Cost and Management Accounting

UNIT – I COST AND MANAGEMENT ACCOUNTING

Meaning – Definition – Scope – Objectives – Function – Merits and Demerits of Cost
and Management Accounting – Distinction between Cost, Management and Financial
Accounting – Elements of Cost – Cost Concepts and Cost Classification.

MEANING – DEFINITION – SCOPE – OBJECTIVES – FUNCTION – MERITS AND

DEMERITS OF COST AND MANAGEMENT ACCOUNTING

Meaning and Definition of Cost Accounting

Cost Accounting is the process of accounting for cost which begins with the
incurrence of cost and ends with the control of cost. In other words, it is a formal
system of accounting by means of which costs of products, services or activities are as
ascertained and controlled.

According to ICMA, London, “Cost Accounting is the process of accounting for cost
which begins with the recording of income and expenditure and ends with the
preparation of periodical statements and reports for ascertaining and controlling
costs”.

Scope of Cost Accounting

1) Cost Ascertainment: It deals with the collection and analysis of expenses, the
measurement of production of the different products at the different stages of
manufacture and the linking up of production with the expenses.
2) Cost Accounting: It is the process of accounting for cost which begins with
recording or expenditure and ends with the preparation of statistical data. It is
formal mechanism by means of which costs of products or services are
ascertained and controlled.
3) Cost Control: Cost control is the guidance and regulation by executive action of
the costs of operating an undertaking. The cost can be controlled by standard
costing, budgetary control, proper presentation and reporting of cost data and
cost audit.

Principles of Cost Accounting

 Cost is related to its Cause
 Cost is charged after it is incurred
 Abnormal costs are excluded from costing
 Past costs are not charged to future period
 Concept of conservation has no place in costing
 Accounting for cost is based on double-entry principle

Objectives of Cost Accounting

(a) Analysis and Ascertainment of Costs: For the ascertainment of cost it involves
further study, analysis and classification of costs such as prime cost, work cost,
production cost, etc.

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 Cost and Management Accounting

(b) Cost Control: Budgets and standards for the consumption of materials, use of
labor, and for expending the overhead are to be set and compared with the
actual performance.
(c) Ascertainment of Profitability: It is the objective of cost accounting to ascertain
the profitability of the activities carried out or planned.
(d) Determination of Selling Price: Cost accounting provides detailed information
about the composition of total cost plus a margin of profit for the determination
of the selling price.
(e) Providing a Basis for Business Policy: The objective of cost accounting is to help
the management in the formulation of business policy and in decision making.

Functions of Cost Accounting

 To set-up and revise standards: Standards, i.e. indices of efficiency are fixed are
revised in the light of data provided by cost accounting.
 To compare performance with standards: Cost accounting provides data on the
basis of which performance of various divisions and departments can be
compared and management can take-up remedial action to control costs.
 To serve as a Tool for Planning and Budgeting: Costing accounting performs the
basic function of acting as a tool for managerial planning and budgeting. It
provides data to make projections of future cost and product lines to be taken-
up.
 To serve as an Index for Managerial Performance: Cost accounting performs the
function of providing an index of managerial performance in different sections,
departments, divisions, etc.
 To Protect Interest of Investors: It compels the manager to prove their efficiency
which increases the profitability of organization. The shareholders can expect
better returns and better security of their investment.
 To Report to the Government: Cost accounting performs the function of
providing government with relevant data which are helpful in framing
budgetary policies, taxation policies, etc.

Advantages of Cost Accounting

 Cost accounting as an aid to management
 Advantage to employee
 Advantage to creditors, investors and bankers
 Advantage to government and the society

Disadvantages of Cost Accounting

o There is an argument that it is unnecessary
o It is expensive
o It is inapplicable to some systems

Meaning and Definition of Management Accounting

Management Accounting is compared of two words „Management‟ and „Accounting‟.
It is the study of managerial aspect of accounting. The emphasis of management
accounting is to redesign accounting in such a way that it is helpful to the

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 Cost and Management Accounting

management in formation of policy, control of execution and appreciation of

effectiveness. It is that system of accounting which helps management in carrying out
its functions more efficiently.

According to Brown and Howard, “The essential aim of management accounting

should be to assist management in decision making and control”.

Characteristics of Management Accounting

a) Providing Accounting Information: Collection and classification of data is the
primary function of accounting department. The information so collected is
used by the management for taking policy decisions:.
b) Cause and Effect Analysis: The figures of profits are compared to sales, different
expenditures, current assets, interest payables, share capital, etc.
c) Use of Special Techniques and Concepts: The techniques used include financial
planning and analysis, standard costing, budgetary control, marginal costing,
etc.
d) Taking Important Decisions: It supplies necessary information to the
management, which may base its decisions on it.
e) Achieving of Objectives: The accounting information helps in achieving
organizational objectives. Historical data is used for formulating plans and
setting up objectives.
f) No Fixed Norms Followed: No specific rules are followed in management
accounting. But in financial accounting certain rules are followed for different
accounting books.
g) Concern with Forecasting: The management accounting is concerned with the
future. It helps the management in planning and forecasting.

