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Chapter 1

We can say that the two largest categories in accounting are Management &
Financial Accounting.
Financial Accounting focuses on communicating the financial position of the
company to external users (banks, investors), prepares financial statements
according to IFRS/ASPE and reports economic events but also influences managers’
behaviour since their compensation is often based on this financial reports.
Management Accounting has a big impact in the decision making process. It`s
internal measures and reports help managers make decisions that are of the best
interest of the company. It is based on cost-benefit analysis and it is designed to
influence the behaviour of managers and employees.
Cost accounting on the other hand supplies information to both financial and
management accounting. It measures, analyses and reports financial and non-
financial information related to the cost of purchasing and using resources in a
company. Therefore, the goals of cost accounting are to determine, report and
analyze the costs and make decisions that will help boost the business. It is also
used to measure and monitor the internal decision making, the performance on all
levels, the alignment of the employees with the company’s goals and strategies.
There are two types of strategies that help an organization to match its capabilities
with the market requirements: cost leadership (generate profit by providing
generic product features-quality and low price) or value leadership (generate profit
by offering unique, innovative product).
Factors/analysis that influence how customers experience their consumption of a
product or service are:
 Value-Chain Analysis representing a sequence of business functions that also
contains customer usefulness. Companies can add value by using the value-
adding activities such as R&D, design, production, marketing, distribution
and customer service.
 Supply-Chain analysis explains the flow of goods, services and information
from their original source to customers, regardless of whether those
activities occur in multiple organizations. This analysis can help implement
new strategies, cut costs and create value.
 Key Success Factors include activities essential for good performance such
as: cost and efficiency, quality, time & innovation.
The five steps in decision making are:
1. Identifying the problem and uncertainties
2. Obtaining information
3. Make predictions about the future
4. Decide on one of the available alternatives
5. Implement the decision, evaluate performance and learn
In order to identify the problems, different reports need to be used. Obtaining
more information is always beneficial when making future predictions. It is
important to examine the alternatives and choose the best of the possible options.
Once the decision is made, companies monitor and evaluate the performance and
learn from this experience.

The guidelines that management accountants use are:

 Cost-Benefit approach (do expected benefits exceed the expected costs?)
 Behaviour and Technical considerations (helps motivate employees to work
fort the interests of the company; helps manager take smart economic
 Different costs for different purposes
Corporate governance is important to companies because it contains activities that
ensure legal compliance such that accountants fulfill their fiduciary responsibilities.
Accountants also have ethical obligations that involve confidentiality, competence,
objectivity and integrity.

Chapter 2
Cost is a resource used to achieve specific objective (actual or past/historic cost vs.
budget cost or future cost). The accumulation of the actual cost is called cost
accumulation (cost pools/buckets). Cost assignment is related to a pool of actual
cost to a specific product.
Manufacturing costs are classified as follows direct material cost, direct
manufacturing labour costs and indirect costs.
 DM: costs directly traceable to the end-product
 DML: costs that result from compensating of all manufacturing labour
directly traceable to the product
 MOH: costs related to the product that cannot be traced to the product on
an economically feasible way (ex. Acc. Depreciation)
Direct costs are related to the distinct cost object and can be traced to it. (DM, DML,
Indirect costs are necessary costs that cannot be traced to the end product. Indirect
manufacturing costs are often called as MOH. Depending on when manufacturing
costs incurred they can be called upstream (incurred prior to production) and
downstream costs (incurred after production).
Factors that can affect the classification of direct/indirect cost classifications are:
- selection of the distinct cost object
- significance of the cost in question
- available information-gathering technology
- design of operations
Prime costs is the sum of DM costs and DML costs;
Conversion costs are all the DML costs and MOH costs. Costs necessary for the
conversion of the prime costs into the final product.
Relevant range: the range of action for a given product where total fixed costs are
constant and also the variable costs per unit are also constant. So if we say that
fixed costs are $200, variable costs are $5 per unit we are assuming that the
relevant range holds true from 1 to 500 units but that after that our fixed and
variable costs might change.
Variable costs are costs that differ with respect to the changes in the level of total
activity because the cost per unit is constant (ex. If the activities go up than the
total variable cost will go up
#of units $per unit total
1 $2 $2
20 $2 $40
Fixed costs are constant within a relevant range of finished outputs, meaning the
more units we produce the more we are spreading out the fixed cost over more
Cost driver is a variable that measures the level of activity/volume that affects the
costs. Fixed costs have a cost driver only in the long run.
Unit cost: total costs done by the company that are necessary for the production
of a single unit, service.
Opportunity costs are assets that we don’t take advantage of when we choose one
option over another
Sunk costs are past costs and we should not take them into consideration when
making decisions.
Product costs (inventoriable costs) are costs that have future benefit and are
included in the manufacturing process. There are three types of inventory: direct
inventory, work in process and finished goods. All of these are included on the
statement of financial position and are considered as assets.
Period costs are not part of the manufacturing process and are therefore not
considered as future asset. They are often referred to as operating expenses, non-
inventoriable costs, upstream and downstream costs.
In order to represent the cost flow we need to start with the materials purchased
that are represented as raw materials on the balance sheet. The second production
stage is WIP which includes direct labour and MOH and is also included in the
balance sheet. The third stage included on the balance sheet is finished good which
only once sold flows to the income statement as COGS. The selling and admin. Costs
are period costs that bypass the balance sheet and flow only to the income
Calculation of cost of direct materials used, total manufacturing costs incurred &
1. Cost of direct materials used:
Beginning inventory of DM
+Purchase of DM
-End inventory of DM
=DM used

