Cost Accounting for Decision Making

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Two broad categories of costs are never relevant in any decision and include:

- Sunk costs.

- Future costs that do not differ between the alternatives.

How to Find relevant cost

- Eliminate costs and benefits that do not differ between alternatives.

- Use the remaining costs and benefits that do differ between alternatives in making the decision. The costs that remain are the differential, or avoidable, costs

How to ascertain cost?

- Proper estimation and allocation of overheads!

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- Cost accumulation

- Is the collection of cost data in an organized way

- Is the process of collecting cost information by some natural classification

- Is the process of accumulating costs that are directly traceable to a cost object

- Cost allocation -

- Is the process of assigning indirect cost to a cost centre or a department(A cost centre is a location, person, item or department or a group of these where cost generating activates are considered to take place )

- Is based on assumed linkages or convenience

- Cost absorption-

- Is the process of assigning overhead costs of departments and cost centers to cost unit or final, cost object.

- Is the process whereby overheads pertaining to various departments are finally absorbed in the cost of product, service, job etc.

- Allocations of overheads are done on the basis of COST DRIVERS.

- COST DRIVERS - are factors that cause changes in resource usage, activity usage, costs and revenues.

- DRIVERS -

- are identified using cause-and -effect reasoning,

- are observable, and

- predict or explain activities’ resource consumption use with reasonable accuracy.

- TYPES OF DRIVERS

- Resource Drivers

- Activity Drivers

- Since activities are spread at all levels in an organization, we have to recognize costs and cost drivers corresponding to each level of activities.

- PEANUT-BUTTER COSTING APPROACH

- It describes that cost system which indiscriminately spreads costs evenly over products/services - like spreading butter on a bread.

- It may result with very high probability in

- Product undercosting

- Product overcosting

- PRODUCT-COST CROSS SUBSIDIZATION

- It describes the fact that at least one miscosted product is resulting in the miscosting of other products in a firm.

- Different purposes and different cost objects:

- Natural Classification - Material, Labour, Expenses

- Changes in Activity/Volume - Variable, Fixed, Semi-variable, Semi-fixed

- Degree of traceability - Direct and Indirect

- Association with Product - Product and Period

- Function - Manufacturing, Marketing, Administrative

- Different purposes and different cost objects

- Relationship with Accounting Period - Revenue and Capital

- Planning, Decision-Making and Control Purposes - Opportunity Cost, Marginal/Differential/ Incremental Costs, Controllable and Uncontrollable, Avoidable and Unavoidable, Sunk Cost, Out-of-Pocket and Imputed Costs, Joint and Separable Cost, Actual and Standard

- To ascertain the cost of a cost object, every firm develops its own COSTING SYSTEM.

- The main function of a costing system is to capture the flows of costs taking place in the process of adding value to the product, i.e. in the value chain.

- Therefore, A costing system in a firm must accommodate the operating characteristics of the firm.

- Identify and eliminate non-value-added activities - which is one of the challenges before us.

Material cost represents cost of all those resources on which processing is to be done or which helps in processing.

- Material cost is incurred with a view to add value to the final product.

- Resources which constitute the material are tangible.

To manage and control the material cost is a challenge before the management from two dimensions -

- one, a slight increase in cost would badly affect profitability; and

- second, it shows a hope of reducing the cost and thereby improve the profit margins.

How much cost to be assigned to the cost of material used depends upon the method of INVENTORY VALUATION used.

- The methods of inventory valuation are in fact methods of pricing of material issue.

- Some of the methods of pricing of material issue are -

- FIFO

- LIFO

- Simple Average

- Weighted Average

- Periodic Simple Average

- Periodic Weighted Average

- Moving Simple Average

- Moving Weighted Average

- HIFO

- Market Price or Replacement Cost

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