accounting..modfd

7/30/2019 Accounting..Modfd

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Financial Accounting, Cost AccountingAnd Management Accounting

Financial accountingFinancial accounting is mainly concerned with

recording business transactions in the books of

account for the purpose of presenting final accounts to

management, shareholders and tax authorities, etc.The information supplied by financial accounting is

summarized in the following three statements at the

end of a period, generally one year.

a) Profit and Loss Account showing the net profit or

loss during the period;

b) Balance Sheet showing the financial position of the


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Firm at a point of time;

c) Cash Flow Statement showing the inflows and

outflows of cash arising from the business activities

during the period covered by the statement.

Cost Accounting

Cost accounting is a relatively recent development.

Modern cost accounting developed only during thenineteenth century.

It is concerned with the ascertainment of past, present

and expected future costs of products manufactured or

services supplied.

The information supplied by cost accounting acts as a

management tool for decision-making, to optimize the

utilization of scarce resources and ultimately add to


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the profitability of business by controlling expenditure

under various heads.

Management Accounting

The Chartered Institute of Management Accountants

(CIMA), London has defined management accounting

as the presentation of accounting information in such

a way as to assist management in the creation ofpolicy and in the day-to-day operations of an

undertaking.


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Limitations of Financial Accounting

1. Shows only overall performance

2. Historical in nature

3. No performance appraisal

4. No material control system

5. No labour cost control6. No proper classification of costs

7. No analysis of losses

8. Inadequate information for price fixation9. No cost comparison

10.Fails to supply useful data to management


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1. Ascertainment of cost

2. Cost control and cost reduction

3. Guide to business policy

4. Determination of selling price

Cost Accounting And Financial Accounting Comparison

Basis Financial Accounting Cost Accounting

1. Purpose The main purpose of financial

accounting is to prepare Profit

and Loss Account and Balance

Sheet for reporting to owners or

shareholders and other outsideagencies, i.e., external users.

The main purpose of cost

accounting is to provide detailed

cost information to management,

i.e., internal users.

2. Statutory

requirements

These accounts have to be

prepared according to the legal

requirements of Companies Act

and Income Tax Act.

Maintenance of these accounts is

voluntary except in certain

industries where it has been

made obligatory to keep costrecords under the Companies Act.


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Basis Financial Accounting Cost Accounting

3.

Periodicity

of reporting

Financial reports (Profit and

Loss Account and Balance

Sheet) are prepared

periodically, usually on anannual basis

Cost reporting is a

continuous process and may

be daily, weekly monthly, etc.

4. Control

aspect

It lays emphasis on the

recording of financial

transactions and does notattach any importance to

the control aspect.

It provides for a detailed

system of controls with the

help of certain specialtechniques like standard

costing and Inventory control

etc.

5. Format ofpresenting

information

Financial accounting has asingle uniform format of

presenting information, i.e.,

Profit and Loss Account,

Balance Sheet and Cash

Flow Statement

Cost accounting has variedforms of presenting cost

information which are

tailored to meet the needs of

management and thus lacks

a uniform format.


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LossLoss is defined as reduction in a firms equity,other than from withdrawals of capital for which no

compensating value has been received.Cost Centre

A cost centre is defined by CIMA, London as alocation, person, or item of equipment (or group of

these) for which costs may be ascertained and used

for the purpose ofcontrol.Cost Unit

A cost unit is defined by CIMA, London as a unit of

product or service in relations to which costs areascertained.Cost ObjectCost object may be defined as anything for which a

separate measurement of cost may be desired.


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Methods of Costing

The methods or types of costing refer to the

techniques and processes employed in the

ascertainment of costs.

1. Job order costing. This method applies wherework is undertaken to customers special

requirements.2. Contract costing or terminal costing. This is avariation of job costing, a contract is a big job and a

job is a small contract. Contract costing is most

suited to construction of buildings dams, bridgesand roads, shipbuilding, etc.

3. Batch costing. This is also a variation of jobcosting. The cost of a batch or group of identical


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products is ascertained and therefore each batch of

products is a cost unit. This method is used in

companies engaged in the production of readymade

garments, toys, shoes, tyres and tubes, componentparts, etc.

4. Process costing. This method is used in massproduction industries manufacturing standardized

products in continuous processes of

manufacturing. The finished product of one

process is passed on to the next process as raw

material. Textile mills, chemical works, sugar mills,refineries, soap manufacturing, etc.

5. Operation costing. A more detailed application ofprocess costing. A process may consist of a

number of operations and operation costing


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involves cost ascertainment for each operation instead

of a process.

