Introduction to Management Accounting

I. Basic Principles of Costing in Service Industry 

• Establish Cost Objects: Identify what you are costing (e.g., a specific service, a  customer, a department). 
• Accumulate Costs under Cost Objects: Gather all costs related to that identified cost  object. 
• Assign Direct Costs Based on Activity or Resources: Directly attribute costs that can  be traced to a specific activity or resource. 
• Allocating Common Cost to the Bond Services: Distribute indirect or shared costs to  the various services provided.  II. Costing in Service Industries - Examples and Concepts 
• Insurance Companies and Banks (Process Costing): These typically use process  costing. 
• Example: Recurring Deposit/Term Deposit: The end product (policy or deposit) is  identical for all customers, making process costing suitable. 
• Initial contact with potential customers. 
• Collecting basic data & discussing options. 
• Arranging for medical check-up (if required). 
• Risk assessment & seeking special quotes. 
• Issuing policy. 
• Each stage is a process, and cost is incurred at every stage. 
• Time required to process policies depends on the nature of the policy. Cost is added  to policies based on the time taken. 
• Similar procedures can be followed for other services, e.g., processing a housing  loan application. 
• Service Sector Examples: 
• Churches, temples, and organizations promoting culture are all part of the service  sector. 
• Includes banking, insurance, transportation, healthcare, tourism, movies, telecom,  IT & BPO, sports, education, and many other services. 
• Indian Railways (Hybrid Costing): 
• Uses a Hybrid Costing System. 
• Cost Object: Train number/name. 
• Cost Structure: 
• All trains passing through a station get a basic charge. 
• Trains that stop at a station get an additional charge. 
• Trains originating from a station are also charged separately. 
• Trains also incur a termination charge from the destination station's holding charge.  III. Job Costing vs. Process Costing 
• Job Costing: 
• Ideal for those companies that receive orders and then manufacture products or  deliver services. 
• Cost Object: A specific job. 
• Resources consumed are tracked using job numbers. 
• Process Costing: 
• Most manufacturing companies where output is identical use process costing. 
• Service companies like banking, telecom, and insurance also use process costing. 
• Each process is a cost center in the process costing system. 
• Common costs are allocated to different processes.  IV. Cost Sheet and Cost Structure 
• Cost Sheet: 
• The final output of the costing department. 
• Shows the cost of production per unit of the end product. 
• In the service industry, it shows the cost of delivering the service. 
• Can summarize costs to find the product-wise total cost and then the unit cost. 
• Typical Structure (Line Items): 
• Material Cost 
• Labor Cost 
• Manufacturing Overhead 
• Administrative Overhead 
• Selling & Distribution Overhead 
• Total Cost 
• Three Broad Categories of Cost Structure: 
• Material Cost 
• Production Centre Cost 
• Support Centre Cost 
• Production Centre: Has three sub-cost items (not detailed in the notes, but implied as  part of the production process).  V. Profit and Markup 
• Profit Margin: The percentage of the selling price that is profit. 
• Markup: The percentage of the cost price that is added as profit. 
• Markup vs. Margin: Markup is always higher than margin when both refer to the same  profit amount.  VI. Support Service Department Cost Allocation 
• Example: Stores Department (or OPD, Consultation, Surgical in a Hospitalization  unit): Not a revenue-generating unit; it's a support service department. 
• Allocation: Instead of calculating cost per unit in rupees, its cost is distributed to  other departments based on a percentage basis of usage.  VII. Financial, Cost, and Management Accounting 
• Purpose of Financial Accounting: To show whether the business earned profit or  incurred loss. 
• Role of Cost Accountant: 
• Tracks movement of all goods and services within the organization. 
• Prepares Inventory Statement for the financial accountant. 
• Prepares a Cost Sheet to show cost per unit of goods or services produced.  VIII. Designing a Costing System 
• Reason for Difference in Quotation: An important reason is the allocation of common  cost between products in a multi-product environment. 
• Cost Accountant's Three-Step Process: 
• Establish cost objects and cost centers. 
• Cost Accumulation. 
• Cost Assignment. 
• Cost Objects: 
• The lowest point at which cost data is collected (e.g., material, salary, expenses). 
• Purpose: Data capturing at the lowest possible level. 
• Cost Centre: A group of related cost objects. 
• A production cost center comprises all production-related cost objects. 
• Cost Accumulation: The cost accountant creates adequate records to capture the  data. 
• Material requisition slip: Contains data related to jobs or processes for which the  material is drawn.  IX. Allocating Common Costs 
• To identify the labor cost related to each product, additional information is needed to  allocate the common cost to the products. 
