Managerial Accounting Summary: Business Economics Ba2
Chapter 1: Managerial Accounting, the Business Organization, and Professional Ethics
1. Financial accounting vs managerial accounting
Financial accounting -> develops information for external decision makers, such as stockholders, suppliers, banks and government regulatory
agencies to inform them about the finances of the company, looks at the company as a whole.
Output = financial statements: the income statement, the statement of stockholders’ equity, the balance sheet, the statement of cash flows.
Relevant and faithfully representative information and focus on the past e.g. 2017 actual performance reported in 2018.
Required to follow Generally accepted accounting principles (GAAP)
Managerial accounting -> produces information for managers within an organization or internal decision makers who direct and control
operations, tools to make decisions needed to be successful and to run the business better. Less precision than financial statement, depends on
the information that the manager needs -> detailed reports prepared on parts of the company (products, departments) on daily/weekly basis.
Relevant information and focus on the future e.g. 2018 budget prepared in 2017.
Not required to follow GAAP
2. Roles of Accounting Information
1) Decision Making: Decisions range from the routine (setting daily production schedules) to
the non-routine (launching a new product line)
2) Planning and Controlling:
Planning refers to setting objectives for an organization and outlining how it will
attain them.
Controlling is monitoring the day-to-day operations and keeping the company on
track (evaluating the results of the plans by comparing the actual results to the
expected results or the budget).
Management by exception: Concentrating on items for which actual amounts differ significantly from budgeted amounts and ignoring areas that
appear to be running smoothly.
U = unfavourable, actual costs exceed the budget and F = favourable, actual costs are less than the budget
Accounting systems: A are formal mechanisms for gathering, organizing, and communicating information about an organization’s activities
Cost-benefit balance: the value of a system must be seen as exceeding its cost.
Behavioural implication: managers should also consider behavioural implications, that is, the system’s effect on employees decisions and
behaviour.
3. Planning and Control for Product Life Cycles and the Value Chain
Product life cycles range from a few months (clothing) to many years (autos). Some products, such as many computer software packages, have
long development stages and relatively short market lives, others such as airplane have a market life many times longer than their development
stage. Many companies are working to shorten the product development phase: to reduce the time which a product generates no revenue and to
bring products to market on a more timely basis.
At each stage, managers face differing costs and potential returns: in the planning process, managers must determine revenues and costs over the
entire life cycle. Throughout the life cycle: accounting also needs to track actual costs and revenues. Periodic comparisons between planned costs
and revenues and actual costs and revenues allow managers to assess the current probability of a product, determine its current life-cycle stage
and make any needed changes in strategy.
Example -> substantial development costs and no revenue during the product development stage. Most of the revenues from the product will be
received during the introduction and mature market stages when there will also be
production costs. During the phase-out of the product, there will be a little revenues =>
thus, the product pricing strategy must recognize the need for revenues during the
introduction and mature market stages to cover both development and phases-out costs as
well as the direct costs of producing the drug.
4. Basic organizational structure
Owners of an organization (shareholders) select the board of directors -> they decide on
the overall decisions but for the day-to-day operations they select the management.
Line managers -> are directly involved with making and selling the organization’s products
or services (green)
Staff positions -> are advisory, they support the line managers (blue).
5. Accountings’ position in the organization
The role of management accountants in organizations has changed rapidly over the last decades: they are spending less time on collecting and
compiling information and preparing standardized reports. They spend more time on interpreting and analysing information, being involved in
decision making.
Chief Financial Officer (CFO)
Controller Functions: Planning for control, reporting and interpreting, evaluating and consulting, tax administration, government
reporting, protection of assets, economic appraisal.
Treasurer Functions: Provision of capital, investor relations, short-term financing, banking and custody, credits and collections,
investments, risk management.
A certified Management Accountant (CMA) is a professional certification credential in the management accounting and financial fields. They must
pass an examination covering financial planning, performance and control and financial decision making. They have expertise in financial
accounting and strategic management, allowing them to make business decisions for their employer based on financial information -> CPA
designation is the internal accountant’s counterpart to the CPA.
A CPA (Certified Public Accountant) -> main jobs in public accounting: auditing client financial statement and issuing an opinion of statements.
