Cost Accounting - Direct cost and Indirect cost

COST ACCOUNTING
Chapter 2 (Garrison)
A cost object is anything for which cost data are desired- including products,
customers, jobs and organizational subunits. A cost object is an item that a
company wants to measure separately. For purposes of assigning costs to
costs objects, costs are classified as either direct cost or indirect cost.
Classifications of cost
Cost
classification Assigning costs to
cost objects
Direct (Easily traceable)
Indirect (Cannot be traced easily)
For
manufacturing
companies
Manufacturing Direct materials
Direct labour
Manufacturinf overhead
Non-manufacturing Selling
Administrative
Preparing
financial
statements
product costs (inventoriable)
Period costs (expensed)
Cost behavior in
response to
change in activity
Variable cost
Fixed cost
Mixed cost
making decisions Differential costs (differs between
alternatives
Sunk cost (should be ignored)
Opportunity cost (Foregone
benefit)

Assigning costs to cost objects
Direct cost: A direct cost is a cost that can be easily and conveniently
traced to a specified cost object. A direct cost is a price that is directly
related to the production of a certain good or service. A direct cost can be
linked to a cost object such as a service, product, or department. The two
basic categories of expenses or prices that businesses might incur are direct
and indirect charges. Direct expenses are frequently variable costs, which
means they change with production levels like inventory.
Direct costs are expenses that your business can completely
attribute to the production of a product. The costs are easily
connected to only one project. Direct costs are not allocated, which
means they are not divided among many departments or projects.
A direct cost can be a fixed cost or variable cost.
An example of a direct cost are the supplies used to make the product. For
example, if you own a printing company, the paper for each project is a
direct cost. The employees who work on the production line are considered
direct labor. Their wages can also be attributed as a direct cost of the
projects.
Indirect cost: Indirect costs are expenses that cannot be traced back to a
single cost object or cost source. During the manufacturing process, items
like products, departments, and customers create costs. These are
considered cost objects because the original manufacturing costs stem from
them. The factory manager’s salary is called a common cost.
Now, consider the sales staff at the company. The sales staff is not
connected to one project. Therefore, their wages are not direct
costs because they cannot be attributed to any one project. Their
wages must be allocated to multiple projects.

Cost classification for manufacturing companies
Costs may be classified as manufacturing costs and non-manufacturing
costs. This classification is usually used by manufacturing companies.
Manufacturing costs
Most manufacturing companies separate their manufacturing costs into two
direct cost categories, direct-materials and direct labor and in one indirect
cost categories, manufacturing overhead.
 Direct materials
 Direct labor
 Manufacturing overhead
Direct materials: Direct material is the physical items built into a product.
For example, the direct materials for a baker include flour, eggs,
yeast, sugar, oil, and water. The direct materials concept is used in cost
accounting, where this cost is separately classified in several types of
financial analysis. Direct materials are rolled into the total cost of goods
produced, which is then subdivided into the cost of goods sold (which
appears in the income statement) and ending inventory (which appears in
the balance sheet). The finished product of a company may become raw
material of another company. For example, cement is a finished product for
manufacturers of cement and raw materials for companies involved in
construction business.
Direct labor: Direct labor refers to the salaries and wages paid to workers
directly involved in the manufacture of a specific product or in performing a
service. The work performed must be related to the specific task. For a
business that provides services to its customers, direct labor is the work
performed by the workers who provide the service directly to the
customers, such as auditors, lawyers, and consultants. Examples of direct
labor cost include labor cost of machine operators and painters in a
manufacturing company. Like direct materials, it comprises of a
significant portion of total manufacturing cost.
The sum of direct materials cost and direct labor cost is known as
prime cost. Prime cost = Direct materials cost + Direct labor cost
Manufacturing overhead: Manufacturing costs other than direct materials
and direct labor are categorized as manufacturing overhead cost (also
known as factory overhead costs). They usually include indirect materials,

