CH1-7

Chapter 1

Management accounting: information for creating value and managing resources

1-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith

Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith

OutlineAustralian organisations in the 21st centuryWhat is management accounting?Management accounting and financial accounting informationManagement accountants within organisationsManagement accounting processes and techniquesPlanning and controlImportant considerations in the design of management accounting systemsManagement accounting and the changing business environment



Australian organisations in the 21st centuryIncreasing global competition in the 1990sReduction or elimination of input tariffs, quotas and bountiesDeregulation of telecommunications industryCorporatisation and privatisation of public sector bodies competing with private sectorChanges in the regulation of labour markets1-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith

(Cont.)


Australian organisations in the 21st century (cont.)Shift from primary production to exporter of resources, to manufacturer, to resurgence of mineral resourcesAustralia is primarily a service-based economyRapid and unpredictable changeIncreasing customer demandsRise of the Internet and e-commerceClimate changeNew organisational structures, strategies and management philosophies



What is management accounting?

the processes and techniques that focus on the effective and efficient use of organisational resources to support managers in their tasks of enhancing both customer value and shareholder value1-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith

(cont.)


What is management accounting? (cont.)Customer valueThe value that a customer places on particular features of a product or serviceShareholder valueThe value that shareholders or owners place on a businessResourcesFinancial and non-financial, including information, work processes, employees, committed customers and suppliersDetermine the capabilities and competencies of the organisation



Management accounting systemsSystems that produce the information required by managers to create value and manage resourcesInclude estimates of the costs of producing goods and services, information for planning and controlling operations and information for measuring performanceAd-hoc information to satisfy managers short term and long term decision-making needs1-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith


Management accounting informationFocus is on the needs of managers within the organisationFlexibility in the nature of information suppliedInfluencesManagers information needs, nature of the resources they manageProduction and service technologies, organisational structure, organisational size, the external environment, level of sophistication of computer systemsUsed by senior managers through to operational managers



Management accounting and financial accounting informationFinancial accountingThe practice of preparing and reporting accounting information for parties outside the organisationCosting systems are common to both financial and management accountingA system that estimates the cost of goods and services as well as the cost of organisational units, such as departments1-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith


Management accountants within organisationsMost large organisations have a finance function at the corporate levelSenior accountantsFinancial controller, chief accountant, finance manager, general manager (GM) of accounting, group accountantAccounting staff may be found in each operating divisionManagement accounting activities increasingly involve managers from other functional areas of the business1-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith


Management accounting processes and techniques

Support the organisations formulation and implementation of strategyContribute to improving the organisations competitive advantage in terms of quality, delivery, time, flexibility, innovation and cost, through modern process improvement and cost management techniques


(cont.)


Management accounting processes and techniques (cont.)

Provide information to help manage resources, through systems of planning and control Provide estimates of the costs of an organisations outputs, to support the strategic and operational decision needs of managers1-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith


Management accounting and strategyManagement accounting can support the organisation's formulation and implementation of strategyVisionThe desired future state or aspiration of an organisationUsed by senior managers to focus the attention and energies of staffMission statementDefines the purpose and boundaries of the organisation


(cont.)


Management accounting and strategy (cont.)ObjectivesSpecific statement of what the organisation aims to achieveOften quantifiedRelates to a specific period of timeStrategiesThe direction that the organisation intends to take over the long term to meet its mission and achieve its objectivesFocus on ways to manage the organisation's resources to create value for customers and shareholders1-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith

(cont.)


Management accounting and strategy (cont.)Major decisions in formulating strategiesIn what business will we operate?How should we compete in that business?What systems and structures should we have in place to support our strategies?Corporate strategy Making choices about the types of businesses to operate in, which businesses to acquire and divest, and how best to structure and finance the organisationIn publicly listed companies, the choice of corporate strategy is influenced by the expectations of major shareholders and securities market1-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith

(cont.)


Management accounting and strategy (cont.)Business (or competitive) strategyThe way a business competes within its chosen marketDistinct business strategies for each business unitStrategy implementationPutting plans into place to implement and support a chosen business strategyNew structures, new systems, new production processes, new marketing approaches, new HRM policies


(cont.)


Management accounting and strategy (cont.)Competitive advantageAdvantages that a business may have over another that are difficult to imitate, achieved through ...Cost leadershipEconomies of production, superior process technologies, tight cost controlProduct differentiationSuperior quality, customer service, delivery performance, product features


(cont.)


