MANAGEMENT ACCOUNTING

Prepared By: Fitsum Kidane (Phd)

Department of Accounting and Finance
Sundaero College

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 CHAPTER I

Introduction to Management
Accounting

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 Management Accounting Overview
• Management accounting measures and reports
financial and non-financial information that helps
managers make decisions to fulfill the goals of an
organization
• It’s all about using information to plan, control
and make decisions.
• Accountants produce information and managers
use information.
• Management accounting focuses on internal
reporting Department of Accounting and Finance,
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 Functions of Management Accounting

• Management accountants perform three functions

Scorekeeping
• accumulate data and report reliable results to all
levels of management
Attention-directing
• make visible opportunities and problems on which
managers need to focus
Problem-solving
• conduct comparative analysis to identify the best
alternatives in relation to the organization’s goals

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Comparison of Financial and Managerial

Accounting
Financial Accounting
1. Users External persons who
make financial decisions
2. Time focus Historical perspective
Managerial Accounting
Managers who plan for
and control an organization
Future emphasis

3. Verifiability Emphasis on Emphasis on relevance

versus relevance verifiability for planning and control

4. Precision versus Emphasis on Emphasis on

timeliness precision timeliness
5. Subject Primary focus is on Focuses on segments
the whole organization of an organization
6. GAAP Must follow GAAP Need not follow GAAP
and prescribed formats or any prescribed format
7. Requirement Mandatory for Not
external reports Mandatory
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 Cost Terms
• An amount that has to be paid or given up in
order to get something.
• In business, cost is usually a monetary
valuation of (1) effort, (2) material, (3)
resources, (4) time and utilities consumed, (5)
risks incurred, and (6) opportunity forgone in
production and delivery of a good or service.

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 Cost Terms
• The term “cost” appears in many contexts and
carries a number of meanings.
• Different categories of cost terms are merely
different ways to look at costs
• They are not necessarily complementary to or
mutually exclusive of other cost categories.

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 Cost Objects, Direct Costs, and Indirect
Costs
• Cost objects are anything for which a separate
measurement of costs is desired.
• Cost drivers are any factors that affect cost.
• What are examples of cost objects?
– individual products
– alternative marketing strategies
– geographic segments of the business
– departments

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 Cost Objects, Direct Costs, and Indirect Costs

What are direct costs?

• Direct costs are those costs that can be
easily and conveniently traced to a unit of product or
other cost object.
• Example: Direct Material and Direct Labor

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Cost Objects, Direct Costs, and Indirect Costs

What are indirect costs?

• Indirect costs are costs that cannot be easily
and conveniently traced to a unit of product
or other cost object.
• Example: Manufacturing overhead

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Manufacturing Overhead
Manufacturing costs cannot be traced directly to specific
units produced.

Examples:
Examples: Indirect
Indirect materials
materials and
and indirect
indirect labor
labor

Materials used to support the Wages paid to employees who

production process. are not directly involved in
production work.
Examples: Lubricants and Examples: Maintenance workers,
cleaning supplies used in the janitors and security guards.
automobile assembly plant.
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 Product Costs and Period Costs
Product costs:
• They are the costs to produce (or purchase)
tangible products intended for sale.
• Product costs include direct materials, direct
labor, and manufacturing overhead.
Period costs are not included in product costs.
They are expensed on the income statement.

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 Comparison of Product and Period Costs
Type of company Inventoriable product Period costs (Expenses)
costs

Service company None Salaries, depreciation,

utilities, advertising,
insurance, property taxes

Merchandising company Purchases plus freight in Salaries, depreciation,

utilities, advertising,
insurance, property taxes
and delivery expense

Manufacturing company Direct materials, Direct Office salaries,

labor and manufacturing depreciation, utilities,
overhead advertising, insurance,
property taxes on office,
selling expenses

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 Prime and Conversion cost
• Prime cost
= Direct material + Direct Labour
• Conversion Costs = Direct Labor +
Manufacturing Overhead
• Conversion costs are costs incurred to convert
the direct materials into a finished product.

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Manufacturing Costs

Direct
Direct Direct
Direct Manufacturing
Manufacturing
Materials
Materials Labor
Labor Overhead
Overhead

The Product

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Classifications of Nonmanufacturing Costs

Administrative
Selling Costs
Costs

Costs necessary to get the All executive,

order and deliver the organizational, and clerical
product. costs.

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Quick Check 
Which of the following costs would be considered
a period rather than a product cost in a
manufacturing company? (There may be more
than one correct answer.)
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 
Which of the following costs would be considered
a period rather than a product cost in a
manufacturing company? (There may be more
than one correct answer.)
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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Balance Sheet
Merchandiser Manufacturer
Current Assets Current Assets
 Cash  Cash
 Receivables  Receivables
 Prepaid Expenses  Prepaid Expenses
 Merchandise Inventory  Inventories:
1. Raw Materials
2. Work in Process
3. Finished Goods

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The Income Statement

Cost of goods sold for manufacturers differs only slightly
from cost of goods sold for merchandisers.

Merchandising Company Manufacturing Company

Cost of goods sold: Cost of goods sold:
Beg. merchandise Beg. finished
inventory $ 14,200 goods inv. $ 14,200
+ Purchases 234,150 + Cost of goods
Goods available manufactured 234,150
for sale $ 248,350 Goods available
- Ending for sale $248,350
merchandise - Ending
inventory (12,100) finished goods
= Cost of goods inventory (12,100)
sold $ 236,250 = Cost of goods
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Inventory Flows

Withdrawals
Withdrawals
Beginning
Beginning Additions
Additions Ending
Ending
balance
balance
+ to
to inventory
inventory
= balance
balance
+ from
from
inventory
inventory

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Quick Check 
If your inventory balance at the beginning of the
month was $1,000, you bought $100 during the
month, and sold $300 during the month, what
would be the balance at the end of the month?
A. $1,000.
B. $ 800.
C. $1,200.
D. $ 200.

