11

INTRODUCTION TO MANAGEMENT INTRODUCTION TO MANAGEMENT ACCOUNTINGACCOUNTING

DEFINITIONS OF ACCOUNTINGDEFINITIONS OF ACCOUNTING““The process of identifying, measuring and The process of identifying, measuring and communicating economic information to permit communicating economic information to permit informed judgements and decisions by users of the info”informed judgements and decisions by users of the info”

MANAGEMENT ACCOUNTINGMANAGEMENT ACCOUNTINGIs concerned with the provision of info to people within Is concerned with the provision of info to people within the organisation to help them make better decisions and the organisation to help them make better decisions and improve the efficiency and effectiveness of existing improve the efficiency and effectiveness of existing operationsoperations

FINANCIAL ACCOUNTINGFINANCIAL ACCOUNTINGIs concerned with the provision of information to Is concerned with the provision of information to external parties outside the organisationexternal parties outside the organisation

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DIFFERENCES BETWEEN MANAGEMENT DIFFERENCES BETWEEN MANAGEMENT ACCOUNTING AND FINANCIAL ACCOUNTINGACCOUNTING AND FINANCIAL ACCOUNTING

LEGAL REQUIREMENTSLEGAL REQUIREMENTS FA – statutory requirement for FA – statutory requirement for public listed copublic listed co

MA – entirely optionalMA – entirely optional

FOCUS ON INDIVIDUAL FOCUS ON INDIVIDUAL PARTS/SEGMENTS OF PARTS/SEGMENTS OF THE BUSINESSTHE BUSINESS

FA – the whole organisationFA – the whole organisation

MA – small part of orgMA – small part of org

GENERALLY ACCEPTED GENERALLY ACCEPTED ACCOUNTING ACCOUNTING PRINCIPLESPRINCIPLES

FA – prepared to confirm GAAPFA – prepared to confirm GAAP

MA – not required to adhere MA – not required to adhere GAAPGAAP

TIME DIMENSIONTIME DIMENSION FA – report what happened in FA – report what happened in the pastthe past

MA – concerned with future MA – concerned with future info & past infoinfo & past info

REPORT FREQUENCYREPORT FREQUENCY FA – detailed set of fin. FA – detailed set of fin. accounts (annually) less accounts (annually) less detailed (semi-annually)detailed (semi-annually)

MA – reports on various MA – reports on various activities (daily, weekly or activities (daily, weekly or monthly interval)monthly interval)

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THE DECISION-MAKING PROCESSTHE DECISION-MAKING PROCESS

Information produced by Information produced by management accountants must management accountants must be judged in the light of its be judged in the light of its ultimate effect on the outcome ultimate effect on the outcome of decisions, a necessary of decisions, a necessary precedent to an understanding precedent to an understanding of management accounting is an of management accounting is an understanding of the understanding of the decision-decision-making process making process

44

THE DECISION-MAKING, PLANNING & THE DECISION-MAKING, PLANNING & CONTROL PROCESSCONTROL PROCESS

1.1. Identify objectivesIdentify objectives

2.2. Search for alternative courses of Search for alternative courses of actionaction

Planning processPlanning process 3.3. Gather data about alternativesGather data about alternatives

4.4. Select alternative courses of actionSelect alternative courses of action

5.5. Implement the decisionsImplement the decisions

6.6. Compare actual and planned Compare actual and planned outcomesoutcomes

Control processControl process

7.7. Respond to divergences from planRespond to divergences from plan

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AN INTRODUCTION TO COST TERMS & AN INTRODUCTION TO COST TERMS & CONCEPTSCONCEPTS

Cost collection system typically Cost collection system typically accounts for costs in 2 broad stages:accounts for costs in 2 broad stages:

Accumulates costs by classifying Accumulates costs by classifying into certain categories e.g. labour, into certain categories e.g. labour, materials and overheads (or by cost materials and overheads (or by cost behaviour such as fixed and variable)behaviour such as fixed and variable)

Assigns these costs to cost objects Assigns these costs to cost objects

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COST TERMS AND CONCEPTSCOST TERMS AND CONCEPTS

Direct and indirect costsDirect and indirect costsPeriod and product costsPeriod and product costsCost behaviour in relation to volume Cost behaviour in relation to volume of activityof activityRelevant and irrelevant costsRelevant and irrelevant costsAvoidable and unavoidable costsAvoidable and unavoidable costsSunk costsSunk costsOpportunity costsOpportunity costsIncremental and marginal costsIncremental and marginal costs