indirect labor, salary of supervisor, lighting, heat and insurance cost of
factory etc. Mostly, manufacturing overhead costs cannot be easily traced
to individual units of finished products. The three types of overhead costs
are:
 Fixed: These costs do not change each month. Also, business activity
does not cause these costs to change. Fixed overhead costs include
rent, mortgage, government fees and property taxes.
 Variable: These are costs that can change with production output.
These items include some operational utilities such as electric, gas and
trash service. Output can also impact shipping costs, maintenance
situations, legal fees and advertising.
 Semi-variable: These items might change over time with increased or
decreased business activity. Business activities may determine the
initial costs but over time, as activity changes, these costs may
increase or decrease. Some examples of semi-variable costs may
include operational utilities, rent or leasing and insurance.
The sum of direct labor cost and manufacturing overhead cost is
known as conversion cost. Conversion cost = Direct labor cost +
Manufacturing overhead cost.
Non-manufacturing costs
Non-manufacturing costs are further divided into the following categories:
 Marketing and selling costs
 Administrative costs
Examples of marketing and selling costs include advertising costs, order
taking costs and salaries of sales persons etc. Examples of administrative
costs include salaries of executives, accounting costs, and general
administration costs etc.
Selling costs include all costs that are incurred to secure customer orders
and get the finished product to the customer. These costs are sometimes
called as order-getting and order-filling costs.
Administrative costs include all costs associated with the general
management of an organization rather than with manufacturing or selling.
Examples of administrative costs include executive compensation, general
accounting, pubic relations and similar costs.

Cost classifications for preparing financial statements
When preparing a balance sheet and an income statement, companies need
to classify their costs as product cost and period cost. To understand the
differences between product cost and period costs, we must first discuss the
matching principle from financial accounting. The matching principle is
based on the accrual concept the costs incurred to generate a particular
revenue should be recognized as expenses in the same period that the
revenue is recognized. Matching Principle is a common accounting concept.
Under this, a company should report an expense in the income statement in
the same period when it earns the revenue.
Product costs
Product cost refers to the costs incurred to create a product. These costs
include direct labor, direct materials, consumable production supplies, and
factory overhead. Product cost can also be considered the cost of the labor
required to deliver a service to a customer. The cost of a product on a unit
basis is typically derived by compiling the costs associated with a batch of
units that were produced as a group, and dividing by the number of units
manufactured. The calculation is:
(Total direct labor + Total direct materials + Consumable supplies
+ Total allocated overhead) ÷ Total number of units = Product unit
cost
These costs are also known as inventoriable costs.
Period costs
Period costs are costs that cannot be capitalized on a company’s balance
sheet. In other words, they are expensed in the period incurred and appear
on the income statement. Period costs are also called period expenses. In
managerial and cost accounting, period costs refer to costs that are not tied
to or related to the production of inventory. Examples include selling,
general and administrative (SG&A) expenses, marketing expenses, CEO
salary, and rent expense relating to a corporate office. The costs are not
related to the production of inventory and are therefore expensed in the
period incurred. In short, all costs that are not involved in the production of
a product (product costs) are period costs.
Prime cost and conversion cost

Prime costs are the sum of direct material costs and
direct labor costs. Conversion cost is the sum of direct
labor costs and manufacturing overhead.
Cost classifications for predicting cost behavior
Variable cost
Variable costs are expenses that vary in proportion to the volume of goods
or services that a business produces. In other words, they are costs that
vary depending on the volume of activity. The costs increase as the volume
of activities increases and decrease as the volume of activities decreases.
For a cost to be variable, it must be variable with respect to something. That
something is its activity based. An activity base is a measure of whatever
causes the incurrence of a variable cost. A activity base is sometimes
referred to as a cost driver.
Fixed cost
The term fixed cost refers to a cost that does not change with an increase or
decrease in the number of goods or services produced or sold. Fixed costs
are expenses that have to be paid by a company, independent of any
specific business activities. This means fixed costs are generally indirect, in
that they don't apply to a company's production of any goods or services.
Let us say, in a milk factory, the monthly payments for the
phone lines and security system and the monthly rent for the
facilities are fixed costs as they do not change according to
how much milk the factory produces. On the other hand, the
factory’s wage costs are variable as it will need to hire more
workers if the production increases. An analytical formula can
track the relationship between fixed cost and variable cost in
management accounting. It is important to know how total
costs are divided between the two types of costs. The division
of the costs is critical, and forecasting the earnings generated
by various changes in unit sales affects future planned
marketing campaigns. Discretionary fixed costs usually come
about from decisions made by management to spend on
certain fixed cost items. Examples of discretionary costs
include advertising, machinery maintenance, and research and
development (R&D) expenditures.
Committed fixed costs represent organizational investments with a
multiyear planning horizon that cannot be significantly reduced

