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MANAGERIAL MANAGERIAL ACCOUNTING & ACCOUNTING &

COSTINGCOSTING

ACC 221: Week 1: Lecture1ACC 221: Week 1: Lecture1

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Objectives of Lecture 1:Objectives of Lecture 1:

Define Managerial AccountingDefine Managerial AccountingGeneral Costs ClassificationsGeneral Costs ClassificationsCosts Classifications on Financial Costs Classifications on Financial StatementsStatementsThe importance of Cost ClassificationsThe importance of Cost Classifications

··for predicting behaviorfor predicting behavior

··forfor allocating costs to ‘cost objects’ allocating costs to ‘cost objects’

··forfor decision Making decision Making

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The Role of Managers and the vital The Role of Managers and the vital support of Managerial Accounting support of Managerial Accounting

to this roleto this role• Managers manage the company on behalf of Managers manage the company on behalf of

the owners and act for the best of owners’ the owners and act for the best of owners’ interestsinterests

ROLE:ROLE: Planning & Deciding: Planning & Deciding: setting goals and define - setting goals and define -

identify techniques to realize the specific identify techniques to realize the specific objectivesobjectives

Direct & Motivate employees:Direct & Motivate employees: supervision and supervision and treatment of personneltreatment of personnel

Controlling company systems and procedures: Controlling company systems and procedures: operation ofoperation of departments, advertising and departments, advertising and marketing, customer satisfaction, accounts marketing, customer satisfaction, accounts payables and receivables, dealing with risks payables and receivables, dealing with risks changes, challenges e.t.c changes, challenges e.t.c

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Managerial AccountingManagerial Accounting also called also called Cost Cost AccountingAccounting is the procedure of is the procedure of identifying, measuring, analyzing and identifying, measuring, analyzing and providing information for the pursuit of providing information for the pursuit of an organization's goals. .an organization's goals. .

Managerial Accounting, in contrast to Financial Accounting, is aimed to help managers inside the organization to take decisions with the information it provides. . Financial Accounting is aimed to provide information to parties outside the organization e.g. Stockholders, Banks, Creditors, Government e.t.c   

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Compared to financial accounting, managerial accounting is a young regulation. As a result, managerial accounting concepts and tools are still developing as new ways are found to provide information that assists management. Moreover, the business environment is changing rapidly. For managerial accounting to be as useful a tool in the future as it has been in the recent past, managerial accounting information must be adapted to reflect those changes. Several changes in the business environment that are especially relevant to managerial accounting are discussed briefly here. The effect of these changes on various topics in managerial accounting will be explored in subsequent lectures.

Objectives of Managerial Objectives of Managerial Accounting Accounting

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A. Providing information for decision making and planning: Practically all major decisions by internal users (i.e., managers) rely largely on managerial accounting information.

Type of data: This information includes financial and nonfinancial data to help managers with strategic planning and decision-making (e.g., the cost of products, budgets, cash flows, amount of materials used and inventories).

B.B. Assisting in directing and controlling: Directing and Assisting in directing and controlling: Directing and controlling day-to-day operations requires a variety of controlling day-to-day operations requires a variety of data about the process of providing a good or servicedata about the process of providing a good or service. .

Directing operational activities: Directing operational activities: The The management team needs data about the cost of management team needs data about the cost of providing goods or services in order to set fees providing goods or services in order to set fees and prices. and prices.

Controlling operations: Controlling operations: Management Management compares actual costs incurred with those compares actual costs incurred with those specified in the budget (specified in the budget (e.g.e.g., analyzing and , analyzing and comparing actual performance to budget plans). comparing actual performance to budget plans).

Attention-directing functions: Attention-directing functions: The attention-The attention-directing function of managerial accounting directing function of managerial accounting information directs managers’ attention to issues information directs managers’ attention to issues that need their attention (that need their attention (i.e.i.e., it highlights , it highlights successful or problem areas). successful or problem areas).