Management accounting and strategy (cont.)Strategic planningLong-term planning, usually undertaken by senior managers with a three- to five-year timeframeInvolves corporate strategy decisionsDraws on management accounting informationImplementing strategiesManagers at all levels share the responsibility for implementationLong-term plans linked to budgeting systemsPerformance measurement systems compare actual outcomes to targets1-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith


PlanningA broad concept that is concerned with formulating the direction for future operationsAllows an organisation to consider and specify all resources needed in the futureOccurs at all levels of the organisationA budget is an example of a short-term plan that summarises the consequences of an organisations operating activities for a specified time period1-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith


ControllingInvolves putting mechanisms in place to ensure that operations proceed according to plan and that objectives are achievedManagement accounting information provides information for control by comparing actual performance with plans, targets or budgetsControl systems are the systems and procedures that provide regular information to assist in control1-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith


Costing goods and servicesEstimates of the cost of producing goods and services are needed to support a range of operational and strategic decisionsRoutine costing systems form part of the financial accounting system, so product costs are prepared to meet external reporting purposesProduct costs are sometimes produced outside of the financial accounting system, to better meet managers decision-making needs These costs may not comply with GAAP or accounting standards



Some important considerations in the design of management accounting systemsBehavioural issuesInformation may impact on individual behaviour, so management accounting systems may have expected and unexpected outcomesA key purpose of management accounting systems is to motivate managers and employees to direct their efforts towards achieving the organisations goalsBudgeting systems, performance measurement and reward systems may be used as motivational tools1-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith

(cont.)


Some important considerations in the design of management accounting systems (cont.)There are costs and benefits of generating and providing management accounting informationCosts Salary of accounting personnel Purchasing and operating computersGathering, storing and processing data, Managers time to read, understand and use the information1-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith

(cont.)


Some important considerations in the design of management accounting systems (cont.)Benefits Improved decisionsMore effective planningGreater operational efficiency at lower costsBetter controlImproved customer and shareholder value1-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith


Management accounting design: contingency and institutional theoriesContingency theory design is influenced by the organisational contextExternal environment, technology, organisational structure and size, national and organisational culture, and strategyThese factors cause systems to be different Institutional theory design is influenced by institutional forces, which explain similaritiesThe need to achieve legitimacy within and beyond their organisationThe tendency for firms to imitate good practice of other firms



Management accounting responses to the changing business environmentBy the 1990s, many organisations realised that they needed to improve their product and service quality, delivery responsiveness and cost performance in order to improve market share and profitsAdoption of new management structures, systems and practices, including new management accounting techniques and systems1-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith

(cont.)


Management accounting responses to the changing business environment (cont.)Conventional management accounting systemsIncludes budgeting, costing systems and financial performance measurement systemsIn wide use for many decades and still used in many organisationsContemporary management accounting systemsIncludes activity-based costing, performance measurement systems (such as balanced scorecards), cost management systems (such as business process re-engineering), new approaches to customer profitability analysis and supplier cost analysis


(cont.)


Management accounting responses to the changing business environment (cont.)Contemporary management accounting techniques have developed to support the adoption of new structures, systems and practicesSome organisations continue to use conventional management accounting systems, while others are in the midst of implementing contemporary systems



Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith

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SummaryManagement accounting supports managers in enhancing customer value and shareholder valueSystems to support formulation and implementation of strategyProcess improvements and cost management techniquesInformation for planning and controlProduct costs for strategic and operational decisionsContemporary management accounting techniques have developed to support new organisational structures, systems and practices, which are a response to a rapidly changing business environment1-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith


Chapter 2

Management accounting: cost terms and concepts



OutlineManagement 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-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith


Management accounting systemsManagement accounting systems are tailored to an organisations 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 environment




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Emphasis on costsWhy do management accountants pay so much attention to costs?Historic focus on production coststo 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 wealth



Cost 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-*Copyright 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 terms




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Classifying 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-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith


Direct 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-*Copyright 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 units 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 centres


(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-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith


Controllable 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-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith



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Costs 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-*Copyright 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-*Copyright 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-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith



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Manufacturing 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 costs


(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 production


(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 occur


(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-*Copyright 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-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith


Product 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 product




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Cost 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 inventoryDirect labour and manufacturing overhead are accumulated in work in process inventory


(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 expenseCost of goods sold is deducted from sales revenue to determine gross profit2-*Copyright 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-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith



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SummaryManagement accounting systems are tailored to an organisations 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 function


