1. Allocate costs between cost of goods sold and inventories for internal and external profit reporting2.Provide relevant information to help managers make better decisions;3.Provide information for planning, control and performance measurement.

Limitations of Financial Accounting

It does not provide detailed cost information for different departments, processes, products, jobs, different services and functions.

It does not set up a proper system of controlling materials, supplies.

It is difficult to know the behaviour of costs in financial accounting as expenses are not classified into fixed and variable, direct and indirect costs.

It does not proved cost data to determine the price of the product being manufactured or the service being rendered to the consumers.

It does not provide necessary information to management in taking important decisions about expansion of business, dropping of a product line, alternative method of production, buy or make etc.

Financial Accounting Vs. Cost AccountingA firm manufactures three products A, B and C

whose costs and revenue figures are given below:

product A Product B Product C TotalMaterials 8000 7000 8000 23000

Labour 5000 6000 4000 15000

Other

Expenses 3000 4000 3000 10000

Sales 20000 21000 12000 53000

Under Financial AccountingRs.

Materials 23000

Wages 15000

Other expenes 10000

Total cost 48000

Sales 53000

Profit 5000

Under Cost Accountingproduct A Product B Product C Total

Material 8000 7000 8000 23000

Wages 5000 6000 4000 15000

Other exp. 3000 4000 3000 10000

Total cost 16000 17000 15000 48000

Sales 20000 21000 12000 53000

Profit(loss) 4000 4000 (3000) 5000

Cost AccountancyChartered Institute of Management Accountants,

London(CIMA) defines Cost Accountancy as “ the application of costing and cost accounting principles, methods and techniques to the science, art and practice of cost control and the ascertainment of profitability as well as presentation of information for the purpose of managerial decision making”

Costing may be defined as “the techniques and process of ascertaining costs”

Cost may be defined as (i) the amount of expenditure (actual or notional) incurred on or attributable to a given thing; or (ii) to ascertain the cost of a given thing.

Assignment -1Lily Shultz is a junior majoring in hotel and

restaurant management. She wants to work for a large hotel chain with the goal of eventually managing a hotel. She is considering the possibility of taking a course in either financial accounting or cost management. Before choosing, however she has asked your to provide her with some information about the advantages that each course offers.Required:Prepare a letter advising Lily about the differences and similarities between financial accounting and cost management. Describe the advantages each might offer the manager of a hotel.

Financial Accounting and Cost Management information system Classify each of the following actions as either being associated with

the financial accounting information system(FS) or the cost management information system:

Determining the future cash flows of a public corporation Filing a corporate income tax report Determining the cost of a product Issuing annual financial statements Reducing costs by improving quality Preparing a performance report that compares actual costs with the

budgeted costs. Preparing financial statement that conform to GAAP Determining the cost of a customer Using cost information to decide whether to keep of drop or product Using future expected earnings to estimate the price of a share of

common stock Using cost information to decide whether to make or buy a

component.

Information for planning, controlling, continuous improvement and Decision makingThe cost and management accountant is

responsible for generating financial information required by the firm for internal and external reporting. This involves responsibility for collecting, processing and reporting information that will help management in their :

PlanningControllingContinuous improvementDecision Making

Flexibility of the cost information systemA member of the board of directors for Stillwater’s

Mission of Hope a non profit shelter for the homeless, asked his accountant how to value the building used as the shelter. In other words, what did it cost?

The accountant’s answer was: why do you want to know? If you need to know the value for insurance purposes– to determine how much insurance to buy—then perhaps replacement cost would be the answer. If you are trying to set a price to sell the building (and build another elsewhere), then current market value of the real estate would be the answer. If you need the cost for the balance sheet, then historical cost is required by GAAP.”

Cost CentreCost centre is a location, person or item of

equipment for which cost may be ascertained and used for the purpose of cost control. In other words any unit of the organisation to which cost can be separately attributed is called a cost centre.

