Meaning Objective Definition of Cost accounting

One of the fundamental functions of businesses accounting can be assisting managerial management. Management control is the process of evaluating efficiency and, if necessary, apply proper steps so that performance happen according to help plan. Consequently, it is critical to strategy and price control. Standard costing is absolutely a technique in order to the particular management to control costs and business surgical procedures. This aims at eliminating waste materials and increasing efficiency in performance through starting specifications or simply formulating price ideas. Cost accounting was primarily developed to meet the info requirements with respect to cost. The personal accounts could provide a historical data. The ascertainment of cost within the basic of historical info was regarded useful at first. The word Standard shows a regular mark or perhaps yardstick. The common cost can be established price which determines before hand what each services or products should price under little bit while . circumstances. In the words of Backer and Jacobsen "Standard cost is the amount the particular businesses thinks a product or the particular procedure of any process for a period should price, established about certain suspected conditions of efficiency, monetary conditions as well as other actors. " The a style of using common costs for your purposes of cost control is termed standard being. In the words of Shadowy and Howard, standard being may be define because " a method of price accounting that even comes close the conventional expense of each and every product and service while using the actual cost to look for the efficiency from the procedure so that any remedial action may be taken immediately. "

Read : Cost Accounting Function and Objection 

The language of price Accountancy defines standard being as "the planning through using standard fees, their comparability with genuine costs, and also the analysis of variance on their causes, and parts of incidence". The common costing is very a system of cost accounting which was created to learn simply how much needs to be the price tag on any product within the existing problems. The genuine cost may be ascertained only one time production can be undertaken. The predetermined cost is as compared with the actual price and variance relating to the two makes it possible for the management to look at necessary helpful methods

What methods adopted for overhead absorption

The method adopted for overhead absorption varies from industry to industry and from one

undertaking to another. Some firms use separate rates for each type after classifying the overhead expenses into several types. The choice of a most equitable method is very important as the method adopted, if unsuitable, will distort costs and will be useless for control and decision making purposes. Type of industry, nature of product and process of manufacture, organization setup, individual requirement and policy of management are the factors which affect the choice of an overhead rate. Besides these, a satisfactory overhead rate should be simple, easy to operate, practical, accurate, economic in application, fairly stable and related to time factor. It should be preferably department rates as compare to blanket rates, homogeneous cost unit and should lay stress on the main production element of the concern.

The main factor should be taken into consideration before formulating overhead rates or deciding upon the basis for applying overheads to product.

Equitable apportionment of overhead.- the overhead rate should be such that overhead should be equitable apportioned to the cost centres or cost units. The amount of overheads recovered should also be equivalent to the amount of overheads incurred.

Simple and easy to understand- the overhead rate should be simple to calculate and easy to understand. It should not require unnecessary or additional clerical work.

Relation with time factor.- overhead rate should have some relation to the time taken by various jobs for completion. Thus, if a job takes twice as much time as another job, the first job should be charged twice the amount charged to the second job. It is because of this reason that direct wages percentage rate is preferred over direct material cost percentage rate.

Separate rates for manual or machine work.- the work done by manual labor should be distinguished from work done by machine and different overhead rates should be applied for manual and machine work.

Different overhead rates for different departments.- different overhead rates should be ascertained for different departments where the nature of the work done by one department is different from the work done by other department or departments.

