Department of Accounting and Finance/ Cost & Management Accounting I/ Lecture note

Chapter I: Fundamentals of Cost Accounting

1.1 Introduction
ll organizations have two things in common. First, every organization has a set of goals or

A objectives. Second, in pursuing an organization's goals, managers need information. The

information needs of management range across financial production, marketing, legal, and
environmental issues.
In pursuing an organization's goals, managers engage in four basic activities: decision
making, planning, directing operations, and controlling. For all of these managerial activities,
managers need information. The information comes from various sources, including economists,
financial experts, marketing and production personnel, and the organization's managerial and cost
accountants. There are also individuals and institutions that need information about the organization
like suppliers, banks, insurances, customers, investors, taxing authorities, regulatory bodies, and so
forth.
The accounting system is the principal and the most credible quantitative information system in
almost every organization. The accounting system provides information for five broad purposes:
1. In formulating overall strategies and long-run plans: this includes new product development
and investment in both tangible (equipment) and intangible (brands, patent, and people) assets,
and frequently involves special purpose reports.
2. For resource allocation decisions such as product and customer emphasis and pricing. This
frequently involves reports on the profitability of products or services, brand categories,
customers, distribution channels, and so on.
3. For cost planning and cost control of operations and activities: this involves reports on
revenues, costs, assets and liabilities of divisions, plants and other areas of responsibility.
4. For performance measurement and evaluation of people: this includes comparison of actual
results with planned results. It can be based on financial or non-financial measures.
5. To meet external regulatory and legal reporting requirements: regulations and statutes
typically prescribe the accounting methods to be followed for external reporting purposes, for
example for tax purposes.
1.1 Definition of Cost accounting and Managements accounting
Management Accounting
 Measures and reports financial and non financial information that helps managers to fulfil the
goals of the organization.
 Concerned with providing information to mangers, i.e. people inside the organization who direct
and control its operations.
 Focuses on internal reporting.
Financial Accounting
 Concerned with providing information to stockholders, creditors and other who are outside the
organization
 Focuses on reporting to external parties.
 It measures and records business transactions and provides financial statements that are based on
GAAPs.
Managers are responsible for the financial statements issued to investors, government regulators, and
other outside parties. Therefore, managers are interested in both management accounting and
financial accounting.

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Department of Accounting and Finance/ Cost & Management Accounting I/ Lecture note

Cost Accountancy: Is an essential part of accountancy, which has been developed to meet the
managerial needs of business. Starting off as a branch of financial accounting, cost accountancy has
developed so fast in the last few decades that it is difficult to give suitable definition, which fully
covers its scope.
Further cost accountancy is regarded as the science, art and practice of cost accountant.
 It is a science in the sense it is body of systematic knowledge having certain principles, which a
cost accountant should follow for the proper discharge of his duties.
 It is an art, as it requires the ability and skill on the part of a cost accountant in applying the
principles of cost accountancy to various managerial problems.
 Cost Accounting primarily deals with collection, analysis of relevant cost data for interpretation
and presentation for various problems of management.
 Cost accounting is a management information system, which analyses past, present, and future
data to provide the basis for managerial decision making.
 In general, cost accounting is thus concerned with recording, classifying and summarizing costs
for determination of costs of products or services, planning, controlling and reducing such costs
and furnishing of information to management for decision making.
Cost Accounting
 Provides information for both management accounting and financial accounting.
 It measures and reports financial and nonfinancial information that relates to the cost of
acquiring or consuming resources by an organization.
Includes those parts of both management accounting and financial accounting where cost
information is collected or analyzed
1.2 Management Accounting Vs Financial Accounting
 Since planning is such an important part of the manager’s job, managerial accounting has a strong
future orientation. But financial accounting primarily provides summaries of past financial
transaction. The difficulty with summaries of the past is that the future is not simply a reflection of
what has happened in the past. Changes are constantly taking place in economic conditions,
customer needs and so on.
 FA data are expected to be objective and verifiable. However, for internal uses the manger wants
information that is relevant even if it is not completely objective or verifiable. By relevant, we
mean appropriate for the problem on hand.
 Timeliness is often more important than precision to managers. If decision must be made, a
manager would much rather has a good estimate now than wait for a week for a more precise
answer. In addition MA places considerable weight on non monetary data. For example,
information about customer satisfaction is more important even though it is difficult to express in
monetary value.
 FA is primarily concerned with reporting for the company as a whole. But MA primary focuses
much more on the parts, or segments of a company. These segments maybe product lines, sales
territories, divisions, departments or ant other categorization of the company’s activities that
management finds useful.
 FA statements prepared for external users must be prepared in accordance with GAAPs. External
users must have some assurance that the reports have been prepared in accordance with some set
of ground rules. MA is not bound by GAAPs. Managers set their own ground rules concerning the
content and form of internal reports. The only constraint is that the expected benefits from using
the information should outweigh the cost of collecting, analyzing, and summarizing the data.
 FA is mandatory; that is, it must be done. But MA is completely optional, so the important
question is always, “Is the information useful?” rather than, “Is the information required?”

