MANAGEMENT ACCOUNTING

Prepared and Presented By: Ram kumar ShahFriday, April 18, 2014

Basic Learning Notes on

Introduction To Management Accounting

Management accounting can be defined as

the process of identifying, analyzing &

communicating the managerial-cum-financial

records to the concerned authorities of

business organization for the purpose of

planning, decision making and controlling.

It is quite different form the financial

accounting.

Management Accounting vs. Financial Accounting

Management and cost Accounting Financial Accounting

It focuses on the small part of the

organization. E.g. Individual product or

Activities.

Financial accounting reports refer to the

whole of the organization.

Cost and Management Accounting is

concerned with the provision of

information to managers that require for

planning, decision making and

controlling.

These reports are useful for the external

users outside the organization like

stakeholder, creditors, governmental

authorities etc.

It looks over the future as well as the past

of organization and has based on

estimation or forecasting.

It reports what has happened in the past.

These reports are made for internal

evaluation and control.

These reports are compulsorily needed

to the governmental authorities.

reports has lack of accuracy. The reports must be accurate.

This type of reports are made daily,

weekly, monthly or as per managerial

needs.

These reports are generally prepared at

the last of an accounting period

Objectives Of Management. Accounting

Changing role of management accountants:

Information for planning, decision making

and controlling

Directing and controlling the daily business

and administrative activities

Motivating to labor and staffs

Measuring the managerial performances

Accumulating costs for stock valuation to

meet the requirements of external reporting

Cost Management: Allocation & Determination

Cost is the price or the expenses which is

sacrificed to the acquiring of any particular

objects. We pay money or exchange the

things to get something; is called the cost.

For example, buying books, travelling

through bus, purchase of machinery or

shares etc. So, in general sense, cost is

expenses made on business activities.

Terminological Meanings

Cost object: for which the cost is incurred.

Cost unit: a unit of the basis of measurement cost.

Cost centers: a department, a unit of concerned authorities or a branch of the org.

Cost accumulation: a process of collecting cost and managerial info. from different cost centers.

Cost allocation: assessing and apportioning units to a cost object for the purpose of determining total cost of the product.

Cost Classification On Different Basis

On the basis of product costing:

1) Direct cost (Prime cost):

The cost which can’t be easily identifiable to a particular cost object. It includes:

a) direct materials/ raw materials: e.g. sugarcane for sugar manufacturing company

b) direct labor: e.g. salary and wages paid to workers and production manager

c) other direct expenses: e.g. cost of product designing, installation cost, royalties, cost of patient rights etc.

Cost Classification On Different Basis

2) Indirect costs or overhead costs:

The cost which can’t be easily traceable to a

particular cost object. These costs do not take part

in production process but help on. It includes:

a) Indirect materials: e.g. oil and grease used in

machinery, stick and paints used in furniture etc.

b) Indirect labor: e.g. factory supervisor or managers.

c) Other overheads cost: e.g. rent, electricity cost,

stationary cost used for manufacturing purpose.

On The Basis Of Profit Maximizing Decisions

1) Relevant costs (Avoidable costs): the cost

which is emerged due to the managerial decisions

and it vary from one alternative to another one.

These are future and differential costs.

2) Irrelevant costs (unavoidable costs): the cost

which are emerged even the decision does not

influence to happen. Such as, the pre-committed

costs, fixed costs or the current portion of past or

long term debts etc.

On The Basis Of Function

1) Manufacturing cost (Factory costs):the cost which emerged during the production process in the factory. E.g. purchase of raw materials, carrying and installation cost etc.

2) General administrative and legal expenses: the cost related to daily administration. E.g. stationary cost, salary to staffs, rent of office etc.

3) Selling and distribution costs: the cost related to selling the products to market, R&D, marketing strategies cost like advertisement costs etc.

On The Basis Of Control

1) Controllable cost: the cost which can be

controlled/ influenced or reduced within the short

period of time by managerial decision and

responsibility centers.