77

DIRECT AND INDIRECT COSTSDIRECT AND INDIRECT COSTS

Direct CostsDirect Costs – – costs that costs that can be specifically and can be specifically and exclusively identified exclusively identified with a particular cost with a particular cost object (e.g. direct object (e.g. direct materials, direct labour, materials, direct labour, direct expenses)direct expenses)

Indirect CostsIndirect Costs – – cannot be cannot be identified specifically and identified specifically and exclusively with a given exclusively with a given cost object (indirect cost object (indirect materials, indirect materials, indirect labour, indirect expenses labour, indirect expenses = Manufacturing = Manufacturing overhead)overhead)

Direct materialsDirect materials xxxxxx

Direct labourDirect labour xxxxxx

PRIME COSTSPRIME COSTS xxxxxx

Manufacturing Manufacturing overheadoverhead

xxxxxx

TOTAL TOTAL MANUFACTURING MANUFACTURING COSTSCOSTS

xxxxxx

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PERIOD AND PRODUCT COSTSPERIOD AND PRODUCT COSTS

PRODUCT COSTSPRODUCT COSTS – – costs that are identified costs that are identified with goods purchased or produced for with goods purchased or produced for resale (in manufacturing org they are costs resale (in manufacturing org they are costs that the accountant attaches to the product that the accountant attaches to the product and included in the inventory valuation for and included in the inventory valuation for finished goods)finished goods)

PERIOD COSTSPERIOD COSTS – – costs that are not included costs that are not included in the inventory valuation and as a result in the inventory valuation and as a result are treated as expenses in the period in are treated as expenses in the period in which they are incurred (no attempt to which they are incurred (no attempt to attach the costs to products for inventory attach the costs to products for inventory valuation purposes) valuation purposes)

ALL COSTS

Direct Materials

Direct Labor

Manufacturing Overhead

Selling Expenses

Administrative Expenses

PrimeCosts

Product CostsManufacturing Costs

Period CostsNonmanufacturing Costs

99

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COST BEHAVIOURCOST BEHAVIOUR

VARIABLE COSTSVARIABLE COSTS –vary in direct proportion to the volume –vary in direct proportion to the volume of activity (e.g. short-term variable manufacturing – of activity (e.g. short-term variable manufacturing – d.material; non-manufacturing – sales commissions)d.material; non-manufacturing – sales commissions)

FIXED COSTSFIXED COSTS – remain constant over wide ranges of – remain constant over wide ranges of activity for a specific time period (e.g. depreciation of activity for a specific time period (e.g. depreciation of factory building, supervisors’ salaries)factory building, supervisors’ salaries)

SEMI-VARIABLE COSTSSEMI-VARIABLE COSTS – include both a fixed and a – include both a fixed and a variable component (e.g. cost of maintenance)variable component (e.g. cost of maintenance)

STEP FIXED COSTSSTEP FIXED COSTS – within a given time period they are – within a given time period they are fixed within specified activity levels, but they eventually fixed within specified activity levels, but they eventually increase or decrease by a constant amount at various increase or decrease by a constant amount at various critical activity levels critical activity levels

1111

VARIABLE COSTSVARIABLE COSTS

COST THAT VARY IN TOTAL DIRECTLY COST THAT VARY IN TOTAL DIRECTLY AND PROPORTIONATELY WITH CHANGES AND PROPORTIONATELY WITH CHANGES IN THE ACTIVITY LEVELIN THE ACTIVITY LEVEL

Eg: if level increases 10%, total variable Eg: if level increases 10%, total variable costs will increase 10%costs will increase 10%

COST PER UNIT AT EVERY LEVEL OF COST PER UNIT AT EVERY LEVEL OF ACTIVITY REMAINSACTIVITY REMAINS

1212

Total Variable Costs(Digital Clocks)

Unit Variable Costs(Digital Clocks)

0

20

40

60

COST

RM’000

Radios produced in (000)

2 4 6 0

5

10

15

20

2 4 6 8

Radios produced in (000)

