Cost MGMT Accounting U1

UNIT 1 i
Management accounting and cost concepts
Unit 1
BAC 301/05
Cost and Management
Accounting
Management
Accounting and Cost
Concepts
ii WAWASAN OPEN UNIVERSITY
BAC 301/05 Cost and Management Accounting
COURSE TEAM
Course Team Coordinator: Dr. Loo Choo Hong
Content Writers: Mr. Lok Char Lee and Dr. Loo Choo Hong
Instructional Designer: Ms. Toh Chee Leng
Academic Members: Ms. Deehbanjili Lakshmayya and Mr. Lim Peng Keat
COURSE COORDINATOR
Dr. Loo Choo Hong
EXTERNAL COURSE ASSESSOR

Associate Professor Dr. Shanmugam Muruswamy, Universiti Tun Abdul Razak
PRODUCTION
Editor: Pelangi Sdn. Bhd.
In-house Editor: Mr. Khoo Chiew Keen
Graphic Designer: Ms. Leong Yin Ling
Wawasan Open University is Malaysia’s first private not-for-profit tertiary institution dedicated to
adult learners. It is funded by the Wawasan Education Foundation, a tax-exempt entity established
by the Malaysian People’s Movement Party (Gerakan) and supported by the Yeap Chor Ee Charitable
and Endowment Trusts, other charities, corporations, members of the public and occasional grants
from the Government of Malaysia.
The course material development of the university is funded by Yeap Chor Ee Charitable and
Endowment Trusts.
© 2008 Wawasan Open University
First revision 2011

Second revision 2014
All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or
transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or
otherwise, without prior written permission from WOU.
Wawasan Open University [DU013(P)]

Wholly owned by Wawasan Open University Sdn. Bhd. (700364-W)
54, Jalan Sultan Ahmad Shah, 10050 Penang.
Tel: (604) 2180333 Fax: (604) 2279214
Email: [email protected]
Website: www.wou.edu.my
UNIT 1 iii
Contents
Unit 1 Management Accounting and
Cost Concepts
Course overview 1
Unit overview 3
Unit objectives 4
1.1 The manager and management accounting 5
Objectives 5
Introduction 5
Management accounting and financial accounting 5
The management accountant’s role in implementing 7

strategy
Value chain, supply chain analysis and key success 8

factors
Organisation structure 14
Profesional ethics 16
Suggested answers to activities 21
1.2 An introduction to cost terms and purposes 23
Objectives 23
Introduction 23
Cost and cost terminology 23
Cost behaviour patterns: Variable costs and fixed costs 26
Unit costs and total costs 30
Business sectors, types of inventory, inventoriable costs 32

and period costs
iv WAWASAN OPEN UNIVERSITY
Different definitions of product costs 36
Suggested answers to activities 39
1.3 Cost-volume-profit relationship 41
Objectives 41
Introduction 41
Cost-volume-profit (CVP) 41
Breakeven point and target operating income 45
Suggested answers to activity 58
Summary of Unit 1 59
Unit practice exercise 61
Suggested answers to self-tests 67
Suggested answers to unit practice exercises 69
References 75
Glossary 77
UNIT 1 1
Course Overview
B AC 301/05 Cost and Management Accounting is a 5-credit higher level course

offered by Wawasan Open University, within the Bachelor of Business in
Accounting programme. It is a core major course and must be taken by all students
to complete their Bachelor of Business in Accounting degree studies. The advisory
prerequisite courses are BBM 205/05 Business Accounting I and BBM 206/05 Business
Accounting II. This is the first of two cost and management accounting courses in
Bachelor of Business in Accounting with BAC 302/05 Advanced Cost and Management
Accounting as the second.
BAC 301/05 Cost and Management Accounting covers a variety of internal company
accounting practices in planning, control and decision-making by management.
While the general subject of accounting can be defined as the identification,
measurement, accumulation, analysis, preparation and communication of the
quantification of economic events within a particular firm, management accounting
can be considered to fulfil these duties with a particular emphasis on cost and price
data. A major means of emphasising cost and price data is to develop budgets and
standards to plan and subsequently monitor the firm’s operations. Since price data
directly affect revenue and cost data directly affect expenses, accurate and useful
management accounting information helps to increase the profits by either increasing
revenue or reducing expenses. Obviously, competent and timely management
accounting is vital for making crucial decisions related to adjusting the revenue or
expenses.
This course contains five units.
Unit 1 deals with the cost and management accountant’s role in the organisation,
cost terms and purposes, and cost-volume-profit relationship. The unit describes
how cost accounting supports management accounting and financial accounting.
Professional ethics issues related to management accounting are also discussed. The
unit further distinguishes between the different types of costs (direct and indirect
costs, fixed and variable costs, unit and total costs). The unit will also cover the
concepts and mechanics of calculating the break even point.
Unit 2 deals with cost behaviours and cost estimation. Accountants are required to
make management planning and control decisions. They need to understand cost
behaviour so that they can make better planning and control decisions.
Unit 2 also discusses how costs behave and explains the techniques of estimating
costs. In order to be more accurate in estimating costs, accountants must understand
the make-up and the behavioural aspects of costs.
The unit will cover some elements of statistics. The high-low and regression analysis
methods, the estimation of regression equation and the goodness of fit will be covered.
Unit 3 explains how the job-order costing system is used by manufacturing and
service companies. Activity-based accounting system, activity-based management
and process product-costing systems are introduced in this unit.
2 WAWASAN OPEN UNIVERSITY
Unit 4 covers budgeting techniques which comprise master budgets, flexible budgets
and standard costs. You will be introduced to standard costing. You will be able to
prepare a budgeted statement of comprehensive income, budget schedules, cash
budgets and budgeted statement of financial position. Flexible and static budgets
are also illustrated. Variance analysis techniques which you will use in your work
to control and measure management’s performance are also discussed in this unit.
The course concludes with Unit 5 which covers product costing and inventory
valuation. The various methods of inventory valuation will also be discussed in
this unit.
By the end of this course, you should be able to:
1. Explain how different costs are used to serve different management

accounting purposes.
2. Apply cost-volume-profit computations in business decision making.
3. Summarise various budgeting approaches.
4. Apply the budgeting approaches to analyse variances.
5. Apply costing systems to various types of operations.

UNIT 1 3
Unit Overview
M anagement accounting information is useful for strategy formulation, budgeting,

production planning, pricing and many other business decisions.
Many large companies are run by senior executives with accounting background. As
a result, the study of cost accounting enables us to understand how managers and
accountants can contribute to the success of their businesses.
Web Reference
Kiruthiga Raguraman ACMA, CGMA, a finance manager at

Centrica Plc has this to say when asked why she chose to become
a management accountant:
In my view, the most important skills one requires in a corporate world

are time management and prioritisation. While all exams help you
in developing your time management skill, my personal favourite is
TOPCIMA1. It mirrors the real world that we face on a day-to-day
basis, by throwing surprises on the exam day and testing your ability
to identify, prioritise and analyse issues and make sensible and feasible
recommendations  all within strict timelines.
To read more of the interview, visit http://www.cimaglobal.com/

Study-with-us/
This unit describes how cost accounting supports management accounting and
financial accounting. Professional ethics issues related to management accounting
are also discussed. The unit further distinguishes between the different types
of costs (direct and indirect costs, fixed and variable costs, unit and total costs)
and the three types of companies in terms of their inventory sections (service
sector, merchandising sector and manufacturing-sector companies). Statements of
comprehensive incomes for a merchandising sector company and manufacturing
sector company are illustrated to help learners visualise the differences between
these two companies. The later part of the unit covers the concepts and mechanics
of calculating the breakeven point (using equation method, Contribution method,
and graph method) and targeted income.
1
This is the final examination of the Chartered Institue of Management Accountants, UK, a profes-
sional body dealing with management accounting.
Unit Objectives
By the end of Unit 1,you should be able to:
1. Distinguish between financial accounting and management accounting.
2. Explain the cost-benefit approach to choosing accounting systems.
3. Describe the role of professional ethics in management accounting.
4. Explain the relationship among cost drivers, variable costs and fixed costs.
5. Construct model statement of comprehensive incomes for a manufacturing

company.
6. Differentiate between inventoriable costs and period costs.
7. Demonstrate three methods of calculating breakeven point and targeted

operating income.
8. Distinguish between contribution and gross margin.

UNIT 1 5
1.1 The Manager and Management

Accounting
Objectives
By the end of this section, you should be able to:
1. Distinguish between financial accounting and management accounting in

terms of purpose of information, primary users, focus and emphasis, etc.
2. Describe the management accountant’s role in implementing strategy,

planning and control.
3. Define professional ethics and explain the standards of ethical conduct for
the management accountant.
Introduction
In this section, you will learn that the management accountant provides information
for managers to make decisions to fulfil the goals of the organisation. The
management accountant also provides information that can affect strategic decisions
and influence the planning and control system of an organisation.
Management accounting and financial accounting

Accounting is defined by the American Institute of Certified Public Accountants
(AICPA) as “the art of recording, classifying, and summarizing in a significant
manner and in terms of money, transactions and events which are, in part at least,
of financial character, and interpreting the results thereof.”
Financial accounting emphasises external reporting to investors, government

agencies, banks and suppliers. Investors review financial statements to make their
investment decisions. Government agencies such as Inland Revenue Board require
financial information for tax purposes. Banks need to review financial statements
and other financial information for lending decisions. Suppliers will review financial
statements before approving credit sales to their customers.
Financial statements are prepared based on generally accepted accounting principles

(GAAP) and approved accounting standards of the respective countries, for example
the Malaysian Financial Reporting Standards (MFRS) in Malaysia.
Many companies implement Enterprise Resource Planning (ERP) system with a

single database that can be used for multiple purposes to support the company’s
business activities, such as purchasing, production, distribution and sales.
Management accounting emphasises the provision and use of accounting information

within organisations. In contrast to financial accounting, management accounting
is forward-looking, intended for internal use by managers, usually confidential
and computed according to the needs of the managers. It helps managers when
making decisions to achieve the organisation’s goals and to develop, communicate
and implement strategy. Managers also use management accounting information
to make decisions related to product design, production, marketing strategy and
performance evaluation.
Table 1.1 summarises the major differences between management accounting and
financial accounting:
Management Accounting Financial Accounting

Purpose Help managers in Communicate financial
making decisions to fulfil information about
organisation’s goals. the organisation’s
performance and
position.
Primary users Internal users such as External users such
managers. as investors, banks,
government agencies
and suppliers.
Focus and emphasis Forward-looking such as Past-oriented in reporting
planning and budgeting the results of business
for next year. operation in previous
years.
Rules of measurement Reference to the needs of According to GAAP and
and reporting the managers. approved accounting
standards.
Time span Hourly, daily, weekly, Quarterly or yearly as
monthly, yearly or longer. required by regulations.
Type of reports Financial and non- Company or group of
financial by products, companies.
departments, territories
and strategies.
Behavioural Influence the behaviour May influence the
implications of managers and other behaviour of managers
employees within the if the compensation
organisation. is based on reported
financial results.
Table 1.1 Differences between management accounting and financial accounting
The history of management accounting
Management accounting was a new invention in the first three decades of the 20th
century. The need to quantify production costs as the reason why “cost accounting”,
the original form of management accounting was needed. The Industrial Revolution
in the United Kingdom, Europe and the United States meant manufacturing evolved
from the simple cottage industry to mass production in a factory.
UNIT 1 7
Hume-Schwarz (2007) describes the evolution of management accounting in the

