BUS 239 MANAGEMENT ACCOUNTING FOR DECISION MAKING

Queen Mary University of London,

Module Leader: Chandres Tejura
Email: c.tejura@qmul.ac.uk
Office hours: Wednesday 11am-1pm, FB 3.44D

Lecture / Seminar 1: An Introduction to Management Accounting and Cost Behaviour

An introduction to Management Accounting

This unit represents the introduction to a field of study known as management accounting. Students
should study a number of introductory management accounting texts to identify the content of this area of
study and its various definitions. One definition is as follows:

‘The process of identification, measurement, accumulation, analysis, preparation, interpretation and

communication of information (both financial and operating) used by management to plan, evaluate and
control within an organisation and to assure use of and accountability for its resources.’

IFAC (International Federation of Accountants)

In 1988 Michael Bromwich identified the following three roles of management accounting:
 internal financial accounting for scorekeeping
 preparing figures for control
 decision-making and problem-solving

Michael Bromwich ‘Managerial Accounting: Definition and Scope from a Managerial View’
Management Accounting September 1988.

This unit will be concerned with the third of these roles.

An Introduction to Costs
To enable the management accounting role to be carried out numbers normally have to be accumulated.
Sometimes these numbers represent non-financial indicators, such as bed occupancy rates in a hospital or
hotel, but more often they represent monetary values, which will be revenues or costs. The accurate
accumulation of relevant cost is an important skill in management accounting and an area of some
controversy.

Key Definitions:

Cost: The amount of expenditure incurred on, or attributable to, a specified thing or activity.
These costs should be well known from financial accounting, for example, purchases and
wages. However, for management accounting, a more detailed analysis is often required.
For example, purchases, normally termed materials, may often be analysed into different
categories (e.g. timber, components, paint): wages, normally termed labour, may be
analysed by different departments or functional areas (e.g. assembly labour, paint shop
supervision cost).

Cost Unit: A quantitative unit of product or service in relation to which costs are ascertained.
Cost units are selected arbitrarily according to the analysis required in management reports.
Examples might be:
 a gallon of beer or the fermentation department in a brewery
 a hip replacement operation or the whole operating theatre

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The Classification of Costs

Costs can be classified in a number of different ways. One obvious way has already been identified
above, by function. Costs may relate to materials, or labour, or machine X, or building Y. The two most
commonly used classifications are (I) whether costs can be identified with a particular cost unit, i.e. are
direct or indirect; and (ii) whether costs change with the level of activity or work done, i.e. are variable or
fixed.

Ability to relate a cost to a cost unit: Direct Costs and Indirect Costs
Direct costs can be identified with a particular cost unit, for example, the amount of wire in a box of paper
clips. Direct costs normally comprise of: direct materials, direct labour and direct expenses.

Costs which cannot be identified with a particular cost unit are known as indirect costs. Such indirect
costs are often termed overheads.

Cost Behaviour: Variable Costs and Fixed Costs

The CIMA definition of cost behaviour is: the way in which costs per unit of output are affected by
fluctuations in the level of activity.

The key concept to understand is that of the level of activity which relates to the amount of work done in
an enterprise. In manufacturing companies, this will be the volume of production, but in service
organisations, the measure will be more difficult. In hospitals, for example, level of activity is often
measured in patient-days.

There are two extremes in cost behaviour: fixed costs and variable costs.

Fixed costs tend to be unaffected by changes in the level of activity. For example, the managing
director’s salary is normally constant regardless of the amount produced. Fixed costs can be thought of as
time costs being dependent on time periods rather than the level of activity. Factory rent will be £X per
annum whether anything is produced or not.

Most so-called fixed costs are in fact step costs, that is, costs which are fixed, but only within specific
levels of activity. The factory rent bill is fixed, but only up to the maximum output of the factory. In
order to expand further, an additional factory would be required causing the rental cost to step up to a
higher level.

Variable costs change directly with the level of activity, as activity increases so do the variable costs in the
same proportion. Materials are the archetypal variable cost.

Many costs, however, include both fixed and variable elements. Such costs are known as semi-variable
costs. For example, the telephone bill normally has two elements: a fixed charge for the rental plus a
charge which varies according to the number of calls. In accounting systems, most costs recorded are an
aggregation of several elements. For example, motor expenses include both road tax (a fixed cost) and
petrol (a variable cost) among other elements. (See question 2 below.)

The analysis of costs into their fixed and variable elements is a difficult and often subjective exercise.
For example, how would you treat wages and depreciation?

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Table 1.1 Financial and management accounting compared

Financial Accounting Management Accounting

Main users External groups Internal management
Primary information Reports on past performance and Forecasts of the future as well as
current position monitoring information on current
and actual past performance
Principal measurement Financial Financial and non-financial
qualitative and quantitative
Level of aggregation Whole organisation Disaggregated, e.g. plant, product
or customer information
Frequency Annual Monthly or more frequent
depending on organisation
Regulation Law and accounting standards, Little formal regulation:
comprising Generally Accepted management discretion over the
Accounting Practice information system
Criteria Truth and fairness; stewardship; Relevance for specific management
comparability with other decisions and control of operations
organisations

Table 6.1 Cost classification terminology

Product
Costs associated with making or acquiring
particular products for sale. *Product costs may be
used as the basis for valuing stock at any point in
time.
Direct
Costs which can be traced directly to a particular
cost object that is a separate aspect of operations,
such as a product, a department or a region.
Variable
Costs that change in proportion to changes in the
level of activity.
Period
Costs not related to products or services
provided. Such costs are treated as expenses
of the period in which they are incurred.
Indirect
Costs which cannot be traced to such objects,
but which are general to a range of activities.
Also referred to as overhead costs.
Fixed
Costs that remain unchanged across different
levels of activity.

*Note that in a service firm, the ‘product’ could be the provision of a particular service.

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Questions

1. Seminar activity, using Excel-

Waygun Motor Cars
Data: Cost of motor car £10,000
Trade-in price after 2 years or
60,000 miles £2,000
Maintenance (6 monthly servicing) £120
Spares (per 1,000 miles) £40
Road Tax (per annum) £150
Insurance (per annum) £450
Tyres (after 25,000 miles) £60
Petrol (per gallon) £2.10

Petrol consumption is 25 mpg.

From the above data you are required:

a) Manually calculate the following costs:

total variable cost, total fixed cost, total cost, variable cost per mile, fixed cost per mile and total
cost per mile. The latter three costs should be shown to the nearest penny.

For zero, 5,000 and 10,000 miles per annum.

b) Test your spreadsheet skills by preparing a model to analyse the data above for each of the
following mileages:
Zero, 5,000, 10,000, 15,000 and 30,000 miles per annum:

2. At home-
Show by means of a graph the behaviour patterns for each of the costs below:

(a) Electricity bill.

(b) Supervisory labour.

(c) A production bonus which is paid when output exceeds 10,000 units. The bonus
amounts in total to £20,000 plus £50 per unit for each additional unit output above 10,000 units.

(d) Sales commission of 2%.

(e) Machine rental costs of a single item of equipment. The agreement is that £10 should be
paid for every machine hour worked each month, subject to a maximum monthly charge of £480.

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