Managerial accounting

Managerial Accounting: Concepts and Principles

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OutlineWhat is managerial accounting?What is managerial accounting?Comparison between managerial Comparison between managerial

accounting and financial accountingaccounting and financial accountingCost classifications in different ways Cost classifications in different ways Flow of manufacturing activitiesFlow of manufacturing activitiesJob order cost accounting systems and Job order cost accounting systems and

process cost accounting systemsprocess cost accounting systemsCost allocationCost allocation

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IntroductionThe previous presentations 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”?

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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

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The Environment of The Environment of Managerial AccountingManagerial Accounting

Complexity andComplexity andsize of organizationssize of organizations

Development ofDevelopment oftechnologytechnology

RegulatoryRegulatoryenvironmentenvironment

CompetitionCompetition

EmphasisEmphasison qualityon quality

Environment of Environment of Managerial AccountingManagerial Accounting

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Managerial Accounting and Managerial Accounting and Financial AccountingFinancial Accounting

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Cost ClassificationsCost ClassificationsCosts can be classified by:

Relevance Behaviour Controllability Traceability Function

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Costs Classification by Relevance

RelevantRelevant If costs influence a decisionIf costs influence a decision

→Costs that are applicable to a particular decision.Costs that are applicable to a particular decision.→Costs that should have a bearing on which Costs that should have a bearing on which

alternative a manager selects.alternative a manager selects.→Costs that are avoidable.Costs that are avoidable.→Future costs that differ between alternatives.Future costs that differ between alternatives.

IrrelevantIrrelevant If costs do not influence a decisionIf costs do not influence a decision

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Sunk CostsSunk Costs All costs incurred in the past that cannot be changed by All costs incurred in the past that cannot be changed by

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

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

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Out-of-pocket costsOut-of-pocket costs require future outlays of cashrequire future outlays of cash associated with a particular decisionassociated with a particular decision relevant for future decisionsrelevant for future decisions Example:Example: Considering the decision to take a Considering the decision to take a

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

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Opportunity CostsOpportunity Costs The potential benefit that is given up when one The potential benefit that is given up when one

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

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

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Costs Classification by BehaviorCosts Classification by Behavior

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

business activity.business activity.Fixed costs Fixed costs

do not change when activity changes.do not change when activity changes.Variable costs Variable costs

change in proportion to changes in the volume change in proportion to changes in the volume of activityof activity

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

Fixed costs per unit decline as activity increases.Fixed costs per unit decline as activity increases.

Costs Classification by Behavior

Volume of ActivityVolume of Activity

Fixe

d co

sts

per u

nit

Fixe

d co

sts

per u

nit

Volume of ActivityVolume of Activity

Tota

l fix

ed c

osts

Tota

l fix

ed c

osts

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


Volume of activityVolume of activity

Tota

l var

iabl

e co

sts

Tota

l var

iabl

e co

sts

Volume of activityVolume of activityVar

iabl

e co

sts

per u

nit

Var

iabl

e co

sts

per u

nit

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Mixed costsMixed costs contain a combination of fixed and variable costs.contain a combination of fixed and variable costs.

Variable Variable Sales CommissionsSales Commissions

Sales Sales

Tota

l Com

pens

atio

nTo

tal C

ompe

nsat

ion

Total mixed cost

Total mixed cost

Fixed Fixed Monthly salaryMonthly salary

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Costs Classification by BehaviorStep-Wise CostsStep-Wise Costs

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

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

Sup

ervi

sory

Sal

arie

sS

uper

viso

ry S

alar

ies

Production VolumeProduction Volume

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Costs Classification by ControllabilityCosts 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 Management often traces costs to cost objects objects To obtain a better measure of their total costTo obtain a better measure of their total cost Cost objects include Cost objects include →ProductsProducts→ServicesServices→DepartmentsDepartments→DivisionsDivisions→Customer groupsCustomer 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 Costs Classification by Functionby Function

Manufacturing CostsManufacturing Costs are necessary and integral to the production of are necessary and integral to the production of

finished goods.finished goods. Examples:Examples: direct labour, direct materials, and direct labour, direct materials, and

manufacturing overhead.manufacturing overhead.Non-Manufacturing CostsNon-Manufacturing Costs

are not integral to the manufacture of finished are not integral to the manufacture of finished goods.goods.

Examples:Examples: selling and administrative expenses. selling and administrative expenses.

