ACTB223

Management Accounting
Semester 1 2007/ 2008

Topic 1: Introduction

Learning Objectives

At the end of this lecture, students will be able to know:

1. Management Accounting v Financial Accounting
2. Theory and practice of Management Accounting
i) The role of Management Accounting
ii) Changes in the business environment
3. Classification of costs and revenues
i) Product and period costs
ii) Elements of manufacturing costs
iii) Costs for decision-making and planning
iv) Classification for cost control

 Management Accounting Basics:

i) Management accounting is a field of accounting that provides economic and
financial information for managers and other internal users.
ii) Management accounting applies to all types of businesses: service, merchandising,
and manufacturing. It also applies to all forms of business organizations:
proprietorships, partnerships, and corporations.

1. Comparing Management and Financial Accounting.

In relation Financial Accounting Management Accounting

to…
USERS/  concerned with the provision of  concerned with the provision of
AUDIENCE information to external parties information to people within the
outside the organisation organisation to help them make
 i.e. for external reporting such as to better decisions
owners, investors, creditors,
bankers, regulators (stock
exchange, tax)
PURPOSE  financial reporting  internal decision-making
TYPE OF  financial measurements  financial and non-financial
INFORMATION  financial statements information
 backward-looking; past information  various internal reports
 future-oriented
REPORT  issued periodically  issued as needed; can be quarterly,
FREQUENCY monthly, weekly, daily, even hourly
PRECISION/  accurate, objective, reliable,  subjective, relevant, involves
NATURE OF auditable estimation/approximations, flexible
INFORMATION
SCOPE/  highly aggregated; summarised  may be more detailed; less
SEGMENT  whole of organisation summarised
 may focus on smaller parts of
organisation as well (e.g. individual
products, activities, departments)

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LEGAL  subject to public & regulator  no restrictions, upon
REQUIREMENTS scrutiny request/necessity
/ RESTRICTIONS  must comply with MASB, Securities  optional, and not subject to
Commission, Company Act rules & regulations
regulations  not required by law

2. Theory and practice of Management Accounting

i) The role of Management Accounting - Management’s activities and
responsibilities can be classified into three broad functions:

The above depicts the major functions performed by managers. Emphasize that
managers make decisions in carrying out these functions and need Management
accounting information as input into their decision making-process.
 Planning requires management to look ahead and to establish objectives.
 Directing and motivating involves coordinating a company’s diverse activities
and human resources to produce a smooth-running operation.
 Controlling is the process of keeping the firm’s activities on track.

ii) Changes in the business environment - Developments in Management

Accounting
a) During the most recent decade, the U.S. economy shifted toward an emphasis
on providing services, rather than goods. The challenges for managerial
accounting are greater in service companies than in manufacturing companies
in some respects.
b) In some instances, the managerial accountant may need to develop new
systems for measuring the cost of serving individual customers. The accountant
may need new operating controls to improve the quality and efficiency of
specific services.
c) The value chain is the term that describes all activities associated with
providing a product or service (i.e. research and development, manufacturing,
delivery, etc.). A critical component of the value chain is the supply chain. The
supply chain is all the activities from receipt of an order to delivery of a product
or service.
d) Many companies now employ enterprise resource planning (ERP) software
systems to manage their supply chain. ERP systems provide a comprehensive,
centralized, integrated source of information used to manage all major business
processes, from purchasing to manufacturing to human resource records.
e) Technology is also affecting the value chain through business-to-business e-
commerce on the Internet. The Internet enables customers and suppliers to
share information nearly instantaneously and has changed the marketplace,
often having the effect of cutting out the “middle man.”
f) Many companies have significantly lowered inventory levels and costs using
just-in-time (JIT) inventory methods. Under a just-in-time method, goods are
manufactured or purchased just in time for use.

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 g) Many companies have installed total quality management (TQM) systems to
reduce defects in finished products. These systems require timely data on
defective products, rework costs, and the cost of honoring warranty contracts.
h) In order to obtain more accurate product costs, many companies now allocate
overhead using activity-based costing (ABC). Under ABC, overhead is allocated
based on each product’s use of activities in making the product.

