Management Accounting

SEMINAR 1 (CHAPTER 1)

1.1 Summary of Cost Classifications

Assigning cost to cost objects:

- Direct and Indirect

Accounting for costs in manufacturing companies:

- Manufacturing costs: Direct labour, Direct materials, Manufacturing Overhead costs

- Non-manufacturing costs: Selling costs, Administrative costs

Preparing financial statements:

- Product costs (inventoriable)

- Period costs (expenses)

Predicting cost behavior in response to changes in activity:

- Variable costs (proportional to activity)

- Fixed costs (constant in total)
- Mixed costs (has variable an fixed elements)

Making decisions:

- Differential costs (differs between alternatives)

- Sunk costs (should be ignored)
- Opportunity costs (foregone benefit)

1.2 Cost Classifications for Assigning Costs to Costs Objects

Cost object: Anything for which cost data are desired – including products, customers, and
organizational subunits. Costs are classified as direct or indirect for purpose of assigning costs to cost
objects

Direct cost: Can be easily and conveniently traced to a specified cost object

Indirect cost: Cannot be easily and conveniently traced to a specified cost object

Common cost: A type of indirect cost. Is a cost that is incurred to support a number of cost objects bit
cannot be traced to them individually
1.3 Cost Classifications for Manufacturing Companies

Direct materials: Materials that go into the final product

Direct labour: Labour costs that can be traced to individual units of product

Manufacturing Overhead: All manufacturing costs except direct labour (eg. janitors, supervisors,
security guards) and direct materials (eg. glue to assemble). Also includes depreciation of manufacturing
equipment, utility costs, property taxes and insurance premiums incurred to operate a manufacturing
facility (only those associated with operating the factory are included in manufacturing overhead)

Conversion cost refers to the sum of direct labour and manufacturing overhead.

Prime cost is the sum of direct materials and direct labour cost.

Non-manufacturing cost (SG&A) are divided into:

1. Selling costs: advertising, shipping, sales travel, sales commissions, sales salaries, and cost of finished
goods warehouses

2. Administrative costs (costs associated with general management): executive compensation, general
accounting, secretarial, public relations, and similar costs as a whole.

1.4 Cost Classifications for Preparing Financial Statements

The matching principle is based on the accrual concept that costs incurred to generate a particular
revenue should be recognised as expenses in the same period that the revenue is recognised.

Product costs (inventoriable costs) include all costs involved in acquiring or making a product. Includes
direct materials, direct labour, and manufacturing overhead.

Product costs are not necessarily recorded as expenses on the income statement in the period in which
they are incurred. Rather, they are recorded as expenses in the period in which the related products are
sold.

Period costs are all the costs that are not product costs. All selling and administrative expenses are
treated as period costs. For example, sales commissions, advertising, executive salaries, public relations,
and the rental costs of administrative offices.

Period cost are not included as part of the cost of either purchased or manufactured goods, instead are
expensed on the income statement in the period in which they are incurred using the usual rules of
accrual accounting.
1.5 Cost Classifications for Predicting Cost Behaviour

Cost behavior refers to how a cost reacts to changes in the level of activity

Cost structure is the relative proportion of each type of cost in an organization

Variable cost: In direct proportion to changes in the level of activity. Eg. costs of goods sold for a
merchandising company, direct materials, direct labour, variable elements of manufacturing overhead
such as indirect materials, supplies and power, and variable elements of selling and administrative
expenses such as commissions and shipping costs

Activity base is a measure of whatever causes he incurrence of a variable cost, also sometimes referred
to as a cost driver (eg. direct labour hours, machine hours, units produced, units sold

Fixed cost remains constant regardless of changes in the level of activity. Eg. Depreciation, insurance
property taxes, rent, supervisory salaries, administrative salaries, advertising

Mixed cost contains both variable and fixed cost elements

Differential cost are always relevant costs. A future cost that differs between any two alternatives is
known as a differential cost. Also known as incremental cost.

Sunk cost is a cost that has already been incurred and that can not be changed by any decision made
now or in the future. Sunk costs should always be ignored.

Opportunity cost is the potential benefit given up when one alternative is selected over another. Not
found in accounting records but must be explicitly considered in every decision a manager makes.

