Man Acct KNUST lecture 1 cost behaviours.ppt

Lecture 1
ACC 557: MANAGEMENT
ACCOUNTING
Managerial Accounting and Cost Concepts
Compiled by:
Kwame Oduro Amoako (PhD)

2-2
Learning Objectives
• Define management accounting
• Distinguish between managerial & financial
accounting.
• Understand basic terms in management
accounting
• Identify and give examples of each of the three
basic manufacturing cost categories.
• To calculate variable and fixed cost from mixed
cost data
• Derive cost function from cost data

Work of Management
Planning
Controlling
Directing and
Motivating
1-3

Directing and Motivating
Directing and motivating involves managing day-
to-day activities to keep the organization running
smoothly.
▫ Employee work assignments.
▫ Routine problem solving.
▫ Conflict resolution.
▫ Effective communications.
1-5

Controlling
The control function ensures
that plans are being followed.
Feedback in the form of performance reports
that compare actual results with the budget
are an essential part of the control function.
1-6

Management Accounting defined
 The Institute of Management Accountants
has defined management accounting as:
 A value-adding continuous improvement
process of planning, designing, measuring and
operating both nonfinancial information
systems and financial information systems that
guides management action, motivates
behavior, and supports and creates the
cultural values necessary to achieve an
organization’s strategic, tactical and operating
objectives

Management Accounting explained
 Be aware that this definition identifies:
 Management accounting as providing both
financial information and nonfinancial
information
 The role of management information as
supporting strategic (planning), operational
(operating) and control (performance
evaluation) management decision making
 In short, management accounting
information is pervasive and purposeful
 It is intended to meet specific decision-making
needs at all levels in the organization

 Examples of management accounting
information include:
 The reported expense of an operating
department, such as the assembly department of
an automobile plant or an electronics company
 The costs of producing a product
 The cost of delivering a service
 The cost of performing an activity or business
process – such as creating a customer invoice
 The costs of serving a customer
Management Accounting Information (3)

 Management accounting also produces
measures of the economic performance of
decentralized operating units, such as:
 Business units
 Divisions
 Departments
 These measures help senior managers
assess the performance of the company’s
decentralized units

 Management accounting information is a
key source of information for decision
making, improvement, and control in
organizations
 Effective management accounting systems
can create considerable value to today’s
organizations by providing timely and
accurate information about the activities
required for their success

Changing Focus
 Traditionally, management accounting
information has been financial information
 Management accounting information has now
expanded to encompass information that is
operational and nonfinancial:
 Quality and process times
 More subjective measurements (such as customer
satisfaction, employee capabilities, new product
performance)
 Three dimensions:
 Financial / Non-financial information
 Internal / External information
 Operational / Strategic information

Comparison of financial and
management accounting

Diff. between cost and management accounting
Cost Accounting Management Accounting
Cost accounting reports are useful
to the management as well as some
external bodies such as debtors of a
concern.
Management accounting
prepares reports exclusively
meant for the management.
Determination of cost and cost
control are the primary roles of cost
accounting.
Efficient and effective
performance of a concern is the
primary role of management
accounting.
Success of cost accounting does not
depend upon management
accounting system.
Success of management
accounting depends on sound
financial accounting system and
cost accounting systems of a
concern.
Only cost accounting principles are
used in it.
Principals of cost accounting and
financial accounting are used in
management accounting.

2-16
Terms in management accounting
•Unit cost is a measure of a company's cost to
build or create one unit of product.
•Example
•For example, let's assume that it costs
Company XYZ GH¢10,000 to purchase 5,000
biscuits that it will resell in its retail outlets.
Company XYZ's unit cost is:
•GH¢10,000 / 5,000 = GH¢2 per unit

2-19
Elements of cost

2-20
The Product
Cost elements
Direct
Materials
Manufacturing
Overhead
Direct
Labor

2-21
Direct Materials
Raw materials that become an integral part of the product and
that can be conveniently traced directly to it.
Example: The flour in the dough.

