1. 11 MANAGERIAL ACCOUNTING & COSTING ACC 221: Week 1: Lecture1 ACC 221: Week 1: Lecture1

2. 12 Objectives of Lecture 1:  Define Managerial Accounting  General Costs Classifications  Costs Classifications on Financial Statements Statements  The importance of Cost Classifications · for predicting behavior · for predicting behavior · for allocating costs to ‘cost objects’ · for allocating costs to ‘cost objects’ · for decision Making · for decision Making

3. 13 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 Managers manage the company on behalf of the owners and act for the best of owners’ interestsROLE: Planning & Deciding: setting goals and define - identify techniques to realize the specific objectives Planning & Deciding: setting goals and define - identify techniques to realize the specific objectives Direct & Motivate employees: supervision and treatment of personnel 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 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

4. 14 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 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

5. 15 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.

6. Objectives of Managerial Accounting 16 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).

7. B. 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. 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). 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). 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. 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. 17

8. C. 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. 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. 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. 18

9. 2.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. 3.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. Rewarding performance: Many large corporations compensate their executives, in part, on the basis of the profit achieved by the subunits they manage. 19

10. 4.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. Evaluation: This allows the firm to evaluate its financial and internal performance, customer satisfaction, and innovation compared to other similar firms. 110

11. Major Themes of Managerial Accounting A. 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. 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. 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. 111

12. B. 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. 112

13. C. 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. 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. Benefits: The benefits include improved decisions, more effective planning, greater efficiency of operations at lower costs, and better directions and control of operations. 113

14. 114 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.

15. 115 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 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. 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: Manufacturing Overheads that is every cost which is not direct material or direct labour e.g: Indirect Labour Indirect Labour Indirect Materials, for instance materials that repair machines Indirect Materials, for instance materials that repair machines Electricity: heating and lighting Electricity: heating and lighting Depreciation & Insurance for manufacturing equipment Depreciation & Insurance for manufacturing equipment

16. 116 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 31 st May Y12. DRCR Stock of Raw M. as at 1st May Y1271.000 Raw Materials Returned1.350 Purchases Raw Materials138.000 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/c

17. 117 DRManufacturing accountCR Opening stock R/M71.000 Purchases of R.M Returned1.350 Add: Purchases R/M138.000Closing Stock65.000 Add: Carriage Inwards6.200Cost of R/M used c/d148.850 215.200 Cost of R/M used b/d148.850 Trading Account- Transfer148.850 €€

18. 118 Prime Cost of Production = Direct Raw Material+Direct Labour+Direct Expenses Prime Cost of Production = Direct Raw Material+Direct Labour+Direct Expenses Direct Expenses examples: Direct Expenses examples: * Royalties: right to manufacture a product * Royalties: right to manufacture a product * Subcontractors payments or outwork e.g. another company or individuals not employed by the * Subcontractors payments or outwork e.g. another company or individuals not employed by the company are paid for doing work on a product company are paid for doing work on a product Conversion Cost = Sum of direct Labour costs + Manufacturing Overheads

19. 119 …continue of example 1: Also the Trial B/ce includes: DR CR Accrued Direct Wages on 1 st May Y12 73,200 (wages of last week of AprilY12 not paid yet) Direct wages paid 372,400 Note: Direct Wages accrued as at 31 st 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.

20. 120 DRManufacturing accountCR Opening stock R/M71.000Return Outwards1.350 Purchases R/M138.000Closing Stock65.000 Carriage Inwards6.200Cost of R/M used c/d148.85 215.200215.20 Cost of R/M used b/d148.850Accrued Dir wages of 1 May Y1273.200 Direct Wages paid372.400 Add: Direct Wages Acrued68.300Prime Cost of Production c/d516.35 589.550589550 Prime Cost of Production b/d516.350Trading Account - Transfer516.35

21. 121 To Manufacturing a/c only goes the Production- Manufacturing Overheads not other overheads such as:  Selling expenses Administrative expenses Administrative expenses Distribution expenses Distribution expenses  Research & Development expenses expenses  Financial Expenses (interests, bank Charges) (interests, bank Charges) Non-Manufacturing exps Non-Manufacturing exps also called Period exps also called Period exps and goes to trading a/c and goes to trading a/c

22. 122 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.

23. 123 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.

24. 124 Cost Classifications on Financial Statements 1. The Balance Sheet 1. The Balance Sheet The Statement of Financial Position (Balance sheet) of a manufacturing company is similar to that of a merchandise company. 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. 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. 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. Work in Progress: products not yet completed fully but partially and require further work to be ready for sale. Also called semi-finished goods. Also called semi-finished goods. Finished goods: completed products not yet sold. Finished goods: 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 ASSETS. inventories as CURRENT ASSETS.

25. 125 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.

26. 126 Example 2 Example 2

27. 127 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.

28. 128 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 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

29. 129 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)

30. 130 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 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 them, the need to see if costs are reasonable and control them, and so forth and so forth Direct cost Indirect cost Cost Object

31. 131 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.

32. 132 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.

33. 133 Queries? Queries?