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Cost and Management AccountingNotes4.Cost Audit: The terminology of ICMA, London, defines cost audit, as “the verification of thecorrectness of cost accounts and of the adherence to the cost accounting plan”. Cost audithas a much wider role to play in an industry or organisation than people could imagine.The aim of cost audit is to highlight the shortcomings inherent in the cost accountingsystem.5.Budgetary Control: According to Heiser, budgetary control can be defined as “an overallblue print of a comprehensive plan of operations and actions expressed in financial terms”.According to him, budgeting process involves the preparation of a budget, comparison ofbudgeted and actual expenditure and income, planning and coordinating for control, etc.Self AssessmentFill in the blanks:4. is the guidance and regulation by executive action of the costs of operatingand undertaking.5.The aim of . is to highlight the shortcomings inherent in the cost accountingsystem.6. process involves the preparation of a budget, comparison of budgeted andactual expenditure and income, planning and coordinating for control, etc.1.3 Relationship between Financial Accounting and Cost AccountingIn a modern system of industrial accounting, there is no independent cost ledger or financialledger, but the complete accounting system is amalgamated into one set of double-entry accounts.In other cases, the figures posted to the cost ledger are reconciled at regular intervals, probablymonthly, with the figures shown in the revenue accounts of the financial ledger.Whichever system is adopted, the expenditure accounts and the cost accounts are interdependent.The application of financial and cost accounting to the service of management should be plannedas one coordinated service, and for this purpose should be under common control. Integrationdoes not, therefore, imply only the amalgamation of two systems or accounts, but it also entails theamalgamation of the accounting sections, including the cost office, into one unified department.It is, furthermore, desirable in the interests of the efficiency of the financial division that clerksshall be given the opportunity of obtaining experience in both financial accounting and costaccounting; in other words, in records of total expense heading and of breakdowns or analyses.Differences between Cost Accounts and Financial Accounts41.Financial accounts deal with all the items of expenses, losses, income and gains in total butthe cost accounts deal with items of cost alone.2.In financial accounts, items of cost that are dealt with are expressed in totals. Therefore,such accounts cannot disclose the cost per unit whereas in cost accounts all expenses areanalyzed very carefully and apportioned accordingly. Hence, cost per unit can be veryeasily determined.3.Financial accounts deal with facts alone whereas cost accounts deal with estimates as wellas facts. Therefore, the result of cost accounts does not always tally with financial accounts.4.Financial accounts cover a long period usually a year, but cost accounts cover comparativelya short period say a week, fortnight or a month.5.Cost accounts do not form part of the ordinary process of double entry systems. Whereasthe financial account must be invariably maintained according to double entry system.LOVELY PROFESSIONAL UNIVERSITY

Unit 1: Introduction to Cost Accounting6.Financial accounts display results in total profits whereas cost accounts give the results ofeach operation.7.All expenses such as interest on capital, depreciation, etc., are normally charged infinancial accounts, which reveals the true and fair affairs of business in general and cost ofproduction in particular. In case of cost accounting, where certain expenses are eliminatedor deleted the cost per unit will be generally unfair.8.Financial accounting will generally present a better picture to the public who cannot understand the intricacies of the maintenance of accounting. Cost accounting, inparticular, is always beneficial from the point of management, rather than from the publicundertaking.NoteNotesDifferences between Financial Accounting and Cost AccountingBasis of DifferencesFinancial AccountingCost AccountingPurpose andObjectiveThe purpose and objective offinancial accounting is externalreporting mainly to owners,creditors, tax authorities,government and investors.The purpose and objective of costaccounting is internal reporting tomanagement.Maintenance ofAccountsThis is to be maintainedcompulsorily by forms of businessorganisations. The preparation ofaccounts must be in accordancewith the statutory provisions ofCompanies Act and Income TaxAct.Cost accounting is maintainedvoluntarily. In some casesgovernment has directed somecompanies to maintain cost accountsto improve efficiency of business orindustry.Profit AnalysisFinancial accounting discloses profitfor the entire business as a whole.Cost accounting shows the profit foreach product, process or operation.RecordingIt classifies, records and analysesthe transactions in a subjectivemanner, i.e., according to the natureof expenses.Cost accounting records theexpenditure in an objective manner,i.e., according to purpose for whichcosts are incurred.Use of ControlTechniquesIt does not make use of any type ofcontrol techniques.It makes use of some importantcontrol techniques such a MarginalCosting, Historical Costing,Budgetary Control, StandardCosting, etc., in order to control cost.Stock ValuationStock is valued at cost or marketprice whichever is less.Stock is always valued of cost price.Pricing PolicyIt fails to guide the formulation ofpricing policy.It provides adequate data forformulating of pricing policy.Facts and FiguresFinancial accounting deals mainlywith actual facts and figures.Cost accounting deals partly withfacts and figures and partly withestimates.Duration ofInformationReportingGenerally, financial accountingprovides financial information oncea year.Cost accounting furnishes cost dataat frequent intervals i.e., reports aredaily, weekly and monthly.Evaluation ofEfficiencyThe information provided byfinancial accounting is not sufficientto evaluate the efficiency of thebusiness activities.The cost data helps in evaluating theefficiency of the business activities.LOVELY PROFESSIONAL UNIVERSITY5

