Management Accounting

Importance of Accounting
Is a system that
Accounting Identifies

Records

Information that is
Relevant Communicates

Reliable

To help users to make better

Comparable decisions
 Difference between Financial Accounting and
Management Accounting
• Financial Accounting for external stakeholders (suppliers, creditors, banks, consumers, regulators, and
investors), internal stakeholders and is about the history of company

• Management accounting for internal stakeholders(employees, managers, the board of directors, investors)
and use historic information of the company to set the future goals, strategic decision making and
operational decision making

• Financial accounting follows a set of common rules known as accounting standards or generally accepted
accounting principles (GAAP, pronounced "gap) and Financial Accounting Standards Board (FASB)

• Management Accounting does not have any certain rules

 Introduction to Management Accounting

• Management Accounting measures, analyzes, and reports financial and nonfinancial information to
internal managers. The goal is to use past performance to predict the future. The internal reports
should plainly inform managers of the financial results of actual operations. The reports should
also show how activities can be changed to affect and improve what will happen in the future.

• Management accounting helps managers within a company to make decisions. Also known
as cost accounting, managerial accounting. The distinction between management accounting and
cost accounting is not clear-cut, and we often use these terms interchangeably.

• Management accountants reorganize and analyze financial and nonfinancial data using rigorous
methods. The rigour of management accounting methods is intended to support managers in their
efforts to decide on changes that will improve future financial success.
 Why is Management Accounting important
Helps in decision making process

• IDENTIFY THE PROBLEM AND UNCERTAINTIES

• OBTAIN INFORMATION (Decisions cannot be reasonably made without relevant and reliable information to
help managers understand the uncertainties)

• PREDICT THE FUTURE

• MAKE DECISIONS BY CHOOSING AMONG ALTERNATIVES

• IMPLEMENT THE DECISION, EVALUATE PERFORMANCE, AND LEARN

 Strategic decision vs. Operational decision
• Strategic decisions are long-term decisions
• Strategic decisions are taken in accordance with organizational mission and vision
• Strategic decisions are considered where the future planning is concerned
• Operational decisions are taken in accordance with strategic decisions
• Operational decisions are related to production and are mid-term

Three guidelines help management accountants provide the most value to their companies in strategic and
operational decision making:
Use a cost–benefit approach
Recognize both behavioural and technical considerations
Use different costs for different purposes
 SWOT Analysis
SWOT Analysis

A SWOT (Strengths, Weaknesses, Opportunities, and Threats ) analysis is a high-level strategic planning model
that helps organizations identify where they’re doing well and where they can improve, both from an internal and
external perspective.
 Benchmarking
Benchmarking is the practice of comparing business processes and performance metrics to industry bests
and best practices from other companies. Dimensions typically measured are quality, time and cost.

Benchmarking is used to measure performance using a specific indicator (cost per unit of measure, productivity
per unit of measure, cycle time of x per unit of measure or defects per unit of measure) resulting in a metric of
performance that is then compared to others.
Classify costs to better understand the business
expenses
Managers need to analyze cost behavior for many reasons. Costs can be used in different ways in managerial
accounting to glean the needed information. Understanding how costs behave can help managers control those
costs, saving money for the company and increasing the profits. Cost behavior is the concept of how costs
change when there is a change in the level of activity in the company.

Variable costs will change with additional production and activity.

Fixed costs occur regardless of the level of production.

Sunk costs A sunk cost refers to money that has already been spent and which cannot be recovered.

Opportunity costs Opportunity cost is the loss or gain of making a decision.

All costs will affect the break-even point and profitability of a company.
 Fixed vs. Variable Costs
Committed fixed costs: These are multiyear organizational investments that cannot be easily changed.
Examples of committed fixed costs include investments in assets such as buildings and equipment, real estate
taxes, insurance expense and some top-level manager salaries.
Discretionary fixed costs: These arise from annual decisions by management and could include advertising,
research, management development programs or large scale public relations plans. These fixed costs can be cut
out with no real damage to the long-term goals of the company.

