Cost and Management Accounting

Introduction to Cost Accounting: Meanings

Cost means the price paid for something. Cost is the amount of expenditure incurred or attributable to a given thing. (CIMA)

Cost is a measurement, in monetary terms , of the amount of resources used for the purpose of production of goods or rendering of services. (ICWAI) Expense is defined as an expired cost resulting from a productive usage of an asset .

Costing
Defined as the techniques and processes of ascertaining costs. (CIMA) The proper allocation of expenditure and involves the collection of costs for every order, job, process, service or unit. Cost Accounting Is the process of accounting for costs from the point at which expenditure is incurred or committed to the establishment of its ultimate relationship with cost centres and cost units. (CIMA)

Cost Accountancy
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. It includes the presentation of information derived there from for the purposes of managerial decision making. (CIMA) Cost accountancy includes costing, cost accounting, cost control and cost audit. Ex: Nature of service being Hospitals, Canteens, Hotels, Cinema, Transport , the cost unit being Per patient-bed, Per patient-day or Per patient week: Per meal-persons: Per room day, Per person per bed: Per man show: Per passenger-kms, Per tonne-kms.

General Principles of Cost accounting

A cost should be related to its causes. A cost should be charged only after it has incurred. The prudence convention should be ignored. Abnormal costs should be excluded from cost accounts. Past costs not to be charged to future period. Principles of double entry should be applied wherever necessary.

Objectives of Cost accounting

Ascertainment of cost. Ascertainment of profit of each activity.

Determination of selling price.

Cost control and Cost reduction. Guiding management in decision making.

Cost Ascertainment Vs Cost Estimation

Is concerned with computation of actual costs incurred. Refers to the methods and process employed in ascertaining costs. Single, Batch, Job, Process, Operating Is predetermined costs. Is the process of predetermining costs of goods or services. Determined in advance of production and precede the operations.

Classification of Costs
Elements. Functions or Operations. Nature or Behavior. Controllability.

Normality.
Association with products.

Cost concepts related to decision making

Differential costs Opportunity costs Imputed costs Future costs Out-of-pocket costs Replacement costs

Clarity of concepts- Irrelevant costs

Historical costs AICPA as the amount , measured in money, of cash expended or other property transferred, capital stock issued, services performed or a liability incurred, in consideration of goods or services received or to be received. It is the cost which is reported in a conventional financial statement. Actual cost ascertainment Sunk costs A sunk cost is one for which expenditure has taken place in the past and which will not be affected by a particular decision under consideration. It is a cost that will not be changed by decisions. These costs are the best basis of predicting future costs.

Installation of costing system

Preliminary investigation Organizational structure Raw materials purchase, storage and issue The existing methods of remunerating labour Size and layout of factory Manufacturing process or methods Nature and number of products The system should be effective in cost control and cost reduction. Simple and easy to operate Economical The system should be introduced gradually

Management accounting
The preparation of accounting information in such a way as to assist management in the creation of policy and in the day-to-day operation of an undertaking is defined as MA. MA is a system for gathering, summarizing, reporting and interpreting accounting data and other financial information primarily for the internal needs of management. It is designed to assist internal management in the efficient formulation, execution and appraisal of business plans..

MA is Process
Identification The recognition and evaluation of business transactions and other economic events for appropriate accounting action. Measurement The quantification, including estimates, of business transactions or other economic events that have occurred or may occur. Accumulation The disciplined and consistent approach to recording and classifying appropriate business transactions and other economic events. Analysis The determination of the reasons for, and the relationships of, the reported activity with other economic events and circumstances. Preparation and Interpretation The meaningful coordination of accounting and/or planning data to satisfy a need for information presented in a logical format, and, if appropriate, including the conclusions drawn from those data. Communication The reporting of pertinent information to management and others for internal and external uses.

Scope
Financial accounting Cost accounting Financial statement analysis Budgeting Inflation accounting Management reporting Quantitative analysis Tax accounting Internal audit Office services

Important points
Marginal cost The variable cost of an additional unit of product or service. Marginal costing Cost ascertainment is made on the basis of nature of cost. It gives consideration to behaviour of costs. CIMA defined as the ascertainment of marginal cost, by differentiating between fixed and variable costs and of the affect on profit of changes in volume or type of output. Main features of MC: Separation of all costs into fixed and variable elements. Exclusion of fixed costs from unit cost calculations.

1. 2.

