Cost and management accountancy

INTERMEDIATE

STUDY NOTES

INTERMEDIATE : PAPER - 10

COST AND

MANAGEMENT

ACCOUNTANCY

The Institute of Cost Accountants of India

CMA Bhawan, 12, Sudder Street, Kolkata - 700 016

First Edition : February 2013

Second Edition : July 2013

Revised Second Edition : November 2014

Published by :

Directorate of Studies

The Institute of Cost Accountants of India (ICAI)

CMA Bhawan, 12, Sudder Street, Kolkata - 700 016

www.icmai.in

Printed at :

Repro India Limited

Plot No. 02, T.T.C. MIDC Industrial Area,

Mahape, Navi Mumbai 400 709, India.

Website : www.reproindialtd.com

Copyright of these Study Notes is reserved by the Insitute of Cost

Accountants of India and prior permission from the Institute is necessary

for reproduction of the whole or any part thereof.

PAPER 10: COST & MANAGEMENT ACCOUNTANCY (CMA)

Syllabus Structure:

The syllabus comprises the following topics and study weightage:

A Cost & Management Accounting – Methods & Techniques 50%

B Cost Records and Cost Audit 20%

C Economics for managerial decision-making 30%

A

50%

C

30%

B

20%

ASSESSMENT STRATEGY

There will be written examination paper of three hours

OBJECTIVES

To provide an in depth knowledge of the detailed procedures and documentation involved in cost ascertainment systems.

Acquire knowledge and skills for application of economics for managerial decision making.

Learning Aims

The syllabus aims to test the student’s ability to:

 Understand the cost and management accounting techniques for evaluation, analysis and application in managerial

decision making;

 Compare and contrast marginal and absorption costing methods in respect of profit reporting;

 Apply marginal and absorption costing approaches in job, batch and process environments;

 Prepare and interpret budgets and standard costs and variance statements;

 Understand CARR and CAR;

 Understand the application of economics in managerial decision-making.

Skill Set required

Level B: Requiring the skill levels of knowledge, comprehension, application and analysis.

Section A : Cost & Management Accounting – Methods & Techniques 50%

1. Cost Accounting Methods and Systems

2. Decision Making Tools

3. Budgeting and Budgetary Control

4. Standard Costing

Section B : Cost Records and Cost Audit 20%

5. Cost Accounting Records and Cost Audit

Section C : Economics for managerial decision-making 30%

6. Economics for managerial decision-making

SECTION A: COST & MANAGEMENT ACCOUNTING – METHODS & TECHNIQUES (50 MARKS)

1. Cost Accounting Methods and Systems

(a) Necessity and importance of cost accounting, what management expects of cost accounting, cost department

organization and relationship with other departments, installation of a costing system and modification thereof; planning

and progressing of accounting, design of forms and records

Syllabus

(b) Accounting entries for an integrated accounting system- cost ledgers; Reconciliation between cost and Financial profit

and loss account; Integrated and non-integrated accounting and reporting

(c) Job, batch, contract costing, process costing (including establishment of equivalent units in stock, work-in –progress and

abnormal loss accounts and use of various methods like first-in-first out), operation costing, operating costing, unit costing,

multiple costing, by-product and joint products

2. Decision Making Tools (advanced level)

(a) Marginal Costing : basic concepts; break even analysis and cost-volume-profit analysis; break-even charts and profit

charts; differential cost analysis; stock valuation under marginal costing techniques versus absorption costing techniques;

applications of marginal costing in decision making

(b) Throughput Accounting (TA) – as a system of profit reporting and stock valuation

(c) Activity-Based Costing (ABC) for profit reporting and stock valuation

(d) Integration of Standard Costing with Marginal Cost Accounting, Absorption Cost Accounting and Throughput

Accounting

(e) Transfer Pricing – determination of inter-departmental or inter-company transfer price

(f) Treatment of special expenses in costs such as – research and development expenses, preliminary expenses, rectification

expenses, costs of obsolescence, etc.