Variable costs will change depending on how many products you buy or manufacture. For a cost to be
considered variable, it needs to vary based on some activity base. An activity base may also be called a cost
driver. Units produced, units sold, direct labor hours and machine hours are all possible activity bases or cost
drivers in a manufacturing facility. Using units sold as a cost driver, you wouldn’t need to buy raw materials for
1,000 widgets if you only have orders for 500. These costs include direct materials, direct labor and some of the
manufacturing overhead items.
 Break Even Point
The breakeven point is the level of production at which the costs of production equal the
revenues for a product. In investing, the breakeven point is said to be achieved when the
market price of an asset is the same as its original cost.

To calculate a break-even point based on units: Divide fixed costs by the revenue per
unit minus the variable cost per unit. The fixed costs are those that do not change no
matter how many units are sold. The revenue is the price for which you're selling the
product minus the variable costs, like labor and materials.

Revenue−Total variable cost=Contribution margin

 Corporate Governance
Corporate governance is the system by which companies are directed and controlled. Boards of directors are
responsible for the governance of their companies. The shareholders' role in governance is to appoint the directors
and the auditors and to satisfy themselves that an appropriate governance structure is in place.

Corporate governance comprises activities undertaken to ensure legal compliance and see that accountants fulfill
their fiduciary responsibilities. The board of directors (BOD) is responsible for holding the
chief executive officer (CEO), chief financial officer (CFO), and chief operating officer (COO) accountable for
the quality of financial information and organizational outcomes.

The main role of corporate governance is to ensures corporate success and proper economic growth.
Only a strong corporate governance maintains investors' confidence, due to which the firm can raise capital efficiently.
 Corporate Social Responsibility
Corporate social responsibility (CSR) is a company's commitment to manage the social, environmental and
economic effects of its operations responsibly and in line with public expectations. CSR activities may
include: Company policies that insist on working with partners who follow ethical business practices.

Components of Corporate Social Responsibility (CSR)

Environment
Ethical Corporate Social Investment (CSI)
Health and safety
Corporate governance
Business ethics
Employment equity
Supply chain/Distribution channel
Customers
 Costs and Cost Terminology
An actual cost is the cost incurred (a historical or past cost), as distinguished from a budgeted cost,
which is a predicted or forecasted cost (a future cost)

Product vs. Period Costs

Period costs include any costs not related to the manufacture or acquisition of your product.
Sales commissions, administrative costs, advertising and rent of office space are all period costs.

Product cost refers to the costs incurred to create a product. These costs include direct labor, direct
materials, consumable production supplies, and factory overhead. Product cost can also be considered
the cost of the labor required to deliver a service to a customer.
Manufacturing Costs A cost object, or cost driver, is anything you would like cost data on. This can include products,
customers, job or subunits of the company. The costs are assigned to these cost objects for multiple purposes, including
pricing, spending control and profitability studies.

Direct materials: These costs can be directly and easily traced to a specified cost object. If you make running shoes,
the materials that are in the shoes are direct materials. If you create printed flyers, the paper they are printed on are
direct materials.

Indirect materials: This includes items of materials that are not easily traceable to a specific cost object.
The oil for a machine, needles for a sewing machine or glue for the running shoes may be too small to worry
about tracking for each item. These materials may be lumped into manufacturing overhead.

Direct labor: The labor cost that can be directly and easily traced to a specified cost object. The employees who
run the presses in a printing company, or those who attach the soles to the shoes are considered direct labor.

Indirect labor: This includes the wages for custodial work, security guards and supervisors. These wages can’t
be directly linked to a particular product, but are needed for the overall operation of the company. These costs,
like indirect materials, might be put into the manufacturing overhead calculation.

Manufacturing overhead: This is a catch-all category and it includes any costs of manufacturing other than materials
and labor. Incidental materials and labor, maintenance on machinery or custodial wages would be included here. Any
expense incurred for the manufacture or acquisition of the product a company makes or sells, that is NOT direct labor
or direct materials, will be put here, and then later allocated.
 Cost–Volume–Profit Analysis
Identify the essential elements of cost–volume–profit analysis, and calculate the breakeven point (BEP)

The CVP model depends on understanding the effects of cost behaviour on profit, and identifies only the relevant
relationships. The following assumptions identify relevant information required to complete a CVP analysis:

•Changes in the sales volume and production (or purchase) volume are identical (purchase volume would apply
to a merchandiser). The ending balances in all inventories are zero. Everything purchased is used in production;
everything produced is sold. For a merchandiser, the sales volume of finished goods purchased for resale is
identical to the sales volume sold.

