cost and management accounts

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COST AND MANAGEMENTACCOUNTS

BYPROF AJAY PANDEY



HISTORY

Accounting for management

Management accounting is a collection andpresentation of relevant economic information

relating to an enterprises for planning,controlling and decision making

It serves for the following purposes

Formulation of policy

Planning controllingDecision making

Disclosure of entity

Safe guarding assets



Role of cost in decision making

Analysis and estimates the profitability.

It assist in setting the prices so as to cover cost and generate anacceptable level of profit

It help in formulation of policies

It helps in formulation of operational efficiency

It help in determination of break even point

It enables to distinguish between profitable and non profitable

Costing checks recklessness and avoids occurrence of mistake

It helps in estimation of and duties by the government

It helps in allocation of actual result with expected result

It helps in investment decision.



Management Vs cost

Cost Accounting:-

Concern with ascertainment,allocation,distribution of accounting aspectof cost

Its data generally serve as a base to which tools and techniques of

management system Scope is narrow

It deals with collection, analysising relevance, interpretation andpresentation for various problem of management

It is planned by the lower level of hierarchy

It does not include financial accounting or tax accounting

It concerned with short term planning

It is historical in its approach as projects about past

It concerned with monitory aspect only

It is basically concerned with collection, classification and analysis of cost data



Management Vs cost

Management accounting

It concerned with impact and effect aspect of cost

Its data derived from both cost and financial accounting

Scope is wider It deals with determination of policy and formulation of

plan

It is planned and placed at a higher level of hierachy

It include both financial and tax accounting

It concerned with long term planning It is also concerned with non monitory aspect as well

It concerned with various department , division of thebussiness,



Types of cost

Classification of cost by : Nature

Material cost:- Cost of material in any form for the purpose of production

Labour cost :- Labour cost includes salary of the permanent or wages of

temporary employee--Cost centre

Direct cost :- It is also known as traceable cost , but in nut shell it is the costwhich can be recovered after sales

Direct material Direct labour

Direct expenses

Indirect Cost It is also known as common cost, which is generally incurredafter the completion of production

Indirect Material

Indirect LabourIndirect expenses



Types of cost

Function/activities

Total cost

Production cost

Prime cost

Factory cost

Administrative cost

Selling and distribution cost

Research and development cost

Time

Historical Cost:- It is the actual cost determined afteroccurrence of the event

Pre-determined cost :-This cost is of the product which arecomputed in advance

Standard cost

Estimated cost



Types of cost

Decision making

Marginal cost:-It is defined as the amount at any givenvolume of output by which aggregate costs are changed if thevolume of output is increased or decreased

Differential cost:- It is also known as incremental cost, it isnothing but the difference in the total cost that will arise fromselection of one alternative to other

Opportunity cost:- It is value of benefits sacrificed in favourof an alternative course of action.

Replacement cost :- It is a cost of replacing an asset

at any given point of time.

Relevant cost:- It is a cost appropriate in aiding to makespecific management decision.

Sunk cost:- It is one for which the expenditure has takenplace in the past.



Other than the discussed costs

there are some more- Normal cost

Abnormal cost

Avoidable cost

Unavoidable cost

Product cost

Traceable cost

Common cost

Controllable cost

Short run/Long run cost

Past/Future cost

Out of Pocket cost

Book cost

Shut Down cost

Urgent cost

Variable cost

Semi-Variable cost

Fixed cost

Semi Fixed cost



Material

Direct MaterialGoods purchased for

incorporation intoproduct for sale is Rawmaterial. And rawmaterial is also knownas direct material. The

direct material costsare those which can beidentified easily.

Indirect MaterialThe cost incurred on

material used tofurther themanufacturing processwhich cannot be tracedinto an end product are

called indirectmaterial.



Components of Direct Material

Indirect Tax.

Transportation, Storage,and Delivery

Charges. Quantity Discount.

Trade Discount.

Cash Discount. Packing and Container Charges.



Illustration

The following details are available in respect of aconsignment of 1250 kg of material-

Invoice Price- Rs 20/kg, Excise Duty- 25% on I/P, Sales tax-

8% on I/P including E/D, Trade Discount- 10% on I/P,Insurance- 1% on Net Price, Delivery Charges- Rs 250.

Cost of Container @ Rs 60/container for 50 kg of material.

Rebate @ 40% if Container is returned within six weekswhich is a normal feature.

One container load of material was rejected on inspectionand not accepted. Cost of unloading and handling [email protected]% cost of material.

Calculate the landing cost of material.



Method of Pricing Material

Issued FIFO Method.

LIFO Method.

HIFO Method. Simple Avg. Cost Method.

Weighted Avg. Cost Method.