(g) Accounting and control of waste, scrap, spoilage, defective, etc

3. Budgeting and Budgetary Control

(a) Budget Concepts and Budget Preparation

(b) Fixed and Flexible Budgets

(c) Fixed, variable, semi-variable and activity-based categorizations of cost and their application in projecting financial

results

(d) Zero Base Budgeting (ZBB)

(e) Budgetary Control

4. Standard Costing

(a) Concept and uses; accounting – methods and reconciliation – stock valuation

(b) Variance Analysis: Cost, Profit and Sales Variances – presentation of variances, investigation of variances, revision of

standards

(c) Reporting – requisites of reports – interpretation and uses for Managerial decision-making activities

(d) Uniform Costing and Inter-firm comparison

SECTION B: COST RECORDS AND COST AUDIT (20 MARKS)

5. Cost Accounting Records and Cost Audit

(a) Cost Accounting Records and Cost Audit under Companies Act, 2013

(b) Nature and scope of Cost Audit

(c) Cost Compliance Reports – by Cost Accountants

(d) Companies (Cost Accounting Record) Rules, 2011 and Companies (Cost Audit Report) Rules, 2011 [To be substituted by

relevant Rules of 2014]

SECTION C: ECONOMICS FOR MANAGERIAL DECISION-MAKING (30 MARKS)

6. Economics for Managerial Decision-Making

(a) Concepts of Markets, analysis of market demand and empirical estimation of demand

(b) Government Intervention and effect

(c) Business and economic forecasting

(d) Empirical production function and cost analysis

(e) Factor demand and input decisions

(f) Pricing Policies

SECTION A

COST & MANAGEMENT ACCOUNTING -

METHODS AND TECHNIQUES

Study Note 1 : Cost Accounting Methods & Systems

1.1 Importance Of Cost Accounting 1.1

1.2 Integrated Accounting System 1.13

1.3 Methods / Types Of Costing 1.46

Study Note 2 : Decision Making Tools (advanced level)

2.1 Marginal Costing 2.1

2.2 Throughput Accounting 2.63

2.3 Activity Based Costing 2.74

2.4 Transfer Pricing 2.83

2.5 Treatment Of Special Expenses In Cost Accounts 2.94

2.6 Integration of Standard Costing with Marginal Cost Accounting, Absorption Cost

Accounting and Throughput Accounting 2.100

Study Note 3 : Budgeting And Budgetary Control

3.1 Budgeting 3.1

3.2 Budgetary Control 3.7

Study Note 4 : Standard Costing

4.1 Standard Costing 4.1

4.2 Uniform Costing 4.61

SECTION B

COST RECORDS AND COST AUDIT

Study Note 5 : Cost Accounting Records and Cost Audit

5.1 Introduction to Cost Audit 5.1

5.2 Origin of Cost Audit 5.2

5.3 Relevance of Cost Audit 5.2

5.4 Objectives of Cost Audit 5.3

5.5 Provision for Cost Audit 5.4

5.6 Companies (Cost Accounting Records) Rules 2011 And Companies

(Cost Audit Report) Rules 2011 [To be substituted by relevant Rules of 2014] 5.6

Content

SECTION C

ECONOMICS FOR MANAGERIAL DECISION MAKING

Study Note 6 : Economics for Managerial Decision Making

6.1 Concepts Of Market And Demand 6.1

6.2 Government Intervention And Effect. 6.33

6.3 Business And Economic Forecasting 6.38

6.4 Empirical Production Function And Cost Analysis 6.46

6.5 Factor Demand And Input Decisions 6.67

6.6 Pricing Policies 6.73

Techniques and Applications of Economics 6.83

Appendix 6.116

Section – A

COST AND MANAGEMENT

ACCOUNTING – METHODS &

TECHNIQUES

Study Note - 1

COST ACCOUNTING METHODS AND SYSTEMS

1.1 Importance of Cost Accounting

1.1.1 Cost Accounting: Cost Accounting may be defined as “Accounting for costs classification and

analysis of expenditure as will enable the total cost of any particular unit of production to be ascertained

with reasonable degree of accuracy and at the same time to disclose exactly how such total cost is

constituted”. Thus Cost Accounting is classifying, recording and appropriate allocation of expenditure

for the determination of the costs of products or services, and for the presentation of suitably arranged

data for the purposes of control and guidance of management.