,6. Expanding and changing role of management accounting
Today, 3 major business trends are influencing management
accounting:
1) Management accounting has expanded from its traditional base in
manufacturing to service or non-profit firms -> Service sectors differs
from the manufacturing sector -> Labour Is a major component of
costs in service firms, the output is usually difficult to measure,
service organizations cannot store their major inputs and outputs.
2) The changing Business Environment -> competition has become
global and pace of innovation has accelerated, poor management
accounting system hinders the best efforts of people in an organization to make the firm truly competitive, enterprise resource planning (ERP)
systems = integrated information systems that support all functional areas of a company (accounting).
3) Changes in business process management -> some companies implement sweeping changes in operations through business process
reengineering, these business process changes affect management accounting because they all directly affect costs.
7. Professional and Business Ethics
Besides technical competence, a code of ethics is an important aspect of being a professional accountant: to maintain their professional
competence, preserve the confidentiality of information, act with integrity and credibility
It is important for accountants to have integrity -> users cannot see the quality of accounting information, they rely on integrity of accountants to
assure integrity of information. If you cannot trust information, it is worthless.
8. Chapter summary
Management accounting assists managers in carrying out their responsibilities, which include 1) planning, 2) directing and motivating, 3)
controlling, and 4) decision making.
Since management accounting is geared to the needs of the manager rather than to the needs of outsiders, it differs substantially from financial
accounting. Management accounting is oriented more towards the future, places less emphasis on precision, emphasizes segments of an
organization (rather than the organization as a whole), is not governed by generally accepted accounting principles, and is not mandatory.
Most organizations are decentralized to some degree. The organization chart depicts who works for whom in the organization and which units
perform staff functions rather than line functions. Accountants perform a staff function – they support and provide assistance to others inside the
organization.
The business environment in recent years has been characterized by increasing competition and a relentless drive for continuous improvement.
Several approaches have been developed to assist organizations in meeting these challenges, including just-in-time (JIT), total quality management
(TQM), and the theory of constraints (TOC).
Ethical standards serve a very important practical function in an advanced market economy. Without widespread adherence to ethical standards,
the economy would slow down dramatically. Ethics are the lubrication that keeps a market economy functioning smoothly.
Chapter 2: An Introduction to Cost Terms, Concepts and Classifications
1. General cost classifications
A cost is a sacrifice or giving up of resources for a particular purpose, the amount the
company incurs to acquire goods or services. Price is the amount the company charges
the customer for goods or services.
Costs can be classified into different categories, depending on their purpose (making
decisions), they are not mutually exclusive.
How costs are classified also depends on the type of business the company engages in:
A service company: A company that sells services- times, skills and knowledge
instead of firms. They don’t carry inventory e.g. Law firm, cleaning companies.
A merchandising company: a company that resells products previously bought from suppliers e.g. Supermarket, shoe/Clothing store.
A Manufacturing company: a company that uses labour, equipment, supplies and facilities to convert raw materials into other goods
e.g. Coca-Cola, Danone, Audi.
Management accounting is as applicable to one type of organization as to another. We consider the cost characteristics of a variety of
organizations, our initial focus are manufacturing companies since their basic activities include most of the activities found in other types of
business organizations.
2. Different costs
Direct materials (DM) -> the raw materials that are converted into the finished
product and whose costs are easily traced to the finished product. E.g. iron castings,
aluminium
Indirect materials -> the raw materials used in production that are difficult or not
cost effective to trace to the finished product => Manufacturing overhead e.g. Glue,
blots, screws, screwdriver, hammer, other tools.
Direct Labour (DL) -> the cost of wages and salaries of employees who convert the raw materials into the finished product. Direct labour is a direct
cost that can be easily traced to the finished product e.g. wages of machine operators and assemblers.
Indirect Labour -> the cost of labour in the factory for persons not directly producing the product the product the labour costs. Indirect labour
cannot be easily be traced to the finished product -> manufacturing overhead e.g. Wages of the Janitor, Salary of the supervisor who does not
actually work on a physical product.
Manufacturing Overhead (Factory overhead, indirect manufacturing costs) -> are manufacturing costs that cannot easily and cost-effectively
traced to a finished product -> it includes all manufacturing costs expect direct materials and direct labour. E.g. of other indirect manufacturing
costs -> Factory rent, factory depreciation, factory utilities)
Non- manufacturing costs:
, Selling costs: costs that are incurred to secure customer order and get the finished product to the customer e.g. Advertising, shipping,
sales travel, sales commissions, sales salaries.
