Session 9

Introduction to Management Accounting

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1. An Overview
 Financial Accounting

Reporting of the financial position and performance of

a firm through financial statements issued to external
users on a periodic basis.

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 Management Accounting

A discipline concerned with the preparation of

financial and related information used by
managers inside organizations to make
strategic, organizational and operational
decisions.

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 Comparison of Financial and Managerial
Accounting
Financial Accounting Managerial Accounting
1. Users External persons who Managers who plan for
make financial decisions and control an organization
2. Time focus Historical perspective Future emphasis
3. Verifiability Emphasis on Emphasis on relevance
versus relevance verifiability for planning and control
4. Precision versus Emphasis on Emphasis on
timeliness precision timeliness
5. Subject Primary focus is on Focuses on segments
the whole organization of an organization
6. GAAP Must follow GAAP Need not follow GAAP
and prescribed formats or any prescribed format
7. Requirement Mandatory for Not
external reports Mandatory

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 Planning

Establish Goals.

Specify How Goals

Will Be Achieved. Expressed in
formal
quantitative
terms

Develop Budgets.

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Controlling
The control function gathers feedback to
ensure that plans are being followed.

Feedback in the form of performance reports

that compare actual results with the budget
are an essential part of the control function.

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 Decision Making

Decision making involves

making a selection among
competing alternatives.

What should
we be selling?
Who should
we be serving?
How should
we execute?
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 Management Accounting

Cost Management
Management Control
Systems Systems

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 Cost Accounting

Cost accounting provides cost information

for both financial reporting
and management decisions.

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 Management Control System

Management control is the process by which managers

gather and use information to aid and coordinate the
planning and control decisions throughout an
organization and influence other members of the
organization to implement the organization’s strategies.

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2. Basic Cost Concepts
 Cost Classifications
 External uses
 For financial reporting purposes, product
cost is determined in a standard way.

 Internal uses
 Inside the organization costs serve many different
purposes, e.g., pricing, product mixing, etc. The way
the cost is to be used will define the way it should be
computed.

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 Types of Cost Classifications

Financial Predicting Cost

Reporting Behavior

Assigning Costs Making Business

to Cost Objects Decisions
 Cost Classifications for Financial
Reporting
According to financial reporting purposes, costs can be classified
into:
Product costs (also called Period costs include all
inventoriable cost) include selling costs and
direct materials, direct administrative costs.
labor, and manufacturing
overhead.

Inventory Cost of Good Sold Expense

Sale

Balance Income Income

Sheet Statement Statement
 Costs

Manufacturing Costs Non-Manufacturing Costs

(Product Costs) (Period Costs)

Direct Manufacturing
Manufacturing Costs Overhead R&D expenses;
Design expense;
Marketing;
Distribution;
After-sale;
All manufacturing
General
Direct Materials costs except direct
Administration
materials and direct
Direct Labor labor
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Manufacturing Costs

Direct Direct Manufacturing

Materials Labor Overhead

The Product
Direct Materials
Raw materials that become an integral
part of the product and that can be
conveniently traced directly to it.

Example: A radio installed in an automobile

 Direct Labor

Those labor costs that can be easily

traced to individual units of product.

“Touch labor”

Example: Wages paid to automobile assembly workers

 Manufacturing Overhead
Manufacturing costs that cannot be traced
directly to specific units produced.

Examples: Indirect materials and indirect labor

Materials used to support Wages paid to employees

the production process.
Examples: lubricants and
cleaning supplies used in the
automobile assembly plant.
who are not directly
involved in production
work.
Examples: maintenance
workers, janitors and
security guards.
 Classifications of Costs
Manufacturing costs are often
classified as follows:
Direct Direct Manufacturing
Material Labor Overhead

Prime Conversion
Cost Cost
Flow of Inventoriable Costs and Period
Costs in Manufacturing Company

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Schedule of Cost of Goods Manufactured of
a Manufacturing company
Cellular Products
Schedule of Cost of Goods Manufactured
For the Year Ended Dec 31, 2009 (in thousands)
Direct materials:
Beginning inventory, Jan 1, 2009 $11,000
Purchases of direct materials 73,000
STEP 1 Cost of direct materials available for use 84,000
Ending inventory, Dec 31, 2009 8,000
Direct materials used $76,000
Direct manufacturing labor 9,000
Manufacturing overhead costs:
Indirect manufacturing labor $7,000
Supplies 2,000
STEP 2 Heat, light, and power 5,000
Depreciation - plant building 2,000
Depreciation - plant equipment 3,000
Miscellaneous 1,000
Total manufacturing overhead costs 20,000
Manufacturing costs incurred during 2009 105,000
Beginning WIP inventory, Jan 1, 2009 6,000
STEP 3 Total manufacturing costs to account for 111,000
Ending WIP inventory, Dec 31, 2009 7,000
Cost of goods manufactured (to Income Statement) $104,000

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 Income Statement of a Manufacturing
Company