2) Uncontrollable costs: the costs which can’t be

controlled within the short period of time by the

managerial decisions. These are unexpected

costs directly incurred.

On The Basis Of Absorption

1) Absorbed costs: the cost which is charged to

the given period of time or to the production cost

of that period. E.g. paying salary, rent of current

month to this month period.

2) Unabsorbed costs: the cost related to this year

is being transferred to another period or to another

year or remaining unchanged to this year; such

costs are called unabsorbed costs. E.g.

Outstanding salary

On The Basis Of Expiry Of Cost

1) Expired cost: the cost which has been expensed

during the given time period and has not remain

the potentiality to produce benefit in future.

2) Unexpired cost: the cost which has not

expensed during its time period and still has the

utility of producing potential benefit in future.

Behavioral Classification

1) Fixed costs: the cost remaining constant at each

activity level of production. For example, rent of

office building, depreciation on machinery etc.

features of fixed cost:

a) same in cost

b) variance in cost per unit that decreases

as per the increment in activity level.

Behavioral Classification

2) Variable costs: the cost which vary according to

the increment or decrement of production units.

These are caused to use the capacity. E.g.

manufacturing costs, selling and administrative

costs etc.

features of variable cost:

1) Change in production amount

2) Same in cost per unit

Behavioral Classification

3) Semi-variable or mixed costs: that cost which

has neither the features of variable nor of the fixed

cost. At the beginning, it is characterized by fixed

cost and later changes to variable cost. E.g.

payment of landline phone, postpaid phone,

electricity charge etc.

Identification Of Cost Behavior

Activity Level (in

units}10,000 units 20,000 units 30,000 units

Total costs: (in Rs.)

Direct materials Rs. 20,000 Rs. 40,000 Variable cost

Cost per unit= Rs. 2 Rs. 2

Direct labor Rs.30,000 Rs. 60,000 Variable cost

Cost per unit= Rs.3 Rs. 3

depreciation Rs. 30,000 Rs. 30,000 Fixed cost

Cost per unit= Rs. 3 Rs. 1.5

Supervision Rs. 25,000 Rs. 45,000 Variable cost

Cost per unit= Rs. 2.5 Rs.

2.25

Rent of factory

buildingRs. 20,000 Rs. 20,000 Fixed cost

Cost per unit= Rs. 2 Rs. 1

Repairing costs Rs. 20,000 Rs. 30,000 semi-variable cost

Cost per unit= Rs. 2 Rs. 1.5

Heat, light & power Rs. 20,000 Rs. 25000 semi-variable cost

Cost per unit= Rs. 2 Rs. 1.25

COST EQUATION

Total costs= total fixed costs + total variable cost

Or,

Y=a + b*X

Where,

a= fixed costs

y= total costs

b= variable cost per unit (VCPU)

X= activity level or production level or machine

hours

Cost Estimation Technique: segregation of cost

High-low point method:

Variable cost per unit(VCPU)

b= high cost─ low cost

high unit ─ low unit

Total cost= fixed cost+ VCPU* activity volume

or, Y=a + b*X,

This method only consider and apply two points of production process i.e. high and low point. On the absence of any one of these points of cost or unit, the total cost can’t be segregated to apportionment- the fixed cost and variable cost.

Cost Estimation Technique: segregation of cost

least-square regression method:

VCPU (b)= n*∑ x y ─ ∑ x. ∑ y

n. ∑x2— (∑x)2

Total cost function: Y=a + b * x

Fixed cost(a)=∑y/n─ ∑b/n*x

This method considers various activity level ofproduction. We prepare a table and find out VCPU and the fixed cost accordingly.

Illustration: High-low Point Method

VCPU(b)= difference in cost/ difference in unit

or, (1000000—800000)/(100000—50000)

=Rs. 4 per unit.

