Chapter 2 Management accounting basic terms and concepts

Chapter 2 Management accounting: basic terms and concepts Copyright 2003 Mc. Graw-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

Management accounting information s Components ÙCosting system ÙBudgeting system ÙPerformance measurement system ÙCost management system s Conventional versus contemporary approaches Copyright 2003 Mc. Graw-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 2

Conventional vs. contemporary management accounting systems Copyright 2003 Mc. Graw-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

Emphasis on cost s Why do management accountants pay so much attention to costs? ÙHistoric focus on production costs, to value inventory and COGS for external reporting ÙReady availability of cost data within the transaction-based accounting system ÙImportance of cost information in managers’ decisions s Non-financial information has assumed increased importance in contemporary management accounting systems Copyright 2003 Mc. Graw-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

Cost classifications s Before classifying costs, need to consider how managers intend to use the cost information in decision making s Different cost and classifications are used for different purposes s The same cost can be classified in a number of ways depending on the intended use of the cost information continued Copyright 2003 Mc. Graw-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

Cost classifications s What are costs? ÙResources given up to achieve a particular objective ÙIf the benefit extends beyond the current accounting period these costs are classified as assets ÙIf the benefit is used, the costs are classified as expense ÙMeasured in monetary terms Copyright 2003 Mc. Graw-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

Cost behaviour s Managers must understand how costs change as the level of activity in the business changes ÙThe level of activity is the level of work performed in the organisation s Variable costs ÙChange in total in direct proportion to a change in the level of activity ÙSometimes referred to as unit-level costs in product costing as they incurred for each unit of product/service produced continued Copyright 2003 Mc. Graw-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

Cost behaviour s Fixed costs ÙRemain unchanged in total despite changes in the level of activity ÙCan be described as committed costs v. Result from an organisation’s ownership or use of premises and its basic organisation structure, and is difficult to change in the short-term Ùor as discretionary costs v. Result from management’s decision to spend a particular amount of money for some purpose, and can be easily changed continued Copyright 2003 Mc. Graw-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

Cost behaviour s Cost drivers ÙAny activities or factors that drive (cause) costs s Conventional approaches focus on production volume as the level of activity (or cost driver) ÙCosts are classified as variable or fixed with respect to production volume s Contemporary approaches recognise that other (non-volume) cost drivers exist Copyright 2003 Mc. Graw-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

Direct and indirect costs s An important function of management accounting is to measure the cost of cost objects ÙCost objects are the items for which management wants a separate measure of costs ÙProducts, projects, contracts and departments are common cost objects in conventional costing systems ÙContemporary costing systems may also include activities and customers as cost objects Copyright 2003 Mc. Graw-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 s In responsibility centres ÙThe costing system may measure the costs of managers’ individual areas of responsibility ÙCosts that can be traced to a particular responsibility centre are direct costs of that centre ÙCosts that relate to responsibility centres, but cannot be traced precisely to specific responsibility centres are indirect costs of those centres continued Copyright 2003 Mc. Graw-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 s Product costs ÙManufacturing costs that can be traced to product in an economic manner are direct product costs ÙIndirect costs are manufacturing costs that cannot be traced to products in an economic manner s Whether a cost is classified as direct or indirect depends on the nature of the cost object Copyright 2003 Mc. Graw-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

Controllable and uncontrollable costs s Managers’ performance evaluation can be enhanced by classifying responsibility centre costs as either controllable by the manager or uncontrollable s Ideally, managers should be held responsible only for costs they can control or significantly influence continued Copyright 2003 Mc. Graw-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 Copyright 2003 Mc. Graw-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

Costs across the value chain s 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 s Provides a useful framework for examining the areas where costs are incurred within a business continued Copyright 2003 Mc. Graw-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 s Upstream costs ÙResearch and development costs include the costs involved in developing new products and processes ÙDesign costs include the costs associated with designing a product or production process ÙSupply costs are the cost of sourcing and managing incoming parts, assemblies and supplies continued Copyright 2003 Mc. Graw-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 s Production costs ÙThe costs incurred to collect and assemble the resources used to produce a product or service s Downstream costs ÙMarketing costs are the cost of selling products and the cost of advertising and promotion ÙDistribution costs are the cost of storing, handling and shipping finished products ÙCustomer service costs are the costs of serving customers, including after-sales service Copyright 2003 Mc. Graw-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

Copyright 2003 Mc. Graw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective

Manufacturing costs s Manufacturing costs are incurred within the factory area, whereas upstream and downstream costs are sometimes called non -manufacturing costs s Manufacturing costs include three categories: direct material, direct labour and manufacturing overhead ÙThis classification assumes that products are the relevant cost objects continued Copyright 2003 Mc. Graw-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

Manufacturing costs s Direct material ÙMaterial that is consumed in the manufacturing process ÙPhysically incorporated into the finished products; and ÙCan be traced to products conveniently s Direct labour ÙThe cost of wages and labour on-costs of staff who work directly on manufacturing a product ÙHowever, contractual arrangement sometimes means that such labour is a committed cost continued Copyright 2003 Mc. Graw-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

Manufacturing costs s Manufacturing overhead ÙAll manufacturing costs other than direct material and direct labour ÙAlso called indirect manufacturing costs or factory burden ÙIncludes the cost of indirect material and indirect labour, depreciation and insurance on factory equipment, utilities and the costs of manufacturing support departments ÙAlso includes cost of overtime premium and idle time continued Copyright 2003 Mc. Graw-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

Manufacturing costs s Conversion costs ÙThe total of direct labour and manufacturing overhead costs ÙThe cost of converting material into product s Prime costs ÙThe total of direct material and direct labour costs ÙThe major cost associated with producing a product continued Copyright 2003 Mc. Graw-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

Manufacturing costs s Contemporary costing systems analyse costs in greater detail than under conventional costing systems ÙLabour costs, and upstream and downstream costs may be classified within an activity framework s In general, direct material tends to be the largest proportion of manufacturing cost, and direct labour costs the smallest Copyright 2003 Mc. Graw-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

Product costs s Managers need estimates of product costs for different purposes s In financial accounting reports ÙTo determine cost of goods sold ÙTo value inventory on hand s For decision making ÙDefinitions of product costs that include nonmanufacturing costs may be used Copyright 2003 Mc. Graw-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

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 Mc. Graw-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 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 Mc. Graw-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 manufacturing business s Raw materials, work in processes and finished goods inventories balances are found in the Statement of Financial Position s s 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 Mc. Graw-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 and benefits of information s Must determine which cost concepts are most appropriate in each situation s Benefits of measuring and classifying costs can be realised through improvements in the quality of managers’ decisions s Information overload occurs when managers receive more information than they can use efficiently Copyright 2003 Mc. Graw-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