MANAGERIAL ACCOUNTING

SOMNATH
DAS
BASICS OF MANAGERIAL ACCOUNTING
Purpose of the course - familiarize you with:
1. Managerial accounting concepts.
2. Managerial accounting practices.
3. Use of managerial accounting information for decision making.
. Pitfalls.
!ccounting is a "ranch of study concerned with the generation # identification $ measurement % and
pro&ision #'ommunication% of information.

Managerial accounting is in particular accounting for the internal management of organizations.
A. Financial versus Managerial Accouning
(inancial !ccounting Management !ccounting
!pproach ) unifying concept: assets*e+uities
) no underlying unity-- many
approaches
,ules ) -.!.!.P. ) no general principles
) mandatory ) mostly optional
Measurement ) almost e.clusi&ely / ) many non-financial elements
) emphasis on precision0 o"1ecti&ity ) su"1ecti&e estimates
Past2(uture ) "ased on past ) many future estimates and forecasts
!ggregation ) o&erall summary of "usiness ) &ery segmented
) general purpose information ) specific purpose reports
(re+uency ) less2mandatory fre+uency ) more fre+uent and optional
3imilarity ) "asic data source same
4nd result ) ends with financial statements )
2
integral part of other "usiness aspects
3
B. Cos Accouning Ter!inolog"
1. 5ature of 'ost
'ost - ! sacrifice of resources: Cost is a measurement in monetary terms of the amount of resources used
for some purpose.
4.pense - 6he cost charged against re&enue in a particular accounting period.
2. Purposes of -athering 'ost 7nformation
,outine decision
making:
Managerial control
!ccounting
5onroutine decision
making
'ost
!ccounting
'ost of -oods 3old
(inancial Product
!ccounting 'osting
7n&entory 8aluation
B. T#ree As$ecs %Basic coss& o' Managerial Accouning(
1. 9ecision Making #9ifferential 'osts%
7nterface with decision models from operations research0 economics and finance0 competiti&e analysis of
costs and prices0 cost of capital calculations and in&estment decisions.
4.ample : 9ominos Pizza almost "ankrupt :; pizza making losses
2. Product 'osting #(ull 'osts%
!ssociating a / &alue for the resources sacrificed in o"taining a product or ser&ice.
- used for financial reporting - &aluation of in&entory0 '<-3.
- used for internal decision making - product pricing0 optimal product mi..
4.ample -poor costing led ,ockwell 7nternational 7nc.0 to o&ercharge customers - high &olume
product - hea&y duty truck a.les - attract competitors selling at lower prices hence trou"le.
-automo"ile industry controlla"le costs.
-steel industry died "ecause of high wages.

3. Planning0 'ontrol $ Performance 4&aluation #,esponsi"ility 'osts%
4
- =uantification of goals0 strategies and forecasts in the form of "udgets - de&elop pro forma
financial statements.
- Measure to what e.tent managers and organizational su"units #responsi"ility centers% did achie&e
their goals.
a% 7nformal control - social psychology.
"% (ormal control - performance e&aluation0 incenti&e pro&isions0 compensation0 promotions and
dismissals.
4.ample: ,eim"ursement mechanisms for hospitals0
5<64:
97((4,456 '<363 (<, 97((4,456 PU,P<343 73 ! ,4'U,,456 6>4M4 75
M!5!-4,7!? !''<U5675-
3. @hat types of costs are incurred in a Manufacturing (irmA
<27
B

