Management Accounting

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 and performance measurement.

Limitations of Financial Accounting It does not provide detailed cost information for

different departments, processes, products, jobs, different services and functions. It does not set up a proper system of controlling materials, supplies. It is difficult to know the behaviour of costs in financial accounting as expenses are not classified into fixed and variable, direct and indirect costs. It does not proved cost data to determine the price of the product being manufactured or the service being rendered to the consumers. It does not provide necessary information to management in taking important decisions about expansion of business, dropping of a product line, alternative method of production, buy or make etc.

Financial Accounting Vs. Cost Accounting A firm manufactures three products A, B and

C whose costs and revenue figures are given below: product A Total Materials 8000 Labour 5000 Other Expenses 3000 Sales 20000

Product B

Product C

7000

8000

23000

6000

4000

15000

4000 21000

3000 12000

10000 53000

Under Financial Accounting Materials Wages Other expenes Total cost Sales Profit

Rs. 23000 15000 10000 48000 53000 5000

Under Cost Accounting product A Product B Product C Total Material Wages Other exp. Total cost Sales Profit(loss)

8000 5000 3000 16000 20000 4000

7000 6000 4000 17000 21000 4000

8000 4000 3000 15000 12000 (3000)

23000 15000 10000 48000 53000 5000

Cost Accountancy Chartered Institute of Management Accountants,

London(CIMA) defines Cost Accountancy as “ the application of costing and cost accounting principles, methods and techniques to the science, art and practice of cost control and the ascertainment of profitability as well as presentation of information for the purpose of managerial decision making” Costing may be defined as “the techniques and process of ascertaining costs” Cost may be defined as (i) the amount of expenditure (actual or notional) incurred on or attributable to a given thing; or (ii) to ascertain the cost of a given thing.

Assignment -1 Lily Shultz is a junior majoring in hotel and

restaurant management. She wants to work for a large hotel chain with the goal of eventually managing a hotel. She is considering the possibility of taking a course in either financial accounting or cost management. Before choosing, however she has asked your to provide her with some information about the advantages that each course offers. Required: Prepare a letter advising Lily about the differences and similarities between financial accounting and cost management. Describe the advantages each might offer the manager of a hotel.

Financial Accounting and Cost Management information system  Classify each of the following actions as either being associated

with the financial accounting information system(FS) or the cost management information system:  Determining the future cash flows of a public corporation  Filing a corporate income tax report  Determining the cost of a product  Issuing annual financial statements  Reducing costs by improving quality  Preparing a performance report that compares actual costs with the budgeted costs.  Preparing financial statement that conform to GAAP  Determining the cost of a customer  Using cost information to decide whether to keep of drop or product  Using future expected earnings to estimate the price of a share of common stock  Using cost information to decide whether to make or buy a component.

Information for planning, controlling, continuous improvement and Decision making The cost and management accountant is

responsible for generating financial information required by the firm for internal and external reporting. This involves responsibility for collecting, processing and reporting information that will help management in their : Planning Controlling Continuous improvement Decision Making

Flexibility of the cost information system A member of the board of directors for Stillwater’s

Mission of Hope a non profit shelter for the homeless, asked his accountant how to value the building used as the shelter. In other words, what did it cost? The accountant’s answer was: why do you want to know? If you need to know the value for insurance purposes– to determine how much insurance to buy—then perhaps replacement cost would be the answer. If you are trying to set a price to sell the building (and build another elsewhere), then current market value of the real estate would be the answer. If you need the cost for the balance sheet, then historical cost is

Cost Centre Cost centre is a location, person or item of

equipment for which cost may be ascertained and used for the purpose of cost control. In other words any unit of the organisation to which cost can be separately attributed is called a cost centre. Types of cost centres: Personal cost centre: person or group of

persons Impersonal cost centre:location or item of equipment, department, a machine  Production cost centre: production departments

Classification of cost  On the basis of nature:  Material  Labour  Overhead or expenses

 On the basis of functions:  Production cost  Administration cost  Selling cost  Distribution cost  Research and Development cost

 On the basis of behaviour:  Fixed cost  Variable cost  Mixed or Semi-Variable or Semi-Fixed cost

On the basis of Management Decision Making Marginal Cost Differential Cost Opportunity Cost Imputed Cost Sunk Cost Relevant Cost Irrelevant Cost Explicit Cost Implicit Cost Avoidable cost Unavoidable Cost

Degree of Traceability Direct cost Indirect Cost

Association with the product Product Cost Period Cost

Basic cost terms:  Following are the descriptions of costs for a small-town café

(column A) and cost types (column B). The cost object is each meal served. A– Costs B—Cost Types 3. Cost of part-time workers(seasonal a. Variable cost fluctuations in breakfast and lunch trade) b. Semivariable 5. Rent of the café building c. Fixed cost 6. Cost of full-time workers 7. Cost of utilities (telephone, gas, electric) 8. Cost of a leased gas-powered grill 9. Cost of cooking ingredients

Marginal Cost

The increase in the total cost due to the

production of one additional unit in the total output is called the marginal cost. It comes basically due to the variable component of the cost of production or sales.

Differential Cost It is the difference of total cost between two

alternatives. For the production of a particular product any one of these two machines can be used:

Fixed Cost

Machine 1

machine 2

20000

18000

Differential Cost 2000

Opportunity Cost

It is the value of benefit sacrificed for

accepting an alternative course of action. In other words, it is the benefit lost when one course of action is selected against the other course of action. For example, one person has 100 cubic feet wood, which can sold for Rs.50000, but if furniture is made of it by spending another Rs.30000 then it can be sold for Rs.100000. Therefore here Rs.50000 is the opportunity cost (i.e., the loss of benefit from first alternative if we go for the second alternative.

Imputed Cost The imputed costs are such hypothetical costs for which the actual cash outlay does not take place but for the purpose of decision making it is taken

Sunk Cost The cost which has taken place in the past

and alternative decision will not affect the cost, such costs are called sunk or historical cost. This type of cost cannot be changed by any decision in future. Examples of sunk costs are the book values of existing assets, such as plant and machineries, inventory etc.

Relevant Cost A relevant cost is that cost which is relevant for decision making. It is a future cost which differs under different options or alternatives.

Fixed, variable and Mixed costs  Adams Ltd. has five manufacturing departments. The

following operating and cost information for the two most recent months of activities are given below: May 2005 June 2005 Units produced 10000 10000 Cost in each department Deptt.A Rs.10000 Rs.10000 Deptt.B 25000 50000 Deptt.C 35000 45000 Deptt.D 18000 64000 Deptt.E 22000 44000 Identify whether the cost in each department is fixed, variable, or mixed.

Relevant, Differential cost Jackson Farm Tools has two options for

repairing its office space, which received extensive wind damage in a recent storm. Cost 1 Cost 2 Cost 3 Cost 4 Total cost

option 1 option 2 Rs.8000 Rs. 8000 6420 2500 16000 0 20400 40800 50820 51300

Illustrations Ill.1. Following data has been extracted from the records of a manufacturing company, whose operations are varying from month to month: level of activity Maximum Minimum machine hours 800000 300000 Manufacturing exp.(Rs. Lakhs) 52 32 Determine the fixed and variable components of manufacturing overheads and hence compute the total manufacturing overhead for an activity level of 500000 machine hours. ILL.2. B&Co. has recorded the following data in the two most recent periods: Volume of production(units) 800 1200 Total cost of production (Rs.) 14,600 19,400