BSC BUSINESS STUDIES

BUSINESS ACCOUNTING
SESSION ELEVEN

After studying this topic you will:

Be able to explain the nature and roles of accounting

Be able to identify the main users of financial information

Identify the characteristics that make accounting information useful

Be able to explain some of the work undertaken by a management accountant

Know the challenges ahead for management accounting

Cost and Management Accounting

Users of Financial Information

Financial v Management Accounting

Financial accounting provides information to those users who are outside the
organisation

Definition

The classification and recording of monetary transactions.

The presentation and interpretation of the results of these transactions in order to assess
performance over a period of time and the financial position at a given date.
The presentation of this information in a way laid down by the Companies Acts and in
accordance with accounting standards.

Management accounting provides information for those users are inside the
organisation and who direct and control its operations.

Cost accounting
Definition
The establishment of budgets, standard costs and actual costs of operations, processes,
activities or products; and the analysis of variances, profitability or the use of funds.
Management accounting
Definition
An integral part of management concerned with identifying, presenting and
interpreting information used for, planning, control, decision making and optimising the
use of resources and the safeguarding of assets.

Financial accounting, cost accounting and management accounting involves

participation of the managers to be effective and thus by a detailed analysis of
expenditure, costing becomes an important element of managerial planning and
control.

Financial

Management

Primary focus is on
the whole organization

Focuses on segments
of an organization

Historical perspective

Future emphasis

3. Users

External

Internal

4. Why

Financial decisions

Plan, control, decisions

Must follow GAAP

and prescribed formats

Need not follow GAAP

or any prescribed format

Verification and
precision

Relevance and
timeliness

1. Focus

2. Viewpoint

5. Regulations
6. Characteristics

The table below lists some of the characteristics of financial accounting and
management accounting systems. Indicate the characteristics for each system by
putting a tick in the relevant column of the table.

Characteristic
To help managers run the business
Produced for shareholders
Formats dictated by accounting rules
Content can include anything useful
Looks mainly at historical information
May includes budgets and future
forecasts
Produced annually or, in some cases,
every six months
Usually produced monthly

Financial
Accounting

Management
Accounting

Characteristics of Management Accounting Information

The characteristics that influence the usefulness of accounting information

Role of Management Accountants and uses of cost information

DECISION MAKING

CONTROLLING

PLANNING

Planning

Involves translating goals and objectives into specific activities and resources
needed to achieve the goals and objectives.

Organisations need to plan for both the short term and also the long term.

A long range plan is necessary to anticipate any future needs or opportunities

that require action now or in the near future.

Long term plans and objectives are converted into a succession of short-term
plans of action that are normally called annual budgets.

Long-term strategic planning

Develop an overseas marketing outlet

Planned acquisitions & disposals of business interests

Short-term operational planning

10

Planned expenditure on fixed assets

Sourcing finance

Control

11

Control is the process of ensuring that the actual outcomes conform with
planned outcomes.

Involves comparing actual performance with the short term plans (budgets and
/ or standards) so that deviations can be identified and corrective action taken
to ensure that the long term objectives are possible.

Provides economic feedback to assist in controlling costs and improving the

efficiency and effectiveness of operations.

Assessing performance - products, divisions, operations.

Variance analysis comparing actual results to the plan / budget / standards

materials, labour and overheads.

Variance reports do not show solutions but highlight where management effort
should be expended to find solution

Decision Making
Three levels of decision making:

12

Strategic level set or change the overall strategic targets of an organisation.

Tactical level concerned with the efficient and effective use of an

organisations resources.

Operational level ensuring that specific tasks are carried out.

What product mix to sell? close or keep open loss making products?

Selling prices? (different customers can be charged / billed out at different

prices)

Choosing a source of finance? bank o/draft, short or long term loan

Credit terms? Are current terms - too generous or too tight?

Cost Terms, Concepts and Classifications

Learning Objectives

13

Be able to appreciate the work undertaken by a Management accountant.

Be able to define key accounting terms with emphasis on Management

Accounting and in particular Job Costing

Know why the study of cost behaviour is important

Change of emphasis

Financial Accounting
A broad overview of the
organisation
nisation with primary
emphasis upon cost
classification according to
type of transaction, eg
salaries, rent, materials,
labour, postage, etc etc

14

Management Accounting
An in-depth,
depth, investigative
reclassification of costs
incurred based on
functions, activities,
products and processes
used for internal planning
and control purposes.

