Management Accounting: Cost Concepts

• Module 2 focuses on management accounting and cost concepts, including cost terms, cost concepts, and cost classifications.

Learning Objectives

• Classify costs for assigning to cost objects as direct or indirect.
• Identify and give examples of basic manufacturing costs
• Understand cost classifications for financial statements, distinguishing between product and period costs.
• Understand cost classifications to predict cost behavior, including variable, fixed, and mixed costs.
• Understand cost classifications for decision-making, like differential, sunk, and opportunity costs.

Cost Terms and Concept

• Management accounting involves planning, performance evaluation, and decision-making, relying on cost and revenue data.
• Management accountants must understand different types of costs for various models.
• In both management and financial accounting, cost is a major component
• Misunderstanding cost can lead to incorrect financial statements
• In management accounting, poor cost understanding results in bad decisions.

Cost Accounting Approaches

• Standard costing assigns "standard" costs to the cost of goods sold (COGS) and inventory instead of actual costs.
• Standard costs are based on efficient labor and material use under standard conditions and are essentially budgeted amounts.
• Companies still pay actual costs even when standard costs are assigned
• Variance analysis assesses the difference between standard and actual costs.
• An unfavorable variance occurs when actual costs exceed expected costs.
• A favorable variance occurs when actual costs are less than expected.
• Rate variance relates to the cost of inputs like labor and materials.
• Volume variance relates to the efficiency or quantity of input used.
• When production exceeds expectations, material costs increase due to the total quantity produced.

Activity-Based Costing

• Activity-based costing (ABC) identifies overhead costs from each department and assigns them to specific cost objects
• The ABC system is based on activities like setting up machines or designing products.
• Activities are cost drivers and the basis for allocating overhead costs.
• Traditionally, overhead costs are assigned by machine hours
• ABC uses activity analysis to identify cost drivers, improving cost accuracy and manager reviews of service/product profitability.
• If a company produces both labor-intensive and machine-intensive products, machine hours don't allocate overhead properly
• With ABC, labor-intensive products get overhead related to labor while machine-intensive products get overhead related to machine use.

Lean Accounting

• Lean accounting improves financial management practices within organizations
• Lean accounting extends lean manufacturing philosophy by minimizing waste to optimize productivity.
• Eliminating wasted time allows accounting staff to focus on value-added tasks.
• Traditional costing is replaced with value-based pricing and lean-focused performance measurements under lean accounting.
• Financial decisions are made based on their impact on the company's total value stream profitability.
• Value streams, the source of a company's bottom-line profitability, are the profit centers.

Marginal Costing

• Marginal costing (cost-volume-profit analysis) assesses the impact on a product's cost when adding one more unit.
• It is useful for short-term economic decisions.
• It helps management identify the impact of varying cost levels and volume on operating profit.
• This analysis is used to gain insight on new products, sales prices, and marketing campaign impacts.
• The break-even point is calculated as total fixed costs divided by the contribution margin.
• Contribution margin, or sales revenue less variable costs, can be calculated per unit to see how much a product contributes to overall profit.

Cost Classification

• Cost refers to the expenditure or sacrifice made to acquire something of value.
• In financial accounting, all transactions are recorded at historical cost.
• Cost is the monetary value of an acquired asset and the sacrifice made to acquire resources.
• Cost is measured in monetary units such as the peso in the Philippines.
• If a machine is purchased while trading in a machine with sale value $1,000 and paying $4,000 cash, cost would be $5,000

Classification Categories

• Costs are classified by management function, traceability, timing against revenue, behavior with activity, and relevance to decision-making.

Management Function

• Manufacturing costs are factory expenses to convert raw materials, including direct materials, labor, and factory overhead.
• Non manufacturing costs don't transform materials to finished goods, including selling and administrative expenses.

Traceability

• Direct costs are traced directly to a cost object, like materials and direct labor, but can include some operating expenses like advertising.
• Indirect costs cannot be traced to a cost object and are common or include factory overhead and operating costs that benefit multiple products.

Timing of Charge Against Revenue

• Product costs are inventoriable and are charged against revenue when sold, encompassing manufacturing costs.
• Period costs are not inventoriable and are charged against revenue immediately, including non-manufacturing, selling, and administrative expenses.

Behavior with Activity

• Variable costs change in proportion to activity, like direct materials, labor, and sales commission.
• Fixed costs remain constant regardless of activity, such as rent, insurance, and straight-line depreciation.
• Mixed costs vary in total but not in proportion to activity, including both fixed and variable components like utility costs with a base fee plus usage charges.

Relevance to Decision Making

• Relevant costs differ under alternative actions.
• Standard costs are predetermined based on reasonable factors like past data, budgets, or industry standards and the actual costs are compared.
• Opportunity cost is the forgone benefit of one alternative over another, like renting out a building instead of using it for production.
• Sunk costs are historical and have no impact on decisions.
• Controllable costs are influenced by the manager and used to evaluate segment managers.

Direct Costs

• Direct costs can be easily and conveniently traced to a unit of product or other cost object.
• Direct material and labor are examples.

Indirect Costs

• Indirect costs cannot be easily traced to a unit of product or other cost object.
• Manufacturing overhead serves as an example.

Making Decisions

• Decisions involve choosing between at least two options.
• Relevant costs and benefits differentiate between alternatives.
• The goal is to ignore all other costs and benefits
• Example of differential cost: A job pays $1,500 in your home town or $2,000 per month less $300 in a different city, what are the diff revenues and costs?
• $2,000 - $1,500 = $500 Revenue is the answer
• $300 Commuting cost is the total difference

Opportunity Costs

• Opportunity Costs can be described as the potential benefit given up when one alternative is selected over another
• Example: A $15,000 earning opportunity is forgone to attend college.

Sunk Costs

• Sunk costs historical.
• Sunk costs cannot be changed by any decision.
• They are not differential costs and should be ignored when making decisions.
• Example: A $10,000 car bought two years ago. The cost of the car is not relevant as it cannot be changed, no matter what is done with the car.