Cost and Management Accounting Systems

Cost and Management Accounting Systems

• Inventory valuation for internal and external profit measurement is a primary function
• Relevant information is given to managers to help with decision making
• Information is provided for planning, control, and performance measurement
• Costs need to be assembled to meet different requirements

Cost Object

• This is any activity or entity for which a separate measurement of cost is required
• Examples include the cost of making a product or providing a service
• A cost collection system accounts for costs in two stages:
• Accumulating costs by classification (labor, materials, overheads)
• Assigning costs to cost objects

Manufacturing Costs

• Direct materials, direct labor, and manufacturing overhead are combined
• Prime cost consist of direct materials and direct labour
• Conversion cost consists of direct labor and manufacturing overhead

Direct Material

• Integration into the product is key.
• It must be conveniently traced directly to it.
• A car radio is an example

Direct Labour

• Labour costs must be easily traced to individual units of product
• Wages paid to car assembly workers are an example

Manufacturing Overhead

• Manufacturing costs cannot be traced directly to specified units produced
• Indirect labor and indirect materials are examples
• Wages to maintenance workers, cleaners, and security guards are examples of indirect labour
• Lubricants and cleaning supplies used in the car assembly plant are examples of indirect materials

Non-Manufacturing Costs

• Costs are sub-classified into two categories: marketing or selling costs, and administrative costs.
• Marketing or selling costs are costs to get the finished product or service to the customer
• Executive, organizational, and clerical costs are administrative costs

Product vs Period Costs

• Product costs are attached to the products
• Product costs are included in the stock (inventory valuation).
• Period costs are not attached to the product
• Product costs are not included in the inventory valuation

Cost Classifications

• Preparing external financial statements:
• Product costs (inventoriable)
• Direct materials
• Direct labour
• Manufacturing overheads
• Period costs (expensed)
• Non-manufacturing costs
• Marketing or selling costs
• Administrative costs
• Predicting cost behavior in response to changes in activity:
• Variable cost (proportional to activity)
• Fixed cost (constant in total)
• Assigning costs to cost objects such as departments or products:
• Direct cost
• Indirect cost
• Making decisions:
• Differential cost
• Sunk cost
• Opportunity cost

Cost Flows

• Costs flow from raw materials to the balance sheet, at which point the raw materials enter production
• Direct labor is used in work in process stock
• Manufacturing overhead also enters work in process stock
• All of these completed goods enter finished goods stock
• From finished goods stock, the goods sold go to profit and loss account: costs of goods sold
• Selling and administrative costs are period costs, which enter selling and administrative expenses
• Raw Materials Stock -> Work in Process stock -> Finished Goods stock -> Costs of goods sold

Profit and Loss Statement

• Cost of goods sold for manufacturers differs slightly from cost of goods sold for merchandisers
• In a merchandizing company, cost of goods sold is equal to = Beginning merchandise inventory + purchases- ending merchandise inventory
• For a manufacturing company, cost of goods sold = Beginning finished goods inventory + cost of goods manufactured - ending finished goods inventory

Product Costs: A Closer Look

• Raw Materials -> Beginning raw materials inventory + raw materials purchased = raw materials available for use in production – Ending raw materials inventory = Raw materials used in production
• Manufacturing costs: direct materials + direct labour + mfg. overhead = total manufacturing costs
• As items are removed from raw materials stock and placed into the production process, they are called direct materials
• Work in progress: beginning work in process inventory + Total manufacturing costs = total work in process for the period- ending work in process inventory = cost of goods manufactured

Costing in Service Organisations

• Services can not be stored as inventory (closing stock)
• Service Outputs are often specially customized for a client making them heterogeneous rather than homogeneous
• Services cannot be counted, measured, inspected, tested or verified in advance of sale - intangible.