Cost Accounting can be explained as follows:

(i) Cost Accounting is the process of accounting for cost which begins with recording of income and

expenditure and ends with the preparation of statistical data.

(ii) It is the formal mechanism by means of which cost of products or services are ascertained and

controlled.

(iii) Cost Accounting provides analysis and classification of expenditure as will enable the total cost

of any particular unit of product / service to be ascertained with reasonable degree of accuracy

and at the same time to disclose exactly how such total cost is constituted. For example it is not

sufficient to know that the cost of one pen is ` 25 but the management is also interested to know

the cost of material used, the amount of labour and other expenses incurred so as to control and

reduced its cost.

(iv) It establishes budgets and standard costs and actual cost of operations, processes, departments

or products and the analysis of variances, profitability and social use of funds.

Thus cost accounting is a quantitative method that collects, classifies, summarises and interprets

information for product costing, operation planning and control and decision making.

1.1.2 Costing: costing is defined as the technique and process of ascertaining costs. The technique in

costing consists of the body of principles and rules for ascertaining the costs of products and services.

The technique is dynamic and changes with the change of time. The process of costing is the day to

day routine of ascertaining costs. It is popularly known as an arithmetic process and daily routine. For

example, if the cost of producing a product say ` 1,500, then we have to refer material, labour and

expenses and arrive at the above cost as follows:

Material ` 800

Labour ` 400

Expenses ` 300

Total ` 1,500

Finding out the breakup of the total cost from the recorded data is a daily process. That is why it is called

daily routine. In this process we are classifying the recorded costs and summarizing each element and

the total is called technique.

This Study Note Includes

1.1 Importance of Cost Accounting

1.2 Integrated Accounting System

1.3 Methods (or) Types of Costing

CosT And MAnAgEMEnT ACCounTAnCy I 1.1

Cost Accounting Methods and Systems

1.2 I Cost And Management Accountancy

1.1.3 Cost Accountancy:

Cost Accountancy is defined as ‘the application of Costing and Cost accounting principles, methods

and techniques to the science, art and practice of cost control and the ascertainment of profitability’.

It includes the presentation of information derived there from for the purposes of managerial decision

making. Thus, Cost Accountancy is the science, art and practice of a Cost Accountant.

(a) It is science because it is a systematic body of knowledge having certain principles which a cost

accountant should possess for proper discharge of his responsibilities.

(b) It is an art as it requires the ability and the skills with which a cost accountant is able to apply the

principles of cost accountancy to various managerial problems.

(c) Practice includes the continuous efforts of a cost accountant in the field of cost accountancy.

Such efforts of a cost accountant also include the presentation of information for the purpose of

managerial decision making and keeping statistical records.

1.1.4 Objectives of Cost Accounting:

The following are the main objectives of Cost Accounting:

(a) To ascertain the costs under different situations using different techniques and systems of costing.

(b) To determine the selling prices under different circumstances.

(c) To determine and control efficiency by setting standards for Materials, Labour and Overheads.

(d) To determine the value of closing inventory for preparing financial statements of the concern.

(e) To provide a basis for operating policies which may be determination of Cost Volume relationship,

whether to close or operate at a loss, whether to manufacture or buy from market, whether

to continue the existing method of production or to replace it by a more improved method of

production....etc.

To appreciate the objectives and scope of Cost Accounting, it would be useful to examine the position

of Cost Accounting in the organisation and its relationship with other functions. In the organisation chart,

the Costing Department occupies an important position, as it is responsible for the following:

(a) For maintaining the records connected with material, labour and expenses.