•All costs are classified as either fixed (FC) or variable (VC). All mixed costs are broken into their respective fixed
and variable components. The fixed costs include both manufacturing and non-manufacturing fixed costs. The
total variable costs include both manufacturing and non-manufacturing variable costs.

•All cost behaviour is linear (a straight line) within the relevant volume range.

•The sales price per unit, variable costs per unit, and total fixed costs and sales (or production) volume are
known. The management information system (MIS) provides all of this information.
•Either the product sold or the product mix remains constant, although the volume changes, within the relevant
volume range.
•All revenue and costs can be calculated and compared without considering the time-value of money.
 Cost–Volume–Profit Analysis
Identify the essential elements of cost–volume–profit analysis, and calculate the breakeven point (BEP)

The only numbers that change from selling different quantities are total revenues and total
variable costs. The difference between total revenues and total variable costs is called
the contribution margin. That is,
Revenue−Total variable cost= Contribution margin
 Cost–Volume–Profit Analysis
Identify the essential elements of cost–volume–profit analysis, and calculate the breakeven point (BEP)

Proof: Revenue, $200 per unit × $8,750

43.75 units

Variable costs, $120 per unit ×  5,250

43.75 units

Contribution margin 3,500

Fixed costs  2,000

Operating income $1,500
 CVP Analysis for Decision Making
CVP analysis is useful for calculating the units that need to be sold to break even, or to achieve a target operating
income or target net income. Managers also use CVP analysis to guide other decisions, many of them strategic
decisions. Consider a decision about choosing additional features for an existing product. Different choices can
affect selling prices, variable cost per unit, fixed costs, units sold, and operating income. CVP analysis helps
managers make product decisions by estimating the expected profitability of these choices.

Strategic decisions invariably entail risk. CVP analysis can be used to evaluate how operating income will be
affected if the original predicted data are not achieved—say, if sales are 10% lower than estimated. Evaluating this
risk affects other strategic decisions a company might make. For example, if the probability of a decline in sales
seems high, a manager may take actions to change the cost structure to have more variable costs and fewer fixed
costs. We return to our earlier example to illustrate how CVP analysis can be used for strategic decisions concerning
advertising and selling price.
 Decision Models and Uncertainty
A decision can be made only on the basis of information that is available at the time of evaluating and making the decision.
By definition, uncertainty rules out guaranteeing that the best outcome will always be obtained. As in our example, it is
possible that bad luck will produce bad outcomes even when good decisions have been made. A bad outcome does not
mean a bad decision was made. The best protection against a bad outcome is a good decision.

It is important to understand the characteristics of uncertainty, so managers can adopt an approach to make decisions in a
world of uncertainty. In the face of uncertainty—the possibility that an actual amount will deviate from an expected
amount—managers rely on decision models to help them make the right choices. A decision model is a formal method for
making a choice, commonly involving both quantitative and qualitative analyses.
 Cost–Volume–Profit Analysis
Identify the essential elements of cost–volume–profit analysis, and calculate the breakeven point (BEP)

The reliability of CVP lies in the assumptions it makes, including that the sales price and
the fixed and variable cost per unit are constant. The costs are fixed within a specified
production level. All units produced are assumed to be sold, and all fixed costs must be
stable.
 Cost–Volume–Profit Analysis
Identify the essential elements of cost–volume–profit analysis, and calculate the breakeven point (BEP)

Contribution Income Statement for month May, 2021

Sales revenue ($500 per unit) $250,000

($250,000/ $500 unit price = 500 units
sold)
Less: Variable costs 110,000

Contribution margin $140,000

(Sales Revenue – Variable Costs)

Less: Fixed costs $100,240

Net Operating income 39,760
(Contribution margin – Fixed Costs)

Profit = (Sales – Variable expenses) – Fixed expenses

 Cost–Volume–Profit Analysis
Identify the essential elements of cost–volume–profit analysis, and calculate the breakeven point (BEP)

Contribution Income Statement

Sales revenue ($500 per unit × 500 units sold) $250,000

Less: Variable costs 110,000

(Total variable cost 110,000/500 units sold = $ 220
per unit)
Contribution margin $140,000
(Sales Revenue – Variable Costs)

