1

BSC BUSINESS STUDIES

BUSINESS ACCOUNTING

SESSION ELEVEN

2

After studying this topic you will:

• Be able to explain the nature and roles of accounting

• Be able to identify the main users of financial information

• Identify the characteristics that make accounting information useful

• Be able to explain some of the work undertaken by a management accountant

• Know the challenges ahead for management accounting

3

Cost and Management Accounting

Users of Financial Information

4

Financial v Management Accounting

Financial accounting provides information to those users who are outside the

organisation

Definition

The classification and recording of monetary transactions.

The presentation and interpretation of the results of these transactions in order to assess

performance over a period of time and the financial position at a given date.

The presentation of this information in a way laid down by the Companies Acts and in

accordance with accounting standards.

5

Management accounting provides information for those users are inside the

organisation and who direct and control its operations.

Cost accounting

Definition

The establishment of budgets, standard costs and actual costs of operations, processes,

activities or products; and the analysis of variances, profitability or the use of funds.

Management accounting

Definition

An integral part of management concerned with identifying, presenting and

interpreting information used for, planning, control, decision making and optimising the

use of resources and the safeguarding of assets.

6

Financial accounting, cost accounting and management accounting involves

participation of the managers to be effective and thus by a detailed analysis of

expenditure, costing becomes an important element of managerial planning and

control.

Financial Management

1. Focus Primary focus is on Focuses on segments

the whole organization of an organization

2. Viewpoint Historical perspective Future emphasis

3. Users External Internal

4. Why Financial decisions Plan, control, decisions

5. Regulations Must follow GAAP Need not follow GAAP

and prescribed formats or any prescribed format

6. Characteristics Verification and Relevance andprecision timeliness

7

The table below lists some of the characteristics of financial accounting and

management accounting systems. Indicate the characteristics for each system by

putting a tick in the relevant column of the table.

Characteristic Financial

Accounting

Management

Accounting

To help managers run the business

Produced for shareholders

Formats dictated by accounting rules

Content can include anything useful

Looks mainly at historical information

May includes budgets and future

forecasts

Produced annually or, in some cases,

every six months

Usually produced monthly

8

Characteristics of Management Accounting Information

The characteristics that influence the usefulness of accounting information

9

Role of Management Accountants and uses of cost information

� DECISION MAKING

� CONTROLLING

� PLANNING

10

Planning

• Involves translating goals and objectives into specific activities and resources

needed to achieve the goals and objectives.

• Organisations need to plan for both the short term and also the long term.

• A long range plan is necessary to anticipate any future needs or opportunities

that require action now or in the near future.

• Long term plans and objectives are converted into a succession of short-term

plans of action that are normally called annual budgets.

Long-term strategic planning

• Develop an overseas marketing outlet

• Planned acquisitions & disposals of business interests

Short-term operational planning

• Planned expenditure on fixed assets

• Sourcing finance

11

Control

• Control is the process of ensuring that the actual outcomes conform with

planned outcomes.

• Involves comparing actual performance with the short term plans (budgets and

/ or standards) so that deviations can be identified and corrective action taken

to ensure that the long term objectives are possible.

• Provides economic feedback to assist in controlling costs and improving the

efficiency and effectiveness of operations.

• Assessing performance - products, divisions, operations.

• Variance analysis – comparing actual results to the plan / budget / standards –

materials, labour and overheads.

• Variance reports do not show solutions but highlight where management effort

should be expended to find solution

12

Decision Making

Three levels of decision making:

• Strategic level – set or change the overall strategic targets of an organisation.

• Tactical level – concerned with the efficient and effective use of an

organisation’s resources.

• Operational level – ensuring that specific tasks are carried out.

• What product mix to sell? – close or keep open loss making products?

• Selling prices? (different customers can be charged / billed out at different

prices)

• Choosing a source of finance? – bank o/draft, short or long term loan

• Credit terms? Are current terms - too generous or too tight?

13

Cost Terms, Concepts and Classifications

Learning Objectives

• Be able to appreciate the work undertaken by a Management accountant.

• Be able to define key accounting terms with emphasis on Management

Accounting and in particular Job Costing

• Know why the study of cost behaviour is important

14

Financial Accounting

A broad overview of the

organisation with primary

emphasis upon cost

classification according to

type of transaction, eg

salaries, rent, materials,

labour, postage, etc etc

Change of emphasis

Financial Accounting

A broad overview of the

nisation with primary

emphasis upon cost

classification according to

type of transaction, eg

salaries, rent, materials,

labour, postage, etc etc

Management Accounting

An in-depth, investigative

reclassification of costs

incurred based on

functions, activities,

products and processes

used for internal planning

and control purposes.