United States of America. Management accounting evolved from the study of cost
accounting. Cost accounting was introduced in the 1940s as an alternative accounting
technique for the manufacturing sectors as compared to the accounting techniques
used in most businesses back then. Back then cost accounting focused on the
manufacturing accounts. In 1940, John Blocker in his textbook “Cost Accounting”
suggested that cost accounting should not remain solely for the use of accountants
in the manufacturing sector. Cost accounting should also be practised in industries
such as construction, mining, utilities and charities.
In United Kingdom, “The Institute of Cost and Works Accountants”(ICWA) was

established in 1919 which specialised in the development of accounting techniques
for use in the internal control of manufacturing, service and public sector operations.
The institute was founded to promote techniques for providing information needed
to plan and manage businesses. In 1922, ICWA held a conference with the aim of
developing scientific costing. In 1972 the institute changed its name to the Institute
of Cost and Management Accountants (ICMA) and in 1986 adopted the current
name Chartered Institute of Management Accountants (CIMA). Today CIMA is the
leading professional body in the areas of product costing, budgeting, management
accounting, investment appraisal and business decision-making.
The Germans contributed to the discipline of management accounting in the 40s

and 50s with Grenzplankostenrechnung (GPK). GPK provided a method whereby
management costs can be calculated and assigned to the costing of products and
services. This is the start of the study of job costing (which we will cover in this
course). The Toyota Production System (TPS) or “Just In Time” manufacturing
introduced between 1948 and 1975 organises manufacturing and logistics for the
automobile manufacturer, including interaction with suppliers and customers. This
is the precursor to lean accounting. Lean accounting helps the enterprise eliminate
waste, free up capacity, speed up the process, eliminate errors and defects, and make
the process clear and understandable.
The management accountant’s role in implementing strategy

Business strategy refers to the aggregated strategies of an organisation. A firm may
formulate a business strategy either in cost leadership, product differentiation, or
focus on sustainable competitive advantage and long-term success. Strategy specifies
how an organisation will compete and the opportunities its managers should pursue.
An organisation should match its own capabilities with the opportunities in the
marketplace to achieve its goals.
Deciding which strategy to be adopted is a critical part of what managers need to

do. Management accountants assist managers to formulate business strategy by
providing information about the cost, productivity and efficiency advantage of their
company relative to its competitors.
Strategy cost management focuses on how cost information is applied to the strategic
direction of the organisation’s products and services. Management accountants help
managers to formulate strategy by providing answers to the following questions:
Questions Answers
• Who are the most important • Selling books online.
customers? • Produce a variety of cars in response
• How to be competitive? to changing customer tastes.
• How to deliver value to customers?
• What are the substitute products in • Designs and fixes the price of new
the marketplace? products after comparing the
• How do they differ in terms of price functionality and quality of other
and quality? products in the marketplace.
• What is our most critical capability? • Uses the reputation of existing brand
• Is it technology, production or to introduce new types of products.
marketing?
• How can we leverage it for new
strategic initiatives?
• Will adequate cash be available to • Issues new debt and equity to fund
fund the strategy, or do we need to strategic acquisition.
raise additional funds ?
Table 1.2 How management accountants help managers to formulate strategies
Nonetheless, the best-designed strategies and the best-developed capabilities need

to be effectively executed.
Value chain, supply chain analysis and key success factors

In addition to a fair price, customers also expect quality products delivered in a timely
way. Therefore, the following analyses are necessary to create value to customers.
1. Value-chain analysis
Products pass through a sequence of activities in the value chain and gain
some value in each activity.
There are six primary business activities as follows:
Primary activities Details

Research and Development Generating and experimenting new ideas
(R&D) related to products, services or processes.
Design of products and Detailed planning, engineering and testing
processes of products and processes.
UNIT 1 9
Production Procuring, transporting and storing (also

called inbound logistics).
Coordinating and assembling resources to

produce a product or deliver a service (also
called operations).
Marketing (including sales) Promoting and selling products or services
to customers or prospective customers.
Distribution Processing orders and shipping products or
services to customers (also called outbound
logistics).
Customer service Providing after-sales service to customers.
Table 1.3 Primary business activities
In addition to the above activities, there is administrative function which

supports the six primary activities. The administrative function includes
the accounting and finance, human resource management, and information
technology.
Customer relationship management (CRM) is a strategy to deepen

relationships with customers, partners and distributors. These business
activities are essential to satisfying the customers and retaining their loyalty.
Depending on the time and industry, some activities are more critical than
others. For example in the pharmaceutical industry, R&D and design of
products and processes are more important than other activities.
Management accountants help managers to track the costs in the value chain,
eventually reducing costs and improving efficiency. Cost-benefit analysis is
usually performed to find out whether it is cheaper to buy or to manufacture.
2. Supply chain analysis
A supply chain is the flow of goods, services and information from supplier
to customer. It is the system of organisations, people, technology, activities,
information and resources related to moving products and services.
The supply chain also includes transporters, warehouses, retailers, and

customers themselves. Within the organisation, the supply chain includes
all activities related to receiving and filling a customer order.
Management accounting emphasises integrating and coordinating activities

in the supply chain and aims to improve performance and reduce costs. For
example, manufacturers require their suppliers to frequently deliver small
quantities of materials directly to the production floor to reduce materials
handling costs.
3. Key success factors
The level of performance is dependent on how an organisation uses the

value chain and supply chain. It is critical to understand the following key
success factors in an organisation:
Key success factors Details

Cost and efficiency Managers must understand the tasks or activities
that cause costs to arise, and monitor the
marketplace to determine prices their customers
are willing to pay for products or services.
Management accounting information helps

managers to calculate the target cost based on
the target price. To achieve the target cost, some
activities will be eliminated , thus reducing costs
in the value chain.
For example, a number of companies have cut

costs by outsourcing some of their business
functions or by moving their manufacturing
operations to other countries.
Quality Companies must design products or services to
meet the expectations of customers and reduce
defects and waste.

managers to evaluate the costs and benefit of
quality management.
For example, Total Quality Management (TQM) is

implemented to improve operations throughout
the value chain.
Time Managers need to understand the costs and
benefits of a product over its life cycle. The rapid
change in technology and innovation has led to
shorter product life cycles. Managers must reduce
the customer response time.

managers to reduce delivery time and reliably
meet promised delivery dates.
For example, output from machine can be

increased by relieving bottleneck constraints.
Innovation The success of company depends on constant
flow of innovative products or services.

managers to evaluate the alternative investment
and R&D decisions.
For example, the success of iPhone is dependent

on innovation.
Table 1.4 Key success factors

UNIT 1 11
Management accountants help managers to benchmark performance of competitors

on the key success factors and alert managers to changes in the marketplace.
Value-chain and supply chain analyses and execution of key success factors are
important in the strategic planning process. However, the success of a strategy
depends on many decisions that managers make to develop, integrate and implement
their strategies.
Decision making, planning and control
Decision making is the mental processes resulting in selected action or actions

among several alternatives. Managers use the five-step decision-making process to
make many different types of decisions. The five-step can be summarised as follows:
Steps Details
Identify the problem and • Problem on how to increase revenues.
uncertainties • Uncertain about the demand for products resulting
from a change in selling price.
Obtain information • Talk to existing and potential customers.
• Review the results of past actions.
• Collect and analyse information regarding
competitors.
Make predictions about • Predict the future on the basis of information
the future gathered.
• Recognise that making predictions requires
judgement.
• Retest the assumptions.
• Review the thinking.
Make decisions by • Align decisions with strategy.
choosing among
alternatives
Implement the decision, • Prepare and implement budget.
evaluate performance • Collect information on how actual performance
and learn compares to planned performance.
• Provide feedback and learning for future decision
making.
Table 1.5 Decision-making process
The performance report prompts investigation and learning. Learning is useful for
making better-informed decisions and plans in the future. Management accountants
may raise several questions regarding problems and opportunities. The possible
questions are:
• Is the strategy attracting more customers?
• Did the marketing and sales department make sufficient efforts to attract new
customers?
• Why is the actual selling price different from the target price?
• Did some sales representatives offer discounted price?
• Did economic conditions cause the decline in revenues?
• Are revenues falling because production standards have declined?
Answers to the above questions could prompt the company to take subsequent
actions to improve its performance.
Management accountant could go further to identify the specific customers that

stopped buying and how sales representatives should follow-up with these customers.
Activity 1.1
Multiple-Choice Questions
1. Which of the following would be considered a user of

management accounting information?
A. Supplier
B. Bank
C. Customer
D. Production manager
2. Which of the following would be considered an external user

of the firm’s accounting information?
A. Sales manager
B. Shareholder
C. Controller
D. Production manager
3. Which of the following is the cause of pressure on companies

to continually attempt to reduce costs?
A. Government pressure
B. Ethical guidelines published by the professional accounting
organisations
C. Increased global competition
D. None of the above
UNIT 1 13
4. Which of the following is NOT normally considered part of a

company’s value chain?
A. Research and development

B. Inspection
C. Production
D. Marketing
5. Planning involves all of the following except
A. selecting the organisation’s goals

B. predicting results under various circumstances
C. implementing the decisions
D. communicating the goals to the organisation
Key management accounting guidelines
Management accountants follow three guidelines to provide the most value to their
companies:
1. Employ a cost-benefit approach;
2. Fully recognise behavioural and technical considerations, and
3. Use different costs for different purposes.
Guidelines Details
Cost-benefit approach Resources should be allocated if the expected benefits
exceed the expected costs.
Management accounting information helps managers to

quantify expected benefits and expected costs.
For example, senior managers compare expected benefits

and expected costs of installing a budgeting system, and
reach a decision.
Behavioural Human (behavioural) considerations encourage managers
and technical and other employees to strive to achieve the goals of the
considerations organisation.
Technical considerations provide managers with the

desired information in an appropriate format and at the
preferred frequency.
Managers and management accountants should not

confine themselves exclusively to technical matters. They
should focus on how to help individuals do their jobs
better.
For example, helping employees to understand which of

their activities adds value and which does not.
Different costs for There are alternative ways to compute costs in different
different purposes decision-making situations. The cost concept used for the
external reporting may not be an appropriate concept for
internal reporting to managers.
Management accounting information results in more

accurate and fairer measure of the performance.
For example, in management accounting, advertising

costs for a new product could be capitalised and then
amortised over several years. Accounting standards
require immediate expensing of advertising costs for
external reporting.
Table1.6 Key management accounting guidelines
Organisation structure
Management accounting and finance functions support managers in attaining the
goals of the organisation.
Line management and staff management
Line management refers to managers in charge of production, marketing and

distribution function. They are directly responsible for achieving the goals of an
organisation. For example, production managers may have to achieve a target
operating income, set certain level of product quality and safety, and ensure the
manufacturing processes comply with environmental laws.
Staff management provides advice, support and assistance to line management. They
consist of management accountants, information technology and human resource
managers.
Normally, a decision making will involve both line management and staff
management. For example, a plant manager (line function) needs to get detailed
budget from management accountant (staff function) before investing in new
equipment.
It is a trend for companies to use management teams to achieve their objectives.

