1. Managerial Accounting:
Concepts and Principles

2. Outline
What is managerial accounting?
Comparison between managerial
accounting and financial accounting
Cost classifications in different ways
Flow of manufacturing activities
Job order cost accounting systems and
process cost accounting systems
Cost allocation
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3. Introduction
 The previous presentations focus on the financial
accounting topics
Please summarize the basic points of financial accounting
→Users/ Time focus/ Emphasis/ Importance/ Subject focus/
Requirements
Thinking
→Is the information provided by financial accounting enough for an
enterprise to conduct its operation and management?
→If not, how to satisfy this demand for the internal used information?
→Have you ever heard ―managerial accounting‖?
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4. What is Managerial Accounting?
An activity that provides financial and
nonfinancial information to managers and
other internal decision makers
Is quite important to planning, control, and
decision making activities
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5. The Environment of
Managerial Accounting
Complexity and
size of organizations
Regulatory Emphasis
environment on quality
Environment of
Managerial Accounting
Competition Development of
technology
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6. Managerial Accounting and
Financial Accounting
Financial Managerial
Accounting Accounting
1. Users Investors, creditors, and Managers, employees, and
other external users other internal users
2. Time focus Historical perspective Future emphasis
3. Emphasis Objectivity and Relevance
Verifiability for planning and control
4. Importance Precision of information Timeliness of information
5. Subject focus Summarized data for Detailed segment reports
the whole organization of an organization
6. Requirements Structured and often Relatively flexible
controlled by GAAP (no GAAP)
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7. Cost Classifications
Costs can be classified by:
Relevance
Behaviour
Controllability
Traceability
Function
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8. Costs Classification by
Relevance
 Relevant
 If costs influence a decision
→Costs that are applicable to a particular decision.
→Costs that should have a bearing on which
alternative a manager selects.
→Costs that are avoidable.
→Future costs that differ between alternatives.
 Irrelevant
 If costs do not influence a decision
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9. Costs Classification by
Relevance
 Sunk Costs
All costs incurred in the past that cannot be changed by
any decision made now or in the future.
should not be considered in decisions.
Irrelevant
Example: You bought an automobile that cost $30,000
two years ago. The $30,000 cost is sunk because whether
you drive it, park it, trade it, or sell it, you cannot change
the $30,000 cost.
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10. Costs Classification by
Relevance
 Out-of-pocket costs
 require future outlays of cash
 associated with a particular decision
 relevant for future decisions
 Example: Considering the decision to take a
vacation or stay at home, if you choose a
vacation, you will only have travel costs (out-of-
pocket costs).
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11. Costs Classification by
Relevance
Opportunity Costs
The potential benefit that is given up when one
alternative is selected over another.
Example: If you were not attending college or
university, you could be earning $25,000 per
year. Your opportunity cost of attending college
or university for one year is $25,000.
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12. Costs Classification by Behavior
Cost behavior refers to
how a cost will react to changes in the level of
business activity.
Fixed costs
do not change when activity changes.
Variable costs
change in proportion to changes in the volume
of activity
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13. Costs Classification by
Behavior
 Total fixed costs remain unchanged
when activity changes within a relevant range.
 Fixed costs per unit decline as activity increases.
Fixed costs per unit
Total fixed costs
Volume of Activity Volume of Activity
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14. Costs Classification by
Behavior
Total variable costs change when activity changes.
Variable costs per unit do not change as activity
increases.
Variable costs per unit
Total variable costs
Volume of activity Volume of activity
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15. Costs Classification by
Behavior
 Mixed costs
contain a combination of fixed and variable costs.
Total Compensation
Variable
Sales Commissions
Fixed
Monthly salary
Sales
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16. Costs Classification by
Behavior
 Step-Wise Costs
remain fixed over limited ranges of volumes but increase
by a lump sum when volume increases beyond maximum
amounts.
Example: additional production supervisors must be
added when another shift is added.
