Module 1: Cost Accounting

At the end of the module, you should be able to:

➢ Understand cost and management accounting framework.

➢ Identify cost and the costing of resource inputs.

➢ Understand accounting for materials.

Introduction

It is vital for the business that all the costs incurred are recorded in a systematic
manner, this method is called cost accounting. It is a branch of accounting that helps us
to classify, record, and allocate the expenditure for the determination of costs of product.
Expenditure involved in business has to be determined to fix the price of a product
produced. Thus, it holds importance to various departments of business. Management,
investors, employees, government and even consumers themselves benefit from cost
accounting.
Cost accounting is an art as well as science. It is a science because it is a body of
systematic knowledge having certain principles. It is an art as it requires the ability and
skill with which a cost accountant can apply the principles of cost accounting in various
managerial problems (Das, 2019).
In this module, as future Cost Accountant we need to learn that the expenditure in
the business is to be understood in terms of material, labor and other direct and indirect
expenses. The major purpose of such classification is to estimate the profit and to
understand its relationship with costs and price. The three elements of a transaction i.e.,
cost, profit and price are necessary components of any business activity (Anbarasu,
2018).
 Module 1: Cost Accounting

Unit 1: introduction to cost accounting

UNIT LEARNING OUTCOMES

• Distinguish between financial, management and cost accounting
• Distinguish between merchandising and manufacturing
• Identify the uses of cost accounting data
• Distinguish between job order costing and process costing

CONTENT:
The major task when it comes to cost accounting is the need to properly plan,
control and to make decision. Cost accounting is a management information system tool
that helps to collect required data, analyzing the present and the future to fit into the
various problems encountered by managers so as to enable them to plan, control and to
make reformed decision (Elizabeth, 2020).

Definitions of Cost Accounting.

According to the Terminology used by the Institute of Cost and Management Accountants,
“Cost accounting is the part of management accounting which establishes budgets and standard
costs and actual costs of operations, processes, departments or products and the analysis of
variances, profitability or social use of funds.”

Difference between financial accounting and cost accounting

Both branch of accounting is complementary to each other. Preparation of both
accounts will help the organization run its business smoothly. The difference between
Cost Accounting and Financial Accounting is given below (Anbarasu, 2018):
Cost Accounting Financial Accounting

1) It helps us to ascertain the cost of goods It helps us to know operational results and
produced. financial position of business.
 2) It provides required information to the It provides information parties involved in
management. business internally and externally.

3) It need not be followed by a system of Audit is a statutory obligation

external audit

4) It classifies the costs into material, labor, Transactions are divided into debit and
fixed overhead and variable overhead. credit terms.

5) Cost sheet is main format of cost Trading and Profit & Loss Account and
accounting Balance Sheet are two consolidated
financial statements.

6) It does not form a basis for tax It forms a basis for deciding the tax
assessment. liabilities of the business.

7) Variance analysis is to identify the It records only actual transactions

favorable and adverse difference between occurring in the course of business
standard cost and actual cost. operations

8) Cost accounting facilitates the Financial statements are annually

presentation of cost information at presented.
regular intervals.

9) Profit or loss is estimated on specific It presents operational results of the entire

product, branch, department or job. business.

10) It is an effective control device Financial accounting is not a control

device. Rather, accounting ratios can be
computed with financial accounting.

11) Unit wise accounting is also prepared. Monetary units alone are yardstick of
financial accounting.

Source: Scrib.com

Difference between management accounting and cost accounting

Management accounting is concerned with all such information that is useful to the
management. The Institute of Cost and Management Accountants of England defines
management accounting as “It is a presentation of accounting information in such a
way as to assist management in the creation of policy and in the day-to-day
operation of an undertaking”. Management accounting consists of some essential
activities:
a. Estimation of cost is one of the basic tasks of management. If it is estimated, the
management will use the estimation in control process and planning decisions.
 b. Controlling the cost is another function of management. Here the cost incurred is
compared with task performed. Corrective measures should be initiated when
costs are excessive.
c. Performance evaluation is another part of management accounting. Managers are
often monitored. Their performance should be consistent with the goals of the
organization. For which, a comprehensive reporting system is required.
d. It supplies information to the management for planning and decision-making.

On the other hand, cost accounting is on cost control and cost determination.
Whereas the management accounting uses the principles and practices of financial
accounting and costing accounting in addition to other managerial techniques for effective
management. The examples of these techniques are standard costing, budgetary control,
uniform costing and inter-firm costing, marginal costing, flow analysis, ratio analysis etc.,
Therefore, the management accounting is an all-inclusive package. It is an application of
managerial aspect of cost accounting.

To conclude, cost accounting is the intersection between financial and managerial

accounting. The information provide by cost accounting is needed and used by both
financial and managerial accounting. Also, cost accounting provides product cost
information for external and internal parties of the business.

