2 - Management Accounting

MANAGEMENT ACCOUNTING

Prepared by:Syazliana KasimFaculty of AccountancyUiTM Shah Alam

Syazliana Hj. Kasim Fakulti Perakaunan UiTM Shah Alam 2

CLASSIFICATION OF COSTS

CONTROLLABLE VS. UNCONTROLLABLE

DIRECT VS.INDIRECT

BEHAVIOUR

PRODUCT VS.PERIOD

FUNCTIONS

NATURE

COSTS


NATURE

Material Labour Expense


FUNCTION

Selling Administration Production Research dan development Distribution and transportation


PRODUCT VS. PERIOD Product cost

Cost of making or buying an inventory for the purpose of resale

Costs that are included on a stock valuation Period cost

Costs that are being charged to the Income Statement for the period which are not directly related to the production of a product or services.

It relates to the passage of time rather than output of individual goods or services.

Costs that will not be included in the stock valuation and calculation of gross profit


BEHAVIOUR

Fixed costs – costs that are not affected in total by the changes in activity level

Variable costs – costs that change in total in direct proportion to the level of activity

Semi-variable costs – costs that have both fixed element and variable element

Stepped costs – costs that are constant for a range of activity levels and then change and then remain constant again for another range


DIRECT VS. INDIRECT

Direct costs – costs that can be directly attributed to any cost centre/cost unit

Indirect costs – costs that cannot be directly attributed to any cost centre/cost unit and thus must be shared on equitable basis.


CONTROLLABLE VS. UNCONTROLLABLE

Controllable costs Costs that are influenced by the

decisions or actions of a manager Example: shut down cost such as

retrenchment benefits Uncontrollable costs

Costs that cannot be influenced by the decisions or actions of a manager

Example: increased cost of raw materials due to inflation


DIRECT MATERIALS

Materials that can be directly attributed to a unit of production, or a specific job, or a service provided directly to a customer.

In a manufacturing business, direct materials are therefore the raw materials and components that are directly input into the products that the organisation makes.

Example: Flour to make bread; steel to make spoon


INDIRECT MATERIALS

Other materials that cannot be directly attributed to a unit of production.

An example of indirect materials might be the oil used for the lubrication of production machinery. This is a material that is used in the production process but it cannot be directly attributed to each unit of finished product.


DIRECT LABOUR

Labour costs incurred in producing a good/service that could directly be attributed to a unit of production.

These are the costs paid to the employees who are directly involved in producing goods or services for customers.

Example: the production operators who works


INDIRECT LABOUR

Employees who are not directly involved in producing goods or services for customers.

Example: factory supervisor’s salaries, storeman’s wages, maintenance workers’ wages


LABOUR COST

There are two types of labour costing that can be applied in any organisation: TIME RELATED PAY OUTPUT RELATED PAY

PIECERATE WITH GUARANTEE DIFFERENTIAL PIECEWORK


TIME RELATED PAY

Under this scheme, employees will be paid for the hours they spent at work regardless of the output of production or output they achieve within that time frame. Salaried employees – salary will be

fixed for each month Hourly rate employees – will be paid

based on a set hourly rate for each hour worked


OUTPUT RELATED PAY Employees will be paid according to results or

piecework whereby a fixed amount will be paid per unit or output achieved irrespective of the time spent.

Piecerate with guarantee If an employee’s earnings for the amount of units

produced in the period are lower than the guaranteed amount, the employee will be paid with the guaranteed amount.

It provides some sense of security if employer does not provide enough work in a particular time.

Differential piecework Piece rate will increase as successive targetsfor a

period are achieved and exceeded.


OVERTIME Overtime is the number of hours worked

greater than the number of hours set by the organisation as the normal working week.

Overtime premium is the amount over and above normal hourly rate that employees are paid for overtime hours.

Overtime premium will be considered as direct cost if the overtime is incurred to fulfill specific request for a customer.

Overtime premium will be considered as indirect cost if the overtime is incurred just because of a general increased level of activity.


DIRECT EXPENSES

These are all business costs that are not classified as materials or labour cost.

These are the costs that are incurred specifically for a particular product, job, batch or service.

For example, royalties paid per unit for copyright design, plant or tool hire charges for a particular job or batch.


INDIRECT EXPENSES Majority of expenses cannot be traced to a specific cost

unit and therefore are classified as indirect expenses or better known as overheads.

