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INTRODUCTION TO MANAGEMENT
ACCOUNTING
DEFINITIONS OF ACCOUNTING
“The
process
of
identifying,
measuring
and
communicating economic information to permit
informed judgements and decisions by users of the
info”
MANAGEMENT ACCOUNTING
Is concerned with the provision of info to people
within the organisation to help them make better
decisions
and
improve
the
efficiency
and
effectiveness of existing operations
FINANCIAL ACCOUNTING
Is concerned with the provision of information to
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external parties outside the organisation
DIFFERENCES BETWEEN MANAGEMENT
ACCOUNTING AND FINANCIAL ACCOUNTING
LEGAL REQUIREMENTS
FA – statutory requirement for
public listed co
MA – entirely optional
FOCUS ON INDIVIDUAL
PARTS/SEGMENTS OF
THE BUSINESS
FA – the whole organisation
MA – small part of org
GENERALLY
ACCEPTED
ACCOUNTING
PRINCIPLES
FA – prepared to confirm GAAP
MA – not required to adhere
GAAP
TIME DIMENSION
FA – report what happened in
the past
MA – concerned with future
info & past info
REPORT FREQUENCY
FA
MA
– detailed set of fin.
accounts (annually) less
detailed (semi-annually)
– reports on various
activities (daily, weekly or
2
monthly interval)
THE DECISION-MAKING PROCESS
Information
produced
by
management accountants must
be judged in the light of its
ultimate effect on the outcome of
decisions, a necessary precedent
to
an
understanding
of
management accounting is an
understanding of the decisionmaking process
3
THE DECISION-MAKING, PLANNING &
CONTROL PROCESS
1.
2.
Search for alternative courses of
action
3.
Planning process
4.
Identify objectives
Gather data about alternatives
Select alternative courses of action
5.
6.
Implement the decisions
Compare actual and planned
outcomes
Control process
7.
Respond to divergences from plan
4
AN INTRODUCTION TO COST TERMS &
CONCEPTS
Cost
collection
system
typically
accounts for costs in 2 broad stages:
Accumulates costs by classifying
into certain categories e.g. labour,
materials and overheads (or by cost
behaviour such as fixed and variable)
Assigns these costs to cost objects
5
COST TERMS AND CONCEPTS
Direct and indirect costs
Period and product costs
Cost behaviour in relation to volume
of activity
Relevant and irrelevant costs
Avoidable and unavoidable costs
Sunk costs
Opportunity costs
Incremental and marginal costs
6
DIRECT AND INDIRECT COSTS
Direct Costs – costs that
can be specifically and
exclusively
identified
with a particular cost
object
(e.g.
direct
materials, direct labour,
direct expenses)
Indirect Costs – cannot
be identified specifically
and exclusively with a
given
cost
object
(indirect
materials,
indirect labour, indirect
expenses
=
Manufacturing overhead)
Direct materials
xxx
Direct labour
xxx
PRIME COSTS
xxx
Manufacturing
overhead
xxx
TOTAL
MANUFACTURING
COSTS
xxx
7
PERIOD AND PRODUCT COSTS
PRODUCT COSTS – costs that are identified
with goods purchased or produced for resale
(in manufacturing org they are costs that
the accountant attaches to the product and
included in the inventory valuation for
finished goods)
PERIOD COSTS – costs that are not included
in the inventory valuation and as a result
are treated as expenses in the period in
which they are incurred (no attempt to
attach the costs to products for inventory
valuation purposes)
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ALL COSTS
Product Costs
Manufacturing Costs
Period Costs
Nonmanufacturing Costs
Direct Materials
Prime
Costs
Direct Labor
Selling Expenses
Administrative Expenses
Manufacturing Overhead
9
COST BEHAVIOUR
VARIABLE COSTS –vary in direct proportion to the volume
of activity (e.g. short-term variable manufacturing –
d.material; non-manufacturing – sales commissions)
FIXED COSTS – remain constant over wide ranges of
activity for a specific time period (e.g. depreciation of