1.6 Cost Classifications for Decision Making

Differential cost (incremental cost) is a future cost that differs between any two alternatives (always
relevant)
Differential revenue is future revenue that differs between any two alternatives

Sunk cost is a cost that has already been incurred and that cannot be changed by any decision made
now or in the future. Sunk costs should always be ignored in a decision

Opportunity cost is the potential benefit given up when one alternative is selected over another. It is
not usually found in accounting records but they are costs that must be explicitly considered in every
decision a manager makes

1.7 Formulas for Calculating Costs

Product cost = Direct Materials + Direct Labour + Manufacturing Overhead

Period cost = Selling Expense + Administrative Expense

Conversion cost = Direct Labour + Manufacturing Overhead

Prime cost = Direct Materials + Direct Labour

Variable Manufacturing cost = Direct Materials + Direct Labour + Variable Manufacturing Overhead

Total Fixed cost = Fixed Manufacturing Overhead + Fixed Selling Expense + Fixed Administrative Expense

Total Variable Costs = Direct Material Costs + Direct Labor Costs + Variable Selling & Administrative Costs

Total Fixed Costs = Total Manufacturing Overhead Costs + Fixed Selling & Administrative Costs

Total Contribution Margin = Total Sales Value - Total Variable Costs

Conversion Costs = Direct Labor Costs + Fixed Manufacturing Overhead Costs + Variable Manufacturing
Overhead Costs

Prime Costs = Direct Material Costs + Direct Labor Costs

Total Product Costs = Direct Materials Costs + Direct Labour Costs+ Variable Manufacturing Overhead
Costs + Fixed Manufacturing Overhead Costs

Total Period Costs = Variable Selling Expenses + Fixed Selling Expenses + Variable Administrative
Expenses + Fixed Administrative Expenses

Total Direct Manufacturing Costs = Direct Materials Costs + Direct Labour Costs

Total Indirect Manufacturing Costs = Variable Manufacturing Overhead Costs + Fixed Manufacturing
Overhead Costs

Total Manufacturing Costs = Direct Materials Costs + Direct Labour Costs + Variable Manufacturing
Overhead Costs + Fixed Manufacturing Overhead Costs

Total Non-manufacturing Costs = Variable Selling Expenses + Fixed Selling Expenses + Variable
Administrative Expenses + Fixed Administrative Expenses
Total Variable Manufacturing Costs = Direct Materials Costs + Direct Labour Costs + Variable
Manufacturing Overhead Costs

Total Fixed Costs = Fixed Manufacturing Overhead Costs + Fixed Selling Expenses + Fixed Administrative
Expenses

Variable Cost per unit of unit Produced = Direct Materials per unit Costs + Direct Labour per unit Costs +
Variable Manufacturing Overhead per unit Cost + Variable Administrative Expenses per unit

Variable Cost per unit of unit Sold = Direct Material per unit Cost + Direct Labour per unit Cost + Variable
Manufacturing Overhead per unit Cost + Variable Administrative Expense per unit + Variable Selling
Expenses per unit

Incremental Cost of Manufacturing Additional Unit = Direct Material per unit Cost + Direct Labour per
unit Cost + Variable Manufacturing Overhead per unit Cost + Variable Administrative Expense per unit

1.8 Using Different Cost Classifications for Different Purposes

The cost of goods sold reports the product costs attached to the merchandise sold during the period

The selling and administrative expenses report all period costs that have been expenses as incurred

Cost of Goods Sold = Beginning Merchandise Inventory + Purchases – Ending Merchandise Inventory
1.10 Quality Costs
SEMINAR 2 (CHAPTER 3 – TRADITIONAL ABSORPTION COSTING SYSTEM)

3.1 Job Order Costing

Bill of Materials is a document that lists the quantity of each type of direct material needed to complete
a unit of product

Job Cost Sheet records the materials, labour, and manufacturing overhead costs charged to that job

Cost Driver is a factor, such as machine-hours, beds occupied, computer time, or flight-hours, that
causes overhead costs.

3.2 Job-Order Costing Using Multiple Predetermined Overhead Rates

3.3 Multiple Predetermined Overhead Rates – An Activity-Based Approach

Activity-based costing is an approach used by companies to create overhead rates based on the
activities it performs (More in APPENDIX 3A and Chapter 5)

3.4 Job-Order Costing – An External Reporting Perspective

Job-order costing systems are normally used to compute unit product costs for internal management
purposes.

Also used to create a balance sheet and income statement for external parties.

Overhead Application and the Income Statement

When a company uses predetermined overhead rates to apply overhead cost to jobs, it is almost a
certainty that the amount of overhead applied to all jobs will differ from the actual amount of overhead
costs incurred during the period.

When a company applies less overhead to production than it actually incurs, it creates what is known as
underapplied overhead.

When it applies more overhead to production than it actually incurs, it results in overapplied overhead.