Administrative costs: costs associated with the general management of an organization rather than with manufacturing or selling e.g.
executive compensation, general accounting, secretarial, public relations, general administration.
Prime cost: combine the direct costs of direct materials and direct labour -> the primary costs in a labour-intensive manufacturing process.
Conversion costs: combine direct labour with manufacturing overhead -> the primary costs in a machine-intensive manufacturing process.
Product costs: costs identified with products manufactured or purchased for resale e.g. direct material costs, direct labour and indirect production
costs. Period costs: become expenses during the current period without becoming part of inventory, associated with nonproduction value-chain
function (R&D, marketing, distribution, insurance).
Matching principle: Costs should be recognized as expenses in the same period in which the related revenues are recognized. E.g. when you make
a cost in order to make tomato soup (product cost), that cost (soup) remains in the balance sheet (inventory) until its sold, so when you get a
revenue, then the cost is recognized as expenses (costs of goods sold) recorded in the income statement together with the revenue.
When the costs is not directly linked to a revenue then the cost should be recognized as expenses on the income statement in the period in which
it expires or is used up (so in the period when the company benefits from the cost) e.g. Insurance costs -> when the company pays insurance costs
in advance for 2 years, the entire amount is not considered an expense of the year in which the payment is made, one half of the costs are
recognized as an expense and recorded in the income statement each year because both years benefit from the insurance payment -> So, in year
1 one half is recognized as an expense and the other half stays on the balance sheet as pre-paid insurance and then in year 2, the other half is
recognized.
3. Cost classifications on financial statements
The financial statements prepared by a manufacturing company are more complex than the statements prepared by a merchandising company
because a manufacturing company must produce its goods as well as market them. The production process gives rise to many costs that do not
exist in a merchandising company and these costs must be properly accounted for on the manufacturing company’s financial statements.
A service firms sells their time and has no inventory A merchandising
company purchases merchandise from suppliers and sell it to customers
and has merchandise inventory (goods purchased from suppliers that are
awaiting resale to customers) on the balance sheet, manufacturing
company purchases raw materials and then convert it into finished good
and carry three separate inventory on the B/S: Raw material inventory
(materials waiting to be processed), work-in process inventory (partially
complete products, some material, labour or overhead has been added)
and finished goods inventory (completed products awaiting sale).
Balance sheet & income statement for manufacturing and merchandising
company.
4. Cost of goods sold
Begin balance (e.g. 20 cans of soup) + additions (more cans of soup) = Available inventory for sale – withdrawals (inventory sold) = ending balance
In merchandising company cost of goods sold = beginning merchandise inventory + purchases – Ending merchandise inventory.
In Manufacturing company cost of goods sold (cost of the finished goods inventory that has been sold) = beginning finished goods inventory + Cost
of goods manufactured – ending finished goods inventory.
COGM (cost of goods manufactured) = The manufacturing costs of the goods that finished the production process in a given accounting
period. The COGM includes the three elements of product costs -> direct labour, direct materials and manufacturing overhead (not all
manufacturing overhead is COGM cause some materials labelled overhead costs are related to a good that is not yet competed and
stored in the work-in process inventory).
1) Calculate the direct materials used (woods, planks): raw materials inventory -> Beginning Direct Materials + purchases of direct materials =
Direct Materials Available for use – Ending Direct Materials = Direct Materials used.
2) Calculate the total manufacturing costs incurred: direct materials used + Direct labour + Total manufacturing overhead = Total manufacturing
Costs incurred during the Year.
3) Calculate cost of goods manufactured: total cost of what was transferred out of work in process inventory and into finished goods inventory,
the work in process inventory -> Beginning WIP inventory + direct materials used + Direct labour + manufacturing overhead = total
manufacturing costs to account for – ending WIP inventory = Cost of Goods manufactured.
4) Calculate cost of goods sold: finished goods inventory -> Beginning FG inventory + Cost of goods manufactured = cost of goods available for
sale – ending FG inventory = Cost of Goods Sold.
Cost is a broad term that describes the amount paid for an activity, product or service and expenses denote the costs deducted from revenue on
an income statement in a given period.