Scope of Management Accounting

Management accounting covers not only the use of financial data and a part of costing
theory but may extend beyond the boundaries of accounting and costing. It requires
the aid of techniques of other disciplines such as economics, finance, mathematics,
statistics and operations research.

In management accounting one has to study the following:

 Financial Accounting: Financial accounting deals with the historical data. The
recorded facts about an organization are useful for future course of action.
 Cost Accounting: Cost Accounting provides various techniques for determining
cost of manufacturing products or services.
 Budgeting and Forecasting: Budgeting means expressing the plans policies and
goals of the enterprise for a definite period in future.
 Inventory Control: Inventory has a special significance in accounting for
determining correct income in a given period.
 Reporting Management: The reports are presented in form of graphs diagrams,
index numbers so as to keep the management informed of various actions.

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 Cost and Management Accounting

 Interpretation of Data: The management accountant interprets various financial

statements to the management.
 Internal Audit: The actual performance of every department and individual is
compared with predetermined standards.
 Tax Accounting: Income statements are prepared and tax liabilities are
calculated. The management is informed about the tax burden.

Objective of Management Accounting

1. Measuring Performance: There are two types of performance that are typically
measured. The first is employee performance. The second performance
measurement is the measurement of efficiency, how the resources are used.
2. Assessing Risks: Risks are an integral part of business. An objective of
management accounting is to assess risk in order to maximize profits.
Generally, if high risk is undertaken there is a equal chance of getting more
profit or more loss and vice-versa.
3. Allocating Resources: Resource allocation is important to any organization.
Management accountant will determine the most efficient way to divide
resources and maximize profits.

Principles of Management Accounting

 Consistency
 Consider all possible losses
 Consider only normal costs
 Convention of the objectivity
 Controllable and uncontrollable costs
 Optimum utilization of resources
 Revaluation accounting

Functions of Management Accounting

 Planning and Forecasting
 Modification of Data
 Financial Analysis and interpretation
 Facilitates Managerial Control
 Communicating Accounting Information
 Supplying Financial Information to Various Levels of Management

Merits /Advantages of Management Accounting

 Increasing Efficiency
 Measurement of Performance
 Maximizing Profitability
 Effective Management Control

Demerits /Disadvantages of Management Accounting

o Based on Accounting Information
o Lack of knowledge
o Evolutionary Stage

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 Cost and Management Accounting

DISTINCTION BETWEEN COST, MANAGEMENT AND

FINANCIAL ACCOUNTING

Point of Management
Cost Accounting Financial Accounting
Difference Accounting
Cost accounting is also Management accounting Financial accounting is
concerned with money as is concerned with all concerned with money as
Orientation a measure of economic situations including the economic resources,
performance. monetary and non- i.e. cash.
monetary events.
Costing accounting aims Management accounting Under Financial
at measuring the is a way of accounting accounting the financial
economic performance of information system which aspect of the firm is dealt
Scope the cost centers and covers financial and cost with by way of preparing
provides suitable cost accounting, and all Trading A/c, Profit and
data to measure the aspects of financial Loss A/c, and Balance
performance. management sheet.
Cost accounting is Management accounting Financial accounting
basically concerned with can be applied for the indicates the position of
collection, classification making the cost the business as a whole
Analysis of
and analysis of cost data. accounting more in the final accounts
Performance
purposeful and prepared for the purpose
management oriented. of reporting and overall
business performance.
Cost accounting also Management accounting Financial account focuses
Time Factor focuses attention on past concentrates on future attention of past and
and current operation. operations, &profitability. current operations.
Cost records are There is no legal Financial accounting
maintained voluntarily in compulsion as such in became compulsory for
order to meet the respect of management every company on
requirement of the accounting system and account of legal provision.
Legal
management. But now hence a company may
Compulsion
Company’s Act, 1956 has keep the system
made it obligatory to keep management accounting
the cost records in some voluntarily to assist the
manufacturing industries. management functions.

ELEMENTS OF COST
Meaning of Cost: Costs that are usually considered an expense of the current period
may not be recorded as such because of special circumstances. Cost is the total spent
for goods or services including money, time and labor. Cost is the value of money that
has been used up to produce something, and hence is not available for use anymore.

According to ICMA London, “Cost is the amount of expenditure (actual or notional)

incurred on, or attributable to, a specified thing or activity or cost unit”.

