1. Cost Accounting Dr S.M.Tariq Zafar M.Com, PGDMM, PhD (Social Sector Investment) syed.zafar@omancollege.edu.omsyed.zafar@omancollege.edu.om, smtariqz2015@gmail.com

2. Study Material Cost Accounting Chapter - I

3. Course Outcome After completing this chapter student will come to know the followings:  What is Cost Accounting  Types of Cost Accounting  Difference Between Cost Accounting and Financial Accounting  What is the Cost Of Carry  What is an Operating Cost  Difference Between Cost of Revenue and Cost of Goods Sold  Objectives of Cost Accounting  Advantages of Cost Accounting  Importance of Cost Accounting

4. What is Cost Accounting: Cost accounting is a type of accounting process that aims to capture a company's costs of production by assessing the input costs of each step of production as well as fixed cost such as depreciation of capital equipment. Cost accounting will first measure and record these costs individually, then compare input results to output or actual results to aid company management in measuring financial performance. While cost accounting is often used within a company to aid in decision making Cost accounting can be most beneficial as a tool for management in budgeting and in setting up cost control programs, which can improve net margins for the company in the future.

5. Development of Cost Accounting Historically it is found that that cost accounting was first developed during the industrial revolution when the emerging economics of industrial supply and demand forced manufacturers to start tracking whether to decrease the price of their overstocked goods or decrease production. During the early 19th century when David Ricardo and T. R. Malthus were developing the field of economic theory, writers like Charles Babbage were writing the first books designed to guide businesses on how to manage their internal cost accounting.

6. Difference Between Cost Accounting and Financial Accounting The key difference between cost accounting and financial accounting is that while in financial accounting the cost is classified depending on the type of transaction, cost accounting classifies costs according to information needs of the management. Cost accounting, because it is used as an internal tool by management, does not have to meet any specific standard set by the Generally Accepted Accounting Principles and as result varies in use from company to company or from department to department. Financial Accounting is what the outside investor community typically sees. Financial accounting is a different representation of costs and financial performance that includes a company's assets and liabilities.

7. Types of Cost Accounting Standard Cost Accounting This type of cost accounting uses ratios to compare efficient uses of labour and materials to produce goods or services under standard conditions. Assessing these differences is called a variance analysis. Traditional cost accounting essentially allocates cost based on one measure, labour or machine hours. Due to the fact that overhead cost has risen proportionate to labour cost since the genesis of standard cost accounting, allocating overhead cost as an overall cost has ended up producing occasionally misleading insights. Some of the issues associated with cost accounting is that this type of accounting emphasizes labour efficiency despite the fact that it makes up a comparatively small amount of the costs for modern companies.

8. Activity Based Costing The Charter Institute of Management Accountants defines activity based accounting as, "an approach to the costing and monitoring of activities which involves tracing resource consumption and costing final outputs, resources assigned to activities, and activities to cost objects based on consumption estimates. The latter utilize cost drivers to attach activity costs to outputs. Activity based costing accumulates the overheads from each department and assigns them to specific cost objects like services, customers, or products.

9. Activity Based Costing (Cont.) The way these costs are assigned to cost objects are first decided in an activity analysis, where appropriate output measures are cost drivers. As result, activity based costing tends to be much more accurate and helpful when it comes to helping managers understand the cost and profitability of their company's specific services or products. Accountants using activity based costing will pass out a survey to employees who will then account for the amount of time they spend on different tasks. This gives management a better idea of where their time and money is being spent.

10. Lean Accounting Lean accounting is an extension of the philosophy of lean Manufacturing and developed by Japanese companies in the 1980s. Most accounting practices for manufacturing work off the assumption that whatever is being produced is done in a large scale. Instead of using standard costing, activity based costing, cost-plus pricing, or other management accounting systems, when using lean accounting those methods are replaced by Value Based Pricing and lean-focused performance measurements, for example, using a box score to facilitate decision making and create simplified and digestible financial reports.

11. Marginal Costing Considered a simplified model of cost accounting, marginal costing (sometimes called cost – volume – profit analysis) is an analysis of the relationship between a product or service's sales price, the volume of sales, the amount produced, expenses, costs and profits. That specific relationship is called the contribution margin. The contribution margin is calculated by dividing revenue minus variable cost by revenue. This type of analysis can be used by management to gain insight on potential profits as impacted by changing costs, what types of sales prices to establish, and types of marketing campaigns.

12. Types of Costs Fixed Cost are costs that don't vary depending ont he amount of work a company is doing. These are usually things like the payment on a building, or a piece of equipment that is depreciating at a fixed monthly rate. Variable Cost are tied to a company's level of production. An example could be a coffee roaster, who after receiving a large order of beans from a far-away locale, has to pay a higher rate for both shipping, packaging, and processing.

