Management Accounting Consultancy Report
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Week2-LectureSlides.pptxChapter 2
Management Accounting: Cost Terms and Concepts
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MONASH
BUSINESS
SCHOOL
Quizzes – Weeks 2 to11
Individual assessment
Topics Covered: subject materials of the previous week
On Moodle under tabs of Week 2 – Week 11
Available from 9:00am Monday to 23:59pm Saturday each week from Week 2 to Week 11
Attempts allowed – one time only for each week’s quiz
Good internet access required
Treat the quiz as an exam – you must finish it in 25 minutes
10 multiple choice questions - both calculative and non-calculative
Study relevant textbook chapters, lecture slides, in-class questions and homework questions before attempting the quiz
Results available on completion of the quiz.
Quiz review with right answers is available after a quiz is closed
www.buseco.monash.edu
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For this topic you should be able to:
Understand what cost is and why cost is important
Recognise the differences between conventional (traditional) and contemporary (modern) costing systems
Explain what is meant by different costs for different purposes
Classify costs according to their behaviour, traceability, controllability, position in the value chain and timing
Understand why cost classification is useful in practice
Prepare a schedule of cost of goods manufactured, cost of goods sold and an income statement.
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Why is Cost Important?
What are costs?
Resources given up to achieve a particular objective.
Measured in monetary terms.
A cost is incurred to obtain a benefit.
In financial accounting:
if the benefit extends beyond the current accounting period the cost is classified as an asset.
If the benefit is used up in the generation of revenue, the cost is classified as an expense.
Importance of costs:
- Many short-term and long-term decisions require an understanding of costs
- Important source of information for decision-making, managing resources, and creating customer and shareholder value
Traditional Approaches to Costing
Monitors financial performance
Controls what’s going on inside the organisation
Provides information to help managers control cost
Looks at difference between actual & planned/budgeted costs
Estimates costs of organisational units (e.g. departments) and/or products (goods and services)
Assumes that production volume is the only factor that can cause costs to change
Information is mainly obtained from financial accounting system
Modern Approaches to Costing
Developed in 1990s in response to changes in the business environment
Pro-active and detailed in providing information to manage resources
Emphasises non-financial and qualitative information
for example, quality, delivery, innovation, sustainability etc.
Focuses on a broader range of costs
for example, costs of activities, products, customers, suppliers etc.
Examines what’s going on inside and outside the organisation
for example in relation to customers, competitors, suppliers etc.
Focus is not only to control costs but to reduce them
The real ‘root’ causes of costs are analysed, and wasteful activities are identified and eliminated
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Different Costs 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
The total amount ($) of cost does not change; only the way we look at it!
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Different classification – exact same cost
Fixed
Indirect
Uncontrollable
Upstream
Period
Research Cost - $1.5 million – Pharmaceutical Company
1. Classifying Costs according to Behaviour
Costs change as the level of activity changes
The level of activity is the level of work performed in the organisation
Units produced, kilometres driven, hours worked
Variable costs
Change in total in direct proportion to a change in the level of activity
Fixed costs
Remain unchanged in total despite changes in the level of activity
Doesn’t mean the cost itself can’t change! But if it does change, this is usually unrelated to a change in the level of activity
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How to Classify a Cost according to Behaviour…
Determine the level of activity – usually this is what causes sales to go up or down
Question whether the cost is impacted significantly by the level of activity or not – is there a ‘direct proportion’ effect?
If yes – variable; If no –fixed
Different classification – exact same cost
Fixed – Does not change in direct proportion to the number of pharmaceutical products sold
Research Cost - $1.5 million – Pharmaceutical Company
Costs are direct or indirect depending on whether they can be traced to a cost object
Cost objects are the items for which management wants a separate measure of costs
Traditional costing systems - products, projects, contracts and departments
Modern costing systems - activities, customers and suppliers as cost objects
2. Classifying Costs according to Traceability
Direct and Indirect Costs
Direct cost - can be traced to a cost object in an economic manner
There is clear and observable relationship between the cost and the cost object
Easy to calculate the cost
Indirect cost – cannot be traced to the cost object in an economic manner
Because the cost has no direct relationship with the cost object, it has to be apportioned or allocated
Direct and Indirect Costs of Your Textbook
Direct Costs
Paper
Wages of factory workers
Indirect Costs
Glue
Salary of forklift driver
or production supervisor
How to Classify a Cost according to Traceability…
Identify the cost object – what do you want to know the cost of?