Less: Fixed costs $100,240

(Optional: Total fixed cost 110,240/500 units sold =
$200.48 per unit )
Net Operating income 39,760
(Contribution margin – Fixed Costs)
 Cost–Volume–Profit Analysis
Identify the essential elements of cost–volume–profit analysis, and calculate the breakeven point (BEP)

Calculate contribution margin to break-even

Per unit price $500

Less: Variable costs $220

($ 220 per unit)
Contribution margin per unit $280
(Sales Revenue – Variable Costs)
Less: Fixed costs $100,240

Calculate break even point $100,240 /280

 Cost–Volume–Profit Analysis
Identify the essential elements of cost–volume–profit analysis, and calculate the breakeven point (BEP)

Contribution Income Statement

Sales revenue ($500 per unit × 358 units $179,000

sold)

Less: Variable costs 78,760

($ 220 per unit X 358 units sold)
Contribution margin $100,240
(Sales Revenue – Variable Costs)

Less: Fixed costs $100,240

($280 per unit )
Net Operating income 0
(Contribution margin – Fixed Costs)
 Cost–Volume–Profit Analysis
Identify the essential elements of cost–volume–profit analysis, and calculate the breakeven point (BEP)

Contribution Income Statement

Sales revenue ($500 per unit × 359 units $179,500

sold)

Less: Variable costs 78,980

($ 220 per unit X 359 units sold)
Contribution margin $100,520
(Sales Revenue – Variable Costs)

Less: Fixed costs $100,240

($279.22 per unit )
Net Operating income per unit 280
(Contribution margin – Fixed Costs)
 Cost–Volume–Profit Analysis
Identify the essential elements of cost–volume–profit analysis, and calculate the breakeven point (BEP)

We do not need to prepare an income statement to estimate profits at a particular sales volume.
Simply multiply the number of unit sold above break-even by the contribution margin per unit.

If unit sold 378 ( 20 units above the break-even point) the net operating income will be
$5600

(20 units X $ 280)

 Cost–Volume–Profit Analysis
Identify the essential elements of cost–volume–profit analysis, and calculate the breakeven point (BEP)

Contribution Income Statement

Sales ($500 per unit × 300 units sold) $150,000

Less: Variable costs 66,000

($ 220 per unit X 300 units sold)
Contribution margin $84,000
(Sales Revenue – Variable Costs)

Less: Fixed costs $100,240

($334.13 per unit )
Net Operating income -16,240
(Contribution margin – Fixed Costs)
 Cost–Volume–Profit Analysis
Identify the essential elements of cost–volume–profit analysis, and calculate the breakeven point (BEP)

Projection Contribution Income Statement

Sales ($500 per unit × 700 units sold) $350,000

Less: Variable costs 154,000

($ 220 per unit X 700 units sold)
Contribution margin 196,000
(Sales Revenue – Variable Costs)

Less: Fixed costs $100,240

($143.20 per unit )
Net Operating income $95,760
(Contribution margin – Fixed Costs)
 Cost–Volume–Profit Analysis
Identify the essential elements of cost–volume–profit analysis, and calculate the breakeven point (BEP)

Strategic Decision Making

Sales ($500 per unit × 700 units sold) $350,000

Less: Variable costs 154,000

($ 220 per unit)
Contribution margin 196,000
(Sales Revenue – Variable Costs)

Less: Fixed costs $100,240

Add: $ 10,000 advertisement cost 10,000
($157.48per unit )
Net Operating income $85,760
(Contribution margin – Fixed Costs)
 Push vs. Pull Manufacturing
Push System: In push model of manufacturing, companies manufacture products based on projected
or anticipated demand. Companies produce units based on forecasted demand and then push these
products into the market. Examples: Promotional Items, Clothing, Perishable & non-perishable
foods etc. Companies must be able to predict the customers' demand in terms of quality and quantity.

