Mashal Institute of Higher Education
Management Accounting
Source person: Kamran Khan
M.Com, B.Com, D.Com… (University of Peshawar)
Lecturer at Mashal Institute of Higher Education
Management Accounting
2
Ch-01 the nature of management accounting and types of cost and cost behaviors
Topic-1 management accounting
Introduction
Managers need information, both financial and non-financial for their decisions. Financial
accounting also providing some information; but the information of financial accounting is not
sufficient for decision making purpose. Management accounting provides information both
financial and non-financial in nature to managers for their planning and controlling activities.
Planning involves setting goals and making plans to achieve them while controlling involves
monitoring and evaluating organizational activities and employees.
Definitions
Management accounting is that branch of accounting which provides information to managers
for decision making purpose.
Management accounting is the process of identification, measurement, accumulation, analysis,
preparation, interpretation and communication of information that assists managers in specific
decision making within the framework of fulfilling the organizational objectives.
Difference between management accounting and financial accounting
Bases of difference
Financial Accounting
Management Accounting
1)Users and decisions makers
3)Flexibility of practice
Investors, creditors, Government, Customers, and
other users external to the organization.
Assist external users in making investment, credit,
tax and other decisions.
Structured and often controlled by GAAP.
Managers, employees, and decision
makers internal to the organization.
Assist managers in making planning, and
control decisions.
Relatively flexible (no GAAP constraints)
4)Timeline of information
Often available when an audit is complete
5)Time dimension
Focus on historical
predictions
6)Focus of information
Emphasis on whole organization
7)Nature of information
Monetary
2)purpose of information
Source person: Mr. Kamran Khan
M.Com, B.Com, D.Com…
information
with
Available quickly without the need to
waiting for an audit.
some Much information are projections,
estimates as well as historical
information also presented.
Emphasis on organization’s projects,
processes and subdivisions.
Monetary but also non-monetary
MIHE
Mashal Institute of Higher Education
Management Accounting
3
Difference between management accounting and cost accounting
Cost accounting is related to the historical information of product and service.
Management accounting is related to historical information of cost accounting as well as
forward-looking information such as budgets.
Topic: types of cost and cost behaviors
Cost classification:
Cost can be classified on different bases. Such as:
1)
2)
3)
4)
Element- cost are classified as material, labor, expenses or (overheads)
By time-Historical or pre-determined.
Behavior- cost are classified as being fixed cost, variable cost, semi-variable costs
Function- costs are classified as being production or non-production costs.
Classification by Element:
a. Materials- the substance from which the product is made. For example for furniture,
wood, nail, steel, and color etc.
b. Labor cost: the wages paid to workers for making product.
c. Factory overhead- All other costs which are not materials or labor costs are the
other costs. This includes indirect labor, indirect materials, factory building and
machineries depreciation and insurance, electricity and stationary consumed at
factory etc.
The material and labor cost may be direct or indirect.
a. Direct labor: the cost of those employees who are directly engaged in making
the product is called direct labor cost.
b. Direct material: the material that is traceable in the product is called direct
material cost.
c. Indirect labor: wages of workers who are not directly engaged in making the
product.
d. Indirect material: the other materials that is not directly traceable in a
product.
Source person: Mr. Kamran Khan
M.Com, B.Com, D.Com…
MIHE
Mashal Institute of Higher Education
Management Accounting
4
Classification by time
According to time cost may be:
1. Historical cost: that cost which is ascertained after they have been incurred. Such costs
are available only when the production of a particular thing has already been done.
2. Pre-determined cost: that cost which is ascertained before they have been incurred. It
may be:
a. Estimated cost: projected cost before goods are produced.
b. Standard cost: cost set in advance for each element of cost like material, labor and
overhead.
Classification by behavior:
1) Fixed cost: the cost which will not change with volume or activity is called fixed cost. Examples;
rent of the building,
2) Variable cost: the cost which will change with volume or activity is called variable cost.
Examples; material cost, labor cost,
3) Semi variable cost: Semi-variable cost contains both fixed cost and variable costs
elements and are therefore partly affected by fluctuations in the level of activity.
Example; landline telephone bill, electricity charges.
Classification by function:
Costs are classified as being production or non-production costs.
1) Production cost: Production costs are the cost which is incurred when raw materials are
converted into finished goods and part-finished good (working in progress).
Production Costs
Direct material
Direct labor
Direct Expenses
Indirect costs
2) Non-production cost: Non-production costs are costs that are not directly associated
with the production processes in a manufacturing organization.
Source person: Mr. Kamran Khan
M.Com, B.Com, D.Com…
MIHE
Mashal Institute of Higher Education
Management Accounting
5
a. Administrative Costs: the costs involved in running the general administration of the
organization. One of the most common examples of administrative expenses is the cost
of utilities. Charges for heating, cooling, power, and water are all usually classified as
administrative expenses. The costs for internet, landline and mobile telephone services
are also included in these expenses. Administrative salaries and wages plus applicable
fringe benefits, auditing, legal fees, office supplies, postage, communications, dues,
subscription, and miscellaneous items of costs.
Maintenance and housekeeping salaries and wages plus fringe benefits, facility cost such as
depreciation, rental of space, maintenance and repair, utilities, insurance
b. Selling Costs: costs associated with seeking and stimulating demand and taking
orders from customers who wish to buy an organization’s products. Examples of
selling overhead are advertisement and publicity expenses, salary, commission and
benefits of sales force, bad debts, and show room costs, costs of catalogue and price lists,
sales office stationary and printing and packing materials.
c. Distribution costs: the cost involved in distribution an organization’s finished
products, such as cost of running the warehouse or delivery costs.
d. Finance Costs: the costs that are incurred in order to finance an organization, for
example, loan interest.
Once costs have been analyzed as being production or non-production costs, management may
wish to collect the costs together on a cost card. A cost card (or cost sheet) or unit cost card
lists out all of the costs involved in making one unit of a product.
Cost behavior per unit of production
Cost per unit behaves differently than the total cost of production. Following tables show the
difference in behavior.
Increasing Production Volume Situation
Fixed cost
Variable cost
Total cost
Per unit
Decrease
Constant
Decrease
Total cost
Constant
Increases
Increase
Decreasing Production Volume Situation
Source person: Mr. Kamran Khan
M.Com, B.Com, D.Com…
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Mashal Institute of Higher Education
Management Accounting
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Per unit
Increase
Constant
Increase
Fixed cost
Variable cost
Total cost
Total cost
Constant
Decreases
Decrease
Increase or decrease in production volume causes no change to the variable cost per unit it
remains constant, assuming there is not rebate in case of bulk purchase and the labor receives
constant rate despite change in production volume.
Whereas, increase in production volume causes a decrease in fixed cost per unit and in the
same way a decrease in production volume causes an increase in fixed cost per unit.
Following example helps understanding this concept.
Total fixed cost
= Rs. 4,000
Per unit variable cost
= Rs. 3
Cost per unit at different activity levels 1000, 2000, 4000, and 5000 units
Fixed cost
Variable cost
Total cost
1000 units
$ Per $ total
unit
4
4000
3
3000
7
7000
20000 units
$ Per $ total
unit
2
4000
3
6000
5
10000
4000 units
$ Per $ total
unit
1
4000
3
12000
4
16000
5000 units
$ Per $ total
unit
0.8
4000
3
15000
3.8
19000
Important terminologies
Cost Unit
It is a unit of a product or service in relation to which the cost is ascertained, i.e. it is the unit of
the output or product of the business. In simple words the unit for which cost of producing the
units is identified /allocated.
Example



