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TOPIC OUTCOMES

Students are able to differentiate between cost/management accounting and financial accounting.
Students are able to understand the concept of cost, cost units and cost centre.
Students are able to identify, define and classify the various types of cost.
Students able to understand the application of management accounting for various industries

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DEFINITION

Financial accounting	Management accounting
Financial accounting is an accounting system that focuses on the preparation of financial statement of an organization to provide the financial information to the interested parties.��	It is an integral part of the management process concerning with identifying, presenting and interpreting information which is used for formulating strategy, planning, controlling, decision making and optimising the use of resources.

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DEFINITION OF COST ACCOUNTING

Cost accounting is basically the next step to costing. Cost accounting involves analysing relevant costing data, interpret it and present various management problems to management.
It can be simplified as recording, classifying and summarising of cost data of an organisation.

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COSTING VS MANAGEMENT ACCOUNTING

BASIS OF COMPARISON	COST ACCOUNTING	MANAGEMENT ACCOUNTING
Meaning	The recording, classifying and summarising of cost data of an organisation is known as cost accounting.	The accounting in which the both financial and non-financial information are provided to managers.
Information Type	Quantitative.	Quantitative and Qualitative.
Objective	Ascertainment of cost of production.	Providing information to managers to set goals and forecast strategies.
Scope	Narrow, as it is limited only up to the cost information.	Its area of operation is wide.
Specific Procedure	Yes	No
Recording	Records past and present data	It gives more stress on the analysis of future projections.

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DIFFERENCES BETWEEN FA & MA

CRITERIA	Financial Accounting	Cost/Management Accounting
User orientation	Caters the needs of external and internal users	Caters the needs of internal users
Report frequency	Report is done in stated period (annually, quarterly)	Report is prepared as required (daily, weekly)
Time dimension	Information is past oriented/ historical	Information is current and futuristic
Legal requirements	Public limited companies are compulsory to reveal the FS	Optional
Standards requirement	GAAP, approved accounting standards	Flexible

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SIMILARITIES OF FA & MA

Both types of information is used for internal reporting.
Both use similar techniques such as marginal costing, budgetary controls and standard costing.
Both types of information is used for the decision-making purposes.

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COST CONCEPT

Cost- amount of expenditure paid for a specific activity
Cost unit- the quantitative units of product/service to measure cost

Eg: a kilogram of flour, a dozen of can

Cost centre- a department/business unit where cost is allocated. It can be location, person, or item of equipment for which costs may be ascertained.

Eg: production department, salesman (commission)

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COSTS

Nature

Function

Normality

Behavior

Controllability

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COST ACCORDING TO NATURE

NATURE

MATERIAL

LABOUR

EXPENSES

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Nature of cost

Material

Cost of material of any nature used for the purpose of production of a product or a service.

Labour

The payment made to the employees, permanent or temporary, for their services.

Expense

Costs other than material cost or labour cost which are involved in an activity.

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TRACEABILITY

Cost can be classified according to whether the cost is directly or indirectly involved in the process of making the product or providing the service.

Direct cost

a cost which is incurred for the benefit of one specific product

Indirect cost

a cost which is incurred for the benefit of more than one cost object or which cannot be easily or efficiently traced to a specific cost object

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CLASSIFICATION OF MATERIALS

The main classifications for materials used by the management accountant are direct materials and indirect materials.

DIRECT MATERIALS

Materials that can be economically attributed to a specific unit of production.
They are directly involved in producing the finished goods.

INDIRECT MATERIALS

Other materials used in the production process that cannot be directly attributed to a unit of production.
They are not involved directly in producing the finished goods, but needed to looks perfect, nice and ready for sales.

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Labour costs can be classified into 2 categories:

Direct labour costs – wages paid to workers who directly involved in the production of goods and service (e.g. machine operators).

Indirect labour costs – wages paid to workers who do not directly involved in the production of goods and service (e.g. factory supervisor).

