The document outlines key concepts of managerial accounting, focusing on cost behavior measurement, cost drivers, and management's influence on costs. It details types of cost functions, methods for measuring costs, and the importance of cost management systems, including activity-based costing. The document emphasizes how various costs impact decision-making within an organization, including fixed, variable, and opportunity costs.

1. MANAGERIAL ACCOUNTING
PRESENTATION

2. CONTENTS
1. Measurement of Cost Behaviour
2. Cost Drivers and Cost Behaviour
3. Management Influence on Cost Behaviour
4. Cost Functions
5. Methods of Measuring Cost Functions
6. Cost Management System
7. ABC System (Concept and Principles)
8. Various Basis of Overhead Distribution
9. Different Cost for Different Decisions

3. Measurement of Cost Behaviour

4. .
Measurement of cost behavior is a crucial aspect of managerial
accounting and financial analysis. It includes how expenses alter
as activity levels inside an organisation change. To make
educated judgements, create budgets, set pricing, and analyse
profitability, cost behaviour is primarily measured.

5. Cost Drivers and Cost Behaviour

6. The cost driver is that variable or factor which has an
effect and causes the relationship with the total cost. It is
the cause and the cost incurred in its effect. Its analysis
means identifying all the possible cost drivers for a
particular type of activity or cost etc., and explains their
cause and effect relationship with the event. It should be
understood that correlation is just a way to prove the
relationship.

7. Types of Cost Drivers
There are many types of cost drivers in cost accounting. As per traditional accounting,
the manufacturing and indirect costs are allocated on the predefined rate based on the
activity performed.
● Activity-based Cost Drivers
● Volume-based Cost Drivers
● Time-based Cost Drivers
● Transaction-based Cost Drivers
● Complexity-based Cost Drivers
● Resource-based Cost Drivers
● Quality or Defect-based Cost Drivers
● Location-based Cost Drivers
● Technology-based Cost Drivers
● Employee-based Cost Drivers
● Maintenance-based Cost Drivers
● Environmental or Sustainability-based Cost Drivers
● Customer-based Cost Drivers

8. Cost behavior is the manner in which expenses are impacted by changes in business activity.
A business manager should be aware of cost behaviors when constructing the annual
budget, to anticipate whether any costs will spike or decline. For example, if the usage of a
production line is approaching its maximum capacity, the relevant cost behavior would be to
expect a large cost increase (to pay for an equipment expansion) if the incremental demand
level increases by a small additional amount. Understanding cost behavior is a critical aspect
of cost-volume-profit analysis.
● Types of Cost Behavior
1. Variable costs:-
Variable cost vary directly with changes in business activity.
1. Fixed costs:-
Fixed costs do not change in response to business activity levels.
1. Mixed costs:-
Mixed costs contain fixed and variable elements.

9. Management Influence on Cost Behaviour

10. ● Management has a significant influence on cost behavior in an organization.
Decisions made by management regarding cost structure, production and capacity
planning, product mix, pricing, cost control measures, outsourcing, technology
adoption, sales, and marketing strategies all impact how costs change in response
to business activity. Understanding cost behavior helps management make
informed decisions, set prices, and achieve financial goals.
● Additionally, management's efforts to control costs and improve efficiency through
process improvements and waste reduction programs can positively affect cost
behavior patterns. Moreover, the adoption of technology and automation can
impact cost behavior by altering the proportions of fixed and variable costs. By
analyzing cost behavior, management can create accurate financial projections,
optimize operations, and make strategic business choices that align with the
organization's objectives.

11. Cost Functions

12. Cost functions are mathematical representations that describe the relationship between the
cost of production and the level of business activity or output. They are a fundamental
concept in economics, accounting, and managerial decision-making. Cost functions help
organizations understand how their costs vary with changes in production volume, which is
crucial for making informed business decisions, setting prices, and assessing profitability.
There are various types of cost functions, depending on the nature of costs and how they
behave:
● Total Cost Function: This function represents the total cost incurred by a company at
different levels of production. It is the sum of all fixed and variable costs for a given
output level. Mathematically, it can be expressed as TC = FC + VC(Q), where TC is
total cost, FC is fixed cost, VC is variable cost, and Q is the quantity of output.
● Average Cost Function: The average cost function calculates the average cost per unit
of output. It is derived by dividing the total cost by the level of production.
Mathematically, it can be expressed as AC = TC / Q, where AC is average cost, TC is
total cost, and Q is the quantity of output.