factory building, supervisors’ salaries)
SEMI-VARIABLE COSTS – include both a fixed and a
variable component (e.g. cost of maintenance)
STEP FIXED COSTS – within a given time period they are
fixed within specified activity levels, but they eventually
increase or decrease by a constant amount at various
critical activity levels
10
VARIABLE COSTS
COST THAT VARY IN TOTAL DIRECTLY
AND PROPORTIONATELY WITH CHANGES
IN THE ACTIVITY LEVEL
Eg: if level increases 10%, total variable
costs will increase 10%
COST PER UNIT AT EVERY LEVEL OF
ACTIVITY REMAINS
11
RM’000
Total Variable Costs
(Digital Clocks)
Unit Variable Costs
(Digital Clocks)
20
60
C
O
S
T
15
40
10
20
5
0
2
4
Radios produced in (000)
6
0
2
4
6
8
Radios produced in (000)
12
FIXED COSTS
COSTS THAT REMAIN THE SAME IN
TOTAL REGARDLESS OF CHANGES IN THE
ACTIVITY LEVELS
Eg: property taxes, insurance, rent,
supervisory salaries and depreciation on
buildings and equipment
FIXED
COSTS
PER
UNIT
VARY
INVERSELY WITH ACTIVITY
13
RM’000
Total Fixed Costs
(Digital Clocks)
Unit Fixed Costs
(Digital Clocks)
20
60
C
O
S
T
15
40
10
20
5
0
2
4
Radios produced in (000)
6
0
2
4
6
8
Radios produced in (000)
14
RELEVANT RANGE
In most business situations, a straight-line variable
costs relationship does not exist for entire range of
possible activity
At abnormally low levels of activity, impossible to be
cost effective – small scale operations – no qty
discount
At abnormally high levels of activity, labour costs
increase sharply – overtime pay; materials costs may
jump – excess spoilage caused by worker fatigue
Real world – the variable cost and changes in the
activity level is often curvilinear
15
RELEVANT RANGE
Total fixed costs also do not have a straight-line
relationship over the entire range of activity
Some fixed costs will not change but other might
change
Increased to a new fixed cost when the size
increases
16
LINEAR BEHAVIOR WITHIN RELEVANT
RANGE
17
MIXED COSTS
SOMETIMES CALLED SEMIVARIABLE COSTS
CONTAIN BOTH A VARAIBLE COST ELEMENT AND A
FIXED COST ELEMENT
MIXED COSTS CHANGE IN TOTAL BUT NOT
PROPORTIONATELY WITH CHANGES IN THE
ACTIVITY LEVEL
18
BEHAVIOUR OF A MIXED COST
RM
200
Total Cost Line
150
C
O
S
T
Variable Cost
Element
100
50
Fixed Cost
Element
0
50
100
150
200
MILES
19
RELEVANT AND IRRELEVANT COSTS
AND REVENUES
RELEVENT COSTS AND REVENUES –
those future costs and revenues that will
be changed by a decision
IRRELEVANT COSTS AND REVENUES –
those that will not be affected by the
decision
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AVOIDABLE ,UNAVOIDABLE, SUNK &
OPPORTUNITY COSTS
AVOIDABLE – those costs that may be saved
by not adopting a given alternative
UNAVOIDABLE – those costs that cannot be
saved
SUNK COSTS – the cost of resources already
acquired where the total will be unaffected by
the choice between various alternatives
OPPORTUNITY COSTS – a cost that measures
the opportunity that is lost or sacrificed when
the choice of one course of action requires that21
an alternative course of action be given up
INCREMENTAL AND MARGINAL COSTS
AND REVENUES
INCREMENTAL (DIFFERENTIAL) COSTS AND
REVENUES – the differences between costs and
revenues for the corresponding items under each
alternative being considered
MARGINAL COST AND REVENUES – similar in
principle to incremental and revenues, main
difference is marginal cost/revenues represents
the additional cost/revenue of one extra unit of
output; incremental costs/revenues represents
the additional cost/revenue resulting from a
group of additional units of output
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INFORMATION TO DECISION-MAKING
COST-VOLUME-PROFIT ANALYSIS
MEASURING RELEVANT COSTS AND
REVENUES FOR DECISION-MAKING
ACTIVITY-BASED COSTING
PRICING
DECISIONS
AND
PROFITABILITY ANALYSIS
DECISION-MAKING
UNDER
CONDITIONS
OF
RISK
AND
UNCERTAINTY