No solutions, only information: Managerial accounting reports No solutions, only information: Managerial accounting reports rarely solve a decision problem, however, these reports often rarely solve a decision problem, however, these reports often direct managers’ attention to an issue that requires their direct managers’ attention to an issue that requires their skills. skills.

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C.C. Motivating managers and employeesMotivating managers and employees: A key : A key purpose of managerial accounting is to motivate purpose of managerial accounting is to motivate managers and other employees to direct their efforts managers and other employees to direct their efforts toward achieving the organization’s goals. This toward achieving the organization’s goals. This motivates managers to achieve the organization’s motivates managers to achieve the organization’s goals by communicating the plans, providing a goals by communicating the plans, providing a measurement of how well the plan was achieved, measurement of how well the plan was achieved, and offering on time an explanation of differences and offering on time an explanation of differences from the plan. from the plan.

1. Budgeting1. Budgeting: : One means of achieving goals is One means of achieving goals is through budgeting. The budget indicates the top through budgeting. The budget indicates the top management’s desire to allocate resources and management’s desire to allocate resources and emphasize certain activities. emphasize certain activities.

Explain deviations-differencesExplain deviations-differences: When actual : When actual operations do not match to the budget, managers will operations do not match to the budget, managers will be asked to explain the reasons for the deviation. This be asked to explain the reasons for the deviation. This creates both an incentive to follow the principles of the creates both an incentive to follow the principles of the budget and avoid possible negative consequences. budget and avoid possible negative consequences.

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2.2. Empowerment (authorization)Empowerment (authorization): : Another way to Another way to motivate employees to assist in achieving the motivate employees to assist in achieving the organization’s goals is through empowerment. organization’s goals is through empowerment. Employee Employee empowerment –give permission to act -empowerment –give permission to act - is the concept of encouraging and authorizing is the concept of encouraging and authorizing workers to take the initiative to improve operations, workers to take the initiative to improve operations, product quality, customer service and reduce costs. product quality, customer service and reduce costs.

3.3. Measuring performance: Measuring performance: Another way of motivating Another way of motivating employees’ toward the organization’s goals is to employees’ toward the organization’s goals is to measure their performance in achieving their goals. measure their performance in achieving their goals. Managerial accounting measures performance for Managerial accounting measures performance for both the entire organization, as in financial both the entire organization, as in financial accounting, but also for many subunits as well (accounting, but also for many subunits as well (e.g.e.g., , divisions, departments, managers). divisions, departments, managers).

Rewarding performance:Rewarding performance: Many large corporations Many large corporations compensate their executives, in part, on the basis of compensate their executives, in part, on the basis of the profit achieved by the subunits they managethe profit achieved by the subunits they manage..

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4.4. Assessing the organization's competitive Assessing the organization's competitive position: position: A crucial role of managerial accounting A crucial role of managerial accounting is to continually assess how an organization is to continually assess how an organization compares with the competition, with an eye compares with the competition, with an eye toward continuously improving. toward continuously improving.

Evaluation:Evaluation: This allows the firm to evaluate its This allows the firm to evaluate its financial and internal performance, customer financial and internal performance, customer satisfaction, and innovation compared to other satisfaction, and innovation compared to other similar firms. similar firms.

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Major Themes of Managerial Major Themes of Managerial AccountingAccounting

A.A. Information and incentivesInformation and incentives: The need for : The need for information is the driving force behind managerial information is the driving force behind managerial accounting. accounting.

Two functionsTwo functions: Managerial accounting : Managerial accounting information serves two functions: a information serves two functions: a decision-decision-facilitatingfacilitating function and a function and a decision-influencingdecision-influencing function. function.

Information is usually supplied to a manager who is the Information is usually supplied to a manager who is the decision-maker to assist him/her in choosing an decision-maker to assist him/her in choosing an alternative. Often that information is also intended to alternative. Often that information is also intended to influence the manager’s decision. It should be noted, influence the manager’s decision. It should be noted, however, that the managerial accounting information however, that the managerial accounting information only facilitates and influences decisions, it does not only facilitates and influences decisions, it does not make final decisions for managers.make final decisions for managers.