The most significant difference

between a manufacturing and a
merchandising business is that a
manufacturer makes goods to sell and a
merchandiser buys or acquires goods for
resale.
 With this, there will be a big difference in computing cost of goods sold (COGS).
In merchandising business, they determine cost of goods sold by accounting for both
existing inventory and new purchases. It is naturally easy for merchandising businesses
to compute their costs because they identify exactly what they paid for their merchandise.
On the other hand, manufacturing businesses must compute their cost of goods sold
based on how much they manufacture and how much it costs them to manufacture the
goods. This requires manufacturing businesses to compute first the cost of goods
manufactured before they can calculate their cost of goods sold. Shown below are
comparison of computation of COGS.

Source: opentextbc.ca

Note: The three inventory accounts in manufacturing are Material inventory, WIP
inventory and Finished Goods Inventory

Source: opentextbc.ca
Example of Cost of Goods Manufactured

Source: opentextbc.ca

Two Basic Product-Costing Systems

1. JOB ORDER COSTING – A system for allocating cost of groups of unique

products. The job order costing system is used when the various items produced
are sufficiently different from each other and each has a significant cost. Since
there is a significant difference in the items manufactured, the job order costing
system entails a separate job cost record for each item (or each job or special
order). The job cost record will present each item's direct materials and direct labor
that were actually used and an allocated amount of manufacturing overhead.

A few examples of the use of job order costing are:

• A company that designs and produces custom-made machines
and/or machine tooling
• A company that constructs custom-designed buildings
• A company that modifies trucks to meet customers' special needs

2. PROCESS COSTING – A system applicable to a continuous process of production

of same or similar goods. When a company's product consists of continuous flows
 of identical, low-cost units, the process costing system is more appropriate. Thus,
this is used when nearly identical units are mass produced.

Furthermore, major difference between job order and process costing are shown
below:

Source: civilserviceindia.com

Source: principlesofaccounting.com
Source: principlesofaccounting.com
 TERMS USED IN COST ACCOUNTING
Budgeted cost: This is a future cost or a predetermined cost collected before it is incurred on
the aggregate or total units of production.
Standard cost: It is a future or a predetermined cost collected before it is incurred but based
on the unit of an item of production.
Actual cost: These are costs that are collected based on historical data that is, costs that are
already been incurred. It is also known as a past cost.
Variance: This is the comparison of the standard costs with the actual costs
Cost unit: This is the unit of the quantity of a product, process, operation and department in
relation to which cost is ascertained. Once costs have been traced to cost centres, they can be
further analyzed in cost units. Examples of cost units include the following: guest per night,
passenger per trip, mile, tonne/mile, patient/night e. t.
Cost centre: This is a product, item of equipment, location, or a person in relation to which
cost is ascertained and accumulated for cost control purposes
Relevant Cost and Irrelevant cost: For the purpose of decision making, costs can be
classified according to whether they are relevant to a particular decision. Relevant costs are
those future costs that will be changed by a decision.
Irrelevant costs are costs that remain constant or the same whether or not a decision a decision
is made. That is, they cannot affect decision.
Avoidable and Unavoidable Cost: Avoidable costs are those costs that may be saved by
not adopting a given alternative, whereas unavoidable costs are not affected by whatever
decision being considered. Only avoidable costs are relevant for decision purposes.
Controllable and Uncontrollable: Controllable costs are costs that can be influenced by the
manager in charge of cost control, whereas uncontrollable costs are costs that cannot be
influenced by the manager in charge of cost control. That is, control cannot be exercise on
uncontrollable costs. Only controllable costs are relevant when making decision.
Opportunity Costs: An opportunity cost is a cost that measures the opportunity that is lost or
sacrificed when the choice of one course of action requires that an alternative course of action
is given up.
Sunk Costs: These are cost of resources already acquired where the total will be unaffected
by the choice between various alternatives. They are costs that have been created by a
decision made in the past and that cannot be changed by any decision that will be made in the
future.
Incremental Costs and Marginal Cost: these are the additional cost resulting from a group
of additional units of output, whereas marginal cost is the additional cost of one extra unit of
output.
Differential costs: these are the difference between the costs of each alternative action that
is being considered.

