CHAPTER 1

Introduction to Cost and

Management Accounting

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 Chapter-1
Introduction
1.1 Cost Accounting

1.1.1 Meaning of cost Accounting

In the early stages Cost Accounting was merely

considered to be a technique for
ascertainment/discover of cost of a products
or services on the basis of historical data.
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Cont.
• In the course of time, now the scope of
cost Accounting includes:-
Ascertainment of cost of a products or
service on the basis of historical data
Cost control
Cost reduction and
Decision making

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Cost Accounting
 Is concerned with
recording,
classifying and
summarizing costs
 for determination of costs of products or services
 Helps management for planning, controlling and reducing
costs
 Provides of information to management for decision making

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 Definitions of cost Accounting

• According to T. Horngren, Foster and Datar,

“Cost accounting measures and reports financial
and other information related to the acquisition
or consumption of an organization’s resources.
• Cost accounting provides information to both
Management accounting and Financial
accounting.”
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 Objectives of Cost Accounting

The main objectives of cost accounting can be summarized as

follows:

 Ascertaining product unit cost

 Controlling cost

 Stimulating cost consciousness/Awareness

 Determining selling price

 Determining profit and loss for various products and services

and inventory valuation and
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 Providing basis for formulating operating policies.
 Advantages of cost accounting

– Helps in optimum utilization of resources- men, materials

and machines

– Identifies the areas requiring corrective action (variance)

– Helps management in formulation of policies (operating

policies)

– Presents tailor made solution for the problem

– Helps management in making short term decisions by use

of techniques like marginal costing (variable costing) 7

 Cont.
• Provides useful data for final accounts by giving costs of

closing stock of raw materials, work in progress and finished

products

• Helps to face increasing difficulties in setting prices and

improving efficiency.

• Focuses attention on the profitability of each product and

service unlike financial accounting, which presents

profitability for company as a whole. 8

 Limitations of Cost accounting

 It is not an exact science and involves inherent element of judgment

 Cost varies with purpose. Therefore, cost collected for one purpose will
not be suitable for another purpose
 CA presents the base for taking the best decisions. It does not give
outright/wholly the solution of the problems
 Most of the CA techniques are based on some pre-assumed notions.

 The area’s most vulnerable to criticism in cost accounting are

arbitrary/random/subjective apportionment /allocation of common costs.
 Different views are held by different cost accountants about the items to
be included in cost.
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 Techniques of Costing

• Management only for controlling costs and making some important

managerial decisions uses the following types of costing techniques.
A. Historical costing
 ascertainment of costs after they have been incurred
 This costing is based on recorded data
 the costs arrived at are verifiable by past events

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 Cont.
B. Standard costing
 a control technique which compares standard
costs and revenues with actual results to obtain
variances.
 SC are used to stimulate improved performance

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Cont…

C. Variable costing

 Is the accounting system in which variable costs are charged to units

produced/services rendered and

 fixed costs of the period are written off in full against contribution margin.

 Contribution margin obtained after deducting variable costs from revenues

that enables to cover fixed costs and operating expanses. CM = TR-TVC

D. Direct costing

 Charging all direct costs to operations

 Indirect costs to be written off against profits

 Direct cost may be either fixed or variable

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 Cont…

E. Absorption or full costing

 The practice of charging all costs both variable and fixed to

operations, products or processes is known as absorption costing.

F. Uniform costing

 A technique, where standardized principles and methods of cost

accounting are employed by a number of different corporation

and firms

 Facilitates inter-firm comparisons

 Establish realistic pricing policies in a competitive market. 13

 Management Accounting

 MA provides information to management /internal users

 Functions of the management are

 Planning

 Organizing

 directing

 controlling

 MA Provide relevant, sufficient, timely, and accurate information for managers

 MA Assist management in planning and the making of rational decisions

 MA Provides financial and non-financial information

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 Objectives of Managerial accounting activity

 Providing managers with information for decision making and

planning

 Assisting managers in directing and controlling operational

activities

 Motivating managers and other employees to wards the

organizational goals

 Measuring the performance of subunits, managers and other

employees within the org 15

 Distinctions between Management Accounting and Financial Accounting

• Management accounting and financial accounting

are linked by their responsibilities for summarizing

and reporting information for interested parties

• Financial accounting reports financial information

that must be disclosed to people outside a

company, such as shareholder, creditors etc. 16

 Cont.
• On the other hand, management accounting exists

primarily for the benefit of managers inside a company,

the people who are responsible for day-to-day

operations.

