Chapter 2 Management accounting: basic terms and concepts

Components of a management accounting system §Costing system - cost of products and organisational units §Budgeting system - planned revenues and costs §Performance measurement - differences between planned and actual performance §Cost management system - managing the causes of cost

Conventional vs contemporary approaches to management accounting §Costing systems l Conventional - focus on products and organisational units, production volume assumed to drive costs l Contemporary - cost of activities, many causes of cost Cont.

Conventional vs contemporary approaches to management accounting §Budgeting systems l Conventional - departmental budgets aggregated to obtain organisation’s overall budget l Contemporary - activity-based budgeting, built around activities Cont.

Conventional vs contemporary approaches to management accounting §Performance measurement l Conventional - focus on controlling costs, differences between actual and budget l Contemporary - feedback on a range of critical success factors; balanced scorecard, benchmarking and activity-based performance measures Cont.

Conventional vs contemporary approaches to management accounting §Cost management systems l Conventional - information for controlling costs l Contemporary - cost control and cost reduction; search for ‘root’ causes

Emphasis on costs §Value chain l upstream costs research and development, product design l manufacturing/production costs l downstream costs selling, distribution, customer support §Historic emphasis on costs l production large proportion of cost l upstream and downstream costs insignificant Cont.

Emphasis on costs §Importance of cost information l all organisations incur costs l management decisions generally cause costs l managers need to understand cost causes to plan and control §Role of non-financial information l decision makers also require qualitative information for decisions

Classifying costs §Costs - resources given up to achieve a particular objective §Classification of costs l variable costs - change in total, in direct proportion to a change in the level of activity l fixed costs - remain unchanged in total despite changes in the level of activity l cost driver - any activity or factor which causes costs to be incurred Cont.

Classifying costs l cost object - items which are assigned a separate measure of cost l direct costs - can be identified with, or traced to, a particular cost object in an economic manner l indirect costs - cannot be identified with or traced to a cost object in an economic manner l direct product costs - manufacturing costs that can be traced to products in an economic manner

Responsibility accounting §Holding individual managers responsible for results of their organisational units l responsibility centres - areas of a business where managers are held responsible for activities and results l controllable costs - costs a specific manager can control or significantly influence l uncontrollable costs - costs a specific manager cannot significantly influence

Costs in manufacturing businesses §Non manufacturing costs l upstream costs research and development product design l downstream costs marketing costs selling (or order-getting costs) distribution (or order-filling costs) customer support Cont.

Costs in manufacturing businesses §Manufacturing costs l direct material - cost of materials consumed in the manufacturing process to produce a product, where the cost can be traced to each product in an economic manner l direct labour - costs of salaries, wages and labour on-costs for personnel who work directly on the manufactured product l manufacturing overhead - all other costs of manufacturing Cont.

Costs in manufacturing businesses §Manufacturing overhead l indirect materials and indirect labour l costs of depreciation, insurance of factory, utilities and manufacturing support departments l costs of manufacturing support departments do not work directly on the manufacturing products but are essential to the manufacturing process l idle time and overtime premium Cont.

Costs in manufacturing businesses §Combined manufacturing costs l conversion costs - direct labour and manufacturing overhead incurred to convert raw materials to finished product l prime costs - direct manufacturing costs traced to a product; direct materials and direct labour

Costs in service businesses §Service firms - produce services rather than goods §Differences between service and manufacturing businesses l most service outputs are intangible l service outputs are often heterogeneous l services are often consumed as they are produced l services are perishable and cannot be stored Cont.

Costs in service businesses §Costs are classified in service businesses to provide information for managers’ decisions §Direct labour costs are significant §Direct material costs are insignificant §Overhead costs may refer to all indirect costs, including production, upstream and downstream costs

Product costs in financial accounting reports §Product costs - regarded as asset until sold §Cost of goods sold - matched against revenue to determine gross margin §Period costs - all costs which are not product costs, expensed in the accounting period in which they are incurred §Selling costs §Administrative costs

Product costs for decision making §For longer-term decisions, product costs may include upstream, manufacturing and downstream costs §For short-term decisions, manufacturing and downstream costs may be considered §Cost structure - relative proportions of an organisation’s variable and fixed costs

Cost flows in a manufacturing business §Inventories l raw materials - costs of all major materials purchased for manufacturing l work in process - products on which manufacture has begun but is only partially complete at balance date l finished goods - manufactured goods that are complete and ready for sale Cont.

Cost flows in a manufacturing business §Schedule of cost of goods manufactured l cost of direct materials, direct labour and manufacturing overhead applied to work in process during the period, and changes in work in progress inventory l Schedule of cost of goods sold l cost of goods sold, and the changes in the finished goods inventory

Costs and benefits of information §Management accountants need to assess the benefits of providing information against the cost of generating, communicating and using that information §Too much information may cause information overload §A recent survey identified monthly reports of less than 10 pages as ‘best practice’

Exhibit 2.1

Exhibit 2.5