Advantages and Dis

Advantages: Assists planning and control Enables Break even analysis Competitive pricing Avoids distortion of profits Simplified measure of relative profitability Disadvantages: Short term considerations Arbitrary exercise Dangers in pricing Lack of general acceptability

Important concepts
Contribution Profit volume ratio ( P/V ratio) Break even point Margin of safety Angle of incidence

Problems
1. From the following data calculate contribution, P/V ratio and Break-even point. Fixed cost Rs.12,000, Selling price Rs.12 per unit and Variable cost Rs.9 per unit. Given Break-even point Rs.30,000, Profit Rs.1,500 and Fixed cost Rs.6,000. Calculate Variable cost. Sales 4000 units @Rs.10 per unit, BEP 1500 units and Fixed cost Rs.3,000. Calculate Variable cost and Profit. Given Fixed cost Rs.8,000, Profit Rs.2,000 and Break-even sales Rs.40,000. What is actual sales.

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3.

4.

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6.

7.

Given selling price Rs.150 per unit, Variable cost Rs.90 per unit and Fixed cost Rs.6 lacs. What is the BEP and the selling price per unit, if BEP is 12000 units? From the following particulars, find out the selling price per unit, if BEP is to be brought down to 9000 units: Variable cost per unit Rs.75, Fixed expenses Rs.2,70,000 and selling price per unit Rs.100. You are given the following data: Fixed expenses Rs.4,000 and BEP Rs.10,000. Calculate P/V ratio, Profit when sales are Rs.20,000 and new BEP if selling price is reduced by 20%.

8.

You are given the following data:

9.

Sales Profit Year 2010 Rs.1,20,000 8,000 Year 2011 Rs.1,40,000 13,000 Find out P/V ratio, BEP, Profit when sales are Rs.1,80,000, Sales required to earn a profit of Rs.12,000 and Margin of safety in year 2010. The xyz Ltd. furnishes you the following income information: Year 2011 First half Second half Rs. Rs. Sales 8,10,000 10,26,000 Profit 21,600 64,800 Calculate P/V ratio, Fixed cost, the amount of profit or loss where sales are Rs.6,48,000 and the amount of sales required to earn a profit of Rs.1,08,000. Assume fixed cost remain the same in both the periods.

10. X Ltd. has earned contribution of Rs.2 lacs and net profit of Rs.1,50,000 on sales Rs.8 lacs. What is its Margin of safety? 11. Indian Plastics make plastic buckets. The following is the accounting information: Variable cost per bucket Rs.20 Fixed cost Rs.50,000 for the year Capacity 2000 buckets per year Selling price per bucket Rs.70 Find (i) the BEP (ii) the number of buckets to be sold to get a profit of Rs.30,000 and (iii) if the company can manufacture 600 buckets more per year with an additional fixed cost of Rs.2,000, what should be the selling price to maintain the profit per bucket as at (ii) above.

12.From the following information relating to Quick Standards Ltd, you are required to find out a) contribution b) BEP in units c) MOS d) Profit. Rs. Total fixed costs 4,500 Total Variable costs 7,500 Total Sales 15,000 Units sold 5,000 Also calculate the volume of sales to earn profit of Rs.6,000

13. If margin of safety is Rs.2,40,000(40% of sales) and P/V ratio is 30%. Calculate a) Break even sales and b) Amount of profit on sales of Rs.9,00,000. 14.The PV ratio of Xltd is 50% and MOS is 40%. Calculate the net profit if the sales volume is RS1,00,000. 15.Ascertain profit, when sales Rs.2,00,000, Fixed cost Rs.40,000 and BEP Rs.1,60,000. Ascertain sales, when fixed cost Rs.20,000, Profit Rs.10,000 and BEP Rs.40,000.

16.Bee & Company has recorded the following data in the two most recent periods. What is the best estimate of the firms fixed costs per period. Total cost of production Volume of production Rs.14,600 800 Rs.19,400 1200 17. Year Sales (Rs) Profit (Rs) 2011 1,50,000 20,000 2012 1,70,000 25,000 You are required to calculate: a) P/V ratio b) BEP c) Sales required to reach a profit of Rs.40,000 d) Profit made when sales are Rs.2,50,000 e) MOS at a profit of Rs 50,000 f) Variable costs of two periods.

18. Raj Corporation Ltd, has prepared the following budget estimates for the year 2012-13: Sales units 15,000 Fixed expenses Rs.34,000 Sales value 1,50,000 Variable costs 6 per unit You are required to : a) Find P/V ratio, BEP and MOS b) Calculate the revised P/V ratio, BEP and MOS in each of the following cases: 1. decrease of 10% in selling price. 2. increase of 10% in variable costs 3. increase of sales volume by 2,000 units 4. increase of Rs.6,000 in fixed costs.