(b) For analysing the all costs of manufacturing, marketing, administration and research and

development.

(c) For issuing control reports and data for decision making to the executives, departmental heads,

sectional heads and supervisors. When management is provided with useful reports, they assist in

controlling costs and optimize the operations.

The effectiveness of the control of cost depends upon proper communication through control reports from

the cost accountant to the various levels of the operating management. The cost accountant must devise

a cost system into which data are marshalled to fit the numerous problems confronting management. The

cost department is intimately connected with the other departments in the organisation. The relationship

of costing department with other departments can be briefly explained as follows:

Manufacturing Department:

Controls the scheduling, manufacturing and inspection of each job or processed products to their

finished stage in terms of efficiency norms established. Costs incurred at each stage are measured and

compared with norms.

Production Planning and Designing Department:

Designing Department involves Costing Department for cost estimates needed for each type of material,

labour and machine process before a decision can be reached in accepting or rejecting a design.

Cost And Management Accountancy I 1.3

Human Resource Department:

Human Resource Department is interested in maintaining the employee records including the employee

cost upto date. The wage rate and methods of remuneration agreed with the employees form the basis

for computing the payroll. Costing Department collects all the data from Human Resource Department

and computes the labour cost per hour or per unit of product / service.

Marketing Department:

Marketing Department needs a good product at a competitive price, while the cost cannot decide the

price, it can influence fixation of price. Besides accurate cost data helps sales manager to distinguish

profitable with non-profitable products and compare cost of marketing against sales volume.

Public Relation Department:

Public Relation Department establishes good relations with the public in general and customers, creditors,

shareholders and employees in particular. The Costing Department provides information concerning

price, cost, etc.

Legal Department:

Legal Department works very closely with Costing Department to keep many affairs of the company in

conformity with the law, specially excise, customs, sales tax and other legislations regarding maintenance

of accounts and cost records.

Finance Department:

The Finance Department relies on the Costing Department for accounting, valuation of inventory,

cash flow statement, etc. Where Finance Department is composed of general accounting and cost

accounting besides taxation and funds management department, it is usual to consider Costing

Department providing unit cost of goods manufactured and sold to General Accounting Department.

1.1.5 Cost Accounting and Management Accounting:

Management Accounting is primarily concerned with the requirements of the management. It involves

application of appropriate techniques and concepts, which help management in establishing a plan for

reasonable economic objective. It helps in making rational decisions for accomplishment of management

objectives. Any workable concept or techniques whether it is drawn from Cost Accounting, Financial

Accounting, Economics, Mathematics and Statistics, can be used in Management Accountancy. The

data used in Management Accountancy should satisfy only one broad test. It should serve the purpose

that it is intended for. A management accountant accumulates, summarises and analysis the available

data and presents it in relation to specific problems, decisions and day-to-day task of management.

A management accountant reviews all the decisions and analysis from management’s point of view

to determine how these decisions and analysis contribute to overall organisational objectives. A

management accountant judges the relevance and adequacy of available data from management’s

point of view.

The scope of Management Accounting is broader than the scope of Cost Accountancy. In Cost

Accounting, primary emphasis is on cost and it deals with its collection, analysis, relevance interpretation

and presentation for various problems of management. Management Accountancy utilizes the principles

and practices of Financial Accounting and Cost Accounting in addition to other management techniques

for efficient operations of a company. It widely uses different techniques from various branches of

knowledge like Statistics, Mathematics, Economics, Laws and Psychology to assist the management in

its task of maximising profits or minimizing losses. The main thrust in Management Accountancy is towards

determining policy and formulating plans to achieve desired objective of management. Management

Accountancy makes corporate planning and strategy effective.

Cost Accounting Methods and Systems

1.4 I Cost And Management Accountancy

From the above discussion we may conclude that the Cost Accounting and Management Accounting

are interdependent, greatly related and inseparable.