2. Total manufacturing costs incurred

DM used
+Direct manufacturing labour
+MOH costs
=Total manufacturing costs incurred

COGM contains the costs of all goods during the process of modification from raw
materials to finished goods and this is how it can be calculated:
Beginning WIP inventory
+Total manufacturing costs incurred
-End WIP inventory
Overtime premium is the salary paid to a worker for the in excess of his/her regular
Idle time is salary paid to worker for the unproductive time caused by lack of
organization, machine breakdown etc.
Chapter 3
CVP (Cost-volume-profit) analysis the relation of net income relative to the changes
in total revenue, total cost or both. CVP analysis is based on few assumptions such
1. Increase or decrease in the amount of quantity produced and sold is the
2. All costs can be classified as variable or fixed costs;
3. The behaviour of the costs is linear within a certain range;
4. The information about the price/unit, variable cost/unit and sales volume is
5. Revenue/cost can be computed without considering the time value of
Unit sales price x Q
-Unit variable cost x Q
= Contribution margin (can be expressed as %, showing how many pennies per $1
of revenue contribute to paying the fixed cost)
-Fixed cost x Q
=Operating income

Total revenue/sales
-Total costs
=Break-even point (can be also expressed as a percentage Fixed cost/Contribution
margin %)
When solving a problem with the CVP analysis approach it is essential we do the
following steps before making a decision.
1. Identify the problem
2. Obtain information
3. Predict the future
4. Choose the right alternative
5. Implement the decision, evaluate the performance and learn
There are three methods on which the CVP relationships can be expressed.
 The equation method:

Revenues – VC – FC = Op.
│ │
(Selling price (VC/unit
Quantity sold) Quantity sold)

 Contribution margin method:

Contribution margin/unit X Quantity sold - Fixed costs

= Op. income

(Selling price – VC/unit)
X quantity sold
BEP=Total fixed costs/Contribution margin/unit
 The graph method is a representation of total costs and revenues graphically.
CVP Analysis can be also used to calculate the desired operating income and
volume of units required to be sold.
Target operating income = Q x (sales price/unit – variable cost/unit) – Fixed cost
Another way of solving for the target operating income when we know the tax rate
is the following:
Target net income/1-tax rate = Target operating income
Volume of units required to be sold = (Fixed cost + Target operating income) /
contribution margin per unit
There are two ways in which costs can be classified (contribution and financial).
Both classifications are including the same costs but they are named differently.
Financial: Sales-COGS=Gross Margin (it is telling us how much more or less than the
purchasing price can a firm charge)
Contribution: Sales-Total VC=Contribution margin
Operating margin = operating income (all business costs – revenue)
Net income margin = net margin
Besides calculating the target operating and net income CVP analysis can be used
also when making strategic decisions (upgrading the product with an additional
feature), can help make smart decisions about advertising or when deciding if the
company should decrease the price.
Margin of safety is the point at which expected or actual revenue exceeds the
breakeven revenue. It can be calculated as dollars, units or as a percentage.
Margin of safety = Budgeted revenue – Break even revenue
When there are different products and services that are being sold the sum of all
total sales volume of the firm is called Sales mix. In such cases, the breakeven
revenue volume can be calculated in bundles.
Break even sales volume in bundles = Fixed costs / Contribution margin per bundle
Sensitivity analysis is a method used by managers that helps see the changes in
outcome if the predicted data is not achieved. This is a way to detect risk and the
risk tolerance.
Operating leverage relates to the effects that fixed costs have on changes in
operating income and the contribution margin.
Degree of op. leverage= Contribution margin/Op.income
Companies with high percentage of fixed costs are capital intensive companies and
have high operating leverage. (Ex. air companies, gold mining etc.)
Chapter 4
Cost assignment: assigning direct and indirect costs to a cost object
Cost tracing: assigning direct cost
Cost allocation: assigning indirect cost
Cost pool: grouping of indirect cost items
Cost allocation base: way to link indirect cost to cost object
Costing systems:
1. Job costing system: cost object →unit/s of specific product/service called job.
2. Process costing system: cost object →group of same or similar
Normal costing: managers want to be able to predetermine and budget for the job
costs at the beginning of the year. Therefore, they use predetermined/budgeted
indirect cost rate which is calculated for each pool.
Normal costing (direct costs) traced direct costs to an object by
=actual direct cost rates x actual direct cost inputs
Normal costing (indirect costs) allocates indirect costs
= budgeted indirect cost rates x actual quantities of the cost allocation bases
Budgeted indirect cost rate = Budgeted annual indirect costs / Budgeted annual
quantity of the cost-allocation base
Steps in the normal costing process:
1. Identify the job chosen as cost object
2. Identify the direct cost of the job
3. Identify the cost-allocation bases to use for allocating indirect cost to the job
(ex. multiple cost-allocation basis)
4. Identify the indirect costs associated with each cost-allocation base
5. Compute the rate per unit used to allocate indirect costs
6. Compute indirect costs
7. Compute total costs
Actual costing: same as Normal costing, the only difference is that the first one uses
actual indirect-cost rates whereas the normal costing uses budgeted indirect cost
Actual MOH = Actual annual MOH cost / Actual annual quantity of the cost
allocation base
Flow of costs in Job Costing
Statement of Financial Position

