Management accounting: basic terms and concepts

Management accounting information

Components
Costing system Budgeting system Performance measurement system Cost management system

Conventional versus contemporary approaches

Conventional vs. contemporary management accounting systems

Emphasis on cost
Why do management accountants pay so much attention to costs?
Historic focus on production costs, to value inventory and COGS for external reporting Ready availability of cost data within the transaction-based accounting system Importance of cost information in managers decisions

Non-financial information has assumed increased importance in contemporary management accounting systems

Cost classifications
Before classifying costs, need to consider how managers intend to use the cost information in decision making Different cost and classifications are used for different purposes The same cost can be classified in a number of ways depending on the intended use of the cost information
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Cost classifications
What are costs?
Resources given up to achieve a particular objective If the benefit extends beyond the current accounting period these costs are classified as assets If the benefit is used, the costs are classified as expense Measured in monetary terms

Cost behaviour
Managers must understand how costs change as the as the level of activity in the business changes
The level of activity is the level of work performed in the organisation

Variable costs
Change in total in direct proportion to a change in the level of activity Sometimes referred to as unit-level costs in continued product costing as they incurred for each unit of product/service produced

Cost behaviour
Fixed costs
Remain unchanged in total despite changes in the level of activity Can be described as committed costs
Result from an organisations ownership or use of premises and its basic organisation structure, and is difficult to change in the short-term

or as discretionary costs
Result from managements decision to spend a continued particular amount of money for some purpose, and can be easily changed

Cost behaviour
Cost drivers
Any activities or factors that drive (cause) costs

Conventional approaches focus on production volume as the level of activity (or cost driver)
Costs are classified as variable or fixed with respect to production volume

Contemporary approaches recognise that other (non-volume) cost drivers exist

Direct and indirect costs

An important function of management accounting is to measure the cost of cost objects
Cost objects are the items for which management wants a separate measure of costs Products, projects, contracts and departments are common cost objects in conventional costing systems Contemporary costing systems may also include activities and customers as cost objects

Direct and indirect costs

In responsibility centres
The costing system may measure the costs of managers individual areas of responsibility Costs that can be traced to a particular responsibility centre are direct costs of that centre Costs that relate to responsibility centres, but cannot be traced precisely to specific responsibility centres are indirect costs of continued those centres

Direct and indirect costs

Product costs
Manufacturing costs that can be traced to product in an economic manner are direct product costs Indirect costs are manufacturing costs that cannot be traced to products in an economic manner

Whether a cost is classified as direct or indirect depends on the nature of the cost object

Controllable and uncontrollable costs

Managers performance evaluation can be enhanced by classifying responsibility centre costs as either controllable by the manager or uncontrollable Ideally, managers should be held responsible only for costs they can control or significantly influence
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Controllable and uncontrollable costs

Costs across the value chain

The value chaina set of linked processes or activities that begins with acquiring resources and ends with providing and supporting product or services that customers value Provides a useful framework for examining the areas where costs are incurred within a business
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Costs across the value chain

Upstream costs
Research and development costs include the costs involved in developing new products and processes Design costs include the costs associated with designing a product or production process Supply costs are the cost of sourcing and managing incoming parts, assemblies and continued supplies

Costs across the value chain

Production costs
The costs incurred to collect and assemble the resources used to produce a product or service

Downstream costs
Marketing costs are the cost of selling products and the cost of advertising and promotion Distribution costs are the cost of storing, handling and shipping finished products Customer service costs are the costs of

Manufacturing costs
Manufacturing costs are incurred within the factory area, whereas upstream and downstream costs are sometimes called non-manufacturing costs Manufacturing costs include three categories: direct material, direct labour and manufacturing overhead
This classification assumes that products are continued the relevant cost objects

Manufacturing costs
Direct material
Material that is consumed in the manufacturing process Physically incorporated into the finished products; and Can be traced to products conveniently

Direct labour
The cost of wages and labour on-costs of staff who work directly on manufacturing a product continued However, contractual arrangement sometimes means that such labour is a committed cost

Manufacturing costs
Manufacturing overhead
All manufacturing costs other than direct material and direct labour Also called indirect manufacturing costs or factory burden Includes the cost of indirect material and indirect labour, depreciation and insurance on factory equipment, utilities and the costs of manufacturing support departments Also includes cost of overtime premium and continued idle time

Manufacturing costs
Conversion costs
The total of direct labour and manufacturing overhead costs The cost of converting material into product

Prime costs
The total of direct material and direct labour costs The major cost associated with producing a continued product

Manufacturing costs
Contemporary costing systems analyse costs in greater detail than under conventional costing systems
Labour costs, and upstream and downstream costs may be classified within an activity framework

In general, direct material tends to be the largest proportion of manufacturing cost, and direct labour costs the smallest

Product costs
Managers need estimates of product costs for different purposes In financial accounting reports
To determine cost of goods sold To value inventory on hand

For decision making

Definitions of product costs that include nonmanufacturing costs may be used

Cost flows in a manufacturing business

1. Material is purchased: cost is added to raw materials inventory 2. Direct materials are consumed in production: cost is removed from raw materials inventory and added to work in process inventory 3. Direct labour and manufacturing overhead are accumulated in work in continued process inventory

Cost flows in a manufacturing business

4. Products are completed: costs are transferred from work in process inventory and added to finished goods inventory 5. Products are sold: costs are transferred from finished goods inventory to cost of goods sold expense 6. Cost of goods sold is deducted from sales continued revenue to determine gross profit

Cost flows in manufacturing business

Raw materials, work in processes and finished goods inventories balances are found in the Statement of Financial Position Cost of goods sold expense can be found in the Statement of Financial Performance The Schedule of Cost of Goods Manufactured and Schedule of Cost of Goods Sold summarise the flow of manufacturing costs

Cost and benefits of information

Must determine which cost concepts are most appropriate in each situation Benefits of measuring and classifying costs can be realised through improvements in the quality of managers decisions Information overload occurs when managers receive more information than they can use efficiently