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FIXED COSTSFIXED COSTS

COSTS THAT REMAIN THE SAME IN COSTS THAT REMAIN THE SAME IN TOTAL REGARDLESS OF CHANGES IN THE TOTAL REGARDLESS OF CHANGES IN THE ACTIVITY LEVELSACTIVITY LEVELS

Eg: property taxes, insurance, rent, Eg: property taxes, insurance, rent, supervisory salaries and depreciation on supervisory salaries and depreciation on buildings and equipmentbuildings and equipment

FIXED COSTS PER UNIT VARY INVERSELY FIXED COSTS PER UNIT VARY INVERSELY WITH ACTIVITY WITH ACTIVITY

1414

Total Fixed Costs(Digital Clocks)

Unit Fixed Costs(Digital Clocks)

0

20

40

60

COST

RM’000

Radios produced in (000)

2 4 6 0

5

10

15

20

2 4 6 8

Radios produced in (000)

1515

RELEVANT RANGERELEVANT RANGEIn most business situations, a straight-line variable In most business situations, a straight-line variable costs relationship does not exist for entire range of costs relationship does not exist for entire range of possible activity possible activity

At abnormally low levels of activity, impossible to be At abnormally low levels of activity, impossible to be cost effective – small scale operations – no qty cost effective – small scale operations – no qty discount discount

At abnormally high levels of activity, labour costs At abnormally high levels of activity, labour costs increase sharply – overtime pay; materials costs may increase sharply – overtime pay; materials costs may jump – excess spoilage caused by worker fatiguejump – excess spoilage caused by worker fatigue

Real world – the variable cost and changes in the Real world – the variable cost and changes in the activity level is often curvilinearactivity level is often curvilinear

1616

RELEVANT RANGERELEVANT RANGETotal fixed costs also do not have a straight-line Total fixed costs also do not have a straight-line relationship over the entire range of activityrelationship over the entire range of activity

Some fixed costs will not change but other might Some fixed costs will not change but other might changechange

Increased to a new fixed cost when the size Increased to a new fixed cost when the size increases increases

1717

LINEAR BEHAVIOR WITHIN RELEVANT LINEAR BEHAVIOR WITHIN RELEVANT RANGERANGE

1818

MIXED COSTSMIXED COSTS

SOMETIMES CALLED SEMIVARIABLE COSTSSOMETIMES CALLED SEMIVARIABLE COSTS

CONTAIN BOTH A VARAIBLE COST ELEMENT AND A CONTAIN BOTH A VARAIBLE COST ELEMENT AND A FIXED COST ELEMENTFIXED COST ELEMENT

MIXED COSTS CHANGE IN TOTAL BUT NOT MIXED COSTS CHANGE IN TOTAL BUT NOT PROPORTIONATELY WITH CHANGES IN THE PROPORTIONATELY WITH CHANGES IN THE ACTIVITY LEVELACTIVITY LEVEL

1919

BEHAVIOUR OF A MIXED COST

0

50

100

150

200

50 100 150 200

RM

COST

MILES

Total Cost Line

Variable Cost Element

Fixed Cost Element

2020

RELEVANT AND IRRELEVANT COSTS RELEVANT AND IRRELEVANT COSTS AND REVENUES AND REVENUES

RELEVENT COSTS AND REVENUESRELEVENT COSTS AND REVENUES – – those future costs and revenues that will those future costs and revenues that will be changed by a decisionbe changed by a decision

IRRELEVANT COSTS AND REVENUESIRRELEVANT COSTS AND REVENUES – – those that will not be affected by the those that will not be affected by the decisiondecision

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AVOIDABLE ,UNAVOIDABLE, SUNK & AVOIDABLE ,UNAVOIDABLE, SUNK & OPPORTUNITY COSTSOPPORTUNITY COSTS

AVOIDABLEAVOIDABLE – those costs that may be saved by – those costs that may be saved by not adopting a given alternativenot adopting a given alternative

UNAVOIDABLEUNAVOIDABLE – those costs that cannot be saved – those costs that cannot be saved

SUNK COSTSSUNK COSTS – the cost of resources already – the cost of resources already acquired where the total will be unaffected by the acquired where the total will be unaffected by the choice between various alternativeschoice between various alternatives