• Some common costs can be meaningfully allocated using the labor cost. 
• At the end of the month, cost data related to various departments (other than the  production center) is gathered. These include: 
• Purchase Department 
• Stores Department 
• Quality Control Department 
• Accounting and Administrative Department 
• Canteen 
• Production cost is transferred from the cost center to the product based on how the  product consumes the services of the production center (one-to-one relationship). 
• For service center costs, there isn't always a direct relationship, so a basis for  allocation needs to be identified. 
• Requires judgment based on the cost and effort relationship.  X. Cost Classification 
• Time: 
• Historical: For financial statements. 
• Replacement: For decision-making (insurance/capital). 
• Budget: For planning and control. 
• Volume: 
• Variable Cost: Material, employee, etc. 
• Fixed Cost: Office rent. 
• Semi-variable Cost: Salary + commission. 
• Step Cost: Depreciation. 
• Financial Statements: 
• Expired: Depreciation. 
• Unexpired: Cost of a new machine. 
• Product: Inventory valuation (raw material). 
• Period: Rent, salary for administration. 
• Decision Making: 
• Relevant Cost 
• Opportunity Cost 
• Sunk Cost: Non-recoverable cost.  XI. Cost Formulas and Calculations 
• Final Cost Sheet: Reflects the cost flow and shows cost incurred at different stages. 
• Prime Cost: 
• The sum of direct material cost and direct labor cost. 
• It's a cost directly associated with the product. 
• Prime Cost = Direct Cost (Labor) + Material Cost (Labor). 
• Indirect Costs: Split into three groups: 
• Manufacturing or Production Overhead 
• Selling and Distribution Overhead 
• Administrative Overhead 
• Cost of Goods Manufactured (COGM): 
• Prime Cost + Manufacturing Overhead. 
• COGM = Prime Cost + Manufacturing Overhead. 
• Total Cost of Sales (or Total Cost per Unit): 
• Sum of Cost of Goods Manufactured, Administrative Overhead, and Selling and  Distribution Overhead. 
• Total Cost of Sales = COGM + AO + S&DO. 
• Profit Margin: Profit / Sales. 
• Conversion Cost: 
• Cost incurred to convert the material into finished goods. 
• Conversion Cost = Direct Labour + Manufacturing Overhead. 
• Profit as a Percentage of Conversion Cost or Conversion Margin: 
• Profit per unit / Conversion Cost. 
• Conversion margin is a more sensible measure than other types of profit measures.  XII. Process Steps of a Costing System 
• Identify Cost Object: Record data at the cost object. 
• Cost Accumulation: Group cost objects to form cost centers. 
• Assign: Assign accumulated cost data to revenue-generating products or services. 
• Common Cost in Organizations: 
• Depending on the organization's nature, between 80% to 90% of the total cost can be  common cost. 
• Common cost is very high when a firm manufactures high-value-added products  using common machines and resources. 
• Common Cost Allocation Basis: 
• Output Quantity 
• Material Cost 
• Labour 
• Machine Hours 
• Activity-Based Costing (ABC) System: For issues of differing cost, accountants  develop an alternative costing system called Activity-Based Costing.  XIII. Costing Systems Overview 
• Job Costing 
• Process Costing  XIV. Management Accounting Functions and Decision Making 
• Management Accounting Function: All managers perform this function when they use  accounting information generated by the accounting system. This information is  specifically for managers. 
• Financial Performance: Managers compute various financial ratios to know the  f  inancial performance of the company. 
• Cost Information Usage: Managers use cost information for: 
• Pricing 
• Outsourcing 
• Discontinuation of a product 
• Many other decisions 
• Cost information is vital for planning and controlling. 
• Management Accounting Covers Four Broad Topics: 
• Product Costing (finding the cost per unit) 
• Planning (related to preparation of budgets) 
• Decision Making (an important function of a managerial job; some decisions are  operational in nature and have a short-term impact) 
• Controlling 
• Operational Decisions Examples (Short-term impact): 
• Pricing a product 
• Offering a discount to customers 
• Extending a credit period 
• Deciding the product mix 
• Strategic Decisions (Long-term impact): 
• Decisions which are strategic in nature, having a long-term impact on the  organization. 
• Example: Buying a machine. 
• Marginal Costing / Cost-Volume-Profit (CVP) Framework: 
• Used for taking decisions involving cost and volume relationships. 
• Budgeting and Control: 
• Managers spend considerable time chasing the budget or trying to control the cost  within the budget.