Lecture No. 2

OBJECTIVES
To understand the basic terminologies used in cost and management accounting

IMPORTANT TERMINOLOGIES

Cost Unit It is a unit of a product or service in relation to which the cost is ascertained, i.e. it is the unit of the out put or product of the business. In simple words the unit for which cost of producing the units is identified /allocated. Example Ball point for a Ball point manufacturing entity Bottle for Beverage producing entity Fan for a Fan manufacturing entity Cost Center Cost centre is a location where costs are incurred and may or may not be attributed to cost units. Examples       Workshop in a manufacturing concern       Auto service department       Electrical service department       Packaging department       Janitorial service department Revenue Centre It is part of the entity that earns sales revenue. Its manager is responsible for the revenue earned not for the cost of operations. Examples       Sales department       Factory outlet Profit Centre Profit centre is a section of an organization that is responsible for producing profit. Examples       A branch       A division Investment Centre An investment centre is a segment or a profit centre where the manager has significant degree of control over his/her division’s investment policies. Examples       A branch       A division Relevant Cost Relevant cost is which changes with a change in decision. These are future costs that effect the current management decision. Examples       Variable cost       Fixed cost which changes with in an alternatives Opportunity cost Irrelevant Cost Irrelevant costs are those costs that would not affect the current management decision. Example A building purchased in last year, its cost is irrelevant to affect management decisions.  Sunk Cost Sunk cost is the cost expended in the past that cannot be retrieved on product or service.  Example The entity purchase stationary in bulk last moth. This expense has been incurred and hence will not be relevant to the management decisions to be taken subsequent to the purchase. Opportunity Cost Opportunity cost is the value of a benefit sacrificed in favor of an alternative.  Example An investor invests in stock exchange he foregoes the opportunity to invest further in his hotel.   The profit which the investor will be getting from the hotel is opportunity cost. Product Cost Product cost is a cost that is incurred in producing goods and services. This cost becomes part of inventory. Example        Direct material, direct labor and factory overhead. Period Cost The cost is not related to production and is matched against on a time period basis. This cost is considered to be expired during the accounting period and is charged to the profit & loss account. Example       Selling and administrative expenses Historical Cost It is the cost which is incurred at the time of entering into the transaction. This cost is verifiable through invoices/agreements. Historical cost is an actual cost that is borne at the time of purchase. Example A building purchased for Rs 400,000, has market value of Rs. 1,000,000. Its historical cost is Rs. 400,000.  Standard Cost Standard cost is a Predetermine cost of the units. Example Standard cost for a unit of product ‘A’ is set at Rs 30. It is compared with actual cost incurred for control purposes. Implicit Cost Implicit cost imposed on a firm includes cost when it foregoes an alternative action but doesn't make a physical payment. Such costs are related to forgone benefits of any single transaction, and occur when a firm: Example Uses its own capital or Uses its owner's time and/or financial resources Explicit Cost Explicit cost is the cost that is subject to actual payment or will be paid for in future. Example       Wage       Rent       Materials Differential Cost or Incremental cost   It is the difference of the costs of two or more alternatives. Example       Difference between costs of raw material of two categories or quality.  Costing: The measurement of cost of a product or service is called costing; however, it is not a recommended terminology. Cost Accounting: It is the establishment of budgets, standard cost and actual costs of operations, processes, activities or products and the analysis of variances, profitability or social use of funds. It involves a careful evaluation of the resources used within the business. The techniques employed are designed to provide financial information about the performance of a business and possibly the direction which future operations should take. Prime Cost: The total costs which can be directly identified with a job, a product or service is known as Prime cost. Thus prime cost = direct materials + direct labor + other direct expenses. Conversion Cost. This is the total cost of converting the raw materials into finished products. The total of direct labor other direct expenses and factory overhead cost is known as conversion cost Cost Accumulation Cost accumulations are the various ways in which the entries in a set of cost accounts (costs incurred) may be aggregated to provide different perspectives on the information. Methods of cost accumulation Process costing It is a method of cost accounting applied to production carried out by a series of operational stages or processes. Job order costing Generally, it is the allocation of all time, material and expenses to an individual project or job.