COST ACCOUNTING 1 (ACCT 403)

Department of Accounting
University of Ghana Business School
Dr. William Coffie
 THE NATURE AND PURPOSE
OF COST AND COST ACCOUNTING
Lesson objectives

• Distinguish between private sector organizations and public sector

organizations.
• Identify factors that inhibit profit maximization of businesses.
• Explain management information system within a business setting and
the users of this information.
• Distinguish between financial accounting and management
accounting.
• Nature of cost and cost classification.
• Elements of cost for various purposes.
Overview of Business Organizations

There are two types of Organizations namely:

• Private Sector (Business) Organizations) and

• Public Sector (Governmental Organizations)

 BUSINESS GOVERNMENTAL
A. Ownership It is owned by individuals or equity owners It is owned by the State. No individual can claim
ownership.
A. Establishment It is established by Registration with the Registrar General It is established by an Act of Parliament.
Department.
(a) Motive It has a profit motive Non-profit in motive
(a) Funding It is funded by the contributions made by owners known It is funded from the Public Fund (Article 175 of
differently as sole proprietors, partners and shareholders 1992 Constitution)
(i) Consolidated Fund
(ii) Contingency Fund
(iii) Any other Fund established by Act of the
Parliament.

(a) Regulatory Frame work It is regulated by: It is regulated by:

(i) Business Registration Act (i) Constitution
(ii) Incorporated Private Partnership Act 1962, Act 152 (ii) Financial Administration Act (Act 654) &
(iii) Company Code 1963 Act 179 Legislative Instrument 1802.
(iv) Any Act, Legislation, Statutes established specifically (iii) Internal Audit Agency Act 658
for the industry it operates e.g. Banking Act, Insurance (iv) Public Procurement Act 663
Act etc. (v) Periodic Directories from the Government.
(a) Performance It is evaluated for Performance, Financial It is evaluated for
Evaluation Criteria Statues and Investment Potential. (i) Efficiency
(ii) Effectiveness
(iii)Economy and
(iv)Value for money

(a) Form It is takes the form of It takes the form

(a) Sole Proprietorship
(b) Partnership
(c) Limited Liability Companies
(i) Ministries, Departments and Agencies
MDA)
(ii) Metropolitan, Municipal and District
Assemblies (MMDA).
(iii) Public Boards and Corporation
(iv) Educational and Research
Institutions
Business Organizations are sub-divided by virtue of what they engage in:

a) Production Organization – involve in production of physical goods. They could be found in:
I. Extractive Industries – engaged in extractions or exploiting of Natural Resources e.g. Timber, Quarry, Oil
and Gas, Farming and Fishing etc.

II. Manufacturing Industries – engaged in converting raw materials into finished goods.

b) Commercial Organization – they buy and sell finished goods.

c) Service Organization – they neither produce nor buy and sell finished goods but render
services to other industries. They are aids to Production and Commerce e.g. Banking,
Insurance, Transportation, Hospitality etc.
Inhibiting factors to profit maximization
• In all of these, they are set up primarily to make profit to
increase or maximize the wealth of the owners (sole proprietors,
partnership, shareholders) etc.
• The owners’ wealth are increased by providing them with
adequate return on (interest, dividend) etc and of (increase in
share price) investment.
• There are however certain factors that can inhibit or constrain a
business organization to make unlimited or adequate profit to
maximize the wealth of the owners. These factors are
Inhibiting factors to profit maximization

Non Controllable Factors Controllable Factors

Political External – competitors
Economic - Customers
Social Internal – corporate governance
Technological - Capacities and capabilities
- Costs
The foregoing means business
organizations have six (6) main
concerns that they seek to address on
daily basis. These have come to be
known as 6cs of management which
are:
Capital Providers – adequate returns