Expenses: Expenses are costs which have been applied against revenue of particular
accounting period in accordance with the principle of matching cost to revenue e.g.
cost goods-sold, office salaries of the period in which they are incurred.

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 Cost and Management Accounting

Elements of Cost
Mere knowledge of total cost cannot satisfy the needs of management. For proper
control and managerial decisions, management is to be provided with necessary data
to analyze and classify costs. For its purpose, the total cost is analyzed by elements of
cost i.e. by the nature of expenses. Strictly speaking and the broad elements of cost
are three i.e. Materials, Labor and Other expenses.

These elements of cost are further analyzed into different elements as follows:

Elements of Cost

Materials Labor Other Expenses

Direct Indirect Direct Indirect Direct Indirect

Overheads

Production or Administration Selling Distribution

Works Overheads Overheads Overheads Overheads

All costs related to production of goods are called manufacturing costs; they are also
referred to as product costs. The following are the classification of costs associated
with manufacturing.
(1) Direct Materials: Direct materials are those materials which can be identified in
the product and can be conveniently measured and directly charged to the
product.

Indirect Materials: The materials which are not classified as direct materials are
called indirect materials. These materials are used for purposes ancillary to the
business and which cannot be conveniently assigned to specific physical units
is termed as “Indirect Material”.

(2) Direct Labor: Human effort is needed for conversion of materials into finished
goods; such human effort is called labor.

Indirect Labor: Labor employed for the purpose of carrying out tasks incidental
to goods produced or services provided, is indirect labor. Wages of store-
keepers, foremen, time-keepers, director‟s fees, salaries of salesmen, etc. are
the examples of indirect labor costs.

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 Cost and Management Accounting

(3) Direct Expenses: All expenses which can be identified to a particular cost
centre and hence directly charged to the centre are known as direct expenses. In
other words, all expenses incurred specifically for a particular product, job are
called direct expenses.
Indirect Expenses: These are expenses which cannot be directly, conveniently
and wholly allocated to cost centres or cost units. Examples of such expenses
are rent, lighting, insurance charges, etc.

(4) Overheads: Overheads may be defined as the aggregate of the cost of indirect
materials, indirect labor and such other expenses including services as cannot
conveniently be charged direct to specific cost units. Thus overheads are all
expenses other than direct expenses. The main groups into which overheads
may be sub-divided are (i) Manufacturing Overheads, (ii) Administration
Overheads, (iii) Selling and Distribution Overheads and (iv) Research and
Development Overheads.

By grouping the elements of cost, the following divisions of cost are obtained:
Direct material + Direct labor + Direct expenses = Prime cost
Prime cost + Factory overheads = Factory cost
Factory cost + Administrative overheads = Production cost
Production cost + Selling & Distribution overheads = Total cost (or)
Ultimate cost

COST CONCEPTS AND COST CLASSIFICATION

A cost accountant is mainly concerned with the following cost concepts:
 Concept of Objectivity: It is this concept gives direction to the activities relating
to cost finding, cost analysis, recording and cost reporting.
 Concept of Materiality: This concept that stress accuracy must be tempered by
good judgment, if no distortion of product cost is likely to result.
 Concept of Time Span: All assumptions relating to different cost exercise remain
valid only during related time span. The statement that cost is fixed is based on
a time span under consideration. No costs will remain fixed for all the time.
 Concept of Relevant Range of Activity: Relevant range of activity represents the
span of volume over which the cost behavior is expected to remain valid. A
fixed cost is fixed only in relation to the relevant range of activity during the
period.
 Concept of Relevant Cost and Benefit: This concept is vital for decision-making
purposes. In evaluating alternative course of action, management should
consider only relevant cost and relevant benefit relating to alternatives under
consideration.

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 Cost and Management Accounting

Objectives of Cost Accounting

The main objectives of cost accounting can be summarized as follows:
 To determining selling price
 To determining and controlling efficiency
 To facilitating preparation of financial and other statements
 To Providing basis for operating policy

Costs Classification
The cost-classification is the process of grouping costs according to their
characteristics. The cost can be classified into the following:
 According to Elements: The cost is classified into (a) Direct cost, (b) Indirect
cost according to elements, viz. materials, labor and expenses. Further it is
classified as direct material and indirect material, direct labor and indirect
labor, direct expenses and indirect expenses.