,aw CDDDDDDE
Materials---FB ,2M B ,2M
Purchased B7n&ty B Used
GDDHDDDI
B

'27
<27 <27
B B

?a"or CDDDDDE CDDDDDE CDDDDDE
Purchases DDDD @ages DDDD B @7P BDDDD B (2- BDDD B3<?9 B
B7n&tyB '<-M B7n&tyB'<-3 B B
GDDHDDI GDDHDDI GDDDDDI
4+uipment B B
Purchases 9epreciation
'27 '27
<ther <ther
'ostsDDDDDDDDD <&erhead
'onsider the a"o&e diagram in terms of:
J the flow of physical units #materials0 la"or0 machine usage0 etc.%
J the flow of costs
5<64 that the accumulation of costs is associated with the accumulation of physical units.
>ence: 7s there a relationship "etween flow2accumulation of costs and the flow2accumulation of physical
units: it is this relationship which we call cost classification.
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6o use cost information effecti&ely0 we need to know how costs change or relate to the physical units or
&olume of acti&ity.
Cost Objects are anything for which a separate measurement of cost is desired.
Cost Accumulation and Cost Assignment. 6wo stages in which an accounting system accounts for costs
are:
K1L cost accumulation and
K2L assignment to &arious cost o"1ects in order to pro&ide manager needed information for decision
making purposes.
'ost 'lassification: 5ow consider some ways of classifying costs:
!. Mased on "usiness function #,$90 9esign0 Production0 Marketing0 9istri"ution0 'ustomer
ser&ice%
M. Mased on financial statement presentation #capitalized0 noncapitalized0 in&entoria"le0 non-
in&entoria"le: product &s. period%
'. Mased on assignment to cost o"1ect #direct &s. indirect%
9. Mased on "eha&ior in relation to cost dri&er #&aria"le &s. fi.ed%
4. Mased on aggregation #total &s. unit%
Product &s Period
9uring a gi&en year all costs incurred "y the firm can "e classified into:
J costs that can "e matched with the process of production: these are called product costs.
J costs that cannot "e matched with units as they are manufactured: these are called period costs.
#6hey can only "e matched with the gi&en period.%
-!!P: all costs of manufacturing are product costsN all selling and administrati&e e.penses are period
costsN @hy is this difference importantA . . . . . . . . .
)ro*uc cos is the sum of the costs assigned to a product for a specific purpose. Exhibit 2-9 Panel A &
B (page ! illustrates three different purposes:
) Product pricing and product emphasis production costs
) 'ontracting with go&ernment agencies O design $ ,$9 costs
) (inancial statements O mktg0 dist"n0 $ customer ser&ice
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costs
Manufacturing 'osts: 6hree manufacturing cost categories
1. Direc !aerials coss - ac+uisition costs of all materials that e&entually "ecome part of the cost
o"1ect #usually final product% that can "e traced in an economically feasi"le way.
2. Direc !anu'acuring la+or coss - compensation of all manufacturing la"or that is specifically
identified with the cost o"1ect that can "e easily traced in an economically feasi"le way.
3. In*irec !anu'acuring coss - all other manufacturing costs that cannot "e indi&idually traced to
the cost o"1ect #final product% in an economical way.
<ther terms used for indirect manufacturing costs include "actor# o$erhea%& manu"acturing o$erhea%&
"actor# bur%en'
T#ree,$ar an* T-o,)ar Cos Classi'icaions. Manufacturing-cost accounting systems normally
classify costs into either three or two categories.
) 7n a three-part system0 costs are classified as direct material0 direct la"or0 and indirect
manufacturing costs.
) 7n a two-part system0 costs are classified as direct materials costs and indirect
manufacturing costs. #,efer to Concepts in Action on page 1 regarding >arley-
9a&idson;s decision to mo&e to a two-part system.%
'. )ri!e coss include all direct manufacturing costs.
9. Conversion coss are all manufacturing costs other than direct materials. 6hey include direct
la"or and indirect manufacturing costs.
9irect &s 7ndirect - @ithin the category of product costs we classify costs into:
J costs for which there is a direct link to indi&idual units of product: these are called direct costsN
e.g. . . . . . . . . . . . . . . . . . . . . . . .
J all other product costs: these are called indirect costsN
e.g. . . . . . . . . . . . . . . . . . . . . . . .
!. 'ost 6racing and 'ost !llocation
1. Direc coss o' a cos o+.ec are related to and can "e race* to a gi&en cost
o"1ect Kproduct0 department0 etc.L in an economically feasi"le way.
2. In*irec coss o' a cos o+.ec are related to "ut cannot "e traced to a gi&en cost
o"1ectN therefore0 indirect costs are allocae* to the cost o"1ect.
3. (actors affecting classification of a cost as direct or indirect:
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a. Materiality of the cost in +uestion
". 7nformation-gathering technology a&aila"le
c. 9esign of operations
d. 'ontractual arrangements
Materials can "e direct or indirect.
?a"or can "e direct or indirect.
<&erhead is always indirect.
9irect 'osts - 'osts that can "e directly related to a cost o"1ect0 e.g. a particular unit of output.
7ndirect 'osts - 'osts that cannot "e directly related to a cost o"1ect.
9irect Materials - materials used in production which end up as part of the finished product. (or
e.ample0 in the manufacture of automo"iles0 steel is a direct material.
7ndirect Materials - materials used in production which do not end up as part of the finished product.
(or e.ample0 in the manufacture of steel0 the oil used to fire the furnaces is an
indirect material.
9irect ?a"or - costs of the workers who work directly on the production process. !n assem"ly
line worker is considered direct la"or.
7ndirect ?a"or - costs of workers who work in the factory "ut not directly on the production
process. 6he factory foreman is considered indirect la"or.
<&erhead - all costs that are not direct materials or direct la"or. <&erhead includes indirect
materials0 indirect la"or0 depreciation on the factory "uilding and e+uipment0 insurance
and ta.es on the factory0 etc.
Product 'ost * 9irect material O 9irect la"or O
Manufacturing <&erhead
*Prime 'ost
O
Manufa
cturing
<&erhe
ad
*9irect Material O 'on&ersion 'ost
'ost 9ri&ers and 'ost Management
8
'ost 9ri&ers:
!. 9ue to increased competition0 organizations are attempting to continuously reduce costs "y:
1. Performing only value a**e* aciviies - those that customers percei&e as adding
&alue0 and
2. 4fficiently managing the use of cost dri&ers in those &alue-added acti&ities.
'ost Meha&ior Patterns: 8aria"le 'osts and (i.ed 'osts
1. /aria+le cos is a cost that changes in total in direct proportion to changes of a cost
dri&er: i.e. a cost is &aria"le if in total it &aries in proportion to changes in the le&el of
production.