Competitors – better and good practices

Customers – quality products at affordable prices

Corporate governance – good management team

Capacities and Capabilities – constant improvement

Costs – effective and efficient in their operations

To achieve these objectives, management must undertake certain
activities which include: Sales, Production, Procurement,
Recruitment and Training, Research and Developing.
The organization consumes resources which has come to be
known as the 4m’s (men, money, machine, materials) when
undertaking these activities. These resources must be managed
(i.e. their use must be planned and controlled).
To effectively manage these resources, when
undertaking activities towards the attainment
of the objectives to address the concern of the
4c’s, management needs information.
Information is powerful and it reduces risk
To obtain information therefore management puts in place a
system that will gather this information. This system is
called Management Information System. It consist of
people, equipment, procedures that are used to gather, sort,
evaluate, distribute, timely, complete, needed and accurate
information to users for informed or right decisions.
Accounting system is part of management
information system just like Production,
Marketing, Procurement system etc.
Accounting as part of information system
therefore basically is to provide information
for users for informed and right decisions.
Users of Accounting Information

Competitors

Shareholders Prospective investors

Accounting Info.
Employees
Government Management
Financial Inst./
Creditors/Suppliers
Analysts
Debtors/Customers 16
Financial Accounting vs Management Accounting
The two fold purpose of accounting system:
a) Providing information about the results of past decision of
an organization and likely results of future decisions.

b) The categorization of users of accounting information into 2

broad users brings about the sub branches of Accounting System.
Financial Accounting vs Management Accounting
•The branch of accounting system that provides information about results
of past decisions and for the External Users is called FINANCIAL
ACCOUNTING.
•The sub system or branch of Accounting System that provides
information on the likely results of future decisions and also information
for internal users is called MANAGEMENT ACCOUNTING.
Differences between Financial and Management Accounting
Financial Accounting Management Accounting

Purpose Provide information about Organizations Provides information for Planning, Control and Decision
performance, financial Status, investment potential. Making in organizations.

Audience Mainly for external users e.g. creditors, share Mainly for internal users, e.g. Board of directors,
holders. management etc.

Timeliness Delayed and historical Future oriented and current

Restriction It is heavily regulated by standards and statutes e.g. Not regulated. No legal requirement to produce report.
IFRS, GAAP etc. Legal requirement to produce Reports are management driven to meet strategic and other
Report. operational requirement.

Scope Reports cover entire organization, Aggregated Segmental reporting on products, customers’ territory,
events etc. Highly disaggregated.

Nature Objective, verifiable and auditable ,purely Subjective, non-verifiable and non-auditable. Both
quantitative quantitative and qualitative (descriptive) and include
other subject areas.
Cost Accounting as part of the Accounting System
a) Importance of cost

Cost is the aggregate monetary value of the resources that are used up or sacrificed
or consumed in the process of producing the product (goods and services).
Importance of cost
Cost is used to determine the selling price of products (goods, services and work).

Profitability, which remains the cardinal aim of every organization is determined by

Revenue – Cost = Profit. Revenue in the equation has two variables which are

Quantity demanded and Price. These two variables are exogenous to the

organization. i.e. (Q x P = Revenue)

Importance of cost
• Note that quantity demanded of a product is of a function (fx) (income, taste,
preference, degree of substitution etc). These are outside the control of the
organization.
• The determination of price as part of the equation; Further apart from cost is
competitor’s reaction and consumers affordability or acceptance.
• Therefore the only variable controllable by the organization as the profit equation
is Cost.
Importance of cost
Michael Porter, a strategic writer postulated that in this business environment of
global competition, shorter product lifecycles and discerning customers, Porter says
that for organizations to survive, they must adopt three generic strategies.

These are:
(i) over all cost leadership

(ii)differentiation and

(iii)focus
DEFINITION OF COSTING TERMS

•In view of the importance of cost which we have defined as the

aggregate monetary value of all resources that were sacrificed or used up
in producing the product (goods and services), organizations must put in
place a sub accounting system that will generate cost information
(product cost) for management.
DEFINITION OF COSTING TERMS

• The process of determining the cost of the product i.e. accumulation and
assignment of cost is costing.