 According to Functions or Operations: According to this classification, costs are

classified under the following functions:
 Production Cost: It includes the cost of direct material, direct labor,
direct expenses and factory overheads.
 Administration Cost: The cost of formulating policy, directing the
organization and controlling the operations of an undertaking which is
not related directly to a product or a service constitute administration
costs.
 Selling Cost: these are costs of seeking to create and stimulate demand
and the cost of securing orders.
 Distribution Cost: The cost of sequence of operations which begin with
making the product available for dispatch and ends with making the
reconditioned returned empty package.
 Research Cost: The costs of searching – new or improved products, new
application of materials, new or improved methods are called research
costs.
 Development Cost: These are costs of the process which begins with the
implementation of the decision to produce a new or improved product.
 Pre-Production Cost: These are those costs which are incurred on making
a trial production run prior to formal production.

 According to Nature or Behavior: On the basis of behavior costs may be

classified as:
(i) Variable Cost: Costs that vary almost in direct proportion to the volume
of production are called variable costs. The examples of such costs are
direct material, direct labor and direct chargeable expenses, such as
electric power, fuel, etc.

(ii) Fixed Cost: Costs which do not vary with the level of production are
known as fixed costs. These costs remain constant irrespective of the

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level of output. Fixed costs remain fixed up to a certain level of

production.

(iii) Semi-Variable Cost: Those costs which are partly fixed and partly
variable are called semi-variable costs. These costs vary with the level
of production but not in direct proportion to the level of production.

 According to Controllability: On the basis of controllability costs may be

classified as under:
a) Controllable Cost: This is a cost which can be influenced by the action of
specified member of an undertaking. The costs which can be controlled
by a specified member who is generally an important link in the
management are the controllable costs.
b) Uncontrollable Cost: It is a cost which cannot be influenced by the
action of a specified member of an undertaking.

 According to Normality: Under this category costs may be categorized as

follows:
i. Normal Cost: It is the cost which is normally incurred at a given level of
output in the conditions in which that level of output is normally
attained. It is charged to costing profit and loss account.
ii. Abnormal Cost: It is the cost which is not normally incurred at a given
level of output in the conditions in which that level output is normally
attained. It is charged to costing profit and loss account.

 According to Time of Periodicity: Under this category costs may be divided as

follows:
a) Historical Cost: The historical cost is the actual cost, determined after the
event. Historical cost valuation states costs of plant and material, for
example, at the price originally paid for them.
b) Future Cost: The future costs are costs expected to be incurred at a later
date. Future costs are relevant for managerial decision making in cost
control, profit projections, expansion programs and pricing, etc.

 According to Association with Product: Under this category costs may be

classified into product cost and period cost as follows:
i. Product Cost: Product costs are those costs which are associated with and
directly identifiable with the product. In other words, costs which are
assigned to the product are product costs.
ii. Period Cost: Period costs are costs that are reported as expenses of the
period in question. These are costs which are not assigned to the product
but are charged against revenue costs of the period in which they are
incurred.

 According to Relevance to Decision-making and Control: Under this category

costs may be classified as follows:

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 Cost and Management Accounting

1. Marginal Cost: It is a variable cost of one unit of a product or a service i.e. a

cost which would be avoided if that unit was not produced or provided.
2. Differential Cost: A difference in cost between one course of action and
another is differential cost.
3. Joint Cost: Whenever two or more products are produced out of the same
basic raw material or process, the cost of material purchased and processing
are called joint costs.
4. Shut-down Cost: A cost will still be required to be incurred even though a
plant is closed or shut-down for a temporary period.
5. Sunk Cost: A cost which has been incurred in the past or sunk in the past
and is not relevant to the particular decision-making, is a sunk cost.
6. Opportunity Cost: According to CIMA, “Opportunity cost is the value of a
benefit sacrificed in favor of an alternative course of action”.
7. Imputed Cost: It is hypothetical cost required to be considered to make costs
comparable. If the owner of the factory charges rent of the factory to the
cost of production to make cost comparable with that of those undertakings
which run production in rented factories.
8. Out-of-pocket Cost: It is the cost which involves current or future
expenditure based on managerial decisions. For example, a company has its
own trucks for transporting goods from one place to another.
9. Replacement Cost: It is the cost of replacing a material or asset by purchase
from the current market. For example, if an „x‟ material was originally
purchased @ Rs.250 per kg and now it can be replaced by purchase from
the market at the current rate of Rs.280 per kg, the replacement cost is
Rs.280 per kg.
10. Programmed Cost: The programmed cost is a cost that is subject to both
management discretion and control but which has little immediate relevance
to current operations although it is generally incurred to ensure long-term
survival. Advertisement, research and development, are examples of
programmed cost.

Text Books & References

1. Shashi K Gupta and Sharma R.K., 2013. Cost and Management Accounting.
Kalyani Publishers, New Delhi.
2. Jain S.P and Narang K.L, 2011. Cost Accounting Principles and Practice. Kalyani
Publishers, New Delhi.
3. Dr.Maheswari S.N, 2014. Cost and Management Accounting. Sultan Chand and
Sons, New Delhi.

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