RELEVANT COSTING FOR DECISION MAKING

Cost Accounting �

In earlier concept, costing was defined as the technique and process of ascertaining costs of a given thing. In sixties, the definition of cost accounting was modified as the � application of costing and cost accounting principles, methods and techniques to the science, art and practice of cost control and ascertainment of profitability of goods or services.� It includes the presentation of information derived there from for the purposes of managerial decision making. It clearly emphasizes the importance of cost accountancy achieved during the period by using cost concepts in ore and more areas and helping management to arrive at good business decisions. To day the scope of cost accounting has enlarged to such an extent that it now refers to the collection and providing all sorts of information that assists the executives in fulfilling the organization goals. Modern cost accounting is being termed as management accounting, since managers being the primary user of accounting information are increasingly using the data provided by the accounts, setting objectives and controlling the operation of the business.
Cost accounting deals with the ascertainment of the cost of product or service. It is a tool of management that provides detailed records and reports on the costs and expenses associated with the operations, mainly for internal control and decision making. Cost accounting basically relates to utilization of resources, such as material , labour, machines,etc and provides information like product cost, process cost, service or utility cost, inventory value etc, so as to enable the management taking important decisions like fixing price, choosing products, preparing quotations, releasing or withholding inventory etc.

OBJECTIVE �

The objective of cost accounting is to provide information to internal managers for better planning and control of operations and taking timely decisions. In the early stages, cost accounting was considered as an extension of financial accounting. Cost records were maintained separately. Cost information and data aware collected from financial books,  since all monetary transactions are entered in the financial books only. After developing product cost or service cost and valuation of inventory , the costing profit and loss account is prepared. The profit and loss figures so derived by the two sets of books i.e. financial accounts and cost accounts would have to be reconciled, since some of the income and expenditure recorded in financial books do not enter into product cost, while some of the expenses are included in cost accounts on notional basis i.e. without having incurred actual expenses. However a system of integrated accounts has been developed subsequently wherein cost and financial accounts are integrated and one set of books can be maintained.  

Relevant cost-

The relevant cost is defined as that cost which has direct bearing upon the profitability of the company . For example the marginal cost is a relevant, which can be avoided if the production is not being undertaken. Where as the fixed cost is not a relevant cost because it has already been incurred and can not be avoided irrespective of whether production has been undertaken or not.

There are other examples of relevant costs as follows-

A)    Differential Cost- It is defined as a technique used in the preparation of ad-hoc information in which only costs and income differences between alternative courses of action are taken in to consideration. Cost may increase or decrease due to change in production, sale , production method, product mix, etc.This change in total cost at a particular level of activity compared to another one is called differential costs, which are obtained by subtracting costs at one level from those at a higher level. Differential cost calculation includes both variable as well   fixed costs which are affected by the alternative course of action. Thus, absorption costing or marginal costing techniques can present the information.

Example-
    Activity Level        75%        60%        Differential
Units            7500        6000        1500

Costs Elements        15000        12500        2500
Direct Materials        7500        6000        1500
Variable Overhead    3600        3000        600
Fixed Overheads    3900        3500        400
            Total    30000        25000        5000

Thus, the differential cost of 1500 units is Rs 1500. in the above presentation , if the additional output does not involve additional fixed costs, then variable costs becomes differential costs and in that case, the latter will have no difference with marginal cost.

Differential Cost             Vs             Marginal Cost

In fact, differential costs are often confused with marginal costs. This is because of the fact that both marginal costing and differential cost analysis system stm from the basic behavior of cost,i.e. fixed and variable . When fixed cost remain unaffected, both marginal costs and differential costs are the same . However they are not the same. The difference are as follows which will not be so under marginal costing.

a) Differential cost is a total concept and applies to a fixed additional quantity of output.
a)Marginal Cost is an unit concept and app lies to output per unit basis.
b) Differential Costs are presented in totals in both formats, i.e. under marginal as well as absorption cost techniques.
    b) Marginal Costing is presented by showing contribution per unit and fixed cost as total amount.
c)Product cost under differential cost analysis may contain fixed cost    c) Product cost under marginal costing contain only variable cost.

Uses of Differential Cost Analysis �

Differential cost analysis may be useful technique in taking appropriate policy decisions such as :-
1)    Acceptance of an additional order at lower than existing price to a special customer,
2)    Acceptance of a export order, requiring additional quality.
3)    Introduction of a new product.
4)    Opening of a new sale territory or Channel of distribution.
5)    Processing of a by- product or joint product beyond the split-off point.

 

Conclusion:

In all such cases, the differential cost is compared with incremental revenue. As long as incremental revenue is more than or equal to incremental or differential cost, the additional activity is justified. However, if differential cost exceeds incremental revenue the project should be abandoned.

Technorati Tags: relevant costing,Cost accounting,Accoutning

del.icio.us Tags: relevant costing,Cost accounting,Accoutning

Difference between financial accounting and cost accounting

Winners of the accountancy awards 2008 at Birmingham City University (Photo credit: Birmingham City University)

Financial Accounting Vs Cost Accounting

1) It involves the preparation of a set of final accounts for each accounting period in accordance with the accounting standards and company legislation. It gives the overall financial picture of a company.	1) It is an internal management tool which provides appropriate timely information of management to help them for taking better decisions by applying the techniques viz; standard costing, budgetary control, marginal costing.
2) It can not provide information for future period	2) It can forecast for future period by the techniques of budgeting.
3) It can not provide information for day to day decision making .	3) It can provide day to day decision by applying the concepts of marginal costing , budgetary control etc.
4) It can not provide information to assess the performance of various persons of the department to see that cost don not exceed the reasonable limit for a given quantum of work.	4) The techniques of budgeting and standard costing enable the management to perform the function.