13. Operating Costs: are costs associated with the day-to-day operations of a business. These costs can be either fixed or variable depending. Direct Cost: is the cost related to producing a product. If a coffee roaster spends 5 hours roasting coffee, the direct costs of the finished product include the labour hours of the roaster, and the cost of the coffee green. The energy cost to heat the roaster would be indirect because they're inexact, hard to trace.

14. What is Applied Cost A term used in cost accounting to denote the cost assigned to something, which may be different from the actual cost. Cost accounting, which compares costs of production to output produced, is often part of a company's decision-making for many processes including budgeting and implementing cost controls. In manufacturing, for example, the applied cost of a car would include overhead costs such as capital equipment depreciation for the machinery used to make the car. Applied cost analysis could be used to improve manufacturing productivity and/or reduce per-unit costs.

15. What is Full Costing Full costing is a managerial accounting method that describes when all fixed and variable costs, including manufacturing costs, are used to compute the total cost per unit. Full costing includes these costs when computing the amount of money it takes to produce and distribute one unit of output. Full costing is also known as "full costs" or " absorption costing “ How a firm expenses its production and distribution costs will impact the structure of internal income statements. Because all costs incurred to sell a product are included with cost of good sold, the firm's gross margin will be lower under the full costing method than the absorption costing method.

16. What is Absorption Costing Absorption costing is a marginal accounting cost method of expensing all costs associated with manufacturing a particular product. Absorption costing uses the total direct costs and overhead costs associated with manufacturing a product as the cost base. Generally accepted accounting principles (GAAP) require absorption costing for external reporting.

17. Absorption Costing (Cont.) Absorption costing is also known as "full absorption costing“ Some of the direct costs associated with manufacturing a product include wages for workers physically manufacturing a product, the raw material used in producing a product, and all of the overhead costs, such as all utility costs, used in producing a good. Absorption costing includes anything that is a direct cost in producing a good as the cost base. This is contrasted with variable costing, in which fixed manufacturing costs are not absorbed by the product. Advocates promote absorption costing because fixed manufacturing costs provide future benefits.

18. What is a Unit Cost A unit cost is the total expenditure incurred by a company to produce, store and sell one unit of a particular product or service. Unit costs include all fixed costs, or overhead costs, and all variable cost, or direct material costs and direct labour costs, involved in production. Determining the unit cost is a quick way to check if companies are efficient in producing their products. Unit cost is an important metric to look at when evaluating a "unit grower" stock, or a stock that chiefly produces items that have a low fixed cost. Generally, the larger a company grows, the lower the unit cost it can achieve through economies of scale. The unit cost is sometimes referred to as the breakeven point, or minimum price, a company must sell the product to not incur losses. A product with a unit cost of $10 per unit may be sold to customers at twice the price, hence, gaining profit for the company.

19. Variable and Fixed Costs Successful companies always look for ways to improve the overall unit cost of their products. This is done by managing the fixed and variable costs. Fixed costs are costs that go into producing a product and are not dependent on the volume of units produced. Examples are rent, insurance and salaries. Fixed costs such as warehouses and production equipment can be managed through long-term rental agreements. Variable costs vary depending on the level of output produced. They are further divided into direct labour costs and direct material costs. Direct labour costs are the salaries paid to those who are directly involved in making the product, while direct material costs are the cost of materials purchased and used in making the product. Variable costs can be improved by sourcing materials from the best cost supplier or by outsourcing the production process to a more efficient manufacturer, such as Apple outsourcing its iPhone production to Foxconn of China.

20. Computing for the Unit Cost Unit cost is determined by combining the variable costs and fixed costs and dividing by the number of total units produced. What is the 'Cost Of Carry' The cost of carry refers to costs incurred as a result of an investment position. These costs can include financial costs, such as the interest costs on bonds, interest expenses on margin accounts and interest on loans used to purchase a security, and economic costs, such as the opportunity costs associated with taking the initial position. Cost to carry may not be an extremely high financial cost if it is effectively managed. For example, the longer a position is made on margin, the more interest payments will need to be made on the account. When making an informed investment decision consideration must be given to all of the potential costs associated with taking that position.

