COST & MANAGEMENT ACCOUNTING

1. COST & MANAGEMENT ACCOUNTING Prof. Ranjan Kumar Bal UTKAL UNIVERSITY

2. COST & MANAGEMENT ACCOUNTING (COMA) Provides information to managers for planning, controlling & decision making. The controller : The Chief Management Accountant “The Controller is compared to a ship’s navigator, with the President (CEO) being the ship’s captain.”

3. ROLE OF THE ACCOUNTANT • TO MANAGE INFORMATION • An Information Technologist • SCORE – KEEPING • ATTENTION DIRECTING • PROBLEM SOLVING

4. CUSTOMER – DRIVEN FOCUS IN MANAGEMENT ACCOUNTING SYSTEM VISION STATEMENT OF MANAGEMENT ACCOUNTING GROUP AT JOHNSON & JOHNSON • Delight our customers. • Develop alternative measurement system. • Keep it simple. • Utilize 20% of time on Accounting & 80% on analysis. • Be the best.

5. ABILITIES & SKILLS for Management Accountants – A Survey Communication (oral, written & presentation) skills Ability to work on a team Analytical / problem-solving skills Solid understanding of accounting Understanding of how a business functions. Computer skills

6. THE MANAGEMENT ACCOUNTANT AND STRATEGIC DECISIONS The management accountant helps to formulate strategy by answering questions such as : • Who are our most important customers ? • How sensitive are their purchases to prices, quality, and service ? • Who are our most important suppliers ? • What substitute products exist in the market place, and how do they differ from our product? • Is the industry demand growing or shrinking ? • Is there overcapacity ?

7. IMPORTANCE OF COMA • Helps in achieving the main objective of the organization • Identifies unprofitable activities. • Improves efficiency/Facilitates cost control. • Helps in planning & preparation of budgets. • Helps in inventory control. • Facilitates decision making.

8. COMA Vs. FINANCIAL ACCOUNTING Similarities • Both are branches of Accounting. • Are concerned with systematic recording and presentation of financial data. • Both follow same principles of Dr. and Cr. • Both have the same source of recording transactions. • Both have the common goal of assisting the organization they serve. • Both are complementary to each other.

9. COMA Vs. FINANCIAL ACCOUNTING : Differences Purpose Periodicity of reporting Customers served Audit Accounts prepared Tax assessment Actual and standard Profit and Loss Monetary and Non-monetary Relative efficiency Constrained by GAAP

10. COST AND MANAGEMENT INFORMATION SYSTEM • COST ACCOUNTING INFORMATION SYSTEM • OPERATIONAL CONTROL SYSTEM OBJECTIVES OF CMIS: • To provide information for costing out services, products and other objects of interest to management. • To provide information for decision making. • To provide information for planning and control.

11. COST MANAGEMENT • Identifies, collects, measures, classifies, & reports information • Useful to managers in costing, planning, controlling, & decision making. Cost Accounting : Evolving into Cost Mgt. • It is associated with Mgt. Accounting

12. THE VALUE CHAIN OF THE BUSINESS FUNCTION • R&D • Design • Production • Marketing • Distribution • Customer service Accounting helps managers: • To administer each of the business functions. • To coordinate the functions of value chain.

13. ENHANCING THE VALUE OF COMA SYSTEM • Customer Focus • Value Chain & Supply Chain Analysis • Key Success Factors –Cost & efficiency, Quality, Time, Innovation, etc. (Distinct or Extinct) • Continuous Improvement (Kaizen) & Benchmarking

14. “We are running harder just to stand still.”“If you’re not going forward, you are going backward.”

15. QUESTIONS • “Management Accounting should not fit the straightjacket of Financial Accounting.” Explain. • A leading management observer stated, “The most successful companies are those that have an obsession for their customers.” Is this statement pertinent to management accountants? Explain.

16. CHANGE Change is the only constant in today’s world.

17. MANAGEMENT AND COMA • Provides adequate, timely and reliable information. • Helps management in managing and controlling costs. • Provides cost-benefit approach for resource allocation. • Helps in decision making: Pricing Product-mix Profit-volume decisions • Helps: Formulation & execution of budgets & standards. • Helps in making special studies and investigations. “ Without proper cost and management accounting, decision would be like taking a jump in the dark.”

18. COST TERMINOLOGY • Cost : Resources sacrificed or Amount of expenditure incurred • Costing : Process of cost accumulation & cost assignment • Cost Object : Anything for which a measurement of cost is desired. • Cost Accumulation : Collection of cost data in some organized way. • Cost Assignment : Cost Tracing & Cost Allocation. • Cost Tracing : Assigning direct cost. • Cost Allocation : Assigning indirect costs. • Cost Driver : A variable that causally affects / influences costs over a given time span

19. COST CLASSIFICATION WHY ? • To Achieve a Purpose / Objective Control, Decision Making • To Facilitate Communication / Reporting

20. COST CLASSIFICATION • Behaviour • Elements • Control • Decision Making • Functions • Nature

21. ELEMENTS OF COST • MATERIAL : Direct Vs. Indirect • LABOUR : Direct Vs. Indirect • EXPENSES : Direct Vs. Indirect Direct cost of a cost object : Traced in an economically feasible (cost effective) way.