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B.B. Behavioural issues: Behavioural issues: The reactions of both The reactions of both individuals and groups to managerial accounting individuals and groups to managerial accounting information will significantly affect the course of information will significantly affect the course of events in an organization. Everyone has behavioural events in an organization. Everyone has behavioural tendencies and intelligence - understanding tendencies and intelligence - understanding limitations that affect their use of information. The limitations that affect their use of information. The better a managerial accountant’s understanding of better a managerial accountant’s understanding of human behaviour is, the more effective he or she human behaviour is, the more effective he or she will be as a provider of information. will be as a provider of information.

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C.C. Costs and benefits: The attractiveness of any Costs and benefits: The attractiveness of any particular managerial accounting technique or particular managerial accounting technique or information must be determined in light of its information must be determined in light of its costs and benefits. costs and benefits.

Costs: Costs: The cost of providing managerial accounting The cost of providing managerial accounting information includes the cost of compensation for the information includes the cost of compensation for the controller and Accounting Department personnel, the controller and Accounting Department personnel, the cost of purchasing and operating computers, and the cost of purchasing and operating computers, and the costs of the time spent by the information users to costs of the time spent by the information users to read, understand, and make use of information. read, understand, and make use of information.

Benefits: Benefits: The benefits include improved decisions, The benefits include improved decisions, more effective planning, greater efficiency of more effective planning, greater efficiency of operations at lower costs, and better directions and operations at lower costs, and better directions and control of operations. control of operations.

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General Cost ClassificationsGeneral Cost ClassificationsBusiness that produce-manufacture goods have the Business that produce-manufacture goods have the Following main Following main 3 cost categories3 cost categories which are included which are included in the in the Manufacturing AccountManufacturing Account and are called and are called Manufacturing Manufacturing CostsCosts::

Direct MaterialsDirect Materials Direct LabourDirect Labour Manufacturing OverheadsManufacturing Overheads

The Manufacturing Account precedes the Trading Account The Manufacturing Account precedes the Trading Account when a manufacturing company prepares the financial when a manufacturing company prepares the financial statements. Conversely a merchandise - Retail companystatements. Conversely a merchandise - Retail companyprepares directly the Trading Accountprepares directly the Trading Account..

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Direct MaterialsDirect Materials divided to divided to Direct Raw Materials:Direct Raw Materials:

basic material from which a product isbasic material from which a product is mademade,, and and Indirect Materials: Indirect Materials: any material that is not part of any material that is not part of the finished product and are treated as the finished product and are treated as manufacturing overheads. manufacturing overheads.

Direct Labour Direct Labour divided to divided to Direct workers Direct workers (touch (touch labour) who are directly involved with the labour) who are directly involved with the manufacture of goods and manufacture of goods and Indirect labour Indirect labour where where employees are not touching the product such as employees are not touching the product such as supervisors, security, cleaners, driver. Also treated supervisors, security, cleaners, driver. Also treated as manufacturing overheads.as manufacturing overheads.

Manufacturing OverheadsManufacturing Overheads that that is every cost which is every cost which is is notnot direct material or direct labour e.g: direct material or direct labour e.g:

Indirect LabourIndirect Labour Indirect Materials, Indirect Materials, for instance materials that repair machinesfor instance materials that repair machines

Electricity: heating and lightingElectricity: heating and lighting Depreciation & Insurance for manufacturing Depreciation & Insurance for manufacturing

equipmentequipment

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HOW WE CALCULATE THE COST OF RAW MATERIALS?HOW WE CALCULATE THE COST OF RAW MATERIALS?

Example1:Example1: The below is a Trial B/ce extract from The below is a Trial B/ce extract from G.X.N.E Manufacturing Ltd as at 31G.X.N.E Manufacturing Ltd as at 31stst May Y12. May Y12.

