1. MBA: MANAGERIAL ACCOUNTING
Lecture 7 & 8 1

2. Objectives of Lecture 1:
Define Managerial Accounting
General Costs Classifications
Costs Classifications on Financial
Statements
The importance of Cost Classifications
·for predicting behavior
·for allocating costs to ‘cost objects’
·for decision Making 1

3. The Role of Managers and the vital support of Managerial Accounting to this role
Managers manage the company on behalf of the owners and act for the best of owners’ interests
ROLE:
Planning & Deciding: setting goals and define - identify techniques to realize the specific objectives
Direct & Motivate employees: supervision and treatment of personnel
Controlling company systems and procedures: operation of departments, advertising and marketing, customer satisfaction, accounts payables and receivables, dealing with risks changes, challenges e.t.c 1

4. Managerial Accounting also called Cost Accounting is the procedure of identifying, measuring, analyzing and providing information for the pursuit of 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   1

5. 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. 1

6. Objectives of Managerial Accounting
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). 1

7. Assisting in directing and controlling: Directing and controlling day-to-day operations requires a variety of data about the process of providing a good or service.
Directing operational activities: The management team needs data about the cost of providing goods or services in order to set fees and prices.
Controlling operations: Management compares actual costs incurred with those specified in the budget (e.g., analyzing and comparing actual performance to budget plans).
Attention-directing functions: The attention-directing function of managerial accounting information directs managers’ attention to issues that need their attention (i.e., it highlights successful or problem areas).
No solutions, only information: Managerial accounting reports rarely solve a decision problem, however, these reports often direct managers’ attention to an issue that requires their skills. 1

8. Motivating managers and employees: A key purpose of managerial accounting is to motivate managers and other employees to direct their efforts toward achieving the organization’s goals. This motivates managers to achieve the organization’s goals by communicating the plans, providing a measurement of how well the plan was achieved, and offering on time an explanation of differences from the plan.
1. Budgeting: One means of achieving goals is through budgeting. The budget indicates the top management’s desire to allocate resources and emphasize certain activities.
Explain deviations-differences: When actual operations do not match to the budget, managers will be asked to explain the reasons for the deviation. This creates both an incentive to follow the principles of the budget and avoid possible negative consequences. 1

9. Empowerment (authorization): Another way to motivate employees to assist in achieving the organization’s goals is through empowerment. Employee empowerment –give permission to act - is the concept of encouraging and authorizing workers to take the initiative to improve operations, product quality, customer service and reduce costs.
Measuring performance: Another way of motivating employees’ toward the organization’s goals is to measure their performance in achieving their goals. Managerial accounting measures performance for both the entire organization, as in financial accounting, but also for many subunits as well (e.g., divisions, departments, managers).
Rewarding performance: Many large corporations compensate their executives, in part, on the basis of the profit achieved by the subunits they manage. 1

10. Assessing the organization's competitive position: A crucial role of managerial accounting is to continually assess how an organization compares with the competition, with an eye toward continuously improving.
Evaluation: This allows the firm to evaluate its financial and internal performance, customer satisfaction, and innovation compared to other similar firms. 1

11. Major Themes of Managerial Accounting
Information and incentives: The need for information is the driving force behind managerial accounting.
Two functions: Managerial accounting information serves two functions: a decision-facilitating function and a decision-influencing function.
Information is usually supplied to a manager who is the decision-maker to assist him/her in choosing an alternative. Often that information is also intended to influence the manager’s decision. It should be noted, however, that the managerial accounting information only facilitates and influences decisions, it does not make final decisions for managers. 1

12. Behavioural issues: The reactions of both individuals and groups to managerial accounting information will significantly affect the course of events in an organization. Everyone has behavioural tendencies and intelligence - understanding limitations that affect their use of information. The better a managerial accountant’s understanding of human behaviour is, the more effective he or she will be as a provider of information. 1

13. Costs and benefits: The attractiveness of any particular managerial accounting technique or information must be determined in light of its costs and benefits.
Costs: The cost of providing managerial accounting information includes the cost of compensation for the controller and Accounting Department personnel, the cost of purchasing and operating computers, and the costs of the time spent by the information users to read, understand, and make use of information.
Benefits: The benefits include improved decisions, more effective planning, greater efficiency of operations at lower costs, and better directions and control of operations. 1

