Summary
Summary Management Accounting
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Summary of Management Accounting from the BSC Economics and Business Economics (EBB846C05). This summary includes the lectures and examples.
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1. Why more Accounting?An accounting system is a formal mechanism for gathering, organizing, and communicating
information about an organization’s activities. Why another accounting course?
1. What are the Users, Purposes and Characteristics of Financial Accounting?
Financial accounting is a branch of accounting that produces for external decision-makers a
mandatory, periodic, standardized and synthetic financial representation of an organization’s
transactions with, as well as rights and duties towards, other constituencies.
It is produced for external users who need this information to decide whether or how they should
deal with the focal organization. The information is comparable, therefore, all firms should follow
the same set of rules to produce and communicate information. It aggregates transactions to a
highly comprehensive and synthetic representation of the organization.
2. What are the Limitations of Financial Accounting?
Every strength is a weakness. Financial accounting does not inform about transactions within the
organization. It lacks flexibility and local adaptation and also lacks in timeliness and future
orientation.
Managers need information which describes in adequate detail the operation they manage.
Managers make decisions every month, week or day. Therefore, managers need relevant
information which can be produced swiftly and “on the spot”.
3. What are the Users, Purposes and characteristics of Management Accounting?
Management accounting is a branch of accounting that produces for internal decision-makers
the financial and non-financial information they need, when they need it to make the best
possible use of available resources and achieve organizational or societal objectives.
For each kind of decision, management accounting helps managers on four occasions:
1. Attention direction: identification of challenges or opportunities on which managers
should focus;
2. Problem solving: the design of alternative courses of action to address these challenges
and seize these opportunities;
3. Alternative evaluation: the assessment of the economic consequences of implementing
each course of actions;
4. Decision making: the choice of the best course of action to achieve organizational goals
(effectiveness) without wasting resources (efficiency).
Since management accounting continuously assess the relation between decisions and their
consequences, it is also a very important tool supporting:
5. Organizational learning: information provided tells managers what works because it was
well implemented, what does not work because it was poorly implemented and what
does not work despite being well implemented.
Management accounting also serves the related purposes of:
6. Motivating, evaluating and rewarding or sanctioning performance: management
accounting information has important behavioral implications and shapes political
struggles within organizations. (left out of this book).
Management accounting emphasizes the absolute primacy of relevance. This means that any
information which does not help make a decision is seen as a distraction and thus purposefully
and systematically ignored, even eliminated. Management accounting relies heavily on
estimations as relevant information is not always available when it is needed.
Even when it is theoretically possible to obtain a more accurate information, if the cost of
increased accuracy exceeds its benefits, management accounting will keep producing a less
accurate information.
1
, 2. What is Costing?
1. Why do you need Costing and how does it work?
What are the Purposes of Costing?
A cost accounting system or costing system is a set of rules, methods and techniques used to
estimate the resources consumed to achieve specific goals.
Costing systems report numbers that indicate the manner in which particular products, services
or customers use the resources of an organization.
Resource allocation
Resources are limited and as a consequence, what some people consume to achieve some
goals becomes unavailable to others to achieve other goals. In such a context, two questions
are a source a major economic, ethical and political challenges: 1) is a specific goal worth the
resources required for this achievement? 2) is there no better use for the resources it takes?
What some goals are worth is not always obvious and becomes the object of intense political
debates, even wars. As for the resources consumed to make a product or provide a service,
they are not easy to estimate either. What is really consumed to achieve a goal, its “true cost”,
can be very difficult to assess accurately and exhaustively. But this is crucial to avoid wasting
resources on less valuable endeavors and diverting them away from the most valuable one.
Process optimization
A well designed cost system also helps managers make the best possible use of resources once
they have been allocated just by providing a good representation of resource flows within the
organization. First, making managers aware of the resources they consume to achieve specific
objectives gives them an incentive to avoid waste. Seconds, costing provides the means to
compare the efficiency of different practices or different units and thus allows benchmarking and
orient sourcing decisions. Third, well designed cost systems also show managers how they can
control costs by managing their causes. Cost information can therefore motivate and orient
efforts to improve process efficiency.
Asset valuation
A cost accounting system is also necessary to value the inventory in the balance sheet, the
costs of goods sold in the income statement, or long-term assets which are produced by the
company for itself.
What are the different steps of Product Costing?
The first step of any costing process is to decide the cost of what you want to know, i.e. the cost
object. Cost objects can be products, services, pieces of equipment, distribution channels,
customer segments, individual customers, territories, outlets, product divisions, functions or
departments.
A cost object is anything for which decision-makers desire a sperate measurement of costs.
Once the cost objects have been decided, cost must be recognized and accumulated.
Management accounting is then more interested in what the transaction was made for, the
purpose, destination or usage of this resource. It is this purpose which justifies (or not) the
acquisition and the consumption of the resource in the first place.
