Management Accounting Concepts

INTRODUCTION TO MANAGEMENT
ACCOUNTING
MN 3043 – Business Economics and Financial Accounting
G.V.N.Mahimi Kanchana
Faculty of Engineering
University of Moratuwa
Learning Outcomes
❑ Analyse the nature, scope and utility of cost

accounting.
❑ Examine how cost accounting arises out of the
need to make business decisions.
❑ Identify the difference between cost, management
and financial accounting.
❑ To familiarize with costing terminology.
What is Management Accounting ?
Management accounting is concerned with the

provision and use of accounting information to
managers within organizations, to facilitate the
managers in their decision making and
management control functions.
Financial Accounting focuses on preparing
information for the use of external decision
makers.
Management Accounting focuses on the
requirements of Managers within the
organization & the information they require
making decisions.
Financial Accounting Vs. Management Accounting
Financial Management
Accounting Accounting
Stewardship or Seek to improve economy, efficiency and
Principal
business forthe effectiveness of operations
Objectives
benefit of
shareholders
Not only look at the past,but
Time
horizon Past the present and the future
which affects the operationof the company
External/
Report Internal parties likeDirectors and Managers
recipients Outsiders namely
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Shareholders and
Government(tax)
Financial Accounting Vs. M.A.Contd…
Summary (usually annual) Detailed monthly and

statement of annual management
profit and loss and accounts showing
other comprehensive results by product
Outputs
income , statement of and function adhoc
financial position and reports
statement of cash flow
Regulating Accounting standards,

Accounting concepts plus None prescribed
framework
statutory requirement by the
companies Act
6
Cost Accounting
❑ Cost refers to the value of resources sacrificed to
achieve a specific objective, such as manufacturing,
acquiring a good or providing a service or it means the
amount of expenditure incurred on, or attributable to a
given thing. Usually cost is measured in monetary
terms.
❑ Cost Accounting is a systematic set of procedures for

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recording and reporting measurements of the cost of
manufacturing goods and performing services in the
aggregate and in detail.
Management Accounting activities include;
1) Explaining production & non production costs & how they are reported
in the financial statements.
2) Computing the costs of providing a service or manufacturing a product.
3) Determining the behavior of costs & expenses as activity levels change.
4) Analyzing cost-volume profit relationships within a Company.
5) Assisting management in profit planning & budgeting.
6) Providing a basis for controlling costs & expenses by comparing

actual results with planned objectives & standard costs.
7) Accumulating & presenting relevant data for management decision

making.
Cost Terms
➢Cost Unit
➢Cost centre
➢Relevant cost
➢Irrelevant cost
➢Opportunity cost
➢Standard cost
➢Sunk cost
Cost Unit
Unit of quantity of product, service or time in
relation to which costs may be ascertained or
expressed.
Ex:
Telecommunication - a minute
Bread production - a bread
Apartment Complex – a single apartment
Cost center
Cost center means “a location, person or item of
equipment (or group of these) for which costs may
be ascertained and used for the purpose of cost
control.”
- The Chartered Institute of Management
Accountants,
Relevant Cost
A managerial accounting term that is used to
describe costs that are specific to management’s
decisions. The concept of relevant cost eliminates
unnecessary data that could complicate the
decision making.
Irrelevant Cost
A managerial accounting term that represents a
cost, either positive or negative, that does not
relate to a situation requiring management’s
decision.
Types of Relevant and Irrelevant Cost
Opportunity Cost
The cost of an alternative that must be

forgone in order to pursue a certain
action. Put another way, the benefits you
could have received by taking an
alternative action.
Standard costs
The standard cost is a production or operating cost that is
carefully predetermined. A standard cost is described as a
predetermined cost, an estimated future cost, an expected
cost, a budgeted unit cost, a forecast cost, or as the “should
be” cost. Standard costs are often an integral part of a
manufacturer’s annual profit plan and operating budgets.
It is a target cost that should be

achieved.
Sunk cost
➢ A cost that has already been incurred and thus
cannot be recovered.
➢ A sunk cost differs from other, future costs that

a business may face, such as inventory costs or
R&D expenses, because it has already
happened.
➢ Sunk costs are independent of any event that

may occur in the future.
Classification of costs
1. Function wise classification

2. Elements wise Classification
3. Behavior wise Classification
Classification of costs cont…
1. Function wise classification (Their ease of
traceability)
➢ Direct cost
▪ Direct material cost
▪ Direct labour cost
▪ Direct other cost
➢ Indirect cost
✓ Production overheads
✓ Non production overheads
▪ Administrative expenses
▪ Selling and distribution expenses
▪ Finance and Other expenses
Direct Cost vs. Indirect Cost
• Direct cost refers to the cost that can be
specifically and exclusively identified with a
particular cost object.
• Indirect cost can’t be specifically and