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ManufacturingManufacturingCostsCosts

DirectDirectMaterialMaterial

DirectDirectLabourLabour

ManufacturingManufacturingOverheadOverhead

Costs Classification by Function

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Direct materialsDirect materials Materials that are clearly and easily identified with a Materials that are clearly and easily identified with a

particular product.particular product. Example:Example: Steel used to manufacture an automobile Steel used to manufacture an automobile

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

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

worker.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

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Manufacturing costs are oftenManufacturing costs are oftencombined as follows:combined as follows:


DirectDirectMaterialMaterial


ManufacturingManufacturingOverheadOverhead

PrimePrimeCostCost

ConversionConversionCostCost

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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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DiscussionsRequired:

Classify each of the items above as product cost or period costs.

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Discussions: the answer

11 ProductProduct 66 PeriodPeriod 1111 ProductProduct

22 ProductProduct 77 ProductProduct 1212 ProductProduct

33 PeriodPeriod 88 ProductProduct 1313 PeriodPeriod

44 ProductProduct 99 ProductProduct 1414 ProductProduct

55 PeriodPeriod 1010 ProductProduct 1515 PeriodPeriod

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Flow of Manufacturing Activities

Raw MaterialsBeginning Inventory

Raw MaterialsPurchases

Goods in ProcessBeginning Inventory Finished 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 OverheadUsed

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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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Goods inGoods in Process Process

Cost of Cost of GoodsGoodsSoldSold

LabourLabour

MaterialsMaterials

Indi

rect

Indi

rect

Indi

rect

Indi

rect

FinishedFinishedGoodsGoods

FactoryFactoryOverheadOverhead

DirectDirect

DirectDirect

AllocateAllocate CompletedCompleted

DeliveredDelivered

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DirectMaterials

Cost per unit for Job No. 1

DirectLabour

FactoryOverhead

Job No. 1 Finished Goods

Job No. 2 Finished Goods

Cost per unit for Job No. 2


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Process Cost Accounting Systems

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

cost items.cost items. Mass produced in automated continuous Mass produced in automated continuous

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

product.product.

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DirectDirectMaterialsMaterials

FinishedFinishedGoodsGoods


FactoryFactoryOverhead Overhead

Process 1Process 1 Process 2Process 2

Cost per Cost per equivalent equivalent

unit for unit for Process 1Process 1

Cost per Cost per equivalent equivalent

unit for unit for Process 2Process 2

Total cost Total cost per per

equivalent equivalent unitunit


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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.


Cost perequivalent

unit

= Product costs for the periodEquivalent units for the period

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

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

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

and labour and overhead at different stages of a and labour and overhead at different stages of a process.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

DifferencesDifferences

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Cost Allocation

Plant-wide Overhead Rate

Two-stage Cost Allocation

Activity-based Costing

Methods of Overhead Cost AllocationMethods of Overhead Cost Allocation

Low

High

Com

plexity

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Cost AllocationCost AllocationPlant-wide Overhead RatePlant-wide Overhead Rate

A single plant-wide overhead rate is relatively A single plant-wide overhead rate is relatively easy to useeasy to use

but may result in inaccurate product costsbut may result in inaccurate product costs

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Cost AllocationCost Allocation Two-stage Cost AllocationTwo-stage Cost Allocation

more accurate method than plant-widemore accurate method than plant-wide Stage 1: Allocate service department costs to Stage 1: Allocate service department costs to

production departments.production departments. Service department Service department costs are assigned to operating (or production) costs are assigned to operating (or production) departments.departments.

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

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Cost Allocation

Maintenance FactoryAccounting

Janitorial

MachiningDepartment

Assembly Department

Stage 1

Service Departments

Stage 2

Job 236 Job 237 Job 238

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Cost AllocationActivity-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

Overhead ActualOverhead Actual Rate Activity Rate Activity××

Rate =Rate = Estimated overhead costs in activity cost poolEstimated overhead costs in activity cost pool Estimated number of activity unitsEstimated number of activity units

Allocate overhead cost:Allocate overhead cost:

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

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Cost AllocationActivity-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

CostCost Cost DriverCost DriverMaterials purchasingMaterials purchasing Number of purchase ordersNumber of purchase ordersMaterials handlingMaterials handling Number of materials Number of materials

requisitionsrequisitionsPersonnelPersonnel Number of employeesNumber of employeesEquipment amortizationEquipment amortization Number of products Number of products

produced or hours of useproduced or hours of useQuality inspectionQuality inspection Number of units inspectedNumber of units inspectedIndirect labour in setting up Indirect labour in setting up equipmentequipment

Number of setups requiredNumber of setups required

Activity-based Costing: Cost and Cost Driver

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Cost AllocationActivity-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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SummaryManagerial 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, behavior,

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

process cost accounting systemsThe methods of cost allocation: plant-wide overhead

rate, two stage cost allocation, activity-based costing

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