PALAWAN STATE UNIVERSITY

College of Business and Accountancy

Department of Accountancy
Puerto Princesa City

MODULE 1:
INTRODUCTION TO COST AND
MANAGEMENT ACCOUNTING
BA2002: COST AND MANAGEMENT ACCOUNTING
2ND Semester | SY: 2020-2021

BSBA-MM 1

LARA CAMILLE C. CELESTIAL, CTT, CMA

College of Business and Accountancy
Palawan State University
 TABLE OF CONTENTS

Title Page of Module 1

Table of Contents 2

Overview 3
Course Outcome 3
Learning Outcomes 3
Summary of Topics 3

Content
Topic 1: Cost Terms & Concepts 4
Topic 2: Cost Classifications 5
2.1: Cost Determination & Reporting Methods 5
2.2: Cost Accounting Approaches 5
2.3: Cost Accounting In Relation to Product 6
2.4: Cost Accounting for External Reporting 7
2.5: Cost Accounting for Predicting Cost Behaviour 7
2.6: Cost Accounting for Decision-Making 8
Topic 3: Cost Accounting VS Management Accounting 9

Reference 11

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 MODULE 1 |
INTRODUCTION TO COST AND MANAGEMENT
ACCOUNTING
Overview
Michael E. Porter in his theory of Generic Competitive Strategies
has described Cost Leadership as one of the three strategic dimensions
(others are ‘Product differentiation’ and ‘Focus or Niche’) to achieve
competitive advantage in industry. Cost Leadership implies producing
goods or provision of services at lowest cost while maintaining quality to
have better competitive price. In a business environment where each
entity is thriving to achieve apex position not only in domestic but global
competitive market, it is essential for the entity to fit into any of the three
competitive strategic dimensions. Cost Leadership, also in line with the
subject Cost and Management Accounting, can be achieved if an entity
has a robust cost and management accounting system in place.

In this module, you will learn various aspects of cost and management accounting and
its application in different manufacturing and service environment.

Intended Learning Outcomes:

 Define the various cost terms used in cost and management accounting
 Identify the various cost classifications and how they are used in the accounting as a
business language
 Enumerate the various:
 classification of cost for determination and reporting methods;
 cost accounting approaches,
 cost classifications in relation to product,
 cost classifications for external reporting purposes,
 cost classifications for predicting cost behavior, and
 cost classifications for decision-making

Topics:
1: Cost Terms & Concepts
2: Cost Classifications
2.1: Cost Determination & Reporting Methods
2.2: Cost Accounting Approaches
2.3: Cost Accounting In Relation to Product
2.4: Cost Accounting for External Reporting
2.5: Cost Accounting for Predicting Cost Behaviour
2.6: Cost Accounting for Decision-Making
3: Cost Accounting VS Management Accounting

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Topic #1: Cost Terms & Concepts

Studying cost and management accounting requires knowledge on the various

terminologies that are commonly used by business practitioners and academicians. As part of
learning more about cost and management accounting, knowing the definition of these various
terms and its applications will make this course understandable from your viewpoint, both as a
learner and a business student. These terms are the following:

a) Cost. This refers to the money or resources sacrificed, forgone, or paid by a business
enterprise to achieve a specific objective.

For example:
A company purchased a computer for 50,000. This is the cost that
would be recorded in a company because it is the money or
resources forgone or sacrificed. This cost is what we called as
historical cost.

b) Cost Object. This refers to the cost of anything which is to be

measured. A cost object is any item such as product, department, customer, or a project
for which the cost is determined and assigned.

For example:

 If one wants to measure the cost of the sales department, then the cost object is the
sales department.
 If one wants to measure the cost of product X, then the cost object is product X.
 If one wants to measure the cost of customer Y, then the cost object is product Y.

The reason why one assigned a cost object is simply to measure the cost of such thing.
Measuring the cost is important in decision-making. If one decides to improve its cost, then
the records can be reeled upon in making the decision.

c) Cost Accumulation. This refers to the accumulation of cost information that will be done
in a systematized manner using an accounting system.

For example:

 If one accumulates cost using job-order system, then the cost accumulation will be
done on a per job basis.
 If one accumulates cost using process cost system, then the cost accumulation will be
done on a per department basis.

d) Cost Assignment. First, this involves the assignment of direct cost to cost object which is
called tracing. Tracing could either be:

 Direct Tracing. It is the process of identifying and assigning costs to a cost object
that can be specifically or physically associated with the cost object. It can be
accomplished by physical observation.
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  Driver Tracing. The use of drivers to assign cost to cost object. This could either
be:
 Activity drivers
 Resource drivers

e) Cost Accounting. It is the calculation of cost of a product or service for planning, directing,
and controlling the activities of the business enterprise thereby improving its product,
service quality, and efficiency.

f) Cost Accounting System. It is the means by which accounting information is processed

and reported.

g) Cost Pools. These are categories into which overhead is divided for the purpose of
calculating multiple overhead rates.

