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Management accounting summary (IB RUG)
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A detailed summary of the relevant chapters of the online book of Management Accounting course.
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CHAPTER 2: WHAT IS COSTINGA cost accounting system or costing system is a set of rules, methods and techniques used to
estimate the resources consumed to achieve specific goals
QUIZ 1 - 2.1 WHY DO YOU NEED COSTING AND HOW DOES IT WORK?
● explain the purposes of costing;
I. Provide information guiding resource allocation
Is a specific goal worth the resources required for its achievement? Need to know value of the
goal and this is not clear in inefficient markets
Is there no better use for the resources it takes? Need to know value of resources consumed
- True cost is difficult to assess accurately and exhaustively but it is crucial to avoid
wasting resources → costing is a set of techniques designed to address this challenge:
II. Provide information guiding process optimization
Help make the best use of resources by providing a good representation of resource flows (how
faithfully these are represented determines the quality of the costing system:
1. Making managers aware of the resources they consume gives them an incentive to avoid
waste
2. Costing provides the means to compare the efficiency of different practices or units
allowing benchmarking and orienting sourcing decisions
3. Showing managers how they can controls costs by managing their causes
III. Used for asset valuation
Costing system then has to comply with International Accounting Standard or Generally
Accepted Accounting Principles - design choices indicated by financial reporting requirements
● describe the different steps of the costing process
Decide the cost of what you want to know: the cost object which is anything for which
decision-makers desire a separate measurement of costs
1. Recognition and accumulation of costs: collection of costs in an organized way
through an accounting system by classifying them based on a predefined set of
categories indicating their nature and purpose
a. A source document is an explicit evidence of a transaction which includes
a code with nature and purpose of the transaction
b. For asset valuation, FA is the basis for cost accumulation. Steps of costing
process for asset valuation:
2. Costs are classified based on whether they follow products in the inventory
(inventoriability); to prepare FA-like reports
a. If they can go in your inventory → manufacturing costs
, b. If they cannot go in your inventory → period costs
3. Costs are classified based on whether they can unambiguously be assigned to a
specific product (traceability); for economic and practical convenience, to
compute the total, final cost for the object
a. Can be assigned unambiguously to a specific product → direct costs
b. Cannot be assigned unambiguously to a specific product → indirect costs
These two classifications do not stand in isolation
4. Identification of cost pools where indirect manufacturing costs will wait for
allocation
5. Selection of allocation base for each cost pool
6. Computation of allocation rate
a. Only after these last three steps can indirect manufacturing costs be
allocated from cost pools to cost objects proportionally to their use of the
allocation base
7. Cost assignment consists in associating costs with cost objects:
a. (direct) cost tracing: assigning direct manufacturing costs to that cost
object
b. (indirect) cost allocation: assigning indirect manufacturing to cost object
in proportion to the cost object’s use of another resource
8. Valuation of inventory and COGS
a. Direct manufacturing costs: corresponding production costs are added to
inventory of each product where they stay until sold. When they go out of
inventory they are expended as COGS and revenue - COGS = gross margin
b. Period costs: expended in the income statement as costs of the period in
which they were incurred and gross margin - period costs = operating
income (which is the profit we are interested in in MA)
c. Then operating income - interest taxes = net income
,2.2 HOW DO YOU RECOGNIZE AND CLASSIFY COSTS FOR COSTING?
● recognize and accumulate costs;
A cost is the value of a resource transformed, destroyed, sacrificed or forgone to achieve a
specific objective. Since we are computing costs for asset valuation, we can rely on FA to
determine what costs are:
In FA, a cost is a consumption of resources resulting in a destruction of wealth and all
changes in wealth are ultimately recorded in the income statement → ask yourself
whether it changes value of assets in the current period (consumed not paid) and will
eventually impact equity (wealth invested by owners) through the income statement:
We are interested in when resources are consumed, which is when they should be recognized
and not when the cash flow happens.
Cost of period = payment in current period - payment for consumptions of prior periods
+ unpaid consumption of current period.
In FA negative externalities are not accounted for, these are costs that are suffered by a third
party as a consequence of the actions of the economic agent. They are destruction of resources
caused by the company but of which someone else (the society, the planet) bears the costs.
● classify costs based on their “inventoriability”;
Manufacturing costs (product costs) are costs incurred to physically make products
(manufacturing or production) and which are therefore assigned to these products and follow
them first in the inventory (balance sheet) and then, when the products are sold, in the COGS.
Period costs are costs incurred for purposes other than physically making products and which
therefore cannot follow them in the inventory. They are therefore expended during the
accounting period in the income statement.
a) Upstream period costs are period costs incurred to design products and production
processes as well as costs of installing production equipment before production can start
b) Downstream period costs or Selling, General and Administrative (SG&A) expenses are
period costs incurred after or next to the production process to advertise, sell and
deliver products, as well as general costs incurred to manage the company.
i) Selling costs: costs incurred to secure customer orders and get the finished
product to the customer
ii) Administrative costs: costs associated with the general management of an
organization rather than with manufacturing or selling
The nature of the cost does not matter, only the purpose of the cost matters in MA.
There are different views regarding product costs:
, Absorption costing is a stock costing method required for external reporting in which all
manufacturing costs are included as inventoriable costs. Product cost thus reflects the full costs
of manufacturing the product - for financial reporting purposes it is the dominant approach
Variable costing is a method of stock costing in which all variable manufacturing costs are
included as inventoriable costs. However, all fixed manufacturing costs are excluded from
inventoriable costs; they are considered as costs of the period in which they are incurred.
Grantt, Kaplan & Atkinson suggest a compromise between these two extremes:
They recommend assigning to the products the costs of the capacity effectively used during the
period rather than the cost of the capacity available and the remaining is identified as costs of
unused capacity; the resources consumed to provide in advance a capacity of production or
delivery and not used in the period during which these resources were available.
Broader definitions of product costs:
Full product costs are the sum of all the costs incurred to design, produce, sell, deliver and
eventually dispose of a product. This kind of cost is the product of life-cycle costing.
Costs of quality refers to the costs of prevention (cost incurred to reduce the likelihood
of defects), appraisal (cost incurred to detect non-conform and defective products),
non-conformance (to quality standards), internal failure (defects identified before
shipping) and external failure (incurred when a customer discovers a defect)
Use manufacturing costs to refer to all costs incurred to physically make a product and avoid
using the term product costs.
● classify costs based on their “traceability”
A direct cost is a resource consumed for a unique and well identified cost object, i.e. uniquely
and unequivocally attributable to this cost object, and which can thus be traced to this cost
object in an economically feasible way.
An indirect cost is a resource consumed by several cost objects and cannot be uniquely and
unequivocally attributed to a specific cost object because it is too costly or impossible to trace:
● Common cost are those which could be technically traced but are too expensive
○ Factors which influence judgment of whether it is too expensive to trace:
1. Materiality of the cost
2. Availability of information gathering technology
3. Design of operations
● Joint costs are those which cannot be technically traced, the point where the joint
products and by-products are separated from each other is the split-off point
○ Joint products are two or more products that have relatively significant sales
values and are not separately identifiable as individual products until they are
separated at the split-off point.
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