Management Accounting

depth, investigative

reclassification of costs

incurred based on

functions, activities,

products and processes

used for internal planning

and control purposes.

15

Determining Product Costs

Job Costing

Many different products produced each period

Products manufactured to order

Costs are linked or allocated to jobs

Cost records must be kept for each distinct product or jog

Determining Product Costs

Job Costing

Many different products produced each period

Products manufactured to

Costs are linked or allocated to jobs

Cost records must be kept for each distinct product or jog

Process Costing

Similar products are produced each period

Products made using automatic single purpose machines

Costs are accumulated and divided by total production to get

an average cost per unit

There is less admin and paperwork due to the "bulk" nature of costs

Process Costing

Similar products are produced

Products made using automatic single purpose machines

Costs are accumulated and divided by total production to get

an average cost per unit

There is less admin and paperwork due to the "bulk" nature of costs

16

Sequence of Events in a Job Order Costing System

Receive order from customer

Schedule the

jobs

order

material,

organise

staff,machine

set up etc

Begin

production

deliver goods

to customer

17

Direct and Indirect Cost Elements

Revenue expenses can also be classified by using the three main cost elements.

� Materials

� Labour

� Expenses

These categories can be further divided into:

Direct costs

Indirect costs

Costs that can be directly associated with a particular unit of

production or service provided

Costs that cannot be directly associated with a particular unit of

production or service provided

18

Classification by element

Materials

• The costs of the purchases of raw materials that are to be used in the

manufacturing process in a manufacturing organisation

Or

• The cost of goods that are to be resold in a retail organisation.

Labour

• The costs of the employees

• Charged to the cost centre which has used their time

• Labour costs can consist of not only basic pay but overtime, commission and

bonuses as well.

Expenses

• Expenses, otherwise known as overheads.

• Costs incurred by an organisation other than materials and labour costs.

• E.g. costs such as rent, rates, heat and power costs, cleaning, advertising etc.

19

SS Ltd manufacturers’ Skirts

Classify each of these costs according to whether they are material, labour or

expenses.

£ Materials Labour Expenses

4000 metres of white cotton

fabric 4,000

2000 hours of sewing

machine operators time 12,500

Rent of the Chester plc

building

3,000

Electricity bill for the whole

company 500

600 metres of white cotton

50

Plastic and Cardboard

packaging 100

20

Direct Materials Materials that are used to manufacture a finished product.

Indirect

Materials

Materials that are used in the production

process but are not incorporated into the product. E.g.

Spare parts for machinery.

Also materials that are shared between products and

that are uneconomic to split between products e.g. a

pot of glue.

Direct labour Wages paid to workers who make the products or provide the

service.

Indirect labour

Wages and salaries of other staff within the business e.g.,

a supervisor is not directly involved in making anything

and may be responsible for a number of

products/product lines. As such their salary will need

sharing across all of these units.

Direct Expenses

Expenses that are related to each unit of production e.g.,

patent royalties

Indirect

Expenses

Indirect Expenses are any other shared cost that is not

material or labour e.g. rent and rates, depreciation,

canteen costs and so on.

Expenses that are not spent on individual units of production

21

P. Ink is a high quality shirt manufacturer.

Classify the following costs by nature (direct or indirect) in the table below.

Cost Direct Indirect

Cost of Egyptian Cotton

Wages paid to cutting and sewing

employees

Oil used to lubricate the sewing

machines

Salesmen’s salaries

(Note: We have assumed here that the cotton is the main cloth for making the shirts.

However, if the cotton is simply for attaching buttons, then you could argue that a

company is unlikely to bother measuring how much cotton is used for a particular

garment and hence it would be indirect)

22

Direct Labour –

Direct Materials –

Direct Expenses -

Prime Costs

Direct labour

Cost Classification

Prime Costs

Direct Expenses

Direct labour

Direct Materials

23

Materials – oils to lubricate machine

Labour – production Supervisors, fork lift truck drivers

Expenses – rent, depreciation of machinery, canteen expenses

Manufacturing Overheads

Indirect

Labour

oils to lubricate machine

production Supervisors, fork lift truck drivers

rent, depreciation of machinery, canteen expenses

Manufacturing Overheads

Indirect

Expenses

Indirect

Labour

Indirect

Materials

24

25

How do we include the correct amount of overheads into the cost of a job?

