Quick Reference Study Notes for Cost Accounting (Foundation)

COST ACCOUNTING

Introduction
Cost accounting basically involves activities like recordation, analysis, and reporting of costs to management. The main purpose behind this type of accounting is to provide insights into the cost structure of a business that can be used to better manage it. As compared to financial accounting, cost accounting is primarily meant for internal operational activities.

Cost accounting is also used to ascertain the asset costs and expenses that are to be stated in the financial statements. For example, in cost accounting procedures a cost accountant calculates the cost of ending inventory, which appears in the balance sheet. Similarly, the accountant records the cost of goods sold, which appears in the income statement. These calculations are not simple, as the cost accountant has to deal with cost layering systems, overhead allocation, and by-product costing splits.

COST CONCEPT:

Cost can be defined as the number of expenses (actual or notional) incurred on or attributable to specified thing or activity.
“Cost is the measurement in monetary terms of the number of resources used for the purpose of production of goods or rendering of services” (Institute of Cost and Work Accounts (ICWA) India).
“A cost is the value of economic resources used as a result of producing or doing the things costed.” (W M Harper)

 

This particular act of the cost will reflect in the manufacturing or rendering of services of the product which will cover all incurring expenditures under various heads.

 

EVOLUTION OF COST ACCOUNTING

In the service industry based industry, every organisation is interested in the cost of ascertaining the cost of the services it provides. The cost per unit is calculated by dividing the total expenditure incurred on the total number of production or the service rendered. This method of cost calculation can be used when there is only one product to consider. If the manufacturing company makes more than one product, then it becomes very important to split the total cost among the number of products that company manufacture.
 

 

               

COSTING, COST ACCOUNTING, AND COST ACCOUNTANCY

Costing: Costing is basically recording and determining the costs of products/services. In other terms, it is also planning and controlling such costs. Costing is defined as, “the techniques and processes of ascertaining costs” (The Chartered Institute of Management Accountants (CIMA). Costing means finding of cos of product or services by any process or technique.

Some of the Basic Principles and rules which are determining the costing are as follows:

 

A. The cost of manufacturing a product.

B. The cost of providing a service.
 

Cost Accounting: Chartered Institute of Management Accountants, London (CIMA) defines Cost Accounting as “the establishment of budgets, standard costs and actual costs of operations, processes, activities or products and the analysis of variances, profitability or the social use of funds”.

The Cost Accounting is entirely a specialized branch of accounting, which involves activities like classification, accumulation, assignment, and control of costs in an organization. Cost accounting basically deals with the collection, analysis of relevant cost-related data for interpretation and presentation for the purpose of various management. Level decisions and solving related accounting and financial problems.

Cost Accountancy: CIMA defines Cost Accountancy as “the application of costing and cost accounting principles, methods, and techniques to the science, art, and practice of cost control and the ascertainment of profitability as well as the presentation of information for the purpose of managerial decision making”.

Cost Accountancy can also be termed as science as it is a knowledge which a cost accountant should possess to carry out his duties and responsibilities. It can be termed as an art as it required skills by the cost accountant to apply principles of cost accountancy to various managerial problems like price, expenditures etc. In Cost Accountancy practice refers to the efforts taken by the Cost Accountant to perform the cost accounting procedures with theoretical knowledge, and sufficient practical training and exposure to real life costing problems.

 

COST ACCOUNTING BASICS
Cost accounting is the like an art of translating the costs incurred by a business into actionable instances that can improve operations and profits. Following are the several basic ways in which we can use cost accounting:

Product costs. This cost calculates the variable costs related to a product and aggregates this information by product. Production cost is typically determined by using a bill of materials and maintained by the engineering department. With this factor of product cost, you can decide whether the prices being set for products are too low. Any price set below the aggregate sum of the variable costs of a product will get you to lose money on every unit that you sold.

Product line costs. This cost is determined by Combining the variable costs of all products in a product line with all overhead costs specifically related to that product line. The additional costs may include the costs related to the production equipment, factory overhead, marketing, and distribution costs. This information provided by Product Line Costs is used to decide whether it is profitable to expand the sales of the product line, or (conversely) to shut down the entire product line.

