Lecture 1: Introduction to Managerial

Accounting, Cost Terms and Concepts

ACC2706
Managerial Accounting
Semester I, AY 2022/23

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 Learning Objectives & References

Learning Objectives
1. Overview of how management accounting can be used for
creating value and managing resources
2. Cost classifications, costs across the value chain,
manufacturing costs, product costs and cost flows in a
manufacturing business

References
Chapter 1 to 2

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 1. What is management accounting?

The processes and techniques that focus on the effective and

efficient use of organisational resources to support managers
in their tasks of enhancing both customer value and
shareholder value.
• Customer value
• The value that a customer places on particular features of a
product or service.
• Shareholder value
• The value that shareholders or owners place on a business.
• Resources
• Can be financial and non-financial.
• Include organisation capabilities and competencies.

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Management accounting vs financial
accounting

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 Customer Value Propositions
Customer
Understand and respond to
Intimacy
individual customer needs
Strategy

Operational Deliver products and services

Excellence faster, more conveniently,
Strategy and at lower prices

Product or Service Offer high quality

Leadership products and services

Price Offer
Leadership value-for-money
Strategy products and services

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 Customer Value Propositions
– Real World Applications
Customer
Intimacy
Strategy

Operational
Excellence
Strategy

Product or Service
Leadership

Price
Leadership
Strategy

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Business Strategy

• In what business will we operate?

• How should we compete with others?
• What systems and structures should
we have in place to support our
strategies?
• Cost leadership strategy uses:
➢ Economies of production
➢ Superior process technologies
➢ Tight cost control

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Business Strategy Apple
Product leadership or
differentiation strategy
uses:
➢ Superior quality
➢ Service excellence
➢ High delivery
performance
➢ Unique product Secret Lab (EY
features Entrepreneur
2020,
Singapore)

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Planning and Control Systems

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 Planning

Strategic planning

• Involves formulation of corporate strategic decisions.

• Involve both long-term and short-term planning

(budgeting).

• Draws on management accounting information (costing,

projected demand and projected resources requirement).

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 Implementation

Implementing plans and strategies

• Includes implementing new structures, systems,

production processes, marketing approaches and human
resource management policies to execute the strategies
and plans.

• Involves implementing performance measurement

systems that compare actual outcomes to set targets.

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 Controlling

• Involves putting mechanisms in place to ensure that

operations proceed according to plan and that objectives are
achieved.

• Involves taking corrective actions when actual performance

deviates from plans and rewarding employees when targets
are met.

• Controls system provides regular information to assist with

controls.

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How management accounting system creates
value
Management accounting produces the information required
by managers to create value for customers and shareholders,
manage resources and make decisions. Specifically,
management accounting:
➢supports the organisation’s formulation and implementation of
strategies to improve its competitive advantage.
➢provides information to help manage resources through planning and
controls systems.
➢provides estimates of the costs of an organisation’s outputs for pricing
and other decision-making.
➢provides information for performance measurement and evaluation
processes. For example, comparisons of actual performance against the
budgets/targets/plans, as in Sales Performance Report and
Manufacturing Cost Variances Report. 13
 Considerations of management accounting
systems
• Behavioural issues
• A key purpose of management accounting systems is to
motivate managers and employees to direct their efforts
towards achieving the organisation’s goals.

• Information may impact on individuals’ behaviour, so

management accounting systems may have unexpected
outcomes, for example, information overload and
dysfunctional behaviours at workplace.

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 Cost and Benefits
of Management Accounting Systems
• Costs include
• manpower for gathering, storing and processing data
• setting up of IT and operational systems
• managers’ time to read, understand and use the
information

Benefits include
• improved management decisions and planning
• improved operational efficiency (lower cost)
• better control – less errors and fraud
• improved customer and shareholder value

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 Responses to the changing business
environment
• Changes in business environment
• Global, fluid, technologically disruptive, and competitive.