These teams include both line and staff management.
The Chief Financial Officer and the Controller
The chief financial controller (CFO) or financial director is the person responsible
for overseeing the financial function of an organisation. In most organisations, the
CFO directly reports to and supports the chief executive officer (CEO).
UNIT 1 15
The functions of a CFO cover the following areas:
Functions Details
Controllership • Provide financial information to managers and other
stakeholders.
• Oversee the accounting information system.
Treasury • Arrange banking facilities and manage the cash flows.
• Invest excess funds in money market.
Risk management • Manage the financial risk such as interest rate risk and
foreign exchange risk.
• Manage the derivative instruments.
Taxation • Liaise with tax agent and tax authority.
• Advise management on tax planning.
Investor relations • Communicate and respond to shareholders regarding
external reporting.
Internal audit • Ensure integrity of the financial information.
Table 1.7 Functions of a Chief Financial Officer
Another important position in the accounting department is called controller or the

chief accounting officer. Controller is the person in charge of management accounting
and financial accounting functions. Normally, the controller reports to CFO. In
many multinational organisations, regional controllers are appointed to support
regional managers in major geographic regions. The controller also helps managers
to make better-informed decisions by reporting and interpreting financial data.
The following diagram shows the reporting relationship for the CEO, CFO and
Controller.
CEO
CFO
Controller Tax Treasury Risk Investor Internal

Management Relation Audit
Figure 1.1 Reporting relationship for the CEO, CFO and Controller
Figure 1.1 shows the formal reporting relationships. In most organisations, there are
informal relationships such as friendship among managers and personal reference
of top management.
Management accountant plays an important role in helping managers to make

decisions. A successful management accountant must be technically competent and
good in interpersonal skills.
Professional ethics
Professional ethics for accountants primarily refer to moral values and judgements of
accountants when they perform their duties. Subsequent to accounting scandals of
large corporations, attention has been drawn to ethical standards accepted within the
accounting profession. In order to restore the public’s confidence in the profession
and prevent fraudulent accounting, various accounting bodies and governments
have developed regulations and taken actions to improve ethical conduct among
the accounting profession.
The Malaysian Institute of Accountants (MIA) has introduced By-Laws on

Professional Ethics which is based on the Code of Ethics for Professional Accountants
issued by the International Federation of Accountants (IFAC). The by-laws among
others cover the following issues:
1. Integrity
2. Objectivity
3. Professional Competence and Due Care
4. Confidentiality
5. Professional Behaviour
6. Public Practice
7. Fees and Other Types of Remuneration
8. Accountants in Business
For the management accountant in practice, the Chartered Institute of Management

Accountants (CIMA) has issued the CIMA Code of Ethics for Professional
Accountants in which all members and students around the world must observe.
This code of ethics like the one by the MIA is based on the guidelines by IFAC
together with inputs from the members worldwide.
Institutional support
Accounting organisations and regulators have issued new legislations and standards
on how to improve internal control, corporate governance, monitoring of managers
and disclosure practices of public companies.
Professional accounting bodies have issued ethical guidelines to govern the conduct
of their members. Generally, the guidelines discuss issues relating to competency,
confidentiality, integrity and credibility.
UNIT 1 17
1. Competency  Includes ongoing development of knowledge and skills as

well as performing duties in accordance with relevant laws, regulations and
technical standards.
2. Confidentiality  Includes refraining from disclosing confidential

information acquired and monitoring subordinates to ensure the maintenance
of confidentiality.
3. Integrity  Includes avoiding actual or apparent conflicts of interest and

refraining from engaging in activities that would prejudice their ability to
perform ethically or that which would discredit the profession.
4. Objectivity  Includes communicating information fairly and objectively

as well as disclosing fully all relevant information needed by intended users.
In addition to the guidelines, members are encouraged to contact respective

professional bodies to discuss their ethical dilemmas.
Professional accountants are advised to evaluate and safeguard against threats to

ethical principles.
Examples of such safeguards include:
• Obtaining advice, where appropriate, from within the employing organisation,

an independent professional advisor or a relevant professional body.
• Using a formal dispute resolution process within the employing organisation.
• Seeking legal advice.
Typical ethical challenges
Management accountants may face ethical dilemmas when performing their duties.
Examples of real-life problems are:
Issues Dilemmas
Capitalise or expense The line manager wants to capitalise the development costs
the development but no credible evidence is available to support that the
costs new product is commercially viable.
Management accountant disagrees with the capitalisation of

the cost but wants to avoid difficult personal confrontation
with the line manager.
Management accountant should treat the development

costs as expense if the line manager is not able to provide
credible evidence.
Accepting “favour” Supplier is bidding for a new contract and the cost issues
are critical to winning the new contract.
Management accountant received an invitation for an all-

expenses-paid weekend vacation from the supplier.
Management accountant should discuss the invitation with

his or her immediate supervisor.
Table 1.8 Ethical dilemmas of a management accountant
Activity 1.2
Multiple-Choice Questions
1. Which of the following activity involves accumulating data and

reporting results to all management levels that describe how the
organisation is doing?
A. Problem-solving
B. Attention directing
C. Scorekeeping
D. Planning
2. A ___________ compares actual results for a period with planned

results for that same period.
A. budget
B. data warehouse
C. statement of financial position
D. performance report
3. An important guideline in helping management accountants

provide the most value to managers is to recognise the technical
considerations and ___________ considerations.
A. behavioural
B. benefit
C. cost
D. expense
UNIT 1 19
4. Who is the person responsible for providing management and

financial accounting information for decision-making purposes?
A. Treasurer
B. Auditor
C. Controller
D. Finance director
5. An example of the characteristics of ___________ would be to

avoid actual or apparent conflicts of interest.
A. competence
B. integrity
C. objectivity
D. confidentiality
Summary
The main objective of financial accounting is external reporting to

shareholders and other stakeholders. Financial statements report on
past financial performance and are prepared in accordance with the
GAAP and approved accounting standards.
Management accounting information is future-oriented and

helps managers to make better-informed decisions. Management
accountants support managers in strategic planning by providing
information about the sources of competitive advantage.
Companies add value to products and services in the value chain.

The six primary business functions are R&D design of products and
processes production marketing distribution and customer service.
Supply chain describes how the goods and services are delivered
from initial sources to end users.
The key success factors of a company are cost and efficiency quality
time and innovation.
Managers use a five-step decision-making process to implement

strategy. The first four steps are the planning decisions and Step 5
is the control decision.
Management accountants need to follow three guidelines so that

they can perform their task to support the managers. They must
employ a cost-benefit approach; recognise both technical and
behavioural considerations; and identify different costs for different
purposes.
In most organisations, chief financial officer (CFO) is the person

responsible for overseeing the financial operations and reporting to
chief executive officer (CEO).
Management accountants must comply with the ethical standards

related to competency, confidentiality, integrity and credibility.
Self-test 1.1
1. Differentiate between “management accounting” and “financial

accounting”.
(WOU June 2010)
2. As professionals the management accountant must comply

with the organisation’s and society’s expectations of ethical
standards. Explain the four basic standards of ethical conduct
that a management accountant must adhere to.
(WOU June 2011)
3. The accounting system is a useful provider of information to its

users.Describe four (4) reasons why the management accounting
system is a useful tool to its users.
(WOU September 2011)

UNIT 1 21
Suggested answers to activities
Feedback
Activity 1.1
1. D
2. B
3. C
4. B
5. C
Activity 1.2
1. C
2. D
3. A
4. C
5. B
UNIT 1 23
1.2 An Introduction to Cost Terms and

Purposes
Objectives
1. Define cost object and list examples.
2. Differentiate between direct costs and indirect costs.
3. Explain the relationship between cost drivers, variable costs and fixed costs.
4. Describe the three types of inventories commonly found in manufacturing

companies.
5. Construct model income statements for a manufacturing company.
6. Differentiate between inventoriable costs and period costs.
Introduction
Companies emphasise costs because every dollar in cost reduction is additional
dollar of operating income. It is essential to understand how to calculate the cost of
products. When times are bad, it is necessary to take measures to reduce the costs.
Unfortunately, some companies collapsed due to higher fixed costs and lower sales.
For example, General Motor (GM) was forced to file for bankruptcy protection
in 2009.
Costs are a critical element in decision-making. Therefore, managers need to obtain

cost information for planning and control purpose, as well as performance evaluation.
Cost and cost terminology

Cost is usually measured in monetary amount. It is a resource sacrificed or forgone
to achieve a specific objective.
Actual cost is the historical amount spent whereas budgeted cost is the predicted or
forecasted amount of cost. Managers need to know both budgeted costs and actual
costs in order to evaluate how well they have performed and learn how they can do
better in the future.
Cost object is anything for which a separate cost measurement is recorded. For
example, a product, an assembly line, a product line, or a department can be a cost
object.
Activity 1.3
General Motors makes several different types of cars. What cost

objects can you think of?
To learn more about General Motors’ Chevrolet in Malaysia, visit

http://chevrolet.com.my/
Cost system determines the costs of various cost objects in two basic stages: cost
accumulation, followed by cost assignment.
Cost accumulation is the collection of cost data in some organised manner by means
of an accounting system. Costs in various categories such as materials and labour
costs are accumulated by means of an accounting system.
Accumulated costs are then assigned to various cost objects. Cost assignment
involves tracing and allocating costs to a product, an assembly line, a product line,
or a department.
Managers use cost information to:
1. Make decisions, for example on how to price products; and
2. implement decisions by influencing and motivating employees to act.
Managers use a five-step process when making decisions and evaluating performance.
Five-step process Details

Identify the problem and • How much to price a product?
uncertainties. • How much it costs to produce?
Obtain information. • Direct and indirect costs of a product in each
business function.
• Information about customers, competitors and
prices of substitute products.
Make predictions about • Predictions about the quantity of product to sell.
the future. • Predict the fixed and variable costs to make a
product.
Make decisions by • Decide on a price to charge.
choosing among
alternatives.
Implement the decision, • Control and monitor product costs.
evaluate performance • Compare actual total and unit costs against
and learn. predicted costs.
UNIT 1 25
Direct costs and indirect costs
Costs are classified into direct costs that are traced to the cost object, and indirect
costs that are allocated to the cost object.
Direct costs are costs that can be traced to a cost object in an economically feasible
(cost -effective) way. It is not always practical to trace the costs to cost object from
a cost-benefit perspective. Direct costs include direct materials and direct labour.
Direct materials are materials that go into the production of the product. For example,
steel and tyres are direct materials to manufacture cars.
Direct labour is cost of labour that can be easily traced to a product. For example,
the wages paid to workers who spend time working on a model of cars.
Indirect costs are also called manufacturing overhead which are related to the cost
object but cannot be traced in an economically feasible way. For example, the salary
paid to a factory manager working on various models of cars.
Indirect costs are not be traced to cost object, they are assigned to a cost object by
allocation. For example, the cleaners who clean the toilets at WOU are indirect
costs to the university. Although the work of the cleaners are integral to the running
of the university, they contribution cannot be directly seen in the course material.
Activity 1.4
Why may the same cost be direct or indirect? Is the salary of line
supervisor direct cost or indirect cost?
Direct costs Indirect costs
Tracing Allocation
Cost object
Figure 1.2 Direct costs and indirect costs