Cost and Management AccountingNotesSelf AssessmentState whether the following statements are true or false:7.Financial accounts deal with all the items of expenses, losses, income and gains in total butthe cost accounts deal with items of cost alone.8.Financial accounts cover a short period usually a week.9.Cost accounting will generally present a better picture to the public who can not understandthe intricacies of the maintenance of accounting.1.4 Role of Cost Accounting in Decision MakingThe cost accounting plays an important role in the following decisions making:61.Determination and Analysis of Cost: The main object of cost accountant is to determinecost per unit or per job or per contract. Thereby the constituents such as prime cost andoverheads that may be fixed, variable, semi-variable can be disclosed, which in turnevaluate the operating efficiency of each departments.2.Cost Control and Cost Reduction: Cost control and cost reduction is an important factorto be considered to know the best result obtained by each department. For this purpose,the standards are fixed and in case the efficiency of each department is more than theanticipated standard, the result will be considered as favourable and vice-versa.3.Planning and Decision-making: This is possible when policies that are framed are properlyimplemented. The technique of cost accounting which produces the best result dependsupon the best tools which are in operation by the management, stock holders, consumersand government.4.A good system of costing will be of varied benefits to the management:(a)Profitable and unprofitable activities can be disclosed by taking necessary stepsperiodically.(b)Costing enables a concern to measure the efficiency maintained and prove it.(c)Costing provides such information upon which estimates and tenders are based.(d)Costing guides future production policies.(e)An efficient check is provided on stores and materials.(f)An efficient check on labour and machines is also possible by providing incentives toworkers.(g)It helps increase profits.(h)It enables a periodical determination of profits or losses without resort to stocktaking.(i)It furnishes reliable data for comparing costs in different periods for differentvolumes of output.(j)The fixation of price cannot be properly done unless proper figures of costs areavailable.(k)The exact cause of increase or decrease in profit or loss can be detected.LOVELY PROFESSIONAL UNIVERSITY

