Lesson 13 Managerial Accounting: Concepts and Principles Task Team of FUNDAMENTAL ACCOUNTING School of Business, Sun Yat-sen University

Lesson 13 Managerial Accounting: Concepts and Principles

Task Team ofFUNDAMENTAL ACCOUNTINGSchool of Business, Sun Yat-sen University

Outline

• What is managerial accounting?• Comparison between managerial accounting and

financial accounting• Cost classifications in different ways • Flow of manufacturing activities• Job order cost accounting systems and process cost

accounting systems• Cost allocation

2

Introduction• The previous 12 chapters focus on the financial

accounting topics– Please summarize the basic points of financial accounting

• Users/ Time focus/ Emphasis/ Importance/ Subject focus/ Requirements

– Thinking• Is the information provided by financial accounting enough for an

enterprise to conduct its operation and management?• If not, how to satisfy this demand for the internal used information?• Have you ever heard “managerial accounting”?

3

What is Managerial Accounting?

• An activity that provides financial and nonfinancial information to managers and other internal decision makers

• Is quite important to planning, control, and decision making activities

4

The Environment of Managerial Accounting

5

Managerial Accounting and Financial Accounting

6

Cost Classifications

• Costs can be classified by:– Relevance– Behaviour– Controllability– Traceability– Function

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Costs Classification by Relevance• Relevant

– If costs influence a decision• Costs that are applicable to a particular decision.• Costs that should have a bearing on which alternative a

manager selects.• Costs that are avoidable.• Future costs that differ between alternatives.

• Irrelevant– If costs do not influence a decision

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Costs Classification by Relevance

• Sunk Costs– All costs incurred in the past that cannot be changed by any

decision made now or in the future.– should not be considered in decisions.– Irrelevant– Example: You bought an automobile that cost $30,000 two

years ago. The $30,000 cost is sunk because whether you drive it, park it, trade it, or sell it, you cannot change the $30,000 cost.

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• Out-of-pocket costs– require future outlays of cash– associated with a particular decision– relevant for future decisions– Example: Considering the decision to take a

vacation or stay at home, if you choose a vacation, you will only have travel costs (out-of-pocket costs).

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• Opportunity Costs– The potential benefit that is given up when one

alternative is selected over another.– Example: If you were not attending college or

university, you could be earning $25,000 per year. Your opportunity cost of attending college or university for one year is $25,000.

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Costs Classification by Behavior

• Cost behavior refers to– how a cost will react to changes in the level of

business activity.

• Fixed costs – do not change when activity changes.

• Variable costs – change in proportion to changes in the volume of

activity

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Costs Classification by Behavior

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• Total fixed costs remain unchangedwhen activity changes within a relevant range.

• Fixed costs per unit decline as activity increases.

Volume of ActivityVolume of Activity

Fix

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osts

per

uni

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ixed

cos

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nit

Volume of ActivityVolume of Activity

Tot

al fi

xed

cost

sT

otal

fixe

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sts

Costs Classification by Behaviour

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• Total variable costs change when activity changes.• Variable costs per unit do not change as activity

increases.

Volume of activityVolume of activity

Tot

al v

aria

ble

cost

sT

otal

var

iabl

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sts

Volume of activityVolume of activityVar

iabl

e co

sts

per

unit

Var

iabl

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sts

per

unit

Costs Classification by Behavior• Mixed costs

– contain a combination of fixed and variable costs.

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Variable Variable

Sales CommissionsSales Commissions

Sales Sales

Tot

al C

ompe

nsat

ion

Tot

al C

ompe

nsat

ion

Total mixed cost

Total mixed cost

Fixed Fixed

Monthly salaryMonthly salary

Costs Classification by Behaviour• Step-Wise Costs

– remain fixed over limited ranges of volumes but increase by a lump sum when volume increases beyond maximum amounts.

– Example: additional production supervisors must be added when another shift is added.

