Costing Principles @ MBA FINANCE

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    Costing Principles

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    Cost and management accounting

    Provides management with costs for products,

    inventories, operations or functions and

    compares actual to predetermined data It also provides a variety of data for many

    day-to-day decision as well as essential

    information for long-range decisions

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    Functions of managerial accounting

    Determining the cost

    Providing relevant information for better

    decision-making Providing information for planning, control,

    decision-making and application

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    Control

    Deals with the maintenance of product costing

    record, comparison of actual performance

    with standards or budgets, anlaysis ofvariances, recommendation of corrective

    actions, controlling cost to ensure operational

    efficiency and effectiveness

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    Decision-making

    Deals with whether it is more profitable to

    make or buy a component, determine the

    economic order quantity and production batchsize, replace fixed asset, add or drop products,

    decide pricing

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    Application

    Cost accounting has extended from

    manufacturing operations to a variety of

    service industries such as hotels, bands,airline, etc

    Cost accounting system should be flexible and

    adaptable to meet the new business

    environment and the changing nature of the

    company

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    Element of cost

    Cost object

    Cost

    Cost unit Cost centre

    Profit centre

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    Cost object

    It is an activity or item or operation for which

    a separate measurement of costs is desired

    E.g. the cost of operating the personneldepartment of a company, the cost of a repair

    fob, and the cost for control

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    Cost

    It is the amount of expenditure incurred on a

    specific cost object

    Total cost = quantity used * cost per unit (unitcost)

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    Cost unit

    It is a quantitative unit of product or service in

    which costs are ascertained, e.g. cost per table

    made, cost per metre of cloth

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    Cost centre

    It is a location or function of an organisation

    in respect of which costs are ascertained

    E.g. the rent, rates and maintenance ofbuildings; the wages and salaries of

    strorekeepers

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    Profit centre

    It is location or function where managers are

    accountable for sales revenues and expenses

    E.g. division of a company that is responsiblefor the sales of products

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    Cost classification

    Direct cost

    Indirect cost (overhead)

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    Direct cost

    Cost that can be identified specifically with or

    traced to a given cost object

    The direct costs consist of the following threeelements:

    Direct materials

    Direct labour

    Direct expenses

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    Direct materials

    The cost of materials the cost of materials

    used entering into and becoming the elements

    of a product or service

    E.g. fabrics in garments

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    Direct labour

    The cost of remuneration for working time

    E.g. assembly workers wages in toy

    assembly

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    Direct expenses

    Other costs which are incurred for a specific

    product or service

    E.g.royalties

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    Indirect cost (overhead)

    Cost that cannot be identified specificallywith or traced to a given cost object

    They are identified with cost centres asoverheads

    Indirect materials

    Indirect labour

    Indirect expenses

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    Indirect materials

    Such as stationery, consumable supplies,

    spare parts for machine that assist to the

    production of final products

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    Indirect labour

    Such as salaries of factory supervision and

    office staff that do not directly involve in

    production of the final product

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    Indirect expenses

    Such as rent, rates, depreciation, maintenance

    expenses that do not have instant relationships

    with the manufacturing processes

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    Cost accumulation

    Prime cost = direct materials + direct labour + direct expenses

    Production cost = Prime cost + factory overhead

    OR= Direct materials + Conversion cost

    *Conversion cost is the production cost of converting raw materials intofinished product

    Total cost = Prime cost + Overheads (admin, selling,distribution cost)OR

    = Production cost + period cost(administrative, selling,distribution and finance cost)

    Period cost is treated as expenses and matched against sales for calculating

    profit, e.g. office rental

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    Cost coding

    A code is a system of symbols designed to be

    applied to a classified set of items to give a

    brief, accurate reference, facilitating entry,

    collation and analysis

    Coding is important in modern computerised

    accounting systems for catergories various

    composite accounting items

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    Reasons

    To reducing error owing to descriptions

    Enable easy recalling

    Reduce computer file size as a code

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    Cost behaviour

    Costs can be classified into variable, fixed,

    semi-variable, or step-costs according to how

    they behave with respect of changes in

    activity levels

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    Variable cost

    It increases or decreases in direct proportion

    to levels of activity, but the unit variable cost

    remains constant

    E.g. cost of food served in a restaurant

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    Fixed cost

    Total fixed cost remains constant over a

    relevant range of activity level but unit fixed

    cost falls with an increase in activity volume

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    Semi-variable cost

    It processes characteristics of both fixed and

    variable cost

    It increases or decreases with activity levelbut not in direct proportion

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    Step cost

    It remains constant for a range of activity

    levels, then, on further increase in activity, the

    cost jumps to a new level and remains

    constant over a certain range until the next

    jump occurs

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    Cost for stock valuation