All costs eventually become expenses, but they are not expenses until accountants deduct them from revenue in the income statement
Product manufacturing costs become an expense on an income statement (cost of goods sold) via the multistep inventory procedure
shown earlier. Selling and administrative costs become expenses immediately in all types of companies.
5. Cost classifications for predicting cost behaviour
, A cost may rise, fall or remain constant -> for planning purposes, the manager must be able to anticipate this. The level of business activity that
requires the use of resources and causes costs is measured through cost drivers.
Cost behaviour = is how the activities of an organization affect its costs, how a cost will react or respond to changes in the level of business activity
within and beyond the relevant range of activity.
Cost traceability: how easy it is to allocate a certain cost to an item produced
Cost driver (activity based) = Is a measure of activities that require the use of resources and thereby cause costs (for example: miles driven, beds
occupied, hours worked, units produced).
Variable costs = A cost that increases or decreases in total in direct proportion to changes in the level of activity (the cost driver): Labour
commissions, raw materials
Example: The number of car batteries increase as there is more output of cars.
Variable cost behaviour = The total variable cost increases proportionately as the number
of cars produced increases. Total variable costs fluctuate but variable costs per unit
remains constant (battery remains 24$ no matter how many there are)
Slope of the line ->
Fixed costs = A cost that remains the same in total, regardless of changes over wide
ranges of volume activity (the cost driver) e.g. rent of a machine. But these costs can
change due to other factors not related to the cost driver such as inflation or increase of
production -> cost of rent of a machine stays the same no matter how many tests are performed but as more tests are performed, the fixed cost
per test goes down (inversely related to changes in # tests -> downward sloping curve).
Fixed costs are only fixed over a relevant range. At some point, fixed capacity elements must be increased e.g. When more than 1000
tests are performed then the hospital must rent an additional machine.
Relevant range = is the range of activity within which the assumptions about variable and fixed
costs are valid.
A particular cost may be variable or fixed, depending on the cost driver
6. Cost classifications for assigning costs to costs objects
A cost is often traced/assigned to a cost object: a product, customer, department, activity etc.
Direct costs -> easily and cost-effectively traced to a cost object e.g. Gears from a bicycle
Indirect costs -> cannot easily and cost-effectively be traced to a cost object e.g. Glue, supervisor’s salary -> to be traced to a cost objects such as
a particular product, the cost must be caused by the cost object ( cost would not be there if it wasn’t for that product).
A cost may be direct or indirect depending on the cost object -> e.g. Salary of a soup factory manager is indirect if the cost object is tomato soup
because the entire manufacturing division process many different soups (salary cannot easily be traced to the tomato soup) and it is a direct cost if
the cost object is the entire manufacturing division -> the salary is determined by how the manufacturing division Is run instead of the product
costs.
Example: when the cost object is the BMW X5’s produced
Direct costs Indirect costs
Variable costs Tires used in the assembly of automobile Power costs at Spartanburg plant -> power
usage is metered only to the plant where
multiple products are assembled
Fixed costs Salary of supervisor on BMW X5 assembly Annual lease costs at Spartanburg plant ->
line Lease is for the whole plant, where
multiple products are produced.
7. Cost classification for decision making
Every decision involves choosing from among at least two alternatives. In business decisions, each alternative will have certain costs and benefits
that must be compared to the costs and benefits of the other available alternatives.
Differential cost and revenue -> A difference in costs and revenues between any two alternatives.
Opportunity Cost -> The potential benefit that is given up when one alternative is selected over another.
Sunk cost -> is a cost that has already been incurred and that cannot be changed by any decision made now or in the future.
8. Conclusion
We looked at how cost will be used for preparing external reports, predicting cost behaviour, assigning costs to cost objects or decision making.
Cost can be classified
1) For purposes of valuing inventories and determining expenses for the statement of financial position and the statement of profit or loss, Cost
are either assigned as product (=assigned to inventories and are considered assets until the products are sold) or period costs (= taken
directly to the statement of profit or loss as expenses in the period in which they are incurred).
2) For purposes of predicting cost behaviour- how costs will react to changes in activity: we have variable and fixed costs.
3) For purposes of assigning costs to cost objects such as products or department are classified as direct (= easily be traced to cost object) or
indirect (not easily traced to cost object).
4) For purposes of making decisions, the concepts of differential costs and revenues, opportunity cost and sunk cost.
Chapter 3: Cost Behavior