• Modern management accounting systems

• Support the adoption of new structures, systems and practices.

• Result in more accurate costing and budgeting, better

inventory management and quality, and improved performance
measurements.

• Include activity-based costing, strategic performance

measurement systems, cost management systems, JIT (just-in-
time) inventory management, new approaches to customer
profitability analysis and non-financial information (in later
chapters).

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 2. Cost Terms and Classifications

• Cost represents the resources given up to achieve a

particular objective.

• Why do management accountants pay so much attention to

costing system?
• Strategic focus (Cost-leadership/Competitiveness).
• Ready availability of cost data.
• Importance of cost information for decision-making e.g.,
pricing.

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 Classifying costs according
to their behaviour
Managers need to understand how costs change as the level
of activity in the business changes.
- Total variable costs change in direct proportion to a change in the
activity level (output units)
- Total fixed costs remain fixed when activity changes
Total cost of batteries

Monthly rent

Fixed cost
Variable cost

Number of autos produced in a Number of autos produced in a month

month 18
Quick Check ✓

Which of the following costs would be variable with

respect to the number of cones sold at a Baskins &
Robbins shop? (There may be more than one correct
answer.)
A. The cost of lighting the store.
B. The wages of the store manager.
C. The cost of ice cream.
D. The cost of napkins for customers.

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 Direct and indirect costs

• An important function of management accounting is to

measure the cost of cost objects
• Cost objects
• are the items for which management wants a separate measure
of costs, e.g. output unit or customer served (service sector), an
organisational unit, department or division in a company.
• Direct costs
• can be identified with or traced to a particular cost object. For
example, direct labour and direct materials traced to the
production outputs.
• Indirect costs
• cannot be economically identified or traced to a cost object. For
example, factory administrative and rental costs cannot be
economically traced to the production outputs.
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 Concept of Responsibility Centers

• Responsibility centres
• A responsibility centre is a unit of an organisation where
the manager is held accountable for the unit’s activities
and performance.

• The costing system measures the costs of organisational

units (responsibility centres).

• Assigning costs to units is part of responsibility

accounting.

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 Controllable and uncontrollable costs

• Managers’ performance evaluation can be enhanced by

classifying responsibility centre costs as either controllable
by the manager or uncontrollable.

• Ideally, managers should be held responsible only for costs

they can control or significantly influence.

• Some costs are controllable in the long term but not in the
short term, for example, equipment leasing costs.
(cont.)
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 Controllable and
uncontrollable costs (Examples)

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 Costs classified by Functions:
Manufacturing versus Non-manufacturing costs

• Manufacturing costs : costs incurred within the factory area

(attributable to manufacturing activities).

For example, direct material, direct labour, factory utilities,

factory rental, property taxes, production supervisor’s salary
and equipment depreciation.
• Non-manufacturing costs: costs incurred outside the factory
area (not attributable to manufacturing activities).

For example, marketing and distribution, finance and

administrative expenses.

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 Classification of Manufacturing costs

• Direct material is
• consumed in the manufacturing process.
• physically incorporated into the finished products.
• can be directly traced to products.
• a variable cost (with respect to production output).

• Direct labour is
• directly traced to a product.
• usually treated as a variable cost unless contractual
arrangements which pay the labour fixed salary.
(cont.)
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 Classification of Manufacturing costs
Manufacturing overheads (or indirect manufacturing costs):

• include all manufacturing costs other than direct material and direct
labour.

• cannot be economically traced to the product.

• include the cost of indirect material and indirect labour, depreciation

and insurance on factory equipment, utilities, and overtime
premium and idle time of factory worker
Overtime Premium Computation:
▪ Total overtime pay is 150% of normal wage (i.e., among the total overtime pay,
50% of normal wage is the overtime premium).
▪ Example: Normal wage is $30/hr. Normal working hours are 40 hours/week. For
the week that the employee works 48 hours,
▪ Direct labour cost is $30 x 48 hours
▪ Manufacturing Overheads - Overtime premium is $15 x 8 hours
(cont.)
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 Classification of Manufacturing costs

Manufacturing overheads :
• Include costs of manufacturing support departments that
do not work directly on producing products but support
the manufacturing activities. For example, equipment
maintenance department.

