Ch02 Management Accounting 5e

Chapter 2
Management accounting: cost terms

and concepts
Copyright 2009 McGraw-Hill Australia Pty Ltd

PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith
Prepared by Kim Langfield-Smith
2-1
Outline
Management accounting systems

Emphasis on costs
Cost classifications: different classifications for different purposes
Classifying costs according to their behaviour
Direct and indirect costs
Controllable and uncontrollable costs
Costs across the value chain
Manufacturing costs
Cost flows in a manufacturing business

2-2
Management accounting systems

Management accounting systems are tailored to an
organisations needs
Components may include systems for
Costing
Budgeting
Performance measurement
Cost management
Conventional versus contemporary approaches

Contemporary approaches developed in the 1990s in response to
changes in the business environment

2-3

2-4
Emphasis on costs
Why do management accountants pay so much attention to
costs?
Historic focus on production coststo value inventory and cost of goods
sold for external reporting
Ready availability of cost data within the transaction-based accounting
system
Importance of cost information in managers decisions
Non-financial information assumes increased importance in

contemporary management accounting systems
Used to make decisions and manage various sources of customer value
and shareholder wealth

2-5
Cost classifications: different

classifications for different
Before we classify costs, we need to consider how
purposes
managers intend to use the information
Different costs and classifications are used for
different purposes
The same cost can be classified in a number of
ways depending on the intended use of the cost
information
(cont.)
2-6
Cost classifications: different

classifications for different
What are costs?
purposes
(cont.)
Resources given up to achieve a particular objective
In financial accounting
if the benefit extends beyond the current accounting period
these costs are classified as assets
If the benefit is used up in the generation of revenue, the
costs are classified as expense
Measured in monetary terms

2-7

2-8
Classifying costs according to

their behaviour
Managers must understand how costs change as

the level of activity in the business changes
The level of activity is the level of work performed in the
organisation
Units produced, kilometres driven, hours worked
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

2-9
Direct and indirect costs

An important function of management accounting
is to measure the cost of cost objects
Cost objects are the items for which management wants
a separate measure of costs
Products, projects, contracts and departments are
common cost objects in conventional costing systems
Contemporary costing systems may also include
activities and customers as cost objects
(cont.)
2-10
Direct and indirect costs (cont.)

Responsibility centres
A responsibility centre is a unit of an organisation where the manager
is held accountable for the units activities and performance
The costing system may measure the costs of managers individual
areas of responsibility
Costs that can be traced to a particular responsibility centre are
direct costs of that centre
Costs that relate to responsibility centres but cannot be traced
precisely to specific responsibility centres are indirect costs of those
centres
(cont.)
2-11
Direct and indirect costs (cont.)

Product costs
Manufacturing costs that can be traced to products in an economic
manner are direct product costs
Indirect costs are manufacturing costs that cannot be traced to products
in an economic manner
Whether a cost is classified as direct or indirect depends on the

nature of the cost object
Do we wish to know the cost of a department, a product, a project, or an
entire company?
A cost can be a direct cost of one cost object and an indirect cost of
another cost object

2-12
Controllable and uncontrollable

costs
Managers performance evaluation can be

enhanced by classifying responsibility centre costs
as either controllable by the manager or
uncontrollable
Ideally, managers should be held responsible only
for costs they can control or significantly influence
Some costs are controllable in the long term but
not in the short term

2-13

2-14

The value chain
A set of linked processes or activities that begins with
acquiring resources and ends with providing and
supporting products and services that customers value
Various cost classifications can be used within the

upstream, downstream and manufacturing areas
To assign cost to products and to provide other
information to help manage resources efficiently and
effectively and to create value
(cont.)
2-15

(cont.)
Upstream costs
Research and development costs include the costs
involved in developing new products and processes
Design costs include the costs associated with designing
a product or production process
Supply costs are the costs of sourcing and managing
incoming parts, assemblies and supplies
(cont.)
2-16

(cont.)
Production costs
The costs incurred to collect and assemble the resources used to

produce a product (i.e. goods or services)
Downstream costs
Marketing costs are the costs of selling products and the costs of
advertising and promotion
Distribution costs are the costs of storing, handling and shipping
finished products
Customer service costs are the costs of serving customers,
including after-sales service

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2-18
Manufacturing costs
Manufacturing costs are incurred within the factory area
Upstream and downstream costs are non-manufacturing
costs
Manufacturing costs include three categories: direct
material, direct labour and manufacturing overhead
This classification as direct or indirect cost assumes that products
are the relevant cost objects
Under conventional product costing, only manufacturing

costs are included in product costs
(cont.)
2-19
Manufacturing costs (cont.)

