAL ACCOUNTING
AND MANAGEMENT ACCOUNTING
DIFFERENCES Between Cost Accounting/ Management Accounting (CA/MA) &
Financial Accounting

Differences: User orientation

Information time frame
Reporting requirement
Reported frequency
 Degree of precision
Reported accounting entity

BASES OF CA/MA FA
DIFFERENCE
User orientation Caters the need of Caters the need of
Internal users External users
Information time Information is current Information is past
frame and futuristic oriented/ historical
Reporting Flexible Structured reporting rules,
requirement Approved accounting
standard
Reported Report is done as Report is done in a stated
frequency required (no specific period (yearly, quarterly,
period) etc)
Degree of Less precise, more Very precise, Objective in
precision subjective principle
Reported Report on segment of Report the business as a
accounting entity business whole

SIMILARITIES Between Cost Accounting/ Management Accounting (CA/MA) &

Financial Accounting
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Similarities: Record-keeping
Performance evaluation
Decision making
Principles of stewardship
Accounting system

ELEMENT OF COSTS
MATERIAL LABOUR EXPENSES

Direct Indirect Direct Indirect Direct Indirect

Prime Cost Overheads

Material cost – as the cost of commodities, other than fixed assets

introduced into products or consumed in the operation of an
organization. Example cost of flour in making bread.

 Sources of information: material requisition form, bin card, invoices

Labour cost – as the cost of employees remuneration as efforts and

skills are involved directly and indirectly in the operation of the
business. Example: wages paid to carpenter in making furniture.

 Sources of information: pay slip, remuneration slip, payment

voucher- salary

Expenses – are all other costs besides material and labour. Example:
rent, electricity, water.

 Sources of information: electricity- electricity bills, rental cost- rental

agreement
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CLASSIFICATION OF COSTS
COST CLASSIFICATION

Nature Behaviour Function Controllability Normality

direct fixed production controllable normal

indirect variable administration uncontrollable abnormal
semi-variable selling and
step distribution
 R&D

NATURE
The material, labour and expenses are the main elements of cost which can be
further classified into its nature either direct or indirect.
Direct Direct material Indirect Indirect material

(prime) Direct labour (overhead) Indirect labour

Direct expenses Indirect expenses

Direct cost = cost that can be directly identified to a particular cost unit, such
as particular product or job. Eg: cost of wood used in the production of
furniture. Total direct costs are known as prime cost.
Indirect cost = cost that cannot be directly identified with a product. Eg: rental
of machine used in the production of furniture. Total indirect costs are known
as the overhead costs.

BEHAVIOUR
Classifying cost according to how they vary with the level of activity is known
as cost behavior analysis. ~The way that a cost change as the volume of
activity increase or decrease.
fixed =costs that do not vary with level of activity, but remain the same
Cost (RM)
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Production
regardless of how much work is done. Eg: factory rent, insurance, depreciation.
Graph:

variable = cost that vary with level of activity, cost that change in total in
direct proportion to the level of activity. Eg: consumables, direct material
~flour in making bread
Graph: Cost (RM)

Production

semi-variable = costs which have both fixed and variable elements. They are
partly fixed and partly variable, so can be referred to either as semi-variable
cost or semi-fixed. Eg: telephone cost, which consist of fixed period rental and
charges for calls made (call charges vary with no of calls made).
Graph:
Cost (RM)

Production

step = also called as step fixed cost. Costs that are constant for a range of
activity levels, and then change, and are constant again for another range. Key
feature of step cost is that they are fixed within a limited range of activity, but
then go up a step as the activity level rises beyond certain level. Eg:
supervisors’ salaries.
Graph: Cost (RM)


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

production
FUNCTION
Classification of cost according to function is a classification according to the
type of activity for which the costs were incurred. According to function the
cost are classified as manufacturing or non-manufacturing.

A - Manufacturing = production
B - Non-manufacturing=administration, marketing, selling & distribution, R&D.

production = indirect cost related to production activities. Eg: Supervisors’

salaries, factory rental.

administration= indirect cost of operation in order to formulate policy and

control cost. eg: manager’s salaries, clerk salaries.

marketing = indirect cost related to marketing( promoting products), selling

and distribution activities/. Eg: printing banner, petrol for delivery van,
salesmen commissions.

 R&D= indirect cost of searching for new ideas, materials, method and new
scientific knowledge to produce new or improved product.

