Table Of ContentOther titles in the CIMA series
Stage 1
Economics for Accountants
Keith West
Quantitative Methods
Kevin Pardoe
Stage 2
Accounting Information Systems and Data Processing
Krish Bhaskar and Richard Housden
Financial Accounting
Peter Taylor and Brian Underdown
Management
Cliff Bowman
Stage 3
Advanced Financial Accounting
Peter Taylor and Brian Underdown
Company Law
Julia Bailey and Iain McCullum
Management Accounting Techniques
David Benjamin and Colin Biggs
Stage 4
Control and Audit in Management Accounting
Jeff Coates, Ray Stacey and Colin Rickwood
Management Accounting: Strategic Planning and Marketing
Patrick McNamee
Financial and Treasury Management
Paul Collier, Terry Cooke and John Glynn
Revision Guides
Advanced Accounting Techniques Groups and Special Transactions Revision
Guide
Peter Taylor and Brian Underdown
Business Law Revision Guide
Stan Marsh
Company Accounting Revision Guide
Peter Taylor and Brian Underdown
Cost Accounting Revision Guide
Colin Drury
Economics Revision Guide
Rob Dixon and Keith West
Quantitative Methods Revision Guide
Paul Goodwin
Cost Accounting
Stage 2
Mark Lee Inman
Senior Lecturer at the Polytechnic of North London, Associate Lecturer at
the Polytechnic of Central London, Associate Lecturer at Webster University,
St Louis, MI, formerly Lecturer at Waltham Forest College, London
Second edition
HEINEMANN PROFESSIONAL PUBLISHING
To Pud, D.D. and Poj
Heinemann Professional Publishing Ltd
Halley Court, Jordan Hill, Oxford 0X2 8EJ
OXFORD LONDON MELBOURNE AUCKLAND SINGAPORE
IBADAN NAIROBI GABORONE KINGSTON
First published 1988
Second edition 1989
© Mark Lee Inman 1988, 1989
British Library Cataloguing in Publication Data
Inman, Mark Lee
Cost accounting.
1. Cost accounting
I. Title
657'.42 HF5686.C8
ISBN 0 434 90832 0
Printed in Great Britain by
Redwood Burn Ltd, Trowbridge
To Pud, D.D. and Poj
Heinemann Professional Publishing Ltd
Halley Court, Jordan Hill, Oxford 0X2 8EJ
OXFORD LONDON MELBOURNE AUCKLAND SINGAPORE
IBADAN NAIROBI GABORONE KINGSTON
First published 1988
Second edition 1989
© Mark Lee Inman 1988, 1989
British Library Cataloguing in Publication Data
Inman, Mark Lee
Cost accounting.
1. Cost accounting
I. Title
657'.42 HF5686.C8
ISBN 0 434 90832 0
Printed in Great Britain by
Redwood Burn Ltd, Trowbridge
Preface
It was with a sense of honour and pride that I accepted the commission
to write the cost accounting text for the Chartered Institute of Manage-
ment Accountants' series of textbooks for the 1987 syllabus.
In the almost seventy years of its existence, cost accounting has been
the very essence of the CIMA and any such text would have to follow a
tradition of excellence forged by very illustrious predecessors indeed. In
approaching the task, therefore, I have been mindful of the traditions of
the CIMA as well as the needs of students in the final years of the
twentieth century. Inevitably, there is much that is traditional in the
text's approach. It aims to match a syllabus that assumes very little
previous knowledge, building where appropriate on Stage 1 and conver-
sion introductory studies, and then prepares the student to tackle a very
critical Stage 2 examination. To achieve this, the approach has been to
build a definite bridge between the introductory subjects, by laying a
very thorough foundation for the Stage 3 management accounting tech-
niques paper and the final management accounting papers. In attemp-
ting to achieve this, there has also been cognisance of the need to relate
across to the parallel financial accounting and management papers. The
student will notice that he/she is introduced to some basic quantitative
analysis very early on. There are two reasons for this. First, to keep
the student's 'hand in' on basic quantitative analysis learned from
Stage 1, and secondly to ease the inevitable trauma that many non-
mathematical students perceive associated with Stage 3 management
accounting techniques. I should, however, emphasize that this book in
no way prepares the student adequately for Stage 3. There is, however,
a by-product to this approach. Students preparing for the final Level of
the Accounting Technicians examinations, and the Level 1 Cost
Accounting paper for the Chartered Association of Certified Accountants
will find this book covers most of their syllabus. It will also provide
graduates, exempt from CACA Level 1 with a useful introduction to the
Level 2 Management Accounting paper.