Inventory Control System

Input Output Ratio:- Input/Output*100. Stock Turnover Ratio:- Cost of Material used

during the period/Avg. Stock of Material during

the period. Economic Order Quantity:- Square root of

2AB/CS, wherein

A= Annual Consumption

C= Cost per unitB= Cost of placing an order

S= Storage and Carrying cost



Contd.

VED Analysis:- It divides item into three categories in descending order-

V= Vital Item

E= Essential Item

D= Desirable Item

FNSD Analysis:- It shows the moving position of stock or inventory.

F= Fast Moving

N= Normal Moving

S= Slow Moving

D= Dead Stock

ABC Analysis:- It divides the stock into three categories namelyClass A- Constitute the most important class of Inventories

Class B- Constitute intermediate position

Class C- Are quite negligible



Labour

Direct Labour:- Thelabour cost incurred onthe employees who are

engaged directly inmaking the pdt, theirwork can be identifiedclearly in the process of

converting the rawmaterials into finishedpdt is called directlabour.

Indirect Labour:- Herethe labour are notdirectly involved in the

process of productioninstead of others non-production activity.



Items of labour Cost

Monetary:- Salaries & Wages and other

Allowances.

Monetary Benefits after sometime in thefuture like EPF, PF, Pension, Gratuity, Bonusetc.

Non-Monetary:- Perquisites.



Job Evaluation Method

Job Ranking Method.

Grade Description Method (Grades are given

on the basis of education, experience etc). Factor Comparision Method (Mental

Requirement, Skill, Physical Requirement,

Responsibilty, Work Condition).

Point Rating Method (Same as Grade).



Remuneration Method

Time Rate.

Piece Rate.



Time Rate

Flat Time Rate Method-Wages= Hrs worked*Wagerate/hr.

High Day System- Wages=

Hrs worked * High day rate. Different Time Rate ( Here

different time rate is fixedaccording to efficiency andskill ).

Halsey Premium Bonus Plan-It is calculated at 50 % of timesaved. Total Wages=( TimeTaken*Hourly rate + 50/100 *time saved * hourly rate ).

Rowan Premium Bonus Plan-(Here no %age is fixed). TotalWages= (Time taken*Hourlyrate ) + Time saved/Std.

time* Time taken* Hour rate. Halsey-Wair Plan- It is

modified system of HalseyPremium Bonus Plan. This iscalled as 33 1/3% - 66 2/3%sharing plan under which

331/3% to employee and662/3 % to employer asbonus. Total Wages= (TimeTaken * Hourly rate) + 331/3 /100 * Time saved * Hrly rate.



�Accelerated Premium Bonus Plan

Under this the worker will be paid bonus with

increase in its efficiency.



�Emersons Efficiency Bonus Plan

Efficiency % Bonus

Below 662/3%

662/3% to 100% Over 100 %

Time Wage no bonus

.01% to 20% 20% above basic wages +

1% increase in efficiency.



Time Rate

Barth Variable Bonus Plan Earnings= Hourly

Rate * Square root of Std. Time * Actual

Time. Bedaux Points Plan = Wages Time Taken *

Hrly rate, Bonus = 75/100 * Bedaux point

saved * point rate.



Piece Rate

St. Piece Rate Method- Wages= No. of pieces

produced * rate per piece.

Piece Rate with Guaranteed Time ratemethod.

Group Bonus Plans.



OVERHEADS

The arrangement of items in logical groups

having regard to their nature or purpose to be

fulfilled Allocation of Overhead The charging of

discrete, identifiable items of cost to cost

centre or cost units , where a cost can be

clearly identified with a cost centre or costunit , then it can be allocated at particularcost centre or unit.



Apportionment of Overhead

The allotment of two or more cost centre of

proportion of the common item of the cost

and the estimated bases of benefit received



Types of ovrhd Basic of

appor

Rent ,rates heating,repair, depreciation

Lighting and heating

Power hour

Marketing anddistribution

Area occupied (Floorarea)

No. of Points

Horse power of machines

Sale value



Method of apportionment

A) Direct Method

B) Step down method

C) Repeated Distribution method D) Simultaneous Equation Method



Method of Absorbtion of

Overhead

A) Production unit method

B) %age of direct cost method

C) % age of direct Labour cost method

D) %age of Prime cost method

E) Machine hour rate method

F) Direct hour rate method



Absorption

� Production Unit Method (PUM)-: Budgeted orActual Overhead/No. of unit produced orbudgeted. Eg- Budgeted Overhead is Rs

2,00,000 p.a. and budgeted production is 50,000.PUM = 2,00,000/50,000 = 4 per unit.

� %age of Direct Material Cost Method(PDMCM):-Budgeted or Actual Overhead/Budgeted or

Actual Direct Material Cost* 100. Eg- BudgetedOverhead = Rs 1,00,000 , Material Cost = Rs4,00,000, PDMCM= 100000/400000*100= 25%of Direct Labour Cost.