Supervisory Salaries
Production Volume
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17. Costs Classification by
Controllability
Controllable vs. not controllable
depends upon the employee’s responsibilities.
Example: A lower level manager may have
control over overtime costs but not over the
purchase of high-cost machinery.
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18. Costs Classification by
Traceability
Management often traces costs to cost
objects
To obtain a better measure of their total cost
Cost objects include
→Products
→Services
→Departments
→Divisions
→Customer groups
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19. Costs Classification by
Traceability
Traceable costs are classified as
Direct costs
→can be conveniently traced to a unit of product or
other cost objective.
→Examples: salaries of production workers, salary of
maintenance department employees.
Indirect costs
→must be allocated to a unit of product or other cost
objective.
→Examples: factory rent, factory light and heat,
factory accounting costs.
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20. Costs Classification by Function
Manufacturing Costs
are necessary and integral to the production of
finished goods.
Examples: direct labour, direct materials, and
manufacturing overhead.
Non-Manufacturing Costs
are not integral to the manufacture of finished
goods.
Examples: selling and administrative expenses.
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21. Costs Classification by Function
Direct Direct Manufacturing
Material Labour Overhead
Manufacturing
Costs
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22. Costs Classification by Function
 Direct materials
Materials that are clearly and easily identified with a
particular product.
Example: Steel used to manufacture an automobile
 Direct labour
Labour costs that are clearly traceable to, or readily
identifiable with, the finished product.
Example: Wages paid to an automobile assembly
worker.
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23. Costs Classification by Function
Manufacturing overhead
All manufacturing costs except direct material
and direct labour.
Manufacturing costs that cannot be traced
directly to specific units produced.
Examples:
→Indirect labour – maintenance
→Indirect material – cleaning supplies
→Factory utility costs
→Supervisory costs
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24. Costs Classification by
Function
Manufacturing costs are often
combined as follows:
Direct Direct Manufacturing
Material Labour Overhead
Prime Conversion
Cost Cost
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25. Costs Classification by
Function
Non-Manufacturing costs (period costs) are
expenses not charged to the product.
Selling Costs
→Costs incurred to obtain customer orders and to
deliver finished goods to customers —advertising
and shipping.
Administrative Costs
→Non-manufacturing costs of staff support and
administrative functions —accounting, data
processing, personnel, research and development.
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26. Discussions
 ABC company manufactures a portable radio
designed for mounting on the wall of the
bathroom. The following list represents some of
the different types of costs incurred in the
manufacture of these radios:
1. The plant manager's salary.
2. The cost of heating the plant.
3. The cost of heating executive offices.
4. The cost of printed circuit boards used in the radios.
5. Salaries and commissions of company salespersons.
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27. Discussions
6. Depreciation on office equipment used in the executive
offices.
7. Depreciation on production equipment used in plant.
8. Wages of janitorial personnel who clean the plant.
9. The cost of insurance on the plant building.
10. The cost of electricity to light the plant.
11. The cost of electricity to power plant equipment.
12. The cost of maintaining and repairing equipment in the
plant.
13. The cost of printing promotional materials for trade
shows.
14. The cost of solder used in assembling the radios.
15. The cost of telephone service for the executive offices.
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28. Discussions
Required:
Classify each of the items above as
product cost or period costs.
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29. Discussions: the answer
1 Product 6 Period 11 Product
2 Product 7 Product 12 Product
3 Period 8 Product 13 Period
4 Product 9 Product 14 Product
5 Period 10 Product 15 Period
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30. Flow of Manufacturing
Activities
Materials Activity Production Activity Marketing Activity
(raw materials) (goods in process) (finished goods)
Goods in Process
Raw Materials Finished Goods
Beginning Inventory
Beginning Inventory Beginning Inventory
Raw Materials Used
Raw Materials Goods
Purchases Manufactured
Direct Labour Used
Factory Overhead
Used
Financial Reports Raw Materials Goods in Process Finished Goods Cost of Goods
Ending Inv. Ending Inv. Ending Inv. Sold (income
statement)
(balance sheet) (balance sheet) (balance sheet)
30