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Quick Check 
If your inventory balance at the beginning of the
month was $1,000, you bought $100 during the
month, and sold $300 during the month, what
would be the balance at the end of the month?
A. $1,000.
B. $ 800. $1,000 + $100 = $1,100
C. $1,200. $1,100 - $300 = $800
D. $ 200.

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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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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 
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 Beg. raw materials $ 32,000
+ Raw materials
B. $272,000 purchased 276,000
= Raw materials available
C. $280,000 for use in production $ 308,000
– Ending raw materials
D. $ 2,000 inventory 28,000
= Raw materials used
in production $ 280,000

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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 
Direct materials used in production totaled
$280,000. Direct labor was $375,000 and factory
overhead was $180,000.Direct
What were total $ 280,000
Materials
manufacturing costs incurred for the month?375,000
+ Direct Labor
+ Mfg. Overhead 180,000
A. $555,000 = Mfg. Costs Incurred
for the Month $ 835,000
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 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
Beginning work in
cost of goods manufactured during the month?
process inventory $ 125,000
+ Mfg. costs incurred
A. $1,160,000 for the period 835,000

B. $ 910,000 = Total work in process

during the period $ 960,000
C. $ 760,000 – Ending work in
process inventory 200,000
D. Cannot be determined.
= Cost of goods
manufactured $ 760,000

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Quick Check 
Beginning finished goods inventory was $130,000.
The cost of goods manufactured for the month was
$760,000. 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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Quick Check 
Beginning finished goods inventory was $130,000.
The cost of goods manufactured for the month was
$760,000. The ending finished goods inventory was
$150,000. What was the cost of goods sold for the
month?
A. $ 20,000.
B. $740,000. $130,000 + $760,000 = $890,000
C. $780,000. $890,000 - $150,000 = $740,000
D. $760,000.

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Cost Classifications for Predicting Cost Behavior

How
How aa cost
cost will
will react
react to
to changes
changes in
in the
the
level
level of
of business
business activity.
activity.

 Total
Total variable
variable costs
costs change
change when
when activity
activity
changes.
changes.

 Total
Total fixed
fixed costs
costs remain
remain unchanged
unchanged when
when
activity
activity changes.
changes.

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Cost Classifications for Predicting Cost Behavior

Behavior of Cost (within the relevant range)

Cost In Total Per Unit

Variable Total variable cost changes
as activity level changes.
Fixed Total fixed cost remains
the same even when the
activity level changes.
Variable cost per unit remains
the same over wide ranges
of activity.
Average fixed cost per unit goes
down as activity level goes up.

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Cost Classifications for Decision Making

Every decision involves a choice between

at least two alternatives.

Only those costs and benefits that differ

between alternatives are relevant to the
decision. All other costs and benefits can and
should be ignored.
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Opportunity Costs
The potential benefit that is given up when one
alternative is selected over another.
Example: If you were not attending college, you
could be earning $15,000 per year. Your
opportunity cost of attending college for one year is
$15,000.

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Sunk Costs

Cannot be changed by any decision. They are

not differential costs and should be ignored
when making decisions.

Example: You bought an automobile that cost

$10,000 two years ago. The $10,000 cost is sunk
because whether you drive it, park it, trade it, or sell
it, you cannot change the $10,000 cost.

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Quick Check 
Suppose you are trying to decide whether to drive
or take the train to Portland to attend a concert.
You have ample cash to do either, but you don’t
want to waste money needlessly. Is the cost of the
train ticket relevant in this decision? In other words,
should the cost of the train ticket affect the decision
of whether you drive or take the train to Portland?
A. Yes, the cost of the train ticket is relevant.
B. No, the cost of the train ticket is not
relevant.

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Quick Check 
Suppose you are trying to decide whether to drive
or take the train to Portland to attend a concert.
You have ample cash to do either, but you don’t
want to waste money needlessly. Is the cost of the
train ticket relevant in this decision? In other words,
should the cost of the train ticket affect the decision
of whether you drive or take the train to Portland?
A. Yes, the cost of the train ticket is relevant.
B. No, the cost of the train ticket is not
relevant.

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Quick Check 
Suppose you are trying to decide whether to drive
or take the train to Portland to attend a concert.
You have ample cash to do either, but you don’t
want to waste money needlessly. Is the annual cost
of licensing your car relevant in this decision?
A. Yes, the licensing cost is relevant.
B. No, the licensing cost is not relevant.

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Quick Check 
Suppose you are trying to decide whether to drive
or take the train to Portland to attend a concert.
You have ample cash to do either, but you don’t
want to waste money needlessly. Is the annual cost
of licensing your car relevant in this decision?
A. Yes, the licensing cost is relevant.
B. No, the licensing cost is not relevant.

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Quick Check 
Suppose that your car could be sold now for
$5,000. Is this a sunk cost?
A. Yes, it is a sunk cost.
B. No, it is not a sunk cost.

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Quick Check 
Suppose that your car could be sold now for
$5,000. Is this a sunk cost?
A. Yes, it is a sunk cost.
B. No, it is not a sunk cost.

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