INTRODUCTION TO COST

ACCOUNTING

LECTURE NOTE
By

Said Ahmed Wehliye

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 Course Contents

1. What are Accounting Disciplines

2. Strategy and Management Accounting
3. The relationships among financial,
management, and cost accounting?
4. Definitions of Cost Accounting
5. Features of Cost Accounting

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Cont..
6. Objectives of Cost Accounting
7. Principles of Cost Accounting
8. Element of costs
9. Cost classification

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Accounting Disciplines
 Financial Accounting – focus on
external users and GAAP rules
 Managerial Accounting – focus on
internal users and is not necessarily
GAAP-driven. Also provides data for
financial accounting. This includes:
 Cost Accounting
 Cost Management
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Strategy and Management
Accounting
 Strategy – specifies how an
organization matches its own
capabilities with the opportunities in the
marketplace to accomplish its objectives
 Strategic Cost Management –
focuses specifically on the cost
dimension within the overall strategy

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 What are the
relationships among
Financial, Management,
and cost accounting

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Meanings
 Financial accounting
 Cost accounting
 Management accounting

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Financial accounting
 Provides information to users who are
external to the business
 It reports on past transactions to draw
up financial statements
 The format are governed by law and
accounting standards established by the
professional accounting policies

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Cost accounting
 Is concerned with internal users of
accounting information, such as
operation managers
 The generated reports are specific to
the requirement of the management
 The reporting can be in any format
which suits the user

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Management accounting
 Comprises all cost accounting functions
 The accounting for product and service
costs, management accounting extends
to use various internal accounting
reports for planning, control and
decision making

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Cost and Management
Accounting

Vs.
Financial Accounting

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 Management Financial
(cost)accounting accounting
Nature Records material, Records company
labour and overhead transaction events
costs in product or job External financial

Reports produced are statements are

for internal produced
management and
control
Accountin Not based on the Follows the double
g system double entry system entry system

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 Management Financial accounting
(cost)accounting

Accounting No need to use Use Generally

principles accounting principles Accepted Accounting

Adopt any Principles for recording
accounting techniques transactions
that generates useful
accounting
information
Users of Used by different Used by external

information levels of management parties: shareholders,

or departments creditors, government,
responsible for etc
respective activities 13
 Management Financial
(cost)accounti accounting
ng
Operation Based on Conforms to company
guidelines management Ordinances, stock
or instructions and exchange rules,
standards requirements HKSSAPs

Time span Reports are Reports are prepared

prepared whenever for a definite period,

needed usually yearly and half
They may be yearly
prepared on a
weekly or daily basis

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 Management Financial accounting
(cost)accounting

Time focus Future orientation: Past orientation: use of

forecasts, estimates and historic data for reporting

historic data for and evaluation
management actions

Perspective Detailed analysis of Financial summary of the

parts of the entity, whole orgainisation
products, regions, etc

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 Cost accounting
vs.
Management accounting

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 Management Cost accounting
accounting
Objective To provide To ascertain and
information for control cost
planning and
decision making by
the management
Concerned with Based on both present
Basic of
recording transactions related and future transactions
to the future for cost ascertainment

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 Management Cost accounting
accounting
Coverage Covers a wider Covers matters
area: financial relating to
accounts, cost ascertainment and
accounts, taxation, control of cost of
etc. product or service

Utility Only the needs of The needs of both

internal internal and external
management interested groups

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 Definitions of Cost
Accounting
 Cost accounting is the classifying,
recording and appropriate
allocation of expenditure for the
determination of the costs of
products or services, and for the
presentation of suitably arranged
data for purposes of control and
guidance of management.
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Definitions of Cost
Accounting (Continues)
 It establishes budgets and standard
costs and actual cost of operations,
processes, departments or products and
the analysis of variances, and
profitability.

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Features of Cost
Accounting
1. It is a process of accounting for costs.
2. It records income and expenditure
relating to production of goods and
services.
3. It provides statistical data on the basis
of which future estimates are prepared
and quotations are submitted.

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Continues..
4. It is concerned with cost ascertainment, cost
control and cost reduction.
5. It establishes budgets and standards so that
actual cost may be compared to find out
deviations or variances.
6. It involves the presentation of right information
to the right person at the right time so that it
may be helpful to management for planning,
evaluation of performance, control and decision
making.