Essentially, the approach has been a traditional discourse through
Vll
viii Preface
the basic elements of cost and cost collection, moving into cost account-
ing techniques and methods. New to cost accounting textbooks is a
chapter on the presentation of information to the users of cost account-
ing information. Aware of developments in cost accounting mechanics,
some introductory coverage has been given to quantitative models, such
as inventory models and linear programming, to the impact of the
SSAPs where they affect the cost accountant, and where there is con-
troversy, space has been given over to a discussion on the research as it
stands to date. This has been done, not purely to give academic respec-
tability, but to help the student prepare for discursive written ques-
tions, and to maintain a healthy interest in his/her subject and its
relevance to everyday tasks.
At the end of each chapter, there is a selection of questions, and I am
grateful to the CIMA and the CACA for permission to use questions from
recent papers.
I must, however, include an apology to the students. After many years
of lecturing to various groups of students, I have always endeavoured to
show where a figure has come from. This has meant that lecture boards
have usually been covered with a maze of vivid green lines! I apologize
for their absence in the text, but every effort has been made to ensure
that worked examples are clearly described and annotated.
Additionally, a book is many people. My debt must be to the staff of
the excellent CIMA library for providing much of the background
material, searching the literature, and unearthing obscure but vital
articles, and often despatching them to me at very short notice. Soot
and her excellent team have been wonderful, and without their efforts
this text would have been lacking indeed. My thanks must also go to
John Hilary and to John Frew for permission to use material hitherto
published in Management Accounting and the Students Newsletter. To the
BTEC (Higher) management accounting class of 1987 at the Central
London Polytechnic who were guinea pigs for many of my teaching
ideas and suffered handouts made of experimental portions of text, as
well as having to work out many of the examples. It says much for the
critical and analytical ability of these students that twelve of the
twenty-eight attained distinctions in their final examinations. The 1987
CACA2.4 class of the Polytechnic of North London have also been guinea
pigs and have made useful contributions. To friends and colleagues
Anne Chan MSc FCCA, (Member of Council CACA), John K. Cunning-
ham MA FCA, John Lane MBIM MUM MIMS FInstD, Carolyn Malinows-
ki BSc. ACMA, Denise J. Donovan BSc. ACA FInstD and W. Stuart Cole
MSc, FInstT who read portions of the text, and/or gave valuable specia-
list advice and comment. However, any mistakes must be my own!
And finally, to my wife, Christine, and two sons, David Duncan and
Malcolm, who tolerated endless hours of me locked away with an IBM
word processor!
Mark Lee Inman
Brentwood, Essex
May 1989
I Introduction
Definitions
The current (January 1986) edition of the CIMA Terminology defines cost
as:
noun 'The amount of expenditure (actual or notional) incurred on, or
attributable to, a specific thing or activity/
verb 'To ascertain the cost of a specified thing or activity/
To these definitions, the CIMA adds the footnote that 'the word 'cost'
can rarely stand alone and should be qualified as to its nature and
limitations.'
Not surprisingly, the CIMA Terminology immediately follows up with
a definition of Cost Accounting, which is 'that part of management
accounting which establishes budgets and standard costs and actual
costs of operations, processes departments or products and the analysis
of variances, profitability or social use of funds'. The traditional term
'costing' is not recommended.
Since this book is a basic preparation for future advanced manage-
ment accounting studies, and since the CIMA definition above refers to
'management accounting' we reproduce the Terminology definition viz.,
The provision of information required by management for such pur-
poses as:
1 Formulation of policies.
2 Planning and controlling the activies of the enterprise.
3 Decision taking on alternative courses of action.
4 Disclosure to employees.
5 Disclosure to those external to the entity.
6 Safeguarding the assets.
To that end, the above involves participation in management to en-
sure that there is effective:
2 Cost Accounting
(a) Formulation of plans to meet objectives (long-term planning).
(b) Formulation of short-term operation plans (budget/profit plan-
ning).
(c) Recording of actual transactions (financial accounting and cost
accounting).
(d) Corrective action to bring future actual transactions into line
(financial control).
(e) Obtaining and controlling finance (treasurership).
(f) Reviewing and reporting on systems and operations (internal
audit/management audit).
For the reader to see the vital importance of the cost accounting
function within the operations management team, we now reproduce a
combination of two organizational charts in the Terminology.
Accounting
I Internal audit/external audit
Management accounting
l 1 1 1
Treasurership Planning Financial Cost accounting
(Funding) budgeting accounting (Product and cost
(Cost of centre classification
capital) and recording)
1 > Financial control < '
(Objective return
< on assets)
In the context of SSAP9 (see page 9), cost is defined as being that
expenditure which has been incurred in the normal course of business
in bringing the product or service to its present location and condition.