OPPORTUNITY COSTSOPPORTUNITY COSTS – a cost that measures the – a cost that measures the opportunity that is lost or sacrificed when the opportunity that is lost or sacrificed when the choice of one course of action requires that an choice of one course of action requires that an alternative course of action be given upalternative course of action be given up

2222

INCREMENTAL AND MARGINAL COSTS INCREMENTAL AND MARGINAL COSTS AND REVENUESAND REVENUES

INCREMENTAL (DIFFERENTIAL) COSTS AND INCREMENTAL (DIFFERENTIAL) COSTS AND REVENUESREVENUES – the differences between costs and – the differences between costs and revenues for the corresponding items under each revenues for the corresponding items under each alternative being consideredalternative being considered

MARGINAL COST AND REVENUESMARGINAL COST AND REVENUES – similar in – similar in principle to incremental and revenues, main principle to incremental and revenues, main difference is marginal cost/revenues represents difference is marginal cost/revenues represents the additional cost/revenue of the additional cost/revenue of one extra unitone extra unit of of output; incremental costs/revenues represents output; incremental costs/revenues represents the additional cost/revenue resulting from the additional cost/revenue resulting from a a group of additionalgroup of additional unitsunits of output of output

2323

INFORMATION TO DECISION-MAKINGINFORMATION TO DECISION-MAKING

COST-VOLUME-PROFIT ANALYSISCOST-VOLUME-PROFIT ANALYSISMEASURING RELEVANT COSTS AND MEASURING RELEVANT COSTS AND REVENUES FOR DECISION-MAKINGREVENUES FOR DECISION-MAKINGACTIVITY-BASED COSTINGACTIVITY-BASED COSTINGPRICING DECISIONS AND PRICING DECISIONS AND PROFITABILITY ANALYSISPROFITABILITY ANALYSISDECISION-MAKING UNDER DECISION-MAKING UNDER CONDITIONS OF RISK AND CONDITIONS OF RISK AND UNCERTAINTYUNCERTAINTYCAPITAL INVESTMENT DECISIONSCAPITAL INVESTMENT DECISIONS

2424

COST-VOLUME-PROFIT (CVP) ANALYSISCOST-VOLUME-PROFIT (CVP) ANALYSIS

A systematic method of examining the A systematic method of examining the relationship between changes in activity (i.e. relationship between changes in activity (i.e. output) and changes in total sales revenue, output) and changes in total sales revenue, expenses and net profitexpenses and net profit

CVP can be used to identify:CVP can be used to identify:

Break-even points (units, sales value, graph)Break-even points (units, sales value, graph) Units to be sold to obtain target profitUnits to be sold to obtain target profit Determine profit from the certain number of sold unitsDetermine profit from the certain number of sold units Selling price to be charged to obtain certain profitSelling price to be charged to obtain certain profit Additional sales units to meet additional costs Additional sales units to meet additional costs

(fixed/variable)(fixed/variable)

2525

MEASURING RELEVANT COSTS AND MEASURING RELEVANT COSTS AND REVENUES FOR DECISION-MAKING REVENUES FOR DECISION-MAKING

SPECIAL SELLING PRICE DECISIONSSPECIAL SELLING PRICE DECISIONS

PRODUCT-MIX DECISIONS WHEN PRODUCT-MIX DECISIONS WHEN CAPACITY CONSTRAINTS EXISTCAPACITY CONSTRAINTS EXIST

DECISIONS ON REPLACEMENT OF DECISIONS ON REPLACEMENT OF EQUIPMENTEQUIPMENT

OUTSOURCING (MAKE OR BUY) OUTSOURCING (MAKE OR BUY) DECISIONSDECISIONS

DISCONTINUATION DECISIONSDISCONTINUATION DECISIONS

2626

ACTIVITY-BASED COSTINGACTIVITY-BASED COSTING

The measurement of indirect relevant costs The measurement of indirect relevant costs for decision-makingfor decision-making

A comparison of traditional and ABC systems:A comparison of traditional and ABC systems:

Traditional – allocates overheads to Traditional – allocates overheads to production and service departments and production and service departments and then reallocates service departments costs then reallocates service departments costs to the production departmentsto the production departments

