1. 1 Chapter 1 Costing Principles Eng. MHMD RAWSHDH

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4. 4 Planning Deals with the estimation of product costs, setting up of costing system to record cost data, preparation of cost standards and budgets, planning of materials and manpower resources, analysing cost behavior with changes in levels of activity

5. 5 Control Deals with the maintenance of product costing record, comparison of actual performance with standards or budgets, anlaysis of variances, recommendation of corrective actions, controlling cost to ensure operational efficiency and effectiveness

6. 6 Decision-making Deals with whether it is more profitable to make or buy a component, determine the economic order quantity and production batch size, replace fixed asset, add or drop products, decide pricing

7. 7 Application Cost accounting has extended from manufacturing operations to a variety of service industries such as hotels, bands, airline, etc Cost accounting system should be flexible and adaptable to meet the new business environment and the changing nature of the company

8. 8 Meanings Financial accounting Cost accounting Management accounting

9. 9 Financial Accounting Financial accounting measures and records business transactions and provides financial statements that are based on Generally Accepted Accounting Principles (GAAP) Managers are responsible for the financial statements issued to investors, government regulators, and other parties outside the organization Financial accounting focuses on external parties Financial accounting reports on what happened in the past

10. 10 Financial accounting Provides information to users who are external to the business It reports on past transactions to draw up financial statements The format are governed by law and accounting standards established by the professional accounting policies

11. 11 Cost Accounting Cost accounting measures and reports information relating to the cost of acquiring and utilizing resources Cost accounting provides information for management and financial accounting Cost management describes the approaches and activities of managers in short-run and long-run planning and control decisions These decisions increase value of customers and lower costs of products and services Cost management is an integral part of a company’s strategy

12. 12 Cost accounting Is concerned with internal users of accounting information, such as operation managers The generated reports are specific to the requirement of the management The reporting can be in any format which suits the user

13. 13 Cost Accounting It provides information for both management accounting and financial accounting. It measures and reports from financial and non financial data.

14. 14 Management accounting Comprises all cost accounting functions The accounting for product and service costs, management accounting extends to use various internal accounting reports for planning, control and decision making

15. 15 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

16. 16 Functions of managerial accounting Determining the cost Providing relevant information for better decision-making Providing information for planning, control, decision-making and application

17. 17 Comparison of cost, management and financial accounting

18. 18 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

19. 19 Management (cost)accounting Financial accounting Accounting 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 information Used by different levels of management or departments responsible for respective activities Used by external parties: shareholders, creditors, government, etc

20. 20 Management (cost)accounting Financial accounting Operation guidelines or standards Based on management instructions and requirements Conforms to company Ordinances, stock exchange rules, HKSSAPs Time span Reports are prepared whenever needed They may be prepared on a weekly or daily basis Reports are prepared for a definite period, usually yearly and half yearly

21. 21 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 Perspective Detailed analysis of parts of the entity, products, regions, etc Financial summary of the whole orgainisation

22. 22 Cost accounting vs. Management accounting

23. 23 Management accounting Cost accounting Objective To provide information for planning and decision making by the management To ascertain and control cost Basic of recording Concerned with transactions related to the future Based on both present and future transactions for cost ascertainment

24. 24 Management accounting Cost accounting Coverage Covers a wider area: financial accounts, cost accounts, taxation, etc. Covers matters relating to ascertainment and control of cost of product or service Utility Only the needs of internal management The needs of both internal and external interested groups

25. 25 Management accounting Cost accounting Types of transactions Deals with both monetary any non- monetary transactions, covering both quantitative and qualitative aspects Deals only with monetary transactions, covering only quantitative aspect

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35. Chapter 2 Basic Cost Terminology © 2012 Pearson Prentice Hall. All rights reserved. Cost—sacrificed resource to achieve a specific objective Actual cost—a cost that has occurred Budgeted cost—a predicted cost Cost object—anything of interest for which a cost is desired

36. Cost Object Examples at BMW © 2012 Pearson Prentice Hall. All rights reserved. Cost ObjectIllustration ProductBMW X 5 sports activity vehicle ServiceDealer-support telephone hotline ProjectR&D project on DVD system enhancement CustomerHerb Chambers Motors, a dealer that purchases a broad range of BMW vehicles ActivitySetting up production machines DepartmentEnvironmental, Health and Safety

37. Basic Cost Terminology © 2012 Pearson Prentice Hall. All rights reserved. Cost accumulation—a collection of cost data in an organized manner Cost assignment—a general term that includes gathering accumulated costs to a cost object. This includes: Tracing accumulated costs with a direct relationship to the cost object and Allocating accumulated costs with an indirect relationship to a cost object

38. Direct and Indirect Costs © 2012 Pearson Prentice Hall. All rights reserved. Direct costs can be conveniently and economically traced (tracked) to a cost object. Indirect costs cannot be conveniently or economically traced (tracked) to a cost object. Instead of being traced, these costs are allocated to a cost object in a rational and systematic manner.

