SUMMARY BEC ACCOUNTING
DRURY, CHAPTER 1: INTRODUCTION TO MANAGEMENT ACCOUNTING
Accounting can be defined as the process of identifying, measuring and communicating economic information
to permit informed judgements and decisions by users of the information. So it is concerned with providing
both financial and non-financial information that will help decision-makers to make good decisions.
There are many different users of accounting information, both internal users within the organisation, as well
as external users such as shareholders, creditors and regulatory agencies, outside the organisation.
DIFFERENCES MANAGEME NT AND FINANCIAL ACC OUNTING
It is possible to distinguish between two branches of accounting, which reflect the internal and external users
of accounting information.
Management accounting Financial accounting
Definition Concerned with the provision of Concerned with the provision of
information to people within the information to external parties outside
organisation to help them make better the organisation (external reporting).
decisions and improve the efficiency and
effectiveness of existing operations.
Users Internal External
Legal requirements Entirely optional Statutory requirement
Focus Often individual parts Whole of the business
Accounting principles Serving management’s needs Generally accepted principles
Time History and future History
Frequency Regular and ad hoc Regular
Detail High Low
Goals - Cost allocation for inventory - True and fair view on financial
valuation and profit measurement position that is uniform and
- Relevant information for decision consistent
makers/managers - Decision making of external
- Information for planning, control stakeholders
and performance management
Cost measurement for different purposes:
- Costs: sacrifices of assets which are unavoidable, measurable and foreseeable
- Cost price: costs per unit output
- Data gathering for decision-making:
o Long run decisions: integral cost price, but also in relation to strategy
o Short run decisions: differential costs or variable costs
THE DECISION -MAKING PROCESS
The first four stages represent the decision-making or planning process. The final two stages represent the
control process (the process of measuring and correcting actual performance to ensure the alternatives that
are chosen and the plans for implementing them are carried out.
1. Identify objectives (aim or direction).
» Maximise/create profit, create employment, market position, continuity, environment, etc.
2. Search for alternative courses of action (possible course of action => strategy).
» Anshoff’s matrix:
» Developing new products for sale in existing markets: product development
» Developing new products for new markets: product diversification
» Developing new markets for existing products: market development
3. Select appropriate alternative courses of action. The alternatives should be evaluated to identify
which course of action best satisfy the objectives of an organisation.
4. Implementing of the decisions
» The budget is the financial plan for implanting the decisions that management has made.
, » The master budget is a single unifying statement of an organisation’s expectations for future
periods comprising budgeted profit and cash flow statements.
5. Comparing actual and planned outcomes.
» To monitor performance, the accountant produces
performance reports and presents them to the
managers who are responsible for implementing
the various decisions. These reports compare actual
outcomes (actual costs and revenues) with planned
outcomes (budgeted costs and revenues).
» Management by exception is a situation in which
management attention is focused on areas where
outcomes do not meet targets.
6. Responding to divergences from plan
» Feedback loops link the stage 6 to stage 4, and stage 6 to stage 1/2.
IMPACT OF CHANGING B USINESS ENVIRONMENT ON MANAGEMENT ACCOUNTING
There are changes in the business environment that have an influence on management accounting systems:
Move from protected markets to highly competitive global markets (due to deregulation and
extensive competition)
Declining product life-cycles (due to intensive global competition, technological innovation, and
increasingly discriminating and sophisticated customer demand)
o A product’s life cycle is the period of time from initial expenditure on research and
development to the time at which support to customers is withdrawn.
Growth in service industry
Advances in manufacturing technologies
o Lean manufacturing systems: system that seek to reduce waste in manufacturing by
implementing just-in-time production systems, focusing on quality, simplifying processes and
investing in advanced technologies.
Impact of information technology
o E-business (the use of information and communication technologies to support nay business
activities, including buying and selling), e-commerce (the use of information and
communication technologies to support the purchase, sale and exchange of goods) and
internet commerce (the buying of selling of goods/services over the internet).
o One advanced IT application that has had a considerable impact on business information
systems is the enterprise resource planning system ERPS (a set of integrated software
application modules that aim to control all information flows within a company).
Environmental issues
Customer orientation
FOCUS ON CUSTOMER SA TISFACTION AND NEW MANAGEMENT APPROACHES
Key success factors that organisations must concentrate on to provide customer satisfaction:
Cost efficiency: keeping costs low and being cost efficient.
Quality: customers are demanding high-quality products and services. Total quality management
(TQM) is a customer-oriented process of continuous improvement that focuses on delivering products
or services of consistent high quality in a timely fashion.
Time as a competitive weapon: more emphasises on time-based measures, like cycle time (the length
of time from start to completion of a product or service). It consists of the sum of processing time,
move time, wait time and inspection time. Focusing on minimising cycle time by reducing time spent
on non-value added activities (activities that can be reduced or eliminated without altering the
product’s service potential to the customer).