Unit 1: Introduction to Cost AccountingSelf AssessmentNotesFill in the blanks:10.Cost control and . is an important factor to be considered to know the bestresult obtained by each department.11.The technique of . which produces the best result depends upon the best toolswhich are in operation by the management, stock holders, consumers and government.1.5 Cost ConceptsThere are some important cost concepts that we must be aware of:1.5.1 Cost UnitCost unit is defined by the ICMA as “a quantitative unit of product or service in relation to whichcosts are ascertained”. A cost unit is a device used for the purpose of splitting total cost into smallersub-divisions attributable to products or service. A cost unit simply stated is a unit of finishedproduct, service of these in relation to which cost is ascertained and expressed. The following aresome of the examples of cost units selected from different industries or organisation:Table 1.1: Cost Units selected from Different IndustriesName of the Industry or OrganisationBrick IndustryProductCost UnitBricksPer 1,000 bricksPower IndustryElectricityPer kilo-watt hourCement IndustryCementPer tonnePharmaceutical IndustryTabletsPer 1,000 tabletsSugar IndustrySugarPer tonneFurniture IndustryTablePer tableHardware IndustryBolts and nutsPer 1,000 piecesCotton Textile IndustryYarnPer KgConstruction CompanyHousePer contractTransport CompaniesServicePer passenger mileHospitalServicePer bed-dayCanteenServicePer meal1.5.2 Cost CentreA cost centre refers to a part of a factory for which costs are accumulated separately. In orderto facilitate charging of costs to cost units, it is necessary to divide the factory or industry intovarious parts which can be used to accumulate costs for subsequent distribution. Each such partof a factory or industry is known as cost centre.Did u know? What is responsibility centre?Cost centre facilitates fixation of responsibility for every officer-in-charge of part ofdepartment or section. Hence cost centre is also known as responsibility centre.Cost centre has been defined by ICMA as “a location, person or item of equipment or group ofthese in respect of which costs may be ascertained and related to cost units”.LOVELY PROFESSIONAL UNIVERSITY7

Cost and Management AccountingNotesThe main kinds of cost centre are given below:Operation and process cost centre,Production and service cost centre, andPersonal and impersonal cost centreThese kinds of cost centre have been shown in the figure given as:Figure 1.1: Cost CentresCost CentresOperation and processcost centre1.Production and servicecost centrePersonal andimpersonal cost centreOperation and Process Cost Centre: Operation cost centre consist of those machines whichcarry out the same operation.A process cost centre is a cost centre in which a specific process or a continuous process ofoperation is carried out.2.Production and Service Cost Centre: A production cost centre is one where actualproduction process is carried out. The manufacturing and non-manufacturing costs arecharged to production cost centre.A service cost centre is one which provides services to other cost centre. Onlynon-manufacturing costs are charged to service cost centre.3.Personal and Impersonal Cost Centre: Personal cost centre consists of a person or group ofpersons. Personal cost centre follows the organisational structure of a factory or organisation.Under this type of cost centre, costs are analysed and accumulated according to; say, factorymanager, sales manager, store keeper, etc. Impersonal cost centre consists of a location ofequipment. A cost centre relating to location may represent an area of sales, warehouse.Cost centre relating to an item of equipment could be a machine or group of machines.Whatever may be the kinds of cost centre, it is determined by taking into consideration thefollowing factors:Responsibilities and accountabilities to be identified,Volume of work to be performed,Uses of cost centres, andCost control activities exercised.Self AssessmentFill in the blanks:812.A . refers to a part of a factory for which costs are accumulated separately.13.A . is a cost centre in which a specific process or a continuous process ofoperation is carried out.14.The manufacturing and non-manufacturing costs are charged to . cost centre.LOVELY PROFESSIONAL UNIVERSITY

Unit 1: Introduction to Cost Accounting1.6 Elements of CostNotesThe correct of interpretation of the term ‘cost’ may also be understood by having knowledgeabout basic elements of cost. These elements have been shown in the following figure.Figure 1.2: Elements of CostElements of rect LabourIndirect adsFactory or WorksOverheadsOffice and n OverheadsThe following is the brief description of these elements of cost:1.Direct Material: Direct material is material that can be directly identified with each unitof the product. Direct material can be conveniently measured and directly charged to theproduct.For example, raw cotton in textile manufactures, sugarcane in sugar industry and leatherfor shoe-making industry.The cost of direct material includes the following:2.3.(a)All type of raw materials issued from the store,(b)Raw materials specifically purchased for the specific job or project,(c)Raw materials transferred from one cost centre to another cost centre.(d)Primary packing material, like cartons, cardboard boxes, etc.Indirect Material: They are those materials which do not normally form a part of thefinished product. It has been defined as “materials which cannot be allocated but whichcan be apportioned to or absorbed by cost centres or cost units”. These are:(a)Stores used in maintenance of machinery, buildings, etc., like lubricants, cottonwaste, bricks and cements.(b)Stores used by the service departments, i.e., non-productive departments like Powerhouse, Boiler house and Canteen, etc.(c)Materials which due to their cost being small, are not considered worth while to betreated as direct materials.Direct Labour: Direct labour is labour that can be identified directly with a unit of finishedproduct. All the labour charges expended in altering the construction, composition,confirmation or condition of the product is included in it. It includes the payment of directwages made to the following groups of direct labour:(a)Direct labour engaged on the actual production of the product.LOVELY PROFESSIONAL UNIVERSITY9