This expenditure should include, in addition to the cost of purchase,
such costs of conversion as are appropriate to that location and condi-
tion. (SSAP9 paragraph 17.)
These definitions contrast markedly from the economist approach
such as those cited by Armand Layne. For example, Alchian's 1972
definition of cost is 'the highest valued opportunity necessary forsaken'.
The reader will observe a blatant flavour of pure economics here, but
since we will need to consider opportunity costs, choice and implica-
tions for decision making below, the economists' approach should not
be dismissed entirely.
Armand Layne's (1984) own definition of cost accounting is, however,
close in concept to that of the CIMA. He defines cost accounting as 'a
conscious and rational procedure by accountants for accumulating cost
(however defined) and relating such costs to specific products or depart-
ments for effective management action. Such costs are used in balance
sheets and income statements for the purposes of stock valuation and
income determinating'.
As we progress through the book, we shall effectively explore and
Introduction 3
related costs
Uncontrollable costs
Time related costs
Figure 1.1 The costing accounting environment
expand on these two definitions. We shall consider costs, cost collection,
cost analysis and techniques as they relate to goods and services. Like-
wise, we shall look at standards, budgets, analysis of variances or
deviations from standard, and effective utilization of funds.
The environment of cost accounting
Figure 1.1 is designed to illustrate the environment of cost, and the
components of cost. The circle can represent any organization. Costs
within the organization can be controlled and contained. The familiar x
and y axes depict time/activity level and money. It is a basic concept of
accounting that money is always used as a means of measuring. On the
graph are two basic types of cost, fixed or time related and variable or
activity related. An earlier edition of the CIMA Terminology defined fixed
costs as 'a cost which accrues in relation to the passage of time and
which, within certain output and turnover limits, tends to be unaffected
by fluctuations in the level of output or turnover. Examples of such
costs are rent, rates, insurance and staff costs.
The constraint within certain output and turnover limits is vital. From
Figure 1.1 it will be evident that a point can be envisaged where output,
turnover or activity can accelerate away and require not just a similar
acceleration in activity related costs, but an increase in fixed or time
related costs. The most obvious example of this would be a thriving
business where activity expands and reaches a point where additional
premises or equipment are required. By contrast, variable costs are
defined as 'a cost which tends to follow (in the short term) the level of
activity'. Traditionally, examples of such costs have been materials
used, direct labour and selected overheads such as power exclusively
4 Cost Accounting
used to drive machines. Reality nowadays is however, somewhat differ-
ent. Materials are only used if there is activity, something is being
made or sold. However, as a result of legislation, guaranteed wages and
union agreements, labour costs have become virtually fixed in many
western countries, although this trend is likely to be reversed as the
century draws to a close. (Chalos and Bader 1986.) By the same token,
many of the overheads for practical purposes cannot be readily activity
related, or the activity related portion is so relatively small in propor-
tion to the total to be immaterial.
From Figure 1.1, therefore, we can envisage costs as having a rela-
tionship with activity, either as the direct cost of operating the activity,
or as a result of maintaining the level of activity in terms of available
facilities. However, there is a third factor that needs to be considered.
Beyond the circle in Figure 1.1 is the external environment. No orga-
nization can operate independently of its environment. It is the environ-
ment that will dictate the demand for its goods or services, the prices
that can be commanded, the share of the market that can be obtained.
Obviously, the environment, that creates an inelastic demand for the
organization's goods or services will create a different internal environ-
ment from that where competition is tough and prices keenly competed
for. The internal priorities will be very different. Likewise, the environ-
ment can, and will, influence costs, material and labour prices and
availability, as well as the cost of the overheads, many of which will be
very difficult to control or respond to in the short time. All these factors
will have a bearing on the cost accounting procedures and the use of
cost accounting information.
The uses of cost accounting
Effective management needs information. Cost accounting is a set of
procedures which takes raw data, and refines it into usable information.
Some of this information is for what Charles Horngren calls scorekeep-
ing, i.e. ascertaining the cost of any ongoing activity, or even computing
the net revenues. Another type of information is attention directing; that
which is designed to draw management's attention to a situation, and
motivate it into doing something about it. A third category can be
identified as statistics and valuations - the correct valuation of stocks,
the use of cost information and data banks.
Another approach, put forward by Mearns (1981) is that cost account-
ing is needed in the exercising of the management functions of planning,
decision making and control. Combining the two concepts will help us to
perceive the role of the cost accounting function. (See Figure 1.2.)
The reader, as a potential cost accountant will be comforted and
gratified by the fact that cost accounting procedures will be required at
almost every stage of the diagram. Going through the Figure 1.2 we
will find that the cost accountant will be in on the planning process,
costing every aspect of the original plan. Where the alternatives are