CONTROLLABILITY
controllable = costs that are influenced or can be controlled by the action of
manager / management
Eg: cost of machines repairs and maintenances are controlled by production
manager, number of employees.
Non-controllable = costs that are beyond the influenced of or cannot be
controlled by manager. Eg:cost of raw material ~depend on supply and
demand.
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 NORMALITY
normal = expected/ unavoidable cost. Cost that are expected and planned
for at a given level of output. Eg: loss of liquids such as petrol that evaporates
under efficient operating condition.
abnormal = unexpected/ avoidable cost. Cost incurred beyond expectation
or not within plan action and avoidable. Eg: unexpected defective units, loss of
production due to machine breakdown.

PERIOD COST AND PRODUCT COST

Period cost: cost that are not included in the inventory valuation and treated
as expenses in the period which they are incurred. Eg: administrative expenses
Product cost: costs that are identified with goods purchased for sales. Eg:
direct wages

AVOIDABLE AND UNAVOIDABLE COST

Avoidable cost: cost that can be eliminated by changing the operation or
taking one course of action rather than the other.
Unavoidable cost: cost that will not be changed, regardless of any decision that
is made.

CONVERSION COST
It is impossible for a product to produce by itself. It needs the service of direct
labour and other facilities such as factory area, machines, power tools and lighting
for factory area. Thus, conversion costs are the combination of direct labour cost
and production overhead in order to convert raw materials into finished goods.

COST ACCOUNTING SYSTEMS

BASIC COSTING PRINCIPLE AND CONCEPT

COST
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 Cost of a product or service is the expenditure incurred on producing it

COST UNIT
Cost always related to objects, functions or services. We associated cost
with quantity of product or service rendered
Cost unit is a quantitative unit of product or service to which cost can be
related
The nature of the unit cost will obviously depend on the type of goods
being produced or of the service being offered by the business concerned
Example
Cost units Uses
Kilowatt hours To ascertain electricity cost
Litres To ascertain the cost of petrol
Tones To ascertain the cost of coal
Consulting hours To ascertain cost of treating a patient

COST CENTER
Cost centers are the breakdown of a business into sections where costs can
be collected or charged
CIMA defines a cost center as ‘a location, person or item of equipment or
(group of these) in respect of which costs may be ascertained and related
to cost units’. centre
Cost center helps the accountant in ascertaining costs and help with the
cost control
Example:
A location, such as sales area
A person such as salesman
An item of equipment, such as delivery van
RESPONSIBILITY CENTERS
Unit of a firm where an individual manager is held responsible for the unit’s
performance.

1. COST OR EXPENSE CENTRES: managers are normally accountable for only

those costs that are under their control
2. REVENUE CENTRES: managers are accountable only for financial outputs in
the form of generating sales revenue

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 3. PROFIT CENTRES: units within an organization whose managers are
accountable for both revenues and costs.
4. INVESTMENT CENTRES: responsibility centers whose managers are
responsible for both sales revenues and cost and in addition have
responsibility and authority to make working capital and capital investment
decisions.

SOURCE DOCUMENTS RELATING TO RELEVANT INFORMATION

Sources Documents Information

Materials purchased -Goods received note -Confirming receipt into
stores
-Purchase invoice -Details of purchase costs
Materials used -Material requisition note -For materials issued to a
particular department
-Job cost card -To record materials used in a
particular job
Labour costs -Payroll records -Total labour costs, analysed
between department
-Job cost cards -Details of labour time/costs
on particular jobs
-Job sheets/ Job time -Details of time spent on
cards different activities and costs
of the time spent
Expenses Purchase invoices, Bills -Expenses incurred
Costs of production Job cost cards, -Overall production cost
Production analysis sheets incurred
Source:(CAT textbook Paper 4)

Analysis and dissemination of information

Cost and management accounting system should generate information in order:
 to allocate cost for internal and external profit measurement and inventory
valuation
 to provide relevant information in helping managers making better
decisions
 to provide information for planning, control and performance
measurement

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 A database should be maintained, with cost appropriately coded and classified, so
that relevant cost information can be extracted to meet each of the above
requirements. A code is a system of symbols to classify item and for reference.

COST STATEMENT/ STATEMENT OF COST

Name of Company
Cost Statement for the ....(year, month, quarter, half-year) ended…
RM RM
Direct material (rm0.50 x 2kg) XX
Direct labour XX
Direct expenses XX
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 PRIME COST XX

Add: Production overhead(indirect mat, lab, exp) XX

Total production cost XX

Add: Non-production overhead

- Administrative overhead XX
2 - Selling & Distribution overhead XX
- Finance overhead XX XXX
Total cost XX

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