UNIT 9: MANAGEMENT
ACCOUNTING: COSTING AND
BUDGETING
LECTURER: JUDITH ROBB-WALTERS
UNIT 9: MANAGEMENT ACCOUNTING:
COSTING AND BUDGETING
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LEARNING OBJECTIVE1: BE ABLE TO ANALYSE
COST INFORMATION WITHIN A BUSINESS
THE BASIC SYLLABUS
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1. Be able to analyse cost information within a business.
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2.Be able to propose methods to reduce costs and
enhance value within a business.
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3. Be able to prepare forecasts and budgets for a
business.
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4. Be able to monitor performance against budgets
within a business.
LEARINGING OUTCOMES
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Be able to analyse cost information within
a business
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At the end of the class the students should be able to:
1.1 Classify different types of cost
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OVERVIEW
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Cost behaviour means how a cost will react
or respond to changes in the level of
business activity. As the activity level rises
and falls, a particular cost may rise and fall as
well – or it may remain constant. For
planning purposes, a manager must be able
to anticipate which of these will happen; and
if a cost can be expected to change, the
manager must know by how much it will
change. To help make such distinctions, costs
are often categorized as variable or fixed.
MATERIALS
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The materials that go into the final product
are called raw materials. This term is
somewhat misleading, since it seems to imply
unprocessed natural resources like wood
pulp or iron ore. Actually, raw materials refer
to any materials that are used in the final
product; and the finished product of one
company can become the raw materials of
another company. Direct materials are those
materials that become an integral
part of the finished product and that can be
physically and conveniently traced to it.
MATERIALS
Sometimes it isn’t worth the effort to
trace the costs of relatively insignificant
materials to the end products. Such minor
 items would include the solder used to
make electrical connections in a TV.
Materials such as solder and glue are
called indirect materials and are included
as part of manufacturing overhead, which
is discussed later in this section.
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LABOUR
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Labour cost is the second important
element of cost of production. Wages,
salaries and other forms of remunerations
represent a major portion of the total
cost of a product or services. The growth
and profitability of the concern depends
upon proper utilization of human
resources or labour forces which in turn
needs proper accounting and control of
cost.
LABOUR
Thus, control of labour cost is a very
significant issue from the viewpoint of
management.
 Types of labour Cost
 The labour cost can be classified into two
types :
 (1) Direct labour Cost.
 (2) Indirect labour Cost.
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overheads
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Overheads – Overheads comprise of indirect materials,
indirect employee costs and indirect expenses which are not
directly identifiable or allocable to a cost object in an
economically feasible way.
Overheads are to be classified on the basis of functions to
which the overheads are related
- Production overheads
- Administrative overheads
- Selling overheads
- Distribution overheads
Overheads may also be classified on the basis of behaviour
such as variable overheads, semi-variable overheads and fixed
overheads.
overheads
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Variable overheads comprise of expenses
which vary in proportion to the change of
volume of production. For example, cost of
utilities etc.
Fixed overheads comprise of expenses
whose value do not change with the change
in volume of production such as salaries,
rent etc.
Semi-variable overheads are partly affected
by change in the production volume.
They are further segregated into variable
overheads and fixed overheads
overheads
Any items of overheads arising out of
abnormal situation in business activity should
 not be treated as overheads. They are
charged to Costing Profit and Loss Account.
 Items not related to business activities such
as donation, loss / profit on sale of assets
 etc are also not to be treated as overheads.
 Borrowing cost and other financial charges
including foreign exchange fluctuations
 will not form the part of overheads.
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DIRECT costs
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Direct costs can be defined as costs which
can be accurately traced to a cost object
with little effort. Cost object may be a
product, a department, a project, etc. Direct
costs typically benefit a single cost object
therefore the classification of any cost either
as direct or indirect is done by taking the
cost object into perspective. A particular
cost may be direct cost for one cost object
but indirect cost for another cost object.
DIRECT costs
Most direct costs are variable but this
may not always be the case. For example,
the salary of a supervisor for a month
who has only supervised the construction
of a single building is a direct fixed cost
incurred on the building.
