Management & Cost Accounting

Chanderprabhu Jain College of Higher Studies & School of Law
Plot No. OCF, Sector A-8, Narela, New Delhi – 110040
(Affiliated to Guru Gobind Singh Indraprastha University and Approved by Govt of NCT of Delhi & Bar Council of India)
Semester: BBA(CAM) Fourth Semester
Name of the Subject:
MANAGEMENT AND COST
ACCOUNTING
Semester: BBA(CAM) Fourth Semester
Name of the Subject:
MANAGEMENT AND COST
ACCOUNTING

(Affiliated to Guru Gobind Singh Indraprastha University and Approved by Govt of NCT of Delhi & Bar Council of India)2
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

3
Functions of managerial
accounting
• Determining the cost
• Providing relevant information for
better decision-making
• Providing information for planning,
control, decision-making and
application

Management
(cost)accounting
Financial accounting
Nature Records material,
labour and overhead
costs in product or job
Reports produced are
for internal
management and
contol
Records company
transaction events
External financial
statements are produced
Accounting
system
Not based on the
double entry system
Follows the double entry
system

Management
(cost)accounting
Financial
accounting
Accountin
g
principles
No need to use
accounting
principles
Adopt any
accounting
techniques that
generates useful
accounting
information
Use Generally
Accepted Accounting
Principles for
recording transactions
Users of
informatio
n
Used by different
levels of
management or
departments
responsible for
respective activities
Used by external
parties: shareholders,
creditors,
government, etc

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
Perspectiv
e
Detailed analysis
of parts of the
entity, products,
regions, etc
Financial summary of
the whole
orgainisation

7
Element of cost
• Cost object
• Cost
• Cost unit
• Cost centre
• Profit centre

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
personnel department of a
company, the cost of a repair fob,
and the cost for control

9
Cost
• It is the amount of expenditure
incurred on a specific cost object
• Total cost = quantity used * cost
per unit (unit cost)

10
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

11
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 of buildings; the
wages and salaries of
strorekeepers

Cost classification
• Direct cost
• Indirect cost (overhead)

13
Direct cost
• Cost that can be identified
specifically with or traced to a
given cost object
• The direct costs consist of the
following three elements:
– Direct materials
– Direct labour
– Direct expenses

14
Indirect cost (overhead)
• Cost that cannot be identified
specifically with or traced to a
given cost object
• They are identified with cost
centres as overheads
– Indirect materials
– Indirect labour
– Indirect expenses

15
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

16
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

17
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

18
Semi-variable cost
• It processes characteristics of both
fixed and variable cost
• It increases or decreases with
activity level but not in direct
proportion

Methods and Techniques of
Costing
• Job Costing
• Contract Costing
• Batch Costing
• Process Costing
• One Operation (Unit or Output)
Costing
• Service (or Operating) Costing

Cost control
• Cost control is the practice of
identifying and reducing
business expenses to increase
profits, and it starts with the
budgeting process. A business owner
compares actual results to the
budget expectations, and if
actual costs are higher than
planned, management takes action.

Steps in Installation of a
Costing System
• Determination of objectives
• Study of the nature of business
• Study of the nature of the
organization
• Deciding the structure of cost
accounts
• Determination of cost rates
• Organization of the cost office
• Introducing the system

Management Accounting
Management accounting is the process of
preparing management reports and
accounts that provide accurate and timely
financial and statistical information to
managers to make short-term and long-term
decisions. It identifies, measures, analyzes,
interprets, and communicates information to
enable an organization to pursue its goals.

The Role of Management
Accounting in an
Organization
• Helping Forecast the Future
• Helping in Make-or-buy Decisions
• Forecasting Cash Flows
• Helping Understand Performance
Variances
• Analyzing the Rate of Return

Financial Statement
Analysis
• Financial statement
analysis (or financial analysis) is
the process of reviewing and
analyzing a company's financial
statements to make better economic
decisions. These statements include
the income statement, balance
sheet, statement of cash flows, and
a statement of changes in equity.

Ratio Analysis
• Ratio Analysis as a tool possesses several
important features. The data, which are
provided by financial statements, are
readily available. The computation of
ratios facilitates the comparison of firms
which differ in size. Ratios can be used to
compare a firm's financial performance
with industry averages. In addition, ratios
can be used in a form of trend analysis to
identify areas where performance has
improved or deteriorated over time.