6. Single, output or unit costing. This method ofcost ascertainment is used when production isuniform and consists of a single or two or three

varieties of the same product. This method is

applied in mines, quarries, brick kilns, steelproductions, flour mills, etc.

7. Operating or service costing. It is used inundertakings which provide services instead of

manufacturing products. For example, transportundertakings (road transport, railways, airlines,

shipping companies), electricity companies, hotels,

hospitals, cinemas, etc.


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8. Multiple or composite costing. This method isused in industries where a number of components

are separately manufactured and then assembled

into a final product. Air-conditioners, refrigerators,

scooters, cars, locomotives.

Techniques of CostingThese techniques may be used for special purpose of

control and policy in any business irrespective of the

method of costing being used there.

1. Standard costing. In this technique, standard costis pre-determined as target of performance, and

actual performance is measured against the

standard. The difference between standard and


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Actual costs are analyzed to know the reasons for the

difference so that corrective actions may be taken.

2. Budgetary control. A budget is an expression of a

firms business plan in financial form and budgetarycontrol is a technique applied to the control of total

expenditure on materials, wages and overheads by

comparing actual performance with plannedperformance.

3. Marginal costing. Marginal costing regards onlyvariable costs as the cost of the products. Fixed

cost is treated as period cost and no attempt ismade to allocate or apportion this cost to individual

cost centres or cost units. This technique is used

to study the effect on profit of changes in volume or

type of output.


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4. Total absorption costing. It is a traditional methodof costing whereby total costs (fixed and variable)

are charged to products.

5. Uniform costing. It simply denotes a situation inwhich a number of firms adopt a uniform set of

costing principles.

Cost Ascertainment and Cost Estimation

Cost ascertainment Cost ascertainment is concernedwith computation of actual costs incurred. Different

types of industries, different methods are employed for

ascertaining cost. These methods are job costing,

contract costing, batch costing, process costing,

operation costing, single costing and multiple costing.


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Ascertainment of actual costs reveals unprofitable

activities, losses and inefficiencies occurring in the

form of idle time, excessive scrap, etc.

Cost estimation Cost estimation is the process of pre-determining costs of goods or services. Estimated

costs are definitely the future costs and are based on

the average of past actual costs adjusted foranticipated changes in future. Cost estimates may

have the following uses:

1. Cost estimates are used in making price quotations

and bidding for contracts.2. Cost estimates are used in the preparations of

budgets.

3. They help in evaluating performance.


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4. They are used in preparing projected financial

statements.

5. Cost estimates may serve as targets in controlling

the costs.

Classifications of Cost

1. Classification into Direct and Indirect Costs

Direct Costs These are those costs which areincurred for and conveniently identified with a

particular cost unit, process or department. Cost ofraw materials used and wages of a machine

operator are common examples of direct costs.

Indirect costs These are general costs and are

incurred for the benefit of a number of cost units,


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processes or departments. Depreciation of machinery,

insurance, lighting, power, rent, managerial salaries,

materials used in repairs, etc., are common examples

of indirect costs.2. Classification into Fixed and Variable Costs

i) Fixed costs. These costs remain constant in totalamount over a specific range of activity for a

specified period of time, i.e., these do not increase

or decrease when the volume of production

changes.

No. of units produced Total fixed cost Rs. Fixed cost per unit Rs.1 20,000 20,000

2 20,000 10,000

20 20,000 1,000

200 20,000 100

2,000 20,000 10


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Total fixed cost lineRs.

Cost

Volume of Production

Behaviour of fixed cost.

Y

XO


Y

XO

Rs.

Cost

Rele ent Range Fi ed cost


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Relevent Range

Fixed costremains fixed only in relation to a

given range of output and for a

given time span. If the output is tobe increased beyond the range, the

fixed cost will also increase.

ii) Variable costs. These costs

tend to vary in direct proportion tothe volume of output. In other

words, when volume of output

increases, total variable cost also

increases, and vice versa, whenvolume of output decreases, total

variable cost also decreases, but

the variable cost per unit remains

fixed.

Fixed CostsRent and lease

Managerial salaries

Building insurance

Salaries and wages

of permanent staff

Municipal taxes.

Variable CostsDirect materials

Direct wages

Power

Royalties

Normal spoilage

Commission of

salesmen

Small tools


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Rs.

Cost


Behaviour of variable cost.

Y

XO


Y

XO

Rs.

Cost

Variable cost per unit


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iii) Semi-variable or semi-fixed costs (mixedcosts). These costs include both a fixed and avariable component. A semi-variable cost often has a

fixed element below which it will not fall at any level of

output.