Accurate cost allocation for manufacturing overhead can be a challenging task. For
example, it is difficult to allocate electricity costs to various products manufactured
in the same factory. Supervision costs are more difficult to assign than materials and
labour costs. Supervisor costs must be allotted based on a certain predetermined basis
such as units produced or hours worked factored into the cost of the product itself.
Factors affecting direct/Indirect classifications
There are several factors that affect the classification of costs as direct or indirect.
Three of these factors are:
1. Materiality of the cost. The smaller the amount of the cost, the less likely
that it is economically feasible to trace that cost to a particular cost object.
For example, the cost of packing material is classified as indirect cost because
it is not economical to trace it to the product.
2. Available information gathering technology. It is now possible to trace

more costs as direct costs with advanced information technology. For
example, bar code technology has made it feasible to trace any small item
used in the manufacturing process.
3. Design of operations. It is easier to trace to the product if a company’s

facility is used exclusively for a specific cost object. For example, the
depreciation of machine can be traced to a product if that machine is used
exclusively to manufacture it.
The classification of direct or indirect costs also depends on the definition of cost
object, the broader the definition of the cost object, the higher the proportion of
total costs that are direct costs. For example, salary of a supervisor can be classified
as direct cost to assembly department but it is classified as indirect cost if the cost
object is a particular model of car.
Broader cost object and higher proportion of direct costs result in more accurate
cost amounts.
Cost behaviour patterns: Variable costs and fixed costs

The behaviour pattern of a cost is the manner in which a cost changes following
changes in a related activity. There are two basic types of cost behaviour patterns
found in accounting system. Costs are classified as fixed or variable from the
behavioural patterns. Understanding these patterns helps managers to adequately
predict costs.
Fixed costs remain constant with changes in the units produced. For example, if
units produced doubles, rental of factory does not increase.
UNIT 1 27
A variable cost changes in total in proportion to changes in the activity level. However,
the variable cost per unit remains constant regardless of units produced. For example,
material cost will increase in the same ratio as the increase of units produced.
Costs are defined as fixed or variable with respect to a specific activity and within
specific period.
To illustrate these two basic types of costs, consider the following cost behaviour
patterns.
Units produced Material cost per unit Total material cost

(Units) (RM) (RM)
0 50 0
100 50 5000
200 50 10000
300 50 15000
400 50 20000
500 50 25000
We can plot a graph based on the information above.
Total material cost

$30,000.00
$25,000.00
$20,000.00
$15,000.00
$10,000.00
$5,000.00
$0.00
0 100 200 300 400 500
Total material cost is represented by a straight line that climbs from left to
right. Material cost is an example of variable cost. As more units are produced,
proportionately more materials are acquired and incurred.
Supervision cost Units produced Supervision cost per unit

(RM) (Units) (RM)
30000 100 300
30000 200 150
30000 300 100
30000 400 75
30000 500 60
Let us plot a graph based on the information above.
Total supervision cost
$35,000.00
$30,000.00
$25,000.00
$20,000.00
$15,000.00
$10,000.00
$5,000.00
$0.00
0 100 200 300 400 500
Total supervision cost is represented by a horizontal line at RM30,000. Supervision

cost is an example of fixed cost. Costs are fixed when total costs remain unchanged
despite significant changes in the units produced.
Fixed costs cannot be quickly and easily changed to match the resources needed or
used.
Individual cost items are not inherently variable or fixed. For example, if wages are
calculated based on a per-shirt-sewed basis, then they are classified as variable costs. In
contrast, if workers are paid on a monthly basis, then they are classified as fixed costs.
Some costs give both fixed and variable elements and are called mixed or semi-
variable costs. For example, selling cost includes basic salary and sales commission.
Sales
Quantity sold Sales commission Basic salary Selling cost
commission
(Units) per unit (RM) (RM) (RM)
(RM)
0 20 0 10000 10000
100 20 2000 10000 12000
200 20 4000 10000 14000
UNIT 1 29
300 20 6000 10000 16000

400 20 8000 10000 18000
500 20 10000 10000 20000
Again, we can plot a graph based on the information above.
Total selling cost
$25,000.00
$20,000.00
$15,000.00
$10,000.00
$5,000.00
$0.00
0 100 200 300 400 500
Cost drivers
An activity is an event, task or unit of work which causes the cost to change, for
example, testing is an activity cost driver. There is a cause-and-effect relationship
between the level of activity and the cost incurred.
Fixed costs have no cost driver in the short run but may have a cost driver in the
long run. For example, in the short run, volume of production is not a cost driver of
testing department. In the long run, however volume of production is a cost driver
because the company can increase or decrease the testing department’s equipment
and staff.
Relevant range
Relevant range is the range of activity within which there is a specific relationship
between the level of activity and the cost in question. Outside this level of activity,
costs behave differently. For example, rental of factory is only fixed in relation to a
given range of activities and specific period of time.
The concept of relevant range is also applicable to the variable cost. For example,
outside the relevant range, direct materials may not change proportionately with
changes in units produced. Observation of the actual costs must be done in order
to determine this range.
Relationships of types of costs
Based on two classifications of costs into direct or in direct and variable or fixed,
costs may be grouped into:
Cost behaviour pattern
Assignment of costs
Direct Indirect
Variable Direct materials such as steels Variable manufacturing
used to manufacture cars. overheads such as electricity cost.
Fixed Direct labour costs such as Fixed manufacturing overheads
salary of the production such as rental of factory.
supervisor of assembly line.
Table 1.9 Classifications of costs
Activity1.5
Calculate the total fixed cost based on the following information

for 2011:
Salaries RM800,000 (75 per cent of employees are paid

on monthly basis)
Packaging RM400,000 (based on units produced)
Shipping RM500,000 (based on units shipped)
Rental of factory RM250,000 per year
Unit costs and total costs

Generally, decision-makers should think in terms of total cost. However, in many
decision analysis situations, calculating unit costs is essential.
Unit costs
Unit costs or average costs are calculated by dividing total costs incurred by the
number of units produced. Managers use unit cost information to decide on the
products they should invest more resources in, such as R&D and marketing, and
the prices they should charge.
If the total cost to produce 500,000 units of chairs is RM4,000,000, then the unit
cost for one chair is calculated as follows:
UNIT 1 31
Total Manufacturing Cost

Unit cost =
Total Units Produced
= RM4,000,0000 / 500,000 units

= RM80 per unit
Unit cost can also be calculated for all activities in the value chain such as product
design, sales visit and customer service. The unit cost of a product is the summation
of unit costs of all activities in the value chain.
Use unit cost cautiously
An overreliance on unit cost could lead to an error in estimating total cost. Managers
should think in terms of total costs rather than unit costs for many decisions.
Assume that the total manufacturing cost to produce 500,000 units of a product
consists of RM15,000,000 of fixed costs and RM25,000,000 of variable costs.
Unit cost = RM80 per unit
A plant manager who uses the unit cost of RM80 will be under actual total costs.
Budgeted total cost = RM80 × 200,000 units = RM16,000,000
Based on the following table, the actual cost should be RM25,000,000 and the
actual unit cost should be increased to RM125.
As a result, the total cost is underestimated by RM9,000,000
Variable cost Total Total

Units Total costs Unit cost
per unit variable cost fixed costs
produced (RM) (RM)
(RM) (RM) (RM)
100,000 50 5,000,000 15,000,000 20,000,000 200.00
200,000 50 10,000,000 15,000,000 25,000,000 125.00
500,000 50 25,000,000 15,000,000 40,000,000 80.00
800,000 50 40,000,000 15,000,000 55,000,000 68.75
1,000,000 50 50,000,000 15,000,000 65,000,000 65.00
Fixed costs, when expressed on a unit basis can be misleading. As a general rule, it
is necessary to calculate total costs before making a particular decision.
Activity 1.6
Mama Industries Ltd manufactures several different dining tables.

Unit costs associated with round table ORD203 are as follows:
Direct materials RM200

Direct manufacturing labor 100
Variable manufacturing overhead 150
Fixed manufacturing overhead 25
Sales commissions (2% of sales) 12
Administrative salaries 20
Total RM507
Required:
Calculate the inventoriable costs per unit associated with Product

ORD203.
Business sectors, types of inventory, inventoriable costs and period

costs
Different economy sectors hold different types of inventory. Generally, these sectors
of economy can be identified by their activities as follows:
Sectors Activities
Manufacturing Purchase materials and convert them into various finished
goods. One example is the factory that makes your IPhones.
Merchandising Purchase and sell tangible products without changing their
basic form. The shop that you purchased your IPhone is an
example of a form of business that does merchandising.
Service Provide services to their clients. The phone operator Celcom
which you subscribed is an example of a service provider.
Types of inventory
The accounting system of a manufacturing company is more complex than for

a merchandising or service company. These companies will have three types of
inventory:
1. Direct Materials consist of raw materials awaiting to be used in the

manufacturing process.
UNIT 1 33
2. Work-in-Process represents product partially worked on but not yet

completed. WIP is a representation of what is on the factory floor.
3. Finished Goods consist of goods completed but not yet sold.
Merchandising companies purchase finished products and do not make changes

to their basic form. Inventory for merchandising company is called merchandise
inventory.
Service sector companies do not hold inventories except for some office supplies
such as papers and stationery.
Manufacturing cost
Manufacturing costs consist of three types:
1. Direct material costs are the costs of materials that become part of the cost
object and can be traced to the cost object in an economically feasible manner.
For example, woods used to manufacture tables and chairs.
2. Direct labour costs include the compensation of manufacturing labour that

can be traced to the cost object in an economically feasible manner. For
example, wages paid to factory workers who convert direct materials to
finished goods.
3. Indirect costs or overhead costs are all manufacturing costs that are related
to the cost object but cannot be traced to that object in an economically
feasible manner. For example, electricity used in the factory for production
and lighting. Overhead costs are allocated rather than traced.
Inventoriable costs
Inventoriable costs, also known as product costs, include all costs of a product that
are considered assets before they are sold. After they are sold to customers, these
costs will become cost of goods sold.
Sectors Inventoriable costs

Manufacturing • Direct material costs
• Direct labour costs
• Indirect costs
Merchandising • Costs to purchase the merchandise, including purchase
price, incoming freight, insurance and handling costs
Service • No inventoriable costs
Table 1.9 Inventoriable costs

Period costs
Period costs are all costs other than manufacturing costs and are treated as expenses
for the period in which they are incurred. These costs include marketing, distribution
and customer service costs. They are not expected to benefit revenues in future
periods. Expensing period costs in current year is necessary so that they are matched
against the current year revenues.
Prime costs and conversion costs
All manufacturing costs are classified into prime costs and conversion costs.
Prime costs = Direct material costs + Direct labour costs
Conversion costs = Direct labour costs + Overhead costs
Conversion costs are all manufacturing costs other than direct material costs; these
costs represent all the manufacturing costs to convert direct materials into finished
goods.
As information-gathering technology improves, companies can add more direct

cost categories.
Measuring labour costs
Labour Costs can be measured in different ways. It is important to define and

understand the ways costs are measured in a particular company or situation.
Many companies use multiple labour cost categories:
1. Direct labour costs
2. Overhead or indirect labour costs which include
a. Indirect compensation for rework, idle time and overtime premium
b. Salaries for managers and supervisors
c. Fringe benefits such as health care and pension