(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 reports



Chapter 3

Cost behaviour, cost drivers and cost estimation



OutlineWhat are cost behaviour, cost estimation and cost prediction?Cost driversCost behaviour patternsThe relevant rangeEngineered, committed and discretionary costsCost structures in modern business environmentsCost estimationPractical issues in cost estimation3-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith


What are cost behaviour, cost estimation and cost prediction?Cost behaviourThe relationship between a cost and the level of activity or cost driverCost estimationThe process of determining the cost behaviour of a particular cost itemCost predictionUsing knowledge of cost behaviour to forecast the level of cost at a particular level of activity 3-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith



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Cost driversA cost driverAn activity or factor that causes costs to be incurredConventional approaches to understanding cost behaviour assume that production or sales are the only cost driverVariable costs are assumed to vary in proportion to the level of production volumeFixed costs remain unchanged as production costs increase or decreaseVolume-based cost drivers include units produced, direct labour hours, direct labour cost and machine hours3-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith

(cont.)


Cost drivers (cont.)Contemporary viewpoints recognise that there are a range of possible cost drivers other than production volume A non-volume cost driver is a cost driver not directly related to production volumeActivity-based approaches classify activities and costs into four levelsUnitBatch ProductFacility


(cont.)


Cost drivers (cont.)Unit level costsRelate to activities performed for each unit producedUse conventional volume-based cost driversBatch level costsRelate to activities performed for a group of product units, such as a batch or a delivery loadProduct (or product-sustaining) levelRelates to activities performed for specific products or product groupsFacility level Costs incurred to run the business, not caused by any particular product3-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith

(cont.)


Cost drivers (cont.)Selecting the best cost driversInput or outputs?Example of an input cost driver is the weight of materialExample of an output driver is the volume of productionCostbenefit principles will determine the choiceHow detailed should the analysis be?As the number of cost categories increases, the accuracy of the resulting information should increaseAgain, costbenefit criteria are importantLong or short term?Cost behaviour and cost drivers can change over timeChoice depends on the intended purpose of the cost analysis3-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith

(cont.)


Cost drivers (cont.)Cost drivers for cost estimation or cost management?Cost drivers that are used to predict costs may differ from those used to manage costsEffective cost management requires the identification of root cause cost driversThe basic factors that cause a cost to be incurredSearch for the true causes of costs


(cont.)


Cost drivers (cont.)When choosing cost drivers the costs and benefits of each driver must be assessed, taking into accountReasons for analysing cost behaviour, such as cost prediction, product costing, cost management, pricingTimeframe for analysing the cost behaviour (short term or long term)Availability of data on cost driversAny other uses that the cost behaviour information might serve3-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith



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Cost behaviour patternsCost behaviour The relationship between a cost and the level of activity (or cost driver)Cost behaviour patternsVariable costsFixed costsStep-fixed costsSemivariable costsCurvilinear costs3-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith

(cont.)


Cost behaviour patterns (cont.)3-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith

Variable costsTotal variable costs increase in direct proportion to changes in the level of activity but the variable cost per unit remains constantThe variable cost per unit is the slope of the cost line in the following cost function:Y = a + bX

Where Y = total cost a = fixed cost component (the intercept on the vertical axis) b = variable cost per unit of activity (the slope of the line) X = the level of activity(cont.)



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Cost behaviour patterns (cont.)Fixed costsAs activity increases or decreases total fixed costs do not change but fixed cost per unit changesFixed cost per unit is often calculated to use in product costs but is of limited use in management decision making as it does not reflect the way that fixed costs actually behaveContemporary approaches to cost analysis recognise that there are cost drivers for some of these fixed costs and very few costs remain fixed3-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith

(cont.)



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Cost behaviour patterns (cont.)Step-fixed costsRemain fixed over a wide range of activity levels but jump to a different amount for levels outside that rangeSemivariable (or mixed) costHas both fixed and variable componentsCurvilinear costHas a curved cost line but is often approximated as a semivariable cost functionAt lower levels of activity there is decreasing marginal costAt higher levels of activity there is increasing marginal cost3-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith

(cont.)