Semi-variable CostsSupervision

Maintenance and repairs

Compensation for accidents

Telephone expensesLight and power

Depreciation


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Cost(Rs.)


Behaviour of semi-variable cost.

OVolume of Production

OVolume of Production

O

Cost(Rs.)

Cost(Rs.)


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Cost(Rs.)


Comparative behaviour of fixed, variable and semi-variable costs.

O

Y

X

A

B

C

A = Fixed cost line

B = Semi-variable cost line

C = Variable cost line


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3. Classifications into Committed and Discretionary

Cost

Fixed costs are further classified into committed costs

and discretionary (or programmed) costs.

Committed Costs These are those costs that areincurred in maintaining physical facilities and

managerial set up. They are unavoidable.Depreciation of plant and equipment is committed

because these facilities cannot be easily changed in

the short run.

Discretionary Costs These are those costs which canbe avoided by management decisions. Advertising,

research and development cost and salaries of low

level managers


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4. Classification into Product Costs and PeriodCosts

Product Costs These are those costs which arenecessary for production. These consist of directormaterials, direct labour and some of the factory

overheads.

Period Costs these are those costs which are notnecessary for production and are incurred even if

there is no production. Such costs are incurred for a

time period and are charged to Profit and Loss

Account of the period. Administration and sellingexpenses are generally treated as period costs.


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Product CostRecorded as an asset

in the form of inventory

in the Balance Sheet

Recorded as an

expense in the Profit

and Loss Account ofthe current period

For unsold goods

Product Cost

Accounting treatment of product and period costs


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5. Classification into Controllable and Non-controllable Costs

Controllable Costs These are the costs which maybe directly regulated. Variable costs are generallycontrollable.

Non-Controllable Costs These are those costs which

cannot be influenced. Controllable costs cannot bedistinguished from non-controllable costs without

specifying the level and scope of management

authority. A cost which is uncontrollable at one level of

management may be controllable at another level of

management. All costs are controllable in the long run

at some appropriate management level.


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a given level of output. Such cost is over and above

the normal cost and is not treated as a part of the cost

of production. It is charged to costing Profit and Loss

Account.

SPECIAL COSTS FOR MANAGEMENT DECISION-

MAKINGRelevant Costs and Irrelevant Costs

Relevant cost Not all costs are relevant for specific

decisions. In decision making, management shouldconsider only future costs and revenues that will differ

under each alternative.

Irrelevant costs These are those costs that will not be

affected by a decision. One may have to decide about


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Making a journey by own car or by a public transport

bus. In this decision, insurance cost of car is irrelevant

because it will not change, whatever alternative is

chosen. However, cost of petrol and other operatingcosts of car will differ under the two alternatives and

thus, are relevant for this decision.

Sunk CostsA sunk cost is an expenditure made in the past that

cannot be changed and over which management no

longer has control. These costs are not relevant for

decision-making about the future. The book value ofan asset currently being used is not relevant in making

the decision to replace. What is relevant is how much

cash could be realised in future by selling it.


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Not all irrelevant costs are sunk costs but all sunk

costs are irrelevant. In choosing from the two

alternative methods of production, if direct material

cost is the same under the two alternatives, it is anirrelevant cost. But direct material cost is not a sunk

cost because it will be incurred in future and is a future

cost.

Differential (or Incremental) Costs

Differential cost is the increase or decrease in total

cost that results from an alternative course of action.

The alternative choice may arise because of change inmethod of production, in sales volume, change in

product mix, make or buy decisions, take or refuse

decision, etc.


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Marginal Cost

Marginal cost is the additional cost of producing one

additional unit. Marginal cost is the same thing as

variable cost. Marginal costing is also a very important

analytical and decision making tool in the hands of

management. It helps in decisions like make or buy,

pricing of products, selection of sales mix, etc.Imputed Costs

These are hypothetical costs which are specially

computed outside the accounting system for the

purpose of decision-making. Interest on capital

invested is a common type of imputed cost. For

example, project A requires a capital investment of Rs.

50,000 and project B Rs. 40,000. Both the projects


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are expected to yield Rs. 10,000 as additional profit.

Obviously, these two projects are not equally profitable

since project B requires less investment and thus, it

should be preferred. Similarly, rental value of buildingowned by a firm is also an imputed cost.

Opportunity Cost

Opportunity cost is the sacrifice involved in acceptingan alternative under consideration. It is a cost that

measures the benefit that is lost or sacrificed. For

example, a company has deposited Rs. 1 lakhs in

bank at 10% p.a. interest. Now, it is considering aproposal to invest this amount in debentures where the

yield is 17% p.a. It the company decides to invest in

debentures, it will have to forego bank interest or Rs.

