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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. 
  • Process Steps for Insurance/Banking: 
  • 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.
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