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Cost behaviour and the relevant rangeThe relevant range is the range of activity over which a particular cost behaviour pattern is assumed to be valid. For example,The relevant range for the variable cost of electricity may hold for 200 to 800 batches of production per month, but outside of that range the variable cost per unit may differThe direct material cost per unit may only hold for production up to 1000 units per day, and for higher volumes the cost per unit may decrease due to cheaper cost of buying material in larger quantitiesThe range of activity which is relevant for a particular cost estimate should be specified3-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith


Engineered, committed and discretionary costsDistinction is useful when estimating costs for budgeting and planning purposesEngineered costsBear a defined physical relationship to the level of outputIf we know the level of activity, we can predict total costCommitted costsArise from an organisations basic structure and facilities, and are difficult to change in the short termDiscretionary costsAre the result of a management decision to spend a particular amount of money for some purposeCan be changed easily3-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith


Shifting cost structures in modern business environmentsA decreasing proportion of production costs no longer vary directly with production volumeAs production becomes more automated there is less reliance on labour and more reliance on equipment. Equipment costs do not vary with production volumeSome employee wage agreements specify fixed salaries and a stabilised workforceWages do not vary with production activity levelsMore difficult to change the number of staff employed as activity levels change



Cost estimationApproaches to cost estimationManagerial judgment Engineering approachQuantitative analysisManagerial judgmentUsing experience and knowledge rather than formal analysis to classify costs as variable, fixed or semivariableFuture costs are estimated by examining past costs and identifying factors that might affect future costsReliability of cost estimates is dependent upon the ability of the manager3-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith

(cont.)


Cost estimation (cont.)The engineering approachStudying processes that result in the incurrence of a costFocuses on the relationships that should exist between inputs and outputsUsing time and motion studies (or task analysis), where employees are observed as they undertake tasksThese techniques are expensive and time-consumingUseful when there is no reliable past data on which to base cost estimatesMost effective when there is a direct relationship between inputs and outputsActivity-based approaches extend task analysis to the study of indirect activities and costs


(cont.)


Cost estimation (cont.)Quantitative analysisFormal analysis of past data to identify the relationships between costs and activitiesA scatter diagram can be useful to plot the data points and to visualise the relationship between cost and the level of activityThe highlow method involves taking the two observations with the highest and lowest level of activity to calculate the cost functionRegression analysis is a statistical technique that uses a range of observations to determine the cost function3-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith

(cont.)


Cost estimation (cont.)Regression analysisA statistical technique used to estimate the relationship between a dependent variable (cost) and independent variables (cost driver)The line of best fit makes deviations between the cost line and the data points as small as possibleSimple regression involves estimating the relationship between the dependent variable (Y) and one independent variable (X)Y = a + bXMore accurate than highlow method as it makes use of all data and has statistical properties that allows inferences to be drawn between cost and activity levels


(cont.)


Cost estimation3-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith

Regression analysisMultiple regression estimates a linear relationship between one dependent variable and two or more independent variablesY = a + b1X1 + b2X2

The regression line can be evaluated using several criteria:Economic plausibilitydoes the regression line make sense?Goodness of fithow well does the line fit the data points?



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Practical issues in cost estimationData collection problemsMissing data Outliersextreme observations of activity or costsMismatched time periods for dependent and independent variablesTrade-offs in choosing the time periodthe number of observations compared to the reliability of past data points as predictors of future cost behaviourAllocated fixed costs may be misleadingInflation may cause past cost data to be less relevant3-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith

(cont.)


Practical issues in cost estimation (cont.)Effect of learning on cost behaviourIn estimating labour costs for relatively new products or processes, labour times per unit may decrease at varying ratesActivity-based approaches allow more complex cost behaviour patterns to be consideredCosts are assigned to activitiesUnit, batch and product level costs are assumed to vary in proportion to their cost drivers3-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith

(cont.)


Practical issues in cost estimation (cont.)The accuracy of cost functionsSometimes budgets and cost estimates capture only approximations of cost behavioursWhy?Limited time and knowledge to undertake appropriate quantitative techniquesThe data required to estimate reliable cost functions may not existA low priority may be given to determining accurate cost behaviour and cost estimation Subjective cost estimates may be considered good enough for the firms needs3-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith

(cont.)


Practical issues in cost estimation (cont.)All cost functions are based on simplifying assumptions, such as:Cost behaviours depend on a single or only a few types of activityCost behaviours are linear within a relevant rangeCosts of producing more accurate cost estimates need to be assessed against the likely benefits



SummaryUnderstanding cost behaviour allows cost prediction for planning and controlConventional cost drivers are volume-based, but more recently may be non-volume relatedCost behaviours range from variable to fixedCosts can be estimated using managerial judgment, engineering approaches and quantitative techniquesCost estimation is fraught with a range of practical difficulties, and the choice of technique involves a cost-benefit trade-off3-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith


Chapter 4

Product costing systems



OutlineProduct costingDifferent costs for different purposesDesigning product costing systemsFlow of costs in manufacturing businessesAllocating overhead costs to productsAccounting for manufacturing overheadsTypes of product costing systemsJob costingProcess costing4-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith


Product costingProduct costing systemsAccumulate product-related costs and use procedures to assign them to the final productsIn some businesses upstream and downstream costs are regarded as product relatedUpstream costsresearch and development, product design, supplyDownstream costsmarketing, distribution, customer serviceProduct costs are the input to the product costing system4-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith


Different product costs for different purposesProduct costs can include upstream, manufacturing and downstream costsInclusion of various costs depends on the timeframe and type of decision to be madeManagers needs for product cost information will vary depending on the type of decision to be made and managers personal preferences4-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)


Different product costs for different purposes (cont.)Cost for inventory valuation for external reporting must include only manufacturing costsFor long-term decisions about products a wider definition may be usedProduct costs are used to value inventory, for short-term decision making and strategic decision making, for planning and controlling costs and for cost reimbursement

4-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)


Different product costs for different purposes (cont.)Current or future product costsCurrent product costs are relevant for inventory valuation Future product costs may be relevant for input into some decisions such as pricingFrequency of cost informationInfrequently for long-term decisions or some short-term decisionsMore regularly for inventory valuationIn summary, product costs may differ overThe range of costs includedCurrent or future costsHow frequently product costing information is required4-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith


Designing product costing systemsIdentify the managers needsAll product cost information may not come from a single product costing systemFuture product costsLong-term product costsInventory valuationCost and benefits of providing various cost estimates must be compared4-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith


Flow of costs in manufacturing businessesFor inventory valuation in external financial reports only manufacturing costs are assigned to products, as required by Australian accounting standardsManufacturing costs consist of: Direct materialDirect labourManufacturing overhead



Flow of costs in manufacturing businesses (cont.)Manufacturing costs flow through several manufacturing ledger accountsRaw materials inventory Work in process inventory Finished goods inventoryCost of goods sold expenseProfit and loss accountAustralian accounting standards require that upstream and downstream costs are expensed in the period in which they are incurredMay be included in product costs where relevant to managers decision making4-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith


Allocating overhead costs to products To estimate the cost of a product we need to identify the cost of resources used to produce the productSome resources are consumed directly by products and are traced directly to each productDirect material and direct labourOverhead costs are essential to production but as they have no observable relationship with the product they need to be allocated to productsThese cost are indirect costs to the product4-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)


Allocating overhead costs to products (cont.)Aggregate overhead costs into cost poolsIdentify the overhead cost driver(s)The factor or activity that causes cost to be incurredCalculate a predetermined (or budgeted) overhead rate per unit of cost driverApply manufacturing overhead costs to products at the budgeted (or predetermined) overhead rate, multiplied by the quantity of cost driver consumed by the product4-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith


Accounting for manufacturing overhead Two types of manufacturing overhead are recorded in an accounting systemActual manufacturing overheadManufacturing overhead costs incurred throughout the accounting periodDebited to the manufacturing overhead accountApplied manufacturing overheadEstimate of the overhead resources used to manufacture a productApplied to products using a predetermined overhead rateCredited to the manufacturing overhead account



Accounting for manufacturing overhead (cont.)At the end of an accounting period total actual manufacturing overhead may not equal total applied manufacturing overheadDisposing of underapplied or overapplied overhead at the end of the accounting periodClose the underapplied or overapplied overhead to cost of goods soldorProrate to cost of goods sold, work in process inventory and finished goods inventory4-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)


Accounting for manufacturing overhead (cont.)Most firms dispose of underapplied or overapplied overhead at the end of the year onlymonthly fluctuations may average out over a year One reason for underapplied or overapplied manufacturing overhead is an error or inaccuracy in the predetermined overhead rate4-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith


Types of product costing systemsConventional product costing systems range from job costing to process costingJob costingManufacturing costs traced to individual jobsProducts produced in distinct jobs/batches which are significantly differentPrinters, furniture manufacturers, machinery manufacturersMany service firms such as lawyers, accountants, consulting engineers4-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)


Types of product costing systems (cont.)Process costingProduction costs traced to process/department and averaged across all units producedMass production or repetitive environmentPetrol production, processed food, chemical and plastics manufacturersRepetitive services such as routine processing of cheques by banks, handling of licence applications by government departments



Types of product costing systems (cont.)Process costing involvesEstimating the cost of production processesCalculating the average cost per unit by dividing the cost of the process by the number of units producedWhere there are sequential processes, the costs of products produced in one department are transferred into the next departmentSome product costing systems have features of both job costing and process costing