21. What is an 'Operating Cost' Operating costs are expenses associated with the maintenance and administration of a business on a day-to-day basis. The operating cost is a component of operating income and is usually reflected on a company’s income statement. While operating costs generally do not include capital outlays, they can include many components of operating a business including:

22. Operating Cost (Cont.)  Accounting and legal fees  Banks charges  Sales and marketing costs  Travel Expenses  Entertainment costs  Non-capitalized research and development expenses  Office supply costs  Rent  Repair and maintenance costs  Utility expenses  Salary and wage expenses The formula for operating cost can be expressed in the following way: Operating Cost = Cost of Goods Sold – Operating Expenses

23. Components of Operating Cost A business’s operating costs are comprised of two components, fixed costs and variable costs, which differ in important ways. A fixed cost is one that does not change with an increase or decrease in sales or productivity and must be paid regardless of the company’s activity or performance. For example, a manufacturing company must pay rent for some sort of factory space regardless of how much it is producing or earning. While it can downsize and reduce the cost of its rent payments, it cannot entirely eliminate these costs, and so they are considered to be fixed. Fixed costs generally include overhead costs, and other examples of fixed costs include insurance, security and equipment.

24. What is a Fixed Cost A fixed cost is a cost that does not change with an increase or decrease in the amount of goods or services produced. Fixed costs are expenses that have to be paid by a company, independent of any business activity. It is one of the two components of the total cost of a good or service, along with Variable Cost. An example of a fixed cost would be a company's lease on a building. If a company has to pay $10,000 each month to cover the cost of the lease but does not manufacture anything during the month, the lease payment is still due in full. In economics, a business can achieve economies of scale when it produces enough goods to spread fixed costs. For example, the $100,000 lease spread out over 100,000 widgets means that each widget carries with it $1 in fixed costs. If the company produces 200,000 widgets, the fixed cost per unit drops to 50 cents.

25. What is a 'Variable Cost' A variable cost is a corporate expense that varies with production output. Variable costs are those costs that vary depending on a company's production volume; they rise as production increases and fall as production decreases. Variable costs differ from fixed Costs such as rent, advertising, insurance and office supplies, which tend to remain the same regardless of production output. Fixed costs and variable costs comprise total cost. Variable costs can include direct material costs or direct labour costs necessary to complete a certain project. For example, a company may have variable costs associated with the packaging of one of its products. As the company moves more of this product, the costs for packaging will increase. Conversely, when fewer of these products are sold the costs for packaging will consequently decrease.

26. What is a Semi-Variable Cost' A semi-variable cost, also known as a semi-fixed cost or a mixed cost, is a cost composed of a mixture of fixed and variable components. Costs are fixed for a set level of production or consumption and become variable after this production level is exceeded. If no production occurs, a fixed cost is still incurred The fixed portion of a semi-variable cost incurs repeatedly, while the variable portion occurs as a function of the activity volume. Management may analyze different activity levels by manipulating the activity level to change the variable costs. A semi-variable cost with lower fixed costs is favourable for a business as the breakeven point is lower.

27. Examples of Semi-Variable Costs Overtime on a production line has semi-variable features. If a certain level of labour is required for production line operations, this is the fixed cost. Any additional production volume that requires overtime results in variable expenses dependent on the activity level. In a typical cell phone billing contract, a monthly flat rate is charged in addition to overage charges based on excessive bandwidth usage. A business likely experiences a similar structure when charged for utilities. Also, a salesperson’s salary typically has a fixed component such as a salary and a variable portion such as a commission. A business experiences semi-variable costs in relation to the operation of fleet vehicles. Certain costs, such as monthly vehicle loan payments, insurance, depreciation and licensing, are fixed and independent of usage. Other expenses including gasoline and oil are related to the use of the vehicle and reflect the variable portion of the cost.

28. What Are The Different Types Of Costs In Cost Accounting? Cost Accounting measures several different types of costs associated with a company’s production processes. Management uses these numbers to evaluate expenses and guide important decisions. Direct Costs include the materials purchased by a company to build its products; for example, the metal a car manufacturer buys to construct its vehicles. An indirect cost is an expense that’s not as easily related to production. Suppose a semiconductor company rents office space and makes microchips. The electricity that powers the building is an indirect cost. Fixed Costs do not vary with output. Equipment a company leases for $2,000 a month is a fixed cost. Variable Costs Variable Costs fluctuate with output. A toy company must package its toys before it can ship them to stores. If it’s producing more toys, packaging costs increase. And operating costs stem from day-to-day business activities, such as storing inventory.

29. Cost of Revenue The cost of revenue is the total costs a business incurs to manufacture and deliver a product or service. Companies list items that should be included among their cost of revenue on their income statements. These expenses represent the direct costs it takes to make the goods or services the company provides. Cost of revenue items can include: Raw materials, such as the paint a painting company uses on a house Labour, such as what the painting company pays its painters to do the job Delivery, such as the gas needed to drive to the job site Marketing, including advertising, website production, flyers and customer giveaways used to get business. Items like rent on a business site or salaries paid to management are not considered costs of revenue.

30. Thanks for Sharing the Knowledge