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Objectives of Cost
Accounting
 Ascertainment and analysis of cost
and income
 Accumulation and Utilisation of cost
data for control purposes
 Providing useful data to
management for taking decisions

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Cont..
 Fixation of selling price
 Cost control and cost reduction
 Ascertaining the profit of each activity
 Determination of break-even point.

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Principles of Cost
Accounting
 Charge of Cost Only after its Incurrence
 Past Costs Should not Form Part of
Future Costs
 Exclusion of Abnormal Costs from Cost
Accounts
 Principles of Double Entry Should be
Followed Preferably

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Application of cost accounting
 Cost accounting has extended from
manufacturing operations to a variety of
service industries such as hotels, bands,
airline, etc
 Cost accounting system should be
flexible and adaptable to meet the new
business environment and the changing
nature of the company
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Element of cost
 Cost
 Cost unit
 Cost object
 Cost centre
 Profit centre

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Cost
 It is the amount of expenditure
incurred on a specific cost object
 Total cost = quantity used * cost per
unit (unit cost)

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Cost unit
 It is a quantitative unit of product or
service in which costs are ascertained,
e.g. cost per table made, cost per
metre of cloth

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Cost object
 It is an activity or item or operation for
which a separate measurement of costs
is desired
 E.goperating the personnel department.
the cost of of a company, the cost of a
repair , and the cost for control

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 Cost centre
 It is a location or function of an
organization in respect of which costs
are ascertained
 E.g. the rent, and maintenance of
buildings; the wages and salaries of
storekeepers

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Profit centre
 It is location or function where
managers are accountable for sales
revenues and expenses
 E.g. division of a company that is
responsible for the sales of products

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Cost classification
 Direct cost
 Indirect cost (overhead)

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Direct cost
 Cost that can be identified specifically
with or traced to a given cost object
 The direct costs consist of the following
three elements:
 Direct materials
 Direct labour
 Direct expenses

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Direct materials
 The cost of materials – the cost of
materials used entering into and
becoming the elements of a product or
service
 E.g. fabrics in garments

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Direct labour
 The cost of remuneration for working
time
 E.g. assembly workers’ wages

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Direct expenses
 Other costs which are incurred for a
specific product or service
 E.g. painting or repairs only in the area
used for business

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Indirect cost (overhead)
 Cost that cannot be identified
specifically with or traced to a given
cost object
 They are identified with cost centres as
overheads
 Indirect materials
 Indirect labour
 Indirect expenses

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Indirect materials
 Such as stationery, consumable
supplies, spare parts for machine that
assist to the production of final products

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Indirect labour
 Such as salaries of factory supervision
and office staff that do not directly
involve in production of the final
product

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 Indirect expenses
 Such as rent, depreciation, maintenance
expenses that do not have instant
relationships with the manufacturing
processes

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 Cost accumulation
•Prime cost = direct materials + direct labour + direct expenses

•Production cost = Prime cost + factory overhead

OR
= Direct materials + Conversion cost
*Conversion cost is the production cost of converting raw materials into
finished product

•Total cost = Prime cost + Overheads (admin, selling,distribution cos

OR
= Production cost + period cost (administrative, selling,
distribution and finance cost)
•Period cost is treated as expenses and matched against sales for calculating
profit, e.g. office rental
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Cost behaviour
 Costs can be classified into fixed,
variable, and step-costs according to
how they behave with respect of
changes in activity levels

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Fixed cost
 Total fixed cost is the cost that remains
constant over a relevant range of
activity level but unit fixed cost falls
with an increase in activity volume

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Variable cost
 Variable cost is the cost that increases
or decreases in direct proportion to
levels of activity, but the unit variable
cost remains constant
 E.g. cost of food served in a restaurant

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Step cost
 It remains constant for a range of
activity levels, then, on further increase
in activity, the cost jumps to a new level
and remains constant over a certain
range until the next jump occurs

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Product cost
 Product cost are related to the goods
purchased or produced for resale
 If the products are sold, the product cost will
be included in the cost of goods sold and
recorded as expenses in current period
 If the products are unsold, the product costs
will be included in the closing stock and
recorded as assets in the balance sheet

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Period cost
 Period cost related to the operation of a
business
 They are treated as fixed cost and charged as
expenses when they are incurred
 They should not be included in the stock
valuation
 E.g. General and administrative expenses,
such as rent, office depreciation, office
supplies, and utilities.
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END
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