Managerial accounting: end of chapter
summary
1. Part 1: An introduction to management accounting, cost terms and cost behaviour
A. Chapter 1: Managerial accounting, the business organization, and professional ethics
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.
B. Chapter 2: An introduction to cost terms, concepts and classifications
In this chapter, we have looked at some of the ways in which managers classify
costs. How the costs will be used – a) for preparing external reports, b) predicting
cost behaviour, c) assigning costs to cost objects, or d) decision making – will
dictate how the costs will be classified:
a) For purposes of valuing inventories and determining expenses for the
statement of financial position and the statement of profit or loss, costs are
classified as either product costs or period costs. Product costs are assigned to
inventories and are considered assets until the products are sold. At the point of
sale, product costs become cost of goods sold on the statement of profit or loss.
In contrast, following the usual accrual practices, period costs are taken directly to
the statement of profit or loss as expenses in the period in which they are
incurred.
o In a merchandising company, product cost is whatever the company paid for
its merchandise. In a manufacturing company, product costs consist of all
manufacturing costs. In both kinds of companies, selling and administrative
expenses are considered to be period costs and are expensed as incurred.
b) For purposes of predicting cost behaviour – how costs will react to changes in
activity – managers commonly classify costs into two categories – variable and
fixed. Variable costs, in total, are strictly proportional to activity. Thus, the variable
cost per unit is constant. Fixed costs, in total, remain at the same level for
changes in activity that occur within the relevant range. Thus, the average fixed
cost per unit decreases as the number of units increases.
c) For purposes of assigning costs to cost objects such as products or
departments, costs are classified as direct or indirect. Direct costs can
, conveniently be traced to the cost objects. Indirect costs cannot conveniently be
traced to cost objects.
d) For purposes of making decisions, the concepts of differential costs and
revenues, opportunity cost and sunk cost are of vital importance. Differential cost
and revenue are the cost and revenue items that differ between alternatives.
Opportunity cost is the benefit that is forgone when one alternative is selected
over another. Sunk cost is a cost that occurred in the past and cannot be altered.
Differential cost and opportunity cost should be considered carefully in decisions.
Sunk cost is always irrelevant in decisions and should be ignored.
These various cost classifications are different ways of looking at costs. A
particular cost, such as the cost of cheese in a cheeseburger, could be a
manufacturing cost, a product cost, a variable cost, a direct cost, and a differential
cost – all at the same time.
C. Chapter 3: Cost behaviour
The ability to predict how cost will respond to changes in activity is critical for
making decisions and for other major management functions. Three major
classifications of costs were discussed – variable, fixed and mixed. Mixed costs
consist of a mixture of variable and fixed elements.
There are five methods of analysing mixed costs that rely on past records of cost
and activity data – account analysis, the engineering approach, the high-low
method, the scatter graph approach, and least-squares regression. Unlike the
account analysis and the engineering approach, the high-low method, the scatter
graph method and the least-squares regression rely on the use of past cost data
to predict costs which is more objective.
The high-low method is the simplest of the three methods and can yield estimates
of fixed and variable costs very quickly, but it suffers from relying on just two data
points.
In most situations, the least-squares regression method should be used to derive
a cost formula, although the scatter graph method can also give good results. The
least-squares method is objective, and a variety of useful statistics are
automatically produced by most software packages along with estimates of the
intercept (fixed cost) and slope (variable cost per unit). Nevertheless, even when
least-squares regression is used, the data should be plotted to confirm that the
relationship is really a straight line.
2. Part 2: Producing costs
A. Chapter 4: Cost accounting and cost allocation
Cost management systems provide cost information for external financial
reporting, for strategic decision making, and for operational cost control.
Cost accounting systems provide cost information about various types of objects -
products, customers, activities, and so on. To do this, a system first accumulated
resource costs by natural classifications, such as materials, labour and energy.
Then, it assigns these costs to cost objects, either tracing them directly or
assigning them indirectly through allocation.
Cost allocation is a four-step process: 1) accumulate indirect costs in one or more
cost pools; 2) select an allocation base for each cost pool. There should be a
strong cause-and-effect relationship between cost-allocation bases and the
indirect costs; 3) determine the percentage of total cost-allocation base units for
each cost object; 4) multiply that percentage by the total costs in the cost pool to
determine the cost allocated to each cost object.
Some costs remain unallocated because the accountants can determine no
plausible and reliable relationship between resource and cost objects.
In this chapter, we developed a general framework for cost allocation: Companies
assign direct and indirect costs to various cost objects, including service
departments, producing departments, products, and customers. All organizations
