Introduction to Accounting IM51005B Lecture 6 Introduction to Management Accounting & Cost terms, concepts and Classification Dr Sarah Lauwo

Objectives of the lecture Understand different roles of management accountants. Distinguish between management accounting and financial accounting. Understand the roles of Management Accountant Identify the characteristics of ethical behaviour by management accountants. Understand the different ways of classifying costs Understand the relevant costs in decision making Understand costs behaviour

Directing and Motivating Work of Management Planning Directing and Motivating Controlling Decision- Making

Managing Resources, Activities, and People Planning An organization . . . Directing Acquires Resources Organized set of activities Controlling Decision Making Hires People

Management Accounting and Financial Accounting Managerial accounting provides information for managers of an organization who direct and control its operations. Financial accounting provides information to stockholders, creditors and others who are outside the organization.

Managerial versus Financial Accounting Accounting System (accumulates financial and managerial accounting data) Managerial Accounting Information for decision making, and control of an organization’s operations. Financial Accounting Published financial statements and other financial reports. Internal Users External Users

Key Guidelines 1. Cost-benefit approach A cost-benefit approach should be used in order to spend resources if they promote decision making that better attains organization goals in relation to the costs of those resources. 2. Full recognition of behavioral as well as technical considerations A management accounting system should have two simultaneous missions for providing information:(1)To help managers make wise economic decisions (2) To help managers and other employees to aim and strive for goals of the organization 3. Using different costs for different purposes A cost concept used for the external reporting purpose need not be the appropriate concept for the purpose of internal routine reporting to managers.

Roles of Management Accountants (1) Problem Solving (2) Score keeping (3) Attention Directing This involves helping managers properly focus their attention. Attention directing should focus on all opportunities to add value to an organization, not just cost-reduction opportunities. 12:01

Problem solving? Score keeping? Attention directing? Example Problem solving? Score keeping? Attention directing? Preparing a monthly statement of UK sales for the IBM marketing manager. Scorekeeping 2. Analyzing, for a Dyson manufacturing manager, the desirability of having some auto parts made in Malaysia. Problem solving 3. Preparing a schedule of depreciation for trucks in the receiving departments Scorekeeping Attention directing 4. Interpreting why the Canterbury distribution centre exceeded its delivery-cost budget 12:04

Code of Ethics for Management Accountants Avoid activities that could affect your ability to perform duties. Refrain from activities that could discredit the profession. Refuse gifts or favours that might influence behavior. Integrity Communicate unfavourable as well as favourable information.

CIMA Code of Ethics for Management Accountants Communicate information fairly and objectively. Objectivity Disclose all information that might be useful to management.

Cost terms , concepts and classification Next…. Cost terms , concepts and classification

Manufacturing vs. Merchandising Merchandisers . . . Buy finished goods Sell finished goods Keep stocks of finished goods Manufacturers . . . Buy raw materials Manual/automated production of goods Sell finished goods Keep stocks of materials + work in progress + finished goods

Manufacturing Cost Concepts Financial Accounting Cost is a measure of resources used or given up to achieve a stated purpose. Management Accounting Product costs are the costs a company assigns to units produced.

Manufacturing Overhead Manufacturing Costs Direct Materials Direct Labour Manufacturing Overhead The Product

Example: A radio installed in a car (1) Direct Materials Those materials that become an integral part of the product and that can be conveniently traced directly to it. Example: A radio installed in a car

Example: Wages paid to car assembly workers (2) Direct Labour Those labour costs that can be easily traced to individual units of product. Example: Wages paid to car assembly workers

Examples: Indirect labour and indirect materials (3) Manufacturing Overhead Manufacturing costs that cannot be traced directly to specific units produced. Examples: Indirect labour and indirect materials Wages paid to employees who are not directly involved in production work. Examples: maintenance workers, cleaners and security guards. Materials used to support the production process. Examples: lubricants and cleaning supplies used in the car assembly plant.