 Examples: Cost of gravel, sand, cement
and wages incurred on production of
concrete.
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INDIRECT costs
Costs which cannot be accurately
attributed to specific cost objects are
called indirect costs. These typically
benefit multiple cost objects and it is
impracticable to accurately trace them to
individual products, activities or
departments etc.
 Examples: Cost of depreciation, insurance,
power, salaries of supervisors incurred in
a concrete plant.
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FIXED COSTS
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A fixed cost is a cost which is incurred
for an accounting period, and which,
within certain activity levels remains
constant.
FIXED COSTS
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Fixed costs can be shown graphically as
follows:
FIXED COSTS
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The total cost remains constant over a given level of activity
but that the cost per unit falls as the level of activity
increases.
Examples of fixed costs include rent, business rates and
executive salaries.
Numerical illustration of a fixed cost graph
If factory rent is $5,000 per month, this cost will be incurred
whether 2 hamburgers are made, or 200 hamburgers are
made - graph 1 demonstrates this.
If 2 hamburgers are made the fixed cost per unit is $5,000/2
i.e. $2,500 per hamburger.
If 200 hamburgers are made the fixed cost per unit is
$5,000/200, i.e. $25 per hamburger.
Therefore, the fixed cost per unit falls at a reducing rate but
never reaches zero - graph 2 demonstrates this.
Variable costs
 Variable
costs are costs that tend to
vary in total with the level of activity.
As activity levels increase then total
variable costs will also increase.
Variable costs
 Variable
costs can be shown
graphically as follows:
Variable costs
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As total costs increase with activity levels, the cost per
unit of variable costs remains constant.
Examples of variable costs include direct costs such as raw
materials and direct labour.
Numerical example of variable costs
A factory is producing shirts. It takes 2 yards to make one
shirt and it costs $2 per yard. If the factory makes 50
shirts if costs $400, if the factory makes 100 shirts it costs
$800. The cost incurred increases inline with the volume
being produced - graph 1 demonstrates this.
The material for each shirt costs 4 x $2 = $8 and it does
not change if more or less shirts are made. The variable
cost per unit remains constant - graph 2 demonstrates
this.
semi-variable costs
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Semi-variable costs contain both fixed and
variable cost elements and are therefore
partly affected by fluctuations in the level
of activity.
semi-variable costs
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Semi-variable costs can be shown
graphically as follows:
semi-variable costs
Examples of semi-variable costs:
 electricity bills (fixed standing charge plus
variable cost per unit of electricity
consumed)
 telephone bills (fixed line rental plus
variable cost per call)
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REVIEW QUESTIONS
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Rule Manufacturing Company – selected data
Five sales reps are paid 10% commissions plus
$5,000 monthly salary each
Utilities cost $10,000 per month plus $10 per
unit manufactured
Materials cost is $75 per unit
Equipment cost $500,000 and has an expected life
of 3,000,000 units with no salvage value
Rent is $100,000 per month
Other salaries are $200,000 per month
From these, we can identify the fixed and variable
costs:
REVIEW QUESTIONS
From the information presented: 1. Identify the fixed and variable costs
 2. Calculate the total fixed and variable
costs.
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BIBLIOGRAPHY
.
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'Cost Terms And Concepts'. 1st ed. McGraw Hill Education, 2015. Print
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Lake Erie. 'Managerial Accounting And Cost Concepts'. 1st ed. 2015. 33.
Print.
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'Labour Cost Control'. A Textbook Of Financial Cost And Management
Accounting. 1st ed. 2015. 368. Print.
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http://www.costauditorindia.co.in/pdf/03CAS-3-Overheads.pdf
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access date: August 31,2015
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Accountingexplained.com,. 'Direct Costs And Indirect Costs Defined |
Examples'. N.p., 2015. Web. 31 Aug. 2015.
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Kfknowledgebank.kaplan.co.uk,. N.p., 2015. Web. 31 Aug. 2015.
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College-cram.com,. 'Fixed Costs And Variable Costs | Finance: Weblog |
College-Cram.Com'. N.p., 2015. Web. 2 Sept. 2015.