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Cost accountancy has made rapid strides during last few decades and has established a distinct and highly specialized framework to assist the business management in planning and controlling its operations.
Cost accounting is nothing but one extension of accounting developed due to need and requirement of management. Under this branch various costs are classified, grouped and analyzed for controlling purpose. Cost determination and cost control are two important crucial areas in which cost accounting works as a tool of management.
The development of cost accounting is of recent origin. this branch has got lot of importance particularly now a days where there is cut throat competitions, heavy industrialization ,industrial development ,concept of large scale production in taking place in the market.
Cost accounting process that form of operating costing which applies where standardized goods are produced. Process costing as a method of cost accounting whereby costs are charged to processes or operations and averages over units produced. Process costing also a form of operation costing as distinguished from specific order costing. The aim of process costing is to determine the total cost each operation and to apply this cost to the product at each state of process. It will then be possible to ascertain cost per unit for each operation or process and in total.
Process costing is easily applicable in these industries where manufacture of product is of uniform standard and there is continuous possess.
The manner in which a specific cost reacts to the changes in activity levels is called Cost Behavior. Cost Behavior is the process in which a cost changes is activity in relation to the change in the related activity. Costs may remain same or can change in proportion to a change in activity.
Understanding of how cost will behave in one particular situation is very important in helping the decision-making process for the management in an organization. The information of cost behavior helps in performing the following important activities:-
ïƒ˜Helping in preparing budgets of the organization
ïƒ˜Predicting the movement of the cash flows through Cash Flow Analysis
ïƒ˜Planning of the dividend to be paid to the shareholders
ïƒ˜Determining what would be the selling price of the output
Depending upon the cost behavior the most common types of cost are Fixed Cost, Variable Cost and Mixed Cost. These costs are discussed as follows:-
i.Fixed Cost: - Fixed costs are those costs which remain fixed throughout the production period whatever the number of units produced may be. Although the total fixed cost remain the same, fixed cost per unit changes with respective increase or decrease in the number of units produced. Depreciation under Straight-Line method is a good example of fixed cost. It is of no concern that the machine produces 100 units or 10,000 units the deprecation remains the same as it does not depends on the production but on the number of years it will last.
Variable Cost: - Variable costs are those cost which do not remain fixed but change with the level of production. It changes in direct proportion with the change in the level of activity. Direct Materials and Direct Labor are generally considered as Variable Costs. Variable Costs are same per unit but total variable cost changes in proportion to the changes in the level of activity or the cost driver.
Iii. Mixes Cost: - Mixed cost contains both fixed as well as variable cost. They are sometimes referred as semi-variable or semi-fixed cost. The fixed component of a mixed cost is the minimum cost of supplying the resource while the variable component is the cost which fluctuates depending upon the level of activity.
Engineering Method: - The engineering method also referred as the 'bottoms-method of cost analysis' is the most detailed and structured of all the techniques of cost analysis. It is very costly to implement this method while performing cost analysis. It reflects the direct build-up of direct lab our, materials and overhead cost. This method is mostly more often used by the contractors as they have ample funds for such kind of research and it usually involves industrial engineers, cost analysts and qualified cost accountants. After the minute details are sorted out during the initial stages, engineers estimate the direct materials and labor cost involved in the project. While calculating the labor cost the standard which is prevalent in the industry is often used to determine what labor categories are required and what number of hours will be required to complete the task. The remaining parts of the work package are calculated by using factors based on the estimated direct lab our or materials required for the project. Engineering cost can be quite accurate as they apply the exhaustive structure of breaking down the cost at each and every level of production procedure. However, a substantial amount of time and effort is required to produce and document such an estimate, which makes it impractical to use it in all elements of an acquisition program's cost. Finally the factors used to determine other costs from direct lab our and materials may not accurately reflect company's current business base or facilities.
The source and the estimates of the engineering method provide much more detailed structure of the costs than the analogy or parametric methods of cost estimation. Therefore, an engineering estimate enables a better visibility into the cost drivers. However, there may be a problem involving engineering method which is that it can be very lab our intensive and slow and expensive in nature. In additions there can still be risks involved in this method as we often apply factors or overhead rates that are not directly related to the direct materials and direct labor. A small error at the lower level can convert into a huge error once the estimated rates are applied to the final estimation.
Accounting Method: - How to separate mix cost?
