CHAPTER 1

MANAGERIAL ACCOUNTING
AND THE BUSINESS
ENVIRONMENT
 LEARNING OUTCOMES
At the end of this chapter, students should be able to:
•Define management and cost accounting and explain their
significance
•Discuss the meaning, approach, techniques and philosophy
of contemporary management accounting
•Define the meaning of each type of cost and classify the
cost according to their functions, behaviour and tracing
method
•Segregate mixed cost using high and low method
 INTRODUCTION

• Management accounting is used to provide

information for management and staff in day-to-
day management of the business.
• Management and employees are internal users of
accounting information.
 DEFINITION OF MANAGEMENT
ACCOUNTING
• The Institute of Cost and Management Accountants
define management accounting as ‘the application of
knowledge and professional skill in supervising and
presenting accounting information in a form that can
assist the management in formulating policies and
planning and controlling business operations’.
 FUNCTIONS OF MANAGEMENT
ACCOUNTING
• Some of the functions carried out by managers are
planning, controlling and decision-making. Management
accountants are also involved in these three main
activities.
• This means that the management accountant supports
the management in achieving the main objectives of the
organization.
 FUNCTIONS OF MANAGEMENT
ACCOUNTING
• Planning
– Managers must plan their work before any decision is taken in
connection with sales, production, and capital expenditure.
• Decision-making
– Managers must allocate resources effectively in the best
possible manner so that return of the organization can be
maximized.
• Controlling
– Management must control the business activities carried out as
a result of decisions made. A form of control is an organizational
chart.
 Chairman of Board

Managing Director

Director of Director of Director of Director of

Production Human Resource Finance Sales

Production Human Resource Financial Sales

Supervisor Manager Controller Coordinator

Salary and Wages

Coordinator Financial Accounting

Account Payable Account Credit

Supervisor Receivable Controller
Management Supervisor
Accounting

Management Project System

Accountant Accountant Accountant Figure 10.1 Organizational chart
 MANAGEMENT INFORMATION SYSTEM

• Accounting is one of the important parts of the overall

information system in any organization.
• Internal and external information users need to make
decisions in allocating limited economic resources.
Accounting system includes activities such as:
– Determining and possessing the relevant
economic information.
 MANAGEMENT INFORMATION
SYSTEM (CON’T)
– Systematically recording all collected information.
– Analyzing and interpreting collected information.
– Reporting information in such a form and manner
that can fulfil managers needs.
• Management accounting measures and reports financial
and non-financial information that can help managers in
making decisions.
 MANAGEMENT INFORMATION
SYSTEM (CON’T)
• It is the duty of managers to ensure that financial
information presented in the financial statement is
published to customers, legislators (government) and
outside parties requirements.
• This shows that managers are interested in both financial
accounting and management accounting.
 MANAGEMENT INFORMATION SYSTEM
(CON’T)
• Cost accounting provides information both for
financial and management accounting.
• Cost accounting measures and reports financial
information and non-financial information in
connection with earnings and uses of organization’s
resources.
 NEW ORGANIZATIONAL FORMS AND
MANAGEMENT
• Current management must implement certain strategy in
order to achieve the business goals.
• Some of the strategies are:
– Benchmarking
– Total Quality Management (TQM)
– Continuous improvement (Kaizen)
– Activity-based Costing (ABC)
 NEW ORGANIZATIONAL FORMS AND
MANAGEMENT (CON’T)
– Re-engineering
– Target costing
– Life-cycle costing
– Theory Of Constraints (TOC)
– Balanced scorecard
 CONTEMPORARY MANAGEMENT
ACCOUNTING

• Any change in the field of science, technology, society,

politics, government policy or business environment
brings change in accounting the practice in general and
management accounting in particular.
• Changes which have already happened and are about to
happen in accounting can be summarized as follows:
– Increased global competition and challenges;
 CONTEMPORARY MANAGEMENT
ACCOUNTING (CON’T)

– Development in manufacturing technology

– Development in information technology, Internet
and e-commerce
– Customer focused
– Emergence of organizational forms and
management
 BENCHMARKING

• Benchmarking is the process undertaken by a business

organization to identify the success factors of their
business activities.
• Research is carried out on the best practice done by
other firms or department in their own organization.
• Based on the results of the study, improvement is made
to achieve the benchmarking or the best indicator.
 TOTAL QUALITY MANAGEMENT (TQM)

• TQM is a process in formulation of policy and

management practices to enhance the best output
and services to customer.
• TQM’s positive effect includes brand loyalty, producing
improved and quality products and improving
competitive advantage among competitors in the
market.
 CONTINUOUS IMPROVEMENT
(KAIZEN)

• Kaizen is a management technique from Japan.

• The objective of this technique is to increase
commitment and dedication of managers and employees
of the organization in achieving quality work in a small
scale but on a continuous basis. Kaizen technique has
close relationship with benchmarking and TQM.
 ACTIVITY-BASED COSTING

• Under this costing method, businesses have to analyze

their activities for improvement in planning, product
costing, operation control and management control.
• This costing method has created one new form of
management practice which is known as Activity Based
Management (ABM).
 RE-ENGINEERING

• Re-engineering means doing improvement on a big

scale. It basically brings drastic and radical change to the
product.
• Examples are renovation, amalgamation, demolization of
physical aspects of the building or facilities that already
exist, or reformation of products in the form of technical
production, product design and process design.
 TARGET COSTING

• Target costing is an effort to determine cost of a product

or service based on the level of competitive price.
• An organization which adopts this approach will try its
best to reduce its product cost, or it will redesign the
product or manufacturing process so as to achieve the
targeted profit.
• The formula to calculate target cost is:
Target Cost = Market Price – Targeted Profit
 LIFE CYCLE COSTING