Innovation and continuous improvement: innovate new products/service and have the capability to
adapt to changing customer requirements. Continuous improvement is an ongoing search to reduce
costs, eliminate waste and improve the quality and performance of activities that increase customer
value or satisfaction. Benchmarking is a mechanism for achieving continuous improvement by
measuring product, services or activities against those of other best performing organisation.
,MANAGEMENT ACCOUNTING AND ETHICAL BEHAVI OUR
The profit maximisation objective should be constrained by the need for firms to also give high priority to their
social responsibilities and ensure that their employees adopt high standards of ethical behaviour (behaviour
that is consistent with the standards of honesty, fairness and social responsibility that have been adopted by
the organisation). A code of ethics has now become an essential part of corporate culture. Guidelines of ethics
are concerned with ensuring that accountants follow fundamental principles relating to:
Integrity (being honest and not being a party to any falsification)
Objectivity (not begin biased or prejudiced)
Confidentiality and professional competence and due care (maintaining the skills required to ensure a
competent and professional service)
Compliance with relevant laws and regulations
FUNCTIONS OF MANAGEMENT ACCOUNTING
A cost and management accounting system should generate information to meet the following requirements:
1) Allocate costs between cost of goods sold and inventories for internal and external profit reporting
2) Provide relevant information to help managers make better decisions
3) Provide information for planning, control, performance measurement and continuous improvement
Financial accounting rules require that we match costs with revenues to calculate profits.
It is appropriate at this point to distinguish between cost accounting and management accounting.
Cost accounting is concerned with cost accumulation for inventory valuation to meet the requirements of
external reporting and internal profit measurement. Management accounting relates to the provision of
appropriate information for decision-making, planning, control and performance evaluation.
DRURY, CHAPTER 2: AN INTRODUCTION TO COST TERMS AND CONCEPTS
Accounting systems measure costs which are used for profit measurement and inventory (stock) valuation,
decision-making, performance measurement and control. The term cost is a frequently used word that reflects
a monetary measure of the resources sacrificed or forgone to achieve a specified objective.
A cost object is any activity for which a separate measurement of costs is desired. A cost object is the
‘something’ of which the users of accounting information want to know the cost.
The cost collection system typically accounts for costs in two broad stages:
1. It accumulates costs by classifying them into certain categories such as by type of expense of by cost
behaviour.
2. It then assigns these costs to cost objects.
Manufacturing organisations purchase raw materials from suppliers and convert these materials into tangible
products through the use of labour and capital inputs. This process results in manufacturing organisations
having the following types of inventory:
- Raw material inventories consisting of purchased raw materials in stock awaiting to be used
- Work in progress inventory consisting of partially completed products
- Finished goods inventory consisting off fully completed products that have not yet been sold
Merchandising companies have only finished goods as inventories.
Service organisations provide tasks or activities for customers; cannot be stored for future use.
DIRECT AND INDIRECT COSTS
Direct material costs represent those material costs that can be specifically and exclusively identified with a
particular cost object. In manufacturing organisations where the cost object is a product, physical observation
can be used to measure the quantity consumed by each individual product and the cost of direct materials can
be directly charged to them; direct materials become part of a physical product.
Direct labour costs are those labour costs that can be specifically and exclusively identified with a particular
cost object. Physical observation can be used to measure the quantity of labour used.
Indirect costs (‘overheads’) cannot be identified specifically and exclusively with a given cost object. They
consist of indirect labour, materials and expenses. In a manufacturing organisation, overheads can be classified:
Manufacturing overheads; all costs of manufacturing apart from direct labour and material
Administrative overheads; all costs associated with the general administration
Marketing (selling) overhead (order-getting/order-filling costs); all costs that are necessary to market
and distribute a product/service
,Prime cost consists of all direct manufacturing costs (i.e. direct material and direct labour costs).
Conversion cost is the sum of direct labour and manufacturing overhead costs; represents the cost of
converting raw materials into finished goods.
Direct costs can be traced easily and accurately to a cost object. In contrast, indirect costs cannot be traced to
cost objects. Instead, an estimate must be made of the resources consume by cost objects using cost
allocations. A cost allocation is the process of assigning costs when a direct measure does not exist for the
quantity of resources consumed by a particular cost object. Cost allocation involve the use of surrogate rather
than direct measures.
PERIOD AND PRODUCT C OSTS
For profit measurement and inventory/stock valuation purposes it is
necessary to classify costs as either product costs or period costs.
Product costs are those costs that are identified with goods
purchased or produced for resale.
Period costs are those costs that are not included in the inventory
valuation and as a result are treated as expenses in the period in
which they are incurred. Hence no attempt is made to attach period
costs to products for inventory valuation purposes.
Both costs are classified as expenses, the difference is the point in
time at which they are so classified.
