ACC0002
Cost and Management Accounting
Lesson 1
Introduction to Cost Accounting, Cost
Assignments and Forecasting Techniques
1
Learning Outcomes
1. Identify the functions of a cost and
management accounting system.
2. Understand how costs are assigned to cost
objects.
3. Explain why departmental overhead rates
should be used in preference to a single
blanket overhead rate.
4. Construct an overhead analysis sheet and
calculate cost centre allocation rates.
2
Learning Outcomes
5. Justify why budgeted overhead rates
should be used in preference to overhead
rates.
6. Use of forecasting techniques.
3
What is Accounting?
A system of recording and processing financial
data
Organizing and presenting the information in a
way useful for decision making
4
A Systems Framework
Operational Model of an Accounting Information System
5
What is
Management Accounting?
An internal accounting system
Designed to support the information
needs of managers
6
Work of Management
Planning
Controlling
Decision
Making
7
Financial Accounting vs Management Accounting
Dimension Financial Accounting Management Accounting
Produces information for use by Produces information for
Users external parties, usually internal use, usually the
shareholders, banks and management and
creditors employees
Time Horizon Report is a historical record of Management report is
performance both a historical record
and a forward planning
tool
Requirement Incorporated companies have No legal requirement
to submit the annual returns,
with certain exemptions
8
Financial Accounting vs Management Accounting
Dimension Financial Accounting Management Accounting
Area of Results are usually Focus on specific
focus aggregated. However, function/area/activities of an
segmented information may entity. Information aid in the
be provided. decision making process, rather
than being an end product of
such a decision making process
Measurem Reports are monetary in Reports may be monetary or
ent nature non-monetary in nature
Regulatory Report must comply with No specific format
rules certain frameworks,
regulated by Companies
Act, Singapore FRS
9
Assigning Costs to Cost Objects
Direct costs Indirect costs
• Costs that can be • Costs that cannot be
easily and conveniently easily and conveniently
traced to a unit of product traced to a unit of product
or other cost object. or other cost object.
• Examples: direct • Example: manufacturing
material and direct labour overhead
Common costs
Indirect costs incurred to support a number of
cost objects. These costs cannot be traced to
any individual cost object.
10
Classifications of Manufacturing
Costs (aka Product Costs)
Direct Direct Manufacturing
Materials Labour Overhead
The Product
11
Direct Materials
Raw materials that become an integral part of
the product and that can be conveniently
traced directly to it.
Example: A radio installed in an automobile
12
Direct Labour
Those labour costs that can be easily traced to
individual units of product.
Example: Wages paid to automobile assembly
workers
13
Manufacturing Overhead
Manufacturing costs that cannot be easily traced
directly to specific units produced.
Examples: Indirect materials and indirect labour
Materials used to support Wages paid to employees
the production process who are not directly
involved in production
Examples: lubricants and work
cleaning supplies used in Examples: maintenance
the automobile assembly workers, supervisors and
plant. security guards.
14
Non-manufacturing Costs (aka
Period Costs)
Selling Administrative
Costs Costs
Costs necessary to
secure the order All executive,
and deliver the organisational, and
product. clerical costs.
15
Non-manufacturing Costs
• Marketing (selling) costs are the costs necessary to
market, deliver, and service a product or service.
• Example: Advertising, sales commissions, and freight
out.
• Administrative costs are the costs associated with
research, development, and general administration of
the organization that cannot reasonably be assigned to
either marketing or production.
• Example: Legal fees, salary of the chief executive
officer.
16
Cost Classifications for Preparing
Financial Statements
Manufacturing costs/Product Non-manufacturing
costs include direct materials, costs/Period costs include
direct labour, and all selling costs and
manufacturing overhead. administrative costs.
Inventory Cost of Good Sold Expense
Sale
SOFP SCI SCI
17
Quick Check ✓
Which of the following costs would be considered a
period rather than a product cost in a
manufacturing company?
A. Manufacturing equipment depreciation.
B. Property taxes on corporate headquarters.
C. Direct materials costs.
D. Electrical costs to light the production facility.
E. Sales commissions.
18
Cost Assignment
Direct and indirect costs
• Direct costs CAN be specifically and exclusively
identified with a given cost object.
• Indirect costs CANNOT be specifically and
exclusively identified with a given cost object.
• Indirect costs (i.e. overheads) are ASSIGNED to
cost objects on the basis of cost allocations.
20
Cost Allocation: Allocation Base
An allocation base, such as direct labour-hours or
machine-hours, is used to assign manufacturing
overhead to individual jobs.
We use an allocation base because:
a.It is impossible or difficult to trace overhead costs to
particular jobs.
b.Manufacturing overhead consists of many different items
ranging from the grease used in machines to the production
manager’s salary.
c.Many types of manufacturing overhead costs are fixed even
though output fluctuates during the period.