39. BMW: Assigning Costs to a Cost Object © 2012 Pearson Prentice Hall. All rights reserved.

40. Cost Examples © 2012 Pearson Prentice Hall. All rights reserved. Direct Costs Parts Assembly line wages Indirect Costs Electricity Rent Property taxes

41. Factors Affecting Direct/Indirect Cost Classification © 2012 Pearson Prentice Hall. All rights reserved. Cost materiality Availability of information-gathering technology Operational design

42. Cost Behavior © 2012 Pearson Prentice Hall. All rights reserved. Variable costs—changes in total in proportion to changes in the related level of activity or volume. Fixed costs—remain unchanged in total regardless of changes in the related level of activity or volume. Costs are fixed or variable only with respect to a specific activity or a given time period.

43. Cost Behavior © 2012 Pearson Prentice Hall. All rights reserved. Variable costs are constant on a per-unit basis. If a product takes 5 pounds of materials each, it stays the same per unit regardless if one, ten, or a thousand units are produced. Fixed costs change inversely with the level of production. As more units are produced, the same fixed cost is spread over more and more units, reducing the cost per unit.

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45. Cost Behavior Visualized © 2012 Pearson Prentice Hall. All rights reserved.

46. Other Cost Concepts © 2012 Pearson Prentice Hall. All rights reserved. Cost driver—a variable that causally affects costs over a given time span Relevant range—the band of normal activity level (or volume) in which there is a specific relationship between the level of activity (or volume) and a given cost For example, fixed costs are considered fixed only within the relevant range.

47. Relevant Range Visualized © 2012 Pearson Prentice Hall. All rights reserved.

48. Multiple Classification of Costs © 2012 Pearson Prentice Hall. All rights reserved. Costs may be classified as: Direct/Indirect, and Variable/Fixed These multiple classifications give rise to important cost combinations: Direct and variable Direct and fixed Indirect and variable Indirect and fixed

49. Multiple Classification of Costs, Visualized © 2012 Pearson Prentice Hall. All rights reserved.

50. Total Costs and Unit Costs 50

51. Total Costs and Unit Costs 51

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53. Total Costs and Unit Costs © 2012 Pearson Prentice Hall. All rights reserved. Unit costs should be used cautiously. Because unit costs change with a different level of output or volume, it may be more prudent to base decisions on a total dollar basis. Unit costs that include fixed costs should always reference a given level of output or activity. Unit costs are also called average costs. Managers should think in terms of total costs rather than unit costs.

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55. Different Types of Firms © 2012 Pearson Prentice Hall. All rights reserved. Manufacturing-sector companies purchase materials and components and convert them into finished products. Merchandising-sector companies purchase and then sell tangible products without changing their basic form. Service-sector companies provide services (intangible products).

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57. Types of Manufacturing Inventories © 2012 Pearson Prentice Hall. All rights reserved. Direct materials—resources in-stock and available for use Work-in-process (or progress)—products started but not yet completed, often abbreviated as WIP Finished goods—products completed and ready for sale

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59. Types of Product Costs © 2012 Pearson Prentice Hall. All rights reserved. Also known as inventoriable costs Direct materials—acquisition costs of all materials that will become part of the cost object. Direct labor—compensation of all manufacturing labor that can be traced to the cost object. Indirect manufacturing—factory costs that are not traceable to the product in an economically feasible way. Examples include lubricants, indirect manufacturing labor, utilities, and supplies.

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63. Accounting Distinction Between Costs © 2012 Pearson Prentice Hall. All rights reserved. Inventoriable costs—product manufacturing costs. These costs are capitalized as assets (inventory) until they are sold and transferred to Cost of Goods Sold. Period costs—have no future value and are expensed in the period incurred.

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67. Cost Flows Visualized © 2012 Pearson Prentice Hall. All rights reserved.

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69. Cost of Goods Manufactured STEP 1 STEP 3 STEP 2 PANEL B: COST OF GOODS MANUFACTURED Cellular Products Schedule of Cost of Goods Manufactured* For the Year Ended December 31, 2011 (in Thousands) Direct materials: Beginning inventory, January 1, 2011$11,000 Purchases of direct materials$73,000 Cost of direct materials available for use$84,000 Ending inventory, December 31, 2011$8,000 Direct materials used$76,000 Direct manufacturing labor$9,000 Manufacturing overhead costs: Indirect manufacturing labor$7,000 Supplies$2,000 Heat, light, and power$5,000 Depreciation-plant building$2,000 Depreciation-plant equipment$3,000 Miscellaneous$1,000 Total manufacturing overhead costs$20,000 Manufacturing cost incurr3ed during 2011$105,000 Beginning work-in-progress inventory, January 1, 2011$6,000 Total manufacturing costs to account for$111,000 Ending work-in-progress inventory, December 31, 2011$7,000 Cost of goods manufactured (to income Statement)$104,000 * Note that this schedule can beco me a Schedule of Cost of Goo ds M anufactured and So ld simply by including the beginning and ending finished go o ds invento ry figures in the suppo rting schedule rather than in the bo dy of the inco me statement.

