ACC/ACF2200 Management Accounting

Management Accounting: Info. for Creating Value and Managing Resources

Definition of Management Accounting & how it differs from Financial Accounting

 MA: the processes and techniques that focus on the effective and efficient use of
organisational resources to support managers in their tasks of enhancing both
customer value and shareholder value
o Customer value
 The value that a customer places on particular features of a product or
service
o Shareholder value
 The value that shareholders or owners place on a business
o Resources
 Economical – including info., work processes, employees, committed
customers and suppliers
 Determine the capabilities and competencies of the organisation

 Financial Accounting
o The practice of preparing and reporting accounting info. for parties outside the
organisation
o Governed by rules/regulations

 FA v MA

Management Accounting System (MAS)

Info. system that produces required info. by managers to create value and manage resources
 Includes:
o Estimates of production costs of goods/services
o Info. for planning & controlling operations
o Info. for measuring performance
o Info. for determining future plans & strategy

Management Accounting Processes & Techniques

  Supporting organisation’s formulation and implementation of strategy
 Contribution to improvement of the organisation’s competitive advantage via the
following aspects:
o Quality
o Delivery
o Time
o Flexibility
o Innovation & Cost
o Modern process improvement
o Cost management techniques
 Providing info. to help manage resources (via planning & controlling)
 Providing estimates of costs of goods & services – used by managers in making
decisions
 Overall, providing info. to support strategic & operational needs of managers

Planning & Control

 Planning
o Formulating direction of future operations
o Consider and specify resources needs in the future
 Control
o Ensure operations proceed accordingly to plan
o MA info. provides info for control by comparing actual performance with
plans, targets or budgets
o Control systems are the systems and procedures that provide regular
information to assist in control
 Cost Terms & Concepts

Definition & Importance of Costs

 Costs = resources given up to achieve a particular objective
 Importance of costs:
o Short-term & Long-term decisions require an understanding of costs
o Important source of information for decision-making, managing resources, and
creating customer and shareholder value

Traditional Approaches to Costing

 Monitors financial performance
 Controls what’s going on inside the organisation
 Provides info. to help managers control cost
 Looks at difference between actual & planned/budgeted costs
 Estimates costs of organisational units (e.g. departments) and/or products (goods &
services)
 Assumes that production volume is the only factor that can cause costs to change
 Info. is mainly obtained from financial accounting system

Modern Approaches to Costing

 Pro-active and detailed in providing info. to manage resources
 Emphasises non-financial and qualitative info.
o For e.g. quality, delivery, innovation, sustainability etc.
 Focuses on a broader range of costs
o For e.g. in relation to customers, competitors, suppliers etc.
 Focus is not only to control costs but to reduce them
 The real ‘root’ causes of costs are analysed, and wasteful activities are identified and
eliminated

Different Costs for Different Purposes

 The same cost can be classified in a number of ways depending on the intended use of
the cost information
o The total amount ($) of cost does not change; only the way we look at it

Behaviour – Cost Classification

1. Identify level of activity
2. If cost is significantly impacted by level of activity = variable, if not = fixed

Traceability – Cost Classification

 Cost objects are the items for which management wants a separate measure of costs
o Traditional costing systems – products, projects, contracts and departments
o Modern costing systems – activities, customers and suppliers as cost objects
 Direct cost – can be traced to a cost object in an economic manner
o Clear, observable relationship between the cost and the cost object
o Easy to calculate the cost
o E.g. Paper, Wages
  Indirect cost – cannot be traced to the cost in an economic manner
o No direct relationship with the cost object, it has to be apportioned or allocated
o E.g. Glue, salary of forklift driver or production supervisor

1. Identify the cost object

2. Is there a easily calculable relationship between the cost and the cost object?
3. If yes – direct, If no – indirect

Controllability – Cost Classification

 Manager’s performance evaluation can be enhanced by classifying responsibility
centre costs as either controllable by the manager or uncontrollable
 Ideally, managers should be held responsible for costs they can control or
significantly influence
 Some costs are controllable in the long term but not in the short term
Responsibility Centres
 A responsibility centre is a unit of an organisation where the manager is held
accountable for the unit’s activities and performance
 The costing system may measure the costs of managers’ individual areas of
responsibility
 Responsibility accounting - holding managers accountable only for the costs that they
are directly responsible for