    Unexpired and expired cost

    Product and period cost

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    Unexpired cost

    Unexpired costs are the resources that havebeen acquired and are expected to contributeto the future revenue

    They will be recorded as assets in currentperiod

    They will be charged as expenses when they

    have been consumed in the generation ofrevenue

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    Expired costs

    Expired costs are the expenses attributable to

    the generation of revenue in the current period

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    Product cost

    Product cost are related to the goods purchased or

    produced for resale

    If the products are sold, the product cost will be

    included in the cost of goods sold and recorded asexpenses in current period

    If the products are unsold, the product costs will be

    included in the closing stock and recorded as assets

    in the balance sheet

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    Period cost

    Period cost related to the operation of a

    business

    They are treated as fixed cost and charged asexpenses when they are incurred

    They should not be included in the stock

    valuation

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    Comparison of cost, managementand financial accounting

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    Meanings

    Financial accounting

    Cost accounting

    Management accounting

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    Financial accounting

    Provides information to users who are

    external to the business

    It reports on past transactions to draw upfinancial statements

    The format are governed by law and

    accounting standards established by the

    professional accounting policies

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    Cost accounting

    Is concerned with internal users of accounting

    information, such as operation managers

    The generated reports are specific to therequirement of the management

    The reporting can be in any format which

    suits the user

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    Management accounting

    Comprises all cost accounting functions

    The accounting for product and service costs,

    management accounting extends to usevarious internal accounting reports for

    planning, control and decision making

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    Cost and management accounting

    Vs.

    Financial accounting

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    Management

    (cost)accounting

    Financial accounting

    Nature Records material,labour and overhead

    costs in product or job

    Reports produced are

    for internalmanagement and

    contol

    Records company

    transaction events

    External financial

    statements are produced

    Accountingsystem

    Not based on thedouble entry system

    Follows the double entrysystem

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    Management

    (cost)accounting

    Financial accounting

    Accounting

    principles

    No need to use

    accounting principles

    Adopt any accounting

    techniques that

    generates usefulaccounting information

    Use GenerallyAccepted

    Accounting Principles for

    recording transactions

    Users of

    information

    Used by different

    levels of management ordepartments responsible

    for respective activities

    Used by external parties:

    shareholders, creditors,government, etc

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    Management

    (cost)accounting

    Financial accounting

    Operation

    guidelines

    or standards

    Based on

    management

    instructions and

    requirements

    Conforms to company

    Ordinances, stock

    exchange rules,

    HKSSAPs

    Time span Reports are preparedwhenever needed

    They may be

    prepared on a weeklyor daily basis

    Reports are prepared for

    a definite period, usually

    yearly and half yearly

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    Management

    (cost)accounting

    Financial accounting

    Time focus Future orientation:forecasts, estimates

    and historic data for

    management actions

    Past orientation: use of

    historic data for reporting

    and evaluation

    Perspective Detailed analysis ofparts of the entity,

    products, regions, etc

    Financial summary of

    the whole orgainisation

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    Cost accounting

    vs.

    Management accounting

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    Management

    accounting

    Cost accounting

    Objective To provideinformation for

    planning and decision

    making by the

    management

    To ascertain and control

    cost

    Basic of

    recording

    Concerned with

    transactions related to

    the future

    Based on both present

    and future transactions for

    cost ascertainment

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    Management

    accounting

    Cost accounting

    Coverage Covers a wider area:financial accounts,

    cost accounts,

    taxation, etc.

    Covers matters relating

    to ascertainment and

    control of cost of product

    or service

    Utility Only the needs ofinternal management

    The needs of both

    internal and external

    interested groups

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    Management

    accounting

    Cost accounting

    Types of

    transactions

    Deals with both

    monetary any non-

    monetary transactions,

    covering both

    quantitative andqualitative aspects

    Deals only with

    monetary transactions,

    covering only quantitative

    aspect