What necessity for classifying overhead into fixed and variable

The necessity for classifying the overhead into fixed and variable arises for fixation of selling price, framing the budget, effective cost control, helps management decisions, marginal costing and break even charts, method of absorption of overheads. The distinction is helpful in determining the price policy of a concern. Sometimes, different prices are charged for the same article in different markets to meet varying degree of competition. However, the lowest selling price of an article is any market should at least cover prime cost plus variable overheads. The corresponding fixed overheads may  or may not be recovered if it is not practical to do so. Such fixed overheads may be recovered from sales in more favorable markets. If the selling price in a market does not cover the variable overheads, it is better not to sell good in that market. Segregating the fixed overhead from the variable overhead will be helpful in framing the fixed budget for various levels of capacity utilization. The behavior of the cost will also forcefully brought out. Fixed expenses are incurred by management decision and as such can be controlled by the top management while variable expenses can be controlled by the lower level of management. By segregating these, the lower levels of management will know the types of expenditure which is with in their control. In management decision regarding the utilization of capacity , this segregation will be found useful. After all the concept of fixed or variable expenditure is in relation to a particular rate of output. For example, supervisory salary may have to be doubled, if a new shift is to be started. In such cases, the management has to see whether the production of the second shift will be able to bear such an increase in the cost of production. the technique of marginal costing, preparation of break- even charts and study of cost volume profit relationship, segregation of cost into fixed and variable is quite essential. Different methods may be adopted for determination of absorption rates for fixed and variable overheads. The fixed overheads rates serves as a measure of utilization of the facilities while the extent of idle capacity is indicated by under absorption.

In short the classification of costs into fixed and variable is not prefect as it is based on assumption that costs are influence only by volume is not true. But there are many other factors which influence cost of production specification, product mix, method of production, technology etc.

Causes of under or over absorption of overheads

Meaning the amount of overhead absorption in cost is the total amount of the overhead costs allocated to individual costs units by application of overhead rate. Overhead cost are fully recovered

from production if actual rate method of absorption is adopted as the amount charged to production is equal to the amount of overhead incurred. But when a predetermined rate is used on the basis of budgeted overhead and the rate is applied to the actual base, the actual overhead expenses may be different from the charged or budgeted overhead expenses. If the amount absorbed is less than the amount incurred which may be due to actual expenses exceeding the estimates and the total output or hours worked being less than estimates, the difference is known as under absorption. Under absorption of overhead thus means the amount by which the absorbed overheads falls short of the actual amount of overhead incurred. It represent understanding the costs as the overhead expenses incurred are not fully recovered in the cost of jobs, process etc. on the other hand, if the amount absorbed is more than the expenditure incurred due to expenses being less than the estimates and the output or hours worked exceeding the estimates., it would mean over absorption of overheads and will be the costs. Over absorption of overhead thus means the excess of overheads absorbed over the actual amount of overhead incurred.

Causes of under or over absorption of overheads

Error in estimating overheads- the total overheads actually incurred for a department may be more or less than the amount estimated because of error in estimating this may due to deliberate decision in this regard of lack of proper control.

There may be some important changes in the work situation such as heavy overtime, introduction of another shift etc.

The actual hors worked may be more or less than hours anticipated

Work in progress might not have been charged with its share of overhead in cost accounts.

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The overhead expenses classification functional classification

Overhead expenses are classified with reference to major activity divisions of a concern; it is called functional classification of overhead. This classification is necessary for the segregation of the cost of each of the principal functional division of the concern and having separate method of accounting and control for the diverse nature of expenses in each division. The main groups forming the basis of the classification are :

• Manufacturing overhead
• Administration overhead
• Selling overhead
• Distribution overhead
• Research and development overhead

Manufacturing or works overhead is the indirect expenses of operating the manufacturing divisions of a concern and cover all indirect expenditure incurred by the undertaking from the receipt of order until its completion ready for dispatch either to the customer or to the finished Goods store. Administration overheads are indirect expenditure by nature and incurred in formulating the policy, directing the organization, controlling and managing the operation of an undertaking which is not related directly to a research, development, production selling activity of function. It consists of all expenses incurred in the direction, control and administration of an undertaking. Selling overheads is the cost of seeking to create and stimulate demand and of securing orders and comprises the cost of soliciting and recurring order for the articles or commodities dealt in and of efforts to find and retain customer. Distribution overhead is the expenditure incurred in the process which begins with making the packed product available for dispatch and ends with making the reconditioned return empty package. And research and development overhead is cost of searching for new and improve products, new applications of materials or product, and new applications and improved method.

