Introduction to management

accounting
 What is management accounting?
 A process of producing financial and non-
financial information for managers
 Managers’ needs include information for
planning and control, and short and long term
decisions
 Management accounting covers all levels of
management from senior managers to shop-
floor supervisors
 Management accounting information
 Management accounting provides relevant
information to managers and employees
 Both financial and nonfinancial information
 Useful for making decisions, allocating resources,
and monitoring, evaluating, and rewarding
performance
 Customized to serve multiple purposes
 Management accounting information
 Management accounting provides information
for different purposes
 for costing of goods, services and organizational
units
 To serve budgeting process
 About performance measurement
 As ad hoc information for short and long term
decision making
Financial and management accounting
 Management accounting information
 Management accounting provides information
for different purposes
 for costing of goods, services and organizational
units
 To serve budgeting process
 About performance measurement
 As ad hoc information for short and long term
decision making
Components of management accounting
 Costing system - cost of products and
organizational units
 Budgeting system - planned revenues and
costs
 Performance measurement - differences
between planned and actual performance
 Cost management - managing the causes of
cost
 What does cost mean?
 The word “cost” has many meanings
 Costs are developed and used for some specific
purpose
 The way the cost is to be used will define the way
it should be computed
 Management accountants have used different
systems, or classifications, to develop cost
information
 Cost definition
 Resources given up to achieve a particular
(cost) objective
 Cost object: Anything for which a separate
measurement of costs is desired
 a product; service;
 project;
 customer;
 activity;
 product line
 Cost classifications
 Different types of costs are classified based on
purposes of the users of the information
 The classification of costs is relative
 Cost classifications
direct vs. indirect costs
 Direct cost
 costs that are related to the particular cost object
and that can be traced to it in an economically
feasible (cost-effective) way
 Indirect
 costs that are related to the particular cost object
but cannot be traced to it in an economically
feasible (cost-effective) way
 Cost classifications
direct vs. indirect costs
 The classification of costs as direct or indirect
can vary as the chosen cost object varies
 Consider a factory supervisor’s salary
 If the cost object is a product the factory
supervisor’s salary is an indirect cost
 If the factory is the cost object, the factory
supervisor’s salary is a direct cost
 Cost classifications
in relation to business processes
Customer
R&D Design Production Marketing Distribution
Service
Costs Costs Costs Costs Costs
Costs

 Production (manufacturing) costs

 Direct materials
 Direct labor
 Production (manufacturing) overheads
 Non-production (non-manufacturing) costs
 Marketing/selling costs
 Administrative costs
 Research and development
 Product design
 Cost classifications
Product cost vs. period cost
 Product cost (inventoriable costs)
 costs of purchasing or manufacturing of goods
 Period cost
 associated with time periods
 Cost classifications
Product cost vs. period cost

BALANCE INCOME
SHEET STATEMENT

PRODUCT
As When is COST OF
INVENTORY
COST incurred sold GOODS SOLD

PERIOD As OPERATING
COST EXPENSE
incurred
Flow of product costs
 Cost behavior
 Different costs vary differently when the level
of activity changes
 Variable costs
 Vary in proportion to changes in the level of
activity
 Fixed costs
 Remain constant in total, regardless of changes in
the level of activity
 Cost behavior

Fixed cost Variable cost

Total

Total
costs

costs
Units Units
 Cost behavior
 The classification of variable and fixed costs is
relative. It is valid in a relevant range of
activity only
 Relevant range is the limit of activity level
within which a specific relationship between
costs and the activity is valid
 Cost behavior
step cost
Total costs

Units
 Cost behavior – different patterns
 Step-fixed costs
 fixed over a range of activity, but jumps to a
different amount for levels outside that range
 Semivariable costs
 fixed and variable components
 Curvilinear costs
 approximated as a curved line
 Cost behavior

Semi-variable cost Curvilinear cost

Total cost
Total costs

Total costs
Var cost
component

Fixed cost
component

Units Units
 Cost estimation
 Cost is an important factor in making
managerial decisions
 Management needs to estimate costs in
assessing and predicting performance
 Cost estimation is done based on the
relationship between cost items and levels of
activity
 Cost estimation
 In reality few costs vary purely in proportion
with levels of activities (pure linear)
Management needs to predict the behavior of
cost in order to forecast the results of the
decisions
 Some approaches cosinclude
 visual fit method
 high-low method
 regression analysis
 Cost estimation
high-low method
 Estimate a cost function by considering data at
the highest and lowest levels of activity
 More objective than visual fit
 Uses only two data points, and ignores the rest
 Procedure
 Estimate variable cost rate (per unit of activity)
 Estimate fixed portion of cost
 Other cost concepts
 Opportunity cost
 An opportunity cost is the sacrifice you make when you use
a resource for one purpose instead of another
 Opportunity costs are implicit costs that do not appear
anywhere in the accounting records
 Management accountants often use the concept of
opportunity cost
 Sunk cost
 A sunk cost is a cost that has already been incurred and that
cannot be changed by any decision made now or in the future
 They should not be used in analyzing future courses of action
 Costing concepts
 Cost object
 Cost center
 Cost unit
 Costing concepts
 Cost Accumulation – the collection of cost
data in an organized way by means of an
accounting system
 Cost Assignment – a general term that
encompasses the gathering of accumulated
costs to a cost object in two ways:
 Tracing costs with a direct relationship to the cost
object, and
 Allocating accumulated costs with an indirect
relationship to a cost object.
 Building blocks of costing system
Cost Tracing
Direct
Costs
Cost Cost
Assignment Cost Allocation Object
Indirect
Costs

 Cost object - anything for which a separate measurement of costs

is desired.
 Direct costs of a cost object - costs that are related to the
particular cost object and can be traced to it in an economically
feasible (cost-effective) way.
 Indirect costs of a cost object - costs that are related to the
particular cost object but cannot be traced to it in an
economically feasible way. Indirect costs are allocated to the
cost object.
 Methods of costing
 Be different in accounting for product cost
 Absorption (full) costing
 All manufacturing (production) costs are treated as
product cost regardless of whether they are
variable or fixed
 Variable (marginal) costing
 Only those manufacturing costs that vary with
output (i.e. variable manufacturing costs) are
treated as product costs