Overview of Management Accounting

and
Cost Terms and Concepts

Lecture 5

1
 Learning Objectives
• Understand the functions of managers
• Define what management accounting is about
• Differentiate between management accounting and
financial accounting
• Understand basic cost concepts and classifications
• Define the three classes of manufacturing costs
• Distinguish between product and period costs
• Indicate how cost of goods manufactured is determined.
• Prepare cost of goods sold statement
• Prepare income statement for a manufacturing company

2
 Functions of Management
• In general, the work that management performs can be classified
as planning, coordinating, controlling and decision making.

1) Planning - involves establishing a basic strategy, selection of long-term and

short-term objectives, drawing up plans and specifying how the plans will
be implemented and the objectives achieved.
2) Coordinating – In performing the coordination function, management must
decide how best to put together the organization’s resources in order to
carry out established plans.
3) Controlling - involves ensuring that the plan is actually carried out and is
appropriately modified as circumstances change.
4) Decision making - is the purposeful selection from among a set of
alternatives in light of a given objective.

• Management accounting information plays a vital role in these

basic management activities-but most particularly in the
planning and control functions.
 Defining Management Accounting
• Management accounting covers the managerial use
of accounting data for planning, control and decision
making activities of an organization.
• Management accounting is concerned with providing
information to managers-that is, the people inside an
organization who direct and control its operations.
• Management accounting function ensures the
appropriate use of and accountability for an
organization’s resources.
• Simply put, management accounting is the
accounting for the planning, control and decision
making activities of an organization.
 The Activities that are part of
Management Accounting
1. Explaining manufacturing and nonmanufacturing costs and how they
are reported in the financial statements .
2. Computing the cost of providing a service or manufacturing a product.
3. Determining the behavior of costs and expenses as activity levels
change and analyzing cost–volume–profit relationships within a
company
4. Accumulating and presenting data for management decision making
5. Determining prices for external and internal transactions
6. Assisting management in profit planning and formalizing these plans in
the form of budgets
7. Providing a basis for controlling costs and expenses by comparing actual
results with planned objectives and standard costs (variance analysis)
8. Accumulating and presenting data for capital expenditure decisions
 Management Accountants – their job is
more than just “crunching numbers”.
• They influence decisions that create value for
their organizations
– including managing risks and implementing strategy
through planning, budgeting and forecasting and
decision support.
• They are strategic business partners who
understand the financial and operational sides of
the business.
– report and analyze not only financial measures, but
also nonfinancial measures of process performance
and corporate social performance
 Defining cost
• Cost is a measurement in monetary terms of the
amount of resources used for the purpose of
production of goods, distribution of goods or
provision of services.
• Simply, cost is the amount incurred for
production of goods, distribution of goods or
provision of services.
• Business entities include:
– Trading (merchandise) company
– Manufacturing Company
– Service Providing Company

7
 Cost Object
• A cost object is anything for which cost data are desired –
including products, customers, jobs and organizational
subunits.
Cost object Examples
Product A bottle of water
Service A hair cut
Project A 3-classroom block completed for
a school
Customer EMBA students
Brand category All the accounting courses offered
at the MBA level at GIMPA
Activity A test to assess the performance
of EMBA students
Department / Division IT Department
Programme The EMBA Programme at GIMPA
8
 Cost Accumulation and Cost Assignment
• A costing system typically accounts for costs in two basic
stages:
1. It accumulates costs by some ‘natural’ (often self-
descriptive) classification such as materials, labour, fuel,
advertising or shipping.
2. It assigns these costs to cost objects.
• Cost accumulation is the collection of cost data in some
organised way through an accounting system.
• Cost assignment is a general term that encompasses both (1)
tracing accumulated costs to a cost object, and (2) allocating
accumulated costs to a cost object. Costs that are traced to a
cost object are direct costs, and costs that are allocated to a
cost object are indirect costs.
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 Direct Costs and Indirect Costs
• Cost tracing and cost allocation - A major question concerning costs
is whether they have a direct or an indirect relationship to a
particular cost object.
• Direct costs of a cost object are costs that are related to the
particular cost object and that can be traced to it in an economically
feasible (cost-effective) way.
• Indirect costs of a cost object are costs that are related to the
particular cost object but cannot be traced to it in an economically
feasible (cost-effective) way. Indirect costs are allocated to the cost
object using a cost-allocation method.