• Financial accounting and management accounting are

part of and use data from a company’s management

information system (MIS).

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 Cont.

• The financial accountant concentrates on using the data

for external reporting and the management accountant is

interested in developing reports and analyses for internal

use.

• A management information system (MIS) is a system that

gathers comprehensive data, organizes and summarizes

them into a form that is of value to functional managers.

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 Cont.
• Much of the information from management
information system is non financial in nature and
is not disclosed in the financial statements, so
financial accountants deal primarily with the
financial information system when developing
external reports and financial statements.

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 Comparison between Financial Accounting and
Management accounting
Areas of comparison Management Accounting Financial Accounting

Report format Flexible format, driven by Based on generally accepted

user’s accounting principles/GAAP

Purposes of reports Provide information for Report on past performance

planning, control,
performance measurement
and decision making

Primary users As a whole business or Division, product wise owners,

aggregate employees, lenders, customers, government
Managers, suppliers agencies

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Cont.
Units of measurement Historical or future dollars, Historical dollars
physical measure in time or
names of objects, or non monitory
events technical innovation

Nature of information Future oriented, objective for Historical objective

decision making, more subjective
for planning relies on estimates

Frequency of reports Prepared as needed, may or may not Prepared on a regular basis
be a regular basis or a regular basis (minimum of once) a year
minimum of once

Legal compulsion As the discretion of management Compulsory

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 Cost accounting and Management accounting

• Cost accounting refers to the accounting procedures relating

to recording of all incomes and expenditure and the

preparation of periodical statements and reports with the

object of ascertaining and controlling costs.

• On the other hand Management accounting involves

collecting, analyzing, interpreting and presenting all

accounting information, which is useful to the management.

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 Cont.
• Management accounting has a wider scope as
compared to cost accounting.
• Cost accounting primarily deals with cost data
while management accounting involves the
considerations of both cost and revenue data

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 Management accounting guidelines
 For the purpose of allocating scarce resources, achieving

targets goals and making sound decisions there are three

guidelines

A. Cost benefit approach

 Resources should be spent if they promote/support decision

making that better attains organizational goals

 The expected benefits from spending resources should

exceed expected costs. Benefits > cost 24

 B. Behavioral and Technical considerations

A management accounting system should have two simultaneous

missions for providing information
 To help managers make wise economic decisions

 To motivate managers and employees to strive for goals of the

organization.

C. Different costs for different purposes.

 “One shoe does not fit all size” notion.

 A cost concept used for the external reporting purpose may not be
appropriate concept for internal routine reporting to managers .
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 Management Philosophies of Continuous improvement

1. Just in time operating Technique (JIT)

2. Total quality management (TQM)
3. Activity Based Management (ABM) and
4. Theory of Constraints (TOC)

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 Cont.
Just in time operating Technique (JIT)
• The JIT requires that all resources including
materials, personnel and facilities be acquired
and used only as needed.
• Its objectives are to improve productivity and
eliminate waste.

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• Total Quality Management (TQM)

• Total Quality management (TQM) is a philosophy

that required that all functions work together to

build quality into the organization product or service

• TQM focuses on improving product quality by

identifying and reducing or eliminating the waste of

resources caused by poor product or service quality.

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 Activity Based Management (ABM)

• ABM categorizes the activities as either adding value to

a product or service or not adding value.

• Activities that add value to a product or service

improve product or service quality and customer

satisfaction.

• All other activities are called non-value activities. They

add cost to a product or service but do not increase its

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 Theory of Constraints

• According to the theory of constraints (TOC),

limiting factors or bottlenecks, occur during the
production of any product or service.
• Once managers identify such a limitation or
constraint, they can focus attention and resources
on it and thus achieve significant improvements.
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The End!!!

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