A. Manufacturing expenses Power for machinery, lighting and heating for factory,

insurance of machinery, depreciation of machineryB. Selling expenses

Advertising, depreciation of packing machine, cost of delivering goods to customers, costs of after-sales service, warehouse rental for storage of goods, commission paid to sales representative

C. Administration expenses Rent of building, business rates, insurance, telephone and

utilities charges, stationery, auditors’ feesD. Finance expenses

Loan interest, lease charges on any equipment or buildings which are being leased rather than being purchased


TYPES OF EXPENSES

Directly attributable expenses These are the expenses that can be directly

attributed to a single cost centre. The process of allotting a whole item of

overhead cost to a cost centre is called allocation.

Apportioned expenses These are the expenses that need to be shared

between a number of cost centres. For example, rental of building, utilities,

insurance etc.


APPORTIONMENT BASIS

Needs to ensure that the basis is suitable for different types of expenses Rent & rates, heating & lighting – floor

area/space occupied Supervision, welfare of employees, canteen

expenses – number of employees Depreciation, insurance of asset – asset values Power consumed – technical estimates Materials handlings – number of material

requisitions


REAPPORTIONMENT OF SERVICE COST CENTRE

Once the overheads have been allocated and apportioned to the cost centres, it is necessary to re-apportion all service cost centres’ overheads to production cost centres.

Only the production cost centres are directly involved in the manufacturing of a product.

The basis for reapportionment will have to depend upon the type of services being provided by these service cost centres.


ABSORPTION OF OVERHEAD COSTS A method of including a fair proportion of the total

overheads costs in the cost of each cost unit. It is part of the process of building up a full product

cost which adds direct costs and a proportion of production overhead costs by means of one or a number of overhead absorption rates.

Absorption basis:- Based on units produced – only suitable if the

products are identical (single product line) Based on time – depending on time spent to produce

one unit of product Labour hour basis – suitable for labour intensive

production cost centres Machine hour basis – suitable for machine intensive

production cost centres


ACTIVITY-BASED COSTING (ABC)

ABC is an approach to the costing and monitoring of activities which involves identifying the activities that are responsible for the generation of costs.

ABC is invented due to known problems of treating the overheads since the manufacturing processes have become more automated and less labour intensive.

The production overheads which are mostly fixed have become a large proportion of the total costs.

The traditional absorption method of overheads have been rendered less useful since it will not provide accurate figures.


PRINCIPLES OF ABC

1. Activities (not products) generate costs.2. Products consume activities.

An activity is a process which adds value and consumes resources.

Cost driver is any factor which causes a change in the cost of an activity. It represents the allocation bases in an ABC system, instead of the traditional overhead apportionment bases in the traditional ansorption costing system.

Cost pool will result from the pooling or accumulation of overhead costs which relate to a specific activity.


ADVANTAGES OF ABC

The perceived benefit of introducing an activity-based costing system is that the unit costs should more accurately reflect the activities performed and therefore the resources used.

An improved more accurate product cost may enable a company to concentrate on a more profitable mix of products or customers. ABC has been effectively used in identifying customers who are unprofitable to service and products which are unprofitable to produce.

It helps identify those activities that add more to value than to cost, so that the non-value added items can be appraised effectively with a view to elimination. As such, it forces managers and supervisors to consider the drivers that affect costs and what these drivers contribute to the final product.

By focusing attention on cost drivers, managers will have a better understanding of the costs of production and the costs of the activities performed by the company.


DISADVANTAGES OF ABC The ability of one cost drives to explain all

the items in a cost pool is questionable. Some measure of cost apportionment may

still be required at the cost pooling stage for items like rent, rates and building depreciation. If an ABC system has many cost pools then the need for cost apportionment may be greater.

ABC is sometimes introduced because it is fashionale and not because it will be used by the management. In such cases the traditional system can be followed as it is simpler to operate.


FORMULA

DIRECT MATERIAL + DIRECT LABOUR + DIRECT EXPENSE = PRIME COST

INDIRECT MATERIAL + INDIRECT LABOUR + INDIRECT EXPENSE = OVERHEADS

PRIME COST + PRODUCTION OVERHEADS = PRODUCTION COST


CAPITAL EXPENDITURE VS. REVENUE EXPENDITURE

Capital expenditure These are the expenditure arising when non-

current assest are being purchased. The amount will not be charged into the I/S as an

expense. It will be written-off as a depreciation charge over

the useful life of the asset. Depreciation expenses will be charged to the I/S

at the end of the accounting period. Revenue expenditure

These are the expenditure incurred on everyday items such as the cost of running fixed assets, rent, business rates, insurance etc.

These expenses will be written-off to the I/S in the period to which it relates.