2-22
Direct Labor
Those labor costs that can be easily traced to individual units of
product.
Example: Wages paid to bakers.

2-23
Manufacturing Overhead
Manufacturing costs that cannot be easily
traced directly to specific units produced.
Examples: Indirect materials and indirect labor
Wages paid to employees
who are not directly
involved in production
work. Examples: clean-up
workers and security
guards.
Materials used to support
the production process.
Examples: lubricants and
cleaning supplies to
maintain the bakery
equipment.

2-25
Classifications of Costs
Function (Management functions) – related to production
or sales
Product or Period
Distribution and selling costs
General and administrative costs
Product costs –
Direct Material
Direct Labor
Factory Overhead
Traceability (cost of tracing cost to a cost driver directly
should be lower than the benefits.
Direct or indirect
Behavior – how costs react to changes in underlying cost
driver
Variable or Fixed

2-26
Classification of cost:
By traceability
Direct costs -
those that can be traced directly to a particular object of
costing such as a particular product, department, or branch.
Examples include materials and direct labor.
 Some operating expenses can also be classified as direct
costs, such as advertising cost for a particular product.
Indirect costs -
those that cannot be traced to a particular object of costing.
They are also called common costs or joint costs.
Indirect costs include factory overhead and operating costs
that benefit more than one product, department, or branch.

2-27
Direct or Indirect?
• A cost classification can vary as the chosen cost object varies
• Consider a factory supervisor’s salary
• If the cost object is a product the factory supervisor’s salary is an indirect cost
• If the factory is the cost object, the factory supervisor’s salary is a direct cost
• A cost object can be any unit of analysis including product, product
line, customer, department, division, geographical area, country,
or continent

2-28
By function (management)
Manufacturing costs/product cost
incurred in the factory to convert raw
materials into finished goods.
It includes cost of raw materials used
(direct materials), direct labour, and
factory overhead.

2-29
Classification of by function:
Period or Nonmanufacturing Costs
Selling &
distribution
Costs
Costs necessary to
secure the order and
deliver the product.
General and
Administrative
Costs
All executive,
organizational, and
clerical costs.

2-30
By function cont’d
Period cost/Non-manufacturing costs
Not incurred in transforming materials to
finished goods.
These include:
selling and distribution expenses (such as
advertising costs, delivery expense, salaries
and commission of salesmen)
Administrative/General expenses (such as
salaries of executives and legal expenses).

2-31
Classification by function:
Product Costs Versus Period Costs
Product costs include
 direct materials,
 direct labor, and
 manufacturing overhead.
Period costs/ Non-
manufacturing
overheads include all
selling costs
administrative costs.

2-32
Prime Cost + Manufacturing Overheads =
TOTAL COST
PRODUCTION COSTS
Production Costs + Selling and Distribution
+ Administration and Financial =

2-33
Self test 1
Group the following cost into direct material, direct labour
costs, direct expenses, selling costs, administrative overheads,
and manufacturing overhead
• i. Wages of employees who build a dining table
• ii. Local FM station advertising cost
• iii. Salary of assembling shop supervisor
• iv. Salary of managing director
• v. Cement for making blocks
• vi. Commission paid to sales person
• vii. Rent on the workshop of retail show room
• viii. Depreciation of office equipment
• ix. Rent of a production machine
• x. Depreciation of workshop tool

2-34
Self test 2

2-35
Solution: 1.
a. total direct manufacturing: ($7.00+ $4.00)  20 000 =
$220 000
b. total indirect manufacturing: ($1.50  20 000) + $100 000 =
$130 000
c. period costs: $70 000 + $50 000 + (1.00 + 0.50)  20 000 =
$150 000
d. variable cost per unit: $7.00 + 4.00 + 1.50 + 1.00 + 0.50 =
$14.00
e. total fixed manufacturing overhead: $100 000

2-37
Solution
•a. 4 hours at $15 = $60
•b. $2 000 + $400 + $220+$1600+$750 = $4970
•c. ($18 + $60) x 500 + $2 620 = $41 620

2-38
Quick Check 
Which of the following costs would be considered a period rather
than a product cost in a manufacturing company?
A. Manufacturing equipment depreciation.
B. Property taxes on corporate headquarters.
C. Direct materials costs.
D. Electrical costs to light the production
facility.
E. Sales commissions.