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The accounting treatment under over absorption of overheads

The accounting treatment of under or over absorption of overheads depends upon the extent of such under or over absorption and the circumstances under which it arises. The following are the main methods of disposal of under or over absorption of overheads.

Use of supplementary Rates

- if the amount of under or over absorption is considerable; the cost of job or process is adjusted by means of supplementary levy of the overhead. Supplementary rate is calculated by dividing the amount of under or over absorption by the actual base. Under absorption is set tight by the plus rate

while over absorption is adjusted by minus rate. The supplementary rates will defeat the purpose for which it is calculated. Supplementary rates is useless in those cases where in order to have a uniform charge of overhead thought out, the accounting period is fixed in order to avoid seasonal fluctuations in the overhead cost or level of activity. Correction of costs through supplementary rate is necessary when the management likes to maintain actual historical costs for future comparison. Its use is made when prices are fixed on cost plus basis. The amount of under or over absorption at the end of the accounting period is adjusted in work in progress, finished stock and cost of sale in proportion to direct labor hours or machine hours or the values of the balances in each of these accounts be the use of supplementary rate. Subsidiary records or individual items are not corrected. The amount so adjusted will be shown in the balance sheet as deductions from or additions to the work in progress and finished good stock. Under this method, the profit for the period will be reduce or increased by the amount adjusted to cost of sales and value of stock will increase or decrease by the amount adjusted to work in progress and finished good stock.

By writing off to costing Profit and Loss accounts

- If the amount of under or over absorption is small it may be written off to costing Profit and Loss account instead of calculating a supplementary rate by complicated procedure. Under absorption due to idle facilities should be written off in this manner whatever the amount may be. The amount of  under or over absorption at the end of accounting period is transferred to the Overhead Suspense Account which is ultimately transferred to the Costing Profit and Loss account or directly to Costing Profit and Loss Account. If some portion of under or Over absorption arises due to abnormal causes such as strikes, lock out etc., then such portion should be carried over to the next year

Absorption in the Accounts in Subsequent Years

- The amount of under or over absorption of overhead may be carried over as deferred charges of deferred credit to the next accounting period by transferring to a Suspense or Overhead Reserve Account. The use of this method is justified when normal business cycle is more than one year and in the case of new projects and schemes when the output is low in the initial stages of production and cannot bear the entire share of overhead. Under such circumstances, it is desirable that some portion of such cost be carried over to the next period to be absorbed in the production of subsequent years.

Objectives of the Fund Flow Statement

Fund flow statement is the statement of sources and uses of fund. Fund flow statement shows the original source from which the cash are receive and the areas that they obtained funds have been applied. Funds flow statement shows various mean by which funds were received during a particular period and the ways in which these funds were applied.

The Objectives of the Fund Flow Statement are

To describe the changes in financial position the goal of funds flow statement is to disclose the cause of changes in the assets, liabilities and value capital between two balance sheet dates. It features the changes economic position of a concern and indicates the various means by which funds were obtained within a particular and the ways to where these funds were employed.

Fund flow statement is to analyze the in business position of a matter. "Balance Sheet" gives a static view of the financial position and the Profit and loss reported by income statement cannot find out about the actual cash out position of a company. Sometimes a strong with high profit might not exactly be able to pay its immediate liabilities due to the shortage of cash. Yet the objective of money statement is to make clear both the causes of various in several assets, financial obligations and capital accounts and their effect on the liquidity position of the care.

With the help of funds flow assertion we get information about the allocation of limited resources with an increase of proficiently and effectively. It gives you the information about the internal and external sources of financing. It gives you data about the unbalance pay for. On the basis of such information a problem can allocate its funds in and long-term areas more properly.

It helps to get Internal and external users of financial claims require funds flow assertion for the purpose of assessing the strengths and weakness of the worried firm. Funds flows affirmation provides information about the changes in net information permit various groups of users to assets and assess the financial position of the firm.