ever for short period of time without making fundamental changes.
Discretionary fixed costs usually arise from annual decisions by
management to spend on certain fixed cost items.
Mixed costs
A mixed cost is an expense that has attributes of both fixed and variable
costs. In other words, it’s a cost that changes with the volume of production
like a variable cost and can’t be completely eliminated like a fixed cost.
Wage costs for employees who are paid a monthly salary plus commissions
are a good example of mixed costs. This is a common compensation
package for salesmen and sales reps. They usually receive a small base
salary and commissions based on how many sales they make during the
period.
The monthly salary is a fixed cost because it can’t be eliminated. Even if the
salesperson doesn’t sell anything during the month, the company still has to
pay the base salary.
The commission, on the other hand, acts more like a variable cost because
it’s based on the productivity of the employee. The more the employee sells
the greater the sales commission expense becomes. The company can
eliminate this expense altogether if it doesn’t sell anything for the month.
Cost classifications for decision making
Differential cost and revenue
A difference in costs between two alternatives is known as a differential
cost. A difference in revenues between two alternatives is known as
differential revenue.
A differential cost is also known as an incremental cost, although technically
an incremental cost should refer only to an increase in cost from one
alternative to another; decreases in costs should be referred to as
decremental cost. Differential cost is a broader term, encompassing both
cost increases and cost decreases between alternatives.
Opportunity cost and sunk cost
Opportunity cost is the potential benefit that is given up when one
alternative is selected over another. A sunk cost is a cost that has already
been incurred and that cannot be changed by any decision made now or in
the future. Because sunk costs cannot be changed by any decision made

now or in the future. And because only differential costs are relevant in a
decision, sunk costs always be ignored.
The analysis of mixed cost
Mixed costs contain elements of both fixed and variable cost behavior. As
with step costs, the fixed elements are determined by the planned range of
activity level. We know of three methods for separating mixed costs into
their fixed and variable cost components:
Scatter graph Plot
The first step in applying high-low method or the least-squares regression
method is to diagnose cost behavior with a scatter graph plot. Two things
should be noted about the scatter graph:
The total maintenance cost, Y is plotted on the vertical axis. Cost is
known as the dependent variable because the amount of cost incurred
during a period depends on the level of activity for the period. (That is,
as the level of activity increases, total cost will also ordinarily increase)
The activity, X (patient days in this case), is plotted on the horizontal
axis. Activity is known as the independent variable because it causes
variations in the cost.
The high-low method
The high low method is based on the rise-over-run formula.

Variable cost = Rise / Run = (Y2-Y1) / (X2 - X1)
Or, Variable cost= (Cost at high activity level- Cost in low activity level) /
(High Activity level-Low activity level)
Or, Variable cost = Change in cost / Change in Activity
For example,
Patient days Maintenance cost
incurred
High activity level 8000 9800
Low activity level 5000 7400
Change 3000 2400
So, Variable cost = Chane in cost / Change in Activity = 2400/3000 = 0.80
Per day (Units)
And Fixed cost element = Total cost – Variable cost element
= 9800 – (0.80*8000)
= 3400
So, total maintenance cost Y = 3400 + 0.80X [Formula ]
The Least-Squares Regression method
Hmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmmm
mmmmmmmmmmmmmmmm
Traditional and contribution format income
statements
The traditional format income statement
Sales
Cost of goods sold
Gross margin
Selling and administrative expenses
Selling
3100
Administrative
1900
Net operating income
12000
6000
6000
5000
1000
The cost of goods sold for a merchandising company can be computed
directly by multiplying the number of units sold by their unit cost or
indirectly using the equation:

Cost of Goods sold = Beginning merchandise inventory + Purchase – Ending
merchandise inventory
The contribution format income statement
Sales
Variable expenses
Cost of goods sold
6000
Variable selling expenses
600
Variable administrative expenses
400
Contribution margin
Fixed expenses
Fixed selling expenses
2500
Fixed administrative expenses
1500
Net operating expenses
12000
7000
5000
4000
1000
Chapter 6 (Garrison)
A segment is a part or activity of an organization about which managers
would like cost, revenue or profit data.
Overview of variable and Absorption costing
As you begin to read about variable and absorption costing income
statements , focus on three key components.

