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Cost & Management Accounting – MGT402 VUTABLE OF CONTENTS
Lecture Topic Page #
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1. COST CLASSIFICATION AND COST BEHAVIOR .........................................................1
2. IMPORTANT TERMINOLOGIES.........................................................................................6
3. FINANCIAL STATEMENTS .................................................................................................10
4. FINANCIAL STATEMENTS (Contd.) .................................................................................16
5. PROBLEMS IN PREPARATION OF FINANCIAL STATEMENTS...........................24
6. PREPARATION OF FINANCIAL STATEMENTS (Contd.) .........................................30
7. MATERIAL .................................................................................................................................35
8. CONTROL OVER MATERIAL ............................................................................................38
9. CONTROL OVER MATERIAL (Contd.).............................................................................44
10. ACCOUNTING FOR LOSSES ..............................................................................................53
11. LABOR .........................................................................................................................................61
12. PAYROLL AND INCENTIVES ............................................................................................71
13. PIECE RATE BASE PREMIUM PLANS .............................................................................80
14. LABOR TURNOVER AND LABOR EFFICIENCY RATIOS & FACTORY
OVERHEAD COST .................................................................................................................85
15. ALLOCATION AND APPORTIONMENT OF FOH COST ........................................90
16. FACTORY OVERHEAD COST ............................................................................................94
17. FACTORY OVERHEAD COST (Contd.) ......................................................................... 101
18. COST ACCOUNTING SYSTEM........................................................................................ 113
19. PROCESS COSTING SYSTEM .......................................................................................... 119
20. PROCESS COSTING SYSTEM (Contd.) .......................................................................... 124
21. PROCESS COSTING SYSTEM (Contd.) .......................................................................... 126
22. PROCESS COSTING SYSTEM (Contd.) .......................................................................... 129
23. PROCESS COSTING SYSTEM (Contd.) .......................................................................... 135
24. PROCESS COSTING SYSTEM (Contd.) .......................................................................... 138
25. COSTING/VALUATION OF JOINT AND BY PRODUCTS .................................... 142
26. COSTING/VALUATION OF JOINT AND BY PRODUCTS (Contd.) .................... 146
27. MARGINAL AND ABSORPTION COSTING ............................................................... 152
28. MARGINAL AND ABSORPTION COSTING (Contd.) ............................................... 155
29. COST – VOLUME – PROFIT ANALYSIS ....................................................................... 165
30. COST – VOLUME – PROFIT ANALYSIS (Contd.) ....................................................... 169
31. BREAK EVEN ANALYSIS – MARGIN OF SAFETY .................................................. 173
32. BREAKEVEN ANALYSIS – CHARTS AND GRAPHS ............................................... 179
33. WHAT IS A BUDGET?......................................................................................................... 184
34. PRODUCTION & SALES BUDGET ................................................................................ 188
35. PRODUCTION COST BUDGET ...................................................................................... 191
36. DIRECT LABOUR AND FACTORY OVERHEAD BUDGET ................................. 194
37. OPERATING EXPENSE BUDGET AND BUDGETED INCOME STATEMENT197
38. CASH BUDGET ..................................................................................................................... 199
39. COMPLEX CASH BUDGET & FLEXIBLE BUDGET ................................................ 202
40. FLEXIBLE & ZERO-BASE BUDGETING .................................................................... 209
41. DECISION MAKING IN MANAGEMENT ACCOUNTING ................................... 215
42. DECISION MAKING (Contd.) ........................................................................................... 218
43. DECISION MAKING (Contd.) ........................................................................................... 223
44. DECISION MAKING (Contd.) ........................................................................................... 230
45. DECISION MAKING (Contd.) ........................................................................................... 236
© Copyright Virtual University of Pakistan
,Cost & Management Accounting–MGT402 VU
LESSON 01
COST CLASSIFICATION AND COST BEHAVIOR
INTRODUCTION
Cost Accounting
Cost Accounting is an expanded phase of financial accounting which provides management
promptly with the cost of producing and/or selling each product and rendering a particular service.
Management Accounting
Management accounting is application of professional knowledge and skill in the preparation and
presentation of financial information in such a way as to assist management in decision making and
in the planning and control of operations of the entity.
