Unformatted text preview: MANAGEMENT ACCOUNTING PART 1
CPA SECTION 2 STUDY TEXT Contact: 0707 737 890 Page 1 MANAGEMENT ACCOUNTING
This paper is intended to equip the candidate with knowledge, skills and attitudes that will enable
him/her to apply management accounting principles and concepts in business
A candidate who passes this paper should be able to:
- Estimate the cost of goods and services
Analyse product costs for manufacturing and non-manufacturing activities
Prepare marginal and absorption cost statements
Analyse an organisation's activities through budgetary control process
Analyse variances for decision making
Use computers in cost management CONTENT
1. Nature and purpose of cost and management accounting
- The nature of cost accounting and costing terms
The role of cost accounting in management
The purposes of cost accounting information
Scope of cost accounting
Meaning of management accounting, scope, limitations, applications
Relationship between cost, financial and management accounting
Selection of an ideal cost accounting system 2. Cost classification
- Definition and purpose of cost classification
Methods of cost classification: By nature/elements of manufacturing costs; Functional
classification; Behavioral classification; Controllability; Time; Financial accounting;
Identification with inventory; For decision making 3. Cost estimation
- Meaning of cost estimation
Methods of estimating cost; non-mathematical methods like engineering method, accounts
analysis method and high-Iow method; mathematical methods like scatter graph method, OLS
regression method (simple linear regression only) 4. Cost accumulation
- Accounting for materials and inventory; material cost records, purchasing procedures, receipt
and issues of material, methods of valuing material issues, inventory control procedures;
economic order quantity (EOQ) and economic batch quantity(EBQ) models and back flush
Contact: 0707 737 890 Page 2 - - Accounting for labour: Methods of labour remuneration, labour control procedures,
maintenance of labour records
Accounting for overheads: Types of overheads, manufacturing, distribution and
administration, service departmental cost allocation and apportionment, overheads analysis,
overhead absorption rates, over or under absorption
Activity based costing 5. Cost bookkeeping
- The flow of costs in a business enterprise
Cost bookkeeping- interlocking and integrated ledger systems 6. Costing methods
- Job order costing
Process costing (including work in progress; joint and by-products)
Unit costing 7. Marginal and absorption costing.
- Distinction between marginal and absorption costing
Valuation of products under marginal and absorption costing
Preparation of marginal and absorption statements; cost of production and profit
Applications of marginal costing: Break-even analysis and charts (single product)
Simplified decision problems; accept or reject, special order, dropping a product, make or buy
Operating statements 8. Budgeting and budgetary control
- Nature and purposes of budgets
Preparation of budgets; master budgets, functional (department budgets, cash budgets),
proforma financial reports (income statements and balance sheets)
Purpose of budgetary control; operation of a budgetary control system, organisation and
coordination of the budgeting function
Distinction between budgeting and budgetary control in the private and public sectors 9. Standard costing
- Types of standards
Principles of setting standards
Standard cost card
Behavioural aspects of standard costing
Generation of standard cost information
Materials, labour and overheads variances; price and efficiency variances Contact: 0707 737 890 Page 3 10. Cost management
- Value chain-research and development-design-production-marketing distribution and
Just in time (JIT)
Use of computers in costing; job costing, inventory management, labour costing, cost entre
analysis, coding, budgeting and decision making 11. Overview of Performance Measurement
- Purpose of performance measurements
Financial performance measures: profitability, liquidity, activity and gearing
Non-financial performance measures. The balanced score card perspective 12. Emerging issues and trends
Topic 1: Nature and purpose of cost and management accounting……………………..…….5
Topic 2: Cost classification…………………………………………………………………...24
Topic 3: Cost estimation…………………………………………………………………...…33
Topic 4: Cost accumulation………………………………………………………………..…48
Topic 5: Cost bookkeeping……………………………………………………………….…126
Topic 6: Costing methods.......................................................................................................139
Topic 7: Marginal and absorption costing..............................................................................182
Topic 8: Budgeting and budgetary control.............................................................................221
Topic 9: Standard costing.......................................................................................................250
Topic 10: Cost management...................................................................................................283
Topic 11: Overview of Performance Measurement...............................................................291 Revised on: June 2016 Contact: 0707 737 890 Page 4 TOPIC 1
NATURE AND PURPOSE OF COST AND ACCOUNTING
THE NATURE OF COST ACCOUNTING AND MANAGEMENT ACCOUNTING
Cost accounting is a type of accounting process that aims to capture a company's costs of production
by assessing the input costs of each step of production as well as fixed costs such as depreciation of
capital equipment. Cost accounting will first measure and record these costs individually, then
compare input results to output or actual results to aid company management in measuring financial
The nature of cost accounting can be brought out under the following headings:
1. Cost accounting is a branch of knowledge: Though considered as a branch of financial
accounting, cost accounting is one of the important branch of knowledge, i.e., a discipline by
itself. It is an organised body of knowledge consisting of its own principles, concepts and
conventions. These principles and rules vary from industry to industry.