First, both income statements include product costs and period costs,
although they define these costs classifications differently.
Second, variable costing income statements are grounded on the
contribution format. They categorize expenses based on cost behavior-
variable costs are reported separately from fixed expenses. Absorption
costing income statements ignore variable and fixed cost distinctions.
Third, variable and absorption costing net operating income figures
often differ from one another. The reason for these differences always
relates to the fact the variable costing and absorption costing income
statements account for fixed manufacturing overhead differently.
Variable costing
Under variable costing, only those manufacturing costs that vary with
output are treated as product costs. This would usually include direct
materials, direct labor and the variable portion of manufacturing overhead.
Fixed manufacturing overhead is not treated as a product cost under this
method. Rather, fixed manufacturing overhead treated as a period cost and
like selling administrative expenses, it is expensed in its entirely each
period.
Variable costing Unit product Cost
Direct Materials
Direct labor
Variable manufacturing overhead
Variable costing Unit product cost
19
11
10
30
Variable costing Income statement
Sales
Variable Expenses
Variable cost of goods sold
Variable selling and administrative
expenses
Total variable expenses
Contribution margin
Fixed expenses
Fixed manufacturing overhead
Fixed selling and administrative expenses
Total fixed expenses
Net operating income (Loss)
February
100,000
25,000
10,000
35,000
65,000
70,000
20,000
90,000
(25000)
march
500,000
125,000
50,000
175,000
325,000
70,000
20,000
90,000
235,000

Absorption costing
Absorption costing treats all manufacturing costs as product costs,
regardless of whether they are variable or fixed. The cost of a unit of
product under the absorption costing method consist of direct materials,
direct labor and both variable and fixed manufacturing overhead. Thus,
absorption costing allocates a portion of fixed manufacturing overhead cost
to each unit of product, along with the variable manufacturing costs.
Because absorption costing includes all manufacturing costs in product
costs, it is frequently referred as the full cost method.
Absorption costing Unit product Cost
Direct Materials
Direct labor
Variable manufacturing overhead
Fixed manufacturing overhead
Variable costing Unit product cost
19
11
10
30
60
Absorption costing Income statement
Sales
Cost of goods sold (Unit product cost * total units)
Gross margin
Selling and administrative expenses
Net operating margin
Reconciliation of Variable costing with
absorption costing income
Step 1: The net operating incomes are reconciled as follows:
Year 1 Year 2
Units in beginning inventory
+ Units produced
- Units sold
= Units in ending inventory
0
50,000
40,000
10,000
10,000
40,000
50,000
0
Step 2:
Year 1 Year 2
Fixed manufacturing overhead in ending inventory
- fixed manufacturing overhead in beginning
inventory
= Manufacturing overhead differed in (released from)
inventory
50000
0
50000
0
50000
(50000)

Step 3:
Year 1 Year 2
Variable costing net operating income
Add: fixed manufacturing overhead cost deferred
in inventory under absorption costing
Deduct: Fixed manufacturing overhead cost
released from inventory under absorption costing
Absorption costing net operating income
190,000
50,000
__________
240,000
320,000
(50,000)
270,000
Advantages of variable costing and contribution
Approach
Variable costing, together with contribution approach, offers appealing
advantages for internal reports. This section will discuss those advantages:
Advantages of Variable Costing
 The data that are required for cost volume profit (CVP) analysis can be
taken directly from a variable costing format income statement. These
data are not available on a conventional income statement based on
absorption costing.
 Under variable costing, the profit for a period is not affected by
changes in inventories. Other things remaining the same (i.e. selling
prices, costs, sales mix, etc.), profits move in the same direction as
sales when variable costing is in use.
 Managers often assume that unit product costs are variable costs. This
is a problem under absorption costing, since unit product costs are a
combination of both fixed and variable costs. Under variable costing,
unit product costs do not contain fixed costs.
 The impact of fixed costs on profits is emphasized under the variable
costing and contribution approach. The total amount of fixed costs
appears explicitly on the income statement. Under absorption, the
fixed costs are mingled together with the variable costs and are buried
in cost of goods sold and in ending inventories.
 Variable costing data make it easier to estimate the profitability of
products, customers, and other segments of the business. With
absorption costing, profitability is obscured by arbitrary allocations of
fixed costs.
 Variable costing ties in with cost control methods such as standard
costs and flexible budgets.

