Management Accounting PPT-1

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Management Accounting

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Cost and management accounting Provides management with costs

for products, inventories, operations or functions and compares actual to predetermined data

It also provides a variety of data for many day-to-day decision as well as essential information for long-range decisions

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Functions of managerial accounting Determining the cost Providing relevant information for

better decision-making Providing information for planning,

control, decision-making and application

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Planning Deals with the estimation of

product costs, setting up of costing system to record cost data, preparation of cost standards and budgets, planning of materials and manpower resources, analysing cost behavior with changes in levels of activity

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Control Deals with the maintenance of

product costing record, comparison of actual performance with standards or budgets, anlaysis of variances, recommendation of corrective actions, controlling cost to ensure operational efficiency and effectiveness

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Decision-making Deals with whether it is more

profitable to make or buy a component, determine the economic order quantity and production batch size, replace fixed asset, add or drop products, decide pricing

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Application Cost accounting has extended

from manufacturing operations to a variety of service industries such as hotels, bands, airline, etc

Cost accounting system should be flexible and adaptable to meet the new business environment and the changing nature of the company

Focus

Stage

CostDetermination

Controland Financial

Transformation

Informationfor

Planning andControl

Management

Transformation

Reduction ofWaste ofResources in

ProcessesBusiness

Transformation

Creation of Value

Resource Usethrough Effective

Transformation

The Evolution of Management Accounting

1990s

1980s

1950s

1910s

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Element of cost Cost object Cost Cost unit Cost centre Profit centre

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Cost object It is an activity or item or operation

for which a separate measurement of costs is desired

E.g. the cost of operating the personnel department of a company, the cost of a repair fob, and the cost for control

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Cost It is the amount of expenditure

incurred on a specific cost object Total cost = quantity used * cost

per unit (unit cost)

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Cost unit It is a quantitative unit of product

or service in which costs are ascertained, e.g. cost per table made, cost per metre of cloth

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Cost centre It is a location or function of an

organisation in respect of which costs are ascertained

E.g. the rent, rates and maintenance of buildings; the wages and salaries of strorekeepers

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Profit centre It is location or function where

managers are accountable for sales revenues and expenses

E.g. division of a company that is responsible for the sales of products

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Cost classification Direct cost Indirect cost (overhead)

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Direct cost Cost that can be identified

specifically with or traced to a given cost object

The direct costs consist of the following three elements: Direct materials Direct labour Direct expenses

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Direct materials The cost of materials – the cost of

materials used entering into and becoming the elements of a product or service

E.g. fabrics in garments

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Direct labour The cost of remuneration for

working time E.g. assembly workers’ wages in

toy assembly

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Direct expenses Other costs which are incurred for

a specific product or service E.g. royalties

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Indirect cost (overhead) Cost that cannot be identified

specifically with or traced to a given cost object

They are identified with cost centres as overheads Indirect materials Indirect labour Indirect expenses

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Indirect materials Such as stationery, consumable

supplies, spare parts for machine that assist to the production of final products

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Indirect labour Such as salaries of factory

supervision and office staff that do not directly involve in production of the final product

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Indirect expenses Such as rent, rates, depreciation,

maintenance expenses that do not have instant relationships with the manufacturing processes

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Cost accumulation

•Prime cost = direct materials + direct labour + direct expenses

•Production cost = Prime cost + factory overheadOR

= Direct materials + Conversion cost*Conversion cost is the production cost of converting raw materials into finished product

•Total cost = Prime cost + Overheads (admin, selling,distribution cost)OR

= Production cost + period cost (administrative, selling, distribution and finance cost)

•Period cost is treated as expenses and matched against sales for calculating profit, e.g. office rental

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Cost coding A code is a system of symbols

designed to be applied to a classified set of items to give a brief, accurate reference, facilitating entry, collation and analysis

Coding is important in modern computerised accounting systems for catergories various composite accounting items

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Reasons To reducing error owing to

descriptions Enable easy recalling Reduce computer file size as a

code

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Cost behaviour Costs can be classified into

variable, fixed, semi-variable, or step-costs according to how they behave with respect of changes in activity levels

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Variable cost It increases or decreases in direct

proportion to levels of activity, but the unit variable cost remains constant

E.g. cost of food served in a restaurant

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Fixed cost Total fixed cost remains constant

over a relevant range of activity level but unit fixed cost falls with an increase in activity volume