Cost and Management AccountingNotes(b)Direct labour engaged in adding this manufacture by way of supervision, maintenanceand tool setting, etc.(c)Inspectors, analysts, etc. specially required for such production.4.Indirect Labour: The wages of that labour which cannot be allocated but which can beapportioned to or absorbed by, cost centres or cost units is known as indirect labour. Inother words, wages paid to labour which are employed other than or production constituteindirect labour costs. Examples of indirect labour are: charge hands and supervisors,maintenance workers, labour employed in service departments, material handling andinternal transport, apprentices, trainees and instructors, factory clerical staff and labouremployed in time and security office, etc.5.Direct or Chargeable Expenses: They include all expenditures other than direct material anddirect labour that are specifically incurred for a particular product or job. Such expensesare charged directly to the particular cost account concerned as part of the prime cost.Examples of direct expenses are: excise duty, royalty, surveyor’s fees, cost of rectifyingdefective work, travelling expenses to the job, experimental expenses of projects, expensesof designing or drawings, repairs and maintenance of plant obtained on hire and hire ofspecial equipment obtained for a contract.6.Indirect Expenses: Indirect expenses are expenses which can not be allocated but which canbe apportioned to or absorbed by cost centres or cost units as rent, insurance, municipaltaxes, salary of manager, canteen and welfare expenses, power and fuel, cost of training fornew employees, lighting and heating, telephone expenses, etc.7.Overheads: Overheads may be defined as the cost of indirect materials, indirect labour andsuch other expenses including services as cannot conveniently be charged direct to specificcost units. Thus, overheads are all expenses other than direct expenses. Overheads may bedivided into following categories:(a)Factory or works overheads cover all indirect expenditure incurred by theundertaking from the receipt of the order until its completion is ready for dispatcheither to the customer or to the finished goods store. The overheads also include:depreciation on plant and machinery, buildings and equipments, insurance chargeson fixed assets, repairs and maintenance of fixed assets, electricity charges, coal andother fuel charges, rent, rates and taxes of works, etc.(b)Office and administrative overhead consists of all expenses incurred in the direction,control and administration of a factory. Examples are the expenses in runningthe general office e.g., office rent, light, heat, salaries, salary to secretaries andaccountants, general managers, directors, executives, investigations and experimentsand miscellaneous fixed charges.(c)Selling overheads comprise the cost of products or distributors of soliciting andrecurring orders for the articles of commodities dealt in and of efforts to find andretain customers.It includes sales office expenses, salesmen’s salaries and commission, showroomexpenses, advertisement charges, fancy packing, samples and free gifts, after salesservice expenses and demonstration and technical advice to potential customers.(d)10Distribution overheads comprise all expenditure incurred from the time the productis completed in the work until it reaches its destination. It includes warehouse rent,warehouse staff salaries, insurance, expenses on delivery vans and trucks, expenseson special packing for bulk transport, losses in warehouse stocks and finished goodsdamaged in transit and cost of repairing, etc.LOVELY PROFESSIONAL UNIVERSITY

Unit 1: Introduction to Cost AccountingSelf AssessmentNotesState whether the following statements are true or false:15.The wages of that labour which cannot be allocated but which can be apportioned to orabsorbed by, cost centres or cost units is known as direct labour.16.Overheads may be defined as the cost of indirect materials, indirect labour and such otherexpenses including services as ca

Unit 1: Introduction to Cost Accounting Notes LOVELY PROFESSIONAL UNIVERSITY 1 Unit 1: Introduction to Cost Accounting CONTENTS Objectives Introduction 1.1 Meaning and Defi nition of Cost Accounting 1.2 Scope and Use of Cost Accounting 1.3 Relationship between Financial Accounting and Cost Accounting 1.4 Role of Cost Accounting in Decision Making