Introduction to Cost and Management Accounting

Cost and Management Accounting involves the calculation & measurement of the resources used by a business in undertaking its various classification of cost

Classification of cost Overview:

Introduction to cost and management accounting

Cost Accounting (classification of cost in cost accounting)

- Cost Accounting involves the calculation and measurement of the resources used by a business in undertaking its various activities and is concerned with identifying cost of various things ( i.e. gathering data about cost of ‘products’ or ‘services’ and ‘cost of activities’).
Management Accounting (cost classification in management accounting)

- Management accounting includes cost accounting as one of its discipline but is wider in scope.
- Management accounting provides information to management that helps it to run the business:

1. it provides detailed financial information so that they plan and control the activities or operation for which they are responsible.
2. this information helps managers to make other decisions i,e. planning, controlling and taking one-off decisions.

ALL organizations needs to know:

how much it costs to make the products or provide its services.
to make sure product/services is sold at a Profit.
to control the entity.
to measure to what extent it is achieving its objectives.
to plan expenditure for future.

Introduction to Costs

Types of organizations

Manufacturing organizations

Types of costing systems they use:

Basic manufacturing costing.
Standard costing.
Process costing.
Job costing.

Service organizations

Types of costing systems they use:

Standard costing.
Job costing.

Key Terminology

Cost object

Any activity for which a separate measurement of costs is needed.

For Example

cost of a department.
cost of a project.

Cost unit

A unit of product or service for which costs are determined.

For Example

cost of A car.
cost of bread items.
cost of An item.

Unit cost

The cost incurred by a company to produce + store + sell one unit of a particular product.
Unit cost includes ALL fixed and variable costs involved in production.

Types of Cost Classification

Classification of Cost by Type

Material costs

Material costs are the costs of any material items purchased with the intention of using them in fairly short term future.

For example

Raw material that go into the production process.
Cost of stationary, cartridges replacement.

Labour costs

Labour costs are the employees remuneration costs paid by the entity and includes;
- wages and salaries of part-time workers, bonuses, pension contribution etc.

Other expenses

That costs which are not Material/ Labour costs and includes;
- cost of services provided by external suppliers, telephone cost, rental costs, depreciation charges.

Classification of Cost by Function

Production costs

The costs that are incurred in manufacturing finished products up to the time goods are completed.

Includes:

Material costs: of raw materials and components used in production.
Labour costs: of all employees working for the manufacturing function.
Other Expenses.

Non-Production costs

Includes:

Administrative costs

Cost of providing administrative services to entity, usually includes;

Salaries to staff in administration.
Cost of office space (rent)
Other expense incurred for administration only.

Selling and Distribution costs

The costs incurred in marketing and selling good or services to customers and costs of delivering the goods.

The costs of after-sales services such as customer support services are usually included in these costs.

They usually include;

Salaries to staff in selling and distribution.
Advertising costs and other marketing costs
Operating costs for delivery vehicles such as fuel costs and repairs.
Other costs incurred for selling and distribution department.

Finance costs

These are the costs that are involved in financing the organization, e.g : Loan interest Bank O/D

They are generally included in administration costs ; or
alternatively finance costs might be excluded from cost accounting system.

* Some costs might be partly production, partly administration and selling & distribution e,g: salaries of managing director, building rental costs.
In such case costs are divided/ apportioned between function s on fair basis.

Cost classification by Nature

Direct costs

Costs that can be traced in FULL to a cost unit i,e. A direct cost can be attributed in its entirety to the cost of an item that is being produced.

The following are direct costs:

Direct Material

All the materials that are used directly in manufacturing a product or providing service.

Direct materials includes both raw materials and components.

Direct Labour

These are specific costs associated with labour-time spent directly on production of goods or services.

Direct Expenses

Expenses that can be attributed directly in full to a cost unit i,e. that have been incurred in full in making a unit of product/service .

* In manufacturing type organization direct expenses are not common.

Indirect costs (overheads)

An indirect cost (overhead cost) is any cost that is not a direct costs.
Indirect costs cannot be attributed directly and full to a cost unit.
Indirect costs include production overheads and non-production overheads. Each of these might include the following:

Indirect Material

Indirect material are any materials that are used/consumed that cannot be attributed in full to the item. They are treated as overhead costs, maybe classified as production overheads, administration overheads, selling and distribution overheads.

For e.g. indirect production material includes some items of cleaning materials and any materials used by staff not engaged in production.

Indirect Labour

They mainly consists of the costs of indirect labour employees (who do not work directly on items that are produced) but may be necessary so that production takes place.

All employees in administration and marketing department including management are indirect labour.

Indirect Expenses

Many costs incurred cannot be directly linked to cost units e.g. Rental costs of factory.

In manufacturing company all costs of administration and selling & distribution are treated as indirect overheads.

Product Cost

Product cost include the prime cost Plus production overhead.
Product cost are associated with goods that are produced or purchased for resale.
They are inventory and only expensed out when sold.

Period Cost

The costs that do not contribute towards the value of inventory.
These are expensed in the period in which they occur.

Cost Behavior

Cost Behavior definition:

Cost behavior refers to the way in which costs changes as volume of the activity changes.
As a general rule, total costs are expected to increase as volume of activity rises.
Understanding of cost behavior helps to;

- forecast/plan what costs ought to be.
- compare actual cost with budgeted.

Cost Classification by behaviour;

Fixed costs

These costs remain fixed/same in total during a period no matter how many units are produced and regardless the volume or scale of a activity.

However, the cost per unit falls because the cost is being spread over a greater number of units.

Semi-Variable cost

A semi-variable cost is a cost that is partly fixed and partly variable.
It is often assumed that total costs of an activity are mixed.

Stepped cost

A cost which is fixed within a limited range of activity and goes up or down in steps when the volume of activity rises above or falls below certain levels.

Variable costs

These costs increase usually by the same amount for each additional unit of product or service provided.
The variable cost of a cost unit is also called marginal cost of unit.
This means that total variable costs increase in direct proportion to the volume of output or activity.
The cost per unit remains fixed . However, total cost increase as more units are made.