exclusively identified with the cost object.
Production Overhead Cost
Manufacturing costs that cannot be traced directly to
specific units produced.
Examples: Indirect Labor , Indirect Materials & other
Wages paid to employees Materials used to support

who are not directly the production process.
involved in production
work. Examples: lubricants and21
Examples: maintenance cleaning supplies used in the
workers, janitors and automobile assembly plant.
security guards.
Classification of costs cont…
2. Elements wise classification
➢ Material Cost
➢ Labor Cost
➢ Other cost
Material Cost
Those materials that become an integral part of the product and
that can be conveniently traced directly to it.
(Rs).
Invoice price xxxx
(-) Trade discount (xxx)
Freight chargers xxxx
Excise duty xxxx
Non refundable VAT xxxx
Non returnable Containers xxxx
Cost of Material XXXX
Practice question 01
The following quotation received from Mr. Nuwan in
respect of a material item;
Lot price,
2000 units Rs. 5.00 each
Trade discount 25% and Cash discount 5% ( if settled
within 10 days)
Freight charges per order Rs. 2,000
Containers charged Rs. 10 each
One container is required for every 100 units.
Calculate the material cost for 6000 units.
Labor Cost
Those labor costs that can be easily traced to individual units
of product.
Other cost
Those costs that can be easily traced to individual units of
product other than Material and labor.
Examples:
Royalty fee
Production license fee
Classification of costs contd…
3. Behavior wise classification
➢ Variable costs
➢ Fixed costs
➢ Semi-variable costs (Step cost)
Variable and Fixed Cost Behaviour
Cost InTotal PerUnit

Total variable cost changes as Variable cost per unit remains the
Variable activity level changes. same over wide ranges of activity.
Total fixedcostremainsthe Fixedcost per unitgoes down

Fixed
same even when the as activitylevelgoes up.
activity level changes.
Semi -Variable Cost Behaviour
Semi-variable cost is an expense which contains both a
fixed-cost component and a variable-cost component.
Example
• Electricity expenses
• Telephone expenses
Total Production cost
The summation of the prime cost and manufacturing
overhead is termed as total manufacturing cost and it
can be depicted as follows;
Direct material cost xxx

Direct labor cost xxx
Direct other cost xxx
Prime cost xxx
Production overhead cost xxx
Total Production cost xxx
Total Production cost
Direct Material
Manufacturing Direct Labour

/Production
Cost Variable Manufacturing OH
Total Fixed Manufacturing OH

Cost
Non- Variable Non-manufacturing OH
Manufacturing
/ Non -
Production Cost Fixed Non-manufacturing OH
Total Cost
Manufacturing Non-Manufacturing/ Non -

/Production Cost Production Cost
Variable Fixed Variable Non- Fixed Non-

Direct Direct Manufacturing Manufacturing manufacturin manufacturin
Material Labour OH OH g OH g OH
Any expense incurred after

completion of the manufacturing
and expense incurred not for
Total Manufacturing Cost production
Manufacturing Cost
• Direct Material – cost of wood , cost of cushion,
cost of paint
• Direct Labour – carpenter’s salary, labour cost of
painting, labour cost of cutting
• Variable Manufacturing OH – Electricity incurred
for factory
• Fixed Manufacturing OH – Factory rent,
Production Manager’s salary
Non-manufacturing OH Cost
• Variable Non-manufacturing OH - Admin
office electricity, commission paid for
sales rep based on number of units sold
• Fixed Non-manufacturing OH – Sales
Cost Object : Chair manager salary, admin office rent

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INTRODUCTION TO MANAGEMENT

❑ Analyse the nature, scope and utility of cost

Management accounting is concerned with the

Summary (usually annual) Detailed monthly and

Regulating Accounting standards,

❑ Cost Accounting is a systematic set of procedures for

2) Computing the costs of providing a service or manufacturing a product.

3) Determining the behavior of costs & expenses as activity levels change.

4) Analyzing cost-volume profit relationships within a Company.

5) Assisting management in profit planning & budgeting.

6) Providing a basis for controlling costs & expenses by comparing

7) Accumulating & presenting relevant data for management decision

The cost of an alternative that must be

It is a target cost that should be

➢ A sunk cost differs from other, future costs that

➢ Sunk costs are independent of any event that

1. Function wise classification

• Indirect cost can’t be specifically and

Examples: Indirect Labor , Indirect Materials & other

Wages paid to employees Materials used to support

2. Elements wise classification

Cost InTotal PerUnit

Total fixedcostremainsthe Fixedcost per unitgoes down

Direct material cost xxx

Manufacturing Direct Labour

Total Fixed Manufacturing OH

Manufacturing Non-Manufacturing/ Non -

Variable Fixed Variable Non- Fixed Non-

Any expense incurred after

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