DR CR

Stock of Raw M. as at 1st May Y12 71.000

Raw Materials Returned 1.350

Purchases Raw Materials 138.000

Carriage Inwards (=costs to transfer R.M in the company) 6.200

Note : The stock of Raw Materials as at 31st May Y12 was € 65000

Required: Extract of the Manufacturing A/cRequired: Extract of the Manufacturing A/c

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DR Manufacturing account CR

           

Opening stock R/M 71.000Purchases of R.M Returned 1.350

Add: Purchases R/M 138.000 Closing Stock 65.000

Add: Carriage Inwards 6.200 Cost of R/M used c/d 148.850

215.200 215.200

Cost of R/M used b/d 148.850Trading Account- Transfer 148.850

€€ €€

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Prime Cost of ProductionPrime Cost of Production = =

Direct Raw Material+Direct Labour+Direct ExpensesDirect Raw Material+Direct Labour+Direct Expenses

Direct Expenses examples:Direct Expenses examples: **Royalties: right to manufacture a productRoyalties: right to manufacture a product

**Subcontractors payments or outwork e.g. another Subcontractors payments or outwork e.g. another company or individuals not employed by thecompany or individuals not employed by the

company are paid for doing work on a productcompany are paid for doing work on a product

Conversion CostConversion Cost = = Sum of direct Labour costs + Manufacturing OverheadsSum of direct Labour costs + Manufacturing Overheads

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……continue of example 1:continue of example 1:Also the Trial B/ce includes: Also the Trial B/ce includes:

DR CR• Accrued Direct Wages on 1st May Y12 73,200 (wages of last week of AprilY12 not paid yet) • Direct wages paid 372,400

Note: Direct Wages accrued as at 31st May Y12 €68,300

Required : Continue the Manufacturing A/c.

Reminder: Only the Direct Wages that concerns the period ofproduction that we study are DEBITED to the Manufacturing a/c.The Accrued Direct Wages are credited or deducted at the debit Site.

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DR Manufacturing account CR

           

Opening stock R/M 71.000 Return Outwards 1.350

Purchases R/M 138.000 Closing Stock 65.000

Carriage Inwards 6.200 Cost of R/M used c/d 148.85

215.200 215.20

Cost of R/M used b/d 148.850 Accrued Dir wages of 1 May Y12 73.200

Direct Wages paid 372.400

Add: Direct Wages Acrued 68.300 Prime Cost of Production c/d 516.35

 

589.550 589550

Prime Cost of Production b/d 516.350 Trading Account - Transfer 516.35

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To Manufacturing a/c only goes the Production-To Manufacturing a/c only goes the Production-Manufacturing Overheads not Manufacturing Overheads not other overheadsother overheads such such as:as:

Selling expensesSelling expenses Administrative expensesAdministrative expenses Distribution expensesDistribution expenses Research & DevelopmentResearch & Development

expensesexpenses Financial Expenses Financial Expenses

(interests, bank Charges)(interests, bank Charges)

Non-ManufacturingNon-Manufacturing exps exps

also also called called Period expsPeriod exps

and and goes to trading a/cgoes to trading a/c

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Two minor categories:Two minor categories:

Selling expsSelling exps are the costs incurred so as the final are the costs incurred so as the final product goes to the customer e.g.product goes to the customer e.g.advertising , shipping , sales commissions , sales advertising , shipping , sales commissions , sales salaries , sales travel. salaries , sales travel.

Administrative exps Administrative exps are all costs linked with the overallare all costs linked with the overall

general administration / management / operation of a general administration / management / operation of a

business rather than with the manufacturing or selling business rather than with the manufacturing or selling

the product e.g. the product e.g.

General accounting, secretarial, public relations,General accounting, secretarial, public relations,

Executives’ compensation, rents of the administrative Executives’ compensation, rents of the administrative

offices e.t.c.offices e.t.c.