COST-VOLUME PROFIT AND BREAK-EVEN ANALYSIS

Break-even refers to the point at which a company neither makes a profit nor suffer a loss.

The management needs to analyse the relationship between cost, volume and profit especially for the purpose of planning and controlling their operations.

When the contribution margin ratio is low, there is a strong need to increase the sales volume as to enable the company to earn higher net profit.

This analysis would assist the management to determine the most profitable combinations of the fixed and variable cost factors.


ASSUMPTIONS IN BREAK-EVEN ANALYSIS

Fixed cost is constant in total. Variable cost is constant per unit. Selling price is constant per unit. All costs can be differentiated into

fixed and variable elements. Efficiency and productivity are

expected to remain at the same level.


LIMITATIONS OF BREAK-EVEN ANALYSIS

A fixed cost is fixed only within a given time span and over a given range of activity called the relevant range. Fixed cost may change from the budget year to budget year or when the activity level changes too greatly.

Variable cost per unit is assumed to be constant. However, variable cost may fall as volume increases and trade discounts or economies of scale are achieved. It will then rise when the demand for resources exceed supply.

Selling price may be reduced to achieve greater volume of sales.

In practice, it is not always feasible to resolve all cost into their fixed and variable elements.

Efficiency and productivity do change thus affecting costs. Volume, though important, is not the only factor affecting

costs. Other factors such as efficiency, productivity, war, government legislation would also affect costs.


MARGINAL COSTING

A costing principle whereby variable costs are charged to cost units and the fixed cost attributable to the relevant period is written-off in full against the contribution for that period.

Marginal costing distinguishes between fixed costs and variable costs.

The marginal cost of a product is its variable costs: direct materials, direct labour and direct expenses and variable overheads.

Contribution is the difference between Sales and Marginal Cost.


USES OF MARGINAL COSTING

As a basis for providing information to the management for planning and decision-making. It is particularly appropriate for short run decisions onvolving changes in volume or activity and the resulting cost changes.

It can also be used in routine cost accounting system for the calculation of cost and the valuation of stocks.


ABSORPTION COSTING

Using absorption costing, all costs are absorbed into production and thus operating statements do not distinguish between fixed and variable costs.

The valuation of stocks and WIP contain both fixed and variable elements.


BUDGETING PROCESS A budget is a plan in monetary terms Benefits of a budgeting system:-

Planning and co-ordination Budget serves a formal planning framework

Authorisation and delegation Need not to continuosly ask for top management’s decision and

responsibility is being delegates to respective managers Performance evaluation

Budget is benchmark to assess performance Trend identification

Early detection of future trends Communication and motivation

Budget is to be used by everyone and act as a source of motivation in the sense that everyone is working on achieving the budget

Control Budget acts as a yardstick which actual performance can be measured

and variances being analysed. Actions could be taken to adjust performance or targets.


BUILDING UP THE BUDGETSALES BUDGET

FACTORY OVERHEADRAW MATERIALS

PRODUCTION BUDGET

LABOUR

COST OF GOODS SOLD BUDGET

SELLING AND DISTRIBUTION EXPENSES BUDGET

GENERAL AND ADMINISTRATION EXPENSES BUDGET

BUDGETED I/S

BUDGETED BALANCE SHEET

CASH BUDGET

CAPITAL EXPENDITURE

BUDGET


STANDARD COSTING AND VARIANCE ANALYSIS

Standard costing is an accounting control system which uses the concept of pre-determined measures which can be used as benchmarks and the feedback features for correcting performance and plans.

Standard costing compares standard costs and revenues with actual results, in order to report variances for the purposes of performance measurement and control.

A standard cost is the planned unit cost of the products, components or services produced in a period.

It is built up from an assessment of the value of cost elements.

Its main uses are providing bases for performance measurement, control by exception reporting, valuing inventory and establishing prices.


TYPES OF STANDARD Basic standard

A standard cost per unit that is established for use over a long period of time.

Current standard A standard that represents costs and efficiencies

that are currently being achieved. Expected/attainable standard

A standard which can be attained if a standard unit of work is carried out efficiently, a machine properly operated or material properly used. Allowances are made for normal losses, waste and machine downtime.

Ideal standard A standard that can be attained under the most

favourable conditions, with no allowance for normal losses, waste and machine downtime.


VARIANCE ANALYSIS

A variance is the difference between an actual cost and an expected (standard) cost.

Variances indicate that actual results are either better or worse than the standard.

When performance is better than standard, the variance is favourable.

When performance is worse than standard, the variance is unfavourable or adverse.

Documents

2 - Management Accounting