Meaning of funds flow statement in management accounting

The term ‘flow’ means movement and includes both ‘inflow’ and ‘outflow’. The term ‘flow of funds’ means transfer of economic values from one asset of equity to another. Flow of funds is said to have taken place when any transaction makes changes in the amount of funds available before happening of the transaction. If the effect of transaction results in the increase of funds, it is called a source of funds and if it results in the decrease of funds, it is known as an application of funds. Further, in case the transaction does not change funds, it is said to have not resulted in the flow of funds. According to the working capital concept of funds the term ‘flow of funds’ refers to the movement of funds in the working capital. If any transaction results in the increase in working capital, it is said to be a source or inflow of funds and if it results in the decrease of working capital, it is said to be an application or out flow of funds.

The flow of funds occur when a transaction changes on the one hand a non current account and on the other a current account and vice- versa.

When a changes in a non current account e.g., fixed assets, long-term liabilities, reserves and surplus, fictitious assets etc., is follow by a change in another non-current account, it does not amount to flow of funds. This is because of the fact that in such cases neither the working capital increases nor decreases. Similarly, when a change in one current account results in a change in another current it does not affect funds. Funds move from non current to current transactions or vice- versa only. In simple language funds move when a transaction affects

    A current asset and fixed asset

    A fixed and current liability

    A current asset and a fixed liability

    A fixed liability and a current liability

And funds do not move when the transaction affects fixed assets and fixed liability or current assets and current liability. To understand flow of funds, it is important to classify various accounts and balance sheet items into current and non- current categories. Current account can either be current assets or current liabilities. Current assets are those assets which in the ordinary course of business can be converted into cash with in a short period of normally one accounting period. Current liabilities are those liabilities which are intended to be paid in the ordinary course of business with in a short period of normally one accounting year out of the current assets or the income of the business. 

What is Role of Working Capital in Business

Working capital is the life blood and nerve centre of a business. Jus as circulation of blood is essential in the human body for maintaining life. Working capital is very essential to maintain the smooth running of a business. No business can run successfully without an adequate amount of working capital. However, it must also be noted that working capital is a means to run the business smoothly and profitably, and not an end. Thus, concept of working capital has its own importance in a going concern. A going concern, usually, has a positive balance of working capital, i.e., the excess of current assets over current liabilities, but sometimes the uses of working capital may be more than the sources resulting into negative value of the working capital. This negative balance is generally offset soon by gains in the following periods. A study of changes in the uses and sources of working capital is necessary to evaluate the efficiency with which the working capital is employed in a business. This involves the need of working capital analysis.

Analysis of working capital can be conducted through devices 

    Ratio Analysis
    Fund Flow Analysis
    Budgeting

Ratio Analysis

 A ratio analysis is a simple arithmetical expression of the relationship of one number to another. The technique of ratio analysis can be employed for measuring short term liquidity or working capital position of a firm.

Fund Flow Analysis

Funds flow analysis is a technical device designated to study the sources from which additional funds were derived and the use to which these sources were put. It is an effective management tool to study changes in the financial position of a business enterprise between beginning and ending financial statements dates. The fund flow analysis consist of

    Preparing schedule of changes in working capital

    Statement of sources and application of funds

Working capital Budget

A budget is a financial and quantitative expression of business plans and policies to be pursued in the future period of time. Working capital budget, as a part of total budgeting process of a business, is prepared estimating future long term and short term working capital needs and sources to finance. 

What is batch costing in cost accounting

Batch costing is a form of specific order costing. Job costing refers to costing of jobs that are executed against specific order where as in batch costing items are manufactured for stock. A finished product may require different components for assembly and may be manufactured in economical batch lots. When orders are received from different customers, there are common products among orders; then production order may be issued for batches, consisting of a predetermined quantity of each type of product. Batch costing method is adopted in such cases to calculate the cost of each such batch. Cost per unit is ascertained by dividing the total cost of a batch by number of items produced in that batch.