Topic #2: Cost Classifications

2.1 COST DETERMINATION AND REPORTING METHODS

a) Actual Costing – a valuation method that uses direct

material, direct labor, and overhead changes in
determining the product cost.

b) Normal Costing - a valuation method that uses actual

cost of direct materials and direct labor in conjunction
with a predetermined overhead rates in determining the
product cost.

c) Standard Costing – a valuation that uses

predetermined norms for direct materials, direct labor,
and overhead for assigning costs to various inventory
accounts and cost of goods sold.

d) Variable Costing – a cost accumulation and reporting method that includes only variable
production costs (direct materials, direct labor, and variable overhead) as inventoriable or
product cost. This is not acceptable for external reporting.

e) Absorption Costing (Full Costing) – a cost accumulation and reporting method that
treats the cost of all manufacturing components (direct material, direct labor, and variable
and fixed overhead) as inventoriable or product cost. This is the traditional approach of
product costing which is used for external reporting.

2.2 COST ACCOUNTING APPROACHES

a) Job-Order Costing – a system of accumulating cost that focuses on a specified product

and is based on customer specification or job order. We refer to these products as

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 heterogeneous products. Heterogeneous products are products depending on the
specification of the project.

Example industries using Job-Order Costing:

 Furniture Manufacturing
 Cosmetic Manufacturing
 Printing Manufacturing

b) Process Costing –a system of cost accumulation that is applicable for producing large
quantities of homogeneous products. The cost is accumulated by department rather than
by job order.

Examples:
 Cement Manufacturing
 Softdrink Manufacturing
 Steel Manufacturing

c) Standard Costing - a system of cost accumulation where a product norm cost is already
established before its manufacturing process. Norm cost means that before producing a
certain product, the company already has the total recognized cost. The actual cost of
producing the product will be analysed in variance analysis. Variance Analysis is a system
used by accountants whereby the variance (the difference between the standard cost and
the actual cost) will be analysed. Standard can be applied to either job order costing or
process costing. You will encounter the detailed discussion regarding this approach on our
next modules.

2.3 COST CLASSIFICATIONS IN RELATION TO PRODUCT

a) Direct Materials – these are the raw materials used that form an integral part of the
product and directly conveniently traced into it.

b) Direct Labor – it is the payroll cost of employees directly doing the job and can be
easily traced to the product.

c) Manufacturing Overhead – it is the cost incurred that is related to the product but part
of direct materials and direct labor. These costs are usually assigned to a product or to
a department. It is sometimes called factory overhead, factory burden, or indirect
manufacturing overhead.

For example:
 Indirect Materials – Factory supplies, Lubricants
 Indirect Labor – Supervision, Inspection, Defective works
 Other Indirect Cost – Insurance, Tax, Utilities

d) Manufacturing Cost – this cost refers to the direct materials, direct labor, and
manufacturing overhead. This is the total cost of the product.

e) Prime Cost – this cost refers to direct materials and direct labor.

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 f) Conversion Cost – this cost refers to direct labor and manufacturing overhead.

2.4 COST CLASSIFICATIONS FOR EXTERNAL REPORTING

a) Period Cost – these are the costs chargeable to the

specific accounting period in order match revenue. It is
normally referred to as operating expenses.

For example:

 Selling Expenses – Advertising, Commission, Delivery

Expenses, etc
 Administrative Expenses – Salaries, Rental, Utilities, etc.

b) Product Cost – these are the costs assignable to the product which become an
expense when the product is sold. When these products are not yet sold, the cost
assigned to the product is considered as an asset.

For example:
Product cost includes purchases of raw materials and its related accounts such as freight
in, purchase discounts, purchase returns, allowances, etc.

2.5 COST CLASSIFICATIONS FOR PREDICTING COST BEHAVIOR

a) Variable Cost – a variable cost has the following characteristics:

 Variability of the total cost in proportion to the volume produced
 Relatively constant on a per unit cost as the volume of products changes within a
relevant range
 Easily assignable to operating departments
 Controllable by operating supervisor

For example: supplies, fuel, lumber, and overtime charges.

b) Fixed Cost – this cost has the following characteristics:

 Fixed total cost within the relevant range
 Decrease in per unit cost as volume increases
 Assignable to departments using allocation methods

For example: salaries of executives, depreciation, property taxes, and patent amortization.

c) Semi-variable Cost (mixed cost) – these are costs that are fixed within the
relevant range, but varies proportionately with output changes.