14. General Cost Classifications
Business that produce-manufacture goods have the Following main 3 cost categories which are included in the Manufacturing Account and are called Manufacturing Costs:
Direct Materials
Direct Labour
Manufacturing Overheads
The Manufacturing Account precedes the Trading Account when a manufacturing company prepares the financial statements. Conversely a merchandise - Retail company prepares directly the Trading Account. 1

15. Indirect Materials, for instance materials that repair machines
Direct Materials divided to Direct Raw Materials: basic material from which a product is made, and Indirect Materials: any material that is not part of the finished product and are treated as manufacturing overheads.
Direct Labour divided to Direct workers (touch labour) who are directly involved with the manufacture of goods and Indirect labour where employees are not touching the product such as supervisors, security, cleaners, driver. Also treated as manufacturing overheads.
Manufacturing Overheads that is every cost which is not direct material or direct labour e.g:
Indirect Labour
Indirect Materials, for instance materials that repair machines
Electricity: heating and lighting
Depreciation & Insurance for manufacturing equipment 1

16. Direct Expenses examples: *Royalties: right to manufacture a product
Prime Cost of Production = Direct Raw Material+Direct Labour+Direct Expenses
Direct Expenses examples:
*Royalties: right to manufacture a product
*Subcontractors payments or outwork e.g. another company or individuals not employed by the
company are paid for doing work on a product
Conversion Cost =
Sum of direct Labour costs + Manufacturing Overheads 1

17. Required: Extract of the Manufacturing A/c
HOW WE CALCULATE THE COST OF RAW MATERIALS? Example1: The below is a Trial B/ce extract from G.X.N.E Manufacturing Ltd as at 31st May Y12. DR CR
Stock of Raw M. as at 1st May Y12
71.000
Raw Materials Returned
1.350
Purchases Raw Materials
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/c 1

18. € € DR Manufacturing account CR Opening stock R/M 71.000
Opening stock R/M
71.000
Purchases of R.M Returned
1.350
Add: Purchases R/M
Closing Stock
65.000
Add: Carriage Inwards
6.200
Cost of R/M used c/d
Cost of R/M used b/d
Trading Account- Transfer € € 1

19. …continue of example 1: Also the Trial B/ce includes:
DR CR
Accrued Direct Wages on 1st May Y ,200
(wages of last week of AprilY12 not paid yet)
Direct wages paid ,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 of
production that we study are DEBITED to the Manufacturing a/c.
The Accrued Direct Wages are credited or deducted at the debit
Site. 1

20. Manufacturing account CRDR
Manufacturing account CR
Opening stock R/M
71.000
Return Outwards
1.350
Purchases R/M
Closing Stock
65.000
Carriage Inwards
6.200
Cost of R/M used c/d
148.85
215.20
Cost of R/M used b/d
Accrued Dir wages of 1 May Y12
73.200
Direct Wages paid
Add: Direct Wages Acrued
68.300
Prime Cost of Production c/d
516.35
589550
Prime Cost of Production b/d
Trading Account - Transfer 1

21. Administrative expenses Distribution expenses Research & Development
To Manufacturing a/c only goes the Production-Manufacturing Overheads not other overheads such as:
Selling expenses
Administrative expenses
Distribution expenses
Research & Development
expenses
Financial Expenses
(interests, bank Charges)
Non-Manufacturing exps
also called Period exps
and goes to trading a/c 1

22. Two minor categories:
Selling exps are the costs incurred so as the final product goes to the customer e.g. advertising , shipping , sales commissions , sales salaries ,sales travel
Administrative exps are all costs linked with the overall general administration / management / operation of a business rather than with the manufacturing or selling the product e.g. General accounting, secretarial, public relations, Executives’ compensation, rents of the administrative offices e.t.c. 1

23. Product Costs Versus Period Costs
Period Costs are all the costs that are not
product costs.
Product Costs include all costs involved in
making a product. It is the cost of Raw Materials
Consumed, the cost of Direct Labour and all
manufacturing expenses.
For e.g. the depreciation of a production machinery is product
Cost (manufacturing overhead) but the depreciation of delivery
Vans is a period overhead.
Also the product-manufacturing costs are called Inventoriable
Costs because they go directly to inventory accounts and not to
expenses accounts. Also they go to Balance Sheet as assets if
they are partially completed (Work In Progress) or unsold at
the end of period. 1

