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3. Cost Accounting

It is the branch of accounting in which all the costs incurred during an activity or to accomplish an aim are collected, classified and recorded. This information is then processed and summarized to analyze the cost incurred in different processes and to arrive at a selling price and also to determine the areas where cost saving measures can be taken to improve efficiency and save cost.

Some of the important uses of cost accounting are:

Cost control

One of the major objectives of cost accounting is to control cost. Every business wants to control costs on inputs and to charge more for its outputs, this can be achieved through cost accounting, as it would help in finding out inefficiencies in the production process which would further enable the management to take necessary action to improve the efficiency of such a process and lead to higher profits in the long term.

Ascertain price of product or service

Cost accounting also equips the businesses to ascertain the selling price of products. The selling price can only be decided upon after taking into account all costs and then deciding how much profit a firm wants to earn and thus it can decide the selling price accordingly.

Profit ascertainment

Cost accounting helps in ascertaining profits and also helps to see the profitability of a certain product and how that particular profit figure is reached upon. Thus the firm also knows what all it can do to maximize profits and minimize costs as cause and effect relationship can be made, which will enable the firm generate maximum value as well as profits.

Assisting management in decisions:

It is an important tool that helps the management make cost decisions and thus take the best route to profitability.

This concept can be illustrated with the following example of a sandwich seller:

A sandwich seller was found to have the following costs to sell sandwiches in a day:

He expects to sell 100 sandwiches in a day and wants to earn 30% of profit on costs. Now he has to decide the cost of each sandwich so as to earn desired profit.

He first adds all the expenses i.e. = $500

Now he wants to earn a profit of 30% on cost thus he finds out that he has to makes sales worth $500 to break even and thus, he has to sell sandwiches worth $650 to earn desired profits.

As he expects to sell 100 sandwiches in a day he decides to price each of his sandwiches at $6.5.

The following example can be further extended to include many variations like how competitors price their sandwiches.

To further illustrate the point consider the previous example the only change being that the other sandwich sellers in the area sell their sandwich at $6.

Now the sandwich seller either has to decrease his profit margin or the cost incurred. Cost accounting helps him find the areas where he can reduce costs so as to attain desired levels of profits. After accounting for different areas where he find that he can reduce the other expenses that he incurs on selling the sandwiches by $30 and can negotiate a reduction of $10 on renting of truck thus saving $40 as expenses which reduces the cost to $460 thus to get his desired profit margin he has to sell $598 worth of sandwiches which allows him to price his sandwiches at $5.98. He thus has a little edge over his competitors and this may help him sell 10 more sandwiches each day thus helping him sell more and in turn earn more.

Cost accounting even with its numerous advantages has certain limitations:

• It is often considered as unnecessary by the organizations as most of the costing figures are already included in the financial accounts of the company.
• It is not applicable in all industries and if it is applicable in some industries it does not give the desired results, which makes it unattractive to use and is considered as one of the major deterrents to universal adoption of cost accounting.
• Failure of costing system, in many cases cost accounting fails, which makes it seem defective, and thus many consider it the failure of the system of cost accounting.
• Cost accounting is considered expensive by many, as the business needs to keep additional books for recording and analyzing at the beginning stage; also it is considered as uneconomical for small businesses.
• It is also considered as inaccurate as many believe it is based on estimation as pre-determined data is used to come up with figures and thus many businesses believe that the results determined from cost accounting are mere estimates and far from the truth.

Coast accounting questions with answers

Question 1: Management accounting information for resource management

You have just been appointed as the management accountant for Close Up and Personal (CUP), a company that sells pottery items, jewellery and cool clothing, featuring personal digital photos. This company employs a team of 12 designers who design the pottery items, jewellery and clothing. These products are manufactured by independent companies. CUP then prints the customer ordered photos onto the products and sells them to customers through six sales outlets located in shopping malls.

Required:

1. Identify the specific types of Management Accounting information that may be needed by the following employees, on a monthly basis, to help them control operations:

• (a) Manager of each retail outlet.
• (b) Manager of the design team.
• (c) Marketing manager responsible for planning advertising campaigns and identifying customer needs.
• (d) manager who manages and renegotiates contracts with the outside manufacturers.

2. The managing director of CUP is interested in developing more sophisticated planning systems but has some doubts over the value of undertaking strategic planning. Prepare a report outlining the importance of planning systems. In your report, consider the interrelationships between the objectives of the company, its strategies and short-term planning systems. Explain how management accounting information may assist in improving the planning function of the company.

Question 2: Schedules of cost of goods manufactured and sold; income statement

The following data refer to Flintoff Fashions for the current year:

Required:

1. Prepare the schedule of cost of goods manufactured for Flintoff Fashions.

Answer:

2. Prepare the schedule of cost of goods sold for Flintoff Fashions.

Answer:

3. Prepare the income statement for Flintoff Fashions.

Answer:

W. 4. Construct an Excel® spreadsheet to solve all the preceding requirements. Include formulas in your spreadsheet wherever possible. Show how both cost schedules and the income statement will change if:

4. (a) raw material purchases amounted to $110 400.

Answer:

4. (a) indirect labour was $9600.

Answer:

Question 3: Cost behavior; engineered cost; committed and discretionary costs: manufacturer

HappyDaze T-shirts manufactures and prints customised designs on T-shirts. Below is a list of some of their major costs.

• (a) Cost of daily radio advertising on the local community radio station.
• (b) Cost of the fabric used to make the T-shirts.
• (c) Cost of the ink used in the designs.
• (d) Salary of the managing director.
• (e) Wages of the production employees who sew and print the T-shirts.
• (f) Cost of movie tickets provided for the Employee of the Month award each month.
• (g) Depreciation of the sewing machines, calculated on a units of production basis.
• (h) Cost of electricity used in the factory building.
• (i) Rent of the building.
• (j) Wages of the staff who package the T-shirts.
• (k) Cost of sewing machine maintenance.
• (l) Cost of the new advertising sign at the front of the factory.
• (m) Cost of the company car used by the managing director.

Required:

For each cost:

1. Indicate whether it is fixed or variable.
2. If the cost is variable, indicate whether it is an engineered cost. Explain why.
3. If the cost is fixed, indicate whether it is committed or discretionary. Explain why.

Answer:

Question 4: Cost of goods manufactured; overapplied or underapplied overhead; journal entries

Cool Cooking Tools Ltd, manufacturer of gourmet cooking utensils, uses job costing. Manufacturing overhead is applied to production at a predetermined overhead rate of 150 per cent of direct labour cost. Any overapplied or underapplied manufacturing overhead is closed to cost of goods sold at the end of each month. Additional information:

Job SR22, consisting of ceramic spoon rests, was the only job in process on 31 January, with accumulated costs as follows:

Jobs BS67, TR29 and GT108 were started during February.
Direct materials requisitions during February totalled $26 000.
Direct labour cost of $20 000 was incurred during February.
Manufacturing overhead incurred in February was $32 000.

The only job still in process on 28 February was job number GT108, with costs of $2800 for direct material and $1800 for direct labour.

Required:

Q4(a). Calculate the cost of goods manufactured for February.

Answer:

Q4(b). Calculate the amount of overapplied or underapplied overhead to be closed to cost of goods sold on 28 February.

Answer:

Q4(c). Prepare journal entries to record the events described in requirements 1 and 2.

Answer:

JOURNAL

Working Notes

1	Calculation of amount transferred to Cost of sales
	Cost of goods Manufactured in February		76000
Add	Opening WIP		9000
Less	Closing WIP		7300
			77700
2	"The entries are made assuming
 non-integrated system of accounting."