2. Fi0e* coss0 in total0 do not change as the related cost dri&er changes0 i.eN a cost is fi.ed
if in total it remains fi.ed #for a gi&en time period% regardless of changes in the le&el of
production #within a rele&ant range of production
3. 3emi-8aria"le23emi-(i.ed:
!ssumptions: 1. costs "eha&ior is dependent on a specified cost o"1ect
2. the time span must "e specified
3. total costs are linear
. there is only one cost dri&er
P. &ariations of the le&el of the cost dri&er are within a rele&ant range
. ! relevan range is the range of the cost dri&er in which a specific relationship "etween
cost and the dri&er is &alid
P. ,elationships of 6ypes of 'osts ((e"er to Exhibit 2-)'!

B
'ost of (ertilizer B
B #6he cost of fertilizer per kiwifruit is fi.ed.%
B
B
GDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDD
8olume of Qiwifruit Production
9

B
'ost of (arm ,ent B
B
B R R
B R R
GDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDD
8olume of Qiwifruit Production
,ele&ant ,ange
#6he cost of rent per kiwifruit &aries with the le&el of production: this is a SspuriousS #meaninglessA%
calculation anyway. @hyA - not controlla"le on a per unit "asis.%
!n information system which "reaks down costs into 8' and (' is costly. #,unning regressions is more
e.pensi&e than not running regressions.% @hy might this classification "e &alua"leA . . .
Toal Coss an* Unis Coss( Pitfalls of U576 'osts:
!. Uni cos is computed "y di&iding some cost total "y some num"er of units. 7t is also
called average cos.
M. 7t is important to use caution when using unit costs. @hene&er fi.ed costs are present0 the
unit cost will change at different &olume le&els. 3ee "ottom of page 3 of the te.t for an
illustration of this point.
(inancial 3tatements and 'ost 6erminology
!. Ca$iali1e* coss are those that are presumed to ha&e future "enefits and are first recorded
as assets when incurred.
M. Nonca$iali1e* coss are recorded as e.penses of the accounting period when they are
incurred.
Service,secor co!$anies pro&ide ser&ices or intangi"le products to their customers - for e.ample0 an
audit or legal ad&ice.
!. 6hese firms do not ha&e in&entories at the end of an accounting period0 and la"or is the
most significant cost category.
M. ! ser&ice-sector income statement and the treatment of capitalized and noncapitalized cost
in a manufacturing sector company are presented in panels ! and M respecti&ely of E0#i+i
2,3 on pageTT of the te.t.
Merc#an*ising, an* Manu'acuring,Secor Co!$anies
Merc#an*ising,secor companies pro&ide tangi"le products they ha&e pre&iously purchased in the same
"asic form from suppliers. 4.amples include retailers0 distri"utors0 and wholesalers.
Manu'acuring,secor companies pro&ide tangi"le products that ha&e "een con&erted to a different form
from that of the products purchased from suppliers. 6hese firms can ha&e %irect materials0 *or+ in
process0 or "inishe% goo%s in$entories at the end of an accounting period.
) Ca$iali1e* invenoria+le coss #also called in&entoria"le costs% are those either
associated with the purchase of goods for resale #merchandising% or with the ac+uisition
and con&ersion of materials and other manufacturing inputs into goods for sale
#manufacturing%. 6hese costs "ecome 'ost of -oods 3old #'<-3% when the in&entory is
sold.
) Ca$iali1e* noninvenoria+le coss are those associated with any aspect of the "usiness
other than in&entory0 e.ample: depreciation.
O$eraing coss include noncapitali,e% costs and the periodic e.pensing of capitali,e% nonin$entoriable
costs #e.g. depreciation% and are consumed in the generation of re&enue.
7ncome 3tatements of Merchandising-3ector firm and Manufacturing-3ector firm are presented in Exhibit
0 panel A on page .. and Exhibit 2-x0 panel A on page ..0 respecti&ely. ! separate 3chedule of 'ost of
-oods Manufactured must "e prepared for the manufacturer #see panel B of Exhibit 2-x%.
9iagrams illustrating the flow of capitalized in&entoria"le0 capitalized nonin&entoria"le0 and noncapitalized
costs are presented in panel M of 4.hi"it 2-. for a merchandising-sector company and in 4.hi"it 2-. for a
manufacturing-sector company0 respecti&ely.
Su!!ar" o' Cos Classi'icaions
P,<9U'6 P4,7<9
9irect
Materials
9irect
?a"or
(actory
<&erhead
( 7 T 4 9
8!,7!M?4
9irect 'osts 7ndirect 'osts
(i.ed 7ndirect
8aria"le 9irect
Menefits of 9efining !ccounting 6erms
!. 7t is important to clearly define what is meant "y or is includi"le in different cost
accounting terms. (or instance0 the e.ample in the te.t indicates that the treatment of
fringe "enefits for manufacturing employees as either direct la"or or indirect
manufacturing costs may ha&e important ta. conse+uences.
M. <ther items that present classification difficulties include: compensation for training time0
idle time0 &acation pay0 sick lea&e0 and e.tra compensation for o&ertime.
'. 7n order to pre&ent disputes0 contracts and laws should "e as specific as possi"le regarding
definitions and measurements of accounting terms.
Su!!ar" Cos Conce$s 4 De'iniions
CONCE)T DEFINITION