UNIT 1 35
Overtime premium and idle time
Overtime premium is the wage rate paid to workers in excess of their regular straight-
time wage rate. It is considered as overhead because the particular job performed
during overtime hours is a matter of chance.
If overtime is not random and relates to a particular job, then it can be classified
as direct labour cost.
Idle time is wage paid for unproductive time caused by lack of orders, machine
breakdowns, work delays, or poor scheduling. Idle time is an overhead because it is
not related to a particular product. For example, the wages paid to your operators
during a work stoppage as a result of raw materials being shipped late into the factory
are a form of idle time.
Activity 1.7
Muttu is paid RM40 an hour for normal working hours and RM60
an hour for overtime. In one week he worked 52 hours, which
included 12 hours of overtime, and 4 hours of idle time caused by
material shortages.
Required:
a. What is Muttu’s total compensation for the week?
b. What amount of compensation would be reported as direct

manufacturing labour?
c. What amount of compensation would be reported as

manufacturing overhead?
Benefits of defining accounting terms
Payroll fringe costs such as health care and pensions may be classified as direct or
indirect labour costs. Most companies prefer to classify these costs as direct costs
in order to increase the ratio of direct labour costs over total costs. Tax authorities
may consider the fringe costs as overhead. In addition to fringe costs, sick leave
and overtime premium also need to be clearly defined in the contracts and laws to
prevent disputes.
Different definitions of product costs

Product cost is the sum of all costs assigned to a product depending on the purpose
of measuring it. Different purposes can result in different measures of product cost.
Product cost is measured differently as follows:
Purpose Definition of product cost

Pricing and product-mix Costs incurred in all business functions of the value
decision chain. Product costs include production costs, R&D
costs, design costs, marketing costs, distribution costs
and customer service costs.
Contracting with Costs which are closely related to delivering products
government agencies under the contract. It is also known as cost plus pricing.
Product costs include production costs, design costs and
part of the R&D costs.
External reporting Costs are calculated in accordance with accounting
standards. Product costs include only inventoriable
costs.
Activity 1.8
Using the five-step process in making decisions, think about how

these different classifications of costs are helpful to managers when
making decisions and evaluating performance.
A framework for cost accounting and cost management
Cost accounting and cost management are commonly used for cost calculation,
planning, control, performance evaluation and decision-making.
Calculating the cost of products, services and other cost objects
The costing system traces direct costs and allocate indirect costs to products and
services. The purpose of cost accounting is to calculate total costs and unit costs of
products and services.
Obtaining information for planning and control and performance

evaluation
A budget forces managers to plan ahead, to coordinate and communicate the plans
within the organisation. It also provides a benchmark to evaluate performance.
Managers compare actual results to planned performance at the end of the financial
period. Variances are differences between actual and planned performance.
UNIT 1 37
Managers need to understand variances as feedback to promote learning and future

improvement. Managers also use non-financial measures such as defect rates and
customer satisfaction ratings, to control and evaluate the performance of various
departments.
Analysing the relevant information in making decisions
Managers must understand what information is relevant and what information is

irrelevant. For example, additional cost to manufacture a product is relevant whereas
past (sunk) cost is irrelevant in making a decision to either manufacture or buy.
In making strategic decisions about which products and quantity to produce,

managers must know how the relevant revenues and costs will change according to
different levels of output.
Statement of Comprehensive Income in manufacturing environment
We just finished looking at the calculations of manufacturing costs for a certain

product. We will now look at how the management accountant will present his
manufacturing data in the financial statements.
The accountant will begin by preparing the Schedule of Cost of Goods Manufactured.
Schedule of Cost of Goods Manufactured

RM RM
Direct materials
Opening Inventory 12,000
Purchases of direct materials 80,000
Cost of direct materials available for use 92,000
Closing Inventory (8,000) 84,000
Direct materials used 18,000
Direct labour
Factory overhead (Indirect manufacturing costs):
Indirect labour 4,000
Supplies 2,000
Electricity 1,500
Depreciation of Plant 1,500
Depreciation of Equipment 2,500
General Factory Expenses 200 11,700
Manufacturing costs incurred during the year 113,700
Opening work-in-process inventory 6,000
Total manufacturing costs to account for 119,700
Deduct closing work-in-process inventory (7,000)
Cost of goods manufactured (to Statement of 112,700
Comprehensive Income)
The preparer will then transfer the Cost of Goods Manufactured to the Statement
of Comprehensive Income.
Statement of Financial Position for the year ended 31 December 2013

RM RM
Sales 210,000
Deduct cost of goods sold:
Opening Finished goods 25,000
Cost of goods manufactured 112,700
Cost of goods available for sale 137,700
Closing Finished goods (18,000)
Cost of goods sold (119,700)
Gross margin (or gross profit) 90,300
Sales and administrative expenses (80,000)
Operating income 10,300
Summary
A cost object is anything for which a separate measurement of

costs is desired. Direct costs can be traced to the cost object in an
economically feasible way. In contrast, indirect costs are related to
the particular cost object but cannot be traced to the cost object
in an economically feasible way. Cost assignment is a general term
that encompasses the assignment of both direct costs and indirect
costs to a cost object. Direct costs are traced to a cost object while
indirect costs are allocated to a cost object.
Cost accounting concepts can be expressed in the three features

of cost accounting that have a wide range of uses in business
applications.
Self-test 1.4
Siap Industries Sdn. Bhd incurred the following manufacturing

costs in January 2011:
Direct material costs RM500,000

Direct labour costs RM200,000
Indirect costs RM100,000
Beginning inventory 0
Unit manufactured 40,000 units
35,000 units were sold during the year for RM25 per unit.
UNIT 1 39
Required:
a. What is the average manufacturing cost per unit?
b. What is the amount of ending finished goods inventory?
c. What is the amount of gross margin?
Suggested answers to activities
Feedback
Activity 1.3
Cost object Illustration

Product Chevrolet, Buick, GMC, Cadillac
Service Telephone hotline providing information and
assistance to dealers
Project R&D project to design new type of car
Customer NAZA Quest Sdn. Bhd.
(authorised distributor in Malaysia)
Activity Setting up machines for production
Department Assembly, Testing and Customer Service
department
Activity 1.4
Depending on the cost object, the same cost can be direct or indirect.
A line supervisor in a factory could be a direct cost if the cost object
is the particular assembly line, but would be indirect if the finished
product is the cost object.
Activity 1.5
Fixed salaries = RM800,000 × 75%

= RM600,000
Fixed rental = RM250,000
Fixed cost = RM850,000

Activity 1.6
RM200 + RM100 + RM150 + RM25 = RM475
Activity 1.7
a. Direct manufacturing labour (52 hours × RM40) + Idle time

(4 hrs × RM40) + Overtime premium (12 hrs × RM20)
= RM2,480
b. Direct manufacturing labour (52 hours × RM40) = RM2,080
c. Manufacturing overhead costs = Idle time (4 hrs × RM40) +

Overtime premium (12 hrs × RM20) = RM400
Activity 1.8
Five-step process Details

Identify the problem • How much to price a product?
and uncertainties. • How much it costs to produce?
Obtain information. • Direct and indirect costs of a
product in each business function.
• Information about customers,
competitors and prices of
substitute products.
Make predictions about • Predictions about the quantity of
the future. product to sell.
• Predict the fixed and variable costs
to make a product.
Make decisions by • Decide on a price to charge.
choosing among
alternatives.
Implement the decision, • Control and monitor product costs.
evaluate performance • Compare actual total and unit
and learn. costs against predicted costs.
UNIT 1 41
1.3 Cost-Volume-Profit Relationship

Objectives
1. Describe the assumptions of cost-volume-profit analysis.
2. Demonstrate three methods for calculating break-even point and target

operating income.
3. Explain how cost-volume-profit analysis is used for decision making.
4. Distinguish between contribution margin and gross margin in manufacturing

and merchandising companies.
5. Construct a P/V chart by using available data and explain its salient features.
Introduction
Cost-Volume-Profit (CVP) analysis is naturally appealing to managers because it
provides a simple relationship between the effects of cost and volume to profit. Users
should be aware of its limitations before applying this simple approach for planning.
This section discusses the limiting assumptions of the CVP model along with the
importance of the decision situation and the time horizon.
Cost-Volume-Profit (CVP)
Cost-volume-profit (CVP) analysis is the study of effects on total revenues, total
costs, and operating income when changes occur in units sold, selling price, variable
cost per unit, or fixed costs of a product.
Managers use CVP analysis to help answer important “what-if ” business questions.
CVP analysis also helps to illustrate how “bottom-line” is affected by changes in
activity levels or selling price or cost components.
CVP analysis is applicable to manufacturers, service organisations, and non-profits

organisations.
Contribution
Contribution (CM) is the difference between total revenues and total variable costs.
Contribution = Total revenues − Total variable costs

Contribution explains how operating income will change at different levels of activity.
Fixed costs will not change no matter how many units of products are sold; total
revenues and total variable costs change as a result of selling different quantities of
products.
Contribution per unit = Selling price − Variable cost per unit
Based on the above formula, Contribution can also be expressed as:
Contribution = (Selling price − Variable cost per unit) × Sales units
Contribution also can be expressed as a percentage.
Contribution per unit

Contribution percentage =
Selling price
Fixed costs are subtracted from Contribution to arrive at operating income.
Operating income = Contribution − Fixed costs
Example of Contribution
Apple Tree provides the following information regarding its product selling price
and costs for one month.
Selling price RM200

Fixed costs RM2,000
Variable cost per unit RM120
Units sold 40 units
Contribution = (RM200 × 40 units) − (RM120 × 40 units)

= RM3,200
Contribution per unit = RM200 − RM120

= RM80
RM80
Contribution percentage =
RM200
= 40%
Operating income = RM3,200 − RM2,000

= RM1,200
UNIT 1 43
Expressing CVP relationships
CVP analysis can be modelled in three ways:
1. The equation method
2. The Contribution method
3. The graph method
Equation method
This method becomes the basis for calculating operating income for different
quantities of units sold.
Operating income = [(Selling price × Quantity sold) − (Variable cost per unit ×
Quantity sold)] − Fixed costs
Using the information from Apple Tree, the operating income is calculated as follows:
Operating income = [(RM200 × 40 units) − (RM120 × 40 units)] − RM2,000

= RM1,200
Contribution method
This method illustrates the basic idea of how each unit sold helps the company to
recover its fixed costs.
Operating income = (Contribution per unit × Quantity sold) − Fixed costs
Using the information from Apple Tree, the operating income is calculated as follows:
Operating income = (RM80 × 40 units) − RM2,000

= RM1,200
Graph method
This method presents total costs and total revenues graphically based on an
assumption that both costs and revenues behave in a linear fashion. We will draw
a break even chart. A break even chart is a graphical representation of the relation
between total value earned and total costs for various levels of productivity.
in RM
Breakeven Sales revenue

point
Sales and costs
Total costs
Total fixed costs
Sales/production
(units)
Breakeven
sales/production
Figure 1.3 Break even chart
To draw a chart the following steps need to be followed:
1. Label the vertical axis “sales and costs in ringgit”.
2. Label the horizontal axis “sales/production (units)”.
3. On another piece of paper sketch the scales that you want to use given the
data, then use this plan on the chart.
4. Plot any two points from the sales revenue data for the sales revenue line
and then draw a straight line for sales revenue (assume that the price per
unit does not change)  if the information is not given for sales revenue,
then work out two points, e.g., for 1000 units sold and 1500 units sold.
The start of the line should be through the origin (where the axes meet).
5. Draw a horizontal line for total fixed costs starting at the point on the vertical
axis for the level of costs.
6. At the same starting point it is possible to draw the total costs line. Total
costs are fixed costs plus variable costs. Work out what the total costs are
for say 1000 units and 1500 units. Then draw a straight line starting from
the same point as the fixed costs and then through the two plotted points.
7. Where the sales revenue crosses the total costs line is the breakeven point.
Read off the units of sales to give the breakeven level of sales.
8. The gap between the total costs line and sales revenue line after the breakeven
point represents the level of profit.
UNIT 1 45
CVP assumptions
CVP analysis is based on a number of assumptions that must be made in conducting

the analysis. The following assumptions are made for CVP analysis:
• Number of units sold is the only revenue and cost driver; revenues and costs
change exclusively due to changes in the number of units sold.
• Total costs can be separated into fixed and variable components.
• Total revenues and total costs are linear; it can be represented as a straight
line.
• Selling price, variable cost per unit, and total fixed costs are known and
constant.
Although these assumptions do not hold over time, they can allow meaningful
analysis. For example, a cost is either variable or fixed depending on the relevant
range and the time period of decision. More cost components are fixed if the time
period is shorter.
It is necessary to consider the relevant range, the length of the time period and the
specific purpose of decision when classifying costs as variable or fixed.
Breakeven point and target operating income