Therefore, when either financial or management accountants receive or produce a source
document attesting of a transaction, they give it a code which does not only tell the nature of the
transaction, but also its purpose. This process is called cost accumulation.
A source document is an explicit evidence of a transaction, such as sales slips, purchase
invoices, and employee time records.
2
,Cost accumulation is the collection of costs in an organized way through an accounting system.
It consists in collecting costs and classifying costs based on a predefined set of categories
indicating their nature and purpose.
For asset valuation, financial accounting serves as the basis for cost accumulation.
The whole process of costing consists then in progressively dividing the flow of accumulated
costs into various streams and channeling these streams towards the cost objects consuming
these resources. In other words, costing models of the journey of resources within the
organization until they leave it, i.e. until they are once again captured by financial accounting
because they are either exchanged with a third party or lost.
The process of costing for inventory valuation involves several steps. First, costs are classified
based on whether they follow products in the inventory. Then they are classified based on
whether they can unambiguously be assigned to a specific product. Costs which should follow
products in the inventory and can be assigned unambiguously to a specific product are traced
directly to that product. However, costs which should follow products in the inventory but cannot
be assigned unambiguously to a specific product must be allocated.
Cost assignment consists in associating costs with the cost objects for which the resources
were consumed. It is the general term which encompasses both cost tracing and cost allocation.
Cost tracing consists in assigning direct manufacturing costs incurred unambiguously for a
specific cost object to that cost object.
Costs allocation consists in assigning indirect manufacturing costs to cost object in proportion to
the cost object’s use of another resource.
Cost allocation is “a process in the process” and involves itself several steps.
The flow of indirect manufacturing costs is subdivided into streams which are
poured in separate cost pools where they wait for allocation. An allocation
base must be chosen for each cost pool and then allocation rates can be
computed. Only then can indirect manufacturing costs be allocated from cost
pools to cost objects proportionally to their use of the allocation base.
Once direct manufacturing costs have been traced and indirect manufacturing
costs allocated to products, the units produced and the corresponding
production costs are added to the inventory of each product. They stay there
until they are sold. Then, they go out of the inventory and expended as costs
of goods sold. By contrast, all the costs which cannot follow products in the
inventory are expended in the income statement as costs of the period in
which they were incurred.
2. How do you Recognize and Classify costs for Costing?
In this section the first three steps of the costing process will be addressed.
What is a Cost?
A cost is the value of a resource transformed, destroyed, sacrificed or forgone to achieve a
specific objective.
Fortunately, since we are computing costs primarily for asset valuation, we can rely on financial
accounting to determine what costs are.
i. What is a Cost for Financial Reporting?
3
, A relatively simple rule to follow to determine what is a cost from a financial accounting
perspective is to ask yourselves whether it changes the value of your assets in the current
period (time matters!) and will eventually impact equity through the income statement.
Note that the timing of the resource consumption matters.
ii. What are the other perspectives on Costs?
Conventions used for financial reporting often result in a disconnect between the book value of
an asset and its economic value. The latter is more difficult to assess. It has to be estimated and
financial accounting limits as much as possible its reliance on estimates. Another limitation of
financial accounting is that it only takes into account the costs for the focal company. What
economists call negative externalities are not accounted for.
A negative externality is a cost that is 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.
For instance, the social and environmental costs of providing poor working conditions or
polluting the environment are often not recorded in financial accounting because there is no
transaction with a third party to account for. The inclusion of externalities is only possible if we
disconnect from financial reporting purposes.
Environmental costs are the costs imposed by the organization on the environment.
How do you Classify Costs based on Inventoriability?
Among all the costs recognized and accumulated, some of them can be assigned to specific
products while other costs are too remote from products for the assignment to be meaningful.
i. What are Inventoriable Costs for Financial Reporting?
Once the costs incurred during the period have been identified and accumulated, the next step
of the costing process for asset valuation costs in separating costs following products in the
inventory and costs expended right away in the income statement.
Manufacturing costs are costs incurred to physically make products and which are therefore
assigned to these products and follow them in the inventory and then, when the products are
sold, in the cost of goods sold. (only costs that are inventoriable)
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.
All costs deemed necessary to ensure ongoing production are manufacturing costs. However,
all costs incurred to design products or production processes are period costs, and more
specifically upstream period costs. (incurred before production)
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.
All costs incurred to advertise, sell or deliver products to the customer as well as costs incurred
to administer the company are also period costs, and more specifically downstream period
costs. (incurred after production)
Selling costs include all costs that are incurred to secure customer orders and get the finished
product to the customer.
Administrative costs include all costs associated with the general management of an
organization rather than with manufacturing or selling.
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.
ii. What are the other possible definitions of Product Costs?
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