Cellular Products
Income Statement
For the Year Ended Dec 31, 2009 (in thousands)
Revenues $210,000
Cost of goods sold:
From Schedule of
Beginning finished goods inventory, Jan 1, 2009 $22,000
Cost of Goods
Cost of goods manufactured 104,000 Manufactured
STEP 4 Cost of goods available for sale 126,000
Ending finished goods inventory, Dec 31, 2009 18,000
Cost of goods sold 108,000
Gross margin (or gross profit) 102,000
Operating costs:
R&D, design, mktg., dist., & cust. -service cost 70,000
Total operating costs 70,000
Operating income $32,000

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Quick Check 
Which of the following costs would be
considered a period rather than a product cost
in a manufacturing company?
A. Manufacturing equipment depreciation.
B. Property taxes on corporate headquarters.
C. Direct materials costs.
D. Electrical costs to light the production
facility.
E. Sales commissions.
Quick Check 
Which of the following costs would be
considered a period rather than a product cost
in a manufacturing company?
A. Manufacturing equipment depreciation.
B. Property taxes on corporate headquarters.
C. Direct materials costs.
D. Electrical costs to light the production
facility.
E. Sales commissions.
Quick Check 
Beginning raw materials inventory was $32,000.
During the month, $276,000 of raw material was
purchased. A count at the end of the month
revealed that $28,000 of raw material was still
present. What is the cost of direct material
used?
A. $276,000
B. $272,000
C. $280,000
D. $ 2,000
Quick Check 
Beginning raw materials inventory was $32,000.
During the month, $276,000 of raw material was
purchased. A count at the end of the month
revealed that $28,000 of raw material was still
present. What is the cost of direct material
used? Beg. raw materials $
A. $276,000 + Raw materials
purchased
B. $272,000 = Raw materials available
for use in production $
C. $280,000 – Ending raw materials
inventory
D. $ 2,000
= Raw materials used
in production $
Quick Check 
Direct materials used in production totaled
$280,000. Direct labor was $375,000 and
factory overhead was $180,000. What were
total manufacturing costs incurred for the
month?
A. $555,000
B. $835,000
C. $655,000
D. Cannot be determined.
 Quick Check 
Direct materials used in production totaled
$280,000. Direct labor was $375,000 and
factory overhead was $180,000. What were
total manufacturing costs incurred for the
month?
A. $555,000
B. $835,000 Direct Materials $ 280,000
C. $655,000 + Direct Labor 375,000
+ Mfg. Overhead 180,000
D. Cannot be determined.
= Mfg. Costs Incurred
for the Month $ 835,000
Quick Check 
Beginning work in process was $125,000.
Manufacturing costs incurred for the month
were $835,000. There were $200,000 of
partially finished goods remaining in work in
process inventory at the end of the month.
What was the cost of goods manufactured
during the month?
A. $1,160,000
B. $ 910,000
C. $ 760,000
D. Cannot be determined.
Quick Check 
Beginning work in process was $125,000.
Manufacturing costs incurred for the month
were $835,000. There were $200,000 of
partially finished goods remaining in work in
process inventory at the end of the month.
What was the cost of goods manufactured
during the month? Beginning work in
A. $1,160,000 process inventory
+ Mfg. costs incurred
$ 125,000

B. $ 910,000 for the period 835,000

C. $ 760,000 = Total work in process
during the period $ 960,000
D. Cannot be determined.
– Ending work in
process inventory 200,000
= Cost of goods
manufactured $ 760,000
Quick Check 
Beginning finished goods inventory was
$130,000. The cost of goods manufactured for
the month was $760,000. And the ending
finished goods inventory was $150,000. What
was the cost of goods sold for the month?
A. $ 20,000.
B. $740,000.
C. $780,000.
D. $760,000.
Quick Check 
Beginning finished goods inventory was
$130,000. The cost of goods manufactured for
the month was $760,000. And the ending
finished goods inventory was $150,000. What
was the cost of goods sold for the month?
A. $ 20,000.
B. $740,000.
$130,000 + $760,000 = $890,000
C. $780,000. $890,000 - $150,000 = $740,000
D. $760,000.
 Cost Classifications for
Internal Uses
 The term “cost” is a relative term, dependent both
on:
 the “cost object” chosen (anything of interest for
which a cost is desired)
 the purpose for which cost is being calculated and
reported.

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 Cost Object -- DELL
Specific Product Dell XPS 600

Project Promotional campaign

Product Category Laptop vs. Desktop

Activity Setting up a new assembly line

Department Customer service department

Region U.S., Asia, Europe

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 What Does Cost Mean?
 The way the cost is to be used will define the way it
should be computed.

 Suppose you are asked to compute the cost of flying one

person from Shanghai to Hong Kong. How do you get a cost
per person?

 Now suppose that you are told that the flight is going
anyway and you must compute the cost of adding one more
person on board. Would you use the same cost to make the
decision?