• Can be fixed or variable, depending if it varies with the

activity (e.g., production output) level. For example,
insurance is fixed while indirect material can be variable
as usage increases with activity level.

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 Classification of Manufacturing costs

Direct Direct Manufacturing

Material Labour Overhead

Prime Costs Conversion Costs

The major cost(s) associated Cost of converting material into
with producing a product a product

• In many industries, direct material (DM) is the largest proportion

of total manufacturing costs and direct labour (DL) is the smallest.
• With automation and more machineries replacing direct labour,
manufacturing overheads become a larger proportion of the
manufacturing costs.
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 Classification of Non-manufacturing
or Period Costs

Selling Administrative
Costs Costs

Costs necessary to secure All other organizational

the order and deliver the supporting costs that are
product. These include costs non-selling and non-
incurred by marketing, manufacturing in nature.
promotions, sales and
delivery activities.
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 Product and Period Costs

Product costs
include direct Period costs include
materials, direct all selling costs and
labor, and administrative
manufacturing costs.
overhead.

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 Khong Guan Biscuits: Manufacturing and Non-
manufacturing costs

DM MOH Selling Administrative

• Ingredients • Quality Checkers
• Advertising • Staff salaries
• Packaging • Factory Supervisors
expenses • Office janitors
material • Tools and machine
• Sales staff • Legal fees
supplies • Audit fees
• Equipment salary
depreciation • Delivery costs
Research and
DL • Factory Rental
Development
Factory
workers • Staff salaries
• Research
expenditure
• Development
costs
Quick Check ✓

Which of the following costs would be

considered a period rather than a product cost
in a manufacturing company?

A. Manufacturing equipment depreciation.

B. Property taxes on corporate headquarters.
C. Direct materials costs.
D. Electrical costs to light the production facility.
E. Sales commissions.

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 Quick Check ✓
The accounting records of Younkin Corporation revealed
the following selected costs: Sales commissions, $61,000;
plant supervision, $215,000. and administrative expenses,
$184,000. Younkin’s period costs total:

A. $245,000.
B. $460,000.
C. $399,000.
D. $276,000.
E. $184,000.

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 Costs across the value chain

The value chain

is a set of
linked processes
or activities that
customers
value.

The value chain

provides a
framework to
identify where
cost are
incurred in an
organisation

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SUMMARY: Different cost classifications

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 Merchandising vs Manufacturing Companies

Merchandisers . . . Manufacturers . . .
➢ Buy finished goods. ➢ Buy raw materials.
➢ Sell finished goods. ➢ Produce
➢ Sell finished goods.
 Balance Sheet

Merchandiser Manufacturer
Current assets Current Assets
◆ Merchandise Inventory Materials waiting
to be processed.
Inventories
Partially complete • Raw Materials
products—some • Work in Process
material, labor, or • Finished Goods
overhead has been
added. Completed products
awaiting sale.

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Cost flows in
manufacturing
business
Explanations on next 2
slides

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 Cost flows in a manufacturing business

• Material is purchased: the cost is added to raw materials

inventory.
• Direct materials are consumed in production: cost is
removed from raw materials inventory and added to work in
process inventory.
• Direct labour and manufacturing overhead are accumulated
in work in process inventory.
• Products are completed: costs are transferred from work in
process inventory and added to finished goods inventory.

(cont.)
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 Cost flows in manufacturing business

• Products are sold: costs are transferred from finished goods

inventory to cost of goods sold expense.
• Cost of goods sold is deducted from sales revenue to
determine gross profit in the income statement.
• Raw materials, work in process and finished goods inventory
balances are reported in the balance sheet.
• The schedule of cost of goods manufactured and schedule of
cost of goods sold summarise the flow of manufacturing
costs.