Determining Product Costs

Job Costing
Many different products
produced each period

Products manufactured to
order

15

Process Costing
Similar products are produced
each period

Products made using automatic

single purpose machines

Costs are linked or allocated

to jobs

Costs are accumulated and

divided by total production to get
an average cost per unit

Cost records must be kept for

each distinct product or jog

There is less admin and paperwork

due to the "bulk" nature of costs

Sequence of Events in a Job Order Costing System

Receive
order from
customer

deliver goods
to customer

Begin
production

16

Schedule the
jobs

order
material,
organise
staff,machine
set up etc

Direct and Indirect Cost Elements

Revenue expenses can also be classified by using the three main cost elements.




Materials
Labour
Expenses

These categories can be further divided into:

Direct costs

Costs that can be directly associated with a particular unit of

production or service provided

Indirect costs

Costs that cannot be directly associated with a particular unit of

production or service provided

17

Classification by element
Materials

The costs of the purchases of raw materials that are to be used in the
manufacturing process in a manufacturing organisation
Or

The cost of goods that are to be resold in a retail organisation.

Labour

The costs of the employees

Charged to the cost centre which has used their time
Labour costs can consist of not only basic pay but overtime, commission and
bonuses as well.

Expenses

18

Expenses, otherwise known as overheads.

Costs incurred by an organisation other than materials and labour costs.
E.g. costs such as rent, rates, heat and power costs, cleaning, advertising etc.

SS Ltd manufacturers Skirts

Classify each of these costs according to whether they are material, labour or
expenses.
Materials
4000 metres of white cotton
fabric
2000 hours of sewing
machine operators time
Rent of the Chester plc
building
Electricity bill for the whole
company
600 metres of white cotton
Plastic and Cardboard
packaging

19

4,000
12,500
3,000
500
50
100

Labour

Expenses

Direct Materials

Indirect
Materials

Materials that are used to manufacture a finished product.

Materials that are used in the production

process but are not incorporated into the product. E.g.
Spare parts for machinery.
Also materials that are shared between products and
that are uneconomic to split between products e.g. a
pot of glue.

Direct labour

Wages paid to workers who make the products or provide the

service.

Indirect labour
Wages and salaries of other staff within the business e.g.,
a supervisor is not directly involved in making anything
and may be responsible for a number of
products/product lines. As such their salary will need
sharing across all of these units.

Direct Expenses

Indirect
Expenses

Expenses that are related to each unit of production e.g.,

patent royalties
Indirect Expenses are any other shared cost that is not
material or labour e.g. rent and rates, depreciation,
canteen costs and so on.
Expenses that are not spent on individual units of production

20

P. Ink is a high quality shirt manufacturer.

Classify the following costs by nature (direct or indirect) in the table below.

Cost

Direct

Indirect

Cost of Egyptian Cotton

Wages paid to cutting and sewing
employees
Oil used to lubricate the sewing
machines
Salesmens salaries

(Note: We have assumed here that the cotton is the main cloth for making the shirts.
However, if the cotton is simply for attaching buttons, then you could argue that a
company is unlikely to bother measuring how much cotton is used for a particular
garment and hence it would be indirect)

21

Cost Classification

Direct
labour

Direct
Materials

Direct
Expenses

Prime Costs
Direct Labour

Direct Materials

Direct Expenses -

22

Indirect
Labour

Indirect
Materials

Indirect
Expenses

Manufacturing Overheads

Materials oils to lubricate machine

Labour production Supervisors, fork lift truck drivers

Expenses rent, depreciation of machinery, canteen expenses

23

24

How do we include the correct amount of overheads into the cost of a job?

We calculate an overhead absorption rate OAR

Manufacturing overheads

OAR

Budgeted total manufacturing overheads

Budgeted total number of units of absorption base

The base is the measure used to share out the cost.

It could be labour hours or machine hours used for
manufacturing overheads

EG

OAR

64,000
160,000
Direct labour hours have been
used in this example

For each direct labour hour worked on a job, 4 per hour of factory overhead will also
be charged into the cost of each job.