Absorption

%age of Direct Labour Cost Method(PDLCM):-Budgeted or Actual Overhead Cost/Budgeted orActual Direct Labour Cost* 100. Eg- Budgeted

Overhead =Rs 100000, Actual Direct Labour= Rs500000, PDLCM= 100000/500000*100= 20% of Direct Labour Cost.

%age of Prime Cost Method (PPCM):- Budgeted

or Actual Overhead/Budgeted Prime Cost%100.Eg- Budgeted Overhead- Rs 200000, Prime Cost-Rs 800000. PPCM= 200000/800000*100= 25% of Prime Cost.



Cost Sheet & Method of Costing

Reconciliation of Cost and Financial a/c.

� Need for Reconciliation 1) The reason fordifference in P/L. 2) To check accuracy of costaccounting. 3) Reliability of cost a/c data. 3)To promote co-ordination and co-operationbetween fin. a/c and cost a/c. 4) To identifythe reason of deviation in profit.

� Method of Reconciliation- a) MemorandumReconciliation a/c. b) ReconciliationStatement.



A) Memorandum Reconciliation

Account To under absorption in

cost a/c.

To under valuation of

opening stock in cost a/c. To over valuation of closing stock in cost a/c.

By profit as per cost a/c.

By over absorption incost a/c.

By items only charged incost a/c.

-Interest on Own Capital.

-Rent on Own Buildings.

By over valuation of opening stock in cost a/c.

By under valuation of closing stock in cost a/c.



A) Memorandum Reconciliation

A/C To item that only effect in fin. a/c

- Brokerage.

- Underwriting Commission.

- Donation.

- Income Tax.

- Goodwill written off.

- Preliminary expenses writtenoff.

- Discount on issue of share &

debentures.- Fines and Penalties.

- Bank interest.

To Net profit as per financial a/c.

By income received onlycredited in financial a/c.

-Interest Received.

-Dividend Received.

-Rent Received.-Transfer fee collected.

By profit on sale of assets.



B)Reconciliation Statement

Profit/Loss as per cost a/c- *Less:- Exp not considered incost a/c- *

Add:- Income not consideredin cost a/c

Trading Profit- *Profit from other activity- *

Income from Investment- *

Previous yrs income- *

Profit on sale of investment- *

Profit on sale of raw materials-*

Abnormal/Non-recurringearning- *

Abnormal losses- *

Expenses relating toprevious yr- *

Lay off wages- *

Differences in

Depreciation- * Delay in payment charges

for bill- *



Reconciliation

Statement(Contd.) Add/Less in difference in opening & closing

stock as per

A) Financial a/c- *B) Finished goods a/c- *

C) Work in progress- *

P/L as per financial a/cs - ***



Unit-II, Marginal Costing

Marginal costing is defined as the amount on

any given volume of output by which

aggregate cost are charged if the volume of output is increased or decreased by one unit.



Diff. betwn Absorption & Marginal

CostingAbsorption Marginal

Total cost i.e both fixedand variable is charged tothe cost of product.

Fixed cost is included in thecost of products.

Profitability is measured by

profit earned by variousproduct or deptt.

Diff btwn sales and totalcost is profit.

Only variable cost is

charged to products. It is not included .

Profitability is judged by

the contribution made by

various products or deptt.



Marginal Cost Equation

Sales = Variable cost + Fixed Exp +/- P/L.

S-V= C (C=Contribution).

Contribution©= Fixed exp+Profit



Practical

Determine the amount of fixed expenses from thefollowing:- Sales= Rs 2,40,000, Direct Material= Rs 80,000,Direct Labour= Rs 50,000, Variable Overhead= Rs 20,000,and Profit= Rs 50,000.

Solution- Marginal Cost Equation= S-V=F+PVariable Cost= DM+DL+Variable Overhead

VC= 80,000 + 50,000 + 20,000

V= 1,50,000

Therfore, S-V=F+P

2,40,000-1,50,000=F+50,000

90,000-50,000=F

F= 40,000.



Contd.

In order to understand the mathematical

relationship between cost, volume and profit,

we need to know the following four concepts- 1) Contribution.

2) Contribution/Sales or Profit Volume Ratio.

3) Break Even Analysis.

4) Margin of Safety.



1) Contribution

Contribution means difference between the

sales and the marginal cost of sales and its

contribution towards fixed expenses andprofit.