Is there a clear, observable and easily calculable relationship between the cost and this cost object? – do the benefits of tracing it outweigh the costs?
If yes – direct; If no - indirect
Therefore…..
Whether a cost is classified as direct or indirect depends on the 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
Different classification – exact same cost
Depends on the cost object:
Research Department = direct cost
Production Department= indirect cost
Research Cost - $1.5 million – Pharmaceutical Company
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
3. Classifying Costs According to Controllability
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
Responsibility accounting – holding managers accountable only for the costs that they are directly responsible for
Examples of Controllable and Uncontrollable costs
Different classification – exact same cost
Depends on the manager:
Research Manager = controllable
Maintenance manager = uncontrollable
Research Cost - $1.5 million – Pharmaceutical Company
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 within the value chain:
Upstream, downstream and manufacturing costs
Allows managers to focus on each stage of the organisation’s activity separately and make decisions related to each stage, for example, whether to outsource.
4. Classifying Costs according to their Position
in the Value Chain
Costs across the Value Chain
Upstream Costs
Research and development costs include the costs involved in developing new products and processes
Design costs include the costs associated with designing a product or production process
Supply costs are the costs of sourcing and managing incoming parts, assemblies and supplies
Downstream Costs
Marketing costs are the costs of selling products and the costs of advertising and promotion
Distribution costs are the costs of storing, handling and shipping finished products
Customer service costs are the costs of serving customers, including after-sales service
Manufacturing Costs
Manufacturing costs are incurred within the factory area
Traditional product costing - only manufacturing costs are included in product costs
Modern costing systems - product costs include an allocation of upstream and downstream costs
Different classification – exact same cost
Upstream
Research Cost - $1.5 million – Pharmaceutical Company
Direct Manufacturing Costs
Direct material:
Physically incorporated into the finished products
Can be traced to products in an economic manner
A variable cost
Direct labour:
The cost of wages and labour on-costs for personnel who work directly on the manufacture of a product
On-costs include payroll tax, insurance, superannuation etc.
Indirect Manufacturing costs
Manufacturing overhead
....or indirect manufacturing costs or factory burden
indirect material
indirect labour
depreciation
insurance on factory equipment
utilities
manufacturing support department costs
overtime premium
idle time
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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
Manufacturing Cost = DM + DL + MOH
Combining Manufacturing Costs
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Product costs:
A cost that is assigned to goods that were either manufactured or purchased for resale
Used to value inventory and cost of goods sold in the balance sheet and income statement
The product cost is regarded as an asset or inventoriable cost until the good is sold
Period costs
All costs that are not product costs
Selling and administrative expenses
Expensed in the period in which they are incurred rather than passing through various stages of inventory
In service firms, all costs are period costs
5. Classifying Costs according to Timing
Different classification – exact same cost
Period
Research Cost - $1.5 million – Pharmaceutical Company
Different classification – exact same cost
Fixed
Direct/Indirect
Controllable/ Uncontrollable
Upstream
Period
Research Cost - $1.5 million – Pharmaceutical Company
Illustration I: Cost Classifications
The cost data in the following page refers to 2017 and relates to Heartstrings Pty. Ltd., a greeting card manufacturer.
Required:
Calculate each of the following:
Total prime costs;
Total manufacturing overhead costs;
Total conversion-costs;
Total product costs;
Total period costs.