19.From the following data, you are required to calculate the BEP and sales value at this point: Selling price per unit Rs 25 Direct Material cost per unit 8 Direct Labour cost per unit 5 Fixed Overheads Rs. 24,000 Variable Overheads @60% on Direct Labour Trade Discount 4% If sales are 15% and 20% above the break even volume, determine the net profits.

20. SV Ltd., a multi product company, furnishes you the following data relating to the year 2011. Ist half year Rs. IInd half year Rs. Sales 45,000 50,000 Total Cost 40,000 43,000 Assuming that there is no change in prices and variable costs and that the fixed expenses are incurred equally in the two half-year periods, calculate for the year 2011: P/V ratio, Break even sales, Fixed expenses, Percentage of MOS.

21.Venus enterprises has the following data 2010 2011 Rs. Lakhs Sales 150 200 Profit 30 50 Calculate a) P/V ratio and total fixed expenses b) Break even level of sales c) sales required to earn a profit of Rs.90 lakhs. d) profit or loss that would arise if the sales were Rs.280 lakhs.

Budgeting and Budgetary control

Introduction
Budget is an important tool of planning and control. Planning involves looking systematically at the future so that decisions can be made today which will bring the company its desired results.

Control is the process of measuring and correcting actual performance to ensure that plans for implementing the chosen course of action are carried.

Definition
CIMA, London, has defined a Budget as a financial and / or quantitative statement, prepared prior to a defined period of time, of the policy to be pursued during that period for the purpose of attaining a given objective. Characteristics---- Primarily a planning device but it also serves as a basis for performance evaluation and control. Prepared either in quantitative terms or in money terms or in both. Purpose is to implement the policies formulated by management for attaining the given objectives. Budgeting is the act of preparing budgets.

Problems
Lack of support of top management. Non-participation by responsible executives. Un reasonable goals. Ill defined organisation. Continuous budget education. Adequate accounting . Cost of the system. Maximum profits. Integration with standard costing system.

Budgetary Control
A system of controlling costs through preparation of budgets. Is the establishment of budgets relating to the responsibilities of executives of a policy and the continuos comparison of the actual with the budgeted results, either to secure by individual action the objective of the policy or to provide a basis for its revision. Objectives: Planning, Co-ordination, Communication, Motivation, Control and Performance evaluation.

Advantages
Compels managers to think ahead-to anticipate and prepare for changing conditions. Co-ordinates the activities of various departments and functions of the business. Increases production efficiency, eliminates waste and controls the costs. Pinpoints efficiency or lack of it. Aims at maximisation of profits. Provides a yardstick against which actual results can be prepared.

Advantages continues
Motivates executives to attain the given goals. Aids in obtaining bank credit. Creates cost consciousness and introduces an attitude of mind in which waste and efficiency cannot thrive. Assists in delegation of authority and assignment of responsibility. Directs capital expenditure in the most profitable direction. Shows management where action is needed to remedy can be compared.

Limitations
The budget plan is based on estimates. Rigidity.

Budgeting is only a tool of management.

Expensive technique.

Zero base budgeting

It was introduced at Texas instruments in USA in 1969 by Peter Phyrr. Method of budgeting whereby all activities are revaluated each time a budget is set. Discrete levels of each activity are valued and a combination chosen to match funds available. A planning and budgeting process which requires each manager to justify his entire budget request in detail from scratch. Each manager states why he should spend any money at all. A system whereby each budget item , regardless of whether it is new or existing, must be justified in its entirety each time a new budget is prepared.

Advantages
All activities included in the budget are justified in cost benefit considerations which promote more effective allocation of resources. Discards the attitude of accepting the current position in favour of an attitude of questioning and challenging each item of budget. Promote a management team of talented and skilful people. Facilitates identification of inefficient and unnecessary activities and avoid wasteful expenditure. Cost behaviour patterns are more closely examined.

Dis advantages
Involves high cost of preparing budgets every year. High volume of paper work. Danger of emphasizing short-term gains at the expense of long- term ones.

Classification of Budgets
On the basis of function and scope Functional Master
On the basis of flexibility Fixed Flexible

Flexible budgeting
Which is designed to change in relation to the level of activity attained. Adaptable to any given set of operating conditions. Useful from control point of view. More realistic, practical and useful.