13. ● Marginal Cost Function: The marginal cost function represents the change in total
cost resulting from producing one additional unit of output. It helps companies
determine the most cost-effective level of production. Mathematically, it can be
expressed as MC = ∆TC / ∆Q, where MC is marginal cost, ∆TC is the change in total
cost, and ∆Q is the change in quantity of output.
● Long-Run and Short-Run Cost Functions: Cost functions can also be classified based
on the time horizon. Long-run cost functions consider all costs to be variable,
allowing the company to adjust its production capacity and change the scale of
operations. Short-run cost functions, on the other hand, have some fixed costs that
cannot be immediately adjusted.
● Step Cost Function: A step cost function represents costs that remain constant within
a specific range of output but jump to a higher level when a certain production
threshold is reached. This results in cost step-ups rather than a continuous cost
curve.

14. Methods of Measuring Cost Functions

15. Measuring cost functions and cost behavior can be accomplished through various
methods. Some of the common methods of measuring and analyzing costs include:
● Historical Data Analysis: One of the simplest methods is to analyze historical cost
data. By examining past financial records and cost reports, managers can identify
patterns and trends in cost behavior.
● Cost-Volume-Profit (CVP) Analysis: CVP analysis is a powerful tool for
understanding cost behavior and its impact on profits. It involves studying the
relationship between sales volume, costs, and profits to determine the breakeven
point and assess the sensitivity of profits to changes in activity levels.
● Regression Analysis: Regression analysis is a statistical method that helps
determine the relationship between a dependent variable (e.g., total cost) and one
or more independent variables (e.g., production volume, time, or other relevant
factors). It is useful for estimating cost functions and predicting costs at different
activity levels.
● High-Low Method: The high-low method is a simple cost estimation technique that
uses the highest and lowest activity levels and corresponding costs to calculate
the variable cost per unit and the fixed cost component of a cost function.

16. ● Scatter Diagrams: Scatter diagrams plot cost data against activity levels to visualize
any potential relationships or patterns between costs and production volume. These
diagrams can provide insights into cost behavior.
● Engineering Studies: In some cases, engineering studies can be conducted to analyze
the physical relationship between input factors and costs. This approach is
particularly useful in manufacturing and engineering-intensive industries.
● Contribution Margin Analysis: Contribution margin analysis focuses on the
contribution of each product or service to cover fixed costs and generate profits. It
helps identify profitable products and assess the cost structure of different offerings.
● Activity-Based Costing (ABC): ABC is a more sophisticated cost allocation method
that assigns costs to specific activities and then to products or services based on their
consumption of those activities. It provides a more accurate understanding of cost
drivers and cost behavior.
● Simulation Modeling: Simulation modeling uses computer simulations to evaluate
different scenarios and assess their impact on costs and profitability. It can be
especially useful when complex interactions between various cost drivers are
involved.

17. Cost Management Systems and
Activity-Based Costing

18. A cost-management system (CMS) is a collection of tools and techniques that identifies
how management's decisions affect costs.
Key features of a cost management system may include:
● Cost Classification: Categorizing costs into various groups (e.g., direct costs, indirect
costs, fixed costs, variable costs) to understand their behavior and impact on business
operations.
● Budgeting and Variance Analysis: Creating budgets to plan for future expenses and
comparing actual costs against budgeted amounts to identify discrepancies
(variances).
● Cost Allocation: Assigning indirect costs to products, services, or projects using
suitable allocation methods, ensuring accurate cost assignment.
● Cost Control Measures: Implementing strategies and initiatives to manage and reduce
costs effectively without compromising product or service quality.
● Performance Measurement: Evaluating the performance of departments, products, or
projects based on their cost efficiency and profitability.

19. Activity-Based Costing is a cost allocation method that aims to allocate indirect costs to products,
services, or projects based on their actual consumption of activities. Traditional cost allocation
methods often use volume-based allocation, which may not accurately reflect the true cost drivers
of different products or services. ABC, on the other hand, identifies and traces costs to specific
activities, providing a more accurate picture of cost behavior.
Key components of ABC include:
● Identifying Cost Drivers: Identifying the activities that cause costs to be incurred within the
organization.
● Cost Pools: Grouping costs into cost pools based on common activities.
● Cost Allocation: Allocating the costs in each cost pool to specific products, services, or
projects based on their consumption of the corresponding activities.
● Better Cost Visibility: ABC provides better cost visibility, allowing managers to identify
which activities contribute most to overall costs and make informed decisions about resource
allocation.
● Enhanced Decision-Making: By understanding the true costs of products and services, ABC
helps managers make more accurate pricing decisions and identify areas for cost reduction or
process improvement.