Cost tracing
Direct costs
Cost Cost Object
Assignment Cost allocation
Indirect costs

10
 Cost Classification
Costs can be classified into various categories:
Their Their ease of Their timing of Their Their relevance
Management traceability charges against behaviour to control and
function revenue according to decision
changes in making
activity levels
Manufacturing Direct costs Product costs Variable costs Controllable and
costs Indirect costs Period costs Fixed costs non-controllable
Non- Semi-variable costs
manufacturing costs Standard costs
costs Incremental costs
Sunk costs
Opportunity costs
Relevant costs

11
 Cost Behaviour Patterns
• Management accounting systems record the cost of resources acquired
and track their subsequent use.
• Tracing these costs allows managers to understand how these costs
behave.
• There are two basic types of cost behaviour pattern found in many of
these systems: variable costs and fixed costs.
• A variable cost is a cost that changes in total in proportion to changes
in the related level of total activity or volume.
• A fixed cost is a cost that does not change in total despite changes in
the related level of total activity or volume.
• A relevant range is the range of the cost driver in which a specific
relationship between cost and the level of activity or volume is valid,
that is the range of activity over which a company expects to operate
during the year.

12
 Total Costs and Unit Costs
• Accounting systems typically report both total-cost and unit-cost
numbers.
• A unit cost (also called an average cost) is calculated by dividing some
amount of total cost by the related number of units. The units might
be expressed in various ways.
• Examples are hours worked, packages delivered or cars assembled.
• Suppose that ¢980,000 of manufacturing costs were incurred to
produce 10 000 units of a finished good. What is the unit
manufacturing cost?
Cost behaviour pattern Total Costs Unit Costs
When item is a variable Total costs change with Unit costs remain the
cost changes in level of cost same with changes in
driver level of cost driver
When item is a fixed Total costs remain the same Unit costs change with
cost with changes in level of cost changes in level of cost
driver driver
13
 Cost Classification: Manufacturing Costs
• Manufacturing costs are those costs associated with the Company’s
manufacturing activities. Most manufacturing companies separate
manufacturing costs into three categories:

• Direct Materials (DM) costs: consist of all those material costs that
can be identified with a specific finished product, e.g. plastic bottles
used in bottled water production, steel used in automobile, wood
used in furniture.

• Direct labour (DL) costs: consist of those labour costs that can be
specifically traced to or identified with a particular finished product –
e.g. wages of assembly line workers at a food processing plant.

• Manufacturing overhead (MOH) costs: consist of all manufacturing

costs other than direct materials and direct labour. They include all
indirect materials and indirect labour costs, depreciation on factory
building, rent, insurance, taxes and maintenance and repairs on
factory facilities. 14
 Cost Classification: Non-Manufacturing Costs

• Non-manufacturing costs (or operating expenses) are

divided into two categories:
1. Selling expenses include all the expenses that are incurred
to secure customer orders and get the finished product to
the customer – e.g. advertising, shipping, sales
commissions, salespersons salaries, costs of finished
goods warehouses
2. General and Administrative expenses include all
executive, organizational and clerical expenses associated
with the general management and administrative
activities of an organization rather than with
manufacturing or selling – examples include executives
salaries, auditing expenses and legal expenses.

15
 Cost Classification – Product vs Period Costs

• Product costs are costs that are a necessary

and integral part of producing the finished
product. Companies record product costs
when incurred, as inventory. All
manufacturing costs are product costs

16
 Cost Classification – Product vs Period Costs

• Period costs are costs that are matched with the

revenue of a specific time period rather than
included as part of the cost of a salable product.
• These are nonmanufacturing costs.
• Period costs include selling and administrative
expenses.
• In order to determine net income, companies
deduct these expenses from revenues in the
period in which they are incurred.
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 Product vs Period Costs

All Costs

Product costs Period costs

Manufacturing costs Non-manufacturing costs

Direct materials Selling

expenses

Direct labour Administrative

expenses

Manufacturing
overhead
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Cost Classification – Prime vs Conversion Costs

• Prime cost is the sum of the direct materials

cost and direct labour cost
• Conversion cost is the sum of direct labour
cost and manufacturing overhead cost.
• The term conversion cost is used to describe
direct labour and manufacturing overhead
because these costs are incurred to convert
materials into the finished product.