The adjustment for underapplied overhead increases the cost of goods sold and decreases net operating
income, whereas the adjustment for overapplied overhead decreases the cost of goods sold and
increases net operating income.
Job Cost Sheets: A Subsidiary Ledger

A job cost sheet accumulates the total direct materials, direct labour, and manufacturing overhead costs
assigned to a job. When all of a company’s job cost sheets are viewed collectively they form what is
known as a subsidiary ledger.

It provides an underlying set of financial records that explain what specific jobs comprise the amounts
reported in Work-in-Process and Finished Goods on the balance sheet as well as Costs of Goods Sold on
the income statement.

Assume Dixon Company started six jobs during its first month of operations and incurred no
undeapplied or overapplied manufacturing overhead.

Jobs A and B were incomplete at the end of the month, Job C was completed but unsold, and Jobs D, E
and F, had been produced and sold during the month. Assume the jonb cost sheets for these six jobs
reported the following costs at the end of the month (in thousands).
Job-Order Costing in Service Companies

Can also be used in service organizations such as law firms, movie studios, hospitals, and repair shops.

In a law firm, each client is a “job” and the costs of that job are accumulated day by day on a job cost
sheet as the client’s case is handled by the firm.

Legal forms and similar inputs represent the direct materials for the job; the time expended by attorneys
is like direct labour; and the costs of secretaries and legal aids, rent, depreciation and so forth,
reporesent the overhead.

In a movie studio, each film produced by the studio is a “job” and the costs of direct materials
(costumes, props, film, etc) and direct labour (actors, directors and extras) are charged to each film’s job
cost sheet.

A share of the studio’s overhead costs, such as utilities, depreciation of equipment, wages of
maintenance workers, and so forth, is also charged to each film.

In summary

Job-order costing systems accumulate a job’s direct materials, direct labour, and manufacturing
overhead costs on a job cost sheet. Selling and administrative costs are not assigned to jobs because
they are treated as period costs.

Job-order costing systems use materials requisition forms and labour time tickets to trace direct
materials and direct labour to jobs.
SEMINAR 2 (CHAPTER 3 APPENDIX 3A – ACTIVITY-BASED ABSORPTION COSTING SYSTEM)

Activity-based absorption costing assigns all manufacturing overhead costs to products based on the
activities performed to make those products.

An activity is an event that causes the consumption of manufacturing overhead resource.

An activity cost pool is a “bucket” in which costs are accumulated that relate to a single activity.

An activity measure is an allocation base that is used as the denominator for an activity cost pool.

An activity rate is used to assign costs from an activity cost pool to products. It is derived by dividing the
quantity of the activity measure in its denominator by the costs accumulated in the numerator of an
activity cost pool.

A batch-level activity is performed each time a batch is handled or processed, regardless of how many
units are in the batch. Include tasks such as placing purchase orders, setting up equipment, and
transporting batches of component parts.

A product-level activity related to specific products and typically must be carried out regardless of how
many batches are run or units of product are produced and sold. Include tasks such as designing a
product and making engineering design changes to a product.
SEMINAR 2 (CHAPTER 3 APPENDIX 3B – THE PREDETERMINED OVERHEAD RATE AND CAPACITY)

First method of computing predetermined overhead rate is the absorption costing approach used
throughout the chapter. It bases the denominator volume for overhead rates on the estimated, or
budgeted, amount of the allocation base for the upcoming period.

The second method, often used for internal management purposes, bases the denominator volume for
overhead rates on the estimated total amount of the allocation base at capacity.

This approach hold two important assumptions:

(1) All manufacturing overhead costs are fixed

(2) The estimated, or budgeted fixed manufacturing overhead at the beginning of the period equals the
actual fixed manufacturing overhead at the end of the period.
SEMINAR 3 (CHAPTER 5: ACTIVITY-BASED COSTING)

3.1 Activity-Based Costing: An Overview

In activity-based costing,

(1) Nonmanufacturing as well as manufacturing costs may be assigned to products, but only on a cause-
and-effect basis

(2) Some manufacturing costs may be excluded from product costs

(3) Numerous overhead cost pools are used, each of which is allocated to products and other costs
objects using its own unique measure of activity

Note: In traditional absorption costing, manufacturing costs are assigned to products and
nonmanufacturing costs are NOT assigned to products

In activity-based costing, manufacturing and nonmanufacturing costs are included when calculating the
entire costs of a product

Direct nonmanufacturing costs such as commissions, shipping costs, warranty repair costs are included

Indirect nonmanufacturing costs that can be traced are also included

Organizations sustaining costs such as security wages are treated as period expenses rather than
assigned to products.