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Lecture Illustration 1: Cost Classifications
| Prime costs | MOH costs | Conversion costs | Product costs | Period costs | ||
| Direct material used in production | $550,000 | |||||
| Advertising expense | $60,000 | |||||
| Depreciation on factory building | $57,500 | |||||
| Direct labour: wages | $242,500 | |||||
| Indirect labour: wages | $70,000 | |||||
| Production supervisor’s salary | $22,500 | |||||
| Service-department costs | $50,000 | |||||
| Direct labour: fringe benefits | $47,500 | |||||
| Indirect labour: fringe benefits | $15,000 | |||||
| Fringe benefits for production supervisor | $4,500 | |||||
| Total overtime premiums paid | $27,500 | |||||
| Cost of idle time | $20,000 | |||||
| Administrative costs | $75,000 | |||||
| Rental of office space for sales personnel | $7,500 | |||||
| Sales commissions | $2,500 | |||||
| Promotion costs | $5,000 | |||||
| Total costs |
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Other production factors: Manufacturing overhead :
factory rent
depreciation
gas, electricity
etc
Direct Materials storage
Work in Progress
in the factory
Physical Flows in Manufacturing
Direct Materials
Direct Labour
Finished Goods Warehouse
Customers
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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
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
Timing of Product Costs in Manufacturing Business
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Cost Flows in a Manufacturing Business
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COGM
COGS
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Costing the Flow of Manufacturing
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
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Illustration 2: Cost Flows
The following accounting information is available for MedCo, Inc.. The information refers to January 2018.
Prepare the following information using the templates provided:
Schedule of Cost of Good Manufactured;
Schedule of Cost of Goods sold;
Statement of Financial Performance.
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| Purchase of raw materials | $90,000 | |||
| Raw materials inventory, January 1 | 10,000 | |||
| Raw materials inventory, January 31 | 17,000 | |||
| Depreciation, factory | 42,000 | |||
| Insurance, factory | 5,000 | |||
| Direct labour cost | 60,000 | |||
| Maintenance, factory | 30,000 | |||
| Administrative expenses | 70,000 | |||
| Sales revenue | 450,000 | |||
| Factory utilities, | 27,000 | |||
| Factory supplies | 1,000 | |||
| Selling expenses | 80,000 | |||
| Indirect labour | 65,000 | |||
| Work in process inventory, January 1 | 7,000 | |||
| Work in process inventory, January 31 | 30,000 | |||
| Finished goods inventory, January 1 | 10,000 | |||
| Finished goods inventory, January 31 | 40,000 |
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Illustration 2: Cost Flows
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| Schedule of Cost of Goods Manufactured | ||
| Direct material: | ||
| Inventory, 1 January | ||
| Add raw materials purchases | ||
| Material available for use | ||
| Less Inventory, 31 January | ||
| Raw material used | ||
| Direct Labour | ||
| Manufacturing overhead: | ||
| Indirect labour | ||
| Depreciation, factory | ||
| Maintenance, factory | ||
| Utilities, factory | ||
| Insurance, factory | ||
| Supplies, factory | ||
| Total manufacturing overhead | ||
| Total manufacturing costs | ||
| Add WIP inventory, 1 January | ||
| Less WIP inventory, 31 January | ||
| Cost of Goods Manufactured (COGM) |
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Illustration 2: Cost Flows
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| Schedule of Cost of Goods Sold | |
| Finished Goods inventory, 1 January | |
| Add COGM | |
| Less Finished Goods inventory, 31 January | |
| Cost of Goods Sold (COGS) | |
| Statement of Financial Performance | |
| Sales revenue | |
| Less COGS | |
| Gross profit | |
| Selling expenses | |
| Administrative expenses | |
| Net profit |
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Summary
Management accounting systems: tailored to the organisation’s needs
Costing systems focus on the cost of products and organisational units
We can distinguish between traditional and modern costing systems
There may be different costs for different purposes
Costs may be classified by behaviour, traceability, controllability, and function
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Summary
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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Acknowledgement
Some slides contained in this presentation were adapted from:
Management Accounting: Information for managing and creating value 8e, Langfield-Smith, Smith, Andon, Hilton and Thorne
Copyright © 2018 McGraw-Hill Education (Australia) Pty Ltd
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