2. Cost accounting is a science: Cost accounting is a science as it is a body of systematic
knowledge relating to not only cost accounting but relating to a wide variety of subjects such
as law, office practice and procedure, data processing, production and material control, etc. It
is necessary for a cost accountant to have intimate knowledge of all these field of study in
order to carry on his day-to-day activities. But it is to be admitted that it is not a perfect
science as in the case of natural science.
3. Cost accounting is an art: Cost accounting is an art in the sense it requires the ability and
skill on the part of cost accountant in applying the principles, methods and techniques of cost
accountancy to various management problems. These problems include the ascertainment of
cost, control of costs, ascertainment of profitability, etc.
4. Cost accounting is a profession: In recent years cost accounting has become one of the
important professions which has become more challenging.
While cost accounting is often used within a company to aid in decision making, financial
accounting is what the outside investor community typically sees. Financial accounting is a different
representation of costs and financial performance that includes a company's assets and liabilities.
Cost accounting can be most beneficial as a tool for management in budgeting and in setting up cost
control programs, which can improve net margins for the company in the future.
One key difference between cost accounting and financial accounting is that while in financial
accounting the cost is classified depending on the type of transaction, cost accounting classifies costs
according to information needs of the management. Cost accounting, because it is used as an internal
Contact: 0707 737 890 Page 5 tool by management, does not have to meet any specific standard and as result varies in use from
company to company or from department to department.
Development of Cost Accounting
Scholars have argued that cost accounting was first developed during the industrial revolution when
the emerging economics of industrial supply and demand forced manufacturers to start tracking
whether to decrease the price of their overstocked goods or decrease production.
During the early 19th century when David Ricardo and T. R. Malthus were developing the field
of economic theory, writers like Charles Babbage were writing the first books designed to guide
businesses on how to manage their internal cost accounting.
By the beginning of the 20th century, cost accounting had become a widely covered topic in the
literature of business management.
Types of Cost Accounting
Standard Cost Accounting
This type of of cost accounting uses ratios to compare efficient uses of labor and materials to
produce goods or services under standard conditions. Assessing these differences is called a variance
analysis. Traditional cost accounting essentially allocates cost based on one measure, labor or
machine hours. Due to the fact that overhead cost has risen proportionate to labor cost since the
genesis of standard cost accounting, allocating overhead cost as an overall cost has ended up
producing occasionally misleading insights.
Some of the issues associated with cost accounting is that this type of accounting emphasizes labor
efficiency despite the fact that it makes up a comparatively small amount of the costs for modern
Activity Based Costing
Activity based accounting is defined as, "an approach to the costing and monitoring of activities
which involves tracing resource consumption and costing final outputs, resources assigned to
activities, and activities to cost objects based on consumption estimates. The latter utilize cost
drivers to attach activity costs to outputs."
Activity based costing accumulates the overheads from each department and assigns them to specific
cost objects like services, customers, or products. The way these costs are assigned to cost objects
are first decided in an activity analysis, where appropriate output measures are cost drivers. As
result, activity based costing tends to be much more accurate and helpful when it comes to helping
managers understand the cost and profitability of their company's specific services or products.
Accountants using activity based costing will pass out a survey to employees who will then account
for the amount of time they spend on different tasks. This gives management a better idea of where
their time and money is being spent. Contact: 0707 737 890 Page 6 Lean Accounting
Lean accounting is an extension of the philosophy of lean manufacturing and production developed
by Japanese companies in the 1980s. Most accounting practices for manufacturing work off the
assumption that whatever is being produced is done in a large scale. Instead of using standard
costing, activity based costing, cost-plus pricing, or other management accounting systems, when
using lean accounting those methods are replaced by value-based pricing and lean-focused
performance measurements, for example, using a box score to facilitate decision making and create
simplified and digestible financial reports.
Considered a simplified model of cost accounting, marginal costing (sometimes called cost-volumeprofit analysis) is an analysis of the relationship between a product or service's sales price, the
volume of sales, the amount produced, expenses, costs and profits. That specific relationship is
called the contribution margin. The contribution margin is calculated by dividing revenue minus
variable cost by revenue. This type of analysis can be used by management to gain insight on
potential profits as impacted by changing costs, what types of sales prices to establish, and types of
Types of Costs
Fixed Costs are costs that don't vary depending ont he amount of work a company is doing. These
are usually things like the payment on a building, or a piece of equipment that is depreciating at a
fixed monthly rate.
Variable costs are tied to a company's level of production. An example could be a coffee roaster,
who after receiving a large order of beans from a far-away locale, has to pay a higher rate for both
shipping, packaging, and processing.
Operating costs are costs associated with the day-to-day operations of a business. These costs can
be either fixed or variable depending.