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Product Costs Versus Period CostsProduct Costs Versus Period Costs

Period Costs Period Costs are all the costs that are not are all the costs that are not product costs.product costs.Product Costs Product Costs include all costs involved ininclude all costs involved inmaking a product. It is the cost of Raw Materials making a product. It is the cost of Raw Materials Consumed, the cost of Direct Labour and all Consumed, the cost of Direct Labour and all manufacturing expenses. manufacturing expenses.

For e.g. the depreciation of a production machinery is product For e.g. the depreciation of a production machinery is product Cost (manufacturing overhead) but the depreciation of delivery Cost (manufacturing overhead) but the depreciation of delivery Vans is a period overhead.Vans is a period overhead.

Also the Also the product-manufacturing costsproduct-manufacturing costs are called are called Inventoriable Inventoriable

CostsCosts because they go directly to inventory accounts and not to because they go directly to inventory accounts and not to expenses accounts. Also they go to Balance Sheet as assets if expenses accounts. Also they go to Balance Sheet as assets if they are partially completed (Work In Progress) or unsold at they are partially completed (Work In Progress) or unsold at the end of period.the end of period.

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Cost Classifications on Financial Cost Classifications on Financial StatementsStatements

1. The1. The Balance SheetBalance Sheet

The Statement of Financial Position The Statement of Financial Position (Balance sheet)(Balance sheet) of a of a manufacturing company is similar to that of a merchandise manufacturing company is similar to that of a merchandise company. company.

However However Manufacturing companies have three classes of Manufacturing companies have three classes of inventories inventories (closing stocks)(closing stocks) - - raw materialsraw materials, , work in work in progressprogress and and finished goods- finished goods- in their balance sheet.in their balance sheet.

Raw MaterialsRaw Materials : materials used to make a product. : materials used to make a product.

Work in ProgressWork in Progress: products not yet completed fully but : products not yet completed fully but partially and require further work to be ready for sale. partially and require further work to be ready for sale.

Also called semi-finished goods.Also called semi-finished goods.

Finished goods: Finished goods: completed products not yet sold.completed products not yet sold.

In Balance Sheet is only shown the closing stocks of the above 3 In Balance Sheet is only shown the closing stocks of the above 3 inventories as CURRENT ASSETSinventories as CURRENT ASSETS..

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2.The Income Statement2.The Income Statement

The Income Statement is consisted of the The Income Statement is consisted of the Trading A/c Trading A/c

and the Profit & Loss A/cand the Profit & Loss A/c. In a Manufacturing company . In a Manufacturing company

the the Manufacturing A/cManufacturing A/c precedes the trading a/c and its precedes the trading a/c and its

result goes to trading a/c so as to determined the result goes to trading a/c so as to determined the costcost

of goods sold of goods sold . Also the opening and closing stock of . Also the opening and closing stock of

Finished goods is also key factor in order to determined Finished goods is also key factor in order to determined

the cost of sales.the cost of sales.

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Example 2Example 2

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The importance of Cost The importance of Cost Classifications for:Classifications for:

1. Predicting behavior1. Predicting behavior Cost Behaviour Cost Behaviour refers to how a cost refers to how a cost

reacts to changes in the level of activity. reacts to changes in the level of activity. As the activity level rises and falls, a As the activity level rises and falls, a particular cost may rise and fall as well – or particular cost may rise and fall as well – or it may remain constant.it may remain constant.

For For planning purposesplanning purposes, a manager must , a manager must be able to predict which of these will be able to predict which of these will happen, and if a cost can be expected to happen, and if a cost can be expected to change, the manager must be able to change, the manager must be able to estimate how much it will change.estimate how much it will change.

To help make such evaluations, costs are To help make such evaluations, costs are often categorized as variable or fixed.often categorized as variable or fixed.