 Variable costing net operating income is closer to net cash flow than
absorption costing net operating income. This is particularly important
for companies having cash flow problems.
Advantages of contribution approach
 More useful for CVP analysis. Variable costing statements provide data
that are immediately useful for CVP analysis since they categorize
costs on the basis of their behavior. In contrast, itis often difficult to
rework absorption costing data so that they can be used in CVP
analysis and in decisions.
 Income is not affected by changes in production volume. Under
absorption costing, reported net operating income is affected by
changes in production since fixed costs are spread across more or
fewer units. This can distort income and may even result in income
moving in an opposite direction from sales. This does not occur under
variable costing.
 Avoids misunderstandings concerning unit product costs. Absorption
costing unit product costs can be easily misinterpreted as variable
costs since they are stated on a per unit basis. Such a misperception
can lead to serious errors in making decisions. Variable costing avoids
this problem since unit costs include only variable costs.
 Fixed costs are more visible. The impact of fixed costs on profits is
emphasized because the total amount of such costs for the period
appears separately and is highlighted in the income statement rather
than being buried in cost of goods sold and ending inventory.
 Understandability. Managers should find it easier to understand
variable costing reports because data are organized by behavior and
because variable costing is much closer to cash flow.
 Control is facilitated. Variable costing ties in with cost control methods
such as flexible budgets.
 Incremental analysis is more straight-forward. Variable cost
corresponds closely with the current out-of-pocket expenditure
necessary to produce and sell products and services and can therefore
be used more readily in incremental analysis than absorption costing
data. And since variable costing net operating income is closer to net
cash flow than absorption costing net operating income, it is likely to
be more useful to companies that have cash flow problems.

Traceable and common fixed costs and segment
margin
A traceable fixed cost of a segment is a fixed cost that is incurred because
of the existence of the segment- if the segment had never existed, the fixed
cost would not have been incurred; and if the segment were eliminated, the
fixed cost would disappear. For example, salary of the manager of a
segment.
A common fixed cost is a fixed cost that supports the operation of more
than one segment, but not traceable in whole or in part to any segment.
Even if a segment were entirely eliminated, there would be no change in a
true common fixed cost. For example, salary of the CEO.
A segment margin is obtained by deducting the traceable fixed costs of a
segment from the segment’s contribution margin. It represents the margin
available after a segment has covered all of its own costs.
Segment income statements-Decision making
and break-even analysis
Break-even analysis
Dollar sales for company to break even= (Traceable fixed expenses +
Common fixed expenses)/ overall CM ratio
Dollar sales for a segment to break-even= segment traceable fixed
expenses / Segment CM ratio
Chapter 8 (Garrison)
This chapter describes the details about preparing a master budget. The
master budget is an essential management tool that communicates
management’s plans throughout the organization, allocates resources, and
coordinates activities. A budget is a detailed plan for the future that is
usually expressed in formal quantitative terms. Once a budget is prepared,
actual spending is compared to the budget to make sure the plan is being
followed.
Budget is prepared for two distinct purposes- planning and controlling.
Planning involves developing goals and preparing various budgets to