CLASSIFICATION OF LABOUR

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COST ACCORDING TO FUNCTION

FUNCTION

PRODUCTION

ADMINISTRATION

RESEARCH & DEVELOPMENT

SELLING AND DISTRIBUTION

FINANCE

NON-PRODUCTION COST

Selling and distribution cost: expenses relating to the sales and transportation of goods from production locations to customers, resellers, or other destinations. Changes in the selling and distribution cost can have an effect on the final sale price of the product, as factors such as shipping costs, tolls, warehouse fees, inventory taxes, and other expenses must be priced in.

Finance cost: is the cost and interest and other charges involved in the borrowing of money to build or purchase assets.

Administration cost : Administrative expenses are costs related to the general administration of the business and incurred at the corporate level, rather than by individual departments or business units.

Research and development : Research and development cost- cost that relates to development/improvement of new/existing products.

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COST BEHAVIOUR

FIXED

COSTS

MIXED

COSTS

VARIABLE COSTS

STEPPED COSTS

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FIXED COST

A fixed cost is a cost that is not affected in total by the changes in activity level.

Example:

Rental payment for a shop premise

Voice over

A fixed cost is a cost that is not affected in total by the changes in activity level

For Example: Rental payment for a shop premise

The amount of rental payment will remain the same every month even if there is no sales made during a particular month. This is because, the rental of the shop premise will normally be under contract agreement for a specified time period. As long as the contract time period has not expired, the business would have to pay on the agreed rental payment every month without fail.

Let’s say Ahmad is an owner of a bookshop who rents a shop premise for his business. He had agreed with the landlord of the premise to rent the place for a minimum period of 1 year with a monthly rental of RM2,000 per month. Therefore, he still has to pay RM2,000 per month even though there will be few days that will be closed during a month that will result in no sales being made. That is why it is said that a fixed cost is not affected in total by the changes in the activity level.

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Fixed Cost

Fixed costs remain the same during the short term and do not vary when the volume of production increases or decreases.
These are the costs that are a function of time rather than production activity and thus are not sensitive to changes in production volume.
Examples of fixed costs would include rent, rates, insurance and management salaries.
Fixed costs in total do not change in response to changes in activity levels.
Fixed cost per unit will change in relation to changes in activity level.

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VARIABLE COST

A variable cost is a cost that changes in total in direct proportion to the level of activity.

Example:

Cost of wood planks in the production of dining tables

Voice Over

A variable cost is a cost that changes in total in direct proportion to the level of activity.

For example, in the business of producing dining tables, the cost of wood planks used as the table tops are considered as variable cost. This is because we would only incur the cost of wood planks if we actually produce the tables. If we do not produce the table, we would not incur any cost associated with the wood planks. That is why the cost is said to be varied with the activity level.

Let’s say, the cost of one wood plank is RM100 per piece. Each unit of a dining table would require one piece of this wood plank. Thus, if we produce 1 unit of dining table, the cost of the wood plank is RM100. But if we produce 100 units of the dining tables, the cost of the wood planks would be RM10,000. The variable cost per unit of the wood plank remains at RM100 per piece but the TOTAL VARIABLE COSTS of the wood planks would increase to RM10,000.

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VARIABLE COST

Variable costs are those costs that changes in direct proportion to changes in the activity level (total variable costs will increase as sales or production volume increases and vice-versa).
Examples would include direct materials (cost of food or beverages for a restaurant or toys in a toyshop)
Variable costs in total change in response to changes in activity levels.
Variable cost per unit will remain constant in relation to changes in sales activity.

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MIXED COST

A mixed cost is a cost that has both fixed element and variable element.

Example:

Salesman remuneration package

Voice Over

A mixed cost is a cost that has both fixed element and variable element.

A good example for this mixed cost is to look at salesman remuneration package. Normally, salesman will be paid a basic monthly salary plus sales commission based on the sales volume made by him.