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Su

perv

iso

ry S

ala

ries

Su

perv

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ries

Production VolumeProduction Volume

Costs Classification by Controllability

• Controllable vs. not controllable– depends upon the employee’s responsibilities.– Example: A lower level manager may have control

over overtime costs but not over the purchase of high-cost machinery.

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Costs Classification by Traceability

• Management often traces costs to cost objects – To obtain a better measure of their total cost– Cost objects include

• Products• Services• Departments• Divisions• Customer groups

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Costs Classification by Traceability

• Traceable costs are classified as– Direct costs

• can be conveniently traced to a unit of product or other cost objective.

• Examples: salaries of production workers, salary of maintenance department employees.

– Indirect costs• must be allocated to a unit of product or other cost

objective.• Examples: factory rent, factory light and heat, factory

accounting costs.

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Costs Classification by Function• Manufacturing Costs

– are necessary and integral to the production of finished goods.

– Examples: direct labour, direct materials, and manufacturing overhead.

• Non-Manufacturing Costs– are not integral to the manufacture of finished

goods.– Examples: selling and administrative expenses.

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Costs Classification by Function

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ManufacturingManufacturingCostsCosts

ManufacturingManufacturingCostsCosts

DirectDirectMaterialMaterial

DirectDirectMaterialMaterial

DirectDirectLabourLabour


ManufacturingManufacturingOverheadOverhead

ManufacturingManufacturingOverheadOverhead

Costs Classification by Function• Direct materials

– Materials that are clearly and easily identified with a particular product.

– Example: Steel used to manufacture an automobile

• Direct labour– Labour costs that are clearly traceable to, or readily

identifiable with, the finished product.– Example: Wages paid to an automobile assembly

worker.

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• Manufacturing overhead– All manufacturing costs except direct material and

direct labour.– Manufacturing costs that cannot be traced directly

to specific units produced.– Examples:

• Indirect labour – maintenance• Indirect material – cleaning supplies• Factory utility costs• Supervisory costs

23


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Manufacturing costs are oftencombined as follows:


• Non-Manufacturing costs (period costs) are expenses not charged to the product.– Selling Costs

• Costs incurred to obtain customer orders and to deliver finished goods to customers —advertising and shipping.

– Administrative Costs• Non-manufacturing costs of staff support and

administrative functions —accounting, data processing, personnel, research and development.

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Discussions• ABC company manufactures a portable radio

designed for mounting on the wall of the bathroom. The following list represents some of the different types of costs incurred in the manufacture of these radios:

1. The plant manager's salary.2. The cost of heating the plant.3. The cost of heating executive offices.4. The cost of printed circuit boards used in the radios.5. Salaries and commissions of company salespersons.

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Discussions6. Depreciation on office equipment used in the executive

offices.7. Depreciation on production equipment used in plant.8. Wages of janitorial personnel who clean the plant.9. The cost of insurance on the plant building.10. The cost of electricity to light the plant.11. The cost of electricity to power plant equipment.12. The cost of maintaining and repairing equipment in the

plant.13. The cost of printing promotional materials for trade

shows.14. The cost of solder used in assembling the radios.15. The cost of telephone service for the executive offices.

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Discussions

• Required:– Classify each of the items above as product

cost or period costs.

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Discussions: the answer

1 Product 6 Period 11 Product

2 Product 7 Product 12 Product

3 Period 8 Product 13 Period

4 Product 9 Product 14 Product

5 Period 10 Product 15 Period

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Flow of Manufacturing Activities

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Raw Materials

Beginning Inventory

Raw Materials

Purchases

Goods in Process

Beginning InventoryFinished Goods

Beginning Inventory

Raw Materials Used

Direct Labour Used

Materials ActivityMaterials Activity

(raw materials)(raw materials)

Financial ReportsFinancial Reports Raw MaterialsRaw MaterialsEnding Inv.Ending Inv.

