Basic cost concepts

Basic cost concepts

1. Basic Cost Concepts

2. Define Terms Cost : Expenditure incurred in producing a product or in rendering a service measurement, in monetary terms , of the amount of resources used for the purpose of production of goods or rendering services.

3. Costing : The technique and process of ascertaining costs. 3) Cost Accounting : Begins with recording of income and expenditure ends with the preparation of periodical statements and reports

4. Cost Accountancy : The application of costing and cost accounting principles, methods and techniques practice of cost control the ascertainment of profitability

5. List the Objetives of Cost Accounting The primary objective of study of cost is to contribute to profitability through Cost Control and Cost Reduction. Ascertainment of Cost: Collection of cost information Determination of Selling Price Ascertaining the profit of each activity Assisting Management in decision-making Cost Control and Cost Reduction

6. Distinguish between Cost Reduction and Cost Control. 1) Permanence Permanent, Real and genuine savings in cost. Temporary saving 2) Saving Focus Saving in Cost per unit Saving either in Total Cost or Cost per unit 3) Product Quality Retained Not a guarantee 4) Nature of Standards Continuous process of critical examination Control is achieved through compliance with standards

7. 5) Dynamic Full Dynamic Less Dynamic 6) Coverage Universally applicable to all areas of business. Does not depend upon standards, though target amounts may be set. Limited applicability to those items of cost for which standards can be set. 7) Nature of Costs Partly on present costs and largely on future costs. present and past behavior of costs 8) Nature of Function Corrective Action - operates even when efficient cost control systems exist. There is room for reduction in the achieved costs. Preventive Function - costs are optimized before they are incurred.

8. 9) Tools & Techniques Value Engineering, (b) Standardisation and Simplification, (c) Work Study, (d) Variety Reduction, (e) Quality Measurement & Research, (f) Operations Research, (g) Market Research, (h)Job Evaluation and Merit Rating, ( i )Improvement in Product Design, (j) Mechanisation and Automation, etc. Budgetary Control and Standard Costing.

9. Bring out the importance of Cost Accounting to Business Concerns. Decision Making: Business decision-making requires analysis of statements indicating the likely effect of various cost control and revenue generation measures on the profits. Cost Control: For example, Material Costs may be controlled by – ensuring un-interrupted supply of material and spares for production, avoiding excessive locking up of funds / capital in stocks of materials and stores, and use of techniques like Value Analysis, Standardization, etc.

10. Budgeting: Budget Estimates are drawn up by Cost Accounting Department, before the start of each activity, to ensure that a practicable course of action is identified, and the actual performance corresponds with the estimated. Measuring Efficiency: Cost Accounting Department can provide information about standards and actual performance of the concerned activity. Price Determination : Curtailment of Loss during off-season: Expansion:

11. Distinguish between Cost Accounting and Financial Accounting. 1) Users of Information Internal Management & External Management Internal Management for proper planning, decision making & cost control 2) Statutory Compliance Companies Act, Income Tax Act Cost Accounting is voluntary, except in cases where Cost Accounting Records Rules mandatorily apply to the enterprise 3) Nature/Objectivity Accounting Policies may differ from one Firm to another Firm. Techniques are generally uniform to all Firms. 4) Focus Recording the transactions. Control Cost

12. 5) Nature of Cost Historical Cost Historical Cost & Standard Cost i.e. Pre determined cost 6) Stock Valuation Cost or NRV whichever is less. Cost 7) Cost Analysis Cost / Expenditure and Profits are generally shown as a whole for the period. Costs are analysed product-wise, department-wise, activity-wise, etc. 8) Time Period F.S. are prepared at the end of the Year Cost data & reports are prepared on continuous basis. 9) Forecasting & Planning Limited Use. Parameters like GP, NP, ROI, EPS, etc. can be laid down. Specific and detailed plan for each product/Useful for Budgeting

13. 10) Utility for decisions Helps only for future decisions with respect to product pricing, make or buy, asset retainment vs replacement, etc. Helps current & future decisions, e.g. product price reduction and higher volume in order to earn target profit, resource re-allocation, etc. Note: Cost Accounting supplements Financial Accounting for analysis and decision-making purposes, as described above. Financial Accounting suffers from limitations of lack of analysis of information, and absence of detailed control and assessment parameters. Better tools of control, analysis and assessment are available. Some examples are Variance Analysis, Budgetary Control, & Marginal Costing. 11) Control & Assessement

14. List the various items of costs on the basis of relevance to decision-making. (A) Relevant Costs: 1) Marginal Cost: Total Variable Cost, Prime Cost plus Variable Overheads. (Marginal Cost is relevant for decision-making, as this cost will be incurred in future for additional units of production.)

