Management accounting: cost terms and concepts

Chapter 2Management accounting: cost terms and concepts2-1Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithOutlineManagement accounting systemsEmphasis on costsCost classifications: different classifications for different purposesClassifying costs according to their behaviourDirect and indirect costsControllable and uncontrollable costsCosts across the value chainManufacturing costsCost flows in a manufacturing business2-2Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithManagement accounting systemsManagement accounting systems are tailored to an organisation’s needsComponents may include systems forCosting Budgeting Performance measurement Cost management Conventional versus contemporary approachesContemporary approaches developed in the 1990s in response to changes in the business environment2-3Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithCopyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith2-4Emphasis on costsWhy do management accountants pay so much attention to costs?Historic focus on production costs—to value inventory and cost of goods sold for external reportingReady availability of cost data within the transaction-based accounting systemImportance of cost information in managers’ decisionsNon-financial information assumes increased importance in contemporary management accounting systemsUsed to make decisions and manage various sources of customer value and shareholder wealth2-5Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithCost classifications: different classifications for different purposesBefore we classify costs, we need to consider how managers intend to use the informationDifferent costs and classifications are used for different purposesThe same cost can be classified in a number of ways depending on the intended use of the cost information2-6Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)Cost classifications: different classifications for different purposes (cont.)What are costs?Resources given up to achieve a particular objectiveIn financial accounting if the benefit extends beyond the current accounting period these costs are classified as assetsIf the benefit is used up in the generation of revenue, the costs are classified as expenseMeasured in monetary terms2-7Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithCopyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith2-8Classifying costs according to their behaviourManagers must understand how costs change as the level of activity in the business changesThe level of activity is the level of work performed in the organisationUnits produced, kilometres driven, hours workedVariable costsChange in total in direct proportion to a change in the level of activityFixed costsRemain unchanged in total despite changes in the level of activity2-9Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithDirect and indirect costsAn important function of management accounting is to measure the cost of cost objectsCost objects are the items for which management wants a separate measure of costsProducts, projects, contracts and departments are common cost objects in conventional costing systemsContemporary costing systems may also include activities and customers as cost objects2-10Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)Direct and indirect costs (cont.)Responsibility centresA responsibility centre is a unit of an organisation where the manager is held accountable for the unit’s activities and performanceThe costing system may measure the costs of managers’ individual areas of responsibilityCosts that can be traced to a particular responsibility centre are direct costs of that centreCosts that relate to responsibility centres but cannot be traced precisely to specific responsibility centres are indirect costs of those centres2-11Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)Direct and indirect costs (cont.)Product costsManufacturing costs that can be traced to products in an economic manner are direct product costsIndirect costs are manufacturing costs that cannot be traced to products in an economic mannerWhether a cost is classified as direct or indirect depends on the nature of the cost objectDo we wish to know the cost of a department, a product, a project, or an entire company?A cost can be a direct cost of one cost object and an indirect cost of another cost object2-12Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithControllable and uncontrollable costsManagers’ performance evaluation can be enhanced by classifying responsibility centre costs as either controllable by the manager or uncontrollableIdeally, managers should be held responsible only for costs they can control or significantly influenceSome costs are controllable in the long term but not in the short term2-13Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithCopyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith2-14Costs across the value chainThe value chainA set of linked processes or activities that begins with acquiring resources and ends with providing and supporting products and services that customers valueVarious cost classifications can be used within the upstream, downstream and manufacturing areasTo assign cost to products and to provide other information to help manage resources efficiently and effectively and to create value2-15Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)Costs across the value chain (cont.)Upstream costsResearch and development costs include the costs involved in developing new products and processesDesign costs include the costs associated with designing a product or production processSupply costs are the costs of sourcing and managing incoming parts, assemblies and supplies2-16Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)Costs across the value chain (cont.)Production costsThe costs incurred to collect and assemble the resources used to produce a product (i.e. goods or services)Downstream costsMarketing costs are the costs of selling products and the costs of advertising and promotionDistribution costs are the costs of storing, handling and shipping finished productsCustomer service costs are the costs of serving customers, including after-sales service2-17Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithCopyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith2-18Manufacturing costsManufacturing costs are incurred within the factory areaUpstream and downstream costs are non-manufacturing costsManufacturing costs include three categories: direct material, direct labour and manufacturing overheadThis classification as direct or indirect cost assumes that products are the relevant cost objectsUnder conventional product costing, only manufacturing costs are included in product costs2-19Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)Manufacturing costs (cont.)Direct material is -Consumed in the manufacturing processPhysically incorporated into the finished productsCan be traced to products convenientlyConsidered a variable costDirect labourThe cost of wages and labour on-costs for personnel who work directly on the manufacture of a productUsually treated as variable costs, however contractual arrangements sometimes mean that such labour is a committed cost and so does not vary with the level of production2-20Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)Manufacturing costs (cont.)Manufacturing overheadAll manufacturing costs other than direct material and direct labourAlso called indirect manufacturing costs or factory burdenIncludes the cost of indirect material and indirect labour, depreciation and insurance on factory equipment, utilities and the costs of support departments for manufacturingIncludes cost of overtime premium and idle time Manufacturing support departments do not work directly on producing products but are necessary for the manufacturing process to occur2-21Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)Manufacturing costs (cont.)Conversion costsThe total of direct labour cost and manufacturing overhead costThe cost of converting material into a productPrime costsThe total of direct material cost and direct labour costThe major cost associated with producing a product2-22Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)Manufacturing costs (cont.)Contemporary costing systems analyse costs in greater detail than conventional costing systemsOnly direct material may be classified as direct product costsLabour costs may be analysed as part of activity costs, as may some upstream and downstream costsIn many industries, direct material is the largest proportion of the manufacturing cost and direct labour costs are the smallest2-23Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithProduct costsManagers need estimates of product costs for different purposesIn financial accounting reportsProduct costs determine cost of goods soldProduct costs help value inventory on handAll costs that are not product costs are called period costsFor management decision makingDefinitions of product costs may include non-manufacturing costs associated with developing, producing and selling the product2-24Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithCopyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith2-25Cost flows in a manufacturing business1. Material is purchased: the cost is added to raw materials inventory2. Direct materials are consumed in production: cost is removed from raw materials inventory and added to work in process inventory Direct labour and manufacturing overhead are accumulated in work in process inventory2-26Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)Cost flows in a manufacturing business (cont.)3. Products are completed: costs are transferred from work in process inventory and added to finished goods inventory4. Products are sold: costs are transferred from finished goods inventory to cost of goods sold expense Cost of goods sold is deducted from sales revenue to determine gross profit2-27Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)Cost flows in manufacturing business (cont.)Raw materials, work in process and finished goods inventory balances are reported in the Balance SheetCost of goods sold expense can be found in the income statementThe schedule of cost of goods manufactured and schedule of cost of goods sold summarise the flow of manufacturing costs2-28Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithCopyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith2-29SummaryManagement accounting systems are tailored to an organisation’s needsCosting systems focus on the cost of products and organisational units and are a component of management accounting systemsWe can distinguish between conventional and contemporary management accounting systemsThere may be different costs for different purposesCosts may be classified by behaviour, traceability, controllability and function2-30Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)Summary (cont.)In manufacturing businesses, production costs typically consist of direct materials, direct labour and manufacturing overhead, in line with external reporting requirementsThe definition of product costs needed to support management decision making may be broader than that used for external reporting purposesProduct costing systems track the manufacturing costs from the beginning of production to finished goods and link the product costing system to the financial accounting reports2-31Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith