 Financial accounting is the systemic recording, reporting and analyzing of financial transaction of

a business. It focus on historical (past) transaction

 Financial reporting focus the on production of financial statement for publication outside the
business. Financial statement must comply with all applicable accounting standard and
regulation to ensure consistency with other business

 Cost accounting focuses on the identification of cost (a monetary valuation or assessment) of

resource and their allocation to product, service and inventory or other item. This provides
business information about how much to cost for a particular goods or service

 Management accounting focuses on providing information for internal use by managers to help
organization operate more effectively. The focus is on past and future data and information

Integrated system: is an accounting system that operate a single set of ledger

Advantages

 More efficients
 Reduce cost
 Save time

Disadvantages

Difficult to extract specific information

Interlocking system: an accounting system that operate two separate accounting ledgers, one for
financial accounting purpose and other cost accounting purpose

Advantages

Easy access to information

Disadvantages

Takes time to reconcile

Computerized system

Files: is a collection of records with similar characteristics. Eg general ledger, receivables and payable
ledger

Records: a record in a file consist of data relating to one unit of information. Eg supplier account in the
payable ledger

Fields: a record consist of number of fields. A fields is an item item of data relating to record.

Cost unit is a unit of products or service to which cost can be related

Cost unit information

 To determine the selling price

 To decide what to produce
 To help with cost control
 To plan and budget

Budget is plan express in monetary or quantity terms. There are different s types of budget eg sales
budget, production budget, expenditure budget etc.

Cost classification: is a process of categorized cost on the bases of shared or common characteristics.
There are five ways of classifying cost

 Function
 Traceability
 Responsibility
 Type
 Behavior

Direct cost: is a cost that can be trace in full to a cost unit. Eg of direct cost

 Direct labor
 Direct expense
 Direct material
 Prime cost ( total direct cost)
Indirect cost: is a cost that can’t be easily traced to a specific cost unit.

 Indirect material
 Indirect labour
 Indirect expenses
 Non production overheads

Indirect labour, materials and expanses can be group in to production overheads

Cost behavior: Is away which cost react as a result in changes in level of activity for eg the number of
unit produced.

Cost behavior can be classified in variable cost and fixed cost

Variable cost: is a costs that changes in response to change in level of activities

Fixed cost: is a costs which are unaffected by the changes in the level of activities

Variable cost: Total cost

This graph shows that the total cost of flour increases as activity increases.

 Note that the cost of flour per loaf does not change. What changes is the total cost of flour
used in production
 For example, the cost of flour per loaf to produce 100 loaves is $0.10 (calculated as $10 /
100 loaves)
 When activity increases to 200 loaves, the cost of flour per loaf remains at $0.10 (calculated
as $20 / 200 loaves).

Variable cost: Cost per unit

This graph shows that the cost of flour per loaf of bread (per unit) remains the same.
Fixed cost: Cost per unit
This graph shows the cost per unit of this fixed cost.

Because the fixed cost of rent remains the same, the fixed cost per unit (loaf of bread)
will decrease as more loaves are produced. This is because the fixed cost of the rent
is spread over more loaves of bread.
 The $1,000 rent per month shared out over 1,000 loaves of bread is a fixed cost of $1 per
unit at this activity level ($1,000 / 1000).
 If RQB produce 2,000 loaves in a month, then the total fixed cost of rent remains at $1,000
but the fixed cost per loaf of bread is now only $0.50 ($1,000 / 2,000)
 RQB now has lower unit costs and higher profit per loaf of bread by producing more
loaves while keeping the rent cost fixed.
Mixed cost: some cost include a fixed element and a variable element. This means that only part of cost
is affected by changes in activity level

Mixed cost are sometimes refer to as semi variable costs or semi fixed costs

Eg of mixed costs

Utility bills

Some wages scheme

Machine or vehicle rental

Mixed cost: Total cost

The following graph shows the behaviour of the total cost of a mixed cost (i.e. the
variable portion of the total cost and the fixed portion of the total cost).

As you can see, the total cost increases as the level of activity increases. For example,
the total cost of renting a vehicle increases as the kilometres driven increases. Note that
even if the rented vehicle is not driven at all, there is still a cost – the fixed rental cost!
Mixed cost: Total cost
The following graph shows the behaviour of the cost per unit of a mixed cost.