1.The expenses budgeted for production of 10,000 units in a factory are furnished below: Rs. per unit Materials 70 Labour 25 Variable costs 20 Fixed costs (Rs.1,00,000) 10 Variable expenses 5 Selling expenses (10% Fixed ) 13 Distribution expenses (20% Fixed ) 7 Administration expenses (Rs. 50,000) 5 Prepare a budget for the production of 8,000units and 6,000units.

Functional Budgets
Sales Production Purchases Cash Capital expenditure Selling and distribution Plant Utilisation Master budget is a summary budget incorporating its component functional budgets and which is finally approved, adopted and employed. Operating budget(Budgeted P&L account) and Financial budget (budgeted Balance sheet)

2.Mafatlal Ltd sells two products of handkerchiefs cotton and silk in four areas North, South, East and West. The following sales are budgeted for the month of September 2012: North cotton 5000 @ Rs.30 each, and silk 3000 @ Rs.15 each. South silk 6000 @ Rs.15 each. East cotton 7500 @ Rs.30 each. West cotton 4000 @ Rs.30 each and silk 2500 @ Rs.15 each. Actual sales for the same period were as follows: North cotton 5750 @ Rs.30 each and silk 3500 @ Rs.15 each. South silk 6250 @ Rs.15 each. East cotton 8250 @ Rs.30 each. West cotton 4750 @ Rs.30 each and silk 2625 @ Rs.15 each.

On the basis of all the relevant factors, the following sales are budgeted for the month of October, 2012. North cotton 6000 and silk 3250 South silk 6500 East cotton 8500 West cotton 4500 and silk 2750. It was decided that additional advertising campaign will be undertaken in south and east which will result in additional sales 1500 cotton in south and 2500 of silk in east. You are required to prepare sales budget for the month of October showing the budgeted and actual sales for the month of September. .

3. The sales manager of Oil and Co. Ltd reports that next year he expects to sell 50000 units of a certain product. The production manager consults the store keeper and casts his figures as follows: Two kinds of raw materials A and B are required for manufacturing a product. Each unit of the product requires 2 kg of A and 3 kg of B. The estimated opening balances at the commencement of the next year are finished product 10000 units; A 12000 kg B 15000 kg. The desirable closing balances at the end of the next year are finished product 14000 units; A 13000 kg and B 16000 kg. Prepare purchase budget for the next year.

4.X Ltd has prepared the following Sales Budget in units for the first five months of 2012: Jan 10800/ Feb 15600/ March 12200/ April 10400/ May 9800 Inventory of finished goods at the end of every month is to be equal to 25% of sales estimate for the next month. On 1st Jan 2012, there were 2700 units of product on hand. There is no work in progress at the end of any month. Every unit of product requires two types of materials i.e., Material A 4 Kgs and Material B 5 Kgs Materials equal to one half of the requirement of next months production are to be in hand at the end of every month. This requirement was met on 1st Jan,2012. Required to prepare for the first quarter 2012 budgets in quantitative: Production budget and Purchase budget

5. Look Ltd produces and sells a single product. Sales budget for the calendar year 2012 by quarter is as under: Quarter No.of units to be sold I 12000 II 15000 III 16500 IV 18000 The year 2013 is expected to open with an inventory of 4000 units of finished product and close with an inventory of 6500 units. Production is customarily scheduled to provide for two-thirds of the current quarters sales demand plus one third of the following quarters demand. The production anticipates sales volume by about one month. The standard cost details for one the standard materials 10 kgs @50 paise per kg.

Direct labour 1 hour 30 minutes @ Rs.4 per hour. Variable overheads 1 hour 30 minutes @ Re. 1 per hour. Fixed overheads 1 hour 30 minutes @ Rs. 2 per hour based on a budgeted production volume of 90000 direct labour hours for the year. 1.Prepare Production Budget for 2013, by quarters, showing the number of units to be produced and the total costs of direct labour, variable overheads and fixed overheads. 2.If the budgeted selling price per unit Rs.17, what would be the budgeted profit for the year as a whole? 3. In which quarter of the year is the company expected to break even?

6.Prepare Cash budget

I II III Opening cash balance 10,000 Collection from customer 1,25,000 1,50,000 1,60,000 Payments: Purchase of materials 20,000 35,000 35,000 Other expenses 25,000 20,000 20,000 Salary and wages 90,000 95,000 95,000 Income tax 5,000 Purchase of machinery -

IV
1,21,000 54,200 17,000 1,09,200 20,000

The company desired to maintain a cash balance of Rs.15,000 at the end of each quarter. Cash can be borrowed or repaid in multiples of Rs.500 at an interest of 10% per annum. Management does not want to borrow cash more than what is necessary and wants to repay as early as possible. In any event, loans cannot be extended beyond four quarters. Interest is compounded and paid when the principle is repaid. Assume that borrowings take place at the beginning and repayments are made at the end of the quarters.