Besides above, the following distinction between financial and cost accounting has been discussed –

i) Purpose- To provide investors, creditor or other external parties with useful information about the financial position, financial performance and cash flow prospect of an enterprise.	i) To provide the manager with information useful for planning, evaluation and rewarding performance and sharing with other outside parties and to apportion decision making authority over the firm resources.
ii) Types of report- Primarily financial statements (profit & loss a/c and balance sheet and cash flow statement and related notes) provides investors, creditors and other users of information to support external decision making process.	ii) Many different types of report depending on the nature of business and the specific information needs of the management. Example; Budget financial projection, bench mark studies, activity based cost report and cost of quality assessment.
iii) Standards for presentation - It follows generally accepted accounting principles including those formally established in the authoritative accounting literature and standard industry practice.	iii) rules are set within the organization to produce information relevant to the needs of management.
i) Time Periods- Usually a year, quarter or month. Most report focus on completed periods. Emphasis is pl aced on the current period with prior periods often shown for comparison.	v) Any period- year, quarter , month,week,day even a work shift .Some reports are historical in nature. Other focus on estimates and results expected in the future period.
ii) User of information- Outsiders as well as managers . These outsiders includes shareholders, creditors, prospective investors, regulatory authorities and the general public.	vi) Management (Different reports to different managers), customers, auditors, suppliers and others involved in an organization value chain.

Related articles

• How best to manage a mobile banking account | CreditRepair.com
• Accounting As an Aid to Management
• What are some of the accounting courses in a college accounting degree?
• Financial Accounting & Management Decision Making

Reconciliation between the financial and Cost Accounts

1.1 Where accounts are maintained on the integral system, there are no separate cost accounts and financial accounts. Hence, the question of reconciliation of cost and financial accounts does not arise. However, where separate sets of books are maintained for cost accounting and financial accounting system, it is imperative that periodically the two accounts are reconciled. A memorandum of reconciliation is prepared, indicating the reasons for difference between the results disclosed by each system.

1.2. The difference between the two sets of accounts arises because of the following reasons-

a) Items includes only in financial accounts-

There are number of items which appear only in financial accounts, and not in cost accounts, since they do not relate to the manufacturing activities, such as,

i) Purely financial charges, reducing profit

- Losses on Capital assets.

- Stamp duty & expense son issue and transfer of stock , shares and bonds.

- Loss on debentures.

- Discount on debentures, bond.

- Fines & penalties.

- Interest on bank loans.

ii) Purely financial income, increasing financial profit

- Rent received.

- Profit on sale of assets.

- Share transfer fee

- Share premium.

- Interest on investment, bank deposits.

- Dividend received.

iii) Appropriation of Profit- Donations and charities.

b) Items included only in cost accounts-

There are very few items, which appears in cost accounts, but not in financial accounts. Because, all expenditure incurred, whether for cash or credit, passes through the financial accounts, and only relevant expenses are incorporated in cost accounts. Hence, only items which can appear in cost accounts but not in financial accounts is a notional charge., such as, I) interest on capital which is not paid but included in cost accounts to show the notional cost of employing capital,

Or II) Rent i.e. charging a notional rent of premises owned.

c) Items included for differently in cost and financial accounting –

i) Overheads- in cost accounts, overheads are applied to cost units at predetermined rates based on estimates, and the amount recovered may differ from actual expenses incurred. If such under-or –over recovery of overheads are not charged off to costing profit & loss a/c, the profits on two sets of books will differ.

ii) Stock Valuation – in financial accounts, stock is valued at lower of cost or market value. In cost accounts, stock is valued at cost adopting one of her methods such as FIFO, LIFO, average etc, which is suitable to the unit. Thus, there may be difference in stock valuation which will reflect difference in profit between the two sets of books.

iii) Depreciation- if different basis is adopted for charging depreciation in cost accounts as compared to financial accounts, the profits will vary.

Cost Accounting

In earlier concept, costing was defined as the technique and process of ascertaining costs of a given thing. In sixties, the definition of cost accounting was modified as the “ application of costing and cost accounting principles, methods and techniques to the science, art and practice of cost control and ascertainment of profitability of goods or services.” It includes the presentation of information derived there from for the purposes of managerial decision making. It clearly emphasizes the importance of cost accountancy achieved during the period by using cost concepts in ore and more areas and helping management to arrive at good business decisions. To day the scope of cost accounting has enlarged to such an extent that it now refers to the collection and providing all sorts of information that assists the executives in fulfilling the organization goals. Modern cost accounting is being termed as management accounting, since managers being the primary user of accounting information are increasingly using the data provided by the accounts, setting objectives and controlling the operation of the business.

Cost accounting deals with the ascertainment of the cost of product or service. It is a tool of management that provides detailed records and reports on the costs and expenses associated with the operations, mainly for internal control and decision making. Cost accounting basically relates to utilization of resources, such as material , labour, machines,etc and provides information like product cost, process cost, service or utility cost, inventory value etc, so as to enable the management taking important decisions like fixing price, choosing products, preparing quotations, releasing or withholding inventory etc.

OBJECTIVE – The objective of cost accounting is to provide information to internal managers for better planning and control of operations and taking timely decisions. In the early stages, cost accounting was considered as an extension of financial accounting. Cost records were maintained separately. Cost information and data aware collected from financial books, since all monetary transactions are entered in the financial books only. After developing product cost or service cost and valuation of inventory , the costing profit and loss account is prepared. The profit and loss figures so derived by the two sets of books i.e. financial accounts and cost accounts would have to be reconciled, since some of the income and expenditure recorded in financial books do not enter into product cost, while some of the expenses are included in cost accounts on notional basis i.e. without having incurred actual expenses. However a system of integrated accounts has been developed subsequently wherein cost and financial accounts are integrated and one set of books can be maintained.