A) Contribution = Selling Price Marginal

Cost Or

B) Contribution = Fixed Exp + Profit Or

C) Contribution = Fixed Exp - Loss



2) Contribution/Sales or

Profit/Volume Ratio The profit volume ratio studies the

profitability operation of a business andestablishes the relationship between

contribution and sales. P/V Ratio = Contribution/Sales (C/S). Or Fixed

Exp+ Profit/Sales (F+P/S). Or Sales VariableCost/Sales (S-V/S) Or Change in profit orContribution/ Change in Sales.

P/V ratio is very useful and is used for thecalculation of:-



Contd.

i) BEP= Fixed Cost/P/v ratio.

ii) Value of sales to earn a desired amount of

profit= Fixed cost + Desired Profit/P/v ratio. iii) VC= Sales (1-p/v ratio).

iv) Profit = (Sales * p/v ratio)- FC.

v) FC= (Sales*p/v ratio)-Profit.

vi) Margin of Safety= Profit/p/v ratio.



Practical

Eg- Calculate p/v ratio from the followinginformation: Selling Price= Rs 10/unit, variablecost= Rs 6/unit, Sales & Profit for two years are-

in 2005 S- Rs 1,50,000 & P- Rs 20,000. In 2006 S-Rs 1,70,000 & S- Rs 25,000. Solution- P/V Ratio= Contribution/Sales*100,

wherein C= S-V, C= 10-6=4, therefore P/V Ratio=4/10*100=40%

Now with the change in profit i.e from 2005 to2006 is Rs 5,000(25,000-20,000). P/V Ratio=Change in Profit/Change in Sales*100.50000/20000*100= 25%.



3) Break Even Point

BEP is the point of sales where there is no

profit or no loss.

BEP (in units)= Total fixed exp./ Selling price Marginal cost per unit). OR

Total Fixed Exp/Contribution.

Break Even Sales= F*S/S-V Or Fixed Exp/p/v

Ratio.



Illustration-6

From the following particulars calculate- 1)

Contribution, 2) P/V Ratio 3) BEP in Units &

Rs. 4) what will be the selling price per unit if the BEP is brought down to 25,000 units.

Fixed Expenses- Rs 1,50,000/-

Variable Cost/ unit- Rs 10/-

Selling Price/ unit- Rs 15/-

Solution:- 1) Contribution= SP-VC= 15-10=5, 2)

P/V Ratio= C/S*100= 5/15*100= 331/3%.



Contd.

3) BEP(in units)= FE/Contribution per unit.

1,50,000/5=30,000. BEP (Rs)= FE/p/v ratio=

1,50,000/ 331/3/100= 15000000/331/3= Rs4,50,000.

4) BEP (units)= F/C= 1,50,000/5= 30,000.

When BEP- 30,000, SP- 15; BEP- 25,000, SP- ?

?= 30,000/25,000*15= Rs 18.



Illustration-7

From the following data calculate-

1) BEP expressed in amount of sales in

Rupees. 2) Number of units that must be sold to earn

profit of 1,20,000 per year.

3) How many units were sold in order to earn

a net income of 15% of sales.

4) Number of units to be sold to earn a target

profit of Rs 1,05,000 after tax (IT rate is 50%).



Contd.

Selling per unit= 40

Variable Manufacturing cost/ unit= 22

Variable Selling cost per unit= 3 Fixed Overhead(Factory)= 1,60,000.

Fixed Selling cost is Rs 20,000.



Solution:-

1) BEP(in units)= FC/SP-MC, wherein FE-

160000+20000= 180000. Selling Price- 40

Variable/Marginal= (22+3)=Rs 25/-

Therefore BEP= 180000/40-25= 180000/15=

12000 units. Therfore in Rs= 12000* 40= Rs

4,80,000.

2) Output to earn profit of Rs 1,20,000/-

FE + Profit/Contribution per unit=

180000+120000/15= 20000 units.



Contd.

3) Let the no. of unit be N

BEP= F+P/Contribution.

N= 180000+(15/100*N*40)/15 N= 180000/15+N15/100*40

N= 180000+N30/5/15

N= 180000+6N/15

15N= 180000+6N

9N=180000

N= 20000units.



Contd.

4) Sales in Unit= F+Profit/tax/ Contribution

S= 180000+105000/50000/15

S= 180000+ 105000*2/15 S= 180000+210000/15

S= 390000/15

S= 26000 units.



Decision making in respect

of BEP The need for a decision arises in business because a

manager is faced with a problem and alternativecourses of action are available. In deciding whichoption to choose he will need all the information

which is relevant to his decision; and he must havesome criterion on the basis of which he can choosethe best alternative. Some of the factors affectingthe decision may not be expressed in monetaryvalue. Hence, the manager will have to make

'qualitative' judgments, e.g. in deciding which of twopersonnel should be promoted to a managerialposition. A 'quantitative' decision, on the other hand,is possible when the various factors, andrelationships between them, are measurable.

cost and management accounts

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