CAPITAL INVESTMENT DECISIONS
23
COST-VOLUME-PROFIT (CVP) ANALYSIS
A systematic method of examining the
relationship between changes in activity
(i.e. output) and changes in total sales
revenue, expenses and net profit
CVP can be used to identify:
 Break-even points (units, sales value, graph)
 Units to be sold to obtain target profit
 Determine profit from the certain number of sold
units
 Selling price to be charged to obtain certain profit
 Additional sales units to meet additional costs
(fixed/variable)
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MEASURING RELEVANT COSTS AND
REVENUES FOR DECISION-MAKING
SPECIAL SELLING PRICE DECISIONS
PRODUCT-MIX
DECISIONS
WHEN
CAPACITY CONSTRAINTS EXIST
DECISIONS ON REPLACEMENT OF
EQUIPMENT
OUTSOURCING
(MAKE
OR
BUY)
DECISIONS
DISCONTINUATION DECISIONS
25
ACTIVITY-BASED COSTING
The measurement of indirect relevant costs
for decision-making
A comparison of traditional and ABC
systems:
 Traditional
–
allocates
overheads
to
production and service departments and
then reallocates service departments costs
to the production departments
 ABC systems – many activity-based cost
centres
(known
as
cost
pools)
are
established
26
THE EMERGENCE OF ABC SYSTEMS
Companies produce a wide range of products; direct
labour represents only a small fraction of total costs
and overhead costs are of considerable importance
Simplistic overhead allocations using a declining
direct labour base cannot be justified
Intense global competition – increased opportunity
cost of having poor cost information and the
decreased cost of operating more sophisticated cost
systems, increased the demand for more accurate
product costs
27
DESIGNING ABC SYSTEMS
Identifying the major activities that take
place in an organisation
Assigning costs to cost pools/cost centres
for each activity
Determining the cost driver for each major
activity
Assigning the cost activities to products
according to the product’s demand for
activities
28
PRICING DECISIONS AND
PROFITABILITY ANALYSIS
Organisations that sell products/services
that are highly customised/differentiated
from each other by special features, or who
are market leaders, have some discretion in
setting selling prices
Price takers – firms have little or no
influence
over
the
prices
of
their
products/services
Price setter – firms have some discretion
over setting the selling price of their
products/services
29
PRICE TAKERS AND PRICE SETTERS
(the cost information required)
A price setting firm facing short-run pricing
decisions
A price setting firm facing long-run pricing
decisions
A price taker firm facing short-run productmix decisions
A price taker firm facing long-run productmix decisions
Pricing methods:
 Cost-plus pricing
 Target costing
30
DECISION-MAKING UNDER CONDITIONS OF
RISK AND UNCERTAINTY
The outcome of a particular decision may be affected
by an uncertain environment that cannot be
predicted and single representative estimate does
not therefore convey all the information that might
reasonably influence a decision
Risk – applied to a situation where there are several
possible outcomes and there is relevant past
experience to enable statistical evidence to be
produced for predicting the possible outcomes
Uncertainty – there are several possible outcomes
but there is little previous statistical evidence to
enable the possible outcomes to be predicted.
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CAPITAL INVESTMENT DECISIONS
Decisions that involve current outlays in
return for a stream of benefits in future
years
It is a part of the capital budgeting
process which concerned with decisionmaking areas:
 Specific investment projects the firm
should accept
 Total amount of capital expenditure the
firm should undertake
 How the portfolio of projects should be
financed
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