Employee costs. This cost determines all aspects of the compensation, benefit, and travel and entertainment costs related to the employees, and aggregating this information by an employee. This information is analyzed by comparing to employee output to see which employees are one of the most cost-effective for the company or organization. It factor also helps to determine the savings to be achieved from the process of employee layoff.

Sales channel costs. This cost factor basically determines the variable costs related to products sold through a particular sales channel process, which can be combined with the overhead costs specific to that channel, to determine the profitability.
Customer costs. This cost factor helps in getting the variable costs of products sold to specific customers and thereafter combined with the other costs that can be directly traceable to those customers, which later determine the profitability of each one. The output result can be a selective reduction in the number of customers with which the company desires or chooses to do business in due course.

Contract costs. The Costs which are assigned to a specific customer contract are compiled, documented, and justified. This type of information is required to compile billings to customers.

Cost reduction analysis. Whenever the business is on the decline, the management seeks the ways to prudently cut costs while retaining the basic functionality of the organization. This analysis results in determining cost accounting are to calculate which costs are discretionary, and so can be deferred without lasting damage to the business.

Constraint analysis. Sometimes there is typically a bottleneck somewhere in the company which limits the amount of profit that the business can generate. If that situation arises, then this relevant cost accounting is to constantly analyze and monitor the utilization of this constraint, the costs incurred to run it.
 

COST ACCOUNTING FORMULAS
 

In the field of cost accounting, there are several formulas which should be monitored on a regular basis. Comparing the results to those of previous periods, one can spot up or down in the performance of an organization, which can then be reviewed and analyzed to see if remedial action should be taken.

Some of the most important formulas used in cost accounting :

 

Net sales percentage. Divide the net sales by gross sales. The result should be close to 1. If the result is not close to 1, it means that the company is losing a large percentage of its sales to sales discounts, returns, and allowances.

 

Gross margin. Gross margin is calculated by subtracting the cost of goods and services from net sales. The result in term of percentage of net sales should be quite consistent from period to period. If its not consistent, the mix of products has changed, the sales department has altered prices, or the cost of materials or labor has changed.

 

Break-even point. Its calculated by dividing total fixed expenses by the contribution margin. This calculation determines the sales level that must be attained in order to earn profits of zero.On basis of this Management must determine the organization's overall ability to meet that minimum sales level on a regular basis in the defined period; otherwise, the company will lose money.
 

Net profit percentage. Net Profit percentage is Net profits divided by Net sales. Compare this result to what was generated in each month for the past few years. If there is a steady downward trend then its a cause of concern to take action since it interprets that expenses have increased or sales margins have decreased.
 

Selling price variance. It is calculated by subtracting the budgeted price from the actual price and multiply by the actual unit sales. If the variance is not favorable, it means that the actual selling price was lower than the standard selling price. This trend indicates that there is an excessive usage of sales discounts or other promotions.
 

Purchase price variance. Its calculated by subtracting the budgeted purchase price from the actual purchase price, and then multiply by the actual quantity. If the variance is not favorable, it indicates that the company is buying materials at a higher cost than anticipated.
 

Material yield variance. Material yield variance is calculated by subtracting the standard unit usage from actual unit usage and multiply by the standard cost per unit. If the variance is not favorable, it means that there may be an excessive amount of scrap in the production process, or spoilage in the warehouse, or a lower quality of materials being acquired.
 

Labor rate variance. Labour rate variance is calculated by subtracting the standard labour rate from the actual labor rate and multiply by the actual hours worked. If the variance is not favorable, the company is paying more than expected for its direct labor, perhaps because higher-grade people are being used, or because a labor contract has increased the labor rate.
 

Labor efficiency variance. Labour efficiency variance is calculated by subtracting the standard hours from actual hours incurred and multiply by the standard labor rate. If the variance is not favorable, it means that the employees are being less efficient than expected. it could be due to poor training, hiring less experienced personnel, or problematic production equipment.

*NOTE : "This study material is collected from multiple sources to make a quick refresh course available to students."
 

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