25

Absorption bases non manufacturing overheads

OAR

Budgeted total non manufacturing overheads

Budgeted total manufacturing cost

EG

OAR

250,000
1,000,000

= 25% or 25p in the

For each of manufacturing cost of a job an extra 25p per of non manufacturing
overhead will also be charged to the cost of each job

26

Job Order Costing Sheet

McGrath Boxes Ltd - Job Cost Sheet
Department:

Small Wooden - Specialty

Date started: 10 Jan 20X1

Item:

Wooden Storage Boxes - Jewellery

Date finished: 10 Jan 20X1

Job Number:

DC001

Quantity:

Customer: Dean Coulter

500

Direct Materials
Requisition
Amount
Number

WSB - DC001
116.00

Direct Labour
Ticket
Hours Amount
Number

RP - Wk 1
8
88.00

Direct Materials
Direct Labour
Direct Expenses
Manufacturing Overhead OAR @ 4 per DLH
Total Production cost
Non Manfacturing Overheads @ 25%
Total Job cost
Profit @ 40% mark - up
Selling price

27

116.00
88.00
24.00
32.00
260.00
65.00
325.00
130.00
455.00

Direct Expenses
Source Amount

Pat 21W
24.00

Manufacturing Overhead
Hours OAR
Amount

8
4.00
32.00

Units Shipped
Number Balance
Shipped
13/01/x1
500
NIL

Date

Expenses

Capital
Expenditure

Revenue
Expenditure

and

Fixed Assets

Depreciation

Direct and
Indirect

Or

Fixed and
Variable

The classifications are important in costing as they are dealt with in different
ways when calculating the cost of a product.
They are also useful to predict how the costs will change as output changes.

28

Types of Expenses

Buildings Costs

Buildings
Services
People Related
Costs
Machinery
Services
Information
Processing

Profesional Fees

Finance Costs
Selling and
Distribution
Costs

29

Rent,
Rent, Rates, Insurance
Depreciation
Utility Costs
Repairs
Repairs and Maintenance
Health
Health and Safety, Training
Canteen Costs
Hire,
Hire, Insurance, Depreciation
Fuel,
Fuel, Maintenance, Cleaning
Telephone, Internet
Postage, Stationary
Audit
Audit and Tax Fees, Solicitors
Market Research
Bank
Bank Charges, Interest
Finance Charges
Advertising,
Advertising, Commissions
Storage
Storage Costs, Carraige
Outwards

MANAGEMENT ACCOUNTING

i.
ii.
iii.
iv.
v.
vi.
vii.

Analyse the following costs between:

Direct materials
Direct labour
Direct expense
Factory indirect expense
Administration expense
Selling and distribution expense
Finance expense

(some terms may be used more than once and some are not used at all)

Cost
a)

Salesmen commission

b)

Indirect labour

c)

Interest on a bank overdraft

d)

Depreciation of plant

e)

Hire of specialised equipment for production

f)

Salary of receptionist

g)

Factory rent

30

Term cost classification

h)

Carriage inwards on raw materials

i)

Raw materials

j)

Rent of warehouse

2 Z wants to price Job ABC123. Below are the specifications of the job:

31

Direct materials

20kg x 20 per kg

Direct labour

40 hrs x 15 per hour

Direct expense

200 (total)

Variable production overheads

40 hrs x 10 per hour

Fixed Non-manufacturing overheads 40 hrs

Additional information:

The fixed non-manufacturing overheads are budgeted at 50,000 in total based on

budgeted total direct labour hours of 10,000 hours.

A Ltd uses a profit margin of 25% on selling price.

Requirement:

Prepare a Job cost sheet for Job ABC123 to show sub-totals for:
i.
ii.
iii.
iv.
v.

Prime cost
Variable Production cost
Total cost
Profit
Selling price

Z Job cost sheet for ABC123

Calculation
Direct materials

Direct labour

32

Direct expense

Prime cost

Variable production overheads

Variable Production cost

Fixed Non-manufacturing overheads

Total cost

Profit 25% margin

Selling price to customer

3. Classify each of the following costs as variable, fixed, mixed, or step by writing an X
under one of the following headings (Sales volume is the cost driver).