31. Job Order Cost
Accounting Systems
Job Order Cost Accounting Systems
The production of products in response to
special orders.
quite flexible in the number of products they
can produce.
→Jobs involving the production of more than one unit
of product are called job lots.
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32. Job Order Cost Accounting
Systems
Direct
Materials
Indirect
Factory Allocate Goods in Completed Finished
Overhead Process Goods
Indirect
Delivered
Cost of
Direct
Labour Goods
Sold
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33. Job Order Cost Accounting
Systems
Direct
Materials
Finished Cost per unit
Job No. 1 for Job No. 1
Goods
Direct
Labour
Finished Cost per unit
Job No. 2 for Job No. 2
Goods
Factory
Overhead
33

34. Process Cost Accounting
Systems
Process Cost Accounting Systems
Used for production of small, identical, low-
cost items.
Mass produced in automated continuous
production process.
Costs cannot be directly traced to each unit of
product.
34

35. Process Cost Accounting
Systems
Direct
Materials
Finished
Process 1 Process 2
Goods
Direct
Labour
Cost per Cost per Total cost
equivalent equivalent per
Factory unit for unit for equivalent
Overhead Process 1 Process 2 unit
35

36. Process Cost Accounting
Systems
Unit cost
To determine the cost of goods transferred from
department to department and to finished
goods, we need to calculate unit cost.
Unit cost is computed by dividing the
accumulated costs by the number of equivalent
units produced in the period.
Cost per Product costs for the period
equivalent
unit
= Equivalent units for the period
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37. Process Cost Accounting
Systems
Costs are accumulated for a period of time
by process or department.
Equivalent units is a concept expressing a
number of partially completed units as a
smaller number of fully completed units.
Example: Three one-third full pitchers are
equivalent to one full pitcher.
Equivalent units may be different for material
and labour and overhead at different stages of a
process.
37

38. Comparing Job Order and
Process Production
Similarities
Same objective
→to determine the cost of products
Same inventory accounts
→raw materials, goods in process, and finished goods
Same overhead assignment method
→predetermined rate times actual activity
38

39. Comparing Job Order and
Process Production
Differences
 Job Order Systems  Process Systems
Custom orders Repetitive production
Heterogeneous Homogeneous offerings
products High output volume
Low output volume Low product flexibility
High flexibility High standardization
Low to medium
standardization
39

40. Cost Allocation
 Methods of Overhead Cost Allocation
Plant-wide Overhead Rate Low
Complexity
Two-stage Cost Allocation
Activity-based Costing
High
40

41. Cost Allocation
Plant-wide Overhead Rate
A single plant-wide overhead rate is relatively
easy to use
but may result in inaccurate product costs
41

42. Cost Allocation
Two-stage Cost Allocation
more accurate method than plant-wide
Stage 1: Allocate service department costs to
production departments. Service department
costs are assigned to operating (or production)
departments.
Stage 2: Allocate production department costs to
cost objects. Costs accumulated within operating
(or production) departments are assigned to cost
objects.
42

43. Cost Allocation
Service Departments
Janitorial Maintenance Factory
Accounting
Stage 1
Machining Assembly
Department Department
Stage 2
Job 236 Job 237 Job 238
43

44. Cost Allocation
Activity-based Costing
Attempts to better allocate costs to the desired
cost objects by focusing on activities consumed
by the cost objects.
Many activities within a department drive
overhead costs.
→Products require activities.
→Activities consume resources.
44

45. Cost Allocation
 Activity-based Costing: Procedures
 Identify activities that consume resources.
 Assign costs to a cost pool for each activity.
 Identify cost drivers associated with each activity.
 Compute overhead rate for each cost pool.
Estimated overhead costs in activity cost pool
Rate =
Estimated number of activity units
 Allocate overhead cost: Overhead
× Actual
Rate Activity
45

46. Cost Allocation
 Activity-based Costing: Identifying Cost
Drivers
Most cost drivers are related to either volume
or complexity of production.
Examples: purchasing, invoicing, quality
inspection, product design.
Three factors in choosing a cost driver:
→ Causal relationship
→ Benefits received
→ Reasonableness.
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47. Cost Allocation
Activity-based Costing: Cost and Cost Driver
Cost Cost Driver
Materials purchasing Number of purchase orders
Materials handling Number of materials
requisitions
Personnel Number of employees
Equipment amortization Number of products
produced or hours of use
Quality inspection Number of units inspected
Indirect labour in setting up Number of setups required
equipment
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48. Cost Allocation
Activity-based Costing: Benefits
More detailed measures of costs
Better understanding of activities
More accurate product costs for . . .
→Pricing decisions
→Product elimination decisions
→Managing activities that cause costs
Benefits should always be compared with costs
of implementation
48

49. Summary
 Managerial accounting is quite important to planning,
control, and decision making activities.
 Managerial accounting and financial accounting are
different in users, time focus, requirements, etc.
 Costs can be classified by relevance, behavior,
controllability, traceability, and function.
 Flow of manufacturing activities.
 Similarities and differences between job order and
process cost accounting systems
 The methods of cost allocation: plant-wide overhead
rate, two stage cost allocation, activity-based costing
49

50. ATTENTION COMMERCE
STUDENTS
ACCOUNTING(FINANCIAL & COST) OF
ICMAP STAGE 1,2,3,4 (CRASH CLASSES)
CA..MODULE B,C,D
PIPFA (FOUNDATION,INTERMEDIATE,FINAL)
ACCA-F1,F2,F3
BBA,MBA
B.COM(FRESH),M.COM
MA-ECONOMICS..O/A LEVELS
KHALID AZIZ…..0322-3385752
http://finance.groups.yahoo.com/group/cost-
accountants