To analyze the cost behavior when the costs are mixed the cost must be split into variable cost and fixed cost. Then we have to perform the following analysis to separate the mixed cost:-
ï‚· Scatter Diagram: In a scatter diagram all the parts would be plotted on a graph with activity on the horizontal axis and the cost on the vertical axis. A line is drawn through the points and an estimate is made for the total fixed costs at the point where the line intersects the vertical axis at zero units of activity.
ï‚· High-Low Method: The high-low method divides the change in the cost of highest and lowest level of activity by the change in the units for the highest and lowest level of the activity to estimate the variable cost.
ï‚· Least Squares regression analysis: The least square regression analysis is the statistical method of calculating the variable cost. It requires the computer spreadsheet program or calculator and uses all the points of data instead of just two points as in high-low method.
Variable costs can be classified in two types. They are true variable costs and step-variable cost.
True Variable Cost: True variable costs are those costs which are directly proportional to the inputs which are required. The amount which is used in the production directly increases as the production increase by the same percentage.
a. Step-Variable Cost: Step variable costs are those costs which can be obtained in the large segments. This costs increase or decrease in response to the fairly wide changes in the activity levels. These costs are constant for certain activity levels and may vary in a step like fashion as the volume increases.
Cost Function: Y= F+VX
This function states that the Total cost(Y) is equal to the sum Fixed Cost(F) and the Variable Cost(V) which is multiplied by the Volume(X) that is amount produced.
Here in the above function,
Y denotes Total Cost, F denotes Fixed Cost, V denotes Variable Cost and X denotes the Volume
Cost accounting also it covers the transaction relating to certain specific activities only e.g. production, sales, services etc. differentiates Cost Accounting from other branches of the accounting profession. If we take the example, financial accounting serves the public i.e. the shareholders by providing financial reporting through various financial statements, financial press releases and other mediums. The purpose of cost accounting is the internal reporting i.e. to the management of every business that governs the basic fundamental system of accounting procedure throughout the world.
On the other hand, Cost Accounting, these accounts are generally prepared to meet the requirement of the management. But now it has been made obligatory to keep cost records under the companies act. Cost Allocation refers to the process in which the costs related to the different levels of production are allocated to their respective work groups where they are classified into different activities required during the production process. It records the expenditure in an objective manner i.e. according to the purpose for which cost are incurred. Cost accounts records both historical and estimated costs. The major categories in which cost can be divided are as follows:-
ï‚· Prime Cost: Prime Cost is the cost which is occurs in the initial level of the production procedure. This cost includes direct material and direct labor cost. This cost also includes other direct expenses which have occurred during this procedure.
ï‚· Works Cost or Manufacturing Cost: Works Cost or the Manufacturing Cost is the cost which occurs after the initial level of production has begun. This cost includes the materials which are indirectly required during the production procedure, like heating and lighting expense, any expense relating to the machinery or the salary paid to the supervisors. Any indirect cost inside the factory premises can be attributed as the work cost.
ï‚· Production Cost: Production cost is also an indirect cost but this cost does not take place inside the factory premises but in the office. Naturally the cost occurred in the office in relation to this work is taken into consideration while calculating the total cost. The costs that are taken into account in this step are like salary paid to the staff related to this work, stationery used in the procedure, office rent paid if it is rented, electricity bill paid of the office, etc.
ï‚· Selling and Distribution Cost: As the name suggests this cost occurs during the selling and distribution of the work undertaken. This cost includes costs like selling expenses, advertising expenses, distribution expenses, etc.
Avoidable Cost: Avoidable Cost is that cost which will not be incurred if an activity is suspended, i.e., if the work undertaken is stopped. This cost also called escapable cost. If we take an example for this that in an organization a particular department is not required so the salary paid to the department can be avoided by scrapping that department. All costs are avoidable, except Sunk Cost and costs that will continue regardless of the decision.
Contribution Margin: contribution Margin is the amount which remains after the deduction of variable expenses from the total sales revenue generated. We can also say that the amount of contribution margin is at first used to cover the fixed costs and then whatever remains that is profit or loss. We can also say that it is the amount available to cover fixed expenses and then to provide profits for the period. The amount of contribution margin is at first used to cover the fixed costs and then whatever remains from it goes towards profits. If the contribution margin is not sufficient to cover the fixed expenses, then a loss occurs for the period. We also can say that contribution margin analysis is a measure of operating leverage. It measures how growth in sales translates to growth in profits.