Standard costing

Meaning
Standard is a predetermined measurable quantity set in defined conditions against which actual performance can be compared, usually for an element of work operation or activity. Standard costing involves the setting of predetermined cost estimates in order to provide a basis for comparison with actual cost. A standard cost is planned cost for a unit of product or service rendered. Standard costing is universally accepted as an effective instrument for cost control in industries.

Problems
1. From the following information calculate material cost variance, material price variance and material usage variance. Standard: Material for 70 kg finished products 100kg Price of material Re.1 per kg Actual: Output 2,10,000 kg Material used 2,80,000 kg Cost of materials Rs. 2,52,000

2.

From the following particulars, compute: MCV, MPV and MUV. Quantity of material purchased 3,000 units Value of material purchased Rs.9,000 Std qty of materials required per ton of output 30 units Std rate of material Rs.2.5 per unit Opening stock of materials Nil Closing stock of materials 500 units Output during the period 80 tons

3.During the month of March,2011the following data available: The standard loss is 30%. Actual yield 115 kgs Calculate material variances.

Standard Units Price

Actual Units Price 80 4.5

60

40

10

70

4.The standard mix to produce 1 unit of product is as follows:

Material A Material B 60 Kg @ Rs. 15 per kg. 80 Kg @ Rs. 20 per kg. = Rs. 900 = Rs. 1,600
= Rs. 2,500

Material C 100 Kg @ Rs. 25 per kg.

During the month of December, 10 units were actually produced and consumption was as follows:
Material A Material B 640 Kg @ Rs. 17.5 per kg. 950 Kg @ Rs. 18.0 per kg. = Rs. 11,200 = Rs. 17,100 = Rs. 23,925

Material C 870 Kg @ Rs. 27.5 per kg.

Calculate MCV, MPV, MUV, MMV.

Labour Variances
The following information is given : Standard hours per unit Standard rate Actual data: Actual production Actual hours Actual rate calculate labour cost variance. 25 Rs.4 per hour

1000 units 30,000 hours 3.90 per hour

A gang of workers normally consists of 30 men, 15 women and 10 boys. They are paid standard hourly rates as under: Men Rs0.80,Women Rs0.60 and Boys Rs0.40. In a normal working week of 40 hours, the gang is expected to produce 2,000 units of output. During the week ended September, the gang consisted of 40 men, 10 women and 5 boys. The actual wages paid were at the rate of Rs.0.70, Rs.0.65 and Rs.0.30 respectively. Four hours were lost due to abnormal idle time and 1600 units were produced.

Calculate:

1. Wage variance, 2. Wage rate variance 3.Labour efficiency variance 4. Gang composition variance 5. Labour idle time variance

Cost Sheet
Prepare condensed profit and loss statement with the help of schedules 1. Cost of sales 2. Selling and distribution expenses. 3.Administration expenses. Inventories: Finished stock 80,000 Raw Materials 1,40,000 Work in progress 2,00,000 Office appliances 17,400 Plant and Machinery 4,60,500 Buildings 2,00,000 Sales 7,68,000 Sales returns 14,000 Materials purchased 3,20,000 Freight incurred on materials 16,000 Purchase returns 4,800 Direct labour 1,60,000 Indirect labour 18,000 Factory supervision 10,000 Repair and upkeep factory 14,000 Heat, light and power 65,000

Rates and taxes Miscellaneous factory expenses Sales commission Sales travelling Sales promotion Distribution Dept. sales and expenses Office salaries and expenses Interest on borrowed funds Closing Inventories: Finished goods Raw materials Work -in progress Accrued expenses on : Direct labour Indirect labour Interest on borrowed funds Depreciation on: Office appliance Plant and machinery Buildings

6,300 18,700 33,600 11,000 22,500 18,000 8,600 2,000 1,15,000 1,80,000 1,92,000 8,000 1,200 2,000 5% 10% 4%

Distribution of costs: Heat , light and power to factory, office and selling in the ratio 8:1:1. Rates and taxes two thirds to factory and onethird to office. Depreciation on buildings to factory, office and selling in the ratio 8:1:1.