Direct costs is the cost related to producing a product. If a coffee roaster spends 5 hours roasting
coffee, the direct costs of the finished product include the labor hours of the roaster, and the cost of
the coffee green. The energy cost to heat the roaster would be indirect because they're inexact, hard
to trace. THE ROLE OF COST ACCOUNTING IN MANAGEMENT
Cost accounting is utilized for a number of purposes, some of which are briefly described in the
a) Accounting for costs
This may be seen as a record keeping or score-keeping role. Information must be gathered
and analyzed in a manner which will help in planning, controlling and decision making
Contact: 0707 737 890 Page 7 b) Planning and budgeting
This involves the quantification of plans for future operations of the enterprise; such plans
may be for the long or short term, for the enterprise as a whole or for the individual aspects of
c) Control of operations of the enterprise
Control may be assisted by the comparison of actual cost information with that included in
the plan. Any differences between planned and actual events can be investigated and
corrective action implemented as appropriate
d) Decision making
Cost accounting information assists in the making of decisions about future operations of the
enterprise; such decisions making may be assisted by the information from cost techniques
and cost-volume-profit analysis.
e) Resource allocation decisions
For example product pricing in determining whether to accept or reject jobs. This is based on
cost and revenue implications of the relevant decisions
f) Performance evaluation
Cost accounting information is used to measure and evaluate actual performance so as to
make a decision of the degree of optimality or efficiency of resource utilization. THE PURPOSES OF COST ACCOUNTING INFORMATION
Functions and objectives of cost and management accounting include the following:
Monitoring & Control
Accountability 1. Planning
Planning is an important function of management accounting which is most effectively performed
by the preparation of budgets and forecasts.
Forecasting is the process of estimation of the expected financial performance and position of a
business in the future. Common types of forecasts include cash flow forecast, projected profit and
loss and balance sheet forecast. Forecasts assist in determining the likely change in the financial
performance and position of a business when considered in the context of the various assumptions
used in forming the projections. Forecasting is the starting point in determining the resource
requirements of a business which are quantified into budgets.
Contact: 0707 737 890 Page 8 Budgets quantify the financial targets to be achieved by the management of an organization.
Budgeting process often begins with the preparation of a master budget which is then used as a basis
for the preparation of departmental and operational budgets. Budgeting helps in the effective
allocation of resources of an organization between competing needs (e.g. departments, products, etc)
in order to achieve the financial goals of a business. Budgets and forecasts help businesses to deal
with potential problems proactively and avoid foreseeable bottlenecks in business resources.
2. Decision Making
Management accounting facilitates the provision of financial information to management for
decision making. Management accounting also involves the evaluation of alternative strategies and
actions by the application of techniques and concepts such as relevant costing, cost-volume-profit
analysis, limiting factor analysis, investment appraisal techniques and client / product profitability
3. Monitoring & Control
Control process in management accounting system starts by defining standards against which
performance may be measured such as standard costs and budgets. Actual results are measured and
any variance between targets and results are analyzed and where necessary, corrective actions are
taken. Management accounting plays a vital role in the monitoring and control of cost and efficiency
of the routine processes and as well as one-off jobs and projects undertaken by an organization.
Management accounting lays great emphasis on accountability through effective performance
measurement. By setting targets for strategic business units and as well as for departments,
management accounting assists in the assignment of responsibility for the achievement of business
targets by individual managers. Responsibility accounting is achieved by appraising the performance
of managers responsible for their business units while giving due consideration for factors not within
their control or influence.
COST ACCOUNTING DEPARTMENT AND ITS RELATION WITH OTHER
Cost accounting department records, classifies and present cost information for manufacturing and
other activities of the organisation. It makes an analysis of cost of manufacturing, marketing and
administration and provides control reports and other decision making data to all levels of
management for the purpose of controlling and reducing costs.
It is, therefore, necessary that cost accounting department should have a proper coordination with
other departments of the organisation. All departments should help each other so that the objective
of minimum possible cost may be achieved without too many bottle-necks.
1. Cost Accounting Department and Production Department:
Cost accounting department and production department are closely related to each other.
Production department is concerned with the conversion of raw materials into finished
Contact: 0707 737 890 Page 9 products. Cost accounting department helps in estimating the various costs involved in the
manufacturing process like material cost, labour cost and other expenses involved for
manufacturing a product.
As per cost estimates, production department makes timely arrangement of material, labour
and other services required for the manufacturing process so that production may go on
smoothly without any interruption. Cost accounting department is concerned with
ascertaining, controlling and reducing cost of the manufacturing process.
The required information regarding costs relating to the manufacturing process both budgeted
and actual is collected by cost accounting department from the production department and
sent to the management for exercising cost control.
In a competitive world for facing competition effectively, reducing cost of production is a
very important function. Both production department and cost accounting department can
help each other in reducing cost of production which is the crying need of the competitive
2. Cost Accounting Department and Purchases Department:
Purchase department is to ensure that right type of material is purchased at a reasonably low
price at a right time from a right supplier and there is no excessive investment in materials.
Continuous availability of material is to be ensured so that production may not be held up for
want of materials.
In these respects cost accounting department can help purchase department by setting various...
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