Job costingBill of materialslists all the materials required for a jobMaterial requisition formsauthorises the movement of raw materials from the warehouse to the production departmentJob cost sheetsummarises the costs of direct material, direct labour and manufacturing overhead for a particular job4-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)


Job costing (cont.)Purchase of materials Raw material inventoryxxxx Account payablexxxx

Transferring direct material to jobs Work in process inventoryxxxx Raw material inventoryxxxx4-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)


Job costing (cont.)Use of indirect material in production Manufacturing overheadxxxx Manufacturing supplies inventoryxxxx

Charging direct labour to jobs Work in process inventoryxxxx Wages payablexxxx4-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)


Job costing (cont.)Accounting for indirect labour Manufacturing overheadxxxx Wages payablexxxx

Accounting for manufacturing expenses Manufacturing overheadxxxx Prepaid rentxxxx Depreciation on equipmentxxxx etc.4-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)


Job costing (cont.)Application of manufacturing overhead Work in process inventoryxxxx Manufacturing overheadxxxx

Completion of production job Finished goods inventoryxxxx Work in process inventoryxxxx4-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)


Job costing (cont.)Sale of goods Accounts receivablexxxx Sales revenuexxxx

Cost of goods soldxxxx Finished goods inventoryxxxx4-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)


Job costing (cont.)Underapplied overhead Cost of goods soldxxxx Manufacturing overheadxxxx

Or the reverse entry if overhead is overapplied4-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith


Process costingThe approach taken in process costing depends on The existence of work in process (WIP) inventory at the end of the accounting periodThe degree to which products are identical in their consumption of direct material and specific production processesSimple forms of process costing assume no WIP inventoryMore complex forms of process costing involving WIP are covered in Chapter 54-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith


SummaryDifferent measures of product costs are appropriate for different purposesPast costs for inventory valuationCurrent and future costs for decision-making, which may include non-manufacturing costsOverhead costs are allocated to product costs according to their consumption of an overhead cost driverThe choice of product costing system depends on the characteristics of the product and production environment and may range from job costing to process costing4-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith


Chapter 5

Process costing and operation costing5-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith


OutlineProcess costingProcess costing with work in process inventoryCalculation of equivalent unitsThe effects of beginning and ending work in process inventoriesProcess costing using the weighted average methodProcess costing using the first-in, first-out (FIFO) methodComparison of weighted average and FIFOProcess costing and spoilageOperation costingOther issues in process costing



Process costingJob costing and process costing are two extremes of the continuum of conventional product costing systemsJob costing systems accumulate the costs of each jobProcess costing systems accumulate the cost of each process then average these costs across all units producedMany businesses use a combination of job and process costing; this is called hybrid costing5-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)


Process costing (cont.)Used by businesses that mass-produce one product or a small range of almost identical productsInvolves a number of processes that are performed repetitivelyUsed by oil refineries, food processors and manufacturers of tobacco, chemicals and paperAlso used by producers of repetitive services such as routine processing of cheques in banks and delivery of standard letters in Australia Post5-*(cont.)Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith


Process costing (cont.)Two main stepsEstimate the cost of the production processCalculate the average cost per unit by dividing the cost of the process by the number of units producedProcess costing can occur where there is no opening or closing WIP inventory (see Chapter 4)More complex process costing takes account of WIP inventoryNeed to calculate equivalent units to apportion cost between new production and inventory5-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith


Process costing with work in process inventoriesWIP inventoryNot all products are complete at the beginning or end of the period (usually a month)Production costs will be calculated after taking into accountUnits started in the previous period and completed in current period (beginning WIP)Units started and completed in the periodUnits that are incomplete at the end of the period (ending WIP)5-*Copyright 2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)


Process costing with work in process inventories (cont.)Partially completed goods at the beginning or end of the period change the way we allocate production costsEquivalent unitsThe amount of production inputs that have been applied to the physical units during productionPhysical units are all units currently in production whether complete or incompleteWIP inventory needs to be converted to equivalent units to provide the basis for calculating product cost



Process costing with work in process inventories (cont.)Materials are input into production at various stagesWe usually assume that labour and overhead are used uniformly throughout the production processTreat collectively as conversion costsUnits in ending WIP are generally at different stages of completion with respect to material and conversion cost



Equivalent unitsEquivalent units are used to calculated unit costs when there is WIPIf WIP is 50% complete for 10 000 litres on hand at the end of the month, it is100% complete for direct materials, which are added at the start of the process 10 000 equiva

CH1-7

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Transcript of CH1-7