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 Classifications of Inventories

• Manufacturing company:
– direct materials inventory
– work-in-process inventory
– finished goods inventory

• Merchandising company:
– finished goods inventory

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 Cost Flows and Classifications

Costs

Raw material Balance Sheet

purchase
DM Inventory
Direct Labour
Income
Work in Process Inventory Statement
Manufacturing
overhead Cost of Goods
Finished Goods Inventory Sold

Selling and Selling and

Administrative Administrative
expenses

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 Statement of Cost of Goods Manufactured
Direct Materials, Opening Inventory XXX
Plus: Purchases of Direct Materials XXX
= Direct materials available for use XXX
Less: Direct Materials, Ending Inventory (XXX)
Direct Materials Used XXX
• Direct labour XXX
• Manufacturing overhead XXX
• Total Manufacturing Costs XXX
• Work-in-Process, beginning XXX
• Less: Work-in-Process, ending (XXX)
• = Cost of goods manufactured XXX

22
 Statement of Cost of Goods Sold (COGS)

Finished goods, beginning xxx

Plus: Costs of goods manufactured xxx
Less: Finished goods, ending (xxx)
= Cost of goods sold xxx

23
 Income Statement

Revenue /sale xxx

Less: Cost of goods sold (COGS) (xxx)
= Gross margin (gross profit) xxx

Less: Operating expenses (period costs) (xxx)

= Operating income xxx

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 Practice Example

• The following information is available for ABC Manufacturing

Company.
March 1 March 31
Direct material inventory ¢12,000 ¢10,000
Work in process inventory ¢2,500 ¢4,000
Materials purchased in March ¢90,000
Direct labor in March ¢75,000
Manufacturing overhead in March ¢220,000

• Prepare the cost of goods manufactured statement for the

month of March.
25
 Manufacturing Costs Problem
The following information is available for the XYZ Corporation for the year
ended Dec 31 2009 (all cost in GH¢).
Cost item Cost Cost item Cost
Property Taxes on factory building 3,000 Depreciation on factory equipment 11,000
Marketing Expenses 37,000 Factory repairs and maintenance 16,000
Finished Goods Inventory Dec 31 2008 27,000 Work in process inventory Dec 31 2008 20,000
Factory Utilities 17,000 Direct Labour 34,000
Work in progress inventory Dec 31 2009 26,000 Indirect Labour 23,000
Depreciation on factory building 9,000 Indirect Materials used 11,000
Non factory administrative expenses 43,000 Misc Factory overhead 4,000
Direct materials used 87,000 Sales 300,000
Finished goods inventory Dec 31 2009 34,000
• Calculate
• 1.Cost of good manufactured
• 2.Cost of good sold
• 3.Operating income
• 4.Prime costs
• 5.Conversion costs
• 6.Period and Product costs
26
 Example of statement COGM and COGS
• The following information is available for the manufacturing operations of
ABC Ltd for the month of March (all figures in GH¢)..

– Direct materials purchased 82,000

– Direct labour payroll 60,000
– Direct labour rate per hour 15
– Factory overhead rate per direct labour hour 10

opening inventory (Mar1) Ending inventory (Mar 31)

Direct materials 30,000 37,000
Work-process 12,000 18,000
Finished goods 72,000 93,000

Calculate:
a) Cost of goods manufactured
b) Cost of goods available for sale
c) Cost of goods sold

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 Question
The following is the only information available for the production costs of ABC
Manufacturers Ltd. All other information was destroyed in a recent flooding.
Current sales GH¢221,400
COGS (as percentage of sales) 68%
Opening Finished Goods Inventory GH¢ 16,700
Ending Finished Goods Inventory GH¢ 31,500
Direct Labour costs incurred GH¢ 60,380
Direct Materials used GH¢ 34,250
Administration and selling costs incurred GH¢ 41,750
Ending Work-in-Process Inventory GH¢ 12,070
Opening Work-in-Process Inventory GH¢ 8,060

Based on the above information, calculate the Cost of Goods Manufactured for
this period?
a) GHC 90,620
b) GHC 132,370
c) GHC 165,352
d) GHC 165,800
28
 Practice Example
• Superior Manufacturing Company has the following cost and expense data for the
year ending December 31, 2013.

Direct materials, 1/1/13 ¢30,000 Insurance, factory ¢14,000

Direct materials, 12/31/13 20,000 Property taxes, factory
building 6,000
Materials purchases 205,000 Sales 1,500,000
Indirect materials 15,000 Delivery expenses 100,000
Work in process, 1/1/13 80,000 Sales commissions 150,000
Work in process, 12/31/13 50,000 Indirect labor 90,000
Finished goods, 1/1/13 110,000 Factory machinery rent 40,000
Finished goods, 12/31/13 120,000 Factory utilities 65,000
Direct labor 350,000 Depreciation, factory building
24,000
Factory manager’s salary 35,000 Administrative expenses 300,000

• Prepare a cost of goods manufactured schedule for Superior Company for 2013.
• Prepare an income statement for Superior Company for 2013. 29