• The product (goods and services) for which cost is being determined is called Cost
object or Cost unit.

• The place, department or activity for which cost is accumulated and assigned or
charged to cost object is known as the Cost Center.
DEFINITION OF COSTING TERMS

Industry sector Cost unit

Brick-making 1000 bricks

Electricity Kilowatt-hour

Professional services Chargeable hour

Education Enrolled student

DEFINITION OF COSTING TERMS

Type of cost center Examples

Service location Stores, canteen

Function Sales representative

Activity Quality control

Item of equipment Packing machine

Cost accounting as a sub system provides cost information to both Financial
Accounting and Management Accounting.

a) To Financial accounting, it provides product information for stock valuation for

the determinations of income or profit.
b) To Management accounting, it provides information for
(i) Planning e.g. budgeting
(ii) control e.g. standard costing
(iii) decision making e.g. make or by discontinuation, further processing decisions
etc.
Relationship between Cost Accounting Financial
and Management Accounting
CLASSIFICATION OF COST

Behavior of cost in
Time when relation to
Management
computed. (Time fluctuation in Degree of averaging
Function
Period) activity level (Cost
Behavior).
Manufacturing
Variable cost Total cost
Historical Cost costs

Fixed cost Unit cost Selling costs

Budgeted or
predetermine Semi- variable Administrative
d Cost Average Cost
(mixed) cost cost
CLASSIFICATION OF COST

Extent of
Time of charging
controllability by
Ease of traceability cost against revenue Decision
management
of cost to product (Accounting Significance
(Managerial
Treatment).
Control).
Relevant Costs
Direct costs Product cost Controllable
Irrelevant Cost

Sunk Cost
Indirect cost Period cost Uncontrollable
Opportunity Cost
ELEMENTS OF COST

The Cost component of a product to an organisation depends upon the use for which
the product is to be put in the organisation. A product could
(a) Procured for its final use e.g. stationary, lubricant.
(b) For resale.
(c) A product could be manufactured by converting raw materials procured in
finished goods.
(d) A product procured to facilitate or used in furthering the activities of the
organization e.g. Capital items like Plants, Vehicles.
Cost of a Product for final use
•The Total Cost is the Cost of Purchase price plus all expenditure
incidental to or Cost of Purchase necessary in bringing the product to
use.

• The cost components of Cost are Pre-Acquisition, Acquisition and Post

Acquisition Cost.
The incidental expenditure to bring the goods to a usable point
are the General and Administrative Expenses e.g. Holding Cost
like Rent, Security Expenses, Salaries and Wages, Stocking etc.
Cost of Goods for Resale
The Total Cost is the Cost of Purchase plus all incidental expenditure necessary to
bring the goods to a saleable point or condition.
(a) The Cost of Purchase is as detailed above.
(b) The incidental expenditure to bring the goods to saleable point are:
(i) General and Administrative Expenses e.g. Holding Cost like Rent of warehouse,
Security Expenses, Salaries and Wages etc.
(ii) Selling and Distribution Expenses like Advertising and Publicity, Sales
commission, Distribution etc.
Cost of a Manufactured Product

• The Total cost of a manufactured product is the “cost of Purchase of

the Raw material to be used in producing the product as in (a) above
Plus cost of conversion as are appropriate to that location or
condition”. Other incidental expenses may have to be incurred.
• Cost of Purchase is as detailed above.
Cost of Conversion
While the manufactured goods are awaiting to be sold or
despatched. Certain incidental expenses have to be
incurred e.g. warehouse
These are General and Administrative Expenses.
Selling and Administrative Expenses are all incurred when
manufactured goods are being sold.
Diagrammatically the Total Cost of a
manufactured Product is:
When a Profit margin is added to the Total Cost, the selling price
of the product is then determined or arrived at.