Ball point for a Ball point manufacturing entity
Bottle for Beverage producing entity
Fan for a Fan manufacturing entity
Cost Center
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M.Com, B.Com, D.Com…
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Mashal Institute of Higher Education
Management Accounting
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Cost centre is a location where costs are incurred and may or may not be attributed to cost
units.
Examples





Workshop in a manufacturing concern
Auto service department
Electrical service department
Packaging department
Janitorial service department
Revenue Centre
It is part of the entity that earns sales revenue. Its manager is responsible for the revenue
earned not for the cost of operations.
Examples


Sales department
Factory outlet
Profit Centre
Profit centre is a section of an organization that is responsible for producing profit.
Examples


A branch
A division
Investment Centre
An investment centre is a segment or a profit centre where the manager has significant degree
of control over his/her division’s investment policies.
Examples


A branch
A division
Relevant Cost
Relevant cost is which changes with a change in decision. These are future costs that effect the
current management decision.
Examples
Source person: Mr. Kamran Khan
M.Com, B.Com, D.Com…
MIHE
Mashal Institute of Higher Education
Management Accounting


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Variable cost
Fixed cost which changes within an alternatives
Irrelevant Cost
Irrelevant costs are those costs that would not affect the current management decision.
Example
A building purchased in last year, its cost is irrelevant to affect management decisions.
Sunk Cost
Sunk cost is the cost expended in the past that cannot be retrieved on product or service.
Example
The entity purchase stationary in bulk last month. This expense has been incurred and hence
will not be relevant to the management decisions to be taken subsequent to the purchase.
Opportunity Cost
Opportunity cost is the value of a benefit sacrificed in favor of an alternative.
Example
An investor invests in stock exchange he foregoes the opportunity to invest further in his hotel.
The profit which the investor will be getting from the hotel is opportunity cost.
Product Cost
Product cost is a cost that is incurred in producing goods and services. This cost becomes part
of inventory.
Example
Direct material, direct labor and factory overhead
Period Cost
The cost is not related to production and is matched against on a time period basis. This cost is
considered to be expired during the accounting period and is charged to the profit & loss
account.
Example
Selling and administrative expenses
Source person: Mr. Kamran Khan
M.Com, B.Com, D.Com…
MIHE
Mashal Institute of Higher Education
Management Accounting
9
Historical Cost
It is the cost which is incurred at the time of entering into the transaction. This cost is verifiable
through invoices/agreements. Historical cost is an actual cost that is borne at the time of
purchase.
Example
A building purchased for Rs 400,000, has market value of Rs. 1,000,000. Its historical cost is Rs.
400,000.
Standard Cost
Standard cost is a Predetermine cost of the units.
Example
Standard cost for a unit of product ‘A’ is set at Rs 30. It is compared with actual cost incurred
for control purposes.
Implicit Cost
Implicit cost imposed on a firm includes cost when it foregoes an alternative action but doesn't
make a physical payment. Such costs are related to forgone benefits of any single transaction,
and occur when a firm:
Example


Uses its own capital or
Uses its owner's time and/or financial resources
Explicit Cost
Explicit cost is the cost that is subject to actual payment or will be paid for in future.
Example



Wage
Rent
Materials
Differential Cost or Incremental cost
It is the difference of the costs of two or more alternatives.
Example Difference between costs of raw material of two categories or quality
Source person: Mr. Kamran Khan
M.Com, B.Com, D.Com…
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Mashal Institute of Higher Education