Now, total fixed cost(a)= Y—b*x

At high activity level,

a= Rs.1000000—Rs. 4*100000 =Rs. 600000

Production in units 50,000 1,00,000

Total cost at Rs. 8,00,000 10,00,000

Illustration: Least-square Regression Method

Machine hour (x)

‘000

Maintenance cost

(Y) ‘000

X*y x2

110 235 25850 12100

100 215 21500 10000

140 260 36400 19600

130 255 33150 16900

120 235 28200 14400

∑x= 600 ∑y= 1200 ∑ x.y = 145100 ∑x2= 73000

Illustration: Least-square Regression Method

Now, VCPU (b)= 5*145100– 600*1200

5*73000– (600)2

= Rs. 1.1 per machine hour

And, a= ∑Y/n-- b. ∑x/n

=1200/5—1.1*600/5 = Rs. 108000

Preparation Of Income Statement

Absorption costing method:

Variable costing method:

Absorption costing method includes both

type of variable and fixed costs to its product

cost.

but, the variable costing method only

considers the variable cost item.

there is difference in answer of these two

distinct methods.

Income Statement As Per Absorption Costing

Particulars Amt Rs. Amt Rs.

Sales revenue xxxx

Less: cost of goods sold (@rs….*sales unit)

direct materials Xxx

direct labor ( @Rs…. *actual output ) Xxx

direct expenses xxx

variable manufacturing expenses xxx

fixed manufacturing overhead cost (SFMOR* actual output) xxx

Add: beginning inventory (beg. Inv. unit*total product cost rate) Xxx

Less; closing inventory (closing inv. * total product cost rate) xxx xxx

Add: under absorption and less: over absorption

Gross

profit……………………………………………………………………......

..........

xxxx

Less: non manufacturing costs:

variable administrative, selling and marketing cost Xxx

fixed administrative, selling and marketing cost xxx xxx

Net xxxx

Income Statement As Per Variable Costing Particulars Amt. Rs. Amt. Rs.

Sales revenue Xxxx

Less: variable cost of goods sold

opening inventory Xxx

Add: direct materials Xxx

direct labor Xxx

direct expenses Xxx

variable manufacturing costs Xxx

Less: closing inventory Xxx Xxxx

Gross contribution

margin……………………………………………………..

xxxx

Less: variable administrative and selling costs Xxx

net contribution

margin…………………………………………………………….

Xxxx

Less: fixed costs

Fixed manufacturing cost Xxx

Fixed administrative, selling and marketing cost xxx xxxx

Net xxxxx

Things To Remember (TTR)

Standard fixed manufacturing overhead(SFMOR) is always calculated under average or normal production level. And,

SFMOR= fixed manufacturing cost/normal output

Product or inventory cost include only the manufacturing or factory fixed and variable costs. In variable costing, other fixed and variable administrative and selling costs are deducted under the headings of fixed cost from net contribution margin.

Preparation Of Reconciled Statements

Reconciliation statement from absorption

costingParticulars Amount Rs.

Net income from absorption costing xxxx

Add: fixed manufacturing cost on opening inventory

(opening inv. Units * SFMOR)

xxxx

Less: fixed manufacturing cost on closing inventory

(closing inv. Units * SFMOR)

xxxx

xxxx

Net income from variable

costing……………………………………………

xxxxxx

Note: while preparing from the variable costing, the fixed

manufacturing cost on opening inv. Must be less and the

another one should have added.

Reconciliation Statement

particulars Amt. Rs.

Net income from absorption costing 110000

Net income from variable costing 90000

# Difference in net

income

20000

Closing inventory 6000

Opening inventory 2000

Change in inventory/

stock (a)

4000

Standard fixed manufacturing overhead rate (SFMOR)

(b)

Rs. 5 per unit

Change in stock valuation (a*b) # 20000

Note: the two indicated symbols of # must be meet in value to be

Cost, Volume And Profit Analysis

To maximize the profit,

the company either

should have increased

the TR or decrease the

VC as much as possible

(but it does not decrease

even after the FC line).