1.1.6 Importance of Cost Accounting

Importance of Cost Accounting may be considered under the following headings:

(A) Importance to Management:

A good Cost Accounting system serves the management in the following ways;

(i) Classification and sub-division of costs: Costs are collected and classified by various ways in

order to provide information to the management for control purposes and to ascertain the

profitability of each area of activity. It enables the concern to measure the efficiency and

then to maintain and improve it.

(ii) Control of material, labour and overhead costs: Various inventory control techniques or methods

of costing are used to control the material cost. For example fixation of maximum level helps

the management to reduce the over-stocking; use of EOQ helps the Purchase Department to

order right quantity. An efficient check on labour and machines is provided by giving detailed

information about availability of machine and labour capacity. The work is so planned that

no section is over-worked and no section remains idle. By classifying the overheads into

controllable and uncontrollable or fixed and variable, helps to control the overhead costs.

Thus cost accounting provides a detailed control of material, labour and overhead costs.

(iii) Price determination: Cost Accounting helps the management to fix the remunerative selling

prices of various items of goods under different circumstances. During the period of depression

a businessman has to become very watchful and vigilant in tracking down the concealed

inefficiencies and sources of wastage, so that he may reduce the cost of production to the

minimum. During depression the businessman has to cut the price to such an extent so as to

recover the variable costs. Cost accounting makes the distinction between fixed and variable

costs and helps the management in determination of prices. If prices are fixed without cost

information, it is possible that prices quoted may be too high or too low.

(iv) Business policy: Business policy may require consideration of alternative methods and

procedures and this is facilitated by cost information correctly presented. Cost accounting

helps the management to take vital decisions such as introduction of new product, selection

of optimum product mix, utilization of spare capacity, replacement of existing assets, etc.

(v) Standards for measuring efficiency: It provides the use of standards to assist management in

making estimates and plans for future and to provide the basis for measuring of efficiency.

Actual are compared with standards to determine the operating efficiency.

(vi) Best use of limited resources: Cost accounting provides the reliable data of costs with regard

to materials, wages and other expenses. This helps the management to get maximum output

at the minimum cost, by indicating where economies may be affected, waste eliminated and

efficiency increased.

(vii) Special factors: Cost accounting informs the management about the special factors such

as optimum profitability, seasonal variations in volume and costs. Idle time of labour and idle

capacity of the machine, etc. It also helps to curtail the losses during the off season.

(B) Importance to Workers:

Cost accounting discloses the relative efficiencies of different workers and thereby facilitates the

introduction of suitable plans of wage payment to reward efficiency and to provide adequate

incentive to the less efficient workers. A good system of costing promotes prosperity of the business

and thus ensures greater security of service and adequate reward to workers.

Cost And Management Accountancy I 1.5

(C) Importance to Creditors and Investors:

It enables the creditors and investors to judge the financial strength and credit worthiness of the

business. A sound business concern with a good system of costing can attract more investors than

a similar concern without an adequate system of costing.

(D) Importance to Government:

It facilitates the assessment of excise duty and income tax and the formulation of policies regarding

industry, export, import, taxation, etc. It also facilitates the preparation of national plans for economic

development. It provides ready figures for use by government by application to problems like price

fixation, price control, tariff protection, and wage level fixation, payment of dividends or settlement

of disputes.

(E) Importance to General Public:

The ultimate aim of costing is to reduce cost of production to the minimum and maximise the profits

of the business. A part of the benefit resulting from the reduction of the cost is usually passed on

to the consumers in the form of lower prices. Besides the installation of a costing system will infuse

confidence in the minds of the public about the fairness of the prices charged.

1.1.7 Advantages of Cost Accounting System:

Cost Accounting has manifold advantages, a summary of which is given below. It is not suggested that

having installed a system of cost accounting, a concern will expect to derive all the benefits stated

here. The nature and the extent of the advantages obtained will depend upon the type, adequacy

and efficiency of the cost system installed and the extent to which the various levels of management

are prepared to accept and act upon the advice rendered by the cost system:

(a) A cost system reveals unprofitable activities, losses or inefficiencies occurring in any form such as

• Wastage of man power, idle time and lost time.