2-39
Quick Check 
Which of the following costs would be considered a period rather than
a product cost in a manufacturing company?
A. Manufacturing equipment depreciation.
B. Property taxes on corporate headquarters.
C. Direct materials costs.
D. Electrical costs to light the production
facility.
E. Sales commissions.

2-40
Other classification of Costs
Direct
Material
Direct
Labor
Manufacturing
Overhead
Prime
Cost
Conversion
Cost

2-41
Other classification of costs:
Differential Cost and Revenue
Costs and revenues that differ among
alternatives.
Example: You have a job paying GH¢1,500 per month in
your hometown. You have a job offer in a neighboring city
that pays GH¢2,000 per month. The commuting cost to
the city is GH¢300 per month.
Differential revenue is:
GH¢2,000 – GH¢1,500 = GH¢500
Differential cost is:
GH¢300

2-42
According to Relevance to Decision Making
• Relevant cost - cost that will differ under
alternative courses of action. In other words,
these costs refer to those that will affect a
decision.
•Standard cost - predetermined cost based on
some reasonable basis such as past
experiences, budgeted amounts, industry
standards, etc. The actual costs incurred are
compared to standard costs.

2-43
According to Relevance to Decision Making:
Opportunity Cost
The potential benefit that is given up
when one alternative is selected over
another.
Example: If you were not attending college, you
could be earning GH¢15,000 per year.
Your opportunity cost of attending college for one
year is GH¢15,000.

2-44
Other classification of costs:
Sunk Costs
Sunk costs have already been incurred and
cannot be changed now or in the future. These
costs should be ignored when making decisions.
Example: Cash paid for goods bought, Salaries paid to
workers, rent paid for office space and are no longer
recoverable. These cedis have been spend in exchange of
goods and services and permanently lost.

2-45
Cost Classifications:
By Cost Behavior
Cost behavior refers to how a cost
will react to changes in the level
of activity. The most common
classifications are:
▫Variable costs.
▫Fixed costs
▫Mixed costs.

2-46
Variable Cost
A cost that varies, in total, in direct proportion to
changes in the level of activity. In some cases your
total texting bill is based on how many texts you
send.
Number of Texts Sent
Total
Texting
Bill

2-47
Variable Cost Per Unit
However, variable cost per unit is constant. In some
cases the cost per text sent is constant at constant
cost per text.
Number of Texts Sent
Cost
Per
Text
Sent

2-48
Fixed Cost
A cost that remains constant, in total, regardless of
changes in the level of the activity. However, if
expressed on a per unit basis, the average fixed cost
per unit varies inversely with changes in activity.
Number of Minutes Used
Within Monthly Plan
Monthly
Cell
Phone
Contract
Fee

2-49
Fixed Cost Per Unit
However, if expressed on a per unit basis, the average fixed
cost per unit varies inversely with changes in activity.
Number of Minutes Used
Within Monthly Plan
Monthly
Cell
Phone
Contract
Fee

2-50
Fixed Costs and the Relevant Range
Fixed costs would increase in a
step fashion at a rate of
GH¢30,000 for each additional
1,000 square feet.
For example, assume office space is available at a
rental rate of GH¢30,000 per year in increments of
1,000 square feet.

2-51
Rent
Cost
in
Thousands
of
Dollars
0 1,000 2,000 3,000
Rented Area (Square Feet)
0
30
60
Fixed Costs and the Relevant Range
90
Relevant
Range
The relevant range
of activity for a fixed
cost is the range of
activity over which
the graph of the
cost is flat.