'ost ! sacrifice of resources
4.pense 6he cost charged against re&enue in a particular accounting
period. @e
generally use the term e0$ense only when speaking of
financial reportsN
e.pired cost.
Cos Conce$s 'or Cos Accouning S"se!s
Product costs 'osts that firms can more easily attri"ute to productsN costs that are part
of in&entory.
Period costs 'osts that firms can more easily attri"ute to time inter&als.
Prime cost 6he component of product cost that constitutes direct la"or $ direct
materials.
'on&ersion cost 6he component of product cost that constitutes direct la"or $ o&erhead.
!"sorption 'ost ! method of in&entory &aluation in which cost firms use all manufacturing costs -
"oth fi.ed and &aria"le - in computing a unit product cost. #also called full cost%
8aria"le cost ! method of in&entory &aluation in which firms use only &aria"le
manufacturing costs in computing the unit product cost. #also called direct cost%
'ost o"1ect !ny item for which the manager wishes to measure cost #e.g.0 product
department%.
9irect costs 'osts directly related to cost o"1ect.
7ndirect costs 'osts not directly related to a cost o"1ect.
'ommon costs 'ost shared "y more than one cost o"1ect.
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CONCE)T DEFINITION

Cos Conce$s Use* in Decision Ma5ing
8aria"le costs 'ost that &ary with the &olume of acti&ity.
(i.ed costs 'osts that do not &ary with &olume of acti&ity o&er a
specified time span.
9ifferential 'osts 'osts that change in response to a particular course of action.
3unk 'osts 'osts that result from an e.penditure made in the past
and that cannot "e changed "y present or future decisions.
<pportunity cost: 6he return that one could realize from the "est foregone
alternati&e use of a resource.
Miscellaneous Cos Conce$s
'ontrolla"le 'osts 'osts that can "e influenced or affected "y a particular indi&idual.
5oncontrolla"le 'osts 'osts that cannot "e influenced or affected "y a particular indi&idual.
!&erage 'osts ! di&ision of the total costs for the period "y some unit of
operations such as num"er of hours worked or num"er of units produced.
6he most fre+uently used a&erage cost is the a&erage unit cost.
=uestion: >ow would you classify o&ertime premium costA
5<64:
7t is important to recognize that the a"o&e cost classifications are no mutually e.clusi&e. (urthermore0
often we cannot uni+uely determine the nature of a gi&en cost item.
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