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Semi-variable cost It processes characteristics of both

fixed and variable cost It increases or decreases with

activity level but not in direct proportion

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Step cost It remains constant for a range of

activity levels, then, on further increase in activity, the cost jumps to a new level and remains constant over a certain range until the next jump occurs

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Cost for stock valuation Unexpired and expired cost Product and period cost

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Unexpired cost Unexpired costs are the resources

that have been acquired and are expected to contribute to the future revenue

They will be recorded as assets in current period

They will be charged as expenses when they have been consumed in the generation of revenue

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Expired costs Expired costs are the expenses

attributable to the generation of revenue in the current period

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Product cost Product cost are related to the goods

purchased or produced for resale If the products are sold, the product cost

will be included in the cost of goods sold and recorded as expenses in current period

If the products are unsold, the product costs will be included in the closing stock and recorded as assets in the balance sheet

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Period cost Period cost related to the

operation of a business They are treated as fixed cost and

charged as expenses when they are incurred

They should not be included in the stock valuation

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Comparison of cost, management and financial accounting

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Meanings Financial accounting Cost accounting Management accounting

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Financial accounting Provides information to users who

are external to the business It reports on past transactions to

draw up financial statements The format are governed by law

and accounting standards established by the professional accounting policies

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Cost accounting Is concerned with internal users of

accounting information, such as operation managers

The generated reports are specific to the requirement of the management

The reporting can be in any format which suits the user

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Management accounting Comprises all cost accounting

functions The accounting for product and

service costs, management accounting extends to use various internal accounting reports for planning, control and decision making

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Cost and management accounting

Vs.Financial accounting

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Management (cost)accounting

Financial accounting

Nature Records material, labour and overhead costs in product or jobReports produced are for internal management and contol

Records company transaction eventsExternal financial statements are produced

Accounting system

Not based on the double entry system

Follows the double entry system

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Accounting principles

No need to use accounting principlesAdopt any accounting techniques that generates useful accounting information

Use Generally Accepted Accounting Principles for recording transactions

Users of information

Used by different levels of management or departments responsible for respective activities

Used by external parties: shareholders, creditors, government, etc

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Operation guidelines or standards

Based on management instructions and requirements

Conforms to company Ordinances, stock exchange rules, HKSSAPs

Time span

Reports are prepared whenever neededThey may be prepared on a weekly or daily basis

Reports are prepared for a definite period, usually yearly and half yearly

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Time focus

Future orientation: forecasts, estimates and historic data for management actions

Past orientation: use of historic data for reporting and evaluation

Perspective

Detailed analysis of parts of the entity, products, regions, etc

Financial summary of the whole orgainisation

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JOB COSTING

PROCESS COSTING

SERVICE OR OPERATING COSTING

BATCH COSTING

CONTRACT COSTING

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Job costing is suitable where work is undertaken to customer’s special requirement and each order is of comparatively short duration.

FEATURES OF JOB COSTING:

Production is undertaken after obtaining customer’s order.

Identity of each order is retained from start to finish.

Cost information is collected from each job.

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Examples of Job Costing:

Machine-tool manufacturing

Foundries

Printing

Furniture-makers

Repair-shops

Garages

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Batch costing is a specific order costing which applies where similar articles are manufactured in batches (either for sale or for use within the undertaking).

FEATURES OF BATCH COSTING:

Reduces overall cost of the product if components are manufactured in batches of large quantity.

Costs are collected against each batch.

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SOME AREAS WHERE BATCH COSTING IS USED:

Radio manufacturing

Television manufacturing

Watch manufacturing

Pen manufacturing

Computer manufacturing

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Contract costing is another variation of job costing. It applies where work is undertaken to customer’s special requirements and each order is of long duration.

FEATURES OF CONTRACT COSTING:

The contract terminates on its completion.

Work is carried out at a site other than contractor’s own premises.

Most items of cost are directly chargeable.

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SOME BUSINESSES WHERE CONTRACT COSTING APPLIES-

Buildings

Dams

Bridges

Ship building

Aircraft manufacturing

And other constructional work.