Position in the Value Chain – Cost Classification

 The value chain:
o A set of linked processes or activities that begins with acquiring resources and
ends with providing and supporting products and services that customers value
Upstream costs =
o Research and development costs
o Design costs
o Supply costs
Downstream Costs =
o Marketing costs
o Distribution costs
o Customer service costs
Manufacturing Costs
o Manufacturing costs are incurred within the factory area
o Modern costing systems – product costs include an allocation of upstream and
downstream costs
o Direct Manufacturing Costs
o Direct material
o Direct labour
o Indirect Manufacturing Costs
o Manufacturing overhead =
 Depreciation
 Insurance
 Utilities
 Overtime premium
o Conversion costs = Direct labour cost + Manufacturing overhead cost
 o The cost of converting material into a product
o Prime costs = Direct material cost + Direct labour cost
o The major cost associated with producing a product
o Manufacturing Cost = DM + DL + MOH

Timing – Cost Classification

 Product costs:
o A cost that is assigned to goods that were either manufactured or purchased
for resale
o Used to value inventory and cost of goods sold in the balance sheet and
income statement
o The product cost is regarded as an asset or inventoriable cost until good is sold
 Period costs
o All costs that are not product costs
o Selling and administrative expenses
o Expensed in the period in which they are incurred rather than passing through
various stages of inventory
o In service firms, all costs are period costs
Cost Behaviour, Cost Drivers & Cost Estimation
Estimation of Cost Behaviour
 Use of cost drivers
 Cost Drivers
o An activity or factor that drives a cost to be incurred
o Consideration needs to be given about the underlying causes of the costs
o What drives it to go up or down
o E.g. A Spray Painting Business
 The cost of paint increases
 As there is an increase in no of cars sprayed
 Cost Driver = No of Cars

Cost Drivers
Conventional approach:
- Uses volume-based cost drivers
- Assumes that all costs are driven by organisation’s level of activity
- This would be accurate for direct product costs such as direct material and labour
Contemporary approach:
- Recognises that there are a range of possible cost drivers other than production
volume that explain cost behaviour
- Uses both volume & non-volume based cost drivers

Activity-Based Approach to Cost Drivers

Classifies costs and drivers into four levels:
- Unit level
o Relate to activities performed for each unit produced
o Use conventional volume-based cost drivers
- Batch level
o Relate to activites performed for a group of product units
o Examples include a batch or a delivery load
- Product (or product-sustaining) level
o Relates to activities performed for specific products or product groups
o E.g. Research & design costs
- Facility level
o Also called facility-sustaining costs
 o Costs incurred to run the business, not caused by any particular product

Cost Behaviour Patterns

- Variable costs
o Change in total
o Direct proportion to changes of level of activity
o Variable cost of cost per unit remain constant
- Fixed costs
o Remain unchanged in total despite changes in level of activity
o Fixed cost per unit changed
- Step-fixed costs

o Remain fixed over a wide range of activity levels but jump to a different
amount for levels outside that range
- Semivariable costs
o Has both fixed and variable components
 - Curvilinear costs
o At lower levels of activity there is a decreasing marginal cost
o At higher levels of activity there is increasing marginal costs
o Marginal cost: the cost of producing one additional unit

Quantitative Analysis
Three Approaches:
- Visual fit method
- High-low method
o Looking at the min and max level of activity (and their corresponding costs)
not the min and max costs
- Regression analysis
o A statistical technique used to estimate the relationship used to estimate the
relationship between a dependent variable (cost) and independent variables
(cost drivers)
o Simple regression: one independent variable
o Multiple regression: multiple independent variables

Evaluating the Regression Line

- R^2 – measures the proportion of change in the dependent variable that is explained
by a change in the independent variable
- R^2 – and adjusted to compensate for a small sample size

Data Collection Problems

- Missing data
- Outliers
- Mismatched time periods
- Trade-offs
- Allocation of fixed costs
- Inflation
- Effect of learning – labour cots decrease over time
 Product Costing Systems

Scope of Product Costs

Allocating Overhead Costs to Products

 To estimate the cost of a product we need to identify the cost of resources used to
produce the product
 Some resources are consumed directly by products and are traced directly to each
product
 Direct material and direct labour
o Overhead costs are essential to production but as they have no observable
relationship with the product they need to be allocated to products
o These cost are indirect costs to the product

Steps in Allocating Overhead (OH) Costs to Products

1. Aggregate overhead costs into cost pools
2. Identify the overhead cost driver
3. Calculate a predetermined (or budgeted) overhead rate per unit
a. E.g. If annual OH budget = $7.5M
Annual labour budget = 50K hours
Budgeted OH rate = $150/hr
4. Apply manufacturing overhead costs to products at the budgeted (or predetermined)
overhead rate, multiplied by the actual quantity of cost driver consumed by the
product
a. E.g. if producing a product required 10 labour hours, $1500 of overhead
would be applied to the product ($150x10)