2-52
Mixed costs
• A mixed cost is a cost that
contains both a
fixed cost component and a
variable cost component.
• It is important to understand
the mix of these elements of
a cost, so that one can predict
how costs will change with
different levels of activity.

2-53
Example 1-Mixed cost
Employee remuneration
• Wage costs for employees who are paid a monthly salary plus
commissions are a good example of mixed costs.
• This is a common compensation package for salesmen and sales reps.
They usually receive a small base salary and commissions based on
how many sales they make during the period.
• The monthly salary is a fixed cost because it can’t be eliminated. Even
if the salesperson doesn’t sell anything during the month, the
company still has to pay the base salary.
• The commission, on the other hand, acts more like a variable
cost because it’s based on the productivity of the employee.
• The more the employee sells the greater the sales commission
expense becomes. The company can eliminate this expense
altogether if it doesn’t sell anything for the month.

2-54
Example 2-Mixed Cost
• Automobile
• Operating an automobile is a classic example of a mixed cost for a
service business.
• If you use a car for business-related travel, for instance, it may involve
certain fixed costs such as annual insurance.
• It also involves variables such as changing fuel prices and differing
amounts of use from one month to another such as distances you
have to travel to meet certain clients, or the frequency thereof.
• As service businesses often involve traveling to client sites for
projects or meetings, company cars can become a significant mixed
cost factor.

2-55
Review: Cost Terminology
•Fixed Costs - Costs that do not change in total with
the volume produced or sold
•Variable Costs - Costs that change in direct
proportion with the volume produced or sold
•Mixed Costs - A combination of fixed and variable
costs
•Semi-variable Cost - Costs that change with volume
produced, but not in direct proportion

2-56
Analyze a mixed cost using a
high-low method and
scatter graph plot

2-57
Fixed Monthly
Utility Charge
Variable
Cost per KW
Activity (Kilowatt Hours)
Total
Utility
Cost
X
Y
A mixed cost contains both variable and fixed elements.
Consider the example of utility cost.
Mixed Costs
(also called semi-variable costs)

2-58
Mixed Costs
The total mixed cost line can be expressed
as an equation: Y = a + bX
Where: Y = The total mixed cost.
a = The total fixed cost (the
vertical intercept of the line).
b = The variable cost per unit of
activity (the slope of the line).
X = The level of activity.
Fixed Monthly
Utility Charge
Variable
Cost per KW
Total
Utility
Cost
X
Y

2-59
Mixed Costs – An Example
If your fixed monthly utility charge is GH¢40, your
variable cost is GH¢0.03 per kilowatt hour, and
your monthly activity level is 2,000 kilowatt hours,
what is the amount of your utility bill?
Y = a + bX
Y = GH¢40 + (GH¢0.03 ×2000)
2,000)
Y = GH¢100

2-60
Methods for Separating Mixed Cost Into Fixed
and Variable Components
•The High-Low Method
•Scatterplot Method
•Specific quantitative methods
•The Method of Least Squares

2-61
Mixed Costs
Fixed Monthly
Utility Charge
Variable
Cost per KW
Total
Utility
Cost
X
Y

2-62
Total cost function or equation

2-63
Number of Packaging
Shipments Costs
January 6,000 GH¢17,000
February 9,000 26,000
March 12,000 32,000
April l0,000 20,000
Illustration:
Determine the cost function using
the following data
High-Low Cost Estimation

2-64
High-Low method of estimating costs
Fixed costs= Total costs – Variable costs

2-65
High activity period
Low activity period
Number of Packaging
Shipments Costs
January 6,000 GH¢17,000
February 9,000 26,000
March 12,000 32,000
April l0,000 20,000
Variable cost
per unit (VC) =
Difference in total costs
Difference in activity
VC = GH¢32,000 - GH¢17,000
12,000 - 6,000
Continued on next slide

2-66
Variable cost
per unit (VC) = GH¢2.50
January
Fixed cost = Total costs - Variable costs
GH¢17,000 = Fixed cost + (GH¢2.50 x 6,000 shipments)
Fixed costs = GH¢2,000
March
GH¢32,000 = Fixed costs + (GH¢2.50 x 12,000 shipments)
Fixed costs = GH¢2,000
Same answer!