Managers want to know how much they must sell to avoid a loss and achieve the
target operating income.
The breakeven point
The breakeven point (BEP) is the quantity of units sold at which total revenues
equal total costs. It is also the level of activity that a company is making zero profit.
In practice, BEP is calculated using the equation or Contribution method.
Equation method
In order to calculate BEP, operating income is RM0 and quantity is denoted as Q.
Using the information from Apple Tree, the BEP is calculated as follows:
(RM200 × Q) – (EM120 × Q) − RM2,000 = RM0

RM80 × Q = RM2,000
Q = RM2,000 / RM80
= 25 units
Contribution method
Operating income is RM0 at BEP.
(Contribution per unit × Quantity sold) – Fixed costs = Operating income
The formula for calculating BEP in terms of units:
Fixed costs
BEP in units = RM2,000/RM80 = 25 units
The formula for calculating BEP in terms of revenues:
Fixed costs
Contribution ratio
BEP in dollars = RM2,000/0.40 = RM5,000
Target operating income
Managers are also concerned about how they can achieve their goals for operating
profit. Target Operating Income (TOI) is the level of activity needed to attain a
specified dollar amount of operating income.
The formula for calculating units to achieve the TOI:
Fixed costs + Target operating income

Using the information from Apple Tree, if the company needs to earn TOI of
RM1,200, the units are calculated as follows:
Units needed to earn TOI = (RM2,000 + RM1,200) / RM80

= 40 units
UNIT 1 47
Alternatively, the formula for calculating revenues to achieve the TOI:
Fixed costs + Target operating income

Contribution ratio
Using the information from Apple Tree, if the company needs to earn TOI of
RM1,200, the revenues needed are calculated as follows:
Revenues needed to earn TOI = (RM2,000 + RM1,200)/0.40

= RM8,000
Activity 1.9
P2 COM produces and sells smartphones. The company expects the

following revenues and costs in 2012 for its new smart phone, ZEE:
Revenues (40,000 sets sold @ RM600 per set) RM24,000,000

Variable costs RM14,400,000
Fixed costs RM5,000,000
Required:
1. How many sets of ZEE must be sold to reach BEP for 2012?
2. How many sets of ZEE must be sold to earn a target operating

income of RM5,000,000?
Using CVP analysis for decision-making
CVP analysis is useful in numerous situations to evaluate anticipated results

from strategic decisions. Generally, managers use CVP analysis to determine the
alternatives that maximise operating income. In addition, it can be used to evaluate
how operating income will be affected if the original predicted data are not achieved.
The following examples illustrate how to use CVP analysis in determining whether
to increase advertising or reduce the selling price.
Example: Decision to advertise
Selling price RM200

Fixed costs RM2,000
Units sold 40 units
The company is considering placing an advertisement which to cause the company

will incur RM1,000 but increase sales by 15%.
The following table presents the CPV analysis.
Without With
advertisement advertisement
(40 units) (46 units)
RM RM
Revenues (40 × RM200); (46 × RM200) 8,000 9,200
Less: Variable costs (40 × RM120); (4,800) (5,520)
(46 × RM120)
Contribution 3,200 3,680
Less: Fixed costs (RM2,000); (RM2,000 + (2,000) (3,000)
RM1,000)
Operating income 1,200 680
Based on the above CPV analysis, the company should not advertise because the
operating income will decrease by RM520.
UNIT 1 49
Alternatively, Apple Tree may consider reducing the selling price.
Example: Decision to reduce selling price
Selling price RM200

Fixed costs RM2,000
Units sold 40 units
The company is considering reducing selling price by RM30 which will increase
sales by 40%.
The following table presents the CPV analysis.
Original selling New selling

price price
(RM200) (RM170)
RM RM
Revenues (40 × RM200); (56 × RM170) 8,000 9,520
Less: Variable costs (40 × RM120); (4,800) (6,720)
(56 × RM120)
Contribution 3,200 2,800
Less: Fixed costs (RM2,000); (RM2,000) (2,000) (2,000)
Operating income 1,200 800
Based on the above CPV analysis, the company should not reduce the selling price
because the operating income will decrease by RM400.
In addition to the above decisions, CVP analysis can be used to determine the
target selling price. Using Apple Tree’s information, the target selling price to earn
operating income of RM1,600 at 40 units is calculated as follows:
Target operating income RM1,600

Add: Fixed costs RM2,000
Target Contribution RM3,600
Divided: Units sold 40 units
Target Contribution per unit RM90
Add: Variable cost per unit RM120
Target selling price RM210
Apple Tree can compare the changes in Contribution to the changes in fixed costs and
should choose the alterative that provides the highest operating income. However,
the company also needs to consider other factors such as quality of the product,
production capacity and customer service.
Sensitivity analysis and margin of safety
Sensitivity analysis is a “what-if ” technique that helps managers to examine how an

outcome will change as a result of changes in variables or underlying assumptions.
It is a tool that helps managers to anticipate the effect of changing variables on
operating income. It recognises uncertainty and the possibility that actual revenue
and costs will differ from budgeted amounts.
Excel spreadsheet is used to process the decision data. The effect and interaction
of changes in selling price, variable cost per unit, fixed costs and target operating
income can be instantly seen on the spreadsheet.
Excel can calculate the required number of units sold to achieve particular operating
income levels, given alternative levels of fixed costs and variable cost per unit.
For example, Apple Tree has a new product with the following information:
Selling price RM400

Fixed costs RM5,600
The number of units to achieve the target operating income of RM4,000 is computed
as 96 units. This can easily be calculated using a spreadsheet like MS-Excel.
UNIT 1 51
Figure 1.5 Calculating operating income using MS-Excel
Margin of safety is the amount by which the current level of sales exceeds the
breakeven point. It may be expressed in units, dollars, or as a percentage and is a
measure of how much sales can decline and still be above breakeven point.
Margin of safety in dollars = Revenues − Breakeven Revenues
Margin of safety units = Sales in units − Breakeven units
Margin of safety in dollars

Margin of safety percentage =
Revenues
Using the information from Apple Tree, the margin of safety is calculated as follows:
Margin of safety in dollars = RM8,000 − RM5,000

= RM3,000
Margin of safety units = 40 units − 25 units

= 15 units
RM3,000
Margin of safety percentage =
RM8,000
= 37.5%
From the above calculations, if sales decrease by 20% which is smaller than margin
of safety, Apple Tree is still making profits.
Cost planning and CVP
In making strategic decisions, managers use CVP analysis to plan the levels of variable
and fixed costs for their organization.
Alternative Fixed-Cost/Variable-Cost Structures
The cost structures determine the risks and returns when fixed costs are substituted
for variable costs. For example, there is an alternative between automation and
labour-based manufacturing operation.
Sensitivity analysis can be utilised in making the decision to substitute fixed costs
for variable costs in the cost structure. The effects of a choice of fixed over variable
in the cost structure are illustrated as follows:
Example: Cost Structures
Apple Tree presents the following cost structures. Selling price of the product is
RM200.
Target operating
Fixed cost Variable cost BEP
Options income of RM2,800
(RM) (RM) (Units)
(Units)
Automation 3,000 100 30 58
Labour- based 2,000 120 25 60
Automation has a higher BEP or more risk of loss than labour-based but requires
fewer units to earn target operating income of RM2,800.
CVP analysis can help managers to evaluate the effects of various cost structures.
UNIT 1 53
Example: Fixed salary versus sales commission
Apple Tree is considering three options to compensate the sales personnel:
Option 1 Fixed salary of RM2,000 per month

Option 2 Basic salary of RM800 plus 15% sales commission
Option 3 Sales commission of RM60 per unit
The selling price is RM200 and the variable cost (excluding sales commission) is
RM120 per unit.
Target operating
Fixed cost Variable cost BEP
Options income of RM2,800
(RM) (RM) (Units)
(Units)
Option 1 2,000 120 25 60
Option 2 800 150 16 72
Option 3 0 180 0 140
Option 1 has the highest BEP or the highest risk of loss if the sales are low. It has the
highest contribution per unit and hence the highest reward if the sales are high.
Option 3 has the lowest BEP or the lowest risk of loss if the sales are low. It has the
lowest Contribution per unit and the lowest reward if the sales are high.
The choice will be influenced by the confidence in the level of demand for the
product and the risk preference of the managers. For example, managers who are
willing to take higher risk will choose option 1 with high potential rewards.
Operating leverage
Operating leverage describes the risk-return trade-off across alternative cost

structures. It measures the effects of fixed costs on changes in operating income
following the changes in Contribution or units sold.
Contribution margin
Degree of operating leverage (DOL) =
Operating income
If DOL is higher, small increases in sales will lead to large increases in operating
income. For example, if DOL is 4 for a company then its operating income will
increase four times following the change in revenues.
The following example illustrates the effects of DOL on operating income.