22. OVERHEADS Manufacturing or Factory Office & Administration Selling & Distribution

23. OTHER CONCEPTS OF COST Fixed, Variable & Semi-variable Controllable & Uncontrollable Relevant & Irrelevant Incremental & Decremental Shutdown & Sunk cost Traceable & Untraceable Joint cost & Conversion cost

24. RELATIONSHIP OF COSTS Direct & Variable Direct & Fixed Indirect & Variable Indirect & Fixed

25. METHODS & TECHNIQUES METHODS - Job Costing - Process Costing TECHNIQUES - Marginal Vs. Absorption Costing - Standard Vs. Historical Costing

26. COST ACCOUNTING OBJECTIVES : • To determine product costs • To facilitate planning & control • To supply information for decision making “IN GOD WE TRUST,EVERYBODY ELSE BRINGS DATA TO THE TABLE.”INFOSYS

27. COST ESTIMATION Statement of Cost : For each cost object or cost centre. Different Columns : Total cost / Cost per unit / Previous period costs / Budgeted costs / Variable & Fixed costs …….. Sources of Data : F.A. & C.A. Time Period : A month or week

28. WHY A COST SHEET ? Fixing selling price Submitting quotations Planning & control of cost To know relative efficiency of products Decision making

29. STATEMENT OF COST COST SHEET • Prime Costs or Direct Costs DM + DL + DE = PC • Production or Works or Factory Costs PC + P. OH. = FC • Office Costs or Cost of Production* FC + O. OH. = COP • Total Cost or Cost of Sales COP + S. OH. = TC *Assumption : Office & Admn. Overheads relate to production.

30. TREATMENT OF STOCK • Raw Material • WIP • Finished Goods Treatment of the amount realized from the sale of scraps / wastes ?

31. ITEMS NOT AFFECTING COST SHEET Income Tax Dividends to Share Holders Interest on Loans Capital Loss Donations Capital Expenditure Discount on Shares & Debentures Underwriting Commission Writing off Goodwill Commission to MD

32. ESTIMATED COST SHEET • Considers all probable changes in cost • Preparation : - Prepare a “Cost Sheet” - Establish relationship - Estimate OH costs - Prepare “Estimated Cost Sheet”

33. CASE The following information are obtained from the records of AB cycles for the month of August: Direct materials : Rs. 19, 80, 000 Direct labour : 18, 00, 000 Factory overheads : 5, 80, 000 Administrative overheads : 3, 90, 000 Outputs for the month : 2,000 cycles. What price the company should quote for an order of 100 cycles? Note: Factory overheads are absorbed on the basis of direct labour and administrative overheads on the basis of works cost.

34. THE FOLLOWING DATA RELATE TO A COMPANY: Expected sales : 50,000 units Direct material cost : Rs. 2.50 per unit Direct labour cost : Rs. 2.00 per unit Variable Overhead : Rs.1.50 per unit Fixed cost : Rs. 1.50 per unit Selling price : Rs.10 per unit The firm expects to get a special export order for 10,000 units at a price of Rs. 7.25 per unit. Advise whether the export order should be accepted or not. The company has a capacity to produce 60,000 units.

35. INFERENCES: • An organization has different costs having different nature. Example: Fixed, Variable, Mixed Cost • These costs behave differently to changes in the level of business activity. • Understanding this relationship helps in planning, control and developing successful business strategies.

36. Cost of a product / process can be ascertained by : • 1. Absorption costing • 2. Marginal costing • ABSORPTION COSTING • Traditional or full cost method : • Cost of a product = V. C. + F. C. • Variable costs are directly charged to the product. • Fixed costs are apportioned on suitable basis. • DISADVANTAGES: • It assumes that prices are simply a function of costs. • It includes past costs which may not be relevant to the pricing decision at hand.

37. MARGINAL COSTING • - Direct Costing / Variable Costing • - A Technique of Costing • Meaning : • Ascertainment of marginal cost by differentiating between F.C. and V.C. and of the effect on profit of changes in volume or type of output. • Cost of a product : Only VCs are considered • : Product cost • FCs : Charged against the revenue of the period. FC = Period costs • Valuation of inventory at M.C. • Contribution = C = S - V = F + P • Price = M.C. + Contribution

38. MARGINAL COST Economists : The cost of producing one additional unit of output is the marginal cost of production. Include an element of FC Accountants : MC is equal to the increase in total VC.