For example: electricity, water, telephone charges, etc.

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2.6 COST CLASSIFICATIONS FOR DECISION-MAKING

a) Differential Cost – is sometimes called incremental cost. It represents the difference in

cost between any two alternatives.

b) Differential Revenue – represents the difference in revenues between any two

alternatives.

Present Proposed Differential Cost & Revenue

Revenue 900,000 1,200,000 300,000
Cost & Expenses 700,000 925,000 225,000
Net Income 200,000 275,000 75,000

A management will now decide based on the differential cost and revenue whether to
adopt or not the proposed condition. If the company will adopt the new proposed condition,
the company can expect a differential net income of ₱75,000.

c) Opportunity Cost – is the potential benefit that one gives up when one alternative is
chosen over the other.

For example:
Assuming Bhie is earning ₱250 as a student assistant in college. Bhie’s friend invited him
to spend a vacation in El Nido on Saturday. He opted to go to El Nido with his friend.

The opportunity cost is ₱250 because this is the cost Bhie gave up for choosing to spend a
vacation on Saturday in El Nido.

d) Sunk Cost – is a cost that has already been incurred and cannot be changed anymore
by any decision made now or in the future.

For example:
Natoy purchased a car for ₱500,000. He found out that days later he needs motorcycle
more than a car. In this case, ₱500,000 is his sunk cost because no amount of regret can
relieve that person of his decision or any future decision that may avoid this cost. It is done
already – he already purchased a car. ₱500,000 is irrelevant to a decision in purchasing a
motorcycle.

e) Avoidable Cost – cost that can be avoided if a certain decision will be made

For example: All cost except:

 Sunk Cost
 Future cost that do not differ between alternatives

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Topic #3: Cost Accounting VS Management Accounting

Cost accounting and management accounting both are internal to the organization.
Both have the same objectives of assisting management in its functions of planning,
decision-making, controlling and techniques like budgetary control, standard costing and
marginal costing owe their existence to cost accounting and have slipped into the kitbag of
the management accountant. There is a good deal of overlapping in their functions.
However, the two systems can be differentiated on the following grounds:

 Cost accounting is concerned more with the ascertainment, allocation, distribution and
accounting aspects of costs. Management accounting is concerned more with impact
and effect aspect of costs.

 Cost accounting data generally serves as a base to which the tools and techniques of
management accounting can be applied to make it more purposeful and management
oriented. Whereas, the management accounting data is derived both, from the cost
accounts and financial accounts.

 The management accountant places the data in a wider perspective than the cost
accountant. This accounts for a greater degree of relevance and objectivity in
management accounting than in cost accounting. It is the management accountant who
is supposed to have a clear idea regarding the items and types of costs required to
analyse and decide specific business problems and the effect of such costs on
alternate solutions. A cost accountant is definitely helpful in collecting such costing data
for the management accountant.

 In the organisational set-up, management accountant generally is placed at a higher

level of hierarchy than the cost accountant.

 The approach of the cost accountant is much narrower than that of a management
accountant, who may have to use certain economic and statistical data along with the
costing data to enable the management to be more accurate the precise in its functions
of planning, decision-making and control.

 Management accounting, in addition to the tools and techniques, like variable costing,
break-even analysis, standard costing, etc., available to cost accounting, also makes
use of other techniques like cash flow, ratio analysis, etc., which are not within the
scope of cost accounting.

 Management accounting includes both financial accounting as well as cost accounting.

It also embraces tax planning and tax accounting. Cost accounting does not include
financial accounting and has nothing to do with tax accounting.
 Management accounting is concerned equally with short-range and long-range
planning and uses highly sophisticated techniques like sensitivity analysis, probability
structures, etc., in the planning and forecasting prices. Cost accounting is more

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 concerned with short-term planning. Evaluation of capital investment projects is the
speciality of management accountant.
 Management accounting is concerned, both, with assisting management in its
functions, as well as evaluating the performance of the management as an institution.
Cost accounting is concerned merely with assisting in management functions and does
not provide for the evaluation of the performance of management.

 Cost accounting is mostly historical in its approach and it projects the past.
Management accounting is futuristic in its approach. Management accounting is more
predictive in nature than cost accounting.

 Cost accounting system can be installed without management accounting. While

management accounting cannot be installed without a proper cost accounting system

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REFERENCES|
Leonardo E. Aliling, CPA, MBA and Ma. Flordeliza L. Anastacio, CPA, PhD, Management Accounting 1
(2015) Rex Publishing

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