achieve the goals. Control involves gathering feedback to ensure that plan
is being properly executed or modified as circumstances changed.
The basic idea underlying responsibility accounting is that a manager
should be held responsible for those items- and only those items- that the
manager can actually control to a significant extent.
The self-imposed budget
A self-imposed budget or participative budget is a budget that is prepared
with the full cooperation and participation of managers at all levels.
Imposed budgeting, also known as top-down budgeting, is the process
wherein the top management of a company prepares a budget and then
imposes it on lower-level managers for implementation. It starts at the top,
where the budget is prepared by senior management according to the goals
that the company wants to achieve in the next financial period.
Advantages: Below are some of the benefits of using the imposed
budgeting process over other forms of budgeting:
1. Greater efficiency
One of the benefits of using imposed budgeting is the efficiency that an
organization achieves. When a department is given an allocation by the
finance department, it must figure out how it will use that budget to achieve
the set targets and objectives of that department. The departmental heads
will be prudent in how they use the money. The prudent approach will help
reduce wastages and allocations to unnecessary expenditures.
2. Faster and less costly process
Imposed budgeting takes less time than bottom-up budgeting because it
only allows the input of key decision-makers. In the case of bottom-up
budgeting, the lower-level staff is required to contribute towards the budget
preparation at the department level. It will take a lot of time and effort
before the final budget is ready.
Imposed budgeting only allows input from a few people who have access to
key information on the company’s performance and, therefore, are better
placed to make suggestions.
3. Better financial control

Imposed budgeting gives management better control over the company’s
financials. Management starts by evaluating the company’s financial needs
and the expense budget required to meet its needs and generate revenues.
It gives them better control in determining how much of the total budget
goes to specific departments, depending on past performance and revenue
projections.
Limitations: The following are some of the limitations of using imposed
budgeting:
1. Lack of motivation
When lower-level staff is not involved in the budget preparation process,
they will feel demotivated because their input is not required. This may
result in tension and loss of productivity.
2. Decline in performance
Imposed budgeting requires departments to prepare their budgets within
the limits of the amounts allocated to them. This means that a department
that requires additional funding to finance its activities will need to work
with the funds allocated from the top management. Lower-level managers
may even use it as an excuse for failing to meet the revenue targets
imposed by the management.
The Master Budgeting
A master budget can be defined as the aggregation of all the lower level
budgets, which are calculated by various functional areas of the business
and is a strategy that documents the financial statements, cash flow
forecast, financial plans, and capital investments.
The beginning balance sheet
An opening balance sheet contains the beginning balances at the start of a
reporting period. These balances are usually carried forward from the
ending balance sheet for the immediately preceding reporting period. If a
business has just begun, then the opening balance sheet will contain no
account balances at all, or perhaps the equity contributions (and offsetting
cash balances) of investors.
Opening balance sheet information is also needed for a budget that
formulates balance sheets for future periods, so that ending balances from

the last actual period are incorporated into the ongoing balance sheet
calculations.
The budgeting Assumption
For both business and personal budgeting purposes, budget assumptions
are expectations -- usually expected or presumed income and expenses.
Making reasonable assumptions when creating a budget for the first time
gives you starting numbers to work with for planning purposes.
The sales budget
A sales budget estimates the sales in units as well as the estimated
earnings from these sales. Budgeting is important for any business. Without
a budget companies can’t track process or improve performance. The first
step in creating a master company while budget is to create a sales budget.
Management carefully analyzes economic conditions, market competition,
production capacity, and selling expenses when developing the sales
budget. All of these factors play an important role in the company’s future
performance. Basically, the sales budget is what management expects to
sell and the revenues collected from these sales.

The Production Budget
Production = Beginning + Sales – ending
Manufacturing companies use production budgets to specify the number of
product units to be manufactured. The production budget is determined
based on sales forecasts. It is adjusted based on the company’s inventory
policy in terms of planned inventory levels. Based on the production budget,
a manufacturer develops cost budgets for direct materials, direct labor, and
overhead costs required for production.