Classifications of Costs Manufacturing costs are often combined as follows: Direct Materials Direct Labour Manufacturing Overhead Prime Cost Conversion Cost

Non-manufacturing Costs Marketing and selling costs Costs of obtaining & processing orders and delivering products to customers Administrative costs All executive, organizational, and clerical costs Also known as ‘PERIOD COSTS’

Product Costs Versus Period Costs Product costs include direct materials, direct labour, and manufacturing overhead. Period costs are not included in product costs. They are expensed on the profit statement. Expense stock Cost of Good Sold Sale Balance Sheet Profit Statement Profit Statement

Balance Sheet Manufacturer Merchandiser Cash Debtors Prepaid Expenses Current Assets Cash Debtors Prepaid Expenses Stock Raw Materials Work in Progress Finished Goods Merchandiser Current Assets Cash Debtors Prepaid Expenses Merchandise Stock

The Profit Statement Cost of goods sold for manufacturers differs only slightly from cost of goods sold for merchandisers.

Manufacturing & Non- Manufacturing Cost Flows Balance sheet Stock Profit Statement Cost Material Purchases Raw Materials Direct labour Work in Progress Manufacturing Overhead Cost of Goods Sold Finished Goods Period Costs Selling and Administrative Selling and Administrative

Product Costs - A Closer Look Costs associated with the goods that are completed during the period are transferred to finished goods stock.

Product Costs - A Closer Look £ 14,200 £ 234,150 £ 248,350 (12,100) £ 236,250

Cost Classifications for Predicting Cost Behaviour How a cost will react to changes in the level of business activity (e.g., production volume, further processing) Total variable costs change when activity changes. Total fixed costs remain unchanged when activity changes.

Total Long Distance Telephone Bill Total Variable Cost Your total long distance telephone bill is based on how many minutes you talk. Total Long Distance Telephone Bill Minutes Talked

Per Minute Telephone Charge Variable Cost Per Unit The cost per long distance minute talked is constant. For example, 10 pence per minute. Per Minute Telephone Charge Minutes Talked

Monthly Basic Telephone Bill Total Fixed Cost Your monthly basic telephone bill probably does not change when you make more local calls. Monthly Basic Telephone Bill Number of Local Calls

Monthly Basic Telephone Bill per Local Call Fixed Cost Per Unit The average cost per local call decreases as more local calls are made. Monthly Basic Telephone Bill per Local Call Number of Local Calls

Cost Classifications for Predicting Cost Behavior

Types of Fixed Costs Fixed Costs Committed Long-term, cannot be reduced in the short term (< 1 year). Discretionary May be altered in the short-term by current managerial decisions Examples Depreciation on Buildings and Equipment Examples Advertising; Research and Development

Some Other Cost Terms Direct costs Indirect costs Costs that can be easily and conveniently traced to a unit of product or other cost objective. Examples: direct material and direct labour. Indirect costs Costs cannot be easily and conveniently traced to a unit of product or other cost object. Example: manufacturing overhead.

Some Other Cost Terms Opportunity Costs Sunk Costs The potential benefit that is given up when one alternative is selected over another. Example: If you were not attending university, you could be earning £15,000 per year. Your opportunity cost of attending university for one year is £15,000. Sunk Costs Sunk costs cannot be changed by any decision. They are not differential costs and should be ignored when making decisions Example: You bought a car that cost £10,000 two years ago. The £10,000 cost is sunk because whether you drive it, park it, trade it, or sell it, you cannot change the £10,000 cost.

Some Other Cost Terms Controllable Costs Costs that managers have some degree of influence in the department such as variable costs (material+ labour) Non-Controllable Costs Generally these are seen as costs to business over which management cannot exert any influence. These are mostly committed costs related to the possession of fixed assets. Discretionary fixed costs, for example, advertising and research and development costs can be thought of as being controllable because they are incurred as a result of decision made by management and can be raised or lowered at fairly short notice