Example: DOL and Operating income
Using the information from Apple Tree and with sales of 80 units, the DOL is
calculated for the three options as follows:
Option 1 Option 2 Option 3

Contribution per unit RM80 RM50 RM20
Contribution RM6,400 RM4,000 RM1,600
Operating income RM4,400 RM3,200 RM1,600
DOL 1.4545 1.2500 1.0000
The effects on the operating income if the sales increase by 50% are as follows:
Option 1 Option 2 Option 3

DOL 1.45 1.25 1.00
Contribution per unit RM80 RM50 RM20
Contribution RM9,600 RM6,000 RM2,400
Operating income RM7,600 RM5,200 RM2,400
Increase in operating income RM3,200 RM2,000 RM800
Percentage increase in operating 72.73% 62.50% 50.00%
income
DOL changes at different levels of sales; its value is dependent on the level of sales.
High DOL is a major reason for financial distress for large corporations with heavy
investments in fixed costs. Managers must understand the trade-off between having
high DOL, high risk and the potential rewards.
A high DOL accelerates the increase in operating income. However, a decrease in

revenues accelerates the decrease in operating income.
Effects of sales mix on income
Most companies sell a large variety of products. Sales mix is the quantities or ratios
of various products or services that constitute the total sales of a company. In CPV
analysis, managers will assume that sales mix of multiple products remains constant
as total units sold changes.
The total number of units that must be sold to BEP in a multiproduct company
depends on the sales mix. CVP analysis with multiple products is performed by
calculating a weighted average Contribution based on a constant sales mix percentage.
UNIT 1 55
The following example illustrates the effects of sales mix on BEP.
Example: Sales mix
Apple Tree produces two different products with the following information.
GREEN RED Total

Expected sales 40 60 100
Revenues, RM200 and RM400 RM8,000 RM24,000 RM32,000
Variable costs RM120 and RM280 RM4,800 RM16,800 RM21,600
Contribution per unit RM80 and RM120 RM3,200 RM7,200 RM10,400
Fixed costs RM5,200
Operating income RM5,200
Assume that the budgeted sales mix is constant at 2:3 (GREEN: RED).
The BEP is calculated for the bundle of 2 units of GREEN and 3 units of RED as follows:
Contribution per unit of GREEN × 2 units RM160

Contribution per unit of RED × 3 units RM360
Contribution per bundle RM520
BEP in bundle = RM5,200 / RM520

= 10 bundles
Units Revenues
BEP of GREEN (10 bundles × 2 units); (20 units × RM200) 20 RM4,000
BEP of RED (10 bundles × 3 units); (30 units × RM400) 30 RM12,000
BEP RM16,000
Alternatively, BEP for company producing multiple products can be calculated

using the Contribution ratio.
Example: Sales mix (Contribution ratio)
Apple Tree produces two different products with the following information.
GREEN RED Total

Expected sales 40 60 100
Revenues, RM200 and RM400 RM8,000 RM24,000 RM32,000
Variable costs RM120 and RM280 RM4,800 RM16,800 RM21,600
Contribution per unit RM80 and RM120 RM3,200 RM7,200 RM10,400
Fixed costs RM5,200
Operating income RM5,200
Revenue of
the bundle
GREEN (2 units × RM200) RM 400
RED (3 units × RM400) RM1,200
RM1,600
Contribution margin per bundle

Contribution ratio for the bundle =
Revenue of the bundle
= RM520 / RM1,600
= 0.325
Fixed costs
BEP revenues =
Contribution margin ratio
= RM5,200 / 0.325
= RM16,000
UNIT 1 57
Contribution versus gross margin
We looked at the Statement of Comprehensive Income in an earlier section in

this unit. Operating income can be presented as Contribution Statement of
Comprehensive Income or Financial Accounting Statement of Comprehensive
Income.
Contribution Statement of Financial Accounting Statement of

Comprehensive Income Comprehensive Income
Revenues XXX Revenues XXX
(−) Variable manufacturing (XX) (−) Costs of goods sold (XX)
costs (XX)
(−) Variable non
manufacturing costs
Contribution XXX Gross margin XXX
(−) Fixed manufacturing (XX) (−) Variable (XX)
costs (XX) nonmanufacturing costs (XX)
(−) Fixed non manufacturing (−) Fixed non manufacturing
costs costs
Operating income XXX Operating income XXX
Figure 5 Contribution versus gross margin
Costs of goods sold = Variable manufacturing costs + Fixed manufacturing costs
Contribution Statement of Comprehensive Income emphasises Contribution; it

indicates how much of a company’s revenues are available to cover fixed costs.
Financial Accounting Statement of Comprehensive Income emphasises gross margin,

costs of goods sold including all variable and fixed manufacturing costs.
Summary
This section discussed the cost-volume-profit (CVP) analysis model

and illustrates how managers use this model to analyse “what-if ”
business questions. There are several assumptions in performing
CVP analysis.
BEP can be calculated for companies with multiple products and

in situations where there is more than one cost driver.
Sensitivity analysis is a valuable tool for managers to determine the

expected outcome of various scenarios.
Operating leverage is presented in DOL; it is a concept that will

help managers to determine the trade-off between risk and reward.
Contribution Statement of Comprehensive Income is different from

Financial Accounting Statement of Comprehensive Income. In Unit 2,
we will look at various techniques used to estimate costs from the
high-low method to the regression analysis method. The first half of
the unit discusses how costs behave and the techniques of estimating
costs. This unit also covers the estimation of regression equation
and explains the goodness of fit.
Self-test 1.5
Choose the correct answer
Break-even analysis assumes that over the relevant range:
A. Variable costs are non-linear.

B. Fixed costs are non-linear.
C. Selling prices are unchanged.
D. Total costs are unchanged.
Suggested answers to activity
Feedback
Activity 1.9
1. BEP = RM5,000,000 / 0.4 = RM12,500,000
2. Revenues to achieve target operating income = RM10,000,000/

0.4 = RM25,000,000
UNIT 1 59
Summary of Unit 1
Summary
In this unit we differentiate the main objectives between financial

accounting and management accounting. The main objective of
financial accounting is external reporting to shareholders and other
stakeholders. On the other hand management accounting support
managers in strategic planning by providing information about the
sources of competitive advantages. We studied how management
accountants add value to the business, and the ethical standards
that a management accountant must uphold.
We also looked at the concepts of direct and indirect cost. A

cost object is anything for which a separate measurement of
costs is desired. Direct costs can be traced to that cost object in
an economically feasible way. Indirect costs are related to the
particular cost object but cannot be traced to that cost object in an
economically feasible way.
We ended this unit with the cost-volume-profit (CVP) analysis

model and how managers use this model to analyse “what-if ”
business questions. From fixed costs to variable costs and mixed
costs contained in this unit, we move to the next unit to learn how
costs (largely mixed) behave. In Unit 2, we will look at various
techniques used to estimate costs from the high-low method to the
regression analysis method.
UNIT 1 61
Unit Practice Exercise

1. Johnson has been employed as an entry-level management accountant for about
two years in a pharmaceutical company. He suspects his immediate supervisor is
involved in a significant fraud regarding the diverting of company assets for
personal use. Briefly describe the steps he should take to resolve this dilemma.
2. Sentosa Resort Hotel is an internationally known resort. It is a five-star hotel

with 250 luxury rooms. The resort has an eighteen-hole golf course, a private
leisure centre, indoor tennis courts, as well as three restaurants. Below are a
series of activities that add value to the guests.
• All hotel staff must attend training regularly.
• Management team focuses on goal-setting in their strategic plan.
• Golf course fairways are trimmed and watered daily.
• Fresh fruit and vegetables are delivered and prepared every day.
• Advanced room reservation system is available.
• Promotion for customers through magazines.
• Maintain high quality, professional service at every stage.
• Transportation is available to take guests to/from airports.
• Contracts with suppliers of meat and fish.
Required:
Classify the above activities as primary or supporting activities in the value chain.
3. The management accountant has issued a report recommending changes to

enhance business performance.
a. Add a new product line.
b. Provide training to operators.
c. Reduce delivery time of goods to customers.
d. Reduce machine set-up time for change order.

e. Benchmark production cost per unit against major competitors.
Required:
Link each of these recommendations to the key success factors.
4. Wonder Sdn. Bhd. makes and sells printers. It takes the following actions, not
necessarily in order given.
a. Ask marketing team to consider ways to get back market share from a
competitor.
b. Calculate market share after introducing new printer.
c. Compare actual costs against budget costs for the production of the new
printer.
d. Propose new product to compete directly with a competitor.
e. Estimate the costs that will be incured to sell 100,000 units of new products
in thenext financial year.
Required:
State whether the above actions are planning decisions or control decisions.
5. Money Come Manufacturing has three cost objects that it uses to accumulate
costs for its manufacturing plants. They are:
Cost object #1: The use of machinery

Cost object #2: Physical building
Cost object #3: Manufacturing labour
The following manufacturing overhead cost categories are found in the

accounting records:
a. Depreciation on machines
b. Lubricants for machines
c. Property insurance
d. Supervisors salaries
e. Fringe benefits
UNIT 1 63
f. Property taxes
g. Electricity
Required:
Assign each of the above costs to the most appropriate cost object.
6. Far East Manufacturing Sdn. Bhd. produces electronic storage devices, and uses
the following three-part classification for its manufacturing costs: direct
materials, direct manufacturing labour, and indirect manufacturing costs. Total
indirect manufacturing costs for January were RM300,000, and were allocated
to each product on the basis of direct manufacturing labour costs of each line.
Actual costs incurred in January for the product, Apple Tree, were:
Apple Tree
Direct manufacturing costs RM400,000
Direct manufacturing labour costs RM200,000
Indirect manufacturing costs RM100,000
Units produced 35,000
Required:
a. Compute the manufacturing cost per unit for Apple Tree produced in
January.
b. Suppose production will be reduced 20 per cent in February. Speculate as

to whether the unit costs in February will most likely be higher or lower
than unit costs in January; it is not necessary to calculate the exact February
unit cost. Briefly explain your reasoning.
7. Top Glass Sdn. Bhd. wants to estimate costs for each product they produce at
the Kedah plant. The Kedah plant produces five products, and runs two flexible
assembly lines. Each assembly line can produce all five products.
Required:
a. Classify each of the following costs as either direct or indirect for each
product.
b. Classify each of the following costs as either fixed or variable with respect
to the number of units produced for each product.
Direct Indirect Fixed Variable

Operators’ wages calculated on
output
Retirement benefits for operators
Component parts
Factory manager’s salary
Depreciation on machinery
Security guard’s wages
Packing materials
8. Each of the following items pertains to Supreme Real Estate (a service sector
company). Classify each item as either inventoriable (I) costs or period (P) costs.
Inventoriable (I) costs or period (P) costs

a. Salary of a receptionist
b. Depreciation on a computer
c. Salary of a real estate agent
9. On the assembly floor, Ahmad is paid RM20 per hour during normal working
hours and RM30 per hour for overtime. In one week he worked 50 hours, which
included 10 hours of overtime.
Required:
a. What amount of compensation would be reported as direct labour cost?
b. What amount of compensation would be reported as overtime premium?
10. Good Hope Plastics Sdn. Bhd. provides the following information for the
year 2012:
Revenues RM5,500,000
Variable manufacturing costs RM 900,000
Variable non manufacturing costs RM 810,000
Fixed manufacturing costs RM 700,000
Fixed non manufacturing costs RM 545,000
UNIT 1 65
Required:
a. Compute Contribution.
b. Compute Contribution percentage.
c. Compute gross margin.
d. Compute gross margin percentage.
e. Compute operating income.
11. Swiss Club is planning to hold the yearly annual dinner. It has two options for
the banquet:
Option 1: Swiss Hotel

a. Fixed facility cost of RM1,000
b. RM64 per person for food
Option 2: Rock Hotel

a. Fixed facility cost of RM3,000
b. A caterer who charges RM50.00 per person for food
It has budgeted RM1,800 for administrative and marketing expenses. It plans to

hire a band which will cost another RM800. Tickets are expected to be RM100
per person.
Required:
a. Which option provides the least amount of risk?
b. Which option has the lowest breakeven point?
c. Which option provides the greatest operating income if 500 tickets were
sold?
d. Which option provides the greatest degree of operating leverage if 500 tickets
were sold?
12. Arizona Sports Sdn. Bhd. sells sports shoes for men and women. The units sold,
selling price and variable costs for each product are as follows:
Men Women
3,000 pairs 2,000 pairs
Selling price RM200.00 RM250.00
Variable costs RM120.00 RM120.00
Fixed costs for the year are RM100,000.
Required:
a. What is the breakeven point in units for each type of shoes, assuming the
sales mix is constant?
b. What is the operating income, assuming the sales mix is constant and the
company will sell 5,000 pairs of shoes?
UNIT 1 67
Suggested Answers to Self-tests
Feedback
Self-test 1.1
Management accounting provides information to internal decision-

makers such as top executives, managers, sales representatives, and
production supervisors. Its purpose is to help managers predict
and evaluate future results. Reports are generated often and usually
broken down into smaller reporting divisions such as department
or product line. There are no rules to be complied with since
these reports are for internal use only. Management accounting
embraces more extensively such topics as the development and
implementation of strategies and policies, budgeting, special studies
and forecasts, influence on employee behaviour, and non-financial
as well as financial information.
Financial accounting provides information to external decision-

makers such as investors and creditors. Its purpose is to present a
fair picture of the financial condition of the company. Reports are
generated quarterly or annually and cover the company as a whole.
The financial statements must comply with accounting standards
of the land.
Self-test 1.2
• Competence: Maintain an appropriate level of professional

expertise by continually developing knowledge and skills.
• Confidentiality: Refrain from using confidential information

for unethical or illegal purpose.
• Integrity: Abstain from engaging in or supporting any activity

that might discredit the profession.
• Credibility: Communicate information fairly and objectively.