Inventory Purchases-Merchandising Company
Budgeted cost of goods sold
Add desired ending merchandise inventory
Total needs
Less beginning merchandise inventory
Required purchases
The direct materials budget
A budget that shows how much quantity of direct raw material is required
according to the production target level for a particular time period is known
as Direct Materials Budget. The preparation of this Budget can be monthly,
quarterly, or yearly. The management determines the time period. Direct
Materials Budget calculates the units of raw material according to the
closing inventory and production targets for that respective year.
Production
X 1 unit e koto raw material lage
+ ending raw materials
- Beginning raw materials
X per unit e koto cost

Direct labor budget
As the word suggests, the Direct Labor Budget relates to the cost of direct
labor involved in production/assembly or service. Specifically, this budget
shows the cost and hours of direct labor that a company requires for
production/extending service. We can say that such a budget allows a
company to manage the labor force it needs. Direct laborers are the
employees that work on the factory floor to produce a product.
A direct labor budget is not entirely a separate budget but rather a part of
the master cost or finance budget. A company prepares this budget after
finalizing the production budget. This is because the production estimate
serves as an input in estimating the direct labor a company needs.
Generally, we prepare the labor budget on a monthly or quarterly basis.

The manufacturing overhead budget
The manufacturing overhead budget lists all costs of production other than
direct materials and direct labor. Direct labor hour * rate + fixed
manufacturing overhead – depreciation
The ending finished goods inventory budget
The ending finished goods inventory budget calculates the cost of the
finished goods inventory at the end of each budget period. It also includes
the unit quantity of finished goods at the end of each budget period, but the
real source of that information is the production budget. The primary

purpose of this budget is to provide the amount of the inventory asset that
appears in the budgeted balance sheet, which is then used to determine the
amount of cash needed to invest in assets.
The selling and administrative expense budget
The selling and administrative expense budget lists the operating expenses
involved in selling the products and in managing the business. Just as in the
case of the factory overhead budget, this budget can be developed using
the cost-volume (flexible budget) formula in the form of y = a + bx.

The cash budget
A cash budget is an estimation of the cash flows of a business over a
specific period of time. This could be for a weekly, monthly, quarterly, or
annual budget. This budget is used to assess whether the entity has
sufficient cash to continue operating over the given time frame. The cash
budget provides a company insight into its cash needs (and any surplus)
and helps to determine an efficient allocation of cash.
Beginning cash balance
Add cash receipts
Total cash available
Less cash disbursement
Excess (deficiency) of cash available over disbursement
Budgeted Income Statement
A budgeted income statement is a financial report that compares the
budgeted revenue and expense figures with the actual performance
numbers achieved during the period. In other words, it’s a report that lists
the predicted numbers side-by-side with the actual numbers to show the
company performance compared with the expected performance.

The budgeted balance sheets
A budgeted balance sheet is a report that management uses to predict the
levels of assets, liabilities, and equity based on the budget for the current
accounting period. In other words, the budgeted balance sheet shows where
all of the accounts would be at the end of a period if the actual company
performance matched the budgeted estimates. Preparing this report is
usually the last step in finalizing a master budget plan.

Chapter 1 (Basu &
Das)
The belief that cost accounting developed after the rise of factory system as
an industrial revolution in England in the 18th century is not true. Some cost
accounting principles were found in application as early as the 14th century.
Some authorities suggests that, the present-day cost accounting procedure
was established before the end of 19th century. However, major
development in this subject were noticed during a quarter century before
the end of the second world war.
The main causes behind the development of cost accounting system may
be enumerated as below:
1. Financial accounting can give the net result of trading during a
particular period. It cannot give the product-wise picture nor it can say
that the result obtained is, what it should be.

2. Financial accounting does not find out the cost of the goods
manufactured and hence it fails to help the most important business
activities like price-fixing, price-cutting during depression, formulating
market policies etc.
3. Financial accounting never aims at making an effort for converting a
losing unit into a profitable one through cost control.
4. Financial accounting does not provide means for controlling different
elements of costs, reduction of expenses, elimination of wastage,
measurement of levels of efficiency etc.
5. Financial accounting presents the total cost as incurred during a
period, and that also, at the end of the period. It cannot present the
cost incurred daily and in the absence of this day-to-day information,
cannot becomes impossible.
6. Financial accounting cannot properly guide the management in respect
of making decision on various matters, such as, closing down a unit
apparently making loss, introducing a new product or product-mix,
going for dumping in foreign markets etc.
7. Financial accounting fails to locate the diseases in an organization due
to which it runs at loss, that is, it fails to point out the excel spot of
inefficiency which may remain in any of the factors-material, labor,
plant and equipment or management.
8. Financial accounting also fails to explain properly the results with
appropriate break-up.
Cost accountancy
Cost accountancy can be defined as the application of costing and cost
accounting principles, methods and techniques to the science, art and
practice of cost control and the ascertainment of profitability. It includes the
presentation of information derived there for the purpose of managerial
decision making.
Costing
Costing refers to the technique and process of ascertaining cost. Again, cost
is defined as the actual or national expenditure incurred on, or attributable
to, a given process, product or service. The technique of costing involves
mainly-
i. Collecting expenditure
ii. Recording and classifying the expenditure according to elements of
cost.