39. SEGREGATION OF SEMI-VARIABLE COSTS • Levels of output compared to levels of expenditure Method : The variable element in semi- vc = Change in amt. of exp. Change in activity/qnty. • High-low method (Range Method) : Similar to the previous method • Methods of least squares Y = a + bx, where Y = Semi-VC, a = FC, b = VC, x = Production in units

40. ABSORPTION COSTING Vs. MARGINAL COSTING 1. Recovery of F.OH. • Abs. Costing : Both F. OH. and V. OH. are charged to production • Mar. Costing : Only V. OH. is charged to production and F.OH. transferred to P. & L. A/C. 2. Valuation of Closing Stock • Abs. Costing : WIP at works cost and F. goods at cost of production. • Mar. Costing : WIP and F. Goods -- Only VCs are considered. 3. Profit Vs. Opening and Closing Stock

41. UTILITY OF MARGINAL COSTING • Helps in determining the volume of production. • Helps in selecting production lines. • Helps in deciding whether to shutdown or continue.

42. MARGINAL COSTING Vs. ABSORPTION COSTING The following information relates to ABC Company for the year 2011-12: Sales 10,000 units at Rs. 5 each; Production 15,000 units at the following costs: Rs. Direct materials 15,000 Direct labour 30,000 Variable expenses 6,000 Fixed expenses 12,000 Determine net profit.

43. Income Statement for the year 2011-12 Sales 50,000 50,000 Marginal Absorption costing Rs. Costing Rs. Cost of Production: Direct materials 15,000 15,000 Direct labour 30,000 30,000 Variable overhead 6,000 6,000 Fixed overhead _ 12,000 51,000 63,000 Less Closing Stock 17,000 21,000

44. Cost of goods sold 34,000 42,000 Contribution (50,000- 34,000) 16,000 4,000 Net profit 8,000 Valuation of closing stock: Marginal costing = (5000/15,000) x 51,000 = Rs. 17,000 Absorption costing = (5000/15,000) x 63,000 = Rs. 21,000 Note: Difference in profit is due to the difference in stock valuation. Less Fixed Overhead 12,000

45. CASE From the following cost, production and sales data of AB Motors Ltd., prepare comparative income statement for three years under (i) Absorption costing method, and (ii) Marginal costing method. Indicate the unit cost for each year under each method. Also evaluate closing stocks. The company produces a single article for sale. PARTICULARS YEARS 2010 2011 2012 Rs Rs. Rs. Selling price per unit 20 20 20 Variable Mfg. Cost per unit 10 10 10 Total fixed manufacturing cost 5000 5000 5000 Opening stock - 500 Units produced 1000 1500 2000 Units sold 1000 1000 1500 Closing stock - 500 1000

46. BREAK-EVEN ANALYSIS • Narrow Sense : • Determination of that level of activity where • total cost equals selling price. • Broad Sense : • The system of analysis which determines the • probable profit at any level of activity. • Refers to Cost-Volume-Profit Analysis • BEP - Represents a minimum acceptable • level of operation • - Level of activity : Income equals Expenditure • - No profit no loss point

47. C = S - V = F + P At BEP, P = 0; Thus, C = F Or, Units at BEP x Contribution per unit = F Or, BEP(units) = F / Contribution per unit BEP (sales) = (F / Cont. per unit) x S.P. per unit = (F/C) x S = F/c/s = F / p/v ratio

48. Contribution Margin Ratio = P/V ratio = Contribution / Sales = C / S = Change in Profit / Change in Sales MOS = Total Sales – BEP

49. BREAKEVEN ANALYSIS FOR MULTIPLE PRODUCTS A multi products Company has a sales ratio of 2: 3: 5 for models X, Y and Z respectively. Total fixed cost for the year are Rs. 2,00,000. The other information are as follows: Model X Model Y Model Z Sales Price Rs. 50 Rs. 25 Rs. 10 Variable Costs Rs. 30 Rs. 15 Rs. 8 Contribution Margin Rs. 20 Rs. 10 Rs. 2 WHAT IS IT’S BEP ?

50. BREAKEVEN ANALYSIS FOR MULTIPLE PRODUCTS A market basket approach is used to compute the breakeven point in units. The average market basket is based on the sales ratio and consists of 10 units with a total contribution of Rs. 80 = { (2 x Rs. 20) + (3 x Rs.10) + (5 x Rs.2) } BEP in market baskets = FC / Contribution of one baskets = Rs.200,000 / Rs.80 = 2,500 baskets. To fill 2,500 baskets : The following units for each model. • Model X : 5000 units ( 2,500 x 2) • Model Y : 7500 units (2,500 x 3) • Model Z : 12500 units (2,500 x 5)