NOTES ON
COSTING PRINCIPLES
Developing an understanding of cost
A well structured business, particularly if it is a manufacturing entity will employ two (2) forms
of accounting system to generate two(2) types of accounts:
1. Financial Accounts – prepared for individuals external to an organization; eg.
shareholders, customers, suppliers,tax authorities, Lenders such as Banks.
2. Management Accounts – prepared for internal managers of the organization.
Evidently, there will be a number of differences between financial accounts and management
Accounts:
Financial Accounts Management Accounts
Financial accounts detail the performance of Management accounts are used to aid
an organization over a defined period and management record, plan and control the
the state of affairs at the end of that period organisation’s activities and to help the
decision making process.
The format of published financial accounts is The format of management accounts is
determined by law entirely at management discretion(devise
your own system and format)
Most financial accounting information is of a Management account incorporate non
monetary nature monetary measures such as quantity
By Law. Limited Companies must prepare No legal requirement to prepare
financial accounts management accounts
Financial accounts concentrate on the Management accounts can focus on specific
business as a whole, aggregating all revenue areas of an organisation’s activity.
and costs.
Financial accounts presents an historic Management Accounts is both a historical
picture of past operations record and future planning tool
Notably, management accounting and cost accounting are used interchangeably - It is not
correct to do so!
Management accounting is concerned with using financial data and communicating it as information to
users, while Cost accounting is concerned with the following:
Preparing statements (eg budgets, costing), Cost data collection and applying costs to inventory, products
and services.
Cost accounting is part of management accounting. Cost accounting provides a bank of data tor the
management accountant to use. Cost accounts aim to establish the following:
- the cost of goods produced or services provided
- the cost of a department or work section
- What revenues have been.
- the profitability of a product, a service, a department, or the organisation in total.
- selling prices with some regard for the costs of sale
- the value of inventories of goods (raw materials, work in progress, finished goods) that are still
held in store at the end of a period, thereby aiding the preparation of a statement of financial
position of the company's assets and liabilities
- future costs of goods and services (costing is an integral part of budgeting (planning) for the
future).
- How actual costs compare with budgeted costs (Budgetary Control - The use of budgets to
monitor the performance of managers against their functional budgets. The system allows for
the continuous comparison of actual with budgeted results at frequent intervals, so that
corrective action may be taken when necessary).
- what Information management needs in order to make sensible decisions about profita and costs.
NB: It would be wrong to suppose that cost accounting systems are restricted to manufacturing
operations although they are probably more developed in this area of work. Services industries,
government departments and welfare activities can all make use of cost accounting information.
Costs in Detail
Direct Cost- costs that can be traced directly to specific units of production such as material,
labour used in the production of the product and associated expenses such as carriage and
containers.
Overheads(Indirect Costs) – Cannot be identified with anyone product because they are
incurred for the benefit of all products rather than anyone specific product, such as factory
overheads, Administrative expenses, selling and distribution expenses, financial charges.
(Name some of these expenses)
NB. Direct Cost + Factory Overhead = Production Cost (only making the Product)
Direct Cost + All Indirect Costs ( ie factory overheads, Administrative expenses, selling and
distribution expenses, financial charges) = Total Cost of Production(making the product and
enabling delivery to the consumer). Technically this is the selling price.
Review definition for Production
Costs can be further classified as:
Fixed Costs – One which does not change as output changes.
List some examples:
Variable Costs – cost change when output changes.
List some examples
Relevant Pricing(costing methods)
Margin and Mark up (refer to accounting Ratios)
Cost- plus pricing is any method of pricing to which a %, to represent profit, is added to total
cost of production
Absorption costing is a method whereby overhead costs are charged to cost centres.
Other Cost Terminologies
Unit Cost - cost assigned to one the production unit of an item.
Illustration:
Cost Centres - parts of a business to which costs can be charged or attached.
eg
Accounting For Overheads
Absorption costing is a method whereby overhead costs are charged to cost centres
either by allocation or apportionment. Illustration.