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SOME AREAS WHERE BATCH COSTING IS USED:

Radio manufacturing

Television manufacturing

Watch manufacturing

Pen manufacturing

Computer manufacturing

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Contract costing is another variation of job costing. It applies where work is undertaken to customer’s special requirements and each order is of long duration.

FEATURES OF CONTRACT COSTING:

The contract terminates on its completion.

Work is carried out at a site other than contractor’s own premises.

Most items of cost are directly chargeable.

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SOME BUSINESSES WHERE CONTRACT COSTING APPLIES-

Buildings

Dams

Bridges

Ship building

Aircraft manufacturing

And other constructional work.

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Process Costing method is applicable where goods result from a sequence of continuous or repetitive operation or process to which costs are charged before being averaged over the units produced during the period.

It is best suitable for organizations where the work cannot be stopped and is continuously performed throughout the year (I.e.24 hours a day and 7 days a week) except for stoppage for maintenance work.

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FEATURES OF PROCESS COSTING:

Production is done having a continuous flow of identical products except where plant and machinery is shut down for maintenance, etc.

Clearly defined process cost centres

Product of one process becomes input-material of another process.

Avoidable and unavoidable losses arise at different stages of manufacture for various reasons. Abnormal gain also arises.

Continuous and Mass production, and loss identity of production against particular order

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Unit cost is computed by dividing total departmental cost by total departmental production including work-in-progress.

As production is continuous, work-in-progress shall remain in partly completed stage at the end of each accounting period.

Process cost for the period shall be apportioned between completed and incomplete units considering stage of completion of units in work-in-process.

Calculation of Effective Units.

Loss in the process due to evaporation, scrap, spoilage, chemical reactions, etc., are added to the good units produced.

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Production is carried out in anticipation of demand.

Costs of completed units of a department are transferred to the next processing department either at total cost or at some predetermined transfer price, just to compare with the market price.

More than one product may emerge at the end of a process / operation.

Depending upon the realizable value of the product, it may be termed as either “Joint Product” or “By product”.

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PROCESS COSTING IS USED IN THE FOLLOWING TYPES OF INDUSTRIES:

Manufacturing industries-

Iron and steel, textiles, chemicals, cement, paper, flour mills, food products, toy making, milk dairies, biscuit manufacturing,etc.

Mining industries-

Coal, Oil, etc.

Public utility services

Generation of Electricity, Gas, Water Supply, etc.

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STEPS INVOLVED1. Process Flowchart

2. Departmentalization

3. Input – Output reconciliation

4. Equivalent production – WIP

5. Accounting of process loss and scrap

6. Accounting for “By products’ and “Joint Products”

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NORMAL LOSS

When loss is due to inherent nature of the process,which can be estimated in advance and added to good units produced.

ABNORMAL LOSS

Loss caused by poor handling of material, bad workmanship, carelessness, bad design, using substantial material, etc., are not normally expected, which are abnormal loss.

ABNORMAL GAIN

Actual Production may be more than the ‘norms’ specified. Like Abnormal Loss, Abnormal Gain has no effect on cost of good units.

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VALUATION OF WORK-IN-PROGRESS

The semi-completed units in each process, posses problem for valuation. It is necessary to assess the amount of work done on these units and express them in terms of completed units.

EQUIVALENT Units is a notional quantity of completed units substituted for an actual quantity of incomplete physical units in progress.

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This method applies to activities that provide a service rather than producing goods.

This method may be used for both services to outside customers as well as internal use (in an manufacturing unit, certain sections may provide ancillary services to production department, such as canteen, maintenance, etc.).

In this method operating costs are collected periodically.

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MAIN FEATURES:

Composite cost units are more commonly used than single cost unit.

Costs are usually grouped under fixed cost or standing charges and variable costs.

THIS METHOD IS USUALLY APPLIED TO:

Transportation services – road, rail, air, etc.

Utility services – hospitals, canteen, etc.

Distribution services – electricity, gas, etc.

Professional services – courier service,

management consultants, etc.