Pull System (Kanban): The pull system is a Lean Manufacturing principle. Pull manufacturing
responds directly to customer demand. This means that the product is only fabricated and assembled
when a customer places an order.
A system is best controlled when material and information flows into and out of the process in a smooth
and rational manner. If inputs arrives before they are needed, unnecessary confusion, inventory, and
costs generally occur.
 5S Workplace
5S is a workplace organization method that can help improve the efficiency and management of
operations. A process is impacted by its environment, as is the ability of personal to respond to process
change. 5S is the one of the first tools to apply in the path to achieving lean enterprise organizations.

Sort: Remove unneeded items. The first step is sorting through the items as required and cleaning up the
work area. Over a period of time, items accumulate into a mess and make it less efficient to search for
needed items, and sometimes even cause safety issues. Never- used items should be discarded
immediately.

Set in order: Arrange the required and rarely required items for ease of accessibility.

Shine: This involves cleaning the work area and equipment.

Standardize: This involves developing checklist, standards, and work instructions to keep the work area
in a clean and orderly condition.

Sustain: This is the most difficult sequence in 5S. Most organizations are initially successful in the first
four steps, but sustaining the efforts and continuing them require support from management and
empowerment of employees.
 Cost Pool and Cost- Allocation Base
COST POOL: A cost pool is a grouping of individual indirect cost items. Cost pools can range from
broad (such as all manufacturing-plant costs) to narrow (such as the costs of operating metal-cutting
machines). Cost pools are often organized in conjunction with cost-allocation bases.

COST-ALLOCATION BASE: A cost-allocation base (e.g., number of machine-hours, or number of

labour-hours) is a systematic way to link an indirect cost or group of indirect costs to cost objects. For
example, if the indirect cost of operating metal-cutting machines is $500,000 based on running these
machines for 10,000 hours, the cost allocation rate is $500,000÷10,000 hours=$50 machine-hour, where
machine-hours are the cost allocation base.
 Distinguish job costing from process costing
Management accountants use two basic types of costing systems to assign costs to products or services:

JOB-COSTING SYSTEM: In this system, the cost object is a unit or multiple units of a distinct product or
service called a job. Each job generally uses different amounts of resources. The product or service is often a
single unit, such as a specialized machine made at Samsung, a repair job done at an Audi service centre. Each
special machine made by Samsung is unique and distinct.

PROCESS-COSTING SYSTEM: In this system, the cost object is masses of identical or similar units of a
product or service. For example, Scotiabank provides the same service to all its customers when processing
customer deposits. In each period, process-costing systems divide the total costs of producing an identical or
similar product or service by the total number of units produced to obtain a per-unit cost. This per-unit cost is the
average unit cost that applies to each of the identical or similar units produced in that period.
Job Costing: Evaluation and Implementation

Job costing is used at a company that manufactures and installs specialized machinery. The management
team may work through the five-step decision-making process in order to estimate the job cost.

IDENTIFY THE PROBLEMS AND UNCERTAINTIES: The decision of whether and how much to
bid for the job depends on how management resolves two critical uncertainties: what it will cost to
complete the job, and the prices that its competitors are likely to bid.

OBTAIN INFORMATION: Evaluate whether doing the job is consistent with the company’s strategy.
Do they want to do more of these kinds of jobs? Is this an attractive segment of the market?

MAKE PREDICTIONS ABOUT THE FUTURE: Managers estimate the cost of direct materials,
direct manufacturing labour, and overhead for the job. They also consider qualitative factors and risk
factors and think through any biases they might have. For example, do engineers and employees working
on the job have the necessary skills and technical competence? How accurate are the cost estimates, and
what is the likelihood of cost overruns?
Job Costing: Evaluation and Implementation

MAKE DECISIONS BY CHOOSING AMONG ALTERNATIVES: The bid price is based on a

manufacturing cost estimate and over manufacturing cost.

IMPLEMENT THE DECISION, EVALUATE PERFORMANCE, AND LEARN: Keep careful track of
all the costs incurred and compare the predicted amounts against actual costs to evaluate how well they did.
 Product Under-costing and Over-costing
Product undercosting—a product consumes a high level of resources but is reported to have a low cost per
unit.
Product overcosting—a product consumes a low level of resources but is reported to have a high cost per unit.

Emma James Jessica Matthew Total Average

Entrée $11 $20 $15 $14 $ 60 $15

Dessert 0 8 4 4 16 4

Drinks 4 14 8 6 32 8

Total $15 $42 $27 $24 $108 $27