• The Life Cycle Costing principle is based on a management

technique used to identify and control costs during the life-
cycle of the product.
• Product life cycle starts from the product design and
purchase of raw materials until the product or services are
delivered to the customers. Even after sales services such as
on-site complaint handling and maintenance are
considered as part of life-cycle costing.
 THEORY OF CONSTRAINTS (TOC)

• TOC is based on the principle that there are at least one

obstacle ahead which can be foreseen in the running or
flow of the system. This is known as a ‘bottleneck’.
• This theory enhances management to identify problems
and to eliminate them during the production process.
• This obstacle can exist during the purchasing and
delivering of the product.
 THEORY OF CONSTRAINTS (CON’T)

• Many managers agree that the effectiveness of product

development and delivery to customers is the main key
of performance indicators of the organization.
• These constraints must be abolished in order for the
organization to be competitive in the global market.
 BALANCED SCORECARD

• The four important dimensions in the balance scorecard

are as follow:
– Financial performance, which measures
profitability and market value of shares as
satisfaction index of the owner or share holders of
the company.
– Customers’ satisfaction, which measures product
and service quality of the company. Under this
dimension, low cost with good quality is an
indicator as to how far the business can satisfy its
customers.
 BALANCED SCORECARD (CON’T)

– Internal business process, which measures the

effectiveness and efficiency process of the
products or services of the organization.
– Learning and innovation measures the ability of
the organization to develop and utilize its human
resources in order to achieve its business strategic
objectives currently and in the future.
 COST ACCOUNTING SYSTEM

• Cost accounting system provides useful information

(related to the cost of the product or services) for
management in decision-making.
• This cost accounting information is used as a control and
tool for the management to measure the performance of
each department and the employees of the organization.
 COST ACCOUNTING SYSTEM (CON’T)

• The cost accounting information is also used by the

management in planning such as budgeting.
• Cost accounting system enables companies to make
decisions as to what type of product to produce, how
much to produce and how the product to be produced.
 COST TERMINOLOGY AND COST
CLASSIFICATION

• The method of classifying cost differs from one

organization to another. However, costs are classified into
three main categories which are as follows:
– Function;
– Behaviour, and
– Tracing and allocating.
 CLASSIFICATION OF COSTS ACCORDING
TO FUNCTION
• Manufacturing Cost (inventory or product cost)
– Prime cost/direct costs
• Direct material cost, and
• Direct labour cost.
– Conversion cost
• Cost of Goods Sold
• Cost of Goods Sold = Opening Inventory + Manufacturing Cost
(Production Cost) – Closing Inventory
 CLASSIFICATION OF COSTS
ACCORDING TO FUNCTION (CON’T)

• Non-manufacturing Cost
– Distribution costs or marketing costs
– General and administration costs
 CLASSIFICATION OF COSTS ACCORDING
TO BEHAVIOUR
• Fixed Cost
• Variable cost
• Mixed Costs
 FIXED COST GRAPH

Fixed cost (RM)

5000

4000

3000 Fixed cost

2000

1000
Level of activity
0 or output (Unit)
100 200 300 400
 VARIABLE COST GRAPH

Total variable cost (RM)

Variable cost
5000
4500
4000
3500
3000
2500
2000
1500
1000
500 Level of activity or
0 output (Unit)
100 200 300 400
 MIXED COST GRAPH

Total cost (RM) Total cost

(Fixed cost + Variable cost)
900 Variable cost
800
700
600
500
400
300
200
100 Fixed cost
0 Level of activity or
100 200 300 400 output (Unit)
 SEGREGATION OF MIXED COST

• Mixed cost can be separated into variable and fixed cost

by using four popular methods. They are:
– High and low method;
– Scatter graph;
– Least-square regression, and
– Linear regression.

• For the purpose of this chapter, the focus is only on

high and low method
 HIGH AND LOW METHOD

• High and low method is a way to determine the

equation of a straight line which connects two points,
that is, the highest and the lowest point.
• The highest point is the highest output or activity of an
output or activity listed in a certain period.
 HIGH AND LOW METHOD (CON’T)

• The summary to determine variable rate and fixed cost can be

shown as follows:
Variable cost (per unit) = Changes in costs/Changes in output or activity
= (Highest cost – Lowest cost) / (Highest output – Lowest output)
and
Fixed cost = Total cost - (Variable cost/unit × Highest output)
(Highest point)
Fixed cost = Total cost - (Variable cost/unit × Lowest output)
(Lowest point)
 COST CLASSIFICATION ACCORDING TO
TRACING AND ALLOCATION
• Direct costs are costs that can be traced to a
business activity, for example, direct material
cost used or direct labour cost (as total job
hour) can be determined based on a products
or services offered.
• Direct material cost and direct labour cost are
the two examples of costs classified according
to tracing.
 COST CLASSIFICATION ACCORDING TO
TRACING AND ALLOCATION (CON’T)

• Indirect labour costs are group of costs shared and

distributed among a group or a batch of business
activity. For example, utility cost and salary of a sales
manager are types of indirect cost which are related to
produce a product or service.
• Indirect cost need cost reallocation
 RELEVANT AND IRRELEVANT COSTS

• Relevant costs are the future costs which vary from

one alternative to another and act as a basis for
decision-making, that is, cost differs with the
change of alternatives.
• Irrelevant costs are the costs which do not differ
between alternatives and are not considered in
decision-making. The irrelevant cost concept is
related to sunk cost.
COST FOR PLANNING AND
CONTROLLING
• THANK YOU