Types of Financial Ratios
• Liquidity ratios
• Asset Management ratios
• Leverage ratios
• Profitability ratios
• Valuation ratios

Marginal Costing
• Marginal Costing is a costing
technique wherein the marginal cost,
i.e. variable cost is charged to units
of cost, while the fixed cost for the
period is completely written off
against the contribution.

Basic Characteristics of
Marginal Costing
• a. It is a technique of analysis and presentation of
costs which help management in taking many
managerial decisions and is not an independent
system of costing such as process costing or job
costing.
• b. All elements of cost—production, administration
and selling and distribution are classified into
variable and fixed components. Even semi-
variable costs are analysed into fixed and variable.
• c. The variable costs (marginal costs) are regarded
as the costs of the products.

• d. Fixed costs are treated as period costs
and are charged to profit and loss account
for the period for which they are incurred.
• e. The stocks of finished goods and work-in-
process are valued at marginal costs only.
• f. Prices are determined on the basis of
marginal cost by adding ‘contribution’
which is the excess of sales or selling price
over marginal cost of sales.
Basic Characteristics of
Marginal Costing

Importance of Marginal
Costing
• The concept of marginal cost is important for
individuals producing or consuming multiple units.
• The concept of marginal cost is very important in
areas of economics such as analyzing optimum
levels of production for a firm. Profit maximizing
output is achieved when marginal cost
equals marginal revenue.

Importance of Marginal
Costing
• Marginal cost is also important for consumers
looking to purchase additional units of a good or
service. Stores will often take advantage of this in
offering deals and sales, such as buy one, get one
half priced or buy one, get one free (BOGO). Not
only does this encourage shoppers to purchase
multiple units, but it likely generates income for
the company as well. Consumers are much more
likely to buy a second item at half-price because
the marginal cost is half of the original cost.

Disadvantages of
Marginal Costing
• Classifying costs: It is very difficult to separate all
costs into fixed and variable costs clearly, since all
costs are variable in the long run. Hence such
classification sometimes may give misleading results.
Furthermore, in a firm with many different kinds of
products, marginal costing can prove less useful.
• Accurately representing profits: Since the closing
stock consists only of variable costs and ignores fixed
costs (which could be considerable), this gives a
distorted picture of profits to shareholders.
• Semi-variable costs: Semi-variable costs are either
excluded or incorrectly analyzed, leading to
distortions.

•Recovery of overheads: With marginal costing, there is
often the problem of under or over-recovery of overheads,
since variable costs are apportioned on an estimated basis
and not on actual value.
•External reporting: Marginal costing cannot be used in
external reports, which must have a complete view of all
indirect and overhead costs.
•Increasing costs: Since it is based on historical data,
marginal costing can give an inaccurate picture in the
presence of increasing costs or increasing production.
Disadvantages of
Marginal Costing

CONTRIBUTION MARGIN
CONTRIBUTION =SELLING PRICE –MARGINAL COST
OR
C=F+P/L
OR
C-F=P/L

BREAK EVEN POINT
B.E.P=FC/P/V
OR
TOTAL FIXED EXPENSES/S.P PER UNIT-MC PER UNIT
OR
TOTAL FIXED EXPENSES/CONTRIBUTION PER UNIT

MARGIN OF SAFETY
MOS=PROFIT/P/V RATIO

Cost-Volume-Profit
Analysis
Cost-volume-profit (CVP) analysis is used to
determine how changes in costs and volume
affect a company's operating income and net
income. In performing this analysis, there are
several assumptions made, including:
• Sales price per unit is constant.
• Variable costs per unit are constant.
• Total fixed costs are constant.
• Everything produced is sold.
• Costs are only affected because activity changes.

BUDGETING
• The budget is the plan which intends to
figure out expected operations revenue
and expenses of an organization for a
future time period. In other words for a
business entity budgeting is the process of
preparing detailed statement of financial
results that are projected for a certain
period of time. Budgeting is to estimate
the future while taking the management
inputs considering internal and external
factors of the organization.

Types of Budgets
• Operating Budget
• Master Budget
• Cash Flow Budget
• Financial Budget
• Static Budget

Zero-Based Budgeting
• Zero-based budgeting (ZBB) is a method of
budgeting in which all expenses must be
justified for each new period. The process of
zero-based budgeting starts from a "zero base,"
and every function within an organization is
analyzed for its needs and costs. Budgets are
then built around what is needed for the
upcoming period, regardless of whether each
budget is higher or lower than the previous one.