20. Various Basis of Overhead Distribution

21. Overhead distribution, also known as overhead allocation or overhead apportionment, refers to
the process of allocating indirect costs to products, services, or cost centers. Overhead costs
cannot be directly traced to specific units of output or activities and are instead spread over
multiple cost objects based on certain allocation bases. Various bases are used for overhead
distribution, and the choice of allocation base depends on the nature of the business and the type
of costs involved. Some common bases of overhead distribution include:
● Direct Labor Hours: Overhead costs are allocated based on the number of direct labor
hours worked on each product or job. This method assumes that overhead costs are
incurred in proportion to the amount of direct labor used.
● Direct Labor Costs: Overhead costs are allocated based on the direct labor costs associated
with each product or job. This method assumes that overhead costs are related to the
labor-intensive nature of certain products.
● Machine Hours: Overhead costs are allocated based on the number of machine hours used
by each product or job. This method is suitable for industries where machine usage is a
significant driver of overhead costs.
● Direct Material Costs: Overhead costs are allocated based on the direct material costs
incurred for each product. This method assumes that overhead costs are influenced by the
complexity of the materials used.

22. ● Units Produced or Sold: Overhead costs are allocated based on the number of units
produced or sold. This method assumes that overhead costs vary with the level of
production or sales.
● Number of Employees: Overhead costs are allocated based on the number of
employees in each department or cost center. This method is common in service-
based industries where labor is a primary cost driver.
● Square Footage/Area: Overhead costs are allocated based on the amount of space
occupied by each cost center or department. This method is useful when overhead
costs are related to the use of space.
● Number of Orders or Setups: Overhead costs are allocated based on the number of
production orders or setups required for each product or job. This method is relevant
for industries with high setup costs.
● Activity-Based Costing (ABC): Unlike traditional overhead allocation, ABC identifies
specific activities as cost drivers and allocates overhead costs based on the actual
consumption of these activities by each product or service.

23. Different Costs for different decisions

24. Different types of costs are relevant for different types of decisions within an organization.
Understanding the various cost classifications helps managers make informed choices based on the
specific objectives and context of each decision. Some common types of costs and their relevance to
different decisions include:
● Fixed Costs:
Fixed costs do not vary with changes in the level of production or business activity. They
remain constant within a specific period. These costs are relevant for decisions related to long-
term planning and capacity management. For example, fixed costs are crucial in determining
break even points, evaluating the financial viability of new projects, and assessing the impact
of changes in production volume on overall profitability.
● Variable Costs:
Variable costs fluctuate directly with changes in the level of production or business activity.
They rise as production increases and decrease with lower production levels. Variable costs
are essential for short-term decision-making, such as setting prices for products and services,
determining the optimal production level, and evaluating the profitability of individual product
lines.
● Semi-Variable Costs (Mixed Costs):
Semi-variable costs consist of both fixed and variable elements. They remain fixed up to a
certain activity level, beyond which they become variable and increase with higher production
levels. Understanding semi-variable costs is important for decisions related to cost control and
capacity planning. Managers need to identify the fixed and variable components to better
manage these costs.

25. ● Direct Costs:
Direct costs are specifically traceable to a particular cost object, such as a product, project, or
department. They can be directly attributed to a specific activity or output. For product pricing
decisions and project budgeting, direct costs are crucial for accurate cost estimation.
● Indirect Costs (Overhead Costs):
Indirect costs cannot be directly attributed to a specific cost object and are instead allocated across
multiple cost objects using an appropriate allocation method. These costs are relevant for decisions
related to cost allocation and cost control strategies. Activity-Based Costing (ABC) is a method used
to allocate indirect costs more accurately based on cost drivers.
● Sunk Costs:
Sunk costs are costs that have already been incurred and cannot be recovered regardless of the
decision made. These costs should be irrelevant for future decision-making, as they cannot influence
the outcomes of the decision.
● Opportunity Costs:
Opportunity costs represent the benefits foregone by choosing one alternative over another. They
are essential for assessing the potential benefits of alternative courses of action. Managers need to
consider opportunity costs when evaluating investment decisions or choosing between mutually
exclusive projects.
● Differential Costs:
Differential costs are the changes in costs between two or more alternatives. These costs are critical
for making decisions involving trade-offs or choosing the most cost-effective option among
alternatives.