COST AND MANAGEMENT ACCOUNTING STUDY NOTES
Introduction
The survival of any business depends on its ability to settle its debts as they fall due (liquidity) and on
having products or services that obtain revenues higher than the costs incurred in producing and
selling them (profitability).
The type of accounting which is concerned with recording transactions with outsiders and in
determining what the business owns and what is owed to it (assets) in comparison to what it owes to
the outsiders (liabilities) and to the owners of the business (capital) at any given time is termed
financial accounting. Financial accounting matches the revenues earned in a period against the
corresponding costs to measure the profitability of the business as a whole.
Thus, financial accounting assists in maintaining liquidity and recording overall profits of the
business. Reports based on financial accounting provide useful information to users, the majority of
whom are outsiders, who may be interested in the business as a whole. For instance, shareholders and
creditors are only concerned with the overall profitability and viability of the business, leaving
managers to focus on the profitability of individual product or service lines, using cost and
management accounting techniques.
Information on the cost incurred in producing and selling individual products or services is not
readily available from the financial accounting records. When a business produces different products
or services, without such information its managers cannot make sensible decisions about controlling
the costs and maximizing the profits earned from a particular line of products or services. To obtain
this information promptly, a mechanism of recording transactions within the business is required.
Cost accounting provides such a mechanism to record the cost of resources used by an individual
product/service line, either by identifying the direct connection (cost allocation) or by sharing out
the common costs on a fair basis (cost apportionment).
The role of cost accounting, a discipline arising out of the costing and estimating practices in
engineering, is vital to the modern business facing increasing competition. Advances in
transportation technology have eroded the geographical barriers to competition, while advances in
communication technology have increased consumer awareness about alternative suppliers and their
pricing.
Increasingly, businesses are facing the challenge of operating in a ‘cost continuous’
environment with little buffer to absorb poor cost management. Cost accounting assists in cost
management by offering various techniques for control and reduction of the different types of costs
incurred by a business.
It also helps in making the best use of the available resources. The discipline of management
accounting emerged as a natural progression from cost accounting as the information requirements of
business managers were better understood and increasingly catered for by accountants.
PREPARED MR. ANTONY AMBIA Page 1
, COST ACCOUNTING
Cost accounting is extensively used in a wide variety of businesses, including hospitals, local
government, banking, retail and manufacturing. The cost accounting system is the basis of an internal
financial information system to assist managers to make business decisions.
What are the commonly used Techniques?
Cost accounting techniques arise because of specific information requirements by
management. In some cases this could relate to how much a product costs to manufacture or how
much a service costs to deliver. Product costing/service costing techniques address this question.
Budgeting techniques assist managers to quantify their future plans in monetary terms and
enable comparisons of actual financial performance with planned. Where actual performance
deviates from planned this may be recorded and subsequently investigated to ascertain the reasons
why this is the case.
Management may also wish to evaluate the way a particular product/service has performed in
the past to determine whether the organization is making best use of the resources available to it, and
would also be interested in the future performance of existing and new products or services. In
making an assessment as to the viability of a particular product or service, the level of risk associated
with it would also have to be assessed and this compared with the possible rewards from the venture,
with due regard to management’s attitude to differing levels of risk.
Appraisal techniques assist management to address this matter.
The techniques introduced under the broad headings of product costing, budgeting and
appraisal. They arise primarily out of the requirement to address the information needs of the
organization and provide the data for subsequent analysis by management. These three headings
reflect the activities of managers: they plan (budget), measure the results of their plans (record actual
product/service costs) and assess the success of those plans (appraisal).
The Scope of Cost Accounting
Examples of information required by management and information provided by a typical costing
system are shown in the list below.
Cost accounting comprises a range of techniques for the purpose of:
Cost ascertainment,
Cost control and cost reduction.
Cost accounting systems and financial accounting systems are different.
Cost accounting is in effect for internal use. Financial accounting forms the basis of external
reporting and is for stewardship purposes.
Cost accounting systems provide information to management for planning, control and decision
making.
Financial accounting is concerned with types of expenditure for the purpose of an overall
profitability statement and statement of assets and liabilities.
Cost accounting is dealt with in this text within three broad headings of product costing,
budgeting and appraisal.
They arise primarily out of the need to address the information needs of the organization.
PREPARED MR. ANTONY AMBIA Page 2
, Costing information is not mutually exclusive. It may be used for many purposes.
Questions for Review
1. What is the purpose of cost accounting?
2. Discuss the similarities and differences between cost accounting and financial accounting.
3. Discuss the types of information needs that have led to the development of:
a. Product costing techniques
b. Budgeting techniques
c. Appraisal techniques
4. Give two examples of where ‘cost per unit of output’ could satisfy management’s information
needs.
5. Give three examples of business decisions where cost accounting information could prove useful.
For Further Reading, Research and Reference
Essential Cost Accounting Terminology
Cost accounting terminology
Basic classification of costs
Cost accounting terminology
Determination of total cost
Cost Behavior
What is cost behavior?