21
Cost Allocation: Manufacturing
Overhead Application
The predetermined overhead rate (POAR) used to
apply overhead to jobs is determined before the
period begins.
Estimated total manufacturing
overhead cost for the coming period
POAR =
Estimated total units in the
allocation base for the coming period
Ideally, the allocation base
is a cost driver that causes
overhead.
22
Cost Allocation: Manufacturing
Overhead Application – Example 1
Assigning indirect costs using blanket/plant-wide
overhead rates
Example
Total overheads = £900 000
Direct labour (or machine hours) = 60 000
Overhead rate = £15 per hour
23
Cost Allocation: Manufacturing
Overhead Application – Example 2
Assume that the company has 3 separate departments and
costs and hours are analysed as follows:
Product Z requires 20 hours (all in department C)
Conclusion: Separate departmental rates should be used since
product Z only consumes overheads in department C.
24
Cost Allocation: Manufacturing
Overhead Application
• A blanket overhead rate can only be justified if all products
consume departmental overheads in approximately the
same proportions
• If a diverse range of products are produced consuming
departmental resources in different proportions, separate
departmental (or cost centre) rates should be established
• Where a department contains a number of different centres
(each with significant overhead costs) and products
consume overhead costs for each centre in different
proportions, separate overhead rates should also be
established for each centre within a department
25
Cost Allocation
A two-stage allocation process to establish
departmental or cost centre overhead rates
Stage 1 – Assign overheads initially to cost centres (aka cost
pools)
Stage 2 – Allocate cost centre overheads to cost objects
(e.g. products) using selected allocation bases/cost
drivers (e.g. direct labour hours or direct machine
hours).
REFER TO COST ALLOCATION WORKSHEET
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The Need for a POAR
Predetermined overhead rates rely upon
estimated data because…
Actual Actual
overhead for overhead costs
the period is can fluctuate
not known until seasonally,
the end of the thus misleading
period. decision
makers. 27
Mixed Costs
(also called semi-variable costs)
A mixed cost contains both variable and fixed
elements. Consider the example of utility cost.
Y
Total Utility Cost
Variable
Cost per KW
X Fixed Monthly
Activity (Kilowatt Hours) Utility Charge
28
Mixed Costs
The total mixed cost line can be expressed
as an equation: Y = a + bX
Where: Y = The total mixed cost.
a = The total fixed cost (the
Y vertical intercept of the line).
b = The variable cost per unit of
Total Utility Cost
activity (the slope of the line).
X = The level of activity.
Variable
Cost per KW
X Fixed Monthly
Activity (Kilowatt Hours) Utility Charge
29
Mixed Costs – An Example
If your fixed monthly utility charge is $40, your
variable cost is $0.03 per kilowatt hour, and your
monthly activity level is 2,000 kilowatt hours, what is
the amount of your utility bill?
Y = a + bX
Y = $ ____ + ($___×____)
Y = $
30
Separating Costs
Accounting records typically show only the total cost
and the associated amount of activity of a mixed
cost item.
Therefore, it is necessary to separate the total cost
into its fixed and variable components.
How do we separate the
costs?
32
Separating Costs (Cont’d)
Three methods:
1.Scattergraph method
2.High-Low method
3.Method of Least Squares (not in exam)
33
Scattergraph Plots – An Example
Assume the following hours of maintenance work
and the total maintenance costs for six months.
34
The Scattergraph Method
Plot the data points on a graph (Total Cost Y “dependent
variable” vs. Activity X “independent variable”).
Y Scattergraph Method
$10,000
Total Maintenance Cost
$9,500
$9,000
$8,500
$8,000
$7,500
$7,000 X
400 500 600 700 800 900
Hours of Maintenance
35
The High-Low Method – An Example
The variable cost
per hour of
maintenance is
equal to the change
in cost divided by
the change in hours.
$2,400
= $6.00/hour
400
36
The High-Low Method – An Example
Total Fixed Cost = Total Cost – Total Variable Cost
Total Fixed Cost = $9,800 – ($6/hour × 850 hours)
Total Fixed Cost = $9,800 – $5,100
Total Fixed Cost = $4,700
37
The High-Low Method – An Example
The Cost Equation for Maintenance
Y = $4,700 + $6.00X
38
Quick Check ✓
Sales salaries and commissions are $10,000
when 80,000 units are sold, and $14,000 when
120,000 units are sold. Using the high-low
method, what is the variable portion of sales
salaries and commission?
a. $0.08 per unit
b. $0.10 per unit
c. $0.12 per unit
d. $0.125 per unit
39
Quick Check ✓
Sales salaries and commissions are $10,000
when 80,000 units are sold, and $14,000 when
120,000 units are sold. Using the high-low
method, what is the fixed portion of sales
salaries and commissions?
a. $ 2,000
b. $ 4,000
c. $10,000
d. $12,000
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