What is Management Accounting?

 Management accounting can be defined as:

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 value.

What to be covered in ACCG200:

 Costing techniques (Weeks 1-8)
 Using costing for decision making (Weeks 9-10)
 Budget setting and evaluating performance against the budget (Weeks 11- 12)

Cost concepts
What are costs?
o Resources given up to achieve a particular objective
o Measured in monetary terms
What is a cost object?
o An item for which management wants a separate measure of costs
What is a cost driver?
o A factor or activity that causes a cost to be incurred
What is the level of activity?
o The level of work performed in the organisation (e.g. hours worked, units produced)

Cost classifications
Different cost classifications are used for different purposes, and the same cost can be classified in a number of ways depending on
the intended use of the cost information.

Basis of classifications Cost Classifications

1.Behaviour Variable and fixed costs
2.Traceability Direct and indirect costs
3.Timing of the expense Product and period costs
4.Manufacturing costs Direct material, direct labour and manufacturing overhead
5.Value chain Upstream, manufacturing and downstream costs
6.Controllability Controllable and uncontrollable costs

1. Basis of classification: Behaviour

Variable cost
o Changes in total in proportion to changes in the level of activity (e.g. cost of electricity used to manufacture a product)
Fixed cost
o Remain unchanged in total despite changes in the level of activity (e.g. rent paid for factory remains unchanged no matter how
many units we produce)

Example 1
ABC Ltd manufactures wooden toys.
Activity level (No. Variable cost Total variable Annual total Fixed cost
of toys produced) per toy cost fixed costs per toy
1 $12 $10,000
1,000
2,000

2. Basis of classification: Traceability

Direct cost
o can be directly identified with or traced or linked to a cost object in an economic manner.
Indirect cost
o cannot be identified with or traced or linked to a cost object in an economic manner.

Example: Assume an office desk is a cost object, then:

1. Cost of wood: Direct or Indirect?

2. Cost of glue: Direct or Indirect?

3. Salary of the production supervisor: Direct or Indirect?

3. Basis of classification: timing of the expense

Product cost
I. The cost assigned to goods/services that were manufactured or purchased for resale.
II. Regarded as a part of the asset / inventory until goods are sold.
Period cost
o The costs expensed in the accounting period in which they are incurred rather than being attached to units purchased or
produced. (e.g. salaries of sales staff, advertising expense, depreciation of office equipment)
4. Basis of classification: Manufacturing/ product costs
Direct material
o Materials that are a part of the final product
o Can be directly traced and linked to product in an economic manner
Direct Labour
o All manufacturing labour that can be directly traced or linked to cost object (e.g. wages paid to production workers, workers’
compensation insurance and superannuation contributions)
Manufacturing overhead (indirect manufacturing costs)
o All manufacturing costs other than direct material and direct labour. (e.g. the cost of indirect material, indirect labour,
depreciation and insurance on factory equipment)

Example 2
For each of the costs listed below, indicate whether it is direct material (DM), direct labour (DL), manufacturing overhead (MOH) or period
cost
Classification
Flour used in making pizza
Salary of production supervisor
Wages of production workers
Depreciation on factory building
Depreciation on head office building
Marketing cost

Manufacturing Overhead
Manufacturing overhead costs also usually include overtime premium and the cost of idle time:
Overtime premium: extra wages paid to an employee who works beyond normal working hours.
e.g. John’s regular wage =$30/hr; and overtime wage = $45/hr. Assume John worked an additional hour and was paid $45 , then
the $45 can be classified
into:
DL:
MOH (overtime premium):

Idle time: the cost of employees’ non-productive time, arising from events such as equipment breakdowns or new setups of
production runs.
e.g. Johns regular wage =$30/hr. Assume John worked 8 hrs, including 1 hour idle time due to machine breakdown. Then the cost
of idle time

Example 3
Highlander Cutlery manufactures kitchen knives. One of the employees, whose job is to cut out wooden knife handles, worked 48 hours
during a week in January, including 1 hour idle time due to power outage. The employee earns $10 per hour for a 38-hour week. For
additional hours, the employee is paid an overtime rate of $15 per hour.
Calculate:
(1) The total cost of the employee’s wages during the week
Total wages
=
=
=

(2) Determine the portion of this cost to be classified in DL, MOH (idle time), MOH (overtime premium).
Direct Labour =
MOH (overtime premium)
=
=
=
MOH (idle time) =

Total Manufacturing
cost

Direct Material cost Direct labour cost Manufacturing overhead

Prime cost Conversation cost

5. Basis of classification: Value chain

Example 4
Ivory Company produces and sells ice-cream. Classify the costs listed below, using these value chain classifications:
Cost Classification
Cost of cream used to make the ice-cream
Electricity used to store finished ice-cream products
Cost of fuel for delivery trucks
Wages paid to staff who make the ice-cream
Wages paid to staff who develop recipes for new ice-
cream flavours
Cost of advertising in the food trade magazines

6. Basis of classification: controllability

Controllable cost
o a cost that a specific manager can control or significantly influence.
Uncontrollable cost
o a cost that a manager cannot control or significantly influence.

Example: For a production manager, are the salaries of the CEOs controllable costs?
Are the wages of production workers controllable costs?

Using cost behaviour patterns to predict costs

High-Low Method is used to estimate cost functions by considering data at the highest and lowest levels of ACTIVITY (cost driver) within
a certain range.

Cost Function:
o Total cost = Fixed Cost + VC per unit of activity x No. of units

Step1 – Select the highest and lowest level of activity

Step 2 – Calculate VC per unit by using
difference in cost level
difference in activity levels
Step 3 - Calculate the Fixed Costs
Step 4 – Write the Cost Function

Example 5
The Longreach Factory has determined machine hours to be the cost driver of the company’s electricity costs. The number of machine
hours is provided in the Table along with the electricity costs for the first half of 2011.

Month Machine Hours Electricity Cost $

January 780 8,200
February 720 8,360
March 800 8,950
April 900 9,360
May 950 9,625
June 920 9,150
Required:
1) Use the high-low method to estimate the company’s electricity cost behaviour and express it in equation form
Step 1
Highest activity level =
Lowest activity level =

Step 2 Variable cost per unit

Difference in cost level =
Difference in activity level

=
=

Step 3 Calculate fixed costs by selecting one of the two points used to calculate the variable costs per unit.
Total costs = FC + VC x No. of Units
=

FC =

Step 4 Write the cost function

Total costs = FC + VC x No. of Units
Total Cost =

2) Predict the electricity cost when 850 machine hours were used.
Total cost =
=

Cost behaviour and the relevant range

The relevant range is the range of activity over which a particular cost behaviour pattern is assumed to be valid.
For example, in Lecture example 6 the relevant range for the electricity cost is between 720 and 950 machine hours. Outside of the
relevant range, the cost behaviour pattern may not hold.

Cost flow in a manufacturing business

Explanations of T-accounts:
1. Material is purchased: the cost is added to RM inventory;
2. DM are consumed in production: cost is removed from RM inventory and added to WIP inventory;
3. DL and MOH are accumulated in WIP inventory;
4. Products are completed: costs are transferred from WIP inventory and added to finished goods inventory;
5. Products are sold: costs are transferred from finished goods inventory to cost of goods sold expense