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 Prepare a schedule of cost of goods
manufactured
Manufacturing Work
Raw Materials Costs In Process

Beginning raw Direct materials Beginning work in

materials inventory + Direct labor process inventory
+ Raw materials + Mfg. overhead + Total manufacturing
purchased = Total manufacturing costs
= Raw materials costs = Total work in
available for use process for the
in production period
– Ending raw materials – Ending work in
inventory process inventory
= Raw materials used = Cost of goods
in production manufactured

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 Prepare a schedule of cost of goods sold

Work
In Process Finished Goods

Beginning work in Beginning finished

process inventory goods inventory
+ Manufacturing costs + Cost of goods
for the period manufactured
= Total work in process = Cost of goods
for the period available for sale
– Ending work in - Ending finished
process inventory goods inventory
= Cost of goods Cost of goods
manufactured sold

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Quick Check ✓

Beginning raw materials inventory was $32,000.

During the month, $276,000 of raw material was
purchased. A count at the end of the month revealed
that $28,000 of raw material was still present. What
is the cost of direct material used?
A. $276,000
B. $272,000
C. $280,000
D. $ 2,000

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Quick Check ✓

Direct materials used in production totaled $280,000.

Direct labor was $375,000 and factory overhead was
$180,000. What were total manufacturing costs
incurred for the month?
A. $555,000
B. $835,000
C. $655,000
D. Cannot be determined.

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Quick Check ✓

Beginning work in process was $125,000.

Manufacturing costs incurred for the month were
$835,000. There were $200,000 of partially
finished goods remaining in work in process
inventory at the end of the month. What was the
cost of goods manufactured during the month?
A. $1,160,000
B. $ 910,000
C. $ 760,000
D. Cannot be determined.

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Quick Check ✓

Beginning finished goods inventory was $130,000.

The cost of goods manufactured for the month was
$760,000. And the ending finished goods inventory
was $150,000. What was the cost of goods sold for
the month?
A. $ 20,000.
B. $740,000.
C. $780,000.
D. $760,000.

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 Summary

• Management accounting supports managers in enhancing

customer value and shareholder value.
• Costing systems focus on the cost of products and
organisational units.
• The classification of costs may vary depending on the
different intended uses of those costs.
• In manufacturing businesses, production costs typically
consist of direct materials, direct labour and manufacturing
overhead.
• Product costing systems track the manufacturing costs from
the beginning of production to finished goods and link the
product costing system to the financial accounting reports.

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Lecture Suppl Question 1
The XYZ Company specializes in producing a set of wood patio furniture consisting of a table
and four chairs. The set enjoys great popularity, and the company has ample orders to keep
production going at its full capacity of 3,900 sets per year. Annual cost data at full capacity
follows:
• Direct factory labor $87,000
• Advertising expense (annual contract) $103,000
• Factory supervisor annual salary $71,000
• Property taxes, factory building $20,000
• Sales commissions based on sales dollars $64,000
• Insurance premium paid for fire protection of factory building $5,000
• Depreciation charge of administrative office equipment $2,000
• Lease cost of factory equipment $11,000
• Indirect materials used in factory $17,000
• Depreciation of factory building $101,000
• Administrative office supplies for billing department $5,000
• Administrative office staff salaries $106,000
• Direct materials used (wood, bolts, etc.) in factory $433,000
• Utilities expenses of factory $44,000
Lecture Suppl Question 1
• Enter the dollar amount of each cost item under the appropriate
headings. Note that each cost item is classified in two ways: (1), as
variable or fixed with respect to the number of units produced and
sold; and (2), as a selling and administrative cost or a product cost. (If
the item is a product cost, it should also be classified as either direct
or indirect as shown.) Total up for each column of cost.