Determination of the economic lot size is important in industries where batch costing is employed. The need for determining economic lot size arises:

    Every time a component or product is to be made, setting up of the tool is involved. Because of this some loss in production time will be there. Therefore, maximum numbers of units are produced once the machine is set in order to reduce the cost per unit. such large production at one run will lead to accumulation of inventory and the costs related thereto. thus there is a quantity for which reduced cost of production is just offset by costs of carrying the quantity inventory.

What is fund flow statement an importance

The basic financial statement, i.e., the balance sheet and profit and loss account or income statement of business, reveal the net effect of the various transactions on the operational and financial position of the company. The balance sheet gives us a summary of the assets and liabilities of an undertaking at a particular point of time. It reveals the financial status of the company. The assets side of a balance sheet shows the deployment of resources of an undertaking while the liability side indicates its obligations, i.e., the manner in which these resources were obtained. The profit and loss account reflects the results of the business operations for a period of time. It contains a summary of expenses incurred and the revenue realized in an accounting period. Both these statements provide the essential basic information on the financial activities of a business, but their usefulness is limited for analysis and planning purpose. The balance sheet gives a static view of the resources or liabilities of a business and uses or assets to which these resources have been put a certain point of time. It does not disclose the cause for changes in the assets and liabilities between two different point of time. The profit and loss account, in a general way, indicates the resources provided by operations. But there are many transactions that take place in an undertaking and which do not operate through profit and loss account. Thus, another statement has to be prepared to show the change in the assets and liabilities from the end of one period of time to the end of another period of time. The statement is called a statement of changes in financial position or a fund flow statement.

The fund flow statement shows movement of funds

The fund flow statement is a statement which shows the movement of funds and is a report of the financial operations of the business undertaking. It indicates various means by which funds were obtained during a particular period and the way in which these funds were employed. In simple words, it is a statement of sources and application of funds.

The interpretation of ratios analysis important factor

The interpretation of ratios is an important factor. Though calculation of ratios is also important but it is only a clerical task whereas interpretation needs skill, intelligence and foresightedness. The inherent limitation of ratios analysis should be kept in mind while interpreting them. The impact of factors such as price level changes, Change in accounting policies, window dressing etc., should also be kept in mind when attempting to interpret. A single ratio in itself does not convey much of the sense. To make ratios useful, they have to be further interpreted. For example, say, the current ratio of 3:1 does not convey any sense unless it is interpreted and conclusion is drawn from it regarding the financial condition of the firm as to whether it is very strong, good, questionable or poor. 

The interpretation of the financial ratios can made

• Generally speaking one cannot draw any meaningful conclusion when a single ratio is considered in isolation. But single ratios may be studied in relation to certain rules of thumb which is based upon well proven conventions as for example 2:1 is considered to be a good ratio for current assets to current liabilities.

• Ratio may be interpreted be calculating a group of related ratios. A single ratio supported by other related additional ratios becomes more understandable and meaningful. For example, the ratio of current assets to current liabilities may be supported by the ratio of liquid assets to liquid liabilities to draw more dependable conclusions.

• One of the easiest and most popular ways of evaluating the performance of the firm is to compare its present ratios with the past ratios called comparison overtime. When financial ratios are compared over a period of time, it gives an indication of the direction of change and reflects whether the firm's performance and financial position has improved, deteriorated or remained constant over a period of time. But while interpreting ratios from comparison over time, one has to be careful about the changes, if any, in the firm's policies and accounting procedure.

• Ratios can also be calculated for future standards based upon the projected or proforma financial statements. These future Ratios may be taken as standard for comparison and the ratios calculated on actual financial statements can be compared with the standard ratios to find out variances, if any. Such variance help in interpreting and taking corrective action for improvement in future.

• Ratios of one firm can also be compared with the ratios of some other selected firms in the same industry at the same point of time. this kind of comparison helps in evaluating relative financial position and performance of the firm. But while making use of such comparison one has to be very careful regarding the different accounting methods, policies and procedures adopted by different firms.