Let’s say Norman is a salesman at a health supplement company. He is paid a basic salary of RM1,800 per month. It is the policy of his company to pay sales commission of 10% of the sales revenue made in any particular month. Assuming that in March, he made total sales revenue of RM15,000. Thus Norman is entitled for a sales commission worth RM1,500. Therefore, Norman will be paid a total of RM3,300 in March. The RM1,800 basic salary is classified as the fixed cost to the company while the sales commission of RM1, 500 is considered to be a variable cost to the company.

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Mixed Costs (Semi-variable cost)�

Fixed Monthly�Electricity Charge

Variable �Cost per KW

Activity (Kilowatt Hours)

Total Electricity Cost

A mixed cost contains both variable and fixed elements. Consider the example of electricity cost.

Total mixed cost

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STEPPED COST

A stepped cost is a cost that is constant for a range of activity levels and then change and then remain constant again for another range

Example:

Supervisors’ salary

Voice Over

Some costs remain fixed over a wide range of activity levels but jump to a different amount for level outside that range. This type of cost is known as a stepped cost. It is a cost that is constant for a range of activity levels and then change and then remain constant again for another range.

Take for an example the supervisors’ salary. Assume that one supervisor can only supervise for a maximum of 10 workers at a time. The salary per one supervisor is RM1,500 per month. This amount of RM1,500 will maintain as long as the number of workers does not exceed 10 people. If we need 11 workers at a time, automatically, we would also need to increase the number of supervisor to two persons. When the number of workers increase to 11 people, the total salary for the supervisors would now be doubled, which is RM3,000 per month. This amount will stay as long as the number of workers do not exceed 20 people.

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Step Cost

The step costs are fixed for a given level of activity but they eventually increase by a significant amount at some critical point.
Examples include renting an additional warehouse unit or hiring an additional supervisor when activity reaches a critical point.

The graph shows that fixed costs are €2,000 up to an activity level of 2,000 meals. At this point the fixed costs increase significantly. Again at 4,000 meals another critical point is reached and fixed costs increase again.

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PRODUCT VS PERIOD COST

Cost of making or buying an inventory for the purpose of resale

PRODUCT COST

Cost that is charged to the Income Statement which is not directly related to production.

PERIOD COST

Voice over

The third classification of a cost is either it is a product cost or a period cost.

A product cost is a cost of making or buying an inventory for the purpose of reselling it. For example, in the case of a manufacturing company, a product cost consists of the cost of raw material, direct labour, direct expenses and manufacturing overhead. For a wholesaler or retailer, the product cost consists of the purchase cost plus the cost of delivering the goods from supplier.

All costs that are not product costs are called period costs. A period cost is a cost that is charged to the Income Statement which is not directly related to production. It relates to the passage of time and not to the output of goods or services. For example, advertising expenses, salaries to administrative workers and depreciation of office equipment.

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CONTROLLABLE VS. UNCONTROLLABLE COST

Controllable cost	Uncontrollable cost
costs that can be controlled by a manager Eg: cost of material used, salary of employee, certain factory overhead costs	costs that beyond managers’ control Eg: depreciation, insurance, tariff, import duty

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NORMALITY

Normal Cost	Abnormal Cost
The regular costs which are incurred in the normal conditions during the normal operations of the organization. Example: repairs, maintenance, salaries paid to employees.�	Unusual or irregular which are not incurred due to abnormal situations of the operations or productions. Example: destruction due to fire, shut down of machinery, lock outs, natural disaster

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Other cost concepts

Opportunity cost- the benefit forgone or lost when one alternative is rejected over another.
Conversion cost – cost of changing raw material to semi finished or finished good.
Relevant cost- future cost that will make a difference in a decision.
Sunk cost- past cost that has no influence in making future decision (irrelevant cost)
Prime cots - prime costs are the costs directly incurred to create a product or service

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