33

VariableFixedMixedStep
1. Total selling and administrative costs
2. Total salary cost of supervisors who are paid for each group
of five employees supervised
3. Raw materials used in production
4. Power consumption in a restaurant
5. Cost of goods sold in a bookstore
6. Salaries of employees who handle 20 claims per month
7. Pulpwood in a paper mill
8. Salaries of two secretaries in the corporate office
9. Total current manufacturing costs
10.The cost of an automobile rented on the basis of a daily
charge plus 0.30 per mile

4. Pen Ltd has the following information available regarding costs at two different
activity levels of monthly production:

Production volume (units)

7,000

10,000

Direct materials

70,000 100,000

Direct labour

56,000

80,000

Indirect materials

21,000

30,000

Supervisors' salaries

12,000

12,000

Depreciation on plant and equipment

10,000

10,000

34

Maintenance

32,000

44,000

Utilities

15,000

21,000

Insurance on plant and equipment

1,600

1,600

Property taxes on plant and equipment

2,000

2,000

Total costs

219,600 300,600

Identify each cost as being variable, fixed or mixed by writing the name of each cost
under one of the following headings:

Variable Costs Fixed Costs Mixed Costs

35

5. Classify the following costs incurred by a step railing manufacturing company as

direct materials, direct labour, factory overhead, or period costs:

a.Wages paid to production workers

b.Utilities in the office
c. Depreciation on machinery in plant
d.Steel
e. Accountant's salary
f. Rent on factory building
g. Rent on office equipment
h. Maintenance workers' wages
i. Utilities in the plant
j. Maintenance on office equipment

6. Match the term to the definition

Total of direct costs

Product produced by an organisation

Dividing costs into production, administration, selling and distribution etc

Cost that can be traced in full to whatever is being costed

36

Organisations departments

A cost that varies with the level of output

G A cost that is incurred in the course of making a product but which cannot be
traced directly and in full to the product

Cost that is incurred for a particular period of time and which, within certain activity
levels, is unaffected by changes in the level of activity

Cost identified with goods produced or purchase for resale and initially included in
value of stock

Prime cost

Cost unit

Classification
by function

Cost centre

Direct cost

Product cost

Overhead

Fixed cost

Variable cost

37

Cost Behaviour
Costs are affected by changes in activity. Generally costs behave in a number of ways
and change when activity levels change.
Cost behaviour patterns:

Fixed costs
Step costs
Variable costs
Semi-variable costs

Basic principles of cost behaviour

As the level of activity rises, costs will usually rise. It will generally cost more to produce
200 units of output than it will to produce 100 units of output.

For many cost accounting purposes, such as budgeting and decision-making, it is

important to classify costs on the basis of the behaviour
i.e. how does total cost change over time.

38

Variable costs
Costs that vary with changes in level of activity
For example, most direct material costs.

Fixed costs
Costs not affected by changes in activity level.
For example, the rent on the factory.

Semi-variable costs
Costs that have a fixed element and a variable element.
For example, the cost of electricity for the factory

Stepped costs
Costs that are fixed up to a particular level of activity, but which rise to a higher (fixed)
level if activity goes beyond that range.
For example, supervisors salaries

39

Fixed v variable

Total
cost

Total
cost

Variable
cost
Fixed cost

Activity level

Activity level

Semi-variable and stepped

Total
cost

Total
cost
Stepped costs

Semi-variable
cost

Activity level

40

Activity level

St Trinians is a themed school-dinners style restaurant in London.

Classify the following costs by their behaviour in the table below.

Cost

Fixed

Variable

Semi-variable

Head chefs salary

Cleaning materials

note

Food served in the

restaurant
Electricity includes a
standing charge
Cost of wine
Cost of staff uniforms

Note: kitchen gets cleaned irrespective of number of customers, so there will be a fixed
element as well as variable.

41

Product Costs V Period Costs

Product Costs

Period Costs

Direct Materials

Period costs such as rent are not

included in product costs. The are
written off entirely in the profit and loss
account

Direct Labour
Direct Expenses
Manufacturing overhead

All charged against sales in the Trading

Account

42

43