10,000 p.a., which is the opportunity cost.


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Replacement Cost

Replacement cost is the current market cost of

replacing an asset.

Out-of-pocket Cost (Explicit and Implicit Cost)

Out-of-pocket cost, also known as explicit costs, are

those costs that involve cash outlays or require the

utilization of current resources. Depreciation on plantand machinery is an implicit cost because it does not

involve any immediate cash outlay.

Future CostThe only relevant costs for decision-making are pre-

determined or future costs. But it is the historical costs

which generally provide a basis for computing future

costs.


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Conversion Cost

This term is used to denote the sum of direct labour

and factory overhead costs in the production of a

product.

It should be noted that labour cost is a part of prime

cost as well as conversion cost.

Direct Material

Direct Labour

Factory Overhead

Prime cost

Conversion cost


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ELEMENTS OF COST

Total Cost

Direct Cost Indirect Cost

DirectMaterial

DirectLabour

DirectExpenses

IndirectMaterial

IndirectLabour

IndirectExpenses

BC S C


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ABC Technique (Selective Control)

ABC technique is a value based system of material control.

ABC technique is sometime called always Better Control

method.

A Items These are high value items which may consistof only a small percentage of the total items handled.

B Items These are medium value materials whichshould be under the normal control procedures.

C Items These are low value materials which mayrepresent a very large number of items.

Category % of total value % of total quantity Type of controlA 70 10 Strict control

B 25 30 Moderate control

C 5 60 Loose control

Total 100 100

The information in the above table has been presented in


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The information in the above table has been presented inthe following diagram:

% of total quantity

ABC categories of stock (cumulative percentages).

95

100

70

50

B C

A

10 40 50 100O


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4. Storage/Warehousing costs.

5. Procurement costs.

6. Reliability of suppliers.7. Minimum order quantities imposed by suppliers.

8. Risk of loss due to (a) obsolescence, (b) deterioration,

(c) evaporation, and (d) fall in market prices, etc.

Maximum Level

This is that level above which stocks should not normally

be allowed to rise.Maximumlevel

Re-order

level

Re-order

quantity

Minimum

consumption

Minimum

re-order period= + - x

Mi i L l


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Minimum Level

It is that level below which stock should not normally be

allowed to fall.

Re-order Level or Ordering LevelThis is that level of material at which purchase requisition

is initiated for fresh supplies.

Maximum

level

Re-order

level

Normal

consumption

Normal

re-order period= - x

Re-orderlevel

Maximumconsumption

Maximumre-order period

= x

Danger Level


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Danger Level

Sometimes purchased materials are not received in time

and stock level goes below the minimum level. In order to

meet such a situation a danger level is fixed. Danger levelis a level at which normal issue are stopped and materials

are issued for important jobs only.

Average Stock Level

This is computed as follows:

Average stock level = (Minimum level + Maximum level)

Alternatively, Average stock level = Minimum level + (Re-order quantity)

Lead time is the time interval between the time when an

item reaches re-order level and a fresh order is placed, to

the time or actual receipt of materials.

Danger

level

Maximum

consumption

Maximum re-order period

Under emergency conditions= x


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Re-order Quantity (Economic Order Quantity or EOQ)

Re-order quantity is the quantity for which order is placed

when stock reaches re-order level. It is the quantity which

is most economical to order. Economic order quantity isthat size of the order which gives maximum economy in

purchasing any material. While setting economic order

quantity, two types of costs should be taken into account:

1. Ordering cost. This is the cost of placing an order withthe supplier. It mainly includes the cost of stationery,

salaries of those engaged in receiving and inspection,

salaries of those engaged in placing order, etc.

2. Cost of carrying stock. This is the cost of holding thestock in storage. It includes the following:


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Cos

t(Rs.)

Units per order

Economic Order Quantity

Y

O

200

400

600

800

250 500 750

Economic order quantity

a) Cost of operating the stores, (salaries, rent, stationery,


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a) Cost of operating the stores, (salaries, rent, stationery,

etc.);

b) The incidence of insurance cost;

c) Interest on capital locked up in store;d) Deterioration and wastage of materials.

Mathematical formulae of EOQ

EOQ =

Where EOQ = Economic Order Quantity

A = Annual consumption in unitsB = Buying or ordering cost per order

C = Cost per unit

S = Storage or carrying cost as a percentage

2.A.B.C.S

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