Direct material is
Consumed in the manufacturing process

Physically incorporated into the finished products
Can be traced to products conveniently
Considered a variable cost
Direct labour
The cost of wages and labour on-costs for personnel who work directly on
the manufacture of a product
Usually treated as variable costs, however contractual arrangements
sometimes mean that such labour is a committed cost and so does not
vary with the level of production
(cont.)
2-20

Manufacturing overhead
All manufacturing costs other than direct material and direct labour
Also called indirect manufacturing costs or factory burden
Includes the cost of indirect material and indirect labour,
depreciation and insurance on factory equipment, utilities and the
costs of support departments for manufacturing
Includes cost of overtime premium and idle time
Manufacturing support departments do not work directly on
producing products but are necessary for the manufacturing
process to occur
(cont.)
2-21

Conversion costs
The total of direct labour cost and manufacturing
overhead cost
The cost of converting material into a product
Prime costs
The total of direct material cost and direct labour cost
The major cost associated with producing a product
(cont.)
2-22

Contemporary costing systems analyse costs in
greater detail than conventional costing systems
Only direct material may be classified as direct product
costs
Labour costs may be analysed as part of activity costs, as
may some upstream and downstream costs
In many industries, direct material is the largest

proportion of the manufacturing cost and direct
labour costs are the smallest

2-23
Product costs
Managers need estimates of product costs for different
purposes
In financial accounting reports
Product costs determine cost of goods sold
Product costs help value inventory on hand
All costs that are not product costs are called period costs
For management decision making

Definitions of product costs may include non-manufacturing costs
associated with developing, producing and selling the product

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2-25
Cost flows in a manufacturing

business
1. Material is purchased: the cost is added to raw
materials inventory
2. Direct materials are consumed in production: cost
is removed from raw materials inventory and
added to work in process inventory
Direct labour and manufacturing overhead are
accumulated in work in process inventory
(cont.)
2-26
Cost flows in a manufacturing

business (cont.)
3. Products are completed: costs are transferred from
work in process inventory and added to finished
goods inventory
4. Products are sold: costs are transferred from
finished goods inventory to cost of goods sold
expense
Cost of goods sold is deducted from sales revenue
to determine gross profit
(cont.)
2-27
Cost flows in manufacturing

business (cont.)
Raw materials, work in process and finished goods

inventory balances are reported in the Balance
Sheet
Cost of goods sold expense can be found in the
income statement
The schedule of cost of goods manufactured and
schedule of cost of goods sold summarise the flow
of manufacturing costs

2-28

2-29
Summary
Management accounting systems are tailored to
an organisations needs
Costing systems focus on the cost of products and
organisational units and are a component of
management accounting systems
We can distinguish between conventional and
contemporary management accounting systems
There may be different costs for different purposes
Costs may be classified by behaviour, traceability,
controllability and function
(cont.)
2-30
Summary (cont.)
In manufacturing businesses, production costs
typically consist of direct materials, direct labour
and manufacturing overhead, in line with external
reporting requirements
The definition of product costs needed to support
management decision making may be broader
than that used for external reporting purposes
Product costing systems track the manufacturing
costs from the beginning of production to finished
goods and link the product costing system to the
financial accounting reports
2-31

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Chapter 2

Management accounting: cost terms

Copyright 2009 McGraw-Hill Australia Pty Ltd

Management accounting systems

Copyright 2009 McGraw-Hill Australia Pty Ltd

Management accounting systems

Conventional versus contemporary approaches

Copyright 2009 McGraw-Hill Australia Pty Ltd

Copyright 2009 McGraw-Hill Australia Pty Ltd

Non-financial information assumes increased importance in

Copyright 2009 McGraw-Hill Australia Pty Ltd

Cost classifications: different

Cost classifications: different

Measured in monetary terms

Copyright 2009 McGraw-Hill Australia Pty Ltd

Copyright 2009 McGraw-Hill Australia Pty Ltd

Classifying costs according to

Managers must understand how costs change as

Copyright 2009 McGraw-Hill Australia Pty Ltd

Direct and indirect costs

Direct and indirect costs (cont.)

Direct and indirect costs (cont.)

Whether a cost is classified as direct or indirect depends on the

Copyright 2009 McGraw-Hill Australia Pty Ltd

Controllable and uncontrollable

Managers performance evaluation can be

Copyright 2009 McGraw-Hill Australia Pty Ltd

Copyright 2009 McGraw-Hill Australia Pty Ltd

Costs across the value chain

Various cost classifications can be used within the

Costs across the value chain

Costs across the value chain

The costs incurred to collect and assemble the resources used to

Copyright 2009 McGraw-Hill Australia Pty Ltd

Copyright 2009 McGraw-Hill Australia Pty Ltd

Under conventional product costing, only manufacturing

Manufacturing costs (cont.)

Consumed in the manufacturing process

Manufacturing costs (cont.)

Manufacturing costs (cont.)

Manufacturing costs (cont.)

In many industries, direct material is the largest

Copyright 2009 McGraw-Hill Australia Pty Ltd

For management decision making

Copyright 2009 McGraw-Hill Australia Pty Ltd

Copyright 2009 McGraw-Hill Australia Pty Ltd

Cost flows in a manufacturing

Cost flows in a manufacturing

Cost flows in manufacturing

Raw materials, work in process and finished goods

Copyright 2009 McGraw-Hill Australia Pty Ltd

Copyright 2009 McGraw-Hill Australia Pty Ltd

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