Performance Budget
• A performance budget is a budget that
reflects the input of resources and the
output of services for each unit of an
organization. This type of budget is
commonly used by government bodies to
show the link between taxpayer funds and
the outcome of services provided by
federal, state or local governments.

Flexible budget
• A flexible budget is a budget that
adjusts or flexes for changes in the
volume of activity. The flexible
budget is more sophisticated and
useful than a static budget, which
remains at one amount regardless of
the volume of activity.

Budgetary control
• A system of management control in
which actual income and spending
are compared with planned income
and spending, so that you can see if
plans are being followed and if those
plans need to be changed in order to
make a profit.

Essentials of Effective
Budgetary Control
• Sound forecasting: The estimates for the future
needs of business should be precise and
accurate. ...
• Goal orientation: ...
• Proper recording system: ...
• Participation: ...
• Top Management support: ...
• Flexibility: ...
• Enforce timeliness: ...
• Efficient organization:

Advantages of Budgetary
Control
• Definite planning
• Enhanced efficiency
• Proper communication
• Control
• Co-ordination

Limitations of Budgetary
Control
• Danger of inaccurate estimates: Budgets are
based on estimates and they involve forecasting
of future events. ...
• Danger of rigidity: ADVERTISEMENTS:
• Human factor
• Expensive
• Hide Inefficiencies
• Departmental Outlook
• Danger of over budgeting

Responsibility
accounting
• Responsibility accounting usually involves
the preparation of annual and monthly
budgets for each responsibility center.
Then the company's actual transactions
are classified by responsibility center and
a monthly report is prepared. The reports
will present the actual amounts for each
budget line item and the variance between
the budget and actual amounts.

Responsibility CentersResponsibility Centers
• A responsibility center is a functional
entity within a business that has its
own goals and objectives, dedicated
staff, policies and procedures, and
financial reports. Such a center is
used to tie specific responsibility for
revenues generated, expenses
incurred, and/or funds invested to
individuals.

Pre-Requisites Of
Responsibility
Accounting• The area of responsibility and authority of each
responsibility center should be clearly defined.
• The set of goals, which each manager of a
responsibility center is supposed to achieve, should
be clearly stated.
• The performance report of a responsibility center
should include only the revenues expenses, profits
and investments that are to be controlled by the
executives of that center.
• The items, which may require management's
attention like variances, should be highlighted in the
performance report for each responsibility center.

Principles of
responsibility accounting
• Determination of responsibility centres.
• A target is fixed for each responsibility centre.
• Actual performance is compared with the target.
• The variances from the budgeted plan are
analysed so as to fix the responsibility of centres.
• Corrective action is taken by the higher
management and is communicated to the
responsibility centre i.e., the individual
responsible.

• Report to responsible individual for
action.
• Transfer Pricing Policy. To get the
desirable result of responsibility
accounting, a suitable transfer
pricing policy should be followed.
Principles of
responsibility accounting

Advantages of
Responsibility
Accounting
• It establishes a sound system of control.
• It is tailored according to the needs of an
organization.
• It encourages budgeting for comparison of
actual achievements with the budgeted
figures.
• It increases interests and awareness among
the supervisory staff as they are called
upon to explain about the deviations for
which they are responsible.

• It simplifies the Structure of reports and
facilitates the prompt reporting because of
exclusion of those items which are beyond
the scope of individual responsibility.
• It is helpful in following management by
exception because emphasis is laid on
reporting exceptional matters to the top
management.
Advantages of
Responsibility
Accounting

Standard Costing
• Standard costing is the practice of
substituting an expected cost for an actual
cost in the accounting records, and then
periodically recording variances showing the
difference between the expected and actual
costs. This approach represents a simplified
alternative to cost layering systems, such as
the FIFO and LIFO methods, where large
amounts of historical cost information must
be maintained for items held in stock.

Advantages of Standard
Costing
• To provide a formal basis for assessing
performance and efficiency.
• To control costs by establishing standards
and analysis of variances.
• To enable the principle of ‘management by
exception’ to be practised at the detailed,
operational level.
• To assist in setting budgets.

Criticism on Standard
Costing
• A lot of input data is required which can be
expensive.
• Standard costing is usually confirmed to
organizations whose processes or jobs are repeti
tive.
• Unless standards are accurately set any
performance evaluation will be meaningless.
• Uncertainty in standard costing can be caused by
inflation, technological change, economic and
political factors etc. Standards, therefore, need to
be continually updated and revised.
• The maintenance of the cost data base is
expensive.