Types of cost centres:Personal cost centre: person or group of personsImpersonal cost centre:location or item of equipment,

department, a machineProduction cost centre: production departmentsService cost Centre: maintenance, canteen deptt.

Classification of costOn the basis of nature:

MaterialLabourOverhead or expenses

On the basis of functions:Production costAdministration costSelling costDistribution costResearch and Development cost

On the basis of behaviour: Fixed cost Variable cost Mixed or Semi-Variable or Semi-Fixed cost

On the basis of Management Decision MakingMarginal CostDifferential CostOpportunity CostImputed CostSunk CostRelevant CostIrrelevant CostExplicit CostImplicit CostAvoidable costUnavoidable Cost

Degree of TraceabilityDirect costIndirect Cost

Association with the productProduct CostPeriod Cost

Basic cost terms:Following are the descriptions of costs for a small-town

café (column A) and cost types (column B). The cost object is each meal served.

A– Costs B—Cost Types1. Cost of part-time workers(seasonal a. Variable cost

fluctuations in breakfast and lunch trade) b. Semi-variable2. Rent of the café building c. Fixed cost3. Cost of full-time workers4. Cost of utilities (telephone, gas, electric)5. Cost of a leased gas-powered grill6. Cost of cooking ingredients

Marginal CostThe increase in the total cost due to the production

of one additional unit in the total output is called the marginal cost. It comes basically due to the variable component of the cost of production or sales.

Differential CostIt is the difference of total cost between two

alternatives. For the production of a particular product any one of these two machines can be used:

Machine 1 machine 2 DifferentialCost

Fixed Cost 20000 18000 2000V.Cost(5 x 5000) 25000 25000 0Total Cost 45000 43000 2000

Opportunity CostIt is the value of benefit sacrificed for accepting an

alternative course of action. In other words, it is the benefit lost when one course of action is selected against the other course of action. For example, one person has 100 cubic feet wood, which can sold for Rs.50000, but if furniture is made of it by spending another Rs.30000 then it can be sold for Rs.100000. Therefore here Rs.50000 is the opportunity cost (i.e., the loss of benefit from first alternative if we go for the second alternative.

Imputed CostThe imputed costs are such hypothetical costs for which the actual cash outlay does not take place but for the purpose of decision making it is taken into consideration. For example interest on owner’s capital, Rent of own building, notional salary of owner.

Sunk CostThe cost which has taken place in the past

and alternative decision will not affect the cost, such costs are called sunk or historical cost. This type of cost cannot be changed by any decision in future. Examples of sunk costs are the book values of existing assets, such as plant and machineries, inventory etc.

Relevant CostA relevant cost is that cost which is relevant for decision making. It is a future cost which differs under different options or alternatives.

Fixed, variable and Mixed costsAdams Ltd. has five manufacturing departments. The

following operating and cost information for the two most recent months of activities are given below:

May 2005 June 2005Units produced 10000 10000Cost in each departmentDeptt.A Rs.10000 Rs.10000Deptt.B 25000 50000Deptt.C 35000 45000Deptt.D 18000 64000Deptt.E 22000 44000Identify whether the cost in each department is fixed, variable,

or mixed.

Relevant, Differential costJackson Farm Tools has two options for

repairing its office space, which received extensive wind damage in a recent storm.

option 1 option 2Cost 1 Rs.8000 Rs. 8000Cost 2 6420 2500Cost 3 16000 0Cost 4 20400 40800Total cost 50820 51300

IllustrationsIll.1. Following data has been extracted from the records of a

manufacturing company, whose operations are varying from month to month:level of activity Maximum Minimummachine hours 800000 300000Manufacturing exp.(Rs. Lakhs) 52 32Determine the fixed and variable components of manufacturing overheads and hence compute the total manufacturing overhead for an activity level of 500000 machine hours.

ILL.2. B&Co. has recorded the following data in the two most recent periods:Volume of production(units) 800 1200Total cost of production (Rs.) 14,600 19,400What is the best estimate of the firm’s fixed costs per period ?