Learning Objectives

Cost Methods & Cost Techniques

Costing Systems/Methods

Cost Classification

Cost Sheet

Cost Methods & Cost Techniques

Cost Methods 1. Job Costing 2. Contract 3. Batch 4.Process( continuous) 5. Service( Operating)

Cost Techniques 1. CVP Analysis 2. Standard Costing 3. Budgetary Control 4. ABC 5. Relevant Costing 6. Target Costing

Costing Systems/Methods

Historical Absorption Direct Marginal Standard Uniform

COST CLASSIFICATION

Elements Behaviour Functions Normality Control Decision Making

Elements MATERIAL

LABOUR

EXPENSES

MATERIAL

Direct: traceable to one particular process, job or product – identified with each unit of product

Example: manufacturing an apparel Cloth, collar, buttons, cufflinks, thread Primary packing material (e.g., carton,

wrapping, cardboard, boxes, etc.)

Fuel, lubricating oil etc for operating & maintenance of machine

Small tools Materials used for repairs & maintenance

LABOUR

Inspectors Supervisors Internal transport staff Storekeeper, maintenance staff

EXPENSES

Expenses leading to a job or contract Traveling expenses for negotiation Special pattern, design Special tools for executing the contract

Rent Insurance Canteen, hospital, power , lighting,

maintenance

BehaviourFixed in short run & long run

VariableVaries with volume and constant per unit

Semi-variableA cost could be variable for one level of activity whereas it couldbe fixed for another.

Not inherently fixed or variable

Many costs are semi-variable in nature

Fixed Cost

Committed Fixed Costs consists largely of those fixed costs that arise from the possession of planti, equipment and a basic organizational structure. For example, once a building is constructed and plant is installed, nothing much can be done to reduce the costs such as depreciation, property taxes, insurance and salaries of the key personnel, etc., without impairing the organization's competence to meet the long-term goals.

Discretionary Fixed Costs : set at fixed amount, for specific time periods by the management, in the budgeting process. These costs directly reflect top management policies and have no particular relationship with volume of output. These costs can therefore be reduced or eliminated entirely, if the circumstances so require. Examples of such costs are: research and development costs, advertising and sales promotion costs, donations, management consulting fees, etc. these costs are also termed as managed or programmed costs.

Functions Production Cost Administration Cost Selling Cost Distribution Cost

Normality

Normal Abnormal

Control

Controllable &Uncontrollable

Planning & Control Budgeted Cost: estimate of

expenditure for different business operations

Standard Cost: for prescribed set of operating conditions, labour, material and overheads are predetermined; budget translated into actual operation through standard costs

Decision Making Marginal vs. Absorption Costing

(with fixed cost and without FC) Sunk - irrelevant Committed – pre committed Opportunity Incremental / Differential Avoidable & Unavoidable controllable / uncontrollable

Relevance

Relevant Irrelevant

Cont…..

Irrelevant cost: not relevant for decision making

Example: Sunk costs: Sunk cost is the cost of abandoned plant less salvage value. Not relevant for decision making.

Imputed (Notional cost): Actually not incurred (interest on own capital, rent on owned building, etc.) Taken into account in capital budgeting decisions.

Replacement cost: Cost of replacing at current market price.

Cont…..

Avoidable and unavoidable cost: Cost that can be avoided by eliminating a product or department is avoidable and that which cannot be, is unavoidable.

Ex. – Rent of factory is unavoidable if a product is discontinued.

Other costs:

Future costs: cost to be incurred in future Programmed cost: Cost incurred as per policy of

top management. Ex.- Donation to charity. Joint cost: cost of joint or by-products incurred

before separation, which cannot be traced to particular products.

Conversion cost: cost of converting raw material to finished goods = Production cost- direct material.

Discretionary cost: not essential for decision on hand. Ex.- Training expenses of workers, R&D cost.

Committed cost: Costs incurred due to past decisions and are not within control in the short run at present. Ex.- Depreciation on Plant, Rent, etc.

INVENTORIABLE COSTS AND PERIOD COSTS

Inventoriable cost/ product cost is that cost which is regarded as asset when incurred, but becomes a part of cost of goods sold when the product is sold. For MUL, all manufacturing cost is inventoriable cost. (Raw material to WIP to Finished goods) For a service sector unit, absence of inventory means all are period costs.

Period costs (non-product cost): all costs in P&L account except cost of goods sold. So, in a mfg. sector unit, all non-manufacturing costs are period costs. (Ex. Distribution cost, design cost, R&D costs, Marketing costs, customer-service costs, etc.)

Documents

Management Accounting PPT-1