We calculate an overhead absorption rate – OAR

Manufacturing overheads

OAR = Budgeted total manufacturing overheads

Budgeted total number of units of absorption base

EG

For each direct labour hour worked on a job, £4 per hour of factory overhead will also

be charged into the cost of each job.

OAR = £64,000

160,000

The base is the measure used to share out the cost.

It could be labour hours or machine hours used for

manufacturing overheads

Direct labour hours have been

used in this example

26

Absorption bases – non manufacturing overheads

OAR = Budgeted total non manufacturing overheads

Budgeted total manufacturing cost

EG

For each £ of manufacturing cost of a job an extra 25p per £ of non manufacturing

overhead will also be charged to the cost of each job

OAR = £250,000

= 25% or 25p in the £ £1,000,000

27

Job Order Costing Sheet

Department: Small Wooden - Specialty Date started: 10 Jan 20X1

Item: Wooden Storage Boxes - Jewellery Date finished: 10 Jan 20X1

Job Number: DC001 Customer: Dean Coulter

Quantity: 500

Manufacturing Overhead

Requisition Amount Ticket Hours Amount Source Amount Hours OAR Amount

Number £ Number £ £ £ £

WSB - DC001 116.00 RP - Wk 1 8 88.00 Pat 21W 24.00 8 4.00 32.00

£

Direct Materials 116.00 Date Number Balance

Direct Labour 88.00 Shipped

Direct Expenses 24.00 13/01/x1 500 NIL

Manufacturing Overhead OAR @ £4 per DLH 32.00

Total Production cost 260.00

Non Manfacturing Overheads @ 25% 65.00

Total Job cost 325.00

Profit @ 40% mark - up 130.00

Selling price 455.00

Direct Materials Direct Labour Direct Expenses

McGrath Boxes Ltd - Job Cost Sheet

Units Shipped

28

Expenses

Capital

Expenditure

Revenue

Expenditure

Fixed Assets

Depreciation

Direct and

Indirect

Fixed and

Variable

and

Or

The classifications are important in costing as they are dealt with in different

ways when calculating the cost of a product.

They are also useful to predict how the costs will change as output changes.

29

Buildings Costs

Buildings Services

People Related Costs

Machinery Services

Information Processing

Profesional Fees

Finance Costs

Selling and Distribution

Costs

Types of Expenses

•Rent, Rates, Insurance

•DepreciationBuildings Costs

•Utility Costs

•Repairs and Maintenance

•Health and Safety, Training

•Canteen CostsPeople Related

•Hire, Insurance, Depreciation

•Fuel, Maintenance, Cleaning

•Telephone, Internet

•Postage, StationaryInformation

•Audit and Tax Fees, Solicitors

•Market ResearchProfesional Fees

•Bank Charges, Interest

•Finance ChargesFinance Costs

•Advertising, Commissions

•Storage Costs, Carraige Outwards

Selling and Distribution

Rent, Rates, Insurance

Repairs and Maintenance

Health and Safety, Training

Hire, Insurance, Depreciation

Fuel, Maintenance, Cleaning

Audit and Tax Fees, Solicitors

Bank Charges, Interest

Advertising, Commissions

Storage Costs, Carraige

30

MANAGEMENT ACCOUNTING

1 Analyse the following costs between:

i. Direct materials

ii. Direct labour

iii. Direct expense

iv. Factory indirect expense

v. Administration expense

vi. Selling and distribution expense

vii. Finance expense

(some terms may be used more than once and some are not used at all)

Cost Term – cost classification

a) Salesmen commission

b) Indirect labour

c) Interest on a bank overdraft

d) Depreciation of plant

e) Hire of specialised equipment for production

f) Salary of receptionist

g) Factory rent

31

h) Carriage inwards on raw materials

i) Raw materials

j) Rent of warehouse

2 Z wants to price Job ABC123. Below are the specifications of the job:

32

Direct materials 20kg x £20 per kg

Direct labour 40 hrs x £15 per hour

Direct expense £200 (total)

Variable production overheads 40 hrs x £10 per hour

Fixed Non-manufacturing overheads 40 hrs

Additional information:

The fixed non-manufacturing overheads are budgeted at £50,000 in total based on

budgeted total direct labour hours of 10,000 hours.

A Ltd uses a profit margin of 25% on selling price.

