UNIT V -COST AND

MANAGEMENT ACCOUNTING
INTRODUCTION
ACCOUNTING

accounting is wider term and includes recording, classifying and summarizing

of business transactions in terms of money, preparation of financial reports and analysis
and interpretation of these reports for the information and guidance of management

Branches of accounting

the business accounting system consist of 3 parts

 Financial accounting

 Cost accounting

 Management accounting
 Financial accounting
financial accounting may be defined as the science and art of
systematically recording, classification and summarizing business
transactions of financial character and finally interpreting the results for
determining the financial profits or loss at the end of an accounting year.

it also shows the financial position of the firm, and thus, records
and reports financial statements-balance sheet, income statements and
cash flow statements.
 COST ACCOUNTIN

Cost is defined as the amount of expenses (actual or notional) incurred on or

attributable to specified thing or activity.

“Cost is the measurement in monetary terms of the amount 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 activity of the cost will reflect in the manufacturing of the product or
rendering of the services which will cover expenditures under various heads.
 COST ACCOUNTING MEANING

cost accounting is concerned with recording, classifying and

appropriate allocation of expenditure for the determination of the cost of
products or services, and for the suitably arranged data for purposes of
control and guidance of information to management for decision making.

 Cost means “the price paid for something”

 Cost ascertain is computation of actual cost incurred.

 Cost estimation is process of determining cost of goods and services.

 EVOLUTION OF COST ACCOUNTING

For examples: salary, materials, other expenses etc. In the case

of service industry, they are interested in the cost of ascertaining the cost
of the services it renders. The cost per unit is arrived by dividing the
total expenditure incurred to the total number of production or the
service rendered. This method can be used when there is only one
product. If the manufacturing company manufactures more than one
product, it becomes imperative to split the total cost among the number
of products.
COST, COSTING, COST ACCOUNTING AND COST
ACCOUNTANCY:
COST:
Cost is defined as the amount of expenses (actual or notional)
incurred on or attributable to specified thing or activity.
For example –
Cost of preparing one cup of tea is the amount incurred on the
elements like material, labor and other expenses, similarly cost of
offering any services like banking is the amount of expenditure for
offering that service. Thus cost of production or cost of service can be
calculated by ascertaining the resources used for the production or
services.
Costing:
Costing is defined as, “the techniques and processes of ascertaining costs” (The
Chartered Institute of Management Accountants (CIMA). Costing means finding of cost
by any process or technique.
According to Wheldon, ‘Costing is classifying, recording, allocation and appropriation
of expenses for the determination of cost of products or services and for the presentation
of suitably arranged data for the purpose of control and guidance of management.
Cost Accounting :-
Cost Accounting primarily deals with collection, analysis of relevant of cost data
for interpretation and presentation for various problems of management. Cost accounting
accounts for the cost of products, service or an operation. It is defined 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’.
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 presentation of information for the purpose of managerial
decision making”.
Cost Accountancy is a science as it is a knowledge which a cost
accountant should possess to carry out his duties and responsibilities.
It is an art as it required skills by the cost accountant to apply
principles of cost accountancy to various managerial problems like price,
expenditures etc. Practice refers to the efforts taken by the Cost
Accountant in the field of cost accountancy. Along with the Theoretical
knowledge, cost accountant should possess sufficient practical training
and exposure to real life costing problems.
SCOPE OF COST ACCOUNTING

 Costing: It is ascertainment of cost of products, processes, jobs

services etc.it is the most important function of cost accounting.
 Cost Recording: It is a maintaining record of all the cost
(expenses) incurred during the process of the production of the
final products/ services. Such records are kept on the basis of
double entry system.
 Cost Analysis: All the costs that are recorded are analyzed and
categorized separately. Example: Direct and Indirect Costs, Fixed
and Variable Costs, etc.
 Cost Control: Cost Accounting, compares the actual cost and
standard cost, the difference between the two are analyzed and
used for cost control purpose.
 Cost Report: Cost accounting generates periodical reports such
as weekly, monthly reports that is used by the management for
taking decisions. These reports are used for planning and
controlling, performance appraisal and management decision
making.
 Cost Audit: It is the verification of cost accounts and to check
on the progress of cost accounting plan. Its main focus is on the
expenditure and efficiency of performance.
IMPORTANCE OF COST ACCOUNTING:

Cost accounting has many importance. Specially, the following parties are
benefitted from it.
 Importance to management
Management is highly benefitted with the introduction of cost accounting. It
helps to ascertain the cost and selling price of the product. Cost data help management
to formulate the business policies.
 Importance to investors
Investors want to know the financial conditions and earning capacity of the
business. An investor must gather information about organization before making
investment decision.
 Importance of consumers
The aim of costing is to reduce the cost of production to minimize the profit of
business. Consumers get quality goods at a lower price.
 Importance to Employees
Cost accounting helps to fix the wages of the workers. Efficient
workers are rewarded for their efficiency. It helps to induce incentive
wage plan in business.
 Importance to Government
government agencies to determine excise duty and income tax.
Government formulates tax policy, industrial policy, export and import
policy based on the information provided by the cost accounting.
OBJECTIVES OF COST ACCOUNTING:
 Ascertaining the Cost: It refers to the cost for a specific product or
activity with a reasonable degree of accuracy.
 Determining the Selling Price: It helps in finalizing the cost of the
product after which the profit margin is added by the manufacturer and
thus the selling price of the product is fixed.
 Cost Control and Cost Reduction: It helps in improving profitability
by controlling and reducing costs. This objective is important for
current scenario due to increase in competition in the business world.
 Management in Decision Making: Taking Management decision in
respect of the price of the product for which the comparison of actual
and standard cost is required to analysis the causes of variation and to
take corrective decisions.
 Ascertaining the Profit: It helps in ascertaining the profit of the business by
matching the cost with the revenue of that activity. The purpose is to determine the
profit or loss of any activity on an objective basis.
 To Provide basis of operating policies
 To provide information about inefficient and carelessness
 To provide information about actual situation of production activity
 To inform the principles and procedures to be followed in Costing System
 To prepare comparative analysis through data collection
 To estimate cost
 To disclose and minimize the waste
Types of Costing

 Job costing
 Process costing
 Marginal Costing
 Standard costing
 Job Costing
 This method is used when costs are accumulated for individual jobs or
projects. It's commonly used in industries like construction, consulting, and
custom manufacturing.
Used in: Customized and project-based industries.
Example:
Construction Company: Building a custom home for a client involves
tracking materials, labor, subcontractor fees, etc., specific to that one project.
Consultancy Firm: Preparing a financial analysis report for a particular
client.
Importance:
Helps in precise cost estimation for customized jobs.
Supports client billing and profitability analysis on a per-job basis.
Assists in future project bidding by providing data on similar past jobs.
 Process Costing
 This method is used when costs are accumulated for a continuous flow of
production or a large number of similar units. It's often employed in
industries like manufacturing, food processing, and chemical production.
Used in: Mass production industries with continuous processes.
Example:
Soft Drink Manufacturer: The cost of producing each bottle of soda is
derived by averaging the total cost of production over all bottles produced.
Textile Industry: Producing meters of fabric through stages like spinning,
dyeing, and finishing.
Importance:
Efficient for cost control in mass production.
Facilitates inventory valuation and pricing decisions.
Ensures smooth cost tracking across continuous processes.
 Marginal Costing
 This method focuses on variable costs, which are costs that change with
the level of production. It's useful for decision-making, such as pricing,
determining production levels, and evaluating the profitability of products.
Used in: Strategic planning and pricing decisions.
Example:
Electronics Manufacturer: While deciding to accept a bulk order at a
reduced price, only additional variable costs like components and labor are
considered—not fixed factory rent.
Importance:
Assists in break-even analysis and profit planning.
Useful for pricing decisions during competitive or seasonal markets.
Helps in assessing impact of additional production or discontinuing a
product.
 Standard Costing
 This method sets predetermined costs for materials, labor, and overhead
based on historical data and industry benchmarks. The actual costs are then
compared to these standards to identify variances and control costs.
Used in: Manufacturing, service industries, and budgeting exercises.
Example:
Car Manufacturer: Sets standard labor hours and material usage for
assembling a vehicle. Actual usage is monitored against these standards to
detect inefficiencies.
Importance:
Enables cost control and operational efficiency.
Useful for performance evaluation of departments and employees.
Supports budgeting and forecasting with a focus on variance analysis.
BUDGET
 What is a Budget?
 A budget is a financial plan that outlines the expected income and expenses
for a defined period.
 In business context, Budget can be a roadmap guiding resource allocation
to achieve organizational goals and objectives efficiently. It also includes
assumptions of future fund needs, setting spending limits, and minimizing
debt. A well-structured budget provides a clear picture of income and
expense sources, which helps keep track of expenses to maintain financial
stability. In addition, it assists in identifying cost-cutting areas and saving
for potential investments in the future.
 Review the budget regularly to ensure its relevance to the changing market
conditions. So, the budget helps businesses and individuals make well-
informed financial decisions and control their overall financial health.
Steps in preparing a budget