(balance sheet)(balance sheet)

Production ActivityProduction Activity

(goods in process)(goods in process)

Goods in ProcessGoods in ProcessEnding Inv.Ending Inv.


Finished GoodsFinished GoodsEnding Inv.Ending Inv.


Cost of Goods Cost of Goods Sold (income Sold (income

statement)statement)

Marketing ActivityMarketing Activity

(finished goods)(finished goods)

Goods

Manufactured

Factory Overhead

Used

Job Order Cost Accounting Systems• Job Order Cost Accounting Systems

– The production of products in response to special orders.

– quite flexible in the number of products they can produce.

• Jobs involving the production of more than one unit of product are called job lots.

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Job Order Cost Accounting Systems

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Goods inGoods in Process Process

Goods inGoods in Process Process

Cost of Cost of GoodsGoodsSoldSold

Cost of Cost of GoodsGoodsSoldSold

LabourLabourLabourLabour

MaterialsMaterialsMaterialsMaterials

Indirect

Indirect

Indirect

Indirect

FinishedFinishedGoodsGoods


FactoryFactoryOverheadOverhead

FactoryFactoryOverheadOverhead

DirectDirect

DirectDirect

AllocateAllocate CompletedCompleted

DeliveredDelivered

Job Order Cost Accounting Systems

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DirectMaterials

DirectMaterials

Cost per unit for Job No. 1


DirectLabour

DirectLabour

FactoryOverhead

FactoryOverhead

Job No. 1Job No. 1 Finished Goods

Finished Goods

Job No. 2Job No. 2 Finished Goods

Finished Goods



Process Cost Accounting Systems

• Process Cost Accounting Systems – Used for production of small, identical, low- cost

items.– Mass produced in automated continuous

production process.– Costs cannot be directly traced to each unit of

product.

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DirectDirectMaterialsMaterials

DirectDirectMaterialsMaterials





FactoryFactoryOverhead Overhead

FactoryFactoryOverhead Overhead

Process 1Process 1Process 1Process 1 Process 2Process 2Process 2Process 2

Cost per Cost per equivalent equivalent

unit for unit for Process 1Process 1







Total cost Total cost per per

equivalent equivalent unitunit

Total cost Total cost per per

equivalent equivalent unitunit

• Unit cost – To determine the cost of goods transferred from

department to department and to finished goods, we need to calculate unit cost.

– Unit cost is computed by dividing the accumulated costs by the number of equivalent units produced in the period.

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Cost perCost perequivalent equivalent

unitunit

Cost perCost perequivalent equivalent

unitunit

== Product costs for the periodProduct costs for the periodEquivalent units for the periodEquivalent units for the periodProduct costs for the periodProduct costs for the period

Equivalent units for the periodEquivalent units for the period


• Costs are accumulated for a period of time by process or department.

• Equivalent units is a concept expressing a number of partially completed units as a smaller number of fully completed units.– Example: Three one-third full pitchers are

equivalent to one full pitcher.– Equivalent units may be different for material and

labour and overhead at different stages of a process.

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Comparing Job Order and Process Production

• Similarities– Same objective

• to determine the cost of products

– Same inventory accounts• raw materials, goods in process, and finished goods

– Same overhead assignment method• predetermined rate times actual activity

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Comparing Job Order and Process Production

• Job Order Systems– Custom orders– Heterogeneous products– Low output volume– High flexibility– Low to medium

standardization

• Process Systems– Repetitive production– Homogeneous offerings– High output volume– Low product flexibility– High standardization

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DifferencesDifferencesDifferencesDifferences

Cost Allocation

– Plant-wide Overhead Rate

– Two-stage Cost Allocation

– Activity-based Costing

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• Methods of Overhead Cost AllocationMethods of Overhead Cost Allocation• Methods of Overhead Cost AllocationMethods of Overhead Cost Allocation

Low

High

Low

High

Co

mp

lexityC

om

plexity

Cost Allocation

• Plant-wide Overhead Rate– A single plant-wide overhead rate is relatively easy

to use– but may result in inaccurate product costs

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Cost Allocation

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• Two-stage Cost Allocation• More accurate method than plant-wide

Stage 1: Allocate service department costs to production departments. Service department costs are assigned to operating (or production) departments.