Requirement:

Prepare a Job cost sheet for Job ABC123 to show sub-totals for:

i. Prime cost

ii. Variable Production cost

iii. Total cost

iv. Profit

v. Selling price

Z Job cost sheet for ABC123

Calculation £

Direct materials

Direct labour

33

Direct expense

Prime cost

Variable production overheads

Variable Production cost

Fixed Non-manufacturing overheads

Total cost

Profit 25% margin

Selling price to customer

3. Classify each of the following costs as variable, fixed, mixed, or step by writing an X

under one of the following headings (Sales volume is the cost driver).

34

VariableFixedMixedStep

1. Total selling and administrative costs

2. Total salary cost of supervisors who are paid for each group

of five employees supervised

3. Raw materials used in production

4. Power consumption in a restaurant

5. Cost of goods sold in a bookstore

6. Salaries of employees who handle 20 claims per month

7. Pulpwood in a paper mill

8. Salaries of two secretaries in the corporate office

9. Total current manufacturing costs

10.The cost of an automobile rented on the basis of a daily

charge plus £0.30 per mile

4. Pen Ltd has the following information available regarding costs at two different

activity levels of monthly production:

Production volume (units) 7,000 10,000

£ £

Direct materials 70,000 100,000

Direct labour 56,000 80,000

Indirect materials 21,000 30,000

Supervisors' salaries 12,000 12,000

Depreciation on plant and equipment 10,000 10,000

35

Maintenance 32,000 44,000

Utilities 15,000 21,000

Insurance on plant and equipment 1,600 1,600

Property taxes on plant and equipment 2,000 2,000

Total costs 219,600 300,600

Identify each cost as being variable, fixed or mixed by writing the name of each cost

under one of the following headings:

Variable Costs Fixed Costs Mixed Costs

36

5. Classify the following costs incurred by a step railing manufacturing company as

direct materials, direct labour, factory overhead, or period costs:

a.Wages paid to production workers

b.Utilities in the office

c. Depreciation on machinery in plant

d.Steel

e. Accountant's salary

f. Rent on factory building

g. Rent on office equipment

h. Maintenance workers' wages

i. Utilities in the plant

j. Maintenance on office equipment

6. Match the term to the definition

A Total of direct costs

B Product produced by an organisation

C Dividing costs into production, administration, selling and distribution etc

D Cost that can be traced in full to whatever is being costed

37

E Organisation’s departments

F A cost that varies with the level of output

G A cost that is incurred in the course of making a product but which cannot be

traced directly and in full to the product

H Cost that is incurred for a particular period of time and which, within certain activity

levels, is unaffected by changes in the level of activity

J Cost identified with goods produced or purchase for resale and initially included in

value of stock

Prime cost Cost unit Classification

by function

Cost centre

Direct cost Product cost

Overhead

Fixed cost Variable cost

38

Cost Behaviour

Costs are affected by changes in activity. Generally costs behave in a number of ways

and change when activity levels change.

Cost behaviour patterns:

• Fixed costs

• Step costs

• Variable costs

• Semi-variable costs

Basic principles of cost behaviour

As the level of activity rises, costs will usually rise. It will generally cost more to produce

200 units of output than it will to produce 100 units of output.

For many cost accounting purposes, such as budgeting and decision-making, it is

important to classify costs on the basis of the behaviour

i.e. how does total cost change over time.

39

Variable costs

Costs that vary with changes in level of activity

For example, most direct material costs.

Fixed costs

Costs not affected by changes in activity level.

For example, the rent on the factory.

Semi-variable costs

Costs that have a fixed element and a variable element.

For example, the cost of electricity for the factory

Stepped costs

Costs that are fixed up to a particular level of activity, but which rise to a higher (fixed)

level if activity goes beyond that range.

For example, supervisors’ salaries

40

Fixed v variable

Semi-variable and stepped

Total cost

Total cost

Semi-variable cost

Activity level Activity level

Stepped costs

Total cost

Total cost

Variable cost

Activity level Activity level

Fixed cost

41

St Trinians is a themed “school-dinners” style restaurant in London.

Classify the following costs by their behaviour in the table below.

Cost Fixed Variable Semi-variable

Head chef’s salary

Cleaning materials note

Food served in the

restaurant

Electricity – includes a

standing charge

Cost of wine

Cost of staff uniforms

Note: kitchen gets cleaned irrespective of number of customers, so there will be a fixed

element as well as variable.

42

Product Costs V Period Costs

Product Costs

Direct Materials

Direct Labour

Direct Expenses

Manufacturing overhead

All charged against sales in the Trading

Account

Period Costs

Period costs such as rent are not

included in product costs. The are

written off entirely in the profit and loss

account

43