Distinguishing between different cost classifications
Cost prediction
Cost behavior analysis: the accounting model vs. the economists’ model
Accounting for Labor Costs
The significance of labor costs
Distinguishing between different remuneration methods
Labor cost data
Accounting for Material Costs
What is material pricing?
Use of different pricing methods
Stock valuation
Treatment of other costs
Absorption costing
What is absorption costing?
The inclusion of overhead into cost units via cost centers
Non-manufacturing overhead
Appraisal of absorption costing
Activity Based Costing
What is activity based costing?
Marginal Costing Systems
What is marginal costing?
The treatment of overhead
PREPARED MR. ANTONY AMBIA Page 3
, Revenue statements in a marginal costing format
The role of contribution
Breakeven (CVP) analysis
Marginal costing vs. absorption (full) costing
Marginal Costing Short-term Decision Making
Planning and Budgeting
What is a budget?
Budgetary control Budgeting appraisal
Zero based budgeting
Activity based budgeting
Standard Costing and Variance Analysis
What is a standard cost?
What is variance analysis?
Variance calculation
Reasons for variances
Variance investigation
Appraisal of standard costing and variance analysis
Capital Investment Appraisal
What is capital investment appraisal?
Conventional capital investment appraisal techniques
Discounted cash flow appraisal techniques
Risk and uncertainty
MANAGERIAL & COST ACCOUNTING
Introduction to Activity Based Costing
Activity based costing (ABC) assigns manufacturing overhead costs to products in a more logical
manner than the traditional approach of simply allocating costs on the basis of machine hours.
Activity based costing first assigns costs to the activities that are the real cause of the overhead. It
then assigns the cost of those activities only to the products that are actually demanding the activities.
Let's discuss activity based costing by looking at two products manufactured by the same company.
Product 124 is a low volume item which requires certain activities such as special engineering,
additional testing, and many machine setups because it is ordered in small quantities. A similar
product, Product 366, is a high volume product—running continuously—and requires little attention
and no special activities. If this company used traditional costing, it might allocate or "spread" all of
its overhead to products based on the number of machine hours. This will result in little overhead
cost allocated to Product 124, because it did not have many machine hours. However, it did demand
lots of engineering, testing, and setup activities. In contrast, Product 366 will be allocated an
enormous amount of overhead (due to all those machine hours), but it demanded little overhead
activity. The result will be a miscalculation of each product's true cost of manufacturing overhead.
Activity based costing will overcome this shortcoming by assigning overhead on more than the one
activity, running the machine.
PREPARED MR. ANTONY AMBIA Page 4
Introduction
The survival of any business depends on its ability to settle its debts as they fall due (liquidity) and on
having products or services that obtain revenues higher than the costs incurred in producing and
selling them (profitability).
The type of accounting which is concerned with recording transactions with outsiders and in
determining what the business owns and what is owed to it (assets) in comparison to what it owes to
the outsiders (liabilities) and to the owners of the business (capital) at any given time is termed
financial accounting. Financial accounting matches the revenues earned in a period against the
corresponding costs to measure the profitability of the business as a whole.
Thus, financial accounting assists in maintaining liquidity and recording overall profits of the
business. Reports based on financial accounting provide useful information to users, the majority of
whom are outsiders, who may be interested in the business as a whole. For instance, shareholders and
creditors are only concerned with the overall profitability and viability of the business, leaving
managers to focus on the profitability of individual product or service lines, using cost and
management accounting techniques.
Information on the cost incurred in producing and selling individual products or services is not
readily available from the financial accounting records. When a business produces different products
or services, without such information its managers cannot make sensible decisions about controlling
the costs and maximizing the profits earned from a particular line of products or services. To obtain
this information promptly, a mechanism of recording transactions within the business is required.
Cost accounting provides such a mechanism to record the cost of resources used by an individual
product/service line, either by identifying the direct connection (cost allocation) or by sharing out
the common costs on a fair basis (cost apportionment).
The role of cost accounting, a discipline arising out of the costing and estimating practices in
engineering, is vital to the modern business facing increasing competition. Advances in
transportation technology have eroded the geographical barriers to competition, while advances in
communication technology have increased consumer awareness about alternative suppliers and their
pricing.
Increasingly, businesses are facing the challenge of operating in a ‘cost continuous’
environment with little buffer to absorb poor cost management. Cost accounting assists in cost
management by offering various techniques for control and reduction of the different types of costs
incurred by a business.
It also helps in making the best use of the available resources. The discipline of management
accounting emerged as a natural progression from cost accounting as the information requirements of
business managers were better understood and increasingly catered for by accountants.
PREPARED MR. ANTONY AMBIA Page 1
, COST ACCOUNTING
Cost accounting is extensively used in a wide variety of businesses, including hospitals, local
government, banking, retail and manufacturing. The cost accounting system is the basis of an internal
financial information system to assist managers to make business decisions.
What are the commonly used Techniques?
Cost accounting techniques arise because of specific information requirements by
management. In some cases this could relate to how much a product costs to manufacture or how
much a service costs to deliver. Product costing/service costing techniques address this question.