24. Cost Classifications on Financial Statements
1. The Balance Sheet
The Statement of Financial Position (Balance sheet) of a manufacturing company is similar to that of a merchandise company.
However Manufacturing companies have three classes of inventories (closing stocks) - raw materials, work in progress and finished goods- in their balance sheet.
Raw Materials : materials used to make a product.
Work in Progress: products not yet completed fully but partially and require further work to be ready for sale.
Also called semi-finished goods.
Finished goods: completed products not yet sold.
In Balance Sheet is only shown the closing stocks of the above 3
inventories as CURRENT ASSETS. 1

25. 2.The Income Statement
The Income Statement is consisted of the Trading A/c
and the Profit & Loss A/c. In a Manufacturing company
the Manufacturing A/c precedes the trading a/c and its
result goes to trading a/c so as to determined the cost
of goods sold . Also the opening and closing stock of
Finished goods is also key factor in order to determined
the cost of sales. 1

26. Example 2 1

27. The importance of Cost Classifications for: 1. Predicting behavior
Cost Behaviour refers to how a cost reacts to changes in the level of activity. As the activity level rises and falls, a particular cost may rise and fall as well – or it may remain constant.
For planning purposes, a manager must be able to predict which of these will happen, and if a cost can be expected to change, the manager must be able to estimate how much it will change.
To help make such evaluations, costs are often categorized as variable or fixed. 1

28. FIXED COSTS: are costs that tends to remain the same
VARIABLE COSTS: are those costs that vary-fluctuate depending on a company’s level of activity. They rise as production increases and fall as production decreases. Examples could be direct materials and labor ,some manufacture overheads, shipping costs, sales commissions e.t.c
Activity Level is the production volume of a company and it can be the units produced, units sold, hours worked e.t.c
FIXED COSTS: are costs that tends to remain the same
regardless of activity level. Such examples are rents,
advertising, insurance, office supplies e.t.c 1

29. The importance of Cost Classifications for: 2
The importance of Cost Classifications for: 2. Allocating costs to ‘cost objects’
‘Cost Object’ is any item or any input use in the production
for which we are separately measuring costs and we directly
link costs with it.
For instance labor is a ‘cost object’ because we determine
the cost of employment ‘per man per hour’ and we find a
fixed rate of employment. Another example is materials: cost
of fabrics used or plastic units.
The company pays €8 per worker per hour
Also ‘Cost Object’ can be a product manufactured by a
company and for which a separate measurement of cost is
desired.
Examples: project, service, customer, jobs, departments
within organization (customer service call, design of a new
product) 1`

30. Costs are allocated to the ‘cost objects’ and they are either direct or indirect costs The reasons that we want to allocate costs to ‘cost objects’ includes :
the need to determine a price for a product,
the need to determine profitability,
the need to see if costs are reasonable and control them,
and so forth
Direct cost
Cost Object
Indirect cost 1

31. An indirect cost is a cost that cannot be easily traced to
Direct Costs: A direct cost is a cost that can be easily traced to a specific cost object, therefore direct labour and raw materials are direct costs.
Indirect Costs:
An indirect cost is a cost that cannot be easily traced to
a specific cost object.
For example the rent expense can not be allocated
directly to the production department or the administration
department and thus we allocate some to each one. 1

32. The importance of Cost Classifications for 3. Decision Making
Costs are an important feature of many business decisions.
In making decisions, it is essential to have awareness and understanding of the concepts:
differential cost, is a broader term, including both cost increases (incremental costs) and cost decreases (decremental costs) between alternatives.
opportunity cost is the potential benefit that is given up when one alternative is selected over another.
and sunk cost. is a cost that has already been incurred and that cannot be changed by any decision made now or in the future. 1

33. Cost Behavior
Cost Behavior: is how a cost will react – change – as changes take place in the activity base. As the activity level rises and falls, a particular cost may rise and fall as well – or it may remain constant.
A cost behavior is a key tool in the hands of managers who are request to predict the costs that will be occurred under various activity levels.
In order to predict costs we use 3 cost behavior patterns:
Variable costs
Fixed Costs
Mixed (semi variable) Costs
Cost Structure is the percentage of each type of cost in
an organization’s total cost of production.