Because the total fixed cost remains the same for all levels of activity, the cost per
unit decreases as the level of activity increases. For example, in a hired vehicle, the total
cost per kilometre decreases when the number of kilometres driven increases
(assuming that the rental agreement is the same price regardless of the number of
kilometres driven).

Why does the total cost per kilometre decrease when more
kilometres are driven?
To see why this is the case, consider the following example:
Sam rents a van at a fixed rental cost of $200. There is an additional variable cost of $1
per kilometre driven. He uses the van to drive to the local town to collect a new
wardrobe. When he returns the van, he has only driven 10 kilometres. The total cost is
therefore $210.
The cost per kilometre is $210/10 = $21. This includes $20 'worth' of the $200 fixed cost
($200/10 kilometres).
The next month Sam rents the van at a fixed rental cost of $200 at $1 per kilometre
driven. On this occasion Sam drives the van to the coast to visit family. When he returns
the van, he has driven 100 kilometres. The total cost is therefore $300.
The cost per kilometre is $300/100, = $3. This includes $2 'worth' of the $200 fixed cost
($200/100 kilometres).
Stepped-fixed costs
The final type of cost behaviour is stepped-fixed costs. Stepped-fixed
costs remain fixed over a certain range of activity, but once the level of
activity increases past a certain point, the cost takes a significant 'step up'. For
example, a jeans manufacturer might have the machinery, employees and
workspace to produce a maximum of 50 pairs of jeans per week. If the weekly
production requirement rises to 200 pairs, then the organisation may need to
invest in new machinery, hire more employees and rent more work space to
meet this production load. This cost behaviour, stepping up in stages, is called
a step cost.

Stepped-fixed costs can be demonstrated on a graph as follows:

Stepped-fixed cost: Total cost

Note that once the upper limit of an activity level is reached then a new higher
level of fixed cost becomes relevant.

Summary
By now, you should have a good understanding of the four different cost
behaviours. Can you think of an example of each type? This will reinforce your
understanding and help you to identify the behaviour in similar products or
services.
It is important for the exam that you can recognise different cost behaviour
patterns, both from graphs and sets of figures. When looking at graphs, train
yourself to always check the labels on the axis – particularly whether the
graph represents total cost or unit cost (you will not be asked to identify the
unit cost for stepped-fixed graphs). Then, identify the pattern of cost behaviour
from the explanations we provided in this unit.

CALCULATING THE COST OF A PRODUCT OR SERVICES

A cost card records the costs involved in the production and sale of a single
unit.
COST CARD
Direct material ***
Direct labour ***
Direct expense ***
Total direct (prime) cost ***
Production overheads ***

Total production cost ***

Non production overheads ***
Total cost ***

Prime cost

The prime cost is useful for measuring the total cost of the main production inputs
(direct materials, direct labour and direct expenses) needed to create an output (a unit
of a product or service).

Production overheads
These are the indirect costs incurred in the production process. They include indirect
materials (for example, the lubricating oils for the machinery), indirect labour (for
example, the wages of supervisors) and indirect expenses (for example, the rental cost
of the factory).
Non-production overheads
These are the overheads not directly related to production incurred in making a unit of
product or service ready to sell – for example, an office manager's wages.
Total cost

Calculating the total cost of making and selling a single unit is essential as many
decisions depend upon the cost (and profit) of a product or service – for example, when
considering an appropriate selling price. If an organisation is going to make a profit, the
selling price per unit must be higher than the total cost per unit. The profit is the
difference between the selling price and the total cost per unit.

Absorption cost and Marginal Cost

Under absorption costing, fixed production overheads are included in the cost per
unit calculation. The unit cost of a product includes all production costs, including
fixed production overhead costs. Absorption costing provides the full cost of
producing an item. This means that the sales price will generate enough revenue to
cover the production overheads as well as the prime cost. In other words, the
production costs are absorbed by production and the subsequent sale of goods.

Under marginal costing (sometimes called variable costing), fixed production

overheads are excluded from the production cost per unit calculation. Fixed
production costs are treated as a cost of the period (a period cost), rather than as
part of the product cost. Marginal costing therefore establishes the total cost of
making each additional unit of output.