Product costs: These are costs that are identified with goods purchased or produced for
resale. In a manufacturing concerned they are attached to the product and are included in the
inventory valuation for finished goods, or for partly completed goods, until they are sold; they
are them recorded as expenses and matched against sale for calculating profit.
 TERMS USED IN COST ACCOUNTING

Product costs: These are costs that are identified with goods purchased or produced for
resale. In a manufacturing concerned they are attached to the product and are included in the
inventory valuation for finished goods, or for partly completed goods, until they are sold; they
are them recorded as expenses and matched against sale for calculating profit.
Period costs: These are cost that are not included in the inventory valuation and as a result
are treated as expenses in the period in which they are incurred.
Cost audit: cost audit is a detailed checking of the costing system, technique and accounts to
verify its correctness and to ensure adherence to the objective of cost accounting. It is also
referring to as an audit of efficiency of details of expenditure while the work is in progress.
Objectives of cost audit
i. to determine and control cost
ii. to provide data for making judgments and decisions on various matters e.g. operation
efficiency
iii. from management’s perspective, to detect errors, frauds and misappropriation and
hence, enhance efficiency
iv. from customers’’ perspective, to obtain more benefit if the cost is reduced due to
effective control implementation as a result of a cost audit
v. from shareholders’ view; to ensure that valuation of closing stock and work in progress
are correct, hence, helps in the computation of more accurate profit figure
vi. from government view; to ensure that costs are reduced so that more tax will be paid
by the company

NOTE! During cost audit, the cost auditor will place his/ her attention on the following
records: record of materials, labor, overhead charges, depreciation, incomplete records,
stores and spare parts records.
EXERCISES:
TRUE-FALSE STATEMENTS
Write TRUE if the statement is correct. Write FALSE if the statement is incorrect.
1. Cost accounting is primarily concerned with accumulating information about
product costs.
2. A job order cost system is most appropriate when a large volume of uniform
products are produced.
3. A process cost accounting system is appropriate for homogeneous products that
are continuously mass produced.
4. A job order cost system and a process cost system are two alternative methods
for valuing inventories.
5. A job order cost system identifies costs with a particular job rather than with a set
time period.
6. A company may use either a job order cost system or a process cost system, but
not both.
7. Management accounting applies to all forms of business organizations
8. Process costing is used by companies making one-of-a-kind products.
9. Determining the unit cost of manufacturing a product is an output of financial
accounting.
10. Managerial accounting applies to all forms of business organizations.

EVALUATION:
Multiple Choice. Encircle the letter of the best answer.
1. A major purpose of cost accounting is to
a. classify all costs as operating or nonoperating.
b. measure, record, and report period costs.
c. provide information to stockholders for investment decisions.
d. measure, record, and report product costs.

2. The two basic types of cost accounting systems are

a. job order and job accumulation systems.
b. job order and process cost systems.
c. process cost and batch systems.
d. job order and batch systems.
3. A process cost system would most likely be used by a company that makes
a. motion pictures.
b. repairs to automobiles.
c. breakfast cereal.
d. college graduation announcements.

4. Which of the following would be accounted for using a job order cost system?
a. The production of personal computers
b. The production of automobiles
c. The refining of petroleum
d. The construction of a new campus building

5. Process costing is used when

a. the production process is continuous.
b. production is aimed at filling a specific customer order.
c. heterogeneous products are involved.
d. costs are to be assigned to specific jobs.

6. Process costing is not used when

a. homogeneous goods are being produced.
b. large volumes are produced.
c. jobs have distinguishing characteristics.
d. a series of connected manufacturing processes is necessary.

7. An important feature of a job order cost system is that each job

a. must be similar to previous jobs completed.
b. has its own distinguishing characteristics.
c. must be completed before a new job is accepted.
d. consists of one unit of output.

8. The flow of costs in a job order cost system

a. involves accumulating manufacturing costs incurred and assigning the
accumulated costs to work done.
b. cannot be measured until all jobs are complete.
c. measures product costs for a set time period.
d. generally follows a LIFO cost flow assumption.

9. Which of the following is not a management function?

a. Constraining
b. Planning
c. Controlling
d. Directing and motivating

10. Which of the following is not an internal user?

a. Creditor
b. Department manager
 c. Cost accountant
d. Controller

11. Management accountants would not

a. Assist in budget planning
b. Prepare reports primarily for external users
c. Determine cost behavior
d. Be concerned with the impact of cost and volume on profits

12. Financial accounting information is used for reporting to

a. External parties
b. Investors
c. Creditors
d. Managers

13. Internal reports are generally

a. Aggregated
b. Detailed
c. Regulated
d. Unreliable

14. Management accounting information

a. Pertains to the entity as a whole and highly aggregated
b. Pertains to sub-units of the entity and may be very detailed
c. Is prepared only once a year
d. Is constrained by the requirements of FASB

15. Internal reports must be communicated

a. Daily
b. Monthly
c. Annually
d. As needed.

ASSIGNMENT:
1. How does management accounting serve both external users and internal users?
2. What is the difference between financial accounting and management
accounting?
3. What cost method must be used by:
a. A company manufacturing school bag
b. A company manufacturing aircraft
c. A company manufacturing candies