3. Classification of costs and revenues

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i) Product Versus Period Costs.
 Product costs are costs that are a necessary and integral part of producing the
finished product.
 Product costs do not become expenses until the inventory to which they attach
is sold.
 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.
 Period costs include selling and administrative expenses and are deducted from
revenues in the period in which they are incurred.

ii) Elements of manufacturing costs

Manufacturing costs are classified as (a) direct materials, (b) direct labor,
or (c) manufacturing overhead.
a) Direct materials are raw materials that can be physically and directly
associated with the finished product during the manufacturing process.
(1) Indirect materials:
 Do not physically become part of the finished product or,
 Cannot be traced because their physical association with the finished
product is too small in terms of cost (i.e. lock washers).
(2) Indirect materials are accounted for as part of manufacturing overhead.
b) Direct labor is the work of factory employees that can be physically and
directly associated with converting raw materials into finished goods.
(1) Indirect labor has no physical association with the finished product, or it is
impractical to trace the costs to the goods produced.
(2) Indirect labor is classified as manufacturing overhead.
c) Manufacturing overhead consists of costs that are indirectly associated with
the manufacture of the finished product.
(1) Manufacturing overhead includes indirect materials, indirect labor,
depreciation on factory buildings and machines, and insurance, taxes, and
maintenance on factory facilities.

iii) Costs for decision-making and planning

 Cost behavior analysis is the study of how specific costs respond to changes
in the level of business activity. Knowledge of cost behavior helps management
plan operations and decide between alternative courses of action.

 The activity index identifies the activity that causes changes in the behavior
of costs; examples include direct labor hours, sales dollars, and units of output.
With an appropriate activity index, costs can be classified as variable, fixed or
mixed.

o Variable costs are costs that vary in total directly and proportionately
with changes in the activity level. Examples of variable costs include direct
materials and direct labor, cost of goods sold, sales commissions, and
freight out. A variable cost may also be defined as a cost that remains the
same per unit at every level of activity.

o Fixed costs are costs that remain the same in total regardless of changes
in the activity level. Examples include property taxes, insurance, rent,
supervisory salaries, and depreciation. Fixed costs per unit vary inversely
with activity; as volume increases, unit cost declines and vice versa.

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o Mixed costs contain both a variable element and a fixed element; they
increase in total as the activity level increases, but not proportionately.
 Semi-fixed or step fixed costs. These are costs that are fixed within
specified activity levels but they eventually increase or decrease by a
constant amount at various critical activity levels. E.g. labor costs. If
production capacity expands to some critical level, and therefore
additional workers will be employed, labor costs could be semi-fixed
 Semi-variable costs - Include both a fixed and a variable component.
These are costs that change with production, but not in direct proportion
to the volume. E.g. telephone charges which has a fixed charge for line
rental of say RM68 per month and a variable charge per minute for call
charges of say RM0.30 per minute.

o Relevant and Irrelevant Costs and Revenues

For decision-making, costs and revenues can be classified according to
whether they are relevant to a particular decision.
 Relevant costs and revenues are those future costs and revenues that
will be changed by a decision, whereas irrelevant costs and revenues are
those that will not be affected by the decision
 E.g. Petrol costs is relevant in deciding whether to have a journey by
own car or public transport. But the neither car insurance nor car tax
costs are relevant.
 Sometimes, the terms avoidable and unavoidable costs might be
replacing the terms relevant and irrelevant costs.

o Sunk costs - The cost of resources already acquired where the total will be
unaffected by the choice between various alternatives
 They are the costs that have been created by the decision made in the
past and that cannot be changed by any decision that will be made in
the future.
 E.g. Let say you want to conduct a project. You have two alternatives
whether using the old machine or replacing it with a new machine. The
cost of purchasing the old machine is therefore sunk cost. Whether you
want to use it or you want to buy a new one, the cost has already
incurred
 Sunk costs are irrelevant for decision making.
 Distinguished from irrelevant costs because not all irrelevant costs are
sunk costs

o Opportunity costs - Cost that measures the opportunity that is lost or

sacrificed when the choice of one course of action requires that an
alternative course of action be given up.
 E.g. if an asset such as capital is used for one purpose, the opportunity
cost is the value of the next best purpose the asset could have been
used for. Acquiring or renting? Let say, you choose to acquire a building.
A saving of RM150 per month of renting might be your opportunity cost.