Under absorption costing, the cost of a unit of output includes the following
costs:
Under marginal costing, the cost of a unit of output includes the following
costs:

Absorption costing: Profit statement format$$

Sales x
Opening inventory x
Total production cost x
Less: Closing inventory (x)
Production cost of sales x
Non-production overheads x
Cost of sales (x)
Profit or loss

Marginal costing : Profit statement

$ $
Sales x
Opening inventory X
Variable production cost X
Less: Closing inventory (x)

Variable production cost of sales X

Variable non-production overheads X

Variable cost of sales x

Contribution x
Less: Fixed overhead (x)

Profit or loss
Marginal costing: Profit statement format

Sales revenue ** selling Price ***

Variable cost (**) variable cost per unit (***)

Contribution ** contribution per unit ***

Absorption costing
Results in the higher inventory valuation of the two methods
Produces an inventory valuation suitable for use in the external financial accounts
Closing inventory value includes a share of fixed production cost

Marginal costing

Fixed costs are charged against the profit of the period in which they are incurred
Focuses on the importance of contribution to fixed overhead and profit
Results in a higher profit figure for the period when inventory volumes decrease

Efficiency ratio = standard hours of actual production * 100%

Actual hours worked

Capacity utilization ratio = actual hours work * 100%

Budget hours

Production volume ratio = standard hours of actual production * 100%

Budgeted hours

Net profit margin = net profit * 100%

Sales

Gross profit margin = gross profit * 100%

Sales

Return on capital employed (ROCE) = Profit *100

Capital employed

ROCE = asset turnover * net profit margin

ROCE is sometimes called return on investment (ROI)

Notional interest charge = capital employed or invested * cost of capital

Capital employed = non-current asset + net current asset

Residual income = operating profit – notional interest charge

Assets turnover = sales revenue

Capital employed

Operation profit ratio = gross profit – sales * 100%

Operating expense
Capital employed = non-current asset + net current asset

CODING SYSTEM

Code is a unique set of characters ( numbers, letters, symbols) used to identify item such as a customer
or type of material.

Characteristics of effective coding system

 Logical and understandable
 Concise
 Unique
 Consistence and uniform
 Potential to expend

Types of coding system

 Sequential
 Blocked
 Faceted
 Hierarchical
 Mnemonic

Advantages of coding system

 Data entry is more efficient as codes are shorter than narrative text and therefore quicker to
enter
 After transactions have been input into the system, codes can be used to search, distinguish and
extract information, making analysis easier
 Codes used frequently become familiar to the staff who use them, which saves time
 Codes are precise and allocated to specific items, which reduces the chance of confusion and
misunderstandings that can arise from narrative descriptions.
ACCOUNTING FOR MATERIALS

Supplier - raw material - work in progress - finished goods - customer

Raw material to order = (expected materials usage + closing material inventory required) – opening
material inventory

Finished goods required to be produced = unit expected to be sold + units required in closing inventory –
units in opening stock

DIRECT AND INDIRECT LABOUR

Types of indirect labour
 Idle time
 General Overtime premium
 Overtime worked to meet specific request

To calculate direct labour costs we need to work out the total number
of active hours worked by the direct workers and multiply this number by the
basic rate they are paid for this work.

Consider the following table of information summarising the direct labour

costs incurred by an organisation for the latest period:

  Hours worked Hourly rate ($)

Basic hours (including 50 hours of idle time) 900 7.50

Overtime 150 10.50

The total number of active hours worked = 900 (basic hours) + 150 (overtime)
− 50 (idle time) = 1,000 hours.
The direct labour cost = 1,000 (hours) × $7.50 = $7,500.

Accounting for labour

 Direct labour costs are debited to a work in progress account

 Indirect labour costs are debited to the production overhead control account
 Both direct and indirect labour costs are credited to the wages control account.

Employee remuneration, productivity and labour cost

Remuneration method one

Employee remuneration is a compensation paid to employee for the exchange for the work they
performed.

Remuneration method 2
Premium bonus schemes are designed to encourage and reward productivity by paying a bonus