Unused capacity costs are not charged to unit product costs unlike traditional absorption costing.
(1) Unit-level activities are performed each time a unit is produced. The costs of unit-level activities
should be proportional to the number of units produced. Eg. providing power to run processing
equipment would be a unit-level activity because power tends to be consumed in proportion to the
number of units produced.

(2) Batch-level activities are performed each time a batch is handled or processed, regardless of how
many unit are in each batch. Eg. tasks such as placing purchase orders, setting up equipment, and
arranging for shipments. Costs at the batch-level depend on the number of batches processed rather
than on the number of units products.

(3) Product-level activities related to specific products and typically must be carried out regardless of
how many batches are run or units of product are produced or sold. Eg. designing a product, advertising
a product, and maintaining a product manager and staff

(4) Customer-level activities relate to specific customers and include activities such as sales calls, catalog
mailings, and general technical support that are not tied to any specific product

(5) Organization-sustaining activities are carried out regardless of which customers are served, which
products are produced, how many batches are run or how many units are made. It includes activities
such as heating the factory, cleaning executive officers, providing a computer network, arranging for
loans, preparing annual reports to shareholders and so on

3.2 Steps for Implementing Activity-Based Costing

Step 1: Define activities, Activity Cost Pools and Activity Measures

Step 2: Assign Overhead Costs to Activity Cost Pools (First-stage allocation)
Step 3: Calculate Activity Rates
Step 4: Assign Overhead Costs to Cost Objects (Second-stage allocation)
Step 5: Prepare Management Reports
3.3 Comparison of Traditional and ABC Product Costs

Product Margins using the Traditional Cost System

Differences between ABC and Traditional Product Costs

Comparison of Traditional and Activity-Based Cost Assignments

SEMINAR 3 (CHAPTER 5 APPENDIX 5A: TIME-DRIVEN ACTIVITY-BASED COSTING)

3.4 Time-Driven Activity-Based Costing

3.5 Capacity Analysis
“What-If” Analysis
Lesson 4

The Budgeting Assumptions

The Sales Budget

The Production Budget

Production requirements are influenced by the desired level of the ending finished goods inventory.
Inventories should be carefully planned.
If it were a merchandising company, it would prepare a merchandise purchases budget instead, showing
the amount of goods to be purchased from suppliers during the period.

The Direct Materials Budget

Prepared after the production requirements have been computed. The direct materials budget details
the raw materials that must be purchased to fulfil the production budget and to provide for adequate
inventories. The required purchases of raw materials are computed as follows:
The Direct Labour Budget

The direct labour budget shows the direct-labour hours required to satisfy the production budget.
The Manufacturing Overhead Budget

The Manufacturing Overhead Budget lists all costs of production other than direct materials and direct
labour. Manufacturing overhead is separated into variable and fixed components.

The Ending Finished Goods Inventory Budget

The Selling and Administrative Expense Budget

The Selling and Administrative Expense Budget lists all the budgeted expenses for areas other than
manufacturing. Also divided into variable and fixed cost components.

The Cash Budget

The Budgeted Income Statement
The Budgeted Balance Sheet
Lesson 5

A planning budget is prepared before the period begins and is valid for only the planned level of activity.
Suitable for planning but inappropriate for evaluating how well costs are controlled.

Planning budget = SH x SR

A flexible budget is an estimate of what revenues and costs should have been, given the actual level of
activity for the period. When a flexible budget is used in performance evaluation, actual costs are
compared to what the costs should have been for the actual level of activity during the period rather
than to the static planning budget.

Flexible budget = AH x SR

Actual results = AH x AR

Direct materials price and quantity variances

Materials price variance = AQ (AP – SP) positive -> U

Materials quantity variance = SP (AQ – SQ) positive -> U

Direct labour rate and efficiency variances

Labour rate variance = AH (AR – SR) positive -> U

Labour efficiency variance = SR (AH – SH) positive -> U

Variable overhead spending and efficiency variances

Spending variance = (AH x AR) – (AH x SR) positive -> U

Efficiency variance = (AH x SR) – (SH x SR) positive -> F

Fixed overhead budget and volume variances

Budget variance = Actual fixed overhead cost – Budget fixed overhead cost positive => U

Volume variance = (Fixed portion of the predetermined overhead rate x Denominator) – SH allowed

positive -> U

Note** Wages and salaries, Equipment depreciation is same in Flexible budget and Planning budget.
Lesson 9

Margin = Net Operating Income/Sales

Turnover = Sales/Average Operating Assets

ROI = Margin x Turnover

Residual Income = Net Operating Income – Minimum Required Return x Average Operating Assets