o Incremental and marginal costs/revenues

 Incremental costs and revenues are the additional costs or revenues that
arise from the production or sale of a group of additional units.
 E.g. You want to set up a branch in Muadzam Shah. Therefore, you need
the analysis on the incremental costs and revenues by setting up such a
new branch (including sales, advertising, staff salaries, travelling, rentals
etc)
 Marginal cost/revenue represents the additional cost/revenue of one
extra unit of output. If let say the cost of producing 1 unit of table is
RM20, how about two units?

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 iv) Classification for cost control
 Costs and revenues must be traced to the individuals who are responsible for
incurring them. This is called responsibility accounting
 In an organisation, normally it has 3 responsibility centres:
o Cost centre – managers are accountable for the expenses that under their
control. E.g. advertising department, purchasing department
o Profit centre – managers are accountable for sales revenue and expenses.
E.g. sales department
o Investment centre – managers are normally accountable for sales revenue
and expenses, but in addition are responsible for some capital investment
decisions.

a) Controllable and non-controllable costs and revenues

 Costs and revenues allocated to responsibility centers should be classified
according to whether or not they are controllable or non-controllable by the
manager of the responsibility center.
 A controllable cost may be defined as a cost that is reasonably subject to
regulation by the manager with whose responsibility that cost is being
identified

20 MINUTE QUIZ

Circle the correct answer.

True/False
1. Managerial accounting is a field of accounting that provides economic information
for external users.
True False

2. The primary users of managerial accounting information are external users who are
stockholders, creditors, and regulatory agencies.
True False

3. The purpose of reports in managerial accounting is to provide special-purpose

information for a particular user for a specific decision.
True False

4. Manufacturing Inventory is one of the three inventory accounts a manufacturing

company may have.
True False

5. Finished Goods Inventory plus Work in Process Inventory constitutes Cost of Goods
Available for Sale.
True False

6. Indirect materials, indirect labor, and maintenance on factory facilities are all
included in manufacturing overhead.
True False

7. Selling and administrative expenses are product costs.

True False

8. The sum of the direct materials costs, direct labor costs, and manufacturing
overhead incurred is the total manufacturing costs for the current period.
True False

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 9. Cost of goods manufactured for a manufacturing company is the equivalent of cost
of goods sold for a merchandising company.
True False

10. The finished goods inventory for a manufacturing company is the equivalent of the
merchandise inventory for a merchandising company.
True False

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Multiple Choice

1. Which of the following does not apply to the content of managerial reports?
a. Reporting standard is relevant to the decision to be made.
b. May extend beyond double-entry accounting system.
c. Pertains to subunits of the entity and may be very detailed.
d. Pertains to the entity as a whole and is highly aggregated.

2. Management functions include

a. planning.
b. directing and motivating.
c. controlling.
d. all of the above.

3. Which of the following inventory accounts is not applicable to a manufacturing

company?
a. Finished Goods Inventory.
b. Merchandise Inventory.
c. Raw Materials Inventory.
d. Work in Process Inventory.

4. If direct materials for one unit of product are $9.00, direct labor for one hour is
$12.00, manufacturing overhead costs are $4.00 per direct labor hour, and one-
fourth hour of direct labor is required to produce one unit of product, how much are
the conversion costs for one unit of product?
a. $4.00.
b. $2.00.
c. $16.00.
d. $12.00.

5. Direct materials and direct labor are

a. period costs.
b. product costs.
c. overhead costs.
d. indirect costs.

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ANSWERS TO QUIZ

True/False
1. False 6. True
2. False 7. False
3. True 8. True
4. False 9. False
5. False 10. True

Multiple Choice
1. d.
2. d.
3. b.
4. a.
5. b.