2-67
Y = GH¢2,000 + GH¢2.50X
Total packing
department costs
Number of
shipments
High-Low Cost Estimation Equation

2-68
Illustration 2: High Low method

2-69
The High-Low Method – An Example 2
= GH¢6.00/hou
GH¢2,400
400

2-70
The High-Low Method – An Example
Total Fixed Cost = Total Cost – Total Variable Cost
Total Fixed Cost = GH¢9,800 – (GH¢6/hour × 850
hours)
Total Fixed Cost = GH¢9,800 – GH¢5,100
Total Fixed Cost = GH¢4,700

2-71
The High-Low Method – An Example
Y = GH¢4,700 + GH¢6.00X
The Cost Equation for Maintenance

2-72
Quick Check 
Sales salaries and commissions are GH¢10,000 when
80,000 units are sold, and GH¢14,000 when 120,000
units are sold. Using the high-low method, what is the
variable portion of sales salaries and commission?
a. GH¢0.08 per unit
b. GH¢0.10 per unit
c. GH¢0.12 per unit
d. GH¢0.125 per unit

2-73
units are sold. Using the high-low method, what is
the variable portion of sales salaries and commission?
a. GH¢0.08 per unit
b. GH¢0.10 per unit
c. GH¢0.12 per unit
d. GH¢0.125 per unit
Quick Check 

2-74
Quick Check 
units are sold. Using the high-low method, what is the
fixed portion of sales salaries and commissions?
a. GH¢ 2,000
b. GH¢ 4,000
c. GH¢10,000
d. GH¢12,000

2-75
units are sold. Using the high-low method, what is
the fixed portion of sales salaries and commissions?
a. GH¢ 2,000
b. GH¢ 4,000
c. GH¢10,000
d. GH¢12,000
Quick Check 
Total cost = Total fixed cost +
Total variable cost
$14,000 = Total fixed cost +
($0.10 × 120,000 units)
Total fixed cost = $14,000 - $12,000
Total fixed cost = $2,000

2-76
Scattergraph Plots – An Example
Assume the following hours of maintenance work
and the total maintenance costs for six months.

2-77
Plot the data points on a graph
(Total Cost Y vs. Activity X).
The Scattergraph Method
$7,000
$7,500
$8,000
$8,500
$9,000
$9,500
$10,000
400 500 600 700 800 900
Scattergraph Method
X
Y
Hours of Maintenance
Total
Maintenance
Cost

2-78
Plot the data points on a graph (total
cost vs. activity).
0 1 2 3 4
*
Cost
10
20
0
*
*
*
*
*
*
*
*
*
Activity - output
X
Y

2-79
Draw a line through the data points with about an
equal numbers of points above and below the line.
0 1 2 3 4
*
Cost
10
20
0
*
*
*
*
*
*
*
*
*
Activity - output
X
Y

2-80
Use one data point to estimate the total level of activity and the total cost.
Intercept = Fixed cost: FC 10
0 1 2 3 4
*
Cost
10
20
0
*
*
*
*
*
*
*
*
*
Activity - output
X
Y
Activity 0.8 units
Total cost = TC11

2-81
Make a quick estimate of variable cost per unit and determine the cost equation.
Variable cost per unit =
1
0.8
= 1.25/ unit of output
Y = 10 + 1.25X
Total Cost at 0.8 units 11 TL
Less: Fixed cost 10 TL
Estimated total variable cost 0.8 units 1 TL
Total cost Number of units

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