Budgeting techniques assist managers to quantify their future plans in monetary terms and
enable comparisons of actual financial performance with planned. Where actual performance
deviates from planned this may be recorded and subsequently investigated to ascertain the reasons
why this is the case.
Management may also wish to evaluate the way a particular product/service has performed in
the past to determine whether the organization is making best use of the resources available to it, and
would also be interested in the future performance of existing and new products or services. In
making an assessment as to the viability of a particular product or service, the level of risk associated
with it would also have to be assessed and this compared with the possible rewards from the venture,
with due regard to management’s attitude to differing levels of risk.
Appraisal techniques assist management to address this matter.
The techniques introduced under the broad headings of product costing, budgeting and
appraisal. They arise primarily out of the requirement to address the information needs of the
organization and provide the data for subsequent analysis by management. These three headings
reflect the activities of managers: they plan (budget), measure the results of their plans (record actual
product/service costs) and assess the success of those plans (appraisal).
The Scope of Cost Accounting
Examples of information required by management and information provided by a typical costing
system are shown in the list below.
Cost accounting comprises a range of techniques for the purpose of:
Cost ascertainment,
Cost control and cost reduction.
Cost accounting systems and financial accounting systems are different.
Cost accounting is in effect for internal use. Financial accounting forms the basis of external
reporting and is for stewardship purposes.
Cost accounting systems provide information to management for planning, control and decision
making.
Financial accounting is concerned with types of expenditure for the purpose of an overall
profitability statement and statement of assets and liabilities.
Cost accounting is dealt with in this text within three broad headings of product costing,
budgeting and appraisal.
They arise primarily out of the need to address the information needs of the organization.
PREPARED MR. ANTONY AMBIA Page 2
, Costing information is not mutually exclusive. It may be used for many purposes.
Questions for Review
1. What is the purpose of cost accounting?
2. Discuss the similarities and differences between cost accounting and financial accounting.
3. Discuss the types of information needs that have led to the development of:
a. Product costing techniques
b. Budgeting techniques
c. Appraisal techniques
4. Give two examples of where ‘cost per unit of output’ could satisfy management’s information
needs.
5. Give three examples of business decisions where cost accounting information could prove useful.
For Further Reading, Research and Reference
Essential Cost Accounting Terminology
Cost accounting terminology
Basic classification of costs
Cost accounting terminology
Determination of total cost
Cost Behavior
What is cost behavior?
Distinguishing between different cost classifications
Cost prediction
Cost behavior analysis: the accounting model vs. the economists’ model
Accounting for Labor Costs
The significance of labor costs
Distinguishing between different remuneration methods
Labor cost data
Accounting for Material Costs
What is material pricing?
Use of different pricing methods
Stock valuation
Treatment of other costs
Absorption costing
What is absorption costing?
The inclusion of overhead into cost units via cost centers
Non-manufacturing overhead
Appraisal of absorption costing
Activity Based Costing
What is activity based costing?
Marginal Costing Systems
What is marginal costing?
The treatment of overhead
PREPARED MR. ANTONY AMBIA Page 3
, Revenue statements in a marginal costing format
The role of contribution
Breakeven (CVP) analysis
Marginal costing vs. absorption (full) costing
Marginal Costing Short-term Decision Making
Planning and Budgeting
What is a budget?
Budgetary control Budgeting appraisal
Zero based budgeting
Activity based budgeting
Standard Costing and Variance Analysis
What is a standard cost?
What is variance analysis?
Variance calculation
Reasons for variances
Variance investigation
Appraisal of standard costing and variance analysis
Capital Investment Appraisal
What is capital investment appraisal?
Conventional capital investment appraisal techniques
Discounted cash flow appraisal techniques
Risk and uncertainty
MANAGERIAL & COST ACCOUNTING
Introduction to Activity Based Costing
Activity based costing (ABC) assigns manufacturing overhead costs to products in a more logical
manner than the traditional approach of simply allocating costs on the basis of machine hours.
Activity based costing first assigns costs to the activities that are the real cause of the overhead. It
then assigns the cost of those activities only to the products that are actually demanding the activities.
Let's discuss activity based costing by looking at two products manufactured by the same company.
Product 124 is a low volume item which requires certain activities such as special engineering,
additional testing, and many machine setups because it is ordered in small quantities. A similar
product, Product 366, is a high volume product—running continuously—and requires little attention
and no special activities. If this company used traditional costing, it might allocate or "spread" all of
its overhead to products based on the number of machine hours. This will result in little overhead
cost allocated to Product 124, because it did not have many machine hours. However, it did demand
lots of engineering, testing, and setup activities. In contrast, Product 366 will be allocated an
enormous amount of overhead (due to all those machine hours), but it demanded little overhead
activity. The result will be a miscalculation of each product's true cost of manufacturing overhead.
Activity based costing will overcome this shortcoming by assigning overhead on more than the one
activity, running the machine.
PREPARED MR. ANTONY AMBIA Page 4