• Wastage of material in the form of spoilage, excessive scrap etc., and

• Wastage of resources, e.g. inadequate utilization of plant, machinery and other facilities

(b) Cost accounting locates the exact causes for decrease or increase in the profit or loss of the

business. It identifies the unprofitable products or product lines so that these may be eliminated or

alternative measures may be taken.

(c) Cost accounts furnish suitable data and information to the management to serve as guide in

making decisions involving financial considerations.

(d) Cost accounting is useful for price fixation purposes. Although sale price is generally related more

to economic conditions prevailing in the market than to cost, the latter serves as a guide to test

the adequacy of selling prices.

(e) With the application of standard costing and budgetary control methods, the optimum level of

efficiency is set.

(f) Cost comparison helps in cost control. Comparison may be period to period, of the figures in respect

of the same unit or factory or of several units in an industry by employing uniform costs and inter￾firm comparison methods. Comparison may be made in respect of cost of jobs, process or cost

centres.

(g) A cost system provides ready figures for use by the Government, wage tribunals and boards, and

labour and trade unions.

(h) When a concern is not working to full capacity due to various reasons such as shortage of demands

or bottlenecks in production, the cost of idle capacity can readily worked out and repealed to the

management.

Cost Accounting Methods and Systems

1.6 I Cost And Management Accountancy

(i) Introduction of a cost reduction programme combined with operations research and value analysis

techniques leads to economy.

(j) Marginal costing is employed for suggesting courses of action to be taken. It is a useful tool for the

management for making decisions.

(k) Determination of cost centres or responsibility centres to meet the needs of a cost accounting system,

ensures that the organizational structure of the concern has been properly laid, responsibilities can

be properly defined and fixed on individuals.

(l) Perpetual inventory system which includes a procedure for continuous stock taking is an essential

feature of a cost system.

(m) The operation of a system of cost audit in the organization prevents manipulation and fraud and

assists in furnishing correct and reliable cost data to the management as well as to outside parties

like shareholders, the consumers and the Government.

1.1.8 Limitations of cost accounting system:

Like any other system of accounting, Cost Accountancy is not an exact science but an art which has

developed through theories and accounting practices based on reasoning and commonsense. Many

of the theories cannot be proved nor can they be disproved. They grownup in course of time to become

conventions and accepted principles of cost accounting. These principles are by no means static,

they are changing from day to day and what is correct today may not hold true in the circumstances

tomorrow.

(a) Large number of Conventions, Estimates and Flexible factors: No cost can be said to be exact as

they incorporate a large number of conventions, estimations and flexible factors such as:

(i) Classification of costs into its elements

(ii) Materials issue pricing based on average or standard costs.

(iii) Apportionment of overhead expenses and their allocation to cost units/centres.

(iv) Arbitrary allocation of joint costs.

(v) Division of overheads into fixed and variable

(b) Cost Accounting lacks the uniform procedures and formats in preparing the cost information of a

product/service. Keeping in view this limitation, all cost accounting results can be taken as mere

estimates.

1.1.9 Objections against cost accounting:

A number of objections are generally raised against the introduction of costing on various grounds. The

following are some of the important objections :

(a) Unnecessary expenditure: It has been argued that costing is of recent origin and that industries

prospered in the past and are still prospering without the aid of costing and, therefore, expenditure

incurred in installing a costing system would be unnecessary expenditure. This argument overlooks

the fact that modern industries are running under highly competitive conditions.

(b) There is no stereotyped system of costing which can be applied to all the industries. It is argued

that modern methods of costing are not applicable to many types of industries.

(c) It is argued that the adoption of costing system failed to produce the desired results.

(d) Installation of a costing system is very expensive.

1.1.10 Installation of Cost System or Cost Accounting System:

There is no readymade cost system suitable for all the businesses. Such system has to be specially designed

for an undertaking to meet its specific needs. Before installing a cost system proper care should be taken