Two distinct method has

different technique of

recording product costs.

Due to effect on product

cost, that also effects on

contribution margin and

accordingly on net

profit.

Things To Remember (TTR)

1) VCPU= VC/ sales unit

2) Required sales in units to earn desire profit

in % of SPPU= FC/ (SPPU—VCPU---

PPU+LPU)

3) PV ratio (CM ratio)=difference in profit

difference in sales revenue

4) CV ratio= 1– PV ratio= 1—(VCPU/SPPU)

5) Margin of safety (MOS)= Actual sales– BEP

sales and,

MOS rate=(MOS/actual sales)*100%

Things To Remember (TTR)

6) PV ratio (CM ratio)=CMPU/SPPU

7) CMPU=(TCM/total sales unit) = SPPU—VCPU

8) While applying equation,

sales= FC+ VC+ profit

9) Cash BEP in Rs. = cash FC only/ PV ratio

10) MOS in Rs.= MOS in units* SPPU

11) Incremental Profit= Incremental sales* PV ratio, or,

Profit=(new sales revenue after increment * PV ratio)--FC and, incremental sales= New—old.

Things To Remember (TTR)

12) BEP in units= FC/(SPPU—VCPU) =FC/CMPU

13) Net profit= sales revenue(TR)– VC—FC and,

CM= sales revenue– VC

14) CMPU= SPPU—VCPU

15) CM ratio(PV ratio)= CM/sales = CMPU/SPPU=(SPPU-VCPU)/SPPU

16) profit= (sales revenue* PV ratio)– FC

17) profit= (sales units*CMPU)– FC

18) BEP in Rs.=FC/ Cm ratio(or, PV ratio)

Things To Remember (TTR)

19) Required sales in units to earn desired

profit(before tax)=(FC + desire profit)/CMPU

20) Required sales in Rs. to earn desired

profit(before tax)=(FC + desire profit)/PV

ratio

21) Required sales in units to earn desired

profit after tax=(FC + (desire profit/(1-

taxrate))/CMPU

22) Required sales in Rs. to earn desired profit

after tax=(FC + (desire profit/(1-tax rate))/PV

ratio

Things To Remember (TTR)

23) Overall (composite, weighted average)

BEP:

Composite CMPU= CMPU* sales mix, For individual BEP:

composite PV ratio= PV ratio*sales mix, A’s BEP= Overall BEP*sales mix

sales ratio A:B= 2:3, TFC= Rs. 180000. =36000*2/5=14400 units

Overall BEP in units= TFC/ Composite CMPU and, for B’s

BEP=36000*3/5

=Rs. 180000/Rs. 5= 36000 units =21600 units

Product SPP

U

VCPU CMPU PV

ratio

Sales

mix

Composi

te CMPU

Composi

te PV

ratio

A 15 10 5 0.3 2/5 2 0.12

B 20 15 5 0.25 3/5 3 0.15

Total 5 0.27

Flexible Budget

Budget is a specimen of costs that issystematically prepared for future use. In everydecision making the budget should haveprepared. We need to classify and segregatecost into fixed and variable cost before draftingthe budget sheet. Flexible Budget is the total offixed and variable costs. To segregate cost wegenerally use high-low point method assimplicity.

Types:

1) Static Budget (Not Changeable)

2) Flexible Budget (Changeable)

Preparation Of Flexible Budget

Particulars 70000 units 80000 units

Variable costs: In Rs. In Rs.

Maintenance cost @ Rs. 0.7 49000 56000

Various costs @ Rs. 0.15 10500 12000

Total Variable

costs:…………………………………………………..

59500 68000

Fixed costs:

Salary 300000 300000

depreciation 60000 60000

Total Fixed

costs:……………………………………………………

…

360000 360000

Total 419500 428000