Controllable Cost: A controllable cost is the cost which can be influenced by its budget holder. Responsibility accounting attempts to associate costs, revenues, assets and liabilities with the manager most capable of controlling it.
Controller: A controller is the person who is responsible to control the cost so that they do not get exaggerated and get inflated. He is responsible of controlling the cost in such a manner which is suitable to avoid cost wastages.
Cost Center: A cost center refers to a part of a business which is included in the overall cost of the organization but it generally does not directly generate any profit. There are many numbers of divisions within an organization that can act as cost centers, like research and development, customer service and marketing. They do not directly generate profit, so they often are some of the first divisions to suffer job cutbacks and layoffs i.e. they are the first one who are axed in the name of cost reduction. However, although they do not generate profit directly, most of the time it is seen that they are crucial to the long-term profitability of a company, so cutting them can be a long-term damage caused to the long-term health of the company.
Direct Center: Direct center refers to the place where the direct costs related to the production procedure are taken into account and it manages all the directly related cost occurring in the organization in relation to the work procedure.
Direct labor: Direct labor refers to the amount required by the labors that are directly related to the production procedure. This is a direct cost and it means the amount which we are spending on the laborers directly related to the production.
Direct Material: Direct Material refers to the raw materials which are directly required during the production procedure. This means that the materials which are required at the beginning of the production procedure which are included in the prime cost are called direct materials.
Expenses: Expenses as the name suggests are the costs which are incurred directly during the production procedure in its initial level. This is also included in the prime cost and is directly related to the production.
Fixed Cost: Fixed costs are those costs which remain fixed throughout the production procedure. This cost never changes for any level of production done or activity performed. So the per unit fixed cost changes with changes in number of units produced whether more or less but the overall fixed cost remains intact.
Opportunity Cost: Opportunity cost refers to the cost which is undertaken while forgoing the other cost advantage. For example if there is requirement of a machine to do the work but the work is performed by the laborers then we are forgoing the cost of the machine which means we are missing the opportunity. This is called the opportunity cost.
Price Elasticity: Price elasticity refers to the degree or responsiveness to the change in the price in relation to the demand of the inputs or the outputs produced. It shows how much the price can be elastic that is how much we can manage the price rise in terms of the demands of the inputs required.
Price inelasticity: this refers to the degree in which the price will not move in terms of the demand of the inputs and output. It does not measure any change in price but it measure how much inputs can be procured in the same price allotted.
Step Cost: Step Cost refers to the cost which is undertaken at various steps of production procedures. At every different step the costs may vary. So these costs also vary accordingly at different steps.
Sunk Cost: Sunk Cost refers to the cost which once used cannot be recovered. These costs are those costs which are generally unrecoverable even after the production procedure. Like when a project starts of building a bridge iron and steel is required when it is applied at the beginning it may not be used further because the rods may have once used for particular purpose may not be required any more. So this cost can be referred as sunk cost.
Total Cost: Total Cost refers to all the costs which occur during the production cycle of certain project. The major components of Total Cost are:
ï‚· Prime Cost
ï‚· Work Cost or Manufacturing Cost
ï‚· Production Cost
ï‚· Selling and Distribution Cost.
Unavoidable Cost: Unavoidable Costs are those cost which cannot be avoided in any circumstances. This cost will take place whatever may be the situation. For example, a sudden rise in the price of input cost, a government regulation which was unexpected to happen or occurring of any shortages of the inputs which can escalate the prices of the input cost. These types of costs are unavoidable in nature and are hence referred as Unavoidable Cost.
3.)The major uses of Activity Based Costing can be seen below as follows:
It helps in determining that which products, 3.) Activity Based Costing (ABC) is the part of Cost Accounting. In Activity Based Accounting system the accounting technique allows a firm to determine the actual cost associated with each output and the services produced by the firm without regard to the structure of the organization. Activity Based Costing (ABC) is the part of Cost Accounting. In Activity Based Accounting system the accounting technique allows a firm to determine the actual cost associated with each output and the services produced by the firm without regard to the structure of the organization. This is a major road block to the business organizations that remain loyal to their current system of accounting and don't want to switch over from it are in spot of bother as to use it or not.