ABC systems – many activity-based cost ABC systems – many activity-based cost centres (known as cost pools) are centres (known as cost pools) are established established

2727

THE EMERGENCE OF ABC SYSTEMSTHE EMERGENCE OF ABC SYSTEMS

Companies produce a wide range of products; direct Companies produce a wide range of products; direct labour represents only a small fraction of total costs labour represents only a small fraction of total costs and overhead costs are of considerable importanceand overhead costs are of considerable importance

Simplistic overhead allocations using a declining Simplistic overhead allocations using a declining direct labour base cannot be justifieddirect labour base cannot be justified

Intense global competition – increased opportunity Intense global competition – increased opportunity cost of having poor cost information and the cost of having poor cost information and the decreased cost of operating more sophisticated cost decreased cost of operating more sophisticated cost systems, increased the demand for more accurate systems, increased the demand for more accurate product costsproduct costs

2828

DESIGNING ABC SYSTEMSDESIGNING ABC SYSTEMS

Identifying the major activities that take Identifying the major activities that take place in an organisationplace in an organisationAssigning costs to cost pools/cost centres Assigning costs to cost pools/cost centres for each activityfor each activityDetermining the cost driver for each major Determining the cost driver for each major activityactivityAssigning the cost activities to products Assigning the cost activities to products according to the product’s demand for according to the product’s demand for activitiesactivities

2929

PRICING DECISIONS AND PRICING DECISIONS AND PROFITABILITY ANALYSISPROFITABILITY ANALYSIS

Organisations that sell products/services Organisations that sell products/services that are highly customised/differentiated that are highly customised/differentiated from each other by special features, or who from each other by special features, or who are market leaders, have some discretion in are market leaders, have some discretion in setting selling pricessetting selling pricesPrice takers – firms have little or no Price takers – firms have little or no influence over the prices of their influence over the prices of their products/servicesproducts/servicesPrice setter – firms have some discretion Price setter – firms have some discretion over setting the selling price of their over setting the selling price of their products/servicesproducts/services

3030

PRICE TAKERS AND PRICE SETTERS PRICE TAKERS AND PRICE SETTERS (the cost information required)(the cost information required)

A price setting firm facing short-run pricing A price setting firm facing short-run pricing decisionsdecisionsA price setting firm facing long-run pricing A price setting firm facing long-run pricing decisionsdecisionsA price taker firm facing short-run product-A price taker firm facing short-run product-mix decisionsmix decisionsA price taker firm facing long-run product-A price taker firm facing long-run product-mix decisionsmix decisions

Pricing methods:Pricing methods: Cost-plus pricingCost-plus pricing Target costingTarget costing

3131

DECISION-MAKING UNDER CONDITIONS OF DECISION-MAKING UNDER CONDITIONS OF RISK AND UNCERTAINTYRISK AND UNCERTAINTY

The outcome of a particular decision may be affected The outcome of a particular decision may be affected by an uncertain environment that cannot be by an uncertain environment that cannot be predicted and single representative estimate does predicted and single representative estimate does not therefore convey all the information that might not therefore convey all the information that might reasonably influence a decisionreasonably influence a decision

Risk – applied to a situation where there are several Risk – applied to a situation where there are several possible outcomes and there is relevant past possible outcomes and there is relevant past experience to enable statistical evidence to be experience to enable statistical evidence to be produced for predicting the possible outcomesproduced for predicting the possible outcomes

Uncertainty – there are several possible outcomes Uncertainty – there are several possible outcomes but there is little previous statistical evidence to but there is little previous statistical evidence to enable the possible outcomes to be predicted.enable the possible outcomes to be predicted.

3232

CAPITAL INVESTMENT DECISIONSCAPITAL INVESTMENT DECISIONS

Decisions that involve current outlays in Decisions that involve current outlays in return for a stream of benefits in future yearsreturn for a stream of benefits in future yearsIt is a part of the capital budgeting process It is a part of the capital budgeting process which concerned with decision-making areas:which concerned with decision-making areas:

Specific investment projects the firm should Specific investment projects the firm should acceptaccept

Total amount of capital expenditure the firm Total amount of capital expenditure the firm should undertakeshould undertake

How the portfolio of projects should be How the portfolio of projects should be financedfinanced