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72. Multiple-Step Income Statement STEP 4 © 2012 Pearson Prentice Hall. All rights reserved. PANEL A: INCOME STATEMENT Cellular Products Income Statement For the Year Ended December 31, 2011 (in thousands) Revenues$210,000 Costs of goods sold: Beginning finished goods inventory, January 1, 2011$22,000 Costs of goods manufactured (see Panel B)$104,000 Costs of goods available for sale$126,000 Ending finished goods inventory, December 31, 2011$18,000 Cost of goods sold$108,000 Gross margin (or gross profit)$102,000 Operating costs R&D, design, mktg., dist., & cust.-service cost$70,000 Total operating costs$70,000 Operating income$32,000

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75. Other Cost Considerations © 2012 Pearson Prentice Hall. All rights reserved. Prime cost is a term referring to all direct manufacturing costs (materials and labor). Conversion cost is a term referring to direct labor and indirect manufacturing costs. Overtime labor costs are considered part of indirect overhead costs.

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77. Different Definitions of Costs for Different Applications © 2012 Pearson Prentice Hall. All rights reserved. Pricing and product-mix decisions—decisions about pricing and maximizing profits Contracting with government agencies—very specific definitions of allowable costs for “cost plus profit” contracts Preparing external-use financial statements—GAAP- driven product costs only

78. Different Definitions of Costs for Different Applications © 2012 Pearson Prentice Hall. All rights reserved.

79. Cost-Volume-Profit Analysis © 2012 Pearson Prentice Hall. All rights reserved.

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81. A Five-Step Decision-Making Process in Planning and Control Revisited 1. Identify the problem and uncertainties 2. Obtain information 3. Make predictions about the future 4. Make decisions by choosing between alternatives, using cost-volume-profit (CVP) analysis 5. Implement the decision, evaluate performance, and learn

82. Foundational Assumptions in CVP Changes in production/sales volume are the sole cause for cost and revenue changes. Total costs consist of fixed costs and variable costs. Revenue and costs behave and can be graphed as a linear function (a straight line). Selling price, variable cost per unit, and fixed costs are all known and constant. In many cases only a single product will be analyzed. If multiple products are studied, their relative sales proportions are known and constant. The time value of money (interest) is ignored.

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91. Basic Formulae © 2012 Pearson Prentice Hall. All rights reserved.

92. CVP: Contribution Margin © 2012 Pearson Prentice Hall. All rights reserved. Manipulation of the basic equations yields an extremely important and powerful tool extensively used in cost accounting: contribution margin (CM). Contribution margin equals revenue less variable costs. Contribution margin per unit equals unit selling price less unit variable costs.

93. Contribution Margin © 2012 Pearson Prentice Hall. All rights reserved. Contribution margin also equals contribution margin per unit multiplied by the number of units sold. Contribution margin percentage is the contribution margin per unit divided by unit selling price.

94. Cost – Volume – Profit Equation © 2012 Pearson Prentice Hall. All rights reserved. Revenue – Variable Costs – Fixed Costs = Operating Income Selling Sales Price Quantity * () (() () * Unit - Variable Costs Sales Quantity - Fixed Costs = Operating Income

95. Breakeven Point At the breakeven point, a firm has no profit or loss at the given sales level. Sales – Variable Costs – Fixed Costs = 0 Calculation of breakeven number of units Breakeven Units = Fixed Costs__ Contribution Margin per Unit Calculation of breakeven revenues Breakeven Revenue = Fixed Costs__ Contribution Margin Percentage

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119. Job Costing

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126. Costing Approaches Actual costing—allocates: Indirect costs based on the actual indirect-cost rates times the actual activity consumption. Normal Costing—allocates: Indirect costs based on the budgeted indirect-cost rates times the actual activity consumption. Both methods allocate direct costs to a cost object the same way: by using actual direct-cost rates times actual consumption.

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128. Costing Approaches Summarized

129. …logically extended Cost pool—any logical grouping of related cost objects Cost-allocation base—acost driver is used as a basis upon which to build a systematic method of distributing indirect costs. For example, let’s say that direct labor hours cause indirect costs to change. Accordingly, direct labor hours will be used to distribute or allocate costs among objects based on their usage of that cost driver.

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