Inventoriable costs

Direct material / Indirect material
Dir.Manuf.labour / Indir. Manuf.labour
↓ ↓
Traced to Allocated to
↓ ↓
Work in process

Finished goods inventory

General ledger: a summary of the job record.
Subsidiary ledgers
 Material records by type of materials
 Labour records by employee
 Manufacturing department OH records by month
 WIP inventory records by job
 Finished goods inventory records by job
 Other subsidiary records
 Non-manufacturing costs and job-costing
Sum of above entries equals the amount that corresponds to the general ledger
control account.
At year-end adjustments are made when the indirect costs allocated differ from
the actual costs incurred (underallocated & overallocated OH/indirect costs).
 Proportion approach (under/overallocated OH) spreads this costs among
WIP, FG, End inventory and COGS
 Write-off to COGS approach
Costing systems based on calculating average costs are simple but can lead to bad
decisions. Broad averaging can lead to product under/over costing and mistakes in
pricing decisions.
Product – cost cross – subsidization: if a company under/overcosts one of its
products it will over/undercost at least one of its other products (commonly used
in situations where the cost is uniformly spread/averaged across multiple
Simple costing system (allocation process):
1. Identify the products that will be used for the cost objects
2. Identify the direct costs of the products
3. Select cost-allocation base for allocating indirect (overhead) costs to the
4. Identify the indirect costs associated with each cost-allocation base
5. Compute the rate
6. Calculate the indirect costs allocated to the products
7. Calculate the total cost of the product ( Direct Costs + Indirect Costs)
Guidelines for Refining a Costing System
a. Direct-cost tracing: try to identify all the direct costs;
b. Indirect-cost pools: keep the indirect cost pools more homogeneous
c. Cost allocation bases: use the cost driver (reason for indirect costs) as cost
allocation base for each homogeneous indirect cost pool
Activity-based costing system
ABC identifies individual activities as the core cost objects (ex. design of
products, setting up machines etc.) It further identifies activities in in the value
chain, calculates costs of separate activities, and assigns costs. Forming activity
cost pools with cost drivers for each activity results in more accurate costing of
the activities and more accurate product costs.
Cost Hierarchies: classification of cost pools based on different cost drivers,
cost-allocation bases etc. Four levels
1. Output unit-level costs: cost of activities preformed on each unit/service (the
cost of this activity increases overtime as the additional units produced
2. Batch-level costs: refer to a group of units of a product/service rather than
each individual unit
3. Product-sustaining costs (service-sustaining costs): costs necessary to
support individual products/services regardless the units/batches of units
4. Facility-sustaining costs: costs that cannot be traced to individual products
or services.
Differences between ABC System & Simple Costing System Using a Single Indirect-
Cost Pool:
- ABC system labels/traces more costs as direct costs
- Creates homogeneous cost pools tied to various activities
- Each cost pool has a cost allocation base
The benefits of the ABC Systems is that managers would avoid making mistakes
such as under/overcosting a product and would make more informed decisions.
When ABC info is used for making management decisions → activity based
management (ABM).
 Pricing and product-mix decisions (ex. match competitor`s price)
 Cost reduction and process improvement decisions (ABC systems can guide
managers as to where and how to reduce prices)
 Design Decisions (simpler design/mould can help reduce costs-less complex
machine setup, reduce required labour)
ABC can be used in both manufacturing and merchandising companies.
 Proposed future plan by management for a certain time period. (Recap of
financial and non-financial plans in one doc.)
 Pro forma statement
Strategic analysis:
 Long run planning (strategic plans) → long run budgets (capital budgets)
 Short run planning (operating plans) → short run budgets (operating, cash &
cash flow budgets)
Operating budget = shows the outcome of operations in value chain business
function. Required schedules when preparing Operating budget:
- Revenue budget (production/cost and inventory depend on it)
- Production budget (units) = Budgeted sales (units) + Target end. finished
goods inventory (units) – beginning finished goods inventory (units)
- DM usage budget and DM purchase budget (this can be calculated with the
info about the quantity of output produced from the production budget)
- DML budget (wage rates, production methods)
- Manufacturing OH budget
- Ending inventory budget
- Cost of goods sold budget = Beg. Finished goods inventory + COGM – End
finished goods inventory
- Other cost budget
Financial budget includes capital & cash budget, budgeted balance sheet & cash
flow statement.
Cash budget = schedule of expected cash receipts and expenditures (important for
calculating the expected interest expense as a result of borrowing. Main sections:
1. Beg. Cash balance + cash receipts = total cash
2. Cash disbursements (DM-purchases; DL-wages; other costs; other
disbursements-PPE, long term invest.;)
3. Financing requirements
4. End. cash balance
Responsibility vs. Controllability
Organizational structure (arrangement of centres of responsibility within an entity)
- Responsibility centre (segment, sub-unit of an organization
where the manager is accountable for specified set of
- Responsibility accounting (system that monitors the
actions of each responsibility centre)
Controllability is the degree of authority that a specific manager has over costs
Human aspects as crucial aspects of budgeting.
Ways on which managers can work in order to get accurate budget forecasts:
- Get independent standards to compare with firm`s forecast
- Manager should stay informed with regards to the operations
within their span of control
- Managers should create environment that discourages
budgetary slack
- Performance evaluation measures
- Set up incentives and consequences for budget performance