iii. Allocation and apportionment of the expenditure to the process,
operation, product or service
Cost center
A cost center is a location, person or item of equipment (or group of persons
or equipment) for which cost may be ascertained and used for the purpose
of cost control. Thus, when a cost center refers to a location( or group
thereof) it is an impersonal cost center and when it refers to a person (or
group of persons) it is a personal cost center.
The purpose of cost center are as follows:
Firstly, cost centers locate the responsibility. The manager of a cost center
is responsible for the contro of costs of that center. Costs are controlled with
relation to cost centers and hence, are often called, ‘responsibility centers’.
Secondly, cost centers facilitate recovery of overhead expenses.
Cost Unit
A cost unit refers to the unit of quantity of product, service or time ( or
combination of these) in relation to which costs may be ascertained or
expressed. Cost centers helps ascertaining the costs by location, person,
equipment, operation or process; but cost units help the subdivision of such
costs as attribute to products or service.
Benefits of cost accounting
Measuring and Improving Efficiency
Cost accounting allows for data that enables the firm to measure efficiency.
This could be efficiencies with respect to cost, time, expenses etc. Standard
costing is then used to compare actual numbers with the industry or
economy standards to indicate changes in efficiency.
Say for example the cost of producing one unit increased from Rs.100/- to
Rs. 110/-. Now was this due to an increase in prices or due to inefficiency
and wastages. Cost accounting will help you measure this.
Identification of Unprofitable Activities
Just because a firm is making overall profits, it does not mean all activities
are profitable. Cost accounting will help us identify the profitable and
unprofitable activities of the firm.

So, activities that cause the firm losses can be made profitable or
eliminated. This can happen due to the cost ascertainment done in cost
accounting.
Fixing Prices
This is one of the important advantages of cost accounting. Many
businesses price their products based on the cost of production of these
products.
To enable this, we first need to calculate the actual cost of production of
these products. Costing makes the distinction between fixed cost and
variable cost, which allows the firm to fix prices in different economic
scenarios. Prices that we fix without the help of cost accounting can be too
high or low, and both cause losses to the business.
Price Reduction
Sometimes during tough economic conditions, like depression, the prices
have to be reduced. In some cases, these prices are reduced to below the
total cost of the product.
This is to help the company survive this tough period. Such decisions the
management has to take are guided by cost accounting.
Control over Stock
Another important advantage of cost accounting is that it helps with
restocking and control over materials. Cost accounting will help us calculate
the most ideal and economic re-order level and quantities.
This will ensure that the firm is never overstocked or understocked. Also
costing allows the management to keep a check over these raw materials,
WIP etc.
Evaluates the Reasons for Losses
Every firm has to deal with periods of profits and losses. But now they must
always evaluate or investigate the reasons for the losses suffered. This will
help to tackle the problem or overcome the cause by some other means
necessary. So if you cannot eliminate the reason you can at least minimize
the losses.
Cost accounting plays a huge role in determining the cause of any losses.
Say, for example, your cost of production is low, and prices are high but yet
losses persist. This can be due to low output levels due to inefficiency. Cost
accounting helps us determine this.

Aids Future Planning
One of the biggest advantages of cost accounting is that it will help the
management with future plans they may have. For any production or selling
plans, it is important to have detailed data about the machines, the labor
capacity, output levels, levels of efficiency of each process etc.
Say for example the management wishes to expand the production to
accommodate sales, cost accounting will help determine if the current
machines can handle these levels of production or not.