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Research &
Customer-
Development Design Production Marketing Distribution
Service
Cost Cost Costs Cost Costs
Costs

Product Cost
for Financial
Statements
(inventoriable
cost)

Product Costs for Reimbursement

under Government Contracts

Product Costs for Pricing and Product-Mix Decision

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 Cost Classifications for Predicting
Cost Behavior
According to cost-behavior pattern, costs can be classified into:

 Variable Costs: change  Fixed Costs: remain

in total in proportion to
changes in the related
level of activity or volume
Example: raw materials
unchanged in total
regardless of changes in the
related level of activity or
vs. volume
Example: supervision costs

Note: if activity increases or decreases significantly, cost relationships between

fixed/variable costs and activity level will probably change.
Relevant Range: the band of normal activity level or volume in which there is a
specific relationship between activity level or volume and the cost in question.

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 Cost Behavior Visualized

Variable Cost Behavior Fixed Cost Behavior

Direct Materials
Supervision
(in thousands)
Cost

$6,000
F = $48,000
4,800 VYV = $300X $48,000

3,600

2,400 24,000

1,200

4,000 8,000 12,000 16,000 20,000 4,000 8,000 12,000 16,000 20,000

Number of Computers Processed Number of Computers Processed

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 Cost Classifications for
Predicting Cost Behavior

Behavior of Cost (within the relevant range)

Cost In Total Per Unit

Variable Total variable cost changes Variable cost per unit remains
as activity level changes. the same over wide ranges
of activity.
Fixed Total fixed cost remains Average fixed cost per unit goes
the same even when the down as activity level goes up.
activity level changes.
Exercise: Variable Cost vs. Fixed Cost

Pizza Hut

 The cost of the ingredients used to make

the pizzas.
 Depreciation, property taxes, and property
insurance.
 Employee wages.
 Cost of electricity.

VC, FC, Semi-fixed, mixed (??)

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 Use Unit Costs Cautiously
Example: $40M of manufacturing costs are incurred in 2014 to
produce 500,000 cellular phones. The $40M costs consist of
$10M of fixed costs and $30M of variable costs?

 How much is the unit cost?

 How much will it cost for manufacturing one more cell
phone? $80?
 If the company receive a special offer and the buyer is
willing to pay $70 per unit. Will you as a manager accept
the offer?
 How much would the budgeted costs be for 2015 if the
expected production is 800,000 units? Is it (800,000*$80)?

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 Use Unit Costs Cautiously
Example: $40M of manufacturing costs are incurred in 2014 to
produce 500,000 cellular phones. The $40M costs consist of
$10M of fixed costs and $30M of variable costs?

 How much is the unit cost? $80?

 How much will it cost for manufacturing one more cell
phone? $60 (= 300M/0.5M)?
 If the company receive a special offer and the buyer is
willing to pay $70 per unit. Will you as a manager accept
the offer? Yes.
 How much would the budgeted costs be for 2015 if the
expected production is 800,000 units? Is it (800,000*$80)?
 NO. 800,000*60+10M=58,000,000.

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 Cost Classifications for Assigning
Cost to Cost Object
According to the methods used to assign costs to cost objects,
costs can be classified into:

 Direct Costs: can be  Indirect Costs: cannot be

conveniently and conveniently or economically
economically traced traced (tracked) to a cost
(tracked) to a cost object object. Instead of being
traced, these costs are
Vs. allocated to a cost object in a
Example: cost of steel and
tires for the BMW X5, rational and systematic
assembly line wages manner
Example: electricity, rent, property
taxes

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Cost Classifications for Decision Making

Alternative A

Alternative B

Only those costs and benefits that differ between

alternatives are relevant in a decision. All other costs
and benefits can and should be ignored. 46
Differential Cost and Revenue
Costs and revenues that differ
among alternatives.
Example: You have a job paying $1,500 per month in
your hometown. You have a job offer in a neighboring
city that pays $2,000 per month. The commuting cost
to the city is $300 per month.

Differential revenue is: Differential cost is:

$2,000 – $1,500 = $500 $300
 Opportunity Cost
The potential benefit that is given up
when one alternative is selected over
another.
Example: If you were not
attending college, you could be
earning $15,000 per year. Your
opportunity cost of attending
college for one year is $15,000.
 Opportunity Cost
 Opportunity cost vs. outlay costs
 Would you pay $1,000 for a ticket to Eason
Chan’s musical?
 If you were given the ticket free of charge, would
you go?

 Psychologists show:
 Many people have a tendency to treat opportunity
and outlay costs differently.
 e.g.., Holding Cost for Inventory (i.e., funds tied up in
inventory are not available for investment elsewhere) is
often ignored.
IMBA6033 Topic 4 Page 4-49
 Sunk Cost
Costs incurred in the past that cannot be
changed by present or future decisions.

A sunk cost is NOT relevant for making decisions.

 Sunk Costs
Sunk costs have already been incurred and
cannot be changed now or in the future.
These costs should be ignored when making
decisions.
Example: You bought an automobile that cost
$10,000 two years ago. The $10,000 cost is sunk
because whether you drive it, park it, trade it, or sell
it, you cannot change the $10,000 cost.
 Summary
 Financial reporting requirement
 Product (Inventoriable) cost
External Use
 Period cost
 Cost assignment method
 Direct cost
 Indirect cost
 Cost behavior
 Variable cost
Internal Use
 Fixed cost
 Decision relevance
 Relevant cost
 Irrelevant cost

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