Activity Based Systems first accumulate overhead costs for each of the activities of an organization, then assigning the costs of activities to the products, services, or other cost objects that caused that activity. To establish a cause-effect relationship between an activity and a cost object, cost drivers are identified for each activity. Activity Based Costing defines the kind of business done by the organization.
Abc System Generates Activities To Matched to The Driver Used To Given Cost of The Product .Execution Of The Abc System There Are Following Steps.
1. Identifying the activities such as engineering, machining, inspection…etc.
2. Determining the activity costs
3. Determining the cost drivers such as machining hours, number of setups, engineering hours…,etc.
4. Collecting the activity data
5. Computing the product cost
Advantages of Activity Based Costing System: As we know everything in the world has some advantages and disadvantages associated with it. Activity Based Costing System has also some advantages as well some disadvantages attached to it. Let's first discuss some of its advantages as follows:
a. The first and most important advantage of the ABC System is that it provides accuracy in regards to the end consumers, product to be manufactured and the stock used by the management in order to maintain the flow of the products so as to reach as quickly as possible to its end users.
b. This system helps in better understanding of the overhead costs. If a person has a good understanding of this system he can easily derive its work procedure which is complicated in other ways. It also helps in understanding the common business resources and their relation to the cost.
c. It is very easy to understand and interpret because it is very easily accessible and usable and can be implemented with practicality so that it meets all the legal norms of the businesses.
d. This system of accounting uses the per unit cost or the marginal cost as the computation of its base rather than using the total cost which are being used by the traditional cost accounting method.
e. This system also works very well with the human resource department as they perform the performance management system.
f. This process allows the companies to chalk put its strategies in relation to the business process to the other end of the line. In this process the firm optimally analyses the supply chain and the channels of value additions.
g. This ABC system helps in processing the benchmark which is a very important part of the quality control system.
When there are advantages to a certain thing it also has some disadvantages. The disadvantages of the ABC System are:
Disadvantages of Activity Based Costing System
The following are the disadvantages of the ABC System:
a. In ABC system we know that a lot of data is required. Sometimes it becomes difficult to collect and gather all the data at a time.
b. In this system of accounting the capital expenditure is high as compared to other methods and the subsequent rise in the cost create an obstruction in the path of the firm's growth.
c. This system provides transparency which is not acceptable by some of the managers of some firms who like to keep some information secret from their owners and shareholders.
Technical Limitations: Activity Based Costing system has some technical limitation also. How good it may sound theoretically but in the real world it is very difficult to implement it. This is a major road block to the business organizations that remain loyal to their current system of accounting and don't want to switch over from it are in spot of bother as to use it or not. They think it to be suitable for their organizations but as it is very lengthy and time consuming that there is always a fear of escalating the cost.
Methodology of ABC System
In this system it is very easy to identify the direct labor and direct material cost but becomes very difficult allocate the indirect costs to the related products. When all the products utilize the same resources in a different manner then it becomes prudent to think about the cost allocation process. The cost driver is the factor which helps in increasing the cost of the work done. For an example if we take a shop we see that how long the shopkeeper takes in finishing one transaction, which can be referred as the cost driver. If he takes long time in handling the customers which means he is driving the cost driver high.
Uses of Activity Based Costing System
ïƒ˜ activities, departments and the people associated are no longer required in the production procedure
ïƒ˜ It helps in providing inputs of great importance in the sectors which are highly profitable.
ïƒ˜ It monitors and controls the cost at each and every level of production as well as on the departmental level
ïƒ˜ It provides a great help in tracking down the unnecessary costs.
In above we can see the cost accounting highly paid and the organization of costing system involves expenditure. Cost accounting system involves number of steps in ascertaining cost such as collection and classification of expenses, allocation and apportionment of expenses etc. All business enterprises cannot make use of single method and technique of costing. A cost accounting system is applicable only to a large sized business and not suitable for small sized business because it is more expensive. Process costing it helps in computation of cost of the process as well as of the end product at short intervals. Total cost of the finished product in the last process is cumulative i.e.it comprises of costs of all processes. Production accumulated and reported by process. The unit of cost is the process under this method of costing. The production is continuous and on large scale basis in anticipation of demand.abc provide accuracy in regards to the end of consumer .it is very easy to understand and usable this also works very well with the human resource.abs system helps in processing and benchmark which is very important part of the quality of control system.