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Department of Accounting and Finance/ Cost & Management Accounting I/ Lecture note

 The field of managerial accounting is less sharply defined. That is to say that managerial
accounting makes heavier use of economics, decision sciences, and behavioural sciences. The
field of financial accounting, in contrast, is more sharply defined. This means that FA makes
lighter use of related disciplines.
Features Managerial Accounting Financial Accounting
Users of Information Managers at various levels Interested parties outside the
within the organization. organization.
Level of Aggregation Detailed information on Summarized information on the
subunits within the organization company as a whole
Information type Economic any physical data as Financial data
well as financial data
Regulation Unregulated, limited only by Regulated by GAAP.
the value-added principle.
Information Characteristics Estimates that promote Factual information that is
relevance and enable characterized by objectivity, reliability,
timeliness. consistency, and accuracy.
Time Horizon Past, present, and future Past only, historically based
Reporting Frequency Continuous reporting Delayed with emphasis on annual
reports
Sources of data The organization’s basic The organization’s basic accounting
accounting system plus various system.
other sources.
Delineation of activates Field is less sharply defined. Field is more sharply defined
Report Requirement Not mandatory Mandatory for external reports
Objectives of cost accounting
1. Ascertainment of cost: - this is the primary objective of cost accounting. For cost
ascertainment, different techniques and systems of costing are used in different industries.
2. Control of cost: - cost control aims at improving efficiency by controlling and reducing
cost.
3. Guide to business policy: - cost accounting aims at serving the needs of management in
conducting the business with utmost efficiency. Cost data provide guidelines for various
managerial decisions like make or buy, selling below cost, etc
4. Determination of selling price: - cost accounting provides cost information on the basis of
selling prices of products or services may be fixed.
Advantages of Cost Accounting to Management
1. Helps in cost control - cost accounting helps in controlling costs with special techniques
like standard costing and budgetary control
2. Reveals profitable and unprofitable activities - a system of cost accounting reveals
profitable and unprofitable activities to reduce or eliminate wastage and inefficiencies.
3. Helps in decision making - it supplies suitable cost data and other related information for
managerial decision making.
4. Aids in formulating policies - costing provide such information that enables the
management to formulate production and pricing policies
5. Guides in fixing selling prices – cost is one of the most important factors to be considered
while fixing selling prices. A system of cost accounting guides the management in the
fixation of selling price.
6. Helps in inventory control – techniques like perpetual inventory system help in controlling
materials cost.

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Department of Accounting and Finance/ Cost & Management Accounting I/ Lecture note

7. Helps in eliminating wastage – costing helps to check various wastage in the form of
material loss, labor time (idle time), expenses like power, lighting, etc.
8. Reveals idle capacity – a concern may not be working to full capacity due to reasons such
as shortage of demand, machine break down or other bottlenecks in production. A cost
accounting system can easily work out the cost of idle capacity so that management may
take immediate steps to improve the position.
9. Checks the accuracy of financial accounts: - cost accounting provides a reliable check on
the accuracy of financial accounts with the help of reconciliation between the two at the end
of the accounting period.
10. Facilitates cost comparison: - cost accounting enables management to make cost
comparisons of various jobs, products, departments, etc so as to improve performance.
11. Helps in cost reduction: - it helps in the introduction of cost reduction program and finding
out new improved ways to reduce costs.

There are many similarities between managerial accounting information and financial information
because they both draw upon data from an origination’s basic accounting system.
The following table shows the difference between cost and management accounting:
Item Cost Accounting Management Accounting
1. Applicability To manufacturing concern To all concern
2. Transaction Internal & External Internal
3. Accounting principle Double entry principle No double entry

The following figure also depicts the relationships among an organization’s basic accounting
system, cost accounting system, management accounting and financial accounting.

Accounting System
 One part of the organization’s management information system.
 Accumulates data for use in both financial and management accounting.

Cost Accounting system

 One part of the organization’s overall accounting system.
 Accumulates cost information

Management Accounting Financial Accounting

Information for decision making,
planning, directing, and controlling an Published financial statements and
organization’s operations, and other financial reports
assessing its competitive position

Internal users of information External users of information

Stockholders, financial analysts,
Mangers at all levels in the lenders, unions, consumer groups, and
organization government agencies 4