1. Setting the goals

Start by defining the purpose behind the budget. Set clear objectives,
with the understand of the purposes of the process for instance, for
short-term financial control, long-term strategic planning, or both.
It is important to understand any organisational goals, strategic
objectives, and top-down targets.
Then, evaluate any assumptions and gain consensus on the goals before
commencing the process. This aligns the budgeting process with the
overall direction of the organisation.
 Types of Budgeting
 Organizations use different budgets to manage their finances depending on their size,
industry type and financial needs. The most common types of budgets are as follows:

1. Operating budget: It highlights the day-to-day expenses and revenue of the

organization and typically includes salaries, utilities, marketing expenses, and salary
projections.
2. Capital budget: It helps organizations assess their financial feasibility for capital
projects by recording their long-term investments in equipment, machinery and
infrastructure.
3. Cash budget: It helps track the organization’s incoming and outgoing cash flows and
predict cash surpluses to meet financial obligations.
4. Master budget: It includes all the individual budgets of different departments or
divisions and is the organization’s overall financial plan.
5. Flexible budget: It is a budget that incorporates minor adjustments based on the
changing environment, like variations in sales and production levels.
 Types of Budgeting
6. Zero-based budget: Every expenditure is justified by analyzing it from scratch. This
approach helps in optimizing resource allocation by reducing unnecessary costs.
7. Sales budget: It predicts the expected sales volumes and revenue for the period
and is the basis for planning production and setting sales revenue targets.
8. Expense budget: The planned expenses for various departments, like marketing,
sales, research and development, and office.
9. Project budget: It is the budget of a specific project and includes expenses, project
profitability and strategies for cost-cutting.
10. Departmental budget: The budget allocated to each department helps the
managers plan their expenses to achieve the organizational and departmental
objectives efficiently.
 Importance of having a Budget
1. Financial control
It is one of the crucial financial planning tools as it helps organizations set goals by
analyzing the various sources of income, expenses, and savings target. This makes
it easier for the organizations to understand their financial viability and allocate
resources.
2. Emergency preparedness
A well-planned budget can help navigate through sudden financial roadblocks by
allocating a part of resources and money to the emergency budget. This emergency
budget acts as a safety net, reducing the increased reliance on debt or external
sources of funds during crisis times.
3. Improved cash flow management
A budget also helps track the cash inflows and outflows, ensuring enough liquidity. It
also helps organizations in efficient payroll processing, inventory management, and
maintenance of vendor payment records. Enhanced cash flow management helps
reduce stress and maintain financial stability.
 Importance of having a Budget
4. Performance evaluation
They serve as benchmarks for effective evaluation of financial performance.
Organizations compare the actual output with the budgeted predictions to gain
insights into their financial health. It also helps assess their spending habits
and sources of revenue and take proactive measures to bridge the gaps in
their financial performance.
5. Communication and accountability
The budget promotes a culture of transparency and accountability within the
organization. Effectively communicating the budget to stakeholders like
investors, partners, and employees helps create a collective sense of financial
understanding. This also helps increase responsibility and accountability
among the employees as they are aware of the allocated resources and
budgets and pool their efforts to achieve the objectives and goals.
Flexible budget format