Objectives
Objective of cost accounting is computation of cost per unit, whereas the objective of management
accounting is to provide information to the management for decision making purposes.
Users of Cost Accounting
Users of cost & management accounting are the decision makers and the managers of the
entity/organization for which all this exercise is undertaken.
Uses of Cost and Management Accounting
1. It determines total cost of production and cost of sales
2. It determines appropriate selling price
3. It discloses the profitable products, areas and activity/capacity levels
4. It is used to decide whether to manufacture or purchase from outside
5. It helps in planning and controlling the cost of production
Elements of Cost
Any product that is manufactured is the result of consumption of some resources. The
management, for its planning and controlling functions, must know the cost of using these
resources. The constituent elements of cost are broadly classified into three distinct elements:
1 Direct Material Cost
2 Direct Labor Cost
3 Other Production Cost
a) Direct Cost
b) Indirect Cost
COST CLASSIFICATION
Elements of cost (Direct Material, Direct Labor, Other Production costs) can be classified as direct
cost or indirect cost.
Direct Cost
A direct cost is a cost that can be traced in full to the product or service for which cost is being
determined. Direct cost can be economically identified with a specific saleable product or service
(cost unit).
a) Direct material costs are the costs of materials that are known to have been used in producing
and selling a product or rendering a service.
b) Direct labor costs are the specific costs of the workforce used to produce a product or
rendering a service.
© Copyright Virtual University of Pakistan 1
,Cost & Management Accounting–MGT402 VU
c) Other direct production costs are those expenses that have been incurred in full as a direct
consequence of producing a product, or rendering a service.
Indirect Cost/Overhead Cost
An indirect cost or overhead cost is a cost that is incurred in the course of producing product or
rendering service, but which cannot be traced in the product or service in full.
Expenditure incurred on labor, material or other services which cannot be economically identified
with a specific cost product or service (cost unit).
Examples include:
Wages of supervisor, cleaning material and workshop insurance etc.
Mater Labor Other Total
Direct Direct Direct Prime Cost
Indirect Indirect Indirect Factory
1. Prime Cost
Direct Material
+Direct Labor
+Other direct production cost
Prime cost.
2. Total Production Cost
Prime Cost
+Factory overhead cost
Total production cost.
3. Conversion Cost
Direct labor cost
+Factory overhead cost
Conversion cost.
COST BEHAVIOR
Cost behavior is the way in which total production cost is affected by fluctuations in the activity
(production) level.
Activity level
The activity level refers to the amount of work done, or the number of events that have occurred.
Depending on circumstances, the level of activity may refer to the volume of production in a
period, the number of items sold, the value of items sold, the number of invoices issued, the
number of invoices received, the number or units of electricity consumed, the labor turnover etc.
Basic principle
The basic principle of cost behavior is that as the level of activity rises, costs will usually rise. For
example; it will cost more to produce 500 units of output than it will cost to produce 100 units; it
will usually cost more to travel 10 km than to travel 2 km. Although the principle is based on the
common sense, but the cost accountant has to determine, for each cost elements, whether which
cost rises by how much by the change in activity level.
Division of cost by its behavior
Basically, the cost of production has two behaviors:
1. Fixed Cost
2. Variable Cost
© Copyright Virtual University of Pakistan 2
, Cost & Management Accounting–MGT402 VU
Fixed Cost
It is a cost which tends to be constant by increase or decrease in the activity level.
This graph shows that the cost remains fixed regardless of the volume of output. Examples
include:
a. Salary of the production manager (monthly/annual)
b. Insurance premium of factory work shop
c. Depreciation on straight line method
Variable Cost
A variable cost is a cost which tends to vary directly with the change in activity level. The variable
cost per unit is the same amount for each unit produced whereas total variable cost increases as
volume of output increases.
This graph shows a proportionate increase in the cost by the increase in the activity level.
Examples include:
a. Cost of raw-material consumed
b. Direct labor cost
c. Selling commission
Further division of cost behavior
1. Step fixed cost
2. Semi variable cost
© Copyright Virtual University of Pakistan 3
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