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VARIABLE COSTS: VARIABLE COSTS: are those costs that vary-fluctuateare those costs that vary-fluctuate depending on a company’s level of activity. They rise depending on a company’s level of activity. They rise as production increases and fall as production as production increases and fall as production decreases. Examples could be direct materials and decreases. Examples could be direct materials and labor ,some manufacture overheads, shipping costs, labor ,some manufacture overheads, shipping costs, sales commissions e.t.csales commissions e.t.c

Activity LevelActivity Level is the is the production volumeproduction volume of a company of a company and it can be the units produced, units sold, hours and it can be the units produced, units sold, hours worked e.t.cworked e.t.c

FIXED COSTS:FIXED COSTS: are costs that tends to remain the same are costs that tends to remain the same

regardless of activity level. Such examples are rents, regardless of activity level. Such examples are rents,

advertising, insurance, office supplies e.t.cadvertising, insurance, office supplies e.t.c

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The importance of Cost The importance of Cost Classifications for: Classifications for:

2. Allocating costs to 2. Allocating costs to ‘cost objects’‘cost objects’‘‘Cost Object’ is any item or any input use in the productionCost Object’ is any item or any input use in the production

for which we are separately measuring costs and we directlyfor which we are separately measuring costs and we directlylink costs with it. link costs with it.

For instance labor is a ‘cost object’ because we determine For instance labor is a ‘cost object’ because we determine the cost of employment ‘per man per hour’ and we find a the cost of employment ‘per man per hour’ and we find a fixed rate of employment. Another example is materials: cost fixed rate of employment. Another example is materials: cost of fabrics used or plastic units. of fabrics used or plastic units. The company pays The company pays €€8 per worker per hour8 per worker per hour

Also ‘Cost Object’ can be a product manufactured by a Also ‘Cost Object’ can be a product manufactured by a company and for which a separate measurement of cost is company and for which a separate measurement of cost is desired.desired.

Examples: project, service, customer, jobs, departments Examples: project, service, customer, jobs, departments within organization (customer service call, design of a new within organization (customer service call, design of a new product)product)

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Costs are allocated to the ‘cost objects’ and Costs are allocated to the ‘cost objects’ and they are either direct or indirect coststhey are either direct or indirect costs

The reasons that we want to allocate costs to The reasons that we want to allocate costs to ‘cost objects’ includes : ‘cost objects’ includes :

the need to determine a price for a product,the need to determine a price for a product, the need to determine profitability,the need to determine profitability, the need to see if costs are reasonable and control the need to see if costs are reasonable and control

them,them,

and so forthand so forth

Direct costDirect cost

Indirect Indirect costcost

Cost ObjectCost Object

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Direct Costs:Direct Costs:

A direct cost is a cost that can be easily traced to a A direct cost is a cost that can be easily traced to a specific cost object, therefore direct labour and raw specific cost object, therefore direct labour and raw materials are direct costs.materials are direct costs.

Indirect CostsIndirect Costs::

An indirect cost is a cost that cannot be easily traced to An indirect cost is a cost that cannot be easily traced to

a specific cost object.a specific cost object.

For example the rent expense can not be allocated For example the rent expense can not be allocated

directly to the production department or the administrationdirectly to the production department or the administration

department and thus we allocate some to each one.department and thus we allocate some to each one.

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The importance of Cost The importance of Cost Classifications for Classifications for 3. Decision Making3. Decision Making

Costs are an important feature of many business Costs are an important feature of many business decisions.decisions.

In making decisions, it is essential to have In making decisions, it is essential to have awareness and understanding of the concepts:awareness and understanding of the concepts:

differential cost, differential cost, is a broader term, including both cost is a broader term, including both cost increases (incremental costs) and cost decreases increases (incremental costs) and cost decreases (decremental costs) between alternatives. (decremental costs) between alternatives.

opportunity cost opportunity cost is the potential benefit that is given up is the potential benefit that is given up when one alternative is selected over anotherwhen one alternative is selected over another..

and sunk cost. and sunk cost. is a cost that has already been incurred is a cost that has already been incurred and that cannot be changed by any decision made now or in and that cannot be changed by any decision made now or in the future.the future.

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Queries?Queries?