Self-test 1.3
a. Formulating overall strategies and long-term plans
b. Resource allocation decisions such as product and customer

emphasis and pricing
c. Cost planning and cost control of operations and activities
d. Performance measurement and evaluation of people
Self-test 1.4
a. RM800,000 / 40,000 = RM20.00
b. (40,000 − 35,000) × RM20 = RM100,000
c. 35,000 × (RM25 − RM20) = RM175,000
Self-test 1.5
The correct answer is (c).

UNIT 1 69
Suggested Answers to Unit Practice

Exercise
Feedback
1. Johnson should take the following actions:
a. Consult internal company procedures to resolve the ethical

issues. The management accountant should make sure
that the facts are accurate, and are not based on rumours or
inaccurate information.
b. If these internal procedures do not resolve the situation,

present the facts to the next higher managerial level.
c. Clarify the relevant ethical issues with an impartial advisor

in professional accounting organisations.
d. Consult own attorney to obtain advice regarding his own

rights and responsibilities.
If the above procedures failed to resolve the ethical situation,

the managerial accountant might have to resign and write
an informative letter to an appropriate representative of the
organisation, and perhaps notify the relevant authorities.
2. • All hotel staff must attend training regularly. (Supporting)
• Management team focuses on goal setting in their strategic

plan. (Supporting)
• Golf course fairways are trimmed and watered daily.

(Primary)
• Fresh fruit and vegetables are delivered and prepared every

day. (Primary)
• Advanced room reservation system is available. (Supporting)
• Promotion to customers through magazines. (Primary)
• Maintain high quality, professional service at every stage.

(Primary)
• Transportation is available to take guests to/from airports.

(Primary)
• Contracts with suppliers of meat and fish. (Supporting)
3. Recommendations Key Success Factor

a. Innovation
b. Cost and quality
c. Time
d. Time and cost
e. Cost
4. Action Decision
a. Planning
b. Control
c. Control
d. Planning
e. Planning
5. Cost object # 1 includes categories a, b, and g.
Cost object # 2 includes categories c and f.
Cost object # 3 includes categories d and e.
6. a. Unit costs for January were:
(RM400,000 + RM200,000 + RM100,000) / 35,000

= RM20 per unit
b. Unit costs should be higher in February if fewer units are to

be produced. Indirect manufacturing costs most likely
include both fixed and variable components. Since fewer
units are expected to be produced in February, total fixed
costs will be spread over fewer units. This will result in an
increase in total cost per unit since variable costs per unit
will most likely not change with the decreased production.
UNIT 1 71
7. Direct Indirect Fixed Variable

Operators’ wages X X
calculated on output
Retirement benefits X X
for operators
Component parts X X
Factory manager's X X
salary
Depreciation on X X
machinery
Security guard’s X X
wages
Packing materials X X
8. Inventoriable (I) costs

or period (P) costs
a Salary of a receptionist Period
b Depreciation on a computer Period
c Salary of a real estate agent Period
9. a. Direct labour cost (50 hours × RM20) = RM1,000
b. Overtime premium (10 hrs × RM10) = RM100
10. a. Contribution RM5,500,000 − RM900,000 − RM810,000

= RM3,790,000
b. Contribution percentage = (RM3,790,000/RM5,500,000)

× 100 = 68.9%
c. Gross margin RM5,500,000 − RM900,000 − RM700,000

= RM3,900,000
d. Gross margin percentage = (RM3,900,000/RM5,500,000)

× 100 = 70.9%
e. Operating income = RM5,500,000 − RM900,000 − RM810,000

− RM700,000 − RM545,000
= RM2,545,000
11. a. Option 1
b. Option 1:
RM100Q − RM64Q − RM1,000 − RM1,800 − RM800 = 0

36Q = RM3,600
Q = 100 tickets
Option 2:
RM100Q − RM50Q − RM1,400 − RM1,800 − 800 = 0

50Q = RM4,000
Q = 80 tickets
c. Option 1:
(RM36 × 500) − RM3,600 = RMRM14,400
Option 2:
(RM50 × 500) – RM5,600 = RM19,400
d. Option 1:
RM36 × 500 / RM14,400 = 1.25
Option 2:
RM50 × 500 / RM19,400 = 1.29
12. a. The BEP is calculated for the bundle of 3 pairs of Men and
2 pairs of Women as follows:
Contribution per pair of Men × 3 pairs RM240

Contribution per pair of Women × 2 pairs RM260
Contribution per bundle RM500
BEP in bundle = RM100,000 / RM500

= 200 bundles
UNIT 1 73
Pairs Revenues
BEP of Men (200 bundles 600 RM120,000
× 3 pairs); (600 pairs ×RM200)
BEP of Women (200 bundles 400 RM150,000
× 2 pairs); (600 pairs × RM250)
BEP RM270,000
b. Men Women Total

Sales in pairs 3,000 2,000 5,000
Revenue (RM) 600,000 500,000 1,100,000

Variable costs (RM) 360,000 240,000 600,000
Contribution (RM) 240,000 260,000 500,000
Fixed costs (RM) 100,000
Operating income (RM) 400,000
UNIT 1 75
References
Horngren, C T, Datar, S M and Rajan, M V (2012) Cost Accounting: A Managerial
Emphasis, 14th edn, USA: Pearson Education Limited.
UNIT 1 77
Glossary
Cost management The approaches and activities of managers
in using resources to increase the value to
customers and to achieve organisational goals.
Strategy The plan on how an organisation will compete

and the opportunities management should
pursue. Strategy focuses on the long term and
is performed by upper management.
Value chain The sequence of business functions in which

customer usefulness is added to products or
services.
Budget The quantitative expression of a proposed plan

of action. It is a planning tool.
Control The action taken to implement the planning

decisions represented by the budget.
Line management Managers who are directly responsible for

attaining the goals of the organisation.
Staff management Managers who are supporting the line

management with advice and assistance.
Cost object Anything for which a measurement of cost is

desired.
Cost accumulation The collection of cost data in some organised

manner by means of an accounting system.
Direct costs Costs that are related to the cost object and
can be traced to it in an economically feasible
(cost-effective) way.
Indirect costs Costs that are related to the cost object but
cannot be traced to it in an economically
feasible way.
Cost assignment The process of tracing direct costs and allocating

indirect costs to a cost object.
Variable costs Costs that change in total in proportion to

changes in the activity level.
Fixed costs Costs that do not change with changes in the

activity level.
Cost driver A variable, such as the level or activity or

volume that causally affects costs over a given
span of time.
Relevant range The range of activity within which costs behave

as predicted.
Inventoriable costs All costs that are considered assets in the

Statement of Financial Position when they are
incurred and this includes direct materials,
direct labour, and factory overhead.
Period costs All costs on the statement of comprehensive

income other than cost of goods sold.
Prime cost All direct costs or direct materials plus direct

labour.
Conversion cost Direct labour plus factory overhead. It is the

cost of converting the materials into a finished
product.
Idle time The wage paid for unproductive time caused

by lack of orders, machine breakdowns, or
other reasons.
Overtime premium The wage rate paid to workers in excess of their

regular straight-time wage rate.
Contribution The difference between total revenues and total

variable costs.
Breakeven Point (BEP) The quantity of output sold at which total

revenues equal total costs.
Target Operating Income The level of sales needed to attain a specified

dollar amount of operating income.
Sensitivity analysis A technique to examine the effect of changes

in the variables that will affect the outcome of
the decision.
UNIT 1 79
Margin of safety The amount by which the current level of sales

exceeds the breakeven point.
Operating leverage The effects of fixed costs on changes in

operating income with changes in Contribution
or volume.
Source: The above definitions are adapted from Horngren, C T, Datar, S M and
Rajan, M V (2012) Cost Accounting: A Managerial Emphasis, 14th edn, USA: Pearson
Education Limited.

Cost MGMT Accounting U1

Uploaded by

Copyright:

Available Formats

Cost MGMT Accounting U1

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Cost MGMT Accounting U1

Uploaded by

Copyright:

Available Formats

UNIT 1 i

Management accounting and cost concepts

EXTERNAL COURSE ASSESSOR

© 2008 Wawasan Open University

First revision 2011

Wawasan Open University [DU013(P)]

1.1 The manager and management accounting 5

Management accounting and financial accounting 5

The management accountant’s role in implementing 7

Value chain, supply chain analysis and key success 8

Suggested answers to activities 21

1.2 An introduction to cost terms and purposes 23

Cost and cost terminology 23

Cost behaviour patterns: Variable costs and fixed costs 26

Unit costs and total costs 30

Business sectors, types of inventory, inventoriable costs 32

Different definitions of product costs 36

Suggested answers to activities 39

1.3 Cost-volume-profit relationship 41

Breakeven point and target operating income 45

Suggested answers to activity 58

Unit practice exercise 61

Suggested answers to self-tests 67

Suggested answers to unit practice exercises 69

B AC 301/05 Cost and Management Accounting is a 5-credit higher level course

This course contains five units.

By the end of this course, you should be able to:

1. Explain how different costs are used to serve different management

2. Apply cost-volume-profit computations in business decision making.

3. Summarise various budgeting approaches.

4. Apply the budgeting approaches to analyse variances.

5. Apply costing systems to various types of operations.

M anagement accounting information is useful for strategy formulation, budgeting,

Kiruthiga Raguraman ACMA, CGMA, a finance manager at

In my view, the most important skills one requires in a corporate world

To read more of the interview, visit http://www.cimaglobal.com/

1. Distinguish between financial accounting and management accounting.

2. Explain the cost-benefit approach to choosing accounting systems.

3. Describe the role of professional ethics in management accounting.

5. Construct model statement of comprehensive incomes for a manufacturing

6. Differentiate between inventoriable costs and period costs.

7. Demonstrate three methods of calculating breakeven point and targeted

8. Distinguish between contribution and gross margin.

1.1 The Manager and Management

1. Distinguish between financial accounting and management accounting in

2. Describe the management accountant’s role in implementing strategy,

Management accounting and financial accounting

Financial accounting emphasises external reporting to investors, government

Financial statements are prepared based on generally accepted accounting principles

Many companies implement Enterprise Resource Planning (ERP) system with a

Management accounting emphasises the provision and use of accounting information

Management Accounting Financial Accounting

Table 1.1 Differences between management accounting and financial accounting

The history of management accounting

Hume-Schwarz (2007) describes the evolution of management accounting in the

In United Kingdom, “The Institute of Cost and Works Accountants”(ICWA) was

The Germans contributed to the discipline of management accounting in the 40s

The management accountant’s role in implementing strategy

Deciding which strategy to be adopted is a critical part of what managers need to