COST BEHAVIOUR IN RELATION TO VOLUME OF ACTIVITY (FIXED AND VARIABLE COSTS)
Variable costs vary in direct proportion to the volume of activity; doubling the level of activity, will double the
total variable costs. Total variable costs are linear and unit variable costs are constant. Semi-variable costs /
mixed costs include both a fixed and a variable component.
Fixed costs remain constant over wide ranges of activity for a specified time period. They are not affected by
changes in activity. Total fixed costs are constant for all units of activity, however, unit fixed costs decrease
proportionally with the level of activity. Semi fixed costs / step-fixed costs are costs that remain fixed within
specified activity levels for a given amount of time but which eventually increase or decrease by a constant
amount at critical activity levels.
Over a period of several years, virtually all costs are variable.
RELEVANT AND IRRELEVANT COSTS AND REVENUES
For decision-making, costs/revenues can be classified to whether they are relevant to a particular decision.
Relevant costs and revenues are those future costs/revenues that will be changed by a decision.
Irrelevant costs and revenues are those that will not be affected by the decision.
In the short term, not all costs/revenues are relevant for decision-making.
AVOIDABLE AND UNAVOI DABLE COSTS
Avoidable costs are those that may be saved by not adopting a given alternative, whereas unavoidable costs
cannot be saved. Only avoidable costs are relevant for decision-making. The decision rule is to accept those
alternatives that generate revenues in excess of the avoidable costs.
SUNK COSTS
Sunk cost are costs that have been incurred by a decision made in the past and that cannot be changed by any
decision that will be made in the future. So it are the cost of resources already acquired where the total will be
unaffected by the choice made between various alternatives. Sunk costs are irrelevant for decision-making, but
not all irrelevant costs are sunk costs.
OPPORTUNITY COSTS
An opportunity cost is a cost that measures the opportunity that is lost or sacrificed when the choice of one
course of action requires that an alternative course of action is given up. Opportunity costs exist if resources
have alternative use and are scarce (e.g. time). Opportunity costs are not recorded in the accounting system
since they do not involve cash outlays.
Opportunity costs are of vital importance for decision-making. If no alternative use of resources exists, then the
opportunity cost is zero. But if resources have an alternative use (and are scarce) then they do exist.
, INCREMENTAL AND MARGINAL COSTS
Incremental costs (differential costs) are the difference between the costs of each alternative action that is
being considered. So it are the additional costs/revenues from the production or sale of a group of additional
units. Incremental costs can include both fixed and variable costs.
Marginal cost and revenue are similar in principle, but the main difference is that we only consider one
additional unit. So it are the additional costs/revenues from one extra unit of output.
THE COST AND MANAGEMENT ACCOUNTING INFORMATION SYSTEM
The management accounting information system should generate information for:
1) Profit measurement and inventory valuation
2) Decision-making
3) Planning, control of performance
Modern information technology allows a business to maintain a database with costs appropriately coded and
classified, so that relevant cost information can be extracted to meet each of the above requirements. A
suitable coding system enables costs to be accumulated by the required cost objects, and also to be classified
by appropriate categories of expense, and also by cost behaviour.
For inventory valuation in a manufacturing organisation, the costs of all partly completed products (i.e. work in
progress) and unsold finished products can be extracted from the database.
Future costs, rather than past costs, are required for decision-making, for example to anticipate price changes.
For cost control and performance measurement, cost and revenues must be traced to the individuals who are
responsible for incurring them. This system is known as responsible accounting (involves the creation of
responsible centres). A responsible centre is an organisation unit or part of a business for whose performance
a manager is held accountable. Responsible accounting enables accountability for financial results and
outcomes to be allocated to individuals throughout the organisation. Performance reports are generated by
extracting costs form the database and are produced at regular intervals for each responsibility centre.
DRURY, CHAPTER 3: COST ASSIGNMENT
In this chapter, the focus will be on the cost assignment system known as job-order costing system (a system
of assigning costs to products or services that is used in situations where many different products or services
are produced).
It is for management accounting important to know the unit costs (cost per unit), because of stock valuation,
planning and control, and decision-making on pricing and investment/replacement.
Cost assignment/cost allocation is the process of allocating costs when the quantity consumed by a particular
cost object cannot be directly measured:
» Allocating direct costs to a cost object is straightforward; direct cost tracing.
» Allocating indirect costs (overheads) to a cost object is harder
as they may be common to several cost objects
Cost allocations involve the use of surrogate rather than direct
measures. The basis that is used to allocate costs to cost objects is called
an allocation base or cost driver.
Cause-and-effect allocation or driver tracing: the use of an
allocation base that is a significant determinant of cost.
ᶥ Activity-based costing (ABC) systems; a subdivision of
absorption costing systems.
Arbitrary allocation: using a cost base that is not a significant determinant of cost.
ᶥ Traditional costing systems; a subdivision of absorption costing systems.
A direct costing system (marginal or variable costing system) assigns only direct costs to cost objects, whereas
an absorption costing system assigns both direct and indirect costs to cost objects.