34. Total Long Distance Telephone Bill
Variable Costs
Are those costs that vary-fluctuate directly as the company’s level of activity changes. They rise as production increases and fall as production decreases.
If activity level by 50% total variable cost by 50%
If activity level by 10% total variable cost by 10%
Your total long distance telephone bill is increasing as the minutes you talk are increasing.
Total Long Distance Telephone Bill
As an example of an activity base, consider your total long distance telephone bill. The activity base is the number of minutes that you talk.
Minutes Talked

35. Per Minute Telephone Charge
Variable Costs
A variable cost remains constant if expressed on a
per unit basis.
So a variable cost is constant per unit but varies in total with the activity level.
The per minute cost of long distance calls is constant, for example, 10¢ per minute.
Per Minute Telephone Charge
Referring to the telephone example, the cost per minute talked is constant (e.g., 10 cents per minute)
Minutes Talked

36. Variable Costs
For a cost to be variable it must be variable in respect to something, that is the activity base. Activity base or cost driver is whatever causes the rise and fall of a variable cost.
For example the direct materials for the production of a ford car is a variable costs. As the output of ford increases, car increases, the direct materials needed increases.

37. A measure of what causes the fluctuation of a variable cost.
The Activity Base
Units produced
Miles driven
Labor hours
Machine hours
A measure of what causes the fluctuation of a variable cost.
An activity base (also called a cost driver) is a measure of what causes the incurrence of variable costs. As the level of the activity base increases, the variable cost increases proportionally. Units produced (or sold) is not the only activity base within companies. A cost can be considered variable if it varies with activity bases such as miles driven, machine hours, or labor hours.

38. VARIABLE COSTS
Extent of Variable Costs: The proportion of variable costs in a firm differs across organizations. For example . .
A service company : audit, consulting, medical, architectural companies have very large fixed costs (salaries etc)
A manufacturing company or a restaurant will often have many variable costs.

39. True Variable Costs. Direct materials is a true or proportionately variable cost because the amount used during a period will vary in direct proportion to the level of production activity, moreover any amounts purchased but not used can be stored and carried forward to the next period as inventory.
Step – Variable Costs. A resource that is acquire in large amount and that increases or decreases only in response to wide changes in activity is known as a step – variable cost. For example, the wages of skilled repair technicians are often considered to be a step – variable costs. Small changes in the level of production are not likely to have any effect on the number of maintenance workers employed.

40. Cost Volume Volume Cost
True Variable Cost
Cost
Volume
Volume
Cost
A step variable cost is a resource that is obtainable only in large chunks and whose costs change only in response to fairly wide changes in activity. For example, maintenance workers are often considered to be a variable cost, but this labor cost does not behave as a true variable cost.
Step-Variable Costs

41. Step variable cost
Small Changes
Wide Changes
Volume
Cost
Volume
Cost

42. FIXED COSTS Are costs that tends to remain the same regardless of
production volume. Such examples are rents, advertising,
insurance, depreciation e.t.c
Average fixed costs per unit decrease as the activity level
increases.

43. Total Fixed Cost Example
Total Fixed Cost of Rent
Fixed Cost of Rent per customer
Per Unit Cost of
Rent
Fixed costs decreases on a per unit basis as the activity level – customers increases
Total Cost of Rent
For example, your monthly basic telephone bill is probably fixed and does not change when you make more local calls.
Number of customers
Number of customers

44. Fixed Cost Per Unit Example
Average fixed costs per unit decrease as the activity level increases.
The fixed cost per local call decreases as more local calls are made.
Monthly Basic Telephone Bill per Local Call
For example, the fixed cost per local call decreases as more local calls are made.
Number of Local Calls

45. 1. Committed Fixed Costs. Investments in facilities, equipment, and the basic organisation structure.
Examples: depreciation on buildings and equipment, real estate taxes, insurance expenses, salaries of managers and operational staff e.t.c
They have long-term nature and they can not be significantly reduced even for short periods of time without affecting seriously the goals and profitability of the company. E.g. if we discharge a manager because operation lowers the cost of re-employment a new is greater than the short-run saving realized.
As it is difficult to change committed costs management should make such engagements only after careful thoughts.

46. 2. Discretionary Fixed Costs
2.Discretionary Fixed Costs. Discretionary Fixed Costs usually arise from annual decisions by management to spend on certain fixed cost items.
Examples: advertising, research, public relations, internship for students, training of employees etc.
Differences with committed fixed costs:
1. Are planning for the short run not for many
years
2. They can be alter or cut-down without serious impact on profitability and goals.
3. They are optional costs and not practically necessary for the operation of the firm.