Assigning Costs

• Costs are assigned to objects for a variety of purposes
• These include pricing, profitability studies and control of spending
• A cost object is anything for which cost data are desired
• Products, product lines, customers, jobs and organizational subunits are cost objects
• Costs are classified as either direct or indirect

Direct Costs

• Costs that can be easily and conveniently traced to a unit of product or other cost objective
• Direct material and direct labour are examples

Indirect Cost

• Costs that cannot be easily and conveniently traced to a unit of product or other cost object
• Manufacturing overhead is an example

Classification By Cost Behavior

• Planning and controlling the activities of an organization require accurate estimates of future fixed and variable costs.
• A variable cost is a cost that varies, in total, in direct proportion to changes in the level of activity.
• A fixed cost is a cost that remains constant, in total, regardless of changes in the level of activity

Cost Behaviour Examples

• Variable Costs:

• Merchandisers: Cost of Goods Sold

• Manufacturers: Direct Material, Direct labour, and Variable Manufacturing Overhead

• Merchandisers and Manufacturers: Sales commissions and shipping costs

• Fixed Costs:

• Merchandisers, manufacturers, and service organisations: Real estate taxes, Insurance, Sales salaries, Depreciation, Advertising

Cost Classifications (cont.)

• A variable cost varies in total, in direct proportion to changes in activity level.
• A fixed cost remains constant in total, regardless of activity level changes.
• Unit fixed costs will decrease as volume increases.
• Unit variable costs will remain constant as volume increases.
• Total variable costs will increase as volume increases.
• Total fixed costs will remain constant as volume increases within the relevant range of activity.

Cost Behavior and Relevant Range

• Cost behavior is defined as the way in which costs change in response to changes in some underlying activity
• Examples of underlying activity include sales volume, production volume, or orders processed
• The relevant range can be defined as the range of activity within which assumptions relative to variable and fixed cost behavior are valid.

Types of Fixed Costs

• Committed - Long term, cannot be reduced in the short term e.g. Depreciation on Buildings and Equipment
• Discretionary - May be altered in the short-term by current managerial decisions e.g.Advertising and Research and Development

Cost Curves

• Fixed costs
• Total cost is fixed
• Unit cost is high at low levels, and drops as production volume goes up
• Variable Costs
• Fixed unit costs
• Total costs increase with volume

Cost Types

• Variable and Fixed Costs

• Total variable cost increases and decreases in proportion to changes in the activity level.

• Total fixed cost is not affected by changes in the activity level within the relevant range.

• Variable costs remain constant per unit/ Fixed costs decrease per unit

• Semi-fixed costs are fixed within specified activity levels.

• Increase or decrease by some constant amount at critical activity levels

• Semi-variable costs include both a fixed and a variable component (e.g. telephone charges).

Mixed Costs

• Mixed costs have both fixed and variable components.
• Total mixed cost = Fixed Monthly Utility Charge + Variable Utility Charge (Y = a + bX)

Decision Making

• A differential cost is a difference in costs between any two alternatives
• An opportunity cost is the potential benefit that is given up when one alternative is selected over another
• A sunk cost is a cost that has already been incurred and cannot be changed by any decision now or in the future

Maintaining a Cost Database

• A cost database should generate information for inventory valuation for internal and external profit measurement.
• The database should assist with providing relevant information to help managers make better decisions
• The database should give information for planning, control and performance measurement
• A database should be maintained, with costs appropriately coded and classified so that relevant information can be extracted

Management Accounting

• Management Accounting is concerned with the provision of information to people within the organization
• Goal is to help them make better decisions and improve the efficiency and effectiveness of existing operations
• Management accounting measures and reports financial and non-financial information to fulfil the goals of the organisation
• Financial accounting focuses on reporting to external parties

Financial vs Management Accounting

• Financial accounting:
• External users
• Focus on the past
• Verifiability
• Emphasis on precision
• Focus on whole organization
• Must follow GAAP
• Management accounting:
• Internal managers
• Focus on the future
• Emphasis on relevance
• Emphasis on timeliness
• Focus on segments of the organization
• Need not follow GAAP

Role of Management Accountant

• Planning: Deciding on organisation goals, predicting results under various alternative ways of achieving those goals
• Control: Deciding and taking actions that implement the planning decisions and performance evaluation
• Budgets: Quantitative expressions of a proposed plan of action by management for a future time period and is an aid to the coordination and implementation of the plan

Performance Reports

• A performance report compares actual results with budgeted amounts
• The performance report indicates if actual revenues exceeded the budgeted amount
• A Performance Report could spur investigation and further decisions

Key Themes

• Customer Focus and Continuous Improvement
• Key Success Factors
• Cost
• Quality
• Ti