1. Management accounting: basic terms and concepts
Chapter 2
Management accounting: basic terms and concepts

2. Management accounting information
Components
Costing system
Budgeting system
Performance measurement system
Cost management system
Conventional versus contemporary approaches
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

3. Conventional vs. contemporary management accounting systems
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

4. Slides prepared by Kim Langfield-Smith
Emphasis on cost
Why do management accountants pay so much attention to costs?
Historic focus on production costs, to value inventory and COGS for external reporting
Ready availability of cost data within the transaction-based accounting system
Importance of cost information in managers’ decisions
Non-financial information has assumed increased importance in contemporary management accounting systems
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

5. Slides prepared by Kim Langfield-Smith
Cost classifications
Before classifying costs, need to consider how managers intend to use the cost information in decision making
Different cost 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
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

6. Slides prepared by Kim Langfield-Smith
Cost classifications
What are costs?
Resources given up to achieve a particular objective
If the benefit extends beyond the current accounting period these costs are classified as assets
If the benefit is used, the costs are classified as expense
Measured in monetary terms
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

7. Slides prepared by Kim Langfield-Smith
Cost behaviour
Managers must understand how costs change as the as the level of activity in the business changes
The level of activity is the level of work performed in the organisation
Variable costs
Change in total in direct proportion to a change in the level of activity
Sometimes referred to as unit-level costs in product costing as they incurred for each unit of product/service produced
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

8. Slides prepared by Kim Langfield-Smith
Cost behaviour
Fixed costs
Remain unchanged in total despite changes in the level of activity
Can be described as committed costs
Result from an organisation’s ownership or use of premises and its basic organisation structure, and is difficult to change in the short-term
or as discretionary costs
Result from management’s decision to spend a particular amount of money for some purpose, and can be easily changed
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

9. Slides prepared by Kim Langfield-Smith
Cost behaviour
Cost drivers
Any activities or factors that drive (cause) costs
Conventional approaches focus on production volume as the level of activity (or cost driver)
Costs are classified as variable or fixed with respect to production volume
Contemporary approaches recognise that other (non-volume) cost drivers exist
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

10. 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
Products, projects, contracts and departments are common cost objects in conventional costing systems
Contemporary costing systems may also include activities and customers as cost objects
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

11. Direct and indirect costs
In responsibility centres
The costing system may measure the costs of managers’ individual areas of responsibility
Costs that can be traced to a particular responsibility centre are direct costs of that centre
Costs that relate to responsibility centres, but cannot be traced precisely to specific responsibility centres are indirect costs of those centres
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

12. Direct and indirect costs
Product costs
Manufacturing costs that can be traced to product in an economic manner are direct product costs
Indirect costs are manufacturing costs that cannot be traced to products in an economic manner
Whether a cost is classified as direct or indirect depends on the nature of the cost object
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

13. 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
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

14. Controllable and uncontrollable costs
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

15. 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 product or services that customers value
Provides a useful framework for examining the areas where costs are incurred within a business
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

16. 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 cost of sourcing and managing incoming parts, assemblies and supplies
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

17. Costs across the value chain
Production costs
The costs incurred to collect and assemble the resources used to produce a product or service
Downstream costs
Marketing costs are the cost of selling products and the cost of advertising and promotion
Distribution costs are the cost of storing, handling and shipping finished products
Customer service costs are the costs of serving customers, including after-sales service
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

18. Slides prepared by Kim Langfield-Smith
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

19. Slides prepared by Kim Langfield-Smith
Manufacturing costs
Manufacturing costs are incurred within the factory area, whereas upstream and downstream costs are sometimes called non-manufacturing costs
Manufacturing costs include three categories: direct material, direct labour and manufacturing overhead
This classification assumes that products are the relevant cost objects
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

20. Slides prepared by Kim Langfield-Smith
Manufacturing costs
Direct material
Material that is consumed in the manufacturing process
Physically incorporated into the finished products; and
Can be traced to products conveniently
Direct labour
The cost of wages and labour on-costs of staff who work directly on manufacturing a product
However, contractual arrangement sometimes means that such labour is a committed cost
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

21. Slides prepared by Kim Langfield-Smith
Manufacturing costs
Manufacturing overhead
All manufacturing costs other than direct material and direct labour
Also called indirect manufacturing costs or factory burden
Includes the cost of indirect material and indirect labour, depreciation and insurance on factory equipment, utilities and the costs of manufacturing support departments
Also includes cost of overtime premium and idle time
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

22. Slides prepared by Kim Langfield-Smith
Manufacturing costs
Conversion costs
The total of direct labour and manufacturing overhead costs
The cost of converting material into product
Prime costs
The total of direct material and direct labour costs
The major cost associated with producing a product
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

23. Slides prepared by Kim Langfield-Smith
Manufacturing costs
Contemporary costing systems analyse costs in greater detail than under conventional costing systems
Labour costs, and upstream and downstream costs may be classified within an activity framework
In general, direct material tends to be the largest proportion of manufacturing cost, and direct labour costs the smallest
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

24. Slides prepared by Kim Langfield-Smith
Product costs
Managers need estimates of product costs for different purposes
In financial accounting reports
To determine cost of goods sold
To value inventory on hand
For decision making
Definitions of product costs that include non-manufacturing costs may be used
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

25. Slides prepared by Kim Langfield-Smith
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

26. Cost flows in a manufacturing business
1. Material is purchased: cost is added to raw materials inventory
2. Direct materials are consumed in production: cost is removed from raw materials inventory and added to work in process inventory
3. Direct labour and manufacturing overhead are accumulated in work in process inventory
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

27. Cost flows in a manufacturing business
4. Products are completed: costs are transferred from work in process inventory and added to finished goods inventory
5. Products are sold: costs are transferred from finished goods inventory to cost of goods sold expense
6. Cost of goods sold is deducted from sales revenue to determine gross profit
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

28. Cost flows in manufacturing business
Raw materials, work in processes and finished goods inventories balances are found in the Statement of Financial Position
Cost of goods sold expense can be found in the Statement of Financial Performance
The Schedule of Cost of Goods Manufactured and Schedule of Cost of Goods Sold summarise the flow of manufacturing costs
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

29. Slides prepared by Kim Langfield-Smith
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

30. Cost and benefits of information
Must determine which cost concepts are most appropriate in each situation
Benefits of measuring and classifying costs can be realised through improvements in the quality of managers’ decisions
Information overload occurs when managers receive more information than they can use efficiently
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith