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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

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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)

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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 (i) Ministries, Departments and Agencies
(b) Partnership MDA)
(c) Limited Liability Companies (ii) Metropolitan, Municipal and District
Assemblies (MMDA).
(iii) Public Boards and Corporation
(iv) Educational and Research
Institutions

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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

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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:

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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).

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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.

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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

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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.

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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).

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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 in the profit
equation is Cost.

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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.

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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

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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.

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Relationship between Cost Accounting Financial

and Management Accounting

CLASSIFICATION OF COST

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

Manufacturing
Variable cost Total cost
Historical Cost costs

Fixed cost Unit cost Selling costs

Budgeted or
predetermined Semi- variable Administrative
Cost Average Cost
(mixed) cost cost

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CLASSIFICATION OF COST

Time of charging cost Extent of

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

Sunk Cost
Indirect cost Period cost Uncontrollable
Opportunity Cost

Elements of Cost
Material
Labour
Expenses

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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 be
(a) Procured for its final use e.g. stationary, lubricant.
(b) Procured for resale.
(c) Manufactured by converting raw materials procured into finished goods.
(d) Procured to facilitate or to be 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.

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(a) Pre-Acquisition Cost

(i) Preliminary Cost e.g. preparation of requisition, vendor selection
(tendering) negotiation etc xxxx
(ii) Placement cost e.g. order placement, stationary, postage xxxx
(iii) Post placement cost e.g. accounting, expediting (progressing) etc. xxxx xxxx
(b) Acquisition Cost
(i) Price (Invoice, FOB, CIF) less any rebate, discount etc xxxx
(ii) Import duties, levies, taxes etc xxxx
(iii) Other directly attributable cost e.g. containers xxxx xxxx
(c) Post Acquisition Cost
(i) Handling Expenses (Inspection, stocking etc) xxxx
(ii) Transportation xxxx
xxxx
Cost of Purchase xxxx

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.

Total Cost is therefore:

(a) Cost of Purchase xxxx
(b) Add General & Administrative Expenses xxxx
Total Cost xxxx

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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.

Total Cost is therefore:

Cost of Purchase xxxx
Add: General & administrative Expenses xxxx
Selling and Distribution xxxx
Total Cost xxxx

To determine Selling Price, profit is added i.e.

Total Cost xxxx
Add: Profit xxxx
Selling Price xxxx

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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
A/. Cost of Conversion is the cost of converting the raw material into finished products.
The details are:
(i) Direct Labour xxx
(ii) Direct Expenses (Royalties, Copy right) xxx
(iii) Production Overheads
(a) Indirect Materials (Lubricants) xxx
(b) Indirect Labour (Supervisor’s Salary) xxx
(c) Indirect Expenses (Utilities, depreciation, Rent) xxx xxxx
(iv) Other attributable Overheads (in bringing
product or Service to its present location xxxx
Cost of Conversion xxxx

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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.

(i) The foregoing means the Total Cost of a manufactured product becomes:
Cost of Purchase xxxx
Cost of Conversion xxxx
Cost of Production xxxx
Add: (i) General and administrative Expenses xxxx
(ii) Selling and Distribution xxxx
Total Cost of Production xxxx
Add Profit xxxx
Selling Price xxxx

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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.

Total Cost xxxx

Add Profit Margin xxxx
Selling Price xxxx

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