Variance analysis
• The primary objective of variance
analysis is to exercise cost control
and cost reduction. Under standard
costing system, the management by
exception principle is applied through
variance analysis. The variances are
related to efficiency. The showing of
efficiency leads to favorable variance. In
this case, the responsible persons are
rewarded.

Types of Variances
On the basis of Elements of Cost.
• Material Cost Variance.
• Labour Cost Variance.
• Overhead Variance

On the basis of Controllability
• Controllable Variance.
• Uncontrollable Variance.
On the basis of Impact
• Favorable Variance.
• Unfavorable Variance
Types of Variances

On the basis of Nature
• Basic Variance.
• Sub-variance.
Types of Variances

Funds flow statement
• The funds flow statement is the earlier
version of the statement of cash flows that is
now required to report changes in an
entity's cash flows during an accounting
period. The funds flow statement was
required under Generally Accepted
Accounting Principles from the period 1971
through 1987. The statement primarily
reported changes in an entity's net working
capital position between the beginning and
end of an accounting period.

• This statement is also called ‘statement of
sources and application of funds ‘and
‘statement of changes in financial position’.
While preparation of funds flow statement,
non-fund transactions are ignored. A funds
flow statement is based on the accrual
accounting system, and does not provide
explanation as to transactions affecting the
cash or cash equivalents. Funds flow is a
broader concept than ‘cashflow’.
Funds flow statement

Identification of Flow of
Funds
‘Flow’ of funds takes place only if a current account is
involved. To identify a flow, journalize the
transaction, identify the two accounts involved as
‘current’ and ‘non-current’ and apply the general
rule.
• Transactions which involve only current accounts do
not result in a flow.
• Transactions which involve only non-current
accounts do not result in a flow.
• Transactions which involve one current account and
one non-current account results in a flow of funds.

Preparation of Funds
Flow Statement
• Preparing a fund flow statement
• Preparing a statement where the working
capital had some changes
• Preparation of account with adjustments in
profits and loss
• Adjustment and their analysis
• Separate ledger preparation
• Handling the provision for taxation and
proposed divider

ADVANTAGES OF FUND
FLOW STATEMENT
• CHANGES IN THE FINANCIAL POSITION OF
THE COMPANY.
• REASON FOR CHANGES IN THE FINANCIAL
POSITION BETWEEN TWO ACCOUNTING
PERIODS.
• FUTURE BUSINESS AND BUDGET
PROJECTIONS
• COMPANY IMAGE

DISADVANTAGES OF
FUND FLOW STATEMENT
• LACKS ORIGINALITY
• BASED ON HISTORICAL DATA
• GOES HAND IN HAND WITH CASH FLOW
STATEMENT
• CANNOT BE USED ON STANDALONE BASIS

Cash Flow Statement
Cash Flow Statement (also called the
Statement of Cash Flows) shows how much
cash is generated and used during a given
time period. It is one of the main financial
statements analysts use in building a three
statement model. The main categories found
in a cash flow statement are the (1)
operating activities, (2) investing activities
and (3) financing activities of a company and
are organized respectively as mentioned.

The total cash provided from or used
by each of the three activities will be
summed to arrive at the total change
in cash for the period, and then
combined with the opening cash
balance to arrive at the cash flow
statement’s bottom line, the closing
cash balance.
Cash Flow Statement

Steps to Preparing the
Statement of Cash Flows
• Step 1. Prepare the operating activities section
by converting net income from an accrual
basis to a cash basis
• Step 2. Prepare the investing activities section
by presenting cash activity for noncurrent
assets.
• Step 3. Prepare the financing activities section
by presenting cash activity for noncurrent
liabilities and owners’ equity.
• Step 4. Reconcile the change in cash.

Importance of Cash Flow
Statement
• Helps to make Cash Forecast
• Helps the Internal Management
• Reveals the Cash Position
• Reveals the result of Cash Planning
• Ascertaining Liquidity and Profitability
Positions

Disadvantages of Cash
Flow Statement
• Since it shows only cash position, it is not
possible to arrive at actual profit and loss
of the company by just looking at this
statement alone.
• In isolation this is of no use and it requires
other financial statements like balance
sheet, profit and loss etc…, and therefore
limiting its use.

Management & Cost Accounting

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