Chapter 2

Management accounting: basic terms and concepts

Components of a management accounting systemCosting system - cost of products and

organisational unitsBudgeting system - planned revenues and

costsPerformance measurement - differences

between planned and actual performanceCost management system - managing the

causes of cost

Conventional vs contemporary approaches tomanagement accounting

Costing systems Conventional - focus on products and

organisational units, production volume assumed to drive costs

Contemporary - cost of activities, many causes of cost

Cont.

Conventional vs contemporary approaches tomanagement accounting

Budgeting systems Conventional - departmental budgets

aggregated to obtain organisation’s overall budget

Contemporary - activity-based budgeting, built around activities

Cont.

Conventional vs contemporary approaches to management accounting

Performance measurement Conventional - focus on controlling costs,

differences between actual and budget Contemporary - feedback on a range of critical

success factors; balanced scorecard, benchmarking and activity-based performance measures

Cont.

Conventional vs contemporary approaches tomanagement accounting

Cost management systems Conventional - information for controlling costs Contemporary - cost control and cost reduction;

search for ‘root’ causes

Emphasis on costs

Value chain upstream costs

• research and development, product design manufacturing/production costs downstream costs

• selling, distribution, customer support

Historic emphasis on costs production large proportion of cost upstream and downstream costs insignificant

Cont.

Emphasis on costs

Importance of cost information all organisations incur costs management decisions generally cause costs managers need to understand cost causes to

plan and control

Role of non-financial information decision makers also require qualitative

information for decisions

Classifying costs

Costs - resources given up to achieve a particular objective

Classification of costs variable costs - change in total, in direct

proportion to a change in the level of activity fixed costs - remain unchanged in total despite

changes in the level of activity cost driver - any activity or factor which causes

costs to be incurred

Cont.

Classifying costs

cost object - items which are assigned a separate measure of cost

direct costs - can be identified with, or traced to, a particular cost object in an economic manner

indirect costs - cannot be identified with or traced to a cost object in an economic manner

direct product costs - manufacturing costs that can be traced to products in an economic manner

Responsibility accounting

Holding individual managers responsible for results of their organisational units responsibility centres - areas of a business

where managers are held responsible for activities and results

controllable costs - costs a specific manager can control or significantly influence

uncontrollable costs - costs a specific manager cannot significantly influence

Costs in manufacturing businesses

Non manufacturing costs upstream costs

• research and development

• product design downstream costs

• marketing costs

• selling (or order-getting costs)

• distribution (or order-filling costs)

• customer support

Cont.

Costs in manufacturing businesses

Manufacturing costs direct material - cost of materials consumed in

the manufacturing process to produce a product, where the cost can be traced to each product in an economic manner

direct labour - costs of salaries, wages and labour on-costs for personnel who work directly on the manufactured product

manufacturing overhead - all other costs of manufacturing

Cont.

Costs in manufacturing businesses

Manufacturing overhead indirect materials and indirect labour costs of depreciation, insurance of factory,

utilities and manufacturing support departments costs of manufacturing support departments

• do not work directly on the manufacturing products but are essential to the manufacturing process

idle time and overtime premium

Cont.

Costs in manufacturing businesses

Combined manufacturing costs conversion costs - direct labour and

manufacturing overhead incurred to convert raw materials to finished product

prime costs - direct manufacturing costs traced to a product; direct materials and direct labour

Costs in service businesses

Service firms - produce services rather than goodsDifferences between service and manufacturing

businesses most service outputs are intangible service outputs are often heterogeneous services are often consumed as they are produced services are perishable and cannot be stored

Cont.

Costs in service businesses

Costs are classified in service businesses to provide information for managers’ decisions

Direct labour costs are significantDirect material costs are insignificantOverhead costs may refer to all indirect

costs, including production, upstream and downstream costs

Product costs in financial accounting reportsProduct costs - regarded as asset until soldCost of goods sold - matched against

revenue to determine gross marginPeriod costs - all costs which are not

product costs, expensed in the accounting period in which they are incurred

Selling costsAdministrative costs

Product costs for decision making

For longer-term decisions, product costs may include upstream, manufacturing and downstream costs

For short-term decisions, manufacturing and downstream costs may be considered

Cost structure - relative proportions of an organisation’s variable and fixed costs

Cost flows in amanufacturing business

Inventories raw materials - costs of all major materials

purchased for manufacturing work in process - products on which

manufacture has begun but is only partially complete at balance date

finished goods - manufactured goods that are complete and ready for sale

Cont.

Cost flows in amanufacturing business

Schedule of cost of goods manufactured cost of direct materials, direct labour and

manufacturing overhead applied to work in process during the period, and changes in work in progress inventory

Schedule of cost of goods sold cost of goods sold, and the changes in the

finished goods inventory

Costs and benefits of information

Management accountants need to assess the benefits of providing information against the cost of generating, communicating and using that information

Too much information may cause information overload

A recent survey identified monthly reports of less than 10 pages as ‘best practice’

Exhibit 2.1

Exhibit 2.5