Chapter 2

Management accounting:
cost terms and concepts

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 Outline

• Management accounting systems

• Emphasis on costs
• Cost classifications
• Direct and indirect costs
• Controllable and uncontrollable costs
• Costs across the value chain
• Manufacturing costs and cost flows

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Management accounting systems
• Management accounting systems are tailored to an organisation’s
needs

• Components may include

– Costing systems( Hệ thống chi phí)
– Budgeting systems( Hệ thống ngân sách)
– Performance measurement systems( Hệ thống đo lường hiệu
suất)
– Cost management systems( Hệ thống quản lý chi phí)
• Traditional versus modern approaches

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Traditional versus modern management

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 Emphasis on costs

• Why do management accountants pay so much attention to

costs?
– Historic focus on production costs
– Ready availability of cost data
– Importance of cost information

• Non-financial information is increasingly important in modern

management accounting systems

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 Different cost classifications
for different purposes
• Before we classify costs, we need to understand how managers
intend to use the information

• Different costs and classifications are used for different

purposes

• The same cost can be classified in a number of ways depending

on the intended use of the cost information

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 What are costs?

• Resources given up to achieve a particular objective

• In financial accounting
─ Asset
─ Expense

• Measured in monetary terms

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 Common cost classifications

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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
• Level of activity
• Cost driver
• Variable costs
• Fixed costs

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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

– Direct costs can be identified with or traced to a particular

cost object

– Indirect costs cannot be economically identified or traced to

a cost object

(cont.)
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 Direct and indirect costs (cont.)
• 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 may measure the costs of managers’

individual areas of responsibility

– Assigning costs to units is part of responsibility accounting

(cont.)

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Direct and indirect costs (cont.)
• Product costs
– Direct product costs
– Indirect product costs
– Nature of the cost object
– Do we wish to know the cost of a department, a product,
a project, or an entire company?
– A cost can be a direct cost of one cost object and an
indirect cost of another cost object

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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

(cont.)
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 Controllable and
uncontrollable costs (cont.)

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 Costs across the value chain
• The value chain
– A set of linked processes or activities that begins with
acquiring resources and ends with providing and supporting
products and services that customers value

• Various cost classifications can be used within the upstream,

downstream and manufacturing areas

(cont.)

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 Costs across the value
chain (cont.)
• Upstream costs
– Research and development ,design and supply costs

• Production costs
– The costs incurred to collect and assemble the resources used
to produce a product

• Downstream costs
– Marketing, distribution and customer service costs

(cont.)
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 Costs across the value
chain (cont.)

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 Manufacturing costs
• Manufacturing costs

• Non-manufacturing costs

• Classification of manufacturing costs

– Direct material, direct labour and manufacturing overhead
– Direct or indirect cost classification assumes that products are
the relevant cost objects

• Traditional product costing

(cont.)
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 Manufacturing costs (cont.)
• Direct material is
– Consumed in the manufacturing process
– Physically incorporated into the finished products
– Can be economically traced to products
– A variable cost (with respect to products)
• Direct labour is
– directly traced to a product
– Usually treated as a variable cost unless contractual
arrangements in place

(cont.)
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 Manufacturing costs (cont.)
• Manufacturing overheads include:
– Indirect manufacturing costs or factory burden
– Indirect material and indirect labour, depreciation and insurance
on factory equipment, utilities and the costs of support
departments for manufacturing
– Overtime premium and idle time
– Manufacturing support departments do not work directly on
producing products

(cont.)
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 Manufacturing costs (cont.)
• Conversion costs
– The total of direct labour cost and manufacturing overhead
cost
– The cost of converting material into a product
• Prime costs
– The total of direct material cost and direct labour cost
– The major cost associated with producing a product

(cont.)
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 Manufacturing costs (cont.)
• Modern costing systems analyse costs in greater detail than
traditional costing systems
– Classifying direct material
– Analysing labour costs may be analysed as part of activity
costs

• In many industries, direct material is the largest proportion of the

manufacturing cost and direct labour costs are the smallest

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 Product costs
• Managers need estimates of product costs for different
purposes

• In financial accounting reports

– Product costs determine cost of goods sold
– Product costs help value inventory on hand
– Period costs

• For management decision making

– Definitions of product costs may include non-manufacturing
costs

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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

(cont.)
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 Cost flows in a manufacturing
business (cont.)
• Products are completed: costs are transferred from work in
process inventory and added to finished goods inventory
• 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

(cont.)
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 Cost flows in manufacturing
business (cont.)
• Raw materials, work in process and finished goods inventory
balances are reported in the balance sheet
• Cost of goods sold expense can be found in the income statement
• The schedule of cost of goods manufactured and schedule of cost
of goods sold summarise the flow of manufacturing costs

(cont.)

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Cost flows in
manufacturing
business (cont.)

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 Summary
• Traditional and modern approaches to management accounting can be
distinguished
• Costing systems focus on the cost of products and organisational units
and are a component of management accounting systems
• The classification of costs may vary depending on the different intended
uses of those costs
• Costs may be classified by behaviour, traceability, controllability and
function
• The value chain provides a framework to identify where cost are incurred
in an organisation

(cont.)
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 Summary (cont.)
• In manufacturing businesses, production costs typically consist of
direct materials, direct labour and manufacturing overhead, in line
with external reporting requirements
• The definition of product costs needed to support management
decision making may be broader than that used for external
reporting purposes
• 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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