Stage 2: Allocate production department costs to cost objects. Costs accumulated within operating (or production) departments are assigned to cost objects.

Cost Allocation

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Cost Allocation

• Activity-based Costing– Attempts to better allocate costs to the desired

cost objects by focusing on activities consumed by the cost objects.

– Many activities within a department drive overhead costs.

• Products require activities.• Activities consume resources.

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Cost Allocation

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Overhead ActualOverhead Actual Rate Activity Rate Activity

××

Rate = Estimated overhead costs in activity cost pool

Estimated number of activity units

Allocate overhead cost:

• Activity-based Costing: Procedures Identify activities that consume resources. Assign costs to a cost pool for each activity. Identify cost drivers associated with each activity. Compute overhead rate for each cost pool.

Cost Allocation• Activity-based Costing: Identifying Cost Drivers

– Most cost drivers are related to either volume or complexity of production.

– Examples: purchasing, invoicing, quality inspection, product design.

– Three factors in choosing a cost driver:• Causal relationship• Benefits received• Reasonableness.

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Cost Allocation

Cost Cost Driver

Materials purchasing Number of purchase orders

Materials handling Number of materials requisitions

Personnel Number of employees

Equipment amortization Number of products produced or hours of use

Quality inspection Number of units inspected

Indirect labour in setting up equipment

Number of setups required

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Activity-based Costing: Cost and Cost Driver

Cost Allocation

• Activity-based Costing: Benefits– More detailed measures of costs– Better understanding of activities– More accurate product costs for . . .

• Pricing decisions• Product elimination decisions• Managing activities that cause costs

– Benefits should always be compared with costs of implementation

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Summary• Managerial accounting is quite important to planning, control,

and decision making activities.• Managerial accounting and financial accounting are

different in users, time focus, requirements, etc. • Costs can be classified by relevance, behaviour,

controllability, traceability, and function.• Flow of manufacturing activities.• Similarities and differences between job order and

process cost accounting systems• The methods of cost allocation: plant-wide overhead rate,

two stage cost allocation, activity-based costing

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Case Study• ABC Company acquired its factory building about 25 years ago.

For a number of years, the company has rented out a small, unused part of the building. The renter's lease will expire soon. Rather than renewing the lease, ABC Company is considering using the space itself to manufacture a new product. Under this option, the unused space will continue to be depreciated on a straight-line basis, as in past years.

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Case Study• Direct materials and direct labour cost for the new product is

$45 per unit. In order to store finished units of the new product, the company will rent a small warehouse nearby. The rental cost is $1,800 per month. It will cost the company an additional $3,500 each month to advertise the new product. A new production supervisor, hired to oversee production of the new product, will be paid $2,500 per month. The company will pay a sales commission of $12 for each unit of product that is sold.

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Case Study• Required:

– Complete the chart below (in the next page) by placing an "" under each column heading that helps to identify the costs listed to the left. You can place an "" under more than one heading for a single cost: for example, a cost may be a product cost, an opportunity cost, and a sunk cost; you would place an "" under each of these headings on the answer sheet opposite the cost.

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Case StudyOpportunity

CostSunk Cost Variable

CostFixed Cost

Product Cost

Selling & Administration

Cost

Rent on unused factory space

depreciation

Direct material + direct labour

Rental cost of warehouse

Advertising cost

Supervisor’s salary

Sales commissions

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The End of Lesson 13

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Lesson 13 Managerial Accounting: Concepts and Principles Task Team of FUNDAMENTAL ACCOUNTING School of Business, Sun Yat-sen University