Cost Accounting for Decision Making

Cost Accounting for Decision Making

• is a course to use ‘cost information’ for decision making…
• Objective …make ourselves to sensitive to COST!

We have to study Cost Accounting for Decision Making for achieving the ultimate objective of a firm: MAXIMIZE VALUE

Value Model of a firm

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Drivers of Value

• Risk
• Benefit
• Cost

Information related to cost makes a manager CONSCIOUS about COST and s/he started managing cost!

Cost should be reduced in a fair and ethical framework to create value for shareholders

Difference between Cost cutting and Cost reduction

Cost Accounting is used to provide management with information about the cost of products or services being produced or sold, with the estimated cost of goods or services to be produced and sold in future, with the cost of goods or services produced and consumed within the company, and with the cost of operations, processes or activities.

Cost Accounting is that part of the accounting system that measures costs for the purposes of managerial decision making and financial reporting.

Who needs cost accounting?

All kinds of organizations --

manufacturing firms, service companies, and non-profit organizations --

need some form of cost accounting.

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Management Accounting is the design and the use of accounting information system inside a company to help the management in making managerial decisions so as to achieve the company’s objectives.

Management Accounting has the following four broad purposes:

• Purpose 1: Formulating overall strategies and long-range plans
• Purpose 2: Resource Allocation and pricing
• Purpose 3: Cost planning and cost control of operations and activities
• Purpose 4: Performance Evaluation and rewards

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Who are cost managers?

• They serve as communicators of company values to employees.
• They have diverse educational backgrounds.
• They need broad knowledge of the organization.

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What is a Cost?

It’s consumption of resources that cost a cost!

“ is money worth/value sacrificed or to be sacrificed for goods and services that are expected to bring a current or future benefit/value to the firm.”

Cost is incurred to create value! No Value without Cost!

• It may be cash or non-cash cost
• No sacrifice, no cost
• Objective is - to get benefit
• Ultimately measurable
• It may be explicit or implicit
• Different cost for different purposes

Why do we calculate cost?

For pricing, determining Profit, Managing Cost

Therefore,  any system in an organization to capture the flows of costs taking place in the process of adding value to the product, i.e. in the value chain.

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Cost is always determined with respect to a cost object.

A cost object is any object/ item/ product/ service/ department etc. for which costs are measured and assigned

A cost object is defined as anything for which a separate measurement of costs is desired.

• Cost object may be –

• Product
• Customer
• Department
• Activity
• Job
• Contract
• Process
• Item

Product Cost VS Service Cost

• Tangible products and intangible services
• Products can be stored but services cannot be
• Products can be separated from the producers while services cannot be separated
• Products are having a very high degree of homogeneity, services have greater chances of variation.
• Centralized mass production of products is possible but that of services is not possible
• Products are comparatively easy to be priced while services are difficult to be priced.

Accuracy in Costing

• NONE KNOWS THE ‘TRUE COST’
• NONE CAN EVER DETERMINE THE ‘TRUE COST’
• THE ‘ACCURATE COST’ IS OF IMMENSE AND CRUCIAL IMPORTANCE
• THE ‘ACCURATE COST’ IS

• A RELATIVE CONCEPT
• BASED ON REASONABLENESS OF UNDERLYING ASSUMPTIONS, LOGIC, OBJECTIVITY AND ERROR OF ESTIMATE

• THE ESTIMATION OF ACCURATE COST HAS ITS OWN ECONOMICS OF INFORMATION

Different Costs

Different purposes and different cost objects:                  

• Natural Classification - Material, Labour, Expenses
• Changes in Activity/Volume - Variable, Fixed, Semi-variable, Semi-fixed
• Degree of traceability - Direct and Indirect
• Association with Product - Product and Period
• Function - Manufacturing, Marketing, Administrative
• Relationship with Accounting Period - Revenue and Capital
• Planning, Decision-Making and Control Purposes - Opportunity Cost, Marginal/Differential/ Incremental Costs, Controllable and Uncontrollable, Avoidable and Unavoidable, Sunk Cost, Out-of-Pocket and Imputed Costs, Joint and Separable Cost, Actual and Standard

Basic elements of Cost

• Material, Labour, Expenses

A relevant cost is a cost that differs between alternatives.

An avoidable cost can be eliminated (in whole or in part) by choosing one alternative over another. Avoidable costs are relevant costs. Unavoidable costs are irrelevant costs.