15. 2) Differential Cost: It is the change in costs due to change in the level of activity or pattern or method of production. Where the change results in increase in cost it is called Incremental Cost If costs are reduced due to decrease of output, the difference is called decremental Costs.

16. 3) Opportunity Cost: The value of sacrifice made or benefit of opportunity foregone in accepting an alternative course of action. For example, a Firm may finance its expansion plan by withdrawing money from its bank deposits. Then, interest lost on the Bank Deposit is the opportunity cost for carrying out the expansion plan.

17. 4) Out-of-pocket Cost: Current or near future outlays of cash for the decision at hand relevant for decision-making short-run concept avoided or saved, if a particular proposal under consideration is not accepted.

18. 5) Replacement Cost: It is the cost at which there could be purchase of an asset or material identical to that which is being replaced or revalued . It is the cost of replacement at current market price and is relevant for decision-making.

19. 6) Imputed Costs: notional costs appearing in the cost accounts only e.g. notional rent charges, interest on capital for which no payment has been made. Where alternative capital investment projects are being evaluated, it is necessary to consider.

20. (B) Irrelevant Costs: Not useful for decision making 1) Sunk Cost: Has already been incurred or sunk in the past. It is not relevant for decision ­making Firm has obsolete stock of materials originally purchased for Rs.50,000 which can be sold as scrap now for Rs.18,000 or can be utilised in a special job, the value of stock already available Rs.50,000 is a sunk cost and is not relevant for decision-making.

21. 2) Absorbed Fixed Costs: Fixed Costs do not change due to increase or decrease in activity Fixed Costs are absorbed in cost of production at a normal rate, they are irrelevant for managerial decision-making. However if Fixed Costs are specific, they become relevant.

22. 3) Committed Costs: Cost in respect of which decision has already been taken, and such decision cannot be altered. e.g. entering into irrevocable agreements for Rent, Technical Collaboration, etc. should be contrasted with Discretionary Costs, which are avoidable costs.

23. Cost Classification for presentation purpose

24. Cost Sheet? What are its uses? Meaning: shows the break-up and build-up of costs document which provides the consolidation of the detailed cost of a Cost Centre or a Cost Unit. Uses: Presentation of Cost information. Determination of Selling Price. Ascertainment of profitability. Preparation of Budgets.

25. Inter-Firm and Intra-Firm Cost Comparison. Preparing Cost Estimates for submitting tenders / quotations. Product-wise and Location-wise Cost Analysis. Disclosure of operational efficiency for Cost Control

26. Items that are not regarded as "Cost" and not included in the Cost Sheet Non-Operating Incomes, e.g. Rent, Interest and Dividends received. Losses or Profits of capital nature, e.g. Profit or Loss on sale of Investments, Plant and Equipment, etc. Items not representing actual costs but dependent on arbitrary decisions and policies of the management, e.g. an unreasonably high salary to the Managing Director, providing for depreciation at a rate exceeding the economic rate. Appropriation of Profits, e.g. Payment of Dividends, Transfers to Reserves, etc.

27. Profit based Outflows, i.e. Income-Tax. [Note: Bonus paid to workers is treated as Cost]. Amounts representing loss on account of inefficiency of a particular activity, e.g. Bad Debts as a result of inefficient credit management, Penalties & Fines due to non-compliance with law, abnormal wastages and losses, etc. Items which may distort comparison, e.g. financial items like interest, discount, etc. and other similar items. Imputed items that are not actually incurred by the firm but constitute arbitrary charges against profit, e.g. interest on own capital at an arbitrary rate. Write-offs of Goodwill, Preliminary Expenses, etc.

28. Particulars Production / Manufacturing A/c Cost Sheet 1. Basis It is prepared on the basis of double-entry system of book-keeping. It is only a statement and hence double-entry system is not applicable. 2. Purpose The primary objective of preparation is Reporting. The primary objective is decision-making. 3. Parts It has two parts - one showing the cost of manufacture and the other part showing Sales and Gross Profit. It is a step-by-step presentation of total cost and shows Prime Cost, Works Cost, Cost of Production, Cost of Goods Sold, Cost of Sales and Profit. 4. Analysis Total Cost is shown in aggregate. Product-wise or Location-wise analysis is not generally given. Cost Sheet shows costs in a detailed and analytical manner, which facilitates cost comparison. 5. Quotations This is not useful for preparing tenders or quotations. Estimated Cost Sheets can be prepared based on past experience, and useful for submitting quotations.

29. Production / Manufacturing A/c Cost Sheet 1) Basis double-entry system of book-keeping only a statement and hence double-entry system is not applicable. 2) Purpose Reporting decision-making. 2) Purpose Reporting decision-making.