Chapter 4 (4-18)

1. Allocation base = direct manufacturing labour costs

Actual MOH rate = Actual annual OH costs / Actual direct manufacturing
labour costs
Actual manuf. OH rate = 2 311 400 / 2 540 000 = 0.91 x 100 = 91%
Budgeted MOH rate = budgeted manuf. OH costs / budgeted direct manuf.
Labour costs
Budgeted MOH rate = 2 210 000 / 2600 000 = 0.85 x 100 = 85%

A) Actual costing (actual cost rates)
Cost Job 26 = 91% (actual manuf. rate) X 27 000 (direct manuf. labour costs)
= 24 570
B) Normal costing (budgeted cost rates)
Cost Job 26 = 85% (budg. manuf. OH rate) x 27 000 (direct manuf. labour costs)
= 22 950
3. Total MOH normal costing = actual direct manuf. labour costs
X budgeted MOH rate
= 2 540 000 X 85% = 2 159 000
Underallocated MOH = Actual MOH cost – Total MOH cost
= 2 311 400 – 2 159 000 = 152 400
There is no under/overallocated OH under the actual costing because this system
is using the actual inputs incurred during the business cycle.
4. Actual: precise, reflects actual costs, no need for additional
Normal: gives the option to make estimates and create budgets at
beginning of the year
Chapter 5 (5-19)

Rate = Total cost pool / Quantity cost drivers

(machining) $6 = 450 000 / (35 000 + 40 000)
(setup) $ 1440/production run = 144 000 / 100
(inspection) $84/inspection hours = 126 000 / 1 500
MOH cost = rate x Quantity cost drivers
Math Financial
6 x 35 000 = 210 000 6 x 40 000 = 240 000
1 440 x 50 = 72 000 1 440 x 50 = 72 000
84 000 x 1000 = 84 000 84 000 x 500 =42 000
336 000 354 000
/ 50 000 /100 000
MOH per cost 7.32 3.54

DM cost 180 000/ 50 000 = 3.6 360 000 / 100 000 = 3.6
DML cost 60 000 / 50 000 = 1.2 120 000/ 100 000 = 1.2
4.8 4.8
+7.32 + 3.54
12.12 8.34