47. Is Labor a Variable or a Fixed Cost?
The behavior of wage and salary costs can differ across countries, depending on labor regulations, labor contracts and custom.
In France, Germany, China, and Japan, management has little flexibility in adjusting the size of the labor force. Labor costs are more fixed in nature. Most companies in the United States continue to view direct labor as a variable cost.
The demand for knowledge workers has grown extremely and most companies consider their employees as a valuable asset. As a result knowledge workers are relatively a fixed cost. On the other hand direct workers are a variable cost because managers prefer to recruit temporary or part-time workers when sales increases rather than keep them permanently at the company and keep payroll budget in a cost-effective level.
Labor costs a mixture of fixed and variable costs

48. IN GENERAL FIXED COSTS CAN CHANGE BUT NOT WHEN SMALL CHANGES OCCUR
IN GENERAL FIXED COSTS CAN CHANGE BUT NOT WHEN SMALL CHANGES OCCUR.THEY ALTER IN LONG RUN WHEN LARGE CHANGES REALIZED IN ACTIVITY BASE.

49. Mixed Costs A mixed cost has both fixed and variable components.
Example with expeditions company:
€25,000 per year for license
€3 per customer
If the company has 1000 customers this
year € € 3x1000= € 28000
If the company has 0 customers this
year € € 3x0= € 25000

50. Mixed Costs

51. Mixed Costs Y Total mixed cost Cost of state license fees X Customers
Example with expeditions company X Y
Total mixed cost
Cost of state license fees
A mixed cost contains both variable and fixed cost elements. For example, utility bills often contain fixed and variable cost components. The fixed portion of the utility bill is constant regardless of kilowatt hours consumed. This cost represents the minimum cost that is incurred to have the service ready and available for use. The variable portion of the bill varies in direct proportion to the consumption of kilowatt hours.
Variable Cost per Customer
Fixed Yearly license Charge
Customers

52. Methods of Measuring Cost Functions
Cost estimation is the process of determining how a particular cost behaves
1. Engineering analysis
2. Account analysis
3. High-low analysis
4. Visual-fit analysis

53. Account Analysis. Each account is classified as either variable or fixed based on the analyst’s prior knowledge of how the cost in the account behaves.
The engineering Approach Cost analysis involves a detailed analysis of what cost behaviour should be, based on an industrial engineer’s evaluation of the production methods to be used, the materials requirements, labour requirements, equipment usage and so on.

54. The first step is to plot the historical data points on a table.
3. High-Low Method
The first step is to plot the historical
data points on a table.
The focus of this method is normally on
the highest- and lowest-activity points.
Difference between the costs corresponding
Variable Model = to the highest and lowest activity levels
Difference between the highest and lowest
activity levels

55. High-Low Method Example
High month: April
Maintenance cost: $47,000
Number of patient-days: 4,900
Low month: September
Maintenance cost: $17,000
Number of patient-days: 1,200
What is the variable cost?

56. High-Low Method Example
($47,000 – $17,000) ÷ (4,900 – 1,200)
= $30,000 ÷ 3,700 = $8.1081
What is the fixed cost?
Two ways to find this
a)$47,000 = Fixed cost + ($8.1081× 4,900)
$47,000 – $39,730 = $7,270
b)$17,000 = Fixed cost + ($8.1081× 1,200)
$17,000 – $9,730 = $7,270

57. The mixed cost line equation in this case is:
Y = *X

58. 4. Visual-Fit Method In the visual-fit method, the cost analyst
visually fits a straight line through a plot
of all of the available data, not just
between the high point and the
low point, making it more reliable
than the high-low method.
Advantages:
More reliable – uses all available data
Disadvantage:
Fit is done through human eye  subjective

59. When the cost has been classified as a semi variable or when the analyst has no clear idea about the behavior of a cost item it is helpful to use the visual fit method to plot (design) recent observations of the cost at various activity levels. So first it makes a table and then a graph-a diagram which displays the results. The resulting diagram helps the analyst to visualize –see and understand- the relationship between cost and the level of activity ( or the cost driver)
Month
Cost for month
Dozen of bakery items sold per month (cost driver)
Jan
5100
75000
Feb
5300
78000
Then make a graph with these data

60. e.g. $ 1500
The visual cost line cut off the vertical axis at $1500 so this give us the estimation of the fixed cost component in the semi variable cost approximation. To determine the variable cost per unit deduct the fixed cost from the total cost at any activity level.

61. Thank you QUESTIONS? 1