Accounting for Manufacturing Overhead

Two types of manufacturing overhead are recorded
- Applied manufacturing overhead
o Estimate of manufacturing overhead used to manufacture a product
o Applied to products using a predetermined OH rate
o Credited to the manufacturing overhead account
 - Actual manufacturing overhead
o Actual manufacturing overhead costs incurred throughout the accounting
period
o Might be different to applied manufacturing overhead
o Debited to the manufacturing overhead account

At the end of the accounting period, total actual manufacturing overhead may not equal total
applied manufacturing overhead
Disposing of underapplied or overapplied overhead at the end of the accounting period. Two
options:
- Close the underapplied or overapplied overhead to cost of goods sold
- Prorate the underapplied or overapplied overhead to cost of goods sold, work in
process inventory and finished goods inventory

Types of Product Costing Systems

Conventional product costing systems range from job costing to process costing
- Depends on the type of product being produced and the production environment

Process Costing
Production costs traced to process/department and averaged across all units produced
Mass production or repetitive processes environment
Steps in determining product cost:
1. Estimate the cost of production processes
2. Calculate the average cost per unit by dividing the cost of the process by the number
of units produced
Where there are sequential processes or departments, costs are transferred from one
department to the next at an average unit cost for the department

Job Costing Systems

Manufacturing costs traced to individual jobs
Products produced are significantly different and may be produced in distinct jobs/batches
- Used by printers, furniture manufacturers, machinery manufacturers
- Use in service firms such as lawyers, accountants, consulting engineer

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 Process Costing & Operation Costing

Job Costing vs Process Costing

- Job costing & process costing are two extremes of the continuum of conventional
product costing systems
- Job costing systems accumulate the costs of each job
- Process costing systems accumulate the cost of each process then average these costs
across all units produced
- Most businesses use a combination of job and process costing; hybrid costing

Process Costing
1. Estimate the cost of the production process
2. Calculate the average cost per unit by dividing the cost of the process by the number
of units produced

Process Costing with Working In Process (WIP)

- Not all products are complete at the beginning or end of the accounting period
(usually a month)
- Sometimes production costs differ from month to month
- So … when WIP exists, production costs should be calculated by taking into account:
o Units started in the previous month (beginning WIP) and completed in the
current month … maybe at a different cost
o Units started and completed during the current month
o Units that are incomplete at the end of the month (engin WIP)… and therefore,
haven’t consumed all their costs yet
- Partially completed goods at the beginning or end of the accounting period are
converted to equivalent units for costing purposes
- Equivalent Units:
o The amount of production inputs that have been applied to the physical units
in production
o Physical units are all units currently in production whether complete or
incomplete
o Conversion of WIP inventory into equivalent units provides the basis for
calculating product cost
Equivalent Units
Calculation of equivalent units:
For WIP of 10,000 litres of a carbonated beverage:
- 100% complete for direct materials, which were all added at the start of the process 
10,000 equivalent units of material
- 50% complete for conversion costs, assuming that conversion costs occur uniformly
across the production process  5,000 equivalent units of conversion

Uses of the Process Costing Report

- Enables managers to estimate and value the cost of inventories
o Inventory values become an input into the Cost of Goods Manufactured, Cost
of Goods Sold and Income Statement
- The unit costs for materials, conversion and in total:
o Provide key inputs into management decisions relating to product price and
product mix
o Provide a basis for assessing product profitability
o Used for control purposes by comparing unit costs over time or with industry
benchmarks

Steps in Process Costing

1. Analyse the physical flow of units
2. Calculate the equivalent units
3. Calculate the unit costs
 4. Analyse the total costs
Products are costed using one of the two assumptions about product flow:
- Weighted Averaged Method
- First-in, First-out (FIFO) method
Comparison
- FIFO assumes that the WIP inventory is completed before the production of new unit
commences
- The weighted average does not make this assumption; it does not distinguish between
opening WIP units and units started during current period

When to Use Weighted Average or FIFO

- The weighted average cost method is most commonly used where inventories are
piled or mixed together and cannot be differentiated, such as chemicals, oils
- FIFO often used in foodstuffs and other goods that have a limited shelf life, because
the oldest goods need to be sold before they pass their sell-by date

Weighted Average Method

1. Analyse the physical flow of units
2. Calculate the Equivalent Units for units completed and transferred out & ending WIP.
The equivalent units in beginning WIP are not identified separately.

3. Calculate the unit costs

- The cost per equivalent unit for DM is the total direct material costs divided by the
total equivalent units for DM
- The cost per equivalent unit for conversion cost is the total conversion cost divided by
the total equivalent units for conversion
- Under the weighted average method the cost per equivalent unit is based on the total
costs incurred including the